Deutsche Bank Reaches $7.2 Billion Settlement Over Toxic Securities
The Obama administration scrambled to resolve its remaining crisis-era megabank mortgage cases, striking a $7.2 billion settlement Thursday with Deutsche Bank AG over toxic securities while separately filing a lawsuit against Barclays PLC alleging more than $30 billion in fraud-tainted sales.
The dramatic back-to-back announcements show the urgency among senior Obama appointees in the Justice Department to resolve the outstanding probes of precrisis conduct at major banks before those officials leave office in mid-January. Part of the rush stems from a great deal of uncertainty about how a Trump administration might pursue, settle or drop the remaining probes, according to people familiar with the discussions.
The Deutsche Bank settlement is likely to bring some relief for the German bank’s shareholders, who earlier in the year worried about a much bigger penalty. The Justice Department had originally sought $14 billion from Deutsche Bank, The Wall Street Journal reported in September, raising concerns about whether the institution would be able to negotiate that down.
Less than half the settlement requires a cash payment that would have an immediate impact on Deutsche Bank’s bottom line. The settlement was divided into a $3.1 billion penalty and a pledge to pay $4.1 billion over time to a “consumer relief” fund to be distributed by the government.
The terms of that relief—including loan modifications to help consumers—still must be finalized between the bank and the government.
Deutsche Bank announced the pact Thursday evening in the U.S., saying it had reached an agreement “in principle” with the Justice Department.
A Justice Department spokesman declined to comment. In major corporate settlements, particularly when the deal isn’t yet finalized, it is not uncommon for firms to announce the framework of a deal before the government, often in the hopes of a garnering a positive reaction from shareholders.
The Deutsche Bank settlement follows similar multibillion-dollar agreements reached over the past three years with other big banks, like J.P. Morgan Chase & Co., Citigroup Inc. and Goldman Sachs Group. Inc.
It has been more unusual for talks to break down and for the Justice Department to file suit the way it did Thursday against Barclays—though it did file two lawsuits against Bank of America Corp. related to precrisis sales of mortgage-backed securities in 2012 and 2013. One of those was thrown out earlier this year on appeal.
The government complaint didn’t quantify the damages it is seeking from Barclays.
Barclays said in a statement that it would seek the suit’s “dismissal at the earliest opportunity,” and that it considers the claims “disconnected from the facts.” Bank officials declined to elaborate on why the talks broke down, but one person familiar with the matter said that continuing the talks under “a fresh pair of eyes”—in a new presidential administration—might be more beneficial.
A prolonged legal battle would be handled by Justice Department officials appointed by President-elect Donald Trump. Neither Mr. Trump nor his aides have indicated how they might handle legacy financial-crisis fallout inherited from President Barack Obama. But Mr. Trump in 2013 criticized J.P. Morgan CEO James Dimon that year as “the worst banker in the United States” for reaching a $13 billion settlement in a similar case. “What happened to the days when you actually go to trial?” Mr. Trump said at the time.
The Deutsche Bank settlement and Barclays suit come as the Justice Department still has probes outstanding with three other big European banks— Credit Suisse Group AG, Royal Bank of Scotland Group PLC and UBS Group AG. While talks with Credit Suisse have been progressing, it wasn’t clear Thursday whether a settlement was certain before year-end, according to people close to the discussions.
The Justice negotiations this year have been a big cloud hanging over an already-fragile European banking industry, weighing on several major lenders’ stock prices. Investors have worried about whether those institutions’ capital is sufficient to cover any possible U.S. fines.
The Deutsche Bank settlement came together quickly in the latter part of this week following intense negotiations between lawyers representing the bank and the government, a person familiar with the matter said. Going into the week, the two sides still had significant differences to overcome, people close to the discussions said.
Deutsche Bank and the government were steadily closing in on terms, including the government’s statement of facts about alleged wrongdoing, each day this week, according to a person close to the talks. The final main issue boiled down to money, the person said.
A Deutsche Bank settlement was appearing more promising earlier Thursday even without the Barclays lawsuit, but the government’s move to sue the U.K. bank added incentive to close a deal, the person said.
The German bank said it will take a roughly $1.17 billion pretax charge this quarter as a result of the $3.1 billion penalty. The additional consumer relief has less immediate and less solid consequences, because it is to be paid out over at least five years, the bank said, adding that the settlement isn’t expected to have a material impact on its 2016 financial results.
Hours before the Deutsche Bank settlement was announced, the Barclays talks broke down as executives at the U.K.’s second-largest bank made clear they were wary of being pressured to make a big payout.
Barclays Chief Executive Jes Staley had told people in recent months that the bank wouldn’t give U.S. authorities a blank check, and wouldn’t settle if he felt the price was too high, according to people familiar with the discussions.
Government officials had discussed with Barclays lawyers the possibility of suing, but the bank only learned Thursday that a lawsuit was arriving the same day, according to a person familiar with the matter.
The impasse between the two sides was still big: They remained multiple billions of dollars apart, with Barclays unwilling to pay $5 billion—an amount the government had said was in the range of possibilities, according to a person familiar with the matter.
The 198-page lawsuit by the U.S. government says the bank “engaged in a fraudulent scheme to sell tens of billions of dollars of residential mortgage-backed securities (RMBS), in which it repeatedly deceived investors about the characteristics of the loans backing those trusts.”
Barclays sold the securities to a wide range of investors, including financial institutions, Fannie Mae and Freddie Mac, federal home-loan banks, credit unions, pension plans, charitable and religious organizations, and university endowments.
“Many of these investors suffered devastating losses,’’ according to the suit, which was filed in a U.S. District Court in New York. The suit singles out two former New York-based Barclays executives, Paul Menefee and John Carroll, who had been hired in 2003 to help run the bank’s asset-securitization team, according to an announcement at the time. Both were previously at Morgan Stanley and left Barclays in 2008.
The complaint is filled with expletive-laced conversations involving those men and others familiar with the loans, taken from transcripts of recorded phone calls and emails. In one, the complaint says that Mr. Menefee, who was in charge of due diligence on the subprime deals at issue, allegedly said that one loan pool “scares the sh*t out of me.’’ At another point, that same executive said about a Wells Fargo & Co. pool, according to the complaint: “We have to eat their sh*t loans.”
Mr. Menefee’s lawyer called the complaint “a misguided attempt’’ to blame his client and others for losses incurred by sophisticated institutional investors after an industrywide housing market collapse.
Mr. Carroll’s lawyer didn’t respond to requests for comment.
The suit also alleges that companies hired to conduct due-diligence checks on the mortgages warned the bank, and those warnings were essentially ignored. “These vendors described some of these securitized loans as ‘craptacular,’ others as ‘scariest collateral,’ and others as having the ‘distinct aroma of default,’” the suit says.
The allegations relate to activities and employees at Barclays, before the bank’s 2008 buy of the collapsed investment bank Lehman Brothers.
During Barclays’s settlement negotiations, one of the key arguments the bank made to Justice Department lawyers was that Barclays was the most-exposed investor in the securities in question, and had already taken a big write-down during the financial crisis as a result of losses.
Barclays also insisted that losses from the securities were related to broad market events, not its own practices, and argued that its due diligence on the deals was deemed at or above industry standards, including by government-backed entities that approved of Barclays’s methodology at the time.
In recent days, government lawyers were scheduling calls with Barclays lawyers, pushing for progress in the talks, a person familiar with the matter said.
On Thursday, the government gave the bank a brief heads-up before filing the complaint about 3 p.m. ET.
Lawyers for the bank could respond to the lawsuit as early as next month, people close the matter said.