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Financial
Industry
Studies
Department

The
Texas
Thrift
Situation:
Implications
for the
Texas

Federal Reserve Bank
of Dallas

September 1988

Financial
Industry

Genie D. Short
Vice President
&

Jeffery W. Gunther
Financial Analyst

This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org)

This study is the first of a series of occasional papers to be produced by the Financial Industry Studies
Department of the Federal Reserve Bank of Dallas. The views expressed are those of the authors and
do not reflect the position of the Federal Reserve Bank of Dallas or the Federal Reserve System.
Additional copies are available free of charge. Please send requests to the Public Affairs Department,
Federal Reserve Bank of Dallas, Station K , Dallas, Texas 75222 (214/651-6289).
This paper may be reprinted on the condition that the source is credited and that the Financial Industry
Studies Department is provided with a copy of the publication containing the reprinted material.

Graphics and Typesetting by the Graphic Arts
Department o f the Federal Reserve Bank o f Dallas

The Texas
Thrift Situation:
Implications for the
Texas Financial Industry
Genie D. Short
and
Jeffery W. Gunther
Recent losses incurred by U.S. thrifts
are sufficiently large to constitute a priority concern for U.S. policymakers.
Last year the U.S. thrift industry recorded a net loss of $6.8 billion. The
unprofitable segment of the industry lost
$13.4 billion, and this was only partially
offset by a $6.6 billion profit recorded
by the profitable institutions. During
the first quarter of this year, U.S. thrifts
lost $3.7 billion, with the unprofitable
S&Ls reporting losses of $5.1 billion.
Much of the industry's problem is concentrated in the Southwest, and particularly in Texas.
The magnitude of the financial losses
reported by Texas thrifts, together with
the weakened financial condition of most
of the state's banks, has impaired confidence in Texas financial institutions.
This is reflected in the interest-rate premiums that are required to attract deposits to these institutions. Relative to
the average cost of interest-bearing deposits at thrifts outside of Texas, the
Texas thrifts paid about 74 basis points
more for their interest-bearing deposits
in the first quarter of 1988. At Texas
banks, the average premium on their
interest-bearing deposits was 31 basis
points. This Texas premium is partly
the result of the aggressive bidding
practices for deposits by the state's most
troubled financial institutions. The
Texas premium also reflects uncertainty
about the viability of many of the financial institutions in the state, due largely
to questions about the value of the nonperforming assets that these institutions
are holding.
This article provides an assessment of
the financial condition of the Texas

banks and thrifts. Analysis of interestexpense data indicates that the Texas financial institutions, banks and thrifts
alike, are required to pay premiums on
their deposits. These data also suggest
that concerns about the financial viability of the state's most troubled financial
institutions have impacted the stronger
institutions in the state. This process not
only weakens the financial condition of
the solvent banks and thrifts, it also penalizes the stronger institutions because
of the problems at the most troubled institutions.
Texas Thrift Situation:
Assessment of the Problem
A large number of the banks and
thrifts in Texas are experiencing serious
financial difficulties. The key factors
contributing to these difficulties are
problems with asset quality and lowered
interest margins. Regarding Texas
thrifts, data included in Table 1 identify
the asset-quality problems that have
emerged during the last three years. At
year-end 1987, Texas thrifts had just under $14 billion in loans that were delinquent for 60 days or more. Of this total,
about $13 billion were in real estate
loans of all categories. Texas thrifts also
held over $9 billion in repossessed real
estate assets, bringing total nonperforming loans plus repossessed assets to 23
percent of their assets.
The sharp rise in nonperforming assets at the Texas thrifts has seriously
impaired the capital positions of these
institutions. In December 1985, Texas
thrifts, as a group, had $3.0 billion in
positive capital. That position declined
to — $1.0 billion by December 1986, and
it fell further to — $11 billion by the first
quarter of 1988. As shown in Table 2,
by March 1988, 130 Texas thrifts were
insolvent, but operating. In terms of
numbers of institutions, these insolvent
thrifts accounted for 47 percent of all
Texas thrifts and, with $46.5 billion in
assets, the insolvent thrifts held 48 percent of the thrift assets in the state. At
the end of the first quarter of 1988, the
capital position of the insolvent Texas
1

Table 1

Loans and Asset Quality at Texas Thrifts
(Billion $, End-of-Period)
1985
Net L o a n s : 1
Real Estate
Total

53.5
59.1

Delinquent Loans:
Real Estate
Total

1986

1987

52.6
58.4

44.5
49.7

3.41

10.36

12.90

3.75

11.28

13.98

Repossessed Assets

1.67

4.75

9.45

Delinquency Rate:
Real Estate
Total

6.4%

19.7%

29.0%

6.3%

19.3%

28.1%

5.9%

16.5%

23.4%

T r o u b l e d Assets/Total
1.
2.
3.
4.

