Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION SECOND QUARTER 2000 

FDIC
 

National
 

Edition
 

Boston 

Chicago 

New 

York 

Atlanta 

Memphis 

Kansas 

City 

San Francisco 

Dallas 

Division of
 

Insurance
 

In Focus This Quarter 

◆ Banking Risk in the New Economy—This article summarizes current economic conditions, with a primary focus on potential risks to insured depository 

institutions. It explores the implications of long-term trends that have led to the 

New Economy. Recent high rates of economic growth with low inflation have been 

made possible by increases in productivity arising from new technologies, higher 

investment spending by businesses, and large-scale industrial restructuring. Underlying these trends has been a financial environment that has largely accommodated 

the growing borrowing needs of consumers and businesses. Market-based financing, 

provided in large part through securitizations and mutual funds, has made capital 

readily available to start-up “new economy” firms as well as mature companies that 

seek to merge or restructure. Despite the clear benefits of market-based financing 

in supporting economic activity, there are also concerns. A recurrence of financial 

market turmoil, such as that experienced in fall 1998, has the potential to quickly 

change the currently positive economic outlook to one that is far more challenging. 

Detail is provided on commercial credit quality, market sources of revenue, and 

other risks to watch in banking. See page 3. 

By the Analysis Branch Staff 

Regional Perspectives 

◆ Atlanta—Economic strength in 

the Atlanta Region, low interest rates, 

and adequate available sources of 

credit have promoted growth in residential real estate construction in 

recent years, particularly in urban 

areas. See page 15. 

◆ Boston—The Boston Region’s 

economy continued to expand in 

1999, but at a slower rate than a 

year ago. Recent trends suggest that 

insured institutions have become 

increasingly exposed to interest rate 

risk. See page 16. 

◆ Chicago—Capital ratios among 

the Region’s insured financial institutions remain high, but a recent downward trend is not consistent with a 

rising risk profile. See page 17. 

◆ Dallas—While the makeup of liabilities in the Dallas Region has not 

changed significantly, many of the 

Region’s banks have shifted to longer 

maturities for a large portion of assets, 

potentially increasing these institutions’ 

vulnerability to rising interest rates. 

See page 18. 

◆ Kansas City—Prices for major 

commodities remain depressed, prolonging farmers’ reliance on government payments. Office construction in 

St. Louis poses a risk of overbuilding, 

given current population and employment trends. See page 19. 

◆ Memphis—The rural economy is 

suffering from continued weaknesses in 

manufacturing and agriculture. Agricultural conditions are expected to 

worsen with a third year of low commodity prices and sharp reductions in 

tobacco production. See page 20. 

◆ New York—In 1999, the strong 

stock market strengthened the Region’s 

economy. Higher interest rates and 

changes in mortgage preferences could 

challenge the interest rate risk management programs of the Region’s banks. 

See page 21. 

◆ San Francisco—Commercial 

lenders headquartered in states registering strong economic growth during 

the 1990s reported rapid growth and 

increased concentrations in traditionally higher-risk loan types as of yearend 1999. See page 22. 

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 National Edition of Regional 

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

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

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

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

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

the Federal Deposit Insurance Corporation. 

Chairman 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 
In Focus This Quarter
 

Banking Risk in the New Economy
 

The Division of Insurance periodically assesses conditions in the economy and the banking industry to identify and evaluate trends that could adversely affect the 

performance of insured depository institutions. At this 

time, the banking industry as a whole continues to 

enjoy record profits and solid financial ratios.1 Much of 

the industry’s strength derives from the remarkable performance of the U.S. economy, which has been expanding for the past nine years. This article explores factors 

that have shaped this unusually robust economic environment and discusses how changes in the economy 

may create new types of risks for insured depository 

institutions. 

During 1999, the FDIC reported the first annual loss for 

the Bank Insurance Fund since 1991. This loss primarily resulted from an uptick in unanticipated and highcost bank failures. Some of these failures were 

associated with high-risk activities such as subprime 

lending, and some were related to operational weaknesses and fraud. The emergence of these problems in 

the midst of a strong economic environment raises concerns about how the condition of the banking industry 

might change if economic conditions deteriorate. 

The Longest U.S. Expansion 

In February 2000, the U.S. economy entered its 108th 

month of expansion, making this the longest period of 

uninterrupted growth in U.S. history.2 This recordsetting performance has also been marked by a recent 

acceleration in the rate of real gross domestic product 

(GDP) growth, which has exceeded 4 percent in each 

year since 1997. Meanwhile, price inflation has 

remained relatively subdued. The core inflation rate, 

which excludes the volatile food and energy components, was just 2.1 percent in 1999, the lowest core rate 

since 1965. 

Recent economic conditions have been highly conducive to strong loan growth, low credit losses, and 

record earnings for the banking industry. The important 

1 For a recent summary of financial performance and condition of the 

banking and thrift industries, see the FDIC Quarterly Banking Profile, fourth quarter 1999, http://www2.fdic.gov/qbp/. 2 The chronology of U.S. business cycles is available from the National Bureau of Economic Research, http://www.nber.org/cycles.html. 

question going forward is how long these favorable conditions might last. Is this remarkable economic performance the result of some long-term upward shift in the 

pace of economic activity, or is it the temporary result 

of a few transitory factors? More important, are there 

new and unfamiliar dangers that, at some point, could 

significantly impair banking industry performance? To 

evaluate these questions, we must assess the factors that 

have contributed to recent economic performance and 

think ahead to possible developments that could end this 

expansion. 

What Is the New Economy? 

The term used most often to describe the recent period 

of economic performance has been somewhat controversial: the New Economy. Much of the controversy has 

arisen because people interpret the term in different 

ways. Wall Street analysts use the term to refer to the 

high-technology sectors of the economy, such as computers and software, biotechnology, and especially the 

Internet. Some of these New 

Economy firms have been able to 

raise large amounts of capital and 

command market valuations in 

the tens of billions of dollars well 

in advance of earning a profit or 

even booking significant cash 

revenues. 

Economists tend to employ the term New Economy in a 

slightly different way. To them, it refers to evidence that 

some of the traditional economic relationships have 

changed. For example, intangible assets now appear to 

play a much larger role in the valuation of investments 

than they have in the past.3 Firms in some industries 

now may exhibit increasing returns to scale (rather than 

diminishing returns), reflecting the fact that the value of 

their product rises as it becomes a de facto industry 

standard.4 Individual decision making, too, may be 

changing. Some believe that investors have reduced the 

risk premium they demand to hold equity positions 

3 Nakamura, Leonard. Federal Reserve Bank of Philadelphia. 

July/August 1999. Intangibles: What Put the New in the New Economy? Business Review. http://www.phil.frb.org/files/br/brja99ln.pdf. 4 Brown, William S. March 2000. Market Failure in the New Economy. Journal of Economic Issues, 219–27. 

Regional Outlook—National Edition 3 Second Quarter 2000 
In Focus This Quarter
 

because of their perception that holding equity is not, 

after all, substantially riskier than holding debt.5 Such a 

shift in investor attitudes could help explain why the 

price-to-earnings ratio for the S&P 500 index has 

recently approached all-time highs.6 

Perhaps the most important underlying change in the 

economy is the relationship between high rates of economic growth and changes in inflation. Economists have 

long maintained that rapid growth in economic activity 

has a tendency to lead to excess demand for goods (thereby raising consumer and producer prices) and excess 

demand for labor (thereby raising wage rates). But during 

the late 1990s, as growth accelerated and inflation 

remained low, economists began to reevaluate their 

notions of these trade-offs. Some argued that the low rate 

of inflation during this expansion was the fortunate result 

of temporary factors, such as a strong dollar and low 

energy prices, both of which could diminish or reverse 

direction over time.7 Only a few analysts were so bold as 

to suggest that the fundamental workings of the economy 

had changed in such a way as to allow a sustained period 

of high economic growth with low inflation. 

An early Wall Street description of the New Economy 

appeared in an article released by Goldman Sachs in 

January 1997.8 It describes a number of fundamental 

changes in the economy—driven by global competition 

and advancing technology—that may permit business 

cycle expansions to last longer than they have in the 

past. At the same time, it warned that longer economic 

expansions might have a tendency to contribute to 

greater financial excess and the possibility of more 

severe recessions and more sluggish recoveries. 

If this hypothesis is correct, and an emerging New 

Economy would contribute to longer expansions and 

more severe recessions, there may be implications for 

how banks manage risks. Since the Great Depression, 

U.S. business cycle recessions have not necessarily been 

catalysts for large numbers of bank and thrift failures. 

5 January 24, 2000. Has the Market Gone Mad? Fortune.
 6 September 1999. Earnings: Why They Matter. Money.
 7 Brown, Lynn Elaine. Federal Reserve Bank of New England.
 

May/June 1999. U.S. Economic Performance: Good Fortune, Bubble,
 

or New Era? New England Economic Review. http://www.bos.frb.org/
 

economic/pdf/neer399a.pdf, and Brinner, Roger E. Federal Reserve
 

Bank of New England. January/February 1999. Is Inflation Dead?
 

New England Economic Review. http://www.bos.frb.org/economic/
 

pdf/neer199c.pdf.
 

8 Dudley, William C., and Edward F. McKelvey. January 1997. The
 

Brave New Business Cycle: No Recession in Sight. U.S. Economic
 

Research, Goldman Sachs.
 

