Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION FIRST QUARTER 1998 

FDIC
 

Dallas
 

Region
 

Division of
 

Insurance
 

Alan C. Bush,
 

Regional Manager
 

Adrian R. Sanchez,
 

Regional Economist
 

Jeffrey A. Ayres,
 

Financial Analyst
 

In Focus This Quarter 

◆ Y2K—Preventing the Year 2000 (Y2K) computer problem is becoming ever more 

costly as the time and resources left to do so disappear. Equally costly, according to 

some estimates, will be the litigation that follows in the problem’s wake. A failure to 

address Y2K exposures immediately and successfully may amount to a gamble backed 

by the value of the bank franchise and the officers and directors who run it. See page 3. 

By Gary Ternullo 

◆ Trends in Commercial Real Estate Loan Pricing and 

Underwriting—An abundant supply of financing is placing pressure on commercial real estate loan pricing and underwriting standards. Underwriting standards are being increasingly influenced by the rapid growth in commercial 

mortgage-backed securities and real estate investment trusts. While many within the 

industry believe that broader public funding of commercial real estate projects will 

lead to greater market transparency and improved underwriting discipline, there 

are a number of unique risk considerations related to the rapid growth and continuing development of these alternative funding sources. See page 7. 

By Steven Burton 

◆ Total Return:A Useful Tool for Monitoring Investment Portfolio 

Risk—The Federal Financial Institutions Examination Council is rescinding the 

1991 policy that required “high-risk” testing for mortgage derivative products and 

has released for comment a policy encouraging risk management across all types of 

instruments on an investment portfolio basis. Total return, a concept that includes 

fluctuations in market value, is a useful tool for measuring the performance of an 

investment portfolio and providing information about market risk at the portfolio 

level. See page 13. 

By Allen Puwalski 

Regular Features 

◆ Regional Economy—Job growth in the Region remained robust in 

1997...leading job-generating industries were business and health services...tighter 

labor markets will constrain job growth in 1998...housing should maintain its current strength buoyed by a healthy economy and low mortgage rates...fallout from 

the Asian currency and financial crisis will result in a reduction in Regional exports 

and a subtraction from growth. See page 16. 

By Adrian R. Sanchez 

◆ Regional Banking—Banks and thrifts in the Dallas Region continue to 

keep pace with national trends...banks with high asset growth rates display higher 

risk profiles...three Dallas Region metropolitan statistical areas (MSAs) are among 

the top 20 in REIT ownership. See page 21. 

By Jeffrey A. Ayres, Alan C. Bush 

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

Insurance Corporation 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, AZ, CA, FJ, FM, GU, HI, ID, MT, NV, OR, UT, WA, WY)
 

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/ 

publish/regout. For more information or to provide comments or suggestions about the Dallas 

Region’s Regional Outlook, please call Alan Bush at (214) 220-3434 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 Andrew C. Hove, Jr. 

Director, Division of Insurance Arthur J. Murton 

Editor George E. French 

Assistant Editors Daniel Frye 

Craig A. Rice 

Publications Manager Teresa J. Franks 
In Focus This Quarter
 

Y2K: Banking in the twenty-first century may provide
 

grand new opportunities—but you have to get there first
 

•	 As a result of a three-decades-old programming 

convention, January 1, 2000, may find some computer systems unable to function correctly, if at 

all. Links within and between systems and organizations make the problem a complex one. 

•	 Cures are expected to be difficult and costly. If 

those cures fail, litigation could be equally costly, 

and much of it may be aimed at directors and 

officers. 

•	 Accordingly, senior bank management should be 

actively involved in making sure the cure takes 

place. A failure to do so amounts to a gamble 

backed by the value of the bank franchise and 

those who run it. 

Complex Problem, Complex Cure 

By now the story is well known. At midnight on 

December 31, 1999, computer systems that process 

dates using only the last two digits of a year will cease 

to function correctly, if at all. Equipment that contains 

embedded systems—chips or circuitry designed to perform specific functions—also may fail. And the problem is pervasive. It lies within systems and between 

systems, in both software and hardware. The large number of ways dates are used, the number of places they 

can occur, and the number of creative ways for naming 

them confounds an accurate assessment. 

Fixing the Year 2000 (Y2K) problem will require considerable time and effort. Computers and applications 

must be inventoried, examined for date usage, corrected 

where necessary, and then tested—not just by themselves but in combination with every other system with 

which they interact. This includes not only a bank’s own 

systems but also those of its servicers, correspondents, 

customers, vendors, and trading counterparties. 

Moreover, there are a variety of ways to address the 

problem, ranging from expanding date fields to four 

digits to simply subtracting 28 years from every date 

before processing—any of which could introduce new 

incompatibility problems when systems that have been 

fixed in different ways attempt to interact.1 And because 

not all systems can be corrected at once, interfaces or 

bridges between corrected and uncorrected systems also 

must be developed to maintain business system continuity. Most important, it must all be done before the 

non-negotiable deadline of December 31, 1999. 

For bank management, there are two ways to find out 

how serious the problem will be. The first is to commit 

resources to determining just how exposed the bank’s 

systems are—the first concrete step in actually solving 

the problem. The second is to gamble the franchise by 

doing little or nothing and letting the century date 

change provide the ultimate stress test. 

Costs 

The costs of a cure are many. First, there are the costs of 

actually finding and fixing the problem. Estimates of 

this cost have ranged widely, although the Gartner 

Group’s estimate of $300 to $600 billion worldwide is 

the most widely quoted. Using a different approach, 

Software Productivity Research (SPR) places the global number at over $1.3 trillion, including a $176 billion 

slice for the United States alone. Then there are the estimated costs of litigation. At the low end, SPR places 

them at $300 billion globally and projects that fully onethird of that amount will be generated in the United 

States. At the high end, the Giga Information Group 

sees a much more litigious future—estimating that 

Y2K-related legal costs could exceed $1 trillion. 

Significant opportunity costs may accrue as well, and 

the degree to which Y2K-related outlays fail to provide 

1 Every 28 years the same combination of dates and days recurs. 

Subtracting 28 years from a date before processing and then adding 

them back upon output has been suggested as a temporary but partial 

remedy because it permits applications to continue measuring time by 

subtracting two-digit years from each other. Windowing is another 

partial correction whereby some two-digit years—say those less than 

“50,” for example—are assumed to be preceded by “20” (thus “49” 

becomes “2049” in date calculations) while the remainder are 

assumed to be preceded by a “19” (thus “50” becomes “1950”). Both 

approaches only delay the need for permanent corrections. 

Dallas Regional Outlook 3	 First Quarter 1998 
In Focus This Quarter
 

more efficient or functional systems will serve as a 

starting point for measuring the value of technology 

investments forgone. These forgone improvements will 

be especially costly for institutions that have started 

their repairs too late. They may find not only that the 

time for system improvements and upgrades has slipped 

away, but that they have insufficient time for anything 

beyond a patchwork solution that will continue to cost 

them beyond the year 2000. 

At the macro level, the tally of potential Y2K costs 

includes declining stock values, business failures, and 

recession. J.P. Morgan has estimated that as much as 40 

percent of organizations’ remediation costs have not 

been accounted for in their information technology budgets, presumably indicating that many firms will see 

their share value erode as the costs of Y2K fixes and 

related losses are priced into their future earnings. The 

cost of not being Y2K compliant might be substantial as 

well. According to the Gartner Group, as many as one 

in two firms may discover just how substantial as they 

head into 1999 with even their most mission-critical 

systems unfixed. The potential for these firms to fail 

looms large among the factors that have led Edward 

Yardeni, chief economist at Deutsche Morgan Grenfell, 

to assign a 40 percent chance of recession in the year 

2000. Peter de Jager, a consultant who also has commented extensively on Y2K issues, went even further, 

suggesting that 1 percent of all businesses would fail 

because of Y2K problems. Whatever the eventual 

number, many of these businesses will also be bank 

borrowers. 

Systems and Systemic Risks 

More immediate than the risk of borrower failures is the 

risk that a bank’s own systems may fail. Banks are heavily dependent on software applications that employ 

dates. Among other things, they use them for calculating interest paid or due and for managing the horizons 

of their assets and liabilities. If these applications begin 

returning erroneous calculations, bank operations could 

be seriously disrupted.2 If they fail altogether, the bank’s 

2 For example, interest due from borrowers for a one-year period 

beginning in 1999 and ending in 2000 might be calculated not as one 

year’s interest due but rather as nearly one century of interest payable 

(00 − 99 = − 99) if only the last two digits of the year are used in the 

calculation. Similarly, any other time calculation that straddles the 

century date change might return answers wrong in both size and 

sign. 

credibility—and hence its franchise value—can be substantially damaged or even irrevocably lost. 

The solution is often described in software terms, but 

executable software is not the only problem. Correcting 

software to process four-digit years does little good if 

bank databases that store the critical information about 

who owes what to whom and when still store them in 

two-digit form. Hardware is another critical area. 

Nearly all electronic devices have embedded, permanently programmed chips that can be difficult to find 

because the functions they perform are not always 

apparent. This situation could lead to a host of nuisances, with automated teller machines, point-of-sale 

terminals, bank vaults, check and credit card processing 

equipment, and even building systems succumbing to 

the Y2K problem. 

This dependence on external components and services 

creates a systemic exposure as well. The substantial 

efficiencies that now exist in transmitting payments 

among and between banks and borrowers are a direct 

result of technology. Servicers and 

clearinghouses fulfill computerintensive intermediary roles in this 

high-velocity business—pooling 

payments from those who owe and 

redistributing them among those 

to whom they are due. Anything 

that interrupts these flows can 

have a substantial impact on the ability of banks to settle with their customers and with each other. 

