Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION THIRD QUARTER 2000 

FDIC
 

New York
 

Region
 

Division of 

Insurance 

Kathy R. Kalser,
 

Regional Manager
 

Robert DiChiara,
 

Financial Analyst
 

Norman Gertner,
 

Regional Economist
 

Alexander J.G.
 

Gilchrist,
 

Economic Analyst
 

Regional Perspectives 

◆ Region’s Economic Conditions—Buoyed by a strong economy, employment 

levels continued to rise as the Region entered the new millennium. Although the 

nation added jobs more quickly over the same period, several areas of the Region 

are experiencing tighter labor markets than the nation. See page 3. 

◆ The Region’s Banking Conditions—The Region’s insured institutions reported sound financial conditions in the first quarter of 2000. Nevertheless, because of 

higher interest rates and competition for core deposits, more of the Region’s institutions showed signs of strained liquidity. See page 5. 

◆ The Region’s Commercial Real Estate (CRE) Markets Appear Better Positioned than a Decade Ago—In contrast to the late 1980s, most of the Region’s 

office markets are experiencing stable or declining office vacancy rates and limited 

new construction. While the Region’s banks reported sound CRE credit quality, the 

percentage of banks that have a concentration in CRE loans has increased, exceeding levels reached prior to the recession of the early 1990s. See page 7. 

By the New York Region Staff 

In Focus This Quarter 

◆ Ranking Metropolitan Areas at Risk for Commercial Real Estate Overbuilding—Commercial real estate construction has boomed in a number of U.S. metropolitan markets during recent years amid falling vacancy rates and growing demand 

for new space. Insured depository institutions have reasserted their role as primary 

sources of capital for this construction boom, particularly in the wake of the 1998 

financial markets crisis that left some important market-based lenders on the sidelines. Recent data for some metropolitan areas show that on-balance-sheet exposures 

of FDIC-insured institutions are by some measures higher now than at the peak of 

the last commercial real estate cycle during the late 1980s. This article reassesses 

major U.S. metropolitan real estate markets in search of possible signs of overbuilding that could drive up vacancy rates and drive down rents in the near term. This 

review points to an underlying trend of markets experiencing more vigorous construction activity across multiple property types. See page 13. 

By Thomas A. Murray, Senior Financial Analyst 

◆ Rising Home Values and New Lending Programs Are Reshaping the Outlook for Residential Real Estate—Rising home prices and high levels of activity in 

the single-family housing market have been supported by excellent economic conditions and generally low interest rates. However, as interest rates have begun to rise, 

housing market activity has slowed. Historically, residential real estate has been one 

of the best-performing asset classes at insured institutions. Concerns have recently 

arisen, however, that new, higher-risk lending lines of business could adversely affect 

the future credit quality of residential real estate portfolios. See page 21. 

By Alan Deaton, Financial Economist 

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

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

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

geographic regions: 

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

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

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

Dallas Region (CO, NM, OK, TX)
 

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

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

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

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

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

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

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

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

Outlook, please call Kathy Kalser at (212) 704-1308 or send an e-mail to kkalser@fdic.gov. 

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

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

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

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

the Federal Deposit Insurance Corporation. 

Chairman Donna Tanoue 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Writer/Editor Kim E. Lowry 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Richard A. Brown 

Ronald L. Spieker 

Publications Manager Teresa J. Franks 
Regional Perspectives
 

Regional Perspectives
 

•	 The Region’s strong economy has stimulated job growth and reduced unemployment in most metropolitan 

areas. Upstate New York and the central cities of Baltimore and Philadelphia, which lagged the Region in 

the 1990s, have shown recent employment gains. 

•	 The Region’s insured institutions reported sound financial conditions at the end of the first quarter of 2000. 

Large banks benefited from increased noninterest income, while small banks reported higher net interest 

margins. However, commercial and industrial loan portfolios in the Region’s insured financial institutions 

showed modest signs of credit quality deterioration. 

•	 More of the Region’s banks showed signs of strained liquidity, reporting securities depreciation and deposit 

outflow. Banks may opt to raise deposit rates or increase borrowings to offset deposit outflow, rather than 

incur securities losses. As the dynamics of funding alternatives change, so, too, should assumptions underlying banks’ risk management tools. 

•	 In contrast to the late 1980s, the Region’s office markets are experiencing stable or declining vacancy rates 

and limited new construction. The proportion of the Region’s banks that specialize in commercial real estate 

loans, however, has increased and exceeds levels reached prior to the last recession. 

Region’s Economic and Banking Conditions 

Job Growth and Declining Unemployment 

Continue in 2000 

Buoyed by a strong economy, employment levels continued to rise as the Region entered the new millennium. 

Between the first quarters of 1999 and 2000, approximately 373,000 new jobs were created, an increase of 

1.7 percent. The Region now has surpassed by a considerable margin the employment peak attained prior to 

the recession of the early 1990s (see Chart 1). Although 

the nation added jobs more quickly over the same period, at 2.3 percent, several areas in the Region are experiencing tighter labor markets than the nation. Many of 

CHART 1 

19 

20 

21 

22 

23 

24 

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

80 

90 

100 

110 

120 

130 

140 

Note: Data represent first quarter employment levels. 

Source: Bureau of Labor Statistics 

Millions of Jobs: 

Region (left) 

Millions of Jobs: 

Nation (right) 

Job Levels Have Exceeded the Peak 

Prior to the Last Recession 

these areas, particularly suburban counties surrounding 

major cities, experienced unemployment rates below 

3.5 percent, approximately one point below the national 

average of 4.4 percent during the first quarter of 2000 

(see Map 1).1 Rural counties in northern and western 

MAP 1 

Tight Labor Market Conditions Surround Region’s
 

Major Cities (First Quarter 2000)
 

Source: Bureau of Labor Statistics 

New York City 

Washington, DC 

Philadelphia 

Baltimore 

Counties with Unemployment Rates above 5.5%
 

Counties with Unemployment Rates between 3.5% and 5.5%
 

Counties with Unemployment Rates below 3.5%
 

1 For purposes of comparison, county and national unemployment 

rates are not seasonally adjusted. 

New York Regional Outlook 3	 Third Quarter 2000 
Regional Perspectives
 

New York and western Pennsylvania are experiencing 

significantly higher rates of unemployment. Nonetheless, many of these areas have been experiencing 

renewed demand for employees. 

The good news is that the robust economy has extended 

to some of the Region’s smaller cities, whose workforces had been growing more slowly (or declining) 

compared with those of the nation. After lagging behind 

the national and state averages for most of the 1990s, 

many of the small to midsize cities in upstate New York, 

including Albany, Binghamton, Syracuse, and UticaRome, added jobs at a faster pace than the nation in 

1999 (see Chart 2). Employment gains in the business 

service, trade, and financial sectors have boosted job 

levels in these cities. While the rate of employment 

growth in some of these areas slowed in first quarter 

2000, the growth rate remains above that of the mid1990s, which was a period of slow or even negative job 

growth. In the mid-1990s, cutbacks in manufacturing 

jobs, particularly in the textile, apparel, chemical, and 

auto-manufacturing industries, hurt some of these local 

economies. Although manufacturing-industry declines 

have continued, the rate of decline has slowed, and 

recent manufacturing job losses have been offset by job 

gains in other sectors. 

Employment growth rates in Baltimore and Philadelphia, which had been lagging behind other parts of the 

Region, also are improving. For most of the 1990s, the 

central cities of Baltimore and Philadelphia had been 

losing jobs. Between 1989 and 1997, Baltimore lost 

almost 70,000 jobs, or 15 percent of its workforce, and 

employment levels in Philadelphia dropped by 94,000 

jobs, or 12 percent. Over the past two years, however, 

CHART 2 

Most Upstate New York Cities Surpassed 

the Nation in Job Growth in 1999 

Buffalo 

Rochester 

United States 

Syracuse 

New York State 

Albany 

Binghamton 

Utica-Rome 

0.0 1.0 2.0 3.0 4.0 

Job Growth (%) 

Source: Bureau of Labor Statistics 

these central cities have posted modest job gains. In 

1999, employment growth in Baltimore increased less 

than 1 percent. Between the first quarters of 1999 and 

2000, however, the employment level in Baltimore rose 

3.5 percent, the largest quarterly gain since 1984. 

Employment has been helped by growth in the construction industry, which rose almost 17 percent in 

1999, in part reflecting new office and hotel construction. In Philadelphia, employment levels also have been 

improving modestly since 1998. Slow declines in manufacturing employment have been offset by gains in 

retail trade and social and educational services. The outlook is for modest job growth in these two cities, 

because of high business costs, sluggish population 

growth, and limited in-migration.2 

Job Growth Sluggish in Puerto Rico 

Puerto Rico has lagged the nation and the Region in 

job growth. Since 1998, employment growth has been 

under 1 percent per year, and first quarter 2000 yearover-year results showed a slight decline. The phase-out 

of Section 936 of the federal tax code, which provided 

substantial federal tax benefits to U.S. manufacturers 

based in Puerto Rico, has hurt the island’s manufacturing sector, which has lost jobs over the past four years. 

While new tax incentives implemented by the Puerto 

Rican government are designed to stem the outflow of 

manufacturing jobs, Puerto Rico continues to face stiff 

competition for manufacturing jobs from other countries, such as Mexico, that have lower labor costs. 

In San Juan, job gains in the construction, telecommunications, business, and social service industries have 

partially offset losses in manufacturing jobs and cutbacks in government employment. San Juan, which represents almost two-thirds of the island’s total workforce, 

has fared better than other parts of Puerto Rico, because 

its economy is more diverse and relies on tourism and 

service-based jobs more than other parts of the island. 

San Juan’s manufacturing industry accounts for 11 percent of its total economic activity, significantly less than 

other metropolitan areas, where manufacturing can 

account for about one-third of total economic activity.3 

As a result, the adverse effect of the loss of Section 936 

tax incentives has been more limited on the island’s 

major city. Other metropolitan areas, however, have felt 

the loss of Section 936 more keenly (see Chart 3). In 

2 Forecast is by Regional Financial Associates. 3 Analysis provided by Regional Financial Associates. 

New York Regional Outlook 4 Third Quarter 2000 
Regional Perspectives
 

CHART 3 

–15 –5 0 5 

Puerto Rico 

San Juan 

Caguas 

Ponce 

Mayaguez 

Source: Bureau of Labor Statistics 

Manufacturing 

Employment 

Percent Change 

Total 

Employment 

In 1999, Manufacturing Job Losses Persisted 

in All Areas of Puerto Rico 

–10 

Ponce, for example, manufacturing employment has 

dropped every year since 1994. In Mayaguez, manufacturing employment dropped more than 12 percent in 

1999, and sharp losses continued during the first quarter of 2000. Losses in the apparel and food-processing 

industries accounted for much of the decline. 

