Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION THIRD QUARTER 2001 

FDIC
 

New York
 

Region
 

Division of 

Insurance 

Kathy R. Kalser,
 

Regional Manager
 

Robert DiChiara,
 

Financial Analyst
 

Norman Gertner,
 

Regional Economist
 

Alexander J.G.
 

Gilchrist,
 

Economic Analyst
 

A Message to Our Readers 

The FDIC community extends its deepest sympathy to the families, friends, and 

co-workers of the victims of the attacks on September 11, 2001. 

The articles in this edition of the Regional Outlook were prepared before the tragic 

events of September 11. We will assess the implications of these events in future issues 

of the Regional Outlook. The public can rest assured that deposit insurance is in full 

force—money is safe in an FDIC-insured account. 

Regional Perspectives 

◆ Differences in the Region’s Local Economies Contributed to Bank Performance—The Region’s counties did not benefit equally from the economic expansion of 

the 1990s. The Region’s vibrant counties, those that exhibited the strongest economic 

performance during the latter half of the 1990s, tend to be the suburban and exurban 

rings around major cities. These counties experienced greater population growth, 

stronger job creation, and more industrial diversity than the less vibrant counties. Local 

economic conditions have contributed to differences in the performance and credit risk 

profiles among the Region’s insured institutions. Banks in the Region’s vibrant counties 

reported stronger loan growth and higher margins, but greater risk profiles, than banks 

in less vibrant counties. See page 3. 

◆ The Region’s Office Markets Are Softening—Although the Region’s office markets 

currently do not exhibit the overbuilding that was prevalent during the 1980s, significantly reduced demand for office space during the first half of 2001 has resulted in higher 

vacancy rates and softening rents. A slowing economy and weakening office market conditions in the Region’s major cities may be affecting commercial real estate loan quality. 

During first quarter 2001, the ratio of past-due commercial real estate loans slightly 

increased; however, the ratio remained at a relatively low level historically. See page 7. 

By the New York Region Staff 

In Focus This Quarter 

◆ Slowing Economy Reduces Demand for U.S. Office Space—A slowing economy 

has contributed to softening in many U.S. office markets during the first half of 2001.The 

office vacancy rate has recorded the largest six-month increase in the past 20 years. A 

combination of trends—a substantial drop in demand for office space and an uptick in 

construction activity in some markets—has led to this slackening. 

This article reviews recent developments in U.S. office markets and describes demandside and supply-side trends that have contributed to the recent weakness. It notes the 

role played by the changing fortunes of high-tech firms in a number of U.S. metro areas 

and how this situation has contributed to large increases in the volume of space available for sublease. Finally, the article focuses on the local construction and commercial 

real estate loan exposures of FDIC-insured banks and thrifts that have the task of managing their risks under changing market conditions. See page 11. 

By Thomas A. Murray 

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

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

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

geographic regions: 

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

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

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

Dallas Region (CO, NM, OK, TX)
 

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

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

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

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

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

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

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

For more information or to provide comments or suggestions about the New York Region’s 

Regional Outlook, please call Kathy Kalser at (917) 320-2650 or send an e-mail to kkalser@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 Donald E. Powell 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Writer/Editor Kim E. Lowry 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Richard A. Brown 

Ronald L. Spieker 

Publications Manager Teresa J. Franks 
Regional Perspectives
 

Regional Perspectives
 

Region’s Economic Buoyancy Has Been Uneven 

Although it is said that a rising tide lifts all boats, some 

boats are more buoyant than others. The Region’s economic tide certainly has risen since the beginning of 

the 1990s, although the degree to which its counties 

have benefited has varied. While certain areas of the 

Region have fared extremely well over the past five 

years, keeping pace with the nation’s economy, others 

have not. Although the Region’s insured institutions 

have benefited from healthy economic conditions during the latter half of the 1990s, differences in local 

economic conditions have affected banks’ performance. With the nation’s economic expansion losing 

momentum, this is an opportune time to review differences in the Region’s economic performance and 

examine how these differences have affected conditions in the banking industry. 

The Region’s economy is diverse. To gauge differences 

in economic performance across the Region’s 178 counties, this article ranks them by the degree of change 

since 1996 in five measures of economic performance. 

The performance measures include changes in employment, population, income, and single-family home 

prices. Industrial diversity relative to the nation also was 

derived. A significant variance from the nation suggests 

that an area is characterized by less industrial diversity, 

or a greater number of jobs concentrated in fewer industries. All else being equal, a difference also could indicate that a county might be more vulnerable to weakness 

in a concentrated industry. Counties that ranked in the 

top third, exhibiting the strongest economic performance, are referred to as “vibrant” counties. Counties 

that ranked in the bottom third are referred to as “less 

vibrant” counties (see Table 1, next page).1 This article 

focuses on the counties that ranked in the top and bottom thirds in terms of change in economic performance 

over the past five years. 

1 Rankings of the five economic variables were summed to form a 

composite ranking for each of the Region’s counties. Counties were 

then ranked by their composite rating and divided into thirds. Puerto 

Rico and the U.S. Virgin Islands were excluded from this analysis 

because of a lack of comparable economic data. Variance in industrial diversity from the nation was calculated using year-end 2000 

employment figures. Personal income and population information by 

county was available through 1999. Employment growth and median 

single-family home prices were available through year-end 2000. 

Big City Suburbs and Exurbs Lead the Region 

in Economic Performance2 

The Region’s vibrant counties tend to be the suburban 

and exurban rings around major cities, even as the central cities themselves experienced less than spectacular 

economic growth (see Map 1, next page). For example, 

a recent report from Rutgers University characterized 

the phenomenon in New Jersey as a geographic transformation, “a pattern of sustained suburbanization and 

economic deconcentration. Sprawling horizontal cities 

have emerged, centered around the state’s suburban and 

exurban highway-oriented growth corridors.”3 While 

this phenomenon is most striking along the Region’s 

I-95 corridor between New York City and Washington, 

DC (Delaware, Maryland, and New Jersey had the 

highest percentages of counties in the top third), it also 

applies to the area from New York City northward up the 

Hudson River valley to Albany. 

The Region’s vibrant counties gained population in the 

latter half of the 1990s, while the less vibrant counties 

lost population. A growing population base not only 

increases the available labor supply from which local 

businesses can draw but also can bolster demand for consumer products and services, stimulating economic 

growth. Between 1996 and 1999, the median population 

growth rate for the Region’s vibrant counties was 2.8 

percent, compared with negative 0.1 percent for the 

Region as a whole. Although Census 2000 data by county are not yet available, these trends suggest that many of 

the Region’s vibrant counties have become home to an 

increasing number of residents from other parts of the 

Region and nation, as well as from other countries.4 

Contributing to, if not causing, the population inflow 

into the Region’s vibrant counties was a higher rate of 

job creation over the past five years. Labor force mobility is one of the hallmarks of a strong economy, and the 

Region’s labor force has been migrating to where the 

2 Merriam-Webster’s Collegiate Dictionary defines an exurb as
 

“a region or settlement that lies outside a city and usually beyond its
 

suburbs and that often is inhabited chiefly by well-to-do families.”
 

3 Hughes, James W., and Joseph J. Seneca. May 2001. Sitar-Rutgers
 

Regional Report. Vol. 4, No. 2, p. 5.
 4 Frey, William H. Regional Shifts in America’s Voting-Aged Population: What Do They Mean for National Politics? 2000. Ann Arbor,
 

Mich.: Population Studies Center at the Institute for Social Research,
 

University of Michigan.
 

New York Regional Outlook 3 Third Quarter 2001 
Regional Perspectives
 

TABLE 1 

Economic Performance Varies across the Region’s Counties 

MEDIAN VARIANCE 

PERSONAL SINGLE­ FROM U.S. 

