Fallout: The Financial Crisis

A high Texas Ratio is bad for banks

Alisa Roth Nov 9, 2009
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Fallout: The Financial Crisis

A high Texas Ratio is bad for banks

Alisa Roth Nov 9, 2009
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TEXT OF STORY

Bill RADKE: So far this year, 115 banks have failed. And experts think there are plenty more to come. So how can you tell how your bank is doing? Well, one predictor is the so-called Texas Ratio. Marketplace’s Alisa Roth reports, this is one test where getting a high score is a bad thing.


Alisa Roth: To calculate the Texas Ratio, you take the bank’s non-performing loans. Divide that number by the tangible equity capital plus money set aside for future loan losses. Are you confused yet?

Bart Narter follows banks for Celent, a consulting firm. He has a simpler way of explaining it.

Bart Narter: It’s essentially bad stuff divided by good stuff.

Put that way, it’s easy to see the logic: the more good stuff you have on yours books, the better shape you’re in. When the ratio of bad stuff to good stuff is around one to one, the bank is more likely to fail.

And there are plenty of banks whose Texas Ratios are right around there. Georgia has the most because banks there were over-exposed to bad real estate. But Florida, Illinois and Minnesota are all well-represented.

Narter says it’s important to realize a bad ratio doesn’t guarantee failure.

NARTER: It’s a ratio like many other ratios, that should be used as a guide. It is a reasonable snapshot, it does not predict the future.

And there’s a twist: The ratio’s accuracy depends on banks reporting their own losses.

David Beim: That number is subjective, you sort of have to guess at that one.

David Beim is a finance professor at Columbia.

Beim: And there are banks that do that conservatively and there are banks that do that less conservatively.

He says it is possible for a bank to be too honest. If they report tons of bad loans and rack up a high score, their Texas Ratio could turn into a self-fulfilling prophecy.

I’m Alisa Roth for Marketplace.

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