Reading the Fine Print: How ArcelorMittal burned their Hybrid Investors

It’s been a while since I posted, so I figure I would post a story about ArcerlorMittal and their Hybrid security.

For those monkeys who don’t know a Hybrid security is, its a security that works and looks like a bond (usually a perpetual bond), but for accounting purposes it counts (partially or in full) as equity.

ArcelorMittal had an outstanding High Yield Hybrid bond that was perpetual and had a coupon of 8.75%. This particular security was very attractive for investors due to its floating reset after its first call, which was in 2018.
Before January 20, this bond was trading in the 108-110 range. However, this bond had a very important caveat: A Rating Agency Event.

Hidden in Page 51 of the prospectus of this security, There is a short explanation of what a Rating Agency Event is. Basically, if one of the rating agencies (Moody’s, Fitch, S&P) changes the way they apply equity treatment to the hybrid, Arcelor has the right to call the security at 101.

After 2010, many newly issued Hybrid bonds have this language in their prospectus, so it’s not exactly a secret. However until last week, no one ever thought that it would come to play. Let me explain:

Last July, Moody’s revised the way their where going to treat the equity capital component of Hybrids. Basically, Hybrids of High Yield issuers would get 0 equity capital treatment. Back when this was announced, a couple of bonds dipped in price, but all issuers, like ArcelorMittal, did not announce early redemption. People suddenly forgot, or were confident that issuers would not apply this caveat, and HY hybrids traded higher and higher towards the end of the year.

On January 20, Arcelor decided out of the blue to call this bond at 101. The bond’s bid that day was 108.50. Every bond holder of the $650m issue instantly lost ~7.50%.

Since then, the Hybrid market has been rattled. Hybrids traded down (The risk-off sentiment of the past week helped push the prices down) and other issuers have taken the advantage to use the caveat to call their own hybrids (albeit the bonds were trading closer to the 101 call). What’s funny is that NO ONE was expecting this to happen.

I managed to get a hold of research from 3 big investment banks that have top ranked European Credit analysts. All have recent reports saying that the chances of the Ratings Agency Event being applied was close to 0. One of the reports was even from January 15!

So what did I learn from this:

1. It is important to read the prospectus, especially if you are investing in complicated structures like a Hybrid High Yield Bond (and trust me, 99% of investors don’t get past the cover page [IMO])

2. Sometimes, companies will make the decision to burn their investors, even if it only makes the slight economic/accounting sense

3. Even the smartest minds on Wall Street will not get it right, even if the message is right in front of their faces. I am sure there were many analysts in Europe that got their ear ripped off by their investors

4. Change in regulation/Change in methodologies by Rating Agencies can seriously affect entire asset classes

5. ArcelorMittal will have a hard time issuing a Hybrid at a cheap price (Or, the market will forget again and Arcelor will win again!)

For those of you who want to learn more, start here:
http://www.ft.com/cms/s/0/83a8c6a6-82b8-11e3-9d7e-00144feab7de.html