TEXT-Fitch: Study Notes Limited Extra Flexibility from Corp Hybrids

Thu Feb 14, 2013 9:38am EST

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Feb 14 - Fitch Ratings highlights that, despite the surge in corporate hybrids observed recently, the additional financial flexibility that these instruments provide for issuers is typically limited.

Subordinated instruments that have an unconstrained ability to defer their interest payments can receive between 50% or 100% equity credit. The precise allocation of equity credit depends amongst other features mainly on whether the instrument is cumulative or non-cumulative and on the security's degree of subordination.

A Fitch report published today provides examples and discussions of the assignment of equity credit for a number of hybrids from both the 2005-2007 vintage (the last cycle) and the most recent issues. Recent hybrid issuers included in the report are Electricite de France' ('A+'; Stable) and its approximately EUR6.2bn hybrid bonds (instrument rating 'A-'; 50% equity credit), Veolia Environnement' ('BBB+'; Negative) EUR1bn and GBP400m bonds (instrument rating 'BBB-'; 50% equity credit) and ArcelorMittal's ('BB+', Stable) USD2.25bn subordinated mandatory convertible bond (instrument rating 'BB-'; no equity credit).

More important within Fitch's analysis than the equity content that an instrument may exhibit based on its individual features is the additional financial flexibility provided by the instrument, as Fitch analyses the credit impact on the assumption of the issuer experiencing financial stress, irrespective of the probability of this occurring.

Fitch views the financial flexibility provided by these instruments generally as limited for several reasons. First, the reputational risk associated with deferring interest is considered high, even for non-financial corporates and would impair the funding options available to the company, possibly severely at a time of wider refinancing stress

Secondly, the propensity to suspend dividends needs to be considered as dividends frequently would have to be suspended prior to deferral, or as resuming suspended dividends may trigger an obligation to pay outstanding coupons. Fitch has undertaken an analysis on 172 corporates in Europe regarding the cessation or cancellation of dividends in the period from 2007-2011 and found few cases of dividend omissions, in particular in investment grade territory. In addition, those found tended to be of rather short time-horizons and related to specific circumstances.

Finally, and perhaps most practically, the magnitude of the relief on cash-flows from deferring has to be taken into account. Fitch has undertaken an analysis of this based on the contribution of deferral to a though-the-cycle funds from operations (FFO) and found that this is low, ranging from 1.1% to 6.2% for the companies covered in the analysis. These figures are insufficient to sustain any but the mildest of financial stresses.

Other than the issuers mentioned above, the report also covers instruments issued by the following issuers: BG Energy Holdings Ltd. ('A', Rating Watch Negative), Siemens ('A+', Stable), Henkel ('A'; Stable), Dong Energy A/S ('BBB+'; Negative), Vattenfall ('A-', Stable) and Casino Guichard-Perrachon SA ('BBB-', Stable), British Land Company PLC ('BBB+'; Stable) and Unibail-Rodamco ('A', Stable).

The full report, "The Rise in European Corporate Hybrids; Equity Credit Alone Not Indicative of Enhanced Financial Flexibility"" is available at fitchratings.com.

Link to Fitch Ratings' Report: The Rise in Corporate Hybrids; Assigned Equity Credit Alone Not Indicative of Strongly Enhanced Financial Flexibility

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