Deutsche Bank is considering an unusual approach to providing relief to subprime mortgage borrowers as part of a $7.2 billion settlement with the U.S. government: lending money to private equity firms and hedge funds.
Germany’s biggest bank, dogged last year by questions about its capital levels, is exploring ways to avoid using its balance sheet to buy soured mortgages that it can partially forgive, according to a person with knowledge of the matter. One option it’s reviewing is to instead lend to firms like Lone Star Funds, which specialize in buying bad mortgages from government auctions and lowering consumers’ obligations. Amanda Williams, a spokeswoman for Deutsche Bank, declined to comment.
Preliminary terms of the agreement with the Department of Justice included $4.1 billion of relief to borrowers over at least five years, Deutsche Bank said last month. The bank is still finalizing the settlement that resolves a years-long U.S. investigation into its dealings in mortgage-backed securities. It’s not clear that the government would allow it to get credit for borrower relief by financing these funds, the person said. Other banks that have settled with the U.S. have bought loans, or have received credit for modifying loans they made themselves, even if they no longer owned them.
“Lending money to private equity or hedge funds would tie up a vastly smaller amount of capital than taking a soured security onto the balance sheet and writing it down to basically zero,” said Piers Brown, an analyst with Macquarie Bank Ltd. “The question is, will the DOJ accept this? They have accepted a lot of fudges from banks before and it would be weird for them to tighten on Deutsche Bank.”
If Deutsche Bank does go this route and the government approves it, the deal could draw protests from consumer activists who argue that banks have not done enough to provide relief to borrowers. Investors have had no trouble getting funding to buy bad loans from Fannie Mae and Freddie Mac, and the government doesn’t need to encourage banks to finance those bids, said Julia Gordon, an executive vice president at the National Community Stabilization Trust, a nonprofit that focuses on housing.
The bank may also look to get credit for any prior financing it provided to investors like private equity firms, the person said, asking not to be identified because the matter is not public. The Justice Department declined to comment.
Deutsche Bank’s settlement is the latest in a string of deals with big banks designed to hold the lenders accountable for excesses in mortgage-backed securities that helped inflate the housing bubble. The Department of Justice has extracted more than $50 billion from banks in these agreements. The German bank’s deal features more consumer relief in percentage terms than prior settlements, which helped lift the company’s shares when it was announced late last month.
The borrower relief provisions of these settlements have garnered criticism from investors, community groups and others, which have said that the banks have not had to bear the burden of the aid offered. Bank of America Corp., for example, received credit for relief on loans it originally made but had sold, and that others had modified.
Lawmakers including Elizabeth Warren joined with consumer groups in 2015 to criticize the kind of government auctions where Deutsche Bank would be funding bidders, saying that investment firms that buy soured loans often rush to foreclose on borrowers instead of modifying their mortgages. The agencies that run or help oversee the auctions — including Fannie Mae, Freddie Mac, their regulator the Federal Housing Finance Agency and the Department of Housing and Urban Development — have changed the rules to make it easier for nonprofits to buy loans. A spokesman for HUD referred to an October 2016 report that shows that the agency has been reaching out to nonprofits.
It may make sense for banks to have an incentive in their settlements to work with nonprofits in auctions rather than investors like private equity firms to earn credit for mortgage relief, said National Community Stabilization Trust’s Gordon.
“It’s outrageous to get credit for financing private equity firms,” Gordon said. “I don’t see how that helps the public good.”
One of the firms that came up in Deutsche Bank’s internal conversations about the settlement is Lone Star Funds, which is among the most active at the auctions, the person said. The Dallas-based private equity manager won $3.9 billion worth of mortgages during a single sale in 2014. The firm has been described by its own investors as “one of the best, if not the best” in the business of profiting from soured home loans.
Lone Star believes there is an opportunity to repair abandoned houses and modify mortgages to keep borrowers in homes, and that it views foreclosure as a last resort, said Christina Pretto, a spokeswoman for the company. It has kept more than 54,000 people in their homes since 2008, she said.
Deutsche Bank is looking to avoid directly holding subprime mortgage assets because under new regulations the loans must be funded with relatively high levels of capital. Investors and analysts fretted about Deutsche Bank’s capital levels for much of last year, although the European Central Bank eased some requirements for the bank last week.