S&P’s Publishes Enhanced Criteria in Analyzing Eligibility of New Classes of Hybrid Capital

Standard & Poor’s has published enhanced criteria for analyzing the eligibility of new classes of hybrid capital issued by insurers and banks. The article, “Mandatory Convertibles: New Hybrid Capital Criteria for Banks and Insurers”, is available on RatingsDirect, Standard & Poor’s Web-based credit analysis system.

“The article addresses how Standard & Poor’s analyzes the quality of hybrid capital, and specifically mandatory convertible securities, in our overall framework for ratings on financial institutions,” Scott Bugie, a managing director in Standard & Poor’s Paris office, said. Bugie emphasized, however, that analytical capital ratios represent only one part of the overall analysis of capital, which in turn can only be considered within the broader commercial and qualitative profile of a rated insurer or bank.

Many financial service companies have recently issued or considered hybrid capital securities that convert on a mandatory basis to new common shares.

“The surge in interest,” explained David Anthony, Director in Standard & Poor’s Financial Services Group, London, “is driven by several factors, notably the weak market for straight equity issues, a desire of institutions to broaden their base of long-term investors, and the fact that some institutions have reached regulatory and market limits for other types of hybrid capital.”

Many of the proposed mandatory convertible issues share the fiscal advantages of other hybrids, which often are issued via a special purpose vehicle so that coupon payments reduce taxable income and provide a tax shelter.

Mandatory convertible securities are a relatively new addition to the growing range of hybrid capital securities that have equity-like characteristics and are included in regulatory capital by banking and insurance regulators. Standard & Poor’s includes hybrid securities, notably preferred shares and long-dated subordinated notes with an interest deferral mechanism, in capital measures within certain limits based on an evaluation of the strengths and limitations of the specific hybrid issue and the broader “quality of capital” analysis of an institution’s capital structure.

Anthony added that while the position of the regulators with respect to a particular hybrid capital security is an important factor in the analysis, Standard & Poor’s view is independent, and can be different, from any regulatory classification.