Assets 4

Mortgage-backed securities are excluded from net loans.
Real estate loans are defined as mortgage loans and contracts, which include residential
and nonresidential construction loans and permanent mortgages.
Delinquent loans are loans overdue 60 days or more.
Troubled assets are defined as delinquent loans and repossessed assets.

S O U R C E : Quarterly Trends, Federal Home Loan Bank o f Dallas.

Table 2

Solvent Versus Insolvent Texas Thrifts
(March 1988)
Solvent

Insolvent

N u m b e r o f Institutions
Percent o f Institutions

148
53%

130
47%

T h r i f t Assets
Percent o f T h r i f t Assets

50.4
52%

46.5
48%

1.6
2.2

-12.8
7.7

Capital ( G A A P , billion $)
Repossessed Assets (billion $)

S O U R C E : Federal Home Loan Bank Board Thrift Financial Report.

Table 3

Management Differences:
Solvent versus Insolvent Texas Thrifts
Solvent
Average Asset

Insolvent

Difference

Growth1

1 9 8 0 - Q 4 to

1984-Q4

23%

39%

1984-Q4 to

1988-Q1

13%

16
— g

**
**

Average Loan Rate2

11.54%

12.30%

0.76

Average Deposit

10.60%

10.96%

0.36

1.
2.
3.

Rate3

Figures are the averages of the annualized growth in assets at individual institutions. Growth
from mergers is included.
Figures are the averages of annualized rates earned on mortgage loans and contracts at individual institutions in the fourth quarter of 1984.
Figures are the averages of annualized rates paid on deposits at individual institutions in the
fourth quarter of 1984.

* * Denotes that the difference is significant at the 9 9 % level of significance.
S O U R C E : Federal Home Loan Bank Board Thrift Financial Report.

thrifts was — $12.8 billion, while the 148
solvent thrifts in the state had $1.6
billion in capital.
Analysis of differences in management
decision-making at the solvent and insolvent Texas thrifts indicates that differences in risk decisions influenced the
magnitude of financial losses at these institutions. The figures in Table 3 suggest
that the thrifts that are now insolvent
pursued more aggressive lending strategies than did the solvent thrifts. The
insolvent thrifts also were more aggressive in bidding for deposits.
Table 3 figures indicate that during
the period from the fourth quarter of
1980 through the fourth quarter of 1984,
while the Texas economy was still relatively strong, the annualized growth in
assets at the Texas thrifts that are now
insolvent was significantly higher than
the average asset growth at the Texas
thrifts that are still solvent. Since 1984,
the asset growth at the insolvent thrifts
has slowed and is now lower than the
asset growth at the group of solvent
thrifts. Regarding loan and deposit
rates, during the fourth quarter of 1984
the average loan rate at thrifts that are
now insolvent was 76 basis points higher
than the average loan rate at the solvent

thrifts. Similarly, during the fourth
quarter of 1984, the group of thrifts that
are now insolvent paid 36 basis points
more for their deposits, on average, than
did the thrifts that are still solvent.
Additionally, Table 3 figures show
that the difference between the average
interest rates paid on deposits at the insolvent and solvent thrifts was less than
the difference between their loan rates.
This suggests that in 1984 thrifts that
became insolvent were more aggressive
in attempting to capture the implicit
subsidy that is provided by insured deposits. These differences suggest that
differences in risk decisions, not just
economic conditions, had a significant
impact on the magnitude of the financial
losses incurred at individual Texas
thrifts.
Southwest Plan
The Federal Home Loan Bank Board
(FHLBB) developed the Southwest Plan
to address the financial difficulties of the
troubled Texas thrifts. The Plan is
composed of two major programs.
First, the F H L B B intends to consolidate
the Texas thrift industry by merging a
number of insolvent thrifts with
stronger institutions. Unprofitable S & L
branches also will be closed. The Plan
3

