Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION FIRST QUARTER 1998 

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 

◆ Y2K—Preventing the Year 2000 (Y2K) computer problem is becoming ever more 

costly as the time and resources left to do so disappear. Equally costly, according to 

some estimates, will be the litigation that follows in the problem’s wake. A failure to 

address Y2K exposures immediately and successfully may amount to a gamble backed 

by the value of the bank franchise and the officers and directors who run it. See page 3. 

By Gary Ternullo 

◆ Trends in Commercial Real Estate Loan Pricing and 

Underwriting—An abundant supply of financing is placing pressure on commercial real estate loan pricing and underwriting standards. Underwriting standards are being increasingly influenced by the rapid growth in commercial 

mortgage-backed securities and real estate investment trusts. While many within the 

industry believe that broader public funding of commercial real estate projects will 

lead to greater market transparency and improved underwriting discipline, there 

are a number of unique risk considerations related to the rapid growth and continuing development of these alternative funding sources. See page 7. 

By Steven Burton 

◆ Total Return:A Useful Tool for Monitoring Investment Portfolio 

Risk—The Federal Financial Institutions Examination Council is rescinding the 

1991 policy that required “high-risk” testing for mortgage derivative products and 

has released for comment a policy encouraging risk management across all types of 

instruments on an investment portfolio basis. Total return, a concept that includes 

fluctuations in market value, is a useful tool for measuring the performance of an 

investment portfolio and providing information about market risk at the portfolio 

level. See page 13. 

By Allen Puwalski 

Regular Features 

◆ Regional Economy—Growth in the Atlanta Region continues to surpass 

that of the nation as a whole, though by a narrowing margin...in many states, 

only metropolitan areas see gains while the economies of rural counties lag 

behind...though diminishing in size, the Atlanta Region’s agricultural sector continues to play a critical role in rural areas. See page 16. 

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

◆ Regional Banking—Strong performance continues for most insured institutions...institutions are finding alternative funding sources to support 

growth...the Region’s agriculture banks may be facing increased competitive 

risks. See page 21. 

By Jack M.W. Phelps, W. Brian Bowling, 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, FJ, FM, GU, HI, ID, MT, NV, OR, UT, WA, WY)
 

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

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

Information Center for current pricing on bulk orders. 

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

publish/regout. For more information or to provide comments or suggestions about the 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 

Assistant Editors Daniel Frye 

Craig A. Rice 

Publications Manager Teresa J. Franks 
In Focus This Quarter
 

Y2K: Banking in the twenty-first century may provide
 

grand new opportunities—but you have to get there first
 

•	 As a result of a three-decades-old programming 

convention, January 1, 2000, may find some computer systems unable to function correctly, if at 

all. Links within and between systems and organizations make the problem a complex one. 

•	 Cures are expected to be difficult and costly. If 

those cures fail, litigation could be equally costly, 

and much of it may be aimed at directors and 

officers. 

•	 Accordingly, senior bank management should be 

actively involved in making sure the cure takes 

place. A failure to do so amounts to a gamble 

backed by the value of the bank franchise and 

those who run it. 

Complex Problem, Complex Cure 

By now the story is well known. At midnight on 

December 31, 1999, computer systems that process 

dates using only the last two digits of a year will cease 

to function correctly, if at all. Equipment that contains 

embedded systems—chips or circuitry designed to perform specific functions—also may fail. And the problem is pervasive. It lies within systems and between 

systems, in both software and hardware. The large number of ways dates are used, the number of places they 

can occur, and the number of creative ways for naming 

them confounds an accurate assessment. 

Fixing the Year 2000 (Y2K) problem will require considerable time and effort. Computers and applications 

must be inventoried, examined for date usage, corrected 

where necessary, and then tested—not just by themselves but in combination with every other system with 

which they interact. This includes not only a bank’s own 

systems but also those of its servicers, correspondents, 

customers, vendors, and trading counterparties. 

Moreover, there are a variety of ways to address the 

problem, ranging from expanding date fields to four 

digits to simply subtracting 28 years from every date 

before processing—any of which could introduce new 

incompatibility problems when systems that have been 

fixed in different ways attempt to interact.1 And because 

not all systems can be corrected at once, interfaces or 

bridges between corrected and uncorrected systems also 

must be developed to maintain business system continuity. Most important, it must all be done before the 

non-negotiable deadline of December 31, 1999. 

For bank management, there are two ways to find out 

how serious the problem will be. The first is to commit 

resources to determining just how exposed the bank’s 

systems are—the first concrete step in actually solving 

the problem. The second is to gamble the franchise by 

doing little or nothing and letting the century date 

change provide the ultimate stress test. 

Costs 

The costs of a cure are many. First, there are the costs of 

actually finding and fixing the problem. Estimates of 

this cost have ranged widely, although the Gartner 

Group’s estimate of $300 to $600 billion worldwide is 

the most widely quoted. Using a different approach, 

Software Productivity Research (SPR) places the global number at over $1.3 trillion, including a $176 billion 

slice for the United States alone. Then there are the estimated costs of litigation. At the low end, SPR places 

them at $300 billion globally and projects that fully onethird of that amount will be generated in the United 

States. At the high end, the Giga Information Group 

sees a much more litigious future—estimating that 

Y2K-related legal costs could exceed $1 trillion. 

Significant opportunity costs may accrue as well, and 

the degree to which Y2K-related outlays fail to provide 

1 Every 28 years the same combination of dates and days recurs. 

Subtracting 28 years from a date before processing and then adding 

them back upon output has been suggested as a temporary but partial 

remedy because it permits applications to continue measuring time by 

subtracting two-digit years from each other. Windowing is another 

partial correction whereby some two-digit years—say those less than 

“50,” for example—are assumed to be preceded by “20” (thus “49” 

becomes “2049” in date calculations) while the remainder are 

assumed to be preceded by a “19” (thus “50” becomes “1950”). Both 

approaches only delay the need for permanent corrections. 

Atlanta Regional Outlook 3	 First Quarter 1998 
In Focus This Quarter
 

more efficient or functional systems will serve as a 

starting point for measuring the value of technology 

investments forgone. These forgone improvements will 

be especially costly for institutions that have started 

their repairs too late. They may find not only that the 

time for system improvements and upgrades has slipped 

away, but that they have insufficient time for anything 

beyond a patchwork solution that will continue to cost 

them beyond the year 2000. 

At the macro level, the tally of potential Y2K costs 

includes declining stock values, business failures, and 

recession. J.P. Morgan has estimated that as much as 40 

percent of organizations’ remediation costs have not 

been accounted for in their information technology budgets, presumably indicating that many firms will see 

their share value erode as the costs of Y2K fixes and 

related losses are priced into their future earnings. The 

cost of not being Y2K compliant might be substantial as 

well. According to the Gartner Group, as many as one 

in two firms may discover just how substantial as they 

head into 1999 with even their most mission-critical 

systems unfixed. The potential for these firms to fail 

looms large among the factors that have led Edward 

Yardeni, chief economist at Deutsche Morgan Grenfell, 

to assign a 40 percent chance of recession in the year 

2000. Peter de Jager, a consultant who also has commented extensively on Y2K issues, went even further, 

suggesting that 1 percent of all businesses would fail 

because of Y2K problems. Whatever the eventual 

number, many of these businesses will also be bank 

borrowers. 

Systems and Systemic Risks 

More immediate than the risk of borrower failures is the 

risk that a bank’s own systems may fail. Banks are heavily dependent on software applications that employ 

dates. Among other things, they use them for calculating interest paid or due and for managing the horizons 

of their assets and liabilities. If these applications begin 

returning erroneous calculations, bank operations could 

be seriously disrupted.2 If they fail altogether, the bank’s 

2 For example, interest due from borrowers for a one-year period 

beginning in 1999 and ending in 2000 might be calculated not as one 

year’s interest due but rather as nearly one century of interest payable 

(00 − 99 = − 99) if only the last two digits of the year are used in the 

calculation. Similarly, any other time calculation that straddles the 

century date change might return answers wrong in both size and 

sign. 

credibility—and hence its franchise value—can be substantially damaged or even irrevocably lost. 

The solution is often described in software terms, but 

executable software is not the only problem. Correcting 

software to process four-digit years does little good if 

bank databases that store the critical information about 

who owes what to whom and when still store them in 

two-digit form. Hardware is another critical area. 

Nearly all electronic devices have embedded, permanently programmed chips that can be difficult to find 

because the functions they perform are not always 

apparent. This situation could lead to a host of nuisances, with automated teller machines, point-of-sale 

terminals, bank vaults, check and credit card processing 

equipment, and even building systems succumbing to 

the Y2K problem. 

This dependence on external components and services 

creates a systemic exposure as well. The substantial 

efficiencies that now exist in transmitting payments 

among and between banks and borrowers are a direct 

result of technology. Servicers and 

clearinghouses fulfill computerintensive intermediary roles in this 

high-velocity business—pooling 

payments from those who owe and 

redistributing them among those 

to whom they are due. Anything 

that interrupts these flows can 

have a substantial impact on the ability of banks to settle with their customers and with each other. 

Accordingly, both the Bank for International 

Settlements and the U.S. Federal Reserve are concerned 

about the Y2K threat for two reasons—first because it 

can interrupt the operations of systems dedicated to 

making interbank payments and second because it can 

interrupt the operations of the individual participants 

and generate a liquidity shock that could cause other 

institutions to fail. 

Unfortunately for banks, even a fully successful, 

industry-wide Y2K fix will not completely mitigate 

their risk. The year 2000 story is simply too dramatic 

and lends itself too well to sensationalism. Therefore, 

in addition to managing the cure, bankers will have to 

manage the perceptions of their customers and of the 

public at large—a considerable challenge given that a 

loss of confidence by a small number of customers 

could precipitate liquidity problems for institutions 

even in the absence of a genuine threat. 

