An Update on Emerging Issues in Banking 

Economic Conditions and Emerging Risks in Banking

April 11, 2002 

Summary

Monitoring developments in the economy, the financial markets, and the 

banking industry is an essential part of risk management for the FDIC. This 

issue of FYI is based on a briefing delivered by staff to the FDIC Board of 

Directors on April 9, 2002. 

The report describes recent signs of a consumer-led recovery in the U.S. 

economy that may have begun in the first quarter. Signs of recovery include: 

positive job growth, higher factory orders, rising consumer confidence, and 

an uptick in housing starts. However, there remains a list of negative factors 

that could dampen the economic recovery or even lead to another recession. 

Warning signs currently include: weakness in corporate profits, declining 

business investment, overcapacity in key industry sectors, rising commercial 

real estate vacancies, and high debt loads for consumers and businesses. 

The key to a robust economic recovery in 2002 would appear to be how 

households and businesses overcome these remaining difficulties (Chart 1). 

Bank financial performance has remained generally strong during the 

recession despite higher losses on commercial and credit card loans. Going 

forward, the biggest single near-term risk to insured institutions appears to 

be subprime consumer lending. Longer-term risks involve the effects of a 

recent slowdown of formerly fast-growing metropolitan areas and interestrate sensitivity at specialized residential mortgage lenders. 

D

U.S. Economy Shows Signs of Recovery

The U.S. economy shows signs of emerging from the recession that began in 

April 2001. An aggressive program of monetary and fiscal stimulus during 

2001 has helped to keep consumer spending strong despite the uncertainties 

posed by the September terrorist attacks and continued bad news from the 

U.S. corporate sector. Recent economic data—including job growth, 

manufacturing activity, housing starts, and consumer confidence—have been 

stronger than analysts' expectations, raising hopes for a synchronized global 

economic recovery led by the U.S (Chart 2). Fifty leading economists surveyed 

by the Blue Chip Economic Indicators have raised their consensus forecast for 

2002 U.S. economic growth to 2.6 percent as of April 10, up from just 1.0 

percent at the beginning of the year. 

D

Obstacles Remain that Could Slow or Stop the Recovery

Amid the recent good news, however, there remain a number of factors that 
call into question whether the U.S. economy will be able to generate a robust 

recovery in 2002. Much of the good news during the last six months has been 

related to consumer spending on housing and durable goods, such as autos. 

Personal consumption expenditures grew at an inflation-adjusted annual rate 

of over six percent in the fourth quarter of last year. However, this boom in 

consumer spending has been fueled largely by a combination of events—

including the 2001 tax cut, low energy prices, and the opportunity to refinance 

mortgage debt at lower rates—that may not recur in the near term. In addition, 

consumers have incurred large amounts of new debt to maintain their 

spending. According to the Federal Reserve Flow of Funds data, the volume of 

mortgage and consumer debt outstanding rose by almost $1.2 trillion between 

year-end 1999 and 2001. 

While price cutting by retailers apparently boosted sales in the fourth quarter of 

2001, it did little to improve corporate earnings. Net income from continuing 

operations for the S&P 500 fell in the fourth quarter by 24 percent from a year 

ago. U.S. industries have slashed their inventories, setting the stage for higher 

orders later in 2002. However, industrial overcapacity and high corporate debt 

loads could discourage the type of large-scale recovery in investment 

spending that is characteristic of a strong economic recovery. U.S. factories, 

utilities and mines operated at less than 75 percent of capacity in the fourth 

quarter, the lowest ratio since 1983. Business fixed, nonresidential investment 

fell at an annualized rate of 13.4 percent during the fourth quarter. 

There is concern that these obstacles to recovery could result in either: 1) a 

slow-growth recovery, or 2) a "double-dip" recession, either of which could 

result in a continuation of rising credit losses and slow loan growth that would 

impair the earnings of FDIC-insured institutions. Key ingredients of most 

plausible economic recovery scenarios would appear to include a recovery in 

corporate profits and business investment that would, in turn, help to support 

equity prices, job growth, and increases in consumer spending. 

