When Euromoney took a detailed look at the corporate hybrid market in its June 2013 issue one of the strong themes coming through from both banks and investors was that the market might be getting ahead of itself. Investor demand was driving riskier issuance from unrated and lower-rated firms, many said, citing deals from Trafigura, Louis Dreyfus, ArcelorMittal and Telecom Italia as evidence. Less than a year later, investors in some of those deals are finding out the hard way exactly what they were talking about.
Hardest hit are those that bought ArcelorMittals $650 million 8.75% hybrid bonds in September 2012. On January 20, the steel maker announced that it would redeem the perpetual bonds by February 20 at 101 less than 18 months after they were originally issued. The news prompted a seven-point price slump, the bond having closed at 108.62 the day before the announcement. This news was followed just a week later on January 29 with the announcement that Telecom Italia is to call its 750 million 7.875% hybrid that was issued in March last year, also at 101.
It cant have come as a complete surprise to investors that ArcelorMittal and Telecom Italia might have been considering their options. Moodys decision to change its hybrid methodology last August and treat hybrid bonds issued by corporates rated Ba1 or lower as 100% debt has put holders of such bonds on high alert. ArcelorMittal was downgraded to Ba1 by Moodys in November 2012, so when the August change in methodology was announced the writing was already on the wall. Telecom Italia was downgraded to Ba1 in October 2013.
What has taken the market by surprise, however, is that Arcelor Mittal has decided to call the issue at 101 with no concessions offered to bondholders. Other issuers that have called hybrids in the past, such as Danish oil and gas company Dong and Dutch network company Alliander, have done so under better terms for their bondholders than the documentation allows. Not so ArcelorMittal, which is not giving an inch and insisting on buying back at 101. Telecom Italia is also calling at 101 but its hybrids were only trading at around 102 prior to the announcement.
Both ArcelorMittal and Telecom Italia issued hybrid bonds to shore up their credit ratings. It didnt work not because the decision to issue a hybrid was wrong but because Moodys changed the goalposts. Telecom Italia had planned to issue 3 billion of hybrid debt programmatically before Moodys change in stance. However, the steelmakers decision to take no prisoners has shocked many. The firm might be prepared to burn its bridges with its hybrid investors because it is reasonably sure that it will not be tapping the market again in a hurry.
In these markets issuers know that even if they burn one group of investors there are plenty more where they came from. If this kind of complacency spreads it could end up being both buyers and sellers that pay the price.