With credit ratings on negative outlook, Swedish car manufacturer Volvo chose a hybrid issue to smooth the road ahead.

Volvo is one of the best-known carmakers in the world. Synonymous with reliability, the brand is often considered dependable to the point of dullness. Its credit rating however, is anything but boring.

Following a significant earnings decline in 2013, the company was given a Baa2/BBB rating by Moody’s and Standard & Poor’s. Early in 2014, both agencies admitted Volvo’s performance had improved but said the outlook remained negative, thanks to costs associated with an efficiency programme and uncertain macroeconomic prospects. 

For a business with a large financing division, this news was less than welcome. So the group began to cast around for a capital markets solution, aided by long-term relationship banks Citi and HSBC. Having known Volvo for many years, the bankers intermittently suggested that a hybrid bond might suit the company well. In recent months, this advice took hold.

The rating game

“Considering we have a captive customer financing business, a good credit rating is important to the Volvo Group and we have had a negative outlook on our rating over the past year. The 50% equity treatment that rating agencies apply to hybrid capital, which improves the credit metrics, was an important feature for us and made us consider doing a hybrid bond,” says Christer Johansson, senior vice-president, investor relations, at Volvo.

Hybrid bonds have grown in popularity over the past few years precisely because they are granted 50% equity status and can help companies to boost their credit rating. Deeply subordinated, they rank just above equity and include equity-like features, such as the ability to defer coupon payments under certain circumstances. They are also very long-dated, at least nominally, although call options are invariably included after the first few years.

“We have an ambition to keep a conservative maturity structure, with limited near-term maturities, in our debt portfolio for the industrial operation,” says Mr Johansson.

Fast mover

Volvo began talking in earnest to Citi and HSBC in the final quarter of 2014, with a view to coming to market before the year-end. “Our assessment was that market conditions as well as interest in the Volvo credit were good and we wanted to move out our maturities,” says Mr Johansson. The company announced its intentions in the last week of November and a comprehensive roadshow programme was organised for Monday December 1. By this stage, the bookrunning squad had expanded to include BNP Paribas, Deutsche Bank, Nordea and SEB.

To ensure maximum coverage in minimum time, three separate teams went to meet investors in Germany, France and the UK on the same day, while a fourth team conducted calls with Swedish investors from Volvo’s headquarters in Gothenburg. The roadshow was crucial because hybrid bonds need more explanation than conventional transactions. This was also the first Swedish corporate hybrid to come to market for 10 years.

Investor participation was high and there was widespread interest in the hybrid deal. An internet option was provided too, where investors could log on and see the roadshow presentation. This was viewed by more than 300 investors. “There was a lot of interest in Volvo Group and this became apparent from the moment we announced the roadshow activities,” says Mr Johansson.

Paying the price

Hybrids have considerable benefits for companies seeking to strengthen their capital structure but there is, of course, a price to pay. Coupons are substantially higher than for standard deals so initial price talk around the Volvo hybrid centred on a coupon of up to 5%. For investors, this was part of the allure for this €1.5bn deal.

“We had a lot of interest from all types of investors and from regions across Europe. We eventually had more than 500 investors in the order book and the book reached €7.4bn,” says Mr Johansson.

The issue itself was rated Ba1/BB+ and was divided between a €900m tranche maturing in 2075, with call options from 2020, and a €600m tranche, maturing in 2078, with call options from 2023.

Both tranches enjoyed an enthusiastic response from investors. The indicated coupon was comparatively generous and Volvo has a rarity value in this market. Investors also expect the company to deleverage over the coming years, which should boost the bonds’ performance in the secondary market.

“The book was widely diversified among different types of investors – asset managers, insurance and pension managers, central banks, regular banks and such like,” says Mr Johansson.

Ultimately, the €900m tranche was issued with a coupon of 4.2% and a reoffer price of 99.781 cents, producing an annual reoffer yield of 4.25%. The coupon on the €660m tranche was set at 4.85%, with a reoffer price of 99.855 cents and an annual reoffer yield of 4.875%.

“We were very happy with the way the deal was received. With the issuance of this hybrid bond, we have limited funding needs for the industrial debt portfolio in 2015,” says Mr Johansson. 

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