Texas Ratio

Recently I was asked if we could provide some indicators on the bank records that would show whether or not a bank is 'distressed'. Today I found this cool chart that someone assembled and posted with Q3 ' Texas Ratios'.

The Texas ratio is a measure of a bank's credit troubles. The higher the Texas ratio, the more severe the credit troubles. Developed by Gerard Cassidy and others at RBC Capital Markets, it is calculated by dividing the value of the lender's non-performing assets (Non performing loans + Real Estate Owned) by the sum of its tangible common equity capital and loan loss reserves. In analyzing Texas banks during the early 1980s recession, Cassidy noted that banks tended to fail when this ratio reached 1:1, or 100%. He noted a similar pattern among New England banks during the recession of the early 1990s.

Texas Ratio Formula

non-performing assets / (tangible common equity + loan loss reserves) = Texas Ratio

I don't know if the 'Texas Ratio' is the gold standard in predicting bank failures or not. There are others, you could look at the Capital Adequacy Ratios ( CAR) for the banks and those are all available in BankProspector. 

More importantly, I can't say for certain that you should be prospecting severely distressed banks. Banks that have severely impaired balance sheets just aren't going to be able to play ball with you.  

In a conversation I had today with Barry Smith, a new BankProspector member and President of Loan Sale Corp. who has a successful track record of trading both performing and non-performing loans, we spoke about the problem with banks being impaired to the point that they cannot realize the true value of their assets and continue to operate. More importantly, we agree that this is one of, if not the biggest, hurdles to doing real deals in today's market. 

If a bank is inadequately capitalized and their collateral is worth significantly less than what is lent, they will not be able to take the hit that's required in order to be able to sell. Let's say for example that a bank loaned $5MM on a commercial property in late 2006 that is today worth $3MM (this is not a stretch). If that loan goes into default, it is not unreasonable to think that a friendly appraiser will be able to point to this property and say it's worth $4MM. 

The fact is that there still aren't enough comps out there to make reasonable appraisals in many cases and the result (that I'm seeing) is really old comps and inflated prices. The FDIC has made it perfectly acceptable for banks to extend and pretend. If I'm the bank and I sell you that property at fair market value, $3MM, I'm losing $1MM off my balance sheet. 

Why would I do that? 

If I'm forced to foreclose after extended non-payment, I'll do it, but I'm probably going to credit bid for pretty darn close to the appraised value if I have balance sheet concerns and I'm going to book that property into REO

The Feds have already told me it's OK to leave it where it is and work it out and that's what I'm going to do.I have no special knowledge, other than that from the BankProspector analysis, about Chestatee Bank in Georgia but I do know a few things. 

First I'll mention that I saw this bank on a recent list as having the highest Texas Ratio of any bank in the U.S. I didn't verify that data but I did see it. I looked the bank up in BankProspector. They have a Tier 1 Capital Ratio of 1.03%, recent requirements for Tier 1 and Tier 1&2 were recently 4% and 8% respectively. That means this bank is low, they have almost no reserves compared to the non-accrual loans and REO on their books. I also know that they have $20MM in construction REO on their books, I love that I could sell that all day long. But wait, for some reason they've been doing nothing but growing their construction REO balance for more than a year! Why aren't they selling? Job security. 

The best play for this bank today is probably to pretend that their construction OREO is still worth something. The alternative is probably to close the bank. Now I know that they've charged off $8MM in construction this year but they have another $26MM in construction non-accrual. Now they only have $61MM in total construction loans. I don't think they're selling notes or REO, they're going to try to get some deposit or other income/capital and keep whistling until they get shutdown or the hand of God reaches down and saves them (too harsh?). 

Would I call these guys? 

As an auctioneer, REO Broker, or note buyer, probably not, as a contractor or property manager, or property preservation expert you bet I would. I'm very interested to hear from my readers and subscribers about 'ratios'. Do you watch them or not? Which ones are important? If we could automate inclusion of some ratios or flags of some kind into BankProspector would that be helpful? Send us your remarks we'd love to hear them.

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