Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION	 SECOND QUARTER 1999 

FDIC
 

San Francisco
 

Region
 

Division of
 

Insurance
 

Catherine I.
 

Phillips-Olsen,
 

Regional Manager
 

Gary C. Zimmerman,
 

Regional Economist
 

Millen L. Simpson,
 

Financial Analyst
 

In Focus This Quarter 

◆ Economic Conditions and Emerging Risks in Banking—This article 

provides an overview of economic conditions and banking industry trends, with a 

primary focus on potential risks to insured depository institutions. 

● Economic Developments—Low interest rates, dormant inflation, and rising 

stock markets have all contributed to a generally positive near-term outlook for 

the U.S. economy. See page 3. 

●	 Trends Affecting Banking Lines of Business—Although credit conditions 

appear strong, risks exist in the major banking lines of business.	 See page 7. 

Consumer Lending—Continued high consumer loan loss rates raise questions 

about how lenders will fare under less favorable economic circumstances. 

See page 8. 

Commercial Lending—Corporate loan growth accelerated in 1998 even as the
 

corporate sector showed signs of stress. See page 9.
 

Commercial Real Estate and Construction Lending—Selected metropolitan
 

markets are experiencing rapid commercial development despite declining
 

indicators of demand. See page 10.
 

Agricultural Lending—Falling commodity prices threaten U.S. farm operators. See page 11.
 

Funding and Interest Rate Risk—Intense competition and the changing term
 

structure of interest rates have presented challenges for banks and thrifts.
 

See page 12. 

● Indicators of Industry Performance—Weaknesses appear to be developing for 

banks with certain types of exposures, and the dispersion in performance among 

insured institutions is increasing. See page 13. 

By the Analysis Branch Staff 

Regional Perspectives 

◆ Economic and Banking Conditions—The San Francisco Region’s economy continues to outperform that of the nation despite a marked slowdown in 

the growth of high-tech manufacturing employment...The Region’s slowdown 

in high-tech manufacturing can be directly attributed to the Asian crisis and overcapacity in several key technology markets...Several states and metropolitan statistical areas, because of their dependence on exports to Asia and the tendency of 

high-tech companies to “cluster” in certain areas, are more at risk to the slowdown...Community banks in metropolitan areas with high-tech clusters tend to 

have higher construction and commercial real estate loan exposures than community banks elsewhere in the Region and the nation. See page 16. 

By the San Francisco Region Staff 

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

Insurance Corporation for the following eight geographic regions: 

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

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

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

Dallas Region (CO, NM, OK, TX)
 

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

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

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

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

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

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

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

publish/regout. For more information or to provide comments or suggestions about the San Francisco Region’s Regional Outlook, please call Catherine I. Phillips-Olsen at (415) 974-4247 or send 

an e-mail to cphillips-olsen@fdic.gov. 

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

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

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

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

the Federal Deposit Insurance Corporation. 

Chairman Donna Tanoue 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Publications Manager Teresa J. Franks 
In Focus This Quarter
 

Economic Conditions and
 

Emerging Risks in Banking
 

Periodically, the Division of Insurance assesses conditions in the economy and across the banking industry in an effort 

to evaluate the types of risks that could adversely affect the performance of insured depository institutions. The analysis that follows describes the salient aspects of this assessment by focusing on three areas: 1) developments and conditions in the U.S. and global economies; 2) trends affecting particular banking lines of business; and 3) selected 

indicators of bank performance. 

In brief, the U.S. economy continues to provide a favorable environment for the banking industry. The industry as a 

whole has exhibited strong loan growth and minimal credit losses. Nevertheless, there are areas of concern, including subprime and high loan-to-value consumer lending, higher levels of leveraged commercial lending, localized 

overbuilding of commercial real estate, and the potential for credit quality problems among agricultural banks. 

Although it is uncertain when, or even if, these concerns will ultimately affect overall industry performance, the 

potential for stress among insured institutions is being monitored. 

Economic Developments
 

Conditions Have Improved Markedly 

since Late 1998 

The U.S. economy is now in its eighth year of expansion, the longest peacetime expansion during the postWorld War II era. Although analysts raised concerns 

about the durability of the expansion amid the late-1998 

financial market turmoil, the economic outlook since 

that time has improved for a number of reasons: 1) the 

75 basis point reduction in short-term U.S. interest rates 

between September and November helped to support 

consumer spending and business investment; 2) following several quarters of decline, U.S. exports rose unexpectedly during the fourth quarter; 3) inflation remained 

dormant even though U.S. labor markets were extremely tight; and 4) equity valuations for large-cap stocks 

rebounded and erased most of the losses incurred during August and September. 

Consumer Spending and Business Investment 

Are Key to Economic Strength 

Most of the standard indicators of health for the U.S. 

economy currently register values associated with the 

best macroeconomic conditions in our history. Growth in 

real gross domestic product (GDP) was 3.9 percent for 

all of 1998—the third consecutive year in which growth 

exceeded 3.5 percent. The U.S. economy added over 3.1 

million jobs during 1998, while unemployment averaged 

just 4.5 percent, the lowest annual figure since 1969. 

Despite this robust economic activity, inflation was also 

the lowest in a generation. Consumer prices rose by just 

1.6 percent in 1998, extending a seven-year streak during which prices have risen by less than 3 percent per 

year. At the same time, strong gains in the productivity 

of U.S. workers helped real hourly earnings rise by 2.7 

percent—the best performance since 1972—while unit 

labor costs of businesses rose by only 1.9 percent. 

Growth in business investment spending, which typically peaks in the early years of an economic expansion, 

has actually accelerated during the current expansion 

(Chart 1, next page). A number of factors appear to be 

responsible for this investment boom. One is the need 

for producers to invest in new technologies in order to 

cut costs and remain competitive. Also, rising stock 

prices, low interest rates, and low yield spreads during 

the past few years have helped keep the cost of capital 

relatively low. The result has been an economic expansion in which approximately 20 percent of net growth in 

real GDP has come from investment in producers’ 

durable equipment, versus approximately 10 percent 

during the long expansions of the 1960s, 1970s, and 

1980s. Bank commercial and industrial lending has 

expanded at an average annual rate of 10.6 percent over 

the past five years, largely on the strength of business 

investment spending. 

The underlying factors that drive consumer spending 

are strong. Low unemployment and rising real incomes 

have boosted the Conference Board’s consumer confiSan Francisco Regional Outlook 3 Second Quarter 1999 
In Focus This Quarter
 

CHART 1 

Low Interest Rates and High Stock Prices
 

Fuel Consumption and Investment
 

Personal Consumption Investment in Producers’ 

Expenditures* (%) Durable Equipment* (%) 

20 9 

15 7
 

5
 10 

3 5 

1 

0 –1 

–5 –3
 

–5
 –10 

* Annual Inflation-Adjusted Rate of Change 

Source: Bureau of Economic Analysis 

1990–91 

Recession 

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

dence index to its highest values since the late 1960s. 

Increases in new home construction reflect these favorable conditions. Almost 1.5 million new homes were 

completed during 1998—the highest level in ten 

years—while a record 4.8 million existing homes were 

sold (Chart 2). U.S. automobile sales reached 15.5 million in 1998, their best performance since 1986. Low 

interest rates also enabled a record number of homeowners to reduce their monthly interest expenses by 

refinancing their mortgages during 1998.1 

Although real disposable personal income grew by 

more than 3 percent during 1998, personal savings was 

essentially zero during the fourth quarter. This was the 

1 The Refinancing Index of the Mortgage Bankers Association posted an all-time high of 4,389 in the second week of October 1998. The 

index is scaled to a level of 100 as of the third week of March 1990. 

CHART 2 

Housing Starts and Home Sales Reflect the 

Strength of the Consumer Sector 

Sources: U.S. Census Bureau; National Association of Realtors 

2,250 

2,750 

3,250 

3,750 

4,250 

4,750 

5,250 

5,750 

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

One-Unit 

Housing 

Starts (000’s) 

550 

650 

750 

850 

950 

1,050 

1,150 

1,250 

1,350 

1,450 

1990–91 Recession 

Existing 1- to 

4-Family 

Sales (000’s) 

lowest rate of personal savings recorded in the United 

States since the Great Depression. The decline in personal savings has prompted much discussion of its causes and potential implications for the economy and for 

consumer credit quality. Most analysts have argued for 

the importance of a “wealth effect” from rising stock 

values on consumer spending.2 They note that although 

consumers are saving little out of current income, 

household wealth continues to grow rapidly, driving 

consumer spending higher. The willingness of American consumers to spend has been a prime factor in prolonging the economic expansion for the United States 

and in supporting the economies of countries around the 

world that depend on exports to the United States. This 

high degree of reliance on the U.S. consumer has led 

analysts to voice concerns that the wealth effect might 

reverse itself, leading to a sharp drop in consumer 

spending if there is a sustained stock market decline. 

Conditions Vary across Industry Sectors 

While overall conditions in the U.S. economy are good, 

certain sectors have been undergoing significant strain 

because of low commodity prices and weak foreign 

demand. 

Commodity price weakness extends across a wide range 

of items, from agricultural goods to industrial commodities to basic manufactured goods (Chart 3). 

Among agricultural commodities, grain prices have 

fallen substantially from their record-high levels of just 

three years ago, while prices for hogs and soybeans have 

also been under severe pressure. Industrial commodity 

prices have fallen sharply, with steel prices down by 

nearly 30 percent since January 1997. Certain manufactured goods show a similar pattern. The price of the 

industrial chemical benzene has fallen by 40 percent 

since January 1997, while the price of computer memory chips fell by more than 80 percent during that time. 

Oil prices decreased by nearly 50 percent between January 1997 and February 1999. Since mid-March, however, oil prices have increased as a result of agreements 

among oil producers to limit output. Analysts are uncer2 Personal savings is measured as the difference between disposable 

personal income (personal income less tax payments) and total consumption outlays. Increasing household wealth may reduce personal 

savings either through a reduction in disposable income or through 

increased consumption outlays. Tax payments resulting from capital 

gains will reduce measured disposable personal income. Increasing 

household wealth may lead to higher consumption outlays by means 

of the wealth effect. 

San Francisco Regional Outlook 4 Second Quarter 1999 
0 

In Focus This Quarter
 

CHART 3 

Price Weakness Extends across 

a Wide Range of Commodities 

Percent Decline in Prices from January 1997 to March 1998 

All 

commodities* Tin Steel Wheat Benzene Crude Oil 

–5 

–5.3%
 

–10
 –7.7%
 

–15
 

–20
 

–25
 

–30 –29.1%
 

–35
 

–36.2%
 –40
 

–40.6%
 –45
 

–50
 –47.4% 

* Producer Price Index (PPI)
 

Source: Journal of Commerce, Bureau of Labor Statistics
 

tain how long any reductions in output will be maintained or how much oil prices may increase during the 

next several months. 