EMPLOYMENT POPULATION INCOME FAMILY HOME INDUSTRIAL 

GROWTH GROWTH GROWTH PRICE CHANGE DIVERSITY* 

(1996–2000) (1996–1999) (1996–1999) (1996–2000) (4Q2000) 

VIBRANT COUNTIES (UPPER 3RD) 6.3% 2.8% 19.6% 31.7% 14.9% 

LESS VIBRANT COUNTIES 

(LOWER 3RD) –0.4% –1.9% 11.3% 12.3% 28.4% 

NEW YORK REGION 2.2% –0.1% 14.2% 20.2% 20.6% 

UNITED STATES 6.7% 2.8% 19.1% 31.7% 

Regional figures depict median absolute change over stated time period. 

*Higher percentage means higher industry concentration than the nation. A county exactly as diverse as the nation 

would have zero variance. 

Sources: Bureau of Economic Analysis, Bureau of Labor Statistics, Economy.com, Census Bureau, National Association 

of Realtors, WEFA, Haver Analytics 

MAP 1 

Economic Bouyancy 

Has Been Uneven 

Source: Bureau of Economic Analysis, Bureau of Labor Statistics, WEFA, 

National Association of Realtors, Census Bureau, Economy.com, Haver Analytics. 

Vibrant 

Average 

Less Vibrant 

jobs are being created. Between 1996 and 2000, median 

job growth in the Region’s 59 economically vibrant 

counties exceeded 6 percent. 

The degree of an area’s industrial diversity also can 

affect its economic performance. As shown in Table 1, 

the Region’s vibrant counties have a more diversified 

job base relative to the nation than the less vibrant counties. Additionally, some of the Region’s vibrant counties 

have benefited from growth in the construction sector 

and the finance, insurance, and real estate (FIRE) sector, which has contributed to favorable trends in personal income levels and population growth. These industry 

sectors have been the engines of economic growth during the current business cycle. Moreover, salaries in 

these sectors, particularly in the securities industry, tend 

to be higher paying, providing a boost for counties with 

larger concentrations of these jobs. 

Hand in hand with rapid job formation and population 

growth are personal income growth and demand 

for housing. As indicated in Table 1, personal income 

increased by almost 20 percent between 1996 and 

1999 in the Region’s vibrant counties. Higher income 

often translates into more money to purchase goods, services, and homes. Reflecting, in part, favorable trends in 

personal income and employment growth, the Region’s 

vibrant counties experienced healthy gains in housing 

prices during the latter half of the 1990s, as median 

home prices increased by almost 32 percent between 

1996 and 2000, similar to the national average. 

Unfavorable Employment and Population Trends 

Hinder Region’s Less Vibrant Counties 

The Region’s less vibrant counties demonstrate that not 

all areas have shared in the nation’s economic expansion. 

Using our five economic categories as a barometer, these 

counties have shown signs of stagnant or modest economic growth at best and, in some cases, a decline in 

economic performance over the past five years. They 

have been adversely affected by negative or minimal 

employment growth and declining populations. Fortyfive of the 59 less vibrant counties suffered net job losses between 1996 and 2000, and those that gained jobs 

averaged less than 0.5 percent growth. Furthermore, 

each of the Region’s less vibrant counties experienced a 

net loss of population between 1996 and 1999. 

New York Regional Outlook 4 Third Quarter 2001 
Regional Perspectives
 

The lack of industrial diversity also has played a role in 

the economic performance of the Region’s less vibrant 

counties. Although these counties generally have reduced 

their reliance on manufacturing jobs over the past decade, 

their share of jobs in the manufacturing industry is roughly twice that in the Region’s vibrant counties. The manufacturing sector has experienced long-term, structural job 

loss as manufacturers have relocated to lower-cost locations outside the Region. Furthermore, as the national 

economy slowed during the past 12 months, layoffs in the 

manufacturing sector have increased as demand for manufactured goods has declined. Additionally, the Region’s 

less vibrant counties have fewer jobs in higher-paying 

construction and service industries and more in the government and military sectors. 

Employment and population trends contributed to two 

other characteristics shared by the Region’s less vibrant 

counties: low real personal income growth and minimal 

appreciation in home prices. At just over 11 percent, 

median personal income growth between 1996 and 1999 

(the latest year for which data are available) in the less 

vibrant counties barely exceeded the nation’s inflation 

rate. With a leveling off in real income, the median 

change in home prices in these counties also barely 

topped inflation over the same period. Changes in median home prices in these counties ranged from a decline 

of more than 5 percent to an increase of approximately 

16 percent, compared with a 9.3 percent compounded 

rate of inflation between 1996 and 1999. 

Differences among Region’s Economies 

Influence Bank Performance 

The rising economic tide has contributed to the generally 

favorable financial conditions reported by the Region’s 

insured institutions. Reflecting robust economic conditions in the latter half of the 1990s, the Region’s banks 

have benefited from strong loan growth, increased 

demand for banking services, and favorable credit quality. Furthermore, they generally have higher capital ratios 

than a decade ago. Nevertheless, local economic conditions have contributed to differences in performance and 

credit risk profiles among the Region’s banks. 

Banks in Vibrant Economies Report Stronger Loan 

Growth, Higher Margins, but Greater Credit Risk 

Insured institutions Regionwide experienced strong 

loan growth during this economic expansion. Loan 

growth was slightly higher for institutions headquartered in the vibrant counties, averaging 11.3 percent 

annually between 1996 and 2000 compared with 9.4 

percent annually for banks in less vibrant counties.5 

During this period, banks in the Region’s vibrant counties moderately increased the proportion of commercial and industrial (C&I) and commercial real estate 

(CRE) loans to total loans, while reducing concentrations of residential and consumer loans. The portfolios 

of insured institutions in the less vibrant counties, 

however, remained largely concentrated in residential 

loans. By year-end 2000, the median ratio for commercial loans to total loans, including CRE and C&I 

loans, was 39 percent for banks in vibrant counties 

compared with 26 percent for banks in less vibrant 

areas. In contrast, the median ratio of residential loans 

to total loans was 47 percent for banks in vibrant counties, compared with 61 percent for banks in less 

vibrant counties. 

The higher level of traditionally higher-yielding loans, 

such as CRE and C&I loans, has contributed to a favorable comparison of the average net interest margin 

(NIM) for banks in the Region’s vibrant counties with 

those in less vibrant areas (see Chart 1, next page). 

During the latter half of the 1990s, NIMs declined for 

institutions throughout the Region, reflecting increased 

competition and a generally flat yield curve. Since 

1999, however, margins earned by institutions in the 

vibrant counties have increased relative to those earned 

by banks in less vibrant counties. The larger proportion 

of commercial loans, which generally garner higher 

yields than residential loans, has contributed in part to 

the relative improvement. 

Changes in bank funding structures also may have contributed to the difference in NIMs. Consistent with 

national trends, the ratio of core deposits to assets has 

declined across the Region as competition for core 

deposits has increased and loan growth has outpaced 

core deposit growth. A larger proportion of core deposits 

can enhance an institution’s NIM because core deposits 

typically are a lower-cost source of funds than noncore 

funding. Insured institutions in the Region’s less vibrant 

5 Banking analysis included 370 insured institutions headquartered in 

the vibrant counties and 166 institutions headquartered in less vibrant 

counties. Excluded from the analysis were institutions with assets 

greater than $40 billion, multinational institutions (those with more 

than 25 percent of assets in foreign offices), institutions in operation 

less than three years, and credit card banks. Institutions headquartered 

in the Region’s three less vibrant counties that are surrounded by 

vibrant metropolitan areas also were excluded. All growth figures 

were adjusted for mergers. 

New York Regional Outlook 5 Third Quarter 2001 
Regional Perspectives
 

counties, despite their greater focus on retail banking, 

have experienced declines in the ratio of core deposits to 

assets that parallel declines experienced by banks in the 

vibrant counties (see Chart 2). Less favorable population 

and personal income trends have challenged the ability 

of banks in less vibrant counties to grow core deposits. 

Between 1996 and 2000, core deposit growth averaged 

3.5 percent annually for banks in the Region’s less 

vibrant counties compared with 5.8 percent for banks in 

vibrant counties and 4.8 percent for the nation. 

