Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION FOURTH QUARTER 2000 

FDIC
 

New York
 

Region
 

Division of 

Insurance 

Kathy R. Kalser,
 

Regional Manager
 

Robert DiChiara,
 

Financial Analyst
 

Norman Gertner,
 

Regional Economist
 

Alexander J.G.
 

Gilchrist,
 

Economic Analyst
 

Regional Perspectives 

◆ The Region’s Economic and Banking Conditions—The Region’s institutions reported generally healthy financial conditions during the first half of 2000. 

Large institutions offset higher funding costs with increased noninterest income, 

while community institutions benefited from slightly higher net interest margins. 

The Region’s large banks continued to report weakening in commercial and industrial loan credit quality. See page 3. 

◆ The Region’s Loan Growth Is Centered in Traditionally Higher-Risk 

Categories—Over the past four years, the Region’s commercial banks have 

reported a shift into higher-yielding, potentially higher-risk commercial loans as 

lenders attempt to maintain earnings in the face of increasing competition and margin pressure. See page 4. 

◆ Some of the Region’s Housing Markets Show Signs of Overheating—Communities surrounding the Region’s larger urban areas, primarily Baltimore, New York City, and Washington, D.C., where job growth has been strong, 

reported significant levels of home price appreciation that have exceeded increases 

in household incomes. By most measures, the current housing boom has been more 

modest than that of the 1980s. See page 6. 

By the New York Region Staff 

In Focus This Quarter 

◆ Emerging Risks in an Aging Economic Expansion—This article focuses on the potential risks of current economic conditions to insured depository institutions. Although the current conditions may appear to be ideal, some imbalances 

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

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

increased corporate leverage and rising potential default risk, and, in some metropolitan areas, overheated housing and commercial real estate markets. At the same 

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

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

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

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

insured institutions. See page 11. 

By the Division of Insurance 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 as an information source on banking and economic issues for insured 

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

geographic regions: 

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

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

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

Dallas Region (CO, NM, OK, TX) 

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

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

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

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

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

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

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

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

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

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

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

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

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

the Federal Deposit Insurance Corporation. 

Chairman Donna Tanoue 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Writer/Editor Kim E. Lowry 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Richard A. Brown 

Ronald L. Spieker 

Publications Manager Teresa J. Franks 

REVISION: 

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

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

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

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

with an additional explanation of how the revision affects the article. 
Regional Perspectives
 

Regional Perspectives
 

•	 During the first half of 2000, the New York Region’s insured institutions reported favorable financial conditions, but large banks faced continued margin pressure and weakening commercial and industrial loan 

credit quality. 

•	 The credit risk profile of the Region’s commercial banks is increasing as loan volume is rising and growth 

is centered in traditionally higher-risk loan categories. 

•	 Housing markets in some of the Region’s major cities may be overheating; however, price appreciation has 

been more modest than during the 1980s housing boom. 

Region’s Economic and Banking Conditions 

Bank Profitability Is Stable but Pressures Persist 

The New York Region’s insured institutions1 reported 

relatively stable profitability during the first half of 

2000. However, higher interest rates compared with a 

year ago pressured net interest margins (NIMs), as 

funding costs increased for all banks. Intense competition for core deposits over the past several years also has 

contributed to margin compression. Erosion of banks’ 

core deposit base has resulted in increased reliance on 

noncore funding sources, which are generally more 

expensive than traditional bank deposits. Furthermore, 

noncore funding sources typically are more interest rate 

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

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

markets, when access to liquidity sources may become 

more difficult. 

Performance measures continued to highlight the differences in revenue models between the Region’s large 

institutions and community banks. Large banks generate significant noninterest income, while smaller banks’ 

earnings are more dependent on spread income. Their 

more diversified revenue stream helped the large institutions (assets greater than $10 billion) maintain profitability levels in the past year despite higher funding 

costs. Large banks reported a stable median return on 

assets (ROA) for the first half 2000 compared with a 

year ago, as increased noninterest income offset a 

decline in the NIM (see Table 1, next page). Noninterest 

income increased less in the first half of 2000 than the 

year-ago period, reflecting competition for fee-based 

services and softness in the financial markets. 

1 Excludes institutions in operation less than three years and credit 

card banks. The banking analysis uses median figures. 

The ROA for the Region’s community banks (assets less 

than $1 billion) declined slightly over the same period, 

as higher operating expenses diluted the effect of an 

improved asset yield and NIM. After a downtrend for 

the past two years, the Region’s community banks 

reported a slightly higher NIM during the first six 

months of 2000 compared with a year ago; higher asset 

yields more than offset increased funding costs. Loan 

growth, which occurred primarily in the typically 

higher-yielding, higher-risk commercial loan categories, may have contributed to community banks’ 

improved asset yield. The median loan-to-asset ratio for 

the Region’s community banks continued upward, 

increasing from 61 percent in second quarter 1999 to 64 

percent in second quarter 2000, with growth concentrated in commercial and industrial (C&I), commercial 

real estate (CRE), and construction and development 

(C&D) loans. The overall growth rate for these categories was almost double that of residential loans over 

the past year. Unlike large banks, community banks did 

not benefit from increased noninterest income. The 

median ratio of noninterest income-to-earning assets 

reported by the Region’s community banks was flat 

compared with a year ago, and less than one-third the 

level reported by large banks. 

Credit Quality of Large Banks’ 

C&I Loan Portfolios Weakens 

Credit quality in most loan categories remained favorable, except for C&I loans held by the Region’s large 

banks; during second quarter 2000, the C&I charge-off 

rate reached its highest level since 1993. Although 

increasing, the C&I charge-off rate reported by the 

Region’s large banks remained substantially below the 

rate during the recession of the early 1990s. 

New York Regional Outlook 3	 Fourth Quarter 2000 
Regional Perspectives
 

Deterioration of large banks’ C&I loans could be the 

result of less disciplined underwriting from 1996 through 

1998, when results of the Federal Reserve Board’s 

Senior Loan Officer Opinion Surveys on Bank Lending 

Practices indicated general easing of C&I lending standards nationwide. While more recent surveys2 indicate 

that the nation’s banks have tightened underwriting standards, warning signs remain. Rating agencies reported 

that downgrades of syndicated loans and corporate bonds 

exceeded upgrades during the first eight months of 2000. 

Moreover, while downgrades were primarily limited to 

health care, manufacturing, and entertainment companies 

in 1999, they extended across more industries in 2000. 

