Riskier Companies Venture Into Europe’s Red-Hot Hybrid Bonds

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Hybrid bonds have been the darling of Europe’s bond market, offering a rare combination of quality companies paying higher yields. But now, both of those benefits are being eroded.

Korian SA, an unrated company that runs nursing homes across Europe, was able to sell a 200 million pound ($282 million) bond with a yield of 4.25% last week. To some investors, it’s evidence that riskier companies are able to dive into a part of the market previously reserved for safer borrowers.

They are “deals that would not get done normally, but are able to ride the hunt for yield,” according to Peter Doherty, head of fixed income at Sanlam Investments U.K. Ltd.

Hybrid bonds combine aspects of debt and equity. They are the first to take losses during times of trouble, but also provide investors with a bigger yield. They’re popular among investors because hybrids tend to come from investment-grade companies, though as Korian showed, that’s not always the case.

Companies that are on firmer financial footing are also squeezing yields lower. Euroclear Investments SA paid just 1.375% coupon on a hybrid bond last week, one of the lowest on record for a European company. The 350 million-euro note from the firm, which operates as a financial services holding company, is callable in 10 years, a long period of time for a hybrid.

The voracious appetite for risk this year has led to a boom in issuance and shrinking premiums. Hybrid bond sales in euros and sterling has exceeded $27 billion in 2021, the highest pace on record, based on data compiled by Bloomberg. The risk premium for euro hybrid bonds is near its lowest level in almost 16 months.

Euro hybrid bonds have returned 0.7% this year, based on ICE BofA indexes. In contrast, senior bonds have a total return of negative 1.1%.

According to most bank strategists, there are still good reasons to be bullish. Bank of America Corp.’s Barnaby Martin is telling clients to keep buying hybrids this year because they’re a good bet when central banks start withdrawing stimulus.

Hybrids tend to have a lower sensitivity to interest rates because investors expect them to be called at the first opportunity, which makes them attractive when government bond yields rise.