Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION THIRD QUARTER 1997 

FDIC
 

New York
 

Region
 

Division of
 

Insurance
 

Suzannah L. Susser,
 

Senior Regional
 

Analyst
 

Norman Gertner,
 

Regional Economist
 

Karen A. Denu,
 

Financial Analyst
 

In Focus This Quarter 

◆ Subprime Lending: A Time for Caution—The extent of subprime lending is increasing as strong competition for high-quality borrowers has 

some lenders moving down the credit quality spectrum. Subprime lending requires 

a commitment of resources and expertise beyond that required in more conservative lending, and the consequences of deficiencies in underwriting, servicing, and 

collection can be severe. See page 3. 

By Kathy R. Kalser, Debra L. Novak 

◆ Retail Shakeout: Causes and Implications for Lenders— 

Despite favorable economic conditions, the retail industry is experiencing slow revenue growth in a highly competitive environment. The confluence of rapid change 

in store formats and slow revenue growth has led to an ongoing shakeout among 

both large and small retail chains, and this shakeout may adversely affect credit 

quality at some insured institutions. See page 6. 

By Richard A. Brown, Diane Ellis 

Regular Features 

◆ Regional Economy—The New York Region adds jobs at an accelerating rate . . . office vacancy rates are on the decline as demand increases . . . consolidation in the health care industry poses risks and uncertainties for the Region’s 

labor market. See page 10. 

By Norman Gertner 

◆ Financial Markets—Securitization of home equity loans is growing 

rapidly . . . consumer debt consolidation loans may be driving this growth . . . signs 

of relaxed underwriting have appeared . . . the arrival of FASITs could increase the 

appetite of community banks to enter the ABS market. See page 14. 

By Allen Puwalski 

◆ Regional Banking—Loan losses at the Region’s credit card banks continue to increase . . . banks may be tightening underwriting standards in response . . . 

competition drives residential loan-to-value ratios higher, increasing risks to lenders. 

See page 18. 

By Karen A. Denu, Suzannah L. Susser 

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, 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. For 

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

Outlook, please call Suzannah Susser at (212) 704-1482 or send an e-mail to ssusser@fdic.gov. 

The views expressed in the Regional Outlook are those of the authors and do not necessarily reflect 

official positions of the Federal Deposit Insurance Corporation. Some of the information used in 

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

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

the Federal Deposit Insurance Corporation. 

Chairman Andrew C. Hove, Jr. 

Director, Division of Insurance Arthur J. Murton 

Editor George E. French 

Managing Editor Stephen Linehan 

Associate Editor Maureen E. Sweeney 

Assistant Editors Paul C. Bishop 

Richard A. Brown 

Steven K. Burton 

Diane Ellis 

Kathy R. Kalser 

Ronald L. Spieker 

Publications Manager Teresa J. Franks 
In Focus This Quarter
 

Subprime Lending: A Time for Caution
 

•	 Subprime lenders specialize in lending to borrowers with blemished or limited credit histories. 

•	 The consequences of deficiencies in underwriting, 

servicing, and collection can be severe with subprime lending. Lenders that fail to dedicate the 

necessary resources in these areas likely will have 

trouble succeeding in the increasingly competitive 

market for subprime loans. 

•	 Some institutions insured by the FDIC have failed 

to properly assess and control the risks associated 

with their subprime lending programs. 

What Are Subprime Loans? 

Faced with strong competition and shrinking margins 

on loans to high-quality borrowers, some lenders are 

moving down the credit quality spectrum. The strategy 

to extend loans to borrowers perceived as less creditworthy is referred to as “subprime” lending. Subprime 

lending is most commonly associated with auto, home 

equity, mortgage, and secured credit card loans to borrowers who have blemished or limited credit histories. 

Generally, the characteristics of a subprime borrower 

include a history of paying debts late, personal bankruptcy filings, or an insufficient credit record. 

Subprime loans also are referred to as marginal, nonprime, or below “A” quality loans. There are no established guidelines for determining the degree to which a 

borrower is considered subprime, so one lender’s “B” 

customer could be another lender’s “C” customer. 

Definitional variations aside, some general market 

parameters on ranking loans are presented in Table 1. 

TABLE 1 

Criteria for Loan Rankings 

GRADE PAYMENTS LATE BANKRUPTCY 

30 DAYS FILING
 

PRIME
 NONE NONE
 

A­ LESS THAN 2 NONE IN 5 YEARS 

B LESS THAN 4 NONE IN 3 YEARS 

LESS THAN 6 NONE IN 2 YEARS 

D CONSTANTLY LATE NONE IN 1 YEAR 

Sources: Duff & Phelps, Standard & Poor’s, Mortgage 

Market Information Services 

How Big Is the Market? 

The lack of a standard definition for a subprime loan 

makes it difficult to accurately determine the extent of 

the market. However, some industry experts estimated 

that during 1996, subprime loans secured by residences, 

including both home equity and mortgage loans, 

amounted to between $100 billion and $150 billion compared to the estimated $800 billion in originations of 

conventional mortgages. Subprime auto loans have been 

estimated to range between $75 billion and $100 billion, 

or about 20 percent of total auto loans outstanding. 

Who Makes Subprime Loans? 

In the past, subprime lending was primarily the domain 

of a limited number of finance companies. These firms 

specialized in making high-priced loans to borrowers 

with limited access to credit. 

The number of subprime lenders, however, has surged 

in recent years as more companies have been attracted 

by the significantly higher rates and fees earned on subprime loans. In some cases, yields on these higher risk 

assets have been as high as 15 percent to 30 percent. 

The new subprime participants include finance companies that traditionally served prime borrowers, new specialized subprime lenders, and banks. 

The increase in the number of subprime lenders has 

been fueled by strong demand from investors for assetbacked securities (ABS). This method of funding 

enables the lender to effectively raise cash at a lower 

rate to fund loan growth. In addition, the subprime ABS 

market has attracted lenders that previously refrained 

from making subprime loans because they did not want 

to maintain these high-risk loans or the associated 

reserves on their balance sheet. By issuing securities 

backed by subprime loans, lenders now have the ability 

to originate subprime loans and sell them to ABS 

investors. 

Favorable stock market conditions also helped to fund 

the growth of subprime lenders. Approximately 30 subprime lenders raised nearly $3 billion from stock offerings from January 1995 through April 1997, according 

to market watchers. This financing avenue may become 

less accessible, as investors’ concerns over financial 

Regional Outlook	 3 Third Quarter 1997 

C 
In Focus This Quarter
 

problems of several major market participants have 

caused stock prices of subprime lenders to decline significantly during the first part of 1997. 

Financial Difficulties of Some Subprime 

Lenders 

Market participants have observed that, as in credit card 

lending, increasing competition may be compelling some 

subprime lenders to compromise underwriting standards 

and lower pricing in order 

to protect market share. Financial 

difficulties reported by major subprime auto lenders Jayhawk 

Acceptance Corporation and 

Mercury Finance Company highlight these concerns. 

Problems in subprime lending are not limited to auto 

loans. Lenders that specialize in subprime home equity 

loans and mortgages also are showing signs of stress. In 

April 1997, Moody’s Investors Service lowered the rating on subordinated debt issued by a leading originator 

of subprime mortgage and home equity loans. The reason was concern over the increasing level of delinquencies in the issuer’s loan portfolio and the highly 

competitive environment for subprime home equity 

loans (see Financial Markets). 

Differences between Prime and Subprime 

Lending 

There are key differences between the underwriting, servicing, and collection methods used for prime and subprime lending programs. The goal of the subprime 

underwriting process is to differentiate those subprime 

borrowers whose past credit problems were due to such 

temporary events as illness or job loss from the habitually bad credits. Subprime lenders often supplement a 

prospective borrower’s credit bureau report with such 

additional information as income, employment history, 

and the nature of prior credit problems. This process 

allows the lender to better determine the credit risk or 

“grade” of the borrower. If this determination is successful, the lender can better establish the price at which 

the loan will be profitable. 

Servicing and collection of subprime loans tends to be 

more labor intensive and costly than in prime lending. 

Subprime lenders tend to monitor payments more closely than prime lenders. Some purportedly call their borrowers regularly to remind them when a payment is due. 

In addition, while prime lenders may be willing to work 

with late borrowers by adjusting minimum amounts or 

payment schedules, subprime lenders generally pursue 

collections more aggressively and repossess collateral 

more quickly. 

Insured Institutions and the Subprime Market 

Bank involvement in subprime lending is difficult to 

quantify because subprime loans are not delineated in 

bank and thrift Call Reports. However, both large and 

small banks reportedly are participating in credit card, 

auto, home equity, and mortgage subprime lending. 

Insured institutions have used various strategies to 

establish a presence in the subprime market. Some 

have: 

•	 acquired or formed joint ventures with companies 

specializing in subprime lending; 

•	 built subprime lending programs internally, using 

existing resources; and 

•	 tapped a network of loan brokers with access to subprime borrowers. Smaller banks entering the market 

for subprime mortgages may use this method more 

commonly. 