Furthermore, the dollar amount of adversely classified 

large syndicated loans under the Shared National Credit 

(SNC) program increased for the second consecutive 

year, rising from $37.4 billion in 1999 to $63.3 billion in 

2000.3 The percentage of criticized loans to total loans 

reviewed has risen from a decade low of 1.3 percent in 

TABLE 1 

1998 to 3.3 percent in 2000 but is below the 10 percent 

peak reached in 1991. Defaults on corporate bonds and 

spreads on high-yield bonds have also increased, further 

indicating weakening commercial credit quality. A less 

liquid secondary market for corporate debt could make it 

more difficult for companies to refinance or restructure 

loans, which could affect the credit quality of the 

Region’s loan portfolios. 

Commercial Loan Growth Increases 

Banks’ Credit Risk Profiles 

The Region’s commercial banks have reported loan 

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

commercial (including C&I and CRE) loans (see Chart 

1). In fact, commercial loans accounted for over half the 

Summary of Banking Performance* 

ASSETS GREATER THAN ASSETS BETWEEN $1 ASSETS LESS 

$10 BILLION BILLION AND $10 BILLION THAN $1 BILLION 

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

ROA 1.28 1.28 1.13 1.05 1.13 1.11 0.90 0.92 0.99 

NIM 3.55 3.75 3.96 3.59 3.60 3.81 3.98 3.91 4.06 

NONINTEREST INCOME/AEA 1.64 1.56 1.43 0.69 0.77 0.73 0.49 0.48 0.47 

NONINTEREST EXPENSE/AEA 3.13 3.25 3.28 2.60 2.53 2.66 2.91 2.84 2.94 

C&I PAST-DUE RATIO 1.73 1.36 1.38 1.28 1.52 1.77 0.93 1.15 1.29 

PAST-DUE RATIO 1.56 1.59 1.90 1.24 1.39 1.79 1.52 1.76 2.08 

CHARGE-OFF RATE 0.26 0.30 0.31 0.12 0.10 0.15 0.03 0.04 0.05 

CORE DEPOSITS/ASSETS 46.62 45.31 52.78 60.20 61.27 61.51 73.18 75.73 77.23 

LOANS/ASSETS 61.08 60.77 59.10 61.89 58.52 60.65 64.25 61.19 61.29 

RESERVES/LOANS 1.42 1.51 1.77 1.13 1.16 1.27 1.02 1.05 1.10 

TIER 1 LEVERAGE RATIO 6.61 6.80 6.21 7.74 7.75 7.97 9.69 9.57 9.73 

TIER 1 RBC RATIO 8.76 8.88 8.28 11.60 11.97 12.86 16.34 16.94 17.45 

* For the six-month period ending June 30. Median data excluding institutions in operation less than three years and 

credit card banks. 

AEA = average earning assets, Past-Due Ratio = Loans past due 30 days or more plus nonaccrual loans divided by 

gross loans, RBC = Risk-based capital 

Source: Bank and Thrift Call Reports 

2 Federal Reserve Board. May and August 2000. Senior Loan Officer Opinion Surveys on Bank Lending Practices. 3 Joint release by the Board of Governors of the Federal Reserve System, Office of the Comptroller of the Currency, and Federal Deposit Insurance Corporation, Bank Regulators’ Data Show Continued Increase in Adversely Classified Syndicated Bank Loans. October 10, 2000. The SNC 

program includes examiners from the three federal regulatory banking agencies: the Federal Reserve Board, the Office of the Comptroller of the 

Currency, and the Federal Deposit Insurance Corporation. The SNC program reviews the credit quality of loans that are at least $20 million and 

shared by three or more insured institutions. Adversely classified loans include syndicated loans that have been rated Substandard, Doubtful, or 

Loss because of significant credit problems or default. 

New York Regional Outlook 4 Fourth Quarter 2000 
Regional Perspectives
 

Region’s total loan growth during this time.4 Furthermore, although residential loans continue to account for 

the largest percentage of the Region’s loans, the level has 

declined. In second quarter 1996, the median ratio of residential loans to total loans for the Region’s commercial 

banks was just over 43 percent, while the median ratio of 

commercial loans to total loans was 31 percent. Four 

years later, the concentration levels of commercial and 

residential loans were almost equal, each approximating 

39 percent of total loans. 

The growth in commercial loan volume reflects a shift 

into higher-yielding, potentially higher-risk loans as 

banks attempt to maintain earnings in the face of 

increasing competition and margin pressure. The 

decline in the proportion of residential loans held in 

bank portfolios also may reflect improved liquidity and 

efficiency in the secondary market for mortgages. The 

growth of the secondary mortgage market has facilitated banks’ sale of mortgages to investors, giving banks 

that originate mortgages an alternative to holding these 

typically lower-yielding loans on their balance sheets. 

Banks with Riskier Loan Profiles Report 

Higher Reserves but Lower Capital Levels 

As C&I loan quality shows signs of weakening, banks 

that have significant concentrations in C&I credits may 

be more vulnerable if credit quality problems persist. 

Commercial banks that reported an above-average 

growth rate and concentration level of C&I loans (C&I 

lenders)5 reported higher median loan loss reserve 

ratios but lower capital ratios than the Region’s other 

banks (non-C&I lenders)6 (see Table 2). Higher loan 

4 Loan growth was computed as the difference in total loans from June 

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

adjusted for mergers. 

5 C&I lenders are commercial banks with above-average growth and 

concentration in C&I loans according to the following criteria: a C&I 

loan growth rate above 14.55 percent (the median growth rate for the 

Region’s banks between the 1999 and 2000 second quarters) and a 

concentration of C&I loans to total loans above 12.96 percent (the 

median ratio for the Region’s banks as of June 30, 2000). The distribution of C&I lenders mirrored the geographic and asset size distribution of all commercial banks in the Region. New York and 

Pennsylvania were home to the largest share of the C&I lenders, and 

approximately 80 percent of the C&I lenders were commercial banks 

with less than $1 billion in assets. Banks less than three years old and 

credit card banks were excluded from the analysis, and the data are 

adjusted for mergers. 

6 Non-C&I lenders are commercial banks that reported an annual C&I 

loan growth rate and ratio of C&I loans to total loans below the median reported by the Region’s commercial banks as of June 30, 2000. 

CHART 1 

Commercial 

& Industrial 

Annual Growth (%) 

Commercial and Industrial 

and Commercial Real Estate Loans 

Show the Highest Growth in the Region 

Note: Excludes credit card banks and banks in operation less than three years. 

Bars represent the median annual growth rates for the period ending June 30 

of each year, adjusted for mergers. 

