Outlook
 

SUMMER 2003 

In Focus This Quarter 

The U.S. banking industry’s strong performance in the face of subpar 

economic growth since early 2002 is remarkable. Together, the banking 

and thrift industries’ net income reached over $105 billion in 2002, the first 

time annual earnings have topped the $100 billion mark. Despite the strong 

performance during 2002, some issues bear watching. These include continued weakness in corporate credit quality, although conditions are generally 

improving as a result of aggressive bad debt workouts by large insured institutions; concerns over a protracted slump in commercial real estate markets, 

which might eventually lead to increased losses; subprime consumer lending, 

given increased household leverage and the ongoing extension of unsecured 

lending (especially credit card debt) to borrowers with less experience in 

managing credit; net interest margin compression; interest rate and funding 

risks related to the unusually low interest rate environment; exposure to 

market-sensitive, noninterest income sources; and the adequacy of internal 

audit and other controls against potential fraud. 

See page 3. 

By Richard Austin, Senior Financial Economist 

Alan Puwalski, Senior Policy Analyst 

Regional Perspectives 

Atlanta—Revenue shortfalls and rising expenditures Kansas City—The number of newly chartered instituhave contributed to deteriorating fiscal conditions among tions has increased significantly in certain metropolitan 

states in the Region. These developments may challenge areas during the past five years. These institutions 

the regional economy and pressure credit quality among performed well during the recent recession; however, 

insured institutions. See page 13. continued economic weakness could pressure earnings 

and credit quality. See page 25. Chicago—Concentrations in commercial real estate 

lending continued to rise among the Region’s insured New York—Many of the Region’s states face budget 

institutions as market fundamentals in the larger metro- shortfalls, which may worsen in the coming fiscal year. 

politan statistical areas weakened. See page 17. Job losses in the financial sector have disproportionately 

hurt New York City and Boston. See page 31. Dallas—Despite a sluggish economy, insured institutions 

based in the Region report favorable conditions; however, San Francisco—The Region’s travel sector remains 

some deterioration has occurred in the consumer loan vulnerable to a sluggish economic recovery and events 

portfolio. Rising debt levels may contribute to additional abroad. Asset quality and earnings among insured instituweakening in credit quality. See page 21. tions based in travel-dependent markets could deteriorate 

if weakness in this sector continues. See page 36. 

By Staff of the Regional Operations Branch 

San 

Francisco 

Kansas 

City 

Dallas Atlanta 

New 

York 

Chicago 

A PUBLICATION OF THE DIVISION OF INSURANCE AND RESEARCH 
The FDIC Outlook is published quarterly by the Division of Insurance and Research 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 six geographic regions: 

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

Jack M. Phelps, Regional Manager, 678-916-2295 

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

David Van Vickle, Regional Manager, 312-382-7551 

Dallas Region (AK, CO, LA, MS, NM, OK, TN, TX) 

Midsouth: Gary Beasley, Regional Manager, 901-821-5234 

Southwest: Alan Bush, Regional Manager, 972-761-2072 

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

John Anderlik, Regional Manager, 816-234-8198 

New York Region (CT, DC, DE, MA, MD, ME, NH, NJ, NY, PA, PR, RI, VI, VT) 

Mid-Atlantic: Kathy Kalser, Regional Manager, 917-320-2650 

New England: Paul Driscoll, Regional Manager, 781-794-5502 

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

Catherine Phillips-Olsen, Regional Manager, 415-808-8158 

The FDIC Outlook provides an overview of economic and banking risks and discusses how these risks relate 

to insured institutions nationally and in each FDIC region. 

Single copy subscriptions of the FDIC 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 FDIC 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 FDIC Outlook, please call Rae-Ann Miller at 202-898-8523 or 

send an e-mail to rmiller@fdic.gov. 

The views expressed in the FDIC 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 Donald E. Powell 

Director, Division of Insurance 

and Research 

Arthur J. Murton 

Executive Editor Maureen E. Sweeney 

Managing Editor Kim E. Lowry 

Editors Rae-Ann Miller 

Richard A. Brown 

Ronald L. Spieker 

Norman Williams 

Publications Manager Teresa J. Franks 
In Focus This Quarter 

Economic Conditions and Emerging 

Risks in Banking 

The U.S. economy has been growing modestly since 

early 2002; however, the Business Cycle Dating 

Committee of the National Bureau of Economic 

Research (NBER) said on April 10, 2003, that it 

needed additional time to interpret the movements of 

the economy last year and this year before it can officially date the economic recovery, which is believed to 

have begun sometime in 2002. Notwithstanding the 

slow growth of the economy during 2002, insured 

commercial banks and savings institutions registered 

record earnings performance. This article explains the 

strong performance of the banking and thrift industries 

through the 2001 recession and during this subsequent 

period of modest economic growth. It also explores 

areas in the banking system that are potentially 

vulnerable because of the narrow underpinnings 

of economic growth. 

Industry Summary 

The U.S. banking industry’s strong performance in the 

face of modest economic growth is remarkable. While 

real gross domestic product (GDP) increased only 2.9 

percent between fourth quarter 2001 and fourth quarter 

2002, insured commercial banks and savings institutions registered record earnings performance. Together, 

the banking and thrift industries’ net income reached 

over $105 billion in 2002, the first time that annual 

earnings have topped the $100 billion mark. While the 

2001 recession contributed to higher provision 

expenses in 2002, low interest rates and strong fee 

income helped boost bank earnings to record levels. 

almost 4 percent. On top of the almost 18 percent 

increase in operating revenue year over year, low interest rates prompted banks to take record gains of over 

$12 billion on the sale of securities. 

A Strong Consumer and a Weak Corporate Sector 

Economic growth since early 2002 has been based 

largely on consumer spending, which has been 

bolstered by gains in aggregate personal income; 

a widespread cashing out of home equity; lower 

monthly debt service as a result of mortgage refinancing and the consolidation of high-cost debt into lowcost, tax-favored mortgage debt; overall growth in 

consumer credit; and fiscal stimulus. In contrast, the 

corporate sector has shown little or no progress in 

expanding investment spending (see Chart 1) or 

employment, thus limiting its contribution to 

economic growth. 

To date, the banking and thrift industries have largely 

been spared the effects of the broader corporate sector 

weakness for several reasons. Commendably, the industry has exercised better risk sharing and developed 

more diversified income sources than in previous 

economic downturns. Also, falling interest rates and 

the strength of the consumer sector have resulted in 

Chart 1 

Business Investment Is Not Yet Contributing
 

Much to Economic Growth
 

Higher provision expenses were far outweighed by a 

large increase in net operating revenue. The banking 

and thrift industries’ net operating revenue increased by 

almost $39 billion in 2002 over the previous year. This 

surge in operating revenue far outweighed the $5.1 

billion increase in loan loss provisions during the year. 

Within operating revenue, net interest income 

increased by $25.2 billion, while noninterest revenue 

increased by $13.7 billion despite a decline in revenues 

associated with capital market activities. 

Business Investment Contribution to


Real GDP (% at annual rate)
 

3 

2 

1 

0 

–1 

–2 

’88 ’90 ’92 ’94 ’96 ’98 ’00 ’02 

–3 

A historically steep yield curve helped boost the indus- Source: Bureau of Economic Analysis 

try net interest margin (NIM) to a five-year high of 

FDIC OUTLOOK 3 SUMMER 2003 
In Focus This Quarter 

a windfall for banks and thrifts through strong 

consumer loan growth, consumer-related fee income, 

and improved NIMs and income—gains that more 

than offset rising provision expenses. With signs that 

the consumer sector may be slowing, and given that 

deposit rates have reached a floor, the primary question 

hanging over financial institutions is whether record 

earnings performance can continue. 

The outlook for industry performance will depend 

on resolving a number of outstanding issues, both 

economic and operational. The following issues 

could challenge continued industry strength and 

earnings growth: 

• an uncertain or stalled transition from consumerdependent economic growth to a broader-based 

recovery, including business investment; 

• restructuring and continued difficulties in the 

corporate sector; 

• vulnerabilities in certain business models conceived 

in a stronger economy; 

• an unprecedented and challenging interest rate 

environment; 

• corporate governance issues and associated reputational risks; and 

• increasing operational risk that, in some cases, has 

resulted from cost cutting at the expense of important loss mitigation functions, such as internal audit. 

Two Views of Recent Economic Weakness 

Assuming that the recovery began sometime in 2002, 

its unbalanced nature is not typical in U.S. economic 

history. Most analysts agree that for economic growth 

to gain momentum, a transition must take place 

whereby an expanding corporate business sector takes 

a growth leadership position, thus compensating for 

potentially slower gains in consumer spending. Greater 

vigor in business investment and inventory accumulation will be major factors in determining the vitality of 

U.S. economic growth—and the direction of insured 

institution performance—for the remainder of 2003. 

the 2001 recession. The first view maintains that a 

postboom structural overhang, characterized by high 

corporate debt and excess capacity, will take years to 

unwind. The second view maintains that much of the 

needed corporate reform and restructuring have been 

completed and that transient factors—the threat of 

terrorism, war in Iraq, unusually severe winter weather, 

and, most recently, the outbreak of the severe acute 

respiratory syndrome (SARS) virus—caused a temporary break in hiring (see Chart 2) and investment in 

early 2003. 

Historically, economic data have been particularly 

mixed around turning points, with various signals 

pointing in different directions. Based on the admittedly mixed evidence, and barring additional significant negative surprises, it appears likely that business 

hiring and investment will pick up, now that many 

of this year’s drags on growth have passed or at least 

moderated. If this scenario plays out, many of the 

banking system’s potential vulnerabilities (discussed 

below) will recede. 

The downside risks are of two sorts. First, the corporate structural overhang may have further to run; if 

so, modest increases in business investment and 

hiring may not adequately replace faltering growth in 

consumer spending. Second, certain geopolitical and 

global economic factors may continue to weigh on 

business confidence, including the potential for a 

protracted U.S. peacekeeping, nation-building presence in Iraq; additional terrorist attacks against the 

United States; and an ongoing global recession— 

recently made worse in some parts of Asia by the 

SARS outbreak. 

Chart 2 

Weakness in Hiring Early This Year May Have 


Been Due to One-Time Factors
 

Total Payroll Employment (peak month=100) 

1990–91 Recession 

2001 Recession 

95 

96 

97 

98 

99 

100 

101 

May, 2003 

–24 –18 –12 –6 0 6 12 18 24 30 36 

Months Before/After Onset of Recession 

Two views prevail as to why corporate sector growth Source: Bureau of Labor Statistics

remains restrained two full years after the beginning of 

FDIC OUTLOOK 4 SUMMER 2003 
In Focus This Quarter 

Banks Have Thrived in the Consumer-Driven 

Recovery 

GDP growth in 2002 reflected the narrow, consumerdriven underpinnings of economic activity, as modest 

contributions to growth from housing and government 

last year were offset by rising imports and a weakening 

in exports late in the year. Despite the corporate bankruptcies, layoffs, and erosion of equity market wealth 

associated with the 2001 recession, consumer spending 

expanded in every quarter throughout the past two 

years. Personal consumption growth has persisted 

because of monetary and fiscal policies that helped, in 

aggregate, to offset job losses and maintain household 

disposable income. 

Aggressive monetary policy easing by the Federal 

Reserve, begun in January 2001, contributed to a 

dramatic shift in the yield curve from inverted in 2000 

to steep and upward sloping by year-end 2001, and 

brought short- and long-term rates down to levels not 

seen for 40 years. Over most of the Fed’s latest easing, 

the month-end spread between three-month and tenyear Treasury rates averaged roughly 230 basis points. 

As a result, on a year-over-year basis during much of 

2002, net interest margins widened among institutions 

of different asset sizes and banking business models 

(including commercial, residential, and consumer 

lenders). Quarterly NIMs rebounded quickly during 

2001 and steadily improved until fourth quarter 2002. 

Over the same period, gains in net interest income, 

resulting largely from Federal Reserve policy, helped 

offset rising charge-offs at banks and thrifts. 

Federal Reserve policy achieved its desired effect on 

consumer demand, and banks benefited from the 

response. By taking on new debt and refinancing existing debt at more favorable rates, households were able, 

for the most part, to continue to service growing debt 

and sustain aggregate demand. Over the past two years, 

cash-out mortgage refinancing freed up an estimated 

$180 billion for consumers to either spend or save (see 

Chart 3). Over that period, households also took out 

an additional $169 billion of consumer debt, according 

to the Federal Reserve’s flow of funds data. The growth 

in consumer indebtedness contributed to insured institutions adding $375 billion to consumer and mortgage 

lending in 2002, accounting for two-thirds of total 

asset growth. 

Mortgage applications increased by 28 percent in 2002, 

from record-high levels in 2001, while refinancing 

activity rose by 36 percent. The booming mortgage 

market provided a windfall for banks and thrifts 

through the inflow of refinancing and mortgage 

origination fees. Through May 2003, mortgage rates 

continued to hold near historic lows, and the refinance 

pipeline remained full. However, analysts’ opinions 

about the strength of refinancing activity going 

forward differ widely. Even if mortgage rates remain 

low, many of the mortgages that can be refinanced 

already have been. Furthermore, stagnation of home 

appreciation could dampen demand for cash-out refinancing, which has been both a driver of consumer 

demand and a support for consumer credit quality. 

Ongoing corporate restructuring may continue to 

weigh on employment growth, which also would 

limit gains in consumer demand. 

Subprime Consumer Credit Quality Remains 

a Concern 

The growth in bank consumer lending has not come 

without credit costs. Credit card charge-offs exceeded 

6 percent of average balances in 2002 as personal 

bankruptcy filings topped 1.5 million for the first 

time. Despite sharply higher loan losses, credit card 

lenders earned a combined return on assets of 3.6 

percent and a return on managed assets of 2.3 percent 

in 2002. Return on equity also has risen for this 

specialty group, despite higher capital requirements 

for certain securitization activities. In terms of earnings, prime consumer lending specialists, in particular, 

generally outperformed the rest of the industry. 

Chart 3 

Households Have Liquidated Equity, 

Increasing Their Ability to Spend 

Source: Freddie Mac, Bureau of Economic Analysis Home Equity Cashed Out, % Share of Personal Consumption (line)

Cash-Out Volume, $2003 Billions (bars) 

0.0 

0.2 

0.4 

0.6 

0.8 

1.0 

1.2 

1.4 

0 

20 

40 

60 

80 

100 

120 

annualized

’93 ’95 ’97 ’99 ’01 ’03 ytd,

FDIC OUTLOOK 5 SUMMER 2003 
In Focus This Quarter 

A weak job market and a slowing in receivables growth 

have contributed to rising charge-offs. Rapid growth of 

accounts can mask deteriorating credit quality trends, 

because new accounts tend to have lower loss rates 

than seasoned accounts. A continued slowdown in the 

growth of credit card receivables will likely result in 

higher loss rates. In addition to cyclical pressures, the 

wider availability of consumer credit over the past 

decade may affect aggregate credit quality adversely. 

At the FDIC consumer debt roundtable on February 

28, 2003, the extension of credit to higher-risk borrowers and growth of the subprime lending industry were 

discussed as part of a long-term “consumer lending 

revolution” that is likely to result in permanently 

higher loss rates for many consumer lenders. While 

higher loss rates, in and of themselves, are not necessarily an impediment to profitability, the extent to which 

some lenders’ credit scoring technology underpredicted 

losses during the recession is a concern. For subprime 

lenders in particular, loss rates rose more than predicted 

during the recession, and some lenders were not 

prepared for the volatility of loss rates demonstrated by 

the higher-risk loan pools. Even rating agencies were 

taken aback by the extent and velocity of portfolio 

deterioration at some credit card lenders. 

As of year-end 2002, the FDIC identified 125 institutions as subprime lenders (with 25 percent or more of 

Tier 1 capital in subprime loans). These institutions 

held $62.8 billion in subprime assets. This level had 

declined from two years earlier, when 156 institutions 

holding $70.3 billion in subprime assets were identified. The decline, by and large, is the result of a 

retrenchment of activity by former subprime lenders, 

and this retrenchment has led to an overall decline in 

the number of problem banks (defined as institutions 

rated a 4 or 5). However, some institutions have 

remained committed to this business line and have 

replaced those that have withdrawn. 

