Outlook
 

FALL 2003 

In Focus This Quarter 

The reluctance of businesses to hire and invest in new equipment has 

been a significant drag on the economy’s progress since the 2001 recession ended. The banking industry, though, has continued to do well and 

credit quality continues to improve despite a climate of subpar economic 

growth. However, as signs have pointed to accelerating U.S. economic 

activity during the third quarter of 2003, long-term interest rates have 

risen sharply. The recent increase in interest rates may raise certain 

concerns for some insured institutions, including reduced refinancing 

demand; asset-extension risk; reduced valuation of mortgage-backed securities and other securities holdings; and more difficulty generating low 

cost, core deposits, as households seek greater yields than those offered by 

bank deposits. See page 3. 

By Risk Analysis Staff 

San 

Francisco 

Kansas 

City 

Dallas Atlanta 

New 

York 

Chicago 

Regional Perspectives 

Atlanta—Weak conditions persist among many segments of 

the commercial real estate sector in most major Southeastern 

markets. However, because property valuations have not 

declined, loan quality at insured institutions has weakened 

only modestly. See page 11. 

Chicago—Information technology advancements have 

improved access to banking services in the Chicago Region 

and across the nation. Layered security can mitigate vulnerabilities arising from increasingly complex computer systems. 

See page 17. 

Dallas—The Region’s rural economy is showing signs of life 

despite a prolonged slump in the agricultural and manufacturing sectors, but recovery is not assured. See page 21. 

Kansas City—Continuing weakness in the aircraft manufacturing sector could begin to have an adverse effect on insured 

institutions headquartered in the Wichita metropolitan statistical area when extensions to unemployment benefits expire. 

See page 25. 

New York—Despite ongoing job losses, the Region’s insured 

institutions are performing well, and asset quality remains favorable. Earnings could suffer from a continued weak economy or 

from interest rate risk inherent in increasing concentrations of 

long-term assets. See page 30. 

San Francisco—Declining tax revenue could prompt layoffs 

in the state and local government sector, contribute to municipal bond downgrades, and constrain the volume of municipal 

deposits, potentially pressuring the asset quality and liquidity 

of insured institutions. See page 33. 

By Regional Operations Staff 

FEDERAL DEPOSIT INSURANCE CORPORATION 
The FDIC Outlook is published quarterly by the Division of Insurance and Research 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 six geographic regions: 

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

Jack M. Phelps, Regional Manager, 678-916-2295 

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

David Van Vickle, Regional Manager, 312-382-7551 

Dallas Region (AR, CO, LA, MS, NM, OK, TN, TX) 

Midsouth: Gary Beasley, Regional Manager, 901-821-5234 

Southwest: Alan Bush, Regional Manager, 972-761-2072 

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

John G. Jenkins, Acting Regional Manager, 816-234-8112 

New York Region (CT, DC, DE, MA, MD, ME, NH, NJ, NY, PA, PR, RI, VI, VT) 

Mid-Atlantic: Kathy Kalser, Regional Manager, 917-320-2650 

New England: Paul Driscoll, Regional Manager, 781-794-5502 

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

Catherine Phillips-Olsen, Regional Manager, 415-808-8158 

The FDIC Outlook provides an overview of economic and banking risks and discusses how these risks relate 

to insured institutions nationally and in each FDIC region. 

Single copy subscriptions of the FDIC 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 FDIC 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 FDIC Outlook, please call Rae-Ann Miller at 202-898-8523 or 

send an e-mail to rmiller@fdic.gov. 

The views expressed in the FDIC 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 Donald E. Powell 

Director, Division of Insurance 

and Research 

Arthur J. Murton 

Executive Editor Maureen E. Sweeney 

Managing Editor Kim E. Lowry 

Editors Rae-Ann Miller 

Richard A. Brown 

Ronald L. Spieker 

Norman Williams 

Publications Manager Teresa J. Franks 
In Focus This Quarter 

At the Crossroads: Banks See Interest Rates Rise 

as Economy Shows Signs of Improvement 

Economic Growth in the Current 

Expansion Has Been Unbalanced 

Since the end of the recession in November 2001, the 

U.S. economy has expanded at a subpar pace. Real 

gross domestic product (GDP) expanded by nearly 

3 percent during 2002 and at an annualized rate of 

roughly 2 percent through June 2003. Thus far, this 

pace has been insufficient to generate net employment gains. While the 2001 inventory correction 

and accompanying cyclical slump are well behind us, 

certain longer-term, secular features (such as strong 

labor productivity growth) are combining with slack 

global demand and global pricing pressures to limit 

the strength and breadth of the ensuing economic 

expansion. 

Household demand has been the major source of real 

GDP growth since the end of the recession. Consumer 

spending accounted for 2 percentage points of the 

overall 2.5 percent average annualized gain in real 

GDP between December 2001 and June 2003. Over 

the same period, the net contribution of all other 

sectors was only 0.5 percentage points of real GDP 

growth. The contributions from government spending, 

new residential investment, and inventory accumulation were nearly offset by expansion of the trade 

deficit and a modest net contraction in business 

investment for plant, equipment, and software, as 

illustrated in Chart 1. 

Chart 1 

Consumer Spending Has Driven Real GDP


 Growth Since the Recession’s End
 

Real GDP Growth and Contributors to Change
 

Compound Annual Growth, 4Q01 to 2Q03
 

–1 0 1 2 3 

Real GDP 

Consumption 

Government 

Housing 

Inventories 

Business Investment 

Net Exports 

Contributions

to GDP growth

(percent) 

Note: GDP = gross domestic product. 

Source: Bureau of Economic Analysis 

The drag on growth from net exports is in part a longterm structural issue but also may reflect unusually slow 

worldwide economic growth. Weak foreign demand has 

limited any improvement that might otherwise have 

resulted from the 7 percent drop in the trade-weighted 

value of the U.S. dollar since December 2001. Real 

imports rose by about 10 percent in 2002, while real 

exports grew by roughly 4 percent. During the first half 

of 2003, real imports continued to inch ahead, while 

real exports fell by about 1 percent. Since real export 

growth appears unlikely to accelerate over the near 

term, it will be critical that domestic spending on capital equipment and inventories gains traction in order to 

provide a more well-rounded, stronger expansion—one 

that is less likely than the present one to be derailed by 

any unforeseen shocks. A stronger business contribution is especially necessary given the recent high degree 

of dependence on the consumer. Household spending 

for goods and services grew throughout the recession for 

the first time on record, while the dip in new residential investment was extremely mild. Consequently, 

pent-up demand from the household sector, which 

traditionally boosts demand and production growth 

immediately after a recession, may not provide as much 

momentum in this expansion. 

While the consumer sector has carried growth in recent 

quarters, the opposite is true of business spending and 

investment. The reluctance of businesses to hire additional employees and invest in new equipment has 

been a significant drag on the economy’s progress since 

the recession ended. Some have attributed this reluctance to sluggish sales growth; however, while not 

robust, sales for all U.S. nonfinancial corporate businesses grew at a 4 percent annualized pace in both 

fourth quarter 2002 and first quarter 2003. By way of 

comparison, sales for these firms grew at an average 

annual pace of about 6 percent between 1995 and the 

beginning of the recession in early 2001. 

Other explanations include excess worldwide production capacity in many sectors, such as motor vehicles 

and parts, commercial aerospace, telecommunications, textiles, chemicals, and agricultural commodities, as well as increasing globalization of economic 

activity—both of which have impinged on pricing 

power in certain domestic industries that either sell 

FDIC OUTLOOK 3 FALL 2003 
In Focus This Quarter 

internationally or produce goods and services exposed 

to import competition. While it is not readily apparent to what extent nonfinancial corporate business 

sales gains have been constrained by price discounting, the trend in the unit price of real nonfinancial 

corporate GDP may offer some insight into the weak 

state of business pricing power in the current environment (see Chart 2).1 

In addition to global supply and pricing pressures, 

strong and enduring labor productivity gains resulting 

from the late 1990s surge in business investment may 

be limiting the need for additional business investment 

and hiring in the near term. Finally, it has been 

suggested that some U.S. firms may have been more 

focused recently on balance sheet restructuring, corporate governance and control issues, accounting and 

financial reporting accuracy, and the correction of 

other imbalances from the 1990s than on expanding 

their markets and operations. Over the next year, most 

of these distractions should fade, although weak global 

demand could continue to weigh on growth until other 

major economies begin to grow at rates approaching 

their potential. 

The Jobless Expansion Is Weighing 

on Economic Growth 

To an even greater extent than was the case after the 

1990–91 recession, the period since November 2001 

can be called a “jobless recovery.” Weak job growth in 

the wake of the last two recessions may reflect that 

they were short and mild compared with previous recessions, which were typically “V-shaped” and had a more 

pronounced upturn of employment soon after the recessions’ ends. Even so, against the benchmark provided 

by the early 1990s jobless recovery, the recent trend in 

U.S. payroll employment may be cause for some 

concern. As Chart 3 shows, nonfarm payrolls in July 

2003 were 2 percent lower than in early 2001. By way 

of comparison, 1.5 years after the peak preceding the 

early 1990s recession, nonfarm payrolls were already 

well on their way to recovery and were less than 1 

percent below the prior high. 

1 This metric is the difference between nominal and inflation-adjusted 

(real) sales (GDP) of nonfinancial corporate businesses. It is essentially the price component of business sales. 

Chart 2 

Chart 3 

’85

 Price per Unit of Real Nonfinancial

Corporate GDP

% change on year ago 

Global Recession Has Limited U.S. 

Firms’ Aggregate Pricing Power 

Source: Bureau of Economic Analysis 

–2 

–1 

0 

1 

2 

3 

4 

5 

’83 ’87 ’89 ’91 ’93 ’95 ’97 ’99 ’01 ’03 

Hiring Faces Stronger Headwinds 

in This Jobless Recovery 

Total Nonfarm Payroll 

Employment (peak month = 100) 

Months Before and After Onset of Recession 

1990–91 Recession 

2001 Recession 

–24 –18 –12 –6 0 6 12 18 24 30 

July 2003 

95 

96 

97 

98 

99 

100 

101 

Source: Bureau of Labor Statistics 

Why has this divergence occurred? An obvious answer 

is the manufacturing sector’s reluctance to hire additional workers. The world continues to experience 

subpar economic growth, replete with excess capacity 

and disinflationary, or outright deflationary, pressures. 

These pressures are likely limiting firms’ collective pricing power, especially in manufacturing. As would be 

expected, firms operating in an environment where the 

price of their product is declining face two options to 

bolster earnings. The first—making up for a lower unit 

price by increasing sales volume—has proved quite 

difficult given the weak state of global demand in 

recent years. This leaves the second option—cutting 

costs and enhancing efficiency by bolstering productivity. Manufacturing firms are more exposed than many 

services firms to pricing pressure, either because their 

markets are global in nature or because they are subject 

to a high degree of import competition. In addition, 

FDIC OUTLOOK 4 FALL 2003 

36 
In Focus This Quarter 

labor productivity gains have been greatest in the 

manufacturing sector, although this may reflect in part 

a better ability to measure output per hour in these 

industries than in services. 

Payroll reductions and a hesitancy to respond to any 

upturn in demand with new hiring are two approaches 

manufacturers are taking to control costs. The U.S. 

economy shed 2.7 million jobs on net between the 

February 2001 peak and July 2003, with 90 percent, or 

2.4 million jobs, coming from manufacturing. Further, 

half the reduction in factory payrolls occurred after the 

end of the recession in November 2001. During that 

time, nonmanufacturing payrolls inched up by roughly 

183,000 positions, due mostly to strength in education 

and health services and, to a lesser extent, local 

government. 

Weak Job Growth Has Been Offset, So 

Far, by Fiscal and Monetary Policy 

Proactive and sizeable fiscal and monetary stimulus 

helped consumer spending carry economic growth 

through both the recent recession and the subsequent 

period of moderate growth and lackluster labor market 

conditions. While wage and salary growth decelerated 

sharply through the 2001 recession and remained sluggish subsequently, overall income continued to grow at 

a somewhat sturdier pace. This was due in part to antirecession income transfer programs, such as unemployment insurance. 

Additionally, gains in after-tax income have generally 

exceeded those for personal income since summer 

2001, reflecting reduced income tax rates enacted in 

20012 (see Chart 4). In addition, the 2003 Jobs and 

Growth Tax Relief Reconciliation Act is expected to 

boost year-ago after-tax income growth beginning in 

July 2003. This stimulus will last through mid-2004, at 

which time, absent further tax cuts, year-over-year 

income growth will return to its underlying trend and 

more closely reflect changes in net employment. 

Monetary policy also has been quite accommodative, 

contributing to lower short-term and mortgage interest 

rates through mid-2003. Lower short-term rates helped 

to reduce the cost of variable-rate consumer credit. 

They also enabled some households to reduce their 

Chart 4 

Tax Rebates and Tax Cuts Have Boosted 

After-Tax Income Growth 

disposable 

(after-tax) income 

0 

1 

2 

3 

4 

5 

6 

7 

8 

9 

10 

1999 

Percent change one year ago 

Source: Bureau of Economic Analysis 

personal income 

2000 2001 2002 2003

debt service burdens not only by refinancing outstanding mortgage debt but also by rolling higher-cost debt 

into lower-cost, fixed-rate, tax-favored mortgage debt. 

In addition, favorable mortgage rates spurred a significant surge in cash-out refinancing volume during the 

past two years.3 Momentum from that surge will 

provide support to consumer liquidity through at least 

the end of 2003 even though a rise in mortgage rates 

after mid-June quickly began to dampen refinancing 

demand. 

What Is the Outlook for Renewed Hiring? 

As of mid-2003, there was little evidence that businesses planned any significant return to hiring. AccordChart 5 

Summer 2003 Manpower Survey Suggested 

Little Interest in New Hiring 

Source: Manpower Inc. and Bureau of Labor Statistics 

Total employment (R)

 Employment % change on year ago 

Manpower Survey Net Percent

Higher, Seasonally Adjusted 

–2 

–1 

0 

1 

2 

3 

4 

0 

5 

10 

15 

20 

25 

30 

’89 ’91 ’93 ’95 ’97 ’99 ’01 ’03 

All industries, 

net hiring (L) 

2 The after-tax income growth stimulus from the tax rebate checks
 

issued that year appear in the graph briefly just after midyear. 3 See In Focus article in the Summer 2003 FDIC Outlook.
 

FDIC OUTLOOK 5 FALL 2003 
In Focus This Quarter 

ing to Manpower Inc., which conducts quarterly 

surveys of the hiring intentions of more than 15,000 

employers in 473 cities, the outlook for near-term job 

gains turned down in the first half of 2003.4 Chart 5 

shows the recent trend in this survey’s measure of net 

hiring strength, which attempts to gauge the share of 

businesses that plan to increase hiring in the next three 

months. In addition, the chart provides the year-ago 

change in U.S. nonfarm employment. The results of 

the third quarter 2003 Manpower survey suggest that 

employment probably will not expand significantly over 

the remainder of the summer. 

A monthly survey of hiring intentions by the National 

Federation of Independent Business also showed little 

hiring interest by small firms in June, while the employment sub-index from the Institute for Supply Management’s July survey of manufacturing offered a similarly 

glum assessment for renewed factory sector hiring. 

