Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION SECOND QUARTER 2001 

FDIC
 

National
 

Edition
 

Boston 

Chicago 

New 

York 

Atlanta 

Memphis 

San 

Francisco Kansas 

City 

Dallas 

Division of
 

Insurance
 

In Focus This Quarter 

◆ Economic Conditions and Emerging Risks in Banking—The banking industry continued to perform strongly through fourth quarter 2000 despite a noticeable 

slowdown in earnings growth. Industry performance during first quarter 2001 is not 

likely to improve dramatically in light of the recent slowdown in the U.S. economy. 

Analysts point to certain adverse trends in portfolio characteristics, particularly 

risk selection and loan concentrations, that could pose risk management problems 

for certain groups of insured institutions. However, the financial strength of the 

industry positions it to continue to meet loan demand from creditworthy borrowers. 

Reflecting the current uncertainty in the economic outlook, the business press has 

coined three scenarios as to where the economy could be headed: The V, U, and L 

scenarios. Analyzing historical relationships between business cycle drivers and 

banking industry performance, this article considers the implications of these scenarios for bank financial performance. See page 4. 

By the Division of Insurance Staff 

Regional Perspectives 

◆ Atlanta—Atlanta Region insured 

institutions may be facing the most challenging environment in nearly a decade 

as key economic sectors weaken while 

competition in the banking industry 

remains strong. See page 15. 

◆ Boston—Strong aggregate capital 

and earnings are helping to mitigate the 

effects of any increase in credit and 

interest rate risk, a continued narrowing 

of net interest margins, and slower economic growth. See page 18. 

◆ Chicago—Insured institutions’ performance remains favorable. Going forward, bank and thrift will be influenced 

by how current risk profiles interact 

with the slowdown in the national economy. See page 21. 

◆ Dallas—The region’s insured institutions are vulnerable to softening in the 

Commercial real estate sector, higher 

energy prices, and agricultural borrowers’ growing reliance on off-farm income 

during a slowing economy. See page 24. 

◆ Kansas City—Government payments 

and off-farm income have mitigated 

the effects of depressed farm operating 

revenues, and as a result, farm banks 

continue reporting favorable financial 

conditions. See page 27. 

◆ Memphis—The Memphis Region’s 

economy slowed sharply during the second half of 2000 and is now considerably 

weaker than the national economy. See 

page 30. 

◆ New York—Weakening credit quality, 

particularly among the Region’s large 

institutions, could pressure profitability, 

as loan loss reserves have declined to the 

lowest level since 1990. See page 33. 

◆ San Francisco—Higher energy 

prices and power shortages, technology 

sector weakness, equity market volatility, and softening in the commercial real 

estate sector could dampen the Region’s 

otherwise strong economic and banking 

conditions. See page 36. 

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

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

financial institutions and financial institution regulators. It is produced for the following eight 

geographic regions: 

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

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

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

Dallas Region (CO, NM, OK, TX)
 

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

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

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

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

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

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

Information Center for current pricing on bulk orders. 

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

more information or to provide comments or suggestions about the National Edition of Regional 

Outlook, please call Lynn Nejezchleb at (202) 898-3898 or send an e-mail to lnejezchleb@fdic.gov. 

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

reflect official positions of the Federal Deposit Insurance Corporation. The analyses presented in 

the publication are for information purposes and should not be construed as formal or informal 

regulatory guidance. 

Some of the information used in the preparation of this publication was obtained from publicly 

available sources that are considered reliable. However, the use of this information does not constitute an endorsement of its accuracy by the Federal Deposit Insurance Corporation. 

Chairman Donna Tanoue 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Writer/Editor Kim E. Lowry 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Richard A. Brown 

Ronald L. Spieker 

Publications Manager Teresa J. Franks 
Letter from the Executive Editor 

To the Reader: 

The goal of the Regional Outlook is to provide useful risk-related information to bankers, banking agency staff, and 

other interested readers. To do this more effectively, the second quarter 2001 edition has a new look. We are publishing a single national edition that provides an overview of economic and banking risks and discussions of these 

risks as they relate to insured institutions in each FDIC Region. We tell the national story and, at the same time, alert 

the reader to specific trends and developments at the regional level. 

After considering our experience with this new format, we may adopt it permanently for the second and fourth quarters of each year. The first and third quarter editions will continue to feature in-depth coverage of the economy and 

banking industry in each Region. Trying new formats will help us find the right balance between regional coverage 

of specific topics and analysis of economic and banking issues that cut across regional lines. 

After you have read this edition of the Regional Outlook, we would like to hear from you. Does this new approach 

provide a more effective vehicle for reporting on banking and economic trends? What other suggestions do you have 

for improving our presentation of risk-related information? Call us with your comments at (877) 275-3342 or 

(800) 925-4618 (TDD) or e-mail them to lnejezchleb@fdic.gov. 

Sincerely, 

George E. French
 

Executive Editor
 

Regional Outlook 3 Second Quarter 2001 
In Focus This Quarter
 

Economic Conditions and Emerging Risks in Banking
 

Introduction 

The banking industry continued to perform strongly 

through fourth quarter 2000, despite a noticeable slowdown in earnings growth resulting from narrowing net 

interest margins (NIMs), increased loan loss provisions, 

and declining noninterest income. Industry performance during first quarter 2001 appears unlikely to 

improve in light of the recent slowdown in the U.S. 

economy. Furthermore, certain adverse trends in portfolio characteristics, including risk selection, loan concentrations, and funding and liquidity concerns, could 

pose risk management problems for certain groups of 

insured institutions. Overall, however, the financial 

strength of the industry positions it to continue to meet 

loan demand from creditworthy borrowers during a 

slowing economy. Using consensus economic scenarios, this article examines the potential effects of the current economic slowdown on banking industry earnings 

and capitalization. 

The Banking Industry Remains Strong 

Call report data continue to reflect the financial strength 

of the banking industry. According to a variety of financial measures, the industry is currently much stronger 

and better prepared for an economic slowdown than in 

1990, when the last recession began. At that time, the 

industry was weakened and recovering from the fallout 

of excessive risk taking and problems relating to the 

agricultural sector, regional recessions, and sharply 

deteriorating conditions in local residential and commercial real estate markets.1 Year-end 2000 data for capital, earnings, nonperforming loans, and exam ratings 

suggest that the financial position of the industry is historically strong, and the industry is better able to withstand similar adverse economic conditions. 

Insured institutions with weak capital ratios have 

declined both in number and as a percentage of all 

insured institutions (see Chart 1). In the mid-1980s, 

1 For further information regarding the state of the banking industry 

in the late 1980s and early 1990s, see Federal Deposit Insurance 

Corporation, History of the Eighties—Lessons for the Future. Vol. I: 

An Examination of the Banking Crises of the 1980s and Early 1990s, 

Washington, DC: FDIC, 1997. www.fdic.gov/bank/historical/ 

history/contents.html. 

about 17 percent of the banking industry, or 3,000 institutions, reported equity and reserves less than 6 percent 

of assets. At that time, nearly 2.5 percent of all institutions were insolvent (reporting equity and reserves less 

than zero percent of assets). As the economy entered a 

recession in the early 1990s, capital positions had 

improved somewhat for most of the industry. By the end 

of 2000, however, the percentage of thinly capitalized 

insured institutions had fallen dramatically: only about 

0.5 percent of the industry, or 45 institutions, held equity and reserves less than 6 percent of assets. 

Higher levels of profitability contributed significantly to 

the improvement in capital levels at insured institutions 

in the late 1980s and early 1990s. During 1986 and 

1987, more than 20 percent of the banking industry, or 

roughly 3,500 institutions, was unprofitable, operating 

with return on assets of less than zero (see Chart 2). By 

the mid-1990s, the industry had reorganized, the credit 

quality of loans had improved, cost-cutting measures had 

led to improved efficiency, and fewer than 5 percent of 

all insured institutions were unprofitable. The number 

of unprofitable institutions has risen to more than 700 

(7.3 percent of insured institutions) as of year-end 2000. 

More than half of those unprofitable institutions are 

new banks that have been chartered since 1997. While 

new banks are often unprofitable during their start-up 

period, the onset of adverse economic conditions will 

pose additional challenges for these institutions. 

The percentage of institutions with high problem loan 

levels and the percentage of institutions with a comCHART 1 

The Number of Thinly Capitalized Institutions 

Has Diminished over the Past Decade 

Percentage of All FDIC-insured Insured Institutions institutions with 

20 

15 

10 

5 

0 

Note: FSLIC = Federal Savings and Loan Insurance Corporation
 

Source: Bank and Thrift Call Reports (FDIC Research Information System)
 

Includes thrifts insured by 

FSLIC prior to 1989. 

equity and 

reserves-toassets less than: 

6.0 percent 

4.0 percent 

2.0 percent 

0.0 percent 

’84 ’85 ’86’87’88’89’90’91 ’92’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 

Regional Outlook 4 Second Quarter 2001 
In Focus This Quarter
 

posite CAMELS rating of 3, 4, or 5 show a similar 

trend.2 As the real estate crisis and regional recessions 

hit the banking industry in the mid- to late 1980s, the 

percentage of institutions with noncurrent loans greater 

than 6 percent of total loans rose past 10 percent. As 

the national and regional economies began to improve 

in the early 1990s, the performance of loan portfolios 

also improved. Today only a handful of institutions 

have high levels of nonperforming loans. Similarly, 

insured institutions rated 3 or lower rose to more than 

25 percent at the beginning of the past decade, fell to 

less than 5 percent by 1997, and rose to 6.4 percent by 

the end of 2000. 

Although the banking industry’s financial performance 

remains solid overall, some signs of deterioration are 

emerging. Aggregate commercial bank and thrift earnings declined modestly in 2000, largely as a result of 

significantly higher loan loss provisions at a few large 

institutions.3 Commercial banks also continued to 

experience downward pressure on NIMs; the industry 

NIM fell to 3.90 percent during fourth quarter 2000, 

the lowest level since 1990. Earnings of insured savings institutions also fell slightly in 2000 in large part 

because of declining NIMs. However, compared to ten 

years ago, when many banks were saddled with 

impaired capital and negative earnings, banks and 

thrifts are currently well positioned to meet loan 

demand from creditworthy borrowers and help support 

economic recovery. 

Risk Management Issues Raise Concerns 

A number of risk management concerns related to 

changes in portfolio characteristics should be weighed 

against this overall financial strength. These concerns 

include loan concentrations, risk selection, funding and 

interest rate risk, off-balance-sheet exposures, and operational risks. 

Loan Concentrations 

Of particular importance at this stage of the business 

cycle are the rising loan concentrations in traditionally 

higher risk loan categories. Chart 3 shows the percent2 The acronym CAMELS refers to the supervisory ratings system
 

applied to insured depository institutions by federal and state regulators.
 

Its component letters stand for: capital, asset quality, management,
 

earnings, liquidity, and sensitivity to market risk.
 

3 Federal Deposit Insurance Corporation, Division of Research
 

and Statistics, Quarterly Banking Profile, fourth quarter 2000,
 

www.fdic.gov/bank/analytical/index.html.
 

CHART 2 

The Percentage of Unprofitable Institutions
 

Has Recently Risen, but Remains Low
 

Compared with the 1980s
 

Percentage of All FDIC-insured Insured Institutions institutions with return Includes thrifts insured by 

FSLIC prior to 1989. on assets less than: 

0.0 percent 

–1.0 percent 

–2.0 percent 

–3.0 percent 

0 

5 

10 

15 

20 

25 

’84 ’86 ’88 ’90 ’85 ’87 ’89 ’91 ’93 ’95 ’97 ’99 ’92 ’94 ’96 ’98 ’00

Note: FSLIC = Federal Savings and Loan Insurance Corporation
 

Source: Bank and Thrift Call Reports (FDIC Research Information System)
 

age of insured institutions with concentrations of commercial and industrial (C&I) loans, commercial real 

estate (CRE) loans, and construction and development 

(C&D) loans expressed as a percentage of equity capital. During the mid-1980s, more than 20 percent of all 

insured institutions held total concentrations in these 

“commercial and construction” loans greater than 400 

percent of equity capital. By the early 1990s, that percentage had fallen by more than half. Since 1995 the 

percentage of institutions with concentrations in these 

loan types has begun to rise sharply and again reached 

20 percent by the end of 2000. 

Loan concentrations such as these traditionally have 

been associated with a higher frequency of failure. 

Chart 4 (next page) shows the percentage of insured 

institutions that failed within three years, according to 

concentrations of commercial and construction 

CHART 3 

Concentrations of High-Risk Loans to Capital
 

Have Risen Sharply since 1995
 

FDIC-insured 400 percent 

Percentage of All institutions with 500 percent 

Insured Institutions high-risk loans-to­ 600 percent 

equity greater than: 700 percent 

’84 ’86 ’88 ’90 ’85 ’87 ’89 ’91 ’93 ’95 ’97 ’99 ’92 ’94 ’96 ’98 ’00

0 

5 

10 

15 

20 

25 

Includes thrifts insured 

by FSLIC prior to 1989. 

Note: High-risk loans are defined as commercial and industrial, commercial real
 

estate, and construction and development loans.
 

FSLIC = Federal Savings and Loan Insurance Corporation
 

Source: Bank and Thrift Call Reports (FDIC Research Information System)
 

Regional Outlook 5 Second Quarter 2001 
In Focus This Quarter
 

loans-to-equity capital. Institutions with elevated concentrations in these loan categories have consistently 

failed in higher proportions than other insured institutions. From 1984 to 1998, institutions with commercial 

and construction loans in excess of 400 percent of capital were two to three times more likely to fail within 

three years. 

Similar concerns are noted for institutions with concentrations specifically in CRE or C&D loans. Some 18.6 

percent of insured institutions showed CRE loan concentrations greater than twice their capital in December 

2000, compared with 12.5 percent in 1989. For C&D 

loans, slightly more than 10 percent of insured institutions show concentrations greater than twice their capital—about the same percentage as in 1989. Again, history shows that the greater the level of concentration in 

these loan types, the greater the risk of failure within 

three years. However, the number of institutions with 

the very highest concentrations in CRE and C&D loans 

is lower than it was in the late 1980s. 

Risk Selection 

Some insured institutions are also holding a higher-risk 

asset mix, including subprime consumer loans, high 

loan-to-value (LTV) mortgages, and syndicated loans to 

highly leveraged companies, than they did a decade ago. 

Subprime lending refers to loans extended to borrowers 

with weak credit histories or questionable repayment 

capacity. In 2000, 13 percent of mortgage originations 

were subprime mortgage loans, up from 5 percent in 

1994. Insured institutions increasingly have become 

involved in subprime lending as this market has expanded. Nearly half of the top 25 subprime mortgage lenders 

are bank or thrift holding companies or their affiliates.4 

Even the best grade of subprime mortgages (A–) is 

nearly four times as likely to be seriously delinquent as 

prime mortgages. Given the high delinquency rate on 

subprime loans even in a strong economy, insured institutions that hold a significant portion of these loans in 

their portfolios may need to prepare for greater credit 

quality challenges should the economy slow further.5 

4 Inside B&C Lending, Bethesda, MD: Inside Mortgage Finance 

Publications, Inc., March 5, 2001, Volume 6, Issue 5, p. 2. 

5 According to Mortgage Information Corporation data from 

September 2000, 0.5 percent of all prime mortgages were seriously 

delinquent (at least 90 days past due or in foreclosure), while 3.4 percent of all A– subprime loans were seriously delinquent. 

CHART 4 

Institutions with Concentrations of High-Risk 

Loans Historically Have a Higher Rate of Failure 

Percentage that Failed FDIC-insured institutions 

within Three Years with high-risk loans-toequity greater than: 

0 

5 

10 

15 

20 

25 700 percent 

600 percent 

500 percent 

400 percent 

All Institutions 

’84 ’86 ’88 ’90 ’85 ’87 ’89 ’91 ’93 ’95 ’97 ’99 ’92 ’94 ’96 ’98 ’00

Includes thrifts insured by 

FSLIC prior to 1989. 

Note: High-risk loans are defined as commercial and industrial, commercial real
 

estate, and construction and development loans.
 