Source: Bank Call Reports 

0 

2 

4 

6 

8 

10 

12 

14 

16 

CRE Residential Consumer 

1998 

1999 

2000 

loss reserve ratios help mitigate the effect of credit 

losses on bank earnings. However, banks with lower 

capital ratios have less cushion to absorb additional 

losses. Also, although not shown in the table, the gap 

between the capital ratios of these two groups has 

widened during the past two years as capital ratios of 

the C&I lenders have declined more than those of nonC&I lenders. While banks’ capital ratios have declined 

nationwide, a greater decline among banks that are 

potentially increasing credit risk profiles poses heightened concern.7 

TABLE 2 

C&I Lenders Report Higher Levels 

of Reserve Coverage but Lower 

Capital Ratios... 

C&I NON-C&I 

RATIO LENDERS LENDERS* 

RESERVES/LOANS 1.28 1.21 

RESERVES/PASTDUE LOANS 203.81 185.27 

PROVISIONS/ 

CHARGE-OFFS 146.78 101.91 

LEVERAGE RATIO 8.38 9.68 

T1 RBC 11.42 15.16 

Data as of June 30, 2000. 

* Banks with below-average growth and concentration 

in C&I loans. 

C&I = commercial and industrial, T1 RBC = Tier 1 riskbased capital ratio 

Source: Bank Call Reports 

7 A comparison of banks that have above-average CRE and C&D loan 

growth and concentrations with those that have below-average growth 

and concentrations showed similar but less noteworthy differences. 

New York Regional Outlook 5 Fourth Quarter 2000 
Regional Perspectives
 

Furthermore, higher operating costs may be constraining the earnings benefit that typically accrues to lenders 

that assume greater credit risk. Although C&I lenders 

reported a higher median asset yield and NIM during 

the second half of 2000, they also reported a lower 

median ROA (see Table 3). Higher overhead (perhaps 

because C&I lending can be more labor intensive than 

mortgage lending) contributed to the lower median 

ROA, as did higher provisions for loan losses. Moreover, should credit quality continue to weaken, banks 

may need to increase provisions for loan losses, further 

pressuring profitability. 

A Slowing Economy Could Heighten Credit Risk 

Although economic conditions were favorable 

throughout most of the Region during the first half of 

2000, some analysts think that the nation’s economy 

may be slowing. Less robust economic growth could 

have implications for commercial loan credit quality. 

Levels of reserve coverage that appear adequate in a 

robust economy could become less so in a slowing 

economy, particularly for institutions that have a larger proportion of higher-risk commercial loans and 

lower capital ratios. Commercial loans can affect an 

institution’s earnings more seriously because they generally result in greater losses per dollar than consumer 

and residential loans.8 Although recent surveys indicate more disciplined underwriting by banks, a prolonged period of economic and financial market 

weakness nevertheless could negatively affect credit 

quality. 

Some of the Region’s Housing Markets 

Show Significant Price Appreciation 

During the past several years, the wealth of new jobs 

and high level of consumer optimism have stimulated 

demand for housing around the Region. Recently, communities surrounding the Region’s larger urban areas, 

primarily New York City, Baltimore, and Washington, 

D.C., where job growth has been strong, reported the 

most significant price appreciation. Price increases in 

these areas had been relatively modest during the mid1990s but rose sharply as the 1990s came to a close. 

Home prices in many of these areas increased at doubledigit rates during the first six months of 2000, far 

8 ING Barings. September 2000. Credit Quality Climbing the Wall of 

Worry. 

TABLE 3 

... and Higher Yields but Lower ROA 

C&I NON-C&I 

RATIO LENDERS LENDERS* 

ROA 1.08 1.15 

ASSET YIELD 7.97 7.69 

NIM 4.43 4.29 

OVERHEAD/AVERAGE 

ASSETS 3.31 3.04 

PROVISIONS/AVERAGE 

ASSETS 0.17 0.09 

Data as of June 30, 2000. 

* Banks with below-average growth and concentration 

in C&I loans. 

ROA = return on assets, C&I = commercial and industrial, NIM = net interest margin 

Source: Bank Call Reports 

exceeding both the general inflation rate of approximately 3 percent and the average price increase for 

homes nationally. 

While residential property prices in the Region’s largest 

metropolitan areas have appreciated faster than the 

national average, home prices in some of the Region’s 

smaller cities have increased more slowly than the 

national average. In fact, the median housing price 

declined in parts of upstate New York over the past several quarters. Slower employment gains and limited 

population growth compared with the rest of the Region 

and the nation have subdued demand for homes in these 

areas. In Philadelphia, housing prices declined over the 

past year, despite employment gains. Like many areas in 

eastern Pennsylvania, the city has experienced population loss and a generally sluggish economy. At the other 

end of the state, in Pittsburgh, figures from the National Association of Realtors show that prices for singlefamily homes essentially have held steady for the past 

two years. 

Shortage of Available Homes Has 

Contributed to Price Appreciation 

During the first half of the 1990s, the Region experienced a relatively low level of new home construction, as 

its economy slowly recovered from the recession of the 

early 1990s. In some of those years, the number of new 

residential housing permits dropped at double-digit 

rates. The number of permits issued increased moderately toward the end of the 1990s, as the economy recovered 

from the recession and demand for new homes increased 

New York Regional Outlook 6 Fourth Quarter 2000 
15 

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Regional Perspectives
 

in many of the Region’s metropolitan statistical areas 

(MSAs). However, the level of permits increased a scant 

2.2 percent in 1999 and declined in 2000, as higher interest rates curtailed new development. 

Despite the vibrant economy and strong demand, construction of new single-family homes generally has 

been modest in the Region’s larger cities. High construction costs and the lack of developable lots have 

limited the supply of new homes. According to Economy.com, home inventories were particularly low in New 

York City, Long Island, Bergen and Passaic counties, 

and Trenton, New Jersey (see Chart 2).9 According to 

a recent report, New York City was one of the two tightest housing markets in the country, along with Los 

Angeles.10 

As a result of the limited supply and strong demand, 

home prices in some of the Region’s major markets have 

been rising three to four times faster than household 

incomes over the past year (see Chart 3, next page).11 

Areas experiencing the greatest price increases relative 

to income include communities adjacent to Baltimore 

and New York City (including New Jersey and Long 

Island). These areas represent some of the Region’s 

largest metropolitan areas and boast the strongest economic growth. 

Recent Price Appreciation Is Pressuring 

Affordability of Homes 

Measures of housing affordability show that it is becoming more difficult to afford a home. The National Association of Realtors’ Composite Housing Affordability 

Index, which measures a household’s ability to purchase 

a single-family home, indicates that during the first seven 

months of 2000, homes became less affordable or more 

costly relative to household income across the nation. 

