European Banks Legal Tab Tops $77 Billion as Probes Widen

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Europe’s biggest banks, led by Lloyds Banking Group Plc and Deutsche Bank AG, have racked up more than $77 billion in legal costs since the financial crisis, five times their combined profit last year.

Since September 2008, the 18 banks with the highest litigation expenses paid at least $24.9 billion settling lawsuits and probes, set aside $31.5 billion to compensate U.K. clients improperly sold products including mortgage insurance and earmarked $20.9 billion for further penalties, data compiled by Bloomberg show. The sum equates to spending $42 million a day. The total may be higher as many settlements aren’t public.

“Banks aggressively followed a very, very return-oriented business model before the crisis,” Martin Hellmich, a professor of risk management and regulation at the Frankfurt School of Finance & Management, said in a phone interview. “Now they’re paying for the past with settlements and fines.”

European banks are meeting the cost of helping some clients launder money and avoid taxes while cheating others by not disclosing the risk of products designed to protect them from interest rate swings and manipulating markets for their own profit. The penalties come as regulators require firms to set aside more funds to strengthen finances and as executives look for ways to boost shareholder returns even amid lower revenue.

Surging Expenses

The six biggest U.S. banks, led by JPMorgan Chase & Co. and Bank of America Corp., have allotted more than $100 billion to lawyers, litigation and settlements since the financial crisis, more than they’ve paid in dividends. Last month New York-based JPMorgan reported its first quarterly loss under Chief Executive Officer Jamie Dimon because of surging legal expenses. The bank this week agreed to the final terms of a $13 billion settlement over its sales of mortgage-backed securities.

Payouts in Europe are accelerating. The 18 banks spent a combined $7.7 billion settling lawsuits and regulatory probes last year, more than doubling from 2011. The figures exclude compensation for U.K. mortgage and interest rate derivatives.

The payments have hurt banks’ profit and slowed efforts to build capital. Future penalties may prompt firms to delay boosting dividends or buying back stock, analysts at KBW, a unit of Stifel Financial Corp., said in a report to clients this month.

Deutsche Bank

Lloyds, Britain’s largest mortgage lender, and Deutsche Bank, Europe’s biggest investment bank by revenue, bore about 31 percent of the total legal costs, company reports show. Lloyds is paying more than 8 billion pounds ($13 billion), the most of any bank, to compensate U.K. customers who were sold loan insurance that didn’t cover them or that they didn’t need. Frankfurt-based Deutsche Bank accounts for 36 percent of the funds that 12 European banks set aside in litigation provisions.

Deutsche Bank’s reserves at the end of September include about $600 million to repurchase U.S. mortgages, funds for a potential settlement with the heirs of a German media tycoon and possible fines for manipulating benchmark interest rates.

Regulators are investigating whether more than a dozen firms, including Deutsche Bank, colluded to manipulate the London interbank offered rate, or Libor, the benchmark for more than $300 trillion of securities worldwide. Barclays Plc, UBS AG, Royal Bank of Scotland Group Plc and Rabobank Groep have been fined a total of about $3.6 billion for rigging Libor.

Discussions Stumble

The European Commission is preparing to hand out penalties in a probe of rate-rigging as soon as next month. HSBC Holdings Plc, Europe’s biggest bank by market value, dropped out of settlement talks after discussions stumbled over liability issues and the possible size of a fine, a person familiar with the matter, who asked not to be identified because the negotiations were confidential, said this month.

Libor probes could cost global investment banks $46 billion and investigations into manipulating currencies could trigger another $26 billion, wrote the KBW analysts, led by Andrew Stimpson in London. That’s in addition to settling claims over faulty mortgages with the Federal Housing Finance Agency, which may total $24 billion, the analysts wrote.

After identifying and punishing manipulation of rates, regulators should develop procedures to make sure the misdemeanors aren’t repeated, said Elke Koenig, president of German banking regulator Bafin.

“Libor was the beginning, now we’re talking about foreign exchange,” she told reporters in Frankfurt last month.

