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Deutsche Bank and Credit Suisse pay billions to settle US probe

Deutsche Bank and Credit Suisse pay billions to settle US probe

By: , David Lynch and 

Deutsche Bank and Credit Suisse have agreed to pay out billions to resolve a probe into the alleged mis-selling of mortgage-backed securities at the height of the US housing bubble, striking deals before the Trump administration takes power.

The deals came as federal prosecutors announced they were suing Barclays and two of its executives over the issue of allegedly fraudulent residential mortgage-backed securities (RMBS). The suit followed the breakdown of talks aimed at reaching a negotiated settlement with the Department of Justice and seeks unspecified civil penalties.

After months of its negotiations with the DoJ, Deutsche said it had reached a $7.2bn deal with US authorities. Germany’s biggest bank had agreed “in principle” to pay a $3.1bn civil penalty and also provide $4.1bn in relief to consumers, over time.

Credit Suisse has also agreed to pay $5.28bn to resolve a DoJ probe of similar alleged actions.

The Swiss bank said it will pay a civil penalty of $2.48bn and, like Deutsche’s agreement, provide consumer relief to the tune of $2.8bn over the course of five years. The Swiss bank said it would take a pre-tax charge, to be taken in the fourth quarter of financial 2016 results, of about $2bn in addition to existing amounts it had set aside for these matters.

Shares in Deutsche Bank were 5 per cent higher in early European trading while Credit Suisse was 2.2 per cent up. Barclays shares were 0.5 per cent lower.

The Deutsche deal caps a turbulent few months for the German bank, which saw its share price drop to a record low in September after it emerged the DoJ had made a $14bn claim.

Investors were so concerned about the Deutsche’s ability to withstand a $14bn hit that Angela Merkel’s administration was forced to state that it would not bail out the bank, whose market capitalisation had sank to just $18bn.

Deutsche had insisted it was not expecting to settle the claims for anything like that sum.

The $7.2bn figure is higher than some analysts and investors had expected, though many may be relieved that the cash component of the deal is $3.1bn.

“We see the announcement by DB today around reaching a settlement in principle with the DoJ on the RMBS issue in the US as very positive,” said Kian Abouhossein of JPMorgan, adding that the settlement “removes a major overhang” from the bank and has a “manageable impact on capital in the short term”.

Ingo Speich, a portfolio manager at Union Investment, one of Deutsche’s top 25 shareholders, said: “It’s a good compromise. The bank has shed one of the issues weighing on it, and a little bit of uncertainty will come out of the share price... It’s not the end of all their problems, but it’s certainly not a disappointment either.”

The consumer relief portions of the settlements are typically far less painful for the banks than the straight payments since they are paid out over a period of years and not in cash. In the case of Deutsche Bank, Mr Abouhossein said the relief would be “primarily in the form of loan modifications and other assistance to homeowners and borrowers, and other similar initiatives to be determined, and delivered over a period of at least five years”.

Deutsche said that any consequences of the consumer relief would not show up in Deutsche’s 2016 results. Credit Suisse said that its consumer relief would take place in the five years after the settlement was agreed.

The Deutsche and Credit Suisse deals are the latest in a series of settlements the US government has reached with banks for creating and selling mortgage-backed securities ahead of the 2008 financial meltdown.

They include a $13bn bill for JPMorgan Chase, $7bn for Citigroup and $17bn for Bank of America. RBS and UBS are both still negotiating settlements with the Department of Justice. RBS was one of the biggest issuers of RMBS before the crisis and is expected to face penalties of as much as $13bn.

In its statement, Deutsche said it expected to record pre-tax charges of about $1.17bn in the fourth quarter, in connection with the DoJ penalty. It added: “The financial consequences, if any, of the consumer relief are subject to the final terms of the settlement, and are not currently expected to have a material impact on 2016 financial results.”

The DoJ declined to comment and Deutsche declined to elaborate beyond its statement. A person familiar with the matter said the DoJ would not make an announcement until an agreement was formally signed.

The Barclays suit claims the bank “securitised billions of dollars of loans it knew had material defects” and financed lenders that it knew were issuing mortgages to customers who would be unable to repay them, prosecutors charged. The loans in question defaulted “at exceptionally high rates early in the life of the deals”.

