Outlook
 

WINTER 2004 

In Focus This Quarter: The U.S. Consumer Sector 

The consumer sector is the powerhouse behind the U.S. economy, accounting for more than two-thirds of total economic activity. 

This issue of FDIC Outlook examines the near-term prospects for the U.S. consumer in terms of spending, job growth, and consumer 

credit quality in the current environment of rising short-term interest rates. This issue also reviews national and regional housing 

markets and the related home equity lending area, as well as auto financing and the up-and-coming market represented by Hispanic households. 

Consumer Sector Outlook for 2005 

Although consumer incomes and spending have been supported in 

recent years by the temporary effects of lower taxes and the liquidation 

of homeowner equity, consumer spending going forward will be more 

dependent on the growth of jobs and incomes. While most consumers 

seem able to manage their debt load, weaker borrowers and those with 

substantial leverage, especially to variable-rate debt, could be at risk as 

interest rates begin to rise. See page 3. 

A Turning Point Ahead? National and Regional Trends in 

Residential Real Estate Markets 

Residential real estate has been a leading sector of the U.S. economy 

for the past three years running. Homeowners have helped keep 

consumer spending strong, thanks in part to the approximately 

$312 billion in equity they extracted from their homes in 2003. But the ongoing boom in real estate prices leaves many wondering 

whether prices and market activity are poised to level off or even decline in coming months. This article revisits recent housing 

market trends from both a national and regional perspective. See page 9. 

Home Equity Lending: Growth and Innovation Alter the Risk Profile 

Home equity lending continues at a strong pace, particularly for home equity lines of credit, and there is concern for heightened 

credit risk as this lending area expands. Current challenges for home equity lenders include rising short-term interest rates, 

increasing consumer indebtedness, and the likelihood that home price gains will level off eventually. See page 17. 

Lending Practices of Captive Auto Lenders Are Driving Risks in Bank Auto Paper 

The auto finance market is highly competitive. Banks must contend with aggressive terms offered by captive finance companies 

while vying with credit unions and other insured financial institutions for market share. As a result, some banks may have loosened auto loan underwriting standards, leaving them vulnerable if interest rates continue to rise or if economic fundamentals 

weaken. Auto loans to marginal or subprime borrowers in particular may be more vulnerable to credit quality deterioration, 

particularly in a rising interest rate environment. See page 24. 

Banks Are Still Sizing Up Opportunities in the Growing Hispanic Market 

The purchasing power of the Hispanic market is already strong and growing, and an assessment of the future potential of this 

market points to continued expansion. The financial needs of the Hispanic population are categorized into stages as they gain 

wealth and their demand for services evolves. In addition, analysis of demographic data and bank activity in this area shows that 

high-growth Hispanic areas experienced substantially faster growth in both deposits and branch formation than did either highly 

concentrated Hispanic areas or the nation as a whole. Large banks and community banks alike will find new and welcome sources 

of revenue if they can customize their products to the unique needs of the Hispanic marketplace. See page 30. 

Tax Cuts Are No Longer Boosting 

Marginal Gains in Take-Home Pay 

Source: Bureau of Economic Analysis. 

Personal Income 

(percent change from prior year) 

99 00 01 02 03 04 

0 

1 

2 

3 

4 

5 

6 

7 

8 

9 

10 

Pre-tax income 

Disposable (after-tax) income 

FEDERAL DEPOSIT INSURANCE CORPORATION 
The FDIC Outlook is published quarterly by the Division of Insurance and Research of the Federal Deposit 

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

institutions and financial institution regulators. It is produced for the following six geographic regions: 

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

Jack M. Phelps, Regional Manager, 678-916-2295 

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

David Van Vickle, Regional Manager, 312-382-7551 

Dallas Region (AR, CO, LA, MS, NM, OK, TN, TX) 

Midsouth: Gary Beasley, Regional Manager, 901-821-5234 

Southwest: Alan Bush, Regional Manager, 972-761-2072 

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

John Anderlik, Regional Manager, 816-234-8198 

New York Region (CT, DC, DE, MA, MD, ME, NH, NJ, NY, PA, PR, RI, VI, VT) 

Mid-Atlantic: Kathy Kalser, Regional Manager, 917-320-2650 

New England: Paul Driscoll, Regional Manager, 781-794-5502 

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

Catherine Phillips-Olsen, Regional Manager, 415-808-8158 

The FDIC Outlook provides an overview of economic and banking risks and discusses how these risks relate 

to insured institutions nationally and in each FDIC region. 

Single copy subscriptions of the FDIC Outlook can be obtained by sending the subscription form found on 

the back cover to the FDIC Public Information Center. 

The FDIC Outlook is available online by visiting the FDIC’s Web site at www.fdic.gov. For more information 

or to provide comments or suggestions about FDIC Outlook, please call Richard A. Brown at 202-898-3927 

or send an e-mail to rbrown@fdic.gov. 

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

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

of this publication was obtained from publicly available sources that are considered reliable. However, the 

use of this information does not constitute an endorsement of its accuracy by the Federal Deposit Insurance 

Corporation. 

Chairman Donald E. Powell 

Director, Division of Insurance 

and Research 

Arthur J. Murton 

Executive Editor Maureen E. Sweeney 

Managing Editor Mary Ledwin Bean 

Editors Jack M. Phelps 

Kathy Kalser 

Ronald L. Spieker 

Richard A. Brown 

Norman Williams 

Publications Managers Elena Johnson 

Geri Bonebrake 

FDIC OUTLOOK 2 WINTER 2004 
Consumer Sector Outlook for 2005
 

It is widely recognized that the consumer is the powerhouse behind the U.S. economy, accounting for more 

than two-thirds of total economic activity. And, despite 

the 2001 recession and a relatively weak labor market 

since then, the consumer has proven to be far more 

resilient than many would have expected. In recent 

years, growth in after-tax income and consumer spending has been much stronger than has historically been 

the case around recessions, especially given the lackluster pace of hiring. In addition, consumer credit growth 

has been robust during a period when a retrenchment 

would have been expected. To stoke their spending, 

consumers have drawn on the increasing equity in their 

homes and the proceeds of substantial tax cuts during 

both 2001 and 2003. However, as the stimulus of the 

tax cuts has been absorbed and the refinancing wave 

appears to have abated, it is now uncertain how fast 

consumer spending can continue to grow. 

This article reviews the various factors that will determine the pace of consumer spending and credit growth 

going forward. It also briefly assesses how higher energy 

costs may be affecting spending and concludes with an 

evaluation of the overall credit health of the consumer. 

Job Growth Drives Income 

After a few rocky years, renewed job growth is again 

supporting income gains. During the 2001 recession 

and for almost two more years, total U.S. payroll 

employment declined. This decline weighed on growth 

in employee compensation and thus on total income 

gains. However, since August 2003, the economy has 

been steadily increasing its employment base, leading to 

renewed vigor in total employee compensation and 

income growth (see Chart 1). In addition to any raises 

offered to existing workers, job gains should continue to 

support overall compensation growth in 2005 and will 

keep incomes and consumer spending expanding. 

However, two other sources of income growth in recent 

years—tax cuts and the liquidation of homeowners’ 

equity—are likely to play a lesser role in 2005. Also, 

higher energy prices may pose a risk to consumer 

spending. 

Tax Cuts and Income Affect Spending 

The tax cuts that helped support take-home pay during 

the 2001 recession and the subsequent episode of weak 

employment growth are no longer boosting income at 

the margin. Household incomes usually do not decline 

on an annual basis. In fact, since 1950, inflationadjusted after-tax incomes only fell once, in 1974, and 

then only by 0.7 percent. Rather, growth in real aftertax income typically slows when the job market weakens substantially. Although the recent experience was 

no exception to this trend, the slowdown in after-tax, 

or so-called “disposable,” income growth was much 

milder than the historical experience might have 

suggested. During the early years after the 2001 recession, disposable incomes grew largely on the strength of 

two well-timed tax cuts that boosted after-tax income 

growth for those still working. 

Tax rebates in the summer of 2001 and reduced tax 

withholdings in 2002 and 2003 increased gains in takehome pay relative to total income. Chart 2 illustrates 

the disparity between before- and after-tax income 

growth. After-tax income received a large boost beginning in late 2001 as tax cuts began to flow into the 

economy—a situation that carried over well into 2004. 

However, in July and August 2004, growth in after-tax 

income fell significantly below that of pre-tax income. 

Since the last round of payroll tax reductions was 

enacted a year earlier in mid-2003, the stimulative 

effects on growth are now diminishing. That is, while 

these tax cuts still provide a higher level of take-home 

Chart 1 

Renewed Job Growth Is Again Supporting 

Compensation and Overall Income Gains 

Nonfarm Payrolls and Employee Compensation 

(percent change from a year ago) 

10 

8 

6 

4 

2 

0 

-2 

-4 

Source: Bureau of Labor Statistics. 

Nonfarm payrolls 

Employee compensation 

Recessions 

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 

FDIC OUTLOOK 3 WINTER 2004 
In Focus This Quarter: The U.S. Consumer Sector 

Chart 2 

Tax Cuts Are No Longer Boosting 

Marginal Gains in Take-Home Pay 

Source: Bureau of Economic Analysis. 

Personal Income 

(percent change from prior year) 

99 00 01 02 03 04 

0 

1 

2 

3 

4 

5 

6 

7 

8 

9 

10 

Pre-tax income 

Disposable (after-tax) income 

pay for many workers, the influence of the tax cuts on 

income growth has ended. 

Although tax cuts are no longer contributing to income 

growth, the increased pace of hiring is having a positive 

effect, which highlights the significance of job growth 

to the outlook for consumer spending and borrowing. 

Without a steady pace of job growth, overall and takehome pay gains would be weaker. 

Households Use Home Equity to Increase Cash Flow 

In addition to tax cuts, the other strong factor in boosting consumer spending at the margin in recent years 

has been homeowners tapping into the accumulated 

equity in their homes. In the five-year period ended 

June 2004, owners’ equity in household real estate rose 

by $3.1 trillion, or 56 percent. One factor behind the 

increase in home equity has been the rapid increase in 

homeownership. The U.S. homeownership rate was 

estimated at 68.9 percent in third quarter 2004, which 

is a nearly 2 percent increase in just five years and the 

equivalent of almost 3.3 million new homeowners. 

The other factor boosting home equity has been rising 

home prices. According to the House Price Index 

published by the Office of Federal Housing Enterprise 

Oversight (OFHEO), nationwide home prices as of 

second quarter 2004 had risen by 9.3 percent from a 

year ago—the fastest annual pace of growth since 1979. 

While prices have risen faster in some areas than in 

others, all 313 metropolitan areas covered by the 

OFHEO data have shown price increases during each of 

the past three years. 

As total homeowner equity has risen, many households 

have sought to liquidate and spend a portion of the 

wealth tied up in their homes. One way to do so is 

during a mortgage refinancing transaction, where the 

homeowner might choose to take cash out or roll a 

second mortgage loan into the first mortgage. According to data provided by Freddie Mac, homeowners 

liquidated some $211 billion in 2003 by refinancing 

their mortgages. According to the Federal Reserve, 

another $101 billion was liquidated by increased 

borrowing against home equity lines of credit 

(HELOCs).1 Taken together, this liquidation of home 

equity contributed an extra $312 billion to household 

cash flow during 2003, an amount of stimulus that 

almost equaled the $332 billion gain in after-tax 

income during the year. 

The current combination of high home prices and 

historically low interest rates continues to induce 

homeowners to liquidate home equity, and increasingly 

they are doing so with HELOC borrowing. Because so 

many homeowners refinanced their mortgages during 

2003 when interest rates were at a multi-decade low, 

a relatively modest rise in mortgage rates in 2004 has 

curbed refinancing activity substantially. The average 

weekly refinancing index of the Mortgage Bankers 

Association declined by 75 percent in the first half of 

2004 from year-ago levels. Meanwhile, the total volume 

of home equity loans outstanding rose by 23 percent 

during the year ending in June, as households turned to 

HELOCs as a source of liquidity. 

A key issue for the consumer spending outlook is 

whether home appreciation can continue to provide a 

ready source of consumer cash. During 2002 and 2003, 

despite the liquidation of roughly $540 billion in homeowner equity and an overall increase in household 

mortgage debt of $1.4 trillion, total homeowner equity 

still rose by $1.2 trillion. Strong home price gains 

depend on continued robust housing demand, but rising 

interest rates may cut into demand and slow the pace of 

price increases. Some analysts have expressed concern 

that the recent rapid pace of home price growth in 

many major markets across the country could lead ultimately to a downturn in home prices and housing 

market activity.2 Should home prices decline in these 

1 See “Home Equity Lending: Growth and Innovation Alter the Risk
 

Profile” by Cynthia Angell in this issue. 


2 See “A Turning Point Ahead? National and Regional Trends in Residential Real Estate Markets” in this issue. 


FDIC OUTLOOK 4 WINTER 2004 
Consumer Sector Outlook for 2005 

markets, homeowner equity—and spending—could also 

be adversely affected. 

Higher Energy Costs Affect Spending 

The recent run-up in energy costs may pose a downside 

risk to consumer spending growth in 2005. Inflationadjusted consumer spending appeared to take a breather 

in second quarter 2004 after an extended period of 

strong growth. After advancing by roughly 3 percent in 

both 2002 and 2003 and then at a 4 percent annual 

rate in first quarter 2004, spending rose at only a 1.6 

percent annualized rate in the second quarter. Sluggish 

real retail sales growth persisted through August, with 

motor vehicle sales being the weakest component. 

Automakers curtailed many of their incentives in early 

2004 and auto loan rates rose modestly, causing weakness in auto demand. However, with the reintroduction 

of incentives and a brief summertime easing in energy 

prices, auto and overall retail sales bounced back in 

September. As a result, inflation-adjusted U.S. 

consumer spending advanced at a sturdy 4.6 percent 

annualized pace during the third quarter. 

Higher energy prices likely played a key role in dampening consumer goods spending in mid-2004. Federal 

Reserve Chairman Alan Greenspan recently noted that 

the 2004 surge in energy costs—and the price of gasoline in particular—weighed on consumer spending 

growth and contributed to a mid-2004 “soft patch” in 

economic growth.3 Although spending for gasoline and 

oil accounts for an average of only 2.5 percent of aftertax personal income (compared to 4.4 percent in 

1981), lower-income households are typically more 

affected by rising energy costs (see Chart 3). 

Consumer sales data offer another indication that lowerincome households may be feeling a greater effect from 

energy price increases. Michael Niemeira, chief economist for the International Council of Shopping Centers, 

estimates that for every 10 percent increase in the price 

of gasoline, sales at discount retailers drop 0.66 percent, 

versus only 0.33 percent at department stores.4 This may 

help explain why recent same-store sales data have 

3 Chairman Alan Greenspan of the Federal Reserve Board, “Economic
 

Outlook,” testimony before the Committee on the Budget, U.S. House
 

of Representatives, September 8, 2004, http://www.federalreserve.gov/
 

boarddocs/testimony/2004/200409082/default.htm.
 

4 Barbara Hagenbaugh, “$50 Oil Probably Won’t Cause a Huge
 

Economic Mess,” USA Today, September 27, 2004.
 

Chart 3 

Consumer Spending on Gasoline and Oil Is Rising 

but Remains Well Below Its Historic Highs 

Personal Gasoline and Oil Consumption

(share of disposable income) 

5.0% 

4.5% 

4.0% 

3.5% 

3.0% 

2.5% 

2.0% 

1.5% 

64 69 74 79 84 89 94 99 

Source: Bureau of Economic Analysis. 

shown stronger growth among high-end retailers than 

among discounters (see Chart 4). Other analysts have 

pointed out that sales growth for high-end items, such as 

private aircraft and pleasure boats, was stronger this year 

than in the past few years. It is likely that other factors, 

such as the relatively faster income growth seen by 

higher-income households recently, have contributed to 

the divergence in sales trends. Nonetheless, the retail 

data provide some anecdotal evidence that higher oil 

and energy prices affect high-income households less 

than other income-level households.5 

Chart 4 

High-End Retail Sales Have Been Less Affected 

by Rising Energy Prices 

Same-Store Sales 

(percent change from year ago, January to August 2004) 

Neiman Marcus 

Nordstrom 

Saks 5th Ave 

Ross Stores 

Target 

Wal-Mart 

0 5 10 15 20 

Source: Bloomberg. 

