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Tuesday, 25 September 2018

Europe Investment-Grade Corporate Bond: Volkswagen's €3.5bn hybrid bond

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Back in style

Volkswagen broke a two-year stranglehold after its emissions scandal to re-enter the capital markets in 2017, and in a series of successful comeback trades its €3.5bn hybrid bond issue was the high point that showed the automaker was back in style.

The first step to VW re-establishing itself as a top player in international bond markets was an €8bn senior unsecured offering in March that attracted €25bn of demand.

The German company’s successful re-entry was helped by a couple of technical factors. With VW redeeming a string of bonds during the lockout, investors following its story had a wall of cash to put to work. The new bonds were also eligible for the ECB’s bond-buying juggernaut, the corporate sector purchase programme.

There were no such safety nets when it came to the hybrid, though. The instruments were out of fashion with some issuers, having taken knocks over fears of changing ratings agency methodologies and soaring funding costs. Hybrids also lack the systemic bid from the ECB.

By the time VW launched the deal in June, euro hybrid supply was relatively muted. The automaker’s trade was just the third of the year.

Nor was VW out of the woods as regards the emissions scandal. The deal was configured to take into account fears over further disclosures. Like the March trade, the transaction was issued using a standalone prospectus, which typically allows more flexibility.

The bonds were also offered in denominations of €100,000 – a way of keeping retail investors shielded from any problems down the road.

A further concern to navigate was VW’s ratings. At the time of execution, the instrument was teetering on the brink of junk territory, with S&P rating the notes BBB– with a negative outlook (Baa2 by Moody’s). Lead managers said that the crucial question was how much demand there would be for a bond rated at that level, and what capacity the market could absorb.

Any apprehension was quashed in emphatic style. In the clearest demonstration that investors were willing to look past the issuer’s troubled history, nearly €11bn of orders flew in from around 750 individual accounts, setting VW up for 2017’s biggest euro hybrid bond offering. 

It priced a €1.5bn perpetual non-call 5.5-year at a yield of 2.75% and a €2bn perp non-call 10 at 3.875%. Order books were €4.5bn and €6.2bn, respectively.

The bond issue was not only big, but it also came tight. The notes were priced about 200bp back of VW’s senior paper, in line with the hybrid differentials of other corporates, and the concession was minimal. Bankers put it at 10bp, though some on the buyside pegged it at virtually nothing.

Bank of America Merrill Lynch (B&D), Credit Agricole, Goldman Sachs, HSBC and MUFG were the lead managers.

To see the digital version of this review, please click here.

To purchase printed copies or a PDF of this review, please email gloria.balbastro@tr.com.

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