April 2, 2015 / 1:16 PM / 3 years ago

Corporate hybrids steal the show

* Corporate hybrid volumes hit record monthly high

* ECB bond buying pushes investors into riskier securities

* Appeal of the asset class to stretch further

By Laura Benitez

LONDON, April 2 (IFR) - Corporate hybrid bond issuance reached record highs in March, as cheap funding costs met with insatiable demand for this once niche product.

Euro-denominated hybrid volumes have topped 16bn so far in 2015 and full-year issuance looks well on track to beat 2014’s total of 28.5bn. March alone saw the highest ever monthly level with 7.8bn sold, according to IFR data.

“One of the key drivers is QE, which is bringing new investors into the corporate hybrid market, while enabling borrowers to issue larger sizes as well as refinance at lower rates,” said Thomas Flichy, head of European corporate hybrids at Barclays.

Even challenging credits like Centrica and Air France-KLM have been able to raise hybrids at relatively low cost. Other firms could push the boundaries further still, while high yield borrowers may also jump on the bandwagon, market players say.

GAME CHANGER

A US$6bn-equivalent deal from Electricite de France in 2013 changed the game for the corporate hybrid market, according to Fred Zorzi, global head of syndicate for bonds and loans at BNP Paribas.

“Since then, there have been trades that have continued to push the boundaries. There was a time when market opinion wavered about whether hybrids will stand the test of time, but it’s clear now that the product is here to stay.”

There is also the prospect of 6-7bn of hybrid issues from the first wave of bonds sold back in 2005 being refinanced on the approach to their first call dates this year, according to Flichy.

Air France-KLM is the most recent example of how far investors are prepared to go in their search for yield. Despite not having paid a dividend in seven years, the unrated company priced the first airline hybrid since 1999.

Dividends are typically a key buffer for investors buying hybrids - which have discretionary coupon payments - as the bonds’ terms include “dividend pushers”, which make coupon payments mandatory following an equity distribution.

NO APPOINTMENT NEEDED

Usually well-flagged affairs, borrowers have started to tap the market in more opportunistic fashion over the last year, with established names such as Bayer, Suez Environnement and Volkswagen issuing deals this year without prior notice.

“Bayer was confident that the market would be receptive and that it could do a drive-by style issue at this size as there are still investors who want to put cash to work in the market, especially for hybrids,” said Philippe Bradshaw, head of corporate and FIG syndicate at RBS, a lead on the Bayer deal.

BNPP’s Zorzi said that while paperwork normally takes around three weeks to prepare, those who are accustomed to doing the ground work are able to turn the documents around at a faster pace.

NOT JUST FOR THE WEAK

The allure of the market has even piqued the interest of highly-rated names. French oil major Total, for instance, issued a 5bn deal in February, despite not being under any pressure to raise capital or defend its balance sheet.

The dual-tranche deal - rated Aa3/A by Moody‘s/S&P - drew in a whopping 20bn of orders while locking in record low coupons.

Hybrids, sometimes used by companies to defend their ratings without tapping the equity markets, receive 50% equity credit at the major rating agencies. However, Total proved that even those with copious cash reserves are finding the cheap funding costs too tempting.

“While there are different reasons for companies issuing hybrids, we’ll definitely see the less obvious issuers taking advantage of the cheaper funding costs,” BNPP’s Zorzi said.

“Looking ahead, we could see high-yield senior names begin issuing hybrid deals. It may be a less natural funding tool and more the exception than the norm, but the possibility for it to happen is there now.” (Reporting by Laura Benitez; Editing by Helene Durand, Alex Chambers, Julian Baker)

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