Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION FIRST QUARTER 2002 

FDIC
 

Atlanta
 

Region
 

Division of
 

Insurance
 

Jack M.W. Phelps,
 

CFA,
 

Regional Manager
 

Scott C. Hughes,
 

Regional Economist
 

Pamela R. Stallings,
 

Senior Financial
 

Analyst
 

Regional Perspectives 

◆ The nation’s economic landscape has altered dramatically over the past year, resulting in perhaps the most challenging environment in a decade for insured institutions. 

◆ The Atlanta Region’s insured institutions that hold large concentrations (at least 15 

percent of assets) in traditionally higher-risk loan categories, as well as non-recessiontested banks, may be more vulnerable to the effects of the current economic downturn. 

◆ These types of insured institutions that have adopted a business model that relies on 

rapid economic growth should evaluate their ability to operate during a period of slow 

economic growth. See page 3. 

By the Atlanta Region Staff 

In Focus This Quarter 

◆ Housing Market Has Held Up Well in This Recession, but Some Issues Raise 

Concern—Recent trends in mortgage underwriting are of particular interest, as an 

estimated $2 trillion in mortgage debt, approximately one-third of the total outstanding, 

was underwritten during 2001. Nonconstruction residential mortgages traditionally 

have represented one of the better-performing loan classes during prior downturns. The 

level of credit risk, however, may be higher this time around because the mortgage lending business has changed since the last downturn. This article examines these changes, 

including increased involvement by insured institutions in the higher-risk subprime 

credit market, the acceptance of higher initial leverage on home purchases, and greater 

use of automated underwriting and collateral valuation processes, which have not been 

recession-tested. 

◆ Home price softening could have an adverse effect on residential construction and 

development (C&D) and mortgage portfolios. In the aggregate, the level of risk appears 

modest. However, insured institutions with significant C&D loan exposures in markets 

that experienced ongoing residential construction during 2001, despite slowing local 

economies, are at higher risk. Weakening home prices could hurt loan quality in selected markets. The San Francisco Bay area stands out as a place to watch in this regard. 

See page 9. 

By Scott Hughes, Regional Economist 

Judy Plock, Senior Financial Analyst 

Joan Schneider, Regional Economist 

Norm Williams, Regional Economist 

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)
 

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

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

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

trends and developments at the regional level. 

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

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

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

For more information or to provide comments or suggestions about the 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 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 
Regional Perspectives
 

Regional Perspectives 


•	 The nation’s economic landscape has altered dramatically over the past year, resulting in perhaps the most 

challenging environment in a decade for insured institutions. 

•	 The Atlanta Region’s insured institutions that hold large concentrations (at least 15 percent of assets) in 

traditionally higher-risk loan categories, as well as non-recession-tested banks, may be more vulnerable to 

the effects of the current economic downturn. 

•	 These types of insured institutions that have adopted a business model that relies on rapid economic growth 

should evaluate their ability to operate during a period of slow economic growth. 

Region’s Economic and Banking Conditions 

The National Economic Downturn May Have 

an Adverse Effect on Certain Types of Insured 

Institutions in the Region 

The nation’s economic landscape has changed dramatically over the past year, resulting in perhaps the most 

challenging environment in a decade for insured institutions. One year ago, many analysts were beginning to 

debate the alternative scenarios that might emerge if 

the nation’s longest economic expansion ended.1 

Unlike the last recession in 1990/1991, which was preceded by regional economic downturns in many areas 

of the country, the current recession is being felt both 

domestically and globally. Global economic weakness 

may affect the depth and duration of the current 

national recession and the subsequent timing and 

strength of a recovery. This article analyzes the recent 

economic downturn, prospects for recovery, and 

effects the recession may have on certain segments of 

insured institutions within the Atlanta Region. 

Roots of the Economic Downturn and Forecast Risks 

Supply-side excesses are a major factor in the current 

downturn. A number of economists believe that the size 

of these excesses is unparalleled compared with other 

post–World War II economic cycles.2 Manufacturing 

1 A good discussion of the “V,” “U,” and “L” scenarios can be found 

in Peter Coy, Marcia Vickers, Rich Miller, Charles Whalen, and Jim 

Kerstetter, March 12, 2001.“How Bad Will It Get?” Business Week. 2 See Stephen Roach, December 14, 2001, “The Character of Economic Recovery—Part I,” Global Economic Forum, Morgan Stanley, 

for a good analysis of the bursting of the bubble-induced excesses of 

capital spending. 

activity started to deteriorate as early as August 2000, 

well before employment peaked in March 2001. The 

uncertainty and subsequent disruptions caused by the 

events of September 11 further intensified the economic 

downturn that started in the spring. The behavior of the 

current downturn is unusual, which further complicates 

economic forecasting. Consensus economic forecasts in 

2001 consistently underestimated the timing and depth of 

the downturn.3 Currently, the consensus forecast is for 

real gross domestic product (GDP) to grow 1.3 percent in 

first-quarter 2002 and 2.9 percent in second-quarter 

2002.4 If the consensus real GDP growth estimates are 

accurate, this downturn would rank as the shallowest and 

as one of the shortest of the post–World War II recessions. 

What Could Spark an Economic Recovery? 

Business investment does not appear to be a strong 

source of growth. A decade of expansion has led to significant overcapacity within the nation’s industrial infrastructure. Accordingly, many industry sectors have seen 

significant downward pricing pressures on intermediate 

and finished goods. The manufacturing utilization rate 

has slipped to levels not seen since the 1982/1983 recession. Hence, the weaknesses in the corporate sector— 

reduced cash flow and underutilized plant and 

equipment—will likely mute any rebound in business 

investment during 2002. 

3 The quarterly median real GDP forecast surveys from the National
 

Association for Business Economics (NABE) consistently called for
 

real GDP growth of 3 percent in 2001.
 

4 February 2002 median real GDP forecast survey from NABE.
 

Atlanta Regional Outlook 3	 First Quarter 2002 
Regional Perspectives
 

Questions remain about consumers’ ability to sustain 

spending at current levels. Consumer debt levels and 

service burdens are at or near all-time highs.5 Increasing unemployment is beginning to reduce personal 

income, and 2002 may see sharper declines in personal income because of cutbacks in flexible compensation such as bonuses, stock options, and stock grants.6 

Also, consumers may need to increase their savings 

from income because of the decline in equity markets. 

During fourth-quarter 2001, purchases of large 

deferrable items—housing and automobiles—reached 

near-record levels because of low interest rates and 

aggressive manufacturer incentives. Usually, consumers scale back on purchases of such items during a 

recession, leading to pent-up demand. Traditionally, 

during previous recessions consumers’ willingness to 

borrow to satisfy this demand has been key to reviving 

economic growth. 

The outlook for a quick turnaround domestically has 

been further complicated by global economic weakness. It has been nearly 30 years since the last global 

recession. DRI-WEFA recently estimated that the 

global economy expanded by less than 2 percent in 

2001—2 percent is often considered the threshold for 

defining a global recession—and will see only limited 

improvement in 2002.7 Weak growth globally coupled 

with continued strength in the trade-weighted value of 

the U.S. dollar could restrict export opportunities, 

weakening recovery prospects. 

Fiscal stimulus under consideration may have less effect 

on the condition of the economy than commonly 

thought. In early 2002, Congress had yet to reach an 

agreement on any additional fiscal stimulus package. As 

the economy slowed, many states and municipalities 

experienced declining income and sales-tax revenue 

collections. In response, many entities have enacted or 

proposed budget cuts or increased taxes, which may offset the benefits of any federal stimulus. 

Downward Pressures on Prices 

Could Heighten Risks to Lenders 

It may take some time for monetary policy to spur economic growth. Although the targeted federal funds rate 

was lowered by 4.75 percentage points in 2001, real 

short-term interest rates (federal funds rate less inflation 

5 “Do worry, be happy,” Financial Times, January 31, 2002.
 6 David Leonhart, December 10, 2001. “Recovery and the Reluctant
 

Consumer,” New York Times.
 7 DRI-WEFA teleconference, November 13, 2001.
 

rate) remain positive.8 After the recession of 1990/1991, 

economic growth did not begin to accelerate until real 

short-term interest rates fell to zero or went negative. 

