Fill - Free fillable A1q2001 Regional Outlook - Atlanta First Quarter 2001 PDF form

Regional Outlook

FEDERAL DEPOSIT INSURANCE CORPORATION FIRST QUARTER 2001

FDIC

Atlanta

Region

Division of

Insurance

Jack M.W. Phelps,

CFA

Regional Manager

Scott C. Hughes,

Regional Economist

Pamela R. Stallings,

Senior Financial

Analyst

Regional Perspectives

◆ Region Is Home to Financially Stressed Industries—Despite nearly a

decade of economic expansion, growth has not been uniform. Some financially

stressed industries may be more vulnerable to an economic downturn or increasing

global competition. See page 4.

◆ Industries Displaying Higher Relative Risk and Larger Exposures in

the Atlanta Region—In nearly one-fourth of all counties in the Atlanta Region,

the majority of the workforce is employed in financially stressed industries. See

page 5.

◆ Risk and Implications—The ripple effect from layoffs in two or more key

industries could adversely affect income levels and weaken consumer and business

credit quality. See page 9.

By the Atlanta Region Staff

In Focus This Quarter

◆ Credit Problems for U.S. Businesses Continue to Rise—Commercial

loan quality indicators of insured banks have steadily worsened since 1998. Factors

contributing to this deterioration include rising financial leverage in the corporate

sector as well as weaknesses within certain domestic industries. Many market

observers also have attributed the increase in problem commercial loans to a

heightened appetite for risk and relaxed underwriting standards from 1996 to 1999.

The apparent softening in economic conditions in recent months reduces prospects

that business loan quality will improve any time soon. In the meantime, lenders,

analysts, and supervisors continue to pay close attention to U.S. business lending

conditions. See page 12.

◆ Outlook for Three Industries Facing Uncertainty—Industries as

diverse as telecommunications, health care, and textiles have been experiencing

problems, despite the economic expansion that began nine years ago. Although the

sources of their difficulties are quite different, these industries share some common

concerns and challenges. Fierce competition characterizes their operating environ-

ment. Armed with a better grasp of the origins of stress in these industries, we will

have a better basis for understanding the lending risks associated with a changing

policy and economic environment in the years to come. See page 20.

By the Division of Insurance Staff

A Publication of the Division of Insurance

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

Insurance Corporation 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, AS, AZ, CA, 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 Informa-

tion Center for current pricing on bulk orders.

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

more information or to provide comments or suggestions about the Atlanta Region’s Regional

Outlook, please call Jack Phelps at (404) 817-2590 or send an e-mail to jphelps@fdic.gov.

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

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

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

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

the Federal Deposit Insurance Corporation.

Chairman Donna Tanoue

Director, Division of Insurance Arthur J. Murton

Executive Editor George E. French

Writer/Editor Kim E. Lowry

Editors Lynn A. Nejezchleb

Maureen E. Sweeney

Richard A. Brown

Ronald L. Spieker

Publications Manager Teresa J. Franks

Letter from the Executive Editor

To the Reader:

The goal of the Regional Outlook is to provide useful risk-related information to bankers, banking agency staff, and

other interested readers. To do this more effectively, the second quarter 2001 edition will have a new look. We will

publish a single national edition that will provide an overview of economic and banking risks and discussions of these

risks as they relate to insured institutions in each FDIC Region. We will tell the national story and, at the same time,

alert the reader to specific trends and developments at the regional level.

After considering our experience with this new format, we may adopt it permanently for the second and fourth quar-

ters of each year. The first and third quarter editions will continue to feature in-depth coverage of the economy and

banking industry in each Region. Trying new formats will help us find the right balance between regional coverage

of specific topics and analysis of economic and banking issues that cut across regional lines.

After you have read the next edition of the Regional Outlook, we would like to hear from you. Does this new

approach provide a more effective vehicle for reporting on banking and economic trends? What other suggestions do

you have for improving our presentation of risk-related information? Call us with your comments at (877) 275-3342

or (800) 925-4618 (TDD) or e-mail them to lnejezchleb@fdic.gov.

Sincerely,

George E. French

Executive Editor

Atlanta Regional Outlook 3 First Quarter 2001

Regional Perspectives

• Despite nearly a decade of economic expansion, growth has not been uniform. Some financially stressed

industries may be more vulnerable to an economic downturn or increasing global competition.

• The majority of the workforce in nearly one-fourth of all counties in the Atlanta Region is employed in

financially stressed industries.

• The ripple effect from layoffs in two or more key industries could adversely affect income levels and weak-

en consumer and business credit quality.

Region’s Economic and Banking Conditions

Region Is Home

to Financially Stressed Industries

Despite nearly a decade of economic expansion, growth

has not been uniform. Some financially stressed indus-

tries may be more vulnerable to an economic downturn

or increasing global competition. Others may be under-

going a structural transformation that has constrained

growth. Evidence of particular industries coming under

pressure may be reflected by the fact that default rates

on speculative bonds have been increasing. By compar-

ing data supplied by three industry analysis providers—

KMV Corporation, Standard & Poor’s (S&P), and

Morningstar—we identified seven industries that are

important in the Atlanta Region and that could be vul-

nerable in an economic downturn. This article also

examines the importance of these financially stressed

industries to the Region’s economy and highlights the

implications for the banking industry.

Methodologies

To rank industry risk, we needed a quantifiable, or more

objective, method of prioritization, one that would allow

us to make risk comparisons not only intraregionally but

also nationally. One approach to quantifying industry risk

is the use of the KMV Corporation’s expected default fre-

quencies (EDFs

) for publicly traded firms. This

approach was referred to in the In Focus segment of the

Regional Outlook, third quarter 1999. KMV Credit

Monitor

) uses a firm’s equity prices and financial state-

ments to derive its EDF

, which is the probability that

the firm will default within a one-year period. The pri-

mary determinants of a firm’s likelihood of default are

the firm’s asset value, the volatility of the asset value, and

the degree of financial leverage. We then assume that

issues facing publicly traded firms also exist for private-

ly held firms in the same industry segment. This

approach

allows us to use median industry EDFs

as an

indication of an industry’s relative risk in the Atlanta

Region. Other measures can then be used to corroborate

a particular industry’s relative level of risk.

Data from S&P’s Monthly Investment Review (Decem-

ber 2000) and industry stock performance (as of Decem-

ber 12, 2000) from Morningstar were used to develop

comparable industry risk rankings. Specifically, the

median value of S&P’s “Buy” and “Sell” ratings for indi-

vidual companies was calculated. S&P ranks individual

companies from “1” (Sell) to “5” (Buy); those industries

with median values ranging from “1” to “3” were includ-

ed in our measurement of industry stress. Using data

from Morningstar, we ranked industries by market capi-

talization weighted returns over the previous six months.

Those industries with the greatest negative returns were

deemed to be stressed.

KMV Corporation, S&P, and Morningstar data are pre-

sented at the national level, which we assume to represent

the market’s perception of relative industry risk. We used

regional industry employment data provided by WEFA,

Inc., to measure regional exposures. The Atlanta Region

was considered to be experiencing a relatively high expo-

sure to an industry if total industry employment in the

Region is 500,000 or more. A downturn in one of these

large industry sectors could have a significant adverse

effect on the Region’s economy. The relationship between

these measures of industry risk and the Region’s expo-

sure to these industries is shown in Chart 1.

In order of KMV expected default frequency in September 2000:

health care; wholesale trade; restaurants; apparel, footwear, and tex-

tiles; agriculture; construction; and retail. For comparison purposes, a

median industry EDF

value of 0.75 was approximately equivalent to

a BBB rating from S&P.

Atlanta Regional Outlook 4 First Quarter 2001

Regional Perspectives

CHART 1

page). Florida traditionally has been home to a large and

growing retirement community. Health services

Several Atlanta Industries Display Higher Levels of Risk

KMV Median Industry Expected

Default Frequency (%)

*Also identified as a higher-risk industry using Standard & Poor’s and Morningstar

Sources: KMV Corporation (9/30/00), Standard & Poor’s (S&P), Morningstar

Atlanta Region Employment

EDF value of 0.75 equivalent to a BBB S&P rating

500,000

1,000,000

1,500,000 2,000,000

2,500,000

3,000,000 3,500,000

Construction*

Restaurants*

Health Care*Wholesale Trade*

Apparel,

Footwear, &

Textiles*

Agriculture*

Retail*

It is important to note that all industries, regardless of

the exposure in the Atlanta Region, were included in the

industry risk ranking. An industry downturn in a large,

rapidly expanding metropolitan area may have a limited

impact on economic growth; however, the effect could

be more severe in a small, rural economy with few eco-

nomic alternatives.

Industries Displaying Higher Relative Risk

and Larger Exposures in the Atlanta Region

The majority of the workforce in nearly one-fourth of

all counties in the Atlanta Region is employed in the

stressed industries we identified through the use of data

supplied by KMV Corporation, Morningstar, and S&P

(see Map 1).

Rural areas tend to have the highest expo-

sure to these industry concentrations and may therefore

be disproportionately affected should an economic

downturn occur. The following discusses recent trends

and developments in these stressed industries and

examines the role of these industries in the Atlanta

Region’s economy.

Health Care

Lower managed-care payments, a critical nursing short-

age, and federal reimbursement cuts are generating con-

siderable pressure on the medical services industry.

However, industry risk may be more pronounced in

Florida, where nearly 40 percent of all medical services

employment in the Region is located (see Map 2, next

Identified stressed industries include health care; wholesale trade;

restaurants; retail; apparel, footwear, and textiles; agriculture; and

construction.

MAP 1

Employment in Several Atlanta Region Counties

Is Concentrated in Higher-Risk Industries*

* High-risk industries include Wholesale Trade; Construction; Health Care;

Apparel, Footwear, and Textiles; Agriculture; Restaurants; and Retail.

Source: WEFA, Inc., 1999

0 to 20

20 to 35

35 to 50

50 to 95

Employment (%)

Atlanta Regional Outlook 5 First Quarter 2001

Regional Perspectives

employment in the state has nearly doubled in the past 15

years, growing from 296,000 in 1985 to 580,000 in

1999. Miami, Sarasota, Tampa, and Orlando are con-

sidered health care hubs for medical products and ser-

vices.

