The CFO Summit 2006

Innovative Financing Hybrid Capital

Laura Koh
Director Asia Capital Markets & Financing

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What Is Hybrid Capital?

Traditional View of Capital
Coupon
Debt

Maturity

Current View of Capital

Debt

Senior claim

Deferrable Coupon
Cumulative or Non Cumulative
Perpetual or Long-dated

Dividends
Equity

Permanent
Voting rights

Hybrid
Capital

Subordinated
No voting rights
Partial equity credit from rating
agencies

Residual claim

Possible equity treatment on

balance sheet

Equity
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Drivers of Growth In Hybrid Capital

Rating Agencies

Auditors

Markets

Moodys and S&P revised or clarified their methodologies for awarding partial
equity credit on Hybrid Capital
Important for companies which are facing ratings downgrade pressure but are
unwilling or unable to issue additional equity to bolster the balance sheet

When certain conditions are met, the Hybrid Capital may be treated as Equity
in the financial statements under IFRS
Particularly useful in the computation of key financial ratios, such as Gearing
Ratio

With USD and rates at historically low levels, investors have to search harder
for yield / returns
Demonstrated a willingness to go down the capital structure to achieve more
yield

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Features of Hybrid Capital Securities

Maturity

Most Hybrid Capital securities are perpetual, but they can be issued with a long-dated
maturity (e.g., 30-49 years)

Coupon Rate

Hybrid Capital securities typically have a stated coupon. The coupon can be:
a fixed rate per annum for the life of the instrument,
a floating rate per annum for the life of the instrument, or
a fixed rate per annum for a certain number of years, then switching to a floating rate
thereafter (i.e., Fixed Rate/Adjustable Rate Preferred, or FRAP)

Interest
Suspension

At the option of the Issuer, interest may be suspended for any interest period, provided that
no dividends shall be paid or declared on the Issuers common stock or any other
shares ranking junior to the Hybrid Capital securities, and
no common stock shall be purchased, retired, or otherwise acquired by the Issuer

Mandatory
Deferral Trigger

Used when Issuer seeks to maximize rating agency equity credit. Following the breach of a
pre-determined financial trigger, interest payments cease automatically. Where applicable,
the Issuer can elect to settle such interest payments with a variable number of common
shares. The trigger type and level are determined on a case-by-case basis
Example: The trigger is breached if average net income for the last 4 quarters is less
than zero
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Features of Hybrid Capital Securities

Coupons can be cumulative or non-cumulative
Coupon
Accumulation

Dividend Stopper

Rank

Cumulative: If coupons are deferred/suspended, they will accrue and will be an obligation of
the company to be paid in the future

Non-cumulative: If coupons are deferred/suspended, no coupons will be paid for that period
and the missed coupons will not become an obligation of the company to be paid in the
future

Precludes dividend payments on securities that rank junior to the Hybrid Capital securities if
interest is not paid on the Hybrid Capital securities
Hybrid Capital securities typically rank junior to all indebtedness of the Issuer, and senior to the
Issuers common stock

Liquidation
Preference

Hybrid Capital securities have a stated liquidation preference per security, which is the dollar
amount that a holder of such a security is entitled to receive out of available funds upon liquidation,
dissolution or winding up, after creditors have been paid, but before common shareholders are paid

Call Rights

Hybrid Capital securities typically can be called by the issuer (a) after the passage of a certain
number of years (e.g., 5 or 10), or (b) upon the occurrence of certain events (e.g., certain changes
in law that occur after the hybrid capital securities are issued)

Replacement
Language

Language that evidences a commitment by an Issuer that it will only call an outstanding security
with the proceeds from an issuance of a security with similar or greater equity-like characteristics
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Hybrid Capital Update

S&Ps Approach to Equity Credit
New category
Old category

Maturity

Minimal Equity Content

10%

20%

30%

Intermediate Equity Content

40%

Maturity lowering to 20 yr

50%

Perpetual

Very High Equity Content

60%

70%

80%

90%

Mandatory Convertible
Convertible

Step-Up

Step-Up (>=100bps)

No Step-Up

Replacement Language
(Legally binding)