During the period from 1983 to 1989, when the U.S. 

economy was in the midst of a long expansion, some 

1,855 insured banks and thrifts failed. This wave of 

failures has been attributed to a variety of factors, 

including severe regional economic downturns, realestate-related problems, stress in the agricultural sector, 

an influx of newly chartered banks and banks that converted charters, and high nominal interest rates.9 However, the potential for significantly more severe national 

recessions would represent largely uncharted territory 

that could cause losses and loss correlations to depart 

from historical norms, posing a new set of risk management challenges for the industry going forward. 

The Productivity Revolution 

As the essential element that links faster economic 

growth and low inflation, productivity growth is the cornerstone of the New Economy. Productivity refers generally to the amount of output that can be obtained from 

a fixed amount of input. Labor productivity is usually 

measured in terms of output per hour. Chart 1 shows 

that output per hour in manufacturing has risen at an 

average annual rate of 4.5 percent during the current 

expansion, compared with rates of just over 2.5 percent 

in the three previous long economic expansions. Moreover, productivity growth accelerated in 1999 to a rate 

of 6.3 percent. Why is productivity growing so fast now 

compared with previous expansions? Even economists 

who believe that economic relationships have fundaCHART 1 

Productivity Has Grown at a Faster Rate in This 

Expansion than in Previous Long Expansions 

Average Year-over-Year Growth 

in Manufacturing Output per Hour 

5.0% 

4.0% 

3.0% 

2.0% 

1.0% 

0.0% 

1961–69 1975–79 1983–90 1991–2000 

Source: Bureau of Labor Statistics (Haver Analytics) 

9 FDIC 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, 16–17. http://www. 

fdic.gov/bank/historical/history/contents.html. 

Regional Outlook—National Edition 4 Second Quarter 2000 
In Focus This Quarter
 

mentally changed are hard-pressed to explain why all of 

the factors came together in the late 1990s and not 

before.10 Still, explanations for the increase in productivity tend to focus on three main factors. 

Increased Competition. Expanding global trade during 

the 1980s and 1990s has subjected U.S. firms to new 

competition from around the world. Annual U.S. 

exports of goods and services grew by over 230 percent 

(after inflation) between 1982 and 1999, while imports 

grew by 315 percent. The construction of new production facilities around the world in industries such as 

autos and chemicals has led to excess manufacturing 

capacity that has kept prices low. In other industries, 

including air travel, trucking, telecommunications, and 

banking, competition has been intensified through 

domestic deregulation. Facing intense competitive pressures and a low rate of general price inflation, firms 

cannot rely on annual price increases to help expand 

top-line revenue. Instead, there is pressure to continually cut costs in order to increase earnings. For many 

firms, this means adopting new technologies and new 

ways of organizing operations. 

Expanded Investment. U.S. firms of all sizes have 

invested in new technologies at a rapid pace during this 

expansion. Chart 2 shows that business investment in 

equipment and software represents almost one-quarter 

of total net GDP growth during this expansion, comCHART 2 

Business Investment in Equipment and Software
 

Has Been Robust during This Expansion
 

Average Percent Contribution of Real Investment 

in Durable Equipment and Software 

to Net GDP Growth by Expansion 

25 

20 

15 

10 

5 

0 

1961–69 1975–79 1983–90 1991–99 

Note: GDP = gross domestic product
 

Source: Bureau of Economic Analysis (Haver Analytics)
 

10 One possible explanation is that there is a learning curve for adopting new technologies and that technology diffusion is an inherently 

slow process. David, Paul A. Organization for Economic Cooperation 

and Development. 1991. Computer and Dynamo: The Modern Productivity Paradox in a Not-Too-Distant Mirror. In Technology and 

Productivity: The Challenge for Economic Policy, 315–47. 

pared with around 15 percent or less during previous 

long expansions. While this investment has been motivated by the need to cut costs, it has also been fueled by 

the availability of new computer technologies that have 

fallen in cost over time and by the ready availability of 

financial capital on favorable terms. 

Industrial Restructuring. The third aspect of the productivity revolution is large-scale restructuring in the 

U.S. corporate sector. Chart 3 shows that both the annual number and dollar volume of mergers in the late 

1990s far exceeded the pace of the so-called merger 

mania of the late 1980s. Two classes of firms are leading the new wave of mergers. First, companies in 

mature industries such as oil, autos, and banking are 

faced with excess productive capacity and intense price 

competition. For these firms, mergers are useful in 

expanding market share and removing redundant operations. Second, the largest dollar volume of mergers is in 

some of the most volatile emerging industries, including telecom, media, and the Internet. It is in these sectors of the economy, in particular, where the business 

models are evolving rapidly and where technological 

standards are still being determined. Firms in these 

industries that can grow rapidly through mergers have 

the chance to achieve long-term market dominance in 

what appear to be some of the fastest growing industries 

of the new century. 

The implications of the productivity revolution for the 

banking industry have been decidedly positive. Higher 

productivity has allowed a long expansion and faster 

economic growth with low inflation, all of which are 

conducive to robust financial performance by depository institutions. Higher rates of business investment 

CHART 3 

Note: M&A = merger and acquisition 

Source: Houlihan Lokey’s Mergerstat 

The Volume of Corporate Mergers Set 

Another New Record in 1999 

Number of M&A Deals M&A Deal Value, Billions of Dollars 

’70 ’72 ’74’76’78’80 ’82 ’84’86 ’88 ’90’92’94’96 ’98 

0 

2,000 

4,000 

6,000 

8,000 

10,000 

1,000 

1,200 

1,400 

1,600 

0 

200 

400 

600 

800 

Regional Outlook—National Edition 5 Second Quarter 2000 
In Focus This Quarter
 

have generated demand for credit that is supplied, in 

part, by banks and thrifts. Perhaps most important, the 

recent large-scale industrial restructuring has been 

highly supportive of strong business credit quality. This 

process has moved economic resources to more productive uses in an orderly fashion, without the high levels 

of bankruptcies and defaults that often accompany 

industrial restructuring. Given the volumes of corporate 

assets that have changed hands in recent years (more 

than $1.4 trillion in 1999 alone), it is fortunate indeed 

that this restructuring has proceeded in this fashion. 

The Role of the Capital Markets 

A critical factor in heightened business investment and 

restructuring during this expansion has been the 

remarkably favorable conditions in the financial markets. Financial capital has generally been readily available to business borrowers, usually on favorable terms. 

One factor that has held down the cost of capital for 

publicly traded corporations has been sharply rising 

stock prices. Many of these firms have been able to use 

equity shares as a currency with which to finance mergers. Furthermore, existing accounting rules do not 

always require the amortization of good will that comes 

onto the balance sheet as a result of a merger.11 

By far the largest amount of external business financing 

has been debt financing. U.S. nonfinancial corporations 

issued net debt in the amount of $535 billion in 1999 

and repurchased equity shares, on net, for the sixth consecutive year. Businesses have used this debt to purchase capital equipment, finance mergers, and buy back 

equity shares. This increase in debt issuance has not 

been limited to highly rated corporations. Venture capital financing amounted to almost $15 billion in the 

fourth quarter of 1999 alone, with over 60 percent of 

that amount going to Internet firms.12 

Banks have been active participants in nearly every 

facet of this financing activity. Syndicated loan origination volumes rose by 17 percent in 1999 to just over 

$1 trillion, despite relatively high credit costs and facility fees, factors that helped keep total volume below 

1997’s record $1.1 trillion in issuance. Syndicated loans 

to leveraged companies also rose 17 percent in 1999 to 

a record $320 billion. More impressive still was the 

growth in high-yield transactions, which rose nearly 50 

11 April 17, 2000. Techdom’s New Bean-Counting Battle. Business 

Week. 

12 May 2000. Venture financing data are derived from a PriceWaterhouseCoopers/Money Tree survey, as cited in Upside, 43. 

percent in 1999 to $190 billion. It is difficult to determine precisely how much syndicated loan exposure 

resides on the books of insured institutions or, more 

important, how much high-yield exposure is retained by 

commercial banks. Loan Pricing Corporation estimates that 64 percent of high-yield volume in the first 

half of 1999 was retained by banks.13 Insured commercial banks are the dominant originators of syndicated 

loans, with a 79 percent market share of investmentgrade originations and a 56 percent market share of 

non-investment-grade originations in 1999. Commercial banks have also expanded their presence in the venture capital market. For some of the largest banks, 

profits from venture capital operations account for a 

large portion of total earnings. Chase Manhattan reported venture capital investment earnings of $2.3 billion in 

1999, accounting for 22 percent of total net income.14 

Innovation in the capital markets continues to provide 

new and more efficient vehicles for business financing. 

For example, issuance of asset-backed securities totaled 

$346 billion in 1999, up from only $50 billion in 1990. 

In this ongoing revolution in finance, market-based 

intermediaries, such as mutual funds and asset pools, 

have assumed an increasing role in the credit markets. 

Chart 4 shows that net holdings of credit market instruments by mutual funds, government-sponsored enterprises, and asset pools exceeded the debt held by 

depository institutions for the first time in 1997. 

CHART 4 

Market-based Lending Is Becoming More 

Important as a Source of Business Financing 

Share of Total Net 

Credit Market Lending1 

70% 

60% 

50% 

40% 

30% 

20% 

10% 

0% 

Market-based Lenders3 

Depository Institutions2 

’60 ’63 ’66 ’69 ’72 ’75 ’78 ’81 ’84 ’87 ’90 ’93 ’96 ’99 

1 Total net credit market lending is defined as net holdings of open-market paper,
 

government and municipal securities, corporate and foreign bonds, mortgages,
 

and other loans.
 

2 Depository institutions include commercial banks, savings institutions, and credit
 

unions.
 

