Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION THIRD QUARTER 1997 

FDIC
 

Memphis
 

Region
 

Division of
 

Insurance
 

Gary L. Beasley,
 

Senior Regional
 

Analyst
 

Robert Burns,
 

Financial Analyst
 

In Focus This Quarter 

■ Subprime Lending: A Time for Caution—The extent of subprime lending is increasing as strong competition for high-quality borrowers has 

some lenders moving down the credit quality spectrum. Subprime lending requires 

a commitment of resources and expertise beyond that required in more conservative lending, and the consequences of deficiencies in underwriting, servicing, and 

collection can be severe. See page 3. 

By Kathy R. Kalser, Debra L. Novak 

■ Retail Shakeout: Causes and Implications for Lenders— 

Despite favorable economic conditions, the retail industry is experiencing slow revenue growth in a highly competitive environment. The confluence of rapid change 

in store formats and slow revenue growth has led to an ongoing shakeout among 

both large and small retail chains, and this shakeout may adversely affect credit 

quality at some insured institutions. See page 6. 

By Richard A. Brown, Diane Ellis 

Regular Features 

◆ Regional Economy—Job growth has slowed and is below the national 

average . . . Kentucky and Louisiana are the fastest growing states in the Region . . . 

economic performance reflects a rural-urban dichotomy . . . Tennessee’s economic 

performance is beyond its cyclical peak. See page 11. 

By Scott C. Hughes, Gary L. Beasley 

◆ Financial Markets—Securitization of home equity loans is growing 

rapidly . . . consumer debt consolidation loans may be driving this growth . . . signs 

of relaxed underwriting have appeared . . . the arrival of FASITs could increase the 

appetite of community banks to enter the ABS market. See page 14. 

By Allen Puwalski 

◆ Regional Banking—Strong banking performance continues . . . industry consolidation is altering the competitive landscape . . . the pooling method of 

accounting may be eliminated . . . the year 2000 cannot be ignored. See page 18. 

By Gary L. Beasley, Tracy F. Hall, Wallace D. Peddicord 

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

Insurance Corporation 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, 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 Memphis Region’s Regional 

Outlook, please call Gary Beasley at (901) 821-5234 or send an e-mail to gbeasley@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 Andrew C. Hove, Jr. 

Director, Division of Insurance Arthur J. Murton 

Editor George E. French 

Managing Editor Stephen Linehan 

Associate Editor Maureen E. Sweeney 

Assistant Editors Paul C. Bishop 

Richard A. Brown 

Steven K. Burton 

Diane Ellis 

Kathy R. Kalser 

Ronald L. Spieker 

Publications Manager Teresa J. Franks 
In Focus This Quarter
 

Subprime Lending: A Time for Caution
 

•	 Subprime lenders specialize in lending to borrowers with blemished or limited credit histories. 

•	 The consequences of deficiencies in underwriting, 

servicing, and collection can be severe with subprime lending. Lenders that fail to dedicate the 

necessary resources in these areas likely will have 

trouble succeeding in the increasingly competitive 

market for subprime loans. 

•	 Some institutions insured by the FDIC have failed 

to properly assess and control the risks associated 

with their subprime lending programs. 

What Are Subprime Loans? 

Faced with strong competition and shrinking margins 

on loans to high-quality borrowers, some lenders are 

moving down the credit quality spectrum. The strategy 

to extend loans to borrowers perceived as less creditworthy is referred to as “subprime” lending. Subprime 

lending is most commonly associated with auto, home 

equity, mortgage, and secured credit card loans to borrowers who have blemished or limited credit histories. 

Generally, the characteristics of a subprime borrower 

include a history of paying debts late, personal bankruptcy filings, or an insufficient credit record. 

Subprime loans also are referred to as marginal, nonprime, or below “A” quality loans. There are no established guidelines for determining the degree to which a 

borrower is considered subprime, so one lender’s “B” 

customer could be another lender’s “C” customer. 

Definitional variations aside, some general market 

parameters on ranking loans are presented in Table 1. 

TABLE 1 

Criteria for Loan Rankings 

GRADE PAYMENTS LATE BANKRUPTCY 

30 DAYS FILING
 

PRIME
 NONE NONE
 

A­ LESS THAN 2 NONE IN 5 YEARS 

B LESS THAN 4 NONE IN 3 YEARS 

LESS THAN 6 NONE IN 2 YEARS 

D CONSTANTLY LATE NONE IN 1 YEAR 

Sources: Duff & Phelps, Standard & Poor’s, Mortgage 

Market Information Services 

How Big Is the Market? 

The lack of a standard definition for a subprime loan 

makes it difficult to accurately determine the extent of 

the market. However, some industry experts estimated 

that during 1996, subprime loans secured by residences, 

including both home equity and mortgage loans, 

amounted to between $100 billion and $150 billion compared to the estimated $800 billion in originations of 

conventional mortgages. Subprime auto loans have been 

estimated to range between $75 billion and $100 billion, 

or about 20 percent of total auto loans outstanding. 

Who Makes Subprime Loans? 

In the past, subprime lending was primarily the domain 

of a limited number of finance companies. These firms 

specialized in making high-priced loans to borrowers 

with limited access to credit. 

The number of subprime lenders, however, has surged 

in recent years as more companies have been attracted 

by the significantly higher rates and fees earned on subprime loans. In some cases, yields on these higher risk 

assets have been as high as 15 percent to 30 percent. 

The new subprime participants include finance companies that traditionally served prime borrowers, new specialized subprime lenders, and banks. 

The increase in the number of subprime lenders has 

been fueled by strong demand from investors for assetbacked securities (ABS). This method of funding 

enables the lender to effectively raise cash at a lower 

rate to fund loan growth. In addition, the subprime ABS 

market has attracted lenders that previously refrained 

from making subprime loans because they did not want 

to maintain these high-risk loans or the associated 

reserves on their balance sheet. By issuing securities 

backed by subprime loans, lenders now have the ability 

to originate subprime loans and sell them to ABS 

investors. 

Favorable stock market conditions also helped to fund 

the growth of subprime lenders. Approximately 30 subprime lenders raised nearly $3 billion from stock offerings from January 1995 through April 1997, according 

to market watchers. This financing avenue may become 

less accessible, as investors’ concerns over financial 

Regional Outlook	 3 Third Quarter 1997 

C 
In Focus This Quarter
 

problems of several major market participants have 

caused stock prices of subprime lenders to decline significantly during the first part of 1997. 

Financial Difficulties of Some Subprime 

Lenders 

Market participants have observed that, as in credit card 

lending, increasing competition may be compelling some 

subprime lenders to compromise underwriting standards 

and lower pricing in order 

to protect market share. Financial 

difficulties reported by major subprime auto lenders Jayhawk 

Acceptance Corporation and 

Mercury Finance Company highlight these concerns. 

Problems in subprime lending are not limited to auto 

loans. Lenders that specialize in subprime home equity 

loans and mortgages also are showing signs of stress. In 

April 1997, Moody’s Investors Service lowered the rating on subordinated debt issued by a leading originator 

of subprime mortgage and home equity loans. The reason was concern over the increasing level of delinquencies in the issuer’s loan portfolio and the highly 

competitive environment for subprime home equity 

loans (see Financial Markets). 

Differences between Prime and Subprime 

Lending 

There are key differences between the underwriting, servicing, and collection methods used for prime and subprime lending programs. The goal of the subprime 

underwriting process is to differentiate those subprime 

borrowers whose past credit problems were due to such 

temporary events as illness or job loss from the habitually bad credits. Subprime lenders often supplement a 

prospective borrower’s credit bureau report with such 

additional information as income, employment history, 

and the nature of prior credit problems. This process 

allows the lender to better determine the credit risk or 

“grade” of the borrower. If this determination is successful, the lender can better establish the price at which 

the loan will be profitable. 

Servicing and collection of subprime loans tends to be 

more labor intensive and costly than in prime lending. 

Subprime lenders tend to monitor payments more closely than prime lenders. Some purportedly call their borrowers regularly to remind them when a payment is due. 

