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Perpetual - but for how long?

24 Jul 2003

While some deals stand out because of their size, others rely on the rarity factor. Scottish Power's $700m perpetual launched in  June is a deal of the latter type, being the first perpetual hybrid convertible issued by a corporate. That means that unlike a normal convertible with a fixed maturity, the bond has an indefinite conversion period unless it is called by the issuer - giving Scottish Power 50% equity credit for what is effectively an eight year bond.

Traditionally this type of hybrid structure has been the preserve of banks and insurance companies, whose need to focus on capital structure have led them to use innovative hybrid instruments to protect their credit rating.

"Companies have become more focused on the ratings in today's more difficult markets," says James Eves, head of equity-linked origination at UBS. "The Scottish Power deal structure has applications for any company that wants to improve or defend its credit rating."

Scottish Power originally considered issuing straight debt, but was wary of damaging its A- credit rating. The structure devised by UBS allows it to effectively issue debt but  achieve 50% equity credit, protecting the utility's rating.

This was achieved by a combination of a lack of maturity, low conversion premium and a replacement capital provision that requires Scottish Power to replace the issue with a similar security if called at any point. Given that there is a hefty coupon step-up after eight years, the bond is unlikely to last longer than that.

If the bonds are not called after eight years, holders will receive a coupon step-up of 400bp over US Libor on top of the existing coupon of 4%.

Although the structure could theoretically be used by any corporate, bankers believe that it would be difficult for some companies. Because Scottish Power is a regulated business, the rating agencies have a level of comfort that in eight years' time it will be able to refinance the convertible. But other companies with a less predictable business model might struggle to win the same level of confidence from the agencies.

24 Jul 2003