Why Banks Raise Hybrids

Hybrid bonds such as preferred shares that havecharacteristics of both debt and equity count toward capitalreserves, allowing banks to replenish their coffers withoutdiluting equity. Hybrids typically allow issuers to defer interest payments without defaulting, and credit-rating companies usually consider the bulk of the money raised as equity, meaning only a portion is counted as debt on an issuer's balance sheet. Merrill Lynch, after writing down the value of $6.5 billionof assets, sold $7 billion of senior unsecured notes in itsbiggest debt offering, attracting investors with spreads as muchas triple what it paid a year ago. Merrill Lynch, the third-biggest U.S. securities firm, also issued $2.55 billion ofperpetual preferred shares that yield 8.625 percent, its largestsale of the securities. The firm split its bond sale between $1.5 billion of 5-year6.15 percent notes that priced to yield 325 basis points morethan Treasuries of similar maturity and $5.5 billion of 10-year6.875 percent notes that paid a spread of 320 basis points,Bloomberg data show. That compares with the 107-basis pointspread Merrill Lynch paid on $1 billion of 10-year notes in April2007. Merrill Lynch may now lose its A1 ranking at Moody'sInvestors Service because the credit rating service won't countthe proceeds of the preferred sale as equity, Sanford C. Bernstein & Co. analyst Brad Hintz said today in a note toclients. Credit-rating companies typically don't allow more than 25 percent of a bank's capital base to be made up of preferred stock, a limit Merrill is ``well over,'' he said.