Opening Remarks for the Eleventh District Banking Conference

On behalf of the Federal Reserve Bank of Dallas and in partnership with the Texas Department of Banking, I’d like to echo Donald’s [Bowers] remarks and welcome you to the second annual Eleventh District Banking Conference. I’d like to personally thank Commissioner Charles Cooper from the Texas Department of Banking, who you will hear from at closing, for his support in partnering on this event and his unwavering leadership and commitment to the Texas banking system throughout his remarkable career.

The Eleventh District, which covers all of Texas, southern New Mexico and northern Louisiana, is home to many community and regional banks. In fact, as the saying goes, everything is bigger in Texas, and we can prove it. The state of Texas alone boasts the greatest number of chartered banks than any other state in the union. Since 2010, as the economy rebounded from the Great Recession, the number of regional and large banking organizations in the Eleventh District has grown from three to over a dozen as a result of organic growth, mergers and relocations of headquarters. The blend of very large, regional and community banks that operate here makes our district one of the most diverse banking portfolios in America, and I truly believe that preserving this mix is critically important to our Texas economy. The people in our communities, from ranchers to oil executives, can find banks that meet their needs and extend them credit, ultimately generating greater economic growth through this model.

Upon arriving here two years ago, I began working with my team on the idea of this conference, and it was really born out of an effort to increase our transparency and outreach to our district banks. That is why today we have curated content directly related to all of you as bankers—and particularly the community bankers in the audience. We aim  to bring awareness and dialogue on risk topics that we felt are relevant, where your views are critically important, and, where possible, we want to provide networking opportunities for you to build relationships with your peers in the room.

Today I’d like to briefly touch upon three topics that are front and center in the banking sector in our region: credit, liquidity and cybersecurity, to set the stage before we hear from our CEO and President Lorie Logan. These views are mine and do not reflect the official views of the Federal Reserve Bank of Dallas or the Federal Reserve System.

Commercial real estate is wide-ranging as a lending sector that is both critical to our regional economic landscape and to the community bank business model. So much can depend upon the class of the property, property type and geography, that making general statements of riskiness in this lending type can be a bit hollow. As such, I’ll go into a few segments that are showing some emerging signs of challenges.

We have observed a lot of supply in multifamily units in the district with tepid demand. In recent years, multifamily loans had been the fastest growing loan type in banks in the district. The common assumption was that more apartments were needed to provide housing for all of the population growth the district was experiencing. Often, a developer would pay a record amount for a parcel of land or an older building and then build a new apartment building with high-end finishes that would be priced on the high side in order to earn a decent return on the initial cost outlaw. Higher construction costs in recent years due to material and labor shortages pushed up expenses, as did higher cost of capital.  

We are observing that some of these properties are falling short of their budgeted projections and not stabilizing at levels to support a valuation needed for permanent financing. Rents are lower than expected. Occupancy is lower than expected. Carrying costs are higher than expected. In some cases, the project sponsors are stepping in to cover cash flow shortfalls to keep interest payments current. When we see these trends, we expect banks to work with their customers to find speedy resolutions; otherwise, these loans may need to be classified or written off if improved financial performance is not achieved.  

With respect to office space, we are seeing continuing high vacancy rates in Houston, Dallas and Austin, which is placing pressure on rents and valuations. While we are seeing more people return to work at their offices—a shift from the pandemic work-from-home format—the vacancies remain high.  

Another final area we are monitoring in commercial real estate is industrial properties that were built to accommodate international trade, given our region’s location along the border. While these properties were built to serve a need, the recent uncertainty with trade policy could curtail demand for these property types. While levels are not immediately concerning, it bears watching to see how banks are reserving for this activity and what concentration levels may mean if certain sectors further decline.

With respect to liquidity, we have seen a significant stabilization of deposit volumes district wide, but the pricing for those funds has cut into bank profitability. Banks and supervisors have been making concerted efforts in the last two years to ensure they have useful contingent funding plans and a variety of funding sources to tap when unexpected funding outflows occur. While Silicon Valley Bank was a very different business model than most traditional banks, the speed and magnitude of their deposit outflow showed us that operational readiness is key in today’s modern digital world.

Here at the Federal Reserve, we continue to work on improving our operational efficiencies, and we recently launched our Discount Window Direct service, which offers online lending to depository institutions eligible for primary credit. In addition, our discount window efforts continue to work with the FHLBs to ensure we reduce any operational frictions in moving collateral. We have representatives from the discount window here at our breaks today who can talk to you about any questions you may have.

Finally, I must mention technology and cyber risk, as it wouldn’t be a banking conference unless we brought up the top risk cited by both supervisors and bankers. Now more than ever, our financial services industry is targeted by criminals to break into systems to take customer data and wreak havoc on the larger financial services population. As our society moves more and more toward an ever-evolving technology world we all—bankers and supervisors—need to upskill in the area of technology. We must evolve these skills to ensure our business decisions drive technology improvements and not the other way around. Such skills also help us stay conversant on how we can proactively avoid the next vulnerability. You’ll find ample places for discussion of these three risks, credit, liquidity, and cybersecurity, during our time today.

In closing, as supervisors and as bankers we share a common goal in creating a healthy banking system in the United States that operates in a safe and sound manner and treats consumers fairly. It’s important that we don’t lose sight of that goal, now more than ever. It’s the public trust built up from decades of supervisors and bankers working on this shared goal that makes this great American banking system work. Engagement at venues such as these is a valuable part of that process. With that, I will turn now to introducing our first segment of the conference.