With a targeted federal funds rate of 1.75 percent in January 2002, there appears to be very little room for further rate cuts should disinflation persist. 

Recessions are typically disinflationary events and can 

lead to deflation under certain circumstances. Supplyside overcapacity, competitive global markets, and softening demand have put downward pressure on many 

prices.9 A much rarer consequence of a recession can be 

a prolonged period of broad decline of prices and nominal wages, an event known as deflation.

10 A persistent 

disinflationary or outright deflationary environment 

could have negative effects on profits and on real asset 

and liability values. Consequently, loan quality may be 

lessened if collateral asset values decline and if borrowers’ ability to service debt is reduced because of lower 

income and cash flow. 

The Recession Has Implications for Insured 

Institutions in the Region that Are Reliant on Rapid 

Economic Growth 

The Region’s insured institutions that hold relatively high 

lending concentrations or those experiencing a recession 

for the first time may be more vulnerable to the effects of 

the current economic downturn.11 The Region’s economic 

growth outpaced the nation’s during the economic expansion. As a result, many community banks12 headquartered 

in the Region grew construction and development (C&D) 

8 Federal funds targeted rate less year-over-year change in personal 

consumption expenditure deflator. Monetary policy actions lowering 

interest rates to revive the economy generally become most effective 

when real short-term interest rates are negative; see Greg Ip. November 12, 2001. “The Outlook—Deflation Concerns,” Wall Street Journal (online edition). 9 The year-over-year percent change in the consumer price index 

declined substantially during 2001 from a peak of 3.7 percent in January to 1.6 percent in December. 

10 The likelihood of the United States experiencing a prolonged bout 

of deflation during the present downturn appears low, but the probability of such an event may be rising as nominal GDP (preliminary) 

declined on a quarterly basis during fourth-quarter 2001. 

11 See Federal Deposit Insurance Corporation, 1997. History of the 

Eighties—Lessons for the Future, for a lengthy discussion and analysis of the role that large lending concentrations played in the potential 

for failure, the frequency of problem bank ratings, and the higher failure rate of new banks during an economic downturn. 

12 Insured commercial banks with assets of $1 billion or less. The 

analysis is limited to this set of institutions because large commercial 

banks (over $1 billion) have decreased lending concentrations and 

become geographically more diverse during the past decade. Also, the 

thrift industry has undergone significant changes in capitalization, 

limiting the ability to make comparisons. 

Atlanta Regional Outlook 4 First Quarter 2002 
Regional Perspectives
 

loans or commercial and industrial (C&I) loans faster 

than the national average. This above-average growth rate 

among the Region’s community banks has resulted in 

concentrations in these business lines that exceed the 

national averages. Currently, the Region has 286 startup 

insured institutions13 that are experiencing an economic 

downturn for the first time (these institutions began operations during the ten-year economic expansion from 

March 1991 through March 2001). 

During the last recession, community banks with a large 

lending concentration (15 percent or more of assets) in 

traditionally higher-risk loan categories14 were more 

likely to receive a problem bank rating.15 As seen in 

Table 1, 417 community banks held more than 15 percent of assets in C&D loans or C&I loans at year-end 

1989. Of these banks, 225, or 52.2 percent, received a 

problem bank rating at some point from year-end 1989 

through year-end 1992. As depicted in Chart 1, community banks with a large lending concentration were twice 

as likely to receive a problem bank rating as those without a large lending concentration. The last economic 

downturn had a lagged effect on community bank performance, as the peak level in problem bank ratings 

occurred after the economy had started to expand. 

Specifically, the period-end high of problem designaTABLE 1 

Large Lending Concentrations Are 

More Prevelant at Community Banks1 

in the Atlanta Region during This 

Economic Cycle than the Last 

12-31­ 9-30­

1989 2001 

TOTAL COMMUNITY BANKS 1,519 1,067 

C&D LOANS 15% 

OF ASSETS 29 104 

C&I LOANS 15% 

OF ASSETS 388 263 

C&D LOANS 25% 

OF ASSETS 1 26 

C&I LOANS 25% 

OF ASSETS 119 64 

1Commercial banks with assets of $1 billion or less. 

Notes: C&D = Construction and Development 

C&I = Commercial and Industrial 

Source: Bank Call Reports 

tions occurred during second-quarter 1992—more than 

a year after the conclusion of the 1990/1991 recession. 

During the current recession, the Region has a greater 

share of community banks with a large lending concentration in C&D and C&I loans than the nation does. At 

third-quarter 2001 about 34 percent of community banks 

reported a large lending concentration in either C&D or 

C&I loans, versus 27.5 percent at year-end 1989. The 

location of community banks with large lending concentrations is shown in Map 1 (next page). Most are in metropolitan areas where economic growth was well above 

the national average during the last expansion. 

The number of community banks in the Region with a 

large C&D lending concentration has increased significantly, and the growth rate of this lending has not abated 

despite slowing economic conditions. The number of 

community banks with 15 percent or more of assets in 

C&D loans has more than tripled, from 29 banks at yearend 1989 to 104 at third-quarter 2001. Community banks 

with this risk exposure represent nearly 10 percent of all 

community banks in the Region, up from nearly 2 percent at year-end 1989. Of greater concern, however, is 

the substantial increase in very large C&D lending concentrations. Currently, 26 community banks have concentrations above 25 percent of assets, versus only one at 

year-end 1989. The substantial increase in C&D lending 

concentrations is further illustrated in Chart 2 (next 

page), which shows a rapid expansion in this lending category since year-end 1997. 

CHART 1 

1Commercial banks with assets of $1 billion or less and construction and 

development loans or commercial and industrial loans 15 percent or 

more of assets 

2Uniform Bank Rating of 3, 4, or 5 

Source: Bank Call Reports, FDIC Examination Database Percentage with a Problem Bank Designation

0 

10 

20 

30 

40 

50 

Community Banks with a Large Lending 

Concentration1 More Often Received a Problem 

Bank2 Designation around the 

1990/1991 Recession 

Community Banks with 

a Large Lending Concentration Community Banks without 

a Large Lending Concentration 

6/30/1990

12/31/1990

6/30/1991

12/31/1991

6/30/1992

12/31/1992 

13 Startups include all commercial bank openings except special-purpose entities, those that opened with an affiliate relationship (financial or managerial), or those resulting from mergers and acquisitions or intercompany reorganizations.
 

14 The analysis of lending concentration is focused on two loan categories—C&D and C&I—because they historically exhibit higher loss rates.
 

15 Problem bank rating is a Uniform Bank Rating (CAMELS) of 3, 4, or 5.
 

Atlanta Regional Outlook 5 First Quarter 2002 
Regional Perspectives
 

MAP 1 CHART 2 

ment in home prices can contribute to elevated numbers 

of problem banks. 

The capital cushion at Atlanta Region community 

Community Banks1 with High Risk Exposures2 

Are Concentrated in Metropolitan Areas 

1Insured commercial banks with assets of $1 billion or less 

2More than 15 percent of assets in either C&I or C&D loans 

Source: Bank Call Reports, third quarter 2001 

Bank Count by County 

14 banks 

7 banks 

3 banks 

County in 

metropolitan area 

Washington, D.C. 

