Remarks
By
Donna Tanoue
Chairman
Federal Deposit Insurance Corporation
Before
RMA's Annual Conference of Lending and Credit Risk Management Nashville,
Tennessee
November 14, 2000
Effective risk management is the bank manager's most important bulwark against credit
loss and bank failure. This is true not only in bad times, but in the best of times.
A century ago, Nashville was triumphantly riding the crest of a strong economic
expansion, whose remnants can still be seen and enjoyed today just 13 miles from
here: Centennial Park - the Parthenon - and the magnificent Union Station.
That boom ended - just like they all do.
Today, the United States is triumphantly riding the wave of the longest economic boom
in our history. As of November 2000, we entered our 115th straight month of expansion.
With this expansion has come the most profitable period in banking history. Record
commercial bank profits have been reported each year since 1992. These record profits
have been accompanied by an equally impressive decline in non-performing bank
assets - from 3.02 percent of total assets in January 1992 to .066 percent as of June 30,
2000.
Real estate markets have become particularly robust in the past decade. Office
Vvacancy rates nationally stood at 8.1 percent through the first half of 2000.
This growth in real estate markets is reflected on bank balance sheets. Commercial real
estate loans grew from $258 billion at the end of 1992 to $447 billion through June of
this year. Construction and development loans have more than doubled to $150 billion
from their low point of $62.6 billion at mid-year 1994.
Much of this growth has occurred over the past two and a half years. In 1998,
construction and development loans grew 21 percent. In 1999, construction and
development loans grew 27 percent. Through June 2000, they grew at a 23.5 percent
annualized rate.
And that brings one to wonder: Can there be too much of a good thing?
I'm not the only one asking questions like that.
By
Donna Tanoue
Chairman
Federal Deposit Insurance Corporation
Before
RMA's Annual Conference of Lending and Credit Risk Management Nashville,
Tennessee
November 14, 2000
Effective risk management is the bank manager's most important bulwark against credit
loss and bank failure. This is true not only in bad times, but in the best of times.
A century ago, Nashville was triumphantly riding the crest of a strong economic
expansion, whose remnants can still be seen and enjoyed today just 13 miles from
here: Centennial Park - the Parthenon - and the magnificent Union Station.
That boom ended - just like they all do.
Today, the United States is triumphantly riding the wave of the longest economic boom
in our history. As of November 2000, we entered our 115th straight month of expansion.
With this expansion has come the most profitable period in banking history. Record
commercial bank profits have been reported each year since 1992. These record profits
have been accompanied by an equally impressive decline in non-performing bank
assets - from 3.02 percent of total assets in January 1992 to .066 percent as of June 30,
2000.
Real estate markets have become particularly robust in the past decade. Office
Vvacancy rates nationally stood at 8.1 percent through the first half of 2000.
This growth in real estate markets is reflected on bank balance sheets. Commercial real
estate loans grew from $258 billion at the end of 1992 to $447 billion through June of
this year. Construction and development loans have more than doubled to $150 billion
from their low point of $62.6 billion at mid-year 1994.
Much of this growth has occurred over the past two and a half years. In 1998,
construction and development loans grew 21 percent. In 1999, construction and
development loans grew 27 percent. Through June 2000, they grew at a 23.5 percent
annualized rate.
And that brings one to wonder: Can there be too much of a good thing?
I'm not the only one asking questions like that.
Your president and CEO Al Sanborn recently wrote to you about rising risk levels. He
pointed out the increased level of problem loans identified in the Shared National Credit
Review exam, the increased corporate leverage, and increases in default rates.
We agree that these are worrisome trends. In addition to these trends, we believe that
some banks have developed certain portfolio characteristics that leave them vulnerable
to potential softening in local real estate markets.
The FDIC has been acting recently as a kind of economic weatherman. We've pointed
out that a number of cities nationwide are at risk for overbuilding commercial real estate.
