American banks that are strapped for cash are turning to private equity firms in an effort to shore up balance sheets and bring ailing earnings back to life. Massive equity firms with deep pockets aren’t hesitating to make sizeable investments in banks whose balance sheets have suffered billions from the credit crunch, while Wall Street analysts predict write-downs to continue for several quarters. Firms such as Texas Pacific Group are making risky bets such as their $7 Billion capital injection into Washington Mutual, in all taking a 50.2% stake in the bank. Washington Mutual has had their shares destroyed by investors in the last few months, and private equity cash dilutes shares and makes it even tougher for investors to profit.
I have analyzed some of America’s largest banks in order to better understand their capital position – there are twenty one banks with current assets exceeding $80 Billion. Washington Mutual alone has in excess of $317B, making it the sixth largest bank according to asset size. Despite its breadth, the asset size of the firm is irrelevant considering the current condition of the bank. Instead, look at the Return on Equity in order to evaluate the risk attached to TPG’s investment. ROE is annualized net income as a percentage of average equity on an annualized basis. In June, 2007, right before the credit crisis began to unfold; Washington Mutual had Return on Equity (ROE) of 12.89% and a stock price of almost $40, respectably. Investors generally consider ROE over 5% or 6% very healthy for a bank. The ROE is currently -17.02% due to heavy losses, and its stock price has dropped simultaneously, and currently hovers around $5. Their losses alone have eaten up a chunk of their equity base, and if losses continue for an extended period of time, there may be little, if any equity left on the balance sheet. Investors will continue punishing the stock as long as write-downs persist, knowing that WaMu is cutting deep into the little amount of capital they have remaining. TPG may be hesitant to double down for a second time if the bank continues to lose money. A bad investment? Not really. But clearly a risky one, as it may have been too early for TPG to jump in to supply the bank with cash. They could have been patient to see how the next few quarters turned out, with the possibility of buying the company cheaper, and with a lot less risk attached to it.
I have analyzed some of America’s largest banks in order to better understand their capital position – there are twenty one banks with current assets exceeding $80 Billion. Washington Mutual alone has in excess of $317B, making it the sixth largest bank according to asset size. Despite its breadth, the asset size of the firm is irrelevant considering the current condition of the bank. Instead, look at the Return on Equity in order to evaluate the risk attached to TPG’s investment. ROE is annualized net income as a percentage of average equity on an annualized basis. In June, 2007, right before the credit crisis began to unfold; Washington Mutual had Return on Equity (ROE) of 12.89% and a stock price of almost $40, respectably. Investors generally consider ROE over 5% or 6% very healthy for a bank. The ROE is currently -17.02% due to heavy losses, and its stock price has dropped simultaneously, and currently hovers around $5. Their losses alone have eaten up a chunk of their equity base, and if losses continue for an extended period of time, there may be little, if any equity left on the balance sheet. Investors will continue punishing the stock as long as write-downs persist, knowing that WaMu is cutting deep into the little amount of capital they have remaining. TPG may be hesitant to double down for a second time if the bank continues to lose money. A bad investment? Not really. But clearly a risky one, as it may have been too early for TPG to jump in to supply the bank with cash. They could have been patient to see how the next few quarters turned out, with the possibility of buying the company cheaper, and with a lot less risk attached to it.
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