(Northern Virginia) 

Miami 

Atlanta 

Tampa 

Orlando 

Naples 

Greensboro 

West Palm Beach 

Greenville 

12/1984

12/1985

12/1986

12/1987

12/1988

12/1989

12/1990

12/1991

12/1992

12/1993

12/1994

12/1995

12/1996

12/1997

12/1998

12/1999

12/2000

09/2001 

C&D Loans as a

Percentage of Assets 

1Commercial banks with assets of $1 billion or less 

Source: Bank Call Reports 

0 

2 

4 

6 

8 

10 

12 

14 

16 

Construction and Development Lending 

Concentrations Increased Substantially at 

Community Banks1 within the Atlanta Region 

during the Last Economic Expansion 

Average C&D Exposure 

Top/Bottom 25th Percentiles 

Top/Bottom 10th Percentiles 

Most community bank C&D lending is for residential 

housing construction, a sector that is not immune to 

downside risk. Although home prices have been fairly 

resilient during the current downturn, in each of the 

past three recessions home prices fell on a real basis.16 

Although residential real estate construction lending is 

not considered as risky as C&D lending for other property types, historical experience suggests that this type 

of lending is not without risk. The community banks 

with a large C&D concentration at year-end 1989 were 

lending primarily in a major Southeastern metropolitan 

market where residential real estate prices were comparatively unaffected by the economic downturn. Median home prices declined by less than 2 percent on 

average, and the price decline was recaptured nominally within four quarters.17 Although residential real 

estate prices declined modestly during the last downturn, 20 of the 29 (69 percent) community banks with a 

large C&D concentration in 1989 eventually received a 

problem bank designation.18 Hence, a modest adjust16 Jathon Sapsford and Patrick Bara, January 2, 2002. “Precarious 

Balances: Spending Tempers Downturn, but Debts May Slow Recovery,” The Wall Street Journal. 7 In sharp contrast, some economically diversified markets outside the 

Region, such as Boston and San Francisco, experienced median home 

price declines of more than 5 percent and far longer recapture periods 

stretching up to 30 quarters. 

18 See FDIC, “Metropolitan Atlanta Construction and Development 

Lending Trends,” Bank Trends, Number 98-06, for further discussion 

and analysis. Insured institutions in this market with large C&D loan 

concentrations exhibited a 21 percent failure rate versus 5 percent for 

institutions without large concentrations. 

banks with a large lending concentration has declined 

modestly, but capital levels among other community 

banks have increased. The average concentration has 

declined slightly from year-end 1989 to third-quarter 

2001 among community banks with a large C&I lending concentration. Over the same period, however, the 

average equity-to-asset ratio at these banks has moderated by 40 basis points to 10.68 percent. For community banks with a large C&D concentration, the 

average lending exposure has increased while the average capital ratio has decreased. Hence, community 

banks in the Region with a large lending concentration 

have about the same capital protection as they did 

going into the last economic downturn. In sharp contrast, average equity-to-asset ratios for other community banks in the Region have increased from 11.63 

percent to 12.51 percent. 

Competitive pressures may be reducing the returns to 

commercial banks involved in C&D lending. Although 

the Call Report does not contain detailed information to 

calculate the yield of this lending category, return on 

assets (ROA) for community banks with a large C&D 

lending concentration has been falling. Specifically, the 

average pretax ROA19 for community banks with a large 

19 Pretax versus after-tax ROA is a better comparative measure 

because of variations in tax positions of individual commercial banks 

(i.e., Subchapter S). Includes community banks with a large C&D 

lending concentration in operation before first-quarter 1991 and still 

open third-quarter 2001. 

Atlanta Regional Outlook 6 First Quarter 2002 
Regional Perspectives
 

C&D lending concentration declined from 1.91 percent 

at year-end 1995 to 1.68 percent at third-quarter 2001. 

This decline is consistent with anecdotal reports from 

bankers at various outreach meetings conducted by the 

FDIC in early 2001.20 In general, bankers reported that 

the pricing of a residential C&D loan had been greatly 

reduced over the past decade.21 

Non-Recession-Tested Institutions 

May Be Challenged 

The Region is home to 25 percent of the nation’s nonrecession-tested insured institutions (see Map 2), which 

history indicates are more likely to receive a problem 

bank rating when they first encounter an economic 

downturn. As discussed in Atlanta Regional Outlook, 

first-quarter 2000, commercial banks located in urban 

areas within the Region experiencing their first recession in 1990/1991 were almost twice as likely to 

receive a problem bank rating as their established or 

recession-tested counterparts. The likelihood of a new 

commercial bank receiving a problem rating (or failing) increases during its formative years and then 

decreases as it reaches maturity (about ten years). In 

1990/1991, commercial banks that began business 

more than three years before the onset of the recession 

were more likely to receive a problem bank designation than those open less than three years. Initial capitalization was not a significant variable in determining 

problem bank status when the age of the startup institutions was controlled. Currently, the Region has 286 

“true” startup institutions, and 99 had been open 

longer than three years before the start of the current 

recession in April 2001. 

Conclusion 

Community banks with a large C&D or C&I lending concentration or newly opened commercial banks are located primarily in urban centers within the Region that may 

exhibit a boom/bust economic growth pattern. As discussed in Atlanta Regional Outlook, Fourth Quarter 

2001, five metropolitan areas—Atlanta, Naples, Orlan20 The Division of Supervision and Division of Insurance of the FDIC’s 

Atlanta Region conducted a series of outreach meetings with bankers 

in Atlanta, Georgia; Charlotte, North Carolina; and Orlando, Florida. 

21 Before the recession of 1990/1991, the yield on a C&D loan was the 

prime rate plus 2 percentage points with an added 2-percentage-point 

commitment fee. Last year, bankers reported that they were fortunate 

to receive prime plus 1 percentage point with a 1-percentage-point 

commitment fee. In some markets, pricing had fallen to prime without a commitment fee. 

MAP 2 

Non-Recession-Tested Banks1 Are 

Concentrated in Metropolitan Areas 

1Includes all commercial bank openings occurring after the 1990/1991 recession 

except special-purpose entities, those that opened with an affiliate relationship 

(financial or managerial), or those resulting from mergers and acquisitions or 

intercompany reorganizations 

Source: Bank Call Reports, third quarter 2001 

Bank Count by County 

14 banks 

County in 

metropolitan areas 

8 banks 

4 banks 

do, Sarasota, and Tampa—were identified as exhibiting 

a confluence of risk factors that could produce more vulnerable banking markets during an economic downturn. 

These areas experienced economic and lending growth 

rates well above national averages, and insured institutions headquartered there generally reported C&D or 

C&I concentration levels above national averages in addition to a greater reliance on noncore funding sources.22 

Historically strong financial conditions among many 

of the Region’s insured institutions may erode if the 

economic downturn continues. Given the robust headwinds the domestic economy is encountering, economic growth may take some time to resume. Moreover, 

after the recovery starts, there is no assurance that 

strong economic growth will return immediately. A 

prolonged period of slow or negative growth combined 

with a softening in asset prices, particularly for commercial and residential real estate, could have significant repercussions for certain insured institutions in 

the Region. Such an environment would likely be more 

challenging for community banks with large lending 

concentrations and startups experiencing their first 

recession. Typically, such institutions perform better in 

22 Noncore funding sources include brokered deposits, time deposits 

of $100,000 or more, federal funds purchased, securities sold subject 

to repurchase agreements, and other borrowed funds. The latter category consists largely of Federal Home Loan Bank advances. 

Atlanta Regional Outlook 7 First Quarter 2002 
Regional Perspectives
 

a rapidly growing economy. For this reason, banks 

with concentrations in traditionally higher-risk assets 

or that have adopted a business model that relies on 

rapid economic growth should evaluate their ability to 

operate during a period of slow economic growth. 

By the Atlanta Region Staff 

Atlanta Regional Outlook 8 First Quarter 2002 
In Focus This Quarter
 

Housing Market Has Held Up Well in This 


Recession, but Some Issues Raise Concern
 

Trends in housing markets are important performance 

drivers for many FDIC-insured institutions. The health of 

residential markets can affect the credit quality of residential mortgage loans, home equity loans, and loans to 

finance residential construction and is linked indirectly to 

the performance of other types of consumer and smallbusiness debt. Further, an estimated $2 trillion in mortgage debt, approximately one-third of the mortgage 

market, was underwritten during 2001, with 56 percent of 

this activity in refinancing transactions.1 This activity 

makes recent trends in underwriting of particular interest. 

An ancillary issue for many mortgage lenders, interest 

rate risk, is not addressed in this article.2 

The U.S. economy entered a recession in March 2001, 

and the question arises as to how consumer creditworthiness, housing values, and recent mortgage-lending 

practices will fare during this downturn. Developments 

contributing to increased credit risk include higher consumer debt burdens, looser mortgage loan underwriting 

standards, and the emergence of subprime mortgage 

lending as a significant line of business for some banks. 

