Wednesday, February 17, 2016

HYBRID BOND...NEVER EXPLAINED PROPERLY

In 2014 I was sitting in an office with my friend and he was over the phone discussing about Hybrid Bonds and investments in asset class. He was able to sell a good amount of Hybrid bond to an client where he earned a hefty commission. The biggest problem of today’s global economy is that liquidity aspects of these Hybrid Bonds were never properly informed to the tax payers and they took a hit at their end under the current circumstance. High yield and returns forced them to drop other safe assets class investments and bring all savings under Hybrid Bonds and Debt.

The fight over asset class investments have been long history since the inception of every new asset class came in the market.  Investors have become smarter and more risk takers without understanding risk factors. I will come to this smart investors segment later in the article.

Hybrid bonds took birth to attract inflows by offering higher yields and returns. But attracting the investments not form investors but form other investment asset class. Yes that’s the main reason why toxic bonds and debt papers are introduced into the market. Hybrid Bonds and Debt are not taken into account of any index also. For the moment, contingent convertible bonds-Hybrid Bonds are not included in any of the fixed-income reference indices such as those compiled by Bank of America Merrill Lynch and Barclays Capital. The consequence is that investors who use those indices as benchmarks do not invest in contingent debt. The Barclays Capital Index Product Group has made it clear that contingent capital is – similar to other mandatory convertibles – not eligible to be included in the broad-based investment-grade Barclays capital bond indices.
Corporate also came up with bonds. But their theory of Bonds issue was split into two segment 1)Investment category and Low category companies. The investment-grade hybrids are labeled “safe haven hybrids,” whereas their lower-rated equivalents are better known as “high beta hybrids. The gimmick of the English word played its game and made investors to burn out billions under the current scenario. These hybrid debts are mostly under deferral system where principle payment is deferred and only the coupon is extended and compensated by a higher yield.

Well the depth of this type of Hybrid Bond/Debt is that four companies raised a total of $4.7bn through convertible bonds in the first half of January 2014 alone.
ArcelorMittal
Italy’s Eni 
Abengoa, the Spanish renewable energy company
Italian real estate group Beni Stabili 
Total convertible issuance for the first 6 months of 2015 was up to USD 50.8 billion.In 2014 there have been 55 convertible bonds issued in Europe so far this year worth a total of $17.3bn, compared with 38 worth a total of $15.6bn at the same stage last year of 2013. I am not getting into the numbers of 2015. The history is yet to unfolded and that’s what’s scary for the markets.

Today’s financial market is linked with every asset class and surprisingly every asset class is competing with against each other. Hybrid bonds like the convertible bonds were issued not only by banks but also by corporate. Share Buyback spooked the capital markets and major indices across the globe. Now a convertible bond is one where investors can convert the same into shares and can take back his proceedings. Smart investors play their trick as they played this time. Now let me share difference between two Hybrid Bonds or Debts being played in the market since many of my readers might get confused. Conversion of the bond into shares or activating the write-down of the face value takes place when the bank or an organization is still a going concern. Now there is another hybrid bond or debt called bail-in capital, where the loss absorption kicks in when the bank fails. Now I hope you are clear that smart investors exited their position and made many times profit as they took advantages of currency depreciation of cross countries to book high margins of profits.

The surprising part was that many banks were not listed and they also came up with convertible bonds structures and product. Massive incentives have been given by the banks to the employees who were engaged in deal with this issue beforehand and to make sure that its solvency is strong enough to weather a possible financial storm and to fend off the loss absorption by getting strong bond investors. The biggest gainers have been the core clients of the banks who exited the Hybrid Bond positions at the time when the markets and the bank shares were trading at the highest levels. On the other hand banks also got relief from the debt service payment. The coupons and the face value no longer need to be repaid.
Now after the smart investors made their money they non smarter got stuck as they have to accept shares at the low share prices provided they are subscribed under forced conversion or at the discretions of the bank. There are many more stories to unfolded about the depth of this Hybrid Bond Market which is many times bigger than the Global equity Market.

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