Master’s Thesis – Majeure Finance Corporate Hybrid Capital Student: Professor: Jean-Louis Lafontaine Stéphane Cavrois H2014 Sophie Javary [email protected] June 2014 1 Table of Content I. Definition and structure of corporate hybrid bonds .................................................. 5 A) Definition ............................................................................................................................................ 5 B) Key features of hybrid bonds ....................................................................................................... 5 i) Maturity .............................................................................................................................................................. 6 ii) Subordination .................................................................................................................................................. 6 iii) Call Option ................................................................................................................................................... 6 iv) Coupon step-ups ............................................................................................................................................. 7 v) Coupon deferral .............................................................................................................................................. 8 vi) Equity Credit .................................................................................................................................................... 9 vii) Replacement language ......................................................................................................................... 10 C) Origins and evolution of the structure ................................................................................... 11 i) Origins of hybrid bonds ............................................................................................................................ 11 ii) Evolution of the structure ....................................................................................................................... 13 D) Differentiation with other asset classes ................................................................................ 14 II. Rating agencies’ considerations ..................................................................................... 16 A) Current methodology applied by S&P .................................................................................... 16 i) Rating framework ....................................................................................................................................... 16 ii) Equity credit duration ............................................................................................................................... 17 iii) How S&P assigns equity credit ........................................................................................................ 18 B) Current methodology applied by Moody’s ............................................................................ 19 i) Rating framework ....................................................................................................................................... 19 ii) Equity credit duration ............................................................................................................................... 20 iii) How Moody’s assigns equity credit ............................................................................................... 21 C) Trends and evolution ................................................................................................................... 22 III. Accounting and tax considerations ........................................................................... 24 A) Accounting considerations – IFRS ............................................................................................ 24 i) No unconditional obligation to deliver cash or any financial asset ...................................... 24 ii) Equity interest in residual value .......................................................................................................... 24 iii) No fixed maturity ................................................................................................................................... 25 B) Tax considerations ........................................................................................................................ 25 IV. Rationale for issuance .................................................................................................... 28 A) Rationale for the issuer ............................................................................................................... 28 i) Strengthening credit profile ................................................................................................................... 28 ii) Cost-effective capital ................................................................................................................................. 29 iii) Strong attractiveness for companies without access to capital markets ...................... 31 iv) Retain financial flexibility ........................................................................................................................ 31 v) Larger investment base ............................................................................................................................ 32 B) Impact on cost of capital and value of the company .......................................................... 32 i) Cost of hybrid is lower than cost of equity and higher than cost of senior debt…. ........ 35 ii) … Which is far from being enough to prove that hybrids decrease the cost of debt ..... 36 iii) Decomposition of hybrid debt as a mix of equity and debt ................................................. 36 iv) Would lead to a null impact on WACC ............................................................................................... 37 v) Except for the extra tax-shield permitted by hybrid capital .................................................... 38 C) Uses of hybrid capital ................................................................................................................... 39 V. Corporate hybrid market .................................................................................................. 41 A) Market evolution ........................................................................................................................... 41 i) Volumes and trends ................................................................................................................................... 41 ii) Non-financial corporate sectors ........................................................................................................... 42 iii) 2015 call hybrids ................................................................................................................................... 45 B) Key drivers of the market ........................................................................................................... 46 2 C) Rationale for investors ................................................................................................................ 48 i) Investors’ views on the market ............................................................................................................. 48 ii) Risk exposure ............................................................................................................................................... 49 D) Investors’ profile ............................................................................................................................ 51 i) Investors’ types ............................................................................................................................................ 51 ii) Geography of hybrid investors .............................................................................................................. 53 VI. Case Study EDF January 2013 ...................................................................................... 54 Summary and Conclusion .......................................................................................................... 62 References: ..................................................................................................................................... 66 Table of Figures Figure 1 - Key features of hybrid bonds .................................................................................................. 5 Figure 2 -Typical hybrid structures from 2012 onwards ................................................................ 7 Figure 3 – Equity & debt like characteristics of coupon deferrals .............................................. 9 Figure 4 – Original structure of RCC ...................................................................................................... 10 Figure 5 – RCC after first call date .......................................................................................................... 11 Figure 6 – Key dates for the development of hybrid bonds ......................................................... 12 Figure 7 – Typical structure of hybrids pre-2010 ........................................................................... 13 Figure 8 – Typical structure of hybrids in 2010/ 2011 ................................................................