Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION THIRD QUARTER 2001 

FDIC 

National Edition 

Division of 

Insurance 

San 

Francisco Kansas 

City 

Dallas 

Memphis 

Atlanta 

New 

York 

Boston 

Chicago 

A Message to Our Readers 

The FDIC community extends its deepest sympathy to the families, friends, and 

co-workers of the victims of the attacks on September 11, 2001. 

The articles in this edition of the Regional Outlook were prepared before the 

tragic events of September 11. We will assess the implications of these events in 

future issues of the Regional Outlook. The public can rest assured that deposit 

insurance is in full force—money is safe in an FDIC-insured account. 

In Focus This Quarter 

◆ Slowing Economy Reduces Demand for U.S. Office Space—A slowing 

economy has contributed to softening in many U.S. office markets during the first 

half of 2001. The office vacancy rate has recorded the largest six-month increase 

in the past 20 years. A combination of trends—a substantial drop in demand for 

office space and an uptick in construction activity in some markets—has led to 

this slackening. 

This article reviews recent developments in U.S. office markets and describes demand-side and supply-side trends that have 

contributed to the recent weakness. It notes the role played by the changing fortunes of high-tech firms in a number of U.S. 

metro areas and how this situation has contributed to large increases in the volume of space available for sublease. Finally, 

the article focuses on the local construction and commercial real estate loan exposures of FDIC-insured banks and thrifts 

that have the task of managing their risks under changing market conditions. See page 3. 

Regional Perspectives 

◆ Atlanta—An analysis of banking markets in the Region’s 

nonmetropolitan counties suggests that community banks 

facing strong competition may exhibit a heightened risk profile but face different challenges, depending on the structure 

of the local economy. See page 12. 

◆ Boston—Effective fraud risk management tools and 

appropriate levels of fidelity insurance may help reduce the 

possibility of fraud and minimize losses at insured institutions as the economy slows. See page 13. 

◆ Chicago—The sluggish economy is pressuring insured 

institution asset quality while mid-year imbalances in the 

Region’s manufacturing and commercial real estate sectors 

temper the economy’s near-term growth prospects. See 

page 14. 

◆ Dallas—The potential for declining levels of off-farm 

income during a slowing economy and reduced government 

payments could weaken many agricultural producers’ ability 

to repay existing debt or acquire new loans. See page 15. 

By Thomas A. Murray 

◆ Kansas City—Recently, farmland values appear to be 

supported increasingly by government payments. The timing 

and amount of these payments are uncertain, making assessment of borrower creditworthiness and collateral protection difficult. See page 16. 

◆ Memphis—A slowing economy is contributing to earnings erosion and adversely affecting consumer and construction credit quality among the Region’s insured institutions. 

See page 17. 

◆ New York—The Region’s counties have not benefited 

equally from the economic expansion, and this has contributed to differences in performance and credit risk profiles 

among insured institutions. See page 18. 

◆ San Francisco—Softness in the Region’s high-tech 

manufacturing and lumber sectors, emerging weakness in 

the tourism industry, and increasing competition could 

weaken insured institutions’ commercial and industrial 

loan quality. See page 19. 

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

Insurance Corporation as an information source on banking and economic issues for insured 

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

geographic regions: 

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

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

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

Dallas Region (CO, NM, OK, TX)
 

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

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

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

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

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

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

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

more information or to provide comments or suggestions about the National Edition of Regional 

Outlook, please call Lynn Nejezchleb at (202) 898-3898 or send an e-mail to lnejezchleb@fdic.gov 

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

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

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

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

the Federal Deposit Insurance Corporation. 

Chairman Donald E. Powell 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Writer/Editor Kim E. Lowry 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Richard A. Brown 

Ronald L. Spieker 

Publications Manager Teresa J. Franks 
In Focus This Quarter
 

Slowing Economy Reduces 


Demand for U.S. Office Space
 

•	 Demand for U.S. office space contracted during 

the first half of this year as the amount of newly 

vacated space exceeded the amount of newly 

occupied space for the first time since at least 

1981. 

•	 The U.S. office vacancy rate jumped 250 basis 

points in the first half of 2001, from 8.3 percent to 

10.8 percent. 

•	 With construction levels remaining high and 

demand still weak, the vacancy rate could rise 

further by year-end. 

Overview 

Commercial real estate (CRE) markets traditionally 

have been—and remain—highly cyclical. During the 

1990s, most U.S. office markets experienced a strong 

upswing. However, declining office employment 

growth along with other recent signs point to a possible 

downturn. As reported by Torto Wheaton Research 

(TWR), the U.S. office vacancy rate, which stood at a 

19-year low of 8.3 percent at the end of 2000, jumped in 

only six months to 10.8 percent, the largest six-month 

increase in the 20 years TWR has tracked these data. 

Office vacancy increases range from modest levels in 

some markets to high levels in markets where supply 

and demand imbalances are more pronounced. 

An uptick in construction activity combined with a substantial drop in demand for office space has led to a 

slackening of office market conditions. In light of the 

ongoing uncertainty as to the near-term direction of the 

U.S. economy, these trends make the current situation 

difficult for office market participants to read. 

This article reviews recent developments in U.S. office 

markets and describes demand-side and supply-side 

trends that have contributed to the recent weakness.1 

It notes the role played by the changing fortunes of 

1 For further discussion of demand and supply trends, see Sally Gordon, “CMBS: Red – Yellow – GreenTM Update, Second Quarter 2001 

Quarterly Assessment of U.S. Property Markets,” Moody’s Investors 

Service, July 6, 2001. 

high-tech firms in a number of metropolitan areas and 

how this situation has increased the volume of space 

available for sublease. Finally, the article focuses on the 

local construction loan exposures of insured banks and 

thrifts that have the task of managing their risks under 

changing market conditions. 

Vacancy Rates Have Risen 

Quickly from Cyclical Lows 

At year-end 2000, the U.S. office vacancy rate stood at 

8.3 percent—a 19-year low. Many individual metro 

areas posted even lower vacancy rates. For example, at 

year-end 2000, vacancies were 4.4 percent of available 

space in Seattle, 1.3 percent in San Jose, and 3.0 percent in Oakland. Beginning with first quarter 2001, as 

a result of a slowing economy and the fallout from the 

so-called “tech-wreck,” the U.S. vacancy rate rose by 

120 basis points to 9.5 percent—the highest absolute 

quarterly increase since these data were first published 

in 1981. Another record increase of 130 basis points 

occurred during the second quarter, bringing the vacancy rate to 10.8 percent. To put these increases in perspective, consider that the national office vacancy rate 

has increased more than 50 basis points in any given 

quarter only twice.2 Nonetheless, the current vacancy 

rate of 10.8 percent remains low by historical standards, as the average rate for the past 20 years has been 

13.9 percent. 

Most of the nation’s large metro areas saw increases in 

office vacancies during the first half of 2001. Fortyeight of the 53 major metropolitan areas tracked by 

TWR recorded a higher vacancy rate in June 2001 than 

at year-end 2000. Thirty-eight markets experienced 

increases of at least 100 basis points, and four markets 

saw vacancy rates jump by more than 600 basis points. 

As shown in Table 1 (next page), most of the markets 

experiencing the largest jump in vacancy rates also are 

home to concentrations of high-tech employment.3 

2 TWR notes increases of 60 basis points in the second quarter of 

1989 and in the first quarter of 1999. 

3 Seven of the ten markets with the highest first-half 2001 vacancy 

rate increases are also among the top ten cities having the greatest 

levels of high-tech employment. 

Regional Outlook—National Edition 3	 Third Quarter 2001 
In Focus This Quarter
 

TABLE 1 

In Many Markets, Office Vacancy Rates Reflect 

Concentrations of High-Tech Employment 

VACANCY RATE VACANCY RATE INCREASE IN HIGH-TECH AS % 

AS OF 6/30/01 AS OF 12/31/00 VACANCY RATE OF TOTAL MARKET 

METRO AREA (%) (%) (BASIS POINTS) EMPLOYMENT 

AUSTIN 11.8 5.0 680 10.1 

SAN JOSE 8.1 1.3 680 27.4 

OAKLAND 9.3 3.0 630 6.5 

SAN FRANCISCO 10.3 4.1 620 8.3 

SEATTLE 9.4 4.4 500 6.6 

KANSAS CITY 15.9 11.0 490 2.7 

BOSTON 8.7 3.9 480 8.2 

PHOENIX 16.9 12.5 440 4.7 

WILMINGTON, DE 10.4 6.2 420 3.8 

WASHINGTON, DC 7.8 3.9 390 7.8 

NATION 10.8 8.3 250 4.8 

Sources: Torto Wheaton Research, Economy.com, Inc. 