Some subprime lenders followed the consumer lending 

revolution to troubled bank status (defined as institutions rated a 3, 4, or 5). Although the number and 

assets of subprime lenders rated 3, 4, and 5 have 

declined since 2000, the volume of subprime assets held 

by troubled institutions is higher. Of the 125 institutions identified as subprime lenders, 48 are rated 3, 4, 

or 5, and the dollar volume of subprime assets held by 

these 48 troubled institutions is $26.1 billion. Two 

years ago, 54 subprime lenders were rated 3, 4, or 5, 

and they held $19.9 billion in subprime assets. The 

majority of the institutions currently identified as most 

susceptible to failure are subprime lenders. 

Ongoing Risks in Consumer Lending 

Several additional factors could lead to a continued rise 

in subprime and prime consumer charge-offs. A continued weak employment picture, unfavorable bankruptcy 

reform, and any decline in the “take-out financing” 

provided by cashed-out home equity could result in 

higher consumer loan charge-offs. 

Credit losses aside, some consumer lending business 

models have been found inadequate for other reasons 

in staving off the market and economic challenges of 

the recession. Among these business models are 

those, such as certain home equity and credit card 

lenders, that relied heavily on the securitization 

market for funding and were, therefore, highly sensitive to pricing in this market. These institutions were 

unable to meet liquidity demands when access to the 

securitization market became more selective.1 

Other business models relied on the generation of fees 

from programs such as the sale of “club” memberships, 

such as frequent flier programs, or credit-life insurance. 

Demand for these products has proved tenuous, and 

credit losses at these lenders are cutting more deeply 

into total revenue as this source of fee income fades. 

Finally, some business strategies have relied on thirdparty relationships that have given rise to significant 

operational risks. In some instances, these relationships 

have resulted in reputational and legal risks for the 

contracting banks; in extreme cases, they have caused 

significant fraud-related losses. 

Credit card lenders face several challenges in the 

future that are not yet reflected in their performance 

results. Securitization costs are rising, not only 

because of market conditions but also as a result of 

increased subordination levels. The latter condition 

resulted from rating agencies’ diminished view of the 

value of early amortization as a credit enhancement. 

Credit card lenders also face generally higher capital 

requirements for retained interests in securitizations 

because of recently enacted regulations and may face 

1 Capital market conditions recently resulted in securitization pricing 

for one credit card lender that some analysts estimate will cost as 

much as an additional $10 million over the life of the transaction 

because of current market selectivity. 

FDIC OUTLOOK 6 SUMMER 2003 
In Focus This Quarter 

higher requirements under the proposed Basel II capital requirements. 

Home equity lending is emerging as another risk 

area in consumer lending. The FDIC has previously 

addressed this issue in its more egregious form—high 

loan-to-value lending—but the risks of other forms of 

home equity lending may be subtler. Lenders have a 

tendency to price this product very thinly because of 

stiff competition and the perception that home equity 

lending will perform similarly to other residential 

lending; however, they may find that borrowers 

behave differently when there is not as much equity 

at stake, even if they face a nominal threat of foreclosure. Stagnant or declining home values in certain 

markets may exacerbate this effect. 

Continued consumer sector strength will depend on 

the resilience of real disposable income growth. An 

active mortgage refinancing market through May 

2003 also bodes well for consumer liquidity, though 

the extent to which consumers choose to spend 

cashed-out equity or reductions in monthly mortgage 

payments remains uncertain—they may choose to 

retire other debt or increase saving instead. Although 

new tax rebates, an additional extension of unemployment benefits, and tax cuts were approved in 

May, monetary and fiscal stimuli may not boost 

consumption growth significantly during the next six 

months, especially if households elect to save more or 

retire debt, rather than increase spending. Any slowdown in consumption growth may impede the overall 

economy’s pace, unless it is offset by another source 

of expanding aggregate demand. 

Business Spending and Hiring Necessary 

to the Recovery 

In contrast to the robust consumer and banking sectors, 

contracting corporate business investment dragged on 

overall U.S. economic growth throughout 2001 and 

most of 2002. After nearly a decade of uninterrupted 

sequential quarterly growth, aggregate real nonresidential investment has contracted more than 10 percent 

over the past two years. In this sense, the 2001 recession can be viewed primarily as a nonfinancial corporate sector recession, as opposed to the “traditional” 

recessions that affect consumers, financial companies, 

and other businesses more evenly. 

Chart 4 

Business Investment Has Yet to Show Any 

Meaningful Upturn 

Source: Bureau of Economic Analysis Nonresidential Fixed Investment (% change at annual rate) 

’89 ’90 ’91 ’93 ’94 ’95 ’96 ’97 ’92 ’98 ’99 ’00 ’02 ’03’01 

Equipment and Software (bars) 

Structures (line) 

–40 

–30 

–20 

–10 

0 

10 

20 

30 

40 

Currently, business investment appears to be the most 

likely replacement for any slowdown in consumer 

spending. Residential investment and government 

spending are expected to continue growing, but probably not at the higher rates necessary to compensate for 

an easing in consumption growth. No improvement is 

foreseen in net exports; in fact, the U.S. current 

account deficit is likely to continue deteriorating over 

the near term despite the dollar’s recent depreciation, 

as weak final demand abroad may more than offset 

lower dollar-denominated prices. 

Although the importance of stronger growth in business investment (and hiring) is clear, there is substantial debate about when the pace of these activities will 

pick up. As seen in Chart 4, equipment and software 

investment had been recovering modestly last year but 

slowed in first quarter 2003. The slowdown, though, 

was mostly due to a drop in transportation equipment 

outlays; technology investment continued to grow. 

Meanwhile, the overall decline in business plant and 

structure investment seemed to stabilize by early 2003. 

While the recession-induced decline in capital equipment spending may be over, a return to strong growth 

remains elusive. Much of the needed corporate restructuring may have occurred already, but the problems of 

high debt loads, excess capacity, and slow revenue 

growth may be slow to abate. 

FDIC OUTLOOK 7 SUMMER 2003 
In Focus This Quarter 

Business Recession Has Hurt 

Commercial Credit Quality 

In contrast to the strong growth of consumer lending, 

commercial credit provided by banks and thrifts 

increased by only $13.8 billion in 2002. During the 

corporate sector shakeout that accompanied the recession, more than 78,000 businesses failed in two years. 

These bankruptcies contributed to 229 defaults on 

almost $197 billion in publicly rated bonds over the 

same period. 

Banks, particularly large banks, have not been immune 

to these corporate credit trends as commercial and 

industrial (C&I) loss rates increased during the past few 

years. Loan losses have been disproportionately borne 

by large banks because of poor risk-selection practices 

during the rapid syndicated loan growth years of 

1996–2000 and high-profile financial woes brought 

on by accounting irregularities exposed at a number of 

formerly investment-grade companies (“fallen angels”). 

Recently, the segment of the industry experiencing 

worsening credit quality trends has narrowed. In fact, 

three large banks accounted for all of the $2.1 billion 

increase in losses on C&I loans at FDIC-insured institutions in 2002. 

Commercial Credit Problems Likely to Abate 

Two trends look promising for commercial credit quality in the near term. First, C&I charge-offs declined in 

fourth quarter 2002 by almost 30 percent from a year 

ago. Second, noncurrent C&I loans (those 90 days or 

more past due or in nonaccrual status) fell by $1.2 

billion during the quarter—the first quarterly decline in 

three years. A continued improvement in noncurrent 

C&I loans will help the industry’s coverage ratio, which 

has been declining since 1998. C&I losses seem to 

follow default rates on noninvestment-grade corporate 

bonds, suggesting continued improvement in C&I loan 

quality this year (see Chart 5). The extent of the 

improvement in commercial credit quality will be evaluated during the 2003 Shared National Credits (SNC) 

Review by the three federal bank regulatory agencies. 

Results for the 2003 review should be available by 

September. 

Chart 5 

Sources: Moody's, FDIC 

Commercial and Industrial (C&I) Loan Loss Rates May 

Follow Speculative Corporate Bond 

Default Rate Lower 

U.S. Speculative-Grade Corporate Bond Issuer 

Default Rate 

C&I Loan Net Charge-Off 

Ratio 

0 

2 

4 

6 

8 

10 

12 

14 

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

C&I 

Bonds 

’91 ’93 ’95 ’97 ’99 ’01 ’03 

Credit Implications of Corporate Sector 

Restructuring 

In addition to the rash of corporate defaults and bankruptcies during this period of restructuring, other businesses have been downsizing, reducing their workforces 

in response to strong domestic and foreign competition 

and lackluster sales growth. Reducing workforces has 

raised productivity levels and helped to maintain profits, but it has also idled large amounts of plants and 

equipment. Industrial capacity utilization tumbled 

precipitously from May 2000 through December 2001, 

falling from 83.6 percent to 74.6 percent, mostly as a 

result of weakness in manufacturing. Although capacity 

use rose somewhat in early 2002, that gain was shortlived. As a result, April 2003 overall capacity utilization of 74.4 percent was little changed from the 

December 2001 rate. 

Reduced workforces and lower capacity utilization (as 

well as historically lean inventories) have implications 

for commercial real estate (CRE) and potential C&I 

loan growth. Because the recession caused demand for 

working capital to diminish, commercial loan demand 

declined also. As a result, although total loans at 

commercial banks have grown steadily for the past few 

years, the percentage of C&I loans to total loans has 

been declining. Historical precedent suggests that C&I 

loan demand will remain lackluster so long as capacity 

utilization remains low and corporate profit growth 

lacks traction. 

In addition, the effects of corporate restructuring have 

been reverberating through the CRE markets, resulting 

FDIC OUTLOOK 8 SUMMER 2003 
In Focus This Quarter 

in continued upward pressure on office vacancy rates 

and unprecedented negative net absorption. Throughout this period of corporate restructuring, many property owners have been confronted by tenants 

demanding lower rents and who are scrambling to pare 

back holdings of office, industrial, apartment, retail, 

and other space. But in spite of the weaknesses in CRE 

market fundamentals, CRE credit quality at insured 

institutions has remained sound. Past-due loans and 

charge-offs remained at near-record lows through yearend 2002 for each of the three commercial real estate 

loan categories: construction and development, multifamily, and nonfarm-nonresidential (see Chart 6). 

A number of factors may explain the disconnect 

between market fundamentals and banks’ CRE credit 

performance. In contrast to the CRE downturn of the 

late 1980s and early 1990s, the current situation is 

due mostly to rapidly diminished demand rather than 

to oversupply. While many landlords have had to 

accept static or lower rents to remain competitive in 

attracting and retaining tenants, few have found this 

situation to be a major hindrance to net cash flow, 

largely because the low interest rate environment has 

enabled property owners to refinance existing CRE 

loans at lower rates. 

The stronger performance of CRE loans at banks and 

thrifts in this cycle is due also to the fact that risk has 

been spread more widely through the tremendous 

growth in commercial mortgage-backed securities 

(CMBS) and real estate investment trust (REIT) activity since the last cycle. Growth in these aspects of 

public real estate markets has enhanced transparency 

and public scrutiny of CRE fundamentals. In addition, 

increased regulator oversight and tighter CRE lending 

requirements may have improved the underlying credit 

quality since the last cycle. 

Several issues regarding commercial real estate 

warrant continued monitoring, however. Many properties that had been under construction are now 

coming on line, and for those that had leases 

executed during the boom period of two years ago, 

the full effect of the decline in market rents has yet 

to be felt. The cash flows generated by these newly 

completed properties could be considerably less than 

was anticipated when the original construction, or 

takeout, financing was arranged. Similarly, as existing 

leases on occupied properties come up for renewal, 

landlords face the prospect of tenants returning 

unused space or requesting rent concessions. In addiChart 6 

Commercial Real Estate (CRE) Loans Continue to Be
 

Protected from Weak Fundamentals...
 

but for How Long?
 

Percent

Percent 

Office Vacancy Rate (right scale) 

0 

2 

4 

6 

8 

10 

12 

14 

10 

15 

20 

0 

5 CRE 

Delinquencies (left scale) 

CRE 

Charge-Offs (left scale) 

’91 ’93 ’95 ’97 ’99 ’01 ’92 ’94 ’96 ’98 ’00 ’02 

Source: Call Reports, Torto Wheaton Research 

tion, sublease space exerts downward pressure on 

market rents as overextended tenants seek to exit 

properties by finding substitute tenants to assume 

their leases at less than market rents. 

The extent to which low rates have kept weak CRE 

market fundamentals from affecting banks’ credit quality will be tested if rates rise before the demand for 

space improves, and some analysts envision a corporate 

restructuring process that could result in just such a 

scenario. Corporate restructuring may continue to push 

the work of some firms offshore, especially laborintensive businesses and those with minimal product 

shipping costs, such as software companies. This 

scenario could be accompanied by rising interest rates 

without a recovery in the demand for industrial space. 

An additional concern that affects both CRE and nonreal estate-related commercial lending is larger companies’ lack of pricing power. The recent slow economic 

growth has limited the ability of larger companies, especially those that face international competition, to raise 

prices. A global recession and slack capacity worldwide 

in many industries has engendered significant disinflationary (and outright deflationary) trends in recent 

years. In the absence of strong revenue growth, income 

growth has become dependent on cost control. As a 

result, large companies have been seeking price reductions from other businesses down the supply chain. For 

example, the major auto manufacturers have recently 

pressed their parts and assembly suppliers for price 

concessions. It is likely that pricing pressures will 

continue to be passed down, affecting revenue at midand small-sized businesses. This could, in turn, affect 

FDIC OUTLOOK 9 SUMMER 2003 
In Focus This Quarter 

the credit quality of the smaller financial institutions 

that lend to these companies. 

Other Emerging Risks in Banking 

Market-Sensitive Revenues 

Diversification of revenue streams has been noteworthy industrywide, with noninterest income continuing 

to grow as a percentage of net operating revenue. 

While such strategies have produced lower earnings 

volatility for many institutions, this has not been 

the case for some of the largest financial companies 

because of heavy reliance on market-sensitive 

revenues. Some institutions have experienced highly 

volatile earnings over the past two years, largely 

because of investment banking, merchant banking, 

and proprietary trading activities. For example, weak 

and volatile financial markets led to losses in private 

equity funds and venture capital activities totaling 

$1.2 billion for commercial banks during 2002. Significant declines in trading revenues were also seen last 

year, particularly at the seven largest banking organizations. Even trust management revenue—a former 

stalwart—has declined as a result of the prolonged 

bear market. In total, market-sensitive revenue for 

commercial banks declined by almost $1.7 billion 

from 2001 to 2002. 

Interest Rate Risk 

In 2002, the historically steep yield curve helped 

boost the industry’s net interest margin to a five-year 

high of almost 4 percent. The significant decline in 

short-term rates, prompted by a series of cuts in the 

federal funds rate starting in January 2001, contribChart 7 Median Net Interest Margin (%) 

Source: Call Reports 

Recent Dip in Median Net Interest Margin Suggests 

that Funding Costs Are Nearing a Floor 

4.0 

4.1 

4.2 

4.3 

4.4 

1999 2000 2001 2002 2003 

uted to a dramatic shift in the yield curve from 

inverted in 2000 to steep and upward sloping by yearend 2001. A steeply upward sloping yield curve has 

persisted since then, although the spread between 

ten-year note and three-month Treasury bill yields 

narrowed from nearly 350 basis points in early 2002 

to 234 basis points by May 20, 2003. This easing of 

longer maturity yields was the result of emerging 

concerns over the U.S. economy’s near-term 

economic growth prospects, as well as expectations 

of further rate reductions by the Federal Reserve. 

In addition to the generally favorable aggregate industry NIM through 2002, NIMs widened among institutions of different asset sizes and banking business 

models (including commercial, residential, and 

consumer lenders). Nevertheless, one area of concern 

arises in an examination of the recent trend in the 

industry’s median NIM (that of a typical institution). 

This measure of NIM contracted in fourth quarter 2002 

(see Chart 7). 

The fourth quarter 2002 narrowing in median NIM 

suggests that the benefit derived from low short-term 

rates may have run its course and that many banks 

are finding significant resistance to lowering funding 

costs any further. The historically low level of shortterm rates has led to a complex interest rate risk 

environment in which various banks are exposed to 

potentially adverse interest rate scenarios. Recent 

FDIC analysis has found that relationships between 

NIM performance and rates appeared to be stronger 

in past higher-rate environments, but recently that 

link has started to break down as rates have fallen 

below a certain point. 