Three trends in the global economy appear to be responsible for weak commodity prices. First, sustained low 

inflation has taken root both in developed nations and in 

many emerging economies. Low inflation has eliminated much of the speculative demand for commodities 

that was evident during the 1970s. Low inflation has 

also made it difficult for manufacturing firms to raise 

prices, while at the same time encouraging the implementation of new technologies to cut costs. Second, 

large-scale investment in plant and equipment during 

the 1990s in both developed and emerging countries has 

added vast amounts of new global manufacturing 

capacity, making industrial overcapacity a source of 

price weakness in a number of industries. Third, successive currency crises and the resulting recessions that 

have taken place in Asia, Eastern Europe, and Latin 

America have reduced global demand for commodity 

goods. Moreover, U.S. firms find that their products are 

less price competitive abroad because of the relative 

strength of the dollar. 

One reason the overall U.S. economy has proven so 

resilient in the face of weakness in the manufacturing 

sector is that firms have been able to restructure to cut 

costs and improve their market positions. Global overcapacity in industries such as oil and autos has been a 

driving force behind the record number and dollar value 

of merger deals announced during 1998. Mega-mergers 

involving Exxon-Mobil and Daimler Benz-Chrysler 

helped push the dollar volume of mergers announced in 

1998 to almost $1.2 trillion—nearly double the level 

announced in 1997 and far greater than any year during 

the “merger mania” of the 1980s (Chart 4). 

U.S. Foreign Trade Reflects Recent Turmoil 

in the Global Economy 

The U.S. economy increasingly relies on exports to fuel 

its overall growth. Between 1994 and 1997, export 

growth contributed about 1 percentage point each year 

to total net growth in real GDP. However, with the onset 

of the Asian economic crisis in 1997, the export sector 

stalled and became a drag on overall U.S. economic 

activity. During the first three quarters of 1998, exports 

decreased at an annualized rate of 4.4 percent, led by 

declines in capital goods, industrial material and supplies, and food and agricultural products. Weakness in 

exports was not limited to Asia; in fact, Canada, Mexico, and South America were also weak markets for U.S. 

goods and services during most of 1998. Declining 

goods exports and rising imports combined to push the 

U.S. balance of trade to a record deficit of $169 billion 

during 1998—a 50 percent increase from the year 

before. The trade deficit continued to increase in early 

1999. Data for January show an imbalance of nearly 

$17 billion, the largest monthly deficit ever recorded. 

Despite the weakness in foreign demand that was 

observed during much of last year, U.S. exports rose 

sharply at the end of 1998. Total exports jumped by 19.7 

percent during the fourth quarter, contributing 2.0 percent of the total 6.0 percent growth in GDP during the 

CHART 4 

0 

1,000 

2,000 

3,000 

4,000 

5,000 

6,000 

7,000 

8,000 

9,000 

0 

200 

400 

600 

800 

1,000 

1,200 

1,400 

Deal Value 

(Billions $) 

(Columns) 

Number of 

Deals (Line) 

Source: Houlihan Lokey’s Mergerstat 

Pressure to Maintain Profit Margins 

Has Led to Record Merger Activity 

Recessions 

’65 ’67 ’69 ’71 ’73 ’75 ’77 ’79 ’81 ’83 ’85 ’87 ’89 ’91 ’93 ’95 ’97 

San Francisco Regional Outlook 5 Second Quarter 1999 
In Focus This Quarter
 

quarter. This unexpected increase in U.S. exports 

involved nearly every region of the world except Eastern Europe. Export shipments increased across most 

product types, with the greatest increase in activity 

observed in capital goods. 

The Outlook for the Global Economy 

Remains Uncertain 

Developments during the past six 

months have resulted in an 

improved outlook for the global 

economy, but some key uncertainties remain. While the global 

financial system is more stable 

today than it was six months ago, 

some of the world’s most important economies either 

remain in recession or are experiencing slower growth. 

In this environment, the potential remains for shocks to 

arise in the global economy that could adversely affect 

the performance of the U.S. economy and the credit 

quality of insured depository institutions. 

Canada. The Canadian economy is healthier than at any 

time during the past several years. Canada’s economy is 

expected to track overall growth in the United States, in 

part because U.S. demand for goods and services is the 

principal support for Canadian exports. Canada’s relatively high dependence on weak commodity industries, 

such as metals, grains, and livestock, poses risks for 

producers and for local economies closely tied to these 

commodities. 

Mexico. Mexican GDP growth was 4.6 percent in 1998, 

reflecting relatively strong employment and wage gains, 

high levels of foreign direct investment, and robust nonoil export growth. Looking ahead, inflation remains a 

concern. At the end of 1998, the inflation rate was 18.7 

percent, up from a low of 15 percent in the middle of the 

year. The Blue Chip Economic Indicators consensus 

forecast calls for real GDP growth of 2.9 percent during 

1999, down from 4.6 percent in 1998. 

Western Europe. Europe’s problems are similar to 

those of the United States in that they stem from declining growth in manufacturing exports. Despite a 175 

basis point cut in short-term interest rates in the U.K. 

since October 1998, the Bank of England forecasts economic growth of less than 1.0 percent in 1999. In Germany, manufacturing activity has also decreased, owing 

to weakness in export markets. German GDP shrank by 

0.4 percent during the fourth quarter of 1998, while 

unemployment remains above 10 percent. In response to 

signs of growing weakness in Germany and other major 

economies in the 11-member “Euro-zone,” the European Central Bank cut short-term interest rates by 50 

basis points to 2.5 percent on April 8, 1999. 

Eastern Europe. Much of Eastern Europe is faced with 

slow growth or recession following the devaluation of 

the ruble and the default on Russian government debt in 

August 1998. The Russian economy shows few signs of 

recovery amid high inflation and halting progress in 

economic reform. Poland and Hungary, Eastern 

Europe’s engines of growth before the Russian crisis, 

are facing rising current account deficits and a slowdown in export growth. 

Asian Pacific Rim. The Japanese economy remains 

mired in a long-running recession that has resulted in a 

greater number of bankruptcies (up 17 percent in 1998), 

falling domestic demand, and pessimism among consumers and businesses alike. Japanese GDP fell by 2.8 

percent during 1998, and analysts call for a drop of 0.8 

percent in 1999. 

There are signs that the worst phase of the Asian economic crisis may have passed.3 In the Philippines, South 

Korea, Hong Kong, and Thailand, current accounts have 

moved from deficit to surplus as devalued currencies 

continue to depress imports. Foreign capital is returning 

to the region, as evidenced by the 27 percent increase in 

foreign direct investment in Korea during 1998. However, weak consumer spending remains a problem for 

the entire region, which ships fully 40 percent of all 

exports to other Asian Pacific Rim nations. 

In China, which has been relatively immune to the worst 

of the region’s economic crisis, slower growth is also 

forcing economic restructuring. With annual economic 

growth below the targeted 8 percent mark, economic 

planners have been forced to reduce production and 

close plants in the oil, steel, glass, and cement industries. Meanwhile, the government is trying to stimulate 

demand by investing in public infrastructure and by urging banks to increase lending to the private sector. 

3 See “The Asian Economic Crisis: Implications for the U.S. Economy,” Regional Outlook, Third Quarter 1998. Also available at 

http://www.fdic.gov/publish/regout/ro19983q/ny/infocus1.html. 

San Francisco Regional Outlook 6 Second Quarter 1999 
In Focus This Quarter
 

Latin America. With the apparent stabilization of the 

Asian economies, attention has now focused on emerging problems in Latin America. The 50 percent devaluation of the Brazilian real versus the dollar that began in 

January 1999 has depressed economic activity and 

renewed fears of inflation. Consensus estimates place 

Brazilian economic growth at negative 3.5 percent for 

1999, while short-term interest rates are likely to remain 

high (currently about 42 percent) to prevent further capital flows out of the country. 

Risks Remain despite a Positive 

U.S. Economic Outlook 

Robust economic growth, low inflation, and stable 

interest rates appear to be the most likely economic scenario for the remainder of 1999, according to the consensus forecast of the Blue Chip Economic Indicators. 

If this outlook actually comes to pass, we can expect 

that the vast majority of insured institutions will continue to enjoy moderate loan growth and generally favorable indicators of financial performance and condition. 

Despite this positive outlook, the risk remains that the 

expansion could be derailed by one of three types of 

shocks. The first would be a resurgence of inflation 

resulting from demand-induced shortages of labor or 

other key economic resources. Although inflation has 

been consistently low in recent years, investors remain 

on the lookout for any signs of higher prices. While it is 

not certain that a recession would result, it is worth noting that rising short-term interest rates in response to 

increasing inflation have preceded every recession during the past 40 years. 

The second type of shock that could end the expansion 

is a sustained period of deflation. Concern about deflation arises from the low prices many commodity producers are receiving and the effects of foreign currency 

devaluations on U.S. import prices. Although these 

trends have helped to keep U.S. inflation and interest 

rates low, at some point they could impose a heavier 

burden on U.S. businesses by shrinking revenues and 

profit margins, mirroring what has already occurred in 

some commodity-based industries.4 

The third type of shock is financial market instability. 

Consumer confidence, which has reflected recent 

increases in stock market wealth, could tumble in the 

event of a severe and prolonged decline in the stock 

market. Business investment has also depended on the 

support of strong and stable financial markets that offer 

firms access to capital on favorable terms and facilitate 

restructuring in troubled industries. A recession accompanied by financial market instability could pose a particular threat to bank loan performance because it would 

likely produce a disorderly shakeout of troubled firms 

marked by a rise in bankruptcies and loan defaults. 

4 See “How Will the Expansion End?” Regional Outlook, Second 

Quarter 1998. Also available at http://www.fdic.gov/publish/regout/ 

ro19982q/sf/infocus2.html. 

Trends Affecting Banking Lines of Business
 

Overview 

Trends in bank and thrift lines of business align closely 

with those of the economy. Most insured institutions 

have prospered during this economic expansion, as 

shown by the industry’s continuing earnings growth, 

strong capital levels, and improving or stable loan performance across most major loan categories. Likewise, 

today’s strong economy depends to a great extent on the 

continuing availability of consumer and business credit 

from banks and thrifts. Even during the closing months 

of 1998, when capital market funding sources became 

quite volatile, credit continued to flow from insured 

institutions. During that turbulent period, insured institutions may have acted as a stabilizing force for businesses, consumers, and farmers by continuing to provide credit, albeit at higher prices and with stricter 

underwriting terms in some cases. 

Although credit conditions appear strong, a number of 

insured institutions’ loan portfolios are shifting toward a 

riskier mix of credits. Underlying reasons for these 

shifts vary, but likely explanations include opportunities 

to earn higher yields and confidence about the overall 

economic outlook. The following paragraphs discuss 

credit risk trends and highlight possible areas of concern in the major lending lines of business at insured 

institutions. The influence of recent interest rate 

changes and competitive factors on asset/liability and 

credit risk management is also explored. 