This does not necessarily mean that these cities are headed inevitably for the kind of
real estate crisis we experienced in the late 1980s and early 1990s. A tornado watch
does not mean severe weather is inevitable. It does, however, mean that conditions
exist for the development of a tornado and that one needs to keep up to date on the
latest weather information.
In the same way, FDIC's recently-released list of cities at risk for overbuilding
commercial real estate"at-risk" list means that bankers in those markets need to keep a
weather eye out, because conditions are favorable for damage to occur in the event of
an economic downturn.
Problems in commercial real estate markets were integral to the 1980's banking crisis in
the United States and were at the heart of the banking crisis in Asia in 1997-1998.
Therefore, the FDIC is especially watchful of steadily increasing volumes of construction
and development loans and commercial real estate loans in the banking industry in
general, particularly when these loans are concentrated in certain markets.
That's why the FDIC two years ago began developing an offsite model for identifying
banks that may be susceptible to a downturn in the local commercial real estate market.
In order to develop a method for identifying these banks, we needed to analyze a
previous real estate crisis.
We chose the New England experience of the early 1990s because the history of the
crisis was very clear., and the crisis occurred well after the Tax Reform Act of 1986 You
may remember that the New England economy had grown rapidly following the 1981-82
recession. Five years later, New England was enjoying a booming commercial and
residential real estate market, and, by the beginning of 1988, the unemployment rate
had fallen to 3 percent.
But the stock market crash in October 1987, combined with other factors such as the
decline in defense spending as the Cold War ended, resulted in a sharp decline in New
England's economy and a collapse in the real estate markets.
With this well-defined economic scenario as a basis, o Our model asks one pointed
question: What would happen to banks today if they encountered a real estate crisis
similar to that of the New England Crisis? At the core of the model is a comparison of
pointed out the increased level of problem loans identified in the Shared National Credit
Review exam, the increased corporate leverage, and increases in default rates.
We agree that these are worrisome trends. In addition to these trends, we believe that
some banks have developed certain portfolio characteristics that leave them vulnerable
to potential softening in local real estate markets.
The FDIC has been acting recently as a kind of economic weatherman. We've pointed
out that a number of cities nationwide are at risk for overbuilding commercial real estate.
This does not necessarily mean that these cities are headed inevitably for the kind of
real estate crisis we experienced in the late 1980s and early 1990s. A tornado watch
does not mean severe weather is inevitable. It does, however, mean that conditions
exist for the development of a tornado and that one needs to keep up to date on the
latest weather information.
In the same way, FDIC's recently-released list of cities at risk for overbuilding
commercial real estate"at-risk" list means that bankers in those markets need to keep a
weather eye out, because conditions are favorable for damage to occur in the event of
an economic downturn.
Problems in commercial real estate markets were integral to the 1980's banking crisis in
the United States and were at the heart of the banking crisis in Asia in 1997-1998.
Therefore, the FDIC is especially watchful of steadily increasing volumes of construction
and development loans and commercial real estate loans in the banking industry in
general, particularly when these loans are concentrated in certain markets.
That's why the FDIC two years ago began developing an offsite model for identifying
banks that may be susceptible to a downturn in the local commercial real estate market.
In order to develop a method for identifying these banks, we needed to analyze a
previous real estate crisis.
We chose the New England experience of the early 1990s because the history of the
crisis was very clear., and the crisis occurred well after the Tax Reform Act of 1986 You
may remember that the New England economy had grown rapidly following the 1981-82
recession. Five years later, New England was enjoying a booming commercial and
residential real estate market, and, by the beginning of 1988, the unemployment rate
had fallen to 3 percent.
But the stock market crash in October 1987, combined with other factors such as the
decline in defense spending as the Cold War ended, resulted in a sharp decline in New
England's economy and a collapse in the real estate markets.
With this well-defined economic scenario as a basis, o Our model asks one pointed
question: What would happen to banks today if they encountered a real estate crisis
similar to that of the New England Crisis? At the core of the model is a comparison of