Full text of District Highlights : September 1987

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DALLAS
Federal Reserve Bank of Dallas

September 1987

Problem Loans Clobber Eleventh District Banks
Profits at Eleventh District commer­
cial banks have suffered dramatically
as a result of the recent downturn in
the local economy. For all District
banks as a group, return on assets
dropped from 0.54 percent in 1985 to
-0.35 percent in 1986. Hardest hit were
the large District banks; their return on
assets fell from 0.48 percent in 1985 to
-0.66 percent in 1986. Last year’s
decline in profitability was mainly the
result of greater provision for loan
losses and a reduction in net interest
margin (Table 1). The adverse move­
ments in these accounts, in turn, re­
flected a sharp and unexpected rise in
problem loans.
Loan Loss Provision Soars

Loan charge-off rates and nonper­
forming loan rates rose markedly in
1986 at the District banks. As a propor­
tion of average loans, charge-offs less
recoveries rose from 1.33 percent in
1985 to 1.95 percent in 1986. Moreover,
as a proportion of end-of-year loans,
nonaccrual loans and loans that were
past due 90 days or more and still ac­
cruing rose from 3.40 percent in 1985 to
5.34 percent in 1986.
These mounting loan difficulties in­
duced the District banks to increase
provision for loan losses substantially
in order to bolster their loan loss re­
serves. The magnitude of the increase
in the provision for loan losses
stemmed from the severity and unan­
ticipated nature of the economic down­
turn and the related rise in problem
loans. For all District banks, provision
for loan losses relative to average
assets surged from 0.94 percent in

1985 to 1.61 percent in 1986. It in­
creased by the greatest margin at the
large District banks, reaching 1.82 per­
cent (Chart 1). At the small banks and
medium-size banks, it increased to 1.40
percent and 1.56 percent, respectively.
Net Interest Margin Declines

The mounting loan difficulties also
contributed to a reduction in net in­
terest margin—interest income less
interest expense relative to average
assets. For all District banks, net in­
terest margin fell from 3.25 percent in
1985 to 2.86 percent in 1986. This

decline occurred as an increasing pro­
portion of loans ceased accruing in­
terest and risk premiums paid to
attract deposits climbed.
According to estimates derived by
comparing net interest margin move­
ments at the District banks with those
at banks in the rest of the nation, about
three-fourths of the decline in net in­
terest margin at the District banks
stemmed from the rise in problem
loans. Problem loans had the largest
estimated effect on net interest margin
at the medium-size District banks
(Continued on back page)

Growth in Services Adds Stability
to Texas Employment
From January 1980 to June this year,
the share of total employment in Texas
accounted for by private serviceproducing industries increased from
54.8 percent to 59.7 percent.’ If the
shift to service-producing industries is
permanent, two effects on the Texas
economy should be decreased employ­
ment variance and an unemployment
rate that, on average, is 1 percentage
point lower than if employment shares
had remained unchanged.
Service Employment Stable

Employment in service-producing in­
dustries generally has lower variance
than in goods-producing industries.
One reason is that services cannot be
stored and, thus, do not suffer from
output swings due to unintended in­
ventory accumulations or depletions.
Another reason is that the service sec­

tor is less unionized, so many shifts in
demand can be accommodated more
easily by wage adjustments than by
employment changes.
The variability of total employment
in a region is determined not only by
the employment variances of its in­
dividual industries but also by their
employment covariances. If employ­
ment in a given industry is not very
responsive to overall movements in
the economy and, thus, has a low
covariance with employment in other
industries and a low variance, then the
increased presence of such an in­
dustry will lower the overall employ­
ment variance of the region. In Texas
the variances and covariances of
the service-producing industries have
generally been lower than those of
goods-producing industries (Table 2).
(Continued on back page)

Table 1
CHANGES IN RETURN ON ASSETS
AT ELEVENTH DISTRICT BANKS

Chart 1
PROVISION FOR LOAN LOSSES IN THE
ELEVENTH DISTRICT, BY BANK SIZE
i—

2.0 PERCENT OF AVERAGE ASSETS

Bank size
Small
Medium
Large
Percentage-point changes
from 1985 to 1986
Change in return on assets
due to change in each item
-.33

Net interest margin..................

-.43

-.46

Net noninterest m argin'..........

-.02

-.01

-.28

Securities gains or losses . . . .

+ .10

+ .06

+ .10

Loan loss provision..................

-.38

-.75

-.83

Taxes .........................................

+ .15

+ .27

+ .20

Change in return on assets ........

-.57

-.90

-1.14

1. Defined as extraordinary items, net of taxes, plus noninterest income less
noninterest expense.
NOTE: Small banks were defined as insured commercial banks having end-of-year
assets under $100 million; medium-size banks, as having assets of $100
million or more but less than $1 billion; and large banks, as having assets
of $1 billion or more.
Details may not add to totals because of rounding.
SOURCES: Board of Governors, Federal Reserve System.
Federal Reserve Bank of Dallas.

Table 2
STANDARDIZED VARIANCES AND COVARIANCES
OF EMPLOYMENT IN TEXAS INDUSTRIES

SOURCES: Board of Governors, Federal Reserve System.
Federal Reserve Bank of Dallas.

Chart 2
PORTFOLIO VARIANCE OF TEXAS EMPLOYMENT
r-

Industry
Government .....................................

.13

.14

Retail trade.......................................

.39

.58

Services.............................................

.46

.53

Finance, insurance, and real estate

.64

.42

Transportation and public utilities .

1.46

1.08

Wholesale trade..............................

1.64

1.23

Construction.....................................

3.91

1.63

Electric and electronic equipment.

8.08

1.75

Oil and gas extraction....................

