As we all know by now, bank earnings were much better than expected. Upon further investigation we can see that the investment banking arms at the banks were particularly profitable. But an even deeper investigation reveals something more alarming about these “profits”. When you back out the gains or losses on the banks’ own bonds or derivatives payable you get a very different picture. Adjusted pre-tax income at JPM falls by 33% and 28% at BAC. At Citi, the pre-tax income is wiped out entirely. As Moody’s points out, its important to make these adjustments because bondholders should view the the large revenue gains with skepticism when considering how severely credit deteriorated at the major banks.
Given (1) the fluctuations in firms’ spreads and firms’ inconsistent disclosures about all sources of DVA, and (2) the additional possibility that firms may be marking distressed assets less conservatively now as a result of recent FASB guidance, one can only estimate the true quality and diversity of trading earnings this quarter. Reported fixed-income, currency and commodity trading (FICC) revenues made a sharp sequential rebound at all firms due to a reduced pace of writedowns on legacy positions (with the notable exceptions of long CMBS positions).
Goldman Sachs had the most stable spreads in the quarter and therefore felt the least “noise” from DVA changes. It also appears that GS (which increased its VAR nearly 22% sequentially) took full advantage of improving liquidity in plain-vanilla products and a less-crowded competitive landscape to capture wider bid-offer spreads and report strong FICC revenues.
Morgan Stanley did not separately disclose the DVA change related to its derivative payable. Its CDS spreads were stable quarter over quarter, so the DVA change on its derivative payable was probably insignificant. Therefore, our adjusted figures are likely representative of the firm’s results.
Customer flows also appeared strong at BAC and Citigroup and both firms benefited from a lower level of writedowns in credit and structured products compared to the fourth quarter.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.