Financial Instruments carried at Fair Value

 (unaudited)

Fair Value Hierarchy

The financial instruments carried at fair value have been categorized under the three levels of the IFRS fair value hierarchy as follows:

Level 1 – Instruments valued using quoted prices in active markets are instruments where the fair value can be determined directly from prices which are quoted in active, liquid markets and where the instrument observed in the market is representative of that being priced in the Group’s inventory.

These include: high-liquidity treasuries and derivative, equity and cash products traded on high-liquidity exchanges.

Level 2 – Instruments valued with valuation techniques using observable market data are instruments where the fair value can be determined by reference to similar instruments trading in active markets, or where a technique is used to derive the valuation but where all inputs to that technique are observable.

These include: many OTC derivatives; many investment-grade listed credit bonds; some CDS; many collateralized debt obligations (“CDO”); and many less-liquid equities.

Level 3 – Instruments valued using valuation techniques using market data which is not directly observable are instruments where the fair value cannot be determined directly by reference to market-observable information, and some other pricing technique must be employed. Instruments classified in this category have an element which is unobservable and which has a significant impact on the fair value.

These include: more-complex OTC derivatives; distressed debt; highly-structured bonds; illiquid asset-backed securities (“ABS”); illiquid CDOs (cash and synthetic); monoline exposures; private equity placements; many commercial real estate (“CRE”) loans; illiquid loans; and some municipal bonds.

Carrying value of the financial instruments held at fair value1

 

Sep 30, 2014

Dec 31, 2013

in € m.

Quoted prices in active market (Level 1)

Valuation technique observable parameters (Level 2)

Valuation technique unobservable parameters (Level 3)

Quoted prices in active market (Level 1)

Valuation technique observable parameters (Level 2)

Valuation technique unobservable parameters (Level 3)

1

Amounts in this table are generally presented on a gross basis, in line with the Group’s accounting policy regarding offsetting of financial instruments, as described in Note 1 “Significant Accounting Policies and Critical Accounting Estimates” of the Financial Report 2013.

2

Predominantly relates to derivatives qualifying for hedge accounting.

3

Includes assets and liabilities held for sale related to Tilney in 2014 and to BHF-BANK in 2013.

4

These are investment contracts where the policy terms and conditions result in their redemption value equaling fair value. See Note 41 “Insurance and Investment Contracts” of the Financial Report 2013 for more detail on these contracts.

5

Relates to derivatives which are embedded in contracts where the host contract is held at amortized cost but for which the embedded derivative is separated. The separated embedded derivatives may have a positive or a negative fair value but have been presented in this table to be consistent with the classification of the host contract. The separated embedded derivatives are held at fair value on a recurring basis and have been split between the fair value hierarchy classifications.

Financial assets held at fair value:

 

 

 

 

 

 

Trading assets

80,637

102,435

13,288

86,634

111,411

12,025

Trading securities

80,385

86,298

8,361

86,325

94,269

6,960

Other trading assets

251

16,137

4,927

309

17,143

5,065

Positive market values from derivative financial instruments

6,271

540,990

8,506

7,421

486,614

10,556

Financial assets designated at fair value through profit or loss

10,271

129,185

3,458

7,083

174,391

3,123

Financial assets available for sale

33,688

21,875

3,831

23,948

21,049

3,329

Other financial assets at fair value2,3

0

3,9102

0

60

7,3472

1

Total financial assets held at fair value

130,867

798,395

29,083

125,146

800,811

29,033

 

 

 

 

 

 

 

Financial liabilities held at fair value:

 

 

 

 

 

 

Trading liabilities

21,016

27,074

12

36,449

19,331

24

Trading securities

21,002

25,924

12

36,438

18,490

24

Other trading liabilities

14

1,150

0

12

841

0

Negative market values from derivative financial instruments

7,011

526,557

5,893

7,815

467,293

8,321

Financial liabilities designated at fair value through profit or loss

1,216

55,197

2,431

197

88,466

1,442

Investment contract liabilities4

0

8,476

0

0

8,067

0

Other financial liabilities at fair value2,3

1

3,8742

(478)5

4

1,4952

(247)5

Total financial liabilities held at fair value

29,244

621,178

7,858

44,465

584,651

9,539

There were transfers between level 1 and level 2 of the fair value hierarchy in the third quarter of 2014 on trading securities (€ 5 billion of assets and € 4.1 billion of liabilities) based on liquidity testing procedures.

Valuation Techniques

The following is an explanation of the valuation techniques used in establishing the fair value of the different types of financial instruments that the Group trades.

Sovereign, Quasi-sovereign and Corporate Debt and Equity Securities: Where there are no recent transactions then fair value may be determined from the last market price adjusted for all changes in risks and information since that date. Where a close proxy instrument is quoted in an active market then fair value is determined by adjusting the proxy value for differences in the risk profile of the instruments. Where close proxies are not available then fair value is estimated using more complex modeling techniques. These techniques include discounted cash flow models using current market rates for credit, interest, liquidity and other risks. For equity securities modeling techniques may also include those based on earnings multiples.