5 Andy Kish, “What We’re Doing Without,” Economy.com, September 

28, 2004. 

FDIC OUTLOOK 5 WINTER 2004 

04 
In Focus This Quarter: The U.S. Consumer Sector 

Chart 5 

The Overall Household Debt-to-Net-Worth Ratio Remains Near Its Historic Highs 

Household Debt 

(share of net worth) 

23% 

21% 

19% 

17% 

15% 

13% 

11% 

9% 

7% 

5% 

52 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 

Source: Federal Reserve. 

Although the recent increase in energy costs may have 

weighed on consumer spending growth during the past 

year, consumers likely will continue to adjust their 

consumption patterns over time to adapt to the higher 

level of energy prices. Given that adjustment process, the 

effect of rising energy costs on consumer spending may 

be less severe during 2005, even if prices remain elevated. 

Increasing Consumer Indebtedness and Worsening 

Credit Quality a Concern 

The continued expansion in consumer indebtedness 

and the rising rate of personal bankruptcy filings in 

recent years has raised concern. If job or income growth 

were to slow or interest rates were to rise significantly, 

consumer credit quality could deteriorate. 

Current levels of consumer debt are probably still 

manageable for most households. At just over 21 

percent in mid-2004, consumer debt as a share of net 

worth was near its high point for the past 55 years (see 

Chart 5). This level of indebtedness has been rising 

steadily over the past several decades. Much of this rise 

is due to two factors: increasing access to credit by 

certain households and rising homeownership. In particular, rising homeownership seems to have played a 

significant role in the increase in indebtedness over the 

past several years. During the five years ended mid2004, household mortgage debt increased by $2.8 trillion, which accounts for 80 percent of the total increase 

in consumer debt over this period. At the same time, 

however, the value of residential real estate owned by 

homeowners rose by $5.9 trillion. So the dramatic 

increase in mortgage debt during the past five years 

was accompanied by an even larger increase in net 

worth, the net effect of which is over $3 trillion. 

Although personal bankruptcy filings have declined in 

recent months, they remain near their all-time highs. 

During 2003, personal bankruptcy filings reached a 

record high of 5.5 per thousand persons; however, 

filings declined an encouraging 4.2 percent on a yearago basis in second quarter 2004. This was the largest 

year-over-year decline since mid-2000. Any sustained 

trend toward fewer personal bankruptcies should indicate improving consumer credit performance. 

So far, the credit position of the consumer appears to be 

stable. According to the Federal Reserve, the aggregate 

consumer debt-service ratio—which reflects minimum 

required payments on credit cards, home mortgages, 

and other consumer loans (but not leases)—has been 

stable at around 13 percent of disposable income since 

the end of the 2001 recession (see Chart 6). 

Although the aggregate consumer debt-service ratio 

remains near its all-time high, some of the reasons for 

this may be structural in nature. The increased availability of credit in recent years, rising homeownership, 

and more sophistication on the part of borrowers and 

lenders (which can be reflected in such developments 

as increased “convenience” use of credit card debt) may 

all be contributing to this higher ratio of minimum 

debt payments to income.6 The fact that delinquency 

6 Alan Greenspan, “The Mortgage Market and Consumer Debt,” 

speech at America’s Community Bankers Annual Convention, 

Washington, D.C., October 19, 2004, http://www.federalreserve.gov/ 

boarddocs/speeches/2004/20041019/default.htm. 

FDIC OUTLOOK 6 WINTER 2004 
Consumer Sector Outlook for 2005 

Chart 6 Chart 7 

The Consumer Debt Burden Remains Near an
 

All-Time High
 

Minimum Debt-Service Burden 

(percent of disposable income) 

13.5 

13.0 

12.5 

12.0 

11.5 

11.0 

10.5 

10.0 

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 

Source: Federal Reserve. 

rates on consumer loans and credit card debt at FDICinsured institutions have held relatively steady during 

the past seven years offers perhaps the strongest 

evidence that consumers continue to be able to service 

their debts. Between 1997 and mid-2004, noncurrent 

credit card loans ranged between 1.84 and 2.00 percent 

of all credit card loans, while noncurrent loans in other 

consumer loan categories ranged between 0.91 and 1.06 

percent.7 

Rising Interest Rates Pose a Risk 

With consumer leverage near record highs, the prospect 

of rising interest rates naturally causes concern. The 

Federal Reserve began raising its interest rate target 

during 2004, and by October 2004, 3-month Treasury 

bill yields had increased by 85 basis points from one year 

earlier. Longer term interest rates, though, were either 

modestly lower or unchanged over this time. Most 

market analysts are expecting interest rates to continue 

rising over the next year. Although exposure to rising 

interest rates is a valid concern, much of the recent 

growth in consumer indebtedness has come in the form 

of fixed-rate mortgages. Currently, mortgages comprise 

73.2 percent of total household debt, versus just under 

69 percent as recently as 2000. Of the $3 trillion in 

additional consumer debt accumulated in the past four 

years through mid-2004, more than 80 percent was 

mortgage-related (see Chart 7). Mortgage debt is 

usually carried at a fixed rate, and as such, monthly debt 

payments are not subject to rising interest rates. 

7 Noncurrent loans are defined as those that are 30 to 90 days past 

due as well as those in nonaccrual status. 

An Abundance of Mortgage Debt May Tend
 

to Insulate Households from the Effects of Rising
 

Interest Rates
 

Household Mortgage Debt


(percent share of year-ago consumer debt growth)
 

Recessions 

40 

50 

60 

70 

80 

90 

100 

89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 

Source: Federal Reserve. 

However, not all mortgage debt has a fixed rate. 

Freddie Mac estimates that between 15 percent and 

20 percent of total outstanding mortgage debt had 

adjustable rates in 2003. Adjustable-rate mortgages 

(ARMs) have become more popular in the mortgage 

market, accounting for at least 30 percent of mortgage 

origination activity over the spring and summer of 

2004.8 While many consumers will be able to manage 

rising mortgage payments on ARMs, the segment of 

newer ARM holders that relied on the lower cost of 

this type of loan as their only means to afford a 

monthly mortgage payment may face some difficulty 

servicing their debt once interest rates rise.9 Although 

there are many types of ARM products, a significant 

share of ARMs still reprice in less than a year.10 

The potential for ongoing increases in interest rates 

over the next year poses another possible risk to 

consumer debt service capacity. Rising interest rates 

may hurt housing affordability, thereby curbing demand 

for new homes and home price appreciation. So, 

although many consumers have been able to substitute 

lower priced fixed-rate mortgage debt for higher-priced 

revolving debt in recent years, this may be less feasible 

in 2005. Should home price appreciation subside 

8 Mortgage Bankers Association, Weekly Mortgage Applications 

Survey. 

9 For a more detailed analysis of the U.S. housing market, see: Cynthia 

Angell, “Housing Bubble Concerns and the Outlook for Mortgage 

Quality,” FDIC Outlook, Spring 2004. 10 Based on 1993, 2000, and 2003 Federal Housing Financing Board 

survey data that reflect responses from its members regarding all 

fully amortized purchase-money conventional first-mortgage loans 

used to finance the purchase of single-family nonfarm homes, including individual townhouse, condominium, and cooperative units. 

FDIC OUTLOOK 7 WINTER 2004 
In Focus This Quarter: The U.S. Consumer Sector 

significantly, many households may meet their incremental credit needs by shifting back toward higherpriced revolving credit lines instead of refinancing their 

homes at lower fixed rates and extracting equity. 

Conclusion 

Consumer income and spending were supported in 

recent years by the temporary effects of lower taxes and 

the liquidation of homeowner equity. The tax cuts, 

however, are no longer boosting consumer income at 

the margin. And although homeowners may continue 

to liquidate accumulated equity, the risk of slower home 

price appreciation in a rising-rate environment could 

reduce the likelihood that home equity will be a significant source of additional consumer spending and 

borrowing in 2005. The prospects for consumer spending, therefore, are likely to depend more on job growth 

and the income gains of existing workers. Stronger job 

growth than that seen during third quarter 2004 and 

somewhat faster income growth may be necessary to 

maintain a strong advance in consumer spending 

during 2005. And persistently high energy prices could 

continue to be an important downside risk to consumer 

spending over the near term. 

Overall household debt levels remain near all-time 

highs, but the recent performance of consumer loan 

credit quality suggests that most consumers are fully 

able to service their current debt loads. Although interest rates likely will keep rising, some factors will insulate many consumers from the risks of rising rates. For 

example, much of the growth in consumer debt in 

recent years came in the form of fixed-rate mortgages, 

where monthly payments are not subject to rising interest rates. Furthermore, many consumers have swapped 

more costly forms of debt, such as credit cards, for 

lower-cost fixed-rate mortgage debt. 

Such actions have reduced overall consumer exposure 

to rising interest rates, but not all consumers have been 

able to avail themselves of these developments. Increasing interest rates could begin to strain some consumers’ 

finances over the coming year, and it will be important 

to monitor certain consumer segments in 2005 for 

emerging signs of weakness. In particular, weaker 

borrowers and consumers with significant leverage and 

exposure to variable-rate debt will remain vulnerable to 

increases in interest rates. 

Nathan Powell, Financial Economist 

FDIC OUTLOOK 8 WINTER 2004 
A Turning Point Ahead? National and Regional 

Trends in Residential Real Estate Markets 

Residential real estate has been a leading sector of the 

U.S. economy for the past three years running. In fact, 

according to a recent Office of Federal Housing Enterprise Oversight (OFHEO) report, every metro area in 

the nation experienced positive house price appreciation in second quarter 2004 (see Table 1).1 This strong 

housing market activity has helped boost U.S. 

construction payrolls by almost 200,000 workers in the 

year ending August 2004, which was almost one out of 

every eight jobs created during that period. Meanwhile, 

homeowners have helped keep consumer spending 

strong, thanks in part to the approximately $312 billion 

in equity they extracted from their homes in 2003.2 But 

the ongoing boom in real estate prices leaves many 

wondering whether prices and market activity are 

poised to level off or even decline in coming months.3 

This article revisits recent housing market trends from 

both a national and regional perspective. 

The national statistics on housing remain most impressive. Some 1.85 million housing units were started in 

2003, the highest total since 1978. Monthly permits for 

new units continue to be issued at a rate of around 2 

million per year, showing that the home construction 

pipeline remains strong. The value of private residential 

construction in second quarter 2004 was 15 percent 

higher than a year ago. Existing home sales have 

continued to climb to new records, reaching an annual 

rate of almost 6.8 million units in second quarter 2004. 

A record 69 percent of U.S. households owned their 

homes as of second quarter 2004, up from 64 percent a 

decade ago. 

1 Office of Federal Housing Enterprise Oversight, “OFHEO House Price 

Index Shows Largest One Year Increase since 1970’s: U.S. House 

Prices Show Annual Rise of 9.36 Percent,” news release, and House 

Price Index report (second quarter 2004), September 1, 2004, 

http://www.ofheo.gov/media/pdf/2q04hpir.pdf. The analysis based 

year-to-year changes on second quarter 2004. OFHEO tracks home 

prices for 328 metropolitan areas. 

2 The extraction of homeowners’ equity is calculated as the sum of 

cash proceeds plus second mortgage balances rolled into refinancing 

($211 billion, according to Freddie Mac) and the net change in home 

equity loans outstanding ($101 billion, according to the Federal 

Reserve Board). 

3 Cynthia Angell, “Housing Bubble Concerns and the Outlook for Mortgage Credit Quality,” FDIC Outlook, Spring 2004, http://www.fdic.gov/ 

bank/analytical/regional/ro20041q/na/infocus.html. 

Market conditions have been unusually conducive to 

strong growth in housing activity. Interest rates for 

long-term fixed-rate mortgages fell to their lowest levels 

in more than a generation in second quarter 2003, 

prompting strong demand for mortgage credit from new 

homebuyers and existing homeowners wishing to refinance.4 Since mid-2003, increases in mortgage rates 

have significantly damped mortgage refinancing activity. But the continued availability of long-term fixedrate mortgages of around 6 percent, along with 

increasing reliance on lower-cost adjustable rate mortgages, has helped keep home sales and home construction at high levels. 

Analysts continue to point out that home price 

increases have outpaced income growth for some 

time, a situation that cannot persist indefinitely (see 

Table 1 

U.S. Metropolitan Areas with Fastest Home 

Price Appreciation, Year Ending June 2004 

Metropolitan Percentage Increase in Value of Home 

Statistical Area Home Price Index Price Index* 

Las Vegas, NV-AZ 24.9 174.7 

RiversideSan Bernardino, CA 24.7 213.6 

Fresno, CA 23.2 186.4 

Fort PiercePort St. Lucie, FL 21.9 197.9 

Orange County, CA 21.6 230.7 

Los AngelesLong Beach, CA 21.5 215.2 

Ventura, CA 21.2 228.6 

Bakersfield, CA 20.5 164.2 

Yuba City, CA 20.4 193.7 

San Diego, CA 20.2 247.5 

U.S. Average 9.4 172.5 

*Index based on 1995 Q1 = 100. 

Source: Office of Federal Housing Enterprise Oversight. 

4 The Freddie Mac contract rate for 30-year fixed-rate first mortgages 

fell to 5.23 percent in June 2003, the lowest monthly level recorded in 

the 34-year history of this series. 

FDIC OUTLOOK 9 WINTER 2004 
In Focus This Quarter: The U.S. Consumer Sector 

Chart 1). Another source of concern is a rising rental 

vacancy rate for residential properties, which now 

exceeds 10 percent of year-round rental housing units 

for the first time on record, led by increases in the 

Midwest and the South.5 

However, as has been said about politics, residential 

real estate trends truly are local. Analyses of metro-area 

price increases versus fundamental factors continue to 

point to a group of cities on the west coast, the east 

coast, and in the southeast where prices appear to have 

diverged most noticeably from underlying fundamentals.6 Still, these analyses cannot predict when or how 

current price discrepancies might be resolved. Of more 

use in this regard may be to assemble anecdotal 

summaries of local trends that may call attention to 

turning points before they become apparent in the 

data. What follows is commentary by analysts in each 

of the Federal Deposit Insurance Corporation’s six 

regional offices and two area offices describing the most 

recent developments in their parts of the nation. 

Atlanta Region: Southeast Housing Markets Are 

Still Going Strong 

Record levels of home sales continue across the 

Atlanta Region, with home price appreciation remaining strong in many metropolitan areas. More than 20 

markets in the Region—all of which were in Florida or 

Virginia—reported home price appreciation in the 

double digits over the past year. However, nearly twothirds of the Region’s metropolitan markets saw price 

gains below the national average, and, primarily in 

Alabama and the Carolinas, increases failed to keep 

pace with inflation. 

Continued price gains have contributed to a decrease 

in affordability in most metropolitan areas, according to 

Economy.com. Over the past year ending second quarter 2004, affordability declined in all but five Atlanta 

Region metropolitan areas. Moreover, in several Florida 

markets as well as Northern Virginia, affordability has 

5 Data from the U.S. Census Bureau. The rental vacancy rate is 

defined as vacant year-round units for rent divided by the sum of 

renter-occupied units plus vacant year-round units rented but awaiting occupancy, plus vacant year-round units for rent. 

6 PMI Mortgage Insurance Co., Economic & Real Estate Trends, 

Summer 2004, http://www.pmigroup.com/lenders/media_ 

lenders/pmi_eret04v3s.pdf; and Celia Chen, “House Price Bubble 

Worries,” Economy.com, July 16, 2004, http://corporate.dismal.com/ 

dismal/pro/article.asp?aid=2872. 

Chart 1 

Growth in U.S. Home Prices Has Outstripped Growth 

in Incomes for Five Consecutive Years 

Percent Change from a Year Ago 

10 Home Recessions 

8 

6 

4 

2 

0 

Price 

Index 

Disposable Per Capita Income

 (four-quarter moving average) 

89 91 93 95 97 99 01 03 

Sources: Office of Federal Housing Enterprise Oversight, U.S. Census Bureau. 

fallen by more than 10 percent. Anecdotal reports 

suggest that some speculative activity in housing is 

occurring in some markets, particularly in South 

Florida. For example, a significant number of condominium units are being delivered in the areas of South 

Florida, the Florida Panhandle, and the Gulf Coast of 

Alabama. These additions to supply are coming from 

two sources: new development and apartment conversions. Further, there is an active precompletion market, 

as some condominiums are being sold multiple times 

(or “flipped”) before delivery. In some cases, interim 

buyers are leveraging their purchases by the use of 

standby letters of credit.7 

Changes in underwriting practices may be contributing 

to ongoing rapid price appreciation in many markets. 

