Bank Hybrids

This Guide provides only a brief overview of the features and risks associated with an investment in Bank Hybrids. You should read the prospectus for a Bank Hybrid carefully, paying attention to the investment risks. In the event you need further information, you should seek professional guidance from your stockbroker, solicitor, accountant or other independent and qualified professional adviser.

Types of Bank Hybrids

In this Guide, when we refer to Bank Hybrids, we are referring to Tier 1 Bank Hybrids or Tier 2 Bank Hybrids that meet APRA's APRA The Australian Prudential Regulation Authority. prudential standards to be treated as regulatory capital of the issuing bank.

Bank Hybrids contain terms that enable them to be converted into ordinary shares, or written-off Write-off If Bank Hybrids are written-off, investors will lose all of the value of their investment and they will not receive any compensation or unpaid distributions or interest. completely in certain circumstances (these circumstances may include, for example, if the bank experiences severe financial difficulty). See Conversion events. There are a number of measures that may be used to assess the strength of a bank and the risk that a bank may experience financial difficulty. Investors should seek to understand what these metrics are and how to measure them.

Term
Distributions
Potential loss of investment
Term
  • Perpetual Perpetual If a security is perpetual, it does not have a fixed maturity date and could exist indefinitely. - Tier 1 Bank Hybrids do not have a fixed maturity date and could exist indefinitely. The face value Face value The face value is typically the issue price, which will be reduced by any partial conversion or write-off. of a Tier 1 Bank Hybrid may never be repaid.
  • Tier 1 Bank Hybrids typically convert into ordinary shares on a fixed date (the scheduled or mandatory conversion date) Scheduled or mandatory conversion date A date on which conversion of a Tier 1 Bank Hybrid is expected to occur (subject to the conversion conditions being met) and set out in the prospectus for the particular Bank Hybrid. See scheduled conversion. , subject to the conversion conditions Conversion conditions Conversion of some Bank Hybrids may be subject to conversion conditions set out in the prospectus for the particular Bank Hybrid. See Case Study 3, including a worked solution, for further detail. being satisfied. The conversion conditions operate to ensure that upon conversion on the scheduled or mandatory conversion date, investors will receive bank ordinary shares worth approximately $101.01 for each Tier 1 Bank Hybrid (based on a face value of $100 per Tier 1 Bank Hybrid and taking into account a 1% discount to the relevant VWAP). However, there is a risk that the conversion conditions are never satisfied and the Tier 1 Bank Hybrid remains on issue indefinitely.
  • Tier 1 Bank Hybrids may contain an early call feature where the face value of the Tier 1 Bank Hybrid may be repaid early in cash on a specified date (known as the call date or the redemption date) at the election of the issuing bank. To repay a Tier 1 Bank Hybrid early, a bank requires prior approval from APRA APRA The Australian Prudential Regulation Authority. (which APRA may withhold).
  • Investors cannot request conversion or early redemption of Tier 1 Bank Hybrids. However, if quoted on the ASX ASX The Australian Securities Exchange. , an investor may choose to sell their Tier 1 Bank Hybrids at the prevailing market price to realise their investment. The market price may be less than the face value of the Tier 1 Bank Hybrid (or the price at which the Tier 1 Bank Hybrid was purchased for on the ASX), or there may be no liquid market in the Tier 1 Bank Hybrids (i.e., there may not be enough buyers or sellers in the market), which may result in investors suffering loss or not being able to realise their investment on the ASX.
Distributions
  • Tier 1 Bank Hybrids pay distributions that are subject to distribution payment conditions Distribution payment conditions There are certain conditions that must be satisfied before distributions can be paid, including (i) that the payments are at the discretion of the bank, (ii) that the payments will not result in a breach of the bank’s regulatory capital requirements or in the bank becoming insolvent, and (iii) that APRA does not object to the payment. . Distributions typically have franking credits Franking credits Franking credits represent each holder’s share of tax paid by the issuing bank on the profits from which the distributions are paid. attached.
