Outlook
 

WINTER 2006 

Region by Region: 


Looking Ahead at Banking Conditions in 2007
 

The U.S. economy is now in its sixth year of expansion. 

Pronounced weakness in the housing sector is being largely 

offset by continued strength in the corporate sector, commercial 

construction activity, and exports. Meanwhile, FDIC-insured 

institutions continue to ride a string of six consecutive years of 

record earnings. Bank capital levels remain at historic highs, 

while loan performance has slipped only slightly from record 

levels. Only one FDIC-insured financial institution has failed 

over the last two and a half years. 

Still, some negative trends have emerged for banks. They 

include a narrowing of net interest margins, particularly among 

larger institutions; increasing concentrations of traditionally 

riskier commercial real estate loans; and emerging signs of credit 

distress in subprime mortgage portfolios. Ultimately, it is local 

economic conditions that are the most important determinants 

of credit quality and earnings strength at the majority of banks 

and thrifts. In this issue of the FDIC Outlook, our regional analysts identify trends that are expected to affect banking in their 

areas during the remainder of 2007. 

VI 

MA

HI

AK

WY

WA

OR

NV

CA

San Francisco

MO

IA

MN

ND

SD

NE

KS

Kansas City

TX

CO

Southwest

TN

LA

MS

AR

Mid-South

FL

WV

Atlanta

IL IN OH

Chicago

MidAtlantic

DC 

PA

NY

NJ

DE 

MD

New

England

ME

CT RI

NH

MT

NM OK

GA

AZ

UT

ID

PR

VT

KY

WI

MI

AL

SC

NC

VA

Local Economic Conditions Are Key Drivers of Bank 

Performance Across FDIC Regions

Atlanta Region: The residential real estate sector has contributed greatly to the recent economic expansion in the Region, 

particularly in metropolitan areas. However, continued weakening in the housing sector could moderate demand for real estate 

construction loans and slow revenue growth from lending activities. See page 3. 

Chicago Region: The Region’s automobile manufacturing industry continues to face an uphill climb, pressuring employment 

growth, housing markets, and the overall performance of FDIC-insured institutions in the Region. Analysts consider the potential 

for strength in other sectors, most notably the services sector, to mitigate the ongoing problems in manufacturing. See page 8. 

Dallas Region: Unlike other areas of the country, the energy and housing sectors have been key drivers of recent economic growth 

in the Southwest (See page 12). Although the overall pace of economic growth across the Mid-South has been favorable, much of 

this growth has occurred in urban areas. Key differences in economic activity exist between rural and urban counties and have 

implications for the local banking industry. See page 16. 

Kansas City Region: The unique rural and agricultural nature of this Region heightens its vulnerability to ongoing rural depopulation trends, dependence on agricultural subsidies, and continuing drought. See page 19. 

New York Region: Weakness in the housing sector is of particular importance due to the relatively large share of residential mortgage lenders in the Mid-Atlantic (See page 23) and New England (See page 27) areas. Analysts in these areas assess the potential for 

strength in other economic sectors to mitigate the negative effects of a housing sector downturn. 

San Francisco Region: The construction sector has driven much of the Region’s recent economic expansion and has contributed 

to high and increasing concentrations of commercial real estate and construction loans. Should the housing sector continue to 

weaken, the effects of a slowing in the construction industry could ripple through local economies. See page 32. 

FEDERAL DEPOSIT INSURANCE CORPORATION 
FDIC Outlook is published quarterly by the Division of Insurance and Research of the Federal Deposit 

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

institutions and financial institution regulators. 

FDIC Outlook provides an overview of economic and banking risks and discusses how these risks relate to 

insured institutions nationally and in each FDIC region. 

Single-copy subscriptions of FDIC Outlook can be obtained by sending the subscription form found on the 

back cover to the FDIC Public Information Center. 

FDIC Outlook is available online by visiting the FDIC’s Web site at www.fdic.gov. For more information or to 

provide comments or suggestions about FDIC Outlook, please call Richard A. Brown at 202-898-3927 or 

send an e-mail to rbrown@fdic.gov. 

The views expressed in FDIC 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 Sheila C. Bair 

Director, Division of Insurance 

and Research 

Arthur J. Murton 

Executive Editor Maureen E. Sweeney 

Managing Editors Kim E. Lowry 

Kathy Zeidler 

Editors Richard A. Brown 

Philip Shively 

Christopher J. Newbury 

Ronald L. Spieker 

Publications Managers Lynne Montgomery 

Elena Johnson 

Contact information for the FDIC’s six geographic regions: 

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

Marlon G. Cook, Acting Regional Manager, 678-916-2171 

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

Richard M. Gilloffo, Regional Manager, 312-382-7543 

Dallas Region 

Mid-South (AR, LA, MS, TN): Gary Beasley, Regional Manager, 901-821-5234 

Southwest (CO, NM, OK, TX): Alan Bush, Regional Manager, 972-761-2072 

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

John Anderlik, Regional Manager, 816-234-8198 

New York Region 

Mid-Atlantic (DC, DE, MD, NJ, NY, PA, PR, VI): Kathy Kalser, Regional Manager, 917-320-2650 

New England (CT, MA, ME, NH, RI, VT): Paul Driscoll, Regional Manager, 781-794-5502 

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

Shayna Olesiuk, Regional Manager, 415-808-7962 

FDIC OUTLOOK 2 WINTER 2006 
Residential Housing Sector 

Key to Atlanta Region Future 

Economic performance in the Atlanta Region is driven 

primarily by manufacturing, tourism, and real estate 

(see Table 1). The structure of the manufacturing sector 

continues to change. Employment in older industries, 

such as textiles, apparel, and furniture manufacturing, 

has continued to erode because of increased use of 

automation and competition from overseas. Between 

2000 and 2005, these industries shed more than 

200,000 jobs across the Region. In contrast, employment in other types of manufacturing has grown 

substantially in recent years. Chief among them is autorelated manufacturing. Although older production 

facilities continue to shut down, the Region’s favorable 

business climate has attracted foreign manufacturers, 

particularly to areas such as Alabama and, most 

recently, La Grange, Georgia. The Region has benefited from growth in other types of manufacturing, such 

as food processing (particularly poultry). As the structural shift in the manufacturing sector continues into 

2007, the Region’s economy is poised to benefit from 

these newer industries. 

In addition, tourism––benefiting from an expanding 

selection of entertainment attractions, long coastline, 

and favorable climate––is a critical component of local 

economies in several areas of the Atlanta Region. 

Currently, this sector of the economy is performing 

well, as hotel occupancy rates in major markets now 

rival or surpass those before the 2001 recession. The 

run-up in transportation costs during the first half of 

2006 appeared to exert only a limited impact on 

tourism. 

Table 1 

Key Sectors of the Atlanta Region Economy 

Will Shape Economic Performance in 2007 

Share of Total 

Sector Employment 

Manufacturing 9.9% 

Tourism-Related 11.2% 

Homebuilding and 

Residential 

Real Estate-Related 9.9% 

Source: Quarterly Census of Employment and Wages (Bureau of Labor Statistics), 

2005 data. 

The residential real estate 

sector also has been a key 

contributor to the Atlanta 

Region’s recent expansion and 

is perhaps the most important 

component of many metropolitan economies. Of the 43 

metropolitan areas nationwide, where at least 10 

percent of total employment is in housing-related 

sectors, 21 are in the Atlanta Region. In addition, the 

Region has outpaced the nation in construction 

employment growth and housing starts in recent years. 

Between 2000 and 2005, for example, construction 

employment in the Region increased at an average 

annual rate of 2.7 percent, compared with 1.4 percent 

nationally. Similarly, regional starts in 2005 were 58 

percent higher than in 2000, compared with a 40 

percent nationwide increase. However, many local 

housing markets are slowing, and this could jeopardize 

the Region’s economic performance into 2007. This 

article assesses the implications of a continued slowdown in the housing sector on the regional economy 

and FDIC-insured institutions. 

FL

WV

Atlanta AL GA

SC

NC

VA

Weakness in the Residential Real Estate Sector 

Weighs on the Region’s Economic Outlook 

Weakness is emerging among several key residential 

real estate supply and demand indicators in Atlanta 

Region housing markets. Construction activity is slowing as the pace of housing starts regionally and nationally fell more than 15 percent between January and 

September 2006, according to estimates from Moody’s 

Economy.com (www.economy.com/default.asp). 

Planned construction activity, as measured by permit 

issuance, suggests continued declines in housing starts. 

During the first nine months of 2006, permit issuance 

dropped in several states, including Florida, Virginia, 

West Virginia, Georgia, and North Carolina (see 

Chart 1). 

Year-ago growth in construction sector employment 

in the Atlanta Region, at 5.3 percent, was double 

the national average in third quarter 2006. However, 

continued declines in homebuilding could constrain 

growth in this critical sector with potentially broader 

implications for the regional economy as demand for 

FDIC OUTLOOK 3 WINTER 2006 
Region by Region: Banking Conditions in 2007 

Chart 1 

Permit Issuance in Several States Has Fallen

Source: U.S. Census Bureau.

September 2006 Year-to-Date Single-Family Permit Issuance

(Year-Ago Percent Change)

Florida

Virginia

U.S.

West Virginia

Georgia

North Carolina

South Carolina

Alabama

–30% –20% –10% 0% 10%

other real estate–related employment—such as realtors, 

building material suppliers, and specialty contractors— 

may moderate. Any slowing in residential building 

activity will be difficult to replace because this sector 

represents almost two-thirds of all construction activity 

in the Region, compared with 55 percent nationally. 

Some of the decline in demand for construction workers could be offset, in part, by growth occurring in 

nonresidential construction activity for which the value 

of put-in-place construction in second quarter 2006 was 

up more than 10 percent from one year earlier. 

The increase in residential building during the past 

several years has driven demand for construction and 

development (C&D) loans at FDIC-insured institutions 

based in the Atlanta Region. Among community institutions, in particular, these loans tend to be for the 

building of residential units.1 This component of the 

commercial real estate (CRE) loan portfolio has been 

the most rapidly growing loan category reported by the 

Region’s community banks and thrifts, with average 

annual accretion of roughly 41 percent during the past 

five years.2 This compares with a 31.2 percent annual 

growth rate nationwide. The rapid pace of C&D loan 

growth has led to record exposures reported by FDICinsured institutions in the Atlanta Region; the median 

C&D-to-Tier 1 capital ratio was 97 percent as of June 

30, 2006, compared with 35 percent nationally. In addition, five of the Region’s seven states ranked among 

the top ten nationally for C&D exposure: Georgia 

1 Community institutions are insured banks and thrifts holding assets
 

less than $1 billion.
 

2 CRE loans consist of construction and development, multifamily, and
 

nonresidential loans. Data from bank call reports are as of June 30.
 

Growth rates are merger adjusted.
 

(second), North Carolina (sixth), Florida (seventh), 

South Carolina (ninth), and Virginia (tenth). 

Moderating Demand for Residential Real Estate Is 

Reflected in Declining Home Sales 

Moderating activity in several Atlanta Region housing 

markets is evidenced by the recent sharp downturn in 

sales of existing homes (see Chart 2). However, these 

declines have not been uniform across the Region. 

Sales in Florida, Virginia, and West Virginia fell more 

rapidly than the national average during the year 

ending second quarter 2006; at the same time, however, 

sales continued to climb in North Carolina, South 

Carolina, and Georgia. In addition, as home sales have 

weakened in some markets, inventories of unsold 

homes have risen dramatically—even in some markets 

where sales remain above year-ago levels. In July 2006, 

year-ago increases in inventory were greatest in 

Orlando, Northern Virginia markets, and the West 

Virginia Eastern Panhandle. The property insurance 

market could exacerbate the slowdown in residential 

real estate sales in many of the Region’s coastal markets 

as higher premiums could constrain affordability. Citing 

heightened reinsurance costs, insurance companies 

have raised premiums for homeowners and commercial 

businesses. In Florida, property insurance premiums for 

most homeowners have more than doubled.3 

Chart 2 

Existing Home Sales in the 

Atlanta Region Have Fallen Sharply

Source: National Association of Realtors.

Atlanta Region

U.S. Year-Ago Percent Change –15%

–10%

–5%

0%

5%

10%

15%

20%

25%

1Q001Q011Q021Q031Q041Q051Q06

3 John Hielscher and Stephen Frater, “‘Sticker Shock’: Florida Homeowners Face Soaring Insurance Costs, with No Sign of Relief in the 

Forecast,” Sarasota Herald-Tribune, June 8, 2006. 

FDIC OUTLOOK 4 WINTER 2006 
Atlanta Region 

Weakness in sales activity likely extends beyond existing homes to new construction. Although not available at the state level, data indicate that new home 

sales across the entire South Census Region have 

fallen while inventories continue to rise.4 Anecdotal 

evidence suggests homebuilders in the Atlanta Region 

are making increased use of advertised incentives, such 

as free upgrades worth thousands of dollars, and other 

concessions to sell new homes. 

Price Appreciation Cools 

As home sales have declined, rates of price appreciation have moderated. By midyear 2006, year-ago 

appreciation rates had decelerated in all states in the 

Atlanta Region, except North Carolina (see Chart 3). 

According to the Office of Federal Housing Enterprise 

Oversight, 40 percent of the Region’s metropolitan 

markets reported that the rate of appreciation slowed 

considerably more than the national average during 

the first six months of 2006. However, several metropolitan markets, primarily in states where home sales 

remained resilient, reported increasing rates of price 

appreciation during this period. 

Although the rate of price appreciation across the 

Region’s housing markets remained positive through 

midyear 2006, the potential for price declines exists in 

Chart 3 

Rate of Home Price Appreciation Has

Decelerated in Parts of the Atlanta Region

Source: Office of Federal Housing Enterprise Oversight.

House Price Index (Year-Ago Percent Change)

0% 10% 20% 30%

Georgia

West Virginia

Alabama

South Carolina

North Carolina

U.S.

Virginia

Florida

2006Q2

2006Q1

4 The South Census Region includes Alabama, Arkansas, Delaware, 

District of Columbia, Florida, Georgia, Kentucky, Louisiana, Maryland, 

Mississippi, North Carolina, Oklahoma, South Carolina, Tennessee, 

Texas, Virginia, and West Virginia. 

some markets over the next several quarters. According to recent projections from Moody’s Economy.com, 

which considers such things as affordability, speculation, and overbuilding, price declines greater than 

10 percent could occur in the Cape Coral, Florida; 

Sarasota, Florida; Naples, Florida; and Washington, 

D.C., metropolitan areas.5 Many other Florida markets 

could see a less-pronounced drop in home prices. The 

bearish outlook for some Atlanta Region metropolitan 

markets also is reflected by The PMI Group’s “Risk 

Index,” which measures the probability that prices will 

decline in a particular market within two years. This 

index suggests that markets such as Fort Lauderdale, 

Virginia Beach, Tampa, and Orlando could experience 

a greater than 30 percent chance of home price 

declines in the near term.6 

Affordability Continues to Fall in Certain Areas of 

the Region 

Rapid rates of price appreciation in recent years, rising 

property taxes and mortgage interest rates, and sharp 

increases in property insurance premiums, particularly 

in coastal markets, have sharply constrained affordability in several areas of the Atlanta Region. The effects 

of declining affordability may be particularly evident in 

areas where households spend an inordinate share of 

income on housing. Data from the U.S. Census 

Bureau’s American Community Survey (2005) show 

that an above-average share of homeowners in some 

areas of the Atlanta Region, most notably South 

Florida, spend more than 30 percent of income on 

housing costs—a level defined as “excessive.”7 Overall, 

Florida ranked fourth nationally for the share of homeowners with excessive housing costs. Although price 

appreciation has moderated somewhat in recent quarters, and the prospect of price declines may loom in 

some areas, affordability likely will continue to weigh 

on the demand for housing in several Atlanta Region 

markets. 

