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Categorized | Banks

Deutsche Bank faces $37m damages lawsuit


Posted on September 30, 2012

Deutsche Bank©Bloomberg

A Puerto Rico-based investor is claiming more than $37m in damages from Deutsche Bank for allegedly dumping “toxic or distressed” loans and derivatives into a structured product that it sold before the onset of the financial crisis.

Arco Capital filed a lawsuit last week at the Southern District Court in New York in which it claims Germany’s largest lender by assets used the $1bn transaction “as a repository for poorly-underwritten, toxic or distressed lending assets”.

    Deutsche Bank said: “We believe these allegations are without merit and will defend against them vigorously.”

    The damage claim adds to a series of lawsuits filed against the world’s largest investment banks including Deutsche over complex investment products that turned sour since the start of the financial crisis.

    Most of these claims are related to US mortgage-backed securities, and this is the first litigation against Deutsche over a corporate loan portfolio.

    Arco Capital, a commercial, infrastructure and real estate investor, accuses Deutsche Bank of fraud and breach of contract over an instrument issued in 2006 that bundled interest payments and default risks for loans granted by the German lender to emerging market companies.

    Deutsche Bank issued this synthetic collateralised loan obligation to reduce the amount of capital it needs to hold on its balance sheet against the underlying loans, according to the lawsuit.

    In January 2007, Deutsche Bank doubled the original size to $1bn. “Deutsche Bank took advantage of the upsize to dump ineligible lending transactions into the reference portfolio, and used its control over the transaction to disguise its misconduct and frustrate the protections that existed for noteholders,” the court filing states.

    It adds that Deutsche Bank henceforth included “poorly underwritten” and “highly risky” loans and changed the definition of reference obligations so that a broad range of derivatives such as interest rate and currency swaps could be added as well.

    A series of loans and derivatives that were added defaulted in the next few years, taking the ultimate loss rate of the financial instrument to 14.28 per cent instead of the 0.85 per cent rate that Deutsche Bank estimated when it first marketed the product to investors, the lawsuit claims.

    Several of the companies that defaulted were Hong Kong-based groups that were later accused by their insolvency administrators and liquidators of accounting breaches or fraud.

    Another company that defaulted on an instrument designed to protect it against interest rate changes has sued Deutsche Bank for selling an unsuitable product, the filing says.

    Arco claims that by including such derivatives and risky loans Deutsche Bank defrauded the CLO’s noteholders. It says it lost in excess of $37m as a result.

    “Between 2007 and the end of the transaction on July 2012, Deutsche Bank wrongfully obtained more than $86m in credit event payments to which it was not entitled,” the lawsuit claims.

    Earlier this year, a fraud claim by Germany’s HSH Nordbank against UBS over a collateralised debt obligation was dismissed by New York’s Supreme Court in what was seen by lawyers as having broader implications for investors seeking damages for losses incurred in the financial crisis.