DOJ SETTLEMENT

Deutsche Bank in New Existential Crisis

Dunkle Wolken sind am 20.05.2015 über der Zentrale der Deutschen Bank in Frankfurt am Main (Hessen) aufgezogen. Für den 21.05.2015 hat die einzige deutsche Bank von Weltrang ihre Aktionäre zur Hauptversammlung eingeladen. Foto: Arne Dedert/dpa [ Rechtehinweis: (c) dpa ]
Deutsche Bank could be forced to sell new shares or parts of its business at discount prices, or be forced to accept a state bailout, if the bank has to pay a $14 billion penalty to U.S. regulators for mortgage improprieties, analysts say.
  • Why it matters

    Why it matters

    The U.S. government’s $14-billion demand to Deutsche Bank for mortgage improprieties could force Germany’s largest bank into a new existential crisis.

  • Facts

    Facts

    • The U.S. Department of Justice is demanding Deutsche Bank pay $14 billion to settle a case involving the sale of mortgage-backed securities during the financial crisis.
    • Other U.S. banks involved in mortgage improprieties were able to negotiate lower similar initial demands in the final settlement, but there is no guarantee Deutsche Bank, as a foreign bank, can do so.
    • News of the settlement demand sent Deutsche Bank’s shares down 8.5 percent on Friday.
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    Audio

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German government officials are dismayed by the leaking of a U.S. Justice Department demand that Deutsche Bank pay $14 billion to settle claims arising from sales of mortgage-backed securities during the financial crisis.

The subject was discussed, Handelsblatt has learned, during a Friday meeting of the Financial Stability Council — a body that includes representatives of the German finance ministry, central bank, and finance regulator BaFin.

The focus of officials’ anger was less the amount itself — everyone thinks it will eventually be reduced — than the leaking of details so early in the settlement negotiation process. Publication of the claim, it was felt, would only make talks more difficult for Deutsche Bank.

Settlement negotiations are normally conducted in confidence, with details only emerging when talks are at an advanced stage. Not this time: Late last Thursday, a well-positioned source leaked details of the Justice Department claim to the Wall Street Journal, according to the newspaper.

The disclosure of the demand, the equivalent of €12.5 billion, had an immediate impact, again throwing the bank into what appears to be a new existential crisis.

Discussion of Deutsche Bank’s shaky capitalization has burst back to life, with renewed speculation on whether Chief Executive John Cryan will be forced to raise new capital, which he had previously ruled out, or make emergency asset sales.

Some have even raised the possibility of a government bailout of Germany’s largest bank, which would be a defining event and a symbolic blow to the image of Europe’s largest economy.

“Deutsche Bank will not be able to pay this fine without raising new capital” was the blunt verdict of Clemens Fuest, the president of the Ifo Institute for Economic Research, one of the country’s leading think tanks.

On Friday, Deutsche shares plummeted 8.5 percent, wiping €1.5 billion off its market value.

“Deutsche Bank will not be able to pay this fine without raising new capital.”

Clemens Fuest, president, Ifo Institute for Economic Research

The bank’s public reaction was swift and decisive. In a statement issued the same night details were leaked, Deutsche said it had “no intent to settle these potential civil claims anywhere near the number cited.”

The bank emphasized the process was at an early stage and that it expected “an outcome similar to those of peer banks which have settled at materially lower amounts.” Analysts and Germany’s finance ministry made similar comments.

Unfortunately, Deutsche Bank has little leeway for nasty surprises.

Its capital ratio, even taking into account the imminent sale of a Chinese subsidiary, is at 11.3 percent. But so far the bank has only made a provision of €5.5 billion for legal settlements.

Finance industry sources said only €2 to €3 billion of this was earmarked for the bank’s U.S. mortgage difficulties, not an amount 4-5 times greater. Every billion beyond that figure will cut 0.25 percentage points off the bank’s capital ratio.

If the bank ends up paying the full €12.5 billion, its capital ratio will drop below 9 percent. Neither financial regulators nor the markets would regard this as acceptable for a major financial institution. In fact, regulators have set the bank a target of 12.25 percent by 2019. The inevitable consequence of such a substantial fall would be to raise capital through share sales or emergency asset sales.

But even with a lower fine, it is possible the bank will need some form of capital injection. Mortgage misconduct is far from the only legal scandal the bank faces, and no one knows for sure what its ultimate liabilities will be.

A money laundering scandal in Russia could bring another €1.5 billion in fines, with further heavy hits looming, thanks to alleged currency manipulation and sanctions busting. Analysts think the total settlement costs may amount to at least another €3.3 billion.

 

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Finding the money for this will be no simple task. Not only is the bank’s capital ratio at the lower limit, but its profitability has also been badly damaged over the past year.

“For Deutsche Bank, the German market offers fewer earning opportunities. It is harder for them to pay off fines like this than it is for U.S. banks,” said Hans-Peter Burghof, a professor of banking at Hohenheim University. Last year the bank recorded a record loss; this year earnings are limping badly.

Many analysts fear the bank may be in a vicious circle, with losses and cancelled dividends pushing down share prices and preventing the rebuilding of a capital buffer.

One thing is clear. With this many unresolved legal issues, any recapitalization is likely to mean selling new shares at knock-down prices. One bright spot for the bank may be ongoing negotiations with finance company Phoenix Group for the sale of Abbey Life, its British insurance subsidiary.

Phoenix recently confirmed talks were at an advanced stage. Any sale would bring €1 billion into Deutsche Bank’s coffers – a welcome sum, but not enough to solve the bank’s problems.

With a general election looming, state help for Deutsche Bank is the last thing the government wants.

So could a state bailout for Deutsche Bank be needed? With next year’s general election looming, and the populist Alternative for Germany party rising in the polls, this would be the last thing the German government wants.

But there is no panic in the federal finance ministry as yet. In the past, American banks have been confronted with similarly breathtakingly initial settlement demands, only to see them radically reduced in the final deal.

Unfortunately, Deutsche Bank may not be so lucky. Even if theories are discounted that the $14-billion charge is payback for European tax demands on Apple, the German bank may face tough treatment in the United States.

The previous settlements referred to by analysts were all made with domestic American institutions, not with foreign banks.

 

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“There are studies that show that the American legal system discriminates against foreign companies,” said Mr. Burghof, the finance professor. A 2006 study by Hong Kong researcher Utpal Bhattacharya shows that foreign companies lose more frequently in American courts, and they are hit with higher fines than their domestic American counterparts.

However, the German government is unlikely to interfere with the American judicial process. “We will not get involved” was the clear message from the finance ministry.

With good reason: Not long ago, French President François Hollande weighed in on behalf of BNP Paribas, then enmeshed in U.S. court proceedings. The intervention appears to have backfired: Soon after, the French bank was hit with a record American fine for sanctions-busting.

 

Jan Hildebrand leads Handelsblatt’s financial policy coverage from Berlin. Yasmin Osman is a financial editor with Handelsblatt’s banking team in Frankfurt. Daniel Schäfer is head of Handelsblatt’s finance pages and based in Frankfurt. Sven Afhüppe is the editor in chief of Handelsblatt. To contact the authors: hildebrand@handelsblatt.com, osman@handelsblatt.com, d.schaefer@handelsblatt.com, afhueppe@handelsblatt.com.

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