With the unveiling of Geithner’s rescue plan for the financials, the Obama administration has clearly fired a shot over the bow of the ship signaling that they are more interested in protecting American taxpayers than financial company shareholders. This is a very bad omen for all financial companies. The U.S. and world governments are doing everything they can to cure the ills of banks and financial services companies. Everyone is looking for a quick fix that will enable the companies and their shareholders to recover. Hank Paulson failed miserably in his attempt to provide a quick fix, and the new plan unveiled by his successor Tim Geithner doesn’t even attempt to provide immediate relief. Unfortunately, there is not an instant cure. The financial companies have been facing a few big problems. The first is that the value of financial companies, including share prices and market caps, has been consistently shrinking. This has been steadily worsening as the shares of many of the financial companies are now trading at prices below their tangible book value. Those lucky enough to have their shares trading at a premium to tangible book value still have shares that are trading at well below their five-year price to tangible book value high multiples. Historically, low valuations and low price-to-book value multiples can be disastrous for any company, especially for those in need of capital. For banks and financial services companies, the prices that their shares are trading at is even more critical because the first ever global recession is now underway. A global recession translates into a significant increase in potential loan write-offs for those in the business of making loans. When loan write-offs due to a recession start hitting a financial company’s balance sheet, the financial company is compelled to raise more equity capital. If its price-to-tangible book value is low, its shareholders face significant dilution. Therefore, the management teams of public companies are apt to sell more shares, especially at prices that are at such low multiples to tangible book value. The compression of the price-to-book multiples for 11 key financial companies illustrates the problem. Historically, low company valuations and low price-to-tangible book multiples make it very difficult for financial services companies—including banks and insurance companies—to maneuver during the current crisis. Citigroup (NYSE: C) and Bank of America (NYSE: BAC) are prime examples. The share prices of both were recently trading at a price to tangible book multiple of 0.6, which equates to the shares of both trading at 60% of tangible book value. If either had to sell common or preferred shares to raise fresh equity capital, their shareholders would suffer extreme dilution. The financial company that appears to be in the best position to weather the current financial storm is Wells Fargo (NYSE: WFC). Its recent price-to-tangible book value multiple was at 4.8, meaning that its share price is trading at a 380% premium to its book value. With multiples at near historic lows, financial companies do not want to go through the pain of diluting shareholders at rock bottom prices. They do whatever they can to avoid having to raise capital, including maintaining questionable or liberal valuations for the assets on their balance sheets. Without the cushion of having their shares trade at a significant premium or at a multiple of tangible book value that would enable them to raise equity capital with minimal dilution to shareholders, financial companies are unwilling to take any risk. Instead of being proactive and making new loans, most banks are waiting out the storm. While shrinking market caps and share prices are a big problem, the even bigger problem is low equity-to-total asset ratios. A majority have equity-to-total asset ratios hovering between 5% and 6%. The equity-to-total asset ratios are critical. Even a 5% devaluation or price decline in total assets would put five of these companies into receivership. An 8% decline in the value or price in total assets would wipe out the equity of 10 of the 11 key financial companies, including Bank of America, Citigroup, JPMorgan (NYSE: JPM), Goldman Sachs (NYSE: GS), Morgan Stanley (NYSE: MS), MetLife (NYSE: MET), Prudential Financial (NYSE: PRU), Hartford Financial (NYSE: HIG), U.S. Bancorp (NYSE: USB), and Lincoln National (NYSE: LNC). Only Wells Fargo, with an equity/total asset ratio of 10.08%, would be able to survive such a mark down. Given the volatility and illiquidity of the non-sovereign debt, corporate bond, and asset-backed securities markets, it’s a miracle that the total assets of these 11 financial companies has not yet declined by more than 10%. The only reason is that most of the financial companies have taken the position that the assets on their balance sheets cannot be “fairly” priced. By taking this position, it enables them to value the assets on their balance sheets at the price they paid for them. The management teams of the financial companies are painfully aware that the minute they begin to sell these assets at any discount to prices listed on their balance sheets, the prices of a good portion of the assets remaining will have to be marked down as well. This is why the financial companies will never voluntarily sell their assets at a discount to the market. The inability of the banks and financial companies to sell their assets at a sufficient discount without having to become insolvent has created the