Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION THIRD QUARTER 1997 

FDIC Dallas
 

Region
 

Division of
 

Insurance
 

Alan C. Bush,
 

Senior Regional
 

Analyst
 

Adrian R. Sanchez,
 

Regional Economist
 

Jeffrey A. Ayres,
 

Financial Analyst
 

In Focus This Quarter 

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

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

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

collection can be severe. See page 3. 

By Kathy R. Kalser, Debra L. Novak 

◆ Retail Shakeout: Causes and Implications for Lenders— 

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

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

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

quality at some insured institutions. See page 6. 

By Richard A. Brown, Diane Ellis 

Regular Features 

◆ Regional Economy—Job growth in the Region continues to slow . . . the 

oil and gas industry is thriving . . . commercial banks are again lending to small and 

middle-tier oil and gas exploration and production companies . . . revised employment numbers show significantly slower growth in New Mexico. See page 11. 

By Adrian R. Sanchez 

◆ Financial Markets—Securitization of home equity loans is growing 

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

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

appetite of community banks to enter the ABS market. See page 15. 

By Allen Puwalski 

◆ Regional Banking—Favorable banking performance conditions . . . 

favorable early harvest results in western Oklahoma and north Texas defy expectations created by bad weather . . . home equity lending may soon arrive in Texas . . . 

the Subchapter S election has been popular in the Dallas region. See page 19. 

By Alan C. Bush, Jeffrey A. Ayres 

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

Insurance Corporation for the following eight geographic regions: 

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

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

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

Dallas Region (CO, NM, OK, TX)
 

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

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

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

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

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

form found on the back cover to the FDIC Public Information Center. Contact the Public 

Information Center for current pricing on bulk orders. 

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

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

Outlook, please call Alan Bush at (214) 220-3434 or send an e-mail to abush@fdic.gov. 

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

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

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

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

the Federal Deposit Insurance Corporation. 

Chairman Andrew C. Hove, Jr. 

Director, Division of Insurance Arthur J. Murton 

Editor George E. French 

Managing Editor Stephen Linehan 

Associate Editor Maureen E. Sweeney 

Assistant Editors Paul C. Bishop 

Richard A. Brown 

Steven K. Burton 

Diane Ellis 

Kathy R. Kalser 

Ronald L. Spieker 

Publications Manager Teresa J. Franks 
In Focus This Quarter
 

Subprime Lending: A Time for Caution
 

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

•	 The consequences of deficiencies in underwriting, 

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

necessary resources in these areas likely will have 

trouble succeeding in the increasingly competitive 

market for subprime loans. 

•	 Some institutions insured by the FDIC have failed 

to properly assess and control the risks associated 

with their subprime lending programs. 

What Are Subprime Loans? 

Faced with strong competition and shrinking margins 

on loans to high-quality borrowers, some lenders are 

moving down the credit quality spectrum. The strategy 

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

lending is most commonly associated with auto, home 

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

Generally, the characteristics of a subprime borrower 

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

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

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

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

Definitional variations aside, some general market 

parameters on ranking loans are presented in Table 1. 

TABLE 1 

Criteria for Loan Rankings 

GRADE PAYMENTS LATE BANKRUPTCY 

30 DAYS FILING
 

PRIME
 NONE NONE
 

A­ LESS THAN 2 NONE IN 5 YEARS 

B LESS THAN 4 NONE IN 3 YEARS 

LESS THAN 6 NONE IN 2 YEARS 

D CONSTANTLY LATE NONE IN 1 YEAR 

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

Market Information Services 

How Big Is the Market? 

The lack of a standard definition for a subprime loan 

makes it difficult to accurately determine the extent of 

the market. However, some industry experts estimated 

that during 1996, subprime loans secured by residences, 

including both home equity and mortgage loans, 

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

conventional mortgages. Subprime auto loans have been 

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

or about 20 percent of total auto loans outstanding. 

Who Makes Subprime Loans? 

In the past, subprime lending was primarily the domain 

of a limited number of finance companies. These firms 

specialized in making high-priced loans to borrowers 

with limited access to credit. 

The number of subprime lenders, however, has surged 

in recent years as more companies have been attracted 

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

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

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

The increase in the number of subprime lenders has 

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

enables the lender to effectively raise cash at a lower 

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

market has attracted lenders that previously refrained 

from making subprime loans because they did not want 

to maintain these high-risk loans or the associated 

reserves on their balance sheet. By issuing securities 

backed by subprime loans, lenders now have the ability 

to originate subprime loans and sell them to ABS 

investors. 

Favorable stock market conditions also helped to fund 

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

to market watchers. This financing avenue may become 

less accessible, as investors’ concerns over financial 

Regional Outlook	 3 Third Quarter 1997 

C 
In Focus This Quarter
 

problems of several major market participants have 

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

Financial Difficulties of Some Subprime 

Lenders 

Market participants have observed that, as in credit card 

lending, increasing competition may be compelling some 

subprime lenders to compromise underwriting standards 

and lower pricing in order 

to protect market share. Financial 

difficulties reported by major subprime auto lenders Jayhawk 

Acceptance Corporation and 

Mercury Finance Company highlight these concerns. 

Problems in subprime lending are not limited to auto 

loans. Lenders that specialize in subprime home equity 

loans and mortgages also are showing signs of stress. In 

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

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

competitive environment for subprime home equity 

loans (see Financial Markets). 

Differences between Prime and Subprime 

Lending 

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

underwriting process is to differentiate those subprime 

borrowers whose past credit problems were due to such 

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

prospective borrower’s credit bureau report with such 

additional information as income, employment history, 

and the nature of prior credit problems. This process 

allows the lender to better determine the credit risk or 

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

the loan will be profitable. 

Servicing and collection of subprime loans tends to be 

more labor intensive and costly than in prime lending. 

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

In addition, while prime lenders may be willing to work 

with late borrowers by adjusting minimum amounts or 

payment schedules, subprime lenders generally pursue 

collections more aggressively and repossess collateral 

more quickly. 

Insured Institutions and the Subprime Market 

Bank involvement in subprime lending is difficult to 

quantify because subprime loans are not delineated in 

bank and thrift Call Reports. However, both large and 

small banks reportedly are participating in credit card, 

auto, home equity, and mortgage subprime lending. 

Insured institutions have used various strategies to 

establish a presence in the subprime market. Some 

have: 

•	 acquired or formed joint ventures with companies 

specializing in subprime lending; 

•	 built subprime lending programs internally, using 

existing resources; and 

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

for subprime mortgages may use this method more 

commonly. 

Through these strategies, insured institutions have: 

•	 extended loans directly to subprime borrowers or 

purchased subprime loans from loan brokers; 

•	 lent to subprime specialty lenders in the form of loan 

participations, warehouse lines, liquidity facilities, 

or dealer lines; and 

•	 serviced subprime loans or invested in asset-backed 

securities secured by subprime loans. 

