Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION FOURTH QUARTER 1997 

FDIC
 

Kansas City
 

Region
 

Division of
 

Insurance
 

Craig A. Rice,
 

Regional Manager
 

Jeffrey W. Walser,
 

Regional Economist
 

John M. Anderlik,
 

Financial Analyst
 

In Focus This Quarter 

◆ Bank Earnings: Competitive Pressures and Cyclical 

Risks—Intense competition to preserve or attract business can lead to relaxed 

underwriting standards and other changes to risk management practices that can 

reduce banks’ ability to weather a downturn. As this economic expansion reaches 

an advanced age, prudent bankers will evaluate their lending standards and reserve 

adequacy with an eye to possible adverse changes in economic conditions. 

See page 3. 

By Ronald Spieker, Steve Linehan, George French 

◆ Strong Demand and Financial Innovation Fuel 

Rebounding Commercial Real Estate Markets—Commercial real 

estate markets in many parts of the United States have rebounded, and commercial 

banks are once again actively pursuing lending opportunities. Banks are not alone, 

however, as a broader and more competitive financing market has emerged. 

Securitization vehicles such as commercial mortgage-backed securities and real 

estate investment trusts are changing how real estate is owned and paid for. 

See page 9. 

By Steven Burton, Gary Ternullo 

Regular Features 

◆ Regional Economy—Performance of rural counties has improved 

since the 1980s, but inequality in growth persists in the 1990s...Branson, Missouri, 

shows signs of slowing down...the aging of farmers poses new challenges to agricultural banks. See page 14. 

By Jeffrey W. Walser, Marsha Martin 

◆ Financial Markets—Bank holding companies of all sizes have issued 

trust preferred stock following the Federal Reserve’s decision in October 1996 to 

count these tax-advantaged, capital securities toward Tier 1 capital...rating agencies and investment analysts have argued that trust preferred stock is a weaker 

form of Tier 1 capital. See page 19. 

By Kathy R. Kalser 

◆ Regional Banking—Strong banking conditions continue...however, 

some weaknesses are noted in South Dakota and North Dakota...strong loan 

growth for community banks is concentrated in real estate...institutions in some 

rural counties may be more susceptible to economic downturns. See page 23. 

By John M. Anderlik, Craig A. Rice 

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

Insurance Corporation for the following eight geographic regions: 

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

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

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

Dallas Region (CO, NM, OK, TX)
 

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

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

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

San Francisco Region (AK, AZ, CA, 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 Kansas City Region’s Regional 

Outlook, please call Craig Rice at (816) 234-8034 or send an e-mail to crice@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 Andrew C. Hove, Jr. 

Director, Division of Insurance Arthur J. Murton 

Editor George E. French 

Managing Editor Stephen Linehan 

Associate Editor Maureen E. Sweeney 

Assistant Editors Suzannah L. Susser 

John D. Weier 

Publications Manager Teresa J. Franks 
In Focus This Quarter
 

Bank Earnings: Competitive Pressures
 

and Cyclical Risks
 

•	 Rapid loan growth, record low credit losses, 

vigorous expansion of income sources, and costcutting continue to propel bank earnings to 

record levels. 

•	 Intense competition to preserve and attract 

business can lead to aggressive loan pricing, 

relaxed loan underwriting standards, increased 

portfolio concentrations, and other changes to 

risk-management practices that can reduce 

banks’ ability to sustain earnings and capital 

through a downturn. 

•	 As this economic expansion approaches an 

advanced age, prudent bankers will allow for the 

possibility of an adverse change in economic 

conditions. 

As the U.S. economic expansion continues through its 

seventh year, the banking industry continues to run at 

full throttle. Earnings climb to ever-higher levels, driven by rapid loan growth, record low credit losses, 

aggressive expansion of income sources, and vigorous 

cost-cutting. Some analysts argue that banking has 

entered a new era in which the development of noninterest income sources and new risk-management techniques will insulate banks from swings in the business 

cycle. 

Yet banks face risks that should not be overlooked. 

Assertions that bank earnings will be less sensitive to 

business cycles remain untested. Meanwhile, competition to attract and maintain business can result in 

relaxed underwriting standards and easing of loan 

terms, or increased focus on business lines whose risks 

are difficult to manage. Policies that boost short-term 

shareholder returns, including high dividends and stock 

repurchase programs, can reduce banks’ capacity to 

weather a future downturn. There is evidence that these 

things are occurring to varying degrees in banking 

today. Accordingly, as this expansion reaches an 

advanced age, prudent bankers will give careful regard 

to the quality and sustainability of the earnings generated by today’s strategic decisions. 

Credit Quality 

Variations in credit quality have been and are likely to 

remain for some time the primary source of large 

swings in bank earnings (see Chart 1). Banks manage 

the risks of large swings in credit quality by adjusting 

underwriting standards and loan terms, by diversifying 

loan portfolio exposures, and by supplying adequate 

amounts to the allowance for loan losses. In large part, 

the degree to which bank earnings can be sustained during a downturn will depend on decisions made about 

these factors during the expansion. 

Some perspective on the cyclical nature of credit quality can be gleaned from Charts 2 and 3 (next page). As 

shown in Chart 2, bank loan growth has exceeded 

growth in gross domestic product (GDP) for ten of the 

past twelve quarters, even without considering the substantial volume of loans originated and sold in securitized pools. Moreover, Chart 3 shows that growth in 

loan losses has tended to follow episodes of rapid loan 

growth. 

Credit standards are important tools for individual 

banks to manage these cyclical fluctuations in credit 

quality. According to the Federal Reserve’s August 1997 

CHART 1 

Earnings Results Are Largely Driven by 

Provision Expenses 

-1.0% 

0.0% 

1.0% 

2.0% 

3.0% 

Return on Avg Assets 

Provision Exp/Avg Assets 

Source: Commercial Bank Call Reports 

-2.0% 

6-’85

12-’86

6-’88

12-’89

6-’91

12-’92

6-’94

6-’97

12-’95 

Kansas City Regional Outlook 3	 Fourth Quarter 1997 
In Focus This Quarter
 

CHART 2 CHART 3 

-15% 

-10% 

-5% 

0% 

5% 

10% 

15% 

20% 

1980 

GDP Growth 

Loan Growth 

Average Loan Growth Has Recently 

Outpaced Nominal GDP Growth 

Source: Commercial Bank Call Reports, Haver Analytics 1982 1984 1986 1988 1990

199219941996 

Source: Commercial Bank Call Reports Loan, GDP Growth (%)

Net Loan Loss Growth (%)

Loan Losses and Loan Growth Are Correlated 

-15 

-10 

-5 

0 

5 

10 

15 

-90 

-60 

-30 

0 

30 

60 

90 

Loan Growth 

Net Loan Loss Growth 

198019831986198919921995 

Senior Loan Officer Survey, during the preceding three 

months, a large percentage of banks had eased terms on 

commercial and commercial real estate loans, including 

reducing loan interest rates, increasing credit lines, and 

easing loan covenants and collateralization requirements. A “small but significant” share reported willingness to accept increased levels of risk on commercial 

real estate loans. In a similar vein, the Federal Deposit 

Insurance Corporation’s (FDIC) Report on Underwriting Practices (second quarter 1997) did not note 

any widespread problems with underwriting practices 

but reported that about 24 percent of institutions examined that were actively involved in construction lending 

were “frequently or commonly” funding speculative 

construction projects. About 18 percent of institutions 

examined that were actively involved in business lending “frequently or commonly” made unsecured business 

loans that lack documentation of financial strength. 

Maintaining an adequate allowance for loan losses is 

another important way for banks to sustain earnings and 

capital during downturns. The aggregate allowance held 

by commercial banks has decreased from 2.74 percent 

of total loans in the first quarter of 1992 to 1.90 percent 

in the second quarter of 1997; 166 banks reported negative loan loss provisions in the second quarter. 

Although in the aggregate these reserve numbers 

remain high relative to the early to mid-1980s, when 

reserve levels ranged from 1.20 percent to 1.74 percent, 

the Office of the Comptroller of the Currency (OCC) 

recently issued an advisory letter expressing concern 

about declining reserve levels and the need to maintain 

an adequate allowance. This letter was a response to 

weakness in the credit card sector and to trends in the 

market for syndicated commercial loans, including 

increasing leverage, declining spreads, and a weakening 

in other underwriting terms, all stemming from increasing competitive pressures. 

Diversifying loan portfolios is another way for banks to 

help reduce susceptibility to economic downturns. It 

has often been noted that the trend toward interstate 

banking and branching may improve loan diversification. It should also be noted, however, that many banks 

retain high concentrations of credit exposure to specific 

economic sectors. For example, commercial real estate 

lending and construction lending has been a source of 

volatility in bank earnings since the real estate investment trust (REIT) crisis of the 1970s. As discussed in 

Strong Demand and Financial Innovation Fuel 

Rebounding Commercial Real Estate Markets, banks 

are leading a resurgence in commercial real-estate lending. As Table 1 shows, 28 percent of FDIC-insured institutions grew their total commercial real estate and 

construction portfolios more than 30 percent from mid1996 to mid-1997, and 16 percent had total commercial 

real estate and construction exposures1 exceeding 200 

percent of equity and reserves. Concentrations and 

rapid growth do not necessarily portend difficulties, but 

the greater the concentration of credit to a specific sector, the greater the importance of strict adherence to 

sound underwriting policies and standards and the 

maintenance of adequate loss reserves. 

The most immediate concerns about credit quality have 

been expressed regarding credit cards and some other 

1 Includes loans secured by multifamily dwellings and nonfarm nonresidential structures, as well as construction loans. 

Kansas City Regional Outlook 4 Fourth Quarter 1997 
In Focus This Quarter
 

consumer debt. Despite seven years of economic expansion, commercial banks’ net credit card charge-offs at 

mid-1997 were running at 5.22 percent of average outstanding balances, matching levels not seen since the 

aftermath of a 56 percent run-up in charge-offs that 

accompanied the recession of 1990 to 1991. Noncurrent 

rates on these loans are at near-historic highs of 1.94 

percent, and some examiners are commenting that these 

rates would be even higher were it not for some of these 

balances being rolled over into home equity debt consolidation loans with loan-to-value ratios as high as 135 

percent. Home equity lines are a rapidly growing business for some banks; 25 percent of banks and thrifts 

grew their home equity lines by more than 30 percent 

during the year ending mid-1997 (see Table 1). 