Chart 8 

Since 2001, the Effective Federal Funds Rate 

Has Fallen Farther than Money Market Rates 

Percent 

7 

6 

5 

4 

3 

2 

1 

0 

Effective 

Federal Funds Rate 

Bank Average 

Money Market and Retail CD Rate 

1999 2000 2001 2002 2003 

Source: BanxCorp/Bloomberg Analytics 

FDIC OUTLOOK 10 SUMMER 2003 
In Focus This Quarter 

At this stage of the rate cycle, banks with the highest 

percentage of very low cost funding appear to be most 

at risk, from a net interest income perspective, to a 

falling or even stable rate environment. This is because 

funding that is already not rate-sensitive will not get 

cheaper, no matter how long low rates persist. In fact, 

the longer low rates persist, the more likely it is that 

the yield on assets of these banks will fall without an 

offsetting decline in funding costs. The risk of lower 

asset pricing was highlighted by the renewed flattening 

of the yield during May 2003. 

Even larger banks (which, because of a higher percentage of market-based funding, reaped the benefit of low 

short-term rates sooner than smaller institutions) have 

not been immune to the magnitude of the rate decline. 

Large-bank assets are currently repricing downward 

more quickly than funding costs (see Chart 8). 

As shown in Chart 8, the effective federal funds rate 

has declined steeply since 2001, almost to the average 

level of retail certificates of deposit (CDs) and bank 

money market rates by early 2003. (The retail CD and 

bank money market average rate provides a proxy for 

deposit costs.) As a result, new money that flows into 

some banks may be invested at a loss, at least initially, 

because the narrow spread between estimated deposit 

costs and the effective federal funds rate (interest paid 

on bank-invested overnight funds) may not cover 

operating expenses. Therefore, some banks face margin 

compression in the current low interest rate environment as higher-yielding loans and securities reprice at 

lower rates, while funding costs seemingly have 

reached a trough. 

Chart 9 

In addition, more positively sloped yield curves have 

historically induced some banks to take on additional 

risks. Banks took a record $12 billion in securities gains 

in 2002. If these securities were not sold to meet loan 

demand, replacing them with lower-yielding assets may 

dampen future profitability. Moreover, flush with 

deposits and challenged for loan growth, banks tend to 

reach for yield in their securities portfolios by extending maturities and, in some cases, increasing the 

complexity of their securities portfolio and, more 

recently, their liability structure. 

A further flattening of the yield curve could result in a 

greater narrowing of NIMs for banks with high concentrations of long-term assets. While measures of such 

concentrations have stabilized during the past few 

years, residential mortgage lenders continue to report 

higher levels of long-term assets as a result of the recent 

refinancing wave. 

The interest rate risk positions of banks with high 

concentrations of long-term assets likely will result in 

NIM compression if short-term interest rates rise. 

Following the 1998 refinancing wave, some banks were 

left with high concentrations of long-term assets, which 

typically expose institutions to a rise in short-term 

interest rates. From mid-1999 through 2000, short-term 

interest rates rose relative to long-term rates (the yield 

curve flattened), and banks with higher concentrations 

of long-term assets reported weaker NIM performance 

than those with lower concentrations of long-term 

assets (see Chart 9). 

From first quarter 1999 through 2000, banks with high 

concentrations of long-term assets reported a decline in 

Net Interest Margin (NIM) Performance Diverged Following 1998 Refinancing Wave for Banks Holding... 

Basis Point Flattening Yield Curve Steepening Yield Curve 

Change in NIM 

...Low Levels of Long-Term Assets 25
 

15
 

5
 

...High Levels of –5 Long-Term Assets
 

–15
 

–25 1999–2000 2001–2002 

Note: A high level of long-term assets is defined as a ratio of long-term assets to earning assets above the 95th percentile. A low level is defined as a ratio below the 25th percentile. 

Source: Bank Call Reports 

FDIC OUTLOOK 11 SUMMER 2003 
In Focus This Quarter 

the median NIM of 15 basis points, compared with an 

increase of 23 basis points for banks with low levels of 

long-term assets. This situation reversed in 2001, as 

banks with high levels of long-term assets began to 

benefit from steepening in the yield curve. However, if 

short-term interest rates rise following the current refinancing wave, as they did after the 1998 wave, this 

group of banks again could experience greater compression in NIMs than other banks. The banks with the 

highest levels of long-term assets are centered in the 

Northeast and on the West Coast. 

Reputational and Legal Risks 

Certain institutions have received heightened 

scrutiny over their dealings with companies such 

as Enron and Worldcom, as well as over their past 

investment banking activities. The reputational 

damage caused by negative media coverage of these 

issues is difficult to measure. 

However, lapses in corporate governance could result 

in direct losses in the form of increased legal costs, 

damages from investor lawsuits, and regulatory fines. 

According to Donald Langevoort of the Georgetown 

Law Center, a likely estimate of eight banks’ scandalrelated exposure to investor lawsuits alone is close to 

$20–$25 billion.2 Any investor litigation is likely to be 

a protracted affair—taking years, not months—and this 

cost may be spread over a long period. However, 

according to one large-capitalization banking analyst 

group, noninterest expenses as a percentage of net operating revenue for the largest financial institutions was 

as much as 780 basis points higher in the fourth quarter 

of 2002 as a result of legal expenses.3 The ultimate 

result could be legal costs amounting to four times more 

than what the largest financial companies have 

reserved for so far. According to some analysts, some 

banks may be reluctant to reserve for potential damages 

because they believe that a provision for lawsuits could 

be viewed as an invitation to sue. 

In addition to legal expenses, banks may find that reputational and legal risk, and the associated uncertainty 

2 Prudential Financial Research, Lawsuits Against Banks, January 14,
 

2003, p. 12.
 

3 FBR Financial Services Research, Bank & Finance Weekly, January
 

15, 2003, p. 5.
 

surrounding ultimate payouts, results in higher market 

funding costs. As news of progress or regress in lawsuits 

is released or even speculated about, bond spreads for 

the companies involved will likely become more 

volatile, and they may find it difficult to raise additional equity should they need it. 

Internal Controls 

The cost to generate each dollar of revenue at insured 

institutions (the efficiency ratio) declined substantially in the past decade, from almost 76 cents at yearend 1990 to almost 56 cents at the end of 2002. Some 

of this decline reflects benign or even positive factors, 

such as consolidation benefits and lower loan workout 

costs. However, bank supervisors are concerned that 

some of this improved efficiency may have come at 

the expense of internal controls or other important 

loss mitigation functions, such as internal audit. For 

this reason, bank supervisors have intensified review 

of efforts to detect and reduce suspicious activities at 

banks. 

Increased reporting of suspicious activities, anecdotal 

evidence from recent Reports of Examination, and the 

nature of enforcement actions brought against banks in 

the last year suggest that bank supervisors have brought 

significant resources to bear on these issues. From the 

perspective of the deposit insurer, these are resources 

well-spent. Since 1997, fraudulent activity and 

accounting irregularities have resulted in the greatest 

losses to the FDIC. Of the 35 failures since 1997, 22 

involved fraudulent activity or accounting irregularities. 

The weighted average loss rates where fraud or irregular 

accounting has been indicated as a significant 

contributing factor to the failure is 37 percent-more 

than twice the average loss rate for similar size institutions since 1986. These failures cost the insurance 

funds almost $2 billion, or 86 percent of the total cost 

to the funds since 1997. 

Richard Austin, Senior Financial Economist 

Allen Puwalski, Senior Policy Analyst 

FDIC OUTLOOK 12 SUMMER 2003 
Regional Perspectives 

Atlanta Regional Perspectives
 

Implications of State and Local 

Government Budget Deficits 

State and local government finances 

in the Atlanta Region have been 

affected adversely by losses in U.S. 

equity markets and the lingering effects of the recent 

recession. Declines in tax 

revenues, the burden of 

funding commitments 

made during the 1990s for 

government programs and 

projects, increased Medicaid 

costs, and the escalating costs of homesurpluses into deficits. These deficits, in 

land defense have converted budget 

combination with statutes that require states to 

maintain balanced budgets, have forced governments to 

seek ways to cut spending and boost revenues. This 

article analyzes the implications of such contractionary 

fiscal policies and discusses the potential effects of 

government policies in the Atlanta Region on the local 

banking industry. 

Large State and Local Budget Deficits 

Have Emerged Quickly since 2001 

The reversal in state and local government fiscal conditions nationally has been unprecedented in terms of 

scale and rapidity since World War II (see Chart 1). 

Chart 1 

Source: Flow of Funds, Bureau of Economic Analysis (Haver Analytics) 

Rapid Deterioration in State and Local Finances 

Nationwide Has Been Unprecedented 

Surplus (+)/Deficit (–)

($ 1996 Billions) 

1Q52 1Q56 1Q60 1Q64 1Q68 1Q72 1Q76 1Q80 1Q84 1Q88 1Q92 1Q961Q00 

80 

–60 

–40 

–20 

0 

20 

40 

60 

Surpluses peaked at nearly $60 billion in early 1999 as 

capital gains and the record-long economic expansion 

supported robust state and local government tax 

revenue increases. Program and project funding 

expanded, and permanent tax cuts were enacted. The 

piercing of the stock market bubble and the decline in 

economic growth from 2000 through 2001, however, 

significantly constrained revenue growth, while spending commitments continued to rise (see Chart 2). 

Other factors have also aggravated the deteriorating 

fiscal conditions, including the costs of homeland 

defense, the spiraling costs of federally mandated 

programs such as Medicaid, and, recently, sharp 

increases in energy prices. Commitments to public 

assistance programs, such as unemployment insurance 

benefits, also helped inflate expenditures. (Between 

2000 and 2001, initial unemployment insurance claims 

rose 33 percent.) The record surpluses of the late 1990s 

evaporated in less than two years, and the rapid erosion 

in fiscal balance sheets has contributed to what many 

governors have described as the worst fiscal crisis for 

states since World War II. Even with a more robust 

recovery, this crisis is expected to persist into the 

future.1 

Chart 2 

State and Local Government Surpluses 

Nationwide Have Evaporated Quickly 

Source: Federal Reserve Board (Haver Analytics) Surplus (+)/Deficit (–) (Seasonally Adjusted Annual Rate, $ Billions)

Total Receipts/Total Expenditures 

(Seasonally Adjusted Annual Rate, $ Billions)

Surplus (+)/Deficit (–) 

Expenditures 

Receipts 

–60 

–40 

–20 

0 

20 

40 

60 

80 

800 

900 

1,000 

1,100 

1,200 

1,300 

1,400 

1Q95 1Q96 1Q97 1Q98 1Q99 1Q00 1Q01 1Q02 

1 See, for example, Dennis Cauchon, “State, Local Spending Up 

Despite Downturn,” USA Today, January 15, 2003, page 1A, and 

“U.S. Governors Say Deficits Worst in Decades, Seek Federal Aid,” 

Todd Zeranksi, Bloomberg.com, February 22, 2003. 

FDIC OUTLOOK 13 SUMMER 2003 
Regional Perspectives 

States Have Three Policy Options Chart 3 

for Closing Budget Deficits Stock Market Declines Have Affected

 Personal Tax Collections Negatively To close budget deficits, as constitutionally mandated 16,000 31 

12,000 

Stock Price Index 

Personal Tax Collections 

27 

State and Local Government

 Personal Tax and Nontax Receipts 

(Seasonally Adjusted Annual

Receipts, $ Billlions) 

by all states except Vermont, states are being forced to 

adopt, or at least consider, policies that generally fall 

into three categories: increasing revenues, cutting 

expenditures, and borrowing. Many policy options may 

be politically difficult to realize, however, given the 

continued weakness of the economic recovery. 

Governments Are Seeking More Revenues 

Stock Price Index: Wilshire 5000

(EOP, 1/2/80=1078.29)

14,000 29 

10,000 25 

8,000 23 

6,000 21 

4,000 19 

2,000 17 

As average real year-over-year growth in total receipts 

in 2002 slumped to 0.2 percent—one-tenth the average of the latter half of the 1990s—state and local 

governments nationwide have expanded efforts to 

identify additional sources of revenue. As revenues are 

drawn from a variety of sources (see Table 1), governments have explored several options for increasing 

receipts while attempting to minimize the costs borne 

by citizens. 

Government Expenditures Are Being Cut 

During fiscal year 2003, more than half the states cut 

spending, the most common way of reducing budget 

deficits. Despite these cuts, however, expenditures 

continued to increase faster than revenues. Cutting 

spending, like raising taxes, may be difficult during 

periods of sluggish growth. Transfer payments through 

Table 1 

– 15 

1Q931Q941Q951Q961Q971Q981Q991Q001Q011Q02 

Source: Wall Street Journal, Flow of Funds (Haver Analytics)
 

EOP = End of Period
 

a variety of programs account for one quarter of all 

state and local outlays. During downturns, public assistance programs can stabilize the economy but subsequently may entail even greater expenditures. Also, 

efforts to constrain spending are complicated by the 

increasing demands of federally mandated programs. 

Higher education represents one area of state government spending that has seen cuts. Governments have 

also explored deferring investments in infrastructure. 

One of the fastest methods to cut expenditures that does 

not directly entail service cuts is to lay off employees. In 

1999, salaries and wages accounted for nearly one-third 

of state and local government costs. Several states have 

explored staff cuts, early retirement initiatives, and wage 

Sales Taxes Account for Largest 

Share of State and Local 

Government Revenue Nationwide 

freezes (or cuts) to pare direct expenditures. 

Borrowing Is Increasingly Common 

Share of Total 

Current Receipts Receipts (%) 

Federal Grants-in-aid 23 

Personal Tax and Nontax Receipts 21 

Income Taxes 16 

Nontaxes 3 

Other 2 

Corporate Profits Tax Accruals 3 

Indirect Business Tax and 

Nontax Accruals 53 

Sales Taxes 26 

Property Taxes 20 

Other 7 

Contributions for Social Insurance 1 

Source: Bureau of Economic Analysis, 2002Q3 

Cutting expenditures and increasing taxes have been 

essential budget-balancing tools during previous downturns; however, state and local governments are 

increasingly turning to borrowing to fill gaps. In real 

terms, borrowings were more than twice as high as of 

third quarter 2002 as year-ago levels and at the highest 

levels since World War II. A recent USA Today 

article2 quotes Utah Deputy Treasurer Richard Ellis 

saying that such a policy is “like using a credit card to 

pay your bills.” Low interest rates have helped minimize 

the cost of state borrowing, but weak economic conditions and heavy borrowing have affected some states’ 

credit ratings adversely, and debt payments may be a 

burden on state budgets in future years. 

2 Dennis Cauchon, “States Choose Debt to Fill Gaps,” USA Today, 

February 26, 2003. 

FDIC OUTLOOK 14 SUMMER 2003 
Regional Perspectives 

Reducing Deficits May Have Negative Implications 

for Local Economies in the Short Run 

Efforts by state and local governments to close budget 

gaps may exacerbate the prevailing weak economic 

conditions. Reduced government spending and tax 

increases that reduce disposable personal income could 

adversely affect economic performance in the short run. 

An expected worsening in state balance sheets in fiscal 

year 2004 may require additional expenditure cuts and 

tax increases. 

Contractionary fiscal policies at the state and local 

levels may be offset in part by the expansionary policies 

of the federal government; however, the increased 

federal expenditures may not be distributed as evenly 

as those made by state and local authorities. State and 

local government spending represents a large share of 

total government spending; federal efforts to stimulate 

the nation’s economy may be less effective. Moreover, 

some analysts argue that recent federal tax cut proposals to spur growth may inadvertently worsen the financial condition of states.3 States will receive, however, a 

one-time $20 billion transfer from the federal government as part of the recently enacted stimulus package. 

Budget Deficits Exist in the Atlanta Region 

State and local governments in the Atlanta Region 

have not been immune to the effects of equity market 

declines and slower national and regional economic 

growth. Florida and North Carolina are projected to 

have the largest budget deficits in the Region at 

approximately $2 billion each.4 In absolute size, 

however, state budget deficits in the Atlanta Region 

are small compared with those in larger states, such as 

California, Texas, and New York. Nonetheless, as a 

percentage of state budgets, deficits in the Region are 

significant, with Alabama, Florida, and North Carolina 

estimated in the double digits (see Chart 4). 

Proposed government policies and actions in the 

Region since fiscal year 2002 have attempted to address 

3 Iris J. Lay, “President’s Tax Proposals Would Reduce State
 

Revenues by $64 Billion Over 10 Years,” Center on Budget and Policy
 

Priorities, February 4, 2003.
 

4 Estimates of budget deficits vary widely depending on the source
 

data. Also, as the issue of state budget deficits is evolving rapidly,
 

revised estimates occur frequently and can change substantially.
 

