What Is the Tangible Common Equity (TCE) Ratio?
The tangible common equity ratio is used to measure a company's financial strength. The TCE ratio measures a firm's tangible common equity (TCE) in terms of the firm's tangible assets. It can be is used to estimate a bank's sustainable losses before shareholder equity is completely wiped out.
- The tangible common equity (TCE) ratio measures a company's financial position based on the physical assets it owns.
- This will exclude intangible assets like intellectual property and goodwill from consideration.
- The TCE Ratio is useful for evaluating companies with a large stock of preferred shares, or financial firms that may not possess a relatively large amount of physical assets.
Understanding the Tangible Common Equity (TCE) Ratio
Tangible common equity, or TCE, is most often used when evaluating the position of financial companies like banks. It looks only at a firm's physical capital to evaluate a financial institution's ability to use them as collateral be able to cover potential losses.
The TCE ratio (TCE divided by the value of the firm's tangible assets) therefore measures the capital adequacy of a financial firm or bank. If tangible common equity greatly exceeds the value of physical assets, the firm may be unable to deal with a large loss by liquidating such assets.
Note that TCE and the TCE ratio are not used in generally accepted accounting principles (GAAP), and are a pro-forma measure used internally by the company's financial officers or accounting department to understand its own risk exposure. Analysts and investors may likewise use this as a capital adequacy ratio, but in conjunction with other measures like Tier 1 capital and liquidity or solvency ratios.
Calculating the TCE Ratio
The tangible common equity ratio is calculated in two steps:
- First, find the value of the firm's tangible common equity, This is calculated by subtracting intangible assets (including goodwill) and preferred equity from the company's book value. Intangible assets often have very low liquidation value. Depending on the firm's circumstances, patents might be excluded from intangible assets for this equation since they, at times, can have a liquidation value.
- The tangible common equity is then divided by the firm's tangible assets, which is calculated by subtracting the firm's intangible assets from total assets. This provides the following ratio:
TCE Ratio = (tangible common equity) / (tangible assets)
What the TCE Ratio Tells You
Tangible common equity is thought to be an estimation of the liquidation value of a firm; it is what might be left over for distribution to shareholders if the firm were liquidated.
The tangible common equity ratio can be used as a measure of leverage. High ratio values indicate less leverage and a larger amount of tangible equity compared to tangible assets. This ratio became popular when evaluating banks during the credit crisis in 2008. It has been used as a measure of how well capitalized a bank is compared to its liabilities and what happens if it converts preferred shares into common stock.