What Is Tangible Common Equity (TCE)?

What Is Tangible Common Equity (TCE)?

Let me explain tangible common equity, or TCE, directly to you. It's a measure of a company's physical capital that we use to evaluate how well a financial institution can handle potential losses. You'll find it especially relevant for analyzing firms that don't have a lot of tangible assets on their books.

To calculate TCE, you subtract intangible assets, including goodwill, and preferred equity from the company's book value. That's the straightforward way to get this figure.

Key Takeaways

Here's what you need to know about TCE. It's that measure of physical capital for assessing a financial institution's loss-handling ability. I find it particularly useful when evaluating companies with large amounts of preferred stock, such as U.S. banks that took federal bailout money during the 2008 financial crisis.

Then there's the TCE ratio, which is TCE divided by tangible assets. This ratio gives you a sense of capital adequacy at a bank, showing the firm's tangible common equity relative to its tangible assets.

Understanding Tangible Common Equity

Companies have both tangible and intangible assets, and the same goes for their equity. Think of a building as tangible, while a patent is intangible. When it comes to financial companies, we most often evaluate them using TCE.

Measuring TCE is key for companies with lots of preferred stock, like those U.S. banks from the 2008 bailout. In exchange for funds, they issued preferred stock to the government. A bank can increase its TCE by converting those preferred shares to common shares.

You can also use TCE to calculate a capital adequacy ratio, which is a conservative way to evaluate a bank's solvency and overall stability.

Important Note

Keep this in mind: TCE isn't required by GAAP or bank regulations. It's typically used internally as one of several indicators for capital adequacy.

Special Considerations

The TCE ratio, again, is TCE divided by tangible assets, and it measures capital adequacy at a bank. It helps estimate how much loss a bank can sustain before shareholder equity is wiped out.

Depending on the situation, you might exclude patents from intangible assets in this calculation, since they can sometimes have liquidation value.

Another approach to evaluating solvency is looking at tier 1 capital, which includes common shares, preferred shares, retained earnings, and deferred tax assets. Banks and regulators track this to assess stability.

Note that lower-risk assets like U.S. Treasury notes are safer than low-grade securities. Regulators don't require regular tier 1 capital submissions, but they factor in during Federal Reserve stress tests on banks.

Example of Tangible Common Equity

Take XYZ Bank in fiscal year 2021 as an example. Their book value was $273.8 billion, with goodwill at $69.01 billion, intangible assets at $2.2 billion, and preferred stock at $24 billion. So, the TCE came out to $178.59 billion after subtracting those from the book value.

Tip

Many banks report tangible common equity in the supplemental documents of their financial statements, so check there if you're analyzing one.

What Does Tangible Common Equity Measure?

TCE gives you an estimation of a firm's liquidation value—what might be left for shareholders if the firm were liquidated.

What Is the Tangible Common Equity Ratio Used For?

The TCE ratio, which is TCE divided by tangible assets, serves as a measure of leverage. Higher ratios mean less leverage and more tangible equity compared to tangible assets.

When Is Tangible Common Equity Useful?

TCE is most useful for evaluating financial companies like banks. It focuses on physical capital to assess how well an institution can use it as collateral to cover potential losses.