Eskom’s debt transfer is likely to be South Africa’s largest liability-management exercise, with the National Treasury indicating that one- to two-thirds of Eskom’s R400bn outstanding debt could be transferred to the sovereign’s balance sheet in 2023.

We believe that there some key issues that need to be addressed before executing a debt plan of this magnitude.

Many questions remain

While the intention behind the much talked-about sovereign debt solution for Eskom is good, more details are required to make sense of the execution risks and the likely outcomes for noteholders.

These critical details include which debt will be assumed first, the size of debt relief required and whether this is a prerequisite to completing Eskom’s divisional unbundling, whether rating agencies would consider the plan a distressed or an opportunistic debt exchange, and when noteholder consent will be solicited.

Sequencing as important as the quantum

In our opinion, if not for the recent fiscal revenue windfalls, the rationale for this debt transfer would have been much harder to accept in terms of its scale, complexity and fiscal impact.

We think sequencing the transaction – starting with term loans and progressing to bonds – is ideal, but Eskom’s current financial standing might call for a more accelerated approach to bring it cashflow relief sooner. We assume R130bn (33%) of development finance institution (DFI) and other rand-denominated term loans and hedges are first in line for transfer to the sovereign as this reduces execution risk with fewer credit counterparties to negotiate with.

To reach two-thirds of debt outstanding, we’ve calculated that R150 bn of bonds would also need to be transferred. The target should be domestic, listed and guaranteed notes (in whole, not in part), while simultaneously redeeming the outstanding Eurorand zero-coupon bonds early to reduce legal complexity between bond programmes. Noteholder consent should be required throughout, and the notice should come shortly after the February 2023 Budget.

Avoiding a distressed exchange

Avoiding a distressed debt exchange (equivalent to a default event) is key. A distressed exchange presumes that notes are haircut and tendered below par and/or that creditors are somehow left worse off in terms of their protections and rights. It also presumes the issuer’s intention with the transaction is to avoid what would have been an inevitable default event had it not been for the debt exchange.  It's likely that Eskom will argue that the intention is not to avoid default, but simply to follow government policy in the reform of the electricity sector towards decarbonisation and a more competitive and secure supply profile.

We believe that the rating agencies are unlikely to call Eskom’s debt transfer a distressed exchange, especially given that Moody’s moved Eskom’s rating outlook to “Positive” from “Negative” upon the debt transfer announcement and S&P’s sovereign analysis assumes noteholders will be made whole in the transfer. However, this is conditional on the final details of the deal not violating the impairment rules in their respective methodologies.

Credit-positive for Eskom

Overall, we assume the debt-transfer plan well be credit-positive for Eskom and credit-neutral for the sovereign, adding roughly 3% to the debt-to-GDP ratio baseline. In our view, increasing SAGB supply in this way is typically bearish for the curve, albeit only temporarily. Liquidity will be limited since only Eskom noteholders can participate but a more lasting steepening bias may be driven by global risk-off sentiment, recession concerns and recurrent fiscal expenditure pressures.