Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION FIRST QUARTER 1999 

FDIC
 

Memphis
 

Region
 

Division of
 

Insurance
 

Gary L. Beasley,
 

Regional Manager
 

David T. Griffiths,
 

Regional Economist
 

Robert L. Burns,
 

Senior Financial
 

Analyst
 

F. Miguel Hasty,
 

Financial Analyst
 

In Focus This Quarter 

◆ High Loan-to-Value Lending: A New Frontier in Home Equity Lending—High loan-to-value home equity loans have grown in popularity as consumers 

have sought ways to consolidate credit card debt and lenders have sought ways to 

deal with declining profit margins on traditional home equity loans. High loan-tovalue loans pose unique risks for lenders because of their hybrid nature: they combine characteristics of both a secured home equity loan and an unsecured consumer 

loan. Losses on such loans are increasing rapidly, and the current rate of loss raises 

concern about how these loans might perform in an economic recession. See page 4. 

By Diane Ellis 

◆ Commercial Development Still Hot in Many Major Markets, but 

Slower Growth May Be Ahead—Following the experience of the 1980s, the 

threat of an oversupply of commercial real estate is watched with keen interest by 

market participants and observers alike. This article highlights nine metropolitan 

areas that may be vulnerable to overbuilding based on the rapid pace of development occurring within those markets, various indicators of current and prospective 

demand, and projections by credible industry analysts. These concerns could be 

mitigated to the extent that reduced credit availability within the capital markets 

leads to a slowing in construction activity. See page 11. 

By Steven Burton 

◆ Recent Trends in Syndicated Lending—A strong U.S. economy, intensifying lender competition, and increasing marketability of bank loans have driven 

record volumes of syndicated lending in the 1990s. These factors led to several years 

of liberalized underwriting in the syndicated market. While evidence suggests that 

some banks have tightened standards and terms for loans to large commercial borrowers, market developments and underwriting trends over the past several years 

have implications for credit quality, earnings, and liquidity at institutions that hold 

or originate syndicated loans. See page 19. 

By Steven E. Cunningham, Ronald L. Spieker 

Regional Perspectives 

◆ Region’s Economic and Banking Conditions—The Region’s economy 

slowed in the third quarter, with significant job losses in nondurable goods manufacturing. Weaker commodity prices, primarily affecting the agriculture and energy sectors, also contributed to the slowdown. Automobile production in Tennessee 

faces challenges from changing consumer preferences. The Region’s banks and 

thrifts reported positive results in the third quarter, but lower net interest margins 

continue to affect earnings performance. See page 25. 

◆ Commercial Real Estate Markets and Lending Trends—Commercial 

real estate development in the Region remains very active while demand for commercial space has started to lag in some metropolitan markets because of slowing 

local economies. Banks and thrifts report rising concentrations in commercial real 

estate, and anecdotal evidence suggests that underwriting standards have relaxed in 

recent years. See page 27. 

By the Memphis Region Staff 

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

Insurance Corporation for the following eight geographic regions: 

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

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

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

Dallas Region (CO, NM, OK, TX)
 

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

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

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

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

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

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

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

publish/regout. For more information or to provide comments or suggestions about the Memphis 

Region’s Regional Outlook, please call Gary Beasley at (901) 821-5234 or send an e-mail to 

gbeasley@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 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Publications Manager Teresa J. Franks 
From the Editor
 

The National Edition of the
 

Regional Outlook is now available
 

To the Reader: 

I am pleased to announce the first publication of the Regional Outlook National Edition. Since its 

inception, the Regional Outlook has been published quarterly in eight separate volumes that were 

tailored specifically for each FDIC Region. This format was ideal for the reader who wanted 

detailed analysis of a specific Region. 

Beginning this quarter, the FDIC will publish in a single volume the highlights of our Regional 

analysis of trends affecting FDIC-insured institutions across the United States. The eight 

unabridged Regional editions will continue to be published for readers who want more detailed 

information about trends in their Regions. All editions will continue to offer the In Focus series of 

articles on trends affecting the risk exposures of FDIC-insured institutions. 

For example, this quarter the In Focus series highlights important trends affecting commercial 

lenders and consumer lenders. The Regional Perspectives articles explore in more detail how these 

and other trends may affect FDIC-insured institutions around the United States. 

Both the Regional and National editions are available by subscription or on the FDIC’s website at 

www.fdic.gov. As always, we welcome your comments on the content or format of this publication. 

Please refer to the back cover and inside the front cover for information about how to subscribe or 

comment. 

Sincerely, 

George French 

Executive Editor 
In Focus This Quarter
 

High Loan-to-Value Lending:
 

A New Frontier in Home Equity Lending
 

•	 High loan-to-value (HLTV) loans are typically 

junior liens on owner-occupied single-family residences, but there is limited collateral protection 

because the combined loan amounts often exceed 

the value of the home. 

•	 Nonbank, specialty lenders have dominated this 

line of business, and their growth has been fueled 

by strong demand for asset-backed securities collateralized by HLTV loans. 

•	 Insured depository institution involvement in 

HLTV lending has been increasing, and opportunities for further involvement opened up when 

market turmoil resulted in a contraction of HLTV 

specialists. 

•	 HLTV lending involves unique risks because it 

combines characteristics of both secured home 

equity lending and unsecured consumer lending. 

Just a few years ago, it would have been difficult to 

imagine a mainstream lender writing a home equity 

loan in excess of the equity that the consumer had in his 

or her home. However, intense competition and declining profit margins in traditional home equity lending 

have lenders looking to boost volume and profits by 

relaxing underwriting standards. At the same time, consumers are signaling their desire to transfer their credit 

card balances to lower-costing home equity loans. 

These trends have given lenders, including insured 

depository institutions, the impetus to enter the HLTV 

home equity market. Furthermore, new opportunities 

have opened up for insured depository institutions to get 

involved in HLTV lending as a result of turmoil in the 

equity and asset-backed securities market, which resulted in a severe liquidity crisis that effectively sidelined 

many HLTV specialists. 

HLTV Lending Taps Consumers’ Desire to Shift 

Credit Card Debt into Home Equity Loans 

For the better part of the 1990s, credit card lending was 

dubbed the Wild West of consumer credit. This title 

was earned, in part, by lenders’ aggressive marketing 

and solicitation of their cards and consumers’ willingness to push their holdings of credit card debt to record 

high levels. After several years of double-digit growth 

in credit card outstandings, the growth has slowed. 

However, this slowdown does not necessarily mean that 

the Wild West has been tamed. In fact, home equity 

lenders are blazing new frontiers in consumer credit. 

Chart 1 shows that the originations of home equity 

loans for asset-backed securitizations have surpassed 

the originations of credit card loans over the past two 

years. 

It could be said that the home equity industry owes its 

resurgence to the boom in credit card lending that preceded it, because today’s home equity borrowers primarily use these loans to consolidate their outstanding 

debt. A survey by the Consumer Bankers Association 

found that, whereas in 1991 home improvement was the 

primary reason for taking out a home equity loan, debt 

consolidation is now the primary reason, with 40 percent of borrowers using a home equity loan for this purpose in 1997. This shift also is evidenced by another 

recent survey by Brittain Associates, Inc., which estimated that during a 24-month period ending June 1998, 

4.2 million households converted $26 billion in credit 

card debt to home equity mortgage debt. Given the high 

levels of credit card debt on households’ balance sheets, 

it should be no surprise that consumers with other borrowing options are looking for ways to consolidate their 

debt and reduce their borrowing costs. 

CHART 1 

Originations of Home Equity Loans Have 

Surpassed Originations of Credit Card 

Loans in the Past Two Years 

Source: Inside MBS & ABS 

1995 1996 1997 9 mos. 1998 

Credit Card 

Home Equity 

$ Billions 

70 

60 

50 

40 

30 

20 

10 

0 

Memphis Regional Outlook 4	 First Quarter 1999 
In Focus This Quarter
 

HLTV Loans Are Hybrid Loans 

HLTV loans are considered hybrid loans and can be 

thought of as a marriage between secured lending and 

unsecured credit card loans. HLTV loans are typically 

junior liens on owner-occupied single-family residences 

where the combined loan amounts exceed the value of 

the home—sometimes by as much as 125 to 150 percent. Some lenders also make HLTV first mortgages, 

which enable consumers to finance their down payment 

and closing costs and consolidate other debts. 

In return for pledging their home as collateral, borrowers are charged lower rates of interest than on unsecured 

consumer loans. Even at 125 to 150 percent loan-tovalue, the rates on HLTV loans generally are lower than 

credit card loans. In 1997, the average rate on an HLTV 

was 13 to 14 percent, whereas the average rate on a 

credit card loan was 16 percent. Because HLTV loans 

carry lower interest rates and are long-term loans (15 to 

30 years), the monthly payment on one is often considerably less than the total monthly payments on the loans 

that were paid off in the consolidation. 

HLTV loans also appeal to consumers because they can 

benefit from the tax deductibility on a portion of their 

interest payments. Current IRS rules allow interest to 

be deducted on that portion of the loan that is equal to 

Typical HLTV 


Borrower Characteristics
 

Annual Income $60,000 

Job Tenure 5 years 

Age Late thirties 

FICO Score 680 

Outstanding Nonmortgage Debt $20,000 

First Mortgage Amount $110,000 

Property Value $130,000 

Typical HLTV 

Loan Characteristics 

Amount $30,000 

Contract Interest Rate 13 to 14% 

Term 25 years 

Loan to Value 110% 

Notes: HLTV = high loan-to-value; FICO = Fair, Isaac Company 

Source: General Accounting Office, based on interviews with 

public and private officials 

or less than the value of the home at the time the loan 

is closed. 

The primary disadvantage of converting unsecured 

credit card and other consumer debt to an HLTV loan 

is that in the event of default, the borrower could lose 

his or her home. However, many consumers burdened 

by the high cost of unsecured consumer debt apparently have viewed the chance to lower their monthly payments as worth the risk. HLTV loans have been 

particularly popular in California, where property 

value declines in the early 1990s left homeowners with 

little or no equity in their homes. The inset box shows 

the typical characteristics of an HLTV loan and an 

HLTV borrower. 

Underwriting of HLTV Loans Emphasizes 

the Borrower’s Credit Quality 

Because of their limited or nonexistent collateral protection, HLTV loans typically are considered unsecured 

loans and the emphasis in underwriting is on the borrower’s credit quality rather than on collateral value. 

Large HLTV lenders use credit scoring to underwrite 

their loans, and a major component of their scoring is a 

credit bureau or Fair, Isaac Company (FICO) score. 

Other important factors are the borrower’s debt-toincome ratio, mortgage credit history, consumer credit 

history, bankruptcies, foreclosures, notice of defaults, 

deeds in lieu of foreclosure, and repossessions. 

HLTV loans are not necessarily subprime loans; the 

term “subprime” refers to the credit quality of the borrower rather than the margin of collateral protection. 

Instead, many lenders assert that HLTV loans are made 

to “prime” borrowers and can point to the fact that 

FICO scores on HLTV loans have been rising, averaging approximately 689 in 1998. Scores above 680 are 

generally associated with “A” credit quality; however, 

the average ignores the fact that major HLTV lenders 

allow FICO scores to go much lower, typically as low as 

620.1 Standard & Poor’s recently reported that performance problems clearly exist on loans for which the 

borrower’s FICO score is below 650.2 

1 H.T. Katz and G.T. Costello, Fitch IBCA Credit Rating Company.
 

“Securitization of 125 LTV Mortgages.” Structured Finance Special
 

Report, March 4, 1998. Underwriting guidelines summary matrices
 

are provided for seven large HLTV lenders.
 

2 “High LTV Security Performance Expected to Improve as FICO
 

Scores Rise and FHA Title 1 Loans Disappear.” Inside MBS & ABS,
 

November 13, 1998, p. 9.
 

Memphis Regional Outlook 5 First Quarter 1999 
In Focus This Quarter
 

TABLE 1 

HLTV Underwriting Guidelines 

QUALIFYING PARAMETERS A+ A B+ B C+ 

FICO SCORE 700+ 680–699 660–679 640–659 629–639 

MORTGAGE HISTORY (PAST 12 MONTHS) 1X30* 1X30 1X30 1X30 1X30 

BANKRUPTCY (YEARS SINCE DISCHARGE) 3 3 3 5 5 

MAXIMUM DEBT TO INCOME (%) 50 50 45 45 40 

MAXIMUM LOAN TO VALUE 125 125 125 125 125 

MAXIMUM CASHOUT $35,000 $25,000 $15,000 $5,000 $1,000 

MAXIMUM LOAN AMOUNT $100,000 $75,000 $65,000 $45,000 $30,000 

* Number of times delinquent multiplied by days delinquent. 

Note: HLTV = High loan-to-value; FICO = Fair, Isaac Company. 