36.26

4.24

Oil field equipment ........................

58.06

5.87

NOTE: Measures are calculated from deviations from trend and are standardized
with respect to their means. Numbers are multiplied by 1,000. For further
details, see the article cited in text footnote 2.
SOURCES: U.S. Bureau of Labor Statistics.
Federal Reserve Bank of Dallas.

LOANS-LARGE WEEKLY REPORTERS
Eleventh Federal Reserve District

105 (INDEX, OCTOBER 1978 = 100)----------------------------------------------

January 1970-June 1987
Variance
Covariance

SOURCES: U.S. Bureau of Labor Statistics.
Federal Reserve Bank of Dallas.

DEPOSITS-LARGE WEEKLY REPORTERS
Eleventh Federal Reserve District

" 22
1. Percent change from same quarter in previous year.
SOURCE: Federal Reserve Bank of Dallas.

1984

I

1985

I

1. Percent change from same quarter in previous year.
SOURCE: Federal Reserve Bank of Dallas.

1986

I

1987

DISTRICT BRIEFS
The Eleventh District economy is starting to grow very slowly.
• After decreasing every month since January,
seasonally adjusted nonagricultural employ­
ment in the District rose in July, with gains
posted in most major categories. In Texas, total
employment declined, however, because of a
large decrease in government jobs. Employ­
ment in Louisiana increased in July after falling
slowly since January, while employment in
New Mexico continued to rise gradually.
• District drilling activity continues to climb. The
rig count increased sharply in July and held
steady through mid-August. Two leading in­
dicators of drilling, well permit applications
and the seismic crew count, suggest further
gains in the second half of 1987.
• Total construction contracts have increased
substantially from the first quarter, but some
sectors show weakness. The recent strength
has been mainly in non-building construction.

UNEMPLOYMENT RATE
r—

Residential contracts have shown a small gain,
while nonresidential contracts have remained
weak. Although major road projects in Texas
may keep non-building construction strong in
the coming months, recent declines in both
single-family and multifamily housing permits
suggest weakness in residential construction.
• Activity is stable or increasing in most
manufacturing industries. The lower value of
the dollar has stimulated orders in the
chemical industry and, more recently, the ap­
parel industry. Orders in the energy-related
durable goods industries remain unchanged,
while orders for construction-related durables
are starting to stabilize at very low levels.
• The District’s banks are still adjusting to
sluggish economic conditions. There has been
virtually no deposit growth at District commer­
cial banks during the past three quarters.

HOUSING PERMITS IN TEXAS

12 PERCENT-------------------------------------------------------------------------

(QUARTERLY AVERAGES,
SEASONALLY ADJUSTED)

!—

16 THOUSAND---------------------------------------------------------------------(QUARTERLY AVERAGES,

ELEVENTH

TEXAS
1984

I

1985

I

1986

I

1987

1. Louisiana, New Mexico, and Texas.
SOURCES: Texas Employment Commission.
U.S. Bureau of Labor Statistics.
Federal Reserve Bank of Dallas.

8 PERCENT’

6

1. Percent change from same quarter in previous year.
SOURCES: U.S. Bureau of Labor Statistics.
Federal Reserve Bank of Dallas.

I

1 9 li

I

1986

TEXAS INDUSTRIAL PRODUCTION INDEX

CONSUMER PRICE INDEX
r -

1984

SOURCES: U.S. Bureau of the Census.
Federal Reserve Bank of Dallas.

(SEASONALLY ADJUSTED)

I

1987

Problem Loans (cont.)

Growth (cont.)

(causing a 0.36-percentage-point drop),
followed by the large banks (with a
0.30-percentage-point drop) and then
the small banks (with a 0.22-percentage-point drop).

Texas Employment Variance Declines

from 20.8 percent to 17.2 percent.

To determine the effect that chang­
ing employment shares have had on
the overall variation of employment in
Texas, a portfolio variance measure
was calculated using a weighted sum
of individual-industry variances and
covariances.1
2 The calculations show
that the employment portfolio variance
increased from 1970 to 1979 but then
flattened and started to decline (Chart
2). A lower portfolio variance means
that for a given set of economic
shocks, the variance of Texas employ­
ment will be lower over time.
Much of the decline in the employ­
ment portfolio variance was due to a
shift in employment shares away from
manufacturing and energy extraction
industries to service-producing indus­
tries. From January 1980 to June 1987,
the share of employment in manufac­
turing and energy extraction declined

Implications

Problem Loans Steer Profitability

Problem loans dominated the Dis­
trict bank profitability picture in 1986.
The effect of the rise in problem loans
in increasing provision for loan losses
and reducing net interest margin ac­
counted for an estimated 79 percent of
the forces that decreased return on
assets at the large District banks. At
the medium-size banks, the effects of
problem loans accounted for an es­
timated 91 percent of the forces
decreasing profitability. At the small
banks, the effects accounted for an
estimated 73 percent of the negative
forces.
—Jeffery W. Gunther

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Although many factors influence the
Texas unemployment rate, a lower
employment variance is generally as­
sociated with a lower average unem­
ployment rate. Using an econometric
model of the Texas economy, it was
estimated that, on the basis of the
declining employment portfolio vari­
ance from 1980 to 1987, the unemploy­
ment rate over time should average
about 1 percentage point lower than
if the state’s industrial structure had
not changed.2
—Keith R. Phillips
1. Private service-producing industries comprise
transportation and public utilities, wholesale
and retail trade, services, and finance, in­
surance, and real estate.
2. See William C. Gruben and Keith R. Phillips,
“ Understanding the Texas Unemployment
Rate,” Federal Reserve Bank of Dallas
Economic Review, November 1986, 17-30.