FEDERAL DEPOSIT INSURANCE CORPORATION FIRST QUARTER 1997
 

FDIC BOSTON
 

REGION
 

DIVISION OF
 

INSURANCE
 

DANIEL FRYE,
 

SENIOR REGIONAL
 

ANALYST
 

NORMAN WILLIAMS,
 

REGIONAL ECONOMIST
 

In Focus This Quaitei
 

• Consumers Declare Bankruptcy in Record Numbers - Despite 

generally favorable economic conditions, the number of consumers declaring 

bankruptcy is on the rise throughout much of the Boston Region. The increases in 

both personal bankruptcy filings and consumer credit losses are part of a national 

trend which has the attention of industry participants, regulators, and Congress. See 

page 3. 

• New Tax Benefits for Owners of Community Banks - The 

Small Business Job Protection Act of 1996 allows closely held banks, thrifts and 

holding companies to take advantage of various pass-through benefits of the subchapter “S” corporation tax structure. These benefits are potentially substantial and may 

increase the inherent value of community banks. See page 6. 

• Savings Association Insurance Fund (SAIF) Capitalized - After more than two years of hard work by regulators, Congress, and the banking and 

thrift industries, the Deposit Insurance Funds Act of 1996 was passed to address the 

serious problems of the SAIF. See page 10. 

Regu[ai Featuies
 

+Regional Economy +Financial and +Regional Banking 

 Commodity Markets 

· Employment · Interest Rates · Overall Conditions 

· Services and Trade · Bond Values · Asset Quality 

· Retail Sector · Bank Stocks · Earnings 

· Housing Markets · New Products · Consolidation 

· Commercial Real Estate · Loan Growth 

· Funding

 See page 13 See page 17 See page 21 

A Publication of the Division of Insurance For Internal Use Only 

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Dear Reader, 

The prototype edition of the Regional Outlook for the Boston Region is attached. The Regional Outlook is produced 

by the Division of Insurance (DOI) and is designed to discuss events and trends affecting insured depository institutions in your region. This publication will be produced and distributed quarterly in our effort to share information 

and work with the Divisions of Supervision (DOS) and Compliance and Consumer Affairs (DCA) to identify emerging risks to insured depository institutions. 

The publication contains two sections. The first section, In Focus This Quarter, contains several articles which are 

designed to address significant issues affecting insured depository institutions. The articles are not intended to represent an exhaustive coverage of the subject matter or to be examination guidance. The second section, Regular Features, will focus on the Regional Economy, Financial and Commodity Markets, and Banking. This section is not intended to be a substitute for your local or national newspaper but is intended to address some emerging trends and 

relate them to insured depository institutions. 

This publication is regional in focus with individual states and metropolitan areas highlighted where possible. We 

recognize the importance of local economic information to examiners and intend to address that particular need more 

thoroughly in another product. DOI will provide periodic economic analyses at the Field Office level in the future. 

This publication may be distributed on a wider basis in the future, but it was designed largely with an examiner audience in mind. DOI is very appreciative of the time and constructive feedback members of DOS’s and DCA’s 

Chicago staffs provided in the design and testing of the Regional Outlook. Many of the suggestions received from 

those individuals were incorporated into this publication. Your comments on the publication’s format and contents, 

including suggestions for future articles, are welcomed. We also would appreciate your thoughts about the desirability of providing this publication by way of our intra-net homepage, or some other electronic format. 

Sincerely, 

Arthur J. Murton 

Director 

The Regional Outlook is published quarterly by the Division of Insurance of the Federal Deposit Insurance Corporation, 550 17th Street N.W., 

Washington, D.C. 20429. Visit the Division of Insurance online at http://fdic01/division/doi/. For more information on this publication, please call Dan 

Frye at (617) 320-1792 or email him at Daniel E. Frye@DOI@Westwood. 

The views expressed in the Regional Outlook are those of the authors and do not necessarily reflect official positions of the Federal Deposit Insurance 

Corporation. Some of the information used in the preparation ofthis publication was obtained frompublicly available sources and is considered reliable. 

However, its use does not constitute an endorsement of its accuracy by the Federal Deposit Insurance Corporation. 

Ricki Helfer, Chairman, Federal Deposit Insurance Corporation 

Arthur J. Murton, Director, Division of Insurance 

Editorial Board	 George E. French, Deputy Director 

Stephen Linehan, Assistant Director, Analysis Branch 

Ronald L. Spieker, Chief, Depository Institutions Analysis Section 

Maureen E. Sweeney, Special Assistant to the Director 

Design and Production	 Steven E. Cunningham, Senior Financial Analyst 

Diane Ellis, Senior Financial Analyst 

The authors wish to acknowledge the assistance provided by Don Inscoe and Jon Wisnieski of the Division of Research and Statistics in providing 

some of the data used in this publication. Any errors are the responsibility of the authors. We would also like to thank the employees of the Division of 

Supervision and Division of Compliance and Consumer Affairs in the Chicago Region for providing feedback used in the development and design of 

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In Focus This Quarter
 

Consumers Declare Bankruptcy in Record Numbers 

Trend Raises Concerns about Consumer Credit 

• 	 Despite favorable economic conditions, personal 

bankruptcy rates are rising throughout the 

Boston Region. 

• 	 Bankruptcy rates in the Region are generally 

lower than the national average. 

• 	 Credit card charge-offs are approaching recession levels. 

Despite generally favorable economic conditions, the 

number of consumers declaring bankruptcy is on the rise 

throughout much of the Boston Region. The increases in 

both personal bankruptcy filings and consumer credit 

losses are part of a national trend which has the attention 

of industry participants, regulators, and Congress. Both 

the Senate and House Banking Committees have held 

hearings on the condition of consumer credit, particularly credit card lending. Much of the concern regarding 

these trends is due to the fact that bankruptcy filings and 

charge-offs are rising despite low unemployment and 

rising income levels. 

How Do the New England States Compare? 

New England’s bankruptcy trends are similar to the 

nation’s but somewhat more favorable (see Chart 1). 

Both New England and national bankruptcies reached 

their prior peak in 1992, declined slightly for two years, 

and are now climbing again. Bankruptcy filings accelCHART 1

erated rapidly during 1996 and have reached new 

record levels. Individually, the six states in the Region 

have followed this same basic pattern. 

National rankings show the following: 

• 	 Rhode Island has the highest level of bankruptcies 

per capita of any state in the Boston Region, ranking 

twentieth nationally with roughly four bankruptcies 

per 1,000 residents. 

• 	 Connecticut and New Hampshire rank twenty-ninth 

and thirty-third, respectively, while Massachusetts 

ranks forty-first. All three states rank significantly 

below the national average. 

• 	 The more rural states of Maine and Vermont rank 

forty-eighth and forty-ninth, both with just over two 

bankruptcies per 1,000 residents. 

Chart 2 shows the rising trend in consumer loan losses 

in the Boston Region as well as the close relationship 

between these losses and personal bankruptcy filings. 

Why Are Consumer Credit Losses Rising in an 

Expanding Economy? 

The emergence of consumer credit problems during an 

expanding economy is not unprecedented. During the 

last economic expansion, consumer delinquency and 

charge-off rates also rose. Consumer debt tends to rise 

when employment rises because households are more 

CHART 2

Regional Bankruptcy Rates Continue To Personal Bankruptcies Correlate with 

Rise but Remain Below the Nation Consumer Loan Charge-offs in the Region 

Per Capita Filings 

4.5 

4.0 

3.5 U.S. 

3.0 

2.5 

2.0 New England 

1.5 

1.0 

Filings 

(000s) 2.5% 

40 2.0% 

30 1.5% 

20 1.0% 

Gross Charge-off Rates 10 0.5% 

0 0.0% 

91 92 93 94 95 96 

90 91 92 93 94 95 96 Sources: Administrative Office of the United States Courts and Bank and 

Source: Administrative Office of the United States Courts 

Thrift Call Reports (RIS). Based on a design by the FDIC's Division of 

Research and Statistics. 

Regional Outlook	 3 First Quarter 1997 

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In Focus This Quarter
 

willing to incur debt and banks are more willing to lend. 

Chart 3 shows that past cycles of rising growth in 

consumer credit have been followed by rising delinquency rates, even during periods of expansion. 