Mitigating this risk has been the steady appreciation of 

home prices, which have shown signs of softening in 

some markets but not to the extent seen at a comparable 

stage in previous recessions. 

Home price weakness may be more pronounced in 2002 

as the effects of the recession take hold, but in the 

authors’ judgment, systemic weakness in home prices is 

unlikely, absent a deep and long recession. Adverse mortgage lending trends are not expected to threaten the capital or earnings of the vast majority of insured 

institutions. Nonconstruction residential mortgages, even 

during the most pronounced periods of stress in the 1980s 

and early 1990s, remained the best-performing loan 

class, especially for lenders specializing in residential 

real estate; and, historically, these mortgages have been 

1 Mortgage Market Forecast, www.mbaa.org/marketdata/forecasts/,
 

January 2002.
 

2 For a discussion of this issue, see “Regional Perspectives,” Boston
 

and Chicago Regions, Regional Outlook, First Quarter 2002.
 

one of the lowest credit-risk loan types for all manner of 

insured institutions.3 

That said, however, there are pockets of risk for 

insured institutions. There is evidence that borrowers 

with weak credit may be experiencing greater repayment difficulties, elevating the risks faced by subprime 

mortgage lenders. Further, a slump in residential real 

estate markets could be especially detrimental to 

insured institutions with significant exposures to 

housing construction because projects might not sell at 

projected asking prices or as quickly as anticipated. 

Finally, in specific markets where housing prices may 

have achieved unsustainable levels, some increase in 

housing-related credit quality problems can be expected, and in this regard, the San Francisco Bay area 

stands out as a place to watch. 

The Recession Thus Far Has Had 

a Minimal Impact on Mortgage 

Delinquencies at Insured Institutions 

Despite three quarters of recession, most housing indicators remained quite healthy this past year relative to 

trends seen in past recessions. For example, new and 

existing home sales both set records during the year, 

while new home construction failed to decline, an 

occurrence not seen in the past six recessions. Another indicator, year-over-year growth in existing home 

prices—as measured by either the Office of Federal 

Housing Enterprise Oversight (OFHEO) repeat sales 

price index or the National Association of Realtors 

(NAR) median single-family price statistic—showed 

deceleration but remained well above trends seen at 

similar points in past recessions. This behavior partly 

reflected the early robustness of household income in 

the face of recession and relatively low fixed mortgage 

rates during 2001, which helped to counter some of the 

3 See “Region’s Insured Institutions Exhibit Lower Risk Profile than 

the Nation’s, Appendix: Risk-Weighting Methodology,” Table A in 

Boston Region, Regional Outlook, First-Quarter 2000. 

Atlanta Regional Outlook 9 First Quarter 2002 
In Focus This Quarter
 

CHART 1 CHART 2 

Through September 2001, Mortgage-


Related Delinquencies Remained Modest
 

Although the Much Larger Market for 

Existing Homes Has Held Up, New Home 

Prices Are Under Pressure 

Percentage Change from

Prior Year 

Sources: Census (new), National Association of Realtors (Existing) 

Existing 

New 

–10 

–5 

0 

5 

10 

15 

20 

,

79 ,81 ,83 ,85 ,87 ,89 ,91 ,93 ,95 ,97 ,99 ,

01 

Percentage 

30+ Days Past Due 

0 

2 

4 

6 

8 

10 

12 

,

91 ,93 ,95 ,97 ,99 Sep ,

01 

0 

1 

2 

3 

4 

5 

6 

Percentage 

30+ Days Past Due 

95th Percentiles (R) 

mortgages equity lines 

75th Percentiles (L) 

NOTE: Sample consists of banks with at least $1 million in equity lines 

or mortgages that are also at least 5 percent of bank's Tier 1 capital. 

Source: Bank and Thrift Call Reports 

initial adverse effects of the recession on housing 

demand. 

One sign of potential weakness appeared late in 2001 

in the modest year-over-year decline in median prices 

of new single-family homes (see Chart 1). Because 

existing home sales outnumber new home sales roughly fivefold, price trends in the latter are generally not 

predictive of prices for the much larger existing home 

market.4 However, as discussed later in this article, 

adverse pricing trends in the new home segment do 

raise concerns for residential developers and insured 

institutions that finance residential construction. 

The steady increase in prices of existing homes depicted in Chart 1 masks considerable regional variation. 

As detailed later in this article, home price growth 

began to weaken in 2001 in a number of metropolitan 

statistical areas (MSAs). While there is no clear common denominator among the markets in which this 

occurred, a number of these markets had both extremely rapid home price growth in the recent past and significant slowdowns in employment growth or outright 

contractions in employment last year. 

Credit quality indicators for insured institutions’ mortgage loans have shown only preliminary signs of 

weakness thus far. Through the first nine months of 

2001, insured institutions showed negligible advances 

in median past-due ratios for mortgages and equity 

4 Existing home prices are also more reflective than new home prices 

of trends in broader economic indicators, such as aggregate per capita personal income. 

lines of credit, although continued strong mortgage 

origination activity in 2001 may have masked (in the 

aggregate) developing credit problems for more seasoned mortgage loans. For institutions that held at 

least $1 million in residential mortgages or home equity lines of credit and whose exposures comprised at 

least 5 percent of Tier 1 capital, some modest deterioration is evident in the worst-performing mortgages 

and home equity lines since 1999, as seen in Chart 2.5 

Even if this recession lingers, worsens, or both, residential mortgage lending (nonconstruction and development-related) likely poses only modest risk to most 

insured institutions’ earnings and capital, since it has 

held up better in prior recessions than other loan types. 

What Are the Risks Facing Housing 

Lenders in 2002 and Beyond? 

In an environment of significantly slower economic 

growth than prevailed during the 1990s, can the 

strength of housing prices and the relatively benign 

credit quality environment for housing lenders be 

expected to continue? The answer will depend on the 

interplay of economic conditions and lenders’ risk profiles. In the remainder of this article, we discuss the 

gradual increase in the risk profile for insured mortgage lenders that appears to have occurred during the 

5 It is interesting to examine the (adverse) tail of the credit quality distribution when looking at residential mortgage trends, as average and 

median past-due ratios move little and are typically very low—thus, 

only the highest 25th and 5th percentiles of past-due ratios are presented in Chart 2. 

Atlanta Regional Outlook 10 First Quarter 2002 
, UT

Miami– 

y, NY

Phoenix, AZ

, NV–AZ 

, MO–IL 

Tucson, AZ

Oklahoma City

, NY

, OK 

Kansas City

Tulsa, OK

, MO–KS

, NC–SC 

mingham, AL

, TN-AR–MS

Honolulu, HI

, SC 

Entire Nation

, FL

e City

alo

ville

 Lauderdale

Alban

Buff

 Louis

Green

egas

lotte

Salt Lak

Memphis

Las V

Char

St.

Bir

Ft.

In Focus This Quarter
 

1990s, as well as some cyclical risks to their performance that may exist as the recession plays out. 

Evolving Lending Practices Have Increased 

the Risk Profile for Mortgage Lenders 

Although history suggests that residential mortgage 

defaults will be relatively low even in a recession, 

changes in the mortgage market since the 1990–1991 

recession could affect mortgage performance during the 

present downturn. Many underwriting changes over the 

past decade have been driven in part by the growing 

importance of the secondary market for mortgage debt, 

and of Fannie Mae and Freddie Mac in particular. In 

1980, federal and related agencies had direct or indirect 

interests in approximately 17 percent of all mortgage 

debt.6 By 2000, their share of the mortgage market had 

increased to roughly 41 percent. Insured bank and thrift 

mortgage exposures grew over the same period, but, as 

a share of direct mortgage debt, bank and thrift mortgage holdings decreased from 59 to 35 percent. These 

trends notwithstanding, insured institutions still provide 

substantial funding, directly or indirectly, to the housing 

market: as of September 30, 2001, 1 to 4 family mortgage loans and mortgage-backed securities held by 

insured institutions aggregated $2.3 trillion, up 37 percent from five years earlier. 