Except for credit cards and some other consumer loans, 

loan losses are at historically low levels. Nevertheless, 

lending decisions that assume a continuation of favorable economic conditions should be closely examined 

this far into the expansion. Institutions that maintain 

strong underwriting standards, an adequate allowance 

for losses, and prudent diversification of the loan portfolio will be best positioned to sustain earnings and capital during a downturn in credit quality. 

Net Interest Margin 

Net interest margin (NIM) is another primary driver of 

bank earnings. Indeed, a sharp improvement in NIM 

TABLE 1 

CHART 4 

Rebound in ROA Since 1990 Fueled 

by Improved NIM and Asset Quality 

0.0% 

0.5% 

1.0% 

1.5% 

2.0% 

1984 1986 1988 1990 1992 1994 1996 

2.5% 

3.0% 

3.5% 

4.0% 

4.5% 

5.0% 

ROA 

Net charge-off ratio 

NIM 

Source: Commercial Bank Call Reports ROA, Net Charge-Off Ratio

NIM (%) 

helped lead the banking industry’s dramatic recovery 

from the last recession (see Chart 4). Commercial 

banks’ NIM has declined slightly in recent years, but at 

4.23 percent still remains near the top of the range 

within which it has fluctuated since 1984 (see Table 2, 

next page). 

The banking industry’s rapid loan growth in recent 

years has been one of the factors supporting the current 

high NIM. (Since loans generally yield more than 

securities, a higher proportion of loans generally 

results in a higher yield on the total portfolio of earning assets.) Economic fundamentals cannot sustain 

rapid loan growth indefinitely, however. Accordingly, a 

Rapid Loan Growth Is 

Occurring at a Significant 

Number of Institutions 

(4 qtrs growth ending 6/97) 

TOTAL LOANS AND LEASES 

CONSTRUCTION LOANS 

COMMERCIAL REAL ESTATE LOANS 

TOTAL CRE 

1-4 FAMILY RESIDENTIAL LOANS 

HOME EQUITY LINES 

TOTAL RESIDENTIAL 

CREDIT CARD LOANS AND RELATED PLANS 

OTHER CONSUMER LOANS 

TOTAL CONSUMER LOANS 

COMMERCIAL LOANS 

Source: Bank & Thrift Call Reports 

Kansas City Regional Outlook 

Percentage of Institutions with Loan 

Category Growth Approximating 

20% to 30% 30% or Total 

More Over 20% 

11 13 24 

4 36 40 

9 27 37 

10 28 38 

11 17 29 

4 25 29 

12 18 29 

4 17 21 

9 18 27 

9 18 27 

9 26 35 

5 Fourth Quarter 1997 
In Focus This Quarter
 

TABLE 2 

1997 Commercial Bank Performance Compared with Historical Averages 

INDUSTRY AVERAGES 

6/30/97 1984-1996 

ANNUALIZED LOW HIGH 

(%) (%) (%) 

NET INTEREST INCOME/AVERAGE EARNING ASSETS 4.23 3.89 4.36 

X AVERAGE EARNING ASSETS/AVERAGE ASSETS 86.50 86.21 88.42 

= NET INTEREST INCOME/AVERAGE ASSETS 3.66 3.36 3.89 

+ NONINTEREST INCOME/AVERAGE ASSETS 2.13 1.10 2.13 

− NONINTEREST EXPENSE/AVERAGE ASSETS 3.50 3.05 3.90 

− PROVISION EXPENSE/AVERAGE ASSETS 0.40 0.28 1.28 

+ OTHER ITEMS/AVERAGE ASSETS 0.03 − 0.02 0.15 

− TAXES/AVERAGE ASSETS 0.68 0.18 0.64 

= NET INCOME/AVERAGE ASSETS (ROA) 1.25 0.10 1.20 

Source: Bank & Thrift Call Reports 

risk in the current environment is that in the effort to 

support their NIM by generating new lending, banks 

may make compromises in loan underwriting, pricing, 

and portfolio diversification. 

Recent pricing trends have tended to weaken NIM, offsetting to a degree the effects of rapid loan growth. On 

the liability side, over the past six years, commercial 

banks’ average annual deposit growth rate of 3.2 percent 

has been outpaced by the 4.9 percent average annual 

growth rate of earning assets. As a result, nondeposit 

borrowings have increased significantly in importance, 

rising from about 12.6 percent of earning assets in 1991 

to 19.1 percent at mid-1997. Since the average cost of 

nondeposit borrowings has exceeded the average cost of 

deposits over the period by an average of 135 basis 

points, the greater use of relatively higher cost borrowings to fund earning asset growth has been an obstacle 

to wider margins. The slower deposit growth can perhaps be attributed to the increasing array of choices 

available to small savers; its effect is that bank funding 

is becoming more expensive and more interest-rate 

sensitive. 

On the asset side, pricing pressures also are frequently 

cited as contributing to sluggish NIM. For example, in 

the aforementioned syndicated lending market, average 

interest spreads charged to noninvestment-grade large 

customers have dropped more than 63 basis points 

between 1992 and 1996, while spreads on investmentgrade debt are at all-time lows. Reportedly, some deals 

are being done at minimal or no risk-adjusted spreads 

simply to preserve lending relationships. Increased 

securitization of various asset types has also had effects 

on pricing. By increasing the depth and liquidity of the 

market for the underlying loans, securitization has tended to lower spreads on these assets, thereby increasing 

competitive pressures on institutions not able to achieve 

the volumes necessary to efficiently utilize this new 

funding vehicle. 

The thin spreads available from high-quality lending 

may tempt some institutions to finance higher yielding, 

riskier credits in an effort to preserve or boost profit 

margins. For example, recent forays by some banks into 

subprime lending (see Subprime Lending: A Time for 

Caution, Third Quarter 1997) may be one indication of 

how competitive pressures on NIMs are affecting bank 

behavior. Over the long term, institutions that manage 

their NIMs with a prudent regard for how their newly 

booked business may fare during a cyclical downturn 

will have a better chance of sustaining earnings performance through the business cycle. 

Growth in Noninterest Income 

Industry analysts often cite the increasing contribution 

of fees and other sources of noninterest income as 

evidence of the evolution of the banking industry. As 

Chart 5 (next page) illustrates, for commercial banks 

with over $1 billion in assets, noninterest income now 

averages over 40 percent of net revenue (net interest 

income plus noninterest income). In contrast, banks 

Kansas City Regional Outlook 6 Fourth Quarter 1997 
In Focus This Quarter
 

CHART 5 Other measures of productivity have shown similar 

Noninterest Revenue to Net Revenue* 

Banks Over $1 Billion 

Banks Under $1 Billion 

Source: Commercial Bank Call Reports 

* Net Revenue = Net interest income plus noninterest income 

10 

20 

30 

40 

50 

6-’85 

Net Revenue (%) 

6-’876-’896-’916-’936-’956-’97 

improvement. For example, commercial banking assets 

per employee doubled, from $1.5 million to $3 million, 

between 1984 and 1997. 

Growth in overhead expense has been contained largely 

through consolidation, technological advances, and low 

levels of problem assets. Mergers have resulted in the 

wringing out of redundant expenses. Information technology (IT) has been deployed to trim underwriting 

expense, manage customer relationships, speed backoffice processing, and facilitate the creation of new 

products and services. Favorable economic conditions 

have reduced costs associated with loan collection and 

asset workouts. 

Whether the downward trend in overhead expenses will 

with under $1 billion show a profile of reliance on more 

traditional banking activities, with only 25 percent of 

revenue from these noninterest sources. 

Noninterest income growth is being driven both by new 

business lines and higher deposit-related fees. 

Examples include fees from sales of mutual funds and 

other nondeposit products, investment banking activities such as securities underwriting and asset management, and increases in traditional fee sources such as 

from automated teller machines. Increasing securitization of assets, in which the accounting conventions convert interest income to noninterest income, has also 

affected the growth in reported noninterest income. 

With the exception of trading revenue, noninterest 

income has historically shown a growth trend that has 

not been especially sensitive to economic cycles. 

However, newer fee-based businesses such as mortgage 

banking, mutual funds, and securities underwriting may 

ultimately share the same cyclical characteristics as traditional bank lines of business, and therefore may not 

reduce banks’ historical exposure to economic cycles. 

The Effect of Expense Control 

on Earnings Performance 

Cost-cutting efforts in banking continue to show their 

effects. Since 1991, commercial banks’ efficiency 

ratio,2 a measure of an institution’s effectiveness in generating revenue, has steadily improved (see Chart 6). 

continue is an open question. Should problem loans 

increase from their cyclical lows, collection and workout costs will increase (evidence of this effect can be 

discerned for the late 1980s in Chart 6). The rapid 

change in information technology may prompt increasing expenditures. The 1996 Atlantic Data Services/ 

Tower Group Survey of Information Technology 

Services in Banking noted that the banking industry is 

“faced with an aging IT infrastructure.” The survey 

suggests that most technology-related expenses could 

increase at a 5.6 percent compounded growth rate until 

the year 2000 and that expenses for outside services 

could increase 11 percent over the same period. The 

ability to generate future revenue gains may depend on 

additional bank investment not only in technology but 

also in the development of new products and services. 

CHART 6 

Commercial Banks’ Efficiency Ratio*
 

Is Steadily Improving
 

70% 

68% 

66% 

64% 

62% 

60% 

58% 

56% 

1984198619881990199219941996 

The efficiency ratio is normally defined as noninterest expense * Noninterest expense/(net interest income + noninterest income) 

Source: Commercial Bank Call Reports divided by the sum of net interest revenue and noninterest revenue.
 

Kansas City Regional Outlook 7 Fourth Quarter 1997
 

2 
In Focus This Quarter
 

In any event, cost-cutting is not without its risks. For 

example, reductions in personnel, or excessive reliance 

on automated underwriting procedures (see Will Credit 

Scoring Transform the Market for Small-Business 

Lending? Second Quarter 1997), may raise concerns 

about the effectiveness of internal administration and 

control processes. Cost-cutting that cuts too deeply into 

customer service can erode franchise value. Mergers 

can reduce redundant expense, but at some point there 

may be diseconomies to managing a large organization. 

