Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION FIRST QUARTER 2002 

FDIC
 

Dallas
 

Region
 

Division of
 

Insurance
 

Alan C. Bush,
 

Regional Manager
 

Adrian R. Sanchez,
 

Regional Economist
 

Jeffrey A. Ayres,
 

Senior Financial
 

Analyst
 

Stephen L. Kiser,
 

Economic Analyst
 

Regional Perspectives 

◆ Metropolitan economies in the Dallas Region have slowed significantly as a 

result of the U.S. recession and in the aftermath of the September 11 attacks— 

Employment growth for the Region in 2002 is likely to slow to its lowest rate since the 

mid-1980s. 

◆ The Denver and Austin MSAs may be vulnerable to weakening housing price 

growth because of overbuilding and sharp declines in employment growth— 

Housing price growth in other MSAs with employment concentrations in troubled 

industries could be adversely affected also. 

◆ Traditionally, residential mortgages have proven to be a lower risk type of lending—However, risk in mortgage lending may be increasing as slowing home prices 

contribute to leaner collateral positions. See page 3. 

By the Dallas Region Staff 

In Focus This Quarter 

◆ Housing Market Has Held Up Well in This Recession, but Some Issues Raise 

Concern—Recent trends in mortgage underwriting are of particular interest, as an 

estimated $2 trillion in mortgage debt, approximately one-third of the total outstanding, 

was underwritten during 2001. Nonconstruction residential mortgages traditionally 

have represented one of the better-performing loan classes during prior downturns. The 

level of credit risk, however, may be higher this time around because the mortgage lending business has changed since the last downturn. This article examines these changes, 

including increased involvement by insured institutions in the higher-risk subprime 

credit market, the acceptance of higher initial leverage on home purchases, and greater 

use of automated underwriting and collateral valuation processes, which have not been 

recession-tested. 

◆ Home price softening could have an adverse effect on residential construction and 

development (C&D) and mortgage portfolios. In the aggregate, the level of risk appears 

modest. However, insured institutions with significant C&D loan exposures in markets 

that experienced ongoing residential construction during 2001, despite slowing local 

economies, are at higher risk. Weakening home prices could hurt loan quality in selected markets. The San Francisco Bay area stands out as a place to watch in this regard. 

See page 9. 

By Scott Hughes, Regional Economist 

Judy Plock, Senior Financial Analyst 

Joan Schneider, Regional Economist 

Norm Williams, Regional Economist 

A Publication of the Division of Insurance 
The Regional Outlook is published quarterly by the Division of Insurance of the Federal Deposit 

Insurance Corporation as an information source on banking and economic issues for insured 

financial institutions and financial institution regulators. It is produced for the following eight 

geographic regions: 

Atlanta Region (AL, FL, GA, NC, SC, VA, WV)
 

Boston Region (CT, MA, ME, NH, RI, VT)
 

Chicago Region (IL, IN, MI, OH, WI)
 

Dallas Region (CO, NM, OK, TX)
 

Kansas City Region (IA, KS, MN, MO, ND, NE, SD)
 

Memphis Region (AR, KY, LA, MS, TN)
 

New York Region (DC, DE, MD, NJ, NY, PA, PR, VI)
 

San Francisco Region (AK, AS, AZ, CA, FM, GU, HI, ID, MT, NV, OR, UT, WA, WY)
 

The first and third quarter issues of the Regional Outlook feature in-depth coverage of the economy and the banking industry in each Region and consist of a national edition and eight regional editions. The second and fourth quarter issues are a single national edition that provides an overview 

of economic and banking risks and discusses how these risks relate to insured institutions in each 

FDIC Region. These issues tell the national story and, at the same time, alert the reader to specific 

trends and developments at the regional level. 

Single copy subscriptions of the Regional Outlook can be obtained by sending the subscription 

form found on the back cover to the FDIC Public Information Center. Contact the Public Information Center for current pricing on bulk orders. 

The Regional Outlook is available on-line by visiting the FDIC’s website at www.fdic.gov. For 

more information or to provide comments or suggestions about the Dallas Region’s Regional 

Outlook, please call Alan Bush at (972) 761-2072 or send an e-mail to abush@fdic.gov. 

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 of this publication was obtained from publicly available sources that are considered 

reliable. However, the use of this information does not constitute an endorsement of its accuracy by 

the Federal Deposit Insurance Corporation. 

Chairman Donald E. Powell 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Writer/Editor Kim E. Lowry 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Richard A. Brown 

Ronald L. Spieker 

Publications Manager Teresa J. Franks 
Regional Perspectives
 

Regional Perspectives
 

• Metropolitan economies in the Dallas Region have slowed significantly as a result of the U.S. recession and 

in the aftermath of the September 11 attacks. In 2002, employment growth for the Region is likely to slow 

to its lowest rate since the mid-1980s. 

•	 The Denver and Austin metropolitan statistical areas (MSAs) may be vulnerable to housing price risk 

because of overbuilding and sharp declines in employment growth. 

• Traditionally, residential mortgages have proven to be a lower-risk type of lending; however, recent developments that are affecting collateral values suggest that risk in mortgage lending may be increasing. 

Region’s Economic and Banking Conditions 

Potential Exists for Housing Price Risk in Key 

Dallas Region Metropolitan Markets 

Several of the nation’s fastest-growing metropolitan 

economies in the past ten years have been in the Dallas 

Region. In addition to robust employment levels, housing 

activity in many of these markets also has been strong, 

spurred more recently by declining mortgage interest 

rates. However, at the same time, other economic sectors 

have slowed. Economic weakening in certain MSAs, as a 

result of either the September 11 attacks or the slowing 

national economy, or both, could undermine the strength 

TABLE 1 

of these housing markets. Moreover, concern exists about 

the downside risks to housing prices in metropolitan areas 

that previously had experienced strong employment 

growth and robust gains in home prices. 

This article considers the metropolitan areas of Denver, 

Austin-San Marcos,1 Dallas, Fort Worth-Arlington,2 

and Houston and examines the susceptibility of these 

MSAs to housing price risk in the near term. These 

MSAs represent key economic centers within the Dallas 

Region and fit the profile of strong employment growth 

and accelerated gains in home prices (see Table 1). 

Dallas Region Metropolitan Areas Were among 

the Nation’s Leaders in Employment Growth 

and Home Price Appreciation during the Period 1998 to 2000 

METROPOLITAN 

AREA 

ANNUAL 

AVERAGE 

EMPLOYMENT 

GROWTH RATE RANK1 PERCENTILE 

ANNUAL 

AVERAGE 

HOME PRICE 

APPRECIATION RANK2 PERCENTILE 

AUSTINSAN MARCOS, TX 

DENVER, CO 

DALLAS, TX 

FORT WORTHARLINGTON, TX 

HOUSTON, TX 

5.87% 

3.81% 

4.20% 

3.91% 

3.20% 

2 

35 

18 

31 

61 

99.6% 

88.1% 

94.0% 

89.5% 

79.1% 

9.74% 

11.32% 

6.58% 

5.44% 

7.67% 

26 

17 

70 

121 

50 

92.3% 

95.1% 

78.8% 

63.3% 

85.0% 

UNITED STATES 2.41% — — 6.47% — — 

1 Employment rankings and percentiles are based on a sample of 289 MSAs. 

2 Some price rankings and percentiles are based on a sample of 328 MSAs. 

Sources: Bureau of Labor Statistics, Office of Federal Housing Enterprise Oversight (Haver Analytics), and the 

author’s own calculations 

1 The Austin-San Marcos MSA will be referred to as Austin in this article. 

2 The Fort Worth-Arlington MSA will be referred to as Fort Worth in this article. 

Dallas Regional Outlook 3	 First Quarter 2002 
Regional Perspectives
 

These MSAs were among the leaders in both categories 

from 1998 to 2000. However, employment growth and 

housing price appreciation slowed during 2001, new 

trends that are likely to continue at least through the first 

half of 2002. 

Denver MSA 

Of the five MSAs, Denver’s home prices appear most 

at risk to a weakening economy and prolonged downturn. From second-quarter 1999 to third-quarter 2001, 

housing prices in this MSA grew at a double-digit rate 

(see Chart 1). Robust employment growth and high 

levels of in-migration have supported this level of 

price appreciation. Since mid- to late 2001, however, 

the Denver economy has been affected adversely by 

the slowing U.S. economy and the effects of September 

11. Year-to-year job growth rates have decelerated 

every month since April 2001, and employment 

declined 0.3 percent in fourth-quarter 2001 from a year 

before (see Table 2). 

