Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION FOURTH QUARTER 1999 

FDIC
 

Atlanta
 

Region
 

Division of
 

Insurance
 

Jack M.W. Phelps,
 

Regional Manager
 

Scott C. Hughes,
 

Regional Economist
 

Pamela R. Stallings,
 

Senior Financial
 

Analyst
 

In Focus This Quarter 

◆ Economic Conditions and Emerging Risks in Banking—This article provides an overview of 

economic conditions and banking industry trends, with a primary focus on potential risks to insured 

depository institutions. 

Indicators of Industry Performance—The reported financial condition of insured banks and 

thrifts is strong. However, despite projected growth in earnings, bank and thrift stocks underperformed the broader market through October 1999. See page 3. 

Economic Conditions—The economy remains generally strong, and the outlook calls for continued growth. Growth is likely to slow, however, in order to correct financial imbalances that have 

developed as a result of a rapid creation of household and commercial credit and borrowing from 

abroad. There is a threat that the adjustment process could be a volatile one. See page 4. 

Emerging Risks in Banking—Rising indebtedness on the part of businesses and households 

raises concerns about future loan performance. Industry responses to intense competition have 

created greater credit, market, and operational risks. See page 8. 

Consumer Lending—Banks and thrifts are becoming increasingly involved in subprime consumer lending, which has raised some supervisory concerns. See page 8. 

Commercial and Industrial Lending—Signs of deterioration in corporate credit quality can be 

found in rising loss rates, slower profit growth, and rising corporate bond defaults. At the same 

time, banks are expanding their lending to heavily indebted companies in the syndicated loan 

market. See page 11. 

Commercial Real Estate and Construction Lending—Loans for real estate construction and 

development are growing rapidly. Despite an uptick in commercial vacancy rates, loan losses 

remain low. See page 12. 

Agricultural Lending—Low commodity prices are hurting farm operating incomes, but widespread effects on farm banks have yet to materialize. See page 13. 

Funding and Interest Rate Risk—Lagging deposit growth has led to a greater reliance on more 

volatile, market-based funding, and some institutions are taking on greater interest rate risk to 

maintain loan growth. See page 14. By the Analysis Branch Staff 

Regional Perspectives 

◆ Atlanta Region economic conditions remain strong despite recent slowing in some rural 

areas—The Atlanta Region’s economic growth exceeds that of the nation, although job growth moderated during the first half of 1999. Favorable economic conditions are reflected in strong loan 

demand, expanded fee income, and a low level of expenses related to asset quality problems at the 

Region’s insured commercial and savings banks. Recently, however, commercial credits at large and 

small banks have weakened as pressures continue on the economically critical agricultural, steel, mining, and textile industries. See page 18. 

◆ Increased use of noncore funding by the Region’s banks may require higher levels of assetside liquidity—Atlanta Region banks increasingly are relying on noncore funds to supportt 

asset growth. While the potential instability of these funds may require higher levels of asset-side 

liquidity, shrinking net interest margins are forcing some banks to sacrifice liquidity by extending loan 

and investment maturities in search of higher yields. However, active secondary markets for bank 

loans and asset-backed securities may help relieve liquidity pressures caused by increased noncore 

funding and longer-maturity assets. See page 22. 

By the Atlanta Region Staff 

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

Insurance Corporation 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, AZ, CA, FJ, FM, GU, HI, ID, MT, NV, OR, UT, WA, WY)
 

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

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

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

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Ronald L. Spieker 

Publications Manager Teresa J. Franks 

Writer/Editor Kim E. Lowry 
In Focus This Quarter
 

Economic Conditions and 


Emerging Risks in Banking
 

The Division of Insurance periodically assesses conditions in the economy and the banking industry to identify and 

evaluate trends that could adversely affect the performance of insured depository institutions. Overall, conditions in 

the economy and banking industry are favorable at this time. However, signs point to vulnerability in the economy 

and in the banking industry that may make the years ahead much more challenging. Three broad themes emerge from 

this assessment: 

•	 Households’ and businesses’ debt levels are on the rise. Spending by households and businesses is growing faster 

than cash income, resulting in rapidly increasing indebtedness. Consumer spending has been driven, in part, by 

large increases in the net worth associated with stock holdings and home equity. Businesses are restructuring and 

investing in new technologies to raise productivity and cut costs. Both consumer and business spending has been 

assisted by ready access to financing. Rising interest rates or slower economic growth could make debt service 

more difficult for borrowers. 

•	 Intense competition in banking is driving business strategies. Competitive pressures have affected nearly every 

facet of the banking business. These pressures are evident in net interest margins, which have suffered from tighter 

loan pricing and higher funding costs. To maintain profits, some institutions are lending to less creditworthy borrowers, expanding into new or higher-yielding activities, creating more complex balance sheet structures, or cutting costs. These strategies may lead to greater credit, market, and operational risks. 

•	 The currently benign economic environment is vulnerable to rapid deterioration in the event of financial market 

instability. During the 1990s, we have witnessed recurring, and perhaps more frequent, episodes of financial market turbulence. Recent episodes have arisen mainly overseas and have had little adverse effect on U.S. economic 

activity. However, the current economic expansion is closely tied to the ready availability of market-based financing for households and businesses and to wealth generated with the help of rising stock prices and falling interest 

rates. For this reason, the currently strong economic outlook may be subject to sudden deterioration in the event 

of market shocks that sharply raise interest rates or lower stock prices. 

The analysis that follows explores these themes in more detail in the following sections: 1) indicators of industry performance, 2) economic conditions, and 3) emerging risks in banking. 

Indicators of Industry Performance 

Industry Financial Performance Is Strong and a decline in provision expense. However, the majority of the decline in net earnings resulted from a $1.5 

According to reported financial information, the bank- billion loss posted by one large bank. 

ing and thrift industries are performing well. As summarized in the FDIC Quarterly Banking Profile, The low overall level of net loan losses has been a key 

second quarter 1999, both the commercial banking and contributor to strong industry performance. Chart 1 

thrift industries report near-record earnings, strong cap- (next page) shows that the average net loan loss ratio for 

ital levels, and manageable volumes of problem assets the industry has been low and stable in recent years. 

and loan losses. Return on assets (ROA) for all insured Similarly, the range between the worst and best 5 perinstitutions in the second quarter was 1.21 percent and cent of net loan loss ratios has narrowed considerably 

return on equity (ROE) was 14.07 percent. ROA and since the early 1990s. More than 95 percent of insured 

ROE were down slightly from the first quarter despite institutions reported a net loan loss ratio of less than 1 

improvement in the industry net interest margin (NIM) percent in 1998, continuing a five-year trend. 

Atlanta Regional Outlook 3	 Fourth Quarter 1999 
In Focus This Quarter
 

CHART 1 

Overview 

ings per share is projected to be 16.9 percent for pubBank Stocks Underperform Despite 

Projected Earnings Growth 

Analysts expect continued earnings growth for banks 

and thrifts in 1999 and 2000. Median growth in earnThe Range of Loan Losses for FDIC-Insured 

Institutions Has Been Stable Recently 

* For institutions with at least 10 percent of assets invested in loans. 

Source: FDIC Bank and Thrift Call Reports (Research Information System) 

–1.0 

0.0 

1.0 

2.0 

3.0 

4.0 

5.0 

6.0 

’84 ’86 ’88 ’90 ’92 ’94 ’96 ’98 

Net Loan Loss Ratio (percent)* 

95th Percentile 

Mean 5th Percentile 

licly traded banks and 19.4 percent for publicly traded 

thrifts for 1999.1 Ratings agencies also view the industry positively. The ratio of upgrades to downgrades for 

ratings issued by Moody’s Investors Service improved 

in the second quarter, with nine companies receiving 

upgrades versus four receiving downgrades. 

Nonetheless, bank and thrift stocks have underperformed the broader market in the first three quarters of 

1999. The SNL Securities Bank Stock Index, which 

tracks more than 450 publicly traded commercial banks, 

declined 6.7 percent between January 1 and September 

30, 1999. The SNL Securities Thrift Stock Index, 

which tracks the performance of about 350 publicly 

traded thrifts, fell 13.7 percent during the same period. 

By contrast, the Standard & Poor’s (S&P) 500 index 

gained 4.6 percent. Analysts cite rising interest rates, 

concerns about problems with corporate credit quality, 

and a decline in bank merger activity as reasons for the 

recent performance of bank and thrift stocks. 

Economic Conditions
 

The U.S. economy has remained generally strong during 

1999, the ninth year of the current economic expansion. 

If growth continues through February 2000—as most 

analysts expect—this expansion will become the 

longest in U.S. history. What is also remarkable about 

this business cycle expansion is the fact that the highest 

rates of growth have occurred during the past two years, 

1997 and 1998. Even as growth has accelerated with 

unemployment declining to 4.2 percent, wage and price 

inflation has remained unusually subdued. While low 

inflation has helped prolong the expansion, it has 

imposed intense price competition on a wide range of 

industries. The currently positive economic outlook is 

subject to possible sudden deterioration in the event of 

financial market shocks that could raise financing costs, 

reduce the availability of financing, or destroy investor 

wealth. 

Commodity Industries Have 

Faced Pricing Pressures 

One disadvantage of low inflation during this expansion 

has been that firms in certain commodity industries 

have suffered from falling prices. Profit margins have 

declined in agriculture, mining, and some manufacturing sectors because of weak or negative revenue growth 

during 1997 and 1998.2 Firms operating in these industries have aggressively cut costs to preserve profit 

margins. Nonetheless, profit growth has been flat or 

negative for a large proportion of S&P 500 firms in the 

mining, textiles, chemicals, iron and steel, and oil and 

gas sectors since 1997. In response, some firms in these 

industries have chosen to consolidate through mergers. 

According to Mergerstat, the dollar volume of merger 

and acquisition transactions involving U.S. firms was a 

record $1.2 trillion in 1998, more than 80 percent above 

1997 levels. 

Business Investment Is Outpacing Cash Flow 

Analysts recently have become concerned about 

increasing levels of debt on corporate balance sheets. 

1 Based on estimates as of November 4, 1999, for 98 commercial 

banks and 33 thrifts that have at least five analyst estimates. 

2 Richard A. Brown and Alan Deaton, “Falling Prices in Commodities 

and Manufacturing Pose Continuing Risks to Credit Quality,” 

Regional Outlook, Third Quarter 1999 (http://www.fdic.gov/bank/ 

analytical/regional/ro19993q/na/t3q1999.pdf). 

Atlanta Regional Outlook 4 Fourth Quarter 1999 
In Focus This Quarter
 

Chart 2 tracks the steady growth of fixed investment by 

U.S. corporations during the current expansion. It also 

shows, however, that growth in cash flow available to 

finance investment has slowed in recent years. This 

“financing gap” has grown steadily, reaching a record 

$86 billion in 1998. 

As a result, corporations must finance an increasing 

portion of investment spending by issuing either net 

new equity or net new debt. In recent years, firms have 

overwhelmingly chosen debt financing. Net issuance of 

corporate debt was $219 billion in 1998, while corporations repurchased equity shares on net for the sixth 

straight year. Corporate borrowing has also continued 

at a brisk pace; domestic commercial and industrial 

(C&I) lending rose by 12.5 percent in the year ending 

June 1999. 