The Role of Capital in the Management 

of Earnings 

Management, shareholders, and analysts often evaluate 

earnings in relation to the level of capital using measures such as return on equity (ROE) and earnings per 

share (EPS). One result has been pressure on banks to 

continue to grow ROE and EPS; these objectives have 

been made progressively more difficult to attain by the 

significant level of capital that has built up over the past 

five years. 

Finding effective ways to deploy historically high capital levels appears to be one driving force behind the 

recent rash of mergers and acquisitions, high dividend 

payout ratios, increased stock repurchases, and the 

development of alternative types of hybrid capital such 

as trust preferred stock (see Financial Markets). For 

example, during 1995 and 1996, major merger and 

acquisition deals included some $835 billion in bank 

and thrift assets. During 1996, commercial banks with 

over $1 billion in assets had an average dividend payout 

ratio over 89 percent, up significantly from the 67 percent payout rate of 1994. Banks with under $1 billion in 

assets averaged 55 percent for 1996 and 52 percent for 

1994. In addition, banks and bank holding companies 

have issued some $21 billion in trust preferred stock 

during the last nine months, some of which has been 

used to fund the almost $42 billion in share repurchase 

programs announced by large banks during 1996 and 

early 1997.3 

While the book value of equity and other capital ratios 

has increased at the aggregate industry level, a number 

of banks are reporting declines in equity capital and 

leverage capital ratios despite positive earnings (see 

Chart 7). For all institutions, the ability to actively man3 Salomon Brothers. 

CHART 7 

An Increasing Number of Profitable Banks Are
 

Reducing Tier 1 Capital*
 

Number of Banks 

800 

600 

400 

200 

0 

1992 1993 1994 1995 1996 

* Both Tier 1 dollar amount and ratio 

Source: Commercial Bank Call Reports 

age capital accounts going forward will depend largely 

on having earnings available above the levels needed to 

fund dividends and growth, after assuming capital protection adequate for the level of business risk. Bankers 

and examiners will need to carefully review strategies 

that increase bank leverage or increase business risk 

without considering the potential effects of a downturn 

in credit quality or other weakening in the economy. 

Summary 

The most profitable period for U.S. banks in the postWorld War II era is paradoxically occurring during a 

time when banks’ traditional business lines are coming 

under greater competitive pressure than ever. While the 

industry as a whole is adapting well to these competitive 

pressures, there may be a tendency for some insured 

institutions to respond by accepting greater risks to preserve or gain business. 

The nature of banking is to profit by taking calculated 

risks, and naturally more profits will be made during the 

expansionary phase of a cycle than during a downturn. 

Nevertheless, the institutions that are best able to sustain their earnings and capital over the complete cycle 

will be those that allow for the possibility of an adverse 

change in business conditions, and prudently balance 

the levels of risk taken with the expected returns. 

Ronald Spieker, Chief, Depository Institutions Section 

Steve Linehan, Assistant Director, Analysis Branch 

George French, Deputy Director 

Kansas City Regional Outlook 8 Fourth Quarter 1997 
In Focus This Quarter
 

Strong Demand and Financial Innovation Fuel
 

Rebounding Commercial Real Estate Markets
 

•	 Commercial banks are leading a resurgence in 

commercial real estate financing; many metropolitan markets are experiencing rapidly rising rents 

and single-digit vacancy rates, suggesting the likelihood of further development. 

•	 New funds directed toward commercial real estate 

are being increasingly supported by commercial 

mortgage-backed securities and real estate investment trusts. 

•	 Some analysts have expressed concern that these 

financing vehicles may serve to heighten competitive pressures that will lead to more aggressive 

loan pricing. 

In the wake of declining values and the large losses of 

the late 1980s and early 1990s, commercial real estate is 

making a comeback. There are two stories here of interest to lenders. The first entails the remarkable resurgence in commercial real estate demand. The second 

involves the major changes taking place in how real 

estate is owned and paid for and—of greater interest to 

banks—who is financing this expanding activity. 

Commercial Banks Show Renewed Interest 

in Commercial Real Estate 

Strong evidence of commercial real estate’s rebound 

can be seen in its renewed attractiveness to lenders. 

TABLE 1 

Federal Reserve figures show that nearly $58 billion of 

new commercial mortgage debt was added to the market in 1995 and 1996 (see Table 1). While this new net 

lending pales in comparison with that of the late 

1980s—when nearly $74 billion in net new debt was 

added in 1987 alone—it positively shines when compared with the $89 billion shrinkage of commercial real 

estate loans from 1991 to 1994. Table 1 shows that commercial banks are leading this resurgence with a $37 

billion net increase in mortgage lending during 1995 

and 1996. 

Perhaps the most convincing evidence of commercial 

real estate’s recovery comes from the market itself. 

Rising prices and tightening supplies of space in most 

major markets and for most property types suggest a 

growing demand for new commercial property stock. 

Numerous indices and market studies support this 

notion: 

•	 As measured by Koll/NREI national composites, 

prices and rents turned up sharply after 1993, with 

rents surpassing their 1988 to 1989 levels by 1995 

(see Chart 1, next page). For office properties in particular, the ten fastest-growing cities in terms of rental 

rates saw increases exceeding 20 percent in 1996.1 

1 Those cities are, in order, Minneapolis, Columbus, Dallas, Portland, 

Salt Lake City, Atlanta, San Jose, Phoenix, San Francisco, and San 

Diego. 

Banks Are Increasing Their Flow of Funds into Commercial Real Estate ($ Billions) 

1991 1992 1993 1994 1995 1996 

NET NEW BORROWING, ALL SOURCES $ − 15.6 $ − 47.1 $ − 21.5 $ − 4.4 $ 22.6 $ 35.1 

COMMERCIAL BANKS 3.1 − 8.4 − 4.3 7.5 18.0 18.7 

CMBSS 1.3 8.7 10.3 11.3 10.6 16.1 

SAVINGS INSTITUTIONS − 22.4 − 18.5 − 7.5 − 6.8 − 1.8 0.8 

LIFE INSURANCE COMPANIES − 5.6 − 15.1 − 13.4 − 10.5 − 3.3 − 2.5 

ALL OTHER SOURCES 8.0 − 13.5 − 6.6 − 5.9 − 0.9 2.3 

EQUITY CAPITAL FLOW, ALL SOURCES $ 4.9 $ 3.1 $ 17.4 $ 21.6 $ 21.5 $ 30.3 

REIT EQUITY OFFERINGS 1.6 2.0 13.2 11.1 8.2 13.0 

PENSION FUNDS − 4.8 − 4.3 − 0.7 9.6 13.8 14.3 

ALL OTHER SOURCES 8.1 5.4 5.0 0.9 − 0.5 3.0 

Sources: Federal Reserve, National Association of Real Estate Investment Trusts (NAREIT), LaSalle Advisors 

Investment Research 

Kansas City Regional Outlook 9	 Fourth Quarter 1997 
In Focus This Quarter
 

•	 Property capitalization rates, which measure the 

annual income generated by a property as a percentage of its purchase price, are falling (see Chart 2). 

These falling rates indicate that investors are paying 

higher prices for each dollar of current income generated by the property. Overall, however, prices have 

not yet caught up with rents, which now exceed their 

previous highs in some markets, suggesting that the 

current recovery is not yet peaking. 

•	 Declining vacancy rates reflect strong demand for 

office properties, which Grubb & Ellis cast as the 

hottest sector in its 1997 forecast. Nationwide, office 

vacancies have fallen dramatically, by 5 to 10 percentage points during the last four years (see Chart 

3). Moreover, Torto-Wheaton Research estimates 

that 21 of the 56 metropolitan areas it tracks had 

single-digit vacancy rates at the end of first quarter 

1997. Not surprisingly, many of the tightest markets 

are those with the greatest rent inflation. 

While the unrestrained commercial development of the 

1980s continues to cast a shadow over the industry, that 

shadow is fading as declining vacancy rates and rising 

rental rates for existing properties fuel optimism 

among lenders and investors and strengthen the case 

for new development. Lenders, examiners, and analysts, however, must be diligent in monitoring commercial real estate markets to identify possible imbalances 

between supply and demand. It is particularly important that lending decisions be made on the basis of economic feasibility and realistic property cash flow 

projections rather than solely on the basis of competitive pressures. 

Borrowers’ Financing Options Expanding 

Although banks are clearly the largest source of financing for resurgent commercial real estate markets, a 

broader and more competitive financing market has 

emerged. In this market, financing often bypasses 

banks, being funneled instead through entities that purchase and securitize commercial real-estate-secured 

debt or the properties themselves, parceling them into 

smaller, more standardized, and thus more liquid pieces 

that are attractive to institutional and individual 

investors alike. This trend is illustrated in Table 1, which 

shows the increasing roles commercial mortgagebacked securities (CMBSs) and real estate investment 

trusts (REITs) have played in funding commercial real 

estate over the past five years. This increase in public 

CHART 1 

Prices and Rents on Upswing Nationwide 

Index (1986 = 1.00)
 

1.30
 

1.20
 Rents
 

1.10
 

1.00
 Prices
 

0.90
 

0.80
 

1990 1991 1992 1993 1994 1995 1996 

Source: Koll National Real Estate Index 

CHART 2 

Property Capitalization Rates Dropping 

8.0 

8.5 

9.0 

9.5 

10.0 

10.5 

11.0 

11.5 

1990 1991 1992 1993 1994 1995 1996 1997 

Overall Cap Rates (%)

Office 

Retail 

Apartment 

Source: Donaldson, Lufkin & Jenrette 

CHART 3 

National Downtown and Suburban
 

Class A Vacancy Rates Falling
 

8 

13 

18 

23 

Downtown 

Suburban 

Vacancy Rates (%) 

1988 1989 1990 1991 1992 1993 1994 1995 1996 

Source: CB Commercial / Torto-Wheaton Research 

Kansas City Regional Outlook 10	 Fourth Quarter 1997 
In Focus This Quarter
 

financing left financial institutions in 1996 with 

approximately a one-third share of all new net commercial real estate financing, down from well over half just 

a decade before. 

