Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION	 SECOND QUARTER 1999 

FDIC
 

New York
 

Region
 

Division of
 

Insurance
 

Kathy R. Kalser,
 

Regional Manager
 

Norman Gertner,
 

Regional Economist
 

Karen A. Wigder,
 

Senior Financial
 

Analyst
 

Alexander J.G.
 

Gilchrist,
 

Economic Analyst
 

In Focus This Quarter 

◆ Economic Conditions and Emerging Risks in Banking—This article 

provides an overview of economic conditions and banking industry trends, with a 

primary focus on potential risks to insured depository institutions. 

● Economic Developments—Low interest rates, dormant inflation, and rising 

stock markets have all contributed to a generally positive near-term outlook for 

the U.S. economy. See page 3. 

●	 Trends Affecting Banking Lines of Business—Although credit conditions 

appear strong, risks exist in the major banking lines of business.	 See page 7. 

Consumer Lending—Continued high consumer loan loss rates raise questions 

about how lenders will fare under less favorable economic circumstances. 

See page 8. 

Commercial Lending—Corporate loan growth accelerated in 1998 even as the
 

corporate sector showed signs of stress. See page 9.
 

Commercial Real Estate and Construction Lending—Selected metropolitan
 

markets are experiencing rapid commercial development despite declining
 

indicators of demand. See page 10.
 

Agricultural Lending—Falling commodity prices threaten U.S. farm operators. See page 11.
 

Funding and Interest Rate Risk—Intense competition and the changing term
 

structure of interest rates have presented challenges for banks and thrifts.
 

See page 12. 

● Indicators of Industry Performance—Weaknesses appear to be developing for 

banks with certain types of exposures, and the dispersion in performance among 

insured institutions is increasing. See page 13. 

By the Analysis Branch Staff 

Regional Perspectives 

◆ Economic and Banking Conditions—The Region’s economy is healthy 

and growing steadily. Heavy reliance on financial services in the Region increases 

potential risk in the event of a stock market downturn. The Region’s banks continue 

to post solid financial results; international banks performed well despite continued 

global turmoil. See page 16. 

◆ Savings Institutions Underperform Commercial Banks—The flat yield 

curve has hurt savings institutions more than commercial banks, depressing interest 

margins and the bottom line. Also, the Region’s savings institutions have higher 

delinquency rates than the rest of the nation. See page 19. 

◆ Consumer Behavior and Lending Trends—Consumer debt levels and 

personal bankruptcies are at all-time highs. Although debt burdens have leveled off 

in the past year, these trends suggest some cause for concern. Credit card banks, 

which face consolidation, competition, and the increasing popularity of new consumer lending products, are especially vulnerable to changes in consumer borrowing behavior. See page 20. 

By the New York Region Staff 

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 New York 

Region’s Regional Outlook, please call Kathy Kalser at (212) 704-1308 or send an e-mail to 

kkalser@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 Donna Tanoue 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Publications Manager Teresa J. Franks 
In Focus This Quarter
 

Economic Conditions and
 

Emerging Risks in Banking
 

Periodically, the Division of Insurance assesses conditions in the economy and across the banking industry in an effort 

to evaluate the types of risks that could adversely affect the performance of insured depository institutions. The analysis that follows describes the salient aspects of this assessment by focusing on three areas: 1) developments and conditions in the U.S. and global economies; 2) trends affecting particular banking lines of business; and 3) selected 

indicators of bank performance. 

In brief, the U.S. economy continues to provide a favorable environment for the banking industry. The industry as a 

whole has exhibited strong loan growth and minimal credit losses. Nevertheless, there are areas of concern, including subprime and high loan-to-value consumer lending, higher levels of leveraged commercial lending, localized 

overbuilding of commercial real estate, and the potential for credit quality problems among agricultural banks. 

Although it is uncertain when, or even if, these concerns will ultimately affect overall industry performance, the 

potential for stress among insured institutions is being monitored. 

Economic Developments
 

Conditions Have Improved Markedly 

since Late 1998 

The U.S. economy is now in its eighth year of expansion, the longest peacetime expansion during the postWorld War II era. Although analysts raised concerns 

about the durability of the expansion amid the late-1998 

financial market turmoil, the economic outlook since 

that time has improved for a number of reasons: 1) the 

75 basis point reduction in short-term U.S. interest rates 

between September and November helped to support 

consumer spending and business investment; 2) following several quarters of decline, U.S. exports rose unexpectedly during the fourth quarter; 3) inflation remained 

dormant even though U.S. labor markets were extremely tight; and 4) equity valuations for large-cap stocks 

rebounded and erased most of the losses incurred during August and September. 

Consumer Spending and Business Investment 

Are Key to Economic Strength 

Most of the standard indicators of health for the U.S. 

economy currently register values associated with the 

best macroeconomic conditions in our history. Growth in 

real gross domestic product (GDP) was 3.9 percent for 

all of 1998—the third consecutive year in which growth 

exceeded 3.5 percent. The U.S. economy added over 3.1 

million jobs during 1998, while unemployment averaged 

just 4.5 percent, the lowest annual figure since 1969. 

Despite this robust economic activity, inflation was also 

the lowest in a generation. Consumer prices rose by just 

1.6 percent in 1998, extending a seven-year streak during which prices have risen by less than 3 percent per 

year. At the same time, strong gains in the productivity 

of U.S. workers helped real hourly earnings rise by 2.7 

percent—the best performance since 1972—while unit 

labor costs of businesses rose by only 1.9 percent. 

Growth in business investment spending, which typically peaks in the early years of an economic expansion, 

has actually accelerated during the current expansion 

(Chart 1, next page). A number of factors appear to be 

responsible for this investment boom. One is the need 

for producers to invest in new technologies in order to 

cut costs and remain competitive. Also, rising stock 

prices, low interest rates, and low yield spreads during 

the past few years have helped keep the cost of capital 

relatively low. The result has been an economic expansion in which approximately 20 percent of net growth in 

real GDP has come from investment in producers’ 

durable equipment, versus approximately 10 percent 

during the long expansions of the 1960s, 1970s, and 

1980s. Bank commercial and industrial lending has 

expanded at an average annual rate of 10.6 percent over 

the past five years, largely on the strength of business 

investment spending. 

The underlying factors that drive consumer spending 

are strong. Low unemployment and rising real incomes 

have boosted the Conference Board’s consumer confiNew York Regional Outlook 3 Second Quarter 1999 
In Focus This Quarter
 

CHART 1 

Low Interest Rates and High Stock Prices
 

Fuel Consumption and Investment
 

Personal Consumption Investment in Producers’ 

Expenditures* (%) Durable Equipment* (%) 

20 9 

15 7
 

5
 10 

3 5 

1 

0 –1 

–5 –3
 

–5
 –10 

* Annual Inflation-Adjusted Rate of Change 

Source: Bureau of Economic Analysis 

1990–91 

Recession 

’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 

dence index to its highest values since the late 1960s. 

Increases in new home construction reflect these favorable conditions. Almost 1.5 million new homes were 

completed during 1998—the highest level in ten 

years—while a record 4.8 million existing homes were 

sold (Chart 2). U.S. automobile sales reached 15.5 million in 1998, their best performance since 1986. Low 

interest rates also enabled a record number of homeowners to reduce their monthly interest expenses by 

refinancing their mortgages during 1998.1 

Although real disposable personal income grew by 

more than 3 percent during 1998, personal savings was 

essentially zero during the fourth quarter. This was the 

1 The Refinancing Index of the Mortgage Bankers Association posted an all-time high of 4,389 in the second week of October 1998. The 

index is scaled to a level of 100 as of the third week of March 1990. 

CHART 2 

Housing Starts and Home Sales Reflect the 

Strength of the Consumer Sector 

Sources: U.S. Census Bureau; National Association of Realtors 

2,250 

2,750 

3,250 

3,750 

4,250 

4,750 

5,250 

5,750 

’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 

One-Unit 

Housing 

Starts (000’s) 

550 

650 

750 

850 

950 

1,050 

1,150 

1,250 

1,350 

1,450 

1990–91 Recession 

Existing 1- to 

4-Family 

Sales (000’s) 

lowest rate of personal savings recorded in the United 

States since the Great Depression. The decline in personal savings has prompted much discussion of its causes and potential implications for the economy and for 

consumer credit quality. Most analysts have argued for 

the importance of a “wealth effect” from rising stock 

values on consumer spending.2 They note that although 

consumers are saving little out of current income, 

household wealth continues to grow rapidly, driving 

consumer spending higher. The willingness of American consumers to spend has been a prime factor in prolonging the economic expansion for the United States 

and in supporting the economies of countries around the 

world that depend on exports to the United States. This 

high degree of reliance on the U.S. consumer has led 

analysts to voice concerns that the wealth effect might 

reverse itself, leading to a sharp drop in consumer 

spending if there is a sustained stock market decline. 

Conditions Vary across Industry Sectors 

While overall conditions in the U.S. economy are good, 

certain sectors have been undergoing significant strain 

because of low commodity prices and weak foreign 

demand. 

Commodity price weakness extends across a wide range 

of items, from agricultural goods to industrial commodities to basic manufactured goods (Chart 3). 

Among agricultural commodities, grain prices have 

fallen substantially from their record-high levels of just 

three years ago, while prices for hogs and soybeans have 

also been under severe pressure. Industrial commodity 

prices have fallen sharply, with steel prices down by 

nearly 30 percent since January 1997. Certain manufactured goods show a similar pattern. The price of the 

industrial chemical benzene has fallen by 40 percent 

since January 1997, while the price of computer memory chips fell by more than 80 percent during that time. 

Oil prices decreased by nearly 50 percent between January 1997 and February 1999. Since mid-March, however, oil prices have increased as a result of agreements 

among oil producers to limit output. Analysts are uncer2 Personal savings is measured as the difference between disposable 

personal income (personal income less tax payments) and total consumption outlays. Increasing household wealth may reduce personal 

savings either through a reduction in disposable income or through 

increased consumption outlays. Tax payments resulting from capital 

gains will reduce measured disposable personal income. Increasing 

household wealth may lead to higher consumption outlays by means 

of the wealth effect. 

