Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION THIRD QUARTER 2000 

FDIC
 

Kansas City
 

Region
 

Division of
 

Insurance
 

John M. Anderlik,
 

Regional Manager
 

Jeff W. Walser,
 

Regional Economist
 

Troy D. Osborne,
 

Financial Analyst
 

Regional Perspectives 

◆ The Region’s Economic Conditions—While the authors of the Federal Agriculture Improvement and Reform Act of 1996 intended to take U.S. farm policy in 

a new direction, reducing farmers’ reliance on governmental aid, the Region’s 

farmers have continued to benefit significantly from federal aid payments. Changes 

in the structure of the agricultural industry and international trade considerations 

will affect the future direction of U.S. farm policy. The farm bill of 2002 could mark 

a crossroads in the development of U.S. farm policy, with far-reaching implications 

for farmers and the bankers who lend to them. See page 3. 

By Jeffrey W. Walser, Regional Economist 

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 11. 

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 19. 

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)
 

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

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

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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 Kansas City Region’s Regional Outlook, please call John Anderlik at (816) 234-8198 or send an e-mail to janderlik@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
 

•	 Although the authors of the Federal Agriculture Improvement and Reform Act of 1996 intended this legislation to take U.S. farm policy in a new direction, reducing farmers’ reliance on governmental aid, the 

Region’s farmers have continued to benefit significantly from federal aid payments. 

•	 Changes in the structure of the agricultural industry and international trade considerations will affect the 

direction of U.S. farm policy. 

•	 The farm bill of 2002 could mark a crossroads in the development of U.S. farm policy, with far-reaching 

implications for farmers and the bankers who lend to them. 

U.S. Farm Policy: Which Direction After 2002? 

During the first half of 2000, the Federal Deposit 

Insurance Corporation (FDIC) hosted five Agricultural 

Bankers’ Roundtables throughout the United States. 

The initial meeting was held on March 28, 2000, in 

Omaha, Nebraska, to discuss the state of the agricultural economy. Fourteen bankers from Iowa and 

Nebraska spoke with FDIC officials about farming 

conditions in these states and their experiences with 

banking clients. These bankers, who operate in an area 

where corn, soybeans, hogs, and cattle are the most 

important agricultural commodities, agreed that their 

borrowers have been adversely affected by the low 

commodity prices that have persisted since 1997. The 

bankers unanimously thought that federal government 

supplemental payments to farmers and federal crop 

insurance were crucial to maintaining the financial 

health of farm borrowers in 1998 and 1999. In fact, 

farm banks in the Kansas City Region as a whole have 

yet to reflect the poor farm economy in reported 

results. See Chart 1. 

The experience of the bankers at the Omaha meeting 

was consistent with information reported by the United 

States Department of Agriculture (USDA). Table 1 

TABLE 1 

shows price trends for the major farm commodities in 

the Kansas City Region. 

Average corn and wheat prices have declined each year 

since 1996, and the price of soybeans has fallen each 

year since 1997. For each of these crops, favorable 

yields and large planted acreages have resulted in significant accumulations of inventories, both in the United States and abroad. Given these large stocks of 

commodities and normal weather conditions, the USDA 

forecasts that prices will remain low in 2000 and 2001. 

Hog prices reached historic lows in late 1998 and early 

1999, but they have recovered partially in 2000 as supplies have declined. Cattle prices continue to improve in 

2000 after four years of low price levels. 

The effect of continued low crop prices and the importance of government payments is apparent in Chart 1 

(next page), which depicts U.S. net farm income in the 

1990s, both the portion earned by farmers and that provided by the federal government. The income earned by 

farmers from their operations has declined each year 

since 1996, but significant government payments have 

supported the level of net farm income. 

Commodity Prices Are Expected to Remain Depressed through 2001 

1996 1997 1998 1999 PROJ. PROJ. 

2000 2001 

CORN 3.24 2.71 2.43 1.94 1.90 1.70 

SOYBEANS 6.72 7.35 6.47 4.93 4.70 4.40 

WHEAT 4.55 4.30 3.38 2.65 2.50 2.50 

HOGS 53.39 51.36 34.72 33.55 44.50 45.50 

CATTLE 65.06 66.32 61.48 65.52 69.00 74.50 

Notes: Grain prices are for marketing year of each crop.
 

Crop quantities are per bushel; livestock are per hundredweight.
 

