The regulator is considering three policy options: changing the design of hybrids so that they more effectively absorb losses, forcing the banks to reduce their reliance on hybrids for their capital buffers, and changes that would shift the investor base away from retail investors.
A design change may result in hybrids being converted to equities when common equity levels fall to 7 per cent, rather than 5.125 per cent. APRA also said increasing the minimum investment size in hybrids could discourage smaller investors from participating. Simply toughening disclosures about their risks would not address the issue.
The APRA statement comes after it fired a warning shot about investor and issuer complacency over bank tier two bonds.
The role of hybrids has become a global focus since Credit Suisse’s AT1 investors were wiped out when the bank was forced into a shotgun merger with UBS.
APRA’s message will serve as a reminder that even though investors regard bank hybrids as safe, the prudential regulator regards them as risky and destined to absorb losses or preserve capital in times of stress.
The regulator launched a similar crackdown on higher ranking subordinated or tier two bonds in late 2022 and early 2023 just as new chairman John Lonsdale assumed the role.
Latest crackdown
APRA told banks and insurers back then not to assume it will approve the refinancing of tier two bonds at higher rates simply to appease the market.
There is some $43 billion of hybrids outstanding on the ASX. National Australia Bank this month issued new hybrids at a margin of 2.8 per cent over the bank rate of 4.1 per cent, or yielding about 6.9 per cent.
The holders are largely retail investors who are attracted to the franked distributions. In fact, the popularity of hybrids has increased as high net worth investors have moved their money out of deposits and into bank hybrids to earn higher yields.
APRA said 53 per cent of hybrids were owned by so-called small investors that held less than $500,000 of a security.
“The Australian market for AT1 is also unusual by global standards, with more than half the bonds held by small retail investors,” APRA said.
“Converting their investments into equity or writing them off could undermine confidence in the financial system and impact the stability of other institutions – a complication that risks impeding the speed of decision-making in a crisis.”
APRA outlined the challenges in the “Australian context” and is wants feedback and proposals to overcome these. It will then consult the industry on changes to the prudential standards or guidance next year.