Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION FOURTH QUARTER 2000 

FDIC
 

National
 

Edition
 

Boston 

Chicago 

New 

York 

Atlanta 

Memphis 

Kansas 

City 

San Francisco 

Dallas 

Division of
 

Insurance
 

In Focus This Quarter 

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

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

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

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

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

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

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

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

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

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

insured institutions. See page 3. 

By the Division of Insurance Staff 

Regional Perspectives 

◆ Atlanta—Interest rate risk may be 

rising among Atlanta Region community banks because of an increase in the 

net duration of assets, the timing of 

interest rate changes, and a lag in the 

repricing of liabilities. See page 12. 

◆ Boston—Slow core deposit growth in 

the Region has caused institutions to 

seek alternative funding sources. 

Increased noncore funding may limit 

liquidity and increase levels of interestrate and credit risk. See page 13. 

◆ Chicago—Recent evidence suggests 

that new banks are exhibiting an increasingly higher risk profile than established 

banks. Challenges in the auto industry 

suggest that the industry’s strong performance may slow. See page 14. 

◆ Dallas—Many insured institutions 

in the Region are expanding loan exposure and are migrating into traditionally higher-risk assets when the economy 

could be slowing, potentially increasing 

the level of credit risk. See page 15. 

◆ Kansas City—Despite record-high 

loan-to-asset ratios, the Region’s community banks have experienced net 

interest margin (NIM) compression 

during the 1990s. Long-term competitive pressures on both sides of the balance sheet have contributed to this NIM 

compression. See page 16. 

◆ Memphis—With increasing competition compressing net interest margins, 

many banks are accepting greater levels 

of credit risk to improve asset yields, 

which could heighten the vulnerability 

of the Region’s banks to any deterioration in economic conditions. See page 17. 

◆ New York—While housing prices 

have increased sharply in areas near 

some of the Region’s larger cities, 

straining home affordability, the 

strength and duration of the current 

housing boom have been more modest 

than the 1980s experience. See page 18. 

◆ San Francisco—Rapid growth in 

commercial real estate development has 

occurred in five metropolitan statistical 

areas; should demand weaken, the 

potential for overbuilding could exist. 

Community banks in these areas have 

experienced rapid loan growth and 

increased concentrations in commercial 

real estate and construction and development loans. See page 19. 

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 National Edition of Regional 

Outlook, please call Lynn Nejezchleb at (202) 898-3898 or send an e-mail to lnejezchleb@fdic.gov. 

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

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

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

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

the Federal Deposit Insurance Corporation. 

Chairman Donna Tanoue 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Writer/Editor Kim E. Lowry 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Richard A. Brown 

Ronald L. Spieker 

Publications Manager Teresa J. Franks 

REVISION: 

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

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

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

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

with an additional explanation of how the revision affects the article. 
In Focus This Quarter
 

Emerging Risks in an Aging Economic Expansion
 

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

However, the economic expansion is aging, and it 

is unlikely that the vigor experienced during the 

first half of 2000 can be sustained. 

•	 Likewise, record banking and thrift industry 

profits, healthy capital cushions, and good asset 

quality of recent years may not be sustainable. 

Declining net interest margins, rising commercial 

loan losses, tighter liquidity, and riskier asset 

composition are among the warning signs that 

industry performance may have peaked for this 

business cycle. 

•	 Specific areas of concern include growing reliance 

on noncore funding; heightened interest rate risk; 

increased exposure to market-sensitive revenues; 

deteriorating credit quality; rising leverage 

among businesses and households; and signs of 

imbalance in some residential and commercial 

real estate markets. 

Although no readily apparent situations or imbalances 

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

present. A highly competitive banking industry shapes 

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

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

pressure to grow earnings and increase shareholder 

value. In addition, local banking environments exist in 

which a confluence of risks is generating heightened 

vulnerability for all participants, even during healthy 

economic times. Complacency in these environments 

may have negative repercussions for many insured institutions going forward. 

Imbalances Are Appearing amid a Healthy 

Macroeconomic Environment 

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

opportunities and risks financial institutions face. The 

current cyclical expansion, now nine and one-half years 

old, is displaying signs of aging while setting a record 

for longevity. A consensus forecast calls for moderate 

real gross domestic product (GDP) growth through 

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

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

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

hovers around recent rates. 

Although the current macroeconomic environment 

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

of concern exist. One is that sustained prosperity tends 

to foster higher levels of risk taking, overconfidence, 

and complacency. For example, the turmoil in world 

foreign exchange and financial markets during 1997 

and 1998 illustrates how dramatic imbalances can 

develop and trigger disruptive adjustments even during 

healthy economic times. 

Currently, no specific situation or imbalance seems to 

threaten the viability of the expansion. However, as 

detailed below, several likely will contribute to slower 

economic growth. Situations that warrant monitoring 

include the following: 

•	 The repercussions from higher energy prices are 

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

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

longer-term rates declined, resulting in a modest 

inversion of the yield curve. This relationship may 

inhibit the profitability of some lenders’ practice of 

borrowing short term and lending longer term and 

also complicate the interest rate risk management 

process for some insured institutions. 

•	 Continuing low unemployment suggests that demand 

for additional workers will go unfilled, thus limiting 

economic growth or triggering bidding wars that 

increase workers’ compensation and, potentially, 

inflation. 

•	 Stock market sentiment is no longer strongly bullish. 

A pullback from high valuations and optimism could 

trigger negative repercussions on consumers’ net 

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

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

dollar may be an unsustainable combination over the 

Regional Outlook—National Edition 3	 Fourth Quarter 2000 
In Focus This Quarter
 

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

relative to the euro and other currencies. 

•	 Household debt burdens are historically high, with 

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

access to credit has increased as lenders competed 

more fiercely for customers. 

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

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

2 to 1 ratio. 

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

dramatically and exceeding gains in median 

incomes. 

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

banks’ construction loan growth also is strong. 

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

Should economic growth slow considerably, current 

vulnerabilities, such as highly leveraged borrowers’ 

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

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

allow current imbalances to intensify or build up. For 

example, speculative construction could accelerate, 

stock market volatility could increase, or ballooning 

trade deficits could generate turmoil in foreign 

exchange markets. 

Signs of Strain Are Also Appearing 

amid Healthy Banking and Thrift Industries 

With the long economic expansion as a backdrop, 

insured institutions in the aggregate are performing 

very well. However, the record profits attained in recent 

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

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

While these are isolated instances, they are indicative of 

the increasingly competitive environment facing the 

financial services industry. 

Overall industry profitability is beginning to soften, led 

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

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

steadily falling since late 1997, have stalled in recent 

quarters, suggesting that recent increases in interest 

rates and energy costs not only are affecting businesses 

but also are taking a toll on some consumers. Other 

signs suggesting that aggregate risk within the system 

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

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

brief discussion of these risks follows. 

