Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION FOURTH QUARTER 2000 

FDIC
 

San Francisco
 

Region
 

Division of
 

Insurance
 

Catherine I.
 

Phillips-Olsen,
 

Regional Manager
 

Phillip E. Vincent,
 

Regional Economist
 

Judy H. Plock,
 

Senior Financial
 

Analyst
 

Shayna M. Olesiuk,
 

Economic Analyst
 

Regional Perspectives 

◆ The rate of employment growth in the San Francisco Region continued to exceed the nation’s as of August 2000—The construction and services sectors led the Region’s job growth, while mining and manufacturing 

employment declined slightly. In the aggregate, the Region’s insured institutions 

reported healthy conditions as of June 30, 2000. Commercial real estate activity has 

increased rapidly in five of the Region’s metropolitan statistical areas (MSAs) 

recently. Should demand weaken, there is potential for overbuilding in these areas. 

Three of these MSAs are highly dependent on historically volatile high-tech manufacturing and services, while two have experienced rapid economic growth driven, 

in part, by the tourism sector. Community banks in these five MSAs may be particularly vulnerable to an economic downturn, given rapid loan growth and relatively high concentrations of commercial real estate and construction and 

development loans. See page 3. 

By the San Francisco Region Staff 

In Focus This Quarter 

◆ Emerging Risks in an Aging Economic Expansion—This article focuses 

on the potential risks of current economic conditions to insured depository institutions. Although the current conditions may appear to be ideal, some imbalances are 

emerging: rising energy prices, tight labor markets, a less robust stock market, a 

large trade deficit and strong U.S. dollar, rising household debt burdens, increased 

corporate leverage and rising potential default risk, and, in some metropolitan 

areas, overheated housing and commercial real estate markets. At the same time, 

aggregate risk within the banking industry appears to have risen, as evidenced by 

softening profitability, growing reliance on noncore funding, heightened levels of 

interest rate risk, and increasing concentrations in traditionally higher-risk loan 

categories. A confluence of these trends could heighten the vulnerability of some 

insured institutions. See page 12. 

By the Division of Insurance Staff 

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

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

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

geographic regions: 

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

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

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

Dallas Region (CO, NM, OK, TX) 

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

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

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

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

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

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

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

more information or to provide comments or suggestions about the San Francisco Region’s 

Regional Outlook, please call Catherine I. Phillips-Olsen at (415) 808-8158 or send an e-mail to 

cphillips-olsen@fdic.gov. 

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

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

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

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

the Federal Deposit Insurance Corporation. 

Chairman Donna Tanoue 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Writer/Editor Kim E. Lowry 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Richard A. Brown 

Ronald L. Spieker 

Publications Manager Teresa J. Franks 

REVISION: 

The article “Ranking Metropolitan Areas at Risk for Commercial Real Estate Overbuilding” in 

the Third Quarter 2000 issue of the Regional Outlook has been revised to correct a data-related 

error. The revision affects Chart 4 and Chart 11 of the report. Please see www.fdic.gov/bank/ 

analytical/regional/ro20003q/correction .html for revised versions of Chart 4 and Chart 11, along 

with an additional explanation of how the revision affects the article. 
Regional Perspectives
 

Regional Perspectives
 

•	 The rate of employment growth in the San Francisco Region continued to exceed the nation’s as of mid2000. The construction and services sectors led the Region’s job growth, while mining and manufacturing 

employment declined slightly. 

•	 Insured institutions in the Region reported overall healthy conditions through June 2000. However, commercial real estate loan concentrations and dependence on noncore funding sources are increasing and may 

contribute to heightened levels of credit and liquidity risks. 

•	 Community banks in five of the Region’s metropolitan statistical areas considered at risk for overbuilding 

could be vulnerable in the event of an economic downturn given their high concentrations of commercial 

real estate and construction and development loans and an increase in new bank formation. 

Region’s Economic and Banking Conditions 

The San Francisco Region’s Employment (1.14 percent), leverage capital (9.4 percent), and delinGrowth Rate Continues to Exceed the Nation’s quent loans to gross loans (1.2 percent).1 However, loan 

growth rates and changes in portfolio composition sugEconomic activity expanded strongly in the San Fran- gest that the Region’s banks are heightening their risk 

cisco Region during the late summer months. Job profiles. In particular, institutions are relying increasgrowth in the Region continued to outpace that of the ingly on noncore funding sources because brisk loan 

nation through midyear 2000. Nonfarm payroll demand continues to outpace core deposit formation. 

employment expanded 2.8 percent in the Region’s 11 In addition, as discussed later in this article, traditionstates from August 1999 through August 2000 com- ally higher-risk, higher-yielding commercial real estate 

pared with 1.9 percent for the United States. Arizona, (CRE) loans account for an increasing share of loans at 

Nevada, Idaho, and California reported the highest many of the Region’s institutions. 

levels of job growth, while Hawaii and Oregon somewhat lagged the nation. Continued high loan growth (18 percent median 

increase between June 1999 and June 2000) and 

Of the Region’s major business sectors, the construc- changes in portfolio composition have implications for 

tion and services sectors experienced the strongest overall credit quality. Although the Region’s median 

employment growth during this period (up 6.2 percent loan delinquency ratio of 1.2 percent experienced a 

and 3.9 percent, respectively); the weakest sectors were year-over-year decline and is below the national avermining and manufacturing, in which jobs declined age of 1.6 percent, loan growth may be masking poten­

(down 0.5 percent and 0.3 percent, respectively). The tial credit risk. Historically, as loan growth rates slow 

rise in oil prices has not yet led to an exploration and and portfolios mature, loan delinquency and charge-off 

production employment boom in states where oil and ratios increase. Already, commercial and industrial 

gas output is important, such as Alaska and Wyoming. (C&I) past-due loan levels are increasing at the 

Boeing’s layoffs have hurt manufacturing employment Region’s large institutions;2 past-due C&I loans now 

in Seattle and Southern California. exceed 2.1 percent of total C&I loans, up from 1.9 percent in June 1999 and 1.6 percent in June 1998. 

Banking Conditions Are Good, but Show Some 

Potential for Weakness 1 Delinquent loans include credits that are past due 30 days or more 

or are not accruing interest because of doubt as to full collectability of principal or interest. In the aggregate, the Region’s 846 insured institutions 2 A large institution is defined as an institution with over $1 billion continue to report healthy ratios for return on assets in total assets. 

San Francisco Regional Outlook 3	 Fourth Quarter 2000 
Regional Perspectives
 

Commercial Real Estate Markets at Risk 

for Overbuilding—Revisited 

CRE development has been brisk in several 

of the Region’s metropolitan statistical 

areas (MSAs), including the Las Vegas, 

Phoenix, Seattle, Salt Lake City, and Portland MSAs. As discussed in the Regional 

Outlook, third quarter 2000, these five markets are considered at risk for CRE overbuilding because of the rapid increase in 

recent construction activity.3 High rates of 

CRE construction may not be a problem if 

absorption of space continues. However, 

lenders should be mindful that continued building could 

make an area vulnerable if the national or local economy weakens, particularly given the historical lag time of 

construction cycles’ response to changes in demand. 

This article explores several trends in these MSAs in 

more depth, focusing on the following aspects of economic growth and trends in CRE lending that could 

adversely affect community banks in these MSAs:4 

•	 On the basis of real personal income trends, these 

MSAs appear to be experiencing economic “booms” 

that could make lenders vulnerable in the event of an 

ensuing “bust”; similar boom-bust patterns contributed to many bank failures in the 1980s. 

•	 The historically volatile high-tech industry, which 

depends on capital markets funding, is driving economic growth in three of the five MSAs. Significant 

tightening in the capital markets could dampen hightech CRE demand. This, in turn, could affect vacancy and rental rates in these markets and, as a result, 

CRE loan collateral values. 

3 Federal Deposit Insurance Corporation. “Ranking Metropolitan 

Areas at Risk for Commercial Real Estate Overbuilding.” Regional 

Outlook, third quarter 2000, pp. 11–18. These 5 MSAs were among 

13 identified nationwide. The selection and ranking of MSAs were 

based primarily on square footage built during 1999 as a percentage 

of preexisting stock in the office, industrial, retail, multifamily, and 

hotel property categories. 

4 For purposes of this article, a community bank is defined as a noncredit-card, commercial bank with less than $1 billion in assets, located in an MSA. Industrial loan corporations, special-purpose lenders 

prevalent in Salt Lake City, are excluded from this group. CRE loans 

are defined as the sum of multifamily; nonfarm, nonresidential; and 

construction and development loans. Because of Call Report data 

limitations, construction and development loans may include amounts 

used to finance residential building. 