New York Regional Outlook 4 Second Quarter 1999 
0 

In Focus This Quarter
 

CHART 3 

Price Weakness Extends across 

a Wide Range of Commodities 

Percent Decline in Prices from January 1997 to March 1998 

All 

commodities* Tin Steel Wheat Benzene Crude Oil 

–5 

–5.3%
 

–10
 –7.7%
 

–15
 

–20
 

–25
 

–30 –29.1%
 

–35
 

–36.2%
 –40
 

–40.6%
 –45
 

–50
 –47.4% 

* Producer Price Index (PPI)
 

Source: Journal of Commerce, Bureau of Labor Statistics
 

tain how long any reductions in output will be maintained or how much oil prices may increase during the 

next several months. 

Three trends in the global economy appear to be responsible for weak commodity prices. First, sustained low 

inflation has taken root both in developed nations and in 

many emerging economies. Low inflation has eliminated much of the speculative demand for commodities 

that was evident during the 1970s. Low inflation has 

also made it difficult for manufacturing firms to raise 

prices, while at the same time encouraging the implementation of new technologies to cut costs. Second, 

large-scale investment in plant and equipment during 

the 1990s in both developed and emerging countries has 

added vast amounts of new global manufacturing 

capacity, making industrial overcapacity a source of 

price weakness in a number of industries. Third, successive currency crises and the resulting recessions that 

have taken place in Asia, Eastern Europe, and Latin 

America have reduced global demand for commodity 

goods. Moreover, U.S. firms find that their products are 

less price competitive abroad because of the relative 

strength of the dollar. 

One reason the overall U.S. economy has proven so 

resilient in the face of weakness in the manufacturing 

sector is that firms have been able to restructure to cut 

costs and improve their market positions. Global overcapacity in industries such as oil and autos has been a 

driving force behind the record number and dollar value 

of merger deals announced during 1998. Mega-mergers 

involving Exxon-Mobil and Daimler Benz-Chrysler 

helped push the dollar volume of mergers announced in 

1998 to almost $1.2 trillion—nearly double the level 

announced in 1997 and far greater than any year during 

the “merger mania” of the 1980s (Chart 4). 

U.S. Foreign Trade Reflects Recent Turmoil 

in the Global Economy 

The U.S. economy increasingly relies on exports to fuel 

its overall growth. Between 1994 and 1997, export 

growth contributed about 1 percentage point each year 

to total net growth in real GDP. However, with the onset 

of the Asian economic crisis in 1997, the export sector 

stalled and became a drag on overall U.S. economic 

activity. During the first three quarters of 1998, exports 

decreased at an annualized rate of 4.4 percent, led by 

declines in capital goods, industrial material and supplies, and food and agricultural products. Weakness in 

exports was not limited to Asia; in fact, Canada, Mexico, and South America were also weak markets for U.S. 

goods and services during most of 1998. Declining 

goods exports and rising imports combined to push the 

U.S. balance of trade to a record deficit of $169 billion 

during 1998—a 50 percent increase from the year 

before. The trade deficit continued to increase in early 

1999. Data for January show an imbalance of nearly 

$17 billion, the largest monthly deficit ever recorded. 

Despite the weakness in foreign demand that was 

observed during much of last year, U.S. exports rose 

sharply at the end of 1998. Total exports jumped by 19.7 

percent during the fourth quarter, contributing 2.0 percent of the total 6.0 percent growth in GDP during the 

CHART 4 

0 

1,000 

2,000 

3,000 

4,000 

5,000 

6,000 

7,000 

8,000 

9,000 

0 

200 

400 

600 

800 

1,000 

1,200 

1,400 

Deal Value 

(Billions $) 

(Columns) 

Number of 

Deals (Line) 

Source: Houlihan Lokey’s Mergerstat 

Pressure to Maintain Profit Margins 

Has Led to Record Merger Activity 

Recessions 

’65 ’67 ’69 ’71 ’73 ’75 ’77 ’79 ’81 ’83 ’85 ’87 ’89 ’91 ’93 ’95 ’97 

New York Regional Outlook 5 Second Quarter 1999 
In Focus This Quarter
 

quarter. This unexpected increase in U.S. exports 

involved nearly every region of the world except Eastern Europe. Export shipments increased across most 

product types, with the greatest increase in activity 

observed in capital goods. 

The Outlook for the Global Economy 

Remains Uncertain 

Developments during the past six 

months have resulted in an 

improved outlook for the global 

economy, but some key uncertainties remain. While the global 

financial system is more stable 

today than it was six months ago, 

some of the world’s most important economies either 

remain in recession or are experiencing slower growth. 

In this environment, the potential remains for shocks to 

arise in the global economy that could adversely affect 

the performance of the U.S. economy and the credit 

quality of insured depository institutions. 

Canada. The Canadian economy is healthier than at any 

time during the past several years. Canada’s economy is 

expected to track overall growth in the United States, in 

part because U.S. demand for goods and services is the 

principal support for Canadian exports. Canada’s relatively high dependence on weak commodity industries, 

such as metals, grains, and livestock, poses risks for 

producers and for local economies closely tied to these 

commodities. 

Mexico. Mexican GDP growth was 4.6 percent in 1998, 

reflecting relatively strong employment and wage gains, 

high levels of foreign direct investment, and robust nonoil export growth. Looking ahead, inflation remains a 

concern. At the end of 1998, the inflation rate was 18.7 

percent, up from a low of 15 percent in the middle of the 

year. The Blue Chip Economic Indicators consensus 

forecast calls for real GDP growth of 2.9 percent during 

1999, down from 4.6 percent in 1998. 

Western Europe. Europe’s problems are similar to 

those of the United States in that they stem from declining growth in manufacturing exports. Despite a 175 

basis point cut in short-term interest rates in the U.K. 

since October 1998, the Bank of England forecasts economic growth of less than 1.0 percent in 1999. In Germany, manufacturing activity has also decreased, owing 

to weakness in export markets. German GDP shrank by 

0.4 percent during the fourth quarter of 1998, while 

unemployment remains above 10 percent. In response to 

signs of growing weakness in Germany and other major 

economies in the 11-member “Euro-zone,” the European Central Bank cut short-term interest rates by 50 

basis points to 2.5 percent on April 8, 1999. 

Eastern Europe. Much of Eastern Europe is faced with 

slow growth or recession following the devaluation of 

the ruble and the default on Russian government debt in 

August 1998. The Russian economy shows few signs of 

recovery amid high inflation and halting progress in 

economic reform. Poland and Hungary, Eastern 

Europe’s engines of growth before the Russian crisis, 

are facing rising current account deficits and a slowdown in export growth. 

Asian Pacific Rim. The Japanese economy remains 

mired in a long-running recession that has resulted in a 

greater number of bankruptcies (up 17 percent in 1998), 

falling domestic demand, and pessimism among consumers and businesses alike. Japanese GDP fell by 2.8 

percent during 1998, and analysts call for a drop of 0.8 

percent in 1999. 

There are signs that the worst phase of the Asian economic crisis may have passed.3 In the Philippines, South 

Korea, Hong Kong, and Thailand, current accounts have 

moved from deficit to surplus as devalued currencies 

continue to depress imports. Foreign capital is returning 

to the region, as evidenced by the 27 percent increase in 

foreign direct investment in Korea during 1998. However, weak consumer spending remains a problem for 

the entire region, which ships fully 40 percent of all 

exports to other Asian Pacific Rim nations. 

In China, which has been relatively immune to the worst 

of the region’s economic crisis, slower growth is also 

forcing economic restructuring. With annual economic 

growth below the targeted 8 percent mark, economic 

planners have been forced to reduce production and 

close plants in the oil, steel, glass, and cement industries. Meanwhile, the government is trying to stimulate 

demand by investing in public infrastructure and by urging banks to increase lending to the private sector. 

3 See “The Asian Economic Crisis: Implications for the U.S. Economy,” Regional Outlook, Third Quarter 1998. Also available at 

http://www.fdic.gov/publish/regout/ro19983q/ny/infocus1.html. 

New York Regional Outlook 6 Second Quarter 1999 
In Focus This Quarter
 

Latin America. With the apparent stabilization of the 

Asian economies, attention has now focused on emerging problems in Latin America. The 50 percent devaluation of the Brazilian real versus the dollar that began in 

January 1999 has depressed economic activity and 

renewed fears of inflation. Consensus estimates place 

Brazilian economic growth at negative 3.5 percent for 

1999, while short-term interest rates are likely to remain 

high (currently about 42 percent) to prevent further capital flows out of the country. 

Risks Remain despite a Positive 

U.S. Economic Outlook 

Robust economic growth, low inflation, and stable 

interest rates appear to be the most likely economic scenario for the remainder of 1999, according to the consensus forecast of the Blue Chip Economic Indicators. 

If this outlook actually comes to pass, we can expect 

that the vast majority of insured institutions will continue to enjoy moderate loan growth and generally favorable indicators of financial performance and condition. 

Despite this positive outlook, the risk remains that the 

expansion could be derailed by one of three types of 

shocks. The first would be a resurgence of inflation 

resulting from demand-induced shortages of labor or 

other key economic resources. Although inflation has 

been consistently low in recent years, investors remain 

on the lookout for any signs of higher prices. While it is 

not certain that a recession would result, it is worth noting that rising short-term interest rates in response to 

increasing inflation have preceded every recession during the past 40 years. 

The second type of shock that could end the expansion 

is a sustained period of deflation. Concern about deflation arises from the low prices many commodity producers are receiving and the effects of foreign currency 

devaluations on U.S. import prices. Although these 

trends have helped to keep U.S. inflation and interest 

rates low, at some point they could impose a heavier 

burden on U.S. businesses by shrinking revenues and 

profit margins, mirroring what has already occurred in 

some commodity-based industries.4 

The third type of shock is financial market instability. 

