Full text of The Southwest Economy : Second Quarter 2019

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Federal Reserve
Bank of Dallas
SECOND QUARTER 2019

Southwest
Economy

}

Texas Facing Historically Tight
Labor Markets, Constraining Growth
PLUS
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Texas Industrial Building Booms as Economy, Population Grow
}}
On the Record: Texas Economy Remains Strong
Despite Challenges

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Eleventh District Banks Have Performed Well Despite Rising
Funding Costs, Nonbank Competition

}}
Spotlight: Mexico's Fiscal Reform Earns Mixed Reviews
}}
Go Figure: Texas Graduation Rates Commendable, b ut State
Could Fall Behind

PRESIDENT’S PERSPECTIVE

T

the current pace of growth
} Ifcontinues,
the Texas economy
will add nearly 300,000 jobs
in 2019. While this is good
news, a number of headwinds
impact the outlook.

exas employment grew at a rate of 2.3 percent
through April, about the same pace as last year
and above the state’s historical average growth
rate of 2.1 percent. If the current pace of growth
continues, the Texas economy will add nearly 300,000
jobs in 2019.
While this is good news, a number of headwinds
impact the outlook. Our May Texas Business Outlook Surveys of over 350 Texas firms indicate slowing
growth and a spike in uncertainty. Business executives express heightened concern regarding trade
policy as well as exceptionally tight labor markets.
In “Texas Facing Historically Tight Labor Markets,
Constraining Growth,” Christopher Slijk notes how
low unemployment in many parts of the state is curbing hiring and pressuring wages. The Texas workforce
has been growing more slowly in recent years, and
migration into the state appears to have slowed since
2015. Smaller Texas metropolitan areas with relatively
lower wage rates face some of the greatest difficulties
in attracting and retaining workers.
In “Eleventh District Banks Have Performed Well
Despite Rising Funding Costs, Nonbank Competition,” Kelsey Reichow and Amy Chapel show that our
region’s banks outperformed national banks in 2018 in
terms of higher profitability and fewer nonperforming
loans. They also note that slower loan growth and the
higher cost of funds remain challenges to the outlook.
In “Texas Industrial Building Booms as Economy,
Population Grow,” Laila Assanie and Michael Weiss
document the industrial building boom that the state
has experienced since 2014. They note the increased
construction related to e-commerce and the new
warehousing needed to locate inventories closer to
customers in order to achieve faster shipping times.
Dallas Fed economists will continue to produce
research that explores key economic trends in the
Eleventh District. This work has critical implications
for how we think about economic growth in our region, the U.S. and the global economy.

Robert S. Kaplan
President and Chief Executive Officer
Federal Reserve Bank of Dallas

Texas Facing Historically
Tight Labor Markets,
Constraining Growth
By Christopher Slijk

}
ABSTRACT: Texas labor
markets have become
very tight in recent years
following steady post-Great
Recession job growth.
Labor force expansion,
once fueled by migration,
has eased, and businesses
report that they cannot
find sufficient numbers
of workers to expand—
particularly for middleskill positions. This has
constrained economic
growth and pressured
wages higher.

T

exas labor markets have become
exceptionally tight over the past
year. Since the end of the oil bust
of 2015–16, many measures of labor
market slack have declined to multidecade lows. This trend has been
largely uniform, affecting all of the
state’s major regions as jobless rates
have reached or surpassed previous
record lows.
These trends coincide with similar
labor constraints across the U.S.
A tight job market significantly affects the economy. It increases workers’
bargaining power and pushes up wages
and benefits. It limits companies’ ability to expand because finding and retaining workers becomes more difficult
even as labor costs increase.
When such labor scarcity becomes
pervasive across industries, it can constrain economic growth and, over the
longer term, may provide stronger incentive for businesses to boost investments in labor-saving technologies.1

Labor Force Migration, Growth
Since the Great Recession ended a
decade ago, the Texas job market has
experienced a robust recovery. Texas’
employment expansion preceded U.S.
job growth, and by 2012, the state had
exceeded its prerecession employment
peak. Texas job growth from 2010 to
2018 outpaced its long-term trend of
2.1 percent on average. Over this time,
Texas became the fourth-fastest-growing state, trailing only Nevada, Florida
and Colorado, despite an oil bust in
2015–16.
Meanwhile, data available covering 2010–17 show the working-age
population (ages 16 to 64) grew just
1.5 percent per year. Migrants to the
state augmented this growth. Domestic

and international migration have accounted for nearly half of overall Texas
population growth since 2010 and an
even larger share of the growth of the
working-age population, reflecting that
many move to Texas for employment.2
Recent data suggest that these movements have slowed; since 2016, the
share of population increase attributable to domestic migration has nearly
halved, dropping average annual
growth to just 1.3 percent over the
past two years (Chart 1). Some of this
deceleration is likely due to the U.S.
economic expansion in recent years—
as employment prospects improved
and unemployment rates declined
broadly across the nation, the need for
job seekers to incur the costs of moving
to Texas for work diminished.
The change in migration patterns has
been most striking in Houston as the
area flipped from being a top region
for domestic migration in 2010–16 to
experiencing a net outflow the following two years.
Data from the Texas Demographic
Center suggest that through 2030, the
majority of overall population growth
in the state and its major metros will
come from a combination of domestic
and international migration.
Natural increase—the number of
births relative to deaths—is expected
to continue declining as a driver of
population growth in Texas and the
rest of the U.S.
This change is even starker among
the working-age population—more
than three-fourths of the 1.4 percent
annual growth expected through 2030
is projected to come from net domestic
and international migration. This will
constitute a majority of labor force
growth over the period.

Southwest Economy • Federal Reserve Bank of Dallas • Second Quarter 2019

3

CHART

1

Despite Slowing in 2016–18, Migration Expected to Fuel Future Texas Growth

Annualized population growth (percent)
3.5

International migration
Domestic migration
Natural increase
Projected total migration
Projected natural increase

3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5

'10-'16

'16-'18

'18-'30

'10-'16

Texas

'16-'18

'18-'30

Dallas–Fort Worth

'10-'16

'16-'18

'18-'30

'10-'16

Houston

'16-'18

'18-'30

San Antonio

'10-'16

'16-'18

'18-'30

Austin

NOTES: Projected natural increase data are based on state population projections produced in 2014. All other data are based on projections produced in 2018.
SOURCES: Census Bureau; Texas Demographics Center.

Record Low Unemployment
With the number of workers failing to
keep up with the rapid increase in employment, labor availability has tightened in Texas. The state unemployment rate, after peaking at 8.3 percent
in late 2009, has steadily declined. The
rate stood at 3.7 percent in April 2019,
its lowest level since records began in
the mid-1970s. Texas’ unemployment
rate of 4 percent or below for over a
year suggests unprecedented labor
market tightness.
Broader measures of labor market
slack further illustrate the unusual level
of constraint. The U.S. Bureau of Labor
Statistics’ broader U-6 measure of state
unemployment—which includes discouraged workers (who have given up
looking for work in the last 12 months)
and those who are working part-time
but would like to work full-time—
reached a record low of 7.2 percent in
early 2019. This is significantly below
the 25-year average of 9.9 percent and
well below the recessionary peak of over
15 percent.
Looking more closely at regions within the state, a similar picture emerges.

4

Jobless rates remain significantly below
their long-term averages and are less
than half of their Great Recession peaks
(Chart 2). Among urban areas, only the
Texas border region has a higher jobless
rate than the U.S. and Texas.

