Bauer’s Adjusted CR vs. the Texas Ratio

Bauer’s Adjusted CR vs. the Texas Ratio

Twenty-seven and a half years ago (January 1986) JRN started its third year with a new tool, Bauer’s Adjusted Capital Ratio.  By subtracting  delinquent loans and repossessed assets  from both the numerator and the denominator of the leverage ratio equation, we could easily see how a bank would look if it were to take a loss on all of its  nonperforming assets. Bauer’s Adjusted CR was a much needed predictive measure of the future health of a bank and it is just as valuable today as it was then.

Mr. Bauer wasn’t the only person to realize that delinquent loans were being sorely overlooked by regulators at that time. (Great minds do sometimes think alike.) Mr. Gerald Cassidy of RBC Capital Markets came up with his own method for evaluating troubled loans right around the same time as Mr. Bauer. Cassidy came up with an equation that divides non-performing assets by the sum of tier 1 capital and reserves. If this Texas Ratio exceeded 100%, the institution was considered doomed to fail. (The name “Texas Ratio“ was fitting due to the large number of Texas Savings and Loans that failed during the 1980s.)

So far in 2013, 16  banks have failed. All had Texas ratios greater than 100% and all had negative Bauer’s adjusted capital ratios. Similarly, 51 banks failed in 2012. All but one had Texas ratios greater than 100% and all but that same one had negative Bauer’s adjusted capital ratios. (List on page 2.)

The one bank that failed without  triggering either ratio was a $20 million, one branch institution that had no delinquent loans but was critically undercapitalized and was suffering huge losses. An additional predictor was not necessary to determine its fate.

Over the years, the results have been similar. Both ratios have merit; one is not better than the other. It comes down to what the user prefers. Our preference is Bauer’s Adjusted CR where negative means “Bad”. But  that’s just us.