Definition of hybrid bonds

They are best-known for their use in bank capital since their equity-like features - such as executives' ability to suspend interest payments or delay redeeming the bonds - gave banking regulators the confidence, pre-crisis, to allow them to count towards banks' regulatory capital.  However, in the event most banks proved reluctant to force hybrid bondholders to take the hit and regulators are since reconsidering what they will allow to count towards regulatory capital.

A new generation of hybrids, known as contingent convertibles, or Cocos, is currently being developed. The products are designed to convert into equity to boost bank capital if the institution comes under extreme stress, but many traditional hybrid investors are balking at the idea of holding instruments so much more like equity than old-style hybrids.

Other sectors, particularly utilities, have also used hybrids as part of efforts to maintain particular credit ratings. Credit ratings agencies consider the bonds as partly equity, meaning they do not add to balance sheet leverage quite as much as regular debt.  As tax authorities consider them debt, the interest payments are usually tax-exempt, unlike regular equity dividends.

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