September 16, 2016 / 12:46 PM / 2 years ago

UPDATE 1-Coupon deferral fears flare up as Deutsche faces fine

* Proposed fine expected to weigh on reserves, capital ratios

* AT1 bonds fall on fresh fears of missed coupons (Adds quotes, context)

By Helene Durand and Alice Gledhill

LONDON, Sept 16 (IFR) - Deutsche Bank’s proposed US$14bn fine from the US Department of Justice has reignited fears around the lender’s ability to pay coupons on its Additional Tier 1 securities, wiping out recent gains after a torrid year.

The requested sanction, for mis-selling mortgage-backed securities and which the bank is contesting, far exceeded the US$3bn-US$5bn that analysts had expected.

Fears around a potential coupon skip had been at the heart of investor concerns in February, sending bonds into a downward spiral that is now threatening to resurface.

A 1.75bn 6% perp non-call April 2022 lost over six points in early trading on Friday, dropping to a cash price bid of 76.85 from 82.96, though it has since climbed back to 77.59, according to Tradeweb prices. A US$1.25bn 6.25% perp non-call April 2020 dropped from 83.66 to 77.9 before recovering to 79.25.

The bonds’ trading levels were already reflecting market concerns around coupon deferral, but these fears could now escalate.

“The recent development is clearly very negative and the risk of coupon deferral is now considerably higher,” said Michael Huenseler, head of credit portfolio management at Assenagon.

“It was widely expected that the settlement would pave the way for other measures, including getting the stock price back on track, and probably a capital raise. The bank’s capital position is not as weak as the market takes it, but it’s clearly one of those banks that does not have as much headroom as CoCo investors would like to see.”

BNP Paribas analysts reckon Deutsche Bank has set aside around 2bn of litigation reserves against this particular case. A settlement higher than that would impact reserves and capital ratios, they said.

“We estimate that there are around 4bn of Available Distributable Items (ADIs) to pay around 800m of Tier 1 coupons in 2017; a fine of more than 6bn would most likely lead to AT1 coupon deferrals,” they wrote in note on Friday.

CAUGHT IN A TRAP

Deutsche Bank will likely make a counter-offer, but the proposed fine would create a hole in its capital base at an already tricky time and potentially force up its funding costs.

On a transitional basis, the lender had 49bn of Common Equity Tier 1 capital at the end of H1 2016, a CET1 ratio of 12.2% and 5.5bn of litigation reserves.

A fine as high as US$14bn could cut over three percentage points from the bank’s CET1 ratio, ING analysts said, potentially pushing it below its minimum regulatory requirement for 2016 of 10.75%.

The bank is unlikely to have to pay the full amount, they said, but the lack of clarity presents yet another hurdle for the bank and investors alike.

“Deutsche Bank will have a harder time defending its position, in all aspects. As long as they don’t have clarity on the final fine, it is hard to see how real the risk of a coupon skip is. They are now caught in a trap,” added Assenagon’s Huenseler.

“Deutsche Bank needs to get more specific with respect to their capital position and plans. They are taking some steps, but in the current environment their communication needs to be better.”

For the bonds to recover there needs to be a narrative that supposes legal settlements will come in considerably below expectations - plus some evidence that earnings have settled, said Richard Thomas, research analyst at Bank of America Merrill Lynch.

“Only then can solvency concerns start to subside, in our view,” he wrote in a note. (Reporting by Alice Gledhill, Helene Durand, editing by Julian Baker)

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