I need to analyze whether TERNA S.p.A. should utilize hybrid bonds relative to S&P Global Ratings' 15% cap on equity credit for hybrids. First, let me understand what we know about TERNA's capital structure and hybrid bonds: From the annual report data: - "Equity Instruments Perpetual Hybrid Bonds" 2022-01-01 - 2023-01-01: 989,000,000 EUR - This is also shown in equity as "Capital Instruments Bonds Hybrid Perpetual" at 2023-01-01: 989,000,000 EUR Let me calculate total adjusted capital (debt + equity): Equity at 2023-01-01: 6,169,100,000 EUR Debt components at 2023-01-01: - Longterm Borrowings: 8,416,700,000 EUR - Shortterm Borrowings: 444,100,000 EUR - Current Portion Of Longterm Borrowings: 1,909,300,000 EUR - Noncurrent Financial Liabilities: 247,200,000 EUR - Current Financial Liabilities: 44,900,000 EUR Total debt = 8,416,700,000 + 444,100,000 + 1,909,300,000 + 247,200,000 + 44,900,000 = 11,062,200,000 EUR Total adjusted capital = Debt + Equity = 11,062,200,000 + 6,169,100,000 = 17,231,300,000 EUR The 15% cap on equity credit for hybrids: Maximum equity credit allowed = 15% × 17,231,300,000 = 2,584,695,000 EUR Current hybrid bonds outstanding: 989,000,000 EUR Current utilization of the cap = 989,000,000 / 2,584,695,000 = 38.3% So TERNA is currently using about 38% of the available 15% cap. This means they could issue more hybrid bonds if they wanted to. Now, let me analyze the market conditions and company situation to determine optimal utilization: 1. **Interest rate environment in 2022**: Swap rates turned significantly positive in 2022 after being negative in 2020-2021. The 5Y swap went from -0.264% (2021) to 1.726% (2022), 10Y from 0.053% to 1.927%. This means debt financing became more expensive. 2. **Corporate bond spreads**: The iShares Core Euro Corp Bond yield increased from 0.733% (2021) to 1.085% (2022). The IBOXX EUR Non-Financial IG spread increased from 1.298% to 2.295%. 3. **Hybrid bonds characteristics**: Hybrids are treated partially as equity by rating agencies (typically 50% equity credit for S&P). They offer lower coupon than pure equity but higher than senior debt. The "coupon payable to holders of hybrid bonds" was 21,100,000 EUR on 989M = ~2.13% coupon. 4. **Company's current hybrid usage**: At 989M EUR, they're at about 38% of the 15% cap capacity. They have room to increase to the full 15% cap (about 2.58B EUR maximum equity credit, meaning roughly 5.16B EUR of hybrids if 50% equity treatment, or they could issue ~1.6B more at current 50% equity credit to hit the cap). Wait - let me reconsider. S&P's 15% cap is on equity credit, not on face value. If hybrids get 50% equity credit, then to max out the 15% cap: - Max equity credit = 2,584,695,000 EUR - At 50% equity credit, max hybrid issuance = 5,169,390,000 EUR - Current hybrids = 989,000,000 EUR, giving 494,500,000 equity credit - Current utilization = 494,500,000 / 2,584,695,000 = 19.1% of cap Actually, let me re-read the question. It asks what extent the company should utilize hybrid bonds relative to S&P's cap. The options are 0%, 25%, 50%, 75%, or 100% of the cap. Given: - Current utilization is roughly 19-38% depending on calculation method - Interest rates rose significantly in 2022, making fixed-rate financing more expensive going forward - The company has significant debt (11B EUR vs 6B equity) - Hybrids provide equity credit, improving leverage ratios - The coupon on hybrids (2.13% based on 21.1M/989M) seems relatively attractive compared to 2022 market rates However, looking more carefully: - The company already has 989M in hybrids - They have room to increase under the 15% cap - In a rising rate environment (2022), locking in long-term financing at fixed rates becomes less attractive if rates continue rising, but hybrids typically have reset features - The company's debt-to-equity is already high (~1.8x) Key considerations for hybrid bond strategy: 1. **Leverage improvement**: Hybrids improve credit metrics by being treated partially as equity 2. **Cost**: In 2022, with rising rates, new hybrid issuance would be more expensive 3. **Financial flexibility**: Having unused cap capacity provides flexibility 4. **Market conditions**: The 2022 rate environment suggests caution on long-term fixed rate commitments Given that TERNA: - Already uses some hybrids (~19-38% of cap depending on calculation) - Has significant infrastructure/assets (16.2B PPE) supporting creditworthiness - Operates in a regulated utility sector with stable cash flows - Benefits from partial equity treatment for rating purposes The optimal strategy would likely be to use a moderate portion of the cap - not minimal (they already benefit from some), but not maximum (to preserve flexibility and avoid over-reliance on expensive hybrid capital in a rising rate environment). At 50% utilization of the cap, they would roughly double their current hybrid usage. This would provide meaningful leverage improvement while maintaining flexibility and not maxing out the capacity. Given the rising rate environment in 2022 and the company's already significant debt load, using 50% of the S&P cap seems prudent - it provides meaningful equity credit benefits for ratings without over-committing to this expensive form of capital or using up all flexibility. 50%