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* Legislation will introduce new form of senior debt
* Deutsche Bank eager to take advantage of cost saving
By Alice Gledhill
LONDON, May 25 (IFR) - German banks are soon to have the option of issuing a new cheaper form of senior debt, a move that will put the sector on an equal footing with its European peers.
Germany took the market by surprise in 2015 with plans to subordinate senior unsecured bonds, helping its lenders meet a European standard known as the Minimum Requirement for own funds and Eligible Liabilities (MREL) in one fell swoop.
Deutsche Bank, for example, can boast of a €62bn stack of plain vanilla senior debt that counts as Total Loss Absorbing Capacity (TLAC), the global equivalent of Europe’s MREL.
However, what initially appeared to be a shrewd move backfired as other European countries ensured their banks had the option of issuing preferred senior alongside the new, costlier “non-preferred senior”, which ranks lower in the case of insolvency.
Germany is now making amends with new legislation that effectively introduces a two-track senior market, expected on July 21 and paving the way for supply. Senior unsecured bonds issued up to July 20 will rank pari passu with non-preferred senior sold thereafter.
“There are definitely issuers lining up; everyone is focusing on it,” said a syndicate official.
Deutsche Bank in particular is champing at the bit to issue this new form of cheaper debt, giving it access to a Single A rated funding instrument as a painful restructuring weighs heavily on its spreads.
Its Jan 1.5% 2022s, rated Baa2/BBB-/BBB+, are trading at 107bp over swaps, compared to Santander’s Feb 1.375% 2022s at 71bp, for example. Deutsche’s preferred bonds will be rated A3/A-/A-.
The bank will be in blackout until late July, but August - though typically a quieter month - could offer a window. Plenty of market participants are hoping Commerzbank will get there first, however, fearing that a cautious level from Deutsche would push up the cost for others.
“If Deutsche were to start, they could put a reference point out there that is going to be super-wide,” said a second banker.
“You could argue that if Commerzbank is first, there is a case for Deutsche to price tighter than if they had been.”
Pricing this new asset class will be a careful balancing act, regardless of who opens the market.
The spread between preferred and non-preferred debt sold in other countries offers a starting point. But smaller German banks will need to tread carefully given their outstanding senior is already so tight, and secondaries do not necessarily reflect the clearing price for new trades.
“It’s not going to be same differentials that you’re seeing in other places, roughly 25bp-30bp - maybe more like 10bp-15bp,” said the first banker.
“Maybe there is room for Deutsche and Commerzbank to be a bit further inside, but I think there is definitely a cap in terms of how tight you can go in terms of outright level.”
Investors may prove resistant to buying German preferred inside high-quality Nordic names. A Berlin Hyp €500m 0.5% Sept 2023, for example, trades at 25bp over swaps, while a Swedbank €500m 0.25% preferred Nov 2022 is at 13bp.
They will also demand a pick-up over Pfandbriefe, though that could prove a moving target if the European Central Bank reduces its asset purchases further later this year, sending covered bonds wider.
The picture is complicated further by the thick layer of German non-preferred senior which cushions any new preferred bonds from future losses.
“That’s a very positive thing,” said Arnaud-Guilhem Lamy, a portfolio manager at BNP Paribas Asset Management. “The less positive aspect is that the loss given default will be higher, because this tranche will be thin.”
He reckons German preferred senior should price around 35%-40% of Tier 2 spreads, just above the current ratio for other countries. European non-preferred senior typically prices just under 50% of Tier 2 levels.
For all the challenges around pricing, demand from banks should help soak up supply - unlike subordinated senior (in all its various guises), preferred senior is eligible as collateral at the ECB.
In any case, issuance expectations are modest. Deutsche Bank aside, German banks are not large issuers of senior debt and the new legislation is unlikely to change the overall supply picture. Added to that, some lenders may stick to the private placement market, which can offer competitive pricing.
It is also unlikely that preferred senior will dislodge the Pfandbrief sector that sits at the heart of most German banks’ funding programmes.
Berlin Hyp, for example, is in no rush to issue preferred senior debt once the law is implemented.
“You won’t find a lot of issuers where preferred senior is thought of as a replacement for covered bond funding, as long as the spread between the two instruments is big enough,” said Bodo Winkler, the bank’s head of funding and investor relations.
“The Pfandbrief instrument has a long, long history in Germany, and in this country we are used to funding everything that we can via covered bonds.” (Reporting by Alice Gledhill, editing by Helene Durand, Philip Wright)