Risks Associated with Subprime Lending Need 

to Be Considered Carefully 

According to a Financial Institutions Letter (FIL), FIL 

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

recent examinations revealed that a number of financial 

institutions involved in subprime lending have failed to 

properly assess and control the risks associated with 

subprime lending. Because of the relatively high default 

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

Regional Outlook	 4 Third Quarter 1997 
In Focus This Quarter
 

lending warrants particular caution and management 

attention. 

Institutions need to be thoroughly aware of the 

increased risks and costs associated with lending to 

higher risk borrowers. Some of these risks include: 

•	 Delinquencies and defaults tend to be more frequent 

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

•	 Loan loss reserves that would have been adequate for 

prime lending may not properly cover higher loss 

rates associated with subprime loans. 

•	 Strains on underwriting and collection resources 

may emerge. 

•	 Because selling collateral is more frequently the 

source of repayment on subprime loans, failure to 

accurately estimate recovery values could severely 

affect the profitability of subprime lenders. For 

example, several subprime auto lenders recently 

reported lower profits when the supply of better 

quality cars coming off leases depressed the prices 

they received on repossessed cars. 

Insured institutions that rapidly increase subprime 

exposures also may need to reevaluate delinquency 

measurement methodologies. Rapid loan growth can 

make it more difficult to accurately track delinquency 

and default trends. Generally loans do not default 

CHART 1 

0% 

10% 

20% 

30% 

40% 

50% 

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

Months since Origination 

"C" Auto Loans 

"A/B" Auto Loans 

"D" Auto Loans 

Source: Fitch Investors Service, L.P. 

Default Rate 

Defaults Are More Frequent and Occur 

Sooner on Lower Quality Auto Loans 

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

a period of time. Delinquency and default rates can be 

deceptively low if the proportion of new loans exceeds 

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

Calculating default rates over time for loans originated 

in a particular period or lending program, instead of as 

a percentage of total outstanding loan balances, helps 

reduce the distortion caused by rapid loan growth. This 

method of computing delinquency and default rates, 

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

Banks involved in subprime lending also should realize 

that the recent increase in subprime lending has 

occurred during relatively healthy economic conditions. 

The repayment capacity of subprime borrowers may be 

more susceptible to downturns in the economy, which 

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

loans. 

In addition, banks that lend to subprime specialty 

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

effect securitization may have on earnings (see 

Financial Markets). 

Conclusion 

The extent of involvement by insured institutions in 

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

resources and expertise. Conversely, deficiencies in 

assessing and controlling the risks of subprime lending 

can have serious consequences. Such deficiencies have 

surfaced at a number of FDIC-insured institutions. 

Striking an appropriate balance between the risks and 

rewards of subprime lending is a challenge for bankers 

and merits the continued attention of bank supervisors. 

Kathy R. Kalser, Chief 

Financial Sector Analysis Section 

Debra L. Novak, 

Division of Resolutions and Receiverships 

Regional Outlook	 5 Third Quarter 1997 
In Focus This Quarter
 

Retail Shakeout: Causes and Implications for Lenders
 

•	 Changes in the marketplace, technology, and 

finance are transforming retailing. 

•	 These trends have given rise to rapid growth in 

the new “big box” store format. 

•	 Consolidation in retailing is evident in mergers, 

acquisitions, and bankruptcies. 

•	 The potential for overbuilding in retail real estate 

markets may pose a risk for insured depository 

institutions. 

For the past two decades, construction of retail space 

has outstripped many indicators of demand such as 

growth in retail sales, population, and income. The 

broadest measure of the industry’s health is sales per 

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

around 35 percent in real terms since 1972. Chart 1 

shows how growth in leasable shopping center space 

has exceeded growth in shopping centers’ sales since 

1972. 

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

industry analysts have concluded that too many stores 

are chasing too few consumer dollars, indicating an 

emerging shakeout in the retail sector. To the extent that 

insured depository institutions provide financing to 

retailers or for retail real estate, they are exposed to 

heightened credit risk as the shakeout unfolds. 

New Forces Are Reshaping the Retail Landscape 

A combination of demographic and economic forces 

has reduced growth in demand for retail goods from the 

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

technology is reconfiguring the way retail goods are 

marketed and delivered, and a low cost of capital has 

stimulated investment in new retail space and new 

retailing concepts. 

A retail industry boom began roughly in 1970 when 

baby boomers and women began entering the work 

force in record numbers. At the same time, proliferation 

in general-purpose credit cards facilitated an extension 

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

CHART 1 

100 

150 

200 

250 

300 

350 

’72 ’76 ’80 ’84 ’87 ’89 ’91 ’93 ’95 

Leasable 

Space* 

Inflation-adjusted 

Sales * 

* Does not include non-shopping center space. 

Source: International Council of Shopping Centers 

1972=100 

Construction of Shopping Center Space Has 

Outstripped Sales Growth 

98 percent increase in inflation-adjusted retail sales 

from 1967 to 1994. 

To meet this demand and serve expanding suburban 

communities, developers built shopping centers at a 

rapid pace. The number of shopping centers, from small 

neighborhood strip centers to huge regional malls, grew 

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

Despite economic conditions that seem favorable for 

the retail sector, revenue growth has been painfully 

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

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

commensurately. An optimistic household sector has 

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

lower interest rates compared to the 1980s. 

Even with generally positive economic conditions, 

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

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

have lagged behind rates of the previous two decades. 

Slow growth in retail revenues can be explained in part 

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

only around two-thirds of the general rate of inflation 

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

personal computer sector has seen actual price deflation. 

Regional Outlook	 6 Third Quarter 1997 
In Focus This Quarter
 

An aging consumer base is another factor holding down 

retail sales growth. The total number of households 

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

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

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

so for the foreseeable future. The total population in the 

20 to 35 age bracket is projected to decline slightly by 

2007. 

Other broad trends have contributed to slower retail 

sales growth. Retail sales as a percentage of personal 

income fell from 46 percent to 38 percent between 1967 

to 1996 as consumers shifted more of their disposable 

income to the purchase of personal services, housing, 

education, travel, and entertainment. A Standard and 

Poor’s Industry Survey reports that consumers have 

reduced their number of trips to shopping malls by 35 

percent since 1980, while total shopping hours are down 

70 percent. 

Looking ahead, mail-order retailing through electronic media, 

including cable television and the 

Internet, may be poised to gain 

significant market share at the 

expense of shopping centers. 

“Virtual shopping malls” such as 

Amazon.com, an Internet bookseller, have made headlines with their initial successes,
 

although analysts caution that widespread adoption of
 

high-tech shopping may be some years down the road. 


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

been investing in technology to cut their expenses and 

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

scanning delivers a vast amount of information that can 

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

advantage for large retail chains with vast marketing 

and distribution networks. 