The maturity distribution of institutions’ loan portfolios also may have contributed to differences in NIMs. 

Banks in the less vibrant counties reported a much 

higher median ratio of long-term assets to total assets 

(44.4 percent) at year-end 2000 than banks in vibrant 

counties (27.5 percent). Because residential loans tend 

to be lower yielding and longer term than commercial 

loans, the larger proportion of residential loans held 

by banks in the Region’s less vibrant economies may 

have contributed to additional margin pressure during 

the late 1990s, a period of low long-term interest rates. 

Although Overall Credit Quality Measures 

Are Favorable, Banks in Less Vibrant Counties 

Exhibit Greater Weakness 

The greater concentration in residential real estate loans 

of insured institutions in less vibrant counties suggests a 

lower credit risk profile than is the case for banks with 

higher concentrations of commercial loans. Such a portfolio is less directly exposed to business lending risks, 

such as softening CRE markets or weakening in corporate earnings. Nevertheless, stagnant real personal 

income and modest employment growth over the past 

five years perhaps have contributed to more modest 

credit quality improvement for banks in the Region’s less 

vibrant counties. During the latter half of the 1990s, the 

ratio of past-due loans to total loans declined across the 

Region; however, institutions in the Region’s vibrant 

economies experienced greater improvement in the pastdue ratio than those in the less vibrant economies. Moreover, recently the median past-due ratio for institutions in 

the Region’s slower-growing economies, although still at 

a relatively low level, has increased more than has the 

ratio for banks in vibrant counties (see Chart 3).6 

6 At year-end 2000, the median past-due ratios for banks headquartered 

in the Region’s less vibrant counties were higher across all loan categories. 

CHART 1 

Banks in Vibrant Economies 

Report Higher NIMs 

NIM (Percent) 

4.3 

4.2 

4.1 

4.0 

3.9 

3.8 

3.7 

3.6 

1995 1996 1997 1998 1999 2000 

Note: Ratios represent median figures.
 

Source: Bank and Thrift Call Reports
 

CHART 2 

Banks across the Region Experience 

Decline in Core Deposits Relative to Assets 

Core Deposits to Assets (Percent) 

82 

80 

78 

76 

74 

72 

70 

Banks in Less Vibrant Counties 

Banks in Vibrant Counties 

68 

1995 1996 1997 1998 1999 2000 

Note: Ratios represent median figures.
 

Source: Bank and Thrift Call Reports
 

CHART 3 

Banks in Vibrant Counties 

Banks in Less Vibrant Counties 

1.0 

1.5 

2.0 

2.5 

3.0 

3.5 

1995 1996 1997 1998 1999 2000 

Banks in Less Vibrant Counties Show 

More Modest Credit Quality Improvement 

Past-Due Ratio (Percent) 

Banks in Less Vibrant Counties 

Banks in Vibrant Counties 

Note: Ratios represent median figures. 

Source: Bank and Thrift Call Reports 

New York Regional Outlook 6 Third Quarter 2001 
Regional Perspectives
 

Lessons Learned from the 

Eighties Banking Crisis 

Despite these recent trends in credit quality, institutions 

in the Region’s rapidly expanding economies, in fact, 

may be more vulnerable to losses than those in slowergrowing economies. According to a Federal Deposit 

Insurance Corporation study of the banking crisis of 

the 1980s, bank failures that occurred a decade ago generally were concentrated in markets that had experienced rapid growth followed by a precipitous decline in 

economic conditions.7 Insured institutions in the more 

robust economies responded to strong economic growth 

7 Federal Deposit Insurance Corporation. History of the Eighties— 

Lessons for the Future, Vol. I: An Examination of the Banking Crises 

of the 1980s and Early 1990s. 1997. Washington, DC: FDIC. 

by providing financing for consumers, businesses, and 

real estate development. In some instances, however, 

rapid economic growth resulted in supply imbalances. 

During the 1980s, the New York Region, in particular, 

experienced significant speculative development in the 

CRE sector. As the economy softened and the economic “boom” devolved into a “bust,” some CRE markets 

across the nation and the Region experienced significant 

deterioration in values that were ultimately absorbed, in 

part, by banks. (For more information on commercial 

real estate conditions in the Region, see Inset Box.) 

Looking Ahead 

The Region’s insured institutions have experienced 

strong loan growth throughout most of this business 

Region’s Office Markets Softened in	 experienced negative net absorption of office space 

during first half 2001 and 48 of those markets record- First Quarter 2001, but Conditions ed rising vacancy rates from year end 2000 through 

Differ from the 1980s	 June 2001. In other words, the amount of office space 

that became available during the first half exceeded 

the amount of space leased. According to Torto One key factor associated with rising levels of bank fail- Wheaton, first quarter 2001 marked the first time this ures during the late 1980s was bank financing of specu­ has occurred. The sudden drop in office demand lative real estate development.8 Unlike during the 1980s, reflected the return of space from numerous failed however, office construction in the Region over the past high-tech ventures and the reluctance of existing firms five years was constrained, reflecting the overhang of to contract for more space during a period of econom­ space completed a decade earlier and a more conserva­ ic uncertainty and declining corporate profitability. tive financing environment. As indicated in Table 2 

(next page), the construction of new office space in the 

Region, as a percentage of existing stock, was signifi­ The Region’s major office markets felt the effects of 

declining office demand as New York City, northern cantly less between 1996 and 2000 than during the late 

New Jersey, Long Island, Philadelphia, Westchester, 1980s. Moreover, demand for office space in the Region, 

Wilmington, and Washington, DC, experienced nega­ as measured by absorption, significantly exceeded office 

tive absorption. The Washington, DC, and Long Island completions during the latter half of the 1990s. This is in 

metropolitan statistical areas (MSAs) experienced stark contrast to what occurred during the 1980s. 

some of the most significant declines in office demand 

in the nation, reflecting, in part, a slowdown in the 

Economic Slowdown Spills Over technology sector. As demand fell, office vacancy 

into Region’s Office Markets rates in all of the Region’s major cities increased in 

first half 2001 (see Table 3, page 9). Higher vacancy 

Despite overall strong office market conditions, evi- rates were accompanied by an increasing number of 

dence suggests that some of the Region’s major CRE reports that rental rates have softened around the 

markets may be experiencing the effects of the current Region.10 

economic slowdown. Accordingly Torto Wheaton9 

states that 33 of 53 major metropolitan office markets 10 See the following: Peter Grant, “More Office Space Is Staying 

Wide Open,” Wall Street Journal, May 14, 2001; “Office Rents Drop 

in Manhattan,” New York Daily News, May 9, 2001; John Jordan, 8 Ibid. “Westchester Office Market Slowing but Still Strong,” Globe.com; 9 Torto Wheaton Research. “Vacancies on the Rise,” Pittsburgh Post-Gazette, May 5, 2001. 

New York Regional Outlook 7	 Third Quarter 2001 
Unlike the 1980s, in the 1990s Office Construction Was Limited 

and Demand for Office Space Exceeded New Supply

Regional Perspectives
 

TABLE 2 

UNLIKE THE 1980S, IN THE 1990S OFFICE CONSTRUCTION WAS LIMITED
 

AND DEMAND FOR OFFICE SPACE EXCEEDED NEW SUPPLY
 

COMPLETIONS TO SUPPLY* (%) ABSORPTION/COMPLETIONS** 

METROPOLITAN AREA 1986–1990 1996–2000 1986–1990 1996–2000 

BALTIMORE 51 14 0.69 1.33 

LONG ISLAND 35 7 0.51 1.62 

NEW YORK CITY 9 1 0.06 18.15 

NORTHERN NEW JERSEY 43 6 0.76 2.60 

PHILADELPHIA 38 8 0.78 1.35 

WASHINGTON, DC 47 10 0.79 1.53 

WESTCHESTER 29 3 0.28 5.22 

WILMINGTON 88 7 0.42 2.57 

UNITED STATES 26 10 0.72 1.45 

* Percentage of office completions over stated period to existing supply at the beginning of the period.
 