Banking Industry Performance Generally Solid Despite Rising Credit 

Losses

Bank earnings have continued to be solid in the recession. Commercial banks 

earned a record $74.3 billion in 2001, helped by securities gains and stable-torising interest margins in a falling interest rate environment. Loss provisions 

rose, particularly for large-bank C&I loans, helping to reduce return on assets 

for commercial banks to a still-healthy 1.16 percent. Credit card loan losses 

also rose in tandem with a record 1.45 million personal bankruptcy filings. 

To the extent that credit problems tend to lag the business cycle, bank credit 

losses may continue to rise for a number of quarters in the future. However, at 

this time the industry overall appears to be well-positioned to weather the 

storm. Unlike the last recession, only very small number of institutions now 

report low ratios of capital to assets or high levels of nonperforming loans to 

total loans. For example, as of year-end 2001, only 55 FDIC-insured 

institutions reported equity capital and reserves less than six percent of their 

total assets, compared to 1,664 institutions at the end of 1990. 

The FDIC provides a comprehensive report on bank and thrift financial 

performance in the Quarterly Banking Profile; the most recent issue covers the 

fourth quarter of 2001. 
Regional Economic Weaknesses Spread During 2001

Weaknesses in bank and thrift credit quality during 2001 were generally 

concentrated in states along the upper and lower Mississippi Valley that rely 

heavily on manufacturing and that have experienced the longest period of 

economic weakness. However, during the second half of 2001 the economic 

slowdown began to spread to metropolitan areas outside the central U.S. that 

have higher employment concentrations in information technology and 

financial services. Commercial real estate markets in many of these 

metropolitan areas deteriorated rapidly during 2001. Bank credit exposures 

tend to be high in these formerly fast-growing metropolitan areas, which may 

well set the stage for higher credit losses in 2002. 

Risks to FDIC-Insured Institutions in the Current Environment

The single most likely source of significant insurance losses related to the 

failure of FDIC-insured institutions in the near-term is subprime consumer 

lending. Some 160 FDIC-insured institutions with 6.3 percent of industry 

assets are currently identified by the FDIC as having subprime consumer or 

mortgage loans greater than 25 percent of Tier 1 capital. This group has 

contributed disproportionately to recent bank failures and additions to the FDIC 

Problem Bank List. The problems of subprime lenders have not been simply 

the result of loan losses that are much higher than those experienced with 

prime consumer loans. More troubling has been the tendency for the credit 

models used by subprime lenders to underpredict actual losses, as noted by 

FDIC examiners and other regulatory sources in recent months.1

Two issues represent intermediate-term risks that could materially affect 

industry earnings and insurance losses over the next one to three years. Early 

analysis of these intermediate term issues is useful in evaluating their potential 

for causing insurance losses and developing regulatory policies to reduce 

losses. 

The first intermediate-term risk involves metropolitan areas that have exhibited 

both a significant slowdown in economic activity and where banks tend to have 

high concentrations of traditionally higher-risk commercial and industrial (C&I), 

commercial real estate (CRE), and construction loans (see Chart 3). 

Concentrations in these loan types increased industry-wide during the late 

1990s, when rapid economic activity in a number of fast-growing metro areas 

included large volumes of commercial real estate and residential construction. 

Why is this a concern? History shows that institutions with high concentrations 

of C&I, CRE, and construction loans have tended to fail at a significantly 

higher rate than other insured institutions.2 These loan types tend to represent 

a higher degree of credit risk that can lead to higher losses when economic 

conditions do not meet lenders' expectations. 

Thus far, the slowdown has not had a material effect on bank earnings in 

these markets. With the benefit of high capital levels and generally modest 

levels of past due loans at present, there appears to be time for lenders to 

adjust strategies to new economic conditions, as needed. 

