Are Hybrids Better Than Bank Stocks?

Are Hybrids Better Than Bank Stocks?

Bank Hybrid securities

Hybrid Securities or Hybrid stock is a financial instrument which possesses the features of both debt and equity. Bank hybrid securities are those securities that are issued by the banks. However, the bank which issues these hybrid securities does not provide any guarantee of receiving any interest which they give on bank deposits. These securities just like any other debt securities, may either pay a fixed or a floating rate of interest. Also possessing the features of equity may also give a higher rate of return than debt securities.

There are two types of bank hybrid securities:

  • Tier 1 hybrids: Tier 1 hybrids are also known as additional tier 1 (AT1), capital notes or convertible preference shares. These do not have any fixed maturity date as they can be converted into ordinary shares in the issuing bank on a fixed date.

Distribution on these securities depends on the discretion of the issuing bank. The bank has no obligation to make any payment in case the issuing bank decides not to make any distribution.

The repayment of the face value or the nominal value of the security before its fixed date also depends as per issuing bank’s discretion.

  • Tier 2 hybrids: Tier 2 hybrids are also known as subordinated notes. These securities have a fixed maturity date — any distribution on this hybrid security in case of solvency. In case there is no distribution on these securities, then these get accumulated till the issuing bank is deemed solvent.

The repayment of the face value depends on the issuing bank’s discretion.

The risk associated with the bank hybrid securities:

Through bank hybrids, the issuing bank protects the risks of its investors by shifting the risk of the bank to the investors of the hybrid securities. The repayment of the capital invested on these hybrid securities is not secured and do not get covered under Financial claim scheme. In case the banks declare itself insolvent, then the Australian Government has no obligations to repay the invested amount.

In case the issuing bank faces a financial crisis, then distribution may defer by many months or can even extend up to years. It also depends on issuing banks discretion to convert these hybrid securities into shares.

The other risks associated with hybrids are interest rate risk, credit risk and last is liquidity risk.

Bank stocks:

Bank stocks are the capital stock of any banking company. These are shares of financial institutions that hold the license to receive, hold deposits and also provide loan the individuals and the business.

To identify whether to buy a bank stock or not depends on the quality of the underlying loan in the bank’s portfolio. The profitability of the bank stocks is better in case the stock is held in a tax-advantaged account. It also depends on the cash dividend yield and its capability of loss reserves. For this, one can do a comparative study for the comparable banks through their income statement and the balance sheet of the banks.

Risk of Bank stocks:

In the case of bank stocks, it is essential that the banks have adequate reserves. For example: if the bank has sufficient reserves to handle 2% of the bad debts and the bad goes for a particular year goes 5% then it would have a devastating impact on the shareholders as their it will wipe out a considerable portion of the book value resulting in huge losses on profit and loss statement.

Conclusion:

Both banks hybrids and bank stock will react similarly in a downturn. However, bank hybrids a little more complicated than bank stocks.


Disclaimer

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