Accordingly, both the Bank for International 

Settlements and the U.S. Federal Reserve are concerned 

about the Y2K threat for two reasons—first because it 

can interrupt the operations of systems dedicated to 

making interbank payments and second because it can 

interrupt the operations of the individual participants 

and generate a liquidity shock that could cause other 

institutions to fail. 

Unfortunately for banks, even a fully successful, 

industry-wide Y2K fix will not completely mitigate 

their risk. The year 2000 story is simply too dramatic 

and lends itself too well to sensationalism. Therefore, 

in addition to managing the cure, bankers will have to 

manage the perceptions of their customers and of the 

public at large—a considerable challenge given that a 

loss of confidence by a small number of customers 

could precipitate liquidity problems for institutions 

even in the absence of a genuine threat. 

Dallas Regional Outlook 4 First Quarter 1998 
In Focus This Quarter
 

Liability in the Executive Suite 

It bears frequent repeating that Y2K is a business problem and not just a technical one. Its intricacies go 

beyond those of the systems themselves and extend into 

the labyrinth of business relationships and fiduciary 

obligations that bind directors and officers—and the 

assorted attorneys, auditors, consultants, and service 

providers who assist them—to their banks. Through this 

network could pass liability and litigation that could be 

several times the cost of fixing the problem itself. And 

although the problem may have had a technical origin, 

claims would likely be directed against those with deeper pockets who jointly and severally, it will be argued, 

should have corrected or disclosed the institution’s Y2K 

exposures. 

While the bank failures of the late 1980s and early 

1990s are often attributed to unforeseen economic 

events, it will be difficult to assert such a defense for a 

failure to address the Y2K problem. It is simply too visible and offers too much advance notice. This is one reason why the potential potency of Y2K litigation should 

be taken seriously. Moreover, placing the blame, no 

matter how well deserved, at the feet of vendors and 

consultants may offer little protection. The Federal 

Financial Institutions Examination Council (FFIEC) 

has indicated that senior bank management should be 

fully aware of their vendors’ progress and develop contingency plans should those vendors fail.3 This pronouncement has elevated the standard for prudent Y2K 

actions in such a way as to make imperative the active 

involvement of top bank management in both solving 

3 Safety and Soundness Guidelines Concerning the Year 2000 Business 

Risk, December 1997. The full text is available on the FFIEC website 

at www.ffiec.gov. 

Managing the Y2K Process 

On May 5, 1997, the Federal Financial Institutions Renovation. Renovation includes not only fixing the 

Examination Council—an interagency group com- problem internally but monitoring the efforts of cusposed of the Federal Deposit Insurance Corporation, tomers, counterparties, vendors, and service 

Federal Reserve, Office of the Comptroller of the providers. The prudent execution of due diligence and 

Currency, Office of Thrift Supervision, and National best practices at this stage will provide a measure of 

Credit Union Administration—released a statement confidence that exposures have been addressed. It 

on Year 2000 project management awareness that will also provide a measure of protection from liabilincluded an outline of the Y2K management process. ity claims should problems nevertheless emerge. 

That outline identified five phases that each financial 

institution would have to navigate in identifying and Validation. Validation means testing how a bank’s 

fixing its Y2K exposures: systems will respond on their own as well as when 

connected with those outside the bank. The FFIEC 

Awareness. Before Y2K exposures can be fixed, they believes that one full year should be available for testmust be seen as problems. Creating awareness, how- ing and correcting problems that either remain or are 

ever, is not easy because the pervasiveness of compo- introduced by the renovation process. Accordingly, 

nents and intersystem links that can harbor or pass the institutions should plan on completing the previous 

problem create complexities that are neither intuitive three phases by the end of 1998. 

nor easily quantified. However, it is critical that senior 

managers understand the problem and fully support Implementation. Testing corrected systems to ensure 

the commitment of resources to fixing it. their compliance does not complete the process. The 

final step is to gain acceptance by the users as to the 

Assessment. In this phase, all information systems, ability of the system to satisfy business requirements. 

electronic equipment, and building systems must be A failure at this stage will require further correction 

evaluated for specific Y2K exposures. Remediation or the implementation of contingency plans. 

plans must then be devised. In addition to plans for 

fixing the problem, contingency plans will be needed For the full text of this and other FFIEC guidance, see
 

as a precaution against unforeseen Y2K failures orig- the FFIEC website at www.ffiec.gov.
 

inating from both within and outside the bank.
 

Dallas Regional Outlook 5 First Quarter 1998 
In Focus This Quarter
 

the problem and ensuring that the franchise will be protected if one or more of those solutions fail. 

Betting the Franchise 

The FFIEC has divided Y2K remediation into five 

phases—awareness, assessment, renovation, validation, 

and implementation (see Inset 1, page 5). As a benchmark for progress, the FFIEC has indicated that the validation phase—the phase in which testing of Y2K fixes 

is conducted—should be well under way for all banks 

by the end of 1998. This leaves less than a year for laggards to complete the first three phases. Banks that are 

not devoting adequate resources to identify and address 

their exposures need to be aware that the consequences 

of delay or inaction could be severe. The bank supervisory agencies, Congress, and the financial markets are 

taking the risk to heart. So too are attorneys intent on 

sharing in what has been described as potentially the 

most expensive litigation in history. 

Insurance companies are concerned as well, as evidenced by extremely high Y2K policy premiums or outright refusal to write Y2K coverage. Thus, any business 

interruptions and liability that emerge may have to be 

financed from the bank income statement and balance 

sheet. As such, a bet that Y2K will not be a problem 

might well amount to a gamble backed by the bank franchise and those who run it. (See Inset 2 below for additional sources of information.) 

Gary Ternullo, Senior Financial Analyst 

gternullo@fdic.gov 

For Further Information 

Further information on the Y2K problem can be obtained from banking regulatory agencies at the websites shown 

below. 

Federal Deposit Insurance Corporation (FDIC) www.fdic.gov 

Federal Financial Institutions Examination Council (FFIEC) www.ffiec.gov 

U.S. Federal Reserve Board of Governors www.bog.frb.fed.us 

National Credit Union Administration (NCUA) www.ncua.gov 

Office of the Comptroller of the Currency (OCC) www.occ.treas.gov 

Office of Thrift Supervision (OTS) www.ots.treas.gov 

The following websites contain additional information concerning the Y2K problem. Their inclusion here does 

not serve as an endorsement by the FDIC of any information contained therein. 

Market Partners Inc.—Year 2000 Resources for Banks www.marketpartners.com 

Gartner Group—Technology Consultant www.gartner.com 

Software Productivity Research (SPR)—Technology Consultant www.spr.com 

De Jager LLC (Peter de Jager)—Technology Consultant www.year2000.com 

Giga Information Group—Technology Consultant www.gigaweb.com 

Y2K LLC (Williams, Mullen, Christian & Dobbins)—Attorneys www.Y2K.com 

Economics Network (Dr. Edward Yardeni)—Economist www.webcom.com/yardeni 

Dallas Regional Outlook 6 First Quarter 1998 
In Focus This Quarter
 

Trends in Commercial Real Estate
 

Loan Pricing and Underwriting
 

•	 An abundant supply of capital is placing significant pressure on commercial real estate loan 

pricing. 

•	 Considerable evidence suggests that a large percentage of insured institutions are easing commercial real estate and construction lending 

underwriting standards. 

•	 The rapid rise in commercial mortgage-backed 

securities and real estate investment trust funding 

could change the way banks underwrite commercial real estate loans and have important effects 

on their competitive position in the lending 

markets. 

As reported in last quarter’s Regional Outlook, banks 

provided the largest share of funding for commercial 

real estate during 1995 and 1996 compared with all 

other financing sources (see Strong Demand and 

Financial Innovation Fuel Rebounding Commercial 

Real Estate Markets). Chart 1 shows that banks’ commercial real estate and construction lending continues 

to increase and that year-over-year growth rates in these 

two loan categories are accelerating. At the same time, 

however, alternative funding sources in the form of 

commercial mortgage-backed securities (CMBS) and 

real estate investment trusts (REITs) are also experiencing significant growth. Commercial Mortgage Alert 

reports that $26 billion in CMBS was issued through 

September 1997, up from $17 billion for the same period in 1996. The same publication projects that CMBS 

issuance will top $40 billion during 1997, compared 

with last year’s record issuance of $29.8 billion. 

Measures of REIT activity also indicate impressive 

growth. According to the National Association of Real 

Estate Investment Trusts, REITs issued $26.3 billion in 

equity through October, compared with $12.3 billion 

for all of 1996. In addition, REIT market capitalization 

rose $50 billion (64 percent) through the first nine 

months of 1997. 

While it is good news to borrowers, the abundance of 

capital for commercial real estate projects raises the 

often-quoted concern that “too much money is chasing 

too few deals.” Market observers worry that fierce competition and an excessive supply of financing are leadCHART 1 

Banks’ Commercial Real Estate and 

Construction Lending Rebounds 

Year-over-Year (%) Growth

Source: Commercial Bank Call Reports 

–30 

–20 

–10 

0 

10 

20 

YE90 YE91 YE92 YE93 YE94 YE95 YE96 3Q97 

Construction Loans 

Commercial Real Estate Loans 

ing to both inadequate loan pricing relative to risks 

borne by lenders and looser loan underwriting standards. This article examines current trends in commercial real estate loan pricing and loan underwriting. It 

also explores the possible influences of CMBS and 

REITs on loan underwriting practices and commercial 

real estate markets. 