3 Market-based lenders include mutual funds, closed-end funds, government-


sponsored enterprises, and asset pools.
 

Sources: Federal Reserve Board (Haver Analytics); Regional Financial Associates
 

13 September 13, 1999. Junk Loan Market Is Feeling the Pinch of 

Oversupply and Rising Interest Rates. The Wall Street Journal. 14 April 3, 2000.What’s Really Driving Banks’ Profits. Business Week. 

Regional Outlook—National Edition 6 Second Quarter 2000 
In Focus This Quarter
 

While the expansion in market-based financing has 

made credit more available to business and consumer 

borrowers, it also creates some concerns. One issue is 

the susceptibility of the financial markets to periodic 

bouts of turmoil. These episodes, such as the one triggered by the Russian government bond default and the 

near-failure of the Long Term Capital Management 

hedge fund in the fall of 1998, can result in the interruption of capital flows even to creditworthy borrowers. 

During the 1998 episode, private yield spreads widened 

sharply as investors sought the safety of U.S. Treasury 

securities. Some companies that had planned to issue 

debt to the markets during that period were unable to do 

so. For companies whose business models depend heavily on a continuous supply of liquidity from the financial markets, the effects of these episodes can be 

catastrophic. For example, the relatively short-lived 

episode of financial turmoil during late 1998 resulted in 

significant liquidity problems 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. 

Because market-based financing has played such a large 

role in facilitating the orderly restructuring of the U.S. 

economy through mergers and the formation of new 

businesses, a recurrence of financial market turmoil 

could contribute to the end of the current expansion. 

Moreover, such an event could have serious consequences for business credit quality. A prolonged interruption of market-based financing could, in this very 

competitive economic environment, prevent businesses 

from restructuring themselves through mergers and 

deprive them of capital needed to invest in cost-cutting 

technologies. The loss of financial flexibility would 

leave businesses much more vulnerable to the effects of 

CHART 5 

competition and could result in more firms seeking 

bankruptcy protection. Such a scenario has the potential 

to bring about a significant increase in charge-off rates 

for business lenders. 

Financial Imbalances 

Another concern that arises from increased dependence 

on market-based financing is that it may contribute to 

the emergence of financial imbalances in the economy. 

These imbalances could, in turn, increase the potential 

for financial market turmoil as a result of some unforeseen shock to the markets. 

As recently as 1993, the public deficit was near the top 

of the list of economists’ concerns about the U.S. economy. During that year, the combined deficit of the federal, state, and local government sectors exceeded $300 

billion. However, on the strength of a long economic 

expansion, lower interest rates, and lower federal spending on defense, the consolidated government sector 

posted its second consecutive surplus in 1999 (Chart 5). 

As the government has moved from deficit to surplus, 

households and businesses have continued to borrow 

hundreds of billions of dollars every year. Taken together, the annual net borrowing of businesses and households has been referred to as the “private deficit.” In 

1999, the private deficit narrowed to $913 billion from 

a record $1.02 trillion the year before. Although this private borrowing indicates confidence on the part of consumers and businesses about future prospects, it also 

raises concerns about the ability to service debt if interest costs rise or if incomes level off or decline. 

Regional Outlook—National Edition 7 Second Quarter 2000 

Flow of Net Sectoral Lending 

(Lending Less Borrowing), 

in Billions of Dollars Domestic Financial Sector 

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

Source: Federal Reserve Board (Haver Analytics) 

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

–1,200 

–900 

–600 

–300 

0 

300 

600 

900 

1,200 

Foreign Sector 

Nonfinancial Business 

Households 

Government 

’80 ’81 ’82 ’83 ’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 
In Focus This Quarter
 

The largest part of the private deficit was again 

financed in 1999 by domestic financial institutions 

($649 billion) and an inflow of capital from abroad 

($207 billion). Both of these sources of financing are 

potential causes for concern. The rapid expansion in 

credit created by the financial sector raises questions 

about credit quality. Financial institutions theoretically 

serve as the gatekeepers of the economy, financing only 

the most creditworthy projects and rejecting those that 

are not viable. The sheer volume of credit extended to 

businesses and households—almost $1.4 trillion in new 

net lending over the past two years—raises the possibility that underwriting has become more lax and that 

average credit quality is slipping. (See the inset box on 

page 17 for a discussion of recent trends in commercial 

credit quality.) 

Reliance on inflows of foreign capital raises a different 

set of issues. The fact that the U.S. economy has been 

growing significantly faster than the economies of its 

major trading partners has contributed to a U.S. trade 

deficit that reached $268 billion in 1999 and could 

exceed $300 billion in 2000. This deficit puts hundreds 

of billions of dollars annually in the hands of foreign 

investors. As long as foreign investors largely choose to 

reinvest their excess dollars in U.S. factories and financial instruments, as has been the case in recent years, 

the United States can continue to enjoy a strong dollar 

and relatively low inflation and low interest rates. However, if foreign investors should choose to invest elsewhere, they must sell their dollars in foreign exchange 

markets. Doing so would put downward pressure on the 

dollar and upward pressure on U.S. inflation and interest rates. 

Recent Shocks to the U.S. Economy 

Despite the potential for a declining dollar as a result of 

U.S. reliance on foreign capital, other adverse developments have confronted the U.S. economy over the past 

year. The two factors of most consequence to the macroeconomic outlook have been rising energy costs and rising interest rates. These trends have played a role in 

recent equity market volatility that may have implications for the future direction of the economy. 

Rising Energy Prices. After declining to a low of 

around $10 per barrel in December 1998, oil prices have 

risen dramatically over the past year and a half. The spot 

price per barrel of West Texas Intermediate crude 

peaked in March 2000 at just under $30 before declining slightly in April. The rapid increase in oil prices during 1999 was sparked by a cutback in output by oilproducing nations that was instituted just as global economic growth was recovering from the crisis of 1998. 

The OPEC nations and other major oil producers 

reached a new agreement in March 2000 that provides 

for a production increase of some 1.5 million barrels a 

day. But, because demand is rising and gasoline inventories remain lean, analysts do not look for a significant 

decline in gasoline prices in the near term.15 

The effects of higher oil prices on the U.S. economy at 

this time are uncertain. According to some estimates, 

the economy is only half as dependent on oil as it was 

25 years ago, when the United States was experiencing 

the effects of its first “oil shock.”16 Still, higher oil 

prices were responsible for nearly all the increase in 

consumer price inflation during 1999. While year-overyear growth in the Consumer Price Index rose from 1.6 

percent in December 1998 to 2.7 percent in December 

1999, the core rate of inflation (excluding food and 

energy items) actually fell. The question now is whether 

higher energy prices will be passed along to the rest of 

the economy through rising wage and price demands 

during the remainder of 2000. 

Rising Interest Rates. From low points at the end of 

1998, both short-term and long-term interest rates have 

risen substantially, contributing to a higher cost of debt 

service for businesses and households. At the short end 

of the yield curve, the Federal Reserve (the Fed) raised 

the Federal Funds rate six times between June 1999 and 

May 2000, for a total increase of 175 basis points. 

While part of this increase merely reversed the reduction in rates that took place in late 1998, the Fed also 

voiced concerns that inflationary pressures might be 

emerging because of continued rapid U.S. economic 

growth. Given the stated commitment of the Federal 

Reserve to price stability, most analysts expect the Fed 

to continue to push short-term rates higher until growth 

in the economy slows to a more sustainable pace.17 

Bond markets also pushed up long-term interest rates 

during this period. The yield on the ten-year Treasury 

15 Energy Information Agency (U.S. Department of Energy). April
 

2000. Short-Term Energy Outlook. http://www.eia.doe.gov/emeu/
 

steo/pub/contents.html.
 

16 March 11, 2000. Fueling Inflation? The Economist.
 17 See, for example, U.S. House of Representatives. February 17,
 

2000. Testimony of Chairman Alan Greenspan Before the Committee
 

on Banking and Financial Services. http://www.federalreserve.gov/
 

boarddocs/hh/2000/February/Testimony.htm.
 

Regional Outlook—National Edition 8 Second Quarter 2000 
In Focus This Quarter
 

As Commercial Credit Quality 

Indicators Slip, Trends in Commercial 

Lending Come to the Forefront 

Commercial lending, which includes both commercial 

and industrial (C&I) and commercial real estate (CRE) 

loans, represents the greatest source of credit risk to 

insured institutions and the deposit insurance funds. C&I 

loan growth continued to be strong in 1999, although it 

did moderate from 1998 levels, and recent underwriting 

surveys have reported a slight tightening of terms.18 Nevertheless, there are signs that commercial credit quality is 

deteriorating.19 Most notably, as seen in Chart 6, C&I loan 

charge-off rates, corporate bond defaults, and corporate 

bond rating downgrades relative to upgrades have all 

been trending upward recently. For example, C&I loan 

loss rates rose to 0.56 percent of total loans in 1999, nearly double the rate of loss experienced in 1997. Although 

C&I loan loss levels are well below historical highs experienced throughout the 1980s and early 1990s, these signs 

of credit quality deterioration are occurring despite 

extremely favorable economic conditions. 

At least three factors have contributed to weakening in 

corporate credit quality. First, corporate indebtedness has 

been rising, as businesses have been spending to increase 

productivity, cut costs, repurchase equity, and finance 

mergers and acquisitions. The second factor relates to a 

greater risk appetite in the financial markets. For example, originations of leveraged syndicated loans—in particular, highly leveraged loans—have tripled over the past 

five years. Finally, stresses within industry sectors hard 

hit by structural changes, global competition, and deflationary pressures have resulted in challenges for 

borrowers. 

