Deutsche Bank was founded way back in 1870 in Berlin. The Bank was formed initially as a special Bank for foreign trade. Its statutes were adopted in 1870 and the same year on March they were granted a banking license by the Prussian government. The Bank is known as German Global Bank, it offers both financial and banking services and has its headquarters in Frankfurt. Currently, the bank is having more than 200,000 workers and has its presence in over 60countries globally. Back in 2009, it was globally the largest bank boasting of 21% share market. Deutsche Bank is the largest bank in German and statistics further reveals that in Europe, it is the largest financial institution in Europe. Since its establishment, the Bank has managed to endure two endure three depressions, two world wars and a German that seemed to be divided. Currently, the Bank has organized itself in different corporate regions namely;
Asset and wealth management
Corporate banking and securities
Non-core operation units
Global transaction banking
Private and business clients
Back in 2012, the bank rolled out its strategies that are aimed to address the challenges in the constantly changing environment. Further the strategiesare aimed at taking the opportunities that present themselves in the market. Despite these strategies that the Bank has laid down, it has continued to face serious challenges with the current one being a fall in its shares in the market and worries of default the contingent convertible bond that it has issued. The paper,therefore, seeks to analyze on what went wrong on the contingent convertible bond, how to fix the challenges, alternative policies that may be pursued and the rules that can be applied to prevent a repeat of the same.
What Went Wrong?
One of the main challenges that the Bank is currently facing is the ability to pay coupon payments of their contingent convertible bonds otherwise known as COCOS. Contingent convertible bonds are not the same as traditional bonds in that the possibility of the bondbeing converted into a contingent is very likely in a specified scenario. One of the scenarios could be when the price of the stock of the corporation exceeds a certain level in a given time duration. As opposed to other convertible bonds, Cocos are not required to be included in the corporations diluted EPS (earnings per share) up to the point that these bonds are appropriate for conversion. Additionally, it is also a form of capital that can be used by the regulators to reinforcement the finances of a bank in instances when the bank is experiencing financial problems. The Cocos are further different with the other forms of bonds since they are designed to be able to convert into shares if a pre-set activate is triggered to offer shock boost to the levels of capitals and reassure investors (Schulman &Allen 52). They have both features of debt and equity.They are aimed to actas mitigate between the shareholders as well as the bondholders in that who will lose first incase capital is lost. The bond gives a bank a go ahead to get ahold on the capital after thefirst repayment or to skip payment of interest coupon. They are at thetime referred to as subordinated securities because as they are subordinates of other securities and can only be paidfor other securities that are held by the issuer have been paid.
Since these bonds are designed in a way that they can absorb losses, they are same as equity securities as opposed to fixed income securities. If a corporation fails to meet a certain level of capital requirement as required by their regulator, the regulator can order the security to be converted. Investors in Coco when a company is undergoing tough times will encounter reduced payment of interest or receive nil interest. In instances where the regulator orders for the conversion of the bond, it increases the probability of the investor getting nothing in a case where the company goes bankrupt.
During the 2007-2008 market mayhem, the financial sector was experiencing serious problems especially the banking sector. Deutsche Bank was not an exception as it too had its share of problems same with other financial institutions. Since then it has continued to experience problems with its finances, a factor that has made it report losses in the few months. The problem with the bank has been traced to the Cocos. The bank issued the bond with a promise to pay the investors a fixed amount of interest at the end of a certainperiod. The bank issued about 5 USD billion worth of the Coco as it attempted to build acquired capital. The issuance was spread along four notes, that is, one was dominated in pounds, another dominated in Euros and two were dominated in U.S dollars. Upon issuance of the bond, the prices have since started going down as investors and investors are getting worried that they may not get the returns that they had anticipated from the bond.
Why It Went Wrong
As noted earlier, the financial sector has been experienced financial difficulties and especially the financial sector. Deutsche Bank has also had its share of these difficulties. These have led to a decrease in the value of its share as well as the price of it securities have also continued to decline. A combination of sagging global growth as well as low-interest rates in the markets has made it difficult for the Bank to earn enough money from its lending activities. Despite the bank having promised investors that it will make coupon payments, the level of earnings that it reported continued to worry investors. Upon assuring investors, the Bank reported a net loss of about 2.1 billion Euros, meaning that its revenue went down by about 15%.
