Nordic Credit Rating (NCR) said today that it had lowered its long-term issuer rating on Sweden-based residential property manager Studentbostäder i Norden AB (publ) to 'CC' from 'CCC'. At the same time, the short-term rating was affirmed at 'N6'. Given the increasing likelihood of a covenant breach and distressed exchange on the company's outstanding bond, as well as the company's weak liquidity, we have extended our Watch Negative placement on the ratings reflecting a material risk for a distressed exchange over the next three to four months.
Rating rationale
The downgrade of the long-term rating reflects the decreasing likelihood that Studentbostäder will avoid a covenant breach on its outstanding SEK 564m senior unsecured bond, maturing on 14 May 2024, as well as doubts over the company's ability to repay the bond at maturity. While there are ways for the company to avoid a default on the bond, we believe the most likely resolution is through a distressed exchange in the near term, accelerated by the imminent covenant breach. In addition, the company remains under significant liquidity pressure.
By our definition, a 'CC' issuer rating represents a high likelihood of a conventional default or a distressed exchange within the next 12 months. A change of terms qualifies as a distressed exchange when the amended terms result in lower value to bondholders than the original terms and is carried out to avoid a near-term default. Although we do not specifically rate Studentbostäder's senior unsecured bonds, a default on the bond would result in a long-term issuer rating of 'SD' to reflect a selective default on the bond, as long as the company fulfils its other commitments. NCR would not consider a covenant breach or a covenant waiver, on their own, as a default on the bond.
The maintenance covenant on Studentbostäder's outstanding bond stipulates an interest coverage ratio (ICR) above 1.5x. At 30 Jun. 2023 the covenant-defined ICR was 1.52x, compared with our adjusted calculation of 1.3x (rolling 12 months), or 1.21x in the quarter. In addition, Studentbostäder has an equity ratio covenant of 20% on the outstanding bond. At 30 Jun. 2023, the equity ratio was 25.4%. While there is some headroom under the covenant, we believe it could be at risk if property valuations continue to fall in line with our expectations (-16% for the full year 2023). We consider the risk of breaching the ICR covenant is imminent, however, as recent interest rate hikes take effect. According to the bond terms, a covenant breach is cause for immediate repayment. Given the low likelihood of interest coverage and repayment risk improving in the near term, in our view, negotiations with bond investors are likely to result in a distressed exchange. Consequently, failure to negotiate a distressed exchange would imply not only a default on the bond but also a very serious situation for the company.
We note that the company recently announced a letter of intent to divest its Danish portfolio (SEK 1.5bn on the balance sheet) and an impending relatively small equity issue (SEK 100m), SEK 50m of which will be paid out in the near term, improving short-term liquidity. The equity issue is contingent on the outcome of an extraordinary general meeting on 20 Jul. 2023, which we believe is likely to give its approval. However, given the small volume of the planned equity issue and Studentbostäder's other liquidity and refinancing needs, we believe the equity issue is unlikely to be of material help in avoiding a distressed exchange on the outstanding bond. In addition, we believe significant uncertainty remains over the potential divestment in Denmark. Based on our estimates of on-balance portfolio value in Denmark, and the SEK 1.2bn in Danish mortgage credit (realkredit) loans per 30 Jun. 2023, we note that the high leverage in the Danish portfolio imply that net cash proceeds from the divestment are not sufficient to cover the outstanding bond volume. Although there are measures the company could take to avoid a distressed exchange, such as further equity issues or divestments, we believe they are unlikely to be successfully executed to such an extent and with such timing as to fully pay off the bond before a distressed exchange becomes necessary. While the company has repurchased a small portion of its outstanding bond, we do not believe it is likely to succeed in voluntary repurchases of the full volume.
Both the long-term issuer rating and the extension of the Watch Negative also reflect concerns about the overall liquidity position, notwithstanding the bond maturity. As of 30 Jun. 2023, the company had SEK 22m in cash, with a net SEK -42m cashflow in the quarter. In addition to the bond, which has an outstanding volume of SEK 564m, the company has SEK 204m in maturing debt, plus SEK 42m in amortisations. While Studentbostäder has demonstrated a good relationship with its banks for project financing, we believe they are unwilling to provide additional loans necessary to repay the bond before maturity.
Watch Negative
The extension of the Watch Negative reflects the increasing likelihood of a covenant breach and distressed exchange, as well as general uncertainty over whether the company's actions to improve its liquidity position will be sufficient. We believe that Studentbostäder is likely to trigger the interest coverage covenant on its bond, and that negotiations with bond investors will result in a distressed exchange. The Watch Negative placement also reflects our belief that material divestments, and possibly further equity injections, are necessary to repay the bond, which matures on 14 May 2024, and our general concern over Studentbostäder's liquidity.
We could lower the rating to 'C' to reflect the announcement of an imminent distressed exchange or default that has not yet materialised. At the time of a default or distressed exchange on the bond or other outstanding debt, we would lower the issuer rating to 'SD', as long as the company fulfils its other commitments, until the future capital structure is defined. We could lower the issuer rating to 'D' if the company files for bankruptcy or in the event of similar action that would likely cause it to miss or delay future contractually required debt service payments.
We could raise the long-term issuer rating back to the 'B' category to reflect a fully resolved situation regarding the outstanding bond, with no immediate concerns of a covenant breach or distressed exchange, and a stabilised capital structure with more moderate concerns about liquidity in the following 12 months.
We expect to resolve the Watch Negative placement no later than in the days following the publication of Studentbostäder's results for the third quarter of 2023, currently scheduled for 9 Nov. 2023.
Related publications:
i) Corporate Rating Methodology, 8 May 2023
ii) Rating principles, 24 May 2022
iii) Studentbostäder i Norden AB (publ) long-term issuer rating lowered to 'CCC'; Rating on Watch Negative, 24 May 2024
iv) Studentbostäder i Norden AB (publ) long-term issuer rating lowered to 'B+'; Outlook negative, 19 Jan. 2023
Rating list | To | From |
---|---|---|
Long-term issuer credit rating: | CC | CCC |
Watch: | Watch Negative | Watch Negative |
Short-term issuer credit rating: | N6 | N6 |
Contacts:
Ylva Forsberg, analyst, +46768806742, ylva.forsberg@nordiccreditrating.com
Yun Zhou, analyst, +46732324378, yun.zhou@nordiccreditrating.com
The methodology documents used for this rating are NCR's Corporate Rating Methodology published on 8 May 2023, NCR's Rating Principles published on 24 May 2022 and NCR's Group and Government Support Rating Methodology published on 18 Feb. 2022. For the full regulatory disclaimer please see the rating report.