Increased home prices relative to household income, coupled with higher mortgage rates, which rose more than 

150 basis points between October 1998 and June 2000, 

contributed to the decline in home affordability. 

Affordability measures for the Region’s cities also have 

increased since 1999, reflecting higher housing prices 

and interest rates, factors that also affect the national 

affordability measure. Unlike in 1990, however, most of 

the Region’s cities have become more affordable relative to the nation (see Table 4, next page).12 Only New 

CHART 2 

Rates of Price Appreciation Reflect the Declining Housing Supply 20 20 

Number of months 

of excess supply 

Housing price increase 

– percent change 

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Note: Housing prices are percent change first quarter 1999 to first quarter 2000.
 

Sources: Excess supply data: Economy.com analysis; housing prices: Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association
 

9 This analysis was presented at the spring 2000 Economy.com
 

Outlook Conference.
 

10 Credit Suisse First Boston. August 2000. August Housing Monthly.
 

11 Household income data are from the Bureau of the Census.
 

Economy.com develops quarterly estimates. Amounts include all
 

wages but not income from capital gains.
 

12 The regional housing affordability measure was calculated internally. The measure assumes that 80 percent of the purchase price of the 

home is financed at the prevailing 30-year fixed conventional mortgage rate provided by the Federal Home Loan Mortgage Corporation. 

The measure uses the median price of a single-family home for each 

metropolitan area published by the National Association of Realtors 

and estimates of household income from Economy.com. The regional measure does not include income from capital gains. A higher number means that the purchase of a home is more expensive, or less 

affordable, relative to household income in that area. 

New York Regional Outlook 7 Fourth Quarter 2000 

15 
 

Regional Perspectives
 

CHART 3 

debt burdens could grow at a time when jobs and livelihoods are less secure. 

Sources:National Association of Realtors, U.S. Bureau of the Census. Quarterly esimates income poivided by Economy.com. 

Housing Price Appreciation Substantially Exceeds Increases in 

Household Income in Baltimore, Parts of New Jersey, and Long Island: 

First Quarter 1999 to First Quarter 2000 

Percent Change 

Household income 

increases Housing price increases 

20 

–15 

–10 

–5 

0 

5 

10 

15 

Monmouth, N.J. 

Bergen-Passaic 

Baltimore 

Newark 

New York City 

Middlesex. N.J. 

Washington, D.C. 

Trenton 

Long Island 

Atlantic City 

United States 

Wilmington 

Pittsburgh 

Albany 

Rochester 

Buffalo 

Syracuse 

Philadelphia 

York City and Bergen County, New Jersey, a New York
 

City suburb, were less affordable (a higher index number) in 2000 than the nation. Because these cities are 

home to many Wall Street commuters, home prices 

reflect the substantial wealth effect of the vibrant financial markets over the past several years. Affordability 

measures for the Region and the nation remain lower 

than 1990 levels, however, in part because of generally 

lower interest rates today than a decade ago. 

Rapid Price Increases May 

Stress Household Budgets 

One consequence of rising home prices, particularly if 

they are increasing substantially faster than household 

income, is that they may place additional financial 

stress on prospective homeowners, who may be faced 

with higher debt servicing costs. According to the Federal Reserve Board, in first quarter 2000, the debt service burden for the nation (the ratio of consumer debt 

payments to disposable personal income) reached the 

highest level since first quarter 1988.13 A higher consumer debt service burden means households have less 

income to cushion against increased or unexpected 

financial responsibilities. If the economy slows, household incomes may decline (or net worth may be 

reduced), and households may increase borrowings to 

compensate for the loss of income. In that situation, 

13 Data indicated that, nationally, consumer debt service burdens have 

risen disproportionately more for lower-income households (incomes 

less than $25,000) and mid-income households (incomes between 

$25,000 and $50,000) than for higher-income households. Debt service burdens by household income level were not available at the state 

level. [Federal Reserve Board, Recent Changes in U.S. Family 

Finances: Results from the 1998 Survey of Consumer Finances.] 

TABLE 4 

After Becoming More Affordable 

in the 1990s, Homes Became Less 

Affordable in 2000 

METRO AREA 1990 1999 2000 

ALBANY 28 16 18 

ATLANTIC CITY 30 NA 18 

BALTIMORE 22 14 18 

BERGEN–PASSAIC, N.J. 36 22 29 

BUFFALO 24 13 14 

LONG ISLAND 26 18 22 

MONMOUTH–OCEAN, N.J. 27 20 23 

NEW YORK CITY 38 24 29 

PHILADELPHIA 16 11 12 

PITTSBURGH 34 19 21 

ROCHESTER 20 13 14 

SYRACUSE 22 13 14 

TRENTON 28 14 NA 

WASHINGTON, D.C. 27 17 18 

WILMINGTON 25 14 16 

United States 24 20 23 

Shaded areas are less affordable than the nation. 

Data represent percentage of income needed to purchase a median-priced house in the second quarter of 

that year. 

NA = not available 

Sources: National Association of Realtors, 

Economy.com, Federal Home Loan Mortgage 

Corporation 

New York Regional Outlook 8 Fourth Quarter 2000 
Regional Perspectives
 

Debt service burdens also have risen in the Region since 

the end of the recession in 1992 (see Table 5). Although 

increasing, except for Delaware and Maryland, the 

Region’s state debt service burdens were below the 

national average at the end of 1999. Higher housing 

prices and a greater percentage of renters have contributed to a lower rate of home ownership in New York 

and New Jersey. Lower home ownership rates could 

cause state debt service burdens to be underestimated 

because rent and lease payments are not included in 

this measure. High per capita incomes in these states 

also contributed to the lower debt service burden ratio. 

Nonetheless, the Region’s debt service burdens are 

increasing, raising concern about consumer credit 

quality.14 

Region’s Recent Housing Boom Has 

Been More Modest than in the 1980s 

Although housing prices have increased sharply in parts 

of the Region, the strength and duration of the Region’s 

current housing boom has been more modest than during the period that preceded the 1990–1991 recession. 

Even in the Region’s larger cities and adjacent areas, 

substantial price appreciation has occurred only during 

the past 12 months. In contrast, in many of the Region’s 

cities, price appreciation during the housing boom of 

the late 1980s lasted for several years.15 During that 

period, home prices in some of the Region’s areas 

increased at double-digit rates every year, compared 

with single-digit rates nationally. During the latter half 

of the 1990s, the percentage increase of home prices in 

the Region was generally less than half that of the 

1980s. Moreover, recently, home prices in many of the 

Region’s cities have increased less than the national 

average. 

