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Financial Policy and Rating

In the first half of 2013 financial markets were affected by the unfavourable difference between interest rates and growth rates in many countries, especially in Europe. The steps taken to reduce public budget deficits have not been able yet to reverse the rising debt-to-GDP ratio. Within the context of a monetary policy defined as "accommodating", the Eurozone's financial system, however, is in less critical conditions than in the past, thanks to the abundance of liquidity injected into the banking system which resulted in the progressive drop in the balance of the ECB's overnight deposit facility used by banks for precautionary purposes.
However, in some countries the inadequate capitalization levels of banks exacerbates the credit crunch, in a macroeconomic context that increasingly undermines the creditworthiness of borrowers, triggering much stricter prudential mechanisms in the provision of credit.

The downgrading of Italy's sovereign credit rating by one notch, from BBB+ to BBB with negative outlook, due to weak economic prospects, did not enhance short-term volatility or produce a substantial medium-term impact. In fact, the impact of the downgrade should be muted by the high share of public debt held by residents, whose demand is rather stable. In addition, the Italian Treasury is on schedule with this year's funding, with interest rates much lower than last year.

Swap rates in euros went hand in hand with rising yields in government bonds in the wake of the U.S. Federal Reserve's intention to taper its bond purchases until the first half of 2014. However, the effect of the increase in long-term interest rates did was the return of their level to the historical norm, from which they had departed significantly as a result of the sharp drop experienced. Europe's current monetary policy, featuring growing support to the monetary system, caused the ECB's key reference rate to fall to 0.5%, keeping short-term rates still stable at fairly low levels.
Spreads continued their positive trend, with that between Italian BTPs and German Bunds, in particular,
reaching 250 bps. However, economic conditions are still in a flux, as the positive phase of the narrowing spread came to an end in mid-May.
Meanwhile, against the backdrop of persisting weakness, macroeconomic data are moderately improving, thus providing support to equities.

Despite the still-critical economic and financial context, the Group continued to pursue its goal of maintaining an adequate match between the maturity profiles of assets and liabilities, linking investments with the maturity and the repayment schedule of the relevant funding instrument, taking into account the need to refinance the current debt structure and the company's modus operandi, and identifying the optimum mix of financing between fixed and variable rates, within the scope of a prudent interest rate risk management strategy designed to achieve predictability in terms of margins and operating cash flows.

To strengthen further the financial structure, and to drive growth, in the first half of 2013 the Group obtained new medium- and long-term loans for a total of €800 million, which were used, among other things, to refinance the puttable bonds and loans in portfolio. In particular, at the beginning of 2013 the Group took advantage of favourable market conditions by placing €700 million in a 15-year bonds issue at a fixed rate of 5.20%. The transaction opened the market for Italian corporate long-term bonds; in fact, the last 15-year bond issue for an Italian company was placed in September 2010.
On 22 May 2013 the Group placed €100 million in bonds in two different tranches, maturing in 10 and 12 years, at the fixed interest rates of 3.375% and 3.5%, respectively.
Moreover, considering current market conditions, to maintain its solid liquidity ratios, the Group obtained additional committed lines of credit for €120 million, thus reaching a total of €540 million.

The Group mitigates its risks through a hedging policy that does not make use of speculative derivatives.

The policies and principles adopted by the Group to manage and control financial risks - such as liquidity risk and related default risk and debt covenants, as well as interest rate and exchange rate risks - are described below.

Liquidity risk
Liquidity risk is defined as the risk whereby, due to its inability to raise new funds or liquidate assets in the market, a company fails to meet its payment obligations.
The Group's aim is to have a level of liquidity which allows it to meet its contractual commitments, both under normal business conditions and during a crisis, by maintaining available credit facilities and liquidity and proceeding with the timely negotiation of loans approaching maturity, optimising the cost of funds according to current and expected market conditions.

The following table represents the "worst case scenario" where assets (cash, trade receivables, etc.) are not considered and financial liabilities - principal and interest - trade payables and interest rate derivative contracts are shown. Call credit facilities are assumed to be repayable on demand while other borrowings mature on the date on which repayment can be demanded.