As the expansion closes out its sixth year, American 

consumers are holding historically high levels of consumer debt -- the ratio of total consumer debt service 

payments, including mortgage, to disposable personal 

income is approaching record highs and is currently at 

17 percent. High debt levels appear to be the result of 

several years of economic expansion along with credit 

card companies’ intensive efforts to generate and feed 

consumers’ appetite for credit. Consumers and their 

lenders are now experiencing the after-effects of this 

credit expansion. 

Why Are Bankruptcy Rates Rising? 

Nonbusiness bankruptcy filings for 1996 will exceed 

one million for the first time in U.S. history. This level 

is 11 percent higher than the peak in the last recession 

and a 14 percent increase over 1995 filings. A variety 

of theories have been advanced to explain this trend. 

These theories include the following: 

• 	 Consumers have overextended themselves. 

• 	 Recent changes in bankruptcy laws make it easier to 

shield assets from creditors. 

• 	 Changes in legal practices promote bankruptcy. 

• 	 The social and financial repercussions associated 

with bankruptcy have diminished. 

In fact, the trend is likely the result of several factors, 

many of which are interrelated. 

A recent study by SMR Research Corporation atCHART 3

tributes differences in filing rates more to state regulations than to economic conditions. The study found that 

bankruptcy is driven by the number of and exposure to 

catastrophic events. The report identifies several important factors such as: 

• 	 inadequate health insurance; 

• 	 inadequate auto insurance; 

• 	 a large percentage of self-employed workers; 

• 	 garnishment of wages; 

• 	 high debt-to-income ratios; and, 

• 	 high divorce rates. 

All of these conditions increase consumers’ exposure to 

catastrophic events, such as job loss, that are typically 

associated with personal bankruptcy. 

Of interest to lenders is that some traditional early 

warning signs of trouble -- such as erratic missed 

payments or paying off a smaller share of outstanding 

balances -- are not evident this time. Some banks are 

finding that obligations due to them are being wiped 

out in bankruptcy court on accounts that showed no 

prior problems. 

Implications for Insured Institutions 

These trends have raised concerns about the outlook for 

credit card lenders. As shown in Chart 4, credit card 

charge-offs are approaching levels not seen since the 

aftermath of the 1990-1991 recession. During that 

recession, charge-off rates increased sharply. The question arises whether there would be a similar sharp 

increase in credit card losses during a future recession, 

driving credit card loss rates to levels well above their 

previous peak. 

This concern is heightened by a number of factors. 

Consumer debt burdens are at historic highs. Profit 

CHART 4

U.S. Consumer Delinquency Rate Tends to 

Rise After Credit Growth Accelerates 

ABA Composite % Change in 

Delinquency Rate Consumer Loans 

30% 2.7% 

2.5% 20% 

2.3% 10% 

2.1% 

0% 1.9% 

1.7% -10% 

80 82 84 86 88 90 92 94 96 

Sources: American Bankers Association and Federal Reserve Flow of 

Funds 

8687888990919293949596 

U.S.Credit Card Charge-Offs Are 

Approaching Levels Not Seen 

Since the Last Recession 

5.0 

4.5 Recession 

4.0 

3.5 

3.0 

2.5 

Source: Federal Reserve Board 

Regional Outlook	 4 First Quarter 1997 

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In Focus This Quarter
 

margins for the nation’s specialty credit card lenders 

(institutions whose total loans exceed 50 percent of 

managed assets and whose credit card loans exceed 50 

percent of total loans) have rapidly narrowed from a 

4.25 percent quarterly return on assets (ROA) in the 

third quarter of 1994 to a 2.02 percent quarterly ROA in 

the third quarter of this year. Competitive pressures on 

pricing and underwriting remain intense, as some companies continue aggressive card solicitations, and there 

are few signs of any slackening of price competition. A 

sharp rate cut for AT&T credit cards, one of the largest 

credit card lenders, is a recent salvo in this price 

competition. Lenders also place great reliance on 

credit scoring models that have not yet been tested in 

a recession and, according to a recent Federal Reserve 

survey, appear overly optimistic in almost two-thirds of 

the banks surveyed. 

Other factors mitigate these concerns to some extent. 

Pricing of credit card loans has traditionally built in a 

margin of comfort for high and volatile losses. Loan 

portfolios are diversified with many small loans to 

individuals. There are preliminary indications that 

lenders and borrowers are retrenching to some extent. 

Consumer credit growth slowed from over 14 percent in 

both 1994 and 1995 to an annualized rate of 8 percent 

(seasonally adjusted) for the first ten months of 1996. In 

the Federal Reserve survey just mentioned, two-thirds 

of banks reported raising the score an applicant must 

achieve to qualify for credit, and one-third reduced 

credit limits for existing customers. 

New England banks, on the whole, show lower delinquency and charge-off rates than the national averages. 

There are only two true credit card banks in the Region, 

both of which have loss rates below the national average, as well as strong earnings and capital. 

Generalizations about the outlook for credit card lending 

are difficult. Trends that describe the industry on 

average may not hold true for particular institutions. 

Performance is likely to vary substantially, with results 

depending on the risk management practices and underwriting standards of each institution. Given the trends 

outlined above, credit card lending practices appear 

worthy of continued close attention by bankers and 

regulatory agencies. 

Diane Ellis, Senior Financial Analyst 

Laura Filkins, Division of Supervision 

Regional Outlook 5 First Quarter 1997 

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In Focus This Quarter
 

New Tax Benefits for Owners of Community Banks 

Subchapter “S” Benefits Now Available 

• 	 Potential benefits are substantial. A layer of tax 

expense has been eliminated. 

• 	 Eligibility is restricted and requires care to maintain. 

• 	 While no application to the banking agencies is 

required, the new tax structure has supervisory 

implications. 

• 	 The new tax structure has some potential drawbacks. 

Introduction 

The Small Business Job Protection Act of 1996 allows 

closely held banks, thrifts and holding companies to take 

advantage of various pass-through benefits of the subchapter “S” corporation tax structure. These benefits 

are potentially substantial and may increase the inherent 

value of community banks. 

Eligibility Is Restricted 

The new law allows, for the first time, financial institutions including banks, thrifts and holding companies to 

elect subchapter “S” status if they meet several criteria. 

The most important of these requirements are that the 

company not use the reserve method of accounting for 

bad debts for tax purposes and that it have 75 or fewer 

eligible shareholders. All shareholders must consent to 

the subchapter “S” election and the IRS must consent to 

any change in the tax accounting for bad debts. To be 

able to receive the benefits for tax year 1997, institutions need to meet the requirements by year-end 1996. 

Reserve accounting for bad debts for tax purposes is an 

issue affecting only smaller institutions. Currently, 

reserve accounting is allowed only for those thrifts and 

banks under $500 million in assets that are not part of a 

group with more than $500 million in assets. To elect 

the new tax status, the subchapter “S” company will 

need to make the accounting change to the specific 

charge-off method for tax purposes. Presumably, the 

IRS will not object to any such change, which can delay 

deductions and increase taxable income, and will allow 

the change to be effective as of the beginning of the tax 

year. 

In relation to shareholder eligibility, ownership of 

subchapter “S” corporations is limited to individuals, 

estates and a few types of trusts. At present, certain 

shareholders, such as corporations, Employee Stock 

Ownership Plans (ESOPs) and other stock bonus 

plans, may not hold shares in subchapter “S” corporations. Once the subchapter “S” election is taken, the 

corporation and its shareholders must take care to 

continue to meet all eligibility requirements or risk 

losing the tax benefits. 

Benefits to Shareholders 

The tax benefits of the “S” corporation are similar to 

those of a partnership. The earnings of the corporation 

generally are not taxed at the corporate level but pass 

directly to shareholders’ personal income. As such, 

cash distributions to shareholders are not subject to 

an additional layer of taxation, which results in a 

reduction in overall 

taxes. Shareholders remain liable for personal 

taxes on their proportion- Industry observers 

ate share of the corpora- have suggested that 

tion’s taxable income. over 1,000 banks 

Distributions formerly nationwide will 

paid directly to the IRS by make the 

the institution generally subchapter “S” 

would be made to the election. 

shareholders, providing 

them with the funds to pay 

income taxes on their share of the corporate income. 

An interagency letter, FIL-91-96 dated October 29, 

1996, notes that these distributions will be treated as 

dividends by the regulatory agencies. 