An Abundance of Capital Has Placed 

Significant Pressure on Commercial Real 

Estate Loan Pricing 

Chart 2 (next page) shows that prime-graded commercial mortgage spreads have steadily declined since 1992 

and are now at levels not seen since the real estate boom 

years of 1988 and 1989. At 113 basis points above tenyear treasuries, current spreads on ten-year commercial 

mortgages are only slightly higher than A-rated ten-year 

industrial corporate bonds, which traded at spreads of 

66 basis points over comparable-term treasuries as of 

September 1997. Some property sectors have experienced more narrowing of spreads than others. 

American Council of Life Insurance (ACLI) data show 

that mortgage spreads relative to treasuries compressed 

31 basis points for industrial, 22 basis points for hotel, 

21 basis points for retail, 11 basis points for multifamily, and 10 basis points for office real estate from March 

1996 to March 1997. Moreover, because of continuing 

downward pressure, current pricing varies little across 

Dallas Regional Outlook 7	 First Quarter 1998 
In Focus This Quarter
 

CHART 2 CHART 3 

Commercial Mortgage Spreads Are Pricing Narrows between High- and
 

Tightening 

Basis Point Spread over

Ten-Year Treasuries 

Source: Barron’s/John B. Levy 

0 

50 

100 

150 

200 

250 

Jan ’87Jan ’89Jan ’91Jan ’93Jan ’95Jan ’97 

Spread between AAA and BBB

Grades (Ten-Year Average Life)

Medium-Grade CMBS 

Basis Points 

140 

120 

100 

80 

60
 

40
 

20
 

0 

Q1 ’95Q3 ’95Q1 ’96Q3 ’96Q1 ’97Q3 ’97 

Source: Nomura Securities International 

the quality spectrum. For instance, Chart 3 indicates 

that spreads between AAA- and BBB-rated CMBS have 

narrowed considerably since year-end 1995, from 110 

basis points to a scant 28 basis points. 

It seems likely that competitive factors will continue to 

place pricing pressure on lenders. The relatively recent 

entrance of Wall Street firms into the financing arena 

via conduits is a striking example of just how competitive the market for commercial real estate financing has 

become.1 Conduits are rapidly becoming the dominant 

issuer of CMBS and underlie much of the rapid growth 

in CMBS noted above. Through the first nine months of 

1997, Commercial Mortgage Alert reported that conduits accounted for 50 percent of total CMBS issuance, 

compared with 30 percent during the same period in 

1996. 

Many industry participants see conduits and REITs as 

significant and increasing competitive threats to traditional lenders. For example, a recent issue of 

Commercial Real Estate South discussed the continuing expansion of conduit business into a much wider 

range of property and credit quality types. This publication noted that conduits have a particular incentive to 

aggressively pursue higher quality loans in order to 

strengthen pools that contain weaker credits. Such 

aggressiveness threatens to squeeze banks’ profit margins on low-risk deals, which might give banks an 

incentive to pursue lower quality credits. Given their 

focus on larger credits, conduits presently pose a competitive threat primarily to larger lenders. However, the 

1 Conduits are entities created to originate mortgage loans for distribution to investors in the secondary market. 

rapid growth of capital within the industry may eventually force larger lenders to target smaller markets, which 

would in turn increase competition at the regional or 

local community level. While their influence is less 

direct, the growing use of REITs to finance commercial 

real estate projects also places pressure on loan pricing 

spreads, since lenders must compete for a smaller pool 

of customers. With their access to a seemingly limitless 

source of public funding, REITs could pose a particular 

threat to community bankers by dominating certain geographic markets or property sectors. 

Narrowing pricing spreads raise concerns over whether 

lenders are being adequately compensated for the operational, funding, credit, and market risk inherent in 

originating, servicing, and holding commercial real 

estate loans. More important, tightening spreads raise 

prospects that lenders will ease other loan terms and 

relax loan standards to the extent that they are unable to 

differentiate their product based solely on price. While 

such easing may enable lenders to retain business in the 

face of stiff competition, imprudent underwriting could 

ultimately lead to higher loan losses than would otherwise be the case in the event of a downturn in commercial property markets. 

Are Commercial Real Estate Loan Underwriting 

Standards Becoming Looser? 

Most industry experts have argued that the memory of 

the real estate downturn of the late 1980s and early 

1990s keeps lenders from becoming overly aggressive 

in making commercial real estate loans despite the 

abundance of funding alternatives currently available to 

Dallas Regional Outlook 8 First Quarter 1998 
In Focus This Quarter
 

borrowers. These experts point out that today’s loan-tovalue (LTV) ratios are lower than they were at the peak 

of the last real estate boom, that lenders are concentrating more on obtaining adequate debt-coverage ratios, 

and that lenders are requiring borrowers to bring more 

cash equity to the table. One might also argue that practices have improved and become much more uniform 

with the implementation of regulatory appraisal standards and the adoption of interagency guidelines for 

real estate lending policies. Rating agencies impose 

additional guidelines and standards as lenders originate 

loans for possible sale into the secondary markets. 

While information about specific quantitative underwriting criteria applied to new loan originations by 

commercial banks is not readily available, some sense 

of industry trends may be gleaned from competitors’ 

practices. For example, the ACLI performs a quarterly 

survey of underwriting criteria for commercial real 

estate loan commitments originated by major life insurance lenders. The ACLI’s second quarter 1997 survey 

indicated that new commitments (total volume of $4.1 

billion) had a weighted average LTV for all property 

types of 66 percent and a weighted average debt-coverage ratio (DCR)2 of 1.6 times. These figures compare 

favorably to an LTV ratio in late 1989 approaching 75 

percent and a DCR just under 1.3 times. 

ACLI data suggest that recent commercial mortgage 

originations are better supported by borrower equity 

and property cash flows than they were in the late 

1980s. It is important to recognize, however, that LTV 

and DCR ratios are driven largely by market conditions 

and expectations. Property valuations take into account 

recent sales and expected cash flows, and cash flows 

available to service debt are based on projected net 

operating revenues, which often incorporate projected 

increases in rents and other revenue sources. In other 

words, the overwhelmingly favorable conditions in 

today’s real estate markets may also be a factor in the 

improved LTV and DCR ratios. Keeping in mind the 

cyclical nature of real estate, one can easily see how a 

shift from today’s positive outlook to a more pessimistic 

outlook might result in a sharp reversal in these commonly cited ratios. 

Notwithstanding these quantitative considerations, 

there are indications that banks are easing commercial 

2 The debt-coverage ratio measures annual net operating income generated by a property relative to annual principal and interest payments 

due on the underlying loan. 

real estate underwriting standards. This evidence, 

derived from industry and examiner surveys conducted 

by the three banking agencies, includes the following 

observations: 

•	 In the Office of the Comptroller of the Currency’s 

(OCC’s) 1997 Survey of Credit Underwriting 

Practices, OCC examiners reported eased commercial real estate lending standards in 38 percent of 

banking companies surveyed. For comparison purposes, the 1996 survey reported eased standards in 

16 percent of banking companies surveyed. Among 

institutions with eased lending standards in the 1997 

survey, examiners noted a 75 percent incidence of 

reductions in loan fees or rate spreads, a 43 percent 

incidence of eased guarantor requirements, and a 29 

percent incidence of lower collateral requirements. 

Examiners cited competitive factors and a change in 

economic outlook as the main reasons for changes in 

underwriting standards. 

•	 Chart 4 summarizes current and historical results of 

the Federal Reserve Board Senior Loan Officer 

Opinion Survey for responses to the question of 

whether bank credit standards for approving applications for commercial real estate loans have eased, 

tightened, or remained unchanged. These survey 

results show that banks have had a tendency to ease 

underwriting standards since the fourth quarter of 

1996. This tendency appears to have become 

stronger through the third quarter 1997 survey but 

moderated somewhat in the most recent survey. The 

most recent survey showed that large banks (over 

$15 billion in assets) were much more likely to indicate easing commercial real estate standards than 

CHART 4 

Survey Shows Tendency to Ease Commercial 

Real Estate Underwriting Standards 

Percentage 

Source: FRB Senior Loan Officer Opinion Surveys 

2Q96 3Q96 4Q96 1Q97 2Q97 3Q97 4Q97 

–15 

–10 

–5 

0 

5 

10 

15 

20 

25

 % Respondents Tightening

 % Respondents Easing

 Net % Tightening (Easing) 

Dallas Regional Outlook 9	 First Quarter 1998 
In Focus This Quarter
 

smaller banks. Specifically, 21 percent of large 

banks reported easing standards, while only 3 percent reported tightening standards. In comparison, 

only 9 percent of smaller banks reported easing 

standards, while 13 percent reported tightening 

standards. 

•	 Results from the FDIC Report on Underwriting 

Practices indicate possible easing of standards for 

construction and development (C&D) loans at 

FDIC-supervised banks. A comparison of examiner 

responses for the third quarter 1997 survey (covering 

examination reports filed from April through 

September 1997) with responses for the third quarter 

1996 survey leads to the following observations3: 

•	 The percentage of banks frequently or commonly 

originating C&D loans tied to speculative projects 

(that is, projects lacking meaningful preleasing or 

presales, or loans without a formal take-out commitment for permanent financing following completion 

of construction) rose markedly, from 11 percent to 

29 percent. 

•	 The percentage of banks frequently or commonly 

granting C&D loans without considering alternative 

repayment sources other than income generated by 

the project being financed rose significantly, from 8 

percent to 20 percent. 