Source: The 10K filing of a major HLTV lender. 

The agencies that rate asset-backed securities collateralized by HLTV loans offer another perspective on the 

credit quality of HLTV borrowers. Moody’s has 

described HLTV borrowers as in the “A–” to “B” 

grades, and Standard & Poor’s has characterized the 

loans as “A–” to “B+” in terms of credit quality. Any 

grade below A can be considered subprime. Indeed, 

according to Mortgage Information Corp., the bulk of 

subprime mortgage activity occurs in the A– category. 

However, some analysts have preferred to characterize 

HLTV borrowers as squarely in between the subprime 

and prime designations. 

Whatever the label given to the quality of borrowers, 

they typically have a large amount of high-cost revolving debt, and converting this debt into a second lien on 

their home is an attractive alternative. They also might 

have some degree of poor credit performance. Table 1 

shows the underwriting criteria used by one of the 

largest HLTV lenders. Because underwriting classification systems are not uniformly applied among 

HLTV lenders, this table should be viewed only as a 

guide. 

Fueled by Easy Access to Capital, 

HLTV Loans Have Grown Rapidly 

On the basis of the volume of loans securitized, the 

HLTV loan market has expanded rapidly over the past 

several years (see Chart 2). Originations have grown 

from $1 billion in 1995 to $8 billion in 1997 and are 

expected to be around $12 billion in 1998. 

Nonbank, specialty finance companies presently dominate the HLTV market, and their easy access to capital 

CHART 2 

High Loan-to-Value Mortgage Production
 

Has Grown Rapidly
 

$ Billions 

14 

12 

10 

8 

6 

4 

2 

0 

1995 1996 1997 1998 (Est.) 

Source: General Accounting Office 

has been an important factor behind their growth. These 

specialists depend on their ability to securitize the loans 

and sell them in the asset-backed securities market. 

Strong investor demand for all kinds of asset-backed 

securities has allowed HLTV lenders to raise a substantial amount of funding without a strong degree of corporate credit quality. However, their reliance on the 

asset-backed securities market to fund operations 

exposes them to liquidity risk if demand for these securities declines. 

A healthy initial public offering market also has fueled 

the growth of these specialty lenders, and gain-on-sale 

accounting has allowed lenders to establish an earnings 

track record and attract debt and equity investors. Gainon-sale accounting requires securitizers to calculate and 

record a gain on sale from securitizations; however, the 

use of gain-on-sale accounting exposes lenders to prepayment risk. If the securitized loans prepay at a faster 

Memphis Regional Outlook 6 First Quarter 1999 
In Focus This Quarter
 

rate than the assumption used to calculate the gain, the 

company could be forced to take a write-down, which 

can affect earnings, liquidity, and capitalization. Institutions that invest in securities collateralized by HLTV 

loans also are exposed to prepayment risk. (For more 

information on gain-on-sale accounting, see “Gain-onSale Accounting Can Result in Unstable Capital Ratios 

and Volatile Earnings” in Regional Outlook, second 

quarter 1998.) 

In addition to the easy access to capital, favorable economic conditions also have encouraged HLTV lending. 

The long economic expansion has brought about the 

return of home price appreciation to nearly all parts of 

the country, which has encouraged HLTV lending 

because rising home values serve to reduce lender and 

investor exposure fairly quickly. The median sales price 

of existing single-family residences has increased an 

average of 4.39 percent per year since 1995, according 

to the National Association of Realtors. 

Market Turmoil Hit HLTV Specialty 

Lenders Hard 

The market volatility that began last summer illustrated the importance of liquidity risk and prepayment 

risk. HLTV specialists were faced with a liquidity 

crunch when they were hit hard in the equity downturn, 

in many cases significantly harder than the general 

market. Investors retreated from HLTV lenders and 

their asset-backed securities, in part as a result of a 

“flight to quality” as the Asian crisis spilled over into 

other global markets. A core of investors participating 

in the HLTV market also exited the market when prepayments occurred at faster rates than anticipated, 

largely a result of lower market interest rates, and 

forced lenders to take write-downs of interest-only 

residuals. Another factor in the investor retreat from 

this market was the growing skepticism concerning the 

performance of HLTV loans during an economic 

downturn. 

When investor demand for asset-backed securities dried 

up, HLTV lenders were unable to securitize their loans 

profitably. This situation created a severe liquidity crisis 

for specialty lenders who relied heavily upon this source 

of funding. As a result, some lenders were forced to put 

themselves up for sale, and others were forced to undergo massive restructuring. 

HLTV Lending Presents Unique Risks 

to Home Equity Lenders 

In addition to the risks associated with the securitization 

of HLTV loans (liquidity and prepayment risk), HLTV 

lending poses some unique risks for lenders who hold 

these loans in their portfolio, service them, or guaranty 

the performance of asset-backed securities. Because 

HLTV loans are a relatively new product, their credit 

risk is untested and could be affected by the following 

factors: 

•	 Increased rate of default. Data on the performance 

of HLTV loans are limited; however, the loss potential is starting to become visible when vintage analysis is performed. Chart 3, next page, shows that when 

recent vintages are adjusted for seasoning, chargeoff rates on HLTV loans are increasing at a rapid 

rate. Both the severity and frequency of default are 

much higher than for traditional A-quality home 

equity loans and are even higher than subprime home 

equity loans. The fact that charge-offs are higher 

than subprime loans suggests that the credit quality 

of HLTV borrowers is not too different from subprime borrowers and that when default occurs, the 

loss is more severe because of the lack of collateral 

protection. Lenders who do not accurately forecast 

the magnitude and costs of default associated with 

HLTV loans, or who make underwriting mistakes, 

might find that this line of business is not as profitable as anticipated. 

Lenders that rapidly increase HLTV exposures 

might consider the use of vintage analysis, also 

called “static pool” analysis, as a means of evaluating loan portfolio performance. This technique is 

effective when there is rapid growth, which can 

make it more difficult to accurately track delinquency and default trends when only an average delinquency or default ratio is calculated. Refer to 

“Subprime Lending: A Time for Caution” in 

Regional Outlook, third quarter 1997, for additional discussion on vintage analysis. 

•	 Untested performance in a recession. HLTV lending has existed for only a few years and has yet to be 

tested by economic recession. The rapid rise in 

charge-offs on HLTV loans has occurred in a relatively robust economic environment, and the losses 

during an economic downturn could be considerably 

Memphis Regional Outlook 7	 First Quarter 1999 
In Focus This Quarter
 

higher than anticipated. Moody’s has asserted that 

losses will mimic those of credit cards, and losses on 

credit card loans are usually higher than other consumer mortgage-related products. 

HLTV lenders’ heavy reliance on credit-scoring 

models raises further questions about how these 

loans might perform in a recession because these 

models are largely unproven in a recession as well. 

To improve the accuracy of credit-scoring models 

and the model’s ability to appropriately price the risk 

assumed, lenders can continually test and refine 

credit-scoring models to ensure that actual performance approximates projections. 

Changes in the borrower’s financial condition present a 

greater risk to HLTV lenders than in other types of 

secured lending, which introduces additional credit 

risks. In the event of default, the lender is likely to suffer a complete loss because foreclosure is probably 

infeasible and the size of HLTV loans is much larger 

than other types of unsecured or partially secured loans. 

Therefore, adverse changes in the borrower’s financial 

condition are very important and can be affected by the 

following factors: 

•	 Debt reloading. The primary reason consumers take 

out an HLTV loan is to consolidate credit card and 

other high-cost consumer debt. However, lenders 

cannot prevent HLTV borrowers from running up 

additional credit card debt after the loan is made. 

Consequently, these loans might serve to only postpone or amplify credit problems. A recent survey by 

CHART 3 

Brittain Associates, Inc., indicates that a large percentage of borrowers who take out home equity 

loans proceed to run up credit card debt shortly 

thereafter. Their survey of over 6,000 borrowers who 

used home equity loans to consolidate their debts 

revealed that only 30 percent of those borrowers 

remained free of credit card debt one year later. 

•	 Long-term exposure. Consumer loans typically 

have been made on a short-term basis; however, 

HLTV loans are made for terms up to 30 years. 

Therefore, the credit quality on an HLTV loan is 

more vulnerable to catastrophic events such as borrower job loss, illness, or divorce. Furthermore, the 

term of these loans far exceeds the predictive power 

of FICO scores, which have proven to be predictive 

for about a two-year period according to Moody’s. 

Because of their fixed terms and limited collateral protection, there are some unique operational risks associated with servicing and collecting an HLTV loan. 

Servicing and collecting an HLTV loan differs somewhat from servicing and collecting both secured lending and credit card lending because of the following 

factors: 

•	 Limited default remedies. The servicing and collecting of HLTV loans are complicated by the fact 

that the threat of foreclosure is not as severe as in traditional secured lending. According to Moody’s, 

HLTV lenders must adopt a collection strategy similar to credit card lenders that will require early intervention and the ability to “talk” the borrower into 

CHART 4 

Note: HLTV = high loan-to-value 

Source: Moody’s Investor Services 

Charge-Offs Are Rising More Rapidly on HLTV 

Loans Than for Any Other Type of Home Equity 

Loan (1996 and 1997 Origination Years); ... 

2 3 4 5 6 7 8 9 10 11 12 13 1415 16 17 18 19 

HLTV 

Home Equity Index 

Composite 

Subprime 

Traditional Home Equity 

Charge-Off Rate (%) 

10 0 

1 

2 

3 

4 

5 

6 

7 

Months of Seasoning 

Note: HLTV = high loan-to-value 

Source: Moody’s Investor Services 

...However, Delinquency Rates on HLTV Loans 

Are Lower Than on Subprime Loans Because 

Loans Are Charged Off Sooner 

(1996 and 1997 Origination Years) 

4567 8 9 10 11 12 13 14 15 16 17 18 19 20 

Months of Seasoning 

Subprime 60 Plus Delinquency Rate 

HLTV 60 Plus 

Delinquency Rate 

HLTV Annualized 

Charge-Off Rate 

Subprime Annualized

 Charge-Off Rate 

Delinquency Rate (%) 

321 0 

2 

4 

6 

8 

10 

12 

14 

Memphis Regional Outlook 8	 First Quarter 1999 
In Focus This Quarter
 

making a payment without resorting to foreclosure. 

However, unlike credit card lenders, HLTV lenders 

have less flexibility in collection because lines cannot be adjusted and interest rates cannot be raised. 

The different demands for servicing and collecting 

these loans, compared with traditional and subprime 

home equity loans, could strain institutions that do 

not have an adequate investment or expertise in collecting these loans. 

According to Moody’s, HLTV lenders generally 

write off their loans as a loss once they become 180 

days delinquent. In contrast, subprime lenders go 

through a lengthy foreclosure procedure. The speedier resolution of HLTV loans is reflected in a lower 

level of delinquencies in HLTV portfolios compared 

with subprime portfolios (see Chart 4, previous 

page). 

•	 Limited borrower flexibility and motivation. After 

a borrower has taken out an HLTV loan, opportunities to refinance are limited, and selling the home 

often is not feasible because of the large amount of 

cash needed at closing. As a result, counseling borrowers might prove to be harder than in credit card 

lending. Also, with negative equity in their homes, 

borrowers might have less incentive and ability to 

work with the lender to bring the loan current than to 

allow foreclosure. 

Insured Depository Institution Involvement 

in HLTV Lending Is Increasing 

Insured depository institution involvement in HLTV 

lending reportedly has been growing. Their precise 

involvement is difficult to quantify because these loans 

are not delineated in bank or thrift Call Reports. However, one indication of their growing involvement is 

cited in the Consumer Bankers Association 1998 home 

equity loan study. Twenty-five percent of respondents to 

its survey offered home equity loans with loan-tovalues in excess of 100 percent, up from only 5.8 percent one year earlier. 

Banks and thrifts can become involved in HLTV lending by using a variety of strategies. They can lend 

directly to HLTV borrowers or purchase HLTV loans 

from loan brokers and hold them in portfolio. Institutions also can originate the loans and securitize them or 

sell them to another company that will securitize them. 

A more indirect way for insured depository institutions 

to get involved in this market is to lend to HLTV specialty lenders in the form of warehouse lines. Institutions also can service HLTV loans or invest in 

asset-backed securities secured by HLTV loans. 

In light of the contraction of HLTV specialists, the 

question arises as to whether banks will view this as an 

opportunity to further expand their presence in HLTV 

lending, given that consumer demand for these products 

is still strong. Recent press reports indicate that this is 

happening, as some insured depository institutions 

recently have piloted HLTV lending programs by buying loans and keeping them in portfolio.3 Another way 

that banks have recently become involved in HLTV 

lending is by investing in HLTV specialists. Many 

HLTV specialists have been looking for opportunities to 

affiliate with firms that have plentiful and stable 

sources of liquidity (“deep pockets”), and insured 

depository institutions have been viewed as ideal candidates. Several of the largest HLTV specialists have an 

insured depository institution as an affiliate. 

