Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION SECOND QUARTER 1998 

FDIC
 

Atlanta
 

Region
 

Division of
 

Insurance
 

Jack M.W. Phelps,
 

Regional Manager
 

Scott C. Hughes,
 

Regional Economist
 

Pamela R. Stallings,
 

Financial Analyst
 

W. Brian Bowling
 

Financial Analyst
 

In Focus This Quarter 

◆ Gain-on-Sale Accounting Can Result in Unstable Capital Ratios and Volatile Earnings—The accounting for transferring and servicing financial assets causes asset sellers, particularly high-growth lenders, to recognize significant noncash income related to retained economic interests in the sold 

assets. This is true whether a company securitizes its own assets or sells its assets as 

a conduit to another securitizer. Values are often driven by management assumptions about future performance of the sold assets. Major writedowns of gain-on-sale 

assets by some finance and mortgage companies underscore the importance of careful scrutiny of these assumptions by banks and their supervisors. See page 3. 

By Allen Puwalski 

◆ How Will the Expansion End?—Analysts are now focusing on when 

and how the current expansion will end. Although no one can accurately predict 

when a recession will begin, two possible scenarios have emerged. Each scenario has 

important implications for lenders as they prepare for the possibility of slower economic growth or recession. See page 7. 

By Paul C. Bishop 

◆ Trends Affecting the Allowance for Loan and Lease Losses— 

In today’s environment, in which loan availability is abundant, growth is strong, and 

competition is fierce, some industry leaders and regulators have expressed concern 

about the loosening of underwriting standards and greater risk in bank loan portfolios. At the same time, the allowance for loan and lease losses (ALLL) relative to 

total loans at many insured institutions is declining. As the economic expansion 

reaches an advanced age, an important question for insured institutions is whether 

their ALLLs adequately reflect the risks associated with changing industry practices. See page 11. 

By Andrea Bazemore 

Regular Features 

◆ Regional Economy—After flattening throughout much of 1997, job 

growth in the Atlanta Region rose to 3.3 percent in the fourth quarter...one area of 

continuing vulnerability within the Region is its exposure to the textile and apparel industries...the Region’s insured institutions have both direct and indirect exposure to these industries. See page 16. 

By Scott C. Hughes, Jack M.W. Phelps, Pamela R. Stallings, W. Brian Bowling 

◆ Regional Banking—In the fourth quarter, merger-related charges lowered bank profits while thrifts experienced narrow net interest margins and higher 

overhead...flattening of the yield curve could reduce net interest income in 

1998...institutions located in areas where textile and apparel employment is high 

are expanding their commercial and industrial lending. See page 20. 

By Jack M.W. Phelps, W. Brian Bowling, Scott C. Hughes, Pamela R. Stallings 

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, AS, AZ, CA, 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 Atlanta 

Region’s Regional Outlook, please call Jack Phelps at (404) 817-2590 or send an e-mail to 

jphelps@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 

Editor George E. French 

Assistant Editors Gary L. Beasley 

Jack M.W. Phelps 

Publications Manager Teresa J. Franks 
In Focus This Quarter
 

Gain-on-Sale Accounting Can Result in Unstable
 

Capital Ratios and Volatile Earnings 


•	 Gains generated from asset sales under SFAS 125 

rely on management assumptions about the lifetime performance of the assets sold and may not 

materialize in cash if the assumptions prove 

incorrect. 

•	 Gain-on-sale accounting has been most significant to securitizers, but nonsecuritizers can and 

do retain economic interests that give rise to significant gain-on-sale assets. 

•	 Finance companies seeking to shift attention from 

gain-on-sale assumptions may find willing bank 

correspondents. 

•	 The rating services have modified capital and 

earnings analysis in order to lessen what they consider distortions caused by SFAS 125. 

Statement of Financial Accounting Standards No. 125 

(SFAS 125),Accounting for Transfers and Servicing of 

Financial Assets and Extinguishing of Liabilities, 

causes asset sellers, particularly high-growth lenders, to 

recognize significant noncash income. Applying SFAS 

125, which became effective on January 1, 1997, can 

give rise to significant noncash gains and related assets 

if an economic interest is retained in assets sold. The 

value of retained interests in assets sold is quantified on 

the basis of management’s assumptions about future 

charge-off rates, repayment rates, and the rate used to 

discount the expected cash flows from the loans sold. 

Because the value of these assets changes when actual 

performance deviates from the assumptions, the quality 

of earnings, capital, and liquidity for a lender that relies 

significantly on gains on sale must be considered carefully. 

The recent writedowns of interest-only (IO) assets by a 

few major finance companies have led to a higher level 

of scrutiny of companies whose financial statements are 

influenced significantly by gain-on-sale accounting. 

The Securities and Exchange Commission has recently 

increased its scrutiny of publicly traded companies that 

use gain-on-sale accounting, and it may soon require 

assumptions regarding defaults, prepayments, and discount rates to be disclosed in financial statements. The 

same companies that enjoyed soaring stock performance thanks to high earnings growth caused by gainon-sale accounting have seen their stock values tumble 

as they have had to write down their gain-on-salerelated assets. 

Several major credit rating companies have recognized 

the significant effect of gain-on-sale accounting under 

SFAS 125 on interpreting financial statements. These 

companies have issued comments or reports dealing 

with SFAS 125’s effect on the quality of earnings and 

capital of the companies they rate and how they adjust 

their analysis as a result. The consensus of these papers 

is that gain-on-sale accounting for companies that securitize often results in significantly higher reported earnings and equity compared to balance sheet 

lenders—without, in many cases, materially changing 

the underlying economics or credit risk to the originator 

of the assets.1 Generally, the rating services have modified capital and earnings analysis in order to lessen 

what they consider distortions caused by SFAS 125. 

There Are Risks Associated with Gain-on-Sale 

Accounting 

The asset booked in connection with an SFAS 125 loan 

sale is an IO strip that represents the present value of 

future excess spread cash flows generated by the transferred assets. Generally, asset-backed securitizations, 

including some classified as mortgage-backed securities, are structured so that each month the expected cash 

flows from the underlying assets will be sufficient to 

pay the investor coupon, the trust expenses, the servicing fee, and net charge-offs. The cash flow that the 

underlying assets will generate each month cannot be 

known with certainty because the underlying asset may 

allow for variable principal payments (e.g., credit card 

accounts), or the borrowers may default. Securitizations 

are structured so that there is enough cushion between 

the expected cash flows and the required payments and 

1 Duff & Phelps Credit Rating Company, “Securitization and Corporate Credit Risk.” Special Report Financial Services Industry, July 

1997; T. E. Foley and M. R. Foley. “Alternative Financial Ratios for 

the Effects of Securitization Tools for Analysis.” Moody’s Special 

Comment, September 1997; H. L. Moehlman, R. W. Merrit, and N. E. 

Stroker. “Capital Implications of Securitization and Effect of SFAS 

125.” Fitch Research, September 16, 1997. 

Atlanta Regional Outlook 3	 Second Quarter 1998 
In Focus This Quarter
 

expected charge-offs to absorb fluctuations in actual 

cash flows and actual charge-offs. This cushion is 

excess spread. As actual cash flows vary from projections, so does the excess spread generated. 

According to SFAS 125, when a company sells assets 

and retains the right to future excess spread cash flows, 

the calculation of the gain on the sale includes the capitalization of this right. In many transactions, the gain 

on sale consists entirely of the fair value of the IO strip 

that represents this right—none of which is necessarily 

received in cash. In addition, with many transactions, 

cash receipt is further delayed while cash flows go to 

fund the spread account, which is analogous to an internal loan loss reserve. 

SFAS 125 states that quoted market prices in active 

markets are the best evidence of fair value and should 

be used whenever available. Although there have been 

some sales of these IO strips, the number of sales is not 

yet sufficient to constitute an active market. When market prices are not available, SFAS 125 states that the 

estimate of fair value should be based on the best information available. In practice, fair value of the excess 

spread is determined by present valuing the expected 

cash flows using a discounted cash flow model. 

The value of the right to future cash flows is determined 

on the basis of management’s assumptions about the 

charge-off rate, the average life of loans, and the rate 

used to discount the cash flows. These input assumptions drive the model results and, therefore, the magnitude of the gain. The stability of the value of the IO will 

depend greatly on the extent to which the input assumptions accurately describe the pool performance over the 

life of the transferred assets. Changes in economic or 

market conditions that were not anticipated in the initial 

cash-flow assumptions will likely cause the pool of 

loans to perform differently than initially projected. 

Gain-on-sale accounting is significant to securitizers. 

To illustrate the significance of the IO account to a 

securitizer’s reported income, consider one major subprime lender. During fiscal year 1997, this company’s 

IO asset grew by over $141 million. Despite a $28 million writedown of the IO asset, the net growth of the 

asset constituted over half of total revenue and over 

eight times net income. The revaluation of the IO was 

necessitated by higher-than-expected prepayment rates. 

Current market conditions were not anticipated by 

many companies that benefited from high earnings 

related to gain-on-sale accounting. Several other major 

securitizers have reduced the carrying value of their IO 

assets in the face of either rising charge-off rates or 

higher prepayment rates. Writing down an IO strip 

largely represents a company’s admission that it will not 

generate on a cash basis income that was booked previously. 

Chart 1 displays the cumulative charge-off rates by vintage for Moody’s index of home equity loan securitizations. The index consists mostly of prime mortgages, so 

the loss rates are still low. However, the rising trend in 

losses is noteworthy and reflects the growing influence 

of subprime securitizations on the index and the related 

decline in underwriting standards as competition has 

increased in this market. Loans originated in 1995 and 

1996 are causing progressively larger and earlier losses. 