A widening financing gap and increasing debt levels 

could pose future problems if there are adverse 

changes in the financial environment. For example, a 

sharp rise in interest rates would increase the debt burden of businesses, hurt their profitability, and impair 

their creditworthiness. Under such a scenario, firms 

might decide to curtail their capital expenditures, 

which would tend to reduce the rate of growth in the 

rest of the economy. 

Consumer Spending 

Continues to Grow 

Strong growth in consumer spending continues to propel the economic expansion. Spending has accelerated 

in recent quarters, in contrast to previous expansions 

when the strongest growth in consumer spending 

occurred early in the recovery. One factor supporting 

the robust pace of spending is housing activity. Singlefamily housing starts rose to an annualized rate of 

more than 1.3 million units in fourth quarter 1998 and 

have remained near that level through third quarter 

1999. Existing home sales also have maintained a 

record pace of 5.3 million units on an annualized basis 

during the second and third quarters. Low mortgage 

interest rates and real income gains have combined to 

push housing affordability to its highest level in many 

years.3 

3 The housing affordability index published by the National Association of Realtors equals 100 when the median family income qualifies 

for an 80 percent mortgage on a median-priced existing singlefamily home. The value of the index as of the third quarter of 1999 

was 127.1. 

CHART 2 

The Financing Gap Has Widened 

for Nonfinancial Corporations 

Source: Federal Reserve Board (Haver Analytics) 

100 

200 

300 

400 

500 

600 

700 

800 

’80 ’82 ’84 ’86 ’88 ’90 ’92 ’94 ’96 ’98 

Billions of Dollars 

Capital Expenditures 

“Financing Gap” 

Cash Flow 

Rapid growth in consumer spending also warrants 

attention. Despite the highest rates of real income 

growth in nine years, consumer spending has grown 

more quickly than disposable personal income. The 

divergence in growth has resulted in a falling personal 

savings rate, which reached a record low in 1999.4 The 

recent decline in the personal savings rate continues a 

trend that has been under way for more than a decade 

(see Chart 3, next page).5 

Analysts cannot fully explain the reasons for the falling 

savings rate, although the “wealth effect” associated 

with the accumulation of capital gains by households is 

believed to be a significant factor. Since 1995, the total 

value of equities, mutual funds, and pension funds 

owned by households has risen by $6.8 trillion, while 

the value of owner-occupied housing net of mortgage 

debt has increased by $812 billion. This accumulation 

of wealth apparently has emboldened consumers to 

spend, as evidenced by data that show aggregate spend4 Personal savings is calculated as the difference between disposable 

personal income (DPI, or total income net of taxes) and consumption 

expenditures. The personal savings rate is equal to personal savings 

divided by DPI. It should be noted that capital gains, even when realized, are not included as income in this calculation, although taxes 

paid on capital gains are deducted from DPI. Consequently, largescale realization of capital gains by households will tend to push 

down the personal savings rate. 

5 The Bureau of Economic Analysis, which tabulates the personal 

savings rate, has recently revised its methodology, leading to a large 

revision in the savings rate data. Earlier estimates reported the personal savings rate to be around negative 1 percent, suggesting that 

households were spending more than their disposable (after-tax) 

income. Revised estimates show that the savings rate for the third 

quarter of 1999 was 2.1 percent. Although higher than previously 

reported, the revised personal savings rate data continue to show a 

downward trend similar to earlier savings rate estimates. 

Atlanta Regional Outlook 5 Fourth Quarter 1999 
In Focus This Quarter
 

CHART 3 

Strong Consumer Spending Has Been 

Accompanied by a Falling Personal Savings Rate 

Source: Bureau of Economic Analysis (Haver Analytics) 

0.0 

2.0 

4.0 

6.0 

8.0 

1Q92 1Q93 1Q94 1Q95 1Q96 1Q97 1Q98 

0.0 

2.0 

4.0 

6.0 

8.0 

10.0 

Personal Savings Rate 

(Percent) 

Personal Consumption Spending 

(Percent change from year ago) 

1Q99 

ing growth exceeding income growth. For the most part, 

when consumers have chosen to convert capital gains to 

spendable cash, they have done so by borrowing—often 

against the equity in their homes or their 401(k) 

accounts. 

The increasing indebtedness of consumers could substantially raise the costs of debt service relative to 

income, especially if interest rates rise or income 

growth slows. Moreover, analysts express concerns 

about a reversal of the wealth effect if there is a significant and sustained decline in equity prices. Any resulting decline in consumer confidence could substantially 

slow the pace of consumer spending, leading to a 

reduced pace of economic growth. 

CHART 4 

The Growing Private Deficit Raises Concerns 

Taken together, the sum of annual net borrowing by 

businesses and households has been referred to as the 

“private deficit.” During the late 1990s, as the combined 

budget of federal, state, and local governments moved 

from deficit to surplus, the private deficit rose sharply; 

between 1996 and 1998, it nearly doubled from $550 

billion to $1.02 trillion (see Chart 4). 

The private deficit was financed from three sources in 

1998. One source was the $73 billion surplus in the 

government sector, the first surplus in 28 years. The 

largest portion of the 1998 private deficit was financed 

by the creation of credit by the domestic financial sector and by an inflow of foreign capital. The rapid creation of credit raises concerns about credit quality, an 

issue that is explored in more detail under Emerging 

Risks in Banking, below. Dependence on foreign capital 

raises questions about what might happen if the foreign 

sector becomes less willing to export capital to the 

United States. 

Recovery Abroad Is Changing 

the Terms of Trade 

During the past three years, the U.S. economy has experienced consistently strong growth with low inflation, 

while the economies of some of its major trading partners have grown more slowly or not at all. Japan was 

mired in its worst recession in decades, while a number 

of countries in Asia, Latin America, and Eastern Europe 

Net Borrowing by Businesses and Households Represents a Growing “Private Deficit” 

Flow of Net Sectoral Lending (lending less borrowing), 

in Billions of Dollars 

Note: “Nonfinancial business” includes farm and nonfarm, corporate and noncorporate businesses. 

Source: Federal Reserve Board (Haver Analytics) 

–1200 

–600 

0 

600 

1200 

’80 ’81 ’82 ’83 ’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 

Foreign Sector 

Domestic Financial Sector 

Nonfinancial Business 

Households 

Government 

Atlanta Regional Outlook 6 Fourth Quarter 1999 
In Focus This Quarter
 

have experienced the harsh fallout resulting from financial market and exchange rate crises. The euro-zone 

economies, Germany and France in particular, have 

grown slowly following the imposition of tight fiscal 

and monetary policies in advance of the introduction of 

the euro on January 1, 1999. 

The net effect of this disparity in growth rates has been 

a growing U.S. trade deficit. The deficit rose by 57 percent in 1998 to $164.3 billion, reflecting a small decline 

in exports and a 5 percent increase in imports. The 

adverse effects of the trade deficit on the U.S. economy 

have been felt primarily by the commodity industries— 

farming, mining, and basic manufacturing. In addition, 

the large trade deficit has resulted in the transfer of billions of dollars to foreign investors. During 1997 and 

1998, many foreign investors used their excess dollars 

to purchase dollar-denominated stocks and bonds. This 

inflow of capital helped keep U.S. equity and bond 

prices high, while pushing up the value of the dollar. 

A global economic recovery during the first three quarters of 1999 has led to higher demand for investment 

capital outside the United States. The International 

Monetary Fund estimates that growth in the global 

economy will increase from 2.5 percent in 1998 to 3.0 

percent in 1999 and 3.5 percent in 2000.6 Foreign 

investors, in anticipation of stronger growth and greater 

investment opportunities abroad, have started to convert 

excess dollar holdings to other currencies, including the 

yen and euro. This change in investment strategy has put 

downward pressure on the value of the dollar. Between 

July and September 1999, the dollar lost approximately 

10 percent of its value against the yen. 

A falling dollar will likely contribute to a recovery of 

U.S. exports in coming months. The index of export 

orders compiled by the National Association of Purchasing Managers points to future growth in shipments 

abroad. The index has signaled growing export orders 

for nine months through October 1999. As Chart 5 

shows, increasing export orders tend to lead the actual 

rise in exports by several months. 

A lower dollar could also place upward pressure on U.S. 

inflation and interest rates. A steady decline in the dollar would make foreign goods more expensive, while 

higher export demand would raise manufacturing output at a time when U.S. labor markets are very tight. The 

prices of several important industrial commodities have 

6 International Monetary Fund, World Economic Outlook, October 

1999. 

CHART 5 

U.S. Exports Fell in 1998, but Rising 

Orders Point to Growth in 1999 

Source: Bureau of the Census; National Association of Purchasing Managers 

(NAPM) (Haver Analytics) 

–10 

–5 

0 

5 

10 

15 

20 

’93 ’94 ’95 ’96 ’97 ’98 ’99 

40 

45 

50 

55 

60 

65 

70 

U.S. Export Growth 

(Percent change from year ago) 

NAPM Export Orders Diffusion Index 

(Greater than 50 signals expansion) 

risen in dollar terms during 1999, led by a doubling in 

the price of oil during the first nine months of 1999. 

Domestically, the producer price index has risen by 

approximately 4 percent since the beginning of the year 

following a two-year decline, reflecting an increase in 

oil and intermediate goods prices. 

Interest rates have risen in step with renewed concerns 

about inflation. The constant maturity yield on 10-year 

Treasury bonds increased by approximately 140 basis 

points in the year ending October 1999, while the Federal Reserve instituted two 25-basis point increases in 

short-term rates during the summer of 1999. 

The Economic Outlook Calls 

for Continued Growth 

One scenario for the year ahead is that the U.S. economy will continue to grow at much the same rate as it 

has during the past few years. As discussed above, 

however, continued rapid growth would lead to even 

greater imbalances in the domestic economy and in the 

foreign sector. For this reason, most economists do not 

believe that rapid growth can continue indefinitely. 

Instead, analysts suggest two possible scenarios for the 

economy. 

The Blue Chip Economic Indicators consensus outlook for the U.S. economy calls for a “soft landing.” 

Gross domestic product is projected to grow at a rate of 

3.8 percent in 1999 with somewhat slower growth of 2.8 

percent in 2000.7 Rising wage pressures, reflecting tight 

7 Blue Chip Economic Indicators, Aspen Publishing, October 10, 

1999. 

Atlanta Regional Outlook 7 Fourth Quarter 1999 
In Focus This Quarter
 

labor markets across the nation, and economic recovery 

abroad are expected to increase the risks of higher U.S. 

inflation. Improving growth prospects in the global 

economy may also lead to a stabilization of commodity 

prices, reversing a trend of falling prices that has until 

recently contributed to lower U.S. inflation. In response 

to expectations of higher inflation, medium-term interest rates are also expected to rise modestly. Slower U.S. 

growth and faster expansion abroad would result in a 

rebalancing of global growth that should narrow the 

U.S. trade deficit and reduce downward pressure on the 

dollar. 

