The Texas ratio is a simple, widely used early‑warning metric for assessing a bank’s credit stress. It compares a bank’s non‑performing assets (NPAs) — loans that are in default or real estate foreclosed by the bank — to the resources the bank has available to absorb losses: tangible common equity plus loan‑loss reserves. A ratio above 100% (or 1.0) means NPAs exceed those loss‑absorbing resources and signals elevated risk that a bank could face serious financial trouble if the NPAs are realized.
Key points
– Purpose: An early‑warning indicator of bank credit problems, developed in the 1980s for Texas banks and popularized by Gerard Cassidy and analysts at RBC Capital Markets.
– Basic interpretation: Texas ratio > 100% is a red flag; lower is better.
– Use case: Useful to investors, depositors (especially with balances > FDIC limits), and analysts as part of a broader credit / asset‑quality review.
– Caveat: It is a blunt tool — context, trends, reserve quality, capital adequacy and other metrics matter.
How the Texas Ratio works (formula and components)
Standard formula:
Texas ratio = Non‑performing assets / (Tangible common equity + Loan‑loss reserves)
What each component generally means:
– Non‑performing assets (numerator): Typically includes nonaccrual loans, delinquent loans (often 90+ days past due), restructured loans that are not performing, and foreclosed real estate (REO). These are assets likely to produce losses.
– Tangible common equity (denominator): Shareholders’ common equity excluding intangible assets such as goodwill and sometimes excluding preferred equity. This is the hard capital available to absorb losses.
– Loan‑loss reserves (denominator): The allowance for loan and lease losses (ALLL) or allowance for credit losses — reserves set aside to absorb expected loan losses.
Note: Some presentations of the Texas ratio omit loan‑loss reserves or use slightly different NPA definitions. The most commonly cited form includes both tangible common equity and loan‑loss reserves.
Interpreting the Texas ratio
– Below 50%: Generally indicates relatively healthy buffer between problem assets and loss‑absorbing resources (but still check trend).
– 50%–100%: Elevated risk; requires closer inspection of trends, reserves, capital and management remediation plans.
– Above 100%: NPAs exceed tangible equity plus reserves — an important warning sign that the bank could be insolvent if NPAs are realized. Historically, banks with ratios above 100% have had higher failure rates, though a high ratio is not an automatic predictor of failure.
Special considerations and limitations
– Trend matters more than a single reading: a rising Texas ratio is more concerning than a single high value that is falling.
– Reserve adequacy and accounting policy: Allowances depend on management judgment and accounting standards, which can vary across banks and change over time. Weak reserves can understate risk.
– Composition of NPAs: A bank with concentrated problem loans in a single sector (e.g., energy, CRE) is riskier than one with diversified smaller problem exposures.
– Off‑balance‑sheet and securitized exposures: Not all problem exposures show up in on‑balance‑sheet NPAs.
– Size and local economic context: Smaller community banks and regional banks in distressed local economies may have higher ratios than large diversified banks.
– Other regulatory and capital metrics matter: CET1, leverage ratios, regulatory actions, stress tests and liquidity measures should be reviewed in addition to the Texas ratio.
Practical step‑by‑step: How to calculate the Texas ratio for a bank
1. Obtain the bank’s latest regulatory or financial statement (quarterly Call Report, 10‑Q/10‑K, investor presentation).
2. Find non‑performing assets: locate line items such as nonaccrual loans, loans 90+ days past due, restructured loans, and foreclosed real estate (REO). Sum them — this is the numerator. (Definitions can vary; use the bank’s reporting definition and be consistent.)
3. Find tangible common equity: start with total common shareholders’ equity, subtract intangible assets (goodwill, core deposits intangibles). Some analysts also remove preferred equity.
4. Find loan‑loss reserves: the allowance for loan and lease losses (ALLL) or allowance for credit losses.
5. Compute: Texas ratio = NPAs / (Tangible common equity + ALLL)
6. Compare: evaluate the ratio relative to historical values for the same bank, peers, and industry averages. Look at trends over several quarters.
Worked example
Given (from the Investopedia example):
– Non‑performing assets = $100 billion
– Tangible common equity = $120 billion
If you use only tangible common equity in the denominator: Texas ratio = $100B / $120B = 0.83 = 83%.
If loan‑loss reserves are material and you add them to the denominator, the ratio will be lower (less risky) than 83%. Always be explicit about which formula you use.
How investors or depositors can use the Texas ratio — practical checklist
1. Look up the Texas ratio and trend over the last 8–12 quarters — is it rising or falling?
2. Compare the bank’s ratio to peers and industry medians (regional and national).
3. Check reserve adequacy: what is the allowance / nonperforming loans coverage ratio? A thin allowance raises concern.
4. Review regulatory capital metrics (CET1, total risk‑based capital) and liquidity measures.
5. Inspect asset concentration: are problem loans concentrated in a vulnerable sector or geography?
6. Check management commentary, remediation plans, charge‑offs and restructuring activity in earnings releases and call transcripts.
7. For depositors with balances > $250,000, consider diversification across institutions or use brokerage sweeps, treasury bills, or other insured options. (FDIC insurance limit is $250,000 per depositor per insured bank, per ownership category.)
8. If the Texas ratio is elevated or rising quickly, monitor for regulatory enforcement actions, ratings downgrades or heightened market concern.
Where to find Texas ratios and source data
– Bank regulatory filings (quarterly Call Reports / FFIEC data, and publicly filed 10‑Q/10‑K for publicly traded banks) contain the underlying items.
– Financial data providers and aggregators (e.g., S&P Global Market Intelligence, Bloomberg, banking research sites) publish Texas ratios or the underlying values. (Investopedia referenced a S&P Global Market Intelligence list of banks with high Texas ratios in Q1 2020.)
– Bank investor relations pages and earnings presentations often disclose NPAs, reserves and tangible equity.
Red flags and follow‑up actions
– Rapidly rising Texas ratio over several quarters.
– Texas ratio > 100% combined with thin ALLL coverage and weak capital ratios.
– Large concentrations in a stressed industry (energy, commercial real estate, hospitality, etc.).
– Management silence or weak plans to deal with NPAs; accelerating charge‑offs.
If you see these red flags: increase monitoring frequency, reduce uninsured deposit exposure, consider diversifying counterparty risk, and for investors, reassess valuation and downside scenarios.
Historical note and real examples
– The metric was developed in the 1980s for Texas banks during the energy downturn and was popularized by Gerard Cassidy and other RBC Capital Markets analysts. It proved useful again for early‑1990s New England bank stress.
– Investopedia cited S&P Global Market Intelligence identifying several small banks with Texas ratios above 100% as of Q1 2020 (examples included First City Bank in Florida and The Farmers Bank in Oklahoma; those examples were small institutions with assets between $75M and $150M).
Bottom line
The Texas ratio is a straightforward, intuitive gauge of a bank’s asset‑quality pressure relative to its loss‑absorbing capacity. It is best used as part of a broader credit and capital assessment: track trends, compare with peers, verify reserves and capital strength, and follow up with deeper analysis when the ratio is elevated.
Sources
– Investopedia. “Texas Ratio”
– S&P Global Market Intelligence. “US banks with the highest Texas ratios in Q1’20.” (cited in Investopedia)
Editor’s note: The following topics are reserved for upcoming updates and will be expanded with detailed examples and datasets.