Are Australian bank hybrids at risk?

Earlier this month, three US-based banks (Silvergate, Signature, and Silicon Valley Bank) collapsed in the face of a classic bank run. A week later, news broke of troubles at the renowned global bank Credit Suisse, following a series of scandals, poor governance, and risky investments.

Last Monday Australian time, under pressure from the Swiss authorities, banking giant UBS announced it is stepping in to acquire Credit Suisse. In addition, a group of global central banks, including the Federal Reserve, the Swiss National Bank, the Bank of England, the Bank of Japan, the European Central Bank (ECB), and the Bank of Canada have announced a coordinated action to enhance liquidity to help shore up the stability of the global financial system.

As a consequence of the acquisition, Credit Suisse was forced to write down its Additional Tier 1 (AT1) bonds (what Australian investors often call ‘hybrids’) to zero, affecting securities with a notional value of 16 billion Swiss francs (A$25.8b). Importantly, depositors and senior bondholders of Credit Suisse were not affected by the sales. However, this has significantly impacted Credit Suisse hybrid investors and their shareholders.

Following the announcement, there were some big swings in European-listed hybrids, with most of them down as much as 15% in early trade. However, later in the trading session, The Single Resolution Board (SRB), the European Banking Authority (EBA), and the ECB confirmed that in the Eurozone, AT1 bonds would only absorb losses after common equity, with the Bank of England also affirming the conventional view of the capital structure hierarchy. This spurred a strong recovery in European bank’s hybrid/AT1s, with most banking securities ending the session higher.

Australian bank hybrids remain resilient

Given these events, it’s important to acknowledge the resilience of Australian hybrid securities, particularly compared to overseas markets.

The Australian Prudential Regulation Authority (APRA) has strict rules in place for banking capital adequacy, and Australian banks are generally considered to be strong and some of the most liquid banks in global markets.

APRA has set a high standard for the amount of money that major Australian banks need to keep in reserve (called the CET1 capital ratio). This standard is at least 10.5%, which is much higher than the effective minimum requirement of 7.0% for European banks. As a result, Australian banks are generally regarded as being better placed to handle tough times than many other banks around the world.

Australian bank hybrids vs European securities

Australian bank hybrids have many features that make them different to European hybrids:

• Unlike European banks, no Australian bank or insurer bond or hybrid has ever been written off or ‘bailed in’. Furthermore, unlike some European hybrids, in the event of a capital trigger or non-viability event the preference for Australian hybrids is equity conversion, with a write off only considered as a last resort.

• Most Australian hybrids are traded on the ASX, which is a transparent exchange with high levels of liquidity (although often less liquid than the shares of the company that issued them). Since the start of 2022, over $9 billion worth of hybrids has been traded.

• In the UK and Europe, some banks have stopped paying income on hybrids, and frequently miss their first optional call/repayment dates. In contrast, to date, no Australian bank or insurer has ever missed a coupon payment.

What to expect moving forward

The situation with Credit Suisse may cause some short-term volatility for Australian bank hybrids. However, given the current attractive yields locally, and the relative stability and resilience of Australian banks historically during tough times, it may benefit hybrid investors to stay local. In any event, investors should ensure their portfolios are well diversified and are invested in liquid securities.

Betashares currently offers two Funds offering diversified exposure to Australian hybrids:

• HBRD Active Australian Hybrids Fund (managed fund) : offers exposure to an actively managed, diversified portfolio of primarily hybrid and other income securities.
• BHYB Australian Major Bank Hybrids Index ETF : offers exposure to an index (before fees and expenses) that provides exposure to a portfolio of listed hybrid securities issued by Australia’s ‘Big 4’ banks.