Innovative structures, such as downpayment assistance 

programs, interest-only mortgages, and piggyback loans, 

may allow buyers to purchase more expensive homes 

than they would otherwise be able to afford.8 Further, 

credit impairment, as reflected by low FICO scores or a 

history of loan defaults, does not appear to be a major 

impediment for prospective mortgage borrowers.9 For 

example, one recent news article reported that a home7 Ryan Dezember, “The Condo Game,” Mobile Register, July 6, 2004. 8 James R. Hagerty, “For These Mortgages, Downside Comes Later,” 

Wall Street Journal, October 5, 2004. A piggyback financing structure 

includes two or more loans at origination: for example, a first mortgage in an amount equal to 80 percent of the purchase price and a 

second mortgage in an amount equal to 20 percent of the purchase 

price. This structure eliminates a monthly payment for private mortgage insurance; hence, the borrower can qualify for a higher-priced 

home with the same fixed budget. 

9 Pamela Yip, “Looser Lending Blamed as Foreclosures Rise,” Dallas 

Morning News, October 4, 2004. 

FDIC OUTLOOK 10 WINTER 2004 
Trends in Residential Real Estate Markets 

buyer was able to secure 100 percent purchase-money 

financing despite having experienced a foreclosure just 

a year earlier.10 

Other factors that could disrupt housing markets, 

particularly in Florida, include heightened storm activity and construction input shortages. Through September 2004, four major hurricanes made landfall in the 

Southeast, and their short- and long-term impacts are 

not yet fully known. Going forward, some locations 

could see reduced demand for housing if storm fears 

persist or if insurance costs become prohibitive. In addition, affordability could worsen because of higher costs 

associated with construction material and labor shortages. Hurricane rebuilding efforts likely will intensify 

the pre-existing shortfall in building inputs. 

Scott Hughes, Regional Economist 

Jack Phelps, Regional Manager 

New York Region: Mid-Atlantic Housing Markets 

Still Sizzle, but Some Markets May Be Losing Steam 

The strong home price appreciation observed across 

much of the nation is also evident in a number of MidAtlantic metropolitan areas. Seven Mid-Atlantic 

metropolitan statistical areas (MSAs) ranked among 

the top 50 MSAs in the nation with regard to home 

price appreciation: Albany, New York; Washington, 

D.C.; Baltimore and Hagerstown, Maryland; and 

Atlantic City, Jersey City, and Monmouth-Ocean 

counties, New Jersey. Moreover, half of the MidAtlantic’s 40 metro areas tracked by OFHEO had 

appreciation rates in excess of the national average of 

9.4 percent. Homes are appreciating at high rates in 

suburban areas of larger cities such as Philadelphia, 

Washington, D.C., and New York City. In fact, home 

price appreciation in and around New York City and 

Washington, D.C., has been so strong for more than 

the last five years that it is beginning to rival and even 

exceed the large price increases of the 1980s. 

But after several years of substantial home price appreciation, there are indications that residential real estate 

markets in Mid-Atlantic states may be starting to cool 

off. In New Jersey, brokers report that while the market 

is still strong, multiple offers are not as commonplace as 

they were a few months ago, and high-priced homes are 

sitting on the market longer. In Baltimore, there are 

10 Clint Williams, “A Hunger for Housing,” Atlanta JournalConstitution, August 28, 2004. 

indications that double-digit price increases were in 

part responsible for a 20 percent increase in new listings, suggesting that high prices were prompting more 

homeowners to put their homes on the market. 

However, reports also suggest that houses in Baltimore, 

as in other parts of the Mid-Atlantic, are staying on the 

market longer. Absent dramatic declines in mortgage 

rates, the increase of housing inventories, combined 

with longer listing periods, may portend a slackening 

pace of home price appreciation. 

The recent surge in home prices is attributable in part 

to historically low mortgage rates, which have boosted 

affordability and allowed households to finance increasingly expensive homes. Affordability has not improved, 

however, in many Mid-Atlantic housing markets, 

because low mortgage rates have been more than offset 

by price increases. According to Economy.com, areas 

in and around New York City have become increasingly 

less affordable relative to the nation, closely followed 

by areas around Baltimore and Washington, D.C.11 

Compared with many other areas in the nation, 

developable land is scarcer—and therefore more 

expensive—in those metropolitan areas; and with 

greater population density, demand for housing generally has exceeded supply. 

A July 2004 study by the Center for Housing Policy 

reported that incomes were lagging substantially behind 

housing prices in many parts of the nation.12 The report 

concluded that workers in formerly middle-class occupations such as nursing, teaching, and law enforcement 

could no longer afford a middle-class home in many of 

the nation’s markets. This trend appears to apply to 

several Mid-Atlantic housing markets. For example, 

brokers and real estate analysts report that many public 

servants cannot afford to live in Ann Arundel County, 

Maryland, and must commute an hour to an hour and 

a half from less expensive homes on Maryland’s eastern 

shore. In Annapolis, Maryland, housing affordability 

has become such an issue for first-time homebuyers that 

the city council voted to impose an “affordability” 

requirement on developers that requires them to 

construct low-cost units in any new subdivision with 

more than 30 homes. Another factor that has reduced 

11 Affordability refers to when median family income qualifies for an 

80 percent mortgage on a median-priced existing single-family home. 

It is based on a 25 percent qualifying ratio for monthly housing 

expense to gross monthly income with a 20 percent down payment. 

12 Barbara J. Lipman, “America’s Newest Working Families: Cost, 

Crowding and Conditions for Immigrants,” Center for Housing Policy: 

National Housing Conference 4 (no. 3), July 2003. 

FDIC OUTLOOK 11 WINTER 2004 
In Focus This Quarter: The U.S. Consumer Sector 

affordability is the rapid increase in property taxes that Chart 2 

has accompanied rising market values. Several years of New England House Values Continue to Increase rising assessments on residential property are starting to 

take a bite out of cash flow for many homeowners. 80 20% 

Permits Authorized (L) 

6-Year Change in 

House Prices, 

Conventional 

Mortgages (R) 

1-Year Change in 

House Prices, 

Conventional 

Mortgages (R) 

88 90 92 94 96 98 00 02 04 

70 

However, not every housing market in the Mid- 60 15% 

Atlantic is soaring. Of 128 U.S. metropolitan areas 

studied by the National Association of Realtors 

(NAR), Syracuse, New York, showed the second 

lowest median price ($94,700) in second quarter 

2004.13 According to the NAR, the year-over-year rate 

Thousands of Units

50 

40 10% 

30 

20 5% 

10 

of home price appreciation in Syracuse declined from 0 0%

15.6 percent in third quarter 2003 to just 2 percent in 

second quarter 2004. However, despite slowing price 

appreciation, local real estate agents report that market 

conditions in Syracuse continue to be strong, because 

the level of home prices remains affordable, interest 

rates remain relatively low, and local economic conditions have improved. Home price appreciation also 

remains modest in other parts of upstate New York and 

in western Pennsylvania. As a result, residents in these 

areas have built up less home equity than in other areas 

and may have had less opportunity to convert home 

equity into cash. 

Norman Gertner, Regional Economist 

Boston Area: New England Home Prices Continue 

Exceptional Growth for at Least the Time Being 

This year is almost certain to be another strong year for 

housing in New England following several years of 

exceptional performance with sustained, sizeable price 

increases. Prices of conventionally financed houses in 

New England are likely to average more than 10 percent 

higher this year relative to last year.14 While a single 

year of double-digit growth is impressive in its own 

right, it is even more remarkable that prices have risen 

on average almost 10 percent per year since 1998 (see 

Chart 2). This six-year performance ranks second only 

to the 1980s housing boom in the modern history of 

the Region. 

Partly in response to ongoing increases in house prices, 

new housing construction has been brisk. New housing 

13 National Association of Realtors, “Median Sales Price of Existing 

Single-Family Homes for Metropolitan Areas,” table, http://www. 

realtor.org/Research.nsf/files/REL04Q2T.pdf/$FILE/REL04Q2T.pdf. 

14 Federal Home Loan Mortgage Corporation, “Conventional Home 

Price Index.” Prices are annualized for 2004 based on first-half 

results. 

-10
 

-20
 -5% 

Sources: U.S. Census Bureau, Federal Home Loan Mortgage Corporation, and Federal
 

Deposit Insurance Corporation via Haver Analytics. 2004 Annualized.
 

permits in the Region were issued at an annualized rate 

of over 50,000 during the first seven months of 2004. 

This is the fastest pace of issuance since 1988, a year 

that, coincidentally, marked the beginning of the end 

of the last New England housing boom. This year and 

2003 also mark the return of multifamily construction 

as a major contributor to the supply of new housing, 

accounting for almost one-quarter of total new 

construction.15 This new increase in supply will tend to 

reduce upward price pressures in the housing market. 

While home price increases have been distributed fairly 

evenly across the Region, new construction has tended 

to be concentrated in the relatively less expensive and 

less densely populated states of northern New England 

(see Chart 3). By contrast, southern New England has 

experienced little, if any, growth in the rate of new residential construction. 

Housing demand in New England remained strong 

even as the national and regional economies entered 

a recession in 2001 and recovered slowly thereafter. 

The recession and weakness in the equity markets 

combined to reduce growth in total personal incomes 

in New England from slightly more than 10 percent 

per annum in early 2000 to no growth only two years 

later. Still, during this period of economic weakness, 

sales of existing single-family units dipped only in New 

Hampshire and in Massachusetts, which is the state 

most affected by the recession. Since then, new home 

15 U.S. Census Bureau via Haver Analytics, “New Privately Owned 

Housing Units Authorized in Permit-Issuing Places,” table. 

FDIC OUTLOOK 12 WINTER 2004 
Trends in Residential Real Estate Markets 

Chart 3 

Northern New England Added More Supply as 

House Prices Rose 

Sources: U.S. Census Bureau, Federal Home Loan Mortgage Corporation, and Federal 

Deposit Insurance Corporation via Haver Analytics, 2004 Data. 

Change in Average Level of 

Building Permits Since 1998 

Average Annual Increase in

House Prices Since 1998 

-20% 

-15% 

-10% 

-5% 

0% 

5% 

10% 

15% 

20% 

25% 

30% 

Maine

Connecticut

Rhode Island

Massachusetts

New

Hampshire

Vermont 

United States 

New England

sales generally have increased within the Region, rising 

to near-record levels in each of the six New England 

states by mid-2004. 

Frederick S. Breimyer, Regional Economist 

Chicago Region: Housing Markets Appear Healthy, 

and Immigrants Play a Role 

High levels of single-family home construction and 

resales in the Region reflect that housing demand 

remained strong through mid-2004.16 The pace of 

home price appreciation varied among the Region’s 

59 MSAs but was generally moderate.17 

Among the Region’s largest MSAs, appreciation was 

strongest in Chicago, where price gains averaged 6.7 

percent a year between the second quarters of 2002 and 

2004. Contrasting home price trends in the Region’s 

most industrialized states, Indiana and Wisconsin, 

partly may reflect the fact that manufacturing employment in Wisconsin rose by 0.9 percent in the year 

ending second quarter 2004 and fell by 0.6 percent in 

Indiana. Eight MSAs in the Region, mostly in Indiana, 

experienced less than 3 percent annual appreciation in 

the past two years. In contrast, seven of 13 MSAs with 

16 The Chicago Region consists of Illinois, Indiana, Kentucky, Michigan, Ohio, and Wisconsin. 

17 Appreciation rates are based on data from OFHEO that measure 

average prices of repeat sales or refinancings on the same singlefamily properties where the transactions involve conforming, conventional mortgages purchased or securitized by Fannie Mae or Freddie 

Mac. 

annual appreciation between 5.0 percent and 9.2 

percent were in Wisconsin. In other MSAs scattered 

throughout the Region, home price appreciation averaged between 3.0 percent and 3.9 percent in 23 of 

them and between 4 percent and 5 percent in the 

remaining 15. 

The Chicago MSA’s large and growing immigrant 

population is helping spur local housing demand. 

Chicago is one of nation’s major immigrant destinations, and most of the estimated 40,000 immigrants to 

Illinois each year settle in Chicago or its suburbs. This 

growing immigrant population provides new customer 

opportunities for residential developers and lenders.18 

In fact, immigrants recently have purchased up to 20 

percent of newly constructed homes in some Chicago 

suburbs, about four times more than ten years ago.19 

Some developers, in turn, increasingly are tailoring 

their construction, design, and marketing to immigrant 

and ethnic groups, and some banks are expanding their 

efforts to serve this market. 

Although some immigrants are considered to be undocumented, they may account for as much as $10 billion 

of potential mortgage lending in the Chicago area.20 

The untapped market is large and potentially profitable 

for lenders, who reportedly charge an additional 25 

basis points to 100 basis points of interest on mortgages 

to undocumented persons, with the markup reflecting 

the size of the down payment and the lack of a secondary market for such loans.21 

Serving this customer pool, however, may require banks 

to modify some long-standing practices. Some lenders 

have changed their policies to accept consular identification cards rather than Social Security cards as identification from depositors and loan applicants. Banks 

making mortgage loans to undocumented immigrants 

forfeit the ability to the sell mortgages in the secondary 

market to Fannie Mae and Freddie Mac, because such 

loans fail to meet their specifications. 

18 See “Banks Are Still Sizing Up Opportunities in the Growing
 

Hispanic Market” by Jeffrey A. Ayres, Stephen L. Kiser, and Adrian R.
 

Sanchez in this issue.
 

19 John Handley, “Destination Chicago: Immigrants Put Their Stamp
 

on Suburban Housing, Buying up to 20% of New-Construction
 

Homes,” Chicago Tribune, May 11, 2003. 
 20 Steve Daniels, “No Documents? No Problem,” Crain’s Chicago
 

Business, April 19, 2004.
 21 Ibid.
 

FDIC OUTLOOK 13 WINTER 2004 
In Focus This Quarter: The U.S. Consumer Sector 

To the extent that banks and thrifts follow prudent risk 

management, operational, and underwriting standards, 

serving immigrants may provide a profitable channel 

for deposit, loan, and fee growth among insured institutions in the Chicago market and in other areas with 

large immigrant populations or inflows. 

Joan Schneider, Regional Economist 

David Van Vickle, Regional Manager 

Kansas City Region: Steady Conditions Predominate 

Housing markets in the Kansas City Region remain 

relatively stable. While home prices in metropolitan 

areas have increased moderately over the past couple 

of years, these increases are generally judged to have 

been in line with job growth and other economic 

fundamentals. 

In the Kansas City metropolitan area, homes in Johnson County, Kansas, continue to have the highest 

average sales prices, followed closely by homes in Platte 

County, Missouri. Within Johnson County, Olathe 

continues to see particularly high levels of new home 

construction to meet the needs of a rapidly increasing 

population. Wyandotte County, Kansas, which has 

more moderate prices than Johnson County, experienced much higher increases in average new home 

prices over the past year (16.8 percent), as the new 

racetrack and shopping continue to draw residents. 

Outlying counties such as Miami County, Kansas, are 

seeing even higher growth in resale prices as buyers 

continue to move further from downtown in search of 

more affordable homes. 

While the Minneapolis-St. Paul metropolitan area has 

experienced strong price increases over the past few 

years, at present, inventories of new and resale homes 

appear to be in balance, with the average home staying 

on the market for about five months before sale. 

However, according to the Minneapolis Area Association of Realtors, demand for higher-priced homes is 

beginning to wane, and selling times are expected to 

increase to over a year in the near future. While the 

median home price in the metropolitan area is higher 

than in the nation as a whole, the relative affordability 

of homes in this market is reflected in a local homeownership rate of more than 75 percent, compared with 

69 percent nationwide. 

In the St. Louis metropolitan area, current sales 

volume is brisk, but the pace is expected to slow over 

the next six months. The median home price has risen 

by about 5 percent during the last year, driven mostly 

by “move-up” sales to larger homes and by historically 

low interest rates. The St. Charles area has seen the 

greatest growth in new home construction, mainly due 

to lower land prices and a greater availability of building sites than in other parts of the metropolitan area. 

