Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION	 FIRST QUARTER 1999 

FDIC
 

National
 

Edition
 

Boston 

Chicago 

New 

York 

Atlanta 

Memphis 

Kansas 

City 

San Francisco 

Dallas 

Division of
 

Insurance
 

In Focus This Quarter 

◆	 High Loan-to-Value Lending: A New Frontier in Home Equity Lending— 

High loan-to-value home equity loans have grown in popularity as consumers have sought 

ways to consolidate credit card debt and lenders have sought ways to deal with declining profit margins on traditional home equity loans. High loan-to-value loans pose unique risks for 

lenders because of their hybrid nature: they combine characteristics of both a secured home 

equity loan and an unsecured consumer loan. Losses on such loans are increasing rapidly, and 

the current rate of loss raises concern about how these loans might perform in an economic 

recession. See page 4. 

By Diane Ellis 

◆ Commercial Development Still Hot in Many Major Markets, but Slower 

Growth May Be Ahead—Following the experience of the 1980s, the threat of an oversupply of commercial real estate is watched with keen interest by market participants and 

observers alike. This article highlights nine metropolitan areas that may be vulnerable to 

overbuilding based on the rapid pace of development occurring within those markets, various indicators of current and prospective demand, and projections by credible industry analysts. These concerns could be mitigated to the extent that reduced credit availability within 

the capital markets leads to a slowing in construction activity. See page 11. 

By Steven Burton 

◆ Recent Trends in Syndicated Lending—A strong U.S. economy, intensifying lender 

competition, and increasing marketability of bank loans have driven record volumes of syndicated lending in the 1990s. These factors led to several years of liberalized underwriting in 

the syndicated market.While evidence suggests that some banks have tightened standards and 

terms for loans to large commercial borrowers, market developments and underwriting 

trends over the past several years have implications for credit quality, earnings, and liquidity 

at institutions that hold or originate syndicated loans. See page 19. 

By Steven E. Cunningham, Ronald L. Spieker 

Regional Perspectives 

◆	 Atlanta—Several of the Region’s real estate markets 

rank among the nation’s most active in new construction, 

with community bank exposure growing in the Atlanta 

market. See page 25. 

◆	 Boston—Asset-quality indicators remain generally 

favorable, but delinquencies and charge-offs are increasing 

in credit card and consumer portfolios. See page 26. 

◆	 Chicago—Over one-third of the Region’s community 

institutions experienced rapid growth in commercial real 

estate and construction loans. See page 27. 

◆	 Dallas—After several years of declining office vacancy 

rates, large amounts of newly constructed office space are 

coming onto the Dallas metropolitan market, making the 

Dallas market vulnerable to overbuilding. See page 28. 

◆	 Kansas City—The outlook for the Region’s farm economy appears unfavorable, as low commodity prices and declining farm income are expected to continue. See page 29. 

◆	 Memphis—Commercial real estate markets remain 

active, with Nashville reporting high levels of construction 

starts despite signs of softening demand for office space. 

See page 30. 

◆	 New York—Regional commercial real estate markets 

remain generally subdued, with some markets reporting 

increased office construction activity and rising demand. 

See page 31. 

◆	 San Francisco—Active commercial real estate development in several of the Region’s markets raises concerns 

about potential overbuilding, while community bank exposure in some of these markets has grown significantly. 

See page 32. 

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

Insurance Corporation for the following eight geographic regions: 

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

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

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

Dallas Region (CO, NM, OK, TX)
 

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

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

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

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

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

form found on the back cover to the FDIC Public Information Center. Contact the Public Information Center for current pricing on bulk orders. 

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

publish/regout. For more information or to provide comments or suggestions about the National 

Edition of Regional Outlook, please call Lynn Nejezchleb at (202) 898-3898 or send an e-mail to 

lnejezchleb@fdic.gov. 

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

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

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

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

the Federal Deposit Insurance Corporation. 

Chairman Donna Tanoue 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Regional Managers 

Atlanta Jack M.W. Phelps 

Boston Daniel Frye 

Chicago Suzannah L. Susser 

Dallas Alan C. Bush 

Kansas City Craig A. Rice 

Memphis Gary L. Beasley 

New York Kathy R. Kalser 

San Francisco Catherine I. Phillips-Olsen 

Publications Manager Teresa J. Franks 
From the Editor
 

To the Reader: 

I am pleased to announce the first publication of the Regional Outlook National Edition. Since its 

inception, the Regional Outlook has been published quarterly in eight separate volumes that were 

tailored specifically for each FDIC Region. This format was ideal for the reader who wanted 

detailed analysis of a specific Region. 

Beginning this quarter, the FDIC will publish in a single volume the highlights of our Regional 

analysis of trends affecting FDIC-insured institutions across the United States. The eight 

unabridged Regional editions will continue to be published for readers who want more detailed 

information about trends in their Regions. All editions will continue to offer the In Focus series of 

articles on trends affecting the risk exposures of FDIC-insured institutions. 

For example, this quarter the In Focus series highlights important trends affecting commercial 

lenders and consumer lenders. The Regional Perspectives articles explore in more detail how these 

and other trends may affect FDIC-insured institutions around the United States. 

Both the Regional and National editions are available by subscription or on the FDIC’s website at 

www.fdic.gov. As always, we welcome your comments on the content or format of this publication. 

Please refer to the back cover and inside the front cover for information about how to subscribe or 

comment. 

Sincerely, 

George French 

Executive Editor 
In Focus This Quarter
 

High Loan-to-Value Lending:
 

A New Frontier in Home Equity Lending
 

•	 High loan-to-value (HLTV) loans are typically 

junior liens on owner-occupied single-family residences, but there is limited collateral protection 

because the combined loan amounts often exceed 

the value of the home. 

•	 Nonbank, specialty lenders have dominated this 

line of business, and their growth has been fueled 

by strong demand for asset-backed securities collateralized by HLTV loans. 

•	 Insured depository institution involvement in 

HLTV lending has been increasing, and opportunities for further involvement opened up when 

market turmoil resulted in a contraction of HLTV 

specialists. 

•	 HLTV lending involves unique risks because it 

combines characteristics of both secured home 

equity lending and unsecured consumer lending. 

Just a few years ago, it would have been difficult to 

imagine a mainstream lender writing a home equity 

loan in excess of the equity that the consumer had in his 

or her home. However, intense competition and declining profit margins in traditional home equity lending 

have lenders looking to boost volume and profits by 

relaxing underwriting standards. At the same time, consumers are signaling their desire to transfer their credit 

card balances to lower-costing home equity loans. 

These trends have given lenders, including insured 

depository institutions, the impetus to enter the HLTV 

home equity market. Furthermore, new opportunities 

have opened up for insured depository institutions to get 

involved in HLTV lending as a result of turmoil in the 

equity and asset-backed securities market, which resulted in a severe liquidity crisis that effectively sidelined 

many HLTV specialists. 

HLTV Lending Taps Consumers’ Desire to Shift 

Credit Card Debt into Home Equity Loans 

For the better part of the 1990s, credit card lending was 

dubbed the Wild West of consumer credit. This title 

was earned, in part, by lenders’ aggressive marketing 

and solicitation of their cards and consumers’ willingness to push their holdings of credit card debt to record 

high levels. After several years of double-digit growth 

in credit card outstandings, the growth has slowed. 

However, this slowdown does not necessarily mean that 

the Wild West has been tamed. In fact, home equity 

lenders are blazing new frontiers in consumer credit. 

Chart 1 shows that the originations of home equity 

loans for asset-backed securitizations have surpassed 

the originations of credit card loans over the past two 

years. 

It could be said that the home equity industry owes its 

resurgence to the boom in credit card lending that preceded it, because today’s home equity borrowers primarily use these loans to consolidate their outstanding 

debt. A survey by the Consumer Bankers Association 

found that, whereas in 1991 home improvement was the 

primary reason for taking out a home equity loan, debt 

consolidation is now the primary reason, with 40 percent of borrowers using a home equity loan for this purpose in 1997. This shift also is evidenced by another 

recent survey by Brittain Associates, Inc., which estimated that during a 24-month period ending June 1998, 

4.2 million households converted $26 billion in credit 

card debt to home equity mortgage debt. Given the high 

levels of credit card debt on households’ balance sheets, 

it should be no surprise that consumers with other borrowing options are looking for ways to consolidate their 

debt and reduce their borrowing costs. 

CHART 1 

Originations of Home Equity Loans Have 

Surpassed Originations of Credit Card 

Loans in the Past Two Years 

Source: Inside MBS & ABS 

1995 1996 1997 9 mos. 1998 

Credit Card 

Home Equity 

$ Billions 

70 

60 

50 

40 

30 

20 

10 

0 

National Regional Outlook 4	 First Quarter 1999 
In Focus This Quarter
 

HLTV Loans Are Hybrid Loans 

HLTV loans are considered hybrid loans and can be 

thought of as a marriage between secured lending and 

unsecured credit card loans. HLTV loans are typically 

junior liens on owner-occupied single-family residences 

where the combined loan amounts exceed the value of 

the home—sometimes by as much as 125 to 150 percent. Some lenders also make HLTV first mortgages, 

which enable consumers to finance their down payment 

and closing costs and consolidate other debts. 

In return for pledging their home as collateral, borrowers are charged lower rates of interest than on unsecured 

consumer loans. Even at 125 to 150 percent loan-tovalue, the rates on HLTV loans generally are lower than 

credit card loans. In 1997, the average rate on an HLTV 

was 13 to 14 percent, whereas the average rate on a 

credit card loan was 16 percent. Because HLTV loans 

carry lower interest rates and are long-term loans (15 to 

30 years), the monthly payment on one is often considerably less than the total monthly payments on the loans 

that were paid off in the consolidation. 

HLTV loans also appeal to consumers because they can 

benefit from the tax deductibility on a portion of their 

interest payments. Current IRS rules allow interest to 

be deducted on that portion of the loan that is equal to 

Typical HLTV 


Borrower Characteristics
 

Annual Income $60,000 

Job Tenure 5 years 

Age Late thirties 

FICO Score 680 

Outstanding Nonmortgage Debt $20,000 

First Mortgage Amount $110,000 

Property Value $130,000 

Typical HLTV 

Loan Characteristics 

Amount $30,000 

Contract Interest Rate 13 to 14% 

Term 25 years 

Loan to Value 110% 

Notes: HLTV = high loan-to-value; FICO = Fair, Isaac Company 

Source: General Accounting Office, based on interviews with 

public and private officials 

or less than the value of the home at the time the loan 

is closed. 

The primary disadvantage of converting unsecured 

credit card and other consumer debt to an HLTV loan 

is that in the event of default, the borrower could lose 

his or her home. However, many consumers burdened 

by the high cost of unsecured consumer debt apparently have viewed the chance to lower their monthly payments as worth the risk. HLTV loans have been 

particularly popular in California, where property 

value declines in the early 1990s left homeowners with 

little or no equity in their homes. The inset box shows 

the typical characteristics of an HLTV loan and an 

HLTV borrower. 

Underwriting of HLTV Loans Emphasizes 

the Borrower’s Credit Quality 

Because of their limited or nonexistent collateral protection, HLTV loans typically are considered unsecured 

loans and the emphasis in underwriting is on the borrower’s credit quality rather than on collateral value. 

Large HLTV lenders use credit scoring to underwrite 

their loans, and a major component of their scoring is a 

credit bureau or Fair, Isaac Company (FICO) score. 

Other important factors are the borrower’s debt-toincome ratio, mortgage credit history, consumer credit 

history, bankruptcies, foreclosures, notice of defaults, 

deeds in lieu of foreclosure, and repossessions. 

HLTV loans are not necessarily subprime loans; the 

term “subprime” refers to the credit quality of the borrower rather than the margin of collateral protection. 

Instead, many lenders assert that HLTV loans are made 

to “prime” borrowers and can point to the fact that 

FICO scores on HLTV loans have been rising, averaging approximately 689 in 1998. Scores above 680 are 

generally associated with “A” credit quality; however, 

the average ignores the fact that major HLTV lenders 

allow FICO scores to go much lower, typically as low as 

620.1 Standard & Poor’s recently reported that performance problems clearly exist on loans for which the 

borrower’s FICO score is below 650.2 

1 H.T. Katz and G.T. Costello, Fitch IBCA Credit Rating Company.
 

“Securitization of 125 LTV Mortgages.” Structured Finance Special
 

Report, March 4, 1998. Underwriting guidelines summary matrices
 

are provided for seven large HLTV lenders.
 

2 “High LTV Security Performance Expected to Improve as FICO
 

Scores Rise and FHA Title 1 Loans Disappear.” Inside MBS & ABS,
 

November 13, 1998, p. 9.
 

National Regional Outlook 5 First Quarter 1999 
In Focus This Quarter
 

TABLE 1 

HLTV Underwriting Guidelines 

QUALIFYING PARAMETERS A+ A B+ B C+ 

FICO SCORE 700+ 680–699 660–679 640–659 629–639 

MORTGAGE HISTORY (PAST 12 MONTHS) 1X30* 1X30 1X30 1X30 1X30 

BANKRUPTCY (YEARS SINCE DISCHARGE) 3 3 3 5 5 

MAXIMUM DEBT TO INCOME (%) 50 50 45 45 40 

MAXIMUM LOAN TO VALUE 125 125 125 125 125 

MAXIMUM CASHOUT $35,000 $25,000 $15,000 $5,000 $1,000 

MAXIMUM LOAN AMOUNT $100,000 $75,000 $65,000 $45,000 $30,000 

* Number of times delinquent multiplied by days delinquent. 