As high-tech markets spurred higher demand for office 

space in the recent past, these markets are now giving 

back greater quantities of previously occupied office 

space. Table 2 (see page 18) lists office vacancy rates 

and changes along with lending concentrations, construction activity levels, and high-tech employment 

percentages for 53 major metropolitan areas and for 

the nation. 

Unlike the last cycle, during which office vacancies 

shot up primarily in overbuilt downtown areas, recent 

increases are occurring more sharply in suburban than 

downtown sections of metropolitan areas. As of June 

30, 2001, the average downtown office vacancy rate 

was 8.5 percent, and the average for suburban markets 

was 12.1 percent. Increases in office availability are 

dispersed among Class A office properties as well as 

Class B/C properties, yet vacancy rates do show disparities across many submarkets. For example, the 

South of Market area in San Francisco reports significantly higher office vacancy rates than the Financial District.4 Similarly, in the Washington, DC, 

metropolitan area, the technology-intensive northern 

Virginia office market has experienced higher office 

vacancy increases than downtown Washington, DC, or 

suburban Maryland. 

4 Louis, Arthur M. July 24, 2001. “Empty Offices, Economic Downturn, Overconstruction Leave Commercial Landlords with More 

Space on their Hands.” San Francisco Chronicle. 

Office Demand Drops 

Net absorption, the primary indicator of demand for 

office space, was negative during first quarter 2001 for 

the first time since TWR began reporting the series.5 

(Negative absorption occurs when space returned to the 

market by existing tenants exceeds the space occupied 

by new tenants.) This negative performance was repeated in the second quarter. The decline in the volume of 

competitively leased space totaled 30 million square 

feet during the first half of 2001. (See Chart 1.) 

The bulk of negative absorption in the first half of 2001 

is due to the return of office space to the market through 

subleasing.6 TWR reports that there were 43 million 

square feet of space “give-backs” through subleasing in 

the first half of 2001, and after offsetting absorption of 

13 million square feet, negative absorption was 30 million square feet. 

Office employment growth, the source of new office 

space demand, tends to be driven by the finance and services sectors.7 Year-over-year job growth in the finance, 

5 Net absorption is the net change in total competitively leased space 

per period, as measured in square feet. 

6 In some metropolitan areas, over half the total office space available 

for rent (vacant space) is sublease space. 

7 TWR constructs its office employment index based on trends in the 

FIRE sector plus selected categories of the services sector. See TWR 

Office Outlook, Spring 2001, Vol. II, p. A.1. 

Regional Outlook—National Edition 4 Third Quarter 2001 
 

In Focus This Quarter
 

CHART 1 

Net Absorption Turned Negative in 2001 

Vacancy Rate (%) 

Square Footage (000s) 

Vacancy 

Rate (%) 

–40,000 

–20,000 

0 

20,000 

40,000 

60,000 

80,000 

100,000 

120,000 

140,000 

Completions 

(S.F.) 

Absorptions 

(S.F.) 

Negative 

Absorption 

’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 

0.0 

2.0 

4.0 

6.0 

8.0 

10.0 

12.0 

14.0 

16.0 

18.0 

20.0 

Notes: 2001 is as of June 30. S.F. = square footage 

Source: Torto Wheaton Research 

insurance, and real estate (FIRE) and services sectors 

combined was more than 3 percent in every month from 

January 1993 through June 2000. Since the middle of 

2000, job growth in these sectors has fallen steadily to a 

year-over-year rate of less than 1.5 percent in June 2001. 

A spring 2001 survey conducted by Salomon Smith 

Barney indicated that tenants estimated their growth in 

office space demand to be only 0.6 percent over the following 12-month period.8 Also contributing to reductions 

in demand are increases in worker layoffs. Announced 

layoffs during the first seven months of 2001 totaled over 

983,000 individuals, more than triple the number of 

announced layoffs during the same period last year.9 

The slowdown in the demand for office space contrasts 

sharply with the situation last year, when absorption 

rates and office employment growth were robust in most 

markets, and leases were executed quickly for newly 

constructed properties. As shown in Chart 2, absorption 

of office space in 2000 actually outstripped the trend in 

office employment by a considerable margin. Why? 

With relatively easy access to initial public offering and 

venture capital funding, many startup firms anticipated 

rapid growth and leased office properties accordingly. In 

fact, venture capital funding facilitated historically higher rates of office space absorption by high-tech and other 

startups. In active bidding wars, new high-tech firms 

increased their office space holdings. A phenomenon of 

space hoarding developed in which some high-tech 

companies leased large quantities of office space in 

anticipation of future expansion. 

8 Boston, Gary, Ross Nussbaum, and Jonathan Litt. May 16, 2001.
 

“Real Estate Demand Survey.” Equity Research: United States, Real
 

Estate Investment Trusts. Salomon Smith Barney. 
 9 Data provided to Haver Analytics by Challenger, Gray & Christmas.
 

More recently, because of a slowing economy, curtailed 

funding, and failures to achieve sales expectations, 

many high-tech and dot-com firms have closed or 

scaled back operations significantly. At the same time, 

traditional firms have reconsidered plans to expand, 

adopting a “wait and see” attitude. Consequently, as 

demand for space declines, large blocks of office space 

are returning to markets for sublease. 

Space available for sublease is similar to landlordoffered space available for rent—space under both categories should count toward a market’s available rental 

space. However, in the case of subleasing, tenants, 

rather than landlords, offer properties for rent. Tenants 

may attempt to sublease the property themselves or use 

a broker; however, in general, only space handled by a 

broker is included in the tally of a market’s available 

rental space. Consequently, current office vacancy 

increases could be higher than reported. 

CHART 2 

Office Demand Spiked in 2000 as Employers
 

Took on More Office Space than Needed
 

Sq. Ft. Absorbed Office Employment 

(000s) Growth (000s) 

120,000 

Office employment 

growth 

Office absorption 

’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 

1,000 

900 100,000 

800 

80,000 700 

60,000 600 

40,000 500 

400 

300 

20,000 

0 

200 

–20,000 100 

–40,000 0 

Note: 2001 is as of June 30. 

Source: Torto Wheaton Research 

Regional Outlook—National Edition 5 Third Quarter 2001 
In Focus This Quarter
 

Meanwhile, Construction Continues 

An uptick in office construction activity that began in 

many metro areas during the late 1990s has been a key 

element contributing to recent increases in office 

vacancies. According to the Bureau of the Census, 

U.S. expenditures on office construction totaled $47.5 

billion in 2000, continuing a seven-year cycle of 

expansion. Adjusted for inflation, this amount represents about 78 percent of the peak level of office 

construction expenditures that occurred in 1985. 

Recently, the pace of construction has slowed slightly, 

falling to an annualized rate of $44.3 billion in 

May 2001. 

Reflecting these large dollar outlays on office construction, TWR projected in December 2000 that 

111.3 million square feet of new office space (or 3.6 

percent of existing stock) would be completed during 2001. This newly completed space will come 

on the market following a period of rising construction activity from 1998 through 2000, during which 

the volume of completed office space averaged 84.9 

million square feet per year. As shown in Chart 3, 

however, current office construction activity as a 

percentage of existing stock falls well below that of 

the 1980s. 

CHART 3 

Many metropolitan areas currently experiencing high 

levels of construction activity also are seeing the largest 

increases in office vacancies. For example, cities that 

are positioned toward the upper right quadrant of Chart 

4 are characterized by higher vacancy rate increases and 

more new office space construction. The ten cities with 

the highest first-half 2001 vacancy rate increases had 

total square footage of under-construction office space 

at 6.5 percent of existing stock as of year-end 2000.10 

By comparison, total office space under construction 

nationally was 4.5 percent of existing stock.11 

Even as most projects move toward completion, some 

developers are reconsidering office construction 

plans. Builders have stopped construction of significant 

projects midstream in the Austin, Dallas, Seattle, and 

northern Virginia markets in response to retrenchment 

by major tenants and competition from subleased space. 