However, while growth in these markets has escalated in

terms of employment, health maintenance organization

(HMO) losses statewide have been high—$67 million

in 1997 and $183 million in 1999—and enrollment

gains have dwindled to enrollment losses, according to

the Florida Hospital Association HMO Indicators

Report. In 1999 alone, eight of Florida’s HMOs ceased

operation. More recently in October 2000, Florida

Health Choice Incorporated began winding down

operations. Although the health care industry is concen-

trated in Florida, small community hospitals in rural

counties throughout the Atlanta Region are frequently

an area’s largest employer. Layoffs at or closures of these

facilities could have a substantial impact on the local

economy.

The nation’s health care industry has changed signifi-

cantly since the 1980s, when managed health care com-

panies were introduced. In 1980, HMO enrollment in

the nation stood at 4 percent of the population, rising to

13.5 percent in 1990 and 28.6 percent by 1998. How-

ever, managed care growth was much slower in the

Southeast because less experienced companies that

offered HMO coverage often found the HMO market to

be unprofitable.

Rising health care costs, difficulties in

maintaining profits without raising premiums, and the

Balanced Budget Act of 1997 have put pressure on

Florida’s managed care companies. Consolidation in the

industry has increased as managed care organizations

have tried to reduce operating costs and lower fees paid

to doctors and hospitals. While stock returns for HMOs

have been positive over the past five years, this trend

may not continue, as indicated by flat returns for the six

months ending December 12, 2000.

Wholesale Trade

The wholesale trade industry is exceptionally broad.

Identifying a single factor that could heighten industry

Third quarter 2000. “Big Business—Big Transformation,” Econ-

South, Federal Reserve Bank of Atlanta.

December 12, 2000. Morningstar.com, Stock Industries. (Total

Returns %).

Wholesale trade, in general terms, includes businesses that supply

products to “...retailers, merchants, contractors, and/or industrial, insti-

tutional, and commercial users but do not sell in significant amounts

to ultimate household consumers.” U.S. Industry and Trade Outlook,

The McGraw-Hill Companies, 2000, p. 41–1.

MAP 2

Source: WEFA, Inc., 1999

Atlanta Region Health Care Employment

Is Concentrated in Florida

Employment

0 to 2,500

2,500 to 10,000

10,000 to 90,000

risk may be problematic. The industry has been under-

going a period of consolidation in recent years, while

increasing use of the Internet has been promoting

greater price competition. Some subsectors of the

industry, such as wholesale office equipment, experi-

enced deterioration in stock performance over the last

half of 2000. Also, as noted in this quarter’s In Focus

segment, Economy.com reported that distributors of

autos and related equipment, farm products, and lumber

have trailed in revenue growth.

In the Atlanta Region, employment in the industry is

dominated by major urban areas with access to ports,

major airports, and interstate highways. Industry job

growth in 1999, at 2.4 percent, significantly outpaced

the national average. The apparent recent moderation of

economic growth in the Region could have a negative

impact on employment if retailers reduce purchases

from wholesalers.

Atlanta Regional Outlook 6 F

irst Quarter 2001

Regional Perspectives

Retail and Restaurants

The rapid growth in disposable income and population

in many areas of the Atlanta Region during the past

decade has supported increased demand for retailing

and restaurants. Moreover, many metropolitan areas,

such as Atlanta, Orlando, Miami, and Charlotte, have

emerged or are emerging as regional shopping centers

that are dependent on continued growth outside the

local area. However, there has been growing concern

that higher energy costs, a changing interest rate envi-

ronment, weakening consumer confidence, and lower

stock returns could curtail consumer spending and

lower profit margins for retailers. As consumers have

become more price conscious, discount stores have

increased market share at the expense of midtier depart-

ment stores. Strong growth in the number of large retail

establishments also has increased competition.

Restaurant industry performance is a function of food

prices, wages, and growth in disposable income. Food

price appreciation, a factor that affects restaurant costs

nationwide, has been rather benign during the past few

years and has lagged overall inflation. Local labor mar-

ket conditions, however, can significantly affect the per-

formance of restaurants as low jobless rates can foster

wage growth. Unemployment rates have declined in

most Atlanta Region metropolitan areas, and labor

shortages, particularly in lower-wage jobs such as food

service, have been widespread. Fewer employees com-

peting for more jobs has resulted in higher wages and

benefits for employees, leaving employers with the

choice of reducing profits or passing the increases in

overhead on to consumers.

Apparel, Footwear, and Textiles

Employment in the Region’s apparel, footwear, and tex-

tile industries is relatively high and is concentrated in

many of the Region’s rural areas. As a result of

increased competition, particularly in the wake of the

implementation of the North American Free Trade

Agreement in 1994, employment in the Region’s appar-

el and shoe industry shrank by more than half during the

1990s, declining to 110,000 in 1999. While the industry

has declined substantially, it remains critical to the

economies of rural areas of Alabama, Georgia, and the

Carolinas, where it is concentrated, because these areas

may lack economic alternatives.

In addition, industry employment has declined as com-

panies move businesses offshore to take advantage of

lower labor costs or modernize existing plants, which

reduces the need for local labor. Seasonality, which can

be affected by weather, fashion trends, and other unpre-

dictab

le variables, also affects industry performance.

This industry could experience excess plant capacity

because production was geared to meet the demands of

the 77 million baby boomers, who number significantly

more than today’s 45 million Generation X-ers.

The ongoing secular decline in textiles will likely con-

tinue in the Atlanta Region. Until recently, strong

domestic demand provided some stability to the textile

industry; however, signs of weakening are beginning to

emerge. In 1999, the Region employed over one-quarter

million workers in textiles, down from nearly 350,000

just ten years earlier. Most textile employment is con-

centrated in the Carolinas and northwest Georgia (see

Map 3), where much of the nation’s carpet and rug pro-

duction is located. Indeed, over 40 percent of the work-

force in Murray County, Georgia, is employed in the

manufacture of carpets and rugs, the highest concentra-

tion of employment in this industry in the Atlanta

MAP 3

Source: WEFA, Inc., 1999

Apparel, Footwear, and Textile Employment

Is Concentrated in the Carolinas,

Northwest Georgia, and South Florida

Employment

0 to 1,000

1,000 to 5,000

5,000 to 25,000

Atlanta Regional Outlook 7 First Quarter 2001

Regional Perspectives

Region. More than one-fourth of the workforce of

Whitfield County, which is adjacent to Murray Coun-

ty, is employed in this industry. Strong economic growth

and low interest rates over the past few years have

spurred demand for carpets. However, a strong dollar

and increasing overseas competition may constrain

exports and encourage imports, and any slowing in eco-

nomic growth could heighten stress in the industry.

Moreover, increased automation of domestic plants may

lead to further layoffs. Declining stock returns reflect

economic challenges to the textile industry, many of

which are likely to persist.

Agriculture

Agriculture is a vital industry for many rural areas of

the Region (see Map 4) and one that has experienced

declining commodity prices, prolonged drought condi-

tions, and huge lawsuits filed against tobacco compa-

nies. Within the Atlanta Region, the tobacco industry

has been particularly vulnerable to losses from litiga-

tion against manufacturers. North Carolina may be

disproportionately affected, as it is the leading tobacco-

producing state and is home to approximately one-

fourth of all tobacco farms. Rising prices for tobacco

products have resulted from manufacturers passing

along most of the burden from lawsuit settlements to

current smokers. Such price increases are expected to

decrease demand by 25 percent over the next ten years,

compared with the 17 percent current rate of decline.

More than half the total employment in several counties

in Florida, Georgia, and Alabama is concentrated in

agriculture. In fact, more than 80 percent of the employ-

ment in Hendry and Glades counties in Florida is con-

centrated in the production of sugar, making this area

particularly vulnerable to a downturn in the agricultural

sector. U.S. Sugar Corporation, Hendry County’s

largest employer, laid off more than 300 workers in fall

2000, with additional layoffs anticipated. As farmers

transition from growing lower-priced commodities,

such as rice and soybeans, to growing sugar, and

imports from Mexico increase, depressed sugar prices

could create additional stress for the industry. The

nation’s largest sugar company filed for bankruptcy pro-

tection in early 2001, an indication of the financial

stress in the industry.

Moreover, persistent drought con-

Economic Research Service/USDA. September 2000. Tobacco and

the Economy. Agricultural Economic Report, No. 789.

“Imperial Sugar, in Default on Debt, Files for Chapter 11 Protec-

tion.” The Wall Street Journal. Section A, page 12, Column 1.

January 17, 2001.

MAP 4

Total Agriculture Employment Is

Highest in South Florida

Source: WEFA, Inc., 1999

Employment

0 to 1,500

1,500 to 5,000

5,000 to 45,000

ditions continue to hamper recovery of farmers not only

in the sugar industry but in other farm commodities as

well.

Construction

Nearly a decade of economic growth has stimulated

demand for residential and commercial construction

activity, particularly in fast-growing metropolitan areas,

as well as for the production of manufactured housing.

As the expansion has continued, however, the potential

for overbuilding exists in some areas.

Commercial construction in the volatile high-tech sec-

tor is an example. Given the strong presence of the

high-tech sector in the Atlanta Region, consolidation in

this industry could slow demand for commercial and

residential properties, adversely affecting absorption

rates. Virginia’s share of employment in the high-tech

sector is also relatively high, particularly in the North-

ern Virginia corridor. Although high-tech industry

growth has been a key driver of the current economic

Atlanta Regional Outlook 8 F

irst Quarter 2001

Regional Perspectives

expansion, the demise of many dot-coms and recent

volatility in the NASDAQ suggest that vulnerabilities

are emerging. Technologies could change, industry

growth could slow, and increasing competition could

diminish market share. Moreover, many of these high-

tech enterprises are not recession-tested, and setbacks in

this sector likely would be felt throughout the local

economy. Already, landlords are increasingly cautious

about leasing to high-tech companies that have no track

record, or profits, to indicate stability. See Regional

Outlook, first quarter 2000, for greater detail on this

topic.

Residential construction activity in the Atlanta Region

is moderating in many areas. In the Atlanta metropoli-

tan area, for example, single-family permit issuance,

though remaining near historical highs, has slipped

from year-ago levels. Moderation in homebuilding has

had a significant effect on construction employment

growth. In 1999, year-over-year construction employ-

ment growth was in the double digits, but it has since

declined substantially. Moderating residential construc-

tion activity has contributed to lower growth throughout

the Region’s economy.

Manufactured housing production is heavily concentrat-

ed in the Atlanta Region. The Region accounted for one-

third of the industry’s national employment in this

construction subsector, and employment has grown

nearly 8 percent annually over the past five years,

according to WEFA, Inc. However, excess capacity and

an increasing number of dealer failures have contributed

to the closing of some facilities and stress in the industry,

according to a recent quarterly report from Cavalier

Homes, Inc.

