Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION THIRD QUARTER 2000 

FDIC
 

Boston
 

Region
 

Division of
 

Insurance
 

Daniel Frye,
 

Regional Manager
 

Norman Williams,
 

Regional Economist
 

Cameron Tabor,
 

Senior Financial
 

Analyst
 

Andrea Plante,
 

Economic Analyst
 

Regional Perspectives 

◆ Region’s Economic and Banking Conditions—Overall job growth remained 

steady in the Boston Region during the first half of 2000, while the increase in per 

capita income in 1999 exceeded that for the nation for the fifth consecutive year. 

The Region’s insured institutions continue to report stable conditions. Widespread 

growth in commercial and industrial and construction and development loans continues. See page 3. 

◆ Capital Ratios at the Region’s Insured Institutions, although High by Historical 

Standards,Are Declining in Some Sectors, while Some Risk Indicators Have Been Rising—Declining capital ratios have been most pronounced in publicly held companies. An increasingly higher-risk asset mix is also contributing to declining 

risk-based capital levels. The trend of declining capital ratios bears watching given 

that some risk indicators are increasing and new risks are emerging. See page 5. 

◆ The Region’s Economic Link to the Stock Market Generates Benefits and Risks— 

Greater Boston and Fairfield County, Connecticut, have benefited meaningfully 

from a strong stock market, but both could experience a significant deceleration in 

growth should capital markets enter a protracted period of weakness. See page 7. 

By the Boston Region Staff 

In Focus This Quarter 

◆ Ranking Metropolitan Areas at Risk for Commercial Real Estate Overbuilding— 

Commercial real estate construction has boomed in a number of U.S. metropolitan 

markets during recent years amid falling vacancy rates and growing demand for new 

space. Insured depository institutions have reasserted their role as primary sources of 

capital for this construction boom, particularly in the wake of the 1998 financial markets crisis that left some important market-based lenders on the sidelines. Recent 

data for some metropolitan areas show that on-balance-sheet exposures of FDICinsured institutions are by some measures higher now than at the peak of the last 

commercial real estate cycle during the late 1980s. This article reassesses major U.S. 

metropolitan real estate markets in search of possible signs of overbuilding that could 

drive up vacancy rates and drive down rents in the near term. This review points to 

an underlying trend of markets experiencing more vigorous construction activity 

across multiple property types. See page 11. 

By Thomas A. Murray, Senior Financial Analyst 

◆ Rising Home Values and New Lending Programs Are Reshaping the Outlook for 

Residential Real Estate—Rising home prices and high levels of activity in the singlefamily housing market have been supported by excellent economic conditions and 

generally low interest rates. However, as interest rates have begun to rise, housing 

market activity has slowed. Historically, residential real estate has been one of the 

best-performing asset classes at insured institutions. Concerns have recently arisen, 

however, that new, higher-risk lending lines of business could adversely affect the 

future credit quality of residential real estate portfolios. See page 19. 

By Alan Deaton, Financial Economist 

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

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

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

geographic regions: 

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

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

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

Dallas Region (CO, NM, OK, TX)
 

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

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

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

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

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

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

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

more information or to provide comments or suggestions about the Boston Region’s Regional Outlook, please call Daniel Frye at (781) 794-5678 or send an e-mail to dfrye@fdic.gov. 

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

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

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

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

the Federal Deposit Insurance Corporation. 

Chairman Donna Tanoue 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Writer/Editor Kim E. Lowry 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Richard A. Brown 

Ronald L. Spieker 

Publications Manager Teresa J. Franks 
Regional Perspectives
 

Regional Perspectives
 

•	 Overall job growth remained steady in the Boston Region during the first half of 2000, while the increase in 

per capita income in 1999 exceeded that for the nation for the fifth consecutive year. 

•	 The Region’s insured institutions continue to report stable conditions. Widespread growth in commercial 

and industrial and construction and development loans continues. 

•	 Capital ratios at the Region’s insured institutions, although solid by historical standards, are declining, 

while some risk indicators have been rising and new risks are emerging. 

•	 Greater Boston and Fairfield County, Connecticut, have benefited meaningfully from a strong stock market, but both could experience a significant deceleration in growth should capital markets enter a protracted period of weakness. 

Region’s Economic and Banking Conditions 

New England Job Growth Remained Solid 

in Early 2000 

The Boston Region continued to experience healthy job 

growth through the first six months of 2000. The 

Region’s nonfarm employment rose an average of 1.9 

percent from year-ago levels, modestly below the 

nation’s 2.3 percent pace. This growth rate equaled the 

1999 pace but fell below 1998 levels. During the first 

half of 2000, New England’s manufacturing sector 

again shed jobs on net, with factory employment dropping an average of 1.2 percent (year-on-year). This rate 

of decline was slightly more than double the national 

rate. As was the case during the past two years, the 

Region’s construction sector posted job growth in 

excess of the nation through mid-2000. The trade and 

finance/insurance/real estate sectors also narrowly 

exceeded national growth rates through June, while 

other sectors lagged. 

Labor markets generally continued to tighten across the 

Region early this year. The Region’s seasonally adjusted 

unemployment rate dropped from 3.1 percent in 

December 1999 to 2.7 percent by June 2000, compared 

with 4.0 percent for the nation as of June 2000. Across 

the Region, seasonally adjusted unemployment rates in 

June were below 3 percent, except in Maine (3.4 percent) and Rhode Island (3.9 percent). Connecticut 

reported the Region’s lowest unemployment rate (2.3 

percent) in June. Midyear unemployment rates were significantly below year-end levels in all states except 

Rhode Island (unchanged) and New Hampshire (higher). While New Hampshire’s rising jobless rate can be 

attributed to a slowing in job growth, Rhode Island’s 

unemployment rate remained essentially unchanged 

between December and June despite an acceleration in 

job growth as more persons entered the labor force, filling new job openings. 

Per capita income data for 1999 show that New England’s 

growth again exceeded the nation’s (see Chart 1). Except 

for the past recession, income growth in the Region has 

typically surpassed that of the nation. Trends in the 

Region’s income (as in many of its other economic 

indicators) are driven by its two most populous states, 

Massachusetts and Connecticut. Although these 

states’ job growth has generally lagged the nation’s 

because of demographic constraints and greater business operating costs, concentrations in well-paying 

industries and professions (and a higher cost of living) 

CHART 1 

1 

2 

3 

4 

5 

6 

7 

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

Personal Income per Capita

(% change on year ago)

Region 

Nation 

Region’s per Capita Income Growth Has 

Outpaced the Nation’s for the Past Five Years 

Source: Bureau of Economic Analysis 

Boston Regional Outlook 3	 Third Quarter 2000 
Regional Perspectives
 

typically have resulted in favorable income comparisons with the nation, particularly during the “Massachusetts Miracle” period in the 1980s. More recently, 

the rapid rise in U.S. equity prices since 1995 has benefited income growth in these two states, given concentrations of employment in the securities and 

information technology industries, as well as higher 

average household holdings of financial assets. In 

1989, before the last recession, the Region’s per capita 

income reached a peak of 120 percent of the national 

level. After falling to less than 116 percent in 1992, this 

ratio increased to 119 percent by 1999. While Connecticut’s per capita income relative to the nation is still 

modestly below its 1990 peak, the ratio of state to U.S. 

per capita income in Massachusetts is now the highest 

in 20 years. 

Banks Report Stable Conditions: Modest Core 

Deposit Runoff and Thinning of Margins 

Continue 

The Region’s insured institutions continue to report stable conditions (see Table 1). Excluding credit card specialists, the aggregate return on assets for the Region 

was 1.29 in first quarter 2000, an increase of 7 basis 

points from the prior year. Net interest margins of the 

Region’s larger institutions (those with assets greater 

than $1 billion) continued to decline, while margins at 

the smaller institutions remained relatively flat. Some 

signs of weakening have emerged, as the aggregate pastdue loan and net charge-off ratios rose slightly as a 

TABLE 1 

result of increases in the larger commercial institutions’ 

commercial and industrial (C&I) portfolios. However, 

the past-due ratio continued to fall in the Region’s 

smaller institutions and remains low in aggregate compared to that of the nation. 

Core deposits as a percentage of assets continued to 

decline for all asset categories in the Region’s insured 

institutions. In the wake of increased competition for 

traditional deposits, institutions are relying more on 

noncore sources of funding to support loan growth. The 

use of noncore funding has been steadily increasing to 

offset slow deposit growth, as total loan growth outpaced core deposit growth in the Region by an average 

of 4 percent over the past four years. This growth in borrowings has been used to fund growth in traditionally 

riskier types of loans. 

C&I lending continues to be brisk and widespread, 

with a median increase of 15 percent for the year ending March 31, 1999, and 19 percent for the 12 months 

ending March 31, 2000. Construction and development 

(C&D) loans have increased throughout the Region as 

well, with median growth rates of 15 percent (year 

ended March 31, 1999) and 18 percent (year ended 

March 31, 2000). Concentration levels of C&D loans 

as a percentage of total assets have increased slightly, 

as have delinquency rates, but remain low compared 

with peak levels witnessed in the early 1990s. Such 

concentration levels bear monitoring, as C&D loans 

have traditionally been a risky segment of the loan 

portfolio. 

Financial Performan

BOSTON REGION* 

MARCH 

’00 ’99 ’98 

ce at Insured Inst

<$1 BILLION* 

MARCH 

’00 ’99 ’98 

itutions Remains

>$1 BILLION 

<$25 BILLION* 

MARCH 

’00 ’99 ’98 

Solid 

>$25 BILLION* 

MARCH 

’00 ’99 ’98 

RETURN ON 

ASSETS (ROA) 1.29 1.22 1.23 1.09 1.06 1.11 1.19 1.05 1.13 1.39 1.34 1.31 

NET INTEREST 

MARGIN (NIM) 3.79 3.86 3.90 3.92 3.78 4.00 3.50 3.55 3.62 3.83 4.00 3.95 

PAST-DUE RATIO 1.69 1.63 1.82 1.41 1.77 2.20 1.18 1.55 1.80 2.02 1.60 1.67 

NET CHARGE-OFF 

RATIO 0.50 0.38 0.48 0.08 0.04 0.07 0.19 0.23 0.27 0.81 0.57 0.74 

CORE DEPOSITS/ 

ASSETS 48.80 51.70 55.21 69.97 71.49 73.80 59.55 62.80 63.78 37.50 40.84 45.56 

NONCORE 

FUNDING/ASSETS 38.15 35.85 33.55 18.95 16.93 14.55 31.38 27.66 27.05 47.44 45.45 42.65 

* All data exclude credit card institutions. 