Atlanta Regional Outlook 4 First Quarter 1998 
In Focus This Quarter
 

Liability in the Executive Suite 

It bears frequent repeating that Y2K is a business problem and not just a technical one. Its intricacies go 

beyond those of the systems themselves and extend into 

the labyrinth of business relationships and fiduciary 

obligations that bind directors and officers—and the 

assorted attorneys, auditors, consultants, and service 

providers who assist them—to their banks. Through this 

network could pass liability and litigation that could be 

several times the cost of fixing the problem itself. And 

although the problem may have had a technical origin, 

claims would likely be directed against those with deeper pockets who jointly and severally, it will be argued, 

should have corrected or disclosed the institution’s Y2K 

exposures. 

While the bank failures of the late 1980s and early 

1990s are often attributed to unforeseen economic 

events, it will be difficult to assert such a defense for a 

failure to address the Y2K problem. It is simply too visible and offers too much advance notice. This is one reason why the potential potency of Y2K litigation should 

be taken seriously. Moreover, placing the blame, no 

matter how well deserved, at the feet of vendors and 

consultants may offer little protection. The Federal 

Financial Institutions Examination Council (FFIEC) 

has indicated that senior bank management should be 

fully aware of their vendors’ progress and develop contingency plans should those vendors fail.3 This pronouncement has elevated the standard for prudent Y2K 

actions in such a way as to make imperative the active 

involvement of top bank management in both solving 

3 Safety and Soundness Guidelines Concerning the Year 2000 Business 

Risk, December 1997. The full text is available on the FFIEC website 

at www.ffiec.gov. 

Managing the Y2K Process 

On May 5, 1997, the Federal Financial Institutions Renovation. Renovation includes not only fixing the 

Examination Council—an interagency group com- problem internally but monitoring the efforts of cusposed of the Federal Deposit Insurance Corporation, tomers, counterparties, vendors, and service 

Federal Reserve, Office of the Comptroller of the providers. The prudent execution of due diligence and 

Currency, Office of Thrift Supervision, and National best practices at this stage will provide a measure of 

Credit Union Administration—released a statement confidence that exposures have been addressed. It 

on Year 2000 project management awareness that will also provide a measure of protection from liabilincluded an outline of the Y2K management process. ity claims should problems nevertheless emerge. 

That outline identified five phases that each financial 

institution would have to navigate in identifying and Validation. Validation means testing how a bank’s 

fixing its Y2K exposures: systems will respond on their own as well as when 

connected with those outside the bank. The FFIEC 

Awareness. Before Y2K exposures can be fixed, they believes that one full year should be available for testmust be seen as problems. Creating awareness, how- ing and correcting problems that either remain or are 

ever, is not easy because the pervasiveness of compo- introduced by the renovation process. Accordingly, 

nents and intersystem links that can harbor or pass the institutions should plan on completing the previous 

problem create complexities that are neither intuitive three phases by the end of 1998. 

nor easily quantified. However, it is critical that senior 

managers understand the problem and fully support Implementation. Testing corrected systems to ensure 

the commitment of resources to fixing it. their compliance does not complete the process. The 

final step is to gain acceptance by the users as to the 

Assessment. In this phase, all information systems, ability of the system to satisfy business requirements. 

electronic equipment, and building systems must be A failure at this stage will require further correction 

evaluated for specific Y2K exposures. Remediation or the implementation of contingency plans. 

plans must then be devised. In addition to plans for 

fixing the problem, contingency plans will be needed For the full text of this and other FFIEC guidance, see
 

as a precaution against unforeseen Y2K failures orig- the FFIEC website at www.ffiec.gov.
 

inating from both within and outside the bank.
 

Atlanta Regional Outlook 5 First Quarter 1998 
In Focus This Quarter
 

the problem and ensuring that the franchise will be protected if one or more of those solutions fail. 

Betting the Franchise 

The FFIEC has divided Y2K remediation into five 

phases—awareness, assessment, renovation, validation, 

and implementation (see Inset 1, page 5). As a benchmark for progress, the FFIEC has indicated that the validation phase—the phase in which testing of Y2K fixes 

is conducted—should be well under way for all banks 

by the end of 1998. This leaves less than a year for laggards to complete the first three phases. Banks that are 

not devoting adequate resources to identify and address 

their exposures need to be aware that the consequences 

of delay or inaction could be severe. The bank supervisory agencies, Congress, and the financial markets are 

taking the risk to heart. So too are attorneys intent on 

sharing in what has been described as potentially the 

most expensive litigation in history. 

Insurance companies are concerned as well, as evidenced by extremely high Y2K policy premiums or outright refusal to write Y2K coverage. Thus, any business 

interruptions and liability that emerge may have to be 

financed from the bank income statement and balance 

sheet. As such, a bet that Y2K will not be a problem 

might well amount to a gamble backed by the bank franchise and those who run it. (See Inset 2 below for additional sources of information.) 

Gary Ternullo, Senior Financial Analyst 

gternullo@fdic.gov 

For Further Information 

Further information on the Y2K problem can be obtained from banking regulatory agencies at the websites shown 

below. 

Federal Deposit Insurance Corporation (FDIC) www.fdic.gov 

Federal Financial Institutions Examination Council (FFIEC) www.ffiec.gov 

U.S. Federal Reserve Board of Governors www.bog.frb.fed.us 

National Credit Union Administration (NCUA) www.ncua.gov 

Office of the Comptroller of the Currency (OCC) www.occ.treas.gov 

Office of Thrift Supervision (OTS) www.ots.treas.gov 

The following websites contain additional information concerning the Y2K problem. Their inclusion here does 

not serve as an endorsement by the FDIC of any information contained therein. 

Market Partners Inc.—Year 2000 Resources for Banks www.marketpartners.com 

Gartner Group—Technology Consultant www.gartner.com 

Software Productivity Research (SPR)—Technology Consultant www.spr.com 

De Jager LLC (Peter de Jager)—Technology Consultant www.year2000.com 

Giga Information Group—Technology Consultant www.gigaweb.com 

Y2K LLC (Williams, Mullen, Christian & Dobbins)—Attorneys www.Y2K.com 

Economics Network (Dr. Edward Yardeni)—Economist www.webcom.com/yardeni 

Atlanta Regional Outlook 6 First Quarter 1998 
In Focus This Quarter
 

Trends in Commercial Real Estate 

Loan Pricing and Underwriting 

•	 An abundant supply of capital is placing signifi- CHART 1 

cant pressure on commercial real estate loan Banks’ Commercial Real Estate and pricing. Construction Lending Rebounds 

• Considerable evidence suggests that a large per- Construction Loans 

centage of insured institutions are easing commercial real estate and construction lending 

underwriting standards. 

• The rapid rise in commercial mortgage-backed 

securities and real estate investment trust funding 

could change the way banks underwrite commercial real estate loans and have important effects 

on their competitive position in the lending 

Year-over-Year (%) Growth

20 Commercial Real Estate Loans 

10 

0 

–10 

–20 

–30 

YE90 YE91 YE92 YE93 YE94 YE95 YE96 3Q97 

markets. 

As reported in last quarter’s Regional Outlook, banks 

provided the largest share of funding for commercial 

real estate during 1995 and 1996 compared with all 

other financing sources (see Strong Demand and 

Financial Innovation Fuel Rebounding Commercial 

Real Estate Markets). Chart 1 shows that banks’ commercial real estate and construction lending continues 

to increase and that year-over-year growth rates in these 

two loan categories are accelerating. At the same time, 

however, alternative funding sources in the form of 

commercial mortgage-backed securities (CMBS) and 

real estate investment trusts (REITs) are also experiencing significant growth. Commercial Mortgage Alert 

reports that $26 billion in CMBS was issued through 

September 1997, up from $17 billion for the same period in 1996. The same publication projects that CMBS 

issuance will top $40 billion during 1997, compared 

with last year’s record issuance of $29.8 billion. 

Measures of REIT activity also indicate impressive 

growth. According to the National Association of Real 

Estate Investment Trusts, REITs issued $26.3 billion in 

equity through October, compared with $12.3 billion 

for all of 1996. In addition, REIT market capitalization 

rose $50 billion (64 percent) through the first nine 

months of 1997. 

While it is good news to borrowers, the abundance of 

capital for commercial real estate projects raises the 

often-quoted concern that “too much money is chasing 

too few deals.” Market observers worry that fierce competition and an excessive supply of financing are leadSource: Commercial Bank Call Reports 

ing to both inadequate loan pricing relative to risks 

borne by lenders and looser loan underwriting standards. This article examines current trends in commercial real estate loan pricing and loan underwriting. It 

also explores the possible influences of CMBS and 

REITs on loan underwriting practices and commercial 

real estate markets. 

An Abundance of Capital Has Placed 

Significant Pressure on Commercial Real 

Estate Loan Pricing 

Chart 2 (next page) shows that prime-graded commercial mortgage spreads have steadily declined since 1992 

and are now at levels not seen since the real estate boom 

years of 1988 and 1989. At 113 basis points above tenyear treasuries, current spreads on ten-year commercial 

mortgages are only slightly higher than A-rated ten-year 

industrial corporate bonds, which traded at spreads of 

66 basis points over comparable-term treasuries as of 

September 1997. Some property sectors have experienced more narrowing of spreads than others. 

American Council of Life Insurance (ACLI) data show 

that mortgage spreads relative to treasuries compressed 

31 basis points for industrial, 22 basis points for hotel, 

21 basis points for retail, 11 basis points for multifamily, and 10 basis points for office real estate from March 

1996 to March 1997. Moreover, because of continuing 

downward pressure, current pricing varies little across 

Atlanta Regional Outlook 7	 First Quarter 1998 
In Focus This Quarter
 

CHART 2 CHART 3 

Commercial Mortgage Spreads Are Pricing Narrows between High- and 

Tightening 

Basis Point Spread over

Ten-Year Treasuries 

Source: Barron’s/John B. Levy 

0 

50 

100 

150 

200 

250 

Jan ’87Jan ’89Jan ’91Jan ’93Jan ’95Jan ’97 

Spread between AAA and BBB


Grades (Ten-Year Average Life)
 

Medium-Grade CMBS 

Basis Points 

140 

120 

100 

80 

60
 

40
 

20
 

0 

Q1 ’95Q3 ’95Q1 ’96Q3 ’96Q1 ’97Q3 ’97 

Source: Nomura Securities International 

the quality spectrum. For instance, Chart 3 indicates 

that spreads between AAA- and BBB-rated CMBS have 

narrowed considerably since year-end 1995, from 110 

basis points to a scant 28 basis points. 

