Capital Notes – What Are They and Should You Invest?

Capital Notes – What Are They and Should You Invest?

The Australian bank capital note market has long been favored by income investors and is worth around $30 billion. Recent issues mean it’s worth examining capital notes, their features and why you would consider investing.

Both Westpac and Macquarie Bank have recently been in the market with a capital notes hybrid raising. In fact, all the banks need to issue capital notes to meet APRA capital requirements and cover other liabilities. There is little growth in the market with new issues typically raising funds to repay existing capital note issues.

What are Capital Notes?

A capital note is a hybrid product and is a perpetual unsecured security that combines features of both shares and bonds – hence the term hybrid security. It is a way for banks and companies to borrow money from investors.

Investors in these bank securities are loaning money to the issuer with no fixed maturity date. In return investors will receive a quarterly distribution and at redemption expect to have face value paid back to them or for funds to be converted to shares. Like shares, capital note securities are traded on the ASX and pay franked distributions.

Why do the banks issue these Capital Notes?

Banks issue these notes to help them raise ‘loss absorbing’ capital they need to meet regulatory capital requirements that were mandated following the 2008 Global Financial Crisis. The Basel III accords focused heavily on minimum capital requirements including review of an institution’s capital adequacy. In short, banks must hold certain levels of capital to ensure they can continue to operate in stressed markets without government help.

Who Would Capital Notes Be Most Suited For?

Bell Potter Securities’ head of fixed income Barry Ziegler says, “These securities suit investors who are prepared to take preferred equity risk of the issuer over a longer duration than a typical retail investment product.

“Investors will also benefit from a higher yield including franking credits for undertaking risk.”

Macquarie Bank’s Capital Notes 3 offer has been priced through a bookbuild at a margin of 2.90% over the 3 Month Bank Bill Rate. Distributions will be quarterly (40% partially franked).

What do you need to be wary of?

The returns are greater than any current bank deposit rates but it’s important that investors understand the inherent risk that comes with these investments.

These hybrid instruments are fully paid, unsecured, subordinated, non-cumulative, mandatorily convertible notes. See the article AMP Hybrid Helps Explain Technical Terms and Returns for definitions of these terms.

Ziegler notes that capital notes are not a bank deposit protected by the Government guarantee scheme and they rank behind deposits, senior debt and subordinated debt in the banks’ capital structure.

“All capital notes are perpetual, they don’t have a maturity date, however, they do have an ‘optional exchange date’ where the issuer at its discretion can redeem,” Ziegler said. “If the issuer doesn’t redeem at first call date, then they must redeem at a later date when conversion conditions are met or at ‘Mandatory Conversion’ date. If conversion conditions are not met, investors must sell securities to recoup capital.

Also read: 
Westpac Capital Notes 8 (WBCPK) Offer Announced 
Macquarie Bank Capital Notes 3 (BCN3) MBLPD Offer Opens  

“It’s important to be aware that distributions are non-cumulative and discretionary. So, they may not be paid and never have to be made up.”

These notes may also be called early where the bank decides to end the investment and can either convert the notes into shares or redeem them by repaying the $100 face value. Most of the bank capital notes have been called at the first opportunity with the banks repaying the $100, or investors being given the opportunity to roll their investment over into a new issue of capital notes.

There are various conversion and trigger events that investors will also need to understand in considering their investment.

Ziegler also cautions about an adverse movement in credit spreads as a result of a tightening in the availability and cost of credit.

“New issues may offer more attractive issue terms and margins, placing downward pressure on the security price,” he said.

“Adverse change in financial performance of the issuer which combined with a major bad debt event could lead to the Common Equity Tier 1 Capital Ratio falling below 5.125%, resulting in automatic conversion of capital notes to shares under the Capital Trigger Event.”

An automatic conversion to bank shares may mean that the shares could be worth less than your initial investment.

A final term worth thinking about is that capital notes are loss absorbing – 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.

The Current Offers

Option to Convert, Redeem or Transfer Notes
Scheduled conversion date
Issue Date
Macquarie Capital Notes 3 (MBLPD) $500m 2.90% 7/9/28
8/9/31 27/8/21
Westpac Capital Notes 8 (WBCPK)


~$1.45b 2.90% 21/9/29
21/6/32 15/9/21

Over the past weeks Macquarie Bank and Westpac have launched capital note issues.

Bell Potter’s Barry Ziegler commented in relation to these: “The Macquarie Bank issue of $500m was three times oversubscribed and closed on the first day.

“Whereas the Westpac Capital Notes 8 saw final broker firm demand in excess of $3.3bn over a two-day offer period. Westpac also announced that reinvestment demand from the WBCPG series exceeded $1.0bn.

“Westpac has allocated around A$1.45bn (upsized from A$1bn) with the ability to accept more or less depending on shareholder and reinvestment offer amounting to hefty scalebacks in the broker firm bookbuild.

“The demand for existing issues has brought about further contraction in credit (risk) spreads, lowering the yield to first call and increasing the price of all series.

“With a cheap and abundant supply of cash in the system chasing yield, we expect further yield contraction in the hybrids sector.”

What is vital is that investors understand the features and risks of any hybrid before investing. You can get these details from the relevant prospectus.


This article does not constitute investment advice and is general in nature. The information does not take into account your objectives, financial situation or needs. It is not specific to you, your needs, goals or objectives. Because of that, you should consider if it is appropriate to you and your needs, before acting on the information. If you don’t know what your needs are, you should consult a trusted and licensed financial adviser who can provide you with personal financial product advice. In addition, you should obtain and read the product disclosure statement (PDS) before making a decision to acquire a financial product. Please read our terms and conditions for further information.