Region’s Institutions Report Healthy Conditions, 

but Funding Pressures Continue 

The New York Region’s insured institutions4 reported 

sound financial conditions in the first quarter of 2000, 

exhibiting higher levels of profitability, favorable credit quality, and stable capital ratios (see Table 1). While 

the average return on assets improved for the Region’s 

TABLE 1 

The Region’s Banks Report Improved Profitability and Sound Credit Quality 

ASSETS ASSETS LESS THAN ASSETS 

GREATER THAN $10 BILLION, GREATER LESS THAN 

ALL INSTITUTIONS* $10 BILLION* THAN $500 MILLION* $500 MILLION* 

MAR MAR MAR MAR MAR MAR MAR MAR MAR MAR MAR MAR 

’00 ’99 ’98 ’00 ’99 ’98 ’00 ’99 ’98 ’00 ’99 ’98 

RETURN ON 

ASSETS (ROA) 1.00 0.99 1.07 1.21 1.16 1.09 1.19 1.17 1.18 0.95 0.94 1.04 

NET INTEREST 

MARGIN (NIM) 3.90 3.81 3.99 3.35 3.42 3.53 3.60 3.59 3.73 4.01 3.88 4.06 

NONINTEREST 

INCOME/AEA 1.07 1.12 1.04 2.41 2.30 1.96 1.39 1.21 1.23 0.93 1.05 0.96 

NONINTEREST 

EXPENSE/AEA 3.24 3.28 3.25 3.33 3.49 3.44 2.94 2.81 2.95 3.33 3.39 3.33 

EFFICIENCY 

RATIO 64.12 65.27 63.86 54.05 56.09 60.67 56.32 56.64 56.53 66.80 67.80 65.78 

CORE DEPOSITS/ 

ASSETS 67.73 69.61 71.00 42.34 43.26 47.56 59.40 59.79 61.60 71.09 73.01 74.03 

NONCORE 

FUNDING/ASSETS 20.67 18.28 16.83 45.17 44.80 40.77 30.01 28.54 26.68 17.04 14.76 13.67 

PAST-DUE RATIO 1.06 1.22 1.37 1.11 1.09 1.12 1.03 1.18 1.30 1.06 1.24 1.39 

NET CHARGEOFF RATE 0.09 0.10 0.10 0.10 0.12 0.12 0.05 0.06 0.08 0.03 0.03 0.04 

TIER 1 

LEVERAGE RATIO 10.52 10.50 10.60 7.14 6.51 6.58 8.93 9.32 9.13 11.11 10.94 11.09 

TIER 1 RISKBASED CAPITAL 

RATIO 19.39 20.44 22.35 10.26 10.01 9.59 15.20 16.18 16.51 20.96 21.88 24.19 

* Data exclude institutions in operation fewer than three years, credit card banks, and five special-purpose institutions. 

AEA = Average earning assets 

Efficiency Ratio = noninterest expense divided by the sum of net interest income and noninterest income 

Past-Due Ratio = loans past due 90 days or more plus nonaccrual loans divided by gross loans 

Source: Bank and Thrift Call Reports 

4 Excludes banks in operation fewer than three years, credit card 

banks, and five special-purpose banks. 

New York Regional Outlook 5 Third Quarter 2000 
Regional Perspectives
 

large, medium, and small institutions compared with the 

first quarter of 1999, factors contributing to improved 

profitability differed based on asset size. In the first 

quarter of 2000, higher noninterest income reported by 

the Region’s large banks (those with total assets greater 

than $10 billion) and medium-sized institutions (those 

with assets between $500 million and $10 billion) offset 

the effect on earnings of a lower average net interest 

margin (NIM). The average NIM for these institutions 

declined because the increase in funding costs exceeded an improvement in the average asset yield. In contrast, the Region’s small banks (those with assets less 

than $500 million) reported a higher average NIM and 

lower noninterest income compared with one year ago. 

As short-term interest rates rose during the first quarter, banks reported 

higher average asset yields. However, the Region’s smaller banks did not 

experience as great an increase in 

interest expense as did larger banks. The 

Region’s large and medium-sized institutions’ funding 

costs increased an average of 29 basis points and 33 

basis points, respectively, while small banks’ average 

funding costs rose by 13 basis points in the first quarter 

of 2000. Small banks benefited from a higher proportion of core deposits to assets on average, as rates on 

core deposits typically lag increases in market interest 

rates. Competition for core deposits, however, could 

reduce small banks’ competitive advantage over time. 

While the Region’s small banks are much less reliant on 

noncore funding than larger banks, noncore funding as 

a percentage of assets increased over year-ago levels, 

continuing a long-term trend. As the proportion of noncore deposits to assets increases, institutions that historically have relied on core deposits may become more 

sensitive to changes in interest rates, because pricing on 

noncore funding tends to be less stable and more sensitive to changes in market interest rates. Furthermore, as 

competition for core deposits intensifies, rates on core 

deposits may need to track market interest rates more 

closely, thereby reducing an institution’s ability to benefit from lagged increases on core deposit rates. In fact, 

according to the 2000 American Bankers Association 

Community Bank Competitiveness Survey, more banks 

have changed deposit pricing strategies in response to 

funding pressures; 42 percent of community banks 

reported more aggressive deposit pricing in 2000, compared with only 24 percent in 1999.5 (For more infor5 American Bankers Association. February 2000. ABA Competitiveness Survey Shows Community Bankers’ Concerns for Funding, 

Employee Recruitment and Technology Issues. 

mation on changes in bank funding strategies, see 

“Banks’ Funding Sources Shift,” Regional Outlook, 

Third Quarter 1999.) 

Except for commercial and industrial (C&I) loans, the 

average past-due ratio declined for all loan categories in 

first quarter 2000 compared with the same periods in 

1999 and 1998. After peaking in the early 1990s, the 

Region’s average C&I past-due and charge-off ratios 

improved, reaching decade-low rates of 1.7 and 0.09 

percent, respectively, in the first quarter of 1997. Since 

then, however, these ratios have gradually risen, reaching 2.03 percent and 0.16 percent in the first quarter of 

this year. Although higher than three years ago, these 

ratios remain below the average past-due ratio of 7.37 

percent and average charge-off rate of 0.52 percent 

reported by the Region’s banks following the recession 

of the early 1990s. 

Trends in the Region’s asset quality measures were consistent with findings from recent national underwriting 

surveys. Surveys conducted by the Federal Deposit 

Insurance Corporation6 and the Federal Reserve 

Board 7 identified generally stable or improved underwriting policies as more banks tightened C&I loan 

underwriting, perhaps in response to recent weakening 

credit quality measures. The surveys, however, also 

cited signs of relaxed underwriting on residential mortgages as the demand for mortgages softened. 

Securities Depreciation and Liquidity Demands 

May Affect Bank Funding Strategies 

Rising interest rates in the second half of 1999 and the 

first quarter of 2000 have resulted in a decline in the 

value of the Region’s banks’ investment portfolios. As 

of March 31, 2000, the Region’s commercial institutions8 reported average depreciation in investment portfolios of 9.62 percent of equity capital, compared with 

average appreciation of 3.13 percent as of December 31, 

1998. The decline was widespread, as the number of the 

Region’s commercial banks that reported depreciation 

in investment portfolios increased between December 

31, 1998 and March 31, 2000. Furthermore, the number 

6 Federal Deposit Insurance Corporation. March 2000. Report on 

Underwriting Practices. October 1999 through March 2000. 

7 Federal Reserve Board. May 2000. Senior Loan Officer Opinion 

Survey on Bank Lending Practices. 

8 Excludes banks in operation fewer than three years, credit card 

banks, and five special-purpose institutions. Also excludes thrift institutions, which do not report securities appreciation and depreciation. 

New York Regional Outlook 6 Third Quarter 2000 
Regional Perspectives
 

of institutions reporting depreciation in excess of 10 

percent of capital increased from five as of December 

31, 1998, to 216 as of March 31, 2000. Most of these 

banks were small and medium-sized institutions. For 

additional information on securities depreciation, see 

“Rising Interest Rates Could Pose Risk to the 

Region’s Insured Institutions” Regional Outlook, 

Second Quarter 2000. 

During periods of declining interest rates, as fixedincome securities increase in value, institutions can supplement liquidity by divesting securities at a gain, 

thereby providing funds and augmenting profits. In a 

rising interest rate environment, however, security sales 

more likely will result in a loss. Although banks may 

elect not to divest securities at a loss when liquidity 

needs are modest, nevertheless, more of the Region’s 

banks reported deposit outflow9 and investment portfolio depreciation in first quarter 2000 than in fourth 

quarter 1998 (Chart 4). As of March 31, 2000, 235 of 

the Region’s commercial banks had deposit outflow and 

securities depreciation, and 89 of these banks reported 

depreciation in excess of 10 percent of capital. In contrast, only 24 commercial banks reported deposit outflow and securities depreciation as of December 31, 

1998, and only three of these banks reported depreciation greater than 10 percent of capital. 

Loan demand also can strain an institution’s liquidity, 

particularly if it is concurrent with deposit outflow and 

investment portfolio depreciation. In fact, the number of 

the Region’s commercial banks that reported a combiCHART 4 Percentage of Banks

0 

20 

40 

60 

Dec 

’98 

Mar 

’99 

Jun 

’99 

Sep 

’99 

Dec 

’99 

Mar 

’00 

Depreciation and Deposit Outflow 

Depreciation, Deposit Outflow, and 

Loan Growth > 5 Percent 

A Growing Number of Banks Have Depreciation

 and Liquidity Demands 

Source: Bank Call Reports 

9 Deposit outflow is defined as annual deposit growth of less than 4 

percent to account for accrued interest on deposits. 

nation of securities depreciation, deposit outflow, and 

yearly loan growth of greater than 5 percent is on the 

rise. Of the 155 institutions that met these criteria as of 

March 31, 2000, 61 reported securities depreciation in 

excess of 10 percent of equity capital. In contrast, as of 

December 31, 1998, only 10 commercial banks met 

these criteria, and no institutions reported depreciation 

greater than 10 percent of capital. 

Implications 

While increased liquidity demands coupled with higher 

levels of securities depreciation do not necessarily mean 

that a bank will resort to selling securities at a loss to 

meet liquidity demands, they are important factors to 

consider in formulating an institution’s funding strategy. 

Depending on the degree of depreciation and liquidity 

needs, banks may prefer to use alternative methods to 

offset deposit outflow while funding loan demand. Institutions may prefer to counter deposit outflow by offering more competitive rates on deposit accounts or by 

increasing noncore funding, in lieu of liquidating securities at a loss. Nevertheless, a number of the Region’s 

institutions recently reported the sale of securities at a 

loss as part of balance sheet restructuring programs. 

Furthermore, as alternative funding options are considered, assumptions used in banks’ asset/liability management (ALM) models should reflect changes in market 

conditions, core deposit behavior, and funding strategies. ALM models typically rely on assumptions concerning deposit rates, repricing frequency, and 

retention. As the dynamics of funding alternatives 

change, so, too, should assumptions underlying banks’ 

risk management tools. 

The Region’s Office Markets Are Robust, but 

Unlike the Late 1980s, Overbuilding Is Less 

of a Concern 

The Region is experiencing strong demand for office 

space, and vacancy rates are at the lowest levels in the 

past decade (see Table 2, next page). Moreover, the 

Region’s commercial real estate (CRE) markets are not 

experiencing the overbuilding that was characteristic of 

the early 1990s. In Manhattan, for example, the largest 

office market in the nation, office vacancy rates stood at 

3.8 percent in the fourth quarter of 1999, the lowest 

level of the decade. Rents in many Class A properties 

surpassed $50 per square foot, and certain top-tier properties were renting for $100 per square foot. Limited 

new construction and soaring rents in Manhattan have 

New York Regional Outlook 7 Third Quarter 2000 
Regional Perspectives
 

TABLE 2 

Region’s Office Vacancy Rates Have 

Declined during the 1990s (%) 

METRO AREA 1990 1995 1999 

BALTIMORE 17.6 13.9 8.1 

LONG ISLAND 22.5 13.8 7.8 

NORTHERN NEW JERSEY 22.5 16.2 8.5 

NEW YORK CITY 15.2 14.9 4.6 

PHILADELPHIA 16.8 13.0 10.3 

WASHINGTON, D.C. 16.6 9.6 5.7 

WESTCHESTER COUNTY 23.9 22.4 18.4 

WILMINGTON NA 13.1 4.8 

UNITED STATES 18.9 14.1 9.5 

Data represent fourth quarter of the year. 

NA = not available 

Source: CB Commercial/Torto Wheaton Research 

prompted many companies to move to the shores of the 

Hudson River in New Jersey, which offer more attractive lease terms and lower rental rates. As a testament to 

the tight office market and surging rental rates in New 

York City, many Manhattan tenants also are moving 

into newly renovated Class B space. 