for implementing the mergers divides
the state into 14 regions. The F H L B B
has stated that the size distribution of the
Texas institutions will remain essentially
unchanged and that competition and
service will be adequate in each of the
14 regions. Thus far, five major mergers
have been completed. The surviving
institutions in those transactions are
Coastal Savings, Southwest Savings,
MeraBank, Sunbelt Savings, and American Federal Savings Bank, the last a
de novo federal savings bank.
The F H L B B has indicated that the
Southwest consolidation plan will provide a mechanism for reducing expenses
and controlling losses from troubled
thrift assets. The agency projects that
expenses will be reduced through a reduction of overlapping and duplicate facilities. In addition, the F H L B B
anticipates that losses from troubled assets will be controlled, as only the most
capable thrift managers will be retained
in the consolidation. The F H L B B emphasizes that in restructuring the industry the use of cash will be minimized,
and the FSLIC will gain a share in the
future profits of the assisted institutions.
The F H L B B also expects the plan to attract a substantial inflow of private capital.
In addition to this consolidation plan,
the agency is attempting to lower the
cost of funds at Southwest thrifts by
implementing a series of programs that
lower the risk premiums on the deposits
of the most troubled thrifts. The Federal Home Loan Bank of Dallas
(FHLB-Dallas) has introduced three
programs to accomplish this objective.
The goal of these funding programs is
to market FSLIC-insured CDs in the national money market to reduce the aggressive bidding practices of insolvent
thrifts in local market areas.
The three funding programs that have
been established thus far include the AsAgent CD program, the Letter of
Credit-Enhanced CD program, and a
third program that utilizes regional brokerage firms to promote the sale of thrift
CDs. 1 The As-Agent CD program was
4

introduced in March 1987. In that program, deposits for the most troubled
S&Ls are purchased through other
stronger thrifts and are then funneled
back to the weaker thrifts. The Letter
of Credit-Enhanced CD program was
introduced in March 1988. That program attempts to lower the cost of thrift
deposits by using letters of credit issued
by the FHLB-Dallas to guarantee 10
percent of the principal of the CDs issued by the troubled Southwest thrifts.
The 10-percent coverage is in addition
to the normal FSLIC-insurance coverage
on deposits up to $100,000. The guarantee from the FHLB-Dallas is offered
to provide additional assurance to large
CD holders that if a thrift institution
fails, depositors will recover accrued interest earned on CDs in denominations
of $100,000 or more.2 Finally, in April
1988, a third program was introduced
that utilizes regional brokerage firms to
promote the sale of $90,000 CDs for
designated troubled thrifts. 3 Thus far,
however, these indirect funding programs have not attracted as much investor interest as had been hoped. And,
although the cost of funds has declined
in some local markets, the deposit premiums have not been eliminated.4
The immediate problem with the
Southwest Plan is that insufficient resources have been allocated to the
F H L B B to eliminate the capital deficiency at Texas thrifts without losses
to depositors. As a result, the
FHLB-Dallas is not able to address adequately the primary cause of the profitability shortfall at the Texas thrifts,
namely the large and growing volume
of nonperforming assets held by these
institutions. Estimates of the cost reductions from thrift mergers cannot be
made without additional information
about the merger plans, but the F H L B B
has indicated that the overall consolidation effort is expected to save Texas
thrifts $650 million per year in operating
costs." That estimate is less than 10 percent of the losses reported by Texas
thrifts in 1987.

Table 4

Loans and Asset Quality: Texas Versus Other U.S. Banks
( B i l l i o n $, E n d - o f - P e r i o d )
1985

1987

1986

Texas

Other

Texas

Other

Texas

Other

39.2
125.4

345.6
1499.6

42.2
120.1

410.2
1627.4

40.3
108.0

512.6
1711.4

1.4

9.5
41.2

2.9

11.4

5.3

12.1

4.6

6.9

44.0

9.6

56.3

Other Real Estate O w n e d

1.0

6.1

2.1

7.0

3.5

7.6

Problem Rate:
Real Estate
Total

3.5%
3.7%

2.8%
2.7%

6.8%
5.8%

2.8%
2.7%

13.0%
8.9%

2.4%
3.3%

T r o u b l e d Assets/Total Assets 2

2.7%

1.9%

4.4%

1.9%

6.9%

2.3%

Net Loans:
Real Estate
Total
Problem Loans:
Real Estate
Total

1.
2.