•	 Community banks in these five MSAs are actively 

financing new and existing CRE development, 

despite the fact that capital markets scaled back CRE 

investments in 1998 and 1999. Moreover, median 

CRE-loan-to-total-asset ratios in each of the five 

MSAs exceed medians reported in other MSAs in 

the Region and across the nation.5 

•	 Unseasoned community banks, which represent a 

significant proportion of community banks in several of these MSAs, report equally high concentrations 

of CRE loans to total assets.6 The ability of these 

institutions to hold high levels of CRE loan concentrations and maintain asset quality has not been tested during an economic downturn. 

As noted in Regional Outlook, third quarter 2000, these 

analyses do not “predict an imminent rise in vacancies 

and losses in the at-risk markets. Instead,... the goal is 

to raise awareness about substantial growth in real 

estate development and the corresponding increases in 

risk exposure to financial institutions.”7 

Are These MSAs Experiencing 1980s-Style 

“Booms” in Real Income Growth? 

Over the past decade, robust economic conditions in 

some of the Region’s large MSAs have spurred higher 

employment, population, and personal income growth 

than the national averages. In several of these areas, real 

. . .estate values are appreciating and real estate construction activity is flourishing. While rapid growth certainly has positive economic implications, an FDIC 

study of banking problems in the 1980s and early 1990s 

suggests that such growth is often associated with speculative CRE development. In addition, bank financing 

of CRE overbuilding may lead to banking problems in 

later years.8 Specifically, History of the Eighties stated 

that “bank failures were generally associated with 

regional recessions that had been preceded by rapid 

5 For purposes of this article, CRE loans include amounts used to 

finance commercial-use properties, as well as to construct and develop real estate. Construction and development loans may include 

amounts used to finance residential real estate construction. 

6 For purposes of this article, unseasoned is defined as an institution 

that has been chartered less than eight years. 

7 Federal Deposit Insurance Corporation. Regional Outlook, pp. 

11–18. 

8 Federal Deposit Insurance Corporation. 1997. History of the 

Eighties—Lessons for the Future. Vol. I: An Examination of the Banking Crises of the 1980s and Early 1990s, pp. 13–33. 

San Francisco Regional Outlook 4	 Fourth Quarter 2000 
Regional Perspectives
 

regional expansions—that is, they were associated with 

‘boom-and-bust’ patterns of economic activity.”9 The 

study found that relatively high growth rates of real personal income across states over a five-year period, followed by subsequent declines (i.e., a state recession)—a 

“boom-and-bust” pattern—were correlated with an 

increase in bank failures in later years.10 

Real personal income growth trends in these five MSAs 

suggest that they may exhibit characteristics of “boom” 

markets. From 1993 through 1998, these five MSAs 

reported real personal income growth that has outpaced 

the nation’s (see Chart 1).11 During this period, Las 

Vegas and Phoenix, respectively, experienced the second and third highest real personal income growth rates 

of the nation’s 300 MSAs. Seattle, Salt Lake City, and 

Portland were among the top 30 MSAs ranked by 

growth in real personal income. 

High-Tech Growth Has Driven Economic 

Expansion in Three MSAs 

Growth in the high-tech sector has contributed significantly to the current expansion and CRE development 

in several of the Region’s MSAs. As discussed in the 

Regional Outlook, third quarter 2000, the high-tech 

sector has fueled job and income growth in the Region. 

Thirteen areas in the Region were identified in that article as “high-tech MSAs” in which the concentrations of 

high-tech employment and job growth in this sector 

exceed the national median. Overlap exists between the 

Region’s high-tech MSAs and areas considered at risk 

for CRE overbuilding: Phoenix, Portland, and Seattle 

were identified in both analyses. These MSAs have 

experienced both rapid rates of high-tech employment 

growth and significant levels of CRE development during the second half of the 1990s. 

Employment in the high-tech sector historically has 

been more volatile than in most other sectors of the 

economy. This sector traditionally has been more 

dependent on the availability of venture capital, which 

ties high tech more closely to the stock market. Therefore, while job growth in the Region’s high-tech MSAs 

has generally been quite strong in recent years, hightech employment could moderate or fall should a down9 Ibid., p. 19.
 

10 Ibid., pp. 19–21.
 

11 The latest data available for MSA personal income are for 1998. The
 

chart covers the period 1993 to 1998.
 

CHART 1 

San Francisco Region MSAs Report Higher Rates 

of Income Growth than the Nation 

Note: MSA = metropolitan statistical area 

Source: Haver Analytics Percent Growth in Real Income (1993 to 1998) 

Real personal income 

Real per capita 

personal income 

Salt 

Lake

 City 

Las 

Vegas 

Phoenix Seattle Portland Nation

0 

10 

20 

30 

40 

50 

60 

turn occur in this sector or the stock market suffer a prolonged decline. Adverse stock market movements could 

quickly amplify supply-demand imbalances and affect 

CRE lenders in high-tech MSAs, particularly those with 

high exposures to CRE loans. 

Economic Expansion Has Contributed to 

Elevated CRE Loan Concentrations and 

Increased Chartering Activity 

Increasingly, community banks have financed CRE 

growth in the Las Vegas, Phoenix, Seattle, Salt Lake 

City, and Portland MSAs. As of June 30, 2000, CRE 

loans typically exceeded one-third of total assets at 

community banks headquartered in these MSAs (see 

Chart 2, next page). These CRE loan concentration levels exceeded those observed in other MSAs nationally.12 

Furthermore, in the five highlighted MSAs, median 

concentration levels of traditionally higher-risk construction and development (C&D) loans were two to 

three times those reported in other MSAs nationally 

(see Chart 3, on page 7). 

In addition to creating increased C&D and CRE loan 

demand, robust economic growth has contributed to significant new bank formation over the past eight years. As 

of second quarter 2000, 24.1 percent of the San Francisco Region’s MSA-based community banks were unseasoned (in operation less than eight years). In contrast, 

over 58 percent of the community banks in these five 

MSAs are unseasoned (see Table 1, next page). New 

12 National comparisons are to median ratios for community banks 

located in MSAs outside of the five highlighted markets. 

San Francisco Regional Outlook 5 Fourth Quarter 2000 
Regional Perspectives
 

CHART 2 

Median CRE Concentrations at Community Banks* in the Five MSAs Exceed Medians in the Nation 

Other MSAs Nationally 

Salt Lake City MSA 

Phoenix MSA 

Seattle MSA 

Seasoned Banks 

Portland MSA Unseasoned Banks 

Las Vegas MSA 

0 10 20 30 40 50 

CRE Loans as a Percentage of Total Assets (median) 

CRE = commercial real estate; MSA = metropolitan statistical area 

* A community bank is defined as a nonspecialty bank located in an MSA with total assets of under $1 billion. Unseasoned banks are those open eight years or less.
 

The Salt Lake City MSA has only one unseasoned community bank.
 

Source: Bank Call Reports as of June 30, 2000
 

chartering activity has been particularly strong in the Las 

Vegas, Phoenix, Portland, and Seattle MSAs, where 

unseasoned community banks account for more than half 

of all community banks within each MSA. Unseasoned 

community banks in the five MSAs alone represent more 

than one-third of all unseasoned community banks in the 

San Francisco Region. In each of the five MSAs, unseasoned banks hold CRE and C&D concentrations significantly higher than those in other MSAs in the Region and 

across the nation (see Charts 2 and 3). 

TABLE 1 

Community banks within these five MSAs might be 

particularly vulnerable to an economic downturn 

because CRE loan concentration levels are high and 

new bank activity has been brisk. An FDIC study of 

bank failures during the late 1980s and early 1990s 

found that high CRE loan concentrations contributed to 

overall losses and bank failures.13 The same study also 

identified disproportionately higher failure rates among 

newly chartered institutions. Any slowing in the economy could negatively affect banks in the Phoenix, Seattle, and Portland MSAs, where employment growth is 

New Community Bank Chartering Activity Has Been Strong 

in the Region’s High-Growth MSAs over the Past Eight Years 

UNSEASONED 

UNSEASONED SEASONED BANKS TO 

LOCATION OF BANK HEADQUARTERS BANK COUNT BANK COUNT TOTAL BANKS 

LAS VEGAS MSA 12 3 80.0% 

PHOENIX MSA 15 8 65.2% 

PORTLAND MSA 9 5 64.3% 

SEATTLE MSA 15 12 55.6% 

SALT LAKE CITY MSA 1 9 10.0% 

TOTAL OF REGION’S FIVE HIGH-GROWTH MSAS 52 37 58.4% 

ALL MSA-BASED BANKS IN THE REGION 135 425 24.1% 

MSA = metropolitan statistical area 

Includes only commercial banks with less than $1 billion in total assets. Excludes any new openings for specialpurpose entities or those resulting from mergers, acquisitions, or intercompany reorganizations. Unseasoned banks 

are defined as institutions in operation eight years or less. 