Sales of existing single-family homes in the Region also 

indicate a more modest housing boom than in the 

1980s. Data from 33 MSAs in the Region and the nation 

show that sales of single-family homes picked up substantially during the latter half of the 1990s. In the 

nation, however, housing sales volume exceeded the 

1980s peak in 1993, while in the Region, sales volume 

lagged the 1980s peak (see Chart 4, next page). The data 

also show a greater percentage decline in home sales in 

14 Chen, Celia. June 30, 2000. “Risky Debt Service Burdens.”
 

www.Dismal.Com.
 15 Analysis includes information for 21 of the Region’s MSAs, using
 

housing price data supplied by the Federal Home Loan Mortgage
 

Corporation and the Federal National Mortgage Association.
 

TABLE 5 

Since 1995, Debt Service Burdens 

Have Been Increasing in the Nation 

and in Most States in the Region 

STATE 1992 1995 1999 

DELAWARE 15.1 14.7 15.0 

MARYLAND 14.8 15.8 16.2 

NEW JERSEY 12.5 13.1 12.8 

NEW YORK 10.2 10.4 10.7 

PENNSYLVANIA 11.3 12.1 13.2 

United States 11.7 12.7 13.5 

Data represent fourth quarter of the year.
 

Debt service burden is defined as household debt
 

service as a percentage of disposable income.
 

Debt burden includes mortgage and consumer installment debt.
 

Shaded areas are those where debt burdens are
 

greater than those of the nation.
 

Source: Economy.com estimates
 

the Region than the nation toward the end of 1999 and 

through the first half of 2000, which coincided with a 

period of rising interest rates and softness in the equity 

markets. Because much of the Region’s housing is 

located near communities dependent on a vibrant Wall 

Street, instability in the stock market and rising interest 

rates may have contributed to reduced home sales. A 

study linking rising interest rates to changes in the 

Region’s gross state product showed that the Region 

appears more sensitive than the nation to changes in 

interest rates.16 

Region’s Housing Markets Experiencing 

Significant Price Appreciation, although 

Not on Par with the 1980s 

Historically, residential real estate markets have been 

susceptible to boom-and-bust economic cycles. During 

the 1980s, several areas of the nation, including Texas 

and New England, experienced an economic boom, 

strong residential real estate development, and substantial home price appreciation. Subsequent regional recessions took a heavy toll on these residential markets.17 

Many parts of the New York Region also experienced 

significant price appreciation during the late 1980s 

16 “Higher Interest Rates May Curtail the Region’s Economic Expansion.” Regional Outlook, fourth quarter 1999.
 17 For more information regarding residential real estate markets
 

throughout the nation, see “Rising Home Values and New Lending
 

Programs Are Reshaping the Outlook for Residential Real Estate.”
 

Regional Outlook, third quarter 2000.
 

New York Regional Outlook 9 Fourth Quarter 2000 
Regional Perspectives
 

CHART 4 

Note: 2000 is through the first half of the year only. 

Sources: National Association of Realtors, U.S. Bureau of the Census, Economy.com 

During the 1990s, Single-Family Home Sales in the United States

 Exceeded the 1980s Peak; Region Sales Lagged the 1980s Experience 

Millions of units 

0 

U.S. sales Region sales 

Thousands of units

200 

300 

400 

500 

600 

700 

1 

2 

3 

4 

5 

6 

’82 ’83 ’84 ’85 ’87 ’88 ’89 ’91 ’92 ’93 ’94 ’96 ’97 ’98 ’86 ’90 ’95 ’99 ’00

through the early 1990s, as the economy expanded and 

incomes improved. Home price appreciation reflected a 

booming economy, but it put increasing budgetary pressure on residents who wished to purchase new homes. 

Some businesses were unable to locate or expand in 

parts of the Region because it was difficult for workers 

to find affordable housing. High-housing-cost areas 

were particularly vulnerable to a relatively mild national recession in the early 1990s that harmed the Region 

more severely. 

Presently, some of the Region’s largest metropolitan 

areas are again experiencing significant home price 

appreciation, reflecting strong economic conditions and 

a limited supply of new homes. Although by most measures the Region’s current housing boom is not as strong 

as that of the late 1980s and early 1990s, price increases 

may be forcing consumers in some areas to stretch budgets and increase debt service burdens. These areas, 

particularly the communities in New York and New Jersey that are within commuting distance of Wall Street, 

are increasingly dependent on strong financial markets. 

With consumers’ portfolios flush with huge bonuses 

and capital gains, double-digit home price appreciation 

can be accommodated. Should the financial markets 

become anemic for an extended period, however, the 

risk of housing price deflation would increase. In that 

event, consumer credit quality could be strained, and 

bank collateral values on residential mortgages could be 

tested. 

New York Region Staff 

New York Regional Outlook 10 Fourth Quarter 2000 
In Focus This Quarter
 

Emerging Risks in an Aging Economic Expansion
 

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

However, the economic expansion is aging, and it 

is unlikely that the vigor experienced during the 

first half of 2000 can be sustained. 

•	 Likewise, record banking and thrift industry 

profits, healthy capital cushions, and good asset 

quality of recent years may not be sustainable. 

Declining net interest margins, rising commercial 

loan losses, tighter liquidity, and riskier asset 

composition are among the warning signs that 

industry performance may have peaked for this 

business cycle. 

•	 Specific areas of concern include growing reliance 

on noncore funding; heightened interest rate risk; 

increased exposure to market-sensitive revenues; 

deteriorating credit quality; rising leverage 

among businesses and households; and signs of 

imbalance in some residential and commercial 

real estate markets. 

Although no readily apparent situations or imbalances 

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

present. A highly competitive banking industry shapes 

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

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

pressure to grow earnings and increase shareholder 

value. In addition, local banking environments exist in 

which a confluence of risks is generating heightened 

vulnerability for all participants, even during healthy 

economic times. Complacency in these environments 

may have negative repercussions for many insured institutions going forward. 

Imbalances Are Appearing amid a Healthy 

Macroeconomic Environment 

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

opportunities and risks financial institutions face. The 

current cyclical expansion, now nine and one-half years 

old, is displaying signs of aging while setting a record 

for longevity. A consensus forecast calls for moderate 

real gross domestic product (GDP) growth through 

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

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

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

hovers around recent rates. 

Although the current macroeconomic environment 

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

of concern exist. One is that sustained prosperity tends 

to foster higher levels of risk taking, overconfidence, 

and complacency. For example, the turmoil in world 

foreign exchange and financial markets during 1997 

and 1998 illustrates how dramatic imbalances can 

develop and trigger disruptive adjustments even during 

healthy economic times. 