Table 1 illustrates the tax advantages of an “S” corporation. In this example, assume that a bank under the 

traditional corporate tax structure (“C” corporation) 

has pre-tax earnings of $1,000, that tax rates are 40 

percent at both the corporate and the shareholder 

level, and that the dividend payout rate is 50 percent 

of net income. These conditions for the bank are 

shown in column A. Under this scenario, the bank 

retains earnings of $300, while the net return to shareholders is $180. 

Column B illustrates how under the “S” corporation 

Regional Outlook	 6 First Quarter 1997 

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In Focus This Quarter
 

structure an additional $120 of earnings is retained at 

the corporate level ($420 versus $300), while the net 

return to shareholders remains the same as under the “C” 

corporation structure ($180). 

If retained earnings are held at the same level under the 

traditional corporate tax structure, as illustrated in Column C, return to shareholders increases to $300, a 67 

percent increase over the return under the “C” corporation structure. For illustration purposes, tax rates were 

held constant at 40 percent but will vary widely depending on such things as geographic location and marginal 

tax rates. As this example illustrates, the “S” corporation structure may be most advantageous for institutions 

in a low growth mode, with little need to retain earnings 

at the corporate level. In these particular cases, the 

return to shareholders can be enhanced significantly. 

In addition to the elimination of a layer of taxation, there 

is an additional tax benefit to the “S” corporation structure, related to the taxation of capital gains. Banks 

generally retain a large portion of income as capital to 

support anticipated growth. Retained earnings increase 

the value of a bank and therefore increase the value of 

its stock. Shareholders of a bank operating under 

traditional corporate tax rules do not receive an increase in the tax basis of their stock based upon this 

increase in value. However, “S” corporation shareholders increase the tax basis of their investment by the 

amount of income retained by the bank. This higher tax 

basis means that shareholders would have a smaller 

capital gain in the event of a stock sale. A smaller 

capital gain translates into a smaller capital gains tax for 

TABLE 1

additional tax savings. 

Adding value and flexibility to the “S” corporation 

structure is the ability to wholly own other “S” corporations. These rules allow holding companies and their 

bank or savings association subsidiaries to be “S” 

corporations. 

Other Tax Liabilities 

For bank or thrift companies that elect to convert to “S” 

corporation status, there are potentially some other corporate tax liabilities for unrealized gains accumulated 

through the date of conversion. As an example, should 

the fair market value of all company assets exceed the 

adjusted tax bases of these assets, there may be some 

corporate tax liability if any assets are later sold. Assets held on conversion date and sold within the next ten 

years require a calculation for “Built-in Gains Tax” 

(BIG tax) to determine any tax at the corporate level. 

Other Drawbacks 

To receive the benefits of the subchapter “S” election, 

the institution will need to meet all the eligibility requirements for every day of the tax year. Furthermore, 

the IRS has not yet resolved all the tax issues related to 

the subchapter “S” election on the part of financial 

institutions. Specific guidelines from the IRS are expected by year-end 1996 which may affect an institution’s decision to elect subchapter “S” status. 

TAX ADVANTAGES OF AN "S" CORPORATION

A B C

"C" CORP "S" CORP "S" CORP

CORPORATE EARNINGS, PRE•TAX

CORPORATE TAXES

NET INCOME AFTER TAX

DIVIDEND/DISTRIBUTION

RETAINED EARNINGS • CORPORATION

SHAREHOLDER INCOME

SHAREHOLDER TAXES*

NET INCOME TO SHAREHOLDER

 $1,000 $1,000 $1,000

400 0 0

600 1,000 1,000

300 580 700

300 420 300

300 580 700

120 400 400

$180 $180 $300

*SHAREHOLDER TAXES FOR "S" CORP ARE BASED ON $1,000 PRE•TAX CORPORATE EARNINGS AT 40%.

Regional Outlook 7 First Quarter 1997 

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In Focus This Quarter
 

The states of Connecticut, Michigan, New Hampshire, 

New Jersey, and Tennessee, as well as the District of 

Columbia, do not recognize the federal subchapter “S” 

election. Therefore, these jurisdictions do not allow the 

pass-through benefits of the “S” corporation for the 

applicable state or district taxes. 

Subchapter “S” institutions remain under the same capital adequacy standards and dividend restrictions as 

other institutions. However, there are times when it may 

be difficult to maintain the subchapter “S” status. An 

example would arise when an institution needs to raise 

capital to meet Prompt Corrective Action (PCA) guidelines. To meet the IRS requirements for subchapter 

“S” election while raising the necessary capital, current shareholders may have to be the primary source 

of new capital. The ability to raise additional capital 

by attracting new eligible shareholders may be difficult 

because the total number of eligible shareholders must 

remain 75 or fewer to preserve the “S” status. Furthermore, no new classes of stock may be issued. Violation 

of any of these criteria would result in the loss of the 

subchapter “S” status and reversion to regular corporate 

tax rules. 

Distributions to shareholders are covered by similar 

restrictions for subchapter “S” corporations as for regular corporations. However, one possible new twist is 

that, in some cases, the tax liability payment for shareholders may be due before distributions are funded from 

the institution. However, this is considered similar to 

pressures brought by shareholders in other corporations 

when they require dividend payments to fund debt payments on stock loans. 

Supervisory Implications 

While an application to bank regulators is not required 

for this tax election, there may be a rise in various 

“phantom bank mergers” or change-in-control applications as companies work to meet shareholder number 

requirements or attempt to get the required 100 percent 

shareholder approval. 

Shareholders may enter agreements that place limits 

on their ability to sell their stock. In addition, the 

mechanics of a conversion will require some special 

expertise for the bank in tax law and accounting. The 

change from the reserve method to the specific chargeoff method for bad debts or the existence of net operating losses may present unique circumstances for each 

institution. 

Bank portfolios also may undergo changes prompted 

by shareholders’ requests. An example might be 

increased purchases of 

tax-free securities to 

meet the desires of 

There may be a rise in shareholders for more 

tax-free interest. An- various “phantom 

other may arise from a bank mergers” or 

tendency to remove ac- change in control 

cumulated earnings to applications as the 

pay personal taxes as companies work to 

the corporation gener- meet shareholder 

ates earnings. This number requirements 

could place a strain on or attempt to get the 

capital in situations required 100 percent 

where growth is strong shareholder approval. 

or delinquent assets are 

rising. 

Election of “S” corporation tax status also has implications for financially troubled institutions and distributions to “S” corporation shareholders. The FDIC 

currently considers such distributions to be dividends; 

therefore, the FDIC has the authority to restrict or 

prohibit distributions in a problem institution. It is 

conceivable that taxes would have to be paid by 

individual shareholders regardless of whether an actual distribution or dividend had been paid. This is 

obviously not advantageous for shareholders. 

Operating losses of an “S” corporation also can 

result in a more rapid deterioration of a bank’s 

financial condition as losses flow through to the 

bottom line, dollar for dollar. This is because the 

“hidden capital” available to most “C” corporations through tax loss carrybacks is not available to 

the “S” corporation. In this situation, shareholders 

will continue to receive a benefit in the form of 

reduced personal income taxes to the extent that the 

bank’s operating losses shelter other personal income. 

While figures on the number of eligible institutions are 

not available, the numbers of small banks in the 

Region may provide some insight. There are approximately 90 banks in the Boston Region with less than 

$250 million in total assets (excluding mutual savings 

banks), and some of these banks may meet the current 

eligibility requirements. It is likely that this type of 

structure will be most beneficial for smaller community banks which are closely held, probably by a 

family or related groups. This type of tax conversion 

is likely to be more common in other regions of the 

country, where small, rural banks are frequently 

owned and operated by family interests. Industry 

Regional Outlook 8 First Quarter 1997 

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In Focus This Quarter
 

observers have suggested that over 1,000 banks nationwide will make the subchapter “S” election. 

There may be an increase in de novo applications and 

leveraged buyouts as investors see the tax advantages to 

owning a bank. Investors in new “S” corporation banks 

can get an immediate return on their investment through 

tax losses. Ordinarily, investors would have to wait 

years until a new bank could achieve a level of profitability sufficient to support dividend payments. 

Changes in tax status also may slow down the pace of 

mergers and acquisitions. Because an institution’s 

shareholders profit from the “S” tax structure, an acquirer might have to pay much more to entice “S” 

corporation shareholders to sell than would normally be 

true for “C” corporation institutions. 

