* Bank's riskiest bonds fall to lowest ever levels
* Coupon cover endangered by potential DoJ fine
* Broader market resists repeat of February's free fall
By Alice Gledhill
LONDON, Sept 30 (IFR) - Deutsche Bank's Additional Tier 1
bonds were at the heart of a savage sell-off this week, falling
to their lowest ever level on Friday in the latest setback for
the bank as it struggles to stem market concerns.
The AT1 bonds, the riskiest form of debt that banks can
sell, have been under intense pressure since mid-September when
the US Department of Justice asked Deutsche to pay US$14bn to
settle an investigation into its selling of mortgage-backed
The potential size of the fine has stoked fears that
reserves for paying coupons on the roughly 5bn-equivalent of
debt could fall short, and that Deutsche would need to seek
The bonds hit fresh lows on Friday after news broke that
clients had started to pull business from the bank, just days
after Deutsche said it does not need to raise extra capital and
that it had not sought a government bailout.
The dire price action evoked February's sell-off, when fears
around Deutsche's AT1 coupon cover first escalated and dragged
the whole AT1 sector into a downward spiral.
There is likely to be little respite until the size of the
fine is known.
"The problem here is lack of visibility, but also the extent
to which Deutsche could take the rest of the AT1 market with it,
as we saw at the turn of the year. For me, that's the bigger
issue. It will again take only a few big holders to throw in the
towel and it could drop very quickly," said one investor.
The fact that AT1 and equity investors track both markets
exacerbates the problem, he added.
"It just becomes circular very quickly until you get to
levels that are completely crazy and you see distressed money
coming back. If it takes another two or three months to get more
visibility on the litigation side, who knows the damage that
will be inflicted on the franchise?"
Deutsche's 1.75bn 6% AT1 callable in 2022 was bid at 69.55
on Friday morning, below the low of 70.2 during the worst of
February's sell-off. The US$1.25bn 6.25% callable in 2020 was
bid at 69.8, also an all-time low. Both notes have fallen around
14 points since September 9.
The sell-off has been so brutal because the fine has greatly
increased the risk of coupon deferral, which would be a first
for the asset class.
To pay the coupons, which amount to around 330m, the bank
must have a sufficient pool of funds known as "available
distributable items". In Deutsche's case this was already
looking slim before the fine, with matters made worse by
Germany's tricky accounting rules.
The bank assured investors in February that it had 4.3bn of
ADIs for 2017, though that factored in the now delayed Hua Xia
Bank stake sale. At least two coupon skips are now priced into
"They are held to ransom by the fact that it is German GAAP
accounting and there are vagaries in it that make it very
difficult for us to see what's going on, and what flexibility
they have to massage the numbers or pass reserves into the
ADIs," said Steve Hussey, head of financial institutions credit
research at AllianceBernstein.
WHAT A TURN OFF
But it is not just Deutsche that could turn off the coupons
- the regulator also has the power to do so.
"That's definitely a risk. The regulator could easily turn
round and say you can't pay any more dividends or coupons until
you raise capital. It would be a bit of a stick to encourage the
capital raise to happen," said Robert Kendrick, a credit analyst
The risk of principal writedown still appears remote,
however. For that to happen, Deutsche's transitional Common
Equity Tier 1 ratio would have to fall to 5.125%, giving a
buffer to trigger of around 20.6bn.
"To get to where you'd take a principal hit, it's way beyond
the losses they'd go through for these settlements. (It would
take) some enormous outside, one-off, overnight trading loss
that brings down the whole bank," added Hussey.
"It's almost inconceivable they'll get to that point."
In contrast to February, the impact on the rest of the AT1
market has been fairly contained.
"The market hasn't reacted as it did back in February, when
I think there was a little bit more misunderstanding by
investors about the potential risks, and maybe now they're being
a bit more discerning and differentiating between different
credits," said AllianceBernstein's Hussey.
The Bank of America Merrill Lynch CoCo index was yielding
5.9% on Thursday, up from 5.7% in August but well inside
February's high of 7.26%, according to Thomson Reuters data.
But the storm has stoked fresh criticism of AT1 capital, an
asset class that has always divided market participants. Indeed,
Deutsche's own chief executive John Cryan decried them as a "bad
product" in March.
"They're just a pretty unhelpful instrument," said
Schroders' Kendrick. "They don't help much on improving the ROE
or anything, they just add a huge degree of uncertainty and
(Reporting by Alice Gledhill, editing by Helene Durand, Matthew
Davies, Julian Baker)