Fill - Free fillable N4q2000 Regional Outlook - New York

Regional Outlook

FEDERAL DEPOSIT INSURANCE CORPORATION FOURTH QUARTER 2000

FDIC

New York

Region

Division of

Insurance

Kathy R. Kalser,

Regional Manager

Robert DiChiara,

Financial Analyst

Norman Gertner,

Regional Economist

Alexander J.G.

Gilchrist,

Economic Analyst

Regional Perspectives

 The Region’s Economic and Banking Conditions—The Region’s insti-

tutions reported generally healthy financial conditions during the first half of 2000.

Large institutions offset higher funding costs with increased noninterest income,

while community institutions benefited from slightly higher net interest margins.

The Region’s large banks continued to report weakening in commercial and indus-

trial loan credit quality. See page 3.

 The Region’s Loan Growth Is Centered in Traditionally Higher-Risk

Categories—Over the past four years, the Region’s commercial banks have

reported a shift into higher-yielding, potentially higher-risk commercial loans as

lenders attempt to maintain earnings in the face of increasing competition and mar-

gin pressure. See page 4.

 Some of the Region’s Housing Markets Show Signs of Overheat-

ing—Communities surrounding the Region’s larger urban areas, primarily Balti-

more, New York City, and Washington, D.C., where job growth has been strong,

reported significant levels of home price appreciation that have exceeded increases

in household incomes. By most measures, the current housing boom has been more

modest than that of the 1980s. See page 6.

By the New York Region Staff

In Focus This Quarter

 Emerging Risks in an Aging Economic Expansion—This article focus-

es on the potential risks of current economic conditions to insured depository insti-

tutions. Although the current conditions may appear to be ideal, some imbalances

are emerging: rising energy prices, tight labor markets, a less robust stock market,

a large trade deficit and strong U.S. dollar, rising household debt burdens,

increased corporate leverage and rising potential default risk, and, in some metro-

politan areas, overheated housing and commercial real estate markets. At the same

time, aggregate risk within the banking industry appears to have risen, as evidenced

by softening profitability, growing reliance on noncore funding, heightened levels of

interest rate risk, and increasing concentrations in traditionally higher-risk loan

categories. A confluence of these trends could heighten the vulnerability of some

insured institutions. See page 11.

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, AZ, CA, FJ, FM, GU, HI, ID, MT, NV, OR, UT, WA, WY)

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

form found on the back cover to the FDIC Public Information Center. Contact the Public 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 New York Region’s Regional

Outlook, please call Kathy Kalser at (212) 704-1308 or send an e-mail to kkalser@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

REVISION:

The article “Ranking Metropolitan Areas at Risk for Commercial Real Estate Overbuilding” in

the Third Quarter 2000 issue of the Regional Outlook has been revised to correct a data-related

error. The revision affects Chart 4 and Chart 11 of the report. Please see www.fdic.gov/bank/

analytical/regional/ro20003q/correction.html for revised versions of Chart 4 and Chart 11, along

with an additional explanation of how the revision affects the article.

Regional Perspectives

• During the first half of 2000, the New York Region’s insured institutions reported favorable financial con-

ditions, but large banks faced continued margin pressure and weakening commercial and industrial loan

credit quality.

• The credit risk profile of the Region’s commercial banks is increasing as loan volume is rising and growth

is centered in traditionally higher-risk loan categories.

• Housing markets in some of the Region’s major cities may be overheating; however, price appreciation has

been more modest than during the 1980s housing boom.

Region’s Economic and Banking Conditions

Bank Profitability Is Stable but Pressures Persist

The New York Region’s insured institutions

reported

relatively stable profitability during the first half of

2000. However, higher interest rates compared with a

year ago pressured net interest margins (NIMs), as

funding costs increased for all banks. Intense competi-

tion for core deposits over the past several years also has

contributed to margin compression. Erosion of banks’

core deposit base has resulted in increased reliance on

noncore funding sources, which are generally more

expensive than traditional bank deposits. Furthermore,

noncore funding sources typically are more interest rate

sensitive. As a result, banks’ liquidity and interest rate

risk management could be challenged, particularly dur-

ing periods of rising interest rates or unstable financial

markets, when access to liquidity sources may become

more difficult.

Performance measures continued to highlight the differ-

ences in revenue models between the Region’s large

institutions and community banks. Large banks gener-

ate significant noninterest income, while smaller banks’

earnings are more dependent on spread income. Their

more diversified revenue stream helped the large insti-

tutions (assets greater than $10 billion) maintain prof-

itability levels in the past year despite higher funding

costs. Large banks reported a stable median return on

assets (ROA) for the first half 2000 compared with a

year ago, as increased noninterest income offset a

decline in the NIM (see Table 1, next page). Noninterest

income increased less in the first half of 2000 than the

year-ago period, reflecting competition for fee-based

services and softness in the financial markets.

Excludes institutions in operation less than three years and credit

card banks. The banking analysis uses median figures.

The ROA for the Region’s community banks (assets less

than $1 billion) declined slightly over the same period,

as higher operating expenses diluted the effect of an

improved asset yield and NIM. After a downtrend for

the past two years, the Region’s community banks

reported a slightly higher NIM during the first six

months of 2000 compared with a year ago; higher asset

yields more than offset increased funding costs. Loan

growth, which occurred primarily in the typically

higher-yielding, higher-risk commercial loan cate-

gories, may have contributed to community banks’

improved asset yield. The median loan-to-asset ratio for

the Region’s community banks continued upward,

increasing from 61 percent in second quarter 1999 to 64

percent in second quarter 2000, with growth concen-

trated in commercial and industrial (C&I), commercial

real estate (CRE), and construction and development

(C&D) loans. The overall growth rate for these cate-

gories was almost double that of residential loans over

the past year. Unlike large banks, community banks did

not benefit from increased noninterest income. The

median ratio of noninterest income-to-earning assets

reported by the Region’s community banks was flat

compared with a year ago, and less than one-third the

level reported by large banks.

Credit Quality of Large Banks’

C&I Loan Portfolios Weakens

Credit quality in most loan categories remained favor-

able, except for C&I loans held by the Region’s large

banks; during second quarter 2000, the C&I charge-off

rate reached its highest level since 1993. Although

increasing, the C&I charge-off rate reported by the

Region’s large banks remained substantially below the

rate during the recession of the early 1990s.

New York Regional Outlook 3 Fourth Quarter 2000

Regional Perspectives

Deterioration of large banks’ C&I loans could be the

result of less disciplined underwriting from 1996 through

1998, when results of the Federal Reserve Board’s

Senior Loan Officer Opinion Surveys on Bank Lending

Practices indicated general easing of C&I lending stan-

dards nationwide. While more recent surveys

indicate

that the nation’s banks have tightened underwriting stan-

dards, warning signs remain. Rating agencies reported

that downgrades of syndicated loans and corporate bonds

exceeded upgrades during the first eight months of 2000.

Moreover, while downgrades were primarily limited to

health care, manufacturing, and entertainment companies

in 1999, they extended across more industries in 2000.

Furthermore, the dollar amount of adversely classified

large syndicated loans under the Shared National Credit

(SNC) program increased for the second consecutive

year, rising from $37.4 billion in 1999 to $63.3 billion in

2000.

The percentage of criticized loans to total loans

reviewed has risen from a decade low of 1.3 percent in

TABLE 1

1998 to 3.3 percent in 2000 but is below the 10 percent

peak reached in 1991. Defaults on corporate bonds and

spreads on high-yield bonds have also increased, further

indicating weakening commercial credit quality. A less

liquid secondary market for corporate debt could make it

more difficult for companies to refinance or restructure

loans, which could affect the credit quality of the

Region’s loan portfolios.