Currently, no specific situation or imbalance seems to 

threaten the viability of the expansion. However, as 

detailed below, several likely will contribute to slower 

economic growth. Situations that warrant monitoring 

include the following: 

•	 The repercussions from higher energy prices are 

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

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

longer-term rates declined, resulting in a modest 

inversion of the yield curve. This relationship may 

inhibit the profitability of some lenders’ practice of 

borrowing short term and lending longer term and 

also complicate the interest rate risk management 

process for some insured institutions. 

•	 Continuing low unemployment suggests that demand 

for additional workers will go unfilled, thus limiting 

economic growth or triggering bidding wars that 

increase workers’ compensation and, potentially, 

inflation. 

•	 Stock market sentiment is no longer strongly bullish. 

A pullback from high valuations and optimism could 

trigger negative repercussions on consumers’ net 

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

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

dollar may be an unsustainable combination over the 

New York Regional Outlook 11	 Fourth Quarter 2000 
In Focus This Quarter
 

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

relative to the euro and other currencies. 

•	 Household debt burdens are historically high, with 

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

access to credit has increased as lenders competed 

more fiercely for customers. 

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

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

2 to 1 ratio. 

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

dramatically and exceeding gains in median 

incomes. 

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

banks’ construction loan growth also is strong. 

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

Should economic growth slow considerably, current 

vulnerabilities, such as highly leveraged borrowers’ 

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

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

allow current imbalances to intensify or build up. For 

example, speculative construction could accelerate, 

stock market volatility could increase, or ballooning 

trade deficits could generate turmoil in foreign 

exchange markets. 

Signs of Strain Are Also Appearing 

amid Healthy Banking and Thrift Industries 

With the long economic expansion as a backdrop, 

insured institutions in the aggregate are performing 

very well. However, the record profits attained in recent 

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

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

While these are isolated instances, they are indicative of 

the increasingly competitive environment facing the 

financial services industry. 

Overall industry profitability is beginning to soften, led 

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

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

steadily falling since late 1997, have stalled in recent 

quarters, suggesting that recent increases in interest 

rates and energy costs not only are affecting businesses 

but also are taking a toll on some consumers. Other 

signs suggesting that aggregate risk within the system 

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

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

brief discussion of these risks follows. 

Funding Patterns Heighten Liquidity Concerns 

Lackluster core deposit growth is placing pressure on 

bank earnings and contributing to rising liquidity risk in 

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

insured institutions was just 2.8 percent. Assets over this 

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

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

sensitivity of these funds put downward pressure on net 

interest margins, particularly in a rising rate environment. 

CHART 1 

Most of $2 Trillion of Asset Growth since 1995
 

Was Funded with Noncore Funds
 

Subordinated Debt 

and Other Liabilities

 5% 

9% 

Equity 

22%
 

Core Deposits
 

64%
 

Noncore Funding
 

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

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

To compensate for higher funding costs, the industry 

has pursued growth in higher-yielding asset classes that 

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

five years has come from nonresidential real estate and 

commercial and industrial loans. 

For institutions that fund illiquid assets with wholesale 

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

costs, thus placing further pressure on margins. In 

efforts to obtain funding, an institution also may pledge 

a greater portion of its best quality assets as collateral, 

further reducing liquidity. Finally, in instances where 

funding needs have exceeded available liquidity, the 

forced sale of illiquid assets to meet funding outflows 

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

greater losses if such an institution failed, because it 

would be relying on proceeds from the liquidation of 

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

the claims of insured depositors. 

Subprime lenders, in particular, tend to rely heavily on 

noncore funding to pursue aggressive growth strategies. 

Chart 2 illustrates the extent to which noncore funding 

exceeds the level of liquid assets for this group. The 

chart suggests the difficulty these institutions may 

encounter if forced to convert assets to meet funding 

outflows. Although subprime lenders may use noncore 

sources to fund riskier assets to a greater extent than the 

industry at large, this illustration exemplifies a systemic 

trend that is raising liquidity risk industrywide and is 

increasing risk to the insurance funds. 

Increasing Levels of Interest Rate Risk 

Challenge Some Institutions 

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

insured institutions. During this period, a vast majority 

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

loans, which they obtained at historically low rates. A 

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

borrowers refinanced were held in the portfolios of 

insured institutions, which contributed to a general 

lengthening of the maturity of assets held at insured 

institutions. 

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

particularly pronounced among mortgage lenders. For 

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

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

almost 45 percent of the median savings bank’s earning 

assets were not scheduled to reprice for five years or 

longer (see Chart 3). 

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

through first quarter 2000, the percentage of fixed-rate 

mortgage-related assets at thrifts with assets less than 

$1 billion rose from 49 percent to 60 percent of 

mortgage-related assets. Some thrifts and savings 

banks, therefore, have significant exposure to rising 

rates from low-yielding long-term assets. 

CHART 2 $ Billions 

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

merger adjusted) 

Subprime Lenders’ Growing Dependence

 on Noncore Funding Strains Liquidity 

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

0 

30 

60 

90 

All other loans 

Residential real estate loans 

Securities and shortterm investments 

Columns: Noncore funding 

CHART 3 

Growing Concentration in Long-Term 

Assets Elevates Interest Rate Risk 

Source: Bank Call Reports, excluding Thrift Financial Report filers 

Share of Assets Maturing or Repricing in Five Years or Longer 

Relative to Total Earning Assets (median percentage) 

Percent 

Savings Banks 

Commercial Banks 

50 

0 

10 

20 

30 

40 

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

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

While most commercial banks do not have as high 

exposure to rising rates as savings banks, some may 

have taken on significant risk. The median savings bank 

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

commercial banks. Although the 93rd percentile is in 

the tail of the commercial bank distribution, almost 600 

commercial banks have a concentration in long-term 

assets that exceeds that of the median savings bank. 

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

While assets have lengthened considerably for many 

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

tending to make bank liabilities more rate sensitive. 

These diverging trends generate concern, especially in a 

rising interest rate environment. That is, rate increases 

drive up the cost of funds more rapidly than earning 

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

rate environment, many institutions’ current postures 

likely would cause heavy margin erosion. 

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

that contains lower credit risk than that of many other 

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

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

with concentrations in long-term assets also may have 

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

earnings. Rising rates could weaken these institutions 

and make it more difficult for them to weather adverse 

economic or other developments. 

Dependence on Market-Sensitive Revenues 

Increases Earnings Volatility for Some 

Institutions 

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

lines susceptible to financial market volatility has 

increased substantially for some of the industry’s largest 

institutions. Among these revenue sources are fees and 

gains from asset management, brokerage, investment 

banking, venture capital, and trading activities. The 19 

institutions most active in these lines of business earned 

over 26 percent of their net operating income from such 

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

volatile sources of revenue. 