  • The distribution rate on Tier 1 Bank Hybrids, assuming they are fully franked, is typically determined as the sum of BBSW BBSW BBSW is a key benchmark interest rate for the Australian money market that moves over time in line with market conditions and monetary policy. It is typically the 90 day bank bill swap rate. plus a margin Margin The margin is fixed at the time of issue and typically reflects the risk premium of a Bank Hybrid above a floating market rate (e.g., BBSW) at the time of issue. , together multiplied by (1-tax rate). In effect, the distribution rate is adjusted to take into account the franking credits that are attached to the distribution payments. As distribution payments are based on BBSW, distribution payments are likely to vary over the term of the Tier 1 Bank Hybrid.
  • For an explanation of how distributions for Tier 1 Bank Hybrids are calculated, see Case Study 1.
  • The ability of an investor to use franking credits, either as an offset to a tax liability or by claiming a tax refund, will depend on the investor’s individual tax position.
  • It is possible that distributions on Tier 1 Bank Hybrids may not be paid as they are at the bank’s absolute discretion and subject to the distribution payment conditions (including, for example, that the payment of the distribution will not result in either a breach of APRA’s APRA The Australian Prudential Regulation Authority. regulatory capital requirements or the bank becoming insolvent). If a distribution is not paid, the missed payment will not be made up (often referred to as being non-cumulative Non-cumulative Unpaid distributions will not accumulate or be made up by the issuing bank. ). However, if a distribution is not paid, the bank will be restricted from paying dividends on its ordinary shares or from buying-back its ordinary shares for a specified period. These restrictions (sometimes referred to as “dividend stoppers” or "capital stoppers" respectively) acts as a protection for Tier 1 Bank Hybrid investors.
Potential loss of investment
  • If a bank’s capital falls below certain capital levels (a capital trigger event Capital trigger event A capital trigger event occurs when the issuing bank determines (or is notified by APRA) that the bank’s common equity tier 1 ratio is equal to or less than 5.125%. See capital trigger event. ), or a non-viability trigger event Non-viability trigger event A non-viability trigger event will occur when APRA notifies a bank in writing that it believes (i) conversion to ordinary shares of some or all of its Bank Hybrids or (ii) a public sector injection of capital or equivalent support, is necessary to prevent the bank becoming non-viable. See non-viability trigger event. occurs (see non-viability trigger event for guidance on when APRA may consider a bank to be non-viable), a bank may be required to convert some or all of its Tier 1 Bank Hybrids into ordinary shares. Conversion of Tier 1 Bank Hybrids following a capital trigger event or a non-viability trigger event is not subject to conversion conditions Conversion conditions Conversion of some Bank Hybrids may be subject to conversion conditions set out in the prospectus for the particular Bank Hybrid. See Case Study 3, including a worked solution, for further detail. being satisfied. If the Tier 1 Bank Hybrids are converted into ordinary shares, the value of ordinary shares an investor receives may be significantly less than the face value Face value The face value is typically the issue price, which will be reduced by any partial conversion or write-off. of their Tier 1 Bank Hybrid. This is because the number of ordinary shares an investor will receive in these circumstances is limited to a maximum conversion number Maximum conversion number The maximum conversion number is a limit or cap on the number of ordinary shares of the bank that may be issued on conversion. For a scheduled or mandatory conversion, the maximum conversion number reflects 50% of the bank's ordinary share price at the time of issue of the Bank Hybrid. For conversion following a non-viability trigger event or a capital trigger event, the maximum conversion number reflects 20% of the bank's ordinary share price at the time of issue of the Bank Hybrid. , which is based on the bank's ordinary share price at the time of issue of the Tier 1 Bank Hybrid (and the bank’s ordinary share price may have dropped considerably due to the bank’s financial difficulty). If for any reason conversion does not occur and if the ordinary shares are not issued for any reason within a specified period, all rights in relation to the Tier 1 Bank Hybrids will be terminated and investors will lose all of the value of their investment and they will not receive any compensation or unpaid distributions.
Term
Interest
Potential loss of investment
Term
  • Fixed maturity date Maturity date The date on which a Tier 2 Bank Hybrid is scheduled to mature. – if a bank is solvent, it must repay the face value Face value The face value is typically the issue price, which will be reduced by any partial conversion or write-off. of its Tier 2 Bank Hybrid on the maturity date.