5 James R. Hagerty and Anjali Athavaley, “The Shifting Consensus of
 

Buying a House,” Wall Street Journal, October 5, 2006.
 6 Economic Real Estate Trends, PMI Mortgage Insurance Company,
 

Fall 2006. The index incorporates home price data from the Office of
 

Federal Housing Enterprise Oversight, employment data from the
 

Bureau of Labor Statistics, and an affordability index calculated by
 

PMI.
 

7 However, the 2005 data do not incorporate the property insurance
 

premium hikes that occurred following the 2005 hurricane season.
 

As a result, the share of homeowners may be even greater now.
 

FDIC OUTLOOK 5 WINTER 2006 
Region by Region: Banking Conditions in 2007 

Negative trends in affordability may have prompted the 

increased use of innovative mortgages.8 In recent years, 

originations of these mortgage products has tripled, 

growing from less than 10 percent in 2003 to about 30 

percent in 2005. According to a Government Accountability Office report, consumer demand for these products increased because low initial monthly payments 

enabled borrowers to purchase homes they might not 

have been able to afford with a conventional fixed-rate 

mortgage. The effects of greater use of these innovative 

mortgages on FDIC-insured institution credit quality 

are uncertain. However, the expiration of low initial 

teaser rates and subsequent interest rate resets may 

stress the future repayment ability of some borrowers. 

Although many banks have mitigated this potential 

credit risk by selling a substantial amount of these 

loans in the secondary market, some exposure may 

remain in the investment portfolio through the 

purchase of mortgage-backed securities that hold these 

innovative mortgages as collateral. In the Atlanta 

Region, these products were particularly popular in 

Florida and Virginia, where rates of home price appreciation have exceeded the national average.9 

Continued Demand for Real Estate Loans Supports 

Bank Revenue Growth 

In recent years, earnings growth among Atlanta Region 

community FDIC-insured institutions has been driven 

primarily by CRE lending. Real estate markets in the 

Southeast have been bolstered by continued in-migration into the Region and solid employment growth 

trends. This, in turn, has increased the potential for 

banks to gain revenue from real estate–related activities. As of second quarter 2006, total income from all 

real estate lending accounted for 60 percent of gross 

revenue at the Region’s community institutions, 

compared with 49.3 percent nationally (see Chart 4). 

Given the importance of this income to the revenue 

stream, any slowdown in the real estate sector could 

adversely affect earnings among those community 

banks in the Atlanta Region with sizable CRE portfolios. Coupled with a flat to slightly inverted yield curve, 

banks may find it difficult to identify other investments 

that would generate a comparable yield. 

8 Innovative mortgages are interest-only and pay option adjustable-


rate mortgage (ARM) nonprime mortgage loans.
 

9 Government Accountability Office, “Alternative Mortgage Products,”
 

September 2006.
 

Chart 4 

Atlanta Region Community Institutions Report 

Continued Growth in Income from Real Estate Loans 

Source: FDIC, data for all insured financial institutions with assets less than $1 billion.

1996 1998 2000 2002 2004 Q2-

2006

0%

10%

20%

30%

40%

50%

60% Total Real Estate Loan Income/Gross Revenue

Higher Real Estate–Related Loan Demand Drives 

Profitability in the Atlanta Region 

Atlanta Region community FDIC-insured institutions 

continue to report solid performance. Despite several 

interest rate hikes, record earnings were reported in 

second quarter 2006. Driven higher by increasing 

demand for real estate–related loans, growth in net 

interest income has bolstered FDIC-insured institution 

profitability across the Region. In addition to top-line 

revenue growth from lending activities, improved efficiencies and a lower provision expense offset declines 

in noninterest income. However, the slowdown in the 

housing market could lead to a moderate demand for 

real estate construction loans, potentially hurting topline revenue growth in 2007. 

For the year ending second quarter 2006, the average 

return-on-assets (ROA) ratio at community institutions 

rose for the fifth consecutive year. However, profitability growth has begun to slow as the percentage of institutions reporting an increase in ROA year-over-year 

declined appreciably during the past 12 months. In 

addition, average net interest margins have trended 

higher as Atlanta Region community institutions 

reported an increase in asset yields that outpaced the 

growth in funding costs. 

Unlike large banks that are reporting margin compression, community institutions typically rely more heavily 

on core deposits to fund loan growth.10 More recently, 

robust loan demand coupled with sluggish core deposit 

10 Large banks hold assets greater than $10 billion. 

FDIC OUTLOOK 6 WINTER 2006 
Atlanta Region 

growth has contributed to an increased exposure to 

noncore sources of funding. These noncore liabilities 

tend to be more volatile and highly sensitive to changes 

in interest rates. As the funding mix has shifted away 

from core deposits, noncore liabilities reached approximately 30 percent of overall funding sources, with a 

heavy emphasis on large time deposits. Going forward, 

a flat yield curve and increased volume of volatile 

liabilities could pressure margins at some of the 

Region’s community institutions. 

Given its relative importance, the residential real estate 

sector likely will continue to shape the Atlanta 

Region’s economic performance into 2007. The impact 

of this sector on FDIC-insured institutions is reflected 

by growing exposures and the close link between earnings and prospects for continued growth in the real 

estate portfolio. 

Marlon G. Cook, Acting Regional Manager, 

macook@fdic.gov 

Scott Hughes, Regional Economist, shughes@fdic.gov 

Ronald W. Sims II, CFA, Senior Financial Analyst, 

rsims@fdic.gov 

FDIC OUTLOOK 7 WINTER 2006 
Future of Chicago Region 

Tied to Manufacturing 

The manufacturing sector has long been the engine of 

growth in the Chicago Region economy. This sector 

is particularly vital to the health of communities in 

Indiana, Michigan, and Ohio, where it represents 16 

percent of all nonfarm employees, compared with 10 

percent nationwide. During the past three years, manufacturing jobs in the Chicago Region have declined by 

3 percent to 3.5 million. This decline reflects both the 

long-term competitive weakening of U.S. firms in 

industries such as steel and autos and the lingering 

effects of the 2001 recession. Increasingly, job losses in 

this critical sector also can be attributed to the effects 

of globalization, whereby U.S. manufacturers have 

extended supply chains beyond domestic borders and 

have come to rely less on domestically sourced inputs. 

The Chicago Region is also home to a disproportionate 

share of employment in the auto manufacturing subsector. As is the case with manufacturing generally, the 

Region’s auto industry has been under considerable 

stress for the past three years, during which the transportation sector as a whole has shed almost 60,000 jobs 

or 9 percent of its previous total. But despite these 

setbacks, pockets of strength in auto manufacturing 

remain. Foreign auto companies continue to perform 

well, and their plans to expand domestic operations 

could bolster the regional economy. At the same time, 

an expanding services sector is helping to mitigate the 

effects of weakness in auto manufacturing. In 2006, 

growth in the services sector helped boost employment 

in all of the Region’s states except Michigan. 

Decline of Auto Giants Highlights Regional 

Manufacturing Woes 

U.S. automakers continue to lose ground to Asian 

competitors. Combined U.S. market share for General 

Motors Corporation, Ford Motor Company, and 

DaimlerChrysler AG fell to an unprecedented low of 

53 percent in 2006, down from 61 percent in 2003. In 

response to falling revenue and operating losses that 

have accompanied declining market share, the largest 

U.S. automakers have announced major restructurings 

that will scale back production, overhead expenses, and 

the number of suppliers. In addition, higher gasoline 

prices in 2005 and 2006 have constrained consumer 

demand for U.S.-based automaker vehicle fleets, particularly less fuel-efficient trucks 

and sport utility vehicles (see 

Chart 1). 

The declining market share of 

U.S.-based automakers also 

has hurt supplier profitability. Several major parts 

suppliers, including the largest, Delphi Corporation 

(Troy, Michigan), have filed for bankruptcy protection 

since 2005. Other major Chicago Region-based suppliers have recently announced job cuts.1 

IL IN OH

Chicago

KY

WI

MI

Against this backdrop, the performance of foreignbased auto makers is positive news for the auto industry. 

Toyota Motor Corporation and Honda Motor Co., Ltd. 

reported record year-to-date U.S. unit sales as of 

September 2006. Both automakers have assembly and 

parts plants as well as a network of suppliers in the 

Region and plan to expand domestic production. 

Honda also announced plans to build an assembly plant 

in Decatur County, Indiana. Honda’s Anna, Ohio, 

engine plant will supply the Decatur plant, which will 

strengthen the west-central Ohio manufacturing sector. 

In addition, Toyota announced a new Camry production line at the Lafayette, Indiana, Subaru facility. 

Chart 1 

Rising Gas Prices Contribute to Lower

Sales for U.S.-Based Automakers

Source: Autodata Corp. (via Moody’s Economy.com), Department of Energy.

46

48

50

52

54

56

58

60

62

64

Q3-02 Q3-03 Q3-04 Q3-05 Q3-06

100

150

200

250

300

Percent Cents per Gallon

Ford, General Motors, and DaimlerChrysler Share of U.S. Vehicle

Market (L) 

Nominal Retail Gas Price (national average) (R) 

1 American Axle & Manufacturing Holdings, Inc. (Detroit, Michigan), 

BorgWarner, Inc. (Auburn Hills, Michigan), Collins & Aikman (Southfield, Michigan), Johnson Controls, Inc. (Milwaukee, Wisconsin), and 

Visteon Corporation (Van Buren Township, Michigan) announced job 

cuts in North American operations in 2006. 

FDIC OUTLOOK 8 WINTER 2006 
Chicago Region 

Auto Sector Declines Affect Employment and 

Housing Markets 

Analysts estimate that the U.S. automotive manufacturing sector generates more than 5 million jobs 

(directly and indirectly) annually that contribute 

approximately $180 billion in disposable income to the 

U.S. economy.2 Three Chicago Region states—Indiana, 

Michigan, and Ohio—are home to 40 percent of the 

nation’s motor vehicle assembly and parts manufacturing jobs.3 However, recent weakness in this sector 

continues to weigh on regional employment growth 

and housing markets. During the past two years, these 

three states also have ranked at the bottom regionally 

in terms of average employment growth in nonmanufacturing sectors such as professional and business, 

leisure and hospitality, and education and health services. Not surprisingly, these states also ranked lowest in 

overall job growth for the Region during 2006. 

Housing markets in auto-dependent states also appear 

to be weakening to a greater degree than markets in 

other areas of the country. Since early 2006, housing 

markets in many parts of the nation have been characterized by slowing rates of price appreciation and 

increasing inventories of unsold homes. Although these 

trends also are evident across much of the Chicago 

Region, the reversal in regional housing market activity 

may not have been as pronounced here, if only because 

previous rates of appreciation and volumes of new 

construction were not as dramatic in the Region as 

they were elsewhere in the country. 

Still, considerable slowing is evident in housing 

markets in areas where concentrations in auto sector 

employment are particularly high. Existing home sales 

in Michigan fell 17 percent in the year ending third 

quarter 2006, the most rapid decline in the Region and 

greater than the national average decline of 13 percent. 

Twenty-four metropolitan statistical areas (MSAs) in 

the nation recorded outright price declines on existing 

home sales in third quarter 2006; 18 of these metro 

areas are in Indiana, Michigan, and Ohio. In addition, 

2 Contributions of the U.S. Motor Vehicle Industry to the Economies of 

the United States, California, New York, and New Jersey in 2003, 

prepared by the University of Michigan Institute of Labor and Industrial Relations and the Center for Automotive Research for the 

Alliance of Automobile Manufacturers, Inc., May 2004. Disposable 

income is the value of compensation (salary and benefits) less transfer payments and taxes. 

3 Indiana, Michigan, and Ohio rank highest in the Region in terms of 

their concentration in auto sector employment. 

Table 1 

The Housing Markets Showing 

Year-over-Year Negative Price Trends 

Are Concentrated in the Midwest 

Year-over-Year 

Percent Change in Home Prices, 

MSA Third Quarter 2006* 

Anderson, Indiana –6.05 

Muncie, Indiana –6.02 

Sandusky, Ohio –3.13 

Ann Arbor, Michigan –3.00 

Springfield, Ohio –2.09 

Holland, Michigan –2.03 

Greeley, Colorado –1.99 

Kokomo, Indiana –1.98 

Detroit, Michigan –1.98 

Brownsville, Texas –1.68 

Warren, Michigan –1.47 

Muskegon, Michigan –1.08 

Owensboro, Kentucky –1.03 

* A total of 24 MSAs had a falling index; this table lists those with declines greater than 

1 percent. 

Source: OFHEO Housing Price Index. 

the vast majority of MSAs that have experienced the 

greatest rates of price depreciation are located in the 

Chicago Region (see Table 1).4 

Services Sector Is a Relative Bright Spot 

Growth in the services sector has managed to offset 

much of the weakness in auto manufacturing in recent 

quarters. The services sector has been an important 

source of job growth for both the nation and the 

Chicago Region since 2003. These gains helped lower 

unemployment in all states in the Region except 

Michigan during the year ending third quarter 2006. 

Services-sector job growth in the Region has been relatively stable since year-end 2003, albeit at rates below 

the national average (see Chart 2). 

Employment in professional and business services 

expanded more rapidly than in any other sector in the 

Region in 2006, followed by growth in the education 

and health services, and leisure and hospitality services 

4 Based on Office of Federal Housing Enterprise Oversight (OFHEO) 

Home Price Index data. Michigan, the state with the highest auto 

employment concentration, was the only state in the nation whose 

index fell year-over-year in third quarter 2006. 

FDIC OUTLOOK 9 WINTER 2006 
Region by Region: Banking Conditions in 2007 

Chart 2 

Regional Employment Growth in Services 

Sector Has Remained Stable

Source: Bureau of Labor Statistics. Percent Change in Payroll Jobs (Year-over-Year)

Q3-02 Q3-03 Q3-04 Q3-05 Q3-06 –0.5

0.0

0.5

1.0

1.5

2.0 Nation, Services

Chicago Region, Services

sectors. Professional and business services jobs tend to 

be relatively high-paying, particularly in Illinois, Michigan, and Wisconsin, where recent growth has been the 

strongest. In Illinois, average annual earnings in the 

professional and business services sector are almost 20 

percent greater than the average across all sectors.5 

Increasing employment in this sector also has bolstered 

office real estate fundamentals in the Chicago area, 

where demand for office space has grown substantially 

in recent months. Year-to-date net absorption (net 

change in occupied space) for Chicago in third quarter 

2006 was more than twice the volume of a year ago.6 

Margin Compression Dampens Profitability 

Despite ongoing economic challenges, FDIC-insured 

institutions in the Region continue to perform fairly 

well. While profitability has dropped somewhat from 

previous levels, the Region’s banks reported a median 

return on assets of 0.92 percent (annualized) for the 

first three quarters of 2006. 

