Deutsche Bank’s CoCo Bonds Speak of Fear of the Worst

The fine that broke the bank?

Deutsche Bank investors just can’t catch a break. They keep thinking that shares have dropped so low that it’s time to grab them. Herd instinct sets in, and this buying perks up the shares. Then the bank’s sins once again come to the foreground. And what investors had grabbed was a falling knife, and fingers are now getting sliced off.

Early morning on Friday in Frankfurt – in the US, Thursday after the markets had closed, a strategic time for bad news – Deutsche Bank announced that the US Justice Department was trying to wring $14 billion out it. The fine is based on the investigation into mortgage backed securities that the bank had rolled into complex toxic products and sold to unsuspecting investors between 2005 and 2007, just before the Financial Crisis.

The Justice Department already nailed other banks for it and extracted large fines; and it’s still investigating some banks, including UBS, Credit Suisse, Royal Bank of Scotland, and Barclays – which saw their shares get pummeled today.

Deutsche Bank has already paid over $9 billion in fines and settlements since 2008. Other scandals are still simmering on the front burner, unresolved, including the money laundering scandal in Russia for which Deutsche Bank has reserved €5.5 billion this summer to cover the fines.

In its statement early Friday in Frankfurt, Deutsche Bank said it “has commenced negotiations” with the Justice Department:

The bank confirms market speculation of an opening position by the DoJ of USD 14 billion and that the DoJ has invited the bank as the next step to submit a counter proposal.

Deutsche Bank has no intent to settle these potential civil claims anywhere near the number cited. The negotiations are only just beginning. The bank expects that they will lead to an outcome similar to those of peer banks which have settled at materially lower amounts.

So let the horse trading begin. As always, a deal will be worked out. For most big banks, it would just add to the cost of doing business. These huge fines might amount to a quarter or two of reported income, nothing more. For a highly profitable, well-capitalized bank that isn’t teetering on the brink, such fines are essentially a slap on the wrist.

But these three conditions – highly profitable, well-capitalized, and not teetering on the brink – are not applicable to Deutsche Bank.

So Friday, all heck broke loose in Frankfurt. Deutsche Bank’s shares plunged 8.6% to €11.97, the biggest drop since June 27 following the Brexit vote. On July 7, they’d hit €11.38, a three-decade low, down nearly 50% from a year earlier, and lower even than during the doom-and-gloom days of the euro debt crisis and the Global Financial Crisis.

Most indicatively, Deutsche Bank’s contingent convertible bonds – the infamous CoCo bonds – plunged 6.5% to 77.61 cents on the euro.

Since taking over, CEO John Cryan’s number one job has been to prop up Deutsche Bank with his rhetoric. Back in February, he explained that the bank’s position was “absolutely rock-solid, given our strong capital and risk position.” He followed up with a ruse to trample on short sellers: On February 12, the bank announced it would buy back $5.4 billion of its own bonds. Shares and bonds soared. Even the CoCo bonds, which weren’t part of the buyback plan, jumped 24% over a few weeks.

It was one of the more ludicrous efforts to prop up shares and bonds. And now shares are even lower than they’d been at the time, and the CoCo bonds have re-collapsed:


To prop up Tier 1 capital, Deutsche Bank raised nearly €20 billion in 2010 and 2014, by selling shares, which diluted existing shareholders, and by issuing CoCo bonds. CoCos are designed to be “bailed in” before taxpayers get to foot the bill. Thus, they’re a measure of how likely investors think a bail-in is.

CoCos have no maturity date, and investors may never get their money back. But the bank can redeem them, usually after five years. Annual coupon payments are contingent on the bank’s ability to keep its capital above certain thresholds. If capital falls below that threshold, the bank won’t make the coupon payment. But investors cannot call a default; they’re just sitting on bonds that have plunged in value and pay no coupon. If regulators deem that the bank is failing, CoCos get “bailed in,” either by getting converted into increasingly worthless shares or by getting canceled.

To entice investors to take these risks, CoCos offer an annual coupon of 6% or higher. Yield-desperate investors jumped on them. The 6% CoCo notes in the chart above traded as high as 104 cents on the euro in early 2014 shortly after they’d been issued, and at 102 in April 2015. Folks are ruing the day they didn’t sell!

When CoCos plunge, it’s a sign investors think those thresholds are approaching, that the bank will have to raise more capital by issuing shares and/or CoCos. But with both plunging, raising capital that way will be prohibitively expensive. So skipping CoCo coupon payments might be the next step to avoid, or delay, falling over the brink. That’s what the market is afraid of.

Clemens Fuest, president of the Ifo Institute in Munich, which produces the closely watched Ifo Business Climate Index, today explained the problem this way (translation mine):

“Deutsche Bank will not be able to pay this fine without a capital increase. The equity of currently €60 billion must not fall anymore. That would further shake the confidence in the soundness of the bank. The profits of the bank are currently so low that they are unlikely to suffice to fill the gap. This is the revenge for the failure by banking supervisors and regulators in recent years to push for a stronger increase in Deutsche Bank’s equity capital.”

If push comes to shove, Deutsche Bank will be bailed out by the German government and/or the ECB. It will not be allowed to topple and shatter the global financial system, as tangled up in it as it is. But its shares and CoCos will be “bailed in” before taxpayers get to dig into their wallets. That’s what the market sees as increasingly likely.