Although the consensus forecast calls for continued 

expansion, an alternative scenario suggests the possibility of a steep decline in economic growth leading to a 

“hard landing.” Sharply higher interest rates, in 

response to a weak dollar and an unexpected acceleration of U.S. inflation, could lead to declining capital 

investment and reduced consumer spending. Rising 

interest rates would increase the debt burden for households and businesses even as measures of indebtedness 

are rising. A significant and sustained decline in equity 

prices may occur if investors become pessimistic as the 

economy slows. The response of the world economy to 

a U.S. recession is difficult to assess. As the past several months have shown, growth in the U.S. economy has 

been an important factor in supporting growth abroad. 

If the U.S. economy were to enter a recession, overall 

global growth could also slow, depending on the extent 

to which recoveries in Europe, Asia, and Latin America 

offset any shortfall in U.S. growth. 

Emerging Risks in Banking
 

Overview 

Favorable economic conditions continue to support 

strong loan growth and healthy loan performance 

among insured institutions. Net loss rates remain low 

relative to the early 1990s for almost every major loan 

category except consumer loans. Loss rates in domestic 

commercial loans, previously at low levels, rose modestly during the first half of 1999. Agricultural loan loss 

rates appear likely to rise in the future due to the effects 

of weak commodity prices on farm incomes. Strong 

loan growth and low loan losses have helped banks 

achieve record and near-record high quarterly profits. 

However, rising indebtedness on the part of businesses 

and households raises concerns about future loan performance, particularly if economic conditions were to 

deteriorate or if interest rates were to rise. 

Strategic responses to competitive pressures point to 

greater credit, market, and operational risks for the 

industry. Intense competition has pressured NIMs and 

has encouraged many lenders to seek higher returns by 

lending to less creditworthy borrowers. In order to 

maintain and grow profits, some insured institutions are 

expanding into activities such as subprime consumer 

lending, high loan-to-value mortgage lending, and lending with minimal or no documentation requirements. 

Rapid growth in syndicated lending to leveraged companies also indicates that large commercial lenders have 

increased their tolerance for risk. Competition has made 

funding with deposits more difficult. As a result, some 

institutions are relying increasingly on securitizations 

and more expensive, market-based sources of funds, 

which can alter an institution’s liquidity position, interest rate risk profile, and operational needs. Institutions 

have also responded to competitive pressures by cutting 

costs or merging in an attempt to achieve greater efficiencies. In some cases, deep reductions in operating 

costs support profits at the expense of less effective 

operational controls. 

Consumer Lending 

Household Borrowing Is on the Rise 

Household borrowing is growing rapidly, consistent 

with high reported levels of consumer confidence and 

strong consumer spending. Mortgage debt, which grew 

by 10.4 percent in the second quarter from year-ago 

levels, is the fastest-growing segment of household 

debt (see Chart 6). Mortgage loan growth has been particularly strong, in part because of rising homeownership, the availability of more low-down-payment loans, 

and the use of mortgage loans to consolidate revolving 

debt balances. Nonrevolving debt grew by 7.3 percent 

in the year ending June 1999, largely because of strong 

sales of new cars. In contrast, credit card and other 

revolving debt increased by only 5.7 percent during the 

same period—a much slower rate of growth than during the mid-1990s. 

Atlanta Regional Outlook 8 Fourth Quarter 1999 
In Focus This Quarter
 

CHART 6 

Household Borrowing Is on the Rise, 

Led by Increases in Mortgage Debt 

Source: Federal Reserve Board (Haver Analytics) 

–10 

–5 

0 

5 

10 

15 

20 

25 

’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 

Percent Change from Year Ago 

Nonrevolving 

Home 

Mortgages Revolving 

A Mortgage Refinancing Boom Has Helped 

Consumers Consolidate Debt 

A key component of the recent shift by consumers from 

credit card debt to mortgage debt has been a surge in 

mortgage refinancing in 1998 and early 1999. The 

Mortgage Bankers Association’s Refinancing Index 

peaked at over 4,300 in October 1998, compared with 

an average monthly index value of 527 during 1997.8 

Many households have refinanced their mortgages to 

obtain cash to pay down credit card and other high-cost 

consumer debt, thereby lowering their monthly financial obligations. According to a Freddie Mac survey of 

1998 refinancing transactions, more than 3 million 

homeowners, or 51 percent of all mortgage-refinance 

borrowers, generated net cash proceeds when they refinanced their loans.9 On average, these borrowers cashed 

out 11 percent of the equity in their homes. On the basis 

of this survey, Bank One Corporation estimated that 

cash out refinancing added about $60 billion in cash 

flow to consumer pocketbooks last year. This extra cash 

flow could help explain recent quarterly declines in personal bankruptcy filings, mortgage delinquencies, and 

consumer credit charge-offs.10 Rising interest rates 

appear to have ended this mortgage refinancing boom. 

The lower volume of mortgage refinancings raises ques8 Index is seasonally adjusted where the week of March 16, 1990 =
 

100.
 

9 Survey cited in a study by the Joint Center for Housing Studies at
 

Harvard University, “The State of the Nation’s Housing: 1999.”
 

10 Tristan Mabry, “This Boom, Some Say, Is on the House,” The Wall
 

Street Journal, July 6, 1999.
 

tions about whether consumers again will increase their 

use of credit cards to finance purchases. If so, there may 

be negative consequences for future consumer debt service burdens and consumer credit quality. 

Credit Card Lenders Face Declining Returns 

After several years of rapid growth in the mid-1990s, 

the credit card industry has become characterized by 

overcapacity and declining margins. At the same time, 

the high level of mortgage refinancings and rising 

household incomes have reduced the dependence of 

consumers on credit card debt. Consequently, credit 

card lenders are struggling to maintain volume as consumers pay off their credit card balances more quickly. 

Overcapacity and declining margins have led lenders to 

search aggressively for new ways to increase revenues. 

One method they have adopted is to charge new fees 

that are triggered by cardholder behavior. Lenders are 

now charging fees for inactive accounts, fees to close 

accounts, and even customer service fees. In addition, 

they are reducing grace periods, curtailing leniency 

periods, and imposing higher penalty interest rates. 

According to RAM Research, banks’ income from 

credit card fees has grown 79 percent over the past two 

years, while card interest income rose only 10 percent.11 

Shrinking margins have also prompted consolidation in 

the credit card industry. Today, the top five issuers control about 60 percent of the total managed assets in the 

credit card sector, up from just 35 percent in 1990.12 

Amid this changing competitive 

landscape, credit quality has 

improved. Credit card charge-off 

levels at insured commercial banks 

hit an all-time high of 5.5 percent 

in the third quarter of 1997 but 

have declined steadily to a level of 

4.1 percent in the second quarter of 

1999. This decline has been attributed to tighter underwriting standards, more aggressive collection efforts, 

and extra household cash flow generated through mortgage refinancings. 

11 Miriam Kreinan Souccar, “Consumer Groups Up in Arms Over
 

Card Penalties,” American Banker, February 26, 1999.
 12 James C. Allen, “Tarnished Platinum,” SNL Securities Bank Mergers & Acquisitions, June 1999.
 

Atlanta Regional Outlook 9 Fourth Quarter 1999 
In Focus This Quarter
 

Subprime Lenders Have Riskier 

Characteristics than the Industry 

Subprime lending to consumers has grown dramatically in recent years. Subprime mortgage originations 

have grown from 5 percent of the total mortgage market in 1994 to 15 percent in 1997.13 The percentage of 

originations fell somewhat in 1998 to 10 percent—not 

because the volume of subprime mortgage originations 

fell but because the volume of prime mortgage originations was at a record high. In fact, in terms of dollars, 

subprime originations grew by 20 percent from 1997 to 

1998, to $150 billion. That figure is up significantly 

from the $35 billion in subprime originations in 1994. 

Estimates of the size of the subprime automobile loan 

market vary somewhere between $50 billion and $75 

billion, but one source estimates that subprime automobile originations jumped 

from about 8 percent of all 

automobile loan originations 

in 1990 to over 18 percent in 

1998.14 Analysts also have indicated that the subprime 

credit card market is the fastest-growing segment of 

credit card lending today. According to RAM 

Research, subprime receivables are growing 45 percent 

annually, compared with 16 percent or less for other 

segments of credit card lending.15 

Intense competitive pressure has contributed to the 

expansion of bank and thrift participation in subprime 

consumer lending. These loan programs offer higher 

margins than prime consumer lending products and 

have become an attractive alternative for banks and 

thrifts that have experienced shrinking margins in credit cards, mortgage lending, and other consumer product 

types. Moreover, the shakeout in the subprime specialty 

finance industry has provided new opportunities for 

insured depository institutions seeking to enter the subprime lending market. In 1999, several insured depository institutions acquired, or announced plans to 

acquire, a subprime specialty finance company. Bank 

and thrift involvement in subprime lending is expected 

to increase. In fact, some industry analysts predict that 

insured depository institutions with subprime affiliates 

13 The Mortgage Market Statistical Annual for 1999, Inside Mortgage Finance Publications, 1999. 

14 Ron Feldman, An Introduction to Subprime Auto Lending for 

Examiners, Federal Reserve Bank of Minneapolis, April 1998, and 

data supplied by CNW Marketing and Research. 

15 Lisa Fickenscher, “Credit Card Issuers Panning for Gold Among 

Tarnished Credit Histories,” American Banker, October 22, 1998. 

will overtake finance companies as leaders in the subprime industry. 

Subprime lending poses entirely new challenges in risk 

management for insured institutions. Not only are 

expected credit losses higher than for prime consumer 

lending, but a number of factors suggest that losses are 

also less predictable: 

•	 Subprime borrowers are more likely to default than 

prime borrowers and may be more vulnerable to 

economic shocks, such as a recession. Borrowers’ 

previous credit problems suggest that they have 

limited financial resources to withstand economic 

difficulties. 

•	 Credit-scoring and pricing models used to underwrite subprime loans are untested in a recession. 

Analysts have noted that credit-scoring models 

are less effective in predicting the likelihood of 

default for subprime borrowers than they are for 

prime borrowers. 

•	 Operational risks are greater in subprime lending. 

Because defaults occur sooner and more often than 

in prime lending, subprime portfolios require a 

greater investment in servicing and collections 

resources. Subprime lenders run a greater risk that 

these resources could become severely strained if the 

level of defaults is not correctly anticipated. 

•	 Liquidity risks are greater in subprime lending. 

Some large-volume subprime lenders heavily depend 

on the ability to securitize and sell loans to the secondary market. But investor demand for paper 

backed by subprime loans may be volatile, as was 

demonstrated during the financial market turmoil of 

late 1998. A number of nonbank subprime lenders 

experienced a liquidity crunch as a result of that market turmoil, and several opted for—or were forced 

into—bankruptcy.16 

•	 Reputation, legal, and compliance risks also are 

important for subprime lenders. Subprime lenders 

generally run a greater risk of violating, or being 

accused of violating, consumer protection laws or 

regulations. The public perception of subprime 

16 Dominic DiNapoli and Ron Greenspan, “The Next Industry Crisis 

Could Be Even Bigger,” American Banker, June 15, 1999. 

Atlanta Regional Outlook 10	 Fourth Quarter 1999 
In Focus This Quarter
 

lenders could be tarnished if a recession were to 

result in substantially higher default rates. 

