Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION THIRD QUARTER 1999 

FDIC
 

Memphis
 

Region
 

Division of
 

Insurance
 

Gary L. Beasley,
 

Regional Manager
 

Robert L. Burns,
 

Senior Financial
 

Analyst
 

F. Miguel Hasty,
 

Financial Analyst
 

In Focus This Quarter 

◆ Falling Prices in Commodities and Manufacturing Pose Continuing 

Risks to Credit Quality—Falling prices are causing problems for a wide range 

of commodity industries—a collection of agricultural, mining, and manufacturing 

industries that produce standardized products and face global competition, mostly 

on the basis of price. Firms in these industries have experienced slow or negative 

profit growth even as they reduce payrolls to cut costs. There are signs that these 

trends are contributing to higher credit risk for insured institutions. The effects of 

these problems on local economies and community banks could grow if low prices 

persist. See page 3. 

By Richard A. Brown and Alan Deaton 

◆ Shifting Funding Trends Pose Challenges for Community Banks— 

Several long-term trends are making it more difficult for some institutions to economically fund asset growth with deposits in today’s marketplace. As a result, 

traditional measures of liquidity and liability composition for commercial banks 

reflected record-low levels of deposit funding at year-end 1998. The need to augment lagging deposit growth to meet loan demand has led many community banks 

to seek more wholesale funding sources, particularly borrowings. If the trend 

toward greater reliance on nondeposit funding continues, liability management 

may become more important and more challenging for community banks that have 

historically relied upon deposits for funding and net interest revenues for profitability. See page 11. 

By Allen Puwalski and Brian Kenner 

Regional Perspectives 

◆ Regional Economic and Banking Conditions—Employment growth 

remains stagnant, with slowing growth reported in most sectors other than the 

rapidly growing construction segment. The gaming industry also continues to 

expand. Within a generally weak manufacturing sector, the automobile industry is 

performing well, but rising gas prices could lead to slower sales for larger vehicles. 

Continuing weakness in the agricultural sector could affect agricultural lenders. 

Overall, banking conditions remain strong, although earnings performance continues to decline on lower net interest margins. See page 18. 

◆ Funding Issues—Funding sources have changed as deposit growth has 

lagged loan growth during this expansion. Greater use of noncore funding sources 

appears to be one factor contributing to lower net interest margins. Such funding 

sources tend to exhibit greater volatility and carry higher interest costs than more 

traditional core funding sources. See page 21. 

By the Memphis Region 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 for the following eight geographic regions: 

Atlanta Region (AL, FL, GA, NC, SC, VA, WV)
 

Boston Region (CT, MA, ME, NH, RI, VT)
 

Chicago Region (IL, IN, MI, OH, WI)
 

Dallas Region (CO, NM, OK, TX)
 

Kansas City Region (IA, KS, MN, MO, ND, NE, SD)
 

Memphis Region (AR, KY, LA, MS, TN)
 

New York Region (DC, DE, MD, NJ, NY, PA, PR, VI)
 

San Francisco Region (AK, AZ, CA, FJ, FM, GU, HI, ID, MT, NV, OR, UT, WA, WY)
 

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

form found on the back cover to the FDIC Public Information Center. Contact the Public Information Center for current pricing on bulk orders. 

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

publish/regout. For more information or to provide comments or suggestions about the Memphis 

Region’s Regional Outlook, please call Gary Beasley at (901) 821-5234 or send an e-mail to 

gbeasley@fdic.gov. 

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

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

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

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

the Federal Deposit Insurance Corporation. 

Chairman Donna Tanoue 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Publications Manager Teresa J. Franks 
In Focus This Quarter
 

Falling Prices in Commodities and Manufacturing 


Pose Continuing Risks to Credit Quality
 

•	 Prices have fallen sharply across a wide range of 

commodities and manufactured goods. 

•	 Signs of stress are apparent in some industry 

sectors. 

•	 These trends are contributing to rising credit risk 

for insured institutions. 

•	 Effects on local economies and community banks 

could grow if low prices persist. 

The performance of the U.S. economy during the midto late-1990s has been generally positive for banking. 

Economic activity grew in 1998 at an inflation-adjusted 

rate of 3.9 percent for the second consecutive year. Continued low inflation has helped to hold interest rates low 

and extend the expansion into its ninth consecutive year. 

However, one downside of low inflation has been that 

firms in certain commodity industries have encountered 

slow or negative growth in revenues because of the low 

prices they receive for their products. 

Commodity industries are defined in this article as a 

collection of agricultural, mining, and manufacturing 

industries that produce standardized products and face 

global competition, mostly on the basis of price. Since 

the beginning of 1997, price weakness has extended 

across a wide range of commodity industries, from agricultural products to oil, chemicals, textiles, paper, semiconductors, steel, and even some segments of the auto 

industry. While many firms have retooled and restructured to cut costs, clear signs of financial stress have 

become apparent. 

The potential importance of problems in commodity 

industries to the FDIC was illustrated by the banking 

problems related to oil and agriculture during the 1980s 

and early 1990s. As documented in a 1997 study by the 

FDIC Division of Research and Statistics, regional 

economic dislocations related to declining farmland 

values and declining oil prices contributed to large 

increases in credit losses and the eventual failure of 

hundreds of federally insured banks and thrifts. The 

analogy to the 1980s is far from perfect—for example, 

oil and agriculture have not experienced booms comparable to those that preceded their collapse in the 

1980s—but exposures to commodity industries remain 

important for many insured institutions. 

This article summarizes recent adverse trends in commodity and manufacturing sectors and discusses why 

industry-sector problems are important in banking. It 

takes a high-level approach, emphasizing the economic 

fundamentals that are driving prices across the economy 

while ignoring many of the industry-specific factors 

that are also driving the performance of individual sectors. The goal is to evaluate the effects of these trends 

on bank credit quality if they persist through 1999 and 

beyond. 

Prices Have Been Declining across a Range 

of Commodities and Manufactured Goods 

Low inflation has been a boon for consumer spending 

and business investment during the economic expansion 

of the 1990s. As of March 1999, the Consumer Price 

Index had risen at an annualized rate of less than 2.0 

percent for 8 consecutive quarters and at an annualized 

rate of less than 4.0 percent for 

33 consecutive quarters. The 

prices of many popular and 

essential consumer goods— 

from computers to gasoline— 

have generally fallen throughout 

the decade, even as the prices of 

most services continue to rise 

steadily. Businesses, too, have 

benefited from the ability to 

purchase goods cheaply, as well as from the generally 

low interest rates that have accompanied low inflation. 

The declining average wholesale price of goods is 

reflected in Chart 1 (next page), which shows changes 

in the producer price index (PPI) and some of its key 

components since the beginning of 1997. The PPI 

focuses on goods, omitting changes in the price of services. The decline of nearly 5 percent in the PPI since 

the beginning of 1997 has been led by falling prices for 

mining products, petroleum, and steel. Moreover, economy-wide price declines for wholesale goods have been 

steady over time, with the PPI registering year-over-year 

declines for 26 consecutive months through May 1999. 

Memphis Regional Outlook 3	 Third Quarter 1999 
In Focus This Quarter
 

CHART 1	 CHART 2 

Widespread Pricing Pressures Are Evident in the 

Components of the Producer Price Index 

Percent Change in Selected Components of the Producer Price 

Index, January 1997 to May 1999 

–45 

–40 

–35 

–30 

–25 

–20 

–15 

–10 

–5 

0 

Agricultural Prices Are Down Sharply Since 1997 

Percent Change in Reported Price Between 

January 1997 and May 1999 

Source: Wall Street Journal (Haver Analytics) 

Cotton 

Corn 

Hogs 

Wheat 

10 

5 

0 

–5 

–10 

–15 

–20 

–25 

–30 

–35 

–40 

Source: Bureau of Labor Statistics (Haver Analytics) All Commodities Lumber & Wood Chemicals Textiles Automobiles Electrical Machinery 

Iron & SteelPetroleumProductsMining 

3.3 

–4.0 

0.6 –1.9 –2.5 –2.5 

–10.0 

–19.8 

–33.2 

Although they are only indirectly included in the PPI 

numbers, the prices of several important agricultural 

commodities have also fallen substantially. Chart 2 

shows that the price of wheat has fallen by more than 35 

percent since January 1997, with the price of corn, 

hogs, and cotton also registering double-digit rates of 

decline. While the price of hogs has rebounded significantly since the end of 1998—more than doubling from 

its low of less than 15 cents per pound—prices for corn, 

wheat, and cotton continued to decline through May 

1999. 

Reasons for Broad-Based Commodity 

Price Weakness 

Pricing trends in disparate industries such as electronics 

and agriculture, or oil and steel, are driven in part by 

industry-specific factors. For example, weather patterns 

heavily influence agricultural prices, while global politics tends to drive world oil price levels. In manufacturing, technological developments can significantly alter 

the demand for a product or its cost of production, 

thereby influencing its market price. For example, 

improvements in semiconductor manufacturing techniques—from shrinking the size of chips to using larger 

silicon wafers—have significantly increased production 

yields in that industry during the 1990s.1 

However, the pervasiveness of recent price declines 

across a wide range of commodities and manufactured 

1 See “Semiconductor Industry Trends,” Standard and Poor’s Industry 

Surveys, May 27, 1999, p. 4. 

goods suggests that a number of common factors are 

driving prices lower: 

•	 Low inflationary expectations. Since 1980, inflation rates have gradually declined worldwide as central banks shifted their focus toward price stability. 

Disinflation has profoundly altered the expectations 

of investors, consumers, and businesses, and in the 

process has altered the course of events in individual markets and in the economy as a whole. As a 

result, commodities have lost much of their appeal 

as a hedge against inflation. This has contributed to 

a decline of more than 50 percent in the price of 

gold since 1980. The expectations of many businesses have also changed, because with less pricing 

power they must continually cut costs to remain 

competitive. 

•	 Overcapacity because of large-scale investment. 

Global investment in productive capacity accelerated 

during the early to mid-1990s in a number of commodity and manufacturing industries. Many U.S. 

firms have implemented new technologies and 

moved their operations closer to their markets or to 

areas where low-cost labor is available. For example, 

major U.S. and foreign automakers have invested billions of dollars in recent years in new production 

facilities in the emerging markets of Asia and Latin 

America as part of a “build-where-you-sell” strategy.2 Because these additions to capacity largely have 

not been offset by the closure of existing plants, analysts say that global productive capacity in autos 

2 Barbara McClellan, “Asia Woes Worsen,” Ward’s Auto World, 

November 1998, pp. 28–31. 