Insured Depository Institutions Are Subject 

to Real Estate Lending Standards 

Unlike many of the specialty finance companies, 

insured depository institutions are subject to regulations 

prescribed by the federal supervisory agencies. In 1992, 

the federal banking and thrift supervisory agencies 

finalized a uniform regulation and interagency guidelines for real estate. The regulation, in part, requires 

institutions to adopt and maintain written policies that 

establish appropriate limits and standards for all real 

estate loans, including HLTV loans. When a bank 

adopts a policy, the regulation requires consideration of 

the Interagency Guidelines for Real Estate Lending 

Policies. These guidelines state that institutions should 

establish their own internal loan-to-value limits for real 

estate loans; however, they also indicate that the internal 

limits should not exceed 90 percent on a home equity 

loan.4 The guidelines recognize that it might be appro3 Timmons, H. “Banks Poised to Move in as High-LTV Lenders Fall.”
 

American Banker, October 28, 1998.
 4 The guidelines state, “A loan-to-value limit has not been established
 

for permanent mortgage or home equity loans on owner-occupied,
 

1- to 4-family residential property. However, for any such loan with a
 

loan-to-value ratio that equals or exceeds 90 percent at origination, an
 

institution should require appropriate credit enhancement in the form
 

of either mortgage insurance or readily marketable collateral.”
 

Memphis Regional Outlook 9	 First Quarter 1999 
In Focus This Quarter
 

priate to deviate from these guidelines and state that 

loans made in exception to these guidelines should be 

identified in the institution’s records and reported to the 

board of directors at least quarterly. Furthermore, the 

guidelines state that the aggregate amount of all loans in 

excess of the supervisory loan-to-value limits should 

not exceed 100 percent of total capital. 

Competition from HLTV Loans Is Driving 

a Loosening in Underwriting on Other 

Home Equity Loans 

Even for insured depository institutions not directly 

involved in the HLTV market, the competition posed 

by this product already is evident in the underwriting 

of other types of home equity products. The Office of 

the Comptroller of the Currency reported in its latest 

survey of the 77 largest national banks in the country 

that underwriting on home equity loans has been loosening for three years, a time period that corresponds 

with the life of the HLTV market. They reported that 

in 1998, the percentage of banks tightening standards 

on credit card loans is nearly matched by the percentage of banks loosening their underwriting standards on 

home equity loans. Competition was cited as the primary reason for loosening home equity standards, and 

an easing of collateral requirements was the primary 

method. 

Conclusion 

HLTV lending has provided a new option for consumers to work their way out from under burdensome 

credit card debt. It also has provided lenders with a new 

and potentially profitable line of business. Insured 

depository institution involvement in this line of business is growing and could continue to grow, especially 

if liquidity problems that have affected HLTV specialists continue. As with any line of business, success is 

dependent upon understanding the particular nature of 

the HLTV business and making the appropriate commitment of resources and expertise. With HLTV lending, there are unique risks involved because of the 

compound nature of these loans, which contain characteristics of both a secured home equity loan and an 

unsecured consumer loan. The risks involved in HLTV 

lending are further heightened by the fact that the performance of these loans is largely untested in an 

adverse economic environment. 

Diane Ellis, Senior Financial Analyst 

Memphis Regional Outlook 10 First Quarter 1999 
In Focus This Quarter
 

Commercial Development Still Hot in Many Major
 

Markets, but Slower Growth May Be Ahead1
 

•	 Oversupply within commercial real estate markets typically arises from the difficulty developers 

face in accurately predicting future demand for a 

given project, particularly when projections are 

based on temporary or unsustainable increases in 

demand. Easy access to investment capital in the 

form of lower borrowing rates or relaxed underwriting standards can exacerbate the overproduction of space. 

•	 This analysis identifies nine major metropolitan 

markets believed to be vulnerable to broad-based 

overbuilding.2 This vulnerability stems from rapid 

ongoing development across multiple property 

types, which threatens to outpace absorption or 

demand levels over the next one to two years. 

Overbuilding concerns are heightened by cyclical 

and secular demographic and economic trends 

that portend lower demand for commercial space. 

•	 Trends in the capital markets may have tempered 

the appetite for further development in some 

rapidly expanding metro areas. Should such 

trends continue, construction activity could moderate, thereby mitigating some of the overbuilding 

concerns expressed in this article. 

Since the boom development years of the 1980s, and the 

bust that followed, the financial community has devoted 

considerable resources to analyzing commercial real 

estate trends. The primary purpose of these efforts is to 

detect, as early as possible, warning signs of potential 

imbalances between supply and demand. The markets 

highlighted in this article are considered vulnerable to 

possible overbuilding on the basis of various early 

warning signs. Each of these markets is experiencing 

rapid commercial real estate development across multi1 In fall 1998, the FDIC’s Division of Insurance published a report ranking the risk of overbuilding within major metropolitan markets (see 

“Ranking the Risk of Overbuilding in Commercial Real Estate Markets,” Bank Trends, October 1998). This paper, which was based mainly on market information as of year-end 1997, highlighted six major 

metropolitan areas where the rapid pace of current construction activities raised concerns over the potential for broad-based overbuilding. 

2 “Broad-based overbuilding” signifies potential overbuilding in two 

or more of five property types: office, industrial, retail, apartment, 

and hotel. 

ple property types. In addition, each market exhibits one 

or more of the following characteristics: high vacancy 

rates relative to the pace of development, declining 

employment growth trends, declining in-migration 

trends, projected increases in vacancy rates by credible 

industry experts, and significant dependence on industry sectors vulnerable to either weak Asian markets or a 

slowing domestic economy. 

The term “vulnerable” is used here to signify a potential, as opposed to a certain, outcome. In previous cyclical downturns, falling commercial real estate values 

were preceded by economic events that resulted in lower 

demand: Declining energy prices preceded the mid1980s decline in Southwestern real estate markets; 

weaknesses in the financial sector preceded the late 

1980s decline in Northwestern real estate markets; and 

sharp defense cutbacks preceded the early 1990s 

decline in Southern California real estate markets. It 

remains to be seen whether weakening Asian markets or 

prospects for slower economic growth serve as catalysts 

for slower commercial real estate demand in the current 

cycle. Whatever the catalyst, markets most affected by a 

downturn in real estate values will be those in which 

optimistic expectations, the basis for current construction activity, fall farthest from the mark. 

Why Do Markets Become Overbuilt? 

Commercial property developers often face substantial 

lags between a project’s conception and its completion: 

The longer the construction period, the greater the 

uncertainty surrounding demand projections. These 

risks can be largely mitigated if the developer enters 

into presale contracts or preleasing agreements with 

financially sound parties prior to breaking ground on 

construction. However, it is not unusual in rapidly 

developing and highly competitive markets for developers to anticipate or “speculate” what demand levels 

will be, based on current trends. If the market in question is experiencing a period of temporary or unsustainable growth (a “boom” period, for example), then 

projections may lead to an overly optimistic outlook 

for future demand, particularly when forecasts are 

weighted heavily toward recent rental, sales, and 

demographic trends. Projection error also arises from 

Memphis Regional Outlook 11	 First Quarter 1999 
In Focus This Quarter
 

the failure to consider competitors’ planned development activities. 

If a developer’s demand projections fail to materialize, 

the result is an overhang of commercial property 

beyond what the market can absorb during a reasonable 

time frame. Easy access to investment capital can exacerbate overproduction of space by reducing or eliminating incentives to make reasoned and prudent 

investment decisions. Excessive leverage, where the 

developer has little personal capital at risk on a particular project, is a familiar example often associated with 

the excessive development of the 1980s. Loan pricing 

that fails to adequately account for the risks involved in 

a construction project is another example of how 

financing incentives could lead to imprudent development decisions. 

Ranking the Risks of Overbuilding 

The October 1998 Bank Trends (see footnote 1) study 

employed a three-step process to rank the vulnerability 

of markets to possible overbuilding. First, major metropolitan markets were ranked in terms of current construction activity3 relative to existing space for each of 

five property types: office, industrial, retail, apartment, 

and hotel. Second, relative construction activity was 

compared with current vacancy rates to assess the competitive pressures faced by newly developed projects. 

Third, market-related research was reviewed to determine which markets analysts considered candidates for 

possible supply/demand imbalances. Although the same 

approach was used in this updated analysis, additional 

factors were considered, including employment and 

population growth trends, the dependence of rapidly 

developing metropolitan areas on specific employers or 

industries, and the relationship between current economic trends and the potential demand for commercial 

real estate space. 

3 Construction activity generally refers to recent completions plus 

projects in process of being built. In the case of office and industrial 

properties, the source of data is CB Commercial/Torto Wheaton 

Research, and construction activity refers to completions for the last 

four quarters plus projects under construction. For all other property 

types, the source is F.W. Dodge and ERE Yarmouth, and construction 

activity refers to completions, projects in process of being built, 

starts, and pending projects. 

Most Active Construction Markets 

Charts 1 through 5 show the level of construction activity, for each property type, relative to the total stock of 

space as of June 30, 1998, for the top 15 major metropolitan markets. Although slowing somewhat, development in the Las Vegas market continues to lead all other 

markets in relative terms for office, industrial, and hotel 

construction. Las Vegas is also among the most active 

markets in apartment and retail construction. Other 

markets experiencing rapid development across multiple property types include Salt Lake City, Charlotte, 

Atlanta, Portland, Phoenix, Orlando, Dallas, Austin, 

Nashville, Jacksonville, and Seattle. As the charts show, 

office, industrial, apartment, and hotel construction 

activity rose from year-end 1997 levels among a majority of the fastest-developing markets. Retail development, however, appears to have slowed in a majority of 

the most active development markets during the first 

half of 1998. 

Comparing Construction Activity 

with Vacancy Rates 

Newly completed speculative projects must compete 

with existing vacant space. Accordingly, it is worthwhile to compare measures of relative construction 

CHART 1 

Source: CB Commercial/Torto Wheaton 

Top 15 Office Construction Markets* 

0 5 10 15 20 

Las Vegas 

Charlotte 

Orlando 

Salt Lake City 

Jacksonville 

Columbus 

Atlanta 

Nashville 

Dallas 

Austin 

Seattle 

Phoenix 

Portland 

Ft. Lauderdale 

Tampa 

National Average

 June 1998

 December 1997 

% of Stock 

* Includes last four 

quarters’ completions 

and projects under 

construction for: 

Memphis Regional Outlook 12 First Quarter 1999 
In Focus This Quarter
 

CHART 2 CHART 3 

Top 15 Industrial Construction Markets* 

% of Stock

0 2 4 6 8 10 12 14 16 

Las Vegas 

Atlanta 

Riverside 

San Diego 

Salt Lake City 

Phoenix 

Austin 

Oakland 

Sacramento 

Tucson 

Baltimore 

Orlando 

Jacksonville 

Orange County 

Seattle 

National Average 

 June 1998

 December 1997 

* Includes last four 

quarters’ completions 

and projects under 

construction for: 

Source: CB Commercial/Torto Wheaton Source: F. W. Dodge, Lend Lease Investment Research 

Top 15 Retail Construction Markets* 

0 2 4 6 8 10 12 

Norfolk 

Orlando 

Las Vegas 

Atlanta 

Charlotte 

Richmond 

Greenville 

Phoenix 

Minneapolis 

Jacksonville 

West Palm Beach 

Dallas 

Baltimore 

San Antonio 

Denver 

National Average

 June 1998

 December 1997 

% of Stock 

* Includes completions, 

starts, projects being 

built, and pending 

projects as of: 

CHART 4 CHART 5 

Source: F. W. Dodge, Lend Lease Investment Research 

Top 15 Apartment Construction Markets* 

0 2 4 6 8 10 

Austin 

Orlando 

Portland 

Las Vegas 

Charlotte 

Dallas 

Phoenix 

Columbus 

Nashville 

Atlanta 

Raleigh 

Denver 

Birmingham 

Greenville 

San Antonio 

National Average 

% of Stock 

* Includes completions, 

starts, projects being 

built, and pending 

projects as of:

 June 1998

 December 1997 

Top 15 Hotel Construction Markets* 

% of Stock

0 5 10 15 20 25 30 35 40 

Las Vegas 

Salt Lake City 

Portland 

Raleigh 

Baltimore 

Tampa 

St. Louis 

Dallas 

Phoenix 

Jacksonville 

Charlotte 

Cincinnati 

Greenville 

Seattle 

Denver 

National Average 

 June 1998

 December 1997 

* Includes completions, 

starts, projects being 

built, and pending 

projects as of: 

Source: F. W. Dodge, Lend Lease Investment Research 

Memphis Regional Outlook 13 First Quarter 1999 
In Focus This Quarter
 

CHART 6	 CHART 7 

Office Development Versus Vacancy Rates Industrial Development Versus Vacancy Rates 

20 12

18 Las Vegas 

Construction Activity as % of Stock 

Construction Activity as % of Stock 

Charlotte Las Vegas 10 

16 Orlando Jacksonville 

Columbus 

Atlanta 

14 Salt Lake Atlanta 8 Riverside 

12 Dallas San Diego Salt Lake 

10 Phoenix 6 

Phoenix Sacramento 

8 Tampa 4 

2 

6 

4 

2 

– 

2 4 6	 8 10 12 14 16 18 

Vacancy Rate (%) 

Source: CB Commercial/Torto Wheaton 

activity with current vacancy rates (as shown in Charts 

6 and 7 for office and industrial space). The main idea 

behind these charts is that market segments with high 

existing vacancy rates raise the degree of competitive 

pressure for newly built space; markets with high 

vacancies may have less justification for continuing 

increases in new stock. 