Note: HLTV = High loan-to-value; FICO = Fair, Isaac Company. 

Source: The 10K filing of a major HLTV lender. 

The agencies that rate asset-backed securities collateralized by HLTV loans offer another perspective on the 

credit quality of HLTV borrowers. Moody’s has 

described HLTV borrowers as in the “A–” to “B” 

grades, and Standard & Poor’s has characterized the 

loans as “A–” to “B+” in terms of credit quality. Any 

grade below A can be considered subprime. Indeed, 

according to Mortgage Information Corp., the bulk of 

subprime mortgage activity occurs in the A– category. 

However, some analysts have preferred to characterize 

HLTV borrowers as squarely in between the subprime 

and prime designations. 

Whatever the label given to the quality of borrowers, 

they typically have a large amount of high-cost revolving debt, and converting this debt into a second lien on 

their home is an attractive alternative. They also might 

have some degree of poor credit performance. Table 1 

shows the underwriting criteria used by one of the 

largest HLTV lenders. Because underwriting classification systems are not uniformly applied among 

HLTV lenders, this table should be viewed only as a 

guide. 

Fueled by Easy Access to Capital, 

HLTV Loans Have Grown Rapidly 

On the basis of the volume of loans securitized, the 

HLTV loan market has expanded rapidly over the past 

several years (see Chart 2). Originations have grown 

from $1 billion in 1995 to $8 billion in 1997 and are 

expected to be around $12 billion in 1998. 

Nonbank, specialty finance companies presently dominate the HLTV market, and their easy access to capital 

CHART 2 

High Loan-to-Value Mortgage Production
 

Has Grown Rapidly
 

$ Billions 

14 

12 

10 

8 

6 

4 

2 

0 

1995 1996 1997 1998 (Est.) 

Source: General Accounting Office 

has been an important factor behind their growth. These 

specialists depend on their ability to securitize the loans 

and sell them in the asset-backed securities market. 

Strong investor demand for all kinds of asset-backed 

securities has allowed HLTV lenders to raise a substantial amount of funding without a strong degree of corporate credit quality. However, their reliance on the 

asset-backed securities market to fund operations 

exposes them to liquidity risk if demand for these securities declines. 

A healthy initial public offering market also has fueled 

the growth of these specialty lenders, and gain-on-sale 

accounting has allowed lenders to establish an earnings 

track record and attract debt and equity investors. Gainon-sale accounting requires securitizers to calculate and 

record a gain on sale from securitizations; however, the 

use of gain-on-sale accounting exposes lenders to prepayment risk. If the securitized loans prepay at a faster 

National Regional Outlook 6 First Quarter 1999 
In Focus This Quarter
 

rate than the assumption used to calculate the gain, the 

company could be forced to take a write-down, which 

can affect earnings, liquidity, and capitalization. Institutions that invest in securities collateralized by HLTV 

loans also are exposed to prepayment risk. (For more 

information on gain-on-sale accounting, see “Gain-onSale Accounting Can Result in Unstable Capital Ratios 

and Volatile Earnings” in Regional Outlook, second 

quarter 1998.) 

In addition to the easy access to capital, favorable economic conditions also have encouraged HLTV lending. 

The long economic expansion has brought about the 

return of home price appreciation to nearly all parts of 

the country, which has encouraged HLTV lending 

because rising home values serve to reduce lender and 

investor exposure fairly quickly. The median sales price 

of existing single-family residences has increased an 

average of 4.39 percent per year since 1995, according 

to the National Association of Realtors. 

Market Turmoil Hit HLTV Specialty 

Lenders Hard 

The market volatility that began last summer illustrated the importance of liquidity risk and prepayment 

risk. HLTV specialists were faced with a liquidity 

crunch when they were hit hard in the equity downturn, 

in many cases significantly harder than the general 

market. Investors retreated from HLTV lenders and 

their asset-backed securities, in part as a result of a 

“flight to quality” as the Asian crisis spilled over into 

other global markets. A core of investors participating 

in the HLTV market also exited the market when prepayments occurred at faster rates than anticipated, 

largely a result of lower market interest rates, and 

forced lenders to take write-downs of interest-only 

residuals. Another factor in the investor retreat from 

this market was the growing skepticism concerning the 

performance of HLTV loans during an economic 

downturn. 

When investor demand for asset-backed securities dried 

up, HLTV lenders were unable to securitize their loans 

profitably. This situation created a severe liquidity crisis 

for specialty lenders who relied heavily upon this source 

of funding. As a result, some lenders were forced to put 

themselves up for sale, and others were forced to undergo massive restructuring. 

HLTV Lending Presents Unique Risks 

to Home Equity Lenders 

In addition to the risks associated with the securitization 

of HLTV loans (liquidity and prepayment risk), HLTV 

lending poses some unique risks for lenders who hold 

these loans in their portfolio, service them, or guaranty 

the performance of asset-backed securities. Because 

HLTV loans are a relatively new product, their credit 

risk is untested and could be affected by the following 

factors: 

•	 Increased rate of default. Data on the performance 

of HLTV loans are limited; however, the loss potential is starting to become visible when vintage analysis is performed. Chart 3, next page, shows that when 

recent vintages are adjusted for seasoning, chargeoff rates on HLTV loans are increasing at a rapid 

rate. Both the severity and frequency of default are 

much higher than for traditional A-quality home 

equity loans and are even higher than subprime home 

equity loans. The fact that charge-offs are higher 

than subprime loans suggests that the credit quality 

of HLTV borrowers is not too different from subprime borrowers and that when default occurs, the 

loss is more severe because of the lack of collateral 

protection. Lenders who do not accurately forecast 

the magnitude and costs of default associated with 

HLTV loans, or who make underwriting mistakes, 

might find that this line of business is not as profitable as anticipated. 

Lenders that rapidly increase HLTV exposures 

might consider the use of vintage analysis, also 

called “static pool” analysis, as a means of evaluating loan portfolio performance. This technique is 

effective when there is rapid growth, which can 

make it more difficult to accurately track delinquency and default trends when only an average delinquency or default ratio is calculated. Refer to 

“Subprime Lending: A Time for Caution” in 

Regional Outlook, third quarter 1997, for additional discussion on vintage analysis. 

•	 Untested performance in a recession. HLTV lending has existed for only a few years and has yet to be 

tested by economic recession. The rapid rise in 

charge-offs on HLTV loans has occurred in a relatively robust economic environment, and the losses 

during an economic downturn could be considerably 

National Regional Outlook 7	 First Quarter 1999 
In Focus This Quarter
 

higher than anticipated. Moody’s has asserted that 

losses will mimic those of credit cards, and losses on 

credit card loans are usually higher than other consumer mortgage-related products. 

HLTV lenders’ heavy reliance on credit-scoring 

models raises further questions about how these 

loans might perform in a recession because these 

models are largely unproven in a recession as well. 

To improve the accuracy of credit-scoring models 

and the model’s ability to appropriately price the risk 

assumed, lenders can continually test and refine 

credit-scoring models to ensure that actual performance approximates projections. 

Changes in the borrower’s financial condition present a 

greater risk to HLTV lenders than in other types of 

secured lending, which introduces additional credit 

risks. In the event of default, the lender is likely to suffer a complete loss because foreclosure is probably 

infeasible and the size of HLTV loans is much larger 

than other types of unsecured or partially secured loans. 

Therefore, adverse changes in the borrower’s financial 

condition are very important and can be affected by the 

following factors: 

•	 Debt reloading. The primary reason consumers take 

out an HLTV loan is to consolidate credit card and 

other high-cost consumer debt. However, lenders 

cannot prevent HLTV borrowers from running up 

additional credit card debt after the loan is made. 

Consequently, these loans might serve to only postpone or amplify credit problems. A recent survey by 

CHART 3 

Brittain Associates, Inc., indicates that a large percentage of borrowers who take out home equity 

loans proceed to run up credit card debt shortly 

thereafter. Their survey of over 6,000 borrowers who 

used home equity loans to consolidate their debts 

revealed that only 30 percent of those borrowers 

remained free of credit card debt one year later. 

•	 Long-term exposure. Consumer loans typically 

have been made on a short-term basis; however, 

HLTV loans are made for terms up to 30 years. 

Therefore, the credit quality on an HLTV loan is 

more vulnerable to catastrophic events such as borrower job loss, illness, or divorce. Furthermore, the 

term of these loans far exceeds the predictive power 

of FICO scores, which have proven to be predictive 

for about a two-year period according to Moody’s. 

Because of their fixed terms and limited collateral protection, there are some unique operational risks associated with servicing and collecting an HLTV loan. 

Servicing and collecting an HLTV loan differs somewhat from servicing and collecting both secured lending and credit card lending because of the following 

factors: 

•	 Limited default remedies. The servicing and collecting of HLTV loans are complicated by the fact 

that the threat of foreclosure is not as severe as in traditional secured lending. According to Moody’s, 

HLTV lenders must adopt a collection strategy similar to credit card lenders that will require early intervention and the ability to “talk” the borrower into 

CHART 4 

Note: HLTV = high loan-to-value 

Source: Moody’s Investor Services 

Charge-Offs Are Rising More Rapidly on HLTV 

Loans Than for Any Other Type of Home Equity 

Loan (1996 and 1997 Origination Years); ... 

2 3 4 5 6 7 8 9 10 11 12 13 1415 16 17 18 19 

HLTV 

Home Equity Index 

Composite 

Subprime 

Traditional Home Equity 

Charge-Off Rate (%) 

10 0 

1 

2 

3 

4 

5 

6 

7 

Months of Seasoning 

Note: HLTV = high loan-to-value 

Source: Moody’s Investor Services 

...However, Delinquency Rates on HLTV Loans 

Are Lower Than on Subprime Loans Because 

Loans Are Charged Off Sooner 

(1996 and 1997 Origination Years) 

4567 8 9 10 11 12 13 14 15 16 17 18 19 20 

Months of Seasoning 

Subprime 60 Plus Delinquency Rate 

HLTV 60 Plus 

Delinquency Rate 

HLTV Annualized 

Charge-Off Rate 

Subprime Annualized

 Charge-Off Rate 

Delinquency Rate (%) 

321 0 

2 

4 

6 

8 

10 

12 

14 

National Regional Outlook 8	 First Quarter 1999 
In Focus This Quarter
 

making a payment without resorting to foreclosure. 

However, unlike credit card lenders, HLTV lenders 

have less flexibility in collection because lines cannot be adjusted and interest rates cannot be raised. 

The different demands for servicing and collecting 

these loans, compared with traditional and subprime 

home equity loans, could strain institutions that do 

not have an adequate investment or expertise in collecting these loans. 

According to Moody’s, HLTV lenders generally 

write off their loans as a loss once they become 180 

days delinquent. In contrast, subprime lenders go 

through a lengthy foreclosure procedure. The speedier resolution of HLTV loans is reflected in a lower 

level of delinquencies in HLTV portfolios compared 

with subprime portfolios (see Chart 4, previous 

page). 

•	 Limited borrower flexibility and motivation. After 

a borrower has taken out an HLTV loan, opportunities to refinance are limited, and selling the home 

often is not feasible because of the large amount of 

cash needed at closing. As a result, counseling borrowers might prove to be harder than in credit card 

lending. Also, with negative equity in their homes, 

borrowers might have less incentive and ability to 

work with the lender to bring the loan current than to 

allow foreclosure. 

Insured Depository Institution Involvement 

in HLTV Lending Is Increasing 

Insured depository institution involvement in HLTV 

lending reportedly has been growing. Their precise 

involvement is difficult to quantify because these loans 

are not delineated in bank or thrift Call Reports. However, one indication of their growing involvement is 

cited in the Consumer Bankers Association 1998 home 

equity loan study. Twenty-five percent of respondents to 

its survey offered home equity loans with loan-tovalues in excess of 100 percent, up from only 5.8 percent one year earlier. 

Banks and thrifts can become involved in HLTV lending by using a variety of strategies. They can lend 

directly to HLTV borrowers or purchase HLTV loans 

from loan brokers and hold them in portfolio. Institutions also can originate the loans and securitize them or 

sell them to another company that will securitize them. 

A more indirect way for insured depository institutions 

to get involved in this market is to lend to HLTV specialty lenders in the form of warehouse lines. Institutions also can service HLTV loans or invest in 

asset-backed securities secured by HLTV loans. 

In light of the contraction of HLTV specialists, the 

question arises as to whether banks will view this as an 

opportunity to further expand their presence in HLTV 

lending, given that consumer demand for these products 

is still strong. Recent press reports indicate that this is 

happening, as some insured depository institutions 

recently have piloted HLTV lending programs by buying loans and keeping them in portfolio.3 Another way 

that banks have recently become involved in HLTV 

lending is by investing in HLTV specialists. Many 

HLTV specialists have been looking for opportunities to 

affiliate with firms that have plentiful and stable 

sources of liquidity (“deep pockets”), and insured 

depository institutions have been viewed as ideal candidates. Several of the largest HLTV specialists have an 

insured depository institution as an affiliate. 