The growing involvement by insured depository institutions in subprime lending has raised significant concerns for bank and thrift supervisors. To address those 

concerns, FDIC Chairman Donna Tanoue recently 

announced that the FDIC will propose to the other federal financial institution regulators that insured depository institutions with concentrations in subprime 

lending be held to higher minimum capital requirements than the current rules dictate.17 The FDIC proposal includes a common supervisory definition of 

subprime lending and ties capital adequacy to the types 

and levels of risks that individual subprime lenders have 

in their portfolios. This proposal will be shared with 

other federal regulators to refine a final approach. 

Commercial and Industrial Lending 

Commercial and Industrial Loan 

Losses Have Been on the Rise 

Insured institutions continue to accommodate the credit needs of business borrowers. Domestic C&I loans 

grew almost 12.5 percent during the year ending in June 

1999 and accounted for 40 percent of all net new loans 

booked during that period. 

Although commercial loan losses are low, there are 

signs that credit quality in C&I portfolios is deteriorating. Net domestic C&I charge-offs during the first half 

of 1999 more than doubled from 1998 levels, while 

noncurrent domestic C&I loans rose by 26 percent. 

Examiners also have reported increasing problems in 

commercial portfolios. The Office of the Comptroller 

of the Currency recently reported that the dollar volume of classified and special-mention Shared National 

Credits rose 70 percent during a recent annual review.18 

Slower profit growth and rising corporate bond defaults 

also point toward somewhat weaker business credit 

17 FDIC Chairman Donna Tanoue in a speech before America’s Community Bankers, Orlando, Florida, November 2, 1999 (http://www. 

fdic.gov/news/news/speeches/chairman/sp02Nov99.html). 

18 “OCC Says Big Commercial Loans Suffering from Lax Underwriting,” American Banker, October 6, 1999, p. 1. The shared national 

credit program is a cooperative interagency program to review large 

credits held at several institutions. Loans subject to review include 

commitments in excess of $20 million that are shared among three or 

more participating lenders. 

quality. While corporate profits grew by an average of 

15 percent per year between 1993 and 1996, economists 

polled by Blue Chip Economic Indicators project 

growth of 6.7 percent for all of 1999, followed by 

growth of only 3.5 percent in 2000.19 Standard & Poor’s 

reported that 55 rated issuers defaulted on $20.5 billion 

in debt during the first six months of 1999.20 This pace 

of defaults is already nearly double levels experienced 

in the first half of 1998 and does not include more 

recent large defaults such as Iridium and Daewoo 

Group. Approximately 85 percent of the defaults that 

occurred during the first half of 1999 were among 

speculative-grade issuers. According to Moody’s, junk 

bond defaults rose to 5.8 percent of issues outstanding 

during the 12 months ending in September 1999, the 

highest level since 1991. 

Rising Losses May Be Attributable 

to Loose Underwriting 

Analysts attribute the recent deterioration in commercial credit quality to weak underwriting standards in 

the corporate debt markets during 1997 and early 

1998.21 Bank underwriting was reported to be particularly accommodating at that time. The Federal Reserve 

Board reported in its May 1998 Senior Loan Officer 

Opinion Survey on Bank Lending Practices that 

domestic banks were “generally eager to make loans to 

businesses” and that during early 1998 “a large percentage cut their spreads on such loans.” Subsequently, the November 1998 Survey reported a “broad 

tightening of business lending practices” associated 

with the financial market turmoil in progress at that 

time. However, regulators have continued to express 

concern about the assumptions underlying bank lending decisions. A Supervision and Regulation Letter 

sent by the Federal Reserve Board of Governors to its 

examiners in September 1999 noted the recent tightening of standards, but stated that “certain deeper issues 

remain,” which relate mainly to overoptimistic 

assumptions about the future repayment capacity of 

business borrowers.22 

19 Blue Chip Economic Indicators, Aspen Publishing, October 10,
 

1999.
 

20 “Defaults Soar in First Half 1999,” Standard & Poor’s, August 12,
 

1999.
 

21 See, for example, “Under Boom Economy, Strain Over Debt,” The
 

Wall Street Journal, August 18, 1999, Section C, p. 1. 
 22 SR 99-23, September 28, 1999. “Recent Trends in Bank Lending
 

Standards for Commercial Loans” (http://www.federalreserve.gov/
 

boarddocs/SRLETTERS/1999/SR9923.HTM).
 

Atlanta Regional Outlook 11 Fourth Quarter 1999 
In Focus This Quarter
 

Leveraged Lending Has Been the Predominant 

Type of Syndicated Lending 

Banks appear to be taking on more risk in the syndicated loan market by expanding their lending to heavily indebted companies. During the first half of 1999, 

leveraged lending was the fastest-growing segment of 

syndicated commercial lending.23 While overall syndicated loan volume was down slightly compared with 

the first half of 1998, syndicated lending to leveraged 

companies rose $7 billion, or 5 percent, on the strength 

of a record volume of “highly leveraged loans.”24 As 

shown in Chart 7, loans to leveraged companies are 

making up a growing proportion of syndicated loan 

originations. 

Factors driving growth in leveraged lending include a 

high volume of corporate mergers and acquisitions, 

increasing investor demand for higher-yielding loans, 

and a shift in preference for loans over bonds by highyield issuers.25 While bank syndicators pass a large volume of these loans along to nonbank investors, a 

23 Syndicated loans are credits extended to large or medium-sized corporate borrowers that are originated by a group, or syndicate, of 

lenders. One type of syndicated lending is leveraged lending, in 

which the borrower’s debt-to-equity ratio is significantly higher than 

the industry average. Loan Pricing Corporation defines “leveraged 

loans” as those for which pricing exceeds 125 basis points over 

LIBOR. 

24 Loan Pricing Corporation defines “highly leveraged loans” as those 

for which pricing exceeds 225 basis points over LIBOR. 

25 According to Mergerstat, the value of mergers and acquisitions 

(M&A) was almost $400 billion during second-quarter 1999. According to Loan Pricing Corporation, syndicated loans originated in the 

second quarter to finance M&A activity totaled some $69 billion—a 

43 percent increase over issuance in the first quarter. 

CHART 7 

Loans to Leveraged Companies
 

Are Making Up A Greater Proportion of
 

Syndicated Loan Originations
 

Originations of Syndicated Loans to Leveraged Companies
 

As a Percentage of Total Syndicated Loans Dollars in Billions 

32% 

350 

300 

60 

50 

250 40 

200 

30 150 

20 100 

10 50 

0 

’90 ’92 ’94 ’96 ’98 ’99:1H* 

0 

* First half, annualized 

Source: Loan Pricing Corporation 

substantial portion of these credits remains on bank balance sheets. Loan Pricing Corporation has reported 

that as much as 64 percent of the value of “highly leveraged” loans originated in the first half of 1999 was 

retained by banks.26 

Commercial Real Estate 

and Construction Lending 

Construction Loan Volume Continues to Rise 

Loans for real estate construction and development 

(C&D) represent one of the fastest-growing segments of 

bank balance sheets, increasing 24 percent during the 

year ending June 1999. Compared with construction 

activity in the mid-1990s, spending on new commercial 

construction has shifted somewhat away from the industrial and retail markets and toward office and hotel construction. Residential construction growth was also 

strong during the first half of 1999, with single-family 

completions increasing 17 percent from a year ago. In 

the midst of this growth in loan volume, loss rates and 

past-due ratios for construction and development loans 

remain very low by historical standards, as indicated in 

Chart 8. 

Office Vacancy Rates Are Rising 

in Many Top Markets 

In previously published reports, Division of Insurance 

analysts identified nine metropolitan real estate markets 

where rapid development threatened to produce nearterm oversupply conditions.27 These cities were identified based on the pace of current construction activity, 

commercial space demand indicators, and independent 

market analysts’ projections. Six of the metropolitan 

areas identified—Atlanta, Phoenix, Orlando, Portland, 

Dallas, and Nashville—subsequently experienced large 

increases in office vacancy rates during the first half of 

1999. These areas have also experienced reduced 

employment growth and slowing net in-migration. 

Higher vacancy rates are often accompanied by slower 

26 “Junk Loan Market Is Feeling the Pinch of Oversupply and Rising 

Interest Rates,” The Wall Street Journal, September 13, 1999. 27 Steven K. Burton, “Commercial Developments Still Hot in Many 

Major Markets, but Slower Growth May Be Ahead,” Regional 

Outlook, First Quarter 1999 (http://www.fdic.gov/bank/analytical/ 

regional/ro19991q/na/infocus2.html) and “Ranking the Risk of 

Overbuilding in Commercial Real Estate Markets,” Bank Trends, 

FDIC Division of Insurance, October 1998 (http://www.fdic.gov/ 

bank/analytical/bank/bt9807.html). 

Atlanta Regional Outlook 12 Fourth Quarter 1999 
In Focus This Quarter
 

CHART 8 

Construction Loan Volume Continues to Rise, 

but Problem Loans Remain Low 

* First half 

Source: FDIC Bank and Thrift Call Reports (Research Information System) 

Construction and Development Loans 

0 

75 

150 

225 

’84 ’87 ’90 ’93 ’96 ’99:1H* 

0 

2 

4 

6 

8 

10 

12 

14 

Percent Nonaccrual Rate 

(Right Scale) 

Loss Rate 

(Right Scale) 

Volume in billions of dollars 

(Left Scale) 

rental-rate growth, which may lead to lower real estate 

values. For example, Atlanta’s vacancy rate rose 1.5 percentage points to 10.3 percent, while growth in rental 

rates slowed noticeably from the pace of the previous 

three years.28 

Surveys Suggest Tighter Standards 

in Commercial Real Estate Lending 

Evaluations of bank loan underwriting suggest a recent 

tightening of lending standards for commercial real 

estate loans. The August 1999 Federal Reserve Board 

Senior Loan Officer Opinion Survey reported a net 

tightening of commercial real estate underwriting standards, continuing a trend begun in late 1998. The 

FDIC’s March 1999 Report on Underwriting Practices 

also found fewer instances of risky lending practices 

with respect to commercial real estate and construction 

lending than in prior reports. The FDIC’s September 

Report showed no significant changes in lending 

standards. 

The FDIC also recently published the findings of a targeted evaluation of the underwriting practices of banks 

operating in three of the fastest-growing metropolitan 

areas in the country—Atlanta, Dallas, and Las Vegas.29 

Results indicated that competition was generally driving 

pricing margins down to very low levels, particularly 

28 Vacancy rates and rental growth rates were obtained from REIS 

Reports. 

29 Steven K. Burton, “Recent Trends in Construction Lending Practices,” Bank Trends, FDIC Division of Insurance, July 1999 (http:// 

www.fdic.gov/bank/analytical/bank/bt9901.pdf). 

compared with the 1980s. In some instances, lenders 

have responded to competitive pressures by making 

structural concessions on loan-to-value, cash equity, 

and recourse terms, particularly for large borrowers. 

However, underwriting standards generally have not 

been as aggressive as practices observed in the 1980s. 