After 21 months of seasoning, the cumulative loss rate 

on loans originated in 1996 is .17 percent—almost six 

times the loss rate experienced by the 1994-originated 

cohort at the same age. Despite the continued low loss 

rates for the home equity market in general, subprime 

lenders are experiencing accelerated loss rates that are 

eroding the value of their interests in excess spreads. 

There may be a tendency for management to base 

assumptions about expected loss rates on loans sold 

solely on past experience with similar loans. Such an 

approach may not capture changes in market conditions 

and trends. For example, the Moody’s data demonstrate 

that loss rates on home equity loans, including first 

liens, have been trending upward rapidly. This trend 

implies that when estimating loss rates, management 

should consider the potential for changes in market conCHART 1 

Vintage Analysis of Home Equity Loan 

Securitizations 

Source: Moody’s Investor Services 

0.00 

0.05 

0.10 

0.15 

0.20 

1 3 5 7 9 11 13 15 17 19 21 

Cumulative 

Loss (%) 

1994 

1995 

1996 

Months 

Atlanta Regional Outlook 4 Second Quarter 1998 
In Focus This Quarter
 

ditions over the life of the sold assets as well as the past 

performance of similar assets. 

Like loss rates, prepayment rates have risen substantially in the subprime mortgage market. Several factors 

have contributed to the rise. One factor is the trend 

toward higher loan-to-value (LTV) loans in the mortgage market, which has allowed borrowers to obtain 

additional cash from their homes without waiting to pay 

down principal. Mortgage bankers report the tendency 

of some subprime borrowers, often debt consolidators, 

to maintain outstanding balances at the highest possible 

LTV. With maximum LTV ceilings rising, debt consolidators can refinance home equity loans without having 

to amortize existing debt. 

Another important factor contributing to rising prepayment rates is competition among lenders for volume 

growth. To continue to grow volume, lenders have been 

sacrificing margins on loans to offer a better rate to borrowers. When estimating prepayment rates for subprime 

borrowers, it has been normal to expect that they would 

need to improve their credit rating, or “credit cure,” 

before they would find it economical to refinance. Stiff 

competition for volume has allowed borrowers to find 

better rates without credit curing and has stimulated 

them to refinance prior to the time estimated at origination. Falling interest rates and a relatively flat yield 

curve are likely to increase prepayment rates. 

In standard finance theory, uncertainty about the future 

level of losses and prepayment rates is compensated for 

by discounting the cash flows at a higher rate. Some 

analysts advocate using a discount rate similar to the 

required rate of return for equity investments. Faced 

with changing conditions, one large finance company 

that specializes in high LTV lending announced in 

December 1997 that it was increasing the discount rate 

it uses to value new IO strips from 12.5 percent to 33 

percent. 

The IO Strip Asset Is Growing at Insured 

Depository Institutions 

As of December 31, 1997, only 30 institutions reported 

this IO asset at more than 5 percent of tier 1 capital. 

However, some institutions have booked gains that 

should have given rise to a call-reportable IO strip but 

did not properly report the assets. Therefore, the current 

reporting may understate the prevalence of the asset. 

Furthermore, the recent attention to gain-on-sale 

accounting from the public equity markets has at least a 

few large finance and mortgage companies seeking 

business strategies that shed IO strip-related volatility 

from their financial statements. One such strategy 

already in use is to leave the economic interest in excess 

spread with the correspondents that originate the loans. 

This is done as follows: The correspondent originates 

loans for purchase by a finance company. The finance 

company pays par for the loans, and instead of being 

paid an origination fee or a premium for the loans, the 

seller retains the right to excess spread generated over 

the life of the loan. The seller books a gain and an IO 

asset that capitalizes this right to receive future cash 

flows. The nature of the IO asset is exactly the same 

whether it arises directly from a securitization or from a 

sale of loans to a securitizer. If this strategy is used 

widely by finance and mortgage companies, then IO 

strips are likely to grow among institutions that originate loans for sale to these companies (see Chart 2). 

For insured depository institutions, the capital effects of 

SFAS 125 need to be evaluated carefully. Analysis of the 

financial statements and leverage ratios of insured institutions should consider fully issues related to the quality of earnings and the stability of capital posed by the 

volatility of the IO strip. Insured institutions that engage 

in significant asset sales while retaining economic interests that give rise to SFAS 125–related assets are subject 

to distortions similar to those of nonbank financial 

companies. 

The activity of originating and selling loans and booking associated gains can lead to capital ratios that 

CHART 2 

IO Strip Is Growing at Insured Institutions 

Source: Bank & Thrift Call Reports 

0.00 

0.50 

1.00 

1.50 

2.00 

2.50 

3.00 

1Q97 2Q97 3Q97 4Q97 

$Billion 

120 

130 

140 

150 

160 

Number of Institutions 

Number of Institutions 

IO Strip 

Atlanta Regional Outlook 5 Second Quarter 1998 
In Focus This Quarter
 

appear high by traditional bank standards. For several 

reasons, the leverage ratio can appear particularly high. 

First, although the asset may be more volatile than 

mortgage serving rights, there is no limit to the amount 

of IO strip that a bank can include in tier 1 capital. Second, the amount of IO strip booked increases capital by 

a gain on the net of the tax effect. The extent to which 

the amount remains in capital depends, of course, on the 

institution’s dividend policy. Third, the denominator of 

the leverage ratio is reduced by the sale because the 

loans are no longer assets of the bank. The cumulative 

result can be a significant boost to the leverage ratio. 

Several insured institutions report an IO strip at greater 

than 25 percent of tier 1 capital. For an institution whose 

primary line of business is originating and selling subprime mortgages, the asset can quickly reach a level 

exceeding tier 1 capital. In a little more than a year of 

originating and selling subprime mortgages to a major 

securitizer, one institution has amassed IO assets that it 

has valued at more than 150 percent of tier 1 capital. 

The institutions that have concentrations of 25 percent 

or more of tier 1 capital in IO assets have a median 

leverage ratio of about 11 percent. In contrast, the median equity capital ratio for nonbank mortgage securitizers tracked by SNL DataSource is about 30 percent. 

Public debt markets or banks that lend to these finance 

companies appear to require significantly higher capital 

levels than regulatory minimums required for banks. 

The potential for growth of the IO 

strip asset at insured institutions 

seems strong. In some circumstances, minimum capital standards for banks may require 

significantly less capital for IO 

asset exposure than the public 

equity markets. Perhaps more 

important, the quick rise of the significance of gain-onsale accounting to the mortgage and consumer credit 

markets exemplifies the speed with which exposure to 

risk can be acquired through the securitization market. 

Strong demand for asset-backed securities coupled with 

changing accounting emphases, which in this case favor 

asset sellers, can lead quickly to substantial exposures. 

Allen Puwalski, Senior Financial Analyst 

Risk-Based Capital (RBC) Treatment of the Gain-on-Sale–Related IO Asset 

If the IO asset derives from excess spread that absorbs tions does not necessarily preclude subprime mortcharge-offs from the sold assets, then the IO strip con- gages in general from receiving the reduced risk 

stitutes recourse from the sold assets for RBC pur- weighting. Although the capital standards require that 

poses. RBC standards require capital to be held mortgages be prudently underwritten to qualify for 

against this exposure. In general, the capital require- the 50 percent risk weighting, it is not entirely clear 

ment for this exposure is the amount of capital that how the term “prudently underwritten” applies to subwould have been required for the assets had they not prime mortgages. A higher expected loss rate alone 

been sold. If the sold assets are one- to four-family may be insufficient cause for presuming that the 

residential mortgages, they may receive a 50 percent mortgages are not prudently underwritten. 

risk weighting. Subprime mortgages are not necessarily precluded from receiving this weighting. The rationale for reducing the capital requirement for 

traditional one- to four-family mortgage lending is 

In order to apply the 50 percent risk weighting, the related to the maturity of the market and consistently 

capital standards require that one- to four-family res- low loss rates. As noted above, the subprime mortgage 

idential mortgages be fully secured and prudently market is changing rapidly, and loss rates can be much 

underwritten. The “fully secured” requirement pre- higher than in traditional mortgage lending. Accordcludes high-LTV loans with LTV ratios of greater ingly, bank managements need to be aware of the 

than 100 percent from receiving reduced capital potential volatility and risks associated with gain-onrequirements, but the language of the RBC regula- sale assets associated with subprime mortgages. 

Atlanta Regional Outlook 6 Second Quarter 1998 
In Focus This Quarter
 

How Will the Expansion End?
 

•	 Despite a very low unemployment rate and high 

industry capacity utilization, inflation has been 

unusually subdued during this expansion, with 

price declines in some sectors. 

•	 After seven years of expansion, most analysts 

expect the economy’s growth to slow in the coming 

months. 

•	 The last seven expansions have ended with an 

inflation-driven increase in short-term interest 

rates; in contrast, some analysts believe that the 

next recession will be caused by a period of falling 

prices for commodities, finished goods, and perhaps wages. 

•	 Insured institutions that base lending and strategic decisions on assumptions of continued robust 

economic growth should scrutinize and test those 

decisions against possible adverse change in economic conditions. 

The current economic expansion is the third longest on 

record since World War II. Since mid-1991, when the 

expansion began, more than 15 million new jobs have 

been created and inflation-adjusted gross domestic 

product (GDP) has increased by nearly 20 percent. In 

fact, the unemployment rate reached a 24-year low 

when it fell to 4.6 percent in November 1997 and again 

in February 1998. At the same time, inflation has 

remained unusually low, at only 2.3 percent during 

1997. 

