18 December 2008

Deutsche stuns market by delaying bond redemption

A move by Deutsche Bank to go against industry practice by passing up an opportunity to redeem a chunk of subordinated debt has escalated the level of turmoil in financial markets as investors worry that problems at the German financial services giant might be greater than imagined.

Meanwhile, at least one analyst is speculating that Canadian banks could follow suit on a portion of the more than $3-billion of bonds that they have coming due in the next few months.

Deutsche Bank stunned the market when it said on Wednesday it will not redeem 1-billion euros of callable bonds at the first opportunity. The debt does not mature until 2014, but it has a call date of January 2009, meaning the debt can be paid back as early as next month.

It is a long-time industry practice for banks to redeem such bonds on the earliest possible date, as proof of the soundness of their balance sheets.

Analysts said Deutsche is the first major player to break the tradition.

The move "raises some awkward questions about [the German bank's] financial position," said CreditSights analyst Simon Adamson. "But more than that, it is a signal that banks do not see a return to more normal funding conditions in the foreseeable future, and that is a damaging statement for the banking sector."

"This is a big deal in the bond market," said another analyst who asked not to be named, pointing out that investors have always taken for granted that such debt always gets paid back at the earliest opportunity.

Banks around the world are under the spotlight as investors try to figure out how this episode of the credit crisis will play out, whether other banks will copy Deutsche or whether it will end up as an isolated occurrence.

"We will see if any of the Canadian banks follow suit," said the analyst, adding that they will do so if they believe they can gain by it.

He said there could be several reasons for Deutsche's decision not to redeem. One possibility is that it simply needs the cash and is willing to pay the penalty for later payment in order to hold onto the money longer. A second possibility is that it already has sufficient funding to keep it going for a considerable period and can afford to take a step that would make it much more expensive to access the credit markets.

"Do you want to shut yourself out of the market, which is what you would do?" the analyst said.

You would also shut your competitors out of the market because the whole sector would likely be tainted.

According to Desjardins Securities analyst Michael Goldberg, Canadian institutions have several bond issues that are callable in the coming months, including Capital Desjardins in March ($450-million), Scotiabank in May ($350-million), Royal Bank ($1-billion) and CIBC ($750-million) in June, and CIBC ($500-million) again in October. The first innovative Tier 1 note issued in Canada from TD Capital Trust of $900-million is callable next December.
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