Although we considered various estimates, we relied heavily for this
 

analysis on data from the Center on Budget and Policy Priorities.
 

the issue of budget deficits; so far, states have been 

more successful in cutting expenditures than boosting 

revenues. Most states, including Alabama and North 

and South Carolina, have tapped their reserve or rainyday funds as a stopgap financing measure. Increases in 

“sin taxes”—particularly on tobacco products—also 

have been considered but have been difficult to enact 

in tobacco-growing states. Recently, Georgia’s new 

governor proposed increases in sin taxes as a way to 

cut two-thirds of the state’s budget deficit. In West 

Virginia, the Senate Finance Committee voted down a 

proposal in early 2003 to nearly double the tax on cigarettes. Many local governments have been increasing 

property taxes to raise revenues. 

Higher education, in particular, has been a target for 

state funding cuts. As a result, public universities have 

been forced to increase tuition sharply, scale back 

planned expansions, and lay off faculty and staff.5 

Funding cuts could significantly hurt communities, 

such as Athens, Charlottesville, and Tuscaloosa, that 

are highly dependent on the economic contributions 

of public universities and that, until now, have been 

insulated from the worst effects of the recession. 

Most states in the Atlanta Region have cut funding for 

programs such as education, economic development, 

and some social services, either through across-theboard spending cuts or by targeting specific programs. 

Layoffs have been essential to cutting expenditures in 

Virginia and North Carolina. Layoffs in government, 

Chart 4 FY2004 Budget Balance ($ Millions) 

Source: Center on Budget and Policy Priorities 

All States in the Atlanta Region Are Running a Deficit 

FY 2004 Deficit as a Share of FY 2002 State Budget (%) 

West Virginia 

Virginia 

Alabama 

North Carolina Florida 

South Carolina 

(2,500) 

(2,000) 

(1,500) 

(1,000) 

(500) 

– 

Georgia 

0 

0 2 4 6 8 10 16 12 14 

5 Private colleges and universities also have encountered funding 

difficulties as the prolonged equities market downturn has reduced 

the size of endowments. 

FDIC OUTLOOK 15 SUMMER 2003 
Regional Perspectives 

as in other sectors of the economy, can affect local 

economic conditions adversely. Although state 

government employment is concentrated in urban 

areas, particularly state capitals, the effects of such 

layoffs on local economic conditions vary according to 

the relative importance of the government sector to the 

local economy. For example, Raleigh is home to the 

largest number of state government workers in the 

Region—63,300 workers in 2002. Atlanta is second, 

with just over 60,000, followed by Tallahassee, with 

51,900. Even though the concentration of state government employment in the Atlanta Region is less than 

the national average, the shares in Raleigh and Tallahassee are nearly three and nine times the national 

average, respectively.6 Thus, in the event of layoffs, 

some metropolitan areas may be hit harder than others. 

Municipal Revenues May Be More 

Stable than State Revenues 

The same developments that have contributed to 

state budget deficits may have affected metropolitan 

areas negatively, but fiscal conditions at local levels 

generally are more stable, according to a recent 

Standard & Poor’s report,7 because they are less likely 

to rely on cyclical sources of funding, such as income 

tax collections. Property taxes account for just over 

one quarter of all municipal revenue. Continued strong 

home sales and home price appreciation during the 

recent recession have bolstered this component of 

municipal revenue, helping to avert more serious 

deterioration in fiscal conditions. 

Some municipalities, however, have encountered 

declining fiscal conditions. In Atlanta, for example, 

government officials dealt aggressively with a $90 

million deficit in 2002 (a 20 percent budget gap) 

through a combination of tax hikes and layoffs. These 

policies proved effective as the city ended the year with 

a $47 million surplus. Continued economic weakness or 

a retrenchment in the housing market, however, could 

place additional burdens on municipalities such as 

Atlanta. 

6 This measurement is commonly referred to as the Location Quotient.
 

See Atlanta Regional Outlook, first quarter 2003, for an explanation of
 

this statistic.
 

7 Karl Jacob, Michael Zinman, Robin Prunty, Jeffrey Panger, Edward
 

McGlade, David Hitchcock, John Kenward, Jane Ridley, James
 

Wiemken, James Breeding, Alexander Fraser, Jeanie Yarbrough,
 

Geoffrey Buswick, Kenneth Gear, Gabriel Petek, and Ian Carroll,
 

“Public Finance Report Card: The Largest Cities,” Standard and
 

Poor’s Ratings Direct, February 19, 2003. 


The Atlanta Region’s Banking Industry Remains 

Strong but Should Be Watchful 

State and local efforts to address budget deficits could 

have adverse effects on the Region’s banking industry. 

Indirect spending cuts in the form of layoffs in areas 

where state government is a critical component of the 

local economy could weaken overall economic conditions further. As a result, credit quality could deteriorate and demand for loans could decline. Cuts in 

education and social service program funding also could 

affect credit quality negatively as consumers are forced 

to pay more expenses out of their own pockets. These 

funding cuts and tax increases could make debt service 

more difficult for consumers as disposable incomes 

decline, leading to weaker credit quality. Although Call 

Report data suggest that banks have weathered the 

recent recession remarkably well, record trends in 

personal bankruptcy filings, residential foreclosures, 

and corporate defaults, as well as the effects of contractionary state and local fiscal policies, could begin to 

adversely affect the performance of insured financial 

institutions. 

Institutions in the Atlanta Region may be directly 

exposed to state and local government agencies 

through their holdings of municipal bonds (munis). 

According to Call Report data, commercial banks with 

assets less than $1 billion headquartered in Alabama, 

Florida, and North Carolina increased muni holdings 

more rapidly than the nation in 2002. Munis are not 

“default-free,” and recent ratings downgrades for several 

states and municipalities illustrate the rising default risk 

of holding these securities.8 Also, munis are not as 

liquid as Treasuries, and because of current fiscal difficulties, the market’s preference for revenue bonds over 

general obligation issues may increase. Recent proposals 

to end double taxation on dividends may affect market 

yields of tax-exempt munis adversely as the benefits of 

holding equities increase. Bank management should 

monitor developments and trends affecting municipal 

borrowers’ fiscal condition as well as the impact of tax 

policy on yields to identify risks to municipal bond 

holdings. 

8 Ted Hampton, “Municipal Bond Credit Rating Cuts Increase 40 

Percent Moody’s Says” Bloomberg.com, February 4, 2003. 

FDIC OUTLOOK 16 SUMMER 2003 
Regional Perspectives 

Chicago Regional Perspectives
 

Asset Quality Deterioration May Have Peaked 

for Many, but Not All, Insured Institutions 

Despite an economic recovery that has been in place 

for several quarters, delinquency trends suggest that 

asset quality could deteriorate further. The median pastdue1 ratio among the Region’s 

insured institutions declined 

slightly during 2002, from 2.20 

percent to 2.14 percent. 

However, during the fourth 

quarter, delinquencies rose yet 

again. In 2002, both the largest 

and smallest institutions 

reported year-over-year declines 

in delinquency levels, while institutions that hold between $250 

million and $1 billion in total assets reported a rise in 

delinquencies. Despite rising delinquencies for these 

midsize banks, the overall past-due levels remained 

relatively favorable at 1.75 percent. Geographically, 

the highest delinquency rate in the Chicago Region is 

among insured institutions based in Indiana, where the 

median level was 2.47 percent, 13 basis points higher 

than a year ago. 

Table 1 

While the slight improvement in overall delinquencies 

in 2002 is encouraging, the share of noncurrent loans 

did not decline. The year-over-year improvement in 

loans 30 to 89 days past due may indicate that overall 

asset quality concerns have peaked in the Region, but 

perhaps not for all locations or types of banks. For 

instance, overall past-due and noncurrent rates 

continue to rise among banks based in Michigan and 

Indiana. With the Region below prerecession levels of 

economic activity and job losses continuing, the economy may not do much to buoy asset quality in the near 

future. Furthermore, recent weakness in the Region’s 

commercial real estate (CRE2 ) markets may affect 

overall asset quality negatively in the near term. 

CRE Fundamentals Present Some Concerns 

Commercial real estate fundamentals have deteriorated 

in the Region and across much of the nation. The 

recession and the sluggish economic recovery led to net 

job losses and diminished demand for office and industrial space. As a result, many leaseholders feel pressured 

to vacate or terminate leases before they expire or renegotiate lease terms. This weakening is evident in higher 

vacancy rates and lower rental rates for many property 

types in the Region’s larger markets (see Table 1). With 

Commercial Real Estate Vacancy Rates Increased among the Larger Chicago Region Markets 

Percentage 

Apartment Office Retail Warehouse Hotel 

2002 2000 2002 2000 2002 2000 2002 2000 2002 2000 

Chicago 

Cincinnati 

Cleveland 

Columbus 

Detroit 

Indianapolis 

Milwaukee 

St. Louis 

4.1 

7.8 

7.1 

8.7 

5.6 

9.5 

7.7 

7.1 

2.5 

6.4 

6.3 

7.6 

3.7 

8.1 

7.3 

5.6 

16.6 

14.8 

18.1 

17.1 

17.1 

17.0 

17.2 

15.4 

10.5 

9.6 

11.5 

10.2 

9.4 

12.9 

12.3 

10.6 

11.7 

15.1 

13.7 

14.8 

14.6 

15.1 

11.9 

13.0 

9.2 

10.8 

11.2 

9.7 

11.3 

10.2 

10.3 

9.4 

10.4 

9.5 

10.5 

13.0 

9.3 

10.8 

7.0 

8.5 

7.3 

7.2 

7.8 

9.8 

6.4 

6.8 

4.6 

5.2 

40.2 

48.4 

45.1 

43.1 

43.2 

44.5 

43.2 

39.5 

30.9 

44.1 

38.7 

36.0 

33.5 

39.5 

38.1 

37.2 

Note: Shaded = Largest increase in each submarket. 

Source: Property & Portfolio Research, Inc. 

1 Past-due includes loans at least 30 days delinquent or in nonaccrual status.
 

2 Commercial real estate lending includes construction and development, multifamily, and nonresidential real estate lending.
 

FDIC OUTLOOK 17 SUMMER 2003 
Regional Perspectives 

lease agreements often spanning several years, the full 

effects of softening CRE fundamentals can take time to 

emerge. When they do, lower cash flows may make 

debt repayment more challenging for some borrowers. 

Commercial real estate is a diverse category, and 

economic trends affect CRE properties at different 

times and to different degrees. For instance, employment trends can significantly affect vacancy rates for 

office space. Year-over-year growth in “office employment”3 in the Chicago Region has declined since 

1997 and was virtually nonexistent during 2002. 

Declining employment among office-using firms in 

the services sector often affects net absorption of 

office space rather quickly, while employment trends 

in the finance, insurance, and real estate (FIRE) 

sectors affect net absorption more slowly.4 Companies 

in the FIRE sectors typically have more square 

footage per employee and can therefore hire additional personnel without immediately needing more 

space. Employment in all of the Region’s larger office 

markets5 is deteriorating. 

Profits have been erratic since 1999 and did not grow 

in the retail sector during third quarter 2002. Retail 

sales growth is not likely to accelerate substantially 

in coming quarters for several reasons. Recent strong 

levels of vehicle purchases likely are waning, job and 

income growth are not robust, and many consumers 

may defer major purchases because of concerns about 

employment security. In this environment, any property 

owner trying to let or sublease retail space likely will 

face ample supply on the market. 

CRE Exposure Has Grown Dramatically among 

Insured Institutions Based in the Chicago Region 

during the Past Ten Years 

As of December 31, 2002, the median level of CRE 

to Tier 1 capital among banks in the Chicago Region 

was 149 percent, steadily increasing during the past 

ten years from 89 percent (see Chart 1). The CRE 

concentration levels of institutions in the 90th 

percentile rose to a greater extent during the same 

3 Office employment is defined here as employment in the finance,
 

insurance, and real estate (FIRE) sectors, plus 45 percent of services
 

employment.
 

4 Winter 2003 Office Outlook, Torto Wheaton Research.
 

5 Detailed information about CRE fundamentals is generally not available for the Region’s smaller markets.
 

Chart 1 Commercial Real Estate Loans/Tier 1 Capital (%) 

Source: Bank and Thrift Call Reports 

Commercial Real Estate Concentrations Continue to 

Rise among Banks in the Chicago Region 

Median concentration 

Top/Bottom 25th percentiles 

Top/Bottom 10th percentiles 

’92 ’93 ‘94 ‘95 ‘96 ‘98 ‘97 ‘99 ’01 ’00 ’02

0 

50 

100 

150 

200 

250 

300 

350 

400 

450 

period, showing that much of the growth in CRE 

has been among institutions that already held 

substantial CRE exposure. Although regional exposure levels have risen dramatically, the median CRE 

exposure in the Chicago Region remains in line with 

that of the nation. 

Institutions with more than $250 million in assets 

(21 percent of the Region’s insured institutions) report 

a median CRE concentration to capital that exceeds 

200 percent. Smaller insured institutions based in the 

Region tend to hold less CRE exposure. 

The highest current exposures in the Region are 

among insured institutions based in Michigan (223 

percent) and Wisconsin (182 percent). The Grand 

Rapids, Michigan, metropolitan statistical area 

(MSA) is home to institutions with the highest CRE 

exposure of any large MSA in the Region, with a 

median exposure of 410 percent of Tier 1 capital. 

Exposures are also relatively high among banks 

based in the Ann Arbor (337 percent), Milwaukee 

(305 percent), Lexington (282 percent), and Chicago 

(281 percent) MSAs. 

Nonresidential Real Estate Lending Has Fueled 

Most of the Growth in the CRE Portfolio 

The median level of nonresidential real estate lending 

is 106 percent of Tier 1 capital, up from 60 percent ten 

years ago. Increases have occurred among institutions 

of all sizes and among banks based in all the Region’s 

states. Again, the smallest institutions (less than $250 

million in assets) have considerably less exposure to 

nonresidential real estate lending. 

FDIC OUTLOOK 18 SUMMER 2003 
Regional Perspectives 

Multifamily residential real estate lending is a relatively 

small segment and has not experienced the growth 

evident in construction and development (C&D) and 

nonresidential loan segments. The current median level 

of multifamily real estate lending is 5 percent of Tier 1 

capital, up slightly from ten years earlier. 

C&D Lending Presents Additional Challenges 

Although C&D lending represents a relatively small 

segment of the CRE portfolio, this loan category likely 

presents the greatest challenges to lenders. Construction lending can take many forms. The primary types of 

construction loans insured institutions make are unsecured front money, land development, commercial, and 

residential. The characteristics of each of these business 

lines vary; however, in all cases the properties usually 

achieve appraised values only after funds are advanced 

and improvements are made. Consequently, C&D lending is typically one of the higher-risk lending segments. 

Nevertheless, only the Dallas Region (including the 

Memphis area) reported a higher overall CRE past-due 

rate. CRE delinquencies among banks in the Chicago 

Region declined, except for insured institutions holding 

assets between $500 million and $1 billion, which 

reported a slight increase. 

Within the Chicago Region, CRE past-due levels and 

trends show some geographic variation. Insured institutions based in Kentucky report the highest CRE pastdue rate and have experienced some deterioration in 

CRE loan quality. Deterioration among insured institutions based in Kentucky is concentrated in the smallest 

institutions (those holding less than $250 million in 

assets). Institutions headquartered in Indiana and 

Michigan also report relatively high past-due rates. 

However, past-dues reported by banks in Indiana have 

improved considerably, while institutions based in 

Michigan have reported some slight deterioration. 

C&D lending has grown considerably among insured 

institutions in the Chicago Region during the past ten 

years. The median ratio of C&D lending to Tier 1 capital was 20 percent at year-end 2002, up from 8 percent 

ten years earlier. In the Region, 194 insured institutions 

hold concentrations that exceed 100 percent of Tier 1 

capital, up from 46 insured institutions ten years ago. 

Recently, C&D lending performance among banks 

based in the Region generally has been positive. The 

C&D portfolios of most of the Region’s insured institutions have performed reasonably well to date. Overall, 

C&D underwriting appears satisfactory. However, the 

Federal Deposit Insurance Corporation’s (FDIC’s) 

September 2002 survey of underwriting practices noted 

that the proportion of banks active in construction 

lending that either “frequently” or “commonly” made 

speculative loans for residential construction projects 

had increased from 26 percent to 29 percent. Also, 

institutions that frequently or commonly failed to use 

realistic appraisal values increased from 12 percent to 

14 percent. 

