The Australian Prudential Regulation Authority’s (APRA) decision to phase out Additional Tier 1 (AT1) bank hybrids by 2032 marks a major structural shift for income-focused investors. The move effectively winds down Australia’s $40+ billion hybrid market and forces investors to reconsider the role hybrids have long played in generating income and franking credits.
Hybrid securities have traditionally offered attractive yields but come with higher credit and tail risk due to their subordinated position in the capital structure. APRA noted that hybrids have not performed as intended during overseas banking crises, highlighting challenges around complexity, legal ambiguity, and the disproportionately high retail ownership in Australia.
With hybrids set for removal as regulatory capital instruments, market participants have been quick to propose alternatives. Options currently emerging include:
- Government, corporate, and high-yield bonds: These provide greater capital stability and more predictable payments than hybrids, though they do not offer franking credits.
- Offshore AT1 and corporate hybrids: Recent deals, such as UBS’s September 2025 AT1 issue in Australian dollars, indicate continuing demand, though these securities fall outside APRA’s oversight and generally do not provide franking credits. Corporate hybrids also exist but operate in a less regulated environment.
- Subordinated debt (Tier 2): APRA has directed issuers toward subordinated bonds as a more reliable capital instrument. With an established ~$120 billion market, substantially larger than the domestic hybrid market, subordinated debt is emerging as the closest structural replacement. As a debt security, it does not deliver franking credits.
- Managed funds: Specialised Income and Specialised High Income funds offer diversified solutions that can approximate the risk/return profile of hybrids while providing professional credit selection and liquidity management.
The phase-out represents a fundamental change for investors who have relied on hybrids for income generation. While the franking benefit will be harder to replace, a broad spectrum of fixed income and multi-asset alternatives are available, each carrying different risk characteristics and tax considerations.