Subordinated Corporate Debt - Linde and Michelin experiment with subordination

  • 16 Jan 2004
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German engineering and gases group Linde may not operate in the sexiest of industries but it certainly spiced up the lives of fixed income bankers and investors in June when it issued the first institutionally targeted corporate subordinated Eurobond.

The undated Eu400m hybrid paper was also the first to have been given equity credit by the rating agencies. The bond is not callable for 10 years and carries a 100bp coupon step-up if not called.

Investors, encouraged by the roadshow and conference calls, snapped up the bonds, and a final order book of Eu1.4bn that included over 100 institutional investors was achieved.

This enabled bookrunners Deutsche Bank and Citigroup to price the paper at 237.5bp over mid-swaps, more than 10bp through the initial price guidance. Linde’s 6.375% June 2007 senior bond was trading at around 70bp over mid-swaps at that time.

“One reason for issuing an undated subordinated bond was to create a part equity substitute in the balance sheet as we wanted to demonstrate commitment to the company’s credit ratings,” says Erhard Wehlen, Linde’s treasurer.

Linde suffered a Standard & Poor’s (S&P) downgrade last year, alongside other German companies such as ThyssenKrupp and Deutsche Post. The rating agency employed a new pension liabilities methodology that treated unfunded pensions as debt. Linde was duly downgraded from A- to BBB+ by S&P in May.

“We also wanted to strengthen the capital base of the company by refinancing senior debt,” says Wehlen. “This fits in with our debt reduction policy — in fact, our senior bondholders are in a better overall position now than perhaps perceived by rating agencies. This bond also diversified our investor base, extended our debt maturity profile, and further enhanced liquidity.”

He also believes the ability to lock in attractive low interest rates was an incentive.

“Treatment for this type of instrument has yet to be finalised and developed further, by rating agencies for example, but it is important for corporates to have this kind of debt available, and development of a new understanding is vital.”

Paying the price
However, not everyone in the market was convinced, despite the deal granting the borrower’s three wishes: substituting bank lines with capital market instruments, aiding debt reduction, and stabilising ratings. “I don’t see why they bothered doing it,” says a banker who studied the deal. “They paid an enormous premium with an interest burden which is three to four times the senior debt level. It depends what equity credit they received but the amount is just not significant for a company with a market capitalisation of Eu4.8bn. The company intended to do it before they were downgraded but it didn’t get done on time. So they carried through with it anyway.

“If it was such a great structure, why haven’t other companies followed suit when we are still in a negative ratings environment?”

Neither were all participants on the buyside impressed.

“With tier one bank capital there is a greater deal of comfort and belief that the call option will be honoured,” says one senior UK investor. “If the bank doesn’t honour the call it would have its funding in the wholesale market seriously curtailed. But Linde is in no way the same kind of league of borrower and in 10 years’ time they have no great pressure to call the bonds. But there are enough euro investors out there that probably don’t understand the structure fully or that are so completely yield hungry they don’t care about the risks and just get involved because they like the name.”

Nonetheless, the precedent set by Linde was followed by Michelin in November. Europe’s biggest tyre maker, rated Baa2/BBB+, issued a 30 year euro denominated subordinated bond via SG (bookrunner) and HSBC.

Apart from being dated, the bond has a similar structure to Linde, being callable after 10 years with a 100bp coupon step-up if not called.

Demand led to the deal being increased from Eu300m to Eu500m and still the book ended up twice oversubscribed. The bond was priced at 195bp over mid-swaps, towards the tight end of the initial price guidance of 190bp-210bp over.

The primary reason for Michelin deciding on a subordinated bond was the family’s reluctance to dilute its shareholding while wanting an improvement in its balance sheet structure.

Although the Michelin deal was a success, the debate on the rationale of hybrid issues for corporates continued. “I might look at it just because it’s so hard to find value in this low yield environment; but if you ask me whether I like this asset class, the answer is no,” said Etienne Gorgeon, portfolio manager in Axa’s euro investment grade team at the time of the Michelin bond. “Banks have a reason to issue tier one bonds, for tax or regulatory purposes, but I don’t see the point for corporates.”

The right cure for the right patient?
Optimists see continued development and growth in the market.

“Analysis has been too narrowly focused on the equity credit element of the Linde hybrid issue and its percentage [which Linde has not disclosed], resulting in disproportionate emphasis on that factor in isolation,” says Carter Kegel, European head of hybrid issues at Deutsche Bank in London. “Hybrids are not a panacea, but could be right for certain borrowers.”

 Kegel believes that most corporates have begun addressing liability management more seriously. A better capital structure would improve corporates’ access to capital markets, and to get there, they can use a mix of instruments — including the hybrid option.

“[The product] will also become less borrower-specific as the market becomes more developed, for example, when there is more research on hybrid issues and there is more clarity on the benefits received,” says Kegel. “Then there will be more growth in this market, although it won’t explode — it is not the type of transaction that will be done five times a month.” 

  • 16 Jan 2004

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Citi 417,651.57 1605 9.04%
2 JPMorgan 380,255.75 1735 8.23%
3 Bank of America Merrill Lynch 360,270.83 1308 7.80%
4 Goldman Sachs 268,034.61 924 5.80%
5 Barclays 267,242.43 1081 5.79%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 HSBC 45,449.36 196 6.57%
2 BNP Paribas 38,734.80 217 5.60%
3 Deutsche Bank 37,615.10 139 5.44%
4 JPMorgan 34,724.19 118 5.02%
5 Bank of America Merrill Lynch 33,835.53 112 4.89%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 JPMorgan 22,475.00 105 8.66%
2 Morgan Stanley 19,057.00 101 7.34%
3 Citi 17,812.08 111 6.86%
4 UBS 17,693.89 71 6.82%
5 Goldman Sachs 17,332.64 99 6.68%