  • Tier 2 Bank Hybrids may contain an early call feature where the face value of the Tier 2 Bank Hybrid may be repaid earlier than the maturity date (known as a call date or early redemption date) at the election of the issuing bank. To repay a Tier 2 Bank Hybrid early, a bank requires prior approval from APRA APRA The Australian Prudential Regulation Authority. (which APRA may withhold).
  • Investors cannot request conversion or early redemption of Tier 2 Bank Hybrids. However, if quoted on the ASX ASX The Australian Securities Exchange. , an investor may choose to sell their Tier 2 Bank Hybrids at the prevailing market price to realise their investment. The market price may be less than the face value of the Tier 2 Bank Hybrid (or the price at which the Tier 2 Bank Hybrid was purchased for on the ASX), or there may be no liquid market in the Tier 2 Bank Hybrids (i.e., there may not be enough buyers or sellers in the market), which may result in investors suffering loss or not being able to realise their investment on the ASX.
Interest
  • Tier 2 Bank Hybrids pay interest, subject to the solvency of the bank.
  • Interest on Tier 2 Bank Hybrids is typically determined as the sum of BBSW BBSW BBSW is a key benchmark interest rate for the Australian money market that moves over time in line with market conditions and monetary policy. It is typically the 90 day bank bill swap rate. plus a margin Margin The margin is fixed at the time of issue and typically reflects the risk premium of a Bank Hybrid above a floating market rate (e.g., BBSW) at the time of issue. . As interest payments are based on BBSW, interest payments are likely to vary over the term of a Tier 2 Bank Hybrid.
  • Any unpaid interest will accumulate and be payable at a later date when the bank is solvent (often referred to as being cumulative Cumulative If interest is not paid in full, unpaid interest will accumulate and compound for payment at a later date if certain conditions are met. ), unless conversion or write-off Write-off If Bank Hybrids are written-off, investors will lose all of the value of their investment and they will not receive any compensation or unpaid distributions or interest. occurs due to the bank becoming non-viable.
  • Tier 2 Bank Hybrid interest payments typically do not have franking credits Franking credits Franking credits represent each holder’s share of tax paid by the issuing bank on the profits from which the distributions are paid. attached to them.
Potential loss of investment
  • If a non-viability trigger event Non-viability trigger event A non-viability trigger event will occur when APRA notifies a bank in writing that it believes (i) conversion to ordinary shares of some or all of its Bank Hybrids or (ii) a public sector injection of capital or equivalent support, is necessary to prevent the bank becoming non-viable. See non-viability trigger event. occurs (see non-viability trigger event for guidance on when APRA APRA The Australian Prudential Regulation Authority. may consider a bank to be non-viable), a bank may be required to convert some or all of its Tier 2 Bank Hybrids into ordinary shares. Conversion of Tier 2 Bank Hybrids following a non-viability trigger event is not subject to conversion conditions Conversion conditions Conversion of some Bank Hybrids may be subject to conversion conditions set out in the prospectus for the particular Bank Hybrid. See Case Study 3, including a worked solution, for further detail. being satisfied. If the Tier 2 Bank Hybrids are converted into ordinary shares, the value of ordinary shares an investor receives may be significantly less than the face value Face value The face value is typically the issue price, which will be reduced by any partial conversion or write-off. of their Tier 2 Bank Hybrid. This is because the number of ordinary shares an investor will receive in these circumstances is limited to a maximum conversion number Maximum conversion number The maximum conversion number is a limit or cap on the number of ordinary shares of the bank that may be issued on conversion. For a scheduled or mandatory conversion, the maximum conversion number reflects 50% of the bank's ordinary share price at the time of issue of the Bank Hybrid. For conversion following a non-viability trigger event or a capital trigger event, the maximum conversion number reflects 20% of the bank's ordinary share price at the time of issue of the Bank Hybrid. , which is based on the ordinary share price at the time of issue of the Tier 2 Bank Hybrid (and the bank’s ordinary share price may have dropped considerably due to the bank’s financial difficulty). If for any reason conversion does not occur and if the ordinary shares are not issued for any reason within a specified period, all rights in relation to the Tier 2 Bank Hybrids will be terminated and investors will lose all of the value of their investment and they will not receive any compensation or unpaid interest.

