By Constantin Gurdgiev
Deutsche’s 6 percent perpetual bonds, CoCos (more on this below), with expected maturity in 2022, used to yield around 7 percent back in January. Having announced massive losses for fiscal year 2015 (first time full year losses were posted by the DB since 2008), Deutsche was under pressure in the equity markets. Rather gradual sell-off of shares in the bank from the start of 2015 was slowly, but noticeably eroding bank’s equity risk cushion. So markets started to get nervous of the second tier of ‘capital’ held by the bank – second in terms of priority of it being bailed in in the case of an adverse shock. This second tier is known as AT1 and it includes those CoCos.
Yields on CoCos rose and their value (price) fell. This further reduced Deutsche’s capital cushion and, more materially, triggered concerns that Deutsche will not be calling in 2022 bonds on time, thus rolling them over into longer maturity. Again, this increased losses on the bonds. These losses were further compounded by the market concerns that due to a host of legal and profit margins problems, Deutsche can suspend payments on CoCos coupons, if not in 2016, then in 2017 (again, more details on this below). Which meant that in markets view, shorter-term 2022 CoCos were at a risk of being converted into a longer-dated and zero coupon instrument. End of the game was: Coco’s prices fell from 93 cents to the Euro at the beginning of January, to 71-72 cents on the Euro on Monday this week.
When prices fall as much as Deutsche’s CoCos, investors panic and run for exit. Alas, dumping CoCos into the markets became a problem, exposing liquidity risks imbedded into CoCos structure. There are two reasons for the liquidity risk here: one is general market aversion to these instruments (a reversal of preferences yield-chasing strategies had for them before); and lack of market makers in CoCos (thin markets) because banks don’t like dealing in distressed assets of other banks. Worse, Asian markets were largely shut this week, limiting potential pool of buyers.
full article at source:http://trueeconomics.blogspot.ie/2016/02/12216-deutsche-bank-crystallising.html?spref=tw