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Bank of America employs DVA to boost results

BofA appears to follow banks such as Citigroup by adding debit valuation adjustments (DVA) to its third quarter results

Bank of America (BofA) has 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.

But it seems the investment bank has followed in the footsteps of other market counterparts by boosting its top-line results with the inclusion of fair value adjustments on structured liabilities.

“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 Debit Valuation Adjustments (DVA), and a pre-tax loss of $2.2 billion related to private equity and strategic investments, excluding CCB.”

The bank says that the fair value adjustment on structured liabilities reflects the widening of the company's credit spreads and does not impact regulatory capital ratios, while the year-ago quarter it references in its results included a $10.4 billion goodwill impairment charge.

"Our focus this quarter was on strengthening the balance sheet by selling non-core assets and building capital to position the company for future growth,” says Bruce Thompson, CFO at BofA. “In that regard, we accomplished a great deal. We reduced the size of our balance sheet by $42 billion from the second quarter of 2011, nearly doubled our tier 1 common equity ratio since early 2009, and continued to have strong liquidity levels, even after significantly reducing both short- and long-term debt.”

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 credit valuation adjustment (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.

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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