It seems likely that competitive factors will continue to 

place pricing pressure on lenders. The relatively recent 

entrance of Wall Street firms into the financing arena 

via conduits is a striking example of just how competitive the market for commercial real estate financing has 

become.1 Conduits are rapidly becoming the dominant 

issuer of CMBS and underlie much of the rapid growth 

in CMBS noted above. Through the first nine months of 

1997, Commercial Mortgage Alert reported that conduits accounted for 50 percent of total CMBS issuance, 

compared with 30 percent during the same period in 

1996. 

Many industry participants see conduits and REITs as 

significant and increasing competitive threats to traditional lenders. For example, a recent issue of 

Commercial Real Estate South discussed the continuing expansion of conduit business into a much wider 

range of property and credit quality types. This publication noted that conduits have a particular incentive to 

aggressively pursue higher quality loans in order to 

strengthen pools that contain weaker credits. Such 

aggressiveness threatens to squeeze banks’ profit margins on low-risk deals, which might give banks an 

incentive to pursue lower quality credits. Given their 

focus on larger credits, conduits presently pose a competitive threat primarily to larger lenders. However, the 

1 Conduits are entities created to originate mortgage loans for distribution to investors in the secondary market. 

rapid growth of capital within the industry may eventually force larger lenders to target smaller markets, which 

would in turn increase competition at the regional or 

local community level. While their influence is less 

direct, the growing use of REITs to finance commercial 

real estate projects also places pressure on loan pricing 

spreads, since lenders must compete for a smaller pool 

of customers. With their access to a seemingly limitless 

source of public funding, REITs could pose a particular 

threat to community bankers by dominating certain geographic markets or property sectors. 

Narrowing pricing spreads raise concerns over whether 

lenders are being adequately compensated for the operational, funding, credit, and market risk inherent in 

originating, servicing, and holding commercial real 

estate loans. More important, tightening spreads raise 

prospects that lenders will ease other loan terms and 

relax loan standards to the extent that they are unable to 

differentiate their product based solely on price. While 

such easing may enable lenders to retain business in the 

face of stiff competition, imprudent underwriting could 

ultimately lead to higher loan losses than would otherwise be the case in the event of a downturn in commercial property markets. 

Are Commercial Real Estate Loan Underwriting 

Standards Becoming Looser? 

Most industry experts have argued that the memory of 

the real estate downturn of the late 1980s and early 

1990s keeps lenders from becoming overly aggressive 

in making commercial real estate loans despite the 

abundance of funding alternatives currently available to 

Atlanta Regional Outlook 8 First Quarter 1998 
In Focus This Quarter
 

borrowers. These experts point out that today’s loan-tovalue (LTV) ratios are lower than they were at the peak 

of the last real estate boom, that lenders are concentrating more on obtaining adequate debt-coverage ratios, 

and that lenders are requiring borrowers to bring more 

cash equity to the table. One might also argue that practices have improved and become much more uniform 

with the implementation of regulatory appraisal standards and the adoption of interagency guidelines for 

real estate lending policies. Rating agencies impose 

additional guidelines and standards as lenders originate 

loans for possible sale into the secondary markets. 

While information about specific quantitative underwriting criteria applied to new loan originations by 

commercial banks is not readily available, some sense 

of industry trends may be gleaned from competitors’ 

practices. For example, the ACLI performs a quarterly 

survey of underwriting criteria for commercial real 

estate loan commitments originated by major life insurance lenders. The ACLI’s second quarter 1997 survey 

indicated that new commitments (total volume of $4.1 

billion) had a weighted average LTV for all property 

types of 66 percent and a weighted average debt-coverage ratio (DCR)2 of 1.6 times. These figures compare 

favorably to an LTV ratio in late 1989 approaching 75 

percent and a DCR just under 1.3 times. 

ACLI data suggest that recent commercial mortgage 

originations are better supported by borrower equity 

and property cash flows than they were in the late 

1980s. It is important to recognize, however, that LTV 

and DCR ratios are driven largely by market conditions 

and expectations. Property valuations take into account 

recent sales and expected cash flows, and cash flows 

available to service debt are based on projected net 

operating revenues, which often incorporate projected 

increases in rents and other revenue sources. In other 

words, the overwhelmingly favorable conditions in 

today’s real estate markets may also be a factor in the 

improved LTV and DCR ratios. Keeping in mind the 

cyclical nature of real estate, one can easily see how a 

shift from today’s positive outlook to a more pessimistic 

outlook might result in a sharp reversal in these commonly cited ratios. 

Notwithstanding these quantitative considerations, 

there are indications that banks are easing commercial 

2 The debt-coverage ratio measures annual net operating income generated by a property relative to annual principal and interest payments 

due on the underlying loan. 

real estate underwriting standards. This evidence, 

derived from industry and examiner surveys conducted 

by the three banking agencies, includes the following 

observations: 

•	 In the Office of the Comptroller of the Currency’s 

(OCC’s) 1997 Survey of Credit Underwriting 

Practices, OCC examiners reported eased commercial real estate lending standards in 38 percent of 

banking companies surveyed. For comparison purposes, the 1996 survey reported eased standards in 

16 percent of banking companies surveyed. Among 

institutions with eased lending standards in the 1997 

survey, examiners noted a 75 percent incidence of 

reductions in loan fees or rate spreads, a 43 percent 

incidence of eased guarantor requirements, and a 29 

percent incidence of lower collateral requirements. 

Examiners cited competitive factors and a change in 

economic outlook as the main reasons for changes in 

underwriting standards. 

•	 Chart 4 summarizes current and historical results of 

the Federal Reserve Board Senior Loan Officer 

Opinion Survey for responses to the question of 

whether bank credit standards for approving applications for commercial real estate loans have eased, 

tightened, or remained unchanged. These survey 

results show that banks have had a tendency to ease 

underwriting standards since the fourth quarter of 

1996. This tendency appears to have become 

stronger through the third quarter 1997 survey but 

moderated somewhat in the most recent survey. The 

most recent survey showed that large banks (over 

$15 billion in assets) were much more likely to indicate easing commercial real estate standards than 

CHART 4 

Survey Shows Tendency to Ease Commercial 

Real Estate Underwriting Standards 

Percentage 

Source: FRB Senior Loan Officer Opinion Surveys 

2Q96 3Q96 4Q96 1Q97 2Q97 3Q97 4Q97 

–15 

–10 

–5 

0 

5 

10 

15 

20 

25

 % Respondents Tightening

 % Respondents Easing

 Net % Tightening (Easing) 

Atlanta Regional Outlook 9	 First Quarter 1998 
In Focus This Quarter
 

smaller banks. Specifically, 21 percent of large 

banks reported easing standards, while only 3 percent reported tightening standards. In comparison, 

only 9 percent of smaller banks reported easing 

standards, while 13 percent reported tightening 

standards. 

•	 Results from the FDIC Report on Underwriting 

Practices indicate possible easing of standards for 

construction and development (C&D) loans at 

FDIC-supervised banks. A comparison of examiner 

responses for the third quarter 1997 survey (covering 

examination reports filed from April through 

September 1997) with responses for the third quarter 

1996 survey leads to the following observations3

: 

•	 The percentage of banks frequently or commonly 

originating C&D loans tied to speculative projects 

(that is, projects lacking meaningful preleasing or 

presales, or loans without a formal take-out commitment for permanent financing following completion 

of construction) rose markedly, from 11 percent to 

29 percent. 

•	 The percentage of banks frequently or commonly 

granting C&D loans without considering alternative 

repayment sources other than income generated by 

the project being financed rose significantly, from 8 

percent to 20 percent. 

•	 The percentage of banks frequently or commonly 

basing C&D loans on unrealistic appraisals rose 

from 5 percent to 11 percent. 

•	 The percentage of banks frequently or commonly 

funding or deferring interest payments during the 

term of construction loans rose from 7 percent to 15 

percent. 

Much of the commentary in recent issues of various 

trade journals echoes the results of these regulatory surveys.4 In brief, many industry participants are seeing a 

higher incidence of (1) banks funding construction loans 

without preleasing commitments on major portions of 

rentable space, (2) banks easing LTV ceilings, (3) 

3 The authors of this survey note that comparisons of survey results 

across time periods must be interpreted with caution since the survey 

samples are dictated principally by examination scheduling factors. 

As a result, sample populations may be materially different from one 

period to another. 

lenders curtailing reserve requirements for such items as 

tenant improvements and insurance, and (4) nonrecourse 

lending. Some industry participants have also noted the 

increasing acceptance of “trended rents,” whereby property valuations are based on positive rent projections 

extrapolated several years into the future. Of course, 

these trended rents will hold true only if economic circumstances remain favorable for extended periods— 

an assumption that may not be reasonable given 

the cyclical nature of real estate coupled with 

the advanced age of the current economic 

expansion. 

With a combination of relatively low 

interest rates, rising real estate prices, 

and an expanding economy, it is perhaps not too surprising that some 

lenders have eased commercial real 

estate underwriting standards. Such 

easing may be a natural response to 

improved confidence in the real estate 

markets. However, indicators that show 

loosening standards may also be warning flags that lenders have succumbed to tighter pricing 

and competitive pressures. To avoid losses like those 

sustained by banks during the last real estate downturn, 

prudent lenders will refrain from incorporating unrealistic expectations into their lending practices. 

CMBS Could Change the Way 

Lenders Underwrite Loans 

Much as residential mortgage lending standards were 

shaped by the advent of mortgage-backed securities, 

CMBS promise to change the way banks underwrite and 

service commercial real estate loans. For instance, lending terms and practices could become increasingly standardized as lenders attempt to improve the liquidity and 

marketability of their commercial mortgage portfolios. 

