Deutsche Bank Capital Structure Dislocation
While this is not a detailed story I think price action in DB securities across the capital structure warrants a look. We all observed the selloff in DB stock (and most other European banks), which accelerated after the poorly announced earnings report. But the real alarm bells went off when the CoCos (Contingent Convertible Notes) got hit, selling off from $95 in January to $71 now (talking about the USD DB 6.25% 5/29/49 issue). This looks like a disaster, and for some it is, but these are not corporate bonds. It appears this may be news to some investors but CoCos are subordinated convertible preferreds (converting to equity in case of a bail-in) with a contingent and non-cumulative coupon. In other words, the payoff is the coupon when all is well (they're callable at the issuer option) or a conversion to a beat-up equity when things are in the doghouse (and the Bank’s capital base is inadequate). So now, the future performance expectation and most likely forced panicked selling into a no-bid market create the cascading price action. The equities are also under pressure from the future expectations of corporate performance but also from potential dilution in case CoCos get converted (not to mention the well developed rumor mill).
That said the selloff in the senior unsecured part of the cap structure is less justified. As an example please look at the USD DB 3.7 5/30/24 which sold off from $102 in January to $92.5 now (spread over UST moved from 140bps in January to about 300bps now). This is a global and liquid issue that has fallen significantly and in my mind offers interesting value proposition.
Ignoring the rumors of DB being the new LEH (probably a reason for another discussion) the risk to CoCos is possibly a skipped coupon beyond 2017, not a conversion as I can see it. But I think that a lot of CoCos owners are mistakenly buying DB CDS to "hedge" them putting direct pressure on the senior unsecured part of the cap structure (DB 5yr EUR CDS moved form 100bps in January to 260bps now).
These "hedges" are ineffective for CoCos (which ere neither deliverable nor well correlated to CDS) but demand for them creates price pressure on the senior unsecured bonds. In fact I would argue that the very existence of CoCos make the senior unsecured bonds safer as the CoCos create a protective buffer by contributing to the equity capital. In other words the price action in CoCos and equities should not be directly representative of the quality of risk at the upper parts of the capital structure.
In conclusion I think the opportunity here is to go long senior unsecured DB bonds like the USD DB 3.7% 5/30/24 in the low 90s before the market normalizes. Equities and CoCos are already beat up and their price action can be still very volatile and unpredictable (although my gut tells me the equity is also too low at $15.5, less than $22bn market cap). This, in my opinion, is a cap structure opportunity where the price action in one part is putting significant pressure in the other, creating a price dislocation without a proportionate risk transmission.