Mortgage- and Other Asset-Backed Securities (MBS/ABS) include residential and commercial MBS and other ABS including CDOs. ABS have specific characteristics as they have different underlying assets and the issuing entities have different capital structures. The complexity increases further where the underlying assets are themselves ABS, as is the case with many of the CDO instruments.

Where no reliable external pricing is available, ABS are valued, where applicable, using either relative value analysis which is performed based on similar transactions observable in the market, or industry-standard valuation models incorporating available observable inputs. The industry standard external models calculate principal and interest payments for a given deal based on assumptions that can be independently price tested. The inputs include prepayment speeds, loss assumptions (timing and severity) and a discount rate (spread, yield or discount margin). These inputs/assumptions are derived from actual transactions, external market research and market indices where appropriate.

Loans: For certain loans fair value may be determined from the market price on a recently occurring transaction adjusted for all changes in risks and information since that transaction date. Where there are no recent market transactions then broker quotes, consensus pricing, proxy instruments or discounted cash flow models are used to determine fair value. Discounted cash flow models incorporate parameter inputs for credit risk, interest rate risk, foreign exchange risk, loss given default estimates and amounts utilized given default, as appropriate. Credit risk, loss given default and utilization given default parameters are determined using information from the loan or CDS markets, where available and appropriate.

Leveraged loans can have transaction-specific characteristics which can limit the relevance of market-observed transactions. Where similar transactions exist for which observable quotes are available from external pricing services then this information is used with appropriate adjustments to reflect the transaction differences. When no similar transactions exist, a discounted cash flow valuation technique is used with credit spreads derived from the appropriate leveraged loan index, incorporating the industry classification, subordination of the loan, and any other relevant information on the loan and loan counterparty.

Over-The-Counter Derivative Financial Instruments: Market standard transactions in liquid trading markets, such as interest rate swaps, foreign exchange forward and option contracts in G7 currencies, and equity swap and option contracts on listed securities or indices are valued using market standard models and quoted parameter inputs. Parameter inputs are obtained from pricing services, consensus pricing services and recently occurring transactions in active markets wherever possible.

More complex instruments are modeled using more sophisticated modeling techniques specific for the instrument and are calibrated to available market prices. Where the model output value does not calibrate to a relevant market reference then valuation adjustments are made to the model output value to adjust for any difference. In less active markets, data is obtained from less frequent market transactions, broker quotes and through extrapolation and interpolation techniques. Where observable prices or inputs are not available, management judgment is required to determine fair values by assessing other relevant sources of information such as historical data, fundamental analysis of the economics of the transaction and proxy information from similar transactions.

Financial Liabilities Designated at Fair Value through Profit or Loss under the Fair Value Option: The fair value of financial liabilities designated at fair value through profit or loss under the fair value option incorporates all market risk factors including a measure of the Group’s credit risk relevant for that financial liability. The financial liabilities include structured note issuances, structured deposits, and other structured securities issued by consolidated vehicles, which may not be quoted in an active market. The fair value of these financial liabilities is determined by discounting the contractual cash flows using the relevant credit-adjusted yield curve. The market risk parameters are valued consistently to similar instruments held as assets, for example, any derivatives embedded within the structured notes are valued using the same methodology discussed in the “Over-The-Counter Derivative Financial Instruments” section above.

Where the financial liabilities designated at fair value through profit or loss under the fair value option are collateralized, such as securities loaned and securities sold under repurchase agreements, the credit enhancement is factored into the fair valuation of the liability.

Investment Contract Liabilities: Assets which are linked to the investment contract liabilities are owned by the Group. The investment contract obliges the Group to use these assets to settle these liabilities. Therefore, the fair value of investment contract liabilities is determined by the fair value of the underlying assets (i.e., amount payable on surrender of the policies).

Analysis of Financial Instruments with Fair Value Derived from Valuation Techniques Containing Significant Unobservable Parameters (Level 3)

Some of the instruments in level 3 of the fair value hierarchy have identical or similar offsetting exposures to the unobservable input. However, according to IFRS they are required to be presented as gross assets and liabilities.

Trading Securities: Certain illiquid emerging market corporate bonds and illiquid highly structured corporate bonds are included in this level of the hierarchy. In addition, some of the holdings of notes issued by securitization entities, commercial and residential MBS, collateralized debt obligation securities and other ABS are reported here. The increase in assets during the period is mainly due to purchases and transfers from level 2 to level 3 partially off-set by sales and transfers out of level 3.

Positive and Negative Market Values from Derivative Instruments categorized in this level of the fair value hierarchy are valued based on one or more significant unobservable parameters. The unobservable parameters may include certain correlations, certain long term volatilities, certain prepayment rates, credit spreads and other transaction-specific parameters.