Widespread availability of credit in recent

years also has led to an increase in repossessions, which

adds to inventories. Many manufacturing plants in the

Region are major employers in rural areas. Further weak-

ening of market conditions or any decline in demand

stemming from an economic downturn could adversely

affect the surrounding economy.

Other Regional Considerations

In addition to the above, certain stressed industries (e.g.,

the North Carolina-based furniture and appliances indus-

tries) are disproportionately represented in the Region.

November 13, 2000. Quarterly Report (SEC form 10-Q), Cavalier

Homes, Inc.

These industries represent the two ends of a product

pipeline—production and distribution. North Carolina is

home to half the Atlanta Region’s employment in the fur-

niture and appliances industries, nearly 80,000 jobs.

According to www.NCFurnitureONLINE.com, over 60

percent of the furniture manufactured in the United

States is made within a 200-mile radius of central North

Carolina. Favorable interest rates over the past few

years, strong housing activity, and high consumer con-

fidence have heightened consumer demand for home

furnishings. Further, the “wealth effect” has encouraged

purchases of big-ticket items, and homebuying has been

at or near record levels during the long-running eco-

nomic expansion. However, higher interest rates or a

slowdown in homebuying could curtail demand for big-

ticket items and negatively affect this industry. Since the

beginning of 2000, the 12-month moving average of

new and existing home sales has been trending down-

ward, and growth in furniture and household equipment

spending has declined slightly. By late 2000, slowing

economic growth prompted some manufacturers to lay

off employees. Weaker demand could adversely affect

not only manufacturers of furniture and appliances but

consumer retailers and wholesalers as well.

Problems in the pulp and paper industry could dispro-

portionately affect the Atlanta Region because of the

industry’s significant presence. Although in continuous

decline since 1989, the industry still employed more

than 125,000 workers in the Region in 1999, according

to WEFA, Inc., estimates. The highest employment con-

centrations are in Georgia, with 33,646 employees;

North Carolina, with 23,644 employees; and Alabama,

with 20,020 employees. In 1996, 24 percent, or $178.9

million, of Alabama’s paper product exports and 13 per-

cent, or $228.7 million, of Georgia’s paper product

exports were shipped to Asia. While these states have

the greatest global exposure, the paper and pulp indus-

try has a presence, albeit more limited, in other states in

the Region, and as a result, these states have some

degree of domestic exposure.

Risk and Implications

A recent nationwide study by the Goldman Sachs

Group Inc.

identifies the theater, drug-store,

consumer-product, asbestos, health care, and textile

Mollenkamp, Carrick. December 29, 2000. “Wall Street Tries to

Spot Which Loans and Banks May Face Problems Soon.” Wall Street

Journal. Section A, page 2, Column 5.

Atlanta Regional Outlook 9 First Quarter 2001

Regional Perspectives

industries as areas of the economy in which debt prob-

lems have emerged. Salomon Smith Barney (SSB)

estimated that loan defaults in these industries would

reach $33 billion during 2001, up from $23 billion in

2000.

On a regional level, the Atlanta Region’s banking indus-

try could be indirectly and directly affected by further

Madan, Horowitz, O’Conner, and Yoo. January 9, 2001. “Getting

Our Arms Around the Credit Issue.” Salomon Smith Barney.

stress in the industries identified in this article. Indi-

rectly, layoffs could result from deteriorating conditions

in markets served by stressed industries. This could neg-

atively affect consumers’ ability to meet debt obliga-

tions and ultimately affect credit quality. Insured

financial institutions also could experience a decline in

asset quality if industries have difficulty meeting finan-

cial obligations.

The Atlanta Region Staff

Atlanta Regional Outlook 10 First Quarter 2001

In Focus This Quarter

Credit Problems for U.S. Businesses

Continue to Increase

• Commercial credit quality trends have been slip-

ping since 1998, despite generally favorable U.S.

business conditions.

• The recent economic slowdown, coupled with

tighter credit conditions, points to continued dete-

rioration in business credit quality over the com-

ing months.

• Trends in bond defaults, syndicated lending, cor-

porate profitability, and expected default levels

reveal a number of industry sectors that pose a

heightened degree of risk to lenders.

Introduction

Continuing increases in problem commercial loans have

focused the spotlight on business lending conditions.

On September 30, 2000, commercial banks reported the

highest relative level of noncurrent

commercial

loans—at 1.52 percent of total commercial loans—

since third quarter 1994. In fact, commercial banks have

been reporting steadily higher rates of noncurrent

domestic commercial loans since the second quarter of

1999. The first quarter 2000 edition of Regional Out-

look identified several factors contributing to the

decline in business credit quality despite the strong eco-

nomic indicators then in place. These factors, which are

still relevant today, include the rise in financial leverage

for domestic corporations, greater investment risk

appetite and looser underwriting standards from 1996 to

1999, and increasing financial stress within various

industry sectors. More recently, an apparent slowdown

in economic growth increases prospects for further

deterioration in business credit conditions.

Large Banks Experience a Reversal

in Commercial Credit Quality Trends

Through much of the 1990s, a sustained period of eco-

nomic growth produced improving commercial loan

credit quality indicators for insured commercial banks.

This trend reversed itself in 1998, when banks began

Nonaccrual loans plus loans 90 days or more delinquent.

experiencing a steady rise in nonperforming and delin-

quent commercial loans. While the initial catalyst for

this reversal was related mainly to events abroad,

slowing domestic economy has since taken center stage

as the underlying driving force behind worsening com-

mercial credit quality trends.

As of September 30, 2000, noncurrent commercial and

industrial (C&I) loans held by commercial banks stood

at $15.6 billion, a 46 percent increase over the previous

year. Roughly 97 percent of this increase is attributable

to the rise in nonaccrual and delinquent credit to U.S.

domiciled borrowers. Net C&I loan loss rates are also

rising. Through the first three quarters of 2000, annual-

ized C&I loan loss rates reached 0.64 percent, up from

0.58 percent in 1999. The last time banks saw C&I loss

rates this high was in 1993 (0.74 percent).

Larger banks, which have the greatest exposures to

large- and middle-market corporate credits, have been

hardest hit by the turnaround in business credit condi-

tions. As shown in Chart 1, banks with over $1 billion

in assets have experienced most of the recent deteriora-

tion in C&I noncurrent loan rates. Since the fourth

quarter of 1997, the noncurrent C&I loan rate of large

CHART 1

Noncurrent Loan Rates

Are Rising at Larger Banks

Percentage of C&I loans on nonaccrual

and 90 days or more past-due

5.2

4.8

4.4

4.0

3.6

3.2

2.8

2.4

2.0

1.6

1.2

0.8

0.4

1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q

Small Banks

(< $1 billion in assets)

Large Banks

(> $1 billion in assets)

’88 ’90 ’91 ’92 ’93 ’95 ’96 ’97 ’98 ’00

Source: Bank Call Reports

Significant events that contributed to higher levels of problem for-

eign loans in 1998 include the collapse of Asian currency exchange

rates and default by the Russian government on its sovereign debts.

Some domestic industries that were highly dependent on exports

(steel, for example) were also adversely affected by these events.

Atlanta Regional Outlook 12 First Quarter 2001

In Focus This Quarter

banks has increased from 0.74 percent to 1.50 percent.

Over the same period, noncurrent C&I loan rates at

small banks were unchanged at 1.64 percent. While the

increase in noncurrent loan rates at larger banks is sig-

nificant, these higher rates remain well below those that

preceded the 1990 to 1991 recession, when noncurrent

loan rates at large banks were in the 3.40 percent to 3.60

percent range.

Much of the recent deterioration in banks’ business

credit quality is attributable to the seasoning of credits

underwritten during a period of relaxed lending stan-

dards. Each of the three bank supervisory agencies has

recognized and warned about the potential impact of

loosened loan underwriting standards in the event of a

slowdown in the economy. For example, just over a year

ago, the Office of the Comptroller of the Currency

(OCC) issued a warning to banks about the “...cumula-

tive effect of the past four years of easing standards...”

for commercial loans.

The shift toward more liberal

credit standards from 1996 to 1999 was fueled by vari-

ous factors, including a robust economy, intense com-

petition to originate syndicated credits, and an increased

appetite for risk. During this period, a number of banks

moved aggressively into non-investment-grade lending to

combat narrowing interest margins and declining invest-

ment-grade yields. According to a recent Standard &

Poor’s commentary, several banks have acknowledged

the role of 1997 and 1998 vintage credits in producing

higher levels of problem loans.

Business Loan Performance Is Not Likely

to Improve Any Time Soon

Prospects for any near-term reversal in deteriorating

commercial loan trends are dimming as signs of slower

economic growth and tighter credit conditions emerge.

Economic indicators suggest an aging economic expan-

sion that is losing momentum. In third quarter 2000, the

U.S. economy recorded its 39th consecutive quarter of

growth. However, real gross domestic product growth

for the third quarter was only 2.2 percent, well below

the previous quarter’s growth of 5.6 percent and below

the 4.9 percent average quarterly growth rate during the

past eight quarters. Corporate earnings also appear to be

slowing. Annualized corporate profit growth in the third

Office of the Comptroller of the Currency Press Release. October 5,

1999.

July 20, 2000. “U.S. Bank Loan Portfolios Reflect Rise in Corporate

Bond Defaults.” Standard & Poor’s Commentary.

quarter slowed to 5.1 percent, down from a 15.6 percent

annualized growth rate in second quarter 2000 and a

10.4 percent average growth rate over the past eight

quarters.

Corporate earnings are widely anticipated to

slow even further based on the number of companies

that have warned of profits falling below expectations

in the fourth quarter.

Prospects for slower economic growth prompted the

Federal Reserve to lower its target for the federal funds

rate (the rate charged on overnight lending) by 1/2 per-

centage point to 6 percent on January 3, 2000. This cut

follows a 175-basis-point increase in the targeted feder-

al funds rate since the end of June 1999. Although high-

er interest rates have undoubtedly raised borrowing

costs for U.S. corporations, business borrowing rates—

even before the Federal Reserve cut interest rates in Jan-

uary 2001—are well below those prevalent during much

of the 1980s (see Chart 2, next page). Moreover,

changes in rates have been far less volatile in the latter

part of the 1990s than they were during the 1980s and

early 1990s.