Funding Patterns Heighten Liquidity Concerns 

Lackluster core deposit growth is placing pressure on 

bank earnings and contributing to rising liquidity risk in 

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

insured institutions was just 2.8 percent. Assets over this 

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

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

sensitivity of these funds put downward pressure on net 

interest margins, particularly in a rising rate environment. 

CHART 1 

Most of $2 Trillion of Asset Growth since 1995
 

Was Funded with Noncore Funds
 

Subordinated Debt 

and Other Liabilities

 5% 

9% 

Equity 

22%
 

Core Deposits
 

64%
 

Noncore Funding
 

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

Regional Outlook—National Edition 4	 Fourth Quarter 2000 
In Focus This Quarter
 

To compensate for higher funding costs, the industry 

has pursued growth in higher-yielding asset classes that 

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

five years has come from nonresidential real estate and 

commercial and industrial loans. 

For institutions that fund illiquid assets with wholesale 

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

costs, thus placing further pressure on margins. In 

efforts to obtain funding, an institution also may pledge 

a greater portion of its best quality assets as collateral, 

further reducing liquidity. Finally, in instances where 

funding needs have exceeded available liquidity, the 

forced sale of illiquid assets to meet funding outflows 

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

greater losses if such an institution failed, because it 

would be relying on proceeds from the liquidation of 

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

the claims of insured depositors. 

Subprime lenders, in particular, tend to rely heavily on 

noncore funding to pursue aggressive growth strategies. 

Chart 2 illustrates the extent to which noncore funding 

exceeds the level of liquid assets for this group. The 

chart suggests the difficulty these institutions may 

encounter if forced to convert assets to meet funding 

outflows. Although subprime lenders may use noncore 

sources to fund riskier assets to a greater extent than the 

industry at large, this illustration exemplifies a systemic 

trend that is raising liquidity risk industrywide and is 

increasing risk to the insurance funds. 

Increasing Levels of Interest Rate Risk 

Challenge Some Institutions 

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

insured institutions. During this period, a vast majority 

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

loans, which they obtained at historically low rates. A 

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

borrowers refinanced were held in the portfolios of 

insured institutions, which contributed to a general 

lengthening of the maturity of assets held at insured 

institutions. 

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

particularly pronounced among mortgage lenders. For 

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

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

almost 45 percent of the median savings bank’s earning 

assets were not scheduled to reprice for five years or 

longer (see Chart 3). 

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

through first quarter 2000, the percentage of fixed-rate 

mortgage-related assets at thrifts with assets less than 

$1 billion rose from 49 percent to 60 percent of 

mortgage-related assets. Some thrifts and savings 

banks, therefore, have significant exposure to rising 

rates from low-yielding long-term assets. 

CHART 2 $ Billions 

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

merger adjusted) 

Subprime Lenders’ Growing Dependence

 on Noncore Funding Strains Liquidity 

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

0 

30 

60 

90 

All other loans 

Residential real estate loans 

Securities and shortterm investments 

Columns: Noncore funding 

CHART 3 

Growing Concentration in Long-Term 

Assets Elevates Interest Rate Risk 

Source: Bank Call Reports, excluding Thrift Financial Report filers 

Share of Assets Maturing or Repricing in Five Years or Longer 

Relative to Total Earning Assets (median percentage) 

Percent 

Savings Banks 

Commercial Banks 

50 

0 

10 

20 

30 

40 

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

Regional Outlook—National Edition 5 Fourth Quarter 2000 
In Focus This Quarter
 

While most commercial banks do not have as high 

exposure to rising rates as savings banks, some may 

have taken on significant risk. The median savings bank 

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

commercial banks. Although the 93rd percentile is in 

the tail of the commercial bank distribution, almost 600 

commercial banks have a concentration in long-term 

assets that exceeds that of the median savings bank. 

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

While assets have lengthened considerably for many 

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

tending to make bank liabilities more rate sensitive. 

These diverging trends generate concern, especially in a 

rising interest rate environment. That is, rate increases 

drive up the cost of funds more rapidly than earning 

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

rate environment, many institutions’ current postures 

likely would cause heavy margin erosion. 

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

that contains lower credit risk than that of many other 

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

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

with concentrations in long-term assets also may have 

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

earnings. Rising rates could weaken these institutions 

and make it more difficult for them to weather adverse 

economic or other developments. 

Dependence on Market-Sensitive Revenues 

Increases Earnings Volatility for Some 

Institutions 

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

lines susceptible to financial market volatility has 

increased substantially for some of the industry’s largest 

institutions. Among these revenue sources are fees and 

gains from asset management, brokerage, investment 

banking, venture capital, and trading activities. The 19 

institutions most active in these lines of business earned 

over 26 percent of their net operating income from such 

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

volatile sources of revenue. 

Turbulence in the financial markets has led to greater 

earnings volatility for some of these institutions. Stress 

in the financial markets could weaken the demand for 

underwriting services or significantly reduce trading 

revenues or venture capital gains. Furthermore, the 

same factors that are causing volatility in the financial 

markets could hamper loan growth and lead to slower 

revenue growth from core business lines. Should 

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

from core business lines, some institutions could face 

significant earnings challenges. 

The Rising Level of Problem Business Loans 

Is Centered in Large Banks 

Second quarter 2000 commercial and industrial (C&I) 

credit quality indicators at banks deteriorated for the 

eighth consecutive quarter. Noncurrent C&I loans— 

those on nonaccrual status plus those 90 days or more 

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

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

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

loan loss rates also continue to edge higher but remain 

well below those experienced by banks in the late 1980s 

and early 1990s.1 

Large banks, particularly those active in syndicated 

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

quality. Recent increases in criticized and classified 

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

lending institutions, are illustrated in Chart 4. In the 

2000 SNC review, criticized and classified credits 

increased 44 percent over 1999 levels to 5.1 percent of 

total SNC commitments. Furthermore, the bulk of the 

increase was in the more severe classified categories, 

which now comprise 64 percent of total criticized and 

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

11During second quarter 2000, banks posted an annualized net C&I 

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

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

rates averaged 1.11 percent from fourth quarter 1991 to fourth quarter 

1993. 

Regional Outlook—National Edition 6 Fourth Quarter 2000 
Agriculture 

tainment 

 Man

uction 

e

u

rade 

x

fac. 

tile 

In Focus This Quarter
 

CHART 4 

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

Source: Shared National Credit Program 

Syndicated Loan Problems Are on the Rise 

Percent

$ Billions 

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

Criticized and 

Classified SNC Loan 

Commitments (right 

scale) 

Percentage of SNC 

Commitments Criticized 

and Classified (left scale) 

0 

2 

4 

6 

8 

10 

12 

14 

16 

0 

20 

40 

60 

80 

100 

120 

140 

C&I loan quality indicators continue to deteriorate 

despite generally favorable economic conditions. Three 

factors explain much of this deterioration: certain weak 

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

1998, when many banks significantly eased business 

lending standards. 

Industry Sector Weaknesses 

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

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

decline in commercial credit quality, problems within 

these two sectors do not account for the full extent of 

the increase in noncurrent loans and problem SNC 

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

in criticized and classified credits from the 1999 to the 

2000 SNC review. However, this increase accounts for 

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

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

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

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

ftp/release/2000-78a.pdf.
 