FSLIC = Federal Savings and Loan Insurance Corporation
 

Source: Bank and Thrift Call Reports (FDIC Research Information System)
 

Insured institutions have participated in an expanding 

market for high-LTV mortgage lending. More than 

20 percent of all mortgages originated during 2000 

were for more than 90 percent of the value of the 

house, almost three times the rate in 1990.6 Like subprime lending, high-LTV lending represents a new line 

of business that remains untested in a slower-growing 

economy. Should the economy enter a prolonged downturn, mortgage losses could be higher than in past 

recessions.7 

Another sign of rising credit risk on bank balance sheets 

is an increase in the proportion of syndicated loan originations extended to leveraged borrowers.8 Originations 

of leveraged loans as a percentage of total syndicated 

loans rose from 17 percent in 1996 to 31 percent in 

1999.9 As the level of problem loans rose and economic conditions weakened in 2000, banks scaled back 

lending to leveraged borrowers to 26 percent of total 

syndicated loans. However, total syndicated loan originations rose to a historic high of nearly $1.2 trillion 

in 2000. 

6 Federal Housing Finance Board data.
 

7 For additional information on high-LTV lending, see Kathy R.
 

Kalser and Deborah L. Novak, “Subprime Lending: A Time for
 

Caution,” Regional Outlook, third quarter 1997; Diane Ellis, “High
 

Loan-to-Value Lending: A New Frontier in Home Equity Lending,”
 

Regional Outlook, first quarter 1999; and Alan Deaton, “Rising
 

Home Values and New Lending Programs Are Reshaping the Outlook
 

for Residential Real Estate,” Regional Outlook, third quarter 2000.
 8 Ronald L. Spieker, “An Overview of Trends in Syndicated and
 

Leveraged Lending,” Bank Trends: Analysis of Emerging Risks in
 

Banking, Number 98-04, February 1998; and Ronald L. Spieker and
 

Steve E. Cunningham, “Recent Trends in Syndicated Lending,”
 

Regional Outlook, first quarter 1999.
 9 Loan Pricing Corporation.
 

Regional Outlook 6 Second Quarter 2001 
In Focus This Quarter
 

U.S Agricultural Sector Continues 

to Struggle; However, Farm Banks’ 

Performance Remains Solid 

•	 U.S. agriculture has struggled during the past three 

years with depressed commodity prices, recurring 

drought conditions, and lagging exports. 

•	 Record government payments in 2000 helped 

farmers mitigate the effects of a stressed agricultural sector. However, government payments are 

forecast to decline in 2001. 

•	 Off-farm income for farm households averaged 

$60,000 at year-end 2000—a 90 percent increase 

since 1991. This income source could be vulnerable in the event of an economic downturn. 

•	 A combination of record government payments and 

increasing levels of off-farm income has helped to 

protect farm bank portfolios from increasing stress 

in the agricultural industry. During 2000, the condition of the nation’s farm banks improved. 

•	 The congressional debate relating to the 2002 farm 

bill will have significant implications for farmers 

as this legislation will establish the level and nature 

of future government payments. 

•	 For a more in-depth look at regional agricultural 

sector conditions and the effects on farm banks, see 

Dallas Regional Perspectives, first quarter 2000, 

Memphis Regional Perspectives, second quarter 

2000, and Kansas City Regional Perspectives in 

this edition. 

Funding and Interest Rate Risk 

A scarcity of core deposits, particularly at community 

banks, during a period of sustained loan growth has 

resulted in an increased reliance on noncore sources of 

funds. This trend has contributed to an ongoing decline 

in NIMs and, in some cases, to increasing sensitivity to 

rising interest rates.10 The recent decline in short-term 

interest rates could alleviate pressure on NIMs for 

many institutions. However, a general decline in interest 

10 For additional information on the effects of increasing levels of 

noncore funding on interest rate risk, see Allen Puwalski, “Increasing 

Interest Rate Risk at Community Banks and Thrifts,” Bank Trends: 

Analysis of Emerging Risks in Banking, Number 00-01, March 2000; 

and Allen Puwalski and Brian Kenner, “Shifting Funding Trends Pose 

Challenges for Community Banks,” Regional Outlook, third quarter 

1999. 

Effects of Higher Energy Prices 

and Energy Shortages Could 

Contribute to a Slowing Economy 

•	 Higher energy prices, particularly for oil, have 

preceded three of the past four U.S. recessions. 

Even though today the U.S. economy is only 60 

percent as dependent on energy overall as it was in 

1973, the economy remains vulnerable to energy 

price shocks because energy consumption continues to increase. 

•	 Overall, rising energy prices and energy shortages 

can be viewed in the context of limited supply and 

excess demand. As such, a solution to, or even an 

easing of, the current situation is not expected in 

the near term. 

•	 Highly leveraged consumers and those on fixed 

incomes could be particularly vulnerable to the 

effects of higher energy prices. Rising natural gas 

prices and insufficient electricity supplies will disproportionately affect particular energy-intensive 

industry sectors, such as heavy manufacturing, 

agriculture (driving up fertilizer and irrigation 

costs), mining, and lodging. Higher fuel prices will 

have significant consequences for consumers, as 

well as the entertainment, travel and leisure, and 

transportation industries. 

•	 The electricity crisis remains primarily a regional 

issue, with heightened vulnerability in the western 

United States. Increasing natural gas prices (prices 

nearly tripled during 2000) are also affecting the 

cost and availability of electricity nationwide as the 

production of electricity now represents the most 

rapidly growing use of natural gas. 

rates also could spur significant growth in mortgage 

refinancing activity, which could lead to greater interestrate sensitivity for institutions that invest heavily in 

fixed-rate assets, such as mortgage-backed securities 

(MBS) and long-term fixed-rate mortgages. The 

Mortgage Bankers Association Refinancing Index has 

risen sharply since fourth quarter 2000, when interest 

rates began to fall.11 Call report data indicate that the 

interest-rate sensitivity of insured institutions may be 

rising. The number of banks with long-term assets 

greater than 40 percent of assets and noncore liabilities 

11 The Refinancing Index rose from 761.5 at year-end 2000 to 2287.0 

as of mid-April 2001. Mortgage Bankers Association of America/ 

Haver Analytics. 

Regional Outlook	 7 Second Quarter 2001 
In Focus This Quarter
 

greater than 20 percent of assets has more than doubled 

since year-end 1997. At the same time, capital market 

developments—such as the emergence of deep, liquid 

markets for interest-rate swaps and floating-rate 

MBS—have expanded the range of tools available to 

bankers to manage interest-rate risk. 

Off-Balance-Sheet Exposures 

Innovations in risk management practices and the desire 

for enhanced fee income have led to a significant 

increase in derivatives activity over the past decade. 

Since 1990, the notional volume of derivatives contracts 

held by commercial banks has risen from $6 trillion 

to $40 trillion.12 The growth in volume highlights the 

importance of maintaining risk management practices 

that are appropriate to this complex business activity. 

Risk-based capital requirements also have created 

incentives for lenders to remove risk from their balance 

sheets through securitization activities and credit derivatives. Significant growth in these off-balance-sheet 

risks poses a variety of issues, such as accurately valuing derivatives exposures and residual assets. 

Since 1992, unused commercial loan commitments and 

letters of credit held by banks have increased rapidly— 

from $776 billion to $1.889 trillion.13 Unused commercial loan commitments present banks with adverse 

selection risks when financially stressed companies 

draw on their credit lines. For example, in recent months 

several large corporations drew on commercial paper 

backup credit lines following downgrades in their 

commercial paper ratings. Also, many households that 

refinanced mortgages as a means of consolidating other 

debts between 1998 and 1999 now may have more 

unused credit available on credit cards and other revolving lines that these households could draw upon immediately if they experience financial distress. 

Operational Risks 

Well-run financial institutions use a variety of risk 

management and audit-related controls to safeguard 

against excessive risk taking, fraud, noncompliance 

with regulatory directives, and errors in financial 

reporting. The need for such systems and controls 

only increases as an institution expands its scope of 

12 Bank call report data. 

13 Bank call report items used to calculate unused commercial loan 

commitments include commercial and similar letters of credit, performance standby letters of credit and foreign office guarantees, and 

“other unused commitments,” which include commitments to extend 

credit through overdraft facilities or commercial lines of credit and 

retail check credit and related plans. 

operations or enters new lines of business. However, 

operational controls do not directly generate revenues, 

and the temptation to cut expenses in this area may be 

great, particularly when an institution is faced with 

prospects for reduced profitability. The role that fraud 

has played in some of the more recent bank failures 

highlights the importance of adequate internal control 

and audit procedures. To a great extent, operational 

risk, as well as off-balance-sheet exposures, can be 

evaluated only by on-site supervisory analysis of risk 

management practices and modeling techniques. 

Current Economic Conditions:
 

Are We Still in a “New Economy”?
 

The economic environment for the banking industry is 

now marked by considerable uncertainty. 

As recently as nine months ago, virtually all the vital 

signs for the U.S. economy were positive. In February 

2000, the economy entered its 108th month of expansion, making this the longest expansion in U.S. history. 

Sustained high rates of productivity growth were making it possible for the economy to grow rapidly (above 

4.0 percent annually for four consecutive years) with 

low to moderate inflation. Equity market valuations 

reflected the optimism of investors and analysts, who 

began to conclude that much had indeed changed in the 

so-called “New Economy.”14 

However, over the past year, three factors have significantly slowed the pace of economic activity. First, the 

cost of borrowing by households and businesses rose in 

2000, in part a result of a cumulative 175 basis point 

increase in the Federal Reserve federal funds target rate 

between June 30, 1999, and May 16, 2000. Second, the 

price of oil in 2000 averaged more than twice that of 

two years earlier, increasing costs for consumers and 

businesses. As winter approached, the energy situation 

worsened as spot prices for natural gas soared and electricity production fell short of demand in California 

and other western states. Finally, high rates of capital 

investment in certain industry sectors led to overcapacity that was pressuring some companies’ ability to service debt. Examples of these companies could be found 

in the entertainment, telecom, and dot-com industries, 

among others.15 

14 See Maureen E. Sweeney et al., “Banking Risk in the New
 

Economy,” Regional Outlook, second quarter 2000.
 15 See Steven Burton, “Credit Problems for U.S. Businesses Continue
 

to Rise,” Regional Outlook, first quarter 2001.
 

Regional Outlook 8 Second Quarter 2001 
In Focus This Quarter
 

By fall 2000, signs of deterioration in economic activity were clearly visible. Equity analysts began cutting 

estimates of corporate earnings growth for the first half 

of 2001. Equity valuations continued to retreat from the 

high levels of early 2000, led by rapidly falling stock 

prices in the high-tech sector. Perhaps more troubling, 

credit spreads on risky corporate debt rose to higher 

levels than had been experienced during the financial 

crisis of late 1998.16 Capital market conditions became 

particularly impaired in December 2000 as issuance of 

high-yield corporate debt virtually stopped.17 

Signs of the economic slowdown were also visible on 

Main Street. Corporate layoff announcements in 

December 2000 tripled from year-ago levels to 133,000, 

and remained above the 100,000 mark through April 

2001 (see Chart 5). The Conference Board’s Index of 

Consumer Confidence fell for five consecutive months 

beginning in September 2000. Data released in early 

2001 showed that capital investment by U.S. companies 

declined in the fourth quarter of 2000 for the first time 

since the 1990 to 1991 recession, while growth in consumer spending was only half what it had been the 

previous year. Weakening in these “twin pillars” of U.S. 

economic activity slowed the growth rate of the economy to a low 1.1 percent in fourth quarter 2000 before 

rebounding slightly to 1.3 percent in first quarter 2001. 

Despite the negative economic news, it is by no means 

clear that the economy will slip into recession. 

Monetary and fiscal policies appear to be aimed at stimulating economic activity. Between January and midMay 2001, the Federal Reserve reduced the federal 

funds target rate five times by a total of 250 basis 

points. Current budget proposals under consideration 

by Congress call for tax cuts in excess of $1 trillion over 

the next ten years. Moreover, despite earnings difficulties in the corporate sector, the consumer sector appears 

to be in better financial shape—at least for the present. 

Unemployment continues to be low (4.5 percent as of 

April 2001), while declining interest rates have contributed to a strong housing market and a renewed wave 

of mortgage refinancing. 

The trend in productivity growth is also unclear. Output 

per hour at nonfarm businesses rose by a strong 4.3 

percent in 2000 and at an annualized rate of 2.0 percent 

in fourth quarter 2000. But productivity essentially 

16 Burton, p. 14.
 

17 Board of Governors of the Federal Reserve System, “Monetary
 

Policy Report to Congress,” February 13, 2001, p. 10.
 

CHART 5 

Corporate Layoff Announcements Rose 

Abruptly Beginning in December 2000 

Source: Challenger, Gray, and Christmas (Haver Analytics) 

Total Corporate Job Cuts 

Announced in Month 

0 

20,000 

40,000 

60,000 

80,000 

100,000 

120,000 

140,000 

160,000 

180,000 

1999 2000 2001 

stood still in first quarter 2001, raising the question of 

whether the high levels of productivity growth that 

have been associated with the New Economy will persist. Strong productivity gains in recent years can be 

attributed, at least in part, to investment in new technologies and efficiencies generated in corporate 

restructuring. It would follow that maintaining productivity growth at or near these levels in the future will 

require a recovery in corporate investment in new technologies and continued access to sufficient financial 

capital to carry out corporate mergers and acquisitions. 

Therefore, it appears that a prompt recovery in financial market performance and economic activity will be 

essential to maintain the productivity growth that has 

been a hallmark of the New Economy. 

Three Factors Will Shape the Economic Outlook 

In this time of economic uncertainty, three factors will 

largely determine whether the United States will fall 

into a recession and how long such a slump could last. 

Consumer and Business Confidence 

The degree of optimism on the part of consumers and 

business managers is an intangible factor that is difficult to predict—or even explain after the fact— but is 

nonetheless crucial to the economic outlook. Although 

the index of consumer confidence declined from a 

cyclical high of 143 in September 2000 to a low of 109 

in April 2001, consumer spending has continued to 

increase.18 Retail sales increased 2.1 percent in the first 

18 The Conference Board, www.conference-board.org. 

Regional Outlook 9 Second Quarter 2001 
In Focus This Quarter
 

quarter of 2001 from year-ago levels. Concern exists, 

however, that high levels of consumer indebtedness and 

a negative household savings rate could result in consumers reducing their spending significantly if the economy enters a recession. Part of this concern centers on 

the so-called wealth effect, whereby consumers are 

thought to increase their spending in proportion to stock 

market gains when equity prices are booming. The corollary is that consumers may reduce their expenditures and 

increase their savings if equity market losses persist. 

The confidence of business managers is also tied to 

events in the capital markets, which to a large extent 

determine the cost of capital. Willingness to invest in new 

equipment is tied not only to the cost of capital but also 

to expectations for future earnings. Investment spending 

fell in the fourth quarter of 2000 as profit expectations 

plummeted (see “Corporate Profits,” below). Business 

investment likely will begin growing again at the doubledigit rates of recent years only after managers see a sufficient decline in the cost of capital and a corresponding 

increase in profits to justify additional spending on 

equipment and software. 

Availability of Capital 

One of the keys to the New Economy has been an 

increasing reliance on market-based sources of financing. In 1997, for the first time, corporate sector borrowing from market-based sources surpassed its borrowing 

from traditional financial institutions.19 Continual 

access to the capital markets has been an integral part of 

many New Economy business plans. Equity initial public offerings (IPOs) on the New York Stock Exchange 

and the NASDAQ totaled 445 in 1999 and 408 in 

2000.20 However, only 17 new companies issued shares 

on the two major exchanges during first quarter 2001. 

A resumption of capital market funding from these 

depressed levels appears necessary for a continuation 

of the New Economy and its high levels of new business 

formation and productivity growth. 

Banks and other traditional intermediaries have proved 

to be more reliable sources of business finance than the 

capital markets in recent years. Holdings of C&I and 

CRE loans by FDIC-insured institutions rose 9.4 percent in 2000, following increases of 11.5 percent in 

19 See Sweeney et al.
 

20 See “Gap Between NYSE and NASDAQ IPOs Gets Smaller,”
 

The Investment Dealers’ Digest, April 9, 2001, and “A Quarter to
 

Forget for Initial Offerings,” EBN, April 9, 2001.
 