Although an active secondary mortgage market has 

broadened homeownership, improved mortgage loan liquidity, and allowed insured institutions to allay credit 

risk, it has also heightened market competition and transformed the lending process. In presecondary market 

CHART 3 

1993 2000 

days, lenders largely had to retain originated mortgages 

in their own portfolios. Consequently, only lenders with 

ready funding sources (such as banks, thrifts, and insurance and finance companies) were able to compete in the 

mortgage markets. The advent of the secondary market 

enlarged the pool of available funding and permitted both 

insured institutions and other originators to transfer their 

mortgage business readily into entities such as mortgage 

pools and trusts. Consequently, many new players, 

including on-line and brick-and-mortar mortgage brokers, have entered the mortgage origination market. 

The resulting robust mortgage loan competition, combined with Internet-based consumer research tools, has 

led to considerable commodification of the mortgage 

market. Rather than competing on the basis of traditional 

relationships, lenders’ market shares are increasingly 

driven by price. For smaller savings institutions that focus 

heavily on residential mortgage underwriting, this issue 

has likely elevated business risk. Heightened competition 

has caused some loosening of mortgage underwriting 

standards and pushed lenders to use technology to expedite and streamline the underwriting process. Consequently, credit-scoring mechanisms and automated 

valuation techniques currently in place have not been 

tested through a full credit cycle. Because pricing competition has pressured margins, some mortgage lenders 

have pursued subprime or high loan-to-value (HLTV) 

mortgages. The ability of insured institutions to mitigate 

subprime losses through an economic downturn is untested to a large extent as well—finance companies dominated the high-risk mortgage market in past recessions. 

High Loan-to-Purchase Price Ratios Are Increasingly Common in Some Metro Areas 

Percentage of Mortgages with Loan-toPurchase Price Ratios Exceeding 90 Percent 

60 

40 

20 

0 

Source: Federal Housing Finance Board 

6 These interests include residential, commercial, and farm real estate debts held directly by, or held in mortgage pools or trusts issued by, federal 

and related agencies. Source: Table 1186, Statistical Abstract of the United States: 2001, page 733. 

Atlanta Regional Outlook 11 First Quarter 2002 
In Focus This Quarter
 

In general, mortgage underwriting standards have loosened industrywide over the past decade. For instance, 

lenders have increasingly accepted higher loan-topurchase price (LTPP) ratios for purchase money mortgages.7 According to the Federal Housing Finance 

Board, LTPP ratios are high and have risen in several 

metropolitan areas over the past seven years (see Chart 3). 

Between 1993 and 2000, the Honolulu, Tulsa, and Tucson markets exhibited the largest increases in mortgages 

with LTPP ratios exceeding 90 percent. 

Although lenders often mitigate the risk of loss associated with low downpayments by requiring private mortgage 

insurance (PMI), recently the mortgage industry has 

allowed borrowers to avoid purchasing PMI. In particular, 

“piggyback” financing has made homeownership 

increasingly possible for households that cannot afford 

the traditional 20 percent down payment or do not wish to 

pay for PMI. With piggyback financing, the borrower 

often arranges a conforming 80 percent LTPP first mortgage and finances a portion of the remaining 20 percent 

with a concurrent second mortgage on the property (e.g., 

“80-10-10”). This type of transaction has become popular 

because interest paid on the (albeit more expensive) second mortgage is tax-deductible, whereas PMI premiums 

are not. Thus, piggyback financing is probably most 

attractive to individuals in higher-cost/tax areas or higher 

tax brackets, such as those in the Northeast and California. This trend effectively shifts the first loss position 

on all low down payment loans to the lender that 

retains the junior position. These institutions are, of 

course, compensated for some of this risk with the 

higher interest rates charged on the piggyback portion 

of these mortgages. 

Competitive factors have prompted the industry to 

enhance underwriting automation. As part of the push, 

credit scoring has become a routine part of the credit 

analysis process, and, increasingly, lenders are using 

automated valuation models (AVMs) to determine collateral coverage. However, credit scoring and collateral valuation models have been in popular use only 

since the 1990–1991 recession; consequently, their 

predictive ability in a downturn is uncertain. Although 

some have touted AVMs as the answer to appraisal 

fraud, the ability of statistical models to simulate the 

qualitative judgments considered critical to traditional 

appraisals is unknown. Paper appraisals reportedly 

7 Purchase money mortgages are loans extended solely for the initial 

purchase of a home. Statistics on loan-to-value ratios for supplemental home equity loans/lines (e.g., piggyback or “80-10-10” financing), as well as refinanced mortgages, are not readily available. 

continue to dominate the industry; however, recently, 

the two largest government-sponsored enterprises have 

begun accepting AVMs in lieu of standard appraisals 

for loans under $275,000.8 For lenders that specialize 

in HLTV mortgages, there is less room for error with 

AVMs. 

Cyclical Weakness Is Already Apparent 

in Subprime Mortgage Lending 

Historically, certain insured institutions have made 

mortgage loans with narrow collateral margins or to 

borrowers with limited or blemished credit histories. 

However, significant entry by FDIC-insured institutions into mortgage lending to borrowers with weak or 

marginal credit, as a targeted line of business, generally has occurred only since the early 1990s. These 

“subprime” mortgages are neither defined nor reported on Bank Call Reports. As a result, gauging the 

extent of bank involvement in subprime lending at any 

point in time is difficult. However, the FDIC estimates 

that fewer than 1 percent of all insured institutions 

have significant subprime residential mortgage exposures. Nevertheless, according to some measures, subprime mortgages as a share of total mortgage 

originations peaked at 13 percent in early 2000, before 

moderating somewhat during the first three quarters of 

last year.9 Thus, a much larger number of institutions 

probably have some limited involvement in subprime 

mortgage lending. A survey by the Minneapolis Federal Reserve Bank found that 29 percent of banks in 

the Minneapolis District offered loans to low-credit 

quality consumer borrowers in 1999.10 

Subprime mortgage loan performance appears to have 

deteriorated notably during 2001. One source of support for this observation comes from delinquency 

trends on Federal Housing Agency (FHA)-insured 

mortgages, which are often granted to first-time homebuyers with troubled credit histories and borrowers 

with low down payments. The Mortgage Bankers 

Association reports that while the national delinquency rate on conventional mortgages rose 58 basis points 

in the year ending third-quarter 2001, the delinquency 

rate on FHA mortgages shot up by 234 basis points, to 

11.4 percent (see Chart 4). This growing gap between 

8 “Automated Appraisals Require Caution by Lenders,” American 

Banker, October 10, 2001. 9 Based on dollar volumes, data from Inside Mortgage Finance Publications, Bethesda, MD. 

10 Ron Feldman and Jason Schmidt, “Why All Concerns About Subprime Lending Are Not Created Equal,” Fedgazette, Minneapolis 

Federal Reserve, July 1999. 

Atlanta Regional Outlook 12 First Quarter 2002 
In Focus This Quarter
 

CHART 4 

Recent Mortgage Delinquencies for HigherRisk Loans Reached All-Time Highs 

Percentage of Mortgages

30+ Days Past Due

FHA 

Conventional 

,

79 ,81 ,83 ,85 ,87 ,89 ,91 ,93 ,95 ,97 ,99 ,01 

0 

2 

4 

6 

8 

10 

12 

Source: Mortgage Bankers Association 

delinquency rates on conventional and governmentinsured mortgages suggests that marginal and subprime borrowers are facing growing repayment 

difficulties. 

A database of more than 6.5 million subprime loans 

tracked by Loan Performance Corporation (formerly 

Mortgage Information Corporation) reported similar 

trends. The nationwide third quarter 2001 ratio of seriously delinquent subprime mortgages was 7.3 percent, up 

from 5.5 percent one year earlier.11 Moreover, subprime 

delinquencies significantly exceeded those found among 

prime mortgages, as just under 0.5 percent of conventional prime mortgages were seriously delinquent.12 Also 

of possible concern are vintage data trends, which show 

how pools of primary and junior-lien subprime mortgages perform over time. Mortgages originated in 2000 

are performing poorly in relation to previous years’ vintages.13 This simply could reflect the impact of the current 

recession. Alternatively, Loan Performance Corporation 

analysts have suggested that the 2001 refinancing boom 

might have created some adverse selection in mortgage 

pools originated during the relatively higher interest rate 

environment of late 1999 and early 2000.14 Because high11 The Market Pulse, Loan Performance Corporation (formerly Mortgage Information Corporation), Winter 2001 and Fall 2001. 