Conversion events

Conversion of Bank Hybrids into ordinary shares (or write-off) may occur in the following circumstances:

Tier 1 and Tier 2 Bank Hybrids

In order to be treated as regulatory capital by APRA APRA The Australian Prudential Regulation Authority. , the terms of Tier 1 Bank Hybrids and Tier 2 Bank Hybrids must contain a non-viability trigger event.

A non-viability trigger event occurs when APRA notifies a bank in writing that it believes:

  • conversion to ordinary shares of some or all of its Bank Hybrids or
  • a public sector injection of capital or equivalent support

is necessary to prevent the bank becoming non-viable. Whether a non-viability trigger event will occur is at the discretion of APRA.

If a non-viability trigger event occurs, the bank may be required to convert some or all of its Tier 1 Bank Hybrids or Tier 2 Bank Hybrids into ordinary shares. Conversion of Bank Hybrids following a non-viability trigger event is not subject to conversion conditions Conversion conditions Conversion of some Bank Hybrids may be subject to conversion conditions set out in the prospectus for the particular Bank Hybrid. See Case Study 3, including a worked solution, for further detail. being satisfied. If Bank Hybrids are converted into ordinary shares, investors will receive a variable number of ordinary shares, limited to a maximum conversion number Maximum conversion number The maximum conversion number is a limit or cap on the number of ordinary shares of the bank that may be issued on conversion. For a scheduled or mandatory conversion, the maximum conversion number reflects 50% of the bank's ordinary share price at the time of issue of the Bank Hybrid. For conversion following a non-viability trigger event or a capital trigger event, the maximum conversion number reflects 20% of the bank's ordinary share price at the time of issue of the Bank Hybrid. . Depending on the price of the ordinary shares at the relevant time, investors may suffer loss as the value of the ordinary shares received by an investor is likely to be significantly less than $101.01 for each Bank Hybrid (based on a face value Face value The face value is typically the issue price, which will be reduced by any partial conversion or write-off. of $100 per Bank Hybrid and taking into account a 1% discount to the relevant VWAP). This is because the maximum conversion number is based on the bank's ordinary share price at the time of issue of the Bank Hybrid (and the bank’s ordinary share price may have dropped considerably due to the bank’s financial difficulty). If for any reason conversion does not occur and ordinary shares are not issued for any reason within a specified period, all rights in relation to the Bank Hybrids will be terminated and investors will lose all of the value of their investment and they will not receive any compensation or unpaid distributions / interest.

APRA has not provided guidance on when it will consider an entity to be non-viable and there are currently no Australian precedents for determining non-viability. However, it is likely that APRA may consider a bank to be non-viable when a bank is:

  • suffering from significant financial stress;
  • insolvent; or
  • unable to raise money in the public or private market.

Tier 1 Bank Hybrids are generally required to be converted into ordinary shares (or written-off Write-off If Bank Hybrids are written-off, investors will lose all of the value of their investment and they will not receive any compensation or unpaid distributions or interest. in certain circumstances) before Tier 2 Bank Hybrids are converted into ordinary shares (or written-off).

