How do I calculate the Texas Ratio?

The Texas Ratio is calculated by dividing a bank's non-performing assets (NPAs) by the sum of its tangible common equity and the allowance for credit losses. The result, expressed as a percentage, shows whether the bank has enough capital and reserves to cover its problem assets. Ratios above 100% have historically been associated with elevated bank failure risk.

The formula for the Texas Ratio is:

Texas Ratio = Non-Performing Assets / (Tangible Common Equity + Allowance for Credit Losses)

The result is expressed as a percentage. A lower ratio is better. The calculation compares a bank's total problem assets against its combined ability to absorb losses from those assets.

Step-by-Step Calculation

1. Calculate non-performing assets (NPAs): Start with non-performing loans, which include loans on non-accrual status plus loans 90 or more days past due and still accruing. Then add OREO (other real estate owned) and any other foreclosed assets. OREO represents properties the bank has taken possession of through foreclosure, and these must be included because they are problem assets the bank still needs to resolve.

2. Calculate tangible common equity (TCE): Begin with total shareholders' equity from the balance sheet. Subtract goodwill, subtract other intangible assets (such as core deposit intangibles and customer relationship intangibles), and subtract any preferred stock. What remains is the hard equity attributable to common shareholders, stripped of assets that cannot absorb losses.

3. Find the allowance for credit losses (ACL) on the balance sheet. This is the reserve the bank has set aside to cover anticipated loan losses.

4. Add tangible common equity and the allowance for credit losses together. This sum represents the bank's total loss-absorbing capacity.

5. Divide non-performing assets by that sum and multiply by 100 to express it as a percentage.

Worked Example

A bank reports the following: $52 million in non-accrual loans, $8 million in loans 90+ days past due, and $7 million in OREO. Total non-performing assets = $52M + $8M + $7M = $67 million.

On the balance sheet, total shareholders' equity is $600 million, goodwill is $70 million, other intangibles are $10 million, and there is no preferred stock outstanding. Tangible common equity = $600M - $70M - $10M = $520 million. The allowance for credit losses is $55 million.

Texas Ratio = $67M / ($520M + $55M) = $67M / $575M = 11.7%

At 11.7%, this bank's problem assets are well within the capacity of its capital and reserves. The combined loss-absorbing cushion is roughly 8.6 times larger than the problem assets.

Where the Name Comes From

The Texas Ratio was developed by Gerard Cassidy and others at RBC Capital Markets during the Texas banking crisis of the 1980s. Texas banks were failing at alarming rates as oil prices collapsed and a real estate bust spread through the state. Analysts needed a quick formula to identify which banks were most likely to fail next.

The ratio they built turned out to be a remarkably effective predictor. Banks whose non-performing assets exceeded their combined tangible equity and reserves failed at significantly higher rates than those below the threshold. The name stuck, and the Texas Ratio has been a standard credit stress screening tool for bank analysts ever since.

Why 100% Is the Critical Threshold

A Texas Ratio above 100% means the bank's non-performing assets exceed its combined tangible equity and loan loss reserves. If the bank had to write off every problem asset at once, it would not have enough capital and reserves to absorb those losses without becoming technically insolvent.

That does not mean failure is automatic. Banks can raise new capital, work out problem loans over time, or sell troubled assets to reduce the numerator. But crossing 100% signals that the margin of safety has been fully consumed, and historically, banks that have sustained ratios above this level have failed at much higher rates.

The risk increases further when the ratio is climbing and the bank shows no signs of resolving its problem assets through workouts, sales, or charge-offs.

Practical Screening Ranges

While 100% is the bright-line danger signal, the ratio communicates useful information at every level:

Below 20%: Asset quality problems are minimal relative to loss-absorbing capacity. The bank has substantial room to weather credit deterioration without capital becoming threatened.

20% to 50%: Credit stress is present but manageable. Worth monitoring the trend, particularly if the ratio has been rising over consecutive quarters.

50% to 100%: Problem assets are consuming a significant share of the bank's cushion. This range calls for close attention to the direction of the trend, the composition of non-performing assets, and whether management has a credible plan for resolution.

Above 100%: Non-performing assets exceed the bank's combined capacity to absorb them. Failure risk becomes elevated and regulatory intervention grows more likely.

Context always matters alongside these ranges. A bank at 60% with a declining trend and active asset resolution efforts is in a very different position than a bank at 40% where the ratio has doubled over two quarters.

Denominator Variations to Watch For

Not every analyst calculates the Texas Ratio the same way, and this creates comparison problems if you are not careful about which version a source is using.

The most common formulation (and the one described on this page) uses tangible common equity plus the allowance for credit losses. Some analysts use total equity instead of tangible common equity, which produces a lower ratio because goodwill and intangibles inflate the denominator. The tangible version is more conservative and widely preferred because goodwill and intangible assets cannot absorb loan losses in practice.

Other variations use only the loan loss reserve (a synonym for the allowance for credit losses) without any equity component, or use total capital and reserves. When comparing Texas Ratios from different sources, always confirm which formula was applied before drawing conclusions.

Common Calculation Mistakes

Forgetting OREO and foreclosed assets: The most frequent error is using only non-performing loans in the numerator instead of total non-performing assets. A bank might report modest NPLs but carry substantial OREO from foreclosures that have already occurred. Leaving those out understates the true stress on the bank.

Using total equity instead of tangible common equity: Total equity includes goodwill and intangible assets that cannot absorb credit losses in practice. Banks that have grown through acquisitions often carry large goodwill balances, and using total equity makes their loss-absorbing capacity look significantly larger than it really is.

Mishandling the allowance for credit losses: The ACL belongs in the denominator, added to tangible common equity. Some errors arise from confusion about whether reserves are already embedded in equity. On the balance sheet, the ACL is a contra-asset that reduces gross loans to net loans. It is not a component of equity, so it must be added separately.

Comparing across different formulations: Pulling a Texas Ratio from one data provider and comparing it directly to a figure from another source that uses a different denominator formula can lead to misleading conclusions about relative credit health. Always verify the formula before making cross-source comparisons.

Why Trend Matters More Than a Snapshot

A single Texas Ratio reading is useful for screening, but the trajectory over several quarters is more revealing. A ratio that has climbed from 15% to 40% over four quarters signals rapidly growing credit problems, even though 40% is still well below 100%. Meanwhile, a bank sitting at 45% with a flat or declining trend may be actively resolving its problem assets.

Pay attention to what is driving the change. Is the numerator (NPAs) growing, or is the denominator (equity and reserves) shrinking? Rising NPAs point to worsening credit quality in the loan book. A shrinking denominator suggests capital erosion, potentially from losses flowing through the income statement. Both moving in the wrong direction simultaneously is the most concerning pattern.

Finding the Data

All the inputs for the Texas Ratio come from public filings:

Non-performing asset data appears in the credit quality disclosures of 10-K and 10-Q filings, as well as quarterly earnings releases. Look for tables that separately break out non-accrual loans, past-due loans, and OREO.

Total equity, goodwill, and intangible assets are line items on the balance sheet.

The allowance for credit losses is on the balance sheet, typically presented as a contra-asset that reduces gross loans to arrive at net loans.

FFIEC call report data, available through the FDIC and FFIEC websites, contains all of these fields in a standardized format. Call reports are especially useful when comparing the Texas Ratio across multiple banks because the data definitions are consistent.