Regional Areas of Strength
West Texas, which includes the
energy-intense Permian Basin and Midland–Odessa, has the lowest unemployment rate in the state, 2.4 percent, and
is one of the tightest labor markets in
the nation. “Man camps” have sprung
up around Midland–Odessa; housing
shortages abound as workers rush into
the region to fill lucrative jobs in the oil
and gas industry.
Along the Interstate 35 corridor’s populous metropolitan areas, labor markets
are constrained, though slightly above
their all-time unemployment lows. The
four largest metros—Dallas, Fort Worth,
Austin and San Antonio—nationally
rank in the top 25 of large metro areas
(population of over 1 million) for lowest
rates of joblessness.
Nevertheless, they continue experiencing strong labor force growth, with

the North Texas region growing well
above average at 2.3 percent, and the
Central/South Texas labor force expanding at close to the state average of
1.5 percent year over year through April.
These regions benefit the most from
migration to the state. The population
age 25 to 64 is expected to grow about
2 percent annually through 2030 based
on recent population trends—and most
of that growth (1.9 percentage points) is
projected to be from a mix of domestic
and international in-migration.
The Gulf Coast region—dominated
by metropolitan Houston—has record
low unemployment after joblessness
rose in the oil bust years of 2015–16. A
net outmigration of people followed the
slump, possibly exacerbated by Hurricane Harvey in August 2017. These
departures, combined with the energy
sector rebound in 2017–18, led to an
unprecedented tightening of regional
labor markets.
The Texas–Mexico border stands
out as the one region with a significantly higher unemployment rate than
the state average. Still, the 4.4 percent
jobless rate in April was a record

Southwest Economy • Federal Reserve Bank of Dallas • Second Quarter 2019

low for the region. Its young, predominantly Hispanic population has
historically grown faster than the state
and national averages.
However, recent slowing in the pace
of labor expansion—down to just 0.4
percent year over year—has pushed
the jobless rate to less than half of
its long-term average. Proximity to
high-paying oilfield jobs in the Eagle
Ford and Permian Basin shale plays,
along with declining appeal as a final
destination for Mexican immigration,
may factor into this slowing. The region
overall has experienced net outmigration since 2013.

Struggling to Hire
Recruiting and retaining hires has
become increasingly difficult for Texas
businesses. Starting in late 2017, a majority of surveyed firms have had difficulties finding qualified applicants to
fill open positions, the Federal Reserve
Bank of Dallas’ Texas Business Outlook
Surveys (TBOS) show.
Comments from businesses have
persistently pointed to the lack of
workers impeding company expansion
and slowing hiring.
“We simply cannot find enough
legal entry-level workers to complete
our work. We are actively turning
away new business. Despite all efforts
including pay increases, hiring and
referral bonuses, etc., we are unable to
keep a full staff,” a survey respondent
in professional and business services
noted in April. “We will ultimately lose
close to $2 million in revenue this year
due to lack of available labor.”
Other survey contacts have mentioned similar constraints, with one
financial services firm saying that the
“lack of a qualified workforce is our
leading contributor to stalled growth.”
While labor tightness is broad
based, it has been particularly acute
for firms seeking to fill mid-skill positions—those requiring some college
or technical training (Chart 3). The
positions include many blue-collar
trades, which respondents have identified as constrained nationally for the
past several years.3 TBOS surveys have
noted increasing difficulty finding

CHART

2

Unemployment Rates Very Low Across All Texas Regions

Percent
12

Peak during Great Recession
April 2019
Average since 1990
Lowest since 1990

10.0

10

8.3

8

11.0
8.8

8.6

7.5

6.9

6
3.6

4

4.4

3.7

3.0

2.8

2.4

3.6

2
0

U.S.

Texas

West
Texas

Central/South
Texas

North
Texas

Gulf Coast

Border

NOTES: West Texas includes the Midland, Odessa, Abilene, Amarillo, Lubbock and San Angelo metropolitan statistical
areas (MSAs). Central/South Texas includes the Austin–Round Rock, San Antonio–New Braunfels, College Station–
Bryan, Kileen–Temple and Waco MSAs. North Texas includes the Dallas, Fort Worth, Sherman and Wichita Falls
MSAs. Gulf Coast includes the Houston–The Woodlands–Sugarland, Beaumont–Port Arthur, Victoria and Corpus
Christi MSAs. Border includes the El Paso, Laredo, McAllen–Edinburg–Mission, and Brownsville–Harlingen MSAs.
SOURCES: Bureau of Labor Statistics; Texas Workforce Commission; adjustments by the Federal Reserve
Bank of Dallas.

CHART

3

Business Surveys Suggest Large Mid-Skill Worker Shortages

Percent reporting difficulty hiring
80

71

70
60

54

Nov. '17
Feb. '18
Aug. '18
Nov. '18

50
40

36

30
20
10
0

Low-skill positions

Mid-skill positions

High-skill positions

NOTE: The question was only posed to firms that noted problems finding qualified workers when hiring.
SOURCE: Federal Reserve Bank of Dallas, Texas Business Outlook Surveys.

mid-skill workers, with nearly threequarters of hiring firms saying they
struggled to recruit for such positions
in November 2018.

Texas Employer Impact
Responding to this persistent inability to find workers, businesses
have looked to a number of alternative

strategies to attract labor. Intensified
recruiting—the predominant method
until mid-2018—included more advertising, greater utilization of employment agencies and sign-on bonuses.
More recently, employers have
turned to increasing wages and benefits as the primary means of dealing
with the labor shortage. The share of

Southwest Economy • Federal Reserve Bank of Dallas • Second Quarter 2019

5

CHART

4

Rate of Pay Raises Broadly Accelerates Across Areas

A. Wage Growth by Texas Region
Percent, seasonally adjusted annualized rate
6
5

West Texas

Central/South Texas

Border

North Texas

4.0

4
3
2

Gulf Coast

2.4
1.7

2.3

3.6

2.0

1.9

1.6

3.5

1.4

1
0

2010–17

2017–19

B. Top Wage-Growth Metros by Texas Region
Percent, seasonally adjusted annualized rate
10.9

12
9

5.0
2.7

5.5

5.5

4.0

2010–17

Dallas–
Plano–
Irving

McAllen–
Edinburg–
Mission

Beaumont–
Port Arthur

Killeen–
Temple

Abilene

2.0

Laredo

College
Station–
Bryan

0

Odessa

3

3.9

Dallas–
Plano–
Irving

4.5

Corpus
Christi

6

7.9

2017–19

NOTES: All wage data are six-month moving averages. 2017–19 data are annualized through April 2019. The colors
of the bars correspond to the region in the state.
SOURCE: Bureau of Labor Statistics, Current Employment Statistics.

TBOS respondents reporting that they
had resorted to such increases has
risen sharply, from about 50 percent
in early 2018 to 67 percent by yearend.4 As one contact in the hospitality
industry noted in March 2019, “Hiring
remains a huge problem, so we anticipate increases in wages and benefits
just to compete.”
Wage growth by region has varied
due to, among other factors, industry
compositional differences and the
lagged effects of labor constraints.
However, most regions of the state
have reported significant acceleration
of average hourly wages since 2017
(Chart 4). In Texas and the U.S., wage
growth from 2010 to 2017 was 2.0 per-

6

cent and 2.1 percent, respectively, but
has since accelerated.
Within the state, some metros experienced particularly large increases.
While wage growth was highest mostly
in areas tied to energy from 2010 to
2017, it has since been strongest in
mostly smaller metro areas with very
low unemployment and weak labor
force growth.
Wages in Abilene, which has a
record-low 2.8 percent unemployment
rate, rose by nearly 8 percent annually
from 2017 through April 2019. Similarly, wage growth in McAllen–Edinburg–
Mission, which has a record-low 5.4
percent unemployment rate, reached
5.5 percent over the period.

Across all industries, businesses are
having difficulty finding any workers,
skilled or unskilled, to expand. Wage
growth may at some point encourage
workers on the sidelines to reenter the
workforce. Additional migration into
Texas, whether domestic or international, could also alleviate worker shortages.
However, federal curbs on international migration and an improved
national economy limit Texas’ ability to
attract new workers.
Until the issue of shortages in Texas
is resolved, it is likely that businesses
will struggle trying to hire employees
or replace workers lost in the course of
normal turnover.
Job growth in the state over the past
two years has held above the long-term
average of 2 percent, and current estimates of 2019 growth suggest that this
will continue, potentially sending the
state unemployment rate even lower by
year-end.
Christopher Slijk is an assistant
economist in the Research Department
at the Federal Reserve Bank of Dallas.