Consumer confidence, which has reflected recent 

increases in stock market wealth, could tumble in the 

event of a severe and prolonged decline in the stock 

market. Business investment has also depended on the 

support of strong and stable financial markets that offer 

firms access to capital on favorable terms and facilitate 

restructuring in troubled industries. A recession accompanied by financial market instability could pose a particular threat to bank loan performance because it would 

likely produce a disorderly shakeout of troubled firms 

marked by a rise in bankruptcies and loan defaults. 

4 See “How Will the Expansion End?” Regional Outlook, Second 

Quarter 1998. Also available at http://www.fdic.gov/publish/regout/ 

ro19982q/sf/infocus2.html. 

Trends Affecting Banking Lines of Business
 

Overview 

Trends in bank and thrift lines of business align closely 

with those of the economy. Most insured institutions 

have prospered during this economic expansion, as 

shown by the industry’s continuing earnings growth, 

strong capital levels, and improving or stable loan performance across most major loan categories. Likewise, 

today’s strong economy depends to a great extent on the 

continuing availability of consumer and business credit 

from banks and thrifts. Even during the closing months 

of 1998, when capital market funding sources became 

quite volatile, credit continued to flow from insured 

institutions. During that turbulent period, insured institutions may have acted as a stabilizing force for businesses, consumers, and farmers by continuing to provide credit, albeit at higher prices and with stricter 

underwriting terms in some cases. 

Although credit conditions appear strong, a number of 

insured institutions’ loan portfolios are shifting toward a 

riskier mix of credits. Underlying reasons for these 

shifts vary, but likely explanations include opportunities 

to earn higher yields and confidence about the overall 

economic outlook. The following paragraphs discuss 

credit risk trends and highlight possible areas of concern in the major lending lines of business at insured 

institutions. The influence of recent interest rate 

changes and competitive factors on asset/liability and 

credit risk management is also explored. 

New York Regional Outlook 7 Second Quarter 1999 
In Focus This Quarter
 

Consumer Lending CHART 5

Debt Growth Sustains Consumer Spending but 

Could Contribute to Financial Strains under 

Less Favorable Economic Conditions 

Much of the strength and stability of the overall U.S. 

economy owes itself to the continuing growth in consumer spending. While higher personal incomes and 

consumer confidence are important contributing factors, lower interest rates and expanding avenues of credit access have also played key roles in supporting 

consumer spending. With mortgage debt leading the 

way, consumer loan growth rates accelerated in 1998. 

The key factor driving mortgage loan growth was lower 

interest rates, which encouraged many consumers to 

purchase homes, refinance existing mortgages, and 

consolidate their personal debts through home equity 

loans. As a result, the growth in home mortgage credit 

during 1998 reached a post-recession high of 10 percent. Other consumer loan types, such as auto and credit card debt, grew at slower but accelerating rates of 8 

percent and 5 percent, respectively. 

Nonmortgage consumer loan loss rates remain above 

previous recession levels despite the apparent strength 

of the consumer sector. Chart 5 shows that nonmortgage consumer loss rates have declined slightly from 

their peak in the fourth quarter of 1997, but remain 

above the rates experienced during the prior recession. 

The chart also shows that consumer credit loss rate 

trends are closely related to the rise in personal bankruptcy filings, which reached an all-time high of 1.4 

million in 1998.5 The good news for consumer lenders 

is that the growth rate in personal bankruptcies has 

slowed. However, this leveling off does not mean that 

consumer credit quality concerns have abated. The 

overriding concern is how personal bankruptcies and 

consumer credit losses, already at high levels, would be 

affected by less favorable economic conditions. Another concern is whether current consumer spending patterns will be supported by a new round of credit card 

growth. Since revolving credit card balances typically 

carry higher interest rates than home equity loans, this 

5 Reasons for the rise in personal bankruptcy rates are further 

explored in a series of Bank Trends articles published by the FDIC. 

See, for example, “A Time Series Model of the U.S. Personal Bankruptcy Rate, 1970-1996,” February 1998, and “The Effect of Consumer Interest Rate Deregulation on Credit Card Volumes, 

Charge-Offs, and Personal Bankruptcy Filings,” March 1998. Both 

reports can be accessed at www.fdic.gov/publish/bktrnds/index.html. 

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

3.0 

1Q91 2Q92 3Q93 4Q94 1Q96 2Q97 3Q98 

0.0 

0.2 

0.4 

0.6 

0.8 

1.0 

1.2 

1.4 

Consumer Charge-Offs and Bankruptcies 

Have Leveled Off at a High Rate 

Bankruptcy Filings 

per 1,000 Population 

(Right axis) 

Sources: Administrative Office of the U.S. Courts; Federal Reserve Board 

1.6 

Consumer Loan 

Charge-Off Rate (%) 

“reloading” of credit card debt would further strain the 

financial flexibility of consumers. 

High Loan-to-Value Mortgage Products 

and Subprime Lending Transform 

Consumer Lending 

Consumer lending practices have changed significantly 

since the last recession. Because of intense competition 

and declining net interest margins, consumer lenders 

are reaching out to borrowers further down the credit 

quality spectrum and relaxing traditional collateral 

requirements. Bank supervisors have indicated that a 

growing number of insured institutions are involved in 

some form of subprime lending. Subprime loans, 

designed for borrowers with blemished or limited credit histories, can take a variety of forms, including home 

equity, automobile, and credit card loans. As compensation for increased risk, subprime loans carry higher 

interest rates than prime-rate loans and often require 

substantial collateral margins. 

Insured institutions are also embracing another relatively new consumer loan product: high loan-to-value 

(LTV) loans. High LTV loans, where the combined 

amount of senior and junior liens against a home 

exceeds its value, are usually made to borrowers with 

“clean” or unblemished credit histories. However, the 

lack of collateral protection results in much higher loss 

experience when a borrower defaults. As Chart 6 shows, 

high LTV loans have had a higher loss rate experience 

(adjusted for seasoning) than either traditional home 

equity loans or subprime loans. Moreover, the delinquency rates on recent-vintage home equity loan pools 

New York Regional Outlook 8 Second Quarter 1999 
In Focus This Quarter
 

CHART 6 

0 

1 

2 

3 

4 

5 

6 

7 

0 2 4 6 8 10 12 14 16 18 20 22 

Months since Origination 

High LTV Mortgages* Have a Higher Loss 

Experience than Other Mortgage Types 

Charge-Off Rate (%) 

* Includes home improvement loans 

Source: Moody’s Investor Services 

High LTV 

Subprime 

Traditional 

Home Equity 

have deteriorated as high LTV loans have proliferated.6 

At the same time, recent regulatory surveys of credit 

underwriting practices show easing standards on home 

equity loans.7 The loss experience of these higher risk 

consumer products during less favorable economic circumstances is unknown and continues to be a concern. 

Commercial Lending 

Commercial Loan Performance Remains 

Strong but Corporate Financial Strains 

Are Developing 

Continued strength in the corporate sector is reflected in 

the level of corporate bankruptcy filings, which have 

declined since the middle of 1997 to just under 10,000 

in the fourth quarter of 1998. Bank losses on commercial credits remain low but did register a modest 

increase during the fourth quarter (see Chart 7). In addition to strong economic fundamentals in high tech, construction, finance, service-related, and other sectors, 

U.S. businesses have benefited from significantly lower 

interest rates and an abundant supply of credit. Credit 

access provided by banks was particularly important to 

U.S. businesses in the latter part of 1998. During this 

6 “Moody’s Home Equity Index Update.” Moody’s Investor Services, 

October 2, 1998, p. 3. 

7 For example, the Office of the Comptroller of the Currency’s “1998 

Survey of Credit Underwriting Practices” indicated that 33 percent of 

the banks offering home equity loans eased standards, compared with 

only 7 percent that tightened standards. The report is available at 

http://www.occ.treas.gov/cusurvey/scup98.pdf. 

period, sharply higher interest rate spreads on corporate 

bonds8 and commercial paper led many companies to 

tap cheaper funding sources, including existing unused 

credit and commercial paper lines held by commercial 

banks. As a result, commercial banks experienced a 15 

percent (annualized) rate of growth in fourth quarter 

1998, the highest rate of commercial loan growth in 16 

years. 

Although commercial loan loss rates are low, financial 

strains are becoming apparent among certain U.S. business sectors. Bank lending to U.S. businesses has grown 

at a faster pace than GDP during each of the past eight 

quarters. Moreover, growth in bank commercial lending 

through 1998 has come at a time when total after-tax 

U.S. corporate profits have begun to decline.9 Deteriorating profits are especially prevalent in sectors with 

exposure to weak commodity prices and slower export 

growth. For many businesses, lower profits have resulted in a reduced capacity to service outstanding debt 

obligations. For instance, a recent Bank of America 

Corporation study reported that amendments to syndicated loans in the latter half of 1998 were driven 

increasingly by borrowers seeking relief from financial 

performance-related covenants.10 Financial strains are 

8 The Merrill Lynch U.S. Investment Grade Corporate Bond Master 

Index indicates that corporate bond spreads over ten-year Treasury 

rates rose 58 percent, an increase of 63 basis points, from the end of 

July 1998 to the end of October 1998. 

9 See the Bureau of Economic Analysis Corporate Profit Index. 10 “Covenants Provide Loan Repricing Opportunity.” Bank of America 

Report, January 25, 1999. 