Optional
Deferability,
Div Stopper
Only

Mandatory Deferability (Partial Credit)

Replacement Language

Deferability

Less Flexibility (Dividend Pusher)

Senior

Subordinated

Tax
Treatment
Examples

Mandatory Deferability (Full Credit)

Rank as
Preferred/
Subordinated

Deductible

Perpetual NC, step-up

Perpetual NC, optional deferral

(replacement language if step-up)

Perpetual NC, Mandatory Deferral Interest

Payments (legally binding replacement
language if step-up)

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Hybrid Capital Update

Moodys Approach to Equity Credit Building Blocks
Replacement

Mandatory Trigger

Optional
Suspension/Deferral

Perpetual
Maturity

Enforceable
Obligation

Non-cumulative

Non-cumulative

Perpetual
Maturity

Enforceable
Obligation

Perpetual
Maturity

Stated Intent

Non-cumulative

Cumulative

60-years or
greater

Stated Intent

Non-cumulative

Cumulative

Perpetual
Maturity

Enforceable
Obligation

Cumulative

Perpetual
Maturity

Stated Intent

Non-cumulative

Term
E Basket
~100% Equity

Non-cumulative

D Basket
~75% Equity

C Basket
~50% Equity

Perpetual
Maturity
Note: Cumulative = cash cumulative distributions or unlimited stock settled distributions
Non-cumulative = non-cumulative distributions or stock settled distributions subject to limitations
Subordination will be equivalent to preferred in all cases
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Non-cumulative

Cumulative

Rating Agencys Financial Ratios Calculation

RCF/Debt, Net Debt/Capitalisation

Adjust debt reflecting the proportion of equity
credit assigned to the instrument
Leverage
Ratios

D basket (75%) $1bn transaction will add $250m

to debt and $750m to equity
Cash flow items (like RCF) will reflect the full
coupon of the instrument

Main ratios are: FFO/Interest and FFO/Fixed

Charges

Interest
Coverage Ratios

For FFO to Interest, Moody's excludes a fraction

of the hybrid's interest payments which is equal
to the equity credit received by the hybrid (i.e. on
a D basket (75%) paying $100 million of interest
per year, only $25 million will be considered as
interest)
For FFO to Fixed Charges, Moodys includes full
coupon as a fixed charge, regardless of equity
content

For leverage ratios (FFO/Debt, Debt/Cap), S&P will

consider the instrument in two ways:

Considered as 100% debt vs. 100% equity

Very High Equity Content Category 100% equity

Low Equity Content Category 100% debt
Intermediate Equity Content Category both set
of ratios are considered
For Interest Coverage (FFO/Interest), S&P will
consider the instrument in two ways:

100% debt vs. 100% equity

Remuneration on instruments in the Very High

Equity Content Category is considered as dividend
payments
Remuneration on instruments in the Low Equity
Content Category is considered as interest
payments
Remuneration on instruments in the Intermediate
Equity Content Category would generally be
considered as interest payments
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Hybrid Capital Markets

IAS Accounting Treatment
A Perpetual Is Classified as Either Debt or Equity
A perpetual security is treated as either debt or equity on the issuers balance sheet
IAS 32 Financial Instruments provides the accounting criteria for classification
True or False: The issuer has an unconditional right to avoid paying cash or financial assets to settle the obligation:

True: Equity

False : Debt

Additional criterion: The holder of equity must have a residual interest in the assets of the issuer after deducting all liabilities
Regulators, rating agencies and tax authorities can have different criteria so classification can differ for different purposes
Hybrid Classifies as Debt Under IAS 32
Terms and Conditions:

IAS 32:
IAS 39:
P&L Volatility:

Maturity:
Ranking:
Call:
Interest Payment:
Interest Deferral:
Step-Up:
Debt
Hedge Accounting for swap
Low

Perpetual
Deeply Subordinated
Non-Call 5
Dividend Pusher Cumulative
Restricted
No

Hybrid Classifies as Equity Under IAS 32

Maturity:
Ranking:
Call:
Interest Payment:
Interest Deferral:
Step-Up:
Equity
No Hedge Accounting for swap
Low to medium

Perpetual
Deeply Subordinated
Non-Call 5
Non-Cumulative
Unrestricted
No

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Vattenfall Case Study

Vattenfall Case Study

Rationale for the Transaction
Why Issue a Hybrid Capital
Security?
Anders Lidefelt,
President of Vattenfall
Treasury

Why we did not Issue a Hybrid

Capital Security Before?