Commercial Loan Growth Increases

Banks’ Credit Risk Profiles

The Region’s commercial banks have reported loan

growth centered in traditionally higher-risk loan cate-

gories. During the past four years, the Region’s commer-

cial banks experienced the greatest annual growth rates in

commercial (including C&I and CRE) loans (see Chart

1). In fact, commercial loans accounted for over half the

Summary of Banking Performance*

ASSETS

GREATER THAN

ASSETS BETWEEN

$1 ASSETS

LESS

$10 BILLION B

ILLION AND

$10 BILLION THAN $1 B

ILLION

JUN ’00 J

UN ’99 J

UN ’98 J

UN ’00 J

’99 JUN ’98 J

UN ’00 J

UN ’99 J

’98

ROA 1.28 1.28 1.13 1.05 1.13 1.11 0.90 0.92 0.99

NIM 3.55 3.75 3.96 3.59 3.60 3.81 3.98 3.91 4.06

ONINTEREST

INCOME

/AEA 1.64 1.56 1.43 0.69 0.77 0.73 0.49 0.48 0.47

NONINTEREST

EXPENSE

/AEA 3.13 3.25 3.28 2.60 2.53 2.66 2.91 2.84 2.94

C&I PAST

-DUE

RATIO

1.73 1.36 1.38 1.28 1.52 1.77 0.93 1.15 1.29

AST-DUE

RATIO

1.56 1.59 1.90 1.24 1.39 1.79 1.52 1.76 2.08

CHARGE

-OFF R

ATE

0.26 0.30 0.31 0.12 0.10 0.15 0.03 0.04 0.05

CORE

DEPOSITS

/ASSETS

46.62 45.31 52.78 60.20 61.27 61.51 73.18 75.73 77.23

LOANS

/ASSETS

61.08 60.77 59.10 61.89 58.52 60.65 64.25 61.19 61.29

RESERVES

/LOANS

1.42 1.51 1.77 1.13 1.16 1.27 1.02 1.05 1.10

TIER

1 L

EVERAGE

RATIO

6.61 6.80 6.21 7.74 7.75 7.97 9.69 9.57 9.73

IER

1 RBC R

ATIO 8.76 8.88 8.28 11.60 11.97 12.86 16.34 16.94 17.45

* For the six-month period ending June 30. Median data excluding institutions in operation less than three years and

credit card banks.

AEA = average earning assets, Past-Due Ratio = Loans past due 30 days or more plus nonaccrual loans divided by

gross loans, RBC = Risk-based capital

Source: Bank and Thrift Call Reports

Federal Reserve Board. May and August 2000. Senior Loan Officer Opinion Surveys on Bank Lending Practices.

Joint release by the Board of Governors of the Federal Reserve System, Office of the Comptroller of the Currency, and Federal Deposit Insur-

ance Corporation, Bank Regulators’ Data Show Continued Increase in Adversely Classified Syndicated Bank Loans. October 10, 2000. The SNC

program includes examiners from the three federal regulatory banking agencies: the Federal Reserve Board, the Office of the Comptroller of the

Currency, and the Federal Deposit Insurance Corporation. The SNC program reviews the credit quality of loans that are at least $20 million and

shared by three or more insured institutions. Adversely classified loans include syndicated loans that have been rated Substandard, Doubtful, or

Loss because of significant credit problems or default.

New York Regional Outlook 4 Fourth Quarter 2000

Regional Perspectives

Region’s total loan growth during this time.

Further-

more, although residential loans continue to account for

the largest percentage of the Region’s loans, the level has

declined. In second quarter 1996, the median ratio of res-

idential loans to total loans for the Region’s commercial

banks was just over 43 percent, while the median ratio of

commercial loans to total loans was 31 percent. Four

years later, the concentration levels of commercial and

residential loans were almost equal, each approximating

39 percent of total loans.

The growth in commercial loan volume reflects a shift

into higher-yielding, potentially higher-risk loans as

banks attempt to maintain earnings in the face of

increasing competition and margin pressure. The

decline in the proportion of residential loans held in

bank portfolios also may reflect improved liquidity and

efficiency in the secondary market for mortgages. The

growth of the secondary mortgage market has facilitat-

ed banks’ sale of mortgages to investors, giving banks

that originate mortgages an alternative to holding these

typically lower-yielding loans on their balance sheets.

Banks with Riskier Loan Profiles Report

Higher Reserves but Lower Capital Levels

As C&I loan quality shows signs of weakening, banks

that have significant concentrations in C&I credits may

be more vulnerable if credit quality problems persist.

Commercial banks that reported an above-average

growth rate and concentration level of C&I loans (C&I

lenders)

reported higher median loan loss reserve

ratios but lower capital ratios than the Region’s other

banks (non-C&I lenders)

(see Table 2). Higher loan

Loan growth was computed as the difference in total loans from June

30, 1996, to June 30, 2000, for the Region’s commercial banks,

adjusted for mergers.

C&I lenders are commercial banks with above-average growth and

concentration in C&I loans according to the following criteria: a C&I

loan growth rate above 14.55 percent (the median growth rate for the

Region’s banks between the 1999 and 2000 second quarters) and a

concentration of C&I loans to total loans above 12.96 percent (the

median ratio for the Region’s banks as of June 30, 2000). The distri-

bution of C&I lenders mirrored the geographic and asset size distrib-

ution of all commercial banks in the Region. New York and

Pennsylvania were home to the largest share of the C&I lenders, and

approximately 80 percent of the C&I lenders were commercial banks

with less than $1 billion in assets. Banks less than three years old and

credit card banks were excluded from the analysis, and the data are

adjusted for mergers.

Non-C&I lenders are commercial banks that reported an annual C&I

loan growth rate and ratio of C&I loans to total loans below the medi-

an reported by the Region’s commercial banks as of June 30, 2000.

CHART 1

Commercial

& Industrial

Annual Growth (%)

Commercial and Industrial

and Commercial Real Estate Loans

Show the Highest Growth in the Region

Note: Excludes credit card banks and banks in operation less than three years.

Bars represent the median annual growth rates for the period ending June 30

of each year, adjusted for mergers.

Source: Bank Call Reports

CRE Residential Consumer

1998

1999

2000

loss reserve ratios help mitigate the effect of credit

losses on bank earnings. However, banks with lower

capital ratios have less cushion to absorb additional

losses. Also, although not shown in the table, the gap

between the capital ratios of these two groups has

widened during the past two years as capital ratios of

the C&I lenders have declined more than those of non-

C&I lenders. While banks’ capital ratios have declined

nationwide, a greater decline among banks that are

potentially increasing credit risk profiles poses height-

ened concern.

TABLE

C&I Lenders Report Higher Levels

of Reserve Coverage but Lower

Capital Ratios...

C&I N

ON-C&I

ATIO

ENDERS LENDERS

RESERVES

OANS 1.28 1.21

ESERVES

/PAST-

UE LOANS 203.81 185.27

ROVISIONS

HARGE

-O

FFS 146.78 101.91

EVERAGE

RATIO 8.38 9.68

T1 RBC 11.42 15.16

Data as of June 30, 2000.

* Banks with below-average growth and concentration

in C&I loans.

C&I = commercial and industrial, T1 RBC = Tier 1 risk-

based capital ratio

Source: Bank Call Reports

A comparison of banks that have above-average CRE and C&D loan

growth and concentrations with those that have below-average growth

and concentrations showed similar but less noteworthy differences.

New York Regional Outlook 5 Fourth Quarter 2000

Regional Perspectives

Furthermore, higher operating costs may be constrain-

ing the earnings benefit that typically accrues to lenders

that assume greater credit risk. Although C&I lenders

reported a higher median asset yield and NIM during

the second half of 2000, they also reported a lower

median ROA (see Table 3). Higher overhead (perhaps

because C&I lending can be more labor intensive than

mortgage lending) contributed to the lower median

ROA, as did higher provisions for loan losses. More-

over, should credit quality continue to weaken, banks

may need to increase provisions for loan losses, further

pressuring profitability.