Despite Increasing Concentrations 

and Weakening Market Fundamentals, 

CRE Loan Quality Remains Sound 

Although CRE loan portfolios generally performed well 

during 2002 (see Table 2), the full effect of weakening 

CRE fundamentals may not have emerged yet. The 

median CRE past-due rate among insured institutions 

based in the Region was 0.92 percent as of December 

31, 2002, down from 1.06 percent 12 months earlier. 

Low Interest Rates and Industry Trends Contributed 

to Favorable Performance of CRE Portfolios 

Several factors have helped bolster CRE loan performance. Low interest rates enabled many property 

owners to reduce debt service requirements by refinancing. Also, even though rental rates fell in a large 

portion of the Region’s markets, many properties 

remain under more favorable leases. Essentially, property owners have been able to reduce debt service 

requirements without experiencing the full effects of 

lower current rental rates. Further improvement in debt 

service reduction may be limited, as interest rates may 

not decline significantly in the near term. Revenue 

Table 2 

Recent Median Commercial Real Estate 

Delinquency Trends Varied among the 

Chicago Region’s States 

4Q02 4Q01 4Q00 4Q99 4Q98 

(%) (%) (%) (%) (%) 

Chicago Region 0.92 1.06 0.36 0.24 0.36 

Illinois 0.59 0.73 0.19 0.10 0.32 

Indiana 1.22 1.47 0.43 0.44 0.48 

Kentucky 1.28 1.13 0.82 0.43 0.68 

Michigan 1.22 1.18 0.15 0.00 0.00 

Ohio 0.99 1.15 0.01 0.03 0.14 

Wisconsin 1.10 1.27 0.61 0.43 0.47 

Source: Bank and Thrift Call Reports 

FDIC OUTLOOK 19 SUMMER 2003 
Regional Perspectives 

streams, however, are likely to decline as leases expire. 

In some cases, there may be no demand for the space. 

Even when demand exists, the new lease rate may be 

less favorable to the lessor. 

Also enhancing CRE loan performance among insured 

institutions is the prevalence of securitized CRE lending, which has helped to spread risk among several 

lenders. Nonbanking entities, such as real estate investment trusts and insurance companies, fund many of the 

larger and more complex CRE projects. Conversely, 

smaller CRE relationships, in which the lender is 

“closer” to the borrower, likely are still heavily funded 

by insured financial institutions. 

Projects with a sufficient amount of owner equity are 

less likely to become nonperforming. The maximum 

loan-to-value limits instituted following the enactment 

of the Federal Deposit Insurance Corporation Improvement Act (FDICIA) may help to minimize the number 

of highly leveraged CRE projects funded by insured 

institutions. FDICIA prompted Part 365 of the FDIC’s 

Rules and Regulations, which requires insured institutions to establish loan-to-value policy limits of 65 

percent for raw land, 80 percent for C&D, and 85 

percent for 1- to 4-family residential development. 

While insured institutions may exceed these limits in 

certain instances, these regulations have provided a 

solid framework for operations. 

And finally, the downturn in the stock market has 

increased the attractiveness to some investors of hard 

assets, such as real estate. Lower interest rates and a 

preference for real estate have lowered capitalization 

rates, supporting property values and helping to maintain equity ratios. 

CRE Portfolios Will Benefit from Close Monitoring 

in the Current Environment 

CRE property values can fluctuate significantly with 

changing market conditions and underlying cash flows. 

As a result, some consider CRE lending inherently 

more risky than many other loan types. In fact, historically, C&D past-due and charge-off rates have demonstrated they can reach relatively high levels among 

insured institutions in the Chicago Region. 

CRE lending is not homogenous, and the risk characteristics may vary significantly by bank size, types of 

properties financed, and location of collateral. Many 

bankers likely have learned the lessons of the late 

1980s and early 1990s. Nevertheless, given the growth 

in CRE exposures and the current softness in certain 

CRE markets, portfolio managers should continue to 

monitor fundamentals of local CRE markets and watch 

for early warning signs, which can include, but are not 

limited to, the following: 

• Cash flow falling below projections in the original 

appraisal, often from rent concessions or sales 

discounts. 

• Changes in concept or plan, such as a condominium 

project converting to an apartment project. 

• Construction delays that lead to cost overruns or a 

renegotiation of loan terms. 

• Slow leasing or lack of sustained sales activity, which 

could lead to protracted repayment or default. 

• Construction draws that exceed the amount needed 

to cover construction costs and related overhead 

expenses. 

• Property owners tapping into equity to keep 

payments current. 

FDIC OUTLOOK 20 SUMMER 2003 
Regional Perspectives 

Dallas Regional Perspectives
 

Insured Institutions in the Region Report Favorable 

Banking Conditions despite a Sluggish Economy 

The 2001 recession and the tepid recovery1 have 

resulted in weak annual average employment growth in 

all states in the Dallas Region during the past two years 

(see Table 1).2 Only the New Mexico economy has 

avoided recession. Strong gains in the government and 

services sectors have contributed to employment gains 

in the state. However, even though employment 

growth in New Mexico exceeds the national average, 

the growth rate slowed during 2002. 

In sharp contrast, Colorado is the only state in the 

Region that remained in recession as of first quarter 

2003.3 The downturn in the high-tech sector and 

ongoing weakness in the financial services sector and 

commercial real estate markets continue to affect the 

Colorado and Texas economies adversely. However, 

increases in defense spending, stronger levels of busiTable 1 

Employment Growth Is Expected to Be 

Modest during 2003 in the Dallas Region 

Average Annual Growth Rates (%) 

Area 1995–2000 2001 2002 2003F 

Arkansas 1.6% –0.4% –0.6% 0.2% 

Colorado 3.8% 0.6% –1.9% 0.0% 

Louisiana 1.6% –0.1% –1.0% –0.1% 

Mississippi 1.4% –2.0% –0.3% 0.2% 

New Mexico 1.8% 1.7% 1.1% 1.3% 

Oklahoma 2.5% 1.0% –1.5% –0.2% 

Tennessee 1.8% –1.5% –0.8% 0.3% 

Texas 3.3% 0.9% –1.0% 0.6% 

Dallas Region 2.7% 0.3% –0.9% 0.3% 

United States 2.4% 0.2% –0.9% 0.2% 

F=forecast 

Sources: Bureau of Labor Statistics (actual); Economy.com (forecast: F) 

1 For purposes of this article, the U.S. recovery is assumed to have 

begun in fourth quarter 2001, when real gross domestic product 

returned to positive growth. 

2 Newly revised payroll employment data from the U.S. Bureau of 

Labor Statistics revealed downward revisions for most states in the 

Region in 2001 and 2002, with significant revisions occurring in 

Louisiana, Oklahoma, and Tennessee. 

3 Economy.com, Regional Outlook forecast, February 19, 2003. 

ness investment, higher energy prices, and improved 

corporate profitability should promote an 

upswing in employment growth rates for 

these states during 2003. 

Employment 

growth in Oklahoma 

declined on an annual 

basis for the first time 

since 1987. Going 

forward, Economy.com 

forecasts a second year of declining 

employment for the state during 2003, 

as weakness in the manufacturing, wholesale trade, and 

transportation sectors is expected to continue to 

constrain the economy. 

Arkansas, Louisiana, Mississippi, and Tennessee 

(states that entered recession before the national downturn) recorded a second consecutive year of employment losses during 2002. The key manufacturing 

sectors in these states were hurt by cheaper imports or a 

decline in exports as well as the national recession. In 

addition to a sluggish manufacturing sector, weakness 

in the hospitality, mining, and construction sectors 

adversely affected the Louisiana economy and spilled 

into the retail trade and services sectors. Employment 

in Louisiana is forecast to decline for the third consecutive year during 2003 because of poor demographics 

and a lack of growth industries and skilled labor.4 

However, except in Louisiana, a weakening U.S. dollar 

(which should contribute to higher levels of exports), 

improving commodity prices, and a recovery in regional 

tourism should improve prospects for employment 

growth. 

Although most of the states in the Region appear 

poised for job gains in 2003, growth is expected to 

be modest. Five quarters into the U.S. recovery, the 

Region has yet to show positive job growth, an unfavorable comparison with what occurred during the 

economic recovery that began in 1991 (see Chart 1, 

next page). Geopolitical uncertainties, a sustained 

period of high energy prices, a volatile U.S. dollar, 

and significant state budget deficits are the greatest 

constraints to the Region’s economic recovery. 

4 Economy.com, Louisiana State Précis Report, March 2003. 

FDIC OUTLOOK 21 SUMMER 2003 
Regional Perspectives 

Chart 1	 mance could be affected adversely, particularly in the 

consumer loan portfolio. Job Growth Remains Negative in the Dallas Region
 

More than a Year into the Economic Recovery
 

2.0 

2Q91 

3Q91 

4Q91 

1Q92 

2Q92 

4Q01 1Q02 2Q02 3Q02 

4Q02 

Rising Debt Levels Coupled with Weak Economic 

Conditions Could Stress Consumers 

Nationally, consumer debt levels grew through the 

recession of 2001 and have continued to grow. AggreYear-Over-Year Growth (%) 1.5 

1.0 

0.5 

gate household debt increased to 10.7 percent in fourth 

0.0 quarter 2002, the highest level since 1989.7 Debt service levels8 reached a historic high in fourth quarter 

–0.5 

–1.0 

2001 and declined slightly in 2002 (see Chart 2).9 The 

rise in debt service levels can be attributed to increased 

mortgage and other types of consumer borrowing. Source: Bureau of Labor Statistics 

Although economic conditions remain sluggish, insured 

institutions based in the Dallas Region reported favorable conditions at year-end 2002. Historically low 

short-term interest rates and an upward-sloping yield 

curve benefited banks and thrifts based in the Region 

as the net interest margin and average return on assets 

reached their highest levels in the past 20 years.5 

A dramatic drop in the median cost of funds to record 

lows is one of several factors contributing to positive 

earnings performance.6 Additions to provision expenses 

were not necessary, as past-due and charge-off rates 

remained moderate for all segments of the portfolio 

except consumer loans. Equity capital levels remain 

strong, as evidenced by a median leverage ratio of 

9.15 percent—among the highest levels in a decade. 

Several factors could explain the apparent disconnect 

between weak economic conditions and strong insured 

institution performance. First, merger and acquisition 

activity has contributed to increased geographic diversification in the loan portfolio, minimizing the level of 

concentration risk. Second, insured institutions have 

improved techniques for gathering data related to 

consumer and corporate borrowers, which has helped 

to improve credit quality. Finally, the increased use of 

Nationally, several factors contributed to an increase 

in debt service levels. The rise in home equity values 

contributed to a surge in cash-out refinancing activity. 

Similarly, historically low interest rates prompted 

consumers to increase borrowing for durable goods, 

such as automobiles and personal computers, and 

boosted home sales to record highs. The increasing 

availability of credit, facilitated by the use of creditChart 2 

Consumer Debt Service Payments as a Percentage of 

Disposable Income Have Risen to Near Record Levels 

in the Dallas Region 

Source: Board of Governors of the Federal Reserve System/Haver Analytics Debt Payments to Income (%) 

0 

2 

4 

6 

8 

10 

12 

14 

16 

Recession 

Ratio of mortgage debt to disposable income 

Ratio of consumer debt to disposable income 

1Q904Q904Q934Q964Q99

3Q02 

securitization has allowed many institutions to sell 

loans, thereby spreading risk. Should economic weakness continue, however, insured institution perfor5 The net interest margin and return-on-assets ratio for insured institutions based in the Dallas Region were 4.35 percent and 1.42 

percent, respectively, for the four quarters ending December 31, 2002. 

6 The cost of funding earning assets dropped to 2.15 percent in fourth 

quarter 2002, a decline of 129 basis points from a year ago. 

7 Federal Reserve Board Flow of Funds data. 

8 The debt service level, commonly referred to as debt service burden, 

is calculated by dividing the sum of required principal and interest 

payments by after-tax personal income (often referred to as disposable personal income). 

9 In contrast to the growth reflected in the Flow of Funds data, the 

Federal Reserve Board Survey of Consumer Finances (SCF) series 

indicates that consumer debt service levels declined from 14.4 

percent in 1998 to 12.5 percent in 2001. The SCF calculations include 

income data from 2000, a period when income levels were increasing 

rapidly. 

FDIC OUTLOOK	 22 SUMMER 2003 
Regional Perspectives 

scoring programs, also contributed to growth in 

consumer debt levels. 

Although many of these factors apply to the Dallas 

Region, this Region also has experienced a more severe 

economic decline than elsewhere in the nation. For 

example, job losses have been significant since the mid1990s in rural areas of the Region that rely heavily on 

the manufacturing sector. Financial stress caused by 

higher debt levels and prolonged economic weakness 

is evident in bankruptcy filings that have risen to the 

highest level since the 1990–1991 recession. As of 

fourth quarter 2002, Tennessee, Arkansas, Mississippi, 

and Oklahoma ranked among the top ten states 

nationwide in per capita bankruptcy filing rates.10 

Higher debt service levels are a key contributing factor 

to the relatively high rate of consumer bankruptcies in 

the Region. Results of the Federal Reserve Board 

Survey of Consumer Finances show that families with 

incomes in the lowest two quintiles are most likely to 

be financially overextended.11 This relationship is 

particularly relevant in the Dallas Region, because per 

capita income levels are among the lowest in the 

nation, suggesting that more consumers in this Region 

are more heavily indebted.12 Furthermore, many of the 

manufacturing job losses have occurred in the lowerskilled and generally lower-paying jobs. Taken together, 

these trends make it more difficult for consumers to 

remain current on their debt payments. 

Consumer Loan Portfolios13 Weaken as the 

Regional Economy Struggles to Recover 

Lingering economic weakness and debt consolidation, 

made possible by cash-out mortgage financing, 

contributed to slow consumer loan growth among 

insured institutions based in the Dallas Region. 

Consumer loan levels have steadily declined since 

mid-2001; this is the only segment of the portfolio 

that exhibited negative growth at year-end 2002 (see 

10 The share of employment in the manufacturing sector in these 

states, except for Oklahoma, exceeds that of the nation. 

11 SCF, 2001. Families in the lowest two income quintiles reported the 

highest percentages of debt, with debt service burdens greater than 

40 percent. 

12 Mississippi and Arkansas reported the lowest per capita personal 

income levels in the nation in fourth quarter 2001 (the most recent data 

available), followed closely by New Mexico, Louisiana, and Oklahoma. 

13 Consumer loans include loans to individuals for household, family, 

and other personal expenditures, excluding loans secured by mortgages on residential properties. 

Chart 3). However, this decline was more than offset 

by an increase in residential and other loan categories.14 

Consumer credit quality has deteriorated recently 

among community banks headquartered in the Dallas 

Region. Consumer past-due loans increased in fourth 

quarter 2002 to the highest levels since first quarter 

1988. The median ratio of total past-due consumer 

loans to total consumer loans was 3.0 percent, significantly exceeding the past-due ratio for residential 

loans.15 Levels of past-due consumer loans were also 

relatively high compared with other areas of the country, and levels varied among states in the Region. Not 

surprisingly, past-due levels were highest among banks 

and thrifts based in states that experienced the longest 

and deepest period of economic weakness (see Table 2, 

next page). Banks headquartered in rural areas of the 

Region may be more vulnerable to deteriorating 

consumer credit quality because of higher exposures16 

and weaker economic conditions. In contrast to the 

trend in past-due levels, the share of total loan losses 

attributable to consumer loans has begun to drop. 

Chart 3 

Insured Institutions Headquartered in the Dallas
 

Region Have Reported Significant Declines in
 

Consumer Loan Growth during the Past Two Years
 Annual Loan Growth* (%) 

–5 

0 

5 

10 

15 

20 

Total Loan Growth 

Consumer Loan Growth 

Recession 

Dec-90Dec-91Dec-92Dec-93Dec-94Dec-95Dec-96Dec-97Dec-98Dec-99Dec-00Dec-01Dec-02

*Merger-adjusted annual growth for community banks, excluding de novos. 

Source: Bank and Thrift Call Reports 

14 Residential loan levels increased 5.8 percent in fourth quarter 2002 

from one year ago. Conversely, consumer loan growth was minus 2.7 

percent for the same period and was below growth reported for the 

period following the 1990–1991 recession. Nationally, consumer loan 

growth dropped 9.5 percent in fourth quarter 2002 from one year ago. 

15 Past-due residential loans were 2.3 percent of total residential 

loans in fourth quarter 2002, compared with 2.5 percent one year 

earlier. 