Analysts are now focusing on when and under what circumstances the current expansion will end. While no 

one can accurately predict when the expansion will end, 

two related but competing theories about how it will end 

have emerged in recent months. The first and more 

familiar scenario occurs when the Federal Reserve 

increases short-term interest rates to prevent a rapid 

increase in inflation caused by an overheating economy. 

The second scenario, a deflation-induced contraction, is 

less familiar in the context of recent recessions. This 

scenario posits a period of falling prices for commodities, finished goods, and, under the most severe circumstances, even wages. 

Whatever the cause of the next downturn, its effects are 

likely to be important for the performance of lenders. 

During the 1990–91 recession, for example, the widespread deterioration of economic conditions was 

reflected in a number of indicators: Inflation-adjusted 

GDP fell by 2 percent; the number of business failures 

rose by nearly 40 percent; unemployment increased by 

more than 40 percent to 9.8 million; the unemployment 

rate peaked at more than 7 percent; single-family housing starts fell by almost 22 percent; and the bank card 

delinquency rate increased from 2.4 percent to 3.3 percent. This experience suggests that no matter what triggers the next downturn, dramatic adverse changes in the 

drivers of bank performance will likely result. 

How Have Economic Expansions 

Usually Ended? 

Although to some extent each business cycle is unique, 

virtually all of the post–World War II expansions have 

shown a similar characteristic: Toward the end of the 

expansion, inflation has accelerated. As the economy 

expands, the prices of inputs, including the wages of 

workers, are bid up as firms compete for resources to 

meet demand. The overall inflation rate will rise if 

prices increase across a large number of industries. Left 

unchecked, an increase in the overall price level may 

itself feed back into the labor market through demands 

for higher wages. 

By raising short-term interest rates, the Federal Reserve 

can limit what might otherwise lead to a rapid increase 

in both wages and prices. Higher interest rates will 

reduce sales of capital goods, housing, and consumer 

durables, the demand for which is very sensitive to the 

level of interest rates. One reflection of this sensitivity 

is the changing pattern of loan growth over the business 

cycle. During periods of expansion, the demand for 

loans grows rapidly as businesses and households borrow to finance purchases of capital goods and consumer 

durables. If short-term interest rates are increased in 

response to inflationary pressures, loan growth will 

slow as businesses and consumers reduce their demand 

for loans. If interest rates continue to increase, loan 

growth may decline as it has done before and during 

each recession. The cyclical movement of loan growth 

(with vertical bars indicating periods of recession) is 

shown in Chart 1 (next page). 

Looking more closely at short-term interest rates, Chart 

2 (next page) illustrates the federal funds rate during the 

Atlanta Regional Outlook 7	 Second Quarter 1998 
In Focus This Quarter
 

CHART 1	 expansion began. During the expansion between 1975 

and 1980, for example, the inflation rate was nearly 12 Commercial Bank Loan Growth percent at the start of the expansion but fell to just over during the Business Cycle 6 percent after four quarters. Inflation remained at 

approximately 6 percent until the twelfth quarter of the 

–5 

0 

5 

10 

15 

20 

25 

1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 

Percent Change—Year Ago 

expansion, after which it accelerated to more than 12 

percent by the end of the 20-quarter expansion. 

The current inflation trend differs from previous expansions in two ways. First, by the later stages of previous 

expansions, inflation was accelerating (see Chart 3). In 

contrast, there are few signs of accelerating consumer 

price inflation during the current expansion. In fact, it 

appears that the rate of inflation is declining; the United 

States has experienced disinflation.1 Second, among 

Source: Federal Reserve 

last seven business cycles. While an increase in shortterm interest rates has preceded each recession, it 

should be noted that an increase in rates is not sufficient 

to induce a recession. An increase in rates in 1984 was 

followed by a period of rapid growth that lasted until 

1990. More recently, the increase in rates during 1994 

was accompanied by a slowdown in the economy, but 

not a recession. 

What Is Different about Inflation 

during This Expansion? 

With history as a guide, one would expect inflation to 

rise as the current expansion matures. Chart 3 illustrates 

consumer price inflation during the four longest postwar expansions, including the current one. The chart 

shows the inflation rate at various points after the 

CHART 2 

expansions that have lasted more than 20 quarters, the 

current rate of inflation is one of the lowest since World 

War II. Consumer inflation is both decreasing and low 

by historical standards. 

What Are the Two Views about 

Future Inflation? 

Two views have developed about how the current 

expansion will end. The debate, couched in terms of the 

expected rate of future inflation, is of more than academic concern. The Federal Reserve’s decision about 

1 In popular discussions of inflation rates and the price level, terminology is sometimes used loosely. To clarify, a declining rate of inflation, properly described as disinflation, means that prices are 

increasing at a progressively slower rate over time. Deflation is 

defined as a generally falling price level or, equivalently, a negative 

inflation rate. 

CHART 3 

Federal Funds Rate and Recent 

Recessions 

0 

5 

10 

15 

20 

1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 

Federal Funds Rate (percent) 

Source: Federal Reserve 

Consumer Price Inflation during Four Longest 

Postwar Expansions 

0 

2 

4 

6 

8 

10 

12 

14 

0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 

Quarters after Start of Expansion 

Percent 

1975–1980 

1982–1990 

1961–1969 

1991–present 

Note: Prices exclude food and energy 

Source: Bureau of Labor Statistics 

Atlanta Regional Outlook 8	 Second Quarter 1998 
In Focus This Quarter
 

whether to change short-term interest rates may be 

influenced by arguments on either side of the debate. 

The Traditional View 

Although inflation has been tame during this expansion, 

adherents of the traditional view believe that impending 

inflation still poses a danger to the longevity of the 

expansion. Evidence cited to support this view includes 

a very low unemployment rate and rising inflationadjusted wages. The reasons for the low inflation rate 

include low energy prices, inexpensive imports, and 

brisk domestic and international competition. These 

factors have delayed the onset of inflationary pressures, 

but they will not remain favorable indefinitely. The 

underlying dynamics have not changed significantly 

from those that led to rising inflation during every other 

recent economic expansion. This is also the view of the 

Federal Reserve Open Market Committee, as stated in 

the minutes of its November 12, 1997, meeting: 

The reasons for the relative quiescence of inflation 

were not fully understood, but they undoubtedly 

included a number of special factors...the risks 

remained in the direction of rising price inflation 

though the extent and timing of that outcome were 

subject to considerable debate. 

—Federal Reserve Bulletin, February 1998, p. 104 

The Deflation View 

Alternatively, some analysts suggest that a recession 

may be brought about by a period of deflation. Advocates of this scenario base their view on the unusually 

low and falling inflation rate in the United States, even 

after seven years of economic expansion. They also suggest that the national economy of the 1990s is markedly different from that of the 1970s and 1980s. Intense 

global competition is now the norm and not the exception. Worker productivity growth is believed to be higher than the official data show, meaning that wage 

growth will not translate as readily as before into price 

increases. The U.S. economy is more prone to a period 

of falling prices than at any time in the recent past, especially in view of decreasing rates of inflation and deflationary forces originating from the ongoing Asian 

financial crisis. 

What Does the Evidence Show? 

Because determining economic policy is necessarily a 

forward-looking process, policymakers look at many 

indicators to determine the likely future course of inflation. A brief review of some of the more popular indicators reveals contradictory readings that can support 

either the inflation or deflation scenario. 

Wage Growth 

The national unemployment rate is currently very low, 

signaling that labor markets are near capacity in terms 

of their ability to create new jobs. The nation’s unemployment rate was below 5 percent for nine months during 1997. This rate has been well below what many 

analysts thought possible without a sharp rise in inflation. As labor market conditions have tightened, wage 

growth has increased. Since 1993 the rate of growth has 

been on a steady upward trend, from a low of just over 

2 percent to about 4 percent in the first quarter of 1998. 

Capacity Utilization 

Capacity utilization, the percentage of industrial capacity that is currently in use, has risen since early 1997. 

Utilization has been around 83 percent since mid-1997, 

a threshold rate that has traditionally signaled impending inflationary pressures at factories, mines, and utilities. 

Commodity Prices 

Many commodities, such as metals, crude oil, and 

unprocessed food products, have exhibited weak prices 

during the past several months. Between mid-1996 and 

early 1998, the Knight-Ridder Commodity Research 

Board Price Index fell by more than 15 percent. Key to 

the decline was a 35 percent decrease in crude oil 

prices. 

Finished Goods Prices 

Since the data show that both labor and physical capital 

are at high rates of utilization, the traditional inflation 

scenario suggests that there will be increasing price 

pressures. In the manufacturing sector, such price pressures would likely show up first in the prices of goods 

as they leave the factory. The price of finished goods 

rose by only 0.4 percent during 1997, however. On a 

monthly basis, prices declined during eight months in 

1997. 

Service Sector Prices 

The service sector accounts for a growing portion of all 

output and employment in the U.S. economy. Labor 

costs generally account for a much higher percentage of 

input costs in the service sector than in the manufacturAtlanta Regional Outlook 9 Second Quarter 1998 
In Focus This Quarter
 

ing industries. Additionally, many service industries 

operate in local markets and are insulated from national or global competition. Consequently, inflation rates 

in the service sector are generally higher than in the 

goods sector. Service sector inflation has, however, 

been on a downward trend, falling from 5.5 percent in 

1990 to 3.1 percent in 1997. 