•	 The percentage of banks frequently or commonly 

basing C&D loans on unrealistic appraisals rose 

from 5 percent to 11 percent. 

•	 The percentage of banks frequently or commonly 

funding or deferring interest payments during the 

term of construction loans rose from 7 percent to 15 

percent. 

Much of the commentary in recent issues of various 

trade journals echoes the results of these regulatory surveys.4 In brief, many industry participants are seeing a 

higher incidence of (1) banks funding construction loans 

without preleasing commitments on major portions of 

rentable space, (2) banks easing LTV ceilings, (3) 

3 The authors of this survey note that comparisons of survey results 

across time periods must be interpreted with caution since the survey 

samples are dictated principally by examination scheduling factors. 

As a result, sample populations may be materially different from one 

period to another. 

lenders curtailing reserve requirements for such items as 

tenant improvements and insurance, and (4) nonrecourse 

lending. Some industry participants have also noted the 

increasing acceptance of “trended rents,” whereby property valuations are based on positive rent projections 

extrapolated several years into the future. Of course, 

these trended rents will hold true only if economic circumstances remain favorable for extended periods— 

an assumption that may not be reasonable given 

the cyclical nature of real estate coupled with 

the advanced age of the current economic 

expansion. 

With a combination of relatively low 

interest rates, rising real estate prices, 

and an expanding economy, it is perhaps not too surprising that some 

lenders have eased commercial real 

estate underwriting standards. Such 

easing may be a natural response to 

improved confidence in the real estate 

markets. However, indicators that show 

loosening standards may also be warning flags that lenders have succumbed to tighter pricing 

and competitive pressures. To avoid losses like those 

sustained by banks during the last real estate downturn, 

prudent lenders will refrain from incorporating unrealistic expectations into their lending practices. 

CMBS Could Change the Way 

Lenders Underwrite Loans 

Much as residential mortgage lending standards were 

shaped by the advent of mortgage-backed securities, 

CMBS promise to change the way banks underwrite and 

service commercial real estate loans. For instance, lending terms and practices could become increasingly standardized as lenders attempt to improve the liquidity and 

marketability of their commercial mortgage portfolios. 

Banks that choose to deviate from these emerging standards will sacrifice flexibility in terms of their ability to 

manage portfolio risks and respond rapidly to liquidity 

demands. 

The ability to securitize commercial real estate loans 

also may fundamentally alter the way lending decisions 

4 See, for example, Commercial Real Estate South, “Public Markets 

Fuel Financing Glut” (October 1997); Midwest Real Estate News, 

“Wall Street and Main Street Squeeze Lenders” (October 1997); and 

Commercial Property News, “Michelson, Greenland Seize Low 

CMBS Spreads” (1 May 1997). 

Dallas Regional Outlook 10	 First Quarter 1998 
In Focus This Quarter
 

are made. Before the development of CMBS markets, 

loan approval was essentially a binary, good-or-bad, 

accept-or-reject decision whose primary focus was on 

the credit risk inherent in a single asset. In contrast, the 

most important elements in CMBS are deal structure, 

price execution for multiple tranches, credit enhancements, and portfolio composition. Here, the loan originator is more likely to use a portfolio approach in 

making credit decisions: That is, how will this loan 

enhance the expected return and risk diversification of 

the overall pool? 

External rating agencies will become increasingly 

important as CMBS markets expand, since these agencies’ guidelines will effectively dictate the underwriting 

standards applied to securitized loans. While such standardization could arguably improve market discipline 

and loan performance disclosure, there are several 

potential risks to consider as the CMBS markets evolve: 

•	 While rating agencies do incorporate qualitative 

considerations into their analysis, issue ratings and 

credit enhancement level decisions are driven primarily by quantitative factors, namely debt service 

coverage and expected loss levels. Moreover, most of 

the qualitative factors the agencies consider involve 

an analysis of portfolio balance and pool diversification. Hence, weak or poor qualitative standards (for 

example, lack of alternative repayment sources or 

minimal borrower equity in the project) applied to 

individual loans within the pool may receive only 

secondary consideration. A quantitative perspective 

also ignores such immeasurable factors as borrower 

“character” and the existence of long-standing 

lender-borrower relationships. 

•	 Rating agencies cannot be relied upon as a backstop 

to unsound underwriting practices. While they generally review a substantial volume of the loans within a pool, typically the largest individual credits, they 

are not practically able to review every credit in the 

securitization. Some within the industry have even 

suggested that investment bankers commonly move 

one problem property, discovered through one 

agency’s sample, into pools reviewed by another 

agency in the hope that it will not be sampled. 

•	 Competition among the rating agencies could 

become a factor in the underwriting process. This 

“shopping of the agencies” could result in continual 

pressure for rating agencies to ease their underwriting guidelines. 

•	 In theory, bank-issued CMBS transfer much of the 

underlying credit risk associated with commercial 

real estate lending to investors. However, like other 

types of asset securitization, CMBS raise concerns 

over the degree to which banks will voluntarily 

absorb investor losses. Bank issuers may be more 

likely than nonbank issuers to provide voluntary support to poorly performing CMBS for at least two reasons: A tarnished reputation in one aspect of a bank’s 

operations could carry over to other business activities like deposit taking and borrowing due to a bank’s 

broad brand name association within the marketplace; and banks often have greater financial 

resources than nonbanks with which to support securitization activities. 

Because the rapid growth in CMBS has been a relatively recent phenomenon, current underwriting guidelines 

applied by the rating agencies to CMBS have not been 

tested during a cyclical downturn in real estate prices. It 

remains to be seen how the market will react to rising 

loan losses that result in investor losses. 

Will Increased Public Funding through CMBS 

and REITs Improve Market Discipline? 

Many contend that the increased transparency brought 

to the market by CMBS will temper cyclical swings in 

real estate values. This viewpoint argues that investors 

will serve as a constraint against the natural tendency to 

overbuild commercial real estate during boom periods, 

since less funding will be allocated to segments of the 

market where excess capacity exists. This viewpoint 

presupposes that the investing public is sophisticated 

enough to recognize when markets are out of balance 

and when projects are economically infeasible. In this 

sense, CMBS shift much of the burden of monitoring 

credit quality standards and credit performance from 

lenders to public investors. 

In contrast, others have argued that lenders are much 

better suited than investors to make judgments about 

credit quality standards and project feasibility. This line 

of reasoning suggests that the increase in public ownership of property through CMBS and REITs could actually reduce market discipline, since the most 

sophisticated participants with access to the best information (that is, lenders) may come to have less at stake 

in making prudent credit decisions. Of course, excessive losses attributable to any one CMBS issuer might 

lead to differentiation in pricing based on investors’ 

Dallas Regional Outlook 11	 First Quarter 1998 
In Focus This Quarter
 

perceptions of the quality of underwriting applied by 

specific issuers.5 

Putting market efficiency arguments aside, the sheer 

volume of REIT and CMBS activity causes some concern over the extent to which such financing is driving 

property valuations. With such an abundance of capital 

flowing into the commercial real estate market, it is perhaps easy to see why lenders might opt to ease standards 

rather than lose business. However, to the extent securitization activities are driving decisions in today’s commercial real estate markets, lenders might wish to 

consider how property values would react if the availability of such financing were sharply diminished. The 

most recent real estate downturn provided a ready 

example of how tighter credit availability compounded 

the effects of declining commercial property values by 

limiting the ability of lenders to sell distressed properties. While there may not be consensus on whether 

CMBS and REITs will temper cyclical price swings, the 

underwriting standards and practices evolving in 

response to these financing vehicles will likely play a 

crucial role in determining the magnitude of losses 

experienced by investors and banks during the next 

downturn in commercial property values. 

Steven Burton, Senior Banking Analyst 

sburton@fdic.gov 

Selected Articles
 

for Further Reading
 

Bloomfield, Craig. “Michelson, Greenland Seize 

Low CMBS Spreads.” Commercial Property News. 

1 May 1997. p. 33. 

“CMBS Issuance Seen Topping $40 Billion.” 

Commercial Mortgage Alert. 10 November 1997. 

p. 1. 

Fitch Investor Services, Inc. “Commercial 

Mortgage Stress Test.” Fitch Research: Structured 

Finance Special Report. 8 June 1992. 

Office of the Comptroller of the Currency. Advisory 

Letter 97-3: Credit Underwriting Standards and 

Portfolio Credit Risk Management. 3 March 1997. 

Sinderman, Martin. “Public Markets Fuel 

Financing Glut.” Commercial Real Estate South. 

October 1997. p. 1. 

Wolf, Barney. “Wall Street and Main Street 

Squeeze Lenders.” Midwest Real Estate News. 

October 1997. p. 1. 

5 The evolution of the credit card securitization markets is one example of how investors now differentiate between issuers in terms of 

pricing. 

Dallas Regional Outlook 12 First Quarter 1998 
In Focus This Quarter
 

Total Return: A Useful Tool for
 

Monitoring Investment Portfolio Risk
 

•	 The Federal Financial Institutions Examination 

Council (FFIEC) is replacing the 1991 policy that 

contained a specific “high-risk test” for mortgage 

derivative products (MDPs) held by insured institutions with a policy that encourages risk management across all types of instruments on an 

investment portfolio basis. 

•	 A good way to start measuring portfolio risk is by 

monitoring an appropriate measure of return. 

•	 Total return, a concept that includes fluctuations 

in market value, is a more appropriate tool than 

simple yield for measuring the performance of an 

investment portfolio, especially one that contains 

bonds with embedded options. 