Through these strategies, insured institutions have: 

•	 extended loans directly to subprime borrowers or 

purchased subprime loans from loan brokers; 

•	 lent to subprime specialty lenders in the form of loan 

participations, warehouse lines, liquidity facilities, 

or dealer lines; and 

•	 serviced subprime loans or invested in asset-backed 

securities secured by subprime loans. 

Risks Associated with Subprime Lending Need 

to Be Considered Carefully 

According to a Financial Institutions Letter (FIL), FIL 

44-97 issued by the FDIC’s Division of Supervision, 

recent examinations revealed that a number of financial 

institutions involved in subprime lending have failed to 

properly assess and control the risks associated with 

subprime lending. Because of the relatively high default 

rates on such loans, the FIL indicates that this type of 

Regional Outlook	 4 Third Quarter 1997 
In Focus This Quarter
 

lending warrants particular caution and management 

attention. 

Institutions need to be thoroughly aware of the 

increased risks and costs associated with lending to 

higher risk borrowers. Some of these risks include: 

•	 Delinquencies and defaults tend to be more frequent 

and occur sooner on lower quality loans (see Chart 1). 

•	 Loan loss reserves that would have been adequate for 

prime lending may not properly cover higher loss 

rates associated with subprime loans. 

•	 Strains on underwriting and collection resources 

may emerge. 

•	 Because selling collateral is more frequently the 

source of repayment on subprime loans, failure to 

accurately estimate recovery values could severely 

affect the profitability of subprime lenders. For 

example, several subprime auto lenders recently 

reported lower profits when the supply of better 

quality cars coming off leases depressed the prices 

they received on repossessed cars. 

Insured institutions that rapidly increase subprime 

exposures also may need to reevaluate delinquency 

measurement methodologies. Rapid loan growth can 

make it more difficult to accurately track delinquency 

and default trends. Generally loans do not default 

CHART 1 

0% 

10% 

20% 

30% 

40% 

50% 

1 4 7 10 13 16 19 22 25 28 31 34 

Months since Origination 

"C" Auto Loans 

"A/B" Auto Loans 

"D" Auto Loans 

Source: Fitch Investors Service, L.P. 

Default Rate 

Defaults Are More Frequent and Occur 

Sooner on Lower Quality Auto Loans 

immediately, but “season” or reach peak loss rates over 

a period of time. Delinquency and default rates can be 

deceptively low if the proportion of new loans exceeds 

the proportion of seasoned loans in a lender’s portfolio. 

Calculating default rates over time for loans originated 

in a particular period or lending program, instead of as 

a percentage of total outstanding loan balances, helps 

reduce the distortion caused by rapid loan growth. This 

method of computing delinquency and default rates, 

known as “static pool” or “vintage analysis,” is a common measurement tool among investment analysts. 

Banks involved in subprime lending also should realize 

that the recent increase in subprime lending has 

occurred during relatively healthy economic conditions. 

The repayment capacity of subprime borrowers may be 

more susceptible to downturns in the economy, which 

could further exacerbate the already high level of delinquencies and defaults typically recorded on subprime 

loans. 

In addition, banks that lend to subprime specialty 

lenders, who rely heavily on securitization, should evaluate the accounting treatment of securitization and the 

effect securitization may have on earnings (see 

Financial Markets). 

Conclusion 

The extent of involvement by insured institutions in 

subprime lending is difficult to quantify. To be successful in subprime lending requires a commitment of 

resources and expertise. Conversely, deficiencies in 

assessing and controlling the risks of subprime lending 

can have serious consequences. Such deficiencies have 

surfaced at a number of FDIC-insured institutions. 

Striking an appropriate balance between the risks and 

rewards of subprime lending is a challenge for bankers 

and merits the continued attention of bank supervisors. 

Kathy R. Kalser, Chief 

Financial Sector Analysis Section 

Debra L. Novak, 

Division of Resolutions and Receiverships 

Regional Outlook	 5 Third Quarter 1997 
In Focus This Quarter
 

Retail Shakeout: Causes and Implications for Lenders
 

•	 Changes in the marketplace, technology, and 

finance are transforming retailing. 

•	 These trends have given rise to rapid growth in 

the new “big box” store format. 

•	 Consolidation in retailing is evident in mergers, 

acquisitions, and bankruptcies. 

•	 The potential for overbuilding in retail real estate 

markets may pose a risk for insured depository 

institutions. 

For the past two decades, construction of retail space 

has outstripped many indicators of demand such as 

growth in retail sales, population, and income. The 

broadest measure of the industry’s health is sales per 

square foot, and, for shopping centers, it has fallen by 

around 35 percent in real terms since 1972. Chart 1 

shows how growth in leasable shopping center space 

has exceeded growth in shopping centers’ sales since 

1972. 

Based on signs of “overstoring,” a number of retail 

industry analysts have concluded that too many stores 

are chasing too few consumer dollars, indicating an 

emerging shakeout in the retail sector. To the extent that 

insured depository institutions provide financing to 

retailers or for retail real estate, they are exposed to 

heightened credit risk as the shakeout unfolds. 

New Forces Are Reshaping the Retail Landscape 

A combination of demographic and economic forces 

has reduced growth in demand for retail goods from the 

boom days of the 1970s and mid-1980s. Meanwhile, 

technology is reconfiguring the way retail goods are 

marketed and delivered, and a low cost of capital has 

stimulated investment in new retail space and new 

retailing concepts. 

A retail industry boom began roughly in 1970 when 

baby boomers and women began entering the work 

force in record numbers. At the same time, proliferation 

in general-purpose credit cards facilitated an extension 

in consumer borrowing power. As a result, there was a 

CHART 1 

100 

150 

200 

250 

300 

350 

’72 ’76 ’80 ’84 ’87 ’89 ’91 ’93 ’95 

Leasable 

Space* 

Inflation-adjusted 

Sales * 

* Does not include non-shopping center space. 

Source: International Council of Shopping Centers 

1972=100 

Construction of Shopping Center Space Has 

Outstripped Sales Growth 

98 percent increase in inflation-adjusted retail sales 

from 1967 to 1994. 

To meet this demand and serve expanding suburban 

communities, developers built shopping centers at a 

rapid pace. The number of shopping centers, from small 

neighborhood strip centers to huge regional malls, grew 

from about 13,000 in 1972 to over 41,000 in 1995. 

Despite economic conditions that seem favorable for 

the retail sector, revenue growth has been painfully 

slow in the 1990s. Payrolls have seen net growth of 13.4 

million jobs since mid-1991, while real disposable personal incomes and consumer confidence have risen 

commensurately. An optimistic household sector has 

shown a willingness to take on debt under these favorable conditions and has done so with the benefit of 

lower interest rates compared to the 1980s. 

Even with generally positive economic conditions, 

retail demand has grown slowly in the 1990s (see Chart 

2, next page). Annual rates of increase in real expenditures on many durable and, especially, nondurable goods 

have lagged behind rates of the previous two decades. 

Slow growth in retail revenues can be explained in part 

by the fact that retail goods overall have risen in price at 

only around two-thirds of the general rate of inflation 

during the 1990s, while the appliance, electronics, and 

personal computer sector has seen actual price deflation. 

Regional Outlook	 6 Third Quarter 1997 
In Focus This Quarter
 

An aging consumer base is another factor holding down 

retail sales growth. The total number of households 

headed by persons age 20 to 35—the age at which families are getting established and acquiring household 

durable goods—is the same now as it was in 1980. The 

lack of growth in this key demographic group has limited growth in retail demand and should continue to do 

so for the foreseeable future. The total population in the 

20 to 35 age bracket is projected to decline slightly by 

2007. 

Other broad trends have contributed to slower retail 

sales growth. Retail sales as a percentage of personal 

income fell from 46 percent to 38 percent between 1967 

to 1996 as consumers shifted more of their disposable 

income to the purchase of personal services, housing, 

education, travel, and entertainment. A Standard and 

Poor’s Industry Survey reports that consumers have 

reduced their number of trips to shopping malls by 35 

percent since 1980, while total shopping hours are down 

70 percent. 

Looking ahead, mail-order retailing through electronic media, 

including cable television and the 

Internet, may be poised to gain 

significant market share at the 

expense of shopping centers. 

“Virtual shopping malls” such as 

Amazon.com, an Internet bookseller, have made headlines with their initial successes, although analysts caution that widespread adoption of high-tech shopping 

may be some years down the road. 

Technology has become a key to distribution and marketing. Faced with slower revenue growth, retailers have 

been investing in technology to cut their expenses and 

boost their bottom lines. For example, point-of-sale 

scanning delivers a vast amount of information that can 

be used to target marketing efforts and manage and control inventories—providing a distinct competitive 

advantage for large retail chains with vast marketing 

and distribution networks. 

