A new era for hybrid bonds

Australia's hybrid bond market rarely makes headlines, but in recent weeks it has been firmly back in the spotlight. The Australian Prudential Regulation Authority (APRA) recently revealed plans to phase out Australian banks' use of additional tier one (AT1) capital [which can be considered riskier, thereby enhancing the overall stability of the banking system].

The announcement came on the heels of a surge in interest in corporate hybrids sparked by the successful raising for Australian Securities Exchange (ASX) listed mall operator Scentre Group. Yarra's outlook for Australia's hybrid bond market - of which bank AT1 hybrids make up around $41 billion - considers these latest proposed regulatory changes while focusing on the future potential for hybrids in funding corporate Australia's energy transition ambitions.

Investors and issuers alike are now navigating a market partly in transition. More immediately it seems that in the wake of APRA's announcement, some are betting that a shrinking pool of Australian bank hybrids will drive up demand, pushing prices higher and yields lower across Australia's big four banks. Since last month's announcement, spreads for Tier 1 securities have contracted ~16bps-so retail investors are eager to bid up assets and get a larger slice of a shrinking pool.

While uncertainty prevails in hybrid bank issuance for now, and short-term opportunities may arise, over the longer-term a broader set of dynamics is emerging for hybrids, particularly in sectors like energy and infrastructure.