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

financing plentiful and cheap. This environment has 

allowed retailers to overhaul retail strategies and invest 

heavily in technology, inventory, and retail space— 

investments that might otherwise have been infeasible. 

Since 1991, around 1.13 billion square feet of new retail 

space has been added nationwide representing an 

increase of about 12 percent to the total stock of retail 

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

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

information systems, although they are known to be 

sizeable. 

Growth of the “Big Box” Format 

Leading retailers have responded to these forces with 

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

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

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

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

arrival of big box stores has left smaller, local retail 

establishments with only a small fraction of their former 

share of the local market. 

The big box format has a number of advantages. Among 

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

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

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

“category killers.” Large retail chains also have more 

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

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

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

capital markets. 

CHART 2 

Inflation-Adjusted Retail Sales Have Grown 

Slowly in the 1990s 

Real Growth in Retail Sales*, 

Compound Annual Rate 

3.0% 

2.5% 

2.0% 

1.5% 

1.0% 

0.5% 

0.0% 

1970s 1980s 1990s 

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

Source: Bureau of the Census and Bureau of Labor Statistics 

Regional Outlook 7 Third Quarter 1997 
In Focus This Quarter
 

Industry Consolidation to Continue 

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

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

be consolidation in the industry as weaker chains give 

way to market leaders. 

One sign of this consolidation is in multibillion dollar 

acquisitions, such as Federated Department Stores’ 

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

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

Nordstrom) now account for 87 percent of department 

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

account for 87 percent of full-line discount department 

store sales. 

Intensely competitive conditions also are reflected by 

retail bankruptcies and restructurings. Both Woolworth 

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

stores in restructurings that reflect the loss of market 

share to Wal-Mart. Smaller companies that have fewer 

restructuring options are more likely to be forced into 

bankruptcy. Dun & Bradstreet reports that domestic 

business failures among retail establishments rose in 

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

of larger chains also filed for bankruptcy during 1995, 

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

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

Today’s Man. 

As the retail shakeout moves forward, any credit losses 

on commercial and industrial loans to retailers are more 

likely to arise from bankruptcies and restructurings than 

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

industry is likely to take place. 

Overbuilding Is a Risk for Retail Real Estate 

Retail industry analysts are particularly concerned 

about the potential for overbuilding of retail space. 

Because of this concern, lenders and examiners should 

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

CHART 3 

0 

20 

40 

60 

80 

100 

120 

140 

160 

’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 

0% 

2% 

4% 

6% 

8% 

10% 

12% 

New Supply Has Recently Outpaced 

Absorption of Retail Space 

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

Vacancy 

Rate 

Net New Supply Absorption 

Millions of 

Square Feet 

Although a vacancy rate of 7.7 percent does not suggest 

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

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

vacancy rate has begun to tick upward since 1995 as net 

completions of new retail space have caught up to and 

surpassed the absorption of that space by retailers (see 

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

industry, reflecting the fact that additions to retail space 

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

local market conditions may be somewhat more volatile 

than the national figures would suggest, particularly in 

areas where a great deal of construction activity has 

recently taken place (see inset, Retail Vacancy Rates 

Rose throughout the Dallas Region in 1996). 

Besides market conditions, underwriting is the other 

major determinant of credit quality in retail real estate 

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

on loans with 1980s-vintage underwriting, particularly 

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

concern that the rapid expansion of space may be 

putting downward pressure on lease rates. In light of an 

ample supply of space and a number of large chains 

continuing to add space, any valuations that assume 

future growth in lease rates should be closely reviewed. 

The viability of rapid expansion on the part of the large 

retail chains would undergo a particularly severe test in 

the event of a recession. 

Richard A. Brown, Chief, Economic Analysis Section 

Diane Ellis, Senior Financial Analyst 

Regional Outlook 8 Third Quarter 1997 
In Focus This Quarter
 

Retail Vacancy Rates Rose throughout the Dallas Region in 1996 

After declining throughout much of the early to mid1990s, retail vacancy rates rose in 1996 in all eight of 

the Dallas Region metropolitan areas covered by The 

Real Estate Report of the FDIC. The upward trend in 

retail vacancy rates was not unique to the Dallas 

Region. The national retail vacancy rate also 

increased last year, to 7.7 percent from 7.4 percent in 

1995. Table 1 compares vacancy rates for the eight 

Dallas Region metro areas with the national average 

over the past four years. Retail vacancy rates in the 

Region are generally higher than the national average, 

with the exception of Tulsa. 

Higher than average growth in population, jobs, and 

incomes in the Region during this expansion have 

attracted greater retail development than in most other 

parts of the country. Now that the Dallas Region is 

shifting from robust to moderate job growth, the 

Region could see a cutback in retail construction in 

1997 and possibly 1998. 

Charts 4 and 5 show the annual changes in the supply 

and absorption of retail space in the Dallas Region’s 

TABLE 1 

Retail Vacancy Rates Edged Up 

in 1996 (percent) 

1993 1994 1995 1996 

NATIONAL 9.0 7.6 7.4 7.7 

AUSTIN, TX MSA* 12.4 10.1 9.3 10.8 

DALLAS, TX PMSA* 15.5 12.0 11.1 11.3 

DENVER, CO PMSA 13.8 9.8 13.1 14.9 

FORT WORTH-ARLINGTON, 

TX PMSA 15.8 12.9 12.2 14.0 

HOUSTON, TX PMSA 16.4 11.9 11.8 12.3 

OKLAHOMA CITY, OK MSA 14.5 10.9 9.2 9.7 

SAN ANTONIO, TX MSA 13.1 11.2 9.8 9.9 

TULSA, OK MSA 6.8 7.6 7.9 9.6 

*MSA = Metropolitan Statistical Area; PMSA = Primary 

Metropolitan Statistical Area 

Source: FDIC Real Estate Report, April 1997 

two largest retail markets: Dallas and Denver. 

Despite a gradual slowing in job growth for the state 

of Texas, employment growth remains very strong in 

Dallas, where the unemployment rate is near a 20­

year low. Nonetheless, absorption of retail space 

cooled off slightly in Dallas in 1996, while the retail 

vacancy rate increased from 11.1 percent in 1995 to 

11.3 percent in 1996. Furthermore, M/PF—a Dallasbased real estate firm—estimates that absorption of 

Dallas-area retail space was down 60 percent in the 

first quarter of 1997 compared to a year ago. But 

M/PF attributes the drop in absorption to a decline in 

the availability of new retail space rather than a significant drop in demand for store space on the part of 

retailers. The amount of new space added to the market was about 77 percent less in the first quarter of 

1997 than the same time a year ago. M/PF also notes 

that sluggish retail sales growth is likely to slow 

future retail development in the Dallas retail market. 