Agricultural Lending 

Low Commodity Prices Stress 

the Agriculture Industry 

Low prices for wheat, corn, hogs, cotton, and oilseeds 

are creating financial difficulties for farmers in the 

nation’s midsection. Several consecutive years of high 

worldwide production have resulted in large inventories 

of grains and oilseeds, which have depressed prices. 

Prices not only have fallen from mid-1990s levels, but 

are also low by historical standards. The United States 

Department of Agriculture (USDA) forecasts for 2000 

show little likelihood of improvement in prices.30 

The financial outlook for significant portions of the 

farm sector has deteriorated. The USDA projects that 

farm income from operations will decline by around 15 

percent in 1999 from year-ago levels. However, total net 

farm income is projected to decline less 

than 1 percent. A projected $16.6 billion in government payments is expected to make up most of the difference 

between operating income and total net 

income.31 Legislation passed in October 

1998 provides for $8.7 billion in emergency aid to affected farmers. 

Farm Banks Continue 

to Perform Well Overall 

Despite the difficulties created by low farm prices, the 

overall financial condition of the 2,250 FDIC-insured 

farm banks continues to be strong.32 Farm banks reported an annualized ROA of 1.21 percent and an equity 

capital-to-assets ratio of 10.5 percent at mid-year 

30 “World Agricultural Supply and Demand Estimates,” USDA, October 10, 1999. 

31 “Potential Impacts of an Agricultural Aid Package,” Agricultural 

Outlook, USDA, September 1999. 32 Farm banks are defined by the FDIC as those with over 25 percent 

of their loans in agricultural production or secured by agricultural real 

estate. 

Atlanta Regional Outlook 13 Fourth Quarter 1999 
In Focus This Quarter
 

1999.33 Loan loss reserves, which stood at 1.58 percent 

of total loans in June, remain high compared to historical levels. Loan performance at farm banks also appears 

to be strong at this time. Total past-due loans made up 

just 2.66 percent of total loans at farm banks in June, a 

level that is only 9 basis points higher than a year ago. 

Moreover, this increase in past-due loans is attributable 

entirely to nonagricultural loans; the level of past-due 

farm loans has not risen over the past 12 months. At the 

same time, higher-than-average nonperforming loan 

levels have been reported by farm banks in the upper 

Midwest and the South. 

There are reasons to believe, however, that it will take 

time for financial distress among farm producers to 

significantly affect loan performance at farm banks. 

One such reason is the increasing use of carryover debt 

to restructure and extend operating loans that cannot 

be fully retired by borrowers during the current crop 

year. The most recent Survey of Agricultural Credit 

Conditions conducted by the Federal Reserve Bank of 

Kansas City indicated an increase in the use of agricultural carryover debt by Tenth District banks.34 

An increase in carryover debt was also noted in 

the FDIC’s March 1999 Report on Underwriting 

Practices, which indicated that almost one-third 

of FDIC-supervised farm banks experienced at least 

a “moderate” increase in agricultural carryover debt 

during the preceding six-month period.35 Although the 

use of carryover debt is not an uncommon practice in 

agricultural lending, it can be a leading indicator of 

declining loan performance. Chart 9 shows that 

increases in carryover debt by Tenth District farm 

banks in 1995 preceded increased loan losses during 

1996. 

33 Twenty-three percent of insured farm banks have adopted a Subchapter S designation since 1997, when banks were first allowed to 

take advantage of the favorable tax treatment available under this section of the Internal Revenue Service code. Because of the effects of 

this tax treatment on reported profitability, farm bank ROA levels 

may not be comparable with ratios from prior periods. 

34 Survey of Agricultural Credit Conditions, Federal Reserve Bank of 

Kansas City, June 29, 1999 (http://www.kc.frb.org/PUBLICAT/ 

RED/PDF/2q99AgCrPress.pdf). The Tenth District comprises significant agricultural areas in Colorado, Kansas, Nebraska, Oklahoma, 

Wyoming, northern New Mexico, and western Missouri. 

35 John M. Anderlik and Jeffrey W. Walser, “Agricultural Sector 

Under Stress: The 1980s and Today,” Kansas City Regional Outlook, 

Third Quarter 1999 (http://www.fdic.gov/bank/analytical/regional/ 

ro19993q/kc/k3q1999.pdf). 

CHART 9 

Rising Levels of Carryover Debt Suggest Future 

Increases in Loan Losses at Farm Banks 

Reports (Research Information System) 

Source: Federal Reserve Bank of Kansas City; FDIC Bank and Thrift Call 

–30% 

–10% 

10% 

30% 

50% 

1Q89 2Q90 3Q91 4Q92 1Q94 2Q95 3Q96 4Q97 1Q99 

–1.0% 

–0.5% 

0.0% 

0.5% 

1.0% 

1.5% 

Net Percentage Reporting 

Higher Agricultural Loan 

Renewals and Extensions 

Moving 4-quarter 

Charge-Off Rate

 (percent) 

Agricultural Production Loans 

(right scale) 

Funding and Interest Rate Risk 

Lagging Deposit Growth Has Led to Greater 

Reliance on Market-Based Funding 

For most of the 1990s, banking industry asset growth 

has outstripped growth in deposits, creating greater 

reliance on more expensive and less stable marketbased sources of funding. The trend in the loan-todeposit ratio for commercial banks, which reached a 

record high of almost 90 percent at June 30, 1999, 

reflects this shift. Deposit growth has not kept pace with 

asset growth, in part because of a low rate of personal 

savings by households and competition for depositor 

funds from higher-yielding investment alternatives and 

nonbanks. Lagging deposit growth is particularly 

important for community banks because these institutions traditionally rely more heavily on deposits to fund 

assets than do larger banks.36 Greater dependence on 

market-based funding can alter the liquidity and interest 

rate risk positions of institutions and may require 

heightened attention to, and expertise regarding, assetliability policies and procedures. 

Growth in Securitization Affects Underwriting 

and the Structure of Bank Balance Sheets 

Banks, and nonbanks in particular, continue to employ 

the securitization market to fund lending activities. 

36 Allen Puwalski and Brian Kenner, “Shifting Funding Trends Pose 

Challenges for Community Banks,” Regional Outlook, Third Quarter 

1999 (http://www.fdic.gov/bank/analytical/regional/ro19993q/na/ 

t3q1999.pdf). 

Atlanta Regional Outlook 14 Fourth Quarter 1999 
In Focus This Quarter
 

Issuance of asset-backed securities and commercial 

mortgage-backed securities (CMBS) totaled $223 billion through the first six months of 1999, and is on pace 

for another record year. Including participation through 

credit card companies and CMBS conduit programs, 

bank-related issuance amounted to about 25 percent of 

total issuance in 1998, a decline from 1997 levels. 

Although insured institutions are not dominant players, 

growth in the securitization market can influence loan 

underwriting practices and the structure of bank balance 

sheets. 

The securitization market competes to originate loans 

that could be made by insured institutions. This competition may tend to erode underwriting standards if securitizers ease terms to maintain sufficient volume to 

support lending pipelines. Recent trends indicate that 

this competition has intensified. For example, market 

observers note that the subordination levels in the 

CMBS market have been declining, which allows securitizers to increase lending volume for a given level of 

capital.37 

When banks do securitize, it is not always clear how 

much risk is transferred. The issue of credit risk transference by commonly used securitization structures 

continues to receive attention from the markets and rating agencies. For example, many analysts agree that 

revolving structures, such as those used to securitize 

credit cards, eliminate only the most catastrophic credit 

risks for issuers.38 In addition, assets created by gain-onsale accounting rules when loans are securitized can be 

37 Securitizations are often structured in tranches such that a subordinated security bears the credit risk for a senior piece. The relative 

size of the subordinated piece affects not only funding costs for the 

issuer, but also the amount of effective leverage achievable through 

securitization. 

38 A common feature of a revolving securitization structure is the provision for an “early amortization.” When a triggering event occurs, 

such as a negative three-month average excess spread, all available 

cash flows are used to pay off bondholder principal. This event causes receivables related to the deteriorating accounts to remain on the 

balance sheet of the issuer. Unless the deterioration in account credit 

quality is very rapid and severe, the bondholders will be repaid completely, and the credit risk will be borne by the issuer. 

volatile and can lead to unstable earnings and capital if 

not properly controlled and administered. 

Banks and Thrifts Appear Increasingly 

Vulnerable to Rising Interest Rates 

Potentially volatile liabilities and long-term assets 

have been growing as a percentage of banking assets. 

Consistent with reduced deposit funding by insured 

institutions, more market-based and potentially volatile 

liabilities have been supporting an increasing proportion of banking assets in recent years (see Chart 10).39 

At the same time, the lengthening maturity of insured 

institution mortgage portfolios has increased the percentage of total bank assets with maturities or repricing 

frequencies of greater than five years. This trend in 

mortgage portfolios is primarily responsible for the 

thrift industry’s increasing interest rate sensitivity. 

According to the Office of Thrift Supervision’s Quarterly Review of Interest Rate Risk, interest rate sensitivity for the median thrift rose in the second quarter of 

1999 for the third consecutive quarter. 

39 Volatile liabilities include borrowings, federal funds purchased, 

repurchase agreements, jumbo certificates of deposit, foreign 

deposits, and trading liabilities. 

CHART 10 

Long-Term Assets and Volatile Liabilities
 

Have Been Growing as a Percentage
 

of Total Assets
 

Percentage of 

Total Assets 

35 

30 

25 

20 

15 

10 

Volatile Liabilities 

Long-Term Assets 

2Q92 2Q93 2Q94 2Q95 2Q96 2Q97 2Q98 2Q99 

Note: Long-term assets have a maturity or repricing frequency of greater than
 

five years.
 

Source: FDIC Bank and Thrift Call Reports (Research Information System)
 

Atlanta Regional Outlook 15 Fourth Quarter 1999 
In Focus This Quarter
 

Operational Risks 

Insured banks and thrifts face numerous business- and 

process-oriented operational risks on a daily basis. At 

the same time, recent industry developments and bank 

failures have highlighted the importance of maintaining 

strong operations. The Basle Committee on Banking 

Supervision reported in late 1998 that “awareness of 

operational risk among bank boards and senior management is increasing.”40 

The competitive environment and shareholder expectations have led many insured institutions to search for 

greater efficiency by cutting costs. In some cases, deep 

cuts in overhead expenses may weaken the effectiveness 

of operating and monitoring systems as well as internal 

controls. Anecdotal evidence from banking regulators 

suggests that internal control and recordkeeping weaknesses are on the rise. Moreover, industry consolidation 

and new business activities are creating bigger, more 

complex, and more decentralized operating environments, especially for the largest institutions. These 

issues are important since operational weaknesses may 

leave institutions more vulnerable to adverse economic 

conditions, insider abuse, or fraud. 

Implications 

This article has summarized the generally favorable current condition of the U.S. economy and banking industry. The economy is in the ninth year of a remarkable 

economic expansion that has been conducive to a high 

level of financial performance on the part of the banking industry. There are, nonetheless, areas of vulnerability that could contribute to a less favorable economic 

environment and less robust financial performance for 

insured institutions in the future. 