Memphis Regional Outlook 4	 Third Quarter 1999 
In Focus This Quarter
 

could exceed demand by more than 20 million units 

annually by 2000.3 A similar situation has developed 

in the semiconductor industry, where capital investment in chipmaking equipment tripled between 1993 

and 1996, contributing to a glut of memory chips and 

plunging prices.4 

•	 Curtailed global demand in the wake of emerging 

market crises. The economic crises that have developed in Asia, Russia, and parts of Latin America 

since 1997 have crimped global demand for commodities and manufactured goods. For example, 

demand for new cars in Korea fell by 50 percent in 

1998.5 Asia received approximately 30 percent of 

U.S. feed grain exports in 1996, but declining Asian 

demand since then has contributed to a sharp decline 

in global grain prices. The slowdown of economic 

activity in crisis countries and the resulting decline 

in their demand for imports is only one factor that 

has hurt the pricing power of U.S. producers. Another problem is the pricing advantage conferred on 

countries that have experienced currency devaluation. Firms operating in a country that has devalued 

its currency experience a reduction in the price of 

their exports in U.S. dollar terms. This process further depresses the pricing power of U.S. farmers and 

businesses that sell their goods in global markets. 

Recently, there have been signs that some hard-hit Asian 

economies may soon begin to recover. However, the 

other factors cited above—low inflationary expectations and rapid investment in productive capacity—may 

well be longer-term trends. In any event, U.S. farmers 

and businesses that participate in commodity industries 

must be prepared for the possibility that pricing pressures will not dissipate in the near term. 

Signs of Stress Are Showing 

for Affected Industry Sectors 

As commodity prices continue to stagnate, signs of 

stress are emerging among firms in the commodity 

industries. A long-term trend toward reduced levels of 

employment in manufacturing has accelerated in the 

midst of the current economic expansion. Chart 3 shows 

that employment levels declined in a wide range of 

commodity industries in the 24 months ending in May 

3 “1997 Automotive Outlook,” Automotive Industries. This report is
 

available at http://www.ai-online.com.
 4 “Semiconductor Industry Trends” (1999), p. 3.
 

5 Barbara McClellan (1998).
 

CHART 3 

Total Percent Change in Payroll Employment, May 1997 to May 1999 

Employment Levels Have Declined across a Wide 

Range of Commodity and Manufacturing Sectors 

* Percent change between 1997 and 1998 based on county-level estimates 

of payroll employment in agriculture and agricultural services 

Sources: Bureau of Labor Statistics (Haver Analytics); WEFA 

Electronics and Semiconductors 

Textiles 

Autos 

Primary Metals/Iron and Steel 

Chemicals 

Oil and Gas 

Mining 

Lumber and Paper 

Agriculture* 

–20 –15 –10 –5 0 

1999. The total manufacturing sector lost more than 

420,000 jobs during that period, while another 64,000 

jobs were lost in the mining sector, which includes oil 

and gas extraction. The trend toward lower levels of 

employment in mining and manufacturing not only 

reflects pricing pressures but also attempts by firms in 

these sectors to maintain profitability by investing in 

labor-saving technologies. 

The profit picture has begun to deteriorate as well for 

firms operating in commodity industries. Four-quarter 

trailing earnings through March 1999 for oil-sector 

firms in the Standard & Poor’s 500 dropped by more 

than 44 percent from a year ago (see Chart 4), while the 

earnings of steel firms fell by almost 32 percent. The 

losses experienced by firms in some of these industrial 

sectors extended to the farm sector as well, where net 

CHART 4 

–50 –40 –30 –20 –10 0 10 20 

Agriculture* 

Year-over-Year Percent Change in Earnings from Continuing Operations 

for S&P 500 Companies, by Sector, for the Year Ending in March 1999 

Earnings Have Declined across a Wide Range 

of Commodity and Manufacturing Sectors 

Oil and Gas 

* 1998 percent change in net farm income 

Sources: Standard and Poor’s (Bloomberg); U.S. Department of Agriculture 

Lumber and Paper 

Mining 

Chemicals 

Primary Metals/Iron and Steel 

Autos 

Textiles 

Electronics and Semiconductors 

Memphis Regional Outlook 5	 Third Quarter 1999 
In Focus This Quarter
 

incomes fell by more than 7 percent in 1998, according 

to the U.S. Department of Agriculture. 

Affected Industries Have Found Ways to Cope 

with Pricing Pressures Thus Far 

Despite the signs of stress in industries where prices are 

weak or declining, U.S. farmers and industrial firms 

have shown themselves to be fairly resilient thus far in 

their ability to cope with the situation. Agricultural producers have been making greater use of carryover debt 

to keep their operations running even if they were not 

able to fully retire their operating loans during the previous crop year. The FDIC Report on Underwriting 

Practices shows that 29 percent of FDIC-supervised 

agricultural lenders reported at least a moderate 

increase in carryover debt during the six-month period 

ending in March 1999, compared with only 10 percent 

in March 1998. Although the use of carryover debt is 

not an uncommon practice in agriculture, it indicates 

that low prices and declining subsidies have contributed 

to financial stress for farmers. 

Many industrial firms have found ways to increase productivity and cut costs to offset declining revenues. 

Chart 5 follows trends in annual total revenue and costs 

for U.S. corporations operating in a selected group of 

commodity industries. It shows that growth in revenue 

and costs slowed noticeably in 1997. Both revenue and 

costs in these sectors declined in 1998, illustrating that 

firms in these sectors have needed to cut costs to preserve profit margins. Cost cutting in the manufacturing 

sector is further illustrated by a steady decline in the 

index of unit labor costs for manufacturing, which started from a value of 100 in 1992 and fell to less than 96 

CHART 5 

U.S. Corporations Operating in 

Commodity Industries Have Trimmed 

Costs to Offset Falling Revenue* 

* Totals represent a summation of revenues and costs for the following industry 

sectors, as reported by the Bureau of the Census: textile mill products, paper and 

allied products, chemicals and allied products, industrial chemicals and synthetics, 

petroleum and coal products, lumber and wood products, iron and steel, electrical 

and electronic equipment, motor vehicles and equipment, and mining. 

Source: Bureau of the Census (Haver Analytics) 

1992 1993 1994 1995 1996 1997 1998 

Billions of Dollars 

Costs 

Revenues 

1,250 

1,450 

1,650 

1,850 

2,050 

2,250 

by the first quarter of 1999. Falling unit labor costs 

means that the productivity of manufacturing workers is 

rising faster than the cost of their services. This trend 

demonstrates that manufacturing firms have been successful at implementing new technologies and new capital equipment to cut production costs. 

Cost savings and industry consolidation have been 

accomplished in part through mergers. According to 

Merger Stat, the dollar volume of merger and acquisition transactions involving U.S. firms exceeded $1.2 

trillion in 1998, an increase of more than 80 percent 

from 1997 levels. Both the number and dollar volume of 

mergers announced in 1998 far exceeded the volumes 

recorded during the “merger mania” of the 1980s. Some 

of the largest mergers announced in 1998 involved 

firms looking for ways to increase market share and cut 

costs in markets characterized by overcapacity. Examples include the $39 billion Daimler-Chrysler transaction announced in May 1998 and the $80 billion 

Exxon-Mobil transaction announced in December 

1998. Furthermore, merger activity recorded in early 

1999 suggests that total merger volume for the year 

could exceed the record pace of a year ago. 

Industries plagued by oversupply and weak prices 

require consolidation to reduce capacity and improve 

profit margins. Mergers and acquisitions represent a 

fairly orderly way for firms operating in a troubled 

industry to consolidate on their own terms. Bankruptcy 

filings are an alternative means for severely troubled 

firms to reduce capacity and achieve consolidation 

within an industry. Regardless of how industry consolidation is achieved, it often results in reductions in 

employment (such as those documented in Chart 3). 

However, from a lender’s perspective, an orderly consolidation process through mergers and acquisitions is 

preferable to a disorderly shakeout of firms through 

bankruptcies. 

Recent favorable capital market conditions have 

allowed firms in troubled industries to consolidate 

through mergers. Acquisitions are sometimes financed 

through corporate borrowings or, more commonly, by 

swapping equity shares that have been rising in value 

during the bull market of the 1990s.6 Recent consolidation in commodity industries could be depicted as an 

6 According to Loan Pricing Corporation’s Gold Sheets, syndicated 

and leveraged lending related to mergers and acquisitions reached a 

record high of $80 billion in the second quarter of 1998, which represents about 30 percent of the total syndicated and leveraged lending 

market for that period. 

Memphis Regional Outlook 6 Third Quarter 1999 
In Focus This Quarter
 

orderly process, associated with record-high merger and 

acquisition activity, near-record-low business bankruptcy filings, and low credit losses on commercial and 

industrial (C&I) loans. However, a sudden change in 

financial market conditions characterized by sharply 

higher interest rates, lower stock values, or both could 

inhibit the ability of businesses to restructure and retool 

on their own. This could lead to a much more disorderly shakeout of firms accompanied by a rise in business 

bankruptcies and losses to lenders. 

Signs Point to Rising Credit Risk 

in the Commodity Industries 

In dollar terms, the largest commercial bank exposures 

to the commodity industries are in the portfolios of 

large banks. Chart 6 provides an estimated breakdown 

of the aggregate exposure of insured institutions to 

commodity industries based on corporate balance sheet 

information collected by the Bureau of the Census.7 The 

chart shows that the aggregate exposure of the bank and 

thrift industries to these sectors is approximately $206 

billion, or 26 percent of the total industry C&I portfolio. The largest single industry exposure is to the chemical industry, which represents approximately 9.5 

7 Because of the limitations of the data, bank exposures to corporations engaged in agriculture are not broken out in Chart 6. 

CHART 6 

Commodity Industries Make Up
 

Over One-Quarter of Bank C&I Loans
 

to Corporate Borrowers
 

Mining Total Loans Lumber & Paper* 3.2% 4.4% Outstanding

as of 12/31/98= Petroleum & Coal $778.3 Billion** 1.2% 

Electronics 

4.2% 

Chemicals* 

9.5% All Other 

73.5% Textiles
 

1.2%
 

Iron & Steel 

1.1% 

Automobiles 

1.7% 

* “Lumber & Paper” includes lumber and wood products and paper and allied 

products as reported by the Bureau of the Census; "Chemicals" includes chemical 

and allied products and industrial chemicals and synthetics as reported by the 

Bureau of the Census. 