Construction and development (C&D) lending continues 

to be one of the fastest growing segments of banks’ loan 

portfolios, while loss rates among CRE and C&D loans 

remain extremely low. However, there are indications 

that conditions could be worsening in some markets. In 

particular, as shown in Chart 7, strong office completions and construction activity have begun to outpace 

absorptions and are projected to continue to do so over 

the next several years. Moreover, these trends have 

implications for vacancy rates. The national office 

vacancy rate moved higher during 1999 for the first time 

since 1991 and is projected to climb higher. 

In addition, some local CRE markets continue to show 

signs of overbuilding. Last year, the FDIC’s Division of 

Insurance identified nine markets in which the pace of 

construction activity threatened to outstrip demand for at 

least two property sectors.20 Seven of these nine markets 

reported an increase in office vacancy rates in 1999. 

CHART 6 

0.0 

1.0 

2.0 

3.0 

4.0 

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

0.0 

1.0 

2.0 

3.0 

4.0 

5.0 

Note: C&I = commercial and industrial 

Source: Moody’s; Bank and Thrift Call Reports (Research Information System) 

Deteriorating Indicators Suggest Weakening 

Business Credit Quality 

Insured Institution C&I 

Charge-off Rate 

Corporate Bond 

Default Rate 

Bond Ratings 

Downgrades to 

Upgrades (columns) 

18 Both the 1999 Senior Loan Officer Opinion Survey (Federal 

Reserve Board) and 1999 Survey of Credit Underwriting Practices 

(Office of the Comptroller of the Currency) point to more stringent 

C&I loan terms since the latter part of 1998. This tightening follows a four-year period of easing C&I loan standards and predominantly reflects an increase in loan pricing. 

19 For additional detail, see Sothoron, Arlinda, and Alan Deaton. 

FDIC Division of Insurance. First quarter 2000. Recent Trends 

Raise Concerns about the Future of Business Credit Quality. 

Regional Outlook. http://www.fdic.gov/bank/analytical/regional/ 

ro20001q/na/Infocus1.html. 

20 These markets are Charlotte, Orlando, Salt Lake City, Dallas, Las 

Vegas, Phoenix, Nashville, Atlanta, and Portland. See Burton, 

Steve. FDIC Division of Insurance. First quarter 1999. Commercial Development Still Hot in Many Major Markets, But Slower 

Growth May Be Ahead. Regional Outlook. http://www.fdic.gov/ 

bank/analytical/regional/ro19991/na/Infocus2.html. 

CHART 7 

0 

20,000 

40,000 

60,000 

80,000 

100,000 

120,000 

140,000 

’78 ’80 ’82 ’84 ’86 ’88 ’90 ’92 ’94 ’96 ’98 ’00 ’02 ’04 

0% 

5% 

10% 

15% 

20% 

Source: CB Commercial/Torto Wheaton Research 

U.S. Office Vacancies Rose Last Year 

for the First Time since 1991 

Completions, Absorption 

(000 sq. ft.) Vacancy

 Rate 

Completions 

Absorption 

Projected

Actual 

Regional Outlook—National Edition 9 Second Quarter 2000
 
In Focus This Quarter
 

note rose from a low of 4.5 percent in October 1998 to 

6.5 percent by May 2000. Analysts have cited renewed 

demand for credit by a recovering world economy as 

well as concerns about inflation arising from the 

increase in energy prices as factors behind the rise in 

long-term rates. 

Higher energy costs and higher interest rates do not 

appear to have significantly slowed the pace of U.S. 

economic activity during the first quarter of 2000. The 

preliminary estimate of real gross domestic product 

growth during the quarter was 5.4 percent—a slowdown 

from the 7.3 percent rate of the fourth quarter of 1999 

but still well above what is considered a sustainable 

pace. Home construction, usually a sector that is particularly sensitive to movements in long-term interest 

rates, has remained surprisingly resilient. Still confident 

of their future prospects, homebuyers have increasingly 

turned to adjustable-rate mortgages to avoid some of the 

immediate costs of higher fixed mortgage rates. 

As for the business sector, higher costs for energy and 

debt service are most significantly affecting “Old Economy” firms that purchase commodity inputs and carry 

significant debt on their balance sheets. Airline companies in the S&P 500, for example, posted a year-overyear decline of 27 percent in net income from 

continuing operations during the first quarter of 2000.21 

Analysts have argued that New Economy firms, by contrast, are less vulnerable to recent economic shocks 

because they tend to carry little debt and consume relatively little energy. 

Equity Market Volatility. The notion that New Economy 

firms are less vulnerable to the effects of higher energy 

costs and higher interest rates may be one of the reasons 

that equity shares of firms in the technology sector 

began to dramatically outperform the broader market, 

beginning around the middle of 1999. Chart 8 shows 

that the technology-heavy NASDAQ index performed 

more or less in tandem with the Dow Jones Industrial 

Average between the end of 1996 and the middle of 

1999, but thereafter the NASDAQ soared far ahead of 

the Dow. Between October 1, 1999, and February 29, 

2000, the NASDAQ rose by 72 percent while the Dow 

declined by 4 percent. Moreover, this striking divergence between the equity returns of Old and New Economy companies was not limited to the U.S. markets. 

Parallel trends were observed in Europe, Japan, Korea, 

21 Bloomberg. The S&P 500 airline industry is composed of AMR 

Corp., Delta Air Lines, Southwest Airlines, and U.S. Airways Group. 

CHART 8 

and Hong Kong. The similarity in performance of the 

high-tech sectors across three continents suggests a 

worldwide flow of liquidity from investors to the shares 

of technology firms. 

However, emerging concerns about the technology sector contributed to significant volatility in technology 

0 

50 

100 

150 

200 

250 

300 

350 

400 

4Q96 4Q97 4Q98 4Q99 

Source: Bloomberg 

Tech Stocks Have, Until Recently, Far 

Outperformed “Old Economy” Stocks Worldwide 

January 1997 = 100 

United States 

NASDAQ 

DJIA 

May 12, 2000 

0 

200 

400 

600 

800 

1,000 

4Q96 4Q97 4Q98 4Q99 

Source: Bloomberg 

January 1997 = 100 

EASDAQ 

Bloomberg European 500 

May 12, 2000 

Europe 

0 

50 

100 

150 

200 

250 

300 

January 1997 = 100 

Japan 

4Q96 4Q97 4Q98 4Q99 

Source: Bloomberg 

JASDAQ 

Nikkei 225 

May 12, 2000 

Regional Outlook—National Edition 10 Second Quarter 2000 
In Focus This Quarter
 

shares during March and April 2000. The NASDAQ 

index lost 30 percent of its value between March 10 and 

May 12, 2000. Analysts cited the Justice Department 

finding against Microsoft and doubts about the ultimate 

profitability of business-to-consumer Internet firms as 

two factors in the sell-off. 

Equity market volatility also poses a threat to the economic outlook. One concern is the so-called “wealth 

effect” that a declining stock market may have on consumer spending. Since 1995, rising stock prices have 

helped raise the market value of equities held by U.S. 

households, plus their holdings of mutual funds, by 

some $5.7 trillion. This windfall is an important reason 

that households have continued to reduce annual personal savings (to just 2.4 percent of disposable income 

in 1999) and increase spending on homes, autos, and 

other consumer goods. Although it is uncertain what 

effect a prolonged stock market correction might have 

on consumer spending, the potential wealth effect has 

surely grown as more households hold a higher percentage of wealth in corporate equities and mutual fund 

shares. (See the inset box at right for a discussion of 

how financial market volatility could affect banks.) 

The Economic Outlook 

Despite the effects of rising energy costs, increasing 

interest rates, and equity market volatility, the U.S. 

economy continues to grow at a robust pace. The consensus forecast of 50 corporate economists surveyed by 

the May 1999 Blue Chip Economic Indicators suggests 

that the economy will grow by 4.7 percent in 2000, 

while consumer prices are projected to rise by 3.0 percent from 1999 levels. Short-term interest rates are projected to rise only slightly by year-end from early May 

levels. In short, the consensus forecast indicates that the 

New Economy formula of rapid economic growth combined with low inflation will continue for the foreseeable future. If actual events conform to this forecast, the 

result will likely be another year of generally low loan 

losses and solid earnings for much of the banking 

industry. (See the inset box on the following page for a 

discussion of other risks to watch in banking.) 

Clearly, risks are associated with the economic outlook. 

Recently, higher oil prices and higher interest rates have 

been the most visible signs of trouble for the economy. 

New Economy companies may be less vulnerable to 

these effects, but even these firms have experienced a 

sharp decrease in equity valuations as investors reevalFinancial Market Volatility Could 

Pare Earnings for Banks Most 

Reliant on Market Sources of 

Revenue 

FDIC-insured banks are deriving an increasing proportion of earnings from noninterest sources (see 

Chart 9), particularly market-sensitive sources of revenue. This is especially true for larger institutions. 

According to Deutsche Banc Alex. Brown, the 18 

most active generators of market-sensitive sources of 

revenue earned over 25 percent of net operating revenue from these potentially volatile business lines.22 

While market-sensitive sources help to diversify revenue streams, they can also introduce increased 

income volatility in the event of financial market turbulence. Deutsche Banc Alex. Brown also reports that 

for those 18 banks that generated the largest amounts 

of market-sensitive revenues during the third quarter 

of 1998, the share of total revenue derived from 

market-sensitive sources declined from 23 percent to 

13 percent. Thus, a more sustained downward trend in 

the financial markets could particularly affect the 

earnings of large banking companies that rely heavily 

on income from sources such as venture capital, asset 

management and brokerage services, and investment 

banking. 

