Bank Stress Tests: Tangible Common Equity a Critical Metric

Includes: BAC, BK, C, GS, JPM, MS, PNC, USB, WFC
by: Deep Value Guy

A recent Reuters report suggests TCE will be a critical metric for the bank stress tests: “U.S. regulators want the top 19 banks being stress-tested to have at least 3% tangible common equity.” In other words, regulators want banks to have a leverage ratio below 33x. (3¢ of TCE for each $1 of tangible assets = 33x leverage)

So ahead of any official announcements regarding stress test parameters, OA thought we’d publish our latest update for banks’ TCE. (For a tutorial on TCE, go to this post and follow the links at the top.)

Using the 3% Test, the results for the nation’s nine largest banks are mixed…..four pass, five fail…..

(Click to enlarge)

To be clear, this is not a prediction of the government’s verdict. As Jack Ciesielski of The Analyst’s Accounting Observer points out: “there is no iconic definition of TCE. Treasury may come up with one of their own that takes into account questionable items” so that all the banks pass. That would be totally consistent with early reports

The banks themselves have varied definitions of TCE. The measure is supposed to be the true acid test of bank capital, which means it should be calculated conservatively. ALL intangible assets have to be backed out.* To calculate the TCE Ratio in the highlighted column, I’m using a very conservative calculation.**

The banks’ own methodology for calculating TCE varies. The “% overstated” column is meant to show which ones have taken the most liberties.

Incidentally, I added the right-most column in order to give readers a sense for the degree of vulnerability on the asset side of bank balance sheets. Level 2 (”mark to model”) and Level 3 (”mark to myth”) asset values are the ones over which management has the most discretion. These days, management can’t be trusted so it’s our bet that those with the biggest discretionary buckets—JP Morgan Chase (NYSE:JPM), BofA (NYSE:BAC), C (NYSE:C)—are the ones sitting on the largest losses.


*All the banks fail to back out mortgage servicing rights from TCE, even though these are intangibles under GAAP. Some banks (BofA, Wells (NYSE:WFC), Chase) have substantial MSRs, others (Goldman Sachs (NYSE:GS), Morgan Stanley (NYSE:MS)) don’t. Some banks add back “def’d tax liabilities” related to intangibles (BNY Mellon (NYSE:BK), Wells, Chase, PNC). This is not conservative. Two banks (Wells, PNC) goosed TCE by reclassifying “noncontrolling minority interests” from liabilities to equity.

**TCE = common shareholder’s equity (excluding noncontrolling minority interests) - goodwill - intangibles - preferred - MSRs.

Fair Disclosure: OA has short positions in companies mentioned in this post

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