From a lender’s perspective, CMBSs offer several 

advantages over traditional portfolio lending. Most significantly, lenders can generate fee income from loan 

production and servicing activities while avoiding the 

excessive concentrations of credit risk that plagued 

lenders during the last real estate downturn.2 According 

to Commercial Mortgage Alert, outstanding CMBSs 

reached $125 billion in 1996 on a record $30 billion of 

new issuance. While outstanding volume is still dwarfed 

by the $3 trillion market for residential mortgagebacked securities (MBSs), the growth in CMBS volume 

has been remarkable considering that such securities 

were virtually nonexistent prior to 1991. 

At present, most commercial banks are not active in 

issuing CMBSs, accounting for only $2.6 billion of 

CMBS issuance in 1996, according to E&Y Kenneth 

Leventhal Real Estate Group. Rather, the primary 

source of these securities is investment banks, which 

generate substantial fees by converting existing loans 

into securities. CMBS issues also are being increasingly underwritten by conduits, which are entities created 

to originate mortgage loans for distribution to investors 

in the secondary market. Nomura Securities 

International estimates that such conduits accounted 

for over one-third of CMBS issuance in 1996, nearly 

double the volume of 1995. Only a handful of the 

largest commercial banks have set up conduit programs—the five largest banks accounted for $3.3 billion of the $10.2 billion in conduit issuance during 

1996. Aside from this relatively small number of bank 

competitors, investment banks are among the largest 

and most active conduit issuers. 

There is no fundamental reason why banks cannot take 

greater part in the rapidly growing CMBS market. In 

fact, they possess many distinct advantages over investment banks. Their distribution networks, lending experience, and back-office capabilities are naturally suited 

to facilitating loan demand, evaluating repayment risk, 

servicing loans, and monitoring a project’s development. Obstacles of scale may preclude smaller institu2 While securitization of loans purports to shift credit risk to investors, 

many analysts and rating agencies have recently expressed concern 

over recourse arrangements, both contractual and voluntary, whereby 

the seller/servicer effectively assumes all or most of losses experienced by the security. 

tions from directly issuing CMBSs ($500 million in volume is often cited as a minimum for efficiently assembling a deal). However, if the CMBS market develops 

like that for MBSs, standardized underwriting may 

enable small institutions to remain competitive either by 

cooperatively forming their own conduits or by selling 

their loans to existing conduits. 

Whether or not banks take part, the continuing development of a market for securitized commercial real estate 

assets raises a number of efficiency issues for direct 

lenders. Securitization provides property developers and 

owners access to a much larger pool of potential funding 

sources and a wider array of funding options. Moreover, 

the costs of public financing reflect efficiencies born of 

standardization and liquidity. In short, investors, including banks, can price, enter, and exit their positions in 

securitized debt more easily than could be done with 

whole loans. While improved efficiencies are a positive 

aspect of the growth in securitized investments, these 

efficiencies threaten to dictate bank pricing, thereby 

potentially reducing margins or driving institutions to 

lend on less economically feasible projects in an effort to 

preserve margins and market share. 

REITs: An Alternative to Traditional 

Capital Sources 

Commercial real estate financing is evolving in other 

ways. REITs have become major players in the industry 

since 1993, accounting for fully one-fifth of funds flowing into real estate in 1996. REITs are much like mutual funds in that they allow indirect investment in real 

estate through purchases of equity in the REIT. The 

REIT itself holds title to the underlying properties and, 

provided it meets certain requirements, can directly pass 

through its earnings to investors without any intermediate tax. Although Moody’s estimates place REIT holdings at less than 3 percent of all U.S. commercial real 

estate, outstanding REIT shares have grown considerably, with market capitalization doubling nearly three 

times in just four years (see Chart 4, next page). 

Accompanying this rise in capitalization has been an 

equally dramatic rise in bank lending to REITs. 

According to Loan Pricing Corporation, bank lending 

to REITs surged to $12.8 billion in 1996, a 16 percent 

increase over 1995’s then-record volume and more than 

a tenfold increase over the period 1990 to 1992. 

The rise in REIT capitalization can be attributed in part 

to pent-up institutional demand for real estate. REITs 

Kansas City Regional Outlook 11 Fourth Quarter 1997 
In Focus This Quarter
 

CHART 4 

REIT Capitalization Soaring 

0 

10 

20 

30 

40 

50 

60 

70 

80

$ Billions 

0 

400 

1996

50 

100 

150 

200 

250 

300 

350 

Market Capitalization (Left Scale) 

Number of REITs (Right Scale) 

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 

Source: National Association of Real Estate Investment Trusts

have a particular appeal to fund managers since they 

offer the benefits of investment diversification without 

the dual headaches of property management and asset 

illiquidity. Aside from the direct credit risk posed by 

lending to REITs, their rising popularity confronts banks 

with an indirect threat as well—the threat that banks 

could be crowded out of lending opportunities if 

investors find REIT funding structures more attractive 

from a cost and control standpoint. The degree to which 

this crowding out may occur is unclear, for according to 

Nomura Research, REITs historically have borrowed 40 

cents for each dollar of real estate held. However, well 

over half of this borrowing takes place through public 

offerings of secured and unsecured debt, leaving only a 

small portion to be financed by banks and other private 

lenders. Because REITs tend to focus on the highest 

quality projects, their increasing presence also creates 

concerns that banks may be driven to lend to less attractive or more risky properties to preserve market share. 

Many analysts have also expressed unease over the rapid 

rise in the valuations of REITs, some of whose shares 

are priced at a considerable premium to the properties 

themselves. Anecdotal evidence suggests that premiums 

as high as 40 percent over market value have been paid 

for some REIT shares in recent months. Such marketbased valuations create concern over the extent to which 

an REIT’s capital structure allows it to pay more for 

properties than an investor who employs greater financial leverage. Accordingly, while REITs may make up a 

fairly nominal amount of overall real estate holdings, 

they may be quite influential in determining how commercial properties are being valued or appraised. 

Commercial Real Estate Securitization: 

Some Broader Implications 

Maturing CMBS markets could eventually improve the 

overall stability of commercial real estate markets not 

only by improving market liquidity but also by enabling 

investors to diversify and share their credit exposures 

among a greater number of participants. In addition, 

loan performance could become increasingly transparent to the general marketplace, thereby encouraging 

more uniform and prudent underwriting standards. 

However, concern naturally arises because CMBSs are 

a major source of commercial real estate market funding that has not been tested through a serious market 

downturn. This situation leads to questions concerning 

the impact they will have on property values and market 

liquidity and whether today’s underwriting terms, driven 

largely by competitive factors, will stand up to tomorrow’s market downturn. Another question is whether the 

standardized structures underlying these securities offer 

enough flexibility to borrowers to renegotiate loan 

terms—a critical workout tool during times of financial 

stress. The answers to these questions will ultimately 

determine the extent to which lenders and investors suffer as a result of the inevitable cyclical swings in commercial property values. 

There are also questions about how REITs will affect 

commercial real estate markets. One argument is that 

the appetite for REIT investments, combined with the 

premiums that the trusts can pay for properties, will 

push the price of commercial space beyond sustainable 

levels. Those who hold this view see REITs, and other 

Wall Street innovations that increase the supply of funding, as potentially amplifying cyclical swings in real 

estate values. The contrary view holds that REITs will 

improve market efficiency by providing continuous 

pricing benchmarks through daily share price movements and thus enforce discipline upon developers and 

lenders. This discipline, it is argued, will prevent excessive development and dampen the severity of real estate 

cycles. 

As an investment, commercial real estate is quickly 

regaining the broad favor it lost during the last market 

downturn. But the channels through which a lender or 

investor can participate in this market are expanding 

even more dramatically. Investment exposures to real 

estate are no longer effectively limited to private equity 

or debt. The choices are multiplying, with liquid public 

markets for both debt and equity providing the foundation for existing and future commercial real estateKansas City Regional Outlook 12 Fourth Quarter 1997 
In Focus This Quarter
 

based instruments—instruments such as swaps, options, 

and property derivatives—that will permit the tailoring, 

hedging, and even creation of synthetic real estate 

investment positions. Although financial institutions are 

participating in this revival, it is clearly a different world 

from the old, and one in which they will have to choose 

how best to compete against—or participate in—these 

new real estate financing strategies. 

Steven Burton, Senior Banking Analyst 

sburton@fdic.gov 

Gary Ternullo, Senior Financial Analyst 

gternullo@fdic.gov 

Demand for Commercial Real Estate 

Remains Strong in Region’s Largest 

Metropolitan Areas 

Office vacancy rates have been declining steadily 

since 1992 in Minneapolis, St. Louis, and Kansas 

City, the largest metropolitan areas in the region. As 

seen in Chart 5, office vacancy in all three markets 

has been below the national average since that time. 

In Minneapolis, office vacancy rates declined to 5.7 

percent in the second quarter of 1997, the lowest level 

recorded in 14 years. The low vacancy rates have led 

to rising rents and intense competition among 

prospective tenants. In Minneapolis, rental rates for 

Class A offices have been rising consistently in both 

the downtown and suburban parts of the market. 

Strong employment growth and continued interest in 

downtown locations have contributed to strong 

demand in the Minneapolis–St. Paul metropolitan 

area. According to data provided by FW Dodge, more 

than 5.6 million square feet of office space has been 

absorbed in the two cities since 1993, with negligible 

new construction during the same period. Responding 

to the present situation, plans for more than 8 million 

square feet of new office space have been announced 

for completion over the next five years. Vacancy rates 

in the industrial market have increased to 8 percent in 

the second quarter of 1997, up from 6 percent in 

1995, following construction of 8.3 million square 

feet in the last half of 1996. Demand for retail space 

remains strong, as almost all of the 2.1 million square 

feet built in 1996 has been rented. 

Office vacancy rates in St. Louis have declined to 10 

percent in 1997, down from nearly 20 percent in 

1990. Growing demand and insignificant added space 

over the period have worked to tighten the market. 

Demand in the suburban market has strengthened 

consistently, and the downtown market has revived in 

1997, after some weakness in 1996. The industrial 

vacancy rate has declined to 2 percent in the second 

quarter of 1997, as new demand outstripped the 2.3 

million square feet built in 1996. In the retail market, 

continued construction of “big-box” retail stores continues to augment supply in both city and suburban 

markets. 

