Stripping out banks’ accounting tricks

IF investment bank analysts remember 2011 for anything other than an earnings wipe-out, it will be the year of the debt value adjustment (DVA) – or “own credit” tweak.

In the first nine months of this year, a drop in the value of Barclays’ debt amounted to a whopping £2.97bn gain on the bottom line.

Barclays, however, strips out the DVA to give an “adjusted” figure. (Also cutting out other annoying one-off charges in the process, though they are easy to add back in).

But why does a drop in the value of bank debt boost profits?

It’s because the debt appears on the liabilities side of the balance sheet. When that debt is written down, a firm appears to have dramatically fewer liabilities.

But in order to take advantage of that change, the bank would have to go out and buy back all of its debt at the lower cost and then re-issue it.

In current funding markets, it would be a brave move: by the time a debt sale got off the ground, prices could have moved the wrong way. So unless a bank has done just that, the DVA can usually be ignored.