Barbara Alonso had never heard of the Texas ratio until about a year ago, when, well into the financial crisis, her firm started getting more and more inquiries about the quick and easy formula for gauging the health of banks — and which are at the highest risk of failure.

“I’ve noticed a few investment banks and analysts out there who actually make it a point of publishing Texas ratios from time to time,” said Alonso, an attorney at Hunton & Williams who represents financial services firms.

“It can be an interesting metric for banks that are interested in expanding through acquisition from the FDIC of failed institutions. There is certainly something of a correlation between banks that are taken over by the FDIC and high Texas ratios.”

Applying the test to South Florida banks shows that nearly 20 percent are in jeopardy.

The Texas ratio dates back nearly a quarter-century, when it was used to determine which institutions during the savings-and-loan crisis were most likely to fail. Developed by veteran Wall
Street analyst Gerard Cassidy and named for the S&L crisis’s hardest hit state, the ratio is found by dividing the dollar value of a bank’s bad assets by it good ones. The result is a score — the lower the number, the healthier the bank.

Always controversial for what is says and doesn’t say about a bank — and for how accurate a predictor of failure it actually is — the ratio hibernated through most of the past two decades before returning to relevance in the current economic crisis as regulators, merger and acquisition attorneys, and investors sought a shorthand formula to track the relative health of increasingly fragile banks.

In South Florida, 16 of 75 South Florida-based banks have Texas ratios exceeding 100, a number that raises alarm among state and federal regulators. Based on March 31 financial FDIC data — the most recent available — the local banks with the worst Texas ratios are Home Federal Bank of Hollywood (286.7), OptimumBank in Plantation (245) and Sterling Bank in Lantana (242.1).

“We’re sorry we’re at the top of the list, but by the same token, we don’t pay much attention to it. It’s not indicative of what our issues are,” said Guy Lazzeri, Home Federal’s chairman and chief executive. “Any ratio of this nature has limitations. You have to look at the underlying collateral and what the collateral value is.”

Home Federal in May signed a merger agreement with Aventura-based Max Holding, which is injecting $15 million into the company. Upon completion, that will rejuvenate the bank — and lower its Texas ratio.

Other banks with poor Texas ratios, however, are still awaiting rescue. For instance, regulators have given Sterling Bank 30 days to raise capital or find an buyer for the institution.

Executives of OptimumBank and Sterling Bank did not return calls for comment.

“In the context of my practice, we use it when we’re conducting due diligence in connection with an acquisition. Historically, it’s a very good predictor of failure,” said Carl Fornaris, a shareholder and co-chair of Greenberg Traurig’s National Financial Institutions Group in Miami.

Fornaris said there is no precise consensus on where a Texas ratio score begins to be a concern, or where to draw the line in terms of when failure seems likely or extremely likely.

“I think 100 percent is the point where there’s a red flag,” Fornaris said, referring to the point when the dollar amounts of good and bad assets in the ratio are even. “In this environment, you

want to keep it as low as you can. There is no safe zone, but the regulatory scrutiny does increase when the Texas ratio exceeds 50 percent. Once it hits 100 percent, that is not positive at all.”

Fornaris said that most banks in the country with Texas ratio scores exceeding 100 are in Florida and Georgia.

“Since more banks are now being taken over in Florida than any other state so far this year, perhaps we should be calling this the Florida ratio,” said Ken Thomas, a Miami-based independent banking analyst.

Thomas said the Texas ratio has become a sort of “acid test” on whether a bank is likely to fail. It is now part of the Federal Financial Institutions Examinations Council’s Uniform Bank Performance Report, but is not called the Texas ratio by name.

The Texas ratio has not been calculated with uniform methodology over the years, contributing to the controversy surrounding its use. For example, the FFIEC includes restructured loans in their calculation, while other sources exclude them from the equation.

The FFIEC adds the dollar amount of a bank’s restructured and non-accrual loans and real estate owned, and divides the total by the dollar amount of its tangible equity capital plus its loan loss reserve allowance.

