While the average person thinks that the economy of Texas is all about oil and ranching, that’s just not true any more. The economy of Texas has become much more diversified over the last few decades, and is supported by a strong technology manufacturing base as well as growing agriculture, mining, and software industries, and of course oil and gas production and services.

A recent report from the equity research team at Sterne Agee takes a closer look at the impact of dramatically lower oil prices on the Texas economy, with a particular focus on the banking sector. SA analyst Brett Rabatin crunches the numbers on the Texas banks in his coverage universe and notes that all would remain profitable even under a “worst case” scenario where energy sector loan defaults reached 20%.

Rabatin also notes that office space is downtown Houston is very likely to get cheaper as 3.1 million sf of new office space will be added in 2015 while the energy industry could be cutting close to 50,000 jobs by the end of the year. He goes on to point out that significant defaults in commercial real estate together with the energy sector would be a much more worrisome situation for Texas banks.

Loan loss provisioning at Texas banks

Texas banks

To date, the SA report highlights that only one bank (ZION) has suggested there might be higher loan loss provisioning because of exposure to the energy sector. Rabatin notes that if “oil prices continue to move lower or stay at current levels, we believe there is some risk managements will talk about higher loan loss provisioning in FY15. Our contacts continue to stress to us that near-term risks remain more contained in service exposure, but if oil prices stay below $55 for a few quarters, forward estimates are more at risk.”

Excess downtown Houston office space

Texas banks

Texas banks

The report does forward the thesis that exposure to commercial real estate could lead Texas banks to risk of larger loan losses. In this regard, 58% of Houston’s downtown office space is connected to the oil & gas production or service industry. Given the high likelihood of job cuts and that 3.1 million square feet of vacant office space will become available in Houston in fiscal year 2015, it seems probable rents are going to drop.and vacancy rates increase

Rabatin crunches the numbers, and says that, based on historical data (including a 0.72 correlation between job growth) and net absorption since 1994, he estimates that 50,000 jobs will be lost. This will reduce net office space absorption by around 1.6 million sf in 2015.

Texas banks