The Denver retail market (Chart 5, next page) experienced a large jump in its vacancy rate to 14.9 percent 

in 1996 from 13.1 percent in 1995, giving it by far the 

highest rate in the Region. Denver job growth shifted 

from extremely rapid in 1994 and 1995 to merely 

strong in 1996. Nevertheless, retailers appear to be 

planning new retail projects as if metropolitan area 

CHART 4 

-2,000 

-1,000 

0 

1,000 

2,000 

3,000 

4,000 

5,000 

6,000 

7,000 

0 

2 

4 

6 

8 

10 

12 

14 

16 

18 

20 

Percent 

Source: FDIC, The Real Estate Report, April 1997 

Vacancy rate 

(right scale) 

Net new supply 

Absorption 

Has Dallas Retail Vacancy Rate

 Bottomed Out in 1996? 

1989 1990 1991 1992 1993 1994 1995 1996 

(000s sq.ft.) 

Regional Outlook 9 Third Quarter 1997 
In Focus This Quarter
 

employment were still growing at 5 percent per year 

or more. Given rising vacancy rates and declining 

rates of job growth, developers might shelve some 

projects currently in the planning phase. Even so, 

Denver’s retail market is drawing a lot of attention, 

with more than one real estate expert having 

described it as overbuilt. According to these experts, 

new entrants to the market have made retailing 

intensely competitive, threatening the long-term viability of some established local retail chains. 

Adrian R. Sanchez, Regional Economist 

CHART 5 

Denver New Supply Outpaced 

Absorption in 1995 and 1996 

-4,000 

-3,000 

-2,000 

-1,000 

0 

1,000 

2,000 

3,000 

4,000 

5,000 

1989 1990 1991 1992 1993 1994 1995 1996 

0 

5 

10 

15 

20 

25 

Net 

new supply 

Absorption 

Vacancy rate 

(right scale) 

Source: FDIC, The Real Estate Report, April 1997 

(000s sq.ft.) Percent 

Regional Outlook 10 Third Quarter 1997 
Regular Features	 Regional Economy
 

Favorable Conditions Return to the Region’s Oil 


and Gas Industry
 

•	 First-quarter employment numbers continue to point toward a slowing of the Dallas Region’s economy. 

•	 The Region’s oil and gas industry is thriving once again and should be an important source of economic 

growth in 1997. 

•	 Major employment revisions reveal a significantly weaker New Mexico economy. 

First-Quarter 1997 Employment Summary 

The Region’s economy continued last year’s slower 

growth pattern into 1997. Job growth in the Dallas 

Region peaked in the first quarter of 1995 at 4.4 percent 

on a year-over-year basis. Since then job growth has 

cooled, falling below 3 percent by the first quarter of 

1996 to 2.6 percent in the first quarter of 1997. This 

marks the Region’s slowest job growth since 1992. 

Among the states in the Region, Oklahoma has 

replaced Colorado as the fastest growing economy, 

with a job growth rate of 3.2 percent. 

Table 1 shows that for each state in the Region, yearover-year job growth slowed during the first quarter of 

1997. Similarly, Table 2 reveals that the major industry 

sectors grew more slowly on a quarterly basis compared 

with their year-over-year growth rates, with the notable 

exception of the Region’s mining sector (which includes 

the oil and gas industry). 

TABLE 1 

Each State’s Employment Has Slowed 

NUMBER EMPLOYED 

(THOUSANDS) 

1997:1Q 

COLORADO 1,930 

NEW MEXICO 700 

OKLAHOMA 1,381 

TEXAS 8,366 

REGION 12,377 

UNITED STATES 121,238 

ANNUALIZED %

% CHANGE CHANGE

FROM FROM

PREVIOUS PREVIOUS

QUARTER YEAR

2.6 3.0 

0.8 1.5 

2.5 3.2 

1.5 2.5 

1.7 2.6 

2.4 2.3 

The Oil and Gas Industry Mounts a Comeback 

Optimism and economic activity are surging once again 

in the oil and gas industry across the Dallas Region. 

Many of the Region’s major oil companies reaped 

record profits in 1996, despite oil prices that were only 

half of what they were 15 years ago, after adjusting for 

inflation. 

The oil and gas industry continued strengthening during 

the first half of 1997 despite oil prices that have fallen 

since reaching a single-day peak of $28.10 per barrel on 

Christmas Eve 1996. A mild winter and increased oil 

supplies from Iraq helped push oil prices down once 

again. The price of West Texas Intermediate (WTI) oil 

as of June 13 was $18.83 per barrel. The Energy 

Information Administration (EIA) of the U.S. 

Department of Energy is forecasting fairly stable crude 

oil and natural gas prices—allowing for normal seasonal differences—for the remainder of 1997 and throughTABLE 2 

Employment Has Slowed in Most 

Industries 

NUMBER EMPLOYED 

(THOUSANDS) 

1997:1Q 

CONSTRUCTION 652 

GOVERNMENT 2,224 

MANUFACTURING 1,482 

MINING 220 

SERVICES 3,429 

TRADE 2,980 

ANNUALIZED % 

% CHANGE CHANGE 

FROM FROM 

PREVIOUS PREVIOUS 

QUARTER YEAR 

0.8 3.7 

0.8 1.2 

0.8 1.5 

6.0 2.1 

3.0 4.4 

1.5 2.5 

Seasonally adjusted payroll employment data Seasonally adjusted payroll employment data 

Source: Bureau of Labor Statistics Source: Bureau of Labor Statistics 

Regional Outlook	 11 Third Quarter 1997 
Regular Features	 Regional Economy
 

out 1998 (see Chart 1). Monthly crude oil prices (WTI) 

are projected to range between $18 and $20 per barrel. 

Meanwhile, monthly average wellhead natural gas 

prices are projected to hover between $2.00 and $2.25 

per million cubic feet. 

Better recovery methods and investment in other technological advances have facilitated expansion into previously untapped oil- and gas-rich areas, according to 

the EIA. These advances have stabilized energy prices. 

Stable prices, in turn, should lead to steady development and production of crude oil and natural gas. The 

Gulf Coast and east Texas have seen tremendous 

upturns in drilling activity, particularly for natural gas. 

At their current levels, oil and gas prices have benefited 

downstream businesses, such as refineries and petrochemical producers, boosting profitability and improving margins substantially. 

Analysts report favorable long-term prospects for the 

oil and gas industry, citing factors such as: 

•	 Strong demand domestically and in developing 

nations. The EIA, in its May 1997 update, is forecasting strong worldwide energy demand (see Chart 

2, next page). Rapid growth in Asia (e.g., China), 

along with strong demand in the mature economies 

(e.g., the United States), will be the driving forces 

behind demand. Natural gas is expected to be the 

fastest growing primary energy source over the forecast period, gaining share relative to oil and coal (see 

Chart 3, next page). 