Tolerance for risk on the part of investors and lenders is

waning. In a November 2000 survey of underwriting

practices, the Federal Reserve Board noted that 44 per-

cent of U.S. banks tightened credit terms for large- and

middle-market borrowers in the past three months, the

highest incidence of tightening since fourth quarter

1990. This tightening of credit terms is primarily in

response to economic concerns, industry-specific prob-

lems, and a lower tolerance for risk. Banks appear to be

especially apprehensive about taking on additional

credit risk related to merger and acquisition financing

deals, new borrowing prospects, and specific industry

segments such as health care, movie theaters, and com-

munications.

Tighter credit terms by banks will have the greatest

impact on high-risk companies, which have fewer

financing options in an environment of slumping bond

and stock prices. Moreover, there appears to be a sig-

nificant increase in the volume of maturing debt that

could be forced into default if capital market or bank

These figures are taken from the U.S. Department of Commerce’s

statistics on corporate profits with inventory valuation adjustments.

According to First Call/Thomson Financial, 505 companies released

warnings that fourth quarter 2000 earnings would fall below expecta-

tions, up 96 percent from the 257 companies with negative profit

warnings for fourth quarter 1999.

See the Federal Reserve Board’s November 2000 Senior Loan Offi-

cer Opinion Survey on Bank Lending Practices.

Atlanta Regional Outlook 13 First Quarter 2001

In Focus This Quarter

CHART 2

Business Borrowing Rates Have Risen but Are Less Volatile than in Past Cycles

Percent

1Q82 3Q83 1Q85 3Q86 1Q88 3Q89 1Q91 3Q92 1Q94 3Q95 1Q97 3Q98 1Q00

Note: LIBOR = London Interbank Offer Rate

Sources: Federal Reserve Board, Moody's, FT London Interbank

3-Month LIBOR

Moody’s Baa Average Yield

Prime Rate

funding is not available. According to Moody’s, some

$108 billion of rated speculative-grade corporate debt

held by banks matures over the next three years, a 40

percent increase over year-earlier levels.

Higher-risk companies also have a lower capacity to

absorb the cost of higher interest rates. Yet many com-

panies with debt maturing in the near term will likely be

forced to pay higher risk premiums than in the past. For

example, Moody’s notes that in November 2000, specu-

lative-grade bond yield spreads over seven-year Trea-

suries reached their widest level since February 1991, at

771 basis points.

Chart 3 illustrates further how credit

spreads between just-investment-grade bond issues and

near-investment-grade bond issues have widened con-

siderably compared with spreads between lower-invest-

ment-grade bond issues since the beginning of 2000.

Some of the most significant increases in credit spreads

have been observed in the high-yield telecommunica-

tions sector, where credit spreads over seven-year Trea-

suries widened by 688 basis points in 2000.

The effects of tighter credit conditions and a reduced

appetite for risk are beginning to emerge in loan origi-

nation volumes. According to Loan Pricing Corpora-

tion, originations of highly leveraged loans

through

December 2000. Moody’s Leveraged Finance Commentary.

Merrill Lynch Global Bond composites. Issues facing the telecom-

munications industry are explored further in the article entitled

“Three Industries Navigating in a Competitively Charged Environ-

ment” in this issue of the Regional Outlook.

Loan Pricing Corporation defines highly leveraged loan transac-

tions as those carrying interest rates of 250 basis points or more over

the London Interbank Offer Rate (LIBOR).

the first three quarters of 2000 fell to $117 billion from

$140 billion for the same period in 1999.

Corporate bond trends provide further evidence of

financial stress in the domestic market and suggest

more near-term deterioration in problem business

loans. Corporate bond default rates have climbed sig-

nificantly since 1997 (see Chart 4). Through Novem-

ber 2000, trailing 12-month default rates on

speculative-grade corporate bonds reached 6.8 per-

cent, up from 3.5 percent at the end of 1998. Higher

default rates have been accompanied by an accelerated

pace of negative ratings revisions, which, according to

Moody’s, reached a rate of 3.2 speculative-grade

downgrades for every speculative-grade upgrade

through the first 11 months of 2000.

More signifi-

CHART 3

Credit Risk Premiums for High-Yield

Bond Issues Have Increased Sharply

Basis Point Yield Spread Between

220

200

180

160

140

120

100

A-rated and

BBB-rated bonds

BBB-rated and

BB-rated bonds

Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov

’99 ’99 ’99 ’99 ’99 ’99 ’00 ’00 ’00 ’00 ’00 ’00

Source: Merrill Lynch

See Moody’s Credit Perspectives, December 4, 2000.

Atlanta Regional Outlook 14 First Quarter 2001

In Focus This Quarter

cant, Moody’s projects that speculative-grade corpo-

rate bond defaults will continue to move higher to 9.1

percent over the coming year. Given a fairly strong

correlation between speculative bond default rates and

banks’ noncurrent loan rates, these projections suggest

a continuing rise in the relative level of problem com-

mercial loans.

Loan Default Risk Is Rising

in a Number of Industry Sectors

Evidence from Corporate Bond Defaults

Corporate bond defaults provide clues as to which

industries may experience a higher rate of defaults.

Chart 4 shows the historical trend in speculative-grade

bond defaults since 1988. The initial upward spike in

default rates in 1998 was largely the result of events

abroad, when 74, or 59 percent, of 126 defaulted issues

were attributed to foreign-domiciled issues.

In 1999,

the distribution of defaults shifted decidedly toward

domestic issues, with U.S. firms accounting for 99, or

67 percent, of 147 defaults. Of the U.S.-domiciled

defaults in 1999, 64 percent were related to industrial

CHART 4

sectors, with concentrations in price-sensitive commod-

ity and trade-dependent sectors such as oil and gas,

shipping, and steel. Other domestic sectors that experi-

enced a noteworthy rise in defaulted issues in 1999 were

telecommunications and health care. Year-to-date 2000

defaults continue to be dominated by U.S. firms.

According to Moody’s, year-to-date defaulted bond

issues have been concentrated in health care; telecom-

munications; and textiles, leather, and apparel.

Evidence from Syndicated Loan Trends

Past growth in syndicated loans may be another indica-

tor of default risk. Many lenders appeared to increase

their appetite for risk from 1996 through 1999, judging

by the growth in leveraged loan and highly leveraged

loan volumes during this period (see Chart 5, next

page).

Because rapid loan growth can be an indicator

of aggressive risk taking, it is important to review some

significant borrowing industries that experienced rapid

credit growth from 1996 to 2000. It is also worthwhile

to review industries where higher-risk (high-yield) bor-

rowing accounted for a substantial proportion of syndi-

cated loan transactions.

Pace of Speculative Bond Defaults Expected to Rise Significantly

Bond Rating Downgrades to Upgrades (right axis)

Trailing 12-Month Speculative-Grade Bond Default Rate

Bank C&I Noncurrent Rate

Projected

Default and Noncurrent Loan Rate (%) Bond Downgrades to Upgrades

’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 3Q’00 3Q’01

YTD*

* Bond default rates through November 30, 2000

Sources: Moody’s, Call Reports

There is a strong correlation between historical speculative-grade corporate bond defaults and noncurrent loan rates. The correlation coefficient

between these two variables for the period 1984 to the present is 0.67.

Indonesia alone accounted for 32 defaulted issues in 1998, and sovereign issuers accounted for 36 percent of defaulted debt volume. Historical

Default Rates of Corporate Bond Issuers, 1998. Moody’s Investor Service.

Historical Default Rates of Corporate Bond Issuers, 1999. Moody’s Investor Service.

Moody’s Credit Perspectives, December 11, 2000. Issues facing the health care and textile industries are explored further in the article entitled

“Three Industries Navigating in a Competitively Charged Environment” in this issue of the Regional Outlook.

Loan Pricing Corporation defines leveraged transactions as those that carry interest rate spreads of 150 basis points or more over LIBOR and

highly leveraged transactions as those that carry spreads of 250 basis points or more over LIBOR. Because these definitions are spread-driven, the

rise in the proportion of higher-yield issuance is attributable in part to a general increase in credit spreads. This was the case particularly during

the 1998 period, when credit spreads rose significantly.

Atlanta Regional Outlook 15 First Quarter 2001

In Focus This Quarter

CHART 5

Source: Loan Pricing Corporation

High-Yield Loan Syndications More

Prevalent from 1996 through 1999

Leverage Lending to Total

Syndicated Lending (%)

Syndicated Loan

Originations ($ billions)

High-Yield Leverage Lending

to Total Syndicated

Lending (left scale)

200

400

600

800

1,000

1,200

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

Table 1 lists selected industries

that accounted for a

significant proportion of syndicated loan volumes from

1996 to 2000, according to Thomson Financial Securi-

ties Data. Industries that experienced some of the most

rapid growth rates in syndicated loan volumes during

that time include utilities, telecommunications, and real

estate investment trusts (REITs). Industries that record-

ed a particularly significant proportion of high-yield

TABLE 1

transactions during that period include real estate and

construction, REITs, health care, and entertainment/

lodging/leisure.

Evidence from Corporate Profit Trends

Industry sector earnings trends may also be an indicator

of industry default risk, because higher defaults are

more likely in sectors with weak earnings. As noted

above, profit growth rates of domestic firms appear to

be decelerating following two years of strong earnings

growth overall. Rapid growth in previous quarters

appears to have been driven in large part by high-tech

and related sectors, such as electronic equipment and

communications. These sectors have to a large extent

overshadowed noteworthy declines in profit growth in

other sectors, such as metals, chemical production,

medical services, property casualty insurance, apparel

and textiles, manufactured housing, agriculture, trans-

portation, and wholesale trade (see Table 2).

Evidence from Credit Risk Models

Credit default models have proliferated in recent years

because of advances in technology, data availability, and

financial theory. One such model is KMV LLC’s Cred-

Historical U.S. Syndicated Loan Trends

Help Identify Possible Sources of Industry Credit Risks

1996

TO 2000

HARE OF AVG. ANNUAL 2000

1996

TO 2000 ISSUANCE ISSUANCE HY AS A %

ISSUANCE GROWTH GROWTH 1996 TO 2000

INDUSTRY (%) (%) (%) ISSUANCE

WHOLESALE AND RETAIL TRADE 7.8 –2 –12 34

LECTRIC, GAS AND SANITARY

UTILITIES 6.5 34 15 19

ELECOMMUNICATIONS 5.4 28 54 29

ONDEPOSITORY INVESTMENT

COMPANIES 5.2 19 24 33

IL AND GAS 4.1 23 83 18

ECURITIES BROKERS/DEALERS 3.7 15 13 4

NTERTAINMENT/LEISURE/LODGING 3.3 5 31 42

EAL ESTATE INVESTMENT TRUST 2.7 27 25 49

EALTH CARE 2.6 –4 –41 44

EAL ESTATE AND CONSTRUCTION 2.5 25 46 50

Note: HY (high-yield) issuance includes deals priced at 125 basis points or more over LIBOR.

