DVA

The bottom line on Citigroup's just released results: the firm reported an adjusted adjusted Net Income number of $3.268 billion ($1.06 EPS), which was "better" than the expected $0.97 (just like JPM's bottom line was better and the initial spike higher in the stock price promptly reverted into the red once people read the footnote text). How did Citi get to this number? It started with an unadjusted $964 million of Net LOSS and then added back a tax provision, CVA losses (as its spread tightened in the quarter), the loss for the sale of MSSB ($4.7 billion pre tax), and miraculously got to $3.3 billion. The MSSB and CVA/DVA adjustment also miraculously increased total revenues from $13.951 billion to $19.411 billion, making a sequential unadjusted 25% drop in Revenues equal to a 3% increase. But even if one were to assume that the bank's $3.3 billion uber-adjusted Net Income number is meaningful in any way, it is certainly notable that $1.509 million of this, or nearly 50% came from the tried and true gimmick: Loan Loss Reserves, which boosted EPS by the same percentage, even as the firm saw its Net Credit Losses soar by 11% from Q2, to $3.979 billion. This was a bigger LLR than in Q2 ($984MM) and Q3 2011 ($1,422MM). Same old goosing gimmicks, different day.

Blowout quarter, or do US bank numbers just blow?

There is a lot of verbiage in the official JPM Q3 Earnings press release which directs to a bottom line number of $1.40, or $5.7 billion on expectations of $1.24, with revenue of $25.9 billion on expectations of $24.53 billion. The primary reason for the lack of disappointment: no major losses in Corporate from CIO, with corporate generating $221 million in Q3, up from a loss of $(1.777) billion in Q2. And then come the adjustments:  $900 million pretax benefit ($0.14 per share after-tax increase in earnings) from reduced mortgage loan loss reserves in Real Estate Portfolios; $825 million pretax incremental charge-offs ($0.13 per share after-tax decrease in earnings) due to regulatory guidance on certain residential loans in Real Estate Portfolios; $888 million pretax benefit ($0.14 per share after-tax increase in earnings) due to extinguishment gains on redeemed trust preferred capital debt securities in Corporate; $684 million pretax expense ($0.11 per share after-tax decrease in earnings) for additional litigation reserves in Corporate; Then there is a DVA loss of $211 MM in banking. Net-net, after taking into account all one-off adjustments, the Q3EPS was really $1.26. But for all the data fudging, and attempts to make the reported EPS non-comparable to the expected one, following an avalanche of one-time adjustments, the bottom line is this: revenues from trading dropped both sequentially and Q/Q while banking expenses rose, Net Interest Margin dropped to a new record low, even as the firm too a major $967 million loan loss reserve release on its loans to $22.8 billion, even as its total Non-Performing Loans rose by a whopping $1.3 billion to $11.370 billion, the largest quarterly jump in years! Just how JPM can justify such a major contribution to earnings coming from loan losses when NPLs have soared is unclear to anyone with a frontal lobe.

Forget the few hundred million dollars in wrist-slap fines the banks face from regulatory discipline over the Libor rate manipulation 'conspiracy fact'. As the WSJ reports this morning, the number of suits and potential liabilities are rising rapidly as cities, insurers, investors, and lenders all jump on the cabal-beating band-wagon. From individual investors claiming lost returns due to low rates to hedge funds squeezed in derivatives trades, liabilities could exceed $176bn as the blood-suckers lawyers note "this is just the beginning" as "scores of interested potential clients" have called. While, obviously, it won't be easy to win in court, the ongoing costs of litigation and potential liability (which will be largely ignored by Messrs. Bove et al. we are sure) range from Macquarie's $176bn estimate to Morgan Stanley's $7.8bn (quite a range) and it will likely take years for the lawsuits to see resolution. Notably though, floating-rate bond-holders are likely to have the most success (and easiest claim) as Darrell Duffie notes "assuming they can convince a jury Libor was too low, it's pretty easy to then show they were paid too little interest" but in the meantime, as CalPERS adds, "we await the regulatory investigations, which will drive the outcome" of litigation.