** Represents the sum of office absorptions divided by total office completions during the period.
 

Values less than 1.0 indicate conditions of oversupply, while values above 1.0 suggest that demand for office
 

space exceeded supply during the period.
 

Source: Torto Wheaton Research
 

Drop in Office Demand along with 

New Construction Could Take Some 

Steam Out of Office Markets 

The outlook for the Region’s office markets remains 

clouded by conflicting data regarding the direction 

of the national and regional economies. Unequivocally, the Region’s office markets currently do not 

exhibit the excessive overbuilding that was prevalent 

during the 1980s. Moreover, despite the spike in 

office vacancy rates in the first quarter, vacancy 

rates in most of the Region’s cities were relatively 

low at quarter-end. Softening demand for office 

space could result in further increases in office 

vacancy rates, while pressuring the relatively high 

office rents in some of the Region’s office markets. 

However, the Region’s office employment growth, 

an indicator of demand for office space, increased 

slightly in many of the Region’s cities during first 

quarter 2001. Continued growth in office employment should help mitigate the dampening effect of 

subleased space returning to the Region’s office 

markets. (For more information on commercial 

real estate trends, see Softening Extends to Other 

Commercial Real Estate.) 

During first half 2001, some areas in the Region exhibited a large decline in office demand and a corresponding increase in vacancy rates while also registering an 

increase in the amount of new space under construction. Office construction has increased modestly in 

many parts of the Region, most notably in northern and 

central New Jersey, Baltimore, and the Washington, 

DC, MSA.11 Construction in northern New Jersey 

reflected in part the overflow of demand from financial 

services companies from Manhattan and growth of 

telecommunications and technology companies such as 

AT&T, Motorola, Lucent Technologies, and Nortel. 

Growth of telecommunication, computer-related services, and bio-tech industries also has led to new office 

development in the areas surrounding Washington, DC, 

particularly suburban Maryland and northern Virginia. 

However, many of these industries have been severely 

affected by the recent softening in the economy. As a 

result, a large amount of previously leased space has 

returned to the market. While some construction projects may be under lease, information on the amount 

and strength of lease commitments is difficult to 

access. Furthermore, if corporate profitability continues to be strained, additional leased space could return 

to the market. 

11 The Washington, DC, MSA includes the District of Columbia 

and surrounding areas of Maryland, Virginia, and West Virginia. 

New York Regional Outlook 8 Third Quarter 2001 
Regional Perspectives
 

TABLE 3 

After Declining through the 1990s, 

Office Vacancy Rates May Be Nearing Bottom 

Metropolitan Area 1990 1995 2000 2001* 

BALTIMORE 17.3% 13.9% 8.3% 8.9% 

LONG ISLAND 22.2% 13.8% 9.0% 10.9% 

NEW YORK CITY 15.5% 14.9% 2.8% 5.1% 

NORTHERN NEW JERSEY 21.3% 17.8% 7.3% 10.9% 

PHILADELPHIA 16.7% 13.4% 9.9% 10.7% 

WASHINGTON, DC 16.8% 9.5% 3.9% 7.8% 

WESTCHESTER 21.9% 22.4% 11.3% 12.5% 

WILMINGTON 22.6% 13.1% 6.2% 10.4% 

UNITED STATES 18.2% 13.8% 8.3% 10.8% 

* 2001 amounts are for second quarter 2001. 

Source: Torto Wheaton Research 

Institutions in Region’s Vibrant Areas 

Have Greater Exposure to CRE Lending 

The Region’s insured institutions that reported 

the highest proportion of CRE loans to assets12 were 

clustered in and around the Region’s major cities. 

Two-thirds of the banks with the highest levels of 

CRE loans are located in the New York, Baltimore, 

Washington, DC, or Philadelphia MSAs. Moreover, 

the Region’s new institutions (those in operation less 

than three years) have been active in CRE lending. 

In fact, today’s crop of new banks has a greater 

proportion of assets in CRE loans than their counterparts did during the height of the 1980s real estate 

boom. New banks’ median concentration of assets in 

CRE loans was 14.9 percent as of year-end 2000, 

compared with 5.7 percent as of year-end 1988. While 

new banks represent 8.5 percent of the Region’s institutions, they represent a disproportionate share (18.8 

percent) of the banks in the top decile of CRE loans 

to assets. The majority of new banks that rank in the 

top decile of CRE loans to assets in the Region are 

located in the New York City or Philadelphia MSAs. 

(For more information on the Region’s new banks, see 

the New York Regional Outlook, first quarter 2001.) 

12 Analysis identified institutions that ranked above the Region’s 90th 

percentile in terms of CRE loans to assets as of year-end 2000. The 

90th percentile for the ratio of CRE loans to assets was 31 percent. 

CRE Credit Quality Ratios Are at Favorable 

Levels; However, Trends Warrant Attention 

Reflecting several years of strong economic growth and 

healthy office market conditions, the average delinquency ratio for CRE loans reported by the Region’s 

insured institutions reached the lowest level during the 

current economic expansion at year-end 2000. Slower 

economic growth and weakening office market conditions in some of the Region’s major cities, however, may 

be affecting CRE loan quality. Since mid-2000, the 

CRE past-due ratio reported by the Region’s most active 

CRE lenders (those in the 90th percentile in terms of 

CRE loans to total assets) has increased slightly, 

although it remains below the national average. The 

average CRE loan past-due ratio for all banks in the 

Region moderately increased in first quarter 2001, consistent with the national trend; however, the ratio 

remains at a relatively low level by historical standards. 

Although reported CRE credit quality remains strong, 

the potential effects of economic weakness on the 

Region’s office markets warrant attention. Should office 

rents fall significantly, properties securing CRE loans 

may realize a decline in cash flow, which would affect 

debt service capacity. In addition, property appraisals or 

repayment schedules on CRE loans made at the height 

of the economic expansion that assume the continuation 

of very high rents may not be sustainable if the economic slowdown becomes more severe or prolonged. 

Therefore, financing terms for new office development 

should consider the potential effects of a further deterioration of office market conditions. 

New York Regional Outlook 9 Third Quarter 2001 
Regional Perspectives
 

cycle, aided by favorable economic performance. Moreover, average capital levels for the Region’s institutions 

are sound. The extreme economic imbalances the 

Region experienced in the 1980s do not appear to have 

been repeated during this business cycle. However, 

banks that operate in the Region’s vibrant economies 

face different risks than those in less vibrant economies. 

Institutions in vibrant economies have a higher credit 

risk profile because of generally greater concentrations 

in commercial loans. Despite this higher credit risk profile, margins declined during the latter half of the 

1990s, contrary to the traditional risk-reward trade-off. 

This decline in margins reflects, in part, a flatter yield 

curve and increased competition for funding and loans. 

Going forward, softening in the Region’s vibrant 

economies may lead to weakened credit quality, further 

pressuring NIMs. Moreover, banks in vibrant markets 

face increasing competition from insured institutions 

and other financial service providers. 

Although institutions in the Region’s less vibrant counties 

generally have more conservative loan portfolios than 

those in vibrant counties, these banks, on average, reported less improvement in credit quality during the height of 

this economic expansion. Recently insured institutions in 

less vibrant counties also have reported greater weakening of credit quality. Moreover, the combination of loweryielding loan portfolios and sluggish core deposit growth 

has contributed to greater relative margin compression 

for insured institutions in the Region’s less vibrant markets. Steepening in the Treasury yield curve during the 

first half of 2001 has mitigated this situation somewhat. 

However, should margin pressure continue unabated over 

a prolonged period, some institutions may attempt to 

enhance profitability by shifting into traditionally higheryielding, higher-risk assets such as commercial loans or 

expanding their geographic lending area, potentially 

heightening risk profiles. 

By the New York Region Staff 

New York Regional Outlook 10 Third Quarter 2001 
In Focus This Quarter
 

Slowing Economy Reduces 


Demand for U.S. Office Space
 

•	 Demand for U.S. office space contracted during 

the first half of this year as the amount of newly 

vacated space exceeded the amount of newly 

occupied space for the first time since at least 

1981. 

