S&P could downgrade more CoCo bonds

Deutsche Bank branch, Hamburg
Deutsche Bank's bonds and shares were hardest hit by the turmoil in markets, prompting the bank to prove its financial strength by spending almost €5bn on a bond buyback Credit: © 2016 Bloomberg Finance LP

More banks could see their contingent convertible (CoCo) bonds downgraded, Standard and Poor's has warned, a week after Deutsche Bank's bonds were targeted by the credit ratings agency.

The price of the risky bonds has crashed by as much as 25pc in recent weeks as a wave of fear swept the market, with investors panicking that Deutsche Bank could struggle to pay the interest coupon on the bonds.

The bank insisted that it has plenty of liquidity available to service its debts and bought back almost €5bn (£3.9bn) of senior bonds to illustrate the point. Since then Deutsche Bank's CoCos have shown some signs of rebounding.

Standard and Poor's said it is analysing more of the bonds across the market, and could choose to downgrade them, too.

"Our ratings are under constant survellience. [The Deutsche downgrade is] not the end of the story, there are quite a few points yet that need to be clarified with additional disclosure from the banks," said S&P's Alexandre Birry.

"We will have to reflect all this new information as it comes to light and see if in some cases there could be a case to widen notching. The risks around coupon deferral seems to be clearer to markets in the current environment. We will continuously try to reflect this new information."

CoCos, classed as AT1 securities, are bonds that are designed to prop up banks if they get into financial trouble, and to make sure that investors contribute to supporting lenders.

The biggest risk is that banks' capital buffers fall below a set level - typically 7pc of assets - this will convert the bonds either into shares or wiping them out altogether.

Deutsche Bank's chief executive John Cryan told staff and customers that the bank is "rock solid"

The less severe - but more likely - outcome is that banks can suspend the interest payments on the bonds, just as they can suspend dividends for shareholders, typically when profits have crashed or the bank is making losses.

CoCos pay a higher interest rate than other bonds to reflect the higher risks being taken by investors. That attracted investors into the novel securities, with wealthy clients of private banks thought to be among the bigger buyers of the bonds.

Retail investors are not able to buy the bonds directly, as regulators ruled that CoCos are too complex for unsophisticated investors to purchase.

However, it is also difficult for many traditional debt and equity funds to buy into the instruments, as CoCos have some qualities of both bonds and shares meaning they do not fall neatly into either such fund's investment brief.