New Value for the Community Bank Charter 

Overall, this newly legislated tax break for closely-held 

financial institutions may invigorate the value of the 

community bank or thrift. However, it also adds a new 

“wrinkle” in the complexity of the examiner’s job. 

While consolidation trends can be expected to continue 

at larger companies, the new tax benefits available for 

closely-held institutions add a new incentive for the 

survival of community banks and thrifts. 

Ronald L. Spieker, Chief,
 

Depository Institutions Analysis Section,
 

Daniel Frye, Senior Regional Analyst *
 

* Extensive review and comments were provided by Robert F. 

Storch, Chief, Accounting Section of the Division of Supervision. 

For More Information 

Subchapter S Election for Federal Income Taxes. FIL91-96. 

Regional Outlook 9 First Quarter 1997 

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In Focus This Quarter
 

Savings Association Insurance Fund (SAIF)

 Capitalized
 FDIC Lowers Assessment Rates 

• 	 SAIF was capitalized through a $4.5 billion 

special assessment. Banks and thrifts in the 

Boston Region paid $70 million of this total. 

• 	 Bank Insurance Fund (BIF) members will bear 

part of the cost of the Financing Corporation 

(FICO) bonds beginning in 1997. 

• 	 The special assessment negatively affects 1996 

operating performance, but earnings prospects 

are greatly enhanced by a proposal to lower 

future SAIF assessment rates. 

Why Was Action Needed? 

After more than two years of hard work by regulators, 

Congress, and the banking and thrift industries, the 

Deposit Insurance Funds Act of 1996 (Act) was 

passed to address the serious problems of the SAIF. 

The difficulties facing the SAIF were substantial and 

demanded a solution. They primarily fell into the 

following areas: 

• 	 SAIF was undercapitalized and there was concern that one large, or several sizable, thrift 

failures could quickly deplete the fund balance. 

TABLE 1

Its balance was $3.9 billion, or 0.55 percent of 

insured deposits, on June 30, 1996, well below 

the target reserve ratio of 1.25 percent of insured 

deposits. 

• 	 Over 45 percent of SAIF assessments were being 

diverted from the SAIF to pay off FICO obligations arising from the thrift failures of the 1980s. 

• 	 The SAIF assessment 

base continued to Nearly 80 percent of 

shrink, with a 22 per- the Boston Region’s 

cent reduction noted institutions paying 

from year-end 1989 to the special 

June of 1996. assessment posted a 

quarterly net 

• 	 Disparity between operating loss for SAIF and BIF premi- the third quarter of ums created strong 1996 ... economic incentives 

for institutions to 

transfer SAIF-assessable deposits to affiliated 

institutions insured by the BIF, contributing to the 

shrinkage in the SAIF assessment base. 

BOSTON REGION INSTITUTIONS AFFECTED BY SAIF SPECIAL ASSESSMENT

# OF INSTITUTIONS

AFFECTED AND TOTAL

ASSESSMENT BY TYPE

BIF INSURED

SAVINGS BANKS

SAIF INSURED

SAVINGS BANKS

COMMERCIAL

BANKS

TOTAL

CONNECTICUT

MASSACHUSETTS

MAINE

NEW HAMPSHIRE

RHODE ISLAND

VERMONT

# $000 # $000 # $000 # $000

4

5

3

2

1

0

1,039

683

1,814

1,023

4,535

 0

12

23

10

 6

 2

 3

17,354

18,685

 2,508

 6,390

 422

 4,640

1

6

0

3

1

0

1,163

8,429

0

 731

 474

 0

17

34

13

11

 4

 3

19,556

27,797

 4,322

 8,144

 5,431

 4,640

TOTAL 15 9,094 56 49,999 11 10,797 82 69,890

SOURCE: DERIVED FROM EARLY ESTIMATES FROM THE FDIC'S DIVISION OF FINANCE.

Regional Outlook	 10 First Quarter 1997 

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In Focus This Quarter
 

What Significant Actions Were Taken? 

Special Assessment: In order to address the immediate 

problems, the Act required the FDIC Board of Directors to impose a special assessment of approximately 

65.7 basis points on SAIF-member institutions. The 

special assessment was designed to increase the fund’s 

level to 1.25 percent of insured deposits effective October 1, 1996. In determining the amount, the Board: 

• 	 Exempted weak and other specifically defined institutions from paying the special assessment. 

• 	 Decreased by 20 percent the amount of SAIFassessable deposits against which the special assessment will be applied for certain Oakar and 

other institutions. (An Oakar institution is a member of one insurance fund that has acquired deposits 

insured by the other fund. The acquired deposits 

retain coverage under the seller’s fund.) 

There were no exempted institutions in the Boston 

Region. Eighty-two institutions in the Boston Region 

collectively paid about $70 million to the SAIF in 

November. As Table 1 (previous page) indicates, the 

special assessment affects more than just thrifts. This is 

due to the substantial number of banks that have acquired SAIF deposits through acquisitions or branch 

TABLE 2

purchases over the last few years. 

FICO Costs: The recently enacted legislation also 

addressed another legacy of the problems thrifts experienced in the 1980s -- FICO bonds issued in 1987 to help 

shore up the former Federal Savings and Loan Insurance 

Corporation (FSLIC). The cost of financing this debt, 

about $800 million per year, was a major reason the 

SAIF had not improved as quickly as the BIF. 

The Act authorized FICO to impose periodic assessments on BIF members in addition to members of SAIF 

that were already being assessed. The FICO charge on 

BIF-assessable deposits must be one-fifth the charge on 

SAIF assessable deposits. As a result, the FICO 

charge on SAIF-assessable deposits for the first semiannual assessment period of 1997 will be 6.48 basis 

points (annualized), and the charge on BIF-assessable 

deposits will be 1.30 basis points (see Table 2). As 

necessary, FICO rates will be adjusted on a quarterly 

basis to reflect changes in the assessable-deposit bases 

for the BIF and the SAIF. Beginning on January 1, 2000, 

or, when the insurance funds merge, whichever occurs 

earlier, BIF and SAIF members will share the FICO 

assessment on a pro rata basis. (FICO assessments will 

be paid in addition to the deposit insurance assessments. 

See discussion below.) 

Final Rule to Lower SAIF Assessment Rates: With 

the SAIF now capitalized by the special assessment, the 

Regional Outlook 11 First Quarter 1997 

FDIC Board of Directors lowered the rates on ongoing 

assessments paid to the SAIF. The Board also widened 

the spread between the lowest and highest rates to 

improve the effectiveness of the FDIC’s risk-based 

premium system. 

The final rule establishes an adjusted SAIF rate schedule of 0 to 27 basis points effective for all non-exempt 

institutions beginning January 1, 1997. (Since only 

SAIF-member savings associations must, by law, pay 

for FICO assessments until the end of 1996, a special 

interim rate was established for SAIF-member savings 

associations for the last quarter of 1996.) 

As is noted in Table 2, institutions exempted from 

paying the special assessment will not benefit initially 

from the lower SAIF assessment rates. They will pay 

according to the 23- to 31-basis point schedule through 

year-end 1999, unless they choose to make a pro rata 

payment of the special assessment in the interim. 

Implications for Insured Institutions 

Institutions that are required to pay the SAIF special 

SUMMARY OF 1997 ASSESSMENT

RATES *

1997 ADJUSTED BIF & SAIF SCHEDULE

CAPITAL SUPERVISORY SUBGROUP

GROUP A B C

1 0 3 17

2 3 10 24

3 10 24 27

EXEMPT INSTITUTION SAIF SCHEDULE

1 23 26 29

2 26 29 30

3 29 30 31

FICO ANNUAL RATES

BIF INSTITUTIONS SAIF INSTITUTIONS

1.30 6.48

* CENTS PER $100 OF DOMESTIC DEPOSITS

SOURCE: FDIC'S DIVISION OF INSURANCE

PROTOTYPE
 
 

 

 

 

 

 

 

 

 

 

 

In Focus This Quarter
 

assessment should have accrued a liability and an off- For More Information 

setting noninterest expense as of September 30, 1996. 

As a result, many such institutions will reflect much 

lower operating earnings this year. In fact, nearly 80 

percent of the Boston Region’s institutions paying the 

special assessment posted a quarterly net operating loss 

for the third quarter of 1996 primarily due to the special 

assessment. 

Concerns over the short-term financial impact described 

above are moderated by much brighter future prospects. 