As a result of the U.S. recession, employment losses have 

spread beyond the metro area’s ailing telecommunications, manufacturing, and travel industries to the transportation; communications; public utilities; finance, 

insurance, and real estate; and service sectors. Notably, 

TABLE 2 

CHART 1 

Housing Affordability in Denver Has 

Declined in the Past Three Years 

Index = 100 

Notes: An index value of 100 means that the typical household has just 

enough income to qualify for an 80 percent mortgage on a median-priced 

home. The higher the index, the more affordable the housing. 

Source: Economy.com 

1Q98

2Q98

3Q98

4Q98

1Q99

2Q99

3Q99

4Q99

1Q00

2Q00

3Q00

4Q00

1Q01

2Q01

3Q01

4Q01 

100 

110 

120 

130 

140 

150 

160 

170 

180 

190 

Denver 

Dallas 

Austin 

Houston 

Fort Worth 

United States 

job losses are occurring in industries that represent 

55 percent of Denver’s total nonfarm employment. 

Weakening in the broad service sector is particularly 

ominous for the metro area’s housing market, as this 

sector employs the most workers (31 percent) and as 

employment did not decline on a quarterly basis during 

the U.S. recession from 1990 to 1991 or the state’s recession from 1986 to 1987. 

In the aftermath of September 11, the air transportation 

industry in the Denver area lost numerous jobs; this 

Employment Growth Rates Dropped 

while Unemployment Rates Jumped Sharply 

NONFARM EMPLOYMENT
 

GROWTH RATES
 UNEMPLOYMENT RATES 

(YEAR-TO-YEAR (YEAR-TO-YEAR 

PERCENT CHANGE) PERCENT CHANGE) 

FOURTH FOURTH FOURTH FOURTH 

QUARTER QUARTER QUARTER QUARTER 

METROPOLITAN AREA 2000 2001 2000 2001 

AUSTIN-SAN MARCOS, TX 5.2 0.7 1.7 4.6 

DENVER, CO 4.0 –0.3 2.0 4.5 

DALLAS, TX 4.4 2.0 2.7 5.6 

FORT WORTH-ARLINGTON, TX 3.2 2.3 2.8 4.6 

HOUSTON, TX 3.0 1.6 3.4 4.4 

UNITED STATES 1.7 –0.6 4.0 5.6 

Notes: Nonfarm employment numbers are preliminary. Unemployment rates are not seasonally adjusted. 

Source: Bureau of Labor Statistics (Haver Analytics) 

3 Ross Devol, Armen Bedroussian, Frank Fogelbach, Nathaniel H. Goetz, Ramon R. Gonzalez, and Perry Wong. January 2002. “The Impact of 

September 11 on U.S. Metropolitan Economies.” Milken Institute. 

Dallas Regional Outlook 4 First Quarter 2002 
Regional Perspectives
 

MSA is a major United Airlines hub. The tourism sector, particularly the lodging and retail trade industries, 

also has been affected adversely. The results of a recent 

study by the Milken Institute estimate that 17,000 jobs 

will be lost in the Denver area this year as a result of the 

September 11 attacks.3 

Denver’s negative job growth rate is the lowest since the 

mid-1980s. Economy.com forecasts virtually flat 

employment growth for Denver in 2002, as a result of 

continuing problems in the high-tech, travel and 

tourism, financial services, and construction and real 

estate sectors. 

Rapidly rising home prices during a period of deteriorating employment growth are unsustainable, and 

could portend weak home price growth, or perhaps 

outright depreciation, to follow in the Denver housing 

market. Housing affordability in Denver declined considerably during the past three years, as the median 

home price soared (see Chart 1). The median price for 

an existing single-family home in the Denver area for 

the year 1998 was $152,200, 18.5 percent above the 

U.S. median. However, by third-quarter 2001, the 

median price for an existing single-family home in 

Denver had climbed to $224,000, 48 percent above the 

U.S. median. Despite lower mortgage interest rates 

during this period, the number of households in Denver that could afford a median-priced home fell 17 percent compared with a 6 percent decline for the nation. 

The decline in housing affordability could be particularly problematic for the first-time buyer and could 

dampen trade-up markets. 

Economists with the governor’s Office of Planning 

and State Budgeting concluded in the December 2001 

Colorado Economic Perspective that housing in the 

state is overbuilt, and a substantial slowing in residential construction through 2002 is expected. As suggested by the following quote from this report, the Denver 

housing market, unlike that of the nation, may be slowing significantly: “The number of unsold homes in the 

Denver area was up 35.4 percent in November 2001, 

compared with November 2000, and new home sales 

in the Denver area fell 34.0 percent through the third 

3 Ross Devol, Armen Bedroussian, Frank Fogelbach, Nathaniel H. 

Goetz, Ramon R. Gonzalez, and Perry Wong. January 2002. “The 

Impact of September 11 on U.S. Metropolitan Economies.” Milken 

Institute. 

quarter of 2001, compared with through the third quarter 2000.”4 

Furthermore, the employment/permit (E/P) ratio5 in 

Denver, a measurement of a housing market’s demand/ 

supply balance, indicates that the current level of housing production far exceeds the amount justified by 

employment growth (see Chart 2). A balanced housing 

market in the Denver housing market is characterized by 

an E/P ratio of 1.57 new jobs to 1 additional housing 

permit.6 As the ratio decreases, fewer new jobs exist to 

support the level of housing construction. Denver’s negative employment growth rate contributed to an E/P 

ratio of –0.12 as of November 2001. 

Poor economic fundamentals (deteriorating employment conditions), declining housing affordability, and 

residential overbuilding are expected to contribute to 

considerable softening in home price growth in 2002. In 

addition, should the recession in Colorado become more 

severe than that of the nation, home prices could fall. 

CHART 2 

Denver and Austin E/P Ratios 

Declined Precipitously in 2001 

Jan 1998

Jul 1998

Jan 1999

Jul 1999

Jan 2000

Jul 2000

Jan 2001

Jul 2001 

Note: The E/P ratio is that of 12-month employment growth to 12-month total 

permits and is an indicator of supply/demand conditions in housing. 

Sources: BLS and Census/Haver 

-0.5 

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

3.0 

3.5 

4.0 

E/P Ratio

Austin 

Denver Dallas

Houston Fort Worth 

4 “Colorado Economic Perspective: State Revenue and Economic 

Projections Through FY 2006–07,” Office of State Planning and 

Budgeting, December 20, 2001, page 46. 

5 The E/P ratio is calculated by dividing 12-month employment 

growth by 12-month total permits. 6 According to the Meyers Group, a residential real estate consulting 

firm, the point of equilibrium for a balanced housing market in the 

United States is 1.26, calculated by taking total employment over total 

households. Applying the same methodology to the Denver MSA, 

using 2000 annual data, yielded an equilibrium value of 1.57. Equilibrium values for the other four MSAs were 1.54 for Austin, 1.65 for 

Dallas, 1.31 for Fort Worth, and 1.53 for Houston. 

Dallas Regional Outlook 5 First Quarter 2002 
Regional Perspectives
 

Austin MSA 

Austin also experienced a sharp run-up in home prices 

beginning in 1999 (see Chart 3) as a result of several 

years of strong employment growth and in-migration. 

However, employment growth rapidly decelerated during 2001 in this MSA, and year-over-year home price 

growth slowed from 15.4 percent in first-quarter 2001 to 

8.2 percent in third-quarter 2001. 

Austin’s job growth rate was 5.2 percent during fourthquarter 2000, ranking eighth among 289 MSAs,7 and the 

MSA reported an unemployment rate of 1.7 percent for 

that quarter. Both measures are indicative of a healthy 

economy. By fourth-quarter 2001, however, job growth 

was a modest 0.7 percent, one of the sharpest declines 

in growth among the nation’s MSAs, and the unemployment rate had jumped to 4.6 percent. 

The Austin economy has been affected adversely by 

weakness in the personal computer, semiconductor, and 

telecommunications sectors, as well as by the serious 

decline in the dot-com industry. Deterioration in these 

high-tech industries began well before the current recession and exerted a more adverse effect on production, 

capital expenditures, employment, and earnings than 

weakening in non-high-tech sectors. Layoffs in the computer, communications equipment, and semiconductor 

manufacturing industries are spilling over into support 

and secondary industries, such as software and computerrelated services, business and professional services, 

financial services, and retailing. More than one-third of 

the output of the Austin economy is related to the hightech sector.8 

Unlike in Denver, the median home price in the Austin 

MSA does not exceed that of the United States significantly. In 1998, the median home price in Austin was 

3.3 percent below the U.S. average; by third-quarter 

2001, it was only 2.5 percent above the national average. 