CHART 9 

15 

30 

45 

60 

75 

90 

1970s 1980s 1990s 

Noninterest Revenues Account for a Growing 

Share of Bank Net Operating Revenue 

Percentage of Net Operating Revenue* 

* Net operating revenue is the sum of net interest income and 

noninterest income. 

Sources: FDIC Historical Statistics on Banking; FDIC Quarterly Banking 

Profile 

Net Interest Income Noninterest Income 

0 

22 Net operating revenue is the sum of interest income and 

noninterest income less interest expense. According to 

Deutsche Banc Alex. Brown, these companies are Bank of 

America Corporation; Bank of New York Company, Inc.; 

Bank One Corporation; Bank Boston; BB&T Corporation; 

Chase Manhattan Corporation; Citigroup, Inc.; First Union 

Corporation; FleetBoston Financial; JP Morgan; KeyCorp; 

Mellon Financial Corporation; National City Corporation; 

PNC Bank Corp.; SunTrust Banks, Inc.; US Bancorp; 

Wachovia Corporation; and Wells Fargo & Company. 

Regional Outlook—National Edition 11 Second Quarter 2000 
In Focus This Quarter
 

Other Risks to Watch in Banking
 

Subprime Lending 

•	 Subprime consumer loan portfolios contributed to 

the large losses associated with recent high-cost 

bank failures. During 1999, the FDIC reported the 

first annual loss for the Bank Insurance Fund since 

1991. The loss was primarily the result of an uptick in 

unanticipated and high-cost bank failures. FDICinsured institutions with at least 20 percent of Tier 1 

capital in subprime loans accounted for 6 of the 13 

bank failures that occurred between January 1998 and 

March 2000. Fraud and inappropriate accounting for 

residuals also played a role in some of these failures.23 

•	 Subprime lending remains an area of concern. 

Insured depository institutions that engage in subprime lending represent a disproportionate share of 

problem institutions. Of the 79 banks and thrifts on 

the problem bank list as of year-end 1999, 21 percent 

were institutions with at least 20 percent of their Tier 

1 capital in subprime loans.24 

Agricultural Lending 

•	 While a majority of agricultural institutions remain 

relatively strong, external conditions have put pressure on some agricultural producers. Many agricultural areas are experiencing low commodity prices as 

well as weather- and disease-related problems. Strong 

global competition and high worldwide production 

over the past several years have resulted in increasing 

inventories of many crops and poor prospects for a 

price turnaround in the near term. Moreover, in spite 

of record government farm payments in 1999, the 

U.S. Department of Agriculture projects that in the 

year 2000 one in four farms will not cover cash 

expenses, up to 20 percent of farmers will experience 

repayment problems, and 5 percent of farmers will be 

“vulnerable.”25 

23 See Puwalski, Allen. FDIC Division of Insurance. Second 

quarter 1998. Gain-on-Sale Accounting Can Result in Unstable 

Capital Ratios and Volatile Earnings. Regional Outlook. http:// 

fdic01/division/doi/outlook/2q1998/atlanta/infocus1.html. 

24 The problem bank list includes all insured depository institutions rated a composite “4” or “5.” 

25 “Vulnerable,” as defined by the U.S. Department of Agriculture 

Economic Research Service, applies to institutions that have 

debt/asset ratios above 0.40 and negative income such that they 

cannot meet current expenses or reduce existing indebtedness. 

•	 Some signs point to growing stress for agricultural 

institutions. Forty-two percent of FDIC-supervised 

banks active in agricultural lending showed a moderate or sharp increase in the level of carryover debt 

during third quarter 1999, compared with just 26 percent during third quarter 1998.26 In addition, net loan 

loss rates for agricultural production loans increased 

in 1999 to the highest level since 1991. However, at 

0.32 percent, the 1999 net loss rate is just one-tenth 

the rate experienced during the height of the agricultural crisis of the mid-1980s.27 

Operational Risk 

•	 Operational risks are becoming more prominent in 

the banking industry. Driven by consolidation and 

expansion into new product lines and markets, financial institutions are seeing an increase in operational 

complexity. Operational risk encompasses a host of 

factors not related to credit or market activities, 

including risks associated with processing transactions, legal liability, fraud, strategic missteps, and 

internal control weaknesses. Operational risks tend to 

be more pronounced when institutions engage in 

rapid growth, far-flung operations, and complex business processes. 

•	 Greater attention is being paid to operational risks 

in the financial industry. Recently, analysts have 

noted that the pressure to meet ambitious postmerger 

earnings predictions can result in cost-cutting measures that jeopardize the comprehensiveness and 

integrity of risk-management systems. In addition, 

the role that fraud has played in recent bank problems 

and failures reinforces the importance of adequate 

internal controls and audit procedures. The significance of operational risks to financial institutions has 

been noted in industry surveys and informationsharing efforts among financial firms.28 NetRisk Inc., 

a Greenwich, Connecticut, consulting firm, recently 

estimated that operational losses among financial 

institutions have exceeded $40 billion over the past 

five years. 

26 September 1999. FDIC Report on Underwriting Practices. 27 See Anderlik, John M., and Jeffrey W. Walser. FDIC Division of 

Insurance. Third quarter 1999. Agricultural Sector Under Stress: 

The 1980s and Today. Regional Outlook. http://www.fdic.gov/ 

bank/analytical/regional/ro19993q/kc/agricult.html. 

28 For additional detail, see March 2000. Operational Risk: The 

Next Frontier. RMA/PricewaterhouseCoopers Survey. April 6, 

2000. Tech Bytes: Banks Join Forces Against Operational Risk. 

American Banker. 

Regional Outlook—National Edition 12	 Second Quarter 2000 
In Focus This Quarter
 

uate the long-term prospects. Equity market volatility 

threatens to dampen consumer confidence and the ability of businesses to continue to merge, restructure, and 

invest. 

The economy has become particularly dependent on 

financing delivered through the capital markets. In this 

more permissive financial environment, rising debt levels and greater dependence on foreign capital have 

emerged as financial imbalances that may contribute to 

future problems for the economy. Businesses and 

households with high levels of debt are more vulnerable 

to problems if interest rates continue to rise or income 

growth falters. Rapid credit creation by the domestic 

financial sector suggests the possibility of lax credit 

underwriting standards. Reliance on foreign capital 

raises concerns about what would happen to the value of 

the dollar and to domestic inflation if foreign investors 

decide to invest elsewhere. 

Some analysts suggest that the New Economy, driven by 

increased productivity, heightened competition, and 

robust investment, may be characterized by longer 

expansions. Financial market imbalances may, however, 

contribute to deeper recessions and more sluggish 

recoveries compared with earlier business cycles. 

For the banking industry, it is clear that a recession 

would mean slower loan growth, deteriorating credit 

quality, and impaired profitability. But the biggest 

threat to the banking industry is a recession that is tied 

to disruptions in the financial markets. The ready availability of financing to start new businesses and restructure old businesses has been key to the New Economy. 

The process by which businesses have invested and 

restructured in response to competition has been orderly from the perspective of bank creditors. If this 

process should be disrupted, we could see a much more 

disorderly process, with more bankruptcies and higher 

losses to lenders. 

This article was prepared and coordinated by the management and staff of the Analysis Branch of the Division of 

Insurance. Contributions and feedback from analysts across the Division were essential to its completion. 

Maureen E. Sweeney, Associate Director 

Paul C. Bishop, Senior Financial Economist 

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

Steve Burton, Senior Banking Analyst 

Steven C. Cunningham, formerly Chief, Financial Institutions Section 

Alan Deaton, Economic Analyst 

Diane Ellis, formerly Senior Financial Analyst 

Mary L. Garner, Senior Financial Analyst 

Brian Kenner, Financial Analyst 

Thomas A. Murray, Senior Financial Analyst 

Allen Puwalski, Senior Financial Analyst 

Arlinda Sothoron, Senior Financial Analyst 

Ronald Spieker, Chief, Regional Programs and Bank Analysis 

Regional Outlook—National Edition 13 Second Quarter 2000 
Regional Perspectives
 

Atlanta Regional Perspectives
 

Economic growth in the Atlanta Region fueled residential real estate development. Economic strength in 

the Atlanta Region, combined with low interest rates 

and adequate available sources of credit, has promoted 

expansion in residential real estate construction in 

recent years, particularly in urban areas. Insured institutions in some of the Region’s metropolitan areas are 

providing residential financing, permanent and construction, at a pace ahead of the national average, which 

may result in higher default rates in the event of an economic downturn. 

Structural and cyclical changes in real estate financing 

also may have implications for banks in the Atlanta 

Region. 

In tandem with the favorable economic drivers, some 

structural changes in residential real estate financing 

during this expansion could influence loss rates in a 

downturn. Low mortgage interest rates, ready availability of credit, and increases in loan-to-value ratios have 

contributed to the rising level of homeownership. Such 

factors have made home buying affordable for many 

first-time buyers who may not have the capacity to service debt should the economy falter. Also, rapid price 

appreciation has allowed many consumers to increase 

their debt levels through home equity lines. Any future 

weakening in housing values could strain households 

that have borrowed extensively on the expectation that 

housing prices will continue to rise. The combination of 

new homeowners and increased borrowing secured by 

home values may expose lenders to greater credit risk. 

An additional significant risk to real estate markets is 

the recent rise in interest rates, which are approaching 

highs not seen since early 1997. According to Freddie 

Mac, mortgage rates as of the third week of March 1999 

were at 8.2 percent, up from 6.5 percent in late 1998. 

