Deutsche Bank's Unexpected Extension of Debt Has Broad Market Implications

Broader market implications from Deutsche Bank’s (DB) unexpected decision to extend €1-billion of its lower-Tier 2 debt beyond the first scheduled call date has forced RBC Capital Markets to downgrade its ranking on the subordinate debt of several of Canada’s largest financial companies.

The changes move Toronto-Dominon Bank (TD), Sun Life Financial Inc. (SLF) and Great-West Lifeco Inc.’s (GWLOF.PK) sub-debt ratings from “outperform” to “sector perform,” the same level as Bank of Nova Scotia (BNS), CIBC (CM) and National Bank. RBC rates Bank of Montreal’s sub-debt at “underperform.”

Analyst Altaf Nanji told clients:

We believe Deutsche Bank’s decision to extend its LT2 debt beyond the short redemption date will have repercussions for all debt securities with a step feature – particularly older vintage securities with steps that are well out of the money.

While he expects that Canadian banks and lifecos will continue to redeem these securities on their short date, the same cannot be said for other markets and international developments could hurt all valuations.

“The decision caused material spread widening in the Canadian sub-debt market,” the analyst said, suggesting that Deutsche Bank may have opened up a Pandora’s Box.

Mr. Nanji cited several reasons why Canadian banks will call on the short date, despite the short-term economic incentive to extend as refinancing levels are now higher in many cases. These include their track record of always doing so, the reputational risk not doing so would present, and the fact that extending the notes erodes the regulatory capital benefit of LT2 debt.