Level 3 derivatives include customized CDO derivatives in which the underlying reference pool of corporate assets is not closely comparable to regularly market-traded indices; certain tranched index credit derivatives; certain options where the volatility is unobservable; certain basket options in which the correlations between the referenced underlying assets are unobservable; longer-term interest rate option derivatives; multi-currency foreign exchange derivatives; and certain credit default swaps for which the credit spread is not observable. The decrease in derivative instruments is mainly due to transfers from level 3 to level 2 due to changes in the observability of input parameters used to value these instruments.

Other Trading Instruments classified in level 3 of the fair value hierarchy mainly consist of traded loans valued using valuation models based on one or more significant unobservable parameters. Level 3 loans comprise illiquid leveraged loans and illiquid residential and commercial mortgage loans.

Financial Assets/Liabilities designated at Fair Value through Profit or Loss: Certain corporate loans and structured liabilities which were designated at fair value through profit or loss under the fair value option are categorized in this level of the fair value hierarchy. The corporate loans are valued using valuation techniques which incorporate observable credit spreads, recovery rates and unobservable utilization parameters. Revolving loan facilities are reported in the level 3 of the hierarchy because the utilization in the event of the default parameter is significant and unobservable.

In addition, certain hybrid debt issuances designated at fair value through profit or loss containing embedded derivatives are valued based on significant unobservable parameters. These unobservable parameters include single stock volatility correlations. The increase in liabilities is primarily due to transfers from level 2 into level 3 due to changes in the observability of input parameters used to value these instruments.

Financial Assets Available for Sale include unlisted equity instruments where there is no close proxy and the market is very illiquid. The increase in the period is mainly due to purchases.

Reconciliation of financial instruments classified in Level 3

 

Sep 30, 2014

in € m.

Balance, beginning of year

Changes in the group of consoli­dated com­panies

Total gains/losses1

Purchases

Sales

Issuances2

Settlements3

Transfers into Level 34

Transfers out of Level 34

Balance, end of period

1

Total gains and losses predominantly relate to net gains (losses) on financial assets/liabilities at fair value through profit or loss reported in the consolidated statement of income. The balance also includes net gains (losses) on financial assets available for sale reported in the consolidated statement of income and unrealized net gains (losses) on financial assets available for sale and exchange rate changes reported in other comprehensive income, net of tax. Further, certain instruments are hedged with instruments in level 1 or level 2 but the table above does not include the gains and losses on these hedging instruments. Additionally, both observable and unobservable parameters may be used to determine the fair value of an instrument classified within level 3 of the fair value hierarchy; the gains and losses presented below are attributable to movements in both the observable and unobservable parameters.

2

Issuances relate to the cash amount received on the issuance of a liability and the cash amount paid on the primary issuance of a loan to a borrower.

3

Settlements represent cash flows to settle the asset or liability. For debt and loan instruments this includes principal on maturity, principal amortizations and principal repayments. 
For derivatives all cash flows are presented in settlements.

4

Transfers in and transfers out of level 3 are related to changes in observability of input parameters. During the period they are recorded at their fair value at the beginning of year. For instruments transferred into level 3 the table shows the gains and losses and cash flows on the instruments as if they had been transferred at the beginning of the year. Similarly for instruments transferred out of level 3 the table does not show any gains or losses or cash flows on the instruments during the period since the table is presented as if they have been transferred out at the beginning of the year.

5

Total gains and losses on available for sale include a gain of € 52 million recognized in other comprehensive income, net of tax, and a gain of € 23 million recognized in the income statement presented in net gains (losses) on financial assets available for sale.

6

Represents assets held for sale related to BHF-BANK.

7

This amount includes the effect of exchange rate changes. For total financial assets held at fair value this effect is a gain of € 489 million and for total financial liabilities held at fair value this is a gain of € 106 million. The effect of exchange rate changes is reported in other comprehensive income, net of tax.

8

For assets, positive balances represent gains, negative balances represent losses. For liabilities, positive balances represent losses, negative balances represent gains.

Financial assets held at fair value:

 

 

 

 

 

 

 

 

 

 

Trading securities

6,960

0

478

2,569

(1,522)

0

(296)

1,728

(1,556)

8,361

Positive market values from derivative financial instruments

10,556

0

(94)

0

0

0

(976)

1,088

(2,068)

8,506

Other trading assets

5,064

0

59

1,800

(1,672)

375

(376)

826

(1,149)

4,927

Financial assets designated at fair value through profit or loss

3,123

0

227

240

(5)

1,408

(1,543)

139

(130)

3,458

Financial assets available for sale

3,329

0

2945

960

(256)

0

(662)

367

(200)

3,831

Other financial assets at fair value6

1

(1)

0

0

0

0

0

0

0

0

Total financial assets held at fair value

29,032

(1)

9637,8

5,568

(3,456)

1,783

(3,853)

4,148

(5,103)