12 The Market Pulse, Loan Performance Corporation, Fall 2001. 13 Per Loan Performance Corporation delinquency data, subprime primary mortgages originated in 2000 displayed higher delinquency 

ratios for their age compared with similarly seasoned subprime loans 

originated in 1996, 1997, 1998, or 1999. Moody’s second-quarter 

2001 Home Equity Index Update found the same to be true of subprime home equity loans. 

14 “Another Look at the 2000 Book,” The Market Pulse, Loan Performance Corporation (formerly Mortgage Information Corporation), 

Winter 2001. 

er-coupon and variable-rate loans comprised a significant 

share of mortgage originations during that period, overall 

prepayment rates on the 2000 vintage might have been 

unusually high during 2001. Consequently, the best-quality loans in the 2000 pool might have refinanced, leaving 

loans of lesser credit quality behind and elevating the 

residual delinquency experience in that pool. 

Given these trends, an important issue for subprime 

lenders is their ability to anticipate and plan for the 

impact of an economic slump on their operations. Some 

institutions clearly adopt subprime lending as part of an 

overall business strategy, setting up monitoring and collection departments geared to dealing with such loans. 

Among large, national lenders, for example, one institution that makes 5 to 10 percent of its loans to subprime 

borrowers recently provided additional resources to its 

loan services and default management departments. This 

action followed a period when one-third of its increase in 

nonperforming single-family mortgage loans was associated with loans to subprime borrowers.15 

C&D Lending Risks May Be Elevated in MSAs 

with Potential Supply/Demand Imbalances 

Historically, lending to finance housing construction is 

riskier than mortgage lending on existing structures. 

Insured institutions report construction and development 

(C&D) lending in a single category that includes both 

commercial and residential construction. While it is thus 

impossible to ascertain from quarterly call reports the 

extent of bank involvement in financing housing construction, anecdotal evidence suggests that, although 

smaller insured institutions engage to some degree in 

commercial property development, their C&D lending 

largely finances single-family construction. If markets 

with an oversupply of housing see weaker economic performance, insured institutions engaged in financing residential real estate development may be at risk. This could 

result in an increase in C&D loan delinquencies, losses, 

and other-real-estate-owned (OREO). 

Demand for housing can be affected by two distinct 

trends: secular, or longer term; and cyclical, or shorter 

term. Over the long term, demographic trends, such as 

population growth rates and concentrations of households by age cohort, can affect overall demand for housing, as well as the types of homes demanded. Demand in 

local housing markets also can be affected by more cyclical factors such as recent changes in economic 

15 Calmetta Coleman, “Default Worries on Home Loans Escalate as 

Lenders Report Delinquency,” Wall Street Journal, October 29, 2001. 

Atlanta Regional Outlook 13 First Quarter 2002 
In Focus This Quarter
 

conditions, including interest rates. New supply of homes 

in local housing markets is produced in response to perceived or estimated future demand. Correct interpretation 

of market and economic signals is critical to the success 

of builders in metropolitan areas; however, this activity is complicated by the lags associated with developing, permitting, and constructing properties. The effect 

of overestimating future demand could be multiplied if 

several builders inaccurately gauge changes in 

demand. Consequently, a construction market with 

numerous smaller developers, such as Atlanta, may 

see amplified swings in construction activity and may 

experience excess supply during certain periods. 

Although conceptually straightforward, measuring the 

balance between housing demand and supply is challenging, particularly at lower geographic levels. Shortcomings in data availability, quality, and timeliness 

can limit the effectiveness of this type of analysis. As 

already mentioned, some insight about current housing 

market conditions in specific metropolitan areas may 

be gained by analyzing both secular and cyclical 

trends. However, given the onset of recession last year, 

the role of cyclical factors is of prime concern at this 

time. 

To measure the cyclical aspect of the relationship 

between a market’s supply and demand, some analysts 

rely heavily on the concept of employment-driven 

demand.16 Such analysis involves tracking a demand/ 

supply ratio based on employment growth and permit 

issuance. Areas where permitting activity continues to 

accelerate while employment levels decrease may produce an increasing imbalance in the local housing 

market.17 

Using a simplified version of employment-driven 

demand, we identified a number of metropolitan areas 

as being at risk for a rising imbalance in their housing 

markets (see Chart 5), the largest of which are Chicago, Greensboro (NC), Minneapolis, Phoenix, Portland (OR-WA), St. Louis, and, most notably, Atlanta. 

These markets are displaying signs that residential 

16 For example, see www.myersgroup.com. 17 This approach, although more reflective of recent economic events 

than perhaps more secular measures, is not without its drawbacks. For 

example, employment data from the Bureau of Labor Statistics’ establishment survey are frequently revised, and, consequently, employment-driven demand may need to be reexamined. 

CHART 5 

–120 

–100 

–80 

–60 

–40 

–20 

20 

40 

60 

(5,000) (2,500) 2,500 5,000 

December 2001 Year-to-Date Permits 

(Year-Ago Change) 

December 2001 Employment

(Year-Ago Change, Thousands) 

Sources: Bureau of Labor Statistics, U.S. Census Bureau (Haver Analytics) 

Some Larger MSAs Continued to See 

Permit Growth during 2001, despite 

Declining Employment 

0 

Greensboro, 

Minneapolis, 

& St. Louis 

Chicago 

Atlanta 

Portland, OR–WA 

Phoenix 

construction activity may not be responding in kind to 

local economies that have started to contract during 

this recession. Further, Phoenix, Portland, and Atlanta 

were identified previously as banking markets exhibiting elevated risk profiles.18 

Chart 6 displays the level (y axis) and trend (x axis) in 

C&D lending exposures for the top 25 MSAs by median C&D concentration as a share of assets.19 It is 

apparent that some markets identified in Chart 5 as 

having significant banking exposure to C&D lending 

also may have a cyclical imbalance in home building. 

Atlanta, for example, demonstrates one of the highest 

exposures, with a ratio of median C&D to total assets 

of 17 percent in third-quarter 2001, a roughly 100­

basis-point increase from year-end 2000. In other 

words, while employment-driven demand has softened 

in the metropolitan area, single-family construction 

activity has continued, and community bank lenders 

may have increased their level of residential financing 

commitments. 

Cyclical Risks May Be Developing 

with Respect to Home Prices 

Popular comparisons have been made recently 

between the healthy run-up in housing prices during 

18 See “In Focus This Quarter,” Regional Outlook, Fourth-Quarter 

2001. 

19 We considered only MSAs that had at least six locally headquartered community banks that engaged in C&D lending activity and 

then charted the top 25 MSAs ranked by September 2001 median 

C&D/assets. 

Atlanta Regional Outlook 14 First Quarter 2002 
In Focus This Quarter
 

CHART 6 

Some Banking Markets Are Seeing Rising Construction and Development (C&D) 

Exposure Coupled with Potentially Growing Supply/Demand Imbalances 

Sources: Bank Call Reports, Bureau of Labor Statistics, U.S. Census Bureau (Haver Analytics) Median C&D Loans-to-Assets (Third-Quarter 2001, %) 

0 

5 

10 

15 

20 

25 

30 

Change in Median C&D Loans-to-Assets 

(Percentage Point Change, from Fourth-Quarter 2000 to Third-Quarter 2001) 

–2 0 2 4 6 8 10 

Salt Lake City 

Atlanta Provo-Orem, UT 

Stockton, CA 

Greensboro 

Portland, OR–WA 

Phoenix 

MSAs with declining employment

 but rising permitting during 2001 

the past several years and the technology stock-fed 

speculative “bubble” in equity prices that persisted 

through early 2000. The subsequent bursting of this 

bubble and the resulting economic distress have raised 

concerns of a sequel featuring housing prices. 