Despite the current rise in mortgage rates, permit 

issuance, absorption of new supply, and existing home 

sales have yet to be significantly affected in the Atlanta 

Region. However, if mortgage rates reach double digits, 

a material effect likely will occur as absorption of new 

supply and existing home sales may slow. 

Atlanta Region banks are exposed to residential construction and development lending. Residential construction and development (C&D) lending exposures at 

some banks operating in many of the Atlanta Region’s 

urban areas are significant. In fourth quarter 1999, 

C&D loans represented 6.6 percent of community bank 

assets in the Region’s metropolitan areas, nearly 50 percent higher than the U.S. metropolitan average. Moreover, compared with the nation, the Region is home to 

urban community banks with much larger than average 

C&D concentrations. Specifically, while the Region 

accounts for 15 percent of the nation’s urban community banks, it is home to 22 percent (123 banks) of the 

nation’s banks with C&D loan exposures above 10 percent of assets. 

Commercial real estate development has 

increased in Northern Virginia. Throughout the latter half of the 1990s, commercial real estate (CRE) development 

has increased substantially as hightech ventures and supporting industries have moved to or expanded in 

the suburban Virginia portion of 

the Washington, D.C., metropolitan 

statistical area. However, technologies can 

change, industry growth can slow, and companies 

can fall out of favor. Also, many of these high-tech 

enterprises may not be recession-tested, and nationwide 

anecdotal evidence shows that some of these firms are 

making rent payments in the form of equity or stock 

options. The effects of any problems in the high-tech 

sector likely would be felt throughout the local economy. Continued balance in Northern Virginia’s CRE markets will depend on the ability of the area’s high-growth 

industries to continue to absorb new construction in the 

pipeline or in the planning stages. 

Nearly all community banks (those headquartered 

locally with assets less than $1 billion) in Northern Virginia are actively involved in real estate lending, with 

C&D loans totaling more than $300 million. Some 

Northern Virginia banks hold C&D loans that account 

for more than 10 percent of total assets. Problems in the 

high-tech-fueled local economy could ultimately affect 

banks’ C&D loan quality. Commercial absorption estimates could be reduced for specific types of space, and 

growth in supporting industries also could be adversely 

affected. The local banking industry’s ability to weather 

an economic or industry downturn may be further complicated by the fact that one-third of Northern Virginia’s 

banks have not been recession-tested, having been 

established after 1991. 

Regional Outlook—National Edition 15 Second Quarter 2000 
Regional Perspectives
 

Boston Regional Perspectives
 

The economy continued to expand, but at a slower 

rate. The Boston Region’s economy experienced another year of solid growth in 1999, but the pace slowed 

from 1998. Total nonfarm job growth decelerated, with 

manufacturing the only sector to show a decline in net 

employment last year. Annual per capita income growth 

(first three quarters) was on par with the 1998 pace and 

rose faster than that of the nation, while housing markets showed some signs of slowing. 

The past year saw a slight decline 

in new home construction and a 

more modest gain in housing 

sales volume relative to 1998. 

Low inventory slows existing 

home sales, increases resale 

prices. New England existing home 

sales growth slowed in 1999 compared with the previous year. Growth 

moderated significantly in most states 

in New England except Maine, which 

reported rapid growth. Sales in Massachusetts actually declined modestly in 1999. Much of the 

slowdown in that state was reportedly the result of a 

limited inventory of homes for sale, particularly in the 

state’s dominant greater Boston market. Home resale 

price gains again exceeded those of the nation, led by 

gains in Massachusetts and New Hampshire that were 

attributable to low inventory and increased demand. 

Insured institutions performed well despite falling 

margins. Boston Region insured institutions reported 

healthy financial conditions in 1999. On an aggregate 

basis, the Region’s insured institutions continue to perform well compared with those of the nation. 

Insured institutions in the Region (excluding credit card 

institutions) reported an aggregate return on assets of 

1.09, down slightly from 1998 because of mergerrelated charges in the Region’s larger institutions. Profitability was depressed by a declining net interest 

margin, caused in part by a flattening of the yield curve. 

Past-due ratios continued to decline and net charge-offs 

remained stable. However, noncore funding as a percentage of assets continued to increase in all asset categories. Commercial and industrial loans and consumer 

loans drove loan growth. 

Many of the Region’s insured institutions face 

increasing exposure to interest rate risk. Recent 

trends suggest that many insured institutions in the 

Region have become increasingly exposed to rising 

interest rates. This trend is particularly evident among 

savings institutions, which represent a large share of 

the Region’s insured institutions. This situation suggests that the Boston Region faces greater interest rate 

risk exposure than other parts of the country. The concentration of assets that either mature or reprice in 

excess of five years has increased because of the prolonged low interest rate period of the past two years. At 

the same time, there appears to be little change in the 

maturity of liabilities to offset the growth in long-term 

assets and mitigate the increasing interest rate risk. Nor 

do institutions appear to be utilizing off-balance-sheet 

mechanisms to mitigate the rising level of risk. Our 

analysis of the sensitivity of nonmaturity deposits suggests that depositors will increasingly seek alternative 

investments once interest rates rise above a certain 

threshold. Thus, holding down costs on nonmaturity 

deposits may not always be the best asset/liability management strategy to control for interest rate risk. 

Results also suggest that short-term exposure to higher 

rates has risen significantly, and the duration of the 

exposure has increased as well, particularly for those 

institutions with high concentrations in long-term 

assets. 

Regional Outlook—National Edition 16 Second Quarter 2000 
Regional Perspectives
 

Chicago Regional Perspectives
 

The Region’s banks and thrifts reported record 

earnings and generally healthy conditions at yearend 1999. However, the range of profitability as measured by return on assets has widened over the past two 

years and is trending downward for the more poorly performing institutions. The number of established1 insured 

financial institutions that were unprofitable increased to 

59, or 3 percent of the Region’s institutions, at December 31, 1999, compared with 35, or 1.7 percent, a year 

earlier. 

The Region’s labor market reflects the economy’s 

health and constraints. High employment is supporting moderate household income growth. The buoyancy 

of domestic demand is being supplemented by a revival 

in demand from abroad. Yet job growth in the Region 

lags the nation, and tight labor markets are tempering 

the capacity of the Region’s economy to expand rapidly. 

Agricultural bankers shared views on current conditions and outlook. On March 30, 2000, the FDIC hosted an agricultural bankers’ roundtable in Springfield, 

Illinois, to discuss the effect that prolonged depressed 

commodity prices are having on small farmers and rural 

agricultural banks. The roundtable participants also 

addressed the long-term structural changes occurring in 

the agricultural industry and in rural communities. 

Going into the 2000 planting season, bankers voiced 

some concerns. First, dry soil conditions have increased 

the potential for drought this summer. In addition, rising 

fuel costs and interest rates will increase farm expendiCHARTS 1 AND 2 

tures. Bankers also indicated that operating lines are 

increasing, an indication that cash reserves may be 

declining. Younger farmers with higher leverage and 

lower cash reserves appear to be most vulnerable to the 

consequences of sustained low commodity prices. 

Although the median Tier 1 leverage ratio remains 

high, the recent downward trend is not consistent 

with increased risk shown in some measurements. 

After rising dramatically in the early 1990s, the median 

Tier 1 leverage ratio has declined modestly during the 

past few years (see Chart 1). Also during this time, the 

Region’s median loan-to-asset ratio is rising and profitability is declining (see Chart 2). 

Strong growth primarily in commercial and commercial 

real estate loan portfolios has driven the increase in the 

loan-to-asset ratio. Traditionally, these 

two segments have been the higheryielding, higher-risk portions of the 

loan portfolio. Yet profitability levels have not improved as a result of 

this loan growth. Other factors, such as 

These factors constrain the ability of the 

increased competition, which may suppress loan yields, and growth in noncore funding, which raises funding 

costs, are dampening profitability. 

Region’s institutions to strengthen capital 

positions. In addition, the financial flexibility afforded 

by some noncore funding sources may be tempting 

more institutions to operate at lower capital levels. 

7.0 

7.5 

8.0 

8.5 

9.0 

9.5 

10.0 

0 

10 

20 

30 

40 

50 

60 

Capital Ratios Have Declined Recently... 

Source: Bank and Thrift Call Reports and Examination Reports for community 

institutions (<$1 billion in total assets), excluding new banks 

Institutions with Less 

than an 8% 

Tier 1 Leverage Ratio 

(right axis) 

Median Tier 1 

Leverage Ratio 

(left axis) 

Mar 1990

Sept 1990

Mar 1991

Sept 1991

Mar 1992

Sept 1992

Mar 1993

Sept 1993

Mar 1994

Sept 1994

Mar 1995

Sept 1995

Mar 1996

Sept 1996

Mar 1997

Sept 1997

Mar 1998

Sept 1998

Mar 1999 

Sept 1999 

Institutions with Capital 

Ratings of 3, 4, or 5 

(right axis) 

0.7 

0.8 

0.9 

1.0 

1.1 

1.2 

1.3 

0.54 

0.56 

0.58 

0.60 

0.62 

0.64 

0.66 

0.68 

Source: Bank and Thrift Call Reports for community institutions (<$1 billion in 

total assets), excluding new banks 

...While Some Measures of Risk Are Rising 

Median Return on Assets 

(left axis) 

Median Loan-to-Asset Ratio 

(right axis) 

Mar 1990

Sept 1990

Mar 1991

Sept 1991

Mar 1992

Sept 1992

Mar 1993

Sept 1993

Mar 1994

Sept 1994

Mar 1995

Sept 1995

Mar 1996

Sept 1996

Mar 1997

Sept 1997

Mar 1998

Sept 1998

Mar 1999

Sept 1999 

Percentage

Percentage 

Percentage 

1 Established insured institutions exclude any banks and thrifts less 

than three years old. 

