David Lando

Copenhagen Business School

Title

Hybrid Bank Capital: The Economics of Uneconomic AT1 Calls

Authors

Mathi Danmark and David Lando

Abstract

Additional Tier 1 (AT1) notes are perpetual, callable notes issued by banks to meet their capital requirements. Banks almost always choose to redeem the notes at the first call date, even when issuing new notes is more expensive than keeping the old ones. We argue from a simple model that this reflects a reputational incentive: failing to call raises expected maturities and future financing costs. Our empirical analysis confirms that such a trade-off exists. Calls reduce yields on other AT1 issues from the same bank, consistent with the reputation effect, but leave other classes of subordinated capital unaffected, indicating that they do not signal financial strength.