With the growing acceptance of hybrid securities by different investor bases, issuers are faced with the choice of which market they should tap. While euros remains the currency of choice for European companies, possibilities in dollars and sterling are growing, and both institutional and retail investors are viable options. This chapter will examine the pros and cons of the different markets.
While decisions about structure may be paramount for corporates when they are preparing to launch a hybrid transaction — get that wrong, and the whole exercise becomes pointless — the choice of which market potential issuers should approach is increasingly coming to the fore.
This is the result of a welcome expansion in the options available to non-financial companies when they launch their hybrids, whether they are from Europe, the US or elsewhere. While the surge in issuance in the summer of 2005 from Europe was targeted squarely at the European institutional investor base, and the first issues from the US were sold domestically, the past year has seen an increasing number of issuers tapping pools of liquidity in different continents.
A transaction that clearly demonstrated this trend was a $1bn perpetual non-call five year issue for German luxury car-maker Porsche in January. "The ability of Porsche to sell an unrated $1bn perpetual non-call five dollar hybrid to Asian retail as opposed to launching a European institutional transaction highlights the diversity of markets available to European corporates," says Jeff Tannenbaum, director of syndicate at Merrill Lynch in London. "And what will be important for European corporates going forward will be their ability to analyse each and every independent market, be it euros, sterling, and dollars, whether that be targeted at either the institutional or retail investor base.
"There are now multiple markets available for issuing the same class of hybrid capital and issuers should not limit themselves to their home market, but look for pricing arbitrage across these markets, because it does exist."
Eirik Winter, co-head of fixed income capital markets at Citigroup in London, agrees. "The choice of market has really opened up for European corporate hybrid issuers," he says. "We have seen Asian targeted dollar denominated supply that gives you more optionality.
"And more recently we have seen the reopening of the US hybrid market, where the cloud that had existed in the form of how the NAIC (National Association of Insurance Commissioners) would classify such instruments has been lifted."
Such developments, as well as the opening of the sterling market by Linde in July, have been a welcome development for issuers, who have been increasingly keen to match-fund their operations across the globe.
"We have issued a couple of Eurobonds in the past and in 2004 sold a US private placement," says Henrik Hänche, head of the Porsche treasury centre in Stuttgart, "so it was now time to tap the US hybrid market with a deal sold primarily to Asian retail and high net worth individuals.
"One part of our funding strategy is to diversify our funding sources and to be in the capital markets where our loyal customers are, and Asia is one of the major markets for Porsche cars. We were already in the market in Europe with our Eurobonds, in the US — which is our major market outside Germany — with the private placement, and now we are present in the Asian market."
Investors would also likely welcome supply being more evenly spread across a variety of markets. This is suggested by the way in which some panicked in May when faced with the prospect of heavy supply in euros.
"Up to that point there had been three markets open to this instrument: the US, the Asian market, and the euro markets," says one syndicate manager in London. "But the Asian market fell apart because of the volatility in emerging markets, and in the US the NAIC had put a halt on hybrid issuance.
"Therefore the euro market was the only one left open and investors saw that there was a risk of seeing large transactions all coming into that market. We saw Axa and Generali from the insurance sector, Linde issuing, and there were expectations of more supply from Bayer and others."
This resulted in spread widening that has since dissipated. "Now that the market is re-opening in Asia and in the US, the oversupply concern is going away," says the syndicate manager.
An investor base that has been untapped for even longer than either Asian retail or the US is the European retail investor base. Retail participation in some European trades, such as sugar company Südzucker, mail order and internet retailer Otto from Germany, and most notably Porsche, has been significant, but not since French retailer Casino launched its Eu600m hybrid in January 2005 has an issue been tailored to attract pure retail investment.
That transaction, led by BNP Paribas and UBS, was a perpetual non-call five issue paying a coupon of 7.5% for the first three years and 100bp over the 10 year constant maturity swap (CMS) rate thereafter. The bonds did not include a step-up.
"At that time the European retail market was on fire," says Barry Donlon, a director on the corporate syndicate desk at UBS in London. "We were selling predominantly perpetual non-call five deals for financial institutions because retail investors were more comfortable with a regulated entity issuing regulatory capital.