Softening Extends to Other 

Commercial Real Estate 

Other major commercial real estate markets are also 

feeling the effects of a slowing economy and, with the 

exception of the retail sector, are experiencing increasing vacancy rates. 

Office Construction Activity Increases in Recent Years yet Remains Well Below Level of the 1980s 

12 

10 

8 

6
 

4
 

2
 

0 

Notes: Construction activity is completions per year divided by prior year-end stock. 2001 is projected. Office Completions Divided by Stock (%) 

’82 ’83 ’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 

Source: Torto Wheaton Research 

10 One measure of a metropolitan area’s exposure to overbuilding 

and rising vacancy rates is the degree of construction activity. This 

measure is found by dividing a metropolitan area’s completions 

square footage or the under-construction square footage by the 

total stock of office property. 

11 The national 4.5 percent level for office properties under construction at December 2000 is higher than the 3.6 percent level for projected completions in 2001 because not all properties being built in 2001 

will be completed during the year. 

Regional Outlook—National Edition 6 Third Quarter 2001 
In Focus This Quarter
 

CHART 4 

Some Markets with Large First Half 2001 Office Vacancy Increases 

Also Have High Construction Activity 

Note: Construction activity is measured by a market's under-construction square footage at year-end 2000 divided by total square footage in that market as of year-end 2000. 

Source: Torto Wheaton Research, Spring 2001 Basis Point Vacancy Increase 

Construction Activity as Percentage of Stock 

Austin 

San Francisco 

San Jose 

Oakland 

Ventura 

Fort Lauderdale 

Seattle 

Miami 

Charlotte 

Orlando 

Las Vegas 

Northern New Jersey 

Phoenix 

Boston 

Washington, DC 

Kansas City 

Wilmington, DE 

Portland 

Atlanta 

Denver 

Columbus 

San Diego 

Nation 

0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0

–200 

–100 

100 

300 

400 

600 

700 

800 

0 

200 

500 

Industrial vacancy rates had fared well in recent years. 

As of year-end 2000, the national vacancy rate of 6.7 

percent was the lowest since 1984. Now, however, a 150­

basis-point increase has occurred, with industrial vacancies increasing to 8.2 percent in the first half of 2001.12 

As the economy and the nation’s high-tech and manufacturing sectors continue to slow, demand for industrial 

space for research and development and storage and distribution is declining. Industrial property subleasing is on 

the rise, and negative absorption occurred in the first half 

of 2001. At the same time, completions of industrial space 

during 2001 are estimated to exceed 220 million square 

feet, the highest level since 1988. Landlords are offering 

concessions, such as lease terms of one year compared 

with five to ten years, in an attempt to attract new tenants. 

Industrial properties are somewhat less exposed to 

risks from overbuilding than office properties because 

of shorter construction periods and the ability to 

respond quickly to any change in demand. An exception 

is the telecommunication hotel,13 a new entry into this 

market. This property type is characterized by a longer 

construction cycle and the fact that it typically has a 

“single use” design. In recent months, construction of 

these structures began in many high-tech markets to 

provide enhanced levels of data service. With declining 

demand, some telecom hotels stand vacant. 

12 Torto Wheaton Research. 

13 Telecom hotels are large, high-energy-consuming warehouses that 

house machinery, servers, routers, and switches that are the physical 

underpinning of the electronic commerce conducted on the Internet. 

They are hotels in the sense that they house equipment belonging to 

many different telecommunication companies. John Holusha, “Home 

for Machinery of the Internet,” The New York Times, August 16, 2000. 

The demand for hotel rooms is adversely affected by a 

slowing economy. Businesses have cut travel budgets 

and consumers have scaled back leisure plans, contributing to a decline in occupancy levels and revenue per 

available hotel room in most markets throughout 2001. 

Currently, upscale and luxury hotels are suffering more 

than limited service hotels. According to Smith Travel 

Research, limited service hotels, particularly budget 

hotels, represent the only lodging sector with higher 

occupancy levels through the first four months of 2001 

when compared to the same four month period in 2000. 

The supply of new hotel properties is lower than in the 

past, as financing for new hotel construction for the 

most part has been curtailed in recent years. However, 

limited service hotels are reported to be overbuilt in a 

number of markets in the Southeast and Southwest.14 

Annualized expenditures for new construction of all 

hotel types were $12.1 billion as of May 2001, falling to 

the lowest level since 1996.15 

The multifamily sector has experienced robust construction and equally strong absorption in recent years 

as new household formation, the driver for apartment 

demand, continues to increase. Annualized construction 

expenditures of $25.5 billion as of May 2001 were at the 

highest level since 1989.16 Despite the relative equilibrium between supply and demand for apartments in most 

markets, vacancy increases and rent declines are occurring in some locations. This decline has been most acute 

14 Kozel, Peter P. June 18, 2001. “U.S. Commercial Property Markets 

in a Slowing Economy: Implications for CMBS Credit Performance.” 

Standard and Poor’s Structured Finance. 

15 Data provided to Haver Analytics by U.S. Bureau of the Census. 

16 Ibid. 

Regional Outlook—National Edition 7 Third Quarter 2001 
 

In Focus This Quarter
 

in the more concentrated high-tech markets, such as San 

Francisco, where reported average rental rates dropped 

8.1 percent between the end of March and the end of 

May 2001.17 

Despite a slowing economy, the retail sector has performed reasonably well, as consumers maintain relatively high spending levels. Many of the store closings 

in 2000 and 2001 have been absorbed by new tenants as 

landlords have acted quickly to avoid letting vacant 

space linger. Meanwhile, robust construction has continued, with total expenditures in 2000 of $52.6 billion 

and an annualized level of $52.2 billion as of May 2001. 

Each of these two years’ expenditure levels exceeds all 

previous years’ retail construction amounts since data 

were first gathered in 1964.18 

Taking note of the robust level of retail construction 

activity, a recent Moody’s article finds that the nation’s 

mall retail and “power center”19 space grew by 3.3 percent in 2000, while population growth expanded by 

only 1.2 percent. The article raises concerns for potential excess supply of retail space resulting from a 

construction rate that is almost triple the population growth rate.20 A negative consequence of the 

high rate of retail construction is found in a recent 

Standard and Poor’s study. This article points out that 

most of the retail mortgages (held in commercial 

mortgage-backed pools of assets) that defaulted during 2000 did so because of competition from new 

retail establishments.21 

Implications for Insured Institutions 

Office vacancy rates during the first half of 2001 

increased at an unprecedented rate. What does this 

mean for insured institutions? On the one hand, at 

mid-2001 vacancy rates remained below their 20-year 

average. Yet the speed of the increase and the number 

17 Associated Press, News in Brief from the San Francisco Bay Area,
 

June 13, 2001.
 

18 Data provided to Haver Analytics by U.S. Bureau of the Census.
 

19 According to the Urban Land Institute, a power center is a community shopping center in which at least 75 to 90 percent of the selling
 

space is devoted to multiple off-price anchors and a discount department store or warehouse club. It is the “power” of its anchors that
 

gives the center its name. 


20 Sally Gordon, op. cit.
 

21 Kozel, Peter P. April 20, 2001. “Outlook for Property Markets in a
 

Slower-Growing Economy and the Implications for CMBS Credit
 

Performance.” Standard & Poor’s Structured Finance.
 

of metropolitan areas that have experienced softening 

make this a trend that deserves the close attention of 

insured institutions, especially those with significant 

concentrations in commercial real estate and construction lending. 

Financial indicators of real estate credit quality in banking remain favorable, with losses and delinquencies 

trending up modestly from minimal levels. Noncurrent 

construction and development (C&D) loans as of March 

31, 2001, remain at a relatively low .92 percent of all 

outstanding C&D loans. (Noncurrent C&D loans as a 

percentage of all C&D loans averaged .93 percent for 

the past five year-ends.) Similarly, noncurrent CRE 

loans22 as of March 31, 2001, were .82 percent of all 

CRE loans, a level consistent with the average for this 

ratio of 1.08 percent for the past five year-ends. Chargeoff ratios at March 31, 2001, for both C&D and CRE 

loans were each at .02 percent and remain below the 

averages of .05 percent for each for the past five yearends. These favorable numbers are the legacy of a 

strong economic expansion, whereas current economic 

events suggest the potential for future deterioration in 

credit quality. 

