Eating your own Coco February 11, 2014 at 11:12 pm

Dealbreaker catches a deeply amusing story from the WSJ:

banks including the U.K.’s Barclays PLC, Germany’s Deutsche Bank AG and Switzerland’s UBS AG could shore up their U.S. subsidiaries… the U.S. units would issue to their parents a type of bond that converts into equity if the U.S. business’s capital falls below a certain level… The European parent companies would finance the purchases of their subsidiaries’ debt by issuing bonds to investors, these people say.

Coco double leverage: very cool. But not very chocolatey, sadly. You can call it an internal convertible if you must. I’m gonna call it something else…

7 Responses to “Eating your own Coco”

  1. This isn’t double leverage at all. It’s just the normal business of transferring capital round a group by issuing internal securities – if this is “double leverage” then we’d better learn to like it because the SPE resolvability model involves doing it on massive scale.

    The alternative solution would be for the US units to issue equity directly to head office; issuing CoCo instead almost certainly saves some tax consequences but has little economic effect because the CoCo turns into equity in all possible circumstances under which anyone might care about equity in the subsidiary. In either case it’s a deduction from parent company CET1 so who cares?

    The article also repeats the old canard that Deutsche Bank “has operated with nearly zero capital” in the USA, which anyone saying it out loud ought to realise can’t possibly have been true.

  2. I was just about to try to link to the Dealbreaker article…

    Hilarious…..

    1. These instruments – in all variations imaginable – are accepted, if so lesser as capital, by many EU Banking regulators.
    2. And if you seriously questioning these and similar….. Quote: “You are not commercial enough.” :-)

  3. Of course it is double leverage: you are creating an equity like thing in the sub funded by straight debt from the parent. It would only not be double leverage if you funded it with something as junior or more junior than it.

    The ‘DB had little equity in the US’ thing is, on its face, true. The US sub did have wafer thin equity. The issue is why. If the parent has enough equity to support all of its subs, why didn’t it put a decent amount of capital into Taunus? (There are plausible answers to that question, I freely admit, like tax.)

  4. Actually, Taunus for years had negative CET, allowable from a Fed exemption when they bought Bankers Trust in distress. This was back when central bankers trusted each other, and when, if DB US had a problem the US would pick up the phone and call Frankfurt.

    LBIE changed the whole dynamic.

  5. Here is a link to a Taunus BHC Performance report – look at the ratios on pages 2 and 14
    http://www.ffiec.gov/nicpubweb/NICDataCache/BHCPR/BHCPR_2816906_20111231.PDF

  6. you are creating an equity like thing in the sub funded by straight debt from the parent. It would only not be double leverage if you funded it with something as junior or more junior than it.

    But this is exactly what would happen; at the level of Deutsche AG Frankfurt, the holdings of (AT1, CoCo or equity) in DB US Holdings Inc would be a deduction from CET1. It’s fundamental to the transaction that it would have to a) leave the consolidated regulatory capital unchanged b) increase the subsidiary capital, c) decrease the parent capital. That’s the transaction that the banks are talking about and it is really worrying that the WSJ has described it so confusingly as to make anyone think it’s otherwise (in particular, “would fund by issuing bonds to investors” is clearly wrong, as there is no cash transaction that takes place at all here – the securities are created by converting intragroup debt).

    The ‘DB had little equity in the US’ thing is, on its face, true

    The statement was “operated with” and the difference matters. DB Securities Inc has always been overcapitalised and is an operating company. DB Trust Company of the Americas, ditto. Putting a non-operating holding company with a lot of goodwill in it as an intermediate step between them and DB AG Frankfurt doesn’t change that picture.

  7. Carter – thank you, useful background.

    dsquared – I’ve lost track of the precise state of the CRD IV deduction rules, but your `at the level of Deutsche AG Frankfurt, the holdings of (AT1, CoCo or equity) in DB US Holdings Inc would be a deduction from CET1′ seems very likely right. If that’s true, then the post’s ‘parent companies would finance the purchases of their subsidiaries’ debt by issuing bonds to investors’ doesn’t matter: they might as well have funded it with equity. So yes, I agree, if the Coco is a CET1 full deduction at the parent, all is well. What I didn’t know was your c).

    I am more puzzled by the fuss over Taunus, though. If the operating companies were well-capitalised – and I have no reason to believe they weren’t – why did DB let so much flack be fired at it? Carter’s right, having negative CET1 is embarrassing and if DB weren’t capital constrained in the US, why did they let the negative PR accumulate rather than introducing a new, decently capitalised US holding company? Or was it just a tax gig?