What it means
How sick is a bank? The Texas ratio answers with one division: problem loans on top, the capital and loan-loss reserves available to absorb them underneath.
The name is the origin: the measure earned its reputation in the 1980s Texas banking collapse, where it flagged failing banks with eerie accuracy. The St.
Louis Fed's banking analytics explain the read: a ratio near or above 100 percent means nonperforming assets rival or exceed the loss-absorbing resources, the danger zone. The numerator is the trouble: nonperforming loans, typically those ninety days past due plus renegotiated ones, the book's known infections.
The denominator is the medicine: tangible equity plus the loan-loss allowance, everything standing between the infections and the deposit insurance fund. The ratio's virtue is stubbornness: unlike earnings, it cannot be polished by a good quarter, because it reads the stock of bad assets against the stock of protection.
The limits are the inputs: banks can delay recognising bad loans, extend-and-pretend keeps the numerator flattering, and the ratio only reads what the books admit. For a non-finance reader, the Texas ratio is a hospital's ratio of critical patients to ICU beds and medicine: past one-to-one, the building's name changes from hospital to triage.
Regulators now publish the ingredients, so analysts can compute the ratio from call reports for every insured bank. Academic work has confirmed the original folklore: high ratios predict failure across decades and states.
The measure survives because it is cheap, public, and hard to argue with.
In practice
Real-world examples.
Example
A screen splits the state's banks into a healthy under-40 field and a construction-lender cluster near 90.
Example
The 115-percent outlier fails within the year, the ratio's historical promise kept.
Example
The cluster survivors cut dividends and raised capital early, grinding back under 60., proving the fever responds to early medicine.
Formula
Calculation
Texas ratio equals nonperforming assets divided by tangible common equity plus loan-loss reserves, times 100; under 50 percent is generally sound, approaching or exceeding 100 percent historically signals high failure risk. Analysts often track the ratio's trend quarterly, since deterioration matters more than any single print. Call-report data makes the computation public for every insured institution.
Worked example (illustrative figures). A bank reports nonperforming assets of $27 million, tangible common equity of $60 million and loan-loss reserves of $30 million. The cushion is $60 million + $30 million = $90 million, so the Texas ratio is $27 million / $90 million x 100 = 30%, comfortably sound. A stressed bank with the same $90 million cushion but $90 million of nonperforming assets has a ratio of $90 million / $90 million x 100 = 100%, the classic warning zone. If its problem assets then grow to $108 million the next quarter while the cushion is unchanged, the ratio rises to $108 million / $90 million x 100 = 120%, and the trend matters as much as the level.Case study
Seen in the real world.
This case study is fictional and illustrative. A made-up community bank investor runs the Texas ratio on her state's banks after a property downturn and finds the field split: most sit under 40 percent, one cluster of construction lenders hovers near 90, and one outlier reports 115. Her deeper dive on the cluster teaches the ratio's language: the 90-percenters are still lending, still paying dividends, and their earnings look respectable, which is exactly why the stock of bad loans against the stock of capital is the only number she trusts. The outlier fails within the year, on schedule with the ratio's history, and the post-failure report shows the numerator had been kind: examiner upgrades moved dozens of loans from watch to loss only at the end. The cluster's divergence becomes her case study in management: the two banks that cut dividends and raised capital early ground their ratios back under 60, and the one that waited for the market to recover was sold at a discount to a rival.
Her investment memo's conclusion is the ratio's enduring pitch: it is a thermometer, not a diagnosis, but in banking the fever is usually the disease. The state's banking map now hangs in her office with the ratios annotated, a decade of fevers and recoveries in one frame. She finishes the project by back-testing her state's failed banks against their ratios five years earlier. Nearly all sat in the danger zone long before closure, while nearly all survivors never entered it. The exercise takes an afternoon of public data, and it permanently changes how she reads a bank's earnings release.
Watch out
Common mistakes.
- Trusting the numerator blindly; slow loss recognition and extend-and-pretend flatter the ratio, so trends and examiner tone matter too.
- Reading it as precise; the threshold is empirical lore, and strong franchises have survived readings weaker banks died from.
- Applying it across regimes; accounting rules and capital standards shift, so compare ratios within the same era and rulebook.
Questions
People also ask.
What is the Texas ratio?
Nonperforming assets divided by tangible equity plus loan-loss reserves, a gauge of whether a bank's bad loans outstrip its cushion.
Why the name?
It proved itself identifying doomed banks in the 1980s Texas banking collapse.
What level is dangerous?
Approaching 100 percent is the classic warning zone, where problem assets rival the resources available to absorb them.
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