In addition, while prime lenders may be willing to work 

with late borrowers by adjusting minimum amounts or 

payment schedules, subprime lenders generally pursue 

collections more aggressively and repossess collateral 

more quickly. 

Insured Institutions and the Subprime Market 

Bank involvement in subprime lending is difficult to 

quantify because subprime loans are not delineated in 

bank and thrift Call Reports. However, both large and 

small banks reportedly are participating in credit card, 

auto, home equity, and mortgage subprime lending. 

Insured institutions have used various strategies to 

establish a presence in the subprime market. Some 

have: 

•	 acquired or formed joint ventures with companies 

specializing in subprime lending; 

•	 built subprime lending programs internally, using 

existing resources; and 

•	 tapped a network of loan brokers with access to subprime borrowers. Smaller banks entering the market 

for subprime mortgages may use this method more 

commonly. 

Through these strategies, insured institutions have: 

•	 extended loans directly to subprime borrowers or 

purchased subprime loans from loan brokers; 

•	 lent to subprime specialty lenders in the form of loan 

participations, warehouse lines, liquidity facilities, 

or dealer lines; and 

•	 serviced subprime loans or invested in asset-backed 

securities secured by subprime loans. 

Risks Associated with Subprime Lending Need 

to Be Considered Carefully 

According to a Financial Institutions Letter (FIL), FIL 

44-97 issued by the FDIC’s Division of Supervision, 

recent examinations revealed that a number of financial 

institutions involved in subprime lending have failed to 

properly assess and control the risks associated with 

subprime lending. Because of the relatively high default 

rates on such loans, the FIL indicates that this type of 

Regional Outlook	 4 Third Quarter 1997 
In Focus This Quarter
 

lending warrants particular caution and management 

attention. 

Institutions need to be thoroughly aware of the 

increased risks and costs associated with lending to 

higher risk borrowers. Some of these risks include: 

•	 Delinquencies and defaults tend to be more frequent 

and occur sooner on lower quality loans (see Chart 1). 

•	 Loan loss reserves that would have been adequate for 

prime lending may not properly cover higher loss 

rates associated with subprime loans. 

•	 Strains on underwriting and collection resources 

may emerge. 

•	 Because selling collateral is more frequently the 

source of repayment on subprime loans, failure to 

accurately estimate recovery values could severely 

affect the profitability of subprime lenders. For 

example, several subprime auto lenders recently 

reported lower profits when the supply of better 

quality cars coming off leases depressed the prices 

they received on repossessed cars. 

Insured institutions that rapidly increase subprime 

exposures also may need to reevaluate delinquency 

measurement methodologies. Rapid loan growth can 

make it more difficult to accurately track delinquency 

and default trends. Generally loans do not default 

CHART 1 

0% 

10% 

20% 

30% 

40% 

50% 

1 4 7 10 13 16 19 22 25 28 31 34 

Months since Origination 

"C" Auto Loans 

"A/B" Auto Loans 

"D" Auto Loans 

Source: Fitch Investors Service, L.P. 

Default Rate 

Defaults Are More Frequent and Occur 

Sooner on Lower Quality Auto Loans 

immediately, but “season” or reach peak loss rates over 

a period of time. Delinquency and default rates can be 

deceptively low if the proportion of new loans exceeds 

the proportion of seasoned loans in a lender’s portfolio. 

Calculating default rates over time for loans originated 

in a particular period or lending program, instead of as 

a percentage of total outstanding loan balances, helps 

reduce the distortion caused by rapid loan growth. This 

method of computing delinquency and default rates, 

known as “static pool” or “vintage analysis,” is a common measurement tool among investment analysts. 

Banks involved in subprime lending also should realize 

that the recent increase in subprime lending has 

occurred during relatively healthy economic conditions. 

The repayment capacity of subprime borrowers may be 

more susceptible to downturns in the economy, which 

could further exacerbate the already high level of delinquencies and defaults typically recorded on subprime 

loans. 

In addition, banks that lend to subprime specialty 

lenders, who rely heavily on securitization, should evaluate the accounting treatment of securitization and the 

effect securitization may have on earnings (see 

Financial Markets). 

Conclusion 

The extent of involvement by insured institutions in 

subprime lending is difficult to quantify. To be successful in subprime lending requires a commitment of 

resources and expertise. Conversely, deficiencies in 

assessing and controlling the risks of subprime lending 

can have serious consequences. Such deficiencies have 

surfaced at a number of FDIC-insured institutions. 

Striking an appropriate balance between the risks and 

rewards of subprime lending is a challenge for bankers 

and merits the continued attention of bank supervisors. 

Kathy R. Kalser, Chief 

Financial Sector Analysis Section 

Debra L. Novak, 

Division of Resolutions and Receiverships 

Regional Outlook	 5 Third Quarter 1997 
In Focus This Quarter
 

Retail Shakeout: Causes and Implications for Lenders
 

•	 Changes in the marketplace, technology, and 

finance are transforming retailing. 

•	 These trends have given rise to rapid growth in 

the new “big box” store format. 

•	 Consolidation in retailing is evident in mergers, 

acquisitions, and bankruptcies. 

•	 The potential for overbuilding in retail real estate 

markets may pose a risk for insured depository 

institutions. 

For the past two decades, construction of retail space 

has outstripped many indicators of demand such as 

growth in retail sales, population, and income. The 

broadest measure of the industry’s health is sales per 

square foot, and, for shopping centers, it has fallen by 

around 35 percent in real terms since 1972. Chart 1 

shows how growth in leasable shopping center space 

has exceeded growth in shopping centers’ sales since 

1972. 

Based on signs of “overstoring,” a number of retail 

industry analysts have concluded that too many stores 

are chasing too few consumer dollars, indicating an 

emerging shakeout in the retail sector. To the extent that 

insured depository institutions provide financing to 

retailers or for retail real estate, they are exposed to 

heightened credit risk as the shakeout unfolds. 

New Forces Are Reshaping the Retail Landscape 

A combination of demographic and economic forces 

has reduced growth in demand for retail goods from the 

boom days of the 1970s and mid-1980s. Meanwhile, 

technology is reconfiguring the way retail goods are 

marketed and delivered, and a low cost of capital has 

stimulated investment in new retail space and new 

retailing concepts. 

A retail industry boom began roughly in 1970 when 

baby boomers and women began entering the work 

force in record numbers. At the same time, proliferation 

in general-purpose credit cards facilitated an extension 

in consumer borrowing power. As a result, there was a 

CHART 1 

100 

150 

200 

250 

300 

350 

’72 ’76 ’80 ’84 ’87 ’89 ’91 ’93 ’95 

Leasable 

Space* 

Inflation-adjusted 

Sales * 

* Does not include non-shopping center space. 

Source: International Council of Shopping Centers 

1972=100 

Construction of Shopping Center Space Has 

Outstripped Sales Growth 

98 percent increase in inflation-adjusted retail sales 

from 1967 to 1994. 

To meet this demand and serve expanding suburban 

communities, developers built shopping centers at a 

rapid pace. The number of shopping centers, from small 

neighborhood strip centers to huge regional malls, grew 

from about 13,000 in 1972 to over 41,000 in 1995. 

Despite economic conditions that seem favorable for 

the retail sector, revenue growth has been painfully 

slow in the 1990s. Payrolls have seen net growth of 13.4 

million jobs since mid-1991, while real disposable personal incomes and consumer confidence have risen 

commensurately. An optimistic household sector has 

shown a willingness to take on debt under these favorable conditions and has done so with the benefit of 

lower interest rates compared to the 1980s. 

Even with generally positive economic conditions, 

retail demand has grown slowly in the 1990s (see Chart 

2, next page). Annual rates of increase in real expenditures on many durable and, especially, nondurable goods 

have lagged behind rates of the previous two decades. 

Slow growth in retail revenues can be explained in part 

by the fact that retail goods overall have risen in price at 

only around two-thirds of the general rate of inflation 

during the 1990s, while the appliance, electronics, and 

personal computer sector has seen actual price deflation. 

