Depfa Funding PLC II, II, IV – Liability management or blackmailing ?

Disclosure: author might own one or several securities mentioned, The discussed securities are illiquid and very risky.

Last year, I introduced Depfa Plc, the subsidiary of the Bank formerly called Hypo Real Estate already and started a position in LT2 bonds.



Just a quick refresher:

Hypo Real Estate was one of the first victims of the financial crisis and was fully nationalised in 2009. At that point in time, “burden sharing” was not yet on the agenda, so both, equity holders got still some money and subordinated debt holders only suffered a loss of coupons for some of the lower tier bonds. All of the bad stuff was transferred into a Government sponsored bag bank (FMS).

The Irish subsidiary DEPFA Plc (which was bought by Hypo Real Estate with perfect timing in 2007), has issued a series of deeply subordinated non-cumulative perpetual bonds via their “Depfa Fúnding” vehicles, namely:

Depfa Funding II (ISIN XS0178243332, issued 2003, Call 2013, Coupon 6.5%, Volume EUR 400 mn)
Depfa Funding III (ISIN DE000A0E5U85, issued 2005, Call 2013, Volume EUR 300 mn)
Depfa Funding IV (ISIN XS0291655727, issued 2007, call 2017, volume EUR 500 mn)

Those bonds stopped paying coupons in 2009.

End of November they came out with a “slightly controversial” liability exercise which basically offers to pay back the bond at 29% of nominal +1% “consent fee” if the holder agrees to change the bond conditions. Among other, Depfa wants to remove most of the bond covenants (dividend stopper, capital stopper etc. ) and change the official redemption amount from 100% to 29%.

Overall, this doesn’t look like a great deal at all, considering that the bonds actually traded up to mid thirties before,

The big questions are:: Why should one actually give consent and why are they doing it this way ?

There is a good thread with some posts (German language) at the Bondboard, especially one link to an IFR article.

The article lists a couple of points which were new to me:

- only a third of the bondholders have to be present (compared to 75% under German law) as this is governed by UK law
- a simple majority of this third (so ~17% of total bondholders) are enough to make the proposal effective

Interestingly, in the interbank market, both for Depfa II and Depfa IV, the banks quote significantly higher prices than the offer (~31.5%-32%).Only for the Depfa III, both in the OTC and in the public market, trades are made at 29%. So the “market” thinks that the Depfa III quorum might succeed, but nor for Depfa II and Depfa IV.

Based on current market prices, it doesn’t seem to make sense to consent to the offer for Depfa II and IV, but rather to actively oppose..

Why does DEPFA make the offer now and why at such a low price ?

In my opinion, the exercise is not driven directly by regulatory pressure. Rather, Ex Hypo Real Estate had committed in spring this year to divest Depfa at some point in time. It is highly unlikely that any bank would buy Depfa, the “target audience” would most likely be some credit hedge fund. However, they would not want a structure, where you can not dividend out anything because you have more than 1 bn EUR of sub bonds sitting there, preventing the owner to distribute dividends.

This could most likely be the first step trying to make Depfa “sellable”. I guess Depfa knows that most investors will not accept the first offer. . So that’s why i think they came out with such a low offer, which should make the investor nervous and prepare them for a second offer which then might be the “real offer”.

So far in such situations (Draeger, HT!, Bertelsmann, it always paid to stay calm and not jump at the first offer from an investor side.

So I am quite tempted to add the Depfa II and / or Depfa IV to the portfolio as a smaller “special situation” investment.. Even Depfa III could be interesting.

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