When Stuart Lewis, Deutsche Bank’s Chief Risk Officer, was asked in an interview if his institution is “the most dangerous bank in the world” – a reference to the IMF’s description of the bank – he had his own confidence-inspiring explanations. Read… “We’re Not Dangerous”: Deutsche Bank’s Chief Risk Officer

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  24 comments for “Deutsche Bank’s CoCo Bonds Speak of Fear of the Worst

  1. Peter says:

    The EU tax of Apple $14 B is still fresh in memory. See how that works?

  2. nick kelly says:

    I have to say I’m disappointed in Germany. I’ve always thought of them as being averse to debt, financial lunacy etc. of the South European type.
    I wonder if they came under US influence, back in the go-go days pre-2007?

  3. Gunther says:

    Deutsche Bank bought Bankers Trust 1998, since then they are a big player on wall street.

  4. Ptb says:

    DXY just cracked 96 again. USD just hit 5 year high against the Mexican peso. Yes, everything is fine out there

  5. Chicken says:

    Hopefully this cycle we can elect another criminal to help get us deeper into the same mess we keep falling deeper into.

  6. David Calder says:

    These are felonies and the best we can do is garner some fines; no jail for anyone.. To get real justice, the CEO of a crooked institution would have to chain himself to a bulldozer in North Dakota..

    • Chicken says:

      Fines paid for by shareholders who weren’t part and parcel to the crimes.

  7. Chicken says:

    On the bright side, perhaps China continues purchasing the remnants of the American industrial engine we’ve turned our backs on if demand for scrap metal recovers.

  8. Humpty Dumpty says:

    What is truly toxic is that these ‘fines’ are paid directly to Democratic party constituencies and front groups, but no one who was really harmed by the banking cock up. Another disgraceful Obama administration touch.

  9. Islander says:

    This potential fine reminds me a lot of the remittance payments Europe had to do after WW1. Or maybe it’s just tit for tat for the AAPL thing. Either way it’s not confidence inspiring and probably a loss for all if serious fines are handed down.

    Now if one really wanted to do something against financial crimes all we’d need to do is legislate better enforcement and clarity within finance. This ‘punish a decade later for geopolitical porpoises’ doesn’t seem very effective for financial stability.

  10. jay moses says:

    the nature of these coco bonds is such as to make me question the sanity of anyone who bought them. do people never learn?

  11. Realist says:

    An interesting detail is that the US has only fined non-US banks like BNP Paribas, HSBC etc and now Deutsche Bank any substantial sums while US banks has been given a soft rap on the fingers in comparision for their wrong doings.

    I find it quite hard to believe that the US bankers have been sooooo much cleaner in their shenanigans compared to those foreigners ;)

  12. Realist
    September 17, 2016 at 5:33 am

    An interesting detail is that the US has only fined non-US banks like BNP Paribas, HSBC etc and now Deutsche Bank any substantial sums while US banks has been given a soft rap on the fingers in comparision for their wrong doings.

    I find it quite hard to believe that the US bankers have been sooooo much cleaner in their shenanigans compared to those foreigners ;)


    • Wolf Richter says:

      Not quite. Among other fines, the DOJ settled its RMBS investigation with:

      – BofA for $16.7 billion
      – JPMOrgan for $9 billion
      – Citigroup for $7 billion

      etc. etc. That’s just the RMBS stuff. They also paid many billions in settlements for other misdeeds. US Banks got hit first.

      Deutsche Bank will settle the RMBS case for less than $14 billion. It might settle for less than $9 billion. If that’s the case, it’ll be in third position.

      • JohnF says:

        Don’t Forget About Goldman Sachs – The Ring Leader – Fined 5 Billion I Believe – Supplies All The Treasury Secretaries For Their Criminal Enterprise – The Bankster System.

  13. Bob says:

    How much did they make though after being fined?????

  14. R Davis says:

    “Deutsche Bank has already paid over $9 BILLION in fines and settlements since 2008.”

    It makes us feel better to know this .. to see that a pound of flesh has been extracted here and there .. for all the indiscretions committed .. for the blatant liberties taken .. only and therefore .. that it doesn’t make sense.

    What do I know .. right.

    If you said to me that these fines are actually a fiction .. a necessary pantomime to give the illusion that the financial world is as we are told .. that planet earth is really round and not flat.
    But you see .. if justice is really being metered out by a regulatory body .. an even more dubiously honest regulatory body .. it is the pot calling the kettle black syndrome in play.

    I’m inclined to believe that all these $9 billion type fines are actually a siphoning of monies to The Establishment Coffers .. wink, wink, say no more.

  15. R Davis says:

    “If push comes to shove, Deutsche Bank will be bailed out by the German government & /or the ECB.”

    Q: Because why .. ? .. would a diseased organ be bailed out / saved at the expense of the stability of the whole nation .. not to mention the financial stability & reputation of the nations function as a viable & worthy of investment, institution.
    Is it actually a matter of the geriatric old guard & their young flesh lackeys struggling to exist in the aftermath of their incompetence / their long drawn out & fumbled suicide.
    A bailout is nothing more than the codependent, malingering, losers holding each other’s heads above water to keep the other from drowning.
    I think so ..

    “It will not be allowed to topple & shatter the global financial system”

    Q: Is that what would happen .. ? .. really ?
    I put it to you that if Deutsche Bank .. or for that matter any major bank were to be left to expire rather than to flush good money down the toilet after it .. there would be an immediate regrouping of global banking & financial institutions & only a bigger piece of the pie for the rest of the crowd.
    Wouldn’t this be a good thing .. an injection of energy to the whole shebang. A declaration that the system is not a mechanism serving the pampered elite .. our betters .. at the expense of the quality of a thriving, existence.

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