Notes
“New Technology Boosts Texas Firms’ Output,
Alters Worker Mix,” by Emily Kerr, Pia Orrenius and
Christopher Slijk, Federal Reserve Bank of Dallas
Southwest Economy, Third Quarter, 2018,
www.dallasfed.org/~/media/documents/research/
swe/2018/swe1803b.pdf.
2
“Gone to Texas: Migration Vital to Growth in the
Lone Star State,” by Pia Orrenius, Stephanie Gullo and
Alexander T. Abraham, Federal Reserve Bank of Dallas
Southwest Economy, First Quarter, 2018,
www.dallasfed.org/~/media/documents/research/
swe/2018/swe1801b.pdf.
3
“Why Are Labor Markets for Blue-Collar Workers
Tighter than for White-Collar Ones?” by Gad Levanon
and Frank Steemers, Conference Board, Oct. 16,
2018, www.conference-board.org/blog/postdetail.
cfm?post=6894.
4
See the Texas Business Outlook Surveys special
questions, Nov. 26, 2018, www.dallasfed.org/research/
surveys/tbos/2018/1811q.aspx.
1

Southwest Economy • Federal Reserve Bank of Dallas • Second Quarter 2019

Texas Industrial Building Booms
as Economy, Population Grow
By Laila Assanie and Michael Weiss

T
}
ABSTRACT: A significant
portion of Texas’ recent
construction activity has
been industrial building,
with Dallas–Fort Worth
leading the nation and
Houston among the top
six markets. Burgeoning
e-commerce, state
population gains and an
expanding export market
have contributed to the
growth spurt that has
included increases in
transportation and logistics
employment.

he boom in Texas commercial real
estate activity is plainly visible
in the high-rises that create the
skylines of the state’s major metropolitan areas and in the sprawling office
campuses dotting its thoroughfares.
Another source of major activity is far
less conspicuous, though it has powered another new wave of commercial
construction and economic activity.
Demand for Texas industrial space,
which includes warehouses, manufacturing plants and research and
development facilities, has been robust
during the ongoing expansion cycle.
Well over 235 million square feet of
space was built and absorbed from
2010 to 2018 statewide, with Dallas–
Fort Worth ranking No. 1 in the country
in construction and in net absorption
(net change in square footage of occupied space) during the period and
Houston placing among the top six.1,2
Texas’ underlying economic expansion has been solid for the most part
since the end of the Great Recession,
CHART

1

supporting healthy and broad-based
gains in the commercial real estate sector—apartments, offices and industrial
space. It was only during the most
recent energy bust, in 2015–16, that
employment growth in the state fell below its long-term average growth rate,
primarily due to Houston's decline.
Commercial construction and real
estate activity play a notable role in
an area’s economic growth, buoying
output and employment growth. The
state’s commercial real estate sector
will likely continue to expand this year,
albeit at a slower pace.

Industrial Construction Gains
Consistent with Texas’ “bigger is
better” ethos, the thriving construction
sector recorded $104.1 billion worth
of total contract values (residential,
nonresidential and nonbuilding) last
year—an inflation-adjusted increase
of 5.9 percent from 2017. The 2018
total was just shy of the previous peak
in 2015, when $104.5 billion of new

DFW and Houston Major Players in the State's Industrial Market

Industrial completions, millions of square feet
50
El Paso
San Antonio
Austin
Fort Worth
Houston
Dallas

45
40
35
30
25
20
15
10
5
0

'08

'09

'10

'11

'12

'13

'14

'15

'16

'17

'18

SOURCE: CBRE Econometric Advisors.

Southwest Economy • Federal Reserve Bank of Dallas • Second Quarter 2019

7

projects broke ground.3 Last year’s
increase was driven by a pickup in residential (single-family and multifamily) and nonbuilding (roads, bridges,
power plants, etc.) construction.
Texas has undergone a period of vast
real estate development since 2010,
partly because so many people have
been drawn to the area. The state’s
population reached 28.7 million in
2018, adding 3.5 million residents since
2010—placing it No.1 among U.S. states
in numeric increase. Texas’ building boom has boosted construction
employment, which rose 3.9 percent
in 2018.
Industrial construction has expanded rapidly since 2010, making Texas
the top-ranking state in the country in
terms of square footage.4 From 2010 to
2018, industrial space built in Texas’
major metros was four times the square
footage of new office space.
Most industrial building occurs
within major metropolitan areas. Since
2014, Texas’ five major metropolitan
areas annually added more than 30
million square feet of industrial property—principally warehouses—with
the total exceeding 40 million square
feet in both 2017 and 2018 (Chart 1). By
comparison, the largest amount added
in any previous year (dating back to
the late 1980s) was 45 million square
feet in 2008, most of it greenlighted just
before the Great Recession that began
in December 2007.
The expansion has been most visible
in DFW and Houston, where occupancy rates for warehouse space have
hovered around 90 percent since 2013.
After a period of such rapid expansion, growth in industrial construction
statewide is ebbing, albeit remaining elevated by historical averages.
Inflation-adjusted construction contract values for warehouses dipped 3.8
percent in 2018 relative to 2017 and
in the first four months of 2019 fell
13.2 percent compared with the same
period in 2018.
Overall, nonresidential construction
contract values (including warehouse
construction) fell 11.6 percent last year
from 2017 totals in Texas while declining 2.3 percent nationally.

8

CHART

2

DFW Industrial Space Completions Outpace Office

Completions, millions of square feet
35
30

Industrial
Office

25
20
15
10
5
0

'08

'09

'10

'11

'12

'13

'14

'15

'16

'17

'18

SOURCE: CBRE Econometric Advisors.

Widespread DFW Growth
DFW gained nearly 25 million
square feet of industrial space in 2018,
following an increase of 29 million
square feet in 2017—the greatest addition of space in at least the past 30
years, the period for which consulting firm CBRE Econometric Advisors
maintains data (Chart 2). Warehouse
growth has been particularly impressive. Since 2010, a total of 117.7 million
square feet have come on the market in
DFW. The total is equivalent to almost
43 Empire State Buildings, the iconic
102-story New York City skyscraper,
and is five-and-a-half times the square
footage of office property added in
DFW during the period.
The warehouse market boom has
reached into southern and western
portions of Dallas that investors previously largely overlooked. It has been
aided by an expansive transportation
and logistics sector, a byproduct of
e-commerce regional expansion that
has contributed to the recent addition
of freight, cargo-handling and fulfillment operations for Amazon, FedEx
and UPS. In 2018, DFW had 10 of the
country’s largest warehouse deals.5
Additionally, burgeoning air freight
operations at Fort Worth Alliance
Airport and Dallas–Fort Worth In-

ternational Airport complement an
extensive ground transport network.
Construction of a regional air hub for
Amazon Air—the first of its kind for the
company and its logistics subsidiary—
is underway at Alliance Airport and
scheduled to become operational this
year.6 Meanwhile, total cargo (freight
and mail) flowing through DFW Airport rose for the fifth straight year in
2018, up 2.7 percent.7
This is no surprise given DFW’s position as a major U.S. trade and distribution center, thanks to its central location and infrastructure. Employment in
the transportation and logistics sector
makes up 4.3 percent of the metro
area’s total employment—a higher
share than other major metros.8 Moreover, healthy growth in the metroplex’s
employment and population base has
fueled demand for consumer goods.
DFW has added 1.1 million residents
since 2010, ranking No. 1 among U.S.
metros in numeric increase; Houston
placed second.
Foreign investors have taken particular notice of the growth in DFW,
ranking the metro No. 2 nationally
behind Los Angeles in terms of foreign
industrial acquisition activity in 2018,
CBRE found.9 Buyers spent $14.4 billion in the U.S., $849 million of that

Southwest Economy • Federal Reserve Bank of Dallas • Second Quarter 2019

in DFW, with investors from Canada,
China and Singapore accounting for
most of the purchases from outside the
country. Foreign investment made up
21 percent of total U.S. investment in
this sector last year.

Trade, Logistics in Houston
E-commerce-related distribution,
last-mile fulfillment facilities and
demand from big-box retailers have
similarly expanded throughout Houston. There were 63 warehouses under
construction in Houston in late 2018,
according to data from Avison Young, a
commercial real estate firm.10 Houston
is also a gateway for commercial and
industrial goods passing through the
Port of Houston—ranking No. 6 in the
nation in container shipping in 2018,
adding a significant global trade aspect
to area activity.11
The energy sector, rebounding from
the 2015–16 slump, has played an
increasing role, spurring growth of
warehouse facilities to ship and handle
energy-related cargo as well as for the
manufacture of energy equipment and
goods, including chemicals.
Houston recorded its second-largest
five-year spurt of new industrial
construction in the period ended last
year—nearly 57 million square feet
completed, of which 48 million square
feet was warehouse space.12
CHART

Overall, industrial construction and
demand paused during the 2015–16
energy bust (Chart 3). After adding
under 1 million square feet of manufacturing facilities in 2014–15, the
area regrouped from the slowdown,
gaining 4.7 million square feet in 2016.
After another slow year with little new
inventory in 2017—coinciding with
Hurricane Harvey devastation, though
industrial properties were largely unaffected—a total of 1.1 million square
feet of manufacturing space entered
the market in 2018.
Moreover, petrochemical plant
growth in Texas has been vibrant during the expansion and helped support
southeast Texas activity. One recently
completed large project is ExxonMobil’s ethane cracker in Baytown.13

