An Introduction To Bank Hybrids

Welcome to ANZ’s introductory guide for Australian retail investors on Australian bank hybrid securities or “Hybrids” (which are also referred to as capital notes or convertible preference shares and are “Additional Tier 1” securities for regulatory purposes).

This will help step you through the important issues and risks that you need to be aware of and consider before you make any investment in Hybrids and will introduce you to terms and concepts used in relation to Hybrids and by financial advisers.

It is not designed to be a guide for any other bank investments, such as subordinated notes (also referred to as “Tier 2” securities for regulatory purposes) or ordinary shares.

Hybrids are complex and each Hybrid is different. Hybrids may not be suitable for all investors. The risks associated with Hybrids could result in the loss of your investment and associated income and the investment performance of Hybrids is not guaranteed.

This website is for informational purposes only and addresses only some of the features and risks associated with an investment in Hybrids. It does not contain investment advice and its content has been prepared without taking into account any investor’s objectives, financial situation or needs. Therefore, before investing in a Hybrid, it is recommended that the investor seek professional guidance which takes into account your particular investment objectives and circumstances from a professional adviser who is licensed by ASIC to give such advice.

An Introduction To Bank Hybrids

What You Should Do Before You Invest?

1. Read the relevant Prospectus in full.

The terms of each Hybrid are different and so it is important that you read the information in the relevant prospectus in its entirety before deciding to invest.

The prospectus for a Hybrid issue will generally be published the bank’s website and on the ASX.

In considering whether to invest in a Hybrid, it is important to consider all risks and other information regarding that investment in light of your particular investment objectives, financial situation and needs and circumstances, as the information in the prospectus will not take into account those objectives and circumstances.

2. Speak to your professional adviser.

If you wish to invest in a Hybrid, it is recommended that you seek professional guidance which takes into account your particular investment objectives and circumstances from a professional adviser who is licensed by ASIC to give such advice.

ASIC has published guidance on how to choose a professional adviser on its MoneySmart website. You can also search ‘choosing a financial adviser’ at www.moneysmart.gov.au.

3. Consider the ASIC guidance for retail investors.

ASIC has published guidance on Hybrids and other similar securities on its MoneySmart website which may be relevant to your consideration of an investment in Hybrids. The guidance includes a series of questions you should ask before investing in Hybrids.

You can also take the MoneySmart hybrids quiz to check your understanding of how Hybrids work, their features and risks.

4. Obtain further information about the issuing bank and the relevant Hybrid.

Bank issuers of Hybrids typically publishes information on the ASX which may have a material effect on the price of a Hybrid, including financial disclosures. You should consider reading this information before deciding to invest in Hybrids.

An Introduction To Bank Hybrids

How Can You Invest in a Bank?

To get started, let’s look at the different ways that an Australian investor can invest in a bank.

Each type of investment has different terms and a different risk and return profile.

  • Savings accounts

    Savings accounts are deposits where interest is earned on the amount deposited and the amount deposited is repayable on request.

    Deposits in aggregate up to a limit, which is currently the first $250,000 invested with the bank, may be protected by the Australian government under the Financial Claims Scheme if the bank is declared subject to the scheme.

  • Term deposits

    Term deposits are deposits where interest is earned on the amount deposited. The deposit is repayable at the end of a fixed term, typically a period of 1, 3 or 6 months but which can also be for up to 5 years or longer.

    Deposits in aggregate up to a limit, which is currently the first $250,000 invested with the bank, may be protected by the Australian government under the Financial Claims Scheme if the bank is declared subject to the scheme.

  • Senior debt

    Senior debt is typically an investment in a bond or note where interest is earned on the amount invested. The amount invested is repayable on a fixed date, typically after between 1 and 10 years.

    Banks do not generally issue senior debt to retail investors.

  • Subordinated debt

    Subordinated debt is an investment in a subordinated bond or note where interest is earned on the amount invested and which meet certain requirements for regulatory purposes. The amount invested is repayable on a fixed date, typically after 10 years. The interest is cumulative which means that if interest is not paid, it remains payable at a later date, subject to conditions. The bank typically has a right to redeem it early in some cases. Subordinated Debt is also loss absorbing in that it may be required to convert into ordinary shares of the bank or be written-off if the bank is in financial difficulties. This means that investors in subordinated debt are at the risk of suffering loss if the bank is in financial difficulties.

