Convertible bonds find favours as refinancing option for German AGs

We report elsewhere in this issue on a number of bond issues from German real estate companies, including TAG Immobilien, Grand City Properties and Austria’s UBM Immobilien, which highlight the increasing role that bonds, and in particular convertible bonds, are playing as a rational alternative source of financing for listed companies. The trend to convertible bonds has been spreading throughout Europe, with transaction volume over the first six months DOUBLING over last year’s volume to about €1.5bn. Around 60% of all new European convertible bonds are now issued by the property sector.

So it was timely for REFIRE to sit down recently with a small group of active bond market participants to learn more about why the market for convertible bonds is growing, and in whose hands these bonds are ultimately landing.

Leading French issuer Société Générale told us that by the end of May this year, 35 convertible bonds were issued across all sectors in Europe, with a value totalling €9.2bn. Last year saw a total of 20 issues for a record €24bn in capital raised for the whole year.

Sitting in on the gathering was Ralf Darpe, Société Générale’s head of equity capital markets and co-head of corporate finance for German-speaking Europe. “This year, convertible bonds of property companies continue to play a major role, because, in view of current low interest rates, they represent an attractive financing tool”, he said. Listed property companies are issuing bonds not only to diversify their financing, but also to strengthen their investor base.

“Property companies in particular benefit from these attractive conditions, due to the fact that low financing costs with long maturity and without collateralization are of special importance”, he said. On average, in recent months investors have granted listed property companies coupons ranging between 0.5% to 2.0% and looked for conversion premiums ranging between 30.0% and 35.0% above the reference price – with an average term of 5 to 7 years.

The advantages of convertible bonds, argued the issuers in the group, lie in the mixture of shares and loans. Investors not only acquire a fixed-rate debenture but also the option of swapping the bonds for shares.

Because conversion prices are clearly above the market price at the time of issue, a rise in share prices means investors profit in addition to annual interest payments. But even if the share price develops positively and the market price of the convertible bond increases, the issuer is able to secure financing at attractive interest rates. According to Société Générale, a quarter of all issuers are now using convertible bonds as a refinancing option. In Darpe’s view, about a quarter of issuers view their convertible bonds purely as a financing option. About 8% issue the bonds to finance acquisition or takeovers.

Also sharing his experience was Gerald Klinck, chief financial officer at publicly-listed housing group Gagfah. In May Gagfah issued a five-year convertible bond of €375m. The fixed-rate coupon was 1.5% p.a. and the initial convertible premium was 30% above the reference price of €11.92 (the share is currently trading at €13.20).

“For us the convertible bond offers an excellent opportunity to optimize our borrowing costs in the current financing environment,” said Klinck. “As a result of the successful emission, we were able to refinance a portfolio unsecured at a favourable interest rate. The low interest payments had a positive effect on our income. Further, these unsecured assets gave us additional financial latitude, such as investing in the existing portfolio or in future acquisitions.”

We also heard from the management of Austrian company Convertinvest, which is an independent asset management company specializing in convertible bonds, and a pioneer in the field of absolute return with convertible bonds. The company is

taking the popularity of convertible bonds as an opportunity to issue a global property convertible bond fund, called Convertinvest Global Convertible Properties. The fund has a volatility of 5.0% and an expected return of 5.0-7.0%, and invests purely in others’ convertible bonds.

Even before launching the fund, said CEO Gerhard Kratochwil, institutionals such as insurances, family offices and foundations invested more than €30m in the fund. Issuer ratings on the fund are performed by rating agency FERI EuroRating.

According to Wolfgang Kubatzki, board member at FERI EuroRating Services who addressed the meeting, “Convertible bonds are complex. When investing in this type of vehicle we recommend investing in professionally and actively-managed funds. As a rating agency we integrate the entire technical know-how of the investment process related to convertible bond funds, so that at the end an attractive product is created.”

As with other bonds, the FERI rating includes a detailed determination of site and user type in each individual company’s portfolio, based on a quantitative company analysis. FERI says it also analyses the individual properties underpinning the bonds, “so that ultimately the evaluations are based on the attractiveness of the property portfolios”, said Kubatzki.

Underlining the current popularity of the bond trend, capital markets researcher Barkow Consulting separately notes that four of the six biggest-ever convertible bonds issued by listed German property companies were placed in the last six months, with a total of €1.1bn. The biggest of these was the €375m Gagfah convertible, which is likewise the biggest since the outset of the financial crisis. Only erstwhile market leader IVG Immobilien AG has ever issued a bigger bond – a €400m bond in 2007 just before the crash. Meanwhile, all of the larger German listed property company’s have issued convertible bonds, with the exception of the biggest company, Deutsche Annington.