Q2 hedge fund reporting season has come and gone. Below is a summary of the key funds, and who held what at the end of June.

While in principle central banks around the world can talk up the market to infinity or until the last short has covered without ever committing to any action (obviously at some point long before that reality will take over and the fact that revenues and earnings are collapsing as stock prices are soaring will finally be grasped by every marginal buyer, but that is irrelevant for this thought experiment) the reality is that absent more unsterilized reserves entering the cash starved banking system, whose earnings absent such accounting gimmicks as loan loss reserve release and DVA, are the worst they have been in years, the banks will wither and die. Recall that the $1.6 trillion or so in excess reserves are currently used by banks mostly as window dressing to cover up capital deficiencies masked in the form of asset purchases, subsequently repoed out. Which is why central banks would certainly prefer to just talk the talk (ref: Draghi et al), private banks demand that they actually walk the walk, and the sooner the better. One such bank, which has the largest legacy liabilities and non-performing loans courtesy of its idiotic purchase of that epic housing scam factory Countrywide, is Bank of America. Which is why it is not at all surprising that just that bank has come out with a report titled "Shipwrecked" in which it says that not only will (or maybe should is the right word) launch QE3 immediately, but the QE will be bigger than expected, but as warned elsewhere, will be "much less effective than QE1/QE2, both in terms of boosting risky assets and stimulating the economy."

Morgan Stanley reported earnings this morning, and showed that unless one has massive loan loss reserves to release, US banks are in big trouble. The firm just reported $0.28 EPS including DVA benefit, on expectations of $0.29. But it was the top line that got blown out, with the firm reporting $7.0 billion in revenue including the DVA fudge, but more importantly $6.6 billion. The expectations was for a $7.58 billion top line: a 14% miss. The top line number plunged over 25% compared to a year ago. The main reason for the collapse in profit: the virtual disappearance of any cash from combined fixed income, commodity and equity sales and trading, which imploded from $3.7 billion a year ago, to just $1.9 billion this quarter. And while the company slashed comp in Q2 as was to be expected following such horrible results, by over 33% to $1.4 billion from $2.2 billion, here is what most are focused on: "As a result of a rating agency downgrade of the Firm's long-term credit rating in June, the amount of additional collateral requirements or other payments that could be called by counterparties, exchanges or clearing organizations under the terms of certain OTC trading agreements and certain other agreements was approximately $6.3 billion, of which $2.9 billion was called and posted at June 30, 2012." In other words, the company has yet to post more than half of its contractually required collateral. In the aftermath of these atrocious earnings, we wish them all the best in getting access to this cash.

There were several numbers one should focus on today's Bank of America earnings release. They were not the Net Income EPS ($0.19 which beat estimates of $0.15), the Income before income taxes of $3.4 billion, nor Revenue net of interest expense ($21.968 which missed expectations of $22.71 billion). Here are the numbers that did matter: Loan Loss Reserve Release $1.9b billion, or 56% of pretax net income, Sales And Trading Revenue exluding DVA plunged by $1.9 billion from Q1 to $3.3 billion (and by $263 million from a year ago), and most importantly, counterparty claims by coutnerparties for Reps and Warranties purposes (remember those? the realization of their size caused the stock to plummet last August) soared from $16.1 billion to $22.7 billion sequentially: the highest it has ever been, even as the company only took a $395 million provision against losses, and the ending Rep and Warranties balance was $16 billion (driven by nearly a doubling in Private repurchase request claims from $4.9 billion to $8.6 billion!), or well below the potential outstanding claims. BAC is now reserve deficient by about $6.7 billion! Considering the company's settlement with Syncora yesterday, and imminent settlement with MBIA this may be a tiny problem.

