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By Marine Cole
Moody's Investors Service placed 775 hybrid securities and subordinated debt worth $450 billion under review for possible downgrade Thursday after it changed its rating methodology of hybrids.
The ratings agency anticipates that 40 percent of the potentially affected hybrid ratings could be lowered by one to two notches, 50 percent by three to four notches, and the remainder by five or more notches.
Before the crisis, banks were the main issuers of hybrids, which are bonds that carry strong features of equity such as long or no maturities and the possibility to defer interest payments. Banks liked issuing hybrids because they could count as regulatory capital but were less costly than regular debt. Hybrids sold by Citigroup and J.P. Morgan Chase are among the securities under review.
Investors in hybrids initially included insurance companies, which liked the high yield they provided. But many of them have already been forced to sell any hybrids in their portfolio since some downgrades have already occurred. Citigroup's hybrids are already rated junk, for instance.
If more hybrids are downgraded, more investors would sell them, making any new debt more expensive for banks.
Moody's wants to take into account in its ratings the fact that some recent government intervention in troubled banks have in many cases been to the detriment of the holders of hybrids. For example, support packages from the government have been contingent upon a bank's suspension of coupon payments to preserve capital.
The review, which is conducted on a global basis, will be completed within the next three months.
Meanwhile, it looks like banks are already onto their next trick to replace hybrids with other types of cheap capital. Contingent convertible bonds also present features of both debt and equity and can help shore up financial institutions' balance sheets.
The Financial Times reported today that the new securities, known as CoCos, have sparked intense interest in the market because they are the first post-crisis offering specifically designed to meet regulators' concerns that existing hybrids didn't act as a cushion between senior bondholders and shareholders as they were supposed to.
CoCos are securities that convert into equity if a pre-set trigger is breached. The Financial Times also noted that CoCo is only one type of such securities among many that banks are considering.
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