Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION THIRD QUARTER 2002 

FDIC
 

New York
 

Region
 

Division of
 

Insurance
 

and Research
 

Kathy R. Kalser,
 

Regional Manager
 

Robert M. DiChiara,
 

Senior Financial
 

Analyst
 

Norman Gertner,
 

Regional Economist
 

Alexander J.G.
 

Gilchrist,
 

Economic Analyst
 

Regional Perspectives 

◆ The Region’s Largest Metropolitan Areas Have Weathered This Recession 

Differently—This article analyzes the timing and severity of job losses among the 

Region’s larger metropolitan statistical areas (MSAs) during the recent economic 

downturn and compares economic performance with that of previous recessions. 

Characteristics of the 2001 recession and economic profiles of the major MSAs 

help explain differences in local employment trends, banking performance, and 

prospects for economic recovery. See page 3. 

◆ Profitability Rebounds among the Region’s Large Banks; However, Challenges Remain—After declining in the second half of 2001, profitability among 

the Region’s large banks rebounded in first quarter 2002. Moderate increases in 

net interest margins and in noninterest income (primarily in consumer lines of 

business) and stabilization of loan loss provisions contributed to higher earnings 

among large banks. However, loan delinquency and charge-off rates remained 

elevated, a situation that could require additional loan loss reserves. See page 8. 

By the New York Region Staff 

In Focus This Quarter 

◆ The Road to Recovery for Commercial Credit Quality: Not without a Few 

Hurdles Ahead—The recession that began in March 2001 has been especially 

hard on the corporate sector. Banks that made loans to affected firms felt the 

immediate effects of the recession through rising problem commercial loans. 

Large banks took the brunt of this commercial credit deterioration, as indicated 

by a somewhat larger uptick in problem commercial loans among large banks 

compared with smaller banks. This credit deterioration was more apparent at 

banks that participated in loan syndications, one of the financing vehicles available primarily to large corporate customers. Various indicators pointing toward 

economic recovery, as well as an apparent decline in rating downgrades and 

default rates among corporate bond issuers in recent weeks, suggest that 

improvement in commercial credit quality may be just ahead. This recovery, however, faces a few hurdles, including continued high leverage, weak earnings, and 

prospects for a more difficult funding environment, particularly for speculativegrade corporations with maturing debt. See page 10. 

By Cecilia Lee Barry, Senior Financial Analyst 

A Publication of the Division of Insurance and Research 
The Regional Outlook is published quarterly by the Division of Insurance and Research of the 

Federal Deposit Insurance Corporation as an information source on banking and economic issues 

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

The first and third quarter issues of the Regional Outlook feature in-depth coverage of the economy and the banking industry in each Region and consist of a national edition and eight regional editions. The second and fourth quarter issues are a single national edition that provides an overview 

of economic and banking risks and discusses how these risks relate to insured institutions in each 

FDIC Region. These issues tell the national story and, at the same time, alert the reader to specific 

trends and developments at the regional level. 

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

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

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

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

Regional Outlook, please call Kathy Kalser at (917) 320-2650 or send an e-mail to kkalser@fdic.gov. 

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

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

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

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

the Federal Deposit Insurance Corporation. 

Chairman Donald E. Powell 

Director, Division of Insurance Arthur J. Murton 

and Research 

Executive Editor George E. French 

Writer/Editor Kim E. Lowry 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Richard A. Brown 

Ronald L. Spieker 

Publications Manager Teresa J. Franks 
Regional Perspectives
 

Regional Perspectives
 

•	 An examination of the economic profiles of the Region’s larger metropolitan areas can help explain the 

timing and severity of economic weakness during this recession, differences in how certain groups of banks 

have performed, and prospects for economic recovery. 

•	 Earnings reported by the Region’s large banks benefited from wider margins and lower loan loss provisions 

in first quarter 2002. However, loan delinquency levels remain elevated, and costs associated with problem 

loans could increase in coming quarters. 

Introduction 

A political axiom states, “Where you stand depends on 

where you sit.” Similarly, your view of the economy 

may depend largely on the location of your window. 

The Region’s largest metropolitan statistical areas 

(MSAs) weathered the recent recession differently—a 

reflection of the disparate economic and industrial 

makeup of these areas. These differences may offer 

clues to the pace of their recovery as well. This article 

analyzes the timing and severity of job losses among 

the Region’s larger metropolitan areas during the 

recent economic downturn and compares economic 

performance with that of previous recessions.1 For 

purposes of this analysis, the Region’s metropolitan 

areas are categorized into three groups: MSAs that 

experienced job losses early in this business cycle 

(Early Losses), MSAs whose economies were more 

directly affected by the events of September 11 (September Effect), and MSAs that experienced minimal 

or no job losses (Sporadic Losses).2 The characteristics 

of the 2001 recession and the economic profiles of 

these groups of MSAs help explain differences in 

employment trends, banking performance, and 

prospects for economic recovery.3 

1 Analysis was limited to the Region’s metropolitan areas that have a 

labor force of at least 200,000 and at least six insured institutions with 

total assets less than $10 billion, excluding credit card banks. 

Twenty-one of the Region’s 45 MSAs met these criteria as of March 

31, 2002. A list of the MSAs included in this analysis appears in the 

appendix table. 

2 Employment data through May 2002. 

3 For purposes of this analysis, the business cycle trough is assumed 

to be December 2001. See DRI-WEFA chief economist’s presentation 

entitled “Are We Headed for a Jobless and Profitless Recovery?” in 

New York City on May 28, 2002. 

How Does This Recession Compare 

with Past Recessions? 

The recent recession displayed some characteristics of 

the 1981–1982 and 1990–1991 recessions but avoided 

others. Similar to the economic downturn of the early 

1980s, the roots of the 2001 recession took hold in the 

nation’s manufacturing sector. In the most recent recession, however, weakness then spread to the information 

technology (IT) sector, as excesses in the IT industry 

became apparent. Subsequently, the IT bubble burst, and 

the effects spilled over to the stock market and contributed to declines on Wall Street, including equity 

financing, brokerage, and merger and acquisition (M&A) 

activity. The Federal Reserve Board’s shift to an expansionary monetary policy and the federal government’s 

fiscal stimuli helped offset the nation’s overall economic 

weakness. However, the events of September 11 were 

particularly detrimental to the Region’s securities and 

investment banking industries, which were already weakened, as they were in the recession of the early 1990s. In 

addition, business and consumer confidence declined 

and fallout spread to the travel, tourism, and transportation industries nationwide. Fortunately, the recent recession has not been characterized by significant consumer 

retrenchment, and the woes of the financial sector did not 

include weakness in the Region’s residential real estate, 

commercial real estate, and banking sectors—unlike the 

1990–1991 downturn. In contrast to the early 1990s 

recession, when housing prices declined sharply, prices 

in most of the Region’s metropolitan areas have remained 

stable or risen during this recession. Moreover, unlike the 

early 1990s, when the Region’s commercial real estate 

markets were characterized by significant excess supply 

of new construction, today’s rising office vacancy rates 

across many of the Region’s metropolitan areas generally 

reflect declining demand for space.4 

4 For more information on how this economic downturn compares 

with past recessions, see Regional Outlook, “In Focus This Quarter,” 

Second Quarter 2002. 