Settlements with US authorities over selling of mortgage securitiesAmount
Bank of America$16.65bn
JPMorgan Chase$13bn
Deutsche Bank$7.2bn
Credit Suisse$5.28bn
Goldman Sachs$5.1bn
Morgan Stanley$2.6bn
Wells Fargo$1.2bn

People close to the Barclays board said it had been prepared only to agree a settlement that was in proportion with those already reached by its US rivals, and was willing to go to court to fight more costly US demands. 

Barclays felt it should pay a fine of only about $1bn if its settlement was to be proportional with those of its US rivals. It was prepared to settle for a total of about $2bn, including customer redress, according to two people briefed on the matter. But the DoJ pushed for something closer to the $5bn settlements that both Deutsche Bankand Credit Suisse were thought to be close to agreeing, the people said. 

People close to the Barclays board said it had been prepared only to agree a settlement that was in proportion with those already reached by its US rivals, and was willing to go to court to fight more costly US demands.

Barclays also has been advised that there is a legal precedent for successfully challenging the DoJ over the RMBS allegations. In May 2016, a US court ruled in favour of Bank of America’s appeal against a DoJ penalty of $1.27bn for toxic mortgages sold by Countrywide, which was acquired by BofA in the financial crisis.

In addition, Barclays has calculated that investors in the residential mortgage-backed securities it issued suffered half the losses of investors in similar products issued by Goldman Sachs and less than a third of those of Citigroup.

While some US banks bet against the RMBS products they sold and kept little if any exposure to them, Barclays told the DoJ that it held the equity tranches of most mortgage securities it issued and so lost money alongside other investors when they went bad.

The DoJ had been pushing the three European banks to agree an omnibus settlement before Donald Trump’s inauguration as US president in the third week of January. Mr Trump is expected to appoint a new leadership team at the DoJ, which is likely to oversee the case against Barclays.

From 2005 to 2007, Barclays fraudulently sold more than $31bn of mortgage-backed securities in 36 separate deals, prosecutors in New York said on Thursday. 

“Barclays jeopardised billions of dollars of wealth through practices that were plainly irresponsible and dishonest,” said Loretta Lynch, the US attorney-general. “We are sending a clear message that the Department of Justice will not tolerate the defrauding of investors and the American people.” 

The US government is charging the defendants with violations of the Financial Institutions Reform, Recovery, and Enforcement Act, via mail fraud, wire fraud, bank fraud and other misconduct. 

The two Barclays executives named in the suit are Paul Menefee, its head banker on subprime residential mortgage-backed securities, and John Carroll, the bank’s head trader for subprime loan acquisitions.

In a statement, the bank rejected the government claims. “Barclays considers that the claims made in the complaint are disconnected from the facts. We have an obligation to our shareholders, customers, clients and employees to defend ourselves against unreasonable allegations and demands. Barclays will vigorously defend the complaint and seek its dismissal at the earliest opportunity.”

The DoJ said the bank had falsely assured investors it had conducted adequate due diligence on the loans underlying its subprime securities and had excluded “unacceptable” loans. “In reality, Barclays’ due diligence on the subject deals was a sham,” prosecutors wrote. 

Even investors in triple A-rated securities, which carry the same rating as US Treasuries, suffered steep losses. 

At issue are loans originated by mortgage companies such as Fremont, New Century, WMC, Countrywide and IndyMac.

According to the complaint filed in federal court on Thursday, the bank misled investors and rating agencies about its loan selection criteria. In some cases, the lawsuit says, the bank found that more than half of the loans it reviewed contained defects, yet officials assured investors they were sound. 

Companies that reviewed the loans for Barclays informed the bank that many did not meet underwriting guidelines or legal standards. “These vendors described some of these securitised loans as ‘craptacular’, others as ‘scariest collateral’, and others as having the ‘distinct aroma of default’,” the lawsuit says. 

Mr Menefee, the Barclays executive in charge of due diligence on the subprime deals, is quoted as calling one loan pool “about as bad as it can be” and saying of a Wells Fargo pool that “we have to eat their shit loans”.

It is not the first time that Barclays has stood its ground against US regulators. In 2014 it pulled out, at the last minute, of an omnibus settlement by six other banks with US and UK regulators over alleged manipulation of foreign exchange rates. In that case, the British bank had wanted to wait until all regulators were ready to settle but it ended up paying a record $2.38bn in fines. 

Now, Barclays appears to believe that it can stand up to the US authorities because there are no other pending legal cases that would give prosecutors leverage. 

Additional reporting by Ben McLannahan

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