JPMorgan Uses Surge In Its Default Risk As A $1.9 Billion "Source" Of Revenue And Net Income

Tyler Durden's picture

A quick look at the JPM earnings this morning would indicate all is well and that the company beat on the top and the bottom line: after all the company generated $23.76 billion in revenue on expectations of $23.26 and EPS of $1.02 relative to an expectation of $0.92. So far so good. The only problem is that unlike in previous quarter, when the primary driver of the bottom line was releasing reserves, this quarter, when everything blew out and blew up, that would have been seen as massively disingenuous, even by such permaclown as Dick Bove (which nonetheless did not stop the bank regardless, and JPM did take a $170 million reserve release, granted less than the $1.2 billion in Q2). So what does JPM do? Why it pulls the "Fair Value Option" card, discussed recently in the context of Morgan Stanley when we speculated whether the bank's biggest asset was their debt. Turns out we had the concept right, but the bank wrong, because $0.29 of EPS Net Income, or $1.9 billion pretax, was a "benefit from debit valuation adjustment (“DVA”) gains in the Investment Bank, resulting from widening of the Firm’s credit spreads." That's right: the fact that JPM spreads blew out in the quarter, and its default risk soared, for one reason or another actually served to "generate" not only net income but also revenue!  And now you see why American banks can never lose - in a good quarter, they release reserves; in a bad quarter they take FVO benefits in the form of Debit Valuation Adjustments, or in this case both! Winner, winner, always a chicken dinner for Jamie Dimon. Expect every other bank to do the same accounting BS this quarter to pad their numbers.

So first the 6th sequential loan loss reserve reduction:


And then the DV(D)A in action:

So what happens when one excludes the ridiculous benefit from the DVA? From the earnings presentation:

  • Net income of $1.6B on revenue of $6.4B; DVA gains of $1.9B pretax ($1.2B after-tax)
  • Fixed Income Markets revenue of $3.3B; Revenue ex. DVA of $2.8B, down 34% QoQ
  • Equity Markets revenue of $1.4B; Revenue ex. DVA of $1.0B, down 9% QoQ
  • Credit Portfolio revenue of $578mm; DVA gains of $979mm

Said otherwise, JPM's Investment Banking earnings were negative on a rational human being basis, when the bank's overall credit deterioration is not used as a source of Earnings. This means the firm missed not only its EPS but its top line by about $1.9 billion!

And that explains why the stock is down. 

For those stunned by this accounting sleight of hand, read our primer on FVO from April 2009:

The Law Of Unintended "Fair Value Option" Consequences

Financial company stock prices have been on a tear these days, undoubtedly based on glowing, solid results. After all didn't Wells just have a blow out quarter? What is that you say, $5 billion in "earnings" were based on FAS 157-4 reversal and accounting gimmicks? Why should that matter to investors who are happy to buy N/M forward PE stocks any time Cramer top ticks the market, or the Power Lunch brigade glowers in the self proclaimed next American Golden Age.

Well, the financial ripfest, while benefiting bank prop desks (or at least the one that is left) may end up having some unfortunate side effects for none other than the banks themselves, and especially their accounting voodoo: the basis for the recently announced stellar financial results.

The issue at hand is the "Fair Value Option", which under US GAAP essentially allows the booking of a pre-tax profit when a bank's debt trades lower in the open market. This benefits banks that opt-in for FVO instead of other accounting approaches such as amortized cost, or historic cost.

And so readers can get a perspective of just how large an accounting "benefit" the FV Option is to financials, observe the table below which compares 2008 bank Net Income with the Pre-Tax Gain from Fair-Valuing of Own Debt.

For a somewhat rough proxy of how the five selected banks' debt securities have traded in recent times, please see the chart below.

Of the 2015 bonds, recent appreciation has been seen in Goldman Sachs and Credit Suisse bonds, while the remainder have remained relatively flat or have even declined. Of course, these are merely proxies and many more securities are calculated for FVO per GAAP.

Regardless, if the equity run up persists, its is inevitable that bond spreads will tighten (see this post for comparisons for credit and equity levels in financials), thereby eroding the FVO pre-tax accounting benefit for companies with appreciating securities, and in fact will result in a negative pre-tax treatment. How much of a negative contributor to EPS it is will ultimately depend on i) how high equity security prices go and ii) how much of a catch up role comparable credit securities play in their price. It is likely that the respective CFOs are too aware of this phenomenon, and could be one explanation for the divergence between equity values and bond prices. If bonds had experienced the same run up as stock prices, the recently announced EPS for the major banks would have been much more adversely impacted.


