Deutsche Bank Opaque Loans From Brazil to Italy Hide
Risk
Deutsche Bank AG (DBK), perennially among the top
three in global credit markets, made billions of dollars of loans to banks
worldwide since 2008 and accounted for them in a way that obscured their continuing
risk to investors.
Germany’s largest bank managed to lend to firms from
Brazil to Italy while making the transactions disappear from its balance sheet,
even though it still is owed the money, according to four people with knowledge
of the practice and internal documents provided to Bloomberg News.
Deals totaling 2.5 billion euros ($3.3 billion)
involving Italy’s Banca Monte dei Paschi di Siena SpA and Banco do Brasil SA
reveal a technique that obscured Deutsche Bank’s lending reach when it sent
cash to the banks, the documents show. The company had talks about a similar
loan to Dexia SA (DEXB) weeks before that firm was rescued, according to the
documents, and it used the same accounting for other deals through 2011, two of
the people with knowledge of the transactions said.
“We should be very concerned about the opacity and
complexity of these transactions,” said Joshua Rosner, an analyst at research
firm Graham Fisher & Co. in New York who warned in early 2007 that
securities linked to subprime loans posed risks to the economy.
The loans are among 395.5 billion euros in assets that
Deutsche Bank excludes from its balance sheet by offsetting them with
equivalent liabilities, according to a person with direct knowledge of the
practice. Deutsche Bank disclosed the amount for the first time in April under
new international financial reporting standards. The total represents 19
percent of the company’s reported assets of 2.03 trillion euros.
‘Intended Spirit’
Kathryn Hanes, a spokeswoman for Deutsche Bank, said
the Frankfurt-based lender follows accounting rules “meticulously,
conservatively and taking into account their intended spirit” and started
reporting “these positions on a gross basis for even greater transparency.” She
said the amount of any offset loans is “immaterial to our balance sheet and key
ratios.”
Thomas Blees, a spokesman in Berlin for KPMG, which
has audited the lender since 1990, declined to comment.
Deutsche Bank’s accounting for the loans, described in
documents for some deals as “enhanced” repos, reduces reported lending as
co-Chief Executive Officers Anshu Jain and Juergen Fitschen seek to convince
investors the company has enough capital compared with assets to cushion
against losses.
‘Market Risk’
The bank profited from arranging side trades around
the loans, including selling credit-default protection on government bonds
later battered by Europe’s sovereign-debt crisis, according to documents
describing the Monte Paschi and Banco do Brasil deals and three people with
knowledge of the transactions who asked not to be identified because the loans
are private.
The loan documents and other published information
don’t show how the lender’s bets fared or whether regulators were aware of the
accounting.
“They’re running a market risk,” said Theodore
Krintas, managing director of Athens-based Attica Wealth Management, which
oversees 100 million euros, including Deutsche Bank stock. “From an investor
point of view, I’d like very much to know.”
Documents about the Monte Paschi and Banco do Brasil
loans describing completed deals show they were structured to allow for the
offsetting, or netting, of assets against liabilities. Deutsche Bank sought to
use similar accounting for a 2009 loan to Verona, Italy-based Banco Popolare SC
(BP), which like Monte Paschi was later bailed out, according to an internal
Deutsche Bank e-mail and a person with knowledge of the deal.
Increased Netting
Deutsche Bank also had long-term repo deals with three
other lenders -- National Bank of Greece SA (ETE), Athens-based Hellenic
Postbank SA (TT) and Qatar’s Al Khaliji -- according to four people with direct
knowledge of the financings. The transactions involved netting, according to
one of the people, who was briefed on how Deutsche Bank accounted for them. No
documents about the three loans were made available to Bloomberg News.
By the third quarter of 2009, the amount of netting
was expanding at a pace that led at least two senior executives to express
concern that the bank’s assets would increase if they could no longer offset
the loans, the person said.
Deutsche Bank’s Hanes said in a written response to
questions about all six deals that “the information is inaccurate” and
“includes references to purported transactions that never occurred, and in
respect of companies for which we have never structured enhanced repurchase
transactions.”