In the office sector, Las Vegas stands out as having the 

highest level of new development combined with high 

existing vacancy rates. Although the pace of development is markedly slower, office markets in both Atlanta 

and Dallas appear to be expanding rapidly despite high 

existing vacancy rates. In the industrial sector, Las 

Vegas, Atlanta, Riverside, Salt Lake City, and Phoenix 

all appear to be experiencing rapid development despite 

relatively high existing vacancy rates. 

Analyst Outlooks for Commercial Real Estate 

Advocate Caution 

The first six months of 1998 saw continuing strong 

market fundamentals in most major markets and 

most property types: CB Commercial/Torto Wheaton 

Research (CBC) reported continuing nationwide 

declines in office and industrial vacancy rates accompanied by increasing rental growth rates,4 Wheat First 

Union (Wheat) reported improvements in occupancy 

and rental rates across the 30 major apartment markets 

it follows,5 and Smith Travel Research (Smith) reported continuing improvements in average daily room rates 

4 CB Commercial/Torto Wheaton Research, The Office Outlook, 

The Industrial Outlook, and The Retail Outlook, Fall 1998. 5 Wheat First Union, Industry Report: Quarterly Apartment Review, 

October 21, 1998. 

– 

2 4 6 8 10 12 

Vacancy Rate (%) 

Source: CB Commercial/Torto Wheaton 

despite a modest decline in occupancy rates for the 

lodging sector (through the first nine months of 1998).6 

The performance of the retail sector has been more 

mixed, as indicated by a significant decline in estimated 

rental growth rates from 1996 to 1997 (CBC) while 

retail vacancy rates have held steady over the past 12 

months (F.W. Dodge).

7 

Despite these generally positive trends, market 

observers are becoming more cautious about the outlook for commercial real estate markets. Much of their 

concern stems from significant increases in projected 

supply in the face of moderating absorption rates. 

CBC, for example, projects that nationwide office 

vacancy rates will rise from 9.3 percent as of June 1998 

to 12.1 percent by June 2000 as a result of a sharp 

increase in completions combined with moderating 

absorption. Markets with the highest and most significant increases in projected office vacancy rates are 

highlighted in a recent Lehman Brothers study, which 

identifies 17 office markets as “danger zones.” 8 

Analysts have also raised concerns over rapid development in other property types. F.W. Dodge, for instance, 

anticipates a sharp rise in the ratio of retail completions 

6 Smith Travel Research, Smith Travel Research Announces 1998 

September and Third Quarter U.S. Lodging Industry Reports, 

www.str-online.com/news/releasedir/pr981104_3rdgtr.html. 7 F. W. Dodge, Real Estate Analysis and Planning Service: 2nd Quarter 1998. 

8 These markets are Salt Lake City, Columbus, Austin, Nashville, 

Charlotte, Orlando, Las Vegas, Baltimore, Atlanta, Dallas, Phoenix, 

Philadelphia, Indianapolis, Chicago, Sacramento, Miami, and Houston (Lehman Brothers, Commercial REIT Research: Eye on Office 

Markets, October 1998). 

Memphis Regional Outlook 14	 First Quarter 1999 
In Focus This Quarter
 

to absorptions over the coming two years. In addition, 

the pace of hotel development has picked up substantially over the past two years to levels not seen since 

the late 1980s (see Chart 8). According to Smith, hotel 

completions continue to outpace demand and are 

expected to result in lower occupancy levels in 1999. 

For the apartment sector, Wheat cautions against a continuing escalation in apartment permits despite some 

expected slowing in employment growth in various 

markets over the coming 12 months.9 

Economic Conditions May Temper 

Commercial Real Estate Demand 

The nation’s economy has shown unprecedented 

resiliency, even as some indicators suggest that growth 

may moderate in the near term. For instance, weakened 

global markets have placed increasing pressures on 

exporters, who have seen a falloff in demand in the 

wake of weaker foreign currencies relative to the dollar. 

Domestic firms, too, face rising competition from 

cheaper imports. These factors have created negative 

near-term expectations for corporate profitability, 

which in turn have resulted in rising layoffs and slowing 

employment growth. Although most economists feel 

that prospects for a recession are remote in the near 

term, even a modest slowdown in economic growth 

could result in higher vacancy rates in markets experiencing rapid development. 

Over the longer term, various economic and demographic trends imply a weaker outlook for commercial 

real estate demand relative to past real estate cycles. In 

a recent analysis of the commercial mortgage-backed 

securities (CMBS) market, Moody’s identifies the following trends, each of which implies secular declines in 

demand for one or more property types10: 

•	 more efficient office space utilization as measured 

by continuing declines in square feet per worker; 

•	 more efficient inventory management as measured 

by a proportional increase in the ratio of inventory 

growth to growth in warehouse space; 

•	 shifts in spending patterns by baby boomers, the 

largest age cohort, away from goods and toward 

services; 

9 Wheat specifically notes deteriorating supply/demand ratios in
 

Dallas, Houston, Orlando, Charlotte, Nashville, and the San Francisco
 

Bay area.
 

10 Moody’s Investor Service, CMBS and the Real Estate Cycle:
 

Less Margin for Error, October 9, 1998.
 

CHART 8 

Hotel Development Heating Up 

(000’s) 

140 

120 

100 

80 

60 

40 

20 

0 

New Rooms Constructed 

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

* September 1998 annualized 

Source: Smith Travel Research 

•	 declining scrappage rates of obsolescent buildings 

because of a decline in the average age of the current 

stock of space relative to the comparable stage of 

prior cycles; and 

•	 expected declines in labor force growth as the 

proportion of older workers increases. 

In addition to these factors, other analysts have pointed 

out that tight labor markets and overtaxed infrastructure 

(e.g., water, roads, sewer, and public transportation) 

constrain demand by limiting growth within a particular 

market. Suburban areas that have seen the bulk of new 

construction over the past few years may be particularly hard hit if there is a backlash against the congestion 

and infrastructure capacity issues that accompany rapid 

growth.11 

Markets Most Vulnerable 

to Overbuilding 

Based on a review of supply and demand trends coupled 

with analyst opinions and projections, the following 

markets appear to be most vulnerable to broad-based 

overbuilding in the coming one to two years (see also 

Table 1, next page, for prevailing trends in these markets). These markets are discussed in more detail in the 

Regional Perspectives section. 

11 See, for example, Price Waterhouse/Lend Lease Investment 

Research, Emerging Trends in Real Estate 1999. 

Memphis Regional Outlook 15	 First Quarter 1999 
In Focus This Quarter
 

TABLE 1 

Markets Most Vulnerable to Overbuilding: Summary of Trends and Expectations 

Construction Employment Net- Projected 

1H97 to 1H98 Activity Growth Migration Vacancy Rate 

Vacancy Rates (’95 to 1H98) Trends Trends Trends 

LAS VEGAS H H C E H 

ATLANTA H H C C H 

NASHVILLE H H C C H 

SALT LAKE CITY H H C C H 

CHARLOTTE E H C E H 

PORTLAND H H C C H 

PHOENIX C H C C H 

DALLAS H H C H H 

ORLANDO E H E H H 

Note: Arrows for vacancy and construction are intended to capture prevailing trends across all property types;
 

experience with respect to a specific property type in a particular area may differ. H = half.
 

Sources: CB Commercial, F.W. Dodge, Regional Financial Associates, and Smith Travel Association.
 

Las Vegas 

Las Vegas’s hotel, office, and industrial development 

far surpasses that of other major markets, with ratios of 

construction activity to current space of 37 percent, 19 

percent, and 12 percent, respectively. Rapid development is occurring despite high and increasing office 

and industrial vacancy rates, which place additional 

competitive burdens on newly completed space. The 

area’s retail and apartment sectors are also developing 

rapidly, ranking third and fourth, respectively, among 

major markets. Although Las Vegas continues to enjoy 

one of the fastest employment growth rates in the country, the rate of job growth has slowed considerably from 

1994 to 1996 levels. Its real estate markets are highly 

dependent on the gaming sector, which could be especially vulnerable to a nationwide slowdown in economic activity. The city would be particularly hard hit by a 

downturn in real estate prices, as fully 10 percent of its 

workforce is employed in the construction sector (twice 

the national rate). 

Atlanta 

Of the nation’s largest metropolitan markets, Atlanta 

ranks among the top ten in office, industrial, retail, and 

apartment construction, with ratios of construction 

activity to current space of 12 percent, 8 percent, 7 percent, and 5 percent, respectively. Development, much of 

which is widely reported to be speculative, is very 

active despite relatively high office and industrial 

vacancy rates. Atlanta’s expanding real estate markets 

have been driven largely by strong in-migration and 

employment growth rates. However, both these rates are 

slowing, and many market observers are concerned that 

the area’s development cycle has reached its peak.12 

Nashville 

Nashville ranks among the top ten metro markets in 

office and apartment development, with ratios of construction activity to existing space of 10 percent and 

6 percent, respectively. Although not among the top 15 

markets, Nashville’s hotel sector is expanding rapidly 

as well (construction activity stands at 12 percent of 

current space). Nashville’s economy is reported to be 

slowing because of recent losses in manufacturing-sector jobs and slowing net-migration rates. The rapid pace 

of development has recently placed downward pressure 

on office, industrial, and hotel occupancy rates. 

Salt Lake City 

Salt Lake City ranks among the top five markets in the 

nation in office, industrial, and hotel development, with 

ratios of construction activity to current space of 14 

percent, 6 percent, and 27 percent, respectively. The 

main drivers behind the area’s rapid development have 

been high-tech corporate expansions, population inmigration, and preparation for the 2002 Winter Olympic 

Games. However, both job growth and in-migration 

rates are slowing, which could result in lower absorption rates for commercial space in the near term. Over 

12 See the November 1998 issue of the Federal Reserve Board’s 

Beige Book. 

Memphis Regional Outlook 16 First Quarter 1999 
In Focus This Quarter
 

the longer term, analysts have expressed concerns that 

development and job growth attributable to the 

Olympics will result in a significant glut of space following the Winter Games. 

Charlotte 

Charlotte ranks among the top five metro areas in 

office, retail, and apartment development, with ratios of 

construction activity to current space of 15 percent, 7 

percent, and 6 percent, respectively. The area’s hotel 

sector is also developing rapidly. Charlotte’s real estate 

markets are highly dependent on the health of the financial industry, which has been the primary driver of 

development activity. However, job growth in the financial services sector has recently slowed, and the manufacturing sector (which accounts for 19 percent of all 

jobs) is experiencing net job losses. 

Portland 

Portland has the third most active hotel and apartment 

development in the nation, with ratios of construction 

activity to current space of 25 percent and 7 percent, 

respectively. The area’s office market is also expanding 

rapidly. Portland’s development has been driven largely 

by in-migration and job growth in the technology sector. 

However, because of the significance of exports to the 

overall economy (exports to Asia account for approximately 7 percent of Oregon’s gross state product), the 

technology sector is particularly vulnerable to weak 

Asian markets. Accordingly, job growth has moderated, 

reaching its lowest level in five years. The area has also 

experienced a recent decline in construction-sector jobs. 

Although still strong, in-migration rates have fallen 

from 1996 levels. 

Phoenix 

Phoenix ranks among the top ten metro markets in 

industrial, retail, hotel, and apartment development, 

with ratios of construction activity to existing space of 

6 percent, 6 percent, 18 percent, and 6 percent, respectively. The area is also experiencing rapid development 

in the office sector. Phoenix has one of the fastestgrowing job markets in the country. Although still 

strong relative to the nation, employment growth has 

slowed somewhat since 1996, as has the rate of inmigration. The prominence of the semiconductor and 

high-tech businesses makes Phoenix especially vulnerable to the economic slowdown in Asia. 

