Wall Street tends to move as a herd and the latest movement has focused investor attention on the tangible common equity (TCE) ratio. This ratio is calculated as total tangible common equity divided by total tangible assets, but some adjustments must fist be made to the numbers. Goodwill and any other intangibles must be subtracted from the numerator and denominator of the formula. Some banks also subtract other comprehensive income (OCI) from equity. The higher ratio a bank has, the less leverage that it carries. (If you're still unsure about what all this could mean for the average investor, you might want to check out Digging Into Book Value first.)
This ratio is one of many measures used to determine the financial stability of a bank. Lately it has taken a higher importance among investors trying to separate the winners from losers in the banking sector.
Tangible Common Equity Plays
Brookline Bancorp (Nasdaq:BRKL) is a small savings and loan that operates out of Massachusetts. It ended the year with a TCE ratio of 17.39%. This has deteriorated slightly over the last year, and was at 19.83% at the end of 2007.
United Financial Bancorp (Nasdaq:UBNK) also operates out of Massachusetts. The bank reported its equity as a percentage of assets ratio of 18.03% at the end of 2008. United didn't call this a "tangible" ratio, but an examination of its balance sheet indicates the presence of very few intangibles.
Clean Balance Sheets
Our third bank from Massachusetts is Westfield Financial (NYSE:WFD). Westfield did not disclose its TCE ratio in its latest press release, but its balance sheet is so clean that dividing its assets by equity gives us a ratio of 23.4% for the quarter ending December 31, 2008.
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Essa Bancorp (Nasdaq:ESSA) is headquartered in Pennsylvania, and finished 2008 with a TCE close to 19%. It maintained its capital during a bad year for the industry by conducting sound underwriting. At the end of 2008 ESSA's nonperforming assets totaled only $3.9 million, which was a low 0.38% of total assets.
Not That Straight Forward
As a sign that Wall Street's obsession with the TCE ratio may be misplaced, let's look at Astoria Financial (NYSE:AF), which is a lender in New York City, but with a nationwide portfolio of loans. The bank reported a low TCE ratio of 4.57% at the end of 2008 and stated it expects to maintain a ratio between 4.5% and 4.75%.
While some might consider this low ratio the indicator of a weak bank, the company felt strong enough to turn down $375 million in new capital from the government. Also, the bank has one reported quarterly loss during the recession.
Although the stock market seems to be signaling an end to the financial crisis, the market can be fickle. Investors might be wise to focus on owning banks with a high tangible equity to tangible asset ratio, as this has become the metric of the moment for how to determine a bank's long-term viability. (Learn more in How Do Banks Determine Risk? and Analyzing A Bank's Financial Statements.)