CHART 1 

$-0 

$0.50 

$1.00 

$1.50 

$2.00 

$2.50 

$3.00 

$3.50 

$4.00 

Jan-95 Jan-96 Jan-97 Jan-98 

$-0 

$5.00 

$10.00 

$15.00 

$20.00 

$25.00 

$30.00 

$/MCF $/Barrel 

History Forecast 

Natural 

Gas Prices Oil Prices 

MCF = Million Cubic Feet 

Source: Energy Information Administration, U.S. Department of Energy 

Analysts Project Stable U.S. Crude 

Oil and Natural Gas Prices 

Jan-99 

•	 Lower costs. Producers are able to remain profitable 

despite lower prices because they have managed to 

cut expenses significantly, reducing their break-even 

costs. Producers also have managed to keep a tight 

rein on inventories and survive on tighter margins. 

•	 New technologies. New technologies like three-dimensional 

seismic mapping and advances in 

drilling technology allow producers to be far more efficient. 

Companies are able to find 

deposits overlooked in the past, 

increase recoveries from existing 

fields, and acquire oil and gas 

from nonconventional sources. 

Moreover, new technologies and 

higher oil prices have allowed 

producers to engage in offshore 

drilling in deeper waters and 

other hard-to-reach places. 

•	 The deregulation of the electricity market. Efforts 

at both the federal and state levels are under way that 

would open up the sale of electricity to free market 

forces. Natural gas firms could benefit from deregulation, since natural gas is cheap and widely used in 

the Southwest to generate electricity. Mergers 

between electric and natural gas firms could 

increase, with firms jockeying for market share 

based on rates and service. Sellers may offer onestop shopping for gas, electricity, and other energy 

sources. 

The Region may be becoming less sensitive to swings in 

oil prices as a result of diversification. Gary Preuss, an 

economist with the Texas Comptroller’s Office, estimated energy’s share of state economic output at 10 percent 

in 1996, down sharply from 26 percent in 1981. 

Obstacles Still Remain: The oil and gas industry is still 

faced with problems on several fronts. First, oil and gas 

firms are having difficulties finding experienced workers, such as machinists. Moreover, prices for certain 

supplies and materials have increased sharply as 

demand has risen. Second, oil refineries already are 

operating at near capacity. In the short run, increased 

demand can be met only by importing oil from overseas 

unless new refineries come on line. Furthermore, some 

analysts contend that years of underinvestment, U.S. 

environmental regulations, and higher compliance costs 

relative to other nations have resulted in a shift of new 

Regional Outlook	 12 Third Quarter 1997 
Regular Features Regional Economy
 

refinery capacity overseas. Third, a wave of consolidation within the industry is likely to continue. Some analysts expect the high cost of new technology and 

resources to lead to a more concentrated industry. Oil 

and gas firms that have disciplined their operations to 

thrive on narrower profit margins will have a greater 

likelihood of surviving this consolidation. 

Implications for Banking: Once again, commercial 

banks are aggressively lending to small and middle-tier 

oil and gas exploration and production companies. Loan 

volumes in the industry have more than doubled—from 

$15.7 billion in 1992 to $33.4 billion in 1996—according to Loan Pricing Corporation, a Reuters company 

based in New York. The implications for bank risks are 

uncertain. Factors that reportedly have lowered the risk 

in oil and gas exploration include (1) technological 

advancements that reduce dry-hole risk and (2) markethedging techniques that help smooth the effect on revenue from price volatility. 

In addition, the lessons of the 1980s are still fresh in the 

minds of many in this Region. Prudent bankers likely 

will avoid lending on the expectation of rapidly rising 

oil prices and will look for companies with good management experience, knowledge of the industry, and 

proven track records. 

Economic Update: Data Revisions Show Slower 

Growth in New Mexico 

Since 1993, New Mexico has vaulted into the ranks of 

the top ten fastest growing states in the nation, as meaCHART 2 

sured by job growth. As early as this year, payroll 

employment data continued to characterize the New 

Mexico economy as robust, with job growth well above 

the national average. However, when this year’s benchmarked numbers were released in early April, they told 

a much different story. New Mexico’s employment 

numbers for both 1995 and 1996 were revised downward, significantly in the case of the latter. 

Revisions were greatest in construction, retail trade, and 

services (see Table 3, next page), industries dominated 

by small businesses where employment numbers are 

hard to estimate. The size of the downward revision, and 

the rate of decline, could be providing an early warning 

signal of a possible weakening in the state’s economy. At 

the very least, a large subtraction from growth has 

altered perceptions about the strength of the New 

Mexico economy. 

In retrospect, the large downward revision in New 

Mexico’s employment numbers merely reflected what 

New Mexico’s other economic indicators were already 

showing—that the state’s economy was slowing. The 

state’s unemployment rate jumped sharply in 1996, 

peaking at 8.5 percent in the third quarter—3 percentage points above the nation. Personal income growth 

decelerated sharply, from 8.3 percent in 1995 to 4.8 percent in 1996. Homebuilders reported a 14 percent drop 

in permit activity during the second half of 1996, and 

retailers complained of weak gross receipts during the 

all-important fourth quarter. 

Implications for New Mexico Banking: Despite the 

revised job numbers, commercial banking in New 

CHART 3 

0 

100 

200 

300 

400 

500 

600 

World Energy Consumption Forecast to Rise . . . 

Quadrillion BTU 

Source: Energy Information Administration 

History Forecast 

1970197519801985199019952000200520102015 

Percent of Total 

Oil Coal Natural Gas Renewables Nuclear

0 

5 

10 

15 

20 

25 

30 

35 

40 

45 

50 

Oil Coal Natural Gas Renewables Nuclear 

. . . with Natural Gas Leading the Pack 

1970 

1995 

2015 

Source: EIA, International Energy Outlook 

Regional Outlook 13 
Regular Features Regional Economy
 

TABLE 3 

New Mexico Employment Growth 

Has Slowed 

BY INDUSTRY, 1996 

CATEGORY REVISED PRELIMINARY DIFFERENCE 

TOTAL 1.7% 3.7% –2.0% 

MINING –2.7% 3.7% –6.4% 

CONSTRUCTION –3.1% 6.7% –9.8% 

MANUFACTURING 1.6% 3.0% –1.4% 

DURABLES 2.1% 4.1% –2.0% 

NONDURABLES 0.6% 0.4% 0.2% 

TPU 0.7% –2.0% 2.7% 

TRADE 1.7% 4.6% –2.9% 

WHOLESALE 0.8% 4.3% –3.5% 

RETAIL 1.9% 4.6% –2.7% 

FIRE 4.8% 1.8% 3.0% 

SERVICES 2.0% 5.4% –3.4% 

GOVERNMENT 2.8% 1.1% 1.7% 

TPU = Transportation and Public Utilities 

FIRE = Finance, Insurance, and Real Estate 

Source: Bureau of Labor Statistics 

Mexico turned in another strong profit performance in 

1996 with a 1.33 percent return on assets, exceeding the 

national average of 1.19 percent. Profitability continued 

to be based upon high and rising net interest margins 

and good credit quality. Meanwhile, nonperforming 

assets were in line with the national average. Slowing 

growth in 1997, however, could make it more difficult 

for bankers to continue to achieve such a strong performance. 

