Hybrids primer: the premium for optionality

Research evidence excerpt

Hybrids primer: the premium for optionality

debt Equity-like flexibility requires additional spread

Refinance an existing hybrid Maintains capital-structure and rating benefits Requires continued market access Replacement economics can anchor the call decision

Adds flexibility during a period of elevated Approaching loss of equity credit may support

Support balance-sheet repair Equity credit may be capped or time-limited

leverage replacement, but does not guarantee a call

Source: BofA Global Research

BofA GLOBAL RESEARCH

Debt legally, but partly equity for ratings

The treatment depends on the lens being applied. Legally, a corporate hybrid remains a

debt instrument that ranks behind senior creditors. Its accounting classification depends

on the applicable standards and contractual terms. For rating purposes, however, part of

the instrument may receive equity credit if it demonstrates sufficient permanence,

subordination and coupon-deferral capacity. Economically, the higher cost relative to

senior debt compensates investors for giving the issuer greater flexibility over the

timing of repayment and, where permitted by the documentation, coupon payments.

Legal maturity can differ from economic maturity

Corporate hybrids may be issued as perpetual securities with no contractual maturity or

as very long-dated notes, often with legal maturities of 30, 60 or more years. In either

case, investors may price the instrument to its first call date when the issuer has

credible economic and rating incentives to redeem or replace it then. The first call is an

issuer option, however, rather than a contractual maturity. Therefore, if refinancing

becomes uneconomic or call incentives weaken, expected maturity can extend abruptly