CityWire – Euro Real Estate: Hybrid Extension Risk

EXECUTIVE SUMMARY

• With elevated hybrid yields, the cost of refinancing hybrids is uneconomical for Real Estate hybrid issuers. Accordingly, extension risk is elevated, even though we have some time before the next Real Estate hybrid call in January-23.
• We discuss the impact of extension and rating agency methodologies when it comes to calling and not replacing. The loss of equity credit from S&P is an incentive to call along with the impact of not calling on the company’s reputation with its bond investors, while calling and not replacing risks the loss of equity credit across all an issuer’s hybrids.
• Of issuers with hybrids callable within the next 24 months, we are most concerned of extension risk at Balder. Despite the fact that the group’s base case is that it calls the 3% ’23s, we view management’s commitment to hybrids as low.
• Akelius is the most likely to call while at the present time we only see minimal extension risk at the likes of Aroundtown, Grand City Properties and Unibail-Rodamco-Westfield.

With hybrid yields having risen materially YTD, all Real Estate hybrid bonds, with the exception of AKFAST 3.875%, are trading meaningfully wide to their respective reset yields. This difference is even more notable when you look at the difference between the approximate yield on a new Perp NC5 relative to the reset yield. This undoubtedly increases extension risk for a sector that has been a frequent issuer in the hybrid space in recent years.

The cost of calling and replacing hybrids at current yields is unappealing in the current market but it does not necessarily mean the bonds will not be called. The reason for this relates to both the rating agency treatment of hybrid capital and the impact on the company’s reputation with its bond investors.

Extension will drive the loss of equity credit at S&P on the specific bond and upset hybrid investors, while calling without replacement risks losing equity credit across all its remaining hybrids, although this is not a hard rule as we discuss in the Appendix below. We would highlight at this point, the sole Moodys rating at Castellum (CASTSS) reduces the incentive to call for this group although note that with this call not until 2026, this is not a near-term concern.

Key questions for investors in assessing extension risk include:

Does the issuer have a high % of hybrids in its cap structure? This speaks both to the importance for the issuer to maintain access to the hybrid market in the future and increases the potential impact of a change in agency treatment of hybrids. At the same time, these issuers arguably have increased scope to reduce hybrids as a % of their capitalisation.