Hybrid debt capital instruments can, under the right conditions, be an important part of your overall investment strategy. Suitable for experienced income and institutional investors, hybrid debt capital instruments are fixed-income securities that combine aspects of both equity and debt. Before diversifying to include hybrid securities in your portfolio, however, make sure your financial status is secure and that you have the knowledge and investment experience to assess the potential merits and risks of these investment options with some degree of confidence.
As fixed-income securities, hybrids pay out a fixed amount of income over time. Most have a par or face value of less than $100, a stated maturity date far into the future, are senior to common stock issuance -- meaning they have a higher priority level – and are usually callable at par value -- meaning the issuer can redeem them at their face value -- five to 10 years after issuance. While the technical definition of hybrid debt capital instruments does not include senior debt -- debt that gets the highest priority in the event a company files for bankruptcy -- you will commonly see it in a list of hybrid security instruments.
Senior Debt Capital
Hybrid debt capital encompasses numerous categories of investment types, each with a different level of payout priority in the event a company goes bankrupt. Among the highest priority are $25 par senior notes, hybrid corporate bonds that are technically, senior debt. Maturity generally occurs within 30 to 40 years, and interest payments, which are mandatory during this time, are taxable. While you have the option to purchase hybrid corporate bonds using the services of a third party, understand that they often come with no issuer guarantee and the possibility of being callable at less than par value. Corporate-backed trust certificates, corporate-backed trust securities, monthly income preferred shares and monthly income debt securities are all examples of third-party hybrid corporate bond offerings.
Junior Debt Capital
Lower-priority debt capital instruments carry greater payout risk and because of this generally have a higher rate of return than senior debt. Examples include enhanced trust preferreds and junior subordinated notes issued by banks, insurance companies and regulated utilities. In addition to carrying greater risk, junior debt capital differs from its senior counterpart in that it often has a longer maturity date of up to 60 years and can come with an option for the issuer to defer interest payments -- although interest will still accrue -- for five to 10 years. However, you may still incur a tax liability for interest on your investment even if the issuer chooses to defer interest payments.
While length-to-maturity, a low minimum investment and a higher priority level payout can make hybrid debt capital instruments attractive, they carry a degree of risk. Look at current market conditions and conduct thorough research on the issuer before investing any of your money. Rising costs, industry competition, poor forecasting methods and internal management practices can all have an effect on the overall stability and credit worthiness of the company, and ultimately affect your potential for profiting from your investment.
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