•	 The U.S. office vacancy rate jumped 250 basis 

points in the first half of 2001, from 8.3 percent to 

10.8 percent. 

•	 With construction levels remaining high and 

demand still weak, the vacancy rate could rise 

further by year-end. 

Overview 

Commercial real estate (CRE) markets traditionally 

have been—and remain—highly cyclical. During the 

1990s, most U.S. office markets experienced a strong 

upswing. However, declining office employment 

growth along with other recent signs point to a possible 

downturn. As reported by Torto Wheaton Research 

(TWR), the U.S. office vacancy rate, which stood at a 

19-year low of 8.3 percent at the end of 2000, jumped in 

only six months to 10.8 percent, the largest six-month 

increase in the 20 years TWR has tracked these data. 

Office vacancy increases range from modest levels in 

some markets to high levels in markets where supply 

and demand imbalances are more pronounced. 

An uptick in construction activity combined with a substantial drop in demand for office space has led to a 

slackening of office market conditions. In light of the 

ongoing uncertainty as to the near-term direction of the 

U.S. economy, these trends make the current situation 

difficult for office market participants to read. 

This article reviews recent developments in U.S. office 

markets and describes demand-side and supply-side 

trends that have contributed to the recent weakness.1 

It notes the role played by the changing fortunes of 

1 For further discussion of demand and supply trends, see Sally Gordon, “CMBS: Red – Yellow – GreenTM Update, Second Quarter 2001 

Quarterly Assessment of U.S. Property Markets,” Moody’s Investors 

Service, July 6, 2001. 

high-tech firms in a number of metropolitan areas and 

how this situation has increased the volume of space 

available for sublease. Finally, the article focuses on the 

local construction loan exposures of insured banks and 

thrifts that have the task of managing their risks under 

changing market conditions. 

Vacancy Rates Have Risen 

Quickly from Cyclical Lows 

At year-end 2000, the U.S. office vacancy rate stood at 

8.3 percent—a 19-year low. Many individual metro 

areas posted even lower vacancy rates. For example, at 

year-end 2000, vacancies were 4.4 percent of available 

space in Seattle, 1.3 percent in San Jose, and 3.0 percent 

in Oakland. Beginning with first quarter 2001, as a 

result of a slowing economy and the fallout from the socalled “tech-wreck,” the U.S. vacancy rate rose by 120 

basis points to 9.5 percent—the highest absolute quarterly increase since these data were first published in 

1981. Another record increase of 130 basis points 

occurred during the second quarter, bringing the vacancy rate to 10.8 percent. To put these increases in perspective, consider that the national office vacancy rate 

has increased more than 50 basis points in any given 

quarter only twice.2 Nonetheless, the current vacancy 

rate of 10.8 percent remains low by historical standards, 

as the average rate for the past 20 years has been 13.9 

percent. 

Most of the nation’s large metro areas saw increases in 

office vacancies during the first half of 2001. Fortyeight of the 53 major metropolitan areas tracked by 

TWR recorded a higher vacancy rate in June 2001 than 

at year-end 2000. Thirty-eight markets experienced 

increases of at least 100 basis points, and four markets 

saw vacancy rates jump by more than 600 basis points. 

As shown in Table 1 (next page), most of the markets 

experiencing the largest jump in vacancy rates also are 

home to concentrations of high-tech employment.3 As 

2 TWR notes increases of 60 basis points in the second quarter of 

1989 and in the first quarter of 1999. 

3 Seven of the ten markets with the highest first-half 2001 vacancy 

rate increases are also among the top ten cities having the greatest 

levels of high-tech employment. 

New York Regional Outlook 11	 Third Quarter 2001 
In Focus This Quarter
 

TABLE 1 

In Many Markets, Office Vacancy Rates Reflect 

Concentrations of High-Tech Employment 

VACANCY RATE VACANCY RATE INCREASE IN HIGH-TECH AS % 

AS OF 6/30/01 AS OF 12/31/00 VACANCY RATE OF TOTAL MARKET 

METRO AREA (%) (%) (BASIS POINTS) EMPLOYMENT 

AUSTIN 11.8 5.0 680 10.1 

SAN JOSE 8.1 1.3 680 27.4 

OAKLAND 9.3 3.0 630 6.5 

SAN FRANCISCO 10.3 4.1 620 8.3 

SEATTLE 9.4 4.4 500 6.6 

KANSAS CITY 15.9 11.0 490 2.7 

BOSTON 8.7 3.9 480 8.2 

PHOENIX 16.9 12.5 440 4.7 

WILMINGTON, DE 10.4 6.2 420 3.8 

WASHINGTON, DC 7.8 3.9 390 7.8 

NATION 10.8 8.3 250 4.8 

Sources: Torto Wheaton Research, Economy.com, Inc. 

high-tech markets spurred higher demand for office 

space in the recent past, these markets are now giving 

back greater quantities of previously occupied office 

space. Table 2 (see page 18) lists office vacancy rates 

and changes along with lending concentrations, construction activity levels, and high-tech employment 

percentages for 53 major metropolitan areas and for 

the nation. 

Unlike the last cycle, during which office vacancies 

shot up primarily in overbuilt downtown areas, recent 

increases are occurring more sharply in suburban than 

downtown sections of metropolitan areas. As of June 

30, 2001, the average downtown office vacancy rate 

was 8.5 percent, and the average for suburban markets 

was 12.1 percent. Increases in office availability are 

dispersed among Class A office properties as well as 

Class B/C properties, yet vacancy rates do show disparities across many submarkets. For example, the 

South of Market area in San Francisco reports significantly higher office vacancy rates than the Financial District.4 Similarly, in the Washington, DC, 

metropolitan area, the technology-intensive northern 

Virginia office market has experienced higher office 

vacancy increases than downtown Washington, DC, or 

suburban Maryland. 

4 Louis, Arthur M. July 24, 2001. “Empty Offices, Economic Downturn, Overconstruction Leave Commercial Landlords with More 

Space on their Hands.” San Francisco Chronicle. 

Office Demand Drops 

Net absorption, the primary indicator of demand for 

office space, was negative during first quarter 2001 for 

the first time since TWR began reporting the series.5 

(Negative absorption occurs when space returned to the 

market by existing tenants exceeds the space occupied 

by new tenants.) This negative performance was repeated in the second quarter. The decline in the volume of 

competitively leased space totaled 30 million square 

feet during the first half of 2001. (See Chart 1.) 

The bulk of negative absorption in the first half of 2001 

is due to the return of office space to the market through 

subleasing.6 TWR reports that there were 43 million 

square feet of space “give-backs” through subleasing in 

the first half of 2001, and after offsetting absorption of 

13 million square feet, negative absorption was 30 million square feet. 

Office employment growth, the source of new office 

space demand, tends to be driven by the finance and services sectors.7 Year-over-year job growth in the finance, 

5 Net absorption is the net change in total competitively leased space 

per period, as measured in square feet. 

6 In some metropolitan areas, over half the total office space available 

for rent (vacant space) is sublease space. 

7 TWR constructs its office employment index based on trends in the 

FIRE sector plus selected categories of the services sector. See TWR 

Office Outlook, Spring 2001, Vol. II, p. A.1. 

New York Regional Outlook 12 Third Quarter 2001 
 

In Focus This Quarter
 

CHART 1 

Net Absorption Turned Negative in 2001 

Vacancy Rate (%) 

Square Footage (000s) 

Vacancy 

Rate (%) 

–40,000 

–20,000 

0 

20,000 

40,000 

60,000 

80,000 

100,000 

120,000 

140,000 

Completions 

(S.F.) 

Absorptions 

(S.F.) 

Negative 

Absorption 

’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 

0.0 

2.0 

4.0 

6.0 

8.0 

10.0 

12.0 

14.0 

16.0 

18.0 

20.0 

Notes: 2001 is as of June 30. S.F. = square footage 

Source: Torto Wheaton Research 

insurance, and real estate (FIRE) and services sectors 

combined was more than 3 percent in every month from 

January 1993 through June 2000. Since the middle of 

2000, job growth in these sectors has fallen steadily to a 

year-over-year rate of less than 1.5 percent in June 2001. 