Median home prices in the Austin MSA lagged those of 

the United States through much of the 1990s and have 

surpassed those of the nation only recently. Moreover, 

housing affordability in the Austin MSA, despite a 

slight deterioration three years ago, remains comparable 

to the national average (see Chart 1). 

7 The 289 MSAs are tracked by Haver Analytics with Bureau of Labor
 

Statistics employment data.
 

8 Standard & Poor’s DRI for the U.S. Conference of Mayors and the
 

National Association of Counties.
 

CHART 3 

Source: Office of Federal Housing Enterprise Oversight 

1998 1999 2000 2001 

Austin Dallas Denver 

Fort Worth Houston United States 

0% 

2% 

4% 

6% 

8% 

10% 

12% 

14% 

16% 

18% 

Percent Change from

a Year Ago 

Housing Price Growth Has Slowed 

since First-Quarter 2001 

However, the Austin E/P ratio declined from 1.91 in 

November 2000 to 0.34 in November 2001 (see Chart 2), 

indicating a growing supply/demand imbalance in residential construction. The drop in the E/P ratio is attributable solely to weak employment growth. The Austin 

MSA added an average of 35,000 jobs annually between 

1998 and 2000; however, in the year ending November 

2001, the MSA added only 4,300 new jobs. During the 

same period, the number of residential building permits 

filed fell from more than 16,000 units to about 12,000 

units, underscoring the weakness in local job growth. 

Homebuilding activity slowed, and the number of 

unsold homes doubled between November 2000 and 

November 2001. 

Housing price growth began slowing in first-quarter 2001 

and is likely to continue slowing through 2002, a trend 

particularly evident for high-priced homes. This sector of 

the real estate market has been hit hard by weakening 

in the high-tech sector and the failure of many Internet 

start-up companies. Economic forecasts developed by 

Economy.com and AngelouEconomics call for a slow 

regional recovery with historically weaker gains in 

employment, population, and retail sales growth. 

Although housing prices are not expected to depreciate 

this year, prolonged difficulties in the high-tech sector 

could change the outlook for home prices in this MSA. 

Dallas, Fort Worth, and Houston MSAs 

The Dallas, Fort Worth, and Houston economies are discussed together because these MSAs are characterized by 

relatively moderate employment growth rates and do not 

show any serious signs of overbuilding. As a result, home 

Dallas Regional Outlook 6 First Quarter 2002 
Regional Perspectives
 

prices in these housing markets are not at risk. Housing 

price growth for these three MSAs has been comparable 

to that of the United States in recent years (see Chart 3). 

Moreover, despite job growth rates that have slowed during the past year, these MSAs continue to add jobs faster 

than the U.S. average, and unemployment rates are at, or 

below, that of the nation (see Table 2). 

These MSAs have been affected by the U.S. recession 

and fallout from September 11. However, these areas 

have diversified during the past ten years, helping them 

withstand problems in the high-tech, energy, transportation, and travel-related industries. Moreover, the weakness in these economies appears to be cyclical rather 

than structural, suggesting that once the U.S. and global 

economies recover, stronger employment growth would 

be expected to resume. 

Housing affordability does not appear to be problematic 

for homebuyers in these MSAs (see Chart 1). Median 

home prices in Dallas, Fort Worth, and Houston were at 

least 10 percent below the U.S. median in 2001. Moreover, 1999 per capita incomes9 for all three MSAs 

exceeded that for the United States. Consequently, a 

greater proportion of households in these metro areas, 

compared with those in the nation as a whole, can afford 

a median-priced home. 

However, November 2001 E/P ratios for these MSAs 

were down substantially from year-earlier levels (see 

Chart 2). The Fort Worth and Houston E/P ratios were 

1.30 and 1.11 in November 2001, down from around 

2.00 a year before. The Dallas E/P ratio fell more precipitously from 2.77 to 1.13. Although these housing 

markets are not considered overbuilt, a softening in supply/demand conditions has occurred. Slowing employment growth and an increase in residential building 

permits are contributing to the lower E/P numbers. 

Employment growth and affordable housing are likely to 

support some housing price appreciation in these markets in 2002, albeit at a slower pace. Weakening demand 

relative to new supply could dampen housing price 

growth. Although prices are not expected to depreciate 

in the Dallas, Fort Worth, or Houston metropolitan markets, housing price growth in submarkets with employment concentrations in troubled industries, such as the 

telecom corridor in North Dallas, could be affected 

adversely. 

9 1999 per capita income figures are the most recently available and 

were supplied by the Bureau of Economic Analysis. 

Mortgage Portfolios in Residential Lending 

Experience Growth 

Trending with the Region’s economic growth during the 

1990s, residential mortgages10 booked by insured institutions headquartered in these five MSAs increased in volume and as a share of total assets. Mortgage loans11 grew 

186 percent (merger-adjusted) in these MSAs during the 

ten years ending September 30, 2001, compared with 

142 percent for the Region and 64 percent for the nation. 

The Houston and Denver banking markets experienced 

the most significant growth in mortgage portfolios, 

increasing 231 percent and 635 percent, respectively. 

Mortgage volume in Houston grew dramatically during 

the 1990s from a small initial base resulting from the 

depressed local economy in the late 1980s. Mortgage 

originations in Denver increased rapidly, largely because 

of major in-migration during the 1990s, motivating institutions to grow balance sheets and shift greater asset 

allocations into mortgages.12 

Thus, despite a slowing economy, mortgage portfolios 

among insured institutions in these MSAs have grown 

significantly, and residential real estate credit quality 

remains strong for these institutions as well. The results 

of a quarterly survey conducted by the Mortgage 

Bankers Association of America (MBAA), a trade 

group representing insured and uninsured mortgage 

lenders, indicate that nationwide 5.00 percent of residential mortgage loans were delinquent by 30 days or 

more in third-quarter 2001, up from 4.12 percent a year 

before. Moreover, the survey results state that the delinquency rate for residential mortgages originated in 

Texas was somewhat worse at 6.65 percent in thirdquarter 2001, up from 5.62 percent a year earlier.13 

Although the MBAA data evidence some credit quality 

deterioration, such weakening has not yet appeared 

among mortgage portfolios of insured institutions; pastdue rates for the nation and Texas were 1.91 and 1.49, 

respectively, as of third-quarter 2001. The past-due rate 

for institutions headquartered in Texas declined slightly 

10 One- to four-family residential mortgages only, not including
 

mortgage-backed securities (MBS). MBS can be diversified geographically and do not represent the same level of exposure as direct
 

mortgages.
 

11 All banking data refer to insured institutions headquartered in that
 

metro area, unless otherwise indicated.
 

12 Insured institutions in the Denver MSA increased mortgages as a
 

percentage of total assets from 11 percent as of September 30, 1991,
 

to 29 percent as of September 30, 2001.
 

13 Data supplied by Haver Analytics. 


Dallas Regional Outlook 7 First Quarter 2002 
Regional Perspectives
 

from a year earlier, suggesting that mortgage underwriting standards of insured institutions may be somewhat 

more conservative than those of other mortgage loan 

originators. 

Slowing Home Price Appreciation May Pressure 

Collateral Values 

Traditionally, residential mortgages in insured institutions have proven to be a lower-risk type of lending. 

However, some recent developments affecting collateral 

values suggest that risk in mortgage lending may be 

growing. The loan-to-value ratio of many new mortgages 

is increasing. More than 20 percent of all mortgages originated nationwide in 2001 were for more than 90 percent 

of the value of the house, almost three times the level in 

1990. In addition, the increasing volume of cash-out refinancings has reduced homeowners’ equity. According to 

the results of a Freddie Mac survey referenced in this 

quarter’s In Focus article, “over half of all recent refinancings involved material ‘cash out’ features,” providing 

less of a buffer for lienholders should mortgages 

default.14 Furthermore, although home prices in these 

MSAs have not shown widespread declines, anecdotal 

reports suggest that high-end home prices are coming 

under pressure, especially in markets that experienced 

substantial growth in the high-tech sector in the late 

1990s but that have since slowed. And finally, recent 

rapid growth in mortgage portfolios among insured institutions in these five MSAs suggests that many of these 

14 “Homeowners Continuing to Increase Their Loan Balances When 

Refinancing, According to Latest Freddie Mac Study,” Freddie Mac 

Press Release, October 24, 2001. 

mortgages are not seasoned and are based on relatively 

high real estate values. Should home prices decline, many 

of these mortgages would be left with leaner collateral 

positions. 

