Hybrid securities are a way for banks and companies to borrow money from investors. They are complex investments that can be very risky. Get financial advice before investing in hybrids.
How hybrid securities and notes work
Companies, banks and insurers issue hybrid securities and notes. They are complex financial products that combine the features of bonds and shares. They can provide income, like a bond, but their value can fall dramatically, like shares.
Hybrids can also have features that impact the future value of your investment. Even experienced investors can struggle to understand the risks and features of some hybrids.
Hybrids generally pay a fixed or floating rate of return until a specified date. However there's no guarantee on the amount and timing of interest payments.
Each hybrid is unique and the names used to describe them may not be consistent. It's important to read the prospectus to check the specific features of each hybrid before investing.
Hybrids may not be suitable for you if you need steady returns or capital security.
Take the Australian Securities Exchange (ASX) online hybrids course to learn more about hybrid securities.
The difference between bank and corporate hybrids
Banks issue hybrids that are 'loss absorbing'. If the bank has financial difficulties, they can convert the hybrids to bank shares. The shares may be worth less than your initial investment, or written off completely.
This means investors, not the bank, are at risk of suffering a loss. This protects the bank's depositors, at the expense of hybrid investors.
When you buy a corporate hybrid you lend money to a company in return for regular interest payments. But the company can defer interest payments for years and may not repay your capital for decades.
Corporate hybrids are also known as 'subordinated notes'. This means corporate hybrid investors get paid last if the company becomes insolvent. Interest payments may also be held back until other debts are paid.
Listed and unlisted companies can issue corporate hybrids. You can:
- buy and sell listed hybrids on a securities exchange such as the Australian Securities Exchange (ASX)
- buy unlisted hybrids directly from the issuer. You can't trade them on the ASX, which means they are harder to sell and harder to value
The risks of hybrid securities and notes
Hybrids have different levels of risk, which depend on the features of the individual hybrid.
Here are some of the most common risks.
- Liquidity – there are fewer buyers and sellers in the market for hybrids. If you need to exit the investment in a hurry, you may have to accept a lower price.
- Interest payments deferred – some hybrids have features that allow the issuer to withhold interest payments if they get into financial difficulty.
- Last to be paid – you can be the last to get your money back if the company becomes insolvent. There may not be any money left for you after other creditors are paid.
- Can convert to shares – this can happen when the value of the bank or company falls. The shares may be worth less than your initial investment.
- Long maturity dates – investment terms can last decades. The longer the maturity, the greater chance the company might default on its obligations or run into financial difficulties.
- Not guaranteed – unlike savings accounts or term deposits with a bank, the Government guarantee doesn't cover hybrids.
- 'Knock out' options – some hybrids are written off completely if the issuer gets into financial difficulty. This means you'll lose all the money you've invested.
What to check before investing in a hybrid security
Understand the features and risks of any hybrid before investing. You can get these details from the prospectus.
Make sure you can answer the following questions:
- What are the risks of investing in this hybrid security, now and in the future?
- Will the returns compensate for the investment risk?
- How does the interest rate compare with other investments? Can other less complex or risky long-term investments provide a similar or better return?
- Does the issuer have to pay interest? Do missed payments accumulate?
- What is the maturity date? Can the issuer repay the investment early?
- Are there any 'trigger events' where your hybrid may convert into ordinary shares, or written off completely?
- Will this product help you achieve your financial goals and objectives?
- Does it suit your investment timeframe and personal risk profile?
- Can you leave this investment if your circumstances change?