Record hybrid growth set to push on into November
A further bout of hybrid issuance in the European corporate market is expected over the next couple of weeks, adding further weight to what has been a record-breaking year for primary supply of the product.
With demand for higher-yielding products returning following the US elections, bankers have suggested that several corporates are considering issuing subordinated debt later this month.
“We don't expect the demand for higher-beta instruments to erode,” said Kapil Damani, head of capital solutions at BNP Paribas.
“We are in a low-growth environment, and a corporate hybrid bond, priced correctly, should represent attractive value for investors."
Demand for corporate hybrids that investors have exhibited has helped underpin just shy of €39bn in euro issuance this year. This breaks all records in terms of annual supply and far surpasses the near €23bn IFR recorded in 2019.
"There has been a tectonic shift around hybrids in 2020 as issuers look to manage their balance sheets or grow them in an M&A mindset,” said Damani.
“For issuers, it is very attractive to generate equity credit from the fixed income market because of how strong the conditions are when compared to the equity market."
The average yield on bonds making up the iBoxx euro non-financials subordinated index is around 2%, its lowest since early March, according to Refinitiv data.
CHANGING ATTITUDES
Bankers have reported a shift in the way CFOs and corporate treasurers have come to view the product as they increasingly value the support that the instrument can provide, especially at a time when balance sheets have been put under pressure by the effects of the Covid-19 pandemic.
This has helped bring a number of first-time issuers to the market this year. BP raised €4.75bn of subordinated debt in June alongside US$5bn and £1.25bn tranches. More recently, Japan Tobacco issued €1bn with its inaugural trade.
“New issuers mean more opportunities to choose from for investors. In that sense the market has developed in a positive direction,” said Peter Kwaak, portfolio manager at Robecco.
“It is true that the share of cyclical sectors in the market has grown in recent years. The oil sector is a good example. Most hybrid investors were already familiar with the oil sector, and with oil prices as a risk factor for hybrids. But with more issuers available to us, we can select those names that offer the best risk/return in our view.”
Not only has the product allowed companies to defend their credit ratings because of its equity-like features, but for those with large-scale investment plans hybrids can provide greater flexibility when it comes to fundraising.
"For companies like those from the energy sector that have a lot of investments to make, in the case of energy companies this would be around the green transition, then hybrids can help fund ambitious transformation plans while managing leverage constraints but still giving the company headroom," said Damani.
Additionally, hybrid bonds provide a useful tool for those firms looking as a temporary equity-like form of financing rather than permanently diluting equity holders, he added.
On the same day that Iberdrola raised it €3bn of hybrid financing in October, it also announced the acquisition of PNM Resources in the US. Also last month, Veolia’s €2bn hybrid issue was linked to its purchase of a stake in Suez.
TREAD CAREFULLY
Despite the overwhelming popularity of the product, caution around what is still high-beta product is clearly still needed.
Unibail-Rodamco-Westfield’s hybrid bonds this week experienced significant volatility, falling their most since April following the rejection of an equity raise by shareholders on Tuesday. The yield-to-call on the REIT’s €1.25bn 2.125% perpetual non-call October 2023s jumped to close to 6.20% on Tuesday, having been seen on Monday at 4.70%, according to Tradeweb.
But while lower yields have meant that investors have been more than happy to take down a large supply of the riskier instrument, predictions are that on the whole further market volatility should not cause the same blowout in spreads that was seen at the start of the year.
“While close to the long-term average, we don’t expect spreads to explode again like they did in March, simply because central banks and governments are supporting the global economy and the world is learning to control the pandemic,” said Kwaak.