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Tangible Common Equity – How Much Is Enough?

Sud­denly, every­one is inter­ested in the amount of tan­gi­ble com­mon equity (“TCE”) invested in banks. Oddly, no one seems to know how much TCE is enough despite TCE being the pri­mary and most impor­tant ele­ment in deter­min­ing the ade­quacy of bank cap­i­tal­iza­tion. Of course, his­tory pro­vides a guide to what is enough TCE and right now banks don’t have enough. Only a mas­sive amount of pub­lic and pri­vate bank invest­ment will fill in the exist­ing cap­i­tal hole which explains the falling stock prices of many banks and finan­cial institutions.

What is “tan­gi­ble com­mon equity” and how is it mea­sured?

Bank­ing reg­u­la­tors started focus­ing on the low level of TCE at large banks right after Tim Gei­th­ner became Trea­sury Sec­re­tary. Ade­quacy of TCE is mea­sured by the TCE ratio which is the amount of TCE divided by amount of tan­gi­ble assets. Banks with higher TCE ratios are bet­ter cap­i­tal­ized and a have lower risk of fail­ure than banks with lower ratios.

TCE is dif­fer­ent than com­mon equity because TCE is reduced by the amount of intan­gi­ble assets owned by a bank. Intan­gi­ble assets are things like good­will and tax ben­e­fits from net oper­at­ing loss carry for­wards. These assets don’t pro­duce income and don’t have a cash equiv­a­lent value. More­over, intan­gi­ble assets can’t sup­port bank­ing oper­a­tions or cover losses. Even worse, intan­gi­ble assets have a child like “pre­tend” qual­ity to them; one minute every­one pre­tends intan­gi­ble assets are there and then the next minute real­ity sets in and they disappear.

Reg­u­la­tors focus on “com­mon equity” and not all forms of cap­i­tal because only com­mon equity can be depended upon in a tough pinch. Other forms of cap­i­tal are “Almost Com­mon Equity” and include pre­ferred stock and sub­or­di­nated debt. Almost Com­mon Equity investors are fair weather friends; they are just like best friends when things are good but when things don’t go well they stop pre­tend­ing. Pre­ferred stock and sub­or­di­nated debt investors think that they are going to get paid back and earn a fixed yield through inter­est and div­i­dend pay­ments and even­tual repay­ment of prin­ci­pal. When things aren’t going well most Almost Com­mon Equity investors turn into cred­i­tors and demand their cash back. Only com­mon stock­hold­ers expect to stick it out through thick and thin.

How much is enough? The 1980s expe­ri­ence.

Since Gei­th­ner men­tioned the stress test, media pun­dits have been argu­ing about how much TCE is enough. Many “experts” say that a 4% or 5% TCE ratio is good enough. Well…I don’t think so.

When I was a young lawyer in the early 1980’s, I remem­ber S&L CEOs telling me that a 4% to 5% TCE ratio was good enough for them. Within a few years every CEO who said that 20 to 1 lever­age was a good idea (that is what 5% TCE ratio means) had been ejected from the indus­try and their insti­tu­tion seized. Some of those CEOs were in jail.

More recent data on TCE from 1995.

But the 1980s was a tough time in Amer­i­can finance and was a long time ago. After all, it was before the inter­net, deriv­a­tive secu­ri­ties and secu­ri­ti­za­tion. To today’s young Turks 1984 is ancient eco­nomic his­tory and before some peo­ple work­ing on Wall Street and in bank­ing were born. So, maybe my mem­ory of ancient his­tory needs to be updated with a more cur­rent exam­ple of ade­quate lev­els of TCE for safe and sound bank­ing operations.

I think the amount of TCE that banks had in the mid-1990s is a bench­mark that cur­rent mar­ket par­tic­i­pants can iden­tify with and accept. After all, by 1995 the inter­net had been invented, most of the Repub­li­can lead­ers who are in the news today were in the news then and secu­ri­ti­za­tion was an accepted form of financing.