For example, the recently failed Peninsula Bank had a Texas ratio of 532 as of March 31, using this formula.

“An easier way to explain this ratio is by calling it the bad-to-good financial ratio,” Thomas said. “When the ratio is 100 percent, that means all of the good can potentially be wiped away by the bad. That is why we want the ratio as low as possible. When the ratio is a large multiple of 100 percent, as was the case for Peninsula, you can see there is little hope.”


While the Texas ratio has proven a reasonably reliable indicator of the strongest and weakest banks, critics caution that it also has its limitations and its controversies.

“As with any one ratio, it is a simplified measure that is subject to criticism, especially by those banks with high ratios,” Thomas said.

Some bankers are especially upset by the FFIEC’s inclusion of restructured loans, which in the vast majority of cases, worsens a bank’s score — at times significantly. Among South Florida banks, Lydian Private Bank scores a 64.2 ratio when restructured loans are not included — a respectable score in the current environment — but soars to 187.7 when its $220 million in restructured loans are factored in.

“We have elected to disclose all of our modified residential loans on our regulatory reports,” said Jay Williams, Lydian’s chief financial officer. “These modifications were to borrowers that elected to change from a loan with a variable rate to a fixed rate for a period of time.”

BankAtlantic’s 58.6 ratio jumps to 92.4 when restructured loans are included.

“You’ve got to include restructured loans, because they are potential problems,” Thomas said.
Others are more ambivalent.

“A restructured loan doesn’t necessarily mean that it’s a loan that is going to go on non-accrual or is going to have problems,” said Simon Cruz, who took the helm of the struggling Bank of Coral Gables in April as its chief executive. He noted that many restructured mortgages, for example, have kept families in their homes.

“To penalize a bank for doing something that in the greater scheme of things is a positive move, giving people the opportunity just to weather the storm … I don’t agree with putting the restructured loans in there.”

The Bank of Coral Gables has a Texas ratio of 208.27 when about $12 million in restructured loans are factored in, and a ratio of 130.9 when they’re removed.

Home Federal’s Lazzeri said the bank has $1 million in restructured loans “that are performing based on the restructure, and yet they’re in the ratio. We took back a couple of houses [after March 31] that are in the ratio, and we’ve already sold those properties for a selling price that is very close to what we’ve written them down to.”

Delays in the court system are also keeping banks from disposing of ratio-included assets in a timely manner, he said.

“Everybody’s got a slight variation on the Texas ratio,” said Christie Sciacca, a director at financial consulting firm LECG. “Some people add troubled debt restructuring, and I don’t have a problem with that, to a point, because they’re troubled debts, and there are usually concessions on rates. The other side of that is they’ve been restructured, which means the borrower can
pay even if it’s at a lower rate.”

He said that while overall a high ratio number is an indicator of serious asset quality problems, “whether or not it’s a good predictor of a bank failure is something else.”

Sam Milne, the chief financial officer at U.S. Century Bank, said the Texas ratio is not something the bank makes a priority of tracking. “It is what it is,” said Milne, whose Doral-based bank’s ratio is 108.16. “The big number is your non-performing assets, and we’re always trying to minimize those — you want to get them off your books as fast as you can. But we don’t really manage by that ratio.”

Milne said the bank will report a profit for the quarter ended June 30 and made money in the previous quarter, “which to me is even a better indicator.”

Alan Levan, chairman of BankAtlantic, said his bank does not follow the Texas ratio.

“The calculation that is most important to us is our capital ratios, which remain among the highest in the industry,” Levan said.

Banks with unusual histories can also find themselves stuck with a skewed Texas ratio.

Miami Lakes-based BankUnited emerged from a May 2009 FDIC takeover rechartered with new owners, flush with nearly $1 billion in new capital and given a fresh start that has made it one of South Florida’s most profitable and arguably its strongest locally owned bank.
Its Texas ratio score: 125.

Spokeswoman Melissa Gracey said that’s because legacy loans from the “old” BankUnited, covered by the bank’s loss share agreement with the FDIC, are still included in its financial reports.