One outlier market in the Region is Wichita, which 

continues to suffer job losses resulting from the struggling aircraft manufacturing industry. Existing home 

prices have fallen over the past year, while new home 

prices have increased slightly. Overall, home prices in 

Wichita have declined about 2 percent this year from 

January through August 2004. 

Tight supplies of building materials are causing 

concerns for some builders and contractors. Recent 

shortages reportedly have added about 6 percent to the 

cost of new construction in the Region and threaten to 

constrain growth going forward. Delays in getting materials to job sites have reportedly increased lead times, 

which are the times between ordering and receiving 

building supplies, to three months. While such delays 

could hamper construction, they have not yet translated into a reduction in building permits, which 

remain strong in the Kansas City, St. Louis, and 

Minneapolis markets. 

John M. Anderlik, Regional Manager 

Shelly M. Yeager, Financial Analyst 

Memphis Area: No Apparent Signs of Overheating 

in Mid-South Markets 

A review of published reports and routine data series 

revealed no imminent signs of market-wide housing 

bubbles for any of the metro areas in the Mid-South, 

which comprises Arkansas, Louisiana, Mississippi, and 

Tennessee. Some factors that seem to be prominent in 

the national markets experiencing the most rapid price 

increases, such as the limited availability of building lots 

and cumbersome entitlement requirements, are largely 

absent in the Mid-South. According to data collected 

by OFHEO, home prices in these four states have 

risen 51 percent in the past ten years compared with 

73 percent for the nation as a whole, and 22 percent in 

the past five years compared with 44 percent for the 

nation. Of all the major markets in the Region, New 

Orleans, Monroe, and Houma, Louisiana, experienced 

the strongest ten-year rate of home price appreciation; 

however, they ranked only 110th, 127th, and 128th in 

FDIC OUTLOOK 14 WINTER 2004 
Trends in Residential Real Estate Markets 

the nation, respectively. Housing affordability has 

remained fairly stable in these markets, as per capita 

income has grown at rates near the national average 

and in line with the pace of home price appreciation. 

As noted in Money Magazine, “If you live in the many 

states where home-price gains have been more modest, 

the odds strongly favor more of the same. There’s a 

much tighter relationship between home prices and 

incomes in Middle America than on the coasts. In 

California and Rhode Island, the correlation between 

home prices and income is ten times weaker. The main 

reason: There’s more buildable land away from the 

coasts, so the balance between supply and demand 

rarely gets out of whack.”22 

Although it does not appear likely that housing prices 

will drop rapidly across the Mid-South Region, some 

submarkets and price ranges could experience imbalances that might result in increased inventories of 

unsold homes, longer selling times, and possible price 

declines. One area that merits close monitoring is the 

starter-home segment, where generational lows in mortgage rates have made owning a home more attractive 

than renting. However, rising interest rates could raise 

monthly payments beyond the capacity of many potential buyers and may also raise the debt-service costs of 

homebuilders, limiting their ability to continue incentive programs that have been stimulating demand. 

Paul Vigil, Financial Analyst 

Dallas Region: Residential Real Estate Round-Up 

Residential mortgage foreclosures in Texas were the 

12th highest in the nation as of mid-year and do not 

appear poised to improve anytime soon. September 

mortgage foreclosures in Dallas County were 21 

percent higher than a year ago, while the increase was 

22 percent in Travis County and 35 percent in Bexar 

County. Growth in jobs and wages remain the key 

drivers supporting home price appreciation, and in this 

regard, each market has its unique set of circumstances. 

Employment growth is still lackluster for most metro 

areas. For example, the Dallas metro area experienced 

two recent job loss announcements. First, Delta 

Airlines stated that it will discontinue operations out of 

22 Jon Birger, “What’s Next for Real Estate: Another Hot Year for Home 

Prices Has Some Wondering Whether Real Estate Is Poised to 

Tumble,” Money Magazine, March 1, 2004. 

Dallas/Fort Worth International Airport, cutting an 

estimated 3,600 direct jobs in North Texas. Electronic 

Data Systems (EDS) also announced a downsizing of 

between 13 percent and 17 percent, affecting some of 

the 7,700 EDS jobs in the Dallas area. 

The San Antonio metropolitan area currently reflects a 

set of contradictory trends that could begin to show up 

in other parts of the country as well. While metro-area 

foreclosure rates are among the highest on record, the 

issuance of residential building permits is also at record 

high levels. One reason these seemingly contradictory 

trends can take place at the same time is that the city 

continues to grow primarily in the north, where most of 

the new building is taking place, while foreclosure rates 

have been increasing in the slower-growing southern 

part of the city. 

In Oklahoma, mortgage foreclosures continue to rise 

to the highest level in a decade, ranking sixth highest 

nationwide. Personal bankruptcy filings per capita in 

Oklahoma are also in the top quartile among the 

states, suggesting that many consumers have been 

under significant financial pressure. Oklahoma 

employment growth turned positive in April for the 

first time since late 2001 but still ranks in the bottom 

half of the nation. 

One Southwest Dallas Region metro area that is listed 

on many analyst watch lists for home price–income 

gaps is Denver, Colorado. According to OFHEO, the 

Denver housing price index has increased 41 percent 

over the past five years, which is the fastest metro rate 

of growth in the four-state Southwest Region. Moreover, the Denver ratio of median home price to household income is at its highest year-end level (4.66 times) 

since 1980. 

Jeffrey A. Ayres, Senior Financial Analyst 

San Francisco Region: Analysts Are Becoming More 

Wary of Price Increases 

Strong home price appreciation in several areas of the 

San Francisco Region has fueled household wealth 

and spending and helped to keep foreclosure and bankruptcy rates low. However, home price increases in 

Nevada, Hawaii, and California, which reported the 

three highest rates of annual home price appreciation 

nationwide in second quarter 2004, may not be 

sustainable. A respondent from the banking industry 

FDIC OUTLOOK 15 WINTER 2004 
In Focus This Quarter: The U.S. Consumer Sector 

who follows the western residential market warned 

that at some point, the trend of increasing appreciation and decreasing affordability will have to come to 

an end, a sentiment echoed by several industry sources 

in the Region. 

Nevada’s rapid home price appreciation was spurred in 

part by robust increases in population, jobs, and new 

home construction costs. Speculative purchase activity 

may have also played a role.23 While home prices in 

Nevada still remained relatively attractive when 

compared with several other West Coast states, a 

respondent in academia noted, “Recent home price 

appreciation has started to dry up housing affordability, 

and this may become an issue for Las Vegas and 

Nevada down the road.” 

Following years of sub-par home appreciation, Hawaii 

home prices picked up steam in 2002 and have continued to appreciate, reaching 19 percent appreciation in 

second quarter 2004. Recent appreciation is attributed 

to an improved economy, favorable interest rates, and 

renewed interest in home buying by both Hawaii residents and investors. Another respondent in the banking industry noted that mainland investors have driven 

much of the state’s home price appreciation, particularly in Maui and Kauai. 

In supply-constrained California, where 13 MSAs 

ranked in the top 20 nationally for annual price appreciation, concerns of an emerging bubble may have 

increased.24 A market respondent defined a bubble as 

when you “buy not for the roof, but for the money, for 

speculation.” The respondent also indicated that speculative home purchases may be on the rise in Southern 

California, although they are not evident in Northern 

California. In particular, Orange County’s “flipping” 

rate, or share of homes sold after being owned less than 

six months, is near its historic high. 

Both single-family and construction lenders could face 

loan growth and asset quality challenges should markets 

cool as a result of rising interest rates. Some insured 

institutions based in areas with rapidly appreciating 

home prices, such as Las Vegas, Honolulu, and Central 

and Southern California could be particularly vulnerable, because they also appear to be exposed to some 

combination of high single-family mortgage or 

construction loan concentrations, significant volumes 

of variable-rate mortgages, and potentially speculative 

purchase activity. 

Shayna Olesiuk, Regional Economist 

Judy Plock, Senior Financial Analyst 

John A. Roberts, Regional Economist 

23 “Foreclosures.com: Las Vegas Home Price Bubble Set to Deflate,” 

Mortgage Mag, August 23, 2004, 

http://www.mortgagemag.com/n/408_032.htm. 

24 Markets reporting the fastest rates of annual price appreciation 

were predominantly in Southern and Central California. 

FDIC OUTLOOK 16 WINTER 2004 
Home Equity Lending: Growth and Innovation 

Alter the Risk Profile 

As a component of the mortgage lending business, 

home equity lending has traditionally been characterized by low credit losses. However, recent trends reveal 

a rapidly changing landscape in the way that home 

equity lines of credit (HELOCs) are used by household 

borrowers and structured by mortgage lenders. Home 

equity debt is rapidly growing as a percentage of total 

household indebtedness, in part as a result of new loan 

programs that make HELOCs more accessible to 

borrowers, including groups of people who previously 

would not have had access to this product. 

Amid these longer term changes in the marketplace, the 

current environment offers the additional challenges of 

rising short-term interest rates and the likelihood that 

home price gains will eventually level off in some of the 

nation’s pricier home markets.1 As a result of these 

trends, it is increasingly uncertain whether the traditionally low credit losses associated with home equity 

lending will remain a permanent attribute of this line 

of business. In any event, the changes being wrought by 

the marketplace are requiring both lenders and borrowers to think about home equity products in new ways. 

(See the inset box for information on HELOCs versus 

home equity loans.) 

Households Shift toward Mortgage Debt 

Over the past 20 years, the composition of household 

debt has shifted decidedly in favor of mortgage debt. 

Chart 1 shows that mortgage debt has risen from 64 

percent of total household debt in 1985 to a new high 

of more than 72 percent in 2003. While the relative 

use of mortgage debt has risen and fallen over time in 

response to such factors as home prices and mortgage 

interest rates, the general trend since the mid-1980s 

has been upward. One important factor in this longterm trend was the Tax Reform Act of 1986, which 

eliminated the tax deduction for consumer credit and 

expanded the home mortgage interest deduction. 

Since 1986, cumulative inflation-adjusted growth in 

household mortgage debt has been 151 percent, 

compared with growth of 88 percent in nonmortgage 

consumer credit. 

1 See “A Turning Point Ahead? National and Regional Trends in Residential Real Estate Markets” in this issue. 

Recently, preference by households for mortgage debt 

has become even more pronounced. Since the end of 

2000, total mortgage debt owed by households has 

soared by $2.25 trillion, or 47 percent. Two principal 

factors account for this recent increase in mortgage 

indebtedness: a rapid accumulation of owners’ equity 

in residential real estate and a sustained decline in 

mortgage rates to historic lows. 

The equity held by U.S. households in their homes 

has also risen sharply of late (by almost $2.2 trillion 

since 2000) as homeownership has spread and home 

prices have surged. The percentage of U.S. households 

that own their own homes reached a record high of 

69.3 percent in second quarter 2004, reflecting the 

addition of more than 12 million new homeowner 

households in the past ten years. This increased 

demand for housing, in turn, has helped push home 

prices higher. The repeat-sale home price index of the 

Office of Federal Housing Enterprise Oversight 

(OFHEO) rose by nearly one-third from 2000 to 2003, 

and none of the 331 individual U.S. metropolitan 

areas covered by the OFHEO index has seen an 

annual price decline since 2000. 

As home prices have surged, home construction has 

remained brisk. The annual number of new homes 

started has exceeded 1.5 million units in every year 

since 2000, rising steadily during that time to an 

18-year high of 1.85 million units in 2003. 

Chart 1 

Mortgage Debt Has Risen as a Percentage of
 

Total Household Debt, Particularly Since the
 

Tax Reform Act of 1986
 

Mortgage Debt to Total Household Debt 

(percent) 

74
 

72
 

70
 

68
 

66
 

64
 

62
 

60
 

58
 

56
 

1986 Tax 

Reform Act 

70 73 76 79 82 85 88 91 94 97 00 03 

Source: Federal Reserve Flow of Funds. 

FDIC OUTLOOK 17 WINTER 2004 
In Focus This Quarter: The U.S. Consumer Sector 

Home Equity Lending: HELOCs versus Home Equity Loans
 

Home equity lending comprises two types of loans secured by junior or senior liens on 1–4 family residential properties: (1) HELOC, an open-end, revolving credit that is typically tied to a variable interest rate and allows borrowing 

of any repaid loan amounts, and (2) home equity loan (HEL), a closed-end, one-time credit with fixed interest rate 

and repayment amounts. Table 1 shows that home equity lending as a whole is dominated by HELOCs, which 

compose almost 80 percent of market share. HELOCs also account for almost all of the recent growth in home equity 

lending, averaging 30 percent quarterly growth since 2000, while HELs have been relatively flat. Because of their high 

market share, soaring growth, and exposure to interest rate risk, HELOCs are the focus of this article. 

Table 1 

Volume of Home Equity Lending by Type of Financial Institution (billions of dollars) 

Year Home Equity Loans Home Equity Lines of Credit 

Banks Thrifts Banks Thrifts 

1990 NA NA $69,441,439 $16,380,648 

1995 $66,116,479 NA 85,027,381 12,889,414 

2000 163,677,595 NA 133,271,483 17,484,625 

2004 (first half) 88,428,888 $19,292,495 356,811,082 58,994,633 

Notes: All FDIC-insured institutions report financial results on a quarterly basis by filing standardized forms: Banks file Reports of Condition and Income (Call Reports) and thrifts file Thrift 

Financial Reports (TFRs). Before 2004, TFR filers did not report home equity loans; Call Report filers began reporting home equity loans in 1991. NA = not available. 

Source: Federal Deposit Insurance Corporation. 

Sustained low mortgage interest rates have provided 

the backdrop for rising mortgage indebtedness, rising 

home prices, and rapid home construction. An industry 

standard measure of mortgage rates is the Freddie Mac 

contract rate for 30-year conventional mortgages. 

Between the inception of this series in 1971 and mid2002, the Freddie Mac contract rate had never dipped 

below 6.5 percent. However, this rate has remained 

below 6.5 percent in every month since June 2002, 

dipping briefly to an all-time low of 5.23 percent in 

June 2003. 

Such historically low mortgage rates not only have 

prompted households to take on mortgage debt to buy 

new homes but have spurred record volumes of mortgage refinancing. Homeowners have taken advantage of 

historically low interest rates to consolidate mortgages 

and refinance at lower rates, often taking cash out. The 

Mortgage Bankers Association (MBA) Mortgage Refinance Index climbed to all-time records in 2001, 2002, 

and 2003. As mortgage rates bottomed out, refinancing 

volumes peaked in June 2003, but they have fallen 

sharply since then. From June 2003 to June 2004, 

30-year fixed mortgage rates increased more than 100 

basis points, and the MBA refinance index dropped to 

its lowest point in two years. Indeed, the MBA recently 

forecast that the dollar volume of refinancings would 

decline 57 percent in 2004 from a record $2.5 trillion 

in 2003.2 

Home Equity Lending Becomes a Preferred Vehicle 

Both during and since the 2002–03 boom in mortgage 

refinancings, HELOCs have experienced explosive 

growth (see Chart 2). The average annualized quarterly 

rate of growth of HELOCs carried on the books of 

FDIC-insured institutions since the end of 2000 has 

been 30.2 percent. HELOCs are now the fastest growing asset class on financial institutions’ balance sheets 

and comprise 7 percent of bank loan portfolios, up from 

3 percent in 2000. 

The rationale for homeowners’ greater use of HELOCs 

is straightforward. With consumer spending outpacing 

income growth in the 2000s, homeowners have turned 

increasingly to home equity lending as a substitute for 

consumer credit to finance new consumption, reduce 

2 Mortgage Bankers Association, “MBA Mortgage Finance Forecast,” 

August 13, 2004. 

FDIC OUTLOOK 18 WINTER 2004 
Home Equity Lending: Growth and Innovation 

Chart 2 

Home Equity Loans Are the Fastest Growing Asset
 

Class on Financial Institutions’ Balance Sheets
 

Percent Change from a Year Ago 

45 

40 

35 

30 

25 

20 

15 

10 

5 

0 

-5 

Source: Federal Deposit Insurance Corporation. 