New York Regional Outlook 3	 Third Quarter 2002 
Regional Perspectives
 

The financial condition of insured institutions also differs from a decade ago. The Region’s insured institutions are generally better capitalized and report more 

favorable credit quality than during the early 1990s.5 

During the current economic downturn, credit quality 

weakness has been largely concentrated in commercial 

and industrial (C&I) loan portfolios, as C&I delinquency rates increased notably during the recent recession, 

particularly for the Region’s large banks (see box on 

page 8). Excluding subprime consumer loans, increases 

in consumer loan delinquency rates among the Region’s 

insured institutions have been relatively modest, reflecting generally favorable conditions in the consumer sector. Consumers and their quest for home ownership, 

supported by low interest rates, helped buffer the effects 

of this economic downturn on the Region’s (and the 

nation’s) economy. Nonetheless, as the timing and 

severity of job losses varied for the three groups of 

MSAs identified in this analysis, so did the degree of 

credit quality weakening for the Region’s insured institutions (see Charts 1 and 2). 

Job Losses Started Earlier in the 

Region’s Manufacturing Areas 

Consistent with trends nationwide, the Region’s metropolitan areas that lost jobs early in this downturn 

CHART 1 

(Early Losses) generally have a high concentration of 

manufacturing employment. The MSAs in this group 

include Buffalo-Niagara Falls, Rochester, and 

Syracuse, NY; Bergen-Passaic and Newark, NJ; and 

Scranton–Wilkes-Barre, PA. The average concentration in manufacturing jobs was 16 percent for these 

MSAs, compared with 13.8 percent for the nation as of 

first quarter 2001. 

Rochester is representative of the Region’s metropolitan 

areas that experienced employment declines early in the 

downturn. With over 20 percent of its employment base 

in manufacturing, Rochester began losing jobs in April 

2001, shortly after the official start of the recession. Job 

losses in the area’s durable goods manufacturing sector 

outpaced job growth in some other industry sectors, 

such as the finance, insurance, and real estate (FIRE) 

sector. In fact, durable goods manufacturing losses 

equaled 108 percent of the area’s total job losses on 

average from second quarter 2001 to first quarter 2002; 

that is, they exceeded the job additions in the city’s 

other business sectors. Employment in the industrial 

machinery and equipment and electronics industries has 

contracted most over the course of this recession. This 

is not surprising, as Rochester is home to the operations 

of several large firms that have struggled with weakness 

in the IT/telecommunications sector, including Global 

Crossing, Kodak, and Xerox. Rochester also has a 

CHART 2 

Timing and Severity of Job Losses among the 

Region’s MSAs Vary... 

Source: Bureau of Labor Statistics, Haver Analytics Year-over-Year-Employment Change (%) 

Sporadic Losses 

–1.5 

–0.5 

0.5 

1.5 

2.5 

Jan 

’01 

Early Losses 

September Effect 

Mar 

’01 

May 

’01 

Jul 

’01 

Sep 

’01 

Nov 

’01 

Jan 

’02 

Mar 

’02 

...as Does the Trend in Credit Quality 

Note: Past-due loans are those 30 days or more past due or in nonaccrual 

status. Two-quarter moving average of median figures shown. 

Source: Bank and Thrift Reports Past-Due Ratio 

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

3Q99 1Q00 3Q00 1Q01 3Q01 1Q02 

Early Losses 

Sporadic Losses 

September Effect 

Recession 

Officially Begins 

5 Unless otherwise noted, the analysis excludes institutions in operation less than three years, institutions with total assets greater than $10 billion, 

and credit card banks. These three groups of institutions were excluded either because their operations have been in existence for too short a time 

to yield useful analysis or because their operations extend much beyond the metropolitan areas in which they are headquartered. The analysis uses 

median figures unless otherwise noted. 

New York Regional Outlook 4 Third Quarter 2002 
Regional Perspectives
 

relatively high exposure to the auto industry through its 

auto parts and supply firms. The auto parts and supply 

industry is rationalizing worldwide, which has contributed to contraction in Rochester’s job market. 

Buffalo and Bergen-Passaic also experienced job 

declines in the manufacturing sector early in this downturn. It is interesting to note that the percentage of job 

losses in Buffalo and Bergen-Passaic has been far less 

than the employment declines these areas experienced 

during the 1990–1991 recession. Bergen’s worst month 

during the last recession, in terms of year-over-year 

percentage job decline, was March 1991, when the 

area shed over 6 percent of its jobs. The worst month 

associated with the 2001 recession to date was September 2001, when the Bergen job market contracted 

by 1.4 percent. Employment contraction in Buffalo 

during the last recession was greatest in September 

1991 (–3.4%) compared with April 2001 (–1.6%) during this downturn. 

Consistent with the economic downturn and job 

declines, credit quality weakened for insured institutions in the Rochester and Buffalo MSAs to a greater 

extent than in the Region and the nation. The past-due 

ratio6 for insured institutions in these two MSAs began 

to increase in first quarter 2000 and reached 2.17 percent in first quarter 2002, which exceeded the regional 

and national averages.7 Moreover, despite weakening 

economic conditions locally, insured institutions in the 

Rochester and Buffalo MSAs have reported an increase 

in the average concentration of traditionally higher-risk 

loan types—that is, C&I and commercial real estate 

(CRE). During the past two years, the average concentration in C&I and CRE loans for insured institutions 

in the Rochester and Buffalo MSAs increased from 

24 percent to 35 percent, rising from below the regional 

average to slightly above average.8 

Insured institutions in the Bergen-Passaic MSA also 

reported an increase in the average concentration of 

C&I and CRE loans to assets over the past two years. 

