U.S. Banks: Still Too Big To Fail

Includes: BAC, C, JPM, USB, WFC
by: Katchum

During the financial collapse of 2008, the problem of the banks was their balance sheet. Banks were highly leveraged compared to their equity. On average, the assets held by the banks was 10 times their equity. This means that a 10% decrease in asset value at constant liability levels could bankrupt the whole company.

The first problem was debt (liabilities on the balance sheets) and the solution was deleveraging. Banks needed to reduce the size of their assets and reduce the size of their liabilities. The second problem was liquidity and the solution was increasing reserve ratios. This article will summarize and analyze what happened during these 3 years after the financial collapse in 2008.

1) Debt increasing

Table 1 summarizes the assets, liabilities and equity of the top 5 financials in the U.S. by quantity of assets. These are J.P. Morgan Chase & Company (JPM), Bank of America Corp (BAC), Citigroup (C), Wells Fargo & Company (WFC), US Bancorp (USB).


Table 1: Balance Sheet of Top 5 Banks by Market Cap

On average the assets and liabilities of the top 5 financial institutions increased 10%. Which means the banks haven't deleveraged at all, they just became even bigger in the last 3 years. Nothing has been addressed. The "too big to fail" risk has become even riskier. This has been especially true for J.P. Morgan Chase & Company and Bank of America Corp.

Citigroup and Wells Fargo & Company have been doing better. Their assets haven't increased over the years, but their liabilities have come down, resulting in a higher equity. Citigroup grew its equity by 19% while Wells Fargo & Company grew its equity by 42% without increasing their assets. J.P. Morgan increased its equity by 10% and Bank of America increased its equity by 28%, but their liabilities went up almost by the same amount.

2) Reserve Ratio declining

The liquidity of a company can be measured by current ratio and cash ratio (a more stringent measurement).

The concept behind this ratio is to ascertain whether a company's short-term assets (cash, cash equivalents, marketable securities, receivables and inventory) are readily available to pay off its short-term liabilities (notes payable, current portion of term debt, payables, accrued expenses and taxes). In theory, the higher the current ratio, the better.

In Table 2 we can see that almost all banks have lower current ratios. The only bank that did well was Bank of America Corp, increasing its current ratio by 11%. With lower current ratios, the liquidity today is worse than in 2008.

Table 2: Current Ratio

The cash ratio is an indicator of a company's liquidity by measuring the amount of cash, cash equivalents or invested funds there are in current assets to cover current liabilities. Let's assume short term investments are counted in the cash equivalents. Table 3 gives the progression of the cash ratio from 2008 to 2012.

Table 3: Cash Ratio

Overall, the cash ratio of the banks went down over the past years. Only Bank of America managed to increase their cash ratio, but it's still low compared to other banks. The cash ratio should be around 1 in order to be able to pay off all the debt when needed. But each of these banks have cash ratios significantly under 1, which is problematic during a liquidity crisis.


Overall, the problems of debt and liquidity haven't been addressed since the crisis of 2008. There has been improvement though in equity value for Citigroup and Wells Fargo & Company and there has been improvement in liquidity at Bank of America Corp.

The coming collapse though, will be even worse than in year 2008, considering the thesis above.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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