First, the special assessment is a one-time charge and 

should not affect future earnings streams of nonexempt 

institutions. Second, the proposed lower SAIF assessment rates should actually help to boost net income in 

1997. Finally, some observers have noted that the 

resolution of the SAIF’s deficiencies should remove 

uncertainties that may have depressed stock prices of 

SAIF-member institutions. Over the longer-term, the 

capitalization of the SAIF and the change in assessment 

rates also pave the way for a dialogue about a possible 

merger of the two deposit insurance funds. 

John D. Weier, Chicago Senior Regional Analyst 

• 	 SAIF Assessments. FIL-88-96 

• 	 Accounting for the SAIF Special Assessment and 

FICO Assessments. FIL-90-96 

• 	 Federal Register 61, No. 201, pp. 53834-53841: 

Assessments. 

• 	 Federal Register 61, No. 201, pp. 53867-53876: 

Proposed Rules - Assessments. 

• 	 Press Release 79-1996 and 63-1996. 

• 	 Chairman Helfer’s Speeches: July 19, 1996, and 

October 28, 1996. 

Regional Outlook	 12 First Quarter 1997 

PROTOTYPE
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Regular Features	 The Regional Economy
 

Boston Region: Recovery Continues Slowly
 

But Steadily
 

• 	 New England has been in recovery for four years, but some areas dominated by depressed industries 

(fishing, defense, insurance) are lagging. 

• 	 Weak population inflows and a generally high cost of doing business are likely to hamper further economic 

growth, increasing the Region’s susceptibility to any U.S. slowdown. 

• 	 The growing importance of financial services to real estate and employment may change the nature of 

economic risks in the Region. Consolidation and deregulation in health care and utilities also may pose 

risks in 1997 and beyond. 

• 	 Commercial real estate markets are tight around the Boston area. Growth in employment from technology 

and financial services companies has absorbed much of the existing space, although speculative building 

Who Will Fill New England’s Jobs? 

The ongoing economic recovery has slowly spread from 

the northern-most states (where jobs lost to the recession have already been restored) to the South. Connecticut, because of its prior reliance on defense manufacturing and a consolidating insurance industry, continues to 

lag the rest of the Region’s recovery. The pace of 

recovery in New England has been anemic, at best. An 

example of this can be seen in the Region’s slow pace of 

job creation in recent years (see Chart 1). In 1996, for 

instance, the Region saw job growth of only 1.2 percent 

— little more than one-half the national pace of 2.2 

percent. 

Population outflows, and thus reductions in the labor 

force, have helped the Region to obtain unemployment 

rates generally below those in the rest of the nation. 

However, low statewide unemployment rates disguise 

some persistent pockets of higher unemployment 

across the Region, particularly in rural areas or in areas 

dominated by one or two industries currently in decline, 

such as defense, insurance, and fishing. 

Future economic growth in New England will hinge on 

drawing new labor supply to the Region and on reemploying qualified but “discouraged” workers who are 

still in the Region but are not counted in the official 

statistics. Firms are currently having trouble filling 

high-end jobs in technology fields due to a limited 

number of qualified U.S. applicants. Further, limits on 

skilled immigrant labor to fill these posts are a concern 

among many technology companies in New England. 

Retailers and other employers that are seeking to fill 

low-wage jobs also are finding it difficult to hire enough 

employees. 

National developments, such as the ongoing consolidation in financial services and health care, as well as 

progress toward electric utility deregulation, may 

pose some risk to the Region’s economy in the coming 

year. Furthermore, the Region’s generally high cost of 

doing business (labor and energy) will likely continue to 

limit development going forward -- particularly in manufacturing. Unfortunately, five of the six New England 

states have the dubious distinction of being in the 

top-ten most costly states in the nation. According to 

rankings by Regional Financial Associates, Connecticut 

ranks second (behind Hawaii), Massachusetts takes 

fourth, Vermont eighth, Rhode Island ninth, and Maine 

tenth -- New Hampshire is close behind in twelfth place. 

Implications: The anemic economic expansion may 

add to consolidation pressures, as banks try to preCHART 1

-6 

-4 

-2 

0 

2 

4 

87 88 89 90 91 92 93 94 95 96 

U.S. 

New England* 

Region's Nonfarm Job Growth Consistently 

Lags the Nation 

(Year Over Year Percent Change) 

Note: Regional data for 1996 are annualized. 

Source: Bureau of Labor Statistics 

Regional Outlook	 13 First Quarter 1997 

PROTOTYPE
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Regular Features The Regional Economy
 

serve revenue and earnings growth. Limits on labor 

supply also could result in rising wages, further hampering the Region’s business climate. The negative effects 

of slow growth in New England may be offset somewhat 

by the diversity of industries in the Region, such as 

financial services and technology companies that rely on 

broader U.S. and international markets for much of their 

revenue growth. Also, as can be seen in Chart 2, the 

Region’s recovery has resulted in fewer business failures, thus reducing credit risks for banks with commercial loan exposures. 

Region Continues Industry Diversification 

Services and Trade Driving Growth: Economic activity in the six-state New England area is centered in 

Massachusetts (47 percent of the Region’s personal 

income) and Connecticut (29 percent). Both states’ 

economies are fairly well diversified across the services, trade, and manufacturing sectors as measured by 

shares of labor income. Services and trade have accounted for most of recent job gains. In Massachusetts 

and Connecticut, industry concentrations exist in financial services (insurance and mutual funds), health care, 

transportation equipment (mostly defense-related), electronics/computers, education, business consulting, and 

allied services. 

While manufacturing employment generally declined 

during the first ten months of 1996, business services 

and health care produced some of the major job gains in 

Massachusetts and Connecticut. 

The northern part of the Region’s economy (Vermont, 

New Hampshire, and Maine) is more intensely driven 

by tourism and natural resource industries (forest prodCHART 2
 

ucts and fisheries) than are the southern-most states. 

Retail Sector Rebounding: Strong labor demand and 

earnings, both for entry-level and skilled/professional 

positions, should help retail sales rebound from a weak 

1995. A strong stock market should support wealtheffect spending for upper-end and luxury retailers, while 

strong home sales should benefit sales of furniture, 

appliances, and other durable goods across the Region 

in the fourth quarter. 

Year-to-date through September 1996, retail sales in 

Massachusetts were up 7.2 percent over 1995. The 

comparable figure for last year was a meager 2.8 percent, while the year-over-year gain in 1994 was 8.4 

percent (the highest since 1988). 

Implications: The retail climate in the Region, mirroring national trends, has seen large mass-market retailers 

acquiring dominance over traditional retailers. This has 

affected local real estate markets, as these new formats 

require larger, built-to-suit space -- usually in suburban 

areas. Fortunately, many smaller retail buildings are 

turning to specialty/non-retail tenants, keeping overall 

vacancy rates low. This reuse of space has mitigated 

risks to financial institutions with retail real estate 

exposure. 

Real Estate Markets Firming 

Existing Home Sales Fully Revived 

Region’s Improved Economy Means Fewer Business Failures 

Note: Data for 1996 are annualized. 

Source: Dun & Bradstreet 

0 

100 

200 

300 

400 

500 

600 

700 

800 

900 

86 87 88 89 90 91 92 93 94 95 96 

NH 

RI 

ME 

VT 

0 

500 

1000 

1500 

2000 

2500 

3000 

3500 

86 87 88 89 90 91 92 93 94 95 96 

MA 

CT 

Regional Outlook 14 First Quarter 1997 

PROTOTYPE
 

 

 

 

 

 

 

 

 

 

 

 

 

Regular Features The Regional Economy
 

Despite a dearth of population growth, existing home 

sales have been strong in many parts of the Region. 

This has been due to the limited availability of rental 

housing and a recovery in home prices; frustrated 

owners have finally seen prices 

surpass their original purchase 

price, encouraging them to list 

their homes. Quarterly sales figures through September 1996 

show that sales rates have 

reached (and surpassed) their 

mid-1980s highs in Massachusetts (see Chart 3). New 

Hampshire sales also have recently surged to new 

all-time highs. Connecticut’s market has recovered 

from its 1990 slump, but sales have remained relatively flat for the last three years. 

During the second quarter of 1996, median existing 

home prices surpassed their late 1980s peak, rising 9 

percent in the greater Boston area from a year earlier 

versus a 7 percent increase nationally. Inflationadjusted prices, however, remain about 20 percent 

below their last high. In Connecticut, prices over the 

year were up 5 percent in Hartford (but off 15 percent 

from their 1988 high). 