She wouldn’t specify what information might be in
error or dispute specific deals.
“We do not comment on client transactions,” Hanes
said.
‘Skewed’ View
Every billion euros Deutsche Bank kept off its balance
sheet inflated measures of its financial health, including capital ratios,
which otherwise might have compelled it to raise more money from investors,
according to Thomas Selling, an emeritus accounting professor at the
Thunderbird School of Global Management in Glendale, Arizona, and a former
academic fellow at the U.S. Securities and Exchange Commission.
“Investors are relying on the financial statements for
an unbiased view of the risk of the bank, and that view has been skewed,” said
Selling, one of three accountants who examined deal documents at the request of
Bloomberg News. “It makes their balance sheet look less risky than it really
is.”
Deutsche Bank ranks last among global banks by at
least one risk measure -- the proportion of tangible capital to total assets,
known as the leverage ratio -- according to data as of Dec. 31 compiled by
Thomas Hoenig, vice chairman of the U.S. Federal Deposit Insurance Corp., which
handles bank failures and sets capital levels along with other bank regulators.
Capital Shortfall
Kian Abouhossein, a JPMorgan Chase & Co. analyst
in London, estimated in a July 4 note to clients that Deutsche Bank may face a
capital shortfall of 12.3 billion euros under a proposal by the Basel Committee
on Banking Supervision to include assets that are off banks’ books in leverage
calculations.
Hanes said the company is “among the best-capitalized
banks in the world in our global peer group” after improvements in its capital
ratio and the sale of stock and subordinated debt this year. Chief Financial Officer
Stefan Krause said in an interview with Boersen-Zeitung published July 6 that
the firm would reduce its balance sheet and set aside profit as regulators
implement stricter leverage rules.
Deutsche Bank has ranked among the top three
underwriters of international bonds, excluding self-led deals, since at least
2002 and is first this year, data compiled by Bloomberg show. It also improved
its standing among loan arrangers to third place this year in Europe, Middle
East and Africa, up from eighth in 2008, the data show.
Short Position
Deutsche Bank relied on what it called
“no-balance-sheet usage” to keep loans off its books, documents for the Monte
Paschi and Banco do Brasil deals show.
In a typical secured borrowing, a bank lends cash it
already has, recording the outlay as an asset on its balance sheet. In
exchange, it gets collateral that it holds until the loan is repaid.
In the no-balance-sheet transactions, Deutsche Bank
received the collateral, sold it and used the cash to make the loan. By selling
the collateral -- government bonds, in the deals reviewed by Bloomberg News --
Deutsche Bank created an obligation to return the securities, allowing it to
net to essentially zero its assets and liabilities, the documents show.
The lender in effect created a short position on the
bonds, according to deal memos and internal e-mails about the transactions. In
a short sale, traders sell borrowed securities and expect to buy them back at a
lower price before returning them to the owner.
Selling Collateral
Deutsche Bank was able to sell the collateral because
it didn’t have to return the bonds under the terms of the agreement. Instead,
the borrower agreed that Deutsche Bank could return the “cheapest-to-deliver”
equivalent in the event of default, the documents show.
The German lender sold insurance against possible
defaults of securities linked to the collateral, in effect moving the risk that
the loan wouldn’t be repaid onto its trading book and away from public
scrutiny, according to accountants who reviewed the documents for Bloomberg
News.
Deutsche Bank is shielded from the deterioration of a
government’s creditworthiness because its client would have to post additional
collateral. It was on the hook if the country defaulted on its bonds, the
accountants said.
“It goes against the spirit of any regulation,” said
Arturo Bris, a finance professor at the IMD business school in Lausanne,
Switzerland, who examined the Deutsche Bank documents. “Risks, like energy, get
transformed but don’t disappear.”
