So now that we’ve had a round after round of private capital injections and hundreds of billions of TARP funds, banks are finally at healthy capital levels right?
Wrong. Meredith Whitney points out in a new report that last quarter the ratings agencies, which still matter somehow, downgraded over $2 trillion of securities. Regulations require banks to reserve more capital when their assets get downgraded, which means banks will require fresh capital in 2009. Of course, there’s no one but the government willing to invest that capital. So we’d better get ready for TARP 2.0.
The downgrades are an ongoing horror for the banks, forcing further writedowns. Whitney estimates that banks will take a total of $13.7 billion in writedowns. Here’s how Whitney breaks down those numbers.
- Citigroup, the sick man of US finance, is looking at $8.8 billion in losses.
- JPMorgan Chase will write down $3.4 billion.
- Bank of America gets hit with $1.3 billion in losses.
As all those writedowns hit, the banks will have to scramble for more capital.
So after that, are we done? Not quite.The banks will also need to set aside more money for loans they made when times were better. The depression that started in 2007 will likely mean far more of those loans will default, so the loan loss reserves at the banks will have to be increased. Here’s Whitney’s view of increased loan loss reserves:
- Citigroup’s will have to book a loan loss provision of $7.9 billion, which is actually only a 8% year over year increase.
- Bank of America’s fourth-quarter credit loss provision will hit $6.7 billion, a 103% year over year increase.
- JPMorgan Chase’s fourth-quarter 2008 credit loss provisions will hit $6.2 billion. That’s a 145% year over year jump.
- Wells Fargo loan loss hits $4.4 billion, a 69% year over year increase.
That adds up to about a $40 billion hole in the balance sheets of our biggest banks. So after that kind of “cathartic puke” where everything but the kitchen sink has been written down and new government capital has fillled the hole, banks will finally be able to rest assured that they are well capitalised. Right? Right?
Nope. Whitney points out that new accounting rules will require banks to move off balance sheet assets back onto their balance sheets. This will force banks to set aside an additional $25 billion in loss reserves against those assets. Those rules are set to go into effect in November 2009, unless the banks convince lawmakers to set them aside before them.
Doug MacIntyre at 24/7 Wall Street points out that this is very bad news for bank stocks.
The calculus on bank stock pricing is remarkably simple Bank of America trades at $14 against a 52-week low of $10 and a 52-week high of $45. Its market cap is $71 billion.
If BAC has to raise $20 billion, it will almost certainly have to do the deal below market, unless the federal government will give it special treatment the way that it did Citi. There is no demand for investing im bank equity. A transaction might go through as low as $10 with warrant coverage on top of that. What happens to the stock of a company with a $71 billion market cap with that kind of dilution at very low pricing? It takes the stock down by 40% or so.
Bank of America is an $8 stock. It may take a while for the market to see that.
For anyone wondering why banks haven’t been lending like crazy with all that TARP money, here’s your answer: they’ve had to use it to plug up their balance sheets.