Deutsche Bank's Surprise Move Rattles Bond Market

Deutsche Bank’s (DB) decision to skip an opportunity to redeem €1-billion of subordinated bonds at the first scheduled call date because replacing them would be more expensive has rattled the bond market. Some suggested the European investment bank’s move, which surprised both investors and experts, has transformed the subordinated debt market. They fear that other banks will follow, which could threaten their relationships with investors and trigger losses.

CreditSights analyst Simon Adamson said:

Deutsche Bank will suffer to some extent from being the first major bank to make such a move, and it raises some awkward questions about its own financial position. But more than that, it is a signal that banks do not see a return to more normal funding conditions in the foreseeable future, and that is a damaging statement for the banking sector.

Desjardins Securities analyst Michael Goldberg labeled it a “confidence-shaking move.“ He said Deutsche Bank either does not understand the extreme importance of confidence when it comes to banking or that its financial position is truly grim.

Mr. Goldberg told clients:

While Deutsche is within its rights not to call these bonds for financial advantage, it has been understood in the bond market that issuers would call bonds with early call options when they become callable.

In fact, just last week Royal Bank of Canada (RY) called a similar bond issue two weeks ahead of the deadline, he added.

The analyst highlighted the fact that there are a number of bond issues callable in the coming months including Capital Desjardins in March (C$450-million), Scotiabank (BNS) in May (C$350M), Royal Bank (C$1-billion) and CIBC (CM) (C$750M) in June, and CIBC (C$500M) again in October. The first innovative Tier 1 note issued in Canada from TD Capital Trust (C$900M) is callable next December.

Deutsche Bank is the first major bank not to call a Lower Tier 2 issue, which rank just below senior bonds. The move has implications for the wider subordinated debt market as well as for extension risk of Tier 1 securities, Mr. Adamson said.

"The announcement... is perfectly logical but has nonetheless shocked the market,” he told clients, adding that it was probably over-conservative.

He added:

The problem is that developments in the financial sector in [the] past few months have significantly reduced both the regulatory and economic incentives to call Lower Tier 2 bonds.

The increased focus on Tier 1 capital and market expectations that these ratios will be higher than regulatory minimums, reduces the need and relevance of this subordinated debt as a capital instrument, Mr. Adamson explained. Instead, it may be increasingly regarded as primarily a funding instrument. Even the highest-rated banks are unable to replace subordinated debt at a lower rate – even with senior debt, the analyst added.

The bank said in a statement:

Deutsche Bank views the holders of the notes as important constituents, like many other important stakeholders, including shareholders, senior creditors, other capital instrument holders, rating agencies, regulators and employees.

However, because the early redemption option is not in-the-money, Deutsche Bank believes the appropriate balance of constituent interests is served by not calling the notes, which are redeemable at the issuer’s option quarterly after January 16, 2009.

Comments

[imnotadoofus:]

NOT CALLING BONDS TRADING BELOW PAR MAKES SENSE, AND THE OPPORTUNISTIC INVESTOR WILL BUY THEM AT A DISCOUNT SINCE IT IS LIKELY THAT WHEN CONDITIONS IMPROVE THEY WILL BE REFINANCED. THE BANK MADE THE IMPORTANT AND APPROPRIATE DECISION, WHETHER ANALYSTS LIKE IT OR NOT

2008 Dec 17 08:48 PM