ACCT1511 TOPIC 10 HOMEWORK

SEMESTER 2, 2013 QUESTION 6 (3 MARKS)

[GROUP 1]

(a) “Deutsche's leverage ratio stood at 1.63 percent, according to Hoenig's numbers, which
are based on European IFRS accounting rules as of the end of 2012.” Explain why Hoenig
thinks this means that Deutsche Bank is undercapitalized. (1 mark).

It only requires a 1.63% fall in value of Deutsche’s assets for it to go bankrupt – a very small
buffer.

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(b) “Using U.S. generally accepted accounting principles, the ratio stood at a much more
comfortable 4.5 percent, Krause said.” Considering the different results between IFRS and
US GAAP, explain the benefit of Australia’s adoption of IFRS (1 mark).

Adopting a global uniform GAAP would benefit international investors in Australian

companies otherwise different accounting standards can give different results in reported
financial statements as can be seen from Deutsche’s different leverage ratios.

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[GROUP 2]

(c) “The difference is due to the way derivatives on a bank's books are measured. Neither
number directly corresponds to the Basel leverage ratio, which calculates capital in another
way ...”. What does this tell you about the risk from derivatives on the balance sheet of
Deutsche Bank? (1 mark).

That the value at risk from derivatives is difficult to price.

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(d) “Deutsche Bank this year is almost done raising 5 billion euros ($6.67 billion) in new debt
and equity, boosting its core capital ratio to around 9.5 percent, which it says has made it one
of the best-capitalized banks among its peers.” What inferences could you reasonably make
about its capital position from this action taken by Deutsche Bank? (1 mark).

That it likely believes that its own capital position is not as strong as it publicly defends and
therefore needs to improve it by capital raising.

A series of capital raising after the above article also show how much more capital Deutsche
Bank’s management actually think it needs. Most recently one with a combination placement
plus rights issue with 25-30% discount:
http://www.zerohedge.com/news/2014-05-18/deutsche-bank-scrambles-raise-capital-will-
sell-%E2%82%AC8-billion-stock-30-discount
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SEMESTER 1, 2012 FINAL EXAM QUESTION 8 (8 MARKS)

[GROUP 3]
(a)
(i) State your assumptions regarding the “Credit Reserve Build/ (Release)”, and conduct
sensitivity analysis on the net income earned during 2011. (2 marks)

Assume all of the credit reserve release is unfounded as the economy is poor and the risk that
customers will default on their loans have not abated.
Assume tax rate is constant = $3,521/14,624 = 24%

NPBT = $14.624 – 8.265 b = $6.359 b

NPAT = $6.359 x 0.76(1-0.24) = $4.833 b

Add back credit reserves release to result in lower profit.

Other acceptable assumptions are that the credit reserve should be the same level as 2011, in
which case $8.265b-$5.665b should be deducted from $14.624b NPBT.

[GROUP 4]
(ii) Assuming the same assumptions as in (i), above, conduct sensitivity analysis on the
leverage ratio (in percent) at the end of financial year 2011. (2 marks)

Using “Stockholder’s Equity”:

BEFORE
Leverage Ratio =177.8 / 1,873.9= 9.49%

AFTER
Reduction in NPAT = $11.215-4.83= $6.4b
Leverage Ratio =(177.8-6.4 = 171.4) / 1,873.9= 9.15%

Leverage Ratio decreases

[GROUP 5]
(b) 1 mark for each item, 1 mark for reason why they matter

• Revenue for 2012 has declined significantly YoY by about 10% even as reported
income increased slightly [Usually, revenue and profit should more in tandem, so
when revenue drops while profit is maintained or increases it gives a red flag that
management may be managing earnings.]

• 4Q2011 profit has decreased significantly compared to 3Q2011

• 4Q2011 profit has decreased significantly compared to 4Q2010
• (despite release in credit reserves)
[You may present the equivalent information using ROE or ROA].
From student:
• Operating expense have increased by 8% between FY10 and FY11, but this has not
yielded a comparable rise in net income, indicating mismanagement and aiding in
reducing net income.

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ADDITIONAL QUESTION: OFF-BALANCE SHEET

[GROUP 6]

(a) The article refers to $1.1 trillion of mysterious assets. Calculate the leverage ratio (in
percent) according to the balance sheet as at 31 December 2007 and if these mysterious assets
were brought back onto the balance sheet.

According to balance sheet:

Leverage ratio = $113.6 / 2,187.63 = 5.19%

Including mysterious assets: $113.6 / (2187.63+1100) = 3.46%

(b) Discuss your concerns, if any, regarding the different inferences from the before/after
mysterious assets analysis.

From the balance sheet, we would infer that a fall in value of assets of 5.2% is required
before shareholders equity is wiped out.

But including the mysterious assets a much lesser value of a 3.46% fall in the value of assets
would be enough to wipe out shareholders equity.

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ADDITIONAL QUESTION: ASSET QUALITY

[GROUP 7]

(a) Discuss your concerns, if any, regarding the above article on the quality of Citigroup’s
Level 3 assets.

• These Level 3 asset values are calculated using financial models based on
management’s assumptions.

As such, the resulting valuation is of uncertain quality and may be overstated.

• As the $134 billion of Level 3 assets exceed shareholders equity of $113 billion, the
risk is that these assets could wipe out the shareholders equity of Citigroup.

• The effectiveness of the hedges may attenuate the possible loss.

[GROUP 8]

(b) Make your assumptions about the value of the level 3 assets and recalculate the leverage
ratio (in percent) taking into account the level 3 assets.

Here we question the quality of assets that are labeled level 3 and re-estimate the impact on
leverage ratio based on our assumptions.

For example, if we think that they represent subprime mortgages of households that can no
longer pay their mortgages and the lack of liquidity is a signal that investors believe that they
have no value and so will not the risk to post a buy offer, then we make the assumption that
they are worth Zero and recalculate shareholders equity accordingly.

Leverage ratio = (113.6 – 134) /(2187.63 – 134) = −0.993%

C would need an extra capital injection 0.993% (about 1% depending on your rounding) to be
able to withstand the loss in asset value.

If you make other assumptions (e.g. a 20% loss in value of level 3 assets) then you would
calculate a different value for leverage ratio. This is what we call sensitivity analysis.

Leverage ratio = (113.6 – 134*0.2) / (2187.63 – 134*0.2) = 4.02%