Hybrid issuers have always been in thrall to the rating agencies — indeed, the only reason to use the structure is to protect a credit rating.
Today, however, hybrid investors are finding themselves at the whim of the agencies, too. This dynamic is only likely to become more pronounced.
Hybrids are a strange beast. Investors love them because they can pick up paper from their favourite investment grade companies at a far higher yield and spread than standard senior debt. They are ranked as low as a debt-like instrument can be in the capital structure, and are often speculative grade, but the chances of a European investment grade company defaulting are vanishingly slim.
Meanwhile, companies endure them as a way to raise money that is not entirely counted as debt for ratings purposes. Ideal if you are refinancing a big, debt-funded, M&A — or if you operate in a high capex industry, like utilities.
In order for companies to get this special 50% equity treatment for their hybrid bonds, they have to jump through very specific hoops laid out by the big three credit rating agencies.
Moody’s this year changed some of those hoops, requiring shorter maturities and — in some cases — granting the bonds a single one-notch downgrade compared to senior debt, instead of the usual two.
This week, Germany’s Bayer printed a hybrid in line with these new requirements, keeping rating agencies happy. By doing so, however, it ended up subordinating its existing hybrid owners even further, with a new layer of capital that sits above hybrids but below senior debt.
Investors, by and large, do not seem to like it. The new bonds did not offer any pricing benefit to Bayer over the existing hybrids, which seems bizarre, given they are structurally senior. Anecdotally, there were some grumbles from accounts.
Tough. This is something the buyside will have to get used to. Hybrids exist to appease rating agencies — and it is not unimaginable that S&P and Fitch are looking at their methodologies in the wake of the Moody’s changes.
If the agencies change the rules, then hybrids will adapt to meet them. It’s an unfamiliar dynamic for investors but, like it or not, they are today just as much under the cosh of the agencies as issuers are when it comes to subordinated corporate debt.