Adrian R. Sanchez, Regional Economist 

Regional Outlook 14 Third Quarter 1997 
Regular Features	 Financial Markets
 

Financial Markets
 

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

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

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

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

Trends in the Home-Equity Asset-Backed 

Market Are Important to Banks 

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

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

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

delinquencies. Banks that are investing in HEL ABS, 

considering securitizing HELs, or lending significantly 

for debt consolidation should be aware of credit quality 

developments in the HEL ABS market. 

The distinction between HELs and first-lien residential 

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

1993 and early 1994 resulted in a change in the makeup 

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

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

lower rates to refinance their first mortgages for 

amounts greater than the remaining principal balance 

instead of adding a second mortgage. 

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

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

burdens. According to the Consumer Bankers 

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

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

to 1992, home improvement was the primary reason for 

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

significant risk implications because, unlike funds lent 

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

The rapid growth of the HEL securitization market has 

been attended by signs of relaxed underwriting. 

Adverse credit quality trends have been particularly 

prominent for loans that were originated in 1995. Chart 

2 (next page) shows the total delinquency rates for 

closed-end loan pools originated in 1995 versus 1994. 

The sharp upward path of delinquency rates for loan 

pools originated in 1995 raises concern that aggressive 

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

levels. Furthermore, HEL originations in 1996 more 

than doubled 1995 levels, causing market observers to 

suspect that underwriting standards continued to lapse. 

CHART 1 

1993 1994 1995 1996

0 

5 

10 

15 

20 

25 

1993 1994 1995 1996

Securitization of Home Equity 

Loans Has Risen Substantially 

Lines of Credit 

Closed End 

Source: Moody’s Investors Service 

$ Billion 

Regional Outlook	 15 Third Quarter 1997 
Regular Features Financial Markets
 

The trends in the HEL ABS market may portend credit 

quality trends in nonsecuritized cash-out refinancing. If 

similar unfavorable trends exist in bank-originated 

cash-out refinancing, evidence of these trends would be 

obscured by banks’ larger and less risky portfolios of 

purchase mortgage loans. The trends would be obscured 

because banks report all first mortgage lending on 1 to 

4 family residential properties without distinguishing 

between purchase mortgages and cash-out refinancings. 

The unfavorable trends in the HEL ABS market suggest 

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

able to monitor trends in the credit quality of these loans 

separate from purchase mortgage loans. 

A Combination of Several Factors Could Induce 

More Banks to Securitize HELs 

Although the present volume of bank-originated HEL 

securitizations is relatively small, banks have recently 

entered this finance company-dominated market, and a 

combination of several factors is likely to cause more to 

follow. First, home equity lines of credit are currently 

growing at rates exceeding total consumer lending, and, 

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

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

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

because bank-originated lines are perceived to have 

lower credit risk. The funding benefits and profitability 

of securitizing bank-originated home-equity lines of 

credit could entice more banks into the securitization 

market. Finally, the combination of these factors with the 

potential cost savings provided by using the new financial asset securitization investment trust (FASIT) structure (see discussion below) could produce momentum 

CHART 2 

0 

2 

4 

6 

8 

10 

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

Months since Origination 

1995-Originated Loans 

Source: Moody’s Investors Service 

Percent 

Higher Delinquency Rates Are Occurring 

Earlier in More Recently Originated Loan Pools 

1994-Originated Loans 

Closed-end Loans 

that will result in banks, large and small, securitizing 

home equity loans in significantly increased amounts. 

Securitizing HELs can change the balance sheet and 

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

sale. Beginning in 1997, 

when a company sells 

loans, it must comply 

with the requirements of 

Financial Accounting 

Standard (FAS) 125. If 

the company retains servicing rights on the assets sold, FAS 125 requires the 

seller to book an asset related to the gain on sale that 

represents the future income derived from servicing the 

loans. This asset is similar to mortgage servicing rights 

in that it represents the present value of future expected 

cash flows derived from loan servicing. One major 

home-equity securitizer, which indicated that FAS 125 

would not materially affect its financial statements, 

reported servicing assets at almost 90 percent of equity, 

and gains associated with the sale of serviced assets at 

71 percent of total revenue. 

The value of servicing assets is based on management’s 

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

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

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

early repayment through foreclosure of serviced assets, 

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

FASITs Promise to Change the ABS Market 

The Small Business Job Protection Act of 1996 created 

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

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

provide tax certainty for ABS issuers and purchasers 

and enhance the flexibility of asset securitizations. The 

FASIT provisions take effect on September 1, 1997. 

The advent of the FASIT is likely to change the ABS 

market in important ways. First, the FASIT will clarify 

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

Regional Outlook 16 Third Quarter 1997 
Regular Features Financial Markets
 

taxation is administratively costly, and it restricts the 

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

pools that can be feasibly securitized. With FASITs and 

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

community banks entering the securitization market. 

ABS issuers believe that the market for their product 

has been hampered by the restrictive nature of current 

asset-backed tax ambiguity, which prevents 

them from responding to 

investor preferences for 

varying maturities, 

coupon types, and prepayment and credit risk 

profiles. FASITs allow 

sponsors the flexibility 

to create multiple-class 

securities that satisfy these preferences with the certainty that the securities will count as debt and that the 

FASIT will not be treated as a taxable corporation. This 

combination of flexibility and tax certainty could lead 

to the kind of innovations in ABS structures that followed the 1986 REMIC legislation, which brought analogous benefits to the mortgage-backed market. 

FASITs will bring to the ABS market the ability to add 

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

revolving construction loans and then replacing the 

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

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

Finally, a FASIT can hold swaps and other hedging 

instruments. Using this feature, an issuer could combine 

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

risk, such as a reverse-index amortizing swap. 

The increased flexibility that the FASIT promises to 

bring the ABS market comes with the potential for 

greatly increased complexity and risk. Banks that invest 

in FASIT securities will need to understand fully not 

only the risk characteristics existing at the outset of 

security but also the risk that could arise throughout the 

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

Changes in Interest Rates and Bond Values 

The Treasury yield curve (see Chart 3) rose following 

March 25, 1997, when the Federal Open Market 

Committee (FOMC) met and raised the target federal 

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

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

Thursday following the meeting and remained there for 

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

1997, and left the target rate unchanged. 

The model portfolio responded to the rise in rates, but 

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

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

Treasury between December 31, 1996, and March 31, 

1997. As discussed in Regional Outlook, Second 

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

Treasury rate than with the 30-year bond rate. 

