Companies Face Refinance or Dump Dilemma for Pricey Debt

Companies with hybrid bonds coming due face a choice from September: Refinance at substantially higher costs or ditch the debt altogether.

(Bloomberg) — Companies with hybrid bonds coming due face a choice from September: Refinance at substantially higher costs or ditch the debt altogether.

As many as 27 companies, including French postal service La Poste SA and energy producer Engie SA, must decide over the next year whether to redeem their hybrid bonds, according to data compiled and analyzed by Bloomberg. While some have already chosen to raise new debt, others are likely to decide over the next few weeks as Europe’s primary bond market revs up after its summer slowdown.

While all companies with maturing debt are staring at higher borrowing costs these days, hybrids are securities with a twist. Because credit-rating companies consider them to be half equity and half debt, they don’t weigh on issuers’ balance sheets as much as a straight corporate bond.

That means there’s more at stake in the decision of whether to issue a new hybrid. The securities typically are already the most expensive form of debt for an issuer, so many may now be tempted to ditch the format if the credit-rating benefits are no longer worth it.

To replace the bonds that are coming due, a company can sell a new hybrid at dramatically higher rates or issue a straight bond that will lead to higher indebtedness and thus possibly affect its credit rating. Another option is to redeem the debt using cash on hand, and not replace it with new borrowing.

“There are two camps of corporate issuers with hybrids: those that see the merit as a well-established part of the capital stack and will likely be replacing them with new hybrid issuances,” said Matthias Reschke, JPMorgan Chase & Co.’s head of European investment-grade finance, and others that saw the attractive pricing as the reason to issue a hybrid “which might not come back to the market at the current yield levels but use alternative sources to support their rating.”

Hybrids pay a coupon, like a bond, and like a stock they typically have no maturity date. But they have call dates, often the first one from five years or more after they’re sold, when the issuer can redeem them at face value. While they’re not obligated to do so, investors usually expect them to. Europe is the biggest market for the securities, which are less common in the US.

The average coupon on bonds with their first call in the next 12 months is 4.1%, with one as low as 1.125%, the data show. But the 16 new hybrids totaling €11.5 billion that were sold in the first half carry an average coupon of 6.9%. Hybrid bonds are the first notes to take losses if a company goes under, so they typically carry higher interest rates than more senior debt.

Deciding not to redeem bonds at the first call date would damage investors’ perception of an issuer and could lead to higher overall debt costs for it.

Some issuers have already pulled the trigger. Volkswagen AG said in July it would redeem its €750 million of 5.125% hybrids on the call date of Sept. 4. The carmaker on Tuesday sold a two-part green deal in euros at yields of 7.5% and 7.875%, attracting over €9 billion of investor orders, according to a person familiar with the matter, who asked not to be identified because they’re not authorized to speak about it. 

Telefonica SA, which also has the first call on an existing hybrid on Sept. 4, followed suit Wednesday, seeking to raise another green hybrid. The Spanish telecommunications company is offering a yield of 7.125% in initial price discussions.

“For many corporates, hybrids are now an established component of the capital structure, and they continue to see value in the instrument even if absolute costs are higher,” said Nik Dhanani, the global head of strategic solutions at HSBC Holdings Plc.

On the other hand, Belgian chemicals manufacturer Solvay SA said it plans to call its bonds on their first call date in November and that hybrid bonds are not expected to be permanent part of the capital structures of its companies.

Spokespeople for La Poste and Engie didn’t respond to requests for comment.

In one industry — real estate — issuers are doing the once-unthinkable. Battered by higher interest rates and sinking property values, some companies have opted to not call their hybrid bonds or are using creative methods to reduce their exposure to hybrids.

Mall landlord Unibail-Rodamco-Westfield SE, for example, in June offered to exchange its €1.25 billion hybrid notes, which pay a coupon of 2.125%, with a new bond paying 7.25% and a cash amount.

Aside from refinancing, there’s little suggestion that new issuers will be turning to the hybrid market in the immediate future.

Most of this year’s new hybrids have been sold to refinance existing securities, said Julian Marks, head of hybrid bonds at Nomura Asset Management UK Ltd. It’s possible that bond redemptions will outweigh new issues, he said, which is positive for bond prices.

“This environment is a great time to be buying corporate hybrids, offering attractive spreads and a low risk of bonds not being called outside the real estate sector,” he added.

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