Australian investors have been blitzed over recent years by newspaper headlines talking about hybrid securities. Many of these hybrids have been issued by high street banks, which can give investors a sense of comfort when it comes to overcoming their concerns about an asset class that can be perceived as risky. Because of this, it can be easy for investors to overlook the risk involved in hybrids in general if they are issued by well-regarded and well-known institutions. Hybrids carry risks that other investment instruments do not.
What is a hybrid?
Hybrids got their name because they have characteristics of both equity and debt: they are a hybrid of the two. The new breed of hybrids that we have seen issued in Australia have been developed to allow banks to shore up their core capital in times of stress. These new ‘Basel III compliant’ hybrids behave very much like regular debt instruments, such as bonds, except when the issuer gets into financial difficulty when they can convert into equity.
As readers of YieldReport will know, the Australian Prudential Regulatory Authority (APRA) can decide to force a bank to convert its hybrid into ordinary shares if it thinks the bank is in trouble. This is called a non-viability trigger and this is the risk that is probably best understood by investors.
But one risk that can be overlooked by investors is that when a new hybrid issue comes along, the prices of the older hybrids drop as smart investors switch into a better yield. This is an issue that investors should fully understand before investing in hybrids.
Some hybrids have maturities of 10 years or even 30 years although many have a call date of five years. This makes them fairly liquid and it is presumed that they will be refinanced every five years. But this is not a given. Issuers of hybrids can do whatever they like, stopping payments or not redeeming them at all. It is important for investors to read the investment prospectus thoroughly and understand the nuances behind the hybrid they are about to buy.