The Federal Financial Institutions Examination Council 

(FFIEC) has released for comment a new Joint Agency 

Policy Statement on Investment Securities and EndUser Derivatives Activities that will replace a statement 

issued February 3, 1992. While much of the content of 

the former statement has been retained, the section 

requiring specific “high-risk” testing for mortgage 

derivative products (MDPs) has been eliminated. The 

“high-risk” test applied specifically to bonds collateralized by residential mortgage pass-through certificates 

or whole loans but that distributed cash flows to bondholders on a basis other than pro rata.1 

The goal of the original policy statement was to deter 

banks from investing in products that presented risks 

that they were not able to adequately monitor and control. MDPs were singled out because of their rapid 

growth, nontraditional and potentially risky nature, and 

common use by insured financial institutions. The new 

policy states that, as a sound management practice, 

institutions should conduct prepurchase and ongoing 

analysis of all their investments at a level appropriate to 

the size and complexity of those holdings. 

1 A security was deemed “high risk” if it exhibited any of the following characteristics: (1) it had a weighted average life of more than ten 

years; (2) its average life extended by more than four years or shortened by more than six years from a 300 basis point parallel shift in 

rates; (3) its price changed by more than 17 percent given a 300 basis 

point parallel shift in rates. 

The policy change is in part a response to increasing 

bank investment in securities that have complex cash 

flows analogous to MDPs but that escaped the analysis 

requirement of the previous policy. Mortgage index 

amortizing notes are an example of popular bank investments that potentially exhibit all the risks of MDPs but 

were not subject to the testing requirement of the soonto-be rescinded policy because they are not collateralized by mortgages. Callable agency and “step-up” 

bonds are popular bank investments because they offer 

a slightly larger spread to Treasury than noncallable 

agency securities, and they were not subject to the 

“high-risk” test under the old policy. However, the additional yield offered on these kinds of securities compensates the investor for assuming additional risk. 

Appropriately measuring portfolio return can enhance 

the ability to monitor the extent to which these kinds of 

securities put future earnings at risk. 

Total Return Analysis Is a Useful Tool for 

Analyzing Risk at the Portfolio Level 

Total return analysis is a basic but useful tool that can 

alert management to the level of certain risks in an 

investment portfolio. It can also provide information 

that is useful for validating the assumptions used in 

more sophisticated models. Total return is calculated 

from three components: beginning price, income and 

reinvested cash flow, and ending price (market value) at 

a horizon date. Total return incorporates the change in 

the market value of the investment, resulting in a more 

comprehensive measure of performance than other 

measures that ignore such changes. Monitoring total 

return on a portfolio basis can provide institutions with 

important information about the risks inherent in the 

portfolio and how these risks may be changing over 

time. 

In two articles in the ABA Banking Journal,

2 Nicholas 

Betzold and Richard Berg convincingly dispute the 

2 The articles were published in December 1996 and April 1997. 

Reprints of the articles are available at the ABA Banking Journal website at http://www.banking.com.aba/backissues.htm. 

Dallas Regional Outlook 13	 First Quarter 1998 
In Focus This Quarter
 

view that if the investment strategy is to buy and hold to 

maturity, total return is not relevant. Consider the following example. In 1990, Bank A purchases a sevenyear security yielding 8.83 percent that is callable after 

three years. At the same time, Bank B buys a noncallable seven-year agency security yielding 8.53 percent. For three years, Bank A’s bond yields 30 basis 

points more than Bank B’s. However, from 1990 to 

1993, interest rates fell almost 300 basis points. Bank 

A’s bond would likely be called, forcing the bank to 

reinvest at a significantly lower rate for the remaining 

four years of the seven-year investment horizon. Over 

the seven-year horizon, Bank A could expect an average 

yield that is about 150 basis points less than Bank B’s. 

From the yield perspective, 

Bank A enjoyed three years of 

superior performance. However, during those three years, 

monitoring total return might 

have revealed a less favorable 

but more accurate picture of 

Bank A’s performance relative 

to Bank B’s. Here is why: As 

rates fell from 1990 to 1993, bonds gained in value. 

However, as rates fell, the market value of the callable 

security would have gained incrementally less than the 

noncallable bond because each downward tick in rates 

increased the expectation that the bond would be called, 

and the higher coupon would be earned over a shorter 

period. In contrast, the noncallable security’s market 

value would have enjoyed the full benefit of the falling 

rate environment because its maturity and cash flows 

are fixed. 

The disparate change in the market value of the two 

bonds reflects the fact that Bank A, in essence, sold a 

call option to the bond issuer. The issuer bought the 

right to repurchase the debt at par after three years. 

Bank A was compensated for selling this right to the 

issuer with increased yield. In the example, the issuer’s 

option to call the bond would have gained value as rates 

fell. The increasing positive value of the call option to 

the issuer represents an increasing negative value to the 

bondholder and erodes the value of the bond. 

Step-up bonds present reinvestment risk similar to that 

of generic callable bonds, but with the added complexity of a coupon that rises, usually annually, if the bonds 

are not called. Total return analysis would similarly 

reveal adverse changes in the value of the embedded 

call options and the extent to which the additional 

coupon is compensating for call risk. 

UBPR Yield 

Bank management often uses the portfolio yield that is 

calculated in the Uniform Bank Performance Report 

(UBPR) to assess performance of the bank’s securities 

portfolio against its peers. This yield measure is calculated by dividing annualized book income on a tax 

equivalent basis (plus or minus amortization or accretion of any premium or discount) by the amortized cost 

of the securities. This measure of present yield says little about potential future yield and the extent to which, 

because implicit options have been sold, the latter has 

been put at risk for the sake of the former. 

Total return measures the risk-adjusted return of a portfolio more closely than yield because it incorporates 

changes in reinvestment risk over time. Ultimately, a 

portfolio manager who earns total returns consistently 

higher than average will earn more in terms of simple 

yield. Conversely, a manager who earns less in terms of 

total return will eventually find an unfavorable reinvestment environment that will erode reported yield. 

The popularity of using yield to gauge the performance 

of bank securities portfolios may be due to the convenient presentation of bank peer portfolio yields in the 

UBPR. Some managers may be reticent to evaluate 

portfolio performance using total return without a peerlike benchmark for calibrating total return expectations. 

Betzold and Berg have devised an investment portfolio 

index (introduced in the April 1997 ABA Banking 

Journal) that is designed to track the total return of a 

typical bank portfolio composed of the same percentages of investment sectors as the average bank. The 

portfolio on which the index is based is rebalanced 

monthly as principal pays down, and it is rebalanced 

quarterly to reflect the latest Call Report data on portfolio allocations. Table 1 depicts the investment weighting of the index as of December 31, 1996, based on 

September 30, 1996, Call Report data. 

According to Betzold and Berg, this index produced 

total returns that closely approximated those of the actuDallas Regional Outlook 14 First Quarter 1998 
In Focus This Quarter
 

al median bank total portfolio measured by Call Report 

data from 1993 through third quarter 1997.3 They concluded that their index seems to provide a reasonable 

proxy for the total return of the “average” bank investment portfolio. 

Chart 1 shows the performance of the index so far this 

year.4 Changes in the index value over time can be translated into total returns that approximate the median 

bank portfolio’s total return. For example, the annualized total return for the index from year-end 1996 

through third quarter 1997 was 6.72 percent and is calculated as follows: 

Calculate the bond equivalent semiannual yield 

and express the semiannual bond equivalent yield 

as an effective annual yield. 

4

: 105.00 3

6.72% = 100 [(:) − 1

100.00 ]

The performance of the index for 1997 suggests that 

banks’ total investment portfolio returns were highly 

negatively correlated with changes in the five-year 

Treasury rate (see Chart 2). This finding indicates that 

changes in total return from period to period can provide useful information about the level of a portfolio’s 

interest rate sensitivity. As emphasized above, these 

changes in total return over time include the effects of 

changes in market value of any call options on a bank’s 

investment securities and hence provide information 

about the degree to which future income is at risk. 

Given the increasing level of optionality embedded in 

the average bank securities portfolio—even if it arises 

solely from callable agency debt and “step-up” structured notes—yield should not be the sole measure of 

overall portfolio performance. Total return analysis is an 

appropriate supplement that gauges the risk-return characteristics of an investment strategy that involves selling 

implicit options. 

Allen Puwalski, Senior Financial Analyst 

3 While the Call Report does not contain the information necessary to
 

compute total return precisely, the authors computed an estimate
 

using the reported yield and market value data.
 

4 The index is published monthly in the ABA Banking Journal.
 

TABLE 1 

Composition of Betzold Berg Index 

December 31, 1996 

PERCENT 

SECURITY TYPE OF INDEX 

TREASURIES 24.52 

AGENCIES 24.38 

MUNICIPAL BONDS 12.26 

FIXED-RATE MORTGAGE OR 

MORTGAGE-RELATED PRODUCTS 19.93 

OTHER SECURITIES 6.09 

ADJUSTABLE-RATE SECURITIES 13.00 

Source: Bank and Thrift Call Reports, September 30, 

1996 

CHART 1 Index Value 

Index Tracks the Total Return of an 

“Average” Bank Portfolio 

Source: ABA Banking Journal 

100.84 

104.31 

Dec Jan Feb Mar Apr 

100 

101 

102 

103 

104 

105 

106 

May Jun Jul Aug Sep 

100.51 100.71 

101.49 

102.23 

103.06 

104.03 

105.00 

100.00 

CHART 2 

Total Return Index Is Correlated 

to Changes in Interest Rates 

Source: ABA Banking Journal, Bloomberg 

5-year Treasury 

(right scale) 

Betzold Berg Index 

(left scale) 

Percent Change Percent Change 

–10 

–5 

0 

5 

10 

Jan-97

Feb-97

Mar-97

Apr-97

May-97

Jun-97

Jul-97

Aug-97

Sep-97 

–0.20 

0.00 

0.20 

0.40 

0.60 

0.80 

1.00 

Dallas Regional Outlook 15 First Quarter 1998 
Regular Features	 Regional Economy
 

Job Growth in the Dallas Region to Slow in 1998
 

•	 Job growth in the Dallas Region decelerated slightly in 1997 and is expected to slow even further in 1998. 