Problem loans are defined as loans overdue 90 days or more, nonaccruing loans, and renegouated loans.
Troubled assets are defined as problem loans and other real estate owned.

SOURCE:

Report o f Condition and Income.

Uncertainty about the market value of
the nonperforming assets held by
undercapitalized Texas thrifts will continue to generate doubts about the future
profitability of these institutions.
Moreover, the decision of thrift regulators to avoid placing further pressure on
real estate values by assisting Texas
thrifts to hold foreclosed real estate and
nonperforming real estate loans on their
books will contribute to this uncertainty.
It is extremely difficult to evaluate the
market value of real estate with too few
market transactions. As a result, uncertainty about the market value of both
real estate loans and O R E (other real estate owned) will continue to raise
questions about the viability of Texas
thrifts. This, together with the uncertainty about the impact of the FSLIC
insolvency on the value of federal deposit guarantees, is likely to induce
depositors to continue to demand risk
premiums on the deposits of Texas financial institutions.''
Financial Condition of Texas Banks
The volume of nonperforming assets
at Texas thrifts is larger than that reported by Texas banks, but the asset-

quality problems at Texas banks are also
unprecedented, at least for the postDepression environment. The data in
Table 4 identify the deterioration in asset
quality that has occurred at Texas banks
in relation to banks outside Texas during
the last three years. Table 4 figures
show that the level of problem loans at
Texas banks increased to $9.6 billion by
the fourth quarter of 1987, with problem
real estate loans accounting for 55 percent of this total. Problem real estate
loans increased from $1.4 billion in the
fourth quarter of 1985 to $5.3 billion in
the fourth quarter of 1987, while the
amount of other real estate owned
( O R E ) increased from $1.0 billion to
$3.5 billion during that same period.
Excluding real estate, the level of problem loans continued to rise during the
last three years, but at a slower pace.
Problem loans, excluding problem real
estate loans, moved from $3.2 billion in
1985 to $4.0 billion in 1986 and reached
$4.3 billion at the end of 1987. Total
problem loans plus other real estate
owned at Texas banks reached $13.1
billion by last year's fourth quarter.
That represents 6.9 percent of the state's
banking assets. In contrast, troubled
5

assets as a percent of total assets at other
U.S. banks was 2.3 percent.
The drag on earnings from these
troubled assets was a key factor in the
sharp rise in bank failures that has occurred in Texas during the last two
years. In 1987, 50 FDIC-insured banks
failed in Texas, representing 27 percent
of all U.S. bank failures.8 Through July
1988, 83 banks in Texas were closed due
to failure, including 40 banks affiliated
with First RepublicBank Corporation.
In addition, in 1987, BancTexas received
special assistance from the FDIC to
avoid closure. And, through July 1988,
First City Bancorporation and two other
smaller Texas banking organizationsTexas Bancorp, and Oak Forest National
Bank— also received special FDIC assistance. In addition, the FDIC has announced a plan to provide special
assistance to facilitate the merger of two
other large Texas bank holding
companies— Texas American Bancshares
and National Bancshares Corporation. 9
Efforts to assist several of the state's
largest banking organizations have alleviated concerns about the financial condition of the assisted banks. But
continued uncertainty about the value
of the nonperforming assets held by
Texas financial institutions is likely to
hinder the inflow of private capital to
the state's financial institutions. This
uncertainty is also likely to induce
depositors to continue to demand risk
premiums on the deposits of Texas financial institutions. These premiums,
together with foregone earnings on
nonperforming assets, will prevent the
Texas institutions from earning a competitive rate of return.
Deposit Rate Premiums at Texas
Banks and Thrifts
Interest-rate premiums on the deposits
of Texas financial institutions are likely
to persist unless more aggressive actions
are taken to remove nonperforming assets from the portfolios of the troubled
institutions. Data on interest expense
from the first quarter of 1988 for Texas
thrifts and banks highlight the higher
funding costs that these institutions
were required to pay. For analysis, the
thrifts and banks were divided into four
grouos on the basis of their capital posi6