** Total includes bank loans not elsewhere classified to the nonfarm nonfinancial 

corporate business sector as reported in the Flow of Funds. Component loan 

amounts represent short-term and long-term bank loans on corporate balance 

sheets, by sector, as reported by the Bureau of the Census. 

Sources: Bureau of the Census (Haver Analytics); Federal Reserve Board 

percent of bank C&I loans. In the syndicated loan market, where large U.S. banks dominate in terms of originations, about 25 percent of all loans made in 1998 were 

to firms operating in the manufacturing sector. 

A rough indicator of recent trends in the credit risk 

associated with bank loans to commodity industries can 

be found in expected default frequencies (EDFs) calculated by KMV Corporation. The EDF is an estimate of 

the probability that a firm will default on its bond obligations within one year.8 Chart 7 tracks the median EDF 

for firms operating in commodity industries compared 

with the median for all other firms rated by KMV. This 

chart shows that while the median EDF for commodity 

industries has consistently exceeded the median for all 

other firms in the recent past, this difference has 

widened appreciably since the middle of 1998. Over the 

past year, the median EDF for commodity industries has 

more than doubled, rising from 0.8 percent to 1.9 percent, while the median EDF for all other firms has doubled as well, from 0.6 percent to 1.2 percent. These data 

indicate that the level of credit risk associated with corporate borrowers has been increasing, led by an 

increased probability of default among firms operating 

in commodity industries. 

8 KMV’s proprietary calculation 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 vulnerability of the firm to large changes in market 

value. 

CHART 7 

The Default Risk of Firms Operating 

in Commodity Industries Has 

Risen over the Past Year 

Median Expected Default Frequency (EDF)* 

(Probability that a Firm Will Default on Bond 

Obligations within One Year) 

KMV’s proprietary calculation 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 vulnerability of the firm to large 

changes in market value. 

* Sectors included in the calculation of EDF for commodity industries include 

the following KMV aggregates: agriculture; automotive; chemicals; electrical 

equipment; electronic equipment; lumber and forestry; mining; oil refining; oil, 

gas, and coal exploration and production; paper; semiconductors; steel and metal 

products; and textiles. 

Source: KMV Corporation 

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

Firms in Other Industry Sectors 

Firms in Commodity Industries 

05/96 12/96 07/97 02/98 09/98 04/99 

Memphis Regional Outlook 7 Third Quarter 1999 
In Focus This Quarter
 

Effects on Local Economies and 

the Banks That Operate in Them 

The economic effects of adversity in commodity industries tend to be most severe in local areas that depend 

heavily on these sectors for employment and income. In 

the 1980s, problems in the agricultural and oil sectors 

kicked off a “rolling recession” that spread through the 

Plains states and oil-producing regions of the southcentral and western states. In agricultural regions, farmland values began to decline around 1981, contributing 

to the failure of hundreds of FDIC-insured banks 

between 1984 and 1990.9 Similarly, declining oil prices 

in the mid-1980s contributed to the failure of federally 

insured banks and thrifts in Texas, Oklahoma, 

Louisiana, and other states, while the attempts of some 

institutions to diversify into risky real estate investments resulted in still more failures. The FDIC’s analysis of these episodes emphasizes how industry-sector 

problems can affect local economies and bank credit 

quality.10 Moreover, the study shows that there can be a 

significant lag between the onset of industry-sector 

problems and the emergence of performance problems 

9 Federal Deposit Insurance Corporation, Division of Research and
 

Statistics (1997). History of the Eighties: Lessons for the Future,
 

Vol. 1, An Examination of the Banking Crises of the 1980s and 


Early 1990s. pp. 275–276, http://www.fdic.gov/databank/hist80/
 

index.html.
 

10 Federal Deposit Insurance Corporation (1997). See Chapters 8 


and 9.
 

TABLE 1 

in the banking industry. Although banks with direct 

credit exposures to a troubled industry are likely to be 

affected first, virtually all banks that operate in areas 

that are heavily dependent on a troubled sector will 

eventually have to contend with the indirect effects on 

the local economy. 

To evaluate the extent of local economic effects that 

might have resulted from the recent adverse trends in 

the commodity industries, we have conducted analysis 

on 1,027 U.S. counties identified as particularly dependent on at least one commodity industry (see Table 1 for 

a list of the commodity industries studied).11 The purpose of this analysis is not to identify every county that 

might be affected by these trends; instead, this analysis 

focuses on the U.S. counties most concentrated in the 

commodity industries and determines if these counties 

and banks that operate in them are showing any symptoms of widespread distress. 

Table 2 compares 1998 average job growth and unemployment rates in these “most concentrated counties” 

against the average for all U.S. counties. This comparison shows that the concentrated counties tended to have 

moderately lower job growth and higher unemployment 

than the U.S. average. However, further analysis shows 

11 Counties identified as being highly dependent on one or more commodity industries had an average population of 36,250 in 1998 versus 

86,055 for all U.S. counties. 

U.S. Counties Most Concentrated in Commodity Industries 

by 1998 Payroll Employment 

NUMBER OF 

PERCENT OF COUNTIES WITH 

1998 COUNTY EMPLOYMENT 

EMPLOYMENT IN CONCENTRATION STATES WITH THE MOST 

THE INDUSTRY IN 1998 DESIGNATED COUNTIES 

AGRICULTURE >30 295 TX, NE, SD, KS, MO 

LUMBER AND PAPER >5 305 GA, AL, MS, AR 

OIL AND GAS >5 83 TX, OK, LA 

CHEMICALS >5 46 TN, IL, NC, TX 

STEEL >5 70 KY, OH, AR, IN 

AUTOS >5 118 MI, IN, OH, KY, TN 

TEXTILES >5 156 GA, NC, SC, VA, AL 

ELECTRONICS AND SEMICONDUCTORS >5 33 TX, NY, IN, IA 

Any Commodity Industry N/A 1,027 TX, GA, NC, TN, AL 

All U.S. Counties N/A 3,142 N/A 

Source: WEFA, based on data from the Bureau of Labor Statistics 

Memphis Regional Outlook 8 Third Quarter 1999 
In Focus This Quarter
 

TABLE 2 

Relative Economic Performance of Counties 

Most Concentrated in Commodity Industries 

1998 AVERAGE 1998 AVERAGE 

EMPLOYMENT GROWTH (%) UNEMPLOYMENT RATE (%) 

AGRICULTURE 1.1 4.8 

LUMBER AND PAPER 1.3 6.9 

OIL AND GAS 1.4 5.6 

CHEMICALS 1.3 6.0 

STEEL 1.7 5.6 

AUTOS 1.8 4.4 

TEXTILES 0.9 5.1 

ELECTRONICS AND SEMICONDUCTORS 1.9 3.7 

Any Commodity Industry 1.3 5.5 

All U.S. Counties 1.6 5.1 

Source: Bureau of Labor Statistics, Household Survey (Haver Analytics) 

that the current situation is not unusual in that job markets in concentrated counties have tended to consistently underperform other U.S. counties over the past two 

decades. On the whole, the economic picture did not 

noticeably deteriorate in 1998 for the concentrated 

counties. Average unemployment declined in 1998 for 

every group of concentrated counties except oil counties, and average job growth increased in every group of 

counties except textile counties. These data indicate that 

while recent problems in the commodity industries 

might be having severe effects in specific areas, these 

problems had not translated into a broader weakening of 

economic performance through the end of 1998. 

The financial performance of insured institutions operating in concentrated counties is evaluated in Table 3 

(next page). The table provides average C&I loan performance and profitability ratios for 1,915 banks and 

thrifts identified as having at least 25 percent of their 

deposits in at least one of the concentrated counties as 

of June 1998.12 The average C&I loan charge-off ratio 

for concentrated counties overall was higher than the 

U.S. average, driven largely by higher average charge12 This analysis identifies the location of deposits by county through 

the Summary of Deposits report for June 1998, the most recent report 

available. The analysis is limited to institutions reporting at least $1 

million in C&I loans as of December 31, 1998. Institutions operating 

in one or more concentrated counties and meeting all the selection 

criteria averaged $195 million in total assets as of December 31, 

1998, compared with an average of $733 million in assets for institutions operating in any U.S. county. 

offs in both agricultural and oil and gas counties. Comparisons of past-due and noncurrent C&I loans also 

indicate that institutions operating in agricultural and 

oil and gas counties tend to have more problem credits 

than the U.S. average.13 During the 12 months ending in 

December 1998, the average noncurrent loan ratio 

jumped from 4.8 percent to 6.1 percent for institutions 

operating in agricultural counties, while the average 

ratio rose from 2.7 percent to 3.8 percent for institutions 

operating in oil and gas counties. 

These results indicate that while profitability in 1998 

remained solid for the average bank operating in concentrated counties, credit losses appeared to be on the 

rise in agricultural and oil and gas counties. However, 

because this analysis relies on annual data that extend 

only through 1998, it is by design a backward-looking 

test for the local effects of problems in the commodity 

industries. There is every reason to expect these credit 

problems to intensify over time if commodity prices 

remain low.14 These considerations suggest that bankers 

in commodity-dependent counties should continually 

13 Past-due loans are defined as loans that have been past due for 30 

to 89 days. Noncurrent loans are defined as loans that have been past 

due for 90 or more days plus loans placed in nonaccrual status. 

14 For more information on how the agricultural outlook could affect 

FDIC-insured institutions, see the statement of FDIC Chairman 

Donna Tanoue to the Committee on Agriculture, U.S. House of 

Representatives, February 12, 1999, http://www.fdic.gov/publish/ 

speeches/99spchs/spc13apr.html. 