29,083

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities held at fair value:

 

 

 

 

 

 

 

 

 

 

Trading securities

24

0

2

0

0

0

(10)

2

(6)

12

Negative market values from derivative financial instruments

8,321

0

(7)

0

0

0

(1,077)

1,067

(2,410)

5,893

Other trading liabilities

0

0

0

0

0

0

0

0

0

0

Financial liabilities designated at fair value through profit or loss

1,442

0

(77)

0

0

31

(16)

1,201

(149)

2,431

Other financial liabilities at fair value

(247)

0

(39)

0

0

0

(123)

24

(92)

(478)

Total financial liabilities held at fair value

9,539

0

(121)7,8

0

0

31

(1,226)

2,294

(2,658)

7,858

 

Sep 30, 2013

in € m.

Balance, beginning of year

Changes in the group of consoli­dated com­panies

Total gains/losses1

Purchases

Sales

Issuances2

Settlements3

Transfers into Level 34

Transfers out of Level 34

Balance, end of period

1

Total gains and losses predominantly relate to net gains (losses) on financial assets/liabilities at fair value through profit or loss reported in the consolidated statement of income. The balance also includes net gains (losses) on financial assets available for sale reported in the consolidated statement of income and unrealized net gains (losses) on financial assets available for sale and exchange rate changes reported in other comprehensive income, net of tax. Further, certain instruments are hedged with instruments in level 1 or level 2 but the table above does not include the gains and losses on these hedging instruments. Additionally, both observable and unobservable parameters may be used to determine the fair value of an instrument classified within level 3 of the fair value hierarchy; the gains and losses presented above are attributable to movements in both the observable and unobservable parameters.

2

Issuances relate to the cash amount received on the issuance of a liability and the cash amount paid on the primary issuance of a loan to a borrower.

3

Settlements represent cash flows to settle the asset or liability. For debt and loan instruments this includes principal on maturity, principal amortizations and principal repayments. For derivatives all cash flows are presented in settlements.

4

Transfers in and transfers out of level 3 during the period are recorded at their fair value at the beginning of year in the table above. For instruments transferred into level 3 the table shows the gains and losses and cash flows on the instruments as if they had been transferred at the beginning of the year. Similarly for instruments transferred out of level 3 the table does not show any gains or losses or cash flows on the instruments during the period since the table is presented as if they have been transferred out at the beginning of the year.

5

Total gains and losses on financial assets available for sale include a loss of € 3 million recognized in other comprehensive income, net of tax, and a gain of € 21 million recognized in the income statement presented in net gains (losses) on financial assets available for sale.

6

This amount includes the effect of exchange rate changes. For total financial assets held at fair value this effect is a negative € 335 million and for total financial liabilities held at fair value this is a positive € 39 million. This predominantly relates to derivatives. The effect of exchange rate changes is reported in other comprehensive income, net of tax.

7

For assets, positive balances represent gains, negative balances represent losses. For liabilities, positive balances represent losses, negative balances represent gains.

Financial assets held at fair value:

 

 

 

 

 

 

 

 

 

 

Trading securities

10,306

0

80

1,231

(2,562)

0

(799)

1,828

(2,419)

7,665

Positive market values from derivative financial instruments

15,210

0

(2,139)

0

0

0

(1,170)

2,273

(2,083)

12,091

Other trading assets

4,609

0

(212)

655

(1,184)

1,235

(330)

561

(408)

4,927

Financial assets designated at fair value through profit or loss

3,956

0

167

50

(13)

897

(1,772)

180

(258)

3,208

Financial assets available for sale

3,940

(80)

(50)5

648

(839)

0

(532)

870

(490)

3,467

Other financial assets at fair value

0

0

0

0

0

0

0

0

0

0

Total financial assets held at fair value

38,021

(80)

(2,154)6,7

2,584

(4,597)

2,132

(4,602)

5,712

(5,657)

31,358

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities held at fair value:

 

 

 

 

 

 

 

 

 

 

Trading securities

318

0

8

0

0

0

(161)

4

(146)

24

Negative market values from derivative financial instruments

9,286

0

(55)

0

0

0

(944)

1,765

(1,537)

8,514

Other trading liabilities

0

0

0

0

0

0

0

11

0

11

Financial liabilities designated at fair value through profit or loss

1,417

0

(172)

0

0

278

(205)

531

(197)

1,653

Other financial liabilities at fair value

(176)

0

59

0

0

0

24

(295)

(0)

(388)

Total financial liabilities held at fair value

10,845

0

(160)6,7

0

0

278

(1,286)

2,017

(1,880)