Business Inventories and Investment 

Also Are Weighing on Growth 

Businesses’ inventory liquidation was a significant drag 

on growth during the 2001 recession. However, as liquidation turned to positive accumulation in 2002, this 

component of business spending became a considerable 

boon to GDP growth (see lighter-shaded bars on Chart 

6). Now that inventories are better aligned with the 

pace of sales, no additional stimulus from inventory 

accumulation is anticipated until aggregate demand 

growth shows a noticeable and sustained pick-up. In 

fact, during the first half of 2003, inventory liquidation 

reduced net economic growth at the margin. 

Business fixed investment in equipment, software, and 

buildings contracted more than usual in the recession 

and has been, at best, an insignificant factor in the 

recovery (see Chart 6). Equipment and software spending, which makes up about 85 percent of total business 

fixed investment, has now grown in four of the last five 

quarters. However, offsetting this spending have been 

outlays on commercial buildings, which fell for ten 

consecutive quarters before rising modestly in the 

second quarter of 2003. The net effect has been that 

4 Employers declare their intentions to increase, decrease, or maintain 

the size of their present workforce for the upcoming three-month 

period. The survey was designed with the assistance of the Survey 

Research Center of the University of Michigan. In Chart 5, the current 

seasonal adjustments are by Manpower, Inc. Haver Analytics, Inc. 

calculated the historical seasonally adjusted series. 

Chart 6 

Business Investment Has Begun To 

Contribute to U.S. Economic Growth 

6
 

5
 

4
 Business inventories

Contribution to GDP Growth

(percentage points) 

Business investment 

–2 

–1 

3 

2 

1 

0 

–3
 

–4
 

1Q01 4Q01 3Q02 2Q03 

Note: GDP = gross domestic product. 

Source: Bureau of Economic Analysis 

business investment (the darker-shaded bars in Chart 6) 

has contributed little to overall economic growth until 

recently.5 

In second quarter 2003, overall business spending rose 

and contributed nearly 1 percentage point to real GDP 

growth because of strength in the equipment and software segment and an increase in spending for structures 

after six quarters of decline. In fact, investment in 

structures leveled out in first-half 2003, albeit at a pace 

about 25 percent slower than in late 2000. Thus, it 

should no longer weigh heavily on overall business 

investment, although high vacancy rates and the 

potential for continued subdued employment growth 

likely will keep this category from contributing much to 

economic growth for some time. 

The recent trend in equipment and software outlays has 

been somewhat mixed, depending on the type of 

investment. Spending for information processing equipment and software rose at a double-digit pace in four of 

the six quarters ending June 2003. Growth in this 

component, which accounts for about 60 percent of 

total investment in equipment and software, helped 

offset continued weakness in spending for industrial 

and transportation equipment. 

Current capacity utilization among U.S. manufacturers 

is below 73 percent, which might suggest that years of 

production growth will be needed before the utilization 

rate returns to 80 percent, a rate typically supportive of 

5 In the national income and product accounts, commercial buildings 

include offices, factories and warehouses, hotels and motels, and retail 

facilities. 

FDIC OUTLOOK 6 FALL 2003 
In Focus This Quarter 

a healthy pace of new investment. The amount of 

excess capacity varies considerably among domestic 

manufacturers, however—as low as 63 percent among 

high-tech firms but 74 percent among other manufacturers as a group. The decline in investment spending 

over the past three years has contributed to slower 

growth in the U.S. capital stock, or its total productive 

capacity. This development, plus rising demand for 

manufacturers’ output, should help ease excess capacity, 

thus bringing closer the time when need for new 

investment arises. 

Along this line, manufacturers’ new orders for nondefense, nonaircraft capital goods started rising in late 

2002. Production of such equipment is typically indicative of broader investment trends, so developments 

through midyear 2003 suggested a potential strengthening of business investment going forward. In addition, 

some firms are experiencing an upturn in orders for 

defense-related goods that will spur further investment. 

Various national and regional surveys of manufacturing 

firms reinforce the idea that conditions are improving, 

and that demand for capital goods will rise in coming 

quarters.6 

Banking Industry Continues to Thrive 

Despite Unbalanced Economic Growth 

During first quarter 2003, net charge-offs at FDICinsured institutions totaled $10.4 billion, $1.2 billion 

(10.6 percent) below the level of first quarter 2002. 

This is the second quarter in a row that industry 

charge-offs have been lower than a year earlier, following two-and-a-half years of rising charge-offs. Significant declines in net charge-offs from credit cards and 

commercial and industrial (C&I) loans, which dropped 

18.5 percent and 10.7 percent, respectively, drove the 

overall improvement.7 

Noncurrent loans—loans past due at least 90 days plus 

those on nonaccrual status—also have improved since 

third quarter 2002. Aggregate noncurrent C&I loans 

fell by $1.3 billion (4.7 percent) during first quarter 

2003, the second consecutive quarterly decline. Devel6 For example, the Empire State Manufacturing Survey by the New
 

York Federal Reserve Bank and the national manufacturing diffusion
 

index from the Institute of Supply Management.
 

7 The 18.5 percent drop in credit card charge-offs was influenced by
 

the sale of a large subprime credit card portfolio in first quarter 2002,
 

which produced a spike in charge-offs at that time.
 

opments at large commercial banks with assets of $1 

billion or more, the group most severely affected by 

troubled corporate borrowers during the recent recession, have driven the overall improvement. The group 

of 413 large commercial banks accounts for just 5 

percent of total insured institutions but held 87 percent 

of C&I loans in first quarter 2003. 

After reaching a peak of $1.05 trillion in fourth quarter 

2000, C&I loans outstanding at all commercial banks 

dropped to $907 billion by first quarter 2003. About 

$57 billion of the decline occurred in the year ending 

first quarter 2003. Shrinking C&I portfolios reflect 

both lower demand, given lackluster business investment, and generally tighter lending standards on the 

part of the banks.8 

Despite weak commercial real estate (CRE) fundamentals in some markets, there has been only a minimal 

effect on bank CRE portfolios. A repeat of the largescale losses in commercial bank CRE portfolios in the 

last cycle does not appear likely. Still, the nation’s 

commercial banks registered increases in noncurrent 

CRE loan portfolios of $530 million, or 7 percent, during 

first quarter 2003, and charge-offs are trending upward. 

As a share of total CRE loans at commercial banks, 

however, the noncurrent portion is still a low 0.95 

percent. This is a moderate increase from 0.90 percent at 

year-end 2002 and 0.94 percent at year-end 2001. 

Chart 7 

Credit Card Lenders* Remain Highly 

Profitable Despite High Charge-off Rates 

* Institutions with credit card loans exceeding 50 percent of assets, including securitized 

receivables. 

Source: FDIC 

Return on average assets 

for credit card lenders 

Net charge-off rate 

for credit card lenders 

0 

2 

4 

6 

8 

1988 1991 1994 1997 2000 March 

2003 

1985 

0 

1 

2 

3 

4 

Percent

Percent 

8 According to the Federal Reserve's Senior Loan Officer Opinion 

Survey on Bank Lending Practices, the net percentage of domestic 

banks reporting tightening standards for commercial and industrial 

(C&I) loans has been positive in every survey conducted since August 

1998. See http://www.federalreserve.gov/boarddocs/SnLoanSurvey 

FDIC OUTLOOK 7 FALL 2003 
In Focus This Quarter 

Charged-off CRE loans have increased steadily from a 

low of $38 million in 1997 to $1.17 billion in 2002 but, 

as a percentage of CRE loans outstanding, increased 

from 0.01 percent in 1997 to just 0.14 percent at yearend 2002. Thus, CRE delinquencies and charge-offs as 

a percentage of total CRE loans remained near historic 

lows during the past two years. 

Commercial banks and thrifts have benefited from 

strong consumer loan demand. This is evidenced by 

growth in consumer loans over the four years ending 

March 31, 2003, which averaged 6 percent—up from 

an average of 3.3 percent in the prior four-year period. 

Even with this growth, banks and thrifts continue to 

report modest levels of noncurrent consumer credits. 

For first quarter 2003, the ratio of noncurrent consumer 

loans to total consumer loans was 1.35 percent. 

Although this average ratio was similar to the levels 

recorded during the two years immediately following 

the 1991 recession, it was below the peak of 1.50 

percent seen during that recession. 

The banking industry also has enhanced its profits 

through credit card lending activities. Institutions classified as credit card lenders reported an annualized 

return on assets (ROA) of 3.66 percent for first quarter 

2003, the highest since first quarter 1994, when the 

figure was 3.81 percent. Despite the recent strength in 

credit card profits, annualized net charge-offs rates 

remained higher in first quarter 2003 than in much of 

the 1990s. Annualized net charge-offs to total loans for 

credit card lenders reached 5.57 percent in first quarter 

2003, well above the 4.97 percent in first quarter 

1992—a year or so after the end of the prior recession. 

Meanwhile, noncurrent credit card loans declined in 

first quarter 2003 by $919 million (or 14.3 percent). 

The higher profit margins of credit card lenders, whose 

businesses are benefiting from improved credit-scoring 

technologies relative to the early 1990s, have helped 

compensate them for the higher credit risks of such 

unsecured lending (see Chart 7). 

The total outstanding debt of U.S. households 

increased by $768 billion in 2002. Mortgage debt 

accounted for 87 percent of this amount. For FDICinsured institutions, mortgage-related lending 

accounted for some 64 percent of net loan growth 

during 2002 and 70 percent of asset growth in first 

quarter 2003. During the year ending March 2003, first 

and junior liens outstanding at insured institutions rose 

15 percent. In addition, the industry has experienced 

double-digit growth in home equity lines of credit. 

Chart 8 

Source: FDIC. “Mortgage specialists” are defined in the FDIC Quarterly Banking Profile, 

First Quarter 2003, as a group of 1,072 FDIC-insured institutions with holdings of residential 

mortgage loans and mortgage-backed securities of more than 50 percent of assets that 

do not also fall under the definitions of international banks, agricultural banks, credit card 

lenders, or commercial lenders. 

Profit Margins Have Risen for 

Large Mortgage Specialists 

Aggregate 

Median

Return on Assets as of March

each year (percent) 

0.0 

0.2 

0.4 

0.6 

0.8 

1.0 

1.2 

1.4 

1.6 

’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 

Home equity lines of credit held by insured institutions 

as of March 2003 totaled $277 billion, up 39 percent 

from a year ago. 

Meanwhile, mortgage-backed securities (MBS) offered 

attractive investments for commercial banks and 

thrifts. The banking industry’s holdings of MBS grew by 

20 percent to nearly $1 trillion between the first quarters of 2002 and 2003, far surpassing previous year-ago 

growth in first quarter holdings. As discussed later, 

these assets likely declined in value late in second quarter 2003, as mortgage interest rates climbed dramatically. 

Despite a rising concentration in mortgage-related 

assets, mortgage debt historically has shown lower 

levels of credit exposure than other loan types. In addition, low interest rates have kept the household debt 

service burden at a reasonable 14 percent of disposable 

income, despite recent large increases in household 

indebtedness. To the extent that most of this recent 

debt accumulation has taken the form of fixed-rate 

mortgage borrowing, household debt service burdens 

may not rise appreciably with higher interest rates over 

the business cycle. Further, any sustained rise in interest 

rates likely would imply that the recent fiscal and 

monetary stimuli have been successful in spurring 

economic growth, so advancing employment and aggregate income would be expected to improve debt service 

capacity. 

Commercial banks and thrifts have profited from the 

boom in mortgage originations. Insured institutions 

identified as mortgage lenders reported a recordbreaking ROA of 1.49 percent in first quarter 2003; 

FDIC OUTLOOK 8 FALL 2003 
In Focus This Quarter 

however, this trend appears to be driven by large Chart 9 

institutions originating mortgage loans and holding Commercial Banks Have Increased Their MBS MBS assets, as the median profitability in this Holdings in Recent Years segment, though also improved, remains within its 10.5 

historical range (see Chart 8). Further, to the extent 

that the recent peak in aggregate profitability reflects 

gains from the sale of MBS and other securities 

through the early part of this year, the recent rise in 

interest rates and subsequent decline in the value of 

securities may detract from earnings in subsequent 

quarters. Finally, even though net charge-offs for 

mortgage lenders also increased modestly, to 0.19 

percent from 0.16 percent in the prior year, these 

low loss rates speak to the relatively low credit risk 

of residential mortgages. 

While stronger economic growth likely will result in a 

continued improvement in credit quality, it also appears 

likely to bring higher interest rates, which will raise the 

cost of credit to borrowers and the cost of funds to 

banks and thrifts. Long-term interest rates have risen 

sharply in the third quarter of 2003, even as the federal 

funds target rate was cut an additional quarter percent 

to 1.0 percent in late June. 

Despite the recent rise in intermediate- and longerterm interest rates, C&I loan growth may strengthen 

as the economy improves. Consumer loans likely will 

continue to grow, though possibly more slowly than 

in the past few years, in light of consumer debt levels 

and a lack of pent-up demand. Rising mortgage rates 

may dampen mortgage refinancing opportunities but 

prompt households to increase their use of home 

equity lines. Commercial real estate loan growth is 

expected to remain anemic and lag the economic 

rebound, given significant amounts of unused space 

available. 

At the height of the bull market in equities, core 

deposits increased by only 3 percent between first quarter 1999 and first quarter 2000. Over the next three 

years, core deposit growth more than doubled, rising 7 

percent in 2000, 8 percent in 2001, and nearly 10 

percent in the year ended first quarter 2003; however, a 

stronger stock market in 2003, coupled with better 

returns in other investment opportunities, may begin to 

reduce the safe-harbor appeal of bank deposits. This 

situation, coupled with record low deposit rates, may 

lead to modest core deposit growth at most insured 

institutions going forward. 

MBS as percent of total assets 10.0 

9.5 

9.0 

8.5 

8.0 

7.5 

7.0 

’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 

6.5 

Note: MBS = Mortgage-backed securities.
 

Source: Federal Reserve Board flow of funds.
 

If banks choose to supplement any shortfall in core 

deposit growth through borrowed funds, to the extent 

these funds are not priced off short rates, funding costs 

will begin to increase at the margin. This rise in funding costs may occur more rapidly than asset prices 

adjust upward, especially if asset prices are tied to a 

short-term rate, such as prime, which likely will remain 

fixed at least through early 2004. 

Despite the boost and earnings brought about by the 

widespread refinancing of mortgage debt and record 

home sales in recent years, interest rate risk issues for 

many mortgage lenders may be elevated. Specifically, 

record long-term, fixed-rate mortgage origination 

volume during the historically low rate environment 

that persisted up to summer 2003 may have generated 

extension risk for many mortgage portfolio holders. 

This can result in net interest margins being squeezed 

as lenders hold low-yielding, long-lived, mortgagerelated assets while funding costs reprice upward along 

with market interest rates. 

Also, banks that are active mortgage loan securitizers 

may see declines in this form of funding as new loan 

originations and refinancings begin to slow down. As 

long-term rates increase, many banks will see their 

unrealized securities gains shrink and perhaps begin to 

experience unrealized losses, further straining liquidity. 

The banking industry as a whole has seen significant 

increases in MBS holdings over the last couple of years 

(see Chart 9). Banks with high proportions of MBS and 

intermediate and long-term agency and treasury securities will be most at risk for future unrealized losses. 