Office vacancy rates in Kansas City reached 11.2 

percent in the second quarter of 1997, somewhat 

above those in Minneapolis–St. Paul and St. Louis, 

but still tight enough to drive rent increases. One 

industry observer noted that single-year increases in 

office rents in 1997 were the highest in his experience. A number of new construction projects scheduled for 1998 and 1999 will add more capacity to the 

stretched market. Industrial vacancy rates reached 8 

percent in the second quarter of 1997, with a number 

of large warehouses in the planning stages. 

Jeffrey W. Walser, Regional Economist 

CHART 5 

4 

6 

8 

10 

12 

14 

16 

18 

20 United States 

Minneapolis St. Louis 

Kansas City 

Office Vacancy Rates in Kansas City Region 

Metro Areas Decline after 1992 

19901991199219931994199519961997 

Source: Haver 

Vacancy Rate % 

Kansas City Regional Outlook 13 Fourth Quarter 1997 
Regular Features	 Regional Economy
 

Kansas City Region: Rural Counties Pursue
 

Widely Divergent Growth Paths
 

•	 The economic performance of the Region’s rural counties has improved substantially from the 1980s, but 

wide inequality in the counties’ growth persists in the 1990s. 

•	 Branson, Missouri, enjoyed a significant tourist-driven boom but it shows signs of slowing. 

•	 The increasing average age of farmers may pose new challenges to agricultural banks. 

Growth Record of Rural Counties: 

A Mixed Bag in the 1990s 

Employment growth in the Kansas City Region lagged 

that of the United States in the 1980s but has been 

stronger in the 1990s. Chart 1 compares growth during 

the period 1980 to 1994 for the United States, the 

Region, and rural and urban counties of the Region. As 

the graph suggests, employment growth in the 72 metropolitan counties was essentially the same in both 

decades: an annual average of 1.68 percent in the 1980s 

and 1.66 percent in the 1990s. The Region’s improved 

record in employment growth can be attributed to the 

turnaround in growth in the 546 rural counties, from 

–0.30 percent in the 1980s to 1.45 percent in the 1990s. 

These rural counties accounted for 41 percent of the 

Region’s population of 18.2 million in 1994. 

During the 1980s, many rural counties were hurt by 

structural changes in agriculture and rural retail trade, 

resulting in declining employment and population 

throughout the decade. The 1980s were a period of 

CHART 1 

Rural Counties Do Their Share for 

Employment Growth in the 1990s 

2.0 1990s

Annual Growth Rate, %

1.5 

1.0 

0.5 

0.0 

1980s 

–0.5 United Kansas City Metro Rural 

States Region Counties Counties 

Source: Bureau of Labor Statistics 

continuing consolidation in agriculture, as advances 

in technology allowed farmers to farm more land at 

less cost. Between the 1982 and 1992 Censuses of 

Agriculture, the number of farms in the seven states of 

the Region declined by 76,000, or more than 14 percent 

of the total. Improved agricultural technology, and the 

fewer, larger farms that followed, reduced employment 

both on the farm and in the industries that support agriculture, such as machinery dealerships, feed mills, and 

lumberyards. Importantly, larger farms tend to rely less 

on the local economy for financing and other inputs. 

The 1980s also saw substantial consolidation in the 

rural retail sector, at the expense of merchants in smaller communities. Large national retailers built a number 

of stores in rural areas, using superior management and 

distribution to underprice their Main Street competitors. 

In a study of Iowa’s rural counties from 1983 to 1993, 

Dr. Kenneth Stone of Iowa State University found the 

introduction of national discount retail stores into 34 of 

Iowa’s larger rural towns caused a decline of 46 percent 

in retail sales in nearby towns with populations of less 

than 1,000. The consolidation of rural retail trade often 

led shoppers to cross county lines, to the detriment of 

their home counties. 

While structural transformation was widespread across 

the Region, not all areas were affected equally. A closer 

examination confirms that the performance of the rural 

counties was far from uniform. The 546 rural counties 

were ranked by average annual employment and per 

capita income growth during the 1980 to 1994 period. 

The 103 counties that were above average in both 

employment and income growth were classified as 

high-growth counties, while those that were below average in both statistics were classified as low-growth 

counties. The remainder of the counties, those with 

above-average performance in one category but not the 

other, were defined as neutral counties. Chart 2 shows 

Kansas City Regional Outlook 14	 Fourth Quarter 1997 
Regular Features 

CHART 2 

Economic Growth Varies Widely 

across Region’s Counties 

County 

Categories 

Low Growth 

High Growth 

Neutral or Metro 

the distribution of high-growth and low-growth rural 

counties in the Region. 

Table 1 displays annual rates of growth in employment 

and per capita income for the categories of counties and 

in the two decades under consideration. The table shows 

the marked divergence between the 103 high-growth 

counties and 164 low-growth counties in the 1980s. 

Both employment and population were declining 

strongly enough in the low-growth counties to result in 

declines for the total of rural counties. As suggested in 

the opening paragraph, rural counties have improved 

TABLE 1 

Low-Growth Counties Improve in the 

1990s but Continue to Lag 

GROWTH RATE 1980S 1990S 1980– 

1994 

EMPLOYMENT: 

METRO 1.68% 1.66% 1.67% 

RURAL − 0.03% 1.54% 0.41% 

HIGH GROWTH 1.15% 2.55% 1.55% 

LOW GROWTH − 1.13% 0.77% − 0.59% 

PER CAPITA INCOME: 

METRO 1.47% 1.25% 1.41% 

RURAL 1.97% 1.19% 1.74% 

HIGH GROWTH 3.07% 1.64% 2.66% 

LOW GROWTH 1.06% 1.08% 1.07% 

Source: Bureau of Labor Statistics, Bureau of 

Economic Analysis 

Regional Economy 

considerably in employment and population growth in 

the 1990s, but it is important to recognize the considerable variation in economic performance across the rural 

counties. Per capita incomes in the low-growth counties 

have grown at about the same rate in both decades, and 

more slowly than in the high-growth and metropolitan 

counties. 

A 1996 study by the Federal Reserve Bank of Kansas 

City1 included a similar analysis of the counties of the 

Region’s seven states, plus those of Montana, Wyoming, 

Colorado, Oklahoma, and New Mexico. This investigation found that low-growth counties were twice as likely to have farming as their principal industry as the 

high-growth counties and 75 percent more likely to 

have retail trade as their principal industry. 

Our study of just the Kansas City Region’s seven states 

does not find such clear-cut differences in the industrial structures of the high-growth and low-growth counties. Approximately half of both sets of counties have 

farming as their most important industry, and the prevalence of retail trade is nearly equal in both sets. This difference in results likely occurs because of important 

differences in the populations examined by the Federal 

Reserve study and the present analysis. The rural counties of the Kansas City Region significantly underperformed those of Montana, Wyoming, Colorado, 

Oklahoma, and New Mexico, the additional five states 

in the Federal Reserve study. Average annual employment growth in the Region’s rural counties was 0.41 

percent during the 1990 to 1994 period, while it was 

1.85 percent in the other five states. 

The rural counties studied in the Kansas City Region 

were less varied in performance and industrial structure 

than the larger set of counties studied in the 12 states, so 

broad measures of industry concentration were less 

likely to show clear-cut patterns. The Federal Reserve 

study tends to support the suggestion that consolidation 

in farming and rural retail trade contributed to poor performance by some rural counties. The present study 

suggests that while such an association may be true on 

average, performance varies significantly within the set 

of farm-based and retail-trade-based counties. Further 

research is needed for a more complete explanation of 

the variation in rural counties’ performance. Measures 

of the degree and speed of consolidation in the farming 

and retail industries would likely lead to a more com1 M. Drabenstott and T. Smith. “The Changing Economy of the Rural 

Heartland.” Economic Forces Shaping the Rural Heartland. Federal 

Reserve Bank of Kansas City, April 1996: 1–11. 

Kansas City Regional Outlook 15 Fourth Quarter 1997 
Regular Features Regional Economy
 

plete understanding of the rural counties’ economic 

growth. 

In Regional Banking Conditions (see page 23), the performances of banks in the high-growth and low-growth 

counties, as defined above, are compared. The analysis 

shows that institutions headquartered in low-growth 

counties were less likely to grow between 1984 and 

1996. Additionally, institutions in the low-growth counties experienced lower earnings during the difficult 

1980s but converged with institutions in the highgrowth counties in the 1990s. 

Branson: Small Town, Big Growth 

When rapid growth in a small rural town is supported by 

a single industry, that area may be quite vulnerable to 

changes in that industry. With such vulnerability, are 

there implications for the local economy and banking in 

the local economy? A look at Branson, Missouri, may 

provide answers. 

Before Branson was mentioned on national television in 

1991 as the “country music capital of the universe,” the 

town was characterized as a rather sleepy community of 

about 3,700 residents in the Ozark Mountain region of 

southern Missouri. It was known regionally for the 

recreational offerings of Silver Dollar City, a historythemed entertainment park, and Table Rock Lake, 

which attracted 3 million visitors in 1986. 

With the influx of country music stars who built their 

own theaters, Branson boomed as few places have 

CHART 3 

boomed before. It is now the most popular destination 

for motor coach tours in America and the second most 

popular holiday destination for motorists. While annual 

visitor counts are no longer provided by the Branson 

Convention and Visitor’s Bureau, the last publication 

shows more than 6.5 million visitors for 1995. 

According to figures published in the Springfield 

Business Journal, the city now has 38 theaters with 

more than 51,000 seats, 199 lodging facilities with 

more than 17,000 rooms, and 163 sit-down restaurants 

with some 25,000 seats. Annual visitor projections once 

ran as high as 10 million visitors by 2000. 

However, there are signs that Branson’s boom has lost 

most of its momentum. Annual visitor counts have hovered in the range of 5.5 million to 6.5 million for four 

years, making the attainment of the projected 10 million 

visitors improbable. The city has recorded no major 

construction projects in two years. As Chart 3 shows, 

the value of new construction has steadily declined from 

a high of $119.5 million in 1993 to only $8.2 million 

through midyear 1997. The employment growth rate, 

which increased greatly during the years of highest construction activity to just over 26 percent in 1993, is 

sharply down since then, with a rate of just over 1 percent in 1996. In addition, in July 1997, a major commercial bankruptcy filing was made by the owners of 

Branson’s Yellow Ribbon Theater. 