Dallas 

Dallas ranks among the top ten metro markets in office, 

hotel, and apartment development, with ratios of construction activity to existing space 

of 10 percent, 19 percent, and 6 

percent, respectively. The area is 

also experiencing rapid development in the retail sector. Dallas’s 

economy remains one of the 

fastest growing in the country, and 

in-migration to the area continues 

to rise. However, economic growth 

has slowed somewhat recently because of weakening 

high-tech and energy sectors. Although its industrial 

base is more diversified today than in the mid-1980s, 

Dallas remains exposed to a large energy sector, whose 

profits are vulnerable to declining oil and energy prices. 

Concerns over the volume of planned office development have led to widely published reports of curtailments in credit availability to speculative office 

projects. Although tighter credit availability may ease 

pressures on vacancy rates over the long term, the market will still have to absorb the large volume of space 

presently under construction, much of which is speculative. 

Orlando 

Orlando ranks among the top three metro markets in 

office, retail, and apartment development, with ratios of 

construction activity to existing space of 15 percent, 9 

percent, and 7 percent, respectively. Of the nine markets 

discussed in this article, Orlando’s current pace of construction is perhaps easiest to support, thanks to rising 

employment and in-migration growth. However, despite 

strong employment growth, office vacancy rates have 

edged higher over the past 12 months because of the 

rapid pace of construction. Orlando may be more vulnerable than other metropolitan areas to a slowdown in 

the national economy owing to its dependence on the 

tourism sector. 

Memphis Regional Outlook 17 First Quarter 1999 
In Focus This Quarter
 

Credit Availability Affects the Pace of 

Commercial Development 

CMBS and real estate investment trusts (REITs) have 

generated a significant share of funding for commercial 

real estate over the past several years.13 As a result, any 

disruption in CMBS and REIT markets strains credit 

availability for new commercial development. For 

instance, widening CMBS spreads in the wake of September’s market volatility have caused many issuers to 

either delay or cancel new CMBS issues. REITs, too, 

have reportedly curtailed purchases because of falling 

per-share values and a corresponding decline in equity 

issues to support acquisitions. 

Weaknesses in the CMBS and REIT markets also may 

be dampening many lenders’ enthusiasm for commercial real estate development. Construction lenders will 

be less willing to make speculative loans to the extent 

that permanent funding is not available, and CMBS and 

REITs served as major providers of such funding. 

REITs were particularly aggressive purchasers in such 

markets as Atlanta, Orlando, and Dallas.14 Tightened 

construction lending conditions appear to be borne out 

by the November 1998 issue of the Federal Reserve 

Board’s Beige Book, which indicates that new construction for speculative commercial projects has either been 

curtailed or come to a virtual halt throughout many Federal Reserve districts, including Atlanta and Dallas. 

Most districts also reported tightened credit conditions 

and higher loan pricing, which could further dampen 

construction activity. 

The turmoil faced by CMBS and REITs presents both 

opportunities and risks for banks. Many industry participants view tighter credit accessibility as a positive 

development in light of the rapid pace of construction, 

13 See “Strong Demand and Financial Innovation Fuel Rebounding
 

Commercial Real Estate Markets” in Regional Outlook, fourth quarter
 

1997.
 

14 See Lehman Brothers, Commercial REIT Data Book, December 9,
 

1997.
 

which, in some cases, has been accompanied by 

extremely tight loan pricing margins and a loosening of 

underwriting standards. However, some lenders may 

view the changing fortunes of CMBS and REITs as an 

opportunity to regain market share. In any case, it will 

take several months for recent market events to be fully 

reflected in hard numbers for construction activity. 

Whether tightening credit availability proves to be a 

temporary phenomenon given the recent, albeit gradual, recovery in CMBS spreads and the broad recovery 

in the equity markets, remains to be seen. 

Summary 

This article updates a previously published analysis that 

used year-end 1997 data to rank the potential vulnerability of major metropolitan areas to overbuilding. 

Using primarily midyear 1998 information, this update 

adds three markets to the six identified in the initial 

analysis as vulnerable to broad-based overbuilding. This 

assessment is based on a number of factors including 

construction activity trends, local area employment and 

population migration trends, as well as a collection of 

views and projections from credible industry analysts. 

For many of these markets, the prospects for near-term 

declines in commercial real estate demand may be 

increasing because of slower economic growth and 

weakened markets abroad. Certain secular demographic and economic trends also suggest the possibility of 

lower demand levels in the current cycle relative to prior 

cycles. Although data through June 1998 indicate ongoing rapid development, there is growing evidence that 

recent events in the capital markets have at least temporarily tempered the appetite for further development 

in some rapidly expanding metro areas. For these markets, most participants view the curtailment in credit 

availability in a positive light because it would serve to 

moderate the severe cyclical swings in real estate values 

experienced by several markets during the 1980s. 

Steven Burton, Senior Banking Analyst 

Memphis Regional Outlook 18 First Quarter 1999 
In Focus This Quarter
 

Recent Trends in Syndicated Lending
 

•	 A strong U.S. economy, intensifying competition, 

and the increasing marketability of bank loans 

have driven record volumes of syndicated lending 

in the 1990s. 

•	 After several years of liberalized underwriting, 

evidence suggests that some banks have tightened 

standards and terms for loans to large commercial borrowers. 

•	 Market developments and underwriting trends 

over the past several years have implications for 

credit quality, earnings, and liquidity at institutions that hold or originate syndicated loans. 

Commercial and industrial lending is a major source of 

revenue for commercial banks, yet this business line has 

lagged other major lending categories in terms of liquidity, standardization, and commoditization. However, in recent years the transformation of commercial 

lending has accelerated and is altering the way lenders 

do business. This trend has been particularly apparent in 

syndicated commercial lending. This article briefly 

defines syndicated loans, reviews the 1990s boom in the 

market, and discusses the implications of competitive 

pressures and secondary market liquidity for underwriting trends and risk profiles of commercial banks active 

in this market. 

Syndicated Lending Overview 

A syndicated loan is a credit extended to one large or 

medium-sized corporate borrower that is originated by 

a group, or syndicate, of lenders. Syndicated lending 

differs slightly from participation lending, which is 

common in commercial banks. Although both types of 

lending allow for flexibility in reducing companyspecific risk and adhering to legal restrictions for loans 

to one borrower, only one lender originates a participation loan, which is then sold in undivided participation 

interests either concurrently or subsequently to third 

parties.1 A syndicate usually consists of a group of institutions that work closely on a number of deals that are 

sold to subscribers at origination. 

1 American Bankers Association, Banking Terminology, 3rd ed., 1989, 

p. 345. 

Syndicated loans can generally be categorized according to rating, terms, pricing, or target investors. The 

investment-grade loan market, often referred to as the 

pro-rata or retail market, is the lowest-risk segment of 

syndicated lending and comprises approximately 80 

percent of all volume originated from 1987 to 1997. 

These loans commonly take the form of liquidity backstops or lines of credit and are marketed to commercial 

bank investors. Loan Pricing Corporation (LPC) 

defines these credits as those rated BBB–/Baa3 or better, or nonrated deals with pricing equal to or less than 

rated deals in these bands. Near-investment-grade, 

leveraged, and highly leveraged markets, often referred 

to as B, C, and D tranche term loans or non-investmentgrade loans, include credits with longer maturities, 

greater risk, and higher pricing. Non-investment-grade 

loans are typically structured for institutional investors 

and compete more directly with the traditional highyield bond market. LPC defines non-investment-grade 

loans as those rated BB+/Ba1 or worse, or nonrated 

deals with pricing greater than deals graded BBB–.2 

Competitive Trends in the 

Syndicated Loan Market 

A handful of large U.S. commercial banking companies 

originate the vast majority of U.S. syndicated corporate 

credits across all quality types. According to LPC, 14 

U.S. banking companies were among the top 25 syndicated lenders (based on the number of agent or co-agent 

transactions) and accounted for half of 1998 syndicated 

loan transactions to U.S. corporations through midNovember.3 In 1997, nine U.S. banking companies were 

among the top 25 and executed 36 percent of the market’s transactions. Before 1997, the most active domestic commercial banks saw their market share erode from 

a peak of 45 percent of transactions in 1992 to 34 percent in 1996, primarily because of intensifying competition from nontraditional syndicated lenders such as 

investment banks and foreign banks. Although U.S. 

banks have recently recovered market share (as Japanese banks have significantly withdrawn from the market), a strong U.S. economy, expanding liquidity in the 

bank loan market, and a trend toward one-stop shopping 

2 Loan Pricing Corporation, Gold Sheets, Third Quarter 1998 Review,
 

p. 2.
 

3 Loan Pricing Corporation, Gold Sheets, November 16, 1998, p. 6.
 

Memphis Regional Outlook 19	 First Quarter 1999 
In Focus This Quarter
 

in the financial services industry have attracted competitors to the syndicated market in the 1990s. 

Syndicated Loan Liquidity 

U.S. commercial banking companies retain or buy a 

large volume of syndicated loans, yet estimates show 

that most of the volume is sold to other institutional 

investors. Information from the shared national credit 

program4 indicates that at year-end 1997, FDIC-insured 

commercial banking companies had extended facilities 

and commitments totaling $1.8 trillion, of which an 

estimated $565 billion was funded. To put this figure in 

perspective, an official of the Office of the Comptroller 

of the Currency estimated that 57 percent of outstanding syndicated loans were held by foreign banks; 26 

percent by originating banks, mutual funds, and insurance companies; and 17 percent by subscribing banks.5 

Indeed, according to BankAmerica Corporation, the 

number of nonbank institutional investors in bank loans, 

including prime rate mutual funds, hedge funds, and 

insurance companies, increased from 14 in 1993 to 

more than 100 in 1998. These investors have played a 

pivotal role in enhancing the bank loan as a distinct 

asset class by increasing trading activity, demanding 

third-party loan ratings, and contributing to the development of loan derivative products. 

Perhaps the most important new development in syndicated lending has been the deepening secondary market 

for bank loans as many new investors seek to purchase 

them. As shown in Chart 1, the volume of secondary 

trading in bank loans has grown sharply, more than 

tripling between 1994 and 1997 to over $60 billion. 

Trading in 1998 through the third quarter was on pace 

to top the 1997 level. Traded loans are often noninvestment-grade issues, which have been the focus of 

most demand by the burgeoning institutional investor 

base. One important force behind the development of a 

bank loan secondary market has been rapid expansion 

in the number of bank loans rated by third-party rating 

services. 

Independent credit ratings of bank loans were initiated 

in 1995 when “several years of rapid development in the 

4 The shared national credit program is a cooperative examination 

program conducted by the three federal banking agencies and cooperating state agencies to review large, complex credits held at multiple institutions. Loans subject to review are syndicated loans or 

groups of loans and commitments of $20 million or more shared by 

three or more supervised institutions. 

5 “Concerns Mounting Over Risks in Booming Syndication Market,” 

American Banker, January 29, 1997, p. 20. 

CHART 1 

Secondary Market Trading in Syndicated 

Loans Has Tripled since 1994 

* annualized 

Source: Loan Pricing Corporation 

0 

10 

20 

30 

40 

50 

60 

70 

’91 ’92 ’93 ’94 ’95 ’96 ’97 3Q98* 

$ Billions of Syndicated Loans 

Traded in the Secondary Market 

syndicated bank loan market generated a critical mass 

of interest in the credit characteristics of these instruments.”6 Standard and Poor’s, Moody’s, Duff and 

Phelps, and Fitch/IBCA are now actively involved in 

rating bank loans. Through 1997, Standard and Poor’s 

and Moody’s combined rated $677 billion in loans. As 

rating activity increases access to and availability of 

standardized analysis and research for bank loans, 

including market analysis, ratings criteria, and historical 

loss recovery rates, investors are becoming more comfortable with loans as a distinct asset class. Moreover, 

independent loan ratings allow investors to value a company’s loans relative to its other rated loans or bonds. 

Bank loan secondary market activity and independent 

ratings have prompted the development of new ways to 

package and improve the market acceptance of these 

assets. As a result, the securitization of bank loans and 

the development of various types of derivative products 

have proliferated. As discussed in “CLOs Lure Another Major Bank Asset off the Balance Sheet,” in Regional Outlook, third quarter 1998, collateralized loan 

obligations (CLOs) are a major market development 

allowing for the securitization of corporate loans. A 

large investor appetite for varied types of asset-backed 

securities and a desire to move assets off the balance 

sheet to lower risk-based capital requirements have 

helped promote a sharp increase in this type of securitization. Loan derivatives also may allow lenders to 

better manage the trade-off between maintaining borrower relationships and avoiding excessive concentrations of risk. This trade-off has become increasingly 

6 “Bankrupt Bank Loan Recoveries,” Moody’s Investor Service, June 

1998, p. 5. 

