The debate over the correct risk profile of hybrid securities intensified on Thursday when Moody’s, the rating agency, said the instruments would usually behave more like debt than equity.
Moody’s stance puts it at odds with US insurance regulators, which last month wrong-footed Wall Street by telling insurers holding one particular hybrid to classify it as common stock.
The position taken by the National Association of Insurance Commissioners has slowed issuance in a market many had expected to boom this year. If applied broadly, it would discourage insurers – which had been buying about 20 per cent of hybrids – from owning them.
But Moody’s said on Thursday: “It is expected that a highly rated hybrid security like [the one in question] will have pricing volatility similar to [the issuer’s] bonds as opposed to its common stock.”
Hybrids combine features of debt and equity in a way that is very cost-effective for issuers.
Moody’s analysis went beyond the specific Lehman Brothers hybrid reclassified by the NAIC. In general, the market value of hybrids that allow the deferral of coupon payments – as is the case for the Lehman issue and other recent hybrid structures – is correlated more closely with an issuer’s debt than its shares, Moody’s said. By contrast, other types of hybrid such as mandatory convertible securities behave more like equity.
The agency’s comments provide ammunition for insurance companies and Wall Street banks as they push to overturn the NAIC’s decision. Market participants have also enlisted the Bond Market Association, a securities industry lobbying group.
“The market has concerns about volatility [triggered by the NAIC’s decision] and the association is looking into whether we can help address those concerns,” the BMA said.
Rating agencies treat recent hybrids as having equity-like features because they act as a cushion protecting senior debt. And in regulated industries such as banking and insurance, watchdogs have accepted them as core, equity-like capital for issuers.
Moody’s said the decision of the NAIC’s Securities Valuation Office to classify the Lehman hybrid as common stock “stands in contrast to how most hybrid securities have historically been classified by the SVO”. The SVO could have labelled the hybrid preferred stock, which is treated much like debt for insurance regulatory purposes.
