Banking Analytics: Understanding Credit Risk with the Texas Ratio

Bank customers may have seen their financial institutions advertise something called the “Texas ratio” as a mark of health. In addition, bank equity and bank-rating analysts often refer to Texas ratios in their write-ups and rankings. At its heart, the Texas ratio measures a bank’s troubled loans against its capital resources to absorb losses from those loans.

The ratio was first developed by equity analyst Gerard Cassidy as part of his analysis during the 1980s Texas banking crisis, when hundreds of Texas banks failed as severe oil price shocks and soaring interest rates caused commercial real estate values to plunge.

The simple formula is nonperforming loans divided by tangible equity and loan loss reserves.A more precise formula: Loans and leases 90 days or more and still accruing, loans on nonaccrual, and other real estate owned as a percentage of total bank equity capital less goodwill and other intangible assets plus the allowance for credit losses and the allocated transfer risk reserve. Ideally, the ratio is low. A ratio of 0% indicates that a bank is carrying no nonperforming loans or foreclosed real estate on its balance sheet, reflecting little risk of loan losses to a bank’s capital. A ratio above 100% implies that a bank may not have enough capital to cover its potential loan losses.

As shown in the figure below, the median Texas ratio across various bank sizes has remained controlled and manageable, even during the COVID-19 pandemic. Near the end of 2022, however, Texas ratios at large and regional banks began increasing, putting them in line with historical figures. Texas ratios at community banks, however, remain subdued, reflecting continual favorable credit conditions at America’s smallest banks.

Median Texas Ratio of U.S. Banks

SOURCES: Consolidated Reports of Condition and Income (Call Report) and authors’ calculations.

NOTES: Community banks have less than $10 billion in total assets; regional banks have between $10 billion and $100 billion in total assets; and large banks have more than $100 billion in total assets.

Note

1. A more precise formula: Loans and leases 90 days or more and still accruing, loans on nonaccrual, and other real estate owned as a percentage of total bank equity capital less goodwill and other intangible assets plus the allowance for credit losses and the allocated transfer risk reserve.