A spring 2001 survey conducted by Salomon Smith 

Barney indicated that tenants estimated their growth in 

office space demand to be only 0.6 percent over the following 12-month period.8 Also contributing to reductions 

in demand are increases in worker layoffs. Announced 

layoffs during the first seven months of 2001 totaled over 

983,000 individuals, more than triple the number of 

announced layoffs during the same period last year.9 

The slowdown in the demand for office space contrasts 

sharply with the situation last year, when absorption 

rates and office employment growth were robust in most 

markets, and leases were executed quickly for newly 

constructed properties. As shown in Chart 2, absorption 

of office space in 2000 actually outstripped the trend in 

office employment by a considerable margin. Why? 

With relatively easy access to initial public offering and 

venture capital funding, many startup firms anticipated 

rapid growth and leased office properties accordingly. In 

fact, venture capital funding facilitated historically higher rates of office space absorption by high-tech and other 

startups. In active bidding wars, new high-tech firms 

increased their office space holdings. A phenomenon of 

space hoarding developed in which some high-tech 

companies leased large quantities of office space in 

anticipation of future expansion. 

8 Boston, Gary, Ross Nussbaum, and Jonathan Litt. May 16, 2001.
 

“Real Estate Demand Survey.” Equity Research: United States, Real
 

Estate Investment Trusts. Salomon Smith Barney. 
 9 Data provided to Haver Analytics by Challenger, Gray & Christmas.
 

More recently, because of a slowing economy, curtailed 

funding, and failures to achieve sales expectations, 

many high-tech and dot-com firms have closed or 

scaled back operations significantly. At the same time, 

traditional firms have reconsidered plans to expand, 

adopting a “wait and see” attitude. Consequently, as 

demand for space declines, large blocks of office space 

are returning to markets for sublease. 

Space available for sublease is similar to landlordoffered space available for rent—space under both categories should count toward a market’s available rental 

space. However, in the case of subleasing, tenants, 

rather than landlords, offer properties for rent. Tenants 

may attempt to sublease the property themselves or use 

a broker; however, in general, only space handled by a 

broker is included in the tally of a market’s available 

rental space. Consequently, current office vacancy 

increases could be higher than reported. 

CHART 2 

Office Demand Spiked in 2000 as Employers
 

Took on More Office Space than Needed
 

Sq. Ft. Absorbed Office Employment 

(000s) Growth (000s) 

120,000 

Office employment 

growth 

Office absorption 

’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 

1,000 

900 100,000 

800 

80,000 700 

60,000 600 

40,000 500 

400 

300 

20,000 

0 

200 

–20,000 100 

–40,000 0 

Note: 2001 is as of June 30. 

Source: Torto Wheaton Research 

New York Regional Outlook 13 Third Quarter 2001 
In Focus This Quarter
 

Meanwhile, Construction Continues 

An uptick in office construction activity that began in 

many metro areas during the late 1990s has been a key 

element contributing to recent increases in office 

vacancies. According to the Bureau of the Census, 

U.S. expenditures on office construction totaled $47.5 

billion in 2000, continuing a seven-year cycle of 

expansion. Adjusted for inflation, this amount represents about 78 percent of the peak level of office construction expenditures that occurred in 1985. 

Recently, the pace of construction has slowed slightly, 

falling to an annualized rate of $44.3 billion in 

May 2001. 

Reflecting these large dollar outlays on office construction, TWR projected in December 2000 that 

111.3 million square feet of new office space (or 3.6 

percent of existing stock) would be completed during 2001. This newly completed space will come 

on the market following a period of rising construction activity from 1998 through 2000, during which 

the volume of completed office space averaged 84.9 

million square feet per year. As shown in Chart 3, 

however, current office construction activity as a 

percentage of existing stock falls well below that of 

the 1980s. 

CHART 3 

Many metropolitan areas currently experiencing high 

levels of construction activity also are seeing the largest 

increases in office vacancies. For example, cities that 

are positioned toward the upper right quadrant of Chart 

4 are characterized by higher vacancy rate increases and 

more new office space construction. The ten cities with 

the highest first-half 2001 vacancy rate increases had 

total square footage of under-construction office space 

at 6.5 percent of existing stock as of year-end 2000.10 By 

comparison, total office space under construction 

nationally was 4.5 percent of existing stock.11 

Even as most projects move toward completion, some 

developers are reconsidering office construction 

plans. Builders have stopped construction of significant 

projects midstream in the Austin, Dallas, Seattle, and 

northern Virginia markets in response to retrenchment 

by major tenants and competition from subleased space. 

Softening Extends to Other 

Commercial Real Estate 

Other major commercial real estate markets are also 

feeling the effects of a slowing economy and, with the 

exception of the retail sector, are experiencing increasing vacancy rates. 

Office Construction Activity Increases in Recent Years yet Remains Well Below Level of the 1980s 

12 

10 

8 

6
 

4
 

2
 

0 

Notes: Construction activity is completions per year divided by prior year-end stock. 2001 is projected. Office Completions Divided by Stock (%) 

’82 ’83 ’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 

Source: Torto Wheaton Research 

10 One measure of a metropolitan area’s exposure to overbuilding 

and rising vacancy rates is the degree of construction activity. This 

measure is found by dividing a metropolitan area’s completions 

square footage or the under-construction square footage by the 

total stock of office property. 

11 The national 4.5 percent level for office properties under construction at December 2000 is higher than the 3.6 percent level for projected completions in 2001 because not all properties being built in 2001 

will be completed during the year. 

New York Regional Outlook 14 Third Quarter 2001 
In Focus This Quarter
 

CHART 4 

Some Markets with Large First Half 2001 Office Vacancy Increases 

Also Have High Construction Activity 

Note: Construction activity is measured by a market's under-construction square footage at year-end 2000 divided by total square footage in that market as of year-end 2000. 

Source: Torto Wheaton Research, Spring 2001 Basis Point Vacancy Increase 

Construction Activity as Percentage of Stock 

Austin 

San Francisco 

San Jose 

Oakland 

Ventura 

Fort Lauderdale 

Seattle 

Miami 

Charlotte 

Orlando 

Las Vegas 

Northern New Jersey 

Phoenix 

Boston 

Washington, DC 

Kansas City 

Wilmington, DE 

Portland 

Atlanta 

Denver 

Columbus 

San Diego 

Nation 

0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0

–200 

–100 

100 

300 

400 

600 

700 

800 

0 

200 

500 

Industrial vacancy rates had fared well in recent years. 

As of year-end 2000, the national vacancy rate of 6.7 

percent was the lowest since 1984. Now, however, a 150­

basis-point increase has occurred, with industrial vacancies increasing to 8.2 percent in the first half of 2001.12 

As the economy and the nation’s high-tech and manufacturing sectors continue to slow, demand for industrial 

space for research and development and storage and distribution is declining. Industrial property subleasing is on 

the rise, and negative absorption occurred in the first half 

of 2001. At the same time, completions of industrial space 

during 2001 are estimated to exceed 220 million square 

feet, the highest level since 1988. Landlords are offering 

concessions, such as lease terms of one year compared 

with five to ten years, in an attempt to attract new tenants. 

Industrial properties are somewhat less exposed to risks 

from overbuilding than office properties because of 

shorter construction periods and the ability to respond 

quickly to any change in demand. An exception is the 

telecommunication hotel,13 a new entry into this market. 

This property type is characterized by a longer construction cycle and the fact that it typically has a “single 

use” design. In recent months, construction of these 

structures began in many high-tech markets to provide 

enhanced levels of data service. With declining demand, 

some telecom hotels stand vacant. 

12 Torto Wheaton Research. 

13 Telecom hotels are large, high-energy-consuming warehouses that 

house machinery, servers, routers, and switches that are the physical 

underpinning of the electronic commerce conducted on the Internet. 