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

that the market expects the curve to continue to flatten 

through the remainder of the year with short rates rising 

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

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

portfolios, the model portfolio has been “shocked” to 

simulate the effect of an instantaneous 25 basis point 

shift in the yield curve on May 28, 1997. 

Again, the interest rate risk benefits of maintaining a 

portfolio of relatively short weighted average life are 

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

lived instruments, and the floating-rate ABS demonCHART 3 

The Treasury Yield Curve Is Steeper 

and Higher since Year-end 1996 

5.0 

5.5 

6.0 

6.5 

7.0 

7.5 

3­

month 

2­

year 

7­

year 

30­

year 

Source: Bloomberg 

Percent 

3/31/97 

4/30/97 

12/31/96 

Regional Outlook 17 Third Quarter 1997 
Regular Features Financial Markets
 

TABLE 1 

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

Portfolio WAL from a 25 bp Rate 

as of 12/31/96 Increase on 

12/31/96 to 5/28/97 

3/31/97 

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

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

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

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

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

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

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

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

strate the least price sensitivity. The municipal bond is 

the most sensitive to rate changes owing to its longer 

maturity. The mortgage passthrough security also is 

more sensitive to rising rates because its weighted-average life (WAL) extends as rising rates discourage the 

underlying mortgage holders from prepaying their 

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

combination unfavorable to the security’s value. 

CHART 4 

Community Bank Stocks in the Dallas Region 

Performed Smoothly Despite Turmoil in the 

Broad Market during the First Quarter of 1997 

Both the Standard & Poor’s (S&P) Composite Bank 

Index and the Dallas Regional Bank Index have been 

subject to similar performance swings this year, but the 

Dallas Regional Bank Index underperformed the S&P 

500 through May 2, 1997 (Chart 4). The S&P 

Composite Bank Index, with an almost 13 percent gain 

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

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

percent on the year. The Dallas Region’s Community 

Bank Index was spared much of the influence of a 

gyrating market, rising in value steadily to a 10.27 percent gain through May 2, 1997, enough to outperform 

the Dallas Regional Bank Index but not the S&P 

Composite Bank Index. 

Allen Puwalski, Banking Analyst 

The Dallas Region’s Community Bank Index Performs Smoothly through a Rough Market 

Change from 12/31/96 

-1% 

4% 

9% 

14% 

19% 

S&P 500 

Dallas Regional Bank Index 

S&P Bank Index Region’s Community Bank Index 

31-Dec

10-Jan24-Jan

7-Feb

21-Feb

7-Mar

21-Mar

4-Apr

18-Apr

2-May 

Source: Bloomberg, American Banker 

Regional Outlook 18 Third Quarter 1997 
Regular Features	 Regional Banking
 

Regional Banking Conditions
 

•	 Favorable performance continues into 1997 for banks and thrifts in the Dallas Region 

•	 Recent weather conditions pose yet another challenge to farm banks in western Oklahoma and the Texas 

Panhandle 

•	 Home equity lending may soon arrive in Texas 

•	 Institutions in the Dallas Region take advantage of the subchapter S corporation tax structure 

Overall Conditions Are Favorable 

First-quarter results show continuing favorable performance for banks and thrifts in the Dallas Region (see 

Chart 1). Banks and thrifts in the Region have outperformed the national average in return on assets (ROA) 

for ten consecutive quarters; however, the Region’s 1.22 

percent ROA for the first quarter of 1997 has narrowed 

to only 2 basis points above the national average. In 

addition, the Region’s institutions: 

•	 enjoyed an eighth consecutive quarter of widening in 

the net interest margin, now at 4.32 percent of average assets, in contrast to the second quarterly decline 

in the nation’s average—now at 4.05 percent; 

•	 increased the leverage capital ratio to 8 percent; and 

•	 continued to modestly increase past-due and noncurrent loans. 

CHART 1 

Dallas Region Institutions Show Financial
 

Strength
 

Percent of Assets 3/97 U.S.

3/96 3/97 8
 

3/95
 6 

4 

2 

0 

Net Past-Due Leverage 

Interest & Ratio 

Margin Noncurrent 

Return on 

Assets 

Loans 

Source: Bank and Thrift Call Reports 

The Region’s asset quality has shown modest deterioration in recent years, but it is difficult to know whether 

this marks the beginning of a trend. 

Although Chart 2 shows a slight but continuing rise in 

past-due and noncurrent loans over the past three years, 

the current levels remain well within historical norms. 

For example, during 1987 through the second quarter of 

1997, past-due and noncurrent loans in the Region 

ranged from 14.79 percent of total loans in 1987 to 2.06 

percent in 1995 and averaged 6.45 percent. 

A More Focused Look at Farm Loans in Western 

Oklahoma and North Texas 

In the second-quarter 1997 Regional Outlook, we commented on potential asset quality problems for farm 

banks, particularly those in the wheat-growing areas of 

western Oklahoma and the Texas Panhandle. Farm 

banks are defined as institutions with agricultural loans 

CHART 2 % Past Due & Noncurrent

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

3.0 

3.5 

4.0 

Real 

Estate 

Comm'l & 

Industial 

Consumer 

Credit Quality Shows Modest Deterioration 

Source: Bank and Thrift Call Reports 

3/97 

3/95 

U.S. 

3/97 

3/96 

Regional Outlook	 19 Third Quarter 1997 
Regular Features	 Regional Banking
 

of 25 percent or more of gross loans. Interestingly, asset 

quality for farm banks in both states held steady, and 

overall performance indicators showed improvement 

during the first quarter of 1997 (see Table 1). 

These recent performance 

trends are encouraging, considering the succession of adverse 

events affecting area farmers 

over the past few years. These 

have included several years of 

adverse weather conditions, 

poor wheat harvests, and, until 

recently, weak cattle prices. 

More recently, a freeze struck 

Kansas, Oklahoma, and the 

Texas Panhandle on April 11 

and 12, and many wheat farmers’ crops have been hit by 

hail, once again jeopardizing wheat production, particularly in southwest Oklahoma. Early harvest results and 

agronomist surveys are indicating much better results 

than were feared after the April freeze. However, cash 

wheat prices (Kansas City hard red winter wheat) have 

dropped from $5.94 per bushel to $3.92, or 34 percent 

over a 12-month period ending June 19, 1997, reflecting 

anticipation of higher production. While improved production should help alleviate pressures on farm bank 

asset quality, the price decline is decreasing the profit 

potential for many farmers. 

Even though cattle prices have increased by over 50 percent since April 1996, many cattle producers have not 

reaped the full benefit since they were forced into sale 

at last summer’s low prices by drought conditions, or 

were otherwise forced to pay higher feed costs. 