A low cost of capital has fueled investment. Low interest rates and a booming stock market have made market 

financing plentiful and cheap. This environment has 

allowed retailers to overhaul retail strategies and invest 

heavily in technology, inventory, and retail space— 

investments that might otherwise have been infeasible. 

Since 1991, around 1.13 billion square feet of new retail 

space has been added nationwide representing an 

increase of about 12 percent to the total stock of retail 

real estate over five years. Net additions to retail inventories since 1991 have totaled almost $33 billion in 

inflation-adjusted dollars, an increase of over 18 percent. No figures are available on investments made in 

information systems, although they are known to be 

sizeable. 

Growth of the “Big Box” Format 

Leading retailers have responded to these forces with 

aggressive expansion in the “big box” store format. Big 

box retailers are typically discount stores and superstores, such as Circuit City, PetSmart, and The Home 

Depot, Inc., which tend to cluster in large strip malls 

called “power centers.” In many towns and cities, the 

arrival of big box stores has left smaller, local retail 

establishments with only a small fraction of their former 

share of the local market. 

The big box format has a number of advantages. Among 

the most important is the ability to offer a large, diverse 

on-shelf selection. This approach enables a single location to dominate that retail category in the local market, 

which is why the big box chains are often referred to as 

“category killers.” Large retail chains also have more 

leverage over suppliers. They can negotiate more favorable prices and demand cooperative advertising from 

manufacturers. Large retailers typically have the financial resources to invest in the latest distribution methods 

and technology. Finally, unlike smaller traditional retailers, these large chains can obtain financing through the 

capital markets. 

CHART 2 

Inflation-Adjusted Retail Sales Have Grown 

Slowly in the 1990s 

Real Growth in Retail Sales*, 

Compound Annual Rate 

3.0% 

2.5% 

2.0% 

1.5% 

1.0% 

0.5% 

0.0% 

1970s 1980s 1990s 

* Retail sales excluding autos, deflated by the consumer price index. 

Source: Bureau of the Census and Bureau of Labor Statistics 

Regional Outlook 7 Third Quarter 1997 
In Focus This Quarter
 

Industry Consolidation to Continue 

Rapid expansion among the large retail chains has contributed to a highly competitive retail sector marked by 

intense battles for domination of the major retail categories. The result of this competition, analysts say, will 

be consolidation in the industry as weaker chains give 

way to market leaders. 

One sign of this consolidation is in multibillion dollar 

acquisitions, such as Federated Department Stores’ 

acquisition of R.H. Macy. The five largest department 

store chains (JC Penney, Federated, May, Dillard, and 

Nordstrom) now account for 87 percent of department 

store sales nationwide. The top three discount department store chains (Wal-Mart, K-Mart, and Target) 

account for 87 percent of full-line discount department 

store sales. 

Intensely competitive conditions also are reflected by 

retail bankruptcies and restructurings. Both Woolworth 

Corp. and K-Mart Corp. recently closed a number of 

stores in restructurings that reflect the loss of market 

share to Wal-Mart. Smaller companies that have fewer 

restructuring options are more likely to be forced into 

bankruptcy. Dun & Bradstreet reports that domestic 

business failures among retail establishments rose in 

1995 by 2.8 percent to 12,952. While most of these failures were individual stores and small chains, a number 

of larger chains also filed for bankruptcy during 1995, 

including Barney’s, Bradlees Inc., Caldor, The 

Clothestime Inc., Edison Brothers Stores, ElderBeerman, Herman’s Sporting Goods, Jamesway, and 

Today’s Man. 

As the retail shakeout moves forward, any credit losses 

on commercial and industrial loans to retailers are more 

likely to arise from bankruptcies and restructurings than 

from mergers and acquisitions. Unfortunately, it is difficult to say in advance exactly how consolidation in the 

industry is likely to take place. 

Overbuilding Is a Risk for Retail Real Estate 

Retail industry analysts are particularly concerned 

about the potential for overbuilding of retail space. 

Because of this concern, lenders and examiners should 

be alert to possible credit quality problems with commercial real estate loans secured by retail properties. 

CHART 3 

0 

20 

40 

60 

80 

100 

120 

140 

160 

’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 

0% 

2% 

4% 

6% 

8% 

10% 

12% 

New Supply Has Recently Outpaced 

Absorption of Retail Space 

Source: FDIC, The Real Estate Report (Summary for 58 major markets) 

Vacancy 

Rate 

Net New Supply Absorption 

Millions of 

Square Feet 

Although a vacancy rate of 7.7 percent does not suggest 

that the U.S. retail market is vastly overbuilt at present, 

there are warning signs. One is that the U.S. aggregate 

vacancy rate has begun to tick upward since 1995 as net 

completions of new retail space have caught up to and 

surpassed the absorption of that space by retailers (see 

Chart 3). Another frequently cited indicator of overbuilding is a falling ratio of sales per square foot in the 

industry, reflecting the fact that additions to retail space 

have outpaced sales growth for some time. In any case, 

local market conditions may be somewhat more volatile 

than the national figures would suggest, particularly in 

areas where a great deal of construction activity has 

recently taken place (see inset, Retail Vacancy Trends 

Reverse in Several New York Region Markets). 

Besides market conditions, underwriting is the other 

major determinant of credit quality in retail real estate 

lending. Market analysts report that many of the problems resulting from local market downturns have been 

on loans with 1980s-vintage underwriting, particularly 

those with high loan-to-value ratios. Analysts also voice 

concern that the rapid expansion of space may be 

putting downward pressure on lease rates. In light of an 

ample supply of space and a number of large chains 

continuing to add space, any valuations that assume 

future growth in lease rates should be closely reviewed. 

The viability of rapid expansion on the part of the large 

retail chains would undergo a particularly severe test in 

the event of a recession. 

Richard A. Brown, Chief, Economic Analysis Section 

Diane Ellis, Senior Financial Analyst 

Regional Outlook 8 Third Quarter 1997 
In Focus This Quarter
 

Retail Vacancy Trends Reverse in
 

Several New York Region Markets
 

Consistent with trends throughout the nation, retail 

vacancy rates in the Region fell between 1993 and 

1995. However, this trend now appears to be reversing (see Table 1). A slight rise in 1996 retail vacancy rates in several markets across the Region 

corresponds to a change in market conditions, as net 

new supply exceeded absorption of retail space for the 

first time since 1991 (see Chart 4). 

The Baltimore and Pittsburgh markets recorded the 

lowest fourth quarter 1996 retail vacancy rates in the 

Region. However, Valuation International, an 

Atlanta-based consortium of appraisers and consultants, estimates that between 1996 and 1999 over 

2 million square feet of new retail space will be constructed in Baltimore and over 3 million square feet of 

new space will be built in Pittsburgh. As a result, 

vacancy rates could rise if retail sales slow. 

Other reports from around the New York Region indicate that certain segments of the retail industry may 

be at risk of excess capacity in the future. One such 

report by New Jersey Business News suggests that 

overcapacity among New Jersey retailers could ultimately lead to instability in the local retail industry 

and even the failure of some large retail outlets. 

Another report by the Albany Times Union indicates 

that retail space in the Albany area has recently been 

increasing by hundreds of thousands of square feet 

per year even while population growth has remained 

TABLE 1 

stagnant and major employers have been cutting back 

their workforces. Four prominent retailers in the 

Albany area have declared bankruptcy in recent 

months. According to a report by the Philadelphia 

Planning Commission, there is currently a record 

high number of dress shops, insurance agencies, coffee bars, and other consumer businesses in the city 

despite the recent decline in the city’s total population. 

The exception to these trends appears to be the New 

York City area. In every year since 1988, the New 

York City area has experienced a net loss of retail 

space. Since that year, the area has lost about 13 million square feet of retail space as a number of large 

department stores went through bankruptcy or downsizing. However, a new proposal by the New York 

City Council designed to rejuvenate the retail industry appears to be gaining support. The proposal is 

modeled after a similar plan put in place in Chicago, 

where large retail districts were established within 

existing manufacturing districts apparently without 

detrimental effects on local businesses. The New 

York City Council plan designates 60 or more sites 

where superstores can be built; however, it would 

allow communities or the council to decide where the 

stores would be located. The city’s administration had 

been pushing vigorously to make it easier for new 

stores to open throughout New York City, which 

would offset the recent losses in the retail business to 

new superstores operating in suburban areas. 

