When two weeks ago the DOJ announced a far larger than expected $14 billion settlement demand from Deutsche Bank, one which if left unrevised would would leave Deutsche Bank short of billions in capital, has since triggered the latest episode of European bank selling and potential contagion, some wondered if there was an element of punitive retaliation aimed at Europe's "assault" on Apple's taxes. That question will surely grow louder when overnight Bloomberg reported that the DOJ is now assessing "how big a criminal fine it can extract from Volkswagen AG over emissions-cheating without putting the German carmaker out of business."
Volkswagen stock promptly dropped over 3% on the news and was down 2.5% as of the latest refresh.
The government and Volkswagen are trying to reach a settlement by January, Bloomberg reported, before a new U.S. administration comes into office and replaces the political appointees who have been overseeing the process. In criminal prosecutions, the Justice Department may assess the impact of a charge or settlement on a business’s viability, and the resulting effect on shareholders and employees. A prosecution’s potential collateral damage is one of the factors the department considers under principles for prosecuting businesses laid out in the “U.S. Attorney’s Manual.”
Bloomberg adds that while in the DB case the penalty may have been overly demanding, as the U.S.’s Volkswagen calculations show, the department is showing that in some cases, it will take a company’s financial health into account. That said, it’s not clear what penalty range the U.S. is considering in the criminal case against Volkswagen. The company had net liquidity of 28.8 billion euros ($32.4 billion) as of June 30, and Chief Financial Officer Frank Witter said his goal is to keep the target for average net liquidity at 20 billion euros to ensure funding needs and protect the company’s credit rating. The carmaker generates several billions of dollars of cash each quarter and could tap into a credit line or raise capital if necessary to pay its obligations.
Volkswagen has already agreed to pay an industry-record $16.5 billion in civil litigation fines in the U.S. after admitting last year that its diesel cars were outfitted with a “defeat device” that allowed them to game U.S. environmental tests. The carmaker is also on the hook for outstanding civil claims from several states and as much as $9.2 billion in investor lawsuits in Germany, where it’s also under criminal investigation.
“The department doesn’t pick a number in a complete vacuum," said William Stellmach, a former federal prosecutor now at Willkie Farr & Gallagher LLP in Washington. "There are a number of cases where it has acknowledged that the impact of a financial penalty on a company was a factor in deciding what that penalty should be.
Nonetheless, the ability-to pay assessment doesn’t necessarily result in a lower number, according to Stellmach, who isn’t involved in the VW case. Rather, the department can structure an agreement to soften some of the sting, such as an installment plan allowing for deferred payments, he said. Companies can also receive credit for penalties assessed by other regulators or authorities both in the U.S. and abroad.
The good news for Volkswagen is that the automaker, and one of Germany's largest employers, has plenty of money to meet further fines, particularly because penalties tend to be paid over long time periods, according to Joel Levington, a Bloomberg Intelligence credit analyst. "Despite all the damage that its reputation has taken, VW is still a company that might be back to generating $5 billion in free cash flow in 2018, and when you generate that kind of cash, it absolves a lot of sins," he said. The Justice Department began negotiations on the criminal penalty in August, one person said.
Bloomberg points out an interesting tangent about Volkswagen's financing unit: "Volkswagen, like most carmakers, also has a financing unit, which offers buyers loans or lease packages when they are ready to buy their cars at a dealership. Should the company’s cash level fall too low, it could spark ratings downgrades by credit agencies, which risks increasing the costs of that unit."
Standard & Poor’s Ratings Services said in a note in February that it would consider lowering the carmaker’s rating only if its litigation costs exceeded 40 billion euros ($45 billion) or if its legal costs caused a severe negative impact on the company’s liquidity position, a scenario it considers unlikely. By that measure, after U.S. civil penalties and accounting for maximum damages in German lawsuits, the company would still have a cushion of about $20 billion to absorb other litigation and investigation-related expenses.
Volkswagen is currently rated BBB-plus by S&P, three levels above junk. S&P has warned that it may cut Volkswagen’s rating further. “The negative outlook is still there and that reflects the risks that there could be more charges,” said Alex Herbert, the London-based analyst who wrote the February report.
Ultimately, however, the question remains: is the DOJ set out on a crusade to "punish" European some of the most iconic European -or rather German- companies, taking a shot first at Deutsche and now Volkswagen, and if so at what point will it deem its overreach to be sufficient. For now, there is no answer and as questions linger, expect European stocks to suffer for the near-future.