We find this very amusing. But then, we have a very dark sense of humour.
Banks have been posting stellar first-quarter results in their fixed income divisions. These shouldn’t really be a surprise. Banks, thanks to US government actions like well-publicised quantitative easing, MBS purchases, etc., have basically been able to frontrun the fixed income market. The fixed income result from Citi, however, is really something special.
From the Daily Reckoning:
But something magic happened in the fixed income trading group for Citi. This is pure gold if you like arcane financial statements packed with fictional earnings. If you dig into the quarterly report, you’ll learn than fixed income trading revenues were boosted by a “net $2.5 billion positive CVA on derivative positions, excluding monolines, mainly due to the widening of Citi’s CDS spread.”
That takes some sorting out. A CVA is a “credit value adjustment.” As you can learn here, it’s the credit risk premium of a derivative contract. …
Citi appears to have reported a $2.5 billion trading gain in the fourth quarter precisely because the market thought the company stood a good chance of failing (hence the widening CDS spread).
You can see Citi’s CDS spreads in this slide from the bank’s Q1 presentation below.
If in a month like March, described by JP Morgan CEO Jamie Dimon as “a little tough”, bank shares rallied and spreads tightened — Citi would have suffered in terms of its CVA.
Therein lies a major Catch-22. If the market thinks Citi is doing well, the bank’s shares could rise, its CDS could tighten, its CVA gains could well reverse, hitting its earnings, and vice versa. If the market thinks it’s doing badly, Citi’s CVA gain will increase, but it could still possibly be in need of more capital.
Related links:
Dissecting bank results – FT Alphaville
The IBs of March – FT Alphaville
The return of the IB capital call – FT Alphaville
On Wells Fargo and banks’ well-being – FT Alphaville