New CDS nearly halves Deutsche Bank default protection costs

May 13 (IFR) - The cost of default protection on Deutsche Bank nearly halved on Monday following the introduction of new derivatives contracts used to insure against German bank debt defaults.

Credit default swaps on Deutsche Bank’s most senior debt securities traded at 99bp, according to IHS Markit - equivalent to an investor paying US$99,000 per year to insure against a default on US$10m of Deutsche debt for five years. That compares with Deutsche’s most senior CDS trading at 180bp on Friday before the introduction of the new contracts.

Analysts said prices could be somewhat volatile as traders attempted to find a level on the new CDS.

Deutsche executives hope the decline in default protection costs will be an important development for Germany’s largest lender, which has battled with soaring CDS spreads in recent years whenever troubles around the bank have flared. In particular, lower CDS could have a meaningful impact on Deutsche’s massive trading operations and trillions of euros in derivatives exposure.

Clients and traders use CDS as a general barometer of a bank’s health - the credit market’s equivalent of a bank’s share price. But they also buy CDS to manage exposure stemming from trading derivatives and other financial instruments with a bank. Lower CDS should make it cheaper for counterparties to trade with German banks.

“For clients, the cost of hedging their exposure when looking to do business with us should fall materially [so that] it becomes more cost-effective to trade with us,” Dixit Joshi, Deutsche’s group treasurer, told IFR in an interview last week.

Deutsche executives have been frustrated by what they see as an unlevel playing field between German lenders and other large European banks due to differences in national legislation on bank debt.

Last July, the German government aligned itself with other European countries such as France by passing legislation allowing local banks to issue senior preferred debt. These bonds rank equal to some large deposits and derivatives and above other kinds of bonds that absorb losses if the bank runs into trouble.

The new CDS launched on Monday are linked to the safer, preferred securities, rather than the riskier, loss-absorbing debt they have been priced against up until now. Both options will be available, but the new contract referencing the safer debt is expected to become the market standard for CDS on German banks.

The new CDS on Commerzbank, Germany’s second largest lender, traded at 67bp on Monday. That compares with 87bp on Friday for CDS insuring against Commerzbank’s riskier debt. Commerzbank has smaller trading operations than Deutsche and investors generally view the bank as safer.

Despite the changes, German bank CDS still trade at higher levels than their European peers, a reflection of their greater perceived risk.

By comparison, CDS on the equivalent level of debt at BNP Paribas and Societe Generale traded at 40bp and 43bp, respectively, on Monday, while CDS on Barclays was 61bp. (Reporting by Christopher Whittall)