A change last year in Moody’s Investors Service ratings methodology assigning 50% equity content to a U.S.-issued hybrid security (up from 25% previously) is a key factor driving outsized market volumes1. The hybrid serves several purposes that interconnect to create a fulsome market, but a common thread is the ability for companies to use a tax-deductible product to lower their cost of funding without risking leverage metrics.
In terms of corporates, utilities have always turned to hybrids to fund capex but a growing need for capital-intensive infrastructure and energy projects to support a tech boom has fueled the need for low-cost capital. Additional refinancing volumes are expected to come in the next two years from multinationals who are facing a maturity wall of Covid-era debt.
Likewise, corporates who have M&A financing needs or who did not de-lever as quickly as they would have liked post-merger are also ripe to reduce their leverage. The new hybrid methodology allows them to buy back their debt in the market and fund it with hybrid capital which essentially cuts their leverage in half. With a 50% equity consideration for every $1 of debt raised, it provides them with an opportunity to re-balance their capital structure and maintain their credit rating without diluting their shareholders.
Investor demand for yield is in no small part propelling interest in this product, even as there’s been a steep drop in premiums on the subordinated debt. Innovative structures such as the introduction of a coupon floor in the security provides a measure of safety which appeals to firms looking for steady, multi-decade returns. Subordination premiums have decreased from an historical average of 250 bps to 164 bps in 2024. Elevated Treasury rates have led to a significant tightening of primary and secondary spreads. As spreads tightened and Treasury yields increased, hybrid debt has offered overall richer returns.
1To get 50% equity treatment by the agency, the security must show payment flexibility, certain length of maturity and subordination
Hybrid Capital at-a-Glance
Our recent panel of experts discussed the resurgence of hybrid securities as an attractive source of capital for corporate issuers. Learn how these securities work, what is driving demand and structural elements that have attracted investors to this asset class.
Q: What is Hybrid Capital and how has it changed over the last year?
A: Hybrids are a type of fixed income security with both equity and bond-like features, but the equity does not convert. A change last year in Moody’s Investors Service ratings methodology assigning 50% equity content to hybrid capital up from 25% previously has increased interest in the product due to its tax advantages and low cost of funding. Listen more at 1:07.
Q: Who uses the product and who is expected to use the product?
A: Traditionally, hybrids have been used by corporates, primarily utilities, to finance capex because the structure allows them to maintain their credit rating while not diluting shareholder holdings. However, in light of anticipated M&A related supply, possibilities are endless. Hear more at 2:28.
Q: What size can this market digest and why?
A: The thirst for yield has fueled larger deal sizes so $2 billion is “easily digestible” and $10 billion or even $20 billion across currencies is not out of the question. Find the answers at 4:56.
Q: What are the structural changes have been made to the product that have made them popular to investors?
A: Aside from the Moody’s change in equity content consideration, unique structures such as coupon floors provide investors more security thus driving volumes higher. Hear more: 8:17.
Q: What are the risks to this market? What can stop issuance or demand?
A: However unlikely, any change to regulatory schemes or a rollback in current equity content methodology from ratings agencies would pose market risk. Hear more from our experts: 22:38.
Q: How do I get more information if determine if hybrid capital is right for my company?
A: Mizuho is a leading Investment & Corporate bank with an experienced bench of professionals that can assist you in structuring, advising on and issuing hybrid solutions. We encourage you to get in touch with your Mizuho Debt Capital Markets professional.