I need to analyze whether EDP, S.A. should utilize hybrid bonds up to S&P Global Ratings' 15% cap of total adjusted capital. First, let me understand what hybrid bonds are and why companies use them. Hybrid bonds are debt instruments with equity-like features (perpetual or very long maturity, deferrable coupons, subordination) that rating agencies may give partial equity credit. S&P typically allows up to 15% equity credit on hybrids relative to total adjusted capital (debt + equity). Let me calculate EDP's current capital structure using the 2022 balance sheet data: **Equity (2022-01-01):** 13,977,565,000 EUR **Total Assets (2022-01-01):** 50,994,152,000 EUR **Total Liabilities (2022-01-01):** 37,016,587,000 EUR Let me verify: Equity + Liabilities = 13,977,565,000 + 37,016,587,000 = 50,994,152,000 EUR ✓ **Total Adjusted Capital = Debt + Equity** I need to identify debt. From the balance sheet: - Long-term Borrowings (2022-01-01): 15,299,588,000 EUR - Current Borrowings and Current Portion of Noncurrent Borrowings (2022-01-01): 1,518,348,000 EUR - Other Noncurrent Financial Liabilities (2022-01-01): 3,039,975,000 EUR - Other Current Financial Liabilities (2022-01-01): 2,781,101,000 EUR Let me also check for 2023 to see the trend: - Long-term Borrowings (2023-01-01): 15,782,604,000 EUR - Current Borrowings (2023-01-01): 4,239,869,000 EUR The company has significant debt. Let me calculate a rough debt figure. Looking at interest expenses can help gauge debt levels: - Finance Costs 2022: 1,753,220,000 EUR - Finance Costs 2021: 875,816,000 EUR The finance costs more than doubled, suggesting significant debt increase or rate increases. Looking at the swap curve data: - 5Y swap went from -0.264% (2021) to 1.726% (2022) - 10Y swap went from 0.053% (2021) to 1.927% (2022) This dramatic rate increase explains part of the finance cost increase. The iShares Core Euro Corp Bond yield went from 0.733% to 1.085%. Now, analyzing whether EDP should use hybrids up to the 15% cap: **Arguments for utilizing the full 15% cap (100% of allowed amount):** 1. **Interest rate environment in 2022**: Rates rose dramatically. Hybrid bonds, being typically longer-dated or perpetual, can lock in rates but with coupon reset features. However, in a rising rate environment, new hybrid issuance would be expensive. 2. **EDP's credit profile**: EDP is a utility with stable, regulated cash flows. Utilities are natural candidates for hybrids due to predictable cash flows. 3. **Current leverage**: Looking at Debt/Equity or Debt/Total Capital. Rough debt estimate: - Long-term borrowings: ~15.3B - Current borrowings: ~1.5B - Other financial liabilities: ~5.8B - Total debt roughly: ~22-25B EUR vs Equity of ~14B This suggests Debt/Total Capital of roughly 60-65%, which is moderately high. 4. **Equity credit benefit**: Hybrids would improve rating agency metrics by getting partial equity treatment, potentially improving credit ratings or outlook. 5. **Dividend capacity**: EDP pays dividends (0.19 EUR/share mentioned, and dividends paid of ~750M EUR). The dividend capacity supports the "equity-like" nature of hybrids. **Arguments against full utilization:** 1. **Rising rate environment in 2022**: With swap curves rising to 1.7-1.9%, issuing long-dated/perpetual hybrids would be expensive. The 10Y swap at 1.927% average in 2022 (up from 0.053%) means hybrid coupons would be significantly higher. 2. **Subordinated debt spread**: The sub-sen delta for iBoxx EUR Non-Financial IG is 0.2%, meaning subordinated debt trades at a spread. Hybrids would likely price even wider. 3. **Existing equity cushion**: With 14B EUR equity, adding more "equity-like" instruments may not be necessary if the company already has reasonable leverage metrics for its rating. 4. **Cost vs. benefit**: Hybrids are typically more expensive than senior debt. If EDP can maintain its ratings without hybrids, why pay the premium? 5. **Market conditions in 2022**: Corporate bond spreads were volatile (iBoxx at 2.295% average, up from 1.298%). Issuing hybrids in stressed markets is expensive. **Analysis of the options:** Given the dramatic rise in rates in 2022 (from near zero/negative to 1.7-1.9% swap rates), this is actually a challenging time to issue hybrids. However, if EDP needs to maintain or improve its credit metrics, some hybrid usage makes sense. Looking at EDP's specific situation: - It's a utility with stable cash flows - It has significant capex needs (investing activities of -3.2B EUR in 2022) - It has a large non-controlling interest component (EDPRenováveis dilution was significant) - The company is growing (assets increased from 51B to 58.8B EUR) The 15% cap on total adjusted capital is a rating agency constraint, not necessarily an economic optimum. Given: - The rising rate environment makes new hybrid issuance expensive - EDP already has significant equity (14B EUR) and institutional partnerships - The company has been active in equity markets (EDPR capital increase, treasury shares) - However, utilities benefit from hybrid treatment and EDP has used hybrids historically A balanced approach would be to use some but not all of the capacity. The 50% or 75% options seem most reasonable. However, considering: - 2022 was a year of rising rates, making new issuance expensive - EDP's business model supports stable cash flows for hybrid servicing - The company has significant growth capex needs - Rating optimization would suggest using some equity credit The most prudent approach in a rising rate environment with already-moderate leverage would be partial utilization - around 50% of the cap. This provides rating benefit without over-committing to expensive perpetual capital in a potentially peak-rate environment. Actually, rethinking: S&P's 15% cap is a maximum. Companies typically want to optimize their WACC and rating. Given EDP's utility status and the 2022 rate environment (which saw significant increases but may stabilize), using half the available capacity (50%) provides flexibility while capturing rating benefits. 50%