Deutsche Bank’s notional derivatives book had huge swings in notional value between its year-end 2014 report and its “passion to perform” year-end 2015 report.
Deutsche Bank did not list the notional value of its derivatives book in its 2016 Quarterly Report.
The bank would like us to take it on faith, that the positive value of its derivatives book is €615 billion while the net positive value of its book is around around €18 billion.
There’s just one little problem: the market believe something is wrong. What is it? Derivatives or something else?
Reader Lars writes
Hello Mish,
I’m investigating changes in Deutsche Bank’s derivatives book.
At 2014 year end, DB had derivatives which notional value was €52 trillion. The positive value was around €630 billion.
At 2015 year end, DB had derivatives which notional value was €42 trillion. The positive value was around €515 billion on total assets of €1.629 trillion.
So during 2015 derivatives exposure (notional) was reduced by €10 trillion or 19%.
As of June 30th 2016, DB does not give a number for notional value but the positive value has again increased to €615 billion. Total assets are €1.8 trillion.
Meanwhile the the net positive value of DBs derivatives portfolio is stable around €18 billion.
What’s Happening?
It is possible that DBs derivatives portfolio has increased in value by €100 billion, roughly 19% in 6 months without the notional amount going up correspondingly?
Did DB offload €10 trillion worth of notional derivatives before year end 2015 only to pad it back later?
Book equity is €67 billion but it’s trading at a 75% discount. The market values DB at €16.5 billion.
Tier 1 bond holders say pretty much the same thing. Bonds sell at a 22% discount to par.
Lars
Comments from Matterhorn Asset Management
I was involved in a three-way email conversation on Deutsche Bank with Lars and Egon von Greyerz at Matterhorn Asset Management AG.
Von Greyerz chimed in with …
Thank for this Lars.
I would not be surprised if they are moving balance sheet risk to derivatives. This is a very common trick to reduce official exposure. Greece did this with the help of Goldman Sachs.
Share price confirms something is seriously wrong.
I saw the “Big Short” for the second time on Saturday. It’s a great film. I told my wife that what happened in 2007-2009 is a walk in the park compared to what we will see next. It’s only a question of when.
Still only 0.5% of world financial assets are insured in the form of physical gold. Investors think that trees will continue to grow to heaven. What a shock they will get.
Kind regards
Egon von Greyerz
Founder & Managing Partner
Matterhorn Asset Management AG
GoldSwitzerland
Accounting Methodology Change
I dove into Deutsche Bank’s 4Q/FY2015 Presentation which contained these statements on various pages.
- Continued strong de-leveraging in the quarter of EUR 44 billion on an FX neutral basis, principally in derivatives.
- Full year 2015 de-leveraging of EUR ~130 billion on an FX neutral basis.
- Equity Derivatives significantly lower y-o-y driven by lower client activity exacerbated by challenging risk management in certain areas.
- Lower loan loss provisions reflecting portfolio quality and the benign economic environment.
- Despite adverse FX impact, non-interest expenses decreased mainly due to lower litigation and performance-related expenses.
- De-risking activity was the main driver of Balance Sheet reductions in 4Q2015.
Consolidation & Adjustments
Income before income taxes (IBIT) does not look pretty, to say the least. And what’s with these accounting methodology changes?
Lower loan loss provisions? In this environment?
Price-to-Book Value
Chart from Y-Charts.
Competitor Price-to-Book Values
Price-to-Book Values US Banks
I do not know if the problem is derivatives, the eurozone mess, negative interest rates, counter-party risk, or some combination of the above, but the above images collectively say something is seriously wrong, not only with Deutsche Bank, but the European banking system in general.
For more on the European bank mess, please see …
- Diving Into Deutsche Bank’s “Passion to Perform” Balance Sheet.
- Italy’s Zombie Banks on Death Bed, Bail-Ins Coming?
- Atlas Rescue Phase II: Italy Eyes Another Private Deal to Bail Out Banks
Mike “Mish” Shedlock
Is Deutsche Bank cooking it’s books? Mike, that’s the funniest headline I’ve read in years. Thanks for the laugh. I can’t stop grinning. Really!
