The Wall Street Journal-20080122-Risk Rises on Hybrid Securities
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Risk Rises on Hybrid Securities
Hybrid securities have in the past been an easy source of capital for cash-strapped financial institutions.
But that has all changed. Risk premiums on these securities -- sandwiched between bank loans and common stock in a company's capital structure -- have risen across the board as investors rethink the aggressive terms and conditions under which they lent to these once credit-healthy borrowers.
Investors appear no longer willing to fund all comers. Friday, Ambac Financial Group Inc., the triple-A-rated bond insurer to lose its top- notch ranking, scrapped a plan to sell equity and equity-linked notes because of market conditions.
This comes at a time when financials are in dire need of funds with no or few strings attached as they struggle to shore up balance sheets dented by sour mortgage investments.
"Financial institutions will raise large amounts of capital in this market at a time when they need it the most and the market will make them pay for it," said Chuck Moon, head of investment-grade credit at Hartford Investment Management, which manages $137 billion in assets. The company, based in Hartford, Conn., also is involved in hybrids. "The market has repriced pretty significantly," he said.
Smarting from mortgage bets gone wrong and after writing off billions of dollars of soured investments, Wall Street firms such as Citigroup Inc. and Merrill Lynch & Co. recently have bolstered their capital base by issuing big chunks of hybrids in the form of preferred stock.
Hybrids are popular among financials because they qualify as Tier 1 capital from a regulatory standpoint, while investors like them because they offer higher returns. Tier 1 capital is a measure of the amount of funds banks must carry to offset the risk related to their assets .
But just as issuers' dependence on hybrids is rising, investors in the market have turned wary, concerned that the aggressive terms they accepted in the good years could come back to haunt them. Some offerings allow borrowers to extend indefinitely the maturity of their hybrid securities; others allow the issuer to defer interest payments in times of stress. Borrowers also may be allowed to interrupt interest payments if they suspend their stock dividend.
"With the turning of the credit cycle in the summer, investors seemed to wake up to the fact there is incremental payment risk," said Scott Sprinzen, a financial-institutions analyst at Standard & Poor's, who also chairs the credit-rating company's new-instruments committee. "Hybrid investors do bear more risk than debt investors."
ACA Gets More Time
ACA Capital Holdings Inc., the parent of bond insurer ACA Financial Guaranty Corp., has obtained more time from its trading partners to work out problems.
The agreement gives ACA Financial Guaranty until Feb. 19 to find a solution to its difficulties.
A downgrade meant it would have to fork out at least $1.7 billion to its counterparties -- cash it didn't have.
