Michael Elsworth, Manager, Fixed Income, Lonsec
In December 2024, APRA announced the phase-out of Additional Tier 1 securities (AT1 or hybrids) as eligible bank capital, a move that will see the $40+ billion Australian bank hybrid market shut by 2032. This announcement of the phase-out of hybrid securities issued by Australian banks has created a challenge for investors accustomed to the income and franking credits generated by these securities.
Hybrid securities carry greater credit risk than typical corporate bonds due to their subordinated status on the balance sheet. They also carry tail risk, including potential conversion to equity and material capital losses, even in scenarios where senior bondholders might recover their investments during severe crises. ‘The purpose of AT1 is to stabilise a bank so that it can continue to operate as a going concern during a period of stress, and support resolution with the capital that is needed to prevent a disorderly failure,’ APRA stated. ‘Unfortunately, international experience has shown that AT1 does not fulfil this function in a crisis situation due to the complexity of using it, the potential for legal challenges and the risk of causing contagion. These risks are heightened in the Australian context due to the unusually high proportion of AT1 held by retail investors.’
There has been no shortage of replacement assets offered up by market participants. Here, we take a brief look at some of the alternatives.
Government bonds / Corporate bonds / High-yield bonds
Bonds generally provide more capital stability for medium to long-term investors than hybrids, which do not offer an agreed schedule of dividend payments or the full principal repayment at the end of a given term. Of course, bonds offer varying levels of credit risk and hence a yield spectrum from safe or risk-free to speculative. Debt instruments such as bonds do not distribute franking credits.
Offshore bank and corporate hybrids
In September 2025 UBS issued an AT1 bond in Australian dollars, becoming the first bank to issue this type of debt in the local market since APRA’s announcement. The deal was heavily oversubscribed, indicating there is still substantial demand for these securities. It seems somewhat odd that the void could potentially be filled by offshore banks and corporates operating outside the remit of Australia’s regulators. Given franking credits are generated by Australian-resident companies, franking credits may not be available to Australian investors.
There are also a limited number of corporate hybrids. Westfield mall owner, Scentre Group, recently issued a $900 million hybrid while petrol retailer Ampol, power grid owner AusNet, and gas pipeline business APA also have hybrids on issue. However, corporate hybrids are far less regulated than the bank hybrid market.
Subordinated debt
APRA now wants hybrid issuers to move to other forms of capital instruments such as subordinated bonds, which are designated as Tier 2 capital. It is important to note that subordinated bonds are unsecured and rank below more senior forms of debt securities such as senior and senior secured bonds. Many consider subordinated debt to be the most genuine hybrid replacement. The subordinated debt market is much bigger than the hybrid market in Australia, with ~$120 billion issued by major Australian banks globally, compared to hybrids which is a ~$40 billion market. It is an established market with institutional investors and actively and passively managed subordinated debt ETFs, providing an accessible fixed income solution for hybrid investors. As a debt security, subordinated debt does not distribute franking credits, which may impact post-tax income for some investors. However, in a post-hybrid world, the only franking credit option remaining is direct equity investment.
Managed Funds
There are many managed funds capable of filling the gap, particularly Specialised Income, Specialised High Income, which are more likely to have objectives that align most closely with the risk and return profile of soon-to-be phased out hybrid securities.
Important Information: This article has been produced by Lonsec Research Pty Ltd ABN 11 151 658 561, AFSL No. 421445 (Lonsec). Generation Development Group Limited ABN 90 087 334 370 is the parent company of Lonsec Research.
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