•	 Housing activity in the Region enjoyed another solid year in 1997, a performance that may be difficult to 

duplicate in 1998. 

•	 Turmoil in Asia’s financial markets may result in reduced exports and job growth in the Region this year. 

Job growth in the Dallas Region continued its gradual 

deceleration last year, approaching 2.4 percent in 

October 1997. A year earlier, the figure was 2.9 percent. 

A cooling off and lackluster performance in the 

economies of Colorado and New Mexico account for 

much of the recent slowing. Nevertheless, all four states 

in the Region were on pace to finish 1997 with slightly 

lower rates of job growth than they had in 1996. 

Services Lead the Way 

The Dallas Region generated almost 300,000 new jobs 

for the 12-month period ended October 1997. Nearly 

two-thirds of the new jobs were concentrated in the 

trade and services sector (see Table 1), similar to the 

distribution for the nation as a whole. The increase in 

jobs was broad based, with every major industry sector 

in the Region contributing. Job growth in the Region 

has advanced at an annual average growth rate of 2.8 

TABLE 1 

percent since the trough of the last U.S. recession 

(March 1991), compared with 1.9 percent for the 

nation. 

The industries of business services, eating and drinking 

establishments, and health services (see Chart 1) 

accounted for nearly two-fifths of all the new jobs in the 

Region. Only one-quarter of all new U.S. jobs, by comparison, were created by these three industries. Greater 

use of outsourcing by large businesses, an aging population, and solid gains in real disposable income contributed to job growth in these industries. 

Unemployment rates in the Region were mixed. Tight 

labor markets and moderate to strong job growth resulted in unemployment rates of 3.3 percent in Colorado 

and 3.7 percent in Oklahoma (through October 

1997)—well below the U.S. average of 5.0 percent. 

Meanwhile, rapid labor force growth as a result of 

strong in-migration kept Texas’s unemployment rate at 

Services and Trade Provide the Bulk of New Jobs in the Dallas Region 

REGIONAL EMPLOYMENT BREAKDOWN FOR THE 12-MONTH PERIOD ENDING OCTOBER 1997 

NUMBER OF GROWTH SHARE OF CONTRIBUTION TO 

JOB CATEGORY NEW JOBS RATE (%) JOBS (%) JOB GROWTH (%) 

TOTAL NONFARM 298,600 2.4 100 N/A 

SERVICES 127,600 3.8 27.5 1.0 

CONSTRUCTION 23,600 3.6 5.3 0.2 

MINING 6,800 3.1 1.8 0.1 

TRADE 64,300 2.2 24.0 0.5 

FIRE 14,600 2.2 5.4 0.1 

TPU 13,500 1.9 5.8 0.1 

MANUFACTURING 23,700 1.6 12.0 0.2 

GOVERNMENT 24,500 1.1 18.2 0.2 

FIRE = Finance, Insurance, and Real Estate 

TCPU = Transportation, Communications, and Public Utilities 

Sources: Haver Analytics, Bureau of Labor Statistics 

Dallas Regional Outlook 16	 First Quarter 1998 
Regular Features Regional Economy
 

CHART 1 

Leading Job-Creating Industries in the Region 

for the 12 Months Ended October 1997 

50,000 

40,000 

30,000 

20,000 

10,000 

0 

Business Eating and Drinking Health 

Services Establishments Services 

Source: Bureau of Labor Statistics 

46,700 

31,800 

23,100 

5.5 percent, while a sluggish economy accounted for 

New Mexico’s jobless rate of 6.3 percent. 

Slowdown to Carry Over into 1998 

Economic analysts are forecasting slower output and 

employment growth for the Dallas Region in 1998. An 

important factor in their assessment is the belief that the 

U.S. economy will slow substantially this year. 

Forecasters are predicting growth in the U.S. real gross 

domestic product (GDP) growth of 2.0 to 2.5 percent in 

1998, a substantial reduction from an estimated 3.7 percent in 1997. 

In addition to the overall slowing of the U.S. economy, 

growing concerns over higher labor, housing, and commercial costs are also blamed for the Region’s expected 

slower growth. Finally, tight labor markets—particularly in high-skill industries—will constrain job growth. 

Employment growth is expected to decelerate from 2.5 

to 3.0 percent in 1997 to 2.0 to 2.5 percent in 1998. 

Chart 2 depicts the convergence in job growth between 

the United States and the Dallas Region that has taken 

place in recent months. A resurgent U.S. economy and a 

slight tapering off in economic growth in the Region are 

responsible for the convergence. Nevertheless, job 

growth in the Region is forecast to finish faster than that 

in the nation in 1998 for the tenth consecutive year. 

Implications: The Region’s banks are still among the 

healthiest in the nation despite a slower-growing economy. Profitability, as measured by return on assets, is 

above 1.20 percent for insured commercial banks in the 

Region as of the end of third quarter 1997. Asset quality is better than that of the nation, with net charge-offs 

and noncurrent assets in the Region below their comparable U.S. numbers. Furthermore, banks in the Region 

remain highly capitalized, have a higher percentage of 

core deposits, and are less “loaned up” than those of the 

nation overall. In the absence of a recession this year, 

and with continued moderate economic growth as a 

backdrop, banks in the Dallas Region should continue 

to perform well in 1998. 

A Record-Breaking Year for Existing Home 

Sales in the Dallas Region 

As a result of continued economic growth and low 

mortgage interest rates, the Dallas Region in 1997 was 

poised to achieve its best year ever in existing home 

sales (almost half a million) since the National 

Association of Realtors began keeping state records in 

1981. The inverse relationship between existing home 

sales in the Dallas Region and contract rates on conventional 30-year mortgages since 1991 is shown in Chart 

3 (next page). Although factors such as housing prices, 

jobs, incomes, and population growth also play an 

important role, both the cost and availability of credit 

explain much of the recent movement in existing home 

sales. With mortgage rates falling below 7.5 percent in 

the second half of 1997 and job growth still moderately 

strong, existing home sales should maintain their current strength through the first half of 1998. 

Another indication of how strong existing home sales 

have been in the Dallas Region has been the rise in median sales prices in some of the Region’s larger metropolCHART 2

 Job Growth between the U.S. and Dallas Region 

Has Converged in Recent Months 

Dallas Region 

United States 

Jan-93

May-93

Sep-93

Jan-94

May-94

Sep-94

Jan-95

May-95

Sep-95

Jan-96

May-96

Sep-96

Jan-97

May-97

Sep-97

5.00% 

4.00% 

3.00% 

2.00% 

1.00% 

0.00% 

Source: Haver Analytics and Bureau of Labor Statistics 

Dallas Regional Outlook 17 First Quarter 1998 
Regular Features Regional Economy
 

CHART 3

 As Mortgage Rates Fall, Existing Home Sales 

in the Region Set Record Highs 

Sources: National Association of Realtors, Federal Home Loan Mortgage 

Corporation, Haver Analytics 

0 

2 

4 

6 

8 

10 

12 

Percent 

0 

100 

200 

300 

400 

500 

600 

Number in Thousands 

Mortgage Rates Existing Home Sales 

Jan-91

Apr-91

Jul-91

Oct-91

Jan-92

Apr-92

Jul-92

Oct-92

Jan-93

Apr-93

Jul-93

Oct-93

Jan-94

Apr-94

Jul-94

Oct-94

Jan-95

Apr-95

Jul-95

Oct-95

Jan-96

Apr-96

Jul-96

Oct-96

Jan-97

Apr-97

Jul-97 

itan areas. Table 2 shows annual average growth rates in 

median sales prices for the United States and selected 

metropolitan areas in the Dallas Region since third quarter 1993. Those areas reporting median sales prices 

growing faster than the U.S. average exhibited faster 

employment growth than the United States as well. 

Existing home sales outlook for 1998. Existing 

home sales in the Dallas Region appeared headed for 

the seventh annual increase in eight years in 1997. 

Whether the Region’s housing market achieves another 

TABLE 2 

solid year in 1998 will depend on the strength of its 

economy and the level of mortgage interest rates. The 

two may not necessarily move in the same direction this 

year. 

For reasons cited earlier, both the U.S. and the Region’s 

economies are expected to experience a moderation in 

economic growth in 1998. At the same time, in-migration from other states is expected to taper off as well. 

Many states are already near full employment and experiencing labor shortages. With so many states enjoying 

favorable economic conditions, the incentive for workers to leave for employment elsewhere diminishes. 

Consequently, slower employment growth and lower 

levels of in-migration may result in softer demand for 

housing. 

Still, a softer economy may also result in lower mortgage interest rates. Mortgage rates have declined since 

spring 1997, with the contract rate on conventional 

30-year mortgages averaging 7.21 percent in November 

1997. Some analysts believe that mortgage rates could 

drop even further in 1998, possibly to their lowest level 

since they briefly fell below 7 percent in September and 

October 1993. In addition to being a stimulus to home 

sales (and residential construction), lower mortgage 

rates could also result in another wave of mortgage refinancings, putting a significant amount of cash into the 

hands of consumers to spend. 

