Hedge funds eye windfall from Commerzbank bond swap

LONDON Fri Feb 24, 2012 7:11am EST

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LONDON (Reuters) - Commerzbank AG's (CBKG.DE) plan to swap debt into shares could be about to hand hedge funds one of their biggest windfalls of the year, after the German bank offered to buy back a slew of bonds at a far higher price than some managers paid for them.

Commerzbank said on Thursday it is offering to swap previously unloved subordinated debt and lower-ranking securities into shares, in an effort to boost its capital by 1 billion euros (849 million pounds) ahead of the European Banking Authority's deadline requiring banks hold core capital of 9 percent.

It is the latest of several banks rushing to boost capital by swapping debt for equity. BNP Paribas BNP.PA and Unicredit (CRDI.MI) are among those to have already used cash to buy back their bonds from investors.

Hedge funds have exploited that rush by snapping up the bonds in the secondary market, according to several funds playing the strategy.

The funds bet banks would decide to boost higher-ranking capital by buying back junior debt, and that a recovery of confidence in the sector would encourage them to pay a higher price than funds originally paid, giving these investors a profit.

The size of the gain to be made by hedge funds will vary according to the type of security they intend to exchange and the price at which they bought.

Some bought Commerzbank bonds for less than 60 cents on the euro late last year, one hedge fund manager said.

"Where there is disruption there comes opportunity and last year there was a huge amount of mark-to-market destruction ... people were attempting to price in a tail risk of the euro breaking up. Bonds dropped 30 to 40 points and that created the opportunity," the manager said.

It is also one of several winning bets for hedge funds involving banks this year, after the ECB's long-term refinancing operations flooded the market with cheap cash, sending bank bond and equity prices, battered for much of 2011, soaring higher.

The manager, who said he had bought some Commerzbank paper for as low as 53 cents on the euro in December, said he was also seeking to "arbitrage" the swap during the week it is on offer, by buying bonds from investors who cannot hold equity.

"What I'm doing this morning is buying bonds off people that can't take equity and hedge it (by shorting the stock)," he said.

MORE TO COME?

Last month French bank BNP Paribas launched an offer to buy back 3 billion euros of hybrid debt.

York Capital Management, GLG Partners and Oceanwood Capital Management were among the funds to initially slam the plan, which offered investors less than 50 percent of par value for their bonds, although the buyback was completed.

Some of the funds are still likely to have profited.

"We think these buybacks were inevitable," another manager told Reuters, involved in both the Commerzbank and the BNP deals.

But the strategy is not without its risks. The recovery in bond prices this year is limiting the capital gains banks can book on any buyback or swap, discouraging some from the transaction and leaving funds holding the debt.

Many who need to raise capital have already launched their offers, keen to move early before the EBA deadline.

Austrian bank Raiffeisen Bank (RBIV.VI) said on Thursday it was launching a repurchase offer worth up to 500 million euros, following an offer by compatriot Erste Group (ERST.VI) last week.

Italian banks such as UniCredit, Intesa Sanpaolo (ISP.MI) and Banco Popolare (BAPO.MI) have also used buybacks of hybrid debt to improve their capital base.

According to the EBA, European banks plan to meet 22 percent of their capital shortfall by converting hybrid instruments - almost on par with the 26 percent coming from capital raising, retained earnings and scrapped dividends.

Despite many banks having already moved, one hedge fund manager expects state-backed Royal Bank of Scotland (RBS.L), could be the next.

(Reporting by Tommy Wilkes; Editing by Jon Loades-Carter and Sinead Cruise)

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