Office markets in New Jersey have benefited from 

spillover demand from New York City as well as the 

state’s strong economy. As in Manhattan, demand for 

space in northern New Jersey exceeded supply in 1999, 

as vacancy rates declined and rents increased in the 

majority of submarkets. Vacancy rates climbed, however, in some areas including the Wayne/Patterson 

market.10 Demand for space has resulted in new construction. In fact, according to Torto Wheaton 

Research,11 new office space constructed in 1999 

equaled almost 140 percent of all space added between 

1993 and 1998. This new supply, however, pales by 

comparison to the amount of office space added in the 

late 1980s. Furthermore, despite the additional space, 

the office vacancy rate for the northern New Jersey area 

declined in 1999. Northern New Jersey’s economy is 

closely linked to that of Manhattan, so any softness in 

the financial sector could weaken this market. Consolidations in the pharmaceutical industry, a major employer in the state, also could affect several real estate 

submarkets. 

10 Studley Report & Spacedata. Central and Northern New Jersey. 

First quarter 2000.
 

11 Torto Wheaton Research. Spring 2000. Office Outlook.
 

Office market conditions in the Region’s second largest 

office market, Washington, D.C., also showed signs of 

tightening. A Grubb & Ellis report12 noted that Washington, D.C., which, except for New York City, has more 

office buildings than any other central city in the nation, 

has benefited from a strong regional economy fueled by 

sizable increases in computer software, telecommunications, and biotechnology employment. Reflecting surging demand for space, vacancy rates in the Washington, 

D.C., metropolitan area averaged 5.6 percent during 

1999, the lowest level since the early 1980s. To help 

meet the demand, approximately 7.2 million square feet 

of new office space was added in 1999, with 1.5 million 

square feet of new office space going to the downtown 

inventory. Although this was the largest amount of 

office space added in a single year since 1990, it 

remained well below the amount built during the 1980s. 

According to the Grubb & Ellis report, virtually all of 

the new construction has been or will be absorbed into 

the market place, and as a result, office vacancy rates 

are expected to remain tight. As in New York, demand 

for office space has spilled over to subpremium space. 

According to Studley Report & Spacedata,13 vacancy 

rates in Class B and C space declined from 8.1 percent 

in the fourth quarter of 1999 to 7.6 percent in the first 

quarter of 2000, and rental rates for Class B and C space 

rose almost 4 percent. 

Strong office employment also has contributed to the 

tightening of office vacancy rates in the Baltimore and 

Philadelphia metropolitan areas. Stimulated by start-up 

high-tech, telecommunication, and biotech companies, 

vacancy rates are the lowest in more than 15 years. 

Although the suburban areas of these cities have benefited from the surging economy more than the central 

business districts, recent job gains in the central cities 

have pushed down vacancy rates there as well. Forecasts 

for 2000 by Landauer Real Estate Counselors, Inc. 

(Landauer),14 suggest that absorption will exceed new 

supply in those metropolitan areas. 

Declining vacancy rates are found not only in the 

Region’s major metropolitan areas, but also in many of 

the smaller or midsized cities. The Landauer report 

described demand for office space in Annapolis, 

Maryland, in 1999 as “unbelievable.” There, the overall office vacancy rate was 3.7 percent, with Class A 

12 Grubb & Ellis. May 5, 2000. Market Monitor: Metropolitan Washington, D.C., Issue 62.
 13 Studley Report & Spacedata. Washington, D.C., and Metropolitan
 

Area. First quarter 2000.
 14 Landauer Real Estate Counselors. 2000 Comparative Statistics.
 

New York Regional Outlook 8 Third Quarter 2000 
Regional Perspectives
 

properties at a scant 0.7 percent. Rental rates for these 

properties were at an all-time high at $25 per square 

foot. Conditions were reportedly so tight that companies 

were forced to locate offices in neighboring counties. In 

Harrisburg, Pennsylvania, office-market conditions 

were almost as tight. Demand for Class A office space 

was under 5 percent, and demand for Class B was 1.9 

percent. Despite slowing employment growth, demand 

for office space was strong, particularly from financial 

and business service companies. According to Landauer, tight market conditions should continue throughout 2000 even with the planned addition of space. Even 

in Rochester, New York, with its relatively slower 

growing economy over the past few years, overall 

demand for office space was very strong in 1999. Class 

A vacancy rates in Rochester’s central business district 

were 6.6 percent, a low for the decade. In Rochester, 

Landauer expects telecommunications and software 

companies to constitute the major growth sectors, with 

new technology firms actively converting old loft space 

to commercial use. 

Are the Region’s Office Markets Less Vulnerable 

to a Downturn than in the Late 1980s? 

Because the Region’s office markets are now so active, 

many analysts have been asking whether current office 

market conditions resemble those of the 1980s. Is there 

a potential for overbuilding and rising vacancy rates 

similar to what occurred in the beginning of the 1990s? 

In the 1970s, high levels of inflation stimulated a wave 

of speculative demand for real estate, and the commercial office sector experienced an unprecedented building boom. Among banks, concentrations of CRE loans 

relative to total assets substantially increased. According to an FDIC analysis,15 from 1980 to 1990, the annual average value of new nonresidential construction was 

$108 billion (in 1992 dollars), up from approximately 

$71 billion during 1975 to 1979. During the 1980s, construction of new office space outpaced demand, as measured by absorption rates. Following a period of 

corporate downsizing, mergers, and consolidations, the 

boom collapsed in the late 1980s, leaving many real 

estate markets across the nation severely depressed, 

with high vacancy rates and falling prices and rents. 

15 Federal Deposit Insurance Corporation. 1997. History of the Eighties, Lessons for the Future. An Examination of the Banking Crisis of 

the 1980s and Early 1990s. 

According to available data, despite the recent resurgence of office construction in the Region, the amount 

of new office space added during the 1990s is substantially less than the amount developed in the prior 

decade (see Chart 5). New office construction in the 

Region between 1995 and 1999 totaled only 16 percent 

of the construction that occurred between 1986 and 

1990. More important, perhaps, while office construction has expanded during the past five years, the 

Region’s share of new construction nationwide has 

declined. Between 1986 and 1990, the Region accounted for approximately 41 percent of the total new construction in the nation. Between 1994 and 1999, it 

accounted for only 18 percent. 

An office-market risk matrix comparing the new office 

construction between 1995 and 1999 with construction 

between 1986 and 1990 indicates that the Region’s CRE 

markets may be less vulnerable to a real estate bubble 

than they were in the early 1990s (see Chart 6, next 

page).16 The Region’s office markets appear less vulnerable to a downturn now because many of the Region’s 

major markets, particularly New York City, Long 

Island, and Westchester County, experienced little or 

no new construction throughout the 1990s. As a result, 

recent demand has outstripped the supply of office 

space, driving down office vacancy rates. Perhaps the 

most important difference is that during the 1980s, large 

tracts of speculative office construction in the Region 

were coming to market, resulting in rising vacancy rates 

even as the economy was growing and office employCHART 5 

0 

10 

20 

30 

40 

50 

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

0 

50 

100 

150 

Data for the New York Region are the total of Baltimore, Northern New Jersey, 

Long Island, New York City, Philadelphia, Washington, D.C., Westchester County, 

and Wilmington, Delaware. 

Source: FDIC Real Estate Data System 

Millions of Sq. Feet: 

Region (left) Millions of Sq. Feet: 

Nation (right) 

New Construction during the Present Expansion 

Has Not Yet Equaled the 1980s 

16 For more information, see Burton, Steven K. October 1998. Ranking the Risk of Overbuilding in Commercial Real Estate Markets. 

Bank Trends. Federal Deposit Insurance Corporation, Division of 

Insurance. 

New York Regional Outlook 9 Third Quarter 2000 
Regional Perspectives
 

CHART 6 

Region’s Cities Had More Overbuilding Risk 

during the Late 1980s than Today 

Vacancy Rate (%) 

24 

21 

18 

15 

12 

9 

6 

3 

0 

0 10 20 30 40 50 60 

New Office Construction as a Percentage of Total Market 

New York City 99 

Westchester 99 

Philadelphia 99 

U.S. Average 99 

Washington, D.C. 99 

Baltimore 99 

Wilmington 99 

Northern N. J. 99 

Long Island 99 

New York City 90 

Wilmington 90 

Baltimore 90 

Washington, D.C. 90 

Northern N.J. 90 

Philadelphia 90 

Westchester 90 

U.S. Average 90 

Long Island 90 

Vacancy rates as of 1990 and 1999. Existing stock as of 1990 and 1999. New 

stock is defined as new construction between 1986 and 1990 and 1995 and 1999. 

Source: C.B. Commercial/Torto Wheaton Research 

ment increasing. The recession of the early 1990s hit the 

Region’s real estate markets harder than other parts of 

the nation, in part because so much new office construction was being completed just as the Region’s 

economy started to contract and demand for space was 

declining (see Chart 7). In contrast, there has been limited office construction in most of the Region’s office 

markets during this economic boom, and vacancy rates 

are declining in most of the Region’s cities. As a result, 

the Region’s CRE markets appear better positioned 

today to weather an economic downturn than they were 

a decade ago. 

The relative lack of office construction in the Region 

also may be partly a result of difficulty in obtaining 

financing. In the early 1990s, as the glut in office space 

rose and loan quality deteriorated, financial institutions 

cut back on financing for office buildings. The soCHART 7 

0 

0.5 

1.0 

1.5 

2.0 

2.5 

3.0 

3.5 

4.0 

1986 1988 1990 1992 1994 1996 1998 

0 

5 

10 

15 

20 

Office Employment 

in millions (left) 

Sources: Torto Wheaton Research and Bureau of Labor Statistics 

Vacancy Rate 

% (right) 

In the 1980s, Vacancy Rates Increased 

despite Rising Office Employment. 

In the 1990s, the Opposite Happened 

called “credit crunch” resulted from diminished access 

to financing and reduced demand for CRE investments. 

Presently financing is available from more sources, particularly with the growth of the commercial and mortgage-backed securities and real estate investment trust 

markets. Nonetheless, anecdotal reports indicate that 

despite strong demand for office space, financing 

remains tight. Discussions with real estate developers 

suggest that more equity is required in today’s market 

than in the 1980s. The legacy of the 1980s real estate 

downturn appears to be a tendency toward greater discipline and less flexibility among today’s providers of 

capital.17 

Despite the relative health of the Region’s office markets, areas of concern exist. The most notable, perhaps, 

is the large amount of office space being filled by hightech and dot-com companies. A recent Wall Street Journal article18 cited an Insignia/ESG (a real estate 

brokerage unit of Insignia Financial Group) report that 

stated that high-tech tenants absorbed almost 3.9 million 

square feet, or about one-third of the total office space 

leased in New York City during the first four months of 

2000. The absorption exceeded that of the city’s financial sector, which leased almost 2 million square feet. 

Some high-tech companies have targeted previously less 

desirable locations that have been retrofitted to accommodate their needs, including special electrical wiring. 

Although demand for office space still far exceeds supply in New York City, dot-com companies are untested in 

their ability to weather stock market slowdowns and may 

face consolidation as the high-tech sector matures. 

Anecdotal evidence indicates that many developers are 

aware of the growing risks of leasing to this sector and 

are requiring more stringent leasing terms, such as larger deposits and more equity. However, the extent of the 

contribution of this new, expanding, yet volatile industry 

to the Region’s CRE markets should be watched closely. 

Growing Proportion of Region’s Banks 

Report CRE Concentrations, but Credit 

Quality Is Sound 

In response to renewed construction of CRE properties 

and perhaps in search of higher-yielding loans, the 

Region’s banks reported that the proportion of CRE 

loans to total assets increased slightly in the past two 

17 Fefferman, Arthur. July 1996. National Real Estate Investor 38(7). 18 Rich, Motoko. May 31, 2000. Landlords Feel Effects of Dot-Com 

Shakeout. The Wall Street Journal. 

