Trade recommendation from 2016

1. DEUTSCHE BANK CAPITAL STRUCTURE TRADE
• DB equity and AT1 markets are pricing bipolar outcomes.
• DB equity (Eur11.41) at 33.7% CET1 tangible book value
implies Common Equity Tier 1 (CET1) ratio at 3.93%.
• Capital shortage implies complete writedown of AT1s
(based on Jun18 interim financials)
• DB AT1 price implies only 25% write-down.
• For markets to converge, gap between equity and AT1
has to narrow

2. DEUTSCHE BANK CAPITAL STRUCTURE TRADE
• Trade idea:
– Short DB 6% AT1s at 75%
– Long DB equity at Eur11.41
– Suggested ratio of equity to AT1: 70%
– Based on equity price, writedown of AT1s and capital
raising of 30% of implied Tangible Book Value (TBV), CET1
would meet regulatory threshold of 5.125%
– Even with equity raise, DB will still trade 30% discount to
TBV. JPM trades at premium to TBV.

3. DEUTSCHE BANK CAPITAL STRUCTURE TRADE
• Scenario 1
– DB reduces leverage through asset reduction
• Likely outcome, rise in equity and AT1s. Equity likely to outperform due to 67%
discount to TBV
• Assuming AT1 pricing back to par, DB shares should rise to to close the gap to TBV
• Assuming it trades par to TBV, shares should trade at Eur33.8. (Note JPM trades at
premium)
• Gains on equity per Eur100 of AT1s = 0.7*75*33.8/11.41=Eur103
• Losses on AT1s = 25pts + carry cost of assumed 8% p.a.=Eur33
• Net Eur70
STATIC OUTCOME DRIVEN SCENARIOS

4. DEUTSCHE BANK CAPITAL STRUCTURE TRADE
• Scenario 2
– DB equity pricing capital condition correctly
• Likely outcome will be complete writedown of AT1s to zero, along with small raise
in equity to keep CET1 at 5.125%
• Assume 30% dilution for new capital raise
• AT1s likely to keep some residual for potential write-up. Assume 10pt recovery
• Losses on equity per Eur100 AT1 =0.7*75*0.30=Eur15.75
• Gains on AT1 =75-10 less 8% carry cost = Eur57.0
• Net Eur41.25

5. DEUTSCHE BANK CAPITAL STRUCTURE TRADE
• Scenario 3
– DB gets bailed in completely
• AT1s gets written down to zero and cancelled
• Equity gets written down to zero
• Losses on equity per Eur100 AT1s = 0.7*75= Eur52.5
• Gains on AT1s = 75 less 8% carry cost = Eur67.0
• Net gain = Eur14.5
• Scenario 4
– DB raises equity without writing down AT1s (very low prob)
• AT1s goes to par
• Equity diluted by 100% but goes to CET1 TBV
• Assume number of shares double.
• CET1 TBV per/share = Eur16.92
• Gains on shares = 0.7*75*16.92/11.41 = Eur77.8
• Losses on AT1s = 25 + carry cost of 8% = Eur33
• Net gain Eur44.85

6. DEUTSCHE BANK CAPITAL STRUCTURE TRADE
• Delta hedging: Proximity of AT1 price to theoretical
should define ratio.
• If AT1 price approach theoretical, ratio should fall
and vice versa.
• Suggested ratio is based on bipolar scenarios from
equity price and AT1 Price