However, in contrast to the Rochester and Buffalo 

MSAs, the average past-due ratio for insured institutions 

6 Past-due loans are defined as loans more than 30 days past due or 

loans in nonaccrual status. 

7 The regional and national averages for the percentage of loans past 

due as of first quarter 2002 are 1.58 percent and 1.97 percent, respectively. 

8 The average concentration of commercial loans to total loans for the 

Region’s banks increased from 28 percent to 34 percent over the same 

period. 

in the Bergen-Passaic MSA has been relatively stable 

during this recession and has remained lower than the 

regional and national averages. However, credit quality 

is typically a lagging indicator and thus may weaken 

further as the effects of the downturn filter through 

insured institutions, particularly if the recovery is slow. 

New York City’s Early Job Losses Were 

Not Due to Manufacturing Weakness 

Like the Region’s other MSAs that experienced job 

declines early in the downturn, New York City had job 

losses during the first part of the recession. However, 

the preponderance of job losses occurred in the FIRE 

and services sectors, not in manufacturing. These sectors began weakening in early 2001 and worsened gradually until September 11. After September 11, New York 

City ranked among the top ten MSAs in the nation in 

terms of percentage of job losses, as businesses quickly 

shed jobs in reaction to the drastic slowdown in the 

area’s tourism, business services, retail, and FIRE industries, among others. 

Despite early entrance into this recession and relatively 

high job losses, credit quality among insured institutions 

in the New York City metropolitan area remained favorable through first quarter 2002. The average past-due 

ratio increased moderately in the second half of 2001, 

consistent with economic weakening, but declined in first 

quarter 2002 and, at 1.36 percent, remained below regional and national averages. Additionally, while softening in 

CRE markets has accompanied moderately increasing 

CRE loan delinquency rates for the area’s banks, the average past-due ratio for CRE loans remains below the 

regional average. Nonetheless, insured institutions in the 

New York City MSA, which hold one-quarter of their 

portfolios in CRE loans, have reported an increase in 

the average CRE loan past-due ratio over the past year, 

from .27 percent to .65 percent. Office vacancy rates in 

New York City increased through second quarter 2002 

but remained below the national average. Continued softness in office market conditions could lead to further 

weakening in CRE loan quality among the area’s banks. 

Some of the Region’s Metropolitan 

Areas Have Lost Few, if Any, Jobs 

Eight of the Region’s MSAs were not pulled into recession by the manufacturing sector decline or the effects 

of September 11. These MSAs experienced minimal or 

New York Regional Outlook 5 Third Quarter 2002 
Regional Perspectives
 

no job losses (Sporadic Losses) between March 2001 

and May 2002. The primary commonality among these 

MSAs is the relatively high growth in government and 

service sector jobs, particularly in the health care sector. 

The concentration of jobs in these sectors has insulated 

many MSAs in this group from the significant contraction experienced by other industry sectors. Government 

employment tends to be acyclical; that is, demand is not 

driven by the business cycle. During the year ended first 

quarter 2002, the government and health services sectors contributed 16,700 and 11,400 jobs, respectively, to 

the eight metro areas in the Region that have experienced only minimal or sporadic job losses. These 

28,100 jobs represented almost 0.5 percent of the aggregate labor force of these MSAs, approximately equal to 

the percentage job growth reported by these areas during the year. In first quarter 2002, job growth among 

these MSAs compared favorably to the nation, which 

experienced negative job growth of 1.24 percent. 

It is not surprising that federal, state, and local governments have continued or expanded hiring, especially in 

the wake of September 11. Heightened security concerns 

have increased demand for military, intelligence, and federal law enforcement officials, as well as for police officers, firefighters, and game wardens to monitor and 

protect public watershed areas and other public sites. In 

the service sector, the health services industry has contributed the most to employment growth. Health services 

also tend to be acyclical, and demand for health care will 

continue to increase as the baby boom generation ages. 

The Nassau-Suffolk and Washington, DC, MSAs are 

examples of areas in the Region that experienced few, if 

any, job losses through May 2002. In Nassau-Suffolk 

the gains in health care and government almost offset 

employment losses in the area’s manufacturing and 

FIRE sectors. In Washington, DC, job increases in these 

industries did make up for losses in the area’s other 

major industry sectors. In central New Jersey (Middlesex and Trenton MSAs), strong gains in government 

and health services were augmented by notable gains in 

retail trade, together adding enough jobs to offset the 

continued losses in the manufacturing, transportation, 

and public utilities sectors. 

In addition to experiencing healthier employment 

growth, many of these metropolitan areas are among 

the wealthiest in the Region, based on home price 

appreciation and personal income growth. Home price 

appreciation in these MSAs averaged 9.2 percent in 

the year ended first quarter 2002, compared with a 6.2 

percent average increase across the Region and 5 percent for the nation (excluding the Region).9 Average 

personal income in these MSAs increased 7.6 percent 

between 1999 and 2000 (the most recent period available) but grew by only 6.7 percent for the Region as a 

whole.10 

Not surprisingly, credit quality reported by insured 

institutions headquartered in these MSAs has been 

more favorable during this economic downturn than 

that of institutions in MSAs that experienced more significant employment declines (see Chart 2, page 4). 

However, while the median loan delinquency ratio was 

lower through first quarter 2002, the median concentration of typically higher-risk loan types, particularly 

CRE loans, was higher than for institutions in the 

Region’s MSAs that experienced significant declines 

in employment.11 Should economic conditions in areas 

that have experienced little, if any, employment 

decline materially change, these insured institutions 

could experience some weakening in commercial 

credit quality. 

Indicative of the stronger economic performance, new 

bank formation during this economic cycle has been 

most active in the MSAs that experienced sporadic job 

decline. New bank formation, most notably in New Jersey’s metropolitan areas, reflects, in part, strong economic conditions and industry consolidation in the late 

1990s. Consequently, before 2001, 28 percent of institutions in this group of MSAs had not previously been 

tested by an economic recession, compared with 16 percent for the Region overall.12 In addition, more than half 

of the untested institutions in these areas are commercial lenders13—that is, active in traditionally higher-risk, 

higher-yielding loan categories. Should overall economic recovery develop slowly, institutions previously 

untested by an economic recession, particularly those 

with high levels of traditionally riskier loans, could be 

more vulnerable to credit quality deterioration. 