1998 and 9.8 percent in 1999. Underwriting surveys 

conducted by the federal banking agencies show that 

banks recently have tightened pricing and terms on 

commercial loans as evidence of corporate weakness 

and slowing economic activity has emerged. However, 

there is little evidence to suggest a significant reduction 

in the availability of bank credit for businesses, particularly in comparison with the recent volatility in the capital markets. Indeed, compared with the condition of the 

banking industry heading into the last recession, today’s 

banking industry is composed of far fewer institutions 

with impaired capital positions and troubled loan portfolios—two factors that can interfere with the ability of 

insured institutions to make loans to creditworthy borrowers. On the whole, the current strong financial condition of the banking industry, and its ability to make 

loans to creditworthy borrowers, appears to be one of the 

brighter spots in the near-term economic outlook. 

Corporate Profits 

Prospects for a rapid and sustained economic recovery 

likely depend on the health of the corporate sector. One 

of the most important and most tangible determinants of 

the near-term economic outlook will be the corporate 

profit equation. 

Recently, the news has been mostly negative. Equity 

analysts repeatedly have cut their 2001 estimates for 

earnings growth by S&P 500 companies, to the point 

that earnings for the year may not grow at all. 

Companies in a wide range of sectors have been hit by 

higher energy, labor, and debt service costs at a time 

when a slowing economy has reduced sales growth. 

Some of the stress in the corporate sector is evidenced 

by rising corporate bond defaults and increasing losses 

on C&I loan portfolios. For example, net charge-offs of 

C&I loans by FDIC-insured institutions rose to more 

than $8 billion in 2000 from less than $5.5 billion in 

1999. On the basis of the slowdown in economic activity in late 2000, commercial loan performance could 

deteriorate further before it improves. 

Economic Scenarios and Bank Performance 

Regardless of whether the U.S. economy goes into 

recession, a transition from the rapid growth of the 

1990s to a period of slower growth will pose challenges 

to insured institutions. Some insight into insured institution performance in a slower-growing economy can 

Regional Outlook 10 Second Quarter 2001 
In Focus This Quarter
 

be gained from an analysis of historical relationships 

in past business cycles.21 Our analysis emphasizes the 

relationships of the major components of banking 

industry profitability to aggregate economic factors, 

acknowledging that these relationships can differ for 

individual banks. Although history need not repeat 

itself, the relationships discussed below have been 

evident in many U.S. business cycles since 1960. 

In recognition of the current uncertainty in the economic outlook, a consensus among business and financial 

analysts has developed since late 2000 outlining three 

possible directions an economic slowdown might take. 

These scenarios have been labeled in the business press 

as the V, U, and L scenarios because of the shape each 

suggests for the depth and duration of the slowdown and 

the rate of recovery in overall economic activity.22 

The V, U, and L scenarios are described in the inset box. 

Chart 6 (next page) characterizes, from a historical perspective, the V and U scenarios that have characterized 

U.S. business cycle downturns since 1960. The chart 

shows that gross domestic product (GDP) growth typically accelerates four quarters before the beginning of a 

recession (period 0) and reaches a negative value 

(a decline in GDP) about three quarters after the beginning of the recession. The U scenario characterizes the 

1990 to 1991 recession and differs from the typical post1960 recessions in that GDP growth did not accelerate 

just before the recession and recovered at a much slower 

pace after the trough of the recession. For example, GDP 

growth did not reach 3 percent (near the long-run potential growth rate of 3.3 percent) until seven quarters after 

the start of the recession. 

Net Interest Margin and the Term Structure 

of Interest Rates 

A steeper yield curve generally results in improvements 

in banks’ NIMs. A consistent, positive relationship 

between banks’ NIMs and the yield spread between 

21 Economic factors such as the growth of aggregate demand, gross 

domestic product (GDP) growth, equity market performance, and 

interest rate levels and term structures are expected to be related to 

banking industry performance. 

22 Another way to view the degree of uncertainty is to recall that, as 

late as November 2000, most analysts were discussing the timing of 

the “soft landing,” interpreted as GDP growth slowing to a sustainable rate of 3 percent. By mid- to late-December 2000, analysts had 

shifted to the V, U, or L scenario characterization of the slowdown, 

with the V-shape being most prominent. By late March 2001, the 

U-shaped scenario had gained more support as the accepted way to 

view the current slowdown in economic activity. 

Three Adverse Scenarios 

V Scenario 

•	 Economy rebounds quickly after a period of slower 

growth that may or may not lead to a brief recession 

•	 Unemployment rate rises slightly, but the labor 

market remains solid, boosting consumer spending 

•	 Fed interest rate cuts spur housing activity, capital 

investment, and equity market values 

•	 Consumer wealth rises and consumer confidence 

rebounds 

•	 Renewed flow of funds into equity markets occurs 

•	 Slowdown and recovery take one year or less, 

following the average V-shaped scenario since 1960 

U Scenario 

•	 Economic growth remains below potential for 

several quarters, with the likelihood of recession 

increasing 

•	 Unemployment rate rises, resulting in a further 

decline in consumer confidence and lower consumer spending 

•	 The Fed aggressively lowers interest rates, which 

spurs spending on housing, consumer durable 

goods, and capital investment 

•	 Equity markets recover after a period of belowaverage returns 

•	 Slowdown and recovery takes one to two years 

L Scenario 

•	 After dipping into recession for several quarters, 

economic growth remains well below potential for 

an extended period 

•	 Consumer confidence remains at depressed levels, 

leading to a drop in housing activity and greatly 

reduced spending on consumer durable goods 

•	 Faced with falling profits, firms engage in widespread job cuts that push up the unemployment rate 

•	 A protracted period of stagnation in equity markets 

occurs 

•	 Fed aggressively lowers interest rates; however, businesses and consumers remain reluctant to borrow 

•	 Slowdown and recovery take longer than two years 

Regional Outlook	 11 Second Quarter 2001 
0 

In Focus This Quarter
 

CHART 6 

GDP Growth Exhibits Different Patterns 

Depending on the Type of Recession 

Year-over-Year Percent Change in Gross Domestic Product 

8 

6 

4
 

2
 

All Other Recessions* 

V-Shaped Recessions 

1990–91 Recession 

U–Shaped Recession 

–2 

–8 –7 –6 –5 –4 –3 –2 –1 0 1 2 3 4 5 6 7 8 

quarters before (–) or after (+) start of recession 

*Line represents the average value associated with four recessions between 

1960 and 1982, treating the twin recessions of the early 1980s as one. 

Source: Bureau of Economic Analysis (Haver Analytics) 

short-term and long-term interest rates has been well 

established for some time.23 As shown in Chart 7, an 

increase in the yield spread is associated with an 

increase in the NIM after one or two quarters. Since the 

early 1990s, moreover, the lag in this relationship has 

shortened. 

Over the past 25 years, an inversion of the yield curve 

(a negative spread) has led most recessions by several 

quarters, although inverted yield curves have not always 

been followed by a recession.24 An inverted yield curve 

suggests that banks are paying higher rates to borrow 

short term and earning lower rates of return on longterm investments. The yield curve became inverted in 

the final two quarters of 2000, and, as anticipated, net 

interest income declined (see Chart 7). The Fed’s 

aggressive easing of the federal funds rate during the 

first quarter of 2001 has already reversed the negative 

spread in the yield curve that was in place at the beginning of the year. 

Chart 8 indicates a tendency for the yield curve to 

become steeper as economic downturns run their 

course. Other things constant, this steepening would 

serve to buffer the NIM, offsetting the effects of declining credit quality as the recession progresses. Under a V 

scenario, the yield curve would be expected to invert 

before the recession and become positive within 12 

months (see Chart 8). 

23 Gerald A. Hanweck and Thomas E. Kilcollin, “Bank Profitability
 

and Interest Rate Risk,” Journal of Economics and Business, Spring
 

1982, Volume 36, Number 1, p. 77.
 

24 Christopher J. Neely, “What Is the Slope of the Yield Curve Telling
 

Us?” Monetary Trends, Federal Reserve Bank of St. Louis, MO,
 

August 2000, p. 1.
 

CHART 7 

The Correlation between Changes in Net Interest 

Margin and the Yield Spread Has Increased 

(Year-over-Year Absolute Change) 

Spread Between 7-Year Treasury Bonds 

Net Interest Margin and 3-Month T-bills (in Basis Points) 

0.50 500 

0.30 300 

0.10 100 

–0.10 –100 

–0.30 –300 Correlation Correlation
 

Coefficient = –0.27
 Coefficient = 0.80 –0.50 –500 

1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 

’85 ’86 ’88 ’89 ’91 ’92 ’94 ’95 ’97 ’98 ’00 

Source: Bank and Thrift Call Reports (FDIC Research Information System) 

Noninterest Income and Stock Prices 

Noninterest income has become an increasingly important source of revenue for banks and thrifts. As a proportion of earning assets, this source of income has 

grown steadily since the mid-1980s, and its growth has 

accelerated since 1992.25 Furthermore, since 1992 this 

income source has become more market sensitive, particularly for large banks, and has shown a positive relationship with the rate of change in the S&P 500 stock 

index (see Chart 9). Changes in this index (year-overyear) have preceded changes in the noninterest income 

ratio by one or two quarters, and since 1992, this time 

lag has shortened. For example, the stock market 

declines of the latter half of 2000 were accompanied by 

CHART 8 

Spread between the Yield on 10-Year Treasury Bonds 

and Yield and the Federal Funds Rate (%) 

*Line represents the average value associated with four recessions between 

1960 and 1982, treating the twin recessions of the early 1980s as one. 

Source: Bureau of Economic Analysis (Haver Analytics) 

The Yield Curve Exhibits Different Patterns 

Depending on the Type of Recession 

months before (–) or after (+) start of recession 

–5.0 

–3.0 

–1.0 

1.0 

3.0 

5.0 

–12 –9 –6 0 3 6 12 15 18 24 

1990–91 Recession 

U-Shaped Recession 

All Other Recessions* 

V-Shaped Recessions 

–3 9 21 

25 Bank call report data. 

Regional Outlook 12 Second Quarter 2001 
In Focus This Quarter
 

CHART 9 

Noninterest Income Has Become Much More 

Sensitive to the Market in Recent Years 

Year-over-Year Absolute 

Difference in Noninterest Income to Year-over-Year Change in Average Earning Assets (%) the S&P 500 Index (%) 

Correlation Correlation 

Coefficient = 0.207 Coefficient = 0.549 

0.50 50

0.30 30 

0.10 10

–0.10 –10 

–0.30 –30

–0.50 –50 

1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 

’85 ’86 ’88 ’89 ’91 ’92 ’94 ’95 ’97 ’98 ’00 

Source: Bank and Thrift Call Reports (FDIC Research Information System) 

a decline in the ratio of noninterest income to earning 

assets reported over the same period. 

The rate of change of the S&P 500 index has shown a 

consistent relationship with the business cycle over the 

past 40 years (see Chart 10). Declines in the S&P 500 

returns have preceded recessions by 12 months and 

have recovered to positive returns within at least 12 

months after the start of the recession. Through 

March 27, 2001, the S&P 500 index had dropped 

20 percent from its high in September 2000; this decline 

is considerably greater than during past recessions 

(see Chart 10). Regardless of whether the economy 

enters recession, if the correlation between stock prices 

and noninterest income is maintained, as suggested in 

Chart 9, the effect could be a decline in noninterest 

income, with the duration and magnitude depending on 

the length of the economic slowdown. 

CHART 10 

Equity Prices Historically Have Tended
 

to Begin Recovery within a Year
 

of the Onset of a Recession
 

Year-over-Year Percent Change in the S&P 500 Index 

40 

30 

20 

10 

0 

–10 

–20 

1990–91 Recession 

U–Shaped 

Recession 

All Other 

Recessions* 

V-Shaped

Recessions 

–12 –9 –6 –3 0 3 6 9 12 15 18 21 24 

months before (–) or after (+) start of recession 

*Includes three recessions between 1960 and 1980. Excludes the double-dip 

recession of the early 1980s. 

Source: Interactive Data Corporation 

Noninterest Expense 

Wages, salaries, and other operating expenses drive 

changes in bank noninterest expenses. The ratio of these 

expenses to earning assets has remained practically constant since 1992. Historically, the ratio of noninterest 

expense to earning assets shows no discernible cyclical 

relationship, possibly because of offsetting factors making up noninterest expense. For example, wages and 

salaries for some banking functions tend to slow during 

a recession, whereas expenses for loan workouts and 

related costs rise. 

Loan Losses 

Over a number of business cycles, bank loans have 

tended to be procyclical, with total loan growth falling 

for three quarters before a recession, continuing to 

decline through the recession, and beginning to rise four 

to five quarters after the beginning of the recession 

(see Chart 11). During the 1990 to 1991 recession, 

which exhibited characteristics of a U-shaped scenario, 

loan growth was negative for five quarters and returned 

to increasing, positive growth some eight quarters after 

the recession had begun. These patterns are similar for 

growth in mortgage, CRE, consumer, and C&I loans. 

This cyclical pattern suggests that the rapid loan growth 

during the upswing of the business cycle may be associated with loans whose credit quality will become 

weaker in the event of an economic slowdown. Recent 

loans, however, typically will not be the ones that initially become nonperforming. Consequently, growth in 

nonperforming loans, loan loss provisions, and loan 

charge-offs would be expected to lag total loan growth 

and the GDP growth cycle. 

CHART 11 

Loan Growth Has Tended to Be Procyclical

 in Past Business Cycles 

Year-over-Year Percent Change in 

Inflation-Adjusted Total Loan Growth 

16 

12 

8 

4 

0 

–4 

1990–91 Recess

All Other Re

V-Shaped Recessions 

ion 

cessions* 

U–Shaped Recession 

–8 –7 –6 –5 –4 –3 –2 –1 0 1 2 3 4 5 6 7 8 

quarters before (–) or after (+) start of recession 

*Line represents the average value associated with four recessions between 

1960 and 1982, treating the twin recessions of the early 1980s as one. 

Source: Federal Reserve Board of Governors Flow of Funds (Haver Analytics) 

Regional Outlook 13 Second Quarter 2001 
In Focus This Quarter
 

During the 1990 to 1991 recession, loan loss provisions 

began to rise six quarters before the beginning of the 

recession. As loan growth slowed dramatically, loan loss 

provisions increased, peaking about five quarters after 

the recession had begun as loan growth was nearing 

its trough (see Chart 12). In many ways, however, the 

1990 to 1991 recession was unique. Coming into that 

recession, commercial real estate was experiencing an 

unrelated downturn, causing loan loss provisions to rise. 

Loan loss provisions may behave differently during 

other business cycles. 

Summary of the Scenario Analysis 

At this point we can summarize our general observations 

about how banks in the aggregate might be expected to 

perform in a slower-growing economy. Noninterest 

income and loan loss provisions would typically worsen 

in the early part of an economic slowdown. At some 

point, the return to an upward sloping yield curve and 

a stock market rebound would boost the NIM and noninterest income, respectively. This boost could occur 

even as loan loss provisions, a more lagging indicator, 

continue to rise. 

These observations are distilled from the experience of 

the past. However, at least two caveats are needed. 

Typically, each business cycle has its own unique features; the present economic slowdown need not follow 

the course of any previous economic downturn. Even 

more important, the results of the scenario analysis 

CHART 12 

–8 –4 0 4

1990–91 Recession 

U-Shaped Recession 

Provisions for Loan and Lease Losses Have 

Tended to Be Inversely Related to Loan Growth 

Sources: Bank and Thrift Call Reports (FDIC Research Information System); 

Federal Reserve Board of Governors Flow of Funds (Haver Analytics) 

quarters before (–) or after (+) start of recession 

Loan Loss Provisions 

to Earning Assets (%) 

Year-over-Year Percent Change in 

Inflation-Adjusted Total Loans 

–0.3 

0.0 

0.3 

0.6 

0.9 

1.2 

–3.0 

0.0 

3.0 

6.0 

9.0 

12.0 

8 

applies to banks in the aggregate, whereas the outcome 

for an individual bank depends on the risks that bank 

assumes and the way it manages those risks. 

