Hybrid-Bond Market Rattled as S&P Changes View on 29 Notes

  • Ratings company to stop treating part of the notes as equity
  • Affected issuers include phone company Telefonica, Repsol

Standard & Poor’s decision to start treating about $23 billion of hybrid bonds as purely debt may deter issuance and rattle market confidence, according to analysts at Barclays Plc and Mitsubishi UFJ Securities International Plc.

The ratings company will no longer assign equity weightings to 29 bonds sold by borrowers including Telefonica SA and Repsol SA, it said in an Oct. 27 statement. The move followed a review of bond documentation, rather than changes in assessment criteria, and there were no effects on the companies’ senior credit ratings.

S&P said it made the change as the 29 bonds can be redeemed even when the issuer is in economic stress, which means they provide less of a cushion for senior debt than previously assumed. The review may slow hybrid-bond sales, which totaled about $50 billion worldwide last year, as issuers use the notes partly because ratings companies typically count part of the notes as equity, leading to lower assessments of indebtedness, and in turn, reduced borrowing costs.

The decision will weigh on supply and valuations and -- “given its broad scope, its abruptness and the lack of grandfathering -- will reverberate through the broader corporate hybrid universe,” Barclays analysts including Dominik Winnicki wrote in a note to investors.

Seeking Solution

Dong Energy A/S Energy, a utility being readied for an initial public offering by the Danish state, said it’s trying to find a solution “as soon as possible” after its 600 million-euro hybrid note was affected by the S&P change. Swedish utility Vattenfall AB said it’s talking to S&P about how to address concerns and get a “prompt restoration” of equity content in its outstanding hybrid issues.

The other affected issuers were Alliander NV, Bertelsmann SE, Centrica Plc, Gas Natural SDG, Merck KGaA, Rexam Plc, RWE AG, SSE Plc, TransCanada Trust and TenneT Holding BV. The 29 bonds are denominated in euros, dollars, pounds and Swedish kronor.

Negative Surprise

“This announcement probably came as a negative surprise to issuers,” said Rick Mattila, head of strategy and research at Mitsubishi in London. “They would have issued the instruments in the belief that equity credit will apply and now it has been removed through no fault of their own."

S&P’s change also prompted CreditSights to cut its recommendation on two higher-priced Telefonica hybrid bonds to underperform from outperform. There is a “material risk” the phone company will redeem bonds at 101 cents on the euro following the new interpretation, said Mark Chapman, a CreditSights analyst in London

Telefonica’s 1 billion euros of 5.875 percent hybrid notes fell 1.9 cents on the euro to 101.5 cents yesterday and are now quoted at 102.4 cents, according to data compiled by Bloomberg. Investors opt for hybrid bonds as they pay more than higher-ranking corporate bonds.

“Syndicates which potentially had hybrids ready to go this week might hold back and see how companies and investors will react,” said Mikkel Velin, a London-based high-yield portfolio manager at Rogge Global Partners. Still, most companies may be able to work round the change by amending documents and in some cases paying a fee to investors, he said.

Companies including Volkswagen AG, Deutsche Lufthansa AG and J Sainsbury Plc have sold about $40 billion of hybrid bonds this year, according to data compiled by Bloomberg. BHP Billiton Ltd. issued the equivalent of about $6.5 billion of bonds in dollars, euros and pounds in hybrid securities this month.

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