"They like buying names they are very comfortable with and banks give them confidence. However, a well known name like Casino also worked because so many investors were familiar with the brand."
The retailer had postponed its issue at the first attempt to launch the hybrid the previous October, but had no difficulties getting its issue away the second time around. Only four hours after the leads opened the books for a Eu150m plus deal orders totalling Eu1bn had been placed, allowing Casino to increase the size to Eu500m. The hybrid was then increased by Eu100m by UBS later in January.
The deal played into the strong market for CMS-linked structures. In the same week that Casino priced its hybrid, for instance, Deutsche Bank and Natexis Banques Populaires issued CMS-linked tier one capital, although these were more heavily structured. Deutsche's Eu900m perpetual non-call five year paid 6% to the call and four times the spread between 10 year and two year CMS, for example.
Losses on some structured CMS trades later in the year, however, stymied further issuance by either corporates or financial institutions as retail investors nursed their wounds.
But Donlon believes that for the right name the retail market in Europe could be reopened. "It is a question of getting on to the radar screens of the brokers and private bankers who are selling to the retail investment community," he says, "and to do that you need a name of the right calibre. Credits such as Porsche and Siemens were ideal candidates and if we see one or two more of that standing the corporate retail market could really open up."
This would also widen the range of structures open to issuers. "Some of the structures that retail are willing to buy would even allow you to achieve greater equity credit from the rating agencies and more flexible features," says Donlon.
Asia makes its mark
Asian retail certainly proved open to the non-step up structure that Porsche was keen to use and offered them in its $1bn deal. "Asian retail investors were more flexible in accepting our terms and conditions," says Hänche.
This, combined with the timing of Porsche's needs — related to its acquisition of a stake in fellow German car-maker Volkswagen — the nature of its business, and its lack or ratings meant that the Asian investor base was the right one for the company, says one banker in London.
"Porsche has significant dollar assets, in terms of their revenue base, and was looking for a natural hedge against that, ie a dollar liability," he says. "The question was then how to do so on an unrated basis and in a way in which they could achieve true perpetual money, as they did not want to have a step-up.
"The logical course for them was therefore not to go to the US institutional market, but to target the Eurodollar, or more specifically Asian and European retail investor bases with a dollar issue. This also simplified any documentation issues."
As with Casino in Europe, Porsche's dollar issue came at a time when the targeted investor base had already shown an enthusiasm for perpetual non-call five paper from financial institutions, and not just from highly rated, well known banks, but also exotic credits such as Brazilian banks and corporates.
Merrill Lynch was able to build a book said to be five times the $1bn issue size at the guidance level of 7.5% and price the issue with a 7.2% coupon. "They have managed to get this away at swaps plus 140bp, which is a great level if you look at where all the other hybrids are trading," said one banker in London. "The reason for this is that they are such a good household name and the bonds sell to retail investors, particularly in Asia. If this had sold mainly to institutional buyers, they would have had to bring it 40bp-50bp wider."
Unfortunately for issuers interested in such pricing possibilities, the attractive execution achieved by Porsche through targeting Asia was closed off. "The macro conditions in the market turned negative soon afterwards," says Tannenbaum at Merrill Lynch. "Treasuries sold off, there were concerns over the direction of the equity markets, and the liquidity within the retail investor base contracted.
However, the outlook is more promising. "We are now starting to see that market come back strongly and I fully expect it to re-open soon," says Tannenbaum, "although not necessarily with corporates. Financials will be the first step, but we will see corporates again in the future."
NAIC clouds clear
The outlook in the US market has also improved lately, after it had been clouded by the decision by the Securities Valuation Office (SVO) of the NAIC — which determines how much capital insurance companies have to hold against investments — to classify some high equity credit, tax-deductible preferred securities as common equity rather than debt, which they had been classed as previously. When the SVO first classified an instrument thus — a $300m 60 year non-call five instrument for Lehman Brothers that had been seen as a landmark when launched in August 2005 — it raised fears that the US institutional bid would fall away as insurance companies left the preferred market.