Growth in the Median Sales Prices of Homes in Selected Metropolitan 

Areas in the Dallas Region 

1997 

MEDIAN SALES PRICE 

THIRD QUARTER THIRD QUARTER 

1993 

ANNUAL 

AVERAGE 

GROWTH 

RATE 

COLORADO SPRINGS, CO 

DENVER, CO 

AUSTIN-SAN MARCOS, TX 

ALBUQUERQUE, NM 

OKLAHOMA CITY, OK 

DALLAS, TX 

TULSA, OK 

$131,800 

144,600 

117,700 

128,400 

80,000 

114,200 

87,100 

$95,000 

105,000 

92,100 

102,600 

65,700 

95,700 

73,500 

8.5% 

8.3 

6.3 

5.8 

5.0 

4.5 

4.3 

UNITED STATES 

HOUSTON, TX 

FORT WORTH, TX 

SAN ANTONIO, TX 

Sources: National Association of Realtors, Haver Analytics 

Dallas Regional Outlook 18 

126,600 

93,100 

93,400 

87,300 

108,100 

81,800 

84,200 

79,400 

4.0 

3.3 

2.6 

2.4 

First Quarter 1998 
Regular Features Regional Economy
 

Implications: Housing will continue to be one of the 

Region’s strongest sectors in 1998. If mortgage rates 

maintain their relatively low levels in 1998, residential 

lending will remain strong for another year. Moreover, 

lenders may be swamped with mortgage refinancing 

applications if mortgage rates stay below 7 percent for 

long. 

Asia’s Financial Crisis and What It Means 

for the Dallas Region 

The financial crisis that began in Southeast Asia during 

the summer of 1997 hurt the performance of stock markets throughout Asia, the United States, Europe, and 

Latin America. Since then, global stock markets continue to be roiled by the ongoing financial instability in 

Southeast Asia. This section will discuss not the causes 

of the crisis but its possible effects on the Dallas 

Region. 

A reduction in exports...The immediate effect of the 

crisis is a reduction in Regional exports resulting from 

the devaluation of certain Asian currencies (see Chart 

4). Currency devaluation causes the prices of exports to 

rise, thus curbing their demand. Exports have been an 

important growth engine for the Region throughout this 

expansion, growing at a double-digit rate (11 percent 

annual average) for the past ten years (1987 to 1996). 

The twin effects of the Asian currency crisis—higher 

export prices and a slackening in Asian domestic 

demand—should result in a rise in imports from Asia to 

the Region and a decline in exports from the Region to 

Asia. 

CHART 4 

Sources: Spot Exchange Middle Rate, NY Close, Haver Analytics

 Southeast Asian Currencies Have 

Taken a Pounding since July 1997 

105 

Thailand Baht 

Philippine Peso 

Malaysia Ringgit 

Indonesia Rupiah 

January 1997 = 100.0 

Jan-97

Feb-97

Mar-97

Apr-97

May-97

Jun-97

Nov-97 

Jul-97

Aug-97

Sep-97

Oct-97 

100 

95 

90 

85 

80 

75 

70 

65 

60 

The Federal Reserve’s December survey of regional 

economic conditions for October and November noted 

a reduced demand for exports of manufactured and 

agricultural goods as a result of Asia’s “financial turmoil and currency weakness.” In particular, telecommunications and petrochemical companies in the Dallas 

Region reported reducing their expectations for growth 

in Asian markets. Other industries that may be affected 

negatively are makers of capital equipment, including 

semiconductors, computers, and industrial machinery. 

Cheaper imports from Asian countries may affect 

apparel and textile manufacturers and producers of consumer electronics and toys. In addition, the Asian financial crisis should soften foreign demand for such key 

commodities as cattle, wheat, and cotton. 

...And slower economic growth. The combination of 

declining U.S. exports and rising U.S. imports should 

result in a ballooning U.S. trade deficit, subtracting economic growth from the U.S. economy. U.S. net exports 

of goods and services (seasonally adjusted annual rate) 

climbed to a deficit of $163 billion in the third quarter 

of 1997—the highest level since 1986. Many economists have already scaled back their original forecasts 

for U.S. real economic growth in 1998 and 1999 as a 

result of the Asian crisis. To what extent the Dallas 

Region will be affected by a slower-growing U.S. economy is difficult to estimate. Less demand for U.S. 

goods, however, will probably result in less demand for 

Regional goods, meaning less hiring (possibly layoffs), 

weaker demand for housing and commercial real estate, 

a reduction in corporate earnings and profits, slower 

business for local suppliers, and less tax revenues for 

state and local governments. 

Mexico’s peso devaluation: a case study. The 

Dallas Region is familiar with the effects of currency 

devaluation. During Mexico’s most recent currency crisis, in late 1994, the Mexican peso lost 50 percent of its 

value against the U.S. dollar in three months. Exports 

from the Dallas Region to Mexico consequently fell 

11.5 percent in 1995. The reduction in regional exports 

that is expected as a result of the current Asian crisis 

may not be as severe, however. 

The total volume of exports from the Dallas Region to 

the Asian nations of Thailand, Malaysia, Indonesia, 

South Korea, and the Philippines represents less than 9 

percent of the Region’s total dollar exports in 1996. That 

is far less than the dollar volume of Regional exports to 

Dallas Regional Outlook 19 First Quarter 1998 
Regular Features Regional Economy
 

Mexico (27 percent) that same year. Nevertheless, some 

reduction in exports to these countries is to be expected, 

along with a slight decrease in economic growth. 

There are benefits to devaluation as well. Perhaps 

the greatest benefit resulting from the devaluations of 

Southeast Asian currencies is their dampening effect on 

U.S. inflation. Cheaper imports will force domestic 

firms to reduce their prices or lose market share. Lower 

inflation may lead to lower interest rates, helping stimulate credit-sensitive industries such as housing and 

automobiles. Finally, some U.S. companies—those with 

substantial assembling operations in Asia—may reap 

significant savings in cheaper labor and production 

costs as a result of the devaluations. 

Implications: The Asian crisis will reduce export 

growth in the Region. Industries most affected should 

be high-technology industries like PC makers and semiconductor producers. Although direct bank lending to 

these companies is not substantial, slower earnings 

growth resulting from weaker conditions in Asia could 

have an indirect impact on banks. Reduced profits could 

mean production cutbacks and layoffs at home while 

delaying expansion plans such as the Intel plant in Fort 

Worth. Moreover, increased competition from Asian 

imports—made cheaper by the currency devaluation— 

may also hurt domestic firms with existing lines of bank 

credit. 

Adrian R. Sanchez, Regional Economist 

Dallas Regional Outlook 20 First Quarter 1998 
Regular Features	 Regional Banking
 

Regional Banking Conditions
 

•	 Banks and thrifts in the Dallas Region continue to keep pace with national trends. 

•	 Banks with high asset growth rates display a higher risk profile. 

•	 Three Dallas Region metropolitan statistical areas (MSAs) are among the top 20 in the nation in real estate 

investment trust (REIT) ownership. 

•	 Banks and thrifts in these areas are displaying strong real estate loan growth despite escalating REIT activity, but underwriting standards could be under some pressure. 

Overview 

The Region’s insured institutions continue to keep pace 

with national profitability averages (see Chart 1). 

During the third quarter of 1997: 

•	 Commercial banks in the Region averaged a return 

on assets (ROA) of 1.24 percent, versus 1.30 percent 

for the nation. Commercial banks account for 94 percent of the banks in the Region and 84 percent of the 

total assets. 

•	 The average net interest margin for all banks in the 

Dallas Region remained steady at 4.28 percent, 25 

basis points above the average for all U.S. banks. 

•	 Total past-due loans in the Region declined slightly 

to 2.20 percent of total loans and leases, below the 

national average of 2.23 percent. 

CHART 1 

Dallas Region Institutions Show 

Financial Strength 

Source: Bank and Thrift Call Reports 

0 

2 

4 

6 

8 

10 

Noninterest 

Income 

Net Interest 

Margin 

Past Due and 

Noncurrent 

Loans 

Leverage 

Ratio 

9/95 

9/97 

9/96 

U.S. 

9/97 

Percent of Assets 

Fast-Growing Banks Display Higher 

Risk Profiles 

Rapid growth is traditionally viewed as a risk indicator. 

This section focuses on the Dallas Region’s most rapidly growing financial institutions. Asset growth can generate high profits in good times but may increase an 

institution’s exposure to an economic downturn. Table 1 

(next page) summarizes a few financial indicators for 

banks in the Dallas Region, grouped according to yearover-year asset growth rates as of third quarter 1997. 

In summary, faster growing banks tend to be more 

aggressive. As Table 1 depicts, these banks have less 

equity, higher yields, and are more “loaned up” than 

other banks. Faster growing banks tend to be larger 

banks, as indicated by the average asset numbers. But as 

indicated by the median asset figures, many small banks 

are growing rapidly as well. 

Naturally there is a close link between the rapid loan 

growth displayed by these institutions and their higher 

profitability. Banks typically achieve the greatest profit margin by making loans rather than holding securities. Since it takes time for new loans to become 

seasoned, it follows that during a period of loan growth 

nonperforming loans would decline as a percentage of 

total assets (in comparison with other banks). 

Consequently, the fastest growing banks in the Dallas 

Region have the lowest level of nonperforming assets. 

