UPDATE 2-Deutsche Bank's $4.8 bln CoCo success sets scene for share sale

Tue May 20, 2014 12:37pm EDT

* Deutsche Bank raises 3.5 bln euros in debut CoCo sale

* Attracts over 25 bln euros of demand

* Successful bond raise to give equity market comfort (Rewrites throughout, adds investor and banker quotes)

By Aimee Donnellan and Helene Durand

LONDON, May 20 (IFR) - Deutsche Bank AG raised 3.5 billion euros ($4.8 billion) from the sale of bonds that recapitalise the bank if it hits trouble, giving a boost to Germany's flagship lender before a jumbo rights issue of new stock next month.

Deutsche Bank attracted over 25 billion euros of demand for the contingent capital bonds, dubbed "CoCos", a level of interest that allowed it to reduce the interest it pays to lure investors into the instruments.

The bank sold more than it had planned of the hybrid bonds in three denominations - euros, dollars and pounds, paying interest of between 6 percent and 7.125 percent - just two days after saying it would raise 8 billion euros in a separate fundraising to address concerns about its capital strength.

"Equity investors should take comfort from the fact that Deutsche Bank can generate such demand for an equity-like product at relatively low cost," said Andrew Fraser, investment director for fixed income at Standard Life Investments.

"It demonstrates that the bank can raise capital through different sources and that the equity market doesn't have to stump up all the cash to meet future regulatory targets," Fraser said.

The bank joins others issuing CoCos, which have become popular in the past year as a way of raising funds without directly issuing new shares. They are an undilutive way for banks to bolster their finances and meet tighter regulations in areas such as their leverage ratio, which measures core capital against total loans.

"This counts one-for-one, just like equity, for the leverage ratio and equity investors should certainly be happy that they're not the only game in town," a banker close to the deal said.

Deutsche Bank's debut issuance of CoCo bonds will improve its leverage ratio by 24 basis points from 2.5 percent, a person close to the transaction said.

Deutsche will set the terms for its 6.3 billion euro rights issue in June and has already secured 1.7 billion from Qatar's royal family. The moves were expected to further improve its leverage ratio to over 3.1 percent.

That is in line with the 3 percent target initially set by global regulators, though supervisors from the United States, Britain and elsewhere are pushing for a higher proportion.

LUCKY TIMING

While the sale of the CoCos, known as Additional Tier 1 (AT1) securities, will boost prospects for the rights issue, the plans to raise equity also helped the success of Tuesday's sale.

The extra equity will provide an extra 8 billion euro cushion before bondholders see their instruments temporarily written down in value, which would occur if the bank's common equity Tier 1 capital ratio falls to 5.125 percent. The bank's cushion before it hits that level will be 38 billion euros.

"The extra layer of equity should make the Additional Tier 1 bonds safer and mean that Deutsche can achieve a better price for this transaction," said Robert Montague, a senior investment analyst at ECM Asset Management.

The bank will pay 6 percent annual interest on 1.75 billion euros of bonds, 6.25 percent interest on a $1.25 billion tranche, and 7.125 percent on 650 million pounds of securities.

The market for AT1 securities fell by around 1 percentage point last week and has not fully recovered. The Bank of America Merrill Lynch CoCo index hit a high of 106.219 on May 13 and has been just above 105.6 this week.

There are still questions around Deutsche Bank's ability to pay interest in the form of coupons if it runs into trouble. These coupon payments on AT1 instruments are fully discretionary, and if switched off they do not accumulate like other capital instruments, instead are lost forever.

They are also subject to profit distribution restrictions once a bank begins eating into its capital conservation buffers, which prevents it from making discretionary distributions.

Deutsche's fundraising will shore up its balance sheet ahead of a European Union health check of banks and will help fund an expansion in U.S. investment banking as its rivals retreat, but the threat of fines and litigation costs remain a concern for some investors.

"Deutsche is facing a lot of litigation issues, which could result in ... charges in coming quarters and might impact their ability to make distributions in a worst-case scenario," said Montague.

The CoCo transaction is being lead managed by Deutsche Bank's own investment bank, together with Banca IMI, Barclays, Commerzbank, Danske Bank, ING, Lloyds, RBI, Santander, Societe Generale, UBS and UniCredit as joint leads. ($1 = 0.7289 Euros) (Editing by David Holmes)

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