16 Consumer loans represented 8.3 percent of total assets in fourth 

quarter 2002 among rural banks in the Dallas Region, relatively 

unchanged from one year ago but higher than in the other FDIC 

Regions. Conversely, banks in metro areas held consumer loans at 

6.5 percent of assets in fourth quarter 2002, down 100 basis points 

from one year ago. 

FDIC OUTLOOK 23 SUMMER 2003 
Regional Perspectives 

However, loss rates remain high relative to other types, 

such as residential loans.17 Furthermore, recent 

increases in past-due loan levels suggest the potential 

for an increase in consumer loan loss rates, particularly 

if the Region’s employment picture remains weak for 

the balance of 2003. 

Looking Ahead 

In light of the weak economic and employment trends 

that are persisting in the Dallas Region, insured institution management should continue to monitor trends in 

the consumer loan portfolio. In addition, management 

should consider offering or supporting programs that 

will enhance financial literacy, such as the FDIC’s 

Money Smart program.18 

17 Established community institutions hold assets less than $1 billion 

and have been in existence for at least three years. Consumer loan 

losses were 39.1 percent of total loan losses in fourth quarter 2002, 

relatively unchanged from one year ago and slightly down from one 

quarter ago. 

18 The FDIC’s Money Smart program enhances consumers’ ability 

to manage their personal finances. Refer to the Consumers and 

Communities section of the FDIC’s website at www.fdic.gov. 

Table 2 

Past-Due Levels among Insured Institutions 

Based in the Dallas Region Raise Concerns 

about Credit Quality 

Ratio of consumer past-due 

loans to total consumer loans 4Q02 (median %)* National 

Area 4Q01 3Q02 4Q02 Rank 

Arkansas 3.7 3.0 3.5 6 

Colorado 1.8 1.9 2.0 30 

Louisiana 3.0 2.6 3.1 7 

Mississippi 5.2 3.8 4.5 1 

New Mexico 2.0 1.6 1.8 31 

Oklahoma 3.1 2.8 3.0 9 

Tennessee 4.3 3.6 4.1 2 

Texas 2.7 2.3 2.7 13 

All other states 2.3 2.0 2.3 

*States with at least 10 established community banks. 

Source: Bank and Thrift Call Reports 

FDIC OUTLOOK 24 SUMMER 2003 
Regional Perspectives 

Kansas City Regional Perspectives
 

The Region’s Economy Is Improving, and 

Banks Report Continued Strong Conditions 

The Kansas City Region economy was 

affected adversely in 2002 by the recession. 

Job growth in most states, although remaining negative during fourth quarter 2002, 

improved by year-end. In particular, employment improved in Nebraska, Minnesota, 

and South Dakota, as laid-off employees began 

to be absorbed into new jobs. Employment was 

most robust in Kansas, as strength in the 

transportation and government sectors helped 

to offset losses in the telecommunications and aircraft 

manufacturing industries. In fact, Kansas is the only 

state in the Region to post positive employment growth 

each quarter during the past three years. On the other 

hand, the Missouri economy continues to struggle with 

massive layoffs in the manufacturing and retail sectors, 

two industries that represent a disproportionately high 

share of the state’s employment.1 

Overall, insured financial institutions in the Region 

reported sound operating results during 2002. Community banks2 and farm banks3 reported improved earnings 

Table 1 

in 2002 as measured by post- and pre-tax 

measures (see Table 1). Net interest 

margins were bolstered in early 2002 by 

a steeply sloped yield curve, which helped 

banks recover some of the margin losses 

caused by rapidly declining interest rates 

during 2001. Levels of past-due loans 

remained moderate in the aggregate 

at year-end 2002. However, a subset of 

banks is reporting elevated levels of 

problem loans; 11 percent of both 

the Region’s community banks and 

farm banks reported past-due ratios 

that exceed 5 percent, a relatively 

high industry benchmark. Overall, capital levels 

increased in 2002 and remain high compared with 

historical levels, and loan loss reserves are stable 

compared with total loan and problem loan levels. 

Drought Conditions Are Worsening and Adversely 

Affecting Insured Institution Performance 

Severe drought conditions continue to affect much of 

the Region. Normally, drought conditions abate considCommunity Banks and Farm Banks in the Region Continue to Report Sound Operating Results 

Community Banks Farm Banks 

2002 2001 2000 2002 2001 2000 

Number of Banks 1,821 1,860 1,918 1,129 1,159 1,211 

Return on Assets (%) 1.28 1.16 1.24 1.27 1.12 1.21 

Pretax ROA (%) 1.59 1.47 1.63 1.58 1.40 1.56 

Net Interest Margin (%) 4.26 4.14 4.31 4.16 4.00 4.10 

Past-Due and Nonaccrual Loan Ratio (%) 2.29 2.39 2.14 2.39 2.44 2.13 

Leverage Capital Ratio (%) 10.40 10.07 10.03 10.68 10.39 10.28 

Loan Loss Reserves/Loans (%) 1.42 1.42 1.41 1.52 1.50 1.51 

ROA = Return on Assets
 

Notes: “Community banks” are defined here as commercial banks with less than $250 million in assets, excluding new banks and specialty banks.
 

“Farm banks” are insured financial institutions at which at least 25 percent of total loans are farm operating loans or loans secured by agricultural real estate.
 

Nearly all farm banks are also considered community banks.
 

Source: Bank and Thrift Call Reports
 

1 For a deeper look into each state’s economic situation, see the FDIC State Profiles at www.fdic.gov.
 2 “Community banks” are defined in this article as insured institutions that hold $250 million or less in assets, excluding de novo and specialty
 

institutions. Thrifts are excluded because of dissimilarities to commercial banks.
 

3 “Farm banks” are defined as insured institutions that hold at least 25 percent of total loans in farm operating loans or loans secured by agricultural real estate.
 

FDIC OUTLOOK 25 SUMMER 2003 
~ 

~ 

Regional Perspectives 

erably with precipitation during the fall and winter, but 

continued dry weather has contributed to deteriorating 

conditions (see Map 1). Although the drought was 

confined to the Region’s western states last summer, dry 

conditions have now spread eastward into Iowa and 

Missouri, and Minnesota is experiencing abnormally 

dry conditions. Nebraska continues to be most 

adversely affected, with approximately two-thirds of the 

state experiencing at least “extreme” drought conditions. The state’s corn, wheat, and soybean harvests 

declined approximately 20 percent from 2001 levels, 

and hard-hit pasturelands made it difficult for ranchers 

to feed herds. Farmers’ strong equity positions and 

reliance on crop insurance appear to have mitigated 

much of the drought’s negative effect on loan quality 

during 2002. However, should drought conditions 

continue into the summer of 2003, local economies 

that depend on the agricultural sector may weaken 

considerably. 

Although farm banks in the aggregate reported solid 

financial results during 2002, the drought has begun 

to affect the performance of banks in areas that have 

experienced a second year of drought: 53 counties in 

eastern Nebraska and 8 counties in the northwestern 

corner of Kansas. The 143 farm banks in these counties 

reported earnings and capital performance similar to 

that of other farm banks in the Region; however, the 

aggregate past-due ratio4 for this group of institutions 

was 2.98 percent at year-end 2002, compared with 2.39 

percent for all farm banks in the Region. Fifteen 

percent of the farm banks in counties that have experienced prolonged drought conditions reported a past-due 

ratio of at least 5 percent. These numbers do not reflect 

a significant degree of deterioration; however, should 

the drought continue for a third year, asset quality 

among these institutions could be affected significantly. 

In addition, asset quality among farm banks in areas 

that experienced a first year of drought in 2002 could 

deteriorate to the same extent as farm banks in secondyear drought areas. 

Some of the Region’s Markets Are Home 

to a Significant Number of New Institutions 

Minimal levels of new bank formation occurred in the 

Region in the years following the 1990–1991 recession; 

however, activity has surged during the past five years. 

New institutions now represent a sizable presence in 

many of the Region’s metropolitan centers, and 2001 

marked the first year that these institutions operated 

during an economic downturn. Our analysis allows us 

to compare current financial conditions between new 

and established institutions and evaluate any differences in light of a continuing fragile economy. 

Map 1 

Much of the Region Continues to Be Affected by Drought Conditions
 

Summer 2002
 Current 

U.S. Drought Monitor July 2, 2002 U.S. Drought Monitor February 25, 2003 Valid 8 a.m. EDT Valid 7 a.m. EST 

DO Abnormally Dry DO Abnormally Dry Drought Impact Types:
 

D1 Drought—Moderate A = Agricultural (crops, pastures,
 Drought Impact Types: 

A = Agriculture D1 Drought—Moderate 

D2 Drought—Severe W = Water (Hydrological) D2 Drought—Severe grasslands) 

W = Hydrological (water) D3 Drought—Extreme 

D4 Drought—Exceptional 

F = Fire danger (Wildfires)

(No type = All 3 Impacts)

D3 Drought—Extreme (No type = both impacts) Delineates dominant impact D4 Drought—Exceptional 

The Drought Monitor focuses on broad-scale conditions. The Drought Monitor focuses on broad-scale conditions. 

Local conditions may vary. See accompanying text summary Local conditions may vary. See accompanying text summary 

for forecast statements. for forecast statements. Released Thursday, February 27, 2003 Released Wednesday, July 3, 2002 Author: David Miskus, JAWF/CPC/NOAA 

http://drought.unl.edu/dm Author: Michael Hayes, NDMC http://drought.unl.edu/dm 

4 Defined as the sum of loans 30 to 89 days past due and in nonaccrual status, divided by total loans. 

FDIC OUTLOOK 26 SUMMER 2003 
Regional Perspectives 

Consolidation throughout the Region Has Obscured 

a Growing Presence of New Institutions 

Consolidation among banks and thrifts headquartered 

in the Region has been significant since the 1980s. 

Nearly one-third of the insured institutions present in 

the Region at the end of the last recession are no 

longer present; the rate of decline peaked in the mid1990s. In the aggregate, the consolidation trend was 

similar between insured institutions headquartered in 

metropolitan statistical areas (MSAs) and nonmetropolitan areas; however, differences exist at the individual MSA level. The level of merger activity tends to 

obscure the fact that the Region has experienced a 

significant level of new bank activity during the past 

few years. 

The Federal Deposit Insurance Corporation (FDIC) 

granted 202 new deposit insurance charters in the 

Region between April 1991, when the 1990–1991 

recession ended, and year-end 2002. The headquarters 

locations of the 202 charters are shown in Map 2, 

which indicates that the majority of charter activity 

was centered in and around MSAs, in particular 

Minneapolis, St. Louis, Kansas City, and Springfield. 

Depopulation has occurred among the Region’s rural 

areas during the past few decades; therefore, it is not 

surprising that new charter activity has been centered 

in metropolitan areas.5 

The 125 light blue dots on Map 2 represent charters 

granted to institutions affiliated with multibank holding companies or otherwise controlled by a chain banking organization or other financial services company. 

Much of this “affiliated charter” activity appears to be 

targeted at new market penetration. Many of the dots 

are concentrated in Iowa and Nebraska, states that 

have relatively more restrictive branching. Thirty-eight 

of these 125 affiliated charters are no longer in existence, primarily because of mergers involving affiliated 

acquirers. 

The 77 dark blue dots represent charters to institutions 

that have no substantive affiliation with multibank 

holding companies, financial services companies, or 

other financial institutions. These independent new 

institutions are less likely to be able to rely on outside 

expertise and support than nonindependent startups 

that have a close affiliation with parent or sister finan5 Refer to the Kansas City Regional Outlook, first quarter 2003, for a 

discussion of depopulation trends. 

Map 2 

Independent Institutions Chartered since the 1991 

Recession Are Concentrated in and 

around Metropolitan Areas 

Dark blue = 

Independents 

Metropolitan Statistical 

Areas (MSAs) 

Light Blue = Nonindependents 

cial institutions or financial services companies. The 

remainder of this article focuses on 72 of the 77 independent new banks that remain in operation6 and 

examines how the financial performance of these institutions fared in the sluggish economy. 

New Bank Entrants since 1991 Are Experiencing 

an Economic Slowdown for the First Time 

The emergence of new banks in the Region could be 

problematic because newly chartered institutions 

historically have exhibited higher risk profiles than 

established institutions. Results of other regulatory 

studies suggest that de novo institutions are more likely 

6 For the remainder of this article, the term “new banks” denotes 

active FDIC-insured institutions headquartered in the Kansas City 

Region that were granted charters between April 1, 1991, and December 31, 2002, and that are considered independent of any multibank 

holding company or any other parent or sister financial institution or 

financial services company. The term “new bank” includes thrift 

activity. 

FDIC OUTLOOK 27 SUMMER 2003 
Regional Perspectives 

Table 2 

New Bank Activity Has Been Recent and Centered in Four of the Region’s Metropolitan Areas 

Number of Newly Chartered Institutions1 Newly Chartered 

Total Number 2 as Percentage of 

Community 1991 to 1996 1997 to 2002 Total of Institutions of Total 

No MSA 2 20 22 1,573 1 

Minneapolis, MN 2 19 21 115 18 

Springfield, MO 2 5 7 24 29 

Kansas City, MO 2 5 7 96 7 

St. Louis, MO 1 5 6 54 11 

Des Moines, IA 1 2 3 26 12 

Dubuque, IA 0 1 1 7 14 

Waterloo, IA 0 1 1 7 14 

Joplin, MO 0 1 1 8 13 

Davenport, IA 1 0 1 11 9 

St. Cloud, MN 0 1 1 21 5 

Wichita, KS 0 1 1 27 4 

Grand Total 11 61 72 1,969 4 

1 As of December 31, 2002, 72 out of 77 independent institutions chartered since 1991 were still in operation. 

2 Total FDIC-insured institutions as of December 31, 2002. 

Source: Bank and Thrift Call Reports, Kansas City Region 

to be assigned “weak”7 examination ratings and are 

more likely than established institutions to fail during 

a recession.8 

Historically, well-run institutions have outperformed 

other institutions during economic downturns. 

Although well-run institutions can experience problems related to poor market conditions, they generally 

do not fail because of an economic downturn. Additionally, management teams that have been through 

economic slumps benefit from firsthand knowledge of 

how quickly asset quality can deteriorate and how 

costly it can be to deal with troubled assets. 

A strong majority (85 percent) of the 72 new banks 

were established between 1997 and 2002, and these new 

banks represent significant proportions of insured institutions presently headquartered in the Minneapolis, St. 

Louis, Kansas City, and Springfield MSAs mentioned 

earlier (see Table 2). Although these MSAs were hurt 

7 A “weak” examination rating is defined here as a composite Uniform
 

Bank Rating of 3, 4, or 5.
 

8 For further discussion of de novo bank performance compared to
 

established bank performance in recessionary times, see Robert
 

DeYoung, “Birth, Growth, and Life or Death of Newly Chartered
 

Banks,” Economic Perspectives, Federal Reserve Bank of Chicago,
 

third quarter 1999, and “De Novo Banking in the Atlanta Region,”
 

Atlanta Regional Outlook, first quarter 2000.
 

by the same economic trends that contributed to the 

national recession, they remain in better condition 

than the hardest-hit MSAs nationally. However, 

employment growth in these four MSAs has slowed, 

particularly in the manufacturing sector, and commercial vacancy rates have increased, reaching or exceeding historical highs set in the early 1990s. 

Given these economic conditions, the following 

sections compare new bank performance with that of 

established institutions in the aforementioned MSAs. 

This discussion draws heavily from data shown in Table 

3. Financial results generally do not stabilize until an 

institution has been in existence for at least three years; 

as a result, Table 3 includes data on the 45 new banks 

chartered before year-end 2000. 

Earnings Lag Those of Established Institutions 

Pretax return on assets (pretax ROA) ratios and net 

interest margins (NIMs) indicate that new bank earnings performance lags that of established institutions. 