Moreover, there is a significant difference between the 

slowest growing half and the fastest growing half in 

terms of valuation reserve coverage of the loan portfolio (see Table 1). Rapidly growing banks tend to have a 

higher percentage of new, unseasoned loans that have 

not demonstrated problems and typically receive lower 

reserve allocations. 

Dallas Regional Outlook 21	 First Quarter 1998 
Regular Features Regional Banking
 

TABLE 1 

Asset Growth Rates 

FINANCIAL INDICATORS TOP 25% 2ND 25% 3RD 25% BOTTOM 25% 

GROWTH RANGE 37+ 17%-37% 6%-17% –6% 

CORE CAPITAL 7.1 7.6 8.5 9.3 

RETURN ON ASSETS 1.3 1.1 1.2 0.9 

NET LOANS/DEPOSITS 82.2 71.5 62.8 56.0 

LOAN RESERVES/TOTAL LOANS 1.3 1.2 1.6 1.6 

NONPERFORMING LOANS/ASSETS 0.6 0.7 0.8 0.7 

AVERAGE ASSETS ($ MILLIONS) 408 261 175 114 

MEDIAN ASSETS ($ MILLIONS) 87 58 54 44 

Source: Bank and Thrift Call Reports 

For all these reasons, in favorable economic environments, banks that are growing tend to experience better 

than average ROAs. However, an aggressive strategy 

can easily rebound unfavorably in an economic downturn, as problem loans become more manifest. In light 

of the extremely rapid growth of some institutions in the 

Region, careful attention to underwriting standards and 

internal controls is warranted, both by the management 

of these institutions and by their supervisors. 

REIT Impact in the Dallas Region 

Much has been reported about the growth of REITs 

throughout the country, but what does this mean to 

banks in the Dallas Region? 

Over the past five years, REITs have experienced explosive growth. According to the National Association of 

Real Estate Investment Trusts (NAREIT), REITs set an 

all-time midyear record for equity offerings, raising 

more than $15.1 billion for the first six months of 1997. 

According to CB Commercial, REITs currently account 

for over $157 billion of property nationwide. While 

REITs can acquire virtually all types of property, retail, 

apartments, and office buildings account for the biggest 

shares, with 32 percent, 24 percent, and 21 percent, 

respectively. For the third quarter of 1997, the office 

segment was the fastest growing, with 33 percent of all 

new acquisitions for that quarter. 

According to the CB Commercial National Real Estate 

Index, three MSAs in the Dallas Region are among the 

top 20 in the nation in REIT ownership. Dallas–Fort 

Worth is rated third and currently reports more than $8 

billion in REIT ownership. Houston ranks sixth, with 

over $5 billion, and Denver is number 20, with almost 

$2 billion. Austin was nineteenth as of June 30, 1997, 

but has recently fallen out of the top 20 despite anecdotal evidence of a hot REIT market. Houston was rated 

first in the top 10 most active REIT acquisition metropolitan areas during the third quarter of 1997 and 

accounted for almost 8 percent of all acquisitions for 

that quarter. 

To put this situation in perspective, we looked at bank 

lending in several key markets versus REIT acquisitions. Since Houston was the fastest growing REIT market in the country for the third quarter of 1997, it is 

useful to examine that market. 

As of September 30, 1997, total real estate loans outstanding at insured institutions (excluding agriculture 

and single-family residential) headquartered in the 

Houston MSA totaled $7.3 billion. REIT ownership in 

CHART 2 

Houston Real Estate Funding 

as of September 30, 1997 

REIT Ownership Bank Lending
 

(All Types)
 

Construction/ 

Development 

Nonfarm/ 

Nonresidential 

Multifamily 

Sources: REIT: Alliance Capital/CB Commercial; Bank lending: Bank Call Reports 

Dallas Regional Outlook 22 First Quarter 1998 
Regular Features	 Regional Banking
 

Houston was slightly over $5 billion (see Chart 2). This 

comparison may overstate the relative importance of 

REITs for two reasons. First, bank loans cover only a 

percentage of total real estate value, while REIT ownership is 100 percent. Second, the $7.3 billion does not 

include loans made by out-of-area banks. Nevertheless, 

these figures clearly show the degree to which REITs 

have become major players in today’s real estate investment environment. 

Why Have REITs Become Major Players in the 

Real Estate Market? 

As in the nation as a whole, office vacancy rates are on 

the decline in major markets in the Dallas Region, as 

long-standing excess office space continues to be 

trimmed (see Table 2). As a reflection of the strong economic conditions in the Region’s major markets, office 

vacancy rates have fallen to their lowest levels in well 

over ten years in Austin, Dallas, Fort Worth, Denver, 

Houston, and Oklahoma City. Office vacancy rates in 

Austin and Denver are now in the single digits. 

As vacancy rates have fallen, rents have risen, improving cash flows and property valuations based on the 

income approach. Combined with the strong underlying 

economy, these factors explain the abundance of capital 

in the commercial real estate market. The ownership 

structure of REITs, their aggressive growth strategies, 

and the current availability of capital are increasing 

transactional liquidity. 

Public ownership of REITs may provide greater market 

discipline, but the risk is that increased competition for 

properties among all types of commercial real estate 

investors (and their lenders) could lead underwriting 

TABLE 2 

Office Vacancy Rates (%) 

JUN 97 DEC 92 

DALLAS REGION 11 19 

AUSTIN 8 18 

DALLAS 15 27 

FORT WORTH 13 20 

DENVER 9 19 

HOUSTON 16 22 

OKLAHOMA CITY 15 25 

Source: CB Commercial/Torto Wheaton Research 

standards to deteriorate. Underwriting surveys conducted by the FDIC and the other federal bank regulatory 

agencies bear out these concerns. Further detail is provided in Trends in Commercial Real Estate Loan 

Pricing and Underwriting. 

Markets That Have High REIT Activity Are 

Seeing Increasing Real Estate Concentrations 

in Banks as Well 

We looked at each of the three MSAs in the top REIT 

ownership list and examined bank performance in these 

markets. Several trends appear: 

•	 Over the past five years, banks in Dallas, Houston, 

and Denver have gravitated toward an increase in 

commercial real estate (CRE) lending (see Table 3, 

next page). The most dramatic example was 

Houston, which saw “CRE banks” (commercial 

banks that have 25 percent or more of their loan portfolios in CRE loans) increase from 53 percent of its 

total commercial banks at December 1992 to 69 percent at September 30, 1997. 

•	 CRE banks tend to be more profitable than other 

banks. The difference is most pronounced in the 

Dallas market, where CRE banks enjoyed an ROA 62 

basis points higher than that for non-CRE banks at 

third quarter 1997 (annualized quarterly). Higher 

returns are generally earned only at the expense of 

higher risks. Accordingly, bankers and their supervisors need to remain vigilant for the effect that strong 

competition from REITs may have on underwriting 

standards and adherence to internal controls. 

•	 CRE banks tend to be slightly better capitalized, as 

indicated by the leverage ratio (see Table 3). For 

example, CRE banks in the Denver MSA average 8.9 

percent leverage, compared with 6.6 percent for nonCRE banks. The Houston market is an exception in 

that CRE and non-CRE banks have essentially the 

same leverage. 

What Are Some of the Implications for the 

Dallas Region Banking Environment? 

Real estate markets in these MSAs have more equity 

and liquidity than they would without REITs, since 

most REITs are financed with equity. This is a positive 

Dallas Regional Outlook 23	 First Quarter 1998 
Regular Features Regional Banking
 

TABLE 3 

Leverage for CRE and Non-CRE Banks 

DEC 92 3Q97 

CRE NON-CRE CRE NON-CRE 

DALLAS 

RETURN ON ASSETS 1.45 1.15 1.95 1.33 

LEVERAGE RATIO 5.55 5.64 9.28 7.08 

NONPERF/TOTAL ASSETS 3.93 0.81 2.25 0.39 

% BANKS 54 46 57 43 

DENVER 

RETURN ON ASSETS 1.17 0.51 1.53 1.19 

LEVERAGE RATIO 7.62 7.21 8.94 6.64 

NONPERF/TOTAL ASSETS 1.30 1.20 0.46 0.16 

% BANKS 51 49 57 43 

HOUSTON 

RETURN ON ASSETS 0.90 1.21 1.14 1.01 

LEVERAGE RATIO 7.19 6.36 7.32 7.36 

NONPERF/TOTAL ASSETS 3.88 2.25 0.52 0.65 

% BANKS 53 47 69 31 

Source: Bank and Thrift Call Reports 

Note: Banks are classified as CRE if construction/development, nonfarm/residential, and multifamily real estate 

loans exceed 25 percent of total loans. 

aspect of REIT investment. Banks also appeared to have 

been able to require more equity in real estate projects 

that they financed during much of the 1990s than during the 1980s. The increased volume of equity currently in real estate provides more protection against 

declining real estate values than existed ten years ago. 

What debt REITs do employ is most likely not local 

bank financing. REITs typically have large credit facilities with money-center banks and insurance companies. Consequently, real estate loan underwriting 

guidelines for large banks may weaken as competition 

forces banks to stretch for deals. 

In summary, at the same time that REITs have grown 

substantially, banks in the surrounding areas have 

moved, and may continue to move, toward more real 

estate lending. While these banks have enjoyed greater 

profits as a result, they could be moving into a dangerous area of concentration. As larger banks feel the 

increasing competition from REITs they may eventually target smaller markets, increasing competition in the 

Region or at the local level. 

By Jeffrey A. Ayres, Alan C. Bush 

Dallas Regional Outlook 24 First Quarter 1998 
✁
 

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