Hybrid securities and notes
Debt and equity
Hybrid securities may be issued by well-known companies, banks
and insurers, but they are very different from other fixed interest
Hybrid securities can expose you to 'equity-like' risks but only
give you 'bond-like' returns. Some allow the issuer to exit the
deal or suspend interest payments when they choose. Others may
convert into ordinary shares, or be written off completely, if the
issuer experiences financial difficulty.
Hybrid securities may not be suitable for you if you need steady
returns or capital security.
What are hybrid
Hybrid securities are a type of investment that have elements of
both debt and equity. They're a way for banks and companies to
borrow money from investors.
Like bonds, hybrid securities typically
promise to pay interest, at a fixed or floating rate until a time
in the future. Unlike a bond, the amount and timing of interest
payments are not guaranteed. They can also be converted into shares
or your investment can be terminated at any time.
Hybrid securities can usually be traded on a secondary market
such as the Australian Securities Exchange (ASX).
Hybrid securities are complex products. Even experienced
investors may struggle to understand the risks involved in trading
them. Don't invest in them if you don't fully understand how
The risks of hybrid
Hybrid securities have higher risks than other types of debt
investments. Here are some of the most common risks.
Investment features and returns often depend on whether a
'trigger event' occurs.
Trigger events include:
- a loss of earnings causing the deferral of interest
- a change in the capital levels of the issuer resulting in a
conversion to equity
- a change in tax laws or regulatory requirements which may give
the company the right to repay the hybrid early or much later than
The issuing company may have limited control over these trigger
events, but they can significantly affect how the investment
behaves or whether you get the payments you expect. These events
can be difficult to predict.
Market price volatility
Like shares, the market price of a listed hybrid security may
fall below the price you paid for it. This may be more likely if
the company suspends or defers interest payments, or its
performance or prospects decline. Changes to the company's share
price or general interest rates may affect the price of a listed
While most hybrids are traded on the ASX, they are often less
liquid than shares. This means that there are fewer buyers and
sellers in the market for this type of investment and if you need
to exit your investment in a hurry, you may have to accept a lower
Hybrid securities are generally unsecured, meaning that
repayment is not secured over an asset. If the company issuing the
security becomes insolvent, you will usually rank behind senior
bondholders and other creditors. This means you'll be among the
last to get your money back, if there's any left after other
creditors have been paid.
Bank hybrid securities
Banks and insurers issue hybrid securities to raise money that
can count as regulatory capital under the prudential standards that
apply to banks and insurers.
These securities are designed to be loss absorbing, which means
you, not the bank, are at risk of suffering a loss. It protects the
bank's depositors, at the expense of hybrid investors.
If the bank experiences financial difficulty, hybrids can be
converted into bank shares, which may be worth less than your
initial investment, or written off completely, meaning you could
lose all your capital.
There are three types of bank hybrid securities: capital notes,
convertible preference shares and subordinated notes.
Capital notes and convertible preference shares
Capital notes and convertible preference shares are very
similar. You should receive:
- regular interest payments, sometimes called distributions or
- ordinary shares or cash on a fixed date in the future, usually
in around 8-10 years; however, the issuer can do this earlier than
Interest may not always be paid on capital notes and convertible
preference shares and missed payments will not accumulate. However,
if payments are not made, the bank can't pay dividends on its
Subordinated notes are like capital notes or convertible
preference shares, but with a fixed maturity date, an expectation
that interest will be paid, and no scheduled conversion into
shares. Interest payments and repayment of your capital have fewer
Corporate hybrids, also known as subordinated notes, are high
risk, complex investments where you lend money to a company in
return for regular interest payments. Interest payments can be
deferred for years and the company may not have to repay your
capital for decades.
Corporate hybrid investors get paid last
Large companies typically borrow money from a number of sources,
including banks, and by issuing wholesale bonds (only available
only to professional investors). This borrowed money is referred to
as 'senior debt' because, if the company becomes insolvent, these
investors are the first to be repaid.
Money a company borrows from smaller investors is generally
'subordinated' to the senior debt, so corporate hybrids are called
'subordinated notes'. If the company becomes insolvent, as a
subordinated note holder you will rank behind the banks, senior
bondholders and other creditors, and will only get your money back
if there is anything left after the senior debt holders have been
Corporate hybrids may have terms that ensure interest payments
to hybrid investors can only be made after interest on senior debt
is paid, or they may prevent hybrid investors being repaid their
principal until all senior debt is repaid or refinanced.
Check the hybrid issuer's credit risk
Always consider the credit risk of a company before investing in
a corporate hybrid. Here are some things to look for in the
prospectus for the hybrid offer:
- How much senior debt does the company currently have?
- How much money is it looking to raise by issuing hybrids?
- Does the company generate enough cash to make payments on both
senior debt and hybrids, now and in the future?
- Are there limits on the company's ability to pay interest or
repay principal to hybrids investors while it has senior debt?
