Have banks hit bottom yet? The numbers say no

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 percent 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 percent of loans. Banking analyst Mike Mayo believes that this figure could be far worse this time around -- hitting 5.5 percent in 2010.

So? If banks need to write off 5.5 percent 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 percent. 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 isYou Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing.

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