HEARD ON THE STREET
Updated January 28, 2013, 1:29 p.m. ET
Yield Hunger May Spur Hybrid Boom
By RICHARD BARLEY
It's as if the credit bubble never burst. The search for yield is driving a comeback for another bull-market structure: corporate hybrid bonds. Last week, French utility EDF sold a record-breaking €6.2 billion ($8.3 billion) equivalent of these securities, which blend features of debt and equity. More issuance seems likely, with borrowers seeking to preserve credit ratings and investors hungry for returns. But higher yields mean higher risk.
Hybrid bonds rely on something of an optical illusion to work. From some perspectives, they look like equity: They are deeply subordinated, carry very long or perpetual maturities, and interest payments can be deferred. That allows ratings firms to count them partly as equity, bolstering debt ratios and relieving ratings pressure. But they also contain debt-like provisions, notably a fixed coupon and the option for issuers to call, or repay, the bonds on specified dates. That provides a lower cost of capital than equity and allows traditional bondholders to buy in the belief that companies will pay the bonds off rather than leave them outstanding.
In the good times, the interests of issuers and investors align. EDF, which like many utilities has big capital-expenditure needs, can raise funding without increasing the risk of ratings downgrades. Investors get high returns: Three of the four hybrid securities EDF sold carried coupons above 5%, a rarity for the investment-grade market given the current low level of rates. Double-B "junk"-rated debt is yielding 3.8%, and corporate debt from Europe's more troubled economies, such as Spain and Italy, just 2.9%, according to Bank of America Merrill Lynch.
But there are reasons for caution. Hybrids face a major test in 2015 as around €10 billion of these securities hit their first call date; whether or not issuers do call these bonds will be crucial.
And the complexity of hybrid bonds can render them illiquid as they are tough to value. During the stress of late 2008, hybrid bond prices fell on average to 60% of face value, BNP Paribas recalls.
True, a rerun of 2008 seems unlikely right now. And if growth is picking up, then corporate hybrid debt should fare well, offering some protection against higher interest rates, as credit spreads should tighten. But investors should remember there's no such thing as a free lunch.
Hybrid bonds rely on something of an optical illusion to work. From some perspectives, they look like equity: They are deeply subordinated, carry very long or perpetual maturities, and interest payments can be deferred. That allows ratings firms to count them partly as equity, bolstering debt ratios and relieving ratings pressure. But they also contain debt-like provisions, notably a fixed coupon and the option for issuers to call, or repay, the bonds on specified dates. That provides a lower cost of capital than equity and allows traditional bondholders to buy in the belief that companies will pay the bonds off rather than leave them outstanding.
In the good times, the interests of issuers and investors align. EDF, which like many utilities has big capital-expenditure needs, can raise funding without increasing the risk of ratings downgrades. Investors get high returns: Three of the four hybrid securities EDF sold carried coupons above 5%, a rarity for the investment-grade market given the current low level of rates. Double-B "junk"-rated debt is yielding 3.8%, and corporate debt from Europe's more troubled economies, such as Spain and Italy, just 2.9%, according to Bank of America Merrill Lynch.
But there are reasons for caution. Hybrids face a major test in 2015 as around €10 billion of these securities hit their first call date; whether or not issuers do call these bonds will be crucial.
And the complexity of hybrid bonds can render them illiquid as they are tough to value. During the stress of late 2008, hybrid bond prices fell on average to 60% of face value, BNP Paribas recalls.
True, a rerun of 2008 seems unlikely right now. And if growth is picking up, then corporate hybrid debt should fare well, offering some protection against higher interest rates, as credit spreads should tighten. But investors should remember there's no such thing as a free lunch.
0 comments:
Publicar un comentario