NAB (AA-) surprised the market with an old-fashioned 10-year, non-call five-year, lower tier 2 subordinated debt issue last week. The market was surprised for several reasons. The deal follows a A$1.0 billion-plus retail issue in the same format undertaken earlier in the year. While that deal was priced at 275 basis points over 90-day bank bills, it now trades at 195 bps over this.The issue undertaken last week amounted to A$950 million and was priced at 220 bps over 90-day bank bills.While NAB may appear to have shown too much generosity in pricing the subordinated notes, there are several good reasons for the pricing.The first is that the bank has A$750 million of subordinated notes that will be called on December 21, and the notes need to be replaced. A second reason is that the retail notes were not rated by Standard & Poor's but the wholesale notes are - and they are rated "A-", three notches below NAB's senior rating, not the usual one notch below. Some investors would have been looking for compensation for this three-notch differential.This is the first wholesale lower tier 2 capital issue by a major bank in the domestic market since S&P changed its bank rating criteria this time last year. One of the changes made was that subordinated debt such as this is now rated one notch off the stand-alone credit profile (SACP) of the bank, not its senior debt rating.Thus, with an SACP of "a" the rating assigned to this instrument is "A-". The reason for the change in approach is that the senior rating assigned to NAB reflects two notches of uplift from the SACP, on the assumption of sovereign support in need. No such assumption is made in relation to subordinated debt in any form.It should also be noted that both this issue and the retail issue will be more expensive for NAB than previous lower tier 2 capital issues. Both sets of subordinated notes will qualify for Basel III transitional relief from APRA from January, 1, 2013, but this means the regulatory capital value of the notes will amortise by 10 per cent per annum, straight line, from that date.Thus, the regulatory capital value of the notes will be only 50 per cent by the time the five-year call dates arrive. NAB will have a great incentive to call the notes at that time. Moreover, APRA will insist.So, why did NAB bother? Why didn't it simply issue Basel III-compliant lower tier 2 capital? The answer is margin.Barclays (A+) issued such debt just the day before the NAB issue. The bonds are referred to as CoCo bonds - contingent capital - because the full value of the bonds will be written off if Barclays' common equity ratio falls below seven per cent (from its current 10.4 per cent).Barclays was overwhelmed with investor demand for the debt, despite the write-off trigger. The bank was seeking US$2.0 billion of lower tier 2 capital and was offering a yield of 7.75 per cent