Tough talks are taking place behind Treasury doors, if Air NZ bail-out set the precedent

Monday, 20 April 2020

The Treasury is drawing on advice from Chapman Tripp, Goldman Sachs and Korda Mentha to negotiate with critical, big businesses that are seeking help because of Covid-19.

ANALYSIS: Big businesses that are knocking on the door of the Treasury asking for special assistance in the wake of the coronavirus outbreak are unlikely to find the Government a push over.

That is if some of the terms of the Government's $900 million 'bail out' of Air New Zealand set the benchmark.

So far the Treasury and Air New Zealand have avoided spelling out one key detail of last month's bail-out, which would be needed to make a final judgment.

The exact terms on which the Government would be able to convert the money it has offered to lend to Air NZ into shares in the airline – should Air New Zealand be unable to repay the loan – remain confidential.

But UBS analyst Marcus Curly said he did not think the deal as a whole was generous.

* Government has no desire to own stakes in big firms but wants to 'keep options on table'

Air NZ could find itself paying 10pc interest on some of the money it borrows from Government.

* Government could end up part-owning dozens or even hundreds of big businesses

* Coronavirus: Air New Zealand will need to borrow more and may have to sell planes, analyst says**

The interest rate the Government would charge on the loan 'reflected its high risk'.

And while not all the terms on which the Government could convert the loan into shares in the airline were known, those that were public favoured the Government, Curly said.

Finance Minister Grant Robertson has said the Government could provide tailored help on a 'case by case' basis to other companies with annual revenues of more than $80m a year that it viewed as critical to the economy.

There were 2189 firms with annual revenues of more than $80m at the end of March, according to Statistics NZ, although probably only a very small proportion of them will be lining up for help.

Businesses with sales of less than $80m are instead eligible for government-backed bridging loans of up to $500,000, which they can apply for through their bank.

Air New Zealand is the only big business that is known to have got the tailored assistance so far, though Treasury spokesman Bryan McDaniel said the department was talking to a number of other firms which it won't name because of 'commercial sensitivity'.

The Treasury has tapped into plenty of expertise, engaging consultants from Chapman Tripp, Goldman Sachs and Korda Mentha to advise it on negotiations.

Airports may be among the businesses seeking help.

Auckland Airport has taken matters into its own hands with a $1.2b capital raising.

No business is likely to get a bargain bail-out from the Treasury.

But Wellington Airport chairman Tim Brown has said it could be desirable for it to secure a convertible loan from the Government as 'a backstop' to, in effect, underwrite any equity raising it had to do.

So far the Treasury has declined to provide any information on any rules that have been developed around the type and scale of the assistance that could be forthcoming to those at the big end of town.

That means that all anyone has to go on as a guide to what may be offered is the deal that has been done with Air New Zealand.

The Government agreed to lend the airline up to $900m for two years, but at what might seem a pretty swingeing interest rate.

Air New Zealand will have to pay between 7 and 8 per cent interest on the first $600m it borrows from the Government, and if the airline needs to dip into the other $300m it will have to pay 9 per cent interest on that.

Those rates will increase by 1 per cent if Air NZ needs any of the money for more than a year, which now seems fairly inevitable.

By way of some comparison, bonds that Air NZ issued to investors in 2016 and that are due to be redeemed in October 2022 were trading at a yield of 4.25 per cent on the NZX debt market on Monday, and had been yielding 2.6 per cent before the crisis.

So the Government is demanding about double the current return on those bonds.

That is not the full story of course.

Economist Benje Patterson says the yield on Air NZ's corporate bonds would be a lot higher than 4.25 per cent if the Government hadn't offered the loan facility, as there would then be more doubt that they could be paid back.

The reason the bonds are trading at a lower yield now, is because the airline has got the government loan, Patterson said.

'If the Government had said 'no', you would have had to price-in the real risk of a default.'

Wellington Airport has also signalled some interest in a convertible loan from the Government.

If Air NZ could have got a loan on the open market it would have been at a still-higher interest rate, he said.

But Patterson is nevertheless impressed with the way the Government balanced its approach to striking a deal with the airline.

'I had thought they might give help on much easier terms.'

The loan has been structured as a 'convertible loan' which means the Government will be entitled to convert the debt into shares in the airline if Air NZ is unable to pay the money back.

What is missing at the moment is the finer detail on the price at which new shares would be issued to the Government if that happened.

Treasury's McDaniel says that would be 'at pricing to be agreed between the Crown and Air NZ taking into account a variety of factors'.

Those factors would include the 'current market share price at the relevant time' and would be subject to 'compliance with applicable law and the NZX and ASX listing rules', he said.

That suggests that rather than agreeing a fixed-conversion price up-front, the Government would get whatever share of the airline that its money would appear to entitle it to, at the time that the airline defaulted.

Since the Government already owns 52 per cent of Air NZ though, it could never claim more than the remaining 48 per cent of the airline in return for its $900m.

Given that Air NZ is only valued at just under $1.6b on the NZX at the moment, that means the Government couldn't recoup all of its loan if it was fully spent and converted to shares at or below the airline's current share price of $1.38.

The stark possibility that raises is that a default could effectively wipe out private ownership in Air New Zealand.

Air New Zealand's current shareholders, however, have the option of paying down the debt themselves through a capital raising, in order to avoid having their shareholdings diluted, if tht looks appealing.

Until or unless that happens, it appears the Government will be firmly ensconced in the co-pilot's seat.

Patterson said it now seemed clear that the impact of the coronavirus on Air New Zealand was going to be much worse than when the deal was signed.

'The description of level 3 and Air New Zealand's interpretation of that, has raised the prospect further that the Government will need to lift its ownership stake down the track,' he said.

Air New Zealand seemed to be of the opinion that there would not be a material amount of domestic air travel even under level 2, he said.

Convertible loans are a fairly common funding mechanism in business, particularly for businesses in some distress.

People could be hearing a lot more about them if the Government does provide more tailored assistance to big business.

Robertson has said the Government has 'no particular desire' to end up owning parts of the businesses it is bailing out.

But he has acknowledged that could be the logical upshot of providing help by way of convertible loans.

Big businesses in the same quandary as Air NZ may might find the only pill in the cabinet is a very bitter one.