We are 100% state owned so our access to

new equity capital is very limited
It was not completely clear what the rating
agencies views were and in general the
equity credit they were assigning was
fairly uninteresting
The volumes that were possible were too
small to be of any particular interest to us

Changes

Moodys in February 2005 changes

its treatment of hybrid products and
Standard & Poors clarifies its
approach to such instruments

Increasing demand from investors looking

for yields
Casino prints the first benchmark size
corporate hybrid offering (600m)

Result

Hybrid Capital Offering

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Vattenfall Case Study

Rating Agencies Treatment
Moodys

Standard & Poors

Senior Rating

A3

A-

Hybrid Rating

Baa1

BBB-

Equity Content

Basket D (75% equity credit)

60% equity credit

Perpetual
Adequate replacement language to mitigate
step-up
Full credit to the mandatory deferral feature

Perpetual
Adequate replacement language to mitigate
step-up
Partial credit to mandatory deferral

Hybrid treated as 75% equity, 25% debt for

ratio purposes

Rationale

Ratio Impact

Agency
Considerations

Ratings placed on positive outlook after

announcement given significant financial
flexibility
Capital structure to be enhanced given
issuance of hybrid

More weight given to leverage and cash flow

coverage ratios that considered the instrument
as all equity
Distributions treated as interest for fixed charge
coverage ratios
Issuance strengthens balance sheet by
enhancing financial flexibility

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Vattenfall Case Study

Benefits for Vattenfall

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Vattenfall Case Study

The Transaction
Summary of Principal Terms

(1) At issuance; in the meanwhile upgraded to A2 (company) and Baa1 (hybrid) respectively
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Vattenfall Case Study

Innovative Structure
Payment Mechanics
75% equity credit from
Moodys (Basket D)

yes

60% Equity credit from

S&P (Intermediate
content)

no

100% tax deductibility

Equity treatment under
IAS 32

Has Mandatory
Non-Payment
Event
occurred?

Has Vatenfall
made a
payment on, or
repurchased
junior or parity
securities?

no

yes

Compulsory
Interest
Payment Date

Optional
Interest
Payment Date

Mandatory NonPayment Date

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Vattenfall Case Study

Key Highlights
Equity Treatment
Highest equity content
non-dilutive corporate debt
security - EVER
Distribution

Structure

Very high quality

Most innovative structure in

the corporate space

1bn Hybrid Capital

Impact on Rating

Ground Breaking Transaction

Significantly positive

First ever perpetual security

for a corporate issuer in the
Nordic Region
Performance
Excellent Extremely
well performing on the
secondary market

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Porsches USD Hybrid Transaction Details

Porsches USD Hybrid Transaction Details

Overview
Highlights

Hybrid Transaction Rationale

The hybrid instrument reinforces the Groups
stated conservative financial strategy, provides
additional financial flexibility, and refinances the
companys strategic liquidity reserves and a
bond maturing in 2007
Porsche is the worlds most profitable car
manufacturer and committed to maintaining a
conservative financial structure and views the
issuance of a hybrid security as a means of
further strengthening its capital base
USD were selected as currency of issue as the
bond can be used to hedge foreign exchange
risks derived from car exports

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Porsches USD Hybrid Transaction Details

Overview (Contd)
Summary of Principal Terms
This is the largest ever unrated perpetual offering (by a large measure) from any corporate globally in
any currency, and the first ever unrated USD perpetual
The hybrid capital notes were accounted for as pure equity under IAS on Porsche's balance sheet and
were afforded full tax deductibility making it an extremely efficient, non-dilutive capital raising for the
company
This hybrid offering also constitutes the first European / Asian fixed rate retail targeted perpetual. The
absence of a step-up provides ultimate flexibility to the issuer
The orderbook was USD 4.25bn with 280 investors participating across Europe and Asia
The transaction is testimony to Merrill Lynch's unparalleled structuring capabilities and also to our
superior penetration of the Asian retail investor base as demonstrated by an entire series of such deals
in the last 24 months since this market opened up with a USD 1.75bn perpetual bond by Merrill Lynch
for Pemex
From an initially marketed benchmark-size deal which implies USD 300mn plus and an initial
guidance of 7.5 area, we ultimately priced USD 1bn at 7.2%
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Porsches USD Hybrid Transaction Details

