Wednesday 14 November 2012 by Legacy

S&P change their view on corporate hybrids

One of the major drivers for Australian corporate hybrid issuance this year has been the 100% equity treatment given to these securities by the credit rating agency Standard & Poor’s (S&P)

Corporations have been able to issue hybrids that provide cheaper funding than ordinary equity, count as equity for ratings purposes but do not dilute ordinary shareholders’ holdings. This has considerable appeal to help maintain issuer’s credit ratings particularly if they are under downward pressure. S&P, one of the largest ratings agencies, has announced that the amount of equity credit assigned to hybrids is under review. This has the potential to impact several recent Australian hybrids.

S&P are instigating a global review of the amount of equity credit to be assigned to corporate hybrids that include step-ups, issuer call options and replacement provisions. The complex structural features of many of the hybrids have been designed to meet the ratings agencies’ criteria to qualify as equity. This review will capture a few of the recently issued Australian corporate hybrids as S&P has stated that the new guidelines will apply to “all existing and future hybrid capital instruments”. S&P has stated that hybrids issued by banks and insurance companies will not be impacted as they are subject to prudential regulation.

The hybrids that are likely to be impacted are those that have high equity credit classification (100% equity content for credit ratios), this includes: Origin (A$ and €), AGL (A$), Santos (€) and Tabcorp (A$). In the general criteria released by S&P they have outlined that high equity credit is unlikely to be achievable for corporate hybrid securities and grandfathering treatment is uncertain – this will bring the treatment of corporate hybrids in line with banks and insurance hybrids. All these securities have issuer calls based on the changes in ratings agency treatment. Origins’ calls are at $101/€101, AGL’s call is at $101, Tabcorp has a call at $100 and Santos has a traditional make-whole call (value of the call is equal to the present value of future cashflows to the first call date. This amount is above the current price). However, this is still subject to a Request for Comment (RFC) process and these securities are likely to retain intermediate equity credit (50% equity content) so there is still value for the issuers in terms of ratings support.

This development further highlights the structural complexity of hybrids with investors’ returns potentially dependent on ratings agency rules. These rules are complex and are subject to change with the impact on hybrid investors uncertain.

The market will be watching for the release of the RFC followed by the final guidelines including any grandfathering provisions.