Regional Outlook	 6 Third Quarter 1997 
In Focus This Quarter
 

An aging consumer base is another factor holding down 

retail sales growth. The total number of households 

headed by persons age 20 to 35—the age at which families are getting established and acquiring household 

durable goods—is the same now as it was in 1980. The 

lack of growth in this key demographic group has limited growth in retail demand and should continue to do 

so for the foreseeable future. The total population in the 

20 to 35 age bracket is projected to decline slightly by 

2007. 

Other broad trends have contributed to slower retail 

sales growth. Retail sales as a percentage of personal 

income fell from 46 percent to 38 percent between 1967 

to 1996 as consumers shifted more of their disposable 

income to the purchase of personal services, housing, 

education, travel, and entertainment. A Standard and 

Poor’s Industry Survey reports 

that consumers have reduced 

their number of trips to shopping 

malls by 35 percent since 1980, 

while total shopping hours are 

down 70 percent. 

Looking ahead, mail-order retailing through electronic media, 

including cable television and the Internet, may be 

poised to gain significant market share at the expense of 

shopping centers. “Virtual shopping malls” such as 

Amazon.com, an Internet bookseller, have made headlines with their initial successes, although analysts caution that widespread adoption of high-tech shopping 

may be some years down the road. 

Technology has become a key to distribution and marketing. Faced with slower revenue growth, retailers have 

been investing in technology to cut their expenses and 

boost their bottom lines. For example, point-of-sale 

scanning delivers a vast amount of information that can 

be used to target marketing efforts and manage and control inventories—providing a distinct competitive 

advantage for large retail chains with vast marketing 

and distribution networks. 

A low cost of capital has fueled investment. Low interest rates and a booming stock market have made market 

financing plentiful and cheap. This environment has 

allowed retailers to overhaul retail strategies and invest 

heavily in technology, inventory, and retail space— 

investments that might otherwise have been infeasible. 

Since 1991, around 1.13 billion square feet of new retail 

space has been added nationwide representing an 

increase of about 12 percent to the total stock of retail 

real estate over five years. Net additions to retail inventories since 1991 have totaled almost $33 billion in 

inflation-adjusted dollars, an increase of over 18 percent. No figures are available on investments made in 

information systems, although they are known to be 

sizeable. 

Growth of the “Big Box” Format 

Leading retailers have responded to these forces with 

aggressive expansion in the “big box” store format. Big 

box retailers are typically discount stores and superstores, such as Circuit City, PetSmart, and The Home 

Depot, Inc., which tend to cluster in large strip malls 

called “power centers.” In many towns and cities, the 

arrival of big box stores has left smaller, local retail 

establishments with only a small fraction of their former 

share of the local market. 

The big box format has a number of advantages. Among 

the most important is the ability to offer a large, diverse 

on-shelf selection. This approach enables a single location to dominate that retail category in the local market, 

which is why the big box chains are often referred to as 

“category killers.” Large retail chains also have more 

leverage over suppliers. They can negotiate more favorable prices and demand cooperative advertising from 

manufacturers. Large retailers typically have the financial resources to invest in the latest distribution methods 

and technology. Finally, unlike smaller traditional retailers, these large chains can obtain financing through the 

capital markets. 

CHART 2 

Inflation-Adjusted Retail Sales Have Grown 

Slowly in the 1990s 

Real Growth in Retail Sales*, 

Compound Annual Rate 

3.0% 

2.5% 

2.0% 

1.5% 

1.0% 

0.5% 

0.0% 

1970s 1980s 1990s 

* Retail sales excluding autos, deflated by the consumer price index. 

Source: Bureau of the Census and Bureau of Labor Statistics 

Regional Outlook 7 Third Quarter 1997 
In Focus This Quarter
 

Industry Consolidation to Continue 

Rapid expansion among the large retail chains has contributed to a highly competitive retail sector marked by 

intense battles for domination of the major retail categories. The result of this competition, analysts say, will 

be consolidation in the industry as weaker chains give 

way to market leaders. 

One sign of this consolidation is in multibillion dollar 

acquisitions, such as Federated Department Stores’ 

acquisition of R.H. Macy. The five largest department 

store chains (JC Penney, Federated, May, Dillard, and 

Nordstrom) now account for 87 percent of department 

store sales nationwide. The top three discount department store chains (Wal-Mart, K-Mart, and Target) 

account for 87 percent of full-line discount department 

store sales. 

Intensely competitive conditions also are reflected by 

retail bankruptcies and restructurings. Both Woolworth 

Corp. and K-Mart Corp. recently closed a number of 

stores in restructurings that reflect the loss of market 

share to Wal-Mart. Smaller companies that have fewer 

restructuring options are more likely to be forced into 

bankruptcy. Dun & Bradstreet reports that domestic 

business failures among retail establishments rose in 

1995 by 2.8 percent to 12,952. While most of these failures were individual stores and small chains, a number 

of larger chains also filed for bankruptcy during 1995, 

including Barney’s, Bradlees Inc., Caldor, The 

Clothestime Inc., Edison Brothers Stores, ElderBeerman, Herman’s Sporting Goods, Jamesway, and 

Today’s Man. 

As the retail shakeout moves forward, any credit losses 

on commercial and industrial loans to retailers are more 

likely to arise from bankruptcies and restructurings than 

from mergers and acquisitions. Unfortunately, it is difficult to say in advance exactly how consolidation in the 

industry is likely to take place. 

Overbuilding Is a Risk for Retail Real Estate 

Retail industry analysts are particularly concerned 

about the potential for overbuilding of retail space. 

Because of this concern, lenders and examiners should 

be alert to possible credit quality problems with commercial real estate loans secured by retail properties. 

CHART 3 

0 

20 

40 

60 

80 

100 

120 

140 

160 

’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 

0% 

2% 

4% 

6% 

8% 

10% 

12% 

New Supply Has Recently Outpaced 

Absorption of Retail Space 

Source: FDIC, The Real Estate Report (Summary for 58 major markets) 

Vacancy 

Rate 

Net New Supply Absorption 

Millions of 

Square Feet 

Although a vacancy rate of 7.7 percent does not suggest 

that the U.S. retail market is vastly overbuilt at present, 

there are warning signs. One is that the U.S. aggregate 

vacancy rate has begun to tick upward since 1995 as net 

completions of new retail space have caught up to and 

surpassed the absorption of that space by retailers (see 

Chart 3). Another frequently cited indicator of overbuilding is a falling ratio of sales per square foot in the 

industry, reflecting the fact that additions to retail space 

have outpaced sales growth for some time. In any case, 

local market conditions may be somewhat more volatile 

than the national figures would suggest, particularly in 

areas where a great deal of construction activity has 

recently taken place (see inset, Retail Construction 

on the Rise in Memphis Region). 

Besides market conditions, underwriting is the other 

major determinant of credit quality in retail real estate 

lending. Market analysts report that many of the problems resulting from local market downturns have been 

on loans with 1980s-vintage underwriting, particularly 

those with high loan-to-value ratios. Analysts also voice 

concern that the rapid expansion of space may be 

putting downward pressure on lease rates. In light of an 

ample supply of space and a number of large chains 

continuing to add space, any valuations that assume 

future growth in lease rates should be closely reviewed. 

The viability of rapid expansion on the part of the large 

retail chains would undergo a particularly severe test in 

the event of a recession. 

Richard A. Brown, Chief, Economic Analysis Section 

Diane Ellis, Senior Financial Analyst 

Regional Outlook 8 Third Quarter 1997 
In Focus This Quarter
 

Retail Construction on the Rise CHART 4

in the Memphis Region
 

Recent conditions have been decidedly upbeat in 

retail real estate markets over large parts of the 

Memphis Region. Declining vacancy rates have been 

observed in the major metropolitan areas, in line with 

the nation’s overall trend during the 1990s. There are 

signs that the rate of new retail construction is picking 

up as the market for leaseable space gets tighter. 

However, the question remains as to whether future 

retail sales growth in the Region will be sufficient to 

support an expanding retail industry. 

