Hybrid Capital and Perpetual Securities
Hybrid securities sit between debt and equity, typically paying a coupon like a bond but with no fixed maturity and deferrable payments like a stock, letting issuers get partial equity credit from rating agencies while still deducting the coupon for tax purposes.
Prerequisites: Term Loan A vs Term Loan B
Most corporate debt has a fixed maturity date and a coupon the issuer must pay or default. Hybrid capital instruments — perpetual bonds, preferred stock, and similar structures — blur that line deliberately: they may pay a bond-like coupon, but have no maturity date, and the issuer can often defer that coupon without triggering a default, much like a company can skip a dividend.
Because hybrids mix debt-like features (a coupon, seniority above common equity) with equity-like features (no maturity, deferrable payments), rating agencies award them partial "equity credit" when assessing leverage, letting a company raise capital that looks more like equity to a rating agency while its coupon often remains tax-deductible like debt.
Why issuers like them
A straight bond raises debt-to-equity ratios and can pressure a credit rating; straight equity dilutes existing shareholders. A hybrid can raise capital counted as, say, 50% equity by a rating agency's methodology, cushioning leverage metrics, while its coupon is frequently still deductible for tax purposes if structured correctly — capturing part of the tax benefit of debt and part of the balance-sheet benefit of equity at once. The tradeoff for investors is a subordinated claim (usually just above common equity) and coupon-deferral risk, which is why hybrids typically carry a higher yield than the same issuer's ordinary bonds.
Worked example
A utility company wants to raise $500 million without hurting its BBB credit rating. Issuing straight debt would push its debt-to-EBITDA ratio to a level rating agencies flag as a downgrade risk. Instead it issues a $500 million perpetual hybrid bond paying a 6% coupon, deferrable for up to five years without default; the rating agency treats 50% of it ($250 million) as debt and 50% as equity for leverage purposes, letting the company raise the full $500 million while its calculated leverage rises by only the equivalent of a $250 million bond.
Related concepts
Further reading
- Moody's and S&P methodology notes on hybrid capital equity credit