Deutsche Bank stopped accepting tenders for a rather big exchange offer on Tuesday.
The German bank had given holders of its $4.25bn 4.25% 2021 senior bonds a chance to swap their notes for an entirely new set of instruments, which would have exactly the same interest rate, interest payment dates and maturity date as the original notes.
Of course it wouldn’t surprise anyone to find out that the two sets of notes were not exactly the same.
Deutsche Bank was looking to reform a part of its stack of senior unsecured bonds in preparation for the total loss-absorbing capacity (TLAC) requirement, and it had tweaked the terms and conditions of the exchange notes to make sure they would comply with the capital standard.
The main point of fault with the original notes was that they gave investors too many rights to accelerate payments — if the issuer failed to pay interest, if it couldn’t stump up principal, or if it couldn’t meet any other financial obligations then noteholders could demand repayment of 100% of their bonds.
But if the German bank wanted any of the chunky $4.25bn offering to comply with Europe’s likely final rules on own funds, it would have to strip those acceleration rights back.
Indeed, when the European Commission suggested amendments to the region’s prudential banking regulation last November, it said that — for a security to be eligible as loss-absorbing capital — investors should only have the right to accelerate future payments of interest or principal “in case of the insolvency or liquidation of the resolution entity”.
Reaching a milestone
All of the biggest US banks removed the acceleration covenants from their senior bonds once the regulator had published its final rules on TLAC. In the UK, Lloyds has stripped out the old acceleration language in its bond prospectuses and refined the securities’ events of default. In Italy, UniCredit has taken the same steps.
Investors, however, appear to be a little more relaxed about the adjustments going on in the senior debt market.
In Europe, FIG bankers maintain that differences in acceleration rights have not been translated into differences in new issue pricing or trading levels within the secondary market. In the US, issuers have not seen even the smallest increase in funding costs since they revised the term sheets of their TLAC senior bonds at the end of last year.
Perhaps it makes sense that the buy-side should shrug off these changes. If regulators are going to make the big shift from “bail-outs” to “bail-ins”, putting creditors on the hook for losses rather than taxpayers, then something is going to have to give.
Market participants have had at least since 2010 to get comfortable with the idea that regulators could use senior bonds to absorb losses in a failing bank, and most will understand that having a crowd of senior bondholders demanding repayments would scupper any orderly wind-down or recapitalisation process.
Yet it is a little remarkable that investors have gone down without a fight, and without demanding even a single basis point of premium.
In losing the right to claim their money back if an issuer stops paying them, investors are losing a great deal of control over their investment — control that used to play a big part in defining the difference between senior and subordinated debt holdings. Where a security ranks in an insolvency is important too, of course, but such pecking orders only give you a place in a queue; they don’t tell you what kind of ticket you’ll have when you get to the door.
Part of the reason these recent shifts have been so seamless is because the financial institutions bond market has been issuer driven for quite some time now. Investors are keen to buy what’s being put in front of them because they want to pick up more returns. They are not stopping to quibble all that much about lost rights or additional risks.
But the slow reworking of acceleration rights within bank senior bond contracts should not be mistaken as an arcane or insignificant development. The process is a milestone in the transformation of the asset class. For that reason alone, these changes deserves scrutiny.