Memphis Regional Outlook 9 Third Quarter 1999 
In Focus This Quarter
 

TABLE 3 

Relative Financial Performance of Insured Institutions Operating in Counties 

Most Concentrated in Commodity Industries 

NUMBER OF AVERAGE C&I AVERAGE AVERAGE NET 

BANKS WITH AT LOANS PAST DUE NONCURRENT C&I LOAN 

INCLUDES ONLY INSURED LEAST 25% OF 30 TO 89 DAYS, C&I LOANS, CHARGE-OFFS, AVERAGE 

INSTITUTIONS WITH DEPOSITS IN A AS PERCENT AS PERCENT AS PERCENT OF RETURN ON 

AT LEAST $1 MILLION DESIGNATED OF LOANS, OF LOANS, AVERAGE LOANS, ASSETS, 

IN C&I LOANS COUNTY 12/31/98 12/31/98 1998 1998 

AGRICULTURE 416 5.08 6.12 1.58 1.16 

LUMBER AND PAPER 465 3.38 1.89 0.78 1.21 

OIL AND GAS 163 3.44 3.78 1.18 1.29 

CHEMICALS 81 2.47 2.97 0.79 1.18 

STEEL 186 2.53 2.06 0.59 1.08 

AUTOS 341 2.64 2.05 0.66 1.12 

TEXTILES 264 2.91 1.92 0.70 1.10 

ELECTRONICS AND 

SEMICONDUCTORS 107 2.71 2.36 0.68 0.87 

Any Commodity 

Industry 1,915 3.39 3.03 0.93 1.13 

All U.S. Counties 8,485 2.91 2.50 0.76 1.05 

Noncurrent loans include loans past due 90 or more days plus loans placed on nonaccrual status. 


C&I = Commercial and industrial.
 

Sources: Summary of Deposits, Division of Research and Statistics, FDIC; Bank and Thrift Call Reports (Research
 

Information System)
 

monitor their local economy for signs of stress related 

to problems in the commodity industries. 

Conclusion 

Businesses operating in a range of commodity and manufacturing industries continue to grapple with weak or 

declining prices. This problem is not solely the result of 

industry-specific factors; it is part of long-term economic trends that may continue for some time. Signs of 

stress among firms in these industries are apparent in 

the form of declining levels of employment and slow or 

negative profit growth. However, there are few signs to 

date of any disorderly industry shakeouts involving 

widespread business bankruptcies and losses to lenders. 

Thus far, most firms have managed to cope with 

the situation by cutting costs and consolidating operations through mergers. At the same time, more forwardlooking indicators show that the level of credit risk 

associated with commodity industries may be on the 

rise. An analysis of the U.S. counties most heavily 

dependent on these industries showed few signs of a 

widespread deterioration in the performance of their 

economies or in the profitability of their local depository institutions through the end of 1998. However, there 

are signs of rising credit losses among local depository 

institutions in counties with the highest concentrations 

of agriculture and oil and gas extraction. A continuation 

of today’s weak pricing picture in these industries has 

the potential to result in higher credit losses for insured 

institutions during the next few years. 

Richard A. Brown, Chief, 

Economic and Market Trends Section 

Alan Deaton, Economic Analyst 

Memphis Regional Outlook 10 Third Quarter 1999 
In Focus This Quarter
 

Shifting Funding Trends Pose Challenges 


for Community Banks 


•	 Several long-term trends are making it more difficult for some institutions to economically fund 

asset growth with deposits in today’s marketplace. 

•	 Lagging deposit growth in recent years has resulted in greater reliance on alternative funding 

sources to meet loan demand. 

•	 Liability management may become more important and more challenging for community banks 

that have historically relied upon deposits for 

funding and net interest revenues for profitability. 

For the past few years, assets have been expanding 

faster than deposits at many commercial banks. The 

result is an increased reliance on equity and borrowings 

for funding. Since 1992, commercial bank assets have 

grown at an average annual rate of 6.3 percent compared with a 3.9 percent average annual growth rate for 

deposits. Traditional measures of liquidity and funding 

for commercial banks reflected record-low levels of 

deposit funding at year-end 1998. Large commercial 

banks have traditionally made greater use of nondeposit 

funding alternatives. However, many community 

banks,1 which have typically relied more on deposit 

funding, may face liability management challenges as a 

result of shifting funding trends. This article surveys the 

factors influencing the ability of banks to fund loan 

growth with deposits, discusses community bank funding trends, and considers the implications of these 

trends for community banks. 

Factors Influencing Deposit Funding Trends 

The percentage of commercial bank assets, particularly 

loans, funded with deposits has declined steadily in the 

1990s. As shown in Chart 1, the industry’s ratios of 

deposits to assets and loans to deposits reflect a longerterm shift away from deposit funding. Although the 

level of these industry ratios is heavily influenced by 

larger banks, the trend toward lower deposit funding 

exists for both large banks and community banks and 

points to secular factors that are affecting banks’ ability 

to raise deposits in step with asset growth. 

Trends in Household Wealth Accumulation 

One factor affecting the ability of banks to attract 

deposits is the recent trend in the way households are 

amassing wealth. While the total wealth of U.S. households has soared in recent years because of unrealized 

capital gains on housing and investments, annual net 

purchases of new financial assets2 by households as a 

percentage of disposable income have actually trended 

downward since the mid-1980s (see Chart 2, next page). 

A falling personal savings rate and fewer purchases of 

financial assets may suggest that households are more 

comfortable consuming a higher percentage of current 

income as long as capital gains are adding to their accumulated wealth. However, because households have 

been setting aside less of their current income for savings, the pool of new funds available to purchase bank 

deposits has been growing more slowly. 

Higher-Yielding Investment Alternatives 

At the same time that households have been setting 

aside less of their current income for savings, the share 

of total new household savings flowing into bank 

deposits has declined in the 1990s as competition from 

higher-yielding alternatives has increased. During the 

1980s, over 30 percent of the cumulative net increase in 

2 Financial assets are defined as deposits, money market and mutual 

fund shares, credit market instruments, corporate equities, life insurance reserves, pension fund reserves, and trust reserves. 

CHART 1 

The Deposit-to-Asset and Loan-to-Deposit
 

Ratios Reflect Reduced Deposit


 Funding for Commercial Banks
 

Recession 

Ratio (%) Deposit-to-Asset Ratio 

90 

85 

80
 

75
 

70
 

65
 

60
 

55
 

50
 

Loan-to-Deposit Ratio 

’70 ’74 ’78 ’82 ’86 ’90 ’94 ’98 

Sources: FDIC Historical Statistics on Banking; Research Information System 1 Defined here as banks with total assets of $1 billion or less. 

Memphis Regional Outlook 11	 Third Quarter 1999 
In Focus This Quarter
 

CHART 2 

Total Annual Additions* to Financial Assets 

of Households and Nonprofit Organizations 

Have Declined with Personal Savings Rate 

Percentage of Disposable 

Personal Income 

Net Acquisition 

15 

10 

5 

0 

20 

of Financial Assets 

Personal Savings 

’80 ’82 ’84 ’86 ’88 ’90 ’92 ’94 ’96 ’98 

* Excludes capital gains 

Sources: Federal Reserve Board; Flow of Funds 

financial assets by households and nonprofit organizations flowed into deposits. In contrast, less than 15 percent of the cumulative net increase in financial assets 

has flowed into deposits during the 1990s, although an 

increasing proportion has been allocated to deposits in 

recent years. 

Not only do banks face intensifying competition from 

other banks and thrifts, as indicated by 66 percent of the 

respondents in Grant Thornton’s 1999 Sixth Annual 

Survey of Community Bank Executives,3 but they also 

3 Grant Thornton’s 1999 Sixth Annual Survey of Community Bank 

Executives, “Community Banks: A Competitive Force,” http://www. 

grantthornton.com/resources/finance/banksurvey99/survey99w.html. 

CHART 3 

face increasing competition from mutual funds and 

other nonbank financial service providers, such as credit unions. 

Mutual Funds. Increasingly, consumers are pursuing 

higher yields by investing in mutual funds. Beyond 

yields, however, many mutual fund companies also are 

competing effectively with banks on the basis of convenience by offering money market accounts that allow 

check writing, automated teller machine cards, and 

check cards. Chart 3 shows the changes in the composition of household liquid assets during the 1990s. In 

1990, bank deposits constituted 38 percent of households’ liquid assets versus 11 percent for mutual funds 

and money market funds; at year-end 1998, the shares 

were nearly even. While some of the change in composition can be explained by rising mutual fund share 

prices, other measures indicate a shifting preference for 

mutual funds as a savings vehicle. For example, data 

from the Investment Company Institute show that net 

inflows into mutual funds have exceeded net increases 

in insured institution deposit accounts in all but three 

quarters during this economic expansion. Moreover, the 

first quarter of 1999 marked the seventeenth consecutive quarter that mutual fund inflows outstripped 

increases in deposits for all FDIC-insured institutions. 

Credit Unions. In addition to mutual funds, credit 

unions also are formidable competitors for consumer 

savings. Membership in credit unions has increased 

more than 20 percent over the past decade, while 

deposits and share accounts have risen by over 90 perHouseholds Are Holding a Greater Share of Liquid Assets in Mutual Funds 

1990 1998 

U.S. Government 

Securities
 

7%
 

Equities, Bonds, 

and 

Commercial 

Paper 44% 

Money Market 

Fund Shares 

5% 

Mutual Fund
 

Shares
 

6%
 

Bank Deposits 

(excl. Foreign) 

38% 

Money Market Mutual Fund 

Fund Shares Shares 

7% 22% 

Equities, Bonds, Bank Deposits 

and Commercial (excl. Foreign) 

Paper 35% 30% 

U.S. Government 

Securities
 

6%
 

Source: Federal Reserve Board 

Memphis Regional Outlook 12 Third Quarter 1999 
In Focus This Quarter
 

cent.4 Credit unions also offer federal insurance on share 

accounts as well as competitive rates on comparable 

deposit-type vehicles relative to other types of financial 

institutions. For example, according to information from 

the National Credit Union Association, on average, 

credit unions have offered rates on one-year share certificates in excess of one-year bank certificates of 

deposit in nine of the past ten years. As shown in Chart 

4, average rates paid by credit unions on one-year share 

certificates over the 12 months ending May 1999 were 

consistently higher than rates offered by banks or thrifts 

and approached retail rates offered by brokerages. 

Demographic Shifts 

Some analysts maintain that rural community banks 

face additional funding challenges as a result of demographic shifts. According to the Federal Reserve Bank 

of Kansas City, rural bankers perceive that sluggish 

deposit growth is at least partially attributable to the 

migration of deposits to cities as urban-dwelling heirs 

of rural depositors relocate funds. While evidence for 

this deposit migration remains anecdotal, economists at 

the Federal Reserve Bank of Kansas City indicate that 

the demographic shift is still in process, and its full 

effect may not be felt for some time. Further challenging deposit growth for banks, additional evidence suggests that urban dwellers tend to place less of their 

4 Center for Credit Union Research, “Credit Union FAQ,” http:// 

wiscinfo.doit.wisc.edu/bschool/cu/cufaq.html. 