Richard A. Brown, Chief, 

Economic and Market Trends Section 

Alan Deaton, Financial Economist 

Gerald Hanweck, Visiting Scholar 

Kim Lowry, Writer/Editor 

Norman Williams, Regional Economist 

The authors would like to thank Paul Bishop and Lisa 

Ryu for their contributions to the analysis of economic 

scenarios in this article. 

Regional Outlook 14 Second Quarter 2001 
Regional Perspectives
 

Atlanta Regional Perspectives
 

Slowing Economy Poses Challenge 

for Region’s Insured Institutions 

Insured institutions may be facing the most challenging 

economic environment in nearly a decade (see this quarter’s In Focus article). Economic growth in the Atlanta 

Region has moderated, but not to the same degree as 

growth in the nation. By early 2001, the Region’s employment growth had slowed to 2.3 percent, down from nearly 3 percent during the first half of 2000. In all states in 

the Region except Florida, job growth rates have declined 

in recent quarters. Despite the slowing, labor markets in 

the Region generally remain historically tight. However, 

the downward trend in unemployment rates may have 

reached its nadir and, particularly in the case of North 

Carolina, jobless rates saw a significant increase in late 

2000. Layoffs, which until recently have been limited primarily to the manufacturing and high-tech sectors, could 

spill over into the rest of the economy. The cumulative 

effect of layoffs across several industries could derail certain areas’ economic growth, particularly in rural portions 

of the Atlanta Region. The magnitude of the Region’s 

slowdown, however, will depend heavily on the depth and 

duration of any slowing in the national economy. 

The slowing economy could pose revenue challenges for 

many insured institutions in the Atlanta Region. Reduced 

demand for credit and tightening underwriting standards 

likely will lead to slower loan growth. Moreover, net interest income could decrease because of the downward shift 

in the yield curve over the past year. Adjustable-rate loan 

products, for the most part, reprice immediately, and lower 

mortgage rates are swelling the refinancing of fixed-rate 

mortgages. For many commercial banks, the benefit of 

lower liability costs may take some time to materialize 

because of the repricing lags of maturity deposits and 

minimal room to lower nonmaturity deposit pricing. 

Additional profit pressures could result from lower levels 

of fee income, particularly fee sources that are market sensitive. The slowing economy also could lead to higher 

credit costs resulting from loan loss provisioning and 

higher overhead charges to collect nonperforming assets. 

Community Banks in Highly Competitive Urban 

Markets Are More Vulnerable to Slowdown 

Although the slowing economy may affect the entire 

Atlanta Region adversely, community banks operating 

in areas where there is a confluence 

metropolitan area. 

of several risk factors could be more 

vulnerable. These risk factors include 

high growth, strong competition, 

aggressive lending practices, and relatively high 

rates of bank formation. 

Although perhaps characteristic of several metropolitan 

areas in the Atlanta Region, 

these attributes may be most 

apparent in the Atlanta 

Market Growth and Bank Formation 

The Atlanta metropolitan area experienced significant 

market growth in the 1990s. Between 1990 and 2000, its 

population increased nearly 40 percent, adding more 

than 1.1 million new residents. The 3.3 percent compound annual rate of increase was more than double the 

national average. A rapid population increase may 

encourage new bank formation (for greater detail, see 

“De Novo Banking in the Atlanta Region,” Atlanta 

Regional Outlook, first quarter 2000). In fact, the 

Atlanta metropolitan area has led the Region in the 

number of new bank charters since the end of the 1990 

to 1991 recession. 

Real Estate Development and Lending 

In response to the rapid population growth of the past 

several years, Atlanta has experienced high levels of 

both commercial and residential construction activity. 

According to F.W. Dodge, the pace of Atlanta’s commercial construction starts during the first three quarters of 

2000 was nearly equal to the sum of the next five largest 

markets in the Atlanta Region.1 Similarly, residential 

permitting in Atlanta during 2000 was greater than the 

combined totals of the next two largest markets, Orlando 

and Charlotte. Unexpected declines in absorption rates 

associated with the recent weakening in economic 

growth may affect the future performance of current real 

estate development, however. The downsizing in the 

high-tech and dot-com industries may prompt existing 

leased commercial space to return to the market. Areas 

such as Atlanta, Raleigh, northern Virginia, Charlotte, 

and Huntsville may be especially vulnerable. Greater 

1 In descending order: Charlotte, Orlando, Ft. Lauderdale, West Palm 

Beach, and Tampa. 

Regional Outlook 15 Second Quarter 2001 
Regional Perspectives
 

difficulty in marketing new space and rising building 

costs (associated with higher energy prices) may be 

prompting developers to tap existing lines of credit. 

Community banks, many of which are non-recessiontested, have been very active in supporting a metropolitan area’s real estate development and could experience 

weakening asset quality in a slower growth market. 

At 15.5 percent, construction and development 

(C&D) lending as a share of assets among Atlanta’s 

community banks was nearly three times the U.S. 

metro average during fourth quarter 2000. This exposure is the highest in the nation and could pose significant credit risk if growth slows. Nearly one-third 

of community banks (39 institutions) in the Atlanta 

metropolitan area report a C&D exposure exceeding 

15 percent. In contrast, before the 1990 to 1991 recession, the number of community banks in Atlanta with 

this exposure peaked at 20 in 1988. Moreover, the 

aggregate C&D exposure at year-end 2000 was 25.9 

percent, in contrast to the previous peak of 21.1 percent 

in 1990 (see Chart 1). Given the high and rising C&D 

exposure, Atlanta may be more vulnerable than several 

other metropolitan markets in the Region to the effects 

of a slowdown in the local real estate market.2 Macon, 

Raleigh, Naples, and Savannah also have exposures 

that exceed the national metropolitan average. 

Competition 

Internet banking, alternative forms of saving and financing, bank acquisition activity, and the surge in new bank 

openings in recent years have altered the banking landscape in many urban areas. Competition has become 

increasingly fierce on both sides of the balance sheet. 

One indicator of the increasing level of competition in 

recent years is the rise in banks’ cost of funds in several 

urban areas, such as West Palm Beach, Macon, Miami, 

and Atlanta. Slowing economic growth may prompt 

some lending institutions to relax underwriting standards to meet growth goals and capture market share. 

It May Not Be Only Atlanta 

Other metropolitan areas in the Region are also exposed 

in varying degrees to each of these potential vulnerabilities. Among them, Charlotte, Greenville, Orlando, and 

2 The fact that C&D exposure can have a significant impact on bank 

performance during an economic downturn is made apparent by 

tracking the performance of banks at year-end 1988 with a C&D 

exposure in excess of 15 percent through the mid-1990s. Each of 

these institutions experienced a downgrade in its Uniform Bank 

Performance rating to a 3, 4, or 5 during that time. The number of 

banks with ratings of 3, 4, or 5 peaked in 1991 during the recession. 

CHART 1 

1

Community banks have assets less than $1 billion. 

2

Large concentrations are more than 15 percent of assets. 

Source: Bank Call Reports, data through December 31, 2000 

The Number of Community Banks1 

with Large Construction & Development 

Loan Concentrations2

 in Metropolitan 

Atlanta Is Increasing 

Ratio of C&D Loans to Assets Number of Banks 

0 

15 

30 

45 

0 

5 

10 

15 

20 

25 

30 

’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 

Greensboro rank relatively high in terms of cost of 

funds growth, C&D exposure, non-recession-tested 

banks, and market growth. Other areas, such as Macon, 

Richmond, Norfolk, and Naples, also exhibit some of 

these higher-risk factors. 

Rural Areas Exhibit Unique Concerns 

Rural areas in the Atlanta Region continue to face challenges in key components of the local economy: agriculture and manufacturing. The recent slowing in economic 

growth may further strain these economies and, consequently, the local banking industry. 

Farming 

A prolonged drought, structural changes in the tobacco 

industry, and continued low commodity prices have 

affected farmers’ cash flow adversely in the Atlanta 

Region. Higher energy and fertilizer costs add further 

pressures. Farmers’ ability to meet financial obligations will depend on continued government support. 

Moreover, farm land values must remain near current 

price levels in order to provide collateral protection for 

lenders. Residential and commercial development 

spreading outward from urban areas has helped to support farm land values. However, this support could 

weaken if economic growth continues to slow in urban 

areas. Anecdotal evidence suggests that farm land values 

not near urban centers have been supported by the purchase of “recreational” farms financed by accumulated 

gains in stock market wealth. Given the recent equity 

market declines, demand for land may decline. Also, 

should economic growth continue to slow, farmers may 

be faced with declining levels of off-farm income. 

Regional Outlook 16 Second Quarter 2001 
Regional Perspectives
 

Financial hardship among Atlanta Region farmers could 

affect rural banks’ asset quality adversely. In fourth 

quarter 2000 the Region was home to 31 agricultural 

banks with assets totaling $2.2 billion. Low commodity 

prices, drought, and higher input costs are most evident 

in Georgia, home of two-thirds of the Region’s farm 

banks. In fourth quarter 2000, the percentage of farm 

loans in the Region’s farm banks that were noncurrent 

or charged off exceeded the national averages by 53 and 

12 basis points, respectively. Farming remains a critical 

component of the economy in many rural areas. 

Therefore, other nonagricultural assets held by rural 

community banks also may be vulnerable if agricultural 

sector weakness filters through the rest of the local 

economy. 

The Lumber Industry 

Economic conditions in the Region’s softwood lumber 

industry have deteriorated recently and may affect many 

rural area economies adversely (see Atlanta Regional 

Outlook, third quarter 1998, for greater detail about this 

industry). The building boom of the mid- to late 1990s 

fueled demand for wood products and resulted in 

increases in lumber prices. In response, the Atlanta 

Region’s lumber industry expanded rapidly. After building peaked in many areas during 1999, loggers and 

sawmills continued producing at high levels to generate 

revenue to service debt incurred by the recent expansion. As a result of excess supply and declining demand, 

prices in the industry have declined significantly in 

recent months. In February 2001, the producer price 

index for softwood lumber was more than 15 percent 

below year-ago levels. As markets have weakened, some 

reports have emerged about credit-quality problems in 

the industry. 

Foreign competition could stress the softwood lumber 

industry further. On March 31, 2001, the Softwood 

Lumber Agreement with Canada expired, prompting concern that imports to U.S. markets will increase significantly. The agreement set a quota on softwood imports 

from Canada, which currently account for one-third of 

the U.S. market. The increase in imports coupled with 

potential further slowing in the U.S. economy and higher 

energy costs could have a negative effect on the already 

troubled lumber industry (which employs nearly 150,000 

in the Atlanta Region), surrounding communities, and, 

ultimately, credit quality in the local economies. 

Other Manufacturing 

Textiles and apparel are large manufacturing employers 

in rural areas of the Atlanta Region (for a more detailed 

discussion of the industry, see Atlanta Regional Outlook, 

second quarter 1998). Slowing economic growth could 

further weaken conditions in these industries; the most 

vulnerable is the carpet and rugs subsector, which has 

experienced substantial growth thanks to the nation’s 

construction boom during the 1990s. 

Atlanta Region Staff 

Regional Outlook 17 Second Quarter 2001 
Regional Perspectives
 

Boston Regional Perspectives
 

The Region’s Economic Expansion 

Continued through Early 2001... 

In 2000, nonfarm payrolls in the Region rose at a somewhat faster pace than in the nation. This gap widened 

during the early months of 2001 because of a continued 

deceleration in annualized U.S. job growth. The 

Region’s rate of decline in factory sector payrolls also 

eased through the 15 months ending March 2001. In 

contrast to the strength in employment, the Region’s 

housing market showed some signs of cooling during 

2000. Permit issuance in 2000 was down 7 percent from 

the prior year, versus a 4 percent drop nationwide, but 

it did rebound in the first quarter of 2001. Also, existing 

home sales in the Region slowed slightly in 2000 

following peak volume in 1999. Despite the slight 

decline in sales, home prices throughout the Region 

continued to rise, suggesting that limited inventory 

(rather than weakened demand) was responsible for the 

reduction in home sales volume. 

...but Its Economic Fate Remains 

Tied to the Nation’s 

The national economic slowdown likely poses the most 

significant risk to the Region’s economy at this time. 

The current absence of widespread economic imbalances in the Region’s economy suggests that the health 

of the national economy will be the most important 

determinant of the Region’s near-term economic performance. Slower growth in the national economy has 

resulted from protracted weakness in the manufacturing 

sector and a more recent, abrupt deceleration in information technology investment and consumer spending 

growth. The Region is just beginning to see the effects 

of the slowing national economy. For instance, after an 

initial lag, the Region’s unemployment claims are now 

rising, in line with the national trend. 

Office Markets around Boston 

Evidenced Some Cooling 

Office real estate conditions eased in the Boston Region 

during first quarter 2001. Office vacancy rates in Boston 

and Cambridge increased slightly from record lows as 

blocks of sublease space were returned to the market 

because of a slowdown in the information technology 

sector. In downtown Boston, 

about 1.1 million square feet 

(about 3 percent of multitenant inventory) were on the 

market to be sublet in first 

quarter 2001, more than three 

quarters of the total amount 

absorbed in 2000. Average rents 

have leveled off between $50 and 

$65 per square foot for Class A 

space, following steady increases through 2000. Asking 

rents on select Class A properties, which commanded 

upwards of $85 per square foot in fourth quarter 2000, 

dropped to roughly $65 to $70 per square foot during 

first quarter 2001. Boston-area industrial markets, 

particularly in the suburbs, continue to exhibit lower 

vacancy rates. Hotel space remains in short supply 

around greater Boston, but demand appears to be softening with the national economy. 

Construction lending in the Region increased during 

the latter half of the current expansion along with commercial real estate market activity and demand for 

space. Aggregate construction and development 

(C&D) loan growth has averaged 20 percent over the 

past three years. However, while C&D lending has 

increased in the nation and the Region, as business 

conditions begin to slow, concentration levels of construction to Tier 1 capital remain low compared with 

the late 1980s (see Chart 1). 

CHART 1 

Note: C&D = construction and development 

Source: Bank and Thrift Call Reports, merger adjusted 

While Construction Lending Rebounds in the 

Region, Concentration Levels Remain Low 

$ billions

Percentage of Tier 1 capital 

$0 

$5 

$10 

$15 

$20 

$25 

0 

20 

40 

60 

80 

100 

120 

140 

1984 1988 1992 1996 2000 

C&D loans 

Concentration 

to Tier 1 

Regional Outlook 18 Second Quarter 2001 
Regional Perspectives
 

The Region’s Banks Are Well Positioned 

to Weather an Economic Slowdown... 

The Region’s insured institutions are facing an uncertain economic environment from a position of relative 

strength. A prolonged period of economic growth has 

contributed to their favorable condition. In addition, the 

positive effects of consolidation, deregulation, technological advances, and market forces should not be 

understated. The combined effect of these factors has 

resulted in the historically high capital and earnings 

levels of the Region’s banks and thrifts. 

Asset quality remains a major driving force behind 

earnings as net charge-off and delinquency ratios continue to reach new lows. In 2000, 44 percent of the 

Region’s institutions had zero or negative net chargeoffs. This was the highest percentage of institutions in 

the Boston Region without net loan losses in a calendar 

year since at least the early 1970s. Delinquencies also 

continued to decline. As a result, provision expense has 

been modest, while the low level of nonperforming 

assets has served to boost net interest income. 

...but Trends in Certain Risk Areas 

Point to Potential Longer-Term Concerns 

While most institutions continue to report strong asset 

quality, some signs of developing problems may portend a downturn in credit quality within the Region. 

Commercial loan losses, while modest, have been rising 

steadily in the Region’s largest institutions, most likely 

as a result of exposures to large, nationally syndicated 

credits that have begun to deteriorate as the economy 

slows and credit availability tightens. The credit card 

portfolios of large-scale credit card lenders also are 

exhibiting signs of weakness. These situations reflect 

the effect of aggressive competition on underwriting 

standards in these specific markets. Many analysts have 

cited the loosening of underwriting standards, particularly in 1997 and 1998, as a major contributor to the 

deterioration noted today. 

Most of the Region’s insured institutions are not participants in the nationally oriented markets cited above, 

but many have expanded commercial loan portfolios 

aggressively over the past few years. Aggregate commercial loan growth in the Region has outpaced that of 

the nation on average for the past four years. In each of 

the past six years, 40 percent or more of the Region’s 

institutions that make commercial loans had commercial loan growth in excess of 20 percent (see Chart 2). 