They are hotels in the sense that they house equipment belonging to 

many different telecommunication companies. John Holusha, “Home 

for Machinery of the Internet,” The New York Times, August 16, 2000. 

The demand for hotel rooms is adversely affected by a 

slowing economy. Businesses have cut travel budgets 

and consumers have scaled back leisure plans, contributing to a decline in occupancy levels and revenue per 

available hotel room in most markets throughout 2001. 

Currently, upscale and luxury hotels are suffering more 

than limited service hotels. According to Smith Travel 

Research, limited service hotels, particularly budget 

hotels, represent the only lodging sector with higher 

occupancy levels through the first four months of 2001 

when compared to the same four month period in 2000. 

The supply of new hotel properties is lower than in the 

past, as financing for new hotel construction for the 

most part has been curtailed in recent years. However, 

limited service hotels are reported to be overbuilt in a 

number of markets in the Southeast and Southwest.14 

Annualized expenditures for new construction of all 

hotel types were $12.1 billion as of May 2001, falling to 

the lowest level since 1996.15 

The multifamily sector has experienced robust construction and equally strong absorption in recent years 

as new household formation, the driver for apartment 

demand, continues to increase. Annualized construction 

expenditures of $25.5 billion as of May 2001 were at the 

highest level since 1989.16 Despite the relative equilibrium between supply and demand for apartments in most 

markets, vacancy increases and rent declines are occurring in some locations. This decline has been most acute 

14 Kozel, Peter P. June 18, 2001. “U.S. Commercial Property Markets 

in a Slowing Economy: Implications for CMBS Credit Performance.” 

Standard and Poor’s Structured Finance. 

15 Data provided to Haver Analytics by U.S. Bureau of the Census. 

16 Ibid. 

New York Regional Outlook 15 Third Quarter 2001 
In Focus This Quarter
 

in the more concentrated high-tech markets, such as San 

Francisco, where reported average rental rates dropped 

8.1 percent between the end of March and the end of 

May 2001.17 

Despite a slowing economy, the retail sector has performed reasonably well, as consumers maintain relatively high spending levels. Many of the store closings 

in 2000 and 2001 have been absorbed by new tenants as 

landlords have acted quickly to avoid letting vacant 

space linger. Meanwhile, robust construction has continued, with total expenditures in 2000 of $52.6 billion 

and an annualized level of $52.2 billion as of May 2001. 

Each of these two years’ expenditure levels exceeds all 

previous years’ retail construction amounts since data 

were first gathered in 1964.18 

Taking note of the robust level of retail construction 

activity, a recent Moody’s article finds that the nation’s 

mall retail and “power center”19 space grew by 3.3 percent in 2000, while population growth expanded by 

only 1.2 percent. The article raises concerns for potential excess supply of retail space resulting from a construction rate that is almost triple the population 

growth rate.20 A negative consequence of the high 

rate of retail construction is found in a recent 

Standard and Poor’s study. This article points out that 

most of the retail mortgages (held in commercial 

mortgage-backed pools of assets) that defaulted during 2000 did so because of competition from new 

retail establishments.21 

Implications for Insured Institutions 

Office vacancy rates during the first half of 2001 

increased at an unprecedented rate. What does this 

mean for insured institutions? On the one hand, at mid2001 vacancy rates remained below their 20-year average. Yet the speed of the increase and the number of 

17 Associated Press, News in Brief from the San Francisco Bay Area,
 

June 13, 2001.
 

18 Data provided to Haver Analytics by U.S. Bureau of the Census.
 

19 According to the Urban Land Institute, a power center is a community shopping center in which at least 75 to 90 percent of the selling
 

space is devoted to multiple off-price anchors and a discount department store or warehouse club. It is the “power” of its anchors that
 

gives the center its name. 


20 Sally Gordon, op. cit.
 

21 Kozel, Peter P. April 20, 2001. “Outlook for Property Markets in a
 

Slower-Growing Economy and the Implications for CMBS Credit
 

Performance.” Standard & Poor’s Structured Finance.
 

metropolitan areas that have experienced softening 

make this a trend that deserves the close attention of 

insured institutions, especially those with significant 

concentrations in commercial real estate and construction lending. 

Financial indicators of real estate credit quality in banking remain favorable, with losses and delinquencies 

trending up modestly from minimal levels. Noncurrent 

construction and development (C&D) loans as of March 

31, 2001, remain at a relatively low .92 percent of all 

outstanding C&D loans. (Noncurrent C&D loans as a 

percentage of all C&D loans averaged .93 percent for 

the past five year-ends.) Similarly, noncurrent CRE 

loans22 as of March 31, 2001, were .82 percent of all 

CRE loans, a level consistent with the average for this 

ratio of 1.08 percent for the past five year-ends. Chargeoff ratios at March 31, 2001, for both C&D and CRE 

loans were each at .02 percent and remain below the 

averages of .05 percent for each for the past five yearends. These favorable numbers are the legacy of a 

strong economic expansion, whereas current economic 

events suggest the potential for future deterioration in 

credit quality. 

The outlook for commercial real estate credit quality 

depends on the depth and duration of the current economic slowdown and on the risk management practices 

of each institution. In this regard, as signs of increasing 

risk materialize in conjunction with a declining economy, lenders appear to be managing risks prudently and 

avoiding speculative lending.23 Anecdotal information 

suggests that borrowers are pressed to obtain higher 

prelease commitment levels in order to gain loan 

approvals. In addition, lenders are requiring more upfront equity.24,25 

The importance of risk management practices is magnified by the heightened lending concentrations currently prevailing at some banks. Institutions with 

elevated concentrations in CRE and C&D lending have 

been more likely to experience significant problems 

during times of economic stress (for further details, 

22 CRE loans are nonfarm, nonresidential loans secured by real estate.
 23 Speculative construction lending is defined as a loan not accompanied by a meaningful presale, prelease, or take-out commitment. 


24 “Capital Is Still Plentiful for Right Projects.” Midwest Real Estate
 

News. July 2001. Vol. 17, No. 7. 
 25 Further information on bank underwriting practices can be found in
 

Federal Deposit Insurance Corporation, Division of Research and
 

Statistics, Report on Underwriting Practices, http://www.fdic.gov/
 

bank/analytical/report/index.html.
 

New York Regional Outlook 16 Third Quarter 2001 
In Focus This Quarter
 

see History of the Eighties26). As shown in Chart 5, the 

percentage of insured institutions with commercial real 

estate loan concentrations between 200 and 400 percent of capital is higher now than it was in the late 

1980s. However, there are relatively fewer institutions 

at the highest concentration level, in excess of 500 

percent of capital. In fact, fewer than 1 percent of 

insured institutions are at this level. A similar story 

holds true for construction loans, as the increasing 

concentrations are in the range of 100 to 300 percent of 

capital (see Chart 6). 

There are a number of issues for construction lenders 

and commercial real estate lenders to consider going 

forward. Because uncovered loans (C&D loans made 

without assurances of a firm take-out commitment) 

tend to be higher-risk, an important part of managing 

the risk in construction lending has traditionally been 

the lender’s ability to obtain a take-out commitment. 

Sources of take-outs for C&D loans include other 

insured institutions, pension funds, foreign investors, 

and life insurance companies, along with public-market 

real estate investment trusts (REITs) and conventional 

mortgage-backed securities (CMBSs). Anecdotal 

reports indicate that shifts in market sentiment in 

recent months have resulted in lowered investments in 

REITs and consequently less available capital for 

REITs to purchase real estate.27 Insured institutions 

CHART 5 

Concentrations of Commercial Real Estate
 

Loans between 200 and 400 Percent of
 

Capital Are Higher Now than in the Late 1980s
 

0 

2 

4 

6 

8 

10 

12 

14 

16 

18 

20

Percentage of Insured Institutions

FDIC-insured institutions 

with commercial real estate 

loans-to-equity capital 

greater than: 

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

300 percent 

400 percent 

500 percent 

200 percent 

Sources: Bank Call Reports, Thrift Financial Reports (Research Information 

System, FDIC) 

26 Federal Deposit Insurance Corporation. History of the Eighties— 

Lessons for the Future, Vol. 1: An Examination of the Banking Crises 

of the 1980s and Early 1990s, Chapters 9 and 10. 1997. Washington, 

DC: FDIC. http://www.fdic.gov/bank/historical/history/index.html. 27 Smith, Ray A. August 1, 2001. “Property Held by Public Firms 

Drops.” The Wall Street Journal. 