The outlook for commercial real estate credit quality 

depends on the depth and duration of the current economic slowdown and on the risk management practices 

of each institution. In this regard, as signs of increasing 

risk materialize in conjunction with a declining economy, lenders appear to be managing risks prudently 

and avoiding speculative lending.23 Anecdotal information suggests that borrowers are pressed to obtain 

higher prelease commitment levels in order to gain loan 

approvals. In addition, lenders are requiring more 

up-front equity.24,25 

The importance of risk management practices is magnified by the heightened lending concentrations currently prevailing at some banks. Institutions with 

elevated concentrations in CRE and C&D lending have 

been more likely to experience significant problems 

during times of economic stress (for further details, 

22 CRE loans are nonfarm, nonresidential loans secured by real estate.
 23 Speculative construction lending is defined as a loan not accompanied by a meaningful presale, prelease, or take-out commitment. 


24 “Capital Is Still Plentiful for Right Projects.” Midwest Real Estate
 

News. July 2001. Vol. 17, No. 7. 
 25 Further information on bank underwriting practices can be found in
 

Federal Deposit Insurance Corporation, Division of Research and
 

Statistics, Report on Underwriting Practices, http://www.fdic.gov/
 

bank/analytical/report/index.html.
 

Regional Outlook—National Edition 8 Third Quarter 2001 
In Focus This Quarter
 

see History of the Eighties26). As shown in Chart 5, the 

percentage of insured institutions with commercial real 

estate loan concentrations between 200 and 400 percent of capital is higher now than it was in the late 

1980s. However, there are relatively fewer institutions 

at the highest concentration level, in excess of 500 

percent of capital. In fact, fewer than 1 percent of 

insured institutions are at this level. A similar story 

holds true for construction loans, as the increasing 

concentrations are in the range of 100 to 300 percent of 

capital (see Chart 6). 

There are a number of issues for construction lenders 

and commercial real estate lenders to consider going 

forward. Because uncovered loans (C&D loans made 

without assurances of a firm take-out commitment) 

tend to be higher-risk, an important part of managing 

the risk in construction lending has traditionally been 

the lender’s ability to obtain a take-out commitment. 

Sources of take-outs for C&D loans include other 

insured institutions, pension funds, foreign investors, 

and life insurance companies, along with public-market 

real estate investment trusts (REITs) and conventional mortgage-backed securities (CMBSs). Anecdotal 

reports indicate that shifts in market sentiment in 

recent months have resulted in lowered investments in 

REITs and consequently less available capital for 

REITs to purchase real estate.27 Insured institutions 

CHART 5 

Concentrations of Commercial Real Estate
 

Loans between 200 and 400 Percent of
 

Capital Are Higher Now than in the Late 1980s
 

0 

2 

4 

6 

8 

10 

12 

14 

16 

18 

20

Percentage of Insured Institutions

FDIC-insured institutions 

with commercial real estate 

loans-to-equity capital 

greater than: 

’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 

300 percent 

400 percent 

500 percent 

200 percent 

Sources: Bank Call Reports, Thrift Financial Reports (Research Information 

System, FDIC) 

26 Federal Deposit Insurance Corporation. History of the Eighties— 

Lessons for the Future, Vol. 1: An Examination of the Banking Crises of 

the 1980s and Early 1990s, Chapters 9 and 10. 1997. Washington, DC: 

FDIC. http://www.fdic.gov/bank/historical/history/index.html. 27 Smith, Ray A. August 1, 2001. “Property Held by Public Firms 

Drops.” The Wall Street Journal. 

CHART 6 

Concentrations of Construction Loans 

Have Moved Higher in Recent Years 

Sources: Bank Call Reports, Thrift Financial Reports (Research Information 

System, FDIC) Percentage of Insured Institutions 

’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00

FDIC-insured institutions with real 

estate construction loans-to-equity 

capital greater than: 300 percent 

200 percent 

400 percent 

100 percent 

0 

2 

4 

6 

8 

10 

12 

14 

may face increased challenges to convert construction 

and development loans into permanent loans should the 

reported REIT situation become a trend and other 

sources of permanent capital become less available to 

purchase C&D loans. 

Monitoring economic trends in general, and local real 

estate trends in particular, becomes even more important during a time of rapid change in market conditions. For example, reliance on appraisals based on 

outdated or top-of-market assumptions can result in a 

divergence between expected and realized collateral 

values or cash flows. Similarly, while preleasing commitments offer significant risk-reduction benefits to 

lenders, during a time of weakening economic conditions there is at least the possibility that a prospective 

tenant will be unable to honor a lease obligation, as 

has been the case with some firms in the high-tech 

sector in recent months. 

Conclusion 

Office market trends cannot, of course, be considered in 

isolation. The recent softening in office markets is a 

symptom of a slowing economy coupled with a rapid 

decline in the fortunes of some high-tech firms. Considered in this broader context, the challenge for insured 

institutions is simply to ensure that risk-management 

strategies are in place that will succeed under a more 

challenging economic environment. 

Thomas A. Murray 

Senior Financial Analyst 

Regional Outlook—National Edition 9 Third Quarter 2001 
In Focus This Quarter
 

TABLE 2 

Office Market and Banking Data on 53 Metropolitan Areas 

MEDIAN HIGH-TECH OFFICE 

2ND BASIS C&D AS AS SPACE 

QUARTER POINT COUNT OF PERCENTAGE PERCENTAGE UNDER 

2001 INCREASE COMMUNITY OF TIER 1 OF TOTAL CONST/ 

METROPOLITAN OFFICE FROM YEAR BANKS WITH CAPITAL AT MARKET STOCK AT 

STATISTICAL AREA VACANCY END 2000 C&D LOANS 3/31/2001 

(%) 

EMPLOYMENT 

(%) 

12/31/2000 

(%) 

ALBUQUERQUE 11.6 –110 9 61.0 6.8 2.0 

ATLANTA 9.8 170 76 172.2 3.8 6.1 

AUSTIN 11.8 680 20 53.4 10.1 9.6 

BALTIMORE 8.9 60 60 22.8 3.6 6.3 

BOSTON 8.7 480 100 24.1 8.2 5.6 

CHARLOTTE 9.0 40 20 48.5 1.7 8.9 

CHICAGO 8.9 130 225 33.5 4.5 4.9 

CINCINNATI 10.1 100 58 32.6 3.1 6.0 

CLEVELAND 13.6 40 16 34.8 3.0 0.8 

COLUMBUS, OH 16.9 350 20 22.4 3.1 5.1 

DALLAS 16.4 110 75 84.5 6.5 3.9 

DENVER 12.7 370 45 70.4 5.2 4.9 

DETROIT 12.0 160 28 35.2 3.1 2.8 

FT. LAUDERDALE 12.8 310 13 19.1 2.7 10.2 

FT. WORTH 16.4 130 36 71.8 3.4 0.7 

FRESNO 14.4 20 5 196.0 0.9 0.8 

HARTFORD 14.0 150 11 25.2 3.5 0.0 

HONOLULU 12.6 –190 3 11.4 0.9 0.0 

HOUSTON 13.6 60 48 65.8 3.1 0.8 

INDIANAPOLIS 15.8 120 21 29.6 3.3 1.4 

JACKSONVILLE 11.7 –20 11 65.2 1.8 3.4 

KANSAS CITY 15.9 490 86 70.8 2.7 1.3 

LAS VEGAS 14.5 290 19 117.7 1.5 7.3 

LONG ISLAND 10.9 190 6 19.1 5.3 1.8 

LOS ANGELES 14.1 150 62 35.4 3.7 2.0 

MIAMI 10.5 310 26 28.1 1.8 9.2 

MINNEAPOLIS 10.8 20 119 44.0 6.0 5.7 

NASHVILLE 12.8 230 20 78.4 1.2 2.0 

NEW YORK 5.1 230 34 10.5 2.4 1.4 

NORTHERN NEW JERSEY 10.9 360 66 15.0 5.6 6.9 

OAKLAND 9.3 630 12 120.0 6.5 7.9 

OKLAHOMA CITY 20.3 20 44 57.8 2.6 0.5 

ORANGE COUNTY 14.7 330 14 34.5 6.4 3.9 

ORLANDO 13.1 110 23 72.1 2.3 8.1 

PHILADELPHIA 10.7 80 68 22.1 4.5 3.2 

PHOENIX 16.9 440 27 114.2 4.7 6.5 

PORTLAND, OR 9.9 280 14 118.8 6.6 6.7 

RIVERSIDE 14.4 –100 18 143.5 1.6 0.3 

SACRAMENTO 6.6 70 11 106.9 3.9 5.6 

SALT LAKE CITY 15.3 280 14 111.7 4.5 4.1 

Regional Outlook—National Edition 10 Third Quarter 2001 
In Focus This Quarter
 

TABLE 2 (CONTINUED) 