tions. Figures on the interest-rate premiums at the Texas thrifts are shown in
Table 5, and those for the Texas banks
are shown in Table 6.
Table 5 figures indicate that during
the first quarter of 1988 Texas thrifts in
all four capital groupings paid deposit
premiums. The thrifts in Group 1 include the top quarter of Texas thrifts
ranked according to their capital positions. The thrifts in Group 4 include the
bottom quarter of Texas thrifts ranked
according to their capital positions.
Differences in capitalization provide a
rough proxy for risk differences among
these financial institutions. Given its
limitations, this risk proxy was used to
determine whether the lower-capitalized
Texas financial institutions were required to pay higher risk premiums.
Risk differentials across the four thrift
groupings are consistent with the risk
differences reflected in their different
capital ratios. For example, the Texas
thrifts with the lowest capital ratios,
having —$11.1 billion in (GAAP) capital, paid 132 basis points more for deposits than did thrifts outside the state,
whereas the premium at Texas thrifts
with the highest capital ratios was 33
basis points. If capitalization is a consistent proxy for degree of risk, the figures in Table 5 identify the impact on
solvent institutions of allowing insolvent thrifts to continue operations. The
data illustrate that the Texas thrifts in
the first grouping, with an average capital ratio of 8.0 percent, reported average
funding costs of 7.29 percent. That
compares unfavorably to average funding costs of 6.96 percent at thrifts outside of Texas, which had an average
capital ratio of only 3.7 percent.
The figures in Table 6 for Texas banks
provide a consistent story. For banks,
the availability of additional data enabled
us to calculate their average cost of large
CDs in addition to their average overall
cost of interest-bearing deposits. The
figures indicate that each group of Texas
banks was required to pay substantially
higher deposit rates than the average
rates paid by banks outside of Texas.

Table 5

Cost of Deposits at Texas Thrifts

(1988-1)

Texas

Cost

A v e r a g e Capital
Ratio

of Deposits

Premium

-11.2

-11.2%

7.70%

0.74

Thrifts

Texas

Average

T o t a l Capital
("GAAP, Billion $)

Thrifts

by Capital

Groupings1

0.8

8.0%

7.29%

0.33 * *

0.8

2.5%

7.50%

0.54

-1.7

- 5 . 5 %

7.73%

0.77

-11.1

-50.3%

8.28%

1.32 * *

42.8

3.7%

6.96%

Other

U.S.

Thrifts
1.
**

—

The Texas thrifts are divided into 4 groups on the basis o f their individual capital ( G A A P ) ratios.
The premium for each o f the groups is significant at the 9 9 % level of significance.

S O U R C E : Federal Home Loan Bank Board Thrift Financial Report.

Table 6

Cost of Deposits at Texas Banks
Domestic Offices
(1988-1)
Average
Average

Primary

Capital Ratio
Texas

Banks

Average Cost:
Large

CDs

8.6%

6.91%

Cost:

Interest-bearing
Deposits
6.47%

Texas Banks by
Capital

Groupings'

13.3%

6.81%

6.34%

9.0%

6.85%

6.44%

7.3%

6.91%

6.48%

4.7%

7.07%

6.63%

9.7%

6.64%

Other U.S.

Banks

6.16%

The Texas banks are divided into 4 groups on the basis of their individual primary capital ratios.

Denotes that the difference between the figure and that for other U.S. banks is significant at the 9 5 %
level of significance.
Denotes that the difference between the figure and that for other U.S. banks is significant at the 9 9 %
level of significance.

SOURCE:

Report of Condition and Income.

Similar to the thrift data, the deposit
premiums at the Texas banks also increased with the higher-risk profiles of
the lower-rated banks.5"
The evidence reported in Tables 5 and
6 suggests that concerns about the state's
most troubled financial institutions have
spilled over to the state's stronger institutions. The data also suggest that
competitive pressures from the state's
most troubled financial institutions required the stronger institutions to pay
higher interest rates on their deposits to
retain adequate funding. This process
not only weakens the financial condition
of the solvent banks and thrifts in Texas,
it also penalizes the stronger institutions
because of the problems of the most troubled institutions. Thus, the efforts of
the F H L B B to assist insolvent institutions to continue operations have a
negative impact on the current operations of the unassisted institutions in
the state. Similarly, decisions by the
FDIC to provide special assistance to
several of the state's largest banking organizations, including the provision of
100-percent deposit guarantees to the
depositors of First RepublicBank Corp.
and First City Bancorp., penalize those
banks that have not received the special
assistance.11

