For some time now, the analysis of insiders on the riskiness of banks (national and supranational supervisory bodies, market analysts, institutional investors, auditing and consultancy firms) has been based on models constructed using a multiplicity of quantitative-qualitative indicators, considered more reliable the more complex.
It is therefore with some surprise that one of the latest releases of the ECB has identified in the indicator called Texas Ratio the summary measure for ordering the banks in relation to the ability to cover the credit risk with their own resources (income and assets), keeping aligned the book value of bad loans to the market value.
The document, which has just been released, is called "Guidelines for Banks on non-performing loans", in which, describing the strategies that should govern the governance of non-performing loans, the situations of the banking systems of the European Union are compared. The document highlights the gap that has arisen in the last ten years between the countries of the North and those of the South.
While in 2007, in fact, the two groups reported almost similar Texas ratio values and attested to absolutely safe levels, today that indicator is above the critical threshold of 100 for the second group and around the value of 40 for the first.
This demonstrates how the trend in asset values net of current and prospective credit risks has recorded profound differences in the prudential policies implemented by bank management in the various countries.
The Texas coefficient should also be seen in relation to the trend of non-performing loans as a percentage of total loans, which, as highlighted in the recent ECB annual report, sees our country in a better position only than Cyprus and Greece.
Also in recent weeks, a study by Mediobanca has calculated the Texas coefficient for Italian banks on 2015 balance sheet data, highlighting the condition of fragility of a hundred of them, of all sizes and types.
Without going into boring illustrations, the Texas coefficient, unlike the Basel capital requirements, is extremely easy to calculate, lending itself to a use by non-experts of considerable explanatory effectiveness.
Let's try to explain how it is constructed, what its meaning is and how the saver/shareholder of a bank should behave in different situations.
How is it calculated and what is the meaning of the Texas coefficient
It is a question of taking the amount of non-performing loans (Section 7 Loans to customers, Item 70, Table 7.1 product composition: non-performing loans) and relating them to the value of the company's equity, which can be found in Section 14, Table 14.4 (tangible assets net). And that's it, thanks to a quick percentage calculation with the calculator on your mobile phone. Repeated with the previous year's data, the operation makes it possible to verify the variation that occurred between two years.
As in any percentage report, the result can be less than 100, i.e. equal to or greater. In the first case, the net value of the bad loans is lower than the assets and, therefore, it must be assumed that adequate write-downs of the receivables have been made over time thanks to the positive results for the period, without affecting equity.
The case in which the bank's assets are entirely invested in non-yielding assets is different, where the part of the bad loans in excess of the assets is financed by means collected against payment. Getting that ratio back below 100 requires massively devaluing non-performing loans, to correct the imbalance.
A brief numerical example will help explain this better. If a bank has assets of 200 and net bad loans of 270, its Texas ratio is equal to 270/200×100, i.e. 135. If it wanted to bring it back to a physiological value of 95, by devaluing bad loans by 80 , should obtain additional capital of the same amount, given that the losses that would arise would a) decrease the existing capital by the same amount, b) increase the Texas ratio.
The bank would therefore not be able to break this vicious circle on its own, with the only option left of resorting to operations of an extraordinary nature (a large capital increase or aggregation with more solid banks).
On the other hand, compliance with the Basel capital requirements (CET 1 and TCR), even to an extent much higher than the minimums, indicates the solid state of a bank provided that the process of aligning the balance sheet value of the assets to risk to actual values has been adequately accomplished over time.
Unfortunately, as we know, the bad loan coverage rates of Italian banks have been and continue to be lower than the actual probabilities of recovery, so the realignment process still to be carried out enhances the significance of the Texas ratio.
The more it is above 100, the higher the probability of bank default and the higher the risk of loss for holders of shares, bonds and deposits above the protected threshold of €100.000 per depositor.
In summary, if your bank has a Texas ratio of less than 100, the situation is calm, if the indicator is slightly higher, a corrective action, however decisive, can probably be carried out, by making a capital increase or by cutting the costs to increase profit margins and then carry out an adequate devaluation of bad loans.
With higher values, the situation, as mentioned, becomes critical, the bank's chances of survival are reduced (as are the chances of attracting new investors) and the risks for its creditors become high. The suggestion is to prepare to abandon ship, moving at least the part of the deposits not protected by the Guarantee Funds, to a bank in better conditions. The same assessment of financial output is to be extended to bonds (including, if possible, subordinated bonds) and shares that must be liquidated.
How to behave in assembly
If our saver is also a shareholder of the bank, it is good that he asks some appropriate questions during the meeting for the approval of the financial statements, before deciding his vote.
Since information on the Texas ratio does not usually appear in the reports of directors and statutory auditors, he should first of all ask for confirmation of the value and form an opinion on the awareness of top management regarding the possible risk situation highlighted by this indicator.
Consequently, questions about what to do for its correction are legitimate, such as: capital strengthening plans, quantification of the write-downs of receivables still necessary, contacts with other banks for mergers, any requests to address to the voluntary or mandatory guarantee funds, prospects evolution, positive or negative, of the situation.
In this regard, it should also be noted that banks that fall within the scope of the Community Directive on the recovery and resolution of banks in crisis (BRDD), are required to prepare and keep up-to-date a recovery plan providing for the adoption of measures aimed at restoring the financial situation after a significant deterioration. The recovery plans require a considerable internal organizational effort, as the banks will have to, among other things, (i) map their legal and business structure, (ii) identify the so-called "core" sectors of the business itself which must be preserved in the event of instability, (iii) identify the business units or investee companies that could be sold in the event of instability and (iv) outline the scenarios that the recovery plan intends to address.
A more lively discussion on these issues will also help the shareholder/saver to get an idea of the adequacy of the corporate bodies, especially when called upon to renew their mandate.
Faced with the deterioration of the situation, it is undeferrable to promote a strong discontinuity with the past, also affecting the practice of the indefinite number of mandates or the passage from one position to another or episodes of familism.
Similarly, the renewal of the bodies must be promoted in the case of sanctions of a certain gravity, especially if they relapse, imposed by the sector Authorities.
Finally, the request for more analytical information is valid in the event of capital increases or following corporate transformation operations (from Popolare to SpA, from BCC to SpA), if financially burdensome.
By the way, do you know why the Texas ratio is called that? Because in the XNUMXs dozens and dozens of small and medium-sized banks went bankrupt in that large American state and, by reconstructing the balance sheet indicators afterwards, it was discovered that the net anomalous loans were all higher than the assets, deducing the cause of death.
In conclusion, financial education, which is being talked about with increasing conviction, consists a) in narrating past banking events, so that lessons learned can be leveraged (the last 35 years of Italian banking crises are unfortunately a very instructive story) , b) in a few essential tools for orienting oneself about the state of health of one's bank (because the differences exist and are also marked in terms of the possibility of survival), c) in some suggestions for consequent behaviour.
Today the European Banking Union is setting up a new framework of rules, in which the centrality of the aware citizen is the essential fluid for the functioning of institutions and markets and our country too, with the latest measures, seems to be decisively oriented towards strengthening critical skills.
Passing from intentions to facts is the best way to definitively lift the veil on the many disconcerting episodes of recent times, and hopefully to prevent new ones, thanks to the possibility of obtaining ever-increasing quality information.
The meetings of the Italian banks in recent weeks are the natural testing ground for testing these proposals.