Source: USDA, July 12, 2000
 

Kansas City Regional Outlook 3	 Third Quarter 2000 
Regional Perspectives
 

CHART 1 

Banking Scorecard
 

In the aggregate, as of March 31, 2000, the Region’s 1,259 farm banks1 continued to report sound conditions. 

Earnings remained strong during 1999 and through the first quarter of 2000. However, higher interest costs and 

increasing competition for loans and deposits caused net interest margins to fall in 1999. Reported capital levels are high compared to historical levels, but have declined since 1998 because of increasing unrealized losses 

on available-for-sale securities. These unrealized losses, which affect capital but have not yet affected earnings, 

totaled $287 million, and reduced farm banks’ aggregate capital ratio from 10.50 percent to 10.07 percent as 

of March 31, 2000. 

Despite continued low commodity prices, problem loans remained manageable, and reserve levels provided a 

cushion against potential loan problems. Record government payments to farmers helped maintain farm banks’ 

relatively low levels of problem loans in 1999, and support payments in 2000 are likely to exceed previous levels. 

Funding is a concern as farm banks’ loan-to-asset ratios continue to rise. Farm banks are finding it difficult to 

increase core deposits and, as a result, are turning to noncore funds, such as large time deposits, Federal Home 

Loan Bank borrowings, and brokered deposits, to support asset growth. 

The Region’s Farm Banks 

Continued to Report Strong Earnings 

March 

’96’95’94’93’92’91’90’89 ’98 ’00

Return on Assets (%) 

0.0 

0.2 

0.4 

0.6 

0.8 

1.0 

1.2 

1.4 

1.6 

1.8 

2.0 

’97 ’99

KC Region 

Farm Banks 

U.S. Farm 

Banks 

Capital Levels Are Declining but Remain High 

Compared to Historical Levels 

March 

9.0 

9.5 

10.0 

10.5 

11.0 

’99’98’97’96’95’94’93’92’91’90’89 ’00

KC Region 

U.S. 

Leverage Ratio (%) 

Net Interest Margins Have Fallen 

Significantly since 1997 

March 

Net Interest Margin (%) 

3.9 

4.0 

4.1 

4.2 

4.3 

4.4 

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

KC 

Region 

U.S. 

Past-Due Loans Remained Low 

and Reserves Remained Strong 

Percentage of Total Loans 

March 

’00’99’98’97’96’95’94’93’92’91’90’89 

Loan Loss Reserves 

Noncurrent 

Loans 

Loans Past-Due 

30–89 Days 

0.0 

1.0 

2.0 

3.0 

4.0 

5.0 

1

Farm banks are defined by the FDIC as FDIC-insured financial institutions with agricultural operating loans and real estate loans secured 

by real estate making up at least 25 percent of total loans. 

Source: Bank Call Reports 

Kansas City Regional Outlook 4 Third Quarter 2000 
Regional Perspectives
 

CHART 2 

Massive Government Payments Have
 

Supported Net Farm Income Levels
 

$ Billion 

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

Note: 2000 includes $6.3 billion in new emergency aid 

Source: Economic Research Service, USDA 

U.S. Net Farm Income 

U.S. Farm 

Operating Income 

Government 

Payments 

60 

50 

40 

30 

20 

10 

0 

The USDA’s forecast for 2000 projects farm operating 

income to be $23.4 billion, the second lowest level for 

the 1990s, but government payments to be $22.7 billion, 

the highest level ever. If this forecast is realized, government payments will account for nearly half of net 

farm income in the nation. 

While the bankers who participated in the roundtable 

discussion acknowledged that the supplemental aid 

packages approved by Congress in 1998 and 1999 were 

critical to the financial health of many of their borrowers, they were uncertain about the future direction of 

U.S. farm policy. Subsequent to the Omaha meeting in 

March, Congress again approved a substantial aid package for agriculture for 2000. However, longer-term 

uncertainty about the direction of farm policy remains a 

substantial risk to the financial health of the Region’s 

farmers and the bankers who lend to them. 

The 1996 Farm Bill, also known as the Federal Agriculture Improvement and Reform (FAIR) Act, established 

the framework for current farm policy. In 2002, the current legislation will expire, and Congress must write a 

new farm bill. This article discusses the issues that 

likely will be addressed as part of the creation of the 

2002 bill and examines possible directions the new legislation could take. 

