OREANDA-NEWS. S&P Global Ratings said today that it assigned its 'BB+' long-term issue rating to the proposed hybrid notes to be issued by Telefonica Europe B. V., the Dutch finance subsidiary of Spain-based telecommunications group Telefonica S. A. (BBB/Stable/A-2), which is also the guarantor of the notes.

The timing and size of the issue will be subject to market conditions. We anticipate the targeted benchmark deal size will be well within 15% of the issuer's capitalization--the limit mentioned in our hybrid criteria. Based on the group's €5.1 billion already issued hybrids (excluding the €1.5 billion mandatory convertible securities), we project the ratio of outstanding hybrids to adjusted capitalization to be in the higher half of the 5%-10% range.

We classify the proposed hybrids as having intermediate equity content until their first call date (the latter being at least five years after issuance), because they meet our criteria in terms of their subordination, permanence, and optional deferability during this period (see "Hybrid Capital Handbook: September 2008 Edition," published on Sept. 15, 2008, on RatingsDirect).

Consequently, in our calculation of the group's credit ratios, we will treat 50% of the principal outstanding and accrued interest under the proposed hybrids as equity rather than as debt, and 50% of the related payments on these securities as equivalent to a common dividend, in line with our hybrid capital criteria. The two-notch difference between our 'BB+' rating on the proposed hybrid notes and our 'BBB' corporate credit rating (CCR) on Telefonica S. A. reflects the following downward adjustments from the CCR:One notch for the proposed notes' subordination because the CCR on Telefonica S. A. is investment grade; andAn additional notch for the optional deferability of interest. The notching of the proposed securities takes into account our view that there is a relatively low likelihood that Telefonica Europe B. V. will defer interest payments. Should our view change, we may significantly increase the number of downward notches that we apply to the issue rating, and this would be sooner than we might take a rating action on the CCR.

The interest to be paid on the proposed securities will increase by 25 basis points (bps) no earlier than year 10, and a further 75 bps 20 years after the first call date. We view the cumulative 100 bps as a moderate step-up, which provides Telefonica Europe B. V. incentive to redeem the instruments at that point.

Consequently, we will no longer recognize the proposed instrument as having intermediate equity content after the first call date at the latest, because the remaining period until its economic maturity would, by then, likely be less than 20 years.

KEY FACTORS IN OUR ASSESSMENT OF THE INSTRUMENT'S PERMANENCE

Although the proposed securities are perpetual, Telefonica Europe B. V. can redeem them as of the first call date, and every year thereafter. If any of these events occur, the company intends to replace the proposed instruments, although it is not obliged to do so.

KEY FACTORS IN OUR ASSESSMENT OF THE INSTRUMENT'S SUBORDINATION

The proposed securities will be deeply subordinated obligations of Telefonica Europe B. V., and will rank pari passu with the hybrids issued in 2013 and 2014.

KEY FACTORS IN OUR ASSESSMENT OF THE INSTRUMENT'S DEFERABILITY

In our view, the issuer's option to defer payment of interest on the proposed securities is discretionary. It may therefore elect not to pay accrued interest on an interest payment date because it has no obligation to do so. However, any outstanding deferred interest payment would have to be settled in cash if an equity dividend or interest on equal-ranking securities is paid, or if common shares or equal-ranking securities are repurchased. That said, this condition remains acceptable under our rating methodology because, once the issuer has settled the deferred amount, it can choose to defer payment on the next interest payment date.

The issuer retains the option to defer coupons throughout the instrument's life. The deferred interest on the proposed securities is cash cumulative and compounding.