October 25, 2016

Deutsche Bank asked to pay $14bn in US probe

Deutsche Bank shares fell sharply on Thursday as Germany’s biggest bank scrambled to downplay the chances of paying $14bn to settle allegations of mis-selling mortgage securities after receiving an unexpectedly large claim from the US Department of Justice.

New York-listed shares in Deutsche fell as much as 7.4 per cent after hours to $13.67. Investors fretted about the crippling impact of such a fine on a bank with a market capitalisation of only €18bn but a balance sheet of €1.6tn that rivals most in the sector.

In a statement, Deutsche insisted it had no intention of settling the claims for anything like the $14bn figure, which was first reported by the Wall Street Journal. “Deutsche Bank has no intent to settle these potential civil claims anywhere near the number cited,” it said.

“The negotiations are only just beginning. The bank expects that they will lead to an outcome similar to those of peer banks which have settled at materially lower amounts.”

Insiders at Deutsche hope that it will be treated in a similar fashion to Goldman Sachs, which faced an initial $15bn claim from the DoJ to settle its alleged mortgage security mis-selling, but ended up paying close to $5bn earlier this year.

Coming only days after the EU stirred up angry reactions from US politicians by ordering Apple to pay €13bn of back taxes in Ireland, there is a strong suspicion in financial circles that Deutsche could be the victim of the US taking revenge on Europe.

The development, which comes eight years ago almost to the day since the collapse of Lehman Brothers, is another reminder of how banks are still grappling with the regulatory fallout from the financial crisis.

The International Monetary Fund said this year that, among globally significant banks, Deutsche “appears to be the most important net contributor to systemic risks”.

Deutsche, which has lost half of its market value in the past year after reporting a heavy loss for 2015, is one of the most weakly capitalised banks in Europe and is widely expected to launch a rights issue once it has resolved its major legal issues.

Although the final settlement has yet to be determined, the disclosure of the DoJ’s $14bn proposal prompted immediate concerns about how Deutsche would cope with such a huge penalty, especially given its already shaky finances.

Simon Herrmann, an analyst of Deutsche at the stock market research group Wise-owl.com in Sydney, agreed that the DoJ tended to make a “traditionally high” opening bid for a settlement.

“I doubt that the final amount will be $14bn . . . and it is yet unclear how much of this fine will be payable in actual cash.”

However, he added: “Deutsche’s financial situation and reputation has worsened since the financial crisis and a $14bn settlement claim would have a severe impact, even though the bank has set aside money for mortgage investigations as part of their broader legal provisions.”

Deutsche has built up a reserve of €5.4bn to deal with its legal woes, although it is unclear how much of that is earmarked for the US mortgage securities probe.

Since he took over last year, John Cryan, Deutsche’s British chief executive, has said that he wants to resolve its big outstanding legal cases as soon as possible. But it had counted on a settlement of about €2.4bn for the US mortgage securities case. It is also being investigated by several regulators around the world for $10bn of suspicious trades at its Russian operation.

A person familiar with the bank’s negotiations with the DoJ predicted there would be a fierce backlash on Friday once politicians and regulators in Berlin and Frankfurt learned of the $14bn initial claim from the DoJ.

While some banks have paid vast sums to settle allegations of mis-selling mortgage securities before the 2008 financial crisis, topped by the record $16.65bn settlement with the DoJ by Bank of America in 2014, few had predicted Deutsche would face such a large initial claim.

The DoJ declined to comment.

With the US closing in on a fiercely contested presidential election between Donald Trump and Hillary Clinton in November, the size of Deutsche’s settlement risks becoming a political football that ends up bearing little relation to the size of penalties paid by other banks.

It is the latest setback for Deutsche in the US. The German bank has made few friends in Washington after a string of controversies.

This summer a US arm of the German lender, Deutsche Bank Trust Corporation, failed the Federal Reserve’s stress tests for a second successive year. It was one of only two among the 33 banks that failed outright this year.

The bank was also fined $55m by the Securities and Exchange Commission for understating the risks to the bank in the crisis.

The claim against Deutsche risks repeating the political controversy that erupted in France after BNP Paribas was fined $8.9bn in 2014 for breaching US sanctions in countries such as Sudan. However, BNP was able to absorb that penalty without raising capital or cutting its dividend.

Deutsche, which has already suspended its dividend for two years after making a €6.8bn loss last year, is in a far weaker position than BNP was at the time.

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