Background—The FAIR Act of 1996 

Since the Agricultural Adjustment Act of 1933, the federal government has tried to boost farm income with 

price supports and supply restriction. Before the 1996 

FAIR Act, the farm program included a system of deficiency payments for major crops. Commodities covered 

by the program were corn, sorghum, barley, wheat, oats, 

rice, and cotton. Under this system, the U.S. Secretary of 

Agriculture announced a target price at the beginning of 

the year, and farmers were paid the difference between it 

and the market price at the end of the year. The deficiency payments served as a risk-reducing mechanism, 

offsetting fluctuations in commodity prices. 

In the 1980s, the system of deficiency payments was 

increasingly criticized. Federal agricultural programs 

were no longer perceived as an efficient and equitable 

means of providing income support for farmers. By 

1995, a consensus had grown in Congress in favor of 

substantial reform of U.S. farm policy, resulting in the 

passage of the FAIR Act of 1996. The FAIR Act introduced a number of fundamental changes in farm policy, 

including the following: 

•	 Decoupling program payments from most production decisions and thus ending the practice of paying 

farmers deficiency payments when prices of commodities fell below target prices. During the early 

1990s, more than 90 percent of the crops grown in 

the Kansas City Region, measured by value, qualified for the deficiency payment program. Following 

the passage of the FAIR Act, farmers began to 

receive aid that is less tied to fluctuations in commodity prices. 

•	 Eliminating federal authority to control the supply of 

program commodities by limiting planted acreage. 

Under previous farm bills, farmers were required to 

“set aside” a portion of their production acreage to 

qualify for deficiency payments. 

•	 Establishing a schedule of fixed income support payments known as “production flexibility payments,” 

based on farmers’ historical pattern of production. 

Farmers receive these payments regardless of their 

present production decisions. These payments are 

declining over the life of the FAIR Act until its expiration in 2002. 

Proponents of the FAIR Act saw the 1996 legislation as 

a historic shift in the direction of farm policy. The new 

program was to minimize many of the distorting effects 

of the existing support programs. The decoupling of 

payments from production decisions and the elimination 

of supply controls allowed farmers to respond to market 

signals and reduce the opportunity costs of idling productive land. The legislation also sought to achieve a 

Kansas City Regional Outlook 5	 Third Quarter 2000 
Regional Perspectives
 

level of budgetary certainty with its schedule of fixed 

and declining payments. In contrast, the previous system 

of deficiency payments created an open-ended obligation that led to high levels of support in the 1980s. 

While the 1996 Farm Bill was widely seen as eliminating traditional farm policy instruments, its reform was 

only partial. Although payments to growers of the program crops were no longer tied to yearly production, 

these payments were not eliminated. Even as the bill 

was being debated, the total cost of farm benefits was 

not expected to be less than that under the traditional 

legislation. Many observers saw the FAIR Act as compensation for ending the government’s future obligation 

to farmers. 

However, contrary to the intentions of the original 

authors of the bill, it did not repeal the 1933 legislation 

of price supports and acreage controls. Therefore, a 

return to high price supports and production controls 

will occur in 2002 if Congress does not act. Some 

observers view the FAIR Act as a “policy experiment” 

rather than a permanent change in practices.1 

The FAIR Act also has not changed farmers’ traditional 

acceptance of government support. Previously, farmers 

were required to accept acreage restrictions in exchange 

for deficiency payments, but the FAIR Act removed this 

requirement. The transition payments under the new legislation were free of such restrictions, so nearly all eligible farmers participated, and the proportion of farmers 

receiving payments from the federal government and 

thereby the constituency associated with government 

payments actually increased. 

The law also retained the controversial “three-entity” 

rule that allows some large farmers to circumvent program payment limitations by establishing eligibility 

through legally separate operations. The retention of 

this rule suggests that the FAIR Act did not address 

equity concerns, as benefits continued to be based on 

past levels of output, effectively concentrating program 

benefits in the hands of large-scale producers. 

Finally, the bill renewed long-term diversions of land 

under the Conservation Reserve Program (CRP), under 

which farmers can voluntarily idle their land for tenyear periods. The bill authorized CRP contracts for 35.4 

million acres. While the ostensible goal of the CRP is to 

1

Agricultural Policy Analysis Center, University of Tennessee. Spring 

2000. Policy Matters, p. 18. 

preserve environmentally sensitive land, it also has had 

the effect of controlling supply. 