One of the biggest challenges to profitability is net 

interest margin (NIM) compression. Chicago Region 

banks reported a 9-basis-point decline in the median 

NIM for the first three quarters of 2006 (annualized) 

compared with the same period a year ago. Narrowing 

NIMs are due in part to the unfavorable environment 

facing the large number of mortgage specialists in the 

5 State sector and average annual earnings based on data from
 

Precis Metro, Chicago, published by Moody’s Economy.com, Inc.,
 

updated October 2006.
 

6 PPR Fundamentals 3Q 2006: Chicago Office, published by Property &
 

Portfolio Research, Inc.
 

Region; only states in the Mid-Atlantic and New 

England are home to a greater share of mortgage 

lenders. Heavy reliance on mortgage lending tends to 

heighten the sensitivity of FDIC-insured institutions to 

both changes in the shape of the yield curve and slowing in regional housing markets. Because mortgage 

lenders tend to borrow using short-term funding sources 

and invest in intermediate- to longer-term assets, these 

institutions typically rely more on spread income (the 

difference between short- and long-term interest rates) 

than other types of banks. The result is often a greater 

vulnerability to declining interest margins in a flat yield 

curve environment. 

A rising cost of funds is also contributing to NIM 

compression at FDIC-insured institutions in the 

Region. At 2.73 percent (annualized) for the first three 

quarters of 2006, the Region’s median cost of funds 

was second highest among the FDIC Regions. This 

relatively high cost of funds results, in part, from 

the combination of rising short-term interest rates, 

increasing reliance on higher-cost noncore funding, 

and relatively slow growth in lower-cost core deposits. 

Meanwhile, asset yields have not kept pace with a 

rising cost of funds despite the presence of two factors 

that served to boost interest income: an increase in the 

median loans-to-assets ratio for the Region to a record 

high 70.4 percent in the third quarter, and an 11.1 

percent rate of growth in higher-yielding commercial 

real estate loans.7 

Auto Sector Weakness Reflected in Weakening 

Credit Quality 

The Region’s economic challenges are also reflected in 

specific credit quality indicators. Mortgage foreclosures 

and personal bankruptcy rates in Indiana, Ohio, and 

Michigan currently exceed those of most other states. 

Personal bankruptcy rates in each of these three states 

were among the eight highest in the nation for third 

quarter 2006.8 These three states also ranked as the top 

three nationwide for mortgage foreclosures in third 

quarter 2006.9 

7 Growth rate based on aggregate merger-adjusted data between
 

September 30, 2005, and September 30, 2006. 


8 Nonbusiness bankruptcies per 1,000 people (quarterly annualized).
 

Administrative Office of the U.S. Courts and Bureau of the Census.
 

9 Indiana, Ohio, and Michigan were ranked first, second, and third,
 

respectively, in state rankings of mortgage foreclosures for third
 

quarter 2006. Quarterly mortgage foreclosures started as a percentage of the number of loans. Mortgage Bankers Association. 


FDIC OUTLOOK 10 WINTER 2006 
Chicago Region 

FDIC-insured institutions in auto-dependent states also 

are reporting rising rates of delinquent loans (see Table 

2). Delinquencies reported by banks in Ohio and 

Michigan are near the ten-year highs reached in the 

2001 recession. Delinquency rates have risen for a 

number of loan categories, with some of the greatest 

deterioration occurring in residential mortgage and 

commercial real estate loan portfolios.10 Similarly, 

banks based in the Detroit and Cleveland metro areas, 

some of the hardest hit by auto sector setbacks, have 

seen delinquent loans rise to higher levels than those 

of banks in most MSAs nationwide. 

Conclusion 

The challenges facing U.S.-based automakers and their 

suppliers will continue to be felt across much of the 

Chicago Region during 2007. U.S. automakers and 

parts suppliers still face structural overcapacity, and 

Table 2 

workforce reductions will probably continue to be part 

of their strategic plans. Banks operating primarily in 

auto-dependent areas may experience slow loan growth 

and subpar loan performance as the auto-sector restructuring proceeds. Notwithstanding these difficulties, 

the regional economy and banking industry should 

continue to benefit from expansion in the services 

sector, which until now has helped keep unemployment 

rates well below recession levels and has supported 

growth in household incomes and spending. Though 

auto-dependent housing markets may struggle, the 

overall outlook for the Region is less pessimistic. 

Among the bright spots is a banking industry that 

remains profitable, well capitalized, and willing to lend 

to creditworthy borrowers. 

Patrick M. Dervin, Regional Economist, pdervin@fdic.gov 

Robert D. Vilim, Senior Financial Analyst, 

rvilim@fdic.gov 

Asset Quality Indicators Reflect Somewhat Higher Risk for FDIC-Insured Banks 


Based in Areas Impacted by the Struggling Auto Sector
 

Delinquency Rates 

Total Loans Residential Mortgage Loans CRE Loans 

Area Rank Sep-06 Sep-05 Rank Sep-06 Sep-05 Rank Sep-06 Sep-05 

Michigan 2 2.3 1.9 1 2.5 1.9 2 1.9 1.2 

Ohio 4 2.0 1.7 5 2.1 1.8 7 1.1 0.8 

U.S. 1.4 1.4 1.3 1.3 0.6 0.5 

Detroit-Warren-Livonia 3 3.1 1.5 4 3.2 1.6 16 2.0 0.9 

Cleveland-Elyria-Mentor 16 2.3 1.5 41 1.9 1.3 8 2.5 1.0 

All Metros 1.1 1.1 0.9 0.9 0.5 0.4 

Note: Metro ranking includes 215 metros in which five or more banks are headquartered. All ratios are median percent. CRE = commercial real estate. 

Source: FDIC. 

10 Commercial real estate loans consist of construction and development, multifamily, and nonresidential real estate loans. 

FDIC OUTLOOK 11 WINTER 2006 
Energy and Housing Likely to Be 

Net Positives for the Dallas 

Southwest in 2007 

FDIC-insured institutions based in the Dallas Southwest continue to report solid performance, with continued strong profitability and loan growth and favorable 

credit quality. The Southwest’s banks and thrifts also 

reported historically low mortgage past-due and chargeoff rates for third quarter 2006. In addition, Texas and 

Colorado continue to rank among the nation’s top five 

states for branch growth.1 Strong performance by the 

area’s insured institutions has been due in large part to 

the relatively healthy local economy, particularly the 

energy and housing sectors. 

Energy and housing have been key drivers of economic 

growth in the Dallas Southwest. Growth in these 

sectors accounts for much of the 2.4 percent job 

growth in 2006—a rate of growth that easily outpaced 

the national average of 1.4 percent. Unlike many 

parts of the country where higher energy prices have 

constrained consumer spending, the surge in energy 

prices provided a net boost to the Dallas Southwest 

economy in 2006 because of the relatively high share 

of employment in energy production and exploration. 

Housing markets also have shown strength relative to 

the nation; most Dallas Southwest metro areas have 

not experienced the home price weaknesses seen elsewhere in the country. Because of the strong underlying 

fundamentals, the energy and housing sectors are likely 

to remain positives for the Dallas Southwest in 2007. 

Energy Sector Drives the Dallas Southwest Economy 

The energy sector plays a leading role in the regional 

economy. Although the Dallas Southwest represents 

only 11 percent of the nation’s nonfarm employment 

and gross domestic product, it accounts for 29 percent 

of U.S. crude oil production, 48 percent of U.S. natural gas production, and 25 percent of total U.S. petroleum industry employment.2 As energy prices have 

risen in recent years, this sector has become an increasingly important driver of economic growth. In 1999, 

oil and gas extraction accounted for approximately 3 

1 Summary of deposit information is collected each June 30. 2 U.S. Bureau of Labor Statistics, U.S. Bureau of Economic Analysis, 

and the Independent Petroleum Association of America. Data are 

for 2003. 

percent of the Southwest’s economic activity 

(measured as a share of 

gross state product), 

compared with approximately 6 percent in 

2004 (the most recent data available).3 The area’s share 

has undoubtedly risen since then, given the spike in oil 

prices in the past two years. 

TX

CO

Southwest

NM OK

Rising energy prices typically have a negative influence 

on U.S. economic activity. However, in energy-producing states, higher prices promote economic activity by 

boosting industry profits and hiring. The current 

strength in oil and natural gas prices has resulted in an 

annual employment growth rate of more than 7.5 

percent in the Dallas Southwest area’s natural resources 

and mining sector in 2006.4 Thus, the regional economy benefits disproportionately compared with the rest 

of the country when energy prices are high. 

Some analysts think oil prices could remain high 

through the end of 2007 despite recent declines. The 

Energy Information Administration (EIA) is projecting 

oil prices (West Texas Intermediate) will linger in the 

$60 to $70 per barrel range in 2007 (see Chart 1). Also, 

global excess production capacity remains extremely 

tight by historical standards, which will likely place 

upward pressure on prices. According to EIA estimates, 

surplus world crude oil production capacity is projected 

to increase slightly in 2007 but will remain near 30-year 

lows. In addition, the Organization of Petroleum 

Exporting Countries (OPEC) announced in October 

that it was cutting daily oil production by 1.2 million 

barrels per day to prevent prices from falling too far 

below $60 a barrel.5 The announced production cuts 

are the first by OPEC since December 2004. Further, 

global economic growth is likely to remain healthy in 

2007 and 2008, boosting demand for oil and supporting 

higher prices in the near term. 

3 Calculated using U.S. Bureau of Economic Analysis gross domestic
 

product data.
 

4 U.S. Bureau of Labor Statistics.
 

5 Stephen Mufson, “OPEC Says It Will Cut 1.2 Million Barrels a Day,”
 

Washington Post, October 20, 2006, page D3. 


FDIC OUTLOOK 12 WINTER 2006 
Dallas Region: Southwest 

Chart 1 Chart 2 

High Oil Prices Will Continue Supporting 

Future Oil Exploration and Development 

F = forecast; WTI = West Texas intermediate crude.

Sources: Wall Street Journal and the Energy Information Administration’s “Short-Term 

Energy Outlook,” January 9, 2007. Crude Oil Prices $/barrel (WTI) $–

$10

$20

$30

$40

$50

$60

$70

2000200120022003200420052006 2007F

Natural Resources and Mining Employment Has

Soared in Tandem with Drilling Activity

Note: Employment and drilling rig numbers are for the Dallas Southwest only.

Sources: Baker Hughes and Bureau of Labor Statistics (Seasonally Adjusted).

Jan92Jan94Jan96Jan98Jan00Jan02Jan04Jan06

160

170

180

190

200

210

220

230

240

250

260

270 Oil and Natural Gas Drilling Rigs Natural Resources and Mining Employment (in thousands)

150

250

350

450

550

650

750

850

950

1,050

1,150

1,250 Employment

Rigs

Employment and Personal Income Growth 

The Dallas Southwest surpassed the nation in employment growth in 2006, and is on pace to surpass the 

nation in personal income growth as well (see Table 1). 

Higher energy prices have generated increased capital 

expenditures in energy exploration and production, 

creating additional jobs in the area’s mining sectors 

(see Chart 2). In addition, demand for oil and natural 

gas field equipment and oil field services is increasing. 

According to Bakers Hughes, active oil and gas rotary 

rigs increased 20 percent in 2006. Moreover, strong 

international energy activity is creating demand for 

oil field equipment and services. The marketing and 

Table 1 

The Dallas Southwest 

Expansion Remains Strong 

Nonfarm Personal 

Employment Income 

Annual Annual 

Area Growth Rate* Growth Rate** 

Colorado 2.1 5.8 

New Mexico 2.7 7.5 

Oklahoma 1.9 8.7 

Texas 2.5 8.3 

Dallas Southwest Region 2.4 7.9 

United States excluding the 1.3 6.4 

Dallas Southwest Region 

* Preliminary average annual employment growth rate for 2006. 

** First three quarters of 2006 compared with same period a year ago. 

Sources: Bureau of Labor Statistics and Bureau of Economic Analysis. 

distribution of energy-based products stimulates additional demand in support activities such as financial 

and legal services, which spurs employment and income 

growth in the Southwest. State government coffers also 

are greatly enhanced by the growth in severance tax 

revenues. 

Housing Sector Remains Strong in Most of the 

Dallas Southwest 

While the housing market is slowing for the nation, 

it continues to be a source of growth for the Dallas 

Southwest area. Nationwide, year-over-year median 

home price growth peaked in third quarter 2005 at 

14.2 percent, but home prices declined 2.7 percent on 

a year-ago basis in fourth quarter 2006.6 This recent 

downturn has so far bypassed key markets in the Dallas 

Southwest, only the Denver-Aurora metro area experienced declining home prices on a year-ago basis in 

third quarter 2006. Existing home sales also have 

outpaced those of the nation. For instance, Texas saw 

existing home sales in the third quarter climb 8.6 

percent higher than year-ago levels. In contrast, nationwide sales were down more than 12 percent on a yearago basis, allowing the area to capture a larger share of 

the nation’s totals (see Chart 3). Texas accounted for 

74 percent of the area’s homebuilding activity in 2006, 

and 66 percent of its existing home sales through the 

first three quarters of 2006, making the state a key 

driver of regional housing trends.7 

6 National Association of Realtors.
 

7 U.S. Census Bureau and the National Association of Realtors.
 

FDIC OUTLOOK 13 WINTER 2006 
Region by Region: Banking Conditions in 2007 

Chart 3 

The Dallas Southwest Has Captured

a Larger Share of U.S. Housing Activity

Dallas Southwest Share of U.S. Housing Activity (%)

Sources: Census Bureau and National Association of Realtors. Percentage Share of Single- Family Building Permits Percentage Share of Existing Existing Single-Family Homes Sales Single-Family Home Sales

Single-Family Building Permits

Sep-01Sep-02Sep-03Sep-04Sep-05Sep-06

12

13

14

15

16

17

10

11

12

13

14

15

Most local markets in the Dallas Southwest have not 

experienced the sudden deceleration in home prices 

seen elsewhere in recent months. In fact, half the 40 

metropolitan areas experienced home price increases 

that outpaced the year-ago rate, compared with less 

than one-fourth of metropolitan areas elsewhere in the 

country.8 Further, despite ongoing home price gains in 

many of the metro areas, local housing markets remain 

relatively affordable, primarily because home price 

gains have not outpaced median family incomes to the 

extent seen in many coastal markets. 

Colorado metro areas are an exception to the area’s 

strong housing performance. Despite continued 

employment growth and relatively low mortgage rates, 

Colorado existing single-family home sales fell for the 

second consecutive quarter on a year-ago basis in third 

quarter 2006. The rapid deterioration in affordable 

housing is the primary reason for weakness in the state’s 

home sales. According to the National Association of 

Home Builders/Wells Fargo Housing Opportunity 

Index (HOI), affordability has declined in all seven 

Colorado metro areas. 

