Commerzbank AG looking to issue Tier 2 SGD bonds

What's happening?

Commerzbank AG, Germany's second largest bank by market cap (EUR 9.3b as of 21 Feb 17), is looking to issue Tier 2 SGD bonds - these are likely to be 10-year bonds which will be callable after 5 years. If launched, the new bonds will be the first SGD-denominated Basel III compliant issue by Commerzbank AG, and are expected to be rated investment-grade (BBB-/BBB by S&P/Fitch). This comes on the back of a SGD Tier 2 bond issue by UOB Ltd priced earlier this week ( UOBSP 3.500% 27Feb2029 Corp (SGD)), possibly marking the start of a busy year for subordinated bank debt issuance in the SGD bond market. We highlight some things investors should know about the upcoming bonds and provide our comments on potential pricing.

Well-capitalized bank despite recent weaker headline profitability

Commerzbank recently reported a weaker set of financial results due to a lacklustre operating environment within Europe, with a net profit of EUR 279m for FY16 compared to EUR 1.084b in FY15. Despite that, we note that the bank remains well-capitalised compared to its peers such as Deutche Bank, reporting a fully phased-in Common Equity Tier 1 (CET1) ratio to risk-weighted assets of 12.3% as of end-Dec 16 (by contrast, Deutche Bank, Germany's largest bank by market cap, reported a CET1 ratio of 11.9%), and well above regulatory minimum of 8.5% required by ECB banking provisions. Additionally, it reported a leverage ratio of 4.8% (Tier 1 capital/total exposure) which is well in access of 3% required by Basel III. Investors may also note that the German government owns 15% of Commerzbank.

About the new Tier 2 bonds

In an investor roadshow held today, the Commerzbank's management stated while the bank's has already fully met its funding needs, its intention to issue new SGD-denominated bonds is to diversify its liability base as well as to diversify its investor base away from Europe-based investors to include institutional investors in Asia.

Investors should note that these new bonds will qualify as Basel III-compliant Tier 2 capital, and hence are subordinated bonds which will contain bail-in provisions in an event of "non-viability" – mandatory loss absorption features which entails a permanent full or partial write-down on the principal should the local regulator (in this case, Germany's Federal Agency for Financial Market Stabilisation "FMSA") decide that the bank faces a going-concern issue or a public sector injection of funds is needed to keep the bank afloat. However, any write-down on these Tier 2 instruments will only occur after all outstanding Additional Tier 1 (AT1) debt have been written off or converted to equity.

The upcoming bonds are likely to have a 10NC5 structure; a 10-year tenor bond which will be callable after 5 years. While investors may be put off by the 10-year tenor, Commerzbank's management indicated that the issuer has a strong incentive to call the issue on the fifth year as a portion of the debt will be amortised and will not recognised as Tier 2 debt upon a non-call. Interest rate risk is also mitigated by the coupon reset (in the event of a non-call) – the reset is expected to be based on the prevailing 5Y SGD SOR rate (plus the initial spread), which effectively means investors will be exposed to 5Y interest rate risk (rather than 10-year risk).

Comments on potential pricing

In evaluating the potential pricing on this new Tier 2 10NC5 bond issue, we may look at outstanding SGD-denominated 10NC5 issues by European banks. We note that there are four investment-grade rated SGD 10NC5 bonds outstanding (See Table 1), trading at YTC of 3.46% – 4.24% and sporting spreads of 148 – 216bps. However, we note that the expected ratings of Commerzbank's upcoming bonds will be 1-2 notches below the instrument ratings of the outstanding SGD T2s, which will entail a more generous yield.

Table 1: Outstanding SGD 10NC5 Tier 2 Bonds