Subordinated debt: A bank hybrid alternative

08 September 2025

3 mins read

Over the next seven years, around $40 billion in investment capital will need to find a new home.

APRA’s decision to phase out Australian bank hybrids by 2032 means Australian investors who hold or were considering hybrids will need to find an alternative solution.

Hybrid investments have long been popular with retail investors seeking relatively easy access to attractive yields – particularly hybrids issued by Australian major banks. Notably, around 20% to 30% of ASX hybrids are owned by retail investors.¹

APRA has mandated the major banks to replace most of their hybrids with subordinated debt, or Tier 2 securities. These take priority over ordinary shares and hybrids in the event of insolvency.

While 2032 may seem like a long way off, the next major call date in September 2025 will see ~$1.7billion returned to investors from Westpac Capital’s Notes 5. By the following June, ~$1.9billion with NAB Capital Notes 3 and ~$1.2billion with CommBank PERLS XIII Capital Notes, along with a number of hybrids from other issuers, will also need to find a new home. And the pool of investable hybrids will keep shrinking.

So where will investors with near term maturities turn?

Subordinated debt: bridging the hybrid gap

“Fixed income plays an important role in investor portfolios – it can provide regular and reliable income, protection in times of volatility, diversification, and a certain amount of liquidity,” says Blair Hannon, Head of ETFs, ANZ with Macquarie Asset Management.

Term deposits, bonds, and private credit are just some of the ways you can achieve these goals – but they vary widely in terms of yield, risk and volatility.

“Whether you’re putting money in the bank or investing in some type of credit instrument, ultimately you are lending money and you want to get that back plus interest in the interim,” says Brett Lewthwaite, Macquarie Asset Management’s CIO and Global Head of Fixed Income.

“You need to do some due diligence on who you’re investing in. If it looks too good to be true, it probably is.”

Lewthwaite describes subordinated debt as “the most genuine hybrid replacement, with a similar risk-return profile across high quality issuers.”

James Blaufelder, Associate Director with Canaccord Genuity, agrees. He describes bank subordinated debt ETFs as the most “like for like” substitution for hybrids.

"They have provided a really solid yield, anything between 5.5 to 6 per cent,” he says, noting they also pay income monthly.^*

The subordinated debt market is much bigger than the hybrid market in Australia, with ~$120billion issued by major Australian banks globally, compared to hybrids which is a ~$40billion market. It’s an established market with institutional investors – and now, with the option to trade actively managed subordinated debt ETFs, it’s an accessible fixed income solution for hybrid investors.

It’s true they don’t provide franking credits, which will impact post-tax income for some investors. But in a post-hybrid world, the only franking credit option remaining is direct equity investment.

Hybrid securities vs ETFs

Subordinated debt has the potential to sit in the ‘just right’ sweet spot of fixed income. It typically offers higher levels of yield than senior bonds or cash, with lower capital risk than equities or hybrids. And it still provides exposure to the same well-capitalised, highly regulated Australian banks.

For example, investing in CBA shares might yield a dividend income of around 3.7%, and CBA senior 5-year bonds coupon income of 4.3%. With franking credits, hybrid investors in CBA Perls XVI capital note could achieve income returns of 6.4% – in line with the slightly higher risk in the bank’s capital structure.

When that option is no longer available, the CBA subordinated debt (5-year equivalent) is the nearest best alternative, with a current running yield of 5.0% (as at 31 July 2025).

For illustrative purposes only and does not consider capital risk.
Past performance is not a reliable indicator of future performance. Source: Bloomberg and Westpac. Data as at 31 July 2025.
CBA PERLS XVI Capital Notes has both net yield (ex-franking credits) and gross yield (inclusive of franking credits). Running Yield, also known as current yield, is the current expected annual income (coupon) a security pays expressed as percentage of its current market price. The running yield of the Fund is the weighted average of the running yields of all the securities in the fund. The Running Yield is not the return of the Fund and does not take into account the Fund’s fees and costs or any capital gains or losses on the Fund’s securities. It is not an actual or estimated return.

An active alternative to hybrids

Before deciding where to allocate in a post-hybrid world, assess the role hybrids play currently in your portfolio. Is it about delivering consistent income to supplement a retirement lifestyle? Or is it more important to provide diversification, downside protection in a volatile market, or simply ease of ASX access?

Whether your preferred alternative is government bonds, subordinated debt, or something higher up the risk spectrum, Lewthwaite and Hannon agree active management in fixed income may be worthwhile seeking out.

“Passive investing can work well for equities markets, but tracking a fixed income index means you’re more likely to be exposed to the most indebted companies or issuers as they will have the highest weight in the index,” explains Hannon.

In the fixed income space, Macquarie Asset Management has a track record of producing outperformance through active management. Our flagship fixed income funds have outperformed the benchmark over one, three and five years.²

Lewthwaite suggests asking fund managers three questions before you switch to a hybrid income alternative:

1. Do you have access to liquidity if you need it?

2. What is the likelihood of a loan going into default?

3. If a loan is in default, how has this been priced?

“It’s worth spending a bit more time investigating, because some alternatives could deliver similar if not better returns, and probably be less volatile than hybrids,” he says.

With over $3.2billion facing hybrid call dates in the next 12 months, advisers will need to fast-track client conversations to prevent missed income opportunities.

As an actively managed fund traded on the ASX, Macquarie’s Subordinated Debt Active ETF (ASX: MQSD) could be one cost-effective potential alternative, with its 0.29% management fee the same as the passive ETF alternative. It aims to provide monthly distributions and exposure to major Australian banks.