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

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

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

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

and the degree of financial leverage.
 

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

evaluate obligor risk and credit risk trends. Applied to 

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

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

Sectors that include a high proportion of firms with 

high default probabilities (median one-year default 

probabilities exceeding 4 percent) are shown in Chart 5. 

Using entertainment as an example, the bars in the chart 

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

entertainment firms had greater than an 8 percent 

chance of defaulting on their obligations within one 

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

The median likelihood of default for all the industries 

shown in the chart far exceeds that of Standard & 

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

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

the chart. 

Rising Corporate Debt Burdens 

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

continue to increase. This ratio reached 83 percent in 

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

year-end 1996. Although debt burdens remain below the 

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

availability. 

CHART 5 

Various Industries Show High Levels 

of Expected Default Risk 

September 1999


9
 September 2000 8 Comparative EDFTM

Median Expected Default Frequency

(EDFTM) (percent)

of S&P Bonds Rated BB 

(as of September 2000) 

Enter 

HealthcareWholesale T

Apparel &T

Misc. Lodging

Mining 

Constr

Retail

0 

1 

2 

3 

4 

5 

6 

7 

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

Regional Outlook—National Edition 7 Fourth Quarter 2000 
In Focus This Quarter
 

Seasoning of 1997–1998 Vintage Loans 

Results of recent supervisory surveys suggest that 

banks are tightening terms and conditions on loans to 

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

this tightening follows a relaxation of standards in prior 

years that has contributed to a heightened level of risk 

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

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

leveraged transactions by Loan Pricing Corporation. 

Leveraged loan originations—those priced at 150 basis 

points or more over the London Inter-Bank Offer Rate 

(LIBOR)—rose from 12 percent of total syndicated 

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

banks have acknowledged that 1997 and 1998 vintage 

credits are beginning to produce higher problem loan 

levels.5 

Household Sector’s Leverage Is High, 

and Imbalances Are Appearing 

Consumers are enjoying the benefits of the economic 

expansion, as jobs are plentiful, home ownership 

remains generally affordable, and credit seems to be 

readily available for financing motor vehicles and other 

major purchases. These conditions contributed to record 

high sales of cars and light trucks during the first nine 

months of 2000, helping sustain the consumer spending 

growth shown in Chart 6. One corollary of high vehicle 

sales, however, is softening prices for used vehicles. 

Consequently, some lessors—including banks—are 

realizing lower-than-expected residual values on leased 

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

lease portfolios. This situation illustrates one problem 

that lenders can encounter even in good economic 

times. 

Spending growth remained robust in recent quarters 

even as gains in disposable income slowed. The gap 

between income and spending growth is “financed” as 

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

combination of these measures. 

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

Bank Lending Practices for May and August 2000 and Surveys of 

Credit Underwriting Practices for 1999 and 2000 from the Office of 

the Comptroller of the Currency. 

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

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

CHART 6 

Household Spending Growth 

Exceeds Income Growth 

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

Real Consumption Spending 

Real Disposable Income 

7 

–1 

0 

1 

2 

3 

4 

5 

6

Annual Growth Rate (percent) 

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

Quarter 3 

From 1995 through 1998, and likely since then, the 

increase in both leverage and debt servicing burdens has 

been concentrated among low- and middle-income 

households. Among families holding debt in 1998, debt 

payments exceeded 40 percent of disposable income for 

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

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

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

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

such instances, lenders could be doubly affected if 

households draw on their credit card and home equity 

lines of credit, further compromising their repayment 

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

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

lending specialists may indicate that strains among 

some households are spilling over to lenders. Moody’s 

Investors Service expects credit card losses to rise 

through 2001, according to a recent analysis of 

prospects for the U.S. credit card industry. 

Overheated residential real estate markets in several 

metropolitan statistical areas (MSAs) may be another 

warning of economic imbalances. Dramatic gains in 

home resale prices in San Francisco stand out (see Chart 

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

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

properties may reflect the fact that affordability is 

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

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

from the 1998 Survey of Consumer Finances.” Federal Reserve 

Bulletin. Vol. 86, 1–29. 

Regional Outlook—National Edition 8 Fourth Quarter 2000 
 

In Focus This Quarter
 

enhanced by gains in wealth rather than in income. 

Even so, similar surges in home resale prices in the 

past often were not sustainable. The subsequent years 

of stagnant or falling collateral values caused financial 

stress among some homeowners and their lenders. 

Further concern about residential real estate lenders 

arises because pockets of speculative construction 

under way in some markets may produce units that 

become increasingly difficult to sell at anticipated asking prices. 

Construction and Development 

Loan Growth Is Accelerating 

Commercial real estate (CRE) construction across all 

property sectors has grown during this expansion, with 

office construction particularly active. The amount of 

office space completed in mid-2000 was the largest 

since 1989 and is projected by Torto Wheaton Research 

to continue rising. Not surprisingly, construction and 

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

concentrations are trending upward rapidly. While total 

private real estate spending grew about 6.5 percent over 

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

insured institutions rose by 26 percent. C&D loan 

growth has remained above 20 percent since 1997, and 

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

1989. 

Such growth is contributing to higher concentrations of 

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

concentrations do not begin to approach those of the 

late 1980s. However, several metropolitan areas have a 

CHART 7 

Median Home Resale Prices Soar 

in San Francisco Bay Area 

Source: National Association of Realtors via Haver Analytics, Inc. Percent Change from Four Quarters Earlier 

Quarter 1 

–10 

–5 

0 

5 

10 

15 

20 

25 

30 

35 

’80 

’82 

’84 

’86 

’88 

’90 

’92 

’94 

’96 

’98 

’00

large percentage of insured institutions reporting high 

and rising concentrations. Table 1 (next page) shows 

MSAs with at least 15 nonspecialized community 

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

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

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

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

The aggregate C&D concentration for all 85 institutions 

in the MSA was 156 percent, the highest among MSAs 

with at least 15 institutions of similar size and nature. 

Several other markets also include significant shares of 

institutions with high concentration levels. 

Nine of the 16 markets highlighted in Table 1 not only 

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

or more property types.8 While these markets show no 

clear signs of emerging economic stress, lenders there 

clearly may be at greater risk should economic or real 

estate conditions sour. Other concerns regarding CRE 

lending arise from a recent Office of the Comptroller 

of the Currency survey, which reports heightened 

credit risk in CRE portfolios and predicts it will 

increase through 2001. In addition, respondents to a 

midyear 2000 FDIC survey of examiners reported 

more frequent comments about excess office and retail 

space. 

Increasing Share of De Novo Institutions 

Raises the Stakes in Some Markets 

A common element among the metropolitan markets 

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

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

of the nonspecialized community institutions are less 

than three years old. The drive to build market share 

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

instances, the aggregate cost of deposits within the 

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

7 The term “nonspecialized community bank” refers to institutions 

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

such as credit card or trust banks. 

