Hybrid bonds are subordinated bonds from the non-financial segment that share certain characteristics with equity. The yields of hybrid bonds are significantly higher than those paid by the senior bonds from the same issuer.
The risk/return profile of this asset class is located on the continuum between equities and senior bonds. Hybrid bonds either come with very long maturities or have no end of maturity at all. The issuer has certain rights of termination during the life of the bond.
Hybrid bonds do not offer a fixed pay-out; the rate of return is linked to the earnings and business situation of the issuer. This means that coupon payments may be suspended, but they are typically recovered as soon as a dividend is paid out.
Coupon payments are fixed for a period of five to twelve years, which is followed by a period of variable rates. If the bond is not redeemed at the initial call date, the coupon turns variable. The percentage of the coupon consists of a referential interest rate and a risk premium. At every new call date, the risk premium on the referential interest rate increases, which incentivises the issuer to redeem the bond as early as possible.
Hybrid bonds come with numerous benefits for issuers. Hybrid issues are less costly than an IPO or a capital increase via shares. In contrast to dividends, the issuer can deduct the coupon payments for tax purposes, and hybrid capital supports the rating of senior bonds. Most rating agencies include up to 50% of hybrid bonds in the issuer’s equity ratio.