Banks: The Problem That Won't Go Die Quietly

Last week, Dominique Strauss-Kahn, the head of the IMF, told a conference in the U.K. that almost half of total bank losses may remain undisclosed on bank balance sheets. In September, the IMF said that banks have yet to unveil $1.5 trillion in losses. With the credit crisis well into its third year, what's a bank share investor to do?

On the bright side ...
Strauss-Kahn believes that U.S. banks have disclosed a higher proportion of loan losses than their European counterparts. The following table shows aggregate provisions for loan losses and actual net losses for 11 major U.S. banks since the beginning of the credit crisis:

 

Q3 2007 -- Q3 2009 (incl.)

Aggregate Provisions for Loan Losses

$237 billion

Aggregate Loss*

$130.1 billion

*This aggregate is a sum of quarterly net losses only. It does not include the net income earned during profitable quarters.
Sample: Bank of America, BofA Merrill Lynch, Bears Stearns Companies, Citigroup, Goldman Sachs, JPMorgan Chase, Lehman Brothers Holdings, Morgan Stanley, Washington Mutual (bankrupt), Wachovia Corporation (acquired), Wells Fargo.
Source: Capital IQ, a division of Standard & Poor's.

In his formal remarks, Strauss-Kahn said that "banking systems in many advanced economies remain undercapitalized, weighed down by leaden legacy assets and, increasingly, non-performing loans." Banks may be reluctant to recognize further losses, as it would shine a light on their capital shortfall.

S&P's handwriting on the wall
Last week, I highlighted some research from Standard & Poor's (a unit of McGraw-Hill (NYSE: MHP  ) ) that suggested that many of the world's largest banks (including some U.S. institutions) would need to raise additional capital. A few readers took me to task due to the fact that S&P's capital ratios were calculated based on end of second-quarter data and did not, therefore, account for any capital raises that have occurred since then. This is, in principle, a valid point, but, as the following table shows, I don't see much evidence that major U.S. banks were substantially better capitalized at the end of the third quarter:

 

Tier 1 Capital Ratio % (Calendar Q3 2009)

Tier 1 Capital Ratio % (Calendar Q2 2009)

JPMorgan Chase (NYSE: JPM  )

10.2

9.7

Wells Fargo (NYSE: WFC  )

10.6

9.8

Bank of America (NYSE: BAC  )

12.3

11.9

Citigroup (NYSE: C  )

12.8

12.7

Goldman Sachs (NYSE: GS  )

14.5

16.1

Morgan Stanley (NYSE: MS  )

15.4

15.8

Source: Capital IQ, a division of Standard & Poor's.

Investors must be vigilant
With that in mind, I'll reiterate my warning to bank share investors: Understand that there is a risk of share dilution and verify that current prices maintain a margin of safety to compensate you for that risk (the massive rally in financials has certainly eroded that margin). In an upcoming Banking Roundtable, I'll be giving my three predictions for the banking sector over the next 10 years; my hunch is that the shakeout has barely begun.

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Read/Post Comments (3) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 01, 2009, at 9:25 PM, jesse2159 wrote:

    Unless, and until, banks become more transparant, don't buy their shares. There are too many financial trip mines, any of which can start a cascading collapse of financial institutions. Banks are now so connected that losses half way around the world affect them also.

  • Report this Comment On December 03, 2009, at 1:56 AM, jomueller1 wrote:

    What ever happened to "mark to market"? Where is government oversight to tell the banks to come clean? Where is oversight to eliminate the obscure "over the counter" (more under the table) markets?

    Telling that other countries' banks are in worse shape does not do any good.

    My question is: "When are the guys who created the trouble going to prison?". If I drive "inconsistently" a cop is right there to fine me even though I did not endanger traffic. The financial crooks do enormous harm and walk home with the money that should be used to recapitalise the banks.

    US is a funny country.

  • Report this Comment On December 06, 2009, at 3:17 PM, Gorm wrote:

    1) Banks got an accounting break in not forcing them to value assets to current market. You always look better when you are solvent!!

    2) Watch what banks do, not what they say! Banks are NOT lending. Why? Because they are already mired in bad debt. Why increase their problems by taking on more risk in an uncertain economy with both residential and commercial real estate values falling - not to mention, problems of unemployment, growing bankruptcies, over-leveraged borrowers, etc.

    3) The Fed is keeping rates low to help banks rebuild their capital base. The illusion is low rates act as a stimulus for consumers and business BUT that is only true "IF" a) banks are lending, b) have NOT created artificially high thresholds for acceptance (FICO, debt to income, down payments, etc). In fact, these zero rates are a) enabling banks to shore up capital and b) most importantly BUY PRECIOUS TIME.

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