Source: Bank and Thrift Call Reports; reported on a merger-adjusted basis 

Boston Regional Outlook 4 Third Quarter 2000 
Regional Perspectives
 

Current Trends in Capital Merit Watching 

Many Insured Institutions Are Reducing Capital CHART 3 

–15 

–0 

–5 

0 

5 

10 

15 

Loan Growth Rates (annual %

’94 ’95 ’96 ’97 ’98 ’99 ’00

change, Q1 to Q1)

Residential 

Source: Call Reports, merger-adjusted, excluding credit card institutions 

Nonresidential Loan Growth in the Region 

Remains Strong 

Nonresidential 

Ratios while Other Indicators of Risk Have 

Been Rising and New Risks Are Emerging 

The Region’s insured institutions report relatively high 

levels of capital; however, aggregate capital ratios have 

been declining. As of first quarter 2000, the aggregate 

Tier 1 leverage ratio was 7.31 percent, 62 basis points 

lower than the 7.93 reported in first quarter 1996 (see 

Chart 2). In addition, over the same period, the aggregate 

Tier 1 risk-based capital ratio of 9.62 percent and the 

total risk-based capital ratio of 12.44 percent fell by 196 

and 111 basis points, respectively. The trend of declining 

capital ratios bears watching, given that some risk indicators are increasing and new risks are emerging. 

One indicator of heightened credit risk is the increase in 

the ratio of risk-weighted assets1 to assets (see Chart 2). 

Generally, risk-weighted assets are calculated by discounting categories of assets and credit equivalent 

amounts of off-balance-sheet items according to their 

perceived risk of loss. Therefore, a higher ratio is theoretically indicative of greater credit risk. 

Two factors appear to contribute to the higher level of 

risk-weighted assets. First, the mix of assets that insured 

institutions maintain on the balance sheet is shifting. 

Residential loans, perceived to have lower credit risk, 

have diminished in size as a percentage of the total loan 

portfolio. As shown in Chart 3, growth in residential 

CHART 2 

Tier 1 Ratio Falls as Risk-Weighted Assets
 

Increase in Region
 

8.4 80 

loans has been slow in comparison to higher-risk loans. 

In addition, concentrations in U.S. Treasuries and government agency securities, which are significantly 

discounted because of their low credit risk, are declining. 

In the first quarter of 2000, U.S. Treasury and government agency securities were 13 percent of total assets, 

versus 20 percent six years earlier. 

The second factor that may have increased riskweighted assets is the growth in off-balance-sheet 

items. Unfunded commitments, other than credit card, 

were 386 percent of Tier 1 capital as of March 31, 2000, 

versus 244 percent as of March 31, 1993. This increase 

in commitments may expose institutions to greater risk 

in the event of a downturn in the economy, as borrowers 

will likely use more of their unfunded lines. 

Increasing levels of asset securitization may also be 

adding to the level of credit risk. Asset securitization 

often results in the highest-quality loans being sold, 

Tier 1 Leverage Ratio

Risk-Weighted Assets

 (% of total assets) 

Q1 Leverage (left scale) 76 8.0 leaving an insured institution with relatively lowerquality assets on the balance sheet. Should the economy 

turn downward, losses on these loans would be more 

likely to increase. In general, the Region’s credit risk 

profile appears to have risen. 

72 

7.6 

68 

7.2 Q1 Assets (right scale) 64 

6.8 60 

6.4 56 

’94 ’96 ’98 ’00 The ability to strengthen capital may also be limited as a 

result of earnings declines caused by lower net interest 

margins. In recent years, interest rate risk at many 

Source: Call Reports, merger-adjusted, excluding credit card institutions insured institutions has risen. Owing to the shape of the 

yield curve, borrowers have been seeking long-term, 

A detailed description of the methodology used to calculate risk- fixed-rate credit, while depositors remain partial to 

weighted assets is in Appendix A of Part 325 of FDIC Rules and Reg- short-term instruments. As a result, many insured 

ulations. 

Boston Regional Outlook 5 Third Quarter 2000 

1 
Regional Perspectives
 

institutions have seen a widening mismatch of maturities 

between assets and liabilities. The widening of maturities may cause interest expense to rise more rapidly than 

interest income if interest rates rise (see Regional Perspectives, second quarter 2000). 

Some advancements in technology may also jeopardize 

earnings. The advent of the Internet has intensified 

local competition, as consumers have more opportunity 

to “shop” rates for loans and deposits or conduct business beyond local markets. The increased competition 

could place additional pressure on margins, as insured 

institutions may be forced to raise deposit rates while 

lowering loan rates. Lower margins arising from higher 

interest rates or greater competition may decrease 

earnings and restrain future capital growth. 

New regulations may also affect the amount of capital a 

bank should hold. Under current prompt corrective 

action rules, an insured institution with a tangible 

equity-to-asset ratio of 2 percent or less can be closed. 

Before these rules were implemented in 1991, in order 

for an insured institution to be closed, the equity-to-asset 

ratio had to be less than zero percent. Consequently, the 

amount of capital cushion available to banks to prevent 

closure has been reduced. 

Besides capital, other funds available to cover losses are 

also diminishing. “Hidden” capital in the form of tax loss 

carrybacks has been greatly reduced. Before 1994, banks 

were allowed to carry back losses for ten years. Currently, however, losses can be carried back only two years. In 

addition, despite increasing credit risk, loan loss reserve 

levels are shrinking. The ratio of loan loss reserves to 

gross loans as of quarter-end is 1.7 percent, down significantly from 3.0 percent in first quarter 1992. 

Finally, the expansion into new business ventures such 

as insurance and securities underwriting and sales could 

maintaining high capital levels, they often do so at the 

expense of equity returns. As a result, some institutions 

may strive to boost returns aggressively through the use 

of leverage. Although borrowing money to purchase or 

originate interest-earning assets may increase earnings, 

it also causes the Tier 1 leverage capital ratio to decline. 

Subsidiaries of large publicly traded banking companies 

in the Region appear to have adopted this strategy. At the 

end of first quarter 2000, the large publicly traded institutions showed a median Tier 1 leverage capital ratio of 

6.72 percent, 109 basis points lower than in first quarter 

1996. During this time, the return on equity increased 

about 353 basis points, while borrowings as a percentage 

of assets increased from 10 percent to 21 percent. As 

seen in Chart 4, the median Tier 1 leverage capital ratio 

for banking subsidiaries of all publicly traded companies 

in the Region has been declining since 1997, primarily 

because of the large institutions, while mutual and closely held institutions’ ratios have been rising. These trends 

suggest that shareholder pressure at publicly traded companies may result in the adoption of potentially higherrisk strategies, including greater operating leverage, to 

increase equity returns and shareholder wealth. 

Large publicly traded institutions are also the primary 

contributors to the decline in the aggregate risk-based 

capital ratio for the Region’s insured institutions. As of 

first quarter 2000, the Tier 1 risk-based capital ratio and 

the total risk-based capital ratio for these institutions 

were 8 percent and 11 percent, respectively. These ratios 

are down by 219 basis points and 133 basis points, 

respectively, from four years earlier. 

The lower risk-based capital ratios may also be attributable to pressure from stockholders. As depicted in 

CHART 4 

Tier 1 Leverage Capital Ratio Is Lower 

in Public Institutions 

also affect the amount of capital that an insured institution should maintain. These activities, along with other 

nontraditional banking services, can increase systems, 

reputational, operational, regulatory, and legal risks. 

Large Publicly Traded Institutions Contribute 

Significantly to Lower Aggregate Capital Ratios 

Given the extraordinary performance of the stock market 

Q1 Median Tier 1 Leverage Ratio

11 

Mutuals 

10 

Closely Held 

9 

Public 8 

Large Public 7 

6 

’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 

over the past few years, publicly traded institutions have 

been pressured to provide higher returns to stockholders. Source: Bank and Thrift Call Reports 

While insured institutions may limit the risk of failure by 

Boston Regional Outlook 6 Third Quarter 2000 
Regional Perspectives
 

CHART 5 

50 

60 

70 

80 

90 

’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 

Risk-Weighted Assets/Assets

Other 

Source: Bank and Thrift Call Reports 

Risk-Weighted Assets Increasing More Rapidly 

in Large Public Institutions 

Large Public 

Chart 5, the increase in risk-weighted assets is particularly pronounced for large publicly traded institutions. 

In general, during periods of economic prosperity, 

higher risk-weighted assets provide greater yields than 

lower risk-weighted assets. Therefore, the increase in 

risk-weighted assets may be a result of some returnconscious management teams shifting the asset mix to 

a greater weighting in traditionally higher-risk loan 

types. 

Summary 

Although capital ratios remain relatively high, the 

amount of risk that insured institutions are accepting 

appears to be increasing. The trend of decreasing capital 

in the face of increasing levels of risk should be monitored to ensure that capital ratios remain adequate. 

In the past few years, large public institutions that have 

tried to provide strong returns to shareholders have 

taken on a greater degree of operating leverage. This 

strategy has improved short-term equity returns during 

the current period of prosperity but may exacerbate 

poor returns during a period of financial hardship. 

Stock Market Gains Have Benefited New England, but May Also Pose a Risk
 

Stock Market Benefits Region’s Consumer 

Confidence and Spending 

New England, particularly Connecticut and Massachusetts, has been among the nation’s greatest benefactors from the late 1990s “wealth effect.” Conceptually, 

the wealth effect is a gain (loss) in household spending 

that occurs given a gain (loss) in net worth. The change 

in spending is usually a small fraction of the change in 

wealth. In recent years, much of the increase in household net worth (leading to increased wealth-effect 

spending) has been driven by a surging stock market. 

Many U.S. households have enjoyed increased employment opportunities, income (through higher pay, 

bonuses, and stock options), and investment gains 

because of a rising stock market. Appreciation in home 

equity is also thought to contribute to household wealth 

and thus to wealth effect spending. A broader definition 

of the wealth effect also would encompass much of the 

recent business investment, hiring, and spending that 

has arisen from the strength in equity markets. The 

strong stock market has boosted business spending and 

investment by providing many firms with a lower cost 

of capital, decreased pension funding costs, and 

increased product demand (arising from business and 

consumer multiplier effects). In New England it is likely 

that the general surge in equity valuations in the latter 

half of the 1990s significantly boosted household 

income, wealth, and business hiring and investment. 

The economic research and consulting firm Economy.com 

has identified Connecticut and Massachusetts as ranking 

among the states most exposed to the wealth effect. This 

assessment is based on criteria such as the location of 

(and employment in) financial services and information 

technology firms, household stock holdings, and state 

and local tax receipts from capital gains and property 

taxes. Although these states have benefited significantly 

from the recent increase in equity prices, they are also 

among the states most at risk from any sustained reversal in U.S. capital markets. 

