TWO German banks plan to skip an important bond-market tradition by declining to buy back their Additional Tier 1 (AT1) notes early.

Holders of these notes have found themselves wiped out in the government-brokered rescue of Credit Suisse Group, sending the cost of refinancing the debt soaring globally. 

This has made exercising a call option on the bonds in order to replace them with new ones less appealing. Not refinancing the debt and paying the higher pre-agreed coupon may be cheaper. 

Deutsche Pfandbriefbank became the first European lender to skip an AT1 call this year. The real estate specialist blamed market conditions and economic costs in its decision to waive the option on 300 million euros (S$431.4 million) of the notes next month, said a statement. 

Another regional lender, Aareal Bank, said it assumed its AT1s wouldn’t be called, but added that a final decision had not been made. On Thursday (Mar 23), a Chinese commercial lender said it will skip a redemption option for a similar type of debt.

“Refinancing an AT1 would be an extremely difficult exercise in the current market backdrop,” said Suvi Platerink Kosonen, banking credit analyst at ING Group. “Markets are currently pricing in a very high likelihood of AT1 notes being extended – and for this to change, the market sentiment would need to improve substantially.”

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Subordinated-debt markets were battered globally by the Credit Suisse write down, amid its emergency takeover by UBS Group. International regulators were quick to cast it as a scenario peculiar to the Swiss market, and that normally shareholders would be the first to take a hit.

Investors generally plan for a call option on a bond to be exercised, and a decision to skip can shake sentiment. A South Korean insurer’s decision to waive a call option in November sparked a region-wide sell-off in perpetual bonds, engulfing one of Korea’s top insurance firms, before the market stabilised.

In Europe, yields for banks’ AT1s remain about 3 percentage points higher than before the banking turmoil started, data compiled by Bloomberg shows. Since lenders need to raise this regulatory debt or sell equity to meet capital requirements, those that need to refinance have few options available.

AT1 notes were created by regulators after the financial crisis as a way to impose losses on creditors when banks start to fail without resorting to taxpayer money. They are viewed by lenders as a means to bolster financial resources that is usually cheaper than normal equity, such as shares. BLOOMBERG