A Slowing Economy Could Heighten Credit Risk

Although economic conditions were favorable

throughout most of the Region during the first half of

2000, some analysts think that the nation’s economy

may be slowing. Less robust economic growth could

have implications for commercial loan credit quality.

Levels of reserve coverage that appear adequate in a

robust economy could become less so in a slowing

economy, particularly for institutions that have a larg-

er proportion of higher-risk commercial loans and

lower capital ratios. Commercial loans can affect an

institution’s earnings more seriously because they gen-

erally result in greater losses per dollar than consumer

and residential loans.

Although recent surveys indi-

cate more disciplined underwriting by banks, a pro-

longed period of economic and financial market

weakness nevertheless could negatively affect credit

quality.

Some of the Region’s Housing Markets

Show Significant Price Appreciation

During the past several years, the wealth of new jobs

and high level of consumer optimism have stimulated

demand for housing around the Region. Recently, com-

munities surrounding the Region’s larger urban areas,

primarily New York City, Baltimore, and Washington,

D.C., where job growth has been strong, reported the

most significant price appreciation. Price increases in

these areas had been relatively modest during the mid-

1990s but rose sharply as the 1990s came to a close.

Home prices in many of these areas increased at double-

digit rates during the first six months of 2000, far

ING Barings. September 2000. Credit Quality Climbing the Wall of

Worry.

TABLE 3

... and Higher Yields but Lower ROA

C&I N

ON-C&I

RATIO LENDERS LENDERS*

ROA 1.08 1.15

SSET YIELD 7.97 7.69

NIM 4.43 4.29

VERHEAD/AVERAGE

ASSETS 3.31 3.04

ROVISIONS/AVERAGE

ASSETS 0.17 0.09

Data as of June 30, 2000.

* Banks with below-average growth and concentration

in C&I loans.

ROA = return on assets, C&I = commercial and industri-

al, NIM = net interest margin

Source: Bank Call Reports

exceeding both the general inflation rate of approxi-

mately 3 percent and the average price increase for

homes nationally.

While residential property prices in the Region’s largest

metropolitan areas have appreciated faster than the

national average, home prices in some of the Region’s

smaller cities have increased more slowly than the

national average. In fact, the median housing price

declined in parts of upstate New York over the past sev-

eral quarters. Slower employment gains and limited

population growth compared with the rest of the Region

and the nation have subdued demand for homes in these

areas. In Philadelphia, housing prices declined over the

past year, despite employment gains. Like many areas in

eastern Pennsylvania, the city has experienced popula-

tion loss and a generally sluggish economy. At the other

end of the state, in Pittsburgh, figures from the Nation-

al Association of Realtors show that prices for single-

family homes essentially have held steady for the past

two years.

Shortage of Available Homes Has

Contributed to Price Appreciation

During the first half of the 1990s, the Region experi-

enced a relatively low level of new home construction, as

its economy slowly recovered from the recession of the

early 1990s. In some of those years, the number of new

residential housing permits dropped at double-digit

rates. The number of permits issued increased moderate-

ly toward the end of the 1990s, as the economy recovered

from the recession and demand for new homes increased

New York Regional Outlook 6 Fourth Quarter 2000

bur

en-

Yor

k C

, D

Regional Perspectives

in many of the Region’s metropolitan statistical areas

(MSAs). However, the level of permits increased a scant

2.2 percent in 1999 and declined in 2000, as higher inter-

est rates curtailed new development.

Despite the vibrant economy and strong demand, con-

struction of new single-family homes generally has

been modest in the Region’s larger cities. High con-

struction costs and the lack of developable lots have

limited the supply of new homes. According to Econo-

my.com, home inventories were particularly low in New

York City, Long Island, Bergen and Passaic counties,

and Trenton, New Jersey (see Chart 2).

According to

a recent report, New York City was one of the two tight-

est housing markets in the country, along with Los

Angeles.

As a result of the limited supply and strong demand,

home prices in some of the Region’s major markets have

been rising three to four times faster than household

incomes over the past year (see Chart 3, next page).

Areas experiencing the greatest price increases relative

to income include communities adjacent to Baltimore

and New York City (including New Jersey and Long

Island). These areas represent some of the Region’s

largest metropolitan areas and boast the strongest eco-

nomic growth.

Recent Price Appreciation Is Pressuring

Affordability of Homes

Measures of housing affordability show that it is becom-

ing more difficult to afford a home. The National Asso-

ciation of Realtors’ Composite Housing Affordability

Index, which measures a household’s ability to purchase

a single-family home, indicates that during the first seven

months of 2000, homes became less affordable or more

costly relative to household income across the nation.

Increased home prices relative to household income, cou-

pled with higher mortgage rates, which rose more than

150 basis points between October 1998 and June 2000,

contributed to the decline in home affordability.

Affordability measures for the Region’s cities also have

increased since 1999, reflecting higher housing prices

and interest rates, factors that also affect the national

affordability measure. Unlike in 1990, however, most of

the Region’s cities have become more affordable rela-

tive to the nation (see Table 4, next page).

Only New

CHART

Rates of Price Appreciation Reflect the Declining Housing Supply

Number of months

of excess supply

Housing price increase

– percent change

–5

–10

–15

Note: Housing prices are percent change first quarter 1999 to first quarter 2000.

Sources: Excess supply data:

Economy.com analysis; housing prices: Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association

This analysis was presented at the spring 2000 Economy.com

Outlook Conference.

Credit Suisse First Boston. August 2000. August Housing Month-

ly.

Household income data are from the Bureau of the Census.

Economy.com develops quarterly estimates. Amounts include all

wages but not income from capital gains.

The regional housing affordability measure was calculated internal-

ly. The measure assumes that 80 percent of the purchase price of the

home is financed at the prevailing 30-year fixed conventional mort-

gage rate provided by the Federal Home Loan Mortgage Corporation.

The measure uses the median price of a single-family home for each

metropolitan area published by the National Association of Realtors

and estimates of household income from Economy.com. The region-

al measure does not include income from capital gains. A higher num-

ber means that the purchase of a home is more expensive, or less

affordable, relative to household income in that area.

New York Regional Outlook 7 Fourth Quarter 2000

Regional Perspectives

CHART 3

debt burdens could grow at a time when jobs and liveli-

hoods are less secure.

Sources:National Association of Realtors, U.S. Bureau of the Census. Quarterly esimates income poivided by Economy.com.

Housing Price Appreciation Substantially Exceeds Increases in

Household Income in Baltimore, Parts of New Jersey, and Long Island:

First Quarter 1999 to First Quarter 2000

Percent Change

Household income

increases

Housing price increases

–15

–10

–5

onm

outh, N.J.

Bergen-Passaic

Baltim

ore

Newark

York

City

iddlesex. N.J.

ashington, D

Trenton

Long

Island

Atlantic

City

United

States

ilm

ington

Pittsburgh

Albany

Rochester

Buffalo

Syracuse

Philadelphia

York City and Bergen County, New Jersey, a New York

City suburb, were less affordable (a higher index num-

ber) in 2000 than the nation. Because these cities are

home to many Wall Street commuters, home prices

reflect the substantial wealth effect of the vibrant finan-

cial markets over the past several years. Affordability

measures for the Region and the nation remain lower

than 1990 levels, however, in part because of generally

lower interest rates today than a decade ago.

Rapid Price Increases May

Stress Household Budgets

One consequence of rising home prices, particularly if

they are increasing substantially faster than household

income, is that they may place additional financial

stress on prospective homeowners, who may be faced

with higher debt servicing costs. According to the Fed-

eral Reserve Board, in first quarter 2000, the debt ser-

vice burden for the nation (the ratio of consumer debt

payments to disposable personal income) reached the

highest level since first quarter 1988.

