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Home >> Keeping Your Money Safe
Gauging Your Bank's Financial Health
by James Millar, PhD
With more and more financial newscasts devoted to the deepening recession and troubles of the banking system in the United States, and more and more newscasts concerning the latest bank failure, deposit holders of US financial institutions might be wondering "How is my bank doing?" One handy gauge of your bank's financial health is the so-called 'Texas Ratio'.
Q: What is the "Texas Ratio" anyway?
A: The Texas ratio is a measure of a bank's credit situation. Gerard Cassidy at RBC Capital Markets generated the ratio after his study of Texas banks in the 1980s recessionary period. The ratio gives an indication of the relationship of a banks 'bad loans' to its equity position.
Q: OK, how do I calculate the Texas Ratio?
A: The Texas Ratio (TR) is found by dividing the bank's non-performing loans by its equity capital and loss allowance. The basic formula is
TR = ($W amount of Non-performing loans +$X amount of loans less than 90 days delinquent) /($Y Equity Capital +$Z Future -Loss Allowance)
Q: What are these inputs?
A: The inputs are fairly straightforward. These are
- Non-performing loans--This is the amount of loans outstanding where payments of interest and principal are past due by 90 days (3 months) or more, or at least 90 days of interest payments have been capitalized or refinanced or delayed. This also includes payments that are less than 90 days overdue but the collectibility of the payments is doubtful.
- Loans less than 90 days delinquent--as the name implies these are loans that are in default for less than 90 days but may not be in sufficient doubt to classify as Non-performing.
- Equity Capital--Shareholders' equity (also stockholders' equity, shareholders' funds, shareholders' capital employed, etc) is ownership equity of shareholders with different classes of shares that carry different ownership rights. This is the total amount for the period under review in the Stockholder's Equity or equivalent on the company's Balance Sheet or Consolidated Balance Sheet.
- Future-Loss Allowance--Also loan loss allowance, amounts made in allowance for impaired loans, or loans that may become uncollectible.
Q: Where can I find these inputs?
A: Where to look for the inputs in the Texas Ratio depends on your financial institution type. For banks, the pertinent report is the "Call Report". For savings associations, savings and loan associations and savings banks use the "Thrift Financial Report." These reports are available at the Federal Financial Institutions Examination Council (FFIEC) webpage. To access a report, you will need an ABA routing number, which you can find on your personal checks (it is the number to the left of your account number). Enter this number at the prompt. If you don't have an account with that particular bank yet you can use this web page to look up the bank's routing number.
Using the Call Report, the information on nonperforming loans is found in "Schedule RC-N - Past Due and Nonaccrual Loans Leases and Other Assets" or equivalent and information on Equity and loan loss allowances is found in "Schedule RC - Balance Sheet". Using the Thrift Financial Report, the information on past due and nonperforming loans is in the "PD - Consolidated Past Due and Nonaccrual" statement and the Equity and loan loss allowance amounts can be found in the "SC-Consolidated Statement of Operations" or equivalent statements.
If you financial institution is publicly traded, it has to file quarterly reports (Form 10-Q or Quarterly Report ) with the United States Securities and Exchange Commission (SEC). Such reports are available free online at http://www.sec.gov/ The forms are in the Edgar Database. Your financial institution's designation of the inputs might be different but the concept is the same for all enterprises. Especially focus on the Balance Sheet (or Consolidated Balance Sheet) and Management Discussion and Analysis section of the report.
Q: What does the ratio mean, and how should I interpret it?
A: In a sense it gives you a coverage ratio, something akin to a Debt to Equity ratio. The Texas Ratio gives you a sense of how well covered the bank's bad loans are. A good rule of thumb to interpret the ratio is that a value close to 100% means a higher risk of future trouble for the bank. You should compare ratios between periods to see how performance evolves over time. If the ratio is declining, that is a good sign. If your bank's Texas Ratio is growing over time or is getting close to 100%, you might consider securing your money elsewhere.
As an example, suppose BigBank publishes its Form 10-Q with the SEC. Suppose you want to find the ratio for the year ended 12/31/XX. From the Form you find that BigBank has $500 billion in non-performing loans and $300 billion of loans less
than 90 days delinquent. Your numerator in the Texas Ratio is $800 billion (500+300).
Then you check the Balance sheet for Stockholder Equity and find a 12/31/XX balance of $1000 billion and $200 billion in future loan-loss allowances. Your denominator is thus $1200 billion (1000+200).
The ratio is then $800/1200*100=67%. This gives you an idea that perhaps your bank is pretty risky (the ratio is getting close to 100%).
But, if you check the ratio next quarter, and find that it has gone up, this might signal an increase in risk of failure and time to switch financial institutions.
While not perfect, the Texas ratio gives you one way to 'check up' on your bank's or financial institutions credit situation, and in these increasingly uncertain times, you need to be aware of your institution's financial fitness.
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Published on BankingQuestions.com 8/14/08
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