=DJ Corporate Bondholders Embrace Wachovia's Hybrid Offering
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By Aparajita Saha-Bubna
Of DOW JONES NEWSWIRES
NEW YORK (Dow Jones)--The investment-grade corporate bond market awarded a warm reception Wednesday to Wachovia Corp.'s (WB) $2.5 billion offering of hybrid securities, despite the complexity of the deal.
This latest take on hybrid securities, which carry both stock and bond features, could set the stage for a new issuance trend among commercial banks, market participants said.
The offering, which was issued by Wachovia Capital Trust III, a Delaware trust sponsored by Wachovia, priced through sole lead manager Wachovia Securities to yield 142 basis points over five-year Treasuries. Structuring partners on the deal include Goldman Sachs.
The notes are rated A2 by Moody's Investors Service and single-A-minus by Standard & Poor's. Wachovia Securities declined to comment about the offering.
"In today's environment, there's a lot of demand for these hybrid securities, especially from a solid credit like Wachovia, because of the additional yield," said Tim Compan, corporate bond portfolio manager at Allegiant Asset Management in Cleveland, with around $6 billion in fixed income assets.
The offering was over-subscribed, say market participants, with investors - ranging from insurance companies, pension funds to money managers and hedge funds - putting in orders to the tune of around $10 billion.
The securities, dubbed as Wachovia Income Trust Securities, or WITS, gained in trading both ahead and after pricing. Risk premiums were recently quoted at a bid of 129 basis points - 13 basis points below where they priced.
Intricate Structure Could Catch On With Banks
The offering comprises fixed-rate junior subordinated notes that become floating rate preferred stock with a perpetual maturity after five years.
Junior subordinated notes lie below bank loans and bonds in a company's capital structure, but above preferred stock. Preferred stock is just a rung above common equity.
Once the fixed-rate notes convert to preferred stock, the coupon payments, or in this case, the dividend payments, are tied to the London interbank offered rate with the yield at 93 basis points over the three-month Libor, which stood at 4.63975% on Wednesday. That said, the issuer doesn't have to make up for missed dividend payments should it choose to suspend them.
Also, at the time of this conversion, the issuer, in this case Wachovia, has the option of buying back the notes.
What sets this deal apart from other recent hybrid offerings is its advantages for commercial banks, which are regulated by the Federal Reserve.
Not only does this type of debt provide a tax-break to the issuer on the coupon payments on the fixed-rate notes, but it also garners approval from the Fed, qualifying as tier 1 capital. In simpler terms, tier 1 capital is the strongest form of capital - money that the issuer gets without obligation of any return, be it interest, principal, or appreciation.
These factors, say market participants, may kick off a flurry of similar issuance by regulated financial institutions, particularly since an estimated $35 billion in an older version of hybrid securities is likely to be redeemed this year by these institutions.
Still, there are investors who are wary of these kinds of deal structures.
Kevin Murphy, portfolio manager at Putnam Investments in Boston, with around $66 billion in fixed income assets, is uncomfortable with buying securities that transform into stock. "We like to see a security that stays at the same point in the capital structure of a company but has a coupon that ticks up in case it isn't called," he said.
While Wachovia doesn't include such a explicit step-up option, other recent hybrid deals have incorporated this provision, where the coupon ticks up if the borrower doesn't buy back the security within a stipulated time period. |