In fact, almost three quarters of established institutions 

report higher pretax ROAs than the median level for 

new banks. New banks’ lower margins can be explained 

by higher funding costs, as these institutions typically 

pay higher rates to attract depositors. In addition, new 

FDIC OUTLOOK 28 SUMMER 2003 
Regional Perspectives Regional Perspectives 

Table 3 

New Banks’ Financial Performance Ratios 

Differ Considerably from Established 

Institutions 

New Established 

Banks Institutions 

Median Figures as of Year-End 2002 

Earnings 

Pretax Return on Assets 1.14 1.56 

Net Interest Margin 3.83 4.38 

Yield on Earning Assets 6.73 6.73 

Yield on Total loans 7.18 7.66 

Cost of Funds 2.77 2.32 

Funding 

Tier 1 Leverage Capital Ratio 7.80 8.51 

Core Deposits to Total Assets 66.69 75.98 

Other Borrowings to Total Assets 8.15 3.50 

Credit Risk 

Loan-to-Asset Ratio 79.34 67.14 

CRE Loans to Tier 1 Capital 324.09 222.88 

Past-Due and Nonaccrual 

Loans to Total Loans 1.08 1.65 

Loan Loss Reserves to Total Loans 1.07 1.26 

Net Charge-Off Ratio 0.08 0.14 

New banks represent 45 of the 72 institutions shown in Table 2 that have been in existence at least three years. 

Established institutions represent MSA-headquartered banks and thrifts established prior 

to April 1, 1991, with total assets under $1 billion, excluding specialty institutions. 

Source: Bank and Thrift Call Reports, Kansas City Region 

banks generally rely more on noncore deposits and 

other borrowings, which can be more costly than core 

funding. 

New bank loan yields also lag those of established 

banks. New banks may offer rate concessions to attract 

loan business, thereby lowering yields. Lower yields also 

could be attributed, at least in part, to high-quality, 

low-yielding loans that “walk” to new charters with 

loan officers hired from established institutions. 

However, as a way of compensating for lower loan 

yields, new banks typically report higher loan-to-asset 

(LTA) ratios than established banks, potentially implying heightened credit risk for new banks.9 

9 LTA ratios were a key barometer of whether a bank would fail during 

the 1980s agricultural crisis. Federal Deposit Insurance Corporation, 

History of the Eighties—Lessons for the Future. Vol I: An Examination 

of the Banking Crisis of the 1980s and Early 1990s, Chapter 8. Washington, DC: FDIC, 1997. See www.fdic.gov/bank/historical/history/ 

index.html. 

Funding Levels Are Lower than 


Those of Established Institutions
 

After three years of operation, new banks typically are 

operating with lower levels of capital funding than 

established institutions. In addition, new banks rely 

more on noncore deposits and other borrowings. The 

median core deposits-to-total assets ratio of new banks 

is typically 9 percentage points lower than that of 

established institutions, and the cost of funds ratio is 

nearly 50 basis points higher. New banks would be 

expected to fare less well than established institutions, 

given their higher LTAs and greater reliance on 

noncore funds. 

Credit Risk Is Higher than That 

of Established Institutions 

The median past-due loan ratio for new banks is considerably lower that that of established banks; however, 

two factors suggest that new banks may take on higher 

levels of credit risk. First, the median LTA ratio for new 

banks is 12 percentage points higher than the median 

LTA of established institutions, and only about one 

quarter of all established institutions report higher LTAs 

than the new bank median. Since loan-to-asset ratios 

tend to indicate the tolerance of management for taking 

on additional risk, higher LTA ratios typically suggest 

higher credit risk in new bank portfolios. 

In addition, new banks exhibit significantly higher 

exposure to commercial real estate (CRE) lending, 

historically a higher-risk lending category. Concern 

about higher CRE-to-capital concentrations is 

compounded by the fact that commercial real estate 

markets have weakened considerably across the country 

during the past two years. Nearly two-thirds of new 

bank activity in the Region is concentrated in or 

around four markets: Minneapolis, St. Louis, Kansas 

City, and Springfield (see Table 2). Office vacancy rates 

in the first three were 19.6 percent, 17.7 percent, and 

18.6 percent as of fourth quarter 2002, eclipsing highs 

reached in the early 1990s.10 While most lending 

institutions based in the Region have not reported 

increased delinquency levels because of deteriorating 

CRE markets, continued weakness could affect credit 

quality adversely, particularly among new banks. 

10 Torto Wheaton Research for Minneapolis, St. Louis, and Kansas 

City. 

FDIC OUTLOOK 29 SUMMER 2003 
Regional Perspectives 

Conclusion 

New bank activity in the Region is a positive sign, 

suggesting heightened economic demand for community banking services. Although new banks typically 

exhibit greater levels of credit risk and report weaker 

earnings prospects, at least initially, than established 

institutions, new charters overall performed well during 

the 2001–2002 recession. However, new charters may 

be more vulnerable to continued economic weakness 

than established institutions. 

FDIC OUTLOOK 30 SUMMER 2003 
Regional Perspectives 

New York Regional Perspectives
 

New York Region Economic Performance Is Mixed 

Economic growth in the New York Region1 during 

2002 remained modest and uneven, like that of the 

nation. The Region’s total nonfarm employment 

declined about 1 percent (the same as the nation’s), 

while the unemployment rate rose about a percentage 

point, averaging 5.5 percent in 2002. Labor markets 

deteriorated to the greatest extent among formerly 

rapidly growing state economies, with concentrations 

of employment in the information technology and 

financial services sectors—for example, in Massachusetts, New York, Delaware, Connecticut, and New Hampshire. Given lackluster 

labor markets, regional per capita personal 

income growth decelerated markedly 

during the first three quarters of 2002 

(on a year-ago basis). However, significant tax relief during the year mitigated 

the effects of weak labor markets on 

disposable income growth.2 

The Region’s housing sector held up well during 2002. 

Historically low mortgage rates continued to support 

home sales, even in states exhibiting net job losses and 

sluggish income growth. Although the rate of home 

price appreciation eased somewhat in certain areas, 

year-ago home price growth remained at double-digit 

rates through fourth quarter 2002 in 7 of the Region’s 

12 states. Pennsylvania, Vermont, Delaware, Maine, 

and Connecticut were the exceptions, though the latter 

two states posted gains just under 10 percent. Meanwhile, new home construction tracked the national 

rate, with significant strength evident in some of the 

Region’s markets, such as the District of Columbia, 

New Hampshire, Maine, Rhode Island, and Delaware. 

Without further strengthening in economic growth, the 

Region’s pace of home sales may slow this year. Should 

this occur, home price gains may moderate in certain 

markets, especially those (mentioned above) in which 

construction activity has accelerated. Although the 

1 The New York Region includes the six New England states (CT, MA,
 

ME, NH, RI, and VT), five Mid-Atlantic states (DE, MD, NJ, NY, and
 

PA), the District of Columbia, Puerto Rico, and the U.S. Virgin Islands.
 

Puerto Rico and the U.S. Virgin Islands were excluded in determining
 

aggregate regional trends.
 

2 2002 state-level disposable personal income data were not available
 

when this article was written. 


potential for continued malaise in job and income 

growth remains a downside risk, aggregate household 

financial stress in the Region is still below the national 

average. 

Bank Earnings Improved 

despite the Weak 

Recovery 

Despite the sluggish economic 

recovery, insured institutions in 

the New York Region3 posted 

a 13 percent increase in net 

income during 2002 (see Table 1, 

next page). Funding costs declined 

early in the year, contributing to a 

widening of net interest margins. However, 

funding costs are now extremely low and 

unlikely to fall any further. As a result, 

margins began to narrow late in 2002 as asset 

yields declined with falling interest rates. 

Commercial banks holding assets less than $10 billion 

reported increases in net income as a result of gains on 

the sale of securities, lower noninterest expenses, and 

declining provision expenses. Overall, loan growth is 

moderate, but it remains strong in commercial real 

estate, construction, and home equity portfolios. 

Despite the weak recovery, credit quality, as evidenced 

by the steady past-due ratio, has remained sound. 

Savings institutions holding assets less than $10 billion 

relied on net interest income to generate earnings. 

Despite declining asset yields across much of the industry, the Region’s savings institutions reported increasing 

margins throughout the year. Overall loan growth 

slowed in 2002 but remains strong in higher-yielding 

commercial and noncommercial real estate, multifamily, 

and home equity loans. Credit quality remains strong 

among the Region’s thrifts. However, should sluggish 

economic growth continue, deterioration could emerge 

in the traditionally higher-risk segments of the portfolio. 

3 Data exclude credit card lenders, de novo institutions open three 

years or less, and other small specialized institutions with less than 

$1 billion in total assets primarily operating nonlending business lines 

(e.g., trust business). 

FDIC OUTLOOK 31 SUMMER 2003 
Regional Perspectives 

Table 1 

New York Region Insured Institutions Continue to Report Healthy Conditions 

Commercial Banks Savings Institutions Insured Institutions 

< $10 billion < $10 billion > $10 billion 

Dec-02 Dec-01 Dec-00 Dec-02 Dec-01 Dec-00 Dec-02 Dec-01 Dec-00 

Return on Assets (ROA) (YTD) 1.17 1.02 1.13 1.02 0.91 0.91 1.04 0.97 1.28 

Median ROA 1.05 1.00 1.07 0.80 0.70 0.77 1.34 1.06 1.18 

Net Interest Margin (YTD) 3.73 3.75 3.83 3.49 3.32 3.36 3.56 3.21 3.28 

Past-Due Ratio 2.28 2.36 2.20 1.44 1.50 1.36 3.39 2.94 2.30 

Earning Asset Yield 5.95 7.16 7.95 6.24 7.16 7.51 5.83 6.68 7.80 

Cost of Funding Earning Assets 2.23 3.41 4.13 2.76 3.84 4.14 2.27 3.47 4.52 

Total Loan Growth (year over year) 5.55 3.59 9.74 3.49 6.50 10.12 4.39 2.00 6.20 

Tier 1 Leverage Ratio 8.20 8.31 8.55 9.30 9.36 9.59 6.88 6.76 7.04 

YTD = Year to Date 

All figures are percentages. 

Note: All data exclude credit card institutions, de novos, and other small specialty institutions. 

Source: Bank and Thrift Call Reports, reported on a merger-adjusted basis. 

The Region’s large institutions boosted income levels 

by increasing net interest income, noninterest income, 

and gains on the sale of securities. Noninterest 

expenses increased slightly but more slowly than net 

operating revenue (net interest income plus noninterest 

income). As a result, the efficiency ratio4 for large 

banks improved during 2002. The cost of funds remains 

at a historically low level. These costs are highly sensitive to changes in short-term interest rates and can 

reprice quickly, increasing exposure to interest rate risk 

and ultimately affecting profitability. The past-due 

ratio5 for large banks increased significantly during the 

past three years and now exceeds the ratio for smaller 

commercial banks by more than 100 basis points. Large 

bank credit problems are centered in exposures to troubled industries, such as the telecommunications, hightech, and airline industries. 

The Sluggish Economy Has Taken 

Its Toll on State Budgets 

The New York Region Faces Budget Shortfalls 

As of first quarter 2003, budgets were balanced for the 

current fiscal year in Rhode Island, Vermont, and 

Delaware, while the remaining states must close deficits 

by the end of June. States face a much bleaker situation 

for fiscal year 2004 because of lower-than-expected 

4 The efficiency ratio measures noninterest expense as a percentage
 

of net operating revenue.
 

5 Past-due loans are 30 or more days delinquent plus loans on nonaccrual.
 

revenues and rising expenditures as a result of the 

recent recession and the lackluster recovery. States in 

the New York Region have a combined $20.5 billion 

deficit for the next fiscal year, roughly one-fourth of the 

estimated total gap for all states in the nation. New 

Jersey, Massachusetts, Connecticut, and Maine estimate that shortfalls will exceed 10 percent of each 

state’s budget, and New York expects a 24 percent 

deficit—roughly $9 billion (see Table 2).6 

Policy Actions Have Been Implemented 

States in the Region have implemented a variety of 

initiatives to reduce expenditures. However, many 

states must also raise revenue to close budget gaps. 

Some states instituted small tax and fee increases 

during FY 2003 rather than increase sales or income 

taxes, to minimize the effects on residents. Most states 

have increased cigarette taxes, and Connecticut and 

Rhode Island have raised fuel taxes. New Jersey 

increased the corporate income tax, and Connecticut 

imposed a minimum tax on limited liability partnerships and S corporations. 

These actions are expected to correct the imbalances 

for FY 2003; however, more severe measures will be 

required to address the worsening situation during FY 

2004. For example, Connecticut and New Jersey are 

proposing personal income tax increases, New York 

may eliminate the sales tax exemption for clothing, 

6 National Conference of State Legislatures, State Budget Update, 

February 2003. 

FDIC OUTLOOK 32 SUMMER 2003 
Regional Perspectives 

Table 2 Insured Institutions Must Remain Alert 

States Must Close Growing Budget Gaps 

Fiscal Year 2003 Fiscal Year 2004 

Deficit % Deficit % 

($mil) budget ($mil) budget 

Connecticut 650 5.4 1,700 12.7
 

Delaware
 0 0.0 196 7.7
 

District of Columbia
 128 3.5 N/A N/A
 

Maine
 43 1.7 475 16.3
 

Maryland
 414 4.0 853 7.8
 

Massachusetts
 650 3.1 3,000 13.0
 

New Hampshire
 58 4.7 148 6.0
 

New Jersey
 1,100 4.7 4,600 18.5
 

New York
 2,500 6.3 9,300 24.0
 

Pennsylvania
 433 2.1 2,400 11.4
 

Rhode Island
 0 0.0 174 6.1
 

Vermont
 0 0.0 30 3.4 

Sources: National Conference of State Legislators State Budget Update, February 2003;
 

District of Columbia and Pennsylvania Budget Offices
 

and Maryland and Massachusetts are considering 

gaming proposals to increase revenues.7 

Some Local Areas May Be More Affected 

Government layoffs have occurred primarily at the 

state level, as state payrolls have declined in Massachusetts, Rhode Island, Delaware, New Jersey, and the 

District of Columbia.8 However, job losses may trickle 

down to municipalities. Stable levels of property tax 

collections have enabled most local government budgets to weather the downturn. However, many states 

have announced plans to scale back aid to local 

governments during FY 2004, which could result in 

spending cuts and tax increases among some municipalities. The Boston, Philadelphia, New York City, 

and Washington, DC, metro areas are home to at least 

200,000 state and local government jobs, although as a 

share of total employment, exposures are less than the 

national average. Employment concentrations in local 

government exceed the national average in the BarreMontpelier, Trenton, Vineland, State College, 

Albany, Binghamton, and Dover metropolitan statistical areas.9 As a result, these areas could be more 

adversely affected by layoffs. 

7 National Association of State Budget Officers, Fiscal Report of
 

States, November 2002.
 8 Based on payroll employment data, year-ago percentage change
 

from fourth quarter 2002.
 

9 The national average as of year-end 2002 was roughly 14.3 percent. 


Overall asset quality remained stable among insured 

institutions headquartered in the New York Region 

during the 2001 recession. However, consumer loan 

delinquencies increased during 2002 as household 

balance sheets were affected adversely by layoffs and 

weak per capita personal income growth. Substantial 

state and local tax increases could offset the proposed 

federal income tax cuts and could contribute to declining levels of disposable income. Households that are 

budgeting for education will be affected by the decision 

of many state universities to raise tuition to compensate 

for lower state funding. In addition, job losses and 

rising debt levels could pressure consumer credit quality. Although the effects likely will be relatively small, 

the quality of consumer and mortgage portfolios at 

some institutions could be affected by borrowers’ 

attempts to solve fiscal problems. 

State and local governments increased debt levels to 

avoid tax increases during FY 2002. Borrowed money 

represented almost 10 percent of state and local 

revenue in 2002, the highest level since the 1950s, 

according to the Commerce Department, and this 

share has almost tripled during the past three years. 

During that time, Standard & Poor’s lowered the credit 

rating for New Jersey because of significant declines in 

projected revenues. The “stable” outlook for Connecticut and Maine was downgraded to “negative,” and the 

“positive” outlook for Massachusetts and Rhode Island 

was downgraded to “stable.”10 The outlook for New 

York City was also recently downgraded from “stable” 

to “negative,” reflecting escalating budget gaps.11 

Highly leveraged state and local governments that 

experience revenue shortfalls could face further downgrades in credit ratings. Such downgrades would 

increase the cost of borrowing. As of fourth quarter 

2002, roughly 11 percent of insured institutions based 

in the New York Region held at least one quarter of 

their securities portfolios in municipal holdings. Institutions that hold these relatively high concentrations 

should continue to analyze any proposals that would 

have an adverse effect on the financial condition of 

state and local governments and their ability to repay 

debt obligations. 

10 Standard & Poor’s Public Finance Report Card: The States,
 

October 7, 2002.
 

11 Standard & Poor’s Public Finance Report Card: The Largest U.S.
 

Cities, February 19, 2003.
 