“We have very insignificant non-performing assets since the new BankUnited started operations,” she said.

Alex Sanchez, president of the Florida Bankers Association, compares the Texas ratio to the FDIC’s Troubled Bank List, noting that 88 percent of the institutions to make that list over the last 40 years have rolled off of it once they fixed their problems.

“I’m not saying the Texas ratio is a bad thing. It’s only a bad thing if that’s all you’re looking at,” he said. “If you look just solely at their Texas ratio at the time they were put on the watch list, you would be like, ‘Oh my God, that bank’s going to fail.’ ”

What the ratio does not reveal is a bank’s management practices, “loans that they’re trying to do a workout on and successfully collected 70 percent of the monies owed, the experience of the bankers, the other factors taken into it.”

With the Texas ratio, Sanchez said, “I’m just reporting that you have a cold, but I haven’t said that you just went to the doctor, that you’re on bed rest, that you’re taking medicine.”

U.S. Century’s Milne agreed.

“You can’t just look at one ratio,” he said. “You have to look at the whole picture. We remain well-capitalized, we were profitable in the first quarter, we will be profitable in the second quarter.”

Sciacca said several factors boost the ratio’s accuracy as a predictor of failure. For example, if a bank has the kind of asset quality problems that gives it a high ratio number, it probably has some sort of regulatory enforcement against it.

“The FDIC is not particularly easy on a bank’s funding when that happens,” he said. “If a bank has brokered deposits, the enforcement action will often say you cannot renew them or take any new ones. Now, the bank could end up with a funding problem.”

As a regulator, “if I have a bank that can’t fund itself and has a liquidity problem, I’m not going to take any chances — I’m not going to stand for a run on the bank,” Sciacca said.
Cruz, the Bank of Coral Gables’s CEO, said the Texas ratio is a good indicator of a bank’s capital position in relation to its troubled loans.

“When you look at it from that perspective, it is a viable ratio,” he said. “At the end of the day, it’s all about capital. You have to be able to either have access to raising capital or have enough to confront the problems you’re having within your portfolio.”

Marta Alfonso, a partner at Miami accounting firm Morrison Brown Argiz & Farra, is a more skeptical follower of the Texas ratio.

“What causes a bank to fail is when they have no liquidity,” something the ratio does not measure, Alfonso said. “It is not of and by itself an indication of failure. It just tells you that they’ve got credit quality problems that really need to be looked at.”

She said, however, that the ratio is a good early warning indicator.

“It gives you an indication of the capital and reserve coverage that a bank has to its non-performing assets in total. That’s not a bad indicator to understand the credit quality of a bank,” Alfonso said, “particularly in this environment, where they’re not able to raise capital or not able to clear those loans through the pipeline. It focuses you on monitoring the trend.”

The ratio also won’t tell an observer what portion of the bank’s loan portfolio is really going to be lost.

“That’s the portion of the portfolio that’s really going to be covered by the loan loss reserve and capital, and you really can’t tell that by the numbers because you really don’t know what the history has been and what the specific reserves are for each one of the portfolios,” Alfonso said. “It assumes that 100 percent of the capital of the bank is available to fund losses on credit risks, which is not the case.”

Sometimes, the reserves themselves may be specifically identified for the true problem loans, and other loans are sitting in the portfolio that may not have been predicted to have credit risk.

“It’s not a true dolla-for-dollar coverage,” she said.

In spite of those flaws, Alfonso said that if a bank’s ratio is sitting over 100, “you should be concerned because those banks are certainly at a much higher risk of failure. Those that have been closed had astronomically high ratios.”

LECG’s Sciacca said a high ratio is certainly an indicator of trouble.
“It brings a lot of other things with it: regulatory scrutiny, enforcement actions, the potential for funding problems and liquidity problems,” Sciacca said. “It is something worth paying attention to. The issue these days is asset quality, particularly in real estate.”

Wayne Tompkins can be reached at (305) 347-6645.