Home Equity 

Lines of Credit 

All Assets 

2Q92 2Q93 2Q94 2Q95 2Q96 

2Q97

2Q98 

2Q99 

2Q00

2Q01

2Q02 

2Q03 

2Q04 

outstanding debt, or purchase a home in a two-loan 

package deal.3 The appeal over other more costly credit 

alternatives derives from the significant advantages of 

comparatively low interest rates, tax deductibility, and 

easy availability, since income and cash flow tests 

matter less for determining credit lines than for credit 

cards or auto loans. Furthermore, because HELOCs 

offer the flexibility to draw money only as needed and 

the convenience of a revolving credit line, borrowers 

favor HELOCs more and more over closed-end home 

equity loans.4 For these reasons, many homeowners are 

converting the equity in their home into cash through 

home equity borrowing and making this kind of transaction an increasingly important part of their household finances. With the dramatic decline in mortgage 

refinancing volumes since mid-2003, a homeowner 

would more likely choose to tap home equity through 

a draw on a HELOC rather than extract cash as part of 

a refinancing. 

A rising volume of HELOC debt also has a rationale 

from the lender’s perspective. Mortgage lenders are 

looking to home equity products to replace loan 

volumes that have declined in the wake of the refinancing boom. According to America’s Community 

3 A home purchase can be transacted with a two-loan package deal, 

or piggyback loan, wherein a buyer typically makes a 10 percent cash 

down payment and finances the rest with a first-lien mortgage of 80 

percent and a home equity loan for the remaining 10 percent. Borrowers who typically use piggyback loans may be financially stretched 

and unable to pay a 20 percent cash down payment, want to sidestep 

private mortgage insurance premiums, or wish to avoid a jumbo-rate 

first mortgage. 

4 HELOCs led home equity loans with 79 percent of market share as of 

June 2004 (see Table 1). 

Chart 3 

Loan Production Efforts Are Targeting Home Equity
 

Lending over Other Loan Types
 

Estimated Changes in Loan Production in 2004 

Home Equity 

Commercial 

Real Estate 

Construction 

Single Family 

Multifamily 

64% 

45% 

38% 

25% 19% 

20% 

27% 

42% 

45% 

56% 

60% 

9% 

13% 

17% 

20% 

0%	 20% 40% 60% 80% 100%

 Increasing Same Decreasing 

Source: America's Community Bankers 2004 Real Estate Lending Survey. 

Bankers’ 2004 Real Estate Lending Survey, 56 percent 

of survey respondents expected single-family residential 

loan production to decline this year as the refinancing 

boom slows; however, by a larger margin (64 percent), 

they expected an increase in home equity lending (see 

Chart 3).5 Clearly, lenders anticipate that consumers 

will turn more to home equity lending as refinancing 

activity wanes. 

The challenge for lenders in this post-refinance period 

is not only to lift production of new HELOCs but also 

to get customers to draw more against existing lines. 

Although HELOC outstandings totaled $415.8 billion 

in second quarter 2004, this represented only half of 

the total approved borrowing limits, or commitments, 

on those lines. The utilization rate for HELOCs was 

almost 49 percent as of second quarter 2004, leaving 

$435 billion sitting untapped in committed home 

equity lines extended by banks (see Chart 4). This 

untapped amount represents a substantial source of 

potential fee income for lenders and available cash for 

consumers. 

New Incentives to Boost Home Equity Borrowing 

In addition to offering low introductory teaser rates 

common with many adjustable-rate credit products, 

lenders have an array of innovative products, marketing 

5 The results of the America’s Community Bankers’ 2004 Real Estate 

Lending Survey correspond with those of the Office of the Comptroller 

of the Currency’s 2003 Survey of Credit Underwriting Practices (see 

note 6), which reported that home equity lending has grown tremendously in recent years and that many banks plan to continue to 

increase this product over the next year. 

FDIC OUTLOOK 19	 WINTER 2004 
2Q90

2Q91

2Q92

2Q93

2Q94

2Q95

2Q96 

2Q97 

2Q98 

2Q99 

2Q00

2Q01

2Q02 

2Q03 

2Q04 

In Focus This Quarter: The U.S. Consumer Sector 

Chart 4 

The Unused Portion of Home Equity Lines of Credit 

Represents a Huge Amount of Potential Borrowing 

HELOC Utilization Rate Unused HELOC Commitments 

(percent) ($ billions) 

65 500 

450 

60 400 

350 

55 300 

250 

50 200 

150 

45 100 

50 

40 0 

Source: Federal Deposit Insurance Corporation. 

techniques, and sales incentives to attract new HELOC 

borrowers and encourage increased draws by existing 

borrowers (see Table 2). The objectives underlying 

lenders’ efforts to increase home equity lending are to 

Table 2 

obtain new borrowers (for whom borrowing cash by 

tapping into their home’s equity with a cash-out refinancing becomes more costly and less appealing as rates 

rise) and to encourage existing HELOC borrowers to 

draw down their unused commitments. 

Not only are many of these structures floating-rate 

products and thus exposed to rising interest rates, 

but many also have a loss experience that has been 

untested by a general downturn in the housing market. 

For example, interest-only loans often require a 

balloon, or lump-sum, payment when the term of 

the loan ends. Home equity disclosures do not require 

the creditor to disclose the amount of any balloon 

payment that will result under the terms of the plan. 

In addition, payments on some loans may not cover 

the interest due so negative amortization will occur, 

resulting in the loan balance increasing rather than 

decreasing and the borrower repaying a much larger 

loan amount in the long run. Lenders who extend 

HELOCs with a credit limit that automatically 

Creative Ways Banks Are Targeting Home Equity Line of Credit (HELOC) Loans 

To Produce New HELOCs, Banks Are 

• Offering loans that meet different needs, such as 

• Purchase-and-renovate loans that allow borrowers to finance a home purchase plus remodeling expenses based on 

the home’s value after improvements are made. 

• Loans whose credit limit increases automatically as the home appreciates in value, with monthly reports of the line 

increase due to equity build-up. 

• Interest-only loans, which often require a balloon, or lump-sum, payment when the plan ends. 

• HELOCs with fixed rates for the first three, five, or seven years to allay fears of rising rates. 

• Sending personalized mailings that estimate equity in a customer’s house and the cash available through home equity 

products. 

• Performing data analyses on mortgage portfolios to alert certain customers that they have been preapproved for a home 

equity product, and offering them a streamlined application with the vast majority of information prepopulated. 

• Using automated valuation models outside of the origination process to identify potential borrowers with delinquent credit 

cards and alert them to the possibility of consolidating credit card debt with a HELOC. 

• Providing online application and decisioning services that enable borrowers to receive instant online approval of their 

HELOC applications and obtain funds in as little as two weeks. 

To Increase the Use of Existing HELOCs, Banks Are 

• Charging nonuse fees on lines that are open but inactive. 

• Giving discounts on interest rates if use is increased by a certain amount. 

• Requiring that a certain outstanding loan balance be maintained for a period of time (e.g., 25 percent of the maximum 

credit line for 36 months) to receive an initial introductory rate and avoid an introductory rate reimbursement fee. 

• Offering lower rates for automatic deduction of loan payments from a bank account. 

• Giving rewards to loan representatives if funds are drawn within six months after a HELOC is opened. 

• Allowing customers to earn reward points if they access HELOC funds with a credit card-type vehicle. 

FDIC OUTLOOK 20 WINTER 2004 
Home Equity Lending: Growth and Innovation 

increases as the home appreciates or a credit line based 

on future value are gambling that home prices will 

continue to increase. Finally, HELOC borrowers who 

increase their draws may not be aware that the higher 

their use of this revolving line of credit, the more it 

negatively affects their credit score. 

Underwriting Practices for HELOCs 

The fact that HELOC credit losses have remained low 

and stable over time can be attributed largely to underwriting practices that evaluate borrowers effectively and 

provide the lender protections against default. Like 

other areas of consumer and mortgage finance, HELOC 

underwriting typically is based on quantitative credit 

models that relate credit scores and other criteria to a 

probability of default. While these models are by no 

means perfect, they offer lenders considerable insight 

into how well actual loan performance compares with 

model-based predictions. Stability in loan performance 

also has been greatly enhanced by the fact that 

HELOCs are secured by the equity in the borrower’s 

home. Depending on the loan-to-value ratio of the 

credit, the presence of collateral may not offer a significant source of recovery to the lender in the case of 

default. Even when this is the case, however, the 

prospect of losing one’s home remains a powerful deterrent against default. 

Because of the tremendous growth of HELOC lending 

in recent years, concern has arisen that home equity 

underwriting practices have eased. Indeed, home 

equity products exhibited the greatest increase in risk, 

according to the 2003 Survey of Credit Underwriting 

Practices conducted by the Office of the Comptroller 

of the Currency (OCC). Although the performance 

of home equity loans remains strong, as demonstrated 

by low delinquency rates, the survey noted that 

“banks need to be alert to the risks that are introduced when high growth is coupled with liberalized 

underwriting.”6 

The OCC’s reference to liberalized underwriting methods may allude to underwriting methods that are increasingly used by home equity lenders but may carry certain 

modeling risk due to the absence of a significant housing market downturn in over a decade and a mild reces6 Office of the Comptroller of the Currency, 2003 Survey of Credit 

Underwriting Practices, September 2003, http://www.occ.treas.gov/ 

2003underwriting/creditunderwriting2003.htm. 

sion in 2001. In 2003, 44 percent of lenders used autodecisioning (defined as systematic credit decisioning 

with no manual intervention) in support of credit underwriting, up from 13 percent in 1999, and 84 percent 

used credit scoring, up from 68 percent in 1999.7 

Lenders should be especially cognizant of underwriting 

practices during a period of change in the macroeconomic environment. The two biggest issues here that 

bring up questions are interest rates and home prices. 

Specifically, how fast and how far will interest rates rise 

during the present period of tightening monetary 

policy? Also, when will home prices ultimately level 

off, and could they actually decline in certain highpriced metropolitan areas? Because HELOC interest 

rates are typically tied to benchmark short-term interest 

rates, rising rates make it more expensive for borrowers 

to service their debt. Higher rates could also dampen 

demand on the part of new homebuyers, thereby slowing the rate of home price increases. Should home 

prices stagnate or fall, the most important effect for 

lenders could well be an erosion in the equity position 

of some homeowners that will marginally reduce their 

incentive to repay the HELOC. 

Lenders should also be aware of HELOC use. Drawdown rates for HELOCs are edging up, from 44.4 

percent in first quarter 2000 to 48.3 percent in first 

quarter 2004. However, these utilization rates remain 

well below the peak of 60.7 percent reached in first 

quarter 1991. The utilization rate is an important 

metric for lenders to watch, because a rise could indicate that consumers are drawing more on HELOCs for 

spendable cash and are in a weaker position to repay 

the loans. 

Credit Performance Remains Strong... 

To date, loan delinquencies have remained at historically low levels due to strong housing market fundamentals and low interest rates. In the area of home 

equity lending, such trends are even more pronounced. 

As home equity lending has soared in the past five 

years, more than doubling its share of total loans in 

bank portfolios, its credit performance has shown 

consistent improvement. The proportion of delinquent 

to total HELOCs was at 0.51 percent in second quarter 

2004 (see Chart 5). This was the second lowest 

7 Consumer Bankers Association, 2003 Home Equity Study, November 

2003. 

FDIC OUTLOOK 21 WINTER 2004 
2Q01

3Q01

4Q01

1Q02

2Q02

3Q02

4Q02

1Q03

2Q03

3Q03

4Q03

1Q04

2Q04 

In Focus This Quarter: The U.S. Consumer Sector 

Chart 5 Chart 6 

Bank Home Equity Loan Performance Continues to Improving Loan Performance May Indicate, However, 

Strengthen and Remains Much Improved Compared That Home Equity Loans Are Highly Unseasoned and 

with the Rest of the Industry May Mask Credit Risk 

Past-Due Loans Weighted Average Seasoning of Home Equity Pools
 

Past-Due and Nonaccrual Draws to Total Loans (months)
 

3.0 Total Loans and Leases 24 1.4

23 1.2 2.5 

(percent) 

2.0 

1.5 

1.0 

0.5 

22 

Past-Due HELOCs 

Past-Due and Nonaccrual Draws to Total Draws 

(percent) 

1.0 21 

20 0.8

19 0.6 

18 0.4 17 

0.2 16 Home Equity Lines of Credit 15 0.0 0.0 

2Q96 2Q97 2Q98 2Q99 2Q00 2Q01 2Q02 2Q03 2Q04 

Source: Federal Deposit Insurance Corporation. 

delinquency rate for all major loan categories, just 

behind multifamily properties at 0.53 percent, and far 

below 1.70 percent for all loans and leases. 

...But Most Loans Are New 

The rapid increase in new loans, however, has shortened the seasoning of home equity pools, or their 

collective “age.” The weighted average seasoning of 

home equity pools has declined considerably, according 

to Moody’s Investors Service quarterly home equity 

index. Seasoning had shortened to just 15.89 months as 

of second quarter 2004 (see Chart 6). Loans typically 

move into their peak period of delinquency risk at 

around 36 months of age.8 Thus, the improving loan 

performance of HELOCs may merely reflect the fact 

that home equity loans are highly unseasoned. This 

situation may mask any potential increase in credit risk 

arising from the more aggressive loan structures introduced in recent years. 

Subprime Borrowers Present Credit Concerns 

Credit quality concerns are most pronounced in the 

case of subprime households. Among subprime HELOC 

borrowers, delinquencies were high at 5.43 percent in 

second quarter 2004, compared with only 0.51 percent 

for overall HELOC borrowers (see Chart 7). Rising 

interest rates may well propel this rate higher, particularly since lower income households, whose incomes 

8 National Mortgage News, October 29, 2001, citing Moody’s Investors 

Service. 

Sources: Moody's Investors Service; Federal Deposit Insurance Corporation. 

may already be strained, account for the highest proportion of subprime home equity borrowers.9 

Risk Management Considerations 

Home equity lines account for a still small, but rapidly 

increasing, portion of the loan portfolios of FDICinsured institutions. Despite the continued low credit 

losses that lenders are experiencing in these portfolios, 

changes in the marketplace are raising some concerns 

about future credit quality trends. Outstanding 

balances continue to rise rapidly as homeowners take 

advantage of increases in their home equity and historically low interest rates. Lenders, in turn, have targeted 

HELOCs as a new growth area in the aftermath of the 

refinancing boom. To further increase loan originations in the home equity lending area, lenders are 

using a number of new marketing techniques and loan 

structures with which they have comparatively limited 

experience to date. 

Although the underwriting techniques typically 

applied to HELOC loans make good use of available 

quantitative data and modeling techniques, there is 

evidence that risks are rising. Besides rapid growth 

and new lending techniques, a changing macroeconomic environment also poses challenges. The recent 

period of historically low interest rates and rapidly 

increasing home prices was particularly conducive to 

the use of HELOC credit by homeowners and to their 

9 Edward M. Gramlich, “Subprime Mortgage Lending: Benefits, Costs, 

and Challenges,” at the Financial Services Roundtable Annual Housing Policy Meeting, Chicago, Illinois, Federal Reserve, May 21, 2004. 

FDIC OUTLOOK 22 WINTER 2004 
Home Equity Lending: Growth and Innovation 

Chart 7 ability to service that debt. However, to the extent 

The Number of Seriously Delinquent Subprime Home 

Equity Borrowers Has Trended Up Sharply Since 2000 

Delinquent Borrowers 

(percent of total) 

7.0 

6.0 

5.0 Subprime Junior Lien Borrowers 

4.0 

3.0 

All HELOC Borrowers 2.0 

1.0 

0.0 

2Q99 4Q99 2Q00 4Q00 2Q01 4Q01 2Q02 4Q02 2Q03 4Q03 2Q04 

Sources: Federal Deposit Insurance Corporation; Loan Performance Corporation. 

that these conditions give way to a period of higher 

interest rates and stable or falling home prices, loan 

performance could deteriorate in the future. Uncertainty about future loan performance is heightened by 

the fact that HELOC portfolios remain highly unseasoned at present. Given these uncertainties, lenders 

and borrowers should not automatically assume that 

their historical loss experience is an accurate guide to 

future repayment ability. To the extent possible, it 

makes sense in this environment to estimate how loss 

projections might change under a less advantageous 

set of market conditions. 