Source: Thomson Financial Securities Data

This list is taken from a group of 50 sectors defined using Standard Industrial Codes (SICs). Only industries that accounted for more than 2 per-

cent of 1996 to 2000 origination volumes were considered for inclusion.

Atlanta Regional Outlook 16 First Quarter 2001

In Focus This Quarter

it Monitor

. This model, which uses publicly available

information to estimate the likelihood of default for

individual firms, is widely used by lenders to monitor

and evaluate obligor risk and credit risk trends. While it

is not the only model available, the KMV model can be

applied consistently and easily to the analysis of indus-

try sector credit risk across a broad range of industry

groupings.

In brief, the KMV model uses options-pricing theory to

derive market-based expected default probabilities or

an expected default frequency (EDF

The model

relies mainly on three pieces of information: (1) a

firm’s asset market value; (2) the volatility of a firm’s

asset market values; and (3) the firm’s capital structure

or financial leverage. Although EDF

scores are com-

pany-specific, median industry expected default prob-

TABLE 2

abilities can be constructed and compared across

industries and across time to discern relative rankings

of industry risk and industry risk trends. These median

EDF

scores also can be mapped to other default mea-

surement scales, such as external rating agency ratings,

based on individual EDF

scores of firms with rated

debt.

Since the second quarter of 1998, median EDF

scores

have risen significantly across a wide range of U.S. non-

financial industry sectors (see Chart 6, next page). The

service and trade sector includes the greatest proportion

of firms with high default risk. The median probability

of default for the manufacturing sector firms is lower,

but it is rising and roughly equaled that of Standard &

Poor’s BB-grade (sub-investment-grade) obligors as of

December 2000.

Various Industries Have Exhibited Negative Profitability Trends

NNUAL GROWTH IN NET INCOME

1998 1996 TO 1999 1994 TO 1999

INDUSTRY TO 1999 (%) AVERAGE (%) AVERAGE (%)

STEEL –1,237.9 –428.6 –187.4

OPPER –80.7 –65.5 13.2

NTERNET –43.2 –42.7 –35.5

IRES AND RUBBER –81.9 –28.6 –12.7

LUMINUM –13.2 –13.9 156.4

HEMICALS –38.1 –3.9 18.4

EDICAL SERVICES AND

INFORMATION SYSTEMS –48.2 –2.5 44.8

ROPERTY CASUALTY INSURANCE –3.9 –2.0 3.8

ECREATIONAL GOODS AND SERVICES .5 2.5 17.1

PPAREL AND TEXTILES 2.5 10.4 3.3

ANUFACTURED HOUSING AND

RECREATIONAL VEHICLES –9.8 11.7 27.3

GRICULTURE –1.3 12.3 4.6

HOLESALE TRADE –8.8 13.7 13.7

EMENT AND AGGREGATES 1.2 21.6 60.5

ILFIELD SERVICES AND PRODUCTION –373.7 39.9 19.3

IRLINES AND FREIGHT –13.2 1,085.5 666.5

LL CORPORATE PROFITS (WITH

INVENTORY VALUATION AND CAPITAL

CONSUMPTION ADJ.) 5.0 4.4 13.6

Sources: Economy.com Precis Reports; U.S. Department of Commerce, Survey of Business Conditions

Typically expressed as the probability of default over the coming year.

Atlanta Regional Outlook 17 First Quarter 2001

In Focus This Quarter

Although no one factor can explain the rise in expected

CHART 6

default measures for U.S. nonfinancial firms, rising

financial leverage is clearly a major determinant. U.S.

corporate debt burdens continue to rise in conjunction

with the longest-running economic expansion in U.S.

history. The debt-to-net-worth ratio (book value) of

nonfarm, nonfinancial businesses rose to 83 percent in

the second quarter of 2000, up from 72 percent at year-

end 1996. Although these figures remain below the rel-

ative debt levels experienced in the late 1980s and early

1990s,

U.S. businesses are nevertheless becoming

increasingly vulnerable to rising credit costs and dis-

ruptions in credit availability. Higher asset value volatil-

ity

has also played a role in rising EDF

scores,

which, as in any options-based credit risk model, leads

to a greater likelihood of default.

Default Risk Is Rising Broadly

among U.S. Nonfinancial Firms

’00

’96

’97

’99

’98

’99

’00

’97

’98

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

Service & Trade

Manufacturing

One-Year EDF™ in Percent

Comparative Median EDF™

of S&P Bonds Rated BB

(as of December 2000)

Chart 7 shows eight of the highest-risk industries in

terms of changes in median EDF

scores over the past

two years. These industries were drawn from a list of 50

financial and nonfinancial sectors segregated by Stan-

dard Industrial Codes (SICs). For each of these 50 sec-

tors, median EDF

scores were determined for

December 2000 and compared with median EDF

scores for the same sector in December 1998. Consis-

tent with general industry observations, entertainment

and leisure, health care, and telecommunications are

among the sectors where default risk has risen most sig-

nificantly over the past two years.

CHART 7

While Chart 7 illustrates sectors undergoing financial

stress, it does not provide information on the relative

importance of these sectors to lenders. Thomson

Financial Securities Data provides information on the

volumes of syndicated loan originations by banks and

nonbanks. Matching industry-expected default trends

with syndicated loan origination trends by industry is

one way to determine the relative importance of higher-

risk industry credit exposures.

Chart 8 shows median EDF

and syndicated loan orig-

ination pairs for selected industries during the past three

Industries That Experienced the Greatest Increase

in Expected Default Risk over the Past Two Years

Median Expected Default

Frequency (EDF™) in Percent

December 1998

December 2000

Comparative Median EDF™

of S&P Bonds Rated BB

(as of December 2000)

Entertainment Health Wholesale Apparel Business Agriculture Telecom Retail

& Leisure Care Trade & Textile Services

The debt-to-net worth ratio for U.S. nonfarm, nonfinancial businesses averaged slightly under 87 percent from 1988 to 1992.

Implicit in changes in stock prices.

Syndicated loan originations are an imperfect measure of actual loan exposures in the financial industry. For example, it is not possible to deter-

mine the level of outstanding exposures simply by summing up origination levels from year to year, because payments on long-term debt are not

considered. Moreover, a substantial volume of debt represents revolving lines of credit where credit exposures roll over on a periodic basis. Nev-

ertheless, trends in originations do contain some information on the relative level of industry exposures, because they show which industries are

borrowing more or less during any given year.

Atlanta Regional Outlook 18 First Quarter 2001

In Focus This Quarter

years. Of the industries shown, the telecommunications

industry appears to present the greatest degree of risk,

given a nearly $50 billion increase in loan volumes from

1998 to 2000, coupled with a 170 percent increase in

median expected default levels over the same period. In

contrast, loans to securities brokers and dealers can be

considered relatively less risky—despite a $17 billion

rise in originations from 1998 to 2000—because of a

fairly modest rise in median expected defaults. It is also

interesting to contrast the health care and entertainment

and leisure sectors. Firms in both sectors have experi-

enced a dramatic rise in expected defaults. However,

since 1998, Thomson Financial Securities Data shows a

significant curtailment in lending to health care compa-

nies, while entertainment and leisure originations have

held steady over the same period. Because banks appear

to be reducing credit exposures to health care firms,

banks should eventually see a decline in the level of

defaulting debt related to this sector.

Chart 8 illustrates how U.S. syndicated loan issuance

and expected default measures can be linked to produce

a better sense of risk-weighted industry exposure vol-

umes held by lenders. On the basis of this type of analy-

sis, producing a list of industry sectors that appear to

pose the greatest degree of syndicated loan default risk

is relatively straightforward. Perhaps not surprisingly,

industries such as telecommunications, wholesale and

retail trade, entertainment and leisure, health care, and

apparel and textiles rank high in terms of risk-weighted

industry credit exposures using this analysis.

Conclusion

Many U.S. banks are experiencing deterioration in busi-

ness loan quality measures. The adverse effects of high-

er interest rates, a tightening of credit terms, slowing

profit growth, and industry sector weaknesses are the

primary contributing factors to this deterioration. Sev-

eral indicators—including a projected increase in cor-

porate bond default rates, rising expected default trends

in certain industry sectors, and evidence of lax under-

writing practices in previous periods—suggest that

banks could experience substantial further deterioration

in business loan quality in the near term.

Although worsening business loan quality is a con-

cern, these negative trends must be put into perspec-

tive. In relative terms, current indicators of business

loan problems do not approach the experience of

banks during the last economic downturn of the early

1990s. Moreover, continued strong earnings and capi-

tal provide a significant buffer for banks to weather

the effects of higher levels of nonperforming business

loans and business loan losses. Nevertheless, the

prospect of a slowdown in the economy raises con-

cerns about the possible severity of commercial loan

problems, a situation that will undoubtedly be watched

closely by both banks and bank supervisors in the

coming months.

Steven Burton, Senior Banking Analyst

CHART 8

Median EDF™ in Percent

Expected Default Data Can Be Used to Risk-Weight Industry Credit Risk

Health Care

Syndicated Loan Originations by Industry Sector ($ Billions)

Entertainment & Leisure

Wholesale Distributors

Telecommunications

Securities Brokers & Dealers

0 20 40 60 80 100

2000

1999

1998

Legend:

2000 Originations and Dec. ’00 EDF™

1999 Originations and Dec. ’99 EDF™

1998 Originations and Dec. ’98 EDF™

Fifty sectors, grouped by SIC codes, were considered.

Atlanta Regional Outlook 19 First Quarter 2001

In Focus This Quarter

Three Industries Navigating

in a Competitively Charged Environment

The rising tide of a booming economy in the United

States has lifted the boats of a broad spectrum of indus-

tries over the past nine years. Some industries, however,

have fallen on hard times despite continued economic

expansion. These industries represent a broad cross-

section of the economy. Problems in these industries were

precipitated by diverse factors, reflecting the differences

among sectors in industries ranging from old economy

(such as textiles) to services (such as health care) to those

on the horizon (such as telecommunications).

These industries will navigate in turbulent waters over

the next few years. All three face an uncertain econom-

ic outlook, changing public policies that can influence

their operating environment, and fierce competition.

The importance of these industries to the U.S. economy

varies based on employment. The telecommunications

industry accounts for about 1.4 million jobs, or 0.85

percent of total U.S. employment.

