Accounting rules that helped U.S. banks list billions of dollars in paper gains on derivatives in the third quarter of 2011—boosting their bottom lines—may now work against some banks as they post losses for that line item in the fourth quarter....
Now, however, these adjustments are about to garner attention again as the pendulum swings the other way, leading banks whose bonds have improved in the most recent quarter to post unrealized losses.
That forecast, by specialists at Quantifi, is based on how much banks' bond spreads have changed and the difference in how much it costs to insure that debt using credit-default swaps. It doesn't account for changes in currency or interest rates, changes in the size of their derivatives portfolios or the changing creditworthiness of their trading partners.
The effects of improved bond spreads in the fourth quarter will become apparent Friday, when J.P. Morgan becomes the first bank to report earnings for that period. Spreads are the extra premium investors demand to own that debt over government bonds; as the price of bank bonds rose, their risk spreads fell.
Spreads on five-year bonds issued by J.P. Morgan tightened 5.6% in the three months ended Dec. 30 and its CDS spreads came in 9.4%, according to data provider Markit. As a result, Quantifi estimates that the DVA losses for J.P. Morgan will be $315 million.
Morgan Stanley's bond spreads widened 4.1% over the same period but its CDS spreads tightened 14.6%, leading Quantifi to estimate its DVA loss at $250 million. Bank of America's bond and CDS spreads both tightened about 3%, producing an estimated DVA loss of $150 million. And Citigroup's bond spreads widened 1.6% while its CDS tightened 11%, leading to a DVA loss estimate of $90 million.
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