According to the OFHEO repeat sales price index, 

there has never been an instance of outright declines in 

aggregate U.S. existing home prices.20 However, home 

prices do exhibit strong cyclical tendencies, with the 

rate of appreciation slowing during national recessions. In addition, there have been some decidedly 

CHART 7 

negative episodes during the past few decades in various metropolitan markets. At the national level, existing-home price growth historically has followed trends 

in population-adjusted personal income growth,21 and 

some have pointed to a growing imbalance between 

the two as a sign that home prices may weaken as the 

effects of the recession take hold (see Chart 7). 

Given that home price bubbles have occurred in the 

past, most notably in Texas, California, and the Northeast during the 1980s, and that their ultimate deflation 

MAP 1 

Change on Year Ago (%) Note: E=estimate 

Sources: OFHEO, U.S. Census Bureau 

The Widening Gap between Home Price and 

Income Growth Has Raised Some Concern 

Per Capita Income 

Home Price Index 

’85 ’87 ’91 ’93 ’97 ’01E ’89 ’95 ’99 

0 

2 

4 

6 

8 

10 

Drops in Affordability since the Mid-1990s
 

Are Most Prevalent in California 


and the Northeast
 

Top 10 percent of
 

MSAs ranked by decline
 

in affordability index, 1996
 

to 2001 (through June)
 

NOTE: Anchorage, AK, is included, but not shown. 

Source: Economy.com 

20 According to the National Association of Realtors’ U.S. median price, a few episodes of price declines (on a quarterly, year-ago basis) are present in the time series—specifically first- and second-quarter 1989; fourth-quarter 1990; and first-quarter 1993—only the 1990 episode occurred
 

during a recession. Also, as shown in Chart 1, U.S. median new home prices have experienced meaningful declines.
 21 This relationship is generally true at the metropolitan level as well.
 

Atlanta Regional Outlook 15 First Quarter 2002 
In Focus This Quarter
 

resulted in significant negative fallout for these areas’ 

economies and insured institutions, it is useful to look 

at these historical examples as a potential “worst-case” 

scenario (with very low probability) for residential 

real estate markets during the current recession. It is 

unlikely that significant, systemic risks from home 

price bubbles have arisen yet for residential lenders. 

Of course, this situation could change if the current 

recession deepens or is protracted, or if growth during 

the subsequent recovery is anemic. Further, national 

trends can obscure dramatic variations in local markets, and a handful of MSAs today are coming off several years of rapid home price growth and falling 

affordability. These markets, and the residential lenders 

targeting them, may be more at risk as local economic 

growth falters. 

Map 1 shows markets that have seen the most significant reductions in affordability (sharp price gains) 

during the past several years. Not surprisingly, many 

of them—namely larger cities in California and the 

Northeast—are those that historically have seen the 

biggest swings in prices and a penchant for speculative 

excess. 

In markets with rapidly declining affordability, credit 

risk arises from the increasing likelihood that new 

borrowers will commit a greater share of household 

financial resources to meet monthly payments. Credit 

problems could become more readily apparent given 

any subsequent disruptions to employment or income 

in these markets—especially among households with 

limited wealth or that require multiple job holders to 

meet mortgage payments. These risks may be amplified by the increased underwriting of HLTV and subprime mortgages during the past decade. 

Disruptions to aggregate household liquidity from lost 

employment or decreased income can result in rising 

mortgage delinquencies. With respect to foreclosures, 

however, some research has suggested that the decline 

in prices relative to the balance owed on the mortgage 

(rising loan-to-value ratio) is the most significant factor.22 Even in instances of prolonged job/income loss, 

owners with positive equity are likely able to sell their 

22 For instance, “Mortgage Default Risk and Real Estate Prices: The 

Use of Index-Based Futures and Options in Real Estate,” Case, 

Shiller, & Weiss, NBER Working Paper #5078, NBER, April 1995, 

finds this to be the case, while citing past work that identified the link 

between rising LTVs and foreclosure rates. 

CHART 8 

Rising Foreclosure Rates Followed Falling 

Home Prices in New England a Decade Ago 

Sources: OFHEO (prices), Mortgage Bankers Association (foreclosures) 

Annual Home Price Change (%) 

’79 ’84 ’89 ’94 ’99 

Inverse 

Price (R) 

Foreclosure (L) 

–20 

–10 

0 

10 

20 

30 

Foreclosure Started

(% of Existing Loans) 

0.00 

0.10 

0.20 

0.30 

0.40 

0.50 

homes profitably, thus avoiding foreclosure. Chart 8 

shows the strong relationship between declining home 

prices and increasing foreclosure rates in New England a decade ago (the chart plots the inverse price 

change in order to emphasize the relationship).23 

The data available through late 2001 were mixed with 

respect to home resale price trends at the MSA level. 

On the one hand, while existing home prices as measured by the OFHEO home price index showed no 

markets with year-over-year price declines in fourthquarter 2001, NAR’s median resale price metric did 

show about a dozen markets with year-over-year 

declines, none exceeding four percent. A deceleration 

in year-over-year home price growth was evident for 

many markets (and the nation) using either measure. It 

should be noted that the OFHEO data do not include 

sales of high-priced homes and are less influenced by 

changes in the mix of homes sold than are average and 

median prices;24 this issue is more meaningful in the 

nation’s most expensive markets, such as MSAs in the 

23 In states where dominant metro areas have seen large price declines 

in past years, such as Massachusetts, this relationship is more pronounced than in larger states or the nation as a whole. For example, 

the two-decade correlation between foreclosures started and price 

change is –78 percent in Massachusetts versus roughly –60 percent in 

both California and the nation. 

24 Data are obtained from aggregating repeat sales or refinancings of 

the same properties over time and using statistical methods to calculate an overall rate of home price appreciation for each market. Sampled properties are confined to those whose mortgages are 

“conventional” and do not exceed a conforming loan limit (set at 

$275,000 in 2001) required for securitization through Fannie Mae and 

Freddie Mac. For more information, see www.ofheo.gov/house/. 

