Totality Deep Dive: Handling the end of Australian bank hybrids

If you rely on Australian bank hybrids for income, your playbook needs a refresh. APRA will remove AT1 (Additional Tier 1) from the prudential framework and fully phase it out by 2032. In practice, most outstanding lines are expected to be dealt with at or before first call dates well ahead of that horizon (APRA 2024 MR).

The “buy, clip and roll” habit that powered retail income for years in Australia is ending. Over the next two to five years, we think liquidity will thin, prices will gravitate to par near call, and the familiar reinvestment pipeline will close (Money Management 2025).

In our view, investors who rebuild their income stack now using simpler capital and broader diversification will have a smoother transition.

This Totality Deep Dive for February 2026 is for general informational purposes only and reflects aggregated market data and publicly available research. It does not consider any reader’s specific financial situation or objectives and should not be used as a basis for investment decisions.

1. What are bank hybrids, and why did they become a retail staple?

AT1 hybrids sit between Tier 2 and common equity in a bank’s capital structure. Tier 2 is a form of loss-absorbing bond that ranks above hybrids but below senior debt, designed to absorb losses in resolution after equity has been impaired (APRA 2024 MR).

AT1 hybrids, by contrast, carry going-concern loss-absorption features, meaning they can be written off or converted to equity earlier in a stress event (APRA 2024 DP). They pay floating-rate distributions (Bank Bill Swap Rates [BBSW] plus margin) and have historically provided franking credits, making them a powerful draw for Australian income seekers (Westpac FAQs (Hybrids)).

Hybrids also carry non-viability triggers that enable regulators to convert or write them down in a crisis. They absorb losses immediately after equity, but before any subordinated or senior debt is touched. This blend of income and contingent loss-absorbing capacity helped build an approximately AUD 40 billion market in Australia, with 20–30% retail ownership (NAB 2025).

2. Why APRA is phasing out AT1 hybrids

a. Crisis performance and instrument complexity

Global stress events, most visibly the 2023 Credit Suisse crisis in which hybrid holders were written off, highlighted that contingent capital instruments such as AT1 can blur the normal order of loss allocation and introduce legal and operational uncertainty at the moment clarity is most needed.

APRA’s assessment is that AT1 hybrids have not consistently provided early, predictable loss absorption, and that the structural complexity of these instruments increases the risk of market contagion during periods of stress.

b. Retail suitability and clarity of capital structure

Australia’s hybrid market is unusual for its high level of retail participation.

APRA is simplifying the capital structure by removing AT1 hybrids—perpetual, highly subordinated instruments designed to absorb losses while a bank is still operating—and increasing the use of Common Equity Tier 1 (CET1) and Tier 2 capital (APRA 2024/25 Hub).

This shift is intended to create a cleaner, more predictable loss-absorbing hierarchy.

For large banks, roughly 1.5% of capital previously supplied by AT1 will be replaced by approximately 1.25% of Tier 2 and 0.25% of CET1. This transition will occur progressively as outstanding AT1 securities reach their call dates, with all AT1 phased out by no later than 2032 (NAB 2025).

3. The runway: the next 2-5 years matter most

While 2032 is the formal end date, realities associated with liquidity will arrive much sooner. A significant share of outstanding retail hybrids will be called within five years. As calls approach, we anticipate prices will converge to par, trading interest will wane, and spreads will widen, magnifying exit costs.

4. Investor implications

• Liquidity decay: Fewer counterparties want short-dated, call-bound lines close to call. Execution costs rise and portfolios get “stickier”.
• Reinvestment risk: The pipeline of new AT1 deals to roll into is ending. Capital will need to move into different instruments and markets.
• After-tax recalibration: Many AT1 distributions included franking. Replacements typically won’t, so investors must avoid excessive focus on headline yields and instead model net-of-tax income.

For investors, the nearest structural successor to AT1 is Tier 2. It sits in the closest position in the capital structure but comes with fewer conditional triggers, mandatory (non-discretionary) coupons, and simpler, more predictable resolution mechanics. This makes Tier 2 a cleaner, more reliable instrument compared with the operational complexity that characterised AT1 hybrids (APRA 2024/25 Hub).

5. Practical alternatives and how to use them

No single product replicates AT1 one for one. In our view, resilient income stacks are built as portfolios, often anchored by Tier 2 and complemented by diversified global fixed income and floating-rate credit, with position-sized private credit where appropriate.

This aligns with APRA’s move away from AT1 toward CET1 and Tier 2, and with industry commentary on where hybrid capital is likely to migrate (DBRS 2024).

a. Tier 2 subordinated debt (the structural successor)

APRA’s framework replaces the former AT1 bucket with approximately 1.25% Tier 2 and 0.25% CET1 for large banks, so Tier 2 issuance is expected to remain a key channel as AT1 winds down.

Tier 2 ranks above AT1 but below senior debt and coupons are non-discretionary, with simpler terms than AT1’s conversion/write-down triggers (NAB 2025). Tier 2 is now also ASX-accessible via a range of ETFs.

b. Diversified global fixed income (core bonds and multi-sector credit)

AUD-hedged global aggregate bond sleeves and multi-sector credit broaden exposure across rates, curve, and corporate/securitised credit.

Industry coverage notes investors are redeploying maturing hybrid capital toward broader fixed income as AT1 supply sunsets; these sleeves generally do not carry franking and returns vary with interest-rate and spread cycles (NAB 2025).

c. Active fixed income ETFs (floating-rate and subordinated strategies)

Managers have launched or retooled active ETFs focusing on floating-rate credit and subordinated debt to serve as hybrid replacements. Listed formats retain ease of execution while adding multi-issuer diversification and active risk controls. Investors may consider pairing a Tier 2 ETF with a flexible/active credit ETF to mix structural clarity (Tier 2) with tactical tilts (active credit) across sectors, regions, and duration.

d. Selective private credit (illiquidity for income)

Private-credit strategies introduce illiquidity and documentation risks and may display valuation lags and manager dispersion; they are used by some investors to seek higher running income and lower correlation to public markets. Sizing and governance typically reflect liquidity needs and due-diligence capacity (Avant 2025).

e. High quality global floating-rate credit

Global FRN strategies (often AUD-hedged) target high-grade banks and corporates, providing rate-sensitive cash flows, and are used as a listed income sleeve.

