Corporate hybrid securities
See through the familiar brands to the
Corporate hybrids, also known as subordinated notes, are high
risk, complex investments where an investor lends 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 hybrids do not include those hybrids issued by banks
and insurers, which are discussed on our bank hybrid
Corporate hybrids can be traded on the ASX. Here we explain the
risks of corporate hybrids and the difference between hybrids
issued by listed and unlisted companies.
get paid last
Large companies typically borrow money from different places,
including directly from banks and by issuing wholesale bonds
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.
Corporate hybrids are one way for companies to borrow money from
smaller investors. The money borrowed from smaller investors is
generally 'subordinated' to the senior debt, and so corporate
hybrids are called 'subordinated notes'.
If the company becomes insolvent, hybrid investors rank behind
banks, senior bondholders and other creditors so they will only get
their money back if there is something left after the senior debt
holders have been paid.
Corporate hybrids can be designed to support a company's senior
debt while the company is still trading. For example the hybrid 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 company's credit
Always consider the credit risk of a company before investing in
a corporate hybrid. Here are some credit risks to consider. You can
find these in the prospectus for the hybrid offer:
- How much senior debt does the company have and 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?
Hybrids issued by listed
Subordinated notes issued by listed companies can include the
following features. Many of these are risk factors:
- Unsecured - Your investment is not secured by
a mortgage or security over any asset.
- Deferral of interest payments - Interest
payments can be stopped for a number of years. The company may have
the option of deferring interest payments or it may be required to
do so if certain financial ratios are breached. Interest owing may
be cumulative but investors will still be temporarily out of
pocket. The decision to hold back interest payments may cause the
market price of the security to fall.
- Long maturity dates - Hybrids can have
investment terms lasting several decades. A 40-year old investing
in a security today, with a 60-year maturity date, would need to
live to 100 to see their investment mature. Securities may be sold
on a secondary market such as the ASX, but only if there is a
demand for that security. The longer the maturity, the greater
chance that the company might default on its obligations or run
into financial difficulties.
- 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 particular date, however this increase may be
very small or not occur for a long time.
Hybrids issued by unlisted
Unlisted companies that issue hybrid securities can have a
different financial structure to listed companies. They may have a
lot more existing senior debt, which ranks ahead of hybrids.
These are the features and risks of subordinated notes issued by
unlisted companies and how they are different to those issued by
- Second ranking security - Hybrid investors may
have the benefit of the same security available to the senior
lenders, but on a second ranking basis. This means that if the
issuer is wound up, any realised assets will first be used to repay
senior lenders, with the real possibility that nothing will be left
for hybrid investors.
- Deferral of interest payments - Interest
payments may be deferred for trigger events based on a wider range
of financial ratios, such as breaching a loan covenant contained in
the terms of senior debt. These 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
- 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 hybrid investors 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
Case study: Chris and Jane are disappointed by subordinated
Several years ago, Chris and Jane each received an
inheritance of $10,000, which they invested in subordinated
Chris invested his money in hybrids issued by Company A. For the
first few years he received interest payments on time, but these
stopped when Company A began to experience financial difficulty.
Chris wants to sell his investment but because the hybrids have
stopped paying interest, and improvements in Company A's financial
position have been slow, the market price for his hybrids has
dropped nearly 90% since they were issued.
Jane invested her money in hybrids issued by Company B. Like
Chris, Jane initially received interest payments as scheduled, but
these stopped when the company was placed into administration. Jane
will have to wait until the senior bondholders and other creditors
have been repaid before she gets any of her original investment
back. She has been advised not to expect any return of her capital,
which makes her investment almost worthless.
Subordinated notes may be issued by
well-known brands and promise attractive returns, but they have
complex features and high risks. Your interest payments can stop at
any time if a trigger event occurs and you may not see even part of
your capital for decades.
Last updated: 14 Aug 2015