Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION FOURTH QUARTER 1997 

FDIC
 

Atlanta
 

Region
 

Division of
 

Insurance
 

Jack M.W. Phelps,
 

Regional Manager
 

Scott C. Hughes,
 

Regional Economist
 

Pamela R. Stallings,
 

Financial Analyst
 

In Focus This Quarter 

◆ Bank Earnings: Competitive Pressures and Cyclical 

Risks—Intense competition to preserve or attract business can lead to relaxed 

underwriting standards and other changes to risk management practices that can 

reduce banks’ ability to weather a downturn. As this economic expansion reaches 

an advanced age, prudent bankers will evaluate their lending standards and reserve 

adequacy with an eye to possible adverse changes in economic conditions. 

See page 3. 

By Ronald Spieker, Steve Linehan, George French 

◆ Strong Demand and Financial Innovation Fuel 

Rebounding Commercial Real Estate Markets—Commercial real 

estate markets in many parts of the United States have rebounded, and commercial 

banks are once again actively pursuing lending opportunities. Banks are not alone, 

however, as a broader and more competitive financing market has emerged. 

Securitization vehicles such as commercial mortgage-backed securities and real 

estate investment trusts are changing how real estate is owned and paid for. 

See page 9. 

By Steven Burton, Gary Ternullo 

Regular Features 

◆ Regional Economy—Growth in the Atlanta Region outside of Florida 

slowed through the first half of 1997...Florida’s strong performance continued... 

single-family residential construction activity cooled...rapid economic development 

in coastal areas highlights the Region’s exposure to hurricanes. See page 14. 

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

◆ Financial Markets—Bank holding companies of all sizes have issued 

trust preferred stock following the Federal Reserve’s decision in October 1996 to 

count these tax-advantaged, capital securities toward Tier 1 capital...rating agencies and investment analysts have argued that trust preferred stock is a weaker 

form of Tier 1 capital. See page 19. 

By Kathy R. Kalser 

◆ Regional Banking—Commercial bank profits remain generally strong, 

but earnings decline at a large number of small banks...insured institutions may 

wish to reassess the adequacy of loan loss reserves and lending standards...borrowers’ difficulty insuring against hurricanes may pose risks to some banks and 

thrifts in the Region. See page 23. 

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

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

Insurance Corporation for the following eight geographic regions: 

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

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

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

Dallas Region (CO, NM, OK, TX)
 

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

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

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

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

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

form found on the back cover to the FDIC Public Information Center. Contact the Public 

Information Center for current pricing on bulk orders. 

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

more information or to provide comments or suggestions about the 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 Andrew C. Hove, Jr. 

Director, Division of Insurance Arthur J. Murton 

Editor George E. French 

Managing Editor Stephen Linehan 

Associate Editor Maureen E. Sweeney 

Assistant Editors Suzannah L. Susser 

John D. Weier 

Publications Manager Teresa J. Franks 
In Focus This Quarter
 

Bank Earnings: Competitive Pressures
 

and Cyclical Risks
 

•	 Rapid loan growth, record low credit losses, 

vigorous expansion of income sources, and costcutting continue to propel bank earnings to 

record levels. 

•	 Intense competition to preserve and attract 

business can lead to aggressive loan pricing, 

relaxed loan underwriting standards, increased 

portfolio concentrations, and other changes to 

risk-management practices that can reduce 

banks’ ability to sustain earnings and capital 

through a downturn. 

•	 As this economic expansion approaches an 

advanced age, prudent bankers will allow for the 

possibility of an adverse change in economic 

conditions. 

As the U.S. economic expansion continues through its 

seventh year, the banking industry continues to run at 

full throttle. Earnings climb to ever-higher levels, driven by rapid loan growth, record low credit losses, 

aggressive expansion of income sources, and vigorous 

cost-cutting. Some analysts argue that banking has 

entered a new era in which the development of noninterest income sources and new risk-management techniques will insulate banks from swings in the business 

cycle. 

Yet banks face risks that should not be overlooked. 

Assertions that bank earnings will be less sensitive to 

business cycles remain untested. Meanwhile, competition to attract and maintain business can result in 

relaxed underwriting standards and easing of loan 

terms, or increased focus on business lines whose risks 

are difficult to manage. Policies that boost short-term 

shareholder returns, including high dividends and stock 

repurchase programs, can reduce banks’ capacity to 

weather a future downturn. There is evidence that these 

things are occurring to varying degrees in banking 

today. Accordingly, as this expansion reaches an 

advanced age, prudent bankers will give careful regard 

to the quality and sustainability of the earnings generated by today’s strategic decisions. 

Credit Quality 

Variations in credit quality have been and are likely to 

remain for some time the primary source of large 

swings in bank earnings (see Chart 1). Banks manage 

the risks of large swings in credit quality by adjusting 

underwriting standards and loan terms, by diversifying 

loan portfolio exposures, and by supplying adequate 

amounts to the allowance for loan losses. In large part, 

the degree to which bank earnings can be sustained during a downturn will depend on decisions made about 

these factors during the expansion. 

Some perspective on the cyclical nature of credit quality can be gleaned from Charts 2 and 3 (next page). As 

shown in Chart 2, bank loan growth has exceeded 

growth in gross domestic product (GDP) for ten of the 

past twelve quarters, even without considering the substantial volume of loans originated and sold in securitized pools. Moreover, Chart 3 shows that growth in 

loan losses has tended to follow episodes of rapid loan 

growth. 

Credit standards are important tools for individual 

banks to manage these cyclical fluctuations in credit 

quality. According to the Federal Reserve’s August 1997 

CHART 1 

Earnings Results Are Largely Driven by 

Provision Expenses 

-1.0% 

0.0% 

1.0% 

2.0% 

3.0% 

Return on Avg Assets 

Provision Exp/Avg Assets 

Source: Commercial Bank Call Reports 

-2.0% 

6-’85

12-’86

6-’88

12-’89

6-’91

12-’92

6-’94

6-’97

12-’95 

Atlanta Regional Outlook 3	 Fourth Quarter 1997 
In Focus This Quarter
 

CHART 2 CHART 3 

-15% 

-10% 

-5% 

0% 

5% 

10% 

15% 

20% 

1980 

GDP Growth 

Loan Growth 

Average Loan Growth Has Recently 

Outpaced Nominal GDP Growth 

Source: Commercial Bank Call Reports, Haver Analytics 1982 1984 1986 1988 1990

199219941996 

Source: Commercial Bank Call Reports Loan, GDP Growth (%)

Net Loan Loss Growth (%)

Loan Losses and Loan Growth Are Correlated 

-15 

-10 

-5 

0 

5 

10 

15 

-90 

-60 

-30 

0 

30 

60 

90 

Loan Growth 

Net Loan Loss Growth 

198019831986198919921995 

Senior Loan Officer Survey, during the preceding three 

months, a large percentage of banks had eased terms on 

commercial and commercial real estate loans, including 

reducing loan interest rates, increasing credit lines, and 

easing loan covenants and collateralization requirements. A “small but significant” share reported willingness to accept increased levels of risk on commercial 

real estate loans. In a similar vein, the Federal Deposit 

Insurance Corporation’s (FDIC) Report on Underwriting Practices (second quarter 1997) did not note 

any widespread problems with underwriting practices 

but reported that about 24 percent of institutions examined that were actively involved in construction lending 

were “frequently or commonly” funding speculative 

construction projects. About 18 percent of institutions 

examined that were actively involved in business lending “frequently or commonly” made unsecured business 

loans that lack documentation of financial strength. 

Maintaining an adequate allowance for loan losses is 

another important way for banks to sustain earnings and 

capital during downturns. The aggregate allowance held 

by commercial banks has decreased from 2.74 percent 

of total loans in the first quarter of 1992 to 1.90 percent 

in the second quarter of 1997; 166 banks reported negative loan loss provisions in the second quarter. 

Although in the aggregate these reserve numbers 

remain high relative to the early to mid-1980s, when 

reserve levels ranged from 1.20 percent to 1.74 percent, 

the Office of the Comptroller of the Currency (OCC) 

recently issued an advisory letter expressing concern 

about declining reserve levels and the need to maintain 

an adequate allowance. This letter was a response to 

weakness in the credit card sector and to trends in the 

market for syndicated commercial loans, including 

increasing leverage, declining spreads, and a weakening 

in other underwriting terms, all stemming from increasing competitive pressures. 

Diversifying loan portfolios is another way for banks to 

help reduce susceptibility to economic downturns. It 

has often been noted that the trend toward interstate 

banking and branching may improve loan diversification. It should also be noted, however, that many banks 

retain high concentrations of credit exposure to specific 

economic sectors. For example, commercial real estate 

lending and construction lending has been a source of 

volatility in bank earnings since the real estate investment trust (REIT) crisis of the 1970s. As discussed in 

Strong Demand and Financial Innovation Fuel 

Rebounding Commercial Real Estate Markets, banks 

are leading a resurgence in commercial real-estate lending. As Table 1 shows, 28 percent of FDIC-insured institutions grew their total commercial real estate and 

construction portfolios more than 30 percent from mid1996 to mid-1997, and 16 percent had total commercial 

real estate and construction exposures1 exceeding 200 

percent of equity and reserves. Concentrations and 

rapid growth do not necessarily portend difficulties, but 

the greater the concentration of credit to a specific sector, the greater the importance of strict adherence to 

sound underwriting policies and standards and the 

maintenance of adequate loss reserves. 

The most immediate concerns about credit quality have 

been expressed regarding credit cards and some other 

1 Includes loans secured by multifamily dwellings and nonfarm nonresidential structures, as well as construction loans. 

Atlanta Regional Outlook 4 Fourth Quarter 1997 
In Focus This Quarter
 

consumer debt. Despite seven years of economic expansion, commercial banks’ net credit card charge-offs at 

mid-1997 were running at 5.22 percent of average outstanding balances, matching levels not seen since the 

aftermath of a 56 percent run-up in charge-offs that 

accompanied the recession of 1990 to 1991. Noncurrent 

rates on these loans are at near-historic highs of 1.94 

percent, and some examiners are commenting that these 

rates would be even higher were it not for some of these 

balances being rolled over into home equity debt consolidation loans with loan-to-value ratios as high as 135 

percent. Home equity lines are a rapidly growing business for some banks; 25 percent of banks and thrifts 

grew their home equity lines by more than 30 percent 

during the year ending mid-1997 (see Table 1). 

Except for credit cards and some other consumer loans, 

loan losses are at historically low levels. Nevertheless, 

lending decisions that assume a continuation of favorable economic conditions should be closely examined 

this far into the expansion. Institutions that maintain 

strong underwriting standards, an adequate allowance 

for losses, and prudent diversification of the loan portfolio will be best positioned to sustain earnings and capital during a downturn in credit quality. 