The linkage between shifts in the stock market and 

household spending can be seen readily at the national 

level. A comparison of quarterly changes (at annual 

rates) in the broadly based Wilshire 5000 stock market 

index with nominal U.S. personal consumption expenditures shows a 0.45 positive correlation between 1995 

and first quarter 2000.2 However, in the absence of 

2 While still positive, this correlation falls to only 0.24 if the entire 

decade of the 1990s (or the 1980 to 2000 period) is considered. 

Boston Regional Outlook 7 Third Quarter 2000 
Regional Perspectives
 

accurate personal consumption expenditure data at the 

state/regional level, we examine consumer confidence 

instead. Shifts in consumer confidence are closely 

linked to changes in consumer spending (including that 

component driven by household wealth). A comparison 

of the Wilshire 5000 with New England and U.S. consumer confidence highlights the stock market’s effect 

on consumer confidence, and thus wealth-effect spending. Looking simply at levels between 1995 and mid2000 it is evident that the near-tripling in the Wilshire 

5000 had a more pronounced effect on New England 

consumer confidence than it did for the nation, especially between 1996 and 1997 (see Chart 6). 

Further, during the market slump in late 1998, the 

decline in New England consumer confidence was 

greater than that for the nation, suggesting the Region 

has a somewhat elevated sensitivity to near-term shifts in 

the stock market. If reliable confidence measures were 

available for greater Boston and Fairfield County, 

Connecticut, this positive correlation likely would be 

much greater than those for either the Region or nation. 

The following section examines employment as a way of 

measuring local drivers of the wealth effect. 

CHART 6 

0 

50 

100 

150 

200 

250 

300 

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

Quarterly Index

’94–’95 avg = 100

National CC 

Wilshire 5000 

New England CC 

The Stock Market Has Some Influence on the 

Region’s Level of Consumer Confidence 

CC = Consumer confidence 

Source: Conference Board and Haver Analytics 

3 For the purposes of this article, the information technology industry 

is defined as the manufacture of computer and office equipment (SIC 

code 357), communication equipment (SIC code 366), and electronic 

components (SIC code 367) as well as computer and data processing 

services (SIC code 737). 

Nature of Local Employment Influences 

Dependence on Stock Market 

The structural nature of county-level employment can 

provide some indication of a local economy’s exposure 

to the vagaries of the stock market. Certain industries, 

such as securities/asset management, usually increase 

employment and pay concurrent with any escalation in 

equity markets. Others, such as information technology,3 rely to a great extent on equity gains or venture capital funding (which is most readily available in bullish 

equity markets) to support ongoing operations. Growth 

at these companies, both internal and through acquisitions, is also financed primarily through equity. Chart 7 

highlights the exposure to securities industry jobs in 

Fairfield County, Connecticut (that state’s most proximate county to New York City’s financial markets) and 

Suffolk County, Massachusetts (Boston). 

The chart plots the share of local securities industry 

jobs relative to the nation during the first quarter of 

each year, with any value above 1 marking a greater 

concentration of these jobs than the nation. Both counties experienced an increase in employment in this 

industry during the 1990s, with Fairfield County’s payrolls peaking at approximately twice the national share 

in recent years. Suffolk County, meanwhile, has come 

full circle from the late 1980s, with its share of securities industry jobs again around seven times the national 

average. 

CHART 7 

1.0 

1.5 

2.0 

2.5 

1990 1992 1994 1996 1998 2000 

6.0 

6.5 

7.0 

7.5 

Suffolk County, MA (right scale) 

Fairfield County, CT (left scale) 

(Securities Industry Employment: County Share/U.S. Share) 

Note: U.S. = 1 

Source: WEFA GoFor, first quarter data 

Boston and Fairfield County Are Much More 

Reliant on Stock Market Jobs than the Nation 

Boston Regional Outlook 8 Third Quarter 2000 
Regional Perspectives
 

Information technology (IT) industries have also generated much of the recent growth in jobs around greater 

Boston (including Worcester County, Massachusetts, 

and southeastern New Hampshire), due in no small 

way to the benefits of a rising equity market. Chart 8 

shows the recent concentration in IT employment relative 

to the nation for those counties around greater Boston, as 

well as that for Chittenden County, Vermont. All of 

these counties reported concentrations that are at least 

double the national average, with Middlesex and Chittenden having more than five times the national share. 

Chittenden’s share largely reflects jobs at one employer, 

IBM, and is concentrated in the manufacturing of electronic components. In fact, Chittenden’s concentration 

of employment in electronic components manufacturing 

is a whopping 18 times that of the nation. Middlesex 

County’s IT employment base, on the other hand, is 

much more diverse, including numerous firms in multiple IT areas. Much of the recent growth in the county’s 

IT employment base has been linked to the rapid expansion of Internet-related businesses. 

Stock Market Wealth Exerts Strong Influence 

on Home Prices in Certain Markets 

Residential real estate prices have also moved higher in 

response to the increased wealth of buyers and a generally limited inventory of homes for sale in certain markets. This has been the case particularly with high-end 

homes in metropolitan markets, where the wealth effect 

among households likely has been most pronounced, 

such as Boston and Stamford (Fairfield County, Connecticut). In addition to boosting the value of primary 

residences, increased discretionary income has helped 

CHART 8 

The Region’s Leading Information Technology* 

Employment Clusters Include These Counties IT* Jobs in 1Q00 County Share/U.S. Share

0 

1 

2 

3 

4 

5 

6 

Middlesex

Essex

Worcester

Norfolk

Hillsborough

Strafford

Rockingham

Chittenden 

U.S. = 1 

* Computer/communication equipment/electronics manufacturing and software 

services (SIC codes 357, 366, 367, and 737) 

Source: WEFA GoFor 

MA NH VT

CHART 9 

–6 

–4 

–2 

0 

2 

4 

6 

8 

10 

12 

Nation 

Boston

Cape Cod 

Stamford 

Springfield 

Hartford

Compound Annual Change (%) 

Source: Freddie Mac (Conventional Home Price Index) 

Metro Areas Where Wealth Effect Predominates 

Have Experienced Stronger Home Price Gains 

’89–’94 

’94–’99 

’98–’99 

to push up sales and prices in markets that have traditionally been associated with second and vacation 

homes, such as on Cape Cod. Chart 9 compares the 

compound annual growth in home resale prices (Freddie Mac conventional home price index) for select markets during the early 1990s with price gains in those 

same markets during the latter 1990s—when the wealth 

effect is thought to have become preeminent. 

Between 1994 and 1999 (and particularly during the 

past two years), prices in those markets most likely 

influenced by the wealth effect generally rose faster 

than the national average. Prices in these areas also rose 

faster than in those New England metropolitan areas 

with lower concentrations of employment in IT and 

financial services, such as Springfield and Hartford. 

This measure of price appreciation captures sales that 

resulted in mortgages of approximately $250,000 or 

less.4 Thus, it excludes high-end home sales that typically benefit the most from a rising stock market. However, 

a similar comparison among Boston, Springfield, and 

Hartford using National Association of Realtors statistics on median home prices (which are somewhat more 

influenced by high-end home sales) yields findings in 

line with those shown in Chart 9. 

4 The price index is based on conventional (non-federally-insured or 

-guaranteed), conforming mortgages (sales and refinancings) purchased by Freddie Mac. Conforming loans meet the agency’s underwriting standards and do not exceed the allowable loan limit (which 

was $252,700 in 2000 for properties in the continental United States). 

Boston Regional Outlook 9 Third Quarter 2000 
Regional Perspectives
 

Implications for Insured Institutions 

Most insured institutions in the Region have very modest 

exposure to highly valued equity markets, both in terms 

of directly held equities and through merchant banking 

operations. However, should the Region’s economy falter 

because of weakness in the stock market, consumer and 

business credit exposure could be negatively affected. 

However, any such weakness likely would need to be 

severe, prolonged, and accompanied by other significant 

factors (such as a national recession) in order to result in 

an outright recession in the Region’s economy. 

Also of concern is that some homes and commercial 

properties currently may be experiencing levels of valuation that are sustainable only under a scenario of strong 

equity markets. For example, the recent rapid advance 

in home prices in those markets most likely influenced 

by the wealth effect may have resulted in somewhat 

inflated collateral values for residential real estate. 

Likewise, the rapid growth in demand for office and 

industrial space arising from the explosive growth in 

Internet-focused firms may have pushed commercial 

rents and prices above longer-term sustainable levels in 

some markets. Thus, property values could fall abruptly should a severe correction in equity markets occur 

that results in significant job or income losses by 

employees at area financial services or IT firms. 

Boston Region Staff 

Boston Regional Outlook 10 Third Quarter 2000 
In Focus This Quarter
 

Ranking Metropolitan Areas at Risk for 


Commercial Real Estate Overbuilding
 

•	 In analyses conducted in 1998 and 1999, nine metropolitan areas were identified as at risk for overbuilding; this analysis notes more vigorous 

building occurring across multiple property types 

and identifies 13 markets, including eight of the 

previous nine, as at risk for overbuilding. 

•	 Construction activity has accelerated during the 

current economic expansion with cyclically high 

levels of supply and demand. 

•	 Capital markets scaled back their investments in 

commercial real estate in 1998 and 1999, while 

FDIC-insured institutions increased their construction and development lending by more than 

20 percent each year. 

The banking industry and the FDIC learned during the 

late 1980s that once commercial real estate (CRE) markets become overbuilt, losses can mount quickly. During the 1980s and early 1990s, losses on CRE loans 

were responsible for hundreds of bank and thrift failures 

and billions of dollars in insurance losses for the FDIC. 

Since then, commercial vacancy rates have improved 

dramatically in a number of major U.S. metropolitan 

markets. In turn, CRE charge-offs reported by FDICinsured institutions have fallen to very low levels—less 

than 0.05 percent of average loans in both 1998 and 

1999. 

Two recent studies published by the FDIC evaluate the 

risk of overbuilding in major U.S. metropolitan areas.1 

These studies identified nine cities—Atlanta, Charlotte, Dallas, Las Vegas, Nashville, Orlando, 

Phoenix, Portland (Oregon), and Salt Lake City—as 

markets at risk for rising commercial vacancy rates. 