Corporate hybrids can be issued by listed and unlisted
Risk in hybrids issued by listed companies
Subordinated notes issued by listed companies may have the
following risk factors:
- Unsecured - Your investment is not secured by
a mortgage or security over any asset.
- Deferral of interest payments -- Interest
payments can be deferred or the company may be required to do so if
certain financial ratios are breached. Interest owing may be
cumulative, but you'll still be temporarily out of pocket, possibly
for years. The decision to hold back interest payments may cause
the market price of the security to fall.
- Long maturity dates - Investment terms can
lasting decades. A 40-year-old who invests in a security with a
60-year maturity would need to live to 100 to see their investment
mature. The longer the maturity, the greater chance that the
company might default on its obligations or run into financial
- Early redemption - The company has the option
to repay your investment after a fixed period, usually around 5
years after the hybrid is issued, but you do not have similar
rights. In some cases, the interest rate will increase if the
hybrid is not redeemed by a certain date, however this increase may
be very small or not occur for a long time.
Risk in hybrids issued by unlisted companies
Unlisted companies that issue hybrid securities can have a
different financial structure from listed companies. They may have
more senior debt, which ranks ahead of hybrid security holders.
The risks of subordinated notes issued by unlisted companies
- Second ranking security - You may benefit from
the same security available to the senior lenders, but on a second
ranking basis. This means that if the issuer is wound up, money
from asset sales will first be used to repay senior lenders, with
the real possibility that nothing will be left for hybrid
- Deferral of interest payments - Interest
payments may be deferred for a wider range of trigger events, such
as breaching a loan covenant contained in the terms of senior debt.
Loan covenants can become stricter over time. For example, they may
require the company to continue to increase its earnings at a
particular rate for the life of the hybrid. This protects the
senior lenders at the expense of hybrid investors.
- Earlier maturity - Hybrid securities issued by
unlisted companies often have a much shorter maturity, say 5 years;
however, the company may only be able to repay you if the senior
debt has been repaid or refinanced first. The company may repay
your investment early, sometimes offering a small premium for doing
so, but only with the agreement of the senior lenders.
What you should know before
investing in a hybrid security
Make sure you fully understand the features and risks of any
hybrid security before you invest. You can get these details from
your financial adviser or from the prospectus. Make sure you
can answer the following questions:
- What are the risks of investing in this hybrid security, now
and in the future?
- Will the returns offered adequately compensate for the
- How does the interest rate compare with other investments? Can
other less complex or risky long-term investments provide a similar
or better return?
- Does the issuer have to pay interest? Do missed payments
- What is the maturity date? Can the issuer repay the investment
- Are there any trigger events (such as 'loss absorption' or
'non-viability') where your hybrid may convert into ordinary
shares, or be written off completely?
- Will this product help you achieve your personal goals and
objectives, and does it suit your investment timeframe and personal
- Can you exit this investment if your circumstances change?
Prospectus terms explained
Here are the meanings of common terms used in hybrid security
- Discretionary non-cumulative distributions -
Interest payments are not guaranteed, they are paid at the
discretion of the issuer. Missed payments do not accumulate.
- Unsecured and not guaranteed - The issuer does
not guarantee your investment will be repaid, and it is not secured
by a mortgage or security over any asset. Unlike savings accounts
or term deposits with a bank, hybrids are not covered by the Government
- Subordinated - If the issuer becomes
insolvent, and there is any money left after senior debt holders
are paid, followed by all other creditors. Subordinated note
holders are paid next, then capital note and convertible preference
shareholders. Ordinary shareholders are paid last.
- Scheduled conversion or mandatory conversion -
Capital notes and convertible preference shares may convert into
ordinary shares in the issuing company on a fixed date, usually
8-10 years after the hybrid is issued, if the issuer's ordinary
share price has not fallen by more than 50% in that time.
- Optional redemption, resale or transfer - The
issuer can repay your investment (or, in some cases, convert it to
ordinary shares) early if they meet certain conditions and receive
regulatory approvals. This can occur on one or more fixed dates,
typically beginning 6 years after the hybrid is issued, or any time
there is a change to laws or regulatory requirements affecting the
- Redemption - The issuer must repay your
investment on maturity, often many years after the hybrid is
- Early redemption - The issuer can repay your
investment early, but only if they receive regulatory approval.
This can occur on one or more fixed dates, typically beginning 5
years after the hybrid is issued, or at any time if there is a
change to laws or regulatory requirements that affect the
- Perpetual - Despite a number of terms
specifying when your investment can be repaid or converted into
shares, capital notes and convertible preference shares have no
fixed maturity, which means your investment may never be
- Interest - This is payable at regular
intervals and is not discretionary.
- Loss absorption event - If the issuer
experiences financial difficulty, they may be required to convert
your investment into ordinary shares or write it off completely,
meaning you could lose some or all of your investment. This could
also be described as a 'capital trigger event' or a 'non-viability
Some hybrid securities are high risk
investments. Make sure you fully understand these complex products
before investing your hard-earned cash.
Last updated: 12 Dec 2018