Accounting tweak hides bank wipeout

ACCOUNTING technicalities have disguised the true extent of the wipeout for Wall Street’s investment banks this quarter, according to data compiled by Financial News.

A run of US bank results for the third quarter of this year exceeded analysts’ expectations last week, but a closer look at the numbers shows that their investment banking businesses have been hit hard by the global economic slowdown.

Stripping out the effect of a debt valuation adjustment (DVA) -- which is a regular feature of results but was particularly acute this year -- pushes the investment banking division of Bank of America Merrill Lynch (BAML) into the red and puts Morgan Stanley’s institutional securities business only close to breaking even, rather than making a considerable gain.

For BAML, it flips the pre-tax profit of $730m into a $970m loss. The equivalent for Morgan Stanley sees the division’s pre-tax earnings number go from $3.34bn to $23m.

The effect is similarly dramatic at rival banks. Goldman Sachs’ $73m loss deepens to $1.18bn, JP Morgan’s investment bank sees its $2.52bn in pre-tax profit cut down to $62m and the equivalent figure for Citi’s securities and banking division plunges from $2.97bn to $1.08bn.

The DVA accounting change affects results every year and has resulted in gains as well as losses, but it makes this quarter’s numbers particularly difficult to compare with others.

It is meant to reflect the changing value of banks’ debt: when they are seen as riskier, the market value of their bonds drops. After a DVA, that appears as a reduction on the liabilities side of the balance sheet.

The effect is that a deterioration in banks’ prospects causes them to book a larger profit than they otherwise would.

British banks, which report results in the next few weeks, do not have the same ability to apply the DVA accounting gains to their earnings numbers.

However, some have in the past attempted to use accounting vagaries to alter headline numbers: Barclays did so using several billion in assets that it converted into a loan to an entity called Protium. It was then forced to reverse the trick due to capital rules.