Deutsche Bank Ignores Sub-Debt Pretend-Maturity

The Financial Post reports:

Deutsche Bank’s 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.

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 was well as for extension risk of Tier 1 securities, Mr. Adamson. said.

I, for one, am very happy with this move. As I wrote in A Vale of Tiers:

Investors tend to trade sub-debt as if it will definitely mature on their step-up date – dealer quotations will often reflect a spread to a Canada bond maturing on the step-up date. However, while one may count on them being called, as expected in good times, this will not necessarily be the case in times of trouble. In times of trouble, three-month BAs + 100bp might look awfully skimpy! Investors should tread very carefully when purchasing debt of this nature.

For years, pseudo-managers have been able to outperform actual bonds simply by purchasing sub-debt and Innovative Tier 1 Capital, justifying these moves on the grounds that the tiered structures are included in the Scotia (now DEX) index. The largest corporate holding in XBB, for instance, is RBC Trust Subordinated Notes, with a pretend-maturity of 2012-4-30.

Sub-Debt has been discussed on PrefBlog, particularly in the posts Cracks Appear in European Sub-Debt Market and Banks and Subordinated Debt.

12 Responses to “Deutsche Bank Ignores Sub-Debt Pretend-Maturity”

  1. lystgl says:

    This is what the new BMO Capital Trust 10.22% notes are no?

  2. […] PrefBlog Canadian Preferred Shares – Data and Discussion « Deutsche Bank Ignores Sub-Debt Pretend-Maturity […]

  3. jiHymas says:

    This is what the new BMO Capital Trust 10.22% notes are no?

    Close. The BMO Capital Trust II issue is Tier 1 capital, so it’s easier to suspend the income payments and it ranks junior to sub-debt.

    In broad principle, however, you’re quite right. The BMO notes will trade with a pretend-maturity of 2013-12-31, with a step-up to 5-Year-Canadas +1050bp on that date.

  4. lystgl says:

    Close. The BMO Capital Trust II issue is Tier 1 capital, so it’s easier to suspend the income payments and it ranks junior to sub-debt.

    Are they considered Tier 1 because of the rule change? Does the same order apply? i.e. As with Boats, Bats, Cats, Trucs, you receive semi-annual interest payments ONLY if the preferred shareholders get theirs or do these get you in line ahead of preferreds?

  5. jiHymas says:

    Are they considered Tier 1 because of the rule change?

    Yes. The 99-year maturity and the cumulative dividends allows them to be considered a bond (with tax deductible interest) by the tax man; prior to the rule change these features would have disallowed its inclusion in Tier 1.

    As with Boats, Bats, Cats, Trucs, you receive semi-annual interest payments ONLY if the preferred shareholders get theirs or do these get you in line ahead of preferreds?

    As far as I know, all the BOATS, BATS etc. are senior to preferreds.

  6. lystgl says:

    From
    http://www2.bmo.com/ar2006/downloads/bmo_ar06_note18.pdf

    “Holders of the BOaTS are entitled to receive semi-annual non­
    cumulative fixed cash distributions as long as the Bank declares
    dividends on its preferred shares, or if no such shares are outstand­
    ing, on its common shares in accordance with ordinary Bank
    dividend practice.”

    I don’t know but could one read this as subordinate to preferreds or on par with preferreds or, should theren’t be any preferreds equal to the common? It doesn’t seem to read to be senior to either?

  7. jiHymas says:

    From the BMO Capital Trust Prospectus dated September 29, 2000:

    Bank Dividend Stopper Undertakings

    In the event that the Trust fails, on any Regular Distribution Date, to pay the Indicated Distribution on the BMO BOaTS in full, the Bank has, pursuant to the Bank Share Exchange Agreement, covenanted for the benefit of holders of BMO BOaTS that it will not declare dividends of any kind on the Dividend Restricted Shares until on or after the Dividend Declaration Resumption Month, being the month that commences immediately after the third Dividend Declaration Month following the Trust’s failure to pay the Indicated Distribution in full on the BMO BOaTS unless the Trust first pays such Indicated Distribution (or the unpaid portion thereof) to holders of BMO BOaTS.

    Any Indicated Distribution (or portion thereof) that the Trust fails to pay to the holders of BMO BOaTS on a Regular Distribution Date will form part of the Accumulated Unpaid Indicated Distribution and is payable on the occurrence of any event giving rise to the obligation of the Trust to pay or cause the payment of the Early Redemption Price or the Redemption Price, as the case may be, as part of such price.

    The Accumulated Unpaid Indicated Distribution (AUID) must be paid to the holder if the bank blocks conversion into Preferred Shares, which are soft-retractible:

    The Class B Preferred Shares Series 7 will pay semi-annual non-cumulative cash dividends as and when declared by the Board of Directors equal to $0.863 and are convertible at the option of the holder into Bank Common Shares, provided that a Loss Absorption Event (as defined herein) has not occurred and is then continuing, on the last day of June and December in each year commencing on December 31, 2010 on at least 60 and not more than 90 days’ prior written notice before the date fixed for conversion into that number of fully-paid and freely tradeable Bank Common Shares determined by dividing $25.00, together with declared and unpaid dividends, if any, on the Class B Preferred Shares Series 7 to the date of conversion by the greater of $2.00 and 95% of the weighted average trading price of a Bank Common Share

    If the BOaTS don’t get their distribution on any date, dividends on preferreds and common are stopped until after the next distribtion date. Thus, resumption of BOaTS distributions will occur prior to resumption of preferred dividends.

  8. […] Sub-Debt has been in the news lately, with Deutsche Bank’s refusal to execute a pretend-maturity, and I have dug up another theoretical paper: What does the Yield on Subordinated Bank Debt […]

  9. […] pretend-managers, very upset by Deutsche Bank’s refusal to execute an out-of-the-money call are very upset: Deutsche Bank AG’s decision to pass up an opportunity to redeem 1 billion euros […]

  10. […] Bank did the business-like thing and didn’t call their sub-debt on the pretend-maturity. The market ripped their faces off. Why? Because Joe at the brokerage had sold all that paper to […]

  11. […] discretion in a manner not guessed beforehand by the market can have severe consequences, as Deutsche Bank found out, as discussed on December 19, […]

  12. […] and hurt when he finds out that it isn’t. As evidence, I can cite what happened when Deutsche Bank refused to honour its sub-debt pretend-maturity. Conversion – or the prospect of conversion – will in such a case exacerbate the panic. […]

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