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Time to take corporate FRNs seriously

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By Addison Gong
21 May 2018

The successes and failures of a handful of deals last week showed that floating rate notes are not just for financial credits, but can also serve corporations well — especially in times of real need.

When GlobalCapital Asia gauged the market’s sentiment last year on the prospects for corporate FRNs, most bankers and investors played them down. Their reasoning was simple: FRNs did not fit into companies’ funding profiles as most issuers prefer to lock in current rates. The added hedging expense also did not make much sense when the cost of printing fixed rate bonds was cheap.

Even when Chinese technology firm Tencent Holdings sold a $500m five year floater as part of a jumbo deal this January, it did not cause much of a ripple as the market was in its best form at the time. Although bankers on the deal were impressed with the $4bn of demand for the format alone, the A2/A+/A+ rated company raised $2.5bn from a 2028 bond with ease, while also taking $1bn each from five and 20 year tranches.

How times have changed. The fixed income market has reached a period where even investment grade rated state-owned enterprises like China Overseas Grand Oceans Group struggle to get a benchmark five year fixed rate bond done. A volatile backdrop and negative headlines around Chinese local government debt also forced provincial financing vehicle Zhongyuan Yuzi Investment Co to postpone a 3.5 year transaction last week. The former is rated Baa2/BBB-/BBB and the latter A-/BBB+.

On the other hand, two other successful deals last week suggest that a change in attitude is needed when it comes to floating rate products. As US interest rates climb, FRNs should no longer be perceived as the preserve of banks and other financial institutions.

There is some merit to this argument. The days when all kinds of borrowers could issue bonds at their desired tenors and at reasonable, or even tight, pricings are gone. Instead, FRNs might be the only hope for some names to issue offshore. When it comes to repeat or high quality borrowers, it offers a way to extend maturity or increase deal sizes. It also safeguards corporations’ credit curves to some extent in a market where lots of companies have to pay 30bp-50bp — if not more — as new issue premiums over their already wider secondary curve in order to raise funds.

Take Peking University Founder Group as an example. The technology conglomerate had regulatory approval to raise $800m from offshore bonds, a size that is too big for the market to digest from an unrated name. The company took a two pronged approach: selling a 2.5 year fixed note in April, followed by a $300m FRN last Monday. It was able to generate incremental demand in a month, while also extending its maturity profile to 2021 with the floater.

In the case of real estate developer China Vanke Co, a five year fixed rate bond would have been a hard sell in this environment, while a three year tenor was too short to cater to its needs. It pulled off a $650m 2023 floating rate bond while paying a negative new issue premium. In comparison, with another 2023 deal a month ago, Vanke paid some 10bp as premium.

It is fair to assume that both issuers swapped their costs into a fixed rate, or at least planned to do so in the future. But bankers on both deals evaded the question.

Private banks and banks took nearly 75% of Founder’s notes, while Vanke’s trade was proof that demand is also there from asset managers, insurers and corporates, with 80% of the bond sold to them.

Vanke also priced about 15bp inside where a fixed rate bond would land, according to bankers. Admittedly, cost savings through FRNs are no guarantee. For instance, Founder had to pay up for its deal. The bond still trades at a premium in the secondary market over its fixed rate curve.

But for now, a floating rate transaction — particularly for high yield names — is not really about getting a pricing arbitrage. No, it is more about being able to get past the finish line with a size and tenor the issuer actually wants.

Debt bankers are understandably divided. While some told GlobalCapital Asia they have been pitching FRNs to corporate clients for months, others remain on the fence. But in a market that jumps at almost every headline, what is clear is that rates will continue to rise and that investors will want to hedge away interest rate risks.

Desperate times usually call for desperate measures. FRNs may just offer corporations a way out.

By Addison Gong
21 May 2018