Statewide Trade Expansion
San Antonio recorded heightened
activity in the five years ended in
2018. Industrial space grew by 10.8
million square feet—about 87 percent
for warehouses and the rest for manufacturing and research and development facilities.
A total of 1.4 million square feet
of industrial space entered El Paso’s
market during the five years ended in
2018, the highest five-year increase
since 2008. The gain coincided with
resurgent maquiladora manufactur-

Industrial Demand in Houston Rebounds
Following 2015–16 Energy Bust

3

Millions of square feet
18
16

Net absorption
Completions

14
12

Transportation, Warehousing Jobs
Employment in the transportation
and warehousing sector has mirrored
the large space increases, particularly
in DFW. Employment in Texas expanded 2.1 percent annually in the five years
ended in 2018, while payrolls in transportation and warehousing rose more
rapidly, 4.3 percent, led by growth in
warehousing and storage employment.
The Dallas, Plano and Irving metropolitan division added 39,025 jobs in
the transportation, warehousing and
utilities sector (a 7.9 percent annual
increase) in 2014–18, while in Fort
Worth–Arlington, sector payrolls grew
by 20,482 jobs (5.5 percent) (Chart 4).
The five-year gains in DFW eclipse
increases in any preceding five-year
period at least as far back as the mid1990s. Sector payrolls grew rapidly in
Austin—an 8.2 percent annualized
rate—during the five-year period.
Houston’s transportation, warehousing
and utilities employment expanded by
17,922 jobs in 2014–18, a 2.6 percent
annualized increase.

Industrial Vacancies Tight

10
8
6
4
2
0
-2
-4

ing and a resulting 47 percent increase
in the number of full truck containers
crossing into the U.S. from Mexico at
the El Paso and nearby Santa Teresa,
New Mexico, ports of entry during the
period, according to U.S. Transportation Department data.14
El Paso’s latest (2014–18) industrial
completions are significantly below the
high recorded in the five-year period
ended in 2000, when U.S.–Mexico
transborder shipping was expanding
rapidly in the wake of the 1994 implementation of the North American Free
Trade Agreement.

'07

'08

'09

'10

'11

SOURCE: CBRE Econometric Advisors.

'12

'13

'14

'15

'16

'17

'18

Demand for industrial space has
taken off with growth in third-party
logistics and in e-commerce, as firms
seek warehouse space close to their
customers. Nationwide, e-commerce
and logistics companies accounted for
61 of the 100 largest warehouse deals
(leases and sales) by square footage in
2018, and DFW had the third-largest
volume of transactions by square footage, according to CBRE Research.15

Southwest Economy • Federal Reserve Bank of Dallas • Second Quarter 2019

9

Third-party logistics firms (transportation/distribution) made up
nearly a third of industrial leasing
by square footage from first quarter
2013 to first quarter 2019 in the Texas
and Oklahoma region, which CBRE
Research combines into a single unit.
Accounting for much of the remainder
of leasing were wholesale, 13 percent;
materials manufacturing, 11 percent;
food and beverage, 10 percent; and ecommerce, 9 percent.
Strong leasing demand has pushed
overall industrial availability rates into
the single digits in Austin, DFW, Houston and San Antonio since early 2016.16

CHART

4

Index, January 2010 = 100
180

Assanie is a senior business economist,
and Weiss is a senior writer/editor in
the Research Department of the Federal
Reserve Bank of Dallas.

Notes
Data for Texas include Austin, Dallas, El Paso, Fort
Worth, Houston and San Antonio. Data are as of first
quarter 2019 from CBRE Econometric Advisors, which
differs from the CBRE Research data series.

1

10

Dallas
Austin
San Antonio
Fort Worth
Texas
El Paso
Houston

170
160
150
140
130
120

Continued Growth in 2019
The outlook for Texas’ industrial
markets is mostly positive for the year.
The state’s broad economic expansion
persists, and job growth is forecast at
over 2 percent.17
Overall, investors expect to be more
conservative in their commercial real
estate acquisitions this year as high
asset prices, financial market volatility, and global and trade uncertainty
damp expectations, according to
CBRE’s 2019 Americas Investor Intentions Survey.18 Still, industrial and
logistics remains the most favored
property sector for investment.
Industrial construction in the five
major metros is elevated, exceeding 47
million square feet as of first quarter
2019.19 Given that vacancy rates are
close to multiyear lows in most major
metros and Texas exports remain close
to all-time highs, the industrial market
appears to be on a solid footing. Uncertainty surrounding U.S. trade policy
is a wild card, but its impact on the
industrial sector thus far appears to be
limited at least in the near term.

Transportation, Warehousing and Utilities Employment
Expands at Rapid Clip in North and Central Texas

110
100
90

'10

'11

'12

'13

'14

'15

'16

'17

'18

'19

NOTE: Data are through March 2019.
SOURCES: Bureau of Labor Statistics; Texas Workforce Commission; seasonal and other adjustments by the
Federal Reserve Bank of Dallas.

Net absorption is the net change in occupied space in
square feet during a given time period. It is measured
by the square feet of completions less the change in
available square footage.
3
Data are from Dodge Analytics.
4
State totals are calculated by adding the square footage
of annual completions in 63 of the largest U.S. industrial
markets at the metropolitan statistical area level.
5
“Dealmakers: E-Commerce & Logistics Firms
Dominate Largest Warehouse Deals in 2018,” U.S.
MarketFlash, CBRE Research, Feb. 20, 2019, www.
cbre.us/research-and-reports/dealmakers-e-commercelogistics-firms-dominate-largest-warehouse-dealsin-2018.
6
“Amazon Taps Fort Worth's Alliance Airport for
Regional Hub, Hundreds of Jobs,” by Bill Hethcock,
Dallas Business Journal, Dec. 11, 2018,
www.bizjournals.com/dallas/news/2018/12/11/amazontaps-fort-worths-alliance-airport-for.html.
7
Data are from DFW International Airport’s website,
www.dfwairport.com/stats/.
8
“At the Heart of Texas: Cities' Industry Clusters
Drive Growth,” Special Report, Federal Reserve Bank of
Dallas, December 2018.
9
“Foreign Investors Pump $14.4 Billion into U.S.
Industrial Real Estate,” U.S. MarketFlash, CBRE
Research, April 17, 2019, www.cbre.us/research-andreports/foreign-investors-pump-14-point-4-billion-into2

industrial-real-estate.
10
“63 Warehouses Under Construction in Houston;
More on the Way as Industrial Market Heats Up,”
RealtyNewsReport.com, Oct. 29, 2018,
http://realtynewsreport.com/2018/10/29/63-warehousesunder-construction-in-houston-more-on-the-way-asindustrial-market-heats-up/.
11
Data are from Port of Houston, www.porthouston.com/
about-us/statistics/.
12
Data from CBRE Econometric Advisors go back to the
late 1980s.
13
“ExxonMobil Starts Up New Ethane Cracker in
Baytown, Texas,” ExxonMobil news release, July 26,
2018, https://news.exxonmobil.com/press-release/
exxonmobil-starts-new-ethane-cracker-baytown-texas.
14
Data are from the U.S. Department of
Transportation, Bureau of Transportation Statistics,
https://data.transportation.gov/Research-and-Statistics/
Border-Crossing-Entry-Data/keg4-3bc2.
15
See note 5.
16
Industrial availability rate data are from CBRE
Econometric Advisors.
17
Dallas Fed Texas Employment Forecast, see
www.dallasfed.org/research/forecast.
18
“Americas Investor Intentions Survey 2019,” CBRE,
www.cbre.us/research-and-reports/Americas-InvestorIntentions-Survey-2019.
19
Data are from CBRE Research as of first quarter 2019.