FDIC OUTLOOK 9 FALL 2003 
In Focus This Quarter 

Banks’ Strong Performance Should Continue, Though 

Higher Interest Rates May Raise Some Concerns 

The reluctance of businesses to hire new employees and 

invest in new equipment has been a significant drag on 

the economy’s progress since the recession ended. Possible explanations include sluggish sales growth in a weak 

global economy and reduced pricing power due to 

excess global capacity, which pressures margins and 

result in heightened cost control efforts. Other explanations include strong and enduring labor productivity 

gains resulting from the late 1990s surge in business 

investment, which may be limiting the need for business investment and hiring in the near term. Finally, it 

has been suggested that some U.S. firms during the past 

year may have been more focused on balance sheet 

restructuring, corporate governance and control issues, 

accounting and financial reporting accuracy, and the 

correction of other imbalances from the 1990s than on 

expanding their markets and operations. Over the next 

year, most of these distractions should fade, although 

weak global demand could continue to weigh on 

growth until other major economies begin to grow at 

rates approaching their potential. 

The banking industry continues to do well and credit 

quality continues to improve despite this climate of 

subpar economic growth. The recent rise in interest 

rates, however, may raise certain concerns for the 

industry, particularly for mortgage lenders. These challenges will take the form of slower growth in residential 

real estate loans, particularly refinance transactions; 

asset extension risk, which may tie up capital that 

could otherwise be deployed at higher interest rates; 

increased unrealized losses in MBS and other securities 

holdings; and a reduced ability to generate low-cost, 

core deposits, as rising interest rates spur households to 

seek greater yields than those offered by bank deposits. 

Risk Analysis Staff 

FDIC OUTLOOK 10 FALL 2003 
Regional Perspectives 

A Recovery in Some Atlanta Region Commercial 

Real Estate Markets Remains 

Constrained by Weak Economic 

Growth 

The recent recession was particularly 

problematic for commercial 

real estate (CRE) markets 

in the Atlanta Region. 

The subsequent “jobless” 

recovery has contributed to 

low absorption rates that 

have prevented some 

markets from rebounding. 

This article examines CRE market conditions by property type in the Region’s 

Atlanta Regional Perspectives 

major metropolitan areas, evaluates levels of 

community bank exposure to CRE lending, and 

identifies areas where prolonged weak economic growth 

and market downturns have resulted in CRE asset quality deterioration. 

Office Markets Have Been Hit Hard 

by the Recent Recession 

The recent recession adversely affected office real estate 

markets in the Atlanta Region. Unlike past economic 

downturns, net absorption rates turned negative in 

many areas as layoffs disproportionately affected salaried 

Chart 1 

office workers. Simultaneously, new space remained in 

the construction pipeline because of developers’ prior 

expectations of continued economic growth. Subsequently, market conditions in many instances deteriorated rapidly as vacancy rates rose significantly (see 

Chart 1). Some metropolitan areas that previously had 

been characterized as tight markets suddenly faced the 

prospect of double-digit vacancy rates. Until recently, 

low interest rates had helped support market values; 

however, as leases expire and rent appreciation remains 

weak owing to continued fragile economic growth, these 

markets may come under pressure. During first quarter 

2003, office market values declined nationwide.1 Widespread deterioration in fundamentals continued to occur 

in the Region’s major metropolitan statistical areas 

(MSAs) as office employment growth remained lackluster in the face of further layoffs, and as space offered for 

sublease continued to inflate vacancy rates. 

Office markets in metropolitan areas that are home to 

large concentrations of high-tech employment 

(Atlanta, Raleigh, Northern Virginia) generally experienced the greatest deterioration. The Raleigh and 

Atlanta MSAs reported the Region’s highest office 

vacancy rates in first quarter 2003, while rates in 

Atlanta and Northern Virginia have more than 

doubled during the past few years. Some submarket 

vacancy rates in Raleigh and Northern Virginia 

recently have spiralled to above 30 percent.2 Though 

submarket vacancies in Atlanta have yet to reach that 

Metropolitan Office Markets in the Atlanta Region Have Been Slow to Recover from the Recession 

Vacancy Rate (%) 

25 

20 

15 

10 

5 

0 

Nation Raleigh 

2001 Q1 

2002 Q1 

2003 Q1 

Atlanta Ft. Northern Jacksonville Orlando Charlotte West Palm Miami Tampa 

Lauderdale Virginia Beach 

Source: Torto Wheaton Research 

1 Dean Starkman, “Property Values Finally Decline With Office Space Falling 1.7%,” Wall Street Journal, May 28, 2003. 2 Northern Virginia submarkets: Herndon and Sterling. Raleigh submarkets: Cary, Glenwood/Creedmoor, Northeast Wake County. 

FDIC OUTLOOK 11 FALL 2003 
Regional Perspectives 

Chart 2 

Industrial Markets Have Continued to Deteriorate in Most of the Region’s Major Metropolitan Statistical Areas Completions, Absorption (000 sf, 2003 Q1)

Completions 

Absorption 

Vacancy Rate 

(Basis point difference, 2003 Q1–2002 Q1)

–1,600 

–1,200 

–800 

–400 

0 

400 

800 

West Palm 

Beach 

Miami Ft. 

Lauderdale 

Atlanta Washington, 

D.C. 

Raleigh 

–600 

–300 

0 

300 

Year-Ago Basis Point Difference 

in Vacancy Rates 

Jacksonville Charlotte Tampa Orlando 

Source: Torto Wheaton Research 

level, some local developers speculate that the downturn in the local office market may be the worst in 

nearly three decades.3 In contrast, vacancy rates in 

office markets characterized by significant back office 

operations and call centers, such as Tampa, have 

declined during the year ending first quarter 2003. 

Industrial Real Estate Market Conditions 

Continued to Weaken in Early 2003 

Industrial real estate market conditions in the 

Atlanta Region began to deteriorate with the onset of 

the recent recession as employment in manufacturing, wholesale trade, and high-tech industries started 

to erode. Average vacancy rates in all major regional 

markets have increased significantly. This trend was 

particularly evident in Atlanta, as net absorption 

rates turned negative even as new completions 

continued. Job losses in the nation’s manufacturing 

sector did moderate in late 2002; however, by early 

2003, the sector, particularly among high-tech industries, weakened again. As a result, the Region’s industrial markets experienced negative net absorption 

(see Chart 2) at levels rivaling those at the beginning 

of the recent recession. Nonetheless, vacancy rate 

increases were not as great as during the onset of the 

recent recession, as completions were much lower.4 

Continued job losses in manufacturing likely will 

forestall a rapid recovery in the Region’s industrial 

real estate markets. 

3 Jarred Schenke, “Developer: Atlanta Office Recession May Rival 

’73–’75,” Atlanta Business Chronicle, March 21, 2003. 4 Average vacancy rates in the Washington, DC, Fort Lauderdale, and 

Raleigh MSAs declined modestly in first quarter 2003 from a year 

earlier. 

Retail Real Estate Has Outperformed Other 

Commercial Real Estate Types in Several Atlanta 

Region Markets 

Retail real estate generally has outperformed other 

market types during and following the recent recession. 

Typically, during an economic downturn, retail real 

estate is pressured by declines in consumption as 

incomes fall and consumers attempt to reduce debt. In 

the recent downturn, however, consumer spending 

remained strong and debt levels increased, supporting 

growth in the retail real estate market. However, 

prolonged weak job growth, the potential for a 

retrenchment in consumer spending, and the risk of a 

“double-dip” recession may increase the vulnerability of 

this market type going forward. 

Following the recent recession, rent appreciation in 

the Orlando and Miami MSAs declined significantly 

as domestic and international visitor spending cooled 

retail markets. Subsequently, however, rents have 

appreciated strongly in most of the Region’s retail real 

estate markets (see Chart 3). Rental rates in the Jacksonville, West Palm Beach, and Tampa MSAs have 

deviated from this pattern during the past year, a trend 

that in part may be due to continued market space 

expansion. Since 1999, total retail stock in the Tampa 

metro area has increased more than 10 percent, nearly 

twice the growth rate of major markets nationally. Yearto-date third quarter 2002 new space construction in 

the Jacksonville metro area was up more than 120 

percent from the previous year. Such supply increases 

prompted one investment bank earlier this year to 

FDIC OUTLOOK 12 FALL 2003 
Regional Perspectives 

Chart 3 

Retail Has Outperformed Other Property Types in Many Atlanta Region Markets 

Source: Torto Wheaton Research Rent Inflation (%, 2002) 

Industrial 

Office 

Retail 

Ft. Lauderdale Charlotte Atlanta Miami Orlando Washington, Jacksonville Tampa 

D.C. 

West Palm 

Beach 

–20 

–15 

–10 

–5 

0 

5 

10 

15 

–25 

characterize this MSA as having the greatest vulnerability to oversupply in the state.5 

Hotel Markets Continued to Struggle in Early 2003 

The recent recession had a chilling effect on the 

Atlanta Region hotel industry, as tourism and convention business declined significantly. Double-digit yearago declines occurred in revenue per available room 

(RevPAR) in all major markets except Columbia, by 

fourth quarter 2001 as occupancy and room rates fell 

substantially. This trend was particularly evident in the 

Orlando and Atlanta MSAs, where the tourism and 

convention businesses are essential components of the 

local economy. By late 2002, the tourism industry was 

showing signs of an emerging recovery, allowing 

Chart 4 

RevPAR to rebound from the lows of the previous 

year. However, in early 2003 the looming military 

campaign in Iraq and apparent weakening economic 

growth dealt another round of setbacks to the tourism 

industry. As Chart 4 shows, RevPAR declined from a 

year earlier in all major markets except Fort Lauderdale, Washington, DC, and Miami for full- and 

limited-service hotels during first quarter 2003. The 

events of early 2003 highlight the vulnerability of the 

hotel real estate market to economic and geopolitical 

uncertainties that could continue to pressure any 

further near-term recovery. Many analysts consider the 

hotel sector the property class most likely to experience defaults.6 Limited-service properties operated by 

independent owners appear more vulnerable to default 

Business and Geopolitical Developments Hurt the Region’s Hotel Industry, 

Except in South Florida and the Washington Metro Area, During First Quarter 2003 

Note: NA – Data not available. 

Source: Torto Wheaton Research Revenue per Available Room (Year-Ago Percentage Change) 

–10 

–8 

–6 

–4 

–2 

0 

2 

4 

Full Service 

Limited Service 

Ft. 

Lauderdale 

Miami West Palm 

Beach 

Washington, Columbia Charlotte Atlanta

D.C 

Raleigh Tampa Richmond Orlando 

(NA) (NA) 

5 Gregory Richards, “Is City Building Its Way into a Retail Space Glut?” Florida Times-Union, April 4, 2003. 6 “CRE Losses Likely to Be Modest in this Cycle,” Citigroup Smith Barney: Equity Research Banks, June 3, 2003. 

FDIC OUTLOOK 13 FALL 2003 
Regional Perspectives 

than full-service properties and chains operated by 

large corporate owners.7 

Weak Economic Growth, Continued Construction, 

and an Increase in Home Ownership Have Pressured 

Multifamily Markets 

The “jobless” recovery and record levels of home ownership brought about by low interest rates have contributed 

to rising apartment vacancies (see Chart 5), while new 

construction continues to inflate multifamily stock in 

the Atlanta Region. Rental vacancies have increased 

across the Region during the past two years, while rent 

inflation remains below the U.S. average in all areas 

except the Miami and Washington, DC, MSAs. Nominal rents declined during the year ending fourth quarter 

2002 in the Charlotte, Greensboro, and Atlanta metro 

areas. Persistent low rent inflation across the Region 

could constrain cash flows for property owners and, as a 

result, adversely affect their credit quality. 

CRE Lenders Have Performed Well, 

but Caution Is Warranted 

CRE lenders in the Region have performed fairly well 

throughout this cycle. Profitability has remained solid 

while capital levels and reserves have held steady.8 

Despite this positive performance, modest signs of asset 

quality weakness have emerged. Total noncurrent loans 

have risen in each of the past two 12-month periods 

ending March 31, 2003, driven primarily by deterioration in commercial and industrial, construction and 

development, and 1- to 4-family loans. Noncurrent 

nonresidential loan levels also have increased moderately. Nevertheless, 34 percent of CRE lenders reported 

an increase in noncurrent CRE loan levels at March 

31, 2003, compared to only 28 percent a year earlier. 

In the Atlanta Region, community institutions are the 

primary funding source of nonresidential real estate 

loans.9 In fact, median CRE exposure among community banks in major CRE markets was 21 percent as of 

March 31, 2003, 6 percentage points higher than the 

median CRE exposure among mid-tier banks in these 

same markets.10 However, community banks headquartered in areas such as Atlanta, Raleigh, and Miami, 

where office vacancy rates have risen by at least 7 

percentage points during the past year, have reported a 

significant divergence in asset performance. Community banks based in the Atlanta MSA reported a 

noticeable increase of 52 basis points (to 0.94 percent) 

in noncurrent CRE loans during the 12-month period 

ending March 31, 2003. This compares to 0.73 percent 

among all CRE lenders across the Region. The exposure of the Atlanta MSA to industries that have been 

hard hit during the past 18 months, such as technology, 

telecom, and tourism, increases the vulnerability of 

institutions headquartered there to rising office vacancy 

rates. In addition, a study conducted by Smith Barney 

suggests that community banks based in the Atlanta 

Chart 5 

Apartment Vacancy Rates Have Risen in Several Atlanta Region Metropolitan Statistical Areas 

0 

5 

10 

15 

20 

25 

West Palm 

Beach 

Atlanta Orlando Miami Ft. 

Lauderdale 

Washington, 

D.C. 

Source: Torto Wheaton Research Vacancy Rate (%) 

2000 Q4 

Raleigh Tampa Greensboro Charlotte U.S. 

Average 

2001 Q4 

2002 Q4 

Norfolk Jacksonville

7 Peter Henderson, “Hotel Industry Sees Downturn Moving Deals,” 

Reuters, June 5, 2003; Barbara DeLollis, “Hotels Upgrade Freebies to Fill 

Empty Rooms; Meals, Sweepstakes Offered,” USA Today, July 8, 2003. 8 For purposes of this analysis, CRE lenders hold at least 25 percent of 

assets in nonresidential real estate loans. 

9 Community banks hold assets less than $1 billion and exclude de 

novos and specialty institutions. 

10 Major CRE markets in the Atlanta Region are Atlanta, Charlotte, Fort 

Lauderdale, Jacksonville, Miami, Orlando, Raleigh, Tampa, and West 

Palm Beach. 

FDIC OUTLOOK 14 FALL 2003 
Regional Perspectives 

area are niche lenders to limited-service hotels.11 Given 

the pressure on the travel industry, hotels are considered the weakest property class in the study. A significant exposure to this industry segment may contribute 

to further credit quality weakness. Because Call Report 

data do not allow for separation of loans by property 

type, it is difficult to discern the level of bank and thrift 

industry exposure to the hotel sector. 