Whether or not the FAIR Act was originally intended as 

a phase-out of the government’s support of agriculture, 

events since 1996 have worked against that reduced 

support. Responding to declining farm incomes, Congress has passed emergency supplemental legislation in 

each of the past three years. In 1998, Congress passed 

an Agriculture Relief Package, including disaster relief 

and market loss assistance, totaling $5.975 billion. This 

package provided relief to farmers who had suffered 

crop losses because of poor weather and disease and to 

farmers who had suffered “loss due to circumstances 

beyond their control. These circumstances include economic dislocation, unilateral trade sanctions and a failure to pursue trade opportunities aggressively.”2 In 

effect, the market-loss assistance portion of the package 

consisted of almost a 50 percent “bonus” transition payment to farmers who had qualified in 1998. In 1999, 

Congress approved an $8.7 billion emergency spending 

bill that provided a combination of disaster and farm 

income assistance.3 Most recently, in late May 2000, 

Congress approved an emergency agriculture spending 

bill, which includes $7.1 billion in direct assistance for 

2000, and $8.2 billion of subsidies delivered through 

crop insurance programs over the next five years.4 

The emergency legislation enacted over the past three 

years has increased farmers’ dependence on government assistance and reflects a growing dissatisfaction 

with the strategy of the FAIR Act. At the USDA’s annual Agricultural Outlook Forum, on February 24, 2000, 

Secretary Dan Glickman represented the current administration’s position: 

During the last two years, Congress and the Administration were compelled to act....This certainly helped 

many farmers. Plenty of them would not have made it 

without that assistance. Nevertheless, I believe 

it...applied a very expensive tourniquet, when the situation actually called for a blood transfusion. Scrambling at the last minute to throw together ad hoc 

assistance is not the best way to help our farmers. 

Why can’t we have all the assistance mechanisms in 

2 Disaster and Tax Relief for American Farmers (http://agriculture.
 

house.gov/105/disaster.htm).
 

3 RL30201: Appropriations for FY2000: U.S. Department of Agriculture and Related Agencies. December 6, 1999. Congressional Research
 

Service Issue Brief, p. 2.
 

4 The Agricultural Risk Protection Act of 2000 (http://agriculture.
 

house.gov/2559conf.htm).
 

Kansas City Regional Outlook 6 Third Quarter 2000 
Regional Perspectives
 

place, ready to kick in when the farm economy heads 

south? Why can’t we fix the leaky roof before it starts 

raining?5 

As we approach 2002, competing philosophies will 

shape the debate about the future of U.S. farm policy. 

Will policymakers modify the 1996 Act, or revert to 

previous policies? The apparent alternatives are well 

summarized by a past USDA chief economist: 

There are two schools of thought on this issue. One 

says, at great cost, we bought our way out of these 

programs and we will stay on schedule and will be 

free of them when the FAIR Act expires. If this occurs, 

advocates say, the FAIR Act will be worth all that it 

cost. The other school of thinking says that if agriculture experiences a substantial decline in income 

(which it did in 1998), we will be right back into price 

supports and supply controls as we were before.6 

While the FAIR Act was a significant departure from 

the usual path of U.S. farm policy, the important economic issues that have driven past debates will continue 

to be part of the discussion when a new farm bill is created in 2002. It is useful, then, to consider the salient 

issues that will frame this debate. 

Determinants of Future U.S. Farm Policy 

Before any discussion of agricultural policy begins, this 

question must be asked: “Do U.S. farmers still require a 

safety net?” When the Agricultural Adjustment Act of 

1933 was passed during the height of the Great Depression, federal aid to farmers was justified as a strategy to 

keep farmers on the land and to improve the incomes of 

farm families relative to urban families. 

The validity of the goal of keeping farmers on their land 

is sometimes disputed on at least two grounds. First, in a 

larger context, the decline in the importance of agriculture is a natural result of economic growth, which many 

observers see as both inevitable and desirable.7 At least 

since the Industrial Revolution, agriculture employment 

has declined. As the U.S. economy has grown, opportunities for employment off the farm have increased and 

5 Glickman, Dan. February 24, 2000, Remarks at the USDA Agricultural Outlook Forum (http://www.usda.gov/oce/waob/oc2000/
 

speeches/glickman.txt).
 

