Preferred senior puts German banks in preferable position

Berlin Hyp, Commerzbank and Deutsche Bank opened the market for German preferred senior unsecured debt – in that order – in the week of August 20, generating EUR 7.28bn of reported aggregate investor demand for EUR 3.05bn of supply. Spread differentials between cheaper senior preferred debt and non-preferred debt emerged in line with other markets. German banks are coming to the preferred senior market backwards-on relative to banks in other European jurisdictions. Their task is to build a preferred senior debt stack sitting on top of outstanding senior debt (which is statutorily subordinated in insolvency or resolution and TLAC/MREL eligible) and new senior non-preferred debt, which is now available as an option.

In the case of other European jurisdictions, the task was the opposite. Banks in a growing universe of countries have been actively building a stack of senior non-preferred debt sitting between their Tier 2 capital and existing senior unsecured lines.

Jurisdictions such as France, Italy, Spain, Austria and Belgium have already incorporated a new class of senior non-preferred debt into their national insolvency laws. By 29 December 2018 all Member States are expected to follow as required by EU Directive 2017/2399.

On July 27, Scope Ratings positioned Deutsche Bank’s preferred senior-equivalent debt ratings at the level of the Issuer Rating: BBB+ (with Negative Outlook) i.e. one notch above non-preferred senior. On July 26, Scope similarly positioned Commerzbank’s preferred senior-equivalent debt ratings at the Issuer Rating level of A (Stable Outlook).

“The level of these ratings matches our approach taken for the other EU banks and derives from the way we have reflected their evolving capital structure in our bank rating methodology,” said Chiara Romano, senior bank analyst at Scope.

In terms of price discovery, the preferred/non-preferred spread differential in other jurisdictions offered a wealth of indications for the German issuers. Against estimated non-preferred spread levels at the time Commerzbank’s preferred seniors were pricing, the trade gave the bank a funding advantage of 30bp-35bp for its five-year tranche and in the region of 45bp-50bp for the 10-year tranche. The bank raised EUR 1.75bn in total.

Deutsche Bank created a saving in the region of 55bp for its EUR 1bn five-year, at the same time as offering a significant spread pick-up to Commerzbank, albeit for a lower-rated and more volatile credit. Those levels are generally around the same as those for banks in other countries.

“With Germany initially opting for a statutory subordination regime, the banks hands were tied between issuing riskier senior unsecured debt or relatively more complex notes (i.e. with payment contingent upon future events) excluded from subordination,”. Romano added.

For some time, this implied comparatively higher borrowing costs, but in light of the changed approach, German banks have been gifted with sizeable MREL/TLAC cushions.

As of YE 2017, Commerzbank had a 4% buffer, including IFRS 9 effects, on its MREL requirement, corresponding to an estimated EUR 6.7bn. Deutsche Bank calculated its MREL/TLAC stack to be EUR 19bn above its MREL requirement and EUR 40bn above the 2019 transitional TLAC requirements (leverage based, which is the most stringent) as of H1 2018. Translated into RWAs, Scope estimates DB’s buffer on its MREL requirement to be 5% (or EUR 17.2bn).

Given Deutsche Bank’s TLAC and MREL surpluses, there is a lot of consideration around potential liability management exercises that would replace de facto senior non-preferred debt with cheaper preferred senior in order to lower overall group funding costs.

Group treasurer Dixit Joshi had pre-empted issuance of senior preferred debt on Deutsche Bank’s Q2 2018 fixed-income call on July 27: “We very much look forward to getting engaged and opening up that market, and certainly using that instrument as part of our toolkit. It will result in a funding cost reduction and funding cost benefit to us, so it’s something that we look to use in the near term,” he had said.