Profit, Not Loss, Thanks to Fair Value Tweak

Deutsche Bank earns $530m after the IASB adjusts a fair value rule, changing a $2.5b writedown to $1.5b.
Marie LeoneOctober 30, 2008

A recent accounting rule change issued by the International Accounting Standards Board seems to have staved off third-quarter trouble for at least one financial institution: Deutsche Bank. The Frankfurt-based bank reported that because it was able to reclassify some assets for accounting purposes, its fair value calculations were limited to a $1.5 billion writedown, rather than a $2.5 billion charge.

As a result, the bank was able to post a $530 million profit for the third quarter, avoiding a loss entirely. Nevertheless, the profit picture was bleak compared to last year, when Deutsche Bank reported $2 billion of net income in the third quarter. This year’s quarterly earnings per share on a diluted basis came in at $1.07, compared to $4.25 for the same period last year. Further, income before taxes was $120 million this year, versus $1.8 billion in 2007.

But the new accounting treatment seems to have bought the bank some time, at least on paper. Earlier this month, accounting regulators from the European Union voted in favor of two IASB fair value rules — IAS 39, the reclassification rule, and a related disclosure rule dubbed IFRS 7. IAS 39 allows companies to reclassify financial assets by moving them from the “held for sale” category to “held for maturity” category. As a result, the company avoids marking the assets to market because any losses are amortized over the life of the loan.

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The reclassification rule mirrors an existing U.S. standard — FAS 115 — and according to IASB should only be applied “in rare circumstances.” Rare, says IASB, may include the deterioration of the world’s financial markets that has occurred during the third quarter of this year.

In addition to the year-over-year results, Deutsche Bank also announced that its Tier 1 capital ratio rose to 10.3 percent, compared to last quarter’s 9.3 percent. What’s more, Deutsche Bank chairman Josef Ackermann said that the bank intends to reduce the size of its balance sheet to further improve its leverage ratio, and plans to “balance [its] dividend policy” by continuing to conserve “capital strength in a highly uncertain environment.”

Looking at the effects of the reclassification amendment on individual business segments, Deutsche Bank noted that for its sales and trading unit, the IAS 39 reclassifications avoided a $683 million negative fair value adjustment. Similarly, in the origination and advisory unit, reclassifications allowed the bank to sidestep a fair value loss of $404 million. In addition, a $189 million downward fair value adjsutment was avoided in the bank’s loan products segment was related to an increase in interest income.