Tangible Common Equity (TCE): Definition, Calculation and Example

What Is Tangible Common Equity (TCE)?

Tangible common equity (TCE) is a measure of a company's physical capital, which is used to evaluate a financial institution's ability to deal with potential losses. It is often used when analyzing financial firms that do not normally have a relatively large amount of tangible assets.

Tangible common equity is calculated by subtracting intangible assets (including goodwill) and preferred equity from the company's book value.

Understanding Tangible Common Equity

Companies own both tangible (physical) and intangible assets. A building is tangible, for instance, while a patent is intangible. The same can be said about a firm's equity. Financial companies are most often evaluated using TCE.

Measuring a company's TCE is particularly useful for evaluating companies that have large amounts of preferred stock, such as U.S. banks that received federal bailout money in the 2008 financial crisis. In exchange for bailout funds, those banks issued large amounts of preferred stock to the federal government. A bank can boost TCE by converting preferred shares to common shares.

Using tangible common equity can also be used to calculate a capital adequacy ratio as one way of evaluating a bank's solvency and is considered a conservative measure of its stability.

Special Considerations

The TCE ratio (TCE divided by tangible assets) is a measure of capital adequacy at a bank. The TCE ratio measures a firm's tangible common equity in terms of the firm's tangible assets. It can be used to estimate a bank's sustainable losses before shareholder equity is wiped out.

Depending on the firm's circumstances, patents might be excluded from intangible assets for the purposes of this equation since they, at times, can have a liquidation value.

Another way to evaluate a bank's solvency is to look at its tier 1 capital, which consists of common shares, preferred shares, retained earnings, and deferred tax assets. Banks and regulators track tier 1 capital levels to assess the stability of a bank.

Notably, lower risk assets held by a bank, such as U.S. Treasury notes, carry more safety than low-grade securities. Regulators do not require regular submissions of tier 1 capital levels, but they come into play when the Federal Reserve conducts stress tests on banks.

Example of Tangible Common Equity

Say that XYZ Bank had for the fiscal year 2021 a book value of $273.8 billion. Its goodwill was $69.01 billion, intangible assets $2.2 billion, and preferred stock $24 billion. Thus, XYZ Bank's tangible common equity at the end of 2021 was $178.59 billion ($273.8 billion - $69.01 billion - $2.2 billion - $24 billion).