Always review each product’s PDS and TMD carefully—including any use of leverage, liquidity management tools, portfolio construction rules, and cycle-through performance—before allocating capital. Understand how distributions are generated, how risk is managed, and how the strategy may behave under different market conditions.

6. After-tax reality: Replacing franking credits

The franking benefit that historically accompanied many Australian bank hybrids is being removed as AT1 securities are phased out. Industry commentary notes that hybrids have traditionally appealed to retail investors in part because of their franking credits, which boosted after-tax income for many investors (ASX 2025; NAB 2025).

Because most successor income instruments do not carry franking, it is important to assess income on a net-of-tax and fees basis rather than relying on headline yields (ASX 2025).

In market practice, investors often use combinations of categories—such as Tier 2, floating-rate or global credit, and active core/multisector fixed income—when rebuilding income sleeves. These combinations can offer diversified sources of income without relying on AT1’s contingent-capital features.

7. Transition considerations during the AT1 phase-out

As AT1 securities are progressively phased out under APRA’s transitional framework (eligible only until their first call dates and no later than 2032 (APRA 2024 DP), investors may encounter several practical considerations when managing existing hybrid exposures. The points below are not recommendations, but describe general factors commonly referenced in market commentary.

a. Understanding call-timing and liquidity

• Hybrid liquidity often becomes more limited as securities approach their first call dates, and trading margins may tighten or widen depending on market conditions (CBA Private 2025; Money Management 2025).
• Investors may find it helpful to be aware of key security characteristics—such as clean price, margin, and call date—so they understand how timing can influence liquidity and pricing.

b. Market conditions and execution environment

• Industry observations suggest that liquidity in listed hybrids can be thinner during periods of market stress, which may affect bid–offer spreads and execution quality (CBA Private 2025).
• Staged or opportunistic trading windows are sometimes discussed in professional commentary as a way market participants navigate thin markets, but approaches vary widely.

c. Preparing for reinvestment windows

• As AT1 issuance winds down, returned capital from called hybrids will typically need to be redirected into other parts of the fixed-income market, since hybrid reinvestment pipelines are diminishing (ASX 2025).
• Many listed income products—such as Tier 2, global fixed income, floating-rate credit, or multi-sector credit—outline their risks, liquidity processes and suitability criteria in their PDS/TMD, which should be reviewed carefully.

d. Monitoring broader credit and rate conditions

• Tier 2 spreads can shift with issuance cycles or macro conditions, and AUD hedging costs can fluctuate over time for global exposures (Money Management 2025; ASX 2025).
• Professional managers may adjust exposures across sectors and geographies in response to these factors; however, approaches differ by strategy and risk appetite.

e. General framing

• Many organisations describe this transition as a shift toward simpler capital instruments and more diversified fixed-income sources, reflecting APRA’s updated prudential architecture and the reduced role of AT1 in the system.

8. Market instruments in focus

• Tier 2 subordinated debt ETFs: Diversified, ASX-listed exposure to Australian bank Tier 2 instruments that sit above AT1 but below senior debt, with non-discretionary coupons and simpler contractual terms than AT1’s convert/write-down triggers.
• Australian credit income (active ETFs): Broad domestic credit sleeves that may include senior, subordinated and legacy hybrid exposures with active risk management.
• Global fixed income (AUD-hedged): Diversified global bond exposures spanning government and investment-grade corporate debt, used to broaden the base of income sources and reduce reliance on a single local market.
• Floating-rate credit (high-grade focus): Listed or pooled floating-rate strategies (often AUD-hedged) targeting high-grade banks and corporates, commonly used to moderate duration and maintain cash-flow cadence during the transition away from AT1.
• Active flexible credit (multi-sector): Manager-led, multi-sector credit strategies that rotate across investment-grade, high-yield and securitised markets, with discretion to adjust credit and duration through the cycle.
• Defensive income: Domestic sovereign and core bond exposures that can function as liquidity and defensive ballast while portfolios are re-positioned away from AT1.

Mentions above are categories, not products, and do not constitute an offer, solicitation or recommendation to trade. Always read the relevant PDS/TMD (including any leverage, liquidity tools and through-cycle methodology) and consider professional advice.

9. The bottom line

APRA is removing a complex, crisis-sensitive layer of bank capital and replacing it with clearer, more reliable instruments. This architecture restores clarity: CET1 at the equity base, Tier 2 as the principal loss-absorbing buffer above equity but below senior creditors, followed by senior debt and deposits.

Don’t wait for 2032 to respond to this change. Manage liquidity decay, avoid call-at-par surprises, and redeploy capital into Tier 2 and diversified fixed income with selective, well-governed private credit where appropriate.

Executed well, a successor portfolio can deliver comparable income, broader diversification, and cleaner downside mechanics than a legacy hybrid allocation.

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Sources: APRA; DBRS; ASX; NAB; Avant Capital; Money Management; CBA Private; Westpac.

Disclaimer: This publication is intended for informational purposes only. Figures represent historical observations and should not be interpreted as financial advice, recommendations, or forecasts. Past performance is not indicative of future results. All information is believed to be accurate at the time of publication but is subject to revision without notice. This Totality Deep Dive was produced by Totality Market Strategist Aaron Zanchetta.