Insured Depository Institutions Are Subject 

to Real Estate Lending Standards 

Unlike many of the specialty finance companies, 

insured depository institutions are subject to regulations 

prescribed by the federal supervisory agencies. In 1992, 

the federal banking and thrift supervisory agencies 

finalized a uniform regulation and interagency guidelines for real estate. The regulation, in part, requires 

institutions to adopt and maintain written policies that 

establish appropriate limits and standards for all real 

estate loans, including HLTV loans. When a bank 

adopts a policy, the regulation requires consideration of 

the Interagency Guidelines for Real Estate Lending 

Policies. These guidelines state that institutions should 

establish their own internal loan-to-value limits for real 

estate loans; however, they also indicate that the internal 

limits should not exceed 90 percent on a home equity 

loan.4 The guidelines recognize that it might be appro3 Timmons, H. “Banks Poised to Move in as High-LTV Lenders Fall.”
 

American Banker, October 28, 1998.
 4 The guidelines state, “A loan-to-value limit has not been established
 

for permanent mortgage or home equity loans on owner-occupied,
 

1- to 4-family residential property. However, for any such loan with a
 

loan-to-value ratio that equals or exceeds 90 percent at origination, an
 

institution should require appropriate credit enhancement in the form
 

of either mortgage insurance or readily marketable collateral.”
 

National Regional Outlook 9	 First Quarter 1999 
In Focus This Quarter
 

priate to deviate from these guidelines and state that 

loans made in exception to these guidelines should be 

identified in the institution’s records and reported to the 

board of directors at least quarterly. Furthermore, the 

guidelines state that the aggregate amount of all loans in 

excess of the supervisory loan-to-value limits should 

not exceed 100 percent of total capital. 

Competition from HLTV Loans Is Driving 

a Loosening in Underwriting on Other 

Home Equity Loans 

Even for insured depository institutions not directly 

involved in the HLTV market, the competition posed 

by this product already is evident in the underwriting 

of other types of home equity products. The Office of 

the Comptroller of the Currency reported in its latest 

survey of the 77 largest national banks in the country 

that underwriting on home equity loans has been loosening for three years, a time period that corresponds 

with the life of the HLTV market. They reported that 

in 1998, the percentage of banks tightening standards 

on credit card loans is nearly matched by the percentage of banks loosening their underwriting standards on 

home equity loans. Competition was cited as the primary reason for loosening home equity standards, and 

an easing of collateral requirements was the primary 

method. 

Conclusion 

HLTV lending has provided a new option for consumers to work their way out from under burdensome 

credit card debt. It also has provided lenders with a new 

and potentially profitable line of business. Insured 

depository institution involvement in this line of business is growing and could continue to grow, especially 

if liquidity problems that have affected HLTV specialists continue. As with any line of business, success is 

dependent upon understanding the particular nature of 

the HLTV business and making the appropriate commitment of resources and expertise. With HLTV lending, there are unique risks involved because of the 

compound nature of these loans, which contain characteristics of both a secured home equity loan and an 

unsecured consumer loan. The risks involved in HLTV 

lending are further heightened by the fact that the performance of these loans is largely untested in an 

adverse economic environment. 

Diane Ellis, Senior Financial Analyst 

National Regional Outlook 10 First Quarter 1999 
In Focus This Quarter
 

Commercial Development Still Hot in Many Major
 

Markets, but Slower Growth May Be Ahead1
 

•	 Oversupply within commercial real estate markets typically arises from the difficulty developers 

face in accurately predicting future demand for a 

given project, particularly when projections are 

based on temporary or unsustainable increases in 

demand. Easy access to investment capital in the 

form of lower borrowing rates or relaxed underwriting standards can exacerbate the overproduction of space. 

•	 This analysis identifies nine major metropolitan 

markets believed to be vulnerable to broad-based 

overbuilding.2 This vulnerability stems from rapid 

ongoing development across multiple property 

types, which threatens to outpace absorption or 

demand levels over the next one to two years. 

Overbuilding concerns are heightened by cyclical 

and secular demographic and economic trends 

that portend lower demand for commercial space. 

•	 Trends in the capital markets may have tempered 

the appetite for further development in some 

rapidly expanding metro areas. Should such 

trends continue, construction activity could moderate, thereby mitigating some of the overbuilding 

concerns expressed in this article. 

Since the boom development years of the 1980s, and the 

bust that followed, the financial community has devoted 

considerable resources to analyzing commercial real 

estate trends. The primary purpose of these efforts is to 

detect, as early as possible, warning signs of potential 

imbalances between supply and demand. The markets 

highlighted in this article are considered vulnerable to 

possible overbuilding on the basis of various early 

warning signs. Each of these markets is experiencing 

rapid commercial real estate development across multi1 In fall 1998, the FDIC’s Division of Insurance published a report ranking the risk of overbuilding within major metropolitan markets (see 

“Ranking the Risk of Overbuilding in Commercial Real Estate Markets,” Bank Trends, October 1998). This paper, which was based mainly on market information as of year-end 1997, highlighted six major 

metropolitan areas where the rapid pace of current construction activities raised concerns over the potential for broad-based overbuilding. 

2 “Broad-based overbuilding” signifies potential overbuilding in two 

or more of five property types: office, industrial, retail, apartment, 

and hotel. 

ple property types. In addition, each market exhibits one 

or more of the following characteristics: high vacancy 

rates relative to the pace of development, declining 

employment growth trends, declining in-migration 

trends, projected increases in vacancy rates by credible 

industry experts, and significant dependence on industry sectors vulnerable to either weak Asian markets or a 

slowing domestic economy. 

The term “vulnerable” is used here to signify a potential, as opposed to a certain, outcome. In previous cyclical downturns, falling commercial real estate values 

were preceded by economic events that resulted in lower 

demand: Declining energy prices preceded the mid1980s decline in Southwestern real estate markets; 

weaknesses in the financial sector preceded the late 

1980s decline in Northwestern real estate markets; and 

sharp defense cutbacks preceded the early 1990s 

decline in Southern California real estate markets. It 

remains to be seen whether weakening Asian markets or 

prospects for slower economic growth serve as catalysts 

for slower commercial real estate demand in the current 

cycle. Whatever the catalyst, markets most affected by a 

downturn in real estate values will be those in which 

optimistic expectations, the basis for current construction activity, fall farthest from the mark. 

Why Do Markets Become Overbuilt? 

Commercial property developers often face substantial 

lags between a project’s conception and its completion: 

The longer the construction period, the greater the 

uncertainty surrounding demand projections. These 

risks can be largely mitigated if the developer enters 

into presale contracts or preleasing agreements with 

financially sound parties prior to breaking ground on 

construction. However, it is not unusual in rapidly 

developing and highly competitive markets for developers to anticipate or “speculate” what demand levels 

will be, based on current trends. If the market in question is experiencing a period of temporary or unsustainable growth (a “boom” period, for example), then 

projections may lead to an overly optimistic outlook 

for future demand, particularly when forecasts are 

weighted heavily toward recent rental, sales, and 

demographic trends. Projection error also arises from 

National Regional Outlook 11	 First Quarter 1999 
In Focus This Quarter
 

the failure to consider competitors’ planned development activities. 

If a developer’s demand projections fail to materialize, 

the result is an overhang of commercial property 

beyond what the market can absorb during a reasonable 

time frame. Easy access to investment capital can exacerbate overproduction of space by reducing or eliminating incentives to make reasoned and prudent 

investment decisions. Excessive leverage, where the 

developer has little personal capital at risk on a particular project, is a familiar example often associated with 

the excessive development of the 1980s. Loan pricing 

that fails to adequately account for the risks involved in 

a construction project is another example of how 

financing incentives could lead to imprudent development decisions. 

Ranking the Risks of Overbuilding 

The October 1998 Bank Trends (see footnote 1) study 

employed a three-step process to rank the vulnerability 

of markets to possible overbuilding. First, major metropolitan markets were ranked in terms of current construction activity3 relative to existing space for each of 

five property types: office, industrial, retail, apartment, 

and hotel. Second, relative construction activity was 

compared with current vacancy rates to assess the competitive pressures faced by newly developed projects. 

Third, market-related research was reviewed to determine which markets analysts considered candidates for 

possible supply/demand imbalances. Although the same 

approach was used in this updated analysis, additional 

factors were considered, including employment and 

population growth trends, the dependence of rapidly 

developing metropolitan areas on specific employers or 

industries, and the relationship between current economic trends and the potential demand for commercial 

real estate space. 

3 Construction activity generally refers to recent completions plus 

projects in process of being built. In the case of office and industrial 

properties, the source of data is CB Commercial/Torto Wheaton 

Research, and construction activity refers to completions for the last 

four quarters plus projects under construction. For all other property 

types, the source is F.W. Dodge and ERE Yarmouth, and construction 

activity refers to completions, projects in process of being built, 

starts, and pending projects. 

Most Active Construction Markets 

Charts 1 through 5 show the level of construction activity, for each property type, relative to the total stock of 

space as of June 30, 1998, for the top 15 major metropolitan markets. Although slowing somewhat, development in the Las Vegas market continues to lead all other 

markets in relative terms for office, industrial, and hotel 

construction. Las Vegas is also among the most active 

markets in apartment and retail construction. Other 

markets experiencing rapid development across multiple property types include Salt Lake City, Charlotte, 

Atlanta, Portland, Phoenix, Orlando, Dallas, Austin, 

Nashville, Jacksonville, and Seattle. As the charts show, 

office, industrial, apartment, and hotel construction 

activity rose from year-end 1997 levels among a majority of the fastest-developing markets. Retail development, however, appears to have slowed in a majority of 

the most active development markets during the first 

half of 1998. 

Comparing Construction Activity 

with Vacancy Rates 

Newly completed speculative projects must compete 

with existing vacant space. Accordingly, it is worthwhile to compare measures of relative construction 

CHART 1 

Source: CB Commercial/Torto Wheaton 

Top 15 Office Construction Markets* 

0 5 10 15 20 

Las Vegas 

Charlotte 

Orlando 

Salt Lake City 

Jacksonville 

Columbus 

Atlanta 

Nashville 

Dallas 

Austin 

Seattle 

Phoenix 

Portland 

Ft. Lauderdale 

Tampa 

National Average

 June 1998

 December 1997 

% of Stock 

* Includes last four 

quarters’ completions 

and projects under 

construction for: 

National Regional Outlook 12 First Quarter 1999 
In Focus This Quarter
 

CHART 2 CHART 3 

Top 15 Industrial Construction Markets* 

% of Stock

0 2 4 6 8 10 12 14 16 

Las Vegas 

Atlanta 

Riverside 

San Diego 

Salt Lake City 

Phoenix 

Austin 

Oakland 

Sacramento 

Tucson 

Baltimore 

Orlando 

Jacksonville 

Orange County 

Seattle 

National Average 

 June 1998

 December 1997 

* Includes last four 

quarters’ completions 

and projects under 

construction for: 

Source: CB Commercial/Torto Wheaton Source: F. W. Dodge, Lend Lease Investment Research 

Top 15 Retail Construction Markets* 

0 2 4 6 8 10 12 

Norfolk 

Orlando 

Las Vegas 

Atlanta 

Charlotte 

Richmond 

Greenville 

Phoenix 

Minneapolis 

Jacksonville 

West Palm Beach 

Dallas 

Baltimore 

San Antonio 

Denver 

National Average

 June 1998

 December 1997 

% of Stock 

* Includes completions, 

starts, projects being 

built, and pending 

projects as of: 

CHART 4 CHART 5 

Source: F. W. Dodge, Lend Lease Investment Research 

Top 15 Apartment Construction Markets* 

0 2 4 6 8 10 

Austin 

Orlando 

Portland 

Las Vegas 

Charlotte 

Dallas 

Phoenix 

Columbus 

Nashville 

Atlanta 

Raleigh 

Denver 

Birmingham 

Greenville 

San Antonio 

National Average 

% of Stock 

* Includes completions, 

starts, projects being 

built, and pending 

projects as of:

 June 1998

 December 1997 

Top 15 Hotel Construction Markets* 

% of Stock

0 5 10 15 20 25 30 35 40 

Las Vegas 

Salt Lake City 

Portland 

Raleigh 

Baltimore 

Tampa 

St. Louis 

Dallas 

Phoenix 

Jacksonville 

Charlotte 

Cincinnati 

Greenville 

Seattle 

Denver 

National Average 

 June 1998

 December 1997 

* Includes completions, 

starts, projects being 

built, and pending 

projects as of: 

Source: F. W. Dodge, Lend Lease Investment Research 

National Regional Outlook 13 First Quarter 1999 
In Focus This Quarter
 

CHART 6	 CHART 7 

Office Development Versus Vacancy Rates Industrial Development Versus Vacancy Rates 

20 12

18 Las Vegas 

Construction Activity as % of Stock 

Construction Activity as % of Stock 

Charlotte Las Vegas 10 

16 Orlando Jacksonville 

Columbus 

Atlanta 

14 Salt Lake Atlanta 8 Riverside 

12 Dallas San Diego Salt Lake 

10 Phoenix 6 

Phoenix Sacramento 

8 Tampa 4 

2 

6 

4 

2 

– 

2 4 6	 8 10 12 14 16 18 

Vacancy Rate (%) 

Source: CB Commercial/Torto Wheaton 

activity with current vacancy rates (as shown in Charts 

6 and 7 for office and industrial space). The main idea 

behind these charts is that market segments with high 

existing vacancy rates raise the degree of competitive 

pressure for newly built space; markets with high 

vacancies may have less justification for continuing 

increases in new stock. 

