Jan 11 As Wall Street banks begin reporting
earnings next week, analysts and investors are once again
prepared for big accounting charges related to changes in the
firms' own credit spreads.
The charges stem from the improving corporate bond markets.
When bonds that banks have issued become more valuable, banks
take charges known as "debt valuation adjustments," or DVAs, to
reflect the fact that buying back debt would be more expensive.
When their bonds weaken, banks can record gains.
Based on movements in banks' credit, debt valuation
adjustments may result in charges as high as $1 billion for
Morgan Stanley and anywhere from $250 million to $500
million for JPMorgan Chase & Co and Citigroup Inc,
said Dmitry Pugachevsky, director of research at analytics firm
Bank of America Corp said earlier this month that
its fourth-quarter earnings will include a charge of
approximately $700 million related to tightening of its own
credit spreads. It declined further comment on Friday.
During the quarter, Bank of America's credit default swaps
fell by 0.43 percentage points, or 24 percent, according to data
from Markit, which tracks credit-default-swap movements.
Credit-default swaps measure the cost of protecting a company's
debt against default, and falling values indicate a company is
perceived as less likely to default.
Investors and analysts have come to ignore big swings in
earnings related to DVAs, which banks have been recording since
2008, when accounting rule allowed the option of accounting for
debt on this basis. At the time, DVAs were a boon to banks,
allowing them to record profit as they were punished in bond
"It doesn't really reflect true state of earnings or true
standing of the bank but, nevertheless, results will swing
depending on changes in the spread," said Pugachevsky.
Banks that opted for this accounting treatment hoped that it
would make their earnings more stable-- in good times, negative
DVAs would cut into profits, but in bad times, positive DVAs
would boost the bottom line. In the current environment, bank
profits are not growing as impressively as their debt values,
resulting in a big drag on profit.
FASB has tentatively agreed to allow changes in the value of
debt to influence a bank's equity rather than its income. But
the U.S. accounting standard-setter has not yet implemented its
Credit default swap levels for Morgan Stanley and Citigroup
dropped by 24 percent last quarter, according to Markit, while
JPMorgan's fell by 26 percent. Pugachevsky does not expect
Goldman Sachs Group Inc to report a big DVA loss because
while its credit default swap prices dropped 22 percent, it
typically hedges against DVA swings. Other banks do not.
Morgan Stanley and JPMorgan declined to comment on any
potential DVA charge. Representatives of Citigroup and Goldman
did not immediately respond to requests for comment.