CHART 6 

Concentrations of Construction Loans 

Have Moved Higher in Recent Years 

Sources: Bank Call Reports, Thrift Financial Reports (Research Information 

System, FDIC) Percentage of Insured Institutions 

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

FDIC-insured institutions with real 

estate construction loans-to-equity 

capital greater than: 300 percent 

200 percent 

400 percent 

100 percent 

0 

2 

4 

6 

8 

10 

12 

14 

may face increased challenges to convert construction 

and development loans into permanent loans should the 

reported REIT situation become a trend and other 

sources of permanent capital become less available to 

purchase C&D loans. 

Monitoring economic trends in general, and local real 

estate trends in particular, becomes even more important during a time of rapid change in market conditions. For example, reliance on appraisals based on 

outdated or top-of-market assumptions can result in a 

divergence between expected and realized collateral 

values or cash flows. Similarly, while preleasing commitments offer significant risk-reduction benefits to 

lenders, during a time of weakening economic conditions there is at least the possibility that a prospective 

tenant will be unable to honor a lease obligation, as 

has been the case with some firms in the high-tech 

sector in recent months. 

Conclusion 

Office market trends cannot, of course, be considered in 

isolation. The recent softening in office markets is a 

symptom of a slowing economy coupled with a rapid 

decline in the fortunes of some high-tech firms. Considered in this broader context, the challenge for insured 

institutions is simply to ensure that risk-management 

strategies are in place that will succeed under a more 

challenging economic environment. 

Thomas A. Murray 

Senior Financial Analyst 

New York Regional Outlook 17 Third Quarter 2001 
In Focus This Quarter
 

TABLE 2 

Office Market and Banking Data on 53 Metropolitan Areas 

MEDIAN HIGH-TECH OFFICE 

2ND BASIS C&D AS AS SPACE 

QUARTER POINT COUNT OF PERCENTAGE PERCENTAGE UNDER 

2001 INCREASE COMMUNITY OF TIER 1 OF TOTAL CONST/ 

METROPOLITAN OFFICE FROM YEAR BANKS WITH CAPITAL AT MARKET STOCK AT 

STATISTICAL AREA VACANCY END 2000 C&D LOANS 3/31/2001 

(%) 

EMPLOYMENT 

(%) 

12/31/2000 

(%) 

ALBUQUERQUE 11.6 –110 9 61.0 6.8 2.0 

ATLANTA 9.8 170 76 172.2 3.8 6.1 

AUSTIN 11.8 680 20 53.4 10.1 9.6 

BALTIMORE 8.9 60 60 22.8 3.6 6.3 

BOSTON 8.7 480 100 24.1 8.2 5.6 

CHARLOTTE 9.0 40 20 48.5 1.7 8.9 

CHICAGO 8.9 130 225 33.5 4.5 4.9 

CINCINNATI 10.1 100 58 32.6 3.1 6.0 

CLEVELAND 13.6 40 16 34.8 3.0 0.8 

COLUMBUS, OH 16.9 350 20 22.4 3.1 5.1 

DALLAS 16.4 110 75 84.5 6.5 3.9 

DENVER 12.7 370 45 70.4 5.2 4.9 

DETROIT 12.0 160 28 35.2 3.1 2.8 

FT. LAUDERDALE 12.8 310 13 19.1 2.7 10.2 

FT. WORTH 16.4 130 36 71.8 3.4 0.7 

FRESNO 14.4 20 5 196.0 0.9 0.8 

HARTFORD 14.0 150 11 25.2 3.5 0.0 

HONOLULU 12.6 –190 3 11.4 0.9 0.0 

HOUSTON 13.6 60 48 65.8 3.1 0.8 

INDIANAPOLIS 15.8 120 21 29.6 3.3 1.4 

JACKSONVILLE 11.7 –20 11 65.2 1.8 3.4 

KANSAS CITY 15.9 490 86 70.8 2.7 1.3 

LAS VEGAS 14.5 290 19 117.7 1.5 7.3 

LONG ISLAND 10.9 190 6 19.1 5.3 1.8 

LOS ANGELES 14.1 150 62 35.4 3.7 2.0 

MIAMI 10.5 310 26 28.1 1.8 9.2 

MINNEAPOLIS 10.8 20 119 44.0 6.0 5.7 

NASHVILLE 12.8 230 20 78.4 1.2 2.0 

NEW YORK 5.1 230 34 10.5 2.4 1.4 

NORTHERN NEW JERSEY 10.9 360 66 15.0 5.6 6.9 

OAKLAND 9.3 630 12 120.0 6.5 7.9 

OKLAHOMA CITY 20.3 20 44 57.8 2.6 0.5 

ORANGE COUNTY 14.7 330 14 34.5 6.4 3.9 

ORLANDO 13.1 110 23 72.1 2.3 8.1 

PHILADELPHIA 10.7 80 68 22.1 4.5 3.2 

PHOENIX 16.9 440 27 114.2 4.7 6.5 

PORTLAND, OR 9.9 280 14 118.8 6.6 6.7 

RIVERSIDE 14.4 –100 18 143.5 1.6 0.3 

SACRAMENTO 6.6 70 11 106.9 3.9 5.6 

SALT LAKE CITY 15.3 280 14 111.7 4.5 4.1 

New York Regional Outlook 18 Third Quarter 2001 
In Focus This Quarter
 

TABLE 2 (CONTINUED) 

Office Market and Banking Data on 53 Metropolitan Areas 

MEDIAN HIGH-TECH OFFICE 

2ND BASIS C&D AS AS SPACE 

QUARTER POINT COUNT OF PERCENTAGE PERCENTAGE UNDER 

2001 INCREASE COMMUNITY OF TIER 1 OF TOTAL CONST/ 

METROPOLITAN OFFICE FROM YEAR­ BANKS WITH CAPITAL AT MARKET STOCK AT 

STATISTICAL AREA VACANCY END 2000 C&D LOANS 3/31/2001 EMPLOYMENT 12/31/2000 

(%) (%) (%) 

SAN DIEGO 9.7 350 21 57.5 6.6 4.9 

SAN FRANCISCO 10.3 620 21 69.0 8.3 9.7 

SAN JOSE 8.1 680 5 174.5 27.4 7.5 

SEATTLE 9.4 500 30 77.1 6.6 9.0 

ST. LOUIS 10.1 –80 80 40.4 2.6 4.8 

STAMFORD 11.2 290 10 43.5 5.6 2.6 

TAMPA 14.8 70 33 40.0 4.2 2.7 

TUCSON 8.8 100 3 178.4 4.4 4.8 

VENTURA 14.2 270 8 49.7 5.4 14.2 

WASHINGTON, DC 7.8 390 61 51.1 7.8 6.3 

WILMINGTON, DE 10.4 420 12 28.4 3.8 1.6 

W. PALM BEACH 12.2 160 18 37.2 2.3 4.8 

WESTCHESTER 12.5 120 4 19.5 12.3 2.1 

NATION 10.8 250 (1) 3,801 (1) 40.1 (2) 4.8 (2) 4.5 

Notes: Only community banks with construction loans are included in this table. Community banks are institutions
 

with assets less than $1 billion. Noncommunity banks are excluded because their lending activities are likely to
 

span a larger area than the MSA in which they are headquartered.
 

Sources: Torto Wheaton Research; Bank and Thrift Call Reports, FDIC Research Information System data;
 

Economy.com, Inc.
 

1. Only community banks with construction loans and located within a MSA are included in these figures. 

2. Percentages shown are the averages for the 53 metropolitan areas. 

New York Regional Outlook 19 Third Quarter 2001 
✁
 

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