Meanwhile, annual home price growth in Colorado 

decelerated from a peak of 6.2 percent in fourth quarter 

2005 to 3.7 percent in third quarter 2006.9 A Moody’s 

Economy.com housing study projects home price 

declines ranging from 1.3 percent to 10.7 percent for 

all seven Colorado metropolitan areas within the next 

two years.10 In addition, Colorado posted the highest 

8 Office of Federal Housing Enterprise Oversight (OFHEO) for the year
 

ending third quarter 2006.
 

9 Ibid.
 

foreclosure rate in the nation as a percent of total 

households (3 percent) in 2006. Overall, Colorado 

foreclosures totaled almost 55,000 last year for an 

increase of 85 percent from 2005, and a percentage 

increase double that of the nation.11 The combination 

of weakening home sales, rising inventories of unsold 

homes, and high levels of foreclosures is likely 

contributing to weak home price trends and may 

present challenges in the near term. 

Nonetheless, a number of factors signal continued 

stability in most of the Southwest’s metropolitan area 

housing markets. According to recent FDIC analyses 

of the nation’s housing cycles, housing busts in the 

United States have been rare and are usually triggered 

by substantial local economic distress, such as the largescale job losses associated with a local recession. Generally, the nation’s housing booms have been followed by 

a period of home price stagnation as incomes slowly 

catch up to housing prices.12 Given these criteria, a 

severe downturn in the Dallas Southwest appears 

unlikely. In fact, several factors point to stability in 

the area’s housing markets in 2007. 

For example, the absence of severe overbuilding in 

many markets should help support home prices. Until 

second quarter 2006, the number of new homes had 

more than kept pace with the strong demand for housing. Since then, homebuilders have limited new 

construction, keeping inventories in check. Also, a 

considerably smaller percentage of mortgages was used 

to buy second/investor homes in 11 of the 14 major 

markets in the Southwest compared to the country as 

a whole.13 Local housing markets with lower levels of 

investor ownership often exhibit less volatility, as 

investors may be more likely to sell a home in a declining market. In addition, Blue Chip Financial Forecasts projects that interest rates on conventional home 

mortgages will remain between 6 and 7 percent through 

the end of 2007, which, if realized, should support 

continued home sales and price gains.14 

10 Moody’s Economy.com, “Housing at the Tipping Point: The Outlook
 

for the U.S. Residential Real Estate Market,” October 2006.
 

11 RealtyTrac press release, “More than 1.2 million foreclosures
 

reported in 2006,” January 25, 2007.
 

12 See FYI: An Update on Emerging Issues in Banking, “U.S. Home
 

Prices: Does Bust Always Follow Boom?” February 10, 2005, and 


FYI Revisited: “U.S. Home Prices: Does Bust Always Follow Boom?”
 

May 2, 2006. 


13 National Association of Realtors, July 2006.
 

14 Blue Chip Financial Forecasts, January 1, 2007.
 

FDIC OUTLOOK 14 WINTER 2006 
Dallas Region: Southwest 

Outlook for 2007 Remains Good, Despite Some Chart 4 

Challenges 

Employment and income growth in the Dallas Southwest are expected to largely outperform the nation 

again in 2007 (see Chart 4). Mining, construction, 

financial activities, professional and business services, 

and educational and health services are among the 

sectors likely to see strong job and income growth 

next year. Finally, the area’s robust population growth 

should support continued strong demand for housing. 

Consensus state forecasts project population growth 

in Colorado, New Mexico, and Texas will outpace the 

nation in 2007—1.6 or 1.7 percent annually for the 

three states compared with 0.9 percent for the nation.15 

Dallas Southwest States Will Grow Similar to

or Faster Than the Nation in 2007

Source: Moody’s Economy.com’s States Economic Forecast, January 2007. Employment Growth (% Change) Texas

Colorado

New Mexico

Oklahoma

Nation Bubble size reflects individual 

state’s gross state product 

Personal Income Growth (% change)

4.0 5.0 6.0 7.0 8.0 0.0

0.5

1.0

1.5

2.0

2.5

3.0

While the Dallas Southwest is expected to remain one 

of the nation’s economic leaders in 2007, there are a 

few clouds on the horizon. In the wake of the 2005 

hurricane season, the accessibility and affordability of 

property and casualty insurance remain in flux for the 

Gulf Coast region. Because housing in the Texas Gulf 

Coast area is at risk from wind and hailstorms, many 

homeowners have seen their premiums and deductibles 

rise in conjunction with reduced policy coverage. The 

lack of affordable casualty insurance could slow development in Texas coastal areas. Moreover, rising insurance premiums could strain borrower finances, thereby 

pressuring repayment capacity and negatively affecting 

insured institution credit quality. 

In addition, there are considerable risks facing the area’s 

agricultural sector in 2007. Declining farm income, 

escalating fuel prices, lingering drought across much 

of the Southwest, and the uncertainty surrounding the 

nature and level of future farm subsidy payments will 

present challenges to farmers and agricultural lenders. 

The United States Department of Agriculture (USDA) 

is forecasting net U.S. farm income to decline 22 

percent in 2006. Also, expenses paid by agricultural 

producers have increased substantially since 2003, 

with the cost of diesel fuel increasing by 45 percent. 

USDA is forecasting producer interest costs to rise 

11.9 percent in 2006. Although conditions at the 

Southwest’s agricultural banks are strong, agricultural 

borrowers may begin to exhibit greater financial stress 

from a combination of higher expenses, lower income, 

and continuing drought conditions, primarily in parts 

of Texas and Oklahoma. Further, any significant cuts 

to the amount of government payments in the 2007 

farm bill could hurt the cash flow positions of agricultural producers and collateral values of farmland in 

areas with high subsidies. 

Jeffrey Ayres, Senior Financial Analyst, jayres@fdic.gov 

Stephen Kiser, Regional Economist, skiser@fdic.gov 

Adrian Sanchez, Regional Economist, asanchez@fdic.gov 

15 Western Blue Chip Economic Forecast, January 2007, and U.S. 

Census Bureau. 

FDIC OUTLOOK 15 WINTER 2006 
Expansion of Mid-South Economy 

Masks Rural-Urban Divide 

The pace of economic growth across the Mid-South 

has been favorable during recent years as more than 

200,000 net new jobs have been added to the regional 

economy since 2001.1 However, much of this growth 

occurred in the urban areas, while rural areas have 

experienced considerably weaker economic conditions 

(see Table 1). Much of this divergence can be 

explained by employment conditions and trends in 

key industry sectors in these areas. Unemployment 

rates in rural areas continue to exceed those in urban 

areas, and rural household incomes remain below those 

in metro areas. To gain insight into the expanding 

urban/rural divide, this article examines key differences 

in economic activity between the Mid-South’s rural 

and urban counties and assesses the implications for 

the local banking industry. 

Breaking down the Mid-South, 94 counties are considered urban, with a median population of 57,000.2 The 

majority (62 percent) of the total population lives in 

these urban counties, primarily in core urban counties.3 

Table 1 

Metropolitan Areas of the Mid-South 

Are Growing Steadily, While Rural 

Areas Continue to Shed Jobs 

Urban Rural 

Area Counties Counties 

Number of Counties 94 212 

Total Population, 2006 9,169,160 5,582,225 

5-Year Median Population Growth, % 4.9 0.4 

Median Household Income, 2006 $38,934 $30,296 

5-Year Median Employment Growth, % 4.8 –3.5 

5-Year Total Jobs Added/Lost 256,947 –52,006 

Source: Bureau of Labor Statistics, median figures, as of year-end 2006. Data for New 

Orleans and Gulfport-Biloxi MSAs excluded because of effects of Hurricane Katrina. 

Another 212 counties are 

considered rural, with a 

median population of 21,200.4 

The remaining 38 percent of 

the total population lives in these rural counties, primarily in small urban clusters or micropolitan areas.5 

TN

LA

MS

AR

Mid-South

Weak economic conditions in rural Mid-South counties can be attributed to greater reliance on the farming and manufacturing sectors, two industries that 

have shed jobs in recent years in part because of 

increasing global competition. Sixty percent of the 

rural counties depend heavily on one of these sectors, 

according to the U.S. Department of Agriculture 

Economic Research Service.6 The median employment 

growth rate in farming- or manufacturing-dependent 

rural counties in the Mid-South during the past five 

years was negative 5.7 percent, compared with negative 2.4 percent for all other rural counties and 4.8 

percent for all urban counties of the Mid-South. 

In contrast, Mid-South urban county economies 

are more diversified, rely less on manufacturing and 

farming, and have benefited from strong demand for 

service-related jobs. Companies have migrated to 

metropolitan counties of the Mid-South that offer 

a relatively high degree of industrial diversification 

and access to quality education and health care. 

The education and health services sector has been a 

key driver of the economies of the Mid-South’s urban 

counties, while the professional and business services, 

leisure and hospitality, and government sectors also 

helped to create more than 250,000 net new jobs since 

2001 (see Table 2). Unlike other areas of the nation, 

housing markets in the Mid-South have remained relatively stable, as evidenced by the solid, but relatively 

modest, number of construction jobs added during the 

1 Excludes New Orleans (Louisiana) and Gulfport-Biloxi (Mississippi)
 

metropolitan areas because of the effects of Hurricane Katrina.
 

2 Urban counties have a population of 50,000 or greater or are considered an adjacent county with a high degree of social and economic
 

integration with the core county, as defined by the Office of Management and Budget (OMB). www.whitehouse.gov/omb/bulletins/fy2006
 

/b06-01_rev_2.pdf.
 

3 Such as Shelby County, Tennessee (Memphis), Davidson County,
 

Tennessee (Nashville), and East Baton Rouge Parish, Louisiana
 

(Baton Rouge). 


4 Rural counties are defined as counties not included in metropolitan
 

statistical areas as defined by the OMB.
 

www.whitehouse.gov/omb/bulletins/fy2006/b06-01_rev_2.pdf.
 5 Such as Tangipahoa Parish, Louisiana (Hammond), St. Landry Parish,
 

Louisiana (Opelousas-Eunice), and Sevier County, Tennessee
 

(Sevierville). 


6 For more information, access the U.S. Department of Agriculture
 

Economic Research Services 2004 County Typology Codes at
 

www.ers.usda.gov/Briefing/Rurality/Typology/.
 

FDIC OUTLOOK 16 WINTER 2006 
Dallas Region: Mid-South 

Table 2 

The Vast Majority of New Jobs 

Have Been Created in the Education 

and Health Services Industries 

Net Jobs Added

(2001–2006) 

Job Sector Urban Rural 

Education and Health Services 88,354 15,685 

Professional and Business Services 43,939 16,819 

Leisure and Hospitality 47,515 5,069 

Government 40,793 1,568 

Trade, Transportation, and Utilities 44,121 – 8,269 

Finance, Insurance, and Real Estate 15,589 – 947 

Other Services 11,853 – 4,862 

Construction 19,225 – 7,051 

Natural Resources and Mining –315 – 3,192 

Information – 4,139 – 3,609 

Manufacturing – 54,809 – 63,217 

Source: Bureau of Labor Statistics, Moody’s Economy.com. Mid-South data exclude New 

Orleans and Gulfport-Biloxi MSAs because of effects of Hurricane Katrina. 

past five years. The Mid-South construction sector 

contributed 8 percent of total new jobs, compared with 

18 percent nationally. 

What may the future hold for the Mid-South’s rural 

and urban areas? The vast majority of the jobs created 

during the past five years have come from the education and health services sector. This trend is likely to 

continue as the Bureau of Labor Statistics projects this 

industry to grow faster and add more jobs than any 

other economic sector in the nation through 2014.7 

The professional and business services and leisure and 

hospitality sectors also are forecasted to generate jobs 

in the near term. However, as has been the case in 

the recent past, most of these job gains are expected 

to occur in the Mid-South urban areas, and rural 

economies likely will continue to struggle. 

A few positives do exist for the economies of MidSouth rural counties. Should the use of biofuels, such 

as ethanol, become more widespread, the production 

of energy alternatives has the potential to stimulate 

economies in some farming-dependent communities. 

The Mid-South is already a leading producer of 

soybeans, sugarcane, and poultry, three materials that 

can be used to produce biofuels. In recent months, 

7 Tomorrow’s Jobs, Bureau of Labor Statistics Occupational Outlook 

Handbook 2006–07 Edition. Available at http://www.bls.gov/oco/pdf 

/oco2003.pdf. 

several biofuel plants have opened and more may 

commence operation.8 Although these biofuel plants 

typically do not employ large numbers of workers, 

these are capital intensive facilities that are expected 

to generate construction jobs and may help spur 

demand for service-related jobs. 

Energy production also may benefit rural areas of the 

Mid-South. The use of new technologies has improved 

oil and natural gas extraction and helped in the identification of new sites, including the Fayetteville Shale 

Play in rural central Arkansas and a major oil reserve 

off the Louisiana coast that could boost the nation’s oil 

reserves by as much as 50 percent.9 Extraction activity 

in these new energy fields is expected to generate relatively higher-paying jobs and diversify the local 

employment base. 

Rural Banks Are Performing Surprisingly Well 

Despite weaker economic conditions across many of 

the Mid-South’s rural counties, community banking 

performance is on par with that in urban counties. The 

urban-based institutions generally report higher net 

interest margins (NIMs) and service fee income levels 

than their rural-based counterparts. However, as of 

third quarter 2006, rural institutions earned a median 

pretax return on assets (ROA) of 1.49 percent, 7 basis 

points higher than banks in urban areas. 

Mid-South rural-based institutions make up for the 

shortfall in NIMs and service fee income by holding 

down overhead expenses. During the five years ending 

third quarter 2006, the median noninterest expense 

ratio reported by rural institutions was 2.99 percent, 

well below the 3.29 ratio posted by Mid-South urbanbased institutions. 

Generally weaker economic conditions have 

constrained branching and de novo activity in MidSouth rural areas in recent years. Metropolitan areas 

added a net total 402 bank branches (13.3 percent) 

during the past five years, while only 56 (2.3 percent) 

were added in rural areas.10 In addition, 24 banks 

8 Elton Robinson, “Are Mid-South Farmers Ready to Become Fuel
 

Producers?” Prism Insight, June 15, 2006. 
 9 Mark Morrison, Stanley Reed, and Chris Palmer, “Plenty of Oil, Just
 

Drill Deeper,” BusinessWeek, September 18, 2006. 
 10 Based on FDIC/OTS Summary of Deposits database as of June 30,
 

2006.
 

FDIC OUTLOOK 17 WINTER 2006 
Region by Region: Banking Conditions in 2007 

Pace of Rebuilding Expected to
 

Differ in New Orleans and
 

Gulfport-Biloxi; Banks in Both
 

Areas Remain Resilient 


Hurricane Katrina severely affected the metropolitan 

areas of New Orleans and Gulfport-Biloxi. To date, job 

recovery in both areas has been weak, a reflection of the 

magnitude of the devastation of homes and businesses.* 

Going forward, the nature and pace of the recovery in 

the New Orleans and Gulfport-Biloxi areas are expected 

to differ considerably. Prospects for growth in GulfportBiloxi appear bright because of fewer rebuilding issues 

and the fact that Mississippi is allowing the gaming 

industry, a key economic driver, to build casinos on 

land, allowing for larger and more luxurious facilities. 

