What is a Texan ratio?
The Texas ratio was developed to warn of credit problems in particular banks or banks in particular regions. The Texas ratio takes the amount of a bank non-performing assets and divide this number by the sum of the tangible common stock and his loan provisions for losses. A ratio greater than 100 (or 1:1) indicates that non-performing assets are greater than the resources the bank may need to cover potential losses on those assets.
Key points to remember
- The Texas ratio assesses the financial condition of a bank.
- The ratio is non-performing assets divided by the sum of a bank’s tangible equity and loan loss reserves.
- The higher the Texas ratio, the more financially troubled a bank can be.
- However, a high ratio in Texas does not mean that the bank will fail.
How the Texas Ratio Works
The Texas ratio was developed as an early warning system to identify potentially problematic banks. It was originally applied to Texas banks in the 1980s and proved useful for New England banks in the early 1990s. The Texas ratio was developed by Gerard Cassidy and other RBC analysts Capital Markets. Cassidy found that banks with a Tex ratio above 100 tend to fail.
During the 1980s, Texas experienced an energy boom. The banks financed the surge, but soon the oil surge subsided and the banks began to struggle. As a result, Texas had the highest number of bank failures from 1986 to 1992 in the country.
Under the Texas ratio, non-performing assets include defaulted loans or real estate that the bank had to foreclose. These could become expenses for the bank. On the other hand, tangible equity does not include intangible assets that cannot be used to cover losses, such as goodwill.
The Texas ratio is useful for investors as well as clients. Banking customers will assess the Texas Ratio to ensure their money is safe. This is especially important if a customer has money outside the Federal Deposit Insurance Corporation (FDIC) coverage limits – $250,000.
The Texas ratio, like many financial ratios, is best used with other analyses. A high ratio does not mean the bank will fail, as many banks can operate with high Texan ratios.
Example of the Texas ratio
A bank has $100 billion in non-performing assets. The total common stock of the bank is $120 billion. The Texas ratio is calculated as non-performing assets divided by common tangible equity. The ratio is 0.83 or 83%, or $100 billion/$120 billion. Although that’s a little high, it’s best to look at the ratio in historical context. Is the ratio increasing or decreasing? If it goes down, the bank may have a solid plan to control non-performing assets.
There are currently (as of March 2020) a number of banks that have Texan ratios above 100%. This includes First City Bank in Florida with a ratio of 646.6% in Texas and The Farmers Bank in Oklahoma at 134.0%. These two banks have assets between 75 and 150 million dollars.
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