USA.gov is trying to hit DB with a fine of $14 billion, which is roughly the amount the market values the equity. Post paying the fine, DB stock should be approaching zero. Any price above Zero is overpriced for DB. Whatever deleveraging is going on, no way it can be fast enough to avert a collapse when the bank is under attack on so many fronts. There were fines for the phony gold price fix “scandal” and now USA.gov blaming the mortgage fraud in the USA on DB. I mean, really. It is liking a horde of hungry mosquitoes sucking all the blood out of the bank. Perhaps Merkel is in on it, figuring a bail-in of DB depositors would legitimize an EU-wide simultaneous bail-in of Italy, Spain, France, Netherlands, Portugal, and any other banks holding depositor money. I smell a giant scam, like Ponzi, John Law and the Mississippi Company on steroids.
USA.gov will just keeping withdrawing money from DB, as they are a gold mine of derivatives to mine for fine revenues. Fines are the way to go, as USA.gov does not have to first deposit money in the bank. Fines are a free withdrawal of money. It is a wonder that the German government is letting all the wealth be siphoned out of its bank into the USA Treasury rather than add the fines (German money) to the German Treasury.
Merkel and Hillary ought to get married, the modern version of Cleopatra and the Roman leaders. It would make for 4 years of good tabloid entertainment, while DB and the EU crumble.
The only question that matters is will ECB be able to bail them out? If so all this does not matter. After all it is the tax-payers who are going to pony up.
As an honest answer to Lars. Coming from someone who regularly analyzed large derivative books. You are missing all information to make any analysis. But it is completely possible for notional to sewing that much while positive does not. Notional means very little when it comes to a derivatives book. Now in this instance, is this the case? Good question but I nor you have any ability to know the answer.
Sure, and Occam wouldn’t have known the answer either. But he would have had a strong, well-founded suspicion…
My friend, using a change in notional to opine about change in positive, is not a well founded suspicion. It is simply confirming, to someone who understands this, that you have no idea what you are saying.
Not that you are wrong, just that metric won’t tell you anything.
i.e, If I am short, and notional exposure drops, I am making money. See the problema.
To wrldtrst. I look at a few facts and question what is happening. Wild swings in positive/negative value does not mean anything?
May or may not. Probably a problem. But fact is if I sell you 1,000 contracts at 10, my notional is 10,000 and my positive is 0. If price goes lower tomorrow to 5. Nominal becomes 1,000 times 5, or 5,000. But yet I went positive 5,000 as nominal dropped. Just simply saying that one cannot confirm one with another.
I don’t work anymore, so I can’t find out.
…and I did not mean to be insulting with the lack of knowledge comment, few should be expected to understand this stuff.
wrldtrst, yes, I am only scratching the surface but I observe fluctuations where there seem to be a stable link between notional and positive value (balance sheet item). Notional goes down 10 trillion in 2015. Then in 2016 positive value increases by 20%. Notional is probably up at 50 trillion again.
Net value remains constant.
Yes, I may be wrong, but based on past facts I am probably right.
Banks have been closing their exposures to each other, and also via tri-party systems. Banks submit their derivatives books to each other to a 3rd party, and in case that you have transitive chains such as A->B->C, the tri-party system can offer suggestions as to which contracts to close, then it’s up to the banks to either accept in full or accept in partial the submissions and send it back and execute. The kicker is, different banks have different degree of models to price assets. Some banks with better models, GS, JPM and now MS were taking advantage of this and also making a little bit of money. While I don’t think that it would account for all the profits claimed, it does add to it while decreasing exposure. Maybe EU bonds being at record low yields is also another program to save EU banks via temporary earnings (from increase in book value of bonds/swaps held)
i think you must have been reading recent article by Reggie Middleton
“It Appears Deutsche Bank Is Prepping for an Avalanche of Fraud Charges Including It’s Gold Derivative Products?”
http://www.zerohedge.com/news/2016-09-04/it-appears-deutsche-bank-prepping-avalanche-fraud-charges-including-its-gold-derivat
quote “Well, everybody already knows that Deutsche Bank is a basket case, but we are showing our clients that the real short opportunities and true systemic risks lie within DB’s counterparties, whom have identified and are in the process of putting share price targets on.”