Source: Bank Call Reports as of June 30, 2000 

13 Federal Deposit Insurance Corporation. 1997. History of the 

Eighties—Lessons for the Future, Vol. I: An Examination of the 

Banking Crises of the 1980s and Early 1990s. pp.31–33 and 137–162. 

San Francisco Regional Outlook 6 Fourth Quarter 2000 
Regional Perspectives
 

CHART 3 

Median C&D Loan Concentrations at Community Banks*
 

Headquartered in the Five MSAs Exceed Medians in the Nation
 

Other MSAs Nationally Seasoned Banks 

Portland MSA Unseasoned Banks 

Salt Lake City MSA
 

Seattle MSA
 

Phoenix MSA
 

Las Vegas MSA
 

0 10 20 30 40 

C&D Loans as a Percentage of Total Assets (median) 

C&D = construction and development; MSA = metropolitan statistical area 

* A community bank is defined as a nonspecialty bank located in an MSA, with total assets of under $1 billion. Unseasoned banks are those open eight years or less.
 

The Salt Lake City MSA has only one unseasoned community bank.
 

Source: Bank Call Reports as of June 30, 2000
 

tied closely to the high-tech industry. Sustained softening in the gaming sector in the Las Vegas MSA or overbuilding in preparation for the 2002 Winter Olympics in 

the Salt Lake City MSA could affect community banks’ 

asset quality in these areas. 

Rapid Economic Expansion Spurred New Bank 

Formation and High CRE Concentrations in the 

Las Vegas MSA 

Las Vegas ranked first among the Region’s large MSAs 

in real personal income growth from 1993 through 

1998, a result of strong in-migration and rapid job creation. Las Vegas also ranked among the top ten MSAs 

nationwide for construction activity in four property 

types: retail, office, industrial, and multifamily. Many 

banks in the Las Vegas MSA have increased their exposures to CRE loans above the national average since 

second quarter 1998. 

Although economic conditions in the Las Vegas MSA 

remained strong through second quarter 2000, overall 

employment growth moderated because fewer new jobs 

were created in the services sector. The gaming industry 

continues to be the primary source of growth, and the 

concentration of jobs and businesses tied to the success 

of this industry makes the MSA more vulnerable in the 

event of a national economic downturn or weakening in 

the tourism industry. In 1999, Las Vegas’s visitor volume increased significantly, and several new hotelcasinos opened.14 However, the Las Vegas Convention 

14 As stated by the Center for Business and Economic Research of the 

University of Nevada, Las Vegas. 

and Visitors Authority stated that a significant decline 

in new construction was expected in 2000. In addition, 

the University of Nevada Las Vegas Center for Business and Economic Research predicted that in 2000, 

growth in visitor volume might moderate from its high 

1999 rate.15 

Given the strong reliance of the Las Vegas MSA on the 

gaming sector, in terms of both employment and revenues, shifts in the sector’s health resonate throughout 

the local economy, particularly in the retail sector (see 

Chart 4, next page). Through year-end 1999, the retail 

market experienced high levels of new construction in 

relation to existing stock. The market appears to have 

generated sufficient demand for additional space, 

because vacancy rates have remained low compared 

with historical rates for the MSA and the nation. However, if visitor volumes moderate, retail absorption rates 

may decline. 

Unlike the retail sector, Las Vegas’s office and industrial markets experienced vacancy rates higher than the 

national average through year-end 1999. In the office 

market, new space completed and in progress continues 

to represent a large share of the MSA’s existing stock. 

Although Las Vegas has lower business costs than several other MSAs in the Region, which may be attractive 

to businesses looking to relocate, its office vacancy rate 

remains higher than the national average. Similarly, 

while the vacancy rate in Las Vegas’s industrial real 

15 Nearly 12,000 new hotel rooms were completed in the Las Vegas 

area in 1999. In comparison, only about 4,200 rooms are planned for 

construction and completion during 2000, according to the Las Vegas 

Convention and Visitors Authority. 

San Francisco Regional Outlook 7 Fourth Quarter 2000 
8 

Regional Perspectives
 

CHART 4 CHART 5 

Gaming Revenues Contribute to Retail
 

Sector Expansion in Las Vegas
 

Retail Starts 

Vacancy Rates in the Phoenix MSA 

Exceed Those of the Nation 

MSA = metropolitan statistical area 

Source: Torto Wheaton 

Office 

Dec-99 

Industrial 

Dec-99 

Retail 

Jun-00 

Multifamily 

Dec-99 

Phoenix Nation

Vacancy Rate (percent) 

0 

4 

8 

12 

16

New Completions (000 square feet) 

5,000 

4,000 

Gaming Revenues 

(left axis) 

(right axis) 

Billions of Dollars 6 

3,000 

2,000 4 

1,000 

2 0 

’94 ’95 ’96 ’97 ’98 ’99 

Sources: Las Vegas Convention and Visitors Authority—Clark County, NV, Gaming 

Revenues; F.W. Dodge—Las Vegas Retail Starts 

estate market has fallen as a result of steady absorption 

of new space, it remains above the national average. 

Rapid CRE development in the Las Vegas MSA has 

contributed to high and increasing levels of C&D and 

CRE loans at community banks. As of June 30, 2000, 

community banks in the MSA reported a median CRE 

loan-to-total-asset ratio of 38.6 percent, up from 32.3 

percent one year earlier. As shown in Chart 2, this CRE 

concentration level is well above that in other MSAs 

nationally. Furthermore, the median ratio of C&D loans 

to total assets is also relatively high at 11.5 percent, up 

from 10.8 percent one year ago. Within the Las Vegas 

MSA, unseasoned banks comprise 80 percent of all 

community banks and hold nearly twice the C&D exposure of seasoned banks. The risk posed by such high 

concentrations of C&D loans is particularly evident 

when measured in relation to Tier 1 capital. Aggregate 

C&D levels equal or exceed Tier 1 capital in 5 of the 

MSA’s 12 unseasoned community banks. Given the 

high proportion of unseasoned institutions, the ability 

of Las Vegas community banks to withstand such high 

concentrations in an economic downturn is largely 

untested. 

An Increasing Amount of Commercial Space 

Is Becoming Available in the Phoenix MSA, 

Financed in Part by Unseasoned Community 

Banks 

Phoenix experienced the second most rapid rise in personal income growth in the Region between 1993 and 

1998 and remains vulnerable to CRE overbuilding. It 

ranks among the top ten MSAs in the nation for new 

construction and starts in four property types: office, 

industrial, retail, and multifamily. Furthermore, vacancy 

rates are higher than the national average in each property type (see Chart 5). Given high levels of construction activity in multiple property types and vacancy 

rates that are already relatively high, community banks 

in the MSA appear vulnerable to economic weakening 

because of increasing exposure to CRE loans. 

While several real estate sectors in the Phoenix MSA 

were identified in the Regional Outlook, third quarter 

2000, to be at risk of overbuilding based on the supply 

of new space, economic indicators give a mixed view of 

potential demand. Although slightly slower than in previous years, the employment growth rate in Phoenix 

through third quarter 2000 was stronger than the national average, particularly in the services, transportation, 

and public utilities sectors. However, the pace of net inmigration has slowed and may constrain job growth and 

demand for CRE space going forward. 

The Phoenix office market, which has been one of the 

most active in the country, appears vulnerable to a 

potential downturn because of the rapid pace of development. The MSA added large amounts of new office 

space during 1999. Despite strong absorption levels, the 

vacancy rate at year-end 1999 was 12.4 percent, the 

highest since 1994. 

The industrial, retail, and multifamily sectors also experienced high rates of construction relative to existing 

stock during 1999. Phoenix is a popular location for 

semiconductor manufacturing operations and high-tech 

research and development, but is showing signs of softening. As of midyear 2000, the vacancy rate for the 

San Francisco Regional Outlook 8 Fourth Quarter 2000 
Regional Perspectives
 

MSA’s industrial properties (8.8 percent) was above the 

national average (6.7 percent). The retail and multifamily CRE sectors have also been very active, likely in 

response to the rapid rates of employment growth in the 

Phoenix MSA. 

Real estate markets in the Phoenix MSA warrant monitoring because its community banks are particularly 

dependent on traditionally higher-risk CRE and C&D 

lending. As of June 30, 2000, community banks in the 

Phoenix MSA reported 38.6 percent of all assets invested in CRE credits, versus 24.7 percent nationally. The 

ratio of CRE loans to total assets is relatively high in 

both established and unseasoned institutions and has 

risen steadily over the past two years. Both seasoned 

and unseasoned community banks also exhibit elevated 

C&D lending exposures, with median C&D loan-tototal-asset ratios of 9.9 and 10.9 percent, respectively. 

These concentration levels exceed those typically found 

in other MSAs across the nation (see Chart 3). As in Las 

Vegas, the proportion of unseasoned banks in the 

Phoenix MSA is high, and 8 of 15 newer banks have 

C&D loan portfolios that exceed Tier 1 capital. 

