Deutsche Bank Probing “Misstated” Derivative Valuations After Finding “Divergences”

Deutsche Bank Probing “Misstated” Derivative Valuations After Finding “Divergences”

by Tyler Durden
Oct 26, 2016 11:28 AM

Perhaps the single biggest reason why Deutsche Bank’s stock has been drastically underperforming most of Europe’s banks, in addition to its skyhigh leverage and lack of capital buffer, is the market’s concern about what is hidden on its books, namely whether the bank’s billions in loans and its trillions in derivatives have been marked correctly. Which is why a just released report from Bloomberg that Deutsche Bank is reviewing whether it “misstated” the value of derivatives in its interest-rate trading business, will hardly spark optimism in the bank’s critical asset marking practices; the good news is that according to the report the biggest German lender is sharing its findings with U.S. authorities, according to people with knowledge of the situation.

Zero-coupon inflation swaps are derivatives that help customers bet on, or hedge against, inflation. Two parties agree to exchange a payment in the future whose size is determined by how much an inflation index rose or fell. The issue, however, is not the underlying security, but the total notional involved, which based on the DB’s latest public filings, could be in the hundreds of billions (or more), and how substantial the impact on DB’s P&L any variation from true market values will be.

Specifically, DB is looking at valuations on a type of derivative known as zero-coupon inflation swaps. The reason for the probe is that, as has been a recurring case with many of its peers of the last few years, the bank found valuations that “diverged from internal models” at which point it began questioning traders.

The push to finally open its books comes after CEO John Cryan’s vow in February to try to resolve his institution’s legal challenges swiftly. As Bloomberg sarcastically adds, “he is still working on it.” The bank has been facing regulatory and enforcement pressure around the world, including a money-laundering investigation tied to its Russia operations, inquiries into mortgage-bond trading before and after the financial crisis and charges that the bank colluded to help falsify the accounts of Italy’s Banca Monte dei Paschi di Siena.

More importantly perhaps is the reason why DB has decided to share its internal probe with the US, whose Justice Department asked in September for a $14 billion settlement, an amount the bank said it wouldn’t pay. The figure was big enough to unleash a selling frenzy in the stock, sending it to all time lows, leading to repeating rumored discussions with outside sources, most recently of Saudi and Chinese origina, about raising capital.

The bank last year hired Steven F. Reich as its general counsel for the Americas to help navigate its legal probes. Reich is a former official at the Justice Department and attorney for former President Bill Clinton.

Perhaps it is time for Deutsche to make some donations to the Clinton Foundation?

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