(Bloomberg) -- Banco Santander SA said it will skip a call option on Additional Tier 1 notes next month, rattling a $340 billion market for risk-laden bank debt.
The lender decided against a redemption citing an “obligation to assess the economics and balance the interests of all investors,” a company spokesman said in an email. Tuesday was the deadline for issuing a notice to use a March 12 call option on a 1.5 billion-euro ($1.7 billion) issue of 6.25 percent perpetual contingent-convertible notes.
The euro AT1s fell more than a cent from Monday’s close to 97 cents on the euro in the wake of the statement, after climbing to almost par last week when a Santander sale of dollar CoCos stoked call optimism. The sell-off may spread to other banks’ AT1s as investors have traditionally priced CoCos in the expectation that they will be called at the first opportunity.
“I anticipate a sharp spread widening across the AT1 market,” Paola Biraschi, an analyst at researcher CreditSights, said before the call announcement. “I don’t think an extension was priced in at all.”
AT1 Test Case
The decision had become a test case for AT1s because it was the first highly uncertain call since the creation of the risk-laden bonds following the financial crisis. The skip may tempt other banks to follow suit, presenting a looming market risk as the number of AT1s with low post-extension rates approaching their first call dates will pick up into next year.
Skipping the call may work out cheaper for Santander than redeeming the notes and selling new ones because the floating rate after extending the existing notes is lower than current market-funding costs. Against that, the bank had to weigh potential reputational damage that could drive up borrowing costs across its future subordinated issuance. Other banks will have to make similar calculations in the months ahead.
“We will continue to monitor the market closely and will seek to exercise call options where we believe it is right to do so,” Santander said.
This year’s sharp drop-off in bond yields marketwide, after last year’s widening, caused further complication for investors trying to work out which way Santander’s management would lean. The market trends contributed to the bank’s euro AT1s falling to 95 cents last month. They bounced back to almost par last week.
AT1s are the riskiest form of bank debt, as the notes can be written off or converted into equity if a lender’s capital level drops too low. Lenders can also skip coupon payments without triggering a default. These risks for investors are offset by high coupons that have let euro investors post total returns of 3.9 percent on CoCos over the past year, according to Bloomberg Barclays index data. That compares with just 0.5 percent for senior euro bank notes.
Banks have rarely broken with convention on calling subordinated notes at the first opportunity. Deutsche Bank AG roiled credit markets in 2008 when it skipped a call option, triggering investor losses. Assumptions were shaken again in 2016 when Standard Chartered Plc and German lender Commerzbank AG extended similar notes.
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