Corporate hybrids: Rating agencies disrupt corporate hybrids again

Louise Bowman
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S&P shift hits €20 billion of bonds; issuers waive call rights to retain equity credit.


Standard & Poor’s has taken heavy criticism for its sudden removal of equity credit from some corporate hybrid bonds after it said that the call language on them was too broad.

Its change of heart on October 27 stunned issuers and investors as it meant that €20 billion worth of hybrid bonds issued by several well-established issuers such as Dong Energy, Vattenfall, Alliander, Centrica, SSE and others went instantly from achieving 50% equity credit to 0%.

The surprise move stemmed from S&P’s concerns over issuer behaviour following any downgrade from investment grade to sub-investment grade. Under Moody’s rating criteria, equity credit would be lost in such an event, and the issuer can call the hybrid. 

However, S&P believes that a hybrid has a primary function in such a situation to absorb losses to protect other more senior obligations, and therefore no longer agrees that such bonds can be called.

The point of difference is small and technical, and has been swiftly dealt with by the affected issuers who committed not to call the bonds if they drop to sub-investment grade. 

On November 10, both Vattenfall and Dong Energy said they had enacted deeds of undertaking under which they irrevocably waived their right to call the bonds. Alliander followed suit on November 12 and more issuers are expected to do the same.


"The deed of undertaking is such a simple solution which can be enacted without bondholder approval and which should not upset anyone that we expect it to be widely adopted," says Andrew Moulder, analyst at CreditSights.

While the episode does not appear to have caused any lasting damage to the sector, it has reawakened investor nervousness over the rating agencies’ ability to disrupt issuer and investor confidence that the hybrid product has matured. 

"This absolutely caught people by surprise," says one hybrid investor. "People felt that it was now very much a standardized market, almost a commodity. This episode has served as a reminder that it isn’t. It is very disappointing." 

Methodology changes at the rating agencies have dogged the development of the corporate hybrid market, but stability since 2013 had lulled the market into a false sense of security. Moody’s decision to remove equity credit from all hybrid bonds issued by a company rated Ba1 or lower in August 2013 caused turbulence and was a reminder that rating methodologies can be subject to rapid change. 

Although S&P’s move in October was a change in opinion rather than methodology, the impact was equally frustrating for some.

"This is a lesson for issuers and structurers that if you move away from standard terms the rating agencies may be unpredictable," says another investor. "This was a simple, small point on an option that hasn’t happened and hasn’t been in the money. If you are a corporate treasurer that has just lost millions of euros worth of equity credit I can imagine this is very annoying."

Trevor Pritchard-160x186
Trevor Pritchard, S&P
Trevor Pritchard, analyst at S&P, tells Euromoney that the divergence in opinion within the agency on the call option meant that a rethink was inevitable. 

"It is not our objective to add to concerns in the market," he explains. "We want to be predictable. That is why we publish our criteria. Different committees had come to different opinions on the view on permanence of some hybrids. That prompted a re-examination of the views on permanence and that led us to reconsider earlier opinions. We stood back and asked whether these hybrid documents were really providing the loss-absorbing cushion that is needed to justify intermediate equity content."

He adds: "Even if the issuer commits to replacement in the event of a call following a rating downgrade – what is the point of the call option then?"

While the agency may feel that its approach to the sector is predictable, many disagree.


"We continue to be amazed by S&P and its vacillation over hybrid bonds," Moulder at CreditSights said when the announcement was made. 

"Moody’s is not guilt-free, with its removal of equity credit for hybrids when the senior rating drops out of investment grade, but it was S&P that changed its methodology and cut equity credit on Dong and Santos to zero from 100% in 2013, it was S&P that suddenly realized Alliander’s replacement capital covenant dropped away when its rating rose, despite having raised its rating to the required threshold some two years earlier and it was S&P that was singularly unhelpful in its comments around hybrid replacement when RWE was trying to decide what to do with its 2010 hybrid (which it called and replaced in 2015)."