it is the Friday of a holiday-shortened summer week I don’t want to hear about it okay?

  • 06 Jul 2012 at 3:14 PM
  • Banks

Banks Are Losing One More Source Of Fake Income

Have you given up on this week yet? Of course you have. Libor Libor Libor Libor, we get it, mistakes were made. Next week though we get the start of bank earnings season, which will at least kick off with a whaling expedition, so that’s something.

One thing that we’ve had to look forward to in recent earnings seasons is getting to talk very seriously about how banks “make money” by becoming worse credits, or less amusingly “lose money” by becoming better credits. This is more or less referred to as “DVA,” for “debit valuation adjustment,” and stems from accounting rules that allow and/or require banks to reflect changes in the fair value of certain of their liabilities – including changes in fair value due to their own deteriorating or improving credit – in their accounting net income. The counterintuitive result is that the worse the bank looks, the better its earnings look. This provides cheap irony, which is a valuable social function because earnings reports are often pretty boring and what else are we going to talk about; it also provides countercyclical bank confidence-boosting (though not countercyclical actual capital), which is also a valuable social function especially if you take away other countercyclical confidence-boosters like lying about your unsecured borrowing costs. (Libor Libor Libor.)

The effect should be particularly interesting this quarter as there’ll be dueling credit effects on earnings. On the one hand, bank credit is broadly wider – I see JPM 5y CDS +44bps for Q2, C +50, BAC +38, GS +46, MS +45 (from Bloomberg CMA) – and when I last did any math on it 1bp of CDS spread seemed to translate into anywhere from ~$2mm (for GS) to ~$22mm (for JPM) of DVA earnings. So there’s potentially $2bn in imaginary earnings in those numbers. Read more »