The Texas ratio was designed to alert stakeholders about potential credit issues at specific banks or in particular regions. This ratio compares a bank’s non-performing assets with the bank’s tangible common equity and loan loss reserves. A ratio exceeding 100 (or 1:1) suggests that non-performing assets are higher than the bank’s resources available to cover potential losses from these assets.
Key Insights
- The Texas ratio is a crucial metric for evaluating a bank’s financial health.
- It is calculated by dividing non-performing assets by the sum of a bank’s tangible common equity and loan loss reserves.
- A higher Texas ratio could signal looming financial troubles for a bank.
- Despite a high Texas ratio, a bank is not necessarily on the brink of bankruptcy.
How the Texas Ratio Works
Conceived as an early warning tool, the Texas ratio helps identify banks with potential problems. Initially applied to Texan banks in the 1980s, it proved beneficial for New England banks in the early 1990s. Gerard Cassidy and analysts at RBC Capital Markets developed this ratio and observed that banks with a Texas ratio exceeding 100 often faced failure.
In the 1980s, Texas experienced an energy boom that caused banks to heavily finance the growth. However, as the boom ended, banks struggled, leading to numerous failures between 1986 and 1992.
Non-performing assets, which are included in the Texas ratio, encompass loans in default and foreclosed real estate, posing potential expenses for banks. Tangible equity considered in the ratio excludes intangible assets like goodwill that can’t cover losses.
Special Considerations
Beyond investors, banking customers can leverage the Texas ratio to ensure the safety of their deposits—particularly crucial for amounts surpassing FDIC insurance limits of $250,000. Combining the Texas ratio with other analytical tools yields the best insights. A high Texas ratio alone isn’t a definitive predictor of bank failure, as many banks continue operating despite elevated ratios.
Illustrative Example: The Texas Ratio
Let’s enhance our understanding with an example. Imagine a bank with $150 billion in non-performing assets and $200 billion in tangible common equity. The Texas ratio is calculated as non-performing assets divided by tangible common equity. The ratio here amounts to 0.75 or 75%, or $150 billion / $200 billion. While this is relatively high, interpreting the ratio within its historical context is crucial. Is the ratio increasing or decreasing? A declining ratio could indicate the bank’s plan to effectively manage non-performing assets.
As of late, some banks have Texas ratios over 100%. For example, as of recent trends, First City Bank in Florida reports a Texas ratio of 646.6%, while The Farmers Bank in Oklahoma stands at 134.0%. These banks possess assets ranging between $75 and $150 million, underscoring the need to carefully monitor and interpret Texas ratios.
Related Terms: non-performing assets, tangible common equity, loan loss reserves, banking stability, FDIC.
References
- S&P Global Market Intelligence. “US banks with the highest Texas ratios in Q1'20”.