In the office sector, Las Vegas stands out as having the 

highest level of new development combined with high 

existing vacancy rates. Although the pace of development is markedly slower, office markets in both Atlanta 

and Dallas appear to be expanding rapidly despite high 

existing vacancy rates. In the industrial sector, Las 

Vegas, Atlanta, Riverside, Salt Lake City, and Phoenix 

all appear to be experiencing rapid development despite 

relatively high existing vacancy rates. 

Analyst Outlooks for Commercial Real Estate 

Advocate Caution 

The first six months of 1998 saw continuing strong 

market fundamentals in most major markets and 

most property types: CB Commercial/Torto Wheaton 

Research (CBC) reported continuing nationwide 

declines in office and industrial vacancy rates accompanied by increasing rental growth rates,4 Wheat First 

Union (Wheat) reported improvements in occupancy 

and rental rates across the 30 major apartment markets 

it follows,5 and Smith Travel Research (Smith) reported continuing improvements in average daily room rates 

4 CB Commercial/Torto Wheaton Research, The Office Outlook, 

The Industrial Outlook, and The Retail Outlook, Fall 1998. 5 Wheat First Union, Industry Report: Quarterly Apartment Review, 

October 21, 1998. 

– 

2 4 6 8 10 12 

Vacancy Rate (%) 

Source: CB Commercial/Torto Wheaton 

despite a modest decline in occupancy rates for the 

lodging sector (through the first nine months of 1998).6 

The performance of the retail sector has been more 

mixed, as indicated by a significant decline in estimated 

rental growth rates from 1996 to 1997 (CBC) while 

retail vacancy rates have held steady over the past 12 

months (F.W. Dodge).

7 

Despite these generally positive trends, market 

observers are becoming more cautious about the outlook for commercial real estate markets. Much of their 

concern stems from significant increases in projected 

supply in the face of moderating absorption rates. 

CBC, for example, projects that nationwide office 

vacancy rates will rise from 9.3 percent as of June 1998 

to 12.1 percent by June 2000 as a result of a sharp 

increase in completions combined with moderating 

absorption. Markets with the highest and most significant increases in projected office vacancy rates are 

highlighted in a recent Lehman Brothers study, which 

identifies 17 office markets as “danger zones.” 8 

Analysts have also raised concerns over rapid development in other property types. F.W. Dodge, for instance, 

anticipates a sharp rise in the ratio of retail completions 

6 Smith Travel Research, Smith Travel Research Announces 1998 

September and Third Quarter U.S. Lodging Industry Reports, 

http://www.str-online.com/news/releasedir/1998/pr981104_3rdqtr.html. 7 F. W. Dodge, Real Estate Analysis and Planning Service: 2nd Quarter 1998. 

8 These markets are Salt Lake City, Columbus, Austin, Nashville, 

Charlotte, Orlando, Las Vegas, Baltimore, Atlanta, Dallas, Phoenix, 

Philadelphia, Indianapolis, Chicago, Sacramento, Miami, and Houston (Lehman Brothers, Commercial REIT Research: Eye on Office 

Markets, October 1998). 

National Regional Outlook 14	 First Quarter 1999 
In Focus This Quarter
 

to absorptions over the coming two years. In addition, 

the pace of hotel development has picked up substantially over the past two years to levels not seen since 

the late 1980s (see Chart 8). According to Smith, hotel 

completions continue to outpace demand and are 

expected to result in lower occupancy levels in 1999. 

For the apartment sector, Wheat cautions against a continuing escalation in apartment permits despite some 

expected slowing in employment growth in various 

markets over the coming 12 months.9 

Economic Conditions May Temper 

Commercial Real Estate Demand 

The nation’s economy has shown unprecedented 

resiliency, even as some indicators suggest that growth 

may moderate in the near term. For instance, weakened 

global markets have placed increasing pressures on 

exporters, who have seen a falloff in demand in the 

wake of weaker foreign currencies relative to the dollar. 

Domestic firms, too, face rising competition from 

cheaper imports. These factors have created negative 

near-term expectations for corporate profitability, 

which in turn have resulted in rising layoffs and slowing 

employment growth. Although most economists feel 

that prospects for a recession are remote in the near 

term, even a modest slowdown in economic growth 

could result in higher vacancy rates in markets experiencing rapid development. 

Over the longer term, various economic and demographic trends imply a weaker outlook for commercial 

real estate demand relative to past real estate cycles. In 

a recent analysis of the commercial mortgage-backed 

securities (CMBS) market, Moody’s identifies the following trends, each of which implies secular declines in 

demand for one or more property types10: 

•	 more efficient office space utilization as measured 

by continuing declines in square feet per worker; 

•	 more efficient inventory management as measured 

by a proportional increase in the ratio of inventory 

growth to growth in warehouse space; 

•	 shifts in spending patterns by baby boomers, the 

largest age cohort, away from goods and toward 

services; 

9 Wheat specifically notes deteriorating supply/demand ratios in
 

Dallas, Houston, Orlando, Charlotte, Nashville, and the San Francisco
 

Bay area.
 

10 Moody’s Investor Service, CMBS and the Real Estate Cycle:
 

Less Margin for Error, October 9, 1998.
 

CHART 8 

Hotel Development Heating Up 

(000’s) 

140 

120 

100 

80 

60 

40 

20 

0 

New Rooms Constructed 

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

* September 1998 annualized 

Source: Smith Travel Research 

•	 declining scrappage rates of obsolescent buildings 

because of a decline in the average age of the current 

stock of space relative to the comparable stage of 

prior cycles; and 

•	 expected declines in labor force growth as the 

proportion of older workers increases. 

In addition to these factors, other analysts have pointed 

out that tight labor markets and overtaxed infrastructure 

(e.g., water, roads, sewer, and public transportation) 

constrain demand by limiting growth within a particular 

market. Suburban areas that have seen the bulk of new 

construction over the past few years may be particularly hard hit if there is a backlash against the congestion 

and infrastructure capacity issues that accompany rapid 

growth.11 

Markets Most Vulnerable 

to Overbuilding 

Based on a review of supply and demand trends coupled 

with analyst opinions and projections, the following 

markets appear to be most vulnerable to broad-based 

overbuilding in the coming one to two years (see also 

Table 1, next page, for prevailing trends in these markets). These markets are discussed in more detail in the 

Regional Perspectives section. 

11 See, for example, Price Waterhouse/Lend Lease Investment 

Research, Emerging Trends in Real Estate 1999. 

National Regional Outlook 15	 First Quarter 1999 
In Focus This Quarter
 

TABLE 1 

Markets Most Vulnerable to Overbuilding: Summary of Trends and Expectations 

Construction Employment Net- Projected 

1H97 to 1H98 Activity Growth Migration Vacancy Rate 

Vacancy Rates (’95 to 1H98) Trends Trends Trends 

LAS VEGAS H H C E H 

ATLANTA H H C C H 

NASHVILLE H H C C H 

SALT LAKE CITY H H C C H 

CHARLOTTE E H C E H 

PORTLAND H H C C H 

PHOENIX C H C C H 

DALLAS H H C H H 

ORLANDO E H E H H 

Note: Arrows for vacancy and construction are intended to capture prevailing trends across all property types;
 

experience with respect to a specific property type in a particular area may differ. H = half.
 

Sources: CB Commercial, F.W. Dodge, Regional Financial Associates, and Smith Travel Association.
 

Las Vegas 

Las Vegas’s hotel, office, and industrial development 

far surpasses that of other major markets, with ratios of 

construction activity to current space of 37 percent, 19 

percent, and 12 percent, respectively. Rapid development is occurring despite high and increasing office 

and industrial vacancy rates, which place additional 

competitive burdens on newly completed space. The 

area’s retail and apartment sectors are also developing 

rapidly, ranking third and fourth, respectively, among 

major markets. Although Las Vegas continues to enjoy 

one of the fastest employment growth rates in the country, the rate of job growth has slowed considerably from 

1994 to 1996 levels. Its real estate markets are highly 

dependent on the gaming sector, which could be especially vulnerable to a nationwide slowdown in economic activity. The city would be particularly hard hit by a 

downturn in real estate prices, as fully 10 percent of its 

workforce is employed in the construction sector (twice 

the national rate). 

Atlanta 

Of the nation’s largest metropolitan markets, Atlanta 

ranks among the top ten in office, industrial, retail, and 

apartment construction, with ratios of construction 

activity to current space of 12 percent, 8 percent, 7 percent, and 5 percent, respectively. Development, much of 

which is widely reported to be speculative, is very 

active despite relatively high office and industrial 

vacancy rates. Atlanta’s expanding real estate markets 

have been driven largely by strong in-migration and 

employment growth rates. However, both these rates are 

slowing, and many market observers are concerned that 

the area’s development cycle has reached its peak.12 

Nashville 

Nashville ranks among the top ten metro markets in 

office and apartment development, with ratios of construction activity to existing space of 10 percent and 

6 percent, respectively. Although not among the top 15 

markets, Nashville’s hotel sector is expanding rapidly 

as well (construction activity stands at 12 percent of 

current space). Nashville’s economy is reported to be 

slowing because of recent losses in manufacturing-sector jobs and slowing net-migration rates. The rapid pace 

of development has recently placed downward pressure 

on office, industrial, and hotel occupancy rates. 

Salt Lake City 

Salt Lake City ranks among the top five markets in the 

nation in office, industrial, and hotel development, with 

ratios of construction activity to current space of 14 

percent, 6 percent, and 27 percent, respectively. The 

main drivers behind the area’s rapid development have 

been high-tech corporate expansions, population inmigration, and preparation for the 2002 Winter Olympic 

Games. However, both job growth and in-migration 

rates are slowing, which could result in lower absorption rates for commercial space in the near term. Over 

12 See the November 1998 issue of the Federal Reserve Board’s 

Beige Book. 

National Regional Outlook 16 First Quarter 1999 
In Focus This Quarter
 

the longer term, analysts have expressed concerns that 

development and job growth attributable to the 

Olympics will result in a significant glut of space following the Winter Games. 

Charlotte 

Charlotte ranks among the top five metro areas in 

office, retail, and apartment development, with ratios of 

construction activity to current space of 15 percent, 7 

percent, and 6 percent, respectively. The area’s hotel 

sector is also developing rapidly. Charlotte’s real estate 

markets are highly dependent on the health of the financial industry, which has been the primary driver of 

development activity. However, job growth in the financial services sector has recently slowed, and the manufacturing sector (which accounts for 19 percent of all 

jobs) is experiencing net job losses. 

Portland 

Portland has the third most active hotel and apartment 

development in the nation, with ratios of construction 

activity to current space of 25 percent and 7 percent, 

respectively. The area’s office market is also expanding 

rapidly. Portland’s development has been driven largely 

by in-migration and job growth in the technology sector. 

However, because of the significance of exports to the 

overall economy (exports to Asia account for approximately 7 percent of Oregon’s gross state product), the 

technology sector is particularly vulnerable to weak 

Asian markets. Accordingly, job growth has moderated, 

reaching its lowest level in five years. The area has also 

experienced a recent decline in construction-sector jobs. 

Although still strong, in-migration rates have fallen 

from 1996 levels. 

Phoenix 

Phoenix ranks among the top ten metro markets in 

industrial, retail, hotel, and apartment development, 

with ratios of construction activity to existing space of 

6 percent, 6 percent, 18 percent, and 6 percent, respectively. The area is also experiencing rapid development 

in the office sector. Phoenix has one of the fastestgrowing job markets in the country. Although still 

strong relative to the nation, employment growth has 

slowed somewhat since 1996, as has the rate of inmigration. The prominence of the semiconductor and 

high-tech businesses makes Phoenix especially vulnerable to the economic slowdown in Asia. 

Dallas 

Dallas ranks among the top ten metro markets in office, 

hotel, and apartment development, with ratios of construction activity to existing space 

of 10 percent, 19 percent, and 6 

percent, respectively. The area is 

also experiencing rapid development in the retail sector. Dallas’s 

economy remains one of the 

fastest growing in the country, and 

in-migration to the area continues 

to rise. However, economic growth 

has slowed somewhat recently because of weakening 

high-tech and energy sectors. Although its industrial 

base is more diversified today than in the mid-1980s, 

Dallas remains exposed to a large energy sector, whose 

profits are vulnerable to declining oil and energy prices. 

Concerns over the volume of planned office development have led to widely published reports of curtailments in credit availability to speculative office 

projects. Although tighter credit availability may ease 

pressures on vacancy rates over the long term, the market will still have to absorb the large volume of space 

presently under construction, much of which is speculative. 

Orlando 

Orlando ranks among the top three metro markets in 

office, retail, and apartment development, with ratios of 

construction activity to existing space of 15 percent, 9 

percent, and 7 percent, respectively. Of the nine markets 

discussed in this article, Orlando’s current pace of construction is perhaps easiest to support, thanks to rising 

employment and in-migration growth. However, despite 

strong employment growth, office vacancy rates have 

edged higher over the past 12 months because of the 

rapid pace of construction. Orlando may be more vulnerable than other metropolitan areas to a slowdown in 

the national economy owing to its dependence on the 

tourism sector. 

National Regional Outlook 17 First Quarter 1999 
In Focus This Quarter
 

Credit Availability Affects the Pace of 

Commercial Development 

CMBS and real estate investment trusts (REITs) have 

generated a significant share of funding for commercial 

real estate over the past several years.13 As a result, any 

disruption in CMBS and REIT markets strains credit 

availability for new commercial development. For 

instance, widening CMBS spreads in the wake of September’s market volatility have caused many issuers to 

either delay or cancel new CMBS issues. REITs, too, 

have reportedly curtailed purchases because of falling 

per-share values and a corresponding decline in equity 

issues to support acquisitions. 