Net Interest Margin 

Net interest margin (NIM) is another primary driver of 

bank earnings. Indeed, a sharp improvement in NIM 

TABLE 1 

CHART 4 

Rebound in ROA Since 1990 Fueled 

by Improved NIM and Asset Quality 

0.0% 

0.5% 

1.0% 

1.5% 

2.0% 

1984 1986 1988 1990 1992 1994 1996 

2.5% 

3.0% 

3.5% 

4.0% 

4.5% 

5.0% 

ROA 

Net charge-off ratio 

NIM 

Source: Commercial Bank Call Reports ROA, Net Charge-Off Ratio

NIM (%) 

helped lead the banking industry’s dramatic recovery 

from the last recession (see Chart 4). Commercial 

banks’ NIM has declined slightly in recent years, but at 

4.23 percent still remains near the top of the range 

within which it has fluctuated since 1984 (see Table 2, 

next page). 

The banking industry’s rapid loan growth in recent 

years has been one of the factors supporting the current 

high NIM. (Since loans generally yield more than 

securities, a higher proportion of loans generally 

results in a higher yield on the total portfolio of earning assets.) Economic fundamentals cannot sustain 

rapid loan growth indefinitely, however. Accordingly, a 

Rapid Loan Growth Is 

Occurring at a Significant 

Number of Institutions 

(4 qtrs growth ending 6/97) 

TOTAL LOANS AND LEASES 

CONSTRUCTION LOANS 

COMMERCIAL REAL ESTATE LOANS 

TOTAL CRE 

1-4 FAMILY RESIDENTIAL LOANS 

HOME EQUITY LINES 

TOTAL RESIDENTIAL 

CREDIT CARD LOANS AND RELATED PLANS 

OTHER CONSUMER LOANS 

TOTAL CONSUMER LOANS 

COMMERCIAL LOANS 

Source: Bank & Thrift Call Reports 

Atlanta Regional Outlook 

Percentage of Institutions with Loan 

Category Growth Approximating 

20% to 30% 30% or Total 

More Over 20% 

11 13 24 

4 36 40 

9 27 37 

10 28 38 

11 17 29 

4 25 29 

12 18 29 

4 17 21 

9 18 27 

9 18 27 

9 26 35 

5 Fourth Quarter 1997 
In Focus This Quarter
 

TABLE 2 

1997 Commercial Bank Performance Compared with Historical Averages 

INDUSTRY AVERAGES 

6/30/97 1984-1996 

ANNUALIZED LOW HIGH 

(%) (%) (%) 

NET INTEREST INCOME/AVERAGE EARNING ASSETS 4.23 3.89 4.36 

X AVERAGE EARNING ASSETS/AVERAGE ASSETS 86.50 86.21 88.42 

= NET INTEREST INCOME/AVERAGE ASSETS 3.66 3.36 3.89 

+ NONINTEREST INCOME/AVERAGE ASSETS 2.13 1.10 2.13 

− NONINTEREST EXPENSE/AVERAGE ASSETS 3.50 3.05 3.90 

− PROVISION EXPENSE/AVERAGE ASSETS 0.40 0.28 1.28 

+ OTHER ITEMS/AVERAGE ASSETS 0.03 − 0.02 0.15 

− TAXES/AVERAGE ASSETS 0.68 0.18 0.64 

= NET INCOME/AVERAGE ASSETS (ROA) 1.25 0.10 1.20 

Source: Bank & Thrift Call Reports 

risk in the current environment is that in the effort to 

support their NIM by generating new lending, banks 

may make compromises in loan underwriting, pricing, 

and portfolio diversification. 

Recent pricing trends have tended to weaken NIM, offsetting to a degree the effects of rapid loan growth. On 

the liability side, over the past six years, commercial 

banks’ average annual deposit growth rate of 3.2 percent 

has been outpaced by the 4.9 percent average annual 

growth rate of earning assets. As a result, nondeposit 

borrowings have increased significantly in importance, 

rising from about 12.6 percent of earning assets in 1991 

to 19.1 percent at mid-1997. Since the average cost of 

nondeposit borrowings has exceeded the average cost of 

deposits over the period by an average of 135 basis 

points, the greater use of relatively higher cost borrowings to fund earning asset growth has been an obstacle 

to wider margins. The slower deposit growth can perhaps be attributed to the increasing array of choices 

available to small savers; its effect is that bank funding 

is becoming more expensive and more interest-rate 

sensitive. 

On the asset side, pricing pressures also are frequently 

cited as contributing to sluggish NIM. For example, in 

the aforementioned syndicated lending market, average 

interest spreads charged to noninvestment-grade large 

customers have dropped more than 63 basis points 

between 1992 and 1996, while spreads on investmentgrade debt are at all-time lows. Reportedly, some deals 

are being done at minimal or no risk-adjusted spreads 

simply to preserve lending relationships. Increased 

securitization of various asset types has also had effects 

on pricing. By increasing the depth and liquidity of the 

market for the underlying loans, securitization has tended to lower spreads on these assets, thereby increasing 

competitive pressures on institutions not able to achieve 

the volumes necessary to efficiently utilize this new 

funding vehicle. 

The thin spreads available from high-quality lending 

may tempt some institutions to finance higher yielding, 

riskier credits in an effort to preserve or boost profit 

margins. For example, recent forays by some banks into 

subprime lending (see Subprime Lending: A Time for 

Caution, Third Quarter 1997) may be one indication of 

how competitive pressures on NIMs are affecting bank 

behavior. Over the long term, institutions that manage 

their NIMs with a prudent regard for how their newly 

booked business may fare during a cyclical downturn 

will have a better chance of sustaining earnings performance through the business cycle. 

Growth in Noninterest Income 

Industry analysts often cite the increasing contribution 

of fees and other sources of noninterest income as 

evidence of the evolution of the banking industry. As 

Chart 5 (next page) illustrates, for commercial banks 

with over $1 billion in assets, noninterest income now 

averages over 40 percent of net revenue (net interest 

income plus noninterest income). In contrast, banks 

Atlanta Regional Outlook 6 Fourth Quarter 1997 
In Focus This Quarter
 

CHART 5 Other measures of productivity have shown similar 

Noninterest Revenue to Net Revenue* 

Banks Over $1 Billion 

Banks Under $1 Billion 

Source: Commercial Bank Call Reports 

* Net Revenue = Net interest income plus noninterest income 

10 

20 

30 

40 

50 

6-’85 

Net Revenue (%) 

6-’876-’896-’916-’936-’956-’97 

improvement. For example, commercial banking assets 

per employee doubled, from $1.5 million to $3 million, 

between 1984 and 1997. 

Growth in overhead expense has been contained largely 

through consolidation, technological advances, and low 

levels of problem assets. Mergers have resulted in the 

wringing out of redundant expenses. Information technology (IT) has been deployed to trim underwriting 

expense, manage customer relationships, speed backoffice processing, and facilitate the creation of new 

products and services. Favorable economic conditions 

have reduced costs associated with loan collection and 

asset workouts. 

Whether the downward trend in overhead expenses will 

with under $1 billion show a profile of reliance on more 

traditional banking activities, with only 25 percent of 

revenue from these noninterest sources. 

Noninterest income growth is being driven both by new 

business lines and higher deposit-related fees. 

Examples include fees from sales of mutual funds and 

other nondeposit products, investment banking activities such as securities underwriting and asset management, and increases in traditional fee sources such as 

from automated teller machines. Increasing securitization of assets, in which the accounting conventions convert interest income to noninterest income, has also 

affected the growth in reported noninterest income. 

With the exception of trading revenue, noninterest 

income has historically shown a growth trend that has 

not been especially sensitive to economic cycles. 

However, newer fee-based businesses such as mortgage 

banking, mutual funds, and securities underwriting may 

ultimately share the same cyclical characteristics as traditional bank lines of business, and therefore may not 

reduce banks’ historical exposure to economic cycles. 

The Effect of Expense Control 

on Earnings Performance 

Cost-cutting efforts in banking continue to show their 

effects. Since 1991, commercial banks’ efficiency 

ratio,2 a measure of an institution’s effectiveness in generating revenue, has steadily improved (see Chart 6). 

continue is an open question. Should problem loans 

increase from their cyclical lows, collection and workout costs will increase (evidence of this effect can be 

discerned for the late 1980s in Chart 6). The rapid 

change in information technology may prompt increasing expenditures. The 1996 Atlantic Data Services/ 

Tower Group Survey of Information Technology 

Services in Banking noted that the banking industry is 

“faced with an aging IT infrastructure.” The survey 

suggests that most technology-related expenses could 

increase at a 5.6 percent compounded growth rate until 

the year 2000 and that expenses for outside services 

could increase 11 percent over the same period. The 

ability to generate future revenue gains may depend on 

additional bank investment not only in technology but 

also in the development of new products and services. 

CHART 6 

Commercial Banks’ Efficiency Ratio*
 

Is Steadily Improving
 

70% 

68% 

66% 

64% 

62% 

60% 

58% 

56% 

1984198619881990199219941996 

The efficiency ratio is normally defined as noninterest expense * Noninterest expense/(net interest income + noninterest income) 

Source: Commercial Bank Call Reports divided by the sum of net interest revenue and noninterest revenue.
 

Atlanta Regional Outlook 7 Fourth Quarter 1997
 

2 
In Focus This Quarter
 

In any event, cost-cutting is not without its risks. For 

example, reductions in personnel, or excessive reliance 

on automated underwriting procedures (see Will Credit 

Scoring Transform the Market for Small-Business 

Lending? Second Quarter 1997), may raise concerns 

about the effectiveness of internal administration and 

control processes. Cost-cutting that cuts too deeply into 

customer service can erode franchise value. Mergers 

can reduce redundant expense, but at some point there 

may be diseconomies to managing a large organization. 

The Role of Capital in the Management 

of Earnings 

Management, shareholders, and analysts often evaluate 

earnings in relation to the level of capital using measures such as return on equity (ROE) and earnings per 

share (EPS). One result has been pressure on banks to 

continue to grow ROE and EPS; these objectives have 

been made progressively more difficult to attain by the 

significant level of capital that has built up over the past 

five years. 