Norman Gertner, Regional Economist 

CHART 4 

Retail Vacancy Rates Have Begun to 

Rise Slightly in the New York Region 

1993 1994 1995 1996 

BALTIMORE MSA* 7.6 5.1 5.4 5.5 

NASSAU-SUFFOLK PMSA* 8.6 8.2 8.4 7.4 

NEW YORK PMSA 14.8 9.9 9.6 9.7 

NEWARK PMSA 5.7 5.5 6.0 6.3 

PHILADELPHIA PMSA 8.2 7.1 6.5 7.4 

PITTSBURGH PMSA 4.3 3.2 3.4 3.2 

WASHINGTON, DC MSA 7.9 7.7 7.2 7.7 

US AVERAGE 9.0 7.6 7.4 7.7 

*MSA = Metropolitan Statistical Area; 

PMSA = Primary Metropolitan Statistical area 

Source: FDIC The Real Estate Report 

-5000 

5000 

10000 

15000 

20000 

25000 

Increased Construction Has Halted 

the Decline in Retail Vacancies 

Vacancy Rate 

(right scale) 

Square 

Feet Net New Supply Absorption 

Source: FDIC Division of Research and Statistics, The Real Estate Report. 

(Summary for the NY Region.) 

0.0 

2.0 

4.0 

6.0 

8.0 

10.0 

12.0 

Percent 

198819891990199119921993199419951996 

0 

Regional Outlook 9 Third Quarter 1997 
Regular Features	 Regional Economy
 

New York Region: Job Growth Is Catching Up 


to the Nation 


•	 The New York Region is adding jobs at an accelerating rate and has significantly closed the gap between the 

Region’s and the nation’s employment growth. 

•	 Office vacancy rates have declined throughout the Region, indicating an increasing demand for office space. 

•	 Consolidation in the health care industry, a major employer in the Region, poses risks and uncertainties for 

the Region’s labor markets. 

The New York Region’s economy began 1997 on a 

strong note with acceleration in job growth during the 

first quarter. Many areas of the Region, including 

Delaware, Maryland, and central Pennsylvania, are 

adding jobs at a faster pace than the national average. 

Still, some cities, including Trenton, Newark, and 

those in upstate New York, lag behind in job creation. 

New Service, Trade, and Construction Jobs 

Drive the Region 

In aggregate, the Region added over 378,000 new jobs 

during the first quarter of 1997. This increase of about 

1.8 percent on an annual basis almost matches the 

national employment growth rate of 2.2 percent. By 

comparison, in 1996, employment growth in the nation 

was more than a full percentage point above that of the 

Region. In 1995, the nation’s growth exceeded the 

Region’s growth by a point and a half. 

During the first quarter of 1997, employment in the 

Region was stimulated mainly by gains in the construction, services, and trade sectors (see Chart 1). 

The service sector represents the largest component of 

the Region’s workforce, accounting for about one-third 

of the total. Growth in high-tech services, tourism, and 

social and educational services is responsible for much 

of the gain in the service sector. Between the first quarter of 1996 and the first quarter of 1997, service 

employment increased by 223,000 jobs. This represents 

an increase of 3.5 percent, one of the sector’s best performances of the decade. Over the same period, trade 

employment increased by 92,000 jobs, an increase of 

2.1 percent. Construction employment jumped about 

55,000 jobs, an increase of 7.9 percent. Much of the 

surge in construction employment can be attributed to 

the mild winter throughout the Region, which boosted 

residential construction activity. The construction sector 

represents only 4 percent of the Region’s total workforce and is subject to cyclical and interest rate swings. 

Nonetheless, its growth is reflective of an increase in 

the Region’s economic growth. 

The Region’s finance, insurance, and real estate (FIRE) 

sector added only 19,000 jobs, an increase of about 1.3 

percent annually. According to the New York State 

Comptroller’s Office, employment growth in the securities industry has been restrained. Securities firms have 

concentrated on controlling costs, investing in laborsaving technology, and building up more profitable 

business areas. In addition, the FIRE sector has been 

hurt by consolidations in the banking and insurance 

industries, which have kept employment growth down. 

Implications: Employment growth in the Region is 

accelerating and catching up to the nation’s pace. More 

jobs and higher incomes generate higher business and 

CHART 1 

Trade 

Transportation 

Construction 

Government 

Source: Bureau of Labor Statistics, First Quarter 1996 - First Quarter 1997 

Construction, Services, and Trade 

Drive Job Growth 

Percent Change in Job Growth 

Manufacturing 

FIRE* 

Services 

-5 0 5 10 

*FIRE - Finance, Insurance, and Real Estate 

Regional Outlook	 10 Third Quarter 1997 
Regular Features Regional Economy
 

consumer confidence and a greater willingness to 

spend and invest. As a result, the environment for 

growth in both commercial and consumer lending portfolios is more favorable. 

State Labor Markets Are Improving 

Favorable economic conditions are evident at the state 

and many metropolitan levels as well. Although it has 

the smallest workforce in the Region, Delaware continues to be the leading state for job growth. In the first 

quarter of 1997, Delaware’s year-over-year employment 

growth was about 4 percent, or 14,000 jobs, its best performance of the decade. The state has benefited from 6.5 

percent growth in business services and 6.3 percent 

growth in the FIRE sector. Employment in Wilmington, 

the state’s largest city and center of employment growth, 

also rose about 4 percent. 

Employment in Pennsylvania during the first quarter of 

1997 rose 2.6 percent, or 137,000 jobs—the state’s best 

quarterly showing of the 1990s. Pennsylvania has benefited from 4 percent growth in service sector employment and 3.1 percent growth in trade employment. 

Business service employment rose 9.8 percent on an 

annual basis, reflecting a large demand for computer 

programmers, systems analysts, and accountants. As a 

result of a mild winter compared to the harsh winter of 

1996–1997, year-over-year construction employment 

rose 11 percent during the first quarter. A 22 percent 

jump in permits for single-family homes suggests continued strength in this sector. 

The central Pennsylvania area is leading the state in job 

growth (see Chart 2). 

Its strength primarily stems from faster growth in the 

service and trade sectors than the rest of the state. In 

particular, the area has benefited from growth in business, social, and educational services. Growth in 

Williamsport has been boosted by a more than 5 percent increase in manufacturing jobs. The area also has 

benefited from a rise in construction activity. First quarter year-over-year construction employment is up over 

11 percent in many parts of central Pennsylvania, fueled 

by a 59 percent rise in permits for single-family homes 

in Harrisburg and a 9 percent rise in Lancaster. 

A recent business roundtable review of central 

Pennsylvania’s economy found strong potential for continued employment and tourist industry growth and predicted a vibrant real estate market. In particular, local 

business leaders expect further economic development 

of research and industrial parks, 

completion of various transportation initiatives, and growth 

in health maintenance organizations to boost the local economy’s growth. By contrast, 

growth in eastern Pennsylvania 

has been more sluggish. That 

part of the state continues to 

lose manufacturing jobs and has not added service sector jobs as fast as the rest of the state. 

Job growth in Maryland also has been led by service 

and construction jobs. Employment rose by 55,000 jobs, 

or 2.6 percent, during the first quarter of 1997 on an 

annual basis. Service sector employment grew 4.3 percent, powered by a 9.5 percent rise in business services. 

An annual outlook conference on the Maryland economy predicted that service employment would account 

for three-fifths of all new jobs created in the next year. 

The forecast, developed by the Regional Economic 

Studies Institute of Towson State University, projected 

that gains in computer-related industries and temporary 

personnel would generate service employment at a 

growing pace. Health services, social services, and 

hotels also were identified as promising areas for additional growth. 

As in the rest of the Region, a mild winter helped construction employment leap by about 11 percent. 

However, the manufacturing, government, and FIRE 

sectors showed little gain. Employment in Baltimore, 

the state’s largest city, grew somewhat more slowly than 

CHART 2 

0 

1 

2 

3 

4 

Pittsburgh Sharon Harrisburg Phila. Scranton 

Central Pennsylvania Leads 

the State in Job Growth 

Central 

Altoona Williamsport Allentown PA 

Source: Bureau of Labor Statistics 

Lancaster 

West 

East 

% Chg. in Employment 

Regional Outlook 11 Third Quarter 1997 
Regular Features Regional Economy
 

the rest of the state and rose by only 1 percent. 

Baltimore’s unemployment rate of 7.8 percent is substantially higher than Maryland’s statewide rate of 4.6 

percent. Baltimore’s labor market has not experienced 

growth in the business service sector as other parts of 

Maryland have. 

Employment growth in New Jersey was just shy of the 

national average; during the first quarter of 1997, it registered 2.2 percent, or 78,000 jobs on an annual basis. 

Job growth continues to be hindered by weakness in 

cities such as Newark and Trenton, which are coping 

with persistent structural unemployment problems. 

Employment gains in these cities ranged from 1 to 1.5 

percent during the first quarter of 1997. 

On the other hand, Atlantic City is showing very strong 

employment performance thanks to the construction of 

several new casinos. Year-over-year employment growth 

in Atlantic City rose 4.4 percent during the first quarter 

of 1997. Planned new construction of $7 billion over the 

next five years should add even more to the employment 

base. Atlantic City, like other major gaming areas in the 

nation, is experiencing rapid growth. The risk is the 

potential for overbuilding, which would ultimately put 

downward pressure on Atlantic City’s economy. 