One issue raised by this report is rising indebtedness on 

the part of households and businesses, which represents 

a growing private deficit. Rising interest rates could 

40 “Operational Risk Management,” Basle Committee on Banking 

Supervision, September 1998 (http://www.bis.org/publ/bcbs42.pdf). 

increase the debt service burden for consumers and 

businesses, making them more vulnerable to a slowing 

economy. An increasing private deficit is problematic 

also because the two major sources of financing—foreign capital inflows and domestic credit creation—have 

the potential to create problems for the economy and for 

lenders. Dependence on foreign capital makes U.S. 

inflation and interest rates highly subject to changes in 

the decisions of foreign investors and the value of the 

dollar. The rapid pace of credit creation by the financial 

sector threatens to impair credit quality. The intuition 

that loose underwriting standards can lead to credit 

quality problems is supported by recent signs of rising 

credit losses in a strong economy. 

The second issue that cuts across this report is the effect 

that competition is having on banking strategies and 

exposures to credit, market, and operational risks. There 

has been an increase in lending to less creditworthy borrowers, including subprime consumer borrowers and 

leveraged corporate borrowers. There is also evidence 

that institutions are pursuing asset-liability structures 

with higher levels of interest rate risk to maintain loan 

growth and meet funding needs. Finally, some of the 

innovations banks have used to counter competitive 

pressures may introduce new risks associated with complex accounting valuations, weakening internal controls, and the need for more intensive loan servicing. 

The third issue is the increasing potential for financial 

market instability, which leaves the economy and the 

banking system vulnerable to sudden shocks. Events 

from fall 1998 showed some of the more damaging 

aspects of these crises, as market-based financing went 

from abundance to scarcity virtually overnight. The 

financial imbalances associated with the rapid creation 

of credit and borrowing from abroad not only create the 

need for the economy to slow down eventually, but also 

threaten to make that adjustment process a 

volatile one. Financial market shocks 

could quickly alter the confidence of 

consumers and businesses and their 

access to financing. Such instability 

could end the current expansion and 

expose underlying weaknesses in 

bank risk-management practices. 

Atlanta Regional Outlook 16 Fourth Quarter 1999 
In Focus This Quarter
 

This article was prepared and coordinated by the staff of the Analysis Branch of the Division of Insurance. Contributions and feedback from analysts across the Division were essential to its completion. 

Maureen E. Sweeney, Associate Director 

Paul C. Bishop, Senior Financial Economist 

Richard A. Brown, Chief, Economic and Market Trends Section 

Steven K. Burton, Senior Banking Analyst 

Steven E. Cunningham, Chief, Financial Institutions Section 

Alan Deaton, Economic Analyst 

Diane Ellis, Senior Financial Analyst 

Brian Kenner, Financial Analyst 

Allen Puwalski, Senior Financial Analyst 

Arlinda Sothoron, Senior Financial Analyst 

Jack Taylor, Senior Financial Analyst 

Atlanta Regional Outlook 17 Fourth Quarter 1999 
Regional Perspectives
 

Regional Perspectives
 

•	 Economic conditions in the Atlanta Region remain strong despite recent slowing in some rural areas with 

declines in the mining, manufacturing, and agricultural sectors. Growth remains very strong in metropolitan areas, where tight labor markets could become a constraining factor. 

•	 The performance of insured institutions reflects the Region’s strong economy. Favorable growth and earnings among metropolitan institutions has resulted in heavy de novo activity in high-growth markets, while 

some rural institutions have seen asset quality weaken because of pressures in the agriculture, textiles and 

apparel, steel, and coal industries. 

•	 Increased noncore funding by banks in the Region may require higher levels of asset-side liquidity to ensure 

that loan demand and deposit withdrawals can be satisfied quickly and with minimal financial impact given 

a less stable funding base. 

Region’s Economic and Banking Conditions 

The Atlanta Region’s economy continues to expand at a 

pace above the national average, although job growth 

has moderated during the first half of 1999. Following 

the prolonged expansion, labor markets generally have 

tightened throughout the Region, particularly in metropolitan areas. In some areas, jobless rates remain near 

25-year lows and below 2 percent. (In some rural areas, 

however, unemployment rates have begun to rise.) 

Factors driving the economic expansion include continued corporate relocation and population in-migration, 

which have fueled growth in demand for local goods 

and services. Inflows of new types of high-tech manufacturing, such as automobile production, have helped 

offset persistent declines among the Region’s traditional 

producers (such as textiles and apparel) and are shifting 

the industrial mix of the Region. Business expansion, 

in-migration, plentiful jobs, and strong income growth, 

combined with historically low interest rates, also have 

fostered strong gains in commercial and residential construction activity. 

Benefiting from the strong economy, commercial and 

savings banks in the Atlanta Region continue to perform 

well. Strong cyclical loan demand, expansion of fee 

income business lines, and low asset-quality-related 

expenses have allowed the Region’s insured institutions 

to maintain healthy returns despite declining net interest 

margins (NIMs). Low interest rates and a lack of pricing power in some competitive urban markets have led 

to further NIM compression at both large and small 

banks over the past four quarters. Larger institutions 

continue to reduce their dependence on the interest 

margin, however, by emphasizing fee income products 

and services. Thus far, fee income production has been 

limited at small banks. Large banks also enjoy scale 

efficiencies on the expense side, as overhead costs generally are lower than at small institutions. In addition to 

a greater reliance on spread income, small bank aggregate returns are being constrained by a growing number 

of de novos that have not yet reached sustainable profitability. De novo activity has been concentrated mostly 

in high-growth metropolitan markets, particularly in 

Florida, Georgia, and North Carolina. 

Asset quality indicators remain strong in the Region, 

with past-due loans measuring less than 2 percent of 

total loans. Commercial and consumer portfolios have 

weakened over the past couple of quarters, however. 

Severely delinquent loans (90 days or more), while still 

under 1 percent for the Region, are at their highest level 

in nine quarters because of increases in commercial and 

consumer delinquencies at some of the Region’s largest 

banks. Meanwhile, the highest overall delinquencies are 

at the smallest banks (assets under $100 million), many 

of which serve rural communities affected by weakness 

in the agriculture, textiles and apparel, coal, and steel 

industries. 

Division between Urban 

and Rural Markets Persists 

Despite eight years of economic expansion, growth in 

the Atlanta Region has not been uniform as urban and 

rural areas have experienced differing levels and types 

of growth. The following discussion revisits this issue, 

first highlighted in the Atlanta Regional Outlook, third 

quarter 1997, which analyzes how divergent growth can 

Atlanta Regional Outlook 18	 Fourth Quarter 1999 
Regional Perspectives
 

lead to different types of risk. Economic gains in the 

Region have been concentrated in urban areas with 

direct access to interstate highways, ports, and major 

airports. These areas, which include Atlanta, Charlotte, Northern Virginia, Orlando, and Raleigh, have 

experienced the lowest levels of unemployment, the 

highest rates of in-migration and corporate expansion 

and relocation, and strong real estate construction 

activity. High rates of growth can have downside risk, 

however. 

Strong Growth Continues in Urban Markets 

One consequence of the strong growth has been rising 

labor shortages, particularly among less skilled workers. Anecdotal evidence suggests that wage growth may 

be rising in some areas, although actual statistical evidence still remains sparse. (Labor costs did rise by 4.5 

percent in the second quarter, the largest increase in five 

years, as productivity slowed.) Total compensation 

(which can include starting and retention bonuses, better medical coverage, tuition reimbursement, and other 

types of employee benefits) may be rising as employers 

try to attract scarce labor. For example, one enterprising 

sporting goods retailer in the Atlanta metropolitan area 

offers employees free ski trips to Colorado to test the 

company’s equipment. Between 1995 and 1998, total 

compensation growth has trended upward. Inability to 

pass on these higher costs in highly competitive markets 

could affect businesses’ profit margins. 

Construction activity has been a primary driver of the 

Region’s above-average economic performance in 

recent years. However, as many of the Region’s rapidly 

growing metropolitan markets have experienced residential and commercial construction booms, a number 

of insured institutions have developed concentrated 

credit exposures to this potentially volatile sector. When 

the previous expansion ended in the late 1980s and real 

estate markets weakened, institutions with excessive 

construction and development (C&D) lending concentrations performed poorly as a group during the downturn that followed. Although capital, reserves, and 

management might be stronger than a decade ago, some 

institutions in rapid-growth markets report exposures 

that are well above the U.S. average and, in some cases, 

even above 1980s levels. The Region’s highest aggregate concentration is in the metropolitan Atlanta area, 

where C&D financing accounts for about 12 percent of 

total assets at banks under $1 billion (nearly three times 

the national average). Other high-growth markets where 

C&D lending exposure is above average and increasing 

include Charlotte and Raleigh, North Carolina; Naples, 

Orlando, and Ft. Walton Beach, Florida; Huntsville, 

Alabama; and Norfolk-Virginia Beach, Virginia. 

Much of the commercial real estate 

development in the Orlando area is 

related to tourism, an industry 

whose expansion is highly correlated with national income growth 

and overseas economic conditions. 

Theme park and hotel investment 

in Orlando has been exceptionally 

heavy in recent years and planned construction activity 

remains high. Some analysts are concerned that Orlando’s tourist industry may become oversaturated, especially in light of recent declines in visitorship from 

outside Florida. 

Because of the importance of construction activity, the 

Atlanta Region’s economy may have a higher interest 

rate exposure. Both short- and long-term interest rates 

have risen over the past few months. The Federal 

Reserve raised its target Federal Funds rate by 25 basis 

points in July and again in August, from 4.75 to 5.25 

percent. Meanwhile, market investors, reacting to signs 

of potential inflation, pushed the 30-year Treasury yield 

up 96 basis points from January through the first week 

of September. While the steeper yield curve may relieve 

some pressure on NIMs for new business, the increase 

may squeeze margins further at banks with large fixedrate loan portfolios funded by short-term or repriceable 

liabilities. Moreover, higher rates could adversely affect 

credit quality by slowing the economy and raising consumer and business debt service requirements. This 

economic effect may be even greater in the Atlanta 

Region than in other parts of the country, as the Southeast economy is largely driven by cyclical industries 

such as real estate C&D and, increasingly, transportation and related production. Eventually, Southeast home 

sales and, consequently, housing construction may be 

affected adversely by rising mortgage rates, which have 

risen 100 basis points to 7.85 percent (30-year; fixed) 

through early September 1999 from the start of the year. 

Rising Rural Unemployment Rates 

While most urban areas have seen strong growth in 

recent years, gains in rural areas have not been as pronounced. In fact, unemployment rates have crept up in 

many rural areas throughout the Atlanta Region over the 

Atlanta Regional Outlook 19 Fourth Quarter 1999 
Regional Perspectives 

past year (see Map 1), challenging the commonly held 

belief that all areas of the Region are experiencing economic gains. Of the Region’s more than 400 rural 

counties, 22 percent saw jobless rates that were up 1 

percentage point or more in the second quarter of 1999 

from one year earlier. Continued textile and apparel job 

losses are partially responsible for this upward trend 

with the loss of thousands of jobs over the past year, 

particularly in Georgia, Alabama, and the Carolinas. 