By contrast, despite noticeable increases in office 

vacancy rates, community banks headquartered in the 

Raleigh and Miami MSAs have reported improving 

CRE asset quality. The ratio of noncurrent nonresidential loans held by community banks in each of these 

MSAs declined during the 12 months ending March 31, 

2003, to roughly 0.22 percent. Nonresidential loans in 

both areas have surged during the past two years. CRE 

loans as a percentage of total loans have risen approximately 28 percentage points, to 48 percent among banks 

based in the Raleigh MSA. This ratio increased almost 

12 percentage points among banks based in the Miami 

MSA, to roughly 51 percent. Regionally, CRE loan 

portfolios grew just under 7 percentage points during 

this period to 44 percent of total loans. 

According to Torto Wheaton Research, forecasts calling 

for steady increases in office employment during each of 

the next six years may be fueling growth in CRE loan 

levels.12 However, at year-end March 31, 2003, a robust 

pace of loan growth may have masked higher past-due 

loan amounts. Management of insured institutions 

should be aware that deterioration in asset quality often 

lags the business cycle, so lenders should monitor 

concentration levels carefully in the near term. Job 

creation is expected to remain stagnant until business 

investment and economic growth accelerate. As a result, 

capital levels may be vulnerable among community 

banks headquartered in areas with significantly higher 

vacancy rates and CRE exposures, such as the Atlanta, 

Raleigh, and Miami MSAs. Continued economic weakness could contribute to an increase in office foreclosures and higher charge-offs among local institutions. 

Conclusion 

Thus far, the Region has experienced no significant 

deterioration in CRE property values. Falling capitalization rates and robust investor demand have supported 

11 “CRE Exposure for the Banking Industry,” Smith Barney: Bank
 

Weekly, March 4, 2003.
 12 TWR Office Outlook, Spring 2003.
 

Perspectives from the FDIC
 

Regional Director 


In the past few years, examinations of banks with 

concentrations of commercial real estate (CRE) 

have generally reflected sound risk management 

practices and overall satisfactory conditions. Nevertheless, the macro trends cited in the accompanying 

article, particularly with regard to the office market, 

prompted the Division of Supervision and Consumer 

Protection to initiate a CRE credit risk analysis pilot 

program in January 2003. The purpose of the pilot 

was to gather significantly more CRE lending data 

than are available from call reports and briefly to 

assess risk management in Atlanta-area banks with 

large CRE concentrations. Preliminary results indicate 

that Federal Deposit Insurance Corporation-supervised 

banks continue to avoid high concentrations in the 

types of CRE loans identified as primarily susceptible 

to declining market conditions (i.e., office, industrial, 

retail, hotel, and multifamily). As a general rule, the 

banks included in the program were focused on the 

development and construction of residential properties, a market that remains relatively strong. Further, 

banks are well aware of CRE lending risks and are 

managing those risks in a satisfactory manner. As 

analysis of the pilot program data is completed, additional information will be presented. It is also likely 

that, as part of our ongoing supervisory efforts, the 

program will be expanded to other geographic areas 

that exhibit considerable stress in CRE markets. 

Mark S. Schmidt 

Regional Director 

Atlanta, Georgia 

prices. Low interest rates and cost-cutting measures also 

have allowed many owners to break even at lower 

occupancy rates. In cases where cash flow has been 

negative, anecdotal reports indicate that owners have 

been able to sell the property for more than the debt 

outstanding. The ability of property owners to sell in 

order to repay debt may diminish should property 

values weaken. Property valuations could soften if 

fundamentals continue to erode. Property cash flow, 

particularly in the office sector, will be reduced as 

expiring leases reprice downward. Also, technology may 

lower the demand for office space and lead to lower 

rental rates. Computer servers have greater capacity but 

are physically smaller and require less square footage 

than they did even five years ago. Electronic storage 

costs continue to fall, allowing firms to migrate from 

FDIC OUTLOOK 15 FALL 2003 
Regional Perspectives 

paper document retention systems, which lessens the 

need for file room. Improvements in telecommunications have allowed many firms to outsource work to 

remote locations, reducing their need for space. The 

recent productivity gains from computing technologies, 

if sustained, will likely reduce the demand for office 

employment. These factors imply that occupancy rates 

may be lower going forward. Lower occupancy rates 

suggest that rental growth rates will be much slower in 

the next expansionary cycle than the last. A reduction 

in cash flow from these structural and cyclical forces— 

reduced occupancy rates and slower rent growth— 

would offset low capitalization rates and likely lead to 

lower valuations. In the current cycle, rising property 

values have contributed to generally strong CRE loan 

performance among insured institutions. Therefore, 

going forward, market participants should monitor 

property valuations for signs that any of the key fundamentals are weakening. 

Atlanta Staff 

FDIC OUTLOOK 16 FALL 2003 
Regional Perspectives 

Chicago Regional Perspectives
 

Improved Security Is Vital as Information 

Technology Grows More Complex 

Perhaps no area of banking has changed as significantly during the past ten years as information technology (IT). For instance, insured institutions 

increasingly have made banking services and data available 

to customers through automatic teller machines (ATMs) 

and transactional websites. 

The complexity of maintaining 

a secure IT environment 

undoubtedly will increase as 

banks continue to enhance technological capabilities and delivery 

channels. 

At the same time, attacks on IT systems are increasing. 

Every day, new vulnerabilities, labeled with such arcane 

names as denial of service attacks, buffer overflow 

attacks, and session hijacking, are reported nationwide.1 

Experts estimate that the number of attacks in 2003 

will be twice that in 2002. The results of a recent 

Computer Security Institute/Federal Bureau of Investigation (CSI/FBI) survey showed that the vast majority 

of companies polled had experienced some type of 

attack in the past 12 months, many resulting in 

substantial financial losses.2 

The growing complexity of the IT environment and the 

potential for substantial monetary losses increase the 

importance of IT security. Vulnerability to security 

breaches has been heightened as a weak economy 

during the last few years may have pressured IT budgets. 

In an effort to cut costs, the outsourcing component of 

IT budgets may grow the most; however, the decision to 

outsource brings with it particular concerns.3 In addition, merger activity raises many IT issues, as complex 

networks must be coordinated or combined. 

1 Denial of service attacks flood a computer network with data in order
 

to deny access to legitimate users. For financial institutions with a
 

heavy on-line presence, these types of attacks can be the most costly.
 

2 2003 CSI/FBI Computer Crime and Security Survey,
 

(www.gocsi.com/forms/fbi/pdf.html).
 3 “Must-Dos Will Keep IT Budgets Growing,” American Banker,
 

December 17, 2002. See FIL-81-2000, Risk Management of Technology
 

Outsourcing, for regulatory guidance (www.fdic.gov/news/news/financial/2000/fil0081.html).
 

IT Security Breaches Present Substantial 

Risks for Insured Institutions 

The potential damage from security breaches is not 

only monetary. Although the potential for massive 

fraud exists if adequate controls are not in place, the 

impact from lost data or a tarnished reputation is hard 

to overestimate. While difficult to quantify, an insured 

institution’s reputation is critical to many customers, 

who expect their confidential financial information to 

be secure. There are several sources of regulatory guidance for insured institutions on safeguarding consumer 

data and best practices for IT security.4 

The increased use of Internet-connected systems 

poses substantial vulnerability for bank-owned 

systems and data. In fact, the CSI/FBI survey reports 

that Internet connections are becoming an increasingly frequent point of attack. The Federal Deposit 

Insurance Corporation (FDIC) has cautioned banks 

that maintain computer networks connected to the 

Internet to be aware that such connections may pose 

risks to their information assets and to ensure that 

their staff or service providers perform regular reviews 

of security. 

Technology Facilitates Retail Delivery of Banking 

Services and Bolsters Bank Productivity 

During the past decade, many relatively new technologies have become increasingly common, even 

among smaller, community institutions. Banks are 

opening their networks to provide enhanced services 

to customers through telephone banking, ATMs, and 

transactional websites. The importance of these electronic distribution mechanisms is underscored by 

some institutions’ business plans, which rely heavily 

on the anticipated benefits of increased customer 

convenience. 

Internally, technological advances have changed the 

dynamics within many insured institutions. For example, some banks are using wireless technologies, and the 

use of customer relationship management (CRM) soft4 Appendix B to Part 364 of the FDIC’s Rules and Regulations establishes guidelines to help ensure that financial institutions appropriately 

safeguard customer data. It calls for insured institutions to develop 

and implement an information security program that involves the 

board of directors, assesses risk, and manages and controls risk associated with protecting customer information. Appendix B lists many 

security measures, some of which are discussed later in this article. 

FDIC OUTLOOK 17 FALL 2003 
Regional Perspectives 

ware is growing.5 Wireless technologies have facilitated 

network connectivity within some institutions and 

among branches. CRM software holds the promise of 

helping banks navigate their complex relationships 

with customers, with the goal of maximizing the profitability of these relationships. 

New Technologies Pose New Challenges 

Many technologies—such as smart cards, electronic bill 

presentment, and the migration of traditional banking 

into the on-line realm—are poised to alter further how 

banks do business (see Chart 1). More insured institutions are moving toward nonproprietary (often very low 

cost) software, such as Linux, as alternatives to costly 

proprietary operating systems. Banks may also adopt 

more advanced authentication schemes, which help 

prove a user’s identity on a computer network. 

Although many bank customers can now access 

account information with an ATM card and a password, biometric technologies, such as retinal or fingerprint scanners, may eventually become the norm. Some 

institutions may be considering the benefits of more 

established technologies, such as moving toward online check imaging. Others are considering ways to 

reconfigure current systems in order to implement realtime processing. 

The use of shared application services may grow in the 

near term as banks “rent” software services or processing time, rather than buy expensive in-house systems. 

Chart 1 

Continued Growth Expected Nationwide 

among Several New Banking Technologies 

Percentage 

100 

90 

80 

70 

60 

50 

40 

30 

20 

10 

0 

Currently Offer

86 Plan to Offer in Three Years 78 

66 65 

58 

42 

38 

25 22 

4 

Electronic Bill Document On-line Loan Electronic Bill Stored 

Payment Imaging Applications Presentment Value Cards 

Source: Grant Thornton’s Annual Survey of Community Bank Executives, 2003 

5 FIL 8-2002, February 1, 2002, Guidance on Managing Risks Associated 

with Wireless Networks and Wireless Customer Access, 

www.fdic.gov/news/news/financial/2002/fil0208.html; and “Small 

Banks Seen Ready to Give CRM Another Look,” American Banker, 

February 4, 2003. 

More customers are now paying bills on-line; soon 

these customers may receive bills on-line as well, and 

banks may play a critical role in developing this capability. 

Against this backdrop of rapid technological change, 

with its accompanying risks, this article explores a key 

concept associated with maintaining a secure IT environment—layered security.6 

“Defense in Depth” Is Key to Successful IT Security 

Perfect security does not exist, and no one solution 

exists for all IT security needs. Persistent and skilled 

perpetrators can eventually compromise any security 

system. Therefore, bank management should not rely 

on one security mechanism. “Layered” security, while 

not a new concept, remains highly effective. By layering IT security, insured institutions can increase the 

likelihood that should one security mechanism fail, 

another will prevent a breach. IT specialists typically 

refer to this concept as “defense in depth.” As one chief 

technology officer said, “It’s like an onion. The more 

layers a hacker has to peel through, the longer it takes 

and more frustrating it becomes to reach the center.”7 

The concept of layered network security may be new to 

some community banks that have migrated only 

recently to more complex computer networks or 

become more reliant on Internet-connected systems. 

While each institution must ultimately assess the level 

of layered security it needs, the following components, 

if incorporated into an overall IT security strategy, can 

help minimize disruptions to, or compromises of, a 

bank’s technology infrastructure. 

Segregation of networks: Maintaining appropriate 

segregation among computer networks is vital. For 

instance, data traffic originating from one (perhaps 

sensitive and confidential) network segment need not 

be broadcast to all servers or workstations on the local 

area network. IT managers may segment the network 

by installing intelligent switches rather than network 

hubs. Similarly, not all information that resides on 

6 The concept of layered controls is referenced in the Information 

Security Booklet of the Federal Financial Institutions Examination 

Council’s Information Technology Examination Handbook, December 

2002, page 13. The handbook can be downloaded from 

www.FFIEC.gov. 

7 “Layering Security to Protect Bank Networks,” Bank Technology 

News, April 4, 2003. 

FDIC OUTLOOK 18 FALL 2003 
Regional Perspectives 

network devices may require the same level of access by 

all users. Further segmenting network information by 

employing the “least privilege” concept, whereby 

employees are given access on a “need to know” or 

“need to do” basis, is also important. 

Firewalls: A firewall is a set of components—hardware 

and software—that resides between two or more 

systems to block unauthorized traffic. Firewalls are 

useful in segregating networks and are the minimum 

security for institutions that maintain a connection to 

the Internet. Firewalls are essentially fences around, 

and sometimes within, a network. Generally, a firewall 

protects against unauthenticated logins to the internal 

network. Often, banks use firewalls between internal 

networks and an Internet connection. Firewalls may 

also create demilitarized zones, a computer host or small 

network inserted as a “neutral zone” between a bank’s 

private network and the outside public network.8 

External monitoring: A layered security process 

requires institutions to consider external measures, 

which enable an institution to see its network from an 

outsider’s perspective. This approach allows monitoring 

of potential issues such as website defacements, hijacking of sessions or transactions, the need for software 

patch revisions, and open ports on a firewall and 

network. 

Continuous vulnerability assessments: All security 

organizations recognize running vulnerability scans of 

an IT infrastructure as a best security practice. Unfortunately, many companies run these scans only annually 

or quarterly. New vulnerabilities occur daily; the CERT 

Coordination Center generally publishes 50 or more a 

week.9 Therefore, IT managers should consider continuous scanning, or at least at more frequent intervals 

than quarterly. For example, frequent scanning would 

have protected companies from vulnerability to the 

“SQLSlammer” worm; information about this vulnerability was available in July 2002, but the worm did not 

fully materialize until 2003.10 Software upgrades, installation of new services, and human error also can 

contribute to the development of vulnerabilities. Insti8 searchwebservices.techtarget.com/sDefinition/ 

0,,sid26_gci213891,00.html, August 4, 2003. 

9 The CERT® Coordination Center (www.cert.org) is a federally funded 

research and development center that addresses computer security 

incidents and vulnerabilities, publishes security alerts, researches 

long-term changes in networked systems, and develops information 

and training to help improve computer security. 

10 The SQLSlammer worm led to the compromise of many vulnerable 

machines and degraded performance on affected networks. 

tuting a scanning process at appropriate intervals can 

help minimize any resulting disruption to the IT infrastructure. 

Intrusion detection: An intrusion detection system 

(IDS) represents another layer of security—a “burglar 

alarm” that informs IT management when someone 

may be attacking the network. An IDS typically scans 

for anomalies in network traffic or data flows that 

match a known pattern of misuse. IT professionals 

normally place an IDS in front of or behind the firewall 

as a network monitor, or an IDS may reside on host 

systems. When placed on the host system, the IDS will 

examine log files for evidence of misuse. An IDS will 

detect attempted intrusions but will not stop or prevent 

them. 

Encryption: When transmitting sensitive data across 

the Internet or another untrusted medium, IT management should ensure that the information is encrypted 

to prevent unauthorized access. IT managers also 

should encrypt sensitive data any time the data reside 

on a database that could be accessed by an unauthorized source—internal or external. 

Virus/worm protection: A virus is a piece of programming code, usually disguised as something else, that 

causes some unexpected and usually undesirable event. 

