As reported last night, things for Germany's largest, and most troubled lender, Deutsche Bank went from bad to worse when just a few weeks after the EU slapped Apple with a $14 billion bill for "back taxes," the U.S. Department of Justice responded in kind with a $14 billion fine of its own to Deutsche Bank to settle an outstanding probe into the company's trading of mortgage-backed securities during the financial crisis. Making matters hostile, in a statement on Friday morning, the German bank's CEO rejected the opening settlement claim and said that he “has no intent to settle these potential civil claims anywhere near the number cited", adding that “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."
Maybe, but the market is not so sure, and after opening for trading minutes ago, Deutsche Bank stock tanked a whopping 8% on news of the DOJ's $14 billion proposed settlement, once again approaching its all time lows.
Putting the settlement in context, BofA paid $17 billion to reach a settlement in a similar case in 2014, while Goldman agreed to a $5.1 billion settlement with the U.S. earlier this year, including a $2.4 billion civil penalty and $875 million in cash payments, to resolve U.S. allegations that it failed to properly vet mortgage-backed securities before selling them to investors as high-quality debt. The settlement included an admission of wrongdoing.
As Bloomberg reports, the bank confirmed that it had started negotiations with the Justice Department to settle civil claims. The $14 billion is considered an “opening bid” that could go “much lower,” according to the Wall Street Journal. On the other hand, in light of the recent European hostility involving AAPL shares, the DOJ may be unwilling to budge. Which is why the final settlement amount is now so critical: according to a JPM calculation, a settlement of about $2.4 billion “would be taken very positively,” and that an agreement exceeding $4 billion would pose questions about the bank’s capital positions and force it to “build additional litigation reserves.”
Others on the sellside are less sanguine: “Overall it’s very negative for the share price if you look at the Justice Department figure but you don’t know where it will end up,” said Andreas Plaesier, an analyst at Warburg Research told Bloomberg. “If you come down to the Goldman amount they may not need to do much in terms of reserves.”
Goldman concluded, laconically, that the settlement news was "negative", noting the following:
- On September 9, Manager Magazin reported DBK was close to a settlement with the DoJ and that the amount could exceed US$2.4bn
- It is unclear if the amount referenced includes consumer relief in addition to monetary payments. The highest RMBS-related monetary payment to the DoJ thus far was US$5bn (by BofA).
- DBK’s total on balance sheet litigation reserves stood at €5.5bn as of 2Q16; this includes provisions for all outstanding litigation, most notably RMBS and the Russian equities matter;
- Management stated with 2Q results that it aims to settle major outstanding litigation items (including RMBS and Russia) by year end.
- Deutsche Bank stated in its 2Q16 report that it has “received subpoenas and requests for information from certain regulators and government entities, including members of the Residential Mortgage-Backed Securities Working Group”. The DoJ is not the only member of the RMBS Working Group (see Ex. 1); DBK has already settled with the FHFA for US$1.9bn.
The implications, according to Goldman are that while DB shares reacted positively to the Manager Magazin report of September 9, ending the day +4%, Goldman there expects "a negative reaction to these
latest developments. That said, we stress that the end settlement figure remains unclear and we do not take a view on the final outcome. From a read-across perspective we expect the shares of European IBs which are yet to settle the RMBS issues (CS, UBS, BARC and RBS) to be impacted today."
Deutsche Bank Chief Executive Officer John Cryan, 55, has struggled to boost profitability as unresolved legal probes and claims compound concerns that the lender will be forced to raise capital or sell assets. Reaching a mortgage deal would clear a major hurdle for the bank, which has paid more than $9 billion in fines and settlements since the start of 2008.
“In defense of protecting its shareholders’ money, Cryan is well within his rights in negotiating a more equitable and just settlement with the U.S. government, and calling this one a punishment that’s several orders of magnitude greater than the crime,” said Tony Plath, a finance professor at the University of North Carolina. Plath expects a final settlement of about $4 billion to $5 billion.
It remains to be seen if the US is willing to entertain such a lowball counteroffer, especially now that US corporations are used as taxable piggybanks by Europe.