Cynthia Angell, Senior Financial Economist 

FDIC OUTLOOK 23 WINTER 2004 
Lending Practices of Captive Auto Lenders Are 

Driving Risks in Bank Auto Paper 

The auto finance market is very competitive, dominated by car manufacturers and their captive finance 

companies that have a direct stake in the success of the 

auto industry.1 To promote sales, auto manufacturers 

offer a wide variety of financial incentives to entice 

customers into car dealership showrooms. These incentives include cash rebates, favorable financing rates 

(as low as 0 percent), lower down payments, and longer 

repayment schedules. 

In the current environment, banks are competing 

against aggressive terms offered by captive finance 

companies, credit unions, and other insured institutions. As a result, banks may have loosened auto loan 

underwriting standards that could leave them vulnerable if interest rates continue to rise or if economic 

fundamentals weaken.2 Fortunately, market conditions 

to date have helped banks maintain asset quality levels 

that are relatively low and stable. 

This article will look at the keenly contested auto lending arena and how banks operate in it. The article also 

examines the factors that may affect auto credit loan 

quality going forward. 

In the Competitive U.S. Auto Industry, Incentives 

Offered to Buyers Have Increased 

Outstanding retail auto loan balances totaled almost 

$740 billion as of 2003; $186 billion of that amount 

represents new credit extended in 2003.3 Therefore, 

each tick, or increase in market share, by auto lenders 

is extremely valuable. A small handful of captive auto 

finance companies, including General Motors Acceptance Corporation (GMAC) and Ford Motor Credit 

Company, account for approximately 56 percent of 

total auto financings; the remaining 44 percent is held 

by banks, credit unions, and other independent finan1 A captive finance company is usually a wholly owned finance
 

subsidiary of a major auto producer, such as General Motors Acceptance Corporation.
 

2 Delinquency and charge-off rates on auto loans are not provided in
 

the Call Reports. 


3 Christine Pratt, “Automobile Finance Industry Overview: Do Portfolio
 

Metrics Constrain IT Investments?” Needham, MA: TowerGroup,
 

September 2004, http://www.towergroup.com.
 

cial institutions.4 Because of the dominance of the 

captive finance companies, banks often have to 

compete with aggressive incentive programs offered by 

non-bank lenders. 

To sustain demand for new models over the past three 

years, automakers have offered low prices and thousands of dollars in incentives for each car (see Chart 1). 

Average annual incentive amounts have increased each 

year since 2001, and 2004 incentives are on pace to 

continue that trend. The discount from the manufacturer’s suggested retail price (MSRP) averaged 18.4 

percent over the first nine months of 2004. These 

incentives, which include cash rebates, price discounts, 

added car extras, and interest rate and lease subsidies, 

contribute to pulling consumers back into the market 

before typical auto needs would dictate.5 Analysts 

expect that after a slowing rate of growth in the first 

half of 2004, incentives will increase in the second half, 

along with prices.6 

Financing terms have become increasingly aggressive 

as lenders find ways to lower borrower payments. Both 

subsidized interest rates and longer loan maturities have 

enabled consumers to afford higher levels of debt owed 

on cars with decreasing average monthly car payments.7 

Federal Reserve data show that the average maturity of 

a new car loan lengthened from 53 months in 1999 to 

62.5 months in fourth quarter 2003, then settled back to 

61 months in June 2004. According to one industry 

analyst, 20 percent of car buyers now choose 72-month 

loans.8 Similar trends were noted on used car loans. Due 

in part to declining loan amounts and increasing loan 

maturities, the average monthly payment on car loans 

declined to $453 in June 2004 from $466 in June 2003 

and from a cyclical peak of $493 in January 2004.9 

4 Deutsche Bank, “U.S. Autos: A Triple Threat,” February 20, 2004. 
 5 Merrill Lynch, “Auto Incentives Monthly Snapshot,” September 2,
 

2004.
 

6 Credit Suisse First Boston, “Big Three Incentives Bounced Higher in
 

July,” August 5, 2004.
 

7 Subsidized interest rates refer to rates on auto loans that are below
 

market interest rates, such as 0 percent financing. Captive finance
 

companies may extend credit on car loans at below market rates to
 

facilitate sales of cars manufactured by their parent company.
 

8 Jason Stein, “Upside Down and Sinking Fast,” Automotive News,
 

February 16, 2004.
 

9 Morgan Stanley, “Rates Rise and Consumers Buy Down,” August 9,
 

2004.
 

FDIC OUTLOOK 24 WINTER 2004 
Lending Practices of Captive Auto Lenders 

Chart 1 

Source: CNW Marketing Research. 

Stiff Competition for Auto Sales Spurs Incentives 

Historical Average: 

13.4% 

Total New Car Incentives (% of MSRP) 

5.0% 

10.0% 

15.0% 

20.0% 

Mar-89 Oct-91 May-94 Dec-96 Jul-99 Feb-02 Sep-04 

Incentives also have been extended to borrowers who 

are already at the margin of affordability, which is clear 

from the increasing rate of publicly issued subprime and 

near-prime auto asset backed securities (ABS) over the 

past few years. Moody’s Investors Services indicates 

subprime and near-prime auto ABS issuance hit an alltime high of $23.8 billion in 2002, up consistently from 

approximately $2 billion in 1994.10 Although issuance 

fell to $18.5 billion in 2003, analysts expect it to 

rebound to $20.5 billion in 2004, based on economic 

and loan origination forecasts. Although issuance 

trends are similar for prime auto ABS, their rate of 

growth since 1994 does not match the rate of growth in 

subprime auto ABS. Favorable financing terms and 

dealer incentives have been offered across the pricing 

spectrum from luxury to economy cars, enabling 

consumers to purchase more car for their dollar. 

Borrowers whose primary concern is the dollar level of 

payments are often less creditworthy and may be more 

vulnerable to default risk should they face any adversity, including rising interest rates on other debt. 

As a result of already high and increasing incentives, 

the volume of new car sales has been expanding. 

Although the rate of new car sales moderated slightly 

during the summer, the volume of sales is still at a 

historically high level. Between August 2003 and 

August 2004, sales of new cars grew at a 2.3 percent 

rate; that rate increased to a 4.8 percent rate in 

September 2004. In contrast to new car sales, which 

have been propelled by various incentives, used car 

10 Moody’s Investors Service, “2003 Review and 2004 Outlook: VehicleBacked Securities Incentives Rule the Road,” January 2004. 

sales increased at a modest 0.6 percent annualized rate 

through August 2004.11 

Expanding Sales Volume and Incentives Have 

Pushed Down Collateral Values 

Used car values are important to auto lenders because 

they are key to determining recoveries in the event of 

vehicle repossession. Although the volatility of used car 

prices (versus those of new cars) makes it difficult for 

lenders to estimate their loss accurately, lenders can 

expect that an economic environment with depressed 

used car values will translate to lower recoveries and 

higher net losses. After declining approximately 13 

percent since the start of the 2001 recession, used car 

values recovered somewhat in 2003 and stayed steady 

through August 2004, although values remain below 

pre-recession levels (see Chart 2). 

The main factors that influence used car values are 

sales incentives for new cars and inventory levels for 

used cars. Higher incentives for new cars negatively 

affect used car values by putting an upper limit on a 

model’s resale value. For example, the Power Information Network says a typical two-year-old sport utility 

vehicle declines in value by $500 for every $1,000 in 

incentives offered on the new model. 

11 Economy.com, “Vehicle Sales,” October 1, 2004; and Credit Suisse 

First Boston, “Specialty Finance September Monthly,” September 2, 

2004. 

FDIC OUTLOOK 25 WINTER 2004 
In Focus This Quarter: The U.S. Consumer Sector 

Chart 2 

Source: Autodata, JPMorgan. Mannheim Used Vehicle Value Index based on 2001 J.D. Power and Associates vehicle segmentation. 

Incentives Put a Cap on Used Car Prices and Loan Recovery Values 

Monthly Light Vehicle Retail Promotion Costs, $ Per Vehicle Mannheim Used Vehicle Value Index 

100 

105 

110 

115 

120 

$1,000 

$1,500 

$2,000 

$2,500 

$3,000 

$3,500 

Jan-00 Dec-00 Nov-01 Oct-02 Sep-03 Aug-04 

Supply and demand factors also influence used car 

values. A greater volume of new car sales increases the 

inventory of used cars on the market, which places 

downward pressure on used car prices. Used car inventories in August 2004 increased by 11.6 percent over 

the same month one year ago. Declining used car 

prices in late 2003 were consistent with year-end new 

car sales promotions that encouraged car owners to 

sell their used cars in favor of brand-new models. 

In addition, used car inventory is affected by fleet sales 

of used cars, such as sales from car rental agencies. 

Because fleet sales tend to be larger volume sales, used 

car prices tend to decline as these cars return to the 

used car market. Recent industry reports suggest that 

some major auto manufacturers have increased fleet 

sales, thereby boosting their sales volume, but these 

higher fleet sales could place pressure on used car 

values going forward.12 For example, midsize cars have 

displayed noticeably weaker used car values, which 

can be attributed in large part to popularity in, and 

eventual disposition from, rental car fleets.13 

Cars coming off leases also affect used car prices by 

adding to the used car inventory. Although leasing was 

popular in the late 1990s, it has become less so in 

recent years, because automakers have lowered their 

estimates of residual auto values offered on car leases. 

Reduced residual values, a consequence of the declining market value of used cars, have made leasing a 

12 Deutsche Bank Securities, Inc., “Beware of False Dawns: March
 

Sales Boosted by Fleet,” March 2004.
 

13 Fitch Ratings Ltd., “2004 Term ABS Outlook and Fourth Quarter
 

Recap,” February 2004.
 

relatively more expensive option than an outright 

purchase. Lower interest rates and other incentives 

also make purchasing the more attractive option. Some 

analysts expect leasing to increase in coming months 

as higher interest rates and a lower volume of mortgage 

refinancing activity make purchases more difficult for 

the average consumer.14 

Negative Equity among Car Owners Has Increased 

An alarming number of recent car buyers have owed 

more on their cars at trade-in than they are worth. 

Earlier this year, J.D. Power and Associates estimated that approximately 38 percent of new car 

buyers are “upside down” (that is, have negative 

equity) at trade-in, which contrasts with 25 percent 

just two years ago.15 Using data from June 2004, one 

analyst estimates that the average buyer becomes 

“right-side up”—that is, when the buyer owes less on 

the loan than the car is worth—at 34 months, up 

from 33 months in May 2004.16 (See the inset box for 

more information on the origination of auto loans 

with negative equity.) 

The amount of time it takes for a borrower to achieve 

positive equity depends on a variety of factors, including the loan amount, loan-to-value ratio, loan maturity, 

and the vehicle’s rate of depreciation. Higher loan-to14 John Porretto, “Auto Leasing Expected to Rise in 2004, a Plus for
 

Dealers,” Detroit News Autos Insider, January 31, 2004.
 15 Danny Hakim, “Owing More on an Auto Than It’s Worth as a Trade-


In,” New York Times, March 27, 2004.
 16 Morgan Stanley, “Consumer Credit: Rates Rise and Consumers Buy
 

Down,” August 9, 2004.
 

FDIC OUTLOOK 26 WINTER 2004 
Lending Practices of Captive Auto Lenders 

Negative Equity Explained
 

A loan typically has negative equity (also known as being upside down) earlier in the loan cycle as the depreciation 

on the car exceeds the principal paydown—the total principal repaid to the lender—on the car loan (see Chart 3). 

Negative equity declines more slowly with lower monthly car payments and more quickly with higher payments. As 

the owner makes payments and the depreciation rate slows, the level of negative equity declines until the owner is 

right-side up, or when the owner owes less on the loan than the car is worth, which is approximately 30 months into 

the loan in the Chart 3 scenario. 

Chart 3 

The Duration of Negative Equity Varies 

Source: Federal Deposit Insurance Corporation. 

Negative Equity 

Loan Amount 

Depreciated Value 

0 

4 

8 

12 

16 

20 

0 3 6 9 12 15 18 21 24 27 30 33 36 39 42 45 48 51 54 57 60 

Dollars (000s) 

Months 

Competition within the industry has led many dealers to roll negative equity into a purchaser’s new loan. A scenario 

in which negative equity is consolidated into a new car loan is described in the table below: 

Table 

Scenario Resulting in Negative Equity 

• 

• 

• 

• 

• 

• 

• 

• 

Dealership offers new car for $25,000. 

Buyer negotiates price to $22,000. 

Buyer and seller agree on $10,000 value of trade-in car and recognize $12,500 debt outstanding on existing car 

loan. 

Dealer adds $2,500 to $22,000 negotiated price of new car, resulting in new purchase price of $24,500. 

Dealer presents lender with loan application for a $24,500 car. 

Lender agrees to finance 95 percent of the $24,500 transaction price ($23,275) on a car with a $25,000 MSRP. 

Customer borrows $23,275 for a car that had a negotiated purchase price of $22,000. 

Loan-to-market market value ratio approximates 106 percent (loan amount of $23,275 as compared with original 

negotiated sales price of $22,000). 

value ratios and longer repayment terms are key factors 

that have contributed to the increased frequency of 

negative equity. Some car owners with high loan-tovalue ratios and extended repayment plans may never 

reach positive equity, as they are enticed back into the 

showroom while owing more on their current vehicles 

than the cars are worth. 

The amount of negative equity on outstanding car 

loans may continue to increase in 2004. While information on the maturity of car loans held by 

FDIC OUTLOOK 27 WINTER 2004 
In Focus This Quarter: The U.S. Consumer Sector 

Chart 4 

Source: Fitch Ratings Ltd. 

Securitized Subprime Auto Loan Losses Are Relatively High 

Annualized Cumulative Net Losses, Prime Annualized Cumulative Net Losses, Subprime 

0.0% 

0.6% 

1.2% 

1.8% 

0% 

2% 

4% 

6% 

8% 

10% 

Apr-01 May-02 Jun-03 Jul-04 

FDIC-insured institutions is not readily available, car 

loan maturities have increased among captive auto 

finance companies. Reports indicate that approximately 

21 percent of Ford Motor Credit’s new car loans in 

2003 span 72 months—compared with 7 percent 

in 2002—even though Ford projects that consumers 

will sell their cars after 40 months. The percentage of 

72-month loans also substantially increased last year 

at GMAC (29 percent) and Chrysler (35 percent).17 

Incentive programs, such as loans recently offered by 

General Motors and Ford with 72-month terms and 

0 percent financing, are likely to continue this trend. 

Credit Quality on Securitized Auto Loans Improved, 

but Subprime Remains Weak 

Improved economic conditions and wholesale vehicle 

prices have contributed to lower delinquencies and 

charge-offs on auto loans in the past year.18 According 

to Fitch Ratings, both delinquencies and charge-off 

rates on securitized prime auto loans improved during 

2004 after some weakness during 2003 (see Chart 4). 

This improvement in loss rates was also partly due to 

some recovery in used car values that helped stabilize 

losses on repossessed cars. For subprime auto loans, 

loss rates improved through August 2004 on a yearover-year basis, but levels and month-to-month 

17 Deutsche Bank Securities, Inc., “Ford Motor Company,” March 

2004. 

18 Although auto loans are not segregated on Call Reports filed by 

insured institutions, credit quality information on securitized auto 

loans is available from various rating agencies. 

volatility remained high (see Chart 4).19 In spite of 

the improvement in 2004, risks to the subprime sector 

remain, including rising interest rates, financially 

weakened consumers, and lower collateral values. 

Looking Forward: Factors That Will Influence Auto 

Credit Loan Quality 

A fundamental gauge of auto loan underwriting is 

credit scores. However, detailed trends in credit score 

history for car loans are proprietary and not readily 

available. A May 2004 Consumer Bankers Association (CBA) study with survey results from respondents 

such as finance companies and insured institutions 

showed a slight improvement in credit scores among 

auto lenders in the past two years.20 The study reported 

that 52 percent of auto loans were assigned scores of 

720 or above in 2003, compared with 50 percent in 

2002. Moreover, according to the study, 24 percent of 

auto loans had scores below 680 in 2003, down from 29 

percent the previous year. However, according to an 

August 2004 report by CreditSights, Inc., an independent research company, the average credit score for 

all consumer loans has drifted up during the past ten 

years or so, from the mid-600s to 700 today, suggesting 

a general inflation of credit scores.21 

19 Fitch Ratings Ltd., “Third Quarter 2004 Term ABS Recap and
 

Outlook: Through the Looking Glass,” October 8, 2004. 