Implications: Expectations for limited population 

growth in the Region probably will mean home sales 

activity will stabilize or fall somewhat from current 

peaks. As banks’ mortgage origination businesses 

come under pressure from lower volume growth, some 

focus may shift to home equity lending. New mortgage 

growth may depend to some extent on the continuation 

of favorable interest rates. Turnover in existing 

homes should be supported by owners seeking to 

trade up (or down) into newer homes and by renters 

driven to ownership by the Region’s rising rental 

rates and dearth of quality rental housing. 

Commercial Real Estate Improved 

TABLE 1
 

COMMERCIAL VACANCY RATES IMPROVED

3Q96 LAST PEAK

INDUSTRIAL OFFICE INDUSTRIAL OFFICE

BOSTON

HART•

FORD

STAM•

FORD

7.9 8.2 10.1 18.4

8.6 22.8 14.3 25.2

6.3 15.0 12.7 32.8

NOTE: DATA COVER THE METROPOLITAN AREA AND ARE AVERAGE FOR

THE PERIOD.

SOURCE: CB COMMERCIAL

CHART 3
 

0 

10 

20 

30 

40 

50 

60 

70 

80 

90 

81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 

Source: National Association of Realtors 

Region's Home Resales Revived 

(000 units, quarterly seasonally adjusted annual rate) 

Massachusetts 

Connecticut 

Apartments: As evident in Table 1, the Region’s 

commercial real estate markets have generally improved since the depths of the last recession. However, pockets of excess office space (and high vacancy 

rates) persist in such cities as Hartford, CT. In 

Massachusetts, the high costs of land and property 

management services, coupled with little lender interest, have limited builders in many areas to only those 

projects with government subsidies -- the number of 

permits issued for multi-family dwellings has stagnated in 1996. As a testament to the tight market, the 

average acquisition cost for class “A” apartments in 

the Boston area rose 8 percent between the third 

quarter of 1996 and a year earlier. At the end of 1995, 

Connecticut had the most abundant supply of unused 

rental housing -- a 15 percent vacancy rate versus 7.6 

percent for the U.S. -- although rates around Hartford 

were a much lower 9 percent. 

Office: Despite a brief rise in the first quarter of 

1996, office vacancy rates have held below 10 percent in the greater Boston area since the middle of 

1995 -- after rising above 18 percent in 1990 and 

1991. By contrast, the national average as of mid1996 was 13 percent. Office vacancy rates for the 

greater Boston area averaged 8.2 

percent in the third quarter of 

1996. 

The Boston metropolitan area’s 

two largest markets are downtown 

(45 percent of inventory) and just 

west of the city, along Route 128 

(29 percent). Cambridge and the combined markets 

along interstate 495 and around Framingham 

(“metrowest”) each account for another 10 percent of 

Regional Outlook 15 First Quarter 1997 

PROTOTYPE
 

 

 

 

 

 

 

 

 

 

 

 

Regular Features The Regional Economy
 

office space. 

Financial services (mutual fund companies), law 

firms, and consulting companies were responsible for 

much of the incremental demand for Boston’s office 

space in 1996. Many research and development-driven 

technology companies seek to position their operations 

near universities in Boston/Cambridge, pushing up demand for office and light industrial space close to 

downtown. Most new office construction likely will be 

limited to the greater Boston area in 1997, with approximately 7 million square feet in the early planning 

stages as of last August. If put in place, this would 

represent a 7 percent addition to existing inventory. 

In Connecticut, Hartford continues to be plagued by 

excess office space. Vacancy rates there (both in the 

downtown and suburban markets) are still above 20 

percent. Construction in Stamford, CT, is beginning to 

recover from a five-year slump caused by corporate 

downsizing and an overbuilt market. Although the 

Region continues to maintain its attractiveness as an 

alternative to nearby midtown Manhattan, vacancy rates 

remain fairly high,but the trend is one of improvement. 

The proportion of unused office space in Stamford 

dropped from 17 to 18 percent in 1995 to 15 percent in 

third quarter 1996. 

Industrial: Industrial vacancy rates in the greater 

Boston area rose through the third quarter of 1996 to 7.9 

percent, after falling to 5 percent in late 1995. Still, the 

current rate remains below the modest peak of 10 

percent in late 1991. Demand remains brisk (and 

vacancy rates low) south of Boston 

for warehouse space, while north of 

the city, growing technology companies are fueling demand for industrial 

facilities. In Connecticut, industrial 

vacancy rates hit 8.6 percent in Hartford, while rates in Stamford continued to decline in 1996, reaching a level of 6.3 percent 

in the third quarter. 

Implications: Despite strong demand for space 

around Boston, development has thus far been limited 

mostly to built-to-suit or significantly pre-leased projects. A reticence to fund speculative projects may 

prevent local markets from becoming overbuilt in 

the near term. Much of greater Boston’s office space 

is occupied by a few industries, such as financial 

services and technology firms. If these key tenant 

industries were to decline, there would be a significant negative impact on occupancy rates. 

Norman Williams, Regional Economist 

Regional Outlook 16 First Quarter 1997 

PROTOTYPE
 

 

 

 

 

 

 

 

 

 

Regular Features	 Financial and Commodity Markets
 

Financial and Commodity Markets
 

• 	 The Treasury yield curve remains steeper than at the beginning of 1996, but it has flattened since July. 

• 	 The Boston Region’s bank stock index has outperformed the S&P 500 so far this year, but it has underperformed the S&P Composite Bank Index. 

• 	 Evidence suggests that changes in the slope of the short-end of the yield curve may be a good predictor of 

bank stock performance relative to the broader market. 

• 	 New yield curve spread futures and options offer an alternative to managing exposures to twists in the 

yield curve. 

Changes in Interest Rates and Bond Values 

As reflected in Chart 1, the yield curve has steepened and 

then flattened this year. The 30-year Treasury yield 

peaked on June 12 and July 5 at 7.19 percent -- 124 basis 

points higher than at the beginning of 1996. It has since 

fallen to 6.40 percent. 

To demonstrate the impact that interest rate fluctuations 

may have had on the market value of a bank’s fixed 

income portfolio, Table 1 presents three types of fixed 

income securities common to a bank’s portfolio: a Treasury bond, a FNMA mortgage pass-through, and a 

callable FNMA Agency bond. The value of each bond 

was computed on January 1, July 1, and November 25, 

1996. Table 1 lists the percent change in the value of 

each bond between those dates. 

Together the bonds lost 5.27 percent of their value 

through July 1, 1996, but they recovered 2.74 percent 

by November. Through the eleven months ending in 

November, the value of the three-bond portfolio was 

down 2.68 percent. On an aggregate basis, the Boston 

Region’s banks fared slightly better. The value of securiTABLE 1

CHART 1
 

The Treasury Yield Curve in 1996 

5.0 

5.5 

6.0 

6.5 

7.0 

3-mo 2-yr. 7-yr. 30-yr. 

11/25/96 

1/1/96 

7/1/96 

Source: Bloomberg 

Percent 

. 

ties holdings for all Call Report filers in the Region 

declined by only 0.91 percent for the nine months ending 

in September. Obviously each institution’s investment 

portfolio performance will vary depending on the types 

of instruments held and the original acquisition price of 

each instrument. 

The Boston Region’s Bank Stock Performance 

EXAMPLE OF RECENT BOND PERFORMANCE

US TREASURY

30-YEAR BOND

$100,000 PAR

7.25% COUPON

7.75 YRS UNTIL MATURITY

FNMA

MORTGAGE PASS-THROUGH

$100,000 PAR

7.5% COUPON

7.59 YRS WAL

FNMA

CALLABLE AGENCY BOND

$100,000 PAR

7.55% COUPON

7.58 YRS UNTIL MATURITY TOTAL

DATE

11/25/96

7/1/96

1/1/96

SOURCE: Bloomberg 

PRICE

$107,375

$103,406

$111,281

CHANGE FROM

PRIOR PERIOD

3.84%

(7.08%)

PRICE

$100,280

$98,130

$102,110

CHANGE FROM

PRIOR PERIOD

2.19%

(3.90%)

PRICE

$102,240

$100,100

$105,020

CHANGE FROM

PRIOR PERIOD

2.14%

(4.68%)

PRICE

$309,895

$301,636

$318,411

CHANGE FROM

PRIOR PERIOD

2.74%

(5.27%)

Regional Outlook	 17 First Quarter 1997 

PROTOTYPE
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Regular Features Financial and Commodity Markets
 

The stock market generally reacts unfavorably to rising interest rates, and reflecting 

this, the S&P 500 gained only 

slightly more than 3 percent through 

July (the latest peak in long-term 

rates). Since July the decline in 

rates has propelled the S&P 500 to 

new record levels, up 21 percent 

this year. The S&P Bank Index, however, has performed well for most of the year, despite the period of 

rising rates that occurred during the first two quarters 

of 1996. 