A higher con-

sumer debt service burden means households have less

income to cushion against increased or unexpected

financial responsibilities. If the economy slows, house-

hold incomes may decline (or net worth may be

reduced), and households may increase borrowings to

compensate for the loss of income. In that situation,

Data indicated that, nationally, consumer debt service burdens have

risen disproportionately more for lower-income households (incomes

less than $25,000) and mid-income households (incomes between

$25,000 and $50,000) than for higher-income households. Debt ser-

vice burdens by household income level were not available at the state

level. [Federal Reserve Board, Recent Changes in U.S. Family

Finances: Results from the 1998 Survey of Consumer Finances.]

TABLE 4

After Becoming More Affordable

in the 1990s, Homes Became Less

Affordable in 2000

ETRO

AREA

1990 1999 2000

ALBANY

28 16 18

TLANTIC

CITY

30 NA 18

ALTIMORE

22 14 18

ERGEN

–PASSAIC

, N.J. 36 22 29

UFFALO

24 13 14

ONG ISLAND

26 18 22

ONMOUTH

–OCEAN

, N.J. 27 20 23

YORK

CITY

38 24 29

HILADELPHIA

16 11 12

ITTSBURGH 34 19 21

OCHESTER 20 13 14

YRACUSE 22 13 14

RENTON

28 14 NA

ASHINGTON, D.C. 27 17 18

ILMINGTON 25 14 16

United States 24 20 23

Shaded areas are less affordable than the nation.

Data represent percentage of income needed to pur-

chase a median-priced house in the second quarter of

that year.

NA = not available

Sources: National Association of Realtors,

Economy.com, Federal Home Loan Mortgage

Corporation

New York Regional Outlook 8 Fourth Quarter 2000

Regional Perspectives

Debt service burdens also have risen in the Region since

the end of the recession in 1992 (see Table 5). Although

increasing, except for Delaware and Maryland, the

Region’s state debt service burdens were below the

national average at the end of 1999. Higher housing

prices and a greater percentage of renters have con-

tributed to a lower rate of home ownership in New York

and New Jersey. Lower home ownership rates could

cause state debt service burdens to be underestimated

because rent and lease payments are not included in

this measure. High per capita incomes in these states

also contributed to the lower debt service burden ratio.

Nonetheless, the Region’s debt service burdens are

increasing, raising concern about consumer credit

quality.

Region’s Recent Housing Boom Has

Been More Modest than in the 1980s

Although housing prices have increased sharply in parts

of the Region, the strength and duration of the Region’s

current housing boom has been more modest than dur-

ing the period that preceded the 1990–1991 recession.

Even in the Region’s larger cities and adjacent areas,

substantial price appreciation has occurred only during

the past 12 months. In contrast, in many of the Region’s

cities, price appreciation during the housing boom of

the late 1980s lasted for several years.

During that

period, home prices in some of the Region’s areas

increased at double-digit rates every year, compared

with single-digit rates nationally. During the latter half

of the 1990s, the percentage increase of home prices in

the Region was generally less than half that of the

1980s. Moreover, recently, home prices in many of the

Region’s cities have increased less than the national

average.

Sales of existing single-family homes in the Region also

indicate a more modest housing boom than in the

1980s. Data from 33 MSAs in the Region and the nation

show that sales of single-family homes picked up sub-

stantially during the latter half of the 1990s. In the

nation, however, housing sales volume exceeded the

1980s peak in 1993, while in the Region, sales volume

lagged the 1980s peak (see Chart 4, next page). The data

also show a greater percentage decline in home sales in

Chen, Celia. June 30, 2000. “Risky Debt Service Burdens.”

www.Dismal.Com.

Analysis includes information for 21 of the Region’s MSAs, using

housing price data supplied by the Federal Home Loan Mortgage

Corporation and the Federal National Mortgage Association.

TABLE 5

Since 1995, Debt Service Burdens

Have Been Increasing in the Nation

and in Most States in the Region

TATE 1992 1995 1999

DELAWARE 15.1 14.7 15.0

ARYLAND 14.8 15.8 16.2

EW JERSEY 12.5 13.1 12.8

EW YORK 10.2 10.4 10.7

ENNSYLVANIA 11.3 12.1 13.2

United States 11.7 12.7 13.5

Data represent fourth quarter of the year.

Debt service burden is defined as household debt

service as a percentage of disposable income.

Debt burden includes mortgage and consumer install-

ment debt.

Shaded areas are those where debt burdens are

greater than those of the nation.

Source:

Economy.com estimates

the Region than the nation toward the end of 1999 and

through the first half of 2000, which coincided with a

period of rising interest rates and softness in the equity

markets. Because much of the Region’s housing is

located near communities dependent on a vibrant Wall

Street, instability in the stock market and rising interest

rates may have contributed to reduced home sales. A

study linking rising interest rates to changes in the

Region’s gross state product showed that the Region

appears more sensitive than the nation to changes in

interest rates.

Region’s Housing Markets Experiencing

Significant Price Appreciation, although

Not on Par with the 1980s

Historically, residential real estate markets have been

susceptible to boom-and-bust economic cycles. During

the 1980s, several areas of the nation, including Texas

and New England, experienced an economic boom,

strong residential real estate development, and substan-

tial home price appreciation. Subsequent regional reces-

sions took a heavy toll on these residential markets.

Many parts of the New York Region also experienced

significant price appreciation during the late 1980s

“Higher Interest Rates May Curtail the Region’s Economic Expan-

sion.” Regional Outlook, fourth quarter 1999.

For more information regarding residential real estate markets

throughout the nation, see “Rising Home Values and New Lending

Programs Are Reshaping the Outlook for Residential Real Estate.”

Regional Outlook, third quarter 2000.

New York Regional Outlook 9 Fourth Quarter 2000

Regional Perspectives

CHART 4

Note: 2000 is through the first half of the year only.

Sources: National Association of Realtors, U.S. Bureau of the Census, Economy.com

During the 1990s, Single-Family Home Sales in the United States

Exceeded the 1980s Peak; Region Sales Lagged the 1980s Experience

Millions of units

U.S. sales

Region sales

Thousands of units

200

300

400

500

600

700

’82 ’99 ’00’86 ’90 ’95’83 ’84 ’85 ’87 ’88 ’89 ’91 ’92 ’93 ’94 ’96 ’97 ’98

through the early 1990s, as the economy expanded and

incomes improved. Home price appreciation reflected a

booming economy, but it put increasing budgetary pres-

sure on residents who wished to purchase new homes.

Some businesses were unable to locate or expand in

parts of the Region because it was difficult for workers

to find affordable housing. High-housing-cost areas

were particularly vulnerable to a relatively mild nation-

al recession in the early 1990s that harmed the Region

more severely.

Presently, some of the Region’s largest metropolitan

areas are again experiencing significant home price

appreciation, reflecting strong economic conditions and

a limited supply of new homes. Although by most mea-

sures the Region’s current housing boom is not as strong

as that of the late 1980s and early 1990s, price increases

may be forcing consumers in some areas to stretch bud-

gets and increase debt service burdens. These areas,

particularly the communities in New York and New Jer-

sey that are within commuting distance of Wall Street,

are increasingly dependent on strong financial markets.

With consumers’ portfolios flush with huge bonuses

and capital gains, double-digit home price appreciation

can be accommodated. Should the financial markets

become anemic for an extended period, however, the

risk of housing price deflation would increase. In that

event, consumer credit quality could be strained, and

bank collateral values on residential mortgages could be

tested.

New York Region Staff

New York Regional Outlook 10 Fourth Quarter 2000

In Focus This Quarter

Emerging Risks in an Aging Economic Expansion

• The economy and the banking and thrift indus-

tries are reporting generally healthy conditions.

However, the economic expansion is aging, and it

is unlikely that the vigor experienced during the

first half of 2000 can be sustained.

• Likewise, record banking and thrift industry

profits, healthy capital cushions, and good asset

quality of recent years may not be sustainable.

