What Is a Texas Ratio?
Let me explain the Texas Ratio to you directly. It's a metric developed to flag potential credit problems at specific banks or in certain regions. You calculate it by taking the bank's non-performing assets and dividing that by the sum of its tangible common equity and loan loss reserves. If the ratio goes over 100—or 1:1—that means the non-performing assets are bigger than what the bank has set aside to handle potential losses on those assets.
Key Takeaways
- The Texas Ratio evaluates a bank’s financial position.
- It's calculated as non-performing assets divided by the sum of tangible common equity and loan loss reserves.
- A higher Texas Ratio points to more potential financial trouble for the bank.
- That said, a high ratio doesn’t automatically mean the bank will go bankrupt.
How the Texas Ratio Works
I want you to understand how this ratio functions as an early warning tool. It was created to spot banks that might be heading for trouble, first used on Texas banks in the 1980s and later proving effective for New England banks in the early 1990s. Gerard Cassidy and other analysts at RBC Capital Markets developed it, finding that banks with a ratio over 100 often fail.
Back in the 1980s, Texas had an energy boom, and banks poured money into it. When the oil surge collapsed, banks struggled, leading to the most bank failures nationwide from 1986 to 1992.
In the ratio, non-performing assets cover things like defaulted loans or foreclosed real estate that could turn into costs for the bank. Tangible equity excludes intangibles like goodwill that can't cover losses.
Special Considerations
You should know that the Texas Ratio is helpful for both investors and customers. As a customer, check it to make sure your money is secure, especially if you have deposits over the FDIC's $250,000 coverage limit.
Like other financial ratios, use the Texas Ratio with additional analyses. A high ratio isn't a sure sign of bankruptcy—plenty of banks operate just fine with elevated ratios.
Example of the Texas Ratio
Here's a straightforward example to show you how it works. Suppose a bank has $100 billion in non-performing assets and $120 billion in total common equity. The Texas Ratio comes out to 0.83 or 83%—that's $100 billion divided by $120 billion. It's on the high side, but you need to consider the historical trend. Is it going up or down? If it's decreasing, the bank might have a good strategy for managing those assets.
As of March 2020, some banks have ratios over 100%, like First City Bank in Florida at 646.6% and The Farmers Bank in Oklahoma at 134.0%. Both have assets between $75 and $150 million.
