In a wide ranging speech to the Actuaries Institute “Banking on Capital” conference in Sydney this week APRA chairman Wayne Byers took the opportunity to remind investors in bank hybrids that the securities are there to do a job in a banking crisis and “they are designed to provide some ‘breathing space’ to allow for orderly resolution.”
In particular Byers was keen to reiterate that, under the new Basel III banking rules, the trigger or ‘bail-in’ mechanisms means a bank in financial difficulty may have its hybrid securities written off completely or converted into equity.
He went on to say “viewing these capital instruments as simply higher-yielding substitutes for vanilla fixed-interest investments, let alone deposits, is something to be counselled against, since from APRA’s perspective holders of these instruments are providing the important first lines of defence that we can call into action, in some instances even ahead of shareholders, to aid an orderly resolution.”
In other words, hybrids are to be seen as a backstop or safety net for the bank and for taxpayers in the event of a bank crisis. The extra yield payable on hybrids is because hybrid holders are taking extra risk. With term deposit yields being driven to record low levels, some investors simply substitute hybrids for basic deposit products in order to tap into the higher yields. Often they believe the name behind the hybrid offers them protection. ‘XYZ Bank won’t go belly up so my capital will be safe’ is heard often but investors may forget a bank does not have to go ‘belly up’ for them to lose their capital. In fact the hybrid securities are designed to prevent the bank from going belly-up.
An outcome where a bank gets into financial trouble is unlikely to be good for any hybrid investors as prices would quickly adjust to reflect the new risk paradigm. Capital losses would be highly likely.
The message is quite clear; hybrid securities can be very effective investments as long as investors understand the risks they are taking and are aware of what may happen to the securities in the event of a banking crisis.