In the example provided, tangible book value is currently reported as $30 but would actually be -$80,00 if all assets were marked down to HTM value. However, under the relatively conservative assumptions illustrated in the model below: If the bank is simply allowed to carry its assets at acquisition cost and to charge the troubled assets off over time -- say 15-20 years -- the tangible book value of the bank will grow organically to $118,302 by 2021 - without any intervention or subsidies by the government whatsoever.

Applying a discount rate of 10%, the net present value of this 2021 book value is $34,268. US banks have historically traded at multiples well in excess of 4 times book value. Applying a conservative multiple of 2.5x book value would yield a market capitalization of $85,670. This is well over 100% above its current value in the stock market, which is at a mere $40,000. The regulatory uncertainty and the talk of cram-downs and/or nationalizations have caused an over-reaction in the market that has caused the market to value many banks well below their intrinsic NPV.

As a check to the reasonableness of my NPV calculation, I determine what would have happened if, with perfect foresight, the losses resulting from the 2007-2009 debacle could have been anticipated. In such a circumstance, what should the pre-crisis value have been? Would this fully discounted value been higher or lower than the current market valuation?

In order to do this, I calculate the NPV of the charge-offs over the 13-year period. This NPV is then subtracted from the pre-crisis value. In addition, an estimate is made of the NPV of the efficiency drag of having to carry non-earning assets on the balance sheet. The resulting residual value is still 200% above the current market capitalization. This confirms that the market, in this instance, has overreacted and is assigning a value well below what it should be.


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In the example provided, it would take the bank approximately 10 years to charge off the losses incurred from the 2007-2009 financial crisis and rebuild tangible book value capitalization to pre-crisis levels of 3.00%. It would take approximately 13 years for the bank to achieve the desired tangible common equity capitalization ratio of 5.00%.

How does this happen? Simple. All troubled legacy assets are placed in a special portfolio of non-performing, non-earning assets that have to be charged off over time. An ROA of 1.1% is applied to the performing earning assets, after charge-offs from delinquencies in these assets. The ROA on earning assets is conservative, given that many US banks have historically achieved ROAs of 1.2%-1.4%. Earnings, asset and book value growth in the example is fully organic and a function of capitalization of earnings and a leveraging of assets at a gradually increasing common equity capitalization ratio. The resulting earnings growth and ROE are in line with or below the typical historical performance for US banks.

How can one be sure that the bank can generate the earnings to dig itself out of the hole? There is every reason to expect it will, as long as the bank is reasonably efficient.

Banking is a unique industry. Unlike virtually any other industry on earth, banks deal in a product that never goes out of style - money. As long as a bank maintains adequate technology and human capital to compete in the marketplace, long-term profitability is virtually assured, because demand is assured. As long as a bank can generate positive cash flows, and as long as the NPV of these cash flows exceeds the NPV of the losses from the defaulted assets, then the present intrinsic value of that bank’s common equity is positive. A bank can therefore have a very negative net worth and still have a highly positive net present value.