However, in New Orleans, hurdles relating to levee 

protection, coastal restoration, and the need to elevate 

homes must be overcome. Although rebuilding will 

promote job growth, severe housing shortages in both 

areas will constrain the number of available workers in 

the near term. 

Overall, insured institution performance in the affected 

areas has been favorable. Banks and thrifts have 

reported strong deposit growth from public and private 

aid and insurance proceeds. Nearly all affected institutions are once again profitable, and many are reporting 

improved profitability, in large part a result of increasing NIMs. The median pretax ROA for all insured 

institutions based in the New Orleans and GulfportBiloxi metropolitan statistical areas (MSAs) climbed to 

1.58 percent in third quarter 2006, the highest level for 

this group of institutions since 1997. Similarly, the 

median NIM now stands at 4.30 percent, the highest 

level since 2000. In the near term, NIMs and profitability are expected to remain elevated because of the 

disbursement of billions of dollars in community development grants to owners of damaged homes. 

After weakening dramatically in the two quarters after 

Hurricanes Katrina and Rita, asset quality is now on par 

with, and in many cases improved from, pre-storm levels. 

In fact, the median past-due ratio for all insured institutions based in the New Orleans and Gulfport-Biloxi 

MSAs declined to an all-time low of 1.17 percent in 

third quarter 2006. Generally, real estate lenders in the 

affected areas required hazard and flood insurance, 

which has helped minimize losses in bank real estate 

loan portfolios. 

* Between October 2005 and November 2006, New Orleans 

recovered approximately 50,000 jobs (23 percent) lost as a result 

of Katrina. Since year-end 2005, the Gulfport-Biloxi area has 

recovered approximately 10,000 jobs (40 percent). 

opened in metropolitan counties, and only 12 opened 

in rural counties during this time. Furthermore, the 

FDIC Summary of Deposits database shows rural areas 

are generally characterized by greater concentrations 

of deposits in fewer institutions, suggesting that MidSouth rural-based community institutions face relatively less competition from other insured financial 

institutions than do banks in urban areas. 

Community banks in rural counties face the prospect 

of much slower growth than their urban counterparts 

in terms of deposits and loans. During the past five 

years, total deposits held in bank branches in MidSouth urban counties increased 44 percent, compared 

with 20 percent growth for banks based in rural counties. Reflecting fewer lending opportunities, community 

banks based in rural counties report weaker loan growth 

rates and lower loan-to-asset ratios than metro-based 

institutions. Although urban-based banks report more 

favorable credit quality, rural-based community banks 

generally mitigate higher past-due and charge-off ratios 

with higher levels of equity capital. 

Overall, continued slow growth by insured institutions 

based in Mid-South rural counties does not by any 

means suggest the demise of the small, rural community 

bank. However, should population continue to move 

from rural to urban areas, as has been the case for 

decades, rural-based banks likely will continue to face 

strikingly different prospects than their urban counterparts. Weaker deposit growth makes funding increasingly difficult, while weaker demand for loans may 

constrain earnings for rural banks. However, consolidation opportunities may exist among rural banks, 

perhaps providing some scale efficiencies in this slowerloan-growth environment.11 

Paul S. Vigil, Financial Analyst, pvigil@fdic.gov 

11 For more information on rural depopulation trends, see the FDIC’s 

Future of Banking studies at www.fdic.gov/bank/analytical/future. 

FDIC OUTLOOK 18 WINTER 2006 
Agricultural and Rural Issues Will
 

Determine Future of Kansas City
 

Region 

Rural and agricultural issues continue to drive the 

Kansas City Region’s economic and banking risk 

profile. The Kansas City Region is the most rural and 

agriculturally dependent of the six FDIC Regions, with 

a share of rural population that is more than twice the 

national average.1 These rural areas tend to rely heavily on agriculture. The Region’s FDIC-insured institutions reflect these rural characteristics. Foremost, the 

Region’s institutions tend to be much smaller than 

elsewhere in the country.2 The Kansas City Region is 

home to only 4 of the nation’s 122 institutions holding 

assets greater than $10 billion. Also, more than half 

the banks in the Region are farm banks, predominately 

located in rural communities.3 

Overall, the agricultural sector is performing well; 

U.S. farmers started 2006 on the heels of record-high 

net farm income. Although income levels declined in 

2006, they are still expected to reach the 10-year 

average in 2006.4 Despite this favorable performance, 

rural and agricultural issues—specifically ongoing rural 

depopulation trends, uncertainty surrounding the next 

farm bill, and continuing hydrological drought conditions—are expected to influence the regional economy and insured financial institutions in the near and 

long term. 

Depopulation Challenges Banks to 

Operate with Smaller Customer Bases 

Residents have been slowly migrating from the Region’s 

rural counties for decades, largely because technological 

advances in agriculture have reduced the need for farm 

1 Almost 35 percent (34.7 percent) of the Region’s population lived in 

rural areas in 2005, compared with less than 16 percent elsewhere in 

the country. U.S. Census, “2005 Estimates of County Population,” 

http://www.census.gov/popest/counties/. 2 More than 86 percent of the Region’s institutions hold less than 

$250 million in assets, while outside the Region two-thirds of banks 

and thrifts are this small. 

3 Farm banks are defined by the FDIC as insured financial institutions 

with at least 25 percent of loan portfolios invested in loans to agricultural operations or secured by agricultural real estate. 

4 U.S. Department of Agriculture, Economic Research Service, 

“2006 Forecast,” http://www.ers.usda.gov/Briefing/FarmIncome 

/nationalestimates.htm. 

laborers.5 In many areas of 

the Region, the pace of 

rural depopulation accelerated in the 1990s, raising 

concerns about the viability 

of many sparsely populated 

counties. This trend has continued into the 2000s, as 

328 of the Region’s rural counties lost population from 

2000 to 2005 at a greater rate than during the 1990s 

(see Map 1). 

MO

IA

MN

ND

SD

NE

KS

Kansas City

To date, FDIC-insured financial institutions in depopulating rural counties have performed well—similar to 

institutions in rural counties with growing populations. 

The primary differences in performance between these 

groups have been in loan and deposit growth, which 

has been considerably lower for institutions in depopulating counties.6 Because depopulation equates to a 

Map 1 

Rural Depopulation Trends Persist in the

Kansas City Region

Source: U.S. Census—County Estimates of Population.

2005 Compared with 2000

Category # of Counties 

Growing 

Declining, 

but not at an 

increasing rate 

Declining faster

than 1990s

49

241

328

5 For a detailed analysis of the causes and implications of rural depopulation in the Great Plains, see Jeffrey Walser and John Anderlik, 

“Rural Depopulation: What Does It Mean for the Future Economic 

Health of Rural Areas and Community Banks That Support Them?” 

FDIC Banking Review 16, no. 3 (2004): pages 57-95. 6 Ibid. An FDIC analysis showed that commercial banks headquartered in metropolitan statistical areas had ten-year annualized asset, 

loan, and deposit growth rates of 8.9 percent, 11.2 percent, and 8.6 

percent, respectively, between 1993 and 2003. In comparison, 

commercial banks headquartered in nonmetropolitan statistical areas 

had growth rates of just 4.4 percent, 6.8 percent, and 3.8 percent, 

respectively. 

FDIC OUTLOOK 19 WINTER 2006 
Region by Region: Banking Conditions in 2007 

declining customer base, this situation is slowly threatening the ability of many rural, community banks to 

obtain adequate funding and generate enough loans to 

remain in business. Many rural banks have opened 

branches in more vibrant counties, with varying results 

depending on the ability of bank management to operate in these new areas. To maximize profits in spite of a 

waning customer base, others have mastered operating 

efficiency by keeping costs down. Still other institutions have turned to the Internet as a source of deposits 

and loans. Although the Internet can be helpful to 

rural banks, it may also prove to be a “two-way street,” 

allowing large banks based in urban areas to successfully 

compete in rural areas. 

Rural depopulation is a slow-moving issue, and 

community banks have been able to adapt to its 

challenges thus far. It is likely that rural banks will 

continue to expand their reach to attract loans and 

deposits, which should stem major problems in the 

near term. Over the long term, however, continued 

depopulation could result in bank consolidation in 

rural areas. Also, as current managers retire, the ability 

to attract and retain qualified bank managers in rural 

areas is a concern that will likely become more pressing in coming years. 

Prosperity of Farmers Depends Heavily on the 

Future of Federal Farm Policy 

The Kansas City Region’s farmers rely heavily on the 

federal government for financial assistance in the form 

of price supports and emergency aid. Corn, soybean, 

and wheat crops are covered by government farm 

programs and are produced heavily in the Region. 

Consequently, government assistance to the Region’s 

farmers has been substantial. Over the past 16 years, 

the federal government has provided nearly half of the 

net farm income for the Region’s farmers compared 

with about a quarter for the rest of the nation (see 

Map 2). 

Because of the Region’s dependence on farm programs, 

producers and rural constituents are paying close attention to congressional discussions of the 2007 farm bill. 

Some in Congress want to continue the 2002 bill, 

which is favorable to farmers; however, the bill has 

opponents in other countries who claim that price 

supports distort world agricultural prices. In fact, Brazil 

has threatened World Trade Organization (WTO) litigation against U.S. corn and soybean programs followMap 2 

The Region’s Farmers Are Very Dependent 

on Federal Farm Payments 

Source: U.S. Department of Agriculture, Economic Research Service.

Government Payments 

to Net Farm Income,

1990–2005 (%) 

26–40

40–60

>60

43

49

53

45

68

35

35

U.S. Average = 25.1%

K.C. Average = 44.9%

ing successful challenges of the U.S. cotton program 

and the European Union sugar program. Others in 

Congress would like to take steps to reduce payments 

to farmers and replace them with funds for rural development.7 Still others would like to expand farm 

programs to include specialty crops, such as vegetables 

and fruits, which could cut funds for traditional 

program crops. 

Given farmers’ historic and ongoing dependence on 

federal farm payments, any changes to current 

programs could hurt their cash flow positions. Policy 

changes also may affect the price of farmland, because 

federal farm supports, which have existed in various 

forms since the 1930s, have been capitalized into property values.8 For example, one U.S. Department of 

Agriculture study estimates that 69 percent of North 

Dakota’s farmland value may be attributed to this 

expected stream of government payments. From a 

lending standpoint, cuts in programs would affect the 

value of underlying real estate collateral and the ability 

of farmers to repay their loans. The Region’s rural 

economies would also be affected by cuts to traditional 

programs, although shifts in funding to rural development could offset some of the potentially negative 

consequences. 

7 The WTO had been negotiating worldwide limits on agricultural 

support programs, which could have altered U.S. policy considerably. 

These negotiations, which had been ongoing since 2001, were 

suspended in July 2006 and are not expected to place mandates on the 

next farm bill. However, some members of Congress believe the next 

farm bill should take steps in the direction of the WTO discussions. 

8 Bruce Gardner, “U.S. Commodity Policies and Land Values,” in 

Government Policy and Farmland Markets, ed. Charles Moss and 

Andrew Schmitz (Ames, IA: Iowa State University Press, 2003). 

FDIC OUTLOOK 20 WINTER 2006 
Kansas City Region 

Long-Term Drought Conditions Continue to Stress 

Farmers 

The ongoing drought is one more agricultural challenge 

facing the Kansas City Region. Much of the Region is 

experiencing drought conditions, and parts of the 

Region—western Nebraska and Kansas, in particular—are well into their seventh year of drought. Conditions have worsened considerably during the past year, 

as below-average rainfall has added to long-term water 

shortages, commonly referred to as “hydrological 

drought” conditions (see Map 3). Timely precipitation 

through the growing season helped farmers in most 

areas produce adequate crop yields. In Kansas, however, 

wheat yields in 2006 were down 21 percent compared 

with 2005 levels; during the 2006 growing season, the 

state received just 14.4 inches of precipitation, 

compared with 21.5 inches the year before.9 

Hydrological drought conditions specifically refer to 

deteriorated levels in streams, reservoirs, and aquifers 

caused by several years of below-average rainfall and 

winter snowpack. In many areas of the Region, hydrological drought conditions are significant. For example, 

the Ogallala aquifer, a massive underground lake that 

sprawls beneath much of the Great Plains, has declined 

30 feet in some areas over the past decade.10 In addition, Lake McConaghy, the largest reservoir in 

Map 3 

Drought Conditions Have Expanded

Substantially in the Kansas City Region

Source: National Drought Mitigation Center.

September 27, 2005 September 26, 2006

A = Agricultural (crops, 

 pastures, grasslands)

H = Hydrological (water)

Abnormally Dry Drought Conditions

Moderate

Severe

Extreme

Exception

9 National Oceanic and Atmospheric Administration, “Climate at a 

Glance,” September 2006, 

http://lwf.ncdc.noaa.gov/oa/climate/research/cag3/ks.html. 10 Editorial, “Irrigation Is Mining a Finite Resource,” McCook Daily 

Gazette, October 3, 2006. 

Nebraska, is filled to only 22 percent of capacity.11 Also, 

stream flows in Kansas are below the levels posted 

during the extreme droughts of the 1930s and 1950s.12 

Water shortages have begun taking their toll on farmers 

who rely on irrigation to grow their crops, largely in 

Nebraska, Kansas, and South Dakota. For example, 

irrigation limits in Nebraska have been placed on about 

one-quarter of the state, and first-time limits will eventually encompass the rest of the state. In addition, 

more restrictive limits may be imposed in some areas. 

The reduction in available water for crop producers in 

the southern portion of Nebraska has already led to 

declines of 4.2 percent in irrigated land values in 2006, 

compared with an increase of 9.6 percent in land values 

statewide.13 The statewide average for irrigated cropland was $2,150 in 2006, compared with $1,450 for 

“dryland” (i.e., nonirrigated land). As irrigation limits 

become more restrictive, crop yields (and thus farm 

revenues) will be adversely affected, and irrigated farmland values will decline toward dryland values. 

It will take a substantial amount of precipitation to 

cure problems caused by the Region’s hydrological 

drought conditions. Unfortunately, the forecast indicates there is an equal chance of drought conditions 

worsening or improving over the next 12 months.14 

Bankers in the Kansas City Region are taking extra 

measures to mitigate loan portfolio risk, including 

conservatively valuing irrigated farmland, stress testing 

agricultural loans for yield shocks, and reviewing farm 

operations more frequently. 

Looking Ahead: 2007 and Beyond 

Of the three rural and agricultural issues facing the 

Kansas City Region, farm policy could exert the greatest impact in 2007. The 2007 farm bill will be viewed 

by many as a major test of corn, soybean, and wheat 

producers’ political strength. Any reductions in federal 

aid would constrain the debt-repayment ability of farm 

borrowers and potentially deflate prices for farmland— 

11 Central Nebraska Public Power and Irrigation District, Reservoir
 

Elevation and Platte River Flow Data, September 2006.
 

