As shares of Deutsche Bank (DB) are down more than 27% for the year, several of its contingent convertible notes are also trading down sharply. Some have fallen as much as 13% in the last month and are now trading below par in the high $70 to low $80 range.
In 2014, Deutsche Bank issued approximately $5 billion worth of contingent convertible bonds to build up its Additional Tier 1 (AT1) capital. The issuance was spread across four notes, two of which were denominated in U.S. dollars, one was denominated in euros, and one was denominated in pounds. The coupon for the notes ranges between 6% and 7.5%, though they are now yielding between 10% and 11.5% due to the recent dip in prices.
Contingent convertible notes, also known as "coco bonds," differ from traditional convertible notes as their conversion to equity is contingent upon an event, such the company's stock price settling below a certain level. As such, they can be used to satisfy a bank's Common Equity Tier 1 capital requirements. In the case of Deutsche Bank, the coco bonds -- currently held as Additional Tier 1 capital -- could be converted to equity, or written down, if the bank's Common Equity Tier 1 capital ratio falls below 5.125%.
So, what's causing the price of the coco bonds to drop? Put simply, Deutsche Bank has been having a difficult time and the notes have characteristics that may be scaring investors away.
The notes are non-cumulative and interest payments could be suspended at the bank's "sole and absolute" discretion, dictated in large part by the bank's' capital level. Typically, hybrid securities such as preferred shares are often cumulative, which means that a company could suspend dividends but they will eventually be due to preferred shareholders.
Although Deutsche Bank assured investors of its ability to make coupon payments on the notes when it announced earnings last week, the quality of those earnings no doubt makes investors skittish. The bank reported a net loss of 2.1 billion euros in the fourth quarter as its revenue fell 15% to 6.6 billion euros.
Even worse, the bank is the subject of many regulatory probes tied to LIBOR, FX and other alleged market manipulation, as well as an investigation for its dealings in mortgage-backed securities. The bank set aside $5.5 billion in litigation reserves but some wonder if that will be enough.
"We know that periods of restructuring can be challenging," co-CEO John Cryan said in the bank's earnings release. "However, I'm confident that by continuing to implement our strategy in a disciplined manner, we can and will transform Deutsche Bank into a stronger, more efficient and better run institution."
Investors, so far, are less confident.