Construction and Development Loan 

Concentrations Have Risen 

Construction and development (C&D) lending is an 

important element of residential lending for many Dallas 

Region insured institutions. While call report data do not 

separate C&D lending into commercial or residential 

categories, discussions with bankers suggest that a 

majority of C&D loans support residential building. 

C&D lending exposure has increased over the past several years, as evidenced by the rise in C&D lending as a 

percentage of Tier 1 capital. At year-end 1998, 7 percent 

of insured institutions headquartered in these MSAs 

reported concentrations of C&D loans in excess of 200 

percent of Tier 1 capital; by September 30, 2001, the 

level in excess of 200 percent more than doubled to 18 

percent. Insured institutions in the Austin MSA reported 

the greatest increase in construction loans. This loan 

type represented 35 percent of Tier 1 capital among 

banks in the Austin MSA as of year-end 1998; by thirdquarter 2001, this share had climbed to 117 percent. 

During a period with a slowing economy and declining 

employment growth, housing inventories may not sell 

well. As a result, builders may not remain current on 

C&D loan payments, pressuring the credit quality of 

insured institutions. 

By the Dallas Region Staff 

Dallas Regional Outlook 8 First Quarter 2002 
In Focus This Quarter
 

Housing Market Has Held Up Well in This 


Recession, but Some Issues Raise Concern
 

Trends in housing markets are important performance 

drivers for many FDIC-insured institutions. The health of 

residential markets can affect the credit quality of residential mortgage loans, home equity loans, and loans to 

finance residential construction and is linked indirectly to 

the performance of other types of consumer and smallbusiness debt. Further, an estimated $2 trillion in mortgage debt, approximately one-third of the mortgage 

market, was underwritten during 2001, with 56 percent of 

this activity in refinancing transactions.1 This activity 

makes recent trends in underwriting of particular interest. 

An ancillary issue for many mortgage lenders, interest 

rate risk, is not addressed in this article.2 

The U.S. economy entered a recession in March 2001, 

and the question arises as to how consumer creditworthiness, housing values, and recent mortgage-lending 

practices will fare during this downturn. Developments 

contributing to increased credit risk include higher consumer debt burdens, looser mortgage loan underwriting 

standards, and the emergence of subprime mortgage 

lending as a significant line of business for some banks. 

Mitigating this risk has been the steady appreciation of 

home prices, which have shown signs of softening in 

some markets but not to the extent seen at a comparable 

stage in previous recessions. 

Home price weakness may be more pronounced in 2002 

as the effects of the recession take hold, but in the 

authors’ judgment, systemic weakness in home prices is 

unlikely, absent a deep and long recession. Adverse mortgage lending trends are not expected to threaten the capital or earnings of the vast majority of insured 

institutions. Nonconstruction residential mortgages, even 

during the most pronounced periods of stress in the 1980s 

and early 1990s, remained the best-performing loan 

class, especially for lenders specializing in residential 

real estate; and, historically, these mortgages have been 

1 Mortgage Market Forecast, www.mbaa.org/marketdata/forecasts/,
 

January 2002.
 

2 For a discussion of this issue, see “Regional Perspectives,” Boston
 

and Chicago Regions, Regional Outlook, First Quarter 2002.
 

one of the lowest credit-risk loan types for all manner of 

insured institutions.3 

That said, however, there are pockets of risk for 

insured institutions. There is evidence that borrowers 

with weak credit may be experiencing greater repayment difficulties, elevating the risks faced by subprime 

mortgage lenders. Further, a slump in residential real 

estate markets could be especially detrimental to 

insured institutions with significant exposures to 

housing construction because projects might not sell at 

projected asking prices or as quickly as anticipated. 

Finally, in specific markets where housing prices may 

have achieved unsustainable levels, some increase in 

housing-related credit quality problems can be expected, and in this regard, the San Francisco Bay area 

stands out as a place to watch. 

The Recession Thus Far Has Had 

a Minimal Impact on Mortgage 

Delinquencies at Insured Institutions 

Despite three quarters of recession, most housing indicators remained quite healthy this past year relative to 

trends seen in past recessions. For example, new and 

existing home sales both set records during the year, 

while new home construction failed to decline, an 

occurrence not seen in the past six recessions. Another indicator, year-over-year growth in existing home 

prices—as measured by either the Office of Federal 

Housing Enterprise Oversight (OFHEO) repeat sales 

price index or the National Association of Realtors 

(NAR) median single-family price statistic—showed 

deceleration but remained well above trends seen at 

similar points in past recessions. This behavior partly 

reflected the early robustness of household income in 

the face of recession and relatively low fixed mortgage 

rates during 2001, which helped to counter some of the 

3 See “Region’s Insured Institutions Exhibit Lower Risk Profile than 

the Nation’s, Appendix: Risk-Weighting Methodology,” Table A in 

Boston Region, Regional Outlook, First-Quarter 2000. 

Dallas Regional Outlook 9 First Quarter 2002 
In Focus This Quarter
 

CHART 1 CHART 2 

Through September 2001, Mortgage-


Related Delinquencies Remained Modest
 

Although the Much Larger Market for 

Existing Homes Has Held Up, New Home 

Prices Are Under Pressure 

Percentage Change from

Prior Year 

Sources: Census (new), National Association of Realtors (Existing) 

Existing 

New 

–10 

–5 

0 

5 

10 

15 

20 

,

79 ,81 ,83 ,85 ,87 ,89 ,91 ,93 ,95 ,97 ,99 ,

01 

Percentage 

30+ Days Past Due 

0 

2 

4 

6 

8 

10 

12 

,

91 ,93 ,95 ,97 ,99 Sep ,

01 

0 

1 

2 

3 

4 

5 

6 

Percentage 

30+ Days Past Due 

95th Percentiles (R) 

mortgages equity lines 

75th Percentiles (L) 

NOTE: Sample consists of banks with at least $1 million in equity lines 

or mortgages that are also at least 5 percent of bank's Tier 1 capital. 

Source: Bank and Thrift Call Reports 

initial adverse effects of the recession on housing 

demand. 

One sign of potential weakness appeared late in 2001 

in the modest year-over-year decline in median prices 

of new single-family homes (see Chart 1). Because 

existing home sales outnumber new home sales roughly fivefold, price trends in the latter are generally not 

predictive of prices for the much larger existing home 

market.4 However, as discussed later in this article, 

adverse pricing trends in the new home segment do 

raise concerns for residential developers and insured 

institutions that finance residential construction. 

The steady increase in prices of existing homes depicted in Chart 1 masks considerable regional variation. 

As detailed later in this article, home price growth 

began to weaken in 2001 in a number of metropolitan 

statistical areas (MSAs). While there is no clear common denominator among the markets in which this 

occurred, a number of these markets had both extremely rapid home price growth in the recent past and significant slowdowns in employment growth or outright 

contractions in employment last year. 

Credit quality indicators for insured institutions’ mortgage loans have shown only preliminary signs of 

weakness thus far. Through the first nine months of 

2001, insured institutions showed negligible advances 

in median past-due ratios for mortgages and equity 

4 Existing home prices are also more reflective than new home prices 

of trends in broader economic indicators, such as aggregate per capita personal income. 

lines of credit, although continued strong mortgage 

origination activity in 2001 may have masked (in the 

aggregate) developing credit problems for more seasoned mortgage loans. For institutions that held at 

least $1 million in residential mortgages or home equity lines of credit and whose exposures comprised at 

least 5 percent of Tier 1 capital, some modest deterioration is evident in the worst-performing mortgages 

and home equity lines since 1999, as seen in Chart 2.5 

Even if this recession lingers, worsens, or both, residential mortgage lending (nonconstruction and development-related) likely poses only modest risk to most 

insured institutions’ earnings and capital, since it has 

held up better in prior recessions than other loan types. 

What Are the Risks Facing Housing 

Lenders in 2002 and Beyond? 

In an environment of significantly slower economic 

growth than prevailed during the 1990s, can the 

strength of housing prices and the relatively benign 

credit quality environment for housing lenders be 

expected to continue? The answer will depend on the 

interplay of economic conditions and lenders’ risk profiles. In the remainder of this article, we discuss the 

gradual increase in the risk profile for insured mortgage lenders that appears to have occurred during the 

5 It is interesting to examine the (adverse) tail of the credit quality distribution when looking at residential mortgage trends, as average and 

median past-due ratios move little and are typically very low—thus, 

only the highest 25th and 5th percentiles of past-due ratios are presented in Chart 2. 