The growth has been particularly pronounced in the 

Region’s savings institutions; more than 50 percent of 

those involved in commercial lending expanded their 

portfolios in excess of 20 percent in each of the past 

three years. For many of these institutions, commercial 

loan concentrations relative to capital remain modest, 

but they are growing rapidly and warrant close scrutiny. 

Competition for commercial loans in the Region clearly has been fierce. Traditional commercial lenders are 

now fighting for business from new entrants into the 

market, including the Region’s savings banks, out-ofRegion banks utilizing credit scoring techniques, and 

nonbank financial companies. To the extent that the 

strong growth has been achieved, in part, by easing 

underwriting standards, problems may begin to emerge 

locally as the economy softens. This situation underscores the importance of strong credit administration 

practices to monitor and manage borrowers effectively 

in an uncertain economic environment. 

Overall, earnings remain fairly strong, particularly for 

commercial banks; however, profits in the Region’s 

savings institutions have been declining steadily over 

the past three years, primarily because of net interest 

margin compression. Commercial banks have not been 

immune to margin compression, but savings institutions have felt the compression more acutely as their 

declines have been steeper on a percentage basis, and 

they typically have a greater reliance on net interest 

income as a percentage of total operating income. 

Between 1997 and 2000, nearly half the Region’s 

insured institutions experienced a net interest margin 

decline of more than 20 basis points; more than a quarter experienced a decline of more than 40 basis points. 

CHART 2 

Source: Bank and Thrift Call Reports Percentage of All Banks 

0 

20 

40 

60 

80 

1985 1988 1994 2000 

10–20% Growth 

21–50% Growth 

> 50% Growth 

Rapid Commercial Loan Growth 

Continues in the Boston Region 

1991 1997 

Regional Outlook 19 Second Quarter 2001 
Regional Perspectives
 

The bulk of the margin erosion occurred in 1998 and 

1999 as a result of the heavy refinancing wave that 

occurred during that period, coupled with an unfavorably shaped yield curve that made it difficult to redeploy prepayments into new investments at favorable 

spreads. Additionally, because the yield curve was low 

and flat, customers preferred fixed-rate loans, and 

many institutions opted to hold onto these loans to prop 

up eroding margins. The asset extension has not been 

countered by a lengthening of liabilities, as the flat 

yield curve has offered little incentive for depositors to 

go long. As a result, the duration of assets expanded 

considerably and was not offset on the liability side of 

the balance sheet; the effect was to heighten exposure 

to rising interest rates for many institutions in the 

Region. The lengthening of assets was evident in both 

commercial and savings institutions (see Chart 3). 

The higher interest rates that prevailed throughout 2000 

significantly dampened prepayments and increased 

the demand for variable-rate loans. However, the imbalances that developed between 1997 and 1999 will take 

several years to correct unless actively managed, and 

only a slight improvement was noted in 2000. Institutions are now facing a renewed wave of refinancing as 

interest rates have fallen considerably in the first quarter. 

The average Mortgage Bankers Association refinancing index during the first quarter of 2001 was the highest on record. Further rate declines, should the economy 

continue to soften, may result in another prolonged refinancing wave, leading to further extension of asset 

maturities and continued margin erosion. 

CHART 3 

Lower Interest Rates May Lead to Higher 

Concentrations in Long-term Assets 

Percentage of Banks with Long-term

Assets/Earning Assets >40% 

Source: Bank and Thrift Call Reports 

0 

10 

20 

30 

40 

50 

60 

70 

Region:

 savings 

banks 

Nation:

 savings banks 

Nation: 

commercial banks 

Region: 

commercial 

banks 

1985 1988 1991 1994 1997 2000

Although active management of securities portfolios, 

extending liabilities via wholesale funding sources, and 

implementation of off-balance-sheet hedging strategies 

can help to mitigate the rising level of interest rate risk, 

banks in the Region have done little to counter asset 

extension. The failure to mitigate the growing imbalances that may result from the current downturn in 

interest rates may lead to undue exposure to a future rise 

in interest rates, particularly if it is accompanied by a 

steepening of the yield curve. The present low interest 

rate environment should provide sufficient opportunity 

to employ risk reduction strategies. 

Boston Region Staff 

Regional Outlook 20 Second Quarter 2001 
Regional Perspectives
 

Chicago Regional Perspectives
 

Banking and Economic Conditions Vary among 

Region’s Larger MSAs 

The Region’s economy softened in 2000, in line with 

national economic developments. A slowing economy 

poses challenges for debt service capacity of businesses 

and consumers, thereby making credit quality of banks 

and thrifts an increasing concern. Intense competition in 

recent years has heightened the risk profile of many of 

the Region’s financial institutions. Given their increased 

risk profiles, banks’ ability to weather credit quality 

deterioration is a key issue to watch. 

This article explores some characteristics of the 

Region’s major banking markets using a combination of 

TABLE 1 

banking and economic data. 

Analyzed are the Region’s 

ten metropolitan statistical 

areas (MSAs), listed in Table 1, 

that have the highest number of 

insured institutions with assets 

of $10 billion or less.1 These 

institutions represent 29 percent of 

the Region’s banks and thrifts.2 

Banking and economic data used for the analysis 

include, but are not limited to, the items in Table 1. 

Economic data include employment volatility and 

industrial diversity statistics.3 These two gauges provide 

insight into how an MSA could be affected by national 

Selected Banking and Economic Measures Show 


Variation among Region’s Larger Metropolitan Areas
 

(nonspecialty banks and thrifts with less than $10 billion in assets)
 

MSA 

CHICAGO 270 94 75 6% ▲66% ▲34% 3.74% 1.74% 147% 

CINCINNATI 62 84 71 0% ▲74% 26% ▼3.55$ 1.81% 130% 

CLEVELAND-LORAIN-ELYRIA 22 96 69 9% 79% 12% 3.58% 1.53% 140% 

COLUMBUS 22 84 71 9% 58% 20% 3.98% ▲1.29% 284% 

DETROIT 35 87 44 31% 79% 21% ▼3.36% 3.13% 73% 

GRAND RAPIDS-MUSKEGON-HOLLAND 20 82 24 20% 82% ▲51% 4.20% 1.70% 254% 

INDIANAPOLIS 24 82 75 4% 75% ▲27% 3.93% ▲2.83% 108% 

MADISON 23 18 60 0% 73% 38% ▼3.18% 0.96% 371% 

MILWAUKEE-WAUKESHA 51 82 60 8% 70% 30% 3.57% 1.96% 177% 

PEORIA-PEKIN 26 41 22 0% ▲60% 26% 3.62% ▲1.79% 245% 

CHICAGO REGION’S ALL MSAS NA NA 7% 70% 28% 4.86% 1.93% 147% 

ENTIRE NATION’S MSAS 100 100 10% 65% 32% 4.75% 1.92% 163% 

NUMBER OFINSTITUTIONS

CYCLICAL EMPLOYMENTVOLATILITY 

INDUSTRIALDIVERSITY INDEXNEW INSTITUTIONS(% OF TOTAL) 

LOAN-TO­ ASSET 

RATIO 

C&I ANDCRE LOANS 

TO 

ASSETS 

NET INTERESTMARGINPDNARATIO*

ALLLCOVERAGE OF

NONPERFORMINGLOANS** 

For banking indicators, shaded cells are the three highest values except for coverage ratios and net interest margins, 

where shading shows the three lowest. Triangles flag the three markets with largest change over two years. For 

economic gauges, shaded cells show employment volatility > 65 percent or diversity index < 50. 

PDNA = Past-due and nonaccrual. *PDNA loans as percentage of loans. **Allowance coverage of nonperforming loans. 

Note: Ratios are aggregates (weighted averages.) 

Sources: Bank and Thrift Call Reports (for December 31, 2000) and Economy.com, Inc. 

1 Institutions with assets greater than $10 billion were excluded because their operations likely span a larger area than the MSA in which they are
 

headquartered. Nevertheless, the indicators in Table 1 undoubtedly affect their risk profiles. Specialty institutions also were excluded.
 

2 Institutions located in the Cincinnati MSA but outside the Chicago Region were included in the ratio computation.
 

3 Data for this analysis are from Economy.com, Inc.
 

Regional Outlook 21 Second Quarter 2001 
Regional Perspectives
 

economic trends. For example, the employment volatility measure shows the degree to which an MSA’s 

employment growth rate varies with the national rate. 

The measure ranges from 0 to 100, with a low value 

indicating that an MSA’s employment swings are mainly independent of national developments and a high 

value indicating the opposite. The industrial diversity 

index measures the industrial diversification of the 

MSA relative to the United States. A high value indicates diversity nearly as broad as the nation’s, while a 

low value suggests that a few industries account for 

most activity in an MSA. All other things being equal, 

the higher the level of industrial diversification, the 

better positioned is an MSA to weather a national 

economic slowdown. 

A comparison of values for Indianapolis and Grand 

Rapids-Muskegon-Holland, which are shown in Table 

1, provides an example of how the gauges can be used 

to assess an MSA’s vulnerability to national economic 

trends. Although the two MSAs are equally affected by 

national employment volatility, a slump in an industry 

operating in both MSAs could have a more damaging 

effect on the Grand Rapids area than on the more diversified Indianapolis area. 

Just as employment volatility and industrial diversity 

differ among MSAs, so does banking industry performance. Banks and thrifts in some MSAs exhibit risks 

that appear relatively stable and modest, while institutions in other MSAs maintain relatively higher risk profiles and face rapidly changing competitive environments. 

Chicago and Milwaukee, two of the larger markets, 

benefit from broad economic diversity. Asset quality 

indicators at Chicago’s institutions remain generally 

favorable, although recent increases in the volume of 

traditionally higher-risk commercial forms of lending 

are among the highest in the Region. Although the pastdue and nonaccrual (PDNA) ratio for insured institutions in the Milwaukee MSA is the third highest among 

the Region’s top MSAs, it is only slightly higher than 

the national level. 

Banking industry performance appears generally favorable for each of the markets analyzed, but a national 

economic slowdown could have a pronounced impact 

on MSAs with limited industrial diversity. Profiles of 

the three MSAs with the lowest industrial diversity 

index values in Table 1 are discussed below. 

Detroit’s industrial diversity is broader than it was in 

the 1980s, although the area remains heavily dependent 

on the motor vehicle sector and associated industries. 

Union workers at assembly plants and elsewhere who 

lose their jobs because of production cutbacks often 

continue to receive some income and benefits, which 

allow them to continue spending and making debt payments. The availability of these income supports is not 

as widespread, however, among nonunionized automobile suppliers or engineering and computer service 

firms tied to the motor vehicle sector. 

The impact of an economic slowdown could be more 

significant for insured institutions in Detroit than for 

institutions in the Region’s other large MSAs because 

they already are experiencing high funding costs, loanto-asset ratios, and past-due ratios, as well as low and 

declining net interest margins. Meanwhile, aggregate 

Tier 1 capital levels and the allowance for loan and 

lease losses (ALLL) to total loans ratio have trended 

downward. A significant percentage of banks in the 

Detroit market are new. Their tendency to have higher 

levels of commercial and industrial (C&I) and commercial real estate (CRE) loans, as well as higher funding costs can be mitigated by higher capital levels. 

Institutions with C&I and CRE loans associated with 

industrial properties may face some challenges ahead. 

The MSA’s vacancy rate for industrial properties has 

climbed over the past two years to 8.5 percent in 2000, 

the highest in the 12 years for which data are available. 

Additionally, vacancy rates for suburban office space 

remain moderate at slightly more than 8 percent, and 

they have been rising since mid-1999. 

The Grand Rapids-Muskegon-Holland area stands 

out as an economic success story of the past decade, 

having benefited from a “Renaissance” development 

zone, the in-migration of people and businesses, and 

strong activity in its dominant sectors. The area’s relatively high degree of cyclical employment volatility and 

low industrial diversity (high exposure to several manufacturing industries) likely will play a significant role in 

its near-term health should recent signs of economic 

weakness intensify. The area’s auto suppliers and equipment manufacturers are relatively efficient and have a 

diversified customer base, but they could be affected 

adversely by recent vehicle production cutbacks and 

intense cost-cutting in this sector. Demand for office 

furniture, another major employment source, remained 

healthy through late 2000. Profitability pressures may 

trigger layoffs at a major office-furniture manufacturer, 

however, and the repercussions of slower growth in 

Regional Outlook 22 Second Quarter 2001 
Regional Perspectives
 

commercial construction nationally in the past year 

likely will be felt with a lag. 

Grand Rapids’ robust economy in recent years has led to 

very strong asset growth which, coupled with regional 

bank consolidation activity, has helped foster the 

entrance of new institutions into the market. The high 

percentage of new institutions has increased the level of 

competition and has contributed to significant increases 

in CRE lending associated with the MSA’s economic 

expansion. The degree of competition in this market 

is underscored by funding costs that are among the 

highest in the nation; however, net interest margins are 

relatively strong given a loan mix weighted toward commercial forms of lending. 

Peoria-Pekin’s economy and financial institutions have 

weathered various economic challenges in the past 

decade, and their experiences may leave them reasonably well positioned for the current slowdown. Peoria’s 

low cyclical employment volatility could shield it somewhat from a national slowdown, although it remains 

vulnerable to the presence of one dominant manufacturer. The MSA’s manufacturing payrolls slid by about 

1 percent over the past year, in line with the national 

pattern. The area’s unemployment rate in January and 

February 2001 averaged 5.4 percent, up from about 4.5 

percent in the same periods in 2000 and 1999, and average weekly hours worked in manufacturing have been 

falling for two years. Consequently, aggregate weekly 

earnings of factory workers in the area are shrinking. 

These trends could affect consumer credit quality and 

pressure the PDNA ratio. Mitigating this concern are 

the relatively low PDNA rate, high coverage of nonperforming loans, and a capital cushion built up at area 

institutions during the past two years. 

Although most banking risk indicators in Peoria remain 

at modest levels relative to the Region’s other large 

MSAs, the loan-to-asset and PDNA ratios are rising. 

Increases in the PDNA ratio in the past two years 

have been fairly widespread across nonresidential 

real estate, 1 to 4 family residential real estate, C&I, and 

consumer loan portfolios. Although consumer lending 

levels have been declining relative to other loan categories, they remain higher than in most other large 

MSAs. 

Chicago Region Staff and Craig Thornton, 

Acting Regional Manager 

Regional Outlook 23 Second Quarter 2001 
Regional Perspectives
 

Dallas Regional Perspectives
 

Vulnerability to a Downturn in the Real Estate 

Market Increases as Insured Institutions 

Expand Concentrations in Traditionally 

Higher-Risk Loan Categories 

Real estate overbuilding contributed greatly to the 

Region’s last banking downturn in the mid- to late 

1980s. Major metropolitan areas, in Texas especially, 

saw significant deterioration in commercial and residential real estate values in a relatively short period.1 

While few expect a downturn in the Region’s real estate 

market as serious as that of the 1980s, the experiences 

of that downturn highlight the risks associated with 

growing concentrations in traditionally higher-risk 

assets, such as commercial real estate and construction 

and development loans. 

At year-end 2000, real estate loans accounted for 56.5 

percent of the Dallas Region’s total bank and thrift loan 

portfolio, the highest level since 1988. The traditionally 

higher-risk categories of commercial real estate and 

construction and development loans have dominated 

loan growth in the Region since 1997 and, at year-end 

2000, accounted for 28.2 percent of the Region’s loans, 

compared with 17.6 percent for the rest of the nation 

(see Chart 1). 

CHART 1 

Dallas Region Expands Exposure 

in Higher-Risk Categories of Real Estate 

Note: Commercial real estate includes commercial, multifamily, and construction 

real estate. 

Source: Bank and Thrift Call Reports Commercial Real Estate as a Percentage of Total Loans

28.2% 

17.6% 

Dallas Region 

U.S. excluding 

Dallas Region 

10 

15 

20 

25 

30 

35 

40 

’80 ’82 ’84 ’86 ’88 ’90 ’92 ’94 ’96 ’98 ’00 

During the last half of the 

1990s, real estate conditions 

improved in many Dallas 

Region markets; however, 

effects of the 1980s downturn linger. According to 

F. W. Dodge (FWD), only 

the Austin and San 

Antonio metropolitan statistical areas (MSAs) currently report 

office vacancy rates lower than the 

national average. Most of the office vacancy 

rates for the Region’s MSAs covered by FWD are 

projected to improve over the next several years, based 

on current construction and absorption estimates. 

