The shocking non-call

A deeply scary event for the capital instrument market occurred today. Deutsche did not exercise a call on a lower Tier 2 instrument, the 3.875% sub notes of 2004/2014. From their press release:

Deutsche Bank has decided not to exercise its early redemption option to call the Notes at par because replacement costs would be more expensive than the existing EURIBOR +88 bps step-up coupon. Accordingly, the Notes' early redemption provision at the option of the issuer is not in-the-money.

The entire capital instrument market is based on the principle that banks will call their sub notes at the earliest opportunity - most investors calculate duration on that basis, and few people calculate an option adjusted spread, viewing the option not to call as reputationally too dangerous to exercise. The world has changed: expect the prices of these things to plummet. It will also become significantly more expensive for banks or insurers to issue hybrid capital instruments. This is really really not good.