Another factor that contributed to its financial problems leading to shrinking of its capital base was that the bank was subject to many regulations, market manipulation, and investigations into its dealings in mortgage securities. Due to these factors, the Bank had set aside approximately $ 5.5 billion for litigation and yet it was viewed not to be enough to bail the Bank out these problems. As these factors made the capital base of the Bank shrink, investors started getting worried whether the Bank will be in a position to pay for coupons. Investors worries were fueled by the fact that the coco bond is non-cumulative and the interest that is payable could be suspended at the sole discretion of the Bank that depended heavily on the capital level of the Bank, and it was now evident that the Banks capital was wanting. Coco is not the same as shares in that even if the bank defaults payment of dividends especially for the preference shares, they will accumulate and get paid on a later date. For coco bond, once interest payable is defaulted it will not be payable at a later date. Deutsche Bank is also enduring the thump on the impact of the general melancholy in the European debt markets. Taking into account Bloomberg information, high return corporate securities issuance in Europe is down about 78 percent as of late, according to guarantors fees. These burdens identify with European banks standpoint for 2016, which connections to development concerns, net premium edge concerns and nature of assets concerns.
The panic spread among all the investors and, as a result, it saw the price of the coco bond sliding down, and chances of default increased. Investors are progressively worried that feeble profit and a worldwide business sector defeat will make it tougher for banks to pay the interest on at any rate some of these securities, or to purchase them back as investors had hoped. The bonds permit banks to skip premium installments without defaulting, and they transform into value in times of anxiety. Deutsche Bank might battle to pay the interest on these securities one year from now. When the Bank noticed that the problems with the issuance of the coco bond were increasing, it decided to take advantage of the unfavorable market conditions to buy back the bond from the investors at a low price (Grundl 72). It can, therefore,be concluded that what went wrong with the coco bond were the financial difficulties that were being faced by the financial sector as well as the capital problem that Deutsche Bank was facing during that period.
How to Fix the Problem
The plan that Deutsche Bank has announced to fix the problem on the coco bond is through buying the bond back. The plan by the Bank is to buy a total of $5.4 billion. It will be spread over- $2 billion will be dollar denominated, and $3.4 will be denominated in Euro. The Bank can take advantage of the conditions in the market to lower its burden of debt at attractive prices. If the Bank manages to repurchase the debt from investors below the price that they had issued, they will end up realizing a profit from the sale. Additionally, the Bank can use its strong financial profile to offer liquidity to its investors. If the Bank manages to repurchase the bond at a lower price than it had issued, in the short run, it will hit own liquidity. Additionally, the profitability that will be realized will improve its statement of financial position in the long run. The benefits of repurchasing the bond will be realized in the future, but the Bank will be hoping that the market position changes to normal.
Deutsche and other European banks are gotten in a situation. Low rates on advances and negative yields on Government securities are pounding their overall revenues (in light of net interest edge the contrast between their loaning rate and their expense of raising assets). The arrangement would be to raise rates on credits. However, doing as such risks sending into bankruptcy and default their negligible borrowers. In the meantime, the pool of such peripheral borrowers is extending with each drop in oil costs and aggressive news from financial development front. So the enchantment potion of QE is currently conveying more harmfulness to the framework than good, but then, the framework requires the mixture to stream on to support itself.
Another alternative policy that the management can use is cutting on costs. Deutsche Bank can cut down on its costs in a bid to save on its expenditure. The cost savings will help the Bank in to increase its capital base as the costs that are saved in the form of finance can be reinvested in the business in more profitable activities. Some of the costs saving methods that can be adopted by Deutsche Bank include job cuts, effecting pay cuts on employees, reducing the amount of bonus that they are offering to its employees among other activities. Further, Deutsche Bank can opt for other forms of settling down the legal litigation as a way of avoiding the fine and penalties that are currently imposed on the Bank. Moreover, the Bank can elect to change its management team or reshuffle them to these legal litigations in an amicable way so as to avoid the harsh court processes. Further, Deutsche Bank can elect not to pay dividends the current year as well as the following year so that they can be able to retain such capital that in turn will help in strengthening its finances as well as increasing the capital base. The Bank can further opt to dispose of some of its non-performing s...
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