A change last year in Moody’s Investors Service ratings methodology assigning 50% equity content to a U.S.-issued hybrid security (up from 25% previously) is a key factor driving outsized market volumes1. The hybrid serves several purposes that interconnect to create a fulsome market, but a common thread is the ability for companies to use a tax-deductible product to lower their cost of funding without risking leverage metrics.
In terms of corporates, utilities have always turned to hybrids to fund capex but a growing need for capital-intensive infrastructure and energy projects to support a tech boom has fueled the need for low-cost capital. Additional refinancing volumes are expected to come in the next two years from multinationals who are facing a maturity wall of Covid-era debt.
Likewise, corporates who have M&A financing needs or who did not de-lever as quickly as they would have liked post-merger are also ripe to reduce their leverage. The new hybrid methodology allows them to buy back their debt in the market and fund it with hybrid capital which essentially cuts their leverage in half. With a 50% equity consideration for every $1 of debt raised, it provides them with an opportunity to re-balance their capital structure and maintain their credit rating without diluting their shareholders.
Investor demand for yield is in no small part propelling interest in this product, even as there’s been a steep drop in premiums on the subordinated debt. Innovative structures such as the introduction of a coupon floor in the security provides a measure of safety which appeals to firms looking for steady, multi-decade returns. Subordination premiums have decreased from an historical average of 250 bps to 164 bps in 2024. Elevated Treasury rates have led to a significant tightening of primary and secondary spreads. As spreads tightened and Treasury yields increased, hybrid debt has offered overall richer returns.