Import Prices 

Since early 1996, import prices have fallen precipitously. The decline is due in part to the rising value of the 

dollar, which has reduced the cost of imports. Nonpetroleum import prices have fallen by 5 percent since 

early 1996. Within that group, capital goods prices have 

decreased by 12 percent over the same period. 

One factor that will continue to put downward pressure 

on prices is the turmoil in Asian markets. Asian 

exporters are now much more competitive with the rest 

of the world, following the drop in the value of their currencies. Consequently, U.S. firms that compete with 

Asian producers will be under greater pressure to cut 

prices. At the same time, reduced Asian demand for 

U.S. exports could lead to a ballooning trade deficit and 

a softening of export prices. In January 1998, for example, the United States reported a record-breaking trade 

deficit of $12 billion, caused in part by slower export 

growth. 

From this brief review, it is apparent that signs of 

impending inflation are at best mixed. Clearly, U.S. 

labor markets are at or near full effective capacity, and 

the utilization of factories and physical capital is also 

very high. There is little evidence that these factors are 

causing an increase in prices at either the producer or 

consumer levels. 

How Will the Expansion End? 

Although no one can accurately determine when the 

expansion will end, most analysts are predicting slower 

economic growth in the second half of 1998. Indicators 

such as the unemployment rate suggest that growth will 

be limited by the availability of labor needed to produce 

an increasing supply of goods and services. Weak or 

declining output prices in some sectors could act as a 

further constraint on economic growth. 

Among economists, the traditional view that the expansion will end following a rise in inflation and an 

increase in short-term interest rates appears to be the 

more prevalent view. Nevertheless, the possibility that 

the next economic downturn might be triggered by the 

ripple effects of declining output prices should not be 

dismissed, especially in light of the potentially adverse 

and less familiar risks associated with deflation. What is 

clear for insured institutions is that at this stage of the 

economic expansion, lending and strategic decisions 

predicated on an assumption of continued robust economic growth should be carefully scrutinized and considered in light of a possible deterioration of economic 

conditions. 

Paul C. Bishop, Economist 

Why Might Deflation 


Be a Concern?
 

The most significant difference between the inflation and deflation scenarios is reflected in the 

response of financial markets. One of the consequences of inflation is that a dollar in the future is 

of less value than today’s dollar. In a deflationary 

environment, the opposite is true—a dollar in the 

future will buy more goods and services than a dollar today. 

In a deflation scenario, debtors would see the real 

value of their financial obligations rise and might 

therefore be hesitant to borrow. A fixed monthly 

mortgage payment, for example, would be paid 

back with increasingly valuable dollars over time. 

Asset values could fall, especially since the purchase of an asset, such as a house, would require 

inflation-adjusted debt repayments that increase 

through time. Likewise, consumer credit debt obligations, such as payments on outstanding credit 

card balances, would become increasingly onerous. 

For households already experiencing credit problems, the prospect of a period of sustained deflation 

would worsen their financial position. At the very 

least, deterioration in credit quality would be 

expected, along with an increase in the number of 

business and personal bankruptcies. 

Atlanta Regional Outlook 10 Second Quarter 1998 
In Focus This Quarter
 

Trends Affecting the Allowance for
 

Loan and Lease Losses
 

•	 Allowance for loan and lease loss (ALLL) levels 

are declining relative to total loans. 

•	 Some industry leaders and regulators have 

expressed concern about the loosening of underwriting standards and greater risk in bank loan 

portfolios. 

•	 Significant growth in riskier loan types calls 

attention to the need to scrutinize closely the adequacy of the allowance. 

Weakening underwriting standards and significant 

growth in riskier loan types have increased the risk 

exposures of some insured institutions to an economic 

downturn. Meanwhile, the ALLL relative to total loans 

has declined in recent years. This article provides information on trends in the ALLL over time and by loan 

type and discusses the factors analysts consider when 

evaluating the adequacy of the ALLL. Special attention 

is given to issues related to the volatility of loan losses 

and the composition of the loan portfolio. 

Historical Perspective on the Allowance 

for Loan and Lease Losses 

The nation is currently witnessing one of the longest 

economic expansions since World War II. It is to be 

expected that some institutions will reduce their ALLL 

CHART 1 

coverage during periods of improved economic conditions. However, in the current environment—in which 

loan availability is abundant, growth is strong, and competition is fierce—some industry leaders and regulators 

have expressed concern about the loosening of underwriting standards and greater risk in bank loan portfolios. At the same time, the ALLL relative to total loans 

for commercial banks has declined to the lowest point in 

a decade (see Chart 1). This allowance ratio has diminished because commercial banks’ loan loss provisions 

have not kept pace with new loan growth. In some 

cases, banks have determined that their allowances are 

higher than necessary and have taken negative loan loss 

provisions, which are credited back to income. 

This decline in reserve coverage has been broad based, 

with the exception of credit card specialists. Commercial banks with concentrations in commercial lending 

and large multinational banks have significantly 

reduced the level of reserves to total loans in recent 

years. Table 1 (next page) shows that since 1993, ALLL 

ratios at both commercial lending banks and multinational banks have declined 31 percent. Moreover, commercial lending banks with assets exceeding $10 billion 

have reduced ALLL ratios by slightly over 37 percent, 

or 98 basis points, over the same period. 

The low level of nonperforming and charged-off loans, 

coupled with prevailing favorable economic conditions, 

is doubtless a significant factor in the reduction of 

Atlanta Regional Outlook 11 Second Quarter 1998 

Commercial Bank Reserves at Lowest Point in a Decade 

Source: FDIC Historical Statistics on Banking, National Bureau of Economic Research, Inc. 

1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

3.0 

% of Loans

Current 

Expansion 

Recessionary 

periods 
In Focus This Quarter
 

TABLE 1 

Commercial Bank Allowance for Loan and Lease Losses to 

Total Loans by Lender Type 

TYPE OF LENDER 

NUMBER OF 

BANKS 

ASSETS 

($BILLIONS) 1997 1996 1995 1994 1993 

MULTINATIONAL 

COMMERCIAL 

CREDIT CARD 

MORTGAGE 

AGRICULTURAL 

11 

3,207 

67 

286 

2,373 

$1,383 

$1,915 

$202 

$120 

$120 

2.14 

1.63 

4.21 

1.26 

1.53 

2.25 

1.71 

3.48 

1.45 

1.66 

2.55 

1.90 

3.21 

1.45 

1.69 

2.83 

2.16 

2.89 

1.69 

1.75 

3.10 

2.37 

3.35 

1.87 

1.83 

Definitions for lender types by order of priority: Multinational—assets >$10 billion and foreign assets >25% of 

assets; Commercial—C&I plus CRE loans >50% of assets; Credit Card—credit card loans >50% of assets; Mortgage— 

1- to 4-family mortgages and mortgage-backed securities >50% of assets; Agricultural—agricultural production and 

agricultural real-estate loans >25% of total loans. 

Source: Bank Call Reports 

ALLL levels. Asset quality indicators such as nonperforming loans and loan loss rates are at historically 

favorable levels. At year-end 1997, the banking industry’s nonperforming loans were just under 1 percent of 

total loans, the lowest in 13 years. The industry’s loan 

charge-off rates (with the exception of consumer loans) 

are also at historical lows. (See the Regional Outlook, 

first quarter 1997, for a detailed discussion of consumer 

loan losses.) However, even with the problems in consumer lending, the banking industry’s aggregate loan 

loss rate is down significantly from levels in the early 

1990s (see Chart 2). 

As the economic expansion reaches an advanced age, 

an important question for insured institutions is 

whether their ALLLs adequately reflect the risks assoCHART 2 

Source: Bank Call Reports 

Asset Quality Indicators Are at Historically 

Favorable Levels 

0.0% 

0.5% 

1.0% 

1.5% 

2.0% 

1985 1987 1989 1991 1993 1995 1997

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

3.0 

3.5 

4.0 

Charge-off 

Rates 

Nonperforming 

Loan Rates 

% of Total Loans 

ciated with changing industry practices. Insured institutions could experience strains on profitability and capital if allowance levels are inadequate. Given changing 

underwriting trends and loan delinquency patterns, a 

related question is whether reliance on past loss experience in setting the allowance will be an adequate measure for current losses. 

Trends in Underwriting Prompt 

Regulatory Cautions 

Over the past year, various underwriting and lending 

practices surveys by the FDIC, the Office of the Comptroller of the Currency (OCC), and the Federal Reserve 

have noted easing of terms and weakening underwriting 

standards on loans, especially in commercial loan portfolios. It is important to note that, in 1997, nearly twothirds of the commercial banking industry’s loan growth 

was centered in the commercial real estate (CRE) and 

commercial and industrial (C&I) loan categories 

(Chart 3). 

In the FDIC’s Report on Underwriting Practices for 

April 1997 through September 1997, examiners noted 

“above-average” risk in current underwriting practices 

for new loans at almost 10 percent of the 1,233 FDICsupervised institutions examined. Of the institutions 

with above-average risk, 12 percent did not adjust pricing for loan risk. Examiners noted that several of the 

852 institutions examined that were making business 

loans had poor underwriting standards, including lack 

of documentation of the borrower’s financial strength 

Atlanta Regional Outlook 12 Second Quarter 1998 
In Focus This Quarter
 

(21 percent) and poor and unpredictable loan repayment 

sources (14 percent). Also, of the 571 institutions 

specifically involved in asset-based business lending, 

20 percent often failed to monitor collateral. Furthermore, 20 percent of the 398 institutions examined that 

were actively engaged in construction lending repeatedly failed to consider alternative repayment sources, and 

29 percent often funded speculative projects. In contrast, just one year earlier, in the Report on Underwriting Practices for April 1996 through September 1996, 

examiners reported that only 11 percent of the institutions examined that were actively engaged in construction lending often funded speculative projects. 

