The Impact Of The Deutsche Bank Fine On Its Capital And On Other Banks
Sep. 20, 2016 2:28 PM ET
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Deutsche Bank AG (DB), Includes:
CS,
RBS,
UBS
Louis Koen
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Summary
The proposed fine is excessive and is likely to be significantly reduced.
The fine, even if reduced, will likely have a negative impact on Deutsche's capital.
A final settlement in the upper scale will result in pressure on other banks to increase provisions for litigation expenses.
The U.S Department of Justice's (DoJ) initial proposed settlement of $14bn for Deutsche Bank's (NYSE:
DB) Residential Mortgage Backed Securities misdeeds has sent shock waves through the market with DB's stock spiraling downwards. The fine also has a material impact on other peers such as RBS (NYSE:
RBS) and Credit Suisse (NYSE:
CS).
The Final Settlement is Likely to be Substantially Lower
DB said that it has "
no intent to settle these potential civil claims anywhere near the number cited." And that "[t]
he bank expects that [the negotiations]
will lead to an outcome similar to those of peer banks which have settled at materially lower amounts."
Earlier this year Goldman Sachs (NYSE:
GS) settled its RMBS related misdeeds with the DoJ at approximately $5.1bn and Morgan Stanley (NYSE:
MS) at approximately $3.2bn. The proposed DB fine is thus nearly 3 times higher than the fine imposed on Goldman Sachs. It should, however, be noted that the MBS amount involved in the FHFA complaint against DB is higher than the amount involved in the GS complaint. JPMorgan (NYSE:
JPM) had settled its RMBS related misdeeds with the DoJ at an amount of $9bn, the value of the MBS subject to an FHFA complaint in that matter is more than double the amount involved in the DB matter.
(Source:
Bloomberg)
The DoJ has been imposing higher fines on banks who have held out on settling the RMBS related disputes.
Analysts had expected the DB settlement to be in the $2bn-$5bn range. Although the $14bn proposed fine will probably be substantially reduced, it now seems likely that the settlement will be higher than analysts' initial estimates.
The Impact on Deutsche Bank's Capital Position and Increased Risk
It is by now well known that DB suffers from a relatively weak capital position and has been described by the International Monetary Fund (IMF) as one of the greatest contributors to systemic risk in the financial system. The proposed fine has further exacerbated concerns over DB's capital position.
JPMorgan has estimated that for each $1bn by which the final settlement exceeds the $3bn-$3.5bn range, DB's capital will be eroded by 24 basis points.
It now seems inevitable that the fine will exceed the $3bn-$3.5bn range indicated by JPM. This will require DB to raise more capital or reduce assets. The bank has already undertaken to reduce assets by, amongst others,
securitizingcorporate loans. Given concerns over Non-Performing Loans (NPL's) in Europe, DB may receive less for their loans than they may have anticipated. The quality of the loans being offloaded will thus have a material impact on the ultimate price obtained therefore.
The extent to which it is exposed to the struggling shipping industry is also not clear as of yet. German Banks have been some of the
biggest lenders to the shipping industry, it is thus probable that DB may have to make write-downs on some of its shipping loans. Any write-downs will further diminish its capital.
Raising capital will certainly not be an easy task given the poor performance of the Bank. The concerns over the Banks solvency further hampers its ability to raise more capital. In deciding what the ultimate fine will be that DB has to pay the DoJ should consider the impact that the fine may have on DB's capital position and ultimately on banks stability in general. While acknowledging the need to take action against banks for their misdeeds, the DoJ should exercise caution when levying fines to avoid being the source of increased systemic risk to the global financial system.
A fine that substantially reduces the Banks capital may lead to insolvency if the bank is unable to raise more capital. It would be politically impossible for the German government to bail-out DB, given that a request by the Italian government to aid its ailing banking sector was denied. The European Union (EU) cannot be seen as having double standards.
The knowledge that a bailout is politically impossible also reduces DB's ability to issue debt with investors particularly concerned over bail-in rules.
The interconnected nature of Banks means that a failure of DB will lead to catastrophic consequences. Many other Banks will not be able to survive a DB collapse, the IMF chart below indicates the interconnection between DB and other banks. From the chart it becomes clear that DB is strongly interlinked with various other banks who have been suffering from weak capital positions in their own right.
(Source:
IMF) "
The blue, purple and green nodes denote European, U.S. and Asian banks respectively. The thickness of the arrows capture total linkages (both inward and outwards), and the arrow captures the direction of net spillover. The size of the nodes reflect asset size."
The total collapse of DB seems unlikely, however, an excessive fine and a weakening capital position may lead thereto.
Ramifications for other Banks
From the Bloomberg chart above it becomes clear that the fines imposed by the DoJ are generally greater when the amount of MBS subject to an FHFA complaint is higher. Many banks have not yet settled their RMBS related misdeeds with the DoJ, wherefore, the ultimate DB settlement could have a material influence on their businesses.
The market is clearly aware of this, which explains the drop in the other banks share prices immediately following the announcement. The bank who is likely to be impacted the most, if the DB fine serves as a guide for future settlements, is RBS. The amount of RBS's MBS subject to an FHFA complaint is more than double that in the DB matter. This means that if the DB matter is settled on the high end, something that now seems highly probable, the ultimate fine imposed on RBS may exceed the record $16.7bn paid by Bank of America.
RBS may face increasing pressure from auditors to increase provisions for litigation expenses, which in turn will deteriorate the Banks Capital. RBS, whose majority shareholder is the U.K. taxpayers, has raked up more than £52bn in losses since 2008.
Credit Suisse will also be materially impacted if the DB fine is ultimately settled at the higher end of the scale. It has yet to reach a settlement with the DoJ on its RMBS misdeeds. The amount of CS RMBS subject to an FHFA complaint is almost the same as that in the DB matter.
Other Banks who have yet to settle their RMBS misdeeds with the DoJ include Barclays (NYSE:
BCS) and UBS (NYSE:
UBS). If the trend, in which banks who settle later ultimately pays more, persists these banks are also likely to face greater fines than initially anticipated. This could have a negative impact on these Banks earnings and capital.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
