Star-Rating Trumps any Single Ratio, But...

Let’s start by saying this: There is not one single ratio that can be looked at to assess the entire strength of a bank. That’s why BauerFinancial looks at a multitude of ratios and data prior to assigning its star-ratings. Yet, since the savings and loan crisis of the 1980s, when so many Texas institutions failed, the Texas Ratio has gained in popularity.

We don’t want to knock the Texas Ratio by any means. In fact, it is one of the many ratios we look at in our analyses. It is even prominently featured in some of our reports (Reg F for example). But, if we were going to choose just one ratio to look at (which we wouldn’t) we would have to pick the Bauer’s Adjusted Capital Ratio (which was developed over a quarter  century ago by Paul A. Bauer).

The two ratios are essentially reverse angles to get to the same (similar) end: a true picture of the bank’s health were it to lose its shirt on all of its bad loans.

Bauer’s Adjusted Capital Ratio essentially takes the leverage ratio, subtracts delinquencies and REO from both the numerator and denominator and recalculates. The closer this Adjusted ratio is to the original, the fewer nonperforming assets the bank has on its books. With Bauer’s Adjusted, anything below zero is considered very bad. (See JRN 27:02 for more information.)

The Texas Ratio does kind of the reverse. It takes all nonperforming assets and divides them by net worth plus reserves. A Texas Ratio greater than 100% is supposedly at risk of failing. 

As you would expect, there is a lot of overlap when comparing the two. But, in the past two months three banks have failed that, based on March 31, 2010 call reports, had Texas Ratios under 100%; Bauer’s Adjusted Capital Ratio was negative in the case of each bank that has failed since the filing  of that data.

None that failed had a positive Bauer’s Adjusted and a Texas Ratio above 100%. The three banks that failed with a Texas Ratio below 100% were:

Arcola Homestead SB, Arcola, IL failed on June 4, 2010. Its Texas Ratio as of March 31, 2010 was 92.86%, Bauer’s Adjusted Capital Ratio was –9.882%.

Ideal Federal SB, Baltimore, MD failed on July 9, 2010.  Its Texas Ratio as of March 31, 2010 was 88.15%, Bauer’s Adjusted Capital Ratio was –4.693%.

Thunder Bank, Sylvan Grove, KS failed on July 23, 2010.  Its Texas Ratio as of March 31, 2010 was 33.81%, Bauer’s Adjusted Capital Ratio was –0.415%.

Of course, all were rated zero-stars. So what it really comes down to is this: if you are only going to look at one piece of data when assessing an institution, choose the star-rating. Bauer’s already done the work for you.