Sharing Information

Bafin is investigating how rates are set at German banks and cooperating with other regulators on probes of the $5.3 trillion-a-day foreign exchange market, according to Koenig.

Bloomberg News reported in June that traders at some banks said they shared information about their foreign exchange positions through instant messages, executed their own trades before client orders and sought to manipulate the benchmark WM/Reuters rates. Those rates determine what many pension funds and money managers pay for currencies.

Charges for Libor represent the second-largest share of fines and settlements after the $4.6 billion in penalties paid by six European banks for allegedly misrepresenting U.S. lending practices and mortgage-backed securities.

Penalties against banks for actions such as selling shoddy mortgage bonds and rigging rates are too high, 28 percent of 750 Bloomberg subscribers said in a Bloomberg Global Poll conducted Nov. 19. About 54 percent said the fines by the U.S. Department of Justice and other regulators were about right or too low. The margin of error was plus or minus 3.6 percentage points.

Six of the companies spent $3.1 billion on fines for avoiding taxes or helping clients do the same while six paid about $2.5 billion for violating U.S. sanctions against Iran and other states. Two firms paid almost $2 billion to settle money laundering cases, the data show. In several cases the companies have appealed the rulings.

Political Message

UBS, Switzerland’s biggest bank, had the largest tax-related penalty when it agreed to pay $780 million and disclose the names of some secret account holders to avoid U.S. prosecution in 2009. Credit Suisse Group AG, the second-largest Swiss bank, set aside $325 million for a settlement with the U.S. in 2011 and wants to reach a deal “as soon as possible,” Chief Financial Officer David Mathers told reporters on a conference call last month.

“Regulators are sending a political message with these probes,” Lutz Roehmeyer, a money manager at Landesbank Berlin Investment who helps oversee about 11 billion euros ($14.8 billion) of assets including banks’ shares and debt, said in a phone interview from Berlin. “They want the banking industry to be cleaner, more conservative and carry lower risk.”

The $77-billion legal tab is less than the $103 billion the six biggest U.S. banks had allotted as of late August to lawyers and litigation, as well as for settling claims for shoddy mortgages and foreclosures since the start of 2008, according to data compiled by Bloomberg.

Transparency Differs

The 18 European banks differ in the level of transparency they offer investors. Barclays and Lloyds don’t disclose their litigation reserves, while Deutsche Bank and France’s Societe Generale SA give quarterly updates on provisions. BNP Paribas SA and ING Groep NV, the biggest Dutch financial services company, do so on an annual basis. UBS discloses both utilized and remaining provisions every quarter.

The total of legal expenses calculated for this story is based on the most recently available data. The list of 18 banks comprises those with disclosed legal costs exceeding $500 million. Seventeen of the banks have assets exceeding $500 billion, putting them among the largest in Europe. The firms don’t specify the funds they set aside for individual cases because they don’t want to concede an advantage to plaintiffs, according to spokesmen for several of the companies.

‘More Pressure’

“We will be getting more pressure from the regulators to tend to over-provision,” Neil Smith, an analyst with Bankhaus Lampe in Dusseldorf with a neutral recommendation on European banks, said in a phone interview. “They just need to get all of this out of the way as quickly as possible. Otherwise it’s going to go on for years and they won’t be able to focus on running the business and strategic issues.”

Several lenders added to their litigation provisions in the third quarter, indicating that more settlements with clients and regulators are due to conclude.

Deutsche Bank co-Chief Executive Officer Anshu Jain raised his bank’s reserves by 1.2 billion euros at the end of September from three months earlier, telling investors on a conference call to expect settlements “in the near future.”

Equity Requirement

Societe Generale boosted its provisions by 200 million euros to 700 million euros at the end of September from three months previously. Last month, UBS delayed a profit goal set for 2015 after the Swiss regulator demanded the company hold more equity for risks related to litigation.