    They may also be referred to as “Tier 2 capital” securities for regulatory purposes.

  • Hybrid securities

    Hybrids are subordinated securities, such as capital notes or preference shares which meet certain requirements for regulatory purposes. Hybrids have no fixed maturity date but may be scheduled to convert into ordinary shares on a fixed date. Interest or dividends are payable on the investment at the bank’s discretion and subject to conditions. Hybrids are also loss absorbing in that they may be required to convert into ordinary shares of the bank or be written-off if the bank is in financial difficulties. This means that investors in Hybrids are at the risk of suffering loss if the bank is in financial difficulties.

    They may also be referred to as “Additional Tier 1 capital” securities for regulatory purposes.

  • Ordinary shares
    Ordinary shares (or equity) are a permanent investment in the bank which is not repayable. The bank may pay dividends at its discretion which typically relate to the bank’s profit. Dividends are paid on a per share basis so the amount of an investor’s dividend is determined by the number of shares held and not on the amount invested.

 

An Introduction To Bank Hybrids

What is a Hybrid?

Let’s look at Hybrids to help you understand their key features.

Hybrids are usually in the form of convertible preference shares or capital notes.

A summary of the key features typically found in a Hybrid, their meaning and the associated risks are outlined in the table below. As you will see, Hybrids are complex and may behave differently to other investments. As such, they may not be suitable for all investors. The risks associated with a Hybrid depend on a range of factors (such as a complex series of events, conditions and approvals) that are outside an investor’s control and in many cases outside the bank’s control.

How can Hybrids be purchased?

Hybrids can be purchased in an initial offering to the market. If they are listed on the ASX, they can also be purchased or sold after issue on the exchange at the prevailing market price.

Why do banks issue Hybrids?

Australian banks issue Hybrids to help the bank meet the capital requirements of their banking regulator, the Australian Prudential Regulation Authority (APRA). APRA requires banks to maintain a level of capital to promote the stability of the bank and protect depositors.

Hybrids are “loss absorbing” which means that investors in Hybrids are at the risk of suffering loss if the bank is in financial difficulty. This is typically effected through Hybrids being converted into shares in the bank or written-off. It is this loss absorption borne by Hybrid investors which protects depositors.

Although the terms may vary between Hybrids, the key features and risks of different Hybrids are similar because they need to satisfy the same regulatory requirements prescribed by APRA.

Perpetual

What does this mean?

Hybrids do not have any fixed maturity date

What are the associated risks?

Hybrids could remain on issue indefinitely if they are not converted or redeemed, in which case investors may not receive their investment back. The return on Hybrids is generally higher than deposits reflecting the increased risk of the investment not being repaid.

Convertible

What does this mean?

Hybrids typically convert into a variable number of ordinary shares in the bank approximately equal to the face value of the investment (i) on or following a scheduled date, typically between 7 to 10 years after they are issued, (ii) on a change of control of the bank or (iii) at the bank’s discretion following certain changes in the tax or regulatory rules or on the same date that the bank has a right to redeem the Hybrid. Conversion is subject to a number of complex conditions.

Conversion may also occur where the bank is in financial difficulty. The section on loss absorption below contains more detail on this scenario.

Investors cannot request any conversion of a Hybrid.

What are the associated risks?

As conversion in any of these circumstances is subject to a number of complex conditions (including the ordinary share price not falling significantly) which could prevent or defer the conversion, a Hybrid may remain on issue indefinitely and investors may not receive their investment back.

Redeemable

What does this mean?

The bank may be permitted to redeem a Hybrid, or transfer it to a third party (also known as a “resale”), early on a specified date which is typically between 5 to 8 years after its issue or following certain changes in the tax or regulatory rules. Any redemption and transfer is subject to a number of conditions.

Investors cannot request early redemption or transfer.

What are the associated risks?

Any redemption or transfer of a Hybrid is subject to restrictions, including the receipt of prior approval from APRA and so may never occur. Investors should not expect that APRA will give its approval.

As a result of redemption or transfer to a third party, an investment in a Hybrid may be repaid earlier than expected at a time when rates on similar instruments are lower, which may mean investors cannot reinvest their investment at a similar rate of return.

Discretionary and non-cumulative distributions

What does this mean?