occurred at these weak financial institutions because depositors, regardless of
deposit size, do not expect that they will
incur financial loss.12 But the policies
that have removed incentives for depositors to reallocate their deposits from the
most troubled institutions in the country
have also removed a market process that
contributes to the overall safety and
soundness of the financial system.
The decision of the FDIC to provide
full deposit guarantees on all of the deposits of First RepublicBank Corp. and
First City Bancorp, was made to dampen
incentives for depositors to withdraw
their funds from these troubled institutions. But those actions also encouraged depositors to shift their funds from
institutions that did not receive guarantees into the large troubled banking organizations that received the special
guarantee. Such policies not only penalize the smaller institutions relative to
the larger ones, they also penalize the
more conservatively-managed institutions over the more aggressive ones.13
Similarly, the funding programs implemented by the FHLB-Dallas encourage
depositors to move their funds into the
more troubled institutions. The Southwest Plan has this result as a stated

Policy Implications: Assessment of
the Issues

Insolvent thrifts are able to continue
to operate in Texas and elsewhere in the
country not because their depositors
view their problems to be temporary nor
because their depositors have confidence
in the financial strength of the FSLIC
insurance fund, but, rather, because, in
all likelihood, the public expects the U.S.
Treasury to provide back-up coverage
to the FSLIC insurance fund.14 The
public also anticipates that this back-up
coverage would enable the appropriate
regulatory agency either to recapitalize
the ailing financial institutions or to
close them without losses to depositors.
At the same time, the investing public
has questions about the manner in which
the Treasury Department would provide
this assistance. Specifically, questions
persist about how the assistance would

The characteristics of the Texas deposit market reflect a new form of crisis
in confidence. Today's crisis is not
characterized by panics and a generalized
loss of confidence, nor by widespread
deposit outflows from insolvent Texas
thrifts to other weak but solvent institutions in Texas or to stronger institutions elsewhere in the country. T o the
contrary, in the current environment,
depositors recognize that many of the
operating Texas thrifts are insolvent.
Depositors also recognize that the financial condition of many other banks
and thrifts in the state is sufficiently
weak to place these institutions at high
risk of becoming insolvent in the near
future. Large deposit outflows have not
8

objective.

be implemented and how it would be financed.
These unknowns complicate assessments of the viability of the troubled financial institutions both in Texas and
elsewhere throughout the country. Regarding the Texas institutions, depositors are requiring risk premiums at
virtually all of them. These risk premiums are not likely to be eliminated until
the uncertainty about the market value
of the nonperforming assets held by the
Texas financial institutions is removed.
Similarly, capital investors are more reluctant to commit capital to the ailing
Texas institutions presumably for two
reasons: 1) because of questions about
the longer-term viability of the institutions and, 2) because investors anticipate that larger subsidies will be
available to acquire these institutions in
the future if their financial condition
should further deteriorate. The expectation that larger subsidies will be available in the future discourages private
capital from flowing into the region at
this time. This expectation also increases the probability that a larger
problem will develop in the future.
Without adequate recapitalization, the
troubled assets held by the Texas financial institutions will continue to generate
a significant drag on earnings, and the
risk premiums required on the deposits
of these institutions will prevent them
from competing effectively for profitable
business with other financial institutions
outside the state. At a minimum, the
need to fund troubled assets with deposits issued at premium rates will prevent Texas institutions from earning a
competitive rate of return. And, given
the normal spreads in the industry, it
could also prevent a large portion of the
Texas institutions from earning a positive return. This, in turn, could impair
the state's economic recovery.
Regional Focus: National Problem
Despite the regional focus on current
difficulties in Texas, the more general
problem of continued operations of insolvent thrifts extends beyond a regional
issue. Insolvent thrifts are operating

