WHEN BOOM GOES BUST : Banking Sinks in Same Dry Well as Texas’ Speculative Fever

The man with the toughest job in Texas banking has a scale model of the Titanic on the sill of his office window.

“Gene Bishop, the chairman of MCorp, gave it to me a few days after I took this job,” said Albert V. Casey, an industry outsider who became chairman and chief executive of First RepublicBank here in April. “He said, ‘You deserve this.’ ”

The sunken luxury liner is an apt symbol, not just for First Republic but for the entire Texas financial industry.

Fifty Texas banks failed last year, more than in any other state and better than a quarter of the nation’s 184 bank failures. Estimates for 1988 are worse: Regulators predict that Texas bank failures will top 70. Texas banks lost $1.7 billion in the first quarter of this year, compared to $2 billion in all of 1987.

First Republic, the state’s biggest bank company, is being kept afloat by a $1-billion federal life preserver. MCorp, the state’s last major independent bank, lost $58 million in the first quarter, and some say it could need an out-of-state partner to survive.

The numbers are even grimmer on the savings and loan side of the ledger. More than a third of the 279 thrifts in Texas are insolvent, and the tab for bailing them out could run as high as $20 billion.

Many experts feel that the size of the thrift problem in Texas requires a federal taxpayer bailout, and $20 billion would translate into about $200 per U.S. taxpayer.

While the depth of the crisis remains unplumbed, the reasons behind the collapse of the state’s financial industry have been well scrutinized and offer a lesson for the rest of the country.

“When you take the whole confluence of events, this may be a microcosm for what could happen elsewhere if you were to have any series of shocks that can affect the regional economy,” said Harvey Rosenblum, director of research at the Federal Reserve Bank of Dallas. “It could be California or Ohio or New England.”

Surely not California, where conventional wisdom says that the economy is too diverse to suffer the shame of Texas. Yet there are enough similarities to necessitate considering the possibility.

For instance, California’s economy depends heavily on agriculture, just as Texas’ was tied to energy. The nation’s three biggest agriculture lenders are Bank of America, Wells Fargo and Security Pacific.

Another similarity is the speculative run-up in real estate prices. Any time housing becomes an investment for reasons other than shelter, its value gets inflated, and the seeds for potential disaster are sown. When economic factors bring the speculation to a halt, prices plunge, leaving banks with loans that are less than the value of the housing.

Building Boom

“What can affect an economy can come out of the blue,” said Alex Sheshunoff, a financial industry analyst in Austin, Tex. “But when real estate starts to look like a basic industry, it is an indicator of some problems.”

California has also been a magnet for the kind of shady manipulators who helped bring down the thrift industry in Texas. That entrepreneurial subset is attracted to both states because their regulations impose fewer restrictions on the way thrifts can invest their funds than most other states do.

For those who say it couldn’t happen here, that is what they used to say about the bottom falling out of oil prices in Texas.

Throughout the late 1970s and early 1980s, Texas enjoyed a building boom of unprecedented proportions. It was fueled largely by rising oil prices, which approached $40 a barrel at their peak in 1981.

But the boom also fed on itself, spawning construction projects at a pace that went beyond what $60 a barrel would have justified.

In 1981, oil prices began to drop. The most oil-dependent sections of Texas, such as Houston, were the first to suffer as layoffs began to spread to related businesses. Yet housing prices kept going up and did not peak in Houston until 1983.

In Dallas and Austin, the decline in Houston was essentially ignored. The big Dallas banks could see that energy loans were no longer a growth area, but they were smug in the knowledge that their local economy was too diversified to suffer the fate of Houston.

At the same time, banks were under pressure from their boards to get in on the real estate bonanza that the thrifts were reaping. Thrifts, flush with new powers under deregulation, were expanding at rates of 300% a year, and banks wanted a piece of the action.

“I remember the head of our department telling us to get out there and make more loans a few days after a board meeting in 1984,” a former loan officer at First Republic said in an interview.

So the big banks began making big loans to the real estate developers, who seemed to be putting up apartment houses and office buildings on every corner.

Texas has four major metropolitan areas--Dallas-Ft. Worth, Houston, San Antonio and Austin. Total real estate loans at the big banks in those cities reached a peak of $32.8 billion in 1986, an increase of more than 50% in three years, according to figures compiled by Sheshunoff & Co.

Housing Prices Plummet

“The good news is that the banks diversified,” the Fed’s Rosenblum said. “The bad news is that the area they chose was real estate.”

The next shock came in January and February of 1986, when oil prices plunged from $28 a barrel to about $10 before stabilizing in the teens. For Texas, where the cost of producing oil is high, the impact was devastating.

Growth stopped. The influx of jobs turned into an outflow. Vacancy rates in office buildings approached 33% in Dallas and Houston, and Austin gained the dubious distinction of having the nation’s highest vacancy rate of 38%. Housing prices across the state plummeted, dropping 35% to 40% in Houston and nearly 20% in Dallas.

