Do Banks Have Enough Equity? You Be The Judge

Top banks are off as much as 50% year to date with the news continuing to get worse for the financial sector. Numerous lawsuits, derivates exposure, higher capital requirements, continued weak housing and european sovereign debt fears continue to weight on bank shares. Given the precipitous selloff, investors may be tempted to dabble in the banking sector which now trades below tangible book value in most cases.

Deutsche Bank Price Stock Chart

Deutsche Bank Price Stock Chart by YCharts

Financials have grown significantly over the last 15 years. Banks made up a small percentage of the market in 1995 but now account for 15% of the S&P 500. The chart below shows the rapid expansion of bank balance sheets. In 1995, Bank of America, Citi, Deutsche Bank and JP Morgan had total assets of just over $1 trillion. Today, they have over $9 trillion on the books.

Bank of America Corporation Total Assets Stock Chart

Bank of America Corporation Total Assets Stock Chart by YCharts

Analyzing the banks can challenge the most sophisticated investors. A simple look at total assets divided shareholder equity provides a telling amount of information about the risks involved in the banking sector.

To quote Warren Buffett, "When assets are twenty times equity-a common ratio in this industry-mistakes that involve only a small portion of assets can destroy a major portion of equity. And mistakes have been the rule rather than the exception at many major banks . . . Because leverage of 20:1 magnifies the effects of managerial strengths and weaknesses, we have no interest in purchasing shares of a poorly-managed bank at a "cheap" price. Instead, our only interest is in buying into well-managed banks at fair prices." Warren has been a big buyer of Wells Fargo and recently took a non-common stock stake in Bank of America.

Below we highlight the major banks equity positions in relation to total assets and rank them by this measure of leverage. This is a good starting point to frame the largest banks and their use of leverage. Leverage is great on the way up but it is equally destructive on the way down. As Buffett points out, relatively small haircuts to assets have a big impacts on the equity.

1. Deutsche Bank (DB) has 2.66 trillion in total assets and $74 billion in shareholders equity. 36X equity.

Deutsche Bank Total Assets Stock Chart

Deutsche Bank Total Assets Stock Chart by YCharts

2. Banco Santander (STD) has $1.77 trillion in total assets and $115 billion in shareholders equity. 15X equity. But if you use tangible equity which is $71 billion the multiple rises to 25X equity.

Banco Santander Total Assets Stock Chart

Banco Santander Total Assets Stock Chart by YCharts

3. Credit Suisse (CS) has $1.12 trillion in total assets and $46 billion in shareholders equity. 24X equity.

Credit Suisse Group Total Assets Stock Chart

Credit Suisse Group Total Assets Stock Chart by YCharts

4. UBS (UBS) has $1.42 trillion in total assets and $59 billion shareholders equity. 24X equity.

UBS Total Assets Stock Chart

UBS Total Assets Stock Chart by YCharts

5. Bank of America (BAC) has $2.26 trillion in assets on 222 billion in shareholder equity. 10X equity. But if you look at tangible equity which is 113 billion the multiple increases to 20X equity.

Bank of America Corporation Total Assets Stock Chart

Bank of America Corporation Total Assets Stock Chart by YCharts

6. Goldman Sachs (GS) has $937 billion in total assets and $72 billion in shareholders equity. 13X equity.

Goldman Sachs Group Total Assets Stock Chart

Goldman Sachs Group Total Assets Stock Chart by YCharts

7. JP Morgan Chase (JPM) grew assets from $700 billion in 2001 to $2.25 trillion today. Shareholder Equity is now $183 billion. 12X equity.

JPMorgan Chase Total Assets Stock Chart

JPMorgan Chase Total Assets Stock Chart by YCharts

8. Morgan Stanley (MS) has $831 billion in total assets with only $68 billion in shareholders equity. 12X equity.

Morgan Stanley Total Assets Stock Chart

Morgan Stanley Total Assets Stock Chart by YCharts

9. Citibank (C) has $1.96 trillion in total assets and $179 billion in shareholders equity. 11X equity.

Citigroup Total Assets Stock Chart

Citigroup Total Assets Stock Chart by YCharts

10. Wells Fargo (WFC) has $1.26 trillion in total assets and 138 billion in shareholders equity. 9X equity.

Wells Fargo Total Assets Stock Chart

Wells Fargo Total Assets Stock Chart by YCharts

The Fed is doing all it can to pump money into the sector and firm up the bank balance sheets, but the economy continues to sputter along. High unemployment, falling home prices and sovereign debt issues continue to weigh on bank balance sheets. Cash strapped consumers and now governments are creating havoc in the banking sector as the question of "haircuts" starts to circulate. The math is pretty simple. Highly levered banks don't have a lot of equity cushion if "haircuts" occur. If asset values fall by 3% - 10%, equity holders' claims on assets are gone.

For more analysis visit our Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.

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