Declining net interest margins, rising commercial

loan losses, tighter liquidity, and riskier asset

composition are among the warning signs that

industry performance may have peaked for this

business cycle.

• Specific areas of concern include growing reliance

on noncore funding; heightened interest rate risk;

increased exposure to market-sensitive revenues;

deteriorating credit quality; rising leverage

among businesses and households; and signs of

imbalance in some residential and commercial

real estate markets.

Although no readily apparent situations or imbalances

suggest that a recession or widespread banking prob-

lems will develop in the near term, warning signs are

present. A highly competitive banking industry shapes

the environment in which pressures on insured institu-

tions are unfolding. The presence of a large share of

newly chartered banks in some areas appears to be rais-

ing the risk profile among all institutions in certain mar-

kets. Publicly owned companies remain under intense

pressure to grow earnings and increase shareholder

value. In addition, local banking environments exist in

which a confluence of risks is generating heightened

vulnerability for all participants, even during healthy

economic times. Complacency in these environments

may have negative repercussions for many insured insti-

tutions going forward.

Imbalances Are Appearing amid a Healthy

Macroeconomic Environment

The performance of the U.S. economy contributes to the

opportunities and risks financial institutions face. The

current cyclical expansion, now nine and one-half years

old, is displaying signs of aging while setting a record

for longevity. A consensus forecast calls for moderate

real gross domestic product (GDP) growth through

2001, following robust gains in the first half of 2000.

Current conditions might be called a “soft landing,” in

which real GDP growth slows to a sustainable noninfla-

tionary rate of 2.5 to 3.5 percent, and unemployment

hovers around recent rates.

Although the current macroeconomic environment

might appear to be the best of all possible worlds, areas

of concern exist. One is that sustained prosperity tends

to foster higher levels of risk taking, overconfidence,

and complacency. For example, the turmoil in world

foreign exchange and financial markets during 1997

and 1998 illustrates how dramatic imbalances can

develop and trigger disruptive adjustments even during

healthy economic times.

Currently, no specific situation or imbalance seems to

threaten the viability of the expansion. However, as

detailed below, several likely will contribute to slower

economic growth. Situations that warrant monitoring

include the following:

• The repercussions from higher energy prices are

unfolding. Historically, oil price shocks have weak-

ened several other long-lived economic expansions.

• Short-term interest rates rose over the past year while

longer-term rates declined, resulting in a modest

inversion of the yield curve. This relationship may

inhibit the profitability of some lenders’ practice of

borrowing short term and lending longer term and

also complicate the interest rate risk management

process for some insured institutions.

• Continuing low unemployment suggests that demand

for additional workers will go unfilled, thus limiting

economic growth or triggering bidding wars that

increase workers’ compensation and, potentially,

inflation.

• Stock market sentiment is no longer strongly bullish.

A pullback from high valuations and optimism could

trigger negative repercussions on consumers’ net

worth and spending as well as on the level of busi-

ness investment.

• A large international trade deficit and strong U.S.

dollar may be an unsustainable combination over the

New York Regional Outlook 11 Fourth Quarter 2000

In Focus This Quarter

long run. Meanwhile, repatriated profits of U.S. cor-

porations are being trimmed by the dollar’s strength

relative to the euro and other currencies.

• Household debt burdens are historically high, with

leverage rising the most in recent years among low-

and middle-income households. These households’

access to credit has increased as lenders competed

more fiercely for customers.

• Corporations are more highly leveraged, and poten-

tial default risk rose in the past year across a range of

industries. Meanwhile, downgrades of publicly trad-

ed corporate debt issues are exceeding upgrades by a

2 to 1 ratio.

• In some metropolitan areas, overheated housing mar-

kets are developing, in which home prices are rising

dramatically and exceeding gains in median

incomes.

• Potential signs of excess commercial real estate con-

struction are appearing in several urban areas where

banks’ construction loan growth also is strong.

Economic indicators of what lies ahead are not clear-

cut, and each possible scenario contains a set of poten-

tial challenges for insured institutions and regulators.

Should economic growth slow considerably, current

vulnerabilities, such as highly leveraged borrowers’

debt loads and overheated housing markets, could wors-

en significantly. As evidenced by the rash of bank fail-

ures during the 1980s, it doesn’t always take a national

recession for problems to develop. Alternatively, sus-

tained rapid growth might foster new vulnerabilities and

allow current imbalances to intensify or build up. For

example, speculative construction could accelerate,

stock market volatility could increase, or ballooning

trade deficits could generate turmoil in foreign

exchange markets.

Signs of Strain Are Also Appearing

amid Healthy Banking and Thrift Industries

With the long economic expansion as a backdrop,

insured institutions in the aggregate are performing

very well. However, the record profits attained in recent

years may not be sustainable. The losses posted recent-

ly by several large institutions are striking examples of

increased appetite for risk resulting in significant finan-

cial loss during a period of strong economic growth.

While these are isolated instances, they are indicative of

the increasingly competitive environment facing the

financial services industry.

Overall industry profitability is beginning to soften, led

primarily by rising commercial loan losses at large insti-

tutions and declining net interest margins in institutions

of all sizes. Credit card loss rates, which had been

steadily falling since late 1997, have stalled in recent

quarters, suggesting that recent increases in interest

rates and energy costs not only are affecting businesses

but also are taking a toll on some consumers. Other

signs suggesting that aggregate risk within the system

has risen include the growing reliance on noncore fund-

ing to support asset growth, heightened interest rate risk

at many institutions, growing concentrations in tradi-

tionally higher-risk loan classes, and a shift in institu-

tions’ overall asset mix toward higher-risk categories. A

brief discussion of these risks follows.

Funding Patterns Heighten Liquidity Concerns

Lackluster core deposit growth is placing pressure on

bank earnings and contributing to rising liquidity risk in

the banking system. During the past five years, the com-

pounded annual rate of core deposit growth for all

insured institutions was just 2.8 percent. Assets over this

time grew at a 6.6 percent rate. Accordingly, a signifi-

cant portion of the industry’s growth has been funded by

noncore sources (see Chart 1). The higher cost and rate

sensitivity of these funds put downward pressure on net

interest margins, particularly in a rising rate environment.

CHART

Most of $2 Trillion of Asset Growth since 1995

Was Funded with Noncore Funds

Subordinated Debt

and Other Liabilities

Equity

22%

Core Deposits

64%

Noncore Funding

Source: Bank and Thrift Call Reports, June 2000 and June 1995

New York Regional Outlook 12 Fourth Quarter 2000

In Focus This Quarter

To compensate for higher funding costs, the industry

has pursued growth in higher-yielding asset classes that

are traditionally both riskier and less liquid. For exam-

ple, almost 37 percent of the asset growth in the past

five years has come from nonresidential real estate and

commercial and industrial loans.

For institutions that fund illiquid assets with wholesale

sources, any adverse events that trigger a lack of confi-

dence in the institution may result in higher funding

costs, thus placing further pressure on margins. In

efforts to obtain funding, an institution also may pledge

a greater portion of its best quality assets as collateral,

further reducing liquidity. Finally, in instances where

funding needs have exceeded available liquidity, the

forced sale of illiquid assets to meet funding outflows

could result in losses if market conditions are unfavor-

able. Presumably, the FDIC, as insurer, would suffer

greater losses if such an institution failed, because it

would be relying on proceeds from the liquidation of

less liquid, and potentially lower-quality, assets to satisfy

the claims of insured depositors.

Subprime lenders, in particular, tend to rely heavily on

noncore funding to pursue aggressive growth strategies.

Chart 2 illustrates the extent to which noncore funding

exceeds the level of liquid assets for this group. The

chart suggests the difficulty these institutions may

encounter if forced to convert assets to meet funding

outflows. Although subprime lenders may use noncore

sources to fund riskier assets to a greater extent than the

industry at large, this illustration exemplifies a systemic

trend that is raising liquidity risk industrywide and is

increasing risk to the insurance funds.

