Deutsche Bank CoCo Bonds Have Bumpy Ride as Lender Strugglesby
Issue is still-low capital levels, potential losses, fines
Bonds rise from record lows as bank reassures on coupons
Investors in Deutsche Bank AG’s riskiest debt are having a bumpy ride as losses push Germany’s biggest lender closer to triggers that would force it to suspend payments on the securities.
Deutsche Bank has the equivalent of about 4.6 billion euros ($5 billion) of contingent convertible bonds, or CoCos, outstanding, according to a presentation for investors. These securities, meant to bolster Tier 1 capital, aren’t dated and coupon payments depend on the lender’s capital level. Deutsche Bank said on Thursday it would be able to pay coupons for 2015, giving the bonds a boost.
“Until today I would have had Deutsche Bank down to make the first coupon pass on its AT1 bonds,” said Mark Holman, chief executive officer of TwentyFour Asset Management in London, referring to Deutsche Bank’s additional Tier 1 notes, which he doesn’t own. “They’re just too close to the wire. They said they were going to pay today but they could just as easily have said they were going to skip. It’s not worth the risk.”
Keeping investors awake at night are Deutsche Bank’s capital levels, which started from a low base and have suffered as the lender restructures, pays fines and racks up losses. German and European banking laws tie the payouts of the bonds to cash and capital requirements. Overall, the Frankfurt-based lender is among the closest of the major banks to breaching the triggers.
While Deutsche Bank’s AT1 bonds all pay coupons of 6 percent or more, investors can’t call a default if they don’t get paid. Once a bank starts to eat into its capital buffers, it must calculate the so-called maximum distributable amount, which determines restrictions on payments under EU rules. German banks must also calculate “available distributable items,” or ADI, a measure based on audited unconsolidated accounts calculated under German accounting principles. Deutsche Bank said the reserves will be sufficient to pay coupons.
“Based on the preliminary 2015 financials, we believe we have sufficient ADI and payment capacity under the German GAAP to pay AT1 coupons,” said Chief Financial Officer Marcus Schenck on the company’s earnings call Thursday, according to a transcript. “We believe we have sufficient general reserves available to cover any shortfall.”
Investors have shied away from the company’s AT1 debt as bad news has followed bad news. The 650 million pounds ($930 million) of 7.125 percent notes callable in April, 2026 were bid at 85.1 pence on the pound, rallying from a record low 84 pence on Jan. 21. Its 6 percent notes callable in April 2022 were at 88 cents on the euro, up 1.5 cents on the euro from a record low set Jan. 21.
The rally in bonds isn’t likely to endure for long, given the problems faced by the bank, according to analysts at CreditSights in London.
“The intention to continue paying AT1 coupons was again confirmed by DB,” analyst Simon Adamson said in a note to clients Thursday. “While this might give a small boost to its AT1s, the market is likely to remain negative given the low ADI cover.”
Deutsche Bank had 2.87 billion euros ADI available at the end of 2014, “the lowest coupon cover of any AT1 issuer,” according to CreditSights.
“Its mostly about the perceived risk to the AT1 coupons,” said Roger Francis, an analyst at Mizhuo International Plc in London. “They said today they have the capacity to pay the coupons and they’re rebuilding capital, and that’s all fine, but there are headwinds.”
The “headwinds” include the risk of fresh litigation and of new regulations forcing the bank to increase the risk-weighted assets it reports, with the resulting decline in it capital ratios, Francis said. On the positive side, as the bank sheds risk regulators may allow it to shrink some of its capital buffers, he said.
“The bank’s restructuring, the board aren’t taking any bonuses, those must be clues as to the state of the bank,” said Holman. “They’re one big fine away from having to skip a coupon.”