12 U.S. Geological Survey, “2000–2006 Flows at Some USGS Stream-


gauges Lower than 1930’s or 1950’s Droughts,” August 10, 2006.
 

13 Cornhusker Economics, University of Nebraska, Lincoln,
 

“Nebraska’s Agricultural Land Markets: Dynamic and Diverse,”
 

March 22, 2006.
 

14 National Weather Service, Climate Prediction Center, September
 

2006.
 

FDIC OUTLOOK 21 WINTER 2006 
Region by Region: Banking Conditions in 2007 

a major source of collateral coverage. Meanwhile, 

long-term drought conditions are expected to affect 

the Region’s farmers well into the future. Rural depopulation has the longest time horizon as the overall 

effects on the Region worsen each year as this trend 

accelerates. 

Two issues on the national radar screen—slowing housing markets and high energy prices—will not affect the 

Kansas City Region to the same extent as other parts 

of the country. The Region’s housing markets have not 

experienced the double-digit price increases seen in 

coastal markets, and, therefore, a slowdown in residential building and home sales is not expected to lead to 

outright declines in home prices. Rather, a deceleration 

in the already moderate rate of appreciation is more 

likely. In addition, higher energy costs have stressed the 

Region’s paycheck-to-paycheck consumers but have 

not substantially constrained most consumer spending. 

However, energy costs have affected farm operations as 

the cost of energy for agricultural use is forecasted to 

increase almost 10 percent in 2006 on the heels of a 

22 percent increase in 2005.15 

John M. Anderlik, Regional Manager, janderlik@fdic.gov 

15 Economic Research Service, 2006 Forecast. 

FDIC OUTLOOK 22 WINTER 2006 
Slower Housing Activity Clouds the 

Mid-Atlantic’s Economic Outlook 

Continued strength on Wall Street and growth of the 

health care and education sectors have been instrumental in the Mid-Atlantic’s current economic expansion.1 

However, recent weakness in the housing sector clouds 

the Region’s economic outlook as home price appreciation is decelerating in a growing number of markets 

across the Mid-Atlantic states.2 Job growth in the 

financial services and education and health care sectors 

may insulate the regional economy from a housing 

market slowdown. Nevertheless, given the importance 

of residential mortgage lending to the Mid-Atlantic’s 

banking landscape—a third of the area’s banks and 

thrifts specialize in residential mortgage lending—the 

slowing housing market may hinder earnings growth 

prospects for FDIC-insured institutions in the MidAtlantic. 

Wall Street Activity Continues to Fuel Mid-Atlantic 

Economic Growth 

The securities industry remains a critical element in the 

Mid-Atlantic economy because of the relatively high 

compensation (including salaries and bonuses) received 

by employees. According to the Securities Industry 

and Financial Markets Association, securities industry 

revenues have increased approximately 93 percent 

over the past two years. In addition, pretax profits are 

expected to be more than 60 percent higher in 2006 

than 2005, which would make 2006 the highest annual 

performance in six years.3 Strong industry performance 

boosted bonuses in the industry to an all-time high in 

2005, and estimates for 2006 indicate that bonuses 

exceeded last year’s levels.4 

Although employment in the Mid-Atlantic securities 

industry has not reached its pre-recession peak, 

compensation remains considerably higher than other 

1 The FDIC’s Mid-Atlantic area includes Delaware, Maryland, New 

Jersey, New York, Pennsylvania, Puerto Rico, and the U.S. Virgin 

Islands. Because of data limitations, the economic discussion 

excludes Puerto Rico and the U.S. Virgin Islands. 

2 Office of Federal Housing Enterprise Oversight, “House Price Appreciation Slows Further,” November 30, 2006. 

3 Securities Industry and Financial Markets Association, “Financial 

Data of NYSE and NASD Firms,” Income Statement and Selected 

Items, Third Quarter 2006. Fernandez, Frank, U.S. Securities Industry 

3Q06 Results. SIMFA Research Reports I, no. 6 (December 13, 2006). 4 New York State Comptroller estimate, December 2006. 

industries. Securities industry employment in New 

York City, the area’s financial nucleus, is down 19 

percent from the pre-2001 recession peak. However, 

the average Wall Street salary is more than five times 

higher than the average salary for other New York City 

industries. Annual compensation in the securities 

industry including salary and bonus averaged approximately $290,000 in New York City in 2005 with the 

average Wall Street bonus of $125,000.5 Security industry bonuses are estimated to increase 15 percent in 

2006 from the 2005 level.6 High earnings in the financial sector continue to boost salaries and job gains in 

such ancillary industries as professional and business 

services. Moreover, new company formation, from 

financial advisory firms to hedge funds, has contributed 

to economic wealth in surrounding states. 

VI 

MidAtlantic

DC 

PA

NY

NJ

DE 

MD

PR

Health Care and Education Have Emerged as Key 

Drivers of Mid-Atlantic Economic Growth 

Education and health care have been two of the bestperforming employment sectors in the Mid-Atlantic 

during the past 15 years, helping to offset weakness in 

the beleaguered manufacturing sector. Since 1990, the 

concentration of manufacturing jobs has declined by 

almost half, while the area’s share of health and education jobs has increased moderately. Despite the recent 

housing boom, the proportion of real estate–related 

jobs to total employment has been relatively stable 

during this time (see Table 1).7 Among the MidAtlantic states, Pennsylvania had the greatest share 

of manufacturing jobs to total employment at 11.7 

percent in third quarter 2006. Pennsylvania has lost 

almost 30 percent of its manufacturing jobs since 1990, 

exceeding the nationwide decline of 20 percent. 

5 Office of the New York State Comptroller, “The Securities Industry in 

New York City,” October 2006. 

6 Office of the New York State Comptroller, “Wall Street Bonuses Set 

New Record,” December 2006. The estimate represents an average 

for all securities industry employees. It does not include stock options 

that have not yet been exercised. 

7 Real estate–related sectors include all construction and financialrelated rental and leasing jobs, as defined by the Bureau of Labor 

Statistics. 

FDIC OUTLOOK 23 WINTER 2006 
Region by Region: Banking Conditions in 2007 

Table 1 Chart 1 

Growth in Mid-Atlantic’s Health 

and Education Employment Has 

Offset Declines in Manufacturing 

Share of Total Employment 

Sector 1990 2006 

Manufacturing 13.6% 8.0% 

Health/Education 12.8% 16.6% 

Financial 7.7% 7.3% 

Real Estate–Related 6.0% 6.5% 

Note: Data are fourth quarter 1990 and third quarter 2006. 

Source: Bureau of Labor Statistics, Haver Analytics. 

Contraction in the manufacturing workforce was more 

severe in the Mid-Atlantic than the nation and 

contributed to slower overall employment growth in 

the area. Among Mid-Atlantic states, only the 

Delaware job growth rate exceeded the nation for 

third quarter 2006.8 Long-term losses of manufacturing jobs have contributed to slower employment 

growth in some Mid-Atlantic areas as workers relocate 

to other parts of the country. However, steady growth 

in education and health care employment has mitigated the effect of manufacturing job losses on the 

Mid-Atlantic economy (see Chart 1). The area lost 36 

percent of manufacturing jobs since 1990. Meanwhile, 

education and health care–related employment in the 

Mid-Atlantic expanded 48 percent, the most rapid 

growth rate among industry sectors. Still, many of the 

new education and health care–related jobs pay less 

than manufacturing jobs, diminishing the positive 

effects of growth in this sector. In 2006, the average 

manufacturing job in the Mid-Atlantic paid more 

than $55,000 while the average salary among education and health care jobs was approximately $41,000. 

The emergence of the health care industry as a growth 

engine reflects, in part, the growing needs of the MidAtlantic’s aging population. According to the U.S. 

Census Bureau, Pennsylvania has the third highest 

percentage of population age 65 and older in the nation 

(about 15 percent of the total state population).9 Coincidently, Pennsylvania’s share of health care jobs to 

total nonfarm employment also ranked third highest in 

the nation, a ranking that has not materially changed 

in more than 15 years.10 New York has the fourth 

largest concentration of health care jobs to total 

8 Data are year-to-year quarterly job growth rates for third quarter
 

2006.
 

9 U.S. Census Bureau and Moody’s Economy.com.
 

Growth in Education and Health Jobs Has Offset 

Manufacturing Job Losses in the Mid-Atlantic

Source: Bureau of Labor Statistics, Haver Analytics.

Manufacturing

Education and Health

Total Employment Growth Percent Change: Year-to-Year –10

–5

0

5

1991 1994 1997 2000 2003 2006

employment, although the state’s share of the over-65 

population ranks only 21st in the nation. Nonetheless, 

New York’s presence as a national center for health 

care services contributes to the state’s large share of 

health care jobs. 

Slower Housing Activity Clouds the Mid-Atlantic’s 

Economic Outlook 

According to the Office of Federal Housing Enterprise 

Oversight (OFHEO), home price appreciation peaked 

in mid-2005 across most Mid-Atlantic housing markets 

and has trended down since then. For the first time in 

ten years, the OFHEO’s home index in New York state 

declined slightly in third quarter 2006 compared with 

the second quarter 2006. In addition, a growing number 

of markets are experiencing price declines. These 

markets include some of the perennially weaker housing markets in western Pennsylvania and upstate New 

York as well as Kingston and Long Island, New York, 

and Ocean City, New Jersey, markets that had previously experienced rapid price appreciation.11 History 

suggests that it could be a number of years until housing fundamentals catch up with home prices, which 

could result in stagnant or slightly lower prices in some 

Mid-Atlantic cities.12 After rising sharply, the inventory 

of unsold homes in some Mid-Atlantic areas stabilized 

toward the end of 2006. However, the level of unsold 

10 Data as of third quarter 2006.
 

11 OFHEO, Third Quarter 2006 Report. 


12 Cynthia Angell and Norman Williams. “U.S. Home Prices: Does Bust
 

Always Follow Boom?” FYI: An Update on Emerging Issues in Banking, February 10, 2005.
 

FDIC OUTLOOK 24 WINTER 2006 
New York Region: Mid-Atlantic 

homes remains high, particularly in the Washington, 

D.C., metropolitan area.13 

In addition, a number of metro areas in the MidAtlantic have seen elevated levels of investor home 

purchases. According to data collected by the Federal 

Financial Institutions Examination Council, Ocean 

City had the highest share of investor-owned housing 

in the nation in 2005 at 83 percent.14 In addition, 

Atlantic City, New Jersey, Glen Falls, New York, 

and Salisbury, Maryland, had higher percentages of 

investor-owned housing than the national average. An 

elevated level of investor ownership may exacerbate 

housing softness because investors may be more likely 

to sell a home in a declining market than someone 

who resides in the home. 

Although slowing appreciation and spot price declines 

suggest an end to the Mid-Atlantic’s housing boom, 

there were fewer and less severe home price declines 

through third quarter 2006 in the Mid-Atlantic states 

than in other parts of the nation, particularly California. According to the OFHEO, quarterly price declines 

occurred in more than half of the 28 California housing 

markets, while only 8 of the Mid-Atlantic’s 42 markets 

experienced price declines. 

Mid-Atlantic Employment May Be Less Sensitive to 

Housing Market Softness 

Employment conditions in the Mid-Atlantic states 

may be less vulnerable to a weaker housing sector than 

some other parts of the nation. Excluding Delaware, 

construction and real estate–related jobs contributed 

less to net new jobs in the Mid-Atlantic states than 

the nation and other states such as Nevada and California (see Chart 2).15 

In addition, except for Maryland, which experienced 

a sharp slowing of real estate–related employment, 

Mid-Atlantic states recorded relatively stable rates of 

construction and real estate–related job growth through 

13 Data from Maryland Association of Realtors and the Metropolitan 

Regional Information System, which covers Maryland and parts of 

Virginia and West Virginia. 

14 Data as of 2005. “Investor-owned housing” is defined as not owneroccupied home mortgages as a share of the sum of owner-occupied 

and not owner-occupied home mortgages. Federal Financial Institutions Examination Council under the Home Mortgage Disclosure Act 

(HMDA) via Moody’s Economy.com. 15 Data as of third quarter 2006. 

Chart 2 

Fewer Jobs Came from Construction and

Real Estate in Most Mid-Atlantic States

Construction and real estate-related sectors include all construction and financialrelated real estate rental and leasing jobs as defined by the Bureau of Labor Statistics. 

Data are not seasonally adjusted.

Source: Bureau of Labor Statistics, Haver Analytics.

NYNJPAMDUSCAFLDENV Percent of New Jobs 2004/Q3–2006/Q3

New Jobs From Construction

New Jobs From Real Estate

10

15

20

25

30

0

5

the first nine months of 2006. Continued growth in 

this sector may be due to increased office construction 

and rehabilitation, particularly in Washington, D.C., 

and New York, which mitigated the effect of slowing 

residential activity on overall construction employment.16 Because employment is a lagging indicator, the 

effects of a housing slowdown on employment may be 

forthcoming. 

Mid-Atlantic Residential Mortgage Lenders 

Experience Greater Net Interest Margin Pressure 

A relatively high concentration of mortgage loans, 

even among institutions that do not specialize in these 

loans, suggests the Mid-Atlantic’s banking industry 

continues to emphasize residential lending despite the 

continued growth in loans for commercial real estate 

(CRE).17 The median concentration of residential 

mortgage loans and mortgage-related securities to capital remains high among many banks and thrifts in the 

Mid-Atlantic states, with Pennsylvania, New Jersey, 

and Maryland ranking in the top ten nationwide.18 The 

median concentration level of CRE loans to capital, 

including loans secured by residential and commercial 

properties, has steadily increased. However, CRE 

16 Dana Hedgpeth, “Vacancy Rates, Asking Rents Hold Steady,” 

Washington Post, November 13, 2006. 17 The Mid-Atlantic median CRE loans-to-Tier 1 capital ratio is higher 

than in the early 1990s but remains just below the national average, at 

180 percent of Tier 1 risk-based capital, compared with 197 percent 

for the nation as of June 30, 2006. 

18 Median amounts as of June 30, 2006. Ratio includes loans secured 

by single-family residences and multifamily loans and mortgagebacked securities to Tier 1 capital. 

FDIC OUTLOOK 25 WINTER 2006 
Region by Region: Banking Conditions in 2007 

concentrations in the Mid-Atlantic states are not as 

elevated as concentrations of residential mortgage loans 

and securities. Among Mid-Atlantic states, at mid-2006, 

Maryland had the highest ranking of concentration to 

capital for CRE and construction and development 

loans, ranking 14th and 17th highest in the nation, 

respectively. 