D
The second intermediate-term risk involves specialized residential mortgage 

lenders that have developed concentrations of long-term assets as a result of 

two recent waves of mortgage origination and refinancing activity that peaked 

in 1998 and 2001, respectively. These concentrations developed largely as a 

result of a strong preference on the part of households for fixed-rate 

mortgages. Institutions with high concentrations of these loans that have not 

pursued effective hedging strategies may be vulnerable to shrinking interest 

margins in a rising interest rate environment. While large residential lenders 

are more likely to manage interest rate risk through the use of sophisticated 

hedging techniques, a significant percentage of mortgage lenders do not. 

Smaller institutions evidence the greatest increase in long-term asset 

concentrations and appear somewhat more vulnerable to rising interest rates. 

1 For example, see Board of Governors of the Federal Reserve System, Senior Loan Officer Survey on Bank 

Lending Practices, 

January 2002, Table 1: Summary of responses from U.S. banks, pp. 13-16. 

http://www.federalreserve.gov/boarddocs/SnLoanSurvey/200202/default.htm

2 See "Economic Conditions and Emerging Risks in Banking," FDIC Regional Outlook, Second Quarter 2001, 

p. 6.

http://www.fdic.gov/bank/analytical/regional/ro20012q/na/index.html

Last Updated 04/11/2002 
Chart 1: Recoveries in corporate profits and business investment will be essential elements of the 

next U.S. economic expansion.

Chart 1A:

Year Quarter

Year-over-Year Change in Quarterly Net Income 

from Continuing Operations for All S&P 500 Firms

1996 4 14.04%

1997 1 15.13%

1997 2 10.74%

1997 3 12.89%

1997 4 7.94%

1998 1 3.63%

1998 2 3.49%

1998 3 -1.78%

1998 4 4.82%

1999 1 10.61%

1999 2 16.18%

1999 3 21.34%

1999 4 22.34%

2000 1 20.39%

2000 2 19.76%

2000 3 17.50%

2000 4 5.22%

2001 1 -7.37%

2001 2 -19.18%

2001 3 -21.56%

2001 4 -24.24%

Source: Bloomberg

Chart 1B:

Year Quarter

Year-over-Year Change in Business Investment in 

Equipment and Software, in Chained 1996 Dollars

1996 4 10.37%

1997 1 9.46%

1997 2 8.92%

1997 3 10.16%
1997 4 9.69%

1998 1 12.23%

1998 2 12.23%

1998 3 9.49%

1998 4 11.70%

1999 1 8.86%

1999 2 7.57%

1999 3 8.44%

1999 4 6.40%

2000 1 8.03%

2000 2 8.62%

2000 3 7.41%

2000 4 6.28%

2001 1 3.38%

2001 2 -1.33%

2001 3 -3.38%

2001 4 -6.36%

Source: Bureau of Economic Analysis
Chart 2: A number of signs point to economic recovery in the U.S.

Chart 2A: Employment Growth

Year Month Annualized Growth in Payroll Employment

2001 January 0.6%

2001 February 1.5%

2001 March 0.5%

2001 April -1.5%

2001 May 0.4%

2001 June -0.9%

2001 July 0.2%

2001 August -0.5%

2001 September -1.5%

2001 October -4.1%

2001 November -3.2%

2001 December -1.0%

2002 January -1.2%

2002 February 0.6%

Source: Bureau of Labor Statistics

Chart 2B: Consumer Confidence

Year Month Consumer Confidence Index (1985=100)

2001 January 115.7

2001 February 109.2

2001 March 116.9

2001 April 109.9

2001 May 116.1

2001 June 118.9

2001 July 116.3

2001 August 114.0

2001 September 97.0

2001 October 85.3

2001 November 84.9
2001 December 94.6

2002 January 97.8

2002 February 94.1

2002 March 110

Source: The Conference Board

Chart 2C: Manufacturing 

Year Month PMI Index (50+ Shows Expansion)