8 See “Ranking Metropolitan Areas at Risk for Commercial Real 

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

identifies markets where new construction is high relative to existing 

stocks of space. 

Regional Outlook—National Edition 9 Fourth Quarter 2000 
In Focus This Quarter
 

TABLE 1 

High C&D Loan Exposure Appears in Various MSAs 

SHARE (%) OF AGGREGATE C&D LOANS 

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

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

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

ATLANTA, GA 65 156 

PHOENIX–MESA, AZ 56 131 

MEMPHIS, TN–AR–MS 52 154 

PORTLAND–VANCOUVER, OR–WA 47 146 

OAKLAND, CA 47 163 

NASHVILLE, TN 44 103 

RIVERSIDE–SAN BERNARDINO, CA 42 110 

SAN DIEGO, CA 41 90 

GRAND RAPIDS–MUSKEGON–HOLLAND, MI 40 81 

SEATTLE–BELLEVUE–EVERETT, WA 39 98 

SALT LAKE CITY–OGDEN, UT 38 56 

FORT WORTH–ARLINGTON, TX 38 110 

DALLAS, TX 36 95 

LAS VEGAS, NV–AZ 35 119 

LEXINGTON, KY 34 80 

DENVER, CO 33 113 

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

card or trust banks. 

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

Outlook, third quarter 2000. 

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

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

profiles are being elevated, and aggregate leverage ratios 

are falling, despite the influx of capital from the new 

institutions. Highly competitive environments have the 

potential to increase risk taking by negatively affecting 

underwriting standards and balance sheet composition. 

Farm Sector Challenges Continue 

Much of the agricultural industry is experiencing 

stress because of low commodity prices, compounded 

in some areas by low yields resulting from weather- or 

disease-related problems. Strong global competition 

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

depressed prices, and limited prospects for a price 

turnaround in the near term. In the aggregate, record 

levels of government payments have helped the 

nation’s farms maintain a generally stable financial 

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

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

Fortunately, the aggregate condition of nearly 2,100 

insured agricultural banks—institutions with 25 percent 

or more of loan portfolios in agricultural credits— 

remains healthy. Generally, agricultural banks continue 

to report favorable asset quality, earnings, and capital 

positions. However, they are experiencing somewhat 

elevated levels of noncurrent loans compared with 

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

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

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

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

Regional Outlook—National Edition 10 Fourth Quarter 2000 
In Focus This Quarter
 

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

farm banks may translate into higher losses in the future 

if commodity prices remain low. 

The strains in the farm sector also have implications for 

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

example, where farmers’ earnings are depressed and the 

economies not well diversified, nonagricultural banks 

are reporting higher noncurrent levels than insured 

institutions elsewhere in the nation. 

Summary 

The long-lived economic expansion has contributed to 

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

matured, both consumer and corporate leverage has risen 

considerably. Bank liquidity is becoming increasingly 

strained by lackluster core deposit growth, which has 

been insufficient to fund strong loan demand. This trend 

has resulted in a decided shift into higher-risk asset 

classes to mitigate margin pressures arising from the 

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

institutions, and after nearly a decade of improving asset 

quality, the level of problem loans is increasing. 

Clearly, high levels of profitability in recent years have 

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

Concern arises because insured institutions’ current 

profitability is being negatively affected by some recent 

trends, despite the sustained economic expansion. And, 

while capital levels have remained fairly stable, the 

amount of risk being leveraged on the industry’s capital 

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

boats, a strong economy can mask potential problems 

that will become evident should the economic tide turn, 

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

and soundness may be most vulnerable in situations 

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

because of repercussions from economic and banking 

forces beyond their control. 

Daniel Frye, Regional Manager 

Joan D. Schneider, Regional Economist 

Steve Burton, Senior Banking Analyst 

Allen Puwalski, Senior Financial Analyst 

Ronald Spieker, Chief, Regional Programs 

and Bank Analysis 

The authors would like to acknowledge 

the Washington and regional staff of 

both the Division of Insurance and 

the Division of Supervision for their 

analyses and comments, which were 

instrumental in writing this article. 

Regional Outlook—National Edition 11 Fourth Quarter 2000 
Regional Perspectives
 

Atlanta Regional Perspectives
 

The interest rate environment faced by commercial 

banks has varied significantly during the past two 

years. Actions by the Federal Reserve Board and the 

U.S. Treasury have significantly affected the nation’s 

interest rate environment and led to a virtually flat yield 

curve. A prolonged flat or inverted yield curve typically is not considered the most conducive market for 

financial intermediaries, as they traditionally earn a 

positive spread by borrowing at the short end of the 

curve and lending or investing at the long end. 

As discussed in Atlanta Regional Outlook, second quarter 1998, rate/volume analysis is “...one effective ex post 

approach to measuring interest rate risk.” Changes in 

interest income and interest expense can be determined 

through a rate/volume analysis, which isolates these 

components’ effects on net interest income (NII) over 

two time intervals. For Atlanta Region community 

banks,1 a rate/volume analysis suggests a minimal 

amount of interest rate risk (IRR) arising from changes 

in the yield curve during the past year. The analysis was 

applied to two four-quarter trailing periods ending second quarter 2000 and second quarter 1999. This group, 

on average, experienced an increase in NII, and the net 

interest spread expanded from 3.73 percent to 3.83 percent. Asset yields rose faster than funding costs, in part 

because of the influence of rates. Conversely, total funding costs remained almost the same; however, notable 

differences exist among the various funding categories. 

The cost of historically rate-sensitive or noncore categories—large time deposits, borrowed funds, and Federal Funds purchased—remained virtually unchanged. 

Core funding that normally is assumed to be less rate 

sensitive—small time deposits, savings, demand and 

money market accounts—experienced a decline in cost 

except for money market accounts. Despite the lower 

cost of most funding sources, total funding costs 

increased nominally because of rapid growth in noncore 

funding. These noncore funding sources increased 25 

percent while total interest-bearing funds grew only 11.7 

percent. As a result, noncore funding now represents a 

substantial and growing share of interest-bearing funding sources for community banks in the Atlanta Region. 

In order to maintain or grow interest income, some 

community banks in the Atlanta Region may be 

1 Includes Atlanta Region commercial banks with assets between $25 

million and $1 billion. The data set contains 763 banks and excludes 

de novos (banks in operation at least three years), specialty banks, and 

banks involved in merger and acquisition activity. 

assuming more credit risk. The greatest contributor to 

the growth in interest income was a significant increase 

in the volume of real estate and commercial and industrial loans. At community banks in the Region, income 

from real estate lending occurred at lower marginal 

rates as the yield declined by 8 basis points to 9.0 percent while most other asset yields were increasing. Construction and development lending, traditionally 

considered a higher-risk form of lending, is growing 

much faster among the Region’s community banks 

compared with their national peers. As a result, the 

decline in yield may suggest that lenders are not being 

adequately compensated on a risk-adjusted basis. 