CHART 7 

0.0 

0.2 

0.4 

0.6 

0.8 

1.0 

1.2 

1.4 

1.6 

1.8 

2.0 

1Q91 3Q92 1Q94 3Q95 1Q97 3Q98 

Sources: U.S. Courts; Bank Call Reports 

Net Charge-Off Rate (%) Business Bankruptcies 

9,000 

10,000 

11,000 

12,000 

13,000 

14,000 

15,000 

16,000 

17,000 

18,000 

19,000 

20,000 

Domestic Commercial Loan Losses Remain Low 

and Business Bankruptcies Decline 

New York Regional Outlook 9 Second Quarter 1999 
In Focus This Quarter
 

also reflected in the level of corporate bond defaults, 

which Standard and Poor’s reported at 48 ($10.8 billion in affected debt) in 1998, up 182 percent from 1997 

levels (up 150 percent in dollar volume terms).11 

As Debt Markets Become More Cautious, 

Syndicated Lending Shifts toward Higher 

Risk Borrowers 

Although the longer-term trend has been toward more 

aggressive corporate lending strategies, many insured 

institutions responded to the financial market turmoil in 

late 1998 with a heightened sense of caution. Recent surveys of underwriting practices conducted by the federal 

banking agencies show that many banks tightened standards in late 1998 across many product lines.12 However, 

tighter lending terms do not appear to have quelled 

either loan demand or loan production substantially. 

Syndicated lending trends suggest an increase in corporate lending risks.13 Despite the flight to quality that 

occurred in the latter part of 1998, syndicated loans to 

leveraged companies jumped 41 percent to $273 billion 

during 1998. Over the same period, nonleveraged loans 

declined 35 percent to $599 billion. Although corporate 

merger activity accounts for much of the increase in 

leveraged lending volume in 1998, some lenders appear 

to be taking advantage of the higher yields available in 

this market relative to yields on lower risk credits. The 

apparent shift toward a higher risk mix of total syndicated credit outstanding is occurring at the same time 

that corporate bond defaults for speculative grade issues 

are trending upward.14 Moreover, trends in corporate 

bond spreads and rating agency actions on corporate 

bond debt suggest a bond market that is becoming 

increasingly cautious about the outlook for U.S. businesses (see Chart 8). 

11 “Corporate Defaults Rise Sharply in 1998,” Standard & Poor’s, 

March 5, 1998. 

12 See Federal Reserve Board Senior Loan Officer Opinion Surveys 

for November 1998 and January 1999, http://www.bog.frb.fed.us/ 

boarddocs/snloansurvey/. 

13 Syndicated loans are credit facilities made to medium and large corporate borrowers by a group or syndicate of lenders. Analysts often 

segment this market into “leveraged” lending (loans to heavily indebted companies) and nonleveraged lending. 

14 Moody’s Investor Services reports that trailing 12-month default 

rates for speculative-grade issuers rose from 2.02 percent at the end 

of 1997 to 3.31 percent at year-end 1998. These default rates compare 

to an all-corporate trailing default rate of 0.68 percent in 1997 and 

1.27 percent in 1998. 

CHART 8 

0.4 

0.6 

0.8 

1.0 

1.2 

1.4 

1.6 

1.8 

2.0 

4Q93 4Q94 4Q95 4Q96 4Q97 4Q98 

–120 

–80 

–40 

0 

40 

80 

120 

160 

200 

Corporate Bond Ratings and Required 

Yields Reflect Greater Market Uncertainty 

Merrill Lynch Corporate Bond 

Master Index Spreads to Comparable

 Maturity Treasuries (bps) 

Sources: Moody’s Investor Service; Merrill Lynch 

Ratio of Corporate 

Upgrades to 

Downgrades 

Commercial Real Estate and 

Construction Lending 

Construction Loan Growth Accelerates 

as Overbuilding Pressures Increase 

in Certain Markets 

In 1998, the value of private commercial construction 

rose 4.0 percent over 1997 levels, reflecting a moderate 

slowdown in growth compared with a compounded 

average annual growth rate of 8.4 percent since 1992. In 

contrast, the pace of residential development has accelerated. The value of private residential construction rose 

11.5 percent in 1998, compared with an annual average 

growth rate of 8.0 percent since 1992. Construction 

loans at insured institutions grew 20 percent in 1998, 

the highest growth rate since 1986.15 

Although market fundamentals are strong throughout 

most major U.S. markets, some metropolitan areas 

appear to be vulnerable to an oversupply of commercial 

space. The Regional Outlook, First Quarter 1999, highlighted nine markets that may be susceptible to commercial overbuilding on the basis of the following 

factors: 1) the rapid pace of current construction activity in those markets; 2) high vacancy rates relative to 

construction in progress in some cases; 3) projections of 

rising vacancy rates by market analysts; and 4) various 

recent shifts in demand indicators. Data through June 

1998 indicate that construction activity in these markets 

15 Construction loan growth captures growth in both residential and 

nonresidential development. 

New York Regional Outlook 10 Second Quarter 1999 
In Focus This Quarter
 

has not yet abated to reflect moderating demand levels.16 

Overbuilding concerns may be tempered to the extent 

that tighter commercial real estate lending standards 

slow the pace of development.17 

Loan Underwriting Study Reveals Sounder 

Practices Compared with the 1980s, but Intense 

Competition Forces Some Concessions on 

Pricing and Structure 

Beginning in August 1998, FDIC analysts set out to 

investigate construction loan underwriting practices in 

banks servicing various rapidly growing markets. The 

study identified several differences between today’s 

lending practices and those prevalent during the last 

cycle. Most importantly, today’s lenders are making 

credit decisions on the basis of improved appraisals, 

increased attention to project cash flows and project 

feasibility, and better market information on competing 

projects. However, intense competition has forced an 

across-the-board reduction in loan pricing margins even 

compared with margins at the height of the 1980s building boom. 

The study also identified some instances of aggressive 

loan structures, including pricing at extremely thin margins, waiving or limiting personal guarantees, waiving 

cash equity requirements, and lending on thin collateral 

margins. Borrowers who secured the most aggressive 

loan terms were typically larger developers, who presumably have the resources and financial flexibility to 

weather adverse conditions. Nevertheless, waiving personal guarantees and eliminating a borrower’s financial 

exposure to project risks are practices often cited in 

conjunction with the heavy construction loan losses 

experienced during the previous real estate downturn. 

Finally, the study found that many real estate investment 

trusts and large corporate developers have been able to 

obtain long-term unsecured financing for development 

purposes. The lack of collateral protection could make 

16 The nine markets are Atlanta, Charlotte, Dallas, Las Vegas,
 

Nashville, Orlando, Phoenix, Portland, and Salt Lake City. “Commercial Development Still Hot in Some Markets but Slower Development May Be Ahead.” Regional Outlook, First Quarter 1999,
 

www.fdic.gov/publish/regout/ro19991q/na/index.html.
 17 Consistent with commercial and industrial underwriting trends,
 

commercial real estate lenders reacted to market volatility in late
 

1998 by tightening loan terms and raising pricing margins. See, for
 

example, the Federal Reserve Board Senior Loan Officer Opinion
 

Survey for November 1998 and January 1999.
 

these loans particularly vulnerable to declining commercial real estate prices.18 

Agricultural Lending 

Farm Banks Threatened by Falling 

Commodity Prices 

Farm banks generally performed well in 1998, reporting 

a modest increase in nonperforming loans from 1.09 

percent at year-end 1997 to 1.13 percent as of year-end 

1998. Although delinquent loans rose only slightly 

in the aggregate, farm banks in some localized areas 

such as northeast North Dakota and northwest Minnesota experienced sharply higher problem loan levels 

and reduced profits in the aftermath of three consecutive years of low prices, bad weather, and crop diseaserelated problems. Moreover, recent surveys by the 

federal banking agencies, which show rising levels of 

farm carryover debt at farm banks, suggest that nonperforming loan data may understate borrower difficulties. 

During 1998, the outlook for significant portions of the 

farm sector deteriorated following a dramatic fall in 

prices for several major farm commodities. Prices for wheat, corn, 

soybeans, and hogs fell to ten-year 

lows and were below the economic breakeven cost of production for 

many producers. For areas heavily 

dependent on these commodities, 

the U.S. Department of Agriculture (USDA) projects that producers will experience 

substantial declines in net cash income from 1999 

through 2003.19 In 1999, the USDA projects farm 

income to fall 7.1 percent, to $44.6 billion, from last 

year’s level of $48 billion. 

Although current conditions have the potential to cause 

stress for substantial numbers of farm banks in certain 

regions, some significant differences exist between 

today’s circumstances and those that led to the farm 

18 Loan covenants may mitigate some of the risks of lending without 

collateral protection. Common covenants include maximum leverage 

ratios, minimum equity requirements, and limits on encumbered 

assets through recourse or cross-collateralization to third parties. 

19 A substantial portion of the USDA’s projected decline in the net 

cash income for U.S. farmers over the next five years is attributable 

to reductions in government payments to farmers. 

New York Regional Outlook 11 Second Quarter 1999 
In Focus This Quarter
 

bank crisis of the mid-1980s. Current favorable factors 

include 1) lower debt-to-equity for farm producers; 2) 

substantially lower interest rates; 3) moderately appreciating farmland prices relative to the more rapid appreciation (and subsequent price corrections that followed) 

in the 1970s and 1980s; and 4) better underwriting practices by farm lenders. Nevertheless, if weak exports of 

farm products and low commodity prices continue for 

the remainder of this year, the condition of farmers 

could deteriorate significantly, increasing financial 

stress at insured farm banks. 

Funding and Interest Rate Risk 

Deposit Funding Becomes 

More Difficult to Obtain 

Competitive pressures in the banking industry are not 

restricted to lending. Insured institutions are also finding it difficult to attract deposits in today’s marketplace, 

largely because of the existence of higher yielding 

investment products. For example, the Investment 

Company Institute reports that net inflows into mutual 

funds have exceeded net increases in deposit accounts 

in all but three quarters since mid-1991. The fourth 

quarter of 1998 marked the sixteenth consecutive quarter that mutual fund inflows outstripped deposit increases. As deposits have become more difficult to attract, 

loan portfolios have expanded in line with the overall 

growth in the economy. As a result, institutions have 

turned increasingly to other borrowings for funding. 

These trends are captured in Chart 9, which shows that 

the ratio of bank and thrift loans to deposits reached a 

record 88 percent in December 1998. Small community 

CHART 9 

banks and thrifts (institutions with less than $1 billion in 

assets) are most affected by deposit trends, since they 

tend to rely more heavily on deposit funding than larger institutions with greater access to the capital markets. 

