Background

In December 2025, APRA finalised the phase-out of bank-issued Additional Tier 1 (AT1) capital instruments, commonly known as bank hybrids, as eligible regulatory capital from 1 January 2027, with transitional treatment for existing instruments.  

For many advisers and income-seeking investors with exposures to hybrids this has caused a dilemma – what to do next? What alternatives are there in the market to replace hybrids, what are the key differences, and can the hybrid yield (along with franking credits) be replaced? 

Hybrids have been an attractive product for investors, particularly for their floating-rate distributions, franking credits and ASX trading, although their market prices, liquidity and distributions can vary. There are several approaches that can be taken by investors, and it’s important to understand the features of each and how they align to client requirements.  

Alternatives to hybrids may include bank subordinated debt, corporate bonds, ETFs, equities, private credit, bank hybrids still outstanding during the transition and some non-bank hybrids, including insurer-issued securities. These alternatives all vary from hybrids to some degree, and each has their own unique characteristics. Put simply, the questions are what role hybrids played in the portfolio and what trade-offs are acceptable - whether that’s yield, capital/price stability, franking credits or credit risk.  

Key issues for investors

Below are some of the key issues facing investors as their hybrid holdings reach call dates or maturity. 

Franking credits 

Franking credits are important for some investors, with their value depending on the investor’s tax circumstances. Franking can be obtained through equities, albeit by taking on additional market/price risk.  

Reinvestment risk  

As hybrids mature (or are redeemed), investors face a situation whereby they run the risk that an equivalent yield cannot be achieved. Furthermore, where an equivalent (or higher) yield can be achieved, it’s often at the expense of taking on additional risk, namely price risk (in the case of equities) or accepting a higher credit risk (in the case of private credit or corporate bonds). 

Liquidity risk (moving to alternatives with less liquidity)

Many proposed hybrid alternatives (such as private credit) can be relatively illiquid, and are not priced frequently, like hybrids are, on the ASX. There are two potential issues here: how current and transparent is the pricing of the securities, and can an investor sell their assets when they want to? We have seen cases where some funds restrict or suspend redemptions under their terms, leaving investors capital tied up for extended periods. 

Alternative products 

Remaining hybrids  

Some investors may choose to remain invested in hybrid securities, including some non-bank issues, such as insurer hybrids, and bank hybrids still outstanding during the transition.. However, as bank hybrids are progressively called or otherwise cease to be outstanding, the investable universe is expected to contract, potentially creating a crowded trade in the remaining securities. Longer-dated hybrids may attract particular interest because they are likely to remain available for longer, but a scheduled call date is not a guarantee of redemption. If demand outpaces supply, prices could potentially be bid higher and yields compressed, reducing the income advantage that has historically attracted investors to the sector. 

Bank subordinated debt 

Bank Subordinated debt (Tier 2 Capital) sits higher on the capital stack compared to hybrids, and as a result, typically provides a lower yield. Bank subordinated debt may be one of the more comparable alternatives, but is not a one-for-one replacement. It ranks ahead of AT1 in the capital structure, while retaining subordination, loss-absorption, liquidity and market risks. If a higher yield is required, bank subordinated debt can be combined with higher yielding corporate bonds in client portfolios, to seek a suitable risk and income profile, depending on prevailing yields. 

Corporate bonds 

Investment grade corporate bonds can provide higher yields than both subordinated debt and hybrids and also provide the benefits of diversification and a large range of available maturities. As the yields are generally higher thank bank subordinated debt, so too is the credit risk. As above, they can be combined with subordinated debt within investor portfolios, to achieve the desired level of risk and return.  

ETFs 

There are several bank/credit/yield ETFs available on the ASX. Key benefits of ETFs include instant diversification, on-exchange tradability, and quoted market prices on trading platforms  Drawbacks however may include a loss of investor control (i.e. an investor loses specific choices regarding issuer, sector and maturity). The underlying benchmark an ETF tracks may also be more conservative than an investors risk appetite, lowering the returns offered. There is also the potential for accumulated fee drag due to the ETF’s management fee (the Management Expense Ratio (MER) which needs to be considered. 

Equities 

Pros: potential upside, plus dividends and franking 

Cons: lower on the capital stack, and higher price volatility. 

Equities offer the advantages of upside to pricing in addition to dividends and franking, liquidity and the convenience and transparency of trading via modern platforms. However, equities rank lower on the capital stack (risk of capital loss) and often come with higher price volatility which some investors, such as those in or approaching retirement, may not be able to tolerate in portfolios. 