Institutionally targeted hybrid issuance — which had only been expanded to include corporates in November, with the launch of a $450m 40 year non-call five issue for toolmaker The Stanley Works — widened in the secondary market and new supply fell sharply.
Fortunately for those with an interest in the market the NAIC relented in September and introduced a temporary classification system under which single-A hybrids would be risk weighted 1.3% and triple-Bs 4.6% — higher than before March, but well down from the 30% they had suffered from in the meantime.
A $350m issue for Florida Power & Light, led by Merrill Lynch, Bank of America, Credit Suisse, JP Morgan and Lehman Brothers, which was the first institutionally targeted corporate hybrid after the NAIC's climb-down, showed a reinvigorated market, attracting $4bn of demand.
"The hybrid capital market seems to be back in business after almost six months of the NAIC's regulatory vapour lock," said David Hendler, a credit analyst with research firm CreditSights.
While US issuers will be the main beneficiaries of this, it will also broaden the range of options for European corporates. "I don't expect to see a huge number of European issuers tapping the US market," says one DCM official in London. "Documentation requirements may be a barrier, but there may be some companies that have strategic needs in dollars or have perhaps bought a US firm that will want to access the market.
"Any such supply will be driven by pricing differentials."
Others agree. "If you look at the senior market, there are some European corporates that can raise money at sharply tighter levels in the US than they can in Europe," says one syndicate manager in London. "It is then a logical follow-through that their levels in the hybrid market would be tighter in the US, so I have a pretty strong view that the US markets will open up for European corporates in hybrid format."
UK consumer products group Diageo, for example, in September raised $300m of long five year, $600m of 10 year, and $600m of 30 year funding via Goldman Sachs, Merrill Lynch and UBS that was priced as much as 10bp inside where banker said it could issue in euros or sterling.
Any such issuance from European corporates in dollars would mirror that of GE Capital in September.
The US company launched a hybrid in September, split into Eu950m and £400m 60 year non-call 10 tranches, with Barclays Capital, JP Morgan, Lehman Brothers and Morgan Stanley bookrunners on the sterling tranche and Deutsche Bank, Goldman Sachs, Lehman Brothers and UBS leading the euro.
GE's transaction came in the week after German electronics and electrical engineering group Siemens had launched simultaneous Eu900m and £750m tranches via Deutsche and UBS.
Linde lifts the market
However, both were following in the footsteps of German industrial gases and forklift truck group Linde, which in July had opened the sterling hybrid market with a £250m issue launched alongside a Eu700m tranche via Barclays, Citigroup, Dresdner Kleinwort and UBS.
Many market participants were surprised to see a German rather than a UK company opening the sterling market, including Erhard Wehlen, group treasurer at Linde in Wiesbaden. "I asked all the banks: why isn't there any UK company in the market?" he says. "Why should a German company have to open this market after there had been so many discussions within the UK Association of Corporate Treasurers about this type of instrument?
"Evidently there was no need at that time for a UK company to issue hybrid debt, but at the same time investors were interested in seeing a corporate."
In fact it appeared that the sterling investor base needed Linde more than Linde needed the sterling investor base.
"At the first meetings with investors they asked how much we would be prepared to pay up," says Wehlen, "and we said: 'Nothing. We don't have to use the sterling market, so take it or leave it.'
"Then people said that they would be interested and in the end the demand from the UK was really quite strong and we were able to increase the amount we were raising in sterling and decrease the euro to give sterling investors more liquidity. For Linde raising sterling as part of our BOC acquisition also makes a lot of sense."
Indeed the order book for the sterling tranche was £1.4bn, with more than 100 accounts participating. Siemens' £750m sterling tranche in September, meanwhile, generated £3.7bn of demand.
Such figures confirm what many bankers had been expecting to see. "The general view for a long time was that the sterling market was very open and liquid," says one syndicate manager in London, "and it was just a question of waiting to see the first issuer."
(See 'Drivers of issuance' for further analysis of the lack of hybrid issuance by UK companies)