EURIBOR

 Banco Sabadell SA won’t use an option to redeem a subordinated bond issue because it would be too expensive to refinance the debt, echoing a decision by Deutsche Bank AG in December.

The market for subordinated bank debt was roiled when Deutsche Bank passed up a chance to redeem 1 billion euros ($1.3 billion) of notes, paying a penalty rate instead. The decision surprised bondholders because borrowers are expected to repay callable notes at the first opportunity and the securities are valued on that basis.

Banco Sabadell, the largest commercial bank in Spain’s Catalunya region, will pay penalty interest of 95 basis points more than the euro interbank offered rate on the bonds after Feb. 18, the bank said in a statement today. The bank currently pays three-month Euribor plus 45 basis points on the 300 million-euro so-called lower-Tier 2 notes.

“This could be a major event if other banks decide to go down that road,” said Andrea Cicione, a strategist at BNP Paribas SA in London. “As soon as two issuers start to do it, a third can do it and it becomes a precedent.”

Banco Sabadell’s bonds due February 2014 fell 6 cents on the euro to 77, according to HVB eTrade prices on Bloomberg. The bonds were at 97 cents in December. The bank has the right to call the notes every three months from February, according to data compiled by Bloomberg.

Average Yield

Fixed-rate, lower-Tier 2 bonds yield about 7.98 percent on average, according to Merrill Lynch & Co.’s Euro Sub-Debt Lower Tier 2 Index.

Banco Sabadell’s notes currently pay a coupon of 4.673 percent, which will fall to about 3 percent after it resets to the new rate, Bloomberg calculations show. The current level was set in November, when Euribor averaged about 4.23 percent. A basis point is 0.01 percentage point.

“In today’s markets it does not make financial sense to call debt which would otherwise be replaced at a significantly higher cost,” Banco Sabadell said in a statement today. That’s “reflected both in the market’s current valuation of the instrument as well as the recent decision taken by other financial institutions in a similar situation,” the bank said.

Regulatory Requirements

European banks use the market for bonds with call dates to meet regulatory reserve requirements, known as Tier 1 and upper- and lower-Tier 2 capital. Lower-Tier 2 bonds are the most senior of these types of subordinated instrument and rank after senior notes and loans for repayment in a bankruptcy.

The Spanish bank this week sold preferred shares, which lenders also use as capital, through its branches to individual investors. The securities pay 6.5 percent for the first two years and then switch to three-month Euribor plus 250 basis points.

Banco Sabadell’s decision not to call the bonds “could lead to repricing of the lower-Tier 2 sector, though most of the extension risk seems to be already priced in,” said Cicione.

Credit-default swaps on Banco Sabadell rose 14 basis points to 304, the highest level in four months, according to CMA Datavision prices at 3:45 p.m. in London.

Default swaps are financial instruments based on bonds and loans that are used to speculate on a company’s ability to repay debt, and an increase signals a deterioration in perceptions of credit quality.

A basis point on a credit-default swap protecting 10 million euros of debt from default for five years is equivalent to 1,000 euros a year. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

Banco Sabadell was due to hold a conference call with investors today, according to the statement.