Finding effective ways to deploy historically high capital levels appears to be one driving force behind the 

recent rash of mergers and acquisitions, high dividend 

payout ratios, increased stock repurchases, and the 

development of alternative types of hybrid capital such 

as trust preferred stock (see Financial Markets). For 

example, during 1995 and 1996, major merger and 

acquisition deals included some $835 billion in bank 

and thrift assets. During 1996, commercial banks with 

over $1 billion in assets had an average dividend payout 

ratio over 89 percent, up significantly from the 67 percent payout rate of 1994. Banks with under $1 billion in 

assets averaged 55 percent for 1996 and 52 percent for 

1994. In addition, banks and bank holding companies 

have issued some $21 billion in trust preferred stock 

during the last nine months, some of which has been 

used to fund the almost $42 billion in share repurchase 

programs announced by large banks during 1996 and 

early 1997.3 

While the book value of equity and other capital ratios 

has increased at the aggregate industry level, a number 

of banks are reporting declines in equity capital and 

leverage capital ratios despite positive earnings (see 

Chart 7). For all institutions, the ability to actively man3 Salomon Brothers. 

CHART 7 

An Increasing Number of Profitable Banks Are
 

Reducing Tier 1 Capital*
 

Number of Banks 

800 

600 

400 

200 

0 

1992 1993 1994 1995 1996 

* Both Tier 1 dollar amount and ratio 

Source: Commercial Bank Call Reports 

age capital accounts going forward will depend largely 

on having earnings available above the levels needed to 

fund dividends and growth, after assuming capital protection adequate for the level of business risk. Bankers 

and examiners will need to carefully review strategies 

that increase bank leverage or increase business risk 

without considering the potential effects of a downturn 

in credit quality or other weakening in the economy. 

Summary 

The most profitable period for U.S. banks in the postWorld War II era is paradoxically occurring during a 

time when banks’ traditional business lines are coming 

under greater competitive pressure than ever. While the 

industry as a whole is adapting well to these competitive 

pressures, there may be a tendency for some insured 

institutions to respond by accepting greater risks to preserve or gain business. 

The nature of banking is to profit by taking calculated 

risks, and naturally more profits will be made during the 

expansionary phase of a cycle than during a downturn. 

Nevertheless, the institutions that are best able to sustain their earnings and capital over the complete cycle 

will be those that allow for the possibility of an adverse 

change in business conditions, and prudently balance 

the levels of risk taken with the expected returns. 

Ronald Spieker, Chief, Depository Institutions Section 

Steve Linehan, Assistant Director, Analysis Branch 

George French, Deputy Director 

Atlanta Regional Outlook 8 Fourth Quarter 1997 
In Focus This Quarter
 

Strong Demand and Financial Innovation Fuel
 

Rebounding Commercial Real Estate Markets
 

•	 Commercial banks are leading a resurgence in 

commercial real estate financing; many metropolitan markets are experiencing rapidly rising rents 

and single-digit vacancy rates, suggesting the likelihood of further development. 

•	 New funds directed toward commercial real estate 

are being increasingly supported by commercial 

mortgage-backed securities and real estate investment trusts. 

•	 Some analysts have expressed concern that these 

financing vehicles may serve to heighten competitive pressures that will lead to more aggressive 

loan pricing. 

In the wake of declining values and the large losses of 

the late 1980s and early 1990s, commercial real estate is 

making a comeback. There are two stories here of interest to lenders. The first entails the remarkable resurgence in commercial real estate demand. The second 

involves the major changes taking place in how real 

estate is owned and paid for and—of greater interest to 

banks—who is financing this expanding activity. 

Commercial Banks Show Renewed Interest 

in Commercial Real Estate 

Strong evidence of commercial real estate’s rebound 

can be seen in its renewed attractiveness to lenders. 

TABLE 1 

Federal Reserve figures show that nearly $58 billion of 

new commercial mortgage debt was added to the market in 1995 and 1996 (see Table 1). While this new net 

lending pales in comparison with that of the late 

1980s—when nearly $74 billion in net new debt was 

added in 1987 alone—it positively shines when compared with the $89 billion shrinkage of commercial real 

estate loans from 1991 to 1994. Table 1 shows that commercial banks are leading this resurgence with a $37 

billion net increase in mortgage lending during 1995 

and 1996. 

Perhaps the most convincing evidence of commercial 

real estate’s recovery comes from the market itself. 

Rising prices and tightening supplies of space in most 

major markets and for most property types suggest a 

growing demand for new commercial property stock. 

Numerous indices and market studies support this 

notion: 

•	 As measured by Koll/NREI national composites, 

prices and rents turned up sharply after 1993, with 

rents surpassing their 1988 to 1989 levels by 1995 

(see Chart 1, next page). For office properties in particular, the ten fastest-growing cities in terms of rental 

rates saw increases exceeding 20 percent in 1996.1 

1 Those cities are, in order, Minneapolis, Columbus, Dallas, Portland, 

Salt Lake City, Atlanta, San Jose, Phoenix, San Francisco, and San 

Diego. 

Banks Are Increasing Their Flow of Funds into Commercial Real Estate ($ Billions) 

1991 1992 1993 1994 1995 1996 

NET NEW BORROWING, ALL SOURCES $ − 15.6 $ − 47.1 $ − 21.5 $ − 4.4 $ 22.6 $ 35.1 

COMMERCIAL BANKS 3.1 − 8.4 − 4.3 7.5 18.0 18.7 

CMBSS 1.3 8.7 10.3 11.3 10.6 16.1 

SAVINGS INSTITUTIONS − 22.4 − 18.5 − 7.5 − 6.8 − 1.8 0.8 

LIFE INSURANCE COMPANIES − 5.6 − 15.1 − 13.4 − 10.5 − 3.3 − 2.5 

ALL OTHER SOURCES 8.0 − 13.5 − 6.6 − 5.9 − 0.9 2.3 

EQUITY CAPITAL FLOW, ALL SOURCES $ 4.9 $ 3.1 $ 17.4 $ 21.6 $ 21.5 $ 30.3 

REIT EQUITY OFFERINGS 1.6 2.0 13.2 11.1 8.2 13.0 

PENSION FUNDS − 4.8 − 4.3 − 0.7 9.6 13.8 14.3 

ALL OTHER SOURCES 8.1 5.4 5.0 0.9 − 0.5 3.0 

Sources: Federal Reserve, National Association of Real Estate Investment Trusts (NAREIT), LaSalle Advisors 

Investment Research 

Atlanta Regional Outlook 9	 Fourth Quarter 1997 
In Focus This Quarter
 

•	 Property capitalization rates, which measure the 

annual income generated by a property as a percentage of its purchase price, are falling (see Chart 2). 

These falling rates indicate that investors are paying 

higher prices for each dollar of current income generated by the property. Overall, however, prices have 

not yet caught up with rents, which now exceed their 

previous highs in some markets, suggesting that the 

current recovery is not yet peaking. 

•	 Declining vacancy rates reflect strong demand for 

office properties, which Grubb & Ellis cast as the 

hottest sector in its 1997 forecast. Nationwide, office 

vacancies have fallen dramatically, by 5 to 10 percentage points during the last four years (see Chart 

3). Moreover, Torto-Wheaton Research estimates 

that 21 of the 56 metropolitan areas it tracks had 

single-digit vacancy rates at the end of first quarter 

1997. Not surprisingly, many of the tightest markets 

are those with the greatest rent inflation. 

While the unrestrained commercial development of the 

1980s continues to cast a shadow over the industry, that 

shadow is fading as declining vacancy rates and rising 

rental rates for existing properties fuel optimism 

among lenders and investors and strengthen the case 

for new development. Lenders, examiners, and analysts, however, must be diligent in monitoring commercial real estate markets to identify possible imbalances 

between supply and demand. It is particularly important that lending decisions be made on the basis of economic feasibility and realistic property cash flow 

projections rather than solely on the basis of competitive pressures. 

Borrowers’ Financing Options Expanding 

Although banks are clearly the largest source of financing for resurgent commercial real estate markets, a 

broader and more competitive financing market has 

emerged. In this market, financing often bypasses 

banks, being funneled instead through entities that purchase and securitize commercial real-estate-secured 

debt or the properties themselves, parceling them into 

smaller, more standardized, and thus more liquid pieces 

that are attractive to institutional and individual 

investors alike. This trend is illustrated in Table 1, which 

shows the increasing roles commercial mortgagebacked securities (CMBSs) and real estate investment 

trusts (REITs) have played in funding commercial real 

estate over the past five years. This increase in public 

CHART 1 

Prices and Rents on Upswing Nationwide 

Index (1986 = 1.00)
 

1.30
 

1.20
 Rents
 

1.10
 

1.00
 Prices
 

0.90
 

0.80
 

1990 1991 1992 1993 1994 1995 1996 

Source: Koll National Real Estate Index 

CHART 2 

Property Capitalization Rates Dropping 

8.0 

8.5 

9.0 

9.5 

10.0 

10.5 

11.0 

11.5 

1990 1991 1992 1993 1994 1995 1996 1997 

Overall Cap Rates (%)

Office 

Retail 

Apartment 

Source: Donaldson, Lufkin & Jenrette 

CHART 3 

National Downtown and Suburban
 

Class A Vacancy Rates Falling
 

8 

13 

18 

23 

Downtown 

Suburban 

Vacancy Rates (%) 

1988 1989 1990 1991 1992 1993 1994 1995 1996 

Source: CB Commercial / Torto-Wheaton Research 

Atlanta Regional Outlook 10	 Fourth Quarter 1997 
In Focus This Quarter
 

financing left financial institutions in 1996 with 

approximately a one-third share of all new net commercial real estate financing, down from well over half just 

a decade before. 

From a lender’s perspective, CMBSs offer several 

advantages over traditional portfolio lending. Most significantly, lenders can generate fee income from loan 

production and servicing activities while avoiding the 

excessive concentrations of credit risk that plagued 

lenders during the last real estate downturn.2 According 

to Commercial Mortgage Alert, outstanding CMBSs 

reached $125 billion in 1996 on a record $30 billion of 

new issuance. While outstanding volume is still dwarfed 

by the $3 trillion market for residential mortgagebacked securities (MBSs), the growth in CMBS volume 

has been remarkable considering that such securities 

were virtually nonexistent prior to 1991. 

At present, most commercial banks are not active in 

issuing CMBSs, accounting for only $2.6 billion of 

CMBS issuance in 1996, according to E&Y Kenneth 

Leventhal Real Estate Group. Rather, the primary 

source of these securities is investment banks, which 

generate substantial fees by converting existing loans 

into securities. CMBS issues also are being increasingly underwritten by conduits, which are entities created 

to originate mortgage loans for distribution to investors 

in the secondary market. Nomura Securities 

International estimates that such conduits accounted 

for over one-third of CMBS issuance in 1996, nearly 

double the volume of 1995. Only a handful of the 

largest commercial banks have set up conduit programs—the five largest banks accounted for $3.3 billion of the $10.2 billion in conduit issuance during 

1996. Aside from this relatively small number of bank 

competitors, investment banks are among the largest 

and most active conduit issuers. 