Nashville has become a leading market for new retail 

development. Chart 4 shows that absorption of retail 

space has outstripped completion of new space for the 

past five years. The result has been a decline in the 

retail vacancy rate from over 20 percent in 1991 to 

just 8.2 percent (0.5 percent above the national average) in 1996. An analyst with Trammel Crow 

describes the Nashville retail market as being “as 

good as it has been for a long time with overall vacancy at a 10-year low, and rental rates up 20 percent to 

25 percent in some markets.” Indications are that the 

recent rise in lease rates appears to be expanding the 

pipeline of new retail construction projects in 

Nashville. The Real Estate Report of the FDIC cited 

a total of 5.1 million square feet of new space in the 

planning stage there as of March 1997, up from only 

2.1 million square feet in May 1996. 

TABLE 1 

Retail Vacancies on Decline in Nashville 

Source: FDIC, The Real Estate Report Vacancy Rate

Millions of Square Feet 

’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 

Vacancy Rate 

(left scale) 

Net New 

Supply 

Absorption 

-2,000 

-1,000 

0 

1,000 

2,000 

3,000 

4,000 

5,000 

0% 

5% 

10% 

15% 

20% 

25% 

A sharp uptick in current and planned retail construction is apparent across the Memphis Region (Table 1). 

Projects in the planning stages have risen by 222 percent in just under a year in the seven metro areas covered by The Real Estate Report. While these figures 

include space in the early planning stages that could 

still be canceled, some significant new projects are 

slated to come on line this year and next year. In 

Memphis, for example, the beginning of 1997 was 

marked by the completion of a 1.1-million-squarefoot regional mall and two “power centers” with 

almost a million square feet of space between them. 

These completions will be followed by a 575,000­

square-foot addition to the Market of Wolfcreek shopping center, slated to be finished in fall 1997. 

Planned Retail Construction Takes Off in the Region 

(Thousands of Square Feet) 

MAY MARCH PERCENTAGE 

1996 1997 CHANGE 

LOUISVILLE KY MSA* 1,911 5,221 173 

NASHVILLE TN MSA 2,063 5,131 148 

KNOXVILLE TN MSA 295 4,692 1,490 

NEW ORLEANS LA MSA 221 3,635 1,544 

MEMPHIS TN MSA 1,187 2,091 76 

BATON ROUGE LA MSA 1,478 2,004 35 

LITTLE ROCK AR MSA 356 1,422 299 

TOTAL FOR 7 MSAS 7,511 24,196 222 

*MSA = Metropolitan Statistical Area 

Source: FDIC, The Real Estate Report 

Regional Outlook 9 Third Quarter 1997 
In Focus This Quarter
 

Amid these signs of a boom in retail construction is a 

somewhat more negative indicator in the form of 

declining rates of growth in inflation-adjusted retail 

sales (Chart 5). Annual increases in real retail sales 

growth (excluding autos) in the East South Central 

Census Region (Alabama, Kentucky, Mississippi, and 

Tennessee) have slipped from the 3 to 7 percent range 

during 1992 through 1994 to 1.9 percent in 1995 and 

–0.5 percent in 1996. The highly cyclical building 

materials sector has led this decline, registering negative growth for the past two years. Cash flow projections for prudently underwritten retail construction 

projects in the Region should account for this slowdown in retail sales growth. 

C. Hayward Majors, Research Assistant 

CHART 5 

Retail Sales Growth Has Declined Lately in
 

Memphis Region States
 

Annual Real Growth in Non-Auto Retail Sales in E. South 

Central Census Region (AL, TN, MS, KY) 

20% Total Retail 

Building Excluding 15% Materials Autos 

Sector
 

5%
 

0%
 

-5% 

’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 

10% 

Retail Sales Deflated by the Consumer Price Index 

Source: Census Bureau, Bureau of Labor Statistics 

Regional Outlook 10 Third Quarter 1997 
Regular Features	 Regional Economy
 

Growth in the Memphis Region Lags the Nation
 

•	 Job growth in the Memphis Region slowed to 1.7 percent in 1996, the lowest level since 1991, and is below 

the national average. 

•	 Labor markets in Nashville, Lexington, southern Louisiana, and southern and eastern portions of 

Mississippi are tight, while rural areas on or near the Mississippi River contend with double-digit unemployment rates. 

•	 The divergent performance of the southern and northern halves of Louisiana likely can be traced to the concentration of the expanding oil and gas and gaming industries in the southern part of the state. 

Economic Growth in the Memphis Region Is 

Below the National Average 

The Memphis Region’s economic growth peaked in 

1994, in terms of job gains, and has since declined, 

falling below the national average for the first time 

since 1987. In 1996, employment in the Region 

increased by 1.7 percent, the slowest gain since 1991, 

and below the national average of 2 percent (see Chart 

1). Similarly, retail sales growth faded and was the 

slowest since 1991 in the Region’s reporting states of 

Louisiana, Kentucky, and Tennessee. Sales rose by 2.3 

percent in Louisiana and 2.8 percent in Kentucky during 1996, down from the double-digit gains recorded in 

1994. Although Tennessee’s 1996 retail sales growth of 

6.5 percent was high relative to the national average of 

4.9 percent, it was less than half the rate of gain at its 

peak in 1992. 

Although the Region’s economic growth has slowed 

since 1994, there was a slight temporary rebound in 

economic activity in early 1997. In January, year-overyear job growth rose to 2.2 percent, shrinking the gap 

with the national increase of 2.4 percent. The increase in 

employment growth was due largely to renewed 

strength in construction, services, and trade and some 

moderation in the ongoing decline in manufacturing. 

Many analysts believe that some of the stronger growth 

earlier in the year was weather-related. The 1996 to 

1997 winter season was relatively mild, which enabled 

greater than normal levels of construction activity. 

Economic growth across all sectors has since moderated. The Region’s construction industry, whose payrolls 

were up 5.4 percent in January from one year earlier, 

saw job growth slip to 1.8 percent in March. This slowdown is mirrored by the first quarter’s 3.7 percent drop 

from one year earlier in residential permit issuance. 

Kentucky and Louisiana Are the Fastest 

Growing States in the Memphis Region 

Kentucky’s 2.4 percent job growth for the year ending 

March 1997 was just above the national average. Even 

so, Kentucky’s economic performance varies geographically. In the northern half of the state, labor markets are 

tight in the suburban areas of Louisville and 

Lexington, as indicated by a comment from an officer 

at a machine tool company in the area that “anymore, 

it’s hard to find anybody with even the simplest skills.” 

Even in the eastern half of the state, where jobless rates 

are often in the double digits (see Map 1, next page), the 

unemployment rate in several counties has fallen by 

over 1 percentage point during the past year. Tighter 

labor markets in the northern half of the state contrast 

with economic conditions in the southern half, which is 

less industrialized and has suffered from the loss of textile jobs, such as the recent layoff of 800 employees of 

Fruit of the Loom in Campbellsville and Jamestown. 

With the exception of Hickman and Fulton counties, all 

CHART 1 

-2% 

-1% 

0% 

1% 

2% 

3% 

4% 

1989 1990 1991 1992 1993 1994 1995 1996 

Job Growth in the Memphis Region Falls 

below National Average 

Memphis Region 

U.S. 

Source: Bureau of Labor Statistics 

Percent Change 

Regional Outlook	 11 Third Quarter 1997 
Regular Features Regional Economy
 

counties in the southwestern corner of the state have 

seen jobless rates climb by over 1 percentage point. 

Unemployment rates remain high as well outside of 

Owensboro and in south-central portions of the state. 

The three fastest growing metropolitan areas in 

Louisiana are in the southern half of the state (see Table 

1). Most parishes there have seen jobless rates decline 

by over 1 percentage point since the first quarter of 

1996. In contrast, parishes near the Mississippi River in 

the northeast section are experiencing unemployment 

rates uniformly above 10 percent. Though gains in gaming and manufacturing boosted job growth in 

Shreveport-Bossier City, surrounding parishes of the 

metropolitan area still have unemployment rates above 

10 percent. 