Dallas Regional Outlook 10 First Quarter 2002 
, UT

Miami– 

y, NY

Phoenix, AZ

, NV–AZ 

, MO–IL 

Tucson, AZ

Oklahoma City

, NY

, OK 

Kansas City

Tulsa, OK

, MO–KS

, NC–SC 

mingham, AL

, TN-AR–MS

Honolulu, HI

, SC 

Entire Nation

, FL

e City

alo

ville

 Lauderdale

Alban

Buff

 Louis

Green

egas

lotte

Salt Lak

Memphis

Las V

Char

St.

Bir

Ft.

In Focus This Quarter
 

1990s, as well as some cyclical risks to their performance that may exist as the recession plays out. 

Evolving Lending Practices Have Increased 

the Risk Profile for Mortgage Lenders 

Although history suggests that residential mortgage 

defaults will be relatively low even in a recession, 

changes in the mortgage market since the 1990–1991 

recession could affect mortgage performance during the 

present downturn. Many underwriting changes over the 

past decade have been driven in part by the growing 

importance of the secondary market for mortgage debt, 

and of Fannie Mae and Freddie Mac in particular. In 

1980, federal and related agencies had direct or indirect 

interests in approximately 17 percent of all mortgage 

debt.6 By 2000, their share of the mortgage market had 

increased to roughly 41 percent. Insured bank and thrift 

mortgage exposures grew over the same period, but, as 

a share of direct mortgage debt, bank and thrift mortgage holdings decreased from 59 to 35 percent. These 

trends notwithstanding, insured institutions still provide 

substantial funding, directly or indirectly, to the housing 

market: as of September 30, 2001, 1 to 4 family mortgage loans and mortgage-backed securities held by 

insured institutions aggregated $2.3 trillion, up 37 percent from five years earlier. 

Although an active secondary mortgage market has 

broadened homeownership, improved mortgage loan liquidity, and allowed insured institutions to allay credit 

risk, it has also heightened market competition and transformed the lending process. In presecondary market 

CHART 3 

1993 2000 

days, lenders largely had to retain originated mortgages 

in their own portfolios. Consequently, only lenders with 

ready funding sources (such as banks, thrifts, and insurance and finance companies) were able to compete in the 

mortgage markets. The advent of the secondary market 

enlarged the pool of available funding and permitted both 

insured institutions and other originators to transfer their 

mortgage business readily into entities such as mortgage 

pools and trusts. Consequently, many new players, 

including on-line and brick-and-mortar mortgage brokers, have entered the mortgage origination market. 

The resulting robust mortgage loan competition, combined with Internet-based consumer research tools, has 

led to considerable commodification of the mortgage 

market. Rather than competing on the basis of traditional 

relationships, lenders’ market shares are increasingly 

driven by price. For smaller savings institutions that focus 

heavily on residential mortgage underwriting, this issue 

has likely elevated business risk. Heightened competition 

has caused some loosening of mortgage underwriting 

standards and pushed lenders to use technology to expedite and streamline the underwriting process. Consequently, credit-scoring mechanisms and automated 

valuation techniques currently in place have not been 

tested through a full credit cycle. Because pricing competition has pressured margins, some mortgage lenders 

have pursued subprime or high loan-to-value (HLTV) 

mortgages. The ability of insured institutions to mitigate 

subprime losses through an economic downturn is untested to a large extent as well—finance companies dominated the high-risk mortgage market in past recessions. 

High Loan-to-Purchase Price Ratios Are Increasingly Common in Some Metro Areas 

Percentage of Mortgages with Loan-toPurchase Price Ratios Exceeding 90 Percent 

60 

40 

20 

0 

Source: Federal Housing Finance Board 

6 These interests include residential, commercial, and farm real estate debts held directly by, or held in mortgage pools or trusts issued by, federal 

and related agencies. Source: Table 1186, Statistical Abstract of the United States: 2001, page 733. 

Dallas Regional Outlook 11 First Quarter 2002 
In Focus This Quarter
 

In general, mortgage underwriting standards have loosened industrywide over the past decade. For instance, 

lenders have increasingly accepted higher loan-topurchase price (LTPP) ratios for purchase money mortgages.7 According to the Federal Housing Finance 

Board, LTPP ratios are high and have risen in several 

metropolitan areas over the past seven years (see Chart 3). 

Between 1993 and 2000, the Honolulu, Tulsa, and Tucson markets exhibited the largest increases in mortgages 

with LTPP ratios exceeding 90 percent. 

Although lenders often mitigate the risk of loss associated with low downpayments by requiring private mortgage 

insurance (PMI), recently the mortgage industry has 

allowed borrowers to avoid purchasing PMI. In particular, 

“piggyback” financing has made homeownership 

increasingly possible for households that cannot afford 

the traditional 20 percent down payment or do not wish to 

pay for PMI. With piggyback financing, the borrower 

often arranges a conforming 80 percent LTPP first mortgage and finances a portion of the remaining 20 percent 

with a concurrent second mortgage on the property (e.g., 

“80-10-10”). This type of transaction has become popular 

because interest paid on the (albeit more expensive) second mortgage is tax-deductible, whereas PMI premiums 

are not. Thus, piggyback financing is probably most 

attractive to individuals in higher-cost/tax areas or higher 

tax brackets, such as those in the Northeast and California. This trend effectively shifts the first loss position 

on all low down payment loans to the lender that 

retains the junior position. These institutions are, of 

course, compensated for some of this risk with the 

higher interest rates charged on the piggyback portion 

of these mortgages. 

Competitive factors have prompted the industry to 

enhance underwriting automation. As part of the push, 

credit scoring has become a routine part of the credit 

analysis process, and, increasingly, lenders are using 

automated valuation models (AVMs) to determine collateral coverage. However, credit scoring and collateral valuation models have been in popular use only 

since the 1990–1991 recession; consequently, their 

predictive ability in a downturn is uncertain. Although 

some have touted AVMs as the answer to appraisal 

fraud, the ability of statistical models to simulate the 

qualitative judgments considered critical to traditional 

appraisals is unknown. Paper appraisals reportedly 

7 Purchase money mortgages are loans extended solely for the initial 

purchase of a home. Statistics on loan-to-value ratios for supplemental home equity loans/lines (e.g., piggyback or “80-10-10” financing), as well as refinanced mortgages, are not readily available. 

continue to dominate the industry; however, recently, 

the two largest government-sponsored enterprises have 

begun accepting AVMs in lieu of standard appraisals 

for loans under $275,000.8 For lenders that specialize 

in HLTV mortgages, there is less room for error with 

AVMs. 

Cyclical Weakness Is Already Apparent 

in Subprime Mortgage Lending 

Historically, certain insured institutions have made 

mortgage loans with narrow collateral margins or to 

borrowers with limited or blemished credit histories. 

However, significant entry by FDIC-insured institutions into mortgage lending to borrowers with weak or 

marginal credit, as a targeted line of business, generally has occurred only since the early 1990s. These 

“subprime” mortgages are neither defined nor reported on Bank Call Reports. As a result, gauging the 

extent of bank involvement in subprime lending at any 

point in time is difficult. However, the FDIC estimates 

that fewer than 1 percent of all insured institutions 

have significant subprime residential mortgage exposures. Nevertheless, according to some measures, subprime mortgages as a share of total mortgage 

originations peaked at 13 percent in early 2000, before 

moderating somewhat during the first three quarters of 

last year.9 Thus, a much larger number of institutions 

probably have some limited involvement in subprime 

mortgage lending. A survey by the Minneapolis Federal Reserve Bank found that 29 percent of banks in 

the Minneapolis District offered loans to low-credit 

quality consumer borrowers in 1999.10 

Subprime mortgage loan performance appears to have 

deteriorated notably during 2001. One source of support for this observation comes from delinquency 

trends on Federal Housing Agency (FHA)-insured 

mortgages, which are often granted to first-time homebuyers with troubled credit histories and borrowers 

with low down payments. The Mortgage Bankers 

Association reports that while the national delinquency rate on conventional mortgages rose 58 basis points 

in the year ending third-quarter 2001, the delinquency 

rate on FHA mortgages shot up by 234 basis points, to 

11.4 percent (see Chart 4). This growing gap between 

8 “Automated Appraisals Require Caution by Lenders,” American 

Banker, October 10, 2001. 9 Based on dollar volumes, data from Inside Mortgage Finance Publications, Bethesda, MD. 