9,813

Sensitivity Analysis of Unobservable Parameters

Where the value of financial instruments is dependent on unobservable parameter inputs, the precise level for these parameters at the balance sheet date might be drawn from a range of reasonably possible alternatives. In preparing the financial statements, appropriate levels for these unobservable input parameters are chosen so that they are consistent with prevailing market evidence and in line with the Group’s approach to valuation control detailed above. Were the Group to have marked the financial instruments concerned using parameter values drawn from the extremes of the ranges of reasonably possible alternatives then as of September 30, 2014 it could have increased fair value by as much as € 3.2 billion or decreased fair value by as much as € 2.9 billion. As of December 31, 2013 it could have increased fair value by as much as € 3.0 billion or decreased fair value by as much as € 2.6 billion. In estimating these impacts, the Group either re-valued certain financial instruments using reasonably possible alternative parameter values, or used an approach based on its valuation adjustment methodology for bid/offer spread valuation adjustments. Bid/offer spread valuation adjustments reflect the amount that must be paid in order to close out a holding in an instrument or component risk and as such they reflect factors such as market illiquidity and uncertainty.

This disclosure is intended to illustrate the potential impact of the relative uncertainty in the fair value of financial instruments for which valuation is dependent on unobservable input parameters. However, it is unlikely in practice that all unobservable parameters would be simultaneously at the extremes of their ranges of reasonably possible alternatives. Hence, the estimates disclosed above are likely to be greater than the true uncertainty in fair value at the balance sheet date. Furthermore, the disclosure is not predictive or indicative of future movements in fair value.

For many of the financial instruments considered here, in particular derivatives, unobservable input parameters represent only a subset of the parameters required to price the financial instrument, the remainder being observable. Hence for these instruments the overall impact of moving the unobservable input parameters to the extremes of their ranges might be relatively small compared with the total fair value of the financial instrument. For other instruments, fair value is determined based on the price of the entire instrument, for example, by adjusting the fair value of a reasonable proxy instrument. In addition, all financial instruments are already carried at fair values which are inclusive of valuation adjustments for the cost to close out that instrument and hence already factor in uncertainty as it reflects itself in market pricing. Any negative impact of uncertainty calculated within this disclosure, then, will be over and above that already included in the fair value contained in the financial statements.

Breakdown of the sensitivity analysis by type of instrument1

 

Sep 30, 2014

Dec 31, 2013

in € m.

Positive fair value movement from using reasonable possible alternatives

Negative fair value movement from using reasonable possible alternatives

Positive fair value movement from using reasonable possible alternatives

Negative fair value movement from using reasonable possible alternatives

1

Where the exposure to an unobservable parameter is offset across different instruments then only the net impact is disclosed in the table.

Securities:

 

 

 

 

Debt securities

765

686

643

542

Commercial mortgage-backed securities

63

54

39

32

Mortgage and other asset-backed securities

225

221

233

229

Sovereign and quasi sovereign debt obligations

62

47

6

6

Corporate debt securities and other debt obligations

414

364

365

275

Equity securities

46

124

32

97

Derivatives:

 

 

 

 

Credit

445

488

524

509

Equity

174

130

281

171

Interest related

692

335

405

255

Foreign exchange

5

4

24

6

Other

113

94

83

61

Loans:

 

 

 

 

Loans

892

819

701

619

Loan commitments

5

5

17

17

Other

112

176

255

277

Total

3,250

2,861

2,966

2,554

Quantitative Information about the Sensitivity of Significant Unobservable Inputs

The behavior of the unobservable parameters on Level 3 fair value measurement is not necessarily independent, and dynamic relationships often exist between both other unobservable parameters, and observable parameters. Such relationships, where material to the fair value of a given instrument, are explicitly captured via correlation parameters, or are otherwise controlled via pricing models or valuation techniques. Frequently, where a valuation technique utilises more than one input, the choice of a certain input will bound the range of possible values for other inputs. In addition, broader market factors (such as interest rates, equity, credit or commodity indices or foreign exchange rates) can also have effects.

The range of values shown below represents the highest and lowest inputs used to value the significant exposures within Level 3. The diversity of financial instruments that make up the disclosure is significant and therefore the ranges of certain parameters can be large. For example, the range of credit spreads on mortgage backed securities represents performing, more liquid positions with lower spreads than the less liquid, non-performing positions which will have higher credit spreads. As Level 3 contains the less liquid fair value instruments, the wide ranges of parameters seen is to be expected, as there is a high degree of pricing differentiation within each exposure type to capture the relevant market dynamics. There follows a brief description of each of the principle parameter types, along with a commentary on significant interrelationships between them.

