Jason Lindt's  Instablog

IMF published their new Financial Stability Report, in which they claim that U.S. banks will have $250B drain on equity capital due to writeoffs in the next two years. The simple math they go through is follows: total write-offs on loans and securities over the cycle for U.S. banks will be $1050B. $500B of that has already been recognized, which leaves $550B remaining. They estimate after-tax pre-provision earnings in 2009-2010 at U.S. banks will be $300B. $550-300B=250B drag on capital. But what happened to applying a tax rate to write-downs, which would presumably reduce net write-down number to 360B, or result in only $60B drag? Pretty significant $200B delta, under which the capital ratios would look not so bad after all.

This not so well-thought out math only adds fuel to the fire burning the bank stocks and shaking the confidence in the system. Lets hope Fed's stress test is more well-thought out, and somebody actually pays attention, rather than just saying 'they are all bankrupt, I don't care what numbers say', like many people seem to be prone to do these days.

Wells Fargo (WFC) reported 0.55 EPS for Q1. On the one hand results are very strong, illustrating the earnings power of the franchise. Company's net charge-offs are up to 3.3B from 2.8B in last quarter, while they also added 1.3B to reserve, but the pre-provision earnings at 9B allow them to easily absorb these losses. Hoorah, all bank shares rallying. Two points of caution on the results though: a) NCOs are lowered as Wachovia's impaired 'Pick-a-Pay' loans are not in the charge-off number - they were written down on acquisition, and until losses on them exceed the initial written-off amount, there're no new charge-offs on them; b) WFC CEO Kovacevich has recently repeatedly ranted against the stress tests calling them 'asinine'. That makes you question whether WFC needs to raise new capital (their Tier 1 at 7.9% is the lowest among all major banks after all), in which case pre-announcing the earnings will give you a nice share price bump, that would allow to tap existing shareholders for capital with less dilution. We'll wait a couple of weeks to see whether this prediction will pan out...