Banks that choose to deviate from these emerging standards will sacrifice flexibility in terms of their ability to 

manage portfolio risks and respond rapidly to liquidity 

demands. 

The ability to securitize commercial real estate loans 

also may fundamentally alter the way lending decisions 

4 See, for example, Commercial Real Estate South, “Public Markets 

Fuel Financing Glut” (October 1997); Midwest Real Estate News, 

“Wall Street and Main Street Squeeze Lenders” (October 1997); and 

Commercial Property News, “Michelson, Greenland Seize Low 

CMBS Spreads” (1 May 1997). 

Atlanta Regional Outlook 10	 First Quarter 1998 
In Focus This Quarter
 

are made. Before the development of CMBS markets, 

loan approval was essentially a binary, good-or-bad, 

accept-or-reject decision whose primary focus was on 

the credit risk inherent in a single asset. In contrast, the 

most important elements in CMBS are deal structure, 

price execution for multiple tranches, credit enhancements, and portfolio composition. Here, the loan originator is more likely to use a portfolio approach in 

making credit decisions: That is, how will this loan 

enhance the expected return and risk diversification of 

the overall pool? 

External rating agencies will become increasingly 

important as CMBS markets expand, since these agencies’ guidelines will effectively dictate the underwriting 

standards applied to securitized loans. While such standardization could arguably improve market discipline 

and loan performance disclosure, there are several 

potential risks to consider as the CMBS markets evolve: 

•	 While rating agencies do incorporate qualitative considerations into their analysis, issue ratings and credit enhancement level decisions are driven primarily 

by quantitative factors, namely debt service coverage 

and expected loss levels. Moreover, most of the qualitative factors the agencies consider involve an 

analysis of portfolio balance and pool diversification. Hence, weak or poor qualitative standards (for 

example, lack of alternative repayment sources or 

minimal borrower equity in the project) applied to 

individual loans within the pool may receive only 

secondary consideration. A quantitative perspective 

also ignores such immeasurable factors as borrower 

“character” and the existence of long-standing 

lender-borrower relationships. 

•	 Rating agencies cannot be relied upon as a backstop 

to unsound underwriting practices. While they generally review a substantial volume of the loans within a pool, typically the largest individual credits, they 

are not practically able to review every credit in the 

securitization. Some within the industry have even 

suggested that investment bankers commonly move 

one problem property, discovered through one 

agency’s sample, into pools reviewed by another 

agency in the hope that it will not be sampled. 

•	 Competition among the rating agencies could 

become a factor in the underwriting process. This 

“shopping of the agencies” could result in continual 

pressure for rating agencies to ease their underwriting guidelines. 

•	 In theory, bank-issued CMBS transfer much of the 

underlying credit risk associated with commercial 

real estate lending to investors. However, like other 

types of asset securitization, CMBS raise concerns 

over the degree to which banks will voluntarily 

absorb investor losses. Bank issuers may be more 

likely than nonbank issuers to provide voluntary support to poorly performing CMBS for at least two reasons: A tarnished reputation in one aspect of a bank’s 

operations could carry over to other business activities like deposit taking and borrowing due to a bank’s 

broad brand name association within the marketplace; and banks often have greater financial 

resources than nonbanks with which to support securitization activities. 

Because the rapid growth in CMBS has been a relatively recent phenomenon, current underwriting guidelines 

applied by the rating agencies to CMBS have not been 

tested during a cyclical downturn in real estate prices. It 

remains to be seen how the market will react to rising 

loan losses that result in investor losses. 

Will Increased Public Funding through CMBS 

and REITs Improve Market Discipline? 

Many contend that the increased transparency brought 

to the market by CMBS will temper cyclical swings in 

real estate values. This viewpoint argues that investors 

will serve as a constraint against the natural tendency to 

overbuild commercial real estate during boom periods, 

since less funding will be allocated to segments of the 

market where excess capacity exists. This viewpoint 

presupposes that the investing public is sophisticated 

enough to recognize when markets are out of balance 

and when projects are economically infeasible. In this 

sense, CMBS shift much of the burden of monitoring 

credit quality standards and credit performance from 

lenders to public investors. 

In contrast, others have argued that lenders are much 

better suited than investors to make judgments about 

credit quality standards and project feasibility. This line 

of reasoning suggests that the increase in public ownership of property through CMBS and REITs could actually reduce market discipline, since the most 

sophisticated participants with access to the best information (that is, lenders) may come to have less at stake 

in making prudent credit decisions. Of course, excessive losses attributable to any one CMBS issuer might 

lead to differentiation in pricing based on investors’ 

Atlanta Regional Outlook 11	 First Quarter 1998 
In Focus This Quarter
 

perceptions of the quality of underwriting applied by 

specific issuers.5 

Putting market efficiency arguments aside, the sheer 

volume of REIT and CMBS activity causes some concern over the extent to which such financing is driving 

property valuations. With such an abundance of capital 

flowing into the commercial real estate market, it is perhaps easy to see why lenders might opt to ease standards 

rather than lose business. However, to the extent securitization activities are driving decisions in today’s commercial real estate markets, lenders might wish to 

consider how property values would react if the availability of such financing were sharply diminished. The 

most recent real estate downturn provided a ready 

example of how tighter credit availability compounded 

the effects of declining commercial property values by 

limiting the ability of lenders to sell distressed properties. While there may not be consensus on whether 

CMBS and REITs will temper cyclical price swings, the 

underwriting standards and practices evolving in 

response to these financing vehicles will likely play a 

crucial role in determining the magnitude of losses 

experienced by investors and banks during the next 

downturn in commercial property values. 

Steven Burton, Senior Banking Analyst 

sburton@fdic.gov 

Selected Articles
 

for Further Reading
 

Bloomfield, Craig. “Michelson, Greenland Seize 

Low CMBS Spreads.” Commercial Property News. 

1 May 1997. p. 33. 

“CMBS Issuance Seen Topping $40 Billion.” 

Commercial Mortgage Alert. 10 November 1997. 

p. 1. 

Fitch Investor Services, Inc. “Commercial 

Mortgage Stress Test.” Fitch Research: Structured 

Finance Special Report. 8 June 1992. 

Office of the Comptroller of the Currency. Advisory 

Letter 97-3: Credit Underwriting Standards and 

Portfolio Credit Risk Management. 3 March 1997. 

Sinderman, Martin. “Public Markets Fuel 

Financing Glut.” Commercial Real Estate South. 

October 1997. p. 1. 

Wolf, Barney. “Wall Street and Main Street 

Squeeze Lenders.” Midwest Real Estate News. 

October 1997. p. 1. 

5 The evolution of the credit card securitization markets is one example of how investors now differentiate between issuers in terms of 

pricing. 

Atlanta Regional Outlook 12 First Quarter 1998 
In Focus This Quarter
 

Total Return: A Useful Tool for
 

Monitoring Investment Portfolio Risk
 

•	 The Federal Financial Institutions Examination 

Council (FFIEC) is replacing the 1991 policy that 

contained a specific “high-risk test” for mortgage 

derivative products (MDPs) held by insured institutions with a policy that encourages risk management across all types of instruments on an 

investment portfolio basis. 

•	 A good way to start measuring portfolio risk is by 

monitoring an appropriate measure of return. 

•	 Total return, a concept that includes fluctuations 

in market value, is a more appropriate tool than 

simple yield for measuring the performance of an 

investment portfolio, especially one that contains 

bonds with embedded options. 

The Federal Financial Institutions Examination Council 

(FFIEC) has released for comment a new Joint Agency 

Policy Statement on Investment Securities and EndUser Derivatives Activities that will replace a statement 

issued February 3, 1992. While much of the content of 

the former statement has been retained, the section 

requiring specific “high-risk” testing for mortgage 

derivative products (MDPs) has been eliminated. The 

“high-risk” test applied specifically to bonds collateralized by residential mortgage pass-through certificates 

or whole loans but that distributed cash flows to bondholders on a basis other than pro rata.1 

The goal of the original policy statement was to deter 

banks from investing in products that presented risks 

that they were not able to adequately monitor and control. MDPs were singled out because of their rapid 

growth, nontraditional and potentially risky nature, and 

common use by insured financial institutions. The new 

policy states that, as a sound management practice, 

institutions should conduct prepurchase and ongoing 

analysis of all their investments at a level appropriate to 

the size and complexity of those holdings. 

1 A security was deemed “high risk” if it exhibited any of the following characteristics: (1) it had a weighted average life of more than ten 

years; (2) its average life extended by more than four years or shortened by more than six years from a 300 basis point parallel shift in 

rates; (3) its price changed by more than 17 percent given a 300 basis 

point parallel shift in rates. 

The policy change is in part a response to increasing 

bank investment in securities that have complex cash 

flows analogous to MDPs but that escaped the analysis 

requirement of the previous policy. Mortgage index 

amortizing notes are an example of popular bank investments that potentially exhibit all the risks of MDPs but 

were not subject to the testing requirement of the soonto-be rescinded policy because they are not collateralized by mortgages. Callable agency and “step-up” 

bonds are popular bank investments because they offer 

a slightly larger spread to Treasury than noncallable 

agency securities, and they were not subject to the 

“high-risk” test under the old policy. However, the additional yield offered on these kinds of securities compensates the investor for assuming additional risk. 

Appropriately measuring portfolio return can enhance 

the ability to monitor the extent to which these kinds of 

securities put future earnings at risk. 

Total Return Analysis Is a Useful Tool for 

Analyzing Risk at the Portfolio Level 

Total return analysis is a basic but useful tool that can 

alert management to the level of certain risks in an 

investment portfolio. It can also provide information 

that is useful for validating the assumptions used in 

more sophisticated models. Total return is calculated 

from three components: beginning price, income and 

reinvested cash flow, and ending price (market value) at 

a horizon date. Total return incorporates the change in 

the market value of the investment, resulting in a more 

comprehensive measure of performance than other 

measures that ignore such changes. Monitoring total 

return on a portfolio basis can provide institutions with 

important information about the risks inherent in the 

portfolio and how these risks may be changing over 

time. 

