NEW YORK, Dec 22 (Reuters) - More banks may follow Deutsche Bank’s decision last week not to redeem a subordinated bond at its call date, re-pricing the market for these lower-quality financial bonds, Moody’s Investors Service said on Monday.
Deutsche Bank DBKGn.DE shocked the markets when it became the first big bank to say it would not exercise an option to redeem a so-called Lower Tier 2 bank bond on its call date in January. The move sparked a sharp loss in similar European subordinated bonds amid fears they would also not be redeemed.
Lower Tier 2 bonds are a type of subordinated debt that ranks between senior debt and equities in claims on a company’s assets in a bankruptcy.
Investors widely expect banks to redeem such bonds on the first call date because interest rates step up if they are left outstanding. If the bonds are not called, investors are left holding a longer-term security that was priced at shorter-term rates.
Funding costs have risen so much that for Deutsche Bank not calling the debt made more sense economically than trying to find replacement capital, Moody’s said in a report.
“Several other banks are in a similar position as Deutsche Bank, and we would expect to see them take similar actions,” Moody’s said. That especially will be the case if Deutsche Bank is seen as having “legitimized” the practice of waiving call options, the agency said.
So-called hybrid securities, a type of subordinated debt or preferred stock with both debt- and equity-like features, may also be at risk of not being called, Moody’s said.
Many hybrids have perpetual or very long maturities, but are typically priced by the market to their first call dates, often 5 to 10 years, Moody’s said.
Hybrids were popular with U.S. corporate borrowers in recent years because they have the favorable tax treatment of debt but are counted mostly as equity by rating agencies.
“For banks with hybrids approaching their call dates, we believe that not calling them is a real possibility,” Moody’s said. “Given the high cost of replacement capital, it will likely be more economic to have them remain outstanding and even be subject to a step-up in rate.”
Moody’s said ratings will not be affected unless a bank’s decision not to call a bond reveals deeper problems or the market reaction causes financing to be permanently shut. “We have no reason to believe that this is the case now,” Moody’s said.
“Moody’s views extension risk -- that is, the risk that a security will not be called at the call date -- as pure market risk and, all else being equal, not a factor in the credit rating process,” the agency said.
Demand for hybrid securities, however, may be dampened for some time, the rating agency said. (Reporting by Dena Aubin; additional reporting by Natalie Harrison; Editing by Andrea Ricci) (firstname.lastname@example.org; +1-646-223-6325; Reuters Messaging: email@example.com))
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