Office Market and Banking Data on 53 Metropolitan Areas 

MEDIAN HIGH-TECH OFFICE 

2ND BASIS C&D AS AS SPACE 

QUARTER POINT COUNT OF PERCENTAGE PERCENTAGE UNDER 

2001 INCREASE COMMUNITY OF TIER 1 OF TOTAL CONST/ 

METROPOLITAN OFFICE FROM YEAR­ BANKS WITH CAPITAL AT MARKET STOCK AT 

STATISTICAL AREA VACANCY END 2000 C&D LOANS 3/31/2001 EMPLOYMENT 12/31/2000 

(%) (%) (%) 

SAN DIEGO 9.7 350 21 57.5 6.6 4.9 

SAN FRANCISCO 10.3 620 21 69.0 8.3 9.7 

SAN JOSE 8.1 680 5 174.5 27.4 7.5 

SEATTLE 9.4 500 30 77.1 6.6 9.0 

ST. LOUIS 10.1 –80 80 40.4 2.6 4.8 

STAMFORD 11.2 290 10 43.5 5.6 2.6 

TAMPA 14.8 70 33 40.0 4.2 2.7 

TUCSON 8.8 100 3 178.4 4.4 4.8 

VENTURA 14.2 270 8 49.7 5.4 14.2 

WASHINGTON, DC 7.8 390 61 51.1 7.8 6.3 

WILMINGTON, DE 10.4 420 12 28.4 3.8 1.6 

W. PALM BEACH 12.2 160 18 37.2 2.3 4.8 

WESTCHESTER 12.5 120 4 19.5 12.3 2.1 

NATION 10.8 250 (1) 3,801 (1) 40.1 (2) 4.8 (2) 4.5 

Notes: Only community banks with construction loans are included in this table. Community banks are institutions
 

with assets less than $1 billion. Noncommunity banks are excluded because their lending activities are likely to
 

span a larger area than the MSA in which they are headquartered.
 

Sources: Torto Wheaton Research; Bank and Thrift Call Reports, FDIC Research Information System data;
 

Economy.com, Inc.
 

1. Only community banks with construction loans and located within a MSA are included in these figures. 

2. Percentages shown are the averages for the 53 metropolitan areas. 

Regional Outlook—National Edition 11 Third Quarter 2001 
Regional Perspectives
 

Atlanta Regional Perspectives
 

The Atlanta Regional Outlook, second quarter 2001, 

examined economic and competitive factors that 

could affect bank performance in metropolitan 

areas; however, some nonmetropolitan counties may 

share similar risk factors. The Atlanta Region’s rapid 

growth over the past decade and the increasingly 

important issue of urban sprawl have blurred the distinctions between many metropolitan and nonmetropolitan counties. To focus on areas where competitive 

pressures may be high, we considered nonmetropolitan 

markets where ten or more insured institutions compete. Of the 424 nonmetropolitan counties in the 

Atlanta Region, only 25 have ten or more insured institutions with offices accepting deposits within the county. Of these 25, all but 3 are adjacent to metropolitan 

areas. 

We developed an economic classification for nonmetropolitan counties by modifying a methodology 

used by the United States Department of Agriculture 

(USDA). The USDA’s Rural-Urban Continuum 

defines counties bordering a metropolitan area with 

at least 2 percent of the workforce commuting to 

that metropolitan area as Adjacent. Otherwise, 

the counties are identified as Not-Adjacent. 

We further classified Adjacent counties into 

three groups: Dependent, Independent, 

and Mixed. 

Dependent counties are adjacent 

counties whose economies are tied 

closely to the bordering metropolitan 

area. Independent counties are those that 

remain heavily dependent on a particular local industry. 

Mixed counties generally appear to be in a transitional 

stage because they continue to be affected by traditional 

industries, yet there may be an increasing spillover 

effect from bordering metropolitan areas. 

Some patterns in banking market structure emerge 

using our classification of nonmetropolitan counties 

that are home to at least ten insured institutions. The 

number of institutions and offices in all market types 

except Independent grew during the latter half of the 

1990s. Although all market types were dominated by 

superregional or regional banking companies, Dependent and Not-Adjacent counties were comparatively 

less concentrated; consequently, the degree of competition may be higher in these areas. In addition, nearly 

one-third of the insured institutions operating in Independent counties are headquartered locally, compared 

with 25 percent among the other county types. Finally, 

Dependent and Not-Adjacent counties, which displayed 

the highest overall levels of per capita income, also hold 

the highest levels of deposits per capita. 

Insured institution performance and the overall risk 

profile can vary significantly by geographic location 

and local economic structure. Community banks1 

headquartered in the 25 counties in our analysis generally exhibit a different risk profile and underperform 

other nonmetropolitan banks. At year-end 2000, Atlanta 

Region community banks operating in highly competitive nonmetropolitan counties held less capital 

and larger loan portfolios—with a greater 

concentration in real estate loans, particularly in the traditionally higher-risk construction and development loans—and 

relied more on borrowed funds because 

of lower core deposit levels than other 

nonmetropolitan areas with fewer market 

participants. These characteristics have been 

apparent during much of the recent economic 

expansion. The risk profile of these community 

banks more closely resembles that of an urban 

bank than does that of the typical nonmetropolitan community bank. Also, while the 

banking markets exhibit more favorable 

growth potential than those of other nonmetropolitan counties, they may be less desirable 

to large insured institutions if the level of competition 

constrains customer profitability. 

1 Community banks include all Call Report filers, commercial banks, 

and state savings banks with assets of $1 billion or less. 

Regional Outlook—National Edition 12 Third Quarter 2001 
Regional Perspectives
 

Boston Regional Perspectives
 

Following the nation, New England’s economic 

growth slowed through midyear 2001. As of June, 

nonfarm employment in the Region was up 1.5 percent 

from year-ago levels, a sizable deceleration from 

the prior year’s pace. Initial unemployment claims 

between January and June significantduring the first quarter. New permit 

ing unemployment and an increase 

ly exceeded year-earlier levels. Risin personal bankruptcy filings 

also resulted from the slowing 

economy by midyear. Despite 

continued strong appreciation 

in home prices, existing home 

sales were flat or down slightly 

volume has been easing since 1998 

in the Region, and much of the 

weakness has been centered in 

southern New England. The Region’s 

economy, along with the nation’s, hinges on 

the continued strength of consumer spending. 

Fraudulent activity poses an ongoing and significant risk to financial institutions. Fraud manifests 

itself in many forms; however, the vast majority of 

fraud is carried out by a firm’s own employees. Effective measures should be in place to protect a firm’s 

assets and minimize potential losses arising from internal fraud, which can lead to loss and, in extreme cases, 

failure. Several studies of the reasons for bank failures 

suggest that insider fraud was a significant contributing 

factor to the failure of anywhere from 11 percent to 33 

percent of failed institutions. In light of the fact that 

nearly 3,000 banks and thrifts have failed in the past 20 

years, these findings underscore the importance of 

managing fraud risk. Historical patterns suggest that 

evidence of fraud increases following a downturn in 

general economic conditions, which reveals situations 

that may be masked during good economic times. In 

fact, Suspicious Activity Report filings related to 

crimes of an internal nature—including bribery, 

embezzlement, misuse of position, and mysterious disappearance—have begun to rise after remaining fairly 

stable during the past three years. 

Fidelity insurance coverage is a necessary safeguard 

against fraud loss. Boards of directors are responsible 

for ensuring that effective measures are in place to minimize potential losses arising from internal fraud. Fraud 

cannot be entirely eliminated; however, strong internal 

controls and comprehensive audit programs are the 

most effective means of both deterring and detecting 

internal fraud. As fraud represents a source of significant or even catastrophic loss to any institution, residual 

risk should be shifted to other parties through appropriate levels of fidelity insurance coverage. Coverage is 

especially important in small institutions that may not 

have the resources to devote to the more sophisticated 

fraud programs that larger institutions are capable of 

administering. 