10 Ron Feldman and Jason Schmidt, “Why All Concerns About Subprime Lending Are Not Created Equal,” Fedgazette, Minneapolis 

Federal Reserve, July 1999. 

Dallas Regional Outlook 12 First Quarter 2002 
In Focus This Quarter
 

CHART 4 

Recent Mortgage Delinquencies for HigherRisk Loans Reached All-Time Highs 

Percentage of Mortgages

30+ Days Past Due

FHA 

Conventional 

,

79 ,81 ,83 ,85 ,87 ,89 ,91 ,93 ,95 ,97 ,99 ,01 

0 

2 

4 

6 

8 

10 

12 

Source: Mortgage Bankers Association 

delinquency rates on conventional and governmentinsured mortgages suggests that marginal and subprime borrowers are facing growing repayment 

difficulties. 

A database of more than 6.5 million subprime loans 

tracked by Loan Performance Corporation (formerly 

Mortgage Information Corporation) reported similar 

trends. The nationwide third quarter 2001 ratio of seriously delinquent subprime mortgages was 7.3 percent, up 

from 5.5 percent one year earlier.11 Moreover, subprime 

delinquencies significantly exceeded those found among 

prime mortgages, as just under 0.5 percent of conventional prime mortgages were seriously delinquent.12 Also 

of possible concern are vintage data trends, which show 

how pools of primary and junior-lien subprime mortgages perform over time. Mortgages originated in 2000 

are performing poorly in relation to previous years’ vintages.13 This simply could reflect the impact of the current 

recession. Alternatively, Loan Performance Corporation 

analysts have suggested that the 2001 refinancing boom 

might have created some adverse selection in mortgage 

pools originated during the relatively higher interest rate 

environment of late 1999 and early 2000.14 Because high11 The Market Pulse, Loan Performance Corporation (formerly Mortgage Information Corporation), Winter 2001 and Fall 2001. 

12 The Market Pulse, Loan Performance Corporation, Fall 2001. 13 Per Loan Performance Corporation delinquency data, subprime primary mortgages originated in 2000 displayed higher delinquency 

ratios for their age compared with similarly seasoned subprime loans 

originated in 1996, 1997, 1998, or 1999. Moody’s second-quarter 

2001 Home Equity Index Update found the same to be true of subprime home equity loans. 

14 “Another Look at the 2000 Book,” The Market Pulse, Loan Performance Corporation (formerly Mortgage Information Corporation), 

Winter 2001. 

er-coupon and variable-rate loans comprised a significant 

share of mortgage originations during that period, overall 

prepayment rates on the 2000 vintage might have been 

unusually high during 2001. Consequently, the best-quality loans in the 2000 pool might have refinanced, leaving 

loans of lesser credit quality behind and elevating the 

residual delinquency experience in that pool. 

Given these trends, an important issue for subprime 

lenders is their ability to anticipate and plan for the 

impact of an economic slump on their operations. Some 

institutions clearly adopt subprime lending as part of an 

overall business strategy, setting up monitoring and collection departments geared to dealing with such loans. 

Among large, national lenders, for example, one institution that makes 5 to 10 percent of its loans to subprime 

borrowers recently provided additional resources to its 

loan services and default management departments. This 

action followed a period when one-third of its increase in 

nonperforming single-family mortgage loans was associated with loans to subprime borrowers.15 

C&D Lending Risks May Be Elevated in MSAs 

with Potential Supply/Demand Imbalances 

Historically, lending to finance housing construction is 

riskier than mortgage lending on existing structures. 

Insured institutions report construction and development 

(C&D) lending in a single category that includes both 

commercial and residential construction. While it is thus 

impossible to ascertain from quarterly call reports the 

extent of bank involvement in financing housing construction, anecdotal evidence suggests that, although 

smaller insured institutions engage to some degree in 

commercial property development, their C&D lending 

largely finances single-family construction. If markets 

with an oversupply of housing see weaker economic performance, insured institutions engaged in financing residential real estate development may be at risk. This could 

result in an increase in C&D loan delinquencies, losses, 

and other-real-estate-owned (OREO). 

Demand for housing can be affected by two distinct 

trends: secular, or longer term; and cyclical, or shorter 

term. Over the long term, demographic trends, such as 

population growth rates and concentrations of households by age cohort, can affect overall demand for housing, as well as the types of homes demanded. Demand in 

local housing markets also can be affected by more cyclical factors such as recent changes in economic 

15 Calmetta Coleman, “Default Worries on Home Loans Escalate as 

Lenders Report Delinquency,” Wall Street Journal, October 29, 2001. 

Dallas Regional Outlook 13 First Quarter 2002 
In Focus This Quarter
 

conditions, including interest rates. New supply of homes 

in local housing markets is produced in response to perceived or estimated future demand. Correct interpretation 

of market and economic signals is critical to the success 

of builders in metropolitan areas; however, this activity is complicated by the lags associated with developing, permitting, and constructing properties. The effect 

of overestimating future demand could be multiplied if 

several builders inaccurately gauge changes in 

demand. Consequently, a construction market with 

numerous smaller developers, such as Atlanta, may 

see amplified swings in construction activity and may 

experience excess supply during certain periods. 

Although conceptually straightforward, measuring the 

balance between housing demand and supply is challenging, particularly at lower geographic levels. Shortcomings in data availability, quality, and timeliness 

can limit the effectiveness of this type of analysis. As 

already mentioned, some insight about current housing 

market conditions in specific metropolitan areas may 

be gained by analyzing both secular and cyclical 

trends. However, given the onset of recession last year, 

the role of cyclical factors is of prime concern at this 

time. 

To measure the cyclical aspect of the relationship 

between a market’s supply and demand, some analysts 

rely heavily on the concept of employment-driven 

demand.16 Such analysis involves tracking a demand/ 

supply ratio based on employment growth and permit 

issuance. Areas where permitting activity continues to 

accelerate while employment levels decrease may produce an increasing imbalance in the local housing 

market.17 

Using a simplified version of employment-driven 

demand, we identified a number of metropolitan areas 

as being at risk for a rising imbalance in their housing 

markets (see Chart 5), the largest of which are Chicago, Greensboro (NC), Minneapolis, Phoenix, Portland (OR-WA), St. Louis, and, most notably, Atlanta. 

These markets are displaying signs that residential 

16 For example, see www.myersgroup.com. 17 This approach, although more reflective of recent economic events 

than perhaps more secular measures, is not without its drawbacks. For 

example, employment data from the Bureau of Labor Statistics’ establishment survey are frequently revised, and, consequently, employment-driven demand may need to be reexamined. 

CHART 5 

–120 

–100 

–80 

–60 

–40 

–20 

20 

40 

60 

(5,000) (2,500) 2,500 5,000 

December 2001 Year-to-Date Permits 

(Year-Ago Change) 

December 2001 Employment

(Year-Ago Change, Thousands) 

Sources: Bureau of Labor Statistics, U.S. Census Bureau (Haver Analytics) 

Some Larger MSAs Continued to See 

Permit Growth during 2001, despite 

Declining Employment 

0 

Greensboro, 

Minneapolis, 

& St. Louis 

Chicago 

Atlanta 

Portland, OR–WA 

Phoenix 

construction activity may not be responding in kind to 

local economies that have started to contract during 

this recession. Further, Phoenix, Portland, and Atlanta 

were identified previously as banking markets exhibiting elevated risk profiles.18 

Chart 6 displays the level (y axis) and trend (x axis) in 

C&D lending exposures for the top 25 MSAs by median C&D concentration as a share of assets.19 It is 

apparent that some markets identified in Chart 5 as 

having significant banking exposure to C&D lending 

also may have a cyclical imbalance in home building. 

Atlanta, for example, demonstrates one of the highest 

exposures, with a ratio of median C&D to total assets 

of 17 percent in third-quarter 2001, a roughly 100­

basis-point increase from year-end 2000. In other 

words, while employment-driven demand has softened 

in the metropolitan area, single-family construction 

activity has continued, and community bank lenders 

may have increased their level of residential financing 

commitments. 

Cyclical Risks May Be Developing 

with Respect to Home Prices 

Popular comparisons have been made recently 

between the healthy run-up in housing prices during 

18 See “In Focus This Quarter,” Regional Outlook, Fourth-Quarter 

2001. 

19 We considered only MSAs that had at least six locally headquartered community banks that engaged in C&D lending activity and 

then charted the top 25 MSAs ranked by September 2001 median 

C&D/assets. 