Derivatives serve no useful purpose to voters. Any financial company that voters are expected to bail out should be forbidden from writing derivatives. AIG set the pattern for bailouts, and now other financial companies think that they too will be able to force voters to bail them out.
Here we go again. The institutions are big boys. Let them pay and fail if that is the option. Financial sector has been coddled for too long. Their shenanigans and greed and greed induced behaviour has gone on for too long.
Always funny watching guys that have zero accounting background, financial statement analysis skills or derivatives knowledge try and “investigate” one of if not the most complicated set of financial statements on the planet. The effort is pointless without the underlying schedules that roll up into the disclosed financials.
So, in other words, “Move along. Nothing to see here”?
Not nearly as funny as watching stocks get marketed to people that have zero accounting background, financial statement analysis skills or derivatives knowledge.
Irregardless, DB needs to raise capital pronto
I suspect that no one ultimately makes money on these derivatives. I you are smart enough to be making money reliably then the counter party must eventually go broke and will not honor the contract. A lot of dust created but no profit ?
Actually, a lot of it is physical risk transferred by real physical companies towards a bank trading desk that then manages that risk. Think of it as a form of structured insurance on risks that need to be managed in a customized fashion. Bank takes on risk at perceived edge, and company can focus on operations.
You keep buying health and car insurance, don’t you?
I see- so quality of underwrighting equals quality of bank profits from derivatives. I guess it makes sense. Sceptical about whether banks can do that well given their recent performance. Certainly it should be bank capital taking the risk rather than bank deposits earning no interest.
Deutsche “Kreditanstalt” Bank
So who do they “off load and unwind” to?
Don’t those guys read the papers too.
This has been happening in the global banking industry for years.
Monkey see, Monkey do.
Its very clear that none of the talking heads have any idea what a derivative is, or the difference between “Notional” and “Risk”.
By way of background, German Banks do not get to net long and short derivatives under the same ISDA to the extent that US Banks do. The Germans like to see the courts having agreed that netting is applicable under an ISDA in a few bankruptcies before they allow for ISDA netting in reg reporting. So as a starting point German banks always look worse on paper. So if DB is long a swap with JPM and short the same swap with JPM it could show up as having one side as exposure, when in reality it has near zero exposure ( coz US Courts have accepted ISDA netting agreements as valid). Likewise if DB is long a swap and short the futures strip ( thus having only a relatively small basis risk) that also probably shows up as 1x the exposure as opposed to near zero.
What is worse, all the big banks have less than perfect reg reporting systems. They fail to fully net the internal corporate relationships and thus DB can be long and short to itself and record both sides of the internal trade as ‘Gross Notional Assets’. Do this a few hundred thousand times, and not get around to tearing up the matching contracts and Gross Notional Assets balloon to the moon. Why would they want to let this happen. Partially it was because Banks didnt care about Gross Notional Assets pre the GFC, and partially it was because idiots in the ‘C” suite liked to talk about how ‘big’ they are.
So Gross Notional means very little. What you care about is exposure net by counterparty, and some measure of how safe the netting agreement is in each country ( just in case the local court tries to cherry pick a pair of matched contracts) to risk adjust this.
Next part. Gross Notional does not equal risk. If you look at the DB reports you see that most of the Gross Notional Exposure is in interest rates < 1 year (note that is not 'credit' which is hard to value but libor and govt rates which are reasonably easy, all libor jokes aside). And if you look closer you will see that a stack of the exposure is to CCP's – ie central counterparties, so it appears that they might have OTC's (swaps) hedged with Futures,
or they have finally started to register swaps with the CPP's.
How much actual dollar risk is there in a billion of notional interest rate risk < 1 year where you are naked long or short? Not as much as ' a billion' would lead you to expect.