A worm is a self-replicating virus that does not alter 

files but resides in active memory and duplicates itself.11 

Many viruses and worms exploit known vulnerabilities 

in operating systems or commonly used applications. IT 

managers should consider using virus protection methods for data entering bank networks, as well as periodic 

scanning of files within the network. All hosts, both 

servers and workstations, should be protected, and 

should have frequent virus definition updates. Also, the 

FDIC has recommended that banks implement an 

effective software patch management program as one of 

the best ways to prevent damage by viruses or worms.12 

Adequately trained staff and users: Placing appropriate emphasis on IT security at the senior management 

and board of directors level is the first step toward 

minimizing system breaches. By establishing effective 

policies and procedures, boards of directors can promote 

an atmosphere that addresses critical security areas and 

establishes appropriate guidelines and standards for all 

11 searchsecurity.techtarget.com/sDefinition/0,,sid14_gci213386,00.html,
 

August 4, 2003.
 

12 FIL 43-2003, Computer Software Patch Management,
 

www.fdic.gov/news/news/financial/2003/fil0343.html.
 

FDIC OUTLOOK 19 FALL 2003 
Regional Perspectives 

employees. A well-educated staff also can help to 

prevent losses resulting from “social engineering 

attacks,” which occur when users are tricked into 

bypassing security procedures (e.g., an employee is 

tricked into revealing his password). 

Successful IT Security Requires Constant Vigilance 

IT security is not a one-time event, but a continuous, 

multifaceted process. The anticipated growth in new 

technologies and the rapidly changing landscape of IT 

call for heightened vigilance, as vulnerabilities can 

appear quickly and compromises can be costly. A 

layered security approach, coupled with well-defined 

exception thresholds and close monitoring, are essential. Each insured institution must assess its own IT 

risk profile; an awareness of available network security 

components and existing regulatory guidance will facilitate the process. 

Mike Anas, Senior Financial Analyst, 

Division of Insurance and Research 

with contributions from the Chicago Region’s 

Division of Supervision and Consumer Protection 

FDIC OUTLOOK 20 FALL 2003 
Regional Perspectives 

Dallas Regional Perspectives
 

Economic Recovery Appears 

Imminent but Fragile 

The Dallas Region’s economy is 

beginning to improve, suggesting that recovery from the 

2001 recession may be taking 

hold. Total nonfarm employment in 

the Region was essentially unchanged 

at midyear 2003 compared to midyear 2002, a 

significant improvement from the loss of 280,000 

jobs in the year-earlier period. Positive employment 

trends are evident in the finance, insurance, and real 

estate sector; health and education services; state and 

local governments; wholesale trade; and professional 

business services. However, conditions in the telecommunications and high-tech industries remain weak. 

Colorado, Louisiana, and Oklahoma continued to lose 

jobs in the second quarter of 2003 on a year-ago basis 

in the durable goods manufacturing, telecommunications, and energy sectors. 

While overall employment trends are becoming more 

favorable, two factors point to a fragile economic recovery in the Region. First, the manufacturing sector 

remains weak. Structural and cyclical weaknesses have 

resulted in job losses, particularly in the subsectors of 

industrial machinery and equipment, textiles and 

apparel, and lumber and wood products. On a positive 

note, the pace of job loss has declined, as many manufacturing plants have reached minimum staffing levels 

necessary to continue operating. 

Second, although government hiring was a bright spot 

during the economic slowdown, financial stress experienced by state and local governments may constrain 

the Region’s job growth going forward. As a result of 

the 2001 recession and subsequent weak U.S. recovery, 

tax revenues are declining in half the Region’s eight 

states, and revenue growth in the other four states is 

well below the trend of the late 1990s. In fact, budget 

deficits are forecast for six of the Region’s eight states in 

2003.1 As a result of the budget problems, states and 

1 State budget figures were reported in the National Conference of 

State Legislatures’ State Budget Update, February 2003. New Mexico 

and Arkansas are not forecasting a budget deficit largely because of 

recent favorable employment trends that have limited state revenue 

declines, and they have been more successful in matching revenues 

with expenditures. 

localities have begun to aggressively scale back spending and 

raise taxes. For example, the 

Tennessee state government 

mandated that all agencies cut spending by 9 percent, permanently eliminated 

many vacant government positions, 

discontinued health coverage for more 

than 160,000 workers, and significantly 

increased tuition at state universities. 

The fragile nature of the economic recovery is also 

apparent in an analysis of the Region’s metro and rural 

areas.2 Overall, metro areas continued to lose jobs in 

the first six months of 2003, though a majority of metro 

counties showed positive employment growth. Rural 

counties, on the other hand, showed aggregate employment growth of 0.6 percent in the first six months of 

2003, compared to losses of 0.9 percent and 0.8 percent 

for all of 2002 and 2001, respectively. The divergence 

between metro and rural performance is not unprecedented during the early stages of recovery. Rural areas 

have preceded the nation out of recession several times 

in the past, and rural job losses occurred earlier in this 

cycle.3 As shown in Chart 1, the recent growth in rural 

employment was led by improvement in the services 

Chart 1 

Source: Bureau of Labor Statistics, rural counties in the Dallas region 

The Region’s Rural Job Growth Has Been 

Fueled by Services; Manufacturing Lags 

Year-over-year Growth (%)

Services 

Construction & Mining 

Manufacturing 

–12 

–10 

–8 

–6 

–4 

–2 

0 

2 

4 

May ’02 Aug ’02 Nov ’02 Feb ’03 May ’03 

2 For this article, rural areas are defined as counties that are not 

included in metropolitan statistical areas. This definition is used in 

calculating employment growth rates and banking performance 

numbers. 

3 Henderson, Jason, “Will the Rural Economy Rebound With the Rest 

of the Nation?” The Main Street Economist, January 2002. 

FDIC OUTLOOK 21 FALL 2003 
Regional Perspectives 

sector and occurred despite continued weakness in 

manufacturing. 

Despite recent employment gains, rural areas face 

many economic challenges in the months to come. 

Rural economies tend to be less diversified than their 

metropolitan counterparts, and often depend on a few 

industries. Structural shifts, such as the movement of 

manufacturing production overseas, have resulted in 

the loss of many high-paying jobs that will not return 

when the recovery becomes more robust. Moreover, 

many of the economic factors that affect the demand 

for rural products are typically global in nature—such 

as the value of the U.S. dollar, foreign incomes and 

preferences, and U.S. farm and trade policies—and are 

beyond the control of rural businesses. In addition, the 

Region’s rural areas are linked closely to the agricultural sector, in which weakness continues to pose challenges for rural economies and rural financial 

institutions. 

The Agricultural Sector Is Showing Signs 

of Improvement, but Challenges Remain 

The Region’s agricultural sector is vast, encompassing 

473 million acres, or 61 percent of the land area. Crops 

are highly diversified throughout the Region; in addition to the southern staples of livestock, cotton, corn, 

soybeans, and wheat, the Region’s farmers produce 

timber, sugar cane, rice, and aquaculture (catfish and 

shrimp). The Region produces the majority of U.S. 

aquaculture and rice, but the annual dollar volume is 

significantly less than is generated by other crops. 

The agricultural industry has been affected adversely 

by low prices for the past seven years, primarily 

because of national and global overproduction (see 

Table 1). National net farm income peaked in 1996 at 

$54.8 billion but then gradually fell through 2001, 

when it was $45.7 billion.4 In 2002, because of the 

severe drought that affected much of the Midwest and 

West, as well as lower levels of government subsidies, 

net farm income fell dramatically to $30.2 billion. 

Regional and national trends in farm income are similar, and 2002 regional data (which will not be available until late 2003) are expected to show a 

significant decline. 

Table 1 

Cotton Prices Remain Weak, but Cattle and 

Other Crop Prices Are Expected to Improve 

1996 2000 2001 2002 Est. 2003 

Cotton 75.40 45.00 49.80 29.80 42.80 

Cattle 65.05 69.65 72.71 67.50 77.50 

Corn 3.24 1.82 1.85 1.97 2.30 

Soybeans 6.72 4.63 4.54 4.25 5.50 

Wheat 4.55 2.48 2.62 2.78 3.56 

Note: Grain prices are for marketing year of each crop. Cotton quantities are per pound; 

other crop quantities are per bushel; livestock are per hundredweight. Broiler prices are 

set by individual contracts and are not available for analysis. 

Sources: USDA World Agricultural Supply and Demand Estimates, July 2003 

The U.S. Department of Agriculture (USDA) forecasts national net farm income to recover to $46.2 

billion in 2003. However, a look at three products that 

are critical to the Region’s agricultural economy 

suggests a mixed outlook for the Region: 

Cattle: The Region produced about one-third, or $13.3 

billion worth, of all U.S. beef in 2001, making livestock 

production a significant economic driver for many rural 

counties. In 2002, drought destroyed grazing lands, forcing many ranchers to sell off herds because of a shortage of feed. As a result, cattle prices declined in late 

2001 and 2002, and ranchers experienced the brunt of 

the declines because cattle are not protected by federal 

farm programs. However, smaller herds have 

contributed to a significant increase in prices during 

2003 (see Table 1), a trend that bodes well for the 

Region’s ranchers. 

Broilers (chickens): The Region’s poultry industry, 

which is highly concentrated in Arkansas, Mississippi, 

and Texas, produced $5.6 billion in cash receipts in 

2001 but is showing clear signs of weakness. Overall 

U.S. production is expected to decline significantly in 

2003 (down 1.1 percent from year-ago levels), as 

companies are placing fewer chicks with producers in 

response to declining overseas demand. Such a trend 

could hurt producers’ incomes, in both the Region and 

the nation, as most producers have significant fixed 

infrastructure costs that must be covered by production 

volume. In addition, producers are being affected 

adversely by outbreaks of avian influenza and Newcastle disease, which could cost the industry more than 

$100 million in 2003.5 

4 Farm Income data are provided by USDA Economic Research Service 

Farm Income Forecast, June 4, 2003. http://www.ers.usda.gov/briefing/ 5 Simon Romero, “Virus Takes a Toll on Texas Poultry Business,” New 

farmincome/data/va_t1.htm. York Times, May 6, 2003. 

FDIC OUTLOOK 22 FALL 2003 
DO Abnormally Dry

D1 Drought—Moderate

D2 Drought—Severe

D3 Drought—Extreme

D4 Drought—Exceptional

Drought Impact Types:

A = Agr cultural (crops, pastures

grasslands)

W = Hydrological (water)

~ (No type = both impacts)

DO Abnormally Dry

D1 Drought Moderate

D2 Drought Severe

D3 Drought Extreme

D4 Drought Exceptional

Drought Impact Types:

A = Agr culture

W = Water (Hydrological)

F = Fire danger (Wildfires)

 Delineates dominant impact

(No type = All 3 Impacts)

~ 

~

~ 

Regional Perspectives 

Cotton: The Region’s cotton industry is significant 

($2.4 billion in cash receipts in 2001, about half the 

U.S. total) but troubled. Cotton prices have been 

below the break-even point of approximately 73 cents 

per pound since 1996, largely because of global overproduction, a situation that was aggravated in 2002 by the 

global recession. Fortunately for producers, the 1996 

and 2002 Farm Bills have implemented favorable 

subsidy schedules for cotton producers. However, these 

payments have also encouraged overproduction and 

therefore have contributed to declining prices. This 

year, continued overproduction, coupled with stable 

demand, could drive prices down about 10 cents per 

pound by harvest time.6 

Overall, the expected improvement in cattle prices 

should bolster the Region’s agricultural sector significantly, offsetting weakness in the cotton and broiler 

markets. Prices for other commodities, such as corn, 

wheat, and soybeans, are expected to improve as well 

(see Table 1). However, the benefits could be derailed 

by continued drought conditions. As shown in Map 1, 

which compares the summers of 2002 and 2003, 

drought remains significant in New Mexico and 

Colorado, and abnormally dry conditions have moved 

into much of Texas. On the positive side, drought 

conditions have abated entirely in Louisiana, Arkansas, 

and Mississippi. Although drought conditions usually 

Map 1 

contribute to higher crop prices because of smaller 

harvests, the benefits accrue only to farmers who can 

raise normal crop levels. 

Rural Bank Performance Is Showing the 

Effects of the Weak Rural Economy 

Overall, rural community banks continue to report 

relatively healthy financial ratios, but the strains of 

the weak rural economy are emerging.7 Pretax earnings increased from 1.45 percent of average assets in 

2001 to 1.60 percent in 2002 as low funding costs 

and a steepening yield curve in the first half of the 

year increased net interest margins.8 However, asset 

quality trends have not been as favorable. Aggregate 

levels of past-due and nonaccrual loans reached 3.23 

percent at March 31, 2003, up 18 basis points from a 

year earlier, and marking the highest first-quarter 

level since 1993. It should be noted, however, that 

this level of problem loans remains far less than what 

rural banks experienced during the agricultural crisis 

of the 1980s. Loan charge-off rates continue to trend 

slowly upward, also signifying some stress in lending 

portfolios. Capital levels, at 10.34 percent of total 

assets, continue to increase, providing protection 

from economic swings. 

Drought Conditions Have Improved Somewhat but Still Threaten the Western Half of the Region 

Summer 2002 Current 

DO Abnormally Dry DO Abnormally Dry Drought Impact Types: Drought Impact Types: A = Agricultural (crops, pastures, i , D1 Drought — —Moderate D1 Drought—Moderate A = Agriculture i 

D2 Drought—Severe grasslands) D2 Drought — —Severe W = Water (Hydrological) 

W = Hydrological (water) F = Fire danger (Wildfires)

(No type = All 3 Impacts)

D3 Drought — —Extreme D3 Drought—Extreme (No type = both impacts) D4 Drought — —Exceptional Delineates dominant impact D4 Drought—Exceptional 

The Drought Monitor focuses on broad-scale conditions.
 

Local conditions may vary. See accompanying text summary
 The Drought Monitor focuses on broad-scale conditions. 

Local conditions may vary. See accompanying text summary for forecast statements. for forecast statements. 

Source: U.S. Drought Monitor, http://www.drought.unl.edu/dm/monitor.html 

6 Carl G. Anderson, “Cotton Market Comments,” Texas A&M University. Vol. 10, No. 7, May 12, 2003.
 

7 The term “community banks” includes all FDIC-insured banks and thrifts with total assets of less than $1 billion, excluding institutions that have
 

been in existence less than three years, and specialty banks, such as credit card institutions.
 

8 Pretax earnings figures are used because a large number of community banks have elected Subchapter S Corporation status, which eliminates
 

income tax at the bank level and prevents accurate after-tax comparisons with banks that have not elected Subchapter S status.
 

FDIC OUTLOOK 23 FALL 2003 
Regional Perspectives 

Map 2 

Source: USDA Census of Agriculture 

Dallas Region Is Home to 38 of the Top 50 

Cotton Counties in the United States 

Additional stress is evident among community banks in 

cotton-producing areas. As illustrated in Map 2, the 

Region is home to 38 of the nation’s top 50 cottonproducing counties, and the aggregate performance of 

community banks headquartered in these counties is 

considerably weaker than that of institutions elsewhere 

in the Region. For example, community banks based in 

cotton-producing counties reported pretax earnings of 

1.24 percent of average assets in 2002, compared to 1.60 

percent for rural community banks in the Region as a 

whole. In addition, almost 9 percent of banks in these 

counties lost money in 2002, compared with 4 percent 

of the Region’s rural community banks overall. 