Distributions are in the form of regular interest or dividend payments based on a pre-determined rate and payable on fixed payment dates. They are subject to the bank’s discretion and a number of conditions (including the bank meeting its capital requirements). Any unpaid distributions do not accumulate.

What are the associated risks?

As the payment of distributions is discretionary and subject to conditions, investors may never receive a distribution. Investors will not have any right to compensation if the bank does not pay a distribution. The return on Hybrids is generally higher than deposits because there is a bigger risk that the distribution will not be paid.

Unsecured

What does this mean?

Hybrids are not guaranteed or secured. They are also not deposits with the bank.

What are the associated risks?

Hybrids are not protected under the Financial Claims Scheme. If there is a shortfall of funds as a winding-up of the bank, investors will not receive some or all of their investment back.

Subordinated

What does this mean?

Although Hybrids have priority over ordinary shares in the winding-up of an issuing bank, they are subordinated to the claims of all other creditors, including depositors.

What are the associated risks?

Investors may have none or only part of their investment repaid in a winding-up of the bank, as it is likely there will be insufficient assets remaining after higher ranking obligations have been repaid.

Loss absorbing

What does this mean?

If the bank experiences severe financial difficulty, Hybrids may be required to absorb losses by being converted into ordinary shares of the bank or by being written-off. This may occur where APRA deems the bank to be non-viable or if the bank’s capital ratios are reduced to a certain level.

What are the associated risks?

The investor may lose some or all of their investment and will not be entitled to any compensation or any unpaid distributions.

Listed

What does this mean?

Hybrids are usually listed, and tradeable, on the ASX.

What are the associated risks?

Market prices for Hybrids may be volatile and the market may experience low liquidity. Trading in Hybrids is typically less liquid than ordinary shares. As a result, if an investor sells a Hybrid on the ASX they may receive less than their investment and may incur a loss.

An Introduction To Bank Hybrids

How do Investments in a Bank Rank?

Each type of investment in a bank will rank differently in a winding up of the bank.

A higher ranking investment will be repaid out of the bank’s available assets in a winding-up of the bank before investments with a lower ranking.

It may be that holders of lower ranking investments, including Hybrids, will only have part or none of their investment repaid, as there may be insufficient assets remaining after higher ranking investments have been repaid first.

As a result, lower ranking investments are riskier and generally pay a higher return. The market price of a lower ranked investment also tends to be more volatile.

Investors in Hybrids are typically the second last group of investors to be repaid if the bank is wound-up. Only ordinary shares rank lower.

Earlier priority, lower return, less risky.

Higher
Ranking
Lower
Ranking
  1. Savings accounts
  2. Term deposits
  3. Senior debt
  4. Subordinated debt
  5. Hybrid securities
  6. Ordinary shares

Later priority, higher return, more risky.

An Introduction To Bank Hybrids

Comparing the Investments

This summary of key differences between different kinds of bank investments in Australia. These will help you consider which kind of investment best suits your particular financial situation and needs.

 SubordinatedProtected under the Financial Claims SchemeListed & TransferableUsual Term / MaturityType of ReturnConditions to distributionsAre distributions at the Bank’s discretion?Are unpaid disributions cumulative?Dividend Stopper if distributions not made?Investor’s early redemption rightsBank’s early redemption rightsMandatory Conversion into ordinary sharesConversion on occurrence of a Trigger EventVoting Rights at a general meeting of the Bank
Savings AccountNoYes, subject to limit currently of $250,000 per account holder with the bankNoAt callVariable interest rateNoNoYesNoYesNoNoNoNo
Term DepositNoYes, subject to limit currently of $250,000 per account holder with the bankNo1 month to 5 yearsFixed interest rateNoNoYesNoYesNoNoNoNo
Retail Subordinated NotesYesNoYesTypically 10 yearsFloating interest rateYesNoYesNoNoYes, subject to conditions and APRA‘s prior approvalNoYes, if the bank is non-viableNo
Hybrid securitiesYesNoYesPerpetual, subject to mandatory converison into ordinary sharesFloating interest ort dividend rateYesYesNoYesNoYes, subject to conditions and APRA‘s prior approvalYes, subject to conditionsYes, if the bank is non-viable or a minimum capital requirement is breachedNo
Ordinary SharesYesNoYesPerpetualVariable dividend (as determined by the bank based n its profit)YesYesNoNoNoNoNot ApplicableNot ApplicableYes