Although the Mid-Atlantic is home to some of the 

nation’s largest and most diversified FDIC-insured institutions, almost one-third specialize in residential mortgage lending (“mortgage lenders”), which is three times 

the national average. Because of differences in the 

balance sheet structure of FDIC-insured mortgage 

lenders, these institutions tend to be more sensitive to 

changes in the yield curve and may be constrained by 

slowing housing activity. Mortgage lenders tend to 

borrow using short-term funding sources and invest in 

intermediate to longer-term assets. As a result, these 

lenders typically rely more on “spread” income—that is, 

the difference between short- and long-term interest 

rates—than other banking business models, resulting 

in greater vulnerability to a flat yield curve.19 

Since mid-2004, the Mid-Atlantic’s mortgage lenders 

have experienced more severe contraction in net interest margin (NIM) than mortgage lenders nationwide 

(see Chart 3). The differences in NIM performance are 

due, in part, to the higher level of long-term assets to 

total assets reported by Mid-Atlantic FDIC-insured 

institutions.20 Long-term assets make earnings more 

“liability sensitive” because asset yields reprice more 

slowly than liability costs when interest rates change. 

After rising steadily during the late 1990s, the share of 

long-term assets to total assets is stabilizing, consistent 

with the increasing popularity of adjustable-rate mortgages. However, the Mid-Atlantic’s median long-term 

asset ratio remains high at 55 percent, approximately 

equal to the 2000 level, compared with 43 percent for 

all mortgage lenders nationally. 

19 For example, through second quarter 2006, the median ratio of 

noninterest income to average assets was 0.45 percent for all FDICinsured institutions headquartered in the Mid-Atlantic, almost double 

the 0.26 percent median for the area’s mortgage lenders. 

20 Long-term assets that mature or reprice in more than five years 

plus collateralized mortgage obligations with an expected life greater 

than three years as a percentage of total assets, as of the end of the 

listed period. Reported for Call Report filers only; this item is not available for FDIC-insured institutions that file thrift financial reports. 

Chart 3 

A Flat Yield Curve Is Pressuring Net Interest

Margins of FDIC-Insured Mortgage Lenders

The yield curve is defined as the difference between the yield on the five-year Treasury 

rate and the three-month Treasury bill. Quarterly data through June 30, 2006. 

Source: FDIC. Annualized Quarterly Rate (median percentage) Yield Curve in Basis Points

`90`92`94`96`98`00`02`04`06

 Yield

Curve

Nation - Mortgage Lenders

2.5

3.0

3.5

4.0

–100

0

100

200

300

400

Mid-Atlantic - Mortgage Lenders

Housing Market Weakness Could Dampen Economic 

and Banking Outlook in 2007 

Mortgage credit quality remained sound through mid2006 as median past-due rates on total loans and residential mortgage loans reported by Mid-Atlanticheadquartered institutions were low and below the 

national median. However, the normal seasoning of 

new mortgage loans—coupled with slowing housingrelated employment, decelerating rates of home price 

appreciation (and price declines), and higher mortgage 

interest rates—could result in some credit quality weakening in 2007 from historically low levels. In addition, 

given the relative importance of the Mid-Atlantic 

housing sector, even modest home price declines could 

have a dampening effect on some local economies. 

Kathy R. Kalser, Regional Manager, kkalser@fdic.gov 

Norman Gertner, Regional Economist, ngertner@fdic.gov 

Alexander Gilchrist, Regional Economist, 

agilchrist@fdic.gov 

Special thanks to Cameron Tabor, Financial Analyst, 

Boston Area Office 

FDIC OUTLOOK 26 WINTER 2006 
Slow Growth Ahead for the 


New England Economy 

Employment in New England continues to expand, but 

concerns persist about the area’s economic outlook (see 

Chart 1). Its growth rate during the past year has been 

half the national average, and, unlike the nation, it has 

not recovered all jobs lost during the 2001 recession. 

During the past several economic expansions, gains in 

the technology sector have contributed strongly to 

growth in the New England economy. However, since 

the last recession, jobs have been slow to return to this 

key sector. On a positive note, job losses in high-technology industries have been offset in part by growth in 

services employment. 

Lowered Expectations for the High-Tech Sector 

The high-tech sector has long been a driver of the New 

England economy, even though this sector’s performance has been somewhat volatile over time. The 

computer-related boom of the 1980s was followed by a 

bust early in the next decade. The communications 

boom of the late 1990s preceded the “tech wreck” early 

in this decade. Since then, employment in almost all 

technology-related industries, except biomedical 

research, has contracted. Job losses were particularly 

heavy in electronic, computer, and communications 

equipment manufacturing. However, in recent years, 

layoffs have slowed, and the high-tech sector is now 

contributing modestly to employment growth. 

Chart 1 

New England Has Not Recovered All of the Jobs

Lost in the Previous Recession

Payroll Employment, Seasonally Adjusted

Source: Bureau of Labor Statistics, Haver Analytics. New England (in millions)United States (in millions)

`90`92`94`96`98`00`02`04`06

New England

United States

5.4

5.6

5.8

6.0

6.2

6.4

6.6

6.8

7.0

7.2

105

110

115

120

125

130

135

140

145

1.8% Below Peak

2.6% Above Peak

A review of high-tech 

employment trends in Massachusetts highlights broader 

regional trends in this sector during the first half of this 

decade.1 Overall, weakness is not occurring to the same 

extent across all subsectors of high tech. High-tech 

intensive industries, those with relatively high shares 

of employment in high-tech occupations, include 

computer system design services, computer and other 

electronic manufacturing, software publishing, Internet 

service providers, and data processing. In addition to 

pharmaceutical, including biotech, and aerospace 

manufacturing (industries with slightly smaller shares 

of high-tech jobs), these industries represented 

MA

New

England

ME

CT RI

NH VT

6.4 percent of total employment in the state in 2005— 

nearly double the 3.4 percent national average. 

Although impressive, this share of total employment 

was down from 7.7 percent in 2001. Other high-tech 

related industries (those with a considerably smaller 

share of high-tech related occupations) generated an 

additional 4.0 percent of all jobs in Massachusetts in 

2005, equal to the national average and only moderately below 2001 levels. Falling into the “other” category are architectural and engineering services, medical 

and technical consulting services, medical equipment 

and supplies manufacturing, and certain durable and 

nondurable manufacturing industries. 

Overall, the near-term employment outlook for the 

high-tech sector remains guarded, and prospects for 

growth are uneven across high-tech subsectors. The 

computer- and information-related industries have 

begun to recover jobs lost during the 2001 recession. 

However, these losses were considerable, and recent 

growth has been comparatively modest. Retooling for 

1 High Tech Employment and Wages by Industry, published by Massachusetts Department of Workforce Development, Division of Career 

Services, Economic Analysis Office, September 2006. Those industries identified as high-tech intensive industries are characterized by 

research and development (R&D) and high-tech occupations at least 

five times the average for all industries. Industries that have shares 

of R&D and high-tech occupations at least twice the average for all 

industries are identified separately as other high-tech related industries. Data for 2001 through 2005 are defined on the basis of the North 

American Industry Classification System and are not compatible with 

data from earlier years. 

FDIC OUTLOOK 27 WINTER 2006 
Region by Region: Banking Conditions in 2007 

Y2K, which was a driving force during the last hightech expansion, was a one-time phenomenon. At best, 

regaining peak employment levels in these industries 

appears years away.2 

By contrast, the outlook for biomedical firms is 

brighter.3 This subsector has been bolstered by breakthroughs, including those in genetic mapping, which 

are contributing to new technologies and opportunities 

for drug development. Further, the aging of the baby 

boom generation is increasing demand for medical services and improving the potential return on investment 

in biomedical research. Although the overall number 

of employees in this industry subsector is comparatively 

small, these firms are distinguished by considerable 

investment in research and development (R&D), with 

high value added per employee. Employment in life 

science-related industries is projected to expand a 

favorable 26 percent from 2004 through 2014.4 Recent 

evidence of the strength of the New England biotech 

sector is the establishment of research facilities by 

Novartis and Bristol Myers Squibb, major pharmaceutical firms. On balance, however, the outlook for 

employment growth in the broadly defined high-tech 

sector is relatively modest, especially when compared 

to previous boom periods. 

High Costs of Doing Business and Living Remain 

Obstacles to Growth . . . 

In addition to weakness in the high-tech sector, the 

New England states face other challenges. High 

employee costs make it more difficult for New England 

businesses to stimulate and sustain economic growth, 

particularly in the greater Boston metropolitan area, 

home to roughly one-third of the area’s total population. A review of salaries and bonuses shows that 

metropolitan areas elsewhere in the country with relatively large shares of high-tech employment generally 

pay employees less than employers in the Boston area.5 

Of six close competitors, only the San Francisco-San 

Jose-Oakland metropolitan area reported higher 

employee costs than Boston in 2005. 

Long-term changes in the Consumer Price Index tell 

much about the cost of living in New England. For one, 

high housing costs are constraining the ability of the 

New England states to attract new businesses and retain 

skilled workers. From 1980 to 2005, the cost of living 

in the Boston metropolitan area increased 3.9 percent 

annually, exceeding the 3.5 percent national average. 

Much of the difference is due to the more rapid 

increase in the cost of shelter.6 In Boston, shelter costs 

rose 4.9 percent, compared with 4.2 percent for the 

country as a whole during this time. 

In addition to the high cost of living, residents in the 

New England states pay more for electricity and natural 

gas than consumers in other parts of the country. The 

area literally is at the end of the nation’s energy 

pipeline. Although the New England states are relatively efficient in their use of energy, New England 

lacks major indigenous supplies.7 Looking ahead, cold 

winters and heavy dependence on home heating oil are 

cause for concern, given the continuing uncertainties 

in the global oil market. 

. . . And Weigh on Demographics 

A relatively high cost of living and doing business may 

be contributing to slowing rates of population growth 

in New England. This, in turn, may constrain business 

opportunities. The area’s population is growing more 

2 Employment in computer-related industries in 2014 is expected to 

be below 2004 employment levels. See Massachusetts Employment 

Projections through 2014, published by Massachusetts Department 

of Workforce Development, Division of Career Services, Economic 

Analysis Office, December 2006. See also accompanying report, 

Current and Projected Employment by Occupation and Education and 

Training Requirements, published concurrently by the Massachusetts 

Department of Workforce Development. 

3 See Massachusetts Employment Projections and Current and 

Projected Employment. 

4 Ibid. 

5 Occupational Pay Relatives, 2005, published by the Bureau of Labor 

Statistics, USDL: 06-1680, September 28, 2006. The greater Boston 

metropolitan area covers most of the commuting suburbs surrounding 

the city of Boston, including those in southern New Hampshire. 

6 Shelter costs include rent paid for primary residences, a similar 

rental valuation for homeowners’ primary residences, and the cost of 

lodging away from home. Rental valuations for homeowners represent almost three-quarters of total shelter expenditures. 

7 Energy Information Administration, State Energy Data 2003: 

Consumption, October 2006, Tables R1 and R2. Energy efficiency is 

measured by per capita usage of British thermal units. 

FDIC OUTLOOK 28 WINTER 2006 
New York Region: New England 

slowly than the U.S. average, in part as a result of outmigration and the fact that the population is older than 

in any other area of the country.8 Five of the six New 

England states have reported slower rates of population 

growth than the nation among working-age individuals 

(25 to 64 years of age) during the past ten years (see 

Chart 2). Looking ahead to the next decade, the U.S. 

Census Bureau forecasts slower growth in this age group 

across the country, but the deceleration in the New 

England states is expected to be greater. 

Taken together, unfavorable demographics and a high 

cost of living and doing business are making it increasingly difficult for firms in New England to remain 

competitive with other areas of the country as they 

attempt to hire and expand operations. For example, 

the August 2006 issue of the Boston Business Journal 

reported on the rising number of unfilled positions for 

many types of jobs and the fact that recruiters are facing 

significant challenges in finding suitable candidates.9 

Emerging Growth in the Services Sector Is a 

Bright Spot 

Given these trends, in addition to weakness in the 

high-tech sector, employment growth in the New 

England services sector is a welcome sign. Although 

Chart 2 

Most of New England Faces Slow

Workforce Growth

Growth in Population of 25- to 64-Year-Olds

Source: U.S. Census Bureau.

Census Bureau Forecast: 2005–2015

History: 1995–2005

0%

4%

8%

12%

16%

20%

U.S. MACT RIMEVTNH

8 For age and population growth data, refer to U.S. Census Bureau 

Web site at www.census.gov. For migration data, see David Agrawal, 

New England Migration Trends, Federal Reserve Bank of Boston, 

New England Policy Center, Discussion Paper 06-1, October 2006. 

9 “Mass. Suffering Talent Shortage,” Boston Business Journal, Vol. 26, 

No. 7, August 4–10, 2006, page 1. 

total growth in the services sector is modest, job growth 

in the professional and business services (which 

includes scientific research and development services) 

and education and health services subsectors is 

expected to be strongest.10 Employment in these two 

subsectors, representing more than 40 percent of New 

England services jobs, is expected to grow at a 1.9 

percent annual rate from 2006 to 2010, more than 

double the rate of total employment growth.11 In addition, employment in the financial services sector, traditionally a leading industry in New England, is expected 

to expand 0.9 percent annually through 2010.12 These 

trends are examples of the ongoing shift of jobs out of 

the traditional manufacturing base of New England 

into service sector jobs. The large number of colleges 

and universities as well as the area’s medical centers 

are contributing to a well-educated workforce that is 

supporting this transition to a knowledge-based, serviceoriented economy.13 Going forward, emerging strength 

in the services sector may provide a much-needed stimulus to the New England regional economy, mitigating 

continued weakness in the high-tech sector. 

Effects of the Housing Slowdown on New 

England Banks 

FDIC-insured institutions in New England continued 

to report strong capital levels and favorable credit 

quality through third quarter 2006. However, earnings 

did decline during the first nine months of 2006. The 

median pretax return on assets of 0.86 percent was the 

lowest since second quarter 1992 and well below the 

national median of 1.39 percent. 

This modest decline in profitability may be explained 

in part by the current unfavorable environment facing 

the nation’s mortgage lenders. The New England states 

are home to the largest share of mortgage lending 

specialists in the nation.14 In fact, the share is more 

than four times the national average (41 percent of 

institutions compared with 10 percent nationwide). 

10 Ibid.
 

11 New England Economic Partnership Economic Outlook 2006–2010,
 

November 14, 2006.
 

12 Ibid.
 

13 The Role and Impact of Colleges and Universities in Greater Boston
 

Today, a seminar conducted by Carol R. Goldberg Seminars and sponsored by the Boston Foundation (2005).
 

14 Mortgage lending specialists are defined as having more than 50
 

percent of total assets in one-to-four family residential loans and
 

mortgage-backed securities.
 

FDIC OUTLOOK 29 WINTER 2006 
Region by Region: Banking Conditions in 2007 

This group of institutions typically operates on 

narrower margins given the lower risk assumed, and the 

naturally lower returns tend to constrain the overall 

profitability of banks and thrifts across New England. 

Seventy-eight percent of all insured institutions in the 

New England states and 85 percent of the mortgage 

lending specialists reported narrowing net interest 

margins during the year ending September 30, 2006, 

compared with 53 percent of all institutions and 

78 percent of mortgage lenders nationwide. Funding 

costs, spurred by higher short-term interest rates, have 

increased more rapidly than asset yields for banks and 

thrifts in New England (see Chart 3). 