IFRS Rules
The deals resembled repurchase agreements, or repos,
in which a borrower sells securities to a lender, promising to buy them back at
a future date at an agreed-upon price. Unlike typical repos, which are reported
as loans and mature in as short a period as hours, the Deutsche Bank trades
lasted five years or longer and weren’t recorded as assets, documents show.
To keep loans off the balance sheet, Deutsche Bank
executives invoked International Financial Reporting Standards rule IAS 32,
which requires certain financial instruments to cancel each other if
obligations are settled simultaneously or net throughout the life of the deal,
the documents show.
“Reporting on a net basis is an obligation, not an
optional accounting treatment,” Deutsche Bank’s Hanes said.
Default Insurance
By agreeing to accept the cheapest asset in the event
of default, Monte Paschi and Banco do Brasil effectively insured the bonds they
gave Deutsche Bank as collateral. They paid interest on the borrowed cash and
kept earning the coupons on the bonds, which they accounted for as still owning
because they were, in effect, due to receive them back, the documents show.
Deutsche Bank in turn earned a premium by acting as a
broker on the default insurance by selling credit-default protection to
investors, allowing the bank to record a profit at the outset. It reaped about
60 million euros that way at the start of the Monte Paschi deal, profit that
was booked by the bank’s rates unit, the documents show.
The deal is described in internal Deutsche Bank memos
as a “structured term” repo. In public filings, Monte Paschi labels the
financing both as a long-term repo and as “total return swaps” in which the
Italian lender receives cash for bonds.
Investors wouldn’t have known the netted-out deals
existed because Deutsche Bank’s regulatory filings describe accounting
practices that indicate it probably was showing the full loan amounts, two
accountants who reviewed the deals said.
Followed Rules
Since 2010, the company’s annual reports have included
repos among the types of transactions it says it normally records in gross
amounts, rather than net.
“Repurchase and reverse repurchase agreements are also
presented gross, as they also do not settle net in the ordinary course of
business,” Deutsche Bank said in the filings.
Still, the company continued to use netting to account
for new long-term repos through at least 2011, according to two people with
knowledge of the treatment. The pace of loans slowed as the European Central
Bank stepped in with its own crisis lending, one person said.
“They cleverly found a way to exploit the law and
followed the rules to the letter,” said Barry Epstein, a principal of forensic
accounting and litigation consulting at Chicago-based Cendrowski Corporate
Advisors, who reviewed deal documents.
The transactions were designed by the company’s
investment bank, whose co-head at the time, Jain, helped build the lender into
one of the world’s biggest securities firms. Jain, 50, was appointed co-CEO of
Deutsche Bank last year.
Monte Paschi
The bank’s 2 billion-euro loan to Monte Paschi in
2008, first disclosed by Bloomberg News in January, is being investigated by
Siena prosecutors because the Italian firm used the transaction to hide losses.
Deutsche Bank hasn’t been accused of wrongdoing in the
matter. The deal “was subject to our rigorous internal approval processes and
also received the requisite approvals of the client,” the firm has said. Jain
declined to comment about the loans to banks.
The documents outlining Deutsche Bank’s design and
bookkeeping of loans to Monte Paschi and Banco do Brasil provide a glimpse of
the other side of such transactions and reveal their deployment beyond Italy.
When credit markets seized up in 2008, executives at
Deutsche Bank’s global rates group in London, led at the time by Michele
Faissola, along with bankers at other units, worked on long-term repo deals to
help quench financial firms’ thirst for cash. Faissola, now the company’s
global head of asset and wealth management, declined to comment.
Dexia Deal
The deals discussed in documents and cited by people
with knowledge of the transactions involved some of the world’s most-troubled
banks and economies at a perilous moment. They included the 2009 loan of 200
million euros to Banco Popolare, which like Monte Paschi took state aid from
Italy.
Deutsche Bank executives approved a similar
transaction with Dexia, the Franco-Belgian lender that was later bailed out,
documents show. In a four-page memo that concludes with the words “Approved 8
August 2008,” the bank’s Accounting Technical Forum described the cash outlay
as a loan.