The Federal Reserve’s Senior Loan Officer Opinion 

Survey for November 1997 and February 1998 both 

indicated some easing of commercial business lending 

terms and standards. Also, the OCC’s 1997 Survey of 

Credit Underwriting Practices stated that the level of 

inherent credit risk continues to increase for components of both commercial and consumer loan portfolios. 

These underwriting trends have resulted in increased 

risk profiles for some insured institutions, while ALLL 

ratios at some institutions continue to decline. 

In August 1997, the OCC issued an Advisory Letter 

voicing its concern about declining allowance levels in 

commercial banks. The OCC cited as primary concerns 

the apparent increases in credit risk reported by examiners, such as weakening underwriting trends in the syndicated loan market, easing of other commercial 

underwriting standards, and consumer lending delinquency and charge-off trends. Moreover, the OCC 

found that some banks were using flawed reserve 

CHART 3 

Loan Growth in 1997 Centered in
 

Commercial Loans
 

% of Total Loan Growth 

–30 

–20 

–10 

0 

10 

20 

30 

40 

50 

60 

70 

80 

Commercial

Consumer

Residential

Mortgages

CRE 

C&I 

Other 

Note: Percent of all loan growth for commercial banks in 1997 

Source: Bank Call Reports 

methodologies for estimating loan loss rates, including 

an overreliance on historical loss rates. 

Factors Affecting Adequacy 

of the ALLL 

In using offsite data to assess allowance adequacy, analysts consider financial ratios such as the allowance to 

total loans, reserve coverage (allowance to nonperforming loans), loan loss provisions to charge-offs, and loan 

delinquency levels. These ratios are evaluated against 

historical benchmarks. At the same time, however, analysts supplement the analysis with consideration of the 

potential effects of current industry trends. For example, the banking industry is currently witnessing higher 

than normal losses in consumer lending spurred by 

increased bankruptcy filings and the migration of loans 

from current to charged off without intervening delinquencies. An institution that has a sizable consumer 

loan portfolio may therefore need to attach more weight 

to recent loan loss data in setting the allowance, since 

historical trends may not adequately reflect reserving 

needs. 

Insured institutions exhibit different management and 

portfolio characteristics that significantly influence the 

level of the allowance. These characteristics include the 

diversification of a loan portfolio (diversification by 

borrower, loan type, geography, or industry), the history and recent trends of credit losses, management’s 

practices in the recognition of losses, trends in past-due 

and nonperforming loans, underwriting practices, and 

economic conditions. 

New techniques continue to be developed to improve 

the reliability of allowance estimates. Management 

information systems, which enable the collection of 

more refined historical data, coupled with the application of statistical techniques, are helping some institutions formulate more statistically reasoned allowance 

estimates. Loan management tools such as credit scoring systems, risk rating systems, and consideration of 

economic cycles in the review of historical loss and 

delinquency data all are aiding bankers in the reserving 

process. While these new techniques provide more analytically defensible estimates, they do not diminish the 

role of judgment in assessing ALLL adequacy. 

The role of judgment in setting the ALLL is underscored by the volatility of loan losses over time. 

Atlanta Regional Outlook 13 Second Quarter 1998 
In Focus This Quarter
 

CHART 4 

Historically, Commercial Loan Loss Rates Have Been Higher and More Volatile 

than Mortgage Loss Rates 

Source: Bank Call Reports 

0.0 

0.2 

0.4 

0.6 

0.8 

1.0 

1.2 

1.4 

1.6 

1991 1992 1993 1994 1995 1996 1997 

Loan Loss Rates (%)

Commercial Real Estate Loans 

Commercial & Industrial Loans 

Residential Mortgages 

“Volatility” in this context refers to the degree to which 

loan losses have diverged or might diverge from the 

long-run averages. Volatility in loan losses can result 

from changes in the business cycle, local economic 

events, and major one-time events. For example, a bank 

relying on a historic average loan loss calculation to 

derive its reserve level could find itself underreserved if 

it does not adjust its historical loss rates for deteriorating economic conditions and suddenly incurs greater 

loan losses than it had anticipated simply on the basis of 

past performance. 

Generally, different types of loans experience varying 

loan loss rates because of the inherently different risks 

and varying levels of volatility within each type. Chart 

4 shows that commercial loans, such as commercial and 

industrial loans and commercial real estate, historically 

have had greater losses than residential loans. Furthermore, the loss rates on commercial loans have not only 

been higher, they have been more volatile over the 

years, while average losses on mortgage loans have varied little. 

Volatility in loan losses is determined not only by economic events but also by banks’ willingness to take risk. 

Banks that adopt more liberal underwriting policies and 

high loan growth objectives may experience greater 

loan default risk and greater volatility in loan loss rates 

than suggested by their own past experience. For example, Chart 4 shows that mortgage lending has had low 

and stable loss rates on average. The recent growth in 

subprime and high loan-to-value mortgage lending, 

however, may result in increased volatility and losses 

for some lenders going forward. 

All of these factors suggest that ALLLs would be 

expected to vary considerably both over time and across 

loan types. Table 2 shows that this has been the case. 

The ALLL is reported as a single line item on the Call 

Report. This makes it difficult to estimate how much of 

the ALLL is attributable to a particular loan type or to 

compare allowance levels for banks with significantly 

different loan portfolios. Table 2 shows the results of a 

statistical regression estimation of commercial bank 

allowance allocations across the various loan types for 

TABLE 2 

ALLL Allocations Have Varied over Time and by Loan Type 

(Commercial Banks under $1 Billion)* 

LOAN TYPE 1997 (%) 1996 (%) 1995 (%) 1994 (%) 1993 (%) 1992 (%) 1991 (%) 

C&I 

CRE 

MORTGAGES 

CREDIT CARDS 

1.71 

1.44 

0.92 

4.47 

1.85 

1.54 

1.00 

4.42 

1.87 

1.77 

1.05 

3.32 

2.06 

1.83 

1.19 

3.11 

2.14 

1.97 

1.22 

3.20 

2.29 

2.02 

1.07 

3.29 

2.45 

1.99 

0.91 

3.59 

* Estimated regression results 

Source: Bank Call Reports 

Atlanta Regional Outlook 14 Second Quarter 1998 
In Focus This Quarter
 

1991 through 1997 for commercial banks with under $1 

billion in assets. Not surprisingly, CRE and C&I loans 

received relatively higher allowance allocations than 

residential mortgage loans, indicating that banks saw 

greater risk in these loan types. Also, credit card loans 

consistently received higher allocations than the other 

loan categories, and the allocations have increased in 

recent years owing to the increased delinquencies and 

charge-offs in this area. 

Conclusions 

The adequacy of the ALLL is measured not only relative to historical loan loss experience but also relative to 

current conditions that may cause losses to differ from 

past experience. Increased losses could result from 

adverse economic developments, from changes in 

banks’ appetite for taking risk, or 

both. In this regard, reported weakening in underwriting standards is 

increasing some banks’ risk exposure to an economic downturn. 

Institutions with high concentrations in riskier loans, significant 

growth in riskier loans, or weaknesses in underwriting may be most at risk. Especially 

for such institutions, the adequacy of the ALLL and its 

methodologies merits close scrutiny. 

Andrea Bazemore, Banking Analyst 

Atlanta Regional Outlook 15 Second Quarter 1998 
Regular Features	 Regional Economy
 

Atlanta Region’s Economic Expansion Continues
 

•	 Economic growth in the Atlanta Region remained above the national average in 1997. 

•	 Heavy rains and adverse weather in southern Georgia place 1998’s agricultural crop at risk. 

•	 The textile and apparel industries remain an important component of the Atlanta Region’s economy despite 

decades of job losses. 

• Financial institutions in the Atlanta Region have direct and indirect exposure to the textile and apparel 

industries. 

After flattening throughout much of 1997, year-overyear job growth in the Atlanta Region rose to 3.3 percent in the fourth quarter, its highest level since early 

1995 (see Chart 1). The growth trend in the Region paralleled that of the nation as a whole. Despite strong levels of domestic demand so far in 1998, many analysts 

believe that regional and national growth will slow later 

in the year as exports weaken in the face of reduced 

Asian demand and a strong U.S. dollar. One area of concern, because of its global exposure, is the Atlanta 

Region’s important textile and apparel industries. 

Florida’s Economy Continues to Expand at an 

Above-Average Rate 

Florida’s economic performance during 1997 and the 

early months of 1998 has been exceptional, with job 

growth during 1997 approaching 4 percent (see Chart 2). 

CHART 1 

Job Growth in the Atlanta Region Continues to
 

Exceed the National Average
 

5.0 Florida 

4.0 North 

Atlanta Region 3.0 United States

2.0 

1.0 

0.0 

–1.0 

–2.0 

Gains in the state have been led by high levels of construction activity, especially in central Florida, where 

theme park–related construction continues. Recent 

reports suggest that damage from March tornadoes in 

that portion of the state have exacerbated already tight 

labor markets for construction workers. 

North Carolina, South Carolina, and Virginia 

Turn in Strong Performances in 1997 

The Carolinas and Virginia saw job growth in excess 

of the national average during 1997. Economic gains, 

however, remain confined to metropolitan areas, particularly along interstate highways. In manufacturing, 

growth is constrained by continued losses in the production of durable goods, particularly textiles and 

apparel. Even in durable goods the rate of decline moderated throughout late 1997. 

