Deutsche’s strategic debt move set to haunt banks
Hybrid bank debt was always about a nod and a wink – regulators and rating agencies saw it as capital, investors saw it as debt.
But in the coming year most of those implicit understandings look like being broken.
These deals, which are supposed to occupy a kind of grey area between debt and equity, have been hugely important in squeezing extra cheap capital into bank balance sheets – and in propping them up in the wake of the financial crisis.
They were sold as so-called tier one and tier two bank capital that, along with equity, is meant to support bank funding and absorb losses. However, the market was always underpinned by the assumption among investors that they would be repaid at the earliest opportunity and so they were priced more like debt than capital.
Now that Deutsche Bank has become the first big bank not to pay back one of its hybrid deals at the first opportunity, many think the entire market might have no future.
Gerry Rawcliffe, group credit officer for banks at Fitch Ratings, sums up the problem neatly.
"On the one hand, banks need to repay these deals at their call dates to keep investors happy and to keep the market open, but on the other hand if they are all called during the worst banking crisis in living memory then they are arguably not capital and they should not be treated as such by regulators."
This is especially true for the tier one bonds that become perpetual issues, meaning they have no final date at which they mature if they are not called. Tier two deals can be perpetual or they can have a final maturity some time after their first call date.
More than €33bn ($47.3bn) worth of such bonds are due to be called in Europe alone over the next 12 months, according to analysts at JPMorgan, including about €2bn from Deutsche Bank.
The big fear for investors in both stock and bond markets is that Deutsche’s decision makes it far more likely that it will now be much harder to sell this kind of debt, closing down yet another avenue for raising funds.
There is also a widespread suspicion that the reason given by Deutsche for its decision was only half the story. Not repaying the bond means that Deutsche must pay a higher penalty coupon. In this case that increase, or step-up, amounts to only about 16 basis points to a total of a little over 4 per cent on current interbank rates.
Deutsche said in a regulatory announcement that this was cheaper than would be the coupon on a new deal.
But many say this is not the point. The decision is likely to be economically beneficial only in the short-term, analysts say, as it is likely to make similar instruments and other senior debt more expensive in the future, in part because it will hurt a bank’s reputation among investors.
"Until recently it was widely assumed that major banks would call these bonds to maintain future access to the market, even if it didn’t work economically," said Hans Peter Lorenzen at Citigroup.
Another banker added: "Deutsche are nailing this decision firmly to the mast of economic interest, but you have to ask two questions. One, can that capital be replaced at any price? Two, has the regulator told Deutsche it can only call the deal if it can replace it?"
Many in the market were expecting this kind of decision to crop up somewhere – but most expected it to come from a smaller, weaker bank. The fact that it is Deutsche that has moved first is further evidence for stock and bond markets about just how strained bank financing is.
"This does indicate renewed concerns about the strain on capital at banks. The equity market already knows this, but it is still reacting because it is another piece of bad news that reconfirms the capital problems," said Kian Abouhossein, European investment banks analyst at JPMorgan.
He added that after the poor earnings news from BNP of France and of losses at HSBC related to the collapsing hedge fund run by Bernard Madoff in the US, investors were realising that there were no safe havens left among financial stocks.
Banks stocks were hit, but so was the cost of protecting the debt of many against default in the credit derivatives markets, as traders bet that the decision would make ordinary bank debt more expensive as well.
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12/18/2008 4:19:37 AM
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