The stellar performance of the money center banks this 

year -- with Citicorp and Chase Manhattan alone up 

over 60 percent on the year -- caused the S&P Bank 

Index to outperform indexes that track the performance 

of the Boston Region’s banks. The Boston Regional 

Bank Index (BRBI), created by the Division of Insurance (DOI), consists of the Boston Region’s ten members of the American Banker Bank Index, which includes the 225 largest publicly-traded banks or bank 

holding companies. The BRBI, which is weighted by 

total market value of shares outstanding, has gained 

32 percent on the year, with performance closely 

tracking the S&P Bank Index. The BRBI shares its 

two largest institutions with the S&P Bank Index: 

Bank of Boston and Fleet Financial Group. 

Do Yield Curve Spreads Provide a Peek at 

Future Bank Stock Performance? 

CHART 2

A recent study by Merrill Lynch suggests that the slope 

of the short-end of the yield curve is a useful predictor 

of near-term bank stock performance relative to the 

broader market. For the period 1950 through 1995, the 

median performance of bank stocks in the study’s universe outperformed the broader S&P 500 index 76 

percent of the time in the twelve months following a 

widening of spreads between the 5-year and 3-month 

Treasuries. In contrast, the median underperformed the 

broader market 75 percent of the time in the twelve 

months following compression in the 5-year and 3-

month spread. Chart 3 on the following page plots this 

concept through 1995. 

The results of this study are intuitive. A steepening 

yield curve favors widening interest margins. The 

opposite is true as the yield curve flattens. 

Did the change in the 5-year/3-month spread over the 

previous year portend the recent strength in bank 

stocks? Not in this case. For the twelve months ending 

October 1996, bank stock performance relative to the 

broader market was strong despite a decline of nearly 

200 basis points in the 5-year/3-month spread during the 

preceding twelve months. 

This recent departure from the historical pattern may 

have resulted from the market’s recognition of 

widespread cost-cutting and “right-sizing” programs, as 

well as merger and acquisition activity. Also, bank 

stock performance has been buoyed by the use of excess 

funds to repurchase outstanding shares at many institutions, which drives earnings per share higher. 

A New Product for Managing Exposures to Yield 

Curve Twists 

Managing earnings exposures to changes in the yield 

The Boston Region's Banks Outperform the S&P 500 

but not the S&P Bank Index 

-10% 

0% 

10% 

20% 

30% 

40% 

50% 

5-Jan

26-Jan

16-Feb

8-Mar

29-Mar

19-Apr

10-May31-May

21-Jun

12-Jul

2-Aug

23-Aug13-Sep

4-Oct

25-Oct

15-Nov

6-Dec 

Change from 1/01/96 

S&P Bank Index 

S&P 500 

Boston Regional Bank Index 

Sourc es: Bloom ber g, Am erican Bank er 

Regional Outlook 18 First Quarter 1997 

PROTOTYPE
 
 

 

 

 

 

 

 

 

 

 

Regular Features Financial and Commodity Markets
 

curve typically requires altering cash market positions, executing customized financial derivatives, or 

contracting multiple positions in exchange-traded 

derivatives instruments. Recently, the 

Chicago Board of Trade (CBOT) introduced new products that may 

eventually simplify managing this 

risk -- Yield Curve Spread Futures 

and Futures Options (YCSF). 

YCSF contracts are structured so the payoff changes 

only in response to changes in spreads between points 

along the Treasury yield curve, rather than shifts in the 

overall level of interest rates. These instruments may 

provide advantages over hedges involving multiple 

positions in interest rate derivatives that attempt to 

isolate spreads along the yield curve. Ten futures 

contracts with spreads that cover the 2-, 3-, 5-, 10-, 

and 30-year maturity points were initially approved 

for trading. Options on these contracts also are 

traded. 

In theory, YCSFs could be used to construct hedges 

for specific interest-sensitive securities, or more 

macro hedges based on an institution’s overall balance sheet structure. Regardless of how they are used, 

a great degree of sophistication would likely be 

needed to construct meaningful hedges. Insured institutions that execute YCSF contracts should be cognizant of the fundamental risks identified in the FDIC’s 

supervisory policy addressing financial derivatives. 

Initial trading in the YCSFs has been thin and for some 

contracts non-existent. A CBOT representative indicated that position holders have been fairly diversified with most of the volume derived from speculators 

and traders for proprietary accounts.

CHART �
 

 Allen Puwalski, Banking Analyst

 Steven E. Cunningham, Senior Financial Analyst 

Twists in the Yield Curve Closely Correlate with 

Subsequent-Year Relative Bank Stock Performance 

-300 

-200 

-100 

0 

100 

200 

300 

196019661972197819841990 

5-year, 3-month Spread 

(bp) 

0 

40 

80 

120 

160 

Relative Bank Stock 

Performance 

(1953=100) 

--- Yield Curve Spread 

Sources: Merrill Lynch, Federal Reserve Board

 12-month Lagged Bank Stock Performance Relative to the S&P 500 

Regional Outlook 19 First Quarter 1997 

PROTOTYPE
 

 

 

 

 

 

 

 

 

Regular Features	 Regional Banking
 

Regional Banking Conditions
 

• 	 Earnings, capital, and asset quality at the Region’s banks reflect the overall health of the banking 

industry. 

• 	 After years of malaise, real-estate construction lending appears to be on the rise. 

• 	 A significant increase in noncore funding sources raises long-term liquidity concerns. 

• 	 Strong growth in, and competition for, consumer and commercial loans may be elevating risk levels. 

• 	 Smaller institutions have had only moderate success in expanding noninterest income sources. 

Overall Banking Conditions Strong 

The ongoing economic recovery in New England continues to positively affect the health of insured banks and 

thrifts in the Boston Region. By most measurements, 

particularly earnings, capital, and asset quality, the 

overall condition of the industry is as strong as it has 

been in at least ten years. However, overall growth of 

the New England banking industry is slow as a result of 

slow growth in the Region’s economy coupled with 

increasingly intense competition on both sides of the 

balance sheet. 

As of September 30, 1996, 98 percent of all institutions 

in the Region were considered “well capitalized.” Only 

one institution was categorized as “undercapitalized.” 

The average Tier 1 capital ratio for the Region’s banks 

was nearly 8 percent, with institutions over $1 billion 

approximating 7.25 percent and all other institutions 

over 9.5 percent. 

While slow growth has positively affected capital levels, it also has made it increasingly difficult for stockCHART 1

0.0 

0.2 

0.4 

0.6 

0.8 

1.0 

1.2 

92 93 94 95 96 

2.5 

3.5 

4.5 

5.5 

6.5 

Boston Region Bank Earnings Improve 

with Credit Quality 

Year-to-date September 

ROA Delinquency 

Rate 

Source: Bank Call Reports 

owned institutions to maintain returns-on-equity at levels demanded by the market. Thus, these institutions 

have been returning an increasingly larger portion of 

retained earnings to their shareholders in the form of 

dividends. For the nine months ended September 1996, 

the dividend payout rate for all stock-owned institutions 

in the Region was 77 percent, up from only 14 percent 

five years ago. The inability to generate growth through 

internal means also may have contributed to increased 

merger and acquisition activity, both regionally and 

nationally. 

Asset Quality Steadily Improving 

Asset quality indicators have shown steady improvement within the Region since 1992 (see Chart 1). These 

aggregate figures mask considerable variation by loan 

category, however. 

Commercial real estate loans continue to have the highest delinquencies across the Region at 3.8 percent. 