This article revisits the FDIC’s previous analysis of 

CRE markets. Using a more restrictive definition of 

at-risk markets, we find that eight of the previously 

identified nine markets remain on the list, joined by 

five additional markets: Denver, Fort Worth, Jacksonville, Sacramento, and Seattle.2 In general, more 

markets are experiencing increased levels of construc1 See “Ranking the Risk of Overbuilding in Commercial Real Estate 

Markets,” Bank Trends, October 1998, and “Commercial Development Still Hot in Many Major Markets, but Slower Growth May Be 

Ahead,” Regional Outlook, first quarter 1999. 

tion activity across multiple CRE property sectors than 

was the case just two years ago. 

Like the two earlier studies, this analysis does not predict an imminent rise in vacancies and losses in the atrisk markets. Instead, as before, the goal is to raise 

awareness about substantial growth in real estate development and the corresponding increases in risk exposure to financial institutions. 

Previous Real Estate Cycles 

Are Well Documented 

Many analysts view the late 1980s U.S. experience as 

the very definition of adverse conditions in CRE markets. The factors that brought about these adverse conditions are well documented.3 During the early and 

mid-1980s, CRE construction boomed. Total office 

space completed in 54 major U.S. markets tracked by 

Torto Wheaton Research exceeded 100 million square 

feet per year every year from 1982 through 1987. 

Insured banks and thrifts were prime sources of credit 

for this building boom. Total outstanding construction 

and development (C&D) loans on the balance sheets of 

insured institutions grew by 52 percent, or $52.5 billion 

dollars, in 1985 alone, followed by three successive 

years of growth in outstanding C&D loans. A key factor 

behind this surge in lending was intense competition 

among lenders. In response to the heightened competition, many lenders loosened their underwriting standards, often extending credit on speculative projects on 

terms that did not protect them from downside risk. 

Examples of aggressive lending practices from this 

period included more collateral-based lending, higher 

loan-to-value limits, reliance on overly optimistic 

appraisals, and inattention to secondary repayment 

sources. 

2 The one metropolitan area identified in the prior analyses as at risk 

for overbuilding that did not fall into the same category using the 

stricter criteria in this analysis is Nashville. Nevertheless, Nashville 

still ranks high in terms of construction activity at fifth highest in the 

U.S. for retail and twelfth highest for office construction activity. 3 See, for example, Freund et al. 1997. History of the Eighties: 

Lessons for the Future, Chapters 9 and 10. FDIC. 

Boston Regional Outlook 11	 Third Quarter 2000 
In Focus This Quarter
 

Poorly underwritten credit and massive increases in 

construction resulted in overbuilding in a number of 

large U.S. metropolitan markets. Nationwide, the office 

vacancy rate for competitively leased space peaked at 

over 19 percent in 1991.4 In the Southwest and New 

England, where the cycle of overlending and overbuilding was most pronounced, metro real estate markets 

were in even worse shape. Office vacancies in Dallas 

peaked at over 27 percent in 1988, while office vacancies in Boston reached over 17 percent in 1990. As 

vacancies rose and rents fell, lenders in the Southwest, 

Northeast, and elsewhere increasingly found themselves in possession of nonperforming loans and 

impaired real estate assets. The result was a sharp 

increase in the number of failed banks in the Southwest 

and Northeast.5 

Following the CRE debacle of the late 1980s and early 

1990s, commercial construction and lending volumes 

slowed. C&D loan growth at FDIC-insured institutions 

declined every year from 1989 through 1994, while a 

similar drop in private construction expenditures lasted 

through 1993. 

Factors Contributing to Cycle 

of Overbuilding in CRE 

One reason that CRE markets are 

prone to periodic bouts of overbuilding is the business cycle itself, 

which saps demand for new space 

when business activity turns downward. But another 

important contributing factor is the lag time in the 

development process as new construction moves from 

inception to completion. Heavy demand at the start of a 

project may wane or vanish before completion occurs. 

In general, the time lag associated with CRE development is longest for hotel and office projects and 

becomes shorter for retail, multifamily, and industrial 

properties, respectively. The associated degrees of lending risk mostly follow the same pattern. In general, less 

risk is associated with industrial buildings and multifamily projects, which typically take less than one year 

to build. 

4 The U.S. vacancy rate is calculated as an aggregate of selected major 

markets tracked by Torto Wheaton Research. 

5 As further detailed in the History of the Eighties, combined assets of 

failed banks in the Northeast and Southwest comprised over 70 percent of assets of all banks failing between 1980 and 1994. 

To the extent that commercial construction projects 

involve a lag between inception and completion, net 

additions to supply can be anticipated in advance. Much 

progress has been made during this real estate cycle 

toward increased availability of information on CRE 

markets, particularly in regard to supply characteristics. 

Market transparency has been promoted in part by a 

heightened level of public ownership of CRE properties 

and the corresponding higher degree of disclosure by 

the owned entities, such as real estate investment trusts 

(REITs) and commercial mortgage-backed securities 

(CMBSs). 

Changes in demand are harder to predict. A current 

example may be the high level of demand generated by 

Internet start-up companies that rely heavily on financing provided by venture capital funds and initial public 

stock offerings. Because many of these start-ups depend 

so heavily on cash inflows from investors as opposed to 

operating revenues, their viability as tenants and their 

continued demand for high volumes of office space may 

depend more on capital market conditions than on their 

own business performance. While demand may appear 

strong under robust business conditions, it is prone to 

decline rather suddenly in the event of an economic 

downturn. Given these attributes of CRE markets, the 

process of gauging the success for lease-up of a proposed project involves not only looking at new supplies 

of competitive space coming onto the market, but also 

evaluating how vulnerable the market is to a downturn 

in demand for space. 

Recent Developments 

Following a lull in commercial construction activity that 

resulted from adverse market conditions in the early 

1990s, construction activity has gradually accelerated 

during the current economic expansion. The increased 

pace of construction occurred first in industrial and 

retail markets, where growth in net new completions of 

space picked up starting in 1993. The pace of multifamily construction accelerated in 1995, followed by 

increasing levels of office and hotel construction in 

1997. Regionally, commercial construction activity 

recovered first in the Southeast and Northwest, where 

the effects of the previous overbuilding had been the 

least pronounced. Only later did the pace of construction increase in California, the Southwest, and the 

Northeast. As the U.S. economic expansion endures into 

its tenth year, construction activity continues to pick up 

steam across most property types. In the 54 major metBoston Regional Outlook 12 Third Quarter 2000 
In Focus This Quarter
 

ropolitan areas tracked by Torto Wheaton Research, 

total annual office space completions rose from just 

over 3 million square feet in 1994 to 78.7 million square 

feet in 1999. 

National private expenditures on hotel and retail construction for 1999 exceeded all prior years on both a 

current-dollar and an inflation-adjusted dollar basis. 

Similarly, national private construction expenditures 

on office space in 1999 were at an all-time high on a 

current-dollar basis. On an inflation-adjusted dollar 

basis, office construction expenditures in 1999 were 

still not as high as they were during the mid-1980s. 

A new characteristic of the CRE industry in the current 

expansion has been the marked increase in capital availability through the financial markets. Annual issuance 

of CMBSs has grown from negligible amounts in 1990 

to over $67 billion in 1999. Financing made available 

through REITs has been the other link to the capital 

markets. REIT market capitalization increased from 

approximately $10 billion in 1994 to nearly $145 billion 

in 1999. 

While the availability of market-based sources of capital has helped to facilitate growth in construction during 

this expansion, the financial market turmoil of late 1998 

cast a cloud over the CMBS market that has yet to lift 

fully. Significant events in the global capital markets in 

1997 and 1998, including the Asian economic crisis and 

the Russian government bond default, significantly curtailed the ability of major CMBS issuers to go to the 

market for financing. Significant liquidity problems 

resulted for a number of commercial mortgage firms. 

Nomura, Lehman Brothers, CS First Boston, and others 

incurred losses, while Criimi Mae, Inc., was forced to 

declare bankruptcy. 

As the capital markets pulled back from CRE investments, insured banks and thrifts stepped in to fill the 

void. Chart 1 shows that the total volume of C&D loans 

on the balance sheets of FDIC-insured institutions rose 

by more than 20 percent per year in both 1998 and 

1999, even as growth in U.S. private construction 

expenditures slowed to a crawl.6 

In terms of overall construction market activity, the 

current situation appears to be one of cyclically high 

6 U.S. private construction expenditures, as calculated by the Bureau 

of the Census, include multifamily (two or more units), industrial, 

office, hotel, and retail space. 

CHART 1 

’86 

Growth Rates (%) 

Growth Rates of Private Construction 

Expenditures and C&D Loans Diverge 

during the Past Two Years 

–30 

–20 

–10 

0 

10 

20 

30 

40 

50 

60 

C&D = construction and development loans 

Sources: Bureau of the Census (Haver Analytics), Bank and Thrift Call Reports 

(Research Information System) 

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

C&D Loans 

Priv. Const. 

levels of supply and demand. Because significant 

growth in net new space is forecast for many markets 

and property types during 2000 and 2001, a drop in 

demand for space could impair absorption rates and 

lead to higher vacancies and lower rents. Most analysts 

feel that future trends in real estate demand will be 

closely linked to national and regional economic conditions. 

Identification of Markets at Risk 

for Overbuilding 

Previous FDIC studies have identified CRE markets at 

risk for broad-based overbuilding on the basis of comparative rankings in the rates of growth in commercial 

space. In a 1998 study, U.S. metropolitan areas were 

ranked according to 1997 new construction activity as a 

percentage of existing stock for the five main property 

types: office, industrial, retail, multifamily, and hotel.7, 8 

In that study, any metro area that appeared in the top 15 

for any two of the commercial property types was 

labeled “at risk.” Nine cities were identified as being at 

risk for overbuilding: Atlanta, Charlotte, Dallas, Las 

Vegas, Nashville, Orlando, Phoenix, Portland 

(Oregon), and Salt Lake City. 

7 Federal Deposit Insurance Corporation. October 1998. Ranking the 

Risk of Overbuilding in Commercial Real Estate Markets, Bank 

Trends. 

8 Construction activity is measured in square feet and includes projects completed during the year, plus projects still under construction 

as of year-end. This figure is then divided by the total stock of space 

to obtain a construction activity percentage for use in comparative 

rankings. 

Boston Regional Outlook 13 Third Quarter 2000 
In Focus This Quarter
 

This study updates the previous results using year-end 

1999 data.9 In doing so, it applies more restrictive criteria to identify at-risk metropolitan real estate markets. As before, the metro areas are ranked according 

to new construction as a percentage of existing stock 

in each of the five main commercial property types. 