Regional Outlook—National Edition 17 Second Quarter 2000 
Regional Perspectives
 

Dallas Regional Perspectives
 

Dallas Region average annual employment outpaced 

other regions as the decade ended. The Dallas Region 

has exceeded the nation in employment growth for 11 

consecutive years. The Dallas Region reported an annual average growth rate of 3 percent during the 1990s, 

outpacing other areas of the country. However, during 

1999, problems in the energy, manufacturing, and agricultural sectors resulted in a growth rate of 2.5 percent, 

the Region’s slowest since 1992. Concerns about rising 

interest rates, higher inflation, stock market volatility, 

possible economic shocks from abroad, and rising business and living costs within the Region could constrain 

the U.S. expansion and regional economic growth. 

Banks and thrifts in the Dallas Region continued to 

report strong earnings and solid credit quality. The 

Region’s insured institutions tracked the 

nation in return on assets (ROA), leverage, and past-due ratios. The 

Region’s banks tend to have a 

slightly higher net interest margin (NIM), but lower noninterest income. These figures 

reflect the Region’s large number of small banks that are 

more reliant on income from loans 

and investments. 

Colorado banks and thrifts continued to post 

impressive gains, as evidenced by an ROA of 1.60 

percent and return on equity over 21 percent. A 

robust economy contributed to strong earnings and 

lower past-due ratios. However, in support of the state’s 

healthy construction sector, real estate loans represented 64 percent of total loans at year-end 1999, up dramatically from 51 percent three years ago. This rapid 

increase in real estate lending may be cause for concern 

should the economy slow. 

Maturities for securities, most notably for the 

Region’s holdings of mortgage-backed securities 

(MBS), remained extended. MBS with maturities in 

excess of 15 years, as of year-end 1999, stood at 63 percent of total MBS portfolios, up from 40 percent two 

years ago. Price volatility and interest rate movements 

affected the value of securities held by banks during 

1998. 

In addition, insured institutions in the Dallas Region 

experienced a fair market value decline for securities 

investments. As of December 31, 1999, the account 

used to track unrealized gains or losses from securities 

available for sale was a negative $1.3 billion, a $1.6 billion decline from year-end 1998. While the decline represents only a fraction of total assets, it accounts for 6 

percent of equity capital. Moreover, securities classified 

as held to maturity (representing 22.5 percent and 18.5 

percent of all securities in the Region and nation, 

respectively) are carried on the balance sheet at book 

value without adjustments for changes in value. If interest rates continue to rise, the income from these securities will be lower than market rates. This adverse effect 

on interest income would likely result in a decline in the 

overall NIM. 

Thus far, increases in Treasury interest rates have 

not translated into lower NIMs in the Region; however, Dallas Region institutions remain vulnerable to 

rising rates. Asset yields may be exposed because of 

the large portion of the Region’s assets invested in longterm fixed-rate securities. As rates increase, the values 

of the fixed-rate securities decline, and the income 

received is less than the prevailing market rate. 

On the interest expense side, the Region’s funding 

advantages—strong core deposit levels and a high volume of non-interest-bearing deposits—may become 

more vulnerable in a rising interest rate environment. 

Although core deposits have historically been stable 

sources of funding and may be less price sensitive than 

other funding sources, at some point in a rising interest 

rate environment the majority of these deposits can be 

rate sensitive and may pressure interest expense. In 

addition, pending legislation to allow banks to pay interest on business checking accounts, if enacted, could 

raise banks’ costs. 

Regional Outlook—National Edition 18 Second Quarter 2000 
Regional Perspectives
 

Kansas City Regional Perspectives
 

Agricultural conditions remain depressed, with little 

improvement expected in 2000. The cumulative effects 

of four consecutive years of bumper crops in major 

agricultural-producing countries continue to depress 

prices for the major field crops. Prices for corn, wheat, 

and soybeans have declined dramatically since 1996. A 

long run of unusually favorable weather, both at home 

and abroad, led to the increasing accumulation of 

stocks, which is the most important determinant of field 

crop prices. 

The outlook for livestock prices is more optimistic. 

Pork industry analysts expect prices to rise above the 

$40 per hundredweight level for 2000. Similarly, cattle 

prices appear headed for improvement this year. 

The U.S. Department of Agriculture (USDA) forecasts 

that U.S. net farm income will decline from $48.1 billion in 1999 to $40.4 billion in 2000. Much of the 

decline is based on assumptions of lower government 

payments in 2000. The USDA forecast for 2000 does 

not assume additional emergency aid in 2000, but 

emergency aid cannot be ruled out in an election year as 

congressional candidates from agricultural-dependent 

areas of the country try to appeal to their constituents. 

Reported farm bank results remain positive. In the 

aggregate, as of year-end 1999, the Region’s 1,279 farm 

banks continued to report sound conditions. Earnings 

remained strong, as seen by the aggregate 1.18 percent 

return on assets ratio, contributing to adequate reported 

capital levels. Funding is a concern as farm banks continue to have difficulty increasing core deposits and are 

turning instead to noncore funds to support asset 

growth. Such funds typically are more expensive and 

volatile than core deposits. As a result, increased interest expenses, coupled with more intense competition for 

loans, have put moderate pressure on net interest margins. Farm banks in the Region reported an aggregate 

net interest margin of 4.09 percent in 1999, down from 

4.15 percent in 1998 and 4.25 percent in 1997. 

The St. Louis office market is heating up. Office 

vacancy rates increased from 8.8 percent at the end of 

1998 to 12.1 percent during the first half of 1999, 

prompting concern about whether this increase is a 

temporary distortion or the beginning of a long-run 

buildup in surplus office space. Presently, office vacancy rates differ greatly among building classes and submarkets. Not surprisingly, the suburban office 

submarkets in St. Louis appear much stronger than the 

downtown submarket. What may be of concern, however, is that the amount of actual and planned office 

space construction appears inconsistent with population and employment trends for the metropolitan area. 

Overbuilding in office space this late into an economic 

expansion may exert downward pressure on rents and 

property values. 

Because the office supply cycle is 

thought to be more closely tied to 

its own supply cycle than to market demand, there is a risk of 

periodic “boom-to-bust” cycles. 

Competitive pressure to build 

may result in an oversupply of 

office space. Office construction 

starts, planned construction, and 

aggressive revitalization efforts all point to an 

increase in future office space during a time when 

office absorption is slowing. 

Torto Wheaton Research predicts that, along with a rise 

in vacancy rates, rents will peak during 1999 and begin 

a long period of decline as newly completed office 

space comes on line. Furthermore, it expects office 

vacancies downtown and in the suburbs to converge in 

the double-digit range, which is a significant increase 

from the present. 

Smaller commercial banks in the St. Louis metropolitan 

area reported that nearly three-fourths of total loans 

were secured by real estate, compared with about onehalf of total loans for banks in Kansas City and Minneapolis. Moreover, commercial banks in St. Louis 

have increased holdings of commercial real estate loans 

to a greater degree than banks in the comparison metropolitan areas. 

The implications of an overbuilt office market to commercial banks are clear. Higher office vacancies could 

result in projects that generate less net operating 

income, which translates into less cash available to service debt. In addition, expectations of slower rental rate 

increases or declining rents will depress the market 

value of office buildings that serve as collateral. Importantly, because of lending limitations, smaller commercial banks are more likely to fund class B and C 

buildings, and these types of properties appear to be 

experiencing the greatest competitive pressure. 

Regional Outlook—National Edition 19 Second Quarter 2000 
Regional Perspectives
 

Memphis Regional Perspectives
 

The Memphis Region experienced generally favorable economic conditions during 1999, although 

employment growth lagged the nation and some sectors outperformed others. The service and retail trade 

sectors, driven by robust consumer spending, contributed significantly to annual employment growth of 

1.5 percent. By contrast, the Region’s manufacturing 

sector lost jobs in 1999, continuing a longer-term trend. 

The strength in urban-concentrated service employment compared with weaknesses in rural-based 

manufacturing is contributing to a growing economic disparity between urban and rural areas. 

Many people in the rural labor force remain dependent 

on manufacturing because of 

the lower skill level required. 

Recent plant closures, particularly in the apparel and 

textile industry, resulted in 

an increasing number of layoffs in rural areas. Continued 

plant closures and job losses in the 

sector could exacerbate already poor 

economic conditions in rural areas, 

many of which also face weak agricultural conditions. 

A third consecutive year of sustained low commodity 

prices will further stress farm financial conditions. 

The U.S. Department of Agriculture (USDA) projects 

net cash income for the farm sector in 2000 to fall to its 

lowest level since 1986. Farmers in the Memphis 

Region are expected to be among the most severely 

affected. Specifically, the USDA projects that 

•	 The Mississippi Delta will experience the largest 

drop in average net cash income in the nation over 

the next two years, with expected declines of 39 percent in 2000 and an additional 30 percent in 2001. 

•	 The Mississippi Delta will report the largest increase 

in the nation in the number of farms with negative 

cash flows. 

•	 Twenty percent of farm businesses in the Mississippi Delta will experience debt repayment difficulties in 2000, which would represent a substantial 

increase from prior years and the highest level in the 

nation. 