Turbulence in the financial markets has led to greater 

earnings volatility for some of these institutions. Stress 

in the financial markets could weaken the demand for 

underwriting services or significantly reduce trading 

revenues or venture capital gains. Furthermore, the 

same factors that are causing volatility in the financial 

markets could hamper loan growth and lead to slower 

revenue growth from core business lines. Should 

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

from core business lines, some institutions could face 

significant earnings challenges. 

The Rising Level of Problem Business Loans 

Is Centered in Large Banks 

Second quarter 2000 commercial and industrial (C&I) 

credit quality indicators at banks deteriorated for the 

eighth consecutive quarter. Noncurrent C&I loans— 

those on nonaccrual status plus those 90 days or more 

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

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

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

loan loss rates also continue to edge higher but remain 

well below those experienced by banks in the late 1980s 

and early 1990s.1 

Large banks, particularly those active in syndicated 

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

quality. Recent increases in criticized and classified 

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

lending institutions, are illustrated in Chart 4. In the 

2000 SNC review, criticized and classified credits 

increased 44 percent over 1999 levels to 5.1 percent of 

total SNC commitments. Furthermore, the bulk of the 

increase was in the more severe classified categories, 

which now comprise 64 percent of total criticized and 

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

11

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

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

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

rates averaged 1.11 percent from fourth quarter 1991 to fourth quarter 

1993. 

New York Regional Outlook 14 Fourth Quarter 2000 
In Focus This Quarter
 

CHART 4 

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

Source: Shared National Credit Program 

Syndicated Loan Problems Are on the Rise 

Percent

$ Billions 

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

Criticized and 

Classified SNC Loan 

Commitments (right 

scale) 

Percentage of SNC 

Commitments Criticized 

and Classified (left scale) 

0 

2 

4 

6 

8 

10 

12 

14 

16 

0 

20 

40 

60 

80 

100 

120 

140 

C&I loan quality indicators continue to deteriorate 

despite generally favorable economic conditions. Three 

factors explain much of this deterioration: certain weak 

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

1998, when many banks significantly eased business 

lending standards. 

Industry Sector Weaknesses 

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

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

decline in commercial credit quality, problems within 

these two sectors do not account for the full extent of 

the increase in noncurrent loans and problem SNC 

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

in criticized and classified credits from the 1999 to the 

2000 SNC review. However, this increase accounts for 

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

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

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

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

ftp/release/2000-78a.pdf.
 

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

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

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

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

and the degree of financial leverage.
 

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

evaluate obligor risk and credit risk trends. Applied to 

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

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

Sectors that include a high proportion of firms with 

high default probabilities (median one-year default 

probabilities exceeding 4 percent) are shown in Chart 5. 

Using entertainment as an example, the bars in the chart 

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

entertainment firms had greater than an 8 percent 

chance of defaulting on their obligations within one 

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

The median likelihood of default for all the industries 

shown in the chart far exceeds that of Standard & 

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

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

the chart. 

Rising Corporate Debt Burdens 

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

continue to increase. This ratio reached 83 percent in 

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

year-end 1996. Although debt burdens remain below the 

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

availability. 

CHART 5 Median Expected Default Frequency (EDFTM) (percent) 

Various Industries Show High Levels 

of Expected Default Risk 

Comparative EDFTM

 of S&P Bonds Rated BB 

(as of September 2000) 

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

Entertainment 

HealthcareWholesale Trade 

Apparel &Textile

Misc. Manufac. LodgingMining 

AgricultureConstruction 

Retail

0 

1 

2 

3 

4 

5 

6 

7 

8 

9

 September 1999

 September 2000 

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

Seasoning of 1997–1998 Vintage Loans 

Results of recent supervisory surveys suggest that 

banks are tightening terms and conditions on loans to 

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

this tightening follows a relaxation of standards in prior 

years that has contributed to a heightened level of risk 

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

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

leveraged transactions by Loan Pricing Corporation. 

Leveraged loan originations—those priced at 150 basis 

points or more over the London Inter-Bank Offer Rate 

(LIBOR)—rose from 12 percent of total syndicated 

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

banks have acknowledged that 1997 and 1998 vintage 

credits are beginning to produce higher problem loan 

levels.5 

Household Sector’s Leverage Is High, 

and Imbalances Are Appearing 

Consumers are enjoying the benefits of the economic 

expansion, as jobs are plentiful, home ownership 

remains generally affordable, and credit seems to be 

readily available for financing motor vehicles and other 

major purchases. These conditions contributed to record 

high sales of cars and light trucks during the first nine 

months of 2000, helping sustain the consumer spending 

growth shown in Chart 6. One corollary of high vehicle 

sales, however, is softening prices for used vehicles. 

Consequently, some lessors—including banks—are 

realizing lower-than-expected residual values on leased 

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

lease portfolios. This situation illustrates one problem 

that lenders can encounter even in good economic 

times. 

Spending growth remained robust in recent quarters 

even as gains in disposable income slowed. The gap 

between income and spending growth is “financed” as 

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

combination of these measures. 

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

Bank Lending Practices for May and August 2000 and Surveys of 

Credit Underwriting Practices for 1999 and 2000 from the Office of 

the Comptroller of the Currency. 

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

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

CHART 6 

Household Spending Growth 

Exceeds Income Growth 

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

Real Consumption Spending 

Real Disposable Income 

7 

–1 

0 

1 

2 

3 

4 

5 

6

Annual Growth Rate (percent) 

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

Quarter 3 

From 1995 through 1998, and likely since then, the 

increase in both leverage and debt servicing burdens has 

been concentrated among low- and middle-income 

households. Among families holding debt in 1998, debt 

payments exceeded 40 percent of disposable income for 

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

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

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

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

such instances, lenders could be doubly affected if 

households draw on their credit card and home equity 

lines of credit, further compromising their repayment 

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

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

lending specialists may indicate that strains among 

some households are spilling over to lenders. Moody’s 

Investors Service expects credit card losses to rise 

through 2001, according to a recent analysis of 

prospects for the U.S. credit card industry. 

Overheated residential real estate markets in several 

metropolitan statistical areas (MSAs) may be another 

warning of economic imbalances. Dramatic gains in 

home resale prices in San Francisco stand out (see Chart 

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

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

properties may reflect the fact that affordability is 

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

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

from the 1998 Survey of Consumer Finances.” Federal Reserve 

Bulletin. Vol. 86, 1–29. 

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

enhanced by gains in wealth rather than in income. 