Weaknesses in the CMBS and REIT markets also may 

be dampening many lenders’ enthusiasm for commercial real estate development. Construction lenders will 

be less willing to make speculative loans to the extent 

that permanent funding is not available, and CMBS and 

REITs served as major providers of such funding. 

REITs were particularly aggressive purchasers in such 

markets as Atlanta, Orlando, and Dallas.14 Tightened 

construction lending conditions appear to be borne out 

by the November 1998 issue of the Federal Reserve 

Board’s Beige Book, which indicates that new construction for speculative commercial projects has either been 

curtailed or come to a virtual halt throughout many Federal Reserve districts, including Atlanta and Dallas. 

Most districts also reported tightened credit conditions 

and higher loan pricing, which could further dampen 

construction activity. 

The turmoil faced by CMBS and REITs presents both 

opportunities and risks for banks. Many industry participants view tighter credit accessibility as a positive 

development in light of the rapid pace of construction, 

13 See “Strong Demand and Financial Innovation Fuel Rebounding
 

Commercial Real Estate Markets” in Regional Outlook, fourth quarter
 

1997.
 

14 See Lehman Brothers, Commercial REIT Data Book, December 9,
 

1997.
 

which, in some cases, has been accompanied by 

extremely tight loan pricing margins and a loosening of 

underwriting standards. However, some lenders may 

view the changing fortunes of CMBS and REITs as an 

opportunity to regain market share. In any case, it will 

take several months for recent market events to be fully 

reflected in hard numbers for construction activity. 

Whether tightening credit availability proves to be a 

temporary phenomenon given the recent, albeit gradual, recovery in CMBS spreads and the broad recovery 

in the equity markets, remains to be seen. 

Summary 

This article updates a previously published analysis that 

used year-end 1997 data to rank the potential vulnerability of major metropolitan areas to overbuilding. 

Using primarily midyear 1998 information, this update 

adds three markets to the six identified in the initial 

analysis as vulnerable to broad-based overbuilding. This 

assessment is based on a number of factors including 

construction activity trends, local area employment and 

population migration trends, as well as a collection of 

views and projections from credible industry analysts. 

For many of these markets, the prospects for near-term 

declines in commercial real estate demand may be 

increasing because of slower economic growth and 

weakened markets abroad. Certain secular demographic and economic trends also suggest the possibility of 

lower demand levels in the current cycle relative to prior 

cycles. Although data through June 1998 indicate ongoing rapid development, there is growing evidence that 

recent events in the capital markets have at least temporarily tempered the appetite for further development 

in some rapidly expanding metro areas. For these markets, most participants view the curtailment in credit 

availability in a positive light because it would serve to 

moderate the severe cyclical swings in real estate values 

experienced by several markets during the 1980s. 

Steven Burton, Senior Banking Analyst 

National Regional Outlook 18 First Quarter 1999 
In Focus This Quarter
 

Recent Trends in Syndicated Lending
 

•	 A strong U.S. economy, intensifying competition, 

and the increasing marketability of bank loans 

have driven record volumes of syndicated lending 

in the 1990s. 

•	 After several years of liberalized underwriting, 

evidence suggests that some banks have tightened 

standards and terms for loans to large commercial borrowers. 

•	 Market developments and underwriting trends 

over the past several years have implications for 

credit quality, earnings, and liquidity at institutions that hold or originate syndicated loans. 

Commercial and industrial lending is a major source of 

revenue for commercial banks, yet this business line has 

lagged other major lending categories in terms of liquidity, standardization, and commoditization. However, in recent years the transformation of commercial 

lending has accelerated and is altering the way lenders 

do business. This trend has been particularly apparent in 

syndicated commercial lending. This article briefly 

defines syndicated loans, reviews the 1990s boom in the 

market, and discusses the implications of competitive 

pressures and secondary market liquidity for underwriting trends and risk profiles of commercial banks active 

in this market. 

Syndicated Lending Overview 

A syndicated loan is a credit extended to one large or 

medium-sized corporate borrower that is originated by 

a group, or syndicate, of lenders. Syndicated lending 

differs slightly from participation lending, which is 

common in commercial banks. Although both types of 

lending allow for flexibility in reducing companyspecific risk and adhering to legal restrictions for loans 

to one borrower, only one lender originates a participation loan, which is then sold in undivided participation 

interests either concurrently or subsequently to third 

parties.1 A syndicate usually consists of a group of institutions that work closely on a number of deals that are 

sold to subscribers at origination. 

1 American Bankers Association, Banking Terminology, 3rd ed., 1989, 

p. 345. 

Syndicated loans can generally be categorized according to rating, terms, pricing, or target investors. The 

investment-grade loan market, often referred to as the 

pro-rata or retail market, is the lowest-risk segment of 

syndicated lending and comprises approximately 80 

percent of all volume originated from 1987 to 1997. 

These loans commonly take the form of liquidity backstops or lines of credit and are marketed to commercial 

bank investors. Loan Pricing Corporation (LPC) 

defines these credits as those rated BBB–/Baa3 or better, or nonrated deals with pricing equal to or less than 

rated deals in these bands. Near-investment-grade, 

leveraged, and highly leveraged markets, often referred 

to as B, C, and D tranche term loans or non-investmentgrade loans, include credits with longer maturities, 

greater risk, and higher pricing. Non-investment-grade 

loans are typically structured for institutional investors 

and compete more directly with the traditional highyield bond market. LPC defines non-investment-grade 

loans as those rated BB+/Ba1 or worse, or nonrated 

deals with pricing greater than deals graded BBB–.2 

Competitive Trends in the 

Syndicated Loan Market 

A handful of large U.S. commercial banking companies 

originate the vast majority of U.S. syndicated corporate 

credits across all quality types. According to LPC, 14 

U.S. banking companies were among the top 25 syndicated lenders (based on the number of agent or co-agent 

transactions) and accounted for half of 1998 syndicated 

loan transactions to U.S. corporations through midNovember.3 In 1997, nine U.S. banking companies were 

among the top 25 and executed 36 percent of the market’s transactions. Before 1997, the most active domestic commercial banks saw their market share erode from 

a peak of 45 percent of transactions in 1992 to 34 percent in 1996, primarily because of intensifying competition from nontraditional syndicated lenders such as 

investment banks and foreign banks. Although U.S. 

banks have recently recovered market share (as Japanese banks have significantly withdrawn from the market), a strong U.S. economy, expanding liquidity in the 

bank loan market, and a trend toward one-stop shopping 

2 Loan Pricing Corporation, Gold Sheets, Third Quarter 1998 Review,
 

p. 2.
 

3 Loan Pricing Corporation, Gold Sheets, November 16, 1998, p. 6.
 

National Regional Outlook 19	 First Quarter 1999 
In Focus This Quarter
 

in the financial services industry have attracted competitors to the syndicated market in the 1990s. 

Syndicated Loan Liquidity 

U.S. commercial banking companies retain or buy a 

large volume of syndicated loans, yet estimates show 

that most of the volume is sold to other institutional 

investors. Information from the shared national credit 

program4 indicates that at year-end 1997, FDIC-insured 

commercial banking companies had extended facilities 

and commitments totaling $1.8 trillion, of which an 

estimated $565 billion was funded. To put this figure in 

perspective, an official of the Office of the Comptroller 

of the Currency estimated that 57 percent of outstanding syndicated loans were held by foreign banks; 26 

percent by originating banks, mutual funds, and insurance companies; and 17 percent by subscribing banks.5 

Indeed, according to BankAmerica Corporation, the 

number of nonbank institutional investors in bank loans, 

including prime rate mutual funds, hedge funds, and 

insurance companies, increased from 14 in 1993 to 

more than 100 in 1998. These investors have played a 

pivotal role in enhancing the bank loan as a distinct 

asset class by increasing trading activity, demanding 

third-party loan ratings, and contributing to the development of loan derivative products. 

Perhaps the most important new development in syndicated lending has been the deepening secondary market 

for bank loans as many new investors seek to purchase 

them. As shown in Chart 1, the volume of secondary 

trading in bank loans has grown sharply, more than 

tripling between 1994 and 1997 to over $60 billion. 

Trading in 1998 through the third quarter was on pace 

to top the 1997 level. Traded loans are often noninvestment-grade issues, which have been the focus of 

most demand by the burgeoning institutional investor 

base. One important force behind the development of a 

bank loan secondary market has been rapid expansion 

in the number of bank loans rated by third-party rating 

services. 

Independent credit ratings of bank loans were initiated 

in 1995 when “several years of rapid development in the 

4 The shared national credit program is a cooperative examination 

program conducted by the three federal banking agencies and cooperating state agencies to review large, complex credits held at multiple institutions. Loans subject to review are syndicated loans or 

groups of loans and commitments of $20 million or more shared by 

three or more supervised institutions. 

5 “Concerns Mounting Over Risks in Booming Syndication Market,” 

American Banker, January 29, 1997, p. 20. 

CHART 1 

Secondary Market Trading in Syndicated 

Loans Has Tripled since 1994 

* annualized 

Source: Loan Pricing Corporation 

0 

10 

20 

30 

40 

50 

60 

70 

’91 ’92 ’93 ’94 ’95 ’96 ’97 3Q98* 

$ Billions of Syndicated Loans 

Traded in the Secondary Market 

syndicated bank loan market generated a critical mass 

of interest in the credit characteristics of these instruments.”6 Standard and Poor’s, Moody’s, Duff and 

Phelps, and Fitch/IBCA are now actively involved in 

rating bank loans. Through 1997, Standard and Poor’s 

and Moody’s combined rated $677 billion in loans. As 

rating activity increases access to and availability of 

standardized analysis and research for bank loans, 

including market analysis, ratings criteria, and historical 

loss recovery rates, investors are becoming more comfortable with loans as a distinct asset class. Moreover, 

independent loan ratings allow investors to value a company’s loans relative to its other rated loans or bonds. 

Bank loan secondary market activity and independent 

ratings have prompted the development of new ways to 

package and improve the market acceptance of these 

assets. As a result, the securitization of bank loans and 

the development of various types of derivative products 

have proliferated. As discussed in “CLOs Lure Another Major Bank Asset off the Balance Sheet,” in Regional Outlook, third quarter 1998, collateralized loan 

obligations (CLOs) are a major market development 

allowing for the securitization of corporate loans. A 

large investor appetite for varied types of asset-backed 

securities and a desire to move assets off the balance 

sheet to lower risk-based capital requirements have 

helped promote a sharp increase in this type of securitization. Loan derivatives also may allow lenders to 

better manage the trade-off between maintaining borrower relationships and avoiding excessive concentrations of risk. This trade-off has become increasingly 

6 “Bankrupt Bank Loan Recoveries,” Moody’s Investor Service, June 

1998, p. 5. 

National Regional Outlook 20 First Quarter 1999 
In Focus This Quarter
 

CHART 2 CHART 3 

0 

200 

400 

600 

800 

1,000 

1,200 

’88 ’90 ’92 ’94 ’96 3Q98* 

Nonleveraged Loans 

Leveraged Loans 

* annualized 

Source: Loan Pricing Corporation 

After Several Record Years, Syndicated 

Loan Originations Have Slowed 

$ Billions of Syndicated 

Loans Originated 

Note: LIBOR = London Interbank Offered Rate 

Source: Loan Pricing Corporation 

New Syndicated Loan Pricing Has Reversed 

after Several Years of Narrowing Spreads 

0 

10 

20 

30 

40 

50 

4Q90 4Q91 4Q92 4Q93 4Q94 4Q95 4Q96 4Q97 11/98 

0 

30 

60 

90 

120 

150 

A Basis Points above LIBOR BB Basis Points above LIBOR 

important with the trend toward one-stop shopping in 

financial services. 

One-Stop Financial Providers 

For several years, analysts have noted a trend toward 

financial services supermarkets—financial institutions 

positioning themselves as providers of a complete array 

of advisory services and financial products. One aspect 

of this trend has been the tendency of traditional 

lenders to improve their ability to offer a full array of 

equity and debt underwriting, as characterized by the 

expansion of Section 20 activities among major U.S. 

commercial banking companies. Traditional securities 

underwriters view entry into the syndicated loan market similarly. For example, no investment bank had a 

syndicated loan underwriting department in 1994, but 

several are now making inroads into the market, especially the leveraged market, and some increased their 

syndicated loan volume fivefold in 1997.7 In some 

cases, the desire of commercial banks to move toward 

one-stop financial services and the resulting approaches to relationship management have affected the underwriting of loans to large commercial borrowers that 

have multiple financing and advisory service needs. 

Historical Perspective on Syndicated 

Loan Underwriting Trends 

Increased interest by investors in bank loans and strong 

competition for business resulted in syndicated lending 

7 “The New Kids in the Syndicate: Investment Banks Are Moving in 

on the Leveraged Syndicated Loan Market,” Bloomberg, March 1998, 

p. 35. 

at historically narrow spreads and on more liberal 

terms. Accordingly, the syndicated loan market was a 

borrowers’ market for much of the 1990s. As shown in 

Chart 2, the volume of syndicated loan originations 

increased almost fivefold between 1991 and 1997, with 

record volume levels achieved in each of these years. 

Much of the volume was driven by growth in the origination of loans for the purpose of refinancing existing 

debt, especially from 1995 to 1997, as borrowers took 

advantage of increased lender competition and investor 

demand to reduce funding costs and extend maturities. 

