Deutsche Bank In­vestors Get a Scare

An odd kind of bank bond called a CoCo starts to look shaky It’s an in­stru­ment “of reg­u­la­tors, by reg­u­la­tors, and for reg­u­la­tors”

Bloomberg Businessweek (Europe) - - MARKETS/ FINANCE -

Shares in Deutsche Bank tum­bled on Feb. 9 to their low­est point since 1992. The big­gest thing driv­ing in­vestors’ pes­simism: a re­port from in­de­pen­dent re­search firm Cred­itSights that said the Frank­furt-based bank might strug­gle to make its pay­ments next year on con­tin­gent con­vert­ible bonds, also known as Co­Cos. Deutsche Bank took the un­usual step of say­ing that it can make pay­ments on the bonds for the next two years, and its shares ral­lied 4.6 per­cent on Feb. 10 on re­ports it might buy back some debt.

The shake-up put a spot­light on Co­Cos, which are no or­di­nary bonds. Un­til re­cently, the in­stru­ments mainly is­sued by Euro­pean banks were the best bet on the global credit mar­kets, gen­er­at­ing re­turns of 8 per­cent in 2015, ac­cord­ing to Bank of Amer­ica Mer­rill Lynch in­dex data. Their yields av­er­age a fat 7 per­cent when short­term rates in Europe are neg­a­tive. But that’s a re­ward for risk: The bonds al­low banks to skip in­ter­est pay­ments with­out de­fault­ing or even con­vert the bonds into equity in times of fi­nan­cial stress—bad news for in­vestors who had planned to col­lect their in­ter­est and prin­ci­pal.

Now bond mar­kets are pay­ing at­ten­tion to the down­side. In less than six weeks this year, CoCo prices have dropped far enough to wipe out the 2015 gains. Euro­pean banks are look­ing much less solid since their pre­vi­ous earn­ings re­ports. Deutsche Bank last month posted its first ful­lyear loss since 2008. Credit Suisse Group— which hasn’t been the fo­cus of the same debt wor­ries—in Fe­bru­ary re­ported its big­gest quar­terly loss since the fi­nan­cial cri­sis. In­vest­ment bank­ing rev­enue in Europe is shrink­ing, even as tum­bling oil prices, China’s slow­down, and a global mar­ket rout are mak­ing the banks’ loans and in­vest­ments look riskier.

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