Seattle MSA Economic Growth May Be 

Slowing, but Community Banks Continue to 

Increase C&D Loan Exposures 

The Seattle MSA has enjoyed strong economic growth 

and CRE development in recent years, and insured institutions have increased CRE loan exposure. Between 

1993 and 1998, real personal income in Seattle 

increased by 33.7 percent, well above the 19.6 percent 

national growth rate during the same period. Chart 6 

shows that year-over-year income growth in the Seattle 

MSA has exceeded the nation’s since 1994. Median 

home prices in Seattle have also risen more rapidly than 

the national average in recent years. Since midyear 

1998, community banks in this MSA have significantly 

increased concentrations in CRE loans. Consequently, 

these insured institutions may be more vulnerable if the 

strength of the real estate market dissipates. 

Although economic conditions in Seattle remain strong, 

evidence of a slowdown is beginning to emerge. Growth 

in the services sector, which accounts for approximately 30 percent of the MSA’s employment, dropped to 3.3 

percent in August 2000, compared with 4.8 percent the 

prior year. In addition, the influx of venture capital 

investment into the Pacific Northwest has declined, and 

in-migration to the Seattle area has begun to slow. Two 

CHART 6 

Seattle MSA Personal Income 

Growth Exceeds the Nation’s 

Percent Change over Year Ago 

MSA = metropolitan statistical area 

Source: Bureau of Economic Analysis via Haver Analytics 

’93 ’94 ’95 ’96 ’97 ’98 

0 

2 

4 

6 

8 

10 

12 Seattle MSA 

United States 

years ago, net migration was just below 24,000, but it 

fell below 8,000 in 1999. These factors could result in 

slowing absorption across the five CRE property types 

in the Seattle MSA. 

As of midyear 2000, Seattle’s vacancy rates in all five 

property types—hotel, retail, multifamily, industrial, 

and office—remained below the national averages. 

However, the hotel, multifamily, and office sectors continue to add space at rapid rates; each ranked among the 

top ten nationally for new completions and starts as of 

year-end 1999. Demand has not kept pace with completions, however. In 1999, the absorption level for the 

hotel sector dropped to less than half of all completions, 

and the occupancy rate fell below 70 percent. Multifamily completions and absorptions are also tracking 

this trend. Although completions in this sector were up 

23 percent in 1999, absorptions increased by only 5 percent. The downtown Seattle office market, with its 

vacancy rate of only 1.2 percent in the second quarter 

2000 (the lowest office vacancy rate of any downtown 

area in the Region), also could weaken if the level of 

construction activity continues at its fast pace and the 

rate of absorption slows. 

Any CRE supply-demand imbalances could have an 

adverse effect on Seattle-based community banks, 

which report high and increasing CRE loan concentrations. The median level of CRE loans to total assets for 

this group of banks topped 34.3 percent as of midyear 

2000, up from 23.9 percent two years earlier. Like overall CRE concentrations, median C&D loan-to-totalasset ratios are relatively high at these institutions. 

However, median C&D concentrations generally 

declined between June 1999 and June 2000, falling 

San Francisco Regional Outlook 9 Fourth Quarter 2000 
Regional Perspectives
 

from 7.7 percent to 6.5 percent. While the MSA’s 15 

unseasoned community banks have reported declining 

C&D loan concentrations year-over-year since June 

1998, the 12 established community banks have reported increasing C&D loan concentrations. Consequently, 

the median ratio of C&D loans to total assets (10.9 percent) at established institutions is nearly double the ratio 

reported by younger institutions (6.5 percent). Regardless, C&D loan concentration levels for Seattle-based 

community banks exceed the national median (see 

Chart 3). 

Despite Potential Overbuilding in the Office and 

Hotel Sectors, Insured Institutions in Salt Lake 

City Report Relatively High CRE Loan 

Concentrations 

Strong employment growth in recent years and 

increased building in anticipation of the 2002 Winter 

Olympics helped Salt Lake City remain among the top 

ten markets nationwide for new office and hotel construction. In addition, since early 1999, seasoned community banks in this MSA have increased exposures to 

CRE loans and, as a result, may be more vulnerable 

should the economy slow. 

Economic conditions remain relatively strong, but evidence of a slowdown is emerging. The overall job 

growth rate in the Salt Lake City MSA slowed to 2.2 

percent in second quarter 2000, nearly the same as the 

national rate. The index of office employment published 

by Torto Wheaton indicates that jobs requiring office 

space, such as those in the services industries and the 

finance, insurance, and real estate sectors are expected 

to grow more slowly, suggesting that future demand for 

new office space could soften. Migration statistics also 

indicate slowing. During 1998 and 1999, the MSA 

experienced a net loss of more than 7,000 residents each 

year (see Chart 7). 

Despite the potential for softening, Salt Lake City ranks 

fourth in the nation for combined 1999 completions and 

starts in the office sector. Torto Wheaton expects completion of new office space to continue; 1.5 million 

square feet are planned for completion in 2000 and 1.1 

million square feet for 2001. However, the vacancy rate 

in this sector is already high—12.5 percent in 1999— 

after being below 8.1 percent almost every year since 

1993. The vacancy rate is likely to continue to rise if 

demand for office space slows as expected, putting the 

Salt Lake City MSA at risk of overbuilding. 

CHART 7 

Salt Lake City MSA Began to Experience 

Net Out-Migration in 1998 

MSA = metropolitan statistical area 

Source: Census Bureau via Regional Financial Associates 

Foreign 

Migration 

Overall Net 

Migration 

Domestic Migration 

(12,000) 

(9,000) 

(6,000) 

(3,000) 

– 

3,000 

6,000 

’95 ’96 ’97 ’98 ’99 

Extensive hotel construction in preparation for the 2002 

Winter Olympics continues to drive down occupancy 

and room rates. In June 2000, the occupancy rate in Salt 

Lake City hotels fell to 68.9 percent, down from 72.9 

percent a year ago, according to the Rocky Mountain 

Lodging Report. Daily room rates also declined during 

the past year. Together, these factors suggest that supply 

is exceeding demand in the hotel sector. 

Robust economic growth has contributed to high and 

increasing concentrations of CRE and C&D lending at 

the area’s community banks. Median concentrations of 

CRE loans to total assets have risen from 31.0 percent 

in June 1998 to 41.7 percent in June 2000. Concentration levels significantly exceed median exposures in 

other MSAs in the nation (see Chart 2). Elevated CRE 

loan concentrations are due largely to these banks’ 

heavy reliance on C&D lending. Construction loans 

now comprise nearly 20 percent of all assets of Salt 

Lake City area community banks. Consequently, C&D 

loan exposures exceed Tier 1 capital levels at 80 percent 

of the area’s community banks. 

Portland’s High-Tech Sector Is Rebounding, and 

Banks Are Reporting Increasing CRE and C&D 

Loan Concentrations 

Real personal income in the Portland MSA increased 

more rapidly than the national average between 1993 

and 1998, in part as a result of the creation of higherpaying high-tech jobs. Overall growth in the MSA has 

spurred development in several CRE sectors. For 

instance, the total number of hotel rooms expanded by 

more than 15 percent between 1998 and 1999. During 

San Francisco Regional Outlook 10 Fourth Quarter 2000 
Regional Perspectives
 

this period, community banks in the Portland MSA 

reported higher median exposure to C&D loans than the 

Region and nation. 

Demand for new CRE development has been driven, in 

part, by employment growth. Total nonfarm employment in Portland grew 1.7 percent between August 1999 

and August 2000. With improved demand from Asia, 

job gains in some of Portland’s electronics manufacturing subsectors have offset declines in other subsectors, 

such as lumber and wood products manufacturing. Furthermore, Portland’s high-tech firms continue to grow 

faster than their counterparts nationally—three times 

faster over the past five years, according to the Institute 

for Portland Metropolitan Studies.16 Despite the apparent turnaround in high-tech job growth following the 

Asian crisis, the MSA’s construction sector experienced 

job gains of only 2.0 percent for the year ending August 

2000, compared with the Region’s 6.2 percent (see 

Chart 8). 

The hotel sector appears to be the most vulnerable 

CRE property type, as the Portland MSA has experienced higher vacancy rates during the first half of 

2000. In addition, the multifamily sector reports a relatively high ratio of new completions and starts to 

existing stock (over 6 percent), compared to the 

national average of slightly more than 2 percent. While 

Portland’s multifamily sector vacancy rate remains 

below the national average, slower net in-migration 

may decrease absorption rates for this type of space 

going forward. 