However, looking forward, prospects appear to be 

improving for the cattle sector, which accounts for 48 

percent of agricultural revenues for Oklahoma and 47 

percent for Texas. Prices are more favorable, feed costs 

are lower, and drought conditions have eased. 

TABLE 1 

Farm Bank Asset Quality Held Firm 

Farm Oklahoma Texas 

Banks 1996 3/97 1996 3/97 

ROA 1.06 1.42 1.15 1.19 

NPA 1.26 1.26 1.01 1.02 

Full Year 1996 3/97 annualized 

ROA = net income to total assets 

NPA = nonperforming assets to total assets 

Home Equity Lending in Texas 

Unlike any other state in the nation, Texas prohibits borrowers from using equity in their homes as collateral for 

loans other than home improvement loans. This prohibition, part of the “homestead exemption,” was written 

into the state’s constitution upon Texas’s induction into 

statehood in 1845, with the idea of helping protect 

homeowners against losing their homes through foreclosure. Currently, the only encumbrances allowed on 

residential real estate designated as a homestead are 

purchase money mortgages, home improvement loans, 

tax liens, or court-imposed partitions to divide a property into shares of unequal value, whereby a lien is 

imposed for the difference. 

After many years of unsuccessful effort, the Texas 

House of Representatives and the Senate passed House 

Joint Resolution #31 by the required two-thirds vote 

necessary to place the issue before Texas voters on 

November 4, 1997. A simple majority vote would 

amend the state’s constitution and place the bill into 

law effective January 1, 1998. Many politicians, 

lenders, and analysts now believe the chances for passage are high because the resistance to permitting this 

type of lending has weakened. In addition, a Wall 

Street Journal poll found that 62 percent of Texans 

would vote for allowing borrowing against the equity 

in their homes. Only 24 percent said they would vote 

against the measure. 

The proposed amendment contains a variety of restrictions: 

•	 Home equity lines of credit (revolving balances) 

would not be allowed. 

•	 Fees and charges to make the loan would be limited 

to 3 percent of the loan amount. 

•	 A homeowner would be able to borrow only to 80 

percent of the fair market value of the residence. 

•	 There would be a 12-day waiting period between 

the application date and the date the loan could be 

funded. 

•	 In the event of default, foreclosures would have to be 

reviewed by a state judge. 

Regional Outlook	 20 Third Quarter 1997 
Regular Features	 Regional Banking
 

•	 Except in the event of fraud, lenders would not be 

able to seek personal liability from the homeowner 

for any deficiency between the amount of the home 

equity loan and the eventual sale price of the home 

following foreclosure. 

This last restriction, which forbids a bank from pursuing deficiency judgments, is a key reason why the 

Independent Bankers Association of Texas—generally 

composed of smaller institutions—opposed the bill in 

its final form. In contrast, large nationwide companies 

have been lobbying hard for home equity lending in 

Texas and are expected to support the bill, given the perceived advantage to their branch networks of marketing 

and originating these loans. 

Home equity loans nationwide account for approximately 6 percent of bank lending. At March 31, 1997, 

Texas banks reported $139.9 billion in total loans. 

While the numerous restrictions make it difficult to 

draw analogies to the broader national experience, some 

analysts estimate that the volume of home equity loans 

could grow to approximately $8 billion if Texas were to 

approximate national averages. State authorities estimated last year that the total 

equity in Texas homes was 

$123.4 billion. Other analysts’ estimates are much 

higher, in the $200 billion 

range. The state’s estimate of 

$8.7 billion as a potential 

market for home equity lending in Texas is consistent 

with the estimate based on the national experience. 

Home equity lending would not necessarily represent 

new lending, but could replace to some extent other 

types of consumer lending such as credit card debt. The 

advantages of home equity lending include a stable collateral source for the lender and tax deductibility of 

TABLE 2 

interest payments for the borrower. According to a 

Federal Reserve Bank of Dallas study, the primary uses 

of home equity loans are to pay off other debts (40 percent) and to make home improvements (38 percent). 

For lenders in Texas, the advent of home equity lending 

could present an opportunity to expand their collateralized consumer lending business and could provide a 

source of additional fee income and a way to expand the 

customer base to cross-sell other products and services. 

Should home equity lending become available in Texas, 

competition will likely be intense as lenders of all types 

endeavor to capture market share. For example, one 

large consumer finance company has already obtained 

state approval to open 100 offices in Texas. (For related 

information on home equity lending, see Financial 

Markets.) 

Institutions in the Dallas Region Take 

Advantage of the Subchapter S Corporation 

Tax Structure 

In the first-quarter 1997 Regional Outlook we reported 

that the Small Business Job Protection Act of 1996 

allows closely held banks, thrifts, and holding companies to take advantage of various pass-through benefits 

of the subchapter S corporation tax structure. In less 

than one year’s time since passage, 3.9 percent, or 509 

banks and thrifts nationwide with $38.3 billion in 

assets, have elected to switch to subchapter S status. In 

the Dallas Region, 8.3 percent, or 131 banks and thrifts 

with $10.5 billion in assets, have changed tax structures. 

Of these, 85 percent have total assets under $100 million. Table 2 shows a distribution by charter type of the 

banks in the Region that have made this election as 

compared with those in the nation. 

The Region’s greater use of the subchapter S election 

may be attributable to its large number of small, closely 

Subchapter S Corporation Banks 

DALLAS REGION # 

ASSETS ($MILLIONS) 

U.S. # 

ASSETS ($MILLIONS) 

Regional Outlook 

MUTUAL 

INSURED 

1 

$1,324 

3 

$2,791 

NATIONAL 

55 

$5,020 

132 

$12,408 

NONMEMBER 

72 

$4,068 

344 

$20,735 

STATE 

MEMBER 

3 

$94 

30 

$2,246 

TOTAL 

131 

$10,506 

509 

$38,180 

Source: Bank Call Reports as of 3-31-97 

21 Third Quarter 1997 
Regular Features Regional Banking
 

held banks. At March 31, 1997, 1,102 banks, or 70 percent of the Region’s total, had assets under $100 million. 

Moreover, an American Bankers Association/ABA 

Banking Journal Community Bank Competitiveness 

Survey (American Bankers Association / ABA Banking 

Journal, April 1997) reports that 53 percent of the community banks surveyed in the Southwest (assets under $1 

billion) feature a controlling interest held by one family, 

compared with 38 percent nationwide. 

At this writing, there is a proposed federal budget measure that would impose initial taxes upon banks and 

thrifts adopting S corporation status that, according to 

CFO Alert (May 12, 1997), “would make the status 

unfeasible to pursue.” Given the large number of eligible banks in the Region, there may be accelerated activity in S corporation adoption in advance of this potential 

“entry tax.” 

Alan C. Bush, Senior Regional Analyst 

Jeffrey A. Ayres, Financial Analyst 

Regional Outlook 22 Third Quarter 1997 

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