“What this means is that a normal, prudent lender that made mortgage loans with 10% down payments, now those properties have much less value than the mortgage,” said Paul M. Horovitz, a banking professor at the University of Houston and former research director for the Federal Deposit Insurance Corp. in Washington. “People tend to walk away or just wait for foreclosure.”

The percentage of loans on which interest was not being paid rose to 11.43% at Texas’ big city banks in 1986 and 14.63% the following year, the worst of any region in the country.

The bad times also pulled down the curtain on the abuses festering within the savings and loan industry.

More than 100 people have been charged in connection with fraud at the failed Empire Savings in Mesquite, Tex., and investigation is continuing. Some Empire-backed construction projects along the so-called “Interstate 30 corridor” outside Dallas were so ill-conceived that they have been demolished by the federal regulators who took them over. Losses from Empire’s portfolio are expected to run $500 million to $750 million.

‘Very Large’ Problem

“What we are now seeing in north Texas just dwarfs the Empire case in terms of dollar losses,” said Marvin Collins, the U.S. Attorney in Dallas. “Without any doubt, it will be billions of dollars of loss.”

With help from Washington, Collins set up a 50-member task force of prosecutors and agents from the FBI and Internal Revenue Service to investigate abuses in the state’s savings and loan and banking industries. Collins said at least 25 thrifts and 10 banks are under investigation for fraud.

“The further we look, the worse it gets,” Collins said. “I don’t think any number of investigators is going to be enough. The problem is very large and very complicated.”

Collins is one who thinks the scope of the troubles at Texas savings and loans will ultimately require a taxpayer bailout of the regulatory agency, the Federal Savings and Loan Insurance Corp. His opinion is shared by many industry experts and analysts.

Texas S&Ls; were $10 billion in the red at the end of March. But Frank W. Anderson, an analyst with the investment banking firm of D. Latin & Co. in Dallas, said the final cost of rescuing the industry will be closer to $20 billion because bad real estate loans are still showing up. For example, Sunbelt Savings & Loan in Dallas lost a reported $1.2 billion in the first three months of 1988.

The banking industry has not been hit as hard as the thrifts, chiefly because commercial banks are prohibited from most of the development-type lending that brought down the savings and loans.

Nonetheless, the state’s biggest banks have been forced to seek outside investors to remain open. Texas Commerce Bank was sold to New York’s Chemical Bank, and Allied Bank was bought by First Interstate of Los Angeles. First City Bank was rescued by investors led by Chicago banker A. Robert Abboud, and First Republic has as its partner the FDIC, which insures deposits in commercial banks and rescues failing institutions.

Damage Assessment

L. William Seidman, chairman of the FDIC, predicted last month in San Antonio that the Texas banking industry will show signs of a turnaround in 1989. But not before more troubles.

“We think this will be the worst year for Texas, and next year will be better,” Seidman said. “From what we can see, the economy is improving. While the real estate market hasn’t shown any improvement, we think the damage, particularly to large banks, will be known and containable.”

Albert Casey is still assessing the damage at First Republic, which is both a child and a casualty of the crisis.

For 59 years, Republic Bank and First National Bank were bitter rivals, “the Hatfields and McCoys” of Dallas banking, according to the Dallas Morning News. But in the face of the banking crisis, a merger seemed the only ticket to survival.

On June 6, 1987, the two rivals became First RepublicBank, the state’s largest bank and the nation’s 13th-largest banking company. Its chairman, Gerald W. Fronterhouse, brushed aside the loan problems and boasted that no federal aid would be required.

The cost savings of the merger and the additional capital raised proved inadequate, however, prompting one analyst to liken the merger to two drunks trying to hold each other up.

The company lost $656 million in 1987. In three months, depositors withdrew more than $1 billion from the bank, including $600 million from the main Dallas branch in five days last March.

On March 14 the bank sought the aid of the FDIC.

Full Extent Unknown

The regulators provided a $1-billion loan as the first stage of what some expect to be a bailout that tops the $4.5-billion price tag for Continental Illinois Bank in 1984. The FDIC also tried to restore confidence by ousting Fronterhouse and persuading the 68-year-old Casey to come out of retirement to resuscitate the banking company.

Casey is a former president of Times Mirror, which publishes the Los Angeles Times, a former chairman of the parent of American Airlines and a former U.S. postmaster general. At a recent meeting with First Republic employees, he said that he had “about an hour and a half” of experience as a banker.

Working seven days a week, Casey is assembling a plan to spin off the worst loans to a separate entity. Despite his hope to present the plan to the FDIC by mid-June, Casey said he does not know the full extent of the potential losses from the loan portfolio.

However, he stressed that the bank is not universally troubled, and, once the bad loans are stripped away, the operation should be profitable. He refused to blame the previous management, saying no one could have foreseen the twin catastrophes of the energy crisis and the collapse of the real estate market.

“You can protect against certain sizes of tragedies, and you cannot protect against others,” Casey said. “You could be a child genius running IBM and McKinsey & Co. (a consulting firm), but if you were in Nagasaki and the bomb came down, it wouldn’t matter how good your management was.”