23 December 2008

Bank of China furious at Deutsche debt move

Investors in bank debt are threatening to boycott lenders that follow Deutsche Bank in breaking an unwritten rule and failing to exercise a call option on subordinated debt.

In a co-ordinated action, angry bond investors are writing to bank treasurers and investor relations heads telling them that any failure to exercise a call option will be considered a breach of trust that could cause all the issuer's debt to be shunned.

Deutsche stunned the debt market last week by choosing not to redeem €1bn (£932m) of subordinated lower tier 2 bonds because to do so was cheaper than refinancing. But though the move saved Germany's biggest bank up to €150m, it caused fury among buyers of the debt who worked on the assumption that bonds would always be redeemed at their first call date.

The letter, seen by The Independent, said a bank's decision not to call debt would be taken to mean "the institution is in such difficulty that it is an impossibility to call the instrument or the institution feels that it is in such a strong position that it can afford to alienate itself from the support of a wide portion of the fixed-income institutional investor community".

Bank of China, a major buyer of bank debt, has gone further in its communication with issuers. The giant Chinese lender's Hong Kong operation has told banks that "any non-call by a given institution will result in that institution's debt (not just lower tier 2 but senior and tier 1 as well) being ineligible for future investment consideration".

Bank of China added that Deutsche Bank had also been removed from consideration as a counterparty for any credit derivative transaction in future.

The bank is writing to all of Britain's banks, along with lenders elsewhere in Europe.

The bond buyers are stressing to issuers that they cannot afford to become debt-market pariahs when their capital buffers against losses are under threat from a global downturn and they may need to raise more capital. Without being able to issue debt, which counts as lower-grade tier 1 and tier 2 capital, institutions would be forced to seek costly new equity, angering their shareholders.

"Non-call may indeed save you some money today but it will seriously impact your capital structure options in the future," Bank of China warned. "Being only left with severely dilutive equity to raise capital is not in anyone's interest."

Deutsche Bank will be hoping that other banks follow its lead, giving it safety in numbers. The wave of threats from investors is intended to stop others opting to join Deutsche, and is the most hard-line response yet to the breaking of the debt-market code.

Refusing to call the debt means that the hybrid notes effectively become longer term and more risky than the investor originally assumed. Deutsche's decision caused the entire subordinated debt class to be repriced last week.

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