Deutsche Bank’s $14 Billion Scare

  • Justice officials had envisioned $3 billion mortgage penalty
  • U.S. added prosecutors and gave RMBS cases a new overseer

Why Deutsche Bank Doesn't Want to Fight the DOJ in Court

This summer, U.S. Justice Department officials working on a mortgage securities investigation of Deutsche Bank AG expected the bank to settle the matter for $2 billion to $3 billion, according to people with knowledge of the matter.

Then came last month’s news that the government had opened settlement talks by asking for $14 billion, a figure that Deutsche Bank said it wouldn’t pay. That September surprise roiled markets and pushed the German lender’s shares to a record low as investors asked whether it would have to raise capital to meet the U.S. demand, even as it grapples with other potentially costly investigations.

It’s unclear what inspired the Justice Department’s higher opening gambit. What’s known is that in the previous months, some of the ground had shifted.

A reorganization at the top of the Justice Department put a different person in charge of mortgage-securities investigations. That official, in a recent speech, criticized banks that hadn’t sufficiently cooperated, saying they were contributing to their own misery. Other forces were at play. Additional prosecutors with more resources had been assigned to the unit running the Deutsche Bank probe, as the government kept up its effort to hold individuals as well as institutions accountable.

Washington Meeting

Deutsche Bank’s shares rose 1 percent to 12.19 euros at 12:05 p.m. in Frankfurt. They’ve dropped about 46 percent this year.

Justice Department spokesman Mark Abueg declined to comment. Renee Calabro, a Deutsche Bank spokeswoman, declined to comment.

Deutsche Bank Chief Executive Officer John Cryan and other top German executives are scheduled to travel to Washington this week as business leaders and central bankers gather for the International Monetary Fund and World Bank Meetings, people with knowledge of the matter have said. The managers may use the trip to also continue negotiations with the Justice Department, they said.

Click here for a Bloomberg Intelligence primer on Deutsche Bank litigation risks

It’s not unusual for the Justice Department to begin settlement negotiations with a number higher than the ultimate penalty, people familiar with the talks have said. The sides may haggle over what behaviors will be admitted, if any, whether individuals will be held to account, and how much of the top-line total may include items besides cash penalties, such as credit for modifying loans.

It’s less common for such figures to spill into the open while talks proceed, as happened on Sept. 15 when the Wall Street Journal reported the $14 billion figure.

The number not only surprised investors but also appeared out of line for prosecutors who were concluding their civil case against the bank over its packaging and sale of residential-mortgage backed securities that fueled the 2008 financial crisis. Five banks had already reached settlements with the Justice Department over similar instruments and practices.

The latest to settle were Morgan Stanley, which agreed to a $2.6 billion penalty in February, and Goldman Sachs Group Inc., which agreed to a $5.1 billion deal with the government in April. In early September, a German magazine said Deutsche Bank might pay more than $2.4 billion, using Goldman’s settlement as a yardstick and not disclosing its sourcing.

Frustrated Officials

When the much higher figure emerged, Deutsche Bank was rattled. Concerned about upsetting U.S. negotiators, the bank sought a green light from the Justice Department before confirming the opening bid in a statement and pointing out it been asked to submit a counteroffer, according to one of the people familiar with the matter. 

Some U.S. officials were frustrated that the private discussions with Germany’s biggest bank had become public, according to two people. In some ways it painted the Justice Department into a corner, since officials could look weak if they ultimately settled for a much smaller number, one of them said.

‘Cloud of Uncertainty’

At the Justice Department, an official known for antitrust investigations of big banks had been promoted to the No. 3 position, overseeing the remaining mortgage investigations. In his previous role, the official, Bill Baer, had taken stands against companies involved in mega-mergers and extracted guilty pleas from several big banks over collusion in currency trades.

Last week in Chicago, Baer assailed banks for their lack of cooperation in mortgage talks, which he said had caused unnecessary delays and led to a “cloud of uncertainty” hanging over some institutions. Baer, in his speech, didn’t cite banks by name.

The U.S. mortgage securities investigation has been overseen since 2012 by a task force assembled by then-Attorney General Eric Holder, with the Deutsche Bank case being run out of the U.S. attorney’s office in Brooklyn. That office, known for its aggressive stance in previous cases, added at least a half-dozen prosecutors in early 2015, a person familiar with the matter said, giving more personnel and time to devote to the remaining cases.

With negotiations now taking place out of the spotlight, analysts and others have been evaluating what the possible penalty might be. The bank has set aside 5.5 billion euros ($6.1 billion) for litigation.

A settlement above that amount would leave the German lender no room to settle other legal issues without increasing capital, JPMorgan analysts have written. Bloomberg Intelligence placed the likely RMBS pact in the $4 billion to $8 billion range based on earlier such bank settlements, but said a final deal amount may be higher given the Justice Department’s $14 billion opening demand.

— With assistance by Robert Schmidt, and Greg Farrell

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