Fidelity insurance coverage levels among insured 

institutions may be worth reviewing in light of deteriorating economic conditions. The median level of 

fidelity coverage has remained fairly constant across all 

asset sizes since the late 1980s. While there has been a 

noticeable rise in financial institution bond (FIB) levels, 

aggregate fidelity coverage has remained fairly flat. The 

increased fidelity coverage provided by Clause A of the 

FIB has been largely offset by elimination of coverage 

under excess employee dishonesty bonds. The increased 

coverage for losses covered by nonfidelity clauses of 

the FIB is a positive trend. However, it is somewhat 

surprising that fidelity coverage has been flat, given the 

fact that a significant percentage of bank failures have 

been attributed directly to insider fraud and abuse. 

Savings banks typically carry lower levels of fidelity 

coverage than do their commercial counterparts. 

Data obtained from the Surety Association of America 

and the Association of Certified Fraud Investigators 

suggest that the risk of fraud and abuse in savings 

institutions, from a fidelity perspective, is not significantly dissimilar to that of commercial organizations. 

As savings institutions make up 70 percent of all banks 

in the Boston Region, this observation is worthy of 

consideration. 

Effective fraud deterrence and detection policies are 

the first lines of defense for minimizing exposure to 

fraud. Fidelity insurance plays an important backup 

role in preserving the solvency of an insured institution 

that is victimized by a significant fraud event. Ensuring 

that all these aspects of an effective fraud risk management program are in place is an important function 

of the board of directors and senior management, 

and becomes particularly important during periods of 

economic uncertainty. 

Regional Outlook—National Edition 13 Third Quarter 2001 
Regional Perspectives
 

Chicago Regional Perspectives
 

Recent economic crosscurrents triggered noticeably 

slower growth and uncertainty about the future for 

households and major industries in the Region. 

Labor markets weaken and households face pressure. 

Employment growth in the Region turned modestly negative in second quarter 2001 as a growing number of layoffs occurred in the manufacturing sector and smaller 

employment gains occurred in most others. Manufacturers trimmed the length of the workweek and, thus, average 

weekly earnings for many workers. Households also faced 

higher energy prices and the average 401(k) retirement 

account balance failed to rise in 2000. All these developments contributed to a decline in consumer confidence. 

Real estate sector presents a mixed picture. Residential resales and permits for new construction remain 

high in the Region. In contrast, conditions in commercial real estate (CRE) markets changed fairly abruptly. 

Weaker conditions were widespread in suburban office 

markets, while vacancy rates jumped for downtown 

office space in Indianapolis and Columbus. 

Inventory correction is a key to the economy’s nearterm health. Production cutbacks are occurring in 

many industries because inventories are 

high relative to the pace of sales. 

The rise in inventory-to-sales ratios 

is most pronounced among producers of durable goods, which 

have a relatively large presence in the Region. A correction seems well under 

way in the light-vehicle 

sector, where domestic 

auto stocks fell considerably 

after year-end 2000 and production turned up in the second 

quarter. In contrast, recent inventoryto-sales ratios were high for primary and fabricated metals and other important sectors despite 

production cutbacks. 

How crosscurrents will play out is unclear. Positive 

developments in the first half of 2001 include lower interest rates, tax rebates, stable residential markets, and reduction of the inventory imbalance for motor vehicles. On the 

other hand, activity in the manufacturing and CRE sectors 

is likely to remain a drag on the economy until current 

imbalances are resolved. 

Sluggish economy pressures banks’ asset quality 

and interest-rate risk management. Although some 

deterioration occurred in first quarter 2001, overall 

asset quality reported for the Region’s banks and 

thrifts appears favorable, while aggregate capital levels 

are high by historical standards. 

Economic weakness may affect insured institution asset 

quality adversely, however, particularly at institutions 

that have exhibited aggressive risk selection. Slower 

economic growth has also contributed to sharp reductions in interest rates, which may improve profitability 

for some insured institutions but present interest-rate 

risk management challenges for others. 

Asset quality has deteriorated somewhat at large 

banks and thrifts. Large institutions in the Region, much 

like their counterparts nationwide, have experienced some 

asset quality weakening. The Region’s large banks and 

thrifts reported a past-due and nonaccrual (PDNA) ratio 

of 2.42 percent on March 31, 2001, up 53 basis points 

from a year earlier and the highest in 12 quarters. The 

2000 Shared National Credit Review program showed a 

second significant increase in classified and criticized 

credits, albeit from a very low base. Indications from the 

2001 review are that this trend is continuing. 

Concentrations in traditionally higher-risk assets 

have increased among community institutions. 

Increasing volumes of traditionally higher-risk loans 

and higher loan-to-asset levels may have heightened the 

credit risk for the Region’s community banks. For 

example, 32 percent of institutions reported CRE exposure in excess of 200 percent of Tier 1 capital in early 

2001, up from 19 percent in 1990. Loan delinquency 

levels have risen recently, yet remain well below levels 

of a decade ago. However, insured institutions with concentrations in CRE, commercial and industrial, or agricultural loans represent a significant share of those 

institutions with higher PDNA ratios. 

In addition to rising credit exposure during the past 

decade, institutions faced an increasingly competitive environment, particularly for traditional funding sources. Competition on both sides of the balance 

sheet has led to significantly lower net interest margins 

despite increased credit exposure. Even so, aggregate 

profitability has held up well, thanks to a low level of 

problem loans, correspondingly low provision expenses, 

and the cultivation of noninterest income. The recent 

economic slowdown may weaken these positive trends. 

Regional Outlook—National Edition 14 Third Quarter 2001 
Regional Perspectives
 

Dallas Regional Perspectives
 

A slowing economy adds more uncertainty to the 

Dallas Region’s agricultural sector. Prolonged price 

weakness, rising expenses, and weather-related issues 

have dampened profitability for most agricultural producers. However, government payments and strong levels of off-farm income have averted more serious 

problems for agricultural producers and their lenders. 

Signs of a slowing economy and prospects for a new 

farm bill could weaken these supports for the industry. 

The effects of a decline in government payments 

may not be felt as acutely in the Dallas Region. 

Government payments and net farm income for 2001 

are forecast to be considerably lower than in 2000. 

However, Congress recently approved an 

additional $5.5 billion of emergency aid 

for the 2001 crop year. While this allocation indicates a certain level of concern 

on behalf of Congress, it is substantially 

less than the $9.7 billion funded last 

year.1 

During 1999, 39 percent of the Dallas 

Region’s net farm income was derived from 

government payments, significantly less than the 

50 percent average nationwide. This difference is attributable to the strong presence of the livestock sector, 

which does not receive government payments. Specifically, 69 percent of the Region’s agricultural cash 

receipts are derived from livestock products, compared 

with 51 percent for the nation.2 Livestock prices have 

performed well during the past two years, and this sector’s current strength has protected the Region’s agricultural industry somewhat from the effects of declining 

government payments this year. 

Off-farm income helps to stabilize the economy. 

Another stabilizing effect on the general farm economy 

is the amount of off-farm income available to cover 

shortfalls in farming operations. The recent economic 

expansion and tightening labor markets have created 

new opportunities for nonfarm employment. Off-farm 

income in Texas and Oklahoma averaged almost 

$80,000 per farm household at year-end 1999—an 

1 Jackson, Ben. May 14, 2001. “Farm Group Sees Shortfall In Budget
 

Aid.” American Banker.
 2 USDA, U.S., and State Income Data 1999. http://www.ers.usda.gov/
 

data/farmincome/finfidmu.htm.
 

increase of 116 percent since 1991, and 38 percent 

greater than the national average.3 

In addition, commercial farms4 saw their share of total 

household income derived from off-farm sources rise to 

69 percent, an increase of 11 percentage points from 

1991 to 1999. This increase helped mitigate problems 

that could have resulted from depressed commodity 

prices and sluggish exports. An economic slowdown 

would diminish the overall prospects for off-farm 

employment and income, increasingly used to supplement total farm household income. 

