The Texas ratio: what it measures and what it misses

The Texas ratio compares a bank's troubled assets with the resources it has to absorb losses on them:

Texas ratio = (noncurrent loans + other real estate owned) ÷ (tangible equity + allowance for loan losses)

The numerator counts loans that are 90 or more days past due or no longer accruing interest, plus property the bank has taken through foreclosure ("other real estate owned", or OREO). The denominator counts the bank's equity cushion plus the reserves it has already set aside for expected loan losses. A ratio of 100% means troubled assets equal the entire loss-absorbing cushion.

The measure was developed by banking analysts in the 1980s while studying the wave of Texas bank failures that followed the collapse in oil prices and regional real estate values. They observed that banks whose troubled assets approached or exceeded their capital plus reserves were far more likely to fail. The ratio became widely cited again during the 2008–2012 failure wave, when many banks with ratios well above 100% did fail — and many others with high ratios survived.

• Low single digits to around 10%: typical for healthy banks in normal credit conditions.
• Rising quarter after quarter: worth attention even at modest levels, because it means problem assets are growing faster than the cushion.
• Approaching 100%: historically associated with serious distress. It does not mean failure is certain; recoveries, capital raises and loan sales can bring it down.

Look at the trend over several quarters and at the institution's capital ratio and earnings alongside it.

• It ignores securities losses. The 2023 failures were driven largely by interest-rate losses on securities and deposit runs, not bad loans. Those banks had low Texas ratios.
• It ignores liquidity. A bank can have few problem loans and still fail if deposits leave faster than it can raise cash.
• It depends on how loans are classified. Modifications, charge-off timing and reserve methodology all affect the inputs. The current expected credit loss (CECL) accounting standard changed how reserves are set.
• It is backward-looking. Loans become noncurrent after borrowers have already fallen behind.
• Different versions exist. Some analysts include loans 90+ days past due that are still accruing or use tangible common equity only. Compare ratios only when they are computed the same way.

That is why the ratio is best read alongside capital, loan quality, earnings and liquidity rather than on its own.