Fitch Ratings formally unveiled its new rating criteria for hybrid securities that analysts here say will bring greater clarity to how these financial instruments are treated by the rating agency.
The new rating criteria, which take effect on Sept. 27, were explained during a press briefing. They apply to hybrids issued by all companies rated by Fitch irrespective of industry segment or geographic location. Previously, a two-pronged approach was used: one for banks, and a second for corporate issues, finance companies and insurers.
The new criteria break hybrids into 5 classes as follows:
– 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.
The classifications would impact financial ratios and potentially the ratings of issuers of hybrid securities, says Keith Buckley, group managing director, global head of insurance in Fitch’s Chicago office.
Thus, for instance, if a security was valued at $1,000 and was classified as a ‘B’, then in its debt-capital ratio, $250 would be treated as equity and $750 as debt, Buckley explained.
Typically, he said, securities are issued at the insurer holding company level, but if a security was issued by an insurance subsidiary, then that unit’s financial ratios would be subject to the new classification.
For purposes of assessing financial ratios under Fitch’s new system, buyers of hybrids will be assessed using its PRISM system of risk assessment, an insurance capital model that Fitch introduced in June 2006.
Buckley said that comparability with other ratings is important to those looking at the ratings of hybrids and consequently, the new system attempts to make it easier to compare ratings with other ratings on a hybrid security.
Another change in the new hybrids rating approach is that the drop-off in the debt-to-equity treatment is less severe, says Ellen Lapson, managing director-global power in Fitch’s New York office. So, for instance, equity or debt treatment might drop from 75% to 50%, but would not drop from 75% down to zero, she explained.
Other modifications in the hybrids rating system include:
– A more detailed analysis of the effective maturity relating to call provisions, rate step-ups, and other factors.