Problems in the agricultural economy have not manifested in bank portfolios, but some weakness is 

emerging. In the aggregate, agricultural banks continue to report strong balance sheets and steady profits 

despite depressed agricultural conditions. 

However, the bottom 5 percent of the Dallas Region’s agricultural banks reported a 

negative average return on assets (ROA), 

continuing a downward trend that began 

in 1997. The difference between the average pretax ROA for the Region’s agricultural banks as a group and the “worst” 

performing members of this group is widening at an accelerating pace. 

The 2002 farm bill is an unknown quantity. While it 

is unclear at this time what direction the new farm bill 

will take, most congressional leaders agree that ad hoc 

disaster payments are not a long-term solution for farm 

policy. Many members of Congress support keeping a 

market-oriented farm bill that also contains provisions 

to support farm income. Taking this a step further, the 

administration’s position, as stated by U.S. Secretary of 

Agriculture Ann Veneman, emphasizes that any safety 

net for farmers and ranchers should be consistent with 

an evolving and dynamic global marketplace.5 However, many industry analysts view ongoing attempts to 

move U.S. producers toward a free market approach as 

problematic because of the subsidies offered by other 

countries in the global agricultural marketplace. 

3 USDA, Household Income Data 1999. http://www.ers.usda.gov/
 

Briefing/FarmIncome/
 

4 Farms reporting annual sales of $50,000 to $250,000.
 

5 Remarks of Secretary of Agriculture Ann M. Veneman at the Sparks
 

Companies 9th Annual Food and Agriculture Policy Conference,
 

Washington, DC, April 17, 2001.
 

Regional Outlook—National Edition 15 Third Quarter 2001 
Regional Perspectives
 

Kansas City Regional Perspectives 


Heavy reliance on government payments makes 

uncertainty about these payments a key concern. 

Despite a prolonged period of low commodity prices, 

the Region’s farm banks continue to report sound asset 

quality, in large part because of increasing government 

support to farmers. Much of this support has been 

ad hoc emergency and loan deficiency payments, which 

represented slightly less than two-thirds of the $22.9 

billion in total payments last year. However, going 

forward, farmers are unsure about the timing and 

amount of these payments at a critical time—when they 

are deciding what to plant. Moreover, the farm bill 

expires in 2002, and it is not clear what direction farm 

support policy will take under new farm legislation. 

The Region’s farmers are highly dependent on government payments, although this dependence varies across 

the Region (see Chart 1). Generally, farm banks with 

the highest concentrations in farm lending and whose 

borrowers show the most reliance on government payments would likely exhibit the greatest exposure to 

changes in the level of government payments. 

Assessing insured institutions’ level of exposure to the 

agricultural sector is one way to evaluate the vulnerability of farm banks to declining government payments. 

Looking at a state’s dependence on government support 

and farm banks’ concentration in farm lending, North 

Dakota stands out in the Region. North Dakota’s farmers are the most dependent on federal payments, and 

farm banks in that state tend to be relatively highly 

concentrated in farm lending. 

CHART 1 

Source: Economic Research Service, USDA 

Government Payments Have Been 

Crucial to Farmers’ Cash Flows 

Direct Government Payments to Net Cash Income 

(1998 and 1999 Combined) 

IA KS MN MO ND NE SD 

Percent 

Region 

0 

20 

40 

60 

80 

100 

The other states present a mixed picture. Although 

Iowa exhibits a relatively high dependence on government payments, its banks tend to be less concentrated 

in farm lending. Conversely, Nebraska and South 

Dakota farm banks tend to be more concentrated in 

agricultural lending, but these states’ farmers appear to 

be less reliant on government payments. 

However, the fact remains that all 

states in the Region are home to 

farmers who are highly reliant 

on government payments and 

to farm banks with relatively 

high concentrations in agricultural lending. As a result, the 

entire Region appears to be 

vulnerable, to some degree, 

to a significant reduction in 

government payments. 

Large government payments have contributed 

to stable land values despite declining farm revenues. 

Despite large declines in farm operating net cash 

income during the past few years, farmland prices are 

holding steady or rising across the Region. In the aggregate, the value of cropland rose 3.6 percent and the 

value of pastureland rose 4.3 percent between year-end 

1996 and year-end 1999, according to the most recent 

data available. 

Nonfarm influences, such as urbanization and nonfarm 

residential and recreational use, are contributing to these 

sustained prices. However, a relatively high level of 

government payments appears to exert the greatest influence. Farmland, like other business property, derives its 

value from the ability to generate cash flow. Therefore, 

because government payments represent a portion of 

farmers’ cash flow, they influence farmland value. 

A reduction in government support could cause rising 

delinquencies and declining collateral protection. An 

analysis of the influence of government payments on land 

prices suggests that such payments accounted for as 

much as 52 percent of the Region-wide value of farmland 

in 1999, up considerably from 14 percent in 1996. As a 

result, even a small reduction in government payments to 

farmers could affect farmland values negatively and 

could result in escalating default rates on farm loans. 

Moreover, collateral protection could be eroded if current 

payments and the expectation of continued payments are 

supporting farmland values. 

Regional Outlook—National Edition 16 Third Quarter 2001 
Regional Perspectives
 

Memphis Regional Perspectives
 

Economic conditions in the Region and the nation 

have slowed considerably in recent quarters, and the 

outlook remains uncertain. While banks and thrifts in 

the Region remain relatively well positioned to meet 

the challenges posed by changing economic conditions, this transition is affecting earnings performance 

and credit quality at insured financial institutions. 

Earnings fell sharply in first quarter 2001, and further economic slowing could contribute to additional earnings erosion. Community banks (those with 

less than $1 billion in total assets) reported a median 

return on assets of 1.03 percent, down from 1.17 

percent one year ago because of increased provision 

expenses and declining margins. Net 

interest margins, 

a vital component of community bank 

earnings, fell to a 

median 4.09 percent, 

the lowest level reported in 

the 17 years for which such data 

have been collected. Several 

factors likely contributed to historically low margins, including 

declining loan volumes, balance 

sheet optionality, and limited 

repricing of deposits. 

Margins should benefit significantly from the considerable steepening of the yield curve during the first 

half of 2001, but this improvement could be offset by 

declining loan levels and increasing levels of nonearning assets if economic conditions deteriorate. Furthermore, additional weakening could contribute to higher 

provision expenses. While many banks and thrifts 

recently tightened lending standards in response to 

changing conditions, credit quality deterioration may 

occur in loans originated during a stronger economic 

period and under less stringent underwriting standards. Many banks and thrifts in the Region already 

report higher loan delinquencies than one year ago, 

with the increase centered in consumer and construction lending. 

A growing consumer debt burden and numerous 

layoffs in recent quarters may lead to higher consumer delinquencies and loan losses. Recent job losses, 

most notably in the stressed manufacturing sector, raise 

concern about the ability of some consumers to meet 

debt service payments, which at a national level have 

climbed as a share of disposable income to the highest 

level since 1987. The Region’s insured financial institutions, particularly those in rural areas, appear more at 

risk to deterioration in consumer loan quality than 

institutions in other parts of the nation because of higher exposure levels and potentially weaker consumer 

finances. Without a quick economic recovery, consumer 

credit quality in the Region may deteriorate further. A 

significant number of layoff announcements continued into second quarter 2001 and many previously 

announced layoffs have only recently occurred, suggesting that the number of unemployed is likely to rise. As 

unemployment benefits, severance packages, and savings 

are exhausted, consumer loan delinquencies may climb. 

Banks and thrifts in some of the Region’s metropolitan areas may be vulnerable to potential residential 

real estate market imbalances. At least half of the 

banks and thrifts headquartered in the Memphis, 

Fayetteville-Springdale, and Lexington metropolitan 

areas report construction and development loan concentrations equivalent to 100 percent of leverage capital. 

Many banks in Little Rock and Nashville also report 

relatively high exposure. Among these five markets, 

Memphis banks appear most vulnerable because of substantially higher concentration levels, a preponderance 

of speculative rather than presold development, and an 

oversupply of existing homes. 

Risk managers face challenges with the economy in 

transition. Strong economic conditions throughout 

most of the 1990s provided creditors with greater comfort and flexibility in the application of underwriting 

standards without incurring substantial additional risk. 

However, the current economic slowing raises the level 

of incremental risk associated with each credit decision. 