New York Regional Outlook 10 Third Quarter 2000 
Regional Perspectives
 

years. CRE loans represented approximately 5.9 percent 

of the Region’s total assets as of March 31, 2000, compared with 5.3 percent two years ago. However, the proportion remains less than the 10.9 percent of assets held 

by the Region’s insured institutions as CRE loans in 

first quarter 1990. 

Although the aggregate proportion of CRE loans to 

assets has increased only slightly, the percentage of the 

Region’s institutions that specialize in CRE lending 

(having more than 20 percent of total assets in CRE 

loans) has increased and exceeded the proportion prior 

to the recession in the early 1990s. In first quarter 2000, 

nearly 26 percent of the Region’s institutions reported at 

least 20 percent of assets in CRE loans, compared with 

19.5 percent in first quarter 1989. While small banks 

(those with assets less than $500 million) constituted 

the majority of these banks (77 percent at the end of 

first quarter 2000), the proportion has declined as the 

Region’s midsized banks (those with assets between 

$500 million and $10 billion) have expanded their CRE 

presence. 

Many of the Region’s smaller banks that specialize in 

CRE lending are concentrated geographically in areas 

of strong economic activity from Westchester County 

and Long Island along the I-95 corridor to Washington, 

D.C., west of Philadelphia in York, Harrisburg, and 

Pittsburgh, and on the Delmarva Peninsula (see Map 

2). In some of the Region’s cities where office employMAP 2 

Counties with Two or More Small CRE Banks
 

Cluster Near Major Cities
 

Two or More 

One or More 

Note: CRE = commercial real estate 

Source: Bank and Thrift Call Reports 

ment has begun to slow, small banks that specialize in 

CRE lending have increased their aggregate proportion 

of CRE loans to assets to levels above those reported 

prior to the last recession in 1990 to 1991. These cities 

include the metropolitan statistical areas of New York 

City, Long Island, Harrisburg, and York, Pennsylvania. 

Reflecting favorable CRE conditions throughout most 

of the Region, the credit quality of CRE loans held by 

the Region’s institutions has improved steadily since the 

last recession but may have plateaued recently. The 

average past-due ratio for all CRE loans in the Region 

has consistently improved since 1992 and was 1.8 percent as of March 31, 2000. The average CRE charge-off 

ratio, net of recoveries, was approximately zero prior to 

the last recession and is again approximately zero as of 

first quarter 2000. Furthermore, the distribution or 

range of past-due ratios on CRE loans reported by all 

institutions in the Region has improved steadily since 

the early 1990s (see Chart 8). Even among the Region’s 

CRE banks, past-due loans and net charge-offs approximate pre-recession levels (see Chart 9, next page). 

Implications 

Most areas in the Region show signs of tight CRE conditions even though office construction has increased. In 

the recession of the early 1990s, new space was being 

added just as the economy slowed. Ten years later, CRE 

conditions are much tighter; however, many economic 

forecasts call for the national economy to slow, which 

could constrain demand for office space in local markets 

if companies limit expansion or contract operations. 

While the Region’s banks on average reported sound 

CRE credit quality measures in the first quarter of 2000, 

CHART 8 

0% 

5% 

10% 

15% 

20% 

25% 

30% 

35% 

40% 

198919901991199219931994199519961997199819992000 

Range of CRE Past-Due Ratio Has Declined 

High 

Low 

Median 

Note: CRE = commercial real estate 

Source: March Call Reports for all institutions in the Region less the highest and 

lowest 2.5 percent 

New York Regional Outlook 11 Third Quarter 2000 
Regional Perspectives
 

CHART 9 

a larger share of banks than in prior years has some concentration in CRE loans. Furthermore, a recent underwriting survey noted an increased frequency of risky 

Loan Quality Has Improved for CRE Specialists 

’89 

March 

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

0% 

10% 

20% 

30% 

40% 

50% 

60% 

-1.0% 

0.0% 

1.0% 

2.0% 

3.0% 

Past Dues (left) 

Charge-Offs (right) 

Source: Call Reports for banks with commercial real estate (CRE) loans greater 

than 20% of assets 

underwriting practices in construction lending in the six 

months ending March 31, 2000.19 Relaxed underwriting 

in the face of a slowing economy could pose problems 

for construction lenders. Smaller banks with more 

localized exposure to CRE markets may be more susceptible to softness in local economies or problems in 

specific industry segments, such as the Internet or 

health care. Nevertheless, as banks expand CRE portfolios, they should be vigilant in monitoring economic 

conditions, which could affect CRE loan quality. 

Kathy R. Kalser, Regional Manager 

Robert DiChiara, Financial Analyst 

Norman Gertner, Regional Economist 

Alexander J.G. Gilchrist, Economic Analyst 

19 Federal Deposit Insurance Corporation. Report on Underwriting 

Practices. October 1999 through March 2000. 

New York Regional Outlook 12 Third Quarter 2000 
In Focus This Quarter
 

Ranking Metropolitan Areas at Risk for 


Commercial Real Estate Overbuilding
 

•	 In analyses conducted in 1998 and 1999, nine metropolitan areas were identified as at risk for overbuilding; this analysis notes more vigorous 

building occurring across multiple property types 

and identifies 13 markets, including eight of the 

previous nine, as at risk for overbuilding. 

•	 Construction activity has accelerated during the 

current economic expansion with cyclically high 

levels of supply and demand. 

•	 Capital markets scaled back their investments in 

commercial real estate in 1998 and 1999, while 

FDIC-insured institutions increased their construction and development lending by more than 

20 percent each year. 

The banking industry and the FDIC learned during the 

late 1980s that once commercial real estate (CRE) markets become overbuilt, losses can mount quickly. During the 1980s and early 1990s, losses on CRE loans 

were responsible for hundreds of bank and thrift failures 

and billions of dollars in insurance losses for the FDIC. 

Since then, commercial vacancy rates have improved 

dramatically in a number of major U.S. metropolitan 

markets. In turn, CRE charge-offs reported by FDICinsured institutions have fallen to very low levels—less 

than 0.05 percent of average loans in both 1998 and 

1999. 

Two recent studies published by the FDIC evaluate the 

risk of overbuilding in major U.S. metropolitan areas.1 

These studies identified nine cities—Atlanta, Charlotte, Dallas, Las Vegas, Nashville, Orlando, 

Phoenix, Portland (Oregon), and Salt Lake City—as 

markets at risk for rising commercial vacancy rates. 

This article revisits the FDIC’s previous analysis of 

CRE markets. Using a more restrictive definition of 

at-risk markets, we find that eight of the previously 

identified nine markets remain on the list, joined by 

five additional markets: Denver, Fort Worth, Jacksonville, Sacramento, and Seattle.2 In general, more 

markets are experiencing increased levels of construc1 See “Ranking the Risk of Overbuilding in Commercial Real Estate 

Markets,” Bank Trends, October 1998, and “Commercial Development Still Hot in Many Major Markets, but Slower Growth May 

Be Ahead,” Regional Outlook, First Quarter 1999. 

tion activity across multiple CRE property sectors than 

was the case just two years ago. 

Like the two earlier studies, this analysis does not predict an imminent rise in vacancies and losses in the atrisk markets. Instead, as before, the goal is to raise 

awareness about substantial growth in real estate development and the corresponding increases in risk exposure to financial institutions. 

Previous Real Estate Cycles 

Are Well Documented 

Many analysts view the late 1980s U.S. experience as 

the very definition of adverse conditions in CRE markets. The factors that brought about these adverse conditions are well documented.3 During the early and 

mid-1980s, CRE construction boomed. Total office 

space completed in 54 major U.S. markets tracked by 

Torto Wheaton Research exceeded 100 million square 

feet per year every year from 1982 through 1987. 

Insured banks and thrifts were prime sources of credit 

for this building boom. Total outstanding construction 

and development (C&D) loans on the balance sheets of 

insured institutions grew by 52 percent, or $52.5 billion 

dollars, in 1985 alone, followed by three successive 

years of growth in outstanding C&D loans. A key factor 

behind this surge in lending was intense competition 

among lenders. In response to the heightened competition, many lenders loosened their underwriting standards, often extending credit on speculative projects on 

terms that did not protect them from downside risk. 

Examples of aggressive lending practices from this 

period included more collateral-based lending, higher 

loan-to-value limits, reliance on overly optimistic 

appraisals, and inattention to secondary repayment 

sources. 

2 The one metropolitan area identified in the prior analyses as at risk 

for overbuilding that did not fall into the same category using the 

stricter criteria in this analysis is Nashville. Nevertheless, Nashville 

still ranks high in terms of construction activity at fifth highest in the 

U.S. for retail and twelfth highest for office construction activity. 3 See, for example, Freund et al. 1997. History of the Eighties: 

Lessons for the Future, Chapters 9 and 10. FDIC. 

New York Regional Outlook 13	 Third Quarter 2000 
In Focus This Quarter
 

Poorly underwritten credit and massive increases in 

construction resulted in overbuilding in a number of 

large U.S. metropolitan markets. Nationwide, the office 

vacancy rate for competitively leased space peaked at 

over 19 percent in 1991.4 In the Southwest and New 

England, where the cycle of overlending and overbuilding was most pronounced, metro real estate markets 

were in even worse shape. Office vacancies in Dallas 

peaked at over 27 percent in 1988, while office vacancies in Boston reached over 17 percent in 1990. As 

vacancies rose and rents fell, lenders in the Southwest, 

Northeast, and elsewhere increasingly found themselves in possession of nonperforming loans and 

impaired real estate assets. The result was a sharp 

increase in the number of failed banks in the Southwest 

and Northeast.5 

Following the CRE debacle of the late 1980s and early 

1990s, commercial construction and lending volumes 

slowed. C&D loan growth at FDIC-insured institutions 

declined every year from 1989 through 1994, while a 

similar drop in private construction expenditures lasted 

through 1993. 

Factors Contributing to Cycle 

of Overbuilding in CRE 

One reason that CRE markets are 

prone to periodic bouts of overbuilding is the business cycle itself, 

which saps demand for new space 

when business activity turns downward. But another 

important contributing factor is the lag time in the 

development process as new construction moves from 

inception to completion. Heavy demand at the start of a 

project may wane or vanish before completion occurs. 

In general, the time lag associated with CRE development is longest for hotel and office projects and 

becomes shorter for retail, multifamily, and industrial 

properties, respectively. The associated degrees of lending risk mostly follow the same pattern. In general, less 

risk is associated with industrial buildings and multifamily projects, which typically take less than one year 

to build. 

4 The U.S. vacancy rate is calculated as an aggregate of selected major 

markets tracked by Torto Wheaton Research. 

5 As further detailed in the History of the Eighties, combined assets of 

failed banks in the Northeast and Southwest comprised over 70 percent of assets of all banks failing between 1980 and 1994. 

To the extent that commercial construction projects 

involve a lag between inception and completion, net 

additions to supply can be anticipated in advance. Much 

progress has been made during this real estate cycle 

toward increased availability of information on CRE 

markets, particularly in regard to supply characteristics. 

Market transparency has been promoted in part by a 

heightened level of public ownership of CRE properties 

and the corresponding higher degree of disclosure by 

the owned entities, such as real estate investment trusts 

(REITs) and commercial mortgage-backed securities 

(CMBSs). 

Changes in demand are harder to predict. A current 

example may be the high level of demand generated by 

Internet start-up companies that rely heavily on financing provided by venture capital funds and initial public 

stock offerings. Because many of these start-ups depend 

so heavily on cash inflows from investors as opposed to 

operating revenues, their viability as tenants and their 

continued demand for high volumes of office space may 

depend more on capital market conditions than on their 

own business performance. While demand may appear 

strong under robust business conditions, it is prone to 

decline rather suddenly in the event of an economic 

downturn. Given these attributes of CRE markets, the 

process of gauging the success for lease-up of a proposed project involves not only looking at new supplies 

of competitive space coming onto the market, but also 

evaluating how vulnerable the market is to a downturn 

in demand for space. 

