Market That S&P Almost Derailed Sputters Back to Life in Europe

  • Hybrids back in vogue with Telefonica and EnBW offerings
  • Record low borrowing costs are luring borrowers back

The first hybrid bond deals in three months are signaling a resurgence in Europe of a market that was almost brought to its knees by S&P Global Ratings.

Telefonica SA, Spain’s largest phone provider, sold 1 billion euros ($1.1 billion) of hybrids, which combine elements of debt and equity, according to a person familiar with the matter, who is not authorized to speak publicly and asked not to be identified. German utility EnBW AG on Monday became the first European company to market the bonds since satellite broadband provider SES SA and France’s Total SA sold notes in June.

Sales of hybrid securities have been sporadic since S&P said last year it would no longer count part of some notes as equity, making them less attractive for borrowers. Although that’s reduced 2016 issuance by 88 percent, yields on the notes have dropped to a record as European Central Bank stimulus suppresses credit market borrowing costs. 

“It looks like a good time to be issuing,” said Julian Marks, a London-based portfolio manager at Neuberger Berman, which oversees $250 billion of assets, including more than $1 billion in corporate hybrid funds. “It makes sense for companies in terms of decreasing their weighted average cost of capital to come to the corporate hybrid market and we are seeing that now.”

Officials at Madrid-based Telefonica couldn’t be immediately contacted for comment on the deal. A spokeswoman for Karlsruhe-based EnBW said on Monday hybrid bonds are a permanent element of the company’s capital structure and market conditions are favorable. 

Hybrid notes typically have maturities of more than 30 years and rank behind regular bonds in a company’s capital structure. They offer relatively high yields and borrowers like them because they can count part of the debt as equity, which reduces assessments of indebtedness.

Unprecedented Lows

Average yields on global hybrids fell to a record-low 3.32 percent on Wednesday, according to Bank of America Merrill Lynch index data, as central bank stimulus helps suppress borrowing costs in global credit markets. 

S&P sent shockwaves through the market when it said in October it would revise the equity content of some hybrid bonds, regarding them instead as 100 percent debt. Issuers including Dong Energy A/S, Vattenfall AB and Alliander NV said they’d adjust provisions in their bonds to meet the rating company’s assessment.

Capital Structure

Telefonica’s plans to reduce its 53 billion-euro debtload were set back in May when the European Union blocked a 10.25 billion-pound ($13.7 billion) sale of its O2 unit to CK Hutchison Holdings Ltd.

“In the case of Telefonica, which is looking for ways to lower financial leverage to thwart any negative rating action, it makes a lot of sense to issue a hybrid into this market,” said Mitch Reznick, the London-based co-head of credit at Hermes Investment Management, which oversees about $35 billion.

The deal added to more than 30 billion euros of bond sales by companies and financial institutions this week, setting 2016 on course for the biggest year of issuance, according to data compiled by Bloomberg going back to 1999. 

Investors are accepting riskier assets as the ECB’s measures send yields on the safest debt plummeting. Germany’s Schaeffler AG is marketing euro and dollar-denominated payment-in-kind bonds due in five, seven and 10 years, according to a person familiar with the plans. That would be the biggest sale of so-called PIKs, which give borrowers the option to pay interest with more debt.

Junk-rated U.S. packaging manufacturer Crown Holdings Inc. is seeking to sell notes in euros and dollars, according to a person familiar with the matter.

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