This article is written in partnership with Euromoney.
Asia’s maturing capital markets are embracing hybrid securities. For both corporates and financial institutions, hybrids allow an approach to fund raising as an equity alternative. While a niche product, hybrids can be used by anyone in any market – as long as they understand how to use it.
Hybrid securities, while documented similarly to traditional debt instruments, allow borrowers to obtain equity content from accounting or rating agencies’ perspective. Contrary to popular belief, hybrid bonds should not be looked at as a debt alternative, but rather as an equity option because many lenders, agencies and regulators give them equity-like treatment. When issuers need to strengthen their balance sheet with equity or capital, hybrids present a non-dilutive and cost efficient alternative to traditional equity alternatives.
Hybrid issuance in Asia ex-Japan has taken off in recent years, paralleling global growth. In 2010, Asian issuers sold just three dollar hybrid deals, for a total volume of USD3.3 billion, according to Dealogic data. In comparison, total DCM issuance volume across G3/SGD in Asia for that year was USD94.3 billion. By the end of 2017, the number of benchmark hybrid deals across corporates and financial institutions had surged to 69, worth USD44.4 billion, representing around 12.8 per cent of the total Asian international DCM issuance. While the volatile 2018 market has set Asian hybrid issuance back, it’s still on track for a fruitful year. Asian borrowers have contributed 21 of the 98 benchmark hybrid deals in the public international markets in 2018 up to October.
While hybrid structures may seem like a defensive strategy, they’re actually often utilised by corporates issuers in a position of strength, when their balance sheets are growing. For example, Baa1 / BBB+ rated Vodafone recently raised more than EUR4 billion in a multi-currency hybrid transaction to back its EUR18 billion Liberty acquisition. Closer to home in Asia, there are numerous examples from investment-grade issuers across a broad range of sectors with the likes of AusNet, CK Hutchison, BHP Billiton, PTTEP, ChemChina, Genting Singapore all opting to use hybrid structures in recent past.
The growth in issuance is supported by interest from investors. CK Hutchison’s use of hybrid securities is a good example of the evolution of the market. When its sister company Cheung Kong Infrastructure Holdings first sold a USD1 billion hybrid back in 2010, 55 per cent of the deal was allocated to private banks, while asset managers took just 36 per cent. Just a few years later, when CK Hutchison sold a USD1 billion hybrid bond in May 2016, more than three-quarters of the trade, or 79 per cent, was allocated to fund managers, insurers and public sector investors, while just 19 per cent went to private banks.
“What we have right now is the growing support from the institutional community, looking at this product as an interesting asset class for their portfolios,” stated Shafiq Kashmiri, Associate Director, Financing Solutions Group, Debt Capital Markets, Asia Pacific at HSBC.
Diversity is a key theme for the hybrid market, and as bankers are quick to emphasise there is no single hybrid structure, nor is there only one type of issuer that can use hybrids.
“We have seen quite a diverse range of issuers and structures, both domestically and globally,” said Sean Henderson Co-head of Debt Capital Markets, Asia Pacific at HSBC. “The market has obviously seen some real changes, as we’ve gone through a relatively bullish environment to a rising interest rate cycle.”
For issuers, the use of hybrid structures may seem confusing, due to the lack of clarity about what constitutes a hybrid bond and when it should be appropriately used. The breadth of the hybrid bond market presents opportunities for borrowers, provided the correct hybrid structure is used. However, hybrid issuance is still a niche and should be used strategically, depending on the issuer needs and the market cycle, rather than purely opportunistically.
For investors, it is all about the structure and the appropriate risk premium above credit risk. For instance, many investors would jump at the issuer-friendly fixed coupon-for-life structures that have been selectively issued in the market by strong credits.
Cheung Kong Property (“CKP”) sold Asia’s largest fixed-for-life hybrid, a USD1.5 billion 4.6 per cent perpetual non call three year trade, in May 2017 when issuance was booming and investors were snapping up deals at prices that were more advantageous for the issuers than investors. The transaction was notable as it was the issuer’s debut transaction in public dollar market, and it managed to garner USD6.9 billion of demand, allowing the company to lock in indefinite equity at an attractive cost of financing.
The Philippines’ Ayala Corp took a similar approach, closing a USD400 million fixed-for-life trade in September 2017. The transaction, which marked the borrower’s first dollar bond in more than a decade, utilised the hybrid investor base to allow the company to secure indefinite funding, given the non-resettable coupon structure.
But these are just one type of issuance, and certainly not a mainstay in the market. “Fixed-for-life or zero-coupon bonds are what we call bull market trades,” said Kashmiri, adding that these more aggressive hybrid structures have been used in the last couple of years because of the strength of the market and relatively benign rates environment. Recent trades have returned to the core principle of looking at attractively priced intermediate duration ‘equity rent’ hybrids rather looking for long-dated or indefinite equity hybrids, he adds.
For investors, the structure is of primary importance, even before the credit itself, said Gareth Nicholson, Head of Fixed Income, Discretionary Portfolio Management at the Bank of Singapore.
“People have obviously accepted some things that maybe they would not [otherwise],” said Nicholson, explaining the appeal of structures like fixed-for-life bonds in a bull market. The buy-side has been in desperate need of yield. “As investors, we know there’s no such thing as a free lunch,” he added, explaining that just like investing in high yield bonds, risks associated with hybrids pick up as the market becomes more volatile. Default rates will rise, which is why it is important for investors to understand the structure of their hybrid investments, and the associated risk, said Nicholson.
More protected structures, such as those with large step-ups or issuances from strong credits with a likelihood to call their notes, will continue to be investors’ preferred play especially in a volatile market, like that seen this year. While less aggressive than a fixed-for-life structure, these hybrids are still attractive for borrowers.
For example, a hybrid structure can serve as a pro-active approach to ratings, while a company is going through expansions via acquisitions. Companies who find their balance sheet stretched may consider a bond with equity treatment to allow them to operate at their current ratings. Such was the case with SoftBank’s USD4.5 billion dual tranche bond sold last year, or BHP Billiton’s massive dual currency USD6.5 billion hybrid sold in October 2015.
Companies like Genting Singapore have also taken advantage of the hybrid structure to tap Asia’s deep local currency markets. One of the benefits of the Asian market is the option of tapping yield seeking high net-worth investor demand in local currencies for hybrid issuance. The Singapore dollar market is generally receptive to hybrid products given the strong and growing private wealth community, but other markets like the Australian dollar, Malaysian ringgit and Thai baht are also viable options if such currencies match the operational needs for issuers.
As for what’s next, it seems likely that investors will see more hybrid issuances from China’s state owned enterprises given the state’s de-leveraging policies. Another thematic could be M&A related financing to pro-actively manage the capital structure to operate at existing ratings or internal gearing targets similar to exercises contemplated by ChemChina, or the Cheung Kong group of companies.
However, these are just the start of options for hybrid products, and borrowers considering them will need to assess their personal needs in the context of the market backdrop. With the right combination of an appropriate structure and targeted investor base, these products could continue to grow within popularity in the Asian market.
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