Standard & Poor's Rattles the Hybrid Debt Market

Rating agency changes its mind on $22 billion worth of hybrid securities.

Hey remember all those hybrid bonds? You know the ones that look like both debt and equity? I don't think they really look like debt and equity, do you? Nah, didn't think so! Cackle, cackle, cackle.

So, one might imagine, went the conversations at rating agency Standard & Poor's. Late last night, S&P announced that it now considers the equity portion of the hybrid bonds sold by 14 companies as "minimal" instead of "intermediate," in a decision that covers roughly €20 billion ($22.2 billion) worth of the securities.

"For the issuers whose hybrids we have reviewed here, although we have revised their credit ratios, the change is within the tolerance of their ratings and outlooks," S&P said in its statement.

That doesn't mean the rating agency's move won't affect the market, however. At issue is whether the decision gives corporate debt issuers the ability to "call" some of securities at or close to par, an action generally detested by investors in bonds that have been trading significantly above face value.

Many such hybrids are callable if rating agencies change methodology, and while S&P explicitly stated that its "criteria for assessing corporate hybrids have not changed," doubts seem to remain in the market.

Here, for instance, is the price action in some perpetual Telefonica bonds this morning:

Source: Bloomberg

And here's the same thing in perpetual debt issued by Alliander:

Source: Bloomberg

Sales of hybrid bonds have soared in Europe, thanks to investors clamoring for higher yields in a region teeming with low interest rates and quantitative easing. Those juicer returns don't come free, however.

As CreditSights analysts put it, aptly, on Wednesday: "If one thing is clear from this it highlights the risks of hybrids and particularly the risks of investment in hybrids trading significantly above par, when typical call events, be they rating, tax or accounting events, can come out of the blue and usually give the issuer a call at 101."

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