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RBS Next In Line For The DoJ?

29 September 2016 by Gary Kirk

Earlier this week we mentioned the market was lacking a clear directional catalyst, but that the impending fine sought by the US Justice Dept (DoJ) against Deutsche Bank for US mortgage malpractices was having an adverse impact on financial credit spreads. As we mentioned, the initial opening gambit of $14bn proposed by the DoJ is almost certainly going to be tempered as negotiations between the two sides reach a conclusion. However, even though the final settlement is likely to be less than the initial headline, it is still going to be a significant blow to the balance sheet of DB, and the management will be challenged to find a short-term solution to restore the CET1 ratio back to a healthy level.

A large number of uncertainties are looming, which may or may not have an adverse impact on investor sentiment over the next few months. For the financial sector the threat of litigation has been an ongoing theme for a number of years and although this is largely drawing to a close, there are still some key events to be concluded, including the finalisation of the settlement for DB. For us though the bigger event has yet to come under the spotlight , namely the DoJ case against the UK’s RBS.

As RBS only issued its most recent AT1 deal on 15 August this year, it suggests that the DoJ can only be at the very early stages of its investigation (otherwise RBS would have been restricted from issuing); so the headline frenzy we have seen for DB is unlikely to start for RBS for some time yet. However, when we look at the numbers that the DoJ are basing their claims on it makes for a sobering read. The volume of MBS complaints in the original claim against JPM was $33bn, which led to an FHFA (the Fannie Mae & Freddie Mac conservator) settlement of $4bn and a DoJ settlement of $13bn – although some legal commentators suggest JPM were dealt with less severely as they were the first major bank to settle. Deutsche Bank had $14.2bn of MBS in the FHFA complaint, of which they have settled $1.93bn with FHFA directly and are negotiating the final settlement with the DoJ – the number creating the current uncertainty. RBS has $32.1bn of MBS in FHFA complaint (i.e. similar to JPM), suggesting the potential settlement, particularly from the DoJ, could be a very punitive number, which we would rather not speculate on here. It does however leave us cautiously watching from the side lines regardless of the attractive yields currently offered in the name.

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