U.S. looks to tangible common equity in stress tests

WASHINGTON (Reuters) - U.S. regulators want the top 19 banks being stress-tested to have at least 3 percent tangible common equity, according to a source familiar with the regulatory talks.

The source said the discussions on that key ratio were still fluid, but regulators are discussing using tangible common equity as a key measure for how the banks would fare if economic conditions deteriorate further.

Tangible common equity (TCE) is a measure of capital strength that has been commanding more investor attention. It looks at how much common equity is supporting a company and ignores intangible assets such as goodwill, on the theory that, in bad times, intangible assets are less likely to have value.

There has been little consensus on what a bank’s appropriate TCE ratio should be. Some argue it should be above 5 percent or 7 percent. Many major banks have had TCE ratios below 3 percent.

Regulators are in the final stages of the examinations in which the 19 largest banks are being tested to see how they would fare should the U.S. recession prove unexpectedly severe.

An official at the Federal Reserve said last week that some results of the stress tests will be revealed on May 4. Regulators will try to prove the rigor of the tests by releasing a document on April 24 that will explain the underlying assumptions, the official said.

The test results will include a capital recovery plan for banks that are deemed short of capital if the economic downturn accelerates.

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One way to raise tangible common equity at banks that have received capital infusions from the government would be to convert the government’s preferred shares to common equity.

U.S. Treasury Secretary Timothy Geithner testified to a congressional watchdog committee on Tuesday that preferred stock conversions “could be helpful” for some banks.

He also said banks will have a range of options for raising capital at the end of the stress tests.

“At the conclusion of this process that the Fed is undertaking to assess the potential capital needs of banks going forward, where there is a need for additional capital, total capital and common capital, those banks will have a suite of options of how they meet that need,” Geithner said. “They will work out with their ... supervisors what’s the best mix of those options.”

Reporting by Karey Wutkowski and Rachelle Younglai; Editing by Lisa Von Ahn and Andre Grenon