Growing risk appetite and low interest rates have ushered in a revival of the market for corporate hybrid bonds in Europe since the start of 2013, with Citi's new products team participating in many of the recent issues.
In the absence of any other indicators, it is still possible to tell that markets have been tuned to ‘risk on’, because corporate hybrid capital is back in vogue. These subordinated equity-cum-debt structures have been hitting fresh highs in issuance volumes and deal size, while attracting new issuer types and new investors. And one of the busiest banks in the segment in 2013 has been Citigroup. As a bookrunner on all types of hybrid issues, both corporate and financial, Citi has been among the market leaders in the Europe, Middle East and Africa (EMEA) region since the start of 2012.
Hybrid capital has long been associated with financial institutions in general, and banks in particular. There has been a hiatus in European bank issuance, however, as everyone waits for details of the EU’s new Capital Requirements Directive to be finalised. Insurance companies have been taking advantage of this lull to issue their own hybrid bonds, before they are crowded out of the market by banks.
Crisis victims
Corporate hybrid has had its own ups and downs. As a more recent asset class, it enjoyed a few vibrant years from 2005 onwards, after ratings agencies became more generous with their equity credit treatment. The attractions for corporate issuers were, and still are, that hybrid bonds are an economical way to strengthen the balance sheet and protect ratings without diluting existing shareholders.
In an age of meagre yields, investors like the higher coupons (which are what they used to get on the senior debt a few years ago). But the quid pro quo is that they stand perilously close to the back of the creditor queue, which is why the instruments took a drubbing during the crisis, with liquidity and issuance seizing up.
Issuance volumes have never been huge, but they fell from a global total of $18.8bn in 2007 to less than $5bn in both 2008 and 2009, according to data provider Dealogic. EMEA issuance in each of those two years was less than $500m. There has been a zigzag recovery since then, with global issuance of $22.8bn in 2010, decreasing to $18.5bn in 2011 as the eurozone crisis intensified, and hitting a record $33bn in 2012. “This is a higher beta instrument, affected by broader market risk appetite,” says Simon McGeary, head of Citi’s EMEA new products group, the remit of which includes hybrid origination.
One reason that corporate hybrid remained a niche market was that many big players saw it as having insufficient depth to serve their purposes. “Some found hybrid interesting but felt the possible deal sizes were just not big enough to move the needle,” says Mr McGeary.
New appetite
One of the developments that began to change that perception was a series of transactions from German power utility RWE. In 2011, the company was hit by the news that Germany would accelerate the phasing out of nuclear generation. Its credit rating was downgraded by Standard & Poor’s and Moody’s shortly thereafter, and remained on a 'negative' outlook.
In August 2011, the company announced a series of defensive measures including disposals, capital expenditure cuts, equity raising and hybrid issuance. Its €2bn hybrid programme included 2012 issues in Swiss francs (SFr150m [$162m] with a 60-year maturity, not callable for five years [NC5], 5%), sterling (£750m [$1.15bn] perpetual NC7, 7%) and US dollars ($1bn with a 60.5-year maturity NC5, 7%). Citi was joint bookrunner on the sterling and US dollar deals.
Growing supply was matched by the emergence of new demand, particularly from the Asian private banks. They started to take an interest in corporate hybrid, and last year absorbed meaningful shares of a $350m 8.25% deal from Louis Dreyfus Commodities and a $650m, 8.75% transaction from steelmaker ArcelorMittal. As names, these signalled a break away from the usual corporate hybrid issuers, typically utilities with stable and predictable cash flows.
Mould breaker
So by the start of 2013, the market was already fairly receptive to the idea of corporate hybrid. But then along came a mould breaker, in the shape of the world’s largest ever corporate hybrid deal. This was a multi-currency, multi-tranche offering from Electricité de France (EDF), which raised the equivalent of €6.2bn in January. BNP Paribas, HSBC and Citi were global coordinators and joint bookrunners.
EDF deployed three separate roadshow teams, one touring the UK and Paris, another criss-crossing continental Europe (as well as making Asian one-on-one calls) and a third straddling the US. This was EDF’s inaugural hybrid deal and it was structured in four separate tranches, all with perpetual maturity, two euro-denominated, one in sterling and one, priced a couple of days after the others, in US dollars.
The euro tranches raised €1.25bn each, the first as an NC7 with a 4.25% coupon, and the second as an NC12, with a coupon of 5.375%. The £1.25bn sterling tranche was an NC13 with a 6% coupon, while the $3bn NC10 dollar issue had a coupon of 5.25%.
The ‘building block’ approach of different currencies and call dates had the effect of widening the pool of demand and boosting the size. It also suited the issuer in other ways. “The point about the EDF transaction was not just its size, but the way it was able to push the first call date beyond year five,” says Vincent Vignale, a director in Citi’s new products group. “That makes a lot of difference. If all the hybrid instruments were callable in five years, you would have the potential for a maturity tower, but pushing it out to years seven, 10, 12 and 13 changes the game. This is long-dated, efficient capital.”
EDF was, Mr Vignale says, the “perfect issuer” for this instrument, a largely state-owned utility from a core eurozone country with an Aa3/A+/A+ senior rating. That all helped it to launch the first European corporate hybrid encompassing US institutional investors, which took 57% of the dollar deal.
Open door
This, it appeared, was just the start. On the same day as the EDF dollar tranche was priced, Baa1/BBB-rated Telekom Austria issued its inaugural hybrid bond, the first ever from a European telecoms operator. Citi was joint structuring adviser and joint bookrunner. Similar to the EDF bonds, the perpetual NC5 paper qualified for 50% equity credit from Moody’s and Standard & Poor’s. The deal featured an ‘equity credit step-down’ whereby it loses S&P’s equity credit if not redeemed on the first call date. It raised €600m, with a 5.625% coupon priced to yield 5.875%.
The UK’s National Grid issued its inaugural dual-tranche hybrid deal in the second week of March (see Issuer Strategy, page 56). It had roadshowed in sterling, euros and dollars but eventually opted to issue only in the first two currencies. It too had an equity credit step-down, as well as a rate reset on the first call date. The transaction raised £1bn in 60-year maturity NC12 (5.625% coupon) and €1.25bn in 63-year maturity NC7 (4.25%), with Citi as joint bookrunner on the sterling tranche.
A couple of days later, Telecom Italia staged its own hybrid debut, with a 60-year maturity NC5 structure raising €750m. Earlier it had announced a programme to raise up to €3bn in hybrid capital over the next 18 to 24 months. It would have launched earlier, but decided to allow the Italian elections to be completed first. The coupon was set at 7.75%, a full 400 basis points above its senior paper, with an interest reset and step-up feature.
By early April, year-to-date global corporate hybrid issuance had already topped $24bn, according to Dealogic. That was more than double the comparable figure of $10.5bn in 2012, which was itself a large increase over previous years. Unusually, the overwhelming majority of this year’s business has come out of EMEA, which accounted for $18.7bn of the total.
“There is a growing maturity of the corporate hybrid market, in terms of depth and understanding of the market,” says Mr McGeary. “The key drivers look set to remain in place, with continued low interest rates and investors keen to find higher yield. Compared to financial hybrid, the structures are relatively investor friendly. But even under more constrained conditions, if interest rates rise, hybrid will still be interesting on a spread basis.”
