US state and national insurance regulators on Wednesday clashed with investment bankers over a surprise decision last month that rattled the market for hybrid securities – complex instruments that combine features of debt and equity.
The National Association of Insurance Commissioners told insurers that owned a particular hybrid, issued last year by Lehman Brothers, to classify it as common stock, a move that discourages them from owning it. The decision hit valuations and slowed issuance in a market many had expected to boom this year.
Most market participants say hybrids behave, at worst, like preferred equity – a classification between debt and common equity that the NAIC’s Securities Valuation Office could have chosen. The SVO has classified many instruments with similar characteristics as preferred equity in the past.
The SVO and the New York State Insurance Department hosted a conference call on the situation on Wednesday but declined to discuss specific features of the Lehman deal that affected the decision, leaving bankers and investors no clearer on the implications for other instruments.
A banker from HSBC also questioned the initial narrow dissemination of the SVO decision on the Lehman hybrid, which moved the market sharply, to just ten insurance companies.
“New York is struggling with whether there are better ways of relaying information,” said Michael Moriarty, director of the state insurance department’s capital markets bureau. But Robert Carcano, senior counsel at the SVO, said: “We do not concern ourselves with communicating with entities other than insurance companies.”
Jill Schildkraut-Katz, global head of issuer product development at Merrill Lynch, asked whether it was safe to assume that a new security of a company that already had a more junior instrument classified as preferred equity by the SVO would be ranked no lower down the scale. “I can’t say,” replied Mr Carcano.
Mr Moriarty said regulators were working to confirm the classification of some common types of hybrids. He added that his department had referred the Lehman hybrid to the SVO because “the insurance industry has, wholesale, reported these things as bonds”, not preferred equity.