Although this analysis does not identify a significant 

amount of IRR, an increase in the net duration of assets, 

the timing of changes in the yield curve, and a lag in 

repricing could mask the degree of IRR. Community 

banks appear more susceptible to IRR as the net duration 

of assets and liabilities has extended. The timing of interest rate changes in tandem with the repricing structure of 

the assets and liabilities can significantly affect the 

level of IRR. Specifically, the yield curve did not 

2000. Therefore, the level of IRR risk may be greater 

sequently declined to 3.99 percent by second quarter 

at 4.08 percent during fourth quarter 1999 and subshift upward and twist until early 2000. As a 

result, we expect the spread to expand during this 

period, because community banks typically hold 

significantly larger volumes of immediately repriceable assets than of liabilities. As liabilities reprice, we expect 

the net interest spread to narrow, given 

the interest rate environment. A quarterly rate/volume analysis, in fact, supports the lag effect, as the spread peaked 

than the long-term rate/volume analysis suggests. 

While the rate/volume analysis has yet to show a 

material variation in NII, the full effect of changes in 

the yield curve probably has not manifested because 

of repricing lags. If the current yield curve remains 

constant, net interest spreads are likely to narrow over 

time. The substantial growth in longer-duration assets 

and shorter-duration liabilities may be beneficial if 

short-term rates fall and the yield curve becomes positively sloped. However, there is no guarantee that this 

will happen. In short, as is often the case, it is not clear 

which way interest rates will move; as a result, extending long-term assets and shortening liabilities is a wager 

that could easily have a heavy cost. 

Regional Outlook—National Edition 12 Fourth Quarter 2000 
Regional Perspectives
 

Boston Regional Perspectives
 

Through late summer 2000, the Region’s economic 

growth cooled from its heated pace of recent years. 

While August 2000 year-to-date total nonfarm job 

growth in the Region essentially matched its 1999 pace 

and continued to trail the nation by a modest margin, 

some sectors exhibited decelerating growth. The 

Region’s rate of decline in factory sector payrolls in 

2000 was less than one-half that seen in 1999 but about 

double the national rate. Seasonally adjusted unemployment rates in August 2000 were well below the national 

rate in all the Region’s states except Rhode Island, and 

most also were at or below year-end 1999 levels. Per 

capita income growth during 

first quarter 2000 generally 

remained well above the 

national rate, continuing 

the five-year trend. 

The Region’s housing markets also showed some signs of 

cooling, as August year-to-date 

permit issuance was down about 

7 percent from the previous year, 

versus a 4 percent drop nationally. Meanwhile, commercial real 

estate markets generally remained 

strong in the Boston Region. The Region’s 

office vacancy rates continued to decline compared 

with one year ago because of lack of construction and 

rising demand. Rents continued to rise. However, the 

scarcity of office and certain kinds of industrial space, 

particularly around greater Boston, may be cause for 

concern. Tenants are leasing space when it is available, 

even if it is not then needed, in anticipation of future 

demand. Such practices not only inflate rents but may 

prove troublesome if market conditions falter, leaving 

tenants with high-rate rental contracts for space that will 

not be occupied. 

The Region’s insured institutions continued to 

report stable conditions. Excluding credit card specialists, the aggregate return on assets for the Region 

was 1.28 percent as of June 30, 2000—little changed 

from the same period in 1999. Some signs of weakening have emerged, principally in the commercial and 

industrial portfolios of the Region’s largest institutions. 

However, the past-due ratio continued to fall in the 

Region’s other institutions and remains low in aggregate 

compared with the nation. Consumer and commercial 

loan growth outside the Region’s largest institutions 

remained strong, while the largest institutions saw no 

growth partly because of sales of loans associated with 

merger-related divestitures. 

Core deposits alone have not been sufficient to fund 

loan and asset growth. To compensate, insured institutions have increasingly turned to alternative funding sources. For the most part, the Region’s loss in core 

deposits has been offset with borrowings, primarily in 

the form of Federal Home Loan Bank (FHLB) 

advances. Borrowings are a more expensive and potentially volatile source of funds. As a percentage of assets, 

borrowings are at a recent all-time high, both in the 

Boston Region and nationally. Increased exposure to 

borrowings may elevate regulatory risk (e.g., if FHLB 

lending capacity is modified), liquidity risk (by tapping 

out credit sources and leaving little reserve borrowing 

capacity), interest rate risk (because of noncore funds’ 

higher sensitivity to market rates), and credit risk (as 

banks reach for asset yield to compensate for higher 

funding costs). Also, a larger share of secured borrowings might lead to greater losses to the insurance fund, 

as secured lenders would be made whole first in the 

event of bank failure, and the FDIC would presumably 

have lower-quality assets available for sale to satisfy its 

obligations to insured depositors. 

In addition to borrowings and core deposits, funds can 

also be obtained from asset sales. Typically, the most 

liquid assets have the least embedded credit risk, and 

their sale can raise the risk profile of an institution. 

Over the past decade, securitization has positively 

affected liquidity levels by allowing insured institutions 

to sell virtually any loan. However, the marketability of 

the loan depends on its quality. If loan quality declines, 

marketability may also decline. Moreover, the highestquality loans may be sold first, which leaves the institution with higher-risk assets. 

Aggregate data for all categories of institutions in the 

Region show declines in historically lower-risk assets, 

such as residential loans, and increases in higher-risk 

assets, such as commercial loans. Provided the economy 

remains strong, higher-risk assets generally offer higher 

returns. These higher returns may offset funding cost 

increases in the short term but may exacerbate earnings 

problems if the economy turns down. Economic problems would also magnify the growing liquidity risk that 

accompanies an increasingly higher-risk asset mix 

funded with potentially volatile sources. 

Regional Outlook—National Edition 13 Fourth Quarter 2000 
Regional Perspectives
 

Chicago Regional Perspectives
 

Aggregate performance stumbles in the second 

quarter. In the aggregate, the Region’s insured institutions reported narrowing margins and lower profitability as of June 30, 2000. Aggregate earnings were 

hampered by an increase in provision expenses and 

securities losses at the Region’s largest commercial 

banks. While overall credit quality is strong in general, 

the largest commercial banks reported a higher level of 

noncurrent loans. Analysts expect problem loans to rise 

over the coming quarters, particularly among the largest 

commercial banks involved in syndicated and leveraged 

lending. 

New bank formation increases the Region’s risk profile. The current rate of new bank formation in the 

Region is high compared with the 1980s and is centered 

in the Region’s larger metropolitan areas. New banks 

historically have exhibited inherently riskier profiles 

than more established institutions. However, recent evidence suggests that this gap between new and established institutions in the Region is widening. This is 

particularly apparent when analyzing the income statement. New banks report higher levels of both interest 

income and interest expense compared with established 

institutions. A wider interest income spread may indicate a more aggressive loan posture and potential credit risk. In fact, the loan-to-asset ratio among new banks 

has increased significantly, and new bank loan portfolios are more heavily weighted toward commercial and 

industrial and commercial real estate loans when compared with established institutions. Both new and established banks report higher funding costs. This trend is 

primarily associated with the increased use of noncore 

funding and a highly competitive environment. However, the increase in new bank funding costs exceeds that 

reported by established institutions and may indicate 

just how aggressively new banks price deposits. In addition, new banks report a heightened reliance on more 

expensive noncore funding. 