Increasing Levels of Interest Rate Risk

Challenge Some Institutions

The refinancing boom of the late 1990s spurred a sig-

nificant shift into longer-maturity assets for many

insured institutions. During this period, a vast majority

of mortgage borrowers opted for longer-term, fixed-rate

loans, which they obtained at historically low rates. A

great deal of the higher-rate or adjustable-rate loans that

borrowers refinanced were held in the portfolios of

insured institutions, which contributed to a general

lengthening of the maturity of assets held at insured

institutions.

The trend toward longer-term, fixed-rate assets has been

particularly pronounced among mortgage lenders. For

example, state-chartered savings banks, which are tradi-

tionally mortgage lenders, have experienced a dramatic

increase in long-term assets. As of June 30, 2000,

almost 45 percent of the median savings bank’s earning

assets were not scheduled to reprice for five years or

longer (see Chart 3).

Fixed-rate mortgage-related assets at federally char-

tered thrifts have risen similarly. From year-end 1995

through first quarter 2000, the percentage of fixed-rate

mortgage-related assets at thrifts with assets less than

$1 billion rose from 49 percent to 60 percent of

mortgage-related assets. Some thrifts and savings

banks, therefore, have significant exposure to rising

rates from low-yielding long-term assets.

CHART

$ Billions

Source: FDIC Division of Supervision and Bank and Thrift Call Reports (data are

merger adjusted)

Subprime Lenders’ Growing Dependence

on Noncore Funding Strains Liquidity

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

All other loans

Residential real estate loans

Securities and short-

term investments

Columns:

Noncore funding

CHART

Growing Concentration in Long-Term

Assets Elevates Interest Rate Risk

Source: Bank Call Reports, excluding Thrift Financial Report filers

Share of Assets Maturing or Repricing in Five Years or Longer

Relative to Total Earning Assets (median percentage)

Percent

Savings Banks

Commercial Banks

’00’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99

New York Regional Outlook 13 Fourth Quarter 2000

In Focus This Quarter

While most commercial banks do not have as high

exposure to rising rates as savings banks, some may

have taken on significant risk. The median savings bank

has a ratio of long-term assets to earning assets that cor-

responds to the ratio level for the 93rd percentile of

commercial banks. Although the 93rd percentile is in

the tail of the commercial bank distribution, almost 600

commercial banks have a concentration in long-term

assets that exceeds that of the median savings bank.

These institutions may be exposed to significant inter-

est rate risk as well.

While assets have lengthened considerably for many

institutions, there has not been a corresponding exten-

sion of liabilities. To the contrary, funding pressures are

tending to make bank liabilities more rate sensitive.

These diverging trends generate concern, especially in a

rising interest rate environment. That is, rate increases

drive up the cost of funds more rapidly than earning

asset yields at institutions with liability-sensitive inter-

est rate risk postures. In a significantly higher interest

rate environment, many institutions’ current postures

likely would cause heavy margin erosion.

Most institutions that have high concentrations in long-

term assets also have strong capital and an asset mix

that contains lower credit risk than that of many other

institutions. Among savings banks, interest rate risk pri-

marily arises from significant concentrations in residen-

tial mortgage loans, whereas the typical commercial

bank’s exposure is more likely to arise from large hold-

ings of long-term securities. However, some institutions

with concentrations in long-term assets also may have

lower capital levels, a higher-risk asset mix, or poor

earnings. Rising rates could weaken these institutions

and make it more difficult for them to weather adverse

economic or other developments.

Dependence on Market-Sensitive Revenues

Increases Earnings Volatility for Some

Institutions

During the recent generally favorable conditions in finan-

cial markets, the share of revenue earned from business

lines susceptible to financial market volatility has

increased substantially for some of the industry’s largest

institutions. Among these revenue sources are fees and

gains from asset management, brokerage, investment

banking, venture capital, and trading activities. The 19

institutions most active in these lines of business earned

over 26 percent of their net operating income from such

sources in the second quarter of 2000. Other large insti-

tutions also have reported a growing dependence on these

volatile sources of revenue.

Turbulence in the financial markets has led to greater

earnings volatility for some of these institutions. Stress

in the financial markets could weaken the demand for

underwriting services or significantly reduce trading

revenues or venture capital gains. Furthermore, the

same factors that are causing volatility in the financial

markets could hamper loan growth and lead to slower

revenue growth from core business lines. Should

increased earnings volatility from exposure to market-

sensitive revenues combine with slower revenue growth

from core business lines, some institutions could face

significant earnings challenges.

The Rising Level of Problem Business Loans

Is Centered in Large Banks

Second quarter 2000 commercial and industrial (C&I)

credit quality indicators at banks deteriorated for the

eighth consecutive quarter. Noncurrent C&I loans—

those on nonaccrual status plus those 90 days or more

past-due—rose 13 percent over first quarter 2000 levels

to $14.5 billion, or 1.4 percent of total C&I loans. Non-

current loan levels for the period ending June 2000 were

40 percent higher than the year-earlier level. Net C&I

loan loss rates also continue to edge higher but remain

well below those experienced by banks in the late 1980s

and early 1990s.

Large banks, particularly those active in syndicated

lending, are bearing the brunt of deteriorating C&I loan

quality. Recent increases in criticized and classified

shared national credits (SNCs), which are loans exceed-

ing $20 million that are shared among three or more

lending institutions, are illustrated in Chart 4. In the

2000 SNC review, criticized and classified credits

increased 44 percent over 1999 levels to 5.1 percent of

total SNC commitments. Furthermore, the bulk of the

increase was in the more severe classified categories,

which now comprise 64 percent of total criticized and

classified credits, compared with 54 percent at the year-

earlier review.

During second quarter 2000, banks posted an annualized net C&I

loss rate of 0.67 percent, up from 0.55 percent for second quarter

1999. For comparison purposes, net quarterly annualized C&I loss

rates averaged 1.11 percent from fourth quarter 1991 to fourth quarter

1993.

New York Regional Outlook 14 Fourth Quarter 2000

In Focus This Quarter

CHART 4

Note: C&I = commercial and industrial; SNC = shared national credit

Source: Shared National Credit Program

Syndicated Loan Problems Are on the Rise

Percent

$ Billions

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

Criticized and

Classified SNC Loan

Commitments (right

scale)

Percentage of SNC

Commitments Criticized

and Classified (left scale)

100

120

140

C&I loan quality indicators continue to deteriorate

despite generally favorable economic conditions. Three

factors explain much of this deterioration: certain weak

industries, rising corporate debt burdens, and the sea-

soning of syndicated loans underwritten from 1997 to

1998, when many banks significantly eased business

lending standards.

Industry Sector Weaknesses

The financial stresses facing healthcare and entertain-

ment companies (cinema operators in particular) have

been well publicized. While the healthcare and enter-

tainment sectors have contributed significantly to the

decline in commercial credit quality, problems within

these two sectors do not account for the full extent of

the increase in noncurrent loans and problem SNC

loans. Both of these sectors are within the broader ser-

vices sector, which experienced a $4.6 billion increase

in criticized and classified credits from the 1999 to the

2000 SNC review. However, this increase accounts for

only 15 percent of the $30.8 billion increase in criti-

cized and classified SNCs overall.

The expected

default probabilities evident in market-based informa-

tion can be used to identify other industry sectors expe-

riencing financial stress. KMV LLC has developed a

model that uses publicly available information to esti-

mate the likelihood of default of individual firms.

See the interagency release of SNC results at www.occ.treas.gov/

ftp/release/2000-78a.pdf.

KMV Credit Monitor

uses information from a firm’s equity prices

and financial statements to derive KMV’s Expected Default Frequen-

cy (EDF

™

), which is the probability of the firm defaulting within a

one-year period. The main determinants of a firm’s likelihood of

default: the firm’s asset value, the volatility of the firm’s asset value,

and the degree of financial leverage.