Implications: Banks in high-growth areas face a unique 

dilemma. Boom years offer opportunities to grow balance sheets and shareholder wealth. But such rewards 

are not without commensurate risk. To take advantage 

of such opportunities, banks may increase staff levels 

and fixed overhead expenses and, most important, conBranson’s Boom Is Illustrated by Construction Values in the City 

$ Millions
 

119.5
 120
 

100
 

87.0
 

80
 

55.1 60
 

44.5
 

39.0 40
 

22.6
 

20
 14.5 10.6 7.4 8.2 

0 

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 

(year to 

Source: City of Branson date) 

Kansas City Regional Outlook 16 Fourth Quarter 1997 
centrate their loan portfolios in real estate construction 

and commercial loans to businesses driven by the boom. 

Such concentrations could possibly leave banks with 

high overhead costs and problematic loans should the 

boom suddenly quit. As in any high-growth area like 

Branson, the banks most at risk are those with little 

opportunity to diversify their portfolios during the 

boom years. 

Aging of Farmers May Pose New Challenges 

to Agricultural Banks 

The average age of farm operators in the United States 

has risen significantly since the World War II period. 

According to U.S. Census of Agriculture data as presented in Table 2, the average age of farm operators 

reached a record high of 53 years by 1992. In the 1992 

census, 47 percent of all farm operators were more than 

55 years old, compared with 42 percent reported in 

1982. For farmers less than 35 years old, the proportions 

were 10 percent in 1992 and 16 percent in 1982. 

During the 1950s and 1960s the average age of farmers 

increased sharply as the expanding economy drew larger proportions of farm children into urban employment. 

The level of new entrants into farming remained low 

during this period, until the average age reached a then 

high level of 51.7 years in 1974. In the 1970s the 

decline in farm numbers slowed as the number of new 

entrants increased for the first time since the postwar 

years. The increase in new entrants can be explained by 

a pair of “booms” in the 1970s. Baby boomers in the 

farm community came of age in the 1970s, resulting in 

a bulge in the number of people with the interest and 

TABLE 2 

Regular Features Regional Economy
 

inclination to pursue farming. At the same time, the 

1970s were marked by a boom in the farm sector, driven 

by strong export demand and easily available credit. 

The census data indicate, however, that the average age 

of farmers has increased sharply in the 1980s and 1990s 

as the number of new entrants has again fallen. For the 

same reasons as for its temporary decline in the 1970s, 

the average age of farmers will probably continue to 

increase in the future. The combination of off-farm 

migration and the declining size of farm families during 

the past several decades means the number of people 

raised on farms is shrinking rapidly. According to estimates by Fred Gale, an economist at the U.S. 

Department of Agriculture, the pool of potential farm 

entrants continues to shrink, as shown in Table 3. 

In addition to the demographic trend, farming has 

become a less attractive career for the prospective 

entrant since the booming 1970s. The increasing size of 

farms, which have grown from an average of 297 acres 

in 1960 to 469 acres in 1996, has led to increased capital requirements to enter farming. Young farmers typically have little equity and often have difficulty 

obtaining sufficient financing, because they have a 

short track record in farm management for prospective 

lenders to evaluate. 

With fewer new farmers able to buy out those who 

retire, the practice of leasing land from absentee landlords has increased. According to a July 25, 1995, article in the American Banker, the proportion of farmland 

held by absentees has been increasing over the past 15 

years and is approaching half of all farmland. 

TABLE 3 

Average Age of Farmers Resumes 

Upward Trend 

Number of Potential Farm Entrants 

Is in Steep Decline 

20 TO 29-YEAR-OLDS 

RAISED ON FARMS 

YEAR (IN THOUSANDS) 

1980 1,443 

1985 917 

1990 671 

1995 454 

2000 (PROJECTED) 375 

YEAR AVERAGE AGE 

1940 46.5 

1959 50.5 

1964 51.3 

1974 51.7 

1978 50.3 

1982 50.0 

1987 52.0 

1992 53.0 

Source: U.S. Census of Agriculture, various years 

NUMBER OF FARMS 

(IN THOUSANDS) 

6,350 

4,105 

3,457 

2,795 

2,436 

2,407 

2,213 

2,108 

Source: Fred Gale, U.S. Department of Agriculture, 

in “The New Generation of American Farmers,” 1994 

Kansas City Regional Outlook 17 Fourth Quarter 1997 
Regular Features	 Regional Economy
 

Implications: The increasing average age of farmers 

may affect agricultural banks in at least three ways: 

•	 New entrants into farming are more likely to rent 

their farmland for longer periods. Tenant farmers who 

lack equity in the form of 

landholdings will tend to be 

a riskier class of borrowers. 

As tenant farming has 

become more prevalent, 

more complex rental agreements have begun to appear 

that are tailored to the risk 

profiles of the landlord and tenant. Agricultural 

lenders will have to gain experience in evaluating the 

risk of tenant enterprises. 

•	 Agricultural banks may face a declining pool of loan 

candidates. The declining number of new entrants 

into farming implies that retiring farmers are more 

likely to sell their land to established farmers, speeding the consolidation of the industry. Larger-scale 

farms are more likely to look outside the local community for financing, decreasing both the size and 

the quality of the market in which community banks 

compete. 

•	 The increasing age of farmers may also negatively 

affect agricultural banks’ source of funding. As an 

increasing proportion of farmland is owned by 

retired farmers or their widows, who are likely to 

move away in retirement, community banks may lose 

important depositors. Similarly, when farmers die 

without passing on the land to their children, the land 

will likely be sold and the wealth distributed outside 

the community to the heirs. 

Jeffrey W. Walser, Regional Economist 

Marsha Martin, Regional Manager, 

Division of Resolutions and Receiverships 

Kansas City Regional Outlook 18	 Fourth Quarter 1997 
Regular Features	 Financial Markets
 

Financial Markets
 

• Bank holding companies of all sizes have issued trust preferred stock following the Federal Reserve’s decision in October 1996 to count these tax-advantaged capital securities toward Tier 1 capital. 

•	 Although the tax-advantaged status of trust preferred stock was not eliminated in the federal budget this 

year, there still exists the possibility that the Internal Revenue Service may alter the tax treatment of trust 

preferred dividends. 

• Institutions contemplating issuing trust preferred stock should be aware of the concerns expressed by rating agencies and of the potential risks associated with excessive reliance on debt-like capital instruments. 

Bank holding company capital requirements were effectively relaxed in October 1996 when the Federal 

Reserve ruled that trust preferred stock may be included in the portion of cumulative preferred stock that can 

compose up to 25 percent of a bank holding company’s 

Tier 1 capital. In the wake of this decision, financial 

institutions moved quickly to issue trust preferred stock. 

Trust preferred stock can be a less expensive form of 

Tier 1 capital for bank holding companies because of 

the tax deductibility of the dividend payments paid on 

this type of preferred stock. 

Approximately 90 banking organizations issued an estimated $21 billion of trust preferred shares from October 

1996 through June 1997.1 The dollar amount of trust 

preferred stock issued represented almost 95 percent of 

the incremental amount of Tier 1 capital added by those 

institutions during the period. A number of these institutions used the proceeds of trust preferred stock issues 

to fund stock buyback programs. As an example of the 

relative importance of these stock buyback programs, 

one large bank holding company’s Tier 1 capital ratio 

would be 7.25 percent excluding the trust preferred 

shares, and 8.34 percent including the shares. 

Rating agencies and investment analysts have argued 

that trust preferred stock is a weaker form of Tier 1 capital because of its limited life and debt-like characteristics. These characteristics include the tax treatment of 

trust preferred dividends,2 the limited life of the shares, 

and the ability of investors to accelerate their claims 

against the bank holding company. Institutions contem1 The amount of trust preferred stock outstanding is not delineated in 

Call Reports. 

2 Trust preferred dividends, unlike dividends on traditional preferred 

stock, are treated as a tax-deductible expense at the bank holding 

company level and as taxable income by investors of the trust preferred shares. 

plating issuing trust preferred stock should be aware of 

the concerns expressed by rating agencies and of the 

possibility that excessive reliance on debt-like capital 

instruments could increase their financial fragility during times of economic stress. 

Trust Preferred Structure 

Provides a Tax-Advantaged 

Capital Funding Alternative 

Trust preferred shares, also 

known as capital securities, are 

traded under different names 

depending on the underwriter, payment terms, and 

maturity. Some of the more common acronyms include 

TOPRS (Trust Originated Preferred Shares), QUIPS 

(Quarterly Income Preferred Shares), and MIPS 

(Monthly Income Preferred Shares). 

Although trust preferreds are issued under different 

names, they share the same basic structure (see Chart 1, 

next page). A non-taxpaying subsidiary, or “trust,” of 

the bank holding company is formed. The trust issues 

two classes of stock: common and preferred shares. The 

common stock of the trust subsidiary is owned by the 

bank holding company, and the trust preferred stock is 

sold to investors. The trust upstreams the proceeds from 

the sale of the preferred shares to the bank holding company in exchange for a long-term, deeply subordinated 

note with terms identical to the trust preferred shares. 

(The subordinated note must be the sole asset of the 

trust and subordinated to all other debt of the bank holding company.) 

On a consolidated basis, the trust preferred stock is 

treated as a minority interest of the bank holding company, and the subordinated note is eliminated as interKansas City Regional Outlook 19	 Fourth Quarter 1997 
Regular Features Financial Markets
 

CHART 1
 

How Is Trust Preferred Stock Structured 

to Count as Tier 1 Capital? 

Trust Preferred 

Proceeds 

Trust Preferred Shares 

Dividend Payments—funded by interest 

received on subordinated note 

Investors in Trust 

Preferred Shares 

Trust Subsidiary 

Issues trust preferred shares 

(structured as a non-taxpaying entity) 

Trust Preferred Proceeds 

(Trust preferred shares treated as 

minority interest by BHC and 

counted toward Tier 1 capital) 

Subordinated Note—same coupon 

and payment terms as trust preferred 

shares, booked as intercompany debt 

and eliminated upon consolidation 

Interest Payments—paid with 

before-tax dollars by the BHC 

Bank Holding Company 

(BHC) 

(BHC owns common stock of 

trust subsidiary) 

Kansas City Regional Outlook 20 Fourth Quarter 1997
 
Regular Features Financial Markets
 

company debt. The interest paid by the bank holding 

company on the subordinated note, which is taxdeductible at the bank holding company level, is used to 

fund the dividends on the trust preferred shares. In 

short, the issuing trust serves as a conduit for exchanging cash flows between the bank holding company and 

the investors in the trust preferred shares. 

