Interest payments may be reduced or stopped
Regulatory capital products nearly always allow the bank to stop paying interest, or reduce the amount of interest they pay, under certain circumstances. Sometimes interest payments are completely the bank’s decision, even if their business is profitable.
It might be difficult to predict the circumstances in which a well-known bank chooses to stop paying interest on its regulatory capital products, but you shouldn’t assume this would never happen.
Redeeming is usually (but not always) the bank’s decision
Although regulatory capital products are long-term investments, sometimes of ‘perpetual’ duration, some investors may expect the bank to buy back or redeem the product after an initial period, often five years. Any buy-back is usually the bank’s decision, and usually needs to be approved by the Reserve Bank.
You shouldn’t assume that because the bank is a household name they will buy back or redeem the products after this initial period.
Regulatory capital products are deliberately designed with features that give banks flexibility over payments. Although it can be difficult to predict when a bank might use these features, you should be aware that they can be used when it’s in the bank’s interests to do so.
The market price can change quickly
Regulatory capital products are usually listed on the NZX, but this doesn’t necessarily mean you will be able to sell them quickly, or at all. The market price can change quickly.
For example, the value of the notes or shares may suddenly fall if the bank suspends or defers interest payments, if they don’t buy back the notes when the market expected them to, or if there is a material change in the company or product credit rating, or in market interest rates.
Regulatory capital products are designed to protect the bank
These products are designed to make banks less likely to become insolvent. Their terms are often controlled by the requirements of ‘prudential regulation’, which is regulated by the Reserve Bank of New Zealand to protect the stability of the financial system, rather than your specific investment.
The risk of loss to the bank is reduced by passing this risk on to investors who purchase their capital notes.
The same features that give banks flexibility to cancel or postpone their obligations create complex risks for investors.