Interest Rate Changes Pose Asset/Liability 

Management Challenges 

Interest margin pressures are posing challenges for 

insured institutions. In addition to the effect of competitive pressures, changes in interest rates have had a substantial influence on institutions’ net interest margins. 

The flattening of the yield curve in 1998, for example, 

appears to have contributed to a decline in margins to 

their lowest levels since 1991 for both large and small 

insured institutions (see Chart 10). For insured institutions with more traditional asset/liability structures 

(longer-term asset holdings funded with shorter-term 

deposits and borrowings), a flatter yield curve results in 

lower spreads between asset yields and interest costs. 

The decline in long-term interest rates during 1998 also 

led to a record volume of mortgage refinance activity, 

as indicated by the Mortgage Bankers Association’s 

Refinancing Index.20 Among many mortgage lenders, 

the most immediate impact from this refinancing activity was the revaluation of servicing assets and lower servicing fee income. Some mortgage lenders also saw a 

significant increase in overhead as they expanded staff 

to accommodate higher loan application volumes. A 

20 This index hit its peak in mid-October and has since declined in line 

with a modest upward movement in fixed mortgage rates. 

CHART 10 

65 

70 

75 

80 

85 

90 

95 

’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 

Loans and Assets Are Growing Faster than 

Deposits at Insured Institutions 

Loans to Deposits 

Deposits to Assets 

Source: Bank Call Reports and Thrift Financial Reports 

Percent 

A Flatter Yield Curve in 1998 Placed 

Pressure on Net Interest Margins 

Sources: Federal Reserve Board; Bank Call Reports; Thrift Financial Reports 

1.0 

1.5 

2.0 

2.5 

3.0 

3.5 

4.0 

4.5 

5.0 

–50 

0 

50 

100 

150 

200 

250 

300 

350 

’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 

Assets 

< $1 Billion 

(right axis) 

10-Year Less 1-Year 

Treasury (bps) 

Mean Net Interest 

Margin (%) 

Assets 

> $1 Billion 

(right axis) 

New York Regional Outlook 12 Second Quarter 1999 
In Focus This Quarter
 

longer-lasting impact involves the shift in borrower 

preferences toward fixed-rate mortgages. According to 

Freddie Mac, approximately 65 percent of adjustablerate mortgages refinanced in 1998 were replaced with 

30-year fixed-rate mortgages. Another 30 percent were 

refinanced into 15- and 20-year fixed-rate mortgages. 

As a result of this activity, mortgage lenders may tend 

to have a higher proportion of assets held in longer-term 

mortgage loans, leading to further margin pressures 

should interest rates rise. 

As discussed in previous sections, many insured institutions appear to be turning toward higher risk consumer 

and corporate lending strategies. Such strategic shifts 

may be at least partially in response to pressures on net 

interest margins. The search for higher yield spreads 

may also explain the continuing growth in nondeposit 

funding sources, which often take the form of complex 

obligations with embedded options that can reduce 

funding costs at the expense of additional interest rate 

risk. 

Indicators of Industry Performance
 

Market Signals for the Banking 

Industry Are Mixed 

Diminished concerns over the near-term economic outlook and reduced financial market volatility resulted in 

a sharp turnaround in investor attitudes toward banks in 

the fourth quarter of 1998. During the quarter, the SNL 

Bank Stock Index21 rose 21 percent, recovering all of 

the value it lost during the turmoil of the third quarter. 

The index has continued to rise in 1999. 

Although equity indicators have been generally positive, ratings actions in 1998 for the long-term debt of 

U.S. banks and finance companies reflect developing 

problems for certain industry segments. In sharp contrast to the previous six years, when upgrades far 

exceeded downgrades, Moody’s downgraded as many 

bank and finance company debt ratings as it upgraded 

during 1998. In the fourth quarter of 1998, Moody’s 

downgraded the long-term debt ratings of 27 bank and 

finance companies and upgraded only 15—the highest 

quarterly ratio of downgrades to upgrades since 1992. 

Downgrades during 1998 were centered in finance 

companies specializing in nonportfolio subprime lending and bank holding companies with exposure to 

emerging markets. 

Bank Performance Remains Strong but 

Earnings Variability Is Increasing 

Recent stable industry profitability in the aggregate has 

masked an increasing range of profit variability for 

individual commercial banks. Over the past six years, 

21 This index tracks the market capitalization of approximately 520 

banking companies. 

the annual aggregate return on average assets (ROA) for 

commercial banks has shown little fluctuation, ranging 

from a low of 1.15 percent in 1994 to a high of 1.24 percent in 1997.22 However, the variability in commercial 

bank profitability, as measured by the distribution of the 

industry’s ROA excluding the top and bottom 5 percent, 

has widened since 1994 (see Chart 11). For example, 

ROA for the worst 5 percent of the industry was negative 0.29 percent or less in 1998, reflecting a steady 

decline from 0.2 percent in 1995. Similarly, ROA for the 

most profitable 5 percent of commercial banks was 

above 2.16 percent, up from 1.94 percent in 1994. 

Reasons for the increasing variability of commercial 

bank ROA can be further analyzed by segregating institutions along predominant product or business lines. 

Chart 12 (next page) details the distribution of 1998 

22 FDIC Quarterly

www2.fdic.gov/qbp. 

CHART 11 

 Banking Profile, Fourth Quarter 1998, 

3.0 

’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 

Source: Bank Call Reports 

Bottom 5th Percentile 

Top 5th Percentile 

Mean 

The Range of Profitability for Commercial 

Banks Is Increasing 

Return on Asset Distribution 

–4.0 

–3.0 

–2.0 

–1.0 

0.0 

1.0 

2.0 

New York Regional Outlook 13 Second Quarter 1999 
In Focus This Quarter
 

CHART 12 

–5% 0% 5% 10% 15% 

1998 Performance Varies by 

Business Specialization 

Return on Assets Percentage Distribution 

Agricultural 

(2,274) 

International 

(11) 

Consumer 

(211) 

Commercial 

(3,150) 

Specialized 

(621) 

Credit Card 

(68) 

Note: Group institution count is in parentheses. 

Source: Bank Call Reports (Research Information System) 

Industry Mean ROA=1.13% 

Bottom Fifth Percentile 

Top Fifth Percentile 

ROA for six selected groups of banks segregated by line 

of business concentrations. This chart reveals that bank 

performance varies considerably by business specialty. 

For example, the distribution of ROA of credit card 

lenders23 differs significantly from that of other bank 

groups, including other consumer lenders.24 Small specialized banks25 and commercial lenders26 followed 

credit card lenders as the groups with the greatest variability in profitability in 1998. Moreover, 75 percent of 

the least profitable commercial banks were members of 

small specialized or commercial groups. New banks 

have also influenced the dispersion of bank ROA. Banks 

chartered in 1997 and 1998 make up more than 60 percent of the industry’s worst performers. However, earnings variability widened in 1998 even when newer 

institutions are excluded from the analysis. 

23 Banks with at least 50 percent of managed loans in managed credit 

card receivables and at least 50 percent of managed loans in total 

managed assets. 

24 Banks with consumer loans and single-family mortgages in excess 

of 50 percent of assets that do not meet separate credit card or mortgage lending concentration thresholds. 

25 Banks with total assets less than $1 billion, and less than 40 percent 

of assets held in loans, that do not fall in other business specialties. 

Members of this group include de novo banks and more seasoned 

banks with low loan activity, such as trust companies. 

26 Banks with 25 percent or more of assets in commercial and commercial real estate loans. 

Far fewer commercial banks posted losses in 1998 than 

during the period from 1984 to 1992. Still, the number 

of unprofitable institutions appears to be rising despite 

generally favorable economic conditions. These concerns are mitigated somewhat, since today’s worstperforming institutions are generally much better 

capitalized and are burdened with fewer problem assets 

than their counterparts during the 1980s. 

Summary 

Most indicators of U.S. economic health remain robust 

in spite of the difficulties posed by low commodity 

prices and falling exports during 1998. The consensus 

forecast of leading economic analysts calls for continued growth in the U.S. economy for the rest of 1999. At 

the same time, a number of threats to this favorable outlook exist, including the possibility of higher inflation 

and higher interest rates stemming from strong economic growth. Other scenarios involve a very different 

threat—namely, price deflation brought on by global 

overcapacity and a decline in U.S. exports. Shocks that 

might arise in the foreign sector or in the financial markets, as experienced during 1998, remain a significant 

concern during 1999. Consumer spending and business 

investment seem particularly vulnerable to such shocks 

at this stage of the expansion. 

Favorable economic conditions are reflected in the overall performance of the banking industry. Still, a number 

of indicators suggest that the risk profile of some 

insured institutions is increasing. Responding to significant competitive pressures, and perhaps emboldened 

by the long duration of the current expansion, many 

institutions are expanding their involvement in higherrisk consumer loan products, such as subprime and high 

LTV loans and higher-risk leveraged commercial loans. 

The overall shift toward higher-risk credits is occurring 

despite signs of financial strain on the part of many consumers (in the form of record personal bankruptcies) 

and businesses (in the form of declining profits and 

increasing bond default rates). Credit-related concerns 

also extend to commercial real estate, where some markets are exhibiting rapid commercial real estate development at the same time that demand indicators are 

New York Regional Outlook 14 Second Quarter 1999 
In Focus This Quarter
 

trending downward. Finally, sustained weak commodity 

prices are placing strains on farmers and could eventually lead to higher agricultural loan delinquencies. 

Bank and thrift net interest margins are being pressured 

by a flatter yield curve and heightened competition. 

Community institutions, which rely most heavily on 

interest income, are particularly vulnerable to tighter 

margins. The major concern in this area is that insured 

institutions will combat falling margins by entering into 

riskier funding and lending strategies. 