Even so, similar surges in home resale prices in the 

past often were not sustainable. The subsequent years 

of stagnant or falling collateral values caused financial 

stress among some homeowners and their lenders. 

Further concern about residential real estate lenders 

arises because pockets of speculative construction 

under way in some markets may produce units that 

become increasingly difficult to sell at anticipated asking prices. 

Construction and Development 

Loan Growth Is Accelerating 

Commercial real estate (CRE) construction across all 

property sectors has grown during this expansion, with 

office construction particularly active. The amount of 

office space completed in mid-2000 was the largest 

since 1989 and is projected by Torto Wheaton Research 

to continue rising. Not surprisingly, construction and 

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

concentrations are trending upward rapidly. While total 

private real estate spending grew about 6.5 percent over 

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

insured institutions rose by 26 percent. C&D loan 

growth has remained above 20 percent since 1997, and 

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

1989. 

Such growth is contributing to higher concentrations of 

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

concentrations do not begin to approach those of the 

late 1980s. However, several metropolitan areas have a 

CHART 7 

Median Home Resale Prices Soar 

in San Francisco Bay Area 

Percent Change from

Four Quarters Earlier 

35 

30 

25 

20 

15 

10 

5 

0 

–5 

–10 ’80 

’82 

’84 

’86 

’88 

’90 

’92 

’94 

’96 

’98 

’00

Quarter 1 

Source: National Association of Realtors via Haver Analytics, Inc. 

large percentage of insured institutions reporting high 

and rising concentrations. Table 1 (next page) shows 

MSAs with at least 15 nonspecialized community 

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

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

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

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

The aggregate C&D concentration for all 85 institutions 

in the MSA was 156 percent, the highest among MSAs 

with at least 15 institutions of similar size and nature. 

Several other markets also include significant shares of 

institutions with high concentration levels. 

Nine of the 16 markets highlighted in Table 1 not only 

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

or more property types.8 While these markets show no 

clear signs of emerging economic stress, lenders there 

clearly may be at greater risk should economic or real 

estate conditions sour. Other concerns regarding CRE 

lending arise from a recent Office of the Comptroller 

of the Currency survey, which reports heightened 

credit risk in CRE portfolios and predicts it will 

increase through 2001. In addition, respondents to a 

midyear 2000 FDIC survey of examiners reported 

more frequent comments about excess office and retail 

space. 

Increasing Share of De Novo Institutions 

Raises the Stakes in Some Markets 

A common element among the metropolitan markets 

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

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

of the nonspecialized community institutions are less 

than three years old. The drive to build market share 

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

instances, the aggregate cost of deposits within the 

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

7 The term “nonspecialized community bank” refers to institutions 

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

such as credit card or trust banks. 

8 See “Ranking Metropolitan Areas at Risk for Commercial Real 

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

identifies markets where new construction is high relative to existing 

stocks of space. 

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

TABLE 1 

High C&D Loan Exposure Appears in Various MSAs 

SHARE (%) OF AGGREGATE C&D LOANS 

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

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

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

ATLANTA, GA 65 156 

PHOENIX–MESA, AZ 56 131 

MEMPHIS, TN–AR–MS 52 154 

PORTLAND–VANCOUVER, OR–WA 47 146 

OAKLAND, CA 47 163 

NASHVILLE, TN 44 103 

RIVERSIDE–SAN BERNARDINO, CA 42 110 

SAN DIEGO, CA 41 90 

GRAND RAPIDS–MUSKEGON–HOLLAND, MI 40 81 

SEATTLE–BELLEVUE–EVERETT, WA 39 98 

SALT LAKE CITY–OGDEN, UT 38 56 

FORT WORTH–ARLINGTON, TX 38 110 

DALLAS, TX 36 95 

LAS VEGAS, NV–AZ 35 119 

LEXINGTON, KY 34 80 

DENVER, CO 33 113 

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

card or trust banks. 

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

Outlook, third quarter 2000. 

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

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

profiles are being elevated, and aggregate leverage ratios 

are falling, despite the influx of capital from the new 

institutions. Highly competitive environments have the 

potential to increase risk taking by negatively affecting 

underwriting standards and balance sheet composition. 

Farm Sector Challenges Continue 

Much of the agricultural industry is experiencing 

stress because of low commodity prices, compounded 

in some areas by low yields resulting from weather- or 

disease-related problems. Strong global competition 

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

depressed prices, and limited prospects for a price 

turnaround in the near term. In the aggregate, record 

levels of government payments have helped the 

nation’s farms maintain a generally stable financial 

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

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

Fortunately, the aggregate condition of nearly 2,100 

insured agricultural banks—institutions with 25 percent 

or more of loan portfolios in agricultural credits— 

remains healthy. Generally, agricultural banks continue 

to report favorable asset quality, earnings, and capital 

positions. However, they are experiencing somewhat 

elevated levels of noncurrent loans compared with 

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

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

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

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

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

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

farm banks may translate into higher losses in the future 

if commodity prices remain low. 

The strains in the farm sector also have implications for 

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

example, where farmers’ earnings are depressed and the 

economies not well diversified, nonagricultural banks 

are reporting higher noncurrent levels than insured 

institutions elsewhere in the nation. 

Summary 

The long-lived economic expansion has contributed to 

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

matured, both consumer and corporate leverage has risen 

considerably. Bank liquidity is becoming increasingly 

strained by lackluster core deposit growth, which has 

been insufficient to fund strong loan demand. This trend 

has resulted in a decided shift into higher-risk asset 

classes to mitigate margin pressures arising from the 

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

institutions, and after nearly a decade of improving asset 

quality, the level of problem loans is increasing. 

Clearly, high levels of profitability in recent years have 

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

Concern arises because insured institutions’ current 

profitability is being negatively affected by some recent 

trends, despite the sustained economic expansion. And, 

while capital levels have remained fairly stable, the 

amount of risk being leveraged on the industry’s capital 

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

boats, a strong economy can mask potential problems 

that will become evident should the economic tide turn, 

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

and soundness may be most vulnerable in situations 

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

because of repercussions from economic and banking 

forces beyond their control. 

Daniel Frye, Regional Manager 

Joan D. Schneider, Regional Economist 

Steve Burton, Senior Banking Analyst 

Allen Puwalski, Senior Financial Analyst 

Ronald Spieker, Chief, Regional Programs 

and Bank Analysis 

The authors would like to acknowledge 

the Washington and regional staff of 

both the Division of Insurance and 

the Division of Supervision for their 

analyses and comments, which were 

instrumental in writing this article. 

New York Regional Outlook 19 Fourth Quarter 2000 
✁
 

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