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What was that about stable earnings?

One analyst is convinced that Bank of America's stock price performance is overdone, and benefits from sleight of hand. In a series of reports published since August last year, David Hendler, financial-services analyst at independent research firm CreditSights, has drawn attention to Bank of America's earnings from derivatives transactions. "We think the key driver of performance has been the company's over-reliance on interest-rate bets that previously went awry and of late have come in the money." Such activity is, he says, a volatile source of earnings. It would also seem to belie Bank of America's executives' table-pounding about the need for consistent earnings and less volatility.

The basics of the trade as Hendler sees it is that the bank's treasury department, run by Al DeMolina, placed a bet in autumn 2000 that US interest rates would fall. And they did it off balance sheet. Instead of buying four-year treasury notes with Libor-based funding, surmises Hendler, it reconstructed the same trade "with four-year receive-fixed generic swaps while paying a Libor rate of interest".

That play has netted the bank close to 4% net interest spreads without much, if any, interest-rate risk. Doing it synthetically also means using far less capital, to the tune of one-twentieth of that needed for a trade that would make use of the balance sheet.

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