9 Office of Federal Housing Enterprise Oversight.
 10 Bureau of Economic Analysis.
 

11 The average concentration of loan portfolios in C&I and CRE loans
 

for insured institutions in the Sporadic Losses group of MSAs is
 

46 percent, compared with 41 percent for the Early Losses group and
 

27 percent for the September Effect group.
 

12 Institutions that had not been tested by an economic recession
 

before 2001 were established after December 31, 1991.
 

13 Commercial lenders hold more than 25 percent of assets in C&I and
 

CRE loans.
 

New York Regional Outlook 6 Third Quarter 2002 
Regional Perspectives
 

The Events of September 11 Pulled Several 

of the Region’s Major MSAs into Recession 

Six of the Region’s 21 major MSAs did not experience 

employment losses until after September 11. These 

areas arguably were pulled into recession by the economic fallout from September 11 (September Effect). 

Unlike the Early Losses and Sporadic Losses groups, no 

one characteristic binds this group of metropolitan 

areas. Three MSAs are relatively large (Philadelphia, 

Baltimore, and Pittsburgh), while the others are smaller (Harrisburg, Wilmington, and Allentown). These 

areas gained jobs in health services but lost jobs in 

manufacturing. Insured institutions headquartered in 

this group of MSAs reported a lower average concentration in typically higher-risk loan types compared 

with the other MSA groups. However, these institutions 

reported an increase in past-due loan ratios at the end of 

2001, consistent with the acceleration of economic 

decline following September 11. 

Pace of Recovery among the Region’s 

Metropolitan Areas Will Differ 

The economic profiles of the Region’s major metropolitan areas affected their performance before and during 

the 2001 recession and will continue to do so during the 

recovery. The MSAs that began losing jobs early in this 

recession (except New York City) will be heavily influenced by trends in the manufacturing sector. Analysis of 

the Institute for Supply Management’s (ISM) manufacturing index shows a lag of 6 to 12 months at the 

national level between the manufacturing index and the 

employment index.14 The lag tends to increase when the 

economy is on the upswing, because employers hesitate 

to add workers until they are confident that the recovery 

“has legs.” The overall manufacturing index turned positive in February 2002. As a result, employment growth 

may be months away. New York City’s recovery will be 

linked to conditions in its financial services sector. 

Metropolitan areas that suffered job declines as a result of 

September 11 are likely to begin showing signs of 

strength roughly on a par with the rest of the nation. The 

relatively high level of industrial diversity (i.e., a diversified employment base across industry sectors) of these 

MSAs has benefited them. In fact, as a group, these six 

MSAs have a higher average industrial diversity than the 

other MSAs analyzed for this article. While this group 

does not benefit from high concentrations in government 

and health services, neither does it have high concentrations in manufacturing. As Chart 3 indicates, employment growth for this group has approximated the national 

average during this economic downturn. Average 

employment changes in this group correlate at a 98.3 percent rate with the United States as a whole, which is higher than each of the other two MSA groups, reinforcing 

the expectation that the economic recovery of this group 

will track that of the nation. 

CHART 3 

1.3 

–0.3 

–1.8 

Year-over-Year Employment

Change (%) (1Q01–1Q02)

–3.3

The Region’s Big Cities React Differently to the Economic Downturn 

MSAs—Sporadic Losses MSAs—September Effect MSAs—Early Losses 

U.S. 

Middlesex 

Monmouth 

Albany 

DC 

Trenton 

Nassau Jersey City 

Lancaster 

Baltimore 

Allentown 

Philadelphia 

Pittsburgh 

Harrisburg 

Wilmington 

Syracuse 

New York 

Newark 

Rochester 

Scranton 

Bergen 

Buffalo 

0 4 8 12 16 

Months of Job Losses 

Note: “Months of Job Losses” is the total number of months in which the MSAs lost jobs, irrespective of when they started losing them. 

Source: Bureau of Labor Statistics, Haver Analytics 

14 The ISM manufacturing index measures the overall health of the nation’s manufacturing index and comprises several components, including new 

orders, shipments, and employment. As of July 2002, the index showed expansion in the sector for six consecutive months. 

New York Regional Outlook 7 Third Quarter 2002 
Regional Perspectives
 

The recovery apparently is further along in the group of 

MSAs that has experienced few, if any, job losses— 

those with comparatively higher concentrations in the 

government and service sectors. However, it likely will 

take time for any economic recovery to be reflected in 

insured institution credit quality. In fact, as credit quality typically lags economic conditions, certain insured 

institutions in the Region may continue to experience 

deterioration in segments of the loan portfolio as the 

economy recovers. 

Profitability Rebounds among 

the Region’s Large Banks; 

However, Challenges Remain 

After declining in the second half of 2001, profitability 

among the Region’s large banks,15 as measured by pretax 

return-on-assets (ROA), increased in first quarter 2002. 

Most of the Region’s large banks reported stable or moderately increasing net interest margins (NIMs) in first 

quarter 2002 compared with the previous quarter. Several of these institutions reported declining asset yields 

but also lower funding costs following the decline in 

short-term market interest rates in late 2001. Large 

banks’ average cost of funds, which is highly sensitive to 

changes in short-term interest rates, reached the lowest 

recorded level at approximately 2 percent in first quarter 

2002.16 Funding costs are likely to level off, as shortterm interest rates began to stabilize in early 2002. 

Profitability also was aided by a moderate increase in noninterest income, although certain business lines did better 

than others. Revenues that are sensitive to equity markets 

(such as investment banking and venture capital revenues) 

declined, while low interest rates helped fixed-income 

underwriting and trading business lines, as well as revenue 

from loan sales and servicing. Additionally, consumer 

lines of business benefited from increased income from 

service charges and other deposit account fees. 

Profitability among the Region’s large banks also 

increased because problem loan costs abated in first 

quarter 2002. Provisions for loan losses leveled off following a sharp increase at the end of 2001, as several 

large banks took charges in response to economic conditions in Argentina, Enron and other corporate bankruptcies, and exposure to the troubled telecommunications 

industry. Profitability for some of the Region’s large 

banks trails levels of a year ago; however, average provision expense moderated in first quarter 2002, helping the 

average ROA to rebound (see Chart 4). Nonetheless, 

loan delinquency17 and charge-off rates remained elevated in first quarter 2002 (see Chart 5), a situation that 

could require additions to loan loss reserves. Furthermore, credit quality improvement typically lags economic recovery, and, as a result, higher levels of 

problem loan costs could continue as the economy 

rebounds and troubled industry sectors restructure. 