Southwest Economy • Federal Reserve Bank of Dallas • Second Quarter 2019

Eleventh District Banks Have
Performed Well Despite Rising
Funding Costs, Nonbank Competition
By Kelsey Reichow and Amy Chapel

}

B

ABSTRACT: Profitability
picked up for Eleventh
District banks in 2018
despite rising funding
costs and slowing loan
growth. Overall asset
quality strengthened,
though room for further
improvement may be
limited. Changes in capital
regulation could affect
bank risk taking.

continued competition from nonbank
lenders. Cybersecurity remains a top
bank risk, largely due to the dynamic
and highly sophisticated nature of cyber risks and evolving external threats.
Still, the majority of cyber breaches
are caused by preventable factors
including poor internal controls,
a failure to keep systems properly
updated or patched and a failure to
follow internal policies.
Asset concentration levels rose at
some banks. Concentration detracts
from one of the most important
strengths in the banking industry—diversification. While capital levels meet
or exceed regulatory requirements,
share buybacks and dividend pay-

ank performance in the Eleventh
Federal Reserve District was
strong in 2018, outpacing the rest
of the country.1 Profitability increased,
returning to prefinancial-crisis levels
of more than a decade ago, and asset
quality strengthened modestly with
improvement in most loan categories.
Given that comparatively smaller
community banks have a larger presence in the district than in the rest of
the U.S., their relatively better performance is a reflection of strong regional economic growth, according to
recently compiled data for 2018.2
Despite the strong performance,
banks face a challenging landscape
in 2019, with rising funding costs and
CHART

1

Bank Profitability Up in District and Nation

Return on assets (percent)
1.6

Eleventh District
1.44

1.4

U.S.
1.35

1.2
1
0.8
0.6
0.4
0.2
0
-0.2

'05

'06

'07

'08

'09

'10

'11

'12

'13

'14

'15

'16

'17

'18

NOTE: Shaded area indicates U.S. recession.
SOURCE: Reports of Condition and Income, Federal Financial Institutions Examination Council.

Southwest Economy • Federal Reserve Bank of Dallas • Second Quarter 2019

11

ments are increasing, which could
strain some banks’ lending during the
next downturn.

2

Savings Account Deposit Rates Trend Higher for Banks of All Sizes

Percent

Profitability Picks Up
Bank profitability improved in
2018—propelled by higher net interest
income and lower tax expense. Eleventh District banks earned an annualized return on assets of 1.44 percent
in 2018, up from 1.15 percent in 2017
(Chart 1). Nationwide, bank profitability picked up 38 basis points to 1.35
percent in 2018 from 0.97 percent
in 2017.
Maintaining current levels of profitability in upcoming quarters may
become more challenging in light of increasing funding pressures and limited
potential for asset quality to improve
further. Higher short-term interest
rates have prompted depositors to
seek greater returns on their
deposit balances.
Community banks, which traditionally faced competition only in
their local markets, now encounter it
from larger banks, online-only banks,
money market funds and nonbank
institutions that are all expanding their
geographic reach online. Faced with
the possibility of losing market share
to digital competitors, banks with a
traditional brick-and-mortar branch
presence have increased rates on deposit accounts.
Since the monetary policy tightening cycle began in December 2015,
rates paid on savings accounts by large
banking organizations (assets exceeding $100 billion) are up 27 basis points
nationally. Rates on savings accounts
among regional banking organizations
(assets between $10 billion and $100
billion) rose 11 basis points, while rates
at community banking organizations
(assets less than $10 billion) edged up
seven basis points (Chart 2).
Some institutions, particularly community banks, have been able to minimize deposit rate increases, largely due
to strong customer relationships and
multiple product offerings.
The extent of funding pressure and
competition for deposits is not fully
captured in deposit rate increases.

12

CHART

0.5
0.4

Large banks
Regional banks
Community banks

0.3
0.2
0.1
0

Jan-15

Jul-15

Jan-16

Jul-16

Jan-17

Jul-17

Jan-18

Jul-18

Jan-19

NOTES: Gray lines indicate federal funds rate hikes. Banks are distinguished by asset size. Community banks have
total assets less than $10 billion; regional banks have total assets of $10 to $100 billion; large banks have total
assets exceeding $100 billion.
SOURCE: S&P Global Market Intelligence.

CHART

3

Asset Quality Improves in the District and Nationally

Noncurrent loans (percent of total loans as of Dec. 31, 2018)
3
Other
Consumer
Commerical & industrial
Commercial real estate
2
Residential real estate

U.S.

Eleventh District
1

0

'14

'15

'16

'17

'18

'14

'15

'16

'17

'18

SOURCE: Reports of Condition and Income, Federal Financial Institutions Examination Council.

Some banks are offering consumers
one-time cash incentives to open savings accounts and hold certain levels of
deposits for a set period.

Asset Quality Strengthens
Bank asset quality improved again
in 2018, although more so nationally
than in the Eleventh District. Among
Eleventh District banks, 0.79 percent

of total loans were noncurrent (past
due 90 days or more or on nonaccrual
status), down from 0.92 percent at
year-end 2017 and below the national
rate of 0.96 percent (Chart 3).
Nationwide, the noncurrent loan
rate declined 21 basis points (an eightbasis-point greater improvement than
the district), from 1.17 percent to 0.96
percent in 2018, with noncurrent loan

Southwest Economy • Federal Reserve Bank of Dallas • Second Quarter 2019

rates falling for most loan categories
but ticking up one basis point for consumer loans.
The credit quality of Eleventh District
banks’ non-business portfolios generally is higher than that of their national
peers—largely due to fewer problem
mortgages and comparatively limited
credit card lending—while the credit
quality of their commercial portfolios
is lower.
CHART

4

During the energy downturn in
2015–16 and its aftermath, commercial and industrial (C&I) loans were
the largest component of noncurrent
loans in the Eleventh District. The
trend reversed in 2018—reflecting
the pass-through impact of improved
energy prices in 2017—with the value
of noncurrent C&I loans declining. The
reduction in the noncurrent C&I portfolio in 2018 was not widespread—80

District Loan Growth Slows, Converges Toward Nation

Year-over-year growth (percent)
12

District Loan Growth Slows

10
8

Eleventh District
4.75

6
4

U.S.
4.44

2
0

percent of the decline in the fourth
quarter can be attributed to three
banks, perhaps suggesting that there is
limited room for further improvement
in asset quality.
Noncurrent residential real estate
loans (0.27 percent of total loans)
were the largest portion of noncurrent
loans in the Eleventh District in 2018,
followed by C&I (0.23 percent) and
commercial real estate (CRE) (0.15 percent). Residential real estate remains
the largest portion of noncurrent loans
nationally at 0.50 percent of the total
portfolio, down from 0.66 percent,
followed by consumer lending (0.18
percent) and C&I (0.14 percent).

'14

'15

'16

'17

'18

SOURCE: Reports of Condition and Income, Federal Financial Institutions Examination Council.

CHART

5

Majority of District, U.S. Banks Have Combined CRE and C&I
Loan Concentrations Exceeding 200 Percent of Capital

Greater than 300% of capital

District

Combined CRE and
C&I loan concentration
C&I loan concentration
CRE loan concentration

200—300% of capital

U.S.

Greater than 300% of capital

Loan growth was little changed at
U.S. banks at 4.44 percent year over
year in fourth quarter 2018. Eleventh
District bank loan growth, while
still outpacing national loan growth,
slowed to 4.75 percent year over year,
converging toward the national growth
rate (Chart 4). The district’s decrease in
year-over-year CRE loan growth from
year-end 2017 (8.44 percent) to yearend 2018 (6.77 percent) contributed to
the slowdown.
Meanwhile, C&I loan growth remained strong, 7.76 percent year over
year in the nation and 6.57 percent in
the district.
A more competitive lending environment has contributed to slower loan
growth for banks even as the economy
continues expanding. Competition
from nonbanks, which are increasing
their lending footprint, is growing. For
example, nonbank retail and broker
mortgage originations nationally accounted for 54.8 percent of the value of
all mortgage originations in 2018, up
from 43.8 percent in 2013.3

Credit Concentration Concerns

200—300% of capital
0

5

10

15

20

25

30

35

40

45

50

Share of banks (percent)
NOTE: Commercial real estate (CRE) loans include commercial land development loans, multifamily loans and
nonowner-occupied nonfarm nonresidential real estate loans. Commercial and industrial (C&I) loans are defined as
C&I loans plus owner-occupied nonfarm nonresidential real estate loans, plus other leases. Loan concentrations are
calculated as a share of total risk-based capital; data are as of 2018.
SOURCE: Reports of Condition and Income, Federal Financial Institutions Examination Council.

