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The Texas economy: the environment for financial institutions.

The Texas Economy: The Environment For Financial Institutions

The 1980s have witnessed a revolution of the financial industry in Texas. From a conservative but thriving industry in 1980, financial institutions soared through deregulation and the real estate boom and disintegrated in the wake of excess banking capacity and the real estate crash. By the end of the decade, the fragments have for the most part been sold to out-of-state investors. Whether Texas will ever reclaim a significant independence for its financial institutions is highly uncertain.

The statistics are indisputable. Of the nearly 1,000 banks that have failed since 1982, 333 are in Texas. Of the $21.6 billion of FDIC cash assistance required from 1984 through 1988, more than $9 billion has been spent on Texas banks. The S & L losses in Texas are staggering and to date, unquantifiable.

Why was Texas more vulnerable than the rest of the nation to extreme instability in its financial institutions?

Depression in the oil markets. While the rest of the nation has enjoyed the longest peacetime expansion since the 1920s, the energy economy has experienced a depression. More than half of the bank failures since 1982 have occurred in Texas, Colorado, Oklahoma, and Louisiana. Oil prices tell far less of the story than real estate, however. The major declines in oil prices occurred before and after the banking crisis did. Deregulation occurred in 1982, after oil prices had dropped below $30 per barrel. Most of the bad real estate loans were put on the books in 1983, 1984, and 1985, before prices dropped again in 1986. The steep oil price decline in 1986 meant that some borrowers could not cover the real estate loans that had already gone bad.

High real interest rates. Banks earn profits on the spread between borrowing and lending rates. Borrowing rates are determined nationwide by monetary policy, while lending opportunities are determined by local conditions. High real interest rates have a disproportionate impact on depressed areas. If Texas had been a nation and could have run its own monetary policy, it would have allowed higher monetary growth and prevented the deflation in asset values. It could also have lowered the cost of funds to the banks.

Texas banking laws. Until 1987, Texas law did not allow for any material branch banking. At the peak in 1986, Texas had 1,991 banks, fully 14.5 percent of the U.S. total. This posed an excess burden of regulatory costs, from the perspective of both banks and regulators. Ironically, the law that was designed to keep banking in local communities had the effect of driving it out of the state.

S & L deregulation. Compounding the problem for banks was S & L deregulation. Growing numbers of institutions were able to use insured deposits to finance high-risk commercial, acquisition, and construction loans. Thrift regulators considered brokered money to be an acceptable means to grow out of the problems caused by low interest rate spreads. The increase in deposit insurance coverage from $40,000 to $100,000 further accelerated the growth process. Unlike banks, Texas thrifts were allowed to branch and could grow considerably faster.

Disparity between entry and exit. A regulated industry that is easy to enter but has no graceful way to exit is a precription for predatory behavior. In such industries, profit margins will be squeezed until excess capacity is ultimately eliminated. On the loan side, too many institutions were chasing too few good loans. On the deposit side, interest expense was 20 to 30 basis pointsl higher for Texas banks than for nonmoney center U.S. banks during the period from 1984 to 1986. This difference existed before the time of the "Texas premium," when the extent of problem loans in Texas was recognized by investors who then demanded higher rates on their certificates of deposit.

Fraud. Fraud is the flip side of Texas optimism. A project that might have been perceived skeptically in the rest of the nation was viewed in Texas as bankable. The massive number of institutions worked against exposing fraud, as regulatory due process was far more time consuming than loan approval to affiliated parties. Even in circumstances involving fraud, Texas' comparatively generous usury and deceptive trade practice laws have led to a multitude of lender liability suits by borrowers.

The magnitude of the damage to financial institutions in Texas is demonstrated y the recent history of the largest institutions. Of the ten largest Texas financial institutions in 1980, each of which was then independent of out-of-state control, all but three have been sold to out-of-state groups, and two of those three have been assisted by the FDIC (see table b elow).

While Texas banks are being combined and acquired by out-of-state interests, the savings and loan industry is in the midst of a much-needed consolidation. Whether the home loan industry has any continuing reason to exist separately is an unresolved issue. Increased securitization of mortgage loans means that raising mortgage funds will be done in the capital markets rather than in the thrift office. Mortgage servicing is already a highly computerized operation provided on a large scale by specialized companies. Sufficient capacity exists in other financial institutions to handle all other real estate loans. The large number of branch offices in Texas enhances consumer convenience but escalates building, personnel, and security costs. Currently, an S & L charter offers few advantages compared to a bank charter. The disadvantages of an S & L charter include new administrative fees, surcharges on deposit insurance, and higher costs of borrowing from the regulators. We are likely to see more acquisitions like the recent purchase of the banking assets of failed University Savings by NCNB-Texas.

Adding to the complexity are regulatory and judicial issues, which will take years to resolve. Among the issues with greatest potential dollar impact are the following:

(1) Will judicial decisions require that the FDIC compensate shareholders of holding company banks that were taken over but were insolvent only because they held bad debt from affiliated banks or their holding company?

(2) Will the courts compensate bondholders of insolvent holding companies where the banks were taken over by the FDIC, leaving the debt to the holding company?

(3) Will there be a reopening of some the 179 S & L "Southwest Plan" transactions that were excessively generous to buyers before the new financial institution legislation was in place?

(4) Will the new capital requirements for savings associations allow them to be viable competitors in the financial markets of the 1990s?

(5) Will recent changes in themarket perception of junk bonds and leveraged buyout risks favor banks as the traditional means of financing, such that interest rate spreads and profitability rise?

In the context of worldwide banking, where nine of the ten largest banks are Japanese, what should have happened in the United States was a consolidation of financial services, not a splintering of them. This consolidation will inevitably occur, because of large economies of scale in financial services and the increasing need for those services on a global scale. Banks are certain to be survivors among the various financial service providers. It is unfortunate that Texas-owned banks, at least for the the immediate future, have missed the opportunity to compete in this worldwide arena.
COPYRIGHT 1989 University of Texas at Austin, Bureau of Business Research
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Author:Bennett, Carol T.F.
Publication:Texas Business Review
Date:Dec 1, 1989
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