In two articles in the ABA Banking Journal,

2 Nicholas 

Betzold and Richard Berg convincingly dispute the 

2 The articles were published in December 1996 and April 1997. 

Reprints of the articles are available at the ABA Banking Journal website at http://www.banking.com.aba/backissues.htm. 

Atlanta Regional Outlook 13	 First Quarter 1998 
In Focus This Quarter
 

view that if the investment strategy is to buy and hold to 

maturity, total return is not relevant. Consider the following example. In 1990, Bank A purchases a sevenyear security yielding 8.83 percent that is callable after 

three years. At the same time, Bank B buys a noncallable seven-year agency security yielding 8.53 percent. For three years, Bank A’s bond yields 30 basis 

points more than Bank B’s. However, from 1990 to 

1993, interest rates fell almost 300 basis points. Bank 

A’s bond would likely be called, forcing the bank to 

reinvest at a significantly lower rate for the remaining 

four years of the seven-year investment horizon. Over 

the seven-year horizon, Bank A could expect an average 

yield that is about 150 basis points less than Bank B’s. 

From the yield perspective, 

Bank A enjoyed three years of 

superior performance. However, during those three years, 

monitoring total return might 

have revealed a less favorable 

but more accurate picture of 

Bank A’s performance relative 

to Bank B’s. Here is why: As 

rates fell from 1990 to 1993, bonds gained in value. 

However, as rates fell, the market value of the callable 

security would have gained incrementally less than the 

noncallable bond because each downward tick in rates 

increased the expectation that the bond would be called, 

and the higher coupon would be earned over a shorter 

period. In contrast, the noncallable security’s market 

value would have enjoyed the full benefit of the falling 

rate environment because its maturity and cash flows 

are fixed. 

The disparate change in the market value of the two 

bonds reflects the fact that Bank A, in essence, sold a 

call option to the bond issuer. The issuer bought the 

right to repurchase the debt at par after three years. 

Bank A was compensated for selling this right to the 

issuer with increased yield. In the example, the issuer’s 

option to call the bond would have gained value as rates 

fell. The increasing positive value of the call option to 

the issuer represents an increasing negative value to the 

bondholder and erodes the value of the bond. 

Step-up bonds present reinvestment risk similar to that 

of generic callable bonds, but with the added complexity of a coupon that rises, usually annually, if the bonds 

are not called. Total return analysis would similarly 

reveal adverse changes in the value of the embedded 

call options and the extent to which the additional 

coupon is compensating for call risk. 

UBPR Yield 

Bank management often uses the portfolio yield that is 

calculated in the Uniform Bank Performance Report 

(UBPR) to assess performance of the bank’s securities 

portfolio against its peers. This yield measure is calculated by dividing annualized book income on a tax 

equivalent basis (plus or minus amortization or accretion of any premium or discount) by the amortized cost 

of the securities. This measure of present yield says little about potential future yield and the extent to which, 

because implicit options have been sold, the latter has 

been put at risk for the sake of the former. 

Total return measures the risk-adjusted return of a portfolio more closely than yield because it incorporates 

changes in reinvestment risk over time. Ultimately, a 

portfolio manager who earns total returns consistently 

higher than average will earn more in terms of simple 

yield. Conversely, a manager who earns less in terms of 

total return will eventually find an unfavorable reinvestment environment that will erode reported yield. 

The popularity of using yield to gauge the performance 

of bank securities portfolios may be due to the convenient presentation of bank peer portfolio yields in the 

UBPR. Some managers may be reticent to evaluate 

portfolio performance using total return without a peerlike benchmark for calibrating total return expectations. 

Betzold and Berg have devised an investment portfolio 

index (introduced in the April 1997 ABA Banking 

Journal) that is designed to track the total return of a 

typical bank portfolio composed of the same percentages of investment sectors as the average bank. The 

portfolio on which the index is based is rebalanced 

monthly as principal pays down, and it is rebalanced 

quarterly to reflect the latest Call Report data on portfolio allocations. Table 1 depicts the investment weighting of the index as of December 31, 1996, based on 

September 30, 1996, Call Report data. 

According to Betzold and Berg, this index produced 

total returns that closely approximated those of the actuAtlanta Regional Outlook 14 First Quarter 1998 
In Focus This Quarter
 

al median bank total portfolio measured by Call Report 

data from 1993 through third quarter 1997.3 They concluded that their index seems to provide a reasonable 

proxy for the total return of the “average” bank investment portfolio. 

Chart 1 shows the performance of the index so far this 

year.4 Changes in the index value over time can be translated into total returns that approximate the median 

bank portfolio’s total return. For example, the annualized total return for the index from year-end 1996 

through third quarter 1997 was 6.72 percent and is calculated as follows: 

Calculate the bond equivalent semiannual yield 

and express the semiannual bond equivalent yield 

as an effective annual yield. 

4

: 105.00 3

6.72% = 100 [(:) − 1

100.00 ]

The performance of the index for 1997 suggests that 

banks’ total investment portfolio returns were highly 

negatively correlated with changes in the five-year 

Treasury rate (see Chart 2). This finding indicates that 

changes in total return from period to period can provide useful information about the level of a portfolio’s 

interest rate sensitivity. As emphasized above, these 

changes in total return over time include the effects of 

changes in market value of any call options on a bank’s 

investment securities and hence provide information 

about the degree to which future income is at risk. 

Given the increasing level of optionality embedded in 

the average bank securities portfolio—even if it arises 

solely from callable agency debt and “step-up” structured notes—yield should not be the sole measure of 

overall portfolio performance. Total return analysis is an 

appropriate supplement that gauges the risk-return characteristics of an investment strategy that involves selling 

implicit options. 

Allen Puwalski, Senior Financial Analyst 

3 While the Call Report does not contain the information necessary to
 

compute total return precisely, the authors computed an estimate
 

using the reported yield and market value data.
 

4 The index is published monthly in the ABA Banking Journal.
 

TABLE 1 

Composition of Betzold Berg Index 

December 31, 1996 

PERCENT 

SECURITY TYPE OF INDEX 

TREASURIES 24.52 

AGENCIES 24.38 

MUNICIPAL BONDS 12.26 

FIXED-RATE MORTGAGE OR 

MORTGAGE-RELATED PRODUCTS 19.93 

OTHER SECURITIES 6.09 

ADJUSTABLE-RATE SECURITIES 13.00 

Source: Bank and Thrift Call Reports, September 30, 

1996 

CHART 1 Index Value 

Index Tracks the Total Return of an 

“Average” Bank Portfolio 

Source: ABA Banking Journal 

100.84 

104.31 

Dec Jan Feb Mar Apr 

100 

101 

102 

103 

104 

105 

106 

May Jun Jul Aug Sep 

100.51 100.71 

101.49 

102.23 

103.06 

104.03 

105.00 

100.00 

CHART 2 

Total Return Index Is Correlated 

to Changes in Interest Rates 

Source: ABA Banking Journal, Bloomberg 

5-year Treasury 

(right scale) 

Betzold Berg Index 

(left scale) 

Percent Change Percent Change 

–10 

–5 

0 

5 

10 

Jan-97

Feb-97

Mar-97

Apr-97

May-97

Jun-97

Jul-97

Aug-97

Sep-97 

–0.20 

0.00 

0.20 

0.40 

0.60 

0.80 

1.00 

Atlanta Regional Outlook 15 First Quarter 1998 
Regular Features	 Regional Economy
 

Growth Continues at a Moderate Pace
 

in the Atlanta Region
 

•	 Growth in the Atlanta Region continues to outpace that of the nation as a whole, although the gap is 

narrowing. 

•	 While growth in Florida remains strong, consumer confidence surveys in the state may point toward declining levels of optimism about the future. 

•	 In many states, only metropolitan areas see job gains, while the economies of rural counties lag behind. 

•	 Though diminishing in size, the Atlanta Region’s agricultural sector continues to play a critical role in rural 

areas. 

Though most analysts in the Atlanta Region contend 

that the current expansion will continue, albeit at a 

slowing pace, the Region is susceptible to national and 

international shocks. At the moment, growth in the 

Atlanta Region continues to surpass that of the nation as 

a whole, though by a narrowing margin. As explained in 

the Regional Outlook, Fourth Quarter 1997, were it not 

for Florida, the Region’s performance would lag behind 

the national average. Slowing job growth, however, may 

prevent further tightening in labor markets across the 

Region. Already, low jobless rates are contributing to an 

acceleration in wage growth in the Region (see Chart 1). 

Economic conditions, however, continue to vary geographically. In the third quarter of 1997, out of the 

Atlanta Region’s 630 counties, 27 percent had jobless 

rates in excess of 7 percent (see Chart 2). Generally 

strong growth remains concentrated in several metroCHART 1 

Nominal Wage and Salary Growth 

Appears to Be Accelerating 

0.0 

1.0 

2.0 

3.0 

4.0 

5.0 

6.0 

7.0 

8.0 

9.0 

10.0 

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

Percent Change from Previous Year

United States 

Atlanta Region 

Source: Bureau of Economic Analysis 

politan areas, while many rural counties continue to 

experience losses. 

Florida Remains the Region’s Top Performer, 

but Are ‘Cracks’Appearing? 

Florida’s performance remains the best in the Region, 

with year-over-year job growth at about 3.5 percent. 

CHART 2 

Labor Markets Are Not Uniform 

Unemployment 

Rates: 1997Q3 

Source: Bureau of Labor Statistics 

1.5% to 3.4% 

3.5% to 6.9% 

7.0% to 25.0% 

Atlanta Regional Outlook 16	 First Quarter 1998 
Regular Features Regional Economy
 

Some areas of weakness, however, may be emerging. 

Labor markets in the southern portion of the state have 

softened, a fact that may be reflected in southeast 

Florida’s flat consumer confidence index. Of more concern is that preliminary data for Florida’s overall consumer confidence index fell by two points in November; 

some analysts in the state, concerned about the risk of 

recession, find these data troubling. A flattening in consumer confidence has occurred even in tourist-fueled 

central Florida, the core of the state’s economic growth. 