Health care, on the

other hand, contributes over 11 million jobs, or 7 per-

cent of total employment. Textile industry employment

has been falling steadily for many years and is now

under 550,000, accounting for less than 0.40 percent of

total U.S. employment.

As diverse as these industries are, a common denomi-

nator exists. Intense competition characterizes their

operating environment, leaving little room for strategic

missteps. Indeed, there have been reports that these

industries have been significant contributors to the

recent rise in problem bank loans.

With a better grasp of the origins of stress in these

industries comes a basis for understanding the lending

risks associated with a changing policy and economic

environment in the years to come. The following dis-

cussion describes trends and developments contributing

to stress in these industries and looks at the near- and

long-term outlook. Our discussion also looks at the

implications for the insured institutions lending to the

telecommunications, health care, and textiles industries.

Source: Economy.com. Includes employment in telecommunications

services, telecommunications equipment manufacturing, and cable

television.

Telecommunications

The telecommunications sector consists of several

industry subsectors, including telecommunications ser-

vices, cable television, and telecommunications equip-

ment, all of which are facing significant challenges.

Telecommunications Services

Rapid growth in the telecommunications services

industry has been fueled by strong domestic consumer

demand. However, the pace of consumption of telecom-

munications services has slowed in recent months. This

sector has experienced booming growth in revenues

from computer network access since 1998, while local

and long distance revenues have grown at a much more

moderate pace (see Chart 1).

Rapid change and intense competition characterize the

industry environment. Long distance businesses, in par-

ticular, have experienced fierce competition, resulting

in severe pricing pressures. Competitors include both

established and new wireline long distance providers, as

well as wireless services. Local telephone companies,

however, have fared well in recent years, as residences

and small businesses have added phone lines to accom-

modate the growing demand for Internet access. How-

ever, as high-speed DSL and cable Internet access

become more readily available, the demand for addi-

tional telephone lines may diminish, cutting into a

lucrative source of revenue for local phone companies.

Capital spending by telecommunications services com-

panies has soared in recent years, although it was

expected to level off in 2000 in response to higher inter-

est rates and reduced earnings growth. Nevertheless,

high levels of telecommunications equipment invest-

ment are expected to continue for the foreseeable future,

as telecom service firms require additional equipment

upgrades to accommodate increased network traffic and

wireless applications (see Chart 2).

Cable TV

Cable TV is another important component of the

telecommunications services industry. According to

Economy.com, “among the current technologies avail-

able, cable is viewed as the leading option for delivering

Atlanta Regional Outlook 20 F

irst Quarter 2001

In Focus This Quarter

CHART 1

* Forecast

Source: Economy.com

Growth in Telecom Services’ Network Access Revenues Soared in Recent Years

Annual % Change in Residential

Service Revenues

Residential—Local

Residential—Long Distance

Residential—Network Access

’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00*

video, telephony, entertainment, and computing ser-

vices to households and businesses.”

Cable TV sales

revenue has grown more than 19 percent a year since

1995. In spite of this stellar revenue growth, most cable

companies are not earning a profit because of the high

levels of capital investment required.

Telecommunications Equipment

The telecommunications equipment industry is growing

rapidly, as telecom service providers rush to upgrade

infrastructure to enhance their offerings of high-speed

broadband services. Telecommunications service

providers are not only upgrading fiber optic and cable

line networks; they are rapidly upgrading antiquated

circuit-switched networks to more efficient packet-

switch networks. However, the growth in revenues and

profits was expected to moderate in 2000 because of

higher interest rates and slower growth in the domestic

economy (see Chart 3, next page).

The wireless phone industry also has experienced prob-

lems since late 2000. The major mobile phone compa-

nies have missed earnings projections, casting doubt on

the growth potential of the industry. Much is riding on

the development of third-generation (3G) wireless tech-

nology, which is expected to allow wireless access to the

Internet, transmission of video and other images, and

videoconferencing—all from a handheld mobile phone.

Although huge amounts of money are being invested to

develop 3G technology, it is unclear what applications

will generate the demand to make the investments prof-

itable.

CHART 2

90,000

80,000

70,000

(In $ millions)

60,000

50,000

40,000

30,000

20,000

10,000

Telecom Services’ Capital Spending Growth Soars

’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00*

* Forecast

Source: Economy.com

September 2000. Economy.com, Precis: Industry: Cable TV.

Atlanta Regional Outlook 21 First Quarter 2001

In Focus This Quarter

CHART 3

Telecom Equipment Sales Revenue

Moderates in 2000

* Forecast

Source: Economy.com

Annual % Change in Telecom

Equipment Sales Revenue

’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00*

Outlook

The telecommunications industry has been badly bat-

tered in both equity and bond markets in the past sever-

al months. A spate of bad news has resulted in sharply

lower stock prices and higher costs in debt markets. As

a result, the availability of financing for some higher-

risk firms is now questionable. Investors are concerned

about the prospect of slowing wireless subscriber

growth, continuing capital expenditures, intense compe-

tition, and the rapid rise in telecom debt

(see Chart 4).

The long-term outlook for the telecommunications ser-

vices industry is positive. The emergence of high-

margin technologies and continued growth in wireless

subscriber rates should enhance profitability in the

future. Consumers and businesses are also expected to

CHART 4

spend an increasing share of their incomes on telecom

services. Nevertheless, strong competition, huge invest-

ments in equipment upgrades, and rapidly changing

technology will force firms to be nimble and innovative.

The long-term outlook for the telecommunications

equipment industry is positive, as the demand for data,

Internet, and wireless services continues to grow

strongly. Nevertheless, individual firms in the industry

face a highly competitive environment and rapidly

changing technology.

Cable TV’s long-term outlook is also positive because

of growing advertising sales and technological develop-

ments that should allow cable firms to offer a broader

array of services. Still, the competitive environment is

fierce. In addition to competing with a host of “tradi-

tional” telecommunications firms, cable firms must

contend with satellite TV providers, which are partner-

ing with major firms to offer sophisticated communica-

tions and entertainment services.

Implications for Banks

The most important characteristics of the telecom

industry with respect to lending risks are its highly com-

petitive environment and its pace of technological

change. These characteristics suggest that the medium-

to long-term outlook for a particular credit may not be

well represented by current conditions. The success of

telecom firms will be based on management’s ability to

adapt to change and compete with a fluid set of com-

petitors.

Source: Standard & Poor's Compustat

Growth in Telecom Debt since 1995 Dwarfs Other Sectors’ Debt Growth

Telecom Industries

Percent Change in Debt

(1995–1999)

Radio/Tel. Broadcast/

Commun. Equip.

Basic Materials

Consumer-

Cyclical

Consumer

Staples

Health Care

Energy

Capital Goods

Technology

Communication

Services

Utilities

Transportation

Radiotelephone

(Wireless)

Telephone,

Except Wireless

Cable and Other

Pay TV Services

100

150

200

250

300

350

400

450

500

Solomon, Deborah, and Nicole Harris. October 18, 2000. “Talks on Merger By AT&T Wireless Face Investor Static.” Wall Street Journal.

Atlanta Regional Outlook 22 First Quarter 2001

In Focus This Quarter

CHART 5

HMO Enrollment Rose Sharply through 1998

as Employers Sought to Contain Health Care Costs

HMO Enrollment as a

Percentage of Population

’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00*

* Forecast

Sources: Economy.com, Interstudy

With both equity and bond markets turning against the

telecommunications industry, cash-hungry telecom

firms may have difficulty obtaining financing. This

could pose a serious risk for banks with a significant

exposure to telecom start-ups without a major partner or

an investor sponsor.

The high capital requirements and financial leverage of

many telecommunications firms complicate these lend-

ing risks. Some of these firms are borrowing heavily to

put into place an infrastructure to accommodate a

demand for services that is yet to come on-stream,

meaning that the payback on this investment may not

occur for a number of years.

Health Care

Industry trends such as declining hospital occupancy

rates and rising outpatient visits to hospitals, intense

competition, and the unexpected results of new

Medicare policy combined to put the health care indus-

try in difficult financial straits during the past few

years. However, subsequent industry consolidation and

streamlining and revised Medicare rules have helped to

stabilize prospects for many health care providers.

Recent Trends and Developments

The health care industry has been suffering since the

implementation of the Balanced Budget Act of 1997

(BBA), which cut Medicare payments much more than

expected. However, two subsequent bills were passed to

“give back” a portion of the Medicare payment cuts

implemented in the BBA. The Balanced Budget Refine-

ment Act of 1999 should restore some $16 billion of the

cuts to health care facilities over five years.

Also, the

recently passed Benefits Improvement and Protection

Act of 2000 (BIPA) will restore about $35 billion in

benefits to the industry over the next five years. BIPA

will provide the greatest benefit to hospitals, managed

care plans, nursing homes, and home health agencies.

The health care industry’s financial situation has stabi-

lized somewhat in the past year because of widespread

consolidation of hospitals and other health care

providers. This has helped the industry reach greater

levels of efficiency as well as improved bargaining

power in negotiations with managed care organizations.

Notwithstanding these favorable developments, other

trends continue to pose serious challenges to many

firms. Higher labor costs, continued HMO penetration,

breakthrough pharmaceutical therapies resulting in

reduced demand for services, and increased outpatient

volumes have buffeted many health care facilities (see

Chart 5 and Chart 6, next page).

Higher-Risk Sectors

A better understanding of risks and trends in health care

can be gained by discussing its specific sectors. We

have segregated these sectors based on the results of an

option-pricing model of firm default risk. These models

estimate the probability that the market value of a firm’s

assets will fall below a level that would trigger default.

Firms that have low stock prices, volatile stock prices,

or high debt levels will tend to be flagged as having

high default risk by such models.

June 15, 2000. Healthcare: Facilities. Standard & Poor’s Industry

Surveys.

Atlanta Regional Outlook 23 First Quarter 2001

In Focus This Quarter

CHART 6

Health care industry subsectors have been grouped into

three categories: higher risk, moderate risk, and lower

Outpatient Visits to Hospitals Grow Steadily

risk, which refer to the degree of default risk relative to

other subsectors in the industry. The estimated default

700

Outpatient Visits to Hospitals

(millions)

600

500

400

300

200

100

’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00*

* Forecast

risk across these subsectors varies substantially. The

highest-risk health care sectors include Offices of Med-

ical Doctors; Skilled Nursing Care Facilities; Home

Health Care Services; Specialized Outpatient Facilities,

NEC; and Health Services (see Chart 7).

