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Tangible Common Equity - now I get it



February 23, 2009 – Comments (0) | RELATED TICKERS: C

Many media stories about how the Feds are going to convert their preferred equity for common stock, and about how this is going to improve the strength of C by improving TCE. Guh? What on earth is TCE? Looked in the usual places, but, surprisingly, found little info. This situation was not helped by the journalists writing these stories who probably do not understand these things any better than I. Found one article that TCE is an indicator of a Bank’s ability to survive. Then, a Fool article that you take net assets and strip out preferred stock equity. When a company liquidates, TCE, at least in theory, tells you how much dough is left behind for the common stock holders, dead last in line for money (so “common” in TCE refers to the cash that common stock holders will get in the event of a liquidation). OK, but still, how does converting preferred to common help the bank survive? Yeah, understood that this action improves the financial ratios, but how?

Then the light bulb went on. Preferred stock is sort of like a debt instrument: they are below bond holders in the pecking order, but above common stock. Holding preferred shares has the implicit promise of getting it paid back, eventually, at least in theory and at the discretion of the company. So, by taking common stock in exchange for their preferred shares, the Fed’s holdings are sort of like convertible stock. Cool: the company gets to take debt off of their books, at the cost of dilution of common shareholders.

Now, an even bigger question: how big a haircut are taxpayers suppose to take in this conversion? C has 5Bs outstanding, price is about $2, so market cap is around $10B. Uncle Sam put in $40B, so he is going to get 20Bs? If he takes “only” 10Bs (2/3 dilution), then taxpayers take a 50% haircut. If shareholders scream bloody murder, Bernanke takes 2Bs (only 1/3 dilution), and this thing will have to be 10-bagger for the taxpayer to get his money back?


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