However, in this analysis, to be considered at risk, a 

metro area must rank in the top ten for any two of the 

property types. Despite the fact that it was harder for 

individual markets to qualify as being at risk, all but 

one of the previously identified nine markets remain 

on the at-risk list. Moreover, they are joined by five 

additional metropolitan areas: Denver, Fort Worth, 

Jacksonville, Sacramento, and Seattle. It is evident 

that more metropolitan areas are emerging with vigorous CRE construction and development across multiple property sectors. 

Most Active Construction Markets 

Charts 2 through 6 represent the property sectors of 

office, industrial, retail, multifamily, and hotel. They 

also list, for each property sector, the metropolitan areas 

having the highest levels of construction activity, relative to existing stock, for the year ending December 31, 

1999. The overall national construction activity rate is 

also shown for comparative purposes for each of the 

property sectors. Each metropolitan area is ranked from 

the highest to lowest for levels of construction activity. 

As shown in these charts, Las Vegas, Orlando, and 

Phoenix are standouts, with each placing among the top 

ten metropolitan areas in the country for construction 

activity in at least four of the five different property sectors. Las Vegas is among the top ten in construction 

activity for all five property sectors except for hotel 

construction, where it ranks twenty-sixth.10 Las Vegas 

ranks first in retail construction and second in industrial construction. Orlando is first in both office and multifamily construction. Phoenix is among the top ten for 

each of the five property sectors except hotel construction, where it ranks sixteenth. 

9 For the five property sectors reviewed in this report, data sources 

were Torto Wheaton Research for office and industrial and F.W. 

Dodge for retail, multifamily, and hotel. Torto Wheaton Research’s 

data for office and industrial encompass 54 and 53 metropolitan statistical areas (MSAs), respectively. F.W. Dodge’s data for retail, multifamily, and hotel encompass 58 MSAs. 

10 Las Vegas has the most hotel rooms in the country, with slightly 

fewer than 124,000 rooms as of year-end 1999. During 1999, Las 

Vegas experienced the greatest addition of rooms (in absolute numbers) of any market. With over 13,000 new rooms added during 1999, 

Las Vegas had nearly twice the level of the next highest metropolitan 

area, which was Orlando, with an additional 7,000 rooms. 

CHART 2 

CHART 3 

CHART 4 

Top 15 Office Development Markets—Construction 

Activity in 1999 as a Percentage of Stock 

(Square Footage) 

Orlando 

Phoenix 

Seattle 

Salt Lake City 

Charlotte 

Columbus 

Jacksonville 

Austin 

Las Vegas Completions Wilmington 

West Palm Beach Under 

Construction Nashville 

Oakland
 

Sacramento
 

Minneapolis
 

National 

0% 5% 10% 15% 20% 25% 

Source: Torto Wheaton Research 

Top 15 Industrial Development Markets— 

Construction Activity in 1999 as a Percentage 

of Stock (Square Footage) 

Riverside 

Las Vegas 

Ventura County 

Fort Lauderdale 

Phoenix 

Sacramento
 

San Diego
 

Fort Worth
 

Cincinnati Completions Atlanta
 

Austin
 Under 

Dallas Construction 

Fresno 

Jacksonville
 

Orlando
 

National
 

0% 2% 4% 6% 8% 10% 12% 14% 16% 

Source: Torto Wheaton Research 

Top 15 Retail Development Markets— 

Construction Activity in 1999 as a Percentage 

of Stock (Square Footage) 

Source: F.W. Dodge 

National 

Greensboro 

Jacksonville 

Denver 

Greenville 

Tampa 

Richmond 

West Palm Beach 

Sacramento 

Atlanta 

Fort Worth 

Nashville 

Phoenix 

Orlando 

Dallas 

Las Vegas 

0% 5% 10% 15% 20% 25% 30% 35% 40% 

Under 

Construction 

Completions 

Boston Regional Outlook 14 Third Quarter 2000 
In Focus This Quarter
 

Other markets deserve notice for their high or moderately high levels of construction activity in one or 

more property sectors. Columbus, Ohio, ranks sixth 

in the nation for its high level of office construction 

and twelfth for both multifamily and hotel construction. Greenville is tenth in the nation for hotel construction and twelfth for retail. West Palm Beach is 

ninth for retail and eleventh for office. Austin is 

eighth for office, eleventh for both multifamily and 

industrial, and thirteenth for hotel. 

C&D Loan Concentrations 

Concentrations of C&D loans at community banks in 

the at-risk markets are generally higher now than they 

were at the peak of the last cycle in the 1980s.11 As 

shown in Chart 7, the median ratio of C&D loans to 

total assets as of March 31, 2000, was higher than the 

median ratio as of December 31, 1988, in ten of the thirteen at-risk markets.12 The median C&D loan concentration is currently higher than the national average in 

all 13 at-risk markets.13 

At present, overall loan performance remains very good 

for the C&D portfolios of insured institutions. Reported 

delinquent and nonaccrual C&D loans remain at nominal levels as a percentage of total loans, although the 

ratio for both measures increased marginally during the 

first quarter of 2000. 

Construction Employment Concentrations 

The percentage of a metropolitan area’s workforce 

employed in construction is an indicator of the sensitivity of the local economy to construction. Six of the 

13 metropolitan areas at risk for overbuilding are found 

among the top 12 most concentrated construction 

employment markets (see Chart 8, next page).14 In addition, all of the 13 have construction concentration levels exceeding the national average. With slightly under 

10 percent of its nonfarm workforce employed in construction, Las Vegas has the highest construction11 Community banks are FDIC-insured institutions with assets less 

than $1 billion. 

12 For community banks that have C&D loans. 

13 Since 1992, the aggregate C&D-to-asset ratio for the nation’s community banks has been higher than the C&D-to-asset ratio for institutions larger than $1 billion. This is a reversal of the condition from 

1984 through 1991 when the aggregate C&D-to-asset ratio for institutions larger than $1 billion exceeded the C&D-to-asset ratio for 

community banks. 

14 Construction concentrations are the percentage of construction 

employees relative to the nonfarm workforce. 

CHART 5 

Top 15 Multifamily Development Markets—
 

Construction Activity in 1999 as
 

a Percentage of Stock (Units)
 

Orlando
 

Charlotte
 

Raleigh
 

Portland
 

Dallas
 

Las Vegas
 

Denver
 

Seattle
 

Atlanta
 Completions Phoenix
 

Austin
 Under
 

Columbus
 Construction
 

Tampa
 

Jacksonville
 

Nashville
 

National
 

0% 2% 4% 6% 8% 10% 12% 

Source: F.W. Dodge 

CHART 6 

Top 15 Hotel Development Markets— 

Construction Activity in 1999 as a Percentage 

of Stock (Square Footage) 

Fort Worth
 

Jacksonville
 

Portland
 

Orlando
 

Salt Lake City
 

Denver
 

Charlotte
 

Dallas
 

Seattle
 Completions Greenville
 

Oakland
 Under 

Columbus, OH Construction 

Austin 

Greensboro 

San Jose 

National 

0 5% 10% 15% 20% 25% 30% 

Source: F.W. Dodge 

CHART 7 

Most of the At-Risk Markets’ Community Banks 

Have Higher Median C&D Loan-to-Asset Ratios 

at 3/31/00 than at Peak of Last Cycle (12/31/88) 

Salt Lake City
 

Atlanta
 

Portland
 

Las Vegas
 

Sacramento
 

Phoenix
 

Seattle
 

Fort Worth
 

Dallas
 3/31/00 

Orlando 12/31/88
 

Charlotte
 

Denver
 

Jacksonville
 

National
 

0 2 4 6 8 10 12 14 16 18 

Median C&D Loan-to-Asset Ratios (%) 

C&D = construction and development 

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

Boston Regional Outlook 15 Third Quarter 2000 
In Focus This Quarter
 

concentrated workforce of all metropolitan areas in the CHART 9 

United States and is slightly over twice the national rate 

of 4.8 percent. 

High Construction Activity and High 

Vacancy Levels 

Newly constructed, speculative space competes directly 

for tenants against already-built and vacant space. To 

assess at-risk markets fully, it is useful to compare the 

levels of construction activity for each metropolitan 

area’s property sector against its associated vacancy 

levels.15 

Charts 9 through 13 show, by property sector, each 

city’s level of construction activity plotted against the 

corresponding vacancy rate. It is axiomatic that a metropolitan area with high vacancies and high construction is cause for concern for builders and lenders alike. 

Many of the 13 At-Risk Markets Report 

High Office Construction Activity and High Office 

Vacancy Rates 

0 

5 

10 

15 

20 

25 

0% 5% 10% 15% 20% 25% Vacancy Rate 

Note: Capitalized cities are among the 13 markets identified as at risk for 

overbuilding. 

Source: Torto Wheaton Research Construction Activity as Percentage of Stock

SEATTLE 

ORLANDO 

CHARLOTTE 

PHOENIX 

Austin 

Wilmington 

SACRAMENTO 

West Palm Beach 

DALLAS 

LAS VEGAS 

SALT LAKE CITY 

JACKSONVILLE 

Riverside Oklahoma City 

Bakersfield 

Columbus 

Nation 

CHART 10 

It follows for metropolitan areas with high construction 

and high vacancy that newly arriving CRE projects will 

face significant competitive pressures in obtaining tenants. Consequentially, barring any preleasing or any 

fundamental upward shifts in demand, rental concessions may be needed to obtain tenants, and property 

values may be depressed. 

CHART 8 

Many of the 13 At-Risk Markets Are among the
 

Nation’s Metropolitan Statistical Areas Having the
 

Highest Construction Employment Levels as of
 

First Quarter 2000
 

LAS VEGAS 

Riverside 

Houston 

PHOENIX 

DENVER 

Greenville 

SALT LAKE CITY 

CHARLOTTE 

Birmingham 

Albuquerque 

Richmond Note: Capitalized cities 

SACRAMENTO are among the 13 

Norfolk markets identified as at 

Oakland risk for overbuilding. 

Raleigh 

National 

0% 2% 4% 6% 8% 10% 12% 

Construction Employees as a Percentage of the Nonfarm Workforce 

Source: Bureau of Labor Statistics (Haver Analytics) 

15 The data vendors do not provide category breakdowns for construction activity into speculative versus nonspeculative (preleased) 

properties. 

Many of the 13 At-Risk Markets Report High 

Industrial Construction Activity and High Industrial 

Vacancy Rates 

0 

2 

4 

6 

8 

10 

12 

14 

16 

Construction Activity as a Percentage of Stock 

0% 2% 4% 6% 8% 10% 12% Vacancy Rate 

Source: Torto Wheaton Research 

Austin Cincinnati 

JACKSONVILLE Fresno 

ORLANDO DALLAS Washington, 

D.C. 

