Fitch Updates Hybrid Securities Rating System

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.