The Texas Ratio

By Matt Carter, Thursday, May 29, 2008.

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There's been a lot of speculation about how many banks will go under as the mortgage loans they made during the housing boom go bad -- speculation that's been spurred in part by news that the FDIC is adding staff to deal with expected bank failures.

RBC Capital Markets predicts at least 150 banks will go under in the next two to three years, Marketwatch reports in a story exploring "Texas Ratios," an "early-warning" system developed by RBC analysts including Gerard Cassidy.

If you take a bank's non-performing loans, divide them by tangible equity capital and money set aside for loan losses, banks with a ratio above 100 percent are likely to fail -- at least that's the way it played out in Texas in the 1980s and New England in the early '90s, Cassidy says.

RBC identifies a bunch of banks with climbing Texas Ratios, including IndyMac Bancorp, which Cassidy claims has a 140 percent ratio of non-performing loans to capital.

Indymac fired back on the official company blog Wednesday, saying the May 21 RBC Capital Markets report the Marketwatch article relied on significantly understated the company's capital. Indymac -- which posted $609 million in losses in 2007 and $184 million in the first qarter of 2008 -- dismissed RBC's claim that the company has a 140 percent Texas Ratio as "materially inaccurate." It's more like 75 percent, or 68 percent, depending on what reserves you want to include, Indymac claims.

Marketwatch notes that the FDIC flagged 76 banks as potentially troubled at the end of 2007, and while that's up 50 percent from 2006, the 50 banks on the list at the time represented a low not seen in at least 25 years.

Meanwhile, Punk Ziegel analyst Richard Bove -- who famously called an end to the credit crunch back in March, and was recently rated by Zacks Investment Research as the one of the top 12 investment analysts in the country -- likes large-cap bank stocks like Bank of America and Wells Fargo. While lenders like Wachovia and Washington Mutual were too heavily dependent on mortgages, Bove tells Forbes, other big lenders count on deposits for their core earnings, and those deposits are growing. Being a contrarian means being wrong sometimes, and following Bove's advice in September -- when he upped his rating on Bear Stearns -- would have cost you a good chunk of change.

Why do we care about Indymac's Texas Ratio and some stock picker's views of Bank of America and Wells Fargo? Dozens of subprime lenders went belly up in 2007, and if banks and savings and loans start disappearing or are forced to make (bigger) cutbacks in mortgage lending, the resulting industry consolidation could reduce competition and raise the cost of borrowing -- something regulators looking at Bank of America's plan to acquire Countrywide Financial Corp. are no doubt mindful of.

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Submitted by Wendy Polisi on June 6, 2008 - 1:14pm.

I think what most people don't realize is that most likely, the mortgage meltdown is just begining! What is going to happen when all of the option ARM loans that were sold to people who shouldn't be in them start to re-cast??

It's going to be the second boom of the mortgage meltdown.