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Morgan Stanley latest to add DVA into Q3 earnings report

Morgan Stanley follows Bank of America and Citigroup in using accounting methods to reveal a rise in income to $2.2 billion for this year’s third quarter.

Morgan Stanley is the latest in a line of banks to add debt valuation adjustment (DVA) – debt-related credit spreads and other credit factors – into its third quarter 2011 earnings report.

The investment bank reported income of $2.2 billion, or $1.14 per diluted share, for the third quarter ended September 30 compared with income of $314 million, or $0.05 per diluted share, for the same period a year ago. Net revenues were $9.9 billion for the current quarter compared with $6.8 billion a year ago.

The group echoed its investment bank counterparts, stating that results for the quarter included positive revenue of $3.4 billion, or $1.12 per diluted share, compared with negative revenue of $731 million a year ago relating to changes in Morgan Stanley's DVA, which is somewhat charts the decline in the bank’s credit worthiness.

Like Citigroup and Bank of America (BofA), DVA features heavily in the firm’s earnings report. Despite being transparent in its reporting, the DVA – and at Citigroup, Credit Valuation Adjustment (CVA) – the tool has contributed significantly to the top-line number.

Morgan Stanley said its compensation expense for the current quarter was $3.7 billion, with a compensation-to-net-revenue ratio of 37%.

“This ratio was affected by DVA, which increased net revenues in the current period,” says the bank in a statement. “Non-compensation expenses of $2.5 billion reflected higher levels of business activity and costs associated with the UK bank levy. For the current quarter, net income applicable to Morgan Stanley, including discontinued operations, was $1.15 per diluted share, compared with a net loss of $0.07 per diluted share in the third quarter of 2010.”

This week, other investment banks have utilised DVA and CVA calculations to bolster top-line earnings numbers.

BofA reported a net income of $6.2 billion, or 56 cents per diluted share, for the third quarter of the year, compared with a net loss of $7.3 billion in the year-ago period.

“There were a number of significant items that affected results in both periods,” says the bank in a statement. “The most recent quarter included, among other things, $4.5 billion (pre-tax) in positive fair value adjustments on structured liabilities, a pre-tax gain of $3.6 billion from the sale of shares of China Construction Bank (CCB), $1.7 billion pre-tax gain in trading DVA, and a pre-tax loss of $2.2 billion related to private equity and strategic investments, excluding CCB.”

Structured liabilities are traditionally used to help corporations manage their risks, which are in effect securities of any asset class that are restructured to facilitate some form of risk transfer.

Along the same lines of accounting gains, Citigroup posted a net income increase of 74% to $3.8 billion, compared with Q3 2010, reflecting the impact of CVA and a $2.6 billion improvement in the cost of credit, which was partially offset by an 8% – or $940 million – increase in operating expenses from the prior-year period.

CVA is the market value of counterparty credit risk, meaning that it is the differential between the risk-free portfolio and the true portfolio value.

Citi’s Q3 results also revealed a 20% year-on-year increase in securities and banking revenues, rising to $6.7 billion. However, the bank included $1.9 billion of positive CVA, from the widening of credit spreads, which means the lessening of credit worthiness and reveals a 12% decline in revenues if this was stripped out of the top-line result.

Similarly, Morgan Stanley, like its counterparts, revealed that sales and trading net revenues were $5.4 billion but included positive revenue of $3.4 billion related to DVA.

Check out the November issue of Euromoney, as we will analyze how continued pressure from the withdrawal of investors in the funding market impacts upon banks’ margins and is prompting radical changes to their business models.

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