In some cases, borrowers were able to refinance loans 

obtained just months earlier at significant savings and 

more favorable terms. 

Chart 3 shows that lending spreads compressed sharply 

from 1993 to 1997, particularly for lower-quality credits. LPC stated that “[e]xcessive competition has driven 

spreads and fees to all-time lows, with the investment 

grade market purely a relationship play.”8 Consistent 

with the financial supermarket concept discussed 

above, as relationship lending proliferated, many 

lenders were evaluating transactions on the basis of 

overall relationship returns rather than individual transaction returns. Consequently, borrowers willing to offer 

an institution ancillary business, such as cash management, securities underwriting, or securitization services, 

were likely to receive more favorable loan pricing than 

borrowers seeking to execute just one loan deal. 

During the same period, a clear trend toward weakened 

underwriting resulted in deteriorating risk/return rela8 Loan Pricing Corporation, Gold Sheets, First Quarter 1995 Review, 

p. 9. 

National Regional Outlook 21 First Quarter 1999 
In Focus This Quarter
 

CHART 4 CHART 5 

0 

20 

40 

60 

80 

100 

’90 ’92 ’94 ’96 3Q98 

364-day Five-Year Three/Four-Year 

After Several Years of Lengthening, the Average 

Maturity of New Investment-Grade Syndicated 

Loans Has Shortened in 1998 

Source: Loan Pricing Corporation 

Origination Volume (%) 

0.0 

1.0 

2.0 

3.0 

4.0 

1Q96 3Q96 1Q97 3Q97 1Q98 3Q98 

0 

5 

10 

15 

Sources: Moody’s Investor Services, Federal Reserve Board 

Trailing 12-Month IssuerBased Default Rate (%) 

Trailing Four-Quarter Average Growth 

in Nonfinancial Corporate Profits (%) 

Defaults on Speculative-Grade Corporate 

Bonds Have Risen and Growth in 

Corporate Profits Is Slowing 

tionships across syndicated lending categories. Financial indicators market analysts use to evaluate whether 

lenders are being adequately compensated for risk 

generally weakened. For example, the ratio of debt to 

earnings before interest, taxes, depreciation, and amortization rose to relatively high levels for an increasing 

number of leveraged and highly leveraged loans.9 Moreover, lengthening maturities reflected looser underwriting. A decline in the spreads between loans of one-year 

and five-year maturities made it cost-effective to borrow for longer periods. LPC indicated that the differential between fees on undrawn 364-day revolving loans 

and undrawn five-year loans had dropped by one-half 

during this period.10 As a result, many borrowers extended maturities on new credits, and, as shown in Chart 4, 

the average maturity of investment-grade loans originated in the mid-1990s lengthened significantly. 

Recent Underwriting Developments 

Beginning in late 1997, lenders and investors began to 

resist aggressively priced investment-grade and nearinvestment-grade loans. This resistance led to a leveling 

of pricing, fewer refinancing opportunities for borrowers, and increased focus on the higher-risk leveraged 

lending market, where nonbank institutional investor 

demand was strong and pricing was richer. In response, 

overall syndicated lending volume declined almost 16 

percent during the first three quarters of 1998 compared 

with the same period in 1997. However, within total 

new syndicated loan volume, leveraged loan origina9 Ibid., pp. 16-17. 

10 Ibid., p. 43. 

tions grew 77 percent to $200 billion during the same 

period, accounting for approximately one-third of all 

syndicated credits—the largest proportion of the market 

since 1989. Of particular note was that this growth in 

higher-risk lending came at a time when losses in speculative-grade bonds had been trending higher and 

growth in profits for nonfinancial U.S. corporations had 

been slowing (see Chart 5). 

Global economic turmoil and the flight to quality that 

disrupted the capital markets during the third quarter of 

1998 spilled over into the bank loan market and solidified a shift to a lenders’ market. LPC noted in its thirdquarter 1998 review of syndicated lending that “[r]ates 

and fees are on the upswing meaning opportunistic refinancings...continue to dwindle. Concessions suddenly 

are going to lenders rather than borrowers, and volume 

continues the drop [from levels] seen earlier in the 

year.”11 Growth in leveraged lending also declined 

sharply as the number of institutional investors in the 

market fell by one-half from the second quarter.12 

The shifting dynamics of the market in late 1998 were 

characterized by the aforementioned slowdown in originations, a sharp increase in pricing (see Chart 3, previous page), and evidence that underwriting had become 

more stringent. The volatility in credit markets resulted 

in deals being rescinded or incorporating “market flex” 

pricing language that enabled lenders to manage the 

yield requirements of investors due to changing yields 

on competing capital markets instruments. The influ11 Loan Pricing Corporation, Gold Sheets, Third Quarter 1998
 

Review, p. 3.
 

12 Ibid.
 

National Regional Outlook 22 First Quarter 1999 
In Focus This Quarter
 

CHART 6	 CHART 7 

(60) 

(40) 

(20) 

– 

20 

40 

60 

4Q90 4Q92 4Q94 4Q96 4Q98 

Some Banks Have Tightened Underwriting 

Standards and Terms to Large and 

Medium-Sized Corporate Borrowers 

Source: Federal Reserve Board 

Net Percentage 

Tightening Underwriting Standards 

Increasing Spreads on Loan Rates 

0 

3 

6 

9 

12 

12/14/94 12/20/95 12/18/96 12/17/97 12/23/98 

Source: Loan Pricing Corporation, Goldman Sachs, Bloomberg 

Total Returns* on Leveraged Loans Have Fallen 

Rolling 52-Week Total Returns Measured by the 

Goldman Sachs/Loan Pricing Corporation 

Liquid Leveraged Loan Index 

* Total Return = Accrued Interest + Bid Changes + Gains from Repayments Total Returns (%) 

ence of the secondary market on new loan pricing 

became apparent as investors required underwriters to 

factor in higher secondary market yields. In addition, as 

shown in Chart 6, the Federal Reserve Board’s November 1998 Senior Loan Officer Opinion Survey on Bank 

Lending Practices reported that a significant minority 

of surveyed lenders had tightened lending standards and 

terms for commercial loans to large and middle-market 

firms.13 On net, nearly 40 percent of domestic bank 

respondents had tightened lending standards for these 

borrowers for the three months ending November 30, 

and nearly half had increased pricing. These percentages are the highest reported since the last recession. 

Underwriting was also influenced by increased borrower demand for bank loans—a secondary effect of the 

market volatility in late 1998. The aforementioned Federal Reserve Board survey noted an increased demand 

for bank commercial loans primarily as a result of shifts 

from other sources of credit, namely the bond and commercial paper markets. For example, one industry participant estimated that the loan market represented 

roughly 60 percent of capital market financing in January 1998, 40 percent in July as the high-yield bond market boomed, and nearly 100 percent in September as the 

bond markets stalled.14 

13 Large or middle market firms are those with annual sales greater
 

than $50 million.
 

14 “Syndicated Lenders Swiftly Surmounted September Dip,” American Banker, December 10, 1998, p. 25.
 

Implications for Insured Institutions 

Although recent evidence suggests that some lenders 

have tightened standards and terms for loans to large 

commercial borrowers, market developments and 

underwriting trends over the past several years have 

implications for credit quality, earnings, and liquidity at 

institutions that hold or originate syndicated loans. 

•	 A slowing economy and stress in industries exposed 

to weakened international economic conditions 

could result in increased losses during an economic 

downturn, especially for banks that are holding 

higher-risk syndicated loans. Although nonbank 

institutional investors hold the bulk of the riskier 

tranches of syndicated deals, some banks ventured 

into riskier, longer-term issues in response to narrow 

pricing on traditional loan pieces held by banks.15 

Should liquidity become an issue in the secondary 

market, banks planning to sell these pieces may face 

losses. For example, as reflected in Chart 7, the 

rolling 52-week total return on the Goldman 

Sachs/LPC Liquid Leveraged Loan Index, which 

measures the performance of a diversified portfolio 

of the most actively traded performing leveraged 

loans, has fallen from over 8 percent in early 1998 to 

less than 4 percent in December 1998. Falling prices 

have caused reduced returns as required spreads on 

these credits have risen. 

15 “Banks Compete with Funds in Buying Long-Term Tranches of 

Syndications,” American Banker, March 19, 1997, p. 1. 

National Regional Outlook 23	 First Quarter 1999 
In Focus This Quarter
 

•	 Downstream subscribers that purchased thinly priced 

or loosely structured loans may not be adequately 

compensated for risk. This lack of compensation may 

be especially important for institutions that do not 

receive ancillary relationship income. Evidence suggests that downstream lenders became more willing 

to accept loans during the 1990s without receiving 

full documentation or making an independent credit 

analysis. The Office of the Comptroller of the Currency reportedly attributed this trend to a desire to 

add loan volume coupled with comfort about company prospects because of the strong economy and 

strong corporate profits.16 As a result, on a riskadjusted basis, the returns on these credits may hamper the performance of investing institutions. 

•	 Sustained reductions in syndicated loan liquidity 

may adversely affect revenues and increase percentages of loan amounts retained by active syndicating 

institutions. If institutional investors remain withdrawn from the loan market for an extended period, 

syndicates may have increasing difficulty marketing 

deals, especially in the non-investment-grade segment. As a result, institutions dependent on revenues 

generated by this activity may face declining income 

as fewer deals are executed, or they may have to hold 

larger percentages of undersubscribed transactions. 

This situation may be further exacerbated by consolidation in the U.S. banking industry, which has combined several major syndicate agents in the 1990s 

and has reduced the number of potential downstream 

investment-grade subscribers in the market. 

•	 Rising demand from borrowers exploiting relative 

pricing in the loan and capital markets may have 

credit and liquidity implications for underwriting 

institutions. Sustained volatility in the capital mar16 “Concerns Mounting over Risks in Booming Syndication Market,” 

American Banker, January 29, 1997, p. 20. 

kets may increase the demand for bank loans and 

will likely significantly increase funding costs for 

many borrowers. For example, LPC recently compared loans that were extended to seven companies 

in early 1998 with similarly structured loans extended to the same companies after the third-quarter disruption in the capital markets. The analysis revealed 

significant increases in required yields, ranging from 

112 to 388 basis points.17 Rising funding costs combined with a trend toward slower growth in corporate 

profits may reduce loan repayment capacity of borrowers in more troubled industries. In addition, 

banks that have extended liquidity backstops or 

backup lines of credit may be required to fund facilities that traditionally are not heavily used by borrowers. For example, without appropriate pricing 

adjustments, banks providing backup commercial 

paper loans may be called upon to fund these facilities as a result of volatility and relatively high 

spreads in the commercial paper market. 

Increases in credit spreads on securities and syndicated 

loans, the recent rise in speculative corporate bond 

defaults, and slowing corporate profits may portend an 

increase in commercial credit problems for commercial 

banks. Now more than ever, those involved in bank risk 

management should pay close attention to fundamentals, including careful credit analysis, diversification, 

and maintenance of prudent underwriting standards. 

Attention to these fundamentals may help alleviate the 

need to overreact to sudden changes in the market 

environment. 

Steven E. Cunningham, CFA, Senior Financial Analyst 

Ronald L. Spieker, Chief, Regional Programs and 

Bank Analysis Section 

17 Loan Pricing Corporation, Gold Sheets, November 16, 1998, p. 21. 

National Regional Outlook 24	 First Quarter 1999 
Regional Perspectives
 

Atlanta Regional Perspectives
 

Some Atlanta Region real estate markets rank 

among the nation’s most active in terms of new construction. This high activity level remains consistent 

with the Region’s economy, which has outperformed the 

U.S. economy for much of the decade. Regional concerns about supply and demand imbalances are primarily associated with the larger, more active markets such 

as Atlanta, Charlotte, and Miami, all of which show 

large numbers of projects under construction and in the 

planning stages despite rising vacancy rates. 

Atlanta’s commercial construction remains near historic 

highs, fueling concern that 

more space may be coming on 

line than can be absorbed, particularly in retail and office 

markets. Annual job growth in 

Atlanta has fallen from 4.6 percent in early 1998 to 3.1 percent 

now, slowing in virtually all areas of the economy 

except for government. Residential construction also 

continues to rise, with Atlanta ranked highest in the 

nation in volume of permits issued during the first half 

of 1998. Construction and development (C&D) lending 

at metro Atlanta community institutions is significantly 

higher than in any other market in the Region. Aggregate C&D lending exposure equaled approximately 13 

percent of assets in the second quarter of 1998, a level 

not seen since the late 1980s. In addition to aggregate 

exposure that is roughly three times the national average, the number of metro Atlanta institutions (28) 

reporting a C&D concentration above 15 percent of 

assets is also three times that of any other metropolitan 

statistical area (MSA) in the nation. 

Population growth, employment gains, and rising 

per capita income in Charlotte have fueled demand 

for new office, retail, industrial, and residential 

space across the seven-county Charlotte-GastoniaRock Hill metropolitan area. Recently, however, the 

pace of new construction has exceeded absorption in 

each of these property types, pushing vacancy rates 

higher. The 21 community institutions headquartered in 

the Charlotte MSA reported an aggregate C&D loansto-assets ratio of 5.7 percent in the second quarter, 

which was above the national average but only about 

half that reported by Charlotte institutions in the late 

1980s. Growth in the Raleigh metropolitan area, though 

moderating, remains well above the national average. 

