The price paid for mortgages: why Deutsche Bank should pay US $14 billion

Shares of Germany’s largest Bank Deutsche Bank (DB) has fallen on Friday, September 16, 8.2%, and the value of risky debt of the Bank — conventionally convertible bonds (AT1) — made a record fall since the summer. Thus the market reacted to reports that the U.S. Department of justice expects to recover from the Bank $14 billion in exchange for the termination of the investigation concerning the actions of the DB with mortgage securities, which among other factors led to the mortgage crisis in USA in 2008.

The Bank confirmed the existence of claims by the Department, but voiced the amount to pay refused. The justice Ministry does not comment the situation.

As said the official representative of Deutsche Bank Joerg Eigendorf, negotiations have just begun and the Bank fundamentally, that they were confidential. Market participants agree that the penalty, even if it’s a significant reduction, could negatively affect the already difficult financial condition of the Bank.

Mortgage question

Deutsche Bank has come to the attention of the American authorities in the case of violations in sales of mortgage bonds in 2011, when the Federal mortgage lending Agency (FHFA), which investigates the consequences of the collapse in the mortgage market in 2008, said the German Bank had not provided full and adequate information about the quality of sold them the securities. The Bank, in particular, has not conducted proper checks of the creditworthiness of the borrowers and turned a blind eye to what their stated income could be overstated. Similar claims, the regulator made in relation to the us Bank of America, JP Morgan Chase, Goldman Sachs, Citigroup, Swiss UBS.

As a result, due to the fact that many borrowers are unable to repay their loans, the paper depreciated, and was a crisis. Only the government-controlled U.S. mortgage agencies Fannie Mae and Freddie Mac who bought the paper including Deutcshe Bank, suffered losses of more than $30 billion, Most of this money had to reimburse the taxpayers. Now the US authorities are making full reparation of all losses of Fannie Mae and Freddie Mac from investments in mortgage securities, presenting requirements for banks.

In 2014, Bank of America has agreed to pay for non-prosecution in the case on violations in the mortgage industry of $16,65 billion, JP Morgan Chase, Citigroup, Goldman Sachs and Morgan Stanley paid $13 billion, $7 billion, $5.1 billion and $3.2 billion respectively.

The prospects of the auction

Deutsche Bank intends to maintain the confidential nature of the negotiations with the Ministry of justice about the amount of the payment because it believed that the emergence of open access to information about the potential amount may adversely affect the Bank. “We don’t want to discuss this case in public. For us is not very good, that figure has become known now. This was not, as we understand that this will have some impact on the dynamics of the negotiations. We want the negotiations remains confidential. We will discuss this in the coming weeks and hope to achieve good results,” said Hagendorf in an interview with CNBC.

Sources of the newspaper Financial Times, Deutsche Bank expects that the Bank will be able to negotiate a significant reduction in the originally stated amount. They cite the example of Goldman Sachs, which the justice Department initially demanded a compensation of $15 billion.

From Citigroup, the U.S. justice Department initially demanded $10 billion, but in the end the parties agreed on payment of $7 billion.

According to one major investor Deutsche Bank, which leads Reuters, the total amount of payment is reduced to €4-4. 5 billion, “but because of the election campaign, it could reach $6-7 billion.

Investor concerns

The fall in the value of securities Deutsche Bank reflects the serious concern of investors influence the potential amount of the fine on the financial position of the Bank capitalization as of September 16 was only €18 billion, and total assets on the balance sheet at €1.6 trillion. At the end of June to cover legal costs was laid down €5.5 billion, while Deutsche Bank reported the intention to increase this amount by year-end. According to Reuters sources close to the Bank, to cover costs in the case of mortgage violations, he also has a €2.5–3 bn.

According to the analyst the German Landesbank Baden-Wuerttemberg (LBBW, one of the top 10 banks in Germany) Ingo of Frommen if the final amount of compensation will exceed $5 billion, “the Bank will no longer be able to avoid having to request additional capital investment”.

According to estimates ING, which results in the Wall Street Journal, if Deutsche Bank will have to pay $14 billion, its ratio of tier I capital will decrease from 12.2% at the end of the first half to around 9% (9% — strip controller). But even if Deutsche Bank will negotiate with the Ministry of justice to solve the issue for half of this amount, the rate will still fall to about 10.6 percent.

Analyst at Dutch Bank ABN AMRO Thomas Kinmont fears that a fine in excess of $11 billion would negatively affect the Bank’s ability to pay the coupon on conditional convertible bonds (AT1) in 2016. This is the most risky debt securities (only a quarter of such bonds of Eurozone banks has an investment rating by Fitch). Thereon are paid a fixed coupon, but the Issuer according to issue documentation, has the right to skip a payment. If the Bank’s capital falls below a certain level, they are converted to shares or be written off.

Deutsche Bank reported that the payment for these AT1 bonds in 2016 pledged €1.1 billion That was enough for payments on the AT1 securities with a maturity date of 30 April 2016, but because of the large size of the fine the opportunity to make the following payments now under threat, said Kinmont .

On 16 September, the value of the bonds Deutsche Bank AT1 €1.75 billion with a coupon rate of 6% per annum decreased by 4 cents (80 cents), which was the largest decline since July 6. AT1 bonds of £650 million with a coupon of 7,125% per annum has decreased by 5 pence to 83 pence, the largest drop since June 23, the date of the referendum on the British exit from the European Union). “They’re dropping like a stone,” said Kinmonth.