Tangible common equity (TCE) is typically an obscure and scarcely mentioned statistic. Investors have long relied on Tier 1 capital ratios and earnings potential to judge a bank's investment merit.
What's changed in the past year is that imploding balance sheets have brought on the possibility of wiping out common shareholders completely. With that bleak reality in place, Tier 1 capital -- which measures a bank's strength irrespective of shareholder classes -- takes a backseat to tangible common equity, which is really what's left over for average Joe shareholders.
Before Citigroup converted preferred shares into common stock, its TCE ratio stood at 1.5%. With the conversion, the ratio strengthens to 4.4% (which is still low -- banks have historically kept the ratio at around 6%). In other words, someone (either from Citi or the government) concluded 1.5% was dangerously low -- low enough to justify diluting the pants off of exisiting investors -- and that something around 4.4% was necessary, at least for the time being.
Back to B of A. While not nearly as dire as Citi, its TCE ratio, at 2.6%, remains among the lowest of the major banks. Every bank is low these days -- JPMorgan Chase (NYSE: JPM) sits at 3.4%, Wells Fargo (NYSE: WFC) is at 3.2%, Goldman Sachs (NYSE: GS), 4.9%; Morgan Stanley (NYSE: MS), 4.4%. But B of A sticks out as the worst. That's likely why so much pessimism has gathered around this stock in recent months.
So what now?
While comparing B of A to Citigroup is hardly apples to apples, the trend is the same: Banks with dangerously low TCE ratios must raise common capital lest even moderate future losses wipe out shareholders.
For B of A to raise its TCE ratio from 2.6% to the 4.4% Citigroup deemed appropriate would require $43 billion of new capital. With a sub-$4 share price and a market cap under $25 billion, the most sensible way to achieve this is converting existing preferred shares into common stock, just like Citigroup did. That wouldn't be impossible, but it would be extremely dilutive and unnerving to existing investors as the seeds of nationalization begin to sprout. (Look what's happened to Citi shares since the conversion took place.)
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