Have we reached the bottom yet? That's a question that people ask me from time to time. I haven't got an answer yet, but today I have some numbers that may give us an idea. And the preliminary verdict is: No!
Why? Because the commercial banking industry in the U.S. is likely to be bankrupt -- by which I mean its liabilities could exceed its assets -- as we approach the bottom.
Just how bad will it get? It could see 41% of its core capital wiped out by loan losses alone. And when you take into account all the toxic waste and derivatives on the banks' books -- its capital looks mighty thin.
To understand how I reached this conclusion -- consider that the banking industry has $6.7 trillion worth of loans and $1.2 trillion in equity capital. During the Great Depression, loan losses peaked in 1934 at 3.4% of loans. Banking analyst Mike Mayo believes that this figure could be far worse this time around -- hitting 5.5% in 2010.
So? If banks need to write off 5.5% of their $6.7 trillion in loans, it would require them to wipe out $369 billion worth of their capital.
That doesn't sound so bad until you consider that banks have a mere $880 billion in so-called Tier I, or core capital. In that context, a $369 billion write-off represents 41%. And regrettably there is a huge amount of potential for additional write-offs totaling in the trillions because the banks have $1.7 trillion in debt securities and $201 trillion in derivatives.
The IMF estimates that the U.S. has $3.1 trillion in toxic waste -- which if written off would likely turn that $1.2 trillion in equity capital negative -- depending on how much of that toxic waste is held by commercial banks.
If we assume that U.S. banks have $1 trillion of toxic waste and they take $369 billion in loan losses, that would leave the industry with a negative net worth of about $169 billion ($1.2 trillion in equity capital less $1.369 trillion in toxic waste and loan losses).
I hope it's not worse.
Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College. His eighth book is You Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing.
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Reader Comments (Page 1 of 1)
4-07-2009 @ 1:03PM
Iridium said...
At least you talk about it. It seems that through all of this talk about the recession ending and the economy picking up, nobody is talking about the banks holding trillions in toxic assets they are just putting in a room and forgetting about.
At some point this stuff has to go on the books. Just like how people are saying that housing is recovering. It isn't recovering when wealthy foreigners are buying up 40 properties for pennies on the dollar to hopefully rent out for more than the mortgage value.
4-07-2009 @ 1:03PM
joe soule said...
You are to optimistic. The banks hold much more toxic stuff than you estimate. If they were only looking at being a few billion in the red after the bottom comes they would be getting ready to go full ahead - or going ahead already. Fact is they know they have trillions of toxic stuff to deal with and need all the cash they can get. No bank will loan to another or to any company that can't retire the loan in short order because they can't let the cash get away to any customer with the massive toxic debt of banks or any that need it for long terms. To many loans are going to fail soon. They must have cash on hand. It gets much worse. Soon.
4-07-2009 @ 2:28PM
Dan Barnett said...
Pete,
Last year you were writing about the banks being leveraged 32-1 loan-capital rate. As you then pointed out, it would take very little (3%) decline to wipe out the assets of the banks.
So why the surprise now?
4-07-2009 @ 7:39PM
winslow said...
The real answer is that no one is believeable any longer. Can't believe CEO's, can't believe politicians, can't believe pundits in the media with an ideological score to settle.
That leaves us with a logical, educated group that is not interested in power-grabbing. How do we get them heard?