Weekend Edition: Bank Hybrids. Just too complex?
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What are bank hybrids (AT1s) and why is APRA planning to phase them out?
Today we are talking hybrids in the banking world. What are they, the role they play, and why ACRA wants to get rid of them and we'll talk to one man who used to think they were a bad idea who now thinks getting rid of them isn't such a great idea either. That's this weekend. The morning call from NAB with Phil Dobby. The weekend edition. And the views expressed, we should point out, on the weekend edition, are not those of NAB. The whole idea is that we get a variety of opinions on a variety of topics. And this is a topic that has ignited a bit of debate amongst certain investors. Bank hybrids. So let's start with the very basic basics. I mean, banks obviously have to secure enough equity to cover unexpected losses, so if they incur a lot of bad debt.
For example, how much equity they require is laid out in the internationally agreed Basal III regulations, which are split between Tier one capital, which is basically money raised from shares and any retained earnings from previous years, and tier two capital, uh which are fixed term bonds issued by the bank, which is obviously a way of getting money without expanding the amount of shares that are in circulation. But there is something in between, a hybrid between the Tier Bond capital, the equity, and the less immediately accessible tier two capital, which is where the bonds are, there's this middle layer called 81s, additional tier one capital, which really gained traction out of the global financial crisis.
So let's look at how they work and what APRA is proposing, which is to get rid of them by January 2027. Let's talk to Chris Joy from Coolabar Capital on all of this. Because Chris, it sounds like you originally thought I thought that it was uh a good idea not having eighty ones. And now you're not so sure. Uh but first of all, uh explain what Eighty ones are, you know, add to my very basic description there.
Yeah, I mean it's just a substitute for equity. Let's just be clear. So it's still part of Tier One capital. So to be clear, Tier One capital comprises two things. Ordinary shares, which are equity. That's what trades on the ASX. And then secondly, additional Tier One capital. Which is another layer of Tier One capital. And that Tier One buffer is the equity on a bank balance sheet. And the idea behind hybrids was that in a crisis When a bank needs additional equity. The hybrids can literally switch into shares. crucially diluting down the shareholders who sit below them in the capital stack. Uh but otherwise, in periods where there was not a crisis, the hybrids would pay you a predetermined uh income yield.
And that's normally um historically been about three percent. Above proxies for the RBA cash rate. So the cash rate's four point one and you're getting a three percent extra margin on hybrids, you're earning seven point one percent via these hybrids. So in summary, they're just another form of equity. They sit within tier one. Above tier one sits subordinated bank bonds, also called tier two capital. Um that can't be switched into equity. In a in a normal crisis. Then above that you have senior bonds, above that you have deposits. And above deposits you actually have another form of a bond called a sing a secured bond or a covered bond. But hybrids were um cheap ways for banks to raise equity.
How do AT1 hybrids fit into the Basel III capital hierarchy and why are they considered a cheap equity substitute?
There's the cost of equity in Australia if you issue equity through a placement or through an IPO for a a big four major bank is probably something in the order of nine to ten percent per annum. And maybe less, um, you know, prior to the recent correction. So if if it costs you just hypothetically, roughly ten percent per annum. in required returns on equity. And you can get away with issuing equity that actually only costs you seven percent per annum. when you raise hybrid money. As a bank, every day of the week you prefer to raise hybrid money. Now to answer your question, like why was I of the view that this was a a good idea getting rid of hybrids? So just to kind of explain one nuance, hybrids have existed for a quarter of a century, well before the two thousand eight crisis.
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Chapters
8 chapters
1
What are bank hybrids (AT1s) and why is APRA planning to phase them out?
0:01–3:31
2
How do AT1 hybrids fit into the Basel III capital hierarchy and why are they considered a cheap equity substitute?
3:31–6:50
3
What are the main arguments for and against eliminating AT1 hybrids, according to Chris Joye?
6:50–9:43
4
How did the Credit Suisse collapse illustrate the risks of AT1 hybrids for retail investors?
9:43–12:57
5
What is the trigger point that forces an AT1 hybrid to convert into ordinary shares?
12:57–16:16
6
How will the removal of hybrids affect retail investors and where might their money flow next?
16:16–19:16
7
What replacement instruments (subordinated bonds, ETFs, corporate hybrids) are likely to emerge after the phase‑out?
19:16–23:21
8
What are the broader implications for bank stability and super‑fund allocations once AT1s disappear?
23:21–26:24