The Handbook of Hybrid Securities: Convertible Bonds, CoCo Bonds and Bail-In

4 Corporate Hybrids

4.1 INTRODUCTION

In the introductory chapter we defined a corporate hybrid as a long-dated, most of the time even perpetual, debt instrument. Very often a set maturity is missing. Through their perpetual nature, these bonds earn an equity status. Hybrids are deeply subordinated and carry a cancelable and variable coupon stream. Because of their subordination in the capital structure, hybrids have as good as no recovery value in case of default. In addition, this debt instrument often has one or more embedded issuer calls. The latter grants the right to the issuer to redeem the security before the scheduled maturity date, if any. In case the issuer of the hybrid bond skips the call and keeps the bond alive, the post-call-date coupon structure changes. Not calling back the bond on the call date often creates a higher interest rate charge for the issuing company, as the coupon stream could be increased with a predefined step-up percentage.

Hybrid bonds are located at the intersection of debt and equity. The fact that these bonds carry regular predefined interest payments makes them bond-like. Further, like coupons on corporate debt, the coupons of the hybrid are generated from the pre-tax income of the company. The interest rate charge is as such tax-deductible for the issuing company. This is in contrast to dividend payments on equity, since these come out of the post-tax income.

The mere fact that the coupons can be deferred without triggering a default event ...