20 Consumer Bankers Association, 2004 Automobile Finance Study,
 

May 2004. This is a national study of indirect auto financing, leasing,
 

and direct floor-plan financing. Surveys were completed in January
 

and February 2004 and based on activity during 2003. 


21 CreditSights, Inc., “Consumer Credit Scoring: Is FICO Fixed?”
 

August 24, 2004, http://www.creditsights.com.
 

FDIC OUTLOOK 28 WINTER 2004 
Lending Practices of Captive Auto Lenders 

While overall credit scores on auto loans among 

lenders may have modestly improved, reports suggest 

that other aspects of auto loan underwriting may have 

eased in the past several years. According to the May 

2004 CBA study, the percentage of auto lenders that 

allowed dealers to approve loans without the lenders’ 

initial approval doubled in 2003, rising from 25 percent 

in 2002 to 51 percent last year. The percentage of 

lenders that accepted indirect auto loan applications 

via the Internet also substantially increased in 2003. 

In addition, processing times for car loan applications 

have declined. For example, the percentage of lenders 

that spent less than ten minutes per loan increased 

from 18 percent to 28 percent during the past year. 

While these results may indicate increased automation 

and efficiency among auto lenders, it may also indicate 

less scrutiny by some lenders. 

Conclusion 

Insured institutions that engage in auto lending, either 

directly or indirectly, operate in a highly competitive 

environment.22 Banks face aggressive competition for 

pricing and terms on car loans from credit unions, other 

insured institutions, and captive finance companies. In 

the face of softening car sales, captive finance companies of large auto manufacturers often use auto lending 

as a loss leader to facilitate sales, thereby driving 

market pricing and terms on auto loans. In addition, 

reports indicate that competition for the various credit 

quality segments of auto loans is intensifying, particularly among mid-prime loans, as lenders attempt to 

stratify segments of the auto loan market.23 

Credit quality on securitized prime auto loans remains 

relatively well-behaved at present. However, auto loan 

maturities are extending, auto loan collateral is increasingly upside down, and lenders continue to finance 

aggressively in the subprime sector. Rising interest 

rates, consumer fundamentals, and economic conditions, as well as institution-specific loan underwriting, 

will be the drivers of auto loan credit quality going 

forward. On the positive side, stabilization in credit 

quality ratios of securitized auto loans during the first 

three quarters of 2004 suggest that improving economic 

conditions could partially mitigate the effects of higher 

loan-to-value ratios, longer maturities, and increasing 

incidences of negative equity on auto loans’ credit quality. However, auto loans to marginal or subprime 

borrowers in particular may remain more vulnerable to 

credit quality deterioration, particularly in a rising rate 

environment. 

Alexander Gilchrist, Regional Economist 

The author wishes to acknowledge the contribution of Edward Butler, Senior 

Examination Specialist, FDIC Division of Supervision and Consumer 

Protection, New York Regional Office, in the preparation of this article. 

22 An indirect loan is a loan that is sold by a dealer or a retailer of 

goods to a third-party financial institution that owns the loan contract 23 Moshe Orenbuch, “Specialty Finance September Monthly,” Credit 

as a holder in due course and collects principal and interest Suisse First Boston, September 2, 2004. Mid-prime loans are defined 

payments from the borrower. as loans with expected cumulative losses of less than 6.0 percent. 

FDIC OUTLOOK 29 WINTER 2004 
Banks Are Still Sizing Up Opportunities in the 

Growing Hispanic Market 

Within the past few years, Hispanics have become the 

largest ethnic group in the United States, and they are 

projected to be one of the fastest growing population 

segments throughout much of the 21st century. Banks 

are increasingly aware of these trends and have been 

looking to expand their presence in this vast market. 

However, Hispanics are not a homogeneous group, and 

current migration patterns clearly show that regional 

and socioeconomic differences within the Hispanic 

population will significantly influence the types of 

banking products and services needed by and designed 

for this group. 

Banks’ interest in the Hispanic market is being driven 

by the search for new sources of revenue and recognition of the substantial growth potential of this underserved market. In addition to the rapid rate of growth 

in the Hispanic population, factors contributing to the 

Hispanic market’s appeal include its relative youth, a 

rapid rise in affluent households, and growing participation rates in financial services. 

This article examines the geographical areas where 

Hispanics now live in the highest concentrations as 

well as areas where Hispanic populations are growing 

the fastest. It also assesses the already strong and growing purchasing power of Hispanics and categorizes their 

financial service needs into stages as they gain wealth 

and their demand for financial services evolves. 

Further, it uses current bank data to gain insight into 

potential areas of financial services growth for banks 

regarding this ethnic group. 

The Hispanic Market Is the Future 

Many industry analysts believe that more than half of 

all U.S. retail banking growth in financial services 

during the next two decades will originate from the 

growing Hispanic market. A projection made in 2003 

by the TowerGroup, a research and advisory firm that 

focuses on the global financial services industry, estimates that up to 70 percent of the growth for U.S. 

financial services between 2003 and 2008 could come 

from the Hispanic market alone.1 In 2003, Eusebio 

1 CMGP Hispano, “U.S. Retail Banking and the Hispanic Market 

Growth Engine,” white paper, March 1, 2004, http://www. 

cmgpartners.com/hispano/HispanicBankingPaperV5.pdf. 

Rivera, the head of Hispanic Initiatives at Bank of 

America, said that “in the next couple of years, 80 

percent of our growth will come from the multicultural 

market, and 60 percent of that will come from the 

Hispanic population.”2 Furthermore, U.S. banks are 

projected to spend over $8.5 billion marketing to and 

servicing the Hispanic market from 2003 to 2005.3 

The New York-based Research & Advisory Group 

projects that between 2002 and 2007 the number of 

Hispanic households with checking accounts will 

increase by 57 percent, those with savings accounts 

will grow by 76 percent, and those using investment 

products will grow by 94 percent.4 Although Hispanics 

represented an average of just 7 percent of all U.S. 

households between 1992 and 2001, they accounted 

for 14 percent of total growth in asset accounts and 

13 percent of growth in debt accounts.5 It is projected 

that between 2001 and 2007, these rates of growth will 

have accelerated further, with a projected 20.5 percent 

growth in asset accounts and 15.5 percent growth in 

debt accounts.6 

Hispanic Market Includes Both High-Concentration 

and High-Growth Areas 

Map 1 shows counties with the largest concentration 

of Hispanics in the United States (above the national 

average of 12.5 percent) based on 2000 census data. 

As of July 1, 2002, more than three-quarters (nearly 30 

million) of Hispanics lived in seven states: California 

(11.9 million), Texas (7.3 million), New York (3.1 

million), Florida (3.0 million), Illinois (1.7 million), 

Arizona (1.5 million), and New Jersey (1.2 million).7 

2 “Latinos Become Key Market for Financial-Service Firms,” Wall
 

Street Journal, October 23, 2003.
 3 “Banks Out to Attract Hispanics: New Immigrants Draw Attention,”
 

Houston Chronicle, January 16, 2003.
 4 “Big Banks Angling for More Minority Depositors,” American
 

Banker, January 30, 2003. Investment products include mutual funds,
 

direct securities investments, cash-value life insurance, annuities,
 

and retirement accounts.
 

5 Federal Reserve Board, 2001 Survey of Consumer Finances, as cited
 

in CMGP Hispano’s “U.S. Retail Banking” (see note 1). 


6 Ibid.
 

7 U.S. Census Bureau, “State Population Estimates by Race Alone and
 

Hispanic or Latino Origin: July 1, 2002,” table 3, September 18, 2003,
 

http://www.census.gov/popest/archives/2000s/vintage_2002/STEST2002-ASRO-03.html.
 

FDIC OUTLOOK 30 WINTER 2004 
Opportunities in the Growing Hispanic Market 

Map 1 Map 2 

High-Concentration Hispanic Areas by County High-Growth Hispanic Areas by County 

Above the national concentration rate of 12.5 percent (385 counties) Over 400 percent increase (227 counties) 

Source: U.S. Census Bureau, 2000. 

Many Hispanics are settling in places that had very 

little Hispanic immigration before the 1980s. In fact, 

every part of the United States experienced an increase 

in Hispanic population during the 1990s, in rural, 

suburban, and urban settings alike. Map 2 shows highgrowth counties, defined as those that experienced 

Hispanic population growth of 400 percent or more 

between 1990 and 2000. In contrast to the concentrations shown in Map 1, much of the high growth was 

centered in Midwestern and Southeastern states. While 

Hispanic populations continue to grow in the highly 

concentrated areas via immigration and birthrates, a 

smaller but fast-growing new wave of Hispanic immigrants are seeking new destinations, particularly in 

suburbs and medium-size cities.8 These areas will 

continue to experience rapid population growth, drawn 

by “the networks of families and friends now being 

established in these communities.”9 Additionally, an 

increasing number of second- or higher-generation 

Hispanics from high-concentration counties are also 

migrating to high-growth counties. 

It is critical to note that there are substantial socioeconomic differences between Hispanics in the fastest 

growing areas of the country and those in traditional 

settlement areas such as the Southwest. Table 1 

8 Audrey Singer, “The Rise of New Immigrant Gateways,” The Brookings Institution, Center on Urban and Metropolitan Policy, The Living
 

Cities Census Series, February 2004, http://www.brookings.edu/
 

dybdocroot/urban/pubs/20040301_gateways.pdf.
 

9 Steven A. Camarota and John Keeley, “The New Ellis Islands: Examining Non-Traditional Areas of Immigrant Settlement in the 1990s,”
 

Center for Immigration Studies, September 2001,
 

http://www.cis.org/articles/2001/back1101.pdf.
 

Source: U.S. Census Bureau, 1990 to 2000. 

compares the differences between these two groups. 

In general, Hispanics in high-concentration counties 

are more likely to be bilingual or speak English, have 

slightly higher incomes, and have more education than 

their counterparts in high-growth Hispanic areas. A 

major reason for the difference between the two groups 

is that many Hispanics in high-growth areas (25 

percent) tend to be recent immigrants. 

Fast Pace of Hispanic Population Growth Primarily 

Due to Immigration 

During the 1990s, the U.S. Hispanic population 

increased by a stunning 58 percent, from 22.4 million 

to 35.3 million, while the rest of the U.S. population 

saw only a 9 percent rate of increase.10 At the end of 

the decade, Hispanics made up 12.5 percent of the U.S. 

population, up from 9 percent in 1990. Massive immigration during this period fueled the overall growth of 

the Hispanic population, accounting for almost half of 

the increase. Moreover, an increasingly large number 

of Hispanics are emigrating from Central and South 

American countries.11 These “other Hispanics,” as they 

are known, are bringing greater diversity to the U.S. 

Hispanic population, making it more difficult to talk 

about Hispanics in general terms. 

10 Data from U.S. 2000 Decennial Census.
 

11 Roberto Suro, “Counting the ‘Other Hispanics’: How Many
 

Columbians, Dominicans, Ecuadorians, Guatemalans and Salvadorans
 

Are There in the United States?” Pew Hispanic Center, May 9, 2002,
 

http://www.pewhispanic.org/site/docs/pdf/other_hispanics.pdf.
 

FDIC OUTLOOK 31 WINTER 2004 
In Focus This Quarter: The U.S. Consumer Sector 

Table 1 

Demographic Characteristics: High-Concentration versus High-Growth Counties 

High Concentration1 High Growth2 

Population 

Total Population (as of 2000) 86,147,017 

Hispanic Population (as of 2000) 25,891,446 

Total Population Growth Rate (1990 to 2000) 17.0% 

Hispanic Population Growth Rate (1990 to 2000) 49.4% 

Share of Hispanic Population 30.1% 

Hispanic Mobility 

Moved from Different State 3.6% 

Moved from Different Country 6.9% 

Hispanic Citizenship 

Noncitizens (Number of Hispanic Origin) 7,507,927 

Noncitizens as a Share of Hispanic Population 29.0% 

Hispanic Language Dominance3 

English Dominant 16.9% 

Bilingual (Spanish) 54.7% 

Spanish Dominant 28.4% 

Hispanic Educational Attainment4 

Less Than High School 50.4% 

High School Graduate 21.6% 

College Graduate 8.8% 

Household Income 

Average Household Income $60,498 

Hispanic Average Household Income $43,301 

Average Household Income Growth (1990 to 2000) 44.2% 

Hispanic Average Household Income Growth (1990 to 2000) 46.7% 

13,447,705 

712,162 

25.4% 

629.5% 

5.3% 

18.6% 

25.1% 

387,627 

54.4% 

12.9% 

37.8% 

49.3% 

59.6% 

18.6% 

8.9% 

$52,486 

$43,286 

56.8% 

31.0% 

Notes: 1 See Map 1. 2 See Map 2. 3 Language dominance is for the age cohort 18 to 64. 4 Educational attainment is measured for those over 25 years of age. 

Source: U.S. 2000 Decennial Census and authors’ calculations. 

The U.S. Hispanic population is expected to continue 

to grow rapidly over the next half-century, tripling in 

size between 2000 and 2050.12 Continued immigration, 

high birthrates, and a young childbearing population 

will all contribute to this increase. In turn, this growing 

Hispanic market will require financial products, such as 

mortgages, home equity lines of credit, and car loans, to 

meet their needs as they start families and rear children. 

12 U.S. Census Bureau, “Census Bureau Projects Tripling of Hispanic 

and Asian Populations in 50 years; Non-Hispanic Whites May Drop 

to Half of Total Population,” news release, March 18, 2004, 

http://www.census.gov/Press-Release/www/releases/archives/ 

population/001720.html. 

Hispanic Immigration and Labor Trends Boost U.S. 

Economy 

The pace of U.S. economic growth during the 1990s 

was aided greatly by immigration. Federal Reserve 

Bank of Dallas economist Pia M. Orrenius found that 

immigration contributed to job growth by providing 

workers to (1) fill an increasing share of jobs overall, 

(2) take jobs in labor-scarce regions, and (3) fill the 

types of jobs native workers often shun.13 

Many foreign-born migrants filled labor force positions 

in certain worker-scarce regions of the country such as 

the Midwest, parts of the Southeast, and New 

13 “U.S. Immigration and Economic Growth: Putting Policy on Hold,” 

Southwest Economy 6 (November/December 2003). 

FDIC OUTLOOK 32 WINTER 2004 
Opportunities in the Growing Hispanic Market 

Table 2 

U.S. Deposit Characteristics Compared to Designated High Hispanic Concentration Areas 

and High Hispanic Growth Areas 

High Concentration High Growth 

Average Branch Deposits (Total Deposits/Number of Branches in 1994, $000s) $61,580 $27,333 

Average Branch Deposits (Total Deposits/Number of Branches in 2000, $000s) $75,059 $38,560 

Average Branch Deposits (Percentage Change 1994 to 2000) 22% 41% 

Change in Branches (1994 to 2000) 4% 8% 

Change in Deposits (1994 to 2000) 26% 53% 

Notes: 1 Deposit and branch information is as of June 30, 1994, and 2000 and excludes U.S. Territories and Puerto Rico. 2 There were 277 counties in the high growth group, compared with 385 

counties in the high concentration group. 

Source: FDIC Summary of Deposits. 

England—some of the fastest growing areas of the 

Hispanic population during the 1990s.14 A significant 

share of employment in fast-growing counties was in 

manufacturing, construction, and agriculture. In 

contrast, Hispanics in the high-concentration counties 

exhibited an employment profile similar to that of the 

total U.S. workforce. 

Finally, the effects of globalization and lower standards 

of living across Latin American countries, as well as 

U.S. economic dependence on migratory labor, suggest 

foreign immigration flows will continue. Although 

activities related to the North American Free Trade 

Agreement (NAFTA) and the maquiladora industry 

have benefited from economic activity along the U.S.­

Mexico border, they also have resulted in some elimination of jobs south of the border, thereby motivating 

Mexican workers to migrate to the United States.15 

Growing Purchasing Power Is Driving Demand for 

Financial Services 

The Selig Center for Economic Growth at the University of Georgia has estimated that Hispanic purchasing 

power as measured by disposable income grew by 194 

percent between 1990 and 2003, from $222 billion to 

$653 billion.16 The latter sum is actually larger than the 

estimated nominal GDP of Mexico in 2003.17 The Selig 

14 Ibid.
 

15 A maquiladora is a factory located in a Mexican border town that
 

imports materials and equipment on a duty- and tariff-free basis for
 

assembly or manufacturing.
 