Below is a chart com­par­ing the amount of TCE that a select group of banks had at the end of 2008 and at the end of 1995. The rea­son I selected the below banks is because I was able to talk a friend at an invest­ment bank to pull the infor­ma­tion for me and this is what he found (thanks Brent!). The sam­ple isn’t ran­dom and lacks the sam­pling purity of an aca­d­e­mic exer­cise. But I know enough about sta­tis­tics to know that the uni­for­mity of the results make it sta­tis­ti­cally sig­nif­i­cant and important.


Tan­gi­ble Com­mon Equity / Tan­gi­ble Assets (%) 





Bank of Amer­ica Cor­po­ra­tion   




Bank of New York Mel­lon Corporation  




BB&T Cor­po­ra­tion   




Cit­i­group Inc.   




JPMor­gan Chase & Co.   




PNC Finan­cial Ser­vices Group, Inc.   




State Street Cor­po­ra­tion   




U.S. Ban­corp   




Wells Fargo & Company  








Source: SNL Finan­cial                 
PNC Finan­cial Ser­vices Group is as of 9/30/08                 
Cit­i­group, Inc was CITICORP in 1995                 


So, how much TCE is enough?

It’s a lot more than the banks cur­rently have and prob­a­bly more than in 1995. Banks need more TCE today because they are riskier com­pa­nies now than they were 13 years ago. Off bal­ance sheet lia­bil­i­ties, credit default swaps and stu­pid deci­sions of the last 8 years didn’t exist in 1995 and need TCE. The cap­i­tal hole in the bank­ing sys­tem to restore TCE lev­els to those that existed in 1995 is in the hun­dreds of bil­lions and even more is required to cover the new lia­bil­i­ties of today’s bank­ing system.

Sophis­ti­cated investors under­stand the mag­ni­tude of the cap­i­tal hole and know that this prob­lem is caus­ing bank stocks to tank. And, sophis­ti­cated investors also under­stand that until large banks get their house in order cor­po­rate earn­ings will be ane­mic (at best). The rea­son the stock mar­ket has been div­ing isn’t because of Obama’s bud­get pro­pos­als, it is because his admin­is­tra­tion is shin­ing a bright light on bank cap­i­tal ratios and their cap­i­tal inadequacy.

It took years of neglect for bank cap­i­tal ratios to drop as far as they did and it will take sev­eral years for banks to repair their bal­ance sheets. Obama didn’t make this prob­lem but we are lucky that his admin­is­tra­tion is try­ing to fig­ure out how to fix it.

Posted in: BANKS, Credit Crisis, economy, Finance, Obama, Politics, Public Policy, REGULATION, Regulatory Reform, Timothy Geithner, Treasury


  1. Rich John

    Nice analy­sis Mark. The table of TCE ratios is reveal­ing. Some adjust­ments though to make them even bet­ter. The C TCE does not reflect the pre­ferred to com­mon con­ver­sion the Feds are doing and is thus mis­lead­ing. And of course it still walks aroung the “ele­phant in the liv­ing room” as we used to say at PruBache and that is shouldn’t equity be hair­cut to reflect the losses we know the banks will have to take. No, not the silly mark-to-market because if there is tru­ely enough TCE those assets will never be sold, but the credit losses on the resi mort­gage, com­mer­cial mort­gages, credit cards, and all other busi­ness loans.

  2. William

    Your arti­cle is very inter­est­ing how­ever TCE 1995 vs 2008 are not com­pa­ra­ble on an apples to apples basis. The intro­duc­tion of Trust Pre­ferred secu­ri­ties in 1997 as a form of Tier 1 cap­i­tal (up to 25% of Tier 1 Cap) that is uti­lized by almost all BHCs would not be reflected in your 2008 fig­ure. So much reg­u­la­tion has been changed since 1995 it would dif­fi­cult to make a real com­par­i­son with­out tak­ing a broader look at the total cap­i­tal struc­ture. TCE as cur­rently defined is too nar­row to gauge the true sol­vency of a BHC.

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