Companies are considering issuing hybrid bonds once more as they look to improve and strengthen their capital structure in the wake of the financial crisis.
Bankers are actively discussing the products, with clients in the latest sign of the current heat in the corporate credit markets. The bonds were last issued in the boom years of 2005-2007, and were considered an example of the sort of financial engineering tarnished by the crisis.
Hybrids are common in the banking and insurance worlds and sit between debt and equity because they contain features of both. This has allowed investors to consider them debt, while companies treat them as mostly equity – which does not risk wrecking a company’s credit ratings as extra debt can.
Trading in existing corporate hybrids has picked up sharply in recent months as bond market strength has driven investors to look further afield for higher returns.
Last week, Hero, a Swiss jam-maker, issued the first hybrid since the crisis began, selling SFr400m ($394m) of unrated paper to mostly Swiss investors. Bankers said, however, the market would need a Europe-wide deal from a bigger name to really prove it had re-opened. Most, however, believe that it is only a matter of time.
“I would not be surprised if there is a deal done before Christmas,” said Eirik Winter, head of European debt capital markets at Citigroup.
Utilities and telecoms companies, with their strong cash flows, are considered the most likely candidates. Vattenfall, the Swedish energy company, issued one of the best-known hybrids to date, selling €1bn of perpetual notes, in June 2005. On Thursday the notes were trading at 95 per cent of par value, up from a low of 74 per cent in the aftermath of Lehman’s collapse a year ago.
Martin Wiwen-Nilsson, co-head of capital markets and risk management of Goldman Sachs’ European financing group, said the talk of hybrids reflected companies being able to once more look at long-term issues.
“Companies are moving from dealing with liquidity issues to balance sheet repair and this is one instrument for that,” he said. “For the right name and if we get the proper structure and pricing, these might well become a hit again.”
However, bankers cautioned against expecting a slew of issuance because the bonds are hard to structure. “The success of any issue will depend on each company’s story – this is not a no-brainer product for all companies,” said Frederic Zorzi, head of European syndicate at BNP Paribas.
The return of corporate hybrids could also be affected by the furore about their banking cousins, which has raised questions about the fundamental role of hybrid capital.
Investors have always bought hybrids in the belief that the issuer would repay the bond at the first opportunity – even though the securities win their equity badge precisely from the fact issuers don’t have to do this.
This was made starkly clear last December, when Deutsche Bank sparked outrage among investors by deciding not to call, or repay, its hybrids. It has since been followed by a long list of banks, many of them doing so at the express behest of the European Commission, which has indicated it expects bondholders, where possible, to share in the pain of bailed out bank investors.
“Two years ago, everyone expected banks to call bonds on the first date and now we know that is not definite,” said Emmanuel Dubois-Pelerin, co-head of S&P’s global corporate criteria committee. “The recent class of corporate hybrids have not been tested – they are not callable until about 2015. One cannot exclude that perhaps in 2015, precisely these issues will affect corporate hybrids if the companies come under strain.”
Currently, investors and issuers alike are also waiting on Moody’s, which is reassessing its criteria for judging how much equity credit to award different structures. To be considered equity in any form, hybrids must give companies leave not to call the bonds, but as Deutsche Bank proved, this is is almost diametrically opposed to investors’ views.
“Corporate hybrid investors are likely to focus on the risks of non-payment and/or the bonds not being called,” said Citi’s Mr Winter. “There is a possible conflict between investors – who want cumulative coupons to minimise non-payment risk – and Moody’s who may want to see non-cumulative structures before giving a deal more equity credit.”
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