Agricultural loan problems could worsen in 2000 and 

2001 as farm conditions in the Region deteriorate. Agricultural production loan past-due ratios and loan loss 

rates increased during 1998 and 1999, as did carryover 

debt levels. Underwriting standards will take on added 

importance as lenders receive an increasing number of 

loan applications from less creditworthy borrowers. 

Also, credit administration and loan review functions 

may require additional attention as existing loan portfolios experience rising delinquencies. 

Lenders in many Mississippi Delta communities also 

face additional economic and demographic hurdles. 

With off-farm employment opportunities a major factor 

in the continuing economic viability of many smaller 

farms, weaknesses in manufacturing sector employment 

may further stress many farmers. Also, the Mississippi 

Delta is losing population as people exit to more economically vibrant areas of the nation. These trends 

could eventually have significant structural implications 

for many Mississippi Delta communities and the financial institutions serving them. 

Tobacco farmers in Kentucky and Tennessee also 

face a bleak outlook for 2000. The amount of annual 

domestic tobacco production is down sharply because 

of reduced U.S. cigarette consumption, lower export 

levels, and increased use of imported tobacco in domestic production. As a result, earlier this year the USDA 

announced the largest reduction in the amount of 

tobacco allowed to be sold in the history of the tobacco 

program (the program strives to maintain stable prices 

by controlling production levels). A cumulative 60 percent reduction in tobacco production for 1999 and 2000 

equates directly to a similar decline in farm income for 

burley tobacco farmers in Kentucky and Tennessee. 

Potential challenges for banks operating in tobaccodependent areas include elevated credit quality concerns, declining overall loan demand, and additional 

funding pressures. The uncertain outlook for tobacco 

farming will require considerable effort by institution 

officers and directors to properly manage current risks 

and plan for future growth. 

Regional Outlook—National Edition 20	 Second Quarter 2000 
Regional Perspectives
 

New York Regional Perspectives
 

Although the Region’s economic growth rate lagged 

the nation’s in 1999, this gap narrowed because of 

the strong stock market and a growing concentration 

of new high value-added jobs. Forecasts by Regional 

Financial Associates call for the Region’s economic 

growth to continue in 2000 but at a slower pace than the 

nation’s. The strong economy has increased demand for 

commercial real estate, particularly in the large urban 

areas. In third quarter 1999, vacancy rates in New York 

City, Washington, D.C., and Wilmington, Delaware, 

were almost half the nation’s average. Vacancy rate 

trends in the Region’s major metropolitan areas differ 

from those reported prior to the recession of the early 

1990s. While vacancy rates for many metro areas were 

lower than the national average during that time, vacancies had started to rise in some areas. This economic 

downturn hit the Region’s real estate markets harder 

than those in other parts of the nation, in part because a 

significant amount of new office construction was 

being completed just as the Region’s economy was contracting and demand for space was declining. 

The Region’s banks benefited from increased noninterest income, stable credit quality, and a steeper 

yield curve in the fourth quarter of 1999. In the latter 

half of 1999, the average net interest margin rose as the 

yield curve steepened following increases in the Federal Funds rate. The ratio of loans to deposits also rose 

during the year, but the Region’s banks faced competition for core deposits, which declined marginally as a 

percentage of assets. 

Lower charge-off rates reported by the Region’s 

credit card specialists partially offset the effect of 

competitive pressures on margins. Although returns 

on credit card lending continue to exceed returns earned 

by most of the banking industry, and credit quality measures improved in 1999, the outlook for credit card 

banks is mixed. As interest rates declined from 1997 

through the first half of 1999, some consumers paid off 

credit debt with proceeds from refinanced mortgage 

loans. Refinancings have declined, however, as interest 

rates have risen, and a potentially slower economy could 

have implications for consumer credit quality. In addition, although average credit card delinquency and 

charge-off rates have improved, in 1999 the consumer 

debt service burden reached its highest level in ten 

years. 

The rise in interest rates could affect interest margins earned by the Region’s banks, particularly those 

that specialize in mortgage lending. The Region could 

be more sensitive to rising interest rates and changes in 

mortgage preferences than the nation because almost 

one-third of the Region’s banks are mortgage specialists, compared with 11 percent of banks elsewhere in 

the nation. Mortgage specialists’ net interest margins 

could be constrained if interest rates continue to rise 

because the maturity distribution of mortgage portfolios 

has lengthened, reflecting consumers’ preference for 

longer-term mortgages. Concurrently, the proportion of 

volatile liabilities at these banks has risen as reliance on 

shorter-term, noncore funding has increased, 

reflecting stiffer competition for core 

deposits. Higher interest rates could 

squeeze earnings if the mismatch 

between the maturity and pricing intervals of loan portfolios 

relative to a bank’s liabilities is 

significant. Faced with margin 

compression, some banks may 

be tempted to invest in higheryielding, traditionally higherrisk securities to supplement 

income. 

Higher interest rates also could affect the valuation 

of bank securities portfolios. Mortgage specialists 

may be more vulnerable to securities depreciation 

caused by rising interest rates because this group holds 

a larger percentage of assets in securities and a higher 

proportion of long-term securities than the rest of the 

Region’s banks. Because longer-term securities are 

more sensitive to interest rate changes than shorter-term 

securities, the Region’s mortgage specialists could be at 

greater risk in a rising interest rate environment. 

Regional Outlook—National Edition 21 Second Quarter 2000 
Regional Perspectives
 

San Francisco Regional Perspectives
 

The San Francisco Region’s economy grew more 

rapidly than the nation’s as measured by increases in 

nonfarm payroll employment, driven primarily by 

strength in the services, trade, and construction sectors. Employment growth rates in Nevada, Arizona, 

Idaho, California, and Utah exceeded that of the 

nation in 1999. However, the Region’s manufacturing 

sector employment contracted, and weakness persisted 

in the agricultural and mining sectors. Consequently, 

because Montana, Wyoming, and Washington depend 

greatly on these industries, these states reported job 

growth for 1999 about equal to the nation, while Oregon, Alaska, and Hawaii lagged the U.S. average. Per 

capita personal income growth and housing price appreciation were robust for most of the Region during 1999. 

The majority of the Region’s insured financial institutions reported sound conditions as of year-end 

1999, the third consecutive year of increasing profits. Combined return on average 

assets for year-end 1999 improved to 1.37 

percent from 1.30 percent a year ago, on 

a merger-adjusted basis. Strong 

growth in fee income and 

declining provision expenses 

offset declining net interest 

margins (NIMs). A lower level 

of provision expenses is attributed to continued improvements 

in reported asset quality. The year-end 

1.69 percent past-due loan ratio was 

the lowest year-end level in the decade. 

Rising interest rates during the latter half of 1999 

could adversely affect profitability of the Region’s 

insured institutions going forward. Increasing interest 

rate sensitivity is most pronounced among the Region’s 

mortgage lenders. These institutions reported the fifth 

consecutive quarter of declining NIMs at year-end 

1999. The Region’s larger commercial lenders also have 

increased levels of interest-sensitive liabilities and are 

experiencing vulnerability to rising interest rates. However, these lenders have not yet experienced earnings 

declines because of sufficient increases in noninterest 

income. Smaller commercial lenders, which primarily 

hold variable-rate portfolios, have benefited in the short 

term from increases in interest rates. These lenders, 

however, could face heightened risk of asset quality 

deterioration if interest rates rise sharply, since variablerate loans increase borrower debt service requirements 

when rates rise. 

Commercial lenders in most of the Region’s states 

experienced rapid growth and increased concentrations in traditionally higher-risk loan types—construction, commercial real estate (CRE), and 

commercial and industrial (C&I) loans—during the 

current economic expansion. Commercial lenders in 

Arizona, Nevada, Utah, and Washington have exceeded 

the nation’s median loan growth rate significantly since 

1992. In addition, commercial lenders in these states 

generally experienced a more rapid loan growth rate than 

the nation’s in construction, CRE, and C&I loans since 

1992. This situation could be cause for concern when 

viewed with the results of examiner surveys indicating 

that the Region’s insured financial institutions may be 

engaging in moderately higher-risk underwriting practices than institutions in other parts of the country. 

Publicly available data indicate certain positive 

trends in the allowance for loan and lease losses 

(ALLL). The Region’s commercial lenders reported 

higher median ALLL levels than the national average 

as of year-end 1999. In addition, ALLL levels declined 

more slowly than reductions in net charge-off rates in 

recent years, and coverage of nonperforming loans is at 

its highest point in 15 years. Most of the Region’s states 

report median ALLL levels above those that preceded 

each state’s previous economic downturn or banking 

crisis. 

Some commercial lenders in fast-growing states, 

however, maintain ALLL levels at or below the 

national level despite rapid growth and increasing 

concentrations in potentially higher-risk loan types. 

For example, insured financial institutions operating in 

Arizona, Nevada, Washington, and Oregon share these 

rapid growth and concentration characteristics. However, in Arizona and Nevada these trends could be mitigated by the fact that many lenders in these states are 

subsidiaries of out-of-state, multibank holding companies that, if necessary, may be able to provide financial 

support and management expertise. In contrast, institutions in Washington and Oregon generally do not have 

the benefit of geographic diversification at the holding 

company level. Generally low historical net charge-off 

experience and relatively strong reported capital levels, 

however, may moderate some risk at Pacific Northwest 

institutions. Nevertheless, because of recent slowing in 

the economies of these two states, now may be a good 

time to consider the effects of rapid growth and increasing concentrations in higher-risk loan types on lending 

strategies and existing portfolios. 

Regional Outlook—National Edition 22 Second Quarter 2000 
✁
 

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