The divergent conditions in the southern and northern 

halves of the state likely can be traced to the concentration of the oil and gas and gaming industries in the 

southern half. The importance of the oil and gas indusMAP 1 

Unemployment Rates 

First Quarter 1997

 Below 3%

 Above 10% 

Economic Performance Reflects 

Rural-Urban Dichotomy 

TABLE 1 

Year-Over-Year Employment Growth, 

First Quarter 1997, Is Higher in 

Southern Louisiana 

LOUISIANA 2.6% 

NORTHERN LOUISIANA 

ALEXANDRIA 2.1% 

MONROE 0.7% 

SHREVEPORT 3.7% 

SOUTHERN LOUISIANA 

BATON ROUGE 4.4% 

HOUMA 5.6% 

LAFAYETTE 4.6% 

LAKE CHARLES 0.9% 

NEW ORLEANS 1.2% 

Source: Bureau of Labor Statistics 

try extends beyond employment in drilling activities. 

The demand for deep-water drilling equipment has 

helped push year-over-year manufacturing job growth 

in Houma and Lafayette into the double digits. The 

multiplier effect also extends to service industries that 

support the oil and gas industry. 

While the oil and gas industry has been a recent source 

of growth for southern Louisiana, another downturn in 

this sector would generate adverse spillover effects to 

the rest of the area. The impact of slower growth in the 

oil and gas industry could cause a ripple effect in the 

economy of southern Louisiana, potentially threatening 

credit quality across a broad spectrum. However, the 

economic diversification of the state’s economy in 

recent years, particularly thanks to expansion of the 

gaming industry, could help mitigate the impact of 

another oil and gas downturn relative to the 1980s experience (see Chart 2, next page). 

Tennessee’s Economic Performance Is beyond 

Its Cyclical Peak 

Tennessee, in sharp contrast to the vigorous growth it 

experienced in the period 1993 to 1995 (Chart 3, next 

page), has become the Region’s slowest growing state. 

March year-over-year employment growth was just 0.1 

percent, as growth in all areas of the state’s economy has 

slowed since January 1997. Construction activity in the 

state slowed as well during the first quarter of 1997. 

Residential permit issuance, after increasing by 15 perRegional Outlook 12 Third Quarter 1997 
Regular Features Regional Economy
 

CHART 2 

-25% 

-20% 

-15% 

-10% 

-5% 

0% 

5% 

10% 

15% 

’75 ’77 ’79 ’81 ’83 ’85 ’87 ’89 ’91 ’93 ’95 

Mining’s Impact on the Louisiana Economy 

LA Mining 

Job Growth 

LA Nonagricultural 

Job Growth 

Source: Bureau of Labor Statistics 

% Change 

cent in 1996, was down 1 percent in the first quarter of 

1997 from one year earlier. 

Employment growth in Tennessee was below the national average in 1996 for the first time since 1990. Job 

growth in Tennessee is concentrated in the middle and 

western sections of the state. Year-over-year job growth 

in Clarksville-Hopkinsville was 3.6 percent in March 

1997, and labor markets in the western suburbs of 

Nashville remain tight, with jobless rates below 3 percent. The eastern half of the state is seeing softer levels 

of growth; employment in the metropolitan areas of 

Chattanooga and Johnson City-Kingsport-Bristol 

was actually below year-ago levels in March. 

Five counties along the North Carolina border have 

double-digit jobless rates. One area of the state that has 

seen a striking change in labor markets is a region 

CHART 3 

-2% 

-1% 

0% 

1% 

2% 

3% 

4% 

5% 

6% 

U.S. 

Tennessee 

Source: Bureau of Labor Statistics 

Percent Change, Year-Ago 

Job Growth in Tennessee Trends Downward 

Jan-90Jan-91Jan-92Jan-93Jan-94Jan-95Jan-96Jan-97 

northeast of Nashville that centers on rural Clay 

County. In the first quarter of 1997, the county’s unemployment rate stood at 30 percent, up from 9.7 percent 

one year earlier. In 1996, the region suffered numerous 

plant closings, including an Oshkosh B’Gosh apparel 

manufacturing facility. Other rural counties throughout 

the state have witnessed similar events as large local 

employers relocate closer to urban centers or transportation routes or move operations offshore. Another 

example is Lewis County, southwest of Nashville, 

where jobless rates reached 17.2 percent in the first 

quarter of 1997. Two major manufacturers in the area, 

Genesco and Henry I. Siegal Co., shut down last year. 

Growth in Mississippi and Arkansas Is on Par 

with the Region 

The other states in the Memphis Region, Arkansas and 

Mississippi, have seen economic growth consistent 

with the Region’s average. Construction has been the 

fastest growing area of Arkansas’s economy. Economic 

performance in Arkansas has not been geographically 

uniform. The Fayetteville-Springfield metropolitan area 

saw year-over-year job growth of 3.4 percent in March 

1997 as the economy was supported by gains in trade, 

services, finance, insurance, and real estate. In contrast, 

as in other states in the Region, jobless rates in several 

counties along the Mississippi River remain in the double digits. 

In Mississippi, labor markets over the year ending in the 

first quarter of 1997 have tightened throughout much of 

the eastern and southern portions of the state. Job 

growth, however, remains concentrated in the BiloxiGulfport-Pascagoula metropolitan area, which is being 

supported by construction activity and expansion of the 

gaming industry. 

Implications: The Memphis Region experienced several years of rapid growth and now appears to be slowing. 

Accordingly, prudent bankers will carefully examine 

financial projections submitted by potential borrowers 

to determine whether the assumptions used remain valid 

in light of recent economic trends. In areas of declining 

job growth, loan demand may begin to wane. In turn, 

this trend could increase the pressure on some institutions to compromise pricing and underwriting standards 

at the expense of credit quality. 

Scott C. Hughes, Atlanta Regional Economist 

Gary L. Beasley, Senior Regional Analyst 

Regional Outlook 13 Third Quarter 1997 
Regular Features	 Financial Markets
 

Financial Markets
 

•	 Deteriorating credit quality trends in the rapidly growing home-equity backed securities market could portend trends in bank residential mortgage lending. 

•	 Financial asset securitization investment trusts, known as FASITs, promise to change the asset-backed securities market significantly and could make securitization more accessible to community banks. 

•	 The Treasury yield curve is steeper and higher than it was at year-end 1996. 

•	 The Memphis Region’s Community Bank Index and Regional Bank Index both failed to match the gains of 

the S&P 500 and S&P Composite Bank Index as of May 2, 1997. 

Trends in the Home-Equity Asset-Backed 

Market Are Important to Banks 

The home-equity loan (HEL) asset-backed securities 

(ABS) market has grown by over $20 billion or 251 percent since 1993, with total issuance of HEL ABS topping $27 billion in 1996 (see Chart 1). The rapid growth 

of the market, which has been driven largely by consumer debt consolidation lending, has been accompanied by abnormally early and high levels of 

delinquencies. Banks that are investing in HEL ABS, 

considering securitizing HELs, or lending significantly 

for debt consolidation should be aware of credit quality 

developments in the HEL ABS market. 

The distinction between HELs and first-lien residential 

mortgages is eroding in the HEL ABS market. The refinancing boom spurred by the decline in rates during 

1993 and early 1994 resulted in a change in the makeup 

of the HEL ABS market, causing much higher percentages of the securities to be backed by first-lien HELs 

than previously had been the case. First-lien home-equity lending, know as cash-out refinancing, grew substantially when home-equity borrowers were motivated by 

lower rates to refinance their first mortgages for 

amounts greater than the remaining principal balance 

instead of adding a second mortgage. 

Debt consolidation is the primary reason for homeequity borrowing. Nonbanks that expanded their mortgage lending capacity during 1993 have been 

aggressively marketing to an increasing number of borrowers who desire to consolidate their growing debt 

burdens. According to the Consumer Bankers 

Association 1997 Home-Equity Loan Study, debt consolidation accounted for 36 percent of home-equity 

lines of credit and 40 percent of closed-end loans. Prior 

to 1992, home improvement was the primary reason for 

home-equity borrowing. This trend toward debt consolidation as the reason for home-equity borrowing has 

significant risk implications because, unlike funds lent 

for home improvement, the proceeds of a debt consolidation loan do not enhance the lender’s collateral value. 

The rapid growth of the HEL securitization market has 

been attended by signs of relaxed underwriting. 