As for the firm's outlook:

  • Not unreasonable right now to expect markets in 4Q to be similar to 3Q
  • Expect lower revenue from 3Q11 run-rate due to declines in asset values
  • Consumer & Business Banking results will reflect the full negative revenue impact from the Durbin Amendment of $300mm+/- in 4Q;  Full year annualized impact of $1.0B+/-
  • Consistent with recent trends, expect continued elevated default management and foreclosure-related costs in Mortgage Banking

So much for financials-led "growth"

And the full JPM earnings statement.


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GeneMarchbanks's picture

Perversion of accounting, what else is new?

qussl3's picture

Watch as EZ banks report "record profits" when they change the accounting rules there.

Insolvency just depends on the rules.

Comay Mierda's picture

a wise man once told me "systemic fraud is evidence of a pending collapse"

but who the fuck knows with these markets. this is surely bullish

wang's picture

Faber on Bloomberg Radio in response to question on buying the banks at these levels

"I speak with many people on Wall Street and they tell me that these banks are trading below their book value, JP Morgan was at $27 last week and it at $32 now"

on China

"China in deep deceleration" "Next to shoe to drop is China ...  creating a downward spiral in the world" etc etc


Smithovsky's picture


Mark-to-market most of these banks have negative book value so they don't ever have to worry about trading below it

TheFourthStooge-ing's picture

JPM is simply using Bialystock and Bloom accounting methods, which have been approved by FASB (Fuck America, Serve Bankers):


riley martini's picture

 Todays fascist media it's un-American to tell the truth about JP Morgan . JP Morgan Chase had to pay $100,000,000 in fines for defrauding families of military personel deployed over seas . The fascist media and JP Morgan shareholders get a well deserved place as tratiors in American history.

TheFourthStooge-ing's picture

DVDA = How America is getting screwed (Double Vaginal, Double Anal a.k.a. quadruple penetration).


Ruffcut's picture

Creative accounting. NO longer bachelor of business, but of the Arts.

Everytime I wave my magic wand over my account statements, money disappears. I'm taking that thing back to wallmarts, today.

B9K9's picture

I guess venting makes people feel better, but all this detailed analysis really is a complete waste of time. (And I say this as a bean counter.)

Rather than dig into financials, or provide illustrations of selective MtM (eg DVA), it is much more beneficial to step back and realize that the TBTF are part & parcel of the Whether this is a 'good' or 'bad' thing is completely besides the point - mere parlor talk for those interested in politics.

For those focused primarily on how this plays out, all you need to realize is if the banks go down, the USA goes down. Hence, they are not going down. Stop.End.Of.Story.

Knowing this, how does one position themselves & family to 'win'? That's the real question. All this complaining reminds me of the scene from Schindler's List where the woman complains to the commandant. His reaction? He pulls out a pistol and shoots her. End of discussion.

The name of the game is to lie low and operate in the open shadows. Don't look prosperous, don't talk, and keep your opinions to yourself, unless you're damn sure the other person knows what the fuck you're talkin' about.

adr's picture

and wow is tha a great world to live in. If things have gone that far it is our duty as American citizens to take down the government and replace it with a new one based on the original constitution.

Where are we Germany 1935 and all Americans are Jews and the bankers all SS? WTF speak out and get your head blown off. 

If that is America and it goes down if the banks go down, take it down.

unununium's picture

Who came and removed that commandant from power?  A bunch of cowards laying low?

Thanks to the penniless OWS protesters - we should all be there with them.

And thanks to the men who founded this country and created the basis for the wealth you are trying to preserve.  If they thought like you, it never would have happened.


riley martini's picture

 Bullshit the sooner those corrupt fascist banks go down the sooner we can return to a more capitalist and just country . To continue to defraud and bailout only does more harm and makes a resolution even more harsh.

Melin's picture

give me free speech or give me death

I've always figured I'd burn at the stake if the Christians take power, get my head lopped off if Islam takes power, or get a bullet thru head if Republicans/Democrats remain in power. 

I'll go down speakin' thank you.

Lord Welligton's picture

Accounting .....

Don't you just love it.

cowdiddly's picture

Thank god, we have Sarbanes Oxley to regulate every one else but the banks out of a job.

Fips_OnTheSpot's picture

All is well! Phew! </s>

Debtless's picture

Fuck JPM. Mobsters.

bania's picture

ZH staff u rock

TooBearish's picture

WTF are they buying their own CDs fer crhissake? I mean they claim income when they fukking spreads narrow - how ini the world can u have it both ways??????

cossack55's picture

Easy. Double-speak, double-truth, double-books, double-GAAP.

merizobeach's picture

And the above-mentioned double-double penny.

