OREANDA-NEWS. Fitch Ratings has published an exposure draft detailing proposed revised criteria for equity credit recognition of hybrids issued by non-financial corporates and REITs. Fitch invites feedback on the proposals during a one-month consultation period that will end on 15 January 2016.

Fitch does not expect any rating impact from the proposed changes and the overall analytical framework remains unchanged.

The main proposals for which feedback is sought are:

Focus on Features
Fitch proposes to change its hybrids criteria to focus on a principles-based approach in assigning EC. As a result, the determination of EC would be based on hybrids' fundamental characteristics and their effectiveness rather than the nomenclature of the instrument.

Long-Dated Mandatory Convertibles
In line with this principles-based approach to assigning EC, mandatory convertibles would no longer be required to convert within five years. Instead, longer-dated mandatory convertibles would be eligible for EC, if they fulfil the criteria for equity recognition.

Aligning REIT Hybrids
Under our proposal, cumulative hybrids issued by REITs will no longer be eligible for 100% EC in line with Fitch's approach for corporate hybrids. Following a review of historical REIT and corporate hybrid deferrals when issuers were in distress, we could not find sufficient evidence that REIT hybrids are more loss-absorbing than those issued by corporates to merit a different treatment between the two.

Equity Settlement on Conversion
Deferred interest of mandatory convertibles for which the issuer has the option to settle in cash or shares on conversion would be eligible for up to 100% EC. In cases where the issuer is required to pay cash, the instrument may receive up to 50% EC. Fitch recognises that for mandatory convertibles, which tend to be short-dated, the interest portion is small - often negligible - compared with the principal.

Fitch does not expect any impact on ratings from its proposed changes, although credit metrics will be affected. Credit metrics will worsen for 26 publicly rated preference share-issuing REITs (all in the US), due to the revision to 50% from 100% EC for REIT cumulative hybrids. In contrast, credit metrics will improve for four publicly rated issuers, due to the assignment of up to 100% EC for mandatory convertibles where the issuer has the option to settle deferred interest in cash or shares on conversion, or 50% EC if settlement must be in cash.

Although we do not expect any rating impact, the actual impact can only be assessed when all instrument features are considered in the full analytical process by a rating committee.

Fitch is inviting market feedback for its proposed revisions until 15 January 2016. Comments can be emailed to 'hybrids.feedback@fitchratings.com'.

Fitch will continue to apply the current criteria to existing hybrids instruments. If the current criteria are updated after considering market feedback, Fitch will review all existing ratings within six months of the new criteria publication.

For new ratings, if there is a difference in the rating under the two criteria then the proposed criteria will be used because it more accurately reflects Fitch's current view. The difference between the two criteria will be disclosed in the accompanying RAC - this will give an indication of the rating impact if the proposed criteria are not adopted and existing criteria are maintained.