STD Banco Santander, S.A. Sponsored Adr (Spain)

By Akane Otani and Georgi Kantchev 

Spanish lender Banco Santander SA said Tuesday it wouldn't redeem a risky kind of bank debt, a move analysts said could ripple across a largely untested corner of the bond market.

The bank's decision not to "call" the EUR1.5 billion ($1.33 billion) bond is believed to be the first of its kind in the so-called additional tier 1 bond market. AT1 debt is considered particularly risky because it has a perpetual maturity -- leaving issuers free not to ever repay bondholders.

But until Tuesday, issuers had always redeemed the securities -- typically by their first so-called call date -- as a courtesy to investors seeking the option to sell some of the debt. And the category of debt has attracted investors because it tends to pay higher interest than other types of bank bonds.

Santander's decision is raising questions about whether investors will start souring on AT1s across the board, which could force European banks to rethink a key way in which they have cushioned themselves against potentially catastrophic losses since the global financial crisis.

"This is a big surprise, the first time a major bank has not called AT1 securities," said Tom Kinmonth, fixed-income strategist at ABN Amro Bank. "It's a sign that the rest of the market may need to reprice them."

Michael Strachan, director of media and financial communications at Santander, said the bank had made the decision after balancing "the interests of all investors." In an email, Mr. Strachan added that the bank would "continue to monitor the market closely and will seek to exercise call options where we believe it is right to do so."

By not redeeming them by their first call date, Santander will leave the bonds outstanding, but switch from a fixed rate to a lower floating coupon rate. That will allow it to end up paying a lower coupon on the debt, 5.54%, than it would by issuing new bonds. The bank issued a dollar-denominated AT1 this week at 7.5%, for instance.

Santander bond prices slipped Tuesday, with AT1s due March 12 last trading at a cash price of 97.63, down from 98.42 Monday and 98.87 Friday, according to Refinitiv.

The bank's decision came as a surprise to investors, not only because issuers have historically called AT1 debt but also because Santander had issued another AT1 -- one carrying a 7.5% coupon -- just last week.

"It's like leading on the market to think they're going to call the bond, " said Paola Biraschi, senior banks analyst at CreditSights.

Some analysts warned that Santander's decision could make investors more reluctant to scoop up other AT1 issuances in the future.

"This will impact banks across Europe. This type of debt will now cost banks more money," ABN Amro's Mr. Kinmoth said.

But initial market reaction looked relatively muted.

The cash price of Santander AT1s with call dates in May fell to 98 from 98.5, while those issued by Barclays PLC and Crédit Agricole SA with call dates in September were either up Tuesday or trading around the flatline.

In postfinancial-crisis Europe, AT1 bonds took off as regulators required banks to rebuild their capital buffers. Such bonds -- which, according to ABN Amro Bank, are valued at about EUR125 billion in the European banking sector -- offered a way for banks to do this without selling new stock and diluting shareholders. And if things went wrong, investors were on the hook.

It isn't the first time the bonds have taken a hit. In 2016, a selloff in European lenders spread to such contingent convertible bonds, or CoCos. At the time, concerns that Deutsche Bank AG might not be able to meet the interest payments on its CoCos sent these securities tumbling across the board. In the end, Deutsche Bank released a statement confirming it would be able to cover the coupon payments.

Write to Akane Otani at akane.otani@wsj.com and Georgi Kantchev at georgi.kantchev@wsj.com

(END) Dow Jones Newswires

February 12, 2019 16:55 ET (21:55 GMT)

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