In a climate of shifting interest rates and tightening bank regulations, Australian investors are increasingly turning to subordinated notes for their attractive yields. But what exactly are subordinated notes, and how do they fit into the 2025 investment landscape? Whether you’re a seasoned fixed income investor or just exploring new options, understanding the mechanics and risks of subordinated notes is crucial.
What Are Subordinated Notes?
Subordinated notes are a type of debt security issued by banks and financial institutions. Unlike senior bonds, these notes sit lower in the repayment hierarchy—meaning, if the issuer defaults, subordinated note holders are paid after senior debt holders, but before equity investors. This ‘junior’ status is what earns them the label ‘subordinated’.
- Higher yields: Because of their increased risk, subordinated notes typically pay higher interest rates than senior bonds.
- Fixed and floating rate options: Investors can choose between fixed or variable interest payments, depending on their risk appetite and outlook for rates.
- Common issuers: Australia’s big four banks (CBA, Westpac, NAB, ANZ) frequently issue subordinated notes as part of their capital requirements.
Why Are Subordinated Notes in the Spotlight in 2025?
The Australian Prudential Regulation Authority (APRA) updated its capital adequacy rules in late 2024, requiring banks to hold more ‘loss-absorbing’ capital. This has led to a fresh wave of subordinated note issuances in 2025, as banks shore up their balance sheets while offering investors enticing returns. For example, Westpac’s recent 2025 subordinated note offered a margin of 2.75% above the 3-month BBSW, outstripping most term deposits and government bonds.
Key reasons for their popularity this year include:
- Attractive yield premium: With the RBA’s cash rate steady at 4.35%, subordinated notes are often yielding 6% or more—appealing in a high-inflation environment.
- Bank credit quality: Australia’s major banks are highly rated, so many investors view subordinated notes as a calculated risk.
- Policy-driven issuance: Regulatory pressure means more supply, giving investors greater choice and often tighter pricing.
The Risks and Rewards: What Investors Should Watch For
While the yield premium is tempting, subordinated notes are not risk-free. Here’s what to consider:
- Credit risk: If a bank runs into trouble, subordinated note holders could face losses—especially under new ‘bail-in’ provisions allowing conversion to equity or write-off in a crisis.
- Liquidity risk: Unlike term deposits, subordinated notes are traded on the ASX, but secondary market liquidity can dry up during market stress, making it hard to exit quickly.
- Call risk: Many subordinated notes have call dates, but early redemption is at the issuer’s discretion, not the investor’s. If rates fall, your note could be called and reinvestment options may be less attractive.
- Complexity: These are not simple savings products—they require an understanding of the issuer’s financial health, market conditions, and the specific note terms.
Example: In 2024, several subordinated notes were called early after the RBA paused rate hikes, leaving investors to reinvest at lower yields. Conversely, during the pandemic, some notes saw their market prices dip well below face value as liquidity dried up.
How to Approach Subordinated Notes in Your Portfolio
For Australians seeking to diversify income streams beyond term deposits and government bonds, subordinated notes can play a valuable role. However, they’re best viewed as part of a broader fixed income strategy, not as a substitute for cash or high-grade bonds.
Tips for 2025:
- Read the prospectus: Understand the note’s structure, maturity, and any conversion or write-off clauses.
- Check the issuer’s credit rating: While Australia’s big banks are robust, smaller issuers may pose higher risk.
- Consider your liquidity needs: Only invest what you can afford to leave untouched until maturity or call date.
- Balance your risk: Mix subordinated notes with safer assets to avoid overexposure to one risk category.
