Recently, the U.S. Department of Justice slapped a $14 billion fine to Deutsche Bank due to sales malpractice that eventually paved the way to the 2008 financial crisis. The bank claimed that it does not intend to settle the fine anywhere near that amount. Negotiations, however, are still ongoing, and as of this date, the bank expects U.S. authorities to eventually lower the initial demand. But, to add salt to injury, the German financial giant also lost its position in the list of New York’s most active commercial real estate lenders for this quarter. How did this all start, and what does it mean for U.S. real estate? Here’s what you need to know.
How did it start?
Over a decade ago, banks sold residential mortgage-backed securities in packages to people who face financial challenges, so when the bubble burst after 2007, a lot of them were unable to pay for these. This was a huge blow to the banks. Normally, a bank needs a certain amount of capital in order to pay back loans, but because unpaid mortgages led to insufficient capital, the banks could not pay for their losses. They had to be bailed out, and this led to the 2008 U.S. Recession.
Since then, the U.S. Federal Reserve has been investigating the banks that were involved in these sales. To government officials, selling packages without warning clients of the potential risks is considered fraudulent, so these big banks are expected to be charged for malpractice. In 2013, J.P. Morgan had to pay $13 billion, and in 2014, Bank of America issued $16.65 billion. It’s 2016, and now, the Department of Justice is demanding Deutsche Bank to pay the price. Unlike the previous banks, however, a settlement of $14 billion will only add to the growing list of complications that Deutsche Bank is facing.
The Case of Deutsche Bank and its Effect on U.S. Real Estate
Until now, Deutsche Bank has been an active lender in U.S. Real Estate. On record, it assisted in financing high profile properties such as 3 Bryant Park and acquisitions like the 41-story tower from Blackstone for $2.2 billion. Outside New York, it financed properties in places like Illinois where it issued $106 million for four industrial properties.
However, Deutsche has been undergoing a lot of turmoil. Since the Recession, frequent changes in leadership and several attempts to restructure operations were made. Despite these efforts, it failed the Federal Reserve’s stress test in capital planning—an announcement that was made shortly after the Brexit. To make things worse, the bank faced several lawsuits, including the manipulation of Libor rates which enabled the bank to make a huge fraction of its money until now. Currently, Deutsche shares are at €12.24, and with the loss of 46% of its market value, it has become the fourth worst performer on the Bloomberg Europe Banks and Financial Services Index. Deutsche’s situation is delicate, to the point that the International Monetary Fund predicts that its collapse can possibly trigger another financial crisis.
With such issues, the $14 billion penalty against Deutsche Bank may ultimately cripple the bank into insolvency. The bank already admitted to having low capital after further investigations showed that it hid a $12 billion loss in order to avoid a bail out. Now, Deutsche is desperately trying to raise its capital. It has already started to cut 9,000 employees, and operations have ceased in 10 countries. At the same time, Deutsche has been placing its assets on sale, such as Abbey Life which was sold to Phoenix Group for £935 million ($1.2 billion). The German bank has even considered shrinking U.S. operations in the future in order to cut costs.
Deutsche Bank may not be the only one to suffer from litigations. With the investigation of operations involved with the financial crisis still ongoing, other major European banks such as Barclays, the Royal Bank of Scotland and Credit Suisse may also face future penalties which can potentially hurt them as players in the country’s real estate industry. Shrinking business operations and expensive penalties against them can sharply reduce their lending power, causing the biggest headaches to those who are in need of those loans. Acquisitions can be much more difficult for new businesses that are hoping to secure a mortgage loan to finance their office spaces. Developers may suffer from headaches, calculating construction costs while considering the new limits to the loans that they can receive. As a result, new developments in real estate can be stalled, creating imbalance in a market that continues to demand for its supply.
Ultimately, the fall of Deutsche can be synonymous to the next Great Recession. The circumstances may be different, but the effects of real estate can be the same, if not more deadly.