Fixed Income Beyond Bank Hybrids

• APRA’s removal of bank hybrids marks a structural shift in how investors access income and manage risk.  

• Tier 2 bonds will replace hybrids, offering lower yield but greater transparency and stability.  

• Investors need a more active, diversified approach to income as rollover certainty disappears. 

The Australian Prudential Regulation Authority (APRA) has confirmed that Additional Tier 1 (AT1) capital instruments — bank hybrids — will be phased out of the Australian banking system. From 1 January 2027, hybrids will no longer qualify as regulatory capital, with a full phase-out by 2032. 
 
The decision follows lessons from the 2023 global banking turmoil, where the Credit Suisse AT1 write-off showed that hybrids acted more as “gone concern” rather than “going concern” capital. APRA concluded that AT1s failed their intended purpose of absorbing losses early enough to stabilise banks in periods of stress. 
 
Under the new framework: 

• Large banks’ hybrid requirements (1.5% of capital) will be replaced with 0.25% CET1 and 1.25% Tier 2. 

• Regional banks will replace AT1 entirely with Tier 2. 

• Overall capital strength remains unchanged, but composition is simpler, more transparent, and more reliable. 
   

While some investors will miss the yield and franking credits hybrids provided, APRA views the long-term benefits of resilience and clarity as outweighing the short-term costs. 

This creates a clear challenge: how to replace reliable, tax-effective income without taking on unintended risk. For over two decades, hybrids offered investors elevated yields and franking credits unmatched by traditional fixed income. They became a core allocation for income-seeking investors particularly in the high-net-worth segment. Their removal represents a structural change in the Australian income market. 
 
Prudential stability now takes precedence over convenience. Investors who once relied on hybrids will need to adapt portfolios to a two-tiered capital structure: Common Equity Tier 1 and Tier 2. 

Tier 2 subordinated bonds will be the most direct replacement for hybrids. They: 

• Pay mandatory coupons. 

• Sit above equity in the capital structure. 

• Are typically rated A-, benefiting from the strong credit standing of Australian banks. 

• Are issued in large, tradeable sizes, though often in wholesale parcels which will exclude retail investors from directly investing on the ASX. 

APRA’s changes are expected to drive $20–30 billion of new Tier 2 issuance in the coming three years, expanding market depth. While yields are modestly lower and franking is absent, the trade-off is reduced risk and greater transparency. 

This means reinvestment decisions need to be made deliberately, not reactively at maturity, to avoid periods of underinvestment.The hybrid market historically provided a form of “rollover certainty” at call dates, with new issues offering investors a simple reinvestment path. That mechanism will no longer exist.  
  
As hybrids mature, their prices will converge toward par, with no replacement issues to roll into. Investors must plan reinvestments well ahead of call dates to avoid reinvestment risk and cash drag. Portfolio activity and discipline will therefore be more important in the years ahead. 

The phase-out also encourages investors to look beyond banks. A broader, more diversified mix of income sources is emerging: 

• Senior and Corporate Bonds: Offering stable income, liquidity and lower volatility than hybrids. 

• Kangaroo Bonds: Offshore bank issuance in AUD, often with stronger loss-absorbing buffers. 

• Private Credit: Select opportunities targeting cash +3–4% returns, requiring careful manager selection given illiquidity. 

• ETFs and Listed Trust: Vehicles providing access to diversified bond pools and subordinated debt, albeit with potential liquidity risks. 

• Corporate and Insurance Hybrids: Non-bank issuers may continue to raise capital via hybrid-like securities, which should be considered selectively. 

Cameron Harrison’s Fixed Income Strategies have held bank hybrid securities (AT1) for over 20 years. Notwithstanding APRA’s phase out of these capital instruments, their importance had already been diminishing within our Fixed Income Strategies over the last few years, particularly our Core Interest Income Strategy.  

We understand APRA’s positioning, though do not fully agree with its rationale.  Hybrids do serve as a useful capital buffer pool within bank capital prudential regulation, and whilst maybe not well understood by retail investors, institutional investors do and can understand the hybrid instrument.  Be that as it may, APRA has resolved its position and investors need to adapt.    

Our Core Interest Income Strategy is a highly diversified portfolio (over 70 individual positions) which invests directly in investment grade, highly liquid traded debt securities across subordinated bank debt, RMBS, ABS, and covered bonds. By investing directly in individual issuer bonds, clients benefit from full transparency, accountability, and flexibility. 

Return Target 

3-Year Government Bond Yield + 2.0% Margin (e.g., 4% bond yield = 6% target return). This is achieved through a diversified portfolio of 50+ investment-grade securities, maintaining a short-to-medium maturity profile for strong liquidity. 

Conclusion 

The Core Interest Income Strategy combines capital stability, reliable income, and liquidity. It is both a standalone alternative to cash/term deposits and a core component of balanced portfolios, delivering returns above government bonds with very low capital risk. 

Performance for our suite of Interest Income Strategies for FY25 are tabled below: 

The most immediate adjustment is the loss of franking credits, which enhanced hybrid returns for many investors. Replacement strategies will require balance: 
 

• Lower-risk Tier 2 bonds and senior credit for portfolio stability. 

• Higher-yield private credit or niche corporates to offset income reductions. 

• Liquidity planning through tradeable bonds and ETFs, complemented by carefully sized illiquid allocations. 

We would caution that with this regulatory change, various products are being brought to market to meet the needs of yield conscious and hungry investors.  Investors should avoid being ‘dazzled’ by target yields and instead rely on proper, independent due diligence that takes account of security diversification, stress testing and volatility, liquidity terms, fees (both direct and indirect), and deed terms.   

The removal of bank hybrids is not simply a regulatory shift — it is the end of a uniquely Australian income product. While hybrids blended debt and equity in a way that suited many investors, they also carried opaque risk. 
 
The new environment provides the opportunity to build multi-layered, actively managed portfolios that are more transparent, more resilient, and more diversified. For high-net-worth investors, this is a chance to move beyond a single, bank-centric product and embrace a broader credit landscape that better aligns income needs with long-term stability, diversification, reduced volatility and improved liquidity.