Hartford 

Long Island 

Westchester 

ATLANTA 

FORT 

WORTH 

PHOENIX 

San Diego 

SACRAMENTO 

Ft. Lauderdale 

LAS VEGAS 

Riverside 

Ventura 

Note: Capitalized cities are among 

the 13 markets identified as at risk 

for overbuilding. 

Nation 

CHART 11 

Many of the 13 At-Risk Markets Report High 

Retail Construction Activity and High Retail 

Vacancy Rates 

0 

5 

10 

15 

20 

25 

30 

35 

40 

0% 2% 4% 6% 8% 10% 12% 14% 16% 

Source: F.W. Dodge 

Vacancy Rate 

Construction Activity as a Percentage of Stock

Note: Capitalized cities 

are among the 13 

markets identified as at 

risk for overbuilding. 

LAS VEGAS 

ORLANDO DALLAS 

PHOENIX 

ATLANTA SACRAMENTO 

Tampa DENVER 

JACKSONVILLE 

Greensboro 

FORT 

WORTH 

W. Palm Beach 

Greenville 

Nation 

Nashville 

Boston Regional Outlook 16 Third Quarter 2000 
In Focus This Quarter
 

What Market Analysts Are Saying 

Views of industry analysts provide additional perspective on the risks pertaining to each of the five property 

sectors and the individual metropolitan areas. 

Office 

Newly constructed nationwide office supply will outpace demand in 2000 and beyond, according to Torto 

Wheaton Research.16 Some 65 million square feet of 

space is scheduled for completion in 2000. However, net 

absorption is projected to be only 58 million square feet 

in 2000, resulting in an excess supply of 7 million square 

feet. Torto Wheaton Research predicts that office completions will outpace absorptions for all projected yearends through 2005, and corresponding vacancy rates will 

climb to slightly more than 14 percent at year-end 2005. 

Overall office fundamentals are in equilibrium, according to Donaldson Lufkin & Jenrette (DLJ), thanks to 

preleasing and sufficient demand.17 Still, DLJ identifies 

a number of markets as being at greater risk for excess 

new supply. DLJ’s markets to watch for possible overbuilding are Charlotte, Fort Lauderdale, Minneapolis, 

and Sacramento. More than 9 percent in new supply is 

projected for Sacramento over the next 18 months, with 

only a 3 percent increase in demand. DLJ identifies the 

Sacramento suburbs as the major center of construction 

activity and notes with concern the existing 13 percent 

suburban vacancy rate for this metropolitan area. 

Overall office construction levels will peak this year, 

according to the Urban Land Institute (ULI).18 Increases 

in suburban office vacancy rates to nearly 11 percent by 

the end of 2000 are projected, with downtown rates falling 

to slightly over 8 percent. ULI notes the possibility of a 

rash of space returns by Internet companies and others in 

the technology sector as a significant going-forward risk. 

Many analysts caution about the ability of new office 

construction to be absorbed in certain markets where 

labor supplies remain tight. In recent Wall Street Journal articles, Dallas and Seattle are reported to be actively recruiting high-tech engineers through immigrants 

from India and China to fill in the gaps in their tight 

labor-market pool for high-technology jobs.19, 20 

16 Torto Wheaton Research. Spring 2000. Office Outlook.
 17 Thierry Perrein, Donaldson, Lufkin & Jenrette. April 2000. DLJ
 

REIT Corporate Handbook, “Cautious Optimism.”
 

18 Urban Land Institute. ULI 2000 Real Estate Forecast.
 19 Templin, Neal. June 7, 2000. Economic Focus: Houston, Dallas
 

Are Draw for Immigrants. The Wall Street Journal.
 20 Barnes, Brooks. June 7, 2000. Economic Focus: Seattle Enjoys
 

Influx of Foreign Workers. The Wall Street Journal.
 

In a recent office market report by Moody’s Investors 

Service, three metropolitan areas (Jacksonville, 

Nashville, and Phoenix) are coded as “red”—indicating 

danger for high supply and declining demand factors.21 

Charlotte is coded as “yellow,” and its office demand is 

projected to grow by only 5 percent this year, while supply will increase by over 11 percent. 

Multifamily 

Recent mortgage rate increases will slow purchases of 

single-family homes, thereby increasing the demand for 

multifamily properties, according to a recent article by 

PaineWebber.22 Nevertheless, concerns are raised for 

oversupply conditions for multifamily construction in 

Atlanta, Dallas, Houston, and Las Vegas—cities characterized as “low barrier-to-entry markets.” 

Markets appearing weak to DLJ for the multifamily 

property sector include Charlotte, Denver, Jacksonville, 

Orlando, Portland, Raleigh, Salt Lake City, and Seattle.23 

Industrial 

Atlanta and Dallas are weaker for the industrial property 

sector, according to DLJ, because of significant new supply levels.24 A 7 percent supply growth is projected for 

Phoenix in 2000, with only a 4 percent increase in demand. 

Retail 

For retail properties, DLJ believes a number of markets 

have excess supply; the standouts are Austin, Las Vegas, 

Orlando, Phoenix, and Sacramento.25 

Hotel 

Analysts point to specific concerns for a “glut” of limited-service hotels in certain markets and note many hotel 

developers taking advantage of low barriers to entry for 

hotel construction. In response, many developers argue 

that “product differentiation” within different hotel sectors justifies further development. 

Growth in expenditures on hotel construction has been 

above 7 percent for each of the past several years, while 

room revenues grew at a more moderate pace, according 

to PaineWebber.26 The poor growth in room revenue is 

attributed to supply exceeding demand. 

21 Gordon, Sally. June 2, 2000. Moody’s Investors Service, Special
 

Report—CMBS: Red-Yellow-Green Update, Second Quarter
 

2000, Quarterly Assessment of U.S. Property Markets.
 

22 PaineWebber. June 6, 2000. Real Estate Investment Trust—
 

Initiating Coverage on the REIT Industry.
 

23 Ibid.
 

24 Ibid.
 

25 Ibid.
 

26 PaineWebber. June 1, 2000. Industry Outlook Lodging, U.S.
 

Hotel Construction Update—First Quarter 2000.
 

Boston Regional Outlook 17 Third Quarter 2000 
In Focus This Quarter
 

CHART 12 CHART 13 

Many of the 13 At-Risk Markets Report High 

Hotel Construction Activity and High Room 

Availability (Vacancy) Rates 

0 

5 

10 

15 

20 

25 

30 

15% 20% 25% 30% 35% 40% 45% 

Vacancy Rate 

Source: F.W. Dodge Construction Activity as a Percentage of Stock

Note: Capitalized cities 

are among the 13 

markets identified as at 

risk for overbuilding. 

FORT WORTH 

JACKSONVILLE 

ORLANDO 

PORTLAND 

DENVER 

SALT LAKE CITY 

Oakland SEATTLE CHARLOTTE 

Nation 

DALLAS 

Austin Columbus Greenville 

Greensboro 

Many of the 13 At-Risk Markets Report High 

Multifamily Construction Activity and High 

Multifamily Vacancy Rates 

0 

2 

4 

6 

8 

10 

12 

3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 

Source: F.W. Dodge Vacancy Rate Construction Activity as a Percentage of Stock

Note: Capitalized cities 

are among the 13 

markets identified as at 

risk for overbuilding. 

ORLANDO 

CHARLOTTE 

PORTLAND Raleigh DALLAS 

DENVER LAS VEGAS SEATTLE 

PHOENIX 

ATLANTA 

Nation 

JACKSONVILLE Columbus 

Tampa Austin 

Indianapolis Houston 

Birmingham 

As shown in the referenced charts, multiple cities are 

experiencing high volumes of construction activity concurrent with high vacancy rates. Seven of the 13 at-risk 

cities show up in the upper-right quadrants, exhibiting 

both high rates of construction and vacancy: Atlanta 

for industrial and multifamily; Dallas for office and 

retail; Fort Worth for retail and hotel; Jacksonville for 

office and hotel; Las Vegas for office and industrial; 

Orlando for office and multifamily; and Salt Lake 

City for office and hotel. 

Other metropolitan areas beyond these 13 are precariously situated at the furthermost positions on the charts 

for high vacancy and high construction levels: Austin 

and Houston for multifamily; Greensboro for hotel; 

Greenville for retail and hotel; and West Palm Beach 

for office and retail. 

Conclusion 

Since 1997, responding to a void left by the departure of 

other capital market lenders, community banks have 

stepped up their CRE lending activity. At the same time, 

more metropolitan areas are emerging with vigorous 

CRE construction and development across multiple 

property sectors. In the 1998 and 1999 FDIC analyses, 

nine metropolitan areas were identified as being at risk 

for overbuilding across multiple property types. In the 

present analysis, 13 metropolitan areas, including eight 

of the nine from the prior analyses, receive this designation. Given strong levels of CRE completions, these 

metropolitan areas are particularly sensitive to any 

decline in real estate demand that could result from a 

slowdown in the national or regional economy. 

Thomas A. Murray, Senior Financial Analyst 

Boston Regional Outlook 18 Third Quarter 2000 
In Focus This Quarter
 

Rising Home Values and New Lending Programs Are 


Reshaping the Outlook for Residential Real Estate
 

•	 Home prices have risen rapidly in several major 

U.S. metropolitan areas. 

•	 The credit quality of residential real estate loan 

portfolios traditionally has been solid. 

•	 New lending programs such as subprime and high 

loan-to-value lending could change the historical 

loss experience associated with residential real 

estate. 

Introduction 

The median price of an existing single-family home has 

been rising rapidly in several U.S. metropolitan areas. 

After a prolonged period of stagnant or slowly rising 

resale prices in many of these markets throughout most 

of the 1990s, prices have rebounded strongly, reaching 

double-digit rates of growth in some areas. Not surprisingly, these markets have also experienced relatively 

robust job growth, particularly in high-tech sectors that 

have been the catalyst for growth in the New Economy.1 

However, as existing home prices in some markets have 

been rising rapidly, new building activity has recently 

begun to slow because of rising interest rates. After 

reaching a 19 percent year-over-year growth rate in the 

fourth quarter of 1998, single-family housing starts 

declined by 2.8 percent in the second quarter of 2000. 

Similarly, year-over-year growth in single-family housing permits declined by 8.4 percent in the second quarter of 2000. Higher home mortgage rates, along with the 

prospect for more moderate job growth, have dampened 

market activity. 