16 Jeffrey M. Humphreys, “The Multicultural Economy 2003: America’s
 

Minority Buying Power,” Georgia Business and Economic Conditions
 

63, no. 2 (Second Quarter 2003), Selig Center for Economic Growth,
 

Terry College of Business, University of Georgia, http://www.selig.uga.
 

edu/forecast/GBEC/GBEC032Q.pdf.
 

17 Energy Information Administration, “Mexico,” Country Analysis
 

Briefs, March 2004, http://www.eia.doe.gov/emeu/cabs/mexico.html.
 

Center also projects that U.S. Hispanic purchasing 

power, stimulated by population and income growth, 

will approach $1 trillion by 2009.18 This aggregate 

income will be spent, saved, and invested, all of which 

will spur demand for checking accounts, consumer 

credit, mortgages, and investment services. 

Hispanic Financial Services Marketplace Is Fertile 

Ground for Banks 

Banking Services Are Currently Underused... 

The rapid growth of the underbanked Hispanic market 

suggests a new growth opportunity for many institutions. Although the volume of deposits per bank 

branch in high-growth Hispanic areas remains substantially below that of the nation, the rate of deposit 

growth in these areas is twice as fast as that of the 

nation, which suggests the gap is rapidly closing. 

...But Projected Growth Is Strong 

Banks and thrifts in many of the fastest growing 

Hispanic counties have the advantage of proximity 

to a potential source of new customers. As shown 

in Table 2, high-growth Hispanic areas experienced 

substantially faster growth in both deposits and 

branch formation than did either highly concentrated 

Hispanic areas or the nation as a whole. Moreover, 

a continued rapid increase in Hispanic populations in 

these areas suggests that strong bank deposit growth 

will continue. 

18 Jeffrey M. Humphreys, “The Multicultural Economy 2004: America’s 

Minority Buying Power,” Georgia Business and Economic Conditions 

64, no. 3 (Third Quarter 2004), Selig Center for Economic Growth, Terry 

College of Business, University of Georgia, http://www.selig.uga.edu/ 

forecast/GBEC/GBEC043Q.pdf. 

FDIC OUTLOOK 33 WINTER 2004 
In Focus This Quarter: The U.S. Consumer Sector 

Gains in Hispanic Labor Force Reflected in Branch 

Growth 

The U.S. Department of Labor’s Bureau of Labor 

Statistics projects that the Hispanic labor force will 

increase by 33 percent between 2002 and 2012, more 

than three times faster than growth in the nonHispanic labor force over the same period.19 Demand 

for Hispanic workers is credited with helping to revitalize U.S. labor markets since the 2001 recession, with 

immigrants playing an important role.20 Hispanic 

employment gains are a reflection of the Hispanic 

labor force growing much more rapidly than other 

segments of the labor force and moving to areas where 

there is a greater demand for labor. This geographic 

movement is also reflected in the increasing number 

of bank branches being opened in the 277 high-growth 

counties where the Hispanic population increased by 

more than 400 percent in the 1990s. The number of 

bank branches grew by 8 percent in the high-growth 

counties versus 5 percent overall, and total deposits in 

those branches grew by 53 percent versus 27 percent 

for the nation as a whole (see Table 2). 

Understanding Unique Needs of the Hispanic 

Community Is Key to Successful Marketing of 

Financial Services 

Marketing approaches targeting the Hispanic community are not yet mainstream. Rather, they are tailored 

to where the Hispanic population currently resides, 

whether in high-growth or high-concentration counties, because acculturation levels among Hispanics in 

these two groups are very different. Generally, Hispanics in high-growth counties have lower levels of education, slightly lower incomes, and less proficiency in 

speaking English. In addition, significant shares of 

Hispanics in high-growth counties are foreign immigrants and consequently have lower citizenship rates. 

Thus, high-growth Hispanic counties will have a 

greater need for financial literacy programs, cash remittance services, and bilingual tellers and loan officers. 

Because this wave of Hispanic immigration is relatively 

new to these areas of the country, banks there face the 

challenge of integrating this growing Hispanic popula19 U.S. Department of Labor, “Labor Force,” Occupational Outlook
 

Quarterly, Winter 2003-04, http://www.bls.gov/opub/ooq/2003/
 

winter/art05.pdf.
 

20 Rakesh Kochhar, “Latino Labor Report, First Quarter, 2004: Wage
 

Growth Lags Gains in Employment,” Pew Hispanic Center, June 2004,
 

http://www.pewhispanic.org/site/docs/pdf/Labor%20Report%202004_1
 

%20Final.pdf.
 

tion into the mainstream of the financial services 

industry. Nevertheless, strong immigration flows will 

continue in high-concentration counties as well, 

providing opportunities for banks there. Overall, the 

growth in Hispanic population and income will be a 

major demographic force for the next half-century. 

Multicultural Events Used in Marketing Programs 

According to the 2003 American Bankers Association Bank Marketing Planning Survey Report, 21 

percent of small banks targeted ethnic communities in 

multicultural marketing events as a means of meeting 

prospective ethnic customers. The survey reported 

that 62 percent of Southwestern banks specifically 

targeted ethnic communities in 2003, most likely 

aimed at their large Hispanic populations. While only 

20 percent of banks headquartered in the Southeast 

directly marketed to ethnic communities in 2003, an 

additional 27 percent say they plan to target ethnic 

communities. This increased interest suggests that 

bankers in the Southeast are becoming more aware of 

the high rate of Hispanic population growth in their 

area and the growing Hispanic market for new bank 

products and services. How banks go about capturing 

this market will depend in large part on the financial 

life cycle (explained below) of the target group. 

Understanding Financial Life Cycles Is Vital 

Most banks are still in the early stages of developing 

their strategies for the Hispanic market. They may 

benefit from determining the financial life-cycle stage 

of their target households (see Chart 1). 

The financial life cycle of Hispanics can be divided 

into four stages: (1) pre-banking services, (2) basic 

banking services, (3) advanced banking services, and 

(4) affluent banking services. As Hispanic households 

earn higher levels of income and become more acculturated into U.S. society, their demand for banking 

products and services will evolve from pre-banking 

services to more affluent banking services. A strong 

correlation exists between financial services participation by Hispanics and their level of acculturation— 

both “the individual acculturation trends of recent 

immigrants and the relative weight of this group to 

overall Hispanic population growth.”21 As Hispanic 

immigrants spend more time in the United States, 

they increasingly avail themselves of different kinds 

21 Strategy Research Corporation, “2002 U.S. Hispanic Market 

Report,” 2002, as cited in CMGP Hispano’s “U.S. Retail Banking” 

(see note 1). 

FDIC OUTLOOK 34 WINTER 2004 
Opportunities in the Growing Hispanic Market 

Chart 1 

In General, as Households Move Toward Higher
 

Incomes, They Progress to Higher Stages of the
 

Financial Life Cycle 

Financial Literacy

and Cash

Remittances

Deposit

Accounts

Credit Cards,

Mortgages, Lines of

Credit, Business Loans

Investments,

Annuities,

Insurance 

Stage 4: 

Affluent 

Banking 

Income 

Stage 1: Stage 2: Stage 3: 

Pre-Banking Basic Advanced 

Banking Banking 

of financial products. As mentioned, most high-growth 

Hispanic counties during the 1990s were in the Midwest 

and Southeast, and Hispanics in these areas are more 

likely to be in one of the first two stages, pre-banking 

or basic banking services. 

Stage 1, Pre-Banking Services 

First-generation (foreign-born) Hispanics are typically 

at the pre-banking services level, or Stage 1, often 

because they have had very few dealings with, or little 

confidence in, banks in their native countries. As a 

result, financial education is a very important need for 

this group, as most immigrants know little about financial planning and other financial services. Banks and 

regulatory agencies are already seeing the value in 

conducting financial literacy workshops, often in cooperation with community groups, to improve financial 

management skills and increase trust in mainstream 

financial institutions (see the inset box regarding the 

FDIC Money Smart program). 

Stage 2, Entry-Level Basic Banking Services 

Entry-level personal basic banking services (Stage 2) 

are aimed at Hispanics seeking products to establish a 

banking relationship and credit needs. A survey by the 

Pew Hispanic Center and the Kaiser Family Foundation estimates that only 65 percent of Hispanics have 

FDIC Money Smart Program 

In addition to its banking supervisory role, the Federal the gaps in other financial education programs. The 

Deposit Insurance Corporation (FDIC) is involved in computer-based instruction (available on CD-ROM and 

financial education to help fight predatory lending, through the FDIC Web site) can be used to complement 

encourage financial institutions to identify untapped classroom instruction or for independent self-paced 

markets, and assist consumers in shaping their financial study by consumers. The material may be photocopied 

future. The FDIC contributes to these goals through its and distributed without authorization from the FDIC 

Money Smart program, which is a set of ten training and is available in English, Spanish, Chinese, Korean, 

modules for instructor and individual use covering basic and Vietnamese. 

financial topics. Topics include a description of deposit Through the Money Smart program, the FDIC is work- and credit services offered by financial institutions, ing toward some ambitious goals, such as enlisting 1,000 choosing and maintaining a checking account, the 

mechanics of budgeting, the importance of saving, and alliance members, including banks, corporations,

how to obtain and use credit effectively. government agencies, and civic, fraternal, and religious

organizations; delivering 100,000 copies of Money 

Money Smart was designed specifically for the 8 million Smart curricula; and reaching 1,000,000 people in all 50 

to 12 million families currently outside of the economic states by December 31, 2007. Money Smart is being 

mainstream, as well as those who may be familiar with taught by a host of diverse organizations in a variety of 

some of the financial basics, but would like to enhance settings, and to date, the program has over 900 alliance 

their financial knowledge in certain areas to operate members. The FDIC has distributed more than 160,550 

more effectively within the banking system. It starts copies of Money Smart and had over 294,400 people 

with the basics but increases in complexity. At present, attend at least one financial education class using the 

the Money Smart program comes in a paper format, on Money Smart curriculum, with more than 39,180 estabCD-ROM, or in a Web-based format. The instructor lishing new banking relationships. To learn more about 

version contains everything necessary to begin teaching the FDIC’s Money Smart program, contact an FDIC 

the program right away and includes take-home book- Community Affairs Officer from one of our eight 

lets and other resources for participants. It can be taught regional or area offices or visit http://www.fdic.gov/ 

in its entirety, or specific modules can be used to fill in consumers/consumer/moneysmart/index.html. 

FDIC OUTLOOK 35 WINTER 2004 
In Focus This Quarter: The U.S. Consumer Sector 

bank accounts, compared with 95 percent of nonHispanic whites.22 The disparity is even greater in areas 

that experienced significant Hispanic immigration in 

the 1990s. Candidates at Stage 2 are likely to be firstgeneration Hispanics who have lived in the United 

States for a time and now need basic checking and 

savings accounts in addition to remittance services. 

Stage 3, Advanced Banking Services 

Advanced banking services (Stage 3) are aimed primarily at second- and third-generation Hispanics looking 

beyond basic banking services and focusing more on 

mortgage, personal, and business lending products. 

Since the 1970s, almost half of the total growth in 

the Hispanic population growth has been driven by 

immigration. However, this trend is reversing. The 

Pew Hispanic Center projects that over the next two 

decades, second- and third-generation Hispanics will 

make up 75 percent of total growth in the Hispanic 

population, with new immigrants representing the 

remaining 25 percent.23 Consequently, the Stage 3 

population group is likely to grow into a large and 

profitable market segment ripe for greater banking 

development. 

Stage 4, Affluent Banking Services 

As second- or higher-generation Hispanics become 

wealthier, better educated, and more acculturated, their 

financial services participation levels rise, and they are 

apt to avail themselves of the higher margin banking 

products and services that make up Stage 4, or affluent 

banking services. According to census data, almost twothirds of Hispanic households had incomes of less than 

$35,000 in 1990 (see Chart 2). However, by 2000, only 

slightly more than half of Hispanic households were 

earning less than $35,000. Middle-income Hispanic 

households (those earning between $35,000 and 

$74,999) rose by more than a quarter during this tenyear period, and affluent Hispanic households (those 

earning $75,000 and above) nearly tripled. A study by 

the Tomas Rivera Policy Institute shows that “Latino 

middle class households—defined as those with annual 

incomes over $40,000—increased from just under 1.5 

22 Mollyann Brodie et al., “2002 National Survey of Latinos,” Pew 

Hispanic Center/Kaiser Family Foundation, December 2002, 

http://www.pewhispanic.org/site/docs/pdf/LatinoSurveyReportFinal.pdf. 23 Roberto Suro and Jeffrey S. Passel, “The Rise of the Second Generation: Changing Patterns in Hispanic Population Growth,” Pew 

Hispanic Center, October 2003, http://www.pewhispanic.org/ 

site/docs/pdf/PHC%20Projections%20final.pdf. 

Chart 2 

The Share of Middle-Income and Affluent Hispanic
 

Households Grew Rapidly during the 1990s
 

Hispanic Households (%)

80
 

67.9
 70
 

1990
 

60
 51.7 2000
 

50
 

40 34.3 

27.1 30
 

20
 14.0
 

10
 5.0
 

0
 < $35,000 $35,000 to 74,999 ≥ $75,000 

Hispanic Household Income 

Sources: U.S. Census Bureau, 1990 and 2000. 

million in 1979 to almost 2.7 million by 1998, or by 

about 80 percent in twenty years.”24 

As their purchasing power continues to increase, 

Hispanics will have a significant need for credit cards, 

residential mortgages, consumer loans, and other 

products. The difference in homeownership rates by 

ethnicity demonstrates the potential demand for 

homeownership in this largely untapped market. 

As of June 30, 2004, the national average for homeownership was 69.3 percent, significantly higher than 

the 47.4 percent rate for Hispanics.25 As Hispanics 

become more acculturated and their incomes rise, 

they should become a major source of demand for 

mortgage products. 

Remittances Are a Hot Product for Immigrants 

Because many Hispanics in the pre-banking group are 

newly arrived in the United States, they are likely to 

make greater use of remittances, a rapidly growing and 

lucrative market estimated at more than $30 billion 

in 2004.26 An article in the Winter 2004 issue of the 

FDIC’s Supervisory Insights, “Linking International 

Remittance Flows to Financial Services: Tapping the 

Latino Immigrant Market,” by Michael Frias, explores 

how recent demographic shifts will continue to influence banks’ strategies for tapping new markets and 

24 “The Latino Middle Class: Myth, Reality and Potential,” Tomas
 

Rivera Policy Institute, February 2001.
 

25 U.S. Census Bureau via Haver Analytics.
 

26 Manuel Orozco, “Remittances to Latin America and the Caribbean:
 

Issues and Perspectives on Development,” Organization of American
 

States (report commissioned by the Summits of the Americas Secretariat), July 14, 2004, http://www.summit-americas.org/Panels/
 

Panel_on_Remittances/Remittances.pdf. 


FDIC OUTLOOK 36 WINTER 2004 
Opportunities in the Growing Hispanic Market 

discusses the implications of the swift growth and 

significant size of the Latino market for the U.S. banking Industry. Both large and small banks are capitalizing 

on remittance flows as a means of bringing “unbanked” 

immigrants into the banking system. 

Conclusion 

Increasing numbers, rising incomes, and a comparatively young population suggest that Hispanics will 

become a major consumer of financial services in the 

years ahead. Greater consumer participation by Hispanics in mainstream financial markets can improve their 

ability to build assets, create wealth, and promote 

economic stability and vitality in their communities. 

By providing needed financial services to this growing 

market, banks will find new and welcome sources of 

revenue. But this market is still in its infancy. As it 

continues to mature, large banks and community banks 

alike will find new opportunities to meet the demands 

of the Hispanic marketplace by customizing their products to its unique needs. 

Jeffrey A. Ayres, Senior Financial Analyst 

Stephen L. Kiser, Regional Economist 

Adrian R. Sanchez, Regional Economist 

FDIC OUTLOOK 37 WINTER 2004 

FDIC OUTLOOK 39 FALL 2004

In Focus This Quarter

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