Corporate hybrids: The bond – “Sweet spot” 2024?
Rising refinancing risks in the high-yield (HY) segment increase the attractiveness of bonds from issuers with strong credit ratings. Yields on subordinated non-financial investment grade (IG) corporate bonds can keep pace with those in the HY segment. Possible interest rate cuts offer further upside potential in 2024. There is now a wide range of green hybrids on offer.
Good environment for IG corporate hybrids
Strong credits will remain in demand in 2024
Hybrid bonds from issuers with strong credit ratings are likely to appeal even more to investors in 2024 than in 2023. Rising refinancing requirements and significantly higher refinancing costs will put pressure on high-yield issuers with weak credit ratings. Default rates are likely to rise. Senior investment grade bonds are also benefiting from the prospect of key interest rate cuts. However, in conjunction with the gradual brightening of the economic outlook, there should be an even stronger tailwind for subordinated IG hybrid bonds. IG hybrid bonds offer yields comparable to those of senior "BB" bonds.
Solid fundamental outlook for IG hybrid issuers
Utilities and oil & gas companies account for the lion's share of the outstanding volume of EUR IG hybrid bonds at 34% and 31% respectively. Following the sharp decline in European utilities’ debt repayment periods in 2023, consensus expects only a slight increase in 2024. The oil & gas sector was able to significantly improve its credit metrics in 2022 thanks to very high oil & gas prices. In 2023, the credit metrics weakened only slightly. By the end of 2024, the consensus is currently even forecasting a slight decrease in the sector’s debt repayment period. Despite high investment requirements for utilities (grid and renewable portfolios) and oil & gas companies (adjustment of business models), the outlooks for the sector credit profiles remain stable.
Green hybrids now account for 17% of the EUR IG hybrid volume. They mainly come from utilities. VW issued green hybrids for the first time in 2023.
Net new hybrid issue volume should remain low
The net new issue volume should remain low, as the costs of hybrid issues remain high from an all-in perspective. Therefore, refinancing transactions should continue to dominate in 2024. EUR 19bn of hybrids have their first call date in 2024, including one from Austria's OMV (call date: 03/19/2024). Some issuers are likely to decide to issue hybrid bonds (for the first time) despite the relatively high costs. One motive in economically challenging times is to strengthen the capital structure. IFRS recognize hybrids 100% as equity. Rating agencies usually classify 50% as equity. Owners' or shareholders' shares are not diluted.
The higher yields on hybrids compared to senior bonds, key interest rate cuts and the gradual brightening of the economic outlook should attract investors in 2024. A low net new issue volume could contribute to spread tightening.
IG corporate hybrids already outperformed senior IG and HY corporate bonds in 4Q 2023.
Author
Erste Bank Research Team
Erste Bank
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