Putting shareholders ahead of hybrid noteholders
New rules came into effect at the start of the year limiting the distributions that banks can make if their common equity tier one capital ratio falls below buffer requirements. This has raised concerns that holders of bank hybrid notes could face an unexpected risk of receiving only partial distribution payments when a bank is not in financial difficulty in the usual sense of the term.If a bank is in danger of breaching the minimum 5.125 per cent common equity trigger or indeed is at the point of non-viability as determined by APRA, distributions will not be paid and conversion of the hybrid notes into ordinary equity is likely. But now if a major bank's common equity tier one capital ratio should fall below eight per cent APRA may require that only a partial distribution be paid on hybrid notes when due.Under APRA's prudential standard APS110, the major banks must have a minimum of common equity tier one capital ratio of 4.5 per cent of risk-weighted assets. To this is added a 2.5 per cent capital conservation buffer and a D-SIB imposition of one per cent.There is also a counter-cyclical buffer that can be applied but this is currently set at zero. Thus a major bank must have a minimum ratio of eight per cent of common equity tier one capital to risk-weighted assets. Should the ratio fall below this level, distributions to shareholders, additional tier one capital (hybrid note holders) and staff bonuses will be restricted.Yesterday, APRA released a clarification paper to APS 110 to address concerns that have been raised that timing differences in the payments of dividends and hybrid distributions may result in a dividend being paid in full and a subsequent hybrid distribution being restricted. A perception that shareholders were being favoured over hybrid note holders would severely damage investor confidence in hybrid notes.Clearly such an outcome would not be in a bank's interest but serves to illustrate the shortcomings of hybrid notes as a form of capital relative to real equity (shareholders' funds).APRA's considered response to the concern raised can be paraphrased as: Tough!APRA expects banks to manage their distributions to shareholders, hybrid note holders and staff in such a way that this outcome is avoided.