CHART 2 

Growth in the Atlanta Region Is Led by Florida 

1.9% 

1.4% 

3.9% 

3.4% 

3.0% 

2.8% 

2.6% 

U.S. average: 

2.6% 

Year-Ago Percent Change

Carolina 

Virginia 

South 

Carolina 

Georgia 

Alabama 

West 

Virginia 

–3.0 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 Q1.90 Q3.90 Q1.91 Q3.91 Q1.92 Q3.92 Q1.93 Q3.93 Q1.94 Q3.94 Q1.95 Q3.95 Q1.96 Q3.96 Q1.97 Q3.97

Year-Ago Percent Change 

Source: Bureau of Labor Statistics	 Source: Bureau of Labor Statistics 

Atlanta Regional Outlook 16	 Second Quarter 1998 
Regular Features Regional Economy
 

Late-Year Rally Boosts Georgia’s Economic 

Performance, but Agricultural Lenders 

Face Risks 

Georgia’s economic performance improved in the latter 

part of 1997 as the constraining impacts of the 1996 

Summer Olympics receded. Growth in the Atlanta metropolitan area accelerated, in part because of gains in 

construction and transportation services. Atlanta’s real 

estate markets also continue to flourish, causing some 

risk of overbuilding, particularly in multifamily and 

retail markets. 

The southern portion of the state has seen record precipitation in recent months, prompting concern about 

agricultural prospects for 1998. Flooding slowed spring 

field preparation and planting activity. Conditions were 

exacerbated further in mid-March 1998 by freezing 

conditions that threatened the state’s peach and blueberry crops, which had seen early growth because of a mild 

winter. Recent reports have estimated that Georgia 

farmers could lose as much as $200 million in 1998 

because of adverse weather conditions. 

Growth in Alabama and West Virginia Continues 

to Lag the Region and the Nation 

Despite strength in some of its metropolitan areas (such 

as Mobile, Birmingham, Tuscaloosa, and Huntsville), 

weakness elsewhere has constrained Alabama’s economic expansion. Similar conditions prevail in West 

Virginia. These states remain exposed to their continued dependence on primary industries (textiles, apparel, 

lumber, and wood pulp in Alabama; energy and metals 

in West Virginia). Growth is constrained by the states’ 

slow population growth as well. 

The Textile and Apparel Industries Are Beset 

by Competitive Pressures 

Although economic growth remains above the national 

average, one vulnerability in the Atlanta Region is its 

exposure to the textile and apparel industries. Last year 

marked the fifth consecutive year of job losses and continued imbalance between imports and exports in these 

industries. Risks to textile- and apparel-related businesses, as well as the insured financial institutions that 

actively lend to those businesses, could rise in the future 

given the industries’ vulnerability to cyclical fluctuations in addition to growing pressures from global markets, automation, and industry consolidation. 

Atlanta Region Is Vulnerable because of Textile 

and Apparel Exposure 

The decline in the textile and apparel industries has 

placed a heavier burden on the Atlanta Region than on 

perhaps any other area of the country. The Atlanta 

Region accounts for approximately 73 percent of all textile industry jobs in the nation. Moreover, the Atlanta 

Region is a significant player in the apparel industry, 

accounting for 25 percent of the nation’s total apparel 

employment. In assessing the impact of the continually 

declining textile and apparel industries, the rural/urban 

dichotomy must be examined carefully. The rural areas 

of the Region have felt the deterioration of these two 

industries most strongly, primarily because of the very 

limited employment opportunities available as plants 

are closed or downsizing becomes necessary. Urban 

areas are less likely to feel severe effects from the 

declining industries because the healthy economy they 

have experienced in recent years has allowed displaced 

employees to move into other jobs. 

Textile and Apparel Exposure by State 

The textile industry comprises approximately 38 percent of all manufacturing jobs in Georgia, with the 

majority of these jobs in the carpet manufacturing sector. In fact, two-thirds of the nation’s carpet manufacturing is done in Georgia. Whitfield, Gordon, Bartow, 

and Floyd counties in Georgia make up the bulk of the 

carpet industry for the Region (see Chart 3, next page). 

These counties in and around the Atlanta metropolitan 

area have flourished as the real estate market has 

expanded. In contrast to textiles, Georgia’s apparel 

industry has continued to deteriorate, losing 15,000 jobs 

since 1995. 

North Carolina’s textile and apparel industries account 

for 6.4 percent of total employment in the state, compared with 19.2 percent in 1973. While declines in the 

industry have become the norm, layoffs and closures in 

the state have been particularly severe recently. Since 

1995, the industry has shed over 30,000 jobs, roughly 

equivalent to the net loss in employment that occurred 

from 1985 to 1995. The northern and western portions 

of the state tend to have the highest concentration of 

textile and apparel jobs. 

South Carolina is dominated by the textile and apparel 

industries, with employment in most counties exceeding 

1,000 workers. The Greenville-Spartanburg-Anderson metropolitan area, which has a heavy concentration 

Atlanta Regional Outlook 17 Second Quarter 1998 
Regular Features Regional Economy
 

CHART 3 

Regional Employment in the Textile 

and Apparel Industries 

Textile and Apparel’s Share 

of Total Employment, 1997 

25% to 60% 

10% to 25% 

0% to 10% 

Source: WEFA, Inc. 

of textile and apparel operations, has also felt decline. 

For example, one company in the area announced in 

January 1998 that it would cut its workforce in half by 

spring. Textile workers in metropolitan areas may be 

absorbed into other sectors of the economy. 

South Florida’s Dade County is another area to feel the 

effects of the declining textile industry, although textiles 

were less than 2 percent of total employment in 1997. 

Textiles and apparel were among the area’s strengths for 

many years, but by now most plants have moved to 

Latin America and the Caribbean. 

Alabama historically has had a large exposure to the 

textile and apparel industries, which still account for 20 

percent of the state’s jobs, even though about 10 percent 

of the industry’s workforce has been eliminated just 

since 1996. Textiles and apparel account for more than 

25 percent of total employment in DeKalb, Chambers, 

and Tallapoosa counties. 

Virginia has several counties that rely heavily on the textile and apparel industries for employment, particularly 

along the Virginia–North Carolina border. In December 

1997, several textile producers in the state indicated that 

their orders had been trimmed by increased Asian 

competition. With the exception of Roane and Ritchie 

counties, West Virginia has a low concentration of 

employment in the textile and apparel industries. 

Industry Drivers 

The textile and apparel industries are extremely cyclical 

and have been driven by consumer income, although the 

industries have been in secular decline for decades 

because of other factors as well. From 1993 on, the 

industry has seen substantial job losses from which it 

has been unable to recover, despite the overall health of 

the U.S. economy. A recent study speculates that weakened growth in demand may be linked to demographic 

changes in the nation. It argues that current plant capacity was developed for the “baby boomer” generation of 

77 million people, not the 45 million “Generation 

X-ers.” As such, overcapacity may be a risk for the 

industry’s long-term health. 

Seasonality is another important driver, particularly in 

the apparel industry. Orders for the season’s apparel are 

based on expected demand, which can be strongly 

affected by factors such as weather, fashion trends, and 

other unpredictable variables. Because of their lack of 

product diversity, niche manufacturers are at a higher 

level of risk from changes in consumer tastes. 

Structural Trends 

Employment in the combined textile and apparel sectors 

is currently about 1.5 million nationwide, although this 

number is decreasing rapidly. In 1997, the textile and 

apparel industries shed more jobs than any other industry—45,000 workers were dropped from the apparel 

industry and 12,000 from the textile industry (see 

Chart 4). 

A changing global environment has been unfolding in 

the textile and apparel industries and was strengthened 

by the passage of the Caribbean Basin Initiative (CBI) 

and the North American Free Trade Agreement 

(NAFTA). The CBI made it possible for U.S. fabrics to 

be shipped offshore, made into garments by low-wage 

workers, and imported into the United States duty-free. 

While U.S. textile and apparel jobs are dwindling, 

NAFTA has had some positive effects for the United 

States in that it has substantially increased U.S. trade 

with Canada and Mexico, encouraging significant new 

fabric business. 

Although Mexico and Canada are the largest exporters 

of textiles and apparel to the United States, about 80 

percent of the yarns and fabrics used to make the apparel are produced in the United States. The effects of the 

Atlanta Regional Outlook 18 Second Quarter 1998 
Regular Features Regional Economy
 

CHART 4 

Job Losses in the Atlanta Region’s Textile and 

Apparel Industries Continue 

-

200 

400 

600 

800 

1,000 

1,200 

1973197519771979198119831985198719891991199319951997 

Level (thousands of jobs) 

–12 

–10 

–8 

–6 

–4 

–2 

0 

2 

4 

6 

8 

10 

Year-Ago Percent Change 

Growth (right scale) 

Level (left scale) 

Source: Bureau of Labor Statistics 

General Agreement on Tariffs and Trade will come into 

play around 2004, when all tariffs on textiles will be 

phased out in all countries, a situation that is expected 

to create additional pressure on the U.S. textile and 

apparel industries. 

While the Asian crisis is adding pressure to an already 

stressed industry, it is but one factor in the decline of the 

textile and apparel industries. For the Atlanta Region, 

long-term economic problems in the “Asia 10” could 

translate into substantial problems for manufacturers 

who export to those countries1 as well. According to the 

Office of Trade and Economic Analysis, the amount of 

total exports, excluding services, destined for the 

“Asian 10” from the Atlanta Region could be upwards 

of $10.4 billion in sales—dollars that could evaporate. 