Memphis Regional Outlook 20 First Quarter 1999 
In Focus This Quarter
 

CHART 2 CHART 3 

0 

200 

400 

600 

800 

1,000 

1,200 

’88 ’90 ’92 ’94 ’96 3Q98* 

Nonleveraged Loans 

Leveraged Loans 

* annualized 

Source: Loan Pricing Corporation 

After Several Record Years, Syndicated 

Loan Originations Have Slowed 

$ Billions of Syndicated 

Loans Originated 

Note: LIBOR = London Interbank Offered Rate 

Source: Loan Pricing Corporation 

New Syndicated Loan Pricing Has Reversed 

after Several Years of Narrowing Spreads 

0 

10 

20 

30 

40 

50 

4Q90 4Q91 4Q92 4Q93 4Q94 4Q95 4Q96 4Q97 11/98 

0 

30 

60 

90 

120 

150 

A Basis Points above LIBOR BB Basis Points above LIBOR 

important with the trend toward one-stop shopping in 

financial services. 

One-Stop Financial Providers 

For several years, analysts have noted a trend toward 

financial services supermarkets—financial institutions 

positioning themselves as providers of a complete array 

of advisory services and financial products. One aspect 

of this trend has been the tendency of traditional 

lenders to improve their ability to offer a full array of 

equity and debt underwriting, as characterized by the 

expansion of Section 20 activities among major U.S. 

commercial banking companies. Traditional securities 

underwriters view entry into the syndicated loan market similarly. For example, no investment bank had a 

syndicated loan underwriting department in 1994, but 

several are now making inroads into the market, especially the leveraged market, and some increased their 

syndicated loan volume fivefold in 1997.7 In some 

cases, the desire of commercial banks to move toward 

one-stop financial services and the resulting approaches to relationship management have affected the underwriting of loans to large commercial borrowers that 

have multiple financing and advisory service needs. 

Historical Perspective on Syndicated 

Loan Underwriting Trends 

Increased interest by investors in bank loans and strong 

competition for business resulted in syndicated lending 

7 “The New Kids in the Syndicate: Investment Banks Are Moving in 

on the Leveraged Syndicated Loan Market,” Bloomberg, March 1998, 

p. 35. 

at historically narrow spreads and on more liberal 

terms. Accordingly, the syndicated loan market was a 

borrowers’ market for much of the 1990s. As shown in 

Chart 2, the volume of syndicated loan originations 

increased almost fivefold between 1991 and 1997, with 

record volume levels achieved in each of these years. 

Much of the volume was driven by growth in the origination of loans for the purpose of refinancing existing 

debt, especially from 1995 to 1997, as borrowers took 

advantage of increased lender competition and investor 

demand to reduce funding costs and extend maturities. 

In some cases, borrowers were able to refinance loans 

obtained just months earlier at significant savings and 

more favorable terms. 

Chart 3 shows that lending spreads compressed sharply 

from 1993 to 1997, particularly for lower-quality credits. LPC stated that “[e]xcessive competition has driven 

spreads and fees to all-time lows, with the investment 

grade market purely a relationship play.”8 Consistent 

with the financial supermarket concept discussed 

above, as relationship lending proliferated, many 

lenders were evaluating transactions on the basis of 

overall relationship returns rather than individual transaction returns. Consequently, borrowers willing to offer 

an institution ancillary business, such as cash management, securities underwriting, or securitization services, 

were likely to receive more favorable loan pricing than 

borrowers seeking to execute just one loan deal. 

During the same period, a clear trend toward weakened 

underwriting resulted in deteriorating risk/return rela8 Loan Pricing Corporation, Gold Sheets, First Quarter 1995 Review, 

p. 9. 

Memphis Regional Outlook 21 First Quarter 1999 
In Focus This Quarter
 

CHART 4 CHART 5 

0 

20 

40 

60 

80 

100 

’90 ’92 ’94 ’96 3Q98 

364-day Five-Year Three/Four-Year 

After Several Years of Lengthening, the Average 

Maturity of New Investment-Grade Syndicated 

Loans Has Shortened in 1998 

Source: Loan Pricing Corporation 

Origination Volume (%) 

0.0 

1.0 

2.0 

3.0 

4.0 

1Q96 3Q96 1Q97 3Q97 1Q98 3Q98 

0 

5 

10 

15 

Sources: Moody’s Investor Services, Federal Reserve Board 

Trailing 12-Month IssuerBased Default Rate (%) 

Trailing Four-Quarter Average Growth 

in Nonfinancial Corporate Profits (%) 

Defaults on Speculative-Grade Corporate 

Bonds Have Risen and Growth in 

Corporate Profits Is Slowing 

tionships across syndicated lending categories. Financial indicators market analysts use to evaluate whether 

lenders are being adequately compensated for risk 

generally weakened. For example, the ratio of debt to 

earnings before interest, taxes, depreciation, and amortization rose to relatively high levels for an increasing 

number of leveraged and highly leveraged loans.9 Moreover, lengthening maturities reflected looser underwriting. A decline in the spreads between loans of one-year 

and five-year maturities made it cost-effective to borrow for longer periods. LPC indicated that the differential between fees on undrawn 364-day revolving loans 

and undrawn five-year loans had dropped by one-half 

during this period.10 As a result, many borrowers extended maturities on new credits, and, as shown in Chart 4, 

the average maturity of investment-grade loans originated in the mid-1990s lengthened significantly. 

Recent Underwriting Developments 

Beginning in late 1997, lenders and investors began to 

resist aggressively priced investment-grade and nearinvestment-grade loans. This resistance led to a leveling 

of pricing, fewer refinancing opportunities for borrowers, and increased focus on the higher-risk leveraged 

lending market, where nonbank institutional investor 

demand was strong and pricing was richer. In response, 

overall syndicated lending volume declined almost 16 

percent during the first three quarters of 1998 compared 

with the same period in 1997. However, within total 

new syndicated loan volume, leveraged loan origina9 Ibid., pp. 16-17. 

10 Ibid., p. 43. 

tions grew 77 percent to $200 billion during the same 

period, accounting for approximately one-third of all 

syndicated credits—the largest proportion of the market 

since 1989. Of particular note was that this growth in 

higher-risk lending came at a time when losses in speculative-grade bonds had been trending higher and 

growth in profits for nonfinancial U.S. corporations had 

been slowing (see Chart 5). 

Global economic turmoil and the flight to quality that 

disrupted the capital markets during the third quarter of 

1998 spilled over into the bank loan market and solidified a shift to a lenders’ market. LPC noted in its thirdquarter 1998 review of syndicated lending that “[r]ates 

and fees are on the upswing meaning opportunistic refinancings...continue to dwindle. Concessions suddenly 

are going to lenders rather than borrowers, and volume 

continues the drop [from levels] seen earlier in the 

year.”11 Growth in leveraged lending also declined 

sharply as the number of institutional investors in the 

market fell by one-half from the second quarter.12 

The shifting dynamics of the market in late 1998 were 

characterized by the aforementioned slowdown in originations, a sharp increase in pricing (see Chart 3, previous page), and evidence that underwriting had become 

more stringent. The volatility in credit markets resulted 

in deals being rescinded or incorporating “market flex” 

pricing language that enabled lenders to manage the 

yield requirements of investors due to changing yields 

on competing capital markets instruments. The influ11 Loan Pricing Corporation, Gold Sheets, Third Quarter 1998
 

Review, p. 3.
 

12 Ibid.
 

Memphis Regional Outlook 22 First Quarter 1999 
In Focus This Quarter
 

CHART 6	 CHART 7 

(60) 

(40) 

(20) 

– 

20 

40 

60 

4Q90 4Q92 4Q94 4Q96 4Q98 

Some Banks Have Tightened Underwriting 

Standards and Terms to Large and 

Medium-Sized Corporate Borrowers 

Source: Federal Reserve Board 

Net Percentage 

Tightening Underwriting Standards 

Increasing Spreads on Loan Rates 

0 

3 

6 

9 

12 

12/14/94 12/20/95 12/18/96 12/17/97 12/23/98 

Source: Loan Pricing Corporation, Goldman Sachs, Bloomberg 

Total Returns* on Leveraged Loans Have Fallen 

Rolling 52-Week Total Returns Measured by the 

Goldman Sachs/Loan Pricing Corporation 

Liquid Leveraged Loan Index 

* Total Return = Accrued Interest + Bid Changes + Gains from Repayments Total Returns (%) 

ence of the secondary market on new loan pricing 

became apparent as investors required underwriters to 

factor in higher secondary market yields. In addition, as 

shown in Chart 6, the Federal Reserve Board’s November 1998 Senior Loan Officer Opinion Survey on Bank 

Lending Practices reported that a significant minority 

of surveyed lenders had tightened lending standards and 

terms for commercial loans to large and middle-market 

firms.13 On net, nearly 40 percent of domestic bank 

respondents had tightened lending standards for these 

borrowers for the three months ending November 30, 

and nearly half had increased pricing. These percentages are the highest reported since the last recession. 

Underwriting was also influenced by increased borrower demand for bank loans—a secondary effect of the 

market volatility in late 1998. The aforementioned Federal Reserve Board survey noted an increased demand 

for bank commercial loans primarily as a result of shifts 

from other sources of credit, namely the bond and commercial paper markets. For example, one industry participant estimated that the loan market represented 

roughly 60 percent of capital market financing in January 1998, 40 percent in July as the high-yield bond market boomed, and nearly 100 percent in September as the 

bond markets stalled.14 

13 Large or middle market firms are those with annual sales greater
 

than $50 million.
 

14 “Syndicated Lenders Swiftly Surmounted September Dip,” American Banker, December 10, 1998, p. 25.
 

Implications for Insured Institutions 

Although recent evidence suggests that some lenders 

have tightened standards and terms for loans to large 

commercial borrowers, market developments and 

underwriting trends over the past several years have 

implications for credit quality, earnings, and liquidity at 

institutions that hold or originate syndicated loans. 

•	 A slowing economy and stress in industries exposed 

to weakened international economic conditions 

could result in increased losses during an economic 

downturn, especially for banks that are holding 

higher-risk syndicated loans. Although nonbank 

institutional investors hold the bulk of the riskier 

tranches of syndicated deals, some banks ventured 

into riskier, longer-term issues in response to narrow 

pricing on traditional loan pieces held by banks.15 

Should liquidity become an issue in the secondary 

market, banks planning to sell these pieces may face 

losses. For example, as reflected in Chart 7, the 

rolling 52-week total return on the Goldman 

Sachs/LPC Liquid Leveraged Loan Index, which 

measures the performance of a diversified portfolio 

of the most actively traded performing leveraged 

loans, has fallen from over 8 percent in early 1998 to 

less than 4 percent in December 1998. Falling prices 

have caused reduced returns as required spreads on 

these credits have risen. 

15 “Banks Compete with Funds in Buying Long-Term Tranches of 

Syndications,” American Banker, March 19, 1997, p. 1. 

Memphis Regional Outlook 23	 First Quarter 1999 
In Focus This Quarter
 

•	 Downstream subscribers that purchased thinly priced 

or loosely structured loans may not be adequately 

compensated for risk. This lack of compensation may 

be especially important for institutions that do not 

receive ancillary relationship income. Evidence suggests that downstream lenders became more willing 

to accept loans during the 1990s without receiving 

full documentation or making an independent credit 

analysis. The Office of the Comptroller of the Currency reportedly attributed this trend to a desire to 

add loan volume coupled with comfort about company prospects because of the strong economy and 

strong corporate profits.16 As a result, on a riskadjusted basis, the returns on these credits may hamper the performance of investing institutions. 

•	 Sustained reductions in syndicated loan liquidity 

may adversely affect revenues and increase percentages of loan amounts retained by active syndicating 

institutions. If institutional investors remain withdrawn from the loan market for an extended period, 

syndicates may have increasing difficulty marketing 

deals, especially in the non-investment-grade segment. As a result, institutions dependent on revenues 

generated by this activity may face declining income 

as fewer deals are executed, or they may have to hold 

larger percentages of undersubscribed transactions. 

This situation may be further exacerbated by consolidation in the U.S. banking industry, which has combined several major syndicate agents in the 1990s 

and has reduced the number of potential downstream 

investment-grade subscribers in the market. 

