* 2010 supply hits $4.3 bln, half 2007 peak levels
* Issuance expected from outside previous industry sectors
* Low rates attract issuers, hybrids good tool to fund M&A
By Natalie Harrison
LONDON, Sept 17 (Reuters) - European corporate treasurers are lining up to sell hybrid bonds, and who can blame them, when investors seem prepared to take so little reward to perch at the precarious end of the risk ladder?
Increasing numbers of European companies are boosting the strength of their balance sheets via these deeply subordinated bonds, which stand below senior creditors in the event of default or credit restructuring.
Holders of France's Thomson SA's 500 million euro subordinated bonds know exactly what that can mean. They stopped receiving coupons in 2009, and got just a 5 percent pay-off when the company restructured.
But investors' voracious appetite for any kind of yield means that borrowers can get away with paying about the same as they would have paid to shift a senior bond two years ago, bankers said.
German utility RWE will be next to take advantage of interest in the bonds, which is running high after long-awaited rating reviews by Moody's and Standard & Poor's left their treatment largely unchanged, removing an element of uncertainty that had hung over the instruments for at least nine months.
"Issuers like these products for their equity features and rating agency credit," said Rob Ritchie, head of Goldman Sachs corporate debt capital markets in Europe.
According to a banker involved in the potential sale, RWE is unlikely to pay a yield in excess of 5.32 percent, which is the current yield on all of the company's outstanding euro-denominated bonds.
SUPERFLIERS DESPITE RISK
If structured appropriately, hybrids effectively allow companies to raise equity more cheaply and quickly than rights issues, with the added benefit of not upsetting shareholders by diluting shares. In addition, coupons are tax deductible and the instruments can help preserve credit ratings.
The deals are flying out of the door despite reservations from investors, mainly because they have few avenues other than high-yield corporate debt to get their hands on coupons around 5 percent.
French utility Suez Environnement drew demand in excess of 6 billion euros for a 750 million euro bond paying 4.82 percent this week.
"You are taking on equity risk, but it is still a bond return. It really does depend on whether you like the name or not," said John Anderson, head of credit at Gartmore Investment Management.
Investors are getting an extra 2 percent interest on average over senior bonds, but that might narrow if demand remains strong.
The main risk associated with hybrids is that coupons are deferred or skipped.
Furthermore, because they carry very long maturities or are even perpetual, investors face uncertainty when they will get their principal back, as there is still no evidence that issuers will refinance at the first call dates, given the relative immaturity of the market.
"At this stage we don't think valuations on the corporate hybrids that have come to market are particularly attractive," said Raphael Robelin, head of investment-grade credit at BlueBay.
Nevertheless, bankers say the hybrid bond market could develop fast as issuers fill their boots with cheap equity to fund expansion.
"If the market remains strong, as we anticipate it will, then it's likely over the next six months that companies outside of the utility and infrastructure sectors will increasingly look at hybrids as a funding tool because of their low cost of capital," said Ritchie.
European utilities Scottish & Southern, Suez Environnement and Australian energy company Santos have pushed this year's supply of hybrid bonds to around $4.3 billion, according to Thomson Reuters data. That is some way off 2007 peak supply, until the credit crisis abruptly shot that fox, but companies are itching to seize the opportunity to borrow at the lowest rates in a decade, bankers say.
Hybrids may also become a more popular tool for mergers and acquisitions funding, particularly if the target company is more highly leveraged than the acquirer, because the instruments help issuers to preserve credit ratings.
State-owned or family-run businesses such as Vattenfall and Dutch utility TenneT will also continue to use hybrids to raise equity they would struggle to get elsewhere. (Additional reporting by Alex Chambers; Editing by Will Waterman)