Mark to Market Would Make Banks Insolvent

The four largest American banks, JP Morgan Chase, Wells Fargo, Bank of America and Citibank together hold $408 billion in tangible common equity and an additional $129 billion in allowances for loan losses.

Their loan portfolios include: $445 billion in home-equity loans; $136 billion in pay-option adjustable rate mortgages; $44 billion in construction loans; $628 billion in residential mortgages; $238 billion in commercial real estate loans; $255 billion in consumer credit card loans; $351 billion in other consumer loans; and $861 billion in other loans. This totals $2.958 trillion.

Tangible common equity plus reserves would only cover a lost rate of approximately 18%. Real estate and banking analysts would likely agree that this is too low given current economic conditions in the real estate and consumer sectors.

If the analysts are right and the rate is too low, only Citibank would be marginally solvent. Three of the four biggest banks have such bad loan portfolios that they would be deemed insolvent under mark-to-market accounting rules.

The current slope in the yield curve is allowing banks to earn their way into more capital. Jamie Dimon is right not to increase his dividend. This isn’t over.

Bernake Anticipates Upcoming Refinancing Cycle

Federal Reserve Chairman Ben Bernacke noted recently that commercial real estate loans will soon need to be restructured.  It is expected that the peak activity will occur in Q2 2012.

To mitigate the possible crisis that could result when property values and debt no longer square — or possibly never did given the lax approval processes that preceded the financial collapse — Bernake urged that cash flow analysis be paramount in developing restructured deals. As Bernanke explained, “Commercial real estate loans should not be marked down because the collateral value has declined. It depends on the income from the property, not the collateral value.”

Bank regulators have not yet publically agreed to using cash flow instead of marked to mark collateral values for determining the value of these loans to be restructured. It is anticipated that they will.

Ben finally gets it.  It’s the economic value that matters, not liquidation price.  Let’s hope all of the other regulators get the memo and apply.  Ben’s prudent proclamation to residential real estate, too.