KMV’s model is used by many lenders to monitor and

evaluate obligor risk and credit risk trends. Applied to

the analysis of industries, the output of KMV’s model is

just one of a number of indicators that suggest weak-

nesses in certain industry sectors.

Sectors that include a high proportion of firms with

high default probabilities (median one-year default

probabilities exceeding 4 percent) are shown in Chart 5.

Using entertainment as an example, the bars in the chart

show that in September 2000, one-half of publicly held

entertainment firms had greater than an 8 percent

chance of defaulting on their obligations within one

year. In September 1999, this same proportion of enter-

tainment companies had a substantially smaller (6 per-

cent) chance of defaulting within a 12-month period.

The median likelihood of default for all the industries

shown in the chart far exceeds that of Standard &

Poor’s-rated, BB-grade (sub-investment-grade) obligors

as of September 2000, as indicated by the dotted line in

the chart.

Rising Corporate Debt Burdens

U.S. corporate debt burdens, as measured by the debt-

to-net-worth ratio for nonfarm, nonfinancial businesses,

continue to increase. This ratio reached 83 percent in

the second quarter of 2000, up from 72 percent as of

year-end 1996. Although debt burdens remain below the

1988–1992 average of almost 87 percent, U.S. busi-

nesses are nevertheless becoming increasingly vulner-

able to rising credit costs and disruptions in credit

availability.

CHART

Median Expected Default Frequency

(EDF™) (percent)

Various Industries Show High Levels

of Expected Default Risk

Comparative EDF™

of S&P Bonds Rated BB

(as of September 2000)

Healthcare

Entertainment

Apparel &Textile

Wholesale Trade

Lodging

Misc. Manufac.

Construction

Agriculture

Mining

Retail

September 1999

September 2000

New York Regional Outlook 15 Fourth Quarter 2000

In Focus This Quarter

Seasoning of 1997–1998 Vintage Loans

Results of recent supervisory surveys suggest that

banks are tightening terms and conditions on loans to

small-, middle-, and large-market obligors. However,

this tightening follows a relaxation of standards in prior

years that has contributed to a heightened level of risk

in banks’ loan portfolios.

Not coincidentally, the period

between 1995 and 1998 saw a sharp rise in the propor-

tion of lower-graded, higher-risk credits categorized as

leveraged transactions by Loan Pricing Corporation.

Leveraged loan originations—those priced at 150 basis

points or more over the London Inter-Bank Offer Rate

(LIBOR)—rose from 12 percent of total syndicated

loan originations in 1995 to 31 percent in 1999. Accord-

ing to a recent Standard and Poor’s commentary, many

banks have acknowledged that 1997 and 1998 vintage

credits are beginning to produce higher problem loan

levels.

Household Sector’s Leverage Is High,

and Imbalances Are Appearing

Consumers are enjoying the benefits of the economic

expansion, as jobs are plentiful, home ownership

remains generally affordable, and credit seems to be

readily available for financing motor vehicles and other

major purchases. These conditions contributed to record

high sales of cars and light trucks during the first nine

months of 2000, helping sustain the consumer spending

growth shown in Chart 6. One corollary of high vehicle

sales, however, is softening prices for used vehicles.

Consequently, some lessors—including banks—are

realizing lower-than-expected residual values on leased

vehicles, which, in turn, are triggering losses in their

lease portfolios. This situation illustrates one problem

that lenders can encounter even in good economic

times.

Spending growth remained robust in recent quarters

even as gains in disposable income slowed. The gap

between income and spending growth is “financed” as

households draw down savings, tap capital gains, refi-

nance mortgages, assume more debt, or undertake some

combination of these measures.

See Federal Reserve Board’s Senior Loan Officer Opinion Survey on

Bank Lending Practices for May and August 2000 and Surveys of

Credit Underwriting Practices for 1999 and 2000 from the Office of

the Comptroller of the Currency.

“U.S. Bank Loan Portfolios Reflect Rise in Corporate Bond

Defaults.” July 20, 2000. Standard and Poor’s Commentary.

CHART 6

Household Spending Growth

Exceeds Income Growth

Source: Bureau of Economic Analysis via Haver Analytics, Inc.

Real Consumption Spending

Real Disposable Income

–1

Annual Growth Rate (percent)

’86 ’87 ’88 ’89 ’90 ’91’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99’00

Quarter 3

From 1995 through 1998, and likely since then, the

increase in both leverage and debt servicing burdens has

been concentrated among low- and middle-income

households. Among families holding debt in 1998, debt

payments exceeded 40 percent of disposable income for

nearly 20 percent in the $10,000 to $24,999 income

group and nearly 14 percent in the $25,000 to $49,999

group.

One concern is that these debt-laden families

may have inadequate financial resources to make pay-

ments should adverse conditions or job loss occur. In

such instances, lenders could be doubly affected if

households draw on their credit card and home equity

lines of credit, further compromising their repayment

ability, in order to sustain spending in excess of income.

The recent rise in credit card losses in banks’ card port-

folios and rising losses in the portfolios of subprime

lending specialists may indicate that strains among

some households are spilling over to lenders. Moody’s

Investors Service expects credit card losses to rise

through 2001, according to a recent analysis of

prospects for the U.S. credit card industry.

Overheated residential real estate markets in several

metropolitan statistical areas (MSAs) may be another

warning of economic imbalances. Dramatic gains in

home resale prices in San Francisco stand out (see Chart

7), but this market is not alone in experiencing appre-

ciation considerably higher than income growth. In

some markets, where financial-services or information-

technology workers are concentrated, bidding wars for

properties may reflect the fact that affordability is

Kennickell, Arthur B., Martha Starr-McCluer, and Brian J. Surette.

January 2000. “Recent Changes in U.S. Family Finances: Results

from the 1998 Survey of Consumer Finances.” Federal Reserve

Bulletin. Vol. 86, 1–29.

New York Regional Outlook 16 Fourth Quarter 2000

In Focus This Quarter

enhanced by gains in wealth rather than in income.

Even so, similar surges in home resale prices in the

past often were not sustainable. The subsequent years

of stagnant or falling collateral values caused financial

stress among some homeowners and their lenders.

Further concern about residential real estate lenders

arises because pockets of speculative construction

under way in some markets may produce units that

become increasingly difficult to sell at anticipated ask-

ing prices.

Construction and Development

Loan Growth Is Accelerating

Commercial real estate (CRE) construction across all

property sectors has grown during this expansion, with

office construction particularly active. The amount of

office space completed in mid-2000 was the largest

since 1989 and is projected by Torto Wheaton Research

to continue rising. Not surprisingly, construction and

development (C&D) loan volume, growth rates, and

concentrations are trending upward rapidly. While total

private real estate spending grew about 6.5 percent over

the four quarters ending midyear 2000, C&D loans at

insured institutions rose by 26 percent. C&D loan

growth has remained above 20 percent since 1997, and

the aggregate volume of C&D loans is the highest since

1989.

Such growth is contributing to higher concentrations of

C&D loans relative to Tier 1 capital. At current levels,

concentrations do not begin to approach those of the

late 1980s. However, several metropolitan areas have a

CHART

Median Home Resale Prices Soar

in San Francisco Bay Area

Percent Change from

Four Quarters Earlier

–5

–10

’80

’00

’82

’84

’86

’88

’90

’92

’94

’96

’98

Quarter 1

Source: National Association of Realtors via Haver Analytics, Inc.

large percentage of insured institutions reporting high

and rising concentrations. Table 1 (next page) shows

MSAs with at least 15 nonspecialized community

banks

and at least one-third of those institutions report-

ing concentrations in C&D loans equal to at least 100

percent of Tier 1 capital. The Atlanta MSA stands out.