In markets where new bank formation has been active, 

institutions may be particularly vulnerable to margin 

compression as new banks attempt to gain market share 

through competitive loan and deposit pricing. As new 

banks compete for deposits, interest rate risk concerns 

may arise, because deposits attracted through competitive pricing may be highly sensitive to interest rates. 

While a more aggressive loan posture may augment 

new bank income, the shift in loan mix could increase 

exposure to credit risk. 

Strong auto sector faces challenges. The auto industry 

plays an important role in the Region’s economy, providing about 3 percent of all jobs in the five-state 

Region. The auto industry’s importance to the Region is 

compounded by its highly cyclical nature. In addition, 

the direction of the industry’s business cycle can shift 

quickly in a changing economic environment. 

The auto industry is in the midst of a two-year expansion, 

but evidence of some potengrowing 

tial weaknesses in the 

industry is emerging. A 

general uneasiness about 

the economy, rising interest rates, fluctuating gasoline prices, and 

foreign competition may dampen future sales. While subsidies 

and other efforts to continue to 

bolster sales of new American 

vehicles insulate the parts 

manufacturers from some market 

pressure, any decline in sales would 

have a strong ripple effect throughout 

the auto supply chain. Auto parts manufacturers operate 

in a competitive environment and have little pricing 

power with auto manufacturers. As a result, auto parts 

manufacturers often are in a weaker financial position. 

The risk profile of auto leasing portfolios remains 

high. Leasing portfolios have experienced problems 

over the past few years, and underwriting trends indicate that this segment may continue to experience weak 

performance. Lessors are facing losses on the sale of 

leased vehicles, write-offs on the carrying value of lease 

residuals, and higher remarketing costs and other 

expenses. 

Regional Outlook—National Edition 14 Fourth Quarter 2000 
Regional Perspectives
 

Dallas Regional Perspectives
 

The competitive advantages enjoyed by the Dallas 

Region, such as lower housing costs and strong job 

growth, contributed to the Region’s booming economy of the 1990s. These competitive advantages, however, have eroded over time and threaten to constrain 

future growth in some areas. In particular, the rapid 

increase in housing prices in the metropolitan areas of 

Denver, Boulder, Colorado Springs, and Austin is creating concern among local officials and residents about 

how housing affordability and economic 

growth could be affected. 

These metropolitan statistical areas 

(MSAs) were among the fastestgrowing areas in the United States 

during the 1990s. The Austin–San 

Marcos MSA added nearly 

300,000 new residents during the 

1990s, and the combined MSAs of 

Denver, Boulder–Longmont, and Colorado Springs added over half a million 

residents. Net domestic in-migration accounted for 

much of this population growth, which strengthened 

demand for short-term housing. The combination of a 

strong demand for housing and an inadequate supply has 

caused housing prices to accelerate. The chart below 

shows the positive relationship between employment 

growth—a proxy for housing demand—and home price 

appreciation in selected MSAs in the Region. 

Insured financial institutions in the Dallas Region 

have increased loan volume as a share of total assets 

to the highest level in the past 14 years. Moreover, this 

CHART 1 

loan growth has risen rapidly over the most recent 21/2­

year period. Emerging risks include the potential for 

increasing levels of credit risk; expanding loan exposure 

at a time when the economy could be slowing; and an 

allowance for loan and lease losses (ALLL) that has 

lagged the Region’s rapid level of loan growth. 

Factors contributing to the increase in loan levels by 

Dallas Region banks and thrifts include relatively low 

loan-to-asset levels and a strong demand for loans generated by the robust Dallas Region economy. In an environment in which loan demand is strong and a strategy 

of holding a large share of securities is less effective 

because of rising interest rates, many insured institutions have begun increasing loan levels to maintain 

profitability. Insured institutions are shifting asset compositions from securities into loans. 

Moreover, the types of loans showing the greatest 

increases include real estate construction (95 percent), 

commercial real estate (54 percent), and commercial 

and industrial (33 percent), all considered historically to 

exhibit higher levels of risk than many other categories 

of loans. Insured institutions in the Dallas Region continue to report the lowest ALLL-to-total loans ratio of 

any FDIC Region. Moreover, the Region’s banks and 

thrifts exhibiting the most rapid loan growth report an 

ALLL ratio that has been declining and is lower than 

that of other insured institutions in the Region. Should 

the economy weaken and loans deteriorate, many institutions may find themselves without adequate buffers 

against future losses. 

A Strong Positive Relationship Exists between Employment Growth and Rising Home Prices 

Conventional Mortgage Home Price Index

Annualized, 1Q95 to 1Q00 (percent) 

9 

8 

7 

6 

5 

4 Santa Fe 

3 

2 Albuquerque 1 

Denver 

Boulder–Longmont 

Houston 

Dallas 

Fort Worth 

San Antonio 

y = 0.9265x + 0.0169

R 2 = 0.4123 

Austin–San Marcos 

Colorado Springs 

Oklahoma City 

Tulsa 

0 

0 1 2 3 4 5 6 

Payroll Employment Growth Rate, Annualized 1Q95 to 1Q00 (percent) 

Sources: Bureau of Labor Statistics (Haver Analytics); Federal Home Loan Mortgage Corporation 

Regional Outlook—National Edition 15 Fourth Quarter 2000 
 

 

Regional Perspectives
 

Kansas City Regional Perspectives
 

Compressing net interest margins (NIMs) are widespread among the Region’s community banks, with 

73 percent of all community banks reporting a 

decline in NIMs since 1992. Concern about the declining NIM trend and its effect on net income is particularly important for the Kansas City Region, because the 

Region is dominated by smaller banks, which typically 

rely more heavily than larger institutions on the NIM to 

generate revenue. 

Legislative, demographic, technological, and other 

changes have increased competition for community 

banks and have contributed significantly to the declining NIMs. Increasing competition for loans occurred 

during the 1990s and has contributed to an ongoing 

decline in loan yields since 1995. On the liability side of 

the balance sheet, competitive pressures for retail 

deposits have hindered community banks’ ability to 

continue to maintain high levels of core deposits. 

Although competitive trends on both sides of the balance sheet have contributed to a narrowing of NIMs, 

community banks have balanced much of this pressure by increasing loan-to-asset (LTA) ratios to historically high levels. Community banks reported an 

increase in the aggregate LTA ratio from 48.7 percent in 

1990 to 62.4 percent in 1999, the highest level ever 

reported. Although increasing LTA ratios helped support NIMs against further decline, this is a departure 

from previous periods, when rising LTA ratios actually 

boosted NIMs (see Chart 1). 

