(This Mar 11 story corrects to make clear Deutsche Bank has decided not to call a bond rather than delay repayment.)

FILE PHOTO: The logo of Deutsche Bank is pictured on a company's office in London, Britain July 8, 2019. REUTERS/Simon Dawson/File Photo

LONDON/FRANKFURT (Reuters) - Deutsche Bank DBKGn.DE has said it will not exercise an option to redeem $1.25 billion of bonds next month, a rare move in the industry that could pave the way for other lenders to follow suit.

With the appetite for risky debt severely hit by recent market volatility, Germany’s biggest bank said on Wednesday it would hold on to $1.25 billion of so-called Additional Tier 1 (AT1) bonds rather than repay them at the first opportunity.

AT1 bonds - more commonly known as a type of contingent convertible, or CoCo, bonds - are the most risky debt banks can issue. They are designed to be perpetual in nature, though banks can repay them after a specified period. In this case, Apr. 30 was the first chance for Deutsche to redeem it.

It is usual for banks to repay them at the first opportunity, but this could change now given the recent blowout in CoCo debt after the coronavirus outbreak hampered risk sentiment and economic expectations. Deutsche Bank could be the first of many to take this option, according to analysts.

“If the market conditions persist like this, we may start seeing bank treasurers start to look at this option more and more,” said Filippo Alloatti, senior credit analyst at Federated Hermes. “I don’t love it as an investor, but as long as there an economic justification for this and the chain of reasoning is clear, we can live with it.”

AT1 securities were designed in the wake of the 2008 financial crisis to try to ensure investors, rather than taxpayers, would be on the hook if a bank ran into financial difficulties.

Banks have almost always redeemed them at the first opportunity, though Banco Santander SAN.MC was one high-profile exception last year, though the Spanish lender did eventually repay bondholders.

“Because of the blowout in this market, there’s a lot more expectations that borrowers will leave AT1s alone and not redeem them,” said a banker who manages bond sales for European companies, including Deutsche Bank. “It is much cheaper for them to hold on to it than to call it.”

He asked not to be named as he is not authorised to speak publicly about his clients.

Other recently issued CoCo bonds have been hit hard by the coronavirus outbreak, especially those by banks in Italy, which has borne the brunt of Europe’s epidemic and has been locked down by the government.

UBI Banca's 400-million-euro AT1 bond issued in January fell seven cents on the euro on Monday, pushing the yield up 174 basis points to 7.17%, while Banco BPM's CoCo bond is now yielding 9.67% compared to 6.6% at the start of the month. IT210511032=, IT208996827=

Market's iBoxx index of euro contingent convertibles .IBXXC2D1 hit its lowest level in six months this week, falling particularly sharply in recent days.

Graphic: Deutsche CoCo bonds hit by decision not to call