market folly

We recently read some very interesting research courtesy of Pali Capital that examined the tangible book/asset ratio of various financial institutions. They looked at this ratio of institutions all over the world and so we wanted to highlight some of the major ones we saw. For instance, we see that Washington Mutual, who already essentially 'went under' by nature of forced acquisition, has a tangible book/asset ratio of 3.66. And, that number is on the higher end of the scale/list. So, the thinking would be that many of the institutions with ratios lower than that could potentially be in trouble as well. Because, after all, their ratios would be categorically 'worse' than that of an institution that's already had problems. Of course, we do realize that each institution is an individual entity and should be treated as such; its situational. But, as we run through the list, you'll start to notice that the lower the ratio, the more troubled banks we run into. Let's have a look, noting that those listed in bold have either already failed, been forcibly acquired, or are known to have major problems.

First, the US banks & their tangible book/asset ratios:

BB&T (BBT) 6.86
PNC (PNC) 5.87
Northern Trust (NTRS) 5.51
Goldman Sachs (GS) 4.86
Morgan Stanley (MS) 4.35
JPMorgan (JPM) 3.83
Washington Mutual (WM) 3.66
---
Wells Fargo (WFC) 3.50
Merrill Lynch (MER) 2.84
Bank of America (BAC) 2.83
US Bancorp (USB) 2.74
Lehman Brothers (LEHMQ) 2.39
Citigroup (C) 1.52

And now the Internationals & their tangible book/asset ratios:

Mediobanca (MB:IM) 8.35
Unione di Banche Italiane (UBI:IM) 5.1
Intensa Sanpaolo (ISP:IM) 4.5
Banco Santander (STD) 3.76
---
Unicredit (UCG) 2.82
Societe Generale (GLE) 2.68
HBOS (HBOS:LN) 2.55
Credit Agricole (EPA:ACA) 2.38
Lloyds (LLOY) 2.26
BNP Paribas (BNP) 2.12
Credit Suisse (CSGN) 1.94
Barclays (BCS) 1.28
ING Groep (ING) 1.18
Deutsche Bank (DB) 1.17
Northern Rock (NRK:LN) 1.07
UBS (UBS) 1.06
RBS (RBS) 0.95

Again, note that those listed in bold have either already failed, been forcibly acquired, or are known to have major problems. You'll also notice that the international banks seem to be in worse shape by examining this ratio alone. So, that should be interesting to watch. It's no surprise to see Citigroup at the bottom of the US list, considering how much trouble they're in and how much government assistance they've needed. And, similarly, RBS has been in a world of hurt on the international side and has the overall lowest ratio of all the institutions measured, regardless of region.

We've noted in the past that hedge fund Paulson & Co has made a fortune by betting against all things sub-prime. Additionally, they've profited from shorting UK financials and in particular, they've focused on Lloyds. Also, in our hedge fund tracking series, we recently covered Paulson's portfolio, which you can view here, along with his year-end letter & report. He's been quite successful, having made correct bets against Barclays, RBS, and Lloyds (which all conveniently fall at the lower end of the list above). We would be remiss though if we didn't point out the fact that John Paulson has become slightly constructive on some other destroyed assets he had been previously short, and is looking to slowly start buying them. It remains to be seen though if he would reverse such a bet against the institutions themselves.

Obviously, not all institutions are listed here. We noted back in January that many people thought HSBC needed capital as well. But then again, who doesn't need capital these days? And, back in October, we had examined the leverage ratios of financial institutions. But then again, who doesn't need to delever these days?

Keep in mind this is simply one aspect of an enormously big picture in a gorge of an industry right now. You cannot even begin to unravel the woven complexities of a financial institution from a few ratios here and there. We just thought the information was interesting and highlighted that even institutions with ratios perceived to be of 'better quality than others' did not escape unscathed (i.e. WaMu). Which, by the way, is pushing the definition of 'quality' to an extreme for sure. Everyone should, of course, take all these ratios and measurements with a grain of salt. For instance, if you look at Bank of America's (BAC) tangible common equity at the end of last year, you'll note that it was a positive $35 billion before acquiring Merrill Lynch (MER), but then falls to a negative number once everything is marked at fair value and adjusted. Jonathan Weil at Bloomberg notes that if you use these fair value numbers, Bank of America needs a ton more common equity. He also examines Wells Fargo (WFC) and finds the same underlying problem. Their tangible common equity was a positive $13 billion at the end of last year. But, if you adjust everything to fair value, it also becomes negative.

This obviously highlights the recurring problems of the abyss known as a financial institution's balance sheet. So many balance sheets essentially have artificial values in place and its impossible to gauge just how well or poorly positioned they might be. We will just go out on a limb (not much of a limb, really) and assume that everyone's just simply going to need more capital. End of.

And now back to your regularly scheduled implosion.