Further, coal mining layoffs have occurred in West 

Virginia, Virginia, and Alabama, partly because of 

growing dependence on fuel oil, competitive issues, and 

environmental controversy. Pulp and timber industries 

are seeing job cuts in portions of Alabama and in the 

western Florida panhandle. Agriculture commodity 

prices have been declining since 1996, and widespread 

drought has further exacerbated conditions in the 

Atlanta Region. 

Textile and apparel job losses continue to mount 

throughout the Region. Job losses in North Carolina and 

South Carolina have been particularly severe as companies pursue cheap labor offshore. Small rural communities have been especially hard-hit; displaced 

workers have limited opportunities because there is less 

diversification of industries than in larger, more urban 

MAP 1 

Unemployment Rates Have Risen 

in Many Rural Counties 

Second quarter 1999 

nonseasonally adjusted 

unemployment up by 

more than 1 percentage 

point over the past 

year. 

County in a metropolitan 

area 

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

areas. North Carolina has lost over 4,100 textile jobs 

since January as employers reduce production costs 

through enhanced technological innovations and movement to areas where labor costs are cheaper. Apparel 

jobs also are dwindling as employers battle heightened 

competition from countries with weakened economies. 

Likewise, South Carolina has felt the effects of the 

declining textile and apparel industries. About 10 percent of all apparel jobs have been eliminated over the 

past year. 

Job losses in the mining industry have claimed hundreds 

of jobs in Alabama, Virginia, and West Virginia. The 

industry declines result from the increasingly mechanized nature of coal mining, competition from other fuel, 

and rising environmental concerns as well as depletion 

of resources, according to Rex Bowman, Richmond 

Times-Dispatch. Jobless rates in Marion, Lamar, 

Fayette, and Pickens counties in Alabama have risen by 

more than 1 percent over the past year, partially as a 

result of a downturn in coal mining. One Tampa-based 

coal mining operation eliminated about 377 jobs in 

Adger, Alabama, in March, and the company is trying to 

dispose of three additional coal mines in Tuscaloosa 

County, which, if closed, could idle an additional 1,650 

workers. In Virginia, about 190 coal mines are currently 

in operation employing about 6,235 miners, down from 

410 mining operations employing 10,696 miners in 

1988, according to the U.S. Department of Energy. Coal 

mining is one of the largest employers in West Virginia 

and is among its highest-paying industries. According to 

the West Virginia Mining & Reclamation Association, 

every coal mining job supports eight other jobs in the 

state’s economy. Coal mining jobs in the state totaled 

over 29,000 at the beginning of the decade, but that 

number had fallen to about 18,000 by 1998. Unemployment rates in the state rose by over 1 percent in 15 counties within the state, with coal mining losses considered 

among the predominant causes. 

Increasing economic stress in rural areas can adversely 

affect credit quality as struggling businesses and displaced workers encounter difficulties servicing their 

debt. Financial institutions with geographic diversity 

may be in a better position to weather economic slowdowns scattered across a wide area. In contrast, smaller 

financial institutions may be more at risk to local economic volatility. Already, small banks in Alabama and 

West Virginia, both beset by declining manufacturing 

sectors, report the highest loan delinquencies in the 

Atlanta Region. 

Atlanta Regional Outlook 20 Fourth Quarter 1999 
Regional Perspectives
 

Some Agricultural Borrowers Struggle 

with Price Declines 

Agricultural losses continue to mount as farmers face 

the second consecutive year of moderate to severe 

drought conditions and the third consecutive year of 

declining agriculture commodity prices (see Atlanta 

Regional Outlook, third quarter 1999, for a more 

detailed discussion of price pressures). Economic 

effects are likely to be most severe in areas that depend 

heavily on agriculture for income and employment. 

Such effects may be direct or indirect (ripple) and may 

pose heightened exposure to area banks if losses continue for the long term. Also, losses may continue even 

after the industry begins to improve. 

Many farmers, particularly those with outstanding 

loans, began 1999 in a weakened financial state as 

a result of severe drought conditions in 1998, when 

federal disaster relief was required for 157 Georgia 

counties, 29 North Carolina counties, 17 Alabama 

counties, and 13 South Carolina counties. Already, federal disaster relief funds have been approved for farmers who qualify in both North and South Carolina as of 

August 1999, with Virginia, West Virginia, Georgia, and 

Alabama expected to seek government assistance during the coming months. A Georgia state climatologist 

announced that Georgia suffered one of the worst 

August droughts ever. Corn, cotton, and soybean crops 

have been particularly hard-hit by prolonged drought 

conditions, with losses expected to meet or exceed those 

suffered last year as a result of insufficient rainfall. The 

Associated Press reported an estimated $100 million in 

crop damage in West Virginia as of August 1999, with 

other states also reporting substantial losses. Early in 

the season, Alabama received sufficient rain to produce 

normal corn yields; however, late crops such as soybeans are expected to suffer damage in excess of 50 

percent. Depleted hay reserves are a growing concern 

throughout the Region; these reserves normally are used 

during the winter months, but have been partially consumed to sustain livestock. Farmers also are concerned 

that parched pasturelands will result in higher costs of 

alternate feed sources throughout the winter months. 

Some farmers increasingly are selling cattle at extremely reduced prices to limit their losses. 

In North Carolina, heavy rains from Hurricane Dennis 

offered little assistance to drought-stricken areas. While 

the storm brought total annual rainfall levels in the state 

close to average, the ground could not absorb such large 

volumes of water at once, causing temporary flooding 

and clogged drainage systems in some areas. Hurricane 

Floyd created catastrophic conditions for the eastern 

sections of the state, with measured rainfall reaching 24 

inches or more in some areas. Many portions of the 

state that needed substantial rainfall to salvage crops 

and pastureland have now suffered total losses from disastrous flooding. In the western section of the state, 

forecasters estimate that significant rainfall over several months would be needed to end the drought. 

Some farmers have diversified their operations and 

increased their planted acreage. However, larger operations may increase the level of capital at risk. Farm 

lenders in Georgia, for example, 

relate that most farmers were able 

to repay operating loans in 1998, 

but many were unable to repay 

long-term debt, according to the 

University of Georgia College of 

Agricultural and Environmental 

Sciences. Potential risk to insured 

financial institutions will depend 

on the duration and severity of the drought. Credit quality, particularly among leveraged farmers, could deteriorate as pressures on the agriculture sector continue to 

build. Persistent low commodity prices and uncertainty 

about future federal programs may pose additional risks 

to banks in farm areas. In the Atlanta Region, agricultural credit risk is concentrated most heavily in Georgia, 

home to 28 of the Region’s 40 agricultural banks, with 

total assets of $1.6 billion. For this group, agricultural 

loan losses have not reached significant levels thus far, 

although delinquencies are up sharply from a year ago 

at some banks. Also, examiners report an increase in 

carryover debt, as several farmers were not able to repay 

last year’s production loans. This increase might only 

delay inevitable losses if current conditions persist. 

Growth in the Atlanta Region continues to exceed the 

national average as in-migration of both new residents 

and businesses fuels the economy; however, many urban 

and rural areas are experiencing disparate economic performance, which could affect asset quality in different 

ways. Urban areas have seen prolonged growth that, in 

some instances, has caused new types of problems such 

as tight labor markets and, indirectly, rising costs of 

doing business. High levels of in-migration and corporate relocation also have contributed to issues such as 

urban sprawl. In contrast, several rural areas have seen 

rising jobless rates over the past year as key traditional 

industries experience continued and, in some cases, 

accelerated erosion of their workforce. Also, agricultural losses continue to mount as drought conditions and 

low commodity prices persist. In either case, financial 

Atlanta Regional Outlook 21 Fourth Quarter 1999 
Regional Perspectives
 

institutions should be aware that situations such as these 

could compromise borrowers’ ability to service debt. 

Increases in Noncore Funding Heighten 

Asset-Side Liquidity Management 

Atlanta Region banks are becoming increasingly reliant 

on potentially volatile (noncore) funding. This reliance 

may require greater management of asset-side liquidity 

going forward. Core deposit growth has not kept pace 

with loan demand during the current economic expansion. That disparity has contributed to increased dependence on noncore deposits1 and borrowings by the 

Region’s banks. These funding sources traditionally 

have been more rate-sensitive, and therefore more 

volatile, than core deposits.2 In addition, borrowings 

often contain embedded options that give the creditor 

the right to reprice the funds if rates rise or to reduce 

credit if asset quality problems develop. Borrowing 

agreements also may require banks to pledge loans or 

investments as collateral, which makes it more difficult 

to sell these agreements. The increase in noncore funding, discussed in Regional Outlook, third quarter 1999, 

raises the question of whether liquidity needs, particularly on the asset side, have increased at the Region’s 

banks. 

Off-Balance-Sheet Commitments Have Grown 

In addition to loan bookings outpacing deposit growth 

during this economic expansion, the level of unfunded 

loan commitments is significantly higher now than in 

the late 1980s. As Chart 1 shows, unfunded commitments totaled 42 percent of assets at large3 banks at 

year-end 1998, up from only 19 percent ten years earlier. Similarly, community bank unfunded commitments 

increased more than threefold from 1988 to 1997 before 

declining in 1998. Absent strong core deposit growth or 

high borrowing capacity, some banks might need to rely 

1 Noncore deposits include time deposits over $100,000, foreignoffice deposits, and brokered deposits. 

2 Core deposits include demand, NOW, savings, and money market 

deposit accounts, as well as nonbrokered time deposits under 

$100,000. 

3 Large banks include commercial banks headquartered in the Atlanta 

Region with assets over $1 billion, excluding credit card specialty 

banks and banks open less than three years. Community banks 

include commercial banks with assets less than $1 billion, excluding 

credit card banks and banks open less than three years. 

CHART 1 

15 

25 

35 

45 

Source: Bank Call Reports 

Unfunded Loan Commitments Have Grown 

Significantly This Decade

 at Atlanta Region Commercial Banks 

Unfunded Loan Commitments

(% of total assets)

Unfunded Loan Commitments

(% of total assets) 

Year 

Banks with 

assets under 

$1 billion 

(right scale) 

Banks with 

assets over 

$1 billion 

(left scale) 

’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’97 ’98 ’96 

5 

10 

15 

20 

on asset liquidity, such as loan or investment sales, to 

ensure that an increasing volume of loan commitments 

can be funded. 

Asset Allocations Must Balance Liquidity 

and Interest Rate Spread Objectives 

Because nondeposit alternatives such as Federal Home 

Loan Bank borrowings, subordinated debt, and federal 

funds purchases consistently have had higher interest 

costs than core deposits (see “Shifting Funding Trends 

Pose Challenges for Community Banks,” Regional 

Outlook, third quarter 1999), banks with high levels of 

noncore funding, on average, report lower NIMs than 

core-funded banks do. Increased noncore funding could 

lead some banks to sacrifice liquidity, extend asset 

maturities, or assume higher credit risk to bolster yields; 

however, that strategy can conflict with the need to 

maintain a minimum level of short-term, high-quality 

liquid assets. Moreover, a more volatile funding base, 

along with higher levels of off-balance-sheet commitments, may call for even higher levels of asset-side 

liquidity than banks have maintained in the past. 