6 Paarlberg, Don. First quarter, 1999. “Obituary for a Farm Program.”
 

Choices, p. 36.
 7 Johnson, D. Gale. 1991. World Agriculture in Disarray. New York:
 

St. Martin’s Press, p. 16.
 

attracted more workers. The trend has been particularly 

pronounced in the twentieth century as the development 

and adoption of new technologies have reduced the 

demand for agricultural labor. Second, experience suggests that federal aid to farmers has not kept workers on 

the farm. This trend is apparent in Chart 3; the data show 

that the share of the U.S. population living on farms has 

declined steadily throughout the past century. 

The continuing significant decline in the farm population suggests that federal farm policy has had little longterm effect on the continuing out-migration from farms. 

The goal of improving farm incomes relative to urban 

incomes may no longer be as relevant as it was in the 

1930s. As advances in technology have reduced the 

costs of agricultural production, commodity prices have 

slowly declined in real terms. As a result, farm operations have consolidated into larger and larger enterprises, as farmers have had to make larger capital 

investments to maintain and increase their incomes. In 

the 1920s, farm incomes averaged about one-quarter of 

nonfarm incomes, and the standard of living of farm 

people was significantly below that of urbanites. Today, 

however, incomes per farm household generally equal 

or exceed those of nonfarm households, and the wealth 

of farm households averages several times that of all 

households. However, these averages mask significant 

variations in the populations discussed. For example, as 

USDA data indicate, half a million farm households in 

the United States reported annual incomes below 

$20,000 in 1997.8 

CHART 3 

8 Harwood, Joy, and Craig Jagger. Fourth quarter, 1999. “Agriculture’s 

Safety Net. Looking Back to Look Ahead.” Choices, p. 59. 

’00 ’10 ’20 ’30 ’40 ’50 ’60 ’70 ’80 ’90 

Sources: Figures for 1900 through 1980: Population and Community in Rural 

America, Lorraine Garkovich; figures for 1990: Calvin Beale, USDA. Farm 

population estimates for 2000 are not available. Percent 

The Farming Community Reduced 

Significantly in the 1900s 

0 

10 

20 

30 

40 Percentage of U.S. Population 

Living on Farms 

1.9% 

39.3% 

Year 

Kansas City Regional Outlook 7 Third Quarter 2000 
Regional Perspectives
 

If federal aid to farmers is likely to continue in some 

form, the more immediate question to consider may be, 

“Which farmers should be assisted?” Traditionally, 

most federal aid to agriculture has been targeted to producers of the seven “program” crops: wheat, corn, 

sorghum, barley, oats, rice, and cotton. The deficiency 

payments were based on the volume of production, not 

on a farmer’s income. As a result, the largest farms 

received the largest payments. The continuing consolidation of agriculture has concentrated agricultural aid 

in the hands of the largest producers. Typically, livestock producers and producers of nonprogram crops 

such as soybeans have benefited much less from federal aid programs. While the FAIR Act decoupled payments from actual production decisions during the 

seven-year life of the current farm bill, the payments 

were based on historical production levels of the program crops. If an important goal of farm policy is to 

improve farmers’ incomes, the traditional deficiency 

payments and the FAIR Act’s transition payments are, 

according to some critics, an inefficient means of 

accomplishing that end. 

International Trade Issues Will Continue to 

Constrain the Direction of U.S. Farm Policy 

Beyond domestic considerations, questions of international trade will continue to constrain the options of 

U.S. policymakers. But certainly, U.S. farm policy is not 

produced in a vacuum. Future directions in farm policy 

must be framed in the context of global economic and 

political realities. Consider the place of U.S. policy 

within the framework of GATT (General Agreement on 

Tariffs and Trade) and its successor, the World Trade 

Organization (WTO). Agricultural policy was not a serious part of the GATT/WTO agenda until 1994, when 

the first guidelines were produced under the Uruguay 

Round of negotiations. 

Since 1994, the United States has been under pressure 

from the European Union (EU) and other exporters of 

agricultural commodities who have significant interest 

in removing barriers to trade from the United States. 

But beyond tariffs, these exporters also have an interest in the explicit and implicit subsidies provided by 

governments to farm producers because it places their 

farmers at a competitive disadvantage. In the United 

States, the FAIR Act and the popular CRP program 

have been criticized for a variety of reasons. The FAIR 

Act was widely hailed by U.S. trading partners and 

competitors for decoupling aid from production decisions, thus moving toward a system of aid that was less 

likely to distort decision making by individual farmers. But policy moves over the past three years have 

not won the support of our trading partners, as “emergency” legislation in 1998, 1999, and 2000 provided 

continued assistance for U.S. farmers and slowed 

downward adjustments in production, which worldwide commodity prices would otherwise dictate. The 

regime of international trade, including WTO rules, 

certainly constrains the direction of U.S. farm policy. 

