When panic gripped AT1

Marcus Schenck: Funding cost still competitive

Did Marcus Schenck have a premonition?

When Deutsche Bank’s chief financial officer sat down with analysts on January 28 to go over details of the bank’s dire results – a loss of €2.1 billion for the fourth quarter of 2015, a loss of €6.8 billion for the whole year – he sought to reassure them on a topic that rarely comes up at such meetings. 

Before drilling down into the numbers on the banks’ main operating businesses for 2015, Schenck turned, unprompted by any questioner, to the volatility of debt markets since the start of 2016. This had led some bank issuers to postpone bond offerings.  “We, however, issued a US dollar unsecured transaction as well as our second Spanish covered bond,” Schenck boasted, “taking our year-to-date issuance to €3.5 billion or 10% of annual requirements, despite being in a quiet period for most of the month.” He continued: “Our funding cost remains competitive and the recent Moody’s downgrade of our long-term ratings has had no material impact on our spreads.”

Schenck declared his confidence that Deutsche Bank would be able to complete its €35 billion funding programme for 2016.

It seemed strange, if not troubling, that any bank CFO should feel the need to crow about continued access to wholesale funding – a given except in times of severe market or issuer-specific stress – even the CFO of a bank that had just reported a hefty annual loss mostly due to large and supposedly exceptional litigation and restructuring expenses. 

Schenck was not quite finished, however. “Based on preliminary 2015 financials, we believe we have sufficient ADI [available distributable items] and payments capacity under German GAAP to pay AT1 [additional tier-1] coupons,” he told analysts. Then, just as Euromoney started to worry that something very serious was amiss, he turned to the divisional breakdowns of revenues and costs. The call swung back onto its familiar track. The analysts’ dreary questions on problems with their earnings models thudded in.

Maybe Schenck didn’t boast loudly enough. 

Investors, having already had over a week since Deutsche’s first profit warning on January 20 to prepare for this detailed confirmation of 2015 losses, paused for a few more days. Then they panicked. 

In the second week of February the bank’s wilting share price collapsed; certain of its AT1 instruments fell to 70% of face value; CDS spreads climbed to crisis level highs. Journalists door-stepped German finance minister Wolfgang Schäuble to ask the extent of his concern about Deutsche Bank. So much for all that bank resolution directive baloney, surely the German government would support Deutsche Bank if needed. Well, wouldn’t it?

At such moments of market panic, comments intended to restore confidence can often misfire. Schäuble said he had no concerns. Deutsche chief executive John Cryan insisted the bank’s capital and risk positions left it rock solid. Suddenly all the memories of 2008 and 2009 came flooding back and investors worried that if a bank CEO was telling them to lie back in their cabins and relax, now might be the moment to rush to the lifeboats. 

And then it stopped. The press handlers spread a story that Deutsche Bank had sufficient liquidity reserves – amounting to €215 billion for a liquidity coverage ratio of 120% – to consider buying back certain bonds now trading below face value. Schenck duly confirmed a formal tender offer for €3 billion of euro-denominated bonds and $2 billion of dollar bonds. Deutsche shares duly bounced off their lows. The wave of selling rolled on towards other targets, first Société Générale, then Credit Suisse, Barclays too.

Had markets panicked for no good reason?

Investors dumping AT1s at the start of February may have noted a CreditSights report into the bank’s shrunken capacity to service coupons published straight after full year results. Analyst Simon Adamson suggested that, even as prices fell and yields on Deutsche Bank AT1s rose into double-digit territory, investors might see better value elsewhere. But he took heart from management’s repeated commitment to paying coupons. “In particular, Deutsche Bank wants to issue further AT1s of €3 billion to €4 billon and knows that skipping a coupon would be disastrous for its ability to do so.”

True, the ADI capacity from which it pays AT1 coupons is much reduced following the losses reported for 2015, down from €2.87 billion at the end of 2014 to just €1 billion today. But this is more than sufficient to meet €350 million of coupon payments due in April. The bank’s fully loaded common equity tier-1 ratio stands at 11.1%. And while this might suffer in the first months of 2016 from a seasonal rise in risk-weighted assets, it is still way above trigger levels. 

Assuming it completes the expected sale of its 19.99% stake in Hua Xia Bank in the next few months and does not get hit by another big annual loss for 2016, Deutsche expects to have €4.3 billion of payment capacity in 2017 to meet AT1 coupons. 

It remains to be seen how its ability to issue AT1s and its price of access have been hit by the recent sell-off and indeed how viable the whole AT1 market may be. Ownership of these instruments does not seem to have passed quite as smoothly from the Asian retail bid that snapped up the first high-yielding contingent convertible bonds to dedicated institutional investors as the banks had asked us to believe.

Will bank issuers hoping to raise cheap regulatory capital through AT1s be quite as committed to servicing coupons on outstanding deals if the market is damaged beyond repair and if the new-issue coupons required are higher than implied cost of equity? It’s hard to say.

It’s not possible either to predict with any confidence if Deutsche Bank might face another loss for this year, so reducing ADIs for 2017, if regulatory fines and settlements, which chief executive John Cryan is now trying to speed up, come in higher than he expects.