The deluge of trust-preferred securities issuance has prompted Fitch Investors Service to change its method for rating preferred debt.
To "eliminate investor confusion," the agency said in a press release that it plans to rate all preferred stock securities on the same scale as investment grade and speculative bonds.
Previously, the agency had three separate scales: two for debt securities and one for preferred securities; now it will only use two. The preferred securities could be rated on the same scale as subordinated debt or just one notch lower than senior debt of the same issuer. Previously, preferred stock was rated two notches lower than senior debt.
The change is "pretty powerful," said Robert Grossman, executive vice president in Fitch's asset-backed securities area. "We are eliminating a system that we have had for a long time."
A recent flood of trust securities issuance by banks taking advantage of a tax deduction and raising regulatory capital prompted Fitch to reevaluate its scale system, said Scott O'Donnell, director of financial institutions.
"The risk that investors were taking with trust preferreds was minimal compared to subordinated debt," Mr. O'Donnell said.
Trust-preferred securities are similar to debt securities in that they offer a fixed dividend and a maturity date.
Fitch, however, has opted to view the trust preferred as more equity- like.
The lines between debt and equity "have been blended with the lengthening of the maturity (30 years for many of the securities) and lack of the redemption feature," said Mr. O'Donnell. "In the particular case of the trust preferred, the ability of the company to defer payment makes it more equity-like."
Since their introduction to the market last month, more than $11 billion of the securities have been issued by banks and insurance companies.
The securities are popular with banks because they are a cheap way to raise regulatory capital.
The change also put Fitch's rating system in line with Standard & Poor's Corp. and Duff & Phelps Credit Rating Agency's scales.
"We have always rated preferred stock with the long-term debt rating," said fixed-income ratings analyst Thomas Stone at Duff. "It is not unusual to see that preferred and subordinated debt are rated the same at the higher end of the scale."
Mr. Stone said investors need a rating system that allows them to compare the risk profile of trust securities with other kinds of debt.
Peter Stimes, vice president at Flaherty & Crumrine Inc., a preferred stock investor, agrees. "The new scales help me compare a straight bond with a hybrid bond," said Mr. Stimes. "It helps me compare the credit quality across the spectrum, which makes my job easier."
Moody's Investor Service, which has two ratings scales for debt and one for preferred stock, is not budging from its system.
"There has been some confusion with the different rating scale since these trust preferreds have come out," said rating analyst Gregory Bauer of Moody's. "But we have had this preferred stock rating for years and will be persistent in our approach."
