North America Investment-Grade Corporate Bond: CVS Health’s US$3bn dual-tranche hybrid
Popping the pill Amid a renaissance for corporate hybrids in 2024, CVS Health’s US$3bn junior subordinated note offering in December stood out and grabbed the attention of Wall Street.
The pharmacy chain and healthcare provider made use of hybrids’ restorative benefits to give it precious breathing room as it looked to reposition its challenged business. Faced with difficulties in its retail and insurance operations, the company’s finances were creaking under the heavy debt load from its spree of large acquisitions, including its US$69bn purchase of Aetna that completed in 2018.
The increased equity credit handed to hybrids under Moody’s revamped treatment of such instruments in late 2023 offered a welcome salve for CVS’s leverage. The rating agency’s methodology change was the principal driver for issuers ramping up sales of such instruments in 2024.
The transaction was paired with a tender offer that partly targeted CVS’s long-dated senior notes trading at a deep discount to par, allowing the company to unlock even more equity.
“It’s turbo-charged deleveraging. Do you pay a little bit more in interest expense when all the dust settles? Possibly, but that’s not the issue. The issue was balance sheet leverage, not interest coverage,” said Kenneth Chang, head of DCM for the Americas at Barclays.
To deliver the US$3bn size that made CVS’s transaction the biggest US dollar hybrid in years, leads included an unusual coupon floor first introduced by Dominion Energy in May. Under the floor’s provisions, the hybrid’s interest rate could not reset below its initial coupon, limiting the downside risk for investors.
That removed a longstanding obstacle for US investors, who had traditionally viewed hybrids with suspicion.
With a strong rally in subordinated debt leading to tighter back-end spreads, investors were wary of the potential extension risk – that is, the chance that the borrower would not redeem the hybrid when first possible because its coupon had reset to a lower rate, a painful outcome for holders.
The floor feature helped drive the order book of US$17bn. From that demand, active leads Barclays, Citigroup and Goldman Sachs were able to raise US$2.25bn from a 7% 30.25-year non-call 5.25 junior subordinated note and US$750m from a 6.75% 30-year non-call 10 tranche.
CVS also stood out as one of the rare issuers of hybrids outside the tool’s typical users. Insurers and utilities remained the main users in 2024 as many blue-chip companies still deemed hybrids an expensive form of capital. But CVS’s offering could help change that view.
“There's a new paradigm that just really opened because of that transaction,” said Chang. “This is going to create a wave of additional supply in broader corporate applications.”
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