Credit Parameters are used to assess the credit worthiness of an exposure, by enabling the probability of default and resulting losses of a default to be represented. The credit spread is the primary reflection of credit worthiness, and represents the premium or yield return above the benchmark reference instrument (typically LIBOR, or relevant Treasury Instrument, depending upon the asset being assessed), that a bond holder would require in order to allow for the credit quality difference between that entity and the reference benchmark. Higher credit spreads will indicate lower credit quality, and lead to a lower value for a given bond, or other loan-asset that is to be repaid to the Bank by the borrower. Recovery Rates represent an estimate of the amount a lender would receive in the case of a default of a loan, or a bond holder would receive in the case of default of the bond. Higher recovery rates will give a higher valuation for a given bond position, if other parameters are held constant. Constant Default Rate (CDR) and Constant Prepayment Rate (CPR) allow more complex loan and debt assets to be assessed, as these parameters estimate the ongoing defaults arising on scheduled repayments and coupons, or whether the borrower is making additional (usually voluntary) prepayments. These parameters are particularly relevant when forming a fair value opinion for mortgage or other types of lending, where repayments are delivered by the borrower through time, or where the borrower may pre-pay the loan (seen for example in some residential mortgages). Higher CDR will lead to lower valuation of a given loan or mortgage as the lender will ultimately receive less cash.

Interest rates, credit spreads, inflation rates, foreign exchange rates and equity prices are referenced in some option instruments, or other complex derivatives, where the payoff a holder of the derivative will receive is dependent upon the behavior of these underlying references through time. Volatility parameters describe key attributes of option behavior by enabling the variability of returns of the underlying instrument to be assessed. This volatility is a measure of probability, with higher volatilities denoting higher probabilities of a particular outcome occurring. The underlying references (interest rates, credit spreads etc.) have an effect on the valuation of options, by describing the size of the return that can be expected from the option. Therefore the value of a given option is dependent upon the value of the underlying instrument, and the volatility of that instrument, representing the size of the payoff, and the probability of that payoff occurring. Where volatilities are high, the option holder will see a higher option value as there is greater probability of positive returns. A higher option value will also occur where the payoff described by the option is significant.

Correlations are used to describe influential relationships between underlying references where a derivative or other instrument has more than one underlying reference. Behind some of these relationships, for example commodity correlation and interest rate-foreign exchange correlations, typically lie macroeconomic factors such as the impact of global demand on groups of commodities, or the pricing parity effect of interest rates on foreign exchange rates. More specific relationships can exist between credit references or equity stocks in the case of credit derivatives and equity basket derivatives, for example. Credit correlations are used to estimate the relationship between the credit performance of a range of credit names, and stock correlations are used to estimate the relationship between the returns of a range of equities. A derivative with a correlation exposure will be either long- or short-correlation. A high correlation suggests a strong relationship between the underlying references is in force, and this will lead to an increase in value of a long-correlation derivative. Negative correlations suggest that the relationship between underlying references is opposing, i.e., an increase in price of one underlying reference will lead to a reduction in the price of the other.

An EBITDA (“earnings before interest, tax, depreciation and amortization”) multiple approach can be used in the valuation of less liquid securities. Under this approach the enterprise value (“EV”) of an entity can be estimated via identifying the ratio of the EV to EBITDA of a comparable observable entity and applying this ratio to the EBITDA of the entity for which a valuation is being estimated. Under this approach a liquidity adjustment is often applied due to the difference in liquidity between the generally listed comparable used and the company under valuation. A higher EV/EBITDA multiple will result in a higher fair value.

Financial instruments classified in Level 3 and quantitative information about unobservable inputs

 

Sep 30, 2014

 

Fair value

 

 

 

 

in € m.
(unless stated otherwise)

Assets

Liabilities

Valuation technique(s)1

Significant unobservable input(s) (Level 3)

Range

1

Valuation technique(s) and subsequently the significant unobservable input(s) relate to the respective total position.

2

Other financial assets include € 73 million of other trading assets, € 379 million of other financial assets designated at fair value and € 137 million other financial assets available for sale.

3

Other financial liabilities include € 928 million of securities sold under repurchase agreements designated at fair value and € 137 million of other financial liabilities designated at fair value.

Financial instruments held at fair value – held for trading, designated at fair value and available-for-sale:

 

 

 

 

 

 

Mortgage- and other asset-backed securities

 

 

 

 

 

 

Commercial mortgage-backed securities

420

0

Price based

Price

0 %

112 %

 

 

 

Discounted cash flow

Credit spread (bps)

229

2,300

 

 

 

 

Constant default rate

 

 

Mortgage- and other asset-backed securities

2,290

0

Price based

Price

0 %

104 %

 

 

 

Discounted cash flow

Credit spread (bps)

37

2,000

 

 

 

 

Recovery rate

0 %

95 %

 

 

 

 

Constant default rate

0 %

22 %

 

 

 

 

Constant prepayment rate

0 %

26 %

Total mortgage- and other asset-backed securities

2,711

0

 

 

 

 

Debt securities and other debt obligations

5,615

1,267

Price based

Price

0 %

247 %

Held for trading

5,129

9

Discounted cash flow

Credit spread (bps)

38

5,000

Sovereign and quasi sovereign obligations

756

 

 

 

 

 

Corporate debt securities and other debt obligations

4,373

 

 

 

 

 

Available-for-sale

486

 

 

 

 

 

Designated at fair value

 

1,258

 