Over the past three years, CRE and
C&I concentrations at some banks
have remained high or increased.
Relative to some other assets, CRE and
C&I assets can be more volatile and
have greater potential to lose value
during an economic downturn. Bank
loan diversification is important, given

Southwest Economy • Federal Reserve Bank of Dallas • Second Quarter 2019

13

a significant correlation between loan
portfolio concentrations—particularly
CRE—and bank failures.4
Nationally, as well as in the district,
27 percent of banks have a CRE concentration above 200 percent of riskbased capital, the financial cushion
available to absorb losses for a given
level of risk (Chart 5).5 However, a
larger share of banks nationally have a
concentration exceeding 300 percent
of risk-based capital—7 percent compared with 4 percent in the district.
C&I concentrations are more significant. Twenty-eight percent of banks nationally have a C&I concentration above
200 percent of risk-based capital compared with 31 percent in the district. A
total of 9 percent of district banks and 8
percent of national banks have concentrations exceeding 300 percent.
Sixty-four percent of U.S. and
district banks have a concentration
above 200 percent of risk-based capital in these two commercial lending
sectors combined. Among national
and district banks, 44 percent have
combined commercial credit concentrations exceeding 300 percent
of risk-based capital.
Rising capital levels may mitigate
credit concerns. Risk-based capital
as a share of risk-weighted assets is
a good measure of an institution’s
capital adequacy.6 This share for the
district was relatively unchanged, rising two basis points in 2018 from 2017.
Nationally, risk-based capital as a
share of risk-weighted assets rose nine
basis points in 2018.

Capital Distributions Grow
Dividend payments and share
repurchases also impact capital levels.
When banks make dividend payments
and repurchase shares (for those that
are publicly traded), capital that otherwise could have been used for loans to
businesses and consumers is returned
to shareholders.
Growing capital distributions faster
than earnings—which banks nationally did in 2017—could strain an
institution’s ability to lend in the next
downturn. Additionally, banks’ return
of capital may indicate they believe

14

CHART

6

Percent
140
120

District Payouts Rise as Banks Retain Fewer Earnings,
Return More Capital to Shareholders

Share repurchase payout ratio
Dividend payout ratio

Percent greater than 100 indicates capital
distributions greater than earnings

100
80
60
40
20
0

'11

'12

'13

'14

'15

U.S.

'16

'17

'18

'11

'12

'13

'14

'15

Eleventh District

'16

'17

'18

NOTE: Share repurchase and dividend ratios calculated as a percentage of net income.
SOURCE: Reports of Condition and Income, Federal Financial Institutions Examination Council.

there are comparatively few attractive
lending prospects in the economy.
Nationally, banks’ dividend and
share buybacks moderated in 2018 (to
91.4 percent of net income, down from
119.6 percent in 2017), with banks paying out slightly less than their earnings.
District banks paid out more earnings
in 2018 than in 2017—payouts totaled
67.4 percent of net income in 2018, up
from 43 percent in 2017 (Chart 6).

Capital Regulations Ease
The purpose of bank capital is to buffer unexpected loss. Inadequate capitalization of banks can reduce overall
credit availability and negatively affect
the economy. Recent legislation directs
a reduction in capital requirements for
U.S. banks.
Specifically, the 2018 Economic
Growth, Regulatory Relief and Consumer Protection Act provides relief
for some large banks on leverage
standards and for community banks
on risk-based capital standards. These
changes have the notable feature of
reducing for each type of bank its most
binding regulatory capital constraint.
Risk-based capital ratios assign
different weights to assets to account

for the difference in their level of risk.
Riskier assets receive a higher weight,
which requires banks to hold more
capital to meet the regulatory requirement. Leverage ratios treat all assets as
having the same risk, requiring banks
to hold the same amount of capital for
any asset.
A new community bank leverage
ratio, a regulatory capital relief provision for community banks, affects a
number of banks in the district.7 A
bank with total assets under $10 billion may opt to report only the community bank leverage ratio—proposed
as a capital-to-asset ratio of 9 percent—rather than the four regulatory
measures of capital adequacy they
currently report.
Backers of the community bank
leverage ratio standard say the
risk-weighted system is unnecessarily complex for smaller institutions.
Community bank leaders have spoken
about the difficulties of dealing with
regulations designed for larger institutions that were more central to the
financial crisis.8
Nonetheless, the new leverage ratio
alone may be insufficient to account
for a bank’s riskiness, and without risk

Southwest Economy • Federal Reserve Bank of Dallas • Second Quarter 2019

weighting, banks may have an incentive to take on more risk.
The Congressional Budget Office
estimates that 70 percent of community banks will opt in to the new
leverage regime, assuming adoption
of the 9 percent threshold.9 A majority
of community banks already exceed
a 9 percent leverage ratio, and within
the district, 88 percent of community
banks have a leverage ratio higher
than 9 percent.

Industry Consolidation Continues
Nationwide, the total number of
banks has declined 35 percent over the
past decade, from 8,279 institutions in
2008 to 5,393 in 2018. Given that technological advances can extend a bank’s
geographic reach, the downward trend
is not necessarily a source of concern
in terms of the provision of financial
services as long as sufficient competition remains.
Lower taxes, higher interest rates
and regulatory changes encouraged
increased merger activity. Lower taxes
can generate additional liquidity that
may be used to acquire other companies. Higher interest rates increase
competition for most banks and make
mergers more attractive for those
requiring access to stable deposits or
needing other efficiencies.
Furthermore, the recently enacted
increase in regulatory thresholds may
encourage merger activity as some
banks have more room to grow before
surpassing the new limits.
Most of the decline in the number of
institutions can be attributed to a lack
of new bank formation and voluntary
mergers rather than bank failures.
Mergers increased from 196 in 2017
to 226 in 2018.10 Smaller banks seeking
to take advantage of economies of
scale drove the majority of the mergers. At the same time, the number
of newly chartered banks across the
nation increased from only five in
2017 to seven in 2018. There were no
bank failures in 2018, compared with
an average of eight during each of the
past five years.

Data suggest banks are becoming more efficient—better leveraging
technology for products, distribution
and analytics and enjoying economies
of scale that come with consolidation.
A measure used to quantify how much
it costs an institution to generate revenue—the efficiency ratio—has declined
since 2014 for all U.S. banks and since
2016 for district banks, indicating increased efficiency.11 The ratio declined
from 65 percent in 2008 to 57 percent in
2018 for U.S. banks and from 66 percent
to 62 percent for district banks.
In spite of the efficiency gains
from mergers, the falling number of
smaller banks can have an unintended
consequence. Community banks are
key providers of credit in rural communities and for small businesses,
which are important contributors to
the economy.

Texas’ 2019 Economic Gains
Eleventh District banks’ performance continued to improve in 2018,
but increased funding pressures and
competition in 2019 will likely pressure
profitability. Asset quality is high and
improved again in 2018, but further
gains may be limited.
Community banks should benefit from regulatory relief this year.
However, due to the new regulations,
institutions’ regulatory capital may
not fully capture the riskiness of loan
portfolios at a time when the number
of institutions with concentrations in
riskier assets is high.
By various measures, banks are
becoming fewer but more efficient as
a result of consolidation, though concerns remain about credit and banking
service availability for small businesses
and rural areas.
Banking industry performance remains highly dependent on economic
conditions. The Dallas Fed forecasts
Texas job growth at slightly over 2 percent in 2019, about the same as in 2018
and close to trend.12 District banks
face challenges this year but should
continue to reflect healthy regional
economic fundamentals.

Reichow was a financial industry
analyst at the Federal Reserve
Bank of Dallas, and Chapel is a
macrosurveillance manager in the
Banking Supervision Department.

Notes
The Eleventh District includes all of Texas, northern
Louisiana and southern New Mexico.
2
Community banks have total assets of less than $10
billion.
3
Inside Mortgage Finance Publications Inc., 2019,
www.insidemortgagefinance.com.
4
See “Estimating Today’s Commercial Real Estate
Risk,” by Pablo D’Erasmo, Federal Reserve Bank of
Philadelphia Banking Trends, First Quarter, 2019,
www.philadelphiafed.org/-/media/research-and-data/
publications/banking-trends/2019/bt-estimating-todayscommercial-real-estate-risk.pdf.
5
Specifically, risk-based capital is a method of
measuring the minimum amount of capital (assets less
liabilities) based on riskiness of the lending portfolio
required by regulation to support an institution’s
operations given its size.
6
Risk-weighted assets are calculated by assigning a
weight to an institution’s assets based on the asset’s
riskiness.
7
Other small-bank regulatory relief provided for by the
Economic Growth, Regulatory Relief and Consumer
Protection Act includes a Volcker Rule exemption, a
shorter required regulatory report, an extended exam
cycle and other mortgage-related exemptions.
8
See “Small Banks Squeezed,” by Jeffery W. Gunther
and Kelly Klemme, Federal Reserve Bank of Dallas 2012
Annual Report.
9
Congressional Budget Office cost estimate,
March 5, 2018, www.cbo.gov/system/files/115thcongress-2017-2018/costestimate/s2155.pdf.
10
2018 merger data for the district were unavailable as
of May 2019.
11
The efficiency ratio is calculated by dividing a bank’s
noninterest expense by its net income.
12
See the Dallas Fed's Texas Employment Forecast at
www.dallasfed.org/research/forecast.
1