CHART 1 

Competitive forces not only are stronger now but 

cannot be expected to dissipate should the economy 

weaken. Therefore, the 1990s could evidence a new 

relationship between LTA ratios 

and the NIM; rising LTA ratios 

would not boost NIMs to the 

high levels previously experienced. Conversely, NIMs 

could decline to even lower 

levels should a recession 

occur. 

If LTAs decline to historically 

“normal” levels during the next 

economic downturn, how far 

could NIMs fall? To answer this question, 

we conducted two analyses, both of which determined 

that community bank NIMs would be significantly 

lower now had LTA ratios not risen so dramatically 

since 1992. This fact suggests that NIMs could decline 

substantially should LTA ratios moderate. 

To compensate for the competitive factors that are compressing NIMs, community banks have increased levels 

of credit risk and interest rate risk. These significant 

changes have helped mitigate NIM compression. However, at this stage of the economic expansion, asset 

quality could be affected should the economy falter. The 

next recession will show whether community banks in 

the Kansas City Region have managed risk wisely and 

whether earnings performance throughout the expansion was commensurate compensation for taking on 

additional risk. 

Regional Outlook—National Edition 16 Fourth Quarter 2000 

Note: This chart was assembled using commercial banks with less than $250 million in assets and excludes de novo banks for their first three years of existence and credit 

card banks. In addition, banks that were involved in a push-down merger were excluded for the year when the merger occurred. Community banks, as defined in this article, 

differ slightly from this definition. This difference was necessary to build the chart back to 1973, because community banks were paired only back to 1990. Numerical differences 

between reported results of community banks and the set of banks used for this analysis are minimal. 

LTA = loan to asset; NIM = net interest margin 

Source: Bank Call Reports 

Increasing LTA Ratios Contributed to Higher NIMs during Prior Expansions, 

but LTA Ratios and NIMs Diverged in the 1990s 

Net Interest Margin (%)

NIM (left axis) 

LTA Ratio (%) 

LTA (right axis) 

’73 ’75 ’77 ’79 ’81 ’83 ’85 ’87 ’89 ’91 ’93 ’95 ’97 ’99 

3.6 

3.8 

4.0 

4.2 

4.4 

4.6 

4.8 

5.0 

45 

50 

55 

60 

65 
Regional Perspectives
 

Memphis Regional Perspectives
 

Management at many banks nationwide faces pressure from stockholders to maintain or improve earnings performance. The duration and continuing strength 

of the economic expansion have provided a positive 

environment for banks and other financial institutions, 

leading to the emergence of considerable competition 

from many newly established banks and nonbanks. 

Resulting pricing pressures for loans and funding have 

adversely affected banks’ net interest margins (NIMs). 

Return on assets and NIMs contracted at most banks in 

the Memphis Region during the late 1990s, following a 

period of exceptionally strong earnings. 

In an effort to maintain NIMs, many banks are 

accepting greater credit risk to improve asset yields. 

Accommodated by strong loan demand, many banks 

responded to declining margins by increasing loan-toasset (LTA) ratios to 

historically high levels. The 

sharp rise over the past 18 

months equals the cumulative 

growth in LTA levels over the preceding six years. Recent growth has been 

concentrated in higher-yielding, and 

traditionally higher-risk, loan types, 

such as commercial real estate and construction and development lending, which has also contributed to heightened levels of credit risk. 

During the first half of 2000, rising loan levels contributed to higher NIMs, which may be difficult to 

sustain. Reported NIMs as of June 30, 2000, were 

somewhat higher than those reported one year earlier. 

While many factors played a part, higher LTA ratios 

appeared to be critical to banks’ improved NIMs. 

Increasing competition, however, could lead to further 

reductions in interest rates charged on loans (relative to 

other interest rates) and lower loan fees, particularly if 

loan demand softens. The cost of funding loan growth 

also could continue to escalate. During the early and 

mid-1990s, loan growth was funded largely through a 

combination of core deposit growth and the liquidation 

of securities portfolios. However, now institutions are 

relying increasingly on typically higher-cost noncore 

funding sources to support higher loan levels. 

Growing exposure to credit risk may increase the 

vulnerability of the Region’s banks to any deterioration in economic conditions. Experiences during the 

banking crises of the 1980s and early 1990s suggest that 

increases in LTA ratios heighten banks’ vulnerability to 

changing economic conditions. A 1997 study conducted by the Federal Deposit Insurance Corporation’s Division of Research and Statistics1 found that banks that 

failed during economic downturns reported higher LTA 

ratios and CRE loan exposure than did surviving banks. 

This study also found that during periods of economic 

expansion preceding regional or sectoral downturns, 

many banks pursued a strategy of aggressive loan 

growth in response to strong credit demand, leading to 

rising LTA ratios at these institutions. Strong growth in 

the economy and in the banking industry experienced in 

the Memphis Region throughout much of the past 

decade is reminiscent of growth experienced by several 

states in the early 1980s that later fell victim to regional or sectoral downturns. 

Reported asset quality remains sound at community 

banks, but repayment difficulties for most loans are 

unlikely to surface until economic conditions erode. 

Should the economy turn down, the severity of credit 

quality deterioration will likely be heavily influenced by 

the current risk selections of banks. 

Capital levels are declining. Some institutions report 

higher capital levels and allowances for loan and lease 

losses in line with risk selections. Other banks, however, 

appear content to rely on continuing economic strength 

to minimize potential long-term credit concerns while 

emphasizing short-term profitability. 

With increasing credit exposure and declining capital levels, risk management is assuming greater 

importance. There is nothing inherently inappropriate 

about a strategy of accepting additional credit risk; 

banks are in the business of accepting and managing 

credit risk. In fact, such a strategy may be more necessary to preserve earnings in today’s competitive banking 

environment. However, with exposure to credit risk rising and capital levels declining, strong risk management 

becomes increasingly critical. While economic conditions remain favorable, bank management may want to 

consider acceptable risk tolerance levels in reviewing 

overall credit exposure and take steps to correct any 

specific underwriting laxity. 

1 Federal Deposit Insurance Corporation. 1997. History of the 

Eighties—Lessons for the Future. Vol. I: An Examination of the Banking Crises of the 1980s and Early 1990s, p. 27. 

Regional Outlook—National Edition 17 Fourth Quarter 2000 
Regional Perspectives
 

New York Regional Perspectives
 

The Region’s insured institutions1 reported relatively stable profitability during the first half of 2000. 

However, higher interest rates compared with a year 

ago pressured net interest margins as funding costs 

increased for banks of all sizes. Intense competition 

for core deposits over the past several years has also 

contributed to margin compression. Erosion of banks’ 

core deposit base has resulted in increased reliance on 

noncore funding sources, which are generally more 

expensive than traditional bank deposits. Furthermore, 

noncore funding sources typically are more interest rate 

sensitive. As a result, banks’ liquidity and interest rate 

risk management could be challenged, particularly during periods of rising interest rates or unstable financial 

markets, when access to liquidity sources may become 

more difficult. 