“DB in effect has a financing transaction and books a
loan to reflect this,” the accounting group said.
A one-page annex explained that Deutsche Bank would
offset the loan with its obligation to return the value of the bonds to
Brussels-based Dexia.
“No such trade was executed between Deutsche Bank and
Dexia,” Hanes said.
Still, the planned financing provided a blueprint
bankers proposed using for future deals, the documents show. A February 2009
memo from the accounting group explained that approval for an enhanced repo
with Banco do Brasil was restricted because of a “limitation of Euro 5bn on the
repo netting determined under the initial Dexia trade approval from 2008.”
Greek Loans
Banco do Brasil, controlled by the Brazilian
government, participated in a five-year deal with Deutsche Bank in 2009, in
which it borrowed about $500 million, according to two people with knowledge of
the financing.
Al Khaliji borrowed $42 million from Deutsche Bank in
2009 in a long-term repo backed by Qatari government bonds, according to an
executive at the Doha-based lender who asked not to be named in line with
company policy.
In Greece, which sparked Europe’s debt crisis by
revealing in October 2009 that its budget deficit was more than double previous
estimates, Hellenic Postbank borrowed at least 100 million euros from Deutsche
Bank, according to two people with knowledge of the deal. National Bank of
Greece, the country’s biggest lender, received 220 million euros, one person
said.
“We cannot give any disclosure or information on that
deal because it was a bilateral transaction between banks,” said Petros
Christodoulou, deputy CEO of National Bank of Greece.
Harris Siganos, CEO of state-controlled Hellenic
Postbank, declined to comment, as did spokesmen for Banco Popolare,
Brasilia-based Banco do Brasil and Dexia.
Bafin, Bundesbank
The documents reviewed by Bloomberg don’t indicate
whether regulators in Germany or elsewhere knew about the deals. Sven Gebauer,
a spokesman for German financial watchdog Bafin, said confidentiality prohibits
the regulator from commenting on specific companies or transactions.
Ute Bremers, a spokeswoman for Frankfurt-based
Bundesbank, Germany’s central bank, declined to comment, as did John Nester at
the SEC in Washington. A spokesman for the London-based International
Accounting Standards Board, which sets rules, said the group doesn’t comment on
how they are applied.
Project Santorini
“The figures should be disclosed,” said Edgar Loew, an
honorary professor at WHU-Otto Beisheim School of Management in Vallendar,
Germany, who examined the Deutsche Bank documents for Bloomberg News. “This
type of accounting was not intended by the rules.”
Loew, who previously held positions at KPMG and
Deutsche Bank, said he wasn’t involved in preparing the bank’s public filings
that would have addressed such deals.
By the end of 2009, the European debt crisis had set
in, pummeling the bonds underlying some of the agreements and eroding the
capital of banks, including Monte Paschi, which used a cash-for-bonds
repurchase agreement with Deutsche Bank to conceal about 429 million euros of
losses.
Siena prosecutors are scrutinizing the deal, dubbed
Project Santorini, as part of probes into fraud, false bookkeeping and
obstruction of regulatory supervision at the world’s oldest bank, court papers
show. The Italian lender restated accounts and, as of March 31, had to post
939.1 million euros of margin, or guarantees on the Deutsche Bank transaction,
which includes an interest-rate swap, Monte Paschi said on April 24.
‘Grave Concerns’
By this year, even the off-balance-sheet lending
couldn’t spare Deutsche Bank from the need to raise more money. It sold almost
$3.9 billion of shares in April and about $1.5 billion of subordinated debt in
anticipation of stricter capital rules.
Shareholders can be certain of a lender’s health only
if they understand the activities a bank engages in, said Christopher Wheeler,
an analyst at Mediobanca SpA in London.
“There’s been a lot of noise around the tools used by
the bank to boost capital and reduce leverage since the crisis,” Wheeler said.
“If this particular kind of mechanism were found to have been used, there would
be grave concerns about whether its current capital and leverage ratios are a
true reflection of the bank’s financial position.”
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