Offices of Medical Doctors are largely physicians’

practice management firms. These firms acquire a prac-

tice of physicians based on a multiple of the practice’s

discounted cash flow. The multiple can be several times

the practice’s asset value at the time of purchase. How-

ever, these firms have had difficulty achieving prof-

itability because of legal restrictions on referrals among

affiliated groups of physicians, as well as the reluctance

of physicians to submit their medical practice to the cri-

teria of cost control.

Total liabilities in this sector have

grown rapidly over the past few years.

Skilled Nursing Care Facilities’ earnings have been

hurt badly by the BBA. However, they stand to benefit

from the Medicare “giveback” provided by the recently

enacted BIPA, which seeks to rectify the deeper-than-

expected cuts in funding resulting from the BBA.

Skilled nursing care facilities’ performance has also

been adversely affected by (1) declining occupancy

Sources: Economy.com, Morgan Quinto

One such model that is readily available is Credit Mon-

itor

, which was developed by KMV LLC.

We stratify

health care sectors based on their median one-year

default probability as estimated by expected default fre-

quencies

(EDFs

) generated by Credit Monitor

Sectors identified in this article as higher-risk sectors,

therefore, are those with a relatively high percentage of

firms with low stock prices, volatile stock prices, or

high debt levels. Readers are cautioned that the risk pro-

file of a specific company may be very different from

the sector risk profiles described here.

CHART 7

Estimated Default Risk Varies Widely among Health Care Subsectors, December 2000

Median Expected Default

Frequency™ (EDF™)

in Percent

Comparative Median EDF™

of S&P Bonds Rated BB

(as of December 2000)

8011:

Doctors

Offices

8051:

Skilled

Nursing

8082:

Home

Health Care

8093:

Spec.

Outpatient,

NEC

8000:

Health

Services

8071:

Medical

Labs

8060:

Hospitals

6324:

HMOs

8090:

Misc. Health

Services

8062:

Med. &

Surgical

Hospitals

Credit Monitor

’s Expected Default Frequency

(EDF

) estimates the probability of default within one year. KMV LLC’s proprietary calcula-

tion for EDF

is based on (1) the current market value of the firm, (2) the structure of the firm’s current obligations, and (3) the vulnerabiltiy of

the firm to large changes in market value measured in terms of asset volatility. EDFs

are one of many potential measures of industry risk, and

their use in this article should not be construed as an endorsement by the FDIC or Credit Monitor

Gruehn, Charles. April 2000. Healthcare Industry Manual. Federal Reserve Bank of Atlanta.

Atlanta Regional Outlook 24 First Quarter 2001

In Focus This Quarter

rates caused at least partly by increased competition

from lower-acuity facilities such as assisted living facil-

ities; (2) rising labor and legal costs; and (3) surging

debt service costs. Many of these firms are experienc-

ing severe financial stress. The stressed facilities have

registered negative net income for the past year or so, as

well as burgeoning debt levels. The high debt levels are

the result of acquisitions of ancillary support services

that in many cases are not generating adequate cash

flow because of the BBA.

Most of these firms have

seen their interest coverage ratios decline sharply over

the past few years.

Home Health Care Services focus primarily on respi-

ratory therapy programs and intravenous and infusion

services. The industry is undergoing financial stress as

a result of the Health Care Financing Administration’s

implementation of a prospective payment system that

reduced reimbursements on respiratory therapy and

infusion therapy.

Specialty Outpatient Facilities, NEC are primarily

engaged in outpatient care of a specialized nature, such

as alcohol and drug treatment and birth control/family

planning. They have permanent facilities and medical

staff to provide diagnosis, treatment, or both for patients

who are ambulatory and do not require inpatient care.

Many of the firms in this sector have experienced a ris-

ing debt burden over the past few years, pushing default

risk to higher levels.

Health Services firms are engaged primarily in furnish-

ing medical, surgical, and other health services. Firms

listed in this broad category rather than more specific cat-

egories include companies providing dental services,

laser eye correction, and physical and occupational ther-

apy. Many publicly traded firms in this category have

experienced sharply rising liabilities over the past three to

four years.

Moderate-Risk Sectors

Moderate-risk health care sectors include medical labo-

ratories, hospitals, and HMOs.

Medical Laboratories provide professional analytic or

diagnostic services to the medical profession or to the

patient as prescribed by a physician. Companies with

diverse financial performance and risk of default are

included in this sector. A number of medical laborato-

Ibid.

ries have registered deteriorating interest coverage

ratios in the past year or two.

Hospitals, as defined for these purposes, are specialty

hospitals. They are primarily engaged in providing diag-

nostic services, treatment, and other hospital services

for specialized categories of patients. Only eight pub-

licly traded firms are listed in this category. They are

involved in providing specialized hospital care such as

rehabilitation, diabetes treatment, and drug and sub-

stance abuse treatment.

Hospital and Medical Service Plans (HMOs) are pri-

marily engaged in providing hospital, medical, and

other health services to subscribers or members in

accordance with prearranged agreements or service

plans. Generally, these service plans provide benefits to

subscribers or members in return for specified sub-

scription charges. Also included in this industry are sep-

arate HMOs that provide medical insurance. After

several years of intense competition among HMOs,

which restricted premium-rate hikes when medical

costs were rising sharply, HMOs began to pursue a more

aggressive approach toward price increases. This new

approach has improved the near- and intermediate-term

outlook for this sector. Yet, the prospect of the passage

of a Patients’ Bill of Rights suggests that rising costs

could be an issue for HMOs in the future. As an indus-

try, HMOs are highly concentrated, with the top 10

HMOs accounting for nearly two-thirds of total HMO

enrollment in the United States.

Lower-Risk Sectors

The lowest-risk sectors in the health care industry

include miscellaneous health and allied services, and

general medical and surgical hospitals. Many of these

firms have an estimated default risk that puts them in

speculative credit risk categories in spite of the fact that

they are considered lower risk compared with other

health care sectors.

Miscellaneous Health and Allied Services firms are

involved in providing kidney or renal dialysis services

and outpatient care of a specialized nature, such as alco-

hol and drug treatment and birth control/family plan-

ning. Some firms are engaged in providing health and

allied services such as blood banks, blood donor sta-

tions, childbirth preparation classes, medical photogra-

phy and art, and oxygen tent services.

August 31, 2000. Healthcare: Managed Care. Standard & Poor’s

Industry Surveys.

Atlanta Regional Outlook 25 First Quarter 2001

In Focus This Quarter

General Medical and Surgical Hospitals provide gen-

eral medical and surgical diagnostic and treatment ser-

vices, other hospital services, and continuing nursing

services. They have an organized medical staff, inpa-

tient beds, and equipment and facilities to provide com-

plete health care. According to a study conducted by

HCIA-Sachs and Ernst & Young, “The BBA created the

greatest financial instability that hospitals have experi-

enced since the creation of Medicare in 1965. Yet the

most severe reductions have just begun to impact hospi-

tals, and will continue to do so through 2002. The

recently enacted Balanced Budget Refinement Act pro-

vides little sustained relief to the industry, and signifi-

cant financial problems are likely to remain.”

The study

also indicates that smaller hospitals (fewer than 100

beds) are in the “greatest financial jeopardy.” The recent

enactment of BIPA will help to stabilize the finances of

hospitals over the next several years. However, other

trends adversely affecting hospitals include as much as

40 percent estimated excess capacity, rising labor costs,

a severe shortage of nurses, continued HMO penetra-

tion, breakthrough pharmaceutical therapies, and

increased outpatient volumes (see Charts 5, 6, and 8).

Outlook

The outlook for the health care industry has improved

substantially in the past year. Industry consolidation and

legislation to give back some of the Medicare cuts

implemented in the Balanced Budget Act of 1997 have

gone a long way to stabilize health care providers’

financial prospects, particularly those of hospitals and

nursing homes.

The passage of a Patients’ Bill of Rights in 2001 could

also strengthen the hand of health care providers rela-

tive to HMOs. Such a bill could contain provisions that

would weaken the position of managed care organiza-

tions to contain costs and negotiate with health service

providers.

Longer term, the demographic trends are positive, with

the population aging and life expectancy increasing.

The result should be a growing demand for health care

services in the future. On the negative side, however, the

current trends toward greater use of outpatient proce-

dures and drug therapies will dampen the demand for

inpatient hospital services.

HCIA-Sachs, LLC, and Ernst & Young, LLP. May 1, 2000. The

Financial State of Hospitals: Post-BBA and Post-BBRA.

CHART 8

Hospital Occupancy Rate

Continues Steady Decline

Hospital Occupancy Rate

(percent)

* Forecast

Sources: Economy.com, Morgan Quinto

’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00*

Implications for Banks

The opportunities for financing health care firms will

continue to grow into the future. Recent experience has

shown that the financial performance of many health

care providers is profoundly influenced by changes in

Medicare policy. As Medicare expenditures grow to

occupy a greater and greater place in the federal budget,

Medicare policy will be scrutinized to an unprecedent-

ed degree, magnifying the importance of understanding

the policy risk associated with health care lending.

Powerful demographic trends should lead to the growth

in demand for many health care services over the next

10 to 20 years. For example, demand for nursing homes

and assisted living facilities will increase sharply as

baby boomers reach old age. However, regional supply

and demand for these services can get out of balance as

providers add facilities to meet demand. Monitoring

local demand and supply trends is an important part of

assessing the credit risks in these loans.

Textiles

The textile industry has been plagued by excess capaci-

ty, fierce competition from cheaper imports, and sag-

ging textile prices. The result was a sharp drop in

industry profits in 1999 and continued weakness in

2000.

Recent Trends and Developments

The textile industry is a mature industry that by a num-

ber of measures has been declining. Intense competition

from low-cost imports has taken its toll on domestic

Atlanta Regional Outlook 26 F

irst Quarter 2001

In Focus This Quarter

textile businesses. Since 1995, textile imports have

increased nearly 50 percent while exports have grown

just under 10 percent. A strong dollar should help tex-

tile imports continue to outpace exports. As a result of

industry consolidation and the movement of many oper-

ations offshore, textile employment has continued to

fall steadily. Textile employment has dropped from

663,000 in 1995 to an estimated 544,000 in 2000.

Closely linked to all these trends, labor productivity in

the textile industry is low relative to the average for

other manufacturing industries because of low output

prices and a heavier reliance on labor in the production

process.

The Department of Commerce reports that the indus-

try’s profit as a percentage of sales declined from 3.2

percent in 1998 to just 1.3 percent in 1999 (see Chart

9).

Also, drought in the South has had an adverse effect

on textile manufacturing firms, as these firms use a

large amount of water in bleaching and dyeing fabric.

