APRA's AT1 hybrid phase-out sends ripples through income focused portfolios
The Australian Prudential Regulation Authority (APRA) has confirmed plans to phase out Additional Tier 1 (AT1) hybrid securities as eligible capital instruments for banks. The transition will begin in 2027 and is scheduled to complete by 2032.
AT1 hybrids — long favoured by private wealth clients for their consistent, franked income — have played a central role in income-focused portfolios, particularly in a low-yield environment. With approximately $44 billion currently on issue, the phase-out signals a significant shift in how banks fund their regulatory capital and how investors may need to rethink their income allocation.
A structural pivot with global roots
APRA’s decision stems from ongoing concerns around the complexity and reliability of AT1s, especially under real-world stress conditions. These concerns were crystallised in the 2023 collapse of Credit Suisse, where $17 billion of AT1 bonds were written off completely, while equity holders received some value through a government-facilitated takeover. The outcome raised fundamental questions about how AT1 instruments behave in a crisis — and whether they provide the orderly, transparent loss-absorbing function regulators expect. APRA’s position is that they don’t — at least not consistently or predictably enough.
In response, APRA will begin gradually removing AT1 eligibility from 2027, giving banks a long runway to restructure their capital mix using Tier 2 subordinated debt or additional common equity. By 2032, AT1 instruments will no longer count toward regulatory capital requirements.
Impacts on Hybrid Investors
This transition has several implications for investors who have relied on hybrids as a key source of tax-effective income.
Disruption to Income: Hybrid securities have traditionally offered 5–7% yields with franking credits. As the market winds down, replacing that level of after-tax income may require moving up the risk curve or into more complex instruments.
Reduced Access to Franked Yield: Hybrids are one of the few widely accessible, fully franked fixed–income–like products. Their exit will leave a gap for SMSFs and retirees seeking consistent tax-effective returns.
Market Liquidity Risk: With no new issuance and a sunset horizon, secondary market activity may slow, impacting pricing and liquidity for those wanting to rebalance or exit.
Alternative Yield Trade-Offs: Alternatives such as Tier 2 bonds, private credit, or unlisted income funds may offer higher yields but come with new trade-offs in terms of liquidity, tax treatment, and credit risk.
What Investors need to consider as bank hybrids phase out
With APRA’s phased exit of bank AT1 hybrids set to begin in 2027, investors face important choices about how to respond — or whether to act at all.
To act or not to act: timing is key
For many, holding existing hybrids to their call dates remains a viable strategy, especially given the extended timeline. But waiting too long to adjust portfolios could mean missing the chance to transition smoothly into other income-generating assets before liquidity tightens or yields shift.
Balancing risk and return
Replacing hybrid income won’t be straightforward. Alternatives such as Tier 2 bonds, private credit, and unlisted income funds offer attractive yields but come with different risk profiles, complexity, and reduced regulatory protections. Assessing the right balance between risk and return will be crucial to maintaining portfolio stability.
Liquidity must match real needs
As secondary market activity slows, investors must ensure their portfolios’ liquidity aligns with actual cash flow requirements, avoiding forced sales at unfavourable prices.
Don’t overlook tax implications
Bank hybrids have long been favoured for their fully franked distributions — a significant benefit for many investors. Alternative income streams may lack these franking credits, potentially increasing tax liabilities and affecting net returns.
Navigating the Shift
The hybrid market isn’t disappearing overnight, but the direction is clear. Investors have time to prepare but should begin reviewing income strategies and identifying new opportunities for stable, tax-aware yield.
Whether that means holding existing hybrids to maturity or gradually reallocating into emerging income strategies, the key is to act deliberately, not reactively. This transition also highlights the growing importance of diversification and active portfolio management. By blending a range of income sources and regularly reviewing allocations, investors can better manage risk, adapt to evolving market conditions, and maintain sustainable income streams over time.