On average, community banks in the Portland MSA 

hold one-third of total assets in CRE loans, up slightly 

from June 1998. While a 33.4 percent median CRE 

loan-to-total-asset ratio in this MSA is comparable to 

other areas in the Region, it exceeds the 24.7 percent 

concentration for the nation (see Chart 2). Both seasoned and unseasoned institutions are active CRE 

lenders; however, the area’s five established institutions 

are particularly exposed to C&D credit risk. These community banks hold 17.9 percent of assets in C&D loans, 

compared with 9.6 percent at unseasoned Portland community banks and 5.8 percent at unseasoned community banks in the rest of the nation (see Chart 3). In the 

16 “The Ecology of the Silicon Forest.” November 21, 2000. Regional 

Connections Project, Portland State University Institute for Portland 

Metropolitan Studies; http://www.upa.pdx.edu/IMS/. 

CHART 8 

Source: Bureau of Labor Statistics via Haver Analytics 

Region 

Portland 

Portland’s Construction Job Growth 

Lags the Region and Nation 

’95 ’96 ’97 ’98 ’99 ’00

Percent Change (year over year)

–4 

–2 

0 

2 

4 

6 

8 

10 

12 

14 

16 

Third Quarter 

Nation 

event of market softening, these five lenders could be 

vulnerable to asset quality slippage. 

Conclusion 

Five of the Region’s large MSAs continue to rank 

among the most active in the nation in terms of increasing supplies of CRE space. Considered in tandem with 

personal income growth rates and other indicators of 

economic activity, robust construction activity suggests 

that these MSAs may be experiencing 1980s-style 

“booms.” High-tech employment growth has spurred 

development in three of the MSAs; sustained growth in 

this sector is somewhat dependent on the availability of 

venture capital, which ties it closely to the stock market. 

Community banks in all five MSAs have generally 

increased levels of and concentrations in CRE and C&D 

loans in response to increased development activity. In 

addition, the Region’s strong economy has contributed 

to a higher rate of new bank formation in these MSAs. 

As a result, not only are community banks in these 

MSAs more highly exposed to traditionally higher-risk 

CRE and C&D loans, but many of the banks in these 

MSAs have not been tested during an economic downturn. If not met with equally vigorous demand for new 

space, sustained construction activity could result in 

some weakening of asset quality among community 

banks. In addition, given the significance of high-tech 

employment in three of the MSAs, CRE asset quality 

could be vulnerable in the event of a prolonged stock 

market decline. 

San Francisco Region Staff 

Stephanie Galloway, Financial Analyst 

San Francisco Regional Outlook 11 Fourth Quarter 2000 
In Focus This Quarter
 

Emerging Risks in an Aging Economic Expansion
 

•	 The economy and the banking and thrift industries are reporting generally healthy conditions. 

However, the economic expansion is aging, and it 

is unlikely that the vigor experienced during the 

first half of 2000 can be sustained. 

•	 Likewise, record banking and thrift industry 

profits, healthy capital cushions, and good asset 

quality of recent years may not be sustainable. 

Declining net interest margins, rising commercial 

loan losses, tighter liquidity, and riskier asset 

composition are among the warning signs that 

industry performance may have peaked for this 

business cycle. 

•	 Specific areas of concern include growing reliance 

on noncore funding; heightened interest rate risk; 

increased exposure to market-sensitive revenues; 

deteriorating credit quality; rising leverage 

among businesses and households; and signs of 

imbalance in some residential and commercial 

real estate markets. 

Although no readily apparent situations or imbalances 

suggest that a recession or widespread banking problems will develop in the near term, warning signs are 

present. A highly competitive banking industry shapes 

the environment in which pressures on insured institutions are unfolding. The presence of a large share of 

newly chartered banks in some areas appears to be raising the risk profile among all institutions in certain markets. Publicly owned companies remain under intense 

pressure to grow earnings and increase shareholder 

value. In addition, local banking environments exist in 

which a confluence of risks is generating heightened 

vulnerability for all participants, even during healthy 

economic times. Complacency in these environments 

may have negative repercussions for many insured institutions going forward. 

Imbalances Are Appearing amid a Healthy 

Macroeconomic Environment 

The performance of the U.S. economy contributes to the 

opportunities and risks financial institutions face. The 

current cyclical expansion, now nine and one-half years 

old, is displaying signs of aging while setting a record 

for longevity. A consensus forecast calls for moderate 

real gross domestic product (GDP) growth through 

2001, following robust gains in the first half of 2000. 

Current conditions might be called a “soft landing,” in 

which real GDP growth slows to a sustainable noninflationary rate of 2.5 to 3.5 percent, and unemployment 

hovers around recent rates. 

Although the current macroeconomic environment 

might appear to be the best of all possible worlds, areas 

of concern exist. One is that sustained prosperity tends 

to foster higher levels of risk taking, overconfidence, 

and complacency. For example, the turmoil in world 

foreign exchange and financial markets during 1997 

and 1998 illustrates how dramatic imbalances can 

develop and trigger disruptive adjustments even during 

healthy economic times. 

Currently, no specific situation or imbalance seems to 

threaten the viability of the expansion. However, as 

detailed below, several likely will contribute to slower 

economic growth. Situations that warrant monitoring 

include the following: 

•	 The repercussions from higher energy prices are 

unfolding. Historically, oil price shocks have weakened several other long-lived economic expansions. 

•	 Short-term interest rates rose over the past year while 

longer-term rates declined, resulting in a modest 

inversion of the yield curve. This relationship may 

inhibit the profitability of some lenders’ practice of 

borrowing short term and lending longer term and 

also complicate the interest rate risk management 

process for some insured institutions. 

•	 Continuing low unemployment suggests that demand 

for additional workers will go unfilled, thus limiting 

economic growth or triggering bidding wars that 

increase workers’ compensation and, potentially, 

inflation. 

•	 Stock market sentiment is no longer strongly bullish. 

A pullback from high valuations and optimism could 

trigger negative repercussions on consumers’ net 

worth and spending as well as on the level of business investment. 

•	 A large international trade deficit and strong U.S. 

dollar may be an unsustainable combination over the 

San Francisco Regional Outlook 12	 Fourth Quarter 2000 
In Focus This Quarter
 

long run. Meanwhile, repatriated profits of U.S. corporations are being trimmed by the dollar’s strength 

relative to the euro and other currencies. 

•	 Household debt burdens are historically high, with 

leverage rising the most in recent years among lowand middle-income households. These households’ 

access to credit has increased as lenders competed 

more fiercely for customers. 

•	 Corporations are more highly leveraged, and potential default risk rose in the past year across a range of 

industries. Meanwhile, downgrades of publicly traded corporate debt issues are exceeding upgrades by a 

2 to 1 ratio. 

•	 In some metropolitan areas, overheated housing markets are developing, in which home prices are rising 

dramatically and exceeding gains in median 

incomes. 

•	 Potential signs of excess commercial real estate construction are appearing in several urban areas where 

banks’ construction loan growth also is strong. 

Economic indicators of what lies ahead are not clearcut, and each possible scenario contains a set of potential challenges for insured institutions and regulators. 

Should economic growth slow considerably, current 

vulnerabilities, such as highly leveraged borrowers’ 

debt loads and overheated housing markets, could worsen significantly. As evidenced by the rash of bank failures during the 1980s, it doesn’t always take a national 

recession for problems to develop. Alternatively, sustained rapid growth might foster new vulnerabilities and 

allow current imbalances to intensify or build up. For 

example, speculative construction could accelerate, 

stock market volatility could increase, or ballooning 

trade deficits could generate turmoil in foreign 

exchange markets. 

Signs of Strain Are Also Appearing 

amid Healthy Banking and Thrift Industries 

With the long economic expansion as a backdrop, 

insured institutions in the aggregate are performing 

very well. However, the record profits attained in recent 

years may not be sustainable. The losses posted recently by several large institutions are striking examples of 

increased appetite for risk resulting in significant financial loss during a period of strong economic growth. 

While these are isolated instances, they are indicative of 

the increasingly competitive environment facing the 

financial services industry. 

Overall industry profitability is beginning to soften, led 

primarily by rising commercial loan losses at large institutions and declining net interest margins in institutions 

of all sizes. Credit card loss rates, which had been 

steadily falling since late 1997, have stalled in recent 

quarters, suggesting that recent increases in interest 

rates and energy costs not only are affecting businesses 

but also are taking a toll on some consumers. Other 

signs suggesting that aggregate risk within the system 

has risen include the growing reliance on noncore funding to support asset growth, heightened interest rate risk 

at many institutions, growing concentrations in traditionally higher-risk loan classes, and a shift in institutions’ overall asset mix toward higher-risk categories. A 

brief discussion of these risks follows. 

Funding Patterns Heighten Liquidity Concerns 

Lackluster core deposit growth is placing pressure on 

bank earnings and contributing to rising liquidity risk in 

the banking system. During the past five years, the compounded annual rate of core deposit growth for all 

insured institutions was just 2.8 percent. Assets over this 

time grew at a 6.6 percent rate. Accordingly, a significant portion of the industry’s growth has been funded by 

noncore sources (see Chart 1). The higher cost and rate 

sensitivity of these funds put downward pressure on net 

interest margins, particularly in a rising rate environment. 

