Charting Banking X: the Texas Ratio in practice
We continue our discussion of banks below $2 billion in assets. From the list of states with Texas ratio below 30%, for me the biggest surprise was Ohio. The reason is that I have found a couple of interesting opportunities in that state and I supposed it was related to generalized bank problems, but it looks t is only a superficial perception based on the state unemployment problems. From the rest, I do not see major surprises based on what we discussed in the previous post.
Like all indicators, the Texas ratio has its limitations. Its general use has led to some banks playing games by being slow to reclassify 30-90 days delinquencies into the non performing bucket. Even more, some banks facing FDIC pressure, or modified loans needed to perform for some quarters before their reclassification, or their natural conservativeness, may have substantial performing loans classified as non-performing. In a couple of weeks I will comment on a bank that conservatively marks to market non-performing loans based on their potential recovery.
That is the reason why there are several variations on the Texas ratio. I personally like to use TCE (tangible common equity) instead of TE, and it has been suggested to me that it may be interesting to add the 30-90 days delinquencies to the NPAs. You get the idea.
Besides their frequency and severity, the other reason why I have placed so much emphasis on C&D loans should now be more clear. For other type of loans the deterioration is gradual and you can follow their progress. Not so for the larger in size with balloon short term maturities C&D loans. So, if a bank does not have explosive risks, indicators like the Texas ratio and its variations can take care of the gradual progress of the rest.
Some potential rules of thumbs from the work we have done until now
- Avoid banks with high percentage of C&D loans >15% of total loans
- Wait for the Texas ratio (non performing assets) stabilization < 60%
- Avoid investing with NPAs > 5%. But if you do, require substantial loan loss reserves >70% of NPLs
- Look for signs of conservative classification of non-performing assets
If you have a bank that passes these tests, I would gladly take a look at it.