European companies that access state support will have to defer coupons of any outstanding hybrid bonds they have, according to new criteria outlined by the European Commission.
Bankers say the bond market is gearing up for new hybrid supply, but that the EC's new guidance shows issuers and investors will have to be careful.
"Issuers need to be thoughtful in the order of their financing, such as those receiving state aid and getting the sequencing right," said a DCM banker. "But the market is ready for a hybrid."
The EC released an "amendment to the Temporary Framework for State aid measures to support the economy in the current Covid-19 outbreak" on Friday, which details criteria under which countries can provide 'Covid-19 recapitalisation measures'.
States may provide aid in the form of equity or hybrid capital instruments, or subordinated debt in order to support struggling corporates, said the EC.
The key takeaway for investors is that companies that receive state support will not be allowed to make discretionary payments, which has potential implications for coupon payments on existing corporate hybrid bonds as these are discretionary, said BNP Paribas analysts.
The EC's new communication states: "As long as the Covid-19 recapitalisation measures have not been fully redeemed, beneficiaries cannot make dividend payments, nor non-mandatory coupon payments, nor buy back shares, other than in relation to the State."
Analysts at BNP Paribas said: "On balance this is a negative for corporate hybrids issued by companies that may need state support since it means that hybrid coupons will have to be deferred."
Hybrids issued by airlines are already pricing in some uncertainty, noted analysts.
Lufthansa's 5.125% August 2075s are quoted at 74 bid, according to MarketAxess data.
"Lufthansa's hybrids are pricing in a potentially worse case than just coupon deferral," wrote BNP analysts.
"It could also potentially have negative implications for EDF hybrids, should the government eventually decide to nationalise it 100%."
EDF's 3.00% perpetual non-call eight-year hybrid, issued in November, was seen at 91 bid.
The European Commission's new communication states that recapitalisations of struggling companies must not exceed the minimum needed to ensure the viability of the beneficiary, and must not improve its capital structure to the one that predates the Covid-19 outbreak.
States can also only provide companies with support if no other appropriate solution can be found, said the EC.
There will also be limits on M&A, expansion and companies must demonstrate an exit strategy from state support.