CHART 1 

Most of $2 Trillion of Asset Growth since 1995
 

Was Funded with Noncore Funds
 

Subordinated Debt 

and Other Liabilities

 5% 

9% 

Equity 

22%
 

Core Deposits
 

64%
 

Noncore Funding
 

Source: Bank and Thrift Call Reports, June 2000 and June 1995 

San Francisco Regional Outlook 13	 Fourth Quarter 2000 
In Focus This Quarter
 

To compensate for higher funding costs, the industry 

has pursued growth in higher-yielding asset classes that 

are traditionally both riskier and less liquid. For example, almost 37 percent of the asset growth in the past 

five years has come from nonresidential real estate and 

commercial and industrial loans. 

For institutions that fund illiquid assets with wholesale 

sources, any adverse events that trigger a lack of confidence in the institution may result in higher funding 

costs, thus placing further pressure on margins. In 

efforts to obtain funding, an institution also may pledge 

a greater portion of its best quality assets as collateral, 

further reducing liquidity. Finally, in instances where 

funding needs have exceeded available liquidity, the 

forced sale of illiquid assets to meet funding outflows 

could result in losses if market conditions are unfavorable. Presumably, the FDIC, as insurer, would suffer 

greater losses if such an institution failed, because it 

would be relying on proceeds from the liquidation of 

less liquid, and potentially lower-quality, assets to satisfy 

the claims of insured depositors. 

Subprime lenders, in particular, tend to rely heavily on 

noncore funding to pursue aggressive growth strategies. 

Chart 2 illustrates the extent to which noncore funding 

exceeds the level of liquid assets for this group. The 

chart suggests the difficulty these institutions may 

encounter if forced to convert assets to meet funding 

outflows. Although subprime lenders may use noncore 

sources to fund riskier assets to a greater extent than the 

industry at large, this illustration exemplifies a systemic 

trend that is raising liquidity risk industrywide and is 

increasing risk to the insurance funds. 

Increasing Levels of Interest Rate Risk 

Challenge Some Institutions 

The refinancing boom of the late 1990s spurred a significant shift into longer-maturity assets for many 

insured institutions. During this period, a vast majority 

of mortgage borrowers opted for longer-term, fixed-rate 

loans, which they obtained at historically low rates. A 

great deal of the higher-rate or adjustable-rate loans that 

borrowers refinanced were held in the portfolios of 

insured institutions, which contributed to a general 

lengthening of the maturity of assets held at insured 

institutions. 

The trend toward longer-term, fixed-rate assets has been 

particularly pronounced among mortgage lenders. For 

example, state-chartered savings banks, which are traditionally mortgage lenders, have experienced a dramatic 

increase in long-term assets. As of June 30, 2000, 

almost 45 percent of the median savings bank’s earning 

assets were not scheduled to reprice for five years or 

longer (see Chart 3). 

Fixed-rate mortgage-related assets at federally chartered thrifts have risen similarly. From year-end 1995 

through first quarter 2000, the percentage of fixed-rate 

mortgage-related assets at thrifts with assets less than 

$1 billion rose from 49 percent to 60 percent of 

mortgage-related assets. Some thrifts and savings 

banks, therefore, have significant exposure to rising 

rates from low-yielding long-term assets. 

CHART 2 $ Billions 

Source: FDIC Division of Supervision and Bank and Thrift Call Reports (data are 

merger adjusted) 

Subprime Lenders’ Growing Dependence

 on Noncore Funding Strains Liquidity 

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

0 

30 

60 

90 

All other loans 

Residential real estate loans 

Securities and shortterm investments 

Columns: Noncore funding 

CHART 3 

Growing Concentration in Long-Term 

Assets Elevates Interest Rate Risk 

Source: Bank Call Reports, excluding Thrift Financial Report filers 

Share of Assets Maturing or Repricing in Five Years or Longer 

Relative to Total Earning Assets (median percentage) 

Percent 

Savings Banks 

Commercial Banks 

50 

0 

10 

20 

30 

40 

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

San Francisco Regional Outlook 14 Fourth Quarter 2000 
In Focus This Quarter
 

While most commercial banks do not have as high 

exposure to rising rates as savings banks, some may 

have taken on significant risk. The median savings bank 

has a ratio of long-term assets to earning assets that corresponds to the ratio level for the 93rd percentile of 

commercial banks. Although the 93rd percentile is in 

the tail of the commercial bank distribution, almost 600 

commercial banks have a concentration in long-term 

assets that exceeds that of the median savings bank. 

These institutions may be exposed to significant interest rate risk as well. 

While assets have lengthened considerably for many 

institutions, there has not been a corresponding extension of liabilities. To the contrary, funding pressures are 

tending to make bank liabilities more rate sensitive. 

These diverging trends generate concern, especially in a 

rising interest rate environment. That is, rate increases 

drive up the cost of funds more rapidly than earning 

asset yields at institutions with liability-sensitive interest rate risk postures. In a significantly higher interest 

rate environment, many institutions’ current postures 

likely would cause heavy margin erosion. 

Most institutions that have high concentrations in longterm assets also have strong capital and an asset mix 

that contains lower credit risk than that of many other 

institutions. Among savings banks, interest rate risk primarily arises from significant concentrations in residential mortgage loans, whereas the typical commercial 

bank’s exposure is more likely to arise from large holdings of long-term securities. However, some institutions 

with concentrations in long-term assets also may have 

lower capital levels, a higher-risk asset mix, or poor 

earnings. Rising rates could weaken these institutions 

and make it more difficult for them to weather adverse 

economic or other developments. 

Dependence on Market-Sensitive Revenues 

Increases Earnings Volatility for Some 

Institutions 

During the recent generally favorable conditions in financial markets, the share of revenue earned from business 

lines susceptible to financial market volatility has 

increased substantially for some of the industry’s largest 

institutions. Among these revenue sources are fees and 

gains from asset management, brokerage, investment 

banking, venture capital, and trading activities. The 19 

institutions most active in these lines of business earned 

over 26 percent of their net operating income from such 

sources in the second quarter of 2000. Other large institutions also have reported a growing dependence on these 

volatile sources of revenue. 

Turbulence in the financial markets has led to greater 

earnings volatility for some of these institutions. Stress 

in the financial markets could weaken the demand for 

underwriting services or significantly reduce trading 

revenues or venture capital gains. Furthermore, the 

same factors that are causing volatility in the financial 

markets could hamper loan growth and lead to slower 

revenue growth from core business lines. Should 

increased earnings volatility from exposure to marketsensitive revenues combine with slower revenue growth 

from core business lines, some institutions could face 

significant earnings challenges. 

The Rising Level of Problem Business Loans 

Is Centered in Large Banks 

Second quarter 2000 commercial and industrial (C&I) 

credit quality indicators at banks deteriorated for the 

eighth consecutive quarter. Noncurrent C&I loans— 

those on nonaccrual status plus those 90 days or more 

past-due—rose 13 percent over first quarter 2000 levels 

to $14.5 billion, or 1.4 percent of total C&I loans. Noncurrent loan levels for the period ending June 2000 were 

40 percent higher than the year-earlier level. Net C&I 

loan loss rates also continue to edge higher but remain 

well below those experienced by banks in the late 1980s 

and early 1990s.1 

Large banks, particularly those active in syndicated 

lending, are bearing the brunt of deteriorating C&I loan 

quality. Recent increases in criticized and classified 

shared national credits (SNCs), which are loans exceeding $20 million that are shared among three or more 

lending institutions, are illustrated in Chart 4. In the 

2000 SNC review, criticized and classified credits 

increased 44 percent over 1999 levels to 5.1 percent of 

total SNC commitments. Furthermore, the bulk of the 

increase was in the more severe classified categories, 

which now comprise 64 percent of total criticized and 

classified credits, compared with 54 percent at the yearearlier review. 

11

During second quarter 2000, banks posted an annualized net C&I 

loss rate of 0.67 percent, up from 0.55 percent for second quarter 

1999. For comparison purposes, net quarterly annualized C&I loss 

rates averaged 1.11 percent from fourth quarter 1991 to fourth quarter 

1993. 

San Francisco Regional Outlook 15 Fourth Quarter 2000 
In Focus This Quarter
 

CHART 4 

Note: C&I = commercial and industrial; SNC = shared national credit 

Source: Shared National Credit Program 

Syndicated Loan Problems Are on the Rise 

Percent

$ Billions 

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

Criticized and 

Classified SNC Loan 

Commitments (right 

scale) 

Percentage of SNC 

Commitments Criticized 

and Classified (left scale) 

0 

2 

4 

6 

8 

10 

12 

14 

16 

0 

20 

40 

60 

80 

100 

120 

140 

C&I loan quality indicators continue to deteriorate 

despite generally favorable economic conditions. Three 

factors explain much of this deterioration: certain weak 

industries, rising corporate debt burdens, and the seasoning of syndicated loans underwritten from 1997 to 

1998, when many banks significantly eased business 

lending standards. 