Market indicators and reported financial data reflect 

favorable industry performance as well as new sources 

of risk. Investor attitudes toward banking companies 

have improved since late 1998 because of an improved 

near-term economic outlook and a reduction in financial market volatility. However, a recent increase in 

ratings downgrades of bank and finance company longterm debt suggests growing concern over bank exposures to such areas as subprime lending and emerging 

markets. Despite relatively strong aggregate industry 

performance, profit variability among individual commercial banks has increased because of new chartering 

activity and pressures in consumer and commercial 

lending. As a result, for the first time since 1992, the 

worst performing 5 percent of all commercial banks 

were unprofitable last year. 

This article was prepared and coordinated by the staff of the Analysis Branch of the Division of Insurance. Contributions and feedback from analysts across the Division were essential to its completion. 

Maureen E. Sweeney, Associate Director 

Paul C. Bishop, Senior Financial Economist 

Richard A. Brown, Chief, Economic and Market Trends Section 

Steve Burton, Senior Banking Analyst 

Steven E. Cunningham, Chief, Financial Institutions Section 

Alan Deaton, Economic Analyst 

Diane Ellis, Senior Financial Analyst 

Jim Heil, Economic Analyst 

Brian Kenner, Financial Analyst 

Allen Puwalski, Senior Financial Analyst 

New York Regional Outlook 15 Second Quarter 1999 
Regional Perspectives
 

Regional Perspectives
 

• The New York Region’s economy is healthy and growing steadily, even though its economic growth still trails 

that of the nation. 

•	 The Region’s banks continue to record favorable financial results. International banks have rebounded 

despite turmoil in the global market. 

•	 The flat yield curve has hurt savings institutions more than commercial banks. Also, the Region’s savings 

institutions have a higher rate of delinquencies than that of the nation. 

•	 Growing levels of consumer debt raise questions about credit quality. Credit card banks face consolidation, 

competition, and the increasing popularity of new consumer lending products, such as high loan-to-value 

home equity and subprime loans. 

Economic and Banking Conditions
 

The Region’s Economy Is Getting Stronger 

With the nation prospering in the 

longest peacetime expansion in 

U.S. history, the Region’s economy 

is growing steadily. The combined 

gross state products for the 

Region1 increased for the seventh 

consecutive year, climbing 2.9 

percent in 1998. While this performance represents the 

highest increase since 1994, it is a full percentage point 

below the national figure (see Chart 1). Higher business 

costs, less available land for development, and weaker 

population growth all contribute to the slower growth of 

the Region compared with that of the nation. Nevertheless, the Region’s economic expansion has generated 

higher incomes and new jobs for many of its residents. 

This in turn has stimulated consumption, particularly in 

housing and automobiles. 

In large measure, the Region’s expanding economic 

output stems from the increasing concentration of highvalue-added industries, such as management consulting, legal services, media and publishing, engineering, 

and financial services. Companies in these sectors generally pay higher salaries than those in other industries 

and generate substantial amounts of revenue per 

employee. As a result, over the past decade workforce 

1 Data supplied by Regional Financial Associates. 

productivity rates2 in the Region have been higher than 

in the nation and have been increasing at a faster rate 

(see Chart 2). Fueled by the stock market, the increased 

profitability of financial service industries in particular 

has contributed to the surge in productivity. 

The Region Is Heavily Dependent 

on Financial Services 

The financial services industry, which includes the 

banking, insurance, real estate, and securities sectors, is 

significantly more concentrated in the Region than in 

the nation. This industry accounted for 25 percent of the 

Region’s total economic output (or gross state product) 

in 1998, compared with 19 percent for the nation. In 

Delaware, the financial sector accounted for 45 percent 

of the gross state product because of its large number of 

credit card banks. An economic diversity index developed by the FDIC3 shows that Delaware is one of the 

least diverse states in the United States. New York, 

which has the largest number of security industry 

employees, generated 31 percent of its gross state product from the financial sector. Because a growing share 

2 Workforce productivity is defined as output divided by the number 

of workers. 

3 The Index of Economic Diversity summarizes how closely the 

state’s economy resembles the nation’s. A lower index value, such as 

that of Delaware, indicates that a state has a higher concentration of 

economic activity than the United States in some industries. 

New York Regional Outlook 16	 Second Quarter 1999 
Regional Perspectives
 

CHART 1 CHART 2 

Index: 1980 = 100. 

Source: Bureau of Labor Statistics and National Income and Product Accounts 

Productivity Is Higher and Increasing Faster 

in the Region than in the Nation 

100 

110 

120 

130 

’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 

Index Value U.S. N.Y. Region 

The Region’s Gross Product Has Grown 

for Seven Consecutive Years, but 

Still Trails the Nation 

–3 

–2 

–1 

0 

1 

2 

3 

4 

’90 

5 

’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 

Percent Change N.Y. Region U.S. 

Source: Regional Financial Associates, National Income and Product Accounts 

of its wealth is generated by Wall Street, New York’s 

economic diversity index has fallen in the past ten 

years. Except for Pennsylvania, all of the other states in 

the Region were higher than the national average in 

financial sector concentration. Reliance on the financial 

sector may increase further over the next few years, with 

continued strong growth in employment on Wall Street. 

Because the relationship between economic growth and 

the stock market is stronger in the New York Region 

than elsewhere, a sustained disruption in the stock market could have particularly adverse consequences for 

the Region’s economy. When the world’s equity markets 

fell in unison during the third quarter of 1998, several 

international banks4 and brokerage houses sustained 

heavy losses. Many of the losses resulted from exposure 

to emerging markets and derivative products. As of 

December 31, 1998, banks in the Region reported 

almost $25 trillion in notional amount of derivatives, or 

80 percent of all derivative contracts held by insured 

institutions in the United States. Several institutions 

announced restructuring plans and layoffs. Moreover, 

prices for some high-end residential real estate in New 

York fell almost immediately as demand softened and 

financing for commercial real estate evaporated. 

Although the stock market quickly recovered and liquidity slowly returned to the financial markets after the 

Federal Reserve Board lowered interest rates, such 

immediate, if short-lived, consequences of a temporary 

market upheaval demonstrate the potential risks of overreliance on the financial services industry. 

4 International banks are banks that have total assets greater than $10 

billion and 25 percent of total assets in foreign assets. 

Global Economic Turmoil Spreads to Brazil 

and Adversely Affects the Region’s Trade 

The recessions in Asia, Brazil, and Russia are putting 

pressure on the economies of both the United States and 

the Region. After having risen for several years, the 

Region’s exports to Brazil dropped 

more than 11 percent between 

1997 and 1998.5 During the same 

period, the Region’s exports to 

Asia dropped more than 14 percent. Industries in the Region that 

are most vulnerable to declining 

exports include chemicals, industrial machines, and 

electrical components. The Region’s exporters could 

face a further drop-off if the Brazilian economy continues to contract. Analysts are calling for a 3 to 4 percent 

decline in Brazil’s gross domestic product in 1999.6 

Moreover, the Region’s manufacturers are being harmed 

by an influx of cheap imports from these troubled 

economies. With the price of imports from emerging 

markets around the world declining because of devalued 

currencies, some of the Region’s manufacturers will be 

hard-pressed to remain competitive. The steel, chemical, and pharmaceutical industries are most susceptible. 

Cheaper imported steel from Brazil, for example, could 

worsen an already bad situation for steel producers in 

areas such as western Pennsylvania, which has been 

5 Data supplied by Regional Financial Associates. 6 Blue Chip Economic Indicators, April 1999. 

New York Regional Outlook 17 Second Quarter 1999 
Regional Perspectives
 

feeling sharp competitive pressure from cheap Asian 

and Russian imports.7 

The Region’s Banks and Thrifts Continue 

to Report Healthy Financial Conditions 

The Region’s banks and thrifts reported generally 

healthy financial conditions in the fourth quarter of 

1998. The Region’s average return on assets (ROA) was 

0.94 percent, compared with 0.97 percent at year-end 

1997. The average net interest margin (NIM) declined 

to 4.0 percent in the fourth quarter, compared with 4.16 

percent a year earlier. The average NIM declined significantly in savings institutions, which experienced a drop 

of 60 basis points from December 31, 1997 (3.54 percent to 2.94 percent). The average reported leverage 

capital ratio remained strong, rising 33 basis points over 

the year-end 1997 figure. Aggregate past-due ratios 

continued to decline, reflecting improvement in almost 

all loan categories, with the exception of commercial 

and industrial loans and loans to consumers, which both 

saw a modest rise in past-due levels. Credit card portfolios,8 the sector with the highest past-due and charge-off 

rates, had aggregate charge-offs of 4.69 percent in 1998, 

the first time that figure fell below 5.0 percent in more 

7 The House of Representatives passed a bill in March that would limit 

U.S. imports to pre-1998 levels. The bill faces opposition both in the 

Senate and at the White House. Its final passage is uncertain. 

8 These figures are for all banks in the Region, not just credit card 

banks. 

than two years. However, aggregate past-due credit card 

loans continued to rise slightly, up to 5.11 percent from 

4.99 percent in 1997. The rise in past-dues occurred in 

the most seriously delinquent loan category, 90 days or 

more past due, suggesting that charge-off levels are 

unlikely to fall significantly in the next few quarters. 

The Region’s International Banks 

Adjust to Emerging Markets 

After reporting lower earnings in the third quarter, most 

of the Region’s international banks rebounded in the 

fourth quarter despite continued weakness in emerging 

markets. These banks are more vulnerable to instability 

in foreign markets because of their significant crossborder exposure and trading activities. For example, as 

of September 30, 1998, exposure of all United States 

banks to Brazil totaled $18.6 billion; more than 71 percent of this exposure was in international banks, most of 

which are in the New York Region.9 The exposure was 

three times greater than the exposure to Russia at the 

height of its crisis last August. While far less than the 

peak of $27 billion in the late 1980s, bank exposure to 

Brazil is still larger than to any country outside Western 

Europe and Canada. Banks had been cutting their 

emerging market exposure in reaction to global turmoil, 

and as a result, total U.S. exposure to Brazil declined by 

32 percent over the past year and a half. 

9 Federal Financial Institutions Examination Council Country 

Exposure Lending Survey, January 13, 1999. 