CHART 4 

Bank One-Year CD Rates Have Recently Lagged
 

Those Offered by Competitors
 

Average Retail Rates Offered for 

One-Year Certificates (%) 

6.0 

3.0 

3.5 

4.0 

4.5 

5.0 

5.5 

Thrifts 

Credit Unions 

Banks 

Brokerages 

Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May 

’98 ’98 ’98 ’98 ’98 ’98 ’98 ’99 ’99 ’99 ’99 ’99 

Sources: BanxQuote and Bank Rate Monitor 

savings in banks than their rural counterparts do.5 This 

trend poses additional consequences for bank deposits 

as rural populations migrate to suburban areas. 

Community Bank Funding Trends 

Community banks traditionally rely more heavily upon 

core deposit funding than larger banks do. For example, 

Chart 5 (next page) shows that 72 percent of aggregate 

community bank assets were funded with core deposits 

at year-end 1998. In contrast, 43 percent of aggregate 

large bank assets at year-end 1998 were funded with core 

deposits. This difference in liability structures reflects 

large banks’ broader use of wholesale funding alternatives and greater access to capital markets instruments. 

While large banks have responded to factors influencing deposit 

growth by making greater use of 

alternative funding sources, 

funding options for community 

banks tend to be more limited. 

Because of high fixed costs, community banks may find 

it more difficult than larger institutions to make costeffective use of capital market instruments such as securitizations or public debt and equity offerings (see 

“Industry Consolidation Presents Unique Risks and 

Challenges for Community Banks,” Regional Outlook, 

Fourth Quarter 1998, for a discussion of additional nondeposit funding sources for community banks). 

The need to augment lagging deposit growth to meet 

loan demand has led many community banks to acquire 

more noncore funds. These funds include time deposits 

greater than $100,000, borrowings, foreign deposits, 

brokered deposits, and demand notes. At year-end 1998, 

nearly 75 percent of community banks held noncore liabilities representing 10 percent or more of total liabilities. As recently as 1993, only 42 percent of community 

banks exceeded that threshold. Moreover, over the same 

five-year period, the ratio of core deposits (defined here 

as total deposits less time deposits greater than 

$100,000 and brokered deposits) to total deposits for all 

community banks declined each quarter. 

5 William R. Keeton, Federal Reserve Bank of Kansas City. “Are 

Rural Banks Facing Increased Funding Pressures? Evidence from 

Tenth District States.” Economic Review, Second Quarter 1998, p. 56. 

Also see “Regional Banking,” Regional Outlook, Kansas City Edition, Second Quarter 1998, p. 24. 

Memphis Regional Outlook 13 Third Quarter 1999 
In Focus This Quarter
 

CHART 5 

Community Banks Relied More Heavily than Large Banks on Core Deposits* at Year-End 1998 

Large Banks Community Banks 

(total assets over $1 billion) (total assets under $1 billion) 

* Core deposits include total domestic deposits less time deposits greater than $100,000 and brokered deposits issued in denominations of less than $100,000. 

Source: Bank Call Reports (Research Information System) 

Other 

Domestic 

Deposits 

7% 

Borrowings 

16% 

Other 

Liabilities 

12% 

Equity and 

Subordinated 

Debt 

9% 

Core 

Deposits 

43% 

Foreign 

Deposits 

13% 

Other Domestic 

Deposits 

11% 

Borrowings 

6% 

Other 

Liabilities 

1% 

Equity and 

Subordinated Debt 

10% 

Core 

Deposits 

72% 

As community banks’ use of noncore funds has 

increased, they are relying more on federal funds purchased, repurchase agreements, other borrowings, 

demand notes, and mortgages (collectively referred to 

as borrowings). After adjusting for mergers, borrowings 

funded 12 percent of new community bank asset growth 

from 1992 through 1998—three times more than the 

percentage of new asset growth funded by borrowings 

from 1985 to 1990. Possibly reflecting a shift toward 

greater acceptance of wholesale funding by community 

bankers, growth in borrowings has been largely driven 

by increased use of nonovernight borrowings,6 which 

have become the dominant form of borrowings at community banks. As shown in Chart 6, the proportion of 

community banks reporting nonovernight borrowings 

has doubled in the 1990s. This trend coincides with 

growing community bank membership in the Federal 

Home Loan Bank (FHLB) system and increasing use of 

FHLB borrowings. 

Federal Home Loan Bank Membership 

Over the past five years, community banks have substantially increased their membership and participation 

in the FHLB system. According to data from the Federal Housing Finance Board, for the five-year period 

ending in 1998, the percentage of FDIC-insured community banks that were members of the FHLB more 

than doubled to 50 percent. Over the same period, FHLB 

advances outstanding for community banks grew by 

more than 50 percent to $47 billion. At year-end 1998, 

6 Nonovernight borrowings are defined here as all borrowings other 

than federal funds purchased and repurchase agreements. 

FHLB advances represented approximately 80 percent 

of all nonovernight borrowings for community banks. 

Analysts have cited a number of reasons why community banks are joining the FHLB system. Community 

banks are using FHLB advances to meet contingent liquidity needs, manage interest rate risk, fund new asset 

growth, and leverage capital to maintain or boost 

returns on equity. Recent surveys indicate that FHLB 

advances will continue to have a role in community 

bank liability management. Almost one-half of respondents to Grant Thornton’s 1999 Annual Survey of 

Community Bank Executives considered FHLB borrowings an important funding source over the next three 

years, and 43 percent plan to increase the use of FHLB 

advances in 1999. Similarly, the American Bankers 

Association’s 1999 Community Bank Competitiveness 

CHART 6 

’97 

0 

10 

20 

30 

40 

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

The Percentage of Community Banks Reporting 

Nonovernight Borrowings* Is Rising 

Community Banks 

Reporting Nonovernight 

Borrowings (%) 

* Includes all borrowings other than federal funds purchased and repurchase 

agreements 

Source: Bank Call Reports (FDIC Research Information System) 

Memphis Regional Outlook 14 Third Quarter 1999 
’

In Focus This Quarter
 

Survey7 reported that FHLB advances are the preferred 

nontraditional funding product. In addition, legislative 

changes enacted in third-quarter 1998 have eased membership requirements for banks with assets less than 

$500 million, significantly increasing access to FHLB 

advances for smaller banks in rural areas. 

Implications of Funding Trends 

for Community Banks 

According to community banker opinion surveys, the 

trend toward greater reliance on noncore or alternative 

funding sources appears likely to continue. Grant 

Thornton’s 1999 Annual Survey of Community Bank 

Executives found that 75 percent of community bankers 

expect funding with core deposits to be more difficult in 

three years than it is today. Moreover, more than 20 percent of community bankers responding to the American 

Bankers Association’s 1999 Community Bank Competitiveness Survey do not expect to derive the bulk of their 

funding from deposits five years from now. Liability 

management is an important aspect of a bank’s operations and a key driver of interest expense. Responses to 

funding challenges will likely influence strategic business decisions that shape the risk profiles of insured 

institutions, particularly community banks that historically have relied more heavily upon core deposits to fund 

asset growth and net interest income for profitability. 

A fundamental challenge that confronts bank management is the strategic response to the increased costs 

associated with wholesale funding sources. As shown in 

Chart 7, the reported interest costs of nondeposit funding alternatives, such as federal funds purchased and 

repurchase agreements, subordinated notes, and FHLB 

advances, have traditionally exceeded the interest cost 

of core deposits for commercial banks. Therefore, as 

institutions that have typically relied upon core deposits 

increase the use of nondeposit sources, funding costs 

will likely rise relative to asset yields. As a result, net 

interest margins (NIMs) may be pressured. 

To some extent bank managers may be able to offset the 

higher interest costs of wholesale funding strategy by 

improving efficiency through greater management of 

overhead expenses and increases in noninterest income. 

However, community banks face challenges to their 

ability to increase noninterest income (see “Industry 

Consolidation Presents Unique Risks and Challenges 

CHART 7 

Subordinated Debt 

FHLB Advances 

0 

1 

2 

3 

4 

5 

6 

7 

8 

’93 ’94 ’95 ’96 ’97 ’98 

Reported Interest Cost for Commercial Banks (%) 

Nondeposit Alternatives Have Typically Cost 

More than Core Deposits 

Federal Funds 

Core Deposits* 

* Core deposit costs equal interest expense on total deposits minus time deposits 

greater than $100,000 divided by average total deposits minus average time 

deposits greater than $100,000. 

Sources: Bank Call Reports (FDIC Research Information System) and Federal 

Home Loan Bank (FHLB) System Annual Reports 

for Community Banks,” Regional Outlook, Fourth 

Quarter 1998), and there are limits to cost cutting. If 

banks are unable to fully offset higher funding costs 

with increases in noninterest income or reductions in 

noninterest expenses, overall profitability could suffer. 

Community bankers in the upper Midwest expressed 

this concern in a 1998 survey conducted by The Federal Reserve Bank of Minneapolis, which found that 57 

percent of respondents expect the shift away from 

deposit funding to decrease bank profitability.8 As bank 

managers search for additional ways to offset the relative rise in funding costs, they may be tempted to 

increase asset yields by pursuing additional portfolio 

risk, in the form of credit or market risk, to generate 

higher asset yields. 

Funding challenges also could alter the liquidity and 

interest rate risk positions of community banks. The relative complexity and volatility of some nondeposit 

sources require greater expertise and attention to assetliability policies and practices to avoid unexpected 

liquidity strains or exposures to changing interest rate 

environments. Strategies that result in the pledging of 

liquid assets, overreliance on purchased funds, or concentrations in price-sensitive long-term assets could 

adversely affect a bank’s relative liquidity or interest 

rate risk position. Moreover, interest rate risk management can be further challenged by the complexity of 

nondeposit funding sources. For instance, some FHLB 

advances may contain embedded options that required 

greater expertise and attention to policies and practices 

that, if not managed properly, could lead to undesirable 

outcomes if interest rates change adversely. 