Recent Developments 

Following a lull in commercial construction activity that 

resulted from adverse market conditions in the early 

1990s, construction activity has gradually accelerated 

during the current economic expansion. The increased 

pace of construction occurred first in industrial and 

retail markets, where growth in net new completions of 

space picked up starting in 1993. The pace of multifamily construction accelerated in 1995, followed by 

increasing levels of office and hotel construction in 

1997. Regionally, commercial construction activity 

recovered first in the Southeast and Northwest, where 

the effects of the previous overbuilding had been the 

least pronounced. Only later did the pace of construction increase in California, the Southwest, and the 

Northeast. As the U.S. economic expansion endures into 

its tenth year, construction activity continues to pick up 

steam across most property types. In the 54 major metNew York Regional Outlook 14 Third Quarter 2000 
In Focus This Quarter
 

ropolitan areas tracked by Torto Wheaton Research, 

total annual office space completions rose from just 

over 3 million square feet in 1994 to 78.7 million square 

feet in 1999. 

National private expenditures on hotel and retail construction for 1999 exceeded all prior years on both a 

current-dollar and an inflation-adjusted dollar basis. 

Similarly, national private construction expenditures 

on office space in 1999 were at an all-time high on a 

current-dollar basis. On an inflation-adjusted dollar 

basis, office construction expenditures in 1999 were 

still not as high as they were during the mid-1980s. 

A new characteristic of the CRE industry in the current 

expansion has been the marked increase in capital availability through the financial markets. Annual issuance 

of CMBSs has grown from negligible amounts in 1990 

to over $67 billion in 1999. Financing made available 

through REITs has been the other link to the capital 

markets. REIT market capitalization increased from 

approximately $10 billion in 1994 to nearly $145 billion 

in 1999. 

While the availability of market-based sources of capital has helped to facilitate growth in construction during 

this expansion, the financial market turmoil of late 1998 

cast a cloud over the CMBS market that has yet to lift 

fully. Significant events in the global capital markets in 

1997 and 1998, including the Asian economic crisis and 

the Russian government bond default, significantly curtailed the ability of major CMBS issuers to go to the 

market for financing. Significant liquidity problems 

resulted for a number of commercial mortgage firms. 

Nomura, Lehman Brothers, CS First Boston, and others 

incurred losses, while Criimi Mae, Inc., was forced to 

declare bankruptcy. 

As the capital markets pulled back from CRE investments, insured banks and thrifts stepped in to fill the 

void. Chart 1 shows that the total volume of C&D loans 

on the balance sheets of FDIC-insured institutions rose 

by more than 20 percent per year in both 1998 and 

1999, even as growth in U.S. private construction 

expenditures slowed to a crawl.6 

In terms of overall construction market activity, the 

current situation appears to be one of cyclically high 

6 U.S. private construction expenditures, as calculated by the Bureau 

of the Census, include multifamily (two or more units), industrial, 

office, hotel, and retail space. 

CHART 1 

’86 

Growth Rates (%) 

Growth Rates of Private Construction 

Expenditures and C&D Loans Diverge 

during the Past Two Years 

–30 

–20 

–10 

0 

10 

20 

30 

40 

50 

60 

C&D = construction and development loans 

Sources: Bureau of the Census (Haver Analytics), Bank and Thrift Call Reports 

(Research Information System) 

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

C&D Loans 

Priv. Const. 

levels of supply and demand. Because significant 

growth in net new space is forecast for many markets 

and property types during 2000 and 2001, a drop in 

demand for space could impair absorption rates and 

lead to higher vacancies and lower rents. Most analysts 

feel that future trends in real estate demand will be 

closely linked to national and regional economic conditions. 

Identification of Markets at Risk 

for Overbuilding 

Previous FDIC studies have identified CRE markets at 

risk for broad-based overbuilding on the basis of comparative rankings in the rates of growth in commercial 

space. In a 1998 study, U.S. metropolitan areas were 

ranked according to 1997 new construction activity as a 

percentage of existing stock for the five main property 

types: office, industrial, retail, multifamily, and hotel.7, 8 

In that study, any metro area that appeared in the top 15 

for any two of the commercial property types was 

labeled “at risk.” Nine cities were identified as being at 

risk for overbuilding: Atlanta, Charlotte, Dallas, Las 

Vegas, Nashville, Orlando, Phoenix, Portland 

(Oregon), and Salt Lake City. 

7 Federal Deposit Insurance Corporation. October 1998. Ranking the 

Risk of Overbuilding in Commercial Real Estate Markets, Bank 

Trends. 

8 Construction activity is measured in square feet and includes projects completed during the year, plus projects still under construction 

as of year-end. This figure is then divided by the total stock of space 

to obtain a construction activity percentage for use in comparative 

rankings. 

New York Regional Outlook 15 Third Quarter 2000 
In Focus This Quarter
 

This study updates the previous results using year-end 

1999 data.9 In doing so, it applies more restrictive criteria to identify at-risk metropolitan real estate markets. 

As before, the metro areas are ranked according to new 

construction as a percentage of existing stock in each of 

the five main commercial property types. However, in 

this analysis, to be considered at risk, a metro area must 

rank in the top ten for any two of the property types. 

Despite the fact that it was harder for individual markets 

to qualify as being at risk, all but one of the previously 

identified nine markets remain on the at-risk list. Moreover, they are joined by five additional metropolitan 

areas: Denver, Fort Worth, Jacksonville, Sacramento, 

and Seattle. It is evident that more metropolitan areas 

are emerging with vigorous CRE construction and 

development across multiple property sectors. 

Most Active Construction Markets 

Charts 2 through 6 represent the property sectors of 

office, industrial, retail, multifamily, and hotel. They 

also list, for each property sector, the metropolitan 

areas having the highest levels of construction activity, 

relative to existing stock, for the year ending December 

31, 1999. The overall national construction activity rate 

is also shown for comparative purposes for each of the 

property sectors. Each metropolitan area is ranked 

from the highest to lowest for levels of construction 

activity. 

As shown in these charts, Las Vegas, Orlando, and 

Phoenix are standouts, with each placing among the top 

ten metropolitan areas in the country for construction 

activity in at least four of the five different property sectors. Las Vegas is among the top ten in construction 

activity for all five property sectors except for hotel 

construction, where it ranks twenty-sixth.10 Las Vegas 

ranks first in retail construction and second in industrial construction. Orlando is first in both office and multifamily construction. Phoenix is among the top ten for 

each of the five property sectors except hotel construction, where it ranks sixteenth. 

9 For the five property sectors reviewed in this report, data sources 

were Torto Wheaton Research for office and industrial and F.W. 

Dodge for retail, multifamily, and hotel. Torto Wheaton Research’s 

data for office and industrial encompass 54 and 53 metropolitan statistical areas (MSAs), respectively. F.W. Dodge’s data for retail, multifamily, and hotel encompass 58 MSAs. 

10 Las Vegas has the most hotel rooms in the country, with slightly 

fewer than 124,000 rooms as of year-end 1999. During 1999, Las 

Vegas experienced the greatest addition of rooms (in absolute numbers) of any market. With over 13,000 new rooms added during 1999, 

Las Vegas had nearly twice the level of the next highest metropolitan 

area, which was Orlando, with an additional 7,000 rooms. 

CHART 2 

CHART 3 

CHART 4 

Top 15 Office Development Markets—Construction 

Activity in 1999 as a Percentage of Stock 

(Square Footage) 

Orlando 

Phoenix 

Seattle 

Salt Lake City 

Charlotte 

Columbus 

Jacksonville 

Austin 

Las Vegas Completions Wilmington 

West Palm Beach Under 

Construction Nashville 

Oakland
 

Sacramento
 

Minneapolis
 

National 

0% 5% 10% 15% 20% 25% 

Source: Torto Wheaton Research 

Top 15 Industrial Development Markets— 

Construction Activity in 1999 as a Percentage 

of Stock (Square Footage) 

Riverside 

Las Vegas 

Ventura County 

Fort Lauderdale 

Phoenix 

Sacramento
 

San Diego
 

Fort Worth
 

Cincinnati Completions Atlanta
 

Austin
 Under 

Dallas Construction 

Fresno 

Jacksonville
 

Orlando
 

National
 

0% 2% 4% 6% 8% 10% 12% 14% 16% 

Source: Torto Wheaton Research 

Top 15 Retail Development Markets— 

Construction Activity in 1999 as a Percentage 

of Stock (Square Footage) 

Source: F.W. Dodge 

National 

Greensboro 

Jacksonville 

Denver 

Greenville 

Tampa 

Richmond 

West Palm Beach 

Sacramento 

Atlanta 

Fort Worth 

Nashville 

Phoenix 

Orlando 

Dallas 

Las Vegas 

0% 5% 10% 15% 20% 25% 30% 35% 40% 

Under 

Construction 

Completions 

New York Regional Outlook 16 Third Quarter 2000 
In Focus This Quarter
 

Other markets deserve notice for their high or moderately high levels of construction activity in one or more 

property sectors. Columbus, Ohio, ranks sixth in the 

nation for its high level of office construction and 

twelfth for both multifamily and hotel construction. 

Greenville is tenth in the nation for hotel construction 

and twelfth for retail. West Palm Beach is ninth for 

retail and eleventh for office. Austin is eighth for 

office, eleventh for both multifamily and industrial, and 

thirteenth for hotel. 

C&D Loan Concentrations 

Concentrations of C&D loans at community banks in 

the at-risk markets are generally higher now than they 

were at the peak of the last cycle in the 1980s.11 As 

shown in Chart 7, the median ratio of C&D loans to 

total assets as of March 31, 2000, was higher than the 

median ratio as of December 31, 1988, in ten of the thirteen at-risk markets.12 The median C&D loan concentration is currently higher than the national average in 

all 13 at-risk markets.13 

At present, overall loan performance remains very good 

for the C&D portfolios of insured institutions. Reported 

delinquent and nonaccrual C&D loans remain at nominal levels as a percentage of total loans, although the 

ratio for both measures increased marginally during the 

first quarter of 2000. 

Construction Employment Concentrations 

The percentage of a metropolitan area’s workforce 

employed in construction is an indicator of the sensitivity of the local economy to construction. Six of the 13 

metropolitan areas at risk for overbuilding are found 

among the top 12 most concentrated construction 

employment markets (see Chart 8, next page).14 In addition, all of the 13 have construction concentration levels 

exceeding the national average. With slightly under 10 

percent of its nonfarm workforce employed in construction, Las Vegas has the highest construction11 Community banks are FDIC-insured institutions with assets less 

than $1 billion. 

12 For community banks that have C&D loans. 

13 Since 1992, the aggregate C&D-to-asset ratio for the nation’s community banks has been higher than the C&D-to-asset ratio for institutions larger than $1 billion. This is a reversal of the condition from 

1984 through 1991 when the aggregate C&D-to-asset ratio for institutions larger than $1 billion exceeded the C&D-to-asset ratio for 

community banks. 

14 Construction concentrations are the percentage of construction 

employees relative to the nonfarm workforce. 