There is no fundamental reason why banks cannot take 

greater part in the rapidly growing CMBS market. In 

fact, they possess many distinct advantages over investment banks. Their distribution networks, lending experience, and back-office capabilities are naturally suited 

to facilitating loan demand, evaluating repayment risk, 

servicing loans, and monitoring a project’s development. Obstacles of scale may preclude smaller institu2 While securitization of loans purports to shift credit risk to investors, 

many analysts and rating agencies have recently expressed concern 

over recourse arrangements, both contractual and voluntary, whereby 

the seller/servicer effectively assumes all or most of losses experienced by the security. 

tions from directly issuing CMBSs ($500 million in volume is often cited as a minimum for efficiently assembling a deal). However, if the CMBS market develops 

like that for MBSs, standardized underwriting may 

enable small institutions to remain competitive either by 

cooperatively forming their own conduits or by selling 

their loans to existing conduits. 

Whether or not banks take part, the continuing development of a market for securitized commercial real estate 

assets raises a number of efficiency issues for direct 

lenders. Securitization provides property developers and 

owners access to a much larger pool of potential funding 

sources and a wider array of funding options. Moreover, 

the costs of public financing reflect efficiencies born of 

standardization and liquidity. In short, investors, including banks, can price, enter, and exit their positions in 

securitized debt more easily than could be done with 

whole loans. While improved efficiencies are a positive 

aspect of the growth in securitized investments, these 

efficiencies threaten to dictate bank pricing, thereby 

potentially reducing margins or driving institutions to 

lend on less economically feasible projects in an effort to 

preserve margins and market share. 

REITs: An Alternative to Traditional 

Capital Sources 

Commercial real estate financing is evolving in other 

ways. REITs have become major players in the industry 

since 1993, accounting for fully one-fifth of funds flowing into real estate in 1996. REITs are much like mutual funds in that they allow indirect investment in real 

estate through purchases of equity in the REIT. The 

REIT itself holds title to the underlying properties and, 

provided it meets certain requirements, can directly pass 

through its earnings to investors without any intermediate tax. Although Moody’s estimates place REIT holdings at less than 3 percent of all U.S. commercial real 

estate, outstanding REIT shares have grown considerably, with market capitalization doubling nearly three 

times in just four years (see Chart 4, next page). 

Accompanying this rise in capitalization has been an 

equally dramatic rise in bank lending to REITs. 

According to Loan Pricing Corporation, bank lending 

to REITs surged to $12.8 billion in 1996, a 16 percent 

increase over 1995’s then-record volume and more than 

a tenfold increase over the period 1990 to 1992. 

The rise in REIT capitalization can be attributed in part 

to pent-up institutional demand for real estate. REITs 

Atlanta Regional Outlook 11 Fourth Quarter 1997 
In Focus This Quarter
 

CHART 4 

REIT Capitalization Soaring 

0 

10 

20 

30 

40 

50 

60 

70 

80

$ Billions 

0 

400 

1996

50 

100 

150 

200 

250 

300 

350 

Market Capitalization (Left Scale) 

Number of REITs (Right Scale) 

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 

Source: National Association of Real Estate Investment Trusts

have a particular appeal to fund managers since they 

offer the benefits of investment diversification without 

the dual headaches of property management and asset 

illiquidity. Aside from the direct credit risk posed by 

lending to REITs, their rising popularity confronts banks 

with an indirect threat as well—the threat that banks 

could be crowded out of lending opportunities if 

investors find REIT funding structures more attractive 

from a cost and control standpoint. The degree to which 

this crowding out may occur is unclear, for according to 

Nomura Research, REITs historically have borrowed 40 

cents for each dollar of real estate held. However, well 

over half of this borrowing takes place through public 

offerings of secured and unsecured debt, leaving only a 

small portion to be financed by banks and other private 

lenders. Because REITs tend to focus on the highest 

quality projects, their increasing presence also creates 

concerns that banks may be driven to lend to less attractive or more risky properties to preserve market share. 

Many analysts have also expressed unease over the rapid 

rise in the valuations of REITs, some of whose shares 

are priced at a considerable premium to the properties 

themselves. Anecdotal evidence suggests that premiums 

as high as 40 percent over market value have been paid 

for some REIT shares in recent months. Such marketbased valuations create concern over the extent to which 

an REIT’s capital structure allows it to pay more for 

properties than an investor who employs greater financial leverage. Accordingly, while REITs may make up a 

fairly nominal amount of overall real estate holdings, 

they may be quite influential in determining how commercial properties are being valued or appraised. 

Commercial Real Estate Securitization: 

Some Broader Implications 

Maturing CMBS markets could eventually improve the 

overall stability of commercial real estate markets not 

only by improving market liquidity but also by enabling 

investors to diversify and share their credit exposures 

among a greater number of participants. In addition, 

loan performance could become increasingly transparent to the general marketplace, thereby encouraging 

more uniform and prudent underwriting standards. 

However, concern naturally arises because CMBSs are 

a major source of commercial real estate market funding that has not been tested through a serious market 

downturn. This situation leads to questions concerning 

the impact they will have on property values and market 

liquidity and whether today’s underwriting terms, driven 

largely by competitive factors, will stand up to tomorrow’s market downturn. Another question is whether the 

standardized structures underlying these securities offer 

enough flexibility to borrowers to renegotiate loan 

terms—a critical workout tool during times of financial 

stress. The answers to these questions will ultimately 

determine the extent to which lenders and investors suffer as a result of the inevitable cyclical swings in commercial property values. 

There are also questions about how REITs will affect 

commercial real estate markets. One argument is that 

the appetite for REIT investments, combined with the 

premiums that the trusts can pay for properties, will 

push the price of commercial space beyond sustainable 

levels. Those who hold this view see REITs, and other 

Wall Street innovations that increase the supply of funding, as potentially amplifying cyclical swings in real 

estate values. The contrary view holds that REITs will 

improve market efficiency by providing continuous 

pricing benchmarks through daily share price movements and thus enforce discipline upon developers and 

lenders. This discipline, it is argued, will prevent excessive development and dampen the severity of real estate 

cycles. 

As an investment, commercial real estate is quickly 

regaining the broad favor it lost during the last market 

downturn. But the channels through which a lender or 

investor can participate in this market are expanding 

even more dramatically. Investment exposures to real 

estate are no longer effectively limited to private equity 

or debt. The choices are multiplying, with liquid public 

markets for both debt and equity providing the foundation for existing and future commercial real estateAtlanta Regional Outlook 12 Fourth Quarter 1997 
In Focus This Quarter
 

based instruments—instruments such as swaps, options, 

and property derivatives—that will permit the tailoring, 

hedging, and even creation of synthetic real estate 

investment positions. Although financial institutions are 

participating in this revival, it is clearly a different world 

from the old, and one in which they will have to choose 

how best to compete against—or participate in—these 

new real estate financing strategies. 

Steven Burton, Senior Banking Analyst 

sburton@fdic.gov 

Gary Ternullo, Senior Financial Analyst 

gternullo@fdic.gov 

Commercial Real Estate in the Demand Forces
 

Atlanta Region: The Atlanta
 While retail building has continued to rise, the 

Metropolitan Area’s Retail Market	 increase in occupied space has declined from its peak 

of 5.76 million square feet in 1994 to 3.0 million 

Commercial construction activity, particularly in square feet in 1996. In the first quarter of 1997, this 

rate of absorption fell to an annualized, seasonally retail markets, in the Atlanta Region has been strong adjusted 2.1 million square feet—less than half the over the past few years. Although vacancy rates have increase in net new supply during the same period. started rising in nearly one-half of the Region’s met- Retail space absorption is driven, in part, by econom­ ropolitan areas, nowhere has the upward pressure ic and demographic factors as faster job, income, and been more noticeable than in Atlanta. In the first 

population growth fuels consumer spending. Since its quarter of 1997, the retail vacancy rate in this metro- peak in 1994, and particularly in the wake of the politan area was 9.6 percent, up 3 percentage points Summer Olympics of 1996, economic growth, like from one year earlier. The rise in Atlanta’s retail 

absorption, in the Atlanta metropolitan area has vacancy rate is largely a product of two diverging slowed markedly. A recent forecast by the American trends: continued growth in retail space construction 

Metro/Study Corporation sees this trend continuing and declining levels of absorption. through the end of 1998. Although population growth 

remains three times the national average, in-migration 

is slowing, constraining faster gains in population. Supply Forces 

Retail space construction has increased substantially Continued strong retail construction may be occursince its cyclical trough in 1991 at 2.13 million square ring at a time when the Atlanta metropolitan area’s 

feet of net new supply. In 1996, 7.76 million square economic growth is slowing, increasing the risk that 

feet of net new supply was injected into the Atlanta the market may become overbuilt. Already Atlanta’s 

metropolitan area market. First quarter 1997 con- retail vacancy rate has increased dramatically, and the 

struction activity also was above the levels from one threat of a shakeout in the market may be on the rise. 

year earlier. There are indications that retail space The potential impact of weakening economic and 

expansion may continue. As of June 1997, retail proj- population growth may warrant more cautious lendects totaling more than 22 million square feet were in ing strategies. 

the planning stages, with three new regional malls 

slated for development over the next few years in the 

Atlanta metropolitan area. Scott C. Hughes, Regional Economist 

Atlanta Regional Outlook 13	 Fourth Quarter 1997 
Regular Features	 Regional Economy
 

Growth in the Atlanta Region Continues to Slow
 

•	 Job growth in the Atlanta Region continued to slow through the middle of 1997 as its economy moved further away from its cyclical peak. 

•	 If not for the continued growth in Florida, the Atlanta Region’s economic performance would be below the 

national average. 

•	 Georgia’s decelerating growth has spread from rural to urban areas as residential construction activity and 

retail employment growth have weakened. 

•	 Forecasters argue that the Atlantic Basin has entered a new era of greater hurricane activity, similar to that 

seen during the 1940s and 1950s. Even if hurricanes are not more frequent, damage from the storms could 

escalate because of the greater levels of economic development and larger populations in coastal areas. 

Quarterly Update 

Job growth in the Atlanta Region peaked in November 

1994, with a year-over-year employment increase of 4.1 

percent (see Chart 1). Gains thereafter moderated 

before edging upward during 1996, partly because of 

preparations for the Olympic Games in Atlanta. Since 

the outset of 1997, however, growth has once again 

decelerated, with year-over-year job growth falling from 

3.4 percent in January to 2.2 percent in June. During the 

first half of 1997, all states except Florida have seen a 

gradual slowdown in job growth. 