For starters the average duration of the risk < 1 year is probably way less than 6 months but lets just assume its 6 months to make this easy. So if rates jump 1% in one step then you have 1billion*1%*0.5 = 5million loss. Run these numbers on the net position and it all looks a lot more pedestrian.
As time goes by DB's book rolls down and the trades that net off expire thus automatically reducing the Gross Notional, along with any residual credit risk on the trades, and P&L falls into cash ( its hard to get cash wrong ).
So DB is not as exposed to market price moves as the tin hats would like you to believe.
But if DB were to go, it would be a shit show. Post Lehman they wont let that happen again, DB's share price reflects the level of dilution a large and forced government injection of equity capital would do to existing shareholders.
DB needs to get its netting under control, they need to do tearups of back to back contracts that dont get netting benefit, and most importantly they need to get costs under control.
As to the 14Bn, thats just daft. If you look at the size of books, and how un agressive DB was vs the US Banks then the number 'should' be in the 1-2Bn range. But its an election year, and we all know what happened last time we had a contested US election (2008). Plus political careers have been made on beating the shit out of banks, its a tried and tested road.
The DOJ should be looking to jail a few people, instead of taking cash from innocent and long suffering DB shareholders.
Excellent comments
Thanks
But something is wrong.
The market says as much.
I failed to add Italian bank or loans to the list.
Most likely it is a combination of things.
Mish
Whats wrong is Cryan is an accountant, nothing wrong with that he is a bloody good one, but its not the vision end of Investment Banking . Cryan should be CFO, COO or Chairman of the board but CEO material for DB sadly he is not and the shareprice reflects that.
Italian Banks and loans, yup they’re a problem, but a survivable one ( you might find the quiet hand of the German Govt involved in how they got there). A bank run based on misreading the data, that could be game over.
The reality today is that everyone cooks the books.
For many, it does not materially affect the ‘value’ of the firm.
For most, it is to ‘prevent’ questions being asked.
However, when it comes to ‘derivatives’, no matter how you present them, ‘true value’ or ‘true liability’ is difficult to assess as COUNTER-PARTY-RISK is present.
For the most part the book is just winding down, same as JPM,
the madness was in the 2003-2008 period,
those deals eventually mature and the result turns into cash (cash is hard to fake)
sometimes its cash into the bank, and sometimes its not.
Also a lot of deals just net out, and there is a process run by a company call TriOptima that basically says,
DB has a peanut butter sandwich,
JPM has ham on rye,
and HSBC has a donut.
JPM hates ham, loves peanut butter, DB loves donuts and HSBC just needs lunch and a date for the middle school dance,
so TriOptima arranges for DB to give JPM the peanut butter sandwich, HSBC to give DB the donut, and HSBC gets a ham on rye and … a DB’s little sister as date for the school dance.
Oh and ‘no backsies’.
Err, the above was a response to Mission Accomplished’s question
So who do they “off load and unwind” to?
Don’t those guys read the papers too.
I really need to learn how to post to blogs
Other point is the state of the German banking market. Whopping great derivative numbers are scary and make headlines (looking at you, Zerohedge) and @fatman is right as regards the workings of the derivative market — it’s not as toxic or as dangerous as Joe Public seems to imagine (though you can still lose loads of money). Imperfect hedges are probably more of a danger than full-on book-cooking.
DB’s big issue is that it doesn’t have a business other than investment banking, and everyone knows how much investors love that trade. No one knows anymore what DB is for. Retail banking in Germany just doesn’t make money, so it can’t turn to that. That explains CBK’s soggy price-to-book, too.
((BTW, here are DB’s derivative numbers for June 30, 2016: https://www.db.com/ir/en/download/FDS_2Q2016.pdf See p. 15. ))
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Hey Mish,
Just realized this, but, the mortgage fraud lawsuit by US Gov. is $14 Billion. DB’s market cap is only $20 Billion, $14 Billion is 70% of market cap. Plus the items you detail below. DB is in need of a state bailout.
DB can chose to exit USA financial markets and ignore the fine.