One part of Treasury Secretary Geithner’s plan to prop up the failing bank sector is a forward-looking “stress test” imposed on every bank with over $100 billion in assets.

Those failing the test would have access to contingent capital that could, thought goes, keep them alive — or zombified, depending how you look at.

How the Treasury — who didn’t see this massacre coming in the first place — expects to accurately predict what sort of massacre lies ahead is beyond me. I assume they’ll come up with some fancy-pants formula to model a “worst case” scenario, and then extrapolate

At any rate, here’s how the fool guess it was done. I used just one statistic: the tangible common equity ratio. Why? Of all of the capital adequacy measures, I feel it’s not only the most accurate, but the most meaningful to average Joe common shareholders.

I took the percentage change in Capital during 2008 and applied it to today’s TCE ratio, in effect giving it a forward-looking “stress test”.
Whatever carnage was inflicted in the past year could easily repeat itself — perhaps on a larger scale — in the next.

Now, I admit: This analysis is crude, rudimentary, and deserving of hole-poking. It’s intentionally simple because, more often than not, complexity leads analysis astray.

Without further ado, let’s take a look (zyakaira notes: should’ve been 6%):

Bank 2007 equity/ assets 2008 equity/assets Forward-looking
JPMorgan Chase (NYSE: JPM) 4.05% 3.31% 2.70%
Citigroup (NYSE: C) 2.27% 1.19% 0.63%
Bank of America (NYSE: BAC) 2.99% 1.97% 1.30%
Wells Fargo (NYSE: WFC) 2.94% 2.25% 1.73%
US Bancorp (NYSE: USB) 3.94% 2.62% 1.74%
Goldman Sachs (NYSE: GS) 5.08% 6.19% 7.55%*
Morgan Stanley (NYSE: MS) 2.50% 4.33% 7.52%*

Source: Capital IQ, a division of Standard & Poor’s, and author’s calculations. Bank of America’s calculation doesn’t include Merrill Lynch — combined company data unavailable. *Raised TCE ratios in 2008.

A few thoughts

Scary numbers, Fools. According to RBC Capital Markets, TCE above 6% has been a historical norm.

Once you get into the 1%’s — where some banks are today — common shareholders are holding on for dear life. Below 1%, and it’s likely gameover.

zyakaira notes: now this we’ve all seen is 3% not 1% >> Shareholders are holding on for dear life, in case you didn’t notice.

Therefore, Citigroup, almost any way you spin it, is headed for zombie land. Bank of America (even without calculating the effects of Merrill Lynch) isn’t far behind. Of the major commercial banks, JPMorgan appears to be best of breed, but hardly qualifies as “safe”. Investment banks Goldman Sachs and Morgan Stanley actually strengthened their TCE ratios in 2008, as they were able to shed assets and de-lever much faster than others. How long that can continue is anyone’s guess. I wouldn’t bet on it.

What’s the takeaway here? My belief is that most investors should avoid all bank stocks like the plague, at least until details of the pending “aggregator bank” Secretary Geithner’s working on become clear. There may indeed be some incredible bargains in bank stocks today, but with this much uncertainty you won’t know what’s cheap until after the fact. There’s plenty of opportunity today. Just don’t waste your time digging for it in bank stock


zyakaira notes: Both Citi and BofA would need to raise much more than $10 billion each that they are currently negotiating with the Obama / Rahm Emmanuel / Geithner administration The safe Tangible Equity Ratio would be 3% at a minimum to safeguard the assets and the bank. The sooner the markets have the capacity to absorb this likely $50 billion and more in capital raising, the sooner the markets will be safe again for all investors. It is going to be a long winter for the markets and if there were a way out, the I would also agree with the fool’s conclusion above and dump the banking stocks but i do not think there is.