Banks face capital shortages of more than $1 trillion, says this analyst who fears shortages will only get worse

With the new year just around the corner, one idea where to invest is in the banking sector, whose margins are benefiting from high interest rates and valuations that are not too demanding.

This claim may surprise those who believe the US banking industry is approximately $2.2 trillion in capital. But he intersects this number in different ways. First, he notes, there is a difference between book equity and tangible equity, the latter being used by banking regulators to assess solvency. It’s a narrower definition, excluding items like goodwill and deferred tax assets, that brings the total down from $2.22 trillion to $1.49 trillion.

Then, based on data from the Federal Deposit Insurance Corp., he subtracts what is called accumulated total other income. “Thanks to QE and now QT, all types of assets have become negative promises of return for banks and non-banks alike. If the coupon pays out less than the financing cost, you’re losing money,” he says. That reduces capital to $1.23 trillion.

Now comes the more controversial part. First, it marks market losses in credit and securities created in 2020 and 2021 for the impact of this year’s Fed rate hikes. That right is enough to drive banks into bankruptcy, with losses of about $1.74 trillion from launch.

Another $794 billion in losses is incurred when banks’ holdings of US Treasury bonds, mortgage-backed securities, and state and local government securities are also marked to market. All told, according to Whalen’s calculations, the banks ran a $1.3 trillion deficit in the second quarter.

Admittedly, and this is very important, banks do not have to mark-to-market their assets. So what’s the concern? This exception is not infinite – banks are allowed to ignore mark-to-market losses as long as they have the ability and intention to do so. “Even if the bank holds these low-coupon assets created between 2020 and 2021 in the portfolio to maturity, cash flow losses and poor yields could eventually force a sale,” Whalen says.

He performed a similar analysis on JPMorgan Chase JPM, which he describes as one of the better-run banks, at +1.64%. Jamie Dimon’s group has a deficit of $16 billion in the second quarter — and a deficit of $58 billion if the mark-to-market adjustment is a steeper 17.5% — versus Whalen’s numbers.

The bigger question is when these asset sales could potentially take place. “Asset sales will be slow, but lenders can force collateral issuance that’s 20 points under water,” he told MarketWatch in an email. And what is now unsustainable will only get worse. “Higher rates only add to the potential mess,” Whalen added.

The market

US stock futures ES00, +0.16%, NQ00, +0.29% were pointing higher in early action. Commodities moved higher, with gains for Oil CL.1, +2.88% and Gold GC00, +1.55%. Dollar DXY was lower at -0.31%.

For more market updates and actionable trading ideas for stocks, options and crypto, subscribe to Investor’s Business Daily’s MarketDiem.

The Buzz

Fed Chair Jerome Powell is scheduled to speak at 1:30 p.m. at the Brookings Institution, the current employer of former Fed Chair Ben Bernanke. There are also two other speakers from the Fed, with Governor Michelle Bowman speaking on banks while Governor Lisa Cook speaking at the Detroit Economic Club.

It’s a big day on the economic calendar, even without the Powell speech. The ADP jobs report, second estimate of third quarter GDP, advanced report on trade for October, Chicago PMI, job vacancies and pending home sales are all due for release with the beige book of economic anecdotes due at 2pm

In the eurozone, annual inflation slowed to 10% in November from 10.6%.

CrowdStrike Holdings CRWD, -1.04%, tumbled after the cybersecurity firm announced a slowdown in subscription revenue growth.

NetApp NTAP, -1.07%, was also down after the cloud computing company forecast earnings well below analyst estimates.

Horizon Therapeutics HZNP, +0.97%, rebounded after the Irish drugmaker announced it was in talks to buy it, with heavyweights including Amgen AMGN, -0.22%, Johnson & Johnson JNJ, -0.70% and Sanofi SAN, -2.89% circling the company.

An Alzheimer’s drug by Biogen BIIB, -0.17% and Eisai 4523, +3.83% moderately reduced cognitive decline but also has side effects.

Walt Disney DIS, -1.05%, said its returning CEO, Bob Iger, will initiate organizational and operational changes that could result in impairments. It flagged the Disney Media and Entertainment division, which includes its streaming services, for changes.

The best of the web

What China’s young protesters want.

Explaining the shortage of electric vehicle charging stations in America.

The Los Angeles City Council’s full commentary on the racist audio that has sent America’s second largest city into an uproar.

top ticker

Here are the most active stock tickers as of 6am.

The graphic

vanguard

Hardship withdrawals are at an all-time high, according to Vanguard. Such withdrawals are only permitted in cases of urgent and urgent financial need and are subject to income tax and a 10% prepayment penalty.

Random Reading

This 22-year-old sells human bones to make a living.

Another world championship is taking place in Qatar – for camels.

Lobsta Mickey – a giant Mickey Mouse statue with lobster claws – is back in Boston.

Need to Know starts early and will be updated by the opening bell, but sign up here to have it delivered to your email box once. The emailed version will be sent around 7:30am EST.

Listen to the Best New Ideas in Money podcast with MarketWatch reporter Charles Passy and economist Stephanie Kelton