Deutsche Bank's weakness weighs on US settlement talks

Germany's largest lender Deutsche Bank may sell off part of its asset management arm, valued by insiders at around 6.0 billion euros, Handelsblatt newspaper reported (AFP Photo/DANIEL ROLAND) (AFP/File)

New York (AFP) - Already hobbled by a weak capital base, Deutsche Bank finds itself in the crosshairs of US prosecutors, who have proposed $14 billion in fines over its role in the 2008 financial crisis.

However, given its size and importance, US authorities may be wary of destabilizing the global financial system by penalizing Germany's largest bank too heavily and endangering its survival -- something the bank may use to its advantage in pending settlement talks, attorneys say.

Deutsche Bank, which federal prosecutors believe knowingly sold toxic mortgage-backed securities between 2006 and 2008, this month publicly rejected the proposed settlement amount, saying it had "no intent" of agreeing to a sum "anywhere near" that amount.

Going public with their position is a rare move to be as open as possible at a time when the bank appears worryingly weak, according to a source with knowledge of the matter."

The bank's share price has tumbled 50 percent since the beginning of the year, bringing its market value below $17 billion. Citigroup, by comparison, is currently valued at $135 billion.

A large fine could drag the company's common equity tier-one ratio, now at 10.8 percent, below the psychological threshold of 10 percent, according to Stephen Ellis of MorningStar.

This, and other question marks over the bank's longer-term viability, have investors deeply worried.

- Room to negotiate -

But weakness could be the bank's trump card.

"When it comes to negotiating over the final bill, Deutsche Bank's weaknesses could actually be strengths," said James Kousouros, a white-collar defense attorney in Manhattan.

Deutsche Bank's ultimate settlement amount will depend in part on the bank's financial stability, a person with knowledge of the matter told AFP.

Other settlement deals show the Department of Justice is willing to negotiate. Citigroup, seen as having similar levels involvement to Deutsche Bank's in the dodgy mortgage-backed securities trade before the crisis, payed $7 billion in 2014, compared to the government's initially proposed $12 billion.

Contacted by AFP, both Deutsche Bank and the Justice Department declined to comment.

The bank's troubles have been evident for months. The International Monetary Fund in June said Deutsche Bank was the financial institution most likely to inflict damages on the global financial sector.

More worrisome, however, the bank's derivatives exposure in 2015 was estimated at $46 trillion, or about 13 times the size of the entire German economy.

In other words, should Deutsche Bank run aground, a bailout would be difficult. But without one, contagion could spread from the German financial system to the global one.

In 2008, Lehman Brothers collapsed, spreading havoc through the global financial system, having had net exposure to derivatives of a little less than a tenth of the value of Deutsche Bank's positions.

"DOJ knows there will be dire ramifications... for countries that Deutsche Bank does play an important role in if they were effectively to take the bank down," said Kousouros.

- Collateral consequences -

He cited the controversial principle that some financial institutions are "too big to fail" and can thus force authorities to preserve them at taxpayers' expense, while those responsible are never held to account.

"The bigger they are, the harder they fall, and when they fall they make a lot of noise," he said.

In pursuing corporate entities, US prosecutors are asked to consider "collateral consequences" that could arise if companies face criminal charges.

New York attorney Alan Futerfas, whose firm has defended clients accused of sanctions violations in Iran, said he emphasizes such questions in settlement talks.

"When I represent an institution in a situation like this, the issue of whether the amount the government is proposing will cause significant financial harm to the business, or whether the business will have to fire people, or whether the business will be able to sustain itself in the wake of the payment, is always an important part of my presentation," he told AFP.

Financial markets have not hid their impatience, especially given that German Chancellor Angela Merkel has ruled out any public bailout of Deutsche Bank.

In a tweet on Tuesday, Christopher Whalen of the Kroll Bond Rating Agency warned that market perceptions are fraught with peril for banks, recalling the demise of investment bank Bear Stearns at the start of the financial crisis.

"Let us recall, the collapse of Bear Stearns was due to a lack of confidence, not a lack of capital," he said on Twitter.