Though investor expectations typically assume that financial institutions will redeem these instruments at their first call date, DB’s decision to forgo the call raised eyebrows, especially as it was the first major issuer to skip a call since the fallout from the writedown of Credit Suisse Group AG’s AT1s in March 2023. Such actions can often be interpreted by the market as potential indicators of financial distress or liquidity issues, which can significantly undermine investor confidence.
Historically, the decision not to redeem AT1s has led to some market volatilities
For instance, Banco Santander decided not to call its EUR1.5 billion ($2.23 billion) AT1 at the first call date on March 12, 2019, amid higher refinancing costs than the AT1’s reset coupon. Following the decision, the AT1 fell from 99 cents to 96.75 cents per dollar.
In November 2022, Korea’s Heungkuk Life Insurance Co (HLI) sent a shockwave through the Korean credit market after delaying a call option on its US$500 million perpetuals. The surprise announcement caused significant price drops in similar instruments issued by financial institutions in the region, with the likes of Kookmin Bank, Shinhan Group and Woori Bank all seeing their perpetuals falling over 5 cents per dollar. Meanwhile, HLI’s perpetual fell by 27 cents to 72 cents per dollar before reversing its decision a week later to stabilise the market sentiment.
Interestingly, despite initial concerns, the market reacted positively to DB’s announcement
The price of the AT1 that will not be called increased by 0.5 cents per dollar, surpassing par value. This positive market response can be attributed to the reset coupon, which is expected to double to around 8.5%, a significant increase from the existing 4.789%. With interest rates rising sharply since 2022, many AT1 holders welcomed the prospect of higher yields, particularly in light of DB’s improving financial performance over the years. This gave the AT1 holders comfort that DB’s decision was ultimately due to economic considerations and not fundamental or liquidity issues. After all, DB has historically skipped calls on instruments where it was uneconomical to do so, typically during periods of idiosyncratic or market stress. This highlights a level of management comfort in this approach.
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Adding to the positive sentiment, on March 24, or one business day after the non-call decision, DB successfully issued a new EUR1.5 billion AT1 at a coupon rate of 7.125%. The offering was met with strong demand, resulting in an impressive order book of EUR10 billion or 6.7 times the issue size. The AT1 spread of 460 basis points (bps) is the tightest DB has seen since 2021, indicating robust investor confidence in DB. However, the tight spread of 460 bps, which will also be used for the next reset margin, may elevate the likelihood of DB not calling back the AT1. The lower reset margin may lead to a lower reset coupon rate should DB forgo the call in 2030, depending on the instrument’s reference rate. We have already seen the prices of the new EUR1.5 billion AT1 fall noticeably in the current tariff-induced market volatility.
Past and present reminders. DB’s non-call decision is a reminder for AT1 investors that the assumption that banks will always redeem these securities at the earliest opportunity may not hold true. While these capital instruments can offer attractive yields, their structure comes with their fair share of risks, especially when the market pricing assumes that calls are a given. This is because AT1s are most likely to be impacted by pullbacks from negative episodic events that may occur as a result of heightened financial market volatility given their exposure to economic conditions, subordinated and loss-absorbing features as well as equity-like characteristics.
DB’s move could signal a future where non-call risks become more common, and, as such, it is crucial for investors to stay vigilant when analysing the specific risks and the returns of each bank's capital instruments. These risks have seemingly increased in the current market environment and considering recent regulator positioning towards increasing the going concern basis or permanency of AT1s following the pandemic and the Credit Suisse Group’s AT1 writedowns in March 2023.
Chin Meng Tee, Andrew Wong, Ezien Hoo and Wong Hong Wei are credit analysts with OCBC