On the surface, Goldman's results, which unlike JPM and Citi do not break out the contribution of DVA, aka the top and bottom line contribution from Goldman's CDS blowing out in Q2, were good because they beat expectations of $6.26 billion in revenue and $1.18 in EPS, printing at $6.63 billion and $1.78/share. Of course, going back 3 weeks and the bottom line estimate would have missed then consensus EPS, but who cares: after tall the firm guided down and all the algos know is that GS beat. The problems arise when one spreads the various top line segments which portend nothing new: Client Flow, a proxy for general credit trading, dropped from $3.5 billion to $2.2 billion in Q2, but better than Q2 2012 when it was just $1.6 billion. However, client flow in equities was an abysmal $1.7 billion, down from $2.3 billion in Q2 and $1.9 billion last year as increasingly less people opt to use Goldman's REDi platform or its equity sales team. But most troubling was the epic collapse in the firm's Investing and Lending group, aka its highest margin, Prop Trading operation, which in the aftermath of the JPM fiasco mysteriously saw its revenue collapse from $1.9 billion to a mere $203 million, down from $1 billion a year earlier, and only the second lowest number in the past 3 years. Did the JPM CIO CDS repricing scandal force all banks to suddenly reevaluate their books and mark mid-market? We don't know, but there were no reason why Goldman's prop traders should have generated only $200 million in a quarter in which the bulk of the heat was focused on JPM and others. And finally, in terms of employee retention, Goldman employees can not be happy: in Q2 average comp to the firm's 32,300 total staff also declined to a multi-year low of $343,003, down from $350,864 last quarter, and down 16% from $408,958 a year earlier.

Here are the key highlights from the just released Citigroup Q2 earnings:

• Net Income of $0.95 or $1.00 excluding CVA and one time loss; Exp $0.86
• Citigroup Net Income of $2.9 Billion; $3.1 Billion Excluding CVA/DVA and the Loss on Akbank;
• Citigroup Revenues of $18.6 Billion; $18.8 Billion Excluding $219 Million of CVA/DVA and the $424 Million Loss on Akbank; Exp. $19.01 Billion
• Where the bottom line beat came from: Loan Loss Reserve Release of $984 Million in Second Quarter, or 35% of pretax net income.
• Complete freeze in capital markets:
  
  • Fixed Income markets revenue plummets from $4.7B in Q1 to $2.8B in Q2 (and down 4% Y/Y from $2.9 billion)
  • Equity Markets revenue slides 39% sequentially from $776MM to $550MM, down 29% Y/Y from $776MM. It's a zombie zone out there
• Total Securities and Banking revenues slide 22%, yet Expenses decline just 4%
• And just like JPM, Americans can't wait to hand over their deposits to Citi: Citigroup Quarter-End Deposits of $914 Billion, 6% Above Prior Year Period
• This compares to total Loans of $655 billion or a $259 billion mismatch; we know that this surplus is what JPM uses as funding for its Treasury/CIO group. Does Citi also use the excess deposits to fund its internal hedge fund?

Much has been said about JPM's CIO Loss (which so far has come at a little over $5 billion, just as we calculated in the hours after the original May 10 announcement). And with the so called final number out of the way, investors in JPM have breathed a sigh of relief and are stepping back into the company hopeful that a major wildcard about the firm's future has been removed. The issue, however, is that the CIO loss was never the question: after all JPM could easily sell debt or raise equity to plug liquidity shortfalls. The real issue is that just as we explained months before the loss was even known, the Treasury/CIO department was nothing short of the firm's unbridled hedge fund which could do whatever it chooses, and not be held accountable to anyone at least until its counterparties broke a story of an epic loss to the media. And thus the problem becomes apparent: now that every action of the CIO group is scrutinized under a microscope by everyone from management to auditors to regulators to analysts to fringe blogs, the high flying days of whale trades are forever gone. The question then is just how big was the contribution of the Treasury/CIO group, which until today was buried deep within JPM's Corporate and PE Group and not broken out. Thanks to the new breakout, reminiscent of Goldman starting to break out its own Prop Trading group some years ago, we now know exactly just how big the contribution to both revenue, but more impotantly, net income was courtesy of JPM's Hedge Fund.

The result is nothing short of stunning.