•	 Rising demand from borrowers exploiting relative 

pricing in the loan and capital markets may have 

credit and liquidity implications for underwriting 

institutions. Sustained volatility in the capital mar16 “Concerns Mounting over Risks in Booming Syndication Market,” 

American Banker, January 29, 1997, p. 20. 

kets may increase the demand for bank loans and 

will likely significantly increase funding costs for 

many borrowers. For example, LPC recently compared loans that were extended to seven companies 

in early 1998 with similarly structured loans extended to the same companies after the third-quarter disruption in the capital markets. The analysis revealed 

significant increases in required yields, ranging from 

112 to 388 basis points.17 Rising funding costs combined with a trend toward slower growth in corporate 

profits may reduce loan repayment capacity of borrowers in more troubled industries. In addition, 

banks that have extended liquidity backstops or 

backup lines of credit may be required to fund facilities that traditionally are not heavily used by borrowers. For example, without appropriate pricing 

adjustments, banks providing backup commercial 

paper loans may be called upon to fund these facilities as a result of volatility and relatively high 

spreads in the commercial paper market. 

Increases in credit spreads on securities and syndicated 

loans, the recent rise in speculative corporate bond 

defaults, and slowing corporate profits may portend an 

increase in commercial credit problems for commercial 

banks. Now more than ever, those involved in bank risk 

management should pay close attention to fundamentals, including careful credit analysis, diversification, 

and maintenance of prudent underwriting standards. 

Attention to these fundamentals may help alleviate the 

need to overreact to sudden changes in the market 

environment. 

Steven E. Cunningham, CFA, Senior Financial Analyst 

Ronald L. Spieker, Chief, Regional Programs and 

Bank Analysis Section 

17 Loan Pricing Corporation, Gold Sheets, November 16, 1998, p. 21. 

Memphis Regional Outlook 24	 First Quarter 1999 
Regional Perspectives
 

Regional Perspectives
 

•	 The Memphis Region’s economy is slowing. Employment growth stalled in the third quarter of 1998, and 

the outlook for important industries such as agriculture and energy is worsening. 

•	 Consumer buying preferences are contributing to diverging production among the Region’s automobile 

manufacturers. All auto manufacturers face concerns about changing global economic conditions. 

•	 Banking conditions remain positive, but earnings performance was dampened by lower net interest margins. Asset-quality indicators were mixed in the third quarter, but remain favorable. 

•	 Metropolitan commercial real estate markets in the Region are active; some markets are becoming vulnerable to overbuilding. Financial institutions report growing exposure to real estate markets, and commercial 

real estate underwriting standards may be easing. 

Region’s Economic and Banking Conditions 

The Region’s Economy Is Slowing 

Recent Regional Perspectives articles have noted decelerating employment growth for the Memphis Region, 

especially when compared with the more stable national employment picture. In the third quarter of 1998, 

there was almost no job growth in the Region. Only 

7,000 nonagricultural jobs were added in the quarter, 

the smallest gain since the 1991 recession. Over the past 

two years, an average of 40,000 new jobs were created 

each quarter. Compared with a national gain of 2 percent in the third quarter, the Region’s job growth was a 

meager 0.3 percent.1 

The slowdown in job growth occurred across most 

industry sectors. Consistent with national trends, 

employment levels declined in the nondurable manufacturing sector. All states in the Region suffered losses in 

this sector, and the Region’s percentage losses were 

much steeper than the nation’s. Many other sectors in 

the Region suffered declines that were not experienced 

nationally. For example, job losses occurred in retail 

and wholesale trade, transportation, finance, insurance, 

and real estate. Increasing federal government jobs and 

a booming construction industry provided some stability to the Region’s employment. The previous engine for 

the Region’s growth, the service sector, performed moderately well. 

1 All data are seasonally adjusted as reported by the Bureau of Labor 

Statistics payroll survey. Percentages expressed here are at an annualized rate over the previous quarter. 

Farming, which is not covered in the employment survey, has also suffered because of low commodity prices 

and adverse growing conditions. The U.S. Department 

of Agriculture projects net cash income to fall about 12 

percent nationally in 1998, but the Memphis Region 

will likely experience a larger decline in farm income 

because of dry growing conditions throughout much of 

the summer and fall. The lower Mississippi Delta states 

were affected most severely, with lower yields and production reported for most crop types. With high ending 

stocks and weak demand forecasts, prices are expected 

to remain depressed through 1999 and possibly longer, 

barring weather-related supply shifts. 

Lower Oil Prices Threaten Louisiana’s Economy 

Southern Louisiana’s economy remains vulnerable to 

weaknesses in the oil sector. Although oil and gas now 

represent a far smaller portion of the economy than they 

did in the 1980s, Louisiana still ranks fifth nationally 

in oil output and second in natural gas production. In 

response to lower oil prices, production and employment are declining. The October 1998 rotary rig count 

was 157, down from its November 1997 high of 274. 

The industry already has reported layoffs, and that trend 

is likely to continue if oil prices remain low. The proposed merger between Exxon and Mobil exemplifies 

the industry’s efforts to cut costs to maintain profitability in a deflationary price environment. Louisiana may 

be subject to a share of the expected 9,000 layoffs. Further mergers in the industry could lead to additional job 

Memphis Regional Outlook 25	 First Quarter 1999 
Regional Perspectives
 

losses. Although large companies with deep pockets 

may be able to operate at a loss for prolonged periods, 

businesses that cannot operate below the typical $14 to 

$16 per barrel break-even range for a sustained period 

have an uncertain future (see Memphis Regional Outlook, second quarter 1998). 

Weaknesses Have Developed 

in the Auto Sector 

The automotive industry is facing new challenges. Concern over excess productive capacity has been magnified 

by the slowdown in world economic growth. In particular, 

the slowing of the Japanese and Korean economies, compounded by weakness in their currencies, has resulted in 

more of their automobiles being offered at low prices. In 

addition, low gasoline prices have been partly responsible 

for a shift in demand from smaller passenger vehicles to 

less economical sport utility vehicles (SUVs) and trucks. 

This trend has led to weaker sales for companies that have 

not been timely in offering SUVs. 

The area most affected by changing consumer preferences 

is central Tennessee. Nissan has been cutting costs 

aggressively, consolidating its vehicle platforms, and suspending some assembly at its Smyrna plant because of 

high inventory levels. The plant will begin producing the 

Xterra, an SUV, next spring. The Saturn plant in Spring 

Hill has been forced to cut production because of falling 

sales. Saturn is expected to produce its own SUV by 2002, 

but the company may be exposed to unfavorable sales 

trends until this product arrives. Tennessee auto production has been declining since midyear 1997 and is now at 

levels that prevailed five years ago. As a result, concerns 

about potential layoffs are mounting. 

In Kentucky the product lines appear to be less subject 

to shifting demand. Ford’s Louisville assembly plant 

produces the popular Explorers and pickup trucks, and 

Toyota’s Lexington plant produces the top-selling Camrys, Avalons, and Sienna minivans. The General Motors 

Bowling Green plant manufactures the much-soughtafter Corvette. Although Kentucky has not suffered the 

production cutbacks experienced by Tennessee, there is 

a potential for layoffs if world demand continues to 

weaken. 

Banking Conditions Remain Favorable, 

but Earnings Performance Declined in 

the Third Quarter 

Banks and thrifts headquartered in the Region reported 

generally healthy financial conditions as of September 

30, 1998, although earnings declined. The Region’s average return on assets was 1.13 percent for the quarter, 

down 5 basis points from both the third quarter of 1997 

and the second quarter of 1998. Lower net interest margins (NIMs) hurt earnings performance. The average 

NIM in the third quarter was 4.40 percent, compared with 

4.58 percent in the third quarter of 1997. As discussed in 

prior Regional Perspectives, the decline in NIMs is primarily attributable to the flattening of the yield curve and 

increased competition. Despite a decline in earnings performance, reported capital ratios remained strong and 

increased slightly from the second quarter. 

Financial institutions reported no significant changes in 

asset-quality indicators in the third quarter. Past-due 

and nonaccrual loan levels were modestly higher than 

those reported one year ago but were slightly lower than 

second-quarter levels. Commercial and industrial loan 

past-due levels increased, while average consumer loan 

past-due levels declined. Loan losses were lower in 

most loan types. Agricultural loan losses increased 

slightly but remained low despite falling commodity 

prices and poor growing conditions. Institutions have 

not yet reported significant changes in asset quality 

resulting from either agricultural weaknesses or the 

Region’s slowing economy; however, a lag is often associated with asset-quality deterioration. 

Memphis Regional Outlook 26 First Quarter 1999 
Regional Perspectives
 

Commercial Real Estate Markets and Lending Trends
 

Market analysts have become increasingly cautious 

about the outlook for commercial real estate (CRE), 

even though national occupancy and rental rates continue to climb. Overbuilding in the 1980s demonstrated that development decisions at the peak of an 

economic cycle are often based on expectations that 

positive conditions will continue. Also, individual 

development decisions may not consider the actions of 

other developers. Active markets could therefore 

rapidly become oversupplied because of a large volume of new development. Although construction 

activity in the Region throughout much of the economic expansion has been driven by increased 

demand, some local economies have begun to cool, as 

shown in Table 1, and demand for commercial space 

has softened. Additional slowing in local or national 

economic conditions could lead to greater supply and 

demand imbalances. 

Although real estate investment trusts have provided 

considerable funding for new development, metropolitan area banks and thrifts in the Region also have experienced considerable growth in both construction and 

development (C&D) and CRE lending. C&D loans have 

risen from an average of 4 percent of total loans at the 

end of 1991 to 7.2 percent as of September 30, 1998. 

Similarly, average CRE lending has increased during 

the same period, rising from 20.7 percent to 25.1 percent of total loans. The increases in both types of lendTABLE 1 

Year-over-Year Job Growth Is 

Slowing in Some Metropolitan Areas 

3RD 3RD 

METROPOLITAN QUARTER QUARTER 

AREA 1997 (%) 1998 (%) 

NASHVILLE 2.9 1.4 

MEMPHIS 1.7 0.9 

KNOXVILLE 1.0 –0.2 

LOUISVILLE 2.9 3.8 

LEXINGTON 3.6 3.2 

LITTLE ROCK 1.7 0.7 

BATON ROUGE 1.7 2.8 

SHREVEPORT 2.0 1.9 

NEW ORLEANS 1.9 0.6 

Source: Bureau of Labor Statistics 

ing have been more pronounced in certain markets in 

the Region. 

Focus on Nashville: Some Market Segments 

May Become Overbuilt 

In 1997, Nashville reported the highest level of commercial construction starts in over a decade. Construction growth continued into 1998, and commercial starts 

through the first half of the year were 27 percent above 

starts reported during the first half of 1997. Because of 

the high level of development and signs of slowing in 

the local economy, Nashville is identified in this issue’s 

In Focus article Commercial Development Still Hot in 

Many Markets, but Slower Growth May Be Ahead as 

one of the primary markets in the nation to watch for 

potential overbuilding. 

Economic growth in Nashville, while continuing to be 

favorable, has slowed in recent years largely because of 

labor market tightness. The non-seasonally adjusted 

unemployment rate declined to 2.8 percent during the 

third quarter of 1998 compared with 4.5 percent reported nationally and 4.2 percent reported for Tennessee. 

The resulting labor shortage is constraining new job 

creation in the area. Year-over-year employment growth 

in the area has declined, and this trend is expected to 

continue over the next few years. Net in-migration also 

is slowing, having steadily declined from 17,700 in 

1994 to 13,200 in 1997.2 Regional Financial Associates 

forecasts additional slowing of net in-migration in coming years, with a low of 5,100 projected for 2000. 

The Nashville office market has entered the later stages 

of the development cycle after several years of outperforming the national office market in both absorption 

and rent appreciation. With consecutive years of growing demand and limited additional supply in the mid1990s, the office market improved significantly. 

Vacancy rates fell from over 20 percent at the start of 

the economic expansion to 6.9 percent by year-end 

1997. However, completion rates have climbed in recent 

years, and absorption began to lag in 1998. As a result, 

office vacancy rates climbed to 9.0 percent at the end of 

2 Although slowing, net in-migration remained an important factor in 

Nashville’s growth, representing 70 percent of total population 

growth from 1994 to 1997. 

Memphis Regional Outlook 27 First Quarter 1999 
Regional Perspectives
 

the third quarter of 1998. Analysts consider the recent 

increase in office vacancy rates in Nashville, shown in 

Chart 1, to be the beginning of a long-term upward 

trend in vacancies rather than just a seasonal or temporary spike. 

According to F.W. Dodge, office construction starts 

were up 16 percent during the first half of 1998, following a 20 percent increase in 1997. CB Commercial/Torto Wheaton Research (CBC) projects 

completions to rise substantially, from 530,000 square 

feet in 1997 to 1,336,000 square feet in 1998. This 7.5 

percent increase in existing office supply would be the 

sixth highest increase in existing stock among the 44 

major metropolitan markets covered by CBC. New construction and speculative development are concentrated 

in the Cool Springs and Brentwood areas. As a result, 

vacancy rates surged in these areas in 1998. 

While office space supply continues to grow, demand is 

waning. Office employment growth has declined steadily since 1995, when it was above 8 percent annually. 