Consumer loan delinquencies are approximately 3.5 

percent. However, whereas the commercial real estate 

loan delinquency rate has fallen steadily, from nearly 10 

percent in the beginning of 1993, consumer loan delinquencies appear to be on the rise. Net charge-offs on 

credit card loans also are beginning to rise but remain 

below the national average at approximately 3 percent. 

Consumer loan underwriting practices, credit scoring 

systems, and collection activities should be closely 

monitored, although this segment of the portfolio does 

not appear to pose a significant risk to the Region at 

present (see Consumers Declare Bankruptcy in 

Record Numbers). 

Regional Outlook	 20 First Quarter 1997 

PROTOTYPE
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Regular Features Regional Banking
 

Earnings Growth Continues 

Earnings of insured institutions 

within the Region are steadily 

improving and are considered 

strong. Commercial banks had a 

return on assets (ROA) of 1.08 

percent for the third quarter (1.30 

percent if one ignores the impact of a one-time restructuring charge taken by a single large bank), while 

mutual savings banks earned 0.95 percent. Federally 

chartered thrifts earned only 0.26 percent as a result of 

the SAIF special assessment; without the special assessment, however, core earnings would have approximated 0.90 percent, in line with mutual savings banks 

and ahead of the 0.75 percent returns posted for 

comparable periods in each of the previous three 

years. Forty-seven of the 56 SAIF-insured institutions 

posted quarterly losses -- all but one of which directly 

resulted from the special assessment. 

Year-to-date ROA for the Region was 1.17 percent 

(1.22 percent adjusted for the one-time charges just 

mentioned), continuing a positive trend in ROA that 

has been evident since 1992 (see Chart 1 on previous 

page). The elimination of the deposit insurance 

assessment for most institutions added approximately five basis points to year-to-date ROA (ten 

basis points in the quarter). 

Like Connecticut’s economy, its banks’ earnings continue to lag the rest of New England as year-to-date 

returns approximate 1 percent. However, this return 

is a significant rebound from the 0.29 percent ROA 

posted in the same period in 1993 (see Table 1). 

For the Region in the aggregate, net interest income to 

average assets continues to decline slightly, but this 

TABLE 1

has been more than offset by improved noninterest 

income and lower overhead. The larger banks are the 

major contributors to the improvement in noninterest 

income, with banks over $1 billion increasing this 

income source as a percentage of assets by 65 basis 

points in the past three years. Banks under $1 billion 

have gained less than one third of this amount and have 

largely attained significant profitability improvement 

through reduced overhead and low provisions for loan 

losses. These sources cannot be relied upon for significant future earnings enhancement as they have already 

been managed down to very low levels. 

Earnings pressures may increase for small institutions, particularly if low overhead and provision expenses cannot be maintained. Augmenting traditional 

lending and deposit taking businesses with more fee 

based activities may be an alternative strategy that will 

be pursued by some institutions. The pressure to pursue 

alternatives to traditional activities may become particularly acute if interest rates decline, since smaller institutions place a much greater reliance on nonmaturity 

deposits as a funding source. As demonstrated in Chart 

2, rates paid on these deposits (cost of funds) have been 

held significantly below market rates (Fed funds). It 

will be difficult to maintain existing margins in a downward rate environment as these deposits, particularly 

NOW and savings accounts, have little room for further 

downward movement. 

Ongoing Consolidation 

As of September 30, 1996, there were 485 insured 

banks and thrifts in the Region, down from 549 (a 12 

percent decline) at year-end 1993 (includes 6 failures). 

Continued consolidation of the industry is likely as 

larger banks seek to expand delivery points and leverage capital, and smaller banks combine to achieve 

economies of scale necessary to grow profitably and 

expand into new business lines. 

CONNECTICUT BANKS, LIKE STATE'S

ECONOMY, CONTINUE TO LAG REGION

(PERCENT EXCEPT # OF BANKS) Consumer & Commercial and Industrial Loan 

ROA ROA NPL PDL # OF Growth Outpacing Real Estate Lending 

STATE Q3 YTD /TL /TL BANKS

Total assets of insured institutions in the Region have 

grown approximately 3.5 percent each year since 1993 

CT 0.96 1.04 2.04 3.62 89

MA 1.08 1.15 1.07 2.22 258 and reached $311 billion as of September 30, 1996. 

ME 1.29 1.26 1.31 2.66 48 The asset mix is essentially unchanged, with approximately 61 percent of total assets centered in loans. 

Within the loan portfolio, however, the mix has been 

NH 1.10 1.50 1.53 3.12 47

RI 1.11 1.42 0.90 1.83 14 shifting away from real estate loans into both commerVT 1.61 1.65 1.46 2.94 29 cial and consumer. New England institutions, at least 

REGION 1.04 1.17 1.27 2.55 485

Regional Outlook 21 First Quarter 1997 

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Regular Features Regional Banking
 

until recently, have not expanded real estate loan 

portfolios despite evidence of improved markets and 

a significant tightening of vacancy rates. 

There are signs that banks are now beginning to look 

to real estate opportunities -- which may result in 

new construction activity 

within the Region. Since yearend 1995, the only sector of the 

real estate portfolio that has had 

meaningful growth is construction loans, which are up 13 percent (up an annualized 17 percent for the most recent quarter). 

Loan commitments for both commercial and residential real estate loans also are on the rise. To date, 

there is very little speculative building activity despite a fairly healthy absorption rate and diminishing supply; however, it appears that the Region’s 

institutions are gradually getting back to real estate 

lending. 

While real estate loans have actually declined 3 percent in aggregate in the past three years, other loan 

categories have grown by 38 percent, led by a 47 

percent increase in consumer loans. Commercial 

loans are up 31 percent over this time frame, as banks 

have aggressively sought these credits to bolster net 

interest income. Commitments for these portfolios 

also are up significantly. There is evidence that 

competition is affecting pricing, particularly in the 

commercial sector, and concerns are raised as to 

whether underwriting standards are being loosened. 

Recent surveys of OCC examiners indicate that the 

inherent credit risk in its larger institutions has 

increased, particularly in consumer and small business loans -- precisely where the growth has been in 

this Region. While recent FDIC examinations found 

that only 7 percent of supervised banks within the 

Region had greater than average risk in the loan 

portfolio, 25 percent cited above average competitive 

pressure that was negatively affecting pricing relative to risk. This may also lead to compromised 

underwriting standards which will become more 

apparent if the economy weakens. 

Increased Reliance on Noncore Funding 

Noted 

Despite the nominal growth that the Region has experienced, banks have become increasingly reliant on 

noncore funding sources to support asset expansion. 

Since the trough in interest rates that occurred in the 

CHART 2
 

2 

3 

4 

5 

6 

7 

1993 1994 1995 1996 

75 

80 

85 

90 

95 

100 

While Protecting Margins, Institutions Have 

Lost Nonmaturity Deposits 

(Quarterly Averages) 

Source: Bank Call Reports 

Rate % Billions $ 

Savings, NOW, 

MMDAs $ 

Fed Funds % 

Cost of Funds % 

fourth quarter of 1993, core deposits (nonmaturity deposits plus CDs under $100,000) have actually declined 

in the Region by $2 billion. The decline in interest 

bearing nonmaturity deposits (savings, NOWs, and 

MMDAs) is even more pronounced and results primarily fromthe industry’s desire to hold down deposit costs 

in order to enhance margins. For bank Call Report 

filers (94 percent of the Region’s assets), these deposits 

have declined $15 billion (15 percent) since December 

1993 and now fund 28 percent of total assets, down 

from 36 percent in 1993. The decline in the nonmaturity 

deposits has been partially offset by retail certificates of 

deposit, but the major source of funds for growth has 

been in noncore deposits and borrowings. These 

sources have grown by $25 billion and now fund nearly 

30 percent of the Region’s assets, up from about 20 

percent only three years ago. This trend is evident for 

institutions of all sizes and may adversely affect liquidity as well as reduce some institutions’ ability to manage 

interest rate risk. 

It is interesting to note that the $20 billion credit union 

industry in New England had deposit growth of $1.6 

billion (10 percent) over the same time frame. Additionally, the Federal Reserve Board’s Flow of Funds 

analysis indicates that household investment in money 

market mutual funds grew by 46 percent during this 

period. These growth patterns suggest that individuals 

continue to seek safe, interest bearing investments and 

have become increasingly willing to move funds outside 

the banking system to find acceptable returns. 

Daniel Frye, Senior Regional Analyst 

Regional Outlook 22 First Quarter 1997 

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