Deutsche Bank vs. DOJ: Here’s why it’s all taking so long

A statue is pictured next to the logo of Germany's Deutsche Bank in Frankfurt, Germany, September 30, 2016.
Kai Pfaffenbach | Reuter

It's been a month since the first mention of reports that Deutsche Bank would have to stump up $14 billion to settle with the U.S. Department of Justice (DOJ).

Despite the bank's stock taking a hammering in the markets -- Deutsche Bank shares are down 45 percent since the start of the year -- we appear to be no closer to a resolution that won't cripple the bank or hurt the DOJ's reputation.

However, a source with knowledge of the negotiations who has asked to remain anonymous because of the sensitivity of the situation has told CNBC that Deutsche Bank is not yet close to agreeing on the settlement. The source further added that the German lender is trying its best to bring down the settlement amount and doing "everything possible" to cut costs across the bank.

Meanwhile, analysts and investors across the globe have been speculating on possible outcomes and the reason for the delay.

"The length of negotiations suggests that Deutsche Bank must be struggling to reduce any penalty to an amount that would not jeopardize its solvency position," Bronka Rzepkowski, lead global strategist at Oxford Economics, told CNBC via email.

"So it would appear that the fines currently proposed by the U.S. Justice Department still exceed Deutsche's 5.5 billion euros ($6 billion) of litigation reserves."

The bank was plunged into crisis after reports that the German lender could face a penalty of up to $14 billion from the DOJ for the misselling of residential mortgage-backed securities (RMBS) in the run-up to the financial crisis of 2008.

German markets news publication Der Platow Brief reported earlier this month, according to Reuters, that Deutsche Bank was looking at a settlement with the DOJ of between $4 billion and $5 billion by the end of October. The newsletter also said that the bank was considering scrapping bonuses and raising fresh capital but it did not cite sources.

But while markets wait for an agreement to be reached, shares of Deutsche Bank have been on a rollercoaster ride on speculation about the settlement figure.

"It is in the interest of (Deutsche Bank) to find an agreement as soon as possible, given mounting concerns regarding its solvency position, reflected by rising CDS (credit default swap) spreads and falling share prices," Rzepkowski said, adding that that given the current estimate of $5 billion-$8 billion in fines there is likely to be a reduction in the bank's U.S. activities.

Possible outcomes?

Rzepkowski also explained that there could be two possible outcomes of the settlement with the DOJ.

"First, we could consider the fines paid by other banks that issued a similar amount of RMBS before the global financial crisis, and were subject to the same litigation. A broad estimate would be between $4 billion and $7 billion, which corresponds to the fees paid by Morgan Stanley and Citi, respectively," Rzepkowski explained.

The second scenario, she said, is a less reliable method that takes into account the discount granted by the DOJ to U.S. banks.

"Applying this discount to the initial proposal of a $14 billion settlement, would reduce the fine to $9 billion to $10 billion. Overall, although it is very difficult to predict, we see the fine as lying between a likely range of 5 billion euros and 8 billion euros."

CNBC got in touch with Deutsche Bank but they declined to comment.

Earlier this month, German local media reports stated that the bank is considering scaling back its U.S. operations amid trying to cut down legal and capital costs.

The source told CNBC that the German lender's decision to scale back its investment banking operations in the U.S. is part of the settlement negotiation between the U.S. Department of Justice and Deutsche Bank.

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However, some analysts view this as a means of the bank cutting costs rather than a move dictated by the DOJ.

"Any reduction in U.S. investment banking operations by Deutsche Bank should be viewed as a proactive way to reduce the risk on its balance sheet (RWAs) to ease pressure on regulatory capital. This announcement may reflect hard negotiations with the DOJ and the expectations that the 5.5 billion euros may fall short of the eventual fine," Rzepkowski said.

She further explained that while there is no doubt that shrinking U.S. business will weigh on future revenues; it could also provide Deutsche Bank immediate relief from capital pressures, which would also reduce dilution risk.

"It is difficult to see how the scaling down of Deutsche Bank's U.S. operations could be part of an impending agreement with the U.S. DOJ. I rather see it as a strategic response to the current challenges faced by the bank."

No bonuses?

Deutsche Bank's Head of Corporate and Investment Banking (CIB) EMEA, Alasdair Warren, told CNBC Wednesday that the U.S. CIB division was an inseparable component of the German bank's offering.

"We have built over the last 15, 20 years a global franchise and if you're going to be globally relevant you have to have a meaningful presence in the U.S. in the same way you've got to have a meaningful presence in Europe - which we clearly have - and a meaningful presence in Asia," he posited.

"That will continue," Warren confirmed.

While markets wait to hear from the DOJ for a final settlement figure, Deutsche Bank is said to have started taking measures to ensure a smooth sail through this crisis. The bank recently also announced a decision to cut 10,000 jobs and put in place a hiring freeze in order to save costs. The bank's CIB head told CNBC Wednesday that expectations among employees in the banking sector have to be much broader than just compensation.

"Compensation dollars or euros at any bank this year with volumes being down are going to be a challenge," he warned.

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