throughout the country. Similarly, the
expectation that a growing portion of
the nation's banks are "too big to fail"
has important moral-hazard implications
on decisions to incur risk at federallyinsured financial institutions nationwide.
These difficult issues, along with the
more general question of how best to
reform the overall U.S. financial structure, are receiving much attention from
all relevant circles—financial market participants, policymakers, academicians,
and politicians.
The numerous issues relevant to financial reform in general are too extensive to be addressed in this paper.15 But
given the far-reaching implications that
these reforms will have on the operations of U.S. financial institutions, it is
our view that the optimal approach to
the problems of the Texas institutions is
to address them as an integral part of a
comprehensive reform of the U.S. financial system. Moreover, it is possible
that the magnitude of current financial
difficulties at Texas financial institutions
offers a common focus that could facilitate the process of negotiating a comprehensive reform plan.
Much has been written on alternative
approaches to financial reform in this
country.16 In this study we will not address the relative merits of these plans.
It is our view, however, that the Texas
problem is part of a broader problem
with the underlying incentive structure
that motivates federally-insured financial
institutions throughout this country to
incur excessive risk. In order to minimize the potential for significant financial problems to emerge elsewhere in the
future, it is preferable to address the
Texas problem in the context of these
broader issues of moral hazard.
Conclusion
In conclusion, the recent record of
U.S. financial problems suggests that
piecemeal efforts of introducing financial
reforms, coupled with policy efforts that
focus on the symptoms of the financial
problems rather than on their underlying
causes, have contributed to, rather than
diminished, unstable financial conditions
in this country. In particular, legislative
changes which have reduced constraints
that were imposed to prevent federally9

insured financial institutions from incurring excessive risk, without
introducing changes to the nation's system of financial safety nets, have contributed to current financial difficulties.
Among other changes, the partial efforts to deregulate U.S. financial institutions that were included in the
Monetary Control Act of 1980 and the
Garn-St Germain Act of 1982 broadened
the financial powers of federally-insured
financial institutions, and pending legislation will broaden them further. But,
thus far, legislation has not been introduced that addresses the moral-hazard
problems which result from 100-percent
deposit guarantees and from federal assistance to recapitalize failed financial
institutions.
The magnitude of current financial
difficulties in Texas and elsewhere in the
country may now be of sufficient concern to facilitate the introduction of a
broad-based proposal to reform the U.S.
financial structure. The purpose of this
study is to examine the magnitude of the
financial difficulties at Texas banks and
thrifts. The issues examined in the study
highlight our concerns about the longterm impact of forbearance policies used
by the F H L B B to enable insolvent thrifts
to continue operating. Similarly, decisions made by the FDIC to assist banks
that are "too big to fail" also raise important policy issues. In particular,
those policies raise serious questions
about the long-term viability of a private
financial system in this country. Efforts
to understand these problems may assist
the process of introducing a viable solution to our need for comprehensive financial reform. Finally, although we
do not minimize the difficulties involved
in implementing a comprehensive plan
to reform the U.S. financial structure, it
is possible that the Texas problem may
be a catalyst for introducing such a plan.

The FHLB-Dallas also is awaiting approval from the
F H L B B of a fourth program called the "DalNote"
program. The "DalNote" program is designed to
have the FHLB-Dallas act as agent to raise funds for
the more troubled Southwest thrifts. The plan calls
for the FHLB-Dallas to issue a special series of secured notes that will be collateralized by
FSLIC-insured CDs. The CDs will be purchased by
the FHLB-Dallas from the more troubled thrifts in
the Dallas District. The collateralized notes issued

by the Dallas Bank are expected to be more attractive
to investors than are FSLIC-insured CDs issued directly by the individual thrifts. The "DalNotes" will
have maturities of six months to three years and they
will be sold in minimum denominations o f $50,000
and in $5,000 multiples thereafter. The F H L B Dallas hopes to raise about $4 billion with this program.
2.

The additional guarantee also reduces depositor
concerns about potential "tie-up" costs that might
accompany the closing o f a troubled thrift given the
reserve deficiency of the F S L I C fund. In essence, the
FHLB-Dallas is providing back-up insurance coverage to thrift depositors. Drexel Burnham Lambert,
Inc. agreed to market these letter o f credit-enhanced
CDs, but interest from other Wall Street brokerage
firms has been limited.

For this program New Orleans-based Howard, Weil,
Labouisse, Fredrichs has agreed to market
FSLIC-insured CDs in denominations of $90,000 on
behalf o f 50 S & L s in the F H L B ' s Dallas District.

Calculations of the average premium paid by Texas
thrifts relative to thrifts outside of Texas indicate
that the Texas thrift premium increased slightly from
67 basis points in I987-IV to 74 basis points in
1988-1. In individual local market areas some declines in premiums were reported. These latter declines could reflect the impact of efforts to close
insolvent thrifts. For example, F H L B B Chairman
M. Danny Wall indicated that the interest rates paid
by some of the competitors of Vernon Savings declined by as much as 100 basis points immediately
following the Vernon closing. See "Regulator Recaps Benefits from Vernon Closing", by David
LaGesse, American Banker, (April 7, 1988), p.3.

