European corporates seize hybrid bond opportunity

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QE drives all-in yields to historic lows; Hybrids now more attractive than triple-B corporates.

By Louise Bowman

Anyone curious as to what the impact of sovereign quantitative easing in Europe has been on the corporate market need look no further than the recent corporate hybrid issued by French oil group Total. In its debut hybrid issuance on February 19 the corporate attracted over €20 billion of orders for a €5 billion deal. The two-tranche deal saw the non-call six tranche price at 2.25% and the NC-10 tranche price at 2.625% for perpetual securities.

Other European firms have been swift to follow suit: Swedish utility Vattenfall issued a €1 billion deal in mid March through Barclays and BNP Paribas that was five times oversubscribed, while on March 17 German auto maker Volkswagen priced two hybrid bonds totaling €2.5 billion through BAML, BNP Paribas, Commerzbank and JPMorgan.

This unprecedented appetite for hybrid risk comes as the impact of the ECB’s bond-buying programme squeezes the last drop of yield from most other sectors of the market.

According to Neil Mehta, fixed-income analyst at Markit, the iBoxx euro non-financials subordinated index had returned an average 3.71% to March 17 in 2015, while the non-financials senior index had returned 1.35%.

"The impact of QE has already been huge in this part of the market," says Thomas Flichy, head of European corporate hybrids at Barclays. "All-in yields are at an all-time low. Corporate hybrids trade at a much lower spread than financial hybrids, but the order book for Total was as big as the 2015 AT1 [additional tier-1] deals issued until mid February combined."

William Weaver-large
  Yield curves are virtually flat to 20 years, so corporates can completely derisk their businesses. If they issue a corporate hybrid, they are effectively raising equity at historically cheap rates which is also tax deductible

William Weaver, Citi

Mehta at Markit explains that the risk/return dynamic between corporate hybrids and triple-B rated corporate credit switched in favour of hybrids in mid-February for the first time in the last five years. This will not have escaped the notice of European corporates, and many expect a sharp uptick in issuance as a result.

"We will see more corporate hybrids," predicts William Weaver, head of Emea debt capital markets and syndicate at Citi in London. Weaver previously ran Citi’s Ceemea DCM business. He was appointed to his new role in late February after the departure of Paul Young for Bank of Tokyo Mitsubishi UFJ in December last year.

"Corporate finance will be driven by strategic drivers rather than treasury drivers," he tells Euromoney. "Corporates don't need funding, but at the CFO/CEO level the disconnect between the cost of equity and the cost of debt can create all sorts of strategic opportunities. Yield curves are virtually flat to 20 years, so corporates can completely derisk their businesses. If they issue a corporate hybrid, they are effectively raising equity at historically cheap rates which is also tax deductible."

Outstanding paper

The QE-driven surge in appetite for hybrid paper coincides with a large volume of outstanding paper that – given where rates are – is likely to be called.

"€10.5 billion hybrids are reaching their first call date this year, and we would expect the vast majority to be replaced with new hybrids," explains Flichy. "It makes a lot of sense to replace those hybrids rather than leave them outstanding."

Indeed, UK energy company SSE issued a £1.2 billion-equivalent hybrid in late February through Barclays, Morgan Stanley, BBVA, BNP Paribas and Lloyds that will likely be used to repay its outstanding hybrid bonds callable in October this year. That deal attracted over €10 billion-worth of orders.

However, the reception afforded Volkswagen’s deal in late March provides a timely reminder that any surge in supply needs to be carefully managed. Guidance was not tightened on the VW deal, and spreads across the market widened on its announcement. Nevertheless, it was swiftly followed by a €2 billion double-B rated hybrid from Spanish energy firm Repsol through BAML, Deutsche Bank and JPMorgan, although the deal was smaller than had been expected. As Euromoney went to press, Air France KLM was planning its first euro hybrid through BNP Paribas, Crédit Agricole, Deutsche Bank, Morgan Stanley and Natixis.

Investor appetite for deals

The dysfunctional yield environment in Europe will certainly make hybrid deals more achievable, but due to their ratings-driven nature such deals do not make sense for everyone.

"Corporate hybrid issuance is less opportunistic than senior unsecured," observes Mark Bamford, global head of debt syndicate at Barclays. "It doesn't hurt that a broader array of companies can sell hybrids. However, investors will need to do more work and will expect to be paid for it," he warns.

Indeed, investor appetite for these deals does not appear to be indiscriminate.

The Total hybrid deal was rated single-A and SSE’s hybrid was rated triple-B flat. Sub-investment grade deals such as that for Danish telecommunications firm TDC, which issued a €750 million double-B rated deal in February, have attracted healthy order books (roughly €3 billion in this case) but most buyers are treading carefully.

"Investors that are very familiar with the product are putting in very large orders and new entrants are also coming in," says Flichy. "Most new entrants are high-quality accounts that are focusing on highly rated issuers."

That may change if more corporates under pressure from the rating agencies, such as perhaps some oil majors, decide to try their luck in the current febrile environment.

"Issuing a corporate hybrid will not move the needle enough to get a rating upgrade and probably won’t even move it within a rating category," admits Citi’s Weaver. "But even if it has been moved halfway within a category it may negate the need for other measures such as an asset disposal."