Fitch Ratings will be using a single system for rating hybrid securities.
Fitch, New York, previously applied separate rules to hybrid securities issued by banks and hybrids issued by other organizations.
Hybrid securities are financial instruments that combine features usually associated with stock with features usually associated with debt securities.
Fitch now will put hybrids in 5 classes, the firm says.
The classes are:
- Class A, 100% debt.
- Class B, 25% equity and 75% debt.
- Class C, 50% equity and 50% debt.
- Class D, 75% equity and 25% debt.
- Class E, 100% equity.
If, for example, a Class B security was valued at $1,000, Fitch would treat $250 of the value as debt and $750 as equity, according to Keith Buckley, group managing director, global head of insurance in Fitch’s Chicago office.
In most cases, Fitch analysts using the new rules will be less likely than analysts using the old rules to end up treating a hybrid as if it were 100% equity, according to Ellen Lapson, a managing director at Fitch.
Insurers that buy hybrids for their investment portfolios prefer to see rating agencies and regulators treat hybrids as if they were debt securities, because risk-based capital ratio rules require insurers to apply a risk-adjustment discount to the reported value of equity investments.
Fitch says its new hybrids rating system also will provide:
- A more detailed analysis of the effective maturity relating to call provisions, rate step-ups, and other factors.
- A refinement of the definition of ‘constraints’ on deferrals. Here, the term “deferrals” refers to an issuer’s right under terms of the hybrid contract to defer making interest or dividend payments on the security.
- Clarified treatment of optional versus mandatory coupon deferrals.
- Limited recognition of pre-bankruptcy loss absorption features.
Fitch typically rates hybrids 1 to 3 rating notches lower than the senior debt of the same issuer, to reflect that it believes hybrid securities are somewhat riskier than traditional debt securities.
In related hybrid securities news, Sharon Haas, a managing director in the New York office of Fitch, says the complexity of new hybrids is actually hurting hybrid market liquidity.
Hybrid holders now have a hard time selling newer hybrids, because the addition of special features has made the products so much more complicated, Haas says.
Limiting the number of hybrid “flavors” might increase market liquidity by making the securities easier to sell, Haas says.