San Francisco Regional Outlook 7 Second Quarter 1999 
In Focus This Quarter
 

Consumer Lending 

Debt Growth Sustains Consumer Spending but 

Could Contribute to Financial Strains under 

Less Favorable Economic Conditions 

Much of the strength and stability of the overall U.S. 

economy owes itself to the continuing growth in consumer spending. While higher personal incomes and 

consumer confidence are important contributing factors, lower interest rates and expanding avenues of credit access have also played key roles in supporting 

consumer spending. With mortgage debt leading the 

way, consumer loan growth rates accelerated in 1998. 

The key factor driving mortgage loan growth was lower 

interest rates, which encouraged many consumers to 

purchase homes, refinance existing mortgages, and 

consolidate their personal debts through home equity 

loans. As a result, the growth in home mortgage credit 

during 1998 reached a post-recession high of 10 percent. Other consumer loan types, such as auto and credit card debt, grew at slower but accelerating rates of 8 

percent and 5 percent, respectively. 

Nonmortgage consumer loan loss rates remain above 

previous recession levels despite the apparent strength 

of the consumer sector. Chart 5 shows that nonmortgage consumer loss rates have declined slightly from 

their peak in the fourth quarter of 1997, but remain 

above the rates experienced during the prior recession. 

The chart also shows that consumer credit loss rate 

trends are closely related to the rise in personal bankruptcy filings, which reached an all-time high of 1.4 

million in 1998.5 The good news for consumer lenders 

is that the growth rate in personal bankruptcies has 

slowed. However, this leveling off does not mean that 

consumer credit quality concerns have abated. The 

overriding concern is how personal bankruptcies and 

consumer credit losses, already at high levels, would be 

affected by less favorable economic conditions. Another concern is whether current consumer spending patterns will be supported by a new round of credit card 

growth. Since revolving credit card balances typically 

carry higher interest rates than home equity loans, this 

5 Reasons for the rise in personal bankruptcy rates are further 

explored in a series of Bank Trends articles published by the FDIC. 

See, for example, “A Time Series Model of the U.S. Personal Bankruptcy Rate, 1970-1996,” February 1998, and “The Effect of Consumer Interest Rate Deregulation on Credit Card Volumes, 

Charge-Offs, and Personal Bankruptcy Filings,” March 1998. Both 

reports can be accessed at www.fdic.gov/publish/bktrnds/index.html. 

CHART 5 

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

3.0 

1Q91 2Q92 3Q93 4Q94 1Q96 2Q97 3Q98 

0.0 

0.2 

0.4 

0.6 

0.8 

1.0 

1.2 

1.4 

Consumer Charge-Offs and Bankruptcies 

Have Leveled Off at a High Rate 

Bankruptcy Filings 

per 1,000 Population 

(Right axis) 

Sources: Administrative Office of the U.S. Courts; Federal Reserve Board 

1.6 

Consumer Loan 

Charge-Off Rate (%) 

“reloading” of credit card debt would further strain the 

financial flexibility of consumers. 

High Loan-to-Value Mortgage Products 

and Subprime Lending Transform 

Consumer Lending 

Consumer lending practices have changed significantly 

since the last recession. Because of intense competition 

and declining net interest margins, consumer lenders 

are reaching out to borrowers further down the credit 

quality spectrum and relaxing traditional collateral 

requirements. Bank supervisors have indicated that a 

growing number of insured institutions are involved in 

some form of subprime lending. Subprime loans, 

designed for borrowers with blemished or limited credit histories, can take a variety of forms, including home 

equity, automobile, and credit card loans. As compensation for increased risk, subprime loans carry higher 

interest rates than prime-rate loans and often require 

substantial collateral margins. 

Insured institutions are also embracing another relatively new consumer loan product: high loan-to-value 

(LTV) loans. High LTV loans, where the combined 

amount of senior and junior liens against a home 

exceeds its value, are usually made to borrowers with 

“clean” or unblemished credit histories. However, the 

lack of collateral protection results in much higher loss 

experience when a borrower defaults. As Chart 6 shows, 

high LTV loans have had a higher loss rate experience 

(adjusted for seasoning) than either traditional home 

equity loans or subprime loans. Moreover, the delinquency rates on recent-vintage home equity loan pools 

San Francisco Regional Outlook 8 Second Quarter 1999 
In Focus This Quarter
 

CHART 6 

0 

1 

2 

3 

4 

5 

6 

7 

0 2 4 6 8 10 12 14 16 18 20 22 

Months since Origination 

High LTV Mortgages* Have a Higher Loss 

Experience than Other Mortgage Types 

Charge-Off Rate (%) 

* Includes home improvement loans 

Source: Moody’s Investor Services 

High LTV 

Subprime 

Traditional 

Home Equity 

have deteriorated as high LTV loans have proliferated.6 

At the same time, recent regulatory surveys of credit 

underwriting practices show easing standards on home 

equity loans.7 The loss experience of these higher risk 

consumer products during less favorable economic circumstances is unknown and continues to be a concern. 

Commercial Lending 

Commercial Loan Performance Remains 

Strong but Corporate Financial Strains 

Are Developing 

Continued strength in the corporate sector is reflected in 

the level of corporate bankruptcy filings, which have 

declined since the middle of 1997 to just under 10,000 

in the fourth quarter of 1998. Bank losses on commercial credits remain low but did register a modest 

increase during the fourth quarter (see Chart 7). In addition to strong economic fundamentals in high tech, construction, finance, service-related, and other sectors, 

U.S. businesses have benefited from significantly lower 

interest rates and an abundant supply of credit. Credit 

access provided by banks was particularly important to 

U.S. businesses in the latter part of 1998. During this 

6 “Moody’s Home Equity Index Update.” Moody’s Investor Services, 

October 2, 1998, p. 3. 

7 For example, the Office of the Comptroller of the Currency’s “1998 

Survey of Credit Underwriting Practices” indicated that 33 percent of 

the banks offering home equity loans eased standards, compared with 

only 7 percent that tightened standards. The report is available at 

http://www.occ.treas.gov/cusurvey/scup98.pdf. 

period, sharply higher interest rate spreads on corporate 

bonds8 and commercial paper led many companies to 

tap cheaper funding sources, including existing unused 

credit and commercial paper lines held by commercial 

banks. As a result, commercial banks experienced a 15 

percent (annualized) rate of growth in fourth quarter 

1998, the highest rate of commercial loan growth in 16 

years. 

Although commercial loan loss rates are low, financial 

strains are becoming apparent among certain U.S. business sectors. Bank lending to U.S. businesses has grown 

at a faster pace than GDP during each of the past eight 

quarters. Moreover, growth in bank commercial lending 

through 1998 has come at a time when total after-tax 

U.S. corporate profits have begun to decline.9 Deteriorating profits are especially prevalent in sectors with 

exposure to weak commodity prices and slower export 

growth. For many businesses, lower profits have resulted in a reduced capacity to service outstanding debt 

obligations. For instance, a recent Bank of America 

Corporation study reported that amendments to syndicated loans in the latter half of 1998 were driven 

increasingly by borrowers seeking relief from financial 

performance-related covenants.10 Financial strains are 

8 The Merrill Lynch U.S. Investment Grade Corporate Bond Master 

Index indicates that corporate bond spreads over ten-year Treasury 

rates rose 58 percent, an increase of 63 basis points, from the end of 

July 1998 to the end of October 1998. 

9 See the Bureau of Economic Analysis Corporate Profit Index. 10 “Covenants Provide Loan Repricing Opportunity.” Bank of America 

Report, January 25, 1999. 

CHART 7 

0.0 

0.2 

0.4 

0.6 

0.8 

1.0 

1.2 

1.4 

1.6 

1.8 

2.0 

1Q91 3Q92 1Q94 3Q95 1Q97 3Q98 

Sources: U.S. Courts; Bank Call Reports 

Net Charge-Off Rate (%) Business Bankruptcies 

9,000 

10,000 

11,000 

12,000 

13,000 

14,000 

15,000 

16,000 

17,000 

18,000 

19,000 

20,000 

Domestic Commercial Loan Losses Remain Low 

and Business Bankruptcies Decline 

San Francisco Regional Outlook 9 Second Quarter 1999 
In Focus This Quarter
 

also reflected in the level of corporate bond defaults, 

which Standard and Poor’s reported at 48 ($10.8 billion in affected debt) in 1998, up 182 percent from 1997 

levels (up 150 percent in dollar volume terms).11 

As Debt Markets Become More Cautious, 

Syndicated Lending Shifts toward Higher 

Risk Borrowers 

Although the longer-term trend has been toward more 

aggressive corporate lending strategies, many insured 

institutions responded to the financial market turmoil in 

late 1998 with a heightened sense of caution. Recent surveys of underwriting practices conducted by the federal 

banking agencies show that many banks tightened standards in late 1998 across many product lines.12 However, 

tighter lending terms do not appear to have quelled 

either loan demand or loan production substantially. 

Syndicated lending trends suggest an increase in corporate lending risks.13 Despite the flight to quality that 

occurred in the latter part of 1998, syndicated loans to 

leveraged companies jumped 41 percent to $273 billion 

during 1998. Over the same period, nonleveraged loans 

declined 35 percent to $599 billion. Although corporate 

merger activity accounts for much of the increase in 

leveraged lending volume in 1998, some lenders appear 

to be taking advantage of the higher yields available in 

this market relative to yields on lower risk credits. The 

apparent shift toward a higher risk mix of total syndicated credit outstanding is occurring at the same time 

that corporate bond defaults for speculative grade issues 

are trending upward.14 Moreover, trends in corporate 

bond spreads and rating agency actions on corporate 

bond debt suggest a bond market that is becoming 

increasingly cautious about the outlook for U.S. businesses (see Chart 8). 

11 “Corporate Defaults Rise Sharply in 1998,” Standard & Poor’s, 

March 5, 1998. 

12 See Federal Reserve Board Senior Loan Officer Opinion Surveys 

for November 1998 and January 1999, http://www.bog.frb.fed.us/ 

boarddocs/snloansurvey/. 

13 Syndicated loans are credit facilities made to medium and large corporate borrowers by a group or syndicate of lenders. Analysts often 

segment this market into “leveraged” lending (loans to heavily indebted companies) and nonleveraged lending. 

14 Moody’s Investor Services reports that trailing 12-month default 

rates for speculative-grade issuers rose from 2.02 percent at the end 

of 1997 to 3.31 percent at year-end 1998. These default rates compare 

to an all-corporate trailing default rate of 0.68 percent in 1997 and 

1.27 percent in 1998. 

