Riskiest Bank Debt May Face First Test at German Ship Lenderby
Bremer losses may endanger payments on additional Tier 1 notes
No bank has missed AT1 coupons in bonds’ three-year history
The bond market created by regulators to avoid panic and state bailouts when lenders get into trouble has come roaring back. It may soon become clear whether that confidence will last.
The first test of the riskiest type of bank debt may may come this month as Bremer Landesbank is likely to disclose losses that could force it to skip coupon payments on additional Tier 1 notes, according to two bondholders, Berlin Portfolio Management GmbH and the asset management unit of Degussa Bank AG. No bank has missed the optional payments on these bonds since their introduction three years ago, and the market reaction will show whether AT1s are steadying capital buffers for weak lenders or a minefield of unappreciated risks for holders.
“A missed coupon could destabilize the market for subordinated bank debt,” said Andrea Blanzuoli, a broker who trades Bremer notes at Synesis Finance SA in Lugano, Switzerland. “Bremer is in a situation that is quite stressful.”
Investor confidence in the $115 billion AT1 market has already proven fragile, with prices collapsing earlier in the year because of industrywide capital concerns centered on Deutsche Bank AG. A recent recovery could unravel following a Bremer announcement because investors may once again focus on the bonds’ risks rather than market-beating interest payments that can surpass 8 percent.
Bremer has “a strong commitment that we intend to pay but we can‘t promise” due to European Central Bank regulations, it said in an e-mailed reply to Bloomberg News questions. The Bremen, northern Germany-based lender said it will be “adequately capitalized” even if it reports a first-half loss on Aug. 31.
Closely held Bremer has become a focus of AT1 concerns because in June it forecast a “mid three-digit million” euro full-year loss due to writedowns on shipping loans. That’s equal to about a third of the reserves listed by the bank in a statement.
The lender intends to boost capital and it’s considering selling more AT1s, as well as securitizing loans for sale, it said in June. Norddeutsche Landesbank, which owns 55 percent of Bremer, plans to inject fresh funds into the bank and to buy out minority shareholders. The parent, also known as NordLB, referred questions about Bremer to the smaller lender.
Bremer’s 150 million euros ($170 million) of AT1s, which were sold last year, have fallen to about 65 cents on the euro, the lowest for any equivalent bond, according to data compiled by Bloomberg. The 8.5 percent and 9.5 percent notes carry annual coupons, the first of which were paid in June.
The bank may have to skip AT1 payments as soon as next year, if unplanned 2016 losses on shipping loans are more than about 500 million euros, said Degussa Bank fund manager Svilen Katzarski, who helps oversee about 700 million euros of assets. Bremer has forecast full-year shipping losses in the “high three-digit” millions of euros.
Bremer’s parent NordLB is also struggling with shipping-loan losses, which have led to a warning that a special entity may not pay coupons on junior bonds next year. That suggests any capital injection into Bremer is unlikely to be enough to end financial pressure and avoid missed AT1 coupons, said Sven Marzahn, the head of portfolio management at Berlin Portfolio, which oversees 300 million euros.
“Skipping coupons for one or two years seems certain,” he said. “The question is will they write down the capital” by wiping out the notes, he said. AT1s can be written off or swapped into shares if capital ratios fall below a trigger level. Coupon payments can be missed without causing a default.
AT1s, which debuted in 2013, have these features because they were designed to shift risk onto investors from taxpayers. They are also intended to help financially stretched lenders quickly boost capital before investor concern spreads to other banks. While lenders including Allied Irish Banks Plc and Erste Group Bank AG have missed payments on other types of junior bonds, no bank has skipped payments on AT1 notes.
If Bremer does miss coupons, the market fallout could be contained by the lender’s small size. Its 30 billion euros of assets are dwarfed by the 1.8 trillion euros at Deutsche Bank. Germany’s biggest lender also has $6 billion of AT1s outstanding, more than 30 times Bremer’s tally.
Still, renewed concerns about the dependability of AT1 payments could derail a recent rebound in sales. August has been the busiest month for AT1s in a year, with UBS Group AG, Royal Bank of Scotland Group Plc and Standard Chartered Plc selling a combined $5.75 billion. Barclays Plc is marketing a $1.5 billion sale, according to a person familiar with the matter, who isn’t authorized to speak publicly and asked not to be identified.
Issuance dried up earlier in the year because of the marketwide selloff and uncertainty caused by the U.K.’s referendum on leaving the European Union. The renewed appetite for AT1s may falter if Bremer misses payments because investors will probably reassess the notes’ risks, said David Hague, who manages debt sales for banks at Nomura International Plc.
“At best, you would expect that they won’t be adding more,” he said. “At worst, you’d expect them to sell any securities with similar risk profiles.”