Year-over-year job growth in the third quarter of 1998 

was 3.4 percent compared with the national average of 

2.6 percent. The Greenville metropolitan area reports 

job growth of over 3 percent, primarily from its emergent industries. 

Miami has maintained stable levels of job growth 

averaging close to 2 percent. The economy remains 

closely linked to overseas developments through international trade. Retail construction has been the most 

active market segment; however, net absorptions 

accounted for only one-third of new completions in the 

second quarter of 1998. Consequently, the retail vacancy rate rose to 7.6 percent from 6.9 percent in 1997. 

Absorption continues to outstrip supply in the office 

market but vacancy rates remain in the double digits. 

Despite brisk construction activity, Miami’s insured 

community institutions report relatively low C&D lending exposure of 3.1 percent of assets. Orlando remains 

one of Florida’s fastest growing economies, with quarterly year-over-year job growth of almost 5 percent. The 

Orlando retail market has been among the most active 

in the nation for regional mall development. Jacksonville’s strong economic performance continues. 

Although job growth moderated slightly in 1998, it 

remains well above 4 percent. 

High-tech industrial and software development continues to foster above-average levels of growth in the 

Northern Virginia area. Year-over-year job growth has 

averaged over 4 percent during the past several quarters. 

Rapid growth in these industries has sustained high 

rates of absorption in the office and industrial markets. 

Norfolk’s economy continues to perform below the 

national average in terms of job growth. Office and 

retail construction starts have risen, while industrial 

construction starts declined by nearly 50 percent from 

1997 levels. Commercial starts, up nearly 40 percent 

during the first half of 1998, are on track to reach their 

highest level in 10 years. 

Annual job growth in Birmingham declined to about 

2 percent during the first three quarters of 1998. The 

Decatur, Alabama, metropolitan area is undergoing 

substantial growth spurred by Boeing’s planned building of a large manufacturing facility. 

National Regional Outlook 25 First Quarter 1999 
Regional Perspectives
 

Boston Regional Perspectives
 

The Boston Region’s insured institutions reported 

strong results through the third quarter of 1998. 

Profitability was driven by the nine organizations with 

over $5 billion in banking assets. Their collective return 

on assets (ROA) of 1.41 percent as of the third quarter 

of 1998 is 7 basis points higher than the ROA one year 

earlier. Gains on the sale of assets at one institution 

were the primary reason for the increase. The Region’s 

remaining 412 insured institutions posted a collective 

ROA of 1.05 percent, down from 1.14 percent in the 

prior year and the lowest level of profitability since the third quarter of 

1996. Margin compression is the primary reason for the earnings decline. 

Asset quality indicators remain generally favorable, but delinquencies 

and charge-offs are increasing in 

credit card and consumer portfolios. Commercial loan losses also 

increased slightly. Credit card loans and commercial 

loans, sectors evidencing signs of weakness, also have 

grown rapidly at the Region’s larger organizations. 

Rapid growth has been a precursor to loan problems in 

the past and bears watching. 

The Boston Region’s economy continued to expand 

at a moderate pace, with the manufacturing sector 

acting as the principal drag on job and income 

growth. In 1997, seasonally adjusted nonfarm employment rose by a monthly average of 15,000 for the 

Region. This pace slowed during the first 11 months of 

1998, with the Region averaging only 7,000 net new 

jobs per month. A weakened hiring picture in the manufacturing sector caused much of the overall slowing. 

Seasonally adjusted manufacturing payrolls fell 1.6 percent in New England between year-end 1997 and 

November 1998. 

Economic growth may slow in 1999, if the manufacturing sector remains weak. Weakened global consumption and investment resulted in reduced export 

demand and increased import competition for the 

Region’s manufacturers in 1998. The negative trade picture could have been worse save for a credit crunch in 

Asia that restrained low-cost exports from flooding into 

the United States. In addition, significant imbalances in 

merchandise trade flows led to disruptions in oceanic 

shipping lines. However, signs in late 1998 pointed to 

an easing in the Asian credit crunch, while shipping 

companies adjusted prices and schedules to accommodate the unbalanced trade flows. 

Given expectations that global demand will remain 

restrained and that import competition will intensify for U.S. producers, continued weakness in the 

manufacturing sector’s employment picture seems 

likely this year. This weakness may raise the risk of 

consumer and business credit default for some local 

insured institutions in areas of New England with an 

above average reliance on manufacturing. These institutions already had reported negative trends by mid-1998. 

Although they represent only 11 percent of the Region’s 

insured institutions (48 institutions with $13 billion in 

assets), they will likely suffer the first effects of an economic downturn and may be a precursor to other, more 

widespread problems. 

Personal bankruptcies in the Region continue to 

trend upward. Bankruptcies in the Region have 

increased 75 percent since 1994 despite strong economic expansion. Although the rate of growth has been 

strong, only Rhode Island exceeds the national filing 

rate per 1,000 persons. However, a slowdown in the 

economy could increase rates further, adversely affecting insured institutions that are heavily involved in credit card and consumer loans. 

Lower interest rates have allowed homeowners to 

refinance mortgage debt and reduce monthly debt 

service levels. Many borrowers have consolidated credit card and other consumer debt into mortgage loans, 

including those with high loan-to-value ratios. Banks 

and thrifts may be poised to move into these markets 

because many nonbank lenders have been forced to curtail their lending activities as a result of a liquidity 

crunch. 

Although there is little evidence of high loan-to-value 

mortgage lending or subprime origination in the 

Region’s insured institutions at present, institutions 

should proceed cautiously if undertaking this type of 

lending, particularly when economic conditions appear 

to be softening. 

National Regional Outlook 26 First Quarter 1999 
Regional Perspectives
 

Chicago Regional Perspectives
 

The Region’s economy showed some signs of weakening toward year-end 1998. Unemployment rates 

edged up in most states, and output fell in several 

important manufacturing industries. Meanwhile, low 

commodity prices trimmed farm income, and farmland 

prices softened. Such developments raise questions 

about the strength of the Region’s economic growth in 

the coming year. 

Many manufacturing industries in the Region are 

responding to slackening domestic and foreign 

demand, competitive pressures from imports, or 

both. Because the manufacturing sector’s share of economic activity in this Region is about 50 percent higher 

than it is nationally, a widespread and sustained weakening among manufacturers could negatively affect 

many households and communities, with potentially 

negative implications for their lenders. 

Partly because of waning strength among some 

major industries, job growth in the Region slowed to 

1.3 percent for the year ending in November, lagging 

the national gain by a percentage point. Manufacturing employment showed no net gain relative to yearend 1997. Although the Region’s unemployment rate 

remains low, it edged up to 3.9 percent at year-end 1998 

from its record low of 3.5 percent in April. 

Significant price weakness persists in the corn, soybean, and hog markets, and the U.S. Department of 

Agriculture projects continued weakness this year. 

This weakness is affecting farmland values in the 

Region, which fell widely in Illinois and Indiana during the third quarter for the first time since 1986. Meanwhile, 43 percent of bankers responding to a recent 

survey by the Chicago Federal Reserve Bank indicated 

that agricultural loan repayments weakened over the 

past year. Although most of the Region’s 500+ farm 

banks are well capitalized, about 8 percent report both 

modest earnings (return on assets of 0.91 or less) and 

reserve coverage of gross loans below 1 percent, which 

may leave them vulnerable to adverse developments in 

the farm sector. 

Although most institutions remain financially strong, 

some are experiencing problems. Loan delinquencies 

exceeding 5 percent were reported by 186 institutions 

(9 percent). However, most of these institutions have relatively strong capital positions. Fifty-eight institutions 

have composite ratings of 3, 4, or 5, mainly the result of 

poorly rated management, asset quality, or earnings. 

Among the 72 unprofitable institutions, 34 have operated for less than five years, 2 are credit card banks, and 

most of the remainder are small institutions with assets 

under $100 million. 

A number of community institutions (those with assets of $1 

billion or less) reported rapid 

loan growth over the past year. 

Fourteen percent expanded their 

total loans by over 20 percent, 

and half of these grew their 

portfolios by 30 percent or 

more. Over one-third of the institutions experienced 

rapid expansion of commercial real estate (CRE) and 

construction loans. Over half of these institutions also 

held high concentrations of CRE loans. Although no 

market in the Region currently shows signs of significant excess space, banks’ exposures vary considerably, 

and local conditions should be monitored for signs of 

weakening market conditions. Concern arises because 

CRE projects under way may add new space when the 

cyclical expansion and demand for space are fading. To 

the extent that current construction is not preleased, the 

potentially negative repercussions from a weakening 

economy on cash flows and owners’ repayment abilities 

are magnified. 

The pervasiveness of rapid loan growth when 

economic growth is slowing raises questions about 

how the loans will perform in coming quarters and 

whether banks and thrifts are taking appropriate 

steps now to minimize potential problems. In addition, the Region’s banks and thrifts are being affected— 

and perhaps challenged—by the low and flat interestrate yield curve and by financial markets’ turmoil and 

volatility during 1998. 

National Regional Outlook 27 First Quarter 1999 
Regional Perspectives
 

Dallas Regional Perspectives
 

The Region’s insured institutions continue to report 

strong results through the third quarter of 1998. 

Aggregate third-quarter return on assets (ROA) of 1.23 

percent and net interest margin (NIM) of 4.34 percent 

were nearly identical to results reported in the third 

quarter of 1997. New Mexico financial institutions 

reported an ROA of 0.99 percent at September 30, 1998, 

down from 1.16 percent at June 30, 1998, and 1.43 percent at September 30, 1997. The primary reason for this 

decline in profitability is the prospective merger of a 

large New Mexico bank 

with an out-of-state bank 

holding company. 

The Region’s farmers and 

ranchers experienced the 

second severe drought in 

three years this past summer. The drought, combined 

with generally low commodity prices, raised concern over the continued financial health of agricultural producers and the potential 

effects on insured institutions that serve them. In the 

Dallas Region, the drought’s effects were most extreme 

in Texas’ high plains, panhandle, and northeast areas 

and south central Oklahoma, as reported by the Palmer 

Drought Severity Index. As of the third quarter of 1998, 

the 111 agricultural banks that serve these areas reported no material effects. However, the full effect of the 

drought may not yet be evident. 

The In Focus article in this Regional Outlook identifies the Dallas primary metropolitan statistical area 

(PMSA) as one of the top ten metro markets in the 

nation in office, hotel, and apartment construction 

activity as measured against existing space. The high 

level of real estate development is not surprising given 

Dallas’ strong economic growth and high levels of inmigration during the 1990s. However, economic growth 

has decelerated somewhat recently because of the 

effects of international developments on the Region’s 

high-tech and energy sectors. Recent developments in 

Latin America and Mexico are likely to slow the 

Region’s export growth further this year. The prospect 

of slower growth combined with the large numbers of 

real estate projects in the pipeline increases the potential for overbuilding in the Dallas PMSA. 

Real estate activity is significant to Dallas Region 

banks and thrifts, as commercial real estate (CRE) 

loans averaged 23.7 percent of gross loans as of 

September 30, 1998, significantly higher than the 

national average of 16.2 percent. Fifty-four community banks and thrifts headquartered in the Dallas PMSA 

have significant CRE exposures. CRE exposure for 

Dallas PMSA institutions has risen in the aggregate by 

more than 115 percent over the past three years. 

The two real estate segments that have experienced 

the highest growth in the Dallas PMSA are the office 

building and residential markets. Since peaking in the 

late 1980s and early 1990s at over 25 percent, office 

vacancy rates in the Dallas PMSA have trended downward to just over 14 percent at year-end 1997. On the 

basis of large amounts of office space expected to be 

coming onto the market, CB Commercial projects 

office vacancy rates in the Dallas PMSA to increase to 

over 18 percent during the next two years. A substantial 

amount of real estate investment trust activity has been 

a major funding source for real estate development in 

the Dallas PMSA. 

International trade has become a major growth 

engine for the Dallas Region this decade. The 

Region’s exports grew 62 percent from 1993 to 1997, 

with Texas the second-largest U.S. exporter of merchandise in 1997. Mexico is the Region’s largest export market, accounting for nearly 30 percent of its exports. The 

Region’s exports showed signs of weakening as 1998 

progressed; however, its strong trade relationship with 

Mexico and Latin America offset weakness in Asian 

exports. Mexico’s economy, however, is expected to 

slow in 1999, and continued Asian economic weakness 

suggests that exports in the Region will slow in 1999. 

National Regional Outlook 28 First Quarter 1999 
Regional Perspectives
 

Kansas City Regional Perspectives
 

The Region’s economy remains fundamentally 

strong, with a low unemployment rate of 3.5 percent. 

The Region’s economy showed evidence of slowing 

growth in the second half of 1998, as annualized 

employment growth in the third quarter slowed to 1.9 

percent, compared with 2.4 percent in the first half of 

the year and 2.4 percent in 1997. This slowing was even 

more pronounced in the Region’s manufacturing sector, 

which grew only 1.2 percent during third-quarter 1998, 

compared with 2.2 percent in the first half of 1998 and 

1.8 percent in 1997. 

Community banks in 

the Region with less 

than $250 million in 

assets continue to operate in sound condition. 

Earnings through the 

first nine months of 

1998 remain solid, with 

an aggregate return-onassets ratio of 1.31 percent, with stable margins and 

moderate provisions for loan losses. Capital levels are 

strong, and loan loss reserves adequately cover very 

moderate levels of problem loans. Liquidity, which continues to tighten as loan growth outstrips deposit 

growth, is still a concern in community banks. 

