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The New Wave of Hybrids—Rethinking the Optimal Capital Structure

The New Wave of Hybrids—Rethinking the Optimal Capital Structure ybrids” is a term that has traditionally been used to refer to securities that have features of both debt and equity. Beginning in 1993 U.S. companies began issuing a type of hybrid called “trust preferreds.” Like debt, these securities called for periodic interest payments that were deductible when calculating corporate income taxes. But unlike conventional debt, the issuers of trust preferreds retained the option to defer interest payments when facing financial difficulty. This ability to defer interest, when combined with maturities of 30 years or more and a subordinated position in the capital structure, allowed the securities to gain partial “equity credit” from the rating agency Standard & Poor’s (S&P). More importantly for bank holding companies, the Federal Reserve (Fed) in 1996 began to allow such securities to qualify as Tier 1 capital when determining a bank’s capital ratios.1 Despite S&P’s and the Fed’s acknowledgement of the equity-like function of trust preferreds, Moody’s for many years viewed trust preferreds as an expensive form of debt. And until fairly recently, this view helped limit their issuance mainly to financial institutions and regulated corporates such as utilities. Then in February 2005, Moody’s changed its guidelines for assessing the equity credit http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Applied Corporate Finance Wiley

The New Wave of Hybrids—Rethinking the Optimal Capital Structure

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Publisher
Wiley
Copyright
Copyright © 2007 Wiley Subscription Services, Inc., A Wiley Company
ISSN
1078-1196
eISSN
1745-6622
DOI
10.1111/j.1745-6622.2007.00146.x
Publisher site
See Article on Publisher Site

Abstract

ybrids” is a term that has traditionally been used to refer to securities that have features of both debt and equity. Beginning in 1993 U.S. companies began issuing a type of hybrid called “trust preferreds.” Like debt, these securities called for periodic interest payments that were deductible when calculating corporate income taxes. But unlike conventional debt, the issuers of trust preferreds retained the option to defer interest payments when facing financial difficulty. This ability to defer interest, when combined with maturities of 30 years or more and a subordinated position in the capital structure, allowed the securities to gain partial “equity credit” from the rating agency Standard & Poor’s (S&P). More importantly for bank holding companies, the Federal Reserve (Fed) in 1996 began to allow such securities to qualify as Tier 1 capital when determining a bank’s capital ratios.1 Despite S&P’s and the Fed’s acknowledgement of the equity-like function of trust preferreds, Moody’s for many years viewed trust preferreds as an expensive form of debt. And until fairly recently, this view helped limit their issuance mainly to financial institutions and regulated corporates such as utilities. Then in February 2005, Moody’s changed its guidelines for assessing the equity credit

Journal

Journal of Applied Corporate FinanceWiley

Published: Jun 1, 2007

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