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These credit instruments, which carry both stock and bond features, have recently been popping up more frequently in the U.S. fixed income debt markets as corporate borrowers explore new financing options without denting their stock prices or credit ratings.

Recently priced deals from a U.S. subsidiary of Swiss insurance firm Zurich Financial Services, Reinsurance Group of America and railroad company Burlington Northern (BNI) are flourishing in the secondary market - a key performance gauge for investors, who are snapping up this relatively new Wall Street innovation.

"Hybrid securities are gaining greater and more widespread acceptance with each deal," said Sid Bakst, a senior portfolio manager at Weiss, Peck & Greer Investments in New York, with around $9 billion in fixed-income assets.

Risk premiums on the hybrid securities sold by Burlington Northern on Monday were 18 basis points tighter in trading Wednesday, while those of the Zurich Financial Services subsidiary were around 10 basis points tighter, said one market participant.

"A large absolute amount of issuance and strong secondary performance is evidence of growing investor interest in the product," said Jim Esposito, head of investment-grade syndicate at Goldman Sachs in New York.

The most recent deal in the hybrid securities arena comes from Calif.-based airline lease firm International Lease Financing Corp., a subsidiary of insurance giant American International Group, Inc. (AIG), which sold a $1 billion two-part offering late Wednesday through Lehman Brothers.

The offering was over-subscribed, with investors - ranging from insurance companies, pension funds to money managers and hedge funds - putting in orders to the tune of over $5 billion, said market participants.

From an investor's perspective, hybrid securities are a great way to rack up returns as values of other fixed-income asset classes peak.

"Given we remain in a historically low interest rate and tight credit spread environment, these products fit a number of investors' needs to pick up incremental yield," said Esposito at Goldman Sachs. The spread is the yield difference between a given bond and comparable Treasurys - that is, the premium offered to investors in exchange for taking on riskier corporate debt.

Hybrid securities give investors with a steady income stream - much like bond coupon payments.

"I am and have been buying hybrid securities, given the additional yield that they are currently coming to market with," said Bakst. He will buy a hybrid, he says, if he is "comfortable with the name and the additional yield is attractive enough."

But there are some conditions under which the issuer is prohibited from making payments, such as, if the company breaches certain financial ratios.

Also, in certain kinds of hybrid securities, the issuer is required to make up missed payments once it resumes paying - but only by using proceeds from the sale of common stock, so as to not endanger its credit ratings.

Investors are also taking in stride the current trading levels of hybrid securities. Typically, new kinds of securities trade infrequently - not unexpected, given their small numbers - which hampers market liquidity, a crucial criterion for many investors. Liquidity refers to the ease with which securities may be bought and sold in capital markets.

"For such a new product, the liquidity we have seen so far is surprisingly strong," said Bakst.

That said, market participants are quick to point out that buying hybrid securities is riskier than senior debt, such as loans and bonds, because they rank lower in the hierarchy of claims during a bankruptcy.

"It's a deeply subordinated security and you have to be comfortable with that," said Kevin Murphy, portfolio manager at Putnam Investments in Boston, with around $66 billion in fixed income assets. Murphy, who owns some hybrid securities, says he invests "on a case by case and industry by industry basis."

There is also concern that once these securities gain a foothold, the generous returns they offer may dry up.

"At some point, the additional yield may be squeezed out of it at which point they may no longer be attractive," said Bakst at Weiss, Peck & Greer Investments.

But for the time being at least, there appears to be no slowing down. Around $40 billion in hybrid securities, including preferred stock - the most common type of hybrids - has already been issued this year, according to Lehman Brothers, which forecasts issuance of $60 billion in 2006.

And, says Scott Romanoff, head of the hybrid capital group at Goldman Sachs, around $35 billion in the older version of hybrid securities is likely to be redeemed next year by financial institutions - possibly spurring issuance.

While hybrid securities have been around for years, they became popular among corporate borrowers this year after ratings agencies - starting with Moody's Investors Service in February - clarified their positions on these securities.

Moody's awarded more equity-like treatment to hybrid securities, making it easier for companies to raise capital without fear of piling on debt and endangering credit ratings.

Similar to shares, hybrid securities generally have a very long or perpetual maturity, although they can be bought back by the company at some point, usually after five or 10 years.

Market participants have predicted these moves by ratings agencies will go a long a way in bringing issuers of hybrid securities out of the woodwork, particularly when they finance mergers and acquisitions.

-By Aparajita Saha-Bubna, Dow Jones Newswires; 201-938-2248; aparajita.saha-bubna@dowjones.com



	December 15, 2005 8:47 a.m. EST