Atlanta Regional Outlook 16 First Quarter 2002 
In Focus This Quarter
 

TABLE 1 

As Recession Evolved, Home Price Appreciation Waned through 2001 

...Further Deceleration in Growth (or Declines) May Be Possible in 2002 

ANNUAL PERCENT CHANGES 

MSAS RANKED 

BY DECELERATION 

IN HOME PRICE INDEX 

FROM 1Q01 TO 4Q01 

OFHEO HOME PRICE INDEX 

NONFARM 

EMPLOYMENT 

1998– 

2000 1Q01 2Q01 3Q01 4Q01 

1998– 

2000 2001 

UNITED STATES 6.3 9.6 9.1 8.8 6.9 2.4 0.3 

SAN JOSE CA PMSA 17.7 24.4 16.9 8.4 0.6 3.4 –0.4 

SANTA CRUZ-WATSONVILLE CA 

PMSA 16.8 25.7 17.3 11.9 5.9 N/A N/A 

SAN FRANCISCO CA PMSA 16.5 19.4 13.9 9.1 3.5 3.3 1.3 

SALINAS CA MSA 13.7 24.3 22.4 19.0 9.4 3.3 0.9 

SANTA ROSA CA PMSA 14.8 22.7 19.6 13.6 8.6 4.1 1.6 

OAKLAND CA PMSA 14.7 22.3 18.0 14.1 8.2 3.4 2.0 

AUSTIN-SAN MARCOS TX MSA 9.4 15.2 12.1 7.7 5.0 5.9 2.1 

MERCED CA MSA 6.4 24.6 21.8 17.3 15.7 N/A N/A 

JAMESTOWN NY MSA 4.9 9.9 0.8 7.4 1.6 N/A N/A 

STOCKTON-LODI CA MSA 9.0 22.8 25.2 20.6 14.9 3.7 3.0 

WHEELING WV-OH MSA 4.1 10.8 7.7 11.7 3.7 1.1 –0.5 

GOLDSBORO NC MSA 4.0 7.9 3.2 1.6 0.9 N/A N/A 

CUMBERLAND MD-WV MSA 2.7 8.6 8.4 8.1 1.8 N/A N/A 

LEWISTON-AUBURN ME NECMA 4.2 14.0 8.6 10.1 7.1 4.4 –0.4 

BANGOR ME NECMA 3.7 13.2 7.4 9.3 6.5 N/A N/A 

FARGO-MOORHEAD ND-MN MSA 4.0 11.1 6.5 5.4 4.6 2.1 –0.3 

BARNSTABLE-YARMOUTH MA 

NECMA 12.8 17.6 14.5 14.6 12.5 3.9 1.3 

PINE BLUFF AR MSA 2.2 6.6 9.7 5.0 0.3 0.8 –1.7 

DUBUQUE IA MSA 3.9 8.8 6.0 6.9 2.5 1.1 –0.6 

BOULDER-LONGMONT CO PMSA 10.9 14.6 11.7 11.7 8.3 5.1 3.2 

DENVER CO PMSA 11.1 13.7 11.8 10.9 7.9 3.8 2.3 

UTICA-ROME NY MSA 3.5 14.6 9.5 8.4 9.1 2.4 0.1 

VALLEJO-FAIRFIELD-NAPA CA PMSA 11.8 20.0 19.1 16.6 14.7 4.7 2.8 

BRYAN-COLLEGE STATION TX MSA 4.8 11.1 2.1 5.6 5.8 4.0 0.7 

SAN DIEGO CA MSA 11.8 15.6 13.8 12.9 10.4 4.3 2.7 

SAN LUIS OBISPO-ATASCADERO­ PASO ROBLES CA MSA 11.4 19.2 18.0 17.8 14.2 N/A N/A 

TUCSON AZ MSA 3.3 8.6 8.0 6.8 3.6 3.5 0.8 

JERSEY CITY NJ PMSA 8.0 11.1 17.6 13.7 6.2 2.1 2.7 

CLARKSVILLE-HOPKINSVILLE TNKY MSA 3.3 9.1 4.2 6.5 4.2 N/A N/A 

RAPID CITY SD MSA 6.2 8.9 9.3 7.7 4.1 3.1 0.1 

LA CROSSE WI-MN MSA 5.7 7.4 5.8 5.1 2.6 2.3 1.0 

ST. CLOUD MN MSA 6.9 10.4 8.5 9.4 5.7 3.8 1.4 

Sources: Office of Federal Housing Enterprise Oversight (OFHEO), Bureau of Labor Statistics 

Atlanta Regional Outlook 17 First Quarter 2002 
 

In Focus This Quarter
 

San Francisco Bay Area25 and parts of the Northeast, 

since prices for high-end homes (typically financed by 

jumbo mortgages) may be more volatile over the economic cycle. 

Table 1 lists markets whose 2001 deceleration in home 

price growth was in the top 10 percent of the more 

than 300 metro areas for which the OFHEO statistic is 

available. The table also provides (where available) 

each MSA’s recent employment trend as an indicator 

of overall economic conditions. These markets may yet 

see even more pronounced deceleration in home price 

growth or even declines in home prices this year (as 

may others not shown). This possibility will be determined for the most part by the performance of each market’s local economy. 

The metro areas in the table are 

ordered by the magnitude of their 

deceleration in home price growth 

over the initial quarters of this recession. As a result, the marked deceleration in year-over-year price 

growth in the recently overheated 

San Francisco Bay Area puts many of its MSAs near the 

top of the list. In the table, San Jose, San Francisco, 

Oakland, Denver, and San Diego also previously were 

identified as banking markets with elevated risk profiles.26 For some of the smaller MSAs in Table 1 with 

more volatile appreciation rates, such as Utica and 

Fargo, comparisons of recent price trends are more 

appropriate using the 1998–2000 average as a benchmark, as these markets experienced pronounced spikes in 

year-ago price growth during first-quarter 2001. 

It is hard to generalize about which markets will see the 

most pronounced home price weakness as the recession 

continues. However, certain markets have shown a tendency in the past to be driven to a greater degree by speculative, rather than fundamental, factors. These markets 

are more likely to see significant downward corrections 

in price when economic activity falls for a prolonged 

period or by a sufficient magnitude. One study from the 

mid-1990s found, in comparing 14 cities in the Northeast and West with 16 inland cities, that while both 

groups tended to respond similarly to local and national 

25 As considered here, this includes the following MSAs: San Jose,
 

Santa Cruz-Watsonville, San Francisco, Santa Rosa, Oakland, Salinas, and Vallejo-Fairfield-Napa.
 

26 See “In Focus This Quarter,” Regional Outlook, Fourth Quarter
 

2001.
 

economic forces (fundamental, or “equilibrium,” price 

drivers), prices in the former group tended to be influenced to a greater degree by speculative, or “disequilibrium,” variables, including recent trends in price 

appreciation.27 Cities along the nation’s coasts also have 

tended to see the most significant price swings over the 

past 20 years. 

History also provides some insights into the nature and 

extent of any price declines in markets where economic 

conditions deteriorate. A study of two significant examples, Boston and Los Angeles in the 1980s and early 

1990s, concluded that declines differed by property type 

(i.e., condos versus single-family) and price class (i.e., 

high-end versus entry-level).28 This dispersion in price 

declines arose from differing rates of appreciation (properties that experienced the greatest inflation during the 

boom saw the largest deflation) and from the nature of 

each city’s economic decline, which differed according to 

concentrations of job losses by industry and wage type, 

underlying demographic factors, and housing supply 

trends. 

Looking at recent developments, it seems that the greatest near-term risk of a significant downward adjustment 

in housing prices is in the San Francisco Bay area. In 

recent years, this area witnessed double-digit home price 

appreciation that exceeded growth in per capita income 

by a wide margin. A recent analysis from the University 

of California-Berkeley’s Haas School of Business forecast that prices in the Bay Area housing market will 

decline by 15 percent overall (and by 30 percent for luxury homes) by the time the local economy’s recession 

ends late this year.29 Meanwhile, the larger MSAs in 

Southern California have not seen as significant a disparity between home price appreciation and personal 

income growth during this cycle as during the 1980s. 

Also in contrast to the 1980s, New England (and the 

Northeast generally) has seen little speculative purchase 

or construction activity in recent years, which should 

help to mitigate any price weakness through the current 

recession in these markets.30 

27 Jesse M. Abraham and Patric H. Hendershott, “Bubbles in Metropolitan Housing Markets,” Working Paper #4774, NBER, June 1994. 

28 Karl E. Case and Robert J. Shiller, “A Decade of Boom and Bust in 

the Prices of Single-Family Homes: Boston and Los Angeles, 1983 to 

1993,” New England Economic Review, March/April 1994. 29 David Goll, “Bay Area Housing Market Will Remain Slow,” East 

Bay Business Times, January 23, 2002. 30 “Regional Perspectives,” Boston Region, Regional Outlook, First 

Quarter 2002. 

Atlanta Regional Outlook 18 First Quarter 2002 
In Focus This Quarter
 

Conclusion 

Home prices are holding up in most markets, and, generally, permanent residential mortgages have fared 

well in prior recessions. However, history might 

understate credit risks for insured institutions during 

this cycle because the mortgage lending business has 

changed since the last recession. Chief among these 

changes are robust mortgage market competition, 

which has contributed to narrower collateral margins; 

increased reliance on underwriting automation; and 

expanded involvement in the subprime credit market. 

In addition, residential C&D lenders in certain markets might be particularly vulnerable, since C&D credits typically undergo higher loss rates and some areas 

are experiencing continued construction despite a 

cyclical slowdown (as measured by employment 

trends). Permanent mortgage lenders in certain areas, 

such as the San Francisco Bay area, could also face 

higher loss rates and foreclosures going forward, as the 

current economic weakness places downward pressure 

on home prices and dampens the ability of households 

to meet mortgage payments. 

Scott Hughes, Regional Economist 

Judy Plock, Senior Financial Analyst 

Joan Schneider, Regional Economist 

Norm Williams, Regional Economist 

Atlanta Regional Outlook 19 First Quarter 2002 
✁
 

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