* New criteria turns hybrids into expensive senior debt
* Reinstating lost equity could be costly
* S&P move could re-price hybrid market
By Laura Benitez
LONDON, Oct 30 (IFR) - Standard & Poor’s shock removal of the equity content it had assigned to 29 corporate hybrid bonds has shone an unfavourable spotlight on the sector and forced both investors and issuers to rethink the risks of this year’s in-vogue product.
Fourteen corporate issuers are now servicing around 20.5bn of expensive senior debt after the equity credit of their hybrids - which justifies the more costly coupon - was removed on Tuesday.
“We were contacted on Monday, but S&P had already made up their minds. It was a quite a surprise to say the least, although we knew it had been an issue because S&P had denied a recent issuer the same clause for its hybrid issue just a few weeks ago,” Johan Gyllenhoff, group treasurer at Vattenfall told IFR.
S&P said it made the decision because it expects hybrids to be a permanent and loss-absorbing part of a company’s capital structure, and not be callable on the off-chance that the bond loses equity treatment due to a rating downgrade, for example.
“There’s a lot of anger out there,” one syndicate official said. “The way S&P communicated the news was utterly incompetent; they didn’t give the companies the chance to rectify the issues at hand, which seems highly unfair.”
The move stems from corporates’ reaction to a Moody’s rating criteria change in July 2013 that removes a hybrid’s equity credit if an issuer’s senior rating falls below investment grade. They inserted language enabling hybrids to be called in the event of equity credit being lost.
The affected hybrids sold off on the news, although have generally recovered most of their losses.
Hybrids have long been pitched as a way for companies to bolster their balance sheets and protect credit ratings because of their subordination to senior debt.
Ultra-cheap funding costs ramped up activity earlier this year, with March seeing the highest ever monthly volume with 7.8bn sold. Over 26bn-equivalent of paper has been issued so far in 2015 - just 2bn shy of last year’s total, which was also a record, according to IFR data.
But investors say S&P’s announcement will be a new blow for an asset class that has already been buffeted by various rating methodology changes and volatile market conditions of late.
“The S&P news is likely to sit uneasy with investors as agencies have changed their rules on hybrids so many times in the past,” said Jens Vanbrabant, head of investment grade credit at ECM Asset Management.
“It only serves as another reminder that there are other risks for this asset class, including change of control clauses, which could now be priced into the market as a result.”
The affected companies are Bertelsmann, RWE, Dong Energy, Vattenfall, Alliander, Gas Natural, Telefonica, Repsol, Merck KGaA, TenneT Holding, Centrica, SSE, TransCanada Trust and Rexam.
Many of those borrowers will spend the coming weeks looking for a solution to reinstate their 50% equity credit, but this too could come at a cost.
Their options could involve a contracted commitment to investors that the hybrids will not be called as a result of ratings deterioration.
“It’s too soon to say how the equity could be retrieved, but it’s likely that issuers will have to some pay heavy fees to investors. The fact that some of these borrowers issued hybrids recently and are now facing more costs is grotesque,” one DCM official said.
Some of the 14 issuers, including Dong and Vattenfall, have already pledged to win back their equity.
“We are willing to be pragmatic and find a solution to restore the equity credit for our hybrid as it’s an important part of our capital structure. We’re willing to explore some of the options and take legal advice, although we have one preferred choice but we’ll have to wait and see,” Vattenfall’s Gyllenhoff said. (Reporting By Laura Benitez, editing by Alex Chambers, Julian Baker)