Deutsche Bank’s Mortgage Suit Exposes Risks to $61 Valuation

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Deutsche Bank

Deutsche Bank (NYSE:DB) has taken some lumps recently. The German investment bank has been sued by the European financial group Dexia for losses incurred on bonds worth $1 billion that the latter bought from Deutsche Bank before the global economic crisis of 2008. [1] The bank is already trying to address growing concerns among investors about its overall performance triggered by the revelation that it had lost the top spot in the German IPO market to Goldman Sachs (NYSE:GS). We detailed this in our article Goldman Trumps Deutsche Bank in Recovering German IPO Market. Deutsche Bank also competes with other global investment banks like Credit Suisse (NYSE:CS), UBS (NYSE:UBS), JPMorgan (NYSE:JPM) and Morgan Stanley (NYSE:MS).

We have a $60.80 price estimate for Deutsche Bank –  which is at a 15% premium to the current market price of the stock.

Blame it on the mortgages

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Dexia is a key lender to local municipalities in France and Belgium and had to be bailed out by the French and Belgian governments along with key shareholders after the 2008 global economic crisis. The company also borrowed substantially from the U.S. Federal Reserve to stay afloat.

Dexia believes that it was misled by Deutsche Bank, which sold bonds packaged by U.S. sub-prime mortgage loans so that it could dispose off “rapidly deteriorating loans on unsuspecting investors.” Dexia had bought such bonds to the tune of $1 billion from Deutsche Bank which turned to junk during the crisis in spite of the triple-A ratings they carried when they were bought.

The company opines that Deutsche Bank knew that the mortgages would end up worthless very soon – an argument they back with the information that the bank entered into a short position on the same mortgages for a value no less than $10 billion.

So what will this mean for Deutsche Bank?

The sales & trading division is the second most valuable business for Deutsche Bank according to our analysis, contributing to more than a quarter of its $60.80 value. While a loss in this lawsuit would not in itself be a major financial cost for Deutsche, it can have a serious repercussion.

If the allegations that Deutsche Bank misled customers into buying high-rated bonds it knew were junk, then this may open the door for other customers who also bought these bonds to put in their claims. Deutsche may very well end up settling all these claims, besides facing fines and other legal proceedings from regulatory authorities.

See our full analysis for Deutsche Bank.

Notes:
  1. Dexia sues Deutsche Bank over mortgage bonds, Reuters, Jul 14 2011 []