Southwest Economy • Federal Reserve Bank of Dallas • Second Quarter 2019

15

ON THE RECORD
A Conversation with Charlie Amato

Texas Economy Remains
Strong Despite Challenges
Charlie Amato is chairman and co-founder of Southwest Business
Corp. (SWBC), a company with 17 lines of business including
insurance brokerage, financial planning, employee benefits
administration and mortgage servicing. Amato, who has more than
40 years of experience in all aspects of insurance operations, offers
insights into issues the Texas economy faces.
Q. While SWBC has worldwide
operations, much of its business is
in Texas. Given that, how do you see
conditions in the state this year?
SWBC is headquartered in San Antonio, and yes, we have offices across the
country. The benefit to being in Texas
is that it’s a pro-business environment,
and our elected officials encourage economic growth.
The economy is the strongest I have
ever seen. Generally speaking, the U.S.
is doing well, and Texas is doing even
better. Within our company, all of the
divisions are making money—and that
is pretty rare. I am optimistic, as uncertainty has decreased since the fourth
quarter of last year and business activity
is robust.

Q. Texas housing prices have
appreciated sharply over the past five
years. How do you see this affecting
housing markets?
There is no question that home price
appreciation has negatively impacted
affordability. However, there are still a
number of good financing options for
most people.
Fannie Mae’s Home Ready mortgage
program and Freddie Mac’s Home Possible mortgage program provide 97
percent financing and waive certain riskbased pricing adjustments for borrowers

16

at or below the HUD median income for
the area. The Federal Housing Administration [FHA] and VA [Veterans Administration] also have good programs for
low- to moderate-income earners.
One of our biggest concerns is related
to the potential consequences of government-sponsored enterprise reform
(covering Fannie Mae and Freddie Mac).
The Dodd–Frank Act established standards that a lender must meet to document that a borrower has the ability to
repay a loan.
A lender has a safe harbor for liability
with respect to loans that meet the requirements deemed to constitute a qualified mortgage [QM]. These QM standards include a debt-to-income ratio cap
of 43 percent or, in the alternative, eligibility for Fannie Mae and Freddie Mac,
FHA or other government programs.
The availability of these governmentsponsored loan programs for higher-indebted borrowers is commonly referred
to as the “QM patch.” Regrettably, the
QM patch is set to expire in 2021. Allowing the QM patch to expire would have a
negative impact on housing affordability
that would disproportionately affect
low- to moderate-income borrowers.
There is a market among private investors for loans that do not meet the
QM standards. However, the interest
rates for those loans are significantly
higher due to the increased risk associated with the lack of a safe harbor.

Q. SWBC is a large insurance
brokerage. How did Hurricane
Harvey affect mortgage delinquency
and what would be the impact of
continued severe weather events?
Our total mortgage delinquency percentage for the Houston area more than
quadrupled from July 2017 to its peak in
October 2017. Delinquencies returned
to normal levels beginning in November 2018.
Quite a bit of the flooding occurred
in areas outside of designated “special
flood hazard areas,” meaning many affected homeowners were not required
to carry flood insurance and few did so.
Since much of the flood coverage that
was in place was purchased through
the National Flood Insurance Program
[NFIP], there was no immediate increase in flood insurance cost. There are
reports that NFIP plans to adopt a new
rating structure, Risk Rating 2.0, where
new rates are expected to take place in
2020. The expected result is likely to increase NFIP insurance costs in higherrisk areas, which could create a drag on
the housing market in those areas.

Q. In general, what percentage of
flood insurance is from private
insurance companies and how will
this change in the future?
Private companies represent about 15
percent of policy premiums, although
much of the private insurance is covering losses exceeding the $250,000 cap
set by the NFIP. Private companies
historically have had difficulty participating in the market. One major issue
has been the inability to properly underwrite policies, with lending regulations
that did not explicitly allow private flood
insurance policies.
Many lenders were hesitant to accept
private flood policies as a result. This
will change due to a final rule issued by
federal lending regulators that takes effect July 1. The likelihood that a private
insurer would be wiped out by a major
flood in a region is small since many
insurers reduce regional risk by reinsurance with companies in different areas

Southwest Economy • Federal Reserve Bank of Dallas • Second Quarter 2019

paying closer attention to younger
} We're
talent—looking for individuals capable of being
groomed into leadership roles.

of the world through intermediaries
such as Lloyd’s of London.
A major impediment to the privatization of the flood insurance market is tied
directly to the guidance and messaging
delivered by the federal government and
its FEMA [Federal Emergency Management Agency] representatives. Even
today, it is difficult to determine if the
government will consider private companies as competitors or partners within
the next five to 10 years.
Recent announcements regarding
FEMA’s plans to revamp the NFIP by
creating a new rating model [Risk Rating 2.0] has caused many private companies to rethink their flood insurance
strategies. In the past, NFIP rates were
the same across any given flood zone.
Private insurers, however, use the latest
mapping tools and improved data to create accurate and precise risk modeling
within flood zones so that they can price
differently based on the risk of flooding.
If FEMA uses a similar pricing method
with its new rating model, then private
insurers may be priced out of the market
in the lower-risk areas of flood zones
where they have successfully acquired
customers in the past.
The fact remains, however, that
despite these challenges, the flood
insurance market will become a more
competitive space as private companies
gain market share and expand their
underwriting guidelines to include
riskier properties. We are confident that
progress will be made and private flood
insurance options will become more
relevant and necessary in the future.

Q. You are involved in the multifamily
housing market in Texas. How is this
sector doing?
The multifamily housing market is still
doing well in Texas. The increase in the

number of jobs is causing more people
to move here. Additionally, we’re seeing a higher percentage of renters in the
general population—some by choice,
some by necessity.
Challenges include limited availability
of suitable sites to construct new multifamily housing, cities’ and communities’
reluctance to allow new multifamily
projects, and increases in construction
costs, including labor and materials.
A significant opportunity is in the
renovation market. Most older developments are located close to jobs, amenities and retail services the tenant market
desires. Usually these types of projects
need minimal remodeling to bring them
up to new construction standards, and
the cost to acquire the project is 20 to 30
percent lower than new construction.

Q. How is labor market tightness
affecting SWBC? Has the company
changed how it does business as
a result?
The impact has been felt in recruiting and retention. On the recruiting
side, the volume of available candidates
has decreased. This has caused us to
become much more adept at the use of
social media to cast a wider net to let
passive candidates know we are hiring,
especially in the very competitive IT [information technology] space.
Generally, we have still been able to
find quality applicants, but the process
has become more elongated to attract
top candidates. Most companies are doing everything possible to retain their
high-performing employees. The number of counteroffers to candidates from
their current employer has grown considerably over the past 12 to 18 months.
Regarding retention, in 2018 SWBC
put in place a top-performer program in
its largest division. This was a way to en-

sure at staff levels that the best-of-the-best
were eligible for incentive compensation
on top of an already strong base pay.
In our real estate business, our construction partners say that with the
aging of true craftsmen and a shortage
of younger qualified tradesmen, work
production and quality have declined.
This results in heavier burdens on superintendents and project managers to
get the job done. We spend more time
analyzing the workload and scheduling
commitments of prospective contractors to ensure timely completion of our
projects. In addition, we’re paying closer
attention to younger talent—looking for
individuals capable of being groomed
into leadership roles.

Q. Historically, the Texas economy
has grown faster than the national
average. Given your experience, why
is this, and will this edge remain in
the future?
Texas has one of the best economies
in the nation. I believe its main strength
is that it’s one of the most diversified
state economies. It also is a low-tax-andregulation state.
An example is the tort reform [affecting civil lawsuits], which was passed in
2003. At the time, the very high cost of
malpractice insurance was driving many
doctors to leave Texas or to retire early.
I was on the board of a hospital at the
time, and it was a severe problem. The
Legislature was able to pull together to
resolve that issue. Texas is a businessfriendly state with regulations that encourage business success, and I don’t
see that changing any time soon.

