Rating agencies give unrated perps an edge

Fri Feb 1, 2013 9:16am EST
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* Asian investors show preference for calls rather than ratings

* Rated companies forced to push redemption further

* IFRS treatment more lenient than S&P, Moody's

By Neha D'Silva

Feb 1 (IFR) - Recently issued subordinated hybrid bonds from Asian companies had one of the worst weeks ever, with some securities dropping 5% in a few days. Counterintuitively, the bonds that outperformed were those of unrated issuers.

The reason, said market participants, is that a difference between how accountants and rating agencies treat perpetual subordinated debt is giving unrated issuers an edge in Asia, where many investors do not require the backing of Moody's or Standard & Poor's to buy a bond.

The issue centres around the equity treatment of so-called hybrid bonds, debt that does not feature a maturity date and allows the creditor to defer interest payments. Companies have taken advantage of investors' search for yield to issue these higher coupon securities that boost the equity on their balance sheets, hence allowing them to incur more debt without breaching limits set by contracts on prior loans or bonds.

If the hybrid bond meets certain requirements, it can improve the company's credit metrics and avoid downgrades by rating agencies. These standards, however, have become a sticky point for investors and issuers in Asia.

S&P requires that corporate issuers include a legally binding replacement capital covenant, which states that if the company redeems the hybrid bonds within the period when it has equity treatment, it will have to do so with money raised through an instrument with similar equity treatment, namely another hybrid or stocks.   Continued...