Industry Sector Weaknesses 

The financial stresses facing healthcare and entertainment companies (cinema operators in particular) have 

been well publicized. While the healthcare and entertainment sectors have contributed significantly to the 

decline in commercial credit quality, problems within 

these two sectors do not account for the full extent of 

the increase in noncurrent loans and problem SNC 

loans. Both of these sectors are within the broader services sector, which experienced a $4.6 billion increase 

in criticized and classified credits from the 1999 to the 

2000 SNC review. However, this increase accounts for 

only 15 percent of the $30.8 billion increase in criticized and classified SNCs overall.2 The expected 

default probabilities evident in market-based information can be used to identify other industry sectors experiencing financial stress. KMV LLC has developed a 

model that uses publicly available information to estimate the likelihood of default of individual firms.3 

2 See the interagency release of SNC results at www.occ.treas.gov/
 

ftp/release/2000-78a.pdf.
 

3 KMV Credit Monitor® uses information from a firm’s equity prices
 

and financial statements to derive KMV’s Expected Default Frequency (EDFTM), which is the probability of the firm defaulting within a
 

one-year period. The main determinants of a firm’s likelihood of
 

default: the firm’s asset value, the volatility of the firm’s asset value,
 

and the degree of financial leverage.
 

KMV’s model is used by many lenders to monitor and 

evaluate obligor risk and credit risk trends. Applied to 

the analysis of industries, the output of KMV’s model is 

just one of a number of indicators that suggest weaknesses in certain industry sectors. 

Sectors that include a high proportion of firms with 

high default probabilities (median one-year default 

probabilities exceeding 4 percent) are shown in Chart 5. 

Using entertainment as an example, the bars in the chart 

show that in September 2000, one-half of publicly held 

entertainment firms had greater than an 8 percent 

chance of defaulting on their obligations within one 

year. In September 1999, this same proportion of entertainment companies had a substantially smaller (6 percent) chance of defaulting within a 12-month period. 

The median likelihood of default for all the industries 

shown in the chart far exceeds that of Standard & 

Poor’s-rated, BB-grade (sub-investment-grade) obligors 

as of September 2000, as indicated by the dotted line in 

the chart. 

Rising Corporate Debt Burdens 

U.S. corporate debt burdens, as measured by the debtto-net-worth ratio for nonfarm, nonfinancial businesses, 

continue to increase. This ratio reached 83 percent in 

the second quarter of 2000, up from 72 percent as of 

year-end 1996. Although debt burdens remain below the 

1988–1992 average of almost 87 percent, U.S. businesses are nevertheless becoming increasingly vulnerable to rising credit costs and disruptions in credit 

availability. 

CHART 5 Median Expected Default Frequency (EDFTM) (percent) 

Various Industries Show High Levels 

of Expected Default Risk 

Comparative EDFTM

 of S&P Bonds Rated BB 

(as of September 2000) 

Source: Credit MonitorTM ©2000, KMV LLC, all rights reserved 

Entertainment 

HealthcareWholesale Trade 

Apparel &Textile

Misc. Manufac. LodgingMining 

AgricultureConstruction 

Retail

0 

1 

2 

3 

4 

5 

6 

7 

8 

9

 September 1999

 September 2000 

San Francisco Regional Outlook 16 Fourth Quarter 2000 
In Focus This Quarter
 

Seasoning of 1997–1998 Vintage Loans 

Results of recent supervisory surveys suggest that 

banks are tightening terms and conditions on loans to 

small-, middle-, and large-market obligors. However, 

this tightening follows a relaxation of standards in prior 

years that has contributed to a heightened level of risk 

in banks’ loan portfolios.4 Not coincidentally, the period 

between 1995 and 1998 saw a sharp rise in the proportion of lower-graded, higher-risk credits categorized as 

leveraged transactions by Loan Pricing Corporation. 

Leveraged loan originations—those priced at 150 basis 

points or more over the London Inter-Bank Offer Rate 

(LIBOR)—rose from 12 percent of total syndicated 

loan originations in 1995 to 31 percent in 1999. According to a recent Standard and Poor’s commentary, many 

banks have acknowledged that 1997 and 1998 vintage 

credits are beginning to produce higher problem loan 

levels.5 

Household Sector’s Leverage Is High, 

and Imbalances Are Appearing 

Consumers are enjoying the benefits of the economic 

expansion, as jobs are plentiful, home ownership 

remains generally affordable, and credit seems to be 

readily available for financing motor vehicles and other 

major purchases. These conditions contributed to record 

high sales of cars and light trucks during the first nine 

months of 2000, helping sustain the consumer spending 

growth shown in Chart 6. One corollary of high vehicle 

sales, however, is softening prices for used vehicles. 

Consequently, some lessors—including banks—are 

realizing lower-than-expected residual values on leased 

vehicles, which, in turn, are triggering losses in their 

lease portfolios. This situation illustrates one problem 

that lenders can encounter even in good economic 

times. 

Spending growth remained robust in recent quarters 

even as gains in disposable income slowed. The gap 

between income and spending growth is “financed” as 

households draw down savings, tap capital gains, refinance mortgages, assume more debt, or undertake some 

combination of these measures. 

4 See Federal Reserve Board’s Senior Loan Officer Opinion Survey on 

Bank Lending Practices for May and August 2000 and Surveys of 

Credit Underwriting Practices for 1999 and 2000 from the Office of 

the Comptroller of the Currency. 

5 “U.S. Bank Loan Portfolios Reflect Rise in Corporate Bond 

Defaults.” July 20, 2000. Standard and Poor’s Commentary. 

CHART 6 

Household Spending Growth 

Exceeds Income Growth 

Source: Bureau of Economic Analysis via Haver Analytics, Inc. 

Real Consumption Spending 

Real Disposable Income 

7 

–1 

0 

1 

2 

3 

4 

5 

6

Annual Growth Rate (percent) 

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

Quarter 3 

From 1995 through 1998, and likely since then, the 

increase in both leverage and debt servicing burdens has 

been concentrated among low- and middle-income 

households. Among families holding debt in 1998, debt 

payments exceeded 40 percent of disposable income for 

nearly 20 percent in the $10,000 to $24,999 income 

group and nearly 14 percent in the $25,000 to $49,999 

group.6 One concern is that these debt-laden families 

may have inadequate financial resources to make payments should adverse conditions or job loss occur. In 

such instances, lenders could be doubly affected if 

households draw on their credit card and home equity 

lines of credit, further compromising their repayment 

ability, in order to sustain spending in excess of income. 

The recent rise in credit card losses in banks’ card portfolios and rising losses in the portfolios of subprime 

lending specialists may indicate that strains among 

some households are spilling over to lenders. Moody’s 

Investors Service expects credit card losses to rise 

through 2001, according to a recent analysis of 

prospects for the U.S. credit card industry. 

Overheated residential real estate markets in several 

metropolitan statistical areas (MSAs) may be another 

warning of economic imbalances. Dramatic gains in 

home resale prices in San Francisco stand out (see Chart 

7), but this market is not alone in experiencing appreciation considerably higher than income growth. In 

some markets, where financial-services or informationtechnology workers are concentrated, bidding wars for 

properties may reflect the fact that affordability is 

6 Kennickell, Arthur B., Martha Starr-McCluer, and Brian J. Surette. 

January 2000. “Recent Changes in U.S. Family Finances: Results 

from the 1998 Survey of Consumer Finances.” Federal Reserve 

Bulletin. Vol. 86, 1–29. 

San Francisco Regional Outlook 17 Fourth Quarter 2000 
In Focus This Quarter
 

enhanced by gains in wealth rather than in income. 

Even so, similar surges in home resale prices in the 

past often were not sustainable. The subsequent years 

of stagnant or falling collateral values caused financial 

stress among some homeowners and their lenders. 

Further concern about residential real estate lenders 

arises because pockets of speculative construction 

under way in some markets may produce units that 

become increasingly difficult to sell at anticipated asking prices. 

Construction and Development 

Loan Growth Is Accelerating 

Commercial real estate (CRE) construction across all 

property sectors has grown during this expansion, with 

office construction particularly active. The amount of 

office space completed in mid-2000 was the largest 

since 1989 and is projected by Torto Wheaton Research 

to continue rising. Not surprisingly, construction and 

development (C&D) loan volume, growth rates, and 

concentrations are trending upward rapidly. While total 

private real estate spending grew about 6.5 percent over 

the four quarters ending midyear 2000, C&D loans at 

insured institutions rose by 26 percent. C&D loan 

growth has remained above 20 percent since 1997, and 

the aggregate volume of C&D loans is the highest since 

1989. 