CHART 5 

Top 15 Multifamily Development Markets—
 

Construction Activity in 1999 as
 

a Percentage of Stock (Units)
 

Orlando
 

Charlotte
 

Raleigh
 

Portland
 

Dallas
 

Las Vegas
 

Denver
 

Seattle
 

Atlanta
 Completions Phoenix
 

Austin
 Under
 

Columbus
 Construction
 

Tampa
 

Jacksonville
 

Nashville
 

National
 

0% 2% 4% 6% 8% 10% 12% 

Source: F.W. Dodge 

CHART 6 

Top 15 Hotel Development Markets— 

Construction Activity in 1999 as a Percentage 

of Stock (Square Footage) 

Fort Worth
 

Jacksonville
 

Portland
 

Orlando
 

Salt Lake City
 

Denver
 

Charlotte
 

Dallas
 

Seattle
 Completions Greenville
 

Oakland
 Under 

Columbus, OH Construction 

Austin 

Greensboro 

San Jose 

National 

0 5% 10% 15% 20% 25% 30% 

Source: F.W. Dodge 

CHART 7 

Most of the At-Risk Markets’ Community Banks 

Have Higher Median C&D Loan-to-Asset Ratios 

at 3/31/00 than at Peak of Last Cycle (12/31/88) 

Salt Lake City
 

Atlanta
 

Portland
 

Las Vegas
 

Sacramento
 

Phoenix
 

Seattle
 

Fort Worth
 

Dallas
 3/31/00 

Orlando 12/31/88
 

Charlotte
 

Denver
 

Jacksonville
 

National
 

0 2 4 6 8 10 12 14 16 18 

Median C&D Loan-to-Asset Ratios (%) 

C&D = construction and development 

Source: Bank and Thrift Call Reports (Research Information System) 

New York Regional Outlook 17 Third Quarter 2000 
In Focus This Quarter
 

concentrated workforce of all metropolitan areas in the CHART 9 

United States and is slightly over twice the national rate 

of 4.8 percent. 

High Construction Activity and High 

Vacancy Levels 

Newly constructed, speculative space competes directly 

for tenants against already-built and vacant space. To 

assess at-risk markets fully, it is useful to compare the 

levels of construction activity for each metropolitan 

area’s property sector against its associated vacancy 

levels.15 

Charts 9 through 13 show, by property sector, each 

city’s level of construction activity plotted against the 

corresponding vacancy rate. It is axiomatic that a metropolitan area with high vacancies and high construction is cause for concern for builders and lenders alike. 

Many of the 13 At-Risk Markets Report 

High Office Construction Activity and High Office 

Vacancy Rates 

0 

5 

10 

15 

20 

25 

0% 5% 10% 15% 20% 25% Vacancy Rate 

Note: Capitalized cities are among the 13 markets identified as at risk for 

overbuilding. 

Source: Torto Wheaton Research Construction Activity as Percentage of Stock

SEATTLE 

ORLANDO 

CHARLOTTE 

PHOENIX 

Austin 

Wilmington 

SACRAMENTO 

West Palm Beach 

DALLAS 

LAS VEGAS 

SALT LAKE CITY 

JACKSONVILLE 

Riverside Oklahoma City 

Bakersfield 

Columbus 

Nation 

CHART 10 

It follows for metropolitan areas with high construction 

and high vacancy that newly arriving CRE projects will 

face significant competitive pressures in obtaining tenants. Consequentially, barring any preleasing or any 

fundamental upward shifts in demand, rental concessions may be needed to obtain tenants, and property values may be depressed. 

CHART 8 

Many of the 13 At-Risk Markets Are among the
 

Nation’s Metropolitan Statistical Areas Having the
 

Highest Construction Employment Levels as of
 

First Quarter 2000
 

LAS VEGAS 

Riverside 

Houston 

PHOENIX 

DENVER 

Greenville 

SALT LAKE CITY 

CHARLOTTE 

Birmingham 

Albuquerque 

Richmond Note: Capitalized cities 

SACRAMENTO are among the 13 

Norfolk markets identified as at 

Oakland risk for overbuilding. 

Raleigh 

National 

0% 2% 4% 6% 8% 10% 12% 

Construction Employees as a Percentage of the Nonfarm Workforce 

Source: Bureau of Labor Statistics (Haver Analytics) 

15 The data vendors do not provide category breakdowns for construction activity into speculative versus nonspeculative (preleased) 

properties. 

Many of the 13 At-Risk Markets Report High 

Industrial Construction Activity and High Industrial 

Vacancy Rates 

0 

2 

4 

6 

8 

10 

12 

14 

16 

Construction Activity as a Percentage of Stock 

0% 2% 4% 6% 8% 10% 12% Vacancy Rate 

Source: Torto Wheaton Research 

Austin Cincinnati 

JACKSONVILLE Fresno 

ORLANDO DALLAS Washington, 

D.C. 

Hartford 

Long Island 

Westchester 

ATLANTA 

FORT 

WORTH 

PHOENIX 

San Diego 

SACRAMENTO 

Ft. Lauderdale 

LAS VEGAS 

Riverside 

Ventura 

Note: Capitalized cities are among 

the 13 markets identified as at risk 

for overbuilding. 

Nation 

CHART 11 

Many of the 13 At-Risk Markets Report High 

Retail Construction Activity and High Retail 

Vacancy Rates 

0 

5 

10 

15 

20 

25 

30 

35 

40 

0% 2% 4% 6% 8% 10% 12% 14% 16% 

Source: F.W. Dodge 

Vacancy Rate 

Construction Activity as a Percentage of Stock

Note: Capitalized cities 

are among the 13 

markets identified as at 

risk for overbuilding. 

LAS VEGAS 

ORLANDO DALLAS 

PHOENIX 

ATLANTA SACRAMENTO 

Tampa DENVER 

JACKSONVILLE 

Greensboro 

FORT 

WORTH 

W. Palm Beach 

Greenville 

Nation 

Nashville 

New York Regional Outlook 18 Third Quarter 2000 
In Focus This Quarter
 

What Market Analysts Are Saying 

Views of industry analysts provide additional perspective on the risks pertaining to each of the five property 

sectors and the individual metropolitan areas. 

Office 

Newly constructed nationwide office supply will outpace demand in 2000 and beyond, according to Torto 

Wheaton Research.16 Some 65 million square feet of 

space is scheduled for completion in 2000. However, net 

absorption is projected to be only 58 million square feet 

in 2000, resulting in an excess supply of 7 million square 

feet. Torto Wheaton Research predicts that office completions will outpace absorptions for all projected yearends through 2005, and corresponding vacancy rates will 

climb to slightly more than 14 percent at year-end 2005. 

Overall office fundamentals are in equilibrium, according to Donaldson Lufkin & Jenrette (DLJ), thanks to 

preleasing and sufficient demand.17 Still, DLJ identifies 

a number of markets as being at greater risk for excess 

new supply. DLJ’s markets to watch for possible overbuilding are Charlotte, Fort Lauderdale, Minneapolis, 

and Sacramento. More than 9 percent in new supply is 

projected for Sacramento over the next 18 months, with 

only a 3 percent increase in demand. DLJ identifies the 

Sacramento suburbs as the major center of construction 

activity and notes with concern the existing 13 percent 

suburban vacancy rate for this metropolitan area. 

Overall office construction levels will peak this year, 

according to the Urban Land Institute (ULI).18 Increases 

in suburban office vacancy rates to nearly 11 percent by 

the end of 2000 are projected, with downtown rates falling 

to slightly over 8 percent. ULI notes the possibility of a 

rash of space returns by Internet companies and others in 

the technology sector as a significant going-forward risk. 

Many analysts caution about the ability of new office 

construction to be absorbed in certain markets where 

labor supplies remain tight. In recent Wall Street Journal articles, Dallas and Seattle are reported to be actively recruiting high-tech engineers through immigrants 

from India and China to fill in the gaps in their tight 

labor-market pool for high-technology jobs.19, 20 

16 Torto Wheaton Research. Spring 2000. Office Outlook.
 17 Thierry Perrein, Donaldson, Lufkin & Jenrette. April 2000. DLJ
 

REIT Corporate Handbook, “Cautious Optimism.”
 

18 Urban Land Institute. ULI 2000 Real Estate Forecast.
 19 Templin, Neal. June 7, 2000. Economic Focus: Houston, Dallas
 

Are Draw for Immigrants. The Wall Street Journal.
 20 Barnes, Brooks. June 7, 2000. Economic Focus: Seattle Enjoys
 

Influx of Foreign Workers. The Wall Street Journal.
 

In a recent office market report by Moody’s Investors 

Service, three metropolitan areas (Jacksonville, 

Nashville, and Phoenix) are coded as “red”—indicating 

danger for high supply and declining demand factors.21 

Charlotte is coded as “yellow,” and its office demand is 

projected to grow by only 5 percent this year, while supply will increase by over 11 percent. 

Multifamily 

Recent mortgage rate increases will slow purchases of 

single-family homes, thereby increasing the demand for 

multifamily properties, according to a recent article by 

PaineWebber.22 Nevertheless, concerns are raised for 

oversupply conditions for multifamily construction in 

Atlanta, Dallas, Houston, and Las Vegas—cities characterized as “low barrier-to-entry markets.” 

Markets appearing weak to DLJ for the multifamily 

property sector include Charlotte, Denver, Jacksonville, 

Orlando, Portland, Raleigh, Salt Lake City, and Seattle.23 

Industrial 

Atlanta and Dallas are weaker for the industrial property 

sector, according to DLJ, because of significant new supply levels.24 A 7 percent supply growth is projected for 

Phoenix in 2000, with only a 4 percent increase in demand. 

Retail 

For retail properties, DLJ believes a number of markets 

have excess supply; the standouts are Austin, Las Vegas, 

Orlando, Phoenix, and Sacramento.25 

Hotel 

Analysts point to specific concerns for a “glut” of limited-service hotels in certain markets and note many hotel 

developers taking advantage of low barriers to entry for 

hotel construction. In response, many developers argue 

that “product differentiation” within different hotel sectors justifies further development. 

Growth in expenditures on hotel construction has been 

above 7 percent for each of the past several years, while 

room revenues grew at a more moderate pace, according 

to PaineWebber.26 The poor growth in room revenue is 

attributed to supply exceeding demand. 

21 Gordon, Sally. June 2, 2000. Moody’s Investors Service, Special
 

Report—CMBS: Red-Yellow-Green Update, Second Quarter
 

2000, Quarterly Assessment of U.S. Property Markets.
 

22 PaineWebber. June 6, 2000. Real Estate Investment Trust—Initiating Coverage on the REIT Industry.
 

23 Ibid.
 

24 Ibid.
 

25 Ibid.
 

26 PaineWebber. June 1, 2000. Industry Outlook Lodging, U.S.
 

Hotel Construction Update—First Quarter 2000.
 

New York Regional Outlook 19 Third Quarter 2000 
In Focus This Quarter
 

CHART 12 CHART 13 

Many of the 13 At-Risk Markets Report High 

Hotel Construction Activity and High Room 

Availability (Vacancy) Rates 

0 

5 

10 

15 

20 

25 

30 

15% 20% 25% 30% 35% 40% 45% 

Vacancy Rate 

Source: F.W. Dodge Construction Activity as a Percentage of Stock

Note: Capitalized cities 

are among the 13 

markets identified as at 

risk for overbuilding. 

FORT WORTH 

JACKSONVILLE 

ORLANDO 

PORTLAND 

DENVER 

SALT LAKE CITY 

Oakland SEATTLE CHARLOTTE 

Nation 

DALLAS 

Austin Columbus Greenville 

Greensboro 

Many of the 13 At-Risk Markets Report High 

Multifamily Construction Activity and High 

Multifamily Vacancy Rates 

0 

2 

4 

6 

8 

10 

12 

3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 

Source: F.W. Dodge Vacancy Rate Construction Activity as a Percentage of Stock

Note: Capitalized cities 

are among the 13 

markets identified as at 

risk for overbuilding. 

ORLANDO 

CHARLOTTE 

PORTLAND Raleigh DALLAS 

DENVER LAS VEGAS SEATTLE 

PHOENIX 

ATLANTA 

Nation 

JACKSONVILLE Columbus 

Tampa Austin 

Indianapolis Houston 

Birmingham 

As shown in the referenced charts, multiple cities are 

experiencing high volumes of construction activity concurrent with high vacancy rates. Seven of the 13 at-risk 

cities show up in the upper-right quadrants, exhibiting 

both high rates of construction and vacancy: Atlanta 

for industrial and multifamily; Dallas for office and 

retail; Fort Worth for retail and hotel; Jacksonville for 

office and hotel; Las Vegas for office and industrial; 

Orlando for office and multifamily; and Salt Lake 

City for office and hotel. 