CHART 8 

0.4 

0.6 

0.8 

1.0 

1.2 

1.4 

1.6 

1.8 

2.0 

4Q93 4Q94 4Q95 4Q96 4Q97 4Q98 

–120 

–80 

–40 

0 

40 

80 

120 

160 

200 

Corporate Bond Ratings and Required 

Yields Reflect Greater Market Uncertainty 

Merrill Lynch Corporate Bond 

Master Index Spreads to Comparable

 Maturity Treasuries (bps) 

Sources: Moody’s Investor Service; Merrill Lynch 

Ratio of Corporate 

Upgrades to 

Downgrades 

Commercial Real Estate and 

Construction Lending 

Construction Loan Growth Accelerates 

as Overbuilding Pressures Increase 

in Certain Markets 

In 1998, the value of private commercial construction 

rose 4.0 percent over 1997 levels, reflecting a moderate 

slowdown in growth compared with a compounded 

average annual growth rate of 8.4 percent since 1992. In 

contrast, the pace of residential development has accelerated. The value of private residential construction rose 

11.5 percent in 1998, compared with an annual average 

growth rate of 8.0 percent since 1992. Construction 

loans at insured institutions grew 20 percent in 1998, 

the highest growth rate since 1986.15 

Although market fundamentals are strong throughout 

most major U.S. markets, some metropolitan areas 

appear to be vulnerable to an oversupply of commercial 

space. The Regional Outlook, First Quarter 1999, highlighted nine markets that may be susceptible to commercial overbuilding on the basis of the following 

factors: 1) the rapid pace of current construction activity in those markets; 2) high vacancy rates relative to 

construction in progress in some cases; 3) projections of 

rising vacancy rates by market analysts; and 4) various 

recent shifts in demand indicators. Data through June 

1998 indicate that construction activity in these markets 

15 Construction loan growth captures growth in both residential and 

nonresidential development. 

San Francisco Regional Outlook 10 Second Quarter 1999 
In Focus This Quarter
 

has not yet abated to reflect moderating demand levels.16 

Overbuilding concerns may be tempered to the extent 

that tighter commercial real estate lending standards 

slow the pace of development.17 

Loan Underwriting Study Reveals Sounder 

Practices Compared with the 1980s, but Intense 

Competition Forces Some Concessions on 

Pricing and Structure 

Beginning in August 1998, FDIC analysts set out to 

investigate construction loan underwriting practices in 

banks servicing various rapidly growing markets. The 

study identified several differences between today’s 

lending practices and those prevalent during the last 

cycle. Most importantly, today’s lenders are making 

credit decisions on the basis of improved appraisals, 

increased attention to project cash flows and project 

feasibility, and better market information on competing 

projects. However, intense competition has forced an 

across-the-board reduction in loan pricing margins even 

compared with margins at the height of the 1980s building boom. 

The study also identified some instances of aggressive 

loan structures, including pricing at extremely thin margins, waiving or limiting personal guarantees, waiving 

cash equity requirements, and lending on thin collateral 

margins. Borrowers who secured the most aggressive 

loan terms were typically larger developers, who presumably have the resources and financial flexibility to 

weather adverse conditions. Nevertheless, waiving personal guarantees and eliminating a borrower’s financial 

exposure to project risks are practices often cited in 

conjunction with the heavy construction loan losses 

experienced during the previous real estate downturn. 

Finally, the study found that many real estate investment 

trusts and large corporate developers have been able to 

obtain long-term unsecured financing for development 

purposes. The lack of collateral protection could make 

16 The nine markets are Atlanta, Charlotte, Dallas, Las Vegas,
 

Nashville, Orlando, Phoenix, Portland, and Salt Lake City. “Commercial Development Still Hot in Some Markets but Slower Development May Be Ahead.” Regional Outlook, First Quarter 1999,
 

www.fdic.gov/publish/regout/ro19991q/na/index.html.
 17 Consistent with commercial and industrial underwriting trends,
 

commercial real estate lenders reacted to market volatility in late
 

1998 by tightening loan terms and raising pricing margins. See, for
 

example, the Federal Reserve Board Senior Loan Officer Opinion
 

Survey for November 1998 and January 1999.
 

these loans particularly vulnerable to declining commercial real estate prices.18 

Agricultural Lending 

Farm Banks Threatened by Falling 

Commodity Prices 

Farm banks generally performed well in 1998, reporting 

a modest increase in nonperforming loans from 1.09 

percent at year-end 1997 to 1.13 percent as of year-end 

1998. Although delinquent loans rose only slightly 

in the aggregate, farm banks in some localized areas 

such as northeast North Dakota and northwest Minnesota experienced sharply higher problem loan levels 

and reduced profits in the aftermath of three consecutive years of low prices, bad weather, and crop diseaserelated problems. Moreover, recent surveys by the 

federal banking agencies, which show rising levels of 

farm carryover debt at farm banks, suggest that nonperforming loan data may understate borrower difficulties. 

During 1998, the outlook for significant portions of the 

farm sector deteriorated following a dramatic fall in 

prices for several major farm commodities. Prices for wheat, corn, 

soybeans, and hogs fell to ten-year 

lows and were below the economic breakeven cost of production for 

many producers. For areas heavily 

dependent on these commodities, 

the U.S. Department of Agriculture (USDA) projects that producers will experience 

substantial declines in net cash income from 1999 

through 2003.19 In 1999, the USDA projects farm 

income to fall 7.1 percent, to $44.6 billion, from last 

year’s level of $48 billion. 

Although current conditions have the potential to cause 

stress for substantial numbers of farm banks in certain 

regions, some significant differences exist between 

today’s circumstances and those that led to the farm 

18 Loan covenants may mitigate some of the risks of lending without 

collateral protection. Common covenants include maximum leverage 

ratios, minimum equity requirements, and limits on encumbered 

assets through recourse or cross-collateralization to third parties. 

19 A substantial portion of the USDA’s projected decline in the net 

cash income for U.S. farmers over the next five years is attributable 

to reductions in government payments to farmers. 

San Francisco Regional Outlook 11 Second Quarter 1999 
In Focus This Quarter
 

bank crisis of the mid-1980s. Current favorable factors 

include 1) lower debt-to-equity for farm producers; 2) 

substantially lower interest rates; 3) moderately appreciating farmland prices relative to the more rapid appreciation (and subsequent price corrections that followed) 

in the 1970s and 1980s; and 4) better underwriting practices by farm lenders. Nevertheless, if weak exports of 

farm products and low commodity prices continue for 

the remainder of this year, the condition of farmers 

could deteriorate significantly, increasing financial 

stress at insured farm banks. 

Funding and Interest Rate Risk 

Deposit Funding Becomes 

More Difficult to Obtain 

Competitive pressures in the banking industry are not 

restricted to lending. Insured institutions are also finding it difficult to attract deposits in today’s marketplace, 

largely because of the existence of higher yielding 

investment products. For example, the Investment 

Company Institute reports that net inflows into mutual 

funds have exceeded net increases in deposit accounts 

in all but three quarters since mid-1991. The fourth 

quarter of 1998 marked the sixteenth consecutive quarter that mutual fund inflows outstripped deposit increases. As deposits have become more difficult to attract, 

loan portfolios have expanded in line with the overall 

growth in the economy. As a result, institutions have 

turned increasingly to other borrowings for funding. 

These trends are captured in Chart 9, which shows that 

the ratio of bank and thrift loans to deposits reached a 

record 88 percent in December 1998. Small community 

CHART 9 

banks and thrifts (institutions with less than $1 billion in 

assets) are most affected by deposit trends, since they 

tend to rely more heavily on deposit funding than larger institutions with greater access to the capital markets. 

Interest Rate Changes Pose Asset/Liability 

Management Challenges 

Interest margin pressures are posing challenges for 

insured institutions. In addition to the effect of competitive pressures, changes in interest rates have had a substantial influence on institutions’ net interest margins. 

The flattening of the yield curve in 1998, for example, 

appears to have contributed to a decline in margins to 

their lowest levels since 1991 for both large and small 

insured institutions (see Chart 10). For insured institutions with more traditional asset/liability structures 

(longer-term asset holdings funded with shorter-term 

deposits and borrowings), a flatter yield curve results in 

lower spreads between asset yields and interest costs. 

The decline in long-term interest rates during 1998 also 

led to a record volume of mortgage refinance activity, 

as indicated by the Mortgage Bankers Association’s 

Refinancing Index.20 Among many mortgage lenders, 

the most immediate impact from this refinancing activity was the revaluation of servicing assets and lower servicing fee income. Some mortgage lenders also saw a 

significant increase in overhead as they expanded staff 

to accommodate higher loan application volumes. A 

20 This index hit its peak in mid-October and has since declined in line 

with a modest upward movement in fixed mortgage rates. 

CHART 10 

65 

70 

75 

80 

85 

90 

95 

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

Loans and Assets Are Growing Faster than 

Deposits at Insured Institutions 

Loans to Deposits 

Deposits to Assets 

Source: Bank Call Reports and Thrift Financial Reports 

Percent 

A Flatter Yield Curve in 1998 Placed 

Pressure on Net Interest Margins 

Sources: Federal Reserve Board; Bank Call Reports; Thrift Financial Reports 

1.0 

1.5 

2.0 

2.5 

3.0 

3.5 

4.0 

4.5 

5.0 

–50 

0 

50 

100 

150 

200 

250 

300 

350 

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

Assets 

< $1 Billion 

(right axis) 

10-Year Less 1-Year 

Treasury (bps) 

Mean Net Interest 

Margin (%) 

Assets 

> $1 Billion 

(right axis) 

San Francisco Regional Outlook 12 Second Quarter 1999 
In Focus This Quarter
 

longer-lasting impact involves the shift in borrower 

preferences toward fixed-rate mortgages. According to 

Freddie Mac, approximately 65 percent of adjustablerate mortgages refinanced in 1998 were replaced with 

30-year fixed-rate mortgages. Another 30 percent were 

refinanced into 15- and 20-year fixed-rate mortgages. 

As a result of this activity, mortgage lenders may tend 

to have a higher proportion of assets held in longer-term 

mortgage loans, leading to further margin pressures 

should interest rates rise. 

As discussed in previous sections, many insured institutions appear to be turning toward higher risk consumer 

and corporate lending strategies. Such strategic shifts 

may be at least partially in response to pressures on net 

interest margins. The search for higher yield spreads 

may also explain the continuing growth in nondeposit 

funding sources, which often take the form of complex 

obligations with embedded options that can reduce 

funding costs at the expense of additional interest rate 

risk. 

Indicators of Industry Performance
 

Market Signals for the Banking 

Industry Are Mixed 

Diminished concerns over the near-term economic outlook and reduced financial market volatility resulted in 

a sharp turnaround in investor attitudes toward banks in 

the fourth quarter of 1998. During the quarter, the SNL 

Bank Stock Index21 rose 21 percent, recovering all of 

the value it lost during the turmoil of the third quarter. 

The index has continued to rise in 1999. 

Although equity indicators have been generally positive, ratings actions in 1998 for the long-term debt of 

U.S. banks and finance companies reflect developing 

problems for certain industry segments. In sharp contrast to the previous six years, when upgrades far 

exceeded downgrades, Moody’s downgraded as many 

bank and finance company debt ratings as it upgraded 

during 1998. In the fourth quarter of 1998, Moody’s 

downgraded the long-term debt ratings of 27 bank and 

finance companies and upgraded only 15—the highest 

quarterly ratio of downgrades to upgrades since 1992. 