“The costs make building capital tougher,” Michael Dawson-Kropf, senior director for financial institutions at Fitch Ratings in Frankfurt, said by telephone. “If it were possible to assign capital requirements to legal risks in an intelligent way, it could increase the alertness of bank management.”

The median core Tier 1 capital adequacy ratio under Basel III rules, a key measure of financial strength, of 20 of Europe’s biggest banks increased to 10.4 percent at the end of September from 10.1 percent three months earlier, data compiled by Bloomberg Industries show.

The 18 banks saw their combined net income slump to $14.3 billion last year from $29.1 billion in 2011, data compiled by Bloomberg show. HSBC recorded the group’s highest profit in each of the last two years.

Spiraling litigation costs haven’t stopped the continent’s banking stocks rising. The gains were helped by a European Central Bank pledge last year to help save the euro by buying the bonds of states that sign up to rescue conditions.

Magnitude Surprises

The median gain of 17 listed banks included in the calculation of legal costs is 16 percent this year. The only banks to decline were Italy’s Banca Monte dei Paschi di Siena SpA, which is seeking to repay a second bailout or face nationalization, Commerzbank AG, which increased capital in May for the fifth time in four years to repay aid to German taxpayers, and Standard Chartered Plc, the U.K. bank that makes three-quarters of its earnings in Asia.

Spokesmen for the 18 companies, which also include Italy’s UniCredit SpA and Intesa Sanpaolo SpA, Spain’s Banco Santander SA as well as Credit Agricole SA of France, declined to comment beyond disclosures already made for past and future legal expenses, or didn’t respond to requests for comment.

“Investors made assumptions about the banks that would be worst hit when scandals like Libor first came up,” Roehmeyer at LBB said. Shareholders “know their banks will be making payments. The only surprise is the magnitude.”

Fannie Sues

Banks will be contending with litigation for several years and the uncertainty will prompt investors to avoid individual stocks, said Christian Hamann, a banking analyst with Hamburger Sparkasse.

Libor manipulation has also resulted in civil suits against the banks which allegedly sought to rig rates for their own profit or to hide their true cost of borrowing.

Fannie Mae, the U.S. government-owned mortgage-financing company, sued nine banks this month alleging that their manipulation of Libor cost it about $800 million. Deutsche Bank and Barclays lost a separate court bid to stop firms from linking claims about rate rigging to lawsuits initially filed over improper sales of interest-rate hedging products.

Banks’ Asbestos

The banks have yet to reach public settlements with plaintiffs in civil suits related to Libor. That will make it harder for them to build reserves for such cases, because accounting standards in Europe say they should draw inferences from previous settlements when calculating potential damages.

Hamann says banks remind him of Europe’s insurers when they grappled with billions of dollars in claims in the late 1990s related to gutting buildings insulated with carcinogenic materials and compensating policyholders.

“This is the asbestos of banks,” he said. “The insurers knew the risks, but their reserves were never enough and they only really got a handle on it in 2004 or 2005. The banks have also underestimated their legal risks.”

The following is a table of the 18 banks’ total costs to settle lawsuits, regulatory probes and other disputes since September 2008 as well as their legal reserves and expenses for U.K. customer redress. Figures are rounded and in millions of dollars.

Company        Costs ’08-’13     Reserves     U.K. Redress
Monte Paschi          437           556            -
Santander           2,186            -           1,091
Barclays            1,330            -           7,106
Credit Agricole       151         1,441            -
Credit Suisse       2,655         1,264            -
Deutsche Bank       1,892         7,500            -
HSBC                4,841            -           4,154
Intesa Sanpaolo       358         1,217            -
Lloyds                912            -          13,637
RBS                 1,167           746          5,496
Societe Generale      160           947            -
Stan. Chartered       667            -             -
UBS                 5,245         1,919            -
UniCredit             661         1,465            -
Rabobank            1,100            -             -
ING                 1,103           289            -
BNP                     5         2,221            -
Commerzbank           552         1,296            -
Total              24,866        20,860         31,484
(Updates with poll on fines in the 18th paragraph.)
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