When it agreed to settle its subprime mortgage case with the Department of Justice, Deutsche Bank agreed to give $4.1 billion of relief to borrowers over at least a 5-year period. However, in an effort to avoid using its balance sheet to buy soured mortgages that it can partially forgive, the bank is considering another approach to meeting that requirement - lending money to private equity firms and hedge funds. Under this option, DB would lend to firms like Lone Star Funds, which specialize in buying bad mortgages from government auctions and lowering consumers’ obligations.

However, it’s not clear that the government would allow Deutsche Bank to get credit for borrower relief by financing these funds. 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.

Presuming the government says ‘Okay’ and Deutsche Bank does go this route, … 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 EVP at the National Community Stabilization Trust, a nonprofit that focuses on housing. 

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 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. A spokesperson for Lone Star said that the company 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. It has kept more than 54,000 people in their homes since 2008.