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Bankers Say Corporate Hybrid Bonds Could Soon Return
LONDON (Dow Jones)--Hybrid bonds could soon be back on the menu for some of Europe's non-financial borrowers as they look to capitalize on investors' desire for higher yields.
The bonds, which mix features of equity and debt, typically thrive in bull markets, and the likely re-emergence of the asset class is another sign of strength in a market that has seen riskier and riskier borrowers able to find credit.
Hybrid bonds might come with juicy yields, but they have also proven to be extremely volatile when things turn sour. France's Thomson S.A. (FD-THM), for example, sold a hybrid bond back in September 2005 and it is now trading at less than one-fifth of face value, according to data provider Markit, and even that level is well up from where it was at the depths of the crisis.
Still, investors have shown significant interest in hybrids, but most issuance has come from Europe's safest banks, with non-financial supply scant. But several bankers said they have started marketing new hybrids from non-financial companies.
"I would be very surprised if we don't see at least one hybrid deal come to market this side of Christmas," one senior European capital markets banker said recently.
"Everyone is saying the market may see a corporate hybrid deal soon, and it would seem that it is only a natural progression in a market where spreads are continually moving tighter," said another syndicate banker.
"We are pretty confident that there will be a hybrid deal, but they are specific to an issuer's requirements and are often issued for balance sheet reasons," he said.
Hybrids sit below senior bonds in company capital structures and have a lesser claim on a company's assets in the case of liquidation. Borrowers like them because they are tax-deductible and they also help support a company's credit rating. Their equity like characteristics, which allow an issuer to get "equity credit" from the ratings agencies, bolster its capital holdings without diluting existing shareholders. They can be particularly beneficial to companies looking to recapitalize their balance sheets following the crisis.
The recent financial turmoil had a devastating effect on the market for hybrids, which lie towards the riskier end of the spectrum for corporate debt.
But a chink of light appeared two weeks ago when Swiss food company Hero (HER-EB) priced a small hybrid bond denominated in Swiss francs, the company's first such offering.
However, Deutsche Boerse AG (DBOEF) remains the only company to make it to market with a euro-denominated hybrid since the start of 2008.
Frazer Ross, managing director in new issue syndicate at Deutsche Bank, said that falling yields for corporate bonds are giving investors a good reason to look more seriously at hybrids.
At the start of 2009, cash-strapped companies were happy to pay a large premium to sell new debt to investors. However, the corporate bond markets have boomed this year, easing the pressure on European companies and slashing the premiums on offer to investors.
"At the start of the year, investors were getting 8% to 10% on triple-B-rated corporate bonds, but now that's more like 5%," said Deutsche Bank's Ross.
"So where, then, does a new hybrid issue price? Existing hybrids are currently yielding roughly around 6% to 8%, so around 50 to 100 basis points [above] that level. You're probably looking at a new issue yielding between 7% and 9%, which looks like a very good deal compared to some single-A rated transactions which yield in the region of 4.0%."
But new deals are unlikely to appear before mid-November, when Moody's Investors Service plans to unveil the new methodology it will use to rate hybrid debt if a review of its current policies dictates a change.
A spokesperson for Moody's said that it hasn't decided whether to modify the ratings on outstanding hybrid bonds if the agency decides to change its methodology
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