Here at FT Alphaville, we do like to cover the effects of gains and losses stemming from changes in banks’ own debt quality.
These, as we’ve written before, are known as CVAs: credit value adjustments.
Friday’s results from Bank of America Merrill Lynch don’t disappoint.
In fact one reason why the bank may have blown through analyst expectations on the day could be connected, in part, to gains it received on CVAs.
From its results statement (p.44) on Friday:
A Solid Start to 2010 Financials
Revenue of $32.3 B up 14% from 4Q09 but down 16% from 1Q09, on a managed basis
– Sales and trading recorded record revenue of $7.0 B including write-downs on legacy assets of only $34 M
– Net interest income continues to be pressured by lack of loan demand
– Merrill Lynch structured notes valuation gain in 1Q10 of $226 M, 4Q09 loss of $1.6 B, and 1Q09 gain of $2.2 B
– Prior year comparison also impacted by 1Q09 revenue of $1.9 B gain from asset sales Expense of $17.8 B up 8% from 4Q09 and 5% from 1Q09
Barclays Capital, for one, warned of a possible CVA gain in its BAC earnings preview on April 7. It lifted its EPS expectation figure to 10 cents a share from 5 cents a share as a result.
As they wrote at the time:
We expect BAC to report 1Q EPS of $0.10 vs. consensus of $0.08 and our prior estimate of $0.05. A better-than-anticipated CVA adjustment due to MER spreads widening during the quarter drove our revision.
On a core basis, BAC has roughly broken-even in each of the past 3 quarters. Relative to 4Q, we expect core balance sheet contraction (lower managed loans, higher deposits), mixed fee income trends (increased trading but pressured IB, core mortgage, deposit and card fees), lower expenses (continued cost saves from acquisitions); improving, yet still elevated asset quality trends (slightly lower NPAs, possibly lower NCOs though continued shift from consumer to commercial), a lower provision (continued decline in reserve building) and a higher share count (issued 1.3B shares in early Dec).
Losses in its higher risk portfolios (mortgage, card, H/E, small biz, CRE) are expected to remain elevated, although results in several of these are expected to be mixed. Linked quarter comparisons may be skewed due to FAS 166/67, which brought $100B (4% of assets) back onto the balance sheet ($70B from credit card trusts) and result in a $6B charge to retained earnings to increase its reserve.
And here, meanwhile, was their initial view on the figures on Friday:
BAC reported 1Q10 EPS of $0.28, above consensus of $0.09, though we believe the market expected results to exceed these expectations post JPM’s figures on Wednesday. Like JPM, results benefited from strong capital markets activity and a reduced loan loss provision. Results included a $1.0 billion reserve release (improved delinquencies/lower bankruptcies Card, stabilization in commercial portfolios; consumer R/E increased). Credit quality continued to improve, with NCO declining in most consumer portfolios, as well as across a broad range of commercial borrowers and industries.
Gains of note include gains on sales of debt securities ($734MM) and a gain from the fair value option impact on MER structured notes ($226MM). Losses of note were merger costs ($521MM), loss from sale of $3 billion discretionary equity securities portfolio ($331MM), OTTI ($235MM, non-agency CMO), and litigation costs ($500MM, same as 4Q). Net these cost it $0.04. Also, reps and warranties expense totaled $500 million (in-line w/ 4Q).
Of course, the quarter’s gain isn’t by any stretch of the imagination anywhere close to the $2.2bn gain BAC registered on credit value adjustments in the same quarter in 2009.
But then again, Merrill Lynch CDS spreads didn’t widen quite as much either:
Related links:
Profiting from your own crummy creditworthiness, redux – FT Alphaville
CVAs or ‘the magic of your own credit on profits’ – Holding to Account
A Citi-fied catch-22 – FT Alphaville