CHART 4 

Large Bank Earnings Have Benefited from 

Lower Loan Loss Provisions 

Notes: ROA=return on assets. PLLL=provisions for loan and lease losses. 

Large banks have total assets greater than $25 billion and exclude credit 

card banks. Median figures displayed. 

Source: Bank Call Reports 

Pretax ROA (%) PLLL to Average Assets (%) 

1.0 

1.5 

2.0 

2.5 

1Q99 3Q99 1Q00 3Q00 1Q01 3Q01 1Q02 

0.0 

0.2 

0.4 

0.6 

0.8 

1.0 

CHART 5 

Commercial and Industrial Loan Delinquency 

Rates and Charge-Offs Remain Elevated 

at Large Banks 

Notes: C&I=commercial and industrial. Delinquent C&I loans are those 30 

days or more past due or in nonaccrual status. Large banks are those with 

total assets greater than $25 billion, excluding credit card banks. Median 

figures. 

Source: Bank Call Reports 

Delinquency Rate on C&I Loans 

Percent 

C&I Charge-Off Rate 

0.0 

1.0 

2.0 

3.0 

4.0 

1Q99 3Q99 1Q00 3Q00 1Q01 3Q01 1Q02 

15 Large banks are defined as institutions with total assets greater 

than $25 billion, excluding credit card banks. Median figures are 

used unless otherwise noted. 

16 Data available since first quarter 1984. 17 Loans 30 days or more past due or in nonaccrual status. 

New York Regional Outlook 8 Third Quarter 2002 
Regional Perspectives
 

APPENDIX TABLE 1 

The Timing of Job Losses among the Region’s MSAs Varied 

during This Recession; History Suggests that Job Losses 

May Continue after Recession Officially Ends 

FIRST MONTH AVERAGE SHARE 

TOTAL MONTHS OF NEGATIVE OF JOB LOSSES 

OF JOB JOB GROWTH AFTER OFFICIAL 

LOSSES DURING IN THIS END OF PRIOR 

MSA THIS RECESSION RECESSION RECESSIONS(1) (%) 

EARLY JOB LOSSES 

BUFFALO-NIAGARA FALLS NY 16 JAN-01 62.60 

BERGEN-PASSAIC NJ PMSA 15 MAR-01 52.17 

SCRANTON—WILKES-BARRE—HAZELTON PA 14 APR-01 52.30 

ROCHESTER NY 14 APR-01 70.45 

NEWARK NJ PMSA 13 MAY-01 58.27 

NEW YORK NY PMSA 12 JUN-01 35.12 

SYRACUSE NY 10 APR-01 54.15 

JOB LOSSES POST-SEPTEMBER 11 

WILMINGTON-NEWARK DE-MD PMSA 9 SEP-01 60.48 

HARRISBURG-LEBANON-CARLISLE PA 8 OCT-01 62.04 

PITTSBURGH PA 8 OCT-01 68.96 

PHILADELPHIA PA-NJ PMSA 7 NOV-01 52.74 

ALLENTOWN-BETHLEHEM-EASTON PA-NJ 7 NOV-01 70.84 

BALTIMORE MD PMSA 4 NOV-01 52.31 

SPORADIC JOB LOSSES 

LANCASTER PA 3 JUL-01 55.32 

JERSEY CITY NJ PMSA 4 JUL-01 52.53 

NASSAU-SUFFOLK NY PMSA 2 APR-01 54.55 

TRENTON NJ PMSA 3 MAR-02 49.92 

WASHINGTON DC-MD-VA-WV PMSA 2 NOV-01 36.96 

ALBANY-SCHENECTADY-TROY NY 1 NOV-01 60.44 

MIDDLESEX-SOMERSET-HUNTERDON NJ PMSA 1 MAY-02 59.09 

MONMOUTH-OCEAN NJ PMSA 0 N/A 25.00 

(1) Includes national recessions during 1980, 1981–82, and 1990–91. 

PMSA = Primary Metropolitan Statistical Area 

Source: Bureau of Labor Statistics 

New York Region Staff 

New York Regional Outlook 9 Third Quarter 2002 
In Focus This Quarter
 

The Road to Recovery for Commercial Credit Quality:
 

Not without a Few Hurdles Ahead
 

Introduction 

The banking industry as a whole has performed well in 

recent years, despite increasing loan delinquencies, 

notably in commercial credits. Although the extent of 

commercial loan deterioration has not reached levels 

experienced in the early 1990s, it nonetheless warrants 

scrutiny. With a variety of economic indicators pointing 

toward recovery, the volume of problem commercial 

loans held by insured institutions could plateau during 

2002. Many banks tightened business loan underwriting 

standards beginning in early 2000, a trend that should 

contribute to an eventual turnaround in commercial loan 

quality. Nevertheless, several factors could delay this 

improvement. Corporate profitability has yet to recover 

fully, and many firms continue to operate with significant financial leverage. Highly leveraged firms are 

especially vulnerable to declining revenues, which 

reduce the cash flow available to service debt obligations. More significantly, lower investor tolerance for 

risk has created a far less hospitable financing market 

for speculative-grade firms, possibly straining liquidity 

and increasing the likelihood that these companies 

could default as debts mature. 

Commercial Credit Deterioration Should 

Subside with the Economic Recovery 

While the banking industry has fared well through the 

latest recession, it did not escape the effects of the troubled corporate sector. Large banks (those with assets 

greater than $1 billion), in particular, have seen a significant rise in noncurrent commercial and industrial 

(C&I) loan and loss rates.1 While total C&I loans represented 25 percent of all outstanding loans held by all 

insured commercial banks as of March 31, 2002, net 

C&I loan losses comprised 32 percent of all loan 

losses. In first quarter 2002, noncurrent C&I loans 

reached 2.6 percent of outstanding loans (2.8 percent 

for large banks), the highest level since fourth quarter 

1993. The four-quarter moving average C&I loss rate 

also rose among small and large banks; however, the 

rate of increase for large banks was significantly higher, 

as shown in Chart 1. 

1 Noncurrent loans are defined as loans 90 or more days past due or 

on nonaccrual status. 