Because of continued overseas competition, the layoffs 

in the textile and apparel industries are expected to continue even if the Asian crisis calms. 

Market Risk and Financial Institution Exposure 

The volatility in the textile and apparel industries can 

affect the Atlanta Region’s financial institutions at two 

levels. First, banks face risk through direct lending to 

manufacturers; second, they have indirect exposure by 

virtue of their interdependent relationship with the local 

economy. 

Direct Exposure: A key risk to financial institutions 

that lend to manufacturers in the textile and apparel 

industries is the fact that they are vulnerable to season1 The “Asian 10” are China, Hong Kong, Indonesia, Japan, Malaysia, 

the Philippines, Singapore, South Korea, Taiwan, and Thailand. 

al and cyclical fluctuations. To meet the fixed cost of 

salaries and overhead during off-peak seasons, manufacturers often use their inventory as collateral to borrow from insured financial institutions and other 

lenders, intending to repay the debt during the peak 

sales season. There is a dual risk in this type of assetbased lending. Sales of seasonal wear are highly dependent on weather and economic conditions. A mild 

winter could severely limit demand for a firm’s product. 

Moreover, there is a high degree of correlation between 

income and job growth and sales in the textile and 

apparel industries. Producing now for consumption 

later in the year, based on assumptions of continued 

rapid growth, entails risk. If weather is abnormal or economic growth is slower than expected, a manufacturer’s 

peak season may leave it unable to service its debt. A 

second common type of short-term financing for textile 

and apparel manufacturers involves accounts receivable 

factoring. Because of slow turnover of receivables into 

cash, manufacturers often sell their invoices to a factoring agent, which, in turn, collects on the invoice. Here, 

the risk from defaulted payment by retailers is absorbed 

by the factoring agent, which can be a bank or nonbank 

entity. Over the past few years, factoring risk has 

increased because of consolidation and higher bankruptcy rates among retailers. 

Indirect Exposure: The indirect impact of textiles and 

apparel on the Region’s banking industry arises from 

the ripple effects of plant closures or layoffs on the surrounding community. As workers lose their jobs, their 

ability to meet financial obligations is jeopardized. This 

situation may occur even when the financial standing of 

the company remains sound, as in the case of a firm discharging employees because of plant automation. In 

areas where the unemployment rate is low or the level of 

economic diversification is high, economic dislocation 

may be lower than in a community where the plant is the 

single largest source of employment and income. In 

rural areas such as the northwestern corner of Georgia, 

textile manufacturing plays a dominant role in the local 

economy. Layoffs or plant closures there could have a 

more pronounced effect on businesses’ and consumers’ 

ability to meet debt obligations than in metropolitan 

areas such as Greenville-Spartanburg-Anderson, which 

has other economic drivers such as transportation 

equipment manufacturing. 

Scott C. Hughes, Regional Economist 

Jack M.W. Phelps, Regional Manager 

Pamela R. Stallings, Financial Analyst 

W. Brian Bowling, Financial Analyst 

Atlanta Regional Outlook 19 Second Quarter 1998 
Regular Features	 Regional Banking
 

Current Regional Banking Conditions
 

•	 Commercial banks performed well in the fourth quarter, despite margin compression and merger-related 

charges. Thrift performance, also affected by lower margins and higher overhead, was weaker in the quarter. 

•	 Growth in net interest income (NII) in 1997 was driven by growth in earning assets, while interest rate 

movements actually constrained NII growth. 

•	 Assessing the degree of interest rate risk at insured institutions becomes more important because of recent 

flattening in the yield curve. 

•	 Insured institutions headquartered in areas where textile and apparel manufacturing employment is high 

have performed well since the last recession. 

Fourth-Quarter Regional Bank and Thrift 

Performance Is Good 

Atlanta Region banks performed well in the fourth quarter of 1997, although aggregate earnings were constrained by merger-related charges at some very large 

banks, as well as by margin compression that affected 

banks of all sizes. The Region reported an annualized 

fourth-quarter return on assets (ROA) of 1.01 percent, 

31 basis points below the previous quarter and 25 basis 

points below the fourth-quarter 1996 return. Higher noninterest charges, particularly at four large banks in Virginia and Florida that were involved in pending 

mergers, contributed to a sharp increase in the overhead 

expense ratio during the quarter. The net interest margin 

fell 13 basis points to 4.29 percent in the period because 

of higher funding costs but remained above the national 

average. A modest increase in reserve provisions and a 

slight drop in noninterest income also affected quarterly 

earnings. The Region’s aggregate leverage capital ratio 

fell slightly in the quarter, but overall capitalization 

remained strong. Delinquency, charge-off, and reserve 

coverage measures all indicated continued strong regional banking conditions. There was further deterioration in 

the consumer credit sector, however. The Region’s credit card loss rate increased throughout the year and was 

above the national average at 5.54 percent during the 

fourth quarter. In general, large banks performed better 

than small ones. The weakness in small-bank earnings 

was largely seasonal, as overhead and provision expenses for this group tend to be highest in the fourth quarter. 

Atlanta Region thrifts underperformed their out-ofregion peers during the quarter with an annualized ROA 

of 0.77 percent. Lower long-term interest rates reduced 

thrift net interest margins throughout the second half of 

1997, and provision expenses and overhead spending 

were higher in the fourth quarter. The Region’s thrifts 

remained very well capitalized, however, with a yearend aggregate leverage ratio above 9 percent. Delinquencies and charge-offs also remained low, and reserve 

coverage of nonperforming loans, already above the 

nationwide thrift average, improved during the quarter. 

Interest Rate Risk for Insured Institutions 

Could Increase 

Several forces currently at work in the general economy 

and the financial services sector could portend higher 

interest rate risk (IRR) for insured institutions. A flattened yield curve, record refinancing activity, potential 

devaluation of mortgage servicing assets, a shift in loan 

demand from adjustable-rate to low-fixed-rate products, 

and intense competition among financial institutions and 

nonbank lenders all could affect intermediated earnings. 

Change in these areas places increased emphasis on 

identifying the extent of IRR in insured institutions. 

IRR can be measured in several ways. Common methods include gap, duration, and simulation analysis, all of 

which are prospective measurement techniques 

designed to estimate net interest income (NII) variability or financial instrument price volatility in future periods. Measuring IRR is extremely difficult regardless of 

the technique used. Typically, most IRR models require 

estimates of, among other things, the direction of 

change for several key interest rates over time, the magnitude and timing of those changes, and the average volume and mix of earning assets and interest-bearing 

liabilities at the time of each change in rates. Embedded 

optionality in many financial instruments and the 

increased use of off-balance sheet derivatives and hedging programs add to the complexity of forecasting IRR. 

Atlanta Regional Outlook 20	 Second Quarter 1998 
Regular Features Regional Banking
 

It is even more difficult to apply these forward-looking 

techniques off site, as the required inputs are not sufficiently detailed in Bank or Thrift Call Reports or other 

public filings. As discussed below, rate/volume analysis 

(see Table 1) is one alternative ex post method that can 

be applied off site to measure IRR exposure during a 

specified period. 

Table 1 details how rate/volume analysis decomposes a 

financial intermediary’s period change in NII. NII 

changes can be attributed to three factors: changes in 

yields and costs (rate variance), fluctuations in earning 

asset and interest-bearing liability volume (volume variance), and residual interest income and expense arising 

from the combination of rate and volume changes (mix 

variance). Conceptually, rate/volume analysis simply 

breaks down NII into its component parts and measures 

the contribution of each component during the period. 

This method is particularly suitable for off-site monitoring, since the required data are readily obtainable 

from Call Reports. Note that Table 1 assumes 1997 as 

the measurement period, but a rate/volume analysis can 

be applied to any two consecutive time periods. 

Subjecting Atlanta Region commercial banks and FDICsupervised savings banks1 to a rate/volume analysis for 

1997, we found that the increase in aggregate NII was 

driven entirely by strong growth in earning assets rela1 Credit card banks are excluded because of their nontraditional balance sheet structure and institutions involved in a merger in 1996 or 

1997 because merger accounting can skew average yield and cost 

data. The universe included 1,055 institutions in 1997. 

TABLE 1 

tive to interest-bearing liabilities, while rate and mix 

variations actually constrained NII growth during the 

year. Table 2 (next page) summarizes the effects of rate, 

volume, and mix variance on 1997 aggregate NII. The 

negative income rate variance and positive expense rate 

variance reflect the flattening of the yield curve (lower 

long-term rates and higher short-term rates) during the 

period. The negative net mix variance also reflects this 

flattening, as new earning assets yielded progressively 

less (long-term rates were falling), while marginal funding costs were higher (short-term rates were rising). 

For comparison, we conducted a rate/volume analysis 

on a similar universe2 of institutions using 1994 data, 

the latest year in which there was notable volatility in 

market interest rates. As in 1997, net earning asset 

growth accounted for the increase in NII in 1994. The 

net rate variance (NRV) again was negative, although 

the rate effect was much larger in 1994 than in 1997, 

implying higher IRR exposure. Mix variance was slightly negative in 1994. 

Rate/volume analysis indicates that, on average, commercial banks and savings banks exhibited greater sensitivity to interest rate changes in 1994 than in 1997 

(measured by NRV as a percentage of prior period NII). 