This estimate was cited in "Plan for Rescuing S & L s
Isn't Promising", by Robert E. Taylor, Wall Street
Journal, (April 21, 1988), p.6.

Concerns about the insolvency of the F S L I C could
also impact investor perceptions about the strength
o f the F D I C fund, particularly given the continued
speculation that the two deposit insurance funds will
be merged. For a more complete discussion of the
condition of the F S L I C and the overall condition of
the thrift industry, see the testimony of Bert Ely,
Corporate Financial Consultant, Ely and Co., Inc.,
to the Senate Banking Committee on May 19, 1988.

The continued rise in nonperforming loans, other
than real estate, remains a source of concern for
Texas banks, but uncertainty about the quality o f
their real estate loan portfolios is the more critical
problem at the present time. At the end of last year,
Texas banks and thrifts had about $31 billion of
troubled real estate assets, including $18 billion in
problem real estate loans and about $13 billion in
foreclosed properties. In addition, the Dallas liquidation office o f the F D I C held another $4 billion in
troubled assets from bank closings that occurred
primarily in Texas and Oklahoma. Similarly, a large
portion o f the $5.2 billion in troubled real estate assets held by the Federal Asset Disposition Association ( F A D A ) in June 1987 was from Texas thrifts.

In addition to the 50 insured banks, 2 private
uninsured Texas banks failed in 1987.

Special assistance to the BancTexas Group impacted
11 banks affiliated with that bank holding company.
The First City transaction involved 60 members o f
that major Texas bank holding company. Special

assistance to Texas Bancorp, involved 2 banks, while
Oak Forest National was a single bank transaction.
There are 24 banks affiliated with Texas American
Bancshares, and 12 banks with National Bancshares
Corporation.
10. A similar pattern was revealed by grouping the Texas
banks according to their C A M E L ratings. The average cost of interest-bearing deposits at banks with
1 and 2 C A M E L ratings was 26 basis points more
than the average cost of interest-bearing deposits at
banks outside o f Texas, whereas Texas banks with a
5 C A M E L rating paid 70 basis points more for their
interest-bearing deposits.
11. The short-term negative impact of these decisions on
the unassisted banks is in addition to the longer-term
moral-hazard dilemma that results from special assistance, including 100-percent deposit guarantees.
For a thorough review of the widely accepted arguments on the moral-hazard dilemma, see George J .
Benston, Robert A. Eisenbeis, Paul M. Horvitz,
Edward J . Kane, and George C. Kaufman, Perspectives on Safe and Sound Banking: Past, Present, and
Future, A Study Commissioned by the American Bankers
Association (Cambridge, Mass: The M I T Press,
1986). That study also includes an extensive bibliography on other related safety and soundness issues.
12. Substantial deposit outflows did occur at First
RepublicBank Corp. earlier this year, but the con-

cerns of depositors of First RepublicBank did not
generate unmanageable spillover runs to other banks
in Texas. The F D I C recently arranged the acquisition of First RepublicBank by North Carolina-based
N C N B Corporation to form a new organization,
N C N B Texas National Bank.
13. On this issue, see Eugenie D. Short, "FDIC Settlement Practices and the Size of Failed Banks",
Economic Review, Federal Reserve Bank of Dallas,
(March 1985), p. 12-20. Regarding the impact of
these policies on risk decisions at small versus large
banks, see Eugenie D. Short, "Bank Problems and
Financial Safety Nets", Economic Review, Federal Reserve Bank o f Dallas, (March 1987), p. 17-28.
14. This issue was recently complicated by the Mouse
Banking Committee's reluctance to affirm a federal
guarantee to F S L I C notes. See Jim McTague,
"FSLIC Hamstrung by Lack o f Federal Guarantees
for its Notes," American Banker, (August 16, 1988),
p. 14.
15. For a thorough overview of these issues, see
Restructuring the Financial System, proceedings of a
Symposium sponsored by the Federal Reserve Bank
of Kansas City, (August 1987).
16. Ibid. See also, "Financial Restructuring",
(November/December 1987).

Challenge,

Full text of Financial Industry Studies : September 1988

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