Downgrades during 1998 were centered in finance 

companies specializing in nonportfolio subprime lending and bank holding companies with exposure to 

emerging markets. 

Bank Performance Remains Strong but 

Earnings Variability Is Increasing 

Recent stable industry profitability in the aggregate has 

masked an increasing range of profit variability for 

individual commercial banks. Over the past six years, 

21 This index tracks the market capitalization of approximately 520 

banking companies. 

the annual aggregate return on average assets (ROA) for 

commercial banks has shown little fluctuation, ranging 

from a low of 1.15 percent in 1994 to a high of 1.24 percent in 1997.22 However, the variability in commercial 

bank profitability, as measured by the distribution of the 

industry’s ROA excluding the top and bottom 5 percent, 

has widened since 1994 (see Chart 11). For example, 

ROA for the worst 5 percent of the industry was negative 0.29 percent or less in 1998, reflecting a steady 

decline from 0.2 percent in 1995. Similarly, ROA for the 

most profitable 5 percent of commercial banks was 

above 2.16 percent, up from 1.94 percent in 1994. 

Reasons for the increasing variability of commercial 

bank ROA can be further analyzed by segregating institutions along predominant product or business lines. 

Chart 12 (next page) details the distribution of 1998 

22 FDIC Quarterly

www2.fdic.gov/qbp. 

CHART 11 

 Banking Profile, Fourth Quarter 1998, 

3.0 

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

Source: Bank Call Reports 

Bottom 5th Percentile 

Top 5th Percentile 

Mean 

The Range of Profitability for Commercial 

Banks Is Increasing 

Return on Asset Distribution 

–4.0 

–3.0 

–2.0 

–1.0 

0.0 

1.0 

2.0 

San Francisco Regional Outlook 13 Second Quarter 1999 
In Focus This Quarter
 

CHART 12 

–5% 0% 5% 10% 15% 

1998 Performance Varies by 

Business Specialization 

Return on Assets Percentage Distribution 

Agricultural 

(2,274) 

International 

(11) 

Consumer 

(211) 

Commercial 

(3,150) 

Specialized 

(621) 

Credit Card 

(68) 

Note: Group institution count is in parentheses. 

Source: Bank Call Reports (Research Information System) 

Industry Mean ROA=1.13% 

Bottom Fifth Percentile 

Top Fifth Percentile 

ROA for six selected groups of banks segregated by line 

of business concentrations. This chart reveals that bank 

performance varies considerably by business specialty. 

For example, the distribution of ROA of credit card 

lenders23 differs significantly from that of other bank 

groups, including other consumer lenders.24 Small specialized banks25 and commercial lenders26 followed 

credit card lenders as the groups with the greatest variability in profitability in 1998. Moreover, 75 percent of 

the least profitable commercial banks were members of 

small specialized or commercial groups. New banks 

have also influenced the dispersion of bank ROA. Banks 

chartered in 1997 and 1998 make up more than 60 percent of the industry’s worst performers. However, earnings variability widened in 1998 even when newer 

institutions are excluded from the analysis. 

23 Banks with at least 50 percent of managed loans in managed credit 

card receivables and at least 50 percent of managed loans in total 

managed assets. 

24 Banks with consumer loans and single-family mortgages in excess 

of 50 percent of assets that do not meet separate credit card or mortgage lending concentration thresholds. 

25 Banks with total assets less than $1 billion, and less than 40 percent 

of assets held in loans, that do not fall in other business specialties. 

Members of this group include de novo banks and more seasoned 

banks with low loan activity, such as trust companies. 

26 Banks with 25 percent or more of assets in commercial and commercial real estate loans. 

Far fewer commercial banks posted losses in 1998 than 

during the period from 1984 to 1992. Still, the number 

of unprofitable institutions appears to be rising despite 

generally favorable economic conditions. These concerns are mitigated somewhat, since today’s worstperforming institutions are generally much better 

capitalized and are burdened with fewer problem assets 

than their counterparts during the 1980s. 

Summary 

Most indicators of U.S. economic health remain robust 

in spite of the difficulties posed by low commodity 

prices and falling exports during 1998. The consensus 

forecast of leading economic analysts calls for continued growth in the U.S. economy for the rest of 1999. At 

the same time, a number of threats to this favorable outlook exist, including the possibility of higher inflation 

and higher interest rates stemming from strong economic growth. Other scenarios involve a very different 

threat—namely, price deflation brought on by global 

overcapacity and a decline in U.S. exports. Shocks that 

might arise in the foreign sector or in the financial markets, as experienced during 1998, remain a significant 

concern during 1999. Consumer spending and business 

investment seem particularly vulnerable to such shocks 

at this stage of the expansion. 

Favorable economic conditions are reflected in the overall performance of the banking industry. Still, a number 

of indicators suggest that the risk profile of some 

insured institutions is increasing. Responding to significant competitive pressures, and perhaps emboldened 

by the long duration of the current expansion, many 

institutions are expanding their involvement in higherrisk consumer loan products, such as subprime and high 

LTV loans and higher-risk leveraged commercial loans. 

The overall shift toward higher-risk credits is occurring 

despite signs of financial strain on the part of many consumers (in the form of record personal bankruptcies) 

and businesses (in the form of declining profits and 

increasing bond default rates). Credit-related concerns 

also extend to commercial real estate, where some markets are exhibiting rapid commercial real estate development at the same time that demand indicators are 

San Francisco Regional Outlook 14 Second Quarter 1999 
In Focus This Quarter
 

trending downward. Finally, sustained weak commodity 

prices are placing strains on farmers and could eventually lead to higher agricultural loan delinquencies. 

Bank and thrift net interest margins are being pressured 

by a flatter yield curve and heightened competition. 

Community institutions, which rely most heavily on 

interest income, are particularly vulnerable to tighter 

margins. The major concern in this area is that insured 

institutions will combat falling margins by entering into 

riskier funding and lending strategies. 

Market indicators and reported financial data reflect 

favorable industry performance as well as new sources 

of risk. Investor attitudes toward banking companies 

have improved since late 1998 because of an improved 

near-term economic outlook and a reduction in financial market volatility. However, a recent increase in 

ratings downgrades of bank and finance company longterm debt suggests growing concern over bank exposures to such areas as subprime lending and emerging 

markets. Despite relatively strong aggregate industry 

performance, profit variability among individual commercial banks has increased because of new chartering 

activity and pressures in consumer and commercial 

lending. As a result, for the first time since 1992, the 

worst performing 5 percent of all commercial banks 

were unprofitable last year. 

This article was prepared and coordinated by the staff of the Analysis Branch of the Division of Insurance. Contributions and feedback from analysts across the Division were essential to its completion. 

Maureen E. Sweeney, Associate Director 

Paul C. Bishop, Senior Financial Economist 

Richard A. Brown, Chief, Economic and Market Trends Section 

Steve Burton, Senior Banking Analyst 

Steven E. Cunningham, Chief, Financial Institutions Section 

Alan Deaton, Economic Analyst 

Diane Ellis, Senior Financial Analyst 

Jim Heil, Economic Analyst 

Brian Kenner, Financial Analyst 

Allen Puwalski, Senior Financial Analyst 

San Francisco Regional Outlook 15 Second Quarter 1999 
 

 

 Services

 FIRE 

ade 

Employment

 Construction 

 & PU

nment

acturing 

rT

.ans

rev Go

uf

r

 Man

T

Regional Perspectives
 

Regional Perspectives
 

•	 The San Francisco Region’s economy, although slowing due to a downturn in employment in hightechnology manufacturing, continues to outperform that of the nation. 

•	 The Region’s slowdown in employment in high-technology manufacturing is primarily attributed to 

the Asian crisis and overcapacity in several technology sectors. 

•	 Several metropolitan statistical areas (MSAs) in the San Francisco Region, which have large “clusters” 

of high-technology firms, are vulnerable to the slowdown in high-technology manufacturing. 

•	 Community banks in the Portland, Salt Lake/Provo, Sacramento, and San Jose MSAs with hightechnology clusters have high exposures to construction and commercial real estate loans. 

High-Technology Slowdown Dampens Region’s Robust Growth
 

Robust Job Growth in 1998, but at 

a Slower Pace than in 1997 

Although the San Francisco Region experienced a significant slowdown in the manufacturing sector during 

1998, it continued to outperform the nation in overall 

job growth (see Chart 1). In the 12 months ending 

December 1998, the Region added jobs at a seasonally 

adjusted 3.0 percent rate—well above the nation’s 2.3 

percent rate. The Region’s economic performance 

reflects strength in a number of industrial sectors, as can 

be seen in Chart 2. The construction, services, financial 

services, and transportation and public utilities sectors 

all reported 3.0 percent or more growth in 1998, following strong growth in 1997. Weakness in global markets appears to have stopped the rapid growth in 

CHART 1 

Source: Bureau of Labor Statistics, nonfarm payroll employment, seasonally 

adjusted, December-over-December percent changes 

San Francisco Region Has Outperformed 

the Nation in Job Growth Rates over the 

Past Several Years 

Employment Growth (Percent)

–2 

–1 

0 

1 

2 

3 

4 

5 

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

SF Region 

Nation 

manufacturing jobs and led to a decline in mining 

employment. Most important, weakening exports and 

surging imports appear to have resulted in a 0.3 percent 

loss in durable goods manufacturing jobs in 1998, a 

sharp contrast with the 5.9 percent increase in 1997. 

Despite its overall strength, performance varied widely 

across the Region in 1998. Although a number of areas 

with large dependence on high-technology manufacturing reported weakness, three states remained among the 

nation’s fastest at adding jobs. Nevada (ranked second), 

Arizona (third), and California (sixth) added jobs at 

annual rates of 3.3 percent or better in 1998, significantly outperforming the nation in job growth (see 

Chart 3, next page). Strong job growth contributed to 

CHART 2 

San Francisco Region’s Manufacturing Job
 

Growth Rate Fell Sharply in 1998, but Most Other
 

Sectors Maintained Their Growth Rates


9

Employment Growth (Percent)

1997 1998 8 

1996 7
 

6
 

5
 

4
 

3
 

1
 

2
 

0
 

Source: Bureau of Labor Statistics, nonfarm payroll employment, seasonally 

adjusted, December-over-December percent changes 

San Francisco Regional Outlook 16	 Second Quarter 1999 
9 

SF Region

.

ada

ona

nia

Utah

Idaho

ashington

Alaska

Montana

Oregon

oming

S

aii w

v

iz

or

Ne

Ha

Calif

Ar

yW

W

Regional Perspectives
 

CHART 3 

Most States in the San Francisco Region Reported 

Slower Job Growth in 1998 than in 1997 

1996 

1997 

1998

Employment Growth (Percent) 

U.

8 

7 

6 

5 

4 

3 

2 

1 

0 

–1 

Source: Bureau of Labor Statistics, nonfarm payroll employment, Decemberover-December percent changes, seasonally adjusted 

strong personal income growth and declining unemployment in the Region. 