Dallas Regional Outlook 14 First Quarter 2002 
In Focus This Quarter
 

CHART 6 

Some Banking Markets Are Seeing Rising Construction and Development (C&D) 

Exposure Coupled with Potentially Growing Supply/Demand Imbalances 

Sources: Bank Call Reports, Bureau of Labor Statistics, U.S. Census Bureau (Haver Analytics) Median C&D Loans-to-Assets (Third-Quarter 2001, %) 

0 

5 

10 

15 

20 

25 

30 

Change in Median C&D Loans-to-Assets 

(Percentage Point Change, from Fourth-Quarter 2000 to Third-Quarter 2001) 

–2 0 2 4 6 8 10 

Salt Lake City 

Atlanta Provo-Orem, UT 

Stockton, CA 

Greensboro 

Portland, OR–WA 

Phoenix 

MSAs with declining employment

 but rising permitting during 2001 

the past several years and the technology stock-fed 

speculative “bubble” in equity prices that persisted 

through early 2000. The subsequent bursting of this 

bubble and the resulting economic distress have raised 

concerns of a sequel featuring housing prices. 

According to the OFHEO repeat sales price index, 

there has never been an instance of outright declines in 

aggregate U.S. existing home prices.20 However, home 

prices do exhibit strong cyclical tendencies, with the 

rate of appreciation slowing during national recessions. In addition, there have been some decidedly 

CHART 7 

negative episodes during the past few decades in various metropolitan markets. At the national level, existing-home price growth historically has followed trends 

in population-adjusted personal income growth,21 and 

some have pointed to a growing imbalance between 

the two as a sign that home prices may weaken as the 

effects of the recession take hold (see Chart 7). 

Given that home price bubbles have occurred in the 

past, most notably in Texas, California, and the Northeast during the 1980s, and that their ultimate deflation 

MAP 1 

Change on Year Ago (%) Note: E=estimate 

Sources: OFHEO, U.S. Census Bureau 

The Widening Gap between Home Price and 

Income Growth Has Raised Some Concern 

Per Capita Income 

Home Price Index 

’85 ’87 ’91 ’93 ’97 ’01E ’89 ’95 ’99 

0 

2 

4 

6 

8 

10 

Drops in Affordability since the Mid-1990s
 

Are Most Prevalent in California 


and the Northeast
 

Top 10 percent of
 

MSAs ranked by decline
 

in affordability index, 1996
 

to 2001 (through June)
 

NOTE: Anchorage, AK, is included, but not shown. 

Source: Economy.com 

20 According to the National Association of Realtors’ U.S. median price, a few episodes of price declines (on a quarterly, year-ago basis) are present in the time series—specifically first- and second-quarter 1989; fourth-quarter 1990; and first-quarter 1993—only the 1990 episode occurred
 

during a recession. Also, as shown in Chart 1, U.S. median new home prices have experienced meaningful declines.
 21 This relationship is generally true at the metropolitan level as well.
 

Dallas Regional Outlook 15 First Quarter 2002 
In Focus This Quarter
 

resulted in significant negative fallout for these areas’ 

economies and insured institutions, it is useful to look 

at these historical examples as a potential “worst-case” 

scenario (with very low probability) for residential 

real estate markets during the current recession. It is 

unlikely that significant, systemic risks from home 

price bubbles have arisen yet for residential lenders. 

Of course, this situation could change if the current 

recession deepens or is protracted, or if growth during 

the subsequent recovery is anemic. Further, national 

trends can obscure dramatic variations in local markets, and a handful of MSAs today are coming off several years of rapid home price growth and falling 

affordability. These markets, and the residential lenders 

targeting them, may be more at risk as local economic 

growth falters. 

Map 1 shows markets that have seen the most significant reductions in affordability (sharp price gains) 

during the past several years. Not surprisingly, many 

of them—namely larger cities in California and the 

Northeast—are those that historically have seen the 

biggest swings in prices and a penchant for speculative 

excess. 

In markets with rapidly declining affordability, credit 

risk arises from the increasing likelihood that new 

borrowers will commit a greater share of household 

financial resources to meet monthly payments. Credit 

problems could become more readily apparent given 

any subsequent disruptions to employment or income 

in these markets—especially among households with 

limited wealth or that require multiple job holders to 

meet mortgage payments. These risks may be amplified by the increased underwriting of HLTV and subprime mortgages during the past decade. 

Disruptions to aggregate household liquidity from lost 

employment or decreased income can result in rising 

mortgage delinquencies. With respect to foreclosures, 

however, some research has suggested that the decline 

in prices relative to the balance owed on the mortgage 

(rising loan-to-value ratio) is the most significant factor.22 Even in instances of prolonged job/income loss, 

owners with positive equity are likely able to sell their 

22 For instance, “Mortgage Default Risk and Real Estate Prices: The 

Use of Index-Based Futures and Options in Real Estate,” Case, 

Shiller, & Weiss, NBER Working Paper #5078, NBER, April 1995, 

finds this to be the case, while citing past work that identified the link 

between rising LTVs and foreclosure rates. 

CHART 8 

Rising Foreclosure Rates Followed Falling 

Home Prices in New England a Decade Ago 

Sources: OFHEO (prices), Mortgage Bankers Association (foreclosures) 

Annual Home Price Change (%) 

’79 ’84 ’89 ’94 ’99 

Inverse 

Price (R) 

Foreclosure (L) 

–20 

–10 

0 

10 

20 

30 

Foreclosure Started

(% of Existing Loans) 

0.00 

0.10 

0.20 

0.30 

0.40 

0.50 

homes profitably, thus avoiding foreclosure. Chart 8 

shows the strong relationship between declining home 

prices and increasing foreclosure rates in New England a decade ago (the chart plots the inverse price 

change in order to emphasize the relationship).23 

The data available through late 2001 were mixed with 

respect to home resale price trends at the MSA level. 

On the one hand, while existing home prices as measured by the OFHEO home price index showed no 

markets with year-over-year price declines in fourthquarter 2001, NAR’s median resale price metric did 

show about a dozen markets with year-over-year 

declines, none exceeding four percent. A deceleration 

in year-over-year home price growth was evident for 

many markets (and the nation) using either measure. It 

should be noted that the OFHEO data do not include 

sales of high-priced homes and are less influenced by 

changes in the mix of homes sold than are average and 

median prices;24 this issue is more meaningful in the 

nation’s most expensive markets, such as MSAs in the 

23 In states where dominant metro areas have seen large price declines 

in past years, such as Massachusetts, this relationship is more pronounced than in larger states or the nation as a whole. For example, 

the two-decade correlation between foreclosures started and price 

change is –78 percent in Massachusetts versus roughly –60 percent in 

both California and the nation. 

24 Data are obtained from aggregating repeat sales or refinancings of 

the same properties over time and using statistical methods to calculate an overall rate of home price appreciation for each market. Sampled properties are confined to those whose mortgages are 

“conventional” and do not exceed a conforming loan limit (set at 

$275,000 in 2001) required for securitization through Fannie Mae and 

Freddie Mac. For more information, see www.ofheo.gov/house/. 