Allocations among broad asset categories such as cash, 

securities, and loans have not changed substantially at 

Atlanta Region banks, but the mix within the loan and 

investment portfolios has. Over the past ten years, cash 

balances have declined somewhat at both large and 

small banks, with the offset being a slight increase in 

investment holdings at large banks and a slightly larger 

loan portfolio at community banks. As discussed 

below, some liquidity has been traded for higher yields 

in the investment portfolio, while a shift in customer 

demand has led to longer maturities (and possibly less 

Atlanta Regional Outlook 22 Fourth Quarter 1999 
Regional Perspectives
 

liquidity) in the loan portfolio. However, evolving secondary markets may have increased loan liquidity for 

some institutions. 

Atlanta Region banks have noticeably shifted out of 

U.S. Treasury securities into agency- and mortgagebacked securities (MBS) during this decade. This transition has implications for liquidity, interest rate risk, 

and cash flow. Treasury securities, normally considered 

the most liquid of all investments, have declined from 

28 percent to 12 percent of total investments at the 

Region’s community banks over the past ten years. 

Large banks have seen a similar reduction in Treasury 

holdings. As Chart 2 shows, the bulk of the migration 

has been into agencies, including agency-issued MBS. 

Agency securities comprised two-thirds of total investments at large and small banks in the Region as of yearend 1998, up sharply from a decade earlier. MBS 

holdings alone doubled from 13 percent to 26 percent of 

community bank investments from 1988 to 1998, while 

nearly tripling, from 27 percent to 63 percent, at large 

banks. MBS typically have longer maturities than Treasury and agency bonds held by banks, thus introducing 

interest rate sensitivity that could depress values (impair 

liquidity) in a rising rate environment. Rate sensitivities 

also make the timing of MBS cash flows less predictable because of prepayment and extension risks. As 

MBS holdings increased in 1998, the share of total 

investments maturing in over five years also increased 

at banks in the Region. Meanwhile, securities maturing 

in less than one year declined as a share of Atlanta 

Region bank investments in 1998. 

Banks most likely have shifted from Treasuries to agencies and MBS in search of higher yields. The spread 

between an option-free ten-year Federal Home Loan 

CHART 2 

Community Bank Investment Portfolios
 

Have Shifted from Treasury to Agency
 

Holdings over the Past Ten Years
 

1988 1998 

Other Other U.S. Treasury 

U.S. Treasury 

Municipal 

40%

25% 28%

7%

40% 

Municipal 

66%

12%

65%

17%

5% 

U.S. Agency U.S. Agency 

(including agency-issued (including agency-issued 

mortgage-backed securities) mortgage-backed securities) 

Bank bond and a ten-year Treasury has averaged about 

56 basis points over the past 18 months, while the 

spread between a generic 7.0 percent coupon agency 

MBS and the ten-year Treasury has averaged about 155 

basis points. And although not quite as liquid as Treasuries, agencies and MBS have a modest liquidity tradeoff. If average daily trading volume4 as a percentage of 

average securities outstanding is used as an indicator 

of market liquidity, approximately 6.7 percent of the 

Treasury market turned over daily in 1998, versus about 

4.1 percent for agency bonds and 3.7 percent for agency 

MBS. In addition, the sheer size of these markets— 

Treasury ($3.2 trillion), agency ($1.4 trillion), and 

agency MBS ($2.2 trillion)—provides some indication 

that all are liquid instruments. That liquidity is limited 

somewhat by pledgings, however. More than one-third 

of community bank investments and more than one-half 

of large bank investments were pledged as collateral 

against bank liabilities as of year-end 1998. 

The composition of the typical loan portfolio at an 

Atlanta Region bank might appear less liquid now than 

a decade ago, as residential mortgages have increased 

relative to consumer and commercial and industrial 

loans (see Chart 3). Consumer loans, which typically 

have shorter maturities, and commercial loans, which 

generally “self-liquidate” over a company’s production 

cycle, might be viewed as more liquid in terms of a 

payback period than mortgages, which can have stated 

maturities of 15 to 30 years.5 As pointed out in the 

4 Average daily trading volume by Primary Dealers with brokers and 

Primary Dealers with customers. 

5 Declining mortgage interest rates in recent years have fueled record 

refinance activity that has substantially shortened the average life of 

a residential mortgage; however, rates have been trending higher 

throughout most of 1999, and prepayments have slowed as a result. 

CHART 3 

Residential Mortgages Have Increased as a Share 

of Total Loans at Banks in the Atlanta Region 

over the Past Ten Years 

Commercial Banks Commercial Banks 

Under $1 Billion Over $1 Billion 

1988 1998 1988 1998 

24% 30% 

19% 

17% 

24% 15% 

28% 32%

Credit Card
 

Commercial


 Real Estate
 

Commercial
 

& Industrial
 

Consumer
 

Residential
 

Mortgage
 17% 

24% 

26% 

24% 

18% 

28% 

12% 

30% 

Note: Banks with assets over $1 billion have shown a similar trend. 

Source: Bank Call Reports Source: Bank Call Reports 

Atlanta Regional Outlook 23 Fourth Quarter 1999 
Regional Perspectives
 

Federal Reserve Bank of New York’s August 1999 

“Current Issues in Economics and Finance: 

Are Banks Still Important for Financing Large Businesses?,” commercial borrowers increasingly are turning to the capital markets (issuing bonds and 

commercial paper) rather than insured institutions to 

meet funding needs. That trend, along with the strong 

housing demand created by a good economy and low 

interest rates, has contributed to the increase in residential mortgage lending shown in Chart 3.6 

The increase in longer term lending may not necessarily 

reduce loan portfolio liquidity. Investor appetite for 

asset-backed securities (ABS7) and MBS8 has created a 

highly liquid market for loans to be securitized9 and sold, 

provided they are underwritten to secondary market 

standards. As shown in Chart 4, total national ABS and 

MBS issuance has risen sharply over the past five years. 

Moreover, securitization has created a market for nearly 

6 The acquisition of thrifts by commercial banks also has contributed 

to higher levels of mortgage lending being reported by commercial 

banks compared with the 1980s. 

7 Asset-backed securities include securitized home equity, auto, credit card, student, and manufactured housing loans. 

8 Data include only mortgage-backed securities issued by the Government National Mortgage Association, Federal National Mortgage 

Association, and Federal Home Loan Mortgage Company. 

9 Securitization refers to the process of pooling loans together into 

bond-like structures that are then sold to investors in the public securities market. 

CHART 4 

Annual Loan Securitizations Have Increased
 

Steadily over the Past Few Years, Reaching a
 

Record $925 Billion in 1998
 

1,000 Total Asset-Backed 

1994 1995 1996 1997 1998 

Annual Issuance ($ Billions) 

Securities Issuance 

Total Agency Mortgage-Backed 

Securities Issuance 

0 

100 

200 

300 

400 

500 

600 

700 

800 

900 

Source: The Bond Market Association 

all types of bank loans, including mortgage, auto, equipment, credit card, and home equity products, to be sold. 

Given the growth of the secondary market in this decade 

and the fact that an increasing number of banks reportedly are involved either in securitization or in selling 

loans to larger issuers, bank loan portfolios arguably 

may be more liquid now than in the 1980s regardless of 

an extension in maturities. Assessing loan liquidity is 

difficult, however, as marketability is driven largely by 

individual bank underwriting standards, production volume, and market access. It is also difficult to discern 

loan sales and securitization activity from Call Reports, 

although anecdotal evidence suggests that some of the 

Atlanta Region’s large banks are actively involved. Community bank participation reportedly is more limited. 

The ability to sell or securitize loans can be a viable 

asset-side funding tool for some institutions; however, 

banks that actively sell loans must be aware of interest 

rate and market risks that can limit their liquidity. Rising interest rates, for example, can depress the value of 

fixed-rate loans, thus reducing the lender’s ability to 

sell them without suffering a principal loss.10 Securitization strategies also are vulnerable to widening credit 

spreads or risk premiums. For example, in fall 1998, 

investor concerns about the Asian and Russian financial crises led to a sudden and dramatic widening of 

spreads that severely reduced secondary-market liquidity. The Bond Market Association reported that ABS 

issuance in the third quarter of 1998 fell nearly $10 billion, or 16.4 percent, from the second-quarter level “as 

investors flocked to the U.S. Treasury market in search 

of quality and liquidity.” That brief liquidity crunch 

contributed to the financial deterioration of several 

nonbank finance companies, including Criimi Mae, 

Southern Pacific Funding Corp., and United Companies Financial Corp., in the second half of 1998. Companies that combined active loan sales with high 

borrowings were hit particularly hard, as the inability to 

sell loans corresponded with a reduction in borrowing 

capacity, thus straining liquidity on both sides of the 

balance sheet. Insured institutions should be less affected by similar circumstances because the quality of their 

10 Secondary market demand for asset-backed securities can strengthen as rates rise, increasing loan liquidity as investors anticipate higher returns as refinance activity slows. 

Atlanta Regional Outlook 24 Fourth Quarter 1999 
Regional Perspectives
 

loans is much stronger, as is their ability to portfolio 

loans if demand weakens. Nonetheless, last year’s market turmoil may have highlighted the risks of overreliance on loan sales and noncore funding as primary 

sources of liquidity. 

Liquidity Management Will Become More 

Complex as Asset and Liability Structures 

Evolve 

Changing balance sheet structures continue to introduce 

new and complex interest rate and market sensitivities 

into the difficult task of asset/liability management. 

Sources of liquidity have expanded on both sides of the 

balance sheet, but potential liquidity pressures also may 

have increased on both sides as funding has become less 

permanent and off-balance sheet commitments are at or 

near ten-year highs. Moreover, strategies that rely on 

nontraditional funding sources such as borrowings and 

loan sales have developed largely in the 1990s and are 

not “recession tested.” As always, the challenge for bank 

managers going forward is to maintain an asset allocation that provides sufficient liquidity for a given funding strategy, while also earning an acceptable return. 

Atlanta Region Staff 

Short-term liquidity issues... 

Bankers continue to plan for the liquidity needs that 

could arise from the approaching year 2000 date 

change. On the liability side, some industry 

observers expect a net deposit outflow as consumers build “emergency” cash positions near yearend. Others contend that deposits will flow into 

U.S. banks in a global “flight to quality.” On the 

asset side, loan funding requirements could 

increase if businesses and consumers draw down 

credit lines to bolster their liquidity positions. 

To ensure liquidity in the banking system, the Federal Reserve Board has announced a number of initiatives, including making additional currency 

available and accepting a wider range of securities 

as collateral for bank borrowings. Further, federal 

regulatory agencies report that more than 99 percent of the nation’s insured institutions have made 

satisfactory progress toward Y2K compliance. 

Reflecting confidence in banks’ preparedness, 

William T. Clifford, president and CEO of Gartner 

Group, Inc., a Connecticut-based consulting firm, 

recently stated that “America’s banking and securities industries have played a leading role in Y2K 

preparedness. There is no reason for consumers to 

withdraw large sums of money from banking, 

retirement, and investment accounts.” 

Atlanta Regional Outlook 25 Fourth Quarter 1999 
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