Bank Hybrids Phase-Out: What APRA’s Decision Means for Fixed Income Portfolios in 2026

By John Baxter, Fixed Income Advisor, LWP Capital

One of the most significant structural changes in Australian retail fixed income in years continues to play out in 2026, as the Australian Prudential Regulation Authority’s decision to phase out the roughly $40 billion bank Additional Tier 1 (AT1) hybrid market reshapes how income investors build their portfolios.

What’s Changing

APRA’s policy, formalised over the past two years, requires major banks to phase out AT1 hybrid securities by 2032, replacing them with a mix of Tier 2 capital instruments and other loss-absorbing capital. In practice, this has meant banks progressively calling existing hybrid notes rather than refinancing them with new hybrid issuance, effectively winding the asset class down from the supply side.

Westpac’s redemption of its Westpac Capital Notes 5 issue was one of the more closely watched examples of this trend, and similar calls have followed across the sector as issuers work through their existing hybrid stacks ahead of the transition timeline.

Why This Matters for Retail Investors

Bank hybrids have long been a favourite among Australian retail and self-managed super fund investors, prized for their familiarity — issued by household-name banks — and for the attractive spread pickup they offered over senior bank debt. Their gradual disappearance leaves a genuine gap in many income-focused portfolios.

“This has been one of the more consequential shifts in the retail fixed income landscape in over a decade,” says John Baxter, fixed income advisor at LWP Capital. “A lot of self-managed super fund investors built substantial hybrid allocations because the securities were easy to understand and traded on the ASX like shares. As that market winds down, those investors need a considered plan for redeploying capital, not just a reaction to individual call announcements.”

Where the Capital Is Going

As call risk on remaining hybrids has diminished — since banks are working through an orderly wind-down rather than opportunistically calling and refinancing — spreads on existing hybrids have tightened considerably, with many now trading below levels that would have seemed attractive just a few years ago. From 2027, remaining hybrid structures are set to transition toward Tier 2 classification, altering their risk profile further.

Much of the capital previously allocated to hybrids has been rotating into the broader Tier 2 and senior bank bond market, as well as into the wider investment-grade corporate bond universe, where all-in yields have become considerably more attractive following the RBA’s tightening cycle.

“At LWP Capital, we’ve been working through this transition with clients methodically over the past eighteen months,” John Baxter notes. “The good news is that today’s higher rate environment means investors don’t need to reach into riskier or more complex structures to replace the income hybrids used to provide — investment-grade bank Tier 2 paper and senior corporate bonds are now yielding levels that weren’t available when this policy was first announced.”

Practical Considerations

Investors still holding legacy hybrid positions should be thinking about several things as 2026 progresses:

• Call risk timing. With the wind-down largely predictable, investors can plan reinvestment ahead of scheduled call dates rather than being caught unprepared.
• Tax and franking credit implications. Hybrid distributions have often carried franking credits that differ from the tax treatment of straight bond interest, and this should factor into any switching decision.
• Structural complexity. As banks shift toward standard Tier 2 instruments, the securities replacing hybrids are generally simpler and more transparent in their loss-absorption mechanics, which many investors will welcome.

The LWP Capital View

“This is a case where a regulatory change that initially looked like it was removing a popular asset class has actually coincided with a broader improvement in fixed income yields across the board,” John Baxter says. “For clients willing to look slightly beyond the familiar hybrid structure, there are genuinely attractive alternatives available in today’s market.”

LWP Capital continues to help clients navigate the remaining hybrid call schedule and identify suitable Tier 2 and senior bond replacements as the AT1 market approaches its 2032 sunset.

John Baxter is a fixed income advisor at LWP Capital. This article is general commentary and does not constitute personal financial advice.