Tier 1 Bank Hybrids only

Tier 1 Bank Hybrids are perpetual Perpetual If a security is perpetual, it does not have a fixed maturity date and could exist indefinitely. but typically have a set date (the scheduled or mandatory conversion date Scheduled or mandatory conversion date A date on which conversion of a Tier 1 Bank Hybrid is expected to occur (subject to the conversion conditions being met) and set out in the prospectus for the particular Bank Hybrid. See scheduled conversion ) on which the instruments are scheduled to convert into ordinary shares. Whether conversion occurs will depend on the conversion conditions Conversion conditions Conversion of some Bank Hybrids may be subject to conversion conditions set out in the prospectus for the particular Bank Hybrid. See Case Study 3, including a worked solution, for further detail. being satisfied. If the conversion conditions are not met on the scheduled or mandatory conversion date, then conversion will not occur until the next distribution payment date on which the conversion conditions are met. The conversion conditions operate to ensure that upon conversion on the scheduled or mandatory conversion date investors will receive bank ordinary shares worth approximately $101.01 for each Tier 1 Bank Hybrid (based on a face value Face value The face value is typically the issue price, which will be reduced by any partial conversion or write-off. of $100 per Tier 1 Bank Hybrid and taking into account a 1% discount to the relevant VWAP).

There is a risk that the conversion conditions are never satisfied and scheduled or mandatory conversion of a Tier 1 Bank Hybrid into ordinary shares never occurs. In this case, investors will continue to hold the Tier 1 Bank Hybrid indefinitely.

Tier 1 Bank Hybrids only

Tier 1 Bank Hybrids are generally required to contain a capital trigger event in order to be eligible to be treated as regulatory capital.

A capital trigger event occurs when a bank determines, or APRA APRA The Australian Prudential Regulation Authority. notifies the bank in writing, that the bank’s common equity Tier 1 ratio is less than or equal to 5.125%.

If a capital trigger event occurs, a bank may be required to convert some or all of its Tier 1 Bank Hybrids into ordinary shares. Conversion of Tier 1 Bank Hybrids following a capital trigger event is not subject to conversion conditions Conversion conditions Conversion of some Bank Hybrids may be subject to conversion conditions set out in the prospectus for the particular Bank Hybrid. See Case Study 3, including a worked solution, for further detail. being satisfied. Following a capital trigger event, the number of Tier 1 Bank Hybrids that are converted into ordinary shares will be the number (or percentage of face value Face value The face value is typically the issue price, which will be reduced by any partial conversion or write-off. ) as is sufficient to restore the bank to a common equity Tier 1 ratio above 5.125%.

If Tier 1 Bank Hybrids are converted into ordinary shares, investors will receive a variable number of ordinary shares, limited to a maximum conversion number Maximum conversion number The maximum conversion number is a limit or cap on the number of ordinary shares of the bank that may be issued on conversion. For a scheduled or mandatory conversion, the maximum conversion number reflects 50% of the bank's ordinary share price at the time of issue of the Bank Hybrid. For conversion following a non-viability trigger event or a capital trigger event, the maximum conversion number reflects 20% of the bank's ordinary share price at the time of issue of the Bank Hybrid. . Depending on the price of the ordinary shares at the relevant time, investors may suffer loss as the value of ordinary shares received by an investor may be significantly less than $101.01 for each Tier 1 Bank Hybrid (based on a face value of $100 per Tier 1 Bank Hybrid and taking into account a 1% discount to the relevant VWAP). This is because the maximum conversion number is based on the bank's ordinary share price at the time of issue of the Tier 1 Bank Hybrid (and the bank’s ordinary share price may have dropped considerably due to the bank’s financial difficulty). If for any reason conversion does not occur and ordinary shares are not issued for any reason within a specified period, all rights in relation to the Tier 1 Bank Hybrids will be terminated and investors will lose all of the value of their investment and they will not receive any compensation or unpaid distributions.

Tier 1 Bank Hybrids are generally required to be converted into ordinary shares (or written-off in certain circumstances) before Tier 2 Bank Hybrids are converted into ordinary shares (or written-off Write-off If Bank Hybrids are written-off, investors will lose all of the value of their investment and they will not receive any compensation or unpaid distributions or interest. ).