Although growth has slowed in all areas of the Atlanta 

Region, decelerating employment gains have been most 

acute in the construction industry, in which year-overyear job growth in June 1997 stood at 3.1 percent, compared with 7.4 percent in January. This level of growth 

was the lowest since December 1992. Although construction activity in multifamily and commercial real 

estate in most areas of the Region remains comparatively strong, single-family home building weakened in all 

states during the first half of 1997. Some of the declines 

in single-family construction could be attributable to the 

Atlanta Region’s slowing population growth. Though 

still above the national average of 0.9 percent, annual 

population growth in the Region was only 1.34 percent 

in 1996. With the exception of 1990, the increase was 

the lowest since 1980. 

If Not for Florida... 

Florida is the Atlanta Region’s fastest-growing state, 

with year-over-year job growth in June 1997 of 3.6 percent (see Chart 2). Moreover, growth in the state generCHART 1	 CHART 2 

Job Growth in the Atlanta Region Outside of 

Florida Slows... 

Jan-90Jan-91Jan-92Jan-93Jan-94Jan-95Jan-96Jan-97 

% Change from Year Earlier 

Atlanta Region less Florida United States 

–3.0 

–2.0 

–1.0 

0.0 

1.0 

2.0 

3.0 

4.0 

5.0 

...While Job Growth in Florida Continues 

to Edge Upward 

% Change from Year Earlier 

Florida United States 

–3.0 

–2.0 

–1.0 

0.0 

1.0 

2.0 

3.0 

4.0 

5.0 

Jan-90Jan-91Jan-92Jan-93Jan-94Jan-95Jan-96Jan-97 

6.0 

Atlanta Regional Outlook 14	 Fourth Quarter 1997 
Regular Features Regional Economy
 

ally has remained above 3 percent throughout 1997. 

Because Florida accounts for 31.6 percent of the 

Region’s population, its growth dominates the economic landscape. Without Florida’s inclusion, year-overyear employment growth in the Atlanta Region would 

have stood at 1.6 percent, below the national average 

(see Chart 1). 

Florida’s divergence from the rest of the Atlanta Region 

may be a result of its economic structure. Tourism, 

which plays an important role in the state’s economy, is 

included in the service sector, the fastest-growing segment of the economy. Moreover, Florida’s construction 

industry also is benefiting from the growth in tourism as 

new theme parks are being built in the Orlando area. 

The importance of tourism is reflected geographically 

throughout the state. Fort Lauderdale, Jacksonville, 

Orlando, and Sarasota all recorded year-over-year job 

growth in excess of 4 percent; gains in less touristdependent metropolitan areas, such as Gainesville and 

Pensacola, were not as strong. In Orlando, year-overyear job growth in June was 5.6 percent. 

Florida’s strong growth in 1997 has come despite a 

slowing in single-family home building. At midyear 

1997, year-to-date single-family permit issuance was 

down 0.2 percent from the same period during 1996. As 

in the Region as a whole, annual population growth in 

Florida has slowed. From 1980 to 1990, population in 

the state increased at an annual rate of 2.9 percent. 

Since then, however, gains in population have been 

decelerating. In 1996, the number of residents in the 

state rose by 1.5 percent. 

Despite continued growth in the economy, Florida’s jobless rate has hovered at nearly 5 percent for the past 

three quarters. One reason for the lack of improvement 

may be that the state’s jobless data are somewhat 

skewed by Miami, which accounts for 15 percent of all 

employment statewide. Labor markets in Miami are not 

as tight as those in the rest of the state, even considering record tourism in the metropolitan area. In June 

1997, year-over-year job growth in the metropolitan 

area was 1.9 percent, and the unemployment rate was 

7.8 percent. Part of the reason for Miami’s weaker performance relative to the state may be its economic 

diversity. While other Florida metropolitan areas rely 

more heavily on the fast-growing tourist trade, Miami 

has had to contend with events such as thousands of job 

losses in its textile and apparel industry. 

Unemployment rates statewide were also elevated by 

weaker economic conditions in Panama City and adjacent counties to the east. In April 1997, the Port St. Joe 

Paper Mill (Gulf County) shut down, idling 1,300 

employees. Consequently, Gulf County saw unemployment rates rise to 16.8 percent in the second quarter of 

1997. Surrounding counties also saw an increase, 

though less dramatic, in jobless rates. Local economic 

conditions have improved, however, as the facility reopened in phases throughout the month of September. 

Growth in Virginia Slows but Remains 

above Average 

Virginia’s job growth slowed in the first half of 1997, 

although its growth continued to exceed the national 

average and is second only to Florida’s in the Atlanta 

Region. Year-over-year employment growth declined 

from a 4.1 percent pace at the 

beginning of the year to a 2.4 percent pace in June. With the exception of finance, insurance, and real 

estate (FIRE) and services, all 

areas of the state’s economy have 

experienced lower levels of 

growth. Gains also vary geographically, remaining concentrated along the so-called 

Golden Crescent that arcs from Northern Virginia, 

through Charlottesville and Richmond, and over to 

Norfolk. Northern Virginia remains the fastest-growing 

component of the Golden Crescent, posting year-overyear job growth of 3.7 percent. Norfolk and 

Charlottesville have seen above-average gains as well. 

However, outside the Crescent and particularly in southcentral portions of the state, many counties have seen 

deteriorating performance. Jobless rates in counties to 

the west of the Richmond metropolitan area have risen 

over the past year. Some of this loosening in labor markets may be attributable to a retail slowdown in nearby 

Richmond, where many local residents are employed. 

On the North Carolina border, Halifax County has seen 

unemployment rates rise into the double digits as 

Georgia-Pacific and smaller textile and apparel mills 

have shut down. 

North Carolina—Construction Activity Slows 

Although on a par with the regional average of 2.2 percent job growth, North Carolina’s economic performance has weakened in recent months. In January 1997, 

Atlanta Regional Outlook 15 Fourth Quarter 1997 
Regular Features Regional Economy
 

year-over-year job growth was at 4.4 percent, ranking 

North Carolina as the Atlanta Region’s fastest-growing 

state. Gains in all areas of the economy have since abated. Construction activity has seen the largest drop in 

growth—from double-digit year-over-year job gains in 

January to 4.2 percent in June. Some of the decrease in 

construction may stem from single-family home building, where permit issuance growth has been slowing in 

recent quarters. Overbuilding in some metropolitan 

areas’ multifamily markets eventually may exacerbate 

the situation. Some analysts expect vacancy rates in 

Raleigh’s multifamily market to climb to 10 percent this 

year given the current level of construction activity. 

Slower commercial building activity also may be contributing to weaker construction employment growth. 

Statewide, the square footage of nonresidential starts in 

the first quarter of 1997 was down 44 percent from one 

year earlier, according to F.W. Dodge. In Charlotte, the 

square footage of nonresidential construction starts was 

down by 33 percent during the same period. Although 

the retail vacancy rate has remained stable at 7.3 percent, there is a risk that it could rise. Charlotte still has 

about 10.2 million square feet of retail space in the 

planning stages, while absorption of retail space has 

declined from an annualized 1,632,000 square feet in 

the first quarter of 1996 to 836,000 square feet in the 

first quarter of 1997. 

West Virginia—Slow but Stable Gains 

The West Virginia economy continues to perform below 

the national average, with year-over-year job growth in 

June 1997 at 1.5 percent. Nonetheless, current levels of 

growth have been more than strong enough to absorb 

new entrants to the state’s labor force. At 6.5 percent, 

the state’s unemployment rate is at its lowest since the 

third quarter of 1979—before the energy bust of the 

1980s hurt the state’s coal mining industry. Mining still 

plays a large role in the state, as does manufacturing. 

Since its peak in the late 1970s, at nearly 70,000, 

employment in mining has fallen by more than half, to 

25,700 jobs in 1996. Manufacturing has lost approximately 40,000 jobs during the same period. Although 

both sectors remain in decline, the slowdown may have 

eased, with employment stabilizing at just over 80,000 

in manufacturing and just over 25,000 in mining. The 

downward drag on the economy could lessen if industry 

consolidation continues to abate. 

Slower Growth Spreads in Georgia 

Nowhere in the Atlanta Region has decelerating growth 

been more apparent than in Georgia. Since April 1997, 

year-over-year job growth in the state has been below 

the national average. In June 1997, job growth in the 

state was 1.2 percent. By contrast, job growth was at its 

height in January 1997, at 3.1 percent. 

In the previous edition of the Regional Outlook, it was 

noted that much of the deceleration in economic growth 

was confined to rural counties, while Georgia’s metropolitan areas continued to experience largely aboveaverage levels of job growth. Several rural counties, 

particularly in the southern half of the state, continue to 

see double-digit unemployment. Some of the slower 

growth in rural areas can be explained by recent job 

losses in the textile and apparel manufacturing industry. 

Not only have manufacturers relocated production overseas, but the automation of some remaining facilities 

also has reduced the need for labor. 

More recently, weaker levels of economic growth have 

appeared in Georgia’s metropolitan areas. In June 

1997, year-over-year job growth in all of Georgia’s 

metropolitan areas was below the nation’s increase of 

2.1 percent: Job growth was 2.0 percent in Albany, the 

state’s fastest-growing metropolitan area; 1.9 percent in 

Atlanta; and 0.1 percent in Athens. The Atlanta metropolitan area is seeing slower growth in its tourist industry and slower gains in retail and residential 

construction activity. 

Year-over-year construction job growth has been negative since April 1997 throughout the entire state. Some 

of the construction industry’s weakness can be traced to 

single-family home building in Georgia, which slowed 

during the first half of 1997 (see Chart 3). Growth in 

permit issuance peaked in 1992 at 24 percent annually 

and has since declined. In the second quarter of 1997, 

single-family permit issuance was 12.8 percent below 

levels from a year earlier. According to Donald 

Ratajczak of Georgia State University’s Economic 

Forecasting Center, the state has seen population growth 

begin to slow, which is likely reducing growth in 

demand for new housing. 

Georgia’s construction industry, especially in Atlanta, 

may be further constrained in the future by the threat of 

overbuilding in retail real-estate markets (see Regional 

Outlook, second quarter). Year-over-year retail employment growth, one proxy for market absorption, has 

Atlanta Regional Outlook 16 Fourth Quarter 1997 
Regular Features Regional Economy
 

CHART 3 

Single-Family Construction Slows in Georgia 

% Change from Year Earlier 

Year-to-Date Single-Family Permit Issuance 

Source: U.S. Census Bureau 

Q1.90 Q1.91 Q1.92 Q1.93 Q1.94 Q1.95 Q1.96 Q1.97 

–15 

–10 

–5 

0 

5 

10 

15 

20 

25 

30 

35 

declined from 3.7 percent in January 1997 to 0.3 percent 

in June in the state. Meanwhile, Atlanta’s retail vacancy 

rate increased by nearly 3 percentage points in one year, 

to 9.6 percent in the first quarter of 1997. Despite the 

increase in vacancies, the metropolitan area still has 

over 22 million square feet of retail space in the planning stages. (At the end of 1996, the Atlanta retail market consisted of 99.7 million square feet.) According to 

the Atlanta Business Chronicle, weakening conditions 

also may be emerging in the industrial market, where 

speculative building is outpacing absorption. 