Sixty-five percent of Atlanta’s 85 nonspecialized com-

munity institutions reported C&D loans exceeding 100

percent of Tier 1 capital on June 30, 2000, and 35 per-

cent reported a concentration exceeding 200 percent.

The aggregate C&D concentration for all 85 institutions

in the MSA was 156 percent, the highest among MSAs

with at least 15 institutions of similar size and nature.

Several other markets also include significant shares of

institutions with high concentration levels.

Nine of the 16 markets highlighted in Table 1 not only

have a relatively high percentage of C&D loan expo-

sure but also appear vulnerable to overbuilding in two

or more property types.

While these markets show no

clear signs of emerging economic stress, lenders there

clearly may be at greater risk should economic or real

estate conditions sour. Other concerns regarding CRE

lending arise from a recent Office of the Comptroller

of the Currency survey, which reports heightened

credit risk in CRE portfolios and predicts it will

increase through 2001. In addition, respondents to a

midyear 2000 FDIC survey of examiners reported

more frequent comments about excess office and retail

space.

Increasing Share of De Novo Institutions

Raises the Stakes in Some Markets

A common element among the metropolitan markets

listed in Table 1 (next page) is the presence of newer

institutions. In 10 of the 16 markets, at least 20 percent

of the nonspecialized community institutions are less

than three years old. The drive to build market share

among these institutions, particularly if they are pub-

licly traded entities, is increasing the competitive pres-

sure on banks and thrifts in these markets. In some

instances, the aggregate cost of deposits within the

MSAs has risen faster than in the nation as a whole, risk

The term “nonspecialized community bank” refers to institutions

with total assets under $1 billion that are not specialty institutions

such as credit card or trust banks.

See “Ranking Metropolitan Areas at Risk for Commercial Real

Estate Overbuilding,” Regional Outlook, third quarter 2000, which

identifies markets where new construction is high relative to existing

stocks of space.

New York Regional Outlook 17 Fourth Quarter 2000

In Focus This Quarter

TABLE 1

High C&D Loan Exposure Appears in Various MSAs

HARE (%) OF AGGREGATE C&D LOANS

MSAS WITH 15 OR INSTITUTIONS* WITH C&D RELATIVE TO AGGREGATE

MORE NONSPECIALIZED CONCENTRATIONS > OR = TIER 1 CAPITAL (AS %)

OMMUNITY INSTITUTIONS* 100% OF TIER 1 CAPITAL IN THIS MSA*

ATLANTA, GA 65 156

HOENIX–MESA, AZ 56 131

MEMPHIS, TN–AR–MS 52 154

PORTLAND–VANCOUVER

, OR–WA 47 146

OAKLAND, CA 47 163

ASHVILLE, TN 44 103

IVERSIDE–SAN B

ERNARDINO, CA 42 110

AN DIEGO

, CA 41 90

RAND RAPIDS

–M

USKEGON–HOLLAND, MI 40 81

SEATTLE

–BELLEVUE–E

VERETT, WA 39 98

ALT

LAKE C

ITY–OGDEN, UT 38 56

ORT

WORTH

–ARLINGTON, TX 38 110

ALLAS, TX 36 95

AS V

EGAS, NV–AZ 35 119

LEXINGTON, KY 34 80

DENVER, CO 33 113

*Sample includes institutions with total assets under $1 billion that are not specialty institutions such as credit

card or trust banks.

Note: Boldface indicates major MSAs identified at risk for excess commercial real estate construction in Regional

Outlook, third quarter 2000.

C&D = construction and development, MSA = metropolitan statistical area

Source: Bank and Thrift Call Reports for June 30, 2000

profiles are being elevated, and aggregate leverage ratios

are falling, despite the influx of capital from the new

institutions. Highly competitive environments have the

potential to increase risk taking by negatively affecting

underwriting standards and balance sheet composition.

Farm Sector Challenges Continue

Much of the agricultural industry is experiencing

stress because of low commodity prices, compounded

in some areas by low yields resulting from weather- or

disease-related problems. Strong global competition

and high worldwide production during the past sever-

al years have resulted in large crop inventories,

depressed prices, and limited prospects for a price

turnaround in the near term. In the aggregate, record

levels of government payments have helped the

nation’s farms maintain a generally stable financial

condition but have not eliminated the stress in this sec-

tor. In fact, the U.S. Department of Agriculture pro-

jects that at least one in four farm businesses in sever-

al regions

will not cover net cash expenses in 2000,

suggesting that the viability of highly leveraged farm-

ers may be in question.

Fortunately, the aggregate condition of nearly 2,100

insured agricultural banks—institutions with 25 percent

or more of loan portfolios in agricultural credits—

remains healthy. Generally, agricultural banks continue

to report favorable asset quality, earnings, and capital

positions. However, they are experiencing somewhat

elevated levels of noncurrent loans compared with

nonagricultural institutions. Agricultural banks are dis-

proportionately represented among the weakest 25 per-

cent of institutions nationwide in terms of noncurrent

These are USDA’s Basin and Range, Mississippi Portal, Fruitful

Rim, and Southern Seaboard regions. See www.ers.usda.gov/

briefing/farmincome/fore/regional/regional.htm.

New York Regional Outlook 18 Fourth Quarter 2000

In Focus This Quarter

loan levels. In addition, rising levels of carryover debt at

farm banks may translate into higher losses in the future

if commodity prices remain low.

The strains in the farm sector also have implications for

nonfarm banks in agricultural areas. In several agriculture-

dependent states, such as Montana and the Dakotas, for

example, where farmers’ earnings are depressed and the

economies not well diversified, nonagricultural banks

are reporting higher noncurrent levels than insured

institutions elsewhere in the nation.

Summary

The long-lived economic expansion has contributed to

the banking and thrift industries’ record levels of prof-

itability and asset quality. However, as the expansion has

matured, both consumer and corporate leverage has risen

considerably. Bank liquidity is becoming increasingly

strained by lackluster core deposit growth, which has

been insufficient to fund strong loan demand. This trend

has resulted in a decided shift into higher-risk asset

classes to mitigate margin pressures arising from the

greater reliance on noncore-funding sources. Further-

more, interest rate risk has risen significantly for many

institutions, and after nearly a decade of improving asset

quality, the level of problem loans is increasing.

Clearly, high levels of profitability in recent years have

been achieved, in part, by an increased appetite for risk.

Concern arises because insured institutions’ current

profitability is being negatively affected by some recent

trends, despite the sustained economic expansion. And,

while capital levels have remained fairly stable, the

amount of risk being leveraged on the industry’s capital

base is on the rise. Just as a rising tide is said to float all

boats, a strong economy can mask potential problems

that will become evident should the economic tide turn,

particularly in institutions or markets where above-

average risk is concentrated. Insured institutions’ safety

and soundness may be most vulnerable in situations

where banks and thrifts are exposed to multiple chal-

lenges, whether because of strategic decisions or

because of repercussions from economic and banking

forces beyond their control.

Daniel Frye, Regional Manager

Joan D. Schneider, Regional Economist

Steve Burton, Senior Banking Analyst

Allen Puwalski, Senior Financial Analyst

Ronald Spieker, Chief, Regional Programs

and Bank Analysis

The authors would like to acknowledge

the Washington and regional staff of

both the Division of Insurance and

the Division of Supervision for their

analyses and comments, which were

instrumental in writing this article.

New York Regional Outlook 19 Fourth Quarter 2000



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

N4q2000 Regional Outlook - New York - Fourth Quarter 2000

View Audit Log
Print With Audit Log
Duplicate Document

Fill Online, Printable, Fillable, Blank N4q2000 Regional Outlook - New York - Fourth Quarter 2000 Form

Related forms

Fillable N4q2000 Regional Outlook - New York - Fourth Quarter 2000

Fill Online, Printable, Fillable, Blank N4q2000 Regional Outlook - New York - Fourth Quarter 2000 Form

Related forms

First 20 documents completely FREE!