2001 January 41.7

2001 February 42.0

2001 March 43.2

2001 April 43.2

2001 May 42.3

2001 June 44.3

2001 July 43.9

2001 August 47.9

2001 September 46.2

2001 October 39.5

2001 November 44.7

2001 December 48.1

2002 January 49.9

2002 February 54.7

Source: National Association of Purchasing Management

Chart 2D: Housing Starts 

Year Month Monthly Housing Starts, Annualized

2001 January 1,666 

2001 February 1,623 

2001 March 1,592 

2001 April 1,626 

2001 May 1,610 

2001 June 1,634 

2001 July 1,660 
2001 August 1,559 

2001 September 1,585 

2001 October 1,518 

2001 November 1,616 

2001 December 1,602 

2002 January 1,721 

2002 February 1,769 

Source: Bureau of the Census
Chart 3

High credit exposures and recent economic weakness could create challenges for lenders in 

certain metro areas

Metropolitan Area

High-Risk Loans* as a 

Percent of Tier 1 Capital 

(Median Value for 

Institutions 

Headquartered in 

Metrolpolitan Area), 

December 2001

Change In Metro 

Area Employment 

Growth Rate (from 

1992-2000 Average 

to 4th Quarter 

2001)

San Jose CA PMSA 6.14 -10.17%

Austin-San Marcos 

TX 2.99 -7.72%

Cedar Rapids IA 2.01 -7.27%

Phoenix-Mesa AZ 6.17 -6.58%

Orlando FL 4.88 -6.43%

Denver CO PMSA 5.47 -6.29%

Rockford IL 2.91 -6.28%

Seattle-BellevueEverett WA PMSA 5.55 -6.25%

Las Vegas NV-AZ 6.49 -6.15%

Atlanta GA 5.93 -5.89%

Portland-Vancouver 

OR-WA PMSA 7.13 -5.86%

Dallas/Ft. Worth 

(combined) 4.80 -5.06%

Grnsbro--WnstnSalem--High Pt NC 3.60 -5.16%

Salt Lake City-Ogden 

UT 5.36 -5.15%

Lawrence MA-NH 

PMSA 1.60 -5.08%

Charlotte-GastoniaRock Hill NC-SC 3.88 -4.70%

San 

Francisco/Oakland 6.36 -4.54%

New York NY PMSA 3.62 -4.45%

Boston MA-NH 

PMSA 2.01 -4.33%

Lexington KY 4.21 -4.20%
Louisville KY-IN 3.87 -4.12%

Minneapolis-St Paul 

MN-WI 4.28 -3.92%

Tampa-St PeteClearwater FL 5.36 -3.91%

Detroit MI 4.91 -3.91%

Decatur IL 1.46 -3.91%

Columbus OH 2.27 -3.87%

Youngstown-Warren 

OH 2.33 -3.85%

Ft Wayne IN 2.20 -3.83%

Duluth-Superior MNWI 3.77 -3.83%

Parkersburg-Marietta 

WV-OH 2.13 -3.81%

Wilmington-Nwrk 

DE-MD PMSA 2.45 -3.76%

Gr RapidsMuskegon-Holland 

MI 7.27 -3.72%

Stamford-Norwalk 

CT PMSA 4.17 -3.71%

Chicago IL PMSA 4.03 -3.60%

Indianapolis IN 3.26 -3.40%

St Cloud MN 2.69 -3.35%

Birmingham AL 4.36 -3.33%

W Palm Bch-Boca 

Raton FL 4.31 -3.22%

Appleton-OshkoshNeenah WI 3.05 -3.20%

Albuquerque NM 5.10 -3.10%

Springfield MO 3.96 -3.08%

Ft Smith AR-OK 3.64 -3.07%

Clvlnd-Lorain-Elyria 

OH PMSA 1.02 -3.07%

Oklahoma City OK 3.93 -3.06%

U.S. 3.37 -3.02%

MilwaukeeWaukesha WI PMSA 3.76 -3.00%
Cincinnati OH-KY-IN 

PMSA 2.26 -2.98%