Some economists feel that consumer spending in the 

state may be reaching a peak, especially if the state’s 

older, more affluent residents defer purchasing bigticket items in the wake of recent volatility in the stock 

market. The component of the survey that deals with 

market conditions for the purchase of major household 

items fell in November as well. The realization of weaker spending levels and its consequent impact on loan 

demand may be emerging already. In the third quarter of 

1997, consumer lending’s share of total loans among the 

state’s insured institutions fell from 18.62 percent a year 

earlier to 17.83 percent. 

Georgia’s Growth Accelerates but 

Is Concentrated in Atlanta 

Georgia’s economy is rebounding from the shadow of 

the post-Olympic blues. In the third quarter of 1997, 

year-over-year job growth increased after several quarters of decline (see Chart 3). More recent monthly data 

indicate that growth has continued to accelerate. Even 

so, the rise in job growth still places Georgia’s rate of 

expansion well below its peak in 1994 and generally on 

a downward trend. The recent acceleration, however, 

CHART 3 

has heightened labor scarcity, particularly in Atlanta, 

where most economic gains remain concentrated. By 

contrast, many other areas of the state continue to see 

weaker employment increases, reinforcing the notion 

that the state’s growth is dichotomous (see Regional 

Outlook, Third Quarter 1997). Despite this recent acceleration, Atlanta’s economic growth potential may be at 

risk in the short term from overbuilding in retail real 

estate, slowing net in-migration, and the threat of rising 

environmental regulation. 

Economic Growth in Alabama and 

North Carolina Slows 

Reflecting the weaker economic performance in 

Alabama and North Carolina is the fact that job 

growth has declined and the jobless rate, unlike trends 

nationally, increased in the third quarter. Weakening 

growth may aggravate credit quality conditions in the 

two states. Personal bankruptcies in the third quarter of 

1997 continued to rise in both states. Part of Alabama’s 

slower growth stems from continued erosion in manufacturing, where losses in the apparel industries over the 

past year approached 4,000 jobs. In North Carolina, the 

most dramatic area of decelerating growth has been in 

retailing, which accounts for 17.5 percent of total 

employment. In the third quarter, employment in this 

segment of the economy was slightly below levels of a 

year ago (see Chart 4). 

Although slower growth in the third quarter has resulted in a slight increase in the jobless rate (3.7 percent), 

labor markets in North Carolina still remain tighter than 

the national average. Continued low rates of unemployCHART 4 

Georgia Job Growth Improves but Remains Retail Employment Slips in North Carolina 

Well Below Peak r

6.0 

 Previous Yea

5.0 

4.0 Georgia 

3.0 

Previous Year 

6.0 

5.0 North Carolina 

4.0 

3.0 

Percent Change from

2.0 

1.0 U.S. 

0.0 

− 1.0 

nt Change from

2.0 

1.0 

0.0 

− 1.0 U.S. 

− 2.0 

Perce− 2.0 

Q1.90Q3.90Q1.91Q3.91Q1.92Q3.92Q1.93Q3.93Q1.94Q3.94Q1.95Q3.95Q1.96Q3.96Q1.97Q3.97 

− 3.0 

Q1.90Q3.90Q1.91Q3.91Q1.92Q3.92Q1.93Q3.93Q1.94Q3.94Q1.95Q3.95Q1.96Q3.96Q1.97Q3.97 

− 3.0 

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

Atlanta Regional Outlook 17 First Quarter 1998 
Regular Features Regional Economy
 

ment may place the economy at increased risk at a time 

when growth is decelerating. A dearth of potential 

applicants ultimately may fuel wage inflation and discourage corporate relocation to North Carolina. 

Already, the state may be confronting problems in the 

telemarketing industry, which depends on the availability of cheap local labor. 

Virginia’s Golden Crescent Continues to 

Capture the Lion’s Share of Gains 

Virginia’s rate of economic growth remains above the 

national average, although the gap has shrunk in recent 

quarters. Employment in the third quarter was up 2.4 

percent from a year earlier. Gains in the state’s economy 

remain divergent with most growth located along the 

Golden Crescent (see Regional Outlook, Fourth Quarter 

1997). That region is being fueled by the growth in business services and commercial real estate, particularly in 

northern Virginia, where recent rapid growth has depleted the area’s supply of available office space. Despite 

sustained growth, Virginia’s economy remains at risk on 

several fronts. In government, for example, the 

Department of Defense recently announced the possibility that thousands of Pentagon workers could be laid off. 

Moreover, the Golden Crescent’s very success may 

become a liability eventually, as anecdotal evidence suggests that property costs, particularly in northern 

Virginia, are rapidly appreciating and may be fueling 

speculative construction activity. 

West Virginia’s Growth Applies Downward 

Pressure to Jobless Rates 

Although West Virginia’s economic performance 

remains below the national average, growth has been 

strong enough to apply downward pressure on jobless 

rates. The third quarter’s 6.6 percent unemployment rate 

is the lowest in nearly 20 years. 

South Carolina’s Gains Are Limited 

Primarily to Urban Areas 

South Carolina’s economic performance continues to 

lag behind that of the nation, although gains have edged 

upward since the beginning of 1997. In the third quarter 

of 1997, year-over-year job growth reached 1.7 percent. 

Though improved since the first quarter, job growth in 

the state still trails the national average by one-half percentage point, and the state’s jobless rate has crept 

upward. Urban areas, which have benefited from gains 

in production of durable goods, especially automotive 

equipment manufacturing, continue to capture the most 

growth. Also, South Carolina has experienced spillover 

growth associated with continued gains in Charlotte, 

North Carolina. Growth in these areas has been strong 

enough to tighten local labor markets considerably. 

Unlike urban areas, rural counties remain constrained 

by ongoing declines in the textile and apparel industry 

and resultant high levels of joblessness. 

Implications: Growth in the Atlanta Region has moderated and remains nearly on a par with the national 

average. However, the economy in some parts of the 

Region has started to see slowing levels of job growth 

and a rise in the jobless rates. A risk to the local banking community is that lending patterns continue to operate under the assumption of further rapid growth. 

Moreover, many rural counties have not shared fully in 

this recovery, and consequently credit quality could 

remain an issue in these areas. 

Competitive Risks Emerge in Agriculture 

Although the Region’s economic exposure to agriculture, including food and tobacco processing, has 

declined in recent decades, the sector remains a vital 

component of the local economy in many rural areas. In 

1994 (the latest available data), agriculture accounted 

for about 5 percent of the Region’s gross state product. 

This figure was above the national average of 3.7 percent but well 

below some states such as Iowa, 

where the share was a significantly higher 12 percent. 

The agricultural sector has undergone a substantial structural 

transformation over the past several decades, in contrast to the 

rest of the nation. Earlier, agriculture in the Region was 

dominated heavily by field crops such as cotton, tobacco, and peanuts. Over time, however, livestock, except 

in Florida, began to play an increasingly important role 

that was magnified by the emergence of the poultry and, 

later, hog industries. By 1990, livestock accounted for 

51 percent of total farm receipts in the Region, and 

since then, livestock’s share of the agricultural base has 

plateaued. The national experience has differed from 

Atlanta Regional Outlook 18 First Quarter 1998 
Regular Features Regional Economy
 

that of the Atlanta Region in that livestock traditionally 

has accounted for a large share of the sector’s health. 

During the 1990s, livestock as a share of agriculture 

actually declined nationally. 

Agriculture in the Region may be facing numerous 

emerging risks to its overall competitiveness that could 

be accentuated by the growing reliance on livestock. 

These competitive risks, aside from the usual vagaries 

of seasonal weather patterns, can be broadly classified 

into three types: market, international, and legislative. 

Market Risks: Supply and demand are creating risks to 

the Atlanta Region’s livestock markets. On the demand 

side, there is an ongoing debate as to whether U.S. consumers are becoming “chickened out.” After years of 

rising poultry consumption, arguably due to the perceived leanness of the meat in an increasingly fat-conscious society as well as to declines in real retail prices, 

many analysts contend that the domestic market for 

poultry has emerged as a mature market with saturated 

demand: Per capita consumption of poultry has leveled 

off over the past few years (see Chart 5). Indeed, in 

1995, per capita poultry consumption actually fell 

slightly for the first time in 20 years. Total per capita 

meat consumption fell in 1995 as well. 

On the supply side, this slowing growth in poultry consumption has occurred at a time when broiler production has expanded steadily. According to the U.S. 

Department of Agriculture, national production is 

expected to increase by 6.6 percent in 1998. The industry has seen substantial capacity expansion in 1996 and 

1997 already. Moreover, pork production is expected to 

CHART 5 

U.S. Per Capita Meat Consumption Levels Off 

0 

20 

40 

60 

80 

100 

120 

140 

160 

1970

197219741976197819801982198419861988199019921994 

Pounds

Red Meat 

Fish 

Chicken 

Source: United States Department of Agriculture/Economic Research Service 

reach near-record levels in 1998 and 1999, possibly 

depressing the price of a “substitute” good. The 

Region’s exposure to the poultry industry is large, particularly in areas such as northern Georgia, which 

accounts for nearly 40 percent of total farm receipts. 

Expanding poultry as well as hog supplies in the face of 

weakening growth in demand could heighten competitive pressures within the poultry industry. One response 

to these pressures, and further evidence of a maturing 

market, is that the broiler market is becoming increasingly differentiated as producers seek to find market 

niches, protect market share, and achieve growth. 

International Risks: International trade has emerged as 

an increasingly important force in the Region (see 

Regional Outlook, Third Quarter 1997). This is true for 

the agricultural sector as well. As domestic markets for 

livestock mature, producers have increasingly set their 

sights on overseas markets. According to one analyst at 

the Alaron Trading Co., 7.5 percent of all beef, 6.4 percent of pork, and 17 percent of broiler production was 

shipped to foreign markets in 1997. These shares are 

expected to increase in 1998. A reduction in meat 

exports, then, could have a significant adverse impact 

on domestic producers. 