To be eligible for Tier 1 capital treatment, trust preferred dividends may be cumulative, but dividends must 

be deferrable for a minimum of five years. If the dividends are not paid for more than five years, the trust 

preferred shares could be exchanged for junior subordinated debt of the trust. After the exchange, the trust preferred holder could declare an event of default and 

accelerate the claim against the bank holding company. 

Trust preferred shareholders would then be treated similarly to deeply subordinated debt holders or preferred 

stockholders of the bank holding company. 

Trust preferred shares typically have maturities of 30 

years or more and contain call options and redemption 

provisions. The redemption provisions, which are subject to Federal Reserve approval, permit the issuer to 

redeem or buy back the preferred shares prior to maturity upon an adverse event such as the loss of Tier 1 capital treatment or the tax deductible status. 

Banks are not permitted to count trust preferred stock 

toward Tier 1 capital because of the cumulative feature 

of trust preferred dividends. While bank holding companies are permitted to include up to 25 percent of Tier 

1 capital as cumulative preferred stock, including trust 

preferred shares, banks must exclude cumulative preferred stock from Tier 1 capital ratios pursuant to the 

Risk-Based Capital Standards set by the Basle Accord. 

Bank Holding Companies of All Sizes 

Have Issued Trust Preferred Stock 

The flood of trust preferred stock issuance was prompted in part by the threat of extinction under the 1997 

federal budget. Bank holding companies rushed to take 

advantage of a potentially short-lived tax loophole, 

while investors were attracted by the opportunity to 

earn higher rates than on similarly rated bank debt. 

Bank holding companies have used proceeds from trust 

preferred stock to retire or call more expensive outstanding preferred issues, to provide capital to bank 

subsidiaries, to finance acquisitions, and to buy back 

common stock. 

As the tax advantage of the trust preferred stock 

remained intact through the budget negotiations, the 

pace of trust preferred issuance subsided from an estimated $4.3 billion in the first quarter of 1997 to just 

under $2.5 billion in the second quarter. Trust preferred 

issuance by larger banks declined as some approached 

their limit on Tier 1 trust preferred, while more smaller 

banks took advantage of the market for trust preferred 

stock. (See Chart 2 for a distribution of the number of 

banks in various size categories that have issued trust 

preferred stock in recent quarters.) Investment bankers 

are reportedly working on new structures that may make 

it easier and more cost effective for smaller institutions 

to issue these capital securities, perhaps through some 

pooling arrangement. 

REIT Preferred Stock—Another Type 

of Tax-Advantaged Tier 1 Capital 

Prior to the Federal Reserve’s announcement last 

October, the REIT (real estate investment trust) preferred stock structure was the chosen way for financial 

institutions to issue tax-advantaged preferred shares. 

Bank-issued REIT preferreds lost favor once trust preferreds debuted, because the trust structure is less costly and easier to administer than REIT preferreds. 

In an REIT preferred structure, the issuer establishes a 

corporation that elects REIT tax status. Proceeds from 

the preferred shares that are sold to investors are used to 

purchase qualifying real estate assets such as mortgagebacked securities or equity interests in real property. 

Cash flow from the real estate assets funds the REIT’s 

CHART 2 

More Small Institutions Issue Trust
 

Preferred Stock
 

Bank Size 

Number of < $10 billion Banks 

$10-100 billion 30 

$100+ billion 25 

20 

15 

10 

5 

0 4Q96 1Q97 2Q97 

Source: Keefe, Bruyette & Woods 

Kansas City Regional Outlook 21 Fourth Quarter 1997 
Regular Features Financial Markets
 

operating costs and preferred dividends. As long as the 

subsidiary continues to qualify for REIT tax status,3 dividend payments on the common and preferred shares 

are tax deductible by the holding company. 

Will the Tax-Advantaged Status of Trust 

Preferred Stock Continue? 

Although the tax-advantaged status of trust preferred 

stock was not eliminated in the federal budget, the possibility still exists that the Internal Revenue Service 

(IRS) may alter the tax treatment of trust preferred dividends. (In the first half of 1997, the IRS issued a ruling 

that eliminated the tax-advantaged status of a specific 

type of preferred stock known as Step-Down preferred 

stock.) If the tax advantage is eliminated, REIT preferred shares might again become a more popular 

means of raising tax advantaged Tier 1 capital. 

Issues and Concerns 

A number of bank holding companies have embarked 

on stock buyback programs financed by trust preferred 

stock issuance, thereby boosting earnings per share by 

reducing the number of common shares outstanding, 

while maintaining Tier 1 regulatory capital ratios. 

Rating agencies and investment analysts, however, 

generally view trust preferreds as analogous to preferred stock or deeply subordinated debt of the issuer. 

In fact, Standard & Poor’s has announced that bank 

holding companies with trust preferred stock in excess 

of 10 percent of Tier 1 capital may be subject to a ratings review. This announcement reflects the view of 

some analysts that trust preferred stock is a weaker 

form of Tier 1 capital than other forms of capital such 

as common and perpetual preferred stock, because of 

its limited life and treatment upon a liquidation of the 

trust. 

A recent regulatory interpretation has underscored the 

debt-like nature of trust preferred stock. The Office of 

the Comptroller of the Currency (OCC) has determined 

that investments by banks in trust preferred stock 

should be treated as investments in debt securities.4 The 

OCC cited a number of similarities between trust preferred stock and debt securities, including the fact that 

an investment in trust preferred securities is functionally equivalent to an investment in the underlying subordinated debt issued by the bank holding company, and 

that the trading characteristics of trust preferred securities are similar to traditional debt securities. 

Banking organizations should be aware of the views of 

rating agencies and bank analysts toward trust preferred 

stock. In times of economic stress, excessive reliance on 

debt-like capital instruments could result in increased 

financial fragility of the overall organization, a higher 

cost of raising new capital, and potential ratings downgrades. In extreme scenarios, pressures on the bank to 

service the obligations (explicit or implicit) of the 

holding company could attract the attention of bank 

regulators. 

Kathy R. Kalser, Chief 

Financial Sector Analysis Section 

3 To qualify as an REIT, the subsidiary must comply with Section 856 

of the U.S. Federal Income Tax Code, which requires that 75 percent 

of the REIT’s income come from real property rents, interest income 

from mortgage debt on real property, and other related sources. In 

addition, the REIT must distribute at least 95 percent of its net income 

to shareholders. 

4 In a letter dated April 8, 1997, the OCC stated that subject to applicable rating and marketability requirements, bank investments in trust 

preferred stock would be treated as Type III investments under 12 

CFR Section 2 1.2 (k). 

Kansas City Regional Outlook 22 Fourth Quarter 1997 
Regular Features	 Regional Banking
 

Regional Banking Conditions
 

•	 The overall condition of the Region’s commercial banks remains sound, with capital and earnings providing considerable financial strength. 

•	 Asset quality remains solid, but some weaknesses are noted in North Dakota and South Dakota. 

•	 Community banks continue to show strong loan growth concentrated in real estate and small business loans. 

•	 A review of bank performance in rural counties suggests that institutions in certain counties are less likely 

to grow and that they may be more susceptible to economic downturns. 

The Region’s Banks Remain Sound 

On an aggregate basis, the Region’s commercial banks 

continue to reflect sound financial conditions. As Chart 

1 indicates, during the second quarter of 1997 the 

Region’s banks: 

•	 maintained their return-on-assets ratio at 1.4 percent, 

compared with the national average of 1.3 percent; 

•	 widened their net interest margin to 4.8 percent, 

compared with the national average of 4.2 percent; 

and 

•	 increased their leverage capital ratio to 8.8 percent, 

compared with the national average of 7.8 percent. 

CHART 1 

Kansas City Region Banks Continue 

Percent to Show Financial Strength 9
 

8
 United States Jun-96 Jun-97 Jun-97
 

7
 

6
 

5
 

4
 

3
 

2
 

1
 

0
 

Jun-95 

Return on Net Interest Past-Due Leverage 

Assets Margin Loan Ratio Ratio 

Source: Bank and Thrift Call Reports 

However, the Dakotas Are Showing 

Some Loan Problems 

Region-wide asset quality remains favorable despite a 

slight upswing in loan delinquency over the past two 

years. Nonperforming assets remain moderate, at 0.7 

percent of total assets, and delinquent loans represent a 

manageable 2.3 percent of total loans. However, not all 

institutions in the Region are enjoying such sound asset 

quality; in particular, community banks with less than 

$100 million in assets in North Dakota and South 

Dakota report levels of past-due loans much higher than 

the average for the Region. 

North Dakota’s community banks reported their third 

consecutive June-over-June increase in loan delinquencies, reaching levels not reported since June 30, 1991. 

Chart 2 shows the trend over the past seven years. 

CHART 2 

Delinquent Loans Continue to Increase in 

North Dakota’s Community Institutions 

% of Total Loans 

5 

Past Due 30–89 Days 

4 Past Due 90+ Days 

3 Nonaccrual 

2
 

1
 

0
 

Jun-91 Jun-92 Jun-93 Jun-94 Jun-95 Jun-96 Jun-97 

Source: Bank and Thrift Call Reports 

Kansas City Regional Outlook 23	 Fourth Quarter 1997 
Regular Features	 Regional Banking
 

Several below-average years for farm producers most 

likely are the cause of this adverse trend. Farm loans 

exceed 25 percent of the total loan portfolios in 95 of 

the 101 community banks in the state. 

The current FDIC Underwriting Survey noted a 

“moderate or sharp” increase in carryover debt in half 

of the North Dakota banks actively making agricultural 

loans examined by the FDIC in the second quarter of 

1997. Surveys for the two quarters ending March 31, 

1997, showed similar trends, with 42.9 percent of 

examiners noting the increase in carryover debt. 

