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Banking

Hybrids: Fitch streamlines its hybrids classification

Simplify, simplify, simplify. Thoreau’s mantra is good advice for rating agencies when it comes to allocating equity credit.

By Zach Fuchs

Every year, the agencies roll out another classification scheme for hybrids. Fitch Ratings has finally streamlined its criteria into a five-tier Class A to E debt-equity continuum with a flat 30% cap on hybrids as a proportion of eligible capital.

On Fitch’s new continuum, Class A is pure equity, while Class E is pure debt. This is the reverse of the basket system employed by Moody’s, in which Basket A represents pure debt.

Crucially, the standards are now the same for banks and corporates. In its previous standard, the agency explained the need for a more conservative approach for bank hybrids, since a beleaguered corporate can skip a payment more easily without rattling the capital markets. Fitch’s former plan depended on the regulatory system to induce banks to issue a greater proportion of higher-quality securities, while it established a strict 15% cap on hybrids for corporates rated AA– or above.

Tolerance levels

Now the 30% tolerance level applies to all sectors. “We’ve gone through the analytics for corporates, insurers, and banks, and there’s no reason why each sector should have a different approach,” says Karsten Frankfurth, head of corporates at Fitch. But these limits can vary between industries when warranted, according to the discussion paper.

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