European Lenders Limp Into 2017 After $12.5 Billion Settlements

  • Deutsche Bank still contends with lawsuits and investigations
  • Shares of European banks fall for third consecutive year

Relief that Deutsche Bank AG and Credit Suisse Group AG cleared legal hurdles is likely to soon give way to concern over a bigger problem: European lenders are still struggling to make money.

While the combined $12.5 billion in settlements the two agreed to pay to resolve U.S. investigations into sales of toxic debt put one dispute behind them, they also highlighted how handicapped their businesses are in generating increased profits -- nowhere more than in Italy, which agreed overnight to pump 20 billion euros ($21 billion) into its banks.

"The settlement is still a blow as the number is large and it will weigh on results for years to come, which will put Deutsche at a disadvantage against U.S. banks," said Ingo Speich, a portfolio manager at Union Invest in Frankfurt who holds both Deutsche Bank and Credit Suisse.

European bank shares are headed for a third straight losing year in 2016, according to the Bloomberg Europe 500 financial-industry index. Return on equity, a key measure of profitability, sank to 5.7 percent at European Union banks as of June, a decline of more than a percentage point from a year earlier, according to the European Banking Authority. In Britain, Royal Bank of Scotland Group Plc, HSBC Holdings Plc and Standard Chartered Plc all watered down or pushed back profit goals this year.

Shrinking profitability has become a “concern for financial stability” because it may reduce banks’ ability to recover from shocks by generating capital or selling stock, Bank of England Governor Mark Carney said on Nov. 30. The week before, European Central Bank President Mario Draghi said profitability “remains a challenge to be addressed.”

Highlighting the challenge is the turmoil in Italy, the euro zone’s third-biggest economy. Banca Monte dei Paschi di Siena SpA turned to the government after failing to raise 5 billion euros in fresh capital, with officials expecting more more lenders to seek lifelines.

“Finally we are heading toward a solution,” Jacopo Ceccatelli, head of Marzotto SIM SpA, a Milan-based broker-dealer, said in a Bloomberg Television interview. “Italy is doing now what other countries have done many years ago to sustain their banking system.”

Still, it’s the troubles at Deutsche Bank, the largest lender in Europe’s dominant economy, that have loomed largest over markets.

The bank’s disclosure early Friday that it would pay $7.2 billion in penalties and consumer relief -- Credit Suisse will pony up $5.3 billion -- helps move it beyond one Justice Department investigation, but leaves several other pending probes into its practices around the world. Authorities are looking into whether it manipulated foreign-currency rates and precious metals prices and whether it facilitated transactions that helped investors illegally transfer billions of dollars out of Russia.

Chief Executive Officer John Cryan has said this year will be the peak of the bank’s restructuring efforts, though legal charges may continue to weigh on his plan to boost profitability. The latest settlement will cause a $1.2 billion pretax hit to fourth-quarter earnings, which may push the bank into its second-straight annual loss.

“We continue to expect 2017 and 2018 to be heavily burdened by litigation settlements totaling around 5 billion euros,” Credit Suisse analysts including Jon Peace wrote in note to clients. The remaining probes “have the potential to create some additional headline risk.”

Settlement Terms

Deutsche Bank agreed to pay a $3.1 billion civil penalty and provide $4.1 billion in relief to consumers under a settlement in principle with U.S. authorities, it said in a statement early Friday. While Credit Suisse also settled, Barclays Plc was unable to come to an agreement and was sued in federal court by the Justice Department.

“We’re finally getting to -- in December of 2016 -- the end of the residential mortgage debacle and all the things and ramifications that came out of that,” Marty Mosby, an analyst at Vining Sparks, said in a telephone interview. “Thank goodness we’re about done with all this.”

Before this week’s agreement, Deutsche Bank had already paid more than $9 billion in fines and settlements worldwide since the start of 2008, according to data compiled by Bloomberg. That includes cases related to violations of U.S. sanctions, rigging of interest-rate benchmarks and allegations that it defrauded Fannie Mae and Freddie Mac, the U.S.-backed mortgage finance companies.

Analysts and investors were split on whether Deutsche Bank will now have to tap investors in its effort to reach its capital targets. The lender’s common equity Tier 1 ratio was 11.1 percent at the end of September, and it aims to reach 12.5 percent by the end of 2018. The bank said in a memo to employees Friday that it is in excess of of all current liquidity and capital requirements.

“I still expect Deutsche Bank to eventually go ahead with a capital increase,” said Boris Boehm, who helps manage 2.1 billion euros, including Deutsche Bank shares, at Aramea Asset Management in Hamburg. “The settlement only removes one of Deutsche Bank’s many problems.”

The U.S. is also investigating whether Deutsche Bank violated anti-bribery laws by employing children of China’s elite. And although it settled U.S. claims that its traders manipulated benchmark interbank interest rates, dozens of related civil lawsuits remain.

QuickTake Q&A: Why Deutsche Bank’s Problem Is Your Problem, Too

The U.S. probes that aren’t settled will be handed over to the incoming administration led by Donald Trump. Deutsche Bank is trying to restructure hundreds of millions of dollars of loans to the Trump Organization as part of an attempt to reduce any conflict of interest between the debt and Trump’s presidency, said a person familiar with the matter.

The lender said in the memo to employees that it “neither expects nor believes it will obtain preferential treatment under a Trump administration.” The bank also said it has found no evidence of a breach of sanctions in an internal investigation of trades in its Russian unit.

Billions Set Aside

Deutsche Bank is grappling with a pile of mortgage litigation separate from the Justice Department investigation. Various mortgage-bond investors have sued the lender, claiming they suffered losses because the bank misrepresented the riskiness of the securities, while a lawsuit filed by BlackRock Inc. and Pacific Investment Management Co. is pending over Deutsche Bank’s role as a trustee for investors in mortgage securities.

Deutsche Bank is fighting 47 civil lawsuits from investors claiming losses from the manipulation of interbank lending rates, according to a regulatory filing. A group of U.S. state attorneys general are also investigating its role in rate setting. Regulators are examining its high-frequency trading practices and its dark pool known as SuperX, and authorities are investigating its conduct in the trading of sovereign and agency bonds, according to regulatory filings.

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