Private credit 

There have been several private credit solutions offered over recent years which have attracted investor attention due to potential diversification benefits and advertised yields that may be higher than those on hybrids. However, these yields raise questions about borrower credit quality in addition to potential issues regarding illiquidity and infrequent pricing (e.g. quarterly), which may cause the risk and return profile to appear ‘smoother’ than they would if they were priced daily or traded on an exchange.  

Some private credit funds and providers have also attracted increased scrutiny from regulators, in part due to the issues noted above. 

Conclusion 

While there are several alternatives to hybrids, none are like-for-like replacements and they typically come with a trade-off, whether lower yield, higher credit risk, or greater volatility and price risk. It’s important for advisers to understand the alternative-specific risks, to effectively create portfolios that meet client requirements.  

Generally speaking, looking at the characteristics of hybrids and the alternatives and considering the role hybrids play in some investment portfolios, a combination of bank subordinated debt, combined with Investment Grade corporate bonds may provide comparable characteristics, depending on the investments and client needs. For those investors potentially willing to accept a slightly lower yield, bank subordinated debt serves this purpose, while ranking higher in the capital stack. There is also a range of corporate bonds with differing yields available, providing investors flexibility in managing the required rate of return and risk for their portfolios.  

 

Stay up to date with the latest insights - sign up to the monthly AXIS email newsletter.

 

This information has been prepared by Australian Investment Exchange Limited (AUSIEX) ABN 71 076 515 930 AFSL 241400, a wholly owned subsidiary of Nomura Research Institute, Ltd. (NRI). AUSIEX is a Market Participant of ASX Limited (ASX) and TMX Australia Exchange Pty Limited (TMX), a Clearing Participant of ASX Clear Pty Limited and a Settlement Participant of ASX Settlement Pty Limited. 

* AUSIEX Fixed Income is provided under FIIG Securities Limited’s Australian Financial Services Licence (AFSL 224659) a wholly owned subsidiary of AUSIEX (ABN 71 076 515 930) (AFSL 241400). 

FIIG Securities Limited (‘FIIG’) provides general financial product advice only. As a result, this document, and any information or advice, has been provided by FIIG without considering one or more of your objectives, financial situation and needs. Because of this, you should, before acting on any advice from FIIG, consider the appropriateness of the advice having regard to your objectives, financial situation and needs. If this document, or any advice, relates to the acquisition, or possible acquisition, of a particular financial product, you should obtain a product disclosure statement relating to the product and consider the statement before making any decision about whether to acquire the product. Neither  

FIIG, nor any of its directors, authorised representatives, employees, or agents, make any representation or warranty as to the reliability, accuracy, or completeness, of this document or any advice. Nor do they accept any liability or responsibility arising in any way (including negligence) for errors in, or omissions from, this document or advice. FIIG, its employees and related parties earn fees and revenue from dealing in the securities as principal or otherwise and may have an interest in any securities mentioned in this document. Any reference to credit ratings of companies, entities or financial products must only be relied upon by a ‘wholesale client’ as that term is defined in section 761G of the Corporations Act 2001 (Cth). FIIG strongly recommends that you seek independent accounting, financial, taxation and legal advice, tailored to your specific objectives, financial situation and needs, prior to making any investment decision. FIIG does not provide tax advice and is not a registered tax agent or tax or financial advisor, nor are any of FIIG’s employees or authorised representatives. A copy of FIIG’s current Financial Services Guide is available at www.fiig.com.au/fsg. 

An investment in notes, bonds or securities should not be compared to a bank deposit. Notes, bonds and securities have a greater risk of loss of some or all of an investor’s capital when compared to bank deposits. Past performance of any product described in any communication from FIIG is not a reliable indication of future performance. Forecasts contained in this document are predictive in character and based on assumptions, such as a 2.5% p.a. assumed rate of inflation (unless otherwise specified), foreign exchange rates, or forward interest rate curves generally available at the time, and no reliance should be placed on the accuracy of any forecast information. The actual results may differ substantially from the forecasts and are subject to change without further notice. FIIG may quote to you an estimated yield when you purchase a bond. This yield may be calculated by FIIG on either A) a yield to maturity date basis; or B) a yield to early redemption date basis. Some bond issuances include multiple early redemption dates and prices, therefore the realised yield earned by you on the bond may differ from the yield estimated or quoted by FIIG at the time of your purchase. The information in this document is strictly confidential. If you are not the intended recipient of the information contained in this document, you may not disclose or use the information in any way. No liability is accepted for any unauthorised use of the information contained in this document. FIIG is the owner of the copyright material in this document unless otherwise specified.