Ratings agency Standard & Poor's is said to be formalizing an international committee that will review its method of allocating equity credit to hybrid transactions, apparently making them look more like equity than debt. The move, which has yet to be formally announced, should make the instruments more palatable to corporate treasurers in Australia where hybrids were quickly gaining a reputation as expensive debt.
Rival Moody's Investors Service issued new hybrid guidelines last year and the result was an immediate up-tick in issuance in the US and Europe. Now Standard & Poor's appears to be following suit, and with S&P being the dominant ratings agency in Australia, dealmakers say the reclassification will certainly give treasurers pause to reconsider the instruments in their funding mix.
Hybrids have been widely used by Australian banks to boost capital ratios and by corporates to fund acquisitions, but in the last 12 months the popularity of the instruments has waned, particularly among highly rated corporate issuers.
"Some companies have been ill advised and have ended up with an oversupply of hybrids that are causing real headaches for treasurers," says one dealmaker in Sydney. "Other companies have come to realize that these securities appear like expensive debt on their balance sheets because of the way the ratings agencies have treated the instruments."
He says the new committee at S&P is likely to suggest guidelines that give more equity credit to instruments that carry certain upgraded equity components such as mandatory deferral triggers and like-for-like replacement structures. The latter ensures that at the time of redemption or rollover, investors are offered a replacement security of equal value.
"The feedback we get from companies is that if the agencies are prepared to apply a 50% equity credit to their hybrid deals then the instruments become attractive. And, if things go the way we expect them to with this new S&P committee, we could have a situation where a non-dilutive deductible security gets 100% equity credit."
He says the new rules won't apply to existing instruments but companies can apply to have their hybrids reclassified at rollover without adversely impacting investors. "Companies would need to restructure the instruments to meet replacement language commitments, but then they should get more favourable treatment."
"With greater clarity provided by the ratings agencies, hybrids will again become another tool in the corporate armory," says the dealmaker.