Alabama’s Economic Performance 

After remaining stable through the first quarter of 1997, 

year-over-year job growth in Alabama has fallen. In 

June 1997, year-over-year job growth in the state was 1 

percent, less than half the 2.1 percent increase at the 

national level. Growth in the state, however, has been 

fast enough to apply downward pressure to jobless rates 

statewide. In the second quarter of 1997, Alabama’s jobless rate was 4.6 percent, the lowest in more than 20 

years. Even in rural areas, such as southwestern 

Alabama, where double-digit jobless rates have been the 

norm, labor markets have been tightening. Construction 

remains the fastest-growing area of the state’s economy, 

with gains of 6.1 percent during the same period, mostly driven by increases in multifamily and, to a lesser 

extent, commercial projects. Through midyear 1997, 

year-to-date multifamily permit issuance was 20.6 percent above the same period one year earlier. 

Commercial (office, industrial, and retail) space construction in the state varies, however. In the fastergrowing metropolitan areas of Birmingham and 

Tuscaloosa, square footage of nonresidential starts was 

up in the first quarter from one year earlier. Tuscaloosa’s 

growth may be largely attributable to Mercedes-Benz’s 

new $300 million automobile production facility. In 

contrast to the strength in multifamily and commercial 

construction, single-family residential permit issuance 

in the second quarter of 1997 was down 7 percent from 

one year earlier. Demand for new housing may be constrained by Alabama’s low rate of population growth; in 

1996, the population rose by 0.6 percent. 

Gains in South Carolina Slow 

Job growth in South Carolina is the slowest in the 

Atlanta Region. In June 1997, year-over-year employment growth in the state was 0.6 percent (see Chart 4). 

Since January, growth in several areas of the state’s 

economy has slowed. The most marked decrease in job 

growth has occurred in South Carolina’s construction 

industry. In January 1997, year-over-year job growth in 

construction stood at 8.2 percent. Performance since 

then has steadily eroded to June’s growth of 1.8 percent. 

Weakening single-family construction may be the 

source of the industry’s current slowdown: Permit 

issuance was up only 0.8 percent in the second quarter 

from one year earlier. This contrasts with the doubledigit gains experienced throughout 1996. South 

Carolina’s textile and apparel industries also have constrained faster growth in the state, with employment 

levels in June down 3.4 percent from one year earlier. 

Implications: With the exception of Florida, the 

Atlanta Region’s economic growth has slowed throughout 1997. Part of the Region’s slower growth is the 

result of weakening levels of construction activity, espeCHART 4 

Job Growth in South Carolina below 

National Average 

% Change from Year Earlier 

0.0 

5.0 

1.0 

1.5 

2.0 

2.5 United States 

South Carolina 

Jan 

96 

Jul 

96 

Jan 

97 

3.0 

Source: Bureau of Labor Statistics 

Atlanta Regional Outlook 17 Fourth Quarter 1997 
Regular Features Regional Economy
 

cially in single-family home building. The Region has 

enjoyed five years of above-average growth. In light of 

slowing momentum, however, lending decisions that are 

based on assumptions of continued rapid growth should 

be examined carefully. Moreover, Georgia and parts of 

North Carolina must still contend with the implications 

of possible overbuilding and speculative construction in 

their multifamily and commercial markets. 

Just Another Hurricane Season? 

During the 1970s, 1980s, and early 1990s, hurricane 

activity stood at historically low levels even though the 

period was punctuated by infrequent large storms that 

caused considerable damage. According to William 

M. Gray and other researchers at Colorado State 

University, by the mid-1990s, hurricane activity began 

to accelerate. Moreover, this higher frequency and 

severity of Atlantic hurricanes may persist well into the 

future, resembling the level of storm activity seen in the 

1940s to 1960s. 

Even if the frequency of hurricanes does not increase, 

the probability of escalating damage from storms is 

likely to rise because of the ongoing rapid development 

in coastal areas of the Atlanta Region. According to the 

U.S. Census Bureau, the population in the Atlanta 

Region’s coastal1 areas has more than doubled, from 

10.6 million (43 percent of the total population of the 

Region) in 1960 to 22.9 million (52 percent of the total 

population) in 1994. More than half of these coastal residents are located in Florida, and they account for 97 

percent of that state’s population. Even after adjusting 

for inflation, the impact of a storm on the scale of 

1 Coastal counties are defined (in 1992) by the National Oceanic and 

Atmospheric Administration (NOAA) as those counties with at least 

15 percent of their land area either in a coastal watershed or in a 

coastal cataloging unit. 

1992’s Hurricane Andrew would likely have been smaller in 1960 because the coastal areas were less developed 

economically and had lower population densities. 

Hurricane Andrew is estimated to have caused more 

than $30 billion in direct damages to Florida and has 

had long-term implications for the ability of residents 

to insure against damages from future storms (see 

Current Regional Banking Conditions). This season’s 

Hurricane Danny was a Category 1 storm (the weakest 

type of hurricane). Even though its effects were limited 

to the Mobile, Alabama, area, the storm caused more 

than $6 billion in damages. Along its overland track 

through the interior of the Atlanta Region, the storm 

caused several million dollars in additional damages. A 

succession of smaller storms could thus incur costs similar to that of a single intense hurricane. 

Implications: The rapid coastal development over the 

past few decades may have been encouraged partly by 

the relative infrequency of hurricane strikes. If the 

Atlantic Basin is entering an era of greater storm activity, there are many targets on the U.S. Eastern Seaboard. 

Greater storm activity also could place development in 

the interior of the Atlanta Region at risk. Many homeowners discovered in the wake of Hurricane Danny that 

they were not insured for floods. Lack of or inadequate 

insurance coverage could jeopardize homeowner solvency in the event of a storm, in turn adversely affecting credit quality for some insured institutions, 

especially small institutions that specialize in lending in 

coastal areas. 

Scott C. Hughes, Regional Economist 

Jack M.W. Phelps, Regional Manager 

Pamela R. Stallings, Financial Analyst 

Atlanta Regional Outlook 18 Fourth Quarter 1997 
Regular Features	 Financial Markets
 

Financial Markets
 

• Bank holding companies of all sizes have issued trust preferred stock following the Federal Reserve’s decision in October 1996 to count these tax-advantaged capital securities toward Tier 1 capital. 

•	 Although the tax-advantaged status of trust preferred stock was not eliminated in the federal budget this 

year, there still exists the possibility that the Internal Revenue Service may alter the tax treatment of trust 

preferred dividends. 

• Institutions contemplating issuing trust preferred stock should be aware of the concerns expressed by rating agencies and of the potential risks associated with excessive reliance on debt-like capital instruments. 

Bank holding company capital requirements were effectively relaxed in October 1996 when the Federal 

Reserve ruled that trust preferred stock may be included in the portion of cumulative preferred stock that can 

compose up to 25 percent of a bank holding company’s 

Tier 1 capital. In the wake of this decision, financial 

institutions moved quickly to issue trust preferred stock. 

Trust preferred stock can be a less expensive form of 

Tier 1 capital for bank holding companies because of 

the tax deductibility of the dividend payments paid on 

this type of preferred stock. 

Approximately 90 banking organizations issued an estimated $21 billion of trust preferred shares from October 

1996 through June 1997.1 The dollar amount of trust 

preferred stock issued represented almost 95 percent of 

the incremental amount of Tier 1 capital added by those 

institutions during the period. A number of these institutions used the proceeds of trust preferred stock issues 

to fund stock buyback programs. As an example of the 

relative importance of these stock buyback programs, 

one large bank holding company’s Tier 1 capital ratio 

would be 7.25 percent excluding the trust preferred 

shares, and 8.34 percent including the shares. 

Rating agencies and investment analysts have argued 

that trust preferred stock is a weaker form of Tier 1 capital because of its limited life and debt-like characteristics. These characteristics include the tax treatment of 

trust preferred dividends,2 the limited life of the shares, 

and the ability of investors to accelerate their claims 

against the bank holding company. Institutions contem1 The amount of trust preferred stock outstanding is not delineated in 

Call Reports. 

2 Trust preferred dividends, unlike dividends on traditional preferred 

stock, are treated as a tax-deductible expense at the bank holding 

company level and as taxable income by investors of the trust preferred shares. 

plating issuing trust preferred stock should be aware of 

the concerns expressed by rating agencies and of the 

possibility that excessive reliance on debt-like capital 

instruments could increase their financial fragility during times of economic stress. 

Trust Preferred Structure 

Provides a Tax-Advantaged 

Capital Funding Alternative 

Trust preferred shares, also 

known as capital securities, are 

traded under different names 

depending on the underwriter, payment terms, and 

maturity. Some of the more common acronyms include 

TOPRS (Trust Originated Preferred Shares), QUIPS 

(Quarterly Income Preferred Shares), and MIPS 

(Monthly Income Preferred Shares). 

Although trust preferreds are issued under different 

names, they share the same basic structure (see Chart 1, 

next page). A non-taxpaying subsidiary, or “trust,” of 

the bank holding company is formed. The trust issues 

two classes of stock: common and preferred shares. The 

common stock of the trust subsidiary is owned by the 

bank holding company, and the trust preferred stock is 

sold to investors. The trust upstreams the proceeds from 

the sale of the preferred shares to the bank holding company in exchange for a long-term, deeply subordinated 

note with terms identical to the trust preferred shares. 

(The subordinated note must be the sole asset of the 

trust and subordinated to all other debt of the bank holding company.) 

On a consolidated basis, the trust preferred stock is 

treated as a minority interest of the bank holding company, and the subordinated note is eliminated as interAtlanta Regional Outlook 19	 Fourth Quarter 1997 
Regular Features Financial Markets
 

CHART 1
 

How Is Trust Preferred Stock Structured 

to Count as Tier 1 Capital? 