constipation or lack of liquidity for the credit markets. This is also the primary reason that former Treasury Secretary Paulson changed his mind and decided to use $350 Billion in TARP I funds to inject preferred equity capital directly into these entities instead of using the funds for their original purpose of purchasing the toxic assets from financial companies. Another problem that could potentially escalate, especially for the banks, is the sharp increase of loan write-offs. Loans made by banks are also considered among the total assets of a company’s balance sheet. It’s hard to imagine that they could keep their loan write-offs below 5% during the current recession. This is another reason that monitoring the equity-to-total asset ratio is critical. It’s also the same reason why the share prices of many of the financial companies are trading at 10-year lows and are priced below book value. Without the $45 billion in TARP I funding provided to both Citigroup and Bank of America, both of the companies would respectively have equity-to-total asset ratios of 3% and 4%. Low equity-to-total asset ratios make it very difficult for Citigroup, Bank of America, and other financial companies to take on any additional risk by purchasing additional assets or making any additional loans. This is because there are very few potential buyers with the wherewithal to purchase even of fraction of the over $2 trillion in assets that are held on each of Citigroup’s and Bank of America’s balance sheets. Given this, it’s inconceivable to concur that an outright sale of their assets could occur at anything lower than 10% discount to the prices booked on their balance sheets. This is why share prices of the former blue-chip banks have been hammered and were most recently trading at a 40% discount to their tangible book values. Given the desperate situation that the financial companies are in—having debt securities that are declining in value and loans that could go into default—it’s easy to see why there has been so much angst in the stock market. Savvy investors and short sellers know that the only acceptable remedy is for them to be able to sell these toxic assets and get them off their balance sheets for something approaching $0.99 on the dollar. Under the new plan from the Obama Administration, this will never happen. This is why the major stock market indexes hit new 2009 lows on February 10, the day that Treasury Secretary Tim Geithner unveiled his plan, which included having private investors determine the price that should be paid to purchase the toxic assets from the financial companies. On the news of Geithner’s plan, the Dow sold off by almost 400 points. Investors had mistakenly been under the belief that Obama was going to create a “bad bank” that was going to utilize government provided funds to purchase the illiquid assets at higher prices than they would have fetched from private investors. The two worsening problems of low price-to-book multiples and low equity-to-asset ratios could prove to be insurmountable. The result has been management teams that have had to maintain a defensive position. They are all hiding under the desk and hoping that (1) the economy will turn around, (2) that the grim reaper of loan defaults will pass them by, or (3) that their share prices will miraculously go back to their previous highs so that they can raise additional equity capital without having to seriously dilute their shareholders. The third problem only recently reared its ugly head. Under the U.S. Treasury’s newly announced plan, all banks and financial companies will be required to undergo a financial “stress test” to determine the degree of their solvency. If they do not pass the test, they will be forced to dilute their shareholders with the prices of their shares at rock bottom prices. And if they are unable to convince investors to drink their poisonous dilution, they will be liquidated. With the unveiling of Geithner’s rescue plan for the financials, the Obama administration has clearly fired a shot over the bow of the ship signaling that they are more interested in protecting American taxpayers than financial company shareholders. This is a very bad omen for all financial companies. My suspicion is that the stress test is being carefully crafted for the purposes of bringing the weak financial companies out from under their rocks. The assets of many of them will wind up being sold to private investors at deep discounts. Shareholders will be left with nothing. My prediction is that there could be a thousand publicly traded financial companies that could see their share prices falls to lows of below $10.00 per share before the Armageddon is over. The end result will be massive and unprecedented consolidation among the financial companies. Many will merge with each other and many will go out of business. Survival of the fittest will be the new game that played by the former masters of the universe. My bet is that Wells Fargo will emerge from the ashes as the largest U.S. financial company. It currently has the highest equity-to- total asset ratio and has a price-to-book multiple of 4.8, which is significantly higher by a wide margin than its nearest competitor, U.S. Bancorp. I also predict that Wells Fargo will be the first one to repay the $25 billion in TARP money that it received in October 2008. Michael Markowski and/or his family members hold shares in each of the companies that he is recommending in this article and may buy or sell such shares at anytime.