Most investors understand how to buy shares in a bank, but there are several other ways to get exposure to the big four (and others), including via Tier 1 and Tier 2 securities.
Tier 1 Capital
From a regulatory perspective, Tier 1 capital is seen as the most loss-absorbent capital and enables the bank to continue its operations without adversely impacting the stability of the broader financial system.
This capital is used by banks to fund core business activities and is comprised of Common Equity Tier 1 (CET1) and Additional Tier 1 (AT1) capital.
CET1 includes common stock (shareholders) and retained earnings from the business which haven’t been paid out as dividends, while AT1 capital includes bank bonds and hybrid instruments like capital notes and convertible preference shares.
The purpose of Tier 1 securities is to be able to absorb losses to protect more senior ranking creditors such as Tier 2 securities, senior bank bonds and depositors.
Tier 2 Capital
Tier 2 capital provides an additional layer of protection for banks and consists of upper and lower tiers of subordinated debt. It’s important to understand that regardless of where these financial instruments sit within the spectrum, they all sit above Tier 1 capital.
This means in the event of liquidation Tier 2 capital holders will be paid out prior to Tier 1 capital holders.
Tier 1 Bank Hybrids
Bank hybrids can form part of either Tier 1 or Tier 2 capital but must meet APRA’s strict requirements to be considered as “regulatory capital”.
Tier 1 bank hybrids typically don’t have a fixed maturity date and are ranked lower in the capital structure than Tier 2 bonds, but higher than ordinary shares. These types of securities offer potentially higher returns but also come with increased risk.
Additionally, Tier 1 hybrids generally convert after a certain time into ordinary shares in what is known as scheduled or mandatory conversion. This typically occurs on a fixed date, but conditions and criteria vary depending upon the security.
A key consideration to be aware of with Tier 1 hybrids is that in times of financial stress, coupon payments can be cancelled.
Tier 2 Bank Hybrids
A Tier 2 bank hybrid security operates in a similar fashion to a bond as it will generally have a fixed maturity date, typically around ten years from the issue date.
These are subordinated debt instruments which sit above ordinary shares, AT1 (Tier 1) hybrids and Tier 1 capital in the capital structure.
How the Australian Bond Exchange Can Help
There are many ways to get exposure to banks beyond investing in shares, including via hybrids, bonds and other financial instruments.
The Australian Bond Exchange is a specialist in fixed-income investments and can provide you with access to a range of unique investment opportunities spanning some of the big four banks and other international names.
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