Worst case scenario 30.06.2013 31.12.2012
mln €1-3 monthsbetween 3 months-1 year1-2 years1-3 monthsbetween 3 months - 1 year1 - 2 years
Bonds12329332232553
Debts and other financial liabilities40317435669107246
Trade payables1,093001,1660 
Total1,4974064481,267339798

In order to guarantee sufficient liquidity to cover all its financial commitments, over the next two years at least (the worst case scenario time horizon given), as at 30 June 2013 the Group had €483.3 million in cash, €540 million in unused committed credit facilities and ample space on its uncommitted credit facilities (€1,500 million).
The credit facilities and related financial assets are not concentrated with any one lender, but are distributed among leading Italian and international banks, with utilisation much lower than the total amount available.

At 30 June 2013, long-term debt accounted for 79% of the Group's total financial debt. The average maturity is around eight years and 50% of the debt matures after five years.

The expected nominal amounts to be repaid over the next five years and after five years are shown below.

Debt nominal amount  (mln€)30.06.201331.12.201431.12.201531.12.201631.12.2017Over 5 yearsTotal
Bonds00050001,6522,152
Convertible bonds14000000140
Bank debt/due to others62011332786581721,376
Total760113327586581,8243,668

Default risk and loan covenants
The risk lies in the possibility that loan agreements signed contain clauses that include the right of the lender to ask for the early repayment of the loan if certain conditions occur, thereby creating a potential liquidity risk.
At 30 June 2013 a significant proportion of the Group's net debt was represented by loan agreements which include a collection of clauses, in line with international practice, which impose a series of negative covenants. The main ones are pari passu, negative pledge and change of control clauses. In relation to mandatory early repayment clauses, there are no financial covenants on the debt, with the exception of the restriction on certain loans (€200 million) which requires the Group's ratings by any rating agency not to fall below investment grade (BBB-).

Interest rate risk
The Group uses external funding sources in the form of medium- to long-term financial debt, various types of short-term credit facilities and invests its available cash primarily in immediately realisable highly liquid money market instruments. Changes in interest rates affect both the financial costs associated with different types of financing and the revenue from different types of liquidity investment, causing an impact on the Group's cash flows and net financial charges.
At 30 June 2013, the exposure to the risk of adverse interest rates changes, with a resulting negative impact on cash flows, was 39.2% of total gross financial debt. The remaining 60.8% was made up of medium/long-term fixed-rate loans, exposing the Group to the risk of change in fair value.
Interest rate risk management policy results, from time to time and depending on market conditions, in a combination of fixed-rate and variable-rate instruments and hedging through derivatives.
Derivatives match perfectly the underlying debt.
The Group's hedging policy does not allow the use of instruments for speculative purposes and is aimed at optimising the choice between fixed and variable rates as part of a prudential approach towards the risk of interest rate fluctuations. Interest rate risk is essentially managed with a view to obtaining predictable margins and cash flows from operating activities.

Gross financial debt (*) 30.06.2013 31.12.2012
mln€without derivativeswith derivatives% with derivativeswithout derivativeswith derivatives% with derivatives
Fixed rate2,4051,91260.80%2,1171,62861.20%
Variablle rate7431,23639.20%5441,03338.80%
Total3,1483,148100%2,6612,661100%

*Gross financial debt: does not include cash and cash equivalents, other current and non-current financial receivables

Exchange rate risk unrelated to commodity risk
The Group adopts a prudential approach towards exposure to currency risk, in which all currency positions are netted or hedged using derivative instruments (cross-currency swaps).
The Group currently has a currency bond of JPY 20 billion, fully hedged with a cross-currency swap.

Rating
Hera S.p.A. has long-term ratings of "Baa1 negative outlook" from Moody's and "BBB+ stable outlook" from Standard & Poor's.
On 10 July 2013, however, following the downgrading of Italy's sovereign rating, Standard & Poor's downgraded the Group's rating to "BBB stable outlook".
Moody's maintained its revised its "Baa1 negative outlook" rating, placing the Hera Group one notch above Italy's credit rating of "Baa2 negative outlook".
Given Italy's current deteriorating macroeconomic conditions and the uncertainty on the country's prospects, the Plan laid our additional actions and strategies aimed at ensuring the maintenance/improvement of satisfactory rating levels.