New York Regional Outlook 18 Second Quarter 1999 
0 0

0

0

0

0 0

Regional Perspectives
 

Savings Institutions Underperform Commercial Banks
 

The Region’s 358 savings institutions (savings banks 

and savings and loan associations) are underperforming commercial banks. As of December 31, 1998, this 

group had an average ROA of 0.71 percent compared 

with 1.10 percent for commercial banks. The primary 

reasons for the difference are lower-than-average NIMs 

and a comparative lack of noninterest income. The 

Region’s savings institutions reported an average NIM 

of 3.37 percent as of year-end 1998 compared with 

4.40 percent for commercial banks, a difference of over 

100 basis points. Savings institutions have a significantly larger portion of their assets in low-yielding residential real estate loans than commercial banks (41 

percent versus 9 percent). With mortgage rates hovering at or below 7 percent throughout 1998, savings 

institutions faced margin pressures as their portfolios 

amassed large volumes of low-yielding, long-term, 

fixed-rate assets. 

The flat yield curve environment of the past two years 

has prevented banks from lowering their short-term 

deposit rates sufficiently to maintain as favorable 

spreads. Savings institutions have been most affected; 

this group’s average cost of funds, at 4.10 percent on 

December 31, 1998, was significantly higher than the 

3.50 percent reported by commercial banks. Savings 

institutions’ interest margins also may be more vulnerable to rising interest rates. In the past, savings institutions have relied heavily on adjustable rate mortgages 

(ARMs) to help manage interest rate risk and maintain 

spreads. With fixed rates so low, however, ARMs have 

TABLE 1 

been losing their popularity among borrowers. ARMs 

accounted for only 15 percent of mortgage originations 

in 1998, down from 22 percent in 1997 (and 39 percent 

in 1994, the peak in this decade).10 In addition, many 

ARM borrowers have been refinancing into fixed-rate 

mortgages in the past two years, further dropping their 

prominence in loan portfolios. This situation is likely to 

exacerbate earnings pressure on savings institutions 

when the current low-interest-rate environment changes. 

Because of the nature of their business, consumeroriented savings institutions lack the cushion of having 

noninterest income as a significant revenue source. Savings banks in the Region have an average ratio of noninterest income to earning assets of 1.26 percent, 

compared with the commercial banks’ average ratio of 

2.59 percent. With fewer opportunities to raise revenue 

through fee income, savings banks’ net income levels 

are squeezed more than those of commercial banks 

when interest margins tighten. 

The Region’s savings institutions also reported higher 

aggregate delinquency rates throughout the 1990s. For 

the Region’s savings banks, the aggregate ratio of noncurrent loans to total loans was 2.1 percent as of 

December 31, 1998, compared with 0.75 percent for the 

rest of the nation (see Table 1). Although the reasons for 

this discrepancy are not precisely known, differences 

in usury and foreclosure laws could be partly responsible. Anecdotal evidence suggests, for example, that 

10 Federal Home Loan Mortgage Corporation. 

The Region’s Savings Banks Have Higher Levels of Noncurrent Loans, 

but Not Charge-Offs 

NONCURRENT LOANS/ CHARGE-OFFS/ 

STATE TOTAL LOANS (%) RANKING* TOTAL LOANS (%) RANKING* 

DELAWARE 2.04 4 0.27 7 

MARYLAND 2.51 2 0.14 22 

NEW JERSEY 4.40 1 0.20 12 

NEW YORK 1.11 10 0.17 18 

PENNSYLVANIA 0.78 26 0.19 14 

WASHINGTON, D.C. 1.75 6 0.02 45 

REGION 2.10 1 0.17 4 

REST OF NATION** 0.75 NA 0.19 NA 

Data as of December 31, 1998. Puerto Rico has no savings banks. 

* Rankings: 1 = highest or worst ratio out of the 50 states. 

** These figures exclude the New York Region. 

Source: Bank and Thrift Call Reports 

New York Regional Outlook 19 Second Quarter 1999 
Regional Perspectives
 

foreclosure proceedings in New Jersey are comparatively lengthy. This skews the state’s noncurrent loan 

ratio, as past-due loans being foreclosed would remain 

on balance sheets for an extended period. Bankruptcy 

levels also may affect noncurrent ratios, just as they 

have a correlation to credit card charge-offs. As of 1998, 

Maryland and Delaware are ranked 1 and 2 in noncurrent loans in the nation and have per capita bankruptcy 

ratios of 6.67 and 5.37, well above the 5.18 figure 

reported for the nation. 

Although charge-offs for the Region’s savings institutions are comparable to national levels, the higher noncurrent loan ratios suggest some elevated risk. The level 

of charge-offs has been low because most of the noncurrent loans are secured by real estate, which institutions 

use as collateral support to minimize losses in the event 

of loan default. This works as long as real estate prices 

remain stable or rise and there is sufficient equity available to secure the loan. Collateral margins are getting 

thinner, however, with the rising trend of low-down-payment mortgages (mortgages with 5 or 10 percent down 

payments) and the increasing popularity of high loan-tovalue (LTV) home equity loans. Therefore, savings institutions may be becoming more susceptible to a real 

estate slump or a slowdown in the Region’s economy. 

Consumer Behavior and Lending Trends
 

Measures of Consumer Debt 

Suggest a Mixed Picture 

A recent analysis by the St. Louis Federal Reserve 

Bank11 found that the nation’s consumers were accumulating debt at a faster pace than their incomes were rising. In 1998, personal income grew 5 percent, 

compared with an 8.8 percent increase in the level of 

household debt. One explanation for the rising debt-toincome level is that households may be borrowing for 

consumption based on accumulated wealth rather than current 

income. The nation’s net worth 

has been rising because of 

increasing household accumulation of corporate equities and 

mutual funds during the historic 

rise in the stock market. This is particularly true in this 

Region, where residents hold 25 percent of equity 

mutual fund assets.12 To illustrate, national debt levels, 

as measured against household net worth, have been 

declining over the past several years as net worth has 

grown faster (see Charts 3 and 4). The proliferation of 

pension funds and 401(k) plans has made household 

balance sheets stronger, which may give consumers 

more confidence to borrow. 

11 “Monetary Trends: Is Household Debt Too High?” Federal Reserve
 

Bank of St. Louis, December 1998.
 

12 “1995 Mutual Fund Facts,” Investment Company Institute.
 

On the other hand, trends in the nation’s debt service 

burden13 seem to have leveled off in the past two years 

after rising sharply from 1994 to 1996. Lower interest 

rates, as well as tightened underwriting standards by 

lenders and higher personal income levels, may be contributing to the stabilization. Debt burdens also may be 

easing because mortgage-related debt is increasingly 

being substituted for credit card and other forms of consumer debt. Mortgages are the fastest growing category 

of consumer debt. In 1998, mortgage debt rose 9.9 percent, while other categories grew 5.5 percent. Mortgage 

debt, whether through first-lien mortgages or home 

equity lines, typically involves lower interest rates and 

longer repayment terms than consumer installment debt 

and credit card lines. Consequently, annual principal 

and interest payments would be lower relative to disposable personal income, even though the amount of 

consumer household liabilities to disposable personal 

income continued to rise in 1998. This ratio has risen 

steadily from 85 percent in 1992 to 99 percent in 1997 

(see Chart 5). 

Debt burden measures, however, do not capture all 

forms of consumer debt payments. Lease obligations 

are excluded from the calculation. In recent years, the 

number of automobile leases has risen dramatically, and 

13 Debt service burden is the total interest and principal payments on 

all consumer and mortgage debt in the household sector compared 

with disposable personal income. Debt service burden levels for 1998 

are assumed to have leveled off in the “Monetary Trends” article cited 

in footnote 11, although the Federal Reserve Board stopped officially calculating this ratio in 1997. 

New York Regional Outlook 20 Second Quarter 1999 
Regional Perspectives
 

CHART 3 CHART 4 

Consumer Debt Is Declining as a
 

Percentage of Net Worth...
 

Debt to Household Net Worth (%) 

17.0 

16.5 

16.0 

15.5 

15.0 

14.5 

14.0 

’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 

Source: Federal Reserve Board. Debt includes mortgages and consumer loans. 

they now account for about 25 percent of personal new 

car transactions, compared with 10 percent in 1991.14 

Current total household debt obligations, if adjusted to 

include contractual lease payments, may actually 

exceed previous highs. 

One trend that supports the concerns raised by high debt 

burdens and growing consumer debt levels is the continued increase in personal bankruptcy filings. Bankruptcies have increased as the level of debt to income 

has climbed in the last few years (see Chart 5). Nationally, personal bankruptcy filings in 1998 totaled a 

record 1.4 million, and filings in the fourth quarter of 

1998 were the highest ever recorded in a fourth quarter. 

Nonetheless, bankruptcies grew by only 3.6 percent in 

1998, compared with the much higher 20 percent rise in 

1997. According to Samuel J. Gerdano, executive director of the American Bankruptcy Institute, “This third 

consecutive record year of bankruptcies correlates 

closely with the increase in debt load carried by American families.” 

While changing consumer borrowing patterns have led 

to apparent improvements in households’ ability to service debt, high debt levels are a cause for concern 

among bank regulators. Households are committed to 

an unprecedented level of debt in the future, whether 

expectations of higher income growth materialize or 

not. Rising asset prices may give households the confidence to borrow heavily against future income growth, 

14 “Breaking the Cycle: It Could Finally Be Different This Time for 

the Autos,” Credit Suisse First Boston, January 29, 1999. 

...Because Net Worth Is Growing Faster 

Percent Change 

14.0 

12.0 

10.0 

8.0 

6.0 

4.0 

2.0 

0.0 

Net Worth 

Consumer Debt 

’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 

Source: Federal Reserve Board 

but consumers may not be able to rely on using capital 

gains to repay debt in the future if that income growth 

does not materialize. For example, retirement plans 

increase net worth, but their liquidity is restricted. Consumers may be overextending themselves, and in an 

economic slowdown, borrowers may be less able to pay 

off their debt obligations. (For more information on 

consumer lending trends, please see In Focus, page 8.) 