With tight labor markets restricting new job formation, 

CBC projects office employment growth at 2 percent 

annually over the next six years. The slowdown is 

expected to result in a drop in office absorption. Among 

the 44 major metropolitan areas covered by CBC, 

Nashville is projected to have the second lowest absorption rate as a percentage of existing stock in 1998. CBC 

projects vacancy rates to exceed 19 percent by 2002 

because of a long-term trend of increasing office supply 

and declining absorption. 

Like the national hotel market, Nashville’s hotel 

segment is vulnerable to overbuilding. As shown in 

Chart 2, the number of available rooms grew more than 

7 percent in 1997, following a 6 percent increase in 

1996. These additions followed a five-year period of 

less than 1 percent annual growth in available rooms. 

This trend is accelerating, according to the Nashville 

Chamber of Commerce, which projects the addition of 

3,600 rooms in 1998, a 12.5 percent increase in one 

year. Occupancy rates have declined from 69 percent 

two years ago to 63 percent as of July 1998 and will 

likely weaken further as additional rooms are completed. Demand for rooms is down sharply, compounding 

oversupply concerns. The Second Quarter 1998 Legg 

Mason Wood Walker Real Estate Cycle Market Monitor ranks the Nashville hotel sector as deteriorating and 

having the highest level of risk for overbuilding among 

metropolitan markets covered by its analysis. 

The apartment market also faces growing supply and 

slackening demand. The Nashville apartment market 

added 5,300 units in 1997, almost double 1996’s results 

and the highest number of completions since 1984, 

according to the Urban Land Institute. Completions 

through the end of 1998 are expected to exceed 1997’s 

results. With more available units, slowing job growth, 

and declining in-migration, the market faces the potential for higher vacancy rates in the near term. Apartment 

rental rates have been flat in recent quarters, and concessions, such as free initial months, have increased. 

Developers appear to have responded to changing 

market conditions. Apartment construction starts are 

sharply lower, which should help the market absorb the 

units already being completed. 

CHART 1 CHART 2 

Nashville Office Completions and 

Vacancies Have Started to Rise 

* represents only six months 

Source: CB Commercial/Torto Wheaton Research 

Completions Vacancy Rate 

’97 Jun-’98* 

0 

5 

10 

15 

20 

25 

Vacancy Rate (%) 

Square Feet (000s) 

0 

100 

200 

300 

400 

500 

600 

700 

800 

900 

1000 

’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 

Absorption 

Nashville’s Growing Number of Hotel
 

Rooms Is Leading to Lower Occupancy
 

8 72

Annual Growth in Rooms (%)

Occupancy Rate 

Growth in Rooms 

’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 Jul-’98 

7 

6 

5 

4 

3 

70 

68 

66 

64 

62 

60 

Room Occupancy Rates (%)

2 58 

1 56 

0 54

Memphis Regional Outlook 

Source: Smith Travel Association 

28 First Quarter 1999 
Regional Perspectives
 

Industrial and retail development also are high, but 

demand is strong in these market segments. In both 

1996 and 1997, Nashville experienced increasing 

vacancy rates in industrial space as new supply exceeded slowing absorption. Rental rates for industrial space 

flattened in 1997 because of continued increases in supply. Considerable new supply, including substantial 

speculative development, is being added in 1998. 

Demand for industrial space is expected to increase in 

the near term and may support current development. 

The retail market continues to experience considerable 

new construction and development. Unlike the office 

and hotel market segments, however, retail vacancy 

rates are falling and rental rates have climbed. 

Nashville banks and thrifts are actively involved in 

financing CRE. The average ratio of C&D loans to total 

loans has more than doubled during the economic 

expansion, rising from under 5 percent of total loans at 

year-end 1991 to 10.4 percent as of September 30, 

1998. Total CRE lending as a percentage of total loans 

has likewise increased, rising from 19 percent at yearend 1991 to 29.3 percent as of September 30, 1998. 

Other Regional Markets Report 

Increasing CRE Activity 

In addition to Nashville, two other metropolitan Tennessee markets show high levels of CRE activity and 

lending. Memphis continues to experience additions to 

its CRE market, although the local economy has slowed 

steadily over the past 12 months. Although the city’s 

overall real estate market remains stable, there is some 

concern that oversupply will develop if building does 

not slow. With new supply entering the market, Memphis office rental rates have declined in the past year. 

Likewise, a high level of apartment development has led 

to increased concessions and flat rental rates. In the near 

term, the city’s industrial market faces pressures from 

new development, but favorable long-term trends are 

expected because of continuing growth in the distribution industry. Banks and thrifts in Memphis have been 

active participants in construction lending, holding 

C&D and CRE loan concentrations above the average 

for metropolitan banks and thrifts in the Region (see 

Table 2). Knoxville also has experienced a substantial 

increase in commercial construction starts in recent 

years, primarily concentrated in the retail sector. Total 

starts were up approximately 13 percent in 1997, and 

starts in the first half of 1998 were up 62 percent compared with the first half of 1997. Knoxville institutions 

TABLE 2 

Commercial Real Estate Lending 

Varies throughout the Region 

AVG. C&D AVG. CRE 

METROPOLITAN LOANS/TOTAL LOANS/TOTAL 

MARKET LOANS (%) LOANS (%) 

NASHVILLE 10.4 29.3 

MEMPHIS 13.4 27.2 

KNOXVILLE 10.4 34.8 

LOUISVILLE 7.8 28.9 

LEXINGTON 9.7 28.4 

LITTLE ROCK 8.7 30.8 

BILOXI-GULFPORT 8.0 27.4 

NEW ORLEANS 5.2 19.2 

REGION AVERAGE 7.2 25.1 

Notes: C&D = Construction and development; CRE = 

Commercial real estate 

Source: Bank and Thrift Call Reports; as of September 

30, 1998 

also hold CRE concentrations well above the average 

for metropolitan banks and thrifts in the Region. 

Kentucky cities have reported even faster growth in 

commercial construction starts through the first half of 

1998 than Tennessee cities. This boom in construction 

was led by gains in Louisville and Lexington, where 

commercial starts were up 82.5 percent and 15.5 percent, respectively. Unlike Nashville and Memphis, however, economies in Louisville and Lexington are not 

slowing. Both cities are experiencing strong economic 

expansion and considerable employment growth. This 

strength is leading to active real estate markets for both 

cities. Louisville’s real estate growth is concentrated in 

retail and office space construction. Office vacancy 

rates are up slightly because of higher completions, but 

remain low. Industrial construction also has accelerated 

as United Parcel Service and Federal Express have 

expanded their distribution facilities. Industrial absorption was strong in the third quarter of 1998, and vacancy rates fell slightly. Lexington’s construction activity is 

led by the retail sector, with starts reaching their highest 

level in a decade at 1.3 million square feet in 1997. 

In contrast to metropolitan markets in Tennessee and 

Kentucky, Little Rock, Arkansas, has experienced a 

period of slow economic growth and stable real estate 

activity. Overall commercial construction starts remain 

low. The office and industrial segments are showing moderate increases in construction activity. Office absorption 

Memphis Regional Outlook 29 First Quarter 1999 
Regional Perspectives
 

has been uneven in recent years, affected in part by banking and health care industry consolidation. Industrial 

space occupancy remains high, with strong leasing activity in 1998. New retail development is likely to occur 

near a new sports arena on the north bank of the Arkansas 

River, which should be completed in late 1999. 

As with Arkansas, Mississippi has reported limited 

growth in commercial construction starts. The state’s 

economy relies heavily on the gaming industry. Rising 

construction payrolls reflect expansion of the gaming 

and hotel industries, particularly in the Biloxi-Gulfport 

market, where job growth is well above the national 

pace. The rapid growth in hotel rooms has caused occupancy rates to fall. Through August 1998 the BiloxiGulfport area room supply increased 10.8 percent from 

August 1997 while room demand increased only 7.8 

percent, according to Smith Travel Association. Room 

occupancy rates fell 2 percentage points to 64.5 percent 

despite a modest decline in average room charges. Significantly more rooms will be available soon. Beau 

Rivages Hotel and Casino is scheduled to open in the 

first quarter of 1999, and upgrades to the 12 existing 

casinos in the area also will add rooms. 

Louisiana’s commercial construction starts rebounded 

in the first half of 1998 from a poor showing in 1997, 

but the state’s economy appears to be slowing. Baton 

Rouge’s economy is strong; however, Shreveport’s 

economy is experiencing below-normal growth, with 

net out-migration being a significant deterrent to development. New Orleans’ economy is stable, but low oil 

prices dampen the outlook because of the city’s dependence on the energy sector. Real estate activity in all 

three markets remains stable with the exception of the 

lodging/hotel market in New Orleans. The Legg Mason 

Wood Walker Real Estate Market Cycle Monitor ranks 

the New Orleans’ lodging/hotel market near the highest 

level of risk for overbuilding among major markets covered. Only Nashville was ranked higher. 

Commercial Real Estate Loan 

Concentrations3 Are Rising 

Consistent with increases in average CRE lending levels discussed earlier, the number of institutions reporting concentrations in CRE loans has increased (see 

Table 3). The significance of the number of institutions 

with such concentrations stems from their potential for 

greater performance volatility during real estate market 

3 Concentrations are defined as 25 percent of total loans. 

downturns. As shown in Chart 3, banks4 in metropolitan 

areas with CRE concentrations experienced substantial 

increases in noncurrent loan levels and loan loss rates 

when commercial vacancy rates spiked from 1984 to 

1986. These two asset-quality indicators remained higher for banks with such concentrations than for other 

banks in metropolitan areas until the early 1990s. 

In addition to experiencing greater asset-quality concerns, 

banks reporting CRE concentrations had failure rates 

more than three times those of other institutions. In the 

Region, 15.4 percent of banks that reported a CRE lending concentration on December 31, 1984, failed by 

December 31, 1990. For other banks in the Region, the 

failure rate during this period was 4.7 percent. 

4 Only commercial banks are considered because insufficient data 

were available for thrifts during the period. 

TABLE 3 

An Increasing Percentage of 

Metropolitan Banks and Thrifts 

Report Commercial Real Estate 

Loan Concentrations 

INSTITUTIONS PERCENTAGE 

REPORT WITH OF ALL 

DATE CONCENTRATIONS INSTITUTIONS 

12/31/90 128 27.2 

12/31/93 160 38.1 

12/31/97 168 46.5
 

9/30/98
 162 47.4 

Note: Concentrations are defined as 25 percent 

of total. 

Source: Bank & Thrift Call Reports 

CHART 3 

’84 

Banks with Commercial Real Estate (CRE) 

Concentrations Experienced More 

Volatility in Asset Quality Than Other Banks 

during the Previous Real Estate Cycle 

Note: Concentrations in CRE are defined as 25 percent of total loans. 

Source: Bank Call Reports 

’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 

Percentage of Total Loans

Noncurrent Loans/Total Loans 

Banks with CRE Concentrations 

Other Banks 

0 

1 

2 

3 

4 

5 

6 

Loan Losses/Average Loans 

Memphis Regional Outlook 30 First Quarter 1999 
Regional Perspectives
 

Underwriting Standards Are Being Pressured 

Although current underwriting standards differ from 

those of the early 1980s, one constant from the previous 

market cycle is intense competition among lenders. This 

competitive environment could lead to weaker underwriting standards. Anecdotal evidence suggests that 

while CRE lending standards in the Region improved 

greatly following the previous real estate market downturn, trends since the mid-1990s have been toward eased 

underwriting. One example is the use of preleasing 

requirements in the Nashville market. Such covenants 

were rarely used in the 1980s but became prevalent in 

the earlier part of the 1990s. In recent years, however, 

preleasing requirements have become less commonplace as lenders have reduced covenants in competition 

for customers. 

The observations of examiners and lenders in the 

Region are supported by findings of national underwriting surveys conducted by federal regulatory agencies in 

1998, which have reported easing underwriting standards for CRE through combinations of pricing and 

structural concessions. By contrast, the November 1998 

Federal Reserve Board Senior Loan Officer Opinion 

Survey on Bank Lending Practices revealed some tightening of CRE standards since midyear 1998. The primary mechanism for this tightening was increased loan 

spreads rather than tightened structural terms. The primary reason respondents listed for tightening CRE 

standards was a less favorable economic outlook; a 

secondary reason was disruption in the commercial 

mortgage-backed securities market. 

Implications for CRE Lending 

Continued growth in CRE development and weakening 

demand in some metropolitan areas could result in overbuilding and increased risk to lenders in these markets. 

The potential combination of higher inherent risk in real 

estate, greater lending exposure, and generally loosening underwriting standards when national and local 

economies are slowing presents conditions that managers 

of insured financial institutions should monitor closely. 

Memphis Region Staff 

Memphis Regional Outlook 31 First Quarter 1999 
✁
 

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