Job growth in Puerto Rico increased a modest 1.9 percent, or 18,000 jobs, during the first quarter of 1997 on 

an annual basis. The Puerto Rican economy has been 

adding jobs throughout the 1990s, mainly in services 

and trade. Growth in manufacturing jobs, once the dominant sector, has been relatively flat. Puerto Rico’s 

unemployment rate has fallen from over 20 percent in 

the 1980s to about 13 percent in early 1997. 

In New York, the state with the largest labor market in 

the Region, first quarter year-over-year employment 

growth rose only 1.1 percent, 86,000 jobs—the slowest 

growth in the Region. Losses in the manufacturing and 

government sectors combined with limited growth in 

the FIRE sector have held down net job growth. Upstate 

New York has been adding comparatively few new jobs 

(see Regional Outlook, Second Quarter 1997). 

Office Market Is Tightening throughout the 

Region 

Strong employment growth is aiding the Region’s office 

markets. According to the most recent data, office 

vacancy rates continue to decline throughout the New 

York Region. 

Table 1 shows that office vacancy rates for many metropolitan areas have fallen to their lowest levels since 

1991. 

According to reports from around the Region, office 

vacancy rates have continued to decline even more during the first quarter of 1997. Some of those reports forecast further tightening in office space and rental rate 

hikes. According to the Grubb and Ellis 1997 Real 

Estate Forecast Report, a shortage of office space will 

soon lead to rental hikes in the suburban New York City 

markets. The report predicts tightening in the Princeton, 

New Jersey, area and continuing recovery in the 

Westchester, New York, market. According to a recent 

report by the Edward S. Gordon Company, only one 

office building is currently being built in New York 

City, the nation’s largest office market. Edward S. 

Gordon projects renewed development activity in New 

York City in the near future because of the decline in 

vacancy rates and the lack of new construction. 

Implications: Given tightening of office vacancy rates, 

some areas in the Region could be poised for an 

increase in commercial real estate development and 

new office building construction. 

TABLE 1 

Office Vacancy Rates Are 

Dropping throughout the Region 

METRO AREA 1991 1993 1995 1996 

BALTIMORE 19.1 17.2 13.8 11.5 

LONG ISLAND 18.9 14.4 13.8 10.5 

MANHATTAN 16.5 15.1 14.9 11.6 

MID-NJ 20.7 18.6 20.5 14.9 

NORTHERN NJ 22.5 20.8 16.2 12.6 

PHILADELPHIA 16.5 16.6 13.3 13.2 

WASHINGTON, D.C. 14.9 11.3 9.6 8.3 

WESTCHESTER, NY 21.5 22.1 22.4 17.0 

WILMINGTON NA 19.5 13.1 12.8 

UNITED STATES 20.4 17.2 13.4 11.1 

Source: CB Commercial Property Information Systems. Units in 

percent. 

Regional Outlook 12 Third Quarter 1997 
Regular Features Regional Economy
 

Health Care Consolidation Poses Uncertainties 

for the Region and the Nation 

Approximately 20 percent of all health care workers in 

the United States are employed in the New York Region. 

That figure represents 1.9 million employees, or about 

9 percent of the Region’s total workforce, compared to 

8 percent for the nation. Health care employment has 

been growing steadily throughout the 1990s (see Chart 3). 

The health care industry has been undergoing extensive 

restructuring that has resulted in changes in health care 

management, costs, and delivery. A study by the Sachs 

Group, a health research organization in Evanston, 

Illinois, reported that the New York Region could be 

more vulnerable than the nation to the new trends generated by managed care. The penetration of managed 

care into the health care industry over the past few years 

has translated into reductions in fees and hospital use 

rates, constraints on care, and consolidations among 

health care institutions, principally hospitals. 

The report stated that hospitals in Pittsburgh, Boston, 

New York, and Philadelphia could lose the most business as managed care 

becomes more widespread. In 

extreme cases, the report indicated that if there is a shift 

exclusively to managed care, 

the demand for hospital beds 

could drop by 50 percent. In 

Pittsburgh, the study forecasted that demand for beds 

would drop 51 percent if the 

city went exclusively to managed care. Hospitals in the New York Region would be 

hit hardest because they tend to keep patients longer 

than do hospitals in other areas of the country. 

Consolidation in health care delivery may not necessarily reduce overall health care employment. A study by 

the New School for Social Research points out that the 

health care system will indeed move away from hospiCHART 3 

Health Care Employment Has Been Rising 

throughout the Decade 

Millions of Jobs 

2 

1.9 

1.8 

1.7 

1.6 

1.5 

Source: Bureau of Labor Statistics 

1990 1991 1992 1993 1994 1995 1996 

tal-based care to outpatient facilities because of the 

emphasis on cost-effectiveness. 

This move may produce a shift in health care jobs. 

Hospitals may eventually have fewer nurses, but many 

dislocated nurses would find work in growing health 

care areas such as nursing homes and home health care. 

However, some health care workers may leave the 

industry because of the generally reduced pay and benefits offered by outpatient facilities relative to hospitals. 

Demographic changes may mitigate some of the 

changes arising from consolidation in the health care 

industry. Demand for health care services should continue to rise as the large baby boom cohort ages and 

requires more medical care. 

Implications: Ongoing consolidation in the health care 

industry could negatively affect the Region’s economy if 

the consolidation results in large job losses. Changes in 

the health care industry could force economic dislocation on hospitals, health care providers, and health care 

workers. 

Norman Gertner, Regional Economist 

Regional Outlook 13 Third Quarter 1997 
Regular Features	 Financial Markets
 

Financial Markets
 

•	 Deteriorating credit quality trends in the rapidly growing home-equity backed securities market could portend trends in bank residential mortgage lending. 

•	 Financial asset securitization investment trusts, known as FASITs, promise to change the asset-backed securities market significantly and could make securitization more accessible to community banks. 

•	 The Treasury yield curve is steeper and higher than it was at year-end 1996. 

•	 During the first quarter of 1997, the New York Region’s Community Bank Index gained steadily despite disturbance in the broad market and other bank indices. 

Trends in the Home-Equity Asset-Backed 

Market Are Important to Banks 

The home-equity loan (HEL) asset-backed securities 

(ABS) market has grown by over $20 billion or 251 percent since 1993, with total issuance of HEL ABS topping $27 billion in 1996 (see Chart 1). The rapid growth 

of the market, which has been driven largely by consumer debt consolidation lending, has been accompanied by abnormally early and high levels of 

delinquencies. Banks that are investing in HEL ABS, 

considering securitizing HELs, or lending significantly 

for debt consolidation should be aware of credit quality 

developments in the HEL ABS market. 

The distinction between HELs and first-lien residential 

mortgages is eroding in the HEL ABS market. The refinancing boom spurred by the decline in rates during 

1993 and early 1994 resulted in a change in the makeup 

of the HEL ABS market, causing much higher percentages of the securities to be backed by first-lien HELs 

than previously had been the case. First-lien home-equity lending, know as cash-out refinancing, grew substantially when home-equity borrowers were motivated by 

lower rates to refinance their first mortgages for 

amounts greater than the remaining principal balance 

instead of adding a second mortgage. 

Debt consolidation is the primary reason for homeequity borrowing. Nonbanks that expanded their mortgage lending capacity during 1993 have been 

aggressively marketing to an increasing number of borrowers who desire to consolidate their growing debt 

burdens. According to the Consumer Bankers 

Association 1997 Home-Equity Loan Study, debt consolidation accounted for 36 percent of home-equity 

lines of credit and 40 percent of closed-end loans. Prior 

to 1992, home improvement was the primary reason for 

home-equity borrowing. This trend toward debt consolidation as the reason for home-equity borrowing has 

significant risk implications because, unlike funds lent 

for home improvement, the proceeds of a debt consolidation loan do not enhance the lender’s collateral value. 

The rapid growth of the HEL securitization market has 

been attended by signs of relaxed underwriting. 

Adverse credit quality trends have been particularly 

prominent for loans that were originated in 1995. Chart 

2 (next page) shows the total delinquency rates for 

closed-end loan pools originated in 1995 versus 1994. 

The sharp upward path of delinquency rates for loan 

pools originated in 1995 raises concern that aggressive 

competition for volume, and apparently relaxed underwriting standards, could lead to unprecedented default 

levels. Furthermore, HEL originations in 1996 more 

than doubled 1995 levels, causing market observers to 

suspect that underwriting standards continued to lapse. 

CHART 1 

1993 1994 1995 1996

0 

5 

10 

15 

20 

25 

1993 1994 1995 1996

Securitization of Home Equity 

Loans Has Risen Substantially 

Lines of Credit 

Closed End 

Source: Moody’s Investors Service 

$ Billion 

Regional Outlook	 14 Third Quarter 1997 
Regular Features Financial Markets
 

The trends in the HEL ABS market may portend credit 

quality trends in nonsecuritized cash-out refinancing. If 

similar unfavorable trends exist in bank-originated 

cash-out refinancing, evidence of these trends would be 

obscured by banks’ larger and less risky portfolios of 

purchase mortgage loans. The trends would be obscured 

because banks report all first mortgage lending on 1 to 

4 family residential properties without distinguishing 

between purchase mortgages and cash-out refinancings. 

