* New criteria turns hybrids into expensive senior debt
* Reinstating lost equity could be costly
* S&P move could re-price hybrid market
By Laura Benitez
LONDON, Oct 30 (IFR) - Standard & Poor's shock removal ofthe equity content it had assigned to 29 corporate hybrid bondshas shone an unfavourable spotlight on the sector and forcedboth investors and issuers to rethink the risks of this year'sin-vogue product.
Fourteen corporate issuers are now servicing around 20.5bnof expensive senior debt after the equity credit of theirhybrids - which justifies the more costly coupon - was removedon Tuesday.
"We were contacted on Monday, but S&P had already made uptheir minds. It was a quite a surprise to say the least,although we knew it had been an issue because S&P had denied arecent issuer the same clause for its hybrid issue just a fewweeks ago," Johan Gyllenhoff, group treasurer at Vattenfall toldIFR.
S&P said it made the decision because it expects hybrids tobe a permanent and loss-absorbing part of a company's capitalstructure, and not be callable on the off-chance that the bondloses equity treatment due to a rating downgrade, for example.
"There's a lot of anger out there," one syndicate officialsaid. "The way S&P communicated the news was utterlyincompetent; they didn't give the companies the chance torectify the issues at hand, which seems highly unfair."
The move stems from corporates' reaction to a Moody's ratingcriteria change in July 2013 that removes a hybrid's equitycredit if an issuer's senior rating falls below investmentgrade. They inserted language enabling hybrids to be called inthe event of equity credit being lost.
The affected hybrids sold off on the news, although havegenerally recovered most of their losses.
LOSING EQUITY AND FAITH
Hybrids have long been pitched as a way for companies tobolster their balance sheets and protect credit ratings becauseof their subordination to senior debt.
Ultra-cheap funding costs ramped up activity earlier thisyear, with March seeing the highest ever monthly volume with7.8bn sold. Over 26bn-equivalent of paper has been issued sofar in 2015 - just 2bn shy of last year's total, which was alsoa record, according to IFR data.
But investors say S&P's announcement will be a new blow foran asset class that has already been buffeted by various ratingmethodology changes and volatile market conditions of late.
"The S&P news is likely to sit uneasy with investors asagencies have changed their rules on hybrids so many times inthe past," said Jens Vanbrabant, head of investment grade creditat ECM Asset Management.
"It only serves as another reminder that there are otherrisks for this asset class, including change of control clauses,which could now be priced into the market as a result."
The affected companies are Bertelsmann, RWE, Dong Energy,Vattenfall, Alliander, Gas Natural, Telefonica, Repsol, MerckKGaA, TenneT Holding, Centrica, SSE, TransCanada Trust andRexam.
THE NEXT STEP?
Many of those borrowers will spend the coming weeks lookingfor a solution to reinstate their 50% equity credit, but thistoo could come at a cost.
Their options could involve a contracted commitment toinvestors that the hybrids will not be called as a result ofratings deterioration.
"It's too soon to say how the equity could be retrieved, butit's likely that issuers will have to some pay heavy fees toinvestors. The fact that some of these borrowers issued hybridsrecently and are now facing more costs is grotesque," one DCMofficial said.
Some of the 14 issuers, including Dong and Vattenfall, havealready pledged to win back their equity.
"We are willing to be pragmatic and find a solution torestore the equity credit for our hybrid as it's an importantpart of our capital structure. We're willing to explore some ofthe options and take legal advice, although we have onepreferred choice but we'll have to wait and see," Vattenfall'sGyllenhoff said. (Reporting By Laura Benitez, editing by Alex Chambers, JulianBaker)
