An investigation carried out by the SEC found that the German lender overvalued a portfolio of derivatives comprising ‘Leveraged Super Senior’ (LSS) trades in its credit correlation book.
Using these leveraged trades, the lender bought protection against credit default losses creating a ‘gap risk’ that the market value of its protection may go beyond the available collateral at some point.
SEC said in a statement that because the trades were leveraged, the collateral posted for these positions by the sellers was only 9% of the $98bn total in purchased protection.
Deutsche Bank was protected only up to the collateral level and not for the full market value of its credit protection.
By adjusting down the value of the LSS positions, Deutsche Bank initially took the gap risk into account in its financial statements.
At that time when the credit markets weakened the bank modified its methodologies for measuring the gap risk.
This is said to have minimized the value assigned to the gap risk until the bank stopped adjusting for gap risk altogether in due course.
According to internal calculations, Deutsche Bank estimated that during the financial crisis it was exposed to a gap risk ranging up to $3.3bn.
SEC Division of Enforcement director Andrew Ceresney said: "At the height of the financial crisis, Deutsche Bank’s financial statements did not reflect the significant risk in these large, complex illiquid positions.
"Deutsche Bank failed to make reasonable judgments when valuing its positions and lacked robust internal controls over financial reporting."
The bank said it has improved policies, procedures and internal controls with regard to the illiquid assets valuation since the financial crisis.
Image: The headquarters of Deutsche Bank in Frankfurt. Photo: courtesy of Thomas Wol