 

 

 

Equity securities

1,398

3

Market approach

Price per net asset value

63 %

100 %

Held for trading

522

3

 

Enterprise value/EBITDA (multiple)

1

14

Designated at fair value

31

0

 

 

 

 

Available-for-sale

845

 

Discounted cash flow

Weighted average cost capital

6 %

13 %

Loans

10,265

0

Price based

Price

0 %

137 %

Held for trading

4,854

0

Discounted cash flow

Credit spread (bps)

59

3,540

Designated at fair value

3,048

 

 

Constant default rate

5 %

20 %

Available-for-sale

2,362

 

 

Recovery rate

15 %

60 %

Loan commitments

0

107

Discounted cash flow

Credit spread (bps)

1

661

 

 

 

 

Recovery rate

35 %

100 %

 

 

 

Loan pricing model

Utilization

0 %

100 %

Other financial instruments

5902

1,0663

Discounted cash flow

IRR

2 %

40 %

Total financial instruments held at fair value

20,577

2,443

 

 

 

 

 

Dec 31, 2013

 

Fair value

 

 

 

 

in € m.
(unless stated otherwise)

Assets

Liabilities

Valuation technique(s)1

Significant unobservable input(s) (Level 3)

Range

1

Valuation technique(s) and subsequently the significant unobservable input(s) relate to the respective total position.

2

Other financial assets include € 784 million of other trading assets, € 502 million of other financial assets designated at fair value, € 588 million other financial assets available for sale and € 1 million of assets held for sale related to BHF-BANK.

3

Other financial liabilities include € 67 million of other financial liabilities designated at fair value.

Financial instruments held at fair value – held for trading, designated at fair value and available-for-sale:

 

 

 

 

 

 

Mortgage- and other asset-backed securities

 

 

 

 

 

 

Commercial mortgage-backed securities

361

0

Price based

Price

0 %

103 %

 

 

 

Discounted cash flow

Credit spread (bps)

100

2,470

 

 

 

 

Constant default rate

1 %

3 %

Mortgage- and other asset-backed securities

2,274

0

Price based

Price

0 %

134 %

 

 

 

Discounted cash flow

Credit spread (bps)

70

3,180

 

 

 

 

Recovery rate

0 %

70 %

 

 

 

 

Constant default rate

0 %

25 %

 

 

 

 

Constant prepayment rate

0 %

30 %

Total mortgage- and other asset-backed securities

2,635

0

 

 

 

 

Debt securities and other debt obligations

4,016

1,205

Price based

Price

0 %

156 %

Held for trading

3,898

16

Discounted cash flow

Credit spread (bps)

438

5,000

Sovereign and quasi sovereign obligations

597

 

 

 

 

 

Corporate debt securities and other debt obligations

3,300

 

 

 

 

 

Available-for-sale

118

 

 

 

 

 

Designated at fair value

 

1,189

 

 

 

 

Equity securities

1,074

8

Market approach

Price per net asset value

62 %

100 %

Held for trading

428

8

 

Enterprise value/EBITDA (multiple)

1

14

Designated at fair value

0

0

 

 

 

 

Available-for-sale

646

 

Discounted cash flow

Weighted average cost capital

7 %

12 %

Loans

8,878

0

Price based

Price

0 %

122 %

Held for trading

4,280

0

Discounted cash flow

Credit spread (bps)

59

3,500

Designated at fair value

2,621

 

 

Constant default rate

5 %

22 %

Available-for-sale

1,976

 

 

Recovery rate

15 %

60 %

Loan commitments

0

186

Discounted cash flow

Credit spread (bps)

5

1,000

 

 

 

 

Recovery rate

35 %

80 %

 

 

 

Loan pricing model

Utilization

0 %

100 %

Other financial instruments

1,8752

673

Discounted cash flow

IRR

2 %

46 %

Total financial instruments held at fair value

18,477

1,466

 

 

 

 

 

 

 

 

 

 

Sep 30, 2014

 

Fair value

 

 

 

 

in € m.
(unless stated otherwise)

Assets

Liabilities

Valuation technique(s)

Significant unobservable input(s) (Level 3)

Range

1

Includes derivatives which are embedded in contracts where the host contract is held at amortized cost but for which the embedded derivative is separated.

