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Stock Analyst Update

DOJ's $14 Billion Ask from Deutsche Bank Rich

The U.S. Department of Justice's proposal that Deutsche Bank pay $14 billion to settle claims of mis-selling mortgage securities is an extravagant negotiating tactic.

The U.S. Department of Justice has proposed that Deutsche Bank pay $14 billion to settle claims of mis-selling mortgage securities. We consider this an extravagant request and certainly an opening negotiating tactic. Deutsche Bank said it has no intent of settling at anywhere close to that figure. For now, we plan to maintain our $18/EUR 16 fair value estimate and no-moat rating, which includes a EUR 5.2 billion capital raise. The bank currently has EUR 5.5 billion in reserves, and we model another EUR 4 billion in charges over the next few years. The bank indicated that it views a $2 billion-$3 billion settlement over this issue as reasonable. Prior settlements with Goldman Sachs ($5 billion) and Bank of America ($16.65 billion) indicate a wide range of possibilities depending on the strength of the evidence gathered by the DOJ and the bank’s relative size in the residential mortgage-backed securities market. We estimate a EUR 8 billion settlement would push the bank’s common equity Tier 1 ratio to about 10.4% from 10.8% once the sale of its stake in Hua Xia is completed.

We are concerned that the settlement news will revive investor worries regarding Deutsche Bank’s overall liquidity as well as systematic issues. We also believe the settlement will lay the groundwork for future settlements with other European banks such as Barclays, UBS, Royal Bank of Scotland, and Credit Suisse. We do think Deutsche Bank is motivated to settle relatively quickly, not only to remove the distraction for its management team, but also because we expect it to engage in a capital raise after the settlement, and this is one of its larger remaining legal issues. As a result, the outcome here could influence the dilutive impact of the subsequent capital raise for shareholders.

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