The other major issue affecting the future of U.S. farm 

policy is the evolving relationship between rural development and agricultural policy. Farmers now make up 

only a small minority of the population of rural areas, so 

some analysts see the need for a rural development policy separate from agricultural policy. As agriculture 

continues to consolidate, the economic viability of 

many rural communities will be at risk. Towns and 

smaller cities that existed primarily to support agricultural activities must find new sources of economic sustenance. Smaller communities will face a number of 

challenges, including maintaining access to financial 

markets, improving access to telecommunications, 

maintaining infrastructure, and developing strategies 

for business assistance. As noted by one observer of the 

rural economy, “it is clear that consolidation in agriculture brings into focus a wide range of policy issues in 

rural America. Most of these lie far afield of the traditional purview of Congressional agriculture committees.”9 The future direction of agricultural policy will be 

shaped by a growing realization that rural development 

issues need to be addressed as well. 

Possible Directions of U.S. Farm Policy 

What direction could the 2002 farm bill take? According to analysts, three different scenarios are possible. 

Under one scenario, the market-oriented features of the 

FAIR Act would be retained, and a schedule would be 

set for ending any remaining payments to export crop 

producers. Permanent farm program legislation would 

be repealed, and the Freedom to Farm Act would be 

acknowledged as a successful buyout of New Deal-era 

farm policies.10 Strong market prices, while not predict9 Drabenstott, Mark. First quarter, 1999. “Consolidation in U.S. Agriculture: The New Rural Landscape and Public Policy.” Economic 

Review. Federal Reserve Bank of Kansas City. 10 Ordern, David, Robert Paarlberg, and Terry Roe. 1999. Policy 

Reform in American Agriculture. Chicago: The University of Chicago 

Press, p. 218. 

Kansas City Regional Outlook 8 Third Quarter 2000 
Regional Perspectives
 

ed in the near term, would be vitally important to realizing this outcome, as many observers argue that the 

high commodity prices of 1996 were instrumental in 

helping the passage of the FAIR Act. In addition, substantial progress would need to be made in international trade negotiations. Supporters of U.S. agriculture 

likely would demand rapid progress by the European 

Union in reforming its Common Agriculture Policy to 

ensure some semblance of parity in international markets. However, if commodity prices are low during the 

period 2000 to 2002, a significant retreat from the 

framework of the 1996 Farm Bill is possible. A retreat 

could restore past techniques of intervention, including 

target prices, increased use of export subsidies, and resurrection of supply control authority. 

A third scenario would retain the core reforms of the 

FAIR Act, including the end of deficiency payments and 

supply controls, but extend or enhance a variety of 

strategies of intervention. Likely strategies would 

include increased reliance on crop insurance, following 

the policies instituted in the Agricultural Risk Protection Act of 2000, which increased premium subsidies. 

In a sense, crop insurance programs, with subsidized 

premiums, serve as a substitute for the ad hoc supplemental aid offered to farmers in 1998, 1999, and 2000. 

Consequently, Congress’s tendency to provide supplemental aid has had adverse incentive effects on the crop 

insurance program. Some academic studies have concluded that crop insurance programs cannot be justified 

on the basis of economic efficiency, but serve as a politically palatable means of transferring income to an 

effective interest group.11 Nonetheless, increased participation in crop insurance likely will decrease political 

pressure for more supplemental aid. 

CRP may be expanded, with eligibility requirements 

loosened. The program has been popular, as it combines 

supply control, income support, and environmental 

goals with minimal administration costs. Under CRP, 

qualified farmers withdraw their land from production 

for ten years in return for fixed annual payments from 

the government. This program provides fixed annual 

cash flow to the participating farmers with no input 

expenditures required. The usefulness of CRP has been 

mixed in the Kansas City Region, as CRP likely is more 

profitable than cultivating less productive farmland. 

Nonetheless, this policy tool likely will continue to be 

an important part of future strategies. 

11 Goodwin, Barry K., and Vincent H. Smith. 1995. The Economics of 

Crop Insurance and Disaster Aid. Washington, D.C.: AEI Press, p. 29. 