7 ABA Banking Journal, February 1999, p. 30. 8 Fedgazette, July 1998, p. 2. 

Memphis Regional Outlook 15 Third Quarter 1999 
In Focus This Quarter
 

Differences between Community Banks with 

High and Low Levels of Core Deposit Funding 

To evaluate how a shift from a core deposit funding 

strategy might change the profile of a community bank, 

TABLE 1 

performance and condition measures for community 

banks that rely most heavily on core deposits were contrasted with those that are least reliant on core deposit 

funding. Table 1 compares 1998 funding, earnings, and 

asset performance measures for these community bank 

Comparison of Banks with High and Low Levels of Core Deposit Funding 

ALL COMMUNITY BANK COMMUNITY BANK 

COMMUNITY BANKS1 AGRICULTURAL LENDERS2 COMMERCIAL LENDERS3 

HIGH CORE LOW CORE HIGH CORE LOW CORE HIGH CORE LOW CORE 

DEPOSIT DEPOSIT DEPOSIT DEPOSIT DEPOSIT DEPOSIT 

FUNDING4 FUNDING4 FUNDING FUNDING FUNDING FUNDING 

Selected Aggregate Measures 

NUMBER OF BANKS IN GROUP 405 405 106 51 126 185 

MEDIAN TOTAL ASSETS ($000S) 46,244 118,358 23,274 58,223 69,479 130,923 

MEMBERS OF FHLB (%) 32.10 49.38 17.92 47.06 38.89 50.81 

HAVE OUTSTANDING FHLB ADVANCES (%) 7.65 40.25 6.60 45.10 7.14 38.38 

Selected Median Liquidity and Funding Measures (%) 

1998 GROWTH IN TOTAL ASSETS 9.02 11.16 5.96 6.42 12.75 18.50 

1998 GROWTH IN TOTAL DEPOSITS 9.74 8.79 6.40 5.31 13.56 11.93 

1998 GROWTH IN BORROWINGS (50.00) 28.62 (64.49) 31.85 (51.87) 42.87 

1998 GROWTH IN TOTAL EQUITY CAPITAL 5.93 7.53 3.46 5.39 9.94 8.85 

TOTAL DEPOSITS-TO-TOTAL ASSETS RATIO 91.04 75.68 90.35 80.22 91.23 77.94 

CORE DEPOSITS-TO-TOTAL ASSETS RATIO 87.29 53.87 87.10 55.81 87.21 54.03 

BORROWINGS TO TOTAL ASSETS RATIO 0 9.58 0 4.15 0 8.55 

TOTAL EQUITY CAPITAL TO TOTAL ASSETS RATIO 8.25 10.24 9.00 10.09 7.74 10.16 

Selected Median Performance Ratios (%) 

RETURN ON EQUITY 12.65 10.19 11.10 10.93 14.49 9.52 

RETURN ON ASSETS 1.07 1.04 1.01 1.19 1.10 0.92 

NET INTEREST MARGIN 4.76 4.03 4.51 3.98 5.25 4.22 

GROSS EARNING ASSET YIELD5 8.17 8.02 8.24 7.89 8.45 8.26 

COST OF FUNDING EARNING ASSETS6 3.33 4.07 3.74 4.05 3.21 4.05 

NONINTEREST INCOME TO AVERAGE ASSETS 0.76 0.61 0.59 0.44 1.01 0.64 

NONINTEREST EXPENSE TO AVERAGE ASSETS 3.49 2.90 3.23 2.40 3.99 3.12 

EFFICIENCY RATIO7 69.01 63.68 68.59 57.48 68.99 67.00 

Selected Median Credit Quality Measures (%) 

NONPERFORMING ASSETS TO TOTAL ASSETS RATIO 0.39 0.44 0.40 0.51 0.46 0.61 

NONCURRENT LOANS TO TOTAL LOANS RATIO 0.53 0.72 0.53 1.02 0.52 0.77 

NET LOAN CHARGE-OFF RATIO 0.11 0.12 0.04 0.15 0.14 0.11 

1998 GROWTH IN NONPERFORMING ASSETS (9.10) 7.50 10.57 11.79 (17.32) 23.97 

1998 GROWTH IN NET LOAN LOSSES 6.09 10.24 (3.90) 23.73 9.59 30.64 

1 Community banks are banks with $1 billion or less in total assets. 

2 Agricultural lenders are banks with 25 percent or more of assets in agricultural real estate loans or agricultural production loans.
 

3 Commercial lenders are banks with 25 percent or more of assets in commercial and commercial real estate loans.
 

4 High core deposit funding group is composed of community banks with core deposits-to-assets ratios in the top 5
 

percent of all community banks, excluding those with equity-to-assets ratios in excess of 25 percent. The low core
 

deposit funding group is composed of community banks with core deposits-to-assets ratios in the bottom 5 percent
 

of all community banks.
 

5 Gross earning asset yield equals interest income divided by average earning assets.
 

6 Cost of funding earning assets equals interest expense divided by average earning assets.
 

7 Efficiency ratio equals noninterest expense divided by the sum of net interest and noninterest income.
 

FHLB = Federal Home Loan Bank
 

Sources: Bank Call Reports (Research Information System); Federal Housing Finance Board 


Memphis Regional Outlook 16 Third Quarter 1999 
In Focus This Quarter
 

groups. High core deposit funders are defined as those 

community banks with core deposit-to-asset ratios in 

the top 5 percent of all community banks at year-end 

1998. Low core deposit funders are those community 

banks with a core deposit-to-asset ratio in the bottom 5 

percent.9 A similar comparison is included for agricultural banks and commercial lending specialists, which 

combined make up roughly 60 percent of each of the 

total community bank funding groups. 

This comparison reveals several differences. First, a 

tradeoff between heavy reliance on core funding and 

asset growth is evident. Median measures for the groups 

indicate that the typical bank that relies less on core 

deposit funding is larger and growing faster than the 

typical bank in the high core funding group. Second, 

less core deposit funding appears to be associated with 

a lower NIM, primarily the result of higher funding 

costs. However, overall profitability 

is similar between the groups 

mainly because of a lower ratio 

of overhead expenses to average assets for the low core 

funders. These characteristics are also evident across 

the agricultural and commercial specialists groups. 

Asset quality indicators suggest that the low core funding groups may exhibit greater credit risk. Although 

higher asset yields resulting from increased portfolio 

risk are not evident, median measures for each low core 

funding group reflect higher levels of noncurrent loans 

and higher growth in nonperforming assets and net loan 

losses relative to its high core funding group counter9 These groups exclude community banks with equity-to-asset ratios 

greater than 25 percent. 

part. For example, the median growth in nonperforming 

assets for commercial lending specialists with less 

reliance upon core deposits was nearly 24 percent in 

1998 versus a 17 percent decline for the high core funding group. 

Summary and Conclusions 

Commercial banks have been experiencing a long-term 

trend toward lower deposit funding of loans and assets. 

Increasing competition among banks and from thrifts, 

nonbanks, and higher-yielding investment alternatives 

has made it more difficult and expensive for some 

banks to attract deposits in step with asset growth. 

While some nondeposit funding alternatives may provide a stable source of funds for insured institutions 

(especially those located in areas characterized by 

aggressive competition and slow deposit growth), better 

matching of asset cash flows, and greater flexibility in 

asset-liability management, they also may pose certain 

risks. To some extent community banks may be able to 

manage noninterest expense and noninterest income to 

offset the relative increase in interest expense incurred 

to acquire nondeposit funding sources. However, if 

overall profitability suffers, banks may be tempted to 

pursue additional portfolio risk to generate higher offsetting asset yields. As a result, liability management 

may become more challenging for community banks 

that have historically relied upon deposits for funding 

and net interest revenues for profitability. In addition, 

the complexity of some nondeposit funding sources 

requires greater expertise and attention to policies and 

practices to avoid unexpected liquidity strains or exposures to changing interest rate environments. 

Allen Puwalski, Senior Financial Analyst 

Brian Kenner, Financial Analyst 

Memphis Regional Outlook 17 Third Quarter 1999 
Regional Perspectives
 

Regional Perspectives
 

•	 The Memphis Region’s employment growth continues a slowing trend. Mississippi’s gaming industry and 

growing construction employment throughout the Region provide some strength. While the manufacturing 

sector remains generally weak, the automobile industry continues to add jobs, although rising gas prices 

could slow sales of large vehicles. Agricultural conditions continue to worsen. 

•	 Banks continue to report strong financial conditions. Earnings performance, however, continues to be pressured by lower net interest margins. 

•	 Funding sources for insured financial institutions have changed as deposit growth has lagged strong loan 

demand during this economic expansion. Institutions are increasingly turning to alternative sources for 

funding. 

Economic Overview
 

Employment Growth Remains Subdued 

The Region’s economy remains sluggish relative to that 

of the nation, as measured by employment growth. The 

first-quarter employment growth rate1 is below the 

national average (see Table 1) and reflects a significant 

decline since first-quarter 1998. Declining growth in 

the services sector, which represents 24.8 percent of 

total employment, has been a major factor in the overall 

slowing in employment growth. Moreover, the manufacturing sector continues to report job losses. Employ1 Unless otherwise noted, employment growth rates represent seasonally adjusted year-over-year growth determined from the Bureau of 

Labor Statistics Household Employment Establishment Survey. 

TABLE 1 

Employment Growth Is Slowing 

in the Region (Year-over-Year) 

1Q98 1Q99 

(%) (%) 

ARKANSAS 3.6 1.1 

KENTUCKY 2.9 0.4 

LOUISIANA 3.3 0.2 

MISSISSIPPI 2.7 0.7 

TENNESSEE 4.4 1.3 

REGION 3.5 0.8 

UNITED STATES 1.8 1.7 

Source: Bureau of Labor Statistics, Household 

Employment Survey 

ment in nondurable goods manufacturing dropped 3.0 

percent, led by Tennessee’s 4.6 percent decline. 

Despite losses in the manufacturing sector, Tennessee 

reported the highest employment growth among the 

Region’s states at 1.3 percent, bolstered by a strong construction sector. Memphis continues to report high residential permit activity, and almost all market segments 

in Nashville remain active. Proposals for considerable 

new road construction are likely to add more jobs to the 

state’s construction sector. Construction employment 

growth was strong throughout the Region at 5.6 percent 

in the first quarter and remains a major factor in new 

job formation. 