The interest rate environments that existed during each 

of those periods explain this finding. Specifically, in 

1994 the Federal Reserve began pushing short-term 

2 The 1994 data set included 1,040 commercial banks and FDICsupervised savings banks. 

Rate/Volume Analysis Methodology 

VARIANCE MEASURES FORMULA COMPONENTS 

INCOME RATE VARIANCE (1997 EARNING ASSET YIELD – 1996 EARNING ASSET YIELD) X 

1996 AVERAGE EARNING ASSETS 

EXPENSE RATE VARIANCE (1997 COST OF FUNDS – 1996 COST OF FUNDS) X 1996 AVERAGE 

INTEREST-BEARING LIABILITIES 

INCOME VOLUME VARIANCE (1997 AVERAGE EARNING ASSETS – 1996 AVERAGE EARNING 

ASSETS) X 1996 EARNING ASSET YIELD 

EXPENSE VOLUME VARIANCE (1997 AVERAGE INTEREST-BEARING LIABILITIES – 1996 AVERAGE 

INTEREST-BEARING LIABILITIES) X 1996 COST OF FUNDS 

INCOME MIX VARIANCE (1997 AVERAGE EARNING ASSETS – 1996 AVERAGE EARNING 

ASSETS) X (1997 YIELD – 1996 YIELD) 

EXPENSE MIX VARIANCE (1997 AVERAGE INTEREST-BEARING LIABILITIES – 1996 AVERAGE 

INTEREST-BEARING LIABILITIES) X (1997 COST – 1996 COST) 

The “net” position for each of the variance measures is the difference between the income and expense variances.
 

For example, the net rate variance is equal to income rate variance – expense rate variance.
 

The sum of the three net variance measures (rate, volume, and mix) should equal the total change in net interest
 

income during the period.
 

Source: FDIC Interest Rate Risk Model
 

Atlanta Regional Outlook 21 Second Quarter 1998 
Regular Features Regional Banking
 

TABLE 2 

1997 Rate/Volume Analysis of Atlanta Region Institutions* 

YEAR TOTAL CHANGE DUE TO 

VARIABLE 1997 1996 CHANGE RATE VOLUME MIX 

INTEREST INCOME 

(TAX EQUIVALENT) 14,091,951 12,822,187 1,269,764 (76,970) 1,351,553 (4,819) 

INTEREST EXPENSE 6,296,444 5,628,857 667,587 30,441 619,003 18,143 

NET INTEREST INCOME 7,795,507 7,193,330 602,177 (107,411) 732,550 (22,962) 

AVERAGE EARNING 

ASSETS 169,604,372 153,414,712 16,189,660 

AVERAGE INTERESTBEARING LIABILITIES 138,755,506 125,158,551 13,596,955 

* Insured institutions include all commercial banks and FDIC-supervised savings banks.Institutions involved in 

mergers in 1996 or 1997 are excluded. Credit card institutions are excluded. 

Source: Bank and Thrift Call Reports 

(federal funds) rates higher very early in the year, so the 

increased funding costs affected NII throughout most of 

the measurement period. In 1997, however, the bulk of 

the decline in long-term rates occurred later in the year, 

so the detrimental impact on asset yields was felt for a 

shorter period. Although NRV was negative in both 

periods, the differing manner in which the yield curve 

flattened in each period affected how the negative NRV 

occurred. For instance, 72 percent of the negative NRV 

in 1997 was due to lower asset yields (declining longterm rates), whereas nearly all (94 percent) of the negative NRV in 1994 resulted from higher funding costs 

(rising short-term rates). 

If we use capitalization, fee income contribution, and 

the net interest spread as indicators of IRR tolerance, it 

appears that overall risk-bearing capacity was higher in 

1997 than in 1994. The aggregate leverage capital ratio 

for the previously defined institution universe was 9.26 

percent in 1997, up from 8.72 percent in 1994. In addition, institutions had a more diverse income stream in 

1997, which reduced reliance on NII to maintain profit 

stability. For this analysis, reliance on NII was measured 

by the ratio of noninterest income to total income, 

where total income was equal to noninterest income 

plus net interest income. A higher ratio indicates greater 

diversification of the income stream and, consequently, 

a higher capacity to withstand negative fluctuations in 

NII. Noninterest income accounted for 26.3 percent of 

aggregate total income in 1997, a modest increase from 

the 1994 level of 25.4 percent. Finally, a comparison of 

aggregate net interest spreads showed a slight (2 basis 

points) contraction from 1994 to 1997— not enough to 

offset the favorable effects of higher capital and greater 

income diversification. 

The IRR exposure of savings banks was higher, on average, than that of commercial banks in both 1994 and 

1997 as measured by the ratio of NRV to the prior year’s 

NII, and their overall risk-bearing capacity was comparatively lower. Savings banks’ risk tolerance benefited 

from higher capital levels in both periods; however, 

these institutions exhibited significantly lower net interest spreads and had very little income source diversification. In 1997, the savings banks in the data set had an 

aggregate leverage capital ratio of 13.47 percent, which 

was well above the commercial bank ratio of 9.17 percent, but noninterest income accounted for only 9.34 

percent of savings banks’ total income during the year, 

versus 26.6 percent for commercial banks. Also, savings 

banks’ 1997 net interest spread of 3.02 percent was 77 

basis points below that of commercial banks. Given 

lower net interest spreads and considerably higher mortgage loan concentrations, savings banks may be more 

vulnerable to an increase in refinancing. As of year-end 

1997, residential mortgage loans comprised nearly 84 

percent of total loans for savings banks in the data set, 

compared with 32 percent for commercial banks. Similar results were evident in the 1994 data. The referenced 

universe of insured institutions did not include traditional thrifts, as average balance and tax-equivalency 

data were not readily available. It is reasonable to conclude, however, that they would exhibit an IRR posture 

similar to that of the savings banks in the data set. 

Although aggregate IRR exposure as measured by 

rate/volume analysis was lower in 1997 than in 1994 for 

the Region’s commercial and savings banks, examiners 

and institution managers should be aware that the ongoing yield curve flattening that began in the second half 

of 1997 could result in higher IRR in 1998. 

Atlanta Regional Outlook 22 Second Quarter 1998 
Regular Features Regional Banking
 

Insured Institutions Have Performed Well 

despite Declines in Textile and Apparel 

Manufacturing 

The secular decline in textile and apparel manufacturing 

has a disproportionate impact on the Atlanta Region (see 

Regional Economy in this issue). While the amount of 

direct lending by insured institutions to textile manufacturers is not extensive, many local economies in the 

Region are dependent on this industry sector. Hence, further plant closings or reductions in employment could 

adversely affect some insured institutions. 

Currently, there are 29 rural counties in the Region 

where textile and apparel employment represents 20 

percent or more of total employment. Headquartered in 

these counties are 53 insured institutions (see Chart 1), 

which are concentrated mostly in three states: Georgia 

(20), Alabama (13), and North Carolina (10). Most 

are commercial banks, but six are traditional thrifts and 

three are FDIC-supervised savings banks. The performance of these insured institutions has improved since 

the 1991 recession, as shown in Table 3. Significant 

improvements have occurred in the weighted-average 

capital ratio and in noncurrent loans and charge-offs. 

However, the improvement in noncurrent loans and 

charge-offs appears to have reached a cyclical low in the 

past year. In general, the performance of commercial 

and industrial (C&I) loans has been weaker than the 

overall loan portfolio. Extensions of credit to textile and 

apparel manufacturers are reported as C&I loans. Over 

the past two years, C&I loan growth has been extremely robust, leading to an increase in this type of lending 

relative to capital and a notable increase in the loan-toTABLE 3 

CHART 1 

Insured Institutions in Counties Where Textile and
 

Apparel Employment Exceeds 20 Percent
 

of Total Employment
 

No banks 

1 to 2 banks 

3 to 4 banks 

5 to 7 banks 

Source: Bank and Thrift Call Reports 

deposit ratio. Because this lending segment performed 

poorly at these insured institutions during the last economic downturn, attention to the ramifications of a 

future downturn on loan quality is warranted. 

Jack M.W. Phelps, Regional Manager 

W. Brian Bowling, Financial Analyst 

Scott C. Hughes, Regional Economist 

Pamela R. Stallings, Financial Analyst 

Performance Trends at Institutions Headquartered in Rural Counties 

with High Textile and Apparel Manufacturing Employment* 

NUMBER AVERAGE C&I NON­ NONCURRENT LOAN C&I LOAN LOANS C&I RETURN 

OF SIZE ($ CAPITAL LOANS TO CURRENT C&I CHARGE­ CHARGE­ TO LOAN ON 

YEAR INSTITUTIONS MILLIONS) RATIO CAPITAL (X) LOANS LOANS OFFS OFFS DEPOSITS GROWTH ASSETS 

1991 49 78.0 9.17 0.98 1.39 2.52 0.43 1.25 67.9 — 0.96 

1992 49 82.8 9.52 0.89 1.09 1.76 0.44 1.18 64.7 0.74 1.27 

1993 49 86.8 10.01 0.77 0.86 1.92 0.14 0.44 64.4 (4.69) 1.31 

1994 50 89.0 9.85 0.80 0.75 1.60 0.14 0.20 67.8 6.90 1.17 

1995 50 96.5 10.76 0.72 0.57 0.85 0.14 0.44 69.4 3.61 1.22 

1996 53 98.4 10.93 0.76 0.60 0.68 0.23 0.39 74.7 13.22 1.17 

1997 53 115.1 10.57 0.95 0.59 0.85 0.19 0.38 77.8 28.57 1.29 

* Defined as counties where textile and apparel manufacturing employment is 20 percent or more of total employment. 

Source: Bank and Thrift Call Reports; WEFA, Inc. 

Atlanta Regional Outlook 23 Second Quarter 1998 
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