Single-family mortgages have traditionally been associated with low loss rates compared with other, higherrisk lending lines at insured institutions. However, the 

real estate market is still susceptible to boom and bust 

cycles, which could pose a risk to institutions with 

exposures to residential real estate. This risk would be 

heightened by the formation of asset price bubbles in 

local markets. Furthermore, as the competition among 

1 For a discussion on what is meant by the term “New Economy,” see 

“Banking Risk in the New Economy,” Regional Outlook, second 

quarter 2000; http://www.fdic.gov/bank/analytical/regional/ro20002q/ 

na/t2q2000.pdf. 

mortgage lenders becomes more intense, insured institutions are increasingly participating in new, higher-risk 

types of mortgage lending, such as high loan-to-value 

(LTV) lending and subprime lending. These new lending practices—still largely untested in a recession— 

raise some concerns about the future credit quality of 

residential loan portfolios. 

Home Prices in Some Local Markets 

Are Soaring 

Home prices have been soaring recently in a number of 

large U.S. metropolitan markets. Rapid price increases 

in some of these areas have come on the heels of a period of slow or stagnant growth (see Chart 1). Table 1 

(next page) identifies the top 20 metropolitan markets 

based on the median price of an existing single-family 

home. Many of the areas identified in the table are also 

places where home prices are increasing most rapidly. 

Healthy job growth, tight labor market conditions, and 

a tight supply of available homes have contributed to 

price increases in these areas. 

Some of the same metropolitan areas that are experiencing significant home price appreciation are also 

highly dependent on the high-tech sector. The shaded 

areas in Table 1 highlight the metro markets that not 

only have the highest median home prices in the nation 

but also have a concentration of high-tech employees in 

the workforce greater than 5 percent. Explosive growth 

CHART 1 

–10% 

–5% 

0% 

5% 

10% 

15% 

20% 

25% 

’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 

Some Large U.S. Metropolitan Areas Have 

Seen the Return of Soaring Home Prices 

Source: National Association of Realtors (Haver Analytics) 

Year-over-Year Growth of the Median Existing Single-Family 

Home Price 

San Francisco 

Boston 

Boston Regional Outlook 19	 Third Quarter 2000 
In Focus This Quarter
 

TABLE 1 

Of the 20 U.S. Cities with the Most Expensive Housing, 

More than Half Have a Concentration in High-Tech Employment 

THE SHADED AREAS INDICATE MARKETS WHERE HIGH-TECH EMPLOYEES CONSTITUTE AT LEAST 

5 PERCENT OF THE TOTAL PAYROLL EMPLOYMENT (SEE NOTE). 

METROPOLITAN STATISTICAL AREA 

RANKING BY MEDIAN HOME PRICE 

MEDIAN PRICE OF AN EXISTING 

SINGLE-FAMILY HOME 

MARCH 2000 

PERCENT CHANGE 

FROM ONE YEAR AGO 

1 SAN FRANCISCO, CA $418,600 25.0% 

2 ORANGE COUNTY, CA $300,800 10.3% 

3 HONOLULU, HI $289,000 –2.0% 

4 BOSTON, MA* $255,000 8.4% 

5 SAN DIEGO, CA $251,400 16.1% 

6 BERGEN-PASSAIC, NJ $250,200 9.8% 

7 NEWARK, NJ $229,500 18.8% 

8 SEATTLE, WA $226,100 8.3% 

9 NEW YORK, NY $221,500 14.3% 

10 NASSAU-SUFFOLK, NY $209,200 12.8% 

11 LOS ANGELES, CA $202,900 5.6% 

12 MIDDLESEX, NJ $198,500 8.6% 

13 MONMOUTH-OCEAN, NJ $186,200 19.4% 

14 DENVER, CO $181,500 12.9% 

15 WASHINGTON, DC-MD-VA $177,500 5.6% 

16 PORTLAND, OR $166,700 0.8% 

17 CHICAGO, IL $166,700 0.4% 

18 LAKE COUNTY, IL $162,600 –2.2% 

19 AURORA-ELGIN, IL $158,200 7.5% 

20 RALEIGH-DURHAM, NC $156,300 –4.2% 

NATION $133,533 2.7% 

* Ranking based on the latest data available (third quarter 1999). 

Note: High-tech, as defined by Dismal Sciences, Inc., includes industries such as pharmaceuticals, computers, 

electronic components, communications equipment, and communications services. 

Sources: National Association of Realtors (Haver Analytics); Dismal Sciences, Inc. 

in technology industries during this expansion has created new job opportunities in many metropolitan areas 

where high-tech companies and employment tend to be 

concentrated. The influx of highly skilled, and often 

highly compensated, high-tech workers into these areas 

has boosted the demand for both new and existing 

homes, pushing up home prices. For example, in San 

Francisco, where high-tech employees now comprise 

7.1 percent of the total workforce, home prices rose by 

22 percent in calendar year 1999 and are expected to 

rise another 14 percent in 2000.2 

2 July 21, 2000. Your Money Matters: Turning Down the Heat on 

Home Prices—Forecasters Find More Evidence That the Market Is 

Cooling; San Francisco Still Rocks. The Wall Street Journal. 

Soaring home prices in these metro areas have created 

the possibility of speculative price bubbles that could 

cause problems for mortgage lenders. If a decline in 

high-tech employment or company earnings were to 

cause a deterioration in home values in these markets, 

the credit quality of mortgage portfolios at insured institutions could be jeopardized. 

Favorable Economic Conditions Have Sustained 

Consumer Spending Patterns 

As the current U.S. expansion entered its 113th month 

in July 2000, consumer spending continued along a path 

of rapid growth. In the second quarter of 2000, personBoston Regional Outlook 20 Third Quarter 2000 
In Focus This Quarter
 

al consumption expenditures increased by 8 percent 

over the previous year. Nearly ideal conditions for consumers have contributed to high levels of spending. The 

unemployment rate remains near the record low of 3.9 

percent set in April 2000, and consumer confidence 

remains near the record high set in January 2000. Moreover, consumer buying power has been boosted by real 

wage gains, generally low interest rates, and stock market earnings. 

One of the only negative aspects for consumers has 

been the recent rise in interest rates, which has 

increased the cost of borrowing. From the end of 1998 

to June 2000, both the bank prime lending rate and the 

average mortgage contract rate for purchase of a previously occupied home rose by more than 100 basis 

points. However, the flexibility offered by adjustablerate mortgages (ARMs) has helped consumers shield 

themselves from the full effects of interest rate increases. As of the second quarter of 2000, the share of ARMs 

as a percentage of all loans closed had risen from 10 

percent in the fourth quarter of 1998 to 30 percent (see 

Chart 2). 

Nonetheless, as interest rates have risen, overall activity 

in the single-family housing market has slowed noticeably. After reaching an annualized rate of 1.4 million 

units in December 1999, monthly starts of single-family 

homes have declined by more than 15 percent to 1.2 

million units in June 2000. Similarly, the annualized 

rate of single-family permits issued in June 2000 was 

down 14 percent from January 2000 levels. The National Association of Realtors (NAR) reports that, despite 

current high levels of activity, deteriorating affordability conditions are expected to slow the resale housing 

market over the course of the year.3 In June 2000, NAR’s 

composite Housing Affordability Index fell to its lowest 

point since September 1996. To the extent that any 

decline in economic conditions would produce a less 

favorable environment for consumers, the housing market would likely slow even further. 

Overall Credit Quality of Residential 

Mortgages Has Been Solid 

Historical losses from residential real estate exposures 

at insured institutions are well documented. In the 

1980s, areas such as Texas, California, and New Eng3 National Association of Realtors Press Release. August 1, 2000. 

Housing Affordability Drops to Eight-Year Low, NAR Reports. 

CHART 2 

6.5% 

7.0% 

7.5% 

8.0% 

8.5% 

9.0% 

Jan-97 Sep-97 May-98 Jan-99 Sep-99 May-00 

5% 

10% 

15% 

20% 

25% 

30% 

35% 

More Consumers Have Chosen ARMs 

as Mortgage Rates Have Risen 

Sources: Federal Reserve Board; Federal Housing Finance Board (Haver 

Analytics) 

Contract Rate on Conventional 

30-Year Mortgage 

Commitments 

Adjustable-Rate Home 

Mortgage Loans as a 

Percentage of All Loans Closed 

land experienced strong economic growth, rapid residential development, and sharp home price appreciation 

that created asset price inflation. Coastal California 

markets, in particular, experienced double-digit growth 

rates that propelled the median home price in California 

to more than double the national average.4 

Regional recessions in many of these areas took a toll 

on residential real estate markets. Home values either 

stagnated or declined precipitously, and the foreclosure 

rate on residential real estate began to rise rapidly. Nevertheless, very few bank failures can be attributed solely to losses on residential mortgages. Loss rates on 

residential loans have traditionally been low compared 

with other loan categories. 

The credit quality of conventional single-family mortgage portfolios has generally been good throughout this 

economic expansion. The percentage of conventional 

loans past due during this expansion has averaged 2.8 

percent, compared with 3.5 percent during the last 

expansion from 1982 to 1990.5 Moreover, past-due conventional loans fell for the sixth consecutive quarter in 

the first quarter of 2000 to 2.3 percent (see Chart 3, next 

page). Foreclosures started, while slightly higher on 

average than the previous expansion, remain at a 

healthy level well below 1 percent of loans (see Chart 4, 

next page). 

4 Federal Deposit Insurance Corporation, Division of Research and 

Statistics. 1997. History of the Eighties: Lessons for the Future. Vol. 

1, An Examination of the Banking Crises of the 1980s and Early 

1990s. http://www.fdic.gov/bank/historical/history/contents.html. 5 “Past due” refers to loans that are 30 or more days past due. 

Boston Regional Outlook 21 Third Quarter 2000 
In Focus This Quarter
 

By contrast, Veterans Administration (VA) and Federal 

Housing Administration (FHA) loans have performed 

less well during this expansion. These loan types are 

both designed to aid less creditworthy borrowers in 

securing a home loan. VA and FHA loans, which 

include a portion of the higher-risk high-LTV and subprime loans, have historically experienced higher pastdue and foreclosure rates than other classes of mortgage 

loans (see Charts 3 and 4). 

The overall performance of 1–4 family residential mortgages at insured institutions has been solid. As of March 

2000, delinquent 1–4 family loans remained well under 

1 percent of total 1–4 family loans, and the percentage 

of charge-offs was nearly zero. Charge-offs may have 

reached the bottom of the credit cycle in 1998, however, after peaking at a record high in 1993 (see Chart 5). 

