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.
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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.
Update, 2024-9-6: There was quite an aftermath to this, as I was reminded when responding to an unrelated comment many years later.
There was material repricing of sub-debt globally:
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.
… and a buyer’s strike was threatened:
Investors in bank debt are threatening to boycott lenders that follow Deutsche Bank in breaking an unwritten rule and failing to exercise a call option on subordinated debt.
In a co-ordinated action, angry bond investors are writing to bank treasurers and investor relations heads telling them that any failure to exercise a call option will be considered a breach of trust that could cause all the issuer’s debt to be shunned.
Deutsche stunned the debt market last week by choosing not to redeem €1bn (£932m) of subordinated lower tier 2 bonds because to do so was cheaper than refinancing. But though the move saved Germany’s biggest bank up to €150m, it caused fury among buyers of the debt who worked on the assumption that bonds would always be redeemed at their first call date.
The letter, seen by The Independent, said a bank’s decision not to call debt would be taken to mean “the institution is in such difficulty that it is an impossibility to call the instrument or the institution feels that it is in such a strong position that it can afford to alienate itself from the support of a wide portion of the fixed-income institutional investor community”.
Bank of China, a major buyer of bank debt, has gone further in its communication with issuers. The giant Chinese lender’s Hong Kong operation has told banks that “any non-call by a given institution will result in that institution’s debt (not just lower tier 2 but senior and tier 1 as well) being ineligible for future investment consideration”.
BCE.PR.F & PPL.PR.A Added to HIMIPref™ Database
December 16th, 2008I have bowed to overwhelming popular demand and added the captioned issues to the database.
BCE.PR.F is a FixedFloater, paying $1.10 annually (paid quarterly) until 2010-2-1, at which point the rate gets reset and it becomes exchangeable with BCE.PR.E. Exchange Dates recur every five years thereafter. For analytical purposes, it is assumed that the conversion to ratchet rate is automatic – this is a valid worst-case assumption, since BCE has the discretion to set the five-year rate to a very low value. It is callable on exchange dates at 25.00 and (when ratcheting) at 25.50 at other times. For analytical purposes this is simplified to two calls at $25.00, on 2010-2-1 and 2015-2-1. Dividends are cumulative. There is no retraction.
PPL.PR.A is a split share based on Canadian banks, paying dividends at a rate of Prime, capped at 7%, collared at 5%. It matures 2012-12-1 at $10.00. There is a special monthly retraction provision with the formula 96%(NAV – C). Dividends are cumulative and paid monthly. Current NAV is $16.08 according to the company. Income coverage, according to May’s semi-annual report is a hair over 1.0:1. Maturity is 2012-12-1; there are no embedded redemptions. Distributions to Capital Units will be halted if the NAV falls below 15.00 (asset coverage of 1.5:1).
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