Slower job creation was evident in the Region’s other 

states. Kentucky and Louisiana had the lowest growth, 

primarily because of continued job losses in nondurable 

goods manufacturing. Employment growth in Arkansas 

and Mississippi was somewhat better, but also was 

affected by losses in the manufacturing industry. Mississippi has benefited considerably from direct employment and construction employment related to the 

gaming industry. 

Mississippi’s Gaming Industry Remains 

Strong in a Slowing State Economy 

Employment gains in Mississippi can be attributed primarily to the continued strength of the state’s gaming 

industry. According to a Mississippi Gaming Commission report in March, approximately 38,000 people, or 

Memphis Regional Outlook 18	 Third Quarter 1999 
Regional Perspectives
 

3 percent of the state’s total employment, were directly 

employed in the gaming industry. Another 28,000 people were indirectly employed by the industry. The opening of the Beau Rivage Hotel/Casino in March 1999 

with 1,800 hotel rooms has added jobs to the thriving 

Gulf Coast gaming market. The size of this segment of 

the economy is apparent in the national revenue rankings of fifth and sixth largest individual gaming markets 

for Tunica County and the Gulf Coast, respectively. 

Other aspects of the state’s economy have also gained 

from the rapid expansion of the gaming industry since 

its birth in 1992. Businesses in gaming areas benefit 

from the out-of-state and local tourism sparked by the 

casinos. 

Spurred largely by new casino development and to a 

lesser extent by the rebuilding of structures damaged by 

Hurricane Georges in the fall of 1998, Mississippi’s 

construction industry employment increased 8.7 percent 

in the first quarter of 1999 from one year ago. Highway 

projects in Tunica County related to increased commuting to casinos from nearby metropolitan Memphis have 

also contributed to rising construction levels. In addition, the Gulf Coast’s residential market is beginning 

to see increases in construction activity; Builder Magazine named Gulfport one of the next big growth 

markets for residential construction. The Mississippi 

hotel and gaming segment, however, is not the only area 

experiencing continued real estate development in the 

Region, as discussed below. 

Real Estate Activity Remains 

High in Some Markets 

As a result of continuing strong construction activity, 

vacancy rates in both the office and industrial markets 

of Nashville are rising, and occupancy levels in the 

hotel sector remain lower than average occupancy levels 

from 1993 to 1997. There is some concern that proposals for increased taxation could hurt Nashville’s image 

as a destination for relocating businesses at a time when 

construction is increasing. The planned construction of 

a new manufacturing facility by Dell Computer Corporation is expected to create between 3,000 and 5,000 

direct jobs and should provide a boost to all segments of 

the city’s real estate market. 

Construction and development (C&D) and commercial 

real estate (CRE) loans by banks and thrifts in Nashville 

continue to increase. As of March 31, 1999, the ratio of 

C&D loans to total loans was 11.2 percent, up from 9.5 

percent one year ago. The ratio of 

CRE loans to total loans has likewise increased from 28.1 percent 

to 32.1 percent. With growing 

levels of C&D and CRE loans, 

institutions are increasing their 

exposure at a time when Torto 

Wheaton Research predicts that office vacancy rates 

will continue to rise during the next year. 

Segments of the New Orleans real estate market have 

been stressed by recent trends. The hotel market 

remains vulnerable to excess capacity caused in part by 

lower demand, as hotels in the city face increased competition from neighboring Mississippi Gulf Coast casinos and lodges. The office segment in New Orleans 

could be severely affected by announced major relocations and layoffs in the energy sector. Amoco is closing 

its New Orleans office, and Texaco, Chevron, and Shell 

have all announced significant layoffs. 

Banks and thrifts headquartered in New Orleans have 

only limited exposure to the city’s real estate market. 

As of March 31, 1999, area institutions reported average C&D and CRE levels of 4.7 percent and 19.3 percent, respectively. These levels are basically unchanged 

from one year ago and remain well below the Region’s 

averages. 

Rising Gasoline Prices Could Affect 

the Region’s Automobile Sector 

Changes in the energy sector affect more than just the 

New Orleans office market. Automobile manufacturers 

in Tennessee and Kentucky, particularly in the truck and 

sport utility vehicle (SUV) market, may be hurt by 

increases in oil prices. The recent surge in truck and 

SUV sales occurred during a period of declining oil 

prices, as shown in Chart 1 (next page). With increases 

in oil prices, some consumer demand could be redistributed to the smaller, more efficient car market. As the 

chart shows, however, the moderate increases in oil 

prices in the mid-1990s appeared to have only a limited 

effect on sales. Many industry analysts feel that oil and 

gasoline prices at their current levels would likewise 

have only a limited negative effect on truck and SUV 

sales. However, some analysts project declining SUV 

sales should oil prices reach $20 per barrel. 

In addition to being sensitive to gasoline prices, sales of 

these large-ticket items are likely responsive to changes 

Memphis Regional Outlook 19 Third Quarter 1999 
Regional Perspectives
 

CHART 1 

Light Truck Sales Are Correlated 

with Changes in Oil Prices 

’82 

700 

600 

500 

400 

300 

200 

100 

’85 ’88 ’91 ’94 ’98 

Light Truck Sales (thousands) 

Source: Bureau of Economic Analysis 

Oil Prices ($/barrel) 

40 

35 

30 

25 

20 

15 

10 

5 

0 

Oil Prices 

Light Truck Sales 

in interest rates. The strong sales during the mid-1990s 

occurred during a period of historically low interest 

rates. Should interest rates and gasoline prices both rise, 

sales could be affected more significantly. 

Ford’s Kentucky assembly plant would likely be affected most quickly from decreased demand for SUVs and 

trucks, as it focuses on the assembly of the Explorer 

sport utility and trucks. The plant is currently undergoing major expansion for the production of an even larger SUV, the Excursion. Tennessee’s automobile sector, 

previously concentrated in small-vehicle production, 

could also be affected, as these producers are entering 

the SUV market. In response to high auto inventory levels, Nissan’s Smyrna plant has begun changing its facilities to produce its own SUV, the Xterra, in the spring of 

2000. Likewise, Saturn in Spring Hill announced plans 

to produce an SUV by 2002. 

Agricultural Conditions Are Deteriorating 

Risks in the agricultural sector are rising, as most agricultural commodity prices remain low (see Falling 

Prices in Commodities and Manufacturing Pose 

Continuing Risks to Credit Quality). With a near-term 

outlook for continued low prices (barring any weatherrelated supply shocks), farm conditions are likely to 

worsen. While the financial condition of agricultural 

lenders2 in the Memphis Region remains strong, trends 

in certain asset-quality indicators, such as rising pastdue loan ratios and carryover debt levels, point to potential future credit problems. 

The 121 agricultural banks in the Region reported a 

sharp increase in past-due agricultural loans in the first 

quarter of 1999, to 6.16 percent of total agricultural 

loans. First-quarter results tend to represent peak levels 

in past-due agricultural loans because of the extension 

and reworking of seasonal credits at that time. The pastdue ratio at the end of the first quarter of 1999, however, is considerably higher than the 3.97 percent and 3.64 

percent average past-due ratios reported in the first 

quarters of 1998 and 1997, respectively. Anecdotal evidence suggests that carryover debt is also increasing. 

The FDIC’s Report on Underwriting Practices for 

October 1998 through March 1999 noted that nationally, almost one-third of FDIC-supervised banks engaged 

in agricultural lending experienced at least a moderate 

increase in carryover debt during the six-month period. 

Even if production improves in 1999, low prices and 

generally rising input costs are likely to considerably 

extend the time required by farmers to repay carryover 

debt. 

Unless commodity prices improve, most industry 

observers expect farm loan collateral values to decline. 

So far, farm real estate values in the Region are generally holding steady, with some declines noted in 

Louisiana. Equipment values are already plunging. 

Anecdotal evidence from bankers suggests that used 

farm equipment values have been halved over the past 

12 months. 

The agricultural sector is not the only area hurt by lower 

commodity prices. See the Memphis Regional Outlook, Second Quarter 1999, for a more detailed analysis 

of the agricultural, energy, timber, and steel industries. 

2 Agricultural lenders are defined as those reporting 25 percent 

or more of total loans in agricultural production or agricultural 

real estate loans at the most recent seasonal borrowing peak on September 30, 1998. 

Memphis Regional Outlook 20 Third Quarter 1999 
Regional Perspectives
 

Banking Overview
 

Banking Conditions 

Remain Favorable 

The Region’s banks and thrifts reported generally strong 

financial conditions in the first quarter of 1999. Average 

leverage capital ratios increased to 11.79 percent, compared with 11.14 percent at the end of the first quarter 

of 1998 and 11.76 percent at year-end 1998. Firstquarter 1999 asset-quality levels remained virtually 

unchanged from the first quarter of 1998. Average total 

past-due loans for banks and thrifts in the Region were 

3.02 percent of total loans, comparable with levels 

reported one year ago. The Region’s slowing economic 

growth does not yet appear to have affected the asset 

quality of its insured financial institutions. 

Recent negative trends in earnings performance continued in the first quarter. The average return on assets 

ratio was 0.92 percent, down 23 basis points from firstquarter 1998. The major factor in declining earnings 

was the continuing slide in net interest margins. The 

average net interest margin was 4.22 percent, down 

from 4.38 percent in the first quarter of 1998. Many factors are contributing to declining net interest margins, 

including increasing competition and changing funding 

trends discussed later in this article. 

Funding Issues
 

Traditional Funding Measures3 Point 

to Tightening Liquidity 

Consistent with national trends, banks and thrifts in the 

Memphis Region are reporting rising loan-to-deposit 

ratios and changing funding trends (see Shifting Funding Trends Pose Challenges for Community Banks). 

As shown in Chart 2, both loan-to-asset and loan-todeposit levels have increased steadily during the current 

economic expansion. This increase is attributable to 

both substantial growth in loans and generally weak 

deposit growth. 

As shown in Table 2 (next page), total loans have 

increased at an average annual rate4 of 8.47 percent since 

1992. This robust growth is attributable to both increased 

consumer loan demand and a shift in institution asset 

composition from investment securities to loans. As 

loans typically offer higher yields than investment securities, the shift to loans likely has been driven in part by 

efforts to improve net interest margins. Loan growth did 

slow somewhat in 1998 as many consumers and busi3 Traditional funding measures discussed in this article, such as the 

loan-to-deposit ratio, have readily acknowledged limitations in 

assessing the true liquidity position of individual financial institutions, but are considered useful as an introduction to changing 

funding trends in the Region. 