In 1998, six states in the Region added jobs at a rate 

similar to the nation’s 2.3 percent increase: Utah (2.7 

percent), Idaho (2.6 percent), Washington (2.4 percent), Alaska (2.1 percent), Montana (1.9 percent), and 

Oregon (1.9 percent). Utah and Oregon had experienced rapid high-tech job growth prior to 1998, when 

both were among the fastest-growing states in the 

Region. Despite weakness in the energy sector, caused 

by the significant reduction in oil prices in 1998, Alaska’s job growth rate was nearly as fast as the nation’s. 

Montana’s job growth held steady in 1998; increases in 

services and financial sector jobs were offset by 

declines in mining and construction jobs. 

Wyoming and Hawaii, however, continue to lag well 

behind both the Region and the nation in economic 

performance. Wyoming’s job growth rate fell from 2.5 

percent in 1997 to 0.4 percent in 1998, ranking it fortyeighth in the nation. Low energy prices in 1998 were 

reflected in job losses in the state’s key mining sector. 

Most other sectors of the economy, except for financial 

services and the service sector, reported slow job 

growth. Hawaii, which remained mired in a recession 

during 1998, was one of only two states in the nation to 

lose jobs. Hawaii continued to report widespread weakness across most sectors of its economy. It also continues to be hurt by softness in Japanese tourism and 

reduced spending by visitors. 

Most Insured Financial Institutions 

Reported Solid Profits for 1998 

The Asian crisis, which was primarily responsible for 

losses in the Region’s manufacturing jobs, did not materially affect the 1998 performance of most insured 

financial institutions. Commercial banks and savings 

institutions without direct international exposure, as 

well as credit card specialty banks,1 benefited from the 

Region’s strong economy and reported solid profits. The 

Region’s generally strong economic performance over 

the year is also reflected in the strong asset quality 

reported by financial institutions. The 1.82 percent pastdue loan ratio posted for year-end 1998 is the lowest in 

the decade for the Region. Furthermore, 41 new banks 

opened for business during 1998. The industrywide 

trend toward consolidation continued, as 58 of the 

Region’s institutions were eliminated through mergers 

and acquisitions. The Region’s first bank failure in over 

a year occurred during 1998. 

For certain banking companies with international, subprime, and agricultural exposures, 1998 was not so 

kind. For example, the primary reason the Region’s 

aggregate return on average assets (ROA) declined from 

the 1.19 percent reported for 1997 to 1.07 percent for 

1998 was the problems experienced by a few large commercial banks with significant international exposure. 

Another illustration of the negative spillover effects of 

international problems is the poor relative performance 

of Hawaii’s community banks.2 These banks reported an 

ROA of only 0.22 percent and a high 5.12 percent pastdue loan ratio because of Hawaii’s continuing recession, 

which has correlated with Japan’s prolonged recession. 

In addition, the Region’s subprime lending specialists 

saw their ROA drop from 1.09 percent in 1997 to 0.59 

percent in 1998, when larger subprime lenders had 

problems profitably securing loans during the third and 

fourth quarters because of capital market turbulence. 

Finally, while Montana’s agricultural banks3 continue to 

1 A credit card specialty bank is an institution with credit card loans 

and secured receivables outstanding greater than 50 percent of its 

total loans, and total loans greater than 50 percent of total assets. 

2 A community bank is a commercial bank with less than $1 billion in 

total assets, excluding specialty credit card banks. Also excluded are 

industrial loan companies and other special-purpose lenders common 

in the Salt Lake City and Phoenix MSAs. 

3 An agricultural bank is an institution with agricultural loans greater 

than 25 percent of total loans. 

San Francisco Regional Outlook 17 Second Quarter 1999 
Regional Perspectives
 

report strong profits, their aggregate past-due loan ratio 

increased from the 3.96 percent reported in 1997 to 4.52 

percent as of December 1998. Several years of 

depressed commodity prices, particularly wheat prices, 

are beginning to erode asset quality at these smaller 

agricultural banks. 

A High-Tech Slowdown Has Hit the Region’s 

Important Manufacturing Sector 

The emerging story in the San Francisco Region’s economy in 1998 was the sudden downturn in manufacturing, especially the high-tech sector. This trend is an 

important concern because both the Region as a whole 

and several metropolitan areas are heavily dependent on 

manufacturing and high-tech for both jobs and exports. 

The main driver of the observed weakness in manufacturing appears to be the Asian crisis (see Strong Economic Growth Is Expected to Continue in the San 

Francisco Region despite Potential Fallout from the 

Asian Crisis, Second Quarter 1998 Regional Outlook) 

and overcapacity in the high-tech 

sector. Weakness in the Asian 

economies that started in 1997 is 

reflected in both a slowdown in U.S. 

exports to Asia and the increased 

competitiveness of Asian products 

following 1997 currency devaluations. After economic struggles of 

the Asian Ten nations in the second 

half of 1997 and 1998, the Region’s 

manufacturing sector reported significant downturns in 1998 in both 

exports and jobs.4 Moreover, the weakness has been 

even more pronounced in several states and MSAs in 

the Region that have especially large high-technology 

job clusters. At least in part because of expanding hightech industries prior to 1998, several of these MSAs 

experienced rapid growth in their residential and commercial real estate (CRE) markets. Consequently, community bank exposure to construction and CRE lending 

has risen far above national averages in Portland, Salt 

Lake/Provo, Sacramento, and San Jose. 

The Region’s high-tech sector is important because of 

the number of jobs and the amount of income it generates. According to the latest Survey of Manufacturing 

(1996) by the Census Bureau, high-technology accounted for more than 438,000, or nearly 15 percent, of the 

Region’s 3.0 million manufacturing jobs.5 Elsewhere in 

the nation, only 6 percent of manufacturing jobs were in 

these high-tech industries. Moreover, the survey showed 

that the Region accounted for more than 32 percent of 

the nation’s computer manufacturing jobs and nearly 37 

percent of the electronic component manufacturing 

jobs, despite accounting for about 18 percent of nonfarm payroll employment nationally. Finally, the hightech sector is slowing at the same time that another key 

industry in the Region, aerospace, is contracting. 

The slowdown in high-technology is also significant 

since high-tech manufactured goods are the Region’s 

leading export products. High-tech goods exported to 

Asia were the fastest-growing segment of the U.S. 

export market prior to 1997. As shown in Table 1, in 

1997, half of the Region’s $165 billion in exports were 

high-tech products, according to the International 

Trade Administration’s (ITA) Exporter Location 

series. Elsewhere in the nation, high-tech accounts for 

only about 37 percent of exports. Within the Region, 

high-tech goods accounted for especially large shares of 

exports from Arizona (77 percent), Idaho (68 percent), 

and California (61 percent). Other states with high-tech 

clusters and export exposures include Oregon (39 percent) and Utah (32 percent). Furthermore, each of these 

states has one or more MSAs with high-tech clusters 

that are even more dependent on high-technology for 

both jobs and exports than the state is. 

The Asian Crisis Hits Home 

The Asian crisis also has exacerbated the hightechnology sector’s ongoing problems with worldwide 

overcapacity, especially in semiconductors, leading to 

layoffs, postponements, and cutbacks. Falling prices, 

typical for the industry but now also driven by the Asian 

currency devaluations of 1997, have added to a need on 

the part of domestic producers to control costs to 

remain competitive in both domestic and foreign markets. Moreover, the retrenching is taking place at the 

same time sub-$1,000 personal computers (PCs) that 

provide cheap access to the Internet have diverted sales 

from high-end producers, causing another shift within 

the industry. 

5 High-tech employment is defined here as jobs related to computers 4 China, Hong Kong, Indonesia, Japan, Malaysia, the Philippines, and office equipment, communication equipment, electronic compoSingapore, South Korea, Taiwan, and Thailand. nents and accessories, and measuring and control devices. 

San Francisco Regional Outlook 18 Second Quarter 1999 
Regional Perspectives
 

TABLE 1 

Despite a Weak Manufacturing Sector, Banking Performance Remains Favorable 

SALT LAKE 

SAN PORT­ CITY/ SACRA­ S.F. 

JOSE PHOENIX LAND PROVO MENTO REGION U.S. 

EMPLOYMENT 

GROWTH1 

DECEMBER ’97­

DECEMBER ’98 

TOTAL NONFARM 

PAYROLL (%) 1.0 4.7 1.7 2.7 3.5 2.9 2.2 

MANUFACTURING (%) –3.0 2.1 –2.9 0.7 –2.1 0.0 –1.2 

DURABLE (%) –3.5 2.2 –2.7 0.7 –2.5 –0.5 –1.1 

1997 

EXPORTS2 

TOTAL EXPORTS ($B) 29.1 11.1 8.9 3.0 1.7 165.2 687.6 

% HIGH TECH 94.9 81.8 42.4 N/A N/A 50.0 40.0 

COMMUNITY 

BANK 

PERFORMANCE 

INDICATORS3 

YEAR-END 

1998 

ROA (%) 1.25 1.03 1.24 1.71 0.71 1.29 1.24 

TIER ONE 

LEVERAGE RATIO (%) 7.86 8.45 12.36 11.40 8.47 10.21 9.51 

PAST DUE RATIO (%) 0.58 0.69 1.39 2.26 2.32 2.20 2.26 

COMMERCIAL 

RE/ASSETS4 (%) 31.66 17.97 26.42 34.12 33.65 25.59 16.45 

CONSTRUCTION 

RE/ASSETS (%) 11.79 5.40 7.81 15.84 12.60 5.71 3.30 

1 Source: Bureau of Labor Statistics; not seasonally adjusted. 

2 Source: International Trade Administration; High tech is defined to include industrial machinery, computers, 

electric and electronic equipment, scientific and measuring instruments. 

3 Source: Bank Call Reports 

4 Commercial real estate represents the sum of nonfarm, nonresidential, multifamily, and construction real estate. 

The rapid expansion in the Region’s high-tech manufacturing jobs came to a halt in 1998 as exports to Asia 

fell. First-quarter 1998 high-tech exports from the 

Region to the Asian Ten nations were down 12.3 percent 

from the same quarter in 1997. Total exports to these 

nations declined by 10.7 percent during the same period. Detailed high-tech employment figures for the 

Region are not available; however, combined data for 

California, Washington, and Oregon show the weakness. All three states reported losses in high-tech jobs. 

In 1998 high-tech jobs in these three states fell by a total 

of 11,200 jobs, after 24,000 jobs were added in 1997. 

For the Region as a whole, the slowdown in hightechnology was most evident in the figures for durable 

goods manufacturing, the job category that includes 

most high-tech manufacturing jobs. Durable goods 

manufacturing jobs fell by 6,600 jobs (–0.3 percent 

annual rate) in 1998, after posting a 112,600 job 

increase (5.9 percent increase) in 1997. 