Signs of weakening in New England housing markets 

could affect the performance of the area’s mortgage 

lenders. Single-family home prices in New England 

appreciated more rapidly than in many other areas 

of the country from 2000 through 2005, averaging 

11.1 percent per year, 2.0 percent above the national 

average (see Chart 4).15 However, the rate of increase 

has decelerated across all New England states except 

Vermont during the past year. In third quarter 2006, 

home prices actually declined slightly in Massachusetts, 

New Hampshire, and Rhode Island. In addition to 

slowing rates of price appreciation, sales activity is 

Chart 3 

More New England Institutions Saw Margins 

Decline in the Last Year than the Nation

Source: FDIC. Change in net interest margin (NIM) calculated Sept. 2005 to Sept. 2006.

NIM Decrease

NIM Increase Percent of Institutions 100

0

80

60

40

20

20

40

60

New England Nation

Chart 4 

Home Price Appreciation Is Slowing in New England

Source: Office of Federal Housing Enterprise Oversight, Haver Analytics.

Price Change over Average of Initial

Three Quarters, 2005 to 2006

2000 to 2005 Average Annual Rate of House Appreciation

U.S.NERINHMAMECTVT

0%

2%

4%

6%

8%

10%

12%

14%

16%

declining and inventories of unsold homes are rising, 

further evidence of a slowing housing market. 

Despite this slowing, mortgage loan growth reported 

by New England-based insured institutions continued 

strong in 2006, with a median growth rate of almost 

10 percent. However, growth in the home equity 

loan portfolio slowed dramatically, falling a median 

4 percent during the year ending third quarter 2006, 

after expanding more than 20 percent in 2004 and the 

first half of 2005. Should housing sales and price appreciation continue to decelerate, mortgage loan growth 

likely will slow. FDIC-insured institutions concentrating in mortgage lending generally derive a large share 

of interest and fee income from mortgage-related activities, such as origination fees and servicing income, and 

these sources of revenue could decline with the current 

slowdown in the housing market. 

Continuing strength in the banking industry is also 

reflected in favorable credit quality. New England 

insured institutions reported a low 0.55 percent median 

past-due ratio for one-to-four family residential mortgage loans in third quarter 2006, compared with 

1.34 percent for the nation (see Chart 5). Overall, loan 

15 Office of Federal Housing Enterprise Oversight, House Price Index 

September 30, 2006, released November 30, 2006. 

FDIC OUTLOOK 30 WINTER 2006 
New York Region: New England 

Chart 5 

Residential Mortgages Past-Due in New England

Are Below National Level

Source: FDIC. Data through September 30, 2006.

Residental Mortgages Past-Due (Nation)

Residental Mortgages Past-Due (New England) Mortgages Past-Due (median %) 0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

`91`92`93 `95 `97`99 `01`03 `05 `94 `96 `98 `00`02 `04 `06

quality is holding up well with a median total past-due 

ratio of 0.86 percent, compared with 1.40 percent for 

institutions elsewhere in the country. 

As mortgage loan portfolios continue to season in the 

face of decelerating rates of home price appreciation 

(or price declines) and the possibility of higher mortgage interest rates, credit quality could weaken in 2007 

from historically low levels of past-dues and chargeoffs. Overall, however, banks and thrifts in New 

England appear prepared to weather the current slowdown in the housing market. 

Frederick S. Breimyer, fbreimyer@fdic.gov 

Susan H. Levy, sulevy@fdic.gov 

S. Cameron Tabor, ctabor@fdic.gov 

FDIC OUTLOOK 31 WINTER 2006 
Construction Sector Key to Growth in 

San Francisco Region 

Robust construction activity, particularly for residential 

real estate projects, has driven the recent economic 

expansion in the San Francisco Region.1 During the 

past two years, the construction sector has generated 

more than 250,000 new jobs across the Region and 

represented almost 20 percent of net job growth, 

compared with 12 percent for the rest of the country. 

As a result, commercial real estate (CRE) and construction loan growth has been strong, resulting in relatively 

high and increasing concentrations and improved asset 

yields for the Region’s banks and thrifts. A slowdown in 

the critical construction sector, however, could jeopardize the sustainability of this strong performance. This 

article assesses the implications for the regional economy and FDIC-insured institutions of continued deceleration in building activity and explores the potential 

for other key sectors to balance this slowing. 

Construction-Related Job Growth Is Vital for 

Several Western States 

Favorable population growth and low interest rates 

have spurred housing demand and boosted construction 

activity in the West. Population growth for the San 

Francisco Region as a whole has outpaced all other 

areas of the country every year since 1990. Furthermore, Nevada and Arizona have reported the most 

rapid rates of population growth in the nation during 

the 1990s and are projected to continue to rank at the 

top through 2010, according to the U.S. Census 

Bureau. As a result of the continued influx of new 

residents and the need for more residential and 

commercial buildings, several state economies now 

rely heavily on the construction sector to generate job 

growth. In particular, the construction sector in Idaho, 

Montana, Nevada, Utah, and Arizona generated at 

least 20 percent of overall net job growth in second 

quarter 2006 (see Chart 1). 

However, given recent signs of cooling in housing 

markets across the West, including declining home 

sales, slowing building activity, and decelerating rates of 

1 For purposes of this analysis, the San Francisco Region includes 

Alaska, Arizona, California, Hawaii, Idaho, Montana, Nevada, Oregon, 

Utah, Washington, and Wyoming. 

home price appreciation, job 

growth in the construction 

sector could become more 

volatile. In particular, California and Nevada reported 

significant year-over-year 

declines in construction job 

growth in 2006. Furthermore, 

the ripple effect of slowing job growth in constructionrelated sectors, such as real estate agencies, mortgage 

finance companies, and retail trade (particularly home 

improvement retailers), could exacerbate the negative 

effects of a construction slowdown on local economies. 

HI

AK

WY

WA

OR

NV

CA

San Francisco

MT

AZ

UT

ID

Going forward, commercial construction, particularly 

in the office and industrial sectors, could balance some 

of the anticipated declines in residential construction 

and buoy job growth overall in the construction sector. 

For example, data from Torto Wheaton Research 

show considerable new commercial property construction activity under way or planned in the Las Vegas 

market. These projects, involving general contractors 

as well as specialty trade workers such as electricians 

and plumbers, could compensate for slowing demand 

for residential construction in the Las Vegas market. 

Torto Wheaton Research also reports high levels of 

commercial construction under way in the Riverside 

and Phoenix metropolitan office and industrial 

markets that similarly could mitigate the negative 

effects of slowing residential construction activity. 

Chart 1 

Western States Rely More on Construction 

Job Growth and Could Be Hurt 

Disproportionately by a Slowdown

Source: Bureau of Labor Statistics.

Share of Total Jobs as of 

Second Quarter 2006

Share of New Jobs Created During 

the Year Ending Second Quarter 2006 Construction Sector Jobs (%)

0

5

10

15

20

25

30

IDMTNVUTAZWAORHIWYCAAK Nation

FDIC OUTLOOK 32 WINTER 2006 
San Francisco Region 

Services and Energy-Related Sectors Are Gaining 

Momentum in the West 

Growth in the services sectors, particularly health care 

and business services, may also temper some of the 

anticipated weakness resulting from slowing residential 

real estate markets. Together, these two service sectors 

added more than 200,000 new jobs in the Region in 

the year ending third quarter 2006. Strong demographic trends in many western states continue to drive 

demand for consumer and business services. Population 

growth was strong among the baby boomer cohort, 

particularly in relatively affordable areas such as 

Nevada, Arizona, and Oregon. In states such as California, where the rising cost of living and declining 

housing affordability have resulted in the exodus of 

baby boomers and retirees, international immigration 

has supported overall population growth.2 In fact, data 

from the U.S. Census 2005 American Community 

Survey indicate that 27.2 percent of California’s population is foreign born, the highest share of any state in 

the nation and more than twice the 12.8 percent share 

that foreign-born residents account for in the nationwide population. 

Higher energy prices have bolstered job growth and 

contributed to economic stability in some resourcedependent areas of the West, particularly Wyoming, 

but also in parts of Montana. Existing mining facilities 

have expanded, and favorable conditions have driven 

exploration and development of new mining sites. This 

upswing in the mining sector, in turn, has contributed 

to increased in-migration, encouraged higher residential and commercial construction activity, and stimulated job growth in other consumer services and retail 

sectors in many local economies.3 For example, as of 

third quarter 2006, Wyoming reported 4.2 percent yearover-year job growth, the most rapid rate in more than 

15 years and the fourth highest rate among all states in 

the nation. 

Construction Lending Has Contributed to Strong 

Profits for FDIC-Insured Institutions in the West 

Construction and development (C&D) loans, a component of CRE lending, has been the most rapidly grow2 “Regional Demographic Trends Affect Local Economies and the
 

Banking Sector,” FDIC Outlook, Spring 2006.
 3 Kirk Johnson, “Flush With Jobs, Wyoming Woos Rust Belt Labor,”
 

New York Times, September 13, 2006.
 

ing portfolio sector reported by banks and thrifts in the 

Region during the past several years.4 In second quarter 

2006, C&D loan growth in 10 of the Region’s 11 states 

outpaced the national median, and 6 of these states 

(Idaho, Nevada, Oregon, Utah, Washington, and 

Wyoming) ranked among the top 10 nationwide for 

growth in this lending segment.5 C&D loan concentrations correspondingly are higher among FDIC-insured 

institutions in the West. The Region’s median C&D 

loans-to-Tier 1 capital ratio has been higher than the 

national average since at least 1990 and was more than 

twice the average for the rest of the country as of 

midyear 2006 (see Chart 2).6 

Since 1998, pretax profits reported by FDIC-insured 

institutions in the West have exceeded those of banks 

and thrifts in the rest of the country (see Chart 3).7 

During this time, expanding C&D and CRE loan portfolios among institutions in the San Francisco Region 

benefited net interest margins and other noninterest 

income.8 The results of a Citigroup study show how 

returns on C&D loans can bolster bank profitability. 

Chart 2 

C&D Concentrations Among San Francisco Region

Insured Institutions Are High and Growing Rapidly

Note: San Francisco Region = AK, AZ, CA, HI, ID, MT, NV, OR, UT, WA, WY, and Pacific 

Islands. Data are as of June 30 of each year. C&D = construction and development.

Source: Federal Deposit Insurance Corporation.

Rest of Nation’s FDIC-Insured Banks and Thrifts

Banks and Thrifts in FDIC’s San Francisco Region C&D Loans-to-Tier 1 Capital Ratio (Median %)

199019921994199619982000200220042006

0

10

20

30

40

50

60

70

80

90

4 For purposes of this analysis, CRE loans include nonfarm nonresidential real estate loans, multifamily housing loans, and C&D loans. 

Complicating this analysis somewhat is the fact that C&D loans, as 

reported in regulatory reports, include loans made for residential and 

commercial property construction. 

5 C&D loan growth in Alaska matched the U.S. annual rate of 27 

percent at midyear 2006. 

6 CRE concentrations also are higher among FDIC-insured institutions 

based in the San Francisco Region with a midyear CRE loans-to-Tier 1 

capital median ratio of 360 percent, compared with 188 percent for 

institutions outside the Region. 

7 Pretax profits are used to improve comparability between the tax 

treatment for Subchapter S and other corporations. 

8 C&D loans generate loan origination fees as well as interest income. 

FDIC OUTLOOK 33 WINTER 2006 
Region by Region: Banking Conditions in 2007 

Chart 3 

San Francisco Region Insured Institutions’ Earnings

Continue to Outpace the Rest of the Nation

Note: San Francisco Region = AK, AZ, CA, HI, ID, MT, NV, OR, UT, WA, WY, and 

Pacific Islands. Data are as of June 30 of each year.

Source: Federal Deposit Insurance Corporation.

Rest of Nation’s FDIC-Insured Banks and Thrifts

Banks and Thrifts in FDIC’s San Francisco Region Pretax Return on Assets (Median %) 1.0

1.2

1.4

1.6

1.8

2.0

199019921994199619982000200220042006

This study estimates that C&D lending is second only 

to credit card lending in generating the highest return 

on assets; non-C&D CRE loans rank third.9 

Low provision expenses during the favorable credit 

environment of the past several years also contributed 

to higher earnings results in the Region as well as 

across the country. However, even as the growth in 

C&D and CRE lending during recent years bolstered 

profits, earnings of many of the Region’s FDIC-insured 

institutions now could weaken because of the ongoing 

retrenchment in the residential sector. Still, FDICinsured institutions in the Region currently report 

favorable asset quality and strong capital positions. For 

example, seven of the Region’s states ranked among 

the lowest in the country for past-due loan levels as of 

midyear 2006, while at the same time banks and thrifts 

in the majority of the states in the Region reported 

median Tier 1 capital-to-asset positions above the 

national average. Therefore, as a result of favorable 

asset quality and capital positions, the Region’s FDICinsured institutions appear well positioned to withstand 

continued slowing in the residential sector. 

Net Interest Margins Likely Will Face Continued 

Pressure 

Unlike banks and thrifts outside the Region, FDICinsured institutions in the West reported a slight 

improvement in net interest margins (NIMs) during 

the year ending second quarter 2006; increases in net 

9 Keith Horowitz, “CRE Disintermediation Is a Big Challenge for Mid 

Cap Banks,” Citigroup Industry Note, June 9, 2006. 

interest income outpaced growth in net interest 

expense in a rising interest rate environment. Similar 

to national trends, however, institutions based in the 

western states now rely more heavily on noncore funding sources; the median ratio of these somewhat more 

volatile deposits to average assets almost doubled 

during the past decade to 23 percent at midyear 2006.10 

A housing sector contraction could amplify this trend 

by limiting sources of core funds from activities such 

as title and escrow deposits. At the same time, FDICinsured institutions based in the San Francisco Region 

are developing Internet-based strategies to advertise 

and compete nationwide for customer deposits.11 

Collectively, these factors could result in a narrowing 

of NIMs for banks and thrifts in the Region. 

Conclusion 

Despite current strong economic and banking conditions in the West, increased reliance on historically 

volatile construction activity may stress local 

economies and the banking sector should the housing 

sector continue to weaken. An extended or sharp slowdown in construction activity could ripple through 

local economies and bank balance sheets and income 

statements. Although strength in other sectors—particularly the services sector—has emerged recently and 

could mitigate some of the negative effects of a slowing 

construction sector, elevated CRE and construction 

lending concentrations at FDIC-insured institutions 

will continue to be monitored closely for any signs of 

weakening in credit quality. 

Shayna M. Olesiuk, Regional Manager, solesiuk@fdic.gov 

Thomas A. Murray, Senior Financial Analyst, 

tmurray@fdic.gov 

10 This compares with a median of 22 percent for the rest of the 

nation. Noncore funding includes brokered deposits, time deposits 

more than $100,000, and other borrowed funds, such as purchased 

federal funds. 

11 Although Internet-derived deposits carry a greater degree of 

volatility because of customer “rate-shopping,” these deposits are 

considered “core” deposits if the amount is less than $100,000. 

FDIC OUTLOOK 34 WINTER 2006