Hybrid securities: The term Hybrid means a mix of two or more components. Hybrid Security is thus defined as a combination of two financial instruments, i.e., debt securities and equity securities.
It includes the combination of both debt and equity features. Just like debt securities, hybrid securities commit to pay a floating or fixed rate of return until a particular time, but the amount and timing of interest payment are not guaranteed, unlike bonds. And like equities, they have inherent nature of risk attached with the uncertainty in price movement and priority in payment at the time of winding up.
Hybrid securities are generally used as a fundraising instrument by Banking and Corporate institutions. The issuer of corporate hybrids may be both listed or unlisted companies that require to borrow funds from investors. But under hybrid securities, issuers have the option to exit from the agreement or suspend interest payments or otherwise they may also choose to convert them into ordinary shares at the time of financial crunch.
It is easy for the investor to build trust on the hybrid securities issued by the listed companies for its transparency in financial reporting and its mandatory compliance with regulatory guidelines. But the question here is should the investors invest in hybrid securities issued by ‘unlisted companies’?
Investors need to be careful as there might be risks when it comes to unlisted companies' hybrids.
The financial model followed by unlisted companies is notably different from that followed by listed companies. The compliance to disclosure of information, the accounting methods used in financials and Loan covenant may be at high risk in unlisted companies.
So, before investing in the hybrid securities of unlisted companies, the investor needs to have a balanced approach. They should keep a close track record of the company’s financial structure with a focus on these three key factors:
Rank of Security- ‘Rank of lenders’ decides who will be paid first at the time of winding up. The subordinate notes issued by unlisted securities are being paid after the senior lenders. This means that if the issuing company winds up, it will first utilize its funds to repay senior debts and maybe then left with nothing to repay the hybrid investors.
Creditworthiness- The investor should analyze the creditworthiness of the company to know its financial backing and past credit record. But besides creditworthiness, there may be a risk of deferral of interest payments due to a varied range of events such as issuers right to suspend the interest amount and breach committed by the company regarding loan covenant contained in senior debt terms.
Industry Performance- Any investment depends upon the area we invest in. So, investors should see the overall performance of the industry in which the company operates in. They should also track the current and historical earnings and cost performance of the company in comparison to other industry players.
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