MSAs with High-Tech Clusters 

Face Higher Risks 

The slowdown in high-technology is even more important at the state and metropolitan area levels because of 

the tendency for high-tech firms, both manufacturers 

and service providers, to cluster around high-tech centers to take advantage of efficiencies for both producers 

and employees. High-tech clusters provide access to 

suppliers along with the benefits of high-tech financing, 

local information, and technology spillovers that 

enhance productivity. Workers in these markets also 

benefit from a wider supply of high-tech employers, 

which increases job opportunities.6 Examples of MSAs 

with high-tech clusters, discussed in more detail later, 

include San Jose, Phoenix, Portland, Salt Lake 

City/Provo, and Sacramento.7 High-tech expansion 

during 1995 through 1997 benefited these clusters; 

however, the weakness in exports starting in the second 

half of 1997 has had a negative effect on the job growth 

rates in these MSAs during 1998. 

6 High-tech firms typically include the availability of skilled pools of 

labor and proximity to universities in their location decisions, along 

with a favorable business environment, cost of living, and availability of transportation. Many high-tech start-ups choose to locate in an 

established high-tech center because of the availability of financing 

as well as the other advantages a high-tech cluster provides. 

7 Each of these areas is home to a number of community banks. The 

Boise MSA, which also has a sizable high-tech cluster, was dropped 

from the analysis because only a few community banks are headquartered there. 

San Francisco Regional Outlook 19 Second Quarter 1999 
Regional Perspectives
 

MSAs with high-tech clusters may face a greater risk 

than those that are less dependent on high-technology, 

especially if a prolonged high-tech slowdown dampens 

exports and jobs in the industry. San Jose, Portland, 

Sacramento, and Boise all experienced rapid job growth 

in durable goods manufacturing in 1997, but they lost 

jobs in 1998 when high-tech began to weaken (see 

Chart 4). Other high-tech centers, namely Phoenix and 

Salt Lake/Provo, added jobs in durable goods manufacturing at a slow pace in 1998. Slowing in overall job 

growth also was more pronounced in the high-tech 

MSAs than in the remainder of the Region. 

The slow or negative growth in these MSAs in 1998 

may be an area of concern because the high-tech sector 

has a history of wide swings in employment growth 

rates compared with most other types of employment 

(see Chart 5). For example, the standard deviation of the 

annual job growth rates for California’s high-tech sector 

from 1973 to 1998 is nearly three times that for total 

employment less high-tech jobs. 

The combination of the Asian situation, the 1998 downturn in high-tech jobs, and an industry with a history of 

large variations could be especially important in states 

and MSAs with large high-technology clusters. These 

MSAs typically are dependent on both high-tech 

employment and exports. Moreover, rapid commercial 

real estate (CRE) development in most of these MSAs 

during the upswing in high-tech has resulted in some 

community banks having a relatively high level of exposure to commercial real estate loans compared with 

their peers elsewhere in the Region or nation (see Table 

1). Thus, the slowdown in high-tech, combined with 

softening in commercial real estate in some of these 

CHART 4 

The High-Tech Slowdown Has Affected
 

Durable Goods Manufacturing Jobs
 

in Most High-Tech Centers
 

SF Region 

San Jose MSA 

Portland

MSA

Salt Lake/ 

Provo MSAs

Sacramento

MSA

Boise MSA 

Durable Goods Manufacturing

Employment Growth (Percent) 

Phoenix MSA 

–6 

–2 

–4 

0 

2 

4 

6 

8 

10 

12 

1997 1998 

1996 

NA 

CHART 5 

* High-tech employment includes manufacturing jobs in computers, electronic 

components, communications equipment, and instruments. 

Source: Bureau of Labor Statistics, nonfarm payroll employment, Decemberover-December percent changes, not seasonally adjusted 

California High-Tech Manufacturing Job 

Growth Rates Vary Much More 

Widely than Other Employment 

Employment Growth (Percent) –10 

–5 

0 

5 

10 

15 

20 

’73 ’75 ’80 ’85 ’90 ’95 ’98 

High-Tech 

Manufacturing*

 Total Employment 

Less High-Tech 

markets (see Regional Outlook, First Quarter 1999, 

Several of the Region’s Metropolitan Areas May Be 

Vulnerable to Overbuilding as a Result of Rapid Commercial Real Estate Development), could adversely 

affect local economic performance and insured institutions that have been heavily involved in construction 

and CRE lending. 

The following paragraphs review high-tech conditions 

and bank exposure in five San Francisco Region MSAs 

with well-developed high-technology clusters. The 

MSAs (listed by size) are San Jose, Phoenix-Mesa, 

Portland-Vancouver, Salt Lake City-Ogden and 

Provo-Orem together, and Sacramento. 

Silicon Valley Slowdown Affects the Bay Area 

The slowdown in San Jose’s manufacturing sector in 

1998 dampened employment growth in the MSA as 

well as in the entire San Francisco Bay Area8 and was a 

key factor in forecasts of slow growth in years ahead. As 

shown in Chart 6, high-technology’s weakness in the 

San Jose MSA was widespread. Computers, defense 

electronics, and electronic components (semiconductors) all reported job losses in 1998 after adding jobs in 

1997. As a consequence of the deterioration in hightech jobs, employment in durable goods manufacturing 

fell 3.5 percent in the 12 months ending December 

1998. Measured by total job growth, San Jose fell from 

being one of the Region’s fastest-growing MSAs to one 

of its slowest-growing MSAs. The San Francisco Bay 

Area also reported softening in job growth trends. 

8 The Bay Area as defined here includes nine counties located in the 

Source: Bureau of Labor Statistics, nonfarm payroll employment, December- following MSAs: San Francisco, San Jose, Santa Rosa, Oakland, and over-December percent changes, not seasonally adjusted Vallejo-Fairfield-Napa. 

San Francisco Regional Outlook 20 Second Quarter 1999 
Regional Perspectives
 

CHART 6 

Employment 

Manufacturing 

Durable Goods 

Computers 

Electronic

Equipment* 

Instruments 

* Includes electronic components and communication equipment 

Source: Bureau of Labor Statistics, December-over-December percent changes, 

not seasonally adjusted 

The San Jose MSA’s High-Tech Job Growth 

Rates Turned Negative in 1998 

High-Tech Employment Growth (Percent) –6 

–4 

–2 

0 

2 

4 

6 

8 

10 

1998 

NA 

1996 

1997 

Moreover, as high-tech slows and the Bay Area’s economy cools, there do not seem to be many signs of a 

rapid turnaround. With the Asian crisis lingering, 

exports falling, and key sectors of the industry still facing overcapacity, Regional Financial Associates (RFA) 

projects a job growth rate of only 1 percent for the San 

Jose MSA in 1999. 

The decline in San Jose’s manufacturing sector is significant because it is the world’s most important hightechnology center. High-tech plays an enormous role in 

the health of the San Jose MSA, as well as that of the 

larger San Francisco Bay Area. At year-end 1998, San 

Jose’s manufacturing sector accounted for almost 27 

percent of total nonfarm payroll employment, almost 

twice the 15 percent figure for the nation. A broader 

measure of high-tech employment used by RFA includes 

high-tech service and communications jobs, as well as 

manufacturing jobs. This broader measure indicates that 

over 25 percent of all jobs in the San Jose MSA are 

high-tech-related.9 This dependence on high-tech also is 

evident in San Jose’s export statistics. According to ITA, 

the San Jose MSA was the nation’s second leading 

export center in 1997, and high-tech related exports 

accounted for $27.6 billion of its $29.1 billion in 

exports. Finally, exports to Asia, which had risen at a 9.5 

percent rate in 1996, declined by 7.8 percent in 1997, 

even though the crisis did not hit until midyear. 

The slower economy in 1998 has not yet adversely 

affected San Jose’s community banks, which produced 

9 RFA uses a broader measure of high-technology that includes 

biotech, medical and photographic instruments, and software services 

in this ratio. 

strong ROAs and reported low past-due loan ratios, also 

shown in Table 1. However, high-tech employment 

expansion during 1996 and 1997 created booms in San 

Jose’s residential and commercial real estate markets. 

The area’s active real estate market, which has only 

recently begun to slow, has provided San Jose’s community banks numerous opportunities in construction 

and CRE lending. San Jose’s community banks have 

increased their construction lending concentrations significantly since year-end 1993, from 5.0 percent to a 

high 11.8 percent of total assets as of year-end 1998, 

much higher than the rest of the Region or the nation, as 

shown in Table 1. The ratio of commercial real estate 

loans (including construction loans) to total assets is 

also much higher in San Jose’s community banks than 

in the rest of the Region or the nation. Furthermore, five 

of the seven community banks in San Jose have commercial and industrial loans totaling more than the 

Regional average of 15 percent of their assets. Although 

asset quality and earnings remain strong in San Jose’s 

community banks, high exposure to construction, commercial real estate, and commercial and industrial loans 

may increase risk in the future should the high-tech 

slowdown continue. 

Phoenix’s Economy Continues to Grow Rapidly 

despite High-Tech Manufacturing Slowdown 

Although the Phoenix-Mesa MSA continues to outperform the Region and the nation in the growth of 

nonfarm payroll employment, its manufacturing sector 

is beginning to slow, principally in the area of hightechnology. Most of Arizona’s manufacturing jobs are 

located in the Phoenix MSA (78 percent), where hightechnology firms such as Motorola, Intel, Honeywell, 

and Allied Signal rank among the top ten employers. 

Despite the fact that Phoenix is relatively less reliant on 

manufacturing (11.3 percent of total employment) than 

the nation (14.5 percent of employment), the MSA 

remains exposed to a slowdown in the manufacturing 

industry because of its high concentration of exports to 

struggling Asian markets. 

The current weakness in Phoenix’s high-technology 

sector may be a direct result of the Asian crisis. According to the ITA Exporter Location data for 1997, the 

Phoenix MSA is especially exposed to slowdowns in the 

global economy, as it ranks tenth in the nation among 

MSAs for dollar value of exports. In addition, the ITA 

stated that over 40 percent of Arizona’s exports are destined for Asia and that 77 percent of the state’s exports 

are high-tech goods. Therefore, deterioration of global 

economic conditions, especially in Asia, may be a main 

San Francisco Regional Outlook 21 Second Quarter 1999 
Employment,

acturing, 

le Goods 

Electronics and Other

Computers and

uments and

otal 

otal Jobs

acturing

cal Equipment

Office Equipment

Related Products 

T

uf Man

Durab

T

uf Man

Instr

iElectr

Regional Perspectives
 

driver in the decline in job growth in durable goods 

manufacturing in 1998, as well as a factor leading to 

slower growth in the future. 

Following the downward trend across the Region, yearover-year employment growth in durable goods manufacturing in the Phoenix MSA has plummeted from a 

sizzling 9.2 percent recorded for the 12 months ending 

December 1997 to a much slower 2.2 percent growth 

rate for the comparable 1998 period. Phoenix’s manufacturing employment slowdown could worsen as a 

result of layoffs recently announced by top employers in 

the MSA. RFA states that Intel and Motorola together 

reported over 4,000 layoffs in 1998. These layoffs could 

have broad-based effects on the aggregate Phoenix 

economy in 1999 and 2000. 