In light of the just announced huge 8-K which has JPM admitting it was mismarking hundreds of billions in CDS, in effect destroying the CDS market for everyone (as we predicted 2 months ago would happen), the firm's earnings (and CIO losses) are very much irrelevant. But here they are regardless: $5 billion in Net Income, which includes a $4.4 billion in CIO losses offset by $1.0 billion from "securities gain in CIO investment securities" i.e., asset sales; also in Q2, the firm took a $2.1 billion "benefit" from reducing loan loss reserves (the usual accounting gimmick), and $0.8 billion DVA "profit" as a result of its CDS blowing up. Finally JPM also announced $0.5 billion gain on a "Bear Stearns related first loss note." In summary, expectations were for $0.76 in EPS; reported EPS Ex-DVA were $1.09, and ex-all one time gains, $0.67. In other words, JPM's bottom line is totally meaningless, as the bulk of profits are from totally garbage and meaningless numbers. The real question is how much net income is now forever gone as a result of i) the unwind of the CIO's synthetic division, aka the most profitable group at JPM, and ii) the fact that the entire firm's CDS marks were made up and will now have to reflect reality. Now, back to the main news of the day: the fact that JPM just threw the entire CDS market under the bus, and England's Lieborgate just arrived in the US courtesy of CDS-gate.

The FDIC decided to wait with its dose of pre-holiday humor until after the Barclays fixing for today's market close turned out to be spot on. And by that we mean that official release of the US banks' "living will" statements, which as far as we know is about the most worthless exercise ever conducted, and about the dumbest thing to be conceived by that very undynamic duo of Barney Frank and Chris Dodd. Because last we checked, the treatment of living wills in bankruptcy court, where all these firms will end up eventually anyway, is... non-existent. But the real fun is when one actually reads this indicative statement from Citigroup: "Citi is today a fundamentally different institution than it was before the crisis." And that's where we stopped. Because it is banks wasting their time (and taxpayer bailout money) on gibberish like this instead of analyzing the risk inherent in their prop positions that guarantees the next CIO-like blow up will not be just $5 billion but far, far more, and will certainly prove that living wills when one has to equitize tens of billions in unsecured debt are worth exactly didely squat.

While no-one knows exactly what the 'whale' trade was (we suspect a senior tranche trade tail-risk hedge whose risk-management hedging went pear-shaped), how much was done ($150bn notional seems consensus), and what the losses are likely to be (approximately $4bn is easy to see given the moves in IG9 10Y alone; though $9bn seems a stretch - albeit the kitchen-sink nature and perhaps inclusion of the losses from the long-book that this was supposed to be hedging - and the other positions that were used to hedge - may push it up to $6bn plus); we prefer to fall back to what has been a tested and true arbiter of JPM's underlying value (ex equity exuberance) - the CDS market. Given the current moves in prices, CDS appear to be looking for another 5-10% downside here before JPM's equity price is back in line with the credit market (of course this could also mean CDS needs to tighten aggressively or both). In the meantime, this message was brought to you by the acronyms DVA, LLP, and DV01; the number '9'; and the word 'book-value'.

We have long said that the maximum potential loss of the JPM CIO trade based on the blow out in IG9 10 year (and associated trades complex), which has about a $200 million DV01, is far beyond not only the $2 billion that Jamie Dimon estimated on May 10, but above our own estimate which was $5 billion on that same day. Today, the NYT "according to people who have been briefed on the situation" which translated means just more media propaganda because all the news on the topic in the past month has been leaks by axed parties, says that 'Losses on JPMorgan Chase’s bungled trade could total as much as $9 billion, far exceeding earlier public estimates, according to people who have been briefed on the situation." Also according to the NYT, and roundly refuting what the other leak had told Bloomberg and other media outlets, "The bank’s exit from its money-losing trade is happening faster than many expected. JPMorgan previously said it hoped to clear its position by early next year; now it is already out of more than half of the trade and may be completely free this year." Obviously, this refutes media "reports" also based on "people familiar" or "conflicted sources" that JPM has unwound its trade, either by novating, or by transferring it over to helpful hedge funds. Bottom line: take everything with a grain of salt until Dimon himself gives an update in two weeks, as this could easily be an upper bound loss estimate starwman to set expectations very low, sending the stock soaring when the "final" announce loss comes in at ~$5 billion, courtesy of other well-known "masking" techniques such as loan loss reserve release and DVA benefits.