The unfavorable trends in the HEL ABS market suggest 

that banks that engage in significant cash-out refinancing and other forms of home-equity lending should be 

able to monitor trends in the credit quality of these loans 

separate from purchase mortgage loans. 

A Combination of Several Factors Could Induce 

More Banks to Securitize HELs 

Although the present volume of bank-originated HEL 

securitizations is relatively small, banks have recently 

entered this finance company-dominated market, and a 

combination of several factors is likely to cause more to 

follow. First, home equity lines of credit are currently 

growing at rates exceeding total consumer lending, and, 

by and large, the deposit growth to fund this lending is 

less than robust. In addition, according to Moody’s 

Investors Service, investor demand is high for bankoriginated home-equity line of credit securitizations 

because bank-originated lines are perceived to have 

lower credit risk. The funding benefits and profitability 

of securitizing bank-originated home-equity lines of 

credit could entice more banks into the securitization 

market. Finally, the combination of these factors with 

the potential cost savings provided by using the new 

financial asset securitization investment trust (FASIT) 

CHART 2 

0 

2 

4 

6 

8 

10 

1 3 5 7 9 11 13 15 17 19 21 23 

Months since Origination 

1995-Originated Loans 

Source: Moody’s Investors Service 

Percent 

Higher Delinquency Rates Are Occurring 

Earlier in More Recently Originated Loan Pools 

1994-Originated Loans 

Closed-end Loans 

structure (see discussion below) could produce momentum that will result in banks, large and small, securitizing home equity loans in significantly increased 

amounts. 

Securitizing HELs can change the balance sheet and 

income statement of the securitizer significantly, resulting in significant servicing assets and gains on sale. 

Beginning in 1997, when a 

company sells loans, it 

must comply with the 

requirements of Financial 

Accounting Standard 

(FAS) 125. If the company 

retains servicing rights on 

the assets sold, FAS 125 

requires the seller to book 

an asset related to the gain on sale that represents the 

future income derived from servicing the loans. This 

asset is similar to mortgage servicing rights in that it 

represents the present value of future expected cash 

flows derived from loan servicing. One major homeequity securitizer, which indicated that FAS 125 would 

not materially affect its financial statements, reported 

servicing assets at almost 90 percent of equity, and 

gains associated with the sale of serviced assets at 71 

percent of total revenue. 

The value of servicing assets is based on management’s 

assumptions about the future cash flows to be generated by the assets. Because these assumptions are based 

largely on historical performance, unexpected deterioration, like that associated with 1995- and possibly 

1996-originated loans, that results in charge-offs or 

early repayment through foreclosure of serviced assets, 

could require the adjustment of the valuation assumptions and the write-down of the servicing assets. 

FASITs Promise to Change the ABS Market 

The Small Business Job Protection Act of 1996 created 

two new sections of the Internal Revenue Code that create and govern FASITs. The FASIT provisions, patterned in part on the real estate mortgage investment 

conduit (REMIC) rules issued in 1986, are intended to 

provide tax certainty for ABS issuers and purchasers 

and enhance the flexibility of asset securitizations. The 

FASIT provisions take effect on September 1, 1997. 

The advent of the FASIT is likely to change the ABS 

market in important ways. First, the FASIT will clarify 

Regional Outlook 15 Third Quarter 1997 
Regular Features Financial Markets
 

the tax treatment of securitizations. Because of the current tax ambiguity, designing ABS structures to avoid 

taxation is administratively costly, and it restricts the 

forms that securitizations can take. The higher administrative cost associated with current securitization techniques establishes a practical minimum size for asset 

pools that can be feasibly securitized. With FASITs and 

the reduced costs associated with tax clarity, the economically feasible pool size may be significantly smaller. The lowering of this threshold could result in more 

community banks entering the securitization market. 

ABS issuers believe that the market for their product 

has been hampered by the restrictive nature of current 

asset-backed tax ambiguity, which prevents them from 

responding to investor preferences for varying maturities, coupon types, and 

prepayment and credit 

risk profiles. FASITs 

allow sponsors the flexibility to create multipleclass securities that 

satisfy these preferences 

with the certainty that the 

securities will count as 

debt and that the FASIT 

will not be treated as a taxable corporation. This combination of flexibility and tax certainty could lead to the 

kind of innovations in ABS structures that followed the 

1986 REMIC legislation, which brought analogous benefits to the mortgage-backed market. 

FASITs will bring to the ABS market the ability to add 

and remove assets throughout the life of a securitization. This feature could be applied by securitizing 

revolving construction loans and then replacing the 

revolving loans with permanent financing when construction is completed. A FASIT also will be able to 

contain a mixed pool of assets such as real estate, nonreal estate assets, and unsecured credit, allowing exposures to very different markets from the same security. 

Finally, a FASIT can hold swaps and other hedging 

instruments. Using this feature, an issuer could combine 

a mortgage passthrough security with a hedging instrument that is designed to offset mortgage prepayment 

risk, such as a reverse-index amortizing swap. 

The increased flexibility that the FASIT promises to 

bring the ABS market comes with the potential for 

greatly increased complexity and risk. Banks that invest 

in FASIT securities will need to understand fully not 

only the risk characteristics existing at the outset of 

security but also the risk that could arise throughout the 

security’s life if assets are to be removed and replaced. 

Changes in Interest Rates and Bond Values 

The Treasury yield curve (see Chart 3) rose following 

March 25, 1997, when the Federal Open Market 

Committee (FOMC) met and raised the target federal 

funds rate 25 basis points to 5.50 percent. The yield on 

the 30-year Treasury bond rose above 7 percent on the 

Thursday following the meeting and remained there for 

the next 23 days. The FOMC met again on May 20, 

1997, and left the target rate unchanged. 

The model portfolio responded to the rise in rates, but 

only modestly (see Table 1). The relatively short weighted average maturity of the portfolio served to moderate 

the effect of the 54 basis point rise in the five-year 

Treasury between December 31, 1996, and March 31, 

1997. As discussed in Regional Outlook, Second 

Quarter 1997, changes in the value of the model portfolio correlate more with changes in the five-year 

Treasury rate than with the 30-year bond rate. 

The yields along the April 30, 1997, yield curve imply 

that the market expects the curve to continue to flatten 

through the remainder of the year with short rates rising 

somewhat. In order to gauge what affect a 25 basis point 

rise in the yield curve could have on bank fixed-income 

portfolios, the model portfolio has been “shocked” to 

CHART 3 

The Treasury Yield Curve Is Steeper 

and Higher since Year-end 1996 

5.0 

5.5 

6.0 

6.5 

7.0 

7.5 

3­

month 

2­

year 

7­

year 

30­

year 

Source: Bloomberg 

Percent 

3/31/97 

4/30/97 

12/31/96 

Regional Outlook 16 Third Quarter 1997 
Regular Features Financial Markets
 

TABLE 1 

Type of Security Par Value Percent Maturity Percent Change Reof or Change sulting from 

Portfolio WAL from a 25 bp Rate 

as of 12/31/96 Increase on 

12/31/96 to 5/28/97 

3/31/97 

U.S. TREASURY 5.6% 2,000 20% 1 YR –0.30% –0.16% 

FNMA AGENCY 5.8% CALLABLE 1,200 12% 2 YR –0.50% –0.38% 

STATE COUNTY MUNICIPAL GO 4.8% 800 8% 11 YR –2.05% –2.03% 

FNMA MORTGAGE PASSTHROUGH 7.5% 3,000 30% 8 YR –1.78% –1.44% 

FNMA (REMIC) 8.0% PAC 2,000 20% 2.5 YR –1.27% –0.50% 

CREDIT CARD ASSET-BACKED SECURITY 1,000 10% 5 YR –0.09% 0.00% 

TOTAL 10,000 100% 4.85 YR –1.08% –0.77% 

Note: Portfolio composition based on estimates derived from aggregated Bank Call Report information. 

simulate the effect of an instantaneous 25 basis point 

shift in the yield curve on May 28, 1997. 

Again, the interest rate risk benefits of maintaining a 

portfolio of relatively short weighted average life are 

apparent. The U.S. Treasury and the agency, the shortest 

lived instruments, and the floating-rate ABS demonstrate the least price sensitivity. The municipal bond is 

the most sensitive to rate changes owing to its longer 

maturity. The mortgage passthrough security also is 

more sensitive to rising rates because its weightedaverage life (WAL) extends as rising rates discourage 

the underlying mortgage holders from prepaying their 

loans. The decline in prepayment rates results in extending the maturity of the security while rates are rising, a 

combination unfavorable to the security’s value. 