Although overall past-due loan levels are roughly the 

same, institutions based in the cotton-producing counties reported higher levels of noncurrent loans (1.54 

percent of total loans) than the Region’s community 

banks (1.27 percent) during first quarter 2003.9 Equity 

capital levels for insured institutions based in the 

cotton-producing counties were reasonably strong at 

9.97 percent of total assets but remain 37 basis points 

below those of all rural community banks in the Region. 

Conclusion 

The Region’s rural economy is showing signs of life 

despite a prolonged slump in the agricultural and 

manufacturing sectors, but recovery is not assured. 

Higher cattle prices should boost the agricultural sector, 

but continued drought conditions in the western half of 

the Region could diminish any positive effects. The 

Region’s manufacturing sector remains weak and may 

stay sluggish for an extended period even after the 

general economy recovers. Community bank performance reflects the economic stress evident in rural areas 

but is expected to improve when the agricultural and 

manufacturing sectors rebound. 

To help rural bankers face economic challenges, the 

Federal Deposit Insurance Corporation is actively 

engaged in outreach to the banking community, particularly in areas that rely significantly on the agricultural 

sector. These meetings, as well as ongoing Director 

College programs, represent an effective way to maintain a dialogue with bankers on the important risk 

management issues facing the industry today. 

Dallas Staff 

9 Noncurrent loans are those that are past due 90 or more days or are 

on nonaccrual status. 

FDIC OUTLOOK 24 FALL 2003 
Regional Perspectives 

Kansas City Regional Perspectives
 

Continued Turmoil in the Airline Industry Does Not 

Bode Well for Some of the Region’s 

Communities and Insured Institutions 

Airlines have experienced historically 

high levels of operating losses as demand 

remains low due to the aftermath of 

9/11, the outbreak of severe acute respiratory syndrome (SARS), the conflict in 

Iraq, and a fragile domestic and global 

economy. Stress in the airline industry 

has spilled over into the aircraft manufacturing sector. The aviation and aerospace 

industries are highly important to the 

economies of some of the Region’s states 

(see Table 1), and aviation and aerospace companies 

are among the top employers in several of the Region’s 

communities (see inset box later in this article). 

However, the share of employment in these industries 

is greatest by far in the Wichita metropolitan statistical 

area (MSA). The sector’s weak performance is expected 

to continue to affect the Wichita economy adversely 

and could contribute to some credit quality deterioration among local insured institutions. 

The U.S. Airline Industry Has 

Not Recovered to Pre-9/11 Levels 

Demand for air travel, measured in passenger boardings, 

has declined significantly since 2000. After growing at 

an annualized rate of 3.4 percent between 1995 and 

2000, year-over-year enplanements were flat in 2001 

(due to the economic downturn and declining business 

Chart 1 

Source: Air Transport Association 

Domestic Air Travel Demand Remains Grounded 

Number of Passenger Boardings (000s) 

0 

10,000 

20,000 

30,000 

40,000 

50,000 

60,000 

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 

2000 

2001 

2002 

2003 

travel) until 9/11 (see Chart 1).1 Business travel represents a greater proportion of boardings and revenue 

passenger miles because of the frequent 

flights.2 Business travelers also are more 

likely to pay full price, as their travel needs 

are more inflexible than those of leisure flyers. 

As a result, the scaling back in business 

travel exerted a disproportionately adverse 

effect on the airline industry’s bottom 

line. 

Although air travel rebounded from a 

virtual standstill in late 2001, it has not 

recovered to pre-9/11 levels. In fact, air 

travel has continued to weaken, in large 

part because of uncertainty about the 

conflict in Iraq and fears about SARS. No clear positive signals have emerged, but many air carrier analysts 

are optimistic that a rebound in the U.S. economy in 

the latter half of 2003 and subsiding fears about SARS 

will contribute to an uptick in air travel. Recently, 

airlines have drastically cut fares to stimulate demand; 

however, lower fares have resulted in declining operating profit margins. Nominal January fares for members 

of the Air Transportation Association (ATA) declined 

precipitously from nearly $150 in 2001 to less than 

$120 in 2003, the lowest level since 1987.3 Air carriers 

also are scaling back the number of flights, modifying 

routes, and withdrawing aircraft from service to reduce 

supply; in addition, nearly 70,000 full-time and 20,000 

part-time workers, or 13 percent of the labor force, 

were laid off between August 2001 and December 

2002.4 

Airlines also face rising fuel prices, the second largest 

operating expense after labor costs. Jet fuel prices nearly 

1 Member airlines are Airborne Express, Alaska, Aloha, America West,
 

American (includes TWA), American Trans Air, Atlas Air, Continental,
 

Delta, DHL Airways, Emery Worldwide, Evergreen International, FedEx,
 

Hawaiian, JetBlue, Midwest Express, Northwest, Polar Air Cargo,
 

Southwest, United, UPS Airlines, and US Airways. Source is ATA’s 2002
 

Annual Report, http://www.ata.org.
 2 “A relatively small group of travelers (the frequent flyers who take
 

more than 10 trips a year) account for a significant portion of air travel.
 

While these flyers represent only eight percent of the total number of
 

passengers flying in a given year, they make about 40 percent of the
 

trips.” www.airlines.org online handbook.
 3 Airfare is for a 1,000-mile journey, exclusive of applicable taxes.
 

Source: Airlines in Crisis – The Perfect Economic Storm, Washington,
 

DC: Air Transport Association of America, Inc., http://www.airlines.org.
 4 Ibid.
 

FDIC OUTLOOK 25 FALL 2003 
Regional Perspectives 

doubled from $0.56 per gallon in December 2001 to 

$1.02 per gallon in February 2003, before declining to 

approximately $0.80 per gallon. To give some perspective, after remaining below $0.60 per gallon for much 

of the 1990s following the Gulf War, jet fuel prices 

have fallen below that level for only three months 

since August 1999. 

Despite Government Assistance, the Financial 

Health of Air Carriers Remains Precarious 

The substantial revenue declines coupled with fuel 

price increases have contributed to record losses for 

the airline industry. The industry reported approximately $16 billion in losses in 2001 and 2002 

combined, the first time losses have occurred in 

consecutive years.5 Industry analysts estimate losses for 

2003 between $5 billion and $8 billion. 

The federal government’s initial response to the problems caused by 9/11 was to enact the Air Transportation Safety and System Stabilization Act on 

September 22, 2001, which authorized $5 billion in 

direct compensation to air carriers affected by the 

attacks.6 This legislation also authorized the establishTable 1 

ment of the Air Transportation Stabilization Board 

(ATSB) with the authority to issue up to $10 billion in 

federal loan guarantees on behalf of airlines. As of May 

2003, $4.6 billion in direct compensation had been 

distributed to 426 air carriers.7 The ATSB approved 5 

of 16 applications, resulting in $1.5 billion in air 

carrier loan guarantees, $900 million of which is 

earmarked for US Airways, Inc.8 

Despite government aid, the airline industry has accumulated staggering debt levels during the last two years. 

The average debt-to-capital ratio has risen from a historical 70 to 80 percent range to 90 percent.9 The current 

situation could become more severe than that following 

the Gulf War, when seven major carriers filed for bankruptcy or liquidated.10 UAL Corp. ($25.2 billion, parent 

company of United Airlines, Inc.) and US Airways, Inc. 

($7.9 billion) filed Chapter 11 bankruptcy in 2002.11 

American Airlines narrowly averted bankruptcy earlier 

this year through significant employee concessions. 

However, the airline’s ability to avoid a cash flow 

crunch is far from certain. The same holds true for many 

other carriers, including Northwest Airlines. 

Kansas Ranks Second Nationally in Aerospace and Aviation Industry Employment, 

Far Higher than Any Other State in the Region 

Jobs per Capita Industry Employment 

State’s Percentage Employed Percentage Ratio of Industry 

Number per National Number of in Aircraft and Parts Employed in Air Payroll Wages to State 

State 1,000 Workers Ranking Workers Manufacturing Transportation ($ millions) Avg. Wage (%) 

Kansas 43 2 57,103 83.9 14.0 2,600 162 

Missouri 17 15 45,706 38.7 58.2 2,000 143 

Minnesota 14 20 37,553 2.1 89.5 1,900 137 

Nebraska 6 39 5,618 5.3 93.4 176 123 

North Dakota 6 40 1,966 30.5 66.1 64 136 

South Dakota 5 47 1,846 4.1 97.5 55 120 

Iowa 5 49 6,463 13.9 85.1 216 111 

Source: Commission on the Future of the U.S. Aerospace Industry, 2001 Reports 

5 2001 airline industry losses totaled $8 billion. Source: Air Carrier Financial Statistics Quarterly, U.S. Department of Transportation,
 

http://www.bts.gov/press. 2002 and 2003 loss estimates collected from variety of national newsprint and financial Web magazine articles.
 6 http://www.thomas.loc.gov.
 

7 U.S. Department of Transportation Web site, http://www.dot.gov/affairs/carrierpayments.html.
 8 ATSB has conditionally approved two of the remaining eleven applications for approximately $117 million and rejected the other nine applications.
 

Sources of data are the ATSB Web site, http://www.treas.gov/offices/domestic-finance/atsb, and an America West Airlines press release dated
 

January 18, 2003, PRNewswire-FirstCall.
 

9 U.S. House Subcommittee on Aviation hearing on financial condition of the airline industry, September 24, 2002, press release,
 

http://www.house.gov/transportation/press/press2002/release354.html.
 10 Between December 1990 and June 1992, six airlines filed Chapter 7 bankruptcy. PanAm, Midway, and MarkAir liquidated. Continental, TWA, and
 

America West reorganized. In addition, Eastern Airlines liquidated during this period. Source: Airlines in Crisis.
 11 BankruptcyData.com. http://www.bankruptcydata.com/research.
 

FDIC OUTLOOK 26 FALL 2003 
Regional Perspectives 

The Aircraft Manufacturing Industry 

Is Critical to the Wichita Economy 

The Wichita MSA, known as the “Air Capital of the 

World,” is heavily concentrated in the aviation and 

aerospace industries. According to a report issued in 

October 2002 by the Commission on the Future of 

the United States Aerospace Industry, Wichita is 

more dependent on the aircraft manufacturing industry 

than any other city in the nation, with 193 aerospace 

and aviation sector employees per 1,000 workers. The 

Seattle MSA, known for its strong ties to Boeing 

Corporation, is a distant second with 93 aerospace and 

aviation sector employees per 1,000 workers. Wichita’s 

top-ten list of employers is a who’s who of aircraft 

manufacturers: for example, Boeing Aircraft Wichita 

(rank 1, 13,650 employees), Cessna Aircraft Company 

(rank 2, 11,400 employees), Raytheon Aircraft 

Company (rank 3, 8,100 employees), and Bombardier 

Aerospace Learjet, Inc. (rank 6, 3,152 employees).12 

The Fortunes of the Wichita Economy 

Are Closely Tied to Airline Carriers 

Following the decline in passenger boardings in 2001, 

ATA-member airlines removed nearly 300 aircraft from 

service and reduced future aircraft delivery plans. Annual 

aircraft orders declined from more than 1,000 between 

1998 and 2000 to fewer than 750 between 2001 and 

2002.13 Options on orders plummeted from nearly 2,750 

aircraft in 2000 to fewer than 1,750 in 2002.14 The 

sudden and steep reduction in aircraft orders has caused 

the “Big 4” employers to cut thousands of jobs; the 

effects of these cuts have hurt hundreds of other small 

ancillary companies in the Wichita MSA (see Table 2). 

Table 2 

Wichita’s “Big 4” Aircraft Manufacturers 

Have Significantly Reduced Employment 

Wichita Employment (000s) Percentage 

Dec ’00 Mar ’03 Change 

Boeing 16,800 12,500 –26 

Cessnaa 12,509 9,200 –26 

Raytheon 10,000 7,100 –29 

Bombardier 3,602 2,200 –39 

a Does not include seven-week furlough of 6,000 beginning June 2003. 

Sources: Wichita Business Journal, Book of Lists 2000; Wichita Business Journal, March 

3, 2003, March 6, 2003, March 20, 2003, and June 2, 2003; Boeing Corporation at 

http:// www.boeing.com/employment/employment_table.html. 

12 Economy.com, Inc., Metro 2003, February 2003. 13 Airlines in Crisis. 

14 Ibid. 

Statistics from the Kansas Department of Human 

Resources show that the unemployment rate in Wichita 

in April 2003 was 6.0 percent, up from 5.6 percent one 

year ago, and well above the 4.4 percent reported at 

year-end 2001.15 Statewide, the unemployment rate was 

4.8 percent, down slightly from 5.0 percent one year ago. 

The number of bankruptcies increased 39 percent 

between year-end 1999 and 2002 and is now 10 percentage points higher than the previous peak in 1998.16 

Despite the significant layoffs, the housing market and 

retail business remained strong throughout 2002. The 

number of single-family housing permits climbed from 

2,226 in 2000 to 2,817 in 2002, a 27 percent increase.17 

Existing home sales were also strong, with sales through 

the first three quarters of 2002 nearly equal to the yearearlier period,18 and existing home prices rose from 

$90,700 in 2000 to $97,600 in 2002.19 

Extended unemployment benefits help explain why the 

Wichita economy has not slowed as much as might 

have been expected. The Economic Security and 

Recovery Act of 2001, enacted on March 9, 2002, 

extended the 26-week unemployment insurance 

program by 13 weeks. The Unemployment Compensation Amendments of 2003 enacted May 2003 extend 

unemployment benefits for displaced workers in the 

airline and related industries an additional 13 weeks.20 

However, softening in the housing market and in consumers’ personal financial conditions could be emerging. 

First-quarter 2003 single-family building permit activity 

was 15 percent below first-quarter 2002 levels, and existing home sales were flat.21 The average marketing period 

for existing home sales now exceeds four months. 

15 Kansas Labor Conditions News Releases, January 2002, June 2002,
 

and June 2003, Kansas Labor Market Information Services, Topeka,
 

KS, http://laborstats.hr.state.ks.us/index.html.
 16 Ibid.
 

17 U.S. Census Bureau, http://www.census.gov/const/www/permitsindex.html.
 

18 U.S. Housing Market Conditions, Housing Market Profiles, Wichita,
 

Kansas, Third quarter 2002, U.S. Department of Housing and Urban
 

Development, Office of Policy Development and Research.
 

19 Economy.com, Inc., Metro 2003, February 2003.
 20 http://www.thomas.loc.gov.
 

21 U.S. Housing Market Conditions, Regional Activity, Great Plains, First
 

quarter 2003, U.S. Department of Housing and Urban Development,
 

Office of Policy Development and Research.
 

FDIC OUTLOOK 27 FALL 2003 
Regional Perspectives 

Aviation and Aerospace Industry Is Among the Top Employers 


in Several of the Region’s Larger Communities
 

In addition to Wichita, the aviation and aerospace 

industry is important to the economies of Cedar 

Rapids, Kansas City, Minneapolis, and St. Louis. The 

largest of these MSAs are in Kansas, Minnesota, and 

Missouri, and these states rank in the top 25 nationally by share of employment in these industries (see 

Table 1). Kansas, because of the significant employment concentration in the aviation sector in Wichita, 

ranks second in the nation behind Washington. 