Other metropolitan areas beyond these 13 are precariously situated at the furthermost positions on the charts 

for high vacancy and high construction levels: Austin 

and Houston for multifamily; Greensboro for hotel; 

Greenville for retail and hotel; and West Palm Beach 

for office and retail. 

Conclusion 

Since 1997, responding to a void left by the departure of 

other capital market lenders, community banks have 

stepped up their CRE lending activity. At the same time, 

more metropolitan areas are emerging with vigorous 

CRE construction and development across multiple 

property sectors. In the 1998 and 1999 FDIC analyses, 

nine metropolitan areas were identified as being at risk 

for overbuilding across multiple property types. In the 

present analysis, 13 metropolitan areas, including eight 

of the nine from the prior analyses, receive this designation. Given strong levels of CRE completions, these 

metropolitan areas are particularly sensitive to any 

decline in real estate demand that could result from a 

slowdown in the national or regional economy. 

Thomas A. Murray, Senior Financial Analyst 

New York Regional Outlook 20 Third Quarter 2000 
In Focus This Quarter
 

Rising Home Values and New Lending Programs Are 


Reshaping the Outlook for Residential Real Estate
 

•	 Home prices have risen rapidly in several major 

U.S. metropolitan areas. 

•	 The credit quality of residential real estate loan 

portfolios traditionally has been solid. 

•	 New lending programs such as subprime and high 

loan-to-value lending could change the historical 

loss experience associated with residential real 

estate. 

Introduction 

The median price of an existing single-family home has 

been rising rapidly in several U.S. metropolitan areas. 

After a prolonged period of stagnant or slowly rising 

resale prices in many of these markets throughout most 

of the 1990s, prices have rebounded strongly, reaching 

double-digit rates of growth in some areas. Not surprisingly, these markets have also experienced relatively 

robust job growth, particularly in high-tech sectors that 

have been the catalyst for growth in the New Economy.1 

However, as existing home prices in some markets have 

been rising rapidly, new building activity has recently 

begun to slow because of rising interest rates. After 

reaching a 19 percent year-over-year growth rate in the 

fourth quarter of 1998, single-family housing starts 

declined by 2.8 percent in the second quarter of 2000. 

Similarly, year-over-year growth in single-family housing permits declined by 8.4 percent in the second quarter of 2000. Higher home mortgage rates, along with the 

prospect for more moderate job growth, have dampened 

market activity. 

Single-family mortgages have traditionally been associated with low loss rates compared with other, higherrisk lending lines at insured institutions. However, the 

real estate market is still susceptible to boom and bust 

cycles, which could pose a risk to institutions with 

exposures to residential real estate. This risk would be 

heightened by the formation of asset price bubbles in 

local markets. Furthermore, as the competition among 

1 For a discussion on what is meant by the term “New Economy,” see 

“Banking Risk in the New Economy,” Regional Outlook, second 

quarter 2000; http://www.fdic.gov/bank/analytical/regional/ro20002q/ 

na/t2q2000.pdf. 

mortgage lenders becomes more intense, insured institutions are increasingly participating in new, higher-risk 

types of mortgage lending, such as high loan-to-value 

(LTV) lending and subprime lending. These new lending practices—still largely untested in a recession— 

raise some concerns about the future credit quality of 

residential loan portfolios. 

Home Prices in Some Local Markets 

Are Soaring 

Home prices have been soaring recently in a number of 

large U.S. metropolitan markets. Rapid price increases 

in some of these areas have come on the heels of a period of slow or stagnant growth (see Chart 1). Table 1 

(next page) identifies the top 20 metropolitan markets 

based on the median price of an existing single-family 

home. Many of the areas identified in the table are also 

places where home prices are increasing most rapidly. 

Healthy job growth, tight labor market conditions, and 

a tight supply of available homes have contributed to 

price increases in these areas. 

Some of the same metropolitan areas that are experiencing significant home price appreciation are also 

highly dependent on the high-tech sector. The shaded 

areas in Table 1 highlight the metro markets that not 

only have the highest median home prices in the nation 

but also have a concentration of high-tech employees in 

the workforce greater than 5 percent. Explosive growth 

CHART 1 

–10% 

–5% 

0% 

5% 

10% 

15% 

20% 

25% 

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

Some Large U.S. Metropolitan Areas Have 

Seen the Return of Soaring Home Prices 

Source: National Association of Realtors (Haver Analytics) 

Year-over-Year Growth of the Median Existing Single-Family 

Home Price 

San Francisco 

Boston 

New York Regional Outlook 21	 Third Quarter 2000 
In Focus This Quarter
 

TABLE 1 

Of the 20 U.S. Cities with the Most Expensive Housing, 

More than Half Have a Concentration in High-Tech Employment 

THE SHADED AREAS INDICATE MARKETS WHERE HIGH-TECH EMPLOYEES CONSTITUTE AT LEAST 

5 PERCENT OF THE TOTAL PAYROLL EMPLOYMENT (SEE NOTE). 

METROPOLITAN STATISTICAL AREA 

RANKING BY MEDIAN HOME PRICE 

MEDIAN PRICE OF AN EXISTING 

SINGLE-FAMILY HOME 

MARCH 2000 

PERCENT CHANGE 

FROM ONE YEAR AGO 

1 SAN FRANCISCO, CA $418,600 25.0% 

2 ORANGE COUNTY, CA $300,800 10.3% 

3 HONOLULU, HI $289,000 –2.0% 

4 BOSTON, MA* $255,000 8.4% 

5 SAN DIEGO, CA $251,400 16.1% 

6 BERGEN-PASSAIC, NJ $250,200 9.8% 

7 NEWARK, NJ $229,500 18.8% 

8 SEATTLE, WA $226,100 8.3% 

9 NEW YORK, NY $221,500 14.3% 

10 NASSAU-SUFFOLK, NY $209,200 12.8% 

11 LOS ANGELES, CA $202,900 5.6% 

12 MIDDLESEX, NJ $198,500 8.6% 

13 MONMOUTH-OCEAN, NJ $186,200 19.4% 

14 DENVER, CO $181,500 12.9% 

15 WASHINGTON, DC-MD-VA $177,500 5.6% 

16 PORTLAND, OR $166,700 0.8% 

17 CHICAGO, IL $166,700 0.4% 

18 LAKE COUNTY, IL $162,600 –2.2% 

19 AURORA-ELGIN, IL $158,200 7.5% 

20 RALEIGH-DURHAM, NC $156,300 –4.2% 

NATION $133,533 2.7% 

* Ranking based on the latest data available (third quarter 1999). 

Note: High-tech, as defined by Dismal Sciences, Inc., includes industries such as pharmaceuticals, computers, 

electronic components, communications equipment, and communications services. 

Sources: National Association of Realtors (Haver Analytics); Dismal Sciences, Inc. 

in technology industries during this expansion has created new job opportunities in many metropolitan areas 

where high-tech companies and employment tend to be 

concentrated. The influx of highly skilled, and often 

highly compensated, high-tech workers into these areas 

has boosted the demand for both new and existing 

homes, pushing up home prices. For example, in San 

Francisco, where high-tech employees now comprise 

7.1 percent of the total workforce, home prices rose by 

22 percent in calendar year 1999 and are expected to 

rise another 14 percent in 2000.2 

2 July 21, 2000. Your Money Matters: Turning Down the Heat on 

Home Prices—Forecasters Find More Evidence That the Market Is 

Cooling; San Francisco Still Rocks. The Wall Street Journal. 

Soaring home prices in these metro areas have created 

the possibility of speculative price bubbles that could 

cause problems for mortgage lenders. If a decline in 

high-tech employment or company earnings were to 

cause a deterioration in home values in these markets, 

the credit quality of mortgage portfolios at insured institutions could be jeopardized. 

Favorable Economic Conditions Have Sustained 

Consumer Spending Patterns 

As the current U.S. expansion entered its 113th month 

in July 2000, consumer spending continued along a path 

of rapid growth. In the second quarter of 2000, personNew York Regional Outlook 22 Third Quarter 2000 
In Focus This Quarter
 

al consumption expenditures increased by 8 percent 

over the previous year. Nearly ideal conditions for consumers have contributed to high levels of spending. The 

unemployment rate remains near the record low of 3.9 

percent set in April 2000, and consumer confidence 

remains near the record high set in January 2000. 

Moreover, consumer buying power has been boosted by 

real wage gains, generally low interest rates, and stock 

market earnings. 

One of the only negative aspects for consumers has 

been the recent rise in interest rates, which has 

increased the cost of borrowing. From the end of 1998 

to June 2000, both the bank prime lending rate and the 

average mortgage contract rate for purchase of a previously occupied home rose by more than 100 basis 

points. However, the flexibility offered by adjustablerate mortgages (ARMs) has helped consumers shield 

themselves from the full effects of interest rate increases. As of the second quarter of 2000, the share of ARMs 

as a percentage of all loans closed had risen from 10 

percent in the fourth quarter of 1998 to 30 percent (see 

Chart 2). 

Nonetheless, as interest rates have risen, overall activity 

in the single-family housing market has slowed noticeably. After reaching an annualized rate of 1.4 million 

units in December 1999, monthly starts of single-family 

homes have declined by more than 15 percent to 1.2 

million units in June 2000. Similarly, the annualized 

rate of single-family permits issued in June 2000 was 

down 14 percent from January 2000 levels. The National Association of Realtors (NAR) reports that, despite 

current high levels of activity, deteriorating affordability conditions are expected to slow the resale housing 

market over the course of the year.3 In June 2000, NAR’s 

composite Housing Affordability Index fell to its lowest 

point since September 1996. To the extent that any 

decline in economic conditions would produce a less 

favorable environment for consumers, the housing market would likely slow even further. 

Overall Credit Quality of Residential 

Mortgages Has Been Solid 

Historical losses from residential real estate exposures 

at insured institutions are well documented. In the 

1980s, areas such as Texas, California, and New Eng3 National Association of Realtors Press Release. August 1, 2000. 

Housing Affordability Drops to Eight-Year Low, NAR Reports. 

CHART 2 

6.5% 

7.0% 

7.5% 

8.0% 

8.5% 

9.0% 

Jan-97 Sep-97 May-98 Jan-99 Sep-99 May-00 

5% 

10% 

15% 

20% 

25% 

30% 

35% 

More Consumers Have Chosen ARMs 

as Mortgage Rates Have Risen 

Sources: Federal Reserve Board; Federal Housing Finance Board (Haver 

Analytics) 

Contract Rate on Conventional 

30-Year Mortgage 

Commitments 

Adjustable-Rate Home 

Mortgage Loans as a 

Percentage of All Loans Closed 

land experienced strong economic growth, rapid residential development, and sharp home price appreciation 

that created asset price inflation. Coastal California 

markets, in particular, experienced double-digit growth 

rates that propelled the median home price in California 

to more than double the national average.4 

Regional recessions in many of these areas took a toll 

on residential real estate markets. Home values either 

stagnated or declined precipitously, and the foreclosure 

rate on residential real estate began to rise rapidly. Nevertheless, very few bank failures can be attributed solely to losses on residential mortgages. Loss rates on 

residential loans have traditionally been low compared 

with other loan categories. 

The credit quality of conventional single-family mortgage portfolios has generally been good throughout this 

economic expansion. The percentage of conventional 

loans past due during this expansion has averaged 2.8 

percent, compared with 3.5 percent during the last 

expansion from 1982 to 1990.5 Moreover, past-due conventional loans fell for the sixth consecutive quarter in 

the first quarter of 2000 to 2.3 percent (see Chart 3, next 

page). Foreclosures started, while slightly higher on 

average than the previous expansion, remain at a 

healthy level well below 1 percent of loans (see Chart 4, 

next page). 

4 Federal Deposit Insurance Corporation, Division of Research and 

Statistics. 1997. History of the Eighties: Lessons for the Future. Vol. 