CHART 3 

Past-Due Rates on FHA and VA Loans Have
 

Historically Been Higher than
 

on Conventional Loans
 

Loans Past Due as a Percentage of All Loans 

10.0 Federal Housing Administration 

8.0 

6.0 

Veterans Administration Loans 

Loans 

4.0 

2.0
 

Conventional Loans
 

0.0
 

4Q82 3Q85 2Q88 1Q91 4Q93 3Q96 2Q99 

Source: Mortgage Bankers Association (Haver Analytics) 

CHART 4 

Foreclosure Rates on FHA and VA Loans
 

Remain Higher than on Conventional Loans
 

Foreclosures Started as a Percentage of All Loans 

0.8 

0.7 Federal Housing Administration 

Loans 

0.6 

0.5 

0.4 

0.3 

0.2 

0.1 

Veterans Administration Loans 

Conventional Loans 

0.0 

4Q82 3Q85 2Q88 1Q91 4Q93 3Q96 2Q99 

Source: Mortgage Bankers Association (Haver Analytics) 

A trend toward higher charge-off rates might be cause 

for concern at a time when conditions in the consumer 

sector seem to be excellent. Moreover, as with regional 

problems that surfaced in the late 1980s and early 

1990s, the aggregate data may still mask evolving 

submarket residential real estate problems associated 

with local economic and business conditions or new, 

higher-risk lending lines of business. 

Concerns have arisen recently about the future of residential loan credit quality and consumer credit quality 

in general. The Board of Governors of the Federal 

Reserve System warned that, although the consumer 

sector seems healthy by most measurable standards, 

“[consumer] delinquency rates may be held down, to 

some extent, by the surge in new loan originations in 

recent quarters because newly originated loans are less 

likely to be delinquent than seasoned ones.”6 Consumer 

credit outstanding grew by nearly 8 percent in the second quarter of 2000, the highest growth rate in the past 

three years. At the same time, 1–4 family loans at 

insured institutions expanded by 11 percent from March 

1999 to March 2000, the highest year-over-year growth 

rate since 1997. 

High growth rates are not the only concern regarding 

the future credit quality of residential loan portfolios. 

Rising interest rates have raised the cost of borrowing 

for consumers at a time when consumer credit has been 

expanding rapidly. Mortgage debt service payments as a 

percentage of disposable personal income rose to nearly 6 percent in the first quarter of 2000, continuing an 

CHART 5 

1–4 Family Loan Charge-Offs May Have 

Reached the Bottom of the Credit Cycle 

1–4 Family Loan Charge-Offs as a Percentage 

of All 1–4 Family Loans 

0.30 

0.25 

0.20 

0.15 

0.10 

0.05 

0.00 

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

Fourth Quarter 

Source: Bank and Thrift Call Report Data (Research Information System) 

6 Board of Governors of the Federal Reserve System. July 20, 2000. 

Monetary Policy Report to the Congress, p. 7. 

Boston Regional Outlook 22 Third Quarter 2000 
In Focus This Quarter
 

upward trend since mid-1994. This level was last 

reached in 1991, when the economy was emerging from 

an economic recession and some local residential markets were in turmoil. Further increases in interest rates 

would push mortgage debt service payments higher, 

which could impair the ability of mortgage holders to 

service both mortgage debt and other consumer debt. 

Moreover, other consumer loans would likely enter 

delinquency before mortgage loans, as consumers are 

more likely to pay their mortgages before other consumer debt. 

New Residential Lending Programs May 

Heighten the Risk Exposure of Insured 

Institutions 

Recent trends in high-LTV and subprime lending have 

heightened the risk exposure of insured institutions. 

Intense competitive pressure in the banking industry has 

narrowed the margins of traditional lending lines, 

inducing banks to seek more profitable lines of business. Both high-LTV and subprime lending offer wider 

margins, but at the price of increased risk to the lender. 

High-LTV loans represent greater risk to lending institutions when collateral values decline. If a home loan is 

underwritten on the basis of an inflated home value, 

there is a greater possibility of default if the value of the 

home declines. Furthermore, a decline in the value of 

the home could reduce the possibility of recovering the 

loan in the event of default and foreclosure. 

The share of high-LTV loan originations is growing.7 

The percentage of loans with an LTV ratio greater than 

90 percent has risen from around 5 percent to more than 

20 percent over the past ten years.8 Table 2 identifies the 

metropolitan areas where more than 30 percent of the 

conventional home loans underwritten in 1999 carried 

an LTV ratio greater than 90 percent. Given that the historical cycles of boom and bust in residential real estate 

have often been geographically isolated, both regional 

and national trends in high-LTV lending should be carefully monitored. 

7 See also Diane Ellis. “High Loan-to-Value Lending: A New Frontier in Home Equity Lending.” Regional Outlook, first quarter
 

1999; http://www.fdic.gov/bank/analytical/regional/ro19991q/na/
 

t1q1999.pdf.
 

8 Federal Housing Finance Board.
 

Subprime lending is a term commonly used to refer to 

loans that are extended to borrowers who are perceived 

as less creditworthy.9 As insured institutions have 

increased their involvement, the subprime lending 

market has presented banks with new growth opportunities and new risks. Subprime loans represent a small 

but growing share of total mortgage originations (see 

Chart 6, next page). To be sure, higher pricing on subprime loans promises wider margins and higher revenues for lenders, but the credit risk associated with 

less-than-prime borrowers requires ongoing oversight 

and management to prevent credit losses from eroding 

margins. Some financial institutions that have either 

grown subprime portfolios or acquired subprime affiliates are now scaling back their involvement in subprime 

TABLE 2 

Pockets of Risk May Be Forming 

Where the LTV Is Highest 

PERCENTAGE 

METROPOLITAN STATISTICAL OF LOANS 

AREA (MSA) OR CONSOLIDATED WITH LTV 

MSA RANKED BY PERCENTAGE OVER 90 OF LOANS WITH LTV GREATER PERCENT 

THAN 90 PERCENT 1999 

1 GREENVILLE-SPARTANBURGANDERSON, SC
 50% 

2 HONOLULU, HI 42% 

3 MEMPHIS, TN 38% 

4 CHARLOTTE-GASTONIAROCK HILL, NC-SC 37% 

5 BIRMINGHAM, AL 35% 

6 HOUSTON-GALVESTONBRAZORIA, TX 35% 

7 ATLANTA, GA 32% 

8 JACKSONVILLE, FL 32% 

9 NASHVILLE, TN 32% 

10 OKLAHOMA CITY, OK 32% 

11 TULSA, OK 32% 

12 GREENSBORO–WINSTONSALEM–HIGH POINT, NC 31% 

13 KANSAS CITY, MO-KS 30% 

14 LAS VEGAS, NV-AZ 30% 

LTV = loan-to-value 

Source: Federal Housing Finance Board 

9 See also Kathy R. Kalser and Debra L. Novak. “Subprime Lending: 

A Time for Caution.” Regional Outlook, third quarter 1997; 

http://www.fdic.gov/bank/analytical/regional/ro19973q/pdf/roa1997. 

pdf. 

Boston Regional Outlook 23 Third Quarter 2000 
In Focus This Quarter
 

lending activities to limit projected losses.10 In some 

cases, excessive losses related to the business of underwriting subprime loans have contributed to the failure 

of insured institutions. 

A recent report from Inside Mortgage Finance states 

that subprime portfolios are showing evidence of weakness.11 According to this report, the serious delinquency 

rate in the overall subprime market rose from 6.5 percent in 1998 to 6.9 percent in 1999.12 Furthermore, the 

percentage of A-rated borrowers in the subprime market 

fell from 59 percent to 53 percent during the same period. The implication is that both subprime and prime 

mortgages originated this year could likely underperform relative to prior years, adversely affecting credit 

quality at insured institutions. 

The potential for higher future losses related to subprime lending is of particular concern. The delinquency rate on subprime mortgages has traditionally been 

much higher than that of prime mortgages. As of 

December 1999, seriously delinquent prime mortgage 

loans comprised only 0.5 percent of total mortgage 

loans, compared with 3.2 percent of the best-rated subprime loans. Subprime mortgage loan seasoning analysis shows that 1999 vintage subprime loans have so far 

outperformed both 1997 and 1998 vintage loans (see 

Chart 7). However, there is a concern that adverse 

CHART 6 

Subprime Mortgage Loans Are Growing as a
 

Percentage of Total Mortgage Originations
 

Subprime Mortgage Subprime Mortgage Loans as a
 

Loan Originations, Percentage of Total Originations
 

200 

in Billions of Dollars 

20% 

150 15% 

100 10% 

50 5% 

0 0% 

’94 ’95 ’96 ’97 ’98 ’99 1Q00 

Sources: The Mortgage Market Statistical Annual for 1999; Inside B&C Lending 

10 Subprime Mortgage Market Faces More Challenges in Second Half 

of Turbulent 2000. Inside Mortgage Finance. July 7, 2000. 11 Mortgage Delinquency Rates Decline in Early 2000 But Industry 

Braces for Shift in the Wind. Inside Mortgage Finance. July 14, 2000. 12 Seriously delinquent loans are defined as loans at least 90 days 

delinquent or in foreclosure. 

changes in economic conditions and the health of the 

consumer sector could cause the foreclosure rate on 

subprime mortgage loans to increase more steeply than 

in prior years. 

Conclusion 

Rising home prices in some U.S. metropolitan areas 

may be a warning sign that asset price bubbles may be 

forming in some areas. A number of these areas also 

contain concentrations of employment in the high-tech 

sector, placing them at higher risk in the event of a 

downturn in that sector. Mortgage lenders in these areas 

should carefully monitor developments that could 

adversely affect home prices and collateral values. 

Nationally, single-family housing market activity 

appears to be slowing after a period of rapid growth 

supported by a long economic expansion and generally 

favorable interest rates. 

Historically, mortgage loans at insured institutions 

have been one of the best-performing asset classes. As 

1–4 family loan charge-offs have approached zero, it 

appears as if the credit cycle may have bottomed out, 

implying that loss rates may be rising. Moreover, as 

insured institutions increase involvement with subprime and high-LTV lending, the potential for higher 

future losses on residential real estate also increases. It 

will be important to keep an eye on developments in 

the economy and the consumer sector that could affect 

the future credit quality of residential real estate at 

insured institutions. 

Alan Deaton, Financial Economist 

CHART 7 

1999 Vintage Subprime Residential Loans Have 

Outperformed Earlier Vintages 

Foreclosure Rate on the Dollar Volume of B&C Grade 

Subprime Single-Family Residence 

7.0% 

6.0% 

5.0% 

4.0% 

3.0% 

2.0% 

1.0% 

0.0% 

1997 Vintage 

1998 Vintage 

1999 Vintage 

6 9 12 15 18 21 24 27 30 33 36 39 

Months of Seasoning 

Source: Mortgage Information Corporation 

Boston Regional Outlook 24 Third Quarter 2000 
✁
 

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