•	 The Lambert–St. Louis International Airport 

became a major hub for American Airlines, Inc., 

with the airline’s acquisition of Trans World 

Airlines, Inc. (TWA) in 2001.22 With more than 

9,000 employees, American Airlines is one of the 

top 15 employers in St. Louis.23 In addition, St. 

Louis is home to one of Boeing’s large aerospace 

divisions. Boeing is the second largest employer in 

St. Louis, employing more than 15,300 workers in 

2002.24 Increased defense spending could help 

bolster the St. Louis economy. 

•	 Minneapolis-St. Paul is headquarters for Northwest 

Airlines, Inc., the world’s fourth largest airline 

company.25 Northwest Airlines was the sixth largest 

employer in Minneapolis-St. Paul at year-end 2001, 

with 18,270 employees.26 

•	 Kansas City has been home to TWA’s (now American Airlines) overhaul and maintenance facility 

since 1957.27 The facility currently employs 2,250 

22 AMR Corp (parent company of American Airlines). Data as of
 

March 2003. http://www.amrcorp.com/facts/hub.html.
 23 The St. Louis Business Journal, January 2003, via Economy.com,
 

Inc., Metro 2003, February 2003.
 24 Ibid.
 

25 Northwest Airlines, Inc., http://www.nwa.com/corpinfo/profi/facts/.
 26 City Business, December 2001, via Economy.com, Inc., Metro
 

2003, February 2003.
 27 Milestones in TWA History, DCS TWA History,
 

http://twdcs.org/history.html.
 

The Local Banking Industry Remains 

Strong for Now, but Stress Is Likely 

Despite the stress in the aviation industry, overall 

credit quality among the 36 insured institutions headquartered in the Wichita MSA has not deteriorated 

substantially. This can be explained in part because 

workers.28 In addition, Vanguard Airlines, Inc., headquartered in Kansas City with over 900 employees, 

filed Chapter 11 bankruptcy in 2002, and is now 

liquidating.29 

•	 Cedar Rapids is the world headquarters of Rockwell 

Collins, Inc., an aircraft-electronics spinoff of 

Rockwell International, Inc.30 Rockwell Collins is 

the metro area’s top employer; the 7,150-person 

local workforce represents about 6 percent of the 

city’s employment, far exceeding the number of 

workers employed by the number two employer 

(Cedar Rapids Community School District, with 

2,775 employees).31 Increased defense spending is 

expected to contribute positively to the Cedar 

Rapids economy. 

Layoffs and wage concessions in the airline industry 

have had a negative effect on employment and aggregate personal income in these communities. However, 

even though aviation and aerospace companies are 

among the largest employers in these communities, the 

relatively high level of industrial diversity helps mitigate the adverse effects of the weak aviation sector. As 

a percentage of total employment, air transportation 

ranks sixth in the Minneapolis MSA and twelfth in St. 

Louis, where aircraft and parts ranks eighth.32 The 

aviation and aerospace sector does not rank in the top 

25 industries in the Kansas City MSA. 

28 Randolph Heaster, “Unions Say American Threatens to File for
 

Bankruptcy, Close KC Overhaul Base,” Kansas City Star, April 9,
 

2003.
 

29 “Vanguard Airlines Plans Bankruptcy,” USA Today, Kansas City,
 

Mo. (AP), July 30, 2002, http://www.usatoday.com/money/biztravel/
 

2002-07-30-vanguard-bk_x.html.
 

30 Rockwell Collins, Inc., http://www.rockwellcollins.com.
 31 Cedar Rapids Area Chamber of Commerce, October 2002, via
 

Economy.com, Inc., Metro 2003, February 2003.
 32 Source of sector employment data for Minneapolis and other
 

communities is Economy.com, Inc., Metro 2003, February 2003.
 

none of these institutions reports direct exposure to 

large aircraft manufacturing companies, and any 

commercial and industrial lending is concentrated in 

small-business credits. However, in a community in 

which one of every five workers is employed in the 

aircraft manufacturing industry, local bank performance is expected to reflect the stress in this sector. 

FDIC OUTLOOK 28	 FALL 2003 
Regional Perspectives 

In Wichita MSA institutions, the median past-due loan 

ratio was 1.76 percent as of March 31, 2003. In comparison, the median past-due ratio for the Kansas City 

Region was 2.30 percent. Delinquencies in residential 

loan portfolios remained relatively low at 2.12 percent, 

although this represents a significant increase from 0.40 

percent two years ago. Again, the absence of increases 

in total nonperforming loans may be attributed to the 

extension of unemployment benefits. However, asset 

quality stress is becoming evident in a subgroup of institutions. The number of institutions headquartered in 

the Wichita MSA reporting delinquency ratios that 

exceed 5 percent has increased from one to seven in the 

past two years. In addition, the proportion of institutions with safety and soundness examinations showing 

Adversely Classified Assets in excess of 25 percent of 

Tier 1 capital has more than doubled from 22 percent to 

47 percent in the same period. 

However, relatively high capital and loan loss reserve 

levels provide a cushion for any asset quality weakness. 

Insured institutions headquartered in the Wichita MSA 

reported a median Tier 1 capital ratio of 9.09 percent as 

of March 31, 2003. Moreover, median ratios of loan 

loss reserves to total loans and nonperforming loans 

were high at 1.36 percent and 236.4 percent, respectively. Earnings remain solid, with a median return on 

assets ratio of 1.00 percent. Fewer than 6 percent of the 

banks were unprofitable at the end of first quarter 2003. 

Wichita Consumers May Face Problems 

When Unemployment Benefits Expire 

Air travel demand has yet to recover fully, and analysts 

expect airlines to continue to post losses. Should the 

aviation industry experience weak operating conditions 

into 2004, airline bankruptcies could rise, slowing any 

recovery for the aircraft manufacturing sector. 

Consumers in the Wichita MSA may find it difficult to 

continue their current spending levels and service their 

debts, particularly when unemployment insurance 

benefit extensions expire. 

Richard D. Cofer, Jr., Senior Financial Analyst 

FDIC OUTLOOK 29 FALL 2003 
Regional Perspectives 

New York Regional Perspectives
 

Region’s Economy Has Improved Modestly; 

However, Its Economic Recovery May Lag the 

Nation’s 

Employment declined sharply in the Region during 

2001; however, the rate of job loss has moderated 

and is now tracking national trends (see Chart 

1).

1 Since March 2001, the beginning of 

the most recent recession, the Region 

has lost about 2 percent of its employment base, virtually the same as the 

nation. However, employment has 

declined more severely in some states, 

such as New York and Delaware. Job 

losses in Massachusetts reached 

almost 5 percent of the March 2001 

level, more than double the national 

average. 

Chart 1 

Note: Mid-Atlantic includes Delaware, the District of Columbia, Maryland, New Jersey, 

New York, and Pennsylvania. New England includes Connecticut, Maine, Massachusetts, 

New Hampshire, Rhode Island, and Vermont. 

Source: Bureau of Labor Statistics 

The Region’s Rate of Job Losses Has Moderated 

Along With the Nation’s 

Year-to-Year Change (%) 

New England 

Mid-Atlantic 

U.S. 

Employment 

4 

–3 

–2 

–1 

0 

1 

2 

3 

’98 ’99 ’00 ’01 ’02 ’03 

NASDAQ 

Peaks 

9/11 Iraq War 

Recession Period 

Several of the Region’s key industries have been hard 

hit by the economic slowdown. Compensation has 

declined significantly in the securities industry. Wall 

Street bonuses have been down sharply for two years, 

and layoffs since December 2000 in New York City 

alone (home to about 20 percent of the nation’s 

employment in this sector) total about 39,000, or 19 

percent of the industry’s workforce. In addition, the 

1 For purposes of this article, the Region includes states in the MidAtlantic and New England. The Mid-Atlantic includes Delaware, Maryland, New Jersey, New York, Pennsylvania, and Washington, DC. New 

England includes Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island, and Vermont. Employment data are through first 

quarter 2003. 

Region’s telecommunications, 

hotel and hospitality, advertising, 

and computer consulting industries remain sluggish. The 

greater Boston area, as well as 

parts of New Jersey that had 

benefited from the high-tech and 

telecom boom of the 1990s, have experienced significant layoffs in these 

troubled sectors. Employment 

declines also have occurred in the 

Region’s manufacturing sector; since the 

beginning of the 2001 recession, the Region 

has lost 14 percent of jobs in the manufacturing 

sector, a slightly higher level than that of the 

nation. 

Renewed Strength in Certain Industry 

Sectors Will Benefit Parts of the Region 

Like that of the nation, the Region’s economic outlook 

appears encouraging in the second half of 2003. Washington, DC, and suburban Baltimore have benefited 

from increased federal spending and expanded employment related to homeland security. In addition, population growth among the “echo boom” generation 

(children of baby boomers) in some of the Region’s 

larger metropolitan areas has increased demand for 

teachers and other education professionals. An aging 

baby boomer generation, in turn, has stimulated 

demand for health care services. 

A stock market rebound is critical to any sustained 

economic recovery in the Region. The market generates substantial compensation for Wall Street employees and affects the business services sector, including 

accounting, legal, and printing services. Moreover, 

stock market activity correlates strongly with the 

Region’s overall employment growth; the Region’s 

(and the nation’s) employment has expanded with 

increases in equity markets during the past decade.

2 

Evidence suggests that conditions on Wall Street may 

be turning around, a trend that would be expected to 

benefit the economies of New York City and Boston. 

In fact, some analysts are anticipating a pickup in 

equity underwriting and mergers and acquisition activity over the next 12 months, although not to the record 

2 The correlation coefficient between the Region’s employment level 

and the Wilshire 5000 was 90 percent for the quarterly periods 

between first quarter 1990 and first quarter 2003. 

FDIC OUTLOOK 30 FALL 2003 
Regional Perspectives 

level of the late 1990s.

3 According to a July 2003 report 

by the Securities Industry Association, profitability in 

the securities industry significantly improved in early 

2003, and industry compensation and employment are 

expected to increase by year-end 2003.

4 

Despite these positive signs, the Region’s employment 

growth in the near term may lag that of the nation. A 

relatively higher cost of doing business in some of the 

Region’s larger cities has resulted in the continued outmigration of certain business sectors, such as manufacturing, to the western and southern United States and 

overseas. In addition, several of the Region’s states and 

cities face serious budget constraints that could hinder 

a recovery further. Sharply lower tax revenue collections in Massachusetts, New York (particularly New 

York City), and New Jersey are contributing to severe 

budget shortfalls. State and local governments have cut 

costs, increased taxes, and restructured debt service in 

an effort to preserve service levels and maintain 

balanced budgets. (For more information on the 

Region’s state budgetary problems, see FDIC Outlook, 

New York Regional Perspectives, Summer 2003). 

Region’s Insured Institutions Continue to Report 

Favorable Conditions Despite Economic Weakness 

The Region’s insured institutions have performed well 

during the mild recession and weak recovery by 

managing interest rate volatility, controlling expenses, 

and managing credit risk. Their earnings continued to 

hold up well in first quarter of 2003 despite economic 

softness and declining interest rates (see Table 1). 

Table 1 

Insured institutions reported declining net interest 

margins (NIMs) in first quarter 2003 as yields on earning assets declined faster than funding costs. The 

median NIM declined 29 basis points to 3.45 percent 

as a percentage of average earning assets in the first 

quarter of 2003 compared to the first quarter of 2002. 

NIMs are under pressure as historically low interest 

rates have contributed to lower yields on certain earning assets, while interest paid on deposits may have 

reached an effective floor. 

Noninterest income as a percentage of average assets 

increased 11 basis points to 0.91 percent (almost 14 

percent) among the Region’s savings institutions, but 

was more than offset by a 14 basis point drop in net 

interest income to 3.09 percent. A decline in noninterest income among the Region’s commercial banks was 

attributed to an 11 percent drop in trust income as the 

value of assets under management declined. In addition, net interest income fell 30 basis points to 2.94 

percent. Overall, insured institutions reported declines 

in noninterest expenses as they continued to control 

staffing levels and employee costs. Commercial bank 

operating efficiency did not improve because net interest income and noninterest income declined. However, 

the efficiency ratio reported by the Region’s savings 

institutions improved to 54.41 percent from 56.65 

percent a year ago as noninterest expenses declined. 

Lower interest rates contributed to appreciation in 

many insured institutions’ securities portfolios. The 

vast majority of institutions sold appreciated securities, 

New York Region Insured Institutions Continue to Report Healthy Conditions 

All Insured Commercial Banks Savings Institutions Insured Institutions 

Institutions < $10 Billion < $10 Billion > $10 Billion 

Mar ’03 Mar ’02 Mar ’01 Mar ’03 Mar ’02 Mar ’01 Mar ’03 Mar ’02 Mar ’01 Mar ’03 Mar ’02 Mar ’01 

Return on Assets (ROA) (YTD) 1.22 1.12 1.10 1.11 1.17 1.15 0.98 1.00 0.88 1.27 1.13 1.12 

Median ROA 0.87 0.89 0.83 1.02 1.04 1.00 0.75 0.77 0.69 1.39 1.31 1.18 

Net Interest Margin (YTD) 3.45 3.74 3.27 3.53 3.74 3.72 3.35 3.45 3.27 3.45 3.78 3.18 

Past-Due Ratio 2.75 2.79 2.26 2.25 2.32 2.36 1.34 1.39 1.36 3.08 3.11 2.38 

Earning Asset Yield 5.33 6.08 7.66 5.37 6.12 7.79 5.62 6.43 7.48 5.28 6.02 7.66 

Cost of Funding Earning Assets 1.88 2.34 4.39 1.84 2.38 4.07 2.28 2.98 4.21 1.84 2.24 4.48 

Total Loan Growth (year over year) 4.14 2.66 5.64 6.82 2.43 8.00 3.63 5.54 8.66 3.69 2.27 4.73 

Tier 1 Leverage Ratio 7.25 7.43 7.24 8.26 8.33 8.44 9.46 9.30 9.50 6.79 7.03 6.77 

Note: YTD = year to date. All figures are percentages. All data exclude credit card institutions, de novos, and other small specialty institutions. 

Source: Bank and Thrift Call Reports, reported on a merger-adjusted basis 

3 Fleet Capital. “Capital Eyes: Monthly Insights on Middle-Market Leveraged Finance,” June 2003.
 

4 Fernandez, Frank A, Monahan, George R, “Securities Industry Update: Turning the Corner,” Securities Industry Association, July 24, 2003.
 

FDIC OUTLOOK 31 FALL 2003 
Regional Perspectives 

and, during first quarter 2003, 86 percent of these 

institutions realized gains. The gains represented 14 

percent ($1.1 billion) of net income, up from 6 

percent a year ago. Should interest rates remain low, 

insured institutions can supplement earnings, as unrealized gains on available-for-sale securities are among 

the highest levels in a decade. However, if interest 

rates rise, this source of income could dry up quickly. 