Gary IN PMSA 1.79 -2.97%

Little Rock-N Little 

Rock AR 4.78 -2.96%

Lincoln NE 5.13 -2.92%

St Louis MO-IL 3.22 -2.91%

Dayton-Springfield 

OH 2.28 -2.89%

Memphis TN-AR-MS 3.95 -2.86%

GreenvilleSpartanburgAnderson SC 4.28 -2.85%

Nashville TN 4.22 -2.81%

Davenport-MolineRock Isl IA-IL 2.10 -2.80%

Ft Lauderdale FL 

PMSA 4.48 -2.72%

Longview-Marshall 

TX 2.30 -2.72%

RichmondPetersburg VA 3.94 -2.70%

Washington DC-MDVA-WV PMSA 3.38 -2.65%

Jacksonville FL 4.12 -2.60%

Peoria-Pekin IL 1.68 -2.58%

Tulsa OK 4.18 -2.53%

Des Moines IA 3.73 -2.53%

McAllen-EdinburgMission TX 5.07 -2.49%

Kansas City MO-KS 3.26 -2.49%

Houston TX PMSA 5.36 -2.49%

Wausau WI 4.16 -2.46%

Newark NJ PMSA 1.83 -2.40%

San Antonio TX 5.67 -2.39%

Bergen-Passaic NJ 

PMSA 2.30 -2.38%

Providence-Fall 

River-Warwick RI 2.31 -2.32%
AllentownBethlehem-Easton 

PA-NJ 1.36 -2.30%

Chattanooga TN-GA 4.45 -2.29%

EvansvilleHenderson IN-KY 1.96 -2.28%

Ann Arbor MI PMSA 4.96 -2.26%

Norfolk-Virginia BchNewport News VANC 4.20 -2.24%

Omaha NE-IA 3.11 -2.14%

Hartford CT 1.77 -2.14%

Fargo-Moorhead NDMN 3.32 -1.99%

Baltimore MD PMSA 1.47 -1.99%

Bloomington-Normal 

IL 2.17 -1.99%

Raleigh-DurhamChapel Hill NC 4.27 -1.92%

Worcester MA-CT 

PMSA 1.30 -1.84%

Harrisburg-LebanonCarlisle PA 2.05 -1.79%

Wichita KS 2.71 -1.76%

Rochester NY 3.19 -1.73%

Pittsburgh PA 1.12 -1.73%

Philadelphia PA 2.27 -1.70%

Madison WI 4.70 -1.60%

Miami FL PMSA 4.66 -1.59%

Scranton--WilkesBarre--Hazelton PA 2.50 -1.58%

Huntington-Ashland 

WV-KY-OH 1.76 -1.58%

San Diego CA 7.19 -1.58%

Orange County CA 

PMSA 5.63 -1.42%

Sioux City IA-NE 3.35 -1.38%

LA-Long Beach CA 

PMSA 6.53 -1.38%
Springfield MA 2.05 -1.36%

Middlesex-SomersetHunterdon NJ PMSA 

(Thous 2.28 -1.36%

Sacramento CA 

PMSA 6.49 -1.31%

Jhnsn Cty-KngsprtBristol TN-VA (Thous 4.06 -1.31%

Sarasota-Bradenton 

FL 5.32 -1.29%

New Orleans LA 2.68 -1.17%

Jersey City NJ 

PMSA 0.65 -1.16%

Albany-SchenectadyTroy NY 2.36 -1.12%

Monmouth-Ocean NJ 

PMSA 2.93 -0.96%

Syracuse NY 1.52 -0.92%

Springfield IL 1.95 -0.80%

FayettevilleSpringdale-Rogers 

AR 4.72 -0.78%

Lubbock TX 4.51 -0.71%

Macon GA 6.34 -0.66%

La Crosse WI-MN 2.97 -0.65%

Lafayette LA 1.85 -0.59%

Champaign-Urbana 

IL 3.25 -0.25%

Knoxville TN 3.72 -0.16%

Riverside-S 

Bernardino CA 

PMSA 6.85 0.22%

Dallas/Ft. Worth 4.80 -5.06%

* High-risk loans include: commercial, construction and commercial real

estate.

Note: The universe excludes banks over $10 billion, credit card and other 

small specialty institutions.

Source: Bureau of Labor Statistics, Haver Analytics, Bank Call Reports; 

Thrift Financial Reports.