Are bank hybrids safe? Not in my book. The yield uplift is simply not worth the credit protection downshift. But there is one difference between Australian bank hybrids versus the CoCo bonds that were hit in the Credit Suisse bail-in. Citi explains.
“It surprised many investors when CS AT1 bonds were wiped out before equity holders”, noted our colleagues in Asian Banks Research team, led by Judy Zhang, head of Pan-Asia Banks research. Judy and team believe the complete write-down of CS AT1 might trigger a repricing of banks’ capital instruments across capital structures, potentially making it difficult for banks to replenish capital via AT1 bonds in the future.
However, the team view “Asia banks’ direct exposure to CSAT1 bonds as small”. Judy and team compare terms & conditions of Asia banks’ AT1 vs. CS AT1 and conclude “we don’t expect the CS AT1 complete write-down to undermine the broader AT1 market in Asia long-term.”
Across the APAC region, the team believe Asian AT1 instruments provide regulators more flexibility to balance the interests of bond and equity holders in a non-viable event. Taking the example in Australia, Judy and team explain banks and APRA are explicitly required to follow creditor order of priority – the common equity instruments must be wiped out first. As well as in China, although there is no explicit language restricting CBIRC from writing-down AT1 ahead of equity holders, Judy and team argue “the China banks’ AT1 terms do offer more flexibility for partial write-downs”.
“Across the region, Australia, China, Korea, Japan, Taiwan, and HK banks have relatively high proportion of AT1 in the total tier-1 capital mix”, explain Judy and team. On a company level, the team believe BoBJ, PSBC, and CEB have higher AT1 capital mix vs. other banks, with AT1 capital accounting for more than 20% of total Tier 1 capital. “But we don’t see any of those banks as highly reliant on AT1 capital for capital replenishment”, reassures Judy and team.
While that might be reassuring, the CS example showed that local hybrid pricing will be influenced by different conditions for credit seniority in other jurisdictions. This is an imminent problem for bank capital.
…one pressure point for the big banks is shaping up to be $20bn of subordinated debt that needs to be issued under new rules introduced by the Australian bank regulator APRA to make what it calls “domestically systemically important” banks even safer.
Here each of the four major banks are required to issue billions of dollars of additional debt under rules to bulk up their so-called tier two capital.
This debt is hybrid in nature, it takes losses after “safer” tier one debt but has the trigger where it can convert to ordinary equity if regulators deem that a bank is not viable. This would have the impact of wiping out any value which is what happened in Credit Suisse’s case – although that was linked to $US17bn of Credit Suisse’s tier one debt instruments. That move up-ended the natural order given Credit Suisse shareholders still emerged with a little more than US80c in the dollar while debt investors were wiped out.
While local investors will understand the difference between Swiss and other regulations, these subordinated instruments will be harder sell to international investors given fallout from the Credit Suisse decision. The APRA rules aren’t due to come in until the start of 2026 but banks have already been making a move on their tier two instruments.
The yields will have to match the risk…