TradingJoe's picture

Well Jamie, you must love the"new" accounting "rules", eh?

scatterbrains's picture

I'm a  little confused.. are you saying that should WFC run into a little loan loss trouble, the fat guy in the bathtub can just make a call to Moody's, order a downgrade and trigger a nice earnings beat ? Do they teach this in community college business courses or do I have to attend something like the Wharton school to achieve this level of understanding ?


cossack55's picture

One must attend the CFR, ICG and Bilderburger conferences for inclusion into that club.  Wharton and Columbia are good starts on the road to hell tho.

jdelano's picture

Eh?  I don't know about Columbia.  I went there as a Dean's Fellow and there wasn't much Bilderburging going on.  Suppose maybe I just wasn't invited to the meetings but none of my friends were either. 

GeneMarchbanks's picture

Occupy the supply of actual(physical) silver and maybe you slay the dragon. One inch punch style.

Ruffcut's picture

Occupy the FASB and attorney generals office.

silver500's picture

for people struggling to understand this:


"Fair value option is an accounting choice under IFRS and US GAAP allowing companies to account for financial liabilities at fair value and to recognize the difference between fair value and carrying value of the liabilities as gains or losses in earnings. Companies can choose which financial liabilities to elect fair value option for, and once elected, the decision is irreversible. . . .

We illustrate the effects of fair value option on earnings with an example by using a corporate A-rated bond index for maturities of 3 to 5 years for financial institutions in the Euro area as a proxy for an average corporate bond. We compare this with the Eurozone sovereign debt index for similar maturities to approximate the yield movements of a government bond.

Suppose in May 2007 a financial institution issues a €500 million bond with a 5- year maturity and an annual coupon of 5%. The government bond yields 4.3% on the same day. The company has elected the fair value option for this debt instrument. By the end of 2007, the corporate bond yield increases by 1.2%, while the government bond yield decreases by 0.1%. We estimate the fair value of the bond to have fallen to €475 million. The bank will report a fair value gain of €25 million on its own debt in FY 07 earnings. Corporate yields continue to rise in 2008 while government bond yields, in contrast, fall, causing further widening corporate credit spread. As a result, the company recognizes fair value of gain of €69 million on own debt in FY 08."



AUD's picture

So a loss for the creditor is carried as an 'asset' by the debtor?

If that's the case, Greece is in fine shape, their 1yr bond is trading close to zero.

SheepDog-One's picture

Got to keep pricing in QE3-4-5 somehow!

A Man without Qualities's picture

The funny thing about this methodology is that as the company moves towards a default, it gets a nice boost to "earning" by being able to discount its liabilities at a higher interest rate, BUT when it does default, all liabilities become due and payable, so the discouting effect vanishes, causing a massive increase in losses at the point of default.

The application of DVA is a perfect example of how the banks use the lobbying system in order to get exactly what they want and the people who sign off on the methodology don't understand what the fuck they are doing.

Imagine trying to explain to your bank manager why, even though you owe them $100k and you have no job, you have a theoretical income of $25k because the probability of them getting their money back has fallen by 25%...

Watson's picture

It's more an example of not thinking things through in detail.

It's obviously better, in general, for any balance sheet item to be marked-to-market.

However (in my opinion), *own assets* should not be included.

unununium's picture

Sounds like the perfect trading setup.

Mike in GA's picture

Heck, this is what is taught from kindergarten on up now - you can never lose. 

Never seen it on quite this scale but it explains why BofNY is the only business entity still in existence that dates back to the foundation of our country.

firstdivision's picture

Well I guess we can be happy they didn't do the ol' Lehmand 105 slide of hand...

sampo's picture


Coke and Hookers's picture

Level playing field! Kapitalism is healthy and there's nothing to worry about. I'm a good slave. Must watch Grey's Anatomy and buy something. Let's invade Iran. Banks are more important than manufacturing companies. Better living through lobotomy. Weeehhhaaa!!


/insanity off

cossack55's picture

Alls happy for Jaime till he finds out he is replacing the chicken on the platter.

wombats's picture

I wonder how much Blythe Masters contributed to revenue, earnings this quarter.  I'm guessing she earned her bonus considering all of the volitility in PMs.

Manipulism's picture

For everybody who is interestet in Richard Suliks own word why he must vote against the EFSF.

His own Blog:

In German.


nathan1234's picture

This bank does not need depositors.

Hopefully people realise it and close their accounts with JPM.



SilverIsKing's picture

Correction: Winner, winner, always a lobster dinner for Jamie Dimon.

Comay Mierda's picture

lets take a look at cashflow...

TooBearish's picture

O yeah thanks makes complete sense now...

broke433's picture


JP Morgan Does it Again

"True to form, J.P. Morgan Chase comes in with quarterly results that eclipse Wall Street's expectations. CEO Jamie Dimon highlights Dow industrials component's "fortress" balance sheet."

merizobeach's picture

Cue laugh-track...


Now sharpen the guillotines.

Martin T's picture

About DVA and FAS 159:

Same pattern as in 2010:

"With the recent increase in volatility in conjunction with a reduction in debt issuance in the second quarter, banks have had a hard time to reap in similar profits they made in Q1."