Adverse credit quality trends have been particularly 

prominent for loans that were originated in 1995. Chart 

2 (next page) shows the total delinquency rates for 

closed-end loan pools originated in 1995 versus 1994. 

The sharp upward path of delinquency rates for loan 

pools originated in 1995 raises concern that aggressive 

competition for volume, and apparently relaxed underwriting standards, could lead to unprecedented default 

levels. Furthermore, HEL originations in 1996 more 

than doubled 1995 levels, causing market observers to 

suspect that underwriting standards continued to lapse. 

CHART 1 

1993 1994 1995 1996

0 

5 

10 

15 

20 

25 

1993 1994 1995 1996

Securitization of Home Equity 

Loans Has Risen Substantially 

Lines of Credit 

Closed End 

Source: Moody’s Investors Service 

$ Billion 

Regional Outlook	 14 Third Quarter 1997 
Regular Features Financial Markets
 

The trends in the HEL ABS market may portend credit 

quality trends in nonsecuritized cash-out refinancing. If 

similar unfavorable trends exist in bank-originated 

cash-out refinancing, evidence of these trends would be 

obscured by banks’ larger and less risky portfolios of 

purchase mortgage loans. The trends would be obscured 

because banks report all first mortgage lending on 1 to 

4 family residential properties without distinguishing 

between purchase mortgages and cash-out refinancings. 

The unfavorable trends in the HEL ABS market suggest 

that banks that engage in significant cash-out refinancing and other forms of home-equity lending should be 

able to monitor trends in the credit quality of these loans 

separate from purchase mortgage loans. 

A Combination of Several Factors Could Induce 

More Banks to Securitize HELs 

Although the present volume of bank-originated HEL 

securitizations is relatively small, banks have recently 

entered this finance company-dominated market, and a 

combination of several factors is likely to cause more to 

follow. First, home equity lines of credit are currently 

growing at rates exceeding total consumer lending, and, 

by and large, the deposit growth to fund this lending is 

less than robust. In addition, according to Moody’s 

Investors Service, investor demand is high for bankoriginated home-equity line of credit securitizations 

because bank-originated lines are perceived to have 

lower credit risk. The funding benefits and profitability 

of securitizing bank-originated home-equity lines of 

credit could entice more banks into the securitization 

market. Finally, the combination of these factors with 

the potential cost savings provided by using the new 

financial asset securitization investment trust (FASIT) 

CHART 2 

0 

2 

4 

6 

8 

10 

1 3 5 7 9 11 13 15 17 19 21 23 

Months since Origination 

1995-Originated Loans 

Source: Moody’s Investors Service 

Percent 

Higher Delinquency Rates Are Occurring 

Earlier in More Recently Originated Loan Pools 

1994-Originated Loans 

Closed-end Loans 

structure (see discussion below) could produce momentum that will result in banks, large and small, securitizing home equity loans in significantly increased 

amounts. 

Securitizing HELs can change the balance sheet and 

income statement of the securitizer significantly, resulting in significant servicing assets and gains on 

sale. Beginning in 1997, 

when a company sells 

loans, it must comply 

with the requirements of 

Financial Accounting 

Standard (FAS) 125. If 

the company retains servicing rights on the assets sold, FAS 125 requires the 

seller to book an asset related to the gain on sale that 

represents the future income derived from servicing the 

loans. This asset is similar to mortgage servicing rights 

in that it represents the present value of future expected 

cash flows derived from loan servicing. One major 

home-equity securitizer, which indicated that FAS 125 

would not materially affect its financial statements, 

reported servicing assets at almost 90 percent of equity, 

and gains associated with the sale of serviced assets at 

71 percent of total revenue. 

The value of servicing assets is based on management’s 

assumptions about the future cash flows to be generated by the assets. Because these assumptions are based 

largely on historical performance, unexpected deterioration, like that associated with 1995- and possibly 

1996-originated loans, that results in charge-offs or 

early repayment through foreclosure of serviced assets, 

could require the adjustment of the valuation assumptions and the write-down of the servicing assets. 

FASITs Promise to Change the ABS Market 

The Small Business Job Protection Act of 1996 created 

two new sections of the Internal Revenue Code that create and govern FASITs. The FASIT provisions, patterned in part on the real estate mortgage investment 

conduit (REMIC) rules issued in 1986, are intended to 

provide tax certainty for ABS issuers and purchasers 

and enhance the flexibility of asset securitizations. The 

FASIT provisions take effect on September 1, 1997. 

The advent of the FASIT is likely to change the ABS 

market in important ways. First, the FASIT will clarify 

Regional Outlook 15 Third Quarter 1997 
Regular Features Financial Markets
 

the tax treatment of securitizations. Because of the current tax ambiguity, designing ABS structures to avoid 

taxation is administratively costly, and it restricts the 

forms that securitizations can take. The higher administrative cost associated with current securitization techniques establishes a practical minimum size for asset 

pools that can be feasibly securitized. With FASITs and 

the reduced costs associated with tax clarity, the economically feasible pool size may be significantly smaller. The lowering of this threshold could result in more 

community banks entering the securitization market. 

ABS issuers believe that the market for their product 

has been hampered by the restrictive nature of current 

asset-backed tax ambiguity, which prevents them from 

responding to investor 

preferences for varying 

maturities, coupon 

types, and prepayment 

and credit risk profiles. 

FASITs allow sponsors 

the flexibility to create 

multiple-class securities 

that satisfy these preferences with the certainty 

that the securities will count as debt and that the FASIT 

will not be treated as a taxable corporation. This combination of flexibility and tax certainty could lead to the 

kind of innovations in ABS structures that followed the 

1986 REMIC legislation, which brought analogous benefits to the mortgage-backed market. 

There are additional innovations made possible by 

FASITs. FASITs will bring to the ABS market the ability to add and remove assets throughout the life of a 

securitization. This feature could be applied by securitizing revolving construction loans and then replacing 

the revolving loans with permanent financing when 

construction is completed. A FASIT also will be able to 

contain a mixed pool of assets such as real estate, nonreal estate assets, and unsecured credit, allowing exposures to very different markets from the same security. 

Finally, a FASIT can hold swaps and other hedging 

instruments. Using this feature, an issuer could combine 

a mortgage passthrough security with a hedging instrument that is designed to offset mortgage prepayment 

risk, such as a reverse-index amortizing swap. 

The increased flexibility that the FASIT promises to 

bring the ABS market comes with the potential for 

greatly increased complexity and risk. Banks that invest 

in FASIT securities will need to understand fully not 

only the risk characteristics existing at the outset of 

security but also the risk that could arise throughout the 

security’s life if assets are to be removed and replaced. 

Changes in Interest Rates and Bond Values 

The Treasury yield curve (see Chart 3) rose following 

March 25, 1997, when the Federal Open Market 

Committee (FOMC) met and raised the target federal 

funds rate 25 basis points to 5.50 percent. The yield on 

the 30-year Treasury bond rose above 7 percent on the 

Thursday following the meeting and remained there for 

the next 23 days. The FOMC met again on May 20, 

1997, and left the target rate unchanged. 

The model portfolio responded to the rise in rates, but 

only modestly (see Table 1). The relatively short weighted average maturity of the portfolio served to moderate 

the effect of the 54 basis point rise in the five-year 

Treasury between December 31, 1996, and March 31, 

1997. As discussed in Regional Outlook, Second 

Quarter 1997, changes in the value of the model portfolio correlate more with changes in the five-year 

Treasury rate than with the 30-year bond rate. 

The yields along the April 30, 1997, yield curve imply 

that the market expects the curve to continue to flatten 

through the remainder of the year with short rates rising 

somewhat. In order to gauge what affect a 25 basis point 

rise in the yield curve could have on bank fixed-income 

portfolios, the model portfolio has been “shocked” to 

simulate the effect of an instantaneous 25 basis point 

shift in the yield curve on May 28, 1997. 

