Wednesday, December 17, 2008

Deutsche rattles the bond market

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You know there’s going to be trouble when a bank starts banding around words like “stakeholders” in regulatory news announcements.

So consider this from Deutsche Bank on Wednesday:

"Deutsche Bank views the holders of the Notes as important constituents, like many other important stakeholders, including shareholders, senior creditors, other capital instrument holders, rating agencies, regulators and employees. In light of the fact that the early redemption option is not in-the-money, Deutsche Bank believes that the appropriate balance of constituent interests is served by not calling the Notes."

The notes in question are €1bn worth of 3.875 per cent 2004/2014 subordinated bonds. The market had been expecting Deutsche to call these notes, at par, at the first available date - January 16. That’s what banks do with such lower Tier 2 capital notes - redeem and re-issue on a regular basis.

Or at least that’s what banks used to do.

On this occasion, Deutsche is allowing the bonds to turn into floating rate notes, paying three month euribor +88bp.

But in finessing its funding costs, Deutsche has seriously spooked the fixed income market. Is this an invitation to all other banks to avoid redemptions where ever possible? What about Tier 1 notes - are redemption conventions going to be broken there too? Should the whole market be pricing in a new level of “extension risk”?

One more point: if a bank like Deutsche is finding the pain of funding acute enough here, it may only be a matter of time before bank issuers start opting for coupon deferrals to limit their outgoings further.

Note the snap view of Jason Rogers at Barclays Capital:

"We expect Deutsche Bank’s (DB) surprise decision today not to call its Lower Tier 2 (LT2) bonds (EUR1bn 3.875% ‘14c09) to rattle valuations of bank bonds with callable structures globally, as investors adjust to the higher probability that other banks will follow DB’s lead. Simply put, while the impact of DB’s move is still unclear, in our view banks can now very easily cite the precedent that has been set by DB as a reason not to call if it does not make economic sense for them to do so. In view of prevailing spread levels and market conditions, we would, in fact, be surprised if a number of banks did not follow DB."

If [this] came as a shock to you, the following list may be of use - it’s all other bank capital instruments callable in the next 12 months, from JP Morgan. (Click for a larger view.)

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