AT1 hybrids gained popularity after the Global Financial Crisis (GFC) as a cost-effective substitute for equity. They typically pay investors a fixed yield and sit above shares in the capital hierarchy. Hybrids offer banks a cheaper alternative to raising equity. Traditional equity issuance requires higher returns (~9-10% p.a.), while hybrids cost around 7% p.a., making them a more attractive option.
For over 25 years, hybrids have been an integral part of global bank funding, providing a stable capital base while allowing banks to avoid excessive dilution of ordinary shareholders. However, post-GFC, regulators introduced new hybrid structures to simplify capital structures and mitigate risk.
The Australian hybrid market, valued at ~$40 billion, has been a successful funding source for banks and offers investors a higher yield than traditional bonds. Australian bank hybrids typically yield 3% above cash rates, compensating investors for potential conversion risks. ASIC and APRA have emphasised transparency in explaining these risks to retail investors. However, the main risk for investors is that hybrids are designed as a stress buffer for banks, and they have the potential to convert into equity during a bank’s financial stress*.
The collapse of Credit Suisse’s AT1 hybrids in 2023 demonstrated the risks associated with these instruments. Instead of converting to equity, Swiss regulators wrote down ~$17 billion worth of AT1s while allowing some equity holders to retain value—violating the capital hierarchy principles of Basel III. This incident led regulators, including APRA, to reassess hybrid structures and investor protections, ultimately deciding to phase them out from 2027.
