No Comments Written by Anthony Truong on April 22, 2009 – 2:08 am

Various US banks, including Bank of America, Citigroup and Goldman Sachs, have recently released ‘better than expected’ quarterly results, causing some commentators to claim that the banking crisis is over, and that perhaps TARP wasn’t needed in the first place to save the financial system.

What’s interesting about these quarterly results isn’t so much the numbers – I mean, they are impressive, given the fact that the US has been in recession since December 2007, unemployment continues to rise at around 600,000 per month, and most economic reports being released are decidedly negative – but how those numbers are derived.

For example, Bank of America reported earnings of $4.25 billion in the first quarter ending 31 March, which is triple the profit they made in the corresponding quarter last year. Within those earnings, $2.2 billion isn’t really profit at all, but a special accounting ‘trick’ that is actually legal. This is how MarketWatch describes it:

” Bank of America also said it booked a gain of $2.2 billion in the first quarter based on the declining value of debt issued by its recently acquired Merrill Lynch unit.

As the price of a certain class of Merrill structured notes fell during the quarter, Bank of America was able to book the amount of that decline as a gain, on the assumption that it could buy back the debt at the cheaper price.” Source: ‘Investors wary as B. of A. results show one-time gains‘ by Greg Morcroft, MarketWatch, April 20, 2009

Yes, that’s right! B of A allowed itself to book a gain of $2.2 billion, because the value of Merrill Lynch’s debt fell during the quarter, which in theory would allow B of A to buy back the debt at a lower price, hence making a profit. In theory. Of course, it’s unlikely that these banks will actually buy back their debt, so the gain pretty much comes from thin air. Of course, it’s legal, so they are entitled to jig the numbers whichever way they please.

Citigroup posted an overall loss for the quarter of $966 million, but if you ignore the effect of preferred stock, it becomes a profit of $1.59 billion, which is of course the number that is being reported and getting all the attention. However, this result would not be possible without Citi booking a ‘gain’ of $2.5 billion using the same account trick:

“Results included a $2.5 billion gain from an accounting rule that allows a company to record a benefit when the market’s view of its creditworthiness declines.

The rule assumes that the company could close out some liabilities at a discount to their value on the company’s books, creating a profit.” Source: ‘Citigroup results top forecasts‘ by Jonathan Stempel and Dan Wilchins, 17 April 2009

Goldman Sachs reported a quarterly profit of $1.8 billion; not to be out-done with accounting tricks, Goldman Sachs decided to move some asset write-downs into the month of December 2008. This month is considered an ‘orphan month’, due to GS changing its reporting structure from fiscal year to the calendar year, as a result of its decision to become a bank holding company last September. GS’ last quarterly report was for the period ending 30 November 2008; this latest quarterly report was for the January through March 2009 period, leaving December 2008. So what does a bank do in these circumstances, knowing that this orphaned month will largely go unnoticed? You stuff it full of write downs! December 2008 saw a pretax loss of $1.3 billion. (Source: ‘Goldman Sachs First Quarter Magic Trick‘, 14 April 2009)

Ah, the wonders of transparent accounting.