The Region’s farm economy is expected to continue 

to endure financial stress in 1999, as farm income 

is expected to decline. In November 1998 the U.S. 

Department of Agriculture (USDA) forecasted net 

farm income for 1998 at $48 billion, down $1.8 billion 

from 1997 and $5.3 billion less than the record level of 

1996. Commodity price forecasts by the USDA suggest that farm income in 1999 will be below the 1998 

level. 

Following significant declines in 1998, prices for 

each of the major field crops are expected to be even 

lower in 1999. Near-record yields for corn and soybean 

crops coupled with weakened export demand resulted in 

significant accumulation of inventories, thus depressing 

prices. Continuing low prices in the wheat market present perhaps the greatest risk in the Region’s agricultural sectors. Two successive years of large crops in the 

United States and abroad have resulted in large accumulations of inventories. 

Hog prices are expected to remain low, but cattle 

prices should improve. Hog prices have declined more 

than 35 percent since 1997, and smaller producers 

unable to meet expenses could be forced out of the 

industry in increasing numbers. Previously forecasted 

profitability in the cattle markets did not occur in 1998 

because of reduced export demand and a shrinking market share for beef. However, improved pricing is expected in 1999, as analysts predict the smallest cattle herd in 

40 years. 

The financial condition of farmers is expected to 

deteriorate significantly if prices do not improve in 

1999 and 2000. A recent Iowa State University study 

projected that one-third of the farms in the study would 

experience financial distress if low prices persisted. The 

conclusion could apply to much of Minnesota, Missouri, and Nebraska, where corn, soybeans, and hogs 

are important commodities. Farm banks’ asset quality, 

earnings, and liquidity could be affected if low prices 

persist. 

The depressed agricultural economy and falling 

commodity prices are negatively affecting land 

prices. Declines in land values have been reported in 

Iowa, North Dakota, Kansas, Missouri, and Nebraska. 

Farmland prices have not declined since the mid-1980s. 

Kansas City’s retail real estate sector appears to be 

in the “oversupply” phase of the real estate cycle. 

Declining consumer confidence, increasing vacancies, 

and rising capitalization rates are signs of potential 

weakening in Kansas City’s retail real estate sector. 

The vacancy rate has risen steadily since 1995, although 

it still remains below the national average of 7.4 percent. 

Community banks in the Kansas City area have participated in the recent real estate development, 

adding nearly $80 million in loans in the past 24 

months. These banks may see higher delinquencies and 

eroding collateral positions as vacancies rise and cash 

flow falls. 

National Regional Outlook 29 First Quarter 1999 
Regional Perspectives
 

Memphis Regional Perspectives
 

The Memphis Region economy is slowing. Only 7,000 

nonagricultural jobs were added in the third quarter of 

1998, the smallest gain since the 1991 recession. The 

slowdown in employment growth occurred across most 

industries, led by job losses in the nondurable manufacturing sector. 

The Region’s agricultural sector has suffered 

because of low commodity prices and adverse growing conditions. The lower Mississippi Delta states were 

affected most severely, with 

lower yields and production 

reported for most crop types. 

Because of high ending stocks 

and weak demand forecasts, 

prices are expected to remain 

depressed through 1999 and 

possibly longer, barring 

weather-related supply shifts. 

Southern Louisiana’s economy remains vulnerable 

to weaknesses in the oil sector. The industry has 

reported layoffs, and more will likely follow if oil prices 

remain low. While large companies with deep pockets 

can operate at a loss for prolonged periods, smaller 

companies that are unable to operate below the typical 

$14 to $16 per barrel break-even range for a sustained 

period have an uncertain future. 

Worldwide demand and consumer buying preferences are contributing to diverging production 

among the Region’s automobile manufacturers. Concern over excess productive capacity in the automobile 

industry has been magnified by the slowdown in world 

economic growth. In particular, the slowing of the 

Japanese and Korean economies and weakness in their 

currencies have resulted in more of their automobiles 

being offered at lower relative prices. In addition, low 

gasoline prices have been partly responsible for a shift 

in demand away from smaller passenger vehicles produced at Nissan and Saturn plants in Tennessee and 

toward sports utility vehicles and trucks produced in 

Kentucky. 

Banking conditions remain positive, but earnings 

performance in the third quarter was dampened 

somewhat by lower net interest margins (NIMs). The 

Earnings Performance Has Declined 

AVERAGE SEP-97 SEP-98 

RETURN ON ASSETS 1.18 1.13 

NET INTEREST MARGIN 4.58 4.40 

Source: Bank & Thrift Call Reports 

average return on assets (ROA) for the quarter was 

down 5 basis points from both the third quarter of 1997 

and the second quarter of 1998 because of lower average NIMs. The decline in NIMs is primarily attributable 

to the flattening of the yield curve and increased 

competition. 

Metropolitan commercial real estate markets in the 

Region are active, and segments of specific markets 

may become vulnerable to overbuilding. Some local 

economies have begun to cool, and demand for commercial space is softening. Additional slowing in local 

or national economic conditions could lead to greater 

supply and demand imbalances. 

In 1997, Nashville reported the highest level of commercial construction starts in over a decade, and this 

trend continued into 1998. This surge in construction is 

occurring in all market segments, but slowing office 

employment growth and declining tourism have led to 

rising vacancy rates in both the office and hotel market 

segments. The Memphis office and apartment markets 

report flattening rental rates resulting from high completion levels and appear vulnerable to overbuilding. 

The New Orleans hotel market is also weakening. 

Financial institutions report growing exposure to 

real estate markets, as average commercial real 

estate loans have increased to 25.1 percent of total 

loans. Construction and development loans have risen 

from an average of 4 percent of total loans at the end of 

1991 to 7.2 percent as of September 30, 1998. Anecdotal evidence suggests that commercial real estate underwriting standards have eased in recent years, primarily 

because of increased competition. Increased lending 

exposure and generally weaker underwriting standards 

combined with greater inherent risk in commercial real 

estate present conditions that managers of insured 

financial institutions should monitor closely. 

National Regional Outlook 30 First Quarter 1999 
Regional Perspectives
 

New York Regional Perspectives
 

The New York Region’s economy continued to 

expand at a moderate but sustained pace. Most areas 

of the Region are experiencing job growth and low 

unemployment. In the first three quarters of 1998, the 

Region added 290,000 new jobs, an increase of 1.4 percent over the same period one year earlier. Yet, as has 

been the case for several years, the Region’s payroll 

employment growth rate is still only about one-half the 

nation’s rate. 

Economic crises in Southeast Asia and Russia and 

their contagion effects continue to affect the U.S. and 

the Region’s economies. Currency devaluations and 

weakened demand from abroad are taking a toll on 

American manufacturers that export to Asia and other 

emerging markets. Trade statistics through October 

released by the Census Bureau show that manufactured 

exports from the Region declined from a similar period 

in 1997. Exports from the rest of the nation were essentially flat. If an economic crisis occurs in Latin America, the Region’s exporters could be harmed further. 

The Region’s banks and thrifts reported generally 

healthy financial conditions in the third quarter of 

1998. The Region’s average return on assets (ROA) was 

1.03 percent, about the same as a year earlier. The average net interest margin (NIM), which fell to 4.05 percent in the third quarter from 4.19 percent a year earlier, 

continued to narrow as a result of a flat yield curve. 

However, the yield curve steepened somewhat in the 

fourth quarter, suggesting that the NIM will stabilize or 

possibly rise in the next few quarters. 

The Region’s community banks (those with assets of 

less than $250 million) continue to report weaker earnings, on average, than their larger counterparts. The 

average ROA among this group was 0.84 percent as of 

September 30, 1998, almost 50 basis points below the 

ROA for institutions with assets greater than $250 million. 

Some major money center banks in the Region 

reported significant reduction in earnings as a 

result of global market turmoil. In the first quarter of 

1998, significant charge-offs were taken as a result of 

the Asian financial crisis. Many large banks reported 

additional credit charge-offs and trading losses in the 

third quarter resulting from the economic collapse of 

Russia. 

Most commercial real estate markets in the Region 

remain fairly subdued compared with other markets in the United States An analysis by Legg Mason 

Wood Walker shows little supply and demand stress in 

the Region’s office markets. In a few markets, however, office construction activity has been increasing and 

rents have been rising as a result of stronger demand. 

Trends in the Philadelphia area’s 

office market suggest that overbuilding may be possible in the 

next few years. Through only the 

second quarter of 1998, office construction surged to 2.2 million 

square feet, surpassing annual levels since 1992. In the Baltimore 

area, office construction was up 79 

percent annually in the first half of 1998. A recent 

Lehman Brothers report places Baltimore on a list of 

markets susceptible to increasing vacancy rates in 

1999. In New York City, a strong economy and the lack 

of major new office construction projects over the past 

several years have driven vacancy rates to more than a 

ten-year low, while office rents have skyrocketed. 

Because of the limited number of new office building 

completions and the area’s strong economy, Wilmington has experienced a decline in office vacancy rates 

from 24 percent in 1991 to 6.3 percent in the second 

quarter of 1998. 

Puerto Rico is recovering from heavy damage 

caused by Hurricane Georges in September 1998. 

Caribbean Business estimates that the total amount 

invested in rebuilding the island’s infrastructure could 

reach $6.5 billion in 1998. Because only 30 to 40 percent of homeowners have hurricane insurance coverage, Puerto Ricans are relying on federal aid to provide 

relief. The agricultural sector was hard hit, and it will 

take some time to recultivate lost crops. 

National Regional Outlook 31 First Quarter 1999 
Regional Perspectives
 

San Francisco Regional Perspectives
 

Four markets in the Region have experienced significant commercial real estate growth in recent years: 

Las Vegas, Phoenix, Portland, and Salt Lake City. 

Community banks with construction and development 

(C&D) loan concentrations are now more common outside California than they are in California. Community 

banks in Las Vegas, Salt Lake City, and Portland have 

especially high exposures to C&D lending. 

The Las Vegas metropolitan statistical area (MSA) is the most 

active construction market in 

hotel, office, and industrial 

space of the nation’s major metropolitan markets. Retail space 

development also is among the 

strongest in the nation. Although 

Las Vegas remains one of the 

Region’s fastest-growing MSAs, 

the area’s growth is heavily dependent on the hotel and 

gaming sectors, which directly account for over 25 percent of the MSA’s employment. The National Real 

Estate Index (NREI) estimates that in order to absorb 

the substantial additions to the hotel stock, visitor count 

must increase significantly by the year 2000, which may 

not occur given that the annual visitor count through 

November 1998 has been flat. Las Vegas’ office market 

also may be oversupplied. The NREI attributes the pressure on both rents and vacancy rates from increased 

office development to speculative construction activity. 

Vacancy rates of 14.3 percent are well above the national average, having risen for the fourth consecutive year. 

While several insured depository institutions operate in 

the Las Vegas MSA, the 11 community banks headquartered in Las Vegas could be harmed most by a slowdown in the area’s economy because of their relatively 

high exposures to C&D lending and their dependence 

on local real estate markets. Aggregate C&D loans 

equal 12.7 percent of total community bank assets in the 

MSA. 

Preparation for the 2002 Winter Olympics, in conjunction with past growth in the high-technology 

industry, helped propel Salt Lake City to one of the 

top three U.S. commercial real estate markets in 

office, industrial, and hotel development. Despite its 

past rapid growth, some general economic indicators 

suggest that Salt Lake City may be slowing down. The 

pace of economic activity declined markedly in 1998, 

with job growth slipping to 2.5 percent. Salt Lake City’s 

community banks have the highest exposure to C&D 

loans of the four metropolitan markets discussed in this 

article. Although the C&D loan growth rate has slowed 

from 49 percent for 1996 to less than 1 percent through 

third-quarter 1998, C&D loans for Salt Lake City community banks remain at a high 15.2 percent of total 

assets, almost triple the 5.7 percent figure for the 

Region. 

Portland’s office, hotel, and industrial markets 

appeared to be at or near the top of the commercial 

real estate business cycle in 1998. Portland’s economy 

and job growth have been slowing like those of Oregon. 

Before 1998, Portland’s office market had been robust, 

with a steady rise in new construction activity, rapid 

absorption of new properties, and declining vacancy 

rates. However, Coldwell Banker Commercial/Torto 

Wheaton Research (CBC) notes that, as the economy 

has begun to slow, Portland’s new office supply may 

begin to outstrip demand. 

Community banks in the Portland MSA have much 

higher exposure to construction and commercial real 

estate lending than do their peers in the Region. 

C&D loans account for 9.2 percent of their total assets 

as of September 30, 1998, much higher than the comparable figures of 5.7 and 3.3 percent for the Region 

and the nation, respectively. 

The Phoenix MSA is in the top ten nationally in the 

development of industrial, hotel, and retail space. 

Strong employment growth in the technology sector 

over the past decade has made Phoenix susceptible to 

global developments affecting this industry, and the 

Asian financial crisis is beginning to affect technology 

employment. The Phoenix MSA was ranked sixth 

among the 54 CBC markets in retail space growth from 

1990 to 1997. Retail vacancy rates, currently above the 

national level of 8.1 percent at 10.3 percent, are expected to remain close to this level through the year 2000. 

Although the 29 community banks in the Phoenix MSA 

have grown their C&D portfolios significantly in the 

past several years, their exposure to C&D loans remains 

well below that of similar-sized institutions in Las 

Vegas, Salt Lake City, and Portland. 

National Regional Outlook 32 First Quarter 1999 
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