CHART 4 

Community Bank Stocks in the New York 

Region Performed Smoothly Despite Turmoil in 

the Broad Market during the First Quarter of 

1997 

Both the S&P Composite Bank Index and the New York 

Regional Bank Index have been subject to similar performance swings this year (see Chart 4). The S&P 

Composite Bank Index, with an almost 13 percent gain 

by May 2, 1997, was still short of its year-to-date high 

on March 7, 1997, at which time it was up almost 20 

percent on the year. The New York Region’s Community 

Bank Index was spared from much of the influences of 

a gyrating market, rising in value fairly steadily to a 

12.82 percent gain through May 2, 1997, outperforming 

both the S&P Composite Bank and New York Regional 

Bank Indices. 

Allen Puwalski, Banking Analyst 

-2% 

3% 

8% 

13% 

18% 

31-Dec 

New York Regional Bank Index S&P 500

Source: Bloomberg, American Banker 

Change from 12/31/96 

Region’s Community Bank Index 

S&P Bank Index 

The New York Region’s Community Bank Index Performs Smoothly through a Rough Market 3-Jan 10-Jan 17-Jan 24-Jan 31-Jan 7-Feb 14-Feb 21-Feb 28-Feb 7-Mar 14-Mar 21-Mar 28-Mar 4-Apr 11-Apr 18-Apr 25-Apr

2-May 

Regional Outlook 17 Third Quarter 1997 
Regular Features	 Regional Banking
 

Current Regional Banking Issues
 

•	 The New York Region’s financial institutions reported solid performance in the first quarter of 1997. 

•	 Credit card losses escalate despite reports of tightening underwriting standards. 

•	 Residential real estate underwriting standards appear to be weakening as banks compete for customers 

with debt consolidation packages and low down payment mortgages. 

•	 Residential real estate development revives in New York City. 

The Region’s Insured Institutions Remain 

Healthy 

The Region’s banks and thrifts continue to report relatively strong financial conditions (see Chart 1). For the 

quarter ended March 31, 1997, insured institutions in 

the New York Region reported: 

•	 a return on assets of 1.14 percent, up from 0.85 percent one year earlier, despite a slight decline in net 

interest margin to 3.61 percent. The increase was due 

mainly to a decline in noninterest expense; 

•	 an average leverage capital ratio of 7.32 percent that 

remained steady from one year earlier; and 

•	 a decline in nonperforming assets to 0.91 percent of 

total assets from 1.11 percent in the first quarter of 

1996, primarily due to improvement in commercial 

real estate loan portfolios. 

Twenty-six insured institutions, with combined assets of 

$18 billion, reported net losses in the first quarter of 

1997. Together, these institutions lost a total of $51.1 

million. 

Credit Card Losses Continue to Escalate 

Many analysts anticipate that credit card losses will 

continue to increase in 1997. This trend is especially 

significant for the New York Region, since the Region’s 

27 insured credit card specialty banks and credit card 

concentration banks (collectively referred to as “credit 

card banks”)1 hold 43 percent of all U.S. commercial 

1

A credit card specialty bank is one whose total loans exceed 50 percent of assets and whose credit card loans exceed 50 percent of total 

loans. A credit card concentration bank has credit card loans exceeding 100 percent of equity capital or 25 percent of total loans. Only 

banks that met the definition on March 31, 1997, are included in this 

analysis. 

banks’ credit card loans and 50 percent of unfunded 

credit card commitments. The New York Region’s credit card banks continue to experience increasing loan 

losses. As of December 31, 1996, these banks had a 

weighted average charge-off rate of 3.72 percent, compared to 3.09 percent as of December 31, 1995. This 

number increased sharply to 4.86 percent at March 31, 

1997. Past-due and nonaccrual rates rose to 4.69 percent on December 31, 1996, from 3.75 percent a year 

earlier. Encouragingly, this figure dropped slightly in 

the first quarter of 1997, to 4.45 percent. 

Banks could face increased risk if the poor performance 

in credit card portfolios migrates to other consumer 

loans. Charge-offs on other consumer (or installment) 

debt remain low but have risen slightly. As of March 31, 

1997, installment debt was charged off at an annual rate 

of 1.49 percent, up from 1.27 percent at year-end 1996 

and from 1.07 percent as of December 31, 1995. 

However, this rate remains substantially below the credit card charge-off rate (see Chart 2). 

CHART 1 

0.0% 

1.0% 

2.0% 

3.0% 

4.0% 

5.0% 

6.0% 

7.0% 

8.0% 

Return 

on Assets 

Net 

Interest 

Margin 

Tier 1 

Leverage 

NPA* to 

Assets 

Source: Bank and Thrift Call Reports 

New York Region Institutions 

Show Financial Strength 

3/95 

3/96 

3/97 

* Nonperforming Assets 

Regional Outlook	 18 Third Quarter 1997 
Regular Features	 Regional Banking
 

According to a February 1997 Moody’s Investor 

Service report, Consumer Finance Industry Outlook, 

delinquencies should begin to moderate or decline in 

the second half of the year if the current credit cycle follows its historical pattern. According to Moody’s, the 

current cycle began with its cyclical low rates of delinquency and charge-offs in the 1993-1994 period following the last recession. Should the typical 5- to 6- year 

duration of a full credit cycle hold true, the current 

cyclical highs in delinquencies should begin to decline 

in the second half of 1997, with the level of charge-offs 

declining in 1998 from their current cyclical highs. 

However, structural, economic, or social changes could 

cause the current cycle to depart from past trends. 

Credit Card Growth Slows, Reflecting 

Tightening Underwriting Standards 

Efforts by credit card banks to tighten underwriting 

standards, coupled with less aggressive marketing tactics over the past year, have begun to affect growth in 

outstanding credit card receivables in the Region’s credit card banks. Total managed credit card receivables 

(credit card receivables managed on balance sheet plus 

those receivables managed that have been securitized 

and sold) increased 28 percent in the 12-month period 

ending March 31, 1997. However, the rate of growth in 

managed receivables was only 2 percent for the first 

quarter of 1997, a considerable slowing. 

Growth in unfunded credit card commitments slowed 

from 32 percent in 1996 to an annualized rate of 19.4 

percent in the first quarter of 1997. During 1996, the 

most significant growth was in the Region’s specialty 

credit card banks with total assets exceeding $5 billion, 

which experienced 38 percent growth. The Region’s 

CHART 2 

0.0 

1.0 

2.0 

3.0 

4.0 

90 91 92 93 94 95 96 Mar-97 

0.0% 

1.0% 

2.0% 

3.0% 

4.0% 

5.0% 

6.0% 

Source: Administrative Office of U.S. Courts and Bank Call Reports 

Based on a Design by FDIC Division of Research & Statistics 

Charge-Off Rates and Bankruptcies 

Move in Tandem 

Bankruptcies 

Per 1,000 

Population 

Charge- Installment Loan Offs

Charge-Offs 

Credit Card 

Charge-Offs 

smaller credit card banks and banks with less of a concentration in credit card lending reported growth in 

unfunded commitments of only 7.8 percent. The disparity in growth rates between large and small credit card 

banks essentially disappeared in the first quarter, 

reflecting the broad trend of scaling back operations in 

the face of rising delinquencies. 

Moody’s Investors Service cites several potential reasons for continued growth in unfunded commitments 

despite tightening underwriting standards. First, 

changes in underwriting standards generally do not have a 

material effect on portfolios for 

12 to 15 months. Second, the 

report states that tightening of 

some standards may be less 

effective than initially planned. 

For example, some issuers may 

have curtailed lending to renters 

because their repayment performance historically has 

been less favorable than that of homeowners. However, 

Moody’s suggests that the link between homeownership 

and creditworthiness may not be as strong as in past 

credit cycles. Low down payment mortgages have made 

homeownership attainable to borrowers previously 

excluded by lack of a down payment. Estimates indicate 

that more than 25 percent of conventional mortgages 

originated in 1996 had a down payment of 10 percent or 

less. Therefore, although banks have tightened underwriting criteria by historical standards, the benefits 

may not be as strong as originally anticipated. 

Many Factors Linked to Rising Bankruptcies 

The correlation between bankruptcy rates and chargeoff rates is strong (see Chart 2). Personal bankruptcies 

in the United States and the New York Region have been 

increasing steadily since 1994. However, the New York 

Region tends to have lower bankruptcy rates than the 

national average. 

Economists predict that bankruptcies will increase by 

10 to 30 percent in 1997. In addition to increasing debt 

burdens, Moody’s Investors Service suggests several 

factors for this rise in bankruptcies, including: 

•	 changing bankruptcy laws that allow debtors to keep 

more assets; 

•	 a diminishing social stigma associated with bankruptcy; 

Regional Outlook	 19 Third Quarter 1997 
Regular Features	 Regional Banking
 

•	 changing attitudes about loyalty and meeting obligations in an era of corporate downsizing and other 

employment dislocations; and 

•	 the expanding presence of legalized gambling. 

