Why The Banking Sector Is Still Shakey

I was just reading Sprott Asset Management report on the banking sector.

You can read the full report here: Don't Bank On The Banks

The table highlighted on page 3.

Page 4.

• In Chart A we provide leverage levels for a few select banks that deserve special mention in our leverage discussion. These three banks were all bailed out by their respective governments. We’d like to draw your attention to their leverage ratios, prior and post-bailout, to emphasize the importance of leverage over time.
  
  We’ll start with Citigroup, which was de facto nationalized by the US government when it received $25 billion from the TARP program, a massive US government guarantee on $306 billion in residential and commercial loans and a $27 billion cash injection for preferred shares. You can see the impact these bailouts had on Citigroup’s leverage ratio over the years, moving it from 37:1 in 2007, increasing to 64:1 at the end of 2008 and back down to 17:1 after the government cash injections. The 64 to 1 ratio required a government bailout. One wonders if 17 to 1 is an appropriate level for Citigroup, given their exposure to high risk assets.
  
  The Royal Bank of Scotland makes Citigroup’s leverage look tame in comparison. Using our definition, we calculated an eye popping leverage ratio of 574:1 in 2007, implying that a mere 0.17% decrease in assets would have wiped out their tangible common equity. Is it any wonder then that the hiccup in the housing market blew them apart? RBS now holds the distinction as the world record holder for the largest bank bailout. The UK Government has earned a 70.3% shareholding in the bank after providing them with their second bailout in November 2009.10 In total, a whopping £53.5 billion has been injected into RBS by the British Government, which is now exposed to losses on £250 billion of RBS balance sheet assets. In return for the government support, RBS has agreed not to pay cash bonuses to any staff earning above £39,000 in 2009, and to defer executive bonuses until 2012. Although they’ve come down since 2007, RBS still maintains a very high leverage ratio. Hopefully two bailouts by the UK government will be enough.
  
  Our final example is Dexia. It was bailed out by three separate governments and its shareholders, receiving €6.4 billion in bailout money from France, Luxembourg and Belgium in September 2008. Dexia is the largest lender to local governments in France and Belgium. According to their latest financial filings, Dexia is operating at a leverage ratio of 116:1, which strikes us as very extreme in this environment. Again – at those leverage levels, the smallest asset decrease would wipe out all tangible common equity. That’s extremely risky for an institution as large as Dexia, and highlights the problems that still plague the global financial system.
  
  The examples above show that our leverage measurement is a good variable to review before making a common equity investment in a bank. The higher the leverage ratio, the greater the risk of losing your common equity. While we haven’t delved into the asset “quality” of any of these banks, we have been watching US bank failures for a market-based indication of the quality of their assets in a liquidation scenario. High profile examples include Colonial Bank, the largest US bank failure thus far in 2009, which had total assets of $25 billion and cost the FDIC $2.8 billion in losses - representing an 11% write-down on their assets. Also notable was Chicago’s Corus Bank, which cost the FDIC $1.7 billion on total assets of $7 billion - representing a 24% write-down. For Colonial, 10:1 leverage was too high, and in the case of Corus, a mere 4:1. Citing the most recent bank failures in the US, it would appear that most financial assets are still being written down by at least 10%. Although each bank is different and has its own specific asset allocation, this raises major cautionary flags for us, given that the banks listed above still utilize leverage ratios well above 20:1. For such a seemingly complicated industry, it surprises us that such a simple red flag continues to stump the regulators who oversee it.
  
  Given the discussion above, is it any wonder why we continue to see banks receive more government cash injections and asset guarantees? And is it any surprise that banks aren’t lending the cash they were given by the central banks? Of course it isn’t. The leverage in the banking system is still too high. Judging by recent comments by finance ministers and central bankers, it is clear to us that they have no plans to address leverage in their regulatory proposals, and until they do, we would advise that you invest in bank stocks with extreme caution. Don’t say you weren’t warned.

Makes you wonder about Citigroup. Their leverage is still 17:1???? Not a worry? Colonial Bank which went down, according to this report, had a leverage of only 10:1. And Corus Bank of Chicago had a leverage of only 4:1!

Hmmm.....

Then I was thinking of Dubai World.

Well two of the shakiest bank mentioned in Sprott Management report, was included in the list of Banks With The Biggest Exposure to The UAE!!!

On the UK Telegraph: Banks braced for record debt defaults in the New Year

• January is traditionally the worst time of year for debt defaults, according to the credit checking company Experian. The recent surge in unemployment and personal insolvencies will make the first quarter "the busiest period ever", the company said.
  
  "Christmas is a catalyst for delinquency and bad debt, with credit card and overdraft debt traditionally peaking in the New Year," Simon Waller, Experian's head of collections for UK and Ireland, said.
  
  "Economic indicators and feedback from our collections clients suggests that the first quarter of 2010 could be the busiest period ever seen."
  
  Experian is anticipating the worst due to the 771,000 job losses in the first nine months of the year, a 94pc increase on 2008, and the record quarterly personal insolvency rate of 41,390 for the three months to September.
  
  Banks have also been cranking up their marketing to households in the run up to Christmas. The Call Prevention Registry has seen a 50pc increase in "nuisance calls" from debt management organisations in the past month trying to persuade customers to take out new loans.
  
  Mr Waller said: "With unemployment at its highest since 1996 and record numbers of redundancies and insolvencies, it is vital for collections departments to do everything to ensure that their people can cope with the influx of new cases."

And over at Jesse's Café: The Dangerous US Financial Sector Still Smoldering