The transactions, which Bloomberg News first reported on July 11, are “offered by banks internationally as part of normal course of business,” Krause said on a call with analysts today. The impact of the loans is “negligible” for Deutsche Bank’s capital ratios and the portfolio has never been “material” since 2008, said Krause, without elaborating.
Deutsche Bank, continental Europe’s biggest bank, is seeking to reassure stakeholders potential losses on the transactions don’t pose a threat amid concern the accounting practice obscures the deals’ continuing risk. The loans for clients that have included Italy’s bailed-out lender Banca Monte dei Paschi di Siena SpA and Banco do Brasil SA were among 395.5 billion euros ($524 billion) in assets that Deutsche Bank excluded from its balance sheet in the first quarter by offsetting them with equivalent liabilities, a person with direct knowledge of the practice told Bloomberg News.
“Any hiding of loans to faltering banks would be particularly explosive as Deutsche Bank already has the highest debt ratio among major banks,” German Green Party member Gerhard Schick, also a member of the Bundestag finance committee, said in an e-mailed response to questions. “These deals aren’t only dangerous for investors, but also for the taxpayers, who would have to stand in in the case of financial difficulties because only little liable capital is available. The public has an interest to quickly get the results.”
Deutsche Bank, based in Frankfurt, reported a 49 percent decline in second-quarter profit today, partly due to higher provisions for legal expenses. Krause, 50, said the company will cut assets by 250 billion euros “over time” to help reduce the bank’s leverage.
The bank’s balance sheet was 1.58 trillion euros at the end of June, when taking into account adjusted assets and the standards of Europe’s latest capital requirements. Under international financial reporting standards, or IFRS, total assets were 1.9 trillion euros. The amount of offset assets that aren’t included in the balance sheet fell to 322 billion euros at the end of June, representing 17 percent of the reported total.
Deutsche Bank relied on what it called “no-balance-sheet usage” to keep loans off its books, documents for the Monte Paschi and state-controlled 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 transactions the bank also dubbed “enhanced repos,” Deutsche Bank was able to sell the collateral, Krause said today, and settles them with cash. Deutsche Bank hedges the “risk inherent in the collateral by selling a credit default swap,” he said.
The sale of securities linked to the collateral in effect moves 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.
Clients benefit by sharing in the proceeds from the CDS sales and by paying “reduced” interest on the borrowings, according to Krause. Under IFRS rule IAS 32, which requires certain financial instruments to cancel each other out should obligations be settled simultaneously or net throughout the life of the deal, Deutsche Bank “has the obligation to account for the net receivable or payable,” Krause said.
Total netted trading liabilities, which include enhanced repos, are about 0.5 percent of the bank’s total net trading liabilities, Krause said.
The loan documents and other published information don’t show how Deutsche Bank’s bets fared or whether regulators were aware of the accounting.
Sven Gebauer, a spokesman for German financial regulator Bafin in Frankfurt, said confidentiality prevented him from commenting on specific companies or transactions.
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