1, An Examination of the Banking Crises of the 1980s and Early 

1990s. http://www.fdic.gov/bank/historical/history/contents.html. 5 “Past due” refers to loans that are 30 or more days past due. 

New York Regional Outlook 23 Third Quarter 2000 
In Focus This Quarter
 

By contrast, Veterans Administration (VA) and Federal 

Housing Administration (FHA) loans have performed 

less well during this expansion. These loan types are 

both designed to aid less creditworthy borrowers in 

securing a home loan. VA and FHA loans, which 

include a portion of the higher-risk high-LTV and subprime loans, have historically experienced higher pastdue and foreclosure rates than other classes of mortgage 

loans (see Charts 3 and 4). 

The overall performance of 1–4 family residential mortgages at insured institutions has been solid. As of March 

2000, delinquent 1–4 family loans remained well under 

1 percent of total 1–4 family loans, and the percentage 

of charge-offs was nearly zero. Charge-offs may have 

reached the bottom of the credit cycle in 1998, however, after peaking at a record high in 1993 (see Chart 5). 

CHART 3 

Past-Due Rates on FHA and VA Loans Have
 

Historically Been Higher than
 

on Conventional Loans
 

Loans Past Due as a Percentage of All Loans 

10.0 Federal Housing Administration 

8.0 

6.0 

Veterans Administration Loans 

Loans 

4.0 

2.0
 

Conventional Loans
 

0.0
 

4Q82 3Q85 2Q88 1Q91 4Q93 3Q96 2Q99 

Source: Mortgage Bankers Association (Haver Analytics) 

CHART 4 

Foreclosure Rates on FHA and VA Loans
 

Remain Higher than on Conventional Loans
 

Foreclosures Started as a Percentage of All Loans 

0.8 

0.7 Federal Housing Administration 

Loans 

0.6 

0.5 

0.4 

0.3 

0.2 

0.1 

Veterans Administration Loans 

Conventional Loans 

0.0 

4Q82 3Q85 2Q88 1Q91 4Q93 3Q96 2Q99 

Source: Mortgage Bankers Association (Haver Analytics) 

A trend toward higher charge-off rates might be cause 

for concern at a time when conditions in the consumer 

sector seem to be excellent. Moreover, as with regional 

problems that surfaced in the late 1980s and early 

1990s, the aggregate data may still mask evolving submarket residential real estate problems associated with 

local economic and business conditions or new, higherrisk lending lines of business. 

Concerns have arisen recently about the future of residential loan credit quality and consumer credit quality 

in general. The Board of Governors of the Federal 

Reserve System warned that, although the consumer 

sector seems healthy by most measurable standards, 

“[consumer] delinquency rates may be held down, to 

some extent, by the surge in new loan originations in 

recent quarters because newly originated loans are less 

likely to be delinquent than seasoned ones.”6 Consumer 

credit outstanding grew by nearly 8 percent in the second quarter of 2000, the highest growth rate in the past 

three years. At the same time, 1–4 family loans at 

insured institutions expanded by 11 percent from March 

1999 to March 2000, the highest year-over-year growth 

rate since 1997. 

High growth rates are not the only concern regarding 

the future credit quality of residential loan portfolios. 

Rising interest rates have raised the cost of borrowing 

for consumers at a time when consumer credit has been 

expanding rapidly. Mortgage debt service payments as a 

percentage of disposable personal income rose to nearly 6 percent in the first quarter of 2000, continuing an 

CHART 5 

1–4 Family Loan Charge-Offs May Have 

Reached the Bottom of the Credit Cycle 

1–4 Family Loan Charge-Offs as a Percentage 

of All 1–4 Family Loans 

0.30 

0.25 

0.20 

0.15 

0.10 

0.05 

0.00 

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

Fourth Quarter 

Source: Bank and Thrift Call Report Data (Research Information System) 

6 Board of Governors of the Federal Reserve System. July 20, 2000. 

Monetary Policy Report to the Congress. p. 7. 

New York Regional Outlook 24 Third Quarter 2000 
In Focus This Quarter
 

upward trend since mid-1994. This level was last 

reached in 1991, when the economy was emerging from 

an economic recession and some local residential markets were in turmoil. Further increases in interest rates 

would push mortgage debt service payments higher, 

which could impair the ability of mortgage holders to 

service both mortgage debt and other consumer debt. 

Moreover, other consumer loans would likely enter 

delinquency before mortgage loans, as consumers are 

more likely to pay their mortgages before other consumer debt. 

New Residential Lending Programs May 

Heighten the Risk Exposure of Insured 

Institutions 

Recent trends in high-LTV and subprime lending have 

heightened the risk exposure of insured institutions. 

Intense competitive pressure in the banking industry has 

narrowed the margins of traditional lending lines, 

inducing banks to seek more profitable lines of business. Both high-LTV and subprime lending offer wider 

margins, but at the price of increased risk to the lender. 

High-LTV loans represent greater risk to lending institutions when collateral values decline. If a home loan is 

underwritten on the basis of an inflated home value, 

there is a greater possibility of default if the value of the 

home declines. Furthermore, a decline in the value of 

the home could reduce the possibility of recovering the 

loan in the event of default and foreclosure. 

The share of high-LTV loan originations is growing.7 

The percentage of loans with an LTV ratio greater than 

90 percent has risen from around 5 percent to more than 

20 percent over the past ten years.8 Table 2 identifies the 

metropolitan areas where more than 30 percent of the 

conventional home loans underwritten in 1999 carried 

an LTV ratio greater than 90 percent. Given that the historical cycles of boom and bust in residential real estate 

have often been geographically isolated, both regional 

and national trends in high-LTV lending should be carefully monitored. 

7 See also Diane Ellis. “High Loan-to-Value Lending: A New Frontier in Home Equity Lending.” Regional Outlook, first quarter
 

1999; http://www.fdic.gov/bank/analytical/regional/ro19991q/na/
 

t1q1999.pdf.
 

8 Federal Housing Finance Board.
 

Subprime lending is a term commonly used to refer to 

loans that are extended to borrowers who are perceived 

as less creditworthy.9 As insured institutions have 

increased their involvement, the subprime lending 

market has presented banks with new growth opportunities and new risks. Subprime loans represent a small 

but growing share of total mortgage originations (see 

Chart 6, next page). To be sure, higher pricing on subprime loans promises wider margins and higher revenues for lenders, but the credit risk associated with 

less-than-prime borrowers requires ongoing oversight 

and management to prevent credit losses from eroding 

margins. Some financial institutions that have either 

grown subprime portfolios or acquired subprime affiliates are now scaling back their involvement in subprime 

TABLE 2 

Pockets of Risk May Be Forming 

Where the LTV Is Highest 

PERCENTAGE 

METROPOLITAN STATISTICAL OF LOANS 

AREA (MSA) OR CONSOLIDATED WITH LTV 

MSA RANKED BY PERCENTAGE OVER 90 OF LOANS WITH LTV GREATER PERCENT 

THAN 90 PERCENT 1999 

1 GREENVILLE-SPARTANBURGANDERSON, SC
 50% 

2 HONOLULU, HI 42% 

3 MEMPHIS, TN 38% 

4 CHARLOTTE-GASTONIAROCK HILL, NC-SC 37% 

5 BIRMINGHAM, AL 35% 

6 HOUSTON-GALVESTONBRAZORIA, TX 35% 

7 ATLANTA, GA 32% 

8 JACKSONVILLE, FL 32% 

9 NASHVILLE, TN 32% 

10 OKLAHOMA CITY, OK 32% 

11 TULSA, OK 32% 

12 GREENSBORO–WINSTONSALEM–HIGH POINT, NC 31% 

13 KANSAS CITY, MO-KS 30% 

14 LAS VEGAS, NV-AZ 30% 

LTV = loan-to-value 

Source: Federal Housing Finance Board 

9 See also Kathy R. Kalser and Debra L. Novak. “Subprime Lending: A Time for Caution.” Regional Outlook, third quarter 1997; 

http://www.fdic.gov/bank/analytical/regional/ro19973q/pdf/roa1997. 

pdf. 

New York Regional Outlook 25 Third Quarter 2000 
In Focus This Quarter
 

lending activities to limit projected losses.10 In some 

cases, excessive losses related to the business of underwriting subprime loans have contributed to the failure 

of insured institutions. 

A recent report from Inside Mortgage Finance states 

that subprime portfolios are showing evidence of weakness.11 According to this report, the serious delinquency 

rate in the overall subprime market rose from 6.5 percent in 1998 to 6.9 percent in 1999.12 Furthermore, the 

percentage of A-rated borrowers in the subprime market 

fell from 59 percent to 53 percent during the same period. The implication is that both subprime and prime 

mortgages originated this year could likely underperform relative to prior years, adversely affecting credit 

quality at insured institutions. 

The potential for higher future losses related to subprime lending is of particular concern. The delinquency rate on subprime mortgages has traditionally been 

much higher than that of prime mortgages. As of 

December 1999, seriously delinquent prime mortgage 

loans comprised only 0.5 percent of total mortgage 

loans, compared with 3.2 percent of the best-rated subprime loans. Subprime mortgage loan seasoning analysis shows that 1999 vintage subprime loans have so far 

outperformed both 1997 and 1998 vintage loans (see 

Chart 7). However, there is a concern that adverse 

CHART 6 

Subprime Mortgage Loans Are Growing as a
 

Percentage of Total Mortgage Originations
 

Subprime Mortgage Subprime Mortgage Loans as a
 

Loan Originations, Percentage of Total Originations
 

200 

in Billions of Dollars 

20% 

150 15% 

100 10% 

50 5% 

0 0% 

’94 ’95 ’96 ’97 ’98 ’99 1Q00 

Sources: The Mortgage Market Statistical Annual for 1999; Inside B&C Lending 

10 Subprime Mortgage Market Faces More Challenges in Second Half 

of Turbulent 2000. Inside Mortgage Finance. July 7, 2000. 11 Mortgage Delinquency Rates Decline in Early 2000 But Industry 

Braces for Shift in the Wind. Inside Mortgage Finance. July 14, 2000. 12 Seriously delinquent loans are defined as loans at least 90 days 

delinquent or in foreclosure. 

changes in economic conditions and the health of the 

consumer sector could cause the foreclosure rate on 

subprime mortgage loans to increase more steeply than 

in prior years. 

Conclusion 

Rising home prices in some U.S. metropolitan areas 

may be a warning sign that asset price bubbles may be 

forming in some areas. A number of these areas also 

contain concentrations of employment in the high-tech 

sector, placing them at higher risk in the event of a 

downturn in that sector. Mortgage lenders in these areas 

should carefully monitor developments that could 

adversely affect home prices and collateral values. 

Nationally, single-family housing market activity 

appears to be slowing after a period of rapid growth 

supported by a long economic expansion and generally 

favorable interest rates. 

Historically, mortgage loans at insured institutions 

have been one of the best-performing asset classes. As 

1–4 family loan charge-offs have approached zero, it 

appears as if the credit cycle may have bottomed out, 

implying that loss rates may be rising. Moreover, as 

insured institutions increase involvement with subprime and high-LTV lending, the potential for higher 

future losses on residential real estate also increases. It 

will be important to keep an eye on developments in 

the economy and the consumer sector that could affect 

the future credit quality of residential real estate at 

insured institutions. 

Alan Deaton, Financial Economist 

CHART 7 

1999 Vintage Subprime Residential Loans Have 

Outperformed Earlier Vintages 

Foreclosure Rate on the Dollar Volume of B&C Grade 

Subprime Single-Family Residence 

7.0% 

6.0% 

5.0% 

4.0% 

3.0% 

2.0% 

1.0% 

0.0% 

1997 Vintage 

1998 Vintage 

1999 Vintage 

6 9 12 15 18 21 24 27 30 33 36 39 

Months of Seasoning 

Source: Mortgage Information Corporation 

New York Regional Outlook 26 Third Quarter 2000 
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