Mark To Market Leaves Some Big Banks Insolvent

A bank is insolvent when it has a negative book value. Normally, book value is a quite accurate measure of a bank's value, but in this unusual times, there can be big disparities between the ordinary book value of bank assets (like loans) and bank liabilities (like deposits), and the value of the same assets and liabilities on a fair market value in what is known as mark-to-market accounting. These mark to market numbers are reported annually (and soon, quarterly) by publicly held banks.

Jonathan Weil at Bloomberg lays out the results for some of our nation's biggest banks:

Bank of America Corp. last week disclosed that its loans at the end of 2008 were worth $44.6 billion less than what its balance sheet said. Wells Fargo & Co. said its loans were worth $14.2 billion less than their book value. The spread at SunTrust Banks Inc. was $13.7 billion. . . .

Loans, for instance, typically are carried at historical cost, reduced only by management’s estimate of how much money the bank will lose on the loans it has made. Meanwhile, market values for many loans have tanked, along with the collateral backing them (if any), as more borrowers miss their payments and investors worry that the banks’ loss forecasts are too low.

Tangible common equity has become the capital benchmark of choice for investors . . . Tangible common starts with common shareholder equity. This amounts to a company’s net assets, minus preferred stock, which is left out because it acts like debt. Tangible common also excludes squishy intangible assets such as goodwill, which is a bookkeeping entry leftover from acquiring other companies, and mortgage-servicing rights, which reflect the value of future income from collecting and processing loan payments. . . .

Bank of America, for instance, had $35.8 billion of tangible common equity as of Dec. 31, before it completed its government-aided acquisition of Merrill Lynch & Co. That figure falls to negative $1.7 billion once it’s adjusted so that all financial assets and liabilities are measured at fair value, using the numbers BofA disclosed in its footnote. The fair-value version shows BofA needs lots more common equity -- badly.

Wells Fargo’s tangible common equity was $13.5 billion as of Dec. 31. On a fair-value basis, it was negative $133 million. That makes the bank’s $40.9 billion stock-market capitalization look awfully rich.

In total, eight of the 24 banks in the KBW Bank Index had negative tangible common equity on a fair-value basis, including SunTrust, KeyCorp, Fifth Third Bancorp, Huntington Bancshares Inc., Marshall & Ilsley Corp. and Regions Financial Corp.

Even with those fair-value tweaks, tangible common still might overstate a bank’s ability to absorb losses. It includes deferred-tax assets, which are pent-up losses that companies hope to use someday to cut their tax bills. The problem with those is that they’re valuable only to profitable companies that are paying income taxes. Wells Fargo’s capital would look even worse if its $13.9 billion of net deferred taxes were excluded. Same at Bank of America, which said it had $8.7 billion of the stuff. . . .

Seven banks in the KBW index said the fair values of their loans were higher than their carrying amounts: Bank of New York Mellon Corp., Northern Trust Corp., People’s United Financial Inc., Comerica Inc., BB&T Corp., Cullen/Frost Bankers Inc. and Commerce Bancshares Inc.

For all but one of those companies, Bank of New York, tangible common equity wound up being higher on a fair-value basis. The same was true at Citigroup Inc. because of lower fair-value figures for its debt.

JPMorgan Chase & Co.’s tangible common equity drops to $56.4 billion, or just 2.7 percent of tangible assets, from $71.9 billion if you plug in the bank’s fair-value figures. Mainly that’s because JPMorgan said its loans were worth $21.7 billion less than their carrying value as of Dec. 31.

This doesn't mean that run of the mill depositors have anything to worry about. The FDIC insures deposits up to $250,000 per bank, per category of account, and a surprisingly large share of the deposits at any given bank are uninsured.

This means that small depositors will lose nothing, even if the bank crashes, and that the FDIC will not incur long term losses, even if a bank collapses and the FDIC has to make good on small deposits, because the FDIC's claims have priority over other claims in bankruptcy. Even the banks that are most insolvent on a market to market basis aren't anywhere near to leaving the FDIC in the lurch in the long run.

But, we can expect to see the market value of insolvent banks fall dramatically in the next few days, and insolevency on a mark to market basis makes the case for nationalizing big banks much stronger. Until now, one of the main arguments for being stingy with troubled car companies, but generous with troubled banks, has been that the banks are profitable, solvent going concerns whose main problem is liquidity. This is not at all obvious now for many of the nation's largest banks.