From TPM Reader JL …
I’ve been involved in the financial services industry for 20 years, most recently as an investment advisor. I’ve been following the whole nationalize/don’t nationalize debate closely. My bias has been toward more aggressive action rather than less. Like many of your readers I’ve been quite disappointed with Geithner’s caution on the issue.
With that as background, I wanted to share some thoughts on Citigroup’s memo to clients. First though, bear with me as I walk through some math.
Let’s focus on those banks undergoing the stress tests and look at them in aggregate The key questions are: 1) what are the remaining losses embedded in their securities and loan portfolios? 2) how much of that can the banks make up for through operating earnings? 3) what’s left over for the taxpayer to cover through capital injections?
As a starting point, let’s use Nouriel Roubini’s January estimate of $3.6 trillion in ultimate losses from U.S. loans and securities. Roubini estimated that U.S. banks & broker-dealers would absorb $1.115 tn in losses on unsecuritized loans (residential mortgages, commercial mortgages, credit cards, etc.) and $629 bn on securities (CDOs etc.). I would guess the banks in question will absorb about 90% and 80% of those two figures respectively (the remainder would fall to smaller banks and to standalone broker-dealers). Applying these percentages give losses of $1.458 tn. Of that, let’s assume 90%, or $1.312 tn, will be realized over the next two years.
Of the $1.312 tn, around $480 bn or so has probably been written down … $400 bn on securities, and $84 bn in loan charge offs. In addition, loan loss reserves are around $120 bn and serve as an additional buffer. Bottom line, around $700 bn needs to be covered by future operating earnings or further capital injections. That $700 billion represents around 7.7% assets.
Now we come to Citi’s memo. Per Citi, pre-tax earnings before write downs for the first two months were around $11 billion. Annualized that comes to $66 billion, or 3.3% of assets. If these numbers are accurate and sustainable and applied to the banks as a group, they could cover the vast majority of the 7.7% in 2009/2010 losses through operating earnings. Extending the math, the taxpayers would only have to cover 1.1% of assets or an additional $100 billion.
Now, I’m not sure how sustainable that 3.3% is and how applicable it is to other banks. But, it does suggest to me that further capital injections might be more in the range of $150 to $250 bn rather than the $200 bn to $400 bn I might have offered up a few days ago. Is that a big deal? I think it may be. For Citi, it could mean that there’s something material left over for current shareholders. For BofA it could mean that they more or less muddle through, perhaps with more taxpayer money, but without majority government ownership. And, maybe JPMorgan Chase and Wells Fargo are ok.
I’m not sure about any of this (nobody is), but I’m definitely a bit more optimistic about the banks than I was before Citi’s memo. And, that hasn’t happened in a long time.
