Even a $ 4 billion settlement “would put questions around capital position,” JP Morgan analyst Kian Abouhossein said in a research note earlier this week.
That was before The Wall Street Journal reported reported that the Justice Department recently opened settlement negotiations with Deutsche Bank asking for $ 14 billion to resolve claims stemming from the German lender’s precrisis sales of residential mortgage-backed securities.
Late on September 15, in response to the Journal report, Deutsche Bank confirmed the government’s $ 14 billion settlement proposal. The bank has “no intent” to pay the Justice Department claims “anywhere near the number cited,” it said in a statement. “The negotiations are only just beginning,” it said, adding that the lender expects an outcome in line with previous settlements at “materially lower amounts.”
Analysts and investors likewise expect an eventual settlement, if there is one, to be significantly lower than the Justice Department’s opening bid. Shareholders were rattled nonetheless. Deutsche Bank’s shares fell more than 8% as of Friday afternoon, and European bank stocks broadly declined.
Based on its roughly $ 18.9 billion market value, Deutsche Bank would be coughing up more than one-fifth of its current market cap if it were to pay a $ 4 billion Justice Department settlement.
Deutsche Bank held $ 6.2 billion in litigation reserves as of June 30. Analysts had been estimating a Justice Department settlement somewhere between $ 2 billion and $ 5 billion, while acknowledging that they don’t have much transparency into the process. Previous deals that banks have struck in parallel mortgage-backed securities probes aren’t necessarily a reliable indicator, lawyers say.
RBC Capital Markets banking analyst Fiona Swaffield had estimated a $ 4 billion settlement for Deutsche Bank. Should it end up being higher, she wrote Friday, Deutsche Bank’s capital targets would appear increasingly unrealistic.
According to Swaffield’s estimates, every additional $ 1 billion in surprise legal costs would whittle 0.24% off of Deutsche Bank’s common equity tier one capital ratio, a key measure of financial strength.
Deutsche Bank is aiming to boost its tier-one capital ratio to at least 12.5% by 2018, from 10.8% as of mid-year. That’s a tough task for the lender, already beset by sagging profits and economic headwinds, without billions of dollars in unexpected legal costs.
JP Morgan’s Abouhossein in a follow-up note Friday said a settlement higher than $ 4 billion would pressure Deutsche Bank to beef up its reserves for other outstanding legal matters, “thus putting capital at risk.”
But Deutsche Bank’s success navigating its thorny field of challenges – including deep cost-cutting and asset sales – depends not just on meeting financial targets, but also on market perception, Abouhossein said.
“The ultimate issue you have to take into account is the confidence that clients and other banks have in Deutsche Bank,” he said. “I think the market at the moment is quite rational. There’s no broken confidence.”
A key reason, in his view, is that Deutsche Bank could raise $ 10 billion in a rights issue, a move that would be painful to shareholders but possible, were it necessary.
Deutsche Bank executives have said this year they have no plans to raise capital anytime soon. They have emphasised efforts to put longstanding legal issues behind the bank, which investors say would remove uncertainties around capital.
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This article was published by The Wall Street Journal