The poultry industry, for example, faces several risks to 

its exports. Russia, which absorbs almost half of the 

exports, recently increased tariffs on U.S. chickens, thus 

making French and Brazilian products cheaper: U.S. 

poultry exports to Russia have slipped already. 

Moreover, the poultry industry must contend with overseas competitors as well. China is expected to emerge 

eventually as a large, low-cost competitor to U.S. producers. Finally, turmoil in many Southeast Asian and 

East Asian financial markets may place local producers 

at risk from the volatility in the exchange rate. 

Depreciating currencies overseas make U.S. exports 

more expensive and could promote further growth in 

production in home countries. 

Export markets extend beyond livestock to field crops 

as well. Nearly half of the nation’s cotton crop is destined for overseas textile and apparel producers, most of 

them in Asia. Georgia is the third largest producer of the 

U.S. upland cotton harvest. Although the cotton industry accounted for 15 percent of Georgia’s agriculture in 

1996, production remains heavily concentrated in the 

southern portion of the state. Large foreign harvests or 

currency depreciation among importer countries (for 

example, in Asia) could place producers in the Region 

at risk. 

Atlanta Regional Outlook 19 First Quarter 1998 
Regular Features Regional Economy
 

Florida’s citrus crop is an example of another agricultural product at risk from international developments. 

Brazil dominates the world’s orange markets, and 

according to Dr. Philip Lesser, a lead researcher at the 

Florida Department of Citrus, “the fate of the Florida 

orange grower has never been more inextricably bound 

to events in Brazil than today. This is owing to the fact 

that as of 1997, four concerns, which control some 80 

percent of Brazilian processing capacity, have acquired 

about one-third of the capacity in Florida.” Record 

crops in 1997 in Brazil, as well as in Florida, have 

depressed prices for citrus pulp. 

Another type of international risk may be political. The 

sugar cane crop accounts for 8 percent of Florida’s farm 

receipts and remains a protected industry under the 

1996 Federal Agriculture Improvement and Reform 

Act. Before 1960, Cuba was a major source of the 

nation’s sugar. An eventual change in leadership in 

Cuba could lead to a lifting of the trade embargo. 

Should this happen, there could be considerable political pressure to eliminate this industry’s protection. 

Legislative Risks: On the national front, perhaps the 

greatest challenge to the Region’s agricultural sector is 

the 1996 Federal Agriculture Improvement and Reform 

Act (see Regional Outlook, First Quarter 1997, Kansas 

City Region and Dallas Region, for detailed discussions 

of potential impacts). The legislation, which eliminates 

acreage reduction programs and allows for planting 

flexibility, will likely expose individual producers to 

much higher levels of risk from price volatility. 

Recent legislative initiatives also pose a risk to the 

Region’s agricultural sector, particularly in North 

Carolina, which has emerged as the nation’s second 

largest hog producer (after 

Iowa). An unfortunate by-product of the industry’s rapid 

growth is the growing concern 

about its environmental impact 

since large spills of animal 

waste have occurred. This pollution, in part, prompted the state 

to pass a moratorium on new or expanded hog operations effective until March 1999. Rising environmental 

concerns contributed to the state’s decision to ban further growth in the hog industry temporarily, and the 

potential for greater regulation will likely raise the cost 

of doing business for hog farmers and reduce their competitiveness. Growth in the hog industry may have been 

diverted out of state already, especially to Georgia, 

where environmental regulation is less stringent. Purvis 

Farms of Robbins, North Carolina, citing “local pork 

politics,” has applied for permits to build a 20,000-sow 

project in Taylor County in southwestern Georgia. If 

built, the project would be the state’s largest hog operation. Another 10,000-sow operation is being considered 

by a Georgia producer in Tattnall County. Moreover, a 

cooperative hopes to build a pig slaughterhouse near 

Albany. Despite prospects for the hog industry, there is 

rising environmental concern in Georgia as well. 

Another legislative risk that North Carolina faces is the 

possibility that Congress may end a federal program 

that imposes quotas on tobacco production and creates 

floor prices for growers. Already at risk from tobacco 

companies’ increasing use of foreign tobacco, growers 

would likely face a large increase in domestic competition, including perhaps the reemergence of tobacco 

farming in Texas, if the program were eliminated. 

Currently, tobacco growers can expect to net $1,900 to 

$2,200 per acre; this price compares favorably with the 

yield of other crops such as cotton ($331/acre), corn 

($160/acre), and soybeans ($76/acre). Specialty crops, 

such as tomatoes ($600/acre), have higher yields. The 

impact of greater competition would likely depress current value of tobacco property and cut farmers’ profits. 

Retired tobacco growers would also be placed at risk 

since there is a market for tobacco quotas that often subsidizes retirement income. 

Implications: The health of different segments of the 

Region’s agricultural sector may be shaped by any one 

of several existing or emerging risks. Moreover, agricultural production varies widely within the Region: 

tobacco and hogs in eastern North Carolina, poultry in 

northern Georgia, and cotton in southern Georgia, for 

example. As such, weakness in one agricultural segment 

can have a profound impact on one local economy but 

little effect elsewhere, even in another section of the 

same state. Lenders should be aware of emerging risks 

for local agriculture and its potential impact not only on 

farmers’ and food processors’ credit, but on the community as a whole. 

Scott C. Hughes, Regional Economist 

Jack M.W. Phelps, Regional Manager 

Pamela R. Stallings, Financial Analyst 

Atlanta Regional Outlook 20 First Quarter 1998 
Regular Features	 Regional Banking
 

Current Regional Banking Conditions
 

•	 Most commercial banks and thrifts posted strong results during the third quarter of 1997 even though economic growth is moderating in the Atlanta Region. 

•	 Small commercial banks in North Carolina are reporting earnings below national and Regional averages. 

•	 Funding strategies are changing at insured institutions, which are increasingly relying on “noncore” funds 

to support asset expansion. 

• Farm banks in the Region are confronted with greater competitive risks, and a number are experiencing 

rising agricultural loan delinquencies. 

Overview 

On an aggregate basis, the Region’s commercial banks 

and thrifts posted strong results in the third quarter of 

1997 despite a moderation in economic activity (see 

Growth Continues at a Moderate Pace in the Atlanta 

Region). Several key performance indicators for small 

institutions (those with assets under $100 million) headquartered in the Region may be seen in Charts 1 and 2. 

In comparison to the national averages, the Region’s 

small institutions have slightly higher net interest margins and much higher capital levels. However, they 

underperform the national averages in return on assets 

and carry higher levels of nonperforming assets. The 19 

small banks in North Carolina had a negative quarterly return on assets of 0.44 percent, as performance is 

being influenced by seven banks that have been open 

less than one year. However, the return for the remaining 12 banks is 0.84 percent, which is still well below 

the Region’s average of 1.12 percent for small banks. 

Asset Funding Has Changed 

During the 1990s, there has been a pronounced change 

in the funding sources of insured financial institutions 

(banks and thrifts). As a result of strong loan growth and 

lackluster core deposit growth, the aggregate loan-todeposit (LTD) ratio for the Region has reached its highest level this decade (see Chart 3, next page, for the 

trends in the LTD and loan-to-asset ratio). About half 

the institutions in the Region had an LTD ratio above 75 

percent at third quarter 1997. While the vast majority of 

this group is small institutions (assets under $100 million), large institutions have the highest LTD ratios. In a 

recent speech to industry analysts and regulators at a 

conference sponsored by the Federal Financial 

Institutions Examination Council, John G. Medlin, 

chairman of Wachovia Corp., said that large banks have 

become highly susceptible to changes in market sentiment because of high LTD ratios and the resulting 

dependence on Wall Street for funding. The upward 

CHART 1	 CHART 2 

The Region’s Small* Institutions Have Higher 

Net Interest Margins and Leverage Ratios 

than National Averages... 

Leverage Capital Ratio 

Source: Bank and Thrift Call Reports 

* Small institutions are those with assets less than $100 million 

14 

12 

10 

8 

6 

4 

2 

0 

Net Interest Margin 

Commercial Banks (Nation) 

Commercial Banks (Region) 

Thrifts (Nation) 

Thrifts (Region) 

Percent 

...But the Region’s Small* Institutions Have Higher 

Levels of Problem Assets and Lower Profitability 

than National Averages 

0.00 

0.25 

0.50 

0.75 

1.00 

1.25 

1.50 

Nonperforming Assets to Assets Return on Assets 

Commercial Banks (Nation) Commercial Banks 

(Region) 

Thrifts (Nation) 

Thrifts (Region) 

Source: Bank and Thrift Call Reports 

* Small institutions are those with assets less than $100 million Percent 

Atlanta Regional Outlook 21	 First Quarter 1998 
78 

76 

74 

72 

70 

Regular Features Regional Banking
 

CHART 3 CHART 4 

Loan-to-Deposit and Loan-to-Asset Ratios Have There Is Upward Trend in the Percentage 

Increased Sharply at Atlanta Region Institutions of Institutions with Higher Loan-to-Deposit 

the Past Few Years Ratios in the Region 

100 < 50% 

20 

40 

60 

80 

0 

Loan-to-Deposit Ratio 

(Median) 50–65% 

65–75% 

>75%

Percent of Institutions 

Percent of Assets 68 

Loan-to-Asset Ratio 66 (Median) 64 

62 

60
 

58
 

1990 1991 1992 1993 1994 1995 1996 1997Q3 

Source: Bank and Thrift Call Reports 

trend in the number of institutions with a high LTD ratio 

can be seen in Chart 4. 