As part of a discussion on continuing income support 

goals, a consensus for income/need-based assistance 

for farmers is likely to materialize. Proposals will 

emerge to provide assistance that will be delivered in 

broader, non-commodity-specific ways.12 For example, 

some have suggested that federal aid be provided to 

farmers based on annual incomes, rather than on the 

crops they produce. If a goal of federal aid is to support 

farm incomes, programs that are focused on those 

farmers most in need could become attractive in the 

future. 

Finally, broader programs of rural development assistance likely will attract increased attention. At the Agricultural Outlook Forum, Secretary Dan Glickman spoke 

of the need for increased attention to rural issues outside the farmstead: 

[another] principle involves integrating rural development into farm policy. In today’s world, most people in rural America cannot make a decent living in 

production agriculture alone....A new farm policy 

must go beyond the wheat program, the rice program, 

the cotton program, and so on to address the more 

fundamental question: how can we help preserve the 

nation’s agrarian tradition by providing more rural 

economic opportunity....Over the last 60 years, agriculture has been dramatically transformed, and yet 

farm policy has remained relatively stagnant. People 

generally do not and cannot farm the way they did in 

the 1930s and 1940s, so government’s role in helping 

them has to change accordingly.13 

While the specific characteristics of the 2002 farm bill 

cannot be predicted precisely, the low commodity prices 

that have persisted since 1997, and Congress’s willingness to provide supplemental legislation, suggest that a 

total dismantling of the traditional farm policy instruments is unlikely. Even though the Farm Bill of 1996 

has attracted considerable criticism in the past three 

years, a consensus still exists that a return to traditional 

farm policy instruments may not be entirely appropriate 

in the modern agricultural economy. 

Changes in agricultural policy are typically slow and 

incremental. The reforms attempted in 1996 significantly departed from traditional policy. While Congress 

has cushioned the farm economy from the effects of the 

12 Harwood and Jagger, p. 59.
 

13 Glickman, Dan. February 24, 2000, Remarks at the USDA Agricultural Outlook Forum (http://www.usda.gov/oce/waob/oc2000/
 

speeches/glickman.txt).
 

Kansas City Regional Outlook 9 Third Quarter 2000 
Regional Perspectives Regional Perspectives
 

new system, change is still in the air. The 2002 farm bill 

likely will address a number of new issues with some 

novel policy initiatives. 

As was evident during the FDIC’s Agricultural Bankers’ 

Roundtable, bankers historically have benefited from 

the traditional federal government aid programs for 

farmers. Deficiency payments to crop producers have 

allowed farmers to repay their loans, even during periods of low commodity prices. However, the passage of 

the 1996 Farm Bill marked a departure from “business 

as usual” in the farm policy arena and set the stage for 

possibly more significant changes when the 2002 farm 

bill is debated. The uncertainty expressed by bankers 

during the FDIC meetings is understandable, as farmers 

and the bankers who lend to them could be operating in 

a new environment after 2002. 

Jeffrey W. Walser, Regional Economist 

Kansas City Regional Outlook 10 Third Quarter 2000 
In Focus This Quarter 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 FDIC-insured 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 

1 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. 

markets are experiencing increased levels of construction 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. 

Kansas City Regional Outlook 11	 Third Quarter 2000 
In Focus This Quarter 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 metKansas City Regional Outlook 12 Third Quarter 2000 
In Focus This Quarter 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. 

Kansas City Regional Outlook 13 Third Quarter 2000 
In Focus This Quarter 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 

Kansas City Regional Outlook 14 Third Quarter 2000 
In Focus This Quarter 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) 

Kansas City Regional Outlook 15 Third Quarter 2000 
In Focus This Quarter 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 

Kansas City Regional Outlook 16 Third Quarter 2000 
In Focus This Quarter 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.
 

Kansas City Regional Outlook 17 Third Quarter 2000 
In Focus This Quarter 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 

Kansas City Regional Outlook 18 Third Quarter 2000 
In Focus This Quarter 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 

Kansas City Regional Outlook 19	 Third Quarter 2000 
In Focus This Quarter 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, personKansas City Regional Outlook 20 Third Quarter 2000 
In Focus This Quarter 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. 

Kansas City Regional Outlook 21 Third Quarter 2000 
In Focus This Quarter 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. 

Kansas City Regional Outlook 22 Third Quarter 2000 
In Focus This Quarter 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. 

Kansas City Regional Outlook 23 Third Quarter 2000 
In Focus This Quarter 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 

Kansas City Regional Outlook 24 Third Quarter 2000 
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