Regardless of whether the recent slowing is a merely a 

temporary inventory adjustment or part of a more pronounced cycle, it does require front-line risk managers 

to adjust to a less forgiving economic climate. 

Regional Outlook—National Edition 17 Third Quarter 2001 
Regional Perspectives
 

New York Regional Perspectives
 

The economic tide has risen since the beginning of the 

1990s; however, the Region’s counties have not benefited 

equally. “Vibrant counties,” those that ranked in the top 

third of economic performance over the past five years,1 

tend to be located in the suburban and exurban rings 

around the Region’s major cities. These counties track the 

I-95 corridor between New York City and Washington, 

DC, and extend up to the Hudson River valley to Albany. 

During the latter half of the 1990s, vibrant counties experienced higher population and employment growth rates 

and had a more diversified job base, relative to the nation, 

than the Region’s less vibrant counties. Many of the 

Region’s vibrant counties also benefited from strong 

growth and higher-paying jobs in the construction, 

finance, insurance, and real estate industries. Conversely, 

the share of jobs in the stressed manufacturing sector in 

the Region’s less vibrant counties, although declining, is 

roughly twice that in vibrant counties. 

Banks in vibrant economies report higher 

margins but greater credit risk. 

The Region’s insured institutions have benefited from the 

rising economic tide, reporting strong loan growth and 

favorable credit quality. The Region’s banks also have 

higher average capital ratios than a decade ago. Nevertheless, local economic conditions have contributed to 

differences in performance and credit risk profiles among 

the Region’s banks. After declining throughout much of 

the late 1990s, net interest margins (NIMs) reported 

by the Region’s banks have improved. However, banks in 

the Region’s vibrant counties reported NIMs increasing 

to a greater degree than did banks 

in less vibrant counties. A moderate increase in the percentage 

of commercial loans, which are 

typically higher-yielding loans, 

and stronger core deposit 

growth have contributed 

to this difference in NIMs. 

Moreover, while institutions 

Region-wide face increased 

competition for core funding, 

banks in the Region’s less vibrant 

economies face the added challenge 

of unfavorable population and personal income growth 

trends. Additionally, banks in less vibrant counties hold 

loan portfolios characterized by a longer maturity, which 

reflects a greater proportion of residential loans. This 

portfolio composition also may have contributed to NIM 

compression when the yield curve was relatively flat in 

the late 1990s. 

Despite slightly higher past-due ratios reported by 

banks in less vibrant counties, insured institutions in the 

Region’s vibrant economies might be more vulnerable 

to losses. According to a Federal Deposit Insurance 

Corporation study of the 1980s banking crisis, bank 

failures that occurred a decade ago generally were concentrated in the Region’s markets that had experienced 

rapid growth, particularly speculative commercial real 

estate (CRE) development.2 The Region does not currently exhibit the economic imbalances it experienced a 

decade ago; however, a softening economy could lead to 

a weakening in credit quality. Moreover, should margin 

pressure increase, banks in less vibrant economies holding lower-yielding portfolios may be tempted to shift 

into traditionally higher-yielding, higher-risk assets or 

expand their geographic lending area, which could 

heighten credit risk profiles. 

Economic slowdown affects office markets. 

Recent evidence suggests that some of the Region’s 

office markets may be experiencing the effects of the 

economic slowdown. According to recent reports,3 many 

of the Region’s major office markets, including New York 

City, northern New Jersey, Long Island, Philadelphia, 

Washington, DC, Westchester, and Wilmington experienced negative absorption, increased vacancy rates, and 

declining rents in the first half of 2001. Despite recent 

increases, vacancy rates in many of the Region’s office 

markets remain below the national average. 

CRE credit quality reported by the Region’s banks has 

remained favorable; however, delinquency ratios have 

slightly increased since mid-2000. Softer economic conditions could pressure vacancy and rental rates, thereby 

affecting the repayment capacity on loans that assume a 

continuation of the high rental rates achieved at the 

height of the recent economic expansion. 

2 Federal Deposit Insurance Corporation. History of the Eighties— 1 The Region’s 178 counties were ranked by the degree of change in Lessons for the Future, Vol. I: An Examination of the Banking Crises 

employment, population, income, and single-family home prices of the 1980s and Early 1990s. 1997. Washington, DC: FDIC. 

between 1996 and 2000 and industrial diversity relative to the nation. 3 Torto Wheaton. 

Regional Outlook—National Edition 18 Third Quarter 2001 
Regional Perspectives
 

San Francisco Regional Perspectives
 

The Region’s employment growth outpaced the 

nation’s, but decelerated through second quarter 

2001. Weakness in the manufacturing and high-tech 

sectors contributed to the slower growth. Should the 

national economy continue to slow, job creation could 

also be affected adversely in the high-tech manufacturing, lumber, and tourism industries, three sectors that 

have contributed significantly to the gross state products of many states in the San Francisco Region. 

Continuing weakness in these key industries could 

contribute to additional deterioration in commercial 

and industrial (C&I) loan quality among the Region’s 

insured institutions. 

High-tech manufacturing, particularly semiconductor production, has slowed owing to worldwide cutbacks in capital expenditures. Many semiconductor 

manufacturers announced disappointing results and 

layoffs during the first half of 2001. The semiconductor industry represents a significant component of 

the high-tech manufacturing sector in Oregon, Idaho, 

Arizona, and northern California. 

Increasing imports and declining overseas demand 

have contributed to weakness in the timber industry. 

In addition, rising energy prices could pressure lumber 

producers and processors further, which could adversely 

affect the economies of Washington, Oregon, and Idaho. 

Continued economic slowing could also affect travelrelated industries that are critical to the economies of 

Hawaii and Nevada. Visitor counts have already 

declined in Hawaii, and the Las Vegas hospitality industry could feel the effects of reduced corporate spending, 

higher energy prices, and increased gaming competition. 

Commercial and industrial delinquency and loss 

rates have increased in recent periods at many of 

the Region’s insured institutions, particularly 

large banks. Between year-end 1999 and March 31, 

2001, delinquent commercial and industrial (C&I) 

loan ratios increased, particularly among large 

institutions. Year-end 2000 C&I loss ratios also rose 

at many of the Region’s established commercial 

lenders, and gross C&I losses represented an increasing share of total loan losses. Overall, commercial 

loan delinquency and loss rates remain low by historical standards; however, rising levels are of concern, 

given that C&I lending contributes significantly to 

many institutions’ loan portfolios and incomes. 

During the late 1990s, increased competition for C&I 

loans contributed to easing underwriting standards, 

which could adversely affect credit quality going forward. Several trends have contributed to the intensity of 

C&I loan competition. Credit-scoring models improved 

the cost-effectiveness of small business lending for larger institutions, prompting many smaller institutions operating without these models to grant underwriting 

concessions. Community banks also have faced 

increased C&I loan competition from thrifts and newly 

chartered banks. Flagging core deposit demand in the late 

1990s contributed to higher funding costs and profit pressures industry-wide, prompting savings institutions and 

new banks to compete directly with commercial banks by 

offering higher-yielding commercial loan products. 

Some of the drivers of increased 

competition are not yet recessiontested. For instance, credit-scoring 

models, developed primarily since 

the last recession, have not been tested 

through a full credit cycle. Likewise, 

new banks and thrifts that have 

increased C&I lending activity recently might not have experience in managing, monitoring, and controlling an 

increased level of C&I credit risk during 

a slowing economy. 

During a period of brisk competition and aggressive 

loan growth, some insured institutions have 

increased C&I loan concentrations and pared 

staffing resources. The relative size of small business 

loans has grown, most notably among metropolitan 

insured institutions with less than $100 million in total 

assets. Given that C&I loan portfolios often experience 

higher loss rates than other loan categories, an increase 

in the average size of a small business transaction could 

weaken loss reserves at small institutions more quickly. 

Finally, sustained C&I loan growth throughout the 

Region has stimulated demand for qualified commercial loan officers. At the same time, however, some 

bankers are reporting a shortage of seasoned commercial lenders, and the level of serviced assets per fulltime equivalent employee ratios are on the rise. 

Should the economy continue to slow, the effects of 

increasing competition could combine with weakness 

in the high-tech manufacturing, lumber, and tourism 

sectors to erode insured institution C&I credit quality. 

Regional Outlook—National Edition 19 Third Quarter 2001 
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