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Wednesday, 22 July 2009

Things are getting better so profits may be down

Yes, really.

You may have followed previous postings about how banks' reported profits were bolstered by marking to market their liabilities. The logic went as follows: The banks had a lot of crummy loans on their boks so their own creditworthiness took a dive. This meant that the margins required by on the market on securities issued by the banks widened considerably, but without necessarily issing any new securities, accounting rules allowed the banks to mark to market the value of existing liabilities at the higher margin, thereby giving a lower value to those liabilities and booking a profit from the reduction in the value of those liabilities. In many cases the extra profit was what allowed the banks to book a positive number and make a distribution.

Now, for the downside, or should that the upside. It seems that with Lehman and Bear Sterns out of the way, Merrill Lynch effectively disappeared, there is less competition, bid-offer spreads on asset trading are looking fatter and banks are looking more profitable and less likely to default on their debts. So spreads on bank paper have narrowed considerably, unwinding last year's profits.

Many banks will report a loss in the next few weeks. UBS already gave a profits warning last month, but expect others to blame "own debt" credit margins for poor figures in the next few weeks, but in much more loudly than when the same accounting rules boosted their results.

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