However, there are signs that the effects of the current 

economic downturn soon could be felt in the real estate 

industry. Results of a March 2001 KPMG survey found 

that 48 percent of the real estate executives polled predicted that property values will decline over the next 

12 months, and 74 percent expect rents to decline.2 

While current real estate supply and demand factors 

appear in balance in most Dallas Region MSAs, should 

economic growth resemble a U- or L-shape scenario (as 

discussed in the In Focus article Economic Conditions 

and Emerging Risks in Banking), employment growth 

could slow quickly, causing pressure on vacancy and 

rental rates for all types of real estate. This situation 

may hold true particularly for MSAs currently experiencing difficulties in high-tech industries such 

as telecommunications, semiconductors, and personal 

computers. 

Signs of a slowing economy and identified weaknesses 

in some of the Region’s important industry sectors may 

be pointing to challenges for insured institutions with 

high volumes of commercial real estate. At year-end 

1997, commercial real estate loans held by 21 percent 

of the Region’s insured institutions exceeded 200 percent of risk-based capital. By year-end 2000, 28 percent 

of the Region’s banks and thrifts were in this category. 

Growing balance sheet concentrations in this traditionally higher-risk category warrant close attention 

because they represent increasing vulnerability to a 

downturn in the real estate sector. 

1 For more information, please refer to History of the Eighties, Federal 2 Robert Julavits, “Realty Execs Say Property Values, Rents Will 

Deposit Insurance Corporation, 1997. Drop,” American Banker, March 21, 2001, p. 11. 

Regional Outlook 24 Second Quarter 2001 
Regional Perspectives
 

Rising Oil and Natural Gas Prices CHART 2

Present a Mixed Picture for the Region Oil and Gas as a Share of 

the Nation’s and Dallas Region’s Economies Oil and gas is an important industry for the Dallas Has Declined Precipitously since the Early 1980s Region. The Region produced more than 715 million 18 

barrels of crude oil in 1997 and employed 185,100 

1982 1998 

3.9% 

0.9% 

17.0% 

4.9% 

workers in the oil and gas extraction industry in 2000. 

According to the U.S. Bureau of Economic Analysis, 

the Dallas Region accounted for more than half the 

nation’s oil and gas output and the industry’s employment in 1998. The Region’s reliance on oil and gas as an 

economic driver, however, has declined dramatically 

over the past 20 years. Oil and gas output as a share of 

overall gross regional product declined from 17 percent 

Oil and Gas Share


of Real Gross Product (%)
16 

14 

12 

10 

8 

6 

4 

2 

0 in 1982 to 5 percent in 1998 (see Chart 2). The growing 

importance of other industries, such as high tech, construction, and financial services, has more than offset 

the decline of oil’s importance to the Region. 

The fallout from higher oil prices on businesses has not 

been widespread. Rather, its effects are being felt by 

significant users of petroleum products. Corporate profitability has eroded in energy-intensive industries such 

as transportation, textiles, lumber, paper, chemicals, 

rubber and plastics, and steel. Higher gasoline and heating oil prices have reduced consumers’ real income, displacing demand for other goods and services. 

Oil and natural gas prices will likely remain high 

throughout 2001 because of lean inventories, particularly of crude oil, and strong demand for natural gas. The 

greatest risk to households and businesses in the Region 

is the growing price volatility. In the event of a disruption to supplies, no matter how minor, sharp price 

spikes are likely; this likelihood has resulted in a “risk 

premium” on the current price of oil and natural gas. 

Rising oil prices played a key role in the Region’s 

booming economy during the 1970s, while declining oil 

prices contributed to its recessions in 1982 and 1986. As 

evidence of differences between the Dallas Region and 

the nation, however, energy prices were a contributing 

factor in three of the past four U.S. recessions. 

During the 1980s, the relationship between the oil and 

gas industry, the Region’s economy, and the fortunes 

of insured institutions was more direct. Today the 

Region’s economies have diversified considerably 

away from oil and gas exploration and production 

toward other key industries. Consequently, most of the 

economic effect of rising oil prices on banks in the 

Dallas Region is channeled indirectly through insured 

institutions’ local economies. 

United States Dallas Region
 

Source: U.S. Bureau of Economic Analysis
 

A Slowing U.S. Economy and New Farm 

Legislation Likely Will Affect the Region’s 

Agricultural Sector 

U.S. agriculture has struggled over the past three years 

because of depressed commodity prices, recurrent 

drought conditions in certain areas, a strong U.S. dollar, 

and lagging exports. Since 1997, the United States 

Department of Agriculture’s all-farm index of prices 

paid by producers has increased while prices received 

by producers have dropped. Consequently, Congress 

has approved historic levels of government payments 

over the past three years, doubling the Region’s receipt 

of government support. 

By 1999, 39 percent of the Dallas Region’s net farm 

income was derived from government payments, significantly less than the 50 percent average nationwide. The 

primary difference is the livestock sector, which does not 

receive government payments. Specifically, 69 percent 

of the Region’s agricultural cash receipts are derived 

from livestock products, compared with 51 percent for 

the nation. Government payments and net farm income 

for 2001 are forecast to be considerably lower than in 

2000. Fortunately, livestock prices have performed well 

during the past two years, and the importance of this 

sector somewhat insulates the Region from the effects of 

lower government payments. However, the health and 

viability of the U.S. livestock industry could be adversely affected if the current outbreak of foot-and-mouth 

disease in Europe spreads to the United States. 

While income from farming operations has suffered, the 

historic economic expansion and tightening labor markets helped create increased opportunities for nonfarm 

Regional Outlook 25 Second Quarter 2001 
Regional Perspectives
 

employment. Off-farm income in the Southern Plains 

averaged almost $80,000 per farm household at yearend 1999—an increase of 116 percent since 1991 and 

38 percent above the U.S. average (see Chart 3). 

Increased reliance on off-farm income helped mitigate 

problems that could have resulted from depressed commodity prices, weather-related losses, and sluggish 

exports. However, this new reliance highlights the 

potential weakness that producers and their lenders may 

face during an economic downturn. 

Record government payments and increasing off-farm 

income benefited the Region’s agricultural bank earnings and credit quality. The Region’s agricultural banks, 

on average, report strong performance. However, total 

loans have increased to the highest level in the past 

ten years, and bank managers are beginning to report 

credit quality deterioration, as evidenced by declining 

borrower equity, increasing carryover debt, and rising 

receivables amid slowing sales for input suppliers. 

Additionally, the ratio of loan loss reserve to total loans 

has not kept pace with loan growth and is at the lowest 

level in a decade. The combination of lower off-farm 

income as a result of slowing economic growth and 

CHART 3 

decreased farm income as a result of declining government payments could weaken many agricultural 

producers’ ability to repay existing debt and could erode 

credit quality at the Region’s agricultural banks. 

Dallas Region Staff 

Off-Farm Income in Southern Plains 

Has More than Doubled since 1991 

Note: Southern Plains includes Texas and Oklahoma. 

Source: USDA Agricultural Outlook, January–February 2001 

National 

Average 

Southern Plains Region 

$80,000

 ($000) 

$20 

$30 

$40 

$50 

$60 

$70 

$80 

$90 

$60,000 

’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 

Regional Outlook 26 Second Quarter 2001 
Regional Perspectives
 

Kansas City Regional Perspectives
 

The Agricultural Sector Remains Depressed, 

with Low Commodity Prices 

The Kansas City Region’s farm sector continues to be 

plagued by low commodity prices. Strong domestic and 

foreign production of wheat, corn, and soybeans has 

resulted in large inventories, depressing prices every 

year since 1996, as shown in Table 1. Moreover, the 

U.S. Department of Agriculture’s (USDA’s) outlook for 

these commodities in the 2001 and 2002 marketing 

years shows little improvement over the low prices seen 

in 2000. On the positive side, cattle prices continue 

upward, and hog prices have rebounded somewhat from 

extremely low levels in 1998 and 1999. 

The low prices contributed to declining farm net 

income. Net farm income for the Region dropped 28 

percent, from $11.1 billion in 1997 to $8.0 billion in 

1999 (the most recent data available on a state basis). 

Estimated 2000 net farm income, based on national 

price levels and regional production estimates, is not 

an improvement over 1999. Yet the Region has not 

experienced any major production problems in the past 

two years, which would have resulted in even lower net 

farm income numbers. 

TABLE 1 

Farm Banks Continue 

to Report Healthy 

Conditions despite 

the Depressed 

Farm Sector 

Despite tough times for 

farmers, the Region’s 

1,212 farm banks,1 

which represent 61 percent 

of the nation’s farm banks, 

reported healthy conditions 

at year-end 2000, capping a 

decade of strong financial performance. For example, 

farm bank earnings, as measured by aggregate return 

on assets,2 were reported at 1.10 percent in 2000, similar to 1998 and 1999 results. In addition, farm bank 

credit quality has been relatively high. As shown in 

Chart 1 (next page), total delinquent and nonperforming loans3 continue to represent a low percentage of 

total loans when compared with historical levels. In 

addition, net loan charge-offs, which represented just 

0.21 percent of total loans as of year-end 2000, have 

not increased significantly. 

Important Commodity Prices Are Expected to Remain Depressed through 2001 

KC REGION 

PROPORTION OF 

EST. PROJ. AGRICULTURAL 

1996 1997 1998 1999 2000 2001 CASH RECEIPTS (%) 

CORN 3.24 2.71 2.43 1.94 1.80 1.85 17 

SOYBEANS 6.72 7.35 6.47 4.93 4.65 4.90 14 

WHEAT 4.55 4.30 3.38 2.65 2.48 2.55 6 

CATTLE 65.05 66.32 61.48 65.56 69.00 75.00 32 

HOGS 56.53 54.30 34.72 34.00 44.00 42.00 10 

Note: Grain prices are for marketing year of each crop. Crop quantities are per bushel; livestock are per hundredweight. 

Source: U.S. Department of Agriculture 

1 Farm banks are defined as banks having farm operating or farm real estate loans totaling at least 25 percent of total loans.
 

2 Return-on-assets ratios were adjusted for banks that have elected Subchapter S tax status to make their earnings comparable to those of non-


Subchapter S institutions.
 

3 Delinquent loans are loans past due between 30 and 89 days. Nonperforming loans are loans that are placed on nonaccrual (not accruing interest)
 

status or past due 90 days or more.
 

Regional Outlook 27 Second Quarter 2001 
Regional Perspectives
 

Reported capital and loan loss reserves, which cushion 

losses in lending and operations, also remain at relatively high levels. The aggregate equity capital ratio was 

10.3 percent and the aggregate ratio of loan loss reserve 

to gross loans was 1.5 percent as of year-end 2000. 

These ratios were much lower at the beginning of the 

1980s agricultural crisis, at 8.7 percent and 1.0 percent, 

respectively.4 

Government Payments, Carryover Debt, 

and Off-Farm Income Have Insulated 

Farm Banks from Problems 

Why have farm banks been able to withstand the poor 

agricultural environment? The answer lies in government payments, carryover debt, and off-farm income, 

which have been critical to farm banks’ reported health 

during the past three years. An examination of these 

factors helps to explain why the Region’s farm 

banks have not reported significant deterioration in 

conditions. 

Most important, government payments to farmers in 

1998, 1999, and 2000 have mitigated some—but not 

all—of the financial stress caused by low commodity 

prices. Nationally, government payments set records in 

each of those years, with payments in 2000 reaching 

$22.1 billion. As the agricultural economy has weakened in the Region, government payments also have 

grown dramatically in importance. 

Chart 2 shows how the percentage of government payments to net farm income in the Region has grown 

from slightly over one-quarter of net farm income in 

1997 to more than 100 percent of net farm income in 

1999. As a result, farmers have become heavily reliant 

on government payments to meet debt obligations. Farm 

bank managers stressed this point during an outreach 

meeting in March 2000,5 stating that many of their 

weaker farm customers waited for government checks 

before repaying operating loans. 

Given the USDA 2001 and 2002 price outlooks, it 

appears that the Region’s farmers will continue to rely 

on government payments in the near term. Any reduc4 See Table 3 in “Agricultural Sector under Stress: The 1980s and 

Today,” Kansas City Regional Outlook, third quarter 1999, at 

http://www.fdic.gov/bank/analytical/regional/ro19993q/kc/k3q1999.pdf. 5 Agricultural Bankers Roundtable meeting hosted by the FDIC in 

Omaha, Nebraska, March 28, 2000. 

CHART 1 

Farm Bank Delinquent Loans Remain Relatively
 

Low, while Reserves Are Relatively High
 

Percent 

0 

1 

2 

3 

4 

Loan Loss 

Reserves 

Loans Past 

Due 30–89 Days 

’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 

Noncurrent Loans 

Source: Bank Call Reports 

tion in government payments could have a negative 

effect on farm banks, as borrowers would find it even 

more difficult to meet loan obligations and living 

expenses. All eyes will be on congressional negotiations 

pertaining to the 2002 farm bill, which could dramatically affect the Region’s farmers and lenders. 

Carryover debt also helps farm banks to report 

strong aggregate conditions. Because of the variability 

in production and price of agricultural products, 

bankers frequently carry over unpaid seasonal operating loans into the next season. The expectation is that 

a good operating season will offset one or two poor 

operating seasons. This practice effectively delays 

recognition of credit stress as these loans do not show 

up in reported delinquency figures. For example, in 

the 1980s farm crisis, farm banks’ delinquency ratios 

CHART 2 

Source: U.S. Department of Agriculture 

The Region’s Farmers Have Become Reliant 

on Government Payments 

Government Payments/Net Farm Income 

Percent 

IA KS MN MO NE ND SD 

1997 1999 1998 

Region 

0 

50 

100 

150 

200 

250 

Regional Outlook 28 Second Quarter 2001 
Regional Perspectives
 

did not rise significantly until 1984, three years into 

the crisis.6 

FDIC examiners report7 that the share of examined 

banks experiencing a “moderate” to “significant” 

increase in carryover debt levels jumped from about 10 

percent in March 1998 to more than 40 percent by 

September 1999. Although the percentage of banks 

experiencing increases has moderated somewhat, it 

remains relatively high. Further persistence of low farm 

revenue could result in higher delinquency numbers at 

farm banks, because carryover debt has limitations, particularly for farmers without substantial real-estate 

equity to secure carryover loan extensions. Farm borrowers’ balance sheets can be stretched only so far 

before bankers are unable or unwilling to extend additional carryover debt. At that point, delinquency levels 

escalate rapidly, as in the early 1980s. 

The third factor that has benefited farm banks is that the 

strong nonfarm economy has boosted farmers’ off-farm 

income levels. Off-farm income represents a large share 

of funds used to meet living expenses or make farmrelated debt payments, particularly for smaller farming 

operations. USDA data for 1999 show that off-farm 

income represents 69 percent of total household income 

for farm households with farm revenues of $50,000 to 

$249,000. These smaller operations are the primary borrowers at many of the Region’s farm banks. Data 

6 For a discussion of how the current agricultural situation differs 

from that of the 1980s, including a discussion of carryover debt, refer 

to the Kansas City Regional Outlook, third quarter 1999, at http:// 

www.fdic.gov/bank/analytical/regional/ro19993q/kc/k3q1999.pdf. 7 FDIC examiner loan underwriting survey results; examinations 

conducted between September 1996 and September 2000. 

released in 1992 by the USDA show that most off-farm 

jobs are not related to farming. In fact, services and 

manufacturing employ 51 percent and 17 percent of 

rural workers, respectively, and government employment accounts for another 17 percent. Therefore, even 

in Midwestern states in which farm production represents the largest source of production output, off-farm 

income represents a critical share of farming families’ 

total income. 

The record-setting national economic expansion has 

been a tremendous boost to off-farm income, helping 

rural areas provide a wide range of employment opportunities. However, recent economic data and news 

releases suggest that the economic growth has slowed 

substantially and might be at or near zero. Reports of 

layoffs, lost shifts, and idled plants are increasing. A 

prolonged or severe economic slowdown could be 

harmful to farm banks’ financial well-being, as farm 

borrowers might lose a substantial portion of household 

income through lost wages. 

Thus far, farm banks have continued to report healthy 

conditions despite a depressed farm economy. However, 

stress cracks in their condition are apparent. 

Government payments and off-farm income have 

played important roles in preventing the cracks from 

widening. Currently there is uncertainty about the 

health of the general economy as well as about the role 

of government in farming and the direction that will be 

taken in the 2002 farm bill. Significant changes in these 

areas or a significant and widespread crop failure could 

expand the stress cracks. 

Richard D. Cofer, Jr. 

Senior Financial Analyst 

Regional Outlook 29 Second Quarter 2001 
Regional Perspectives
 

Memphis Regional Perspectives
 

The Region’s Economy Has Stalled 

The Memphis Region’s economy slowed sharply during the second half of 2000 and is now considerably 

weaker than the national economy. Payroll employment 

was stagnant in the fourth quarter of 2000 and first quarter of 2001.1 Personal income growth likewise slowed. 

The Region’s economic performance 

was hampered by 

waning consumer 

confidence, lower 

corporate profits, disappointing retail sales, and declining construction activity related 

to the national slowdown. The 

Region also was disproportionately affected by weaknesses in 

manufacturing. 

Nationally, the manufacturing sector is contracting. The 

National Association of Purchasing Managers’ Index2 

has been below 50, a level typically associated with a 

downturn in manufacturing, since the third quarter of 

2000 (see Chart 1). The effects of the current slowdown 

in this sector are more pronounced for the Memphis 

Region than for the nation because of a higher concentration of manufacturing employment and the poor performance of the Region’s manufacturing industries 

compared with the sector as a whole. Many of the 

Region’s manufacturing companies have closed plants 

or laid off employees to reduce costs. The downturn in 

manufacturing has led to slower growth in other important sectors such as services, retail, and construction. 

Mississippi’s economy appears to be in a serious downturn. Mississippi shed almost 20,000 jobs during the 

nine months ended March 31, 2001, considerably more 

1 Seasonally adjusted annualized employment growth during the first 

three months of 2001 (measuring only changes from December 31, 

2000, to March 31, 2001) that was a meager 0.3 percent, compared 

with the 3.2 percent annualized growth reported for the same period 

in the prior year, provides an indication of the magnitude of the recent 

slowdown. 

2 The index is based on a survey of more than 250 companies within 

21 industries in all 50 states and covers areas such as production, 

orders, commodity prices, inventories, and vendor performance as 

well as employment. 

job losses than the state reported during the 1990 to 

1991 national downturn. Although the losses were 

driven by weaknesses in manufacturing, almost all 

sectors have been affected. With the maturation of the 

gaming industry, job formation in the construction and 

service sectors, previous drivers of state employment 

growth, evaporated. Also, the agricultural sector continues to face low commodity prices and escalating 

costs, and the timber industry is struggling with lower 

demand following a severe winter. As a result of these 

negative trends, personal income growth in the fourth 

quarter of 2000 slowed to its lowest rate since 1983. 

While some positive developments are expected, primarily the initial construction work for a new automobile manufacturing facility, the state’s economic recovery appears to be largely contingent on improvement 

in the national economy. 

The current slowdown in Mississippi follows a decade 

of strong economic growth spurred in large part by 

gaming and hotel development. Many insured financial 

institutions in the state responded with rapid growth of 

their own in the 1990s to match the booming economy. 

This period of expansion, in the economy and among 

insured financial institutions, makes adapting to the 

current downturn all the more difficult for the management of banks and thrifts. 

The economies of Arkansas and Tennessee also may 

be vulnerable. Arkansas is even more dependent on 

manufacturing employment than is Mississippi, and 

CHART 1 

NAPM Index 

Three-month moving average change 

in Region’s manufacturing jobs 

Manufacturing Job Losses in the Region Mount 

Note: NAPM = National Association of Purchasing Managers 

Sources: Bureau of Labor Statistics and National Association of Purchasing 

Managers 

Mar ’90 

Apr ’91 

May ’92 

Jun ’93 

Jul ’94 

Aug ’95 

Sep ’96 

Oct ’97 

Nov ’98 

Dec ’99 

Jan ’01 

20 

30 

40 

50 

60 

70 NAPM Index 

Change in Employment (000s)

–10 

–8 –6 

–4 

–2 

0 

2 

4 

6 

8 

Regional Outlook 30 Second Quarter 2001 
Regional Perspectives
 

continued weaknesses in the sector could begin to affect 

the state’s overall economic health.3 After slowing 

appreciably in the fourth quarter of 2000, employment 

growth in Tennessee during the first three months of 

2001 was close to zero. The rate of deceleration in 

employment growth over the preceding six months suggests that the state’s economy has been affected disproportionately by the current national slowdown. 

Bank Credit Quality Has Deteriorated 

with Economic Conditions 

As the national and regional economies slowed during 

the second half of 2000, large banks (those with total 

assets of $1 billion or more) began reporting deterioration in credit quality. Past-due loan ratios increased and 

loan losses rose in the third and fourth quarters of 2000 

among the Region’s 25 largest insured financial institutions (see Chart 2). In response to changing economic 

conditions and credit quality concerns, these banks 

began to reduce loan exposure levels early in 2000 and 

more recently began to add to allowances for loan and 

lease losses. 

Community banks (those with total assets of less than 

$1 billion) also reported deterioration in asset quality. In 

fact, community banks in the Region reported the 

largest spike and the highest aggregate ratio of past-due 

loans among the FDIC’s eight Regions as of December 31, 2000.4 Rising delinquencies were widespread, 

with almost two-thirds of the Region’s banks and thrifts 

reporting increases in past-due loan levels from the 

prior year. Loan loss rates also increased for most institutions. Community banks and large banks have 

responded differently to changing economic conditions. 

Whereas many of the Region’s largest banks have 

slowed loan growth and boosted reserves for loan losses, 

many community banks have not. 

3 Manufacturing employment represents 22 percent of Arkansas’ 

total nonagricultural employment, compared with a national level of 

14 percent. Job losses in the manufacturing sector contributed to 

negative job formation in the state in January and February 2001. 

4 Memphis Region community banks reported an aggregate past-due 

loan ratio (loans reported as nonaccrual or past due 30 days or more) 

of 2.86 percent at year-end 2000. This represents a notable increase 

over the 2.47 percent reported as of December 31, 1999, and the 2.48 

percent reported as of September 30, 2000, and is the highest yearend past-due loan level reported in the Region since 1992. 

CHART 2 

Loan Losses Rise at Large Banks 

Loan Loss Rate (%) 

Note: Large banks are the 25 largest institutions in the Memphis Region, all with 

assets of $1 billion or more. 

Source: Bank and Thrift Call Reports 

Annualized net loan 

loss rate per quarter Four-quarter 

moving average 

4Q894Q904Q914Q924Q934Q944Q954Q964Q974Q984Q99

4Q00 

1.0 

0.0 

0.1 

0.2 

0.3 

0.4 

0.5 

0.6 

0.7 

0.8 

0.9 

Higher delinquencies were reported for almost every 

loan category, with consumer loans showing the largest 

jump.5 Consumer loan portfolios likely were affected by 

the fourth quarter layoffs as well as by growing consumer debt burdens. Commercial and industrial loan 

delinquencies also increased as many area businesses 

experienced declining profitability associated with the 

slowing economy. Construction loan delinquencies 

were also notably higher, likely influenced by the growing inventories of unsold newly constructed homes in 

many areas. 

Higher Credit Exposure Could Increase 

the Vulnerability of the Region’s Banks 

If economic conditions deteriorate further, Memphis 

Region banks and thrifts could be affected by credit 

quality problems more severely than during the previous economic downturn because of higher credit exposure levels. The aggregate loan-to-asset ratio for the 

Region’s community banks at year-end 2000 was well 

above levels reported prior to the 1990 to 1991 recession 

(see Chart 3).6 Furthermore, loan portfolios at year-end 

2000 were much more heavily concentrated in traditionally higher-risk loan types, primarily in commercial 

real estate and construction and development lending, 

5 The aggregate consumer loan past-due ratio for community banks 

and thrifts in the Region increased from 3.15 percent of total consumer loans at year-end 1999 to 3.68 percent at year-end 2000. 

6 The aggregate loan-to-asset ratio for Memphis Region community 

banks at year-end 2000 was 66 percent, compared with 56 percent 

reported at year-end 1989. 

Regional Outlook 31 Second Quarter 2001 
Regional Perspectives
 

increasing the susceptibility of area banks to any downturn in local real estate market conditions. 

Credit exposure levels are particularly high in many of 

the Region’s metropolitan areas, such as Lexington, 

Memphis, and Nashville. In many metropolitan areas, 

growing competitive pressures have led to rapidly escalating funding costs. In response, many insured institutions, accommodated by previous economic strength, 

accepted higher credit exposure in order to improve 

asset yields and maintain net interest margins. 

As a result, bank earnings may be more vulnerable to 

changes in economic conditions than in prior periods 

of slowing. Pressures on net interest margins, previously masked to some extent by increasing credit 

exposure and asset yields, may intensify as loan 

demand wanes and banks and thrifts tighten underwriting standards in response to worsening economic 

conditions. 

Higher credit exposure also may necessitate additional 

provisions to the allowance for loan and lease losses. In 

recent years, most banks’ provisions covered relatively 

low loan loss rates; however, allowance levels did not 

keep pace with burgeoning loan portfolios. While lower 

allowance levels may have been appropriate during a 

time of economic prosperity, provisions may need to 

increase in the near term given the weakness in area economic conditions and rising delinquencies and loss rates. 

CHART 3 Loans as a Percentage of Assets 

Memphis Region Banks Report 

High Credit Exposure 

Source: Bank and Thrift Call Reports 

0 

10 

20 

30 

40 

50 

60 

70 

Other loans 

Commercial real estate 

Consumer 

Residential 

Commercial and industrial 

1Q891Q901Q911Q921Q931Q941Q951Q961Q971Q98 1Q991Q00

The effects of the slowing national economy are beginning to be felt by community banks. This seems particularly true for institutions in the Midwest and Midsouth, 

where economic conditions have weakened the most 

and credit quality concerns are emerging. The extent of 

credit quality deterioration and the resulting pressure on 

earnings and capital levels depend largely on the duration and severity of economic weakness in the nation 

and Region, as well as the response of financial institution management to changing conditions. 

Memphis Region Staff 

Regional Outlook 32 Second Quarter 2001 
Regional Perspectives
 

New York Regional Perspectives
 

Region’s Economy, although Slowing, Performed 

Well; However, Pockets of Weakness Are Emerging 

Some measures indicate that relative to that of the nation, 

the Region’s economy, although slowing, performed well 

through first quarter 2001. The Region’s labor markets 

were tight, commercial and residential real estate conditions were generally favorable, and consumer spending 

was stable.1 Furthermore, except for manufacturing, the 

Region’s industry sectors reported job growth in 2000, 

albeit at a lower rate than in 1999 (see Chart 1). 

Pockets of weakness are emerging, however, particularly among communities that have a higher concentration 

of manufacturing jobs. Reduced demand nationwide 

for manufactured products, including automobiles, 

computers, electronic equipment, and industrial 

machinery, has resulted in job losses in areas such as 

Buffalo and Elmira, New York, and Reading and 

York, Pennsylvania. These metropolitan areas, as well 

as several others in Pennsylvania and northern and 

western New York, which also have a high concentration 

of manufacturing jobs, could be hurt by reduced 

demand for durable manufactured goods. 

Furthermore, some of the Region’s office markets may 

be more vulnerable to an economic downturn. Office 

construction has been at substantially lower levels during 

the 1990s business cycle than during the 1980s, 

CHART 1 Construction

Services

TCPU

Trade

FIRE

Government

Percent Change 

–5 

0 

5 

10 

1999 2000 

Manufacturing

Region’s Job Growth Slows 

across Industry Sectors 

Notes: Data represent percentage changes from December 1998 

to December 1999 and December 1999 to December 2000. 

TCPU = transportation, communication, and public utilities 

FIRE = finance, insurance, and real estate 

Source: Bureau of Labor Statistics 

1

Federal Reserve Beige Book, New York and Philadelphia Districts, 

March 7, 2001. 

and vacancy rates remain generally low.

and suburban 

ticularly among Internet and other 

Moreover, layoffs, parHowever, office construction has increased 

implications for the Region’s economy, 

2 

in northeastern New Jersey3 

Maryland.4 

high-technology firms, could 

result in leased space returning to these markets as new 

construction is completed. 

Uncertainty on Wall Street has 

particularly in New York City and surrounding areas. 

Although the finance, insurance, and real estate (FIRE) 

sector does not account for the largest proportion of the 

Region’s job base, it represents a significant share of 

the Region’s economy, as it provides some of the 

highest-paying jobs. The FIRE sector accounts for 

more than one-quarter (25.7 percent) of the Region’s 

combined gross state products.5 Moreover, the Region’s 

FIRE sector has grown faster than its overall economy, 

increasing 5.4 percent between 1997 and 1998 compared with 4.2 percent for the Region’s economy as a 

whole. Layoffs by the Region’s large brokerage firms, 

however, have increased. Furthermore, a decline in initial public offerings and merger activity has contributed 

to a drop in earnings reported by the Region’s large 

banks (assets greater than $10 billion), which derive a 

significant portion of operating income from marketsensitive revenues. 

The Region’s and the nation’s economies also are linked 

to Wall Street by the wealth effect created by the rising 

stock market in the 1990s. Rising equity values have contributed to increased household net worth and have fueled 

consumer spending on homes, autos, and other purchases. 

During 2000, however, the wealth effect turned negative, 

as the nation’s household net worth declined for the first 

time since 1945, reflecting declining equity prices. 

Reduced household net worth could depress consumer 

spending across the Region and the nation. 

2 For additional information on commercial real estate conditions, see
 

New York Regional Outlook, third quarter 2000.
 3 Kathleen Lynn, “Space Tight, Outlook Bright for Commercial Real
 

Estate,” Bergen Record, February 4, 2001.
 4 Grubb & Ellis, Real Estate Forecast for Washington, D.C., 2001.
 5 Bureau of Economic Analysis. Excludes Puerto Rico, which was not
 

available. Data for 1998 are the most recent available.
 

Regional Outlook 33 Second Quarter 2001 
Regional Perspectives
 

Credit Quality among the Region’s 

Insured Institutions Shows Signs of Weakening 

While reported credit quality indicators at year-end 

2000 were generally sound, some weakening was evident, particularly among commercial and industrial 

(C&I) loans at the Region’s large banks. Large banks’ 

C&I past-due and charge-off ratios increased; however, 

these ratios remain below levels reached a decade ago. 

During 2000, the median C&I loan past-due ratio for 

the Region’s large banks increased to 2.17 percent from 

1.46 percent in 1999, while the C&I net charge-off 

ratio increased slightly to 0.47 percent from 0.44 percent. In comparison, during 1991, the median C&I 

past-due and net charge-off ratios reported by the 

Region’s large banks reached 6.77 percent and 2.40 

percent, respectively. Much of the C&I credit deterioration has been attributed to large syndicated loans 

booked between 1996 and 1998, when underwriting 

standards eased. Recent surveys prepared by the 

Federal Reserve Board6 indicate that nationwide, 

banks have tightened underwriting standards over the 

past year. Nevertheless, some indicators suggest that 

C&I credit quality may weaken further as C&I loans 

underwritten three years ago season and as the economy slows.7 Furthermore, C&I credit-quality weakness 

may be extending beyond the Region’s large banks, 

as regional banks (assets between $1 billion and $10 

billion) also reported higher C&I past-due and chargeoff rates. 

The slowing economy also may be having a negative 

effect on credit quality at the Region’s community 

banks (those with assets less than $1 billion8). While 

past-due ratios remain generally favorable, 57 percent 

of the Region’s community banks reported an increase 

in the past-due ratio during the second half of 2000. The 

increase primarily reflected weakness in residential 

mortgages, consistent with national trends. According 

to the Mortgage Bankers Association of America, in 

fourth quarter 2000, the percentage of delinquent mortgages in the United States reached the highest level 

since 1992. Moreover, weakening credit quality reported by community banks headquartered in the Region’s 

manufacturing-dependent counties suggests that these 

banks may be experiencing the effects of the national 

6 Federal Reserve Board, The Senior Loan Officer Opinion Survey on
 

Bank Lending Practices, March 2001.
 7 Moody’s Investors Service, U.S. Banking Sector: Commentary of 4th
 

Quarter 2000 Earnings, February 2001.
 8 Excluding insured institutions less than three years old and credit
 

card specialists.
 

economic slowdown more than community banks headquartered in counties less reliant on manufacturing 

jobs.9 Throughout the late 1990s, community banks in 

manufacturing-dependent counties reported a lower 

ratio of past-due residential loans than the Region’s 

other community banks; however, in 2000, this trend 

reversed, likely reflecting weakness in manufacturing 

employment. 

In addition, while community banks’ C&I past-due 

ratios remained favorable in 2000, the amount of pastdue C&I loans increased. Past-due ratios were largely 

diluted by strong commercial loan growth experienced 

over the past two years. The increase in past-due loans 

suggests that improvements in credit quality that 

occurred throughout the late 1990s are waning as economic conditions soften. Moreover, although commercial real estate (CRE) loan quality reported by the 

Region’s community banks also was relatively favorable, a slowing economy could weaken office market 

conditions and adversely affect credit quality. Twothirds of the Region’s community banks have increased 

CRE loan exposure as a percentage of total assets since 

1998. Furthermore, a high percentage of the Region’s 

newer institutions have increased CRE loan exposure. 

CRE loans constitute the largest share of new banks’ 

loans, more than the Region’s established community 

banks and more than new banks a decade ago. For more 

information on the Region’s new banks, see New York 

Regional Outlook, first quarter 2001. 

Weakening credit quality could lead to higher loan loss 

provisions and lower profitability for the Region’s 

banks, as allowance for loan and lease losses (ALLL) 

levels have not kept pace with loan growth (see 

Chart 2, next page). The median ratio of ALLL to 

Gross Loans for the Region’s banks declined throughout the current economic expansion, falling to the lowest level since 1990. Nevertheless, capital ratios of the 

Region’s banks are higher than a decade ago, providing 

additional cushion against potential losses. 

9 Manufacturing-dependent areas are defined as counties whose 

manufacturing employment concentration is greater than the national average of approximately 15 percent. Of the 178 counties in the 

New York Region, 80, or 45 percent, have a ratio of manufacturing 

jobs to total jobs of greater than 15 percent. As of December 31, 

2000, 212 established community institutions were headquartered in 

the Region’s manufacturing-dependent counties. 

Regional Outlook 34 Second Quarter 2001 
Regional Perspectives
 

Asset Extension Could Pressure NIMs 

Following the Mortgage Refinancing Wave 

Relatively low long-term interest rates and a flat yield 

curve, which prevailed periodically during the late 

1990s and 2000, fueled consumers’ preference for longterm, fixed-rate loans and contributed to lower net interest margins (NIMs) for the Region’s community banks. 

These banks are generally more affected by NIM compression because of their dependence on the NIM or 

“spread” income, while large institutions derive much 

of their revenue from noninterest income. 

More than two-thirds of the Region’s community banks 

have reported an increase in concentration of long-term 

assets since 1997. In fact, 30 percent of the nation’s 

community banks that hold a large concentration of 

long-term assets are headquartered in the Region,10 

reflecting its greater concentration of mortgage 

lenders.11 Moreover, the proportion of long-term assets 

(those that reprice after five years) may increase further 

should the level of mortgage refinancing continue at a 

high level.12 

While concentrations in longer-term assets should help 

bolster bank margins in a declining interest rate environment, a subsequent rise in rates, as occurred following the 1998 refinancing wave, could exacerbate NIM 

compression, particularly among institutions with high 

concentrations of long-term assets. As interest rates 

CHART 2 

Note: Data represent year-end median amounts. 

ALLL = allowance for loan and lease losses 

Source: Bank and Thrift Call Reports, excluding institutions in operation fewer 

than three years and credit card specialists 

Loans to Assets 

(percent) 

ALLL-to-Gross 

Loans (percent) 

Loan Growth Outpaces Loan Loss Reserves 

’93 ’94 ’00 

0.8 

1.0 

1.2 

1.4 

1.6 

58 

60 

62 

64 

66 

’95 ’96 ’97 ’98 ’99 

climbed following the 1998 mortgage refinancing 

wave, margins of community banks with greater concentrations in long-term assets tightened more than 

margins of other community banks.13 Should the 1998 

scenario repeat, banks with higher concentrations of 

long-term assets could again experience greater margin 

compression, highlighting the importance of interest 

rate risk management. 

Kathy R. Kalser, Regional Manager 

Robert M. DiChiara, Financial Analyst 

Norman Gertner, Regional Economist 

Alexander J. G. Gilchrist, Economic Analyst 

10 Established community banks with a ratio of assets maturing after
 

five years to earning assets above the 90th percentile. Of the 443
 

banks that meet this criterion nationally, 135 are in the Region.
 

11 Banks that have greater than 50 percent of assets in 1 to 4 family
 

real estate loans and mortgage-backed securities.
 

12 According to the Mortgage Bankers Association of America’s 13 The median NIM decline from 1998 to 2000 for community banks
 

Mortgage Application Index for Refinancing, the level of mortgage with high concentrations in long-term assets was 10 basis points,
 

refinancings increased sharply during first quarter 2001. compared with 3 basis points for other community banks. 


Regional Outlook 35 Second Quarter 2001 
Regional Perspectives
 

San Francisco Regional Perspectives
 

Economic and Banking Conditions 

Are Sound but Face Increasing Pressures 

The Region’s economy remained sound and expanded 

faster than the nation’s through first quarter 2001, albeit 

at a slower pace than in previous periods. Because of 

this slowing, there is concern about the sustainability of 

the Region’s growth. For instance, the Oregon economy 

has softened significantly since mid-2000, mainly 

because of contraction in the forestry and manufacturing sectors. In addition, continued slowing in the 

national economy or a confluence of key developments 

could dampen the Region’s economy. In particular, 

energy price increases and power interruptions, technology sector and equity market volatility, and commercial 

real estate market softness could affect growth 

prospects adversely. 

As of December 31, 2000, a majority of the Region’s 

insured financial institutions reported sound financial 

conditions; however, the trend toward tighter liquidity 

and weaker asset quality continued. For example, twothirds of institutions open three years or more reported 

year-over-year declines in core-deposit-to-asset ratios. 

In addition, delinquent commercial and industrial (C&I) 

loan ratios increased noticeably throughout the Region; 

institutions with more than $1 billion in total assets 

reported almost a 60 percent year-over-year increase in 

the median past-due C&I loan ratio. 

The Energy Crisis in the West Poses 

Both Immediate and Long-Term Problems 

The recent surge in natural gas prices in conjunction 

with electricity cost and availability problems could 

slow the Region’s economy. The mining, lodging, and 

agriculture sectors appear particularly vulnerable. In 

addition, highly leveraged households or marginally 

profitable businesses could be affected disproportionately by higher energy bills. 

Natural gas prices nearly quadrupled nationwide during the winter of 2000. In California, where inadequate pipeline capacity further constrained supplies, 

the spot price for natural gas surged even higher and 

continues to hover well above the national average (see 

Chart 1). Rising natural gas prices, coupled with 

an inadequate number of power plant facilities in 

California, drought conditions 

in the Pacific Northwest, and 

California’s ill-structured 

electricity deregulation program, also led to significant 

increases in wholesale electricity costs. Overall, these factors 

have contributed to rising retail 

gas and electricity prices 

in many western states 

and electricity availability 

problems in California. 

Rising energy prices and decreased electricity reliability could affect the Region’s energy-intensive industries 

adversely. For example, mining and lodging consume a 

significant amount of electricity and could be affected 

disproportionately by higher energy costs. Mining is 

particularly important to the economies of Alaska, 

Idaho, Montana, Nevada, Utah, and Wyoming, while 

lodging is a major industry in Nevada and Hawaii. 

Escalating energy prices and rolling outages already 

have affected several agricultural subsectors. Dairy, 

greenhouse, and poultry producers not only use large 

amounts of natural gas but also depend on electricity as 

a critical element of production. In addition, agricultural operations that use fertilizer and irrigation could 

experience cash flow pressures. The combined effects 

on these areas of agriculture could be especially damaging to California, which has a significant percentage 

of irrigated crops and exposure to the dairy and greenhouse industries. The resulting pressure on farm cash 

flows could affect the 125 insured financial institutions 

in the Region that have agricultural loan exposures 

exceeding 100 percent of Tier 1 capital. California 

accounts for nearly 20 percent of these lenders. 

Higher retail energy prices act very much like a tax that 

reduces consumers’ discretionary spending. Data suggest that energy price increases have a relatively greater 

impact on lower-income households than on higherincome ones. Consequently, credit quality at the 

Region’s subprime lenders could be most affected by 

rising household energy costs. 

Energy will remain a longer-term issue in the West. The 

threat of rolling outages will not be eliminated until 

California’s investor-owned utilities become solvent and 

Regional Outlook 36 Second Quarter 2001 
Regional Perspectives
 

CHART 1 

Higher Wholesale Electricity and Natural Gas Prices Contributed to California’s Energy Crisis 

$/MMBTU

$/MWh

California Wholesale Electricity (right axis) 

“Henry Hub” Natural Gas* 

(left axis) 

California Natural Gas (left axis) 

0 

4 

8 

12 

16 

20 

100 

200 

300 

400 

0 

Jan ’00 

Feb ’00 

Mar ’00 

Apr ’00 

May ’00 

Jun ’00 

Jul ’00 

Aug ’00 

Sep ’00 

Oct ’00 

Nov ’00 

Dec ’00 

Jan ’01 

Feb ’01 

Notes: MMBTU = millions of British Thermal Units 

MWh = megawatt hour 

*The Henry Hub (near major producing areas and many pipeline interconnections in Louisiana) is the official delivery point for natural gas futures trading on the New York 

Mercantile Exchange. 

Sources: California Energy Commission and Enerfax.com 

adequate generation capacity is built or conservation 

efforts become more effective. Given the interconnectedness of the West’s power distribution network, other states 

also will continue to be affected. 

Equity Market Weakness May Disproportionately 

Affect the San Francisco Region 

Venture capital funding, which had been the growth 

engine in several of the Region’s metropolitan statistical 

areas (MSAs) over the past several years, contracted 

during the fourth quarter of 2000. Northern California,1 

Los Angeles/Orange County, and Washington reported noticeable declines in venture capital funding, which 

contributed to layoffs and closings of a significant 

number of high-tech firms during late 2000 and early 

2001. California and Washington accounted for about 

33 percent and 5 percent, respectively, of all dot-com 

closures through February 2001. Furthermore, the significant number of layoffs reported in the surviving 

e-commerce, dot-com, and computer sectors nationwide correlates strongly with the large decline in the 

tech-heavy NASDAQ Composite Index between March 

2000 and March 2001. 

Weakness in the stock market also could affect household financial positions and consumer spending 

adversely. The net worth of U.S. households dropped 

2 percent during 2000, the first annual decline in 55 

years.2 Although the percentage drop was not large, 

1 Aggregated by PricewaterhouseCoopers; includes Silicon Valley and
 

the San Francisco Bay Area.
 

2 Federal Reserve Board, Flow of Funds Data (B.100 Balance Sheet
 

of Households and Nonprofit Organizations), March 9, 2001. 


consumers may spend less on retail goods and tourist 

activities, both of which are important to several states 

in the Region, including Nevada and Hawaii. In addition, declining equity market values could dampen trust 

income at insured institutions because trust revenues are 

usually tied to asset market values. Trust income has 

become increasingly important for some insured institutions. For instance, for the 76 institutions in the Region 

that reported income from fiduciary activities as of 

December 31, 2000, the median ratio of trust income to 

total noninterest income was 14 percent, up steadily 

from 9 percent five years earlier. 

Sustained Softening in the Commercial 

Real Estate Sector Could Affect a Majority 

of the Region’s Insured Institutions 

Softness in some commercial real estate (CRE) markets 

could adversely affect insured financial institutions in the 

Region with elevated CRE loan3 concentrations. As of 

December 31, 2000, more than half of the Region’s metropolitan insured institutions reported CRE loan concentrations exceeding 300 percent of Tier 1 capital, compared with only 29 percent of metropolitan institutions 

based elsewhere in the nation. Institutions with significant exposures to office, industrial, retail, and hotel properties in the Region’s high-tech MSAs4 and tourism areas 

could be most vulnerable to a downturn in this sector. 

3 CRE loans include nonfarm-nonresidential, multifamily, and construction loans. Because of Call Report limitations, CRE loans may 

include credits used to finance residential construction projects. 

4 There are 13 MSAs in Arizona, California, Idaho, Oregon, and 

Washington, where the growth and concentration of high-tech 

employment exceeds the national average. (See San Francisco 

Regional Perspectives, third quarter 2000, for details.) 

Regional Outlook 37 Second Quarter 2001 
Regional Perspectives
 

Demand for office and industrial space in the Region 

has been affected primarily by softness in the technology sector. Technology firm failures and layoffs reportedly have increased available office sublease space and 

placed downward pressure on CRE rents in the San 

Francisco, San Jose, and Seattle MSAs as well as the 

West Los Angeles office market. Given waning absorption rates and new construction in the pipeline, Torto 

Wheaton Research forecasts significant office vacancy 

rate increases in several of the Region’s high-tech 

MSAs over the next two years (see Table 1). 

Demand for hotel and retail commercial space also could 

suffer as a result of diminished consumer confidence 

and falling retail sales. Hotel and retail space in Nevada 

and Hawaii could be most vulnerable if a slowing economy contributes to a decline in leisure and business 

travel. Already, Las Vegas Strip hotels have reported 

falling room rates, a result in part of the slowing economy and of rising energy prices in California.5 Demand 

for retail space also could wane throughout the Region, 

given reports of declining retail sales in the West.6 

Insured Institutions in High-Tech Areas 

Could Be Most Affected 

Of particular concern are insured institutions operating in certain MSAs in the San Francisco Region that 

are affected by a combination of the economic developments discussed in this article. The confluence of 

problems in the energy sector, volatility in the equity 

markets, and a weakening CRE sector could adversely 

affect CRE lenders in high-tech MSAs in California, 

Washington, and Oregon. These urban areas could be 

5 Hubbel Smith, “Air Service to Las Vegas Keeps Growing But a Drop
 

in Strip Hotel Room Rates May Signal Sagging Tourism Demand,
 

Analyst Suggests,” Las Vegas Review-Journal, March 23, 2001.
 

www.lvrj.com/lvrj_home/2001/Mar-23-Fri-2001/business/
 

15700408.html
 

6 Bank of Tokyo Mitsubishi/Union Bank of Switzerland, Warburg
 

Retail Sales Survey, February 2001.
 

TABLE 1 

Office Vacancy Rates Are Forecast to 

Increase in Most High-Tech MSAs 

FOURTHQUARTER TWO-YEAR 

2000 VACANCY 

MSA NAME1 VACANCY2 FORECAST 

VENTURA HIGH HIGH3 

SAN JOSE LOW HIGH3 

OAKLAND LOW HIGH3 

ORANGE COUNTY HIGH HIGH 

PORTLAND MODERATE HIGH4 

SAN DIEGO MODERATE HIGH3,4 

SAN FRANCISCO LOW HIGH3 

PHOENIX HIGH MODERATE 

SACRAMENTO MODERATE MODERATE4 

SEATTLE LOW MODERATE 

NATION Moderate Moderate 

Note: Torto Wheaton Research does not track the
 

Boise, Santa Cruz, or Santa Rosa office markets.
 

1 Listed in order of two-year forecast vacancy rate.
 

2 High = greater than 10%; Moderate = 5–10%; Low =
 

less than 5%.
 

3 Forecast to increase significantly (i.e., increase by
 

500 basis points or more).
 

4 Forecast to increase in suburban areas, but remain
 

stable or decrease in downtown areas.
 

Source: Torto Wheaton Research
 

disproportionately affected by constrained energy 

supplies, declining levels of venture capital investment, 

layoffs among high-tech companies, and rising CRE 

vacancy rates. 

San Francisco Region Staff 

Regional Outlook 38 Second Quarter 2001 
✁
 

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