Dallas Regional Outlook 16 First Quarter 2002 
In Focus This Quarter
 

TABLE 1 

As Recession Evolved, Home Price Appreciation Waned through 2001 

...Further Deceleration in Growth (or Declines) May Be Possible in 2002 

ANNUAL PERCENT CHANGES 

MSAS RANKED 

BY DECELERATION 

IN HOME PRICE INDEX 

FROM 1Q01 TO 4Q01 

OFHEO HOME PRICE INDEX 

NONFARM 

EMPLOYMENT 

1998– 

2000 1Q01 2Q01 3Q01 4Q01 

1998– 

2000 2001 

UNITED STATES 6.3 9.6 9.1 8.8 6.9 2.4 0.3 

SAN JOSE CA PMSA 17.7 24.4 16.9 8.4 0.6 3.4 –0.4 

SANTA CRUZ-WATSONVILLE CA 

PMSA 16.8 25.7 17.3 11.9 5.9 N/A N/A 

SAN FRANCISCO CA PMSA 16.5 19.4 13.9 9.1 3.5 3.3 1.3 

SALINAS CA MSA 13.7 24.3 22.4 19.0 9.4 3.3 0.9 

SANTA ROSA CA PMSA 14.8 22.7 19.6 13.6 8.6 4.1 1.6 

OAKLAND CA PMSA 14.7 22.3 18.0 14.1 8.2 3.4 2.0 

AUSTIN-SAN MARCOS TX MSA 9.4 15.2 12.1 7.7 5.0 5.9 2.1 

MERCED CA MSA 6.4 24.6 21.8 17.3 15.7 N/A N/A 

JAMESTOWN NY MSA 4.9 9.9 0.8 7.4 1.6 N/A N/A 

STOCKTON-LODI CA MSA 9.0 22.8 25.2 20.6 14.9 3.7 3.0 

WHEELING WV-OH MSA 4.1 10.8 7.7 11.7 3.7 1.1 –0.5 

GOLDSBORO NC MSA 4.0 7.9 3.2 1.6 0.9 N/A N/A 

CUMBERLAND MD-WV MSA 2.7 8.6 8.4 8.1 1.8 N/A N/A 

LEWISTON-AUBURN ME NECMA 4.2 14.0 8.6 10.1 7.1 4.4 –0.4 

BANGOR ME NECMA 3.7 13.2 7.4 9.3 6.5 N/A N/A 

FARGO-MOORHEAD ND-MN MSA 4.0 11.1 6.5 5.4 4.6 2.1 –0.3 

BARNSTABLE-YARMOUTH MA 

NECMA 12.8 17.6 14.5 14.6 12.5 3.9 1.3 

PINE BLUFF AR MSA 2.2 6.6 9.7 5.0 0.3 0.8 –1.7 

DUBUQUE IA MSA 3.9 8.8 6.0 6.9 2.5 1.1 –0.6 

BOULDER-LONGMONT CO PMSA 10.9 14.6 11.7 11.7 8.3 5.1 3.2 

DENVER CO PMSA 11.1 13.7 11.8 10.9 7.9 3.8 2.3 

UTICA-ROME NY MSA 3.5 14.6 9.5 8.4 9.1 2.4 0.1 

VALLEJO-FAIRFIELD-NAPA CA PMSA 11.8 20.0 19.1 16.6 14.7 4.7 2.8 

BRYAN-COLLEGE STATION TX MSA 4.8 11.1 2.1 5.6 5.8 4.0 0.7 

SAN DIEGO CA MSA 11.8 15.6 13.8 12.9 10.4 4.3 2.7 

SAN LUIS OBISPO-ATASCADERO­ PASO ROBLES CA MSA 11.4 19.2 18.0 17.8 14.2 N/A N/A 

TUCSON AZ MSA 3.3 8.6 8.0 6.8 3.6 3.5 0.8 

JERSEY CITY NJ PMSA 8.0 11.1 17.6 13.7 6.2 2.1 2.7 

CLARKSVILLE-HOPKINSVILLE TNKY MSA 3.3 9.1 4.2 6.5 4.2 N/A N/A 

RAPID CITY SD MSA 6.2 8.9 9.3 7.7 4.1 3.1 0.1 

LA CROSSE WI-MN MSA 5.7 7.4 5.8 5.1 2.6 2.3 1.0 

ST. CLOUD MN MSA 6.9 10.4 8.5 9.4 5.7 3.8 1.4 

Sources: Office of Federal Housing Enterprise Oversight (OFHEO), Bureau of Labor Statistics 

Dallas Regional Outlook 17 First Quarter 2002 
 

In Focus This Quarter
 

San Francisco Bay Area25 and parts of the Northeast, 

since prices for high-end homes (typically financed by 

jumbo mortgages) may be more volatile over the economic cycle. 

Table 1 lists markets whose 2001 deceleration in home 

price growth was in the top 10 percent of the more 

than 300 metro areas for which the OFHEO statistic is 

available. The table also provides (where available) 

each MSA’s recent employment trend as an indicator 

of overall economic conditions. These markets may yet 

see even more pronounced deceleration in home price 

growth or even declines in home prices this year (as 

may others not shown). This possibility will be determined for the most part by the performance of each market’s local economy. 

The metro areas in the table are 

ordered by the magnitude of their 

deceleration in home price growth 

over the initial quarters of this recession. As a result, the marked deceleration in year-over-year price 

growth in the recently overheated 

San Francisco Bay Area puts many of its MSAs near the 

top of the list. In the table, San Jose, San Francisco, 

Oakland, Denver, and San Diego also previously were 

identified as banking markets with elevated risk profiles.26 For some of the smaller MSAs in Table 1 with 

more volatile appreciation rates, such as Utica and 

Fargo, comparisons of recent price trends are more 

appropriate using the 1998–2000 average as a benchmark, as these markets experienced pronounced spikes in 

year-ago price growth during first-quarter 2001. 

It is hard to generalize about which markets will see the 

most pronounced home price weakness as the recession 

continues. However, certain markets have shown a tendency in the past to be driven to a greater degree by speculative, rather than fundamental, factors. These markets 

are more likely to see significant downward corrections 

in price when economic activity falls for a prolonged 

period or by a sufficient magnitude. One study from the 

mid-1990s found, in comparing 14 cities in the Northeast and West with 16 inland cities, that while both 

groups tended to respond similarly to local and national 

25 As considered here, this includes the following MSAs: San Jose,
 

Santa Cruz-Watsonville, San Francisco, Santa Rosa, Oakland, Salinas, and Vallejo-Fairfield-Napa.
 

26 See “In Focus This Quarter,” Regional Outlook, Fourth Quarter
 

2001.
 

economic forces (fundamental, or “equilibrium,” price 

drivers), prices in the former group tended to be influenced to a greater degree by speculative, or “disequilibrium,” variables, including recent trends in price 

appreciation.27 Cities along the nation’s coasts also have 

tended to see the most significant price swings over the 

past 20 years. 

History also provides some insights into the nature and 

extent of any price declines in markets where economic 

conditions deteriorate. A study of two significant examples, Boston and Los Angeles in the 1980s and early 

1990s, concluded that declines differed by property type 

(i.e., condos versus single-family) and price class (i.e., 

high-end versus entry-level).28 This dispersion in price 

declines arose from differing rates of appreciation (properties that experienced the greatest inflation during the 

boom saw the largest deflation) and from the nature of 

each city’s economic decline, which differed according to 

concentrations of job losses by industry and wage type, 

underlying demographic factors, and housing supply 

trends. 

Looking at recent developments, it seems that the greatest near-term risk of a significant downward adjustment 

in housing prices is in the San Francisco Bay area. In 

recent years, this area witnessed double-digit home price 

appreciation that exceeded growth in per capita income 

by a wide margin. A recent analysis from the University 

of California-Berkeley’s Haas School of Business forecast that prices in the Bay Area housing market will 

decline by 15 percent overall (and by 30 percent for luxury homes) by the time the local economy’s recession 

ends late this year.29 Meanwhile, the larger MSAs in 

Southern California have not seen as significant a disparity between home price appreciation and personal 

income growth during this cycle as during the 1980s. 

Also in contrast to the 1980s, New England (and the 

Northeast generally) has seen little speculative purchase 

or construction activity in recent years, which should 

help to mitigate any price weakness through the current 

recession in these markets.30 

27 Jesse M. Abraham and Patric H. Hendershott, “Bubbles in Metropolitan Housing Markets,” Working Paper #4774, NBER, June 1994. 

28 Karl E. Case and Robert J. Shiller, “A Decade of Boom and Bust in 

the Prices of Single-Family Homes: Boston and Los Angeles, 1983 to 

1993,” New England Economic Review, March/April 1994. 29 David Goll, “Bay Area Housing Market Will Remain Slow,” East 

Bay Business Times, January 23, 2002. 30 “Regional Perspectives,” Boston Region, Regional Outlook, First 

Quarter 2002. 

Dallas Regional Outlook 18 First Quarter 2002 
In Focus This Quarter
 

Conclusion 

Home prices are holding up in most markets, and, generally, permanent residential mortgages have fared 

well in prior recessions. However, history might 

understate credit risks for insured institutions during 

this cycle because the mortgage lending business has 

changed since the last recession. Chief among these 

changes are robust mortgage market competition, 

which has contributed to narrower collateral margins; 

increased reliance on underwriting automation; and 

expanded involvement in the subprime credit market. 

In addition, residential C&D lenders in certain markets might be particularly vulnerable, since C&D credits typically undergo higher loss rates and some areas 

are experiencing continued construction despite a 

cyclical slowdown (as measured by employment 

trends). Permanent mortgage lenders in certain areas, 

such as the San Francisco Bay area, could also face 

higher loss rates and foreclosures going forward, as the 

current economic weakness places downward pressure 

on home prices and dampens the ability of households 

to meet mortgage payments. 

Scott Hughes, Regional Economist 

Judy Plock, Senior Financial Analyst 

Joan Schneider, Regional Economist 

Norm Williams, Regional Economist 

Dallas Regional Outlook 19 First Quarter 2002 
✁
 

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