Such growth is contributing to higher concentrations of 

C&D loans relative to Tier 1 capital. At current levels, 

concentrations do not begin to approach those of the 

late 1980s. However, several metropolitan areas have a 

CHART 7 

Median Home Resale Prices Soar 

in San Francisco Bay Area 

Percent Change from

Four Quarters Earlier 

Quarter 1 

–10 

–5 

0 

5 

10 

15 

20 

25 

30 

35 

’80 

’82 

’84 

’86 

’88 

’90 

’92 

’94 

’96 

’98 

’00

large percentage of insured institutions reporting high 

and rising concentrations. Table 1 (next page) shows 

MSAs with at least 15 nonspecialized community 

banks7 and at least one-third of those institutions reporting concentrations in C&D loans equal to at least 100 

percent of Tier 1 capital. The Atlanta MSA stands out. 

Sixty-five percent of Atlanta’s 85 nonspecialized community institutions reported C&D loans exceeding 100 

percent of Tier 1 capital on June 30, 2000, and 35 percent reported a concentration exceeding 200 percent. 

The aggregate C&D concentration for all 85 institutions 

in the MSA was 156 percent, the highest among MSAs 

with at least 15 institutions of similar size and nature. 

Several other markets also include significant shares of 

institutions with high concentration levels. 

Nine of the 16 markets highlighted in Table 1 not only 

have a relatively high percentage of C&D loan exposure but also appear vulnerable to overbuilding in two 

or more property types.8 While these markets show no 

clear signs of emerging economic stress, lenders there 

clearly may be at greater risk should economic or real 

estate conditions sour. Other concerns regarding CRE 

lending arise from a recent Office of the Comptroller 

of the Currency survey, which reports heightened 

credit risk in CRE portfolios and predicts it will 

increase through 2001. In addition, respondents to a 

midyear 2000 FDIC survey of examiners reported 

more frequent comments about excess office and retail 

space. 

Increasing Share of De Novo Institutions 

Raises the Stakes in Some Markets 

A common element among the metropolitan markets 

listed in Table 1 (next page) is the presence of newer 

institutions. In 10 of the 16 markets, at least 20 percent 

of the nonspecialized community institutions are less 

than three years old. The drive to build market share 

among these institutions, particularly if they are publicly traded entities, is increasing the competitive pressure on banks and thrifts in these markets. In some 

instances, the aggregate cost of deposits within the 

MSAs has risen faster than in the nation as a whole, risk 

7 The term “nonspecialized community bank” refers to institutions 

with total assets under $1 billion that are not specialty institutions 

such as credit card or trust banks. 

8 See “Ranking Metropolitan Areas at Risk for Commercial Real 

Estate Overbuilding,” Regional Outlook, third quarter 2000, which 

identifies markets where new construction is high relative to existing 

stocks of space. 

Source: National Association of Realtors via Haver Analytics, Inc. 

San Francisco Regional Outlook 18 Fourth Quarter 2000 
In Focus This Quarter
 

TABLE 1 

High C&D Loan Exposure Appears in Various MSAs 

SHARE (%) OF AGGREGATE C&D LOANS 

MSAS WITH 15 OR INSTITUTIONS* WITH C&D RELATIVE TO AGGREGATE 

MORE NONSPECIALIZED CONCENTRATIONS > OR = TIER 1 CAPITAL (AS %) 

COMMUNITY INSTITUTIONS* 100% OF TIER 1 CAPITAL IN THIS MSA* 

ATLANTA, GA 65 156 

PHOENIX–MESA, AZ 56 131 

MEMPHIS, TN–AR–MS 52 154 

PORTLAND–VANCOUVER, OR–WA 47 146 

OAKLAND, CA 47 163 

NASHVILLE, TN 44 103 

RIVERSIDE–SAN BERNARDINO, CA 42 110 

SAN DIEGO, CA 41 90 

GRAND RAPIDS–MUSKEGON–HOLLAND, MI 40 81 

SEATTLE–BELLEVUE–EVERETT, WA 39 98 

SALT LAKE CITY–OGDEN, UT 38 56 

FORT WORTH–ARLINGTON, TX 38 110 

DALLAS, TX 36 95 

LAS VEGAS, NV–AZ 35 119 

LEXINGTON, KY 34 80 

DENVER, CO 33 113 

*Sample includes institutions with total assets under $1 billion that are not specialty institutions such as credit 

card or trust banks. 

Note: Boldface indicates major MSAs identified at risk for excess commercial real estate construction in Regional 

Outlook, third quarter 2000. 

C&D = construction and development, MSA = metropolitan statistical area 

Source: Bank and Thrift Call Reports for June 30, 2000 

profiles are being elevated, and aggregate leverage ratios 

are falling, despite the influx of capital from the new 

institutions. Highly competitive environments have the 

potential to increase risk taking by negatively affecting 

underwriting standards and balance sheet composition. 

Farm Sector Challenges Continue 

Much of the agricultural industry is experiencing 

stress because of low commodity prices, compounded 

in some areas by low yields resulting from weather- or 

disease-related problems. Strong global competition 

and high worldwide production during the past several years have resulted in large crop inventories, 

depressed prices, and limited prospects for a price 

turnaround in the near term. In the aggregate, record 

levels of government payments have helped the 

nation’s farms maintain a generally stable financial 

condition but have not eliminated the stress in this sector. In fact, the U.S. Department of Agriculture projects that at least one in four farm businesses in several regions9 will not cover net cash expenses in 2000, 

suggesting that the viability of highly leveraged farmers may be in question. 

Fortunately, the aggregate condition of nearly 2,100 

insured agricultural banks—institutions with 25 percent 

or more of loan portfolios in agricultural credits— 

remains healthy. Generally, agricultural banks continue 

to report favorable asset quality, earnings, and capital 

positions. However, they are experiencing somewhat 

elevated levels of noncurrent loans compared with 

nonagricultural institutions. Agricultural banks are disproportionately represented among the weakest 25 percent of institutions nationwide in terms of noncurrent 

9 These are USDA’s Basin and Range, Mississippi Portal, Fruitful 

Rim, and Southern Seaboard regions. See www.ers.usda.gov/ 

briefing/farmincome/fore/regional/regional.htm. 

San Francisco Regional Outlook 19 Fourth Quarter 2000 
In Focus This Quarter
 

loan levels. In addition, rising levels of carryover debt at 

farm banks may translate into higher losses in the future 

if commodity prices remain low. 

The strains in the farm sector also have implications for 

nonfarm banks in agricultural areas. In several agriculturedependent states, such as Montana and the Dakotas, for 

example, where farmers’ earnings are depressed and the 

economies not well diversified, nonagricultural banks 

are reporting higher noncurrent levels than insured 

institutions elsewhere in the nation. 

Summary 

The long-lived economic expansion has contributed to 

the banking and thrift industries’ record levels of profitability and asset quality. However, as the expansion has 

matured, both consumer and corporate leverage has risen 

considerably. Bank liquidity is becoming increasingly 

strained by lackluster core deposit growth, which has 

been insufficient to fund strong loan demand. This trend 

has resulted in a decided shift into higher-risk asset 

classes to mitigate margin pressures arising from the 

greater reliance on noncore-funding sources. Furthermore, interest rate risk has risen significantly for many 

institutions, and after nearly a decade of improving asset 

quality, the level of problem loans is increasing. 

Clearly, high levels of profitability in recent years have 

been achieved, in part, by an increased appetite for risk. 

Concern arises because insured institutions’ current 

profitability is being negatively affected by some recent 

trends, despite the sustained economic expansion. And, 

while capital levels have remained fairly stable, the 

amount of risk being leveraged on the industry’s capital 

base is on the rise. Just as a rising tide is said to float all 

boats, a strong economy can mask potential problems 

that will become evident should the economic tide turn, 

particularly in institutions or markets where aboveaverage risk is concentrated. Insured institutions’ safety 

and soundness may be most vulnerable in situations 

where banks and thrifts are exposed to multiple challenges, whether because of strategic decisions or 

because of repercussions from economic and banking 

forces beyond their control. 

Daniel Frye, Regional Manager 

Joan D. Schneider, Regional Economist 

Steve Burton, Senior Banking Analyst 

Allen Puwalski, Senior Financial Analyst 

Ronald Spieker, Chief, Regional Programs 

and Bank Analysis 

The authors would like to acknowledge 

the Washington and regional staff of 

both the Division of Insurance and 

the Division of Supervision for their 

analyses and comments, which were 

instrumental in writing this article. 

San Francisco Regional Outlook 20 Fourth Quarter 2000 
✁
 

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