Nonetheless, banking conditions in the MSA remain 

robust. Two trends in the MSA’s insured institutions are 

worth noting. First, there has been significant growth in 

both the aggregate amount of assets held at community 

banks as well as in the number of community banks in 

the area. Since 1995, 11 new community banks have 

been chartered in Phoenix, bringing the total to 22. During this period, total assets at insured institutions in 

Phoenix have nearly doubled, from $1.5 billion at yearend 1995 to $3.1 billion at year-end 1998. This increase 

may lead to more competition among lenders. The second trend is the strong asset quality reported at insured 

institutions. The past-due loan ratio for banks in 

Phoenix is 0.69 percent as of year-end 1998, materially 

less than the ratio for the Region as a whole. 

Weakening Exports to Asia Hit 

Portland’s Economy Hard 

Portland has been significantly hurt by the Asian crisis. 

Much of Portland’s economic strength prior to 1998 

was attributable to its growing manufacturing sector, 

particularly high-technology. Intel, Tektronics, Boeing, 

and similar firms transformed Portland into one of the 

hottest high-tech centers in the nation. These firms 

brought in jobs directly and indirectly through rapid 

construction of new plants, service firms, and housing 

production. Labeled the “Silicon Forest,” Portland’s 

durable goods manufacturing jobs account for nearly 

half of all manufacturing jobs in the state. However, 

after significantly outpacing the nation in terms of job 

growth, population growth, and economic prosperity, 

Portland’s economy is showing signs of slowing (see 

Chart 7). 

CHART 7 

The Portland MSA Lost High-Tech Manufacturing 

Jobs in 1998 after Strong Growth in Prior Years 

15.0 1996 1997 10.0 

5.0 

0.0 

–5.0 

–10.0 

1998 –15.0 

–20.0 

High-Tech Manufacturing Job

–25.0

Growth (Percent) 

Source: Bureau of Labor Statistics, nonfarm payroll employment series,
 

December-over-December percent changes, not seasonally adjusted
 

At the core of this problem is the decline in exports to 

Asian markets, as products produced in the United 

States have become relatively more expensive than 

goods produced in Asia. Growth and oversupply in the 

sub-$1,000 PC market have put additional pressure on 

already thinning profit margins. Chart 4 shows that 

durable goods manufacturing in Portland lost jobs at a 

rate of 2.7 percent in 1998. As Chart 7 shows, jobs in 

computers and office equipment have been hit hardest. 

Computer manufacturing jobs fell 19.8 percent in the 

past year owing to substantial layoffs. Most manufacturing plant expansions have either been postponed or 

cancelled. Komatsu, which once promised to be the 

largest semiconductor producer in Silicon Forest, 

recently announced the closure of its third facility in the 

area, a facility where it had earlier planned a further 

$50 million investment. Intel, which has its largest operation in Portland and is Portland’s largest employer, 

announced a corporationwide layoff of 3,000 last 

spring. This deterioration in high-tech job growth has 

caused dependent secondary markets such as construction and commercial real estate to slow as well. Yearover-year job growth in the construction sector was only 

2 percent as of December 1998. 

Table 1 shows that although Portland’s community 

banks continue to report strong performance and capital 

levels well in excess of minimum requirements, they 

have become significantly more exposed to commercial 

real estate. In the past five years, these institutions have 

increased their total loan concentrations in commercial 

real estate (including construction loans) from 17 percent to 26 percent of their assets. At the same time, there 

San Francisco Regional Outlook 22 Second Quarter 1999 
Regional Perspectives
 

has been an uptick in past-due and noncurrent loan status for multifamily and construction and land development loans.10 Nonetheless, the allowance for loan and 

lease losses, at 1.19 percent of total loans, has remained 

well below the average 1.66 percent for similar-sized 

institutions in the Region. In fact, 8 of the 12 community banks in the Portland MSA have less than the 

Regional and national averages in loan loss reserves to 

total loans. 

Utah’s Metropolitan Areas Show 

Deterioration in High-Technology Sectors 

In 1998, combined employment figures for the Salt Lake 

City and Provo MSAs showed continued weakness in 

durable goods manufacturing, likely because of a reduction in high-technology exports to Asia (see Chart 4). 

High-tech had contributed significantly to the economic 

expansion of the MSAs over the past decade. Hightechnology firms such as Novell, Gateway, and Intel 

helped fuel this growth by opening and expanding facilities. The current high-tech slowdown warrants monitoring, because during the past high-growth period for 

these MSAs, community banks significantly increased 

their exposure to traditionally higher-risk loan categories 

such as construction and commercial real estate loans. 

According to ITA, as of the first quarter of 1998, Utah’s 

exports to Asia declined 14 percent from the same quarter in 1997. This figure is in sharp contrast to the rapid 

export growth that both Salt Lake City and Provo experienced during the 1993 to 1997 period. The deterioration in export markets is reflected in the employment 

statistics of these MSAs as well. 

The slowdown in manufacturing may pose an emerging 

risk for community banks operating in these MSAs, 

since they have some of the highest construction and 

CRE loan concentrations in the Region. Community 

banks in these MSAs have significantly increased their 

exposure to construction loans since year-end 1993. As 

Table 1 shows, community banks in Provo and Salt 

Lake City now have combined construction loans to 

total assets of over 15 percent, well above averages for 

both the Region and the nation. Their CRE loan exposure is also quite high. While these institutions continue 

to report strong earnings and asset quality, the local 

economy’s recent slowing may increase the risks associated with a heavy concentration in construction lending. 

Technology Slowdown Hits Sacramento while 

Defense Employment Continues to Decline 

Much like some of the Region’s other high-technology 

centers, the Sacramento MSA saw its manufacturing 

employment growth rate slow considerably during 

1998. As shown in Chart 4, durable goods manufacturing jobs fell 2.5 percent in 1998, after rising nearly 10 

percent in 1997. Prior to 1998, the Sacramento area had 

benefited from relocating Silicon Valley firms, which 

had moved to escape the higher costs of Silicon Valley. 

This influx of technology companies has spurred residential and commercial real estate development in certain areas of the MSA. While the expansion of high-tech 

companies has brought jobs to an MSA traditionally 

dependent on government employment and suffering 

from defense cutbacks, it has made the MSA more susceptible to the global trends hurting some firms that 

manufacture PCs and semiconductors. 

The growth in manufacturing employment prior to 1998 

helped keep Sacramento’s employment growth rate 

above that of the nation since year-end 1995. The MSA 

benefited from its proximity to Silicon Valley during the 

1990s, when such prominent companies as Intel, 

Packard Bell/NEC, Hewlett-Packard, Oracle, and 

Apple Computers opened or expanded operations. As 

Chart 8 shows, the strong growth in manufacturing has 

helped offset declines in defense employment, in 

particular the closings of Mather Air Force Base and the 

CHART 8 

Durable Goods Manufacturing Employment 

Has Offset Defense Employment Declines 

in Sacramento 

Defense and Durable Goods

Manufacturing Employment (thousands)

Payroll Employment (thousands) 

0 

100 

200 

300 

400 

500 

600 

700 

0 

5 

10 

15 

20 

25 

30 

35 

40 Total Payroll Employment 

(Right Axis) 

U.S. Department of Defense 

Employment (Left Axis) 

Durable Goods Manufacturing 

Employment (Left Axis) 

4Q 4Q 4Q 4Q 4Q 4Q 4Q 4Q 4Q 4Q 4Q 

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

10 Source: Bureau of Labor Statistics, nonfarm payroll employment, not seasonally These categories are two of the three loan categories that comprise adjusted

commercial real estate loans.
 

San Francisco Regional Outlook 23 Second Quarter 1999
 
Regional Perspectives
 

Sacramento Army Depot, as well as the privatization 

and downsizing of McClellan Air Force Base. 

While the Sacramento MSA remains an attractive 

destination for high-technology companies in the long 

term, manufacturing employment contracted during 

1998, primarily because of technology layoffs. 

According to RFA, Packard Bell/NEC cut employment 

at its south Sacramento PC manufacturing plant owing 

to the intense cost competition in the sub-$1,000 PC 

market. Intel and Hewlett-Packard, which together 

contribute about 10,000 jobs to the MSA, postponed 

further plant expansion in 1998 because of oversupply 

in the processor and PC markets, according to RFA and 

the Sacramento Business Journal. The slowdown is 

potentially troublesome since, according to RFA, up to 

3,000 workers at McClellan will lose their jobs by 2001, 

as several airplane maintenance contracts shift from 

McClellan to Hill Air Force Base in Utah. 

Despite the recent slowdown, the expansion of 

technology companies has led to strong residential and 

commercial real estate development, especially in 

warehouse and research and development (R&D) 

properties, in south Placer County, the Highway 50 

corridor, and south Sacramento. The ten community 

banks headquartered in Sacramento have benefited 

from the hot property market, as construction loans now 

equal 12.6 percent of total assets, significantly above 

the national and regional averages (see Table 1). Their 

ratio of commercial real estate loans to total assets 

is also well above regional and national averages. 

Further, economic growth, as well as past banking 

consolidations, have spurred several new community 

bank charters. The slowdown in manufacturing and 

defense, coupled with the increased competition from 

newly chartered banks, could increase risk for 

community banks operating in the area, which continue 

to hold higher levels of nonperforming assets than peers 

in the Region and nation. 

Conclusion 

The San Francisco Region continues to exhibit robust 

growth, albeit at a slower pace than in 1997; the slowdown can be attributed to a contraction in manufacturing employment, particularly high-tech manufacturing. 

The slowdown in this sector is important because the 

growth in high-tech manufacturing employment prior to 

1998 was one of the key reasons that the San Francisco 

Region has outperformed the national economy since 

1994. The Asian financial crisis was the primary culprit 

in slowing the Region’s high-tech manufacturing 

employment growth, since the Region is heavily dependent upon high-tech exports to Asia. However, thus far, 

there is little evidence that the 1998 slowdown in hightechnology has hurt the performance of most of the 

Region’s financial institutions. 

Several MSAs in the Region are more vulnerable to the 

slowdown in technology than others because high-tech 

companies tend to cluster in MSAs with well-educated 

workforces, strong transportation systems, and vibrant 

R&D centers. These MSAs include San Jose, Phoenix, 

Portland, Salt Lake City/Provo, and Sacramento. Partly 

as a result of the clustering of high-tech companies and 

rapid high-tech employment growth prior to 1998, each 

of these markets has experienced strong residential and 

commercial real estate development. Moreover, community banks in these MSAs, for the most part, have 

higher construction and commercial real estate loan 

concentrations than their peers in the Region and the 

nation. Community banks with high levels of construction and commercial real estate loan concentrations 

should consider the potential risk of continued weakness in the high-tech sector and its effect on their local 

economy. 

San Francisco Region Staff 

San Francisco Regional Outlook 24 Second Quarter 1999 
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