CHART 3 

The Treasury Yield Curve Is Steeper 

and Higher since Year-end 1996 

5.0 

5.5 

6.0 

6.5 

7.0 

7.5 

3­

month 

2­

year 

7­

year 

30­

year 

Source: Bloomberg 

Percent 

3/31/97 

4/30/97 

12/31/96 

Regional Outlook 16 Third Quarter 1997 
Regular Features Financial Markets
 

TABLE 1 

Type of Security Par Value Percent Maturity Percent Change Reof or Change sulting from 

Portfolio WAL from a 25 bp Rate 

as of 12/31/96 Increase on 

12/31/96 to 5/28/97 

3/31/97 

U.S. TREASURY 5.6% 2,000 20% 1 YR –0.30% –0.16% 

FNMA AGENCY 5.8% CALLABLE 1,200 12% 2 YR –0.50% –0.38% 

STATE COUNTY MUNICIPAL GO 4.8% 800 8% 11 YR –2.05% –2.03% 

FNMA MORTGAGE PASSTHROUGH 7.5% 3,000 30% 8 YR –1.78% –1.44% 

FNMA (REMIC) 8.0% PAC 2,000 20% 2.5 YR –1.27% –0.50% 

CREDIT CARD ASSET-BACKED SECURITY 1,000 10% 5 YR –0.09% 0.00% 

TOTAL 10,000 100% 4.85 YR –1.08% –0.77% 

Note: Portfolio composition based on estimates derived from aggregated Bank Call Report information. 

Again, the interest rate risk benefits of maintaining a 

portfolio of relatively short weighted average life are 

apparent. The U.S. Treasury and the agency, the shortest 

lived instruments, and the floating-rate ABS demonstrate the least price sensitivity. The municipal bond is 

the most sensitive to rate changes owing to its longer 

maturity. The mortgage passthrough security also is 

more sensitive to rising rates because its weighted-average life (WAL) extends as rising rates discourage the 

underlying mortgage holders from prepaying their 

loans. The decline in prepayment rates results in extending the maturity of the security while rates are rising, a 

combination unfavorable to the security’s value. 

The Memphis Region’s Community Bank Index 

and Regional Bank Index Underperformed the 

S&P 500 through May 2, 1997 

The S&P Composite Bank Index and the Memphis 

Regional Bank Index have been subject to similar performance swings this year (Chart 4). The S&P 

Composite Bank Index, with an almost 13 percent gain 

by May 2, 1997, was still short of its year-to-date high 

on March 7, 1997, when it was up almost 20 percent on 

the year. The Memphis Region’s Community Bank 

Index and Regional Bank Index followed different paths 

to similar performance levels of 8.51 percent and 8.94 

percent, respectively, as of May 2, 1997. Both indices 

underperformed the S&P 500’s 9.75 percent gain. 

Allen Puwalski, Banking Analyst 

CHART 4 

-1% 

4% 

9% 

14% 

19% 

S&P 500 

Regional Bank Index 

S&P Bank Index 

Source: Bloomberg, American Banker 

Change from 12/31/96 

Region’s Community Bank Index 

The Memphis Region’s Bank Indices Followed Different Paths 

to Gains that Are Less than the S&P 500 and Bank Index 

31-Dec

10-Jan 

3-Jan

17-Jan24-Jan31-Jan

7-Feb

14-Feb21-Feb28-Feb

7-Mar

14-Mar21-Mar28-Mar

4-Apr

11-Apr18-Apr25-Apr

2-May 

Regional Outlook 17 Third Quarter 1997 
Regular Features	 Regional Banking
 

Current Regional Banking Conditions
 

•	 Moderate increases in consumer loan delinquencies are the exception to otherwise favorable first-quarter 

operating results. 

•	 The competitive landscape for Memphis Region banks is changing with a continuing trend toward fewer 

and larger institutions. 

•	 The “year 2000” problem could be costly to insured institutions that fail to adequately assess exposure and 

implement timely corrections. 

•	 Proposed accounting changes may eliminate the popular pooling method of accounting for mergers and 

acquisitions. 

First-Quarter Reports Reflect Overall Good 

Earnings, Capital, and Asset Quality 

On an aggregate basis, the Region’s banks and thrifts 

continue to exhibit relatively strong financial conditions. During the first quarter of 1997, the Region’s 

banks and thrifts: 

•	 maintained leverage capital at just under 9 percent of 

average assets; 

•	 improved aggregate return on assets (ROA) by 4 

basis points to 1.28 percent (see Chart 1); and 

•	 reported low nonperforming assets (0.68 percent of 

assets) and past due loans (2.51 percent of total 

loans) despite a continuation in the trend toward 

higher delinquencies for credit cards. 

While Region-wide conditions are strong, ROAs for 

commercial banks were behind year-ago levels in 

Louisiana, Kentucky, and Mississippi. Louisiana 

banks experienced the only significant decline, with 

ROAs falling 17 basis points, to 12 percent below the 

level generated during the first quarter of 1996. The 

decline is primarily the result of higher provisions for 

loan and lease losses necessitated by rising credit card 

losses. 

Region-wide losses on credit card loans represented 31 

percent of all loan losses in the first quarter of 1997, 

compared to 27 percent in the first quarter of 1996. 

tions headquartered in Tennessee, at 5.6 percent, and in 

Louisiana, at 4.2 percent. Banks in these two states 

accounted for three-fourths of the credit card loans in 

the Region. 

Consolidation Has Affected the Structure of the 

Memphis Region’s Banks during the 1990s 

The national trend toward banking industry consolidation is occurring in the Memphis Region as well (see 

Table 1, next page). Bank failures have played little role 

in this consolidation. There have been only ten failures 

since the end of 1990, compared to a net decline of 240 

institutions. Consolidation has been driven, instead, by 

mergers and acquisitions. This activity has contributed 

to the decline in the number of small banks and the 

increasing share of assets held by the largest banks. 

CHART 1 

First Quarter 1997 ROA Levels 

Compared to the Same Period 

in 1996 

1 

1.1 

1.2 

1.3 

1.4 

1.5 

AR KY LA MS TN 

% 

Mar-96 

Mar-97 

Source: Bank and Thrift Call Reports Annualized credit card loss rates as a percentage of outstanding credit card balances were highest in instituRegional Outlook	 18 Third Quarter 1997 
Regular Features Regional Banking
 

TABLE 1 

The Number of Insured Institutions in the Memphis 

Region Has Declined 

% CHANGE 

DEC-90 DEC-92 DEC-94 MAR-97 90-97 

LA 278 261 240 208 -25% 

KY 393 367 339 314 -20% 

MS 149 143 128 123 -17% 

TN 302 289 281 261 -14% 

AR 276 277 274 252 -9% 

REGION 1,398 1,337 1,262 1,158 -17% 

U.S. 15,158 13,852 12,603 11,335 -25% 

Source: Bank Structure Data 

Small banks, those with assets below $50 million, have 

seen their ranks thinned by 42 percent, or 226 institutions since the start of 1991. Small institutions held just 

under 4 percent of the Region’s total assets at the end of 

the first quarter of 1997, down from almost 8 percent in 

1990. Conversely, institutions with total assets exceeding $1 billion increased their share of total assets to 43 

percent from 35 percent in 1990. 

The reduction in the number of insured institutions 

would have been much greater if not for the opening of 

67 new institutions during the period. In some communities, merger and acquisition activities appear to have 

stimulated the formation of new banks. Tennessee and 

Kentucky have seen the most new institutions established since the end of 1993, 17 and 12, respectively. 

Louisiana did not have any new institutions open 

between 1991 and 1996, although two new institutions 

opened there during the first quarter of 1997. 

CHART 2A 

Memphis Region Banking 

Company Structure by Total Assets, 

December 1990 

Concurrent with the consolidation trend, structural 

changes also have occurred in the ownership of banks. 

Since 1990, the share of the Region’s bank assets controlled by multibank holding companies has increased 

from 48 percent to 67 percent (see Charts 2A and 2B). 

Consolidation, however, has not reduced the number of 

banking offices. In fact, at the end of the first quarter 

there were 3 percent more banking offices operating in 

the Region than at year-end 1991. All of this increase 

has been in branches owned by multibank holding companies, where the average number of branches increased 

threefold to almost 11 per bank. In contrast, banks operating either under a one-bank holding company or as 

independent banks experienced slight declines in the 

number of offices operated. 