4 These growth rates have been adjusted for merger activity and do 

not include reported results of financial institutions in operation for 

less than three years at each reporting date. The rates presented are 

median growth rates at each period. 

nesses curtailed major expenditures and some institutions began efforts to limit growing credit exposure. 

Loan growth is only part of the equation for rising loanto-deposit ratios; weak deposit growth appears to have 

been a much more important factor in recent trends. As 

shown in Table 2, deposit growth, particularly core 

deposit growth, has not kept pace with loan growth during the expansion. Core deposits grew at an annual rate 

of 4.07 percent from 1992 to 1998. As this growth 

would naturally include some retention of interest paid 

on existing deposits, banks and thrifts have obviously 

encountered considerable difficulty in attracting new 

deposits during this period. Some reasons for this weak 

CHART 2 

Average Loans Increased 

during the Recent Expansion 

Recession 

Percent of Total 

80 

70 

60 

50 

40 

Loans/Deposits 

Loans/Assets 

’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 

Source: Bank and Thrift Call Reports 

Memphis Regional Outlook 21 Third Quarter 1999 
1 1

1 1

Regional Perspectives
 

TABLE 2 

Deposit Growth Has Lagged Loan Growth during the Expansion 

1992 1993 1994 1995 1996 1997 1998 AVERAGE 

LOAN GROWTH (%)) 4.70 7.18 9.64 10.22 9.71 10.09 7.73 8.47 

CORE DEPOSIT GROWTH (%) 5.17 1.97 1.97 4.13 4.51 3.91 6.81 4.07 

DEPOSIT GROWTH (%) 4.43 2.18 2.97 6.10 5.90 5.35 7.83 4.97 

Note: Growth rates are merger adjusted and exclude new banks. 

Source: Bank and Thrift Call Reports 

deposit growth include lower consumer savings rates, 

rising consumer investments in mutual funds and other 

alternative vehicles, and increasing competition from 

credit unions and brokerage firms. 

Investments in mutual funds and other vehicles have 

grown considerably during the expansion. While direct 

evidence of the growth in these investments is not available at a state level, reported annual capital gains realizations can be used as a proxy for this growth. From 

1991 to 1996, net capital gains increased 158 percent in 

the Region, compared with 140 percent nationally.5 This 

finding implies that the national trend of rising mutual 

fund and stock market investing is occurring at a similar rate in the Memphis Region. The diversion of a larger share of declining consumer savings to mutual fund 

and direct equity investments is likely a limiting factor 

in the growth of insured institutions’ deposits. 

Rising direct competition for deposits also is hindering 

growth at banks and thrifts. Credit union membership 

has increased significantly in the Memphis Region. 

From 1993 to the first quarter of 1999, membership 

rose by over 17 percent. More significantly, the total 

assets of credit unions headquartered in the Region 

grew by 107 percent during the same period. This shift 

of at least a portion of customers’ deposit relationships 

to credit unions is likely the result of highly competitive 

interest rates offered by these institutions. Credit unions 

are not the only source of competition to the traditional 

domain of banks and thrifts, however. Anecdotal evidence suggests that consumers are increasingly migrating to brokerage firms offering deposit functions 

similar to those of banks and thrifts, such as transaction 

accounts, often at higher interest rates. 

As shown in Table 2, both deposit and core deposit 

growth rates increased significantly in 1998. This 

growth appears to have continued into the first quarter 

5 Source: RFA Industry Services. 

of 1999 and may be attributable in part to increased 

stock market volatility in the second half of 1998. Rising interest rates on many deposit products during the 

year also may have contributed. Even with the surge in 

deposit growth and a slowing of loan growth in 1998, 

core deposit growth continued to trail loan growth. As a 

result, institutions had to rely on noncore funding 

sources to support loan growth, as discussed later in this 

article. 

Tightening Liquidity Is Most 

Evident for Larger Institutions 

Large insured institutions (those with assets over $500 

million) have experienced a greater increase in average 

loan-to-deposit ratios than other institutions. From 

1992 to 1998, the median loan-to-deposit ratio for large 

institutions grew from 66.4 percent to 82.0 percent. 

This growth is greater than that reported by smaller 

institutions. 

Compared with their smaller counterparts, large institutions have reported a combination of slightly faster loan 

growth and substantially slower deposit growth. The 

annual loan growth rate for large institutions from 1992 

to 1998 was 8.56 percent, only slightly higher than the 

growth rate of other institutions. Large institutions 

reported an annual deposit growth rate of 4.0 percent, 

almost 100 basis points lower than that reported by 

small institutions. The disparity is even more obvious if 

only core deposits are considered. Core deposits6 at 

larger institutions grew at only a 2.8 percent annual rate 

during the period. 

6 While the distinction between core and noncore funding is becoming increasingly blurred, core deposits are still considered a generally 

more stable source of funding. Core deposits include the sum of 

demand deposits, negotiable order of withdrawal accounts, automatic 

transfer service accounts, money market demand accounts, other 

savings, and time deposits under $100,000. 

Memphis Regional Outlook 22 Third Quarter 1999 
Regional Perspectives
 

Some possible factors driving the slow core deposit 

growth among large banks include greater competition 

and the effects of merger activity. As larger banks tend 

to have operations centered in metropolitan areas, they 

often face greater competition for deposits. This competition is not limited to other banks and thrifts, as many 

more alternatives for both loans and deposits, such as 

mortgage companies and brokerage firms, tend to operate in metropolitan areas. Also, larger banks in recent 

years have tended to be active acquirers of other financial institutions. Acquiring institutions tend to lose market share in the first few years following an acquisition 

(see “Effects of Mergers on Community Banks,” Memphis Regional Outlook, Fourth Quarter 1998). The loss 

of a portion of acquired deposits would result in a lower 

overall deposit growth rate. 

The tightening in the Region’s average liquidity ratios is 

not being driven just by large institutions, however. As 

shown in Chart 3, the distribution of loan-to-deposit 

ratios at all the Region’s banks and thrifts has shifted 

appreciably. Most institutions now fall into higher loanto-deposit ratio ranges than in 1992. The median loanto-deposit ratio has increased from 59.5 percent in 1992 

to 70.6 percent at the end of 1998. 

Institutions Are Increasingly Relying 

on Other Funding Sources 

With core deposit growth unable to keep pace with 

deposit growth, banks and thrifts are increasingly using 

noncore funding sources. As shown in Chart 4, noncore 

funding has grown steadily, from 11.9 percent of total 

CHART 3 

Higher Loan-to-Deposit Ratios 

Are Evident throughout the Region 

0 

30 

25 

20 

15 

10 

5 

0 

20 40 60 80 100

Percent of Banks within Each Range 

Source: Bank and Thrift Call Reports 

1992 1998 

Loan-to-Deposit Ratio Ranges (%) 

110+ 

CHART 4 

Institutions Report Increasing Reliance 

on Noncore Funding Sources 

1990 

100 

90 

80 

70 

60 

50 

40 

30 

20 

Percent of Funding

Noncore Deposits 

Core Deposits 

Equity 

1992 1994 1996 1998 

Source: Bank and Thrift Call Reports 

funding (including equity) in 1992 to 18.9 percent in 

1998. These noncore funding sources include brokered 

deposits, certificates of deposit in amounts of $100,000 

or more, federal funds purchased and securities sold 

subject to repurchase agreements, and other borrowed 

funds. The latter category consists primarily of Federal 

Home Loan Bank advances.7 The recent growth in noncore funding has been concentrated in large certificates 

of deposit and other borrowed funds. 

Consistent with the decline in average core deposit levels, the number of institutions reporting low core 

deposit levels is growing. In 1992, only 33 institutions, 

or less than 3 percent of all institutions in the Region, 

reported core funding to total liabilities ratios below 70 

percent.8 By March 31, 1999, this number had increased 

to 134, or almost 15 percent of insured institutions. 

Lower Core Funding Levels Point to 

Lower Net Interest Margins 

A comparison of earnings performance from 1992 to 

1998 by a group of banks and thrifts with low core funding relative to other insured institutions reveals some 

potential earning implications of recent funding trends. 

The low core funding group is defined as institutions 

reporting core deposit totals that are less than 70 percent of total liabilities. 

7 As of March 31, 1999, Federal Home Loan Bank advances in the 

Region represented 72.7 percent of reported other borrowed funds. 

For a more detailed discussion of the use of Federal Home Loan Bank 

advances, see the Memphis Regional Outlook, First Quarter 1998. 8 This analysis excludes institutions that had been in operation for less 

than three years as of each reporting date. 

Memphis Regional Outlook 23 Third Quarter 1999 
Regional Perspectives
 

Funding trends also vary by primary lines of business. 

As shown in Chart 5, average loan-to-deposit ratios 

have increased across business specialization lines, 

but are higher for commercial and mortgage lenders. 

While agricultural lenders have reported a considerable increase in ratios since 1992, average loan-todeposit ratios in this group remain lower than for 

other groups. Mortgage lenders reported the greatest 

increase among the specialization groups. 

Mortgage lenders also reported the lowest utilization 

of core deposits as a funding source, at 76.9 percent 

of total liabilities, and the greatest reliance on other 

borrowed funds such as Federal Home Loan Bank 

borrowings, at 10 percent of total liabilities. Their 

higher use of other borrowed money is consistent with 

their need to fund longer-term mortgage-related 

assets. In many cases, mortgage lenders may be able 

to match borrowing terms to the expected maturing of 

assets. 

Definitions for Business Specialization: 

Agricultural Banks: Institutions with 25 percent or 

more of total loans in agricultural production and 

farm real estate loans. 

Commercial Lenders: Institutions with 25 percent or 

more of total assets in commercial and industrial 

loans and commercial real estate loans. 

Mortgage Lenders: Institutions with 50 percent or 

more of total assets in one- to four-family mortgage loans and mortgage-backed securities. 

Other Small Nonspecialized Banks: Institutions with 

less than $1 billion in total assets and no direct specialization. 

Other categories of institutions not depicted in Chart 

5 because of their limited numbers in the Region 

include International Banks, Credit Card Banks, Consumer Lenders, Other Specialized Banks, and Other 

Large Nonspecialized Banks. 

CHART 5 

Mortgage and Commercial Lenