Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION THIRD QUARTER 2000 

FDIC
 

Memphis
 

Region
 

Division of
 

Insurance
 

Gary L. Beasley,
 

Regional Manager
 

Harry W. John,
 

Regional Economist
 

Robert L. Burns,
 

Senior Financial
 

Analyst
 

F. Miguel Hasty,
 

Financial Analyst
 

Regional Perspectives 

◆ Overview of Economic and Banking Conditions—Memphis Region employment 

growth continues to lag that of the nation. Employment growth has been driven by gains 

in the construction and service sectors as well as in Kentucky’s automobile industry. Job 

growth in the Region’s automobile sector may slow, however, as the potential for a slackening economy, higher interest rates, and high gasoline prices point to a potential slowing of automobile sales. Bank performance was largely unchanged in the first quarter 

of 2000, but earnings pressures remain. See page 3. 

◆ The Level of Risk in Construction Lending May Rise with Interest Rates— 

Although overall construction activity in the Region remains fairly robust by historical 

standards, development is slowing as interest rates have risen and demand has begun to 

wane. Even as construction activity moderates, many banks and thrifts in the Memphis 

Region continue to aggressively grow construction loan portfolios. See page 7. 

By the Memphis Region Staff 

In Focus This Quarter 

◆ Ranking Metropolitan Areas at Risk for Commercial Real Estate Overbuilding— 

Commercial real estate construction has boomed in a number of U.S. metropolitan markets during recent years amid falling vacancy rates and growing demand for new space. 

Insured depository institutions have reasserted their role as primary sources of capital for 

this construction boom, particularly in the wake of the 1998 financial markets crisis that 

left some important market-based lenders on the sidelines. Recent data for some metropolitan areas show that on-balance-sheet exposures of FDIC-insured institutions are by 

some measures higher now than at the peak of the last commercial real estate cycle during the late 1980s. This article reassesses major U.S. metropolitan real estate markets in 

search of possible signs of overbuilding that could drive up vacancy rates and drive down 

rents in the near term. This review points to an underlying trend of markets experiencing 

more vigorous construction activity across multiple property types. See page 13. 

By Thomas A. Murray, Senior Financial Analyst 

◆ Rising Home Values and New Lending Programs Are Reshaping the Outlook for 

Residential Real Estate—Rising home prices and high levels of activity in the singlefamily housing market have been supported by excellent economic conditions and generally low interest rates. However, as interest rates have begun to rise, housing market 

activity has slowed. Historically, residential real estate has been one of the best-performing asset classes at insured institutions. Concerns have recently arisen, however, 

that new, higher-risk lending lines of business could adversely affect the future credit 

quality of residential real estate portfolios. See page 21. 

By Alan Deaton, Financial Economist 

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, AZ, CA, FJ, 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 Memphis Region’s Regional 

Outlook, please call Gary Beasley at (901)821-5234 or send an e-mail to gbeasley@fdic.gov. 

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

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

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

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

the Federal Deposit Insurance Corporation. 

Chairman 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 
Regional Perspectives
 

Overview of Economic and Banking Conditions 

•	 Although the Region’s employment growth lags the nation’s, overall economic conditions remain positive. 

•	 Arkansas and Kentucky continue to benefit from strong construction and service-sector job growth; 

Louisiana struggles because of stagnant oil and gas industry employment. 

•	 Pressures on bank and thrift net interest margins abated in the first quarter of 2000 but are likely to resume 

with weakening loan demand, a compression of spreads between short- and long-term interest rates, and 

balance sheet repricing. 

The past 15 months have been marked by the efforts of 

the Federal Reserve to slow economic growth and combat inflationary pressures by raising short-term interest 

rates. Conditions at midyear 2000 suggest that while 

growth and inflationary concerns may have moderated, 

the national economy remains strong. Although the 

effects of recent rate increases may not yet be completely realized at either the national or regional level, 

additional rate hikes appear likely. The outlook for the 

Region’s economy, as a result, is continued slow growth 

as specific sectors continue to adjust to the higher interest rate environment. 

Memphis Region Employment Growth Improves 

Slightly 

Economic performance in the Memphis Region, as measured by payroll employment, edged up at the end of second quarter 2000. The Region’s payroll employment rose 

1.7 percent compared with 1.4 percent for the same period in 1999 (see Table 1). Although the Region’s job 

growth continues to lag the nation’s, employment conditions remain strong by historical standards. At the end of 

TABLE 1 

Memphis Region Employment Growth 

Increases Slightly 

2Q99 2Q00 

ARKANSAS 1.6 2.8 

KENTUCKY 2.6 2.4 

LOUISIANA –0.2 1.1 

MISSISSIPPI 2.1 0.3 

TENNESSEE 1.3 1.9 

REGION 1.4 1.7 

NATION 2.3 2.4 

Source: Bureau of Labor Statistics 

the second quarter of 2000, the Region’s average unemployment rate was a low 4.5 percent. 

The service sector, the largest and fastest-growing segment of the Region’s economy, continued to add jobs. 

Year-over-year job growth in this sector was unchanged 

at 2.4 percent at the end of second quarter 2000 compared with 2.4 percent over the same period last year. 

Gains in professional service jobs led the growth. 

By contrast, employment growth in the Region’s retail 

sector is slowing. Year-over-year retail job growth in the 

first half of 2000 rose 1.1 percent compared with 1.9 

percent during the same period a year ago. Consumer 

spending, which has fueled one of the longest economic expansions in the nation’s history, appears to be slowing in response to rising interest rates. In addition to 

increasing the real cost of borrowing, higher interest 

rates could adversely affect stock market performance, 

leading to weaker consumer confidence and a decline in 

consumer spending, which could weaken retail sales. 

Arkansas and Kentucky Report Strong Growth 

Although the Region as a whole reported little change, 

job formation in Arkansas and Kentucky was strong. 

Employment growth in these two states exceeded averages in the Region and the nation, benefiting from 

strong construction and service sector growth. 

Many areas in the nation reported slowing construction, 

but Arkansas’s year-over-year construction job growth 

rose sharply, boosted by strong residential construction 

and numerous infrastructure projects, particularly highway improvements. Also, the state’s retail job growth 

was the highest in the Region, with residential construction activity fueling demand for retail sales of 

appliances, furniture, and other household goods. 

Memphis Regional Outlook 3	 Third Quarter 2000 
Regional Perspectives
 

In addition to construction and service sector growth, 

Kentucky benefited from gains in automobile industry 

employment. In 1999, employment in the state’s automobile industry grew by more than 12 percent, adding 

over a full percentage point to the manufacturing sector’s employment growth. Employment gains in automobile manufacturing continued into the first half of 

2000 but may have peaked as the potential for a slackening economy, higher interest rates, and high gasoline 

prices point to slowing automobile sales (see page 5). 

Louisiana’s Labor Markets Continue to 

Languish 

Louisiana’s economy is constrained by exposure to 

retrenchment occurring in the oil and gas industry. 

Despite a sharp upturn in oil prices since early 1999, 

employment growth in Louisiana’s energy sector has 

remained flat (see Chart 1). 

When oil prices dropped in 1998, many energy companies laid off workers in an effort to reduce operating 

expenses. The number of operating oil rigs dropped 

sharply, reducing exploration and development payrolls 

in the sector while curtailing domestic production. In 

addition, many oil and gas companies reduced overhead expenses by curtailing administrative operations. 

Shell, Chevron, and Texaco announced administrative 

staff reductions in New Orleans in 1998 and early 

CHART 1 

1999. While most of these administrative job losses 

occurred in New Orleans, many smaller oil companies 

and oilfield service companies in Lafayette and in the 

Acadiana area also reduced payrolls. Further energy 

sector job losses occurred with consolidation in the 

industry. Amoco, for example, closed its New Orleans 

office after being acquired by British Petroleum. 

Despite the rebound in prices and concurrent increase in 

the number of operating oil rigs in 1999 and 2000, the 

recovery in exploration and development jobs has been 

offset by continued losses of administrative jobs. 

Although gasoline prices are currently high and will 

likely be high in the near future, oil industry employment may continue to decline1 as cost-cutting and consolidation in the industry continue. As a result, 

weakness in the oil and gas sector will likely continue to 

hamper Louisiana’s employment growth. 

Banks and Thrifts Report Stable Earnings 

Performance, but Margin Pressures Are Likely 

to Resume 

Aggregate earnings performance at the Region’s banks 

and thrifts in the first quarter of 2000 changed little 

from the prior year. Net interest margins (NIMs), which 

had fallen steadily over the prior two years, improved 

slightly in the first quarter of 2000, as did returns on 

assets. 

Louisiana’s Energy Sector Employment Is Stagnant despite the Upturn in Oil Prices 

Energy Sector Employment

(Thousands) 

68 

66 

64 

62 

60 

58 

56 

54 

52 

50 

48 

Oil Prices Energy Sector Employment 

35 

30 

25 

20 

15 

10 

5 

Oil Prices ($/Barrel) 

Jun Aug Oct Dec Feb Apr Jun Aug Oct Dec Feb Apr Jun 

’98 ’98 ’98 ’98 ’99 ’99 ’99 ’99 ’99 ’99 ’00 ’00 ’00 

Source: Bureau of Labor Statistics 

1 According to John S. Herold Inc., an energy consulting firm, oil 

industry employment is expected to decline 6 percent each year 

through 2008. 

Memphis Regional Outlook 4 Third Quarter 2000 
Regional Perspectives
 

Automobile Sector Outlook Dims
 

The automobile-manufacturing sector is a major contributor to the Memphis Region’s economy. Kentucky and 

Tennessee are ranked fifth and sixth, respectively, in the 

nation in total motor vehicle employment. Major automobile producers such as Ford, Nissan, Saturn, and Toyota as 

well as numerous parts suppliers are located in these two 

states. Direct employment in the automobile sector totals 

73,000, with 1,400 new jobs added in 1999 on strong 

automobile sales. Double-digit automobile sales growth 

may be vulnerable, however, as demand is likely to weaken as a result of rising interest rates, high gasoline prices, 

and a slackening national economy. 

Light trucks have grown in importance. Sales of light 

trucks, which include trucks, minivans, and sports utility 

vehicles (SUVs), eclipsed those of passenger cars in the 

1990s as consumer buying preferences changed. Low 

interest rates and falling gasoline prices throughout most 

of the late 1990s allowed automobile buyers to indulge 

their tastes for larger vehicles. Strong demand for SUVs 

in particular helped to offset sometimes sluggish car 

sales. At Ford, for example, SUVs represented almost 20 

percent of all vehicles sold in 1999, up from just 5 percent 

in 1990. 

The trend to light trucks is strongly evidenced in the 

Region’s automobile production. The Ford plant in 

Louisville, Kentucky, produces trucks and Explorer 

SUVs. It also is the only production facility for Ford’s 

largest SUV, the Excursion. Nissan began production of 

its SUV, the Xterra, at its Smyrna, Tennessee, plant in 

1999. Saturn is currently retooling its Spring Hill, Tennessee, plant to begin production of an SUV in 2001. 

Because of the high profit margins for light trucks, competition in this market segment, as well as in the automobile industry in general, is growing. Chrysler, Ford, and 

General Motors (GM) lost nearly 3 percent of the domestic market to foreign competitors in 1999 and are expected to lose more with the announcements by foreign 

automobile manufacturers of new domestic capital investments totaling over $2 billion. Foreign automobile manufacturers are expected to flood the U.S. market with more 

than 500,000 more minivans, trucks, and SUVs annually 

over the next three years. This increased production by 

foreign manufacturers at a time of potentially waning 

consumer demand could result in a domestic oversupply 

and may eventually lead to layoffs in the sector. 

Automobile sales are slowing. National automobile production and sales have been increasing over the past four 

years but are now slowing. In May 2000, total sales of 

U.S. cars and light trucks declined by 2 percent from the 

previous year, the first drop since August 1998.2 In 

response, automobile producers have reduced production 

slightly from 1999’s record pace to minimize growing 

inventories. Even so, Chrysler, Ford, and GM have reported higher truck inventories. As previously discussed, the 

recent popularity of trucks, SUVs, and minivans is 

strengthening competition in this market segment, with 

light truck production projected to expand in the second 

half of 2000.3 

Some regional producers continue to transition to new 

products. Nissan Motor Corporation struggled throughout the 1990s, but sales are improving with the introduction of the new SUV Xterra in 1999, produced at its 

Smyrna, Tennessee, plant. Nissan also revealed plans to 

build a new full-size truck at the plant and expand current 

production facilities. In an attempt to diversify its product 

mix and penetrate the SUV market, Saturn and parent 

company GM are investing $1.5 billion in the production 

of a new SUV in 2001. The retooling for SUV production 

at a time when SUV sales could be hampered by interest 

rate hikes, high fuel prices, and more intense competition 

may present additional challenges for the company. 

Conclusion. While the automobile sector remains 

healthy, initial signs of weakening have emerged. Analysts suggest that higher interest rates could slow vehicle 

demand with a 6- to 12-month lag, and that such effects 

could be felt next year.4 The effects on automobile producers in the Memphis Region may be more pronounced 

because of exposure in the light truck market segment, 

particularly SUVs. Higher gasoline prices could hurt 

SUV sales because they are much less fuel efficient than 

smaller vehicles. In addition, higher interest rates could 

disproportionately affect SUV sales because of these 

vehicles’ higher purchase price. Ford recently announced 

a 25 percent reduction in production of its largest SUV, 

the Excursion, through 2001 in the face of intense competition and lower than expected consumer demand. 

Harry W. John, Regional Economist 

Nicole Janda, Research Assistant 

2 The decline in 1998 was largely attributable to a strike by GM 

autoworkers, resulting in revenue losses of over $3 billion and 

almost eight weeks of halted production. The strike affected over 

200,000 workers and thousands of independent parts suppliers and 

resulted in a decline of domestic production for the second and 

third quarters of 1998. 

3 Phillippi, Joseph. July 17, 2000. Auto Trends. Paine Webber 

Research Note. 

4 JP Morgan. May 19, 2000. Monthly Auto Review: May Industry 

Update. 

Memphis Regional Outlook 5 Third Quarter 2000 
Regional Perspectives
 

One factor contributing to the recent improvement in 

NIMs is the acceleration in the long-term trend of rising 

loan-to-asset levels (see Table 2). NIMs typically 

increase as banks and thrifts shift assets from securities 

portfolios and other asset categories to loans, which 

often offer higher yields. While loan-to-asset levels 

have climbed steadily at the Region’s insured financial 

institutions since the mid-1990s, the increase from the 

first quarter of 1999 to the first quarter of 2000 was particularly sharp. Even within loan portfolios, recent 

growth has been concentrated in construction and commercial real estate loans. Despite the shift toward higheryielding, and traditionally higher-risk, assets in recent 

quarters, NIMs have declined or have shown only slight 

improvement. With loan demand reportedly softening,5 

insured financial institutions may find generating additional loan growth increasingly difficult. Further shifts 

into loans during a period of softening demand could 

reduce yields because of rising competition or a loosening of credit standards. 

Another factor that benefited NIMs in recent quarters 

was a widening of yield curve spreads. Banks and thrifts 

in the Memphis Region, like insured financial institutions nationwide, have historically reported improved 

NIMs during periods of widening yield curve spreads 

and declining NIMs during periods of narrowing 

spreads. The spread between one-year and ten-year 

Treasury bonds extended from 20 basis points at the 

beginning of 1999 to 80 basis points by midyear 1999. 

However, in the first half of 2000, spreads narrowed 

again. At the end of May 2000, the spread between the 

one-year and ten-year Treasury bonds was only 11 basis 

points. As a result, bank NIMs may again be pressured 

from the effects of a flat yield curve. 

Margins also may be compressed as balance sheets 

reprice to the current rate environment. Banks and thrifts 

TABLE 2 

Aggregate Memphis Region Earnings 

Performance Changes Little despite 

Growth in Loan Portfolio 

1Q00 1Q99 

RETURN ON ASSETS 1.20 1.21 

NET INTEREST MARGIN 4.13 4.07 

LOANS/ASSETS 65.3 61.9 

Source: Banks and Thrift Call Reports 

5 As noted in recent Federal Reserve Board Senior Loan Officer Opinion Survey on Bank Lending Practices and Beige Book reports. 

in the Region remain liability sensitive; in other words, 

liabilities are likely to reprice more rapidly than assets. 

As a result, all other things being equal, rising interest 

rates can be expected to affect NIMs adversely. The 

Memphis Regional Outlook, first quarter 2000, 

described how changes in balance sheet composition during the late 1990s, primarily a lengthening of asset maturities and greater reliance on wholesale funding sources, 

may have contributed to an even greater sensitivity of 

community bank earnings to rising interest rates. 

Noninterest Income Sources for Insured 

Financial Institutions Also Are Affected by 

Interest Rate Changes 

In addition to pressuring NIMs, recent rate changes may 

affect noninterest income adversely at many insured 

financial institutions. While the growing importance of 

fee income represents some level of diversification of 

revenue sources, many of these fees, like NIMs, are 

responsive to changes in interest rates or other financial 

markets. Large segments of noninterest income are generated by mortgage banking, investment banking, and 

retail brokerage activity, which remain sensitive to 

volatile financial markets. Mortgage banking, in particular, is affected by interest rate changes. 

Earnings at the Region’s large banks, those with assets 

of $1 billion or more, have been affected by swings in 

noninterest income levels in 2000 because of financial 

market volatility. These large institutions reported considerable growth in noninterest income sources 

throughout the 1990s. In the first quarter of 2000, however, noninterest income levels at these institutions 

dropped as a share of gross revenue.6 Higher rates since 

June 1999 have led to significant reductions in mortgage loan originations and related fee income at many 

financial institutions. One highly publicized example 

was First Tennessee National Corporation. In the first 

quarter of 2000, the company announced lower than 

expected quarterly earnings and warned of lower yearend results because of the negative effect of rising interest rates on the company’s mortgage operations. 

Robert L. Burns, Senior Financial Analyst 

Harry W. John, Regional Economist 

F. Miguel Hasty, Financial Analyst 

6 Gross revenue is defined as net interest income and noninterest 

income. Noninterest income as share of gross revenue fell to 34.3 percent in the first quarter of 2000 from 36.6 percent a year earlier. 

Memphis Regional Outlook 6 Third Quarter 2000 
Regional Perspectives
 

Risk in Construction Lending May Rise 


with Interest Rates
 

•	 Residential real estate activity is slowing in the nation and the Region. Recent trends in home price appreciation suggest some weakening in the Region’s housing markets relative to the nation’s. 

•	 Commercial real estate markets in the Region remain active, but the pace of new construction is moderating. Vacancy rates in some market segments are rising. 

•	 Construction and development lending exposure at insured financial institutions is growing rapidly. With 

demand moderating for both commercial and residential properties, construction loan credit quality may 

weaken. 

Real estate markets in the Memphis Region are in transition. Population and employment growth and increasing income and wealth levels, along with low interest 

rates, contributed to booming residential development 

in the late 1990s. Likewise, a strong economy and 

expanding labor markets fueled growth in commercial 

real estate. Although overall construction activity in the 

Region remains fairly robust by historical standards, 

development is slowing as interest rates have risen and 

demand for homes is waning. 

Even as activity moderates, many banks and thrifts in 

the Memphis Region continue to grow construction 

loan portfolios aggressively. Construction loans7 constituted the fastest-growing segment of loan portfolios at 

community banks (those with total assets of less than $1 

billion) over the preceding three years. During this period, strong annual loan portfolio growth, averaging 11.5 

percent, has been eclipsed by a 21.5 percent annual 

increase in construction loan portfolios. Furthermore, 

growth in construction loans for the 12-month period 

ending March 31, 2000, a period including nine months 

of rising interest rates and slowing real estate development, was higher than in either of the two preceding 

years (see Chart 2). 

Residential Markets Are Cooling 

Nationally, housing markets and residential construction 

activity are slowing in response to rising interest rates. 

For the second quarter of 2000, the average loan commitment interest rate on a 30-year fixed-rate mortgage 

7 As reported on bank call reports, construction loans include both 

residential and commercial development. 

CHART 2 

0 

5 

10 

15 

20 

25 

30 

1Q98 1Q99 1Q00 

Strong Construction Loan Growth Reported 

at Community Banks in the Memphis Region 

Note: Community banks are those with less than $1 billion in total assets. Growth 

rates are calculated on a merger-adjusted basis. 

Source: Bank Call Reports Annual Growth (%) 

Construction Loans 

All Other Loans 

was 8.32 percent, up 110 basis points from the same period in 1999 and the highest level reported since the first 

quarter of 1995. With the sharp rise in mortgage interest 

rates, new home sales have dipped in recent months. In 

response, housing construction starts have declined even 

more sharply, reaching their lowest level in more than two 

years as of June 2000.8 The volume of single-family 

housing permits, a leading indicator of housing construction, also fell in June for the fifth consecutive month. 

Consistent with the nationwide slowdown in housing 

markets, single-family permits in the Memphis Region 

declined by 11.0 percent in the second quarter of 2000, 

compared with growth of 6.7 percent during the same 

8 Nationally, single-family housing starts in May dropped 5.4 percent 

from April and were 3.4 percent below levels reported in May 1999, 

according to the Bureau of the Census. Starts declined a further 3 percent in June and were 1 percent below levels reported in June 1999, the 

beginning of the current round of Federal Reserve interest rate hikes. 

Memphis Regional Outlook 7	 Third Quarter 2000 
Regional Perspectives
 

period in 1999. Single-family permits were lower in 

every state in the Region. Mississippi posted the largest 

reversal, as single-family permits fell by over 16 percent 

compared with growth of nearly 15 percent during the 

same period a year ago. Many of the Region’s metropolitan areas are experiencing similar declines in real 

estate activity (see Table 3), in stark contrast to strong 

gains in permitting activity in 1999. While the decline 

in permitting is consistent with slowing home sales and 

growing inventories of unsold homes in many metropolitan areas, home construction activity in the midSouth remains strong by historical standards. To some 

extent the slowdown in activity reported in early 2000 

represents a retreat from record levels reached in many 

parts of the Region in 1999 to lower but still high levels 

of construction. 

Home price appreciation in the Region moderated 

recently although it remained strong at the national 

level, suggesting weakening local markets compared 

with national conditions. Appreciation in median home 

sales prices has slowed dramatically in every state in the 

Region except Kentucky (see Chart 3). Home prices in 

the Region increased considerably faster than those in 

the nation from 1994 to 1998, but began to slow in 

1999, even as appreciation escalated nationally. This 

divergence between the Region and the nation widened 

further in the first quarter of 2000. Trends in the Region 

may indicate some combination of overbuilding by 

developers, growing inventories of homes available for 

sale, or slowing demand. 

TABLE 3 

CHART 3 

Home Price Appreciation in
 

Region, unlike the Nation, Slows
 

1994–98 avg. Arkansas
 

Kentucky
 

Louisiana
 1999 

Mississippi 1Q00 

Tennessee 

Nation 

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 

Year-over-Year % Change 

Source: Office of Federal Housing Enterprise 

Historically, residential real estate construction has 

been vulnerable to oversupply following periods of 

rapid expansion in the sector. With the long economic 

expansion and, until recently, strong growth in residential construction, many new developers, builders, and 

contractors were attracted to the residential sector. 

Some new market participants may have only limited 

experience and financial resources. Also, some experienced builders may have become overly reliant on previous market strength and may now be overextended on 

speculative developments. With rising interest rates and 

weakening demand, property buyers are likely to be 

more selective. Builders concentrated in specific price 

ranges, such as those involved in higher-priced speculative home construction or those concentrated in particular geographic areas, may be affected more adversely. 

Single-Family Building Permits in the Region Fall 

2Q00 2Q99 CHANGE (%) 

BATON ROUGE, LA 640 850 –24.7 

BILOXI-GULFPORT, MS 1,054 1,205 –12.5 

JACKSON, MS 1,100 1,355 –19.5 

LEXINGTON, KY 1,703 1,697 0.4 

LITTLE ROCK, AR 1,178 1,184 –0.5 

LOUISVILLE, KY 2,794 3,239 –13.7 

MEMPHIS, TN 3,338 4,089 –18.4 

NASHVILLE, TN 4,768 5,653 –15.7 

NEW ORLEANS, LA 1,574 1,810 –13.0 

REGION 36,571 41,207 –11.3 

UNITED STATES 615,928 638,405 –3.5 

Source: FDIC Real Estate Data System 

Memphis Regional Outlook 8 Third Quarter 2000 
Regional Perspectives
 

As home sales in these market segments could slow 

dramatically, builders may find themselves with higher 

levels of unsold inventories and may have to absorb 

higher interest expenses to develop and carry the property. This situation would likely lead to concessions to 

induce sales, and prices could decline. 

Commercial Construction Continues to Grow, 

albeit More Slowly 

In contrast to a 4.2 percent decline in commercial construction starts nationally, Memphis Region commercial 

construction starts increased 2.2 percent in 1999, according to F.W. Dodge. Although this growth rate may appear 

modest, it builds upon a sharp 26.7 percent jump in commercial starts in 1998. In early 2000, the volume of 

planned commercial real estate projects in the Region 

continued to climb, suggesting the potential for increased 

development in the future. Growth in commercial real 

estate planning was concentrated in a few markets, primarily Little Rock, Louisville, and Nashville. 

The Memphis Regional Outlook, first quarter 1999, 

discussed extensively the potential for supply and 

demand imbalances in specific metropolitan real estate 

markets in the Region. Concerns were raised about high 

development levels in Nashville and a potential shortterm rise in vacancies in the Memphis industrial market. 

Since that issue was published, vacancy rates have 

climbed for Nashville’s office, retail, and industrial 

market segments while the city’s burgeoning hotel sector struggles with excess capacity. Memphis has reported rising industrial segment vacancy rates, but the 

longer-term outlook for the segment remains positive, 

given the city’s expanding distribution industry. New 

Orleans has reported somewhat higher retail vacancy 

rates than in the past. 

Commercial real estate markets are likely to face additional challenges as a result of changing economic conditions. The viability of commercial projects is a 

function of the cost of development, financing expenses, and obtainable rental income. Higher interest rates 

lead to higher financing expenses. Also, the potential 

for slowing national and regional economies could 

impair future rental income growth. As a result, new 

commercial developments may become less economically viable and lead to increased risk to lenders. For 

additional information on challenges facing commercial 

real estate, see the “Ranking Metropolitan Areas at Risk 

for Commercial Real Estate Overbuilding” article in 

this issue. Further discussion of the deterioration in 

Nashville’s commercial real estate market can be found 

on page 12. 

Exposure to Construction and Development 

Lending Rises 

Construction lending represents a disproportionately 

large share of recent loan growth at Memphis Region 

community banks, accounting for almost 10 percent of 

loan growth over the preceding three years.9 As a result, 

exposure levels at these banks have risen from an average of 2.8 percent of total assets10 on March 31, 1997, to 

4.0 percent on March 31, 2000, slightly above national 

levels. 

Community banks are now more concentrated in construction and development lending than their larger 

counterparts. While large banks, those with more than 

$1 billion in total assets, have historically been involved 

heavily in construction lending, the average exposure of 

large banks at the end of first quarter 2000 is considerably lower than levels reported from 1985 to 1990 (see 

Chart 4, next page). In contrast, community banks are 

reporting much greater exposure to construction lending than in prior periods. Concentration levels reported 

by community banks at the end of the first quarter of 

2000 are almost double those reported by these banks 

immediately prior to the 1990–91 recession. 

Not surprisingly, exposure is highest among the 255 

community banks headquartered in metropolitan areas 

(Table 4, next page). Construction loan portfolios at 

these banks, as at their large bank counterparts, likely 

include a mix of commercial and residential development. However, portfolios at metropolitan community 

9 Construction loans comprised an average 4.8 percent of total loans 

at Memphis Region community banks on March 31, 1997, while construction loan growth during the following three years comprised 9.4 

percent of total loan growth. At many banks, particularly those in 

metropolitan areas, construction loan growth represented an even 

higher level of total loan growth. 

10 Construction loan exposure in this article is measured as a percentage of total assets. While overall loan portfolios also have grown as a 

percentage of total assets, construction loan exposure is rising sharply 

relative to both assets and loans. Average aggregate construction loan 

exposure at the Region’s community banks grew from 4.7 percent of 

total loans on March 31, 1997, to 6.2 percent of total loans on March 

31, 2000. 

Memphis Regional Outlook 9 Third Quarter 2000 
Regional Perspectives
 

TABLE 4 

Construction Exposure Is Greatest 

in Community Banks in MSAs 

CONSTRUCTION LOANS 

AS % OF ASSETS 

BANKS 1Q90 1Q00 

LARGE BANKS 4.1 3.6 

COMMUNITY BANKS 1.8 4.0 

IN MSA 2.6 5.7 

OUTSIDE MSA 1.1 2.9 

MSA=metropolitan statistical area 

Source: Bank Call Reports 

banks may contain higher inherent risk than portfolios 

at large banks, as community bank portfolios are often 

limited to one market and therefore may be less geographically diverse. 

The number of banks reporting high levels of construction loan exposure has likewise increased. Among the 

Region’s community banks headquartered in metropolitan areas, 116 banks, or 45 percent, report construction 

loan exposure equivalent to 5 percent or more of total 

assets. The only area of the nation with a higher share of 

metropolitan community banks reporting such high 

exposure levels is the West Coast. Furthermore, 47 of 

the Region’s community banks headquartered in metropolitan areas reported construction loan exposure 

greater than 10 percent of total assets. 

CHART 4 

Among community banks in metropolitan areas, concentrations in construction and development loans are highest 

in institutions with less than $250 million in total assets. 

Some of these smaller institutions may not have the same 

level of employee resources as larger banks to oversee 

loan origination and loan administration functions should 

local real estate market conditions deteriorate. In addition, 

several of these small banks are recently chartered institutions that have yet to weather an economic downturn. 

Banks in certain metropolitan areas have considerably 

greater exposure to changing real estate market conditions (see Table 5, page 11). Community banks in 

Baton Rouge, Memphis, and Nashville report average 

aggregate construction loan exposure well above the 

average for all metropolitan statistical areas in both the 

Region and nation. Aggregate exposure at banks headquartered in the Memphis metropolitan area is the third 

highest among all metropolitan areas nationwide, 

behind only Atlanta and Portland. Twelve banks headquartered in Memphis report construction loan exposure equivalent to 10 percent or more of total assets. 

Reported Credit Quality Remains Strong, but 

Risks in Construction Lending Are Higher 

Although slight deterioration has occurred recently, construction loan credit quality among the Region’s banks 

remains favorable.11 Also, construction credit underwrit0 

1 

2 

3 

4 

5 

6 

7 

8 

9 

10 

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

Large Banks Community Banks 

C & D Loans/Total Assets (%) 

Construction Loan Exposure Is Growing Faster at Community Banks 

C & D = construction and development 

Source: Bank and Thrift Call Reports, first quarter data 

11 At the end of the first quarter of 2000, past-due construction loans 

represented 2.08 percent of total construction loans, up from 1.86 percent in the first quarter of 1999. Construction and development loan 

losses in recent years remain low but have steadily climbed from 0.04 

percent of average construction loans in 1997 to 0.12 percent in 1999. 

Memphis Regional Outlook 10 Third Quarter 2000 
Regional Perspectives
 

TABLE 5 

Construction Loan Exposure Is High in Baton Rouge, Memphis, and Nashville 

CONSTRUCTION LOANS AS % OF ASSETS 

LOCATION 1Q98 1Q99 1Q00 

MSAS NATIONWIDE 3.8 4.3 5.0 

MSAS REGION-WIDE 4.4 4.9 5.7 

BATON ROUGE, LA 3.2 5.2 9.0 

MEMPHIS, TN 8.0 10.1 12.3 

NASHVILLE, TN 6.3 7.6 8.9 

MSA= metropolitan statistical area 

Note: Community banks are those with less than $1 billion in total assets. 

Source: Bank Call Reports 

ing standards are considered stronger than in prior periods of robust real estate activity, such as that preceding 

the 1980s real estate crisis. One common theme for both 

periods, however, is intense competition among lenders 

in the Region. Construction loans typically represent an 

opportunity for higher yields than do many other traditional loan types, making them attractive for institutions 

seeking to bolster flagging net interest margins. 

Construction lending also generally is considered the 

most complex and labor-intensive type of lending performed by most community banks and can represent the 

highest degree of risk. Prudent management must evaluate credit standards continuously and adjust to changing economic and market conditions. Management also 

must be prepared to anticipate changing conditions in 

order to manage risk exposure effectively. Although 

asset quality indicators remain strong, the high volume 

of recent construction loan originations and growing 

exposure at community banks during a period of generally slowing real estate markets are cause for some concern. Strong underwriting standards and portfolio 

administration practices need to be maintained to guard 

against the potential for weakening credit quality in the 

future. 

Robert Burns, Senior Financial Analyst 

Harry John, Regional Economist 

Memphis Regional Outlook 11 Third Quarter 2000 
Regional Perspectives
 

Although overall economic conditions remain positive, Nashville’s employment growth has dropped 

sharply during the previous two years and is currently well below the national average. With a low 2.3 

percent unemployment rate reported at the end of 

May 2000, labor market tightness is a primary factor 

constraining employment growth. Net in-migration 

has also slowed dramatically based on estimates by 

Regional Financial Associates, dropping from 18,300 

in 1994 to an estimated 9,500 in 1999 as labor markets in surrounding areas have flourished, reducing 

incentives for migration to Nashville. 

Despite a moderating economy, Nashville reported the 

highest level of commercial real estate construction 

starts in 1999 since the previous cyclical peak in 1988. 

Recent construction is driven by development in the 

office and retail sectors. With slowing office employment growth and considerable office completions in 

recent years, Nashville’s office vacancy rate climbed 

from 6.9 percent in 1997, well below the national average, to 11.2 percent at year-end 1999, above the 

national average. A further vacancy rate increase is 

reported in CB Torto Wheaton’s unaudited first quarter 2000 report to 12.7 percent. In addition to rising 

vacancies, Nashville reported a 2.7 percent decline in 

rent levels from 1998 to 1999. Even with rising vacancies and declining rents, high office construction 

activity is continuing. 

Community bank exposure to commercial real estate 

markets has increased sharply in recent years. This is 

particularly true for construction and development 

lending, which now represents an average of 10 percent of total assets at community banks and thrifts 

headquartered in Nashville. During the 12-month 

period ended March 31, 2000, commercial real estate 

loans at area community banks and thrifts grew by 36 

percent, compared with 14.7 percent growth in all 

other loan types. 

Robert L.Burns, Senior Financial Analyst 

Focus on Nashville’s Commercial Real Estate Markets 

Nashville Office: Completions, Absorptions, and Vacancy Rate 

Year Ends 

Square Feet (000s)

Vacancy Rate (Percent) 

Source: Torto Wheaton Research 

0.0 

5.0 

10.0 

15.0 

20.0 

25.0 

0 

500 

1,000 

1,500 

2,000 

2,500 

Completions Absorptions 

Actual Forecast 

Vacancy 

’86 ’87 ’88 ’89 ’90 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 

Memphis Regional Outlook 12 Third Quarter 2000
 
In Focus This Quarter
 

Ranking Metropolitan Areas at Risk for 


Commercial Real Estate Overbuilding
 

•	 In analyses conducted in 1998 and 1999, nine metropolitan areas were identified as at risk for overbuilding; this analysis notes more vigorous 

building occurring across multiple property types 

and identifies 13 markets, including eight of the 

previous nine, as at risk for overbuilding. 

•	 Construction activity has accelerated during the 

current economic expansion with cyclically high 

levels of supply and demand. 

•	 Capital markets scaled back their investments in 

commercial real estate in 1998 and 1999, while 

FDIC-insured institutions increased their construction and development lending by more than 

20 percent each year. 

The banking industry and the FDIC learned during the 

late 1980s that once commercial real estate (CRE) markets become overbuilt, losses can mount quickly. During the 1980s and early 1990s, losses on CRE loans 

were responsible for hundreds of bank and thrift failures 

and billions of dollars in insurance losses for the FDIC. 

Since then, commercial vacancy rates have improved 

dramatically in a number of major U.S. metropolitan 

markets. In turn, CRE charge-offs reported by FDICinsured institutions have fallen to very low levels—less 

than 0.05 percent of average loans in both 1998 and 

1999. 

Two recent studies published by the FDIC evaluate the 

risk of overbuilding in major U.S. metropolitan areas.1 

These studies identified nine cities—Atlanta, Charlotte, Dallas, Las Vegas, Nashville, Orlando, 

Phoenix, Portland (Oregon), and Salt Lake City—as 

markets at risk for rising commercial vacancy rates. 

This article revisits the FDIC’s previous analysis of 

CRE markets. Using a more restrictive definition of 

at-risk markets, we find that eight of the previously 

identified nine markets remain on the list, joined by 

five additional markets: Denver, Fort Worth, Jacksonville, Sacramento, and Seattle.2 In general, more 

markets are experiencing increased levels of construc1 See “Ranking the Risk of Overbuilding in Commercial Real Estate 

Markets,” Bank Trends, October 1998, and “Commercial Development Still Hot in Many Major Markets, but Slower Growth May 

Be Ahead,” Regional Outlook, First Quarter 1999. 

tion activity across multiple CRE property sectors than 

was the case just two years ago. 

Like the two earlier studies, this analysis does not predict an imminent rise in vacancies and losses in the atrisk markets. Instead, as before, the goal is to raise 

awareness about substantial growth in real estate development and the corresponding increases in risk exposure to financial institutions. 

Previous Real Estate Cycles 

Are Well Documented 

Many analysts view the late 1980s U.S. experience as 

the very definition of adverse conditions in CRE markets. The factors that brought about these adverse conditions are well documented.3 During the early and 

mid-1980s, CRE construction boomed. Total office 

space completed in 54 major U.S. markets tracked by 

Torto Wheaton Research exceeded 100 million square 

feet per year every year from 1982 through 1987. 

Insured banks and thrifts were prime sources of credit 

for this building boom. Total outstanding construction 

and development (C&D) loans on the balance sheets of 

insured institutions grew by 52 percent, or $52.5 billion 

dollars, in 1985 alone, followed by three successive 

years of growth in outstanding C&D loans. A key factor 

behind this surge in lending was intense competition 

among lenders. In response to the heightened competition, many lenders loosened their underwriting standards, often extending credit on speculative projects on 

terms that did not protect them from downside risk. 

Examples of aggressive lending practices from this 

period included more collateral-based lending, higher 

loan-to-value limits, reliance on overly optimistic 

appraisals, and inattention to secondary repayment 

sources. 

2 The one metropolitan area identified in the prior analyses as at risk 

for overbuilding that did not fall into the same category using the 

stricter criteria in this analysis is Nashville. Nevertheless, Nashville 

still ranks high in terms of construction activity at fifth highest in the 

U.S. for retail and twelfth highest for office construction activity. 3 See, for example, Freund et al. 1997. History of the Eighties: 

Lessons for the Future, Chapters 9 and 10. FDIC. 

Memphis Regional Outlook 13	 Third Quarter 2000 
In Focus This Quarter
 

Poorly underwritten credit and massive increases in 

construction resulted in overbuilding in a number of 

large U.S. metropolitan markets. Nationwide, the office 

vacancy rate for competitively leased space peaked at 

over 19 percent in 1991.4 In the Southwest and New 

England, where the cycle of overlending and overbuilding was most pronounced, metro real estate markets 

were in even worse shape. Office vacancies in Dallas 

peaked at over 27 percent in 1988, while office vacancies in Boston reached over 17 percent in 1990. As 

vacancies rose and rents fell, lenders in the Southwest, 

Northeast, and elsewhere increasingly found themselves in possession of nonperforming loans and 

impaired real estate assets. The result was a sharp 

increase in the number of failed banks in the Southwest 

and Northeast.5 

Following the CRE debacle of the late 1980s and early 

1990s, commercial construction and lending volumes 

slowed. C&D loan growth at FDIC-insured institutions 

declined every year from 1989 through 1994, while a 

similar drop in private construction expenditures lasted 

through 1993. 

Factors Contributing to Cycle 

of Overbuilding in CRE 

One reason that CRE markets are 

prone to periodic bouts of overbuilding is the business cycle itself, 

which saps demand for new space 

when business activity turns downward. But another 

important contributing factor is the lag time in the 

development process as new construction moves from 

inception to completion. Heavy demand at the start of a 

project may wane or vanish before completion occurs. 

In general, the time lag associated with CRE development is longest for hotel and office projects and 

becomes shorter for retail, multifamily, and industrial 

properties, respectively. The associated degrees of lending risk mostly follow the same pattern. In general, less 

risk is associated with industrial buildings and multifamily projects, which typically take less than one year 

to build. 

4 The U.S. vacancy rate is calculated as an aggregate of selected major 

markets tracked by Torto Wheaton Research. 

5 As further detailed in the History of the Eighties, combined assets of 

failed banks in the Northeast and Southwest comprised over 70 percent of assets of all banks failing between 1980 and 1994. 

To the extent that commercial construction projects 

involve a lag between inception and completion, net 

additions to supply can be anticipated in advance. Much 

progress has been made during this real estate cycle 

toward increased availability of information on CRE 

markets, particularly in regard to supply characteristics. 

Market transparency has been promoted in part by a 

heightened level of public ownership of CRE properties 

and the corresponding higher degree of disclosure by 

the owned entities, such as real estate investment trusts 

(REITs) and commercial mortgage-backed securities 

(CMBSs). 

Changes in demand are harder to predict. A current 

example may be the high level of demand generated by 

Internet start-up companies that rely heavily on financing provided by venture capital funds and initial public 

stock offerings. Because many of these start-ups depend 

so heavily on cash inflows from investors as opposed to 

operating revenues, their viability as tenants and their 

continued demand for high volumes of office space may 

depend more on capital market conditions than on their 

own business performance. While demand may appear 

strong under robust business conditions, it is prone to 

decline rather suddenly in the event of an economic 

downturn. Given these attributes of CRE markets, the 

process of gauging the success for lease-up of a proposed project involves not only looking at new supplies 

of competitive space coming onto the market, but also 

evaluating how vulnerable the market is to a downturn 

in demand for space. 

Recent Developments 

Following a lull in commercial construction activity that 

resulted from adverse market conditions in the early 

1990s, construction activity has gradually accelerated 

during the current economic expansion. The increased 

pace of construction occurred first in industrial and 

retail markets, where growth in net new completions of 

space picked up starting in 1993. The pace of multifamily construction accelerated in 1995, followed by 

increasing levels of office and hotel construction in 

1997. Regionally, commercial construction activity 

recovered first in the Southeast and Northwest, where 

the effects of the previous overbuilding had been the 

least pronounced. Only later did the pace of construction increase in California, the Southwest, and the 

Northeast. As the U.S. economic expansion endures into 

its tenth year, construction activity continues to pick up 

steam across most property types. In the 54 major metMemphis Regional Outlook 14 Third Quarter 2000 
In Focus This Quarter
 

ropolitan areas tracked by Torto Wheaton Research, 

total annual office space completions rose from just 

over 3 million square feet in 1994 to 78.7 million square 

feet in 1999. 

National private expenditures on hotel and retail construction for 1999 exceeded all prior years on both a 

current-dollar and an inflation-adjusted dollar basis. 

Similarly, national private construction expenditures 

on office space in 1999 were at an all-time high on a 

current-dollar basis. On an inflation-adjusted dollar 

basis, office construction expenditures in 1999 were 

still not as high as they were during the mid-1980s. 

A new characteristic of the CRE industry in the current 

expansion has been the marked increase in capital availability through the financial markets. Annual issuance 

of CMBSs has grown from negligible amounts in 1990 

to over $67 billion in 1999. Financing made available 

through REITs has been the other link to the capital 

markets. REIT market capitalization increased from 

approximately $10 billion in 1994 to nearly $145 billion 

in 1999. 

While the availability of market-based sources of capital has helped to facilitate growth in construction during 

this expansion, the financial market turmoil of late 1998 

cast a cloud over the CMBS market that has yet to lift 

fully. Significant events in the global capital markets in 

1997 and 1998, including the Asian economic crisis and 

the Russian government bond default, significantly curtailed the ability of major CMBS issuers to go to the 

market for financing. Significant liquidity problems 

resulted for a number of commercial mortgage firms. 

Nomura, Lehman Brothers, CS First Boston, and others 

incurred losses, while Criimi Mae, Inc., was forced to 

declare bankruptcy. 

As the capital markets pulled back from CRE investments, insured banks and thrifts stepped in to fill the 

void. Chart 1 shows that the total volume of C&D loans 

on the balance sheets of FDIC-insured institutions rose 

by more than 20 percent per year in both 1998 and 

1999, even as growth in U.S. private construction 

expenditures slowed to a crawl.6 

In terms of overall construction market activity, the 

current situation appears to be one of cyclically high 

6 U.S. private construction expenditures, as calculated by the Bureau 

of the Census, include multifamily (two or more units), industrial, 

office, hotel, and retail space. 

CHART 1 

’86 

Growth Rates (%) 

Growth Rates of Private Construction 

Expenditures and C&D Loans Diverge 

during the Past Two Years 

–30 

–20 

–10 

0 

10 

20 

30 

40 

50 

60 

C&D = construction and development loans 

Sources: Bureau of the Census (Haver Analytics), Bank and Thrift Call Reports 

(Research Information System) 

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

C&D Loans 

Priv. Const. 

levels of supply and demand. Because significant 

growth in net new space is forecast for many markets 

and property types during 2000 and 2001, a drop in 

demand for space could impair absorption rates and 

lead to higher vacancies and lower rents. Most analysts 

feel that future trends in real estate demand will be 

closely linked to national and regional economic conditions. 

Identification of Markets at Risk 

for Overbuilding 

Previous FDIC studies have identified CRE markets at 

risk for broad-based overbuilding on the basis of comparative rankings in the rates of growth in commercial 

space. In a 1998 study, U.S. metropolitan areas were 

ranked according to 1997 new construction activity as a 

percentage of existing stock for the five main property 

types: office, industrial, retail, multifamily, and hotel.7, 8 

In that study, any metro area that appeared in the top 15 

for any two of the commercial property types was 

labeled “at risk.” Nine cities were identified as being at 

risk for overbuilding: Atlanta, Charlotte, Dallas, Las 

Vegas, Nashville, Orlando, Phoenix, Portland 

(Oregon), and Salt Lake City. 

7 Federal Deposit Insurance Corporation. October 1998. Ranking the 

Risk of Overbuilding in Commercial Real Estate Markets, Bank 

Trends. 

8 Construction activity is measured in square feet and includes projects completed during the year, plus projects still under construction 

as of year-end. This figure is then divided by the total stock of space 

to obtain a construction activity percentage for use in comparative 

rankings. 

Memphis Regional Outlook 15 Third Quarter 2000 
In Focus This Quarter
 

This study updates the previous results using year-end 

1999 data.9 In doing so, it applies more restrictive criteria to identify at-risk metropolitan real estate markets. 

As before, the metro areas are ranked according to new 

construction as a percentage of existing stock in each of 

the five main commercial property types. However, in 

this analysis, to be considered at risk, a metro area must 

rank in the top ten for any two of the property types. 

Despite the fact that it was harder for individual markets 

to qualify as being at risk, all but one of the previously 

identified nine markets remain on the at-risk list. Moreover, they are joined by five additional metropolitan 

areas: Denver, Fort Worth, Jacksonville, Sacramento, 

and Seattle. It is evident that more metropolitan areas 

are emerging with vigorous CRE construction and 

development across multiple property sectors. 

Most Active Construction Markets 

Charts 2 through 6 represent the property sectors of 

office, industrial, retail, multifamily, and hotel. They 

also list, for each property sector, the metropolitan 

areas having the highest levels of construction activity, 

relative to existing stock, for the year ending December 

31, 1999. The overall national construction activity rate 

is also shown for comparative purposes for each of the 

property sectors. Each metropolitan area is ranked 

from the highest to lowest for levels of construction 

activity. 

As shown in these charts, Las Vegas, Orlando, and 

Phoenix are standouts, with each placing among the top 

ten metropolitan areas in the country for construction 

activity in at least four of the five different property sectors. Las Vegas is among the top ten in construction 

activity for all five property sectors except for hotel 

construction, where it ranks twenty-sixth.10 Las Vegas 

ranks first in retail construction and second in industrial construction. Orlando is first in both office and multifamily construction. Phoenix is among the top ten for 

each of the five property sectors except hotel construction, where it ranks sixteenth. 

9 For the five property sectors reviewed in this report, data sources 

were Torto Wheaton Research for office and industrial and F.W. 

Dodge for retail, multifamily, and hotel. Torto Wheaton Research’s 

data for office and industrial encompass 54 and 53 metropolitan statistical areas (MSAs), respectively. F.W. Dodge’s data for retail, multifamily, and hotel encompass 58 MSAs. 

10 Las Vegas has the most hotel rooms in the country, with slightly 

fewer than 124,000 rooms as of year-end 1999. During 1999, Las 

Vegas experienced the greatest addition of rooms (in absolute numbers) of any market. With over 13,000 new rooms added during 1999, 

Las Vegas had nearly twice the level of the next highest metropolitan 

area, which was Orlando, with an additional 7,000 rooms. 

CHART 2 

Top 15 Office Development Markets—Construction 

Activity in 1999 as a Percentage of Stock 

(Square Footage) 

Orlando 

Phoenix 

Seattle 

Salt Lake City 

Charlotte 

Columbus 

Jacksonville 

Austin 

Las Vegas Completions Wilmington 

West Palm Beach Under 

Construction Nashville 

Oakland 

Sacramento 

Minneapolis 

National 

0% 5% 10% 15% 20% 25% 

Source: Torto Wheaton Research 

CHART 3 

Top 15 Industrial Development Markets— 

Construction Activity in 1999 as a Percentage 

of Stock (Square Footage) 

Riverside 

Las Vegas 

Ventura County 

Fort Lauderdale 

Phoenix 

Sacramento 

San Diego 

Fort Worth 

Cincinnati Completions Atlanta 

Austin Under 

Dallas Construction 

Fresno 

Jacksonville 

Orlando 

National 

0% 2% 4% 6% 8% 10% 12% 14% 16% 

Source: Torto Wheaton Research 

CHART 4 

Top 15 Retail Development Markets— 

Construction Activity in 1999 as a Percentage 

of Stock (Square Footage) 

Las Vegas 

Dallas 

Orlando 

Phoenix 

Nashville 

Fort Worth 

Atlanta 

Sacramento 

West Palm Beach Completions Richmond 

Tampa Under 

Greenville Construction 

Denver 

Jacksonville 

Greensboro 

National 

0% 5% 10% 15% 20% 25% 30% 35% 40% 

Source: F.W. Dodge 

Memphis Regional Outlook 16 Third Quarter 2000 
In Focus This Quarter
 

Other markets deserve notice for their high or moderately high levels of construction activity in one or more 

property sectors. Columbus, Ohio, ranks sixth in the 

nation for its high level of office construction and 

twelfth for both multifamily and hotel construction. 

Greenville is tenth in the nation for hotel construction 

and twelfth for retail. West Palm Beach is ninth for 

retail and eleventh for office. Austin is eighth for 

office, eleventh for both multifamily and industrial, and 

thirteenth for hotel. 

C&D Loan Concentrations 

Concentrations of C&D loans at community banks in 

the at-risk markets are generally higher now than they 

were at the peak of the last cycle in the 1980s.11 As 

shown in Chart 7, the median ratio of C&D loans to 

total assets as of March 31, 2000, was higher than the 

median ratio as of December 31, 1988, in ten of the thirteen at-risk markets.12 The median C&D loan concentration is currently higher than the national average in 

all 13 at-risk markets.13 

At present, overall loan performance remains very good 

for the C&D portfolios of insured institutions. Reported 

delinquent and nonaccrual C&D loans remain at nominal levels as a percentage of total loans, although the 

ratio for both measures increased marginally during the 

first quarter of 2000. 

Construction Employment Concentrations 

The percentage of a metropolitan area’s workforce 

employed in construction is an indicator of the sensitivity of the local economy to construction. Six of the 

13 metropolitan areas at risk for overbuilding are 

found among the top 12 most concentrated construction employment markets (see Chart 8, next page).14 In 

addition, all of the 13 have construction concentration 

levels exceeding the national average. With slightly 

under 10 percent of its nonfarm workforce employed in 

construction, Las Vegas has the highest construction11 Community banks are FDIC-insured institutions with assets less 

than $1 billion. 

12 For community banks that have C&D loans. 

13 Since 1992, the aggregate C&D-to-asset ratio for the nation’s community banks has been higher than the C&D-to-asset ratio for institutions larger than $1 billion. This is a reversal of the condition from 

1984 through 1991 when the aggregate C&D-to-asset ratio for institutions larger than $1 billion exceeded the C&D-to-asset ratio for 

community banks. 

14 Construction concentrations are the percentage of construction 

employees relative to the nonfarm workforce. 

CHART 5 

Top 15 Multifamily Development Markets—
 

Construction Activity in 1999 as
 

a Percentage of Stock (Units)
 

Orlando
 

Charlotte
 

Raleigh
 

Portland
 

Dallas
 

Las Vegas
 

Denver
 

Seattle
 

Atlanta
 Completions Phoenix
 

Austin
 Under
 

Columbus
 Construction
 

Tampa
 

Jacksonville
 

Nashville
 

National
 

0% 2% 4% 6% 8% 10% 12% 

Source: F.W. Dodge 

CHART 6 

Top 15 Hotel Development Markets— 

Construction Activity in 1999 as a Percentage 

of Stock (Square Footage) 

Fort Worth
 

Jacksonville
 

Portland
 

Orlando
 

Salt Lake City
 

Denver
 

Charlotte
 

Dallas
 

Seattle
 Completions Greenville
 

Oakland
 Under 

Columbus, OH Construction 

Austin 

Greensboro 

San Jose 

National 

0 5% 10% 15% 20% 25% 30% 

Source: F.W. Dodge 

CHART 7 

Most of the At-Risk Markets’ Community Banks 

Have Higher Median C&D Loan-to-Asset Ratios 

at 3/31/00 than at Peak of Last Cycle (12/31/88) 

Salt Lake City
 

Atlanta
 

Portland
 

Las Vegas
 

Sacramento
 

Phoenix
 

Seattle
 

Fort Worth
 

Dallas
 3/31/00 

Orlando 12/31/88
 

Charlotte
 

Denver
 

Jacksonville
 

National
 

0 2 4 6 8 10 12 14 16 18 

Median C&D Loan-to-Asset Ratios (%) 

C&D = construction and development 

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

Memphis Regional Outlook 17 Third Quarter 2000 
In Focus This Quarter
 

concentrated workforce of all metropolitan areas in the CHART 9 

United States and is slightly over twice the national rate 

of 4.8 percent. 

High Construction Activity and High 

Vacancy Levels 

Newly constructed, speculative space competes directly 

for tenants against already-built and vacant space. To 

assess at-risk markets fully, it is useful to compare the 

levels of construction activity for each metropolitan 

area’s property sector against its associated vacancy 

levels.15 

Charts 9 through 13 show, by property sector, each 

city’s level of construction activity plotted against the 

corresponding vacancy rate. It is axiomatic that a metropolitan area with high vacancies and high construction is cause for concern for builders and lenders alike. 

Many of the 13 At-Risk Markets Report 

High Office Construction Activity and High Office 

Vacancy Rates 

0 

5 

10 

15 

20 

25 

0% 5% 10% 15% 20% 25% Vacancy Rate 

Note: Capitalized cities are among the 13 markets identified as at risk for 

overbuilding. 

Source: Torto Wheaton Research Construction Activity as Percentage of Stock

SEATTLE 

ORLANDO 

CHARLOTTE 

PHOENIX 

Austin 

Wilmington 

SACRAMENTO 

West Palm Beach 

DALLAS 

LAS VEGAS 

SALT LAKE CITY 

JACKSONVILLE 

Riverside Oklahoma City 

Bakersfield 

Columbus 

Nation 

CHART 10 

It follows for metropolitan areas with high construction 

and high vacancy that newly arriving CRE projects will 

face significant competitive pressures in obtaining tenants. Consequentially, barring any preleasing or any 

fundamental upward shifts in demand, rental concessions may be needed to obtain tenants, and property values may be depressed. 

CHART 8 

Many of the 13 At-Risk Markets Are among the
 

Nation’s Metropolitan Statistical Areas Having the
 

Highest Construction Employment Levels as of
 

First Quarter 2000
 

Many of the 13 At-Risk Markets Report High 

Industrial Construction Activity and High Industrial 

Vacancy Rates 

0 

2 

4 

6 

8 

10 

12 

14 

16 

Construction Activity as a Percentage of Stock 

0% 2% 4% 6% 8% 10% 12% Vacancy Rate 

Source: Torto Wheaton Research 

Austin Cincinnati 

JACKSONVILLE Fresno 

ORLANDO DALLAS Washington, 

D.C. 

Hartford 

Long Island 

Westchester 

ATLANTA 

FORT 

WORTH 

PHOENIX 

San Diego 

SACRAMENTO 

Ft. Lauderdale 

LAS VEGAS 

Riverside 

Ventura 

Note: Capitalized cities are among 

the 13 markets identified as at risk 

for overbuilding. 

Nation 

LAS VEGAS 

Riverside 

Houston 

PHOENIX 

DENVER 

Greenville 

SALT LAKE CITY 

CHARLOTTE 

Birmingham 

Albuquerque 

Richmond Note: Capitalized cities 

SACRAMENTO are among the 13 

Norfolk markets identified as at 

Oakland risk for overbuilding. 

Raleigh 

National 

0% 2% 4% 6% 8% 10% 12% 

Construction Employees as a Percentage of the Nonfarm Workforce 

Source: Bureau of Labor Statistics (Haver Analytics) 

15 The data vendors do not provide category breakdowns for construction activity into speculative versus nonspeculative (preleased) 

properties. 

CHART 11 

Many of the 13 At-Risk Markets Report High 

Retail Construction Activity and High Retail 

Vacancy Rates 

0 

5 

10 

15 

20 

25 

30 

35 

40 

0% 2% 4% 6% 8% 10% 12% 14% 16% 

Source: F.W. Dodge 

Vacancy Rate 

Construction Activity as a Percentage of Stock

Note: Capitalized cities 

are among the 13 

markets identified as at 

risk for overbuilding. 

LAS VEGAS 

ORLANDO DALLAS 

PHOENIX 

ATLANTA SACRAMENTO 

Tampa DENVER 

JACKSONVILLE 

Greensboro 

FORT 

WORTH 

W. Palm Beach 

Greenville 

Nation 

Nashville 

Memphis Regional Outlook 18 Third Quarter 2000 
In Focus This Quarter
 

What Market Analysts Are Saying 

Views of industry analysts provide additional perspective on the risks pertaining to each of the five property 

sectors and the individual metropolitan areas. 

Office 

Newly constructed nationwide office supply will outpace demand in 2000 and beyond, according to Torto 

Wheaton Research.16 Some 65 million square feet of 

space is scheduled for completion in 2000. However, net 

absorption is projected to be only 58 million square feet 

in 2000, resulting in an excess supply of 7 million square 

feet. Torto Wheaton Research predicts that office completions will outpace absorptions for all projected yearends through 2005, and corresponding vacancy rates will 

climb to slightly more than 14 percent at year-end 2005. 

Overall office fundamentals are in equilibrium, according to Donaldson Lufkin & Jenrette (DLJ), thanks to 

preleasing and sufficient demand.17 Still, DLJ identifies 

a number of markets as being at greater risk for excess 

new supply. DLJ’s markets to watch for possible overbuilding are Charlotte, Fort Lauderdale, Minneapolis, 

and Sacramento. More than 9 percent in new supply is 

projected for Sacramento over the next 18 months, with 

only a 3 percent increase in demand. DLJ identifies the 

Sacramento suburbs as the major center of construction 

activity and notes with concern the existing 13 percent 

suburban vacancy rate for this metropolitan area. 

Overall office construction levels will peak this year, 

according to the Urban Land Institute (ULI).18 Increases 

in suburban office vacancy rates to nearly 11 percent by 

the end of 2000 are projected, with downtown rates falling 

to slightly over 8 percent. ULI notes the possibility of a 

rash of space returns by Internet companies and others in 

the technology sector as a significant going-forward risk. 

Many analysts caution about the ability of new office 

construction to be absorbed in certain markets where 

labor supplies remain tight. In recent Wall Street Journal articles, Dallas and Seattle are reported to be actively recruiting high-tech engineers through immigrants 

from India and China to fill in the gaps in their tight 

labor-market pool for high-technology jobs.19, 20 

16 Torto Wheaton Research. Spring 2000. Office Outlook.
 17 Thierry Perrein, Donaldson, Lufkin & Jenrette. April 2000. DLJ
 

REIT Corporate Handbook, “Cautious Optimism.”
 

18 Urban Land Institute. ULI 2000 Real Estate Forecast.
 19 Templin, Neal. June 7, 2000. Economic Focus: Houston, Dallas
 

Are Draw for Immigrants. The Wall Street Journal.
 20 Barnes, Brooks. June 7, 2000. Economic Focus: Seattle Enjoys
 

Influx of Foreign Workers. The Wall Street Journal.
 

In a recent office market report by Moody’s Investors 

Service, three metropolitan areas (Jacksonville, 

Nashville, and Phoenix) are coded as “red”—indicating 

danger for high supply and declining demand factors.21 

Charlotte is coded as “yellow,” and its office demand is 

projected to grow by only 5 percent this year, while supply will increase by over 11 percent. 

Multifamily 

Recent mortgage rate increases will slow purchases of 

single-family homes, thereby increasing the demand for 

multifamily properties, according to a recent article by 

PaineWebber.22 Nevertheless, concerns are raised for 

oversupply conditions for multifamily construction in 

Atlanta, Dallas, Houston, and Las Vegas—cities characterized as “low barrier-to-entry markets.” 

Markets appearing weak to DLJ for the multifamily 

property sector include Charlotte, Denver, Jacksonville, 

Orlando, Portland, Raleigh, Salt Lake City, and Seattle.23 

Industrial 

Atlanta and Dallas are weaker for the industrial property 

sector, according to DLJ, because of significant new supply levels.24 A 7 percent supply growth is projected for 

Phoenix in 2000, with only a 4 percent increase in demand. 

Retail 

For retail properties, DLJ believes a number of markets 

have excess supply; the standouts are Austin, Las Vegas, 

Orlando, Phoenix, and Sacramento.25 

Hotel 

Analysts point to specific concerns for a “glut” of limited-service hotels in certain markets and note many hotel 

developers taking advantage of low barriers to entry for 

hotel construction. In response, many developers argue 

that “product differentiation” within different hotel sectors justifies further development. 

Growth in expenditures on hotel construction has been 

above 7 percent for each of the past several years, while 

room revenues grew at a more moderate pace, according 

to PaineWebber.26 The poor growth in room revenue is 

attributed to supply exceeding demand. 

21 Gordon, Sally. June 2, 2000. Moody’s Investors Service, Special
 

Report—CMBS: Red-Yellow-Green Update, Second Quarter
 

2000, Quarterly Assessment of U.S. Property Markets.
 

22 PaineWebber. June 6, 2000. Real Estate Investment Trust—
 

Initiating Coverage on the REIT Industry.
 

23 Ibid.
 

24 Ibid.
 

25 Ibid.
 

26 PaineWebber. June 1, 2000. Industry Outlook Lodging, U.S.
 

Hotel Construction Update—First Quarter 2000.
 

Memphis Regional Outlook 19 Third Quarter 2000 
In Focus This Quarter
 

CHART 12 CHART 13 

Many of the 13 At-Risk Markets Report High 

Hotel Construction Activity and High Room 

Availability (Vacancy) Rates 

0 

5 

10 

15 

20 

25 

30 

15% 20% 25% 30% 35% 40% 45% 

Vacancy Rate 

Source: F.W. Dodge Construction Activity as a Percentage of Stock

Note: Capitalized cities 

are among the 13 

markets identified as at 

risk for overbuilding. 

FORT WORTH 

JACKSONVILLE 

ORLANDO 

PORTLAND 

DENVER 

SALT LAKE CITY 

Oakland SEATTLE CHARLOTTE 

Nation 

DALLAS 

Austin Columbus Greenville 

Greensboro 

Many of the 13 At-Risk Markets Report High 

Multifamily Construction Activity and High 

Multifamily Vacancy Rates 

0 

2 

4 

6 

8 

10 

12 

3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 

Source: F.W. Dodge Vacancy Rate Construction Activity as a Percentage of Stock

Note: Capitalized cities 

are among the 13 

markets identified as at 

risk for overbuilding. 

ORLANDO 

CHARLOTTE 

PORTLAND Raleigh DALLAS 

DENVER LAS VEGAS SEATTLE 

PHOENIX 

ATLANTA 

Nation 

JACKSONVILLE Columbus 

Tampa Austin 

Indianapolis Houston 

Birmingham 

As shown in the referenced charts, multiple cities are 

experiencing high volumes of construction activity concurrent with high vacancy rates. Seven of the 13 at-risk 

cities show up in the upper-right quadrants, exhibiting 

both high rates of construction and vacancy: Atlanta 

for industrial and multifamily; Dallas for office and 

retail; Fort Worth for retail and hotel; Jacksonville for 

office and hotel; Las Vegas for office and industrial; 

Orlando for office and multifamily; and Salt Lake 

City for office and hotel. 

Other metropolitan areas beyond these 13 are precariously situated at the furthermost positions on the charts 

for high vacancy and high construction levels: Austin 

and Houston for multifamily; Greensboro for hotel; 

Greenville for retail and hotel; and West Palm Beach 

for office and retail. 

Conclusion 

Since 1997, responding to a void left by the departure of 

other capital market lenders, community banks have 

stepped up their CRE lending activity. At the same time, 

more metropolitan areas are emerging with vigorous 

CRE construction and development across multiple 

property sectors. In the 1998 and 1999 FDIC analyses, 

nine metropolitan areas were identified as being at risk 

for overbuilding across multiple property types. In the 

present analysis, 13 metropolitan areas, including eight 

of the nine from the prior analyses, receive this designation. Given strong levels of CRE completions, these 

metropolitan areas are particularly sensitive to any 

decline in real estate demand that could result from a 

slowdown in the national or regional economy. 

Thomas A. Murray, Senior Financial Analyst 

Memphis Regional Outlook 20 Third Quarter 2000 
In Focus This Quarter
 

Rising Home Values and New Lending Programs Are 


Reshaping the Outlook for Residential Real Estate
 

•	 Home prices have risen rapidly in several major 

U.S. metropolitan areas. 

•	 The credit quality of residential real estate loan 

portfolios traditionally has been solid. 

•	 New lending programs such as subprime and high 

loan-to-value lending could change the historical 

loss experience associated with residential real 

estate. 

Introduction 

The median price of an existing single-family home has 

been rising rapidly in several U.S. metropolitan areas. 

After a prolonged period of stagnant or slowly rising 

resale prices in many of these markets throughout most 

of the 1990s, prices have rebounded strongly, reaching 

double-digit rates of growth in some areas. Not surprisingly, these markets have also experienced relatively 

robust job growth, particularly in high-tech sectors that 

have been the catalyst for growth in the New Economy.1 

However, as existing home prices in some markets have 

been rising rapidly, new building activity has recently 

begun to slow because of rising interest rates. After 

reaching a 19 percent year-over-year growth rate in the 

fourth quarter of 1998, single-family housing starts 

declined by 2.8 percent in the second quarter of 2000. 

Similarly, year-over-year growth in single-family housing permits declined by 8.4 percent in the second quarter of 2000. Higher home mortgage rates, along with the 

prospect for more moderate job growth, have dampened 

market activity. 

Single-family mortgages have traditionally been associated with low loss rates compared with other, higherrisk lending lines at insured institutions. However, the 

real estate market is still susceptible to boom and bust 

cycles, which could pose a risk to institutions with 

exposures to residential real estate. This risk would be 

heightened by the formation of asset price bubbles in 

local markets. Furthermore, as the competition among 

1 For a discussion on what is meant by the term “New Economy,” see 

“Banking Risk in the New Economy,” Regional Outlook, second 

quarter 2000; http://www.fdic.gov/bank/analytical/regional/ro20002q/ 

na/t2q2000.pdf. 

mortgage lenders becomes more intense, insured institutions are increasingly participating in new, higher-risk 

types of mortgage lending, such as high loan-to-value 

(LTV) lending and subprime lending. These new lending practices—still largely untested in a recession— 

raise some concerns about the future credit quality of 

residential loan portfolios. 

Home Prices in Some Local Markets 

Are Soaring 

Home prices have been soaring recently in a number of 

large U.S. metropolitan markets. Rapid price increases 

in some of these areas have come on the heels of a period of slow or stagnant growth (see Chart 1). Table 1 

(next page) identifies the top 20 metropolitan markets 

based on the median price of an existing single-family 

home. Many of the areas identified in the table are also 

places where home prices are increasing most rapidly. 

Healthy job growth, tight labor market conditions, and 

a tight supply of available homes have contributed to 

price increases in these areas. 

Some of the same metropolitan areas that are experiencing significant home price appreciation are also 

highly dependent on the high-tech sector. The shaded 

areas in Table 1 highlight the metro markets that not 

only have the highest median home prices in the nation 

but also have a concentration of high-tech employees in 

the workforce greater than 5 percent. Explosive growth 

CHART 1 

–10% 

–5% 

0% 

5% 

10% 

15% 

20% 

25% 

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

Some Large U.S. Metropolitan Areas Have 

Seen the Return of Soaring Home Prices 

Source: National Association of Realtors (Haver Analytics) 

Year-over-Year Growth of the Median Existing Single-Family 

Home Price 

San Francisco 

Boston 

Memphis Regional Outlook 21	 Third Quarter 2000 
In Focus This Quarter
 

TABLE 1 

Of the 20 U.S. Cities with the Most Expensive Housing, 

More than Half Have a Concentration in High-Tech Employment 

THE SHADED AREAS INDICATE MARKETS WHERE HIGH-TECH EMPLOYEES CONSTITUTE AT LEAST 

5 PERCENT OF THE TOTAL PAYROLL EMPLOYMENT (SEE NOTE). 

METROPOLITAN STATISTICAL AREA 

RANKING BY MEDIAN HOME PRICE 

MEDIAN PRICE OF AN EXISTING 

SINGLE-FAMILY HOME 

MARCH 2000 

PERCENT CHANGE 

FROM ONE YEAR AGO 

1 SAN FRANCISCO, CA $418,600 25.0% 

2 ORANGE COUNTY, CA $300,800 10.3% 

3 HONOLULU, HI $289,000 –2.0% 

4 BOSTON, MA* $255,000 8.4% 

5 SAN DIEGO, CA $251,400 16.1% 

6 BERGEN-PASSAIC, NJ $250,200 9.8% 

7 NEWARK, NJ $229,500 18.8% 

8 SEATTLE, WA $226,100 8.3% 

9 NEW YORK, NY $221,500 14.3% 

10 NASSAU-SUFFOLK, NY $209,200 12.8% 

11 LOS ANGELES, CA $202,900 5.6% 

12 MIDDLESEX, NJ $198,500 8.6% 

13 MONMOUTH-OCEAN, NJ $186,200 19.4% 

14 DENVER, CO $181,500 12.9% 

15 WASHINGTON, DC-MD-VA $177,500 5.6% 

16 PORTLAND, OR $166,700 0.8% 

17 CHICAGO, IL $166,700 0.4% 

18 LAKE COUNTY, IL $162,600 –2.2% 

19 AURORA-ELGIN, IL $158,200 7.5% 

20 RALEIGH-DURHAM, NC $156,300 –4.2% 

NATION $133,533 2.7% 

* Ranking based on the latest data available (third quarter 1999). 

Note: High-tech, as defined by Dismal Sciences, Inc., includes industries such as pharmaceuticals, computers, 

electronic components, communications equipment, and communications services. 

Sources: National Association of Realtors (Haver Analytics); Dismal Sciences, Inc. 

in technology industries during this expansion has created new job opportunities in many metropolitan areas 

where high-tech companies and employment tend to be 

concentrated. The influx of highly skilled, and often 

highly compensated, high-tech workers into these areas 

has boosted the demand for both new and existing 

homes, pushing up home prices. For example, in San 

Francisco, where high-tech employees now comprise 

7.1 percent of the total workforce, home prices rose by 

22 percent in calendar year 1999 and are expected to 

rise another 14 percent in 2000.2 

2 July 21, 2000. Your Money Matters: Turning Down the Heat on 

Home Prices—Forecasters Find More Evidence That the Market Is 

Cooling; San Francisco Still Rocks. The Wall Street Journal. 

Soaring home prices in these metro areas have created 

the possibility of speculative price bubbles that could 

cause problems for mortgage lenders. If a decline in 

high-tech employment or company earnings were to 

cause a deterioration in home values in these markets, 

the credit quality of mortgage portfolios at insured institutions could be jeopardized. 

Favorable Economic Conditions Have Sustained 

Consumer Spending Patterns 

As the current U.S. expansion entered its 113th month 

in July 2000, consumer spending continued along a path 

of rapid growth. In the second quarter of 2000, personMemphis Regional Outlook 22 Third Quarter 2000 
In Focus This Quarter
 

al consumption expenditures increased by 8 percent 

over the previous year. Nearly ideal conditions for consumers have contributed to high levels of spending. The 

unemployment rate remains near the record low of 3.9 

percent set in April 2000, and consumer confidence 

remains near the record high set in January 2000. Moreover, consumer buying power has been boosted by real 

wage gains, generally low interest rates, and stock market earnings. 

One of the only negative aspects for consumers has 

been the recent rise in interest rates, which has 

increased the cost of borrowing. From the end of 1998 

to June 2000, both the bank prime lending rate and the 

average mortgage contract rate for purchase of a previously occupied home rose by more than 100 basis 

points. However, the flexibility offered by adjustablerate mortgages (ARMs) has helped consumers shield 

themselves from the full effects of interest rate increases. As of the second quarter of 2000, the share of ARMs 

as a percentage of all loans closed had risen from 10 

percent in the fourth quarter of 1998 to 30 percent (see 

Chart 2). 

Nonetheless, as interest rates have risen, overall activity 

in the single-family housing market has slowed noticeably. After reaching an annualized rate of 1.4 million 

units in December 1999, monthly starts of single-family 

homes have declined by more than 15 percent to 1.2 

million units in June 2000. Similarly, the annualized 

rate of single-family permits issued in June 2000 was 

down 14 percent from January 2000 levels. The National Association of Realtors (NAR) reports that, despite 

current high levels of activity, deteriorating affordability conditions are expected to slow the resale housing 

market over the course of the year.3 In June 2000, NAR’s 

composite Housing Affordability Index fell to its lowest 

point since September 1996. To the extent that any 

decline in economic conditions would produce a less 

favorable environment for consumers, the housing market would likely slow even further. 

Overall Credit Quality of Residential 

Mortgages Has Been Solid 

Historical losses from residential real estate exposures 

at insured institutions are well documented. In the 

1980s, areas such as Texas, California, and New Eng3 National Association of Realtors Press Release. August 1, 2000. 

Housing Affordability Drops to Eight-Year Low, NAR Reports. 

CHART 2 

6.5% 

7.0% 

7.5% 

8.0% 

8.5% 

9.0% 

Jan-97 Sep-97 May-98 Jan-99 Sep-99 May-00 

5% 

10% 

15% 

20% 

25% 

30% 

35% 

More Consumers Have Chosen ARMs 

as Mortgage Rates Have Risen 

Sources: Federal Reserve Board; Federal Housing Finance Board (Haver 

Analytics) 

Contract Rate on Conventional 

30-Year Mortgage 

Commitments 

Adjustable-Rate Home 

Mortgage Loans as a 

Percentage of All Loans Closed 

land experienced strong economic growth, rapid residential development, and sharp home price appreciation 

that created asset price inflation. Coastal California 

markets, in particular, experienced double-digit growth 

rates that propelled the median home price in California 

to more than double the national average.4 

Regional recessions in many of these areas took a toll 

on residential real estate markets. Home values either 

stagnated or declined precipitously, and the foreclosure 

rate on residential real estate began to rise rapidly. Nevertheless, very few bank failures can be attributed solely to losses on residential mortgages. Loss rates on 

residential loans have traditionally been low compared 

with other loan categories. 

The credit quality of conventional single-family mortgage portfolios has generally been good throughout this 

economic expansion. The percentage of conventional 

loans past due during this expansion has averaged 2.8 

percent, compared with 3.5 percent during the last 

expansion from 1982 to 1990.5 Moreover, past-due conventional loans fell for the sixth consecutive quarter in 

the first quarter of 2000 to 2.3 percent (see Chart 3, next 

page). Foreclosures started, while slightly higher on 

average than the previous expansion, remain at a 

healthy level well below 1 percent of loans (see Chart 4, 

next page). 

4 Federal Deposit Insurance Corporation, Division of Research and 

Statistics. 1997. History of the Eighties: Lessons for the Future. Vol. 

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

1990s. http://www.fdic.gov/bank/historical/history/contents.html. 5 “Past due” refers to loans that are 30 or more days past due. 

Memphis Regional Outlook 23 Third Quarter 2000 
In Focus This Quarter
 

By contrast, Veterans Administration (VA) and Federal 

Housing Administration (FHA) loans have performed 

less well during this expansion. These loan types are 

both designed to aid less creditworthy borrowers in 

securing a home loan. VA and FHA loans, which 

include a portion of the higher-risk high-LTV and subprime loans, have historically experienced higher pastdue and foreclosure rates than other classes of mortgage 

loans (see Charts 3 and 4). 

The overall performance of 1–4 family residential mortgages at insured institutions has been solid. As of March 

2000, delinquent 1–4 family loans remained well under 

1 percent of total 1–4 family loans, and the percentage 

of charge-offs was nearly zero. Charge-offs may have 

reached the bottom of the credit cycle in 1998, however, after peaking at a record high in 1993 (see Chart 5). 

CHART 3 

Past-Due Rates on FHA and VA Loans Have
 

Historically Been Higher than
 

on Conventional Loans
 

Loans Past Due as a Percentage of All Loans 

10.0 Federal Housing Administration 

8.0 

6.0 

Veterans Administration Loans 

Loans 

4.0 

2.0
 

Conventional Loans
 

0.0
 

4Q82 3Q85 2Q88 1Q91 4Q93 3Q96 2Q99 

Source: Mortgage Bankers Association (Haver Analytics) 

CHART 4 

Foreclosure Rates on FHA and VA Loans
 

Remain Higher than on Conventional Loans
 

Foreclosures Started as a Percentage of All Loans 

0.8 

0.7 Federal Housing Administration 

Loans 

0.6 

0.5 

0.4 

0.3 

0.2 

0.1 

Veterans Administration Loans 

Conventional Loans 

0.0 

4Q82 3Q85 2Q88 1Q91 4Q93 3Q96 2Q99 

Source: Mortgage Bankers Association (Haver Analytics) 

A trend toward higher charge-off rates might be cause 

for concern at a time when conditions in the consumer 

sector seem to be excellent. Moreover, as with regional 

problems that surfaced in the late 1980s and early 

1990s, the aggregate data may still mask evolving submarket residential real estate problems associated with 

local economic and business conditions or new, higherrisk lending lines of business. 

Concerns have arisen recently about the future of residential loan credit quality and consumer credit quality 

in general. The Board of Governors of the Federal 

Reserve System warned that, although the consumer 

sector seems healthy by most measurable standards, 

“[consumer] delinquency rates may be held down, to 

some extent, by the surge in new loan originations in 

recent quarters because newly originated loans are less 

likely to be delinquent than seasoned ones.”6 Consumer 

credit outstanding grew by nearly 8 percent in the second quarter of 2000, the highest growth rate in the past 

three years. At the same time, 1–4 family loans at 

insured institutions expanded by 11 percent from March 

1999 to March 2000, the highest year-over-year growth 

rate since 1997. 

High growth rates are not the only concern regarding 

the future credit quality of residential loan portfolios. 

Rising interest rates have raised the cost of borrowing 

for consumers at a time when consumer credit has been 

expanding rapidly. Mortgage debt service payments as a 

percentage of disposable personal income rose to nearly 6 percent in the first quarter of 2000, continuing an 

CHART 5 

1–4 Family Loan Charge-Offs May Have 

Reached the Bottom of the Credit Cycle 

1–4 Family Loan Charge-Offs as a Percentage 

of All 1–4 Family Loans 

0.30 

0.25 

0.20 

0.15 

0.10 

0.05 

0.00 

’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 

Fourth Quarter 

Source: Bank and Thrift Call Report Data (Research Information System) 

6 Board of Governors of the Federal Reserve System. July 20, 2000. 

Monetary Policy Report to the Congress. p. 7. 

Memphis Regional Outlook 24 Third Quarter 2000 
In Focus This Quarter
 

upward trend since mid-1994. This level was last 

reached in 1991, when the economy was emerging from 

an economic recession and some local residential markets were in turmoil. Further increases in interest rates 

would push mortgage debt service payments higher, 

which could impair the ability of mortgage holders to 

service both mortgage debt and other consumer debt. 

Moreover, other consumer loans would likely enter 

delinquency before mortgage loans, as consumers are 

more likely to pay their mortgages before other consumer debt. 

New Residential Lending Programs May 

Heighten the Risk Exposure of Insured 

Institutions 

Recent trends in high-LTV and subprime lending have 

heightened the risk exposure of insured institutions. 

Intense competitive pressure in the banking industry has 

narrowed the margins of traditional lending lines, 

inducing banks to seek more profitable lines of business. Both high-LTV and subprime lending offer wider 

margins, but at the price of increased risk to the lender. 

High-LTV loans represent greater risk to lending institutions when collateral values decline. If a home loan is 

underwritten on the basis of an inflated home value, 

there is a greater possibility of default if the value of the 

home declines. Furthermore, a decline in the value of 

the home could reduce the possibility of recovering the 

loan in the event of default and foreclosure. 

The share of high-LTV loan originations is growing.7 

The percentage of loans with an LTV ratio greater than 

90 percent has risen from around 5 percent to more than 

20 percent over the past ten years.8 Table 2 identifies the 

metropolitan areas where more than 30 percent of the 

conventional home loans underwritten in 1999 carried 

an LTV ratio greater than 90 percent. Given that the historical cycles of boom and bust in residential real estate 

have often been geographically isolated, both regional 

and national trends in high-LTV lending should be carefully monitored. 

7 See also Diane Ellis. “High Loan-to-Value Lending: A New Frontier in Home Equity Lending.” Regional Outlook, first quarter
 

1999; http://www.fdic.gov/bank/analytical/regional/ro19991q/na/
 

t1q1999.pdf.
 

8 Federal Housing Finance Board.
 

Subprime lending is a term commonly used to refer to 

loans that are extended to borrowers who are perceived 

as less creditworthy.9 As insured institutions have 

increased their involvement, the subprime lending 

market has presented banks with new growth opportunities and new risks. Subprime loans represent a small 

but growing share of total mortgage originations (see 

Chart 6, next page). To be sure, higher pricing on subprime loans promises wider margins and higher revenues for lenders, but the credit risk associated with 

less-than-prime borrowers requires ongoing oversight 

and management to prevent credit losses from eroding 

margins. Some financial institutions that have either 

grown subprime portfolios or acquired subprime affiliates are now scaling back their involvement in subprime 

TABLE 2 

Pockets of Risk May Be Forming 

Where the LTV Is Highest 

PERCENTAGE 

METROPOLITAN STATISTICAL OF LOANS 

AREA (MSA) OR CONSOLIDATED WITH LTV 

MSA RANKED BY PERCENTAGE OVER 90 OF LOANS WITH LTV GREATER PERCENT 

THAN 90 PERCENT 1999 

1 GREENVILLE-SPARTANBURGANDERSON, SC
 50% 

2 HONOLULU, HI 42% 

3 MEMPHIS, TN 38% 

4 CHARLOTTE-GASTONIAROCK HILL, NC-SC 37% 

5 BIRMINGHAM, AL 35% 

6 HOUSTON-GALVESTONBRAZORIA, TX 35% 

7 ATLANTA, GA 32% 

8 JACKSONVILLE, FL 32% 

9 NASHVILLE, TN 32% 

10 OKLAHOMA CITY, OK 32% 

11 TULSA, OK 32% 

12 GREENSBORO–WINSTONSALEM–HIGH POINT, NC 31% 

13 KANSAS CITY, MO-KS 30% 

14 LAS VEGAS, NV-AZ 30% 

LTV = loan-to-value 

Source: Federal Housing Finance Board 

9 See also Kathy R. Kalser and Debra L. Novak. “Subprime Lending: A Time for Caution.” Regional Outlook, third quarter 1997; 

http://www.fdic.gov/bank/analytical/regional/ro19973q/pdf/roa1997. 

pdf. 

Memphis Regional Outlook 25 Third Quarter 2000 
In Focus This Quarter
 

lending activities to limit projected losses.10 In some 

cases, excessive losses related to the business of underwriting subprime loans have contributed to the failure 

of insured institutions. 

A recent report from Inside Mortgage Finance states 

that subprime portfolios are showing evidence of weakness.11 According to this report, the serious delinquency 

rate in the overall subprime market rose from 6.5 percent in 1998 to 6.9 percent in 1999.12 Furthermore, the 

percentage of A-rated borrowers in the subprime market 

fell from 59 percent to 53 percent during the same period. The implication is that both subprime and prime 

mortgages originated this year could likely underperform relative to prior years, adversely affecting credit 

quality at insured institutions. 

The potential for higher future losses related to subprime lending is of particular concern. The delinquency rate on subprime mortgages has traditionally been 

much higher than that of prime mortgages. As of 

December 1999, seriously delinquent prime mortgage 

loans comprised only 0.5 percent of total mortgage 

loans, compared with 3.2 percent of the best-rated subprime loans. Subprime mortgage loan seasoning analysis shows that 1999 vintage subprime loans have so far 

outperformed both 1997 and 1998 vintage loans (see 

Chart 7). However, there is a concern that adverse 

CHART 6 

Subprime Mortgage Loans Are Growing as a
 

Percentage of Total Mortgage Originations
 

Subprime Mortgage Subprime Mortgage Loans as a
 

Loan Originations, Percentage of Total Originations
 

200 

in Billions of Dollars 

20% 

150 15% 

100 10% 

50 5% 

0 0% 

’94 ’95 ’96 ’97 ’98 ’99 1Q00 

Sources: The Mortgage Market Statistical Annual for 1999; Inside B&C Lending 

10 Subprime Mortgage Market Faces More Challenges in Second Half 

of Turbulent 2000. Inside Mortgage Finance. July 7, 2000. 11 Mortgage Delinquency Rates Decline in Early 2000 But Industry 

Braces for Shift in the Wind. Inside Mortgage Finance. July 14, 2000. 12 Seriously delinquent loans are defined as loans at least 90 days 

delinquent or in foreclosure. 

changes in economic conditions and the health of the 

consumer sector could cause the foreclosure rate on 

subprime mortgage loans to increase more steeply than 

in prior years. 

Conclusion 

Rising home prices in some U.S. metropolitan areas 

may be a warning sign that asset price bubbles may be 

forming in some areas. A number of these areas also 

contain concentrations of employment in the high-tech 

sector, placing them at higher risk in the event of a 

downturn in that sector. Mortgage lenders in these areas 

should carefully monitor developments that could 

adversely affect home prices and collateral values. 

Nationally, single-family housing market activity 

appears to be slowing after a period of rapid growth 

supported by a long economic expansion and generally 

favorable interest rates. 

Historically, mortgage loans at insured institutions 

have been one of the best-performing asset classes. As 

1–4 family loan charge-offs have approached zero, it 

appears as if the credit cycle may have bottomed out, 

implying that loss rates may be rising. Moreover, as 

insured institutions increase involvement with subprime and high-LTV lending, the potential for higher 

future losses on residential real estate also increases. It 

will be important to keep an eye on developments in 

the economy and the consumer sector that could affect 

the future credit quality of residential real estate at 

insured institutions. 

Alan Deaton, Financial Economist 

CHART 7 

1999 Vintage Subprime Residential Loans Have 

Outperformed Earlier Vintages 

Foreclosure Rate on the Dollar Volume of B&C Grade 

Subprime Single-Family Residence 

7.0% 

6.0% 

5.0% 

4.0% 

3.0% 

2.0% 

1.0% 

0.0% 

1997 Vintage 

1998 Vintage 

1999 Vintage 

6 9 12 15 18 21 24 27 30 33 36 39 

Months of Seasoning 

Source: Mortgage Information Corporation 

Memphis Regional Outlook 26 Third Quarter 2000 
✁
 

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Boston _________ Kansas City _________ San Francisco _________ All _________ 

Chicago _________ Memphis _________ 

Federal Deposit Insurance Corporation 

Washington, DC 20429-9990 

OFFICIAL BUSINESS 

PENALTY FOR PRIVATE USE, $300 

BULK RATE
 

MAIL
 

Postage &
 

Fees Paid
 

FDIC
 

Permit No. G-36