As firms meet investor demand for assets that might lock in high yields for several years ahead of a predicted interest rate decrease, the U.S. market for one of the riskiest types of corporate debt is rising this year. Companies can delay interest payments to junior subordinated debt holders, who are paid last in the event of a default. For maturities up to 40 years, high-risk bonds yield more than senior bonds, but issuers usually call or redeem them in five or 10 years.
These hybrid bonds, like stocks, are low in a company's capital structure but pay interest. Investors are hurrying to buy securities that will pay high interest for years as the Federal Reserve is likely to decrease rates later this year.
Five corporations have offered $4.6 billion of junior subordinated debt this year, and a sixth will go public on Thursday to match demand. Barclays data predicts $8 billion issued in full-year 2023, far quicker than the past two years.
Junior subordinated bond sales might exceed $15 billion to $20 billion this year, according to Barclays analyst Bradford Elliott. He said $1 billion had been invested in hybrid bond funds since October. As debt matures, renewed interest gives companies more funding options.
On Feb. 1, Moody's rating methodology changed, making hybrid bonds more appealing to firms, bankers and analysts said. Last month, Moody's increased its equity credit to 50% from 25% when evaluating hybrid debt or counting half of an issuer's subordinated debt as equity capital. The shift, per S&P and Fitch, allows corporations to raise cash via hybrid bonds without damaging their credit ratings.
NextEra Energy Capital (NEE.N) refinances short-term commercial paper with junior subordinated debt proceeds this year. Energy Transfer (ET.N), which owns and operates a diverse energy portfolio, refinanced preferred shares, a riskier hybrid bond than junior subordinated debt.
Daniel Botoff, global head of debt capital market syndicate at RBC Capital Markets, said junior subordinated debt was tax-favored over preferred shares. "It is more cost-efficient for companies to issue junior subordinated debt whose interest payments were tax-deductible to refinance taxable preferred stock that is becoming callable," said Botoff.
Elliott said strong demand tightened corporate hybrid bond credit spreads, or the premium paid over Treasuries, by over 200 basis points from October's top of 523 basis points.
This year, six corporations issued subordinated notes at 6% to 8% yields, 150-200 basis points higher than their senior bonds. In January, Energy Transfer raised its offering to $800 million from $500 million, indicating strong demand. Informa Global Markets reported $5 billion in orders.
Hybrid bonds are "sensitive to macro conditions," said Payden & Rygel global credit strategist Tim Crawmer. "They have a higher correlation to improving credit quality and improving equity risk sentiment than they do to interest rates."
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