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Bank Trends

FDIC, Division of Insurance, Bank Trends - Analysis of Emerging Risks In Banking
 March, 2002
 Number 02-03
Adrian Sanchez 
(972) 761-2074 

Houston's Downturn Comes Later but Will Linger Longer

Forces driving the U.S. economy in 2001 intersected in the Houston metropolitan area. After racing ahead of the national economy early in the year, Houston faced weakening energy prices, layoffs at computer manufacturers and airlines, the bankruptcy of Enron, and the most costly tropical storm in U.S. history. The many FDIC-insured institutions that conduct business in this market, especially the 58 institutions headquartered in Houston must adjust from a period of extraordinarily rapid growth to one in which the economic fundamentals seem to have changed.

Houston1 started 2001 with strong employment growth and a low unemployment rate, despite a national economy that was showing signs of slowing. High energy prices and a healthy housing market, spurred by low mortgage interest rates, were primary factors in Houston's robust economy. By late 2001, a number of factors began to take their toll on the Houston economy.

A principal reason why Houston's economy has deteriorated since mid-year 2001, and may lag the national economy in 2002, is the shift in the energy outlook. Despite some success in diversifying its economy since the 1980s, the energy industry continues to dominate Houston's economic landscape; the share of local economic activity attributable to the oil and gas industry remains near 50 percent2.

The Baker-Hughes domestic drilling rig count - a key industry indicator - which stood at nearly 1,300 in July 2001, fell 35 percent to about 850 by early February 2002 (see Chart 1). Energy firms are reporting lower fourth quarter earnings dampening the outlook for profits, and causing cutbacks in capital expenditures and exploration budgets. Soft demand for petroleum and natural gas-related products, the result of warmer than average weather and sluggish U.S. and global economic growth, is expected to continue to constrain energy prices3.

Secondary economic effects arising from a less than robust energy sector are affecting other industries such as construction, retailing and business services. These spin-off effects are expected to dampen Houston's total nonfarm employment growth rate this year, causing the metro economy to experience

The Decline in Oil Prices Has Caused Drilling Activity to Recede As Well as the Domestic Rig Count D

a belated and slow recovery to its trend employment growth rate in 2002.

Houston has also felt the effects of the slowdown facing computer manufacturers. Houston-based Compaq Computer Corporation laid off 3,000 workers in the metro area as a result of slow computer sales. Compaq's anticipated merger with Hewlett-Packard, if completed, could result in the loss of 15,000 additional jobs at the two companies, although not all the job losses are expected to occur in Houston4.

The decline in air travel in the wake of the September 11 attacks also affected Houston as Continental Airlines cut 3,000 jobs5. According to one study, the Houston metro area is expected to experience job losses of 29,000, mostly in travel and tourism, stemming from September 116.

More recently, the financial implosion of Enron Corp., the largest corporate bankruptcy ever, led to lay offs of two-thirds of its 7,500 Houston-based employees.

All of these events are affecting office vacancy rates. The Houston office market finished 2001 with a 15 percent vacancy rate, up two percentage points from the prior year7. Declining employment growth, possible negative absorption -- a decline in occupied space -- and new inventory being completed this year will likely put additional stress on this key ratio. The Enron collapse will add to this problem. The 40 story, 1.25 million square foot Enron Center will be completed this year and will add another three percent of office space to Houston's downtown market. Not only will Enron not be moving into this building, it also appears another 600,000 square foot building the company occupies may be vacated. Job layoffs and corporate mergers / relocations (despite additional jobs anticipated from the third quarter 2002 merger between Conoco and Phillips Petroleum that will be headquartered in Houston) will likely contribute to overall weakness in absorption. Collectively these events will likely put downward pressure on office rents as the office market softens.