CHART 1 

Large Banks Experience a Rapid Rise in 

Commercial and Industrial Loan Loss Rates 

Source: Bank Call Reports, FDIC Research Information System 

Large banks 

(> $1 billion in assets)

Four-Quarter Moving Average Commercial

and Industrial Loss Rates (%)

Small banks 

(< $1 billion in assets) 

0.0 

0.2 

0.4 

0.6 

0.8 

1.0 

1.2 

1.4 

1.6 

1.8 

2.0 

2.2 

1Q90 3Q91 1Q93 3Q94 1Q96 3Q97 1Q99 3Q00 1Q02 

Improving economic conditions and tighter underwriting standards suggest that commercial credit quality 

should improve. A range of indicators suggests that economic recovery is under way, albeit more slowly than 

some expected earlier this year. The housing sector 

remains robust, job conditions have stabilized, and real 

gross domestic product (GDP) grew 5.0 percent in first 

quarter 2002. Although GDP grew at a slower pace of 

1.1 percent in second quarter 2002, business equipment 

spending increased 2.9 percent, in contrast to a decrease 

of 2.7 percent in first quarter 2002. Also, the manufacturing sector began to show signs of recovery with the 

Institute for Supply Management (ISM) index for 

manufacturing reaching 56.2 and 50.5 in June and July 

2002, respectively. The ISM index has remained above 

50, which signals an economic expansion, for the six 

consecutive months since February 2002. Also, the 

index of coincident indicators, a gauge of current economic activity, rose 0.3 percent in June 2002. Furthermore, a survey of 50 leading corporate economists by 

Blue Chip Economic Indicators shows that analysts 

expect the U.S. economy to grow at a rate of 3.3 percent 

in third quarter 2002.2 

Recent changes in underwriting standards also bode 

well for credit quality at commercial banks. The Federal 

2 Blue Chip Economic Indicators, July 2002. Also see Regional 

Outlook, Second Quarter 2002, “Back to the Future: How This 

Downturn Compares to Past Recessions.” See http://www.fdic.gov/ 

bank/analytical/regional/ro20022q/na/index.html. 

New York Regional Outlook 10 Third Quarter 2002 
In Focus This Quarter
 

Reserve Board’s Senior Loan Officer Opinion Survey 

on Bank Lending Practices, which focuses on 

changes in the supply of and demand for bank loans to 

businesses and households over the previous three 

months, has shown consistent tightening of business 

loan standards during the past two years. The April 

2002 survey indicated some further tightening of standards, but the percentage of banks reporting this tightening has declined since the January survey, consistent 

with the anticipation of a continued economic 

rebound.3 Since credit quality typically lags the business cycle, near-term recovery appears more likely, 

provided the economy continues to improve. This 

recovery in commercial credit quality, however, is not 

without a few hurdles ahead. 

High Default Rates, Rating Downgrades, 

and Bankruptcies Persist 

While the U.S. economy is showing signs of recovery 

and underwriting standards have tightened, corporate 

credit quality could continue to be affected by several 

adverse trends. The number of bankruptcies filed by 

public companies this year is on pace to challenge 

the record set in 2001.4 Furthermore, default rates for 

CHART 2 

Current U.S. Corporate Credit Deterioration Is 

U.S. speculative-grade corporate bond issuers remained 

high at 10.3 percent in June 2002, and the high ratio of 

corporate rating downgrades to upgrades indicates continuing weakness in the corporate sector (see Chart 2).5 

The main reasons for rating downgrades have been poor 

profitability and high leverage. 

Corporate Profitability Remains Fragile 

Corporate profitability has been depressed since first 

quarter 2001 (see Chart 3). However, this trend is improving slowly in 2002. U.S. corporate profits rose during 

second quarter 2002 for the first time in five quarters.6 

However, the rate of recovery is not expected to be strong 

in 2002, as some 93 companies in the Standard & Poor’s 

500 have announced that third quarter earnings will be 

less than expected, more than twice the number of companies that have announced they will beat estimates.7 In 

fact, earnings forecasts have been revised downward 

consistently for the past several months, and analysts 

have warned recently that earnings estimates for the 

second half of 2002 are likely to be reduced. The bright 

spot in earnings continues to be the consumer sector, 

with automobile manufacturers and certain retail areas 

posting strong sales. The worst-performing sectors on a 

CHART 3 

Corporate Profits Remained Depressed 

Approaching Early 1990s Levels 

0 

1 

2 

3 

4 

5 

6 

7 

8 

9 

10 

11 

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

3.0 

3.5 

4.0 

4.5 

5.0 

Percent Ratio 

Bank commercial and 

industrial noncurrent 

rate (left scale) 

U.S. speculative-grade bond 

issuer default rate (left scale) 

U.S. Corporate bond ratings downgrades 

to upgrades (right scale) 

1988 1990 1992 1994 1996 1998 2000 1Q02 

Year-over-year growth in net income from

continuing operations for all S&P 500 firms (%)

35 

25 

15 

5 

–5 

–15 

–25 

through the First Quarter of 2002 

1997 1998 1999 2000 2001 2002 

Sources: Moody’s, Bank Call Reports, FDIC Research Information System 

3 Senior Loan Officer Opinion Survey on Bank Lending Practices, 

The Federal Reserve Board, April 2002. The survey reported that the 

percentage of domestic banks that reported tightened standards on 

C&I loans to large and middle-market firms (annual sales of at least 

$50 million) since the January survey declined to 25 percent from 

45 percent. The percentage of domestic banks that report tightened 

standards on business loans to small firms declined more, from 42 

percent in January to 15 percent in April. 

4 Bankruptcydata.com reports that 257 publicly traded companies 

filed for bankruptcy in 2001, while 114 companies had filed by 

June 30, 2002. 

Source: Standard & Poor’s 

5 In the first half of 2002, Moody’s downgraded 262 companies and 

upgraded 59, producing a downgrades to upgrades ratio of 4.4:1. 

6 On a year-over-year basis, 371 companies in the Standard & Poor’s 

500 Index that reported earnings through July 26, 2002, posted 

profits. 

7 Danielle Sessa, “U.S. Stocks Slide as Johnson & Johnson, Pepsi 

Shares Tumble,” Bloomberg.com, July 19, 2002. 

New York Regional Outlook 11 Third Quarter 2002 
In Focus This Quarter
 

year-over-year basis appear to be energy, transportation, 

utilities, capital goods, and communications services.8 

The latest recession was driven primarily by the sharp 

decline in the demand for capital goods. With the slow 

economic recovery, businesses have continued to limit 

capital spending. The rate of recovery for corporate profitability will depend in large part on how soon and to 

what extent businesses resume spending. 

