Prices for the riskiest bonds sold by some of Europe’s largest banks plumbed new lows on Monday, the latest sign of investors reassessing their outlook for the continent’s financial institutions.
Deutsche Bank's € 1.75bn contingent convertible bond traded below 75 cents on the euro — its lowest level — a 19 per cent fall in price this year. Other European bank cocos also hit new lows on Monday, with Santander and UniCredit bonds touching 85 and 76.3 cents on the euro, respectively.
Deutsche Bank on Monday night sought to allay concerns over its ability to pay coupons on its hybrid capital by spelling out its payment capacity for 2016 and 2017.
The bank said its capacity for 2016 stood at € 1bn, which it said was enough to cover the € 350m of payments due by April 30. It added that for 2017, its capacity was expected to be € 4.3bn, before taking into account whatever profit or loss it makes this year.
Since the financial crisis, regulators have encouraged banks to sell coco bonds because they can be converted to equity or written down if the issuer runs into trouble and its capital levels fall below a certain level.
The sharp drop in the value of some coco debt reflects broad selling of banking sector shares around the world, with some stocks last week touching their weakest levels in a generation.
Global financials came under further pressure on Monday, with Deutsche Bank, Credit Suisse and Commerzbank at fresh share price lows, while Morgan Stanley closed down 7 per cent, Goldman Sachs 4.6 per cent and Bank of America 5.2 per cent.
"The equity correction has to do with the big unknown, which is the possibility of a global recession," said Filippo Alloatti, a senior credit analyst at Hermes. He added that coco prices were now very highly correlated with bank stock price movements.
So far, no bank has actually defaulted on a coco bond.
At the same time, Deutsche’s five-year senior credit default swaps, which offer protection against default on senior debt, spiked to three-and-a-half-year highs on Monday. CDS do not cover cocos, so the relationship between the two is not clear.
“There’s no real reason for the CDS to be moving higher along with stress about coco payments but it is relatively straightforward to hedge in CDS, and the CDS market is more liquid than cash,” said Chris Telfer, portfolio manager at ECM Asset Management.
Investors have been cautious about bank bonds since losses were imposed on senior creditors at Portugal's Novo Banco at the end of December. That move, along with lingering concerns over non-performing loans, set the tone for an unforgiving start to 2016.
While coco bonds, also known as additional tier one (AT1) capital, are best known for the risk of writedown, investors in European issuers are also concerned that banks under stress might start missing coupon payments.
"Because the coupon payment is optional, then if bank profitability is weak, and dividends get shut off, there is the fear that there's a read through to AT1 coupons," said Lloyd Harris, an analyst at Old Mutual Global Investors.
Europe’s € 95bn coco bond market is also highly technical. The instruments are perpetual, but market expectations that issuers will exercise options to buy back the debt in the future have also driven price activity.
(Copyright The Financial Times 2016)