Structural and cyclical factors have contributed to the 

rise in LTD ratios. Increased competition and shifts in 

consumer preferences toward noninsured investment 

products have contributed to a disintermediation of traditional “core” funds at insured institutions. Ordinarily, 

core funds are viewed as small, stable demand, savings, 

and time deposits that have little sensitivity to price 

(interest rate) or credit quality. Upward pressure on the 

LTD ratio also has resulted from strong loan growth, 

which is associated with the lengthy economic expansion. Thus, insured institutions have had to find alternative “noncore” funding sources to support the growth in 

their loan portfolios. These noncore funding sources 

include large time deposits, short-term debt, and 

Federal Home Loan Bank (FHLB) advances. The 

increased use of noncore funding is displayed in Chart 

5. FHLB advances are being used by a larger number of 

insured institutions. Regionwide, all thrifts and about 50 

1990 1991 1992 1993 1994 1995 1996 1997Q3
 

Source: Bank and Thrift Call Reports
 

able instruments has led to an increase in cash flow. The 

amortization of these instruments may not always be 

predictable, but they can be a sizable liquidity source. 

Also, the ability to securitize assets in public markets 

has increasingly become easier. The changes in funding 

have not slowed loan originations or adversely affected 

liquidity in the aggregate. Finally, FDIC examiners have 

reported liquidity problems in only a handful of small 

institutions. 

The increased use of noncore funding may lead to 

greater funding costs and liquidity concerns during 

periods of rapidly fluctuating interest rates. Yet some 

noncore funding, such as FHLB advances, can be relatively stable and less costly than other alternatives. 

Changes in funding sources and asset holdings may 

have altered traditional methods of measuring liquidity 

and increased the complexity of managing this aspect of 

CHART 5 

15 

20 

25 

30 

35 

1990 1991 1992 1993 1994 1995 1996 1997Q3 55 

60 

65 

70 

75 

Percent of Assets 

Atlanta Region Institutions Have 

Changed Their Funding Strategies 

Core Deposits

 (Right Scale) 

Noncore Funding 

(Left Scale) 

Percent of Assets 

Source: Bank and Thrift Call Reports 

percent of commercial banks were members of the 

Federal Home Loan Bank of Atlanta. As of October 

1997, commercial banks had $12.7 billion in aggregate 

outstanding advances and $35.9 million in unused letters of credit (membership data for banks in West 

Virginia are not available from the Federal Home Loan 

Bank of Pittsburgh). 

Normally, high LTD ratios have suggested a tightening 

of liquidity; however, structural changes in public markets and the securities and loan portfolios of insured 

institutions may have reduced the effectiveness of LTD 

ratio as a liquidity indicator. The large increase in mortgages and related products and other consumer receivAtlanta Regional Outlook 22 First Quarter 1998 
Regular Features Regional Banking
 

an institution’s operations. While no significant problems have surfaced with the shifts in funding, it is 

important that bank and thrift managers remain cognizant of the potentially greater liquidity and interest 

rate risks that accompany noncore funding, particularly 

if a large portion of funding derives from limited 

sources. 

Agricultural Banking Trends in the Region 

Although agriculture’s share of the Region’s economy 

has been declining over the past five years (see Growth 

Continues at a Moderate Pace in the Atlanta Region), 

there has been no similar decline in the number of 

insured institutions that have a concentration of agricultural (ag) loans.1 As shown in Table 1, since 1991 the 

number of agricultural institutions has been around 90, 

and currently 104 institutions are considered to have an 

agricultural lending concentration. Over this period, no 

thrifts have met this criterion, and 94 of the ag banks are 

state nonmembers. Moreover, as seen in Chart 6 (next 

page), two-thirds of the ag banks are located in Georgia 

(69). Most of the remaining ag banks are in Alabama 

(14) and Florida (11). Surprisingly, very few ag banks 

are headquartered in North Carolina, where agriculture 

accounts for the largest share of gross state product 

among all the states in the Region. This is probably 

attributable to the comparatively liberal branching laws 

of the state, which have fostered the growth of large 

statewide institutions that have more diversified loan 

portfolios. Lastly, most ag banks are situated in counties 

1 For this article, agricultural institutions are defined as those with 

agricultural loans (production and real estate loans secured by farm 

properties) that constitute 10 percent or more of assets. 

TABLE 1 

where the unemployment rate is much higher and job 

growth is much lower than the Region’s average. 

As shown in Chart 6, most of the ag banks in the Region 

are concentrated in a belt that stretches from southeast 

Alabama across southern Georgia. In this area, field 

crops generally predominate; cotton, peanuts, corn, and 

rye are the leading cash crops. However, chicken broiler production—normally concentrated in northern 

Georgia and Alabama—has increased in this area. 

According to the Georgia Farm Bureau, Georgia grows 

more peanuts, pecans, and rye than any other state and 

ranks second only to Arkansas in broiler production. In 

cotton, Georgia ranks second to Texas, with more than 

14,000 acres planted in 1997. The average size of the 

estimated 43,000 farms in Georgia is 274 acres, compared with the U.S. average of 470 acres. 

Currently, the average size of an ag bank is $63.2 million, and they range in size from $7.9 million to $235 

million. Most are very strongly capitalized, with an 

average leverage capital ratio of 10.73 percent. The 

trends in earnings performance have been positive since 

1991, but through the first three quarters of 1997, four 

ag banks had negative earnings. While ag loans have 

shown steady growth, the average concentration has 

remained fairly stable at about 1.5 times capital. 

However, 30 banks have ag loans that are more than 

twice their capital, with the largest concentration being 

5.3 times. Of these 30 banks with large concentrations, 

24 are located in Georgia, including 15 of the 16 largest 

portfolio concentrations. 

As displayed in Table 1, ag loan performance has generally been worsening since 1993, as shown by the rising trends in noncurrent ag loans and an increase in ag 

Noncurrent Agricultural Loans Are on the Rise 

AG LOANS NON­ NON­ LOAN AG LOAN LOANS AG RETURN 

# OF AVERAGE CAPITAL TO CURRENT CURRENT CHARGE- CHARGE­ TO LOAN ON 

AG SIZE RATIO CAPITAL LOANS AG LOANS OFFS OFFS DEPOSITS GROWTH ASSETS 

YEAR BANKS (MILLIONS) (%) (TIMES) (%) (%) (%) (%) (%) (%) (%) 

1991 92 48.1 9.67 1.60 1.77 1.07 0.73 0.20 69.04 — 0.82 

1992 94 52.0 10.04 1.53 1.51 1.48 0.60 0.35 72.10 7.08 1.11 

1993 90 57.7 10.36 1.50 1.34 1.17 0.60 0.28 72.80 5.85 1.15 

1994 87 50.5 10.66 1.62 1.32 1.76 0.63 0.83 71.20 17.05 1.24 

1995 85 52.9 10.69 1.55 1.34 2.00 0.31 0.45 70.60 7.57 1.31 

1996 88 56.6 10.53 1.56 1.70 2.30 0.42 0.40 71.40 7.75 1.27 

97Q3 104 63.2 10.73 1.54 1.48 1.85 0.20 0.18 76.20 6.16 1.40 

Source: Bank Call Reports 

Atlanta Regional Outlook 23 First Quarter 1998 
Regular Features Regional Banking
 

CHART 6 

Agricultural Banks Are Concentrated in Southeast
 

Alabama and Southern Georgia
 

Number of 

Agricultural 

Banks 

Headquartered 

by County 

3 

2 

1 

0 

Note: Agricultural banks are institutions with total agriculture loans greater than 

10 percent of assets. 

loan charge-offs since the early 1990s. Because of seasonality, the current third-quarter figures cannot be 

compared with the last year-end figures. However, 

when compared with the same period last year, noncurrent ag loans are 28 basis points higher and ag loan 

charge-offs are slightly higher. Normally, the year-end 

figures rise, as most ag loans are structured for repayment during the second half of the year to coincide with 

the harvesting of crops. Hence, it is likely that the deteriorating trend in ag loan performance will continue in 

1997, according to the interim comparison. In 1996, 

noncurrent ag loans rose 73 basis points from the third 

quarter to the fourth quarter. A similar increase in 1997 

would push the noncurrent ag loan ratio above 2.5 percent. Moreover, unfavorable weather during parts of the 

growing season in 1997 may affect ag loan performance. Areas of Alabama were afflicted with too much 

moisture (Hurricane Danny), and southern Georgia suffered from prolonged periods of dryness during the 

growing season. 

Currently, 47 ag banks do not report any noncurrent ag 

loans. Fifteen ag banks have a noncurrent ag loan ratio 

above 5 percent, with the highest being nearly 21 percent. Among these 15 ag banks, noncurrent ag loans 

represent a disproportionate share of their problem 

loans, and 1 ag bank reports that almost 42 percent of 

its ag production loans are noncurrent. FDIC examiners 

have seen a rise in problem ag loans at some ag banks 

due to weather-related problems. 

The upward trend in problem ag loans merits the continued attention of bankers and their supervisors, especially when one considers the competitive risks facing 

the agricultural sector discussed in Growth Continues 

at a Moderate Pace in the Atlanta Region. In addition, 

changing competitive factors, particularly the 1996 

Farm Bill, could expose agricultural producers and consequently their lenders to new risks. Some agricultural 

analysts have predicted that this legislation will lead to 

increased volatility in the prices of agricultural commodities as federal price supports, quotas, and transition payments are reduced or eliminated. If so, 

producers and credit suppliers will need to develop and 

implement new risk management techniques to reduce 

their exposures to commodity price swings. The costs of 

these systems may reduce profitability for both producers and lenders. Some small producers and lenders may 

shy away from obtaining new risk management products because of their cost, which may lead to greater 

credit risk in the long term. 

The importance of agriculture to the Region’s banks 

extends beyond the set of agricultural banks identified 

in this article. For instance, the University of Georgia 

Farm Extension Service reports that the farm and forest production and farm inputs and machinery sectors 

contribute almost $7 billion of the state’s output and 

employ more than 90,000 people. Accordingly, the performance of all insured institutions operating in markets 

influenced by agriculture may be affected by events in 

this sector. 

Jack M.W. Phelps, Regional Manager 

W. Brian Bowling, Financial Analyst 

Pamela R. Stallings, Financial Analyst 

Scott C. Hughes, Regional Economist 

Atlanta Regional Outlook 24 First Quarter 1998 
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