Nature also played a hand in the Houston economy in 2001. Major flooding from tropical storm Allison damaged an estimated 3,000 homes and businesses in the Houston area in June 2001, including up to eight medical facilities affected by high water8. Damages topped $6 billion with insured losses of $2.5 billion - nearly 90 percent of the total losses for the storm occurring in the Houston metropolitan area - making Allison the costliest tropical storm in U.S. history9.

Collectively, the ripple effects of these events are spreading throughout the Houston economy. The Houston Purchasing Managers Index (PMI), based on a survey of 80 purchasing executives in key Houston industries, fell below 50 beginning in October 2001 and is now below the national index (see Chart 2). The PMI composite index is a leading indicator of the Houston economy, and readings below 50 are believed to signal a contraction in the metro economy over the next quarter or two. The Bloomberg Houston, Texas Index, a price-weighted index designed to measure the performance of the Houston economy, has fallen about 25 percent since May 200110.

 The Houston Purchasing Manufacturing Index Only Recently Dipped Below 50, And Is Now Lower Than The U.S. PMI NumberD

Implications for Insured Institutions
The consequences of the slowing economy will present challenges to the 58 FDIC-insured institutions headquartered in the Houston metropolitan area. Lending to most of the large companies mentioned (Enron, Continental Airlines, Compaq) is from large banks outside Houston. However, area banks lend to employees, smaller businesses and proprietors that work for or are tied to these large companies and their industry sectors. Thus, there are also likely to be consequences affecting Houston's smaller institutions in 2002 and beyond.

Asset quality indicators, including delinquency rates and loss experience, are favorable compared to national benchmarks. However, lost jobs, failed or bankrupt businesses and defaulted contracts are likely to prolong Houston's sluggish economic performance and thus have a negative affect on asset quality and earnings.

Rapid loan growth introduces additional uncertainties. Loan growth over the past five years by Houston area banks (126 percent, merger adjusted) has far outpaced the nation's 38 percent. Many of these loans were made during a stronger economic period and have not been tested by a recession. By some measures, reserves have failed to keep pace with loan growth. Reserve coverage for all loans (1.06 percent) is far below the nation's 1.61 percent, although reserve levels, as a share of noncurrent loans, at Houston area institutions exceed the national benchmark (144 percent versus 129 percent).

Through the first three-quarters of 2001 the median return on assets for FDIC-insured institutions headquartered in the Houston metropolitan area was 0.85 percent, significantly below the national median of 1.00 percent. Preliminary year-end 2001 data suggest that performance of this group of institutions weakened further with a median return on assets of 0.66 percent. Financial performance has thus far been affected by tight interest margins and low fee-based revenues rather than loan-loss provisions. Provision expenses as a share of average assets for Houston area banks as of September 30, 2001 were less than one-third the average for all banks in the nation. Should asset quality deterioration materialize, a need for additional provisions would compound the earnings issues for Houston area banks.

About the Author

Adrian Sanchez is a Regional Economist in the Division of Insurance Dallas Regional Office.
(972) 761-2074

1 References to Houston in this Bank Trends are for the metropolitan statistical area and include the following counties: Chambers, Fort Bend, Harris, Liberty, Montgomery and Waller.
2 "Diversification of Houston's Economic Base", Houston Business, September 2000.
3 Standard & Poor's Industry Survey, "Oil & Gas: Equipment & Services", January 2002.
4 "Enron collapse latest shock to Houston's economy," Forbes.com, January 29, 2002 (Reuters).
5 "Continental to furlough 3,000 in Houston, cut back flights," Houston Chronicle.com, September 15, 2001.
6 "The Impact of September 11 on U.S. Metropolitan Economies," The Milken Institute, January 2002.
7 Torto Wheaton Research, 4th Quarter 2001 data.
8 "National Flood Summary," June 9, 2001, National Weather Service.
9 "Tropical Storm Allison, June 2001," Risk Management Solutions Inc.
10 Source: Bloomberg.com, February 5, 2002.

Last Updated 3/20/2007 insurance-research@fdic.gov

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