Credit quality in most loan categories remained 

favorable, except for C&I loans held by the Region’s 

large banks. During second quarter 2000, the commercial and industrial loan (C&I) charge-off ratio for the 

Region’s large banks reached its highest level since 

1993 but was below the rate experienced during the 

recession of the early 1990s. Recent underwriting surveys indicate tighter C&I underwriting by banks nationwide; however, an increased number of criticized 

Shared National Credits, higher corporate bond 

defaults, and widening spreads on high-risk loans indicate that C&I credit problems may not be over. 

The Region’s commercial banks have reported loan 

growth centered in traditionally higher-risk categories. During the past four years, the Region’s commercial banks experienced the greatest annual growth 

rates in commercial (including C&I and commercial 

real estate) loans. In fact, commercial loans accounted 

for more than half the Region’s total loan growth during 

this time.2 Furthermore, although residential loans continue to account for the largest percentage of the 

Region’s loans, the current level almost equals the share 

of commercial loans. 

The growth in commercial loan volume reflects a shift 

by banks into higher-yielding, potentially higher-risk 

credits as lenders attempt to maintain earnings in the 

1 Excludes institutions in operation less than three years and credit 

card banks. The banking analysis uses median figures. 

2 Loan growth was computed as the difference in total loans from 

June 30, 1996, to June 30, 2000, for the Region’s commercial banks, 

adjusted for mergers. 

face of increasing competition and margin pressure. 

Higher operating costs and increased provisions, however, have constrained the earnings benefit that typically accrues to lenders that assume greater credit risk. 

Banks with riskier credit profiles and lower capital 

ratios may be more vulnerable if commercial credit 

quality problems persist. 

During the past several years, significant employment gains and high consumer optimism have stimulated demand for housing around the Region. 

Recently, communities surrounding the Region’s larger 

urban areas, primarily New York City, Baltimore, and 

Washington, D.C., where job growth has been strong, 

reported the most significant price appreciation. 

Home prices in many of these areas increased 

at double-digit rates during the first six 

months of 2000, far exceeding the 

average price increase for homes 

nationally. Housing prices in 

some of these areas have benefited from strong Wall Street conditions and may be vulnerable to 

weakening in the financial markets. Nevertheless, the Region’s current housing boom has been more modest 

than the 1980s experience. 

As a result of limited supply and strong demand, 

home prices in some of the Region’s major markets 

have been rising three to four times the rate of 

increase in household incomes over the past year.3 

One consequence of rising home prices, particularly if 

they are increasing substantially faster than household 

income, is that it may place additional financial stress 

on prospective homeowners, who may be faced with 

higher debt servicing costs. According to the Federal 

Reserve Board, in first quarter 2000, the debt service 

burden for the nation—the ratio of consumer debt payments to disposable personal income—reached the 

highest level since first quarter 1988. Consumer debt 

service burdens also have increased in many of the 

Region’s states, raising concern about consumer credit 

quality, particularly if the economy weakens. 

3 Household income data are from the Bureau of the Census. Economy.com develops quarterly estimates. Amounts include all wages but 

not income from capital gains. 

Regional Outlook—National Edition 18 Fourth Quarter 2000 
Regional Perspectives
 

San Francisco Regional Perspectives
 

The San Francisco Region continued to experience 

robust economic conditions through midyear 2000. 

Arizona, Nevada, Idaho, and California reported the 

highest levels of employment growth among the states 

in the Region, while job growth in Hawaii and Oregon 

lagged the national average. The construction and service sectors added jobs; however, employment in the 

mining and manufacturing industries declined. The rise 

in oil prices has not stimulated exploration and production in Wyoming and Alaska, where oil and gas output 

is important. 

Insured institutions reported healthy financial 

results as of June 30, 2000, but overall risk profiles 

may be increasing. Earnings, leverage capital, and 

delinquent loans were reported at acceptable levels at 

midyear 2000. However, loan growth rates 

gest that some of the Region’s banks are 

and changes in portfolio composition sugheightening their risk profiles. Insured 

institutions continued to 

grow loan portfolios more 

rapidly than deposits, resulting in an increasing reliance 

on noncore funding. In addition, a sizable portion of the 

Region’s loan growth has resulted 

from increases in traditionally 

higher-risk, higher-yielding commercial real estate (CRE) and construction and development (C&D) loans. High loan 

growth rates also may be forestalling increases in delinquent loan levels. However, as loan portfolios season, 

this trend could reverse. In fact, commercial and industrial loan delinquencies are rising at some of the 

Region’s larger institutions. 

Several of the San Francisco Region’s metropolitan 

statistical areas (MSAs) have recently experienced a 

rapid increase in construction activity. High rates of 

CRE construction activity may not be a problem if 

absorption of space continues. However, as discussed in 

Regional Outlook, third quarter 2000, should demand 

weaken, the potential for overbuilding could exist. 

This article looks at five of these MSAs—Las Vegas, 

Phoenix, Seattle, Salt Lake City, and Portland— 

focusing on the economic drivers of the growth in 

CRE activity and on the levels of CRE and C&D 

lending at community banks in these areas. However, as was the case with the analysis presented in 

Regional Outlook, third quarter 2000, rising vacancies 

in the at-risk markets are not being predicted. Rather, 

the purpose is to raise awareness about substantial 

growth in real estate development and the corresponding increases in risk exposure to insured financial 

institutions. 

These five MSAs exhibited substantial increases in 

real personal income between 1993 and 1998. During 

this time, real personal income growth outpaced the 

national average. The FDIC study, History of the Eighties—Lessons for the Future, found that “boom and 

bust” economic activity (in part measured by fluctuations in real personal income growth) was correlated 

with an increase in bank failures. 

Growth in the high-tech sector has significantly contributed to the Region’s current economic expansion 

and to CRE development in several of the Region’s 

MSAs. The Phoenix, Seattle, and Portland MSAs are 

identified as “high-tech MSAs” (see San Francisco 

Regional Outlook, third quarter 2000) and as areas vulnerable to CRE overbuilding. Employment in the hightech sector has historically been volatile. This sector 

also has been traditionally dependent on the availability 

of venture capital, which ties the high-tech sector more 

closely to the stock market. As a result, a downturn in 

the high-tech sector or a prolonged decline in the stock 

market could adversely affect local economies in these 

MSAs. 

Insured institutions in these MSAs have played an 

important role in financing the increased levels of 

CRE activity. As a result, rising CRE and C&D loan 

exposures at community banks in these MSAs could 

heighten these institutions’ vulnerability in an economic downturn. As of June 30, 2000, concentrations of 

CRE and C&D loans at insured institutions in the five 

MSAs exceeded the median for all other MSAs in the 

nation. In addition, new chartering activity has been 

strong in these MSAs, and the number of unseasoned 

institutions (in operation less than eight years) has 

grown significantly. Elevated CRE and C&D loan concentrations and an increase in new bank formation 

could be a concern, given that insured institutions sharing these characteristics experienced higher failure rates 

during the last recession. 

Regional Outlook—National Edition 19 Fourth Quarter 2000 
✁
 

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