Fitch Expects Companies to Replace Lost Capital with New Equity

Fitch believes that many insurance companies that suffered losses from the events of Sept. 11 are planning to replace lost capital with new equity and hybrid equity offerings. Given industry loss estimates due to the events of Sept. 11 that range from $30 billion to $70 billion, as much as $20 billion of capital raised by the industry could be through hybrid equity offerings.

Fitch has published a new criteria report entitled “Hybrid Securities: Evaluating the Credit Impact” that discusses the impact of hybrid securities on an issuer’s credit ratings and overall financial profile. This report allows issuers and users of ratings to better pre-judge how the replacement of lost common equity with hybrid equity may impact the capital strength of a company and its ratings. A strong balance sheet is even a more important issue today than it was before Sept. 11 as many purchasers of insurance are now weighing an insurer’s financial strength more heavily in the decision making process.

Hybrid securities combine features of both debt and equity and include a host of security types including traditional preferred stock, optionally convertible debt and preferred stock, mandatorily convertible securities, and instruments with deferrable interest and dividends such as trust preferred stock. Issuance of hybrid securities has been very popular among corporate and financial service issuers as an alternative to straight debt due to partial equity treatment by creditors and rating agencies.

Within the report, Fitch provides a detailed explanation of its policy on allocating equity credit to certain types of hybrids, based on Fitch’s conceptual “equity-debt continuum”.

Fitch went ahead and analyzed the debt-like or equity-like features of a hybrid security based greatly on the cash flow flexibility provided to the issuer. The report also provides examples of adjustments to credit ratios for different types of hybrids.