Because of improving global demand and plant closings

in the United States, many analysts believe textile prices

have now reached a low point. Indeed, data for 2000

show a slight increase and some firming of prices in the

first three quarters of the year (see Chart 10, next page).

Nevertheless, the profit picture seems to have weakened

further in 2000 because of an increase in nonoperating

expenses.

Publicly traded firms in the textile industry can be sep-

arated into six major categories: knitting mills, textile

mill products, broadwoven fabric mills–cotton, broad-

woven fabric mills–manmade fiber/silk, carpets/rugs,

and miscellaneous fabricated textile products. The

default risk characteristics of these sectors vary signifi-

cantly as measured by the median EDF

Higher-Risk Sectors

The higher-risk sectors include knitting mills, Broad-

woven Fabric Mills–Cotton, and Textile Mill Products

(see Chart 11, next page).

Economy.com. November 2000. Apparel and Textiles, Precis Indus-

try.

Office of Textiles and Apparel, U.S. Dept. of Commerce. Septem-

ber 6, 2000. Current Situation in the U.S. Textile, Apparel, and Man-

made Fiber Industries.

Kilman, Scott, and Amy Merrick. July 25, 2000. “Drought in the

South Crimps Economy in Region.” Wall Street Journal.

CHART 9

Textile Industry Profits as a

Percentage of Sales Fall in 1999

4.0

3.5

3.0

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

Percent

2.5

2.0

1.5

1.0

0.5

Source: U.S. Dept. of Commerce,

Current Situation in the U.S. Textile,

Apparel, and Manmade Fiber Industries,

September 6, 2000

Knitting Mills are engaged in knitting, dyeing, and fin-

ishing hosiery, stockings, outerwear, underwear, and

other products from yarn or knitted fabrics. Two public

firms in this industry accounted for 66 percent of the

sector’s 1999 sales. Three out of eight firms in this sec-

tor reported net losses and six out of eight reported

declining sales in 1999. The trends are similar in 2000

based on incomplete available data.

Broadwoven Fabric Mills–Cotton are engaged primar-

ily in weaving fabrics more than 12 inches in width,

wholly or chiefly by weight of cotton. One dominant

firm accounted for nearly 38 percent of the sales of all

publicly traded firms in this sector in 1999. The perfor-

mance of firms in this sector was mixed in 1999. Six out

of nine of these firms recorded negative net income in

1999. Two companies reported a sizable increase in

1999 net income. Incomplete 2000 results suggest that

six firms are in the black, leaving just three with nega-

tive net income.

Textile Mill Products is a broad category that includes

establishments engaged in performing any of the fol-

lowing operations: (1) preparation of fiber and subse-

quent manufacturing of yarn, thread, braids, twine, and

cordage; (2) manufacturing broadwoven fabrics, narrow

woven fabrics, knit fabrics, and carpets and rugs from

yarn; (3) dyeing and finishing fiber, yarn, fabrics, and

knit apparel; (4) coating, waterproofing, or otherwise

treating fabrics; (5) the integrated manufacture of knit

apparel and other finished articles from yarn; and (6)

the manufacture of felt goods, lace goods, nonwoven

fabrics, and miscellaneous textiles. Two firms dominate

this sector. Together, they accounted for over 60 percent

of the sector’s sales in 1999 (considering publicly traded

Atlanta Regional Outlook 27 First Quarter 2001

In Focus This Quarter

CHART 10

Textile Prices Begin to Recover in 2000

Producer Price Index

for Textile Mill Products

(NSA, Dec 1984=100)

Source: Bureau of Labor Statistics

113

114

115

116

117

118

119

120

’95 ’96 ’97 ’98 ’99 ’00

firms only). Net income for both firms was off sharply

in 1999. Still, some companies registered net income

gains in 1999, building on several years of growth in net

earnings. Although the 2000 data are incomplete, most

firms in this sector have reported weak earnings.

Indeed, several firms have reported more quarters of

negative than positive net income.

Moderate-Risk Sectors

The moderate default risk sectors include Miscella-

neous Fabricated Textile Products and Broadwoven Fab-

ric Mills–Manmade Fiber/Silk.

Miscellaneous Fabricated Textile Products includes

businesses primarily involved in manufacturing curtains

and draperies, house furnishings, textile bags, and canvas

and related products; performing pleating, decorative and

novelty stitching, and tucking for the trade; manufactur-

CHART 11

ing automotive trimmings, apparel findings, and related

products; Schiffli machine embroideries; and manufac-

turing fabricated textile products, not elsewhere classi-

fied. Net income for three out of the five publicly traded

firms in this sector was negative in 1999. Two of those

firms have experienced losses for at least two years’ run-

ning. Most of these firms reported negative net income

through the first two or three quarters of 2000. The three

largest firms’ total debt has grown considerably over the

past few years. The increase is related primarily to

financing acquisitions.

Broadwoven Fabric Mills–Manmade Fiber/Silk are

engaged in weaving fabrics more than 12 inches in

width using primarily silk and manmade fibers, includ-

ing glass. Net income for each of the six publicly trad-

ed firms in this category was down in 1999—in most

cases down sharply. Earnings for most of these firms

Estimated Default Risk in Textile Industry Subsectors, December 2000

Median Expected Default

Frequency™ (EDF™)

in Percent

Comparative Median EDF™

of S&P Bonds Rated BB

(as of December 2000)

2250:

Knitting Mills

2211: Brdwoven

Fabric Mill, Cotton

2200:

Textile Mill

Products

2390:

Misc Fabricated

Textile Pds

2221:

Brdwovn Fabric

Manmade, Silk

2273:

Carpets

and Rugs

Atlanta Regional Outlook 28 First Quarter 2001

In Focus This Quarter

appear to have continued to deteriorate in 2000. Interest

coverage ratios for several firms were down in 1999 and

2000 because of lower income, higher liabilities in

some cases, and higher interest rates.

Lower-Risk Sector

Manufacturers of carpets and rugs represent the only

lower-risk sector in the textile industry.

Carpets/Rugs businesses are involved in manufactur-

ing woven, tufted, and other carpets and rugs. This sec-

tor, as a group, experienced strong income growth in

1999. Only one out of six publicly traded firms failed to

make a profit in 1999, and several firms reported siz-

able profit increases. Available 2000 data suggest that

each of these firms will have generated positive earn-

ings. Two firms dominate the carpet and rug sector,

accounting for about 65 percent of 1999 sales for the

group. Carpet and rug manufacturing is capital and

research intensive, which gives the U.S.-based firms a

comparative advantage over overseas companies, which

do not have the same level of access to capital markets

and an educated workforce.

Outlook

Some positive factors could temper the adversity being

experienced by the U.S. textile industry. Low fiber costs

and an improved trade situation with Asia should

strengthen the textile industry in the future. Labor pro-

ductivity has been rising slowly, as firms continue to

invest in labor-saving computer technology and equip-

ment. The industry is pursuing various strategies to

remain competitive, including consolidations and merg-

ers and setting up operations in Mexico.

Nevertheless,

the current slowdown in the U.S. economy and the

increased risk of an actual recession has posed chal-

lenges for the textile industry.

Another concern for U.S. producers is trade liberaliza-

tion and its effect on textile imports. The normalization

of trade relations with China and the elimination of

import quotas by 2005 according to the World Trade

Organization (WTO) Agreement on Textiles and Cloth-

ing could lead to even greater imports.

Implications for Banks

Banks lending to textile firms face an array of risks

emanating from the economic environment in which

these firms operate. These risks include the ebb and

flow of demand associated with the business cycle of

the U.S. and world economies; the exchange rate of the

U.S. dollar, which affects the competitiveness of domes-

tically produced textile products; and the prices of both

inputs and textile products. U.S. trade policy will also

have a profound impact on the competitive environment

in which domestic textile firms operate. Banks need to

monitor these developments carefully.

Concentration risk can be a significant issue for some

banks. Textile mill employment is highly concentrated

geographically. About 72 percent of all textile mill jobs

are located in five southeastern states (North Carolina,

Georgia, South Carolina, Alabama, and Virginia).

Almost 29 percent of these jobs are in North Carolina

alone. Another 18 percent are in Georgia. Even within

these states, textile employment can be regionally con-

centrated, introducing concentration risk to banks with

significant exposures to local textile firms. This risk is

measured in terms of not only the volume of textile

loans in the portfolio but also the spillover effects that

plant layoffs can have in the community.

In an increasingly global market, credit risk in textiles

will depend on decisions about production processes

and intercompany linkages. For example, capital-

intensive domestic producers may be in a better position

to compete with offshore firms with greater access to

cheap labor resources. Some textile firms may be able

to enhance profitability and control risk by entering into

partnerships with domestic and overseas organizations.

Stephen Gabriel, Financial Economist

Reichard, Robert. January 2000. “New Year Offers Problems and

See “Regional Economy,” Atlanta Regional Outlook, second quar-

Opportunities,” Textile World.

ter 1998.

Atlanta Regional Outlook 29 First Quarter 2001

✁

Subscription Form

To obtain a subscription to the FDIC Regional Outlook, please print or type the following information:

Institution Name __________________________________________________________________________

Contact Person __________________________________________________________________________

Telephone __________________________________________________________________________

Street Address __________________________________________________________________________

City, State, Zip Code __________________________________________________________________________

Please fax or mail this order form to: FDIC Public Information Center

801 17th Street, N.W., Room 100

Washington, D.C. 20434

Fax Number (202) 416-2076

Please indicate below each Region’s issue you wish to receive:

Atlanta _________ Dallas _________ New York _________ National _________

Boston _________ Kansas City _________ San Francisco _________ All _________

Chicago _________ Memphis _________

Federal Deposit Insurance Corporation

Washington, DC 20429-9990

OFFICIAL BUSINESS

PENALTY FOR PRIVATE USE, $300

BULK RATE

MAIL

Postage &

Fees Paid

FDIC

Permit No. G-36

Download
Save PDF to desktop

Email
Email completed PDF

Send for Signing
Email for others to sign

Print
Print document

NAME

A1q2001 Regional Outlook - Atlanta First Quarter 2001

View Audit Log
Print With Audit Log
Duplicate Document

Fill Online, Printable, Fillable, Blank A1q2001 Regional Outlook - Atlanta First Quarter 2001 Form

Related forms

Fillable A1q2001 Regional Outlook - Atlanta First Quarter 2001

Fill Online, Printable, Fillable, Blank A1q2001 Regional Outlook - Atlanta First Quarter 2001 Form

Related forms

First 20 documents completely FREE!