The volume of long-term assets (five years or greater) 

continued to grow among the Region’s insured institutions as mortgage refinancing activity remained strong 

during the past year. Commercial banks reported a 9 

percent median growth rate in long-term assets, the 

seventh consecutive year of strong growth, as borrowers preferred longer-term, fixed-rate loans. The 27 

percent median ratio of long-term assets to total assets 

is historically high among the Region’s commercial 

banks. The Region’s savings banks reported 40 percent 

of assets in the long-term category, although the 

growth has slowed. Savings institutions have shifted 

portfolio emphasis into variable-rate commercial and 

commercial real estate loans. These portfolios have 

experienced double-digit growth since 1999 and grew 

at a median rate of more than 10 percent last year. 

In addition to strong loan growth, insured institutions 

reported robust deposit growth. The median growth 

rate of non-interest-bearing deposits was about 13 

percent from March 2002 through March 2003. The 

growth in deposits can be attributed, at least in part, to 

the fact that consumers are willing to accept the tradeoff between potentially higher, yet volatile, equity 

market returns and the security of insured deposits 

during a period of stock market uncertainty. During 

the same period, noncore funding increased at a 

median rate of just over 10 percent. Meanwhile, institutions continued to use leverage programs that raise 

low-cost, noncore funds and invest in assets to increase 

net interest income. Deposits and borrowings represent 

an inexpensive source of short-term funds, allowing 

insured institutions some control over NIMs. However, 

as consumers become more confident in investing in 

alternative products, funding costs could increase. 

Higher funding costs, coupled with large concentrations of long-term assets, could heighten interest rate 

risk, directly affecting the bottom line if interest rates 

move adversely. 

Despite the weak economy, asset quality measures 

continue to appear favorable, helping to boost profitability among the Region’s insured institutions. On an 

aggregate basis, during the past year total past-due loans 

declined; however, deterioration has occurred among 

certain groups of banks and specific loan types. For 

example, during the 12-month period ending March 

2003, the median past-due ratio for single-family residential real estate loans increased 40 basis points to 

1.16 percent among the Region’s large savings institutions (those with assets of at least $10 billion) and 19 

basis points to 1.42 percent among small commercial 

institutions (those with assets of less than $10 billion). 

The latter group also reported a 15 basis point increase 

in the commercial loan past-due ratio to 1.65 percent 

during this period. Although some insured institutions 

reported greater increases in past-due loans, aggregate 

levels remain historically low and manageable. Loan 

losses and provision expenses also remain low, helping 

to boost earnings. 

Going forward, certain trends could constrain insured 

institutions’ profitability. Strong loan growth may be 

masking some of the negative effects of the slow economy, but should the Region’s economy remain sluggish, 

commercial and commercial real estate loan portfolios 

could begin to show deterioration, resulting in higher 

charge-off rates and provision expenses. On the other 

hand, even a recovering economy may present challenges, as rising interest rates would affect the value of 

fixed-rate securities portfolios adversely and could hurt 

NIMs in institutions that have invested significantly in 

long-term assets. 

New York Staff 

FDIC OUTLOOK 32 FALL 2003 
Regional Perspectives 

San Francisco Regional Perspectives 

State Budget Deficits Could 

Constrain the Region’s 

Economic Recovery 

The fragile economy, 

sustained weakness in the 

high-tech sector and stock 

markets, and a temporary decline 

in oil prices during 2001 have 

affected state government tax 

collections adversely and may 

constrain the economic recovery in the San Francisco 

Region. State tax collections declined more than 10 

percent in the Region during fiscal year 2002 (see Table 

1), following almost a decade of average annual revenue 

growth of 6.7 percent. Tax collections rebounded somewhat in fiscal year 2003, in part thanks to tax increases, 

but budget gaps were expected to persist in most of the 

Region’s states through fiscal year 2004.

1 Strategies used 

by state governments to mitigate the effects of reduced 

tax collections, such as eliminating staff, cutting expenditures, and raising taxes or fees, could hurt local 

economies. This is particularly true in areas in which 

strong job growth in the state and local government 

sector bolstered local economies during the recent recession. This article assesses the potential effects of these 

strategies on local economies as well as on insured institutions headquartered in the San Francisco Region. 

The Severity of Budget Deficits 

Varies Across the Region 

The size of projected 2004 state budget deficits varies 

significantly and depends greatly on each state’s source 

of tax revenues. State economies that relied more heavily on volatile tax sources, such as personal income or 

corporate taxes, were affected more adversely during 

the 2001 recession and are not expected to recover 

quickly. In contrast, states that relied more on sales 

taxes exhibited less tax revenue stress. 

Tax revenue declined dramatically during fiscal year 

2002 among the Region’s state governments that relied 

heavily on personal income tax collections. Significant 

job losses, particularly in the high-paying technology 

sector, contributed to personal income tax shortfalls in 

1 National Conference of State Legislatures, State Budget Update: 

April 2003, April 2003. 

California, Idaho, Oregon, and Arizona.2 Sustained 

weakness in the stock market also contributed to 

declining personal income tax collections as capital 

gains and employee stock option wealth evaporated. 

Personal income taxes, which represented more than 

35 percent of all state tax collections in the Region 

during fiscal year 2002, declined 23 percent, compared 

with 11 percent for the nation. Personal income tax 

collections in the Region are not expected to recover 

soon because of the sluggish near-term outlook in the 

high-tech industry and the stock market. 

Corporate tax collections have declined in states with a 

high concentration of employment in the high-tech 

industry, which has slowed dramatically during the past 

couple of years. In California, corporate tax collections 

declined almost 23 percent during fiscal year 2002, in 

large part because of stress in the high-tech sector and 

the general economic downturn. In addition, a temporary decline in oil prices during 2001 hurt corporate tax 

revenue in Alaska, where collections fell by nearly 

one-third during fiscal year 2002. 

As a result of declining revenue from personal and 

corporate taxes, reliance on sales taxes has increased. 

However, even among the states that generated a 

significant share of revenue from sales taxes, Arizona 

and Nevada are projecting two of the five highest relative budget shortfalls in the Region. The key tourism 

sector slowed during the 2001 recession and after 9/11, 

contributing to declines in overall tax revenue. In 

addition, robust employment growth in Arizona and 

Nevada during the past decade has pressured state and 

local governments to keep pace with needed public 

services, such as enhancements to infrastructure and 

education. Rising government expenditures have left 

these states particularly vulnerable to the recent slowdown in tax collections and the resulting shortfall. 

State Budget Woes Could Affect Local Economies 

and Insured Institutions Adversely 

The Region’s state and local government sector represented one of the few sources of job growth during the 

2 Idaho, Oregon, Arizona, and California ranked among the top seven 

states nationally during 2001 in the share of employment in the electronic component manufacturing industry. 

FDIC OUTLOOK 33 FALL 2003 
Regional Perspectives 

Chart 1 

Stress in State and Local Government Sector
 

May Constrain Region’s Economic Recovery
 

Nonfarm Employment

(Year-over-Year Percentage Change) 

–3 

–2 

–1 

0 

1 

2 

3 

4 

5 

’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 

San Francisco Region State 

& Local Government 

San Francisco Region Total 

Recessions 

(gray bars) 

Sources: Bureau of Labor Statistics; National Bureau of Economic Research 

recent recession; however, employment growth in this 

sector decelerated sharply during 2002 and early 2003 

(see Chart 1).

3 Layoffs in the state and local government sector could dampen the Region’s recovery, impair 

the debt servicing ability of individuals and businesses, 

and challenge the performance of insured institutions. 

In addition, bank asset quality and liquidity could be 

affected adversely by exposures to municipal bonds, 

loans, or deposits during a time of increasing fiscal stress. 

Decelerating growth in the state and local (nonfederal) 

government sector could have a disproportionate effect 

on insured institutions operating in states that have 

higher exposures to nonfederal government jobs and 

expect budget deficits in fiscal year 2004, such as Alaska, 

Nevada, Idaho, and Washington (see Table 1). Alaska’s 

relatively large reserve funds are expected to mitigate 

the risk of layoffs among its state and local government 

employees, however. Throughout the Region, less-populated, rural areas may be particularly vulnerable to additional layoffs because nonfederal government jobs 

typically represent a relatively high share of employment 

in rural counties.

4 Job losses in rural areas could further 

pressure already high delinquent loan ratios reported 

3 Employment growth in the state and local government sector during 

2001 was amplified somewhat by the reclassification of Native American tribal jobs into the sector beginning in January 2001. Even absent 

this reporting change, state and local government job increases 

during 2001 far outpaced growth rates reported in other major industry 

groupings. 

4 As of 2000, the median ratio of state and local government employment to total nonfarm employment was 20 percent in counties with 

nonfarm labor forces of 150,000 or fewer, well above the 13 percent 

median in counties with larger workforces (includes only those counties that reported state or local government employment for 2000 via 

Global Insight). 

among insured institutions based outside of metropolitan areas. Since 1998, established community banks 

headquartered in rural areas have reported higher pastdue loan ratios than those based in metropolitan areas.

5,6 

Job losses in the nonfederal government sector also 

could have a disproportionate effect on counties that 

are home to state capitals. For example, in counties 

surrounding seven of the Region’s state capitals, at least 

20 percent of nonfarm workers are employed in the 

nonfederal government sector—Juneau County, AK 

(37 percent); Thurston County, WA (37 percent); 

Table 1 

Declining State Taxes Could Hamper 

Job Growth in the Region 

Estimated State Tax for State and 

2004 Fiscal 2002 Local Gov. 

Deficit (%) a (% Change) b Job Sharec 

Alaska 25.0 –23.7 23.2 

Arizona 25.0 1.4 15.3 

California 20.6 –14.0 15.6 

Oregon 17.0 –12.8 15.9 

Nevadad 9.8 3.0 18.8 

Washington 8.9 –0.4 17.4 

Idaho 8.8 –11.2 18.0 

Montana 8.3 –3.5 11.4 

Hawaii 2.9 –2.5 15.6 

Utah 0.0 –3.6 15.5 

Wyoming 0.0 –2.7 23.6 

San Francisco Region –10.5 15.8 

Nation –4.7 14.9 

a Estimated state deficit for the fiscal year ending June 30, 2004, as a percentage of the 

General Fund Budget. 

b Year-over-year percentage change for fiscal year 2002. 

c Represents state and local government employment as a share of nonfarm employment 

for April 2003. 

d Because Nevada’s information was not available for fiscal year 2004, the deficit and 

General Fund Budget data for fiscal year 2003 are shown. 

Sources: National Conference of State Legislatures; Bureau of Labor Statistics; U.S. 

Census Bureau 

5 This grouping excludes insured commercial banks open less than 

three years, industrial loan companies, and any insured banks reporting more than $1 billion in total assets, consumer loans exceeding 300 

percent of Tier 1 capital, unfunded loan commitments exceeding total 

assets, or loan-to-asset ratios less than 25 percent. These criteria help 

isolate insured institutions that are more likely to invest a high share of 

assets in the headquarters county. Thrift Financial Report filers are 

excluded from this analysis because of data limitations. 

6 As of March 31, 2003, the median past-due loan ratio among established community banks based outside of the Region’s metropolitan 

statistical areas (MSAs) was 2.6 percent, compared with 1.1 percent 

among established community banks headquartered within MSAs. 

Disparities in median delinquencies could be due in part to differences 

in the geographic, size, and age composition or asset niche of MSAbased insured institutions compared with rural institutions. 

FDIC OUTLOOK 34 FALL 2003 
Regional Perspectives 

Carson City County, NV (30 percent); Sacramento 

County, CA (28 percent); Laramie County, WY (26 

percent); Marion County, OR (24 percent); and Lewis 

and Clark County, MT (24 percent).

7 Should deficit 

strategies prompt layoffs in the government sector, 

borrowers could find it more difficult to service their 

debts, and insured institution asset quality could weaken. 

Fiscal woes also could affect the quality of bonds issued 

by municipalities. As a result, insured institutions could 

experience some weakening in securities portfolio 

credit quality and liquidity. Across the Region, weaker 

tax revenues contributed to fewer municipal bond 

rating upgrades during 2002 and early 2003.

8 During 

the 15-month period ending March 2003, Moody’s 

Investors Service downgraded general obligation bonds 

issued by the states of California and Oregon and 

several health, housing, education, lease, and redevelopment bonds issued by local municipalities in Arizona, 

California, Hawaii, Oregon, and Washington. 

Although municipal bond exposures among insured 

banks based in California, Arizona, and Nevada (states 

experiencing some of the Region’s more severe deficits) 

are low, holdings among banks based in the Region’s 

more rural states—Alaska, Idaho, Wyoming, Montana, 

and Oregon—are higher (see Table 2). 

Table 2 

State and local budget deficits also could pressure 

liquidity among insured institutions that rely on state 

and local public deposits to fund assets. Declining tax 

revenues could constrain municipal deposit volumes 

should state and local payrolls decline or should municipalities have less excess cash available to invest in 

certificates of deposit. Liquidity pressures could be more 

significant among banks headquartered in Wyoming, 

Washington, Montana, Alaska, and Idaho, where 

median municipal deposit-to-total asset ratios are 

higher than in the Region as a whole (see Table 2). 

The Effects of Fiscal Stress on Local Economies 

and Insured Institutions Could Lag 

Although budget deficits have been in the news for some 

time, some state and local governments have only begun 

to announce layoffs, cut services, and increase tax rates. 

Thus, the Region’s local economies and insured institutions have not yet felt the full effects of this heightened 

fiscal stress. Bank management should continue to monitor any deterioration in credit quality or liquidity resulting from budget shortfalls and deficit reduction strategies. 

John A. Roberts, Regional Economist 

Judy H. Plock, Senior Financial Analyst 

Municipal Securities and Deposit Exposures Tend to Be Higher 

Among Insured Institutions Based in the Region’s Rural States 

General Obligation Municipal Loans & Municipal Deposits/ Municipal Loans, Securities Bond Ratings Securities/Total Assets Total Assets & Deposits/Total Assets 

State Moody’s S&P (Median %) (Median %) (Median %) 

Alaska Aa2 AA 4.3 2.4 8.9 

Arizona NR NR 0.0 0.0 0.0 

California A2 BBB 0.0 0.5 1.5 

Hawaii Aa3 AA– 0.1 1.5 4.7 

Idaho NR NR 2.8 2.1 7.9 

Montana Aa3 AA– 2.6 2.8 6.5 

Nevada Aa2 AA 0.0 0.0 0.2 

Oregon Aa3 AA 2.9 1.8 4.7 

Utah Aaa AAA 0.0 0.1 0.3 

Washington Aa1 AA+ 0.5 4.5 6.4 

Wyoming NR NR 2.6 9.1 13.7 

San Francisco Region 0.4 1.3 3.4 

Nation 2.5 5.2 9.5 

Notes: S&P = Standard and Poor’s. NR = Not rated, in part because these states had no general obligation debt outstanding. Region data exclude insured banks headquartered in American 

Samoa, Federated States of Micronesia, and Guam. 

Sources: Moody’s Investors Service and Standard and Poor’s via Bloomberg (July 30, 2003); Bank Call Reports (March 31, 2003) 

7 Nonfederal government employment concentrations are based on employment estimates for 2000 from Global Insight.
 

8 For more information, see Moody’s Investors Service, “Special Comment: Sluggish Economy Weighs Down Municipal Rating Revisions in 2002,”
 

January 2003, and “Special Comment: First Quarter Muni Upgrade/Downgrade Ratio Nears Parity; States’ Fiscal Stress Hits Localities,” April 2003.
 

FDIC OUTLOOK 35 FALL 2003 
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