FDIC OUTLOOK 33 SUMMER 2003 
Regional Perspectives 

New York Region Financial Services Sector Hit Harder than Nation’s 

The Region, primarily New York City, has sustained Chart 1 

greater employment losses in the financial services 

sector than the nation. During 2002, jobs in the 

financial sector, which includes banking, securities, 

and real estate firms, increased by 0.6 percent 

nationwide, while the Region’s financial employment declined by about 1 percent. Many of the 

Region’s financial employment losses can be traced 

to New York City and Boston, and to a lesser extent 

to southern Connecticut and Bergen-Passaic counties in New Jersey. In New York City, financialsector job losses have declined sharply since peaking 

in 2000 (see Chart 1). 

Employment losses in the financial sector have hurt 

New York City and Boston more than the nation 

because financial-sector employment is a significant 

economic driver in these metropolitan areas. Financial-sector employment in the New York City metro 

area represented almost 12 percent of employment 

and more than 30 percent of nonfarm earnings 

during 2000.12 Although the Boston economy is 

slightly less concentrated in financial-sector jobs 

than New York, employment in this sector represented almost 9 percent of jobs and 12 percent of 

earnings, compared with 6 percent and 10 percent, 

respectively, for the nation. 

The greater decline in financial-sector employment 

in New York City stems from job losses in the securities industry, which makes up the largest part of the 

financial sector. Moreover, compensation in the 

securities industry (including salary and bonuses) 

generally is significantly greater than in other industries. During 2002, employment in the New York 

City securities industry fell almost 10 percent, while 

Wall Street bonuses, a significant component of total 

compensation, are estimated to have declined 37 

percent in 2002, following a 35 percent drop in 

2001. In Boston, securities employment declined by 

5 percent, compared with a 4.5 percent decline in 

the nation. 

Layoffs in the securities industry have contributed 

to weakness in the Boston and New York office 

markets. Financial, law, and professional service 

12 Earning results are from 2000, the last year available. 

Source: Bureau of Labor Statistics 

Recent Employment Losses in the Financial Sector 

Have Been Greatest in New York City 

Year-over-Prior-Year Percentage Change

–8 

–6 

–4 

–2 

0 

2 

4 

6 

199119921993199419951996199719981999200020012002 

Nation 

New York City 

firms lease about 68 percent of total office space in 

Boston.13 Financial-sector employment in New York 

City fell 6 percent between 2000 and 2002, primarily 

owing to layoffs in the securities industry. These 

losses contributed to a threefold increase in New 

York City office vacancy rates, from 2.8 percent to 

9 percent.14 

Financial-sector job losses in Boston and New York 

City are consistent with weak business conditions 

in the securities industry nationwide. In 2002, the 

U.S. stock market suffered the third consecutive 

year of losses; 2002 represented the greatest annual 

loss since 1977, and pretax profits in the securities 

industry fell to an eight-year low. Investment banking activity, including initial public offerings, 

equity underwriting, and mergers and acquisition 

activity, declined sharply in 2002. According to 

the Securities Industry Association, the value of 

announced mergers and acquisitions of U.S. 

companies in 2002 fell 41 percent, the lowest level 

since 1994 and down 74 percent from the peak in 

2000.15 Commissions, trading activity, mutual fund 

sales, asset management fees, and margin revenue 

also were down sharply. 

13 Susan Diesenhouse, “Layoffs Create a Glut of Space in the
 

Boston Area,” New York Times, p. C-6, February 5, 2003.
 14 Torto Wheaton Research. 
 15 Grace Toto, “Monthly Statistical Review,” SIA Research Reports.
 

Vol. IV, No. 1, January 31, 2003.
 

FDIC OUTLOOK 34 SUMMER 2003 
Regional Perspectives 

The outlook for the financial sector is mixed. 

According to Moody’s Investors Service, factors 

such as high debt service burdens, weak U.S. corporate investing and capital spending, and ongoing litigation faced by many securities firms may delay a 

recovery in securities industry profits,16 which will, in 

turn, constrain any rehiring on Wall Street. On the 

other hand, the boom in mortgage refinancing has 

boosted employment in mortgage banking, offsetting 

16 Moody’s Investors Service, 2003, U.S. Securities Industry 

Outlook, February 2003. 

some job losses in the securities industry. Nonetheless, the impact of the securities industry on the New 

York City economy is apparent, and any continued 

weakness and consolidation could undermine its 

economic recovery. Employment in the Boston 

financial sector, which is dependent on asset 

management companies such as Fidelity, likely will 

not rebound significantly until mutual fund investors 

gain more confidence in the equity markets, which 

have been buffeted by poor corporate earnings, 

corporate scandals, and an unstable international 

situation. 

FDIC OUTLOOK 35 SUMMER 2003 
Regional Perspectives 

San Francisco Regional Perspectives
 

Payroll employment growth in the San 

Francisco Region slightly outperformed 

that of the nation during 2002, primarily 

thanks to strength in the government 

and services sectors. Robust hiring in 

the education sector, particularly at the 

local level, led employment growth in 

several states. The services sector in 

Nevada and Hawaii and in several of the 

Region’s metropolitan statistical areas 

(MSAs) also benefited from a recovery in 

tourism, which had declined significantly after 9/11. 

Insured institutions headquartered in the 

San Francisco Region have performed 

well during the recession; however, bank and thrift 

performance remains vulnerable to several trends, 

Table 1 

including the effects of continued slow job growth at 

home and unrest abroad. This article explores how the 

sluggish economy and international events have hurt 

the travel and tourism sector in the San Francisco Region and the implications of 

these trends for the Region’s insured 

institutions. 

Travel and Tourism Are Important 

Economic Drivers in Several of the 

San Francisco Region Markets 

Twelve of the Region’s MSAs that are home to 

at least five insured institutions rank within 

the top quintile nationally for travel- and 

tourism-related employment. Tourism-related 

job growth in most of these markets slowed considerTravel and Tourism Employment Has Declined in the Honolulu, 


Seattle, and San Francisco MSAs during the Past Two Years
 

Compound Compound
 

Travel and
 Annual Annual Share of 

Tourism Tourism Tourism Count of Community

Metropolitan Employment Employment Employment Community Nonspecialty Median PastStatistical1 Share in 2000: Growth Growth Nonspecialty Institutions < 9 Due Loan 

Area (MSA) National Rank2 1995–2000 (%) 2000–2002 (%) Institutions3 Yrs. Old (%) Ratio4 (%) 

Las Vegas, NV 2 5.3 –0.2 

Honolulu, HI 9 –1.5 –2.8 

Anchorage, AK 10 4.4 2.2 

San Francisco, CA 13 4.2 –1.1 

Salt Lake City, UT 27 8.2 2.1 

Santa Barbara, CA 31 3.0 1.6 

Billings, MT 34 6.4 4.9 

Phoenix, AZ 37 3.9 –0.4 

San Diego, CA 41 5.2 5.0 

San Luis Obispo, CA 42 5.8 1.0 

Orange County, CA 43 4.3 4.6 

Seattle, WA 60 3.6 –2.1 

Total U.S. 4.5 1.5 

21 

8 

8 

25 

14 

8 

6 

25 

22 

7 

17 

37 

3,268 

76 1.63 

0 1.5 

0 1.84 

8 0.92 

36 2.97 

25 1.66 

17 2.73 

64 0.7 

50 0.6 

43 0.69 

53 0.09 

49 1.12 

17 1.52 

1 Includes MSAs in the San Francisco Region that rank in the top 20 percent of 318 MSAs nationally for employment concentrations in travel and tourism employment and that have a least five
 

established community insured institutions based in each of those markets. 


2 Travel and tourism employment includes jobs in lodging, recreation, and air transportation services.
 

3 Community institutions are defined as insured institutions holding less than $5 billion in total assets that are not specialty institutions or industrial loan companies. Figures for the U.S. are
 

calculated on MSA-based institutions meeting the aforementioned definition. Honolulu and Anchorage data include nonspecialty insured institutions (regardless of size) headquartered in
 

Hawaii and Alaska, respectively.
 

4 Includes loans that are 30 days or more past due or in nonaccrual status. Median was calculated on community nonspecialty institutions in operation at least three years.
 

Sources: Global Insight; Bank and Thrift Call Reports (December 31, 2002)
 

FDIC OUTLOOK 36 SUMMER 2003 
Regional Perspectives 

ably from 2000 through 2002 as a result of the recession 

and the 9/11 attacks (see Table 1). In addition, hotel 

revenues and occupancy rates have declined significantly during the past two years. Between 1995 and 

2000, the robust economy, rapid construction of theme 

hotels in Las Vegas, and the 2000 Winter Olympics in 

Salt Lake City contributed to an annual employment 

growth rate in the tourism sector that exceeded 5 

percent in several MSAs. Subsequent declines in business and leisure travel during 2001 and 2002 significantly dampened employment growth in this sector in 

the Las Vegas, Honolulu, San Francisco, Phoenix, 

and Seattle markets. 

Declines in the Number of Air Passengers 

Adversely Affect Air Services and Aerospace 

Employment 

Although air travel recovered somewhat during 2002, 

the decline since 2000 continues to hurt airline 

employment. Airlines laid off around 13 percent of 

their workforce between August 2001 and December 

2002.1 Airline profits remain pressured by declines in 

air travel caused by the war in Iraq, rising fuel prices, 

and escalating leverage. Several airports in the Region 

that are hubs for financially troubled airlines are particularly vulnerable to additional layoffs: San Francisco 

and Los Angeles (United), Honolulu (Hawaiian Air 

and Northwest), and Phoenix and Las Vegas (American). As of early April, United and Hawaiian Air had 

filed for bankruptcy during the past year. 

The slowdown in travel and tourism also has led to 

layoffs in the commercial aerospace industry, in particular at Boeing, the Seattle MSA’s largest employer. 

According to the Air Transport Association, orders for 

aircraft fell more than 35 percent during the last half of 

2002 compared with the last half of 2000, continuing a 

two-year trend. Boeing eliminated 18 percent of its 

Washington workforce during 2002 and has announced 

plans to lay off more workers. The Seattle MSA, which 

continues to feel the impact of the high-tech downturn, is characterized by relatively high shares of 

employment in the tourism and aerospace industries. 

As a result, it remains vulnerable to continued weakness in these sectors. 

Lodging Employment Is Hurt by Reduced Travel 

The decline in foreign and domestic travelers has 

affected the San Francisco Region’s lodging industry 

adversely during the past two years. Although employment in the hospitality sector has improved since 9/11, 

the overall number of lodging jobs in the Honolulu, Las 

Vegas, Phoenix, Santa Barbara, and Seattle MSAs was 

lower at year-end 2002 than at the end of 2000.2 In 

addition, according to Torto Wheaton Research, 

revenue per available room (RevPAR) was sharply 

lower between 2000 and 2002 in the Region’s tourismChart 1 Chart 2 

RevPAR Has Declined to the Greatest Extent 

in the San Francisco MSA 

Note: RevPAR = revenue per available room. Comparable data not available for 

Las Vegas. 

Source: Torto Wheaton Research 

Phoenix 

Tucson 

Seattle 

Honolulu 

Orange County 

San Francisco 

San Diego 

Compound Annual Rate of Change in RevPAR (%) 

1995–2000 

2000–2002 

–25 –20 –15 –10 –5 0 5 10 15 

Lodging Jobs Are an Important Component of 

Tourism Employment in the Las Vegas MSA 

Note: MSA = metropolitan statistical area. 

Source: Global Insight (2002 estimates) 

Share of Nonfarm Employment (%) 

0 6 12 3 9 15 18 21 24 27

Anchorage 

Las Vegas 

Honolulu 

San Francisco 

Salt Lake City 

Billings 

Santa Barbara 

San Diego 

Orange County 

Phoenix 

San Luis Obispo 

Seattle 

Nation 

Lodging 

Air Transport 

Amusement 

1 Air Transport Association, “Airlines in Crisis; the Perfect Economic 

Storm,” March 11, 2003, p. 14. (http://www.airlines.org/public/industry/bin/AirlinesInCrisis.pdf) 2 Based on estimates available from Global Insight. 

FDIC OUTLOOK 37 SUMMER 2003 
Regional Perspectives 

dependent markets, most notably San Francisco (see 

Chart 1). Trends in RevPAR are a key indicator of the 

health of the tourism industry, particularly in markets 

that rely heavily on lodging employment (see Chart 2). 

Most Insured Institutions Remain Strong 

Continued layoffs in the travel and tourism sectors and 

weak RevPAR levels could have an adverse effect on 

established community institutions3 headquartered in 

markets with relatively high shares of travel-related 

employment. Low interest rates likely have mitigated 

the effects of reduced travel on the ability of many businesses and individuals in tourism-dependent areas to 

service debts. In fact, at year-end 2002, the median pastdue loan ratio had declined year-over-year in 9 of the 

Region’s 12 travel-exposed markets; however, delinquencies remained high among established community 

institutions headquartered in the Salt Lake City and 

Chart 3 

Billings MSAs (see Table 1). In contrast, established 

community institutions based in Alaska and in the 

Santa Barbara and Las Vegas MSAs reported rising 

median past-due loan ratios. 

Loan and age mixes among insured institutions in the 

12 tourism-dependent markets referred to in Table 1 

could magnify asset quality and earnings pressures 

should weaknesses persist in the tourism and aerospace 

sectors. Insured institutions based in these markets hold 

elevated concentrations in commercial real estate4 and 

commercial and industrial loans, two traditionally 

higher-risk loan categories (see Chart 3). Moreover, a 

high proportion of insured institutions in some of these 

markets are relatively unseasoned, which could make 

them vulnerable should economic disruptions hamper 

loan growth or asset quality, both of which are important for break-even earnings performance in the early 

years of operation. As of fourth quarter 2002, 20 percent 

of all community institutions in these 12 markets were 

C&I and CRE Loans Represent More than Half the Assets in 

Key Tourism-Dependent Markets 

Note: C&I = commercial and industrial; CRE = commercial real estate. 

*Except for Hawaii and Alaska, includes insured institutions headquartered in a metropolitan statistical area that hold less than $5 billion in total assets and have been open 

more than three years. Excludes specialty insured institutions. 

Data for Alaska and Hawaii include nonspecialty institutions of all sizes, headquartered throughout the state. 

Source: Bank and Thrift Call Reports (December 31, 2002) 

Loan Category/Total Assets (Median %) 

0 

10 

20 

30 

40 

50 

60 

CRE 

C&I 

Las Vegas 

San Diego

San Francisco 

Phoenix 

Seattle

Orange County 

Salt Lake City

San Luis Obispo

Santa Barbara 

Billings 

Alaska* 

Hawaii* 

Nation 

3 For purposes of this analysis, outside of Anchorage and Honolulu, established community institutions are defined as insured institutions holding 

less than $5 billion in total assets that have been open more than three years and are not specialty institutions or industrial loan companies. 

These data restrictions were used to isolate insured institutions that might have loan concentrations within the headquarters MSA and to mitigate the effects of unseasoned loan portfolios or newly chartered institutions on performance measures. Because they typically derive a significant share of deposits from the MSA in which they are headquartered, institutions holding up to $5 billion in assets were included. Specialty 

institutions and industrial loan companies were excluded because they lack traditional bank asset mixes (e.g., low loan-to-asset ratios) or pursue 

loan niches with broader geographic reach. As a result, performance measures might not reflect economic conditions within the headquarters 

MSA. In the cases of Honolulu and Anchorage, statistics for all established nonspecialty insured institutions were used, given the isolated nature 

of these banking markets and the relatively small number of insured institutions. 

4 Commercial real estate loans include mortgages secured by nonfarm-nonresidential, multifamily, and construction projects. 

FDIC OUTLOOK 38 SUMMER 2003 
Regional Perspectives 

less than three years old, and another 26 percent were 

less than nine years old. As noted in Table 1, at least 

half of all community institutions in the Las Vegas, 

Phoenix, Orange County, and San Diego markets 

have been in operation less than nine years. 

Conclusion 

The travel and tourism sector, although recovering 

from the effects of 9/11, remains vulnerable to global 

political and economic uncertainties, new terror alerts, 

and a weak national economy. Established community 

institutions based in most of the Region’s 12 traveldependent MSAs have not reported rising past-due 

loan ratios despite tourism sector layoffs, airline bankruptcies, and declines in RevPAR. However, without a 

quick rebound in the travel sector, banks and thrifts 

operating in these markets remain vulnerable to asset 

quality and earnings pressures. 

FDIC OUTLOOK 39 SUMMER 2003 
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