Trust Preferred 

Proceeds 

Trust Preferred Shares 

Dividend Payments—funded by interest 

received on subordinated note 

Investors in Trust 

Preferred Shares 

Trust Subsidiary 

Issues trust preferred shares 

(structured as a non-taxpaying entity) 

Trust Preferred Proceeds 

(Trust preferred shares treated as 

minority interest by BHC and 

counted toward Tier 1 capital) 

Subordinated Note—same coupon 

and payment terms as trust preferred 

shares, booked as intercompany debt 

and eliminated upon consolidation 

Interest Payments—paid with 

before-tax dollars by the BHC 

Bank Holding Company 

(BHC) 

(BHC owns common stock of 

trust subsidiary) 

Atlanta Regional Outlook 20 Fourth Quarter 1997
 
Regular Features Financial Markets
 

company debt. The interest paid by the bank holding 

company on the subordinated note, which is taxdeductible at the bank holding company level, is used to 

fund the dividends on the trust preferred shares. In 

short, the issuing trust serves as a conduit for exchanging cash flows between the bank holding company and 

the investors in the trust preferred shares. 

To be eligible for Tier 1 capital treatment, trust preferred dividends may be cumulative, but dividends must 

be deferrable for a minimum of five years. If the dividends are not paid for more than five years, the trust 

preferred shares could be exchanged for junior subordinated debt of the trust. After the exchange, the trust preferred holder could declare an event of default and 

accelerate the claim against the bank holding company. 

Trust preferred shareholders would then be treated similarly to deeply subordinated debt holders or preferred 

stockholders of the bank holding company. 

Trust preferred shares typically have maturities of 30 

years or more and contain call options and redemption 

provisions. The redemption provisions, which are subject to Federal Reserve approval, permit the issuer to 

redeem or buy back the preferred shares prior to maturity upon an adverse event such as the loss of Tier 1 capital treatment or the tax deductible status. 

Banks are not permitted to count trust preferred stock 

toward Tier 1 capital because of the cumulative feature 

of trust preferred dividends. While bank holding companies are permitted to include up to 25 percent of Tier 

1 capital as cumulative preferred stock, including trust 

preferred shares, banks must exclude cumulative preferred stock from Tier 1 capital ratios pursuant to the 

Risk-Based Capital Standards set by the Basle Accord. 

Bank Holding Companies of All Sizes 

Have Issued Trust Preferred Stock 

The flood of trust preferred stock issuance was prompted in part by the threat of extinction under the 1997 

federal budget. Bank holding companies rushed to take 

advantage of a potentially short-lived tax loophole, 

while investors were attracted by the opportunity to 

earn higher rates than on similarly rated bank debt. 

Bank holding companies have used proceeds from trust 

preferred stock to retire or call more expensive outstanding preferred issues, to provide capital to bank 

subsidiaries, to finance acquisitions, and to buy back 

common stock. 

As the tax advantage of the trust preferred stock 

remained intact through the budget negotiations, the 

pace of trust preferred issuance subsided from an estimated $4.3 billion in the first quarter of 1997 to just 

under $2.5 billion in the second quarter. Trust preferred 

issuance by larger banks declined as some approached 

their limit on Tier 1 trust preferred, while more smaller 

banks took advantage of the market for trust preferred 

stock. (See Chart 2 for a distribution of the number of 

banks in various size categories that have issued trust 

preferred stock in recent quarters.) Investment bankers 

are reportedly working on new structures that may make 

it easier and more cost effective for smaller institutions 

to issue these capital securities, perhaps through some 

pooling arrangement. 

REIT Preferred Stock—Another Type 

of Tax-Advantaged Tier 1 Capital 

Prior to the Federal Reserve’s announcement last 

October, the REIT (real estate investment trust) preferred stock structure was the chosen way for financial 

institutions to issue tax-advantaged preferred shares. 

Bank-issued REIT preferreds lost favor once trust preferreds debuted, because the trust structure is less costly and easier to administer than REIT preferreds. 

In an REIT preferred structure, the issuer establishes a 

corporation that elects REIT tax status. Proceeds from 

the preferred shares that are sold to investors are used to 

purchase qualifying real estate assets such as mortgagebacked securities or equity interests in real property. 

Cash flow from the real estate assets funds the REIT’s 

CHART 2 

More Small Institutions Issue Trust
 

Preferred Stock
 

Bank Size 

Number of < $10 billion Banks 

$10-100 billion 30 

$100+ billion 25 

20 

15 

10 

5 

0 4Q96 1Q97 2Q97 

Source: Keefe, Bruyette & Woods 

Atlanta Regional Outlook 21 Fourth Quarter 1997 
Regular Features Financial Markets
 

operating costs and preferred dividends. As long as the 

subsidiary continues to qualify for REIT tax status,3 dividend payments on the common and preferred shares 

are tax deductible by the holding company. 

Will the Tax-Advantaged Status of Trust 

Preferred Stock Continue? 

Although the tax-advantaged status of trust preferred 

stock was not eliminated in the federal budget, the possibility still exists that the Internal Revenue Service 

(IRS) may alter the tax treatment of trust preferred dividends. (In the first half of 1997, the IRS issued a ruling 

that eliminated the tax-advantaged status of a specific 

type of preferred stock known as Step-Down preferred 

stock.) If the tax advantage is eliminated, REIT preferred shares might again become a more popular 

means of raising tax advantaged Tier 1 capital. 

Issues and Concerns 

A number of bank holding companies have embarked 

on stock buyback programs financed by trust preferred 

stock issuance, thereby boosting earnings per share by 

reducing the number of common shares outstanding, 

while maintaining Tier 1 regulatory capital ratios. 

Rating agencies and investment analysts, however, 

generally view trust preferreds as analogous to preferred stock or deeply subordinated debt of the issuer. 

In fact, Standard & Poor’s has announced that bank 

holding companies with trust preferred stock in excess 

of 10 percent of Tier 1 capital may be subject to a ratings review. This announcement reflects the view of 

some analysts that trust preferred stock is a weaker 

form of Tier 1 capital than other forms of capital such 

as common and perpetual preferred stock, because of 

its limited life and treatment upon a liquidation of the 

trust. 

A recent regulatory interpretation has underscored the 

debt-like nature of trust preferred stock. The Office of 

the Comptroller of the Currency (OCC) has determined 

that investments by banks in trust preferred stock 

should be treated as investments in debt securities.4 The 

OCC cited a number of similarities between trust preferred stock and debt securities, including the fact that 

an investment in trust preferred securities is functionally equivalent to an investment in the underlying subordinated debt issued by the bank holding company, and 

that the trading characteristics of trust preferred securities are similar to traditional debt securities. 

Banking organizations should be aware of the views of 

rating agencies and bank analysts toward trust preferred 

stock. In times of economic stress, excessive reliance on 

debt-like capital instruments could result in increased 

financial fragility of the overall organization, a higher 

cost of raising new capital, and potential ratings downgrades. In extreme scenarios, pressures on the bank to 

service the obligations (explicit or implicit) of the 

holding company could attract the attention of bank 

regulators. 

Kathy R. Kalser, Chief 

Financial Sector Analysis Section 

3 To qualify as an REIT, the subsidiary must comply with Section 856 

of the U.S. Federal Income Tax Code, which requires that 75 percent 

of the REIT’s income come from real property rents, interest income 

from mortgage debt on real property, and other related sources. In 

addition, the REIT must distribute at least 95 percent of its net income 

to shareholders. 

4 In a letter dated April 8, 1997, the OCC stated that subject to applicable rating and marketability requirements, bank investments in trust 

preferred stock would be treated as Type III investments under 12 

CFR Section 2 1.2 (k). 

Atlanta Regional Outlook 22 Fourth Quarter 1997 
Regular Features	 Regional Banking
 

Current Regional Banking Conditions
 

•	 Although the Atlanta Region’s economy is showing signs of slowing, most commercial banks reported strong 

second-quarter earnings. However, many small banks had second-quarter earnings lower than last year’s. 

•	 During the quarter, the Atlanta Region gained commercial banking assets from other sections of the country as superregional banks in North Carolina consolidated out-of-state operations. 

•	 Given the length of the current economic expansion, insured institutions may wish to reassess the adequacy of loan loss reserves and lending standards. 

•	 The prospects of more frequent and more intense hurricanes and the increased difficulty of obtaining insurance coverage could pose risks to some commercial banks and thrifts in the Atlanta Region. 

Commercial Bank Profits Generally 

Remain High 

For the most part, commercial banks in the Atlanta 

Region continue to report strong earnings even though 

the Region’s economy is starting to slow (see Growth in 

the Atlanta Region Continues to Slow for an analysis of 

current economic conditions in the Region). In the 

aggregate, commercial banks had a second-quarter 

return on assets (ROA) of 1.25 percent, down slightly 

from 1.28 percent for the second quarter of 1996. The 

ROA for commercial banks in the Atlanta Region just 

edged the second-quarter national average of 1.24 percent this year and 1.27 percent a year ago. Return on 

equity (ROE) showed a larger decline, dropping from 

15.33 percent during the second quarter of 1996 to 

14.31 percent in this year’s second quarter. National figures for second-quarter ROE were 14.72 percent this 

year and 15.41 percent last year. The reduction in both 

ROA and ROE is mostly due to lower fee income, primarily at banks with assets over $10 billion. Higher capital levels also contributed to the lower ROE. Currently, 

the leverage ratio stands at 8.89 percent for the second 

quarter, versus 8.40 percent a year ago. 

Another noteworthy item in the second-quarter figures 

is the large addition of commercial banking assets to the 

Region. During the quarter, banking assets in North 

Carolina rose nearly 64 percent from last quarter to 

$343 billion as several of the superregional banks headquartered in the state consolidated their out-of-state 

operations in June. Going forward, the large internal 

reorganization of assets by these companies will limit 

the analytical value of Call Report data for certain geographic areas in the Atlanta Region. 

As seen in Chart 1, the earnings performance at small 

banks—those with assets of $100 million or less—compares unfavorably with last year’s figure in all states 

except Alabama. The drop in ROA is due to higher loan 

loss provisions and overhead and slightly lower fee 

income. The changes in these items were much greater 

at small banks in Florida and North Carolina; the average small-bank ROA in these two states has been well 

below the peer average for the Region the past two 

years. Regionwide, 271 small banks reported a lower 

ROA, with the median decline being 25 basis points. 

However, the news is not totally negative at all small 

banks, as 358 banks had a second-quarter ROA that 

exceeded last year’s. 

The aggregate ROA for Georgia banks showed a precipitous decline, dropping from 1.27 percent last year to 

CHART 1 

Second-Quarter Earnings Are Lower 

at Small Banks 

Note: Small banks include commercial banks with assets of $100 million or less. 

Source: Bank Call Reports 

0.00% 0.25% 0.50% 0.75% 1.00% 1.25% 1.50% 1.75% 2.00% 

WV 

VA 

SC 

NC 

GA 

FL 

AL 

Second Quarter 1997 Second Quarter 1996 

2Q 1997 Region 

Average = 1.10 

2Q 1996 Region 

Average = 1.17 

Atlanta Regional Outlook 23	 Fourth Quarter 1997 
Regular Features Regional Banking
 

0.83 percent this year. As seen in Chart 2, most of the 

decline is due to the loss reported at medium-size banks 

(those with assets between $1 billion and $10 billion), 

which was large enough to move the state average. 

