Lufthansa freezes hybrid bond payment coupons to follow EU rules

State aid packages to help airlines stay afloat during the pandemic are causing pain months later for investors who’ve been told they won’t be collecting interest on Deutsche Lufthansa AG bonds.

The German airline said on Wednesday that it will suspend coupon payments on 500 million euros ($610 million) of junior-ranking notes to comply with European Commission rules. Once the aid package expires, the company will make up for the lost interest, it said.

The event was seen as a one-off stemming from an effort by the EU to level out the playing field where state-supported airlines enjoy an advantage over rivals. The bonds have already recovered from the news, which initially caused them to slump more than 8 cents. They were bid at 96.1 cents on the euro Thursday, according to Bloomberg data.

The suspension is not related to the company’s liquidity or credit stress and “is a specific and isolated case,” said Andrea Seminara, chief executive at Redhedge Asset Management. “We think corporate hybrids coupon deferral risk continues to remain low.”

The kind of subordinated debt Lufthansa sold is known as a hybrid because of its equity-like characteristics. In the eyes of ratings firms, the borrowings count toward a company’s equity provisions and coupon payments are discretionary.

Investors have gravitated to them because they typically pay higher yields than plain-vanilla debt in exchange for the higher risks: deferred interest, maturities that can be extended after redemption dates and being among the first to take losses in a default.

Lufthansa’s securities, sold in 2015, have interest for the year to February 2022 fixed at 4.382%.

Coupon deferrals are rare in the hybrid bond market and can cause havoc, with investors in high-yielding instruments losing a substantial part of their income. Sudzucker International Finance’s 700 million euro hybrid bonds slumped more than 10 cents on a single day in 2019 when it said it could cancel coupons due to insufficient cash flow. Prices jumped just as swiftly when the cash flow event was averted.

Disruption to debt repayments comes at an awkward time for Lufthansa as it fights to recover from the coronavirus slump in travel. Executives at the airline have said they planned to tap corporate bond markets to help them restructure debt owed to the German government and investor jitters over bond issues or rising interest rates would complicate that plan.

State Bailout

Europe’s largest airline received a 9 billion-euro state bailout last year after the coronavirus pandemic ended a decades-long boom in air travel. The carrier is working with banks on a plan to raise about 3 billion euros in equity to help repay its state coronavirus bailout, people familiar with the matter said previously. The company also has permission from shareholders to issue 1.5 billion euros in various bonds.

The firm also raised 1.6 billion euros of bonds in April to partly repay the government rescue.

Earlier this month, Lufthansa became the latest carrier to lower its expectations for summer travel, saying a significant market recovery won’t come until the second half as inoculation programs progress. It estimates full-year capacity at around 40% of pre-crisis levels, meaning it will struggle to halt its cash drain after it posted a record 6.7 billion euro annual loss for 2020.