Coupled with the most recent data from the U.S. 

Department of Agriculture, which shows that North 

Dakota farmers exceed the national average in their 

debt-to-equity ratios, such increases in carryover debt 

may further compound problems for highly leveraged 

farm borrowers. 

This year does not appear to be any 

more favorable to North Dakota’s farmers and, consequently, banks in the state. 

Farmers’ fortunes depend heavily on 

income from wheat production, which 

represents approximately 44 percent of 

North Dakota’s total agricultural cash 

receipts. This year the wheat crop yield 

was reduced by early dry conditions and 

later by disease and insects. Indications are that yields 

were down by nearly 17 percent from 1996. In addition, 

although cattle prices have improved significantly in 

1997, poor pasture conditions and higher hay prices have 

limited ranchers’ profitability. 

Also of continuing concern are the effects of the flooding on businesses and residents in the Red River Valley, 

many of whom were devastated by the spring flooding. 

As noted in the third-quarter issue of the Regional 

Outlook, most businesses and residents did not carry 

flood insurance. An analysis of quarterly banking data 

for banks and thrifts in the Red River Valley1 as of June 

30, 1997, did not yet indicate any higher loan delinquency resulting from flooding. However, increases in 

loan delinquency may lag because of payment deferrals 

1 Delinquency rates were compared with those for the previous quarter and one year earlier for 53 banks and thrifts headquartered in 

counties bordering the Red River. The institutions were in Minnesota 

and North Dakota. Large institutions with branches outside the Red 

River Valley were excluded from the analysis. 

and other cooperative arrangements between banks and 

affected borrowers. 

In South Dakota, the 90 community banks reported 

past-due loans of 4.1 percent as of June 30, 1997, which 

compares unfavorably with the 3.6 percent shown a year 

earlier. Several poor years for cattlemen and the harsh 

winter of 1996/97 may be partly responsible for the high 

levels. However, average core capital of 12 percent mitigates most concerns about the condition of community 

banks in South Dakota. In addition, improved profitability for cattlemen in a state where livestock is the 

number one commodity should improve debt repayment 

capabilities for many bank loan customers. 

Community Institutions Maintain 

Strong Loan Growth 

Community institutions2 continued to show strong loan 

growth in the 12 months ending June 30, 1997. Data 

indicate that such institutions posted annual loan growth 

of 13.1 percent, which exceeded asset growth for the 

third consecutive June-over-June period. Table 1 shows 

selected loan figures for the Region’s community institutions. Following is a closer look at those figures: 

•	 Real estate loans, which comprise almost half of 

total loans, led the growth and marked the third consecutive June-over-June period that such loans grew 

faster than loans in general. Single-family residence 

loans grew by the largest dollar amount, $1.7 billion, 

while real estate construction and land development 

loans continued to post large percentage gains. 

•	 Agricultural loans (not secured by real estate), 

which at $10.1 billion represent more than one-fifth 

of total loans, grew at an 8.9 percent pace—slower 

than total loans, but a significant increase over the 

1.7 percent and 1.8 percent growth rates posted in 

the 12 months ending June 30, 1995, and June 30, 

1996, respectively. 

2 Community institutions are defined here as FDIC-insured banks and 

savings and loans that had less than $100 million in assets as of June 

30, 1997. There are 2,039 such community institutions in the Kansas 

City Region. 

Kansas City Regional Outlook 24	 Fourth Quarter 1997 
Regular Features	 Regional Banking
 

TABLE 1 

Community Institutions Show Strong 

Growth across Many Loan Categories 

6/30/97 CHANGE CHANGE 

LEVEL FROM FROM 

(MILLIONS) 6/30/96 6/30/93 

TOTAL ASSETS 77,968 8.3% 24.4% 

TOTAL LOANS 46,821 13.1 46.0 

RE LOANS 23,338 15.2 56.4 

RE AGRICULTURE 5,131 10.6 44.3 

RE CONSTRUCTION 1,168 20.3 154.9 

RE RESIDENTIAL 11,990 16.3 54.1 

RE NONRESIDENTIAL 4,586 16.9 61.6 

AGRICULTURAL LOANS 10,114 8.9 28.1 

SMALL-BUS. LOANS 6,770 12.9 52.5 

UNDER $100,000 4,920 10.8 33.7 

$100,000–$250,000 823 17.7 115.7 

$250,000–$1 MILLION 1,027 20.1 172.0 

CONSUMER LOANS 5,573 9.9 33.1 

CREDIT CARDS 281 − 4.4 − 3.9 

Note: Does Not Include All Categories of Loans; 

RE = Real Estate 

Source: Bank and Thrift Call Reports 

•	 Despite the advent of credit-scoring models at larger 

institutions that are expected to increase competition 

for small-business loans3 (SBLs), community institutions continue to grow SBLs at a strong pace. SBLs 

under $100,000 grew at the slowest pace of the three 

SBL categories shown on Table 1, but the 10.8 percent pace was faster than it had been each of the 

three previous June-over-June periods. Larger SBLs 

continued their rapid growth and have more than 

doubled over the past four years. 

•	 Community institutions appear to have responded to 

record consumer bankruptcy rates and high credit 

card delinquency by reducing their levels of credit 

card loans outstanding. Credit card loans shrank by 

4.4 percent, following a 16.5 percent drop in the previous 12-month period. 

Implications: Strong loan growth is likely the product 

of the strong expansionary economy in the Region. On 

the positive side, since loan interest income generally 

3 Small-business loans are defined here as loans categorized as commercial and industrial loans with original amounts of $1 million or 

less reported on the June Call Reports. 

represents community institutions’ largest revenue 

source, this growth has contributed to community institutions’ strong earnings in recent years. On the negative 

side, rapid loan growth could lead to future problems if 

underwriting procedures were relaxed to attain such 

growth. However, current underwriting practices appear 

prudent; the second quarter 1997 FDIC Underwriting 

Survey from 167 Kansas City Region bank examinations found that 8.8 percent of state nonmember banks 

displayed tighter underwriting practices, while none had 

looser practices. 

‘Low-Growth County’ Institutions Grow 

Slower and May Be More Susceptible to 

Economic Downturns 

The article Growth Record of Rural Counties:A Mixed 

Bag in the 1990s has several implications for the 

Region’s banks. It describes how rural counties have 

grown at widely different rates. This was particularly 

true in the 1980s, which were marked by farm and retail 

consolidation, as well as several devastating years for 

farmers. However, the article also shows that in the 

1990s, rural counties of all types in the Region have 

shown a strong resurgence. An analysis of banking data4 

for financial institutions in the Region mirrors the article’s findings. The data indicate that institutions in lowgrowth counties (LGC institutions) tend to grow slower 

than institutions in high-growth counties (HGC institutions) despite improvement in the overall economic climate. In addition, the data suggest that LGC institutions 

perform similarly to HGC institutions in strong economic periods but may be more susceptible to economic downturns. The key findings are discussed below. 

LGC institutions are less likely to grow than HGC institutions in both strong and weak economic periods. 

Chart 3 (next page) illustrates that in every year 

between 1985 and 1995, LGC institutions were less 

likely to increase in asset size than their HGC counterparts. As a result of these yearly differences, LGC institutions grew their aggregate assets at an annual 1.5 

4 To analyze banking trends in the Region’s rural counties, we gathered banking information for all FDIC-insured financial institutions 

headquartered in those counties from 1984 through 1996. Institutions 

headquartered in low-growth counties were segregated from those 

located in high-growth counties. In addition, four very large savings 

and loans that were located in low-growth counties and failed or 

merged during the analysis period were excluded because of their 

overwhelming influence on the average results. 

Kansas City Regional Outlook 25	 Fourth Quarter 1997 
Regular Features Regional Banking
 

CHART 3 CHART 4 

LGC Institutions Are Less Likely to Grow The Disparity in Rural Institutions’ 

Than HGC Institutions Earnings Disappeared in the 1990s 

90 1.4

% of Institutions That Grew 

LGC Inst. 

HGC Inst. HGC Inst.

LGC Inst. 

% Return on Assets 1.2 

1.0 

0.8 

0.6 

0.4 

0.2 

80 

70 

60 

50 0.0 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996

198519861987198819891990199119921993199419951996 

Source: Bank and Thrift Call Reports 

percent pace from 1984 through 1996, while HGC institutions grew by 2.5 percent. 

LGC institutions and HGC institutions have performed 

very similarly since 1990 in terms of earnings, capital 

levels, and problem asset levels. As shown in Chart 4 

(next page), both LGC and HGC institutions have 

posted strong earnings in the 1990s. In addition, both 

have similar and strong capital bases, as well as low 

levels of nonperforming assets. This convergence in 

banking performance despite a substantial difference 

in the counties’ economic growth rates suggests that 

bankers in the low-growth counties have adapted to 

their environments. 

While it is clear that LGC and HGC institutions perform similarly well in good times, LGC institutions may 

be more susceptible to economic downturns. In fact, 

LGC institutions were more than twice as likely to fail 

during the last banking crisis as HGC institutions. 

Since 1984, 5.9 percent of LGC institutions have failed, 

compared with only 2.6 percent of HGC institutions. In 

total, 56 LGC institutions and 12 HGC institutions have 

Source: Bank and Thrift Call Reports 

failed during that period. In addition to failures, LGC 

institutions performed more poorly as a group and were 

slower to recover. As shown in Chart 3, poor farming 

conditions caused rural banking income to be quite 

weak in the 1980s, and LGC institutions were more 

affected than HGC institutions. Rural counties bottomed out in 1986 at the height of the crisis, but LGC 

institutions barely broke even while HGC institutions 

posted a modest return on assets of 36 basis points. 

HGC institutions then improved their earnings faster 

than LGC institutions. By 1990, the crisis had ended 

and the differences were minimal. 

The point here is not to be ominous, since rural institutions as a whole have performed quite well in the 1990s, 

whether their counties were low growth or high growth. 

However, because LGC institutions may be more vulnerable to the onset of adverse economic factors, 

bankers in low-growth counties should be especially 

prepared for the next, inevitable downturn. 

John M. Anderlik, Financial Analyst 

Craig Rice, Regional Manager 

Kansas City Regional Outlook 26 Fourth Quarter 1997 
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