While the six banks in this group reported an ROA of 

− 1.55 percent, down significantly from 1.02 percent a 

Noncurrent 

Loans Loan Loss Reserves 

Net Charge-Offs 

90 days or more and nonaccruals), at 0.82 percent of 

loans, are well below their peak level of 2.5 percent in 

1992. Net charge-offs peaked at 1.25 percent of loans in 

1991, bottomed in 1994 at 0.29 percent, and have since 

trended upward to 0.47 percent in 1996. Nevertheless, 

about one-third of net charge-offs over the past two 

years come from credit card loans issued by monoline 

specialty banks. The charge-off ratio would decline 15 

basis points to 0.32 percent in 1996 if the handful of 

credit card banks were excluded from the analysis. 

In the aggregate, commercial banks in the Atlanta 

Region continue to reduce the relative size of the 

allowance for loan losses. As seen in Chart 3, loan loss 

reserves have declined relative to loans after reaching a 

peak level during the height of the last recession in 

1991. The decline in this ratio is due mostly to loan 

growth. Loan loss provisions have averaged 110 percent 

of net charge-offs the past five calendar years, not 

enough to maintain the loan loss reserve ratio in the face 

of loans growing at a 9.4 percent annual compound rate. 

CHART 2 

Credit Card Bank Drives Down Earnings 

at Georgia Bank Peer Group 

CHART 3 

Since 1994, Reserves Have Declined While
 

Net Charge-Offs and Noncurrent Loans
 

Have Edged Up
 

3.00 

year earlier, only one bank in this peer group actually 2.50 

reported a loss. The poor-performing bank is a credit 2.00 

card bank that is divesting assets in order to facilitate its 

sale. 

% of Loans

1.50 

1.00 

Trends in noncurrent loans and net charge-offs are 0.50 depicted in Chart 3. Noncurrent loans (those past due 

0.00 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 

Source: Bank Call Reports 

Although the ratio of reserves to loans is a way to assess 

reserve adequacy, it should not be the sole measurement 

in the assessment. Ultimately, the composition and 

quality of each institution’s loan portfolio is the primary determinant of an adequate loan loss reserve. For 

some institutions in the Region, a less risky loan portfolio may explain a relative decline in loan loss 

reserves. For example, in the aggregate, residential real 

estate lending as a share of assets increased during the 

period 1987 to 1996. As discussed below, however, 

some institutions have increased their pool of risky 

loans. 

Although most indicators of the health of commercial 

banks are favorable, there are some areas of potential 

concern. First, there has been an increase in the number 

of banks with large real estate construction loan concentrations. Last year, only 228 banks in the Region had 

a real estate construction loan concentration that 

exceeded 5 percent of assets, compared with 266 this 

year. Moreover, 48 banks have a concentration in excess 

of 15 percent of assets, up from 38 last year. Second, the 

rapid annual compound growth rate of loans may result 

in a tendency to understate past-due and charge-off 

3.00 

2.50 

2.00 

ratios; many of these new loans have not seasoned, nor 

have they been recession-tested. Finally, some concerns 

Georgia 

Georgia 2Q 1997 United States

2Q 1996 2Q 1997 

1.50 about underwriting standards continue to surface. The 1.00 recent Federal Reserve Senior Loan Officer Opinion 0.50
 

0.00
 Survey on Bank Lending Practices found that a large 

–0.50 number of banks have eased interest rates and other –1.00 terms on commercial and commercial real estate loans –1.50 

–2.00 because of competitive pressures. In like fashion, the Under $100 Million $1 Billion Over
 

$100 Million to $1 Billion to $10 Billion $10 Billion
 Comptroller of Currency, in Advisory Letter 97-8, alerted national banks to review their reserve practices 

% of Assets 

Source: Bank Call Reports because of concerns about trends in the syndicated loan 

Atlanta Regional Outlook 24 Fourth Quarter 1997 
Regular Features Regional Banking
 

market, a general relaxation of commercial underwriting standards, and possible flawed methods for estimating losses on pools of loans. 

Implications: Given the long economic expansion and 

signs of increased loan underwriting risks at some institutions, a number of industry observers argue that now 

is a good time to revise and strengthen lending and 

reserve practices. Such steps may be particularly important for institutions in the southeast, given some signs 

that the Region’s economy is slowing (see Growth in 

the Atlanta Region Continues to Slow). 

Storm Warnings 

Hurricanes have always posed a risk to some parts of 

the Atlanta Region. Before the start of this year’s season, hurricane expert William M. Gray of Colorado 

State University forecasted a new era of more frequent 

and intense storms. This forecast, if accurate, could 

lead to levels of destruction higher than those in prior 

eras. Moreover, the damage potential has been heightened by the rapid economic growth along the Atlantic 

and Gulf coastlines the past two decades (for further 

analysis of growth trends, see Just Another Hurricane 

Season?). 

While all of the coastal states in the Atlanta Region have 

been devastated by hurricanes, Florida has been struck 

by more storms and experienced the greatest damage. 

As seen in Table 1, the Florida Department of Insurance 

reports that the state has had six storms since 1992 that 

have caused more than $1 million in insured losses. 

Collectively, these storms resulted in insured losses of 

approximately $19 billion. The most devastating storm, 

Hurricane Andrew, struck South Florida in 1992 and 

caused approximately $36 billion in damages (1996 

dollars), with insured losses of about $16 billion. 

TABLE 1 

The large losses from Hurricane Andrew caused many 

insurers to declare bankruptcy or leave the state. 

According to the Florida Association of Insurance 

Agents, nearly 100 of its members went out of business, 

along with many other agencies that were not members. 

One insurance company even paid many of its policyholders a year’s worth of premiums to move their business to another underwriter. As a result, many home 

owners and small-business owners are having difficulty 

finding affordable property and business-interruption 

insurance. The premium rates for some comprehensive 

packages have increased as much as fourfold, and 

deductibles have increased by as much as tenfold over 

their pre–Hurricane Andrew levels. 

Florida is not alone in its insurance problems. Most 

North Carolina insurance companies are reluctant to 

write home owners’ policies along the coastline. 

According to the North Carolina Department of 

Insurance, of the 629 insurance companies licensed in 

the state, only 33 will underwrite policies in the beach 

territory. Of those 33 insurers, 10 companies write 93.6 

percent of the policies and 3 companies write 67 percent. Alabama has had similar experiences with the 

reluctance of insurers to serve its coastline residents. In 

general, fewer insurance companies are willing to 

underwrite policies that cover property located in the 

potential path of a hurricane. 

Because of the dwindling number of private insurers 

willing to underwrite coastal property, several state 

insurance commissioners have enacted joint underwriting funds, which are considered “last resort” insurance 

for property owners who have not been able to obtain 

private insurance. In 1987, the Alabama Insurance 

Underwriting Association established a Beach Plan to 

enable property owners to finance the purchase and 

improvement of their property. The North Carolina 

General Assembly also created a Beach Plan to cover 

Insured Losses from Recent Tropical Storms and Hurricanes in Florida 

STORMS DATES LOSSES 

HURRICANE ANDREW AUGUST 24–26, 1992 $16 BILLION 

HURRICANE OPAL OCTOBER 4–5, 1995 $2.5 BILLION 

HURRICANE ERIN AUGUST 1–4, 1995 $350 MILLION 

TROPICAL STORM JOSEPHINE OCTOBER 4–8, 1996 $65 MILLION 

TROPICAL STORM GORDON NOVEMBER 14–16, 1994 $60 MILLION 

TROPICAL STORM BERYL AUGUST 15–17, 1994 $8 MILLION 

Source: Florida Department of Insurance 

Atlanta Regional Outlook 25 Fourth Quarter 1997 
Regular Features Regional Banking
 

storm damage and the Fair Access to Insurance 

Requirement Plan to cover wind damage. Georgia, 

Virginia, West Virginia, and South Carolina depend 

solely on the private market to provide insurance coverage for storm damage. 

Florida has the most noteworthy plan, known as the 

Florida Residential Property and Casualty Joint 

Underwriting Association (JUA). Although the JUA was 

set up as a last-resort insurer, it has grown rapidly to 

about 900,000 policyholders, or about 100,000 policies 

fewer than the state’s largest private insurer. The JUA 

covers 18 percent of all Florida residents and is heavily 

concentrated in southern Florida, where it has an exposure of more than $4 billion. Another last-resort carrier 

is the Florida Windstorm Underwriting Association 

(FWUA). This state insurer was 

originally set up in 1970 to cover 

high-risk parts of the Florida Keys 

but has grown since to cover property owners in 25 of Florida’s 35 

coastal counties. Although the JUA 

and FWUA provide coverage for 

many that would otherwise be uninsured, their ability to withstand a 

major storm is in doubt, as the 

majority of annual premiums are merely covering routine claims. Many insurance analysts have expressed 

concerns about the financial health of both last-resort 

insurers because their ability to raise a large amount of 

capital on short notice is limited by their small backup 

lines of credit. 

Private insurers are also struggling with the escalating 

cost of reinsurance. As a result of the cost increases, 

many companies have raised their deductibles or loss 

maximums before reinsurance is effective. Most companies have purchased some protection for losses 

caused by a catastrophic storm like Hurricane Andrew. 

However, many companies are not protected if their 

coverage areas are struck by a series of smaller storms 

that have losses below their reinsurance threshold. 

The potential problems with insurance providers, statesponsored and private, could have serious credit-risk 

implications for some commercial banks and thrifts. 

Loans secured by property in coastal areas may be 

underinsured or uninsured. Also, small-business loans 

could become impaired because of a lack of businessinterruption insurance. The risk exposure for insured 

institutions extending credit in coastal areas may have 

increased substantially over the past ten years. For 

example, commercial banks with assets under $250 million headquartered in Florida’s coastal counties have 

increased their residential real estate lending from $2.1 

billion to $5.4 billion and business loans from $0.9 billion to $2.1 billion. Although most lenders in coastal 

areas are cognizant of the risks posed by hurricanes, 

many contend that there is little they can do because of 

the competitive lending environment in which they 

operate. Nevertheless, finding ways to manage and contain potential credit exposure arising from hurricanes 

will be an important challenge to insured institutions in 

these areas. 

Jack M.W. Phelps, Regional Manager 

Pamela R. Stallings, Financial Analyst 

Scott C. Hughes, Regional Economist 

Atlanta Regional Outlook 26 Fourth Quarter 1997 
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