(As many as 10 to 15 percent of personal bankruptcies reportedly are related in some way to gambling 

losses.) 

Will High Debt Burdens Hamper the Economy? 

The sharp increase in household indebtedness and the 

rising share of income going to payments on credit 

cards, mortgages, auto loans, and other household loans 

(see Chart 3) have recently caused concern in the banking industry. A February 1997 report by the Federal 

Reserve Bank of New York found that consumer expenditures decline because of a tightening credit supply, not 

because of high debt levels. The report studied the link 

between rising debt service burdens and consumer 

spending and found that a rise in household debt is less 

likely to reduce consumer spending. Consumers will 

continue to spend in anticipation of increased earnings. 

Only when incomes fall for an extended period of time 

will households cut expenditures and reduce debt loads. 

What does this mean for the banking industry? 

Consumers may continue to increase debt service burdens despite rising delinquencies, charge-offs, and 

bankruptcies. Banks may be more vulnerable to a downturn in the economy if this trend continues, because 

consumers will be less able to service higher accumulated levels of debt if income levels decline. 

CHART 3 

Consumer Debt Service Payments Are 

Near Highs 

18.0% 

13.0% 

14.0% 

15.0% 

16.0% 

17.0% 

DSP* as % of Disposable 

Personal Income 

’80 ’82 ’84 ’86 ’88 ’90 ’92 ’94 ’96 

* Debt service payments include scheduled payments on mortgages,
 

credit cards, auto loans, and other household loans.
 

Source: Board of Governors of the Federal Reserve System
 

Competition and Rising Consumer Debt Are 

Changing Residential Lending Standards 

The consumer finance industry’s current highly competitive environment, combined with a rising level of 

consumer debt, appears to be affecting residential real 

estate lending. Analysts indicate that competition is at 

least partially responsible for an industry trend toward 

rising loan-to-value (LTV) ratios in the residential real 

estate lending arena. In fact, some banks are extending 

mortgages with LTV ratios of as much as 125 percent of 

appraised value, up from previous standards of 80 percent to 90 percent. 

The rise in LTV ratios appears to be partially attributable to the current popularity of consolidating consumer 

debt through home equity loans (see Financial 

Markets). Strong consumer demand, higher yields compared to traditional mortgage loans, and a familiar 

source of collateral are drawing some banks to this 

product. A strengthening housing market provides some 

comfort level despite rising LTV ratios (see Table 1). 

While this type of debt consolidation product is not 

new, the easing of terms for home equity loans is apparently a factor in the recent rapid growth in these loans, 

TABLE 1 

Median Home Prices Rise (Selected 

Areas within the Region) 

12/31/95-12/31/96 

MEDIAN PRICE %CHANGE 

BALTIMORE $110,500 –0.18% 

WASHINGTON, DC $159,000 2.45% 

ATLANTIC CITY $107,300 2.58% 

BERGEN-PASSAIC $200,200 8.63% 

NEWARK $198,700 3.98% 

TRENTON $135,800 8.64% 

ALBANY $106,100 0.19% 

BUFFALO $81,100 0.87% 

NASSAU-SUFFOLK $158,700 2.39% 

NEW YORK-LONG 

ISLAND $172,900 2.73% 

ROCHESTER $85,200 0.59% 

SYRACUSE $79,100 0.00% 

PHILADELPHIA $124,400 9.70% 

PITTSBURGH $81,500 0.62% 

U.S. $117,600 3.34% 

Source: National Association of Realtors 

Regional Outlook	 20 Third Quarter 1997 
Regular Features Regional Banking
 

according to the January 1997 Federal Reserve Senior 

Loan Officer Opinion Survey. One-third of the survey 

respondents (out of about 60 large domestic banks) said 

that easing terms on home equity loans, including entering the market for low-equity or no-equity loans, had 

boosted the volume of these loans on their books. 

Some banks in the Region have created various packages that combine a regular mortgage with a home equity loan for up to another 15 percent of the purchase 

price. This up-front combination of a conventional 

mortgage and a home equity loan is “the big thing—and 

it’s new to the Northeast,” said one executive mortgage 

banker. One year ago many banks would not go beyond 

75 percent LTV; now borrowers may get up to 95 percent. According to the Mortgage-Backed Securities 

Letter, homebuilders are becoming increasingly tuned 

in to this product and are using it to qualify more new 

homebuyers. 

Do Rising Loan-to-Value Ratios Increase Risk? 

Residential mortgage lending (loans secured by 1 to 4 

family residential real estate) represents a significant 

business for banks in the Region. A total of 250 institutions (out of 979) hold such loans in amounts exceeding 

50 percent of total loans and 100 percent of Tier 1 capital. As of March 31, 1997, insured institutions in the 

Region had increased mortgage loan holdings to $252.3 

billion, or 2 percent over one year earlier, to approximately 27 percent of aggregate total loans. Mortgage 

loans are the second largest loan category for the 

Region’s banks behind commercial and industrial loans. 

Any change in residential mortgage underwriting could 

therefore have a significant effect on the risk profile of 

the Region’s banks. 

CHART 4 

0 

5 

10 

15 

20 

25 

30 

1969197519851996 

Source: F.W. Dodge/McGraw-Hill 

Residential Construction in New York City 

May Be Poised for a Rebound 

Number of Units (000s) 

19801990 

A recent study by the Office of Thrift Supervision indicates that LTV ratios explain more of the variation in 

default rates than any other factor. The data show that 

the percentage of high LTV loans (LTV ratios greater 

than 90 percent) increased significantly, from 7 percent 

in 1993 to 26 percent in 1995. The data also show that 

delinquency rates generally rise along with rising LTV 

ratios. Mortgages in the 96 to 105 percent LTV segment 

have delinquency rates nearly eight times as high on 

average as mortgages with LTV ratios at or below 80 

percent. 

Loan-to-value ratios are just one gauge of credit underwriting and must be assessed within the context of compensating factors such as 

shifting credit profiles, 

reserve policies, innovations in credit scoring, and 

collection capabilities. 

However, Fitch Research 

notes that loosening credit 

standards could materially 

affect long-term profitability and asset quality if home prices experience a sharp 

deterioration. High LTV mortgages, whether in the 

form of debt consolidation packages or affordable purchase mortgages, expose underwriters to additional risk 

if the favorable economic conditions experienced over 

the past six years do not continue indefinitely. A decline 

in housing values could undermine the collateral protection that residential real estate provides. Further, 

there is the possibility that some consumers will 

increase credit card and other consumer debt after a 

debt consolidation package is completed, thereby weakening their ability to repay outstanding debts and 

increasing the likelihood of bankruptcy. 

One Segment of Commercial Real Estate 

Development Revives in New York City 

After several years of little construction activity, residential real estate development activity is re-emerging 

in New York City (see Chart 4). Higher residential rental 

prices and strong residential sales indicate a tightening 

market. The Halstead Property Company reported that 

apartment rental rates in the city increased by double 

digits in the third quarter of 1996 compared to one year 

earlier. A Corcoran Group survey of the Manhattan 

condominium and cooperative market revealed that the 

number of sales rose over 23 percent in 1996. As a 

result, developers have many apartment building proRegional Outlook 21 Third Quarter 1997 
Regular Features Regional Banking
 

jects planned, although few are currently at the construction stage. Although construction and development 

lending have remained static in banks in the 

Manhattan and New York East Field Offices in the 

first quarter, the number of planned projects suggests 

that bank loans for such undertakings will be increasing 

in the future. 

Some developers have indicated that residential real 

estate development dollars are increasingly available; 

however, both the lenders and the rules have changed. 

Lenders are demanding substantial up-front cash commitments from developers and are requiring written preleasing commitments from tenants. If there are cost 

overruns during construction, lenders are requiring that 

the amount of the overrun be made up immediately by 

the developer. To the extent that lenders adhere to these 

strict underwriting standards, the risk profile of this 

segment of the loan portfolio will be strengthened. 

Karen A. Denu, Financial Analyst 

Suzannah L. Susser, Senior Regional Analyst 

For More Information 

Consumer Finance Industry Outlook, Moody’s 

Investors Service, February 1997. 

Financial Institutions Special Report, Fitch Research, 

March 3, 1997. 

McCarthy, Jonathan, Current Issues in Economics and 

Finance — Debt, Delinquencies, and Consumer 

Spending, Federal Reserve Bank of New York, 

February 1997. 

Mortgage-Backed Securities Letter, April 14, 1997. 

National Mortgage Default Rates and the Vintage 

Effect, Office of Thrift Supervision, First Quarter 

1997. 

Senior Loan Officer Opinion Survey on Bank Lending 

Practices, Federal Reserve Board, January 1997. 

Regional Outlook 22 Third Quarter 1997 

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