* Value of hybrids stretches beyond ratings protection
* Socio-political factors make RWE's downgrade an exception
* Relative cost of hybrid remains lower than raising equity
* Germany's Linde is possible candidate for hybrid issuance
By Josie Cox
LONDON, Aug 10 (IFR) - Issuing hybrids might not guarantee
struggling corporates' credit ratings, but they can play a vital
role in generating capital and funding M&A, bankers say.
RWE's downgrade last month, just weeks after the utility
completed a USD2bn hybrid bond programme, initially appeared to
expose a major flaw in the instrument - especially as the
securities cost the company a lofty 7% in coupon payments.
But rather than slamming hybrids as an expensive piece of
debt, bankers rushed to the instrument's defence by pointing out
they can be a more cost-effective way of raising equity than
"RWE obviously failed to achieve one of its goals of the
programme -- namely to protect its rating -- but it did
achieve its goal of raising funds at the cheapest possible level
considering its needs," one syndicate banker said.
RWE's hybrid programme, implemented in August 2011, proved a
vital lifeline for the company left reeling after the nuclear
Fukushima disaster in March 2011.
A decision by Germany to exit nuclear power put huge
pressure on the major players in the utilities sector, including
RWE, forcing them to announce asset disposal plans in order to
finance the transition to alternate power generation.
In a move to shore up capital, RWE announced a rights issue
at the end of 2011, but that fell EUR400m short of the planned
EUR2.5bn target - leaving hybrids to plug the gap.
The new shares sold at EUR26 and based on this, as well as
the EUR2 dividend that the company pays, this equates to a
dividend yield of 7.6% -- substantially higher than the coupon
on the hybrid. Furthermore, bond coupons payments are
tax-deductible, unlike equity dividends.
When Standard & Poor's and Fitch trimmed RWE's rating by one
notch to BBB+ and A- respectively in July, both said that they
expected nuclear provisions to continue to weigh on the group's
Kapil Damani, senior capital structurer at BNP Paribas,
points out that the efficacy of the instrument relies in part
upon a stable business risk profile.
"Hybrids are sometimes touted as a solution to everything
and while they are a very appropriate and suitable instrument in
many cases, it's important to bear in mind the strains and
socio-political pressures RWE is facing."
Hybrid bonds -- which are a blend of debt and equity -- rank
subordinated to senior bonds and therefore pay significantly
higher coupons to compensate investors for that risk.
Corporate hybrids, unlike their bank counterparts, also have
an edge because coupons are both deferrable and cumulative -
giving treasurers greater flexibility.
In addition, while a capital hike can significantly burden
the stock price and dishearten equity investors, the
non-dilutive nature of hybrids means that they can strengthen
return on equity and earnings per share metrics for a company.
"It would be wrong to write off hybrids as a means of
protecting ratings, just because of the recent downgrades on
RWE, which we thought was rather unfortunate," AJ Davidson, head
of hybrid capital and balance sheet solutions for EMEA and Asia
Pacific at RBS says.
"From a cost perspective, hybrids are still a very sensible
In fact, the relative stability of credit markets at a time
when equity market volatility remains elevated, should harness
the instrument's value, bankers say.
While the VIX -- the implied volatility index on the S&P 500
-- is still trading above pre-Lehman levels, cash continues to
pour into corporate credit which is considered a haven. And
hybrids, although riskier, offer the most attractive yields in
that asset class.
One fund manager, who holds RWE's USD500m 60.5-year
NC5.5-year hybrid due in 2072, said that the rating cut had not
changed his opinion of the credit or made him reconsider his
"RWE remains a robust credit and I see the ratings change as
insignificant," he said, adding that he also still holds hybrid
bonds in BG Energy
The use of hybrids in M&A funding has also widened their
One name that is tipped to access the hybrid bond market is
German industrial gas firm Linde, bankers have said.
The company, which in June said that it had agreed to pay
USD4.6bn for Lincare Holdings - a Florida provider of oxygen and
respiratory therapy services to patients in the home - is no
stranger to the hybrid market.
"It's still apparent that an increasing number of corporates
are embracing hybrids as a non-dilutive capital-raising
instrument," Damani said.
"In the case of acquisitions, hybrids can be a very good
tool to plug equity gaps."
Linde has three hybrids outstanding, collectively amounting
to around EUR1.5bn. Following its takeover of the UK's BOC for
EUR12bn in 2006, Linde then launched a EUR1bn hybrid deal.
In addition to this, the company faces redemptions of around
EUR400m next year, which need to be refinanced too.
Other potential candidates for the instrument include
Vattenfall, which sold a very well-received hybrid transaction
in 2005, and Austrian credits such as OMV, Voestalpine and
Wienerberger, which have also been in the market in the past.
(Reporting by Josie Cox, IFR Markets; Editing by Natalie