Implications: The trend toward fewer but larger institutions is altering the competitive landscape for insured 

CHART 2B 

Memphis Region Banking
 

Company Structure by Total Assets,
 

March 1997
 

No Holding Company 

Unitary Holding Company 11%

22% 

Multi-Bank 

Holding Company 

67% 

Source: Bank Call Reports & Structure Data 

Regional Outlook 19 Third Quarter 1997 
Regular Features	 Regional Banking
 

institutions. In particular, some small community banks 

are coming under greater competitive pressures from 

larger institutions that are using an increasing number 

of smaller branches, such as those found in many supermarkets in the Region, to reach their retail clientele. 

Some money center and large regional banks also have 

begun recently to compete more aggressively for certain 

lines of business, such as small business loans and various types of consumer loans, traditionally dominated 

by community banks (refer to the second quarter 1997 

Regional Outlook article, “Will Credit Scoring 

Transform the Market for Small Business Lending?”). 

According to a 1997 survey of community bank executives by Grant Thornton, an accounting and management consulting firm, an increasing number of small 

institutions are looking to technology, such as the 

Internet, as a way to remain competitive. There were 84 

banks, or 8 percent of the Region’s total banks, known 

to have Internet sites at the end of May 1997. Many of 

those institutions are community banks, and most of 

them currently offer limited services over the Net. 

While technology such as the Internet may improve 

competitiveness, it also has the potential to greatly complicate internal controls and can be costly when the 

requisite expertise is not readily available within the 

institution. 

A Popular Method of Accounting for Mergers 

May Be Eliminated 

Increased merger activity in the nation, as well as in the 

Region, has increased the importance of merger 

accounting methods in both the regulatory and corporate arenas. Presently, merging companies have the 

option of accounting for the transaction using the pooling of interests (pooling) method or the purchase 

method of accounting. 

Merger Methods Provide Different Advantages: A 

pooling transaction is a combination of the assets and 

liabilities of two or more entities through an exchange 

of common stock. This method allows the merging 

companies to simply combine their assets, liabilities, 

and equity accounts at book value on a line-by-line 

basis. However, eligibility for using the pooling method 

requires adherence to 12 criteria outlined in Accounting 

Principals Board No. 16. The benefits of using the pooling method include the following: 

•	 No goodwill is created, thus avoiding the drag on 

reported earnings that comes from amortizing such 

accounts. 

•	 Assets with significant appreciation are booked at 

historical cost, so taxes are avoided. 

•	 The expensive and frequently complex market valuation of the balance sheet is avoided. 

•	 Regulatory capital ratios are not affected by the need 

to deduct goodwill. 

In comparison, the purchase method accounts for a 

business combination as the acquisition of one company by another. The assets and liabilities of the acquired 

firm are transferred to the acquirer at fair market value. 

Any excess of the purchase price over the fair market 

value of the assets and liabilities acquired is first allocated to identifiable intangibles and then to goodwill. 

Goodwill is not recognized as an asset for regulatory 

capital purposes. Potentially attractive features of the 

purchase method include the following: 

•	 A combination of both stock and cash may be used 

to complete the purchase. 

•	 There is more flexibility in disposing of assets, 

which is often desirable for cost-cutting reasons. 

•	 A recent change to the Call Report lengthened the 

amortization period for goodwill from 15 to 25 

years. 

•	 Stock buyback plans are not restricted by accounting 

requirements. 

Purchase Method of Accounting May Become More 

Popular: Recent action by the Securities and Exchange 

Commission (SEC) and changes being discussed by the 

Financial Accounting Standards Board may result in 

greater use of the purchase method of accounting. With 

Staff Accounting Bulletin No. 96, March 1996, the SEC 

eliminated a loophole used by some merger participants 

applying the pooling method and wanting to execute a 

stock buyback plan. Stock buyback plans have been 

popular as a means of reducing the dilution of earnings 

per share that frequently occurs when additional shares 

are issued to complete a merger. The purchase method 

of accounting does not restrict buyback programs, but 

the pooling method does include some restrictions. It is 

reported that the Financial Accounting Standards Board 

is considering eliminating the use of the pooling 

method to bring the United States in line with international accounting standards. Those standards generally 

allow pooling only when it is impossible to determine 

which company is the acquirer, such as in a merger of 

equals. 

Regional Outlook	 20 Third Quarter 1997 
Regular Features Regional Banking
 

Historically, most mergers in the Memphis Region have 

used the pooling method. Poolings reached a high of 79 

percent of all transactions in 1994 (see Chart 3). 

Beginning in 1994, banking companies in the Memphis 

Region have mirrored the national trend toward purchase-method transactions. This trend has occurred 

despite the fact that many of the mergers involve nonpublicly traded institutions, suggesting that stock buyback programs may not be a motivating factor in the 

accounting method selected. 

The Banking Industry’s Reliance on Automation 

Means the Year 2000 Problem Cannot Be 

Ignored 

Significant concern has been voiced in various media 

over the potential impact of the year 2000 on computer 

systems and other devices containing microprocessors. 

The importance of this issue has been underscored by 

cost estimates to U.S. business for this problem totaling 

in the hundreds of billions of dollars. 

The year 2000 (Y2K) problem 

primarily relates to the fact that 

the year portion of dates in 

many computer systems is represented by just two digits. As a 

result, some systems may interpret the date 01/01/00 as 

January 1, 1900, rather than January 1, 2000. 

Financial institutions may be especially susceptible to 

the Y2K problem because of their heavy use of computer systems to do things such as maintaining deposit and 

CHART 3 

loan records. Like many businesses, financial institutions also rely on a number of devices that contain 

microprocessors, ranging from telephone voice mail 

systems to security and climate control devices. All 

these devices could be affected by Y2K problems. 

The potential risks of the Y2K problem extend beyond 

the direct use of computers by financial institutions. For 

example, loan customers could suffer serious business 

disruptions if electronic inventory and other control systems falter. 

Correcting the problem is a relatively straightforward 

task but involves an enormous amount of time reviewing computer code. Alternatively, the problem may 

require replacing computer software and hardware. 

Expenditures made in modifying software to address 

the Y2K problem must be charged to expense as 

incurred pursuant to a Financial Accounting Standards 

Board Emerging Issues Task Force decision rendered 

June 10, 1996 (Issue No. 96-14). 

Implications: The previously noted survey by Grant 

Thornton found that most community banks consider 

the year 2000 problem a nonissue. According to the survey, only 7 percent of respondents indicated that it is a 

major concern. When asked what steps they have taken 

to fix the problem, 26 percent said they did not have a 

problem. While indeed many institutions may not have 

the problem, prudent bankers will have a plan to thoroughly audit their systems and the systems of their servicers to ensure that they are in fact year 2000 

compliant. 

With Financial Institution Letter 50-97, dated May 9, 

1997, the FDIC announced the issuance of a Federal 

Memphis Region Mergers in the 1990s Are Typically Accounted for Using the 

Pooling Method 

0% 

10% 

20% 

30% 

40% 

50% 

60% 

70% 

80% 

1990 1991 1992 1993 1994 1995 1996 

PURCHASE % OF ALL NUMBERS 

POOLING % OF ALL NUMBERS 

Source: Bank Call Reports 

Regional Outlook 21 Third Quarter 1997 
Regular Features Regional Banking
 

Financial Institutions Examination Council press 

release containing guidance for insured institutions on 

the Y2K problem. The document includes an examination questionnaire and procedures guide that cover the 

following issues: 

• awareness of the problem; 

• assessment of the risk posed by the problem; 

• renovation of affected systems; 

• validation of system changes; and 

• implementation and certification. 

The full text of this document is available on the FDIC’s 

Internet site at www.fdic.gov. Copies may also be 

obtained through the Public Information Center (800­

276-6003). 

Gary L. Beasley, Senior Regional Analyst 

Tracy F. Hall, Division of Supervision 

Wallace D. Peddicord, Division of Supervision 

Regional Outlook 22 Third Quarter 1997 

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