Warning on Hybrid PreferredStocks - Financials (Fitch)

PRESS RELEASE: Fitch On Bank Hybrid Capital In 2009



Fitch Ratings-London-04 February 2009: Fitch Ratings says that the risk of deferred interest payments on bank hybrid capital instruments (which share characteristics of debt and equity) has increased materially for the banks most under pressure in the current financial crisis, due to significantly lower operating earnings, or losses, combined with high levels of government support, according to a comment published today.

"Central to this matter is the question of the extent to which the government support that has flowed - and will, in Fitch's opinion, continue to flow - in the world's banking systems can be relied upon to extend to existing holders of deeply subordinated bank capital instruments," says Gerry Rawcliffe, Group Credit Officer in Fitch's Financial Institutions group.

Fitch does not believe investors should view such support as continuing endlessly. Absent evidence of a normalising of operating conditions, regulators may well exhibit some bias toward protecting taxpayer funds. This could include looking to put hybrids into deferral.
"In certain cases the investment risks faced by investors in these instruments is sufficiently material for Fitch to view them as not being of investment grade," says Rawcliffe

Fitch's hybrid capital rating criteria (July 2005) do not assume that government support would be forthcoming for these instruments, and that the key driver of hybrid capital ratings is the stand-alone strength of an institution, as expressed in its Individual Rating. Fitch believes that the current exceptional circumstances merit a conservative application of the existing criteria, especially given the uncertainty and opaqueness surrounding the regulatory considerations in respect of hybrid capital.

In response to the heightened risk of hybrid coupon deferral and, in extreme cases, outright principal loss, Fitch has already taken rating actions that have widened the number of notches between the Issuer Default Rating (IDR) and the rating assigned to the hybrid and preferred instruments for select issuers. Given that the deferral decision process potentially involves both regulatory and political considerations, and the possibility that the situation regarding bank hybrid capital could change very quickly, Fitch expects to maintain downgraded hybrid capital instruments on Rating Watch Negative. For instruments with low investment grade ratings, the Rating Watch Negative indicates that a move into sub-investment grade is a real possibility.

Fitch regards a deferral on a hybrid instrument as non-performance from a ratings perspective. Deferral will lead to the assignment of instrument ratings consistent with non-performing obligations, typically in the low 'B' to 'CCC'- 'C' range. Loss expectations will be derived from a combination of the expected duration of the coupon deferral and the cumulative versus non-cumulative nature of the instrument.

The full comment, "Fitch Sees Elevated Risk of Bank Hybrid Captial Coupon Deferral in 2009", is available on the agency's subscription website, www.fitchresearch.com.