Texas Ratio

What Is a Texas Ratio?

The Texas ratio was developed to caution of credit problems at particular banks or banks in particular areas. The Texas ratio takes the amount of a bank's non-performing assets and partitions this number by the sum of the bank's [tangible common equity](/substantial common-equity) and its loan loss reserves. A ratio of more than 100 (or 1:1) shows that non-performing assets are greater than the resources the bank might have to cover likely losses on those assets.

How the Texas Ratio Works

The Texas ratio was developed as an early warning system to distinguish potential problem banks. It was initially applied to banks in Texas during the 1980s and proved helpful for New England banks in the mid 1990s. The Texas ratio was developed by Gerard Cassidy and different analysts at RBC Capital Markets. Cassidy found that banks with a Texas ratio of greater than 100 will generally fail.

During the 1980s Texas saw an energy boom. Banks financed the flood, however soon the oil flood subsided and banks began to battle. Thus, Texas saw the best number of bank failures from 1986 to 1992 in the nation.

As part of the Texas ratio, non-performing assets incorporate loans that are in default or real estate the bank has needed to abandon. These could become expenses for the bank. On the opposite side, unmistakable equity does exclude intangibles that can't be utilized to cover losses, like goodwill.

Special Considerations

The Texas ratio is valuable for investors as well as customers. Banking customers will evaluate the Texas ratio to guarantee their money is safe. This is especially important in the event that a customer has money outside the Federal Deposit Insurance Corporation (FDIC) coverage limits — $250,000.

The Texas ratio, in the same way as other financial ratios, is best used with different examinations. A high ratio doesn't mean the bank will fail, as many banks can operate with high Texas ratios.

Illustration of the Texas Ratio

A bank has $100 billion in non-performing assets. The bank's total common equity is $120 billion. The Texas ratio is calculated as non-performing assets separated by unmistakable common equity. The ratio is 0.83 or 83%, or $100 billion/$120 billion. Albeit this is to some degree high, it's best to check out at the ratio in the historical setting. Is the ratio rising or falling? In the event that it's falling, the bank might have a strong plan for keeping non-performing assets in check.

There are a number of banks right now (as of March 2020) that have Texas ratios of more than 100%. This incorporates First City Bank in Florida with a 646.6% Texas ratio and The Farmers Bank in Oklahoma at 134.0%. Both of these banks have assets somewhere in the range of $75 and $150 million.

Highlights

• The ratio is non-performing assets separated by the sum of a bank's unmistakable common equity and loan loss reserves.
• The Texas ratio surveys a bank's financial position.
• A high Texas ratio, notwithstanding, doesn't mean the bank will fail.
• The higher the Texas ratio the more financial difficulty a bank may be in.