Investing in a Bank

There are a number of ways to invest in a Bank, including investing in Hybrids. Some are simple and very common. Others, like Hybrids, are complex and more risky, but may pay higher distributions to investors. Money invested in a Bank helps fund its activities, such as lending to households and businesses.

Introducing Hybrids

Hybrids (including Tier 1 Hybrids and Tier 2 Notes) are the focus of this website. These securities are called “hybrids” because they contain some features typical of debt investments, and some features typical of equity securities (Ordinary Shares). Banks issue Hybrids primarily to meet specific capital requirements imposed by APRA and to fund their activities.

There are a variety of reasons why investors may choose to include Hybrids in their investment portfolio.

These include the potential, in certain market conditions, for Hybrids to offer:

higher yields than other less risky investments in a Bank (such as term deposits); and
lower volatility than Ordinary Shares.

Hybrids may also appeal to investors as they may be able to be traded on the ASX.

Hybrids also carry specific risks of which investors should be aware. In certain circumstances, Hybrid investors may lose all or a significant amount of their investment.

Ways to Invest in a Bank

The table below describes some common types of investments in a Bank, including Hybrids, and some of their typical features. The terms of particular investments may vary.

Savings Accounts	Savings accounts include transactional, savings and cheque accounts. These accounts allow an investor to withdraw their money at any time and tend to offer a very low rate of interest, if any.
Term deposits	Term deposits are savings accounts with a fixed term, which are typically between one month and five years. In return for “locking away” an investor’s money for a set period, term deposits tend to pay a higher rate of interest compared to savings accounts.
Senior debt	Senior debt takes various forms, such as “senior bonds”, “commercial paper” or “certificates of deposit”, which generally pay a fixed or floating (also known as variable) rate of interest, and are usually repayable on a fixed date between one month and 10 years from issuance. These securities are referred to as “senior”, because, if a Bank is wound up, the investor is entitled to be repaid before Hybrid investors and holders of Ordinary Shares. Banks generally do not issue senior debt to retail investors.
Hybrids	Hybrids may take the form of: Tier 2 Notes, often called “subordinated notes” Tier 1 Hybrids, often called “capital notes” or “convertible preference shares” Banks issue Hybrids primarily to meet specific capital requirements imposed by APRA and to fund their activities.
Ordinary Shares	Ordinary Shares entitle investors to a share in the ownership of the Bank. In the event of failure of the Bank, Ordinary Shares carry no right to return the capital to investors until all higher ranking claims have been paid. Investors may receive dividends at the Bank’s discretion and have a right to vote at general meetings of the Bank’s shareholders. Ordinary Shares of most Banks can generally be traded on the ASX.

Ranking and subordination

If a Bank becomes insolvent and is wound up, there will be an order in which funds available at that time are distributed to investors. The table above summarises the order of repayment (otherwise known as ranking) in a winding up, with investments at the top of the table repaid before investments at the bottom.

Claims in respect of Hybrids are “subordinated” to claims in respect of most other investments in a Bank, such as senior debt and deposits, which are “unsubordinated”. This means that, in a winding up of the Bank, claims in respect of Hybrids will only be repaid after prior ranking claims have been paid in full, and only to the extent that sufficient funds remain.

Whilst Hybrid investors may receive a higher yield than unsubordinated investors, if the Bank becomes insolvent, Hybrid investors face a greater risk that they will lose some or all of their investment.

Hybrids are not protected under the Financial Claims Scheme

The Financial Claims Scheme may apply to some forms of investment in a Bank if the Bank is in severe financial difficulty. Investors should be aware that Hybrids are not protected under the Financial Claims Scheme.

Comparing the key features of common investments in a bank

	Protected under the Financial Claims Scheme	Usual term	Early redemption at the Bank’s option	Payments during the term	Tradeable on the ASX	Loss Absorption – Conversion or Write-Off
Savings Accounts	Yes	No fixed term – repayable at call	Not applicable	Floating rate interest, if any	No	No
Term Deposits	Yes	Typically between 1 month and 5 years	No	Fixed rate interest	No	No
Senior Debt	No	Typically between 1 month and 10 years	Terms may permit early repayment at the option of the Bank (or the investor)	Generally fixed or floating rate interest	Generally, no	No
Tier 2 Notes	No	Typically around 10 years, subject to conditions	Yes, subject to APRA approval	Typically, floating rate interest, non-discretionary, subject to Solvency Condition	Generally, yes	Yes, if a Non-Viability Trigger Event occurs (unless APRA requires only Tier 1 Hybrids to be Converted or Written-Off)
Tier 1 Hybrids	No	Perpetual, with Mandatory Conversion, subject to conditions	Yes, subject to APRA approval	Typically franked, floating rate, discretionary distribution, subject to Payment Restrictions	Generally, yes	Yes, if a Non-Viability Trigger Event or Common Equity Trigger Event occurs
Ordinary Shares	No	Perpetual	Not applicable	Typically franked, discretionary distribution	Yes	No

TYPES OF BANK CAPITAL

The Bank regulator, APRA, specifies capital requirements with which Banks must comply. These requirements are designed to protect depositors, promote financial system stability and reduce the need for taxpayer support when a Bank is in distress or has incurred significant losses.

Bank capital is divided into three categories:

Common Equity Tier 1 Capital
Additional Tier 1 Capital (of which Tier 1 Hybrids are an example)
Tier 2 Capital (of which Tier 2 Notes are an example)

POST-GLOBAL FINANCIAL CRISIS CHANGES TO BANK CAPITAL REQUIREMENTS

Following the global financial crisis, Bank capital requirements have been strengthened. These requirements affect the amount of capital that a Bank must hold and the features that Hybrids must contain in order to count as capital. In particular, Hybrids are required to be “loss absorbing” in the event that a Bank is in distress or has incurred significant losses.

A Bank may lose money for many reasons — for example, if it has lent money to customers who do not repay it. If those losses are very large, the Bank’s assets may not be sufficient to return the full amount invested by investors in the Bank.

HOW LOSS ABSORPTION MAY IMPACT AN INVESTOR

The inclusion of “loss absorption” features in Hybrids means that Hybrid investors may suffer losses on their investment before investors in more secure investments such as savings accounts, term deposits and senior debt.

If a Bank sustains significant losses or is in severe financial difficulty, Hybrids may be required to be Converted or Written-Off. This feature of Hybrids is often referred to as “Loss Absorption”, since it results in some of the Bank’s losses being “absorbed” by the Hybrid investor, reducing the impact on investors in more secure investments and the need for taxpayer support.

Hybrid investors could lose some of all of their money invested if the Loss Absorption features are triggered.

MORE INFORMATION ABOUT RANKING AND SUBORDINATION

Tier 1 Hybrids rank behind all investments other than Ordinary Shares. Tier 2 Notes rank behind all investments other than Ordinary Shares and Tier 1 Hybrids. This means that in a winding up of the Bank, there is a risk that Hybrid investors will lose some or all of their investment.

If a Hybrid is Converted, investors will hold Ordinary Shares, which are the lowest ranking investments in the Bank. Depending on the circumstances of the Conversion, Hybrid investors may receive Ordinary Shares that are worth significantly less than the Face Value, and may lose all or a significant amount of the money invested as a consequence. In the event of a winding up, investors in Hybrids may receive no return at all.

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