Deutsche Bank to Sell Notes That Share Losses in Crisis

Deutsche Bank AG (DBK), Europe’s largest investment bank by revenue, said it will sell at least 1.5 billion euros ($2.1 billion) of notes that can incur losses in a crisis, helping the firm meet stricter limits on leverage.

Holders of the subordinated bonds would lose at least part of their investment should the bank’s common equity Tier 1 capital ratio fall below 5.125 percent under gradually implemented Basel III rules, the Frankfurt-based firm said yesterday in a regulatory statement. Deutsche Bank would have the option of restoring debtholders’ rights should capital recover at a later date.

Banks are shrinking their balance sheets and selling bonds that can be written off or converted to shares in a crisis to meet a measure of financial strength known as the leverage ratio, or capital as a share of total assets. Deutsche Bank is selling the bonds, which force management to halt payouts if losses erode mandatory capital buffers, as a first step in its plan to raise 5 billion euros of additional Tier 1 capital.

“I don’t see any major risks to these in the near term, by which I mean the time it will take them to raise the total 5 billion euros,” said Eva Olsson, an analyst at Mitsubishi UFJ Securities in London. “After that, the risks rise because Deutsche Bank is likely to continue to be dismissive of bondholders and more focused on shareholders. That’s a risk that’s specific to Deutsche Bank.”

Popularity

While notes such as Deutsche Bank’s are gaining popularity among European firms looking to boost capital, the instruments have yet to be fully tested in emergencies, said Barbara Matthews, managing director of BCM International Regulatory Analytics LLC, a Washington-based consulting firm.

“Hybrid securities that were supposed to act like equity didn’t do their part in the U.S. during the last crisis, so I’m worried about the triggers and market perception of the issuer at that time,” said Matthews, a former U.S. Treasury attache to the European Union. “But there’s general hope that these are designed better and will act differently.”

European banks have issued the equivalent of about $35 billion of additional Tier 1 securities since Banco Bilbao Vizcaya Argentaria SA, Spain’s second-largest lender, opened the market a year ago. Of the total, $24 billion has been issued this year.

Deutsche Bank is the first German lender to say it will tap the market after tax authorities clarified how they plan to treat the securities earlier this month. Other German lenders such as Commerzbank AG may not yet be ready to follow suit because they are still restructuring and will probably find it cheaper to issue the securities if they get closer to completing that process, Olsson said.

U.S. Experience

U.S. banks sold $149 billion of trust-preferred securities from 2003 to 2008. The bonds were treated as capital by regulators because the issuer could stop making interest payments during stressful times. Still, most banks were reluctant to do so during 2008’s crisis, and those that did lost funding from other creditors concerned about the institutions’ financial health.

U.S. lawmakers discontinued the instruments’ use as capital in 2010. While international rules that year also narrowed the definition of what counts as capital, the European Union has been more flexible in its implementation, permitting a wider spectrum of hybrid securities.

First Step

Deutsche Bank plans to sell a total of 5 billion euros of subordinated debt by the end of next year. Denominations of the notes will be 100,000 euros or more, depending on the currency of the individual tranches, the company said. Each note will carry a warrant entitling the owner to purchase one Deutsche Bank share, according to the statement.

The 5.125 percent trigger compares with Deutsche Bank’s common equity Tier 1 ratio under gradually implemented Basel III standards of 13.2 percent at the end of March, which the company disclosed in a presentation of first-quarter earnings on its website today. That’s more than three times the current regulatory requirement, it said.

The company’s leverage ratio under full implementation of European Union capital standards stood at 3.2 percent at the end of March, up from 3.1 percent three months earlier, the company said. The minimum Basel leverage requirement is 3 percent for European banks.

Subordinated debt can offer investors a higher return than notes with less risk. Deutsche Bank will brief investors on its notes over the coming week and hold a conference call on May 7.

To contact the reporters on this story: Nicholas Comfort in Frankfurt at ncomfort1@bloomberg.net; Yalman Onaran in New York at yonaran@bloomberg.net; John Glover in London at johnglover@bloomberg.net

To contact the editors responsible for this story: Frank Connelly at fconnelly@bloomberg.net; Peter Eichenbaum at peichenbaum@bloomberg.net Mark Bentley, Keith Campbell

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