Texas ratio sizes up risk, has its critics

To get a handle on how the current mortgage meltdown and related crises rocking Wall Street are impacting your local bank, you might want to learn a term spawned by an earlier crisis — the “Texas ratio.”

The ratio attempts to gauge the risk that a bank or thrift will run into financial trouble by comparing the size of its problem loans and similar assets to the amount of capital and reserves it has set aside to cover potential losses on those loans.

Gerard Cassidy, a veteran banking analyst, is credited with devising the ratio in the early 1990s, when the savings and loan crisis that started in the 1980s was still gripping the nation.

Texas was a hot spot for thrift and bank failures at the time.

His logic was that a bank that has a Texas ratio topping 100 percent faces significant risk of potential insolvency because its problem loans are bigger than its available capital to cover potential losses.

Of the eight banks nationwide that have failed in the past three months, all but one had high Texas ratios, according to Matthew Anderson, a partner with Foresight Analytics in Oakland, Calif. Alpharetta-based Integrity Bank had the highest Texas ratio among the nation’s financial institutions in the first and second quarters before it failed in August.

However, critics of the Texas ratio argue that it is a single snapshot of a bank’s condition and doesn’t reflect its ability to improve operations or raise additional capital.

“The Texas ratio really doesn’t tell the whole story,” said Mark Conner, president of FirstCity Bank in Stockbridge.

Traditionally, the ratio is calculated by starting with the total of an institution’s nonperforming assets and loans that are at least 90 days past due. That figure is then divided by the company’s sum of tangible equity — which excludes goodwill and other intangible assets — plus loan loss reserves, or money set aside to cover expected losses on loans.

Some industry analysts have tweaked the formula. Atlanta-based FIG Partners, which supplied data for these stories, also includes the value of foreclosed properties and all delinquent loans in its calculations, arguing that it provides a broader measure of potential risks.