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Case
study Prof. Ian Giddy, New York University March 14 2006 (Reuters) - USB Capital IX, a unit of US Bancorp sold $1.25 billion in perpetual fixed to floating rate Income Trust Securities ("ITS"), said market sources. Wachovia Securities, Goldman Sachs & Co. and UBS Investment Bank were the joint lead managers for the sale.
Hybrid securities, which combine the benefits of equity and tax-deductible debt, have taken off because they are partly treated as equity by credit rating agencies and they do not weigh on credit ratings as traditional debt issuance can. Hybrid bonds combine the regular interest payments of bonds with features of equity, including ultralong or perpetual maturities and the opportunity to defer coupon payments. These products have been around for awhile, but Moody's gave the bonds a boost when it clarified its position by issuing guidelines on how it would treat the products. U.S. issues are not tax deductible if they have a perpetual maturity, the FT notes. However, rating agencies require long maturities in order to give the debt a high-credit-rating equity treatment. A compromise has been found in the 40- to 60-year maturity range, which is long enough for Moody's to assign a "D-basket" equity credit. This means 75 percent of the funds raised are treated as equity. Demand for the securities is being driven as investors reach for more yield than traditional corporate bonds. Hybrids are riskier than traditional bonds because they rank lower in a company's capital structure and their income is not as secure. One cloud came in March 2006 when an insurance regulator classified a hybrid sold by Lehman Brothers as common equity, making it more expensive for insurance companies to hold. The Lehman-issued enhanced capital advantage preferred securities, or Ecaps, was classified as common equity by the National Association of Insurance Commissioners. The NAIC is responsible for assigning and valuing securities owned by state regulated insurance companies. Lehman said that it disagrees with the classification, arguing that the instrument has many debt-like features and should be classified as "worse case" preferred equity, according to sources that listened to the call. It is more expensive for insurers to hold securities classified as common equity because they are required to pay a 15 percent capital charge against the security, which is significantly higher than charges for holding preferred stock or debt. Insurers are estimated to hold roughly between 10 percent and one third of hybrids sold. Most of the issues are from financial institutions, but a few corporations have taken advantage of the dual-benefit instruments. Example: a $450 million issue for toolmaker Stanley Works, a structure dubbed an Etrups, or Enhanced Trust Preferred Security. Hybrids have also caught on outside the US -- in Europe (Porsche, Casino), Asia, and even in Eastern Europe. For example, Mol, the Hungarian oil and gas company, has issued €610m of hybrid bonds with speculative-grade ratings that can be converted into shares in the company. The Mol perpetual notes are
priced with a coupon of 4 per cent and a conversion premium of 30 per
cent. The bonds can be converted into the company's shares after between five and
10 years, while the bonds can be bought back by the issuer after 10
years. Bond investors are also entitled to any dividend payments from
Mol.
Questions 1.
How did this deal work? How would it be priced? |