Financial instruments held at fair value:

 

 

 

 

 

 

Market values from derivative financial instruments:

 

 

 

 

 

 

Interest rate derivatives

2,420

1,560

Discounted cash flow

Swap rate (bps)

1

1,334

 

 

 

 

Inflation swap rate

0 %

8 %

 

 

 

Option pricing model

Inflation volatility

0 %

8 %

 

 

 

 

Interest rate volatility

10 %

88 %

 

 

 

 

IR – IR correlation

(8) %

100 %

 

 

 

 

Hybrid correlation

(70) %

95 %

Credit derivatives

3,518

1,925

Discounted cash flow

Credit spread (bps)

1

3,500

 

 

 

 

Recovery rate

0 %

100 %

 

 

 

Correlation pricing model

Credit correlation

13 %

93 %

Equity derivatives

965

1,244

Option pricing model

Stock volatility

7 %

95 %

 

 

 

 

Index volatility

7 %

96 %

 

 

 

 

Index – index correlation

33 %

98 %

 

 

 

 

Stock – stock correlation

9 %

95 %

FX derivatives

293

425

Option pricing model

Volatility

1 %

25 %

Other derivatives

1,309

2611

Discounted cash flow

Credit spread (bps)

29

1,500

 

 

 

Option pricing model

Index volatility

2 %

24 %

 

 

 

 

Commodity correlation

(30) %

100 %

 

 

 

 

Commodity forward (€/Ton)

62

74

Total market values from derivative financial instruments

8,506

5,415

 

 

 

 

 

Dec 31, 2013

 

Fair value

 

 

 

 

in € m.
(unless stated otherwise)

Assets

Liabilities

Valuation technique(s)

Significant unobservable input(s) (Level 3)

Range

1

Includes derivatives which are embedded in contracts where the host contract is held at amortized cost but for which the embedded derivative is separated.

Financial instruments held at fair value:

 

 

 

 

 

 

Market values from derivative financial instruments:

 

 

 

 

 

 

Interest rate derivatives

2,551

2,156

Discounted cash flow

Swap rate (bps)

2

1,336

 

 

 

 

Inflation swap rate

0 %

8 %

 

 

 

Option pricing model

Inflation volatility

0 %

3 %

 

 

 

 

Interest rate volatility

10 %

95 %

 

 

 

 

IR – IR correlation

(2) %

91 %

 

 

 

 

Hybrid correlation

(70) %

95 %

Credit derivatives

4,377

2,334

Discounted cash flow

Credit spread (bps)

2

4,093

 

 

 

 

Recovery rate

0 %

75 %

 

 

 

Correlation pricing model

Credit correlation

13 %

88 %

Equity derivatives

1,419

1,987

Option pricing model

Stock volatility

10 %

100 %

 

 

 

 

Index volatility

11 %

98 %

 

 

 

 

Index – index correlation

62 %

98 %

 

 

 

 

Stock – stock correlation

10 %

97 %

FX derivatives

529

455

Option pricing model

Volatility

0 %

30 %

Other derivatives

1,680

1,1421

Discounted cash flow

Credit spread (bps)

320

1,500

 

 

 

Option pricing model

Index volatility

4 %

23 %

 

 

 

 

Commodity correlation

(30) %

100 %

 

 

 

 

Commodity forward (€/Ton)

97

106

Total market values from derivative financial instruments

10,556

8,074

 

 

 

 

Unrealized Gains or Losses on Level 3 Instruments held or in Issue at the Reporting Date

The unrealized gains or losses are not due solely to unobservable parameters. Many of the parameter inputs to the valuation of instruments in this level of the hierarchy are observable and the gain or loss is partly due to movements in these observable parameters over the period. Many of the positions in this level of the hierarchy are economically hedged by instruments which are categorized in other levels of the fair value hierarchy. The offsetting gains and losses that have been recorded on all such hedges are not included in the table below, which only shows the gains and losses related to the level 3 classified instruments themselves held at the reporting date in accordance with IFRS 13. The unrealized gains and losses on level 3 instruments are included in both net interest income and net gains on financial assets/liabilities at fair value through profit or loss in the consolidated income statement.

 

Three months ended

in € m.

Sep 30, 2014

30.9.2013

Financial assets held at fair value:

 

 

Trading securities

448

79

Positive market values from derivative financial instruments

121

(1,387)

Other trading assets

(11)

34

Financial assets designated at fair value through profit or loss

142

208

Financial assets available for sale

73

(24)

Other financial assets at fair value

0

0

Total financial assets held at fair value

772

(1,089)

Financial liabilities held at fair value:

 

 

Trading securities

0

3

Negative market values from derivative financial instruments

102

(457)

Other trading liabilities

0

0

Financial liabilities designated at fair value through profit or loss

(32)

(27)

Other financial liabilities at fair value

17

(62)

Total financial liabilities held at fair value

88

(543)

Total

860

(1,632)

Recognition of Trade Date Profit

If there are significant unobservable inputs used in a valuation technique, the financial instrument is recognized at the transaction price and any trade date profit is deferred. The table below presents the year-to-date movement of the trade date profits deferred due to significant unobservable parameters for financial instruments classified at fair value through profit or loss. The balance is predominantly related to derivative instruments.

in € m.

Sep 30, 2014

30.9.2013

Balance, beginning of year

796

699

New trades during the period

601

340

Amortization

(204)

(231)

Matured trades

(106)

(93)

Subsequent move to observability

(52)

(40)

Exchange rate changes

8

(17)

Balance, end of period

1,043

658