Deutsche Bank, UniCredit CoCo Coupons at Risk, CreditSights Says

  • Last year’s losses eat into ability to pay optional coupons
  • Issue at Deutsche Bank differs from problem at UniCredit

Deutsche Bank AG, UniCredit SpA and two smaller banks risk being unable to pay interest on their riskiest bonds, raising the specter of a repeat of the turbulence that roiled the market in the first quarter of 2016.

The two lenders, both among the world’s biggest institutions, plus Spain’s Banco Popular SA and Germany’s Bremer Landesbank AG, had losses last year that may put them in breach of regulatory limits on discretionary payouts, according to analysts Simon Adamson and Puja Poojara at CreditSights in London. While all four probably will be able to pay, the fact it’s an issue highlights the risks in holding contingent convertible, or CoCo, bonds, Adamson said in a telephone interview.

The lenders are likely to report losses in the final quarter for different reasons, including Deutsche Bank’s $7.2 billion settlement with the U.S. Dept. of Justice, raising the question of whether they will have the cash to be able to make payments such as those on their additional Tier 1 notes. While failure to pay interest would be tantamount to default for most debt securities, coupon payments on CoCos are discretionary. Once missed, they are also gone forever.

“There’s a sort of theme emerging that these banks had heavy losses last year for all sorts of reasons,” said Adamson in a telephone interview. “That’s affected profits, and therefore retained profits,” he said. In the case of UniCredit, “there are huge provisions that have called into question whether it will be able to raise new capital fast enough to meet regulatory thresholds.”

Low Risk

Just like last year, the issue for Deutsche Bank is its “available distributable items,” a measure based on the parent bank’s audited unconsolidated accounts calculated under German accounting principles, according to CreditSights, which judges its risk of non-payment as low but of high impact. For UniCredit, the problem is the “maximum distributable amount,” which instead is based on European banking law.

Christian Streckert, a spokesman for Deutsche Bank, declined to comment. Eloy Ecija, a spokesman at Banco Popular, had no immediate comment. UniCredit spokesman Andrea Morawski couldn’t be reached. Bremer Landesbank had no immediate comment.

Charges and provisions mean Banco Popular is set to report a net loss of at least 2.4 billion euros, according to CreditSights’ estimates, raising the question whether its ADIs are enough. While a large loss would “seriously dent” its ADIs “our base case is that it should be able to continue to service its AT1s,” Adamson and Poojara said in a note to clients today. The impact of a missed payment would be medium, they said.

The risk of non-payment is highest at BremerLB because of the shipping loan provisions it is having to make, CreditSights said. The impact on outside investors would probably be low because parent NordLB owns a large part of its AT1s.

National Law

For analysts, figuring out whether banks have enough ADIs to make coupon payments is complicated by the fact that the measure is calculated for the parent company, whose accounts may be hard to get hold of, Adamson said. The measure is calculated in accordance with national corporate law, so what makes up ADIs differs from jurisdiction to jurisdiction. In addition, German accounting principles differ from international standards typically used in other European countries.

“ADIs were never really thought of as constraint,” said Adamson. “It’s kind of odd that they have become a point of contention. The fact that they’re a matter of conjecture makes them a real area of uncertainty.”

UniCredit’s problem stems from its decision to take 8.1 billion euros of loan loss provisions as well as almost 2 billion euros of other charges, potentially pushing its capital levels below the threshold that triggers MDA restrictions that would prevent it making AT1 payments.

The issue of MDAs and their interaction with bank-specific Pillar 2 capital requirements was behind much of the volatility last year and prompted supervisors’ decision to split Pillar 2 capital into a public requirement and a non-public guidance. That reduced the risk of a bank breaching requirements and suspending AT1 payments.

UniCredit’s planned 13 billion-euro capital increase would allow it to meet requirements easily, but an unexpected delay caused by a shock to the markets could derail that prospect, in which case it could become unable to pay interest on its CoCo bonds.

“Their capital levels would be restored quickly but they might miss a coupon that couldn’t be recouped,” said Adamson. “That would probably generate quite a big effect on the AT1 market and shows that the risks aren’t just academic.”

Before it's here, it's on the Bloomberg Terminal.