Transaction Summary
Issuer
Guarantor

Porsche International Financing plc

Dr. Ing. h.c.F. Porsche Aktiengesellschaft

Ratings
Tenor
Compensation Payments

Not rated
Perpetual NC5
Fixed rate of 7.2% per annum payable quarterly

Optional Redemption
Special Event Redemption

Redeemable at par on 01 February 2011 and any compensation payment date thereafter
Redeemable at par if either the Issuer or the Guarantor is required to pay additional tax amounts
Redeemable at par if interest expenses cease to qualify as tax-deductible payments for the Issuer
Redeemable at par if the proceeds of the securities may no longer be accounted for as equity of the
Guarantor

Optional Compensation
Payments

The Issuer may defer payment of compensation on a cumulative (but not compounding) basis on any
compensation payment date if (i) no dividend or other payment was resolved on in respect of shares of the
Guarantor, (ii) no dividend or other payment was resolved, paid or made in respect of any junior or parity
securities qualifying as equity of the Guarantor and (iii) the Guarantor has not repurchased any parity or junior
securities or any shares.

Payment of Arrears of
Compensation

Arrears of compensation will become due on any compensation payment date on which the Issuer pays
compensation (whether due to non-satisfaction of the deferral conditions or due to the Issuer electing not to
defer). Arrears will also become due on the earlier of: redemption of the securities, the date on which an order
is made for the winding-up or liquidation of the Issuer or the Guarantor and the date on which the Issuer or
Guarantor makes any payment on any parity or junior security qualifying as equity of the Guarantor.

Status of the Guarantee

Denominations
Sole Bookrunner and Sole
Structural Advisor

At least pari passu with any present or future capital securities and guarantees thereon
Senior to common and preferred equity of the Guarantor
Junior to all unsubordinated and subordinated creditors of the Guarantor and guarantees thereon

USD 2,000
Merrill Lynch

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Porsches USD Hybrid Transaction Details

Summary of Payment Mechanics

Has Porsche
resolved
on a
payment/divide
nd
in respect of
shares?

Yes

No

Has Porsche
resolved
on or made a
payment
on junior or
parity
securities
qualifying as
equity of the
Guarantor?

Yes

No

Has Porsche
repurchased
any
junior or parity
securities
or any shares?

No

Dividend History per Preferred Share(1)

Optional
Compensation
Payment Date

Yes

Compulsory
Compensation
Payment Date

(1)
(2)
(3)
(4)
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Please note that preferred shareholders receive an additional 0.06 dividend p.a., compared to ordinary shareholders; No special dividends illustrated
Based on Porsche Groups net income
Subsequent payment in January 1997
Includes a special dividend of 14.00 per share, leading to a total dividend of 17.00 per share

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Disclaimers
Merrill Lynch prohibits (a) employees from, directly or indirectly, offering a favorable research
rating or specific price target, or offering to change such rating or price target, as consideration
or inducement for the receipt of business or for compensation, and (b) Research Analysts from
being compensated for involvement in investment banking transactions except to the extent
that such participation is intended to benefit investor clients.
This proposal is confidential, for your private use only, and may not be shared with others
(other than your advisors) without Merrill Lynch's written permission, except that you (and each
of your employees, representatives or other agents) may disclose to any and all persons,
without limitation of any kind, the tax treatment and tax structure of the proposal and all
materials of any kind (including opinions or other tax analyses) that are provided to you relating
to such tax treatment and tax structure. For purposes of the preceding sentence, tax refers to
U.S. federal and state tax. This proposal is for discussion purposes only. Merrill Lynch is not
an expert on, and does not render opinions regarding, legal, accounting, regulatory or tax
matters. You should consult with your advisors concerning these matters before undertaking
the proposed transaction.

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