Deutsche Bank's Rising Risk May Stir Concern in Market for Notes

  • Default swaps climbed as high as 242 basis points on Monday
  • Securities tarnished in 2008 by Lehman Brothers bankruptcy

The rising cost of protecting against a Deutsche Bank AG default may revive concerns that companies issuing structured notes are becoming riskier.

The price of Deutsche’s five-year credit default swaps, which offer insurance against the bank’s potential inability to repay its debt, have climbed from less than 100 basis points on Jan. 1 to as much as 242 on Monday, according to CMA data. Structured notes, which bundle bank debt with derivatives, were tarnished in 2008 when Lehman Brothers Holdings Inc.’s bankruptcy wiped out most of the value of its products.

The issue of counter party risk, which had faded over the last few years, may be about to re-emerge and could affect decisions by distributors and investors on which products to avoid. Last year, Deutsche Bank issued at least $5.73 billion of structured notes worldwide, according to data compiled by Bloomberg, which doesn’t include transactions that aren’t reported. The company has $87.6 billion of senior unsecured bonds outstanding, according to Bloomberg data.

“Counter-party credit is something people have been aware of, but haven’t really had to do too much about” lately because chances of default have been so low, said David Stuff, chief executive of structured-product provider Cube Investing in London. “But we’re starting to see that come back on the agenda.”

Once a bank’s five-year CDSs advance above 200 basis points to 250, he said, a lot of dealers “are going to get very twitchy.” Credit default swaps on structured-note issuers have risen broadly, though most remain below 160 basis points.

Improved Terms

Deutsche Bank, Credit Suisse Group AG and Barclays Plc are among banks whose shares are taking a beating as they pursue restructurings that have dented earnings. Investors in Frankfurt-based Deutsche are concerned about its ongoing litigation costs and at one point raised questions about its ability to pay coupons on its contingent convertible bonds, or CoCos, according to Geoffroy de Pellegars, an analyst at BNP Paribas SA in London.

An increase in credit risk can improve terms on structured notes, which often helps improve their sales volumes. Last month, Deutsche Bank sold $320 million of the securities in the U.S., nearly three times the $112 million it issued a year earlier and the most since May, Bloomberg data show.

On Jan. 7, the bank issued one-year U.S. notes tied to the Standard & Poor’s 500 Index that pay an 8 percent coupon as long as the benchmark doesn’t drop more than 15 percent, according to a prospectus filed with Securities and Exchange Commission. Three weeks later, after the price of its CDSs jumped by about half, the bank sold an almost identical security offering a 9 percent coupon.

However, too much risk can drive away CDS investors. When Morgan Stanley’s five-year credit default swaps climbed to 583 basis points in October 2011, the highest since the 2008 financial crisis, its U.S. structured note sales dropped 69 percent during that quarter from a year earlier.

Troy Gravitt, a spokesman for Deutsche Bank in New York, declined to comment.

Deutsche Bank’s shares jumped as much as 17 percent on Feb. 10, as the bank considered a bond buyback to help ease investor concerns about its funds, a person with knowledge of the matter told Bloomberg News. The stock closed at $15.51 Thursday and is down almost 50 percent in the past year.

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