Credit Card Growth Slows, although 

Unfunded Commitments Surge 

Consumer borrowing behavior is very important to the 

New York Region because of the Region’s concentration 

CHART 5 

Debt Levels Correlate with Bankruptcies 

400 

600 

800 

1,000 

1,200 

1,400 

1,600 

’80 

(in 000’s) 

Source: U.S. Office of Administrative Courts, Federal Reserve Board 

200 

0 

Personal 

Bankruptcies 

(left axis) 

Consumer Debt as a 

Percentage of 

Disposible Income 

(right axis) 

50.0 

60.0 

70.0 

80.0 

90.0 

100.0 

’82 ’84 ’86 ’88 ’90 ’92 ’94 ’96 ’98 

(%) 

New York Regional Outlook 21 Second Quarter 1999 
Regional Perspectives
 

of credit card banks.15 Credit card loans in the Region 

totaled $97 billion on December 31, 1998, which represents 40 percent of the $242 billion in total credit card 

receivables outstanding in the nation. The Region’s 14 

credit card banks hold 75 percent of its credit card loans. 

The growth rate of the Region’s credit card banks recently has slowed; managed receivables16 actually declined by 

2 percent in 1998, compared with a 21 percent increase 

in 1997, although this decline may be partly because of 

asset sales. Nationally, total managed receivables 

increased by 16 percent in 1998.17 The record-high consumer debt levels and refinancings to lower-rate, taxdeductible home mortgages and home equity loans are 

dampening credit card receivable growth. 

Although the rate of increase of card receivables 

declined in 1998, unfunded commitments on credit 

cards surged 24 percent. Although this may suggest that 

consumers are using credit prudently, sizable credit 

lines suggest that banks are aggressively courting consumers, which may haunt lenders should the economy 

weaken. For all banks in the nation, unused credit lines 

topped $2 trillion at year-end 1998, which means that 

consumers are only using 20 percent of their available 

credit card lines. The Region’s banks have a similar percentage of unfunded commitments, which grew 25 percent in 1998. With $216 billion in managed receivables 

and $927 billion in unfunded commitments, their customers are using about 19 percent of their available 

credit. Institutions that do not monitor card usage closely could be more vulnerable to credit quality problems, 

because cardholders could draw down unused lines 

when they face financial distress. Although banks can 

reduce card lines voluntarily, knowing when to do so is 

difficult; warning signs may not be readily apparent, 

and trouble may be noticed only after cardholders have 

run up their balances. 

Intense Competition Leads to Consolidation 

among Credit Card Issuers 

Fierce competition within the credit card industry has 

led to consolidation in the form of mergers as well 

as portfolio acquisitions. The economies of scale and 

marketing muscle of the largest card issuers are increasingly seen as necessities for success, leading several 

15 Credit card banks are defined as banks with total loans equal to at 

least 50 percent of total assets and credit card loans of at least 50 percent of total loans. 

16 Managed receivables include on-balance-sheet credit card loans and 

securitized credit card loans. On-balance-sheet credit card loans in 

the Region were up about 5 percent from a year earlier, although 

nationally growth was flat. 

17 Based on Reports of Condition and Income for December 31, 1998. 

middle-tier players to leave the business altogether. 

According to R.K. Hammer Investment Bankers, a 

record $32 billion of receivables changed hands in 

1998, compared with $11 billion in 1997 and $7 billion 

in 1996. In this Region, middle-tier players such as 

Chevy Chase Bank, PNC Bank, and Mellon Bank sold 

their portfolios last year, saying that they cannot be 

profitably competitive in such a scale-driven business 

line. At the same time, MBNA Bank and Chase Manhattan, among others, expanded their presence by purchasing portfolios. 

The advantages of specialization in 

this highly competitive sector can 

be illustrated in the performance of 

credit card banks. The Region’s 

credit card banks reported an aggregate ROA of 3.66 percent for the 

year ended 1998, compared with 0.94 percent for the 

Region as a whole. This is the highest ROA the credit 

card banks have reported in more than three years, 

despite a NIM that has not changed much over time. The 

improvement in ROA stems from a significant increase 

in noninterest income as a percentage of earnings assets, 

which rose to 17.47 percent as of December 31, 1998, 

from 9.35 percent three years ago. By comparison, noninterest income to earning assets averaged 3.24 percent 

for the rest of the Region’s institutions. Credit card banks 

have been very aggressive in finding ways to increase 

fee income in order to offset the effects of various competitive pressures (such as teaser rates) on margins. 

Credit card banks’ high ROA comes despite charge-offs 

that have exceeded the peak levels seen during the last 

recession. While charge-offs in 1998 fell to 4.84 percent 

of total loans, almost 80 basis points lower than in 1997, 

past-due levels increased. In 1998, past-dues on credit 

card loans were 5.09 percent, slightly higher than a year 

earlier. High delinquencies suggest that charge-offs may 

not drop significantly in the coming quarters, as lowerquality loans migrate through the payment cycle. 

‘125’ Home Equity Loans Increase in Popularity 

In recent years, home equity loans have expanded beyond 

the traditional market to a hybrid product now commonly known as high LTV loans or “125s.” These loans are 

typically second liens wherein the combined LTV ratio is 

125 percent or more. They usually are offered to borrowers of high credit quality because collateral protection is 

limited; however, this is not always the case. (See “High 

Loan-to-Value Lending:A New Frontier in Home Equity Lending,” in Regional Outlook, First Quarter 1999, 

for more details on these loans.) 

New York Regional Outlook 22 Second Quarter 1999 
Regional Perspectives
 

More and more consumers are using home equity loans 

for debt consolidation. A survey by the Consumer 

Bankers Association found that 40 percent of borrowers used their home equity loans for debt consolidation 

in 1997. Americans borrowed $183 billion in home 

equity loans and lines of credit in 1986, roughly onethird of all consumer borrowing excluding mortgages, 

according to the Federal Reserve Board. By 1997, that 

figure had jumped to $697 billion, or more than half of 

all consumer borrowing (excluding mortgages). Much 

of that growth can be attributed to lower mortgage interest rates and the relaxation of collateral requirements in 

the past decade, plus banks’ aggressive marketing of 

such products. But many people who use home equity 

loans to consolidate debt may not be able to control 

their spending. According to a 1998 study by Brittain 

Associates, 4.2 million American homes converted $26 

billion of credit card debt into home equity debt from 

1996 to 1998. Two-thirds of those surveyed charged 

their credit cards back up again in less than a year. 

While this market segment has been served predominantly by nonbank lenders, some banks and thrifts in the 

Region have entered the high LTV market. The growth 

of 125s poses several risks to insured institutions. While 

there are limited data on the performance of high LTV 

loans, the loss potential is starting to become visible. 

Vintage analysis18 shows that charge-off rates on high 

LTV loans are increasing at a rapid rate. Both the severity and frequency of default are much higher than for 

traditional “A”-quality home equity loans and are even 

higher than subprime home equity loans (loans to borrowers of weaker credit quality but with full collateral 

protection). These statistics raise questions regarding 

the actual credit quality of the borrowers and suggest 

that high LTV loans may result in increased risk of loss 

because of the lack of collateral protection. A recent 

Office of the Comptroller of the Currency survey19 suggested that underwriting standards on home equity 

loans were easing. Further, because these loans have 

been in existence for only a few years, they have not 

been tested in a recession, and loss rates in an economic downturn are uncertain. Moody’s Investor Service 

has suggested that loss rates should track unsecured 

consumer loans, such as credit cards, which are very 

susceptible to downturns in the economy. 

18 Vintage analysis involves analyzing portfolios of loans made at different times by using the length of time the loans have been outstanding (seasoning) as a benchmark for comparison. 

19 “1998 Survey of Credit Underwriting Practices,” Office of the 

Comptroller of the Currency, 1998. 

Subprime Lending Also Increases 

Just as high LTV lending is growing because of industry 

competition and consumer demand, a subprime market 

has emerged to cater to borrowers with less-than-stellar 

credit. “Subprime” refers to a borrower’s characteristics, 

not a specific type of loan. Subprime borrowers usually 

have high debt-to-income levels, blemished credit histories, little or no equity in their homes, or a combination 

of these factors. The most common forms of subprime 

loans are mortgages, credit cards, debt consolidation 

loans (home equity loans), or automobile loans. While 

there is no centralized reporting of subprime lending, 

growth in the various sectors is rapid. Inside Mortgage 

Finance estimates that originations of subprime mortgages, for example, amounted to $150 billion in 1998, 

up from $125 billion in 1997. 

As with high LTV borrowers, subprime borrowers have 

been served predominantly by nonbank lenders; however, some banks and thrifts in the Region have entered 

the subprime market, across various loan types. Subprime lending poses several risks to insured institutions. 

First, and perhaps most apparent, is the increased credit risk associated with lending to borrowers of weaker 

credit quality. Some lenders attempt to compensate for 

this risk by charging higher interest rates and more fees. 

Nonetheless, the success of risk-based pricing varies 

among institutions, and many pricing models have not 

been tested in an economic downturn. This may be 

especially relevant to the subprime credit card lenders, 

who have lower-quality borrowers and little or no collateral. Second is the intense competition in the market, 

which may lead to price competition and looser underwriting standards. Already, underwriting guidelines in 

the subprime market can differ substantially across 

originators, and seemingly minor differences can have a 

significant effect on the credit quality of the loans. For 

bank management and regulators, understanding the 

effect of subtle differences in underwriting standards, 

evaluating the management and control of exceptions to 

written guidelines, and gauging the effect of the changing competitive landscape are all critical to the understanding and evaluation of risk in the subprime market.20 

The New York Region Staff 

20 For more information, please refer to Financial Institution Letter 

20-99, “Interagency Guidance on Subprime Lending,” FFIEC, March 

4, 1999. Also see OCC supplemental letter on subprime lending risk 

issues, dated April 5, 1999. 

New York Regional Outlook 23 Second Quarter 1999 
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