Southwest Economy • Federal Reserve Bank of Dallas • Second Quarter 2019

17

SPOTLIGHT

Mexico’s Fiscal Reform Earns Mixed Reviews
By Jesus Cañas

M

exico historically has had one
of the lowest tax-to-grossdomestic-product (GDP) rates
in Latin America and by far the lowest
among Organization for Economic
Cooperation and Development
(OECD) nations.
To compensate for the lack of tax
collection to fund government, Mexico
has depended heavily on its stateowned oil company, Pemex. Thus,
when oil production began declining
in 2004, fiscal reform gained urgency.
The Mexican government, seeking to put public sector finances on a
sustainable path, adopted a major tax
overhaul in 2013. It sought to broaden
the tax base and increase tax rates.
The reform included higher tax rates
on certain products and services—junk
food, sugary drinks and private school
tuition—and on certain groups, such
as higher-income households. It also
unified the value-added tax throughout the country, ending lower sales
tax rates in border regions (a change
recently reversed).
The revised rules also imposed a
10 percent capital gains tax on profits
from shares traded on the Mexican
stock exchange and offered incentives to bring the more than 5 million
informal-sector businesses into the
formal sector, where their operations
could be overseen and taxed.1

Independence from Oil
The fiscal reform succeeded in
reducing Mexico’s dependence on oil
revenue (Chart 1). Its share of total
government revenue declined from 35
percent in 2013 to 19 percent in 2018.
The overhaul also succeeded in raising
Mexico’s non-oil tax-to-GDP ratio from
15 percent in 2013 to 18 percent in
2018, putting it on par with Colombia
but still behind Chile and El Salvador.2
The major contributors to the
increase in non-oil revenue collection have been the middle class and
the corporate sector—accounting for

18

CHART

1

Mexico Reduces Oil Dependence After Fiscal Reform

Oil revenue/total government revenue (percent)
50
45
40
35
30
25
20
15
10
5
0

Avg. before reform
30%

'90

'92

'94

'96

'98

'00

'02

Avg. after reform
21%

'04

'06

'08

'10

'12

'14

'16

'18

SOURCES: Secretaría de Hacienda y Crédito Público (Mexico Secretariat of Finance and Public Credit).

1.3 percentage points of the increase.
Higher taxes on gasoline and diesel
brought in another 1.5 percentage
points of the gain.

Tax Receipts Still Lag
Mexico’s total government revenue
as a share of GDP was 22 percent in
2018, close to the 23 percent average in
Latin America and the Caribbean, but
still the lowest among OECD members,
who average 34 percent.3
As a result, Mexico spends a relatively small amount on public services.
While low taxes are generally a positive
for growth, the limited public outlays
restrain expenditures for education,
health and infrastructure. Mexico’s
education spending fell 2.2 percent
annually between 2014 and 2018,
while health expenditures declined 2.9
percent annually during the period.
Government investment, including
infrastructure, has fallen over the past
10 years.
While Mexico’s recently elected
government canceled a new $13 billion
Mexico City airport, it has announced
plans for other infrastructure projects,
among them a Maya train linking five
states in southeast Mexico and ultimately connecting the Pacific Ocean
and the Gulf of Mexico.
Additional plans include paving 300
roads in the southern state of Oaxaca,

providing nationwide internet coverage
with free access in schools, hospitals
and public spaces, building 100 public
universities and construction of an $8
billion refinery. Realization of these
projects is uncertain given the new
government has also declared a firm
commitment to fiscal discipline.
Mexico’s deficits have averaged 2.4
percent of GDP since the fiscal reform,
and national debt has been stable at 47
percent of GDP. (By comparison, the
U.S. debt-to-GDP ratio exceeds
105 percent.)
Near-term concerns include the stillprecarious position of Pemex’s impact
on the overall economy. Oil production
continues to fall, and the state-owned
oil company has considerable debt
and pension obligations. The major
debt-rating agencies have downgraded
Pemex debt, putting pressure on
Mexico’s sovereign debt outlook.

Notes
“Mexico Tax Reform Bill Approved for 2014,”
International Tax Review, December 2013, www.
internationaltaxreview.com/Article/3348483/Mexico-TaxReform-Bill-approved-for-2014.html?ArticleId=3348483.
2
Total tax-to-GDP ratio, including oil revenues, fell from
23 percent in 2013 to 22 percent in 2018 mainly due to
falling oil production and lower oil prices.
3
“Economic Survey of Mexico,” Organization for
Economic Cooperation and Development, May 2019,
www.oecd.org/economy/mexico-economic-snapshot/.
1

Southwest Economy • Federal Reserve Bank of Dallas • Second Quarter 2019

GO FIGURE

Texas Graduation Rates Commendable,
but State Could Fall Behind
Design: Darcy Taj; Content: Grant Strickler

High School Rate Ranks No. 4 in U.S.

College Rate Is on Par with U.S.

61%

90%
graduate

graduate

Texas high school graduation rates rank highly
among the states and ahead of the U.S. overall.

Texas equals the U.S. in graduation rates from
four-year public colleges.

However, College Rates by Race
and Ethnicity Reveal Gaps
Texas college graduation rates are far higher for
white students than Hispanic or black students.

White

While Texas College Graduation
Rates Are Ahead of U.S. ...

70%

54%

44%

graduate

graduate

graduate

Hispanic

Black

… the State’s College Student
Population Is More Diverse

70% 67%
54% 52%

White

44% 42%

52%

Black

Texas*

Hispanic
Texas

U.S.

28%
U.S.*

*Share of students enrolled at public
universities who are either Hispanic or black.

Texas Faces a Significant Graduation Rate Gap
Hispanic and black students together constitute a majority in Texas public universities—and
the share is likely to grow. Yet Hispanic and black students graduate at much lower rates
than non-Hispanic white students. Texas must close this graduation rate gap or risk falling
behind the nation in terms of educational outcomes.

NOTES: The high school graduation rate is the four-year adjusted rate for the cohort graduating in 2017. College graduation rates are six-year rates at public four-year institutions for the
cohort entering in 2011. Race groups are non-Hispanic. The share of college students is for 2017 enrollment.
SOURCES: U.S. Department of Education, National Center for Education Statistics, and Digest of Education Statistics; Texas Education Agency and Texas Higher Education Coordinating
Board; National Student Clearinghouse.

Federal Reserve Bank of Dallas
P.O. Box 655906
Dallas, TX 75265-5906

SNAPSHOT

PRSRT STD
U.S. POSTAGE

PAID

DALLAS, TEXAS
PERMIT #1851

Shale Breakevens Anchor Oil Prices

T

he oil price that companies need to profitably drill
new wells has closely tracked prices for long-dated oil
futures in recent years. The emergence of U.S. shale
production seems to be playing a large role in anchoring long-term oil prices.
The breakeven price is of great interest because it provides
information on how activity in the oil sector might adjust if oil
prices move dramatically. Its relevance has only grown over
the past decade with the emergence of shale oil in the United
States. Shale has a shorter lead time between drilling and
production relative to traditional oil projects, making it more
responsive to oil price movements.
The average breakeven price of West Texas Intermediate
crude oil has fallen 4 percent (or $2 per barrel) over the past
year, to $50 per barrel, according to the latest Dallas Fed
Energy Survey.
—Adapted from Dallas Fed Economics, May 21, 2019,
by Michael D. Plante and Kunal Patel

CHART

1

Average Breakeven Prices in U.S. Range from
$48 to $54 per Barrel

Permian
(other)
$54
Permian
(Delaware)
$49
Permian
(Midland)
$49

SCOOP/STACK
$53
Other U.S.
(nonshale)
$49
Other U.S.
(shale)
$49

Eagle Ford
$51

NOTES: In the March 2019 Dallas Fed Energy Survey, executives from 82 exploration
and production firms answered the question, "In the top two areas which your firm
is active: What WTI oil price does your firm need to profitably drill a new well?" The
survey collection period was March 13–21.
SOURCE: Federal Reserve Bank of Dallas.

Federal Reserve
Bank of Dallas

Southwest Economy
is published by the Federal Reserve Bank of Dallas. The views expressed are those of
the authors and should not be attributed to the Federal Reserve Bank of Dallas or the
Federal Reserve System.
Articles may be reprinted on the condition that the source is credited to the Federal
Reserve Bank of Dallas.
Southwest Economy is available on the Dallas Fed website, www.dallasfed.org.

Marc P. Giannoni, Senior Vice President and Director of Research
Pia Orrenius, Keith R. Phillips, Executive Editors
Michael Weiss, Editor
Kathy Thacker, Associate Editor
Dianne Tunnell, Associate Editor
Justin Chavira, Graphic Designer
Olumide Eseyin, Graphic Designer
Darcy Taj, Graphic Designer
Davian Lynn Hopkins, Graphic Designer

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