The prospect of slow earnings growth could be particularly problematic for many highly leveraged corporations. Debt levels relative to cash flow have been 

rising because of anemic earnings (see Chart 4). Negative earnings news also comes at a time when several 

well-publicized accounting irregularities have shaken 

investors’ confidence in corporate earnings reports. A 

Huron Consulting Group study of financial restatements indicates that during the past five calendar 

years, the number of restated financial statements filed 

by public companies has grown from approximately 

120 in 1997 to 270 in 2001.9 The number of restatements continued to grow in 2001, despite a reduction in 

the number of public companies. That study found that 

CHART 4 

the largest source of restatements relates to how companies recognize revenue. With depressed corporate 

profits and diminishing investor confidence, some 

firms with debts maturing in the near term may have 

difficulty refinancing. 

Firms with Maturing Debts Could Face 

a Critical Period in the Near Term 

Moody’s estimates that $141 billion worth of U.S. 

speculative-grade corporate bonds and rated bank debt 

will come due over the next three years: $27 billion 

(19 percent) in 2002, $54 billion (38 percent) in 2003, 

and $60 billion (43 percent) in 2004.10 To put these 

numbers into perspective, total U.S. corporate bond 

defaults were $115 billion in all of 2001, of which 

95 percent of those defaulting were speculative-grade 

borrowers. Although Moody’s expects the bulk of 

high-yield debt maturing in 2002 to be refinanced 

despite unfavorable market conditions, concern exists 

about the large percentage of issues rated B1 or lower 

that will come due in 2003 and 2004 (see Chart 5).11 

CHART 5 

Corporate Debt Continues to Rise 

Relative to Cash Flows 

Source: Federal Reserve Board Ratio of nonfarm, nonfinancial debt to cash flow 

3.5 

4.0 

4.5 

5.0 

5.5 

6.0 

1975 1978 1981 1984 1987 1990 1993 1996 1999 1Q02 

Forty-Seven Percent of U.S. Speculative-Grade
 

Bonds and Bank Debt Maturing in 2003–2004
 

Are Rated B1 or Lower
 

Ba1 to Ba3 

53% 

B1 to B3 

36% 

Caa1 or lower 

11% 

Source: Moody’s 

8 Charles L. Hill, et al., This Week in Earnings, Thomson First Call, 

July 22, 2002. 

9 A Study of Restatement Matters, for the five years ended December 

31, 2001, Huron Consulting Group, June 2002. This study excluded 

restatements caused by changes in accounting principles and 

nonfinancial-related restatements. 

10 Tom Marshella, et al., “Refunding Risk for U.S. Speculative Grade 

Borrowers, 2002–2004,” Global Credit Research, Moody’s Investors 

Service, December 2001. Figures related to refunding risk presented 

throughout this article are taken from Moody’s refunding risk studies, 

conducted annually since November 1998. 

11 Speculative-grade debt ratings assigned by Moody’s in the order of 

declining credit quality are as follows: Ba, B, Caa, Ca, and C. 

Moody’s also applies numerical modifiers 1, 2, and 3 in each generic 

rating classification. The modifier 1 indicates that the obligation 

ranks in the higher end of its generic rating category, while the 

modifier 3 indicates a ranking in the lower end of that generic rating 

category. 

New York Regional Outlook 12 Third Quarter 2002 
In Focus This Quarter
 

Credit deterioration of bank loans is similar to the cur- TABLE 1 

rent trend in corporate bonds. Migration of maturing 

loans into lower grade categories has accelerated in 

recent years (see Chart 6). This ratings decay reflects 

the borrowers’ deteriorated financial condition and the 

effects of liberal underwriting conditions from 1996 to 

1998, when speculative-grade originations were more 

common. For example, the 1999 and 2000 refunding 

risk studies conducted by Moody’s noted that 16 percent 

and 17 percent, respectively, of all rated bank loans 

maturing in 2002 were rated B1 or lower. The trend 

worsened significantly in 2001, when the study noted 

that 39 percent of bank loans maturing in 2002 were 

rated B1 or lower. When firms have to refinance lowgrade debts in today’s environment, they may face 

additional pressure on earnings and liquidity. 

Loss Severity Has Increased 

with Higher Default Rates 

Moody’s credit ratings reflect the likelihood of default 

and the severity of loss given default. As a result, the 

migration of maturing bonds and loans into lower 

grades implies a greater risk of default or increased loss 

severity upon default, or perhaps both. Moody’s notes, 

as part of its 15th annual study of global corporate 

defaults and ratings performance, that average recovery 

rates fell for the third straight year in 2001.12 The recovery rate has deteriorated for all levels of security and 

CHART 6 

The Proportion of Maturing Bank Loans Rated
 

B1 or Lower Is Increasing
 30 

Ba 25 

Average Speculative-Grade 

Recovery Rates in 2001 Show a 

Declining Trend in Nearly All Levels 

of Security and Subordination 

AVERAGE
 

RECOVERY
 

PER $100
 

1982– 

SENIORITY/SECURITY 2000 2001 

SENIOR SECURED BANK LOAN $67.06 $54.68 

EQUIPMENT TRUST $64.65 NA 

SENIOR SECURED BONDS $52.09 $58.00 

SENIOR UNSECURED BONDS $43.82 $36.20 

SENIOR SUBORDINATED BONDS $34.59 $19.90 

SUBORDINATED BONDS $31.83 $16.45 

JUNIOR SUBORDINATED BONDS $22.48 NA 

Note: NA=not available 

Source: Moody’s 

subordination except for senior secured bonds (see 

Table 1). 

Higher-Risk Borrowers Pay High Premiums 

A speculative-grade company refinancing debt today 

will face a much higher price, in terms of spreads over 

a cost of funds index or risk-free instruments, compared to several years ago. Yield spreads between 

investment-grade and speculative-grade bonds have 

widened significantly since early 2000 (see Chart 7), in 

part because of lower investor tolerance for risk, rising 

CHART 7 

$ Billions 

20 

15 

10 

5 

0 

B1 or Lower 

2002 2003 2004 

Credit Costs for Higher-Risk Borrowers Rose 

Dramatically in Recent Years 

Sources: Merrill Lynch Bond Global Bond Indices, Federal Reserve Board Basis point spread over ten-year constant-maturity Treasuries

Investment-grade bonds 

High-yield bonds 

0 

100 

200 

300 

400 

500 

600 

700 

800 

900 

1000 

Jun 

’98 

Dec 

’98 

Jun 

’99 

Dec 

’99 

Jun 

’00 

Dec 

’00 

Jun 

’01 

Dec 

’01 

Jun 

’02 

Source: Moody’s 

12 David Hamilton, et al., “Default & Recovery Rates of Corporate 

Bond Issuers: A Statistical Review of Moody’s Ratings Performance 

1970–2001,” Global Credit Research, Moody’s Investors Service, 

February 2002. The recovery rate is defined as the secondary market 

price of the defaulted instrument approximately one month after the 

time of default. 

New York Regional Outlook 13 Third Quarter 2002 
In Focus This Quarter
 

defaults, and weakening corporate cash flows. After 

narrowing a bit in first quarter 2002, spreads have 

widened again on renewed concerns about accounting 

irregularities and the realization that the economic 

recovery may come at a slower pace than anticipated. 

Lower investor tolerance for risk has affected not only 

speculative-grade borrowers but also some investmentgrade borrowers. For example, the commercial paper 

(CP) market, which many investment-grade borrowers 

have used as a cheap source of funding, is no longer 

readily available to all investment-grade borrowers.13 

Drawn-Down Commercial Paper Back-up Lines 

Heighten Commercial Bank Exposure14 

Since its peak at the end of 2000, the CP market for 

domestic nonfinancial companies has shrunk by almost 

50 percent (see Chart 8). A reduction in the need for 

working capital and heavy refinancing activity have 

contributed to this contraction. However, the record 

number of downgrades among issuers of CP in 2001 

also contributed to this decline. Money market funds 

cannot hold more than 5 percent of assets in CP graded 

less than A1/P1/F1.15 Thus, the recent flux of downgrades effectively squeezed some issuers out of this 

market and forced them to refinance with fixed-rate 

bonds.16 Also, fears of deteriorating credit quality have 

shut some investment-grade companies out of the CP 

market. Since the collapse of Enron, investors have been 

reluctant to hold the debt of certain companies. Some of 

these companies reported accounting irregularities, and 

the restatement of financial statements revealed previously hidden losses. In some cases, issuers that were not 

involved with accounting irregularities were forced to 

draw on bank credit lines when they were unable to roll 

over their CP because of the lack of demand or extreme13 Commercial paper is short-term promissory notes issued by large 

firms, generally maturing in nine months or less. It is an important 

source of short-term funding for corporations that need a steady 

stream of working capital. 

14 A CP back-up line is a commitment to provide a liquidity support 

for a company’s CP program. It is typically a revolving credit, a 

364-day facility. The rationale is that the borrower does not intend 

to use the back-up line, which generally costs more than issuing 

CP, unless the CP cannot be rolled over or repaid. 

15 The CP market can be divided into three tiers: Tier 1 (A1/P1/F1 or 

better), Tier 2 (A2/P2/F2), and Tier 3 (A3/P3/F3). The first two 

groups make up the bulk of the market. The first rating refers to a 

rating assigned by Standard & Poor’s, while the second and third 

reflect ratings assigned by Moody’s and Fitch, respectively. 

16 Moody’s Investors Service, Moody’s Credit Perspectives, December 

31, 2001. Moody’s downgraded 38 commercial paper programs from 

P1 in 2001. 

CHART 8 

Domestic Nonfinancial Commercial Paper 

Outstandings Have Declined amid Investors’ 

Jitters about Credit Quality 

Source: Federal Reserve Board (Haver Analytics) $ Billions 

100 

150 

200 

250 

300 

350 

2Q95 2Q96 2Q97 2Q98 2Q99 2Q00 2Q01 2Q02 

ly high rates demanded by investors. When a CP issuer 

draws down on the back-up line, rating agencies often 

view this as a weakness in the company’s liquidity, and 

a rating downgrade can occur. In turn, lower ratings lead 

to higher funding costs for the borrowers. 

The steepness of the current yield curve also results in 

significantly higher refinancing costs for investmentgrade corporations that no longer have access to shortterm funding through the CP market. As these 

companies are forced to borrow longer term, they face 

higher refinancing costs in the long-term end of the 

current yield curve.17 For example, if a Tier 1 corporation formerly issuing 90-day CP was forced to issue 

ten-year fixed-term debt in mid-July 2002, the cost 

would have been almost 350 basis points higher than 

issuing 90-day CP. 

Using back-up lines of credit when companies cannot 

roll over maturing CP has become expensive for some 

issuers. Bankers are realizing that initial pricing does 

not reflect the risk inherent in drawn-down lines. As a 

result, bankers have started to impose high utilization 

premiums on BBB-rated CP back-up lines. Also, borrowers recently have been seeking term-out options, 

another sign that refunding risk is a concern.18 Recent 

transactions reported by Loan Pricing Corporation 

show that some investment-grade companies are seek17Bloomberg Fair Market Sector Curves, July 5, 2002. The spread
 

between 60-day and five-year Treasury instruments was nearly 300
 

basis points. 


18 Once the back-up line has been drawn down, the borrower again has
 

to repay or roll over the debt. A revolving facility can be “termed out”
 

so that it becomes an installment loan with a much longer maturity,
 

such as three to five years. Such an option, however, can be costly.
 

New York Regional Outlook 14 Third Quarter 2002 
In Focus This Quarter
 

ing term-out options even at a fee of 200 basis points. 

The higher premiums demanded reflect both the volatility in the market and deteriorating credit quality indicated by high default rates and rating downgrades in 

recent quarters. 

Conclusion 

During the boom times of the late 1990s, corporations 

enjoyed an abundance of liquidity sources and easy 

access to capital. Many corporations used debt to 

finance business expansions, and rolling over maturing 

debt was not a significant concern. Recently, however, 

stock prices have been declining and investors have 

been concerned about the possibility of more corporate 

financial restatements. In this environment, highly 

leveraged borrowers worry about maturing debts and 

refunding risk implications. Lenders are demanding 

higher spreads because of the volatile financial markets 

and the deteriorated financial condition and debt ratings 

of many borrowers. In general, firms seeking to roll 

over maturing debt clearly face a less hospitable financing market today. With corporate profitability not yet 

strong, highly leveraged companies may find it increasingly difficult to meet debt service requirements and 

loan covenants. Despite these hurdles, the economy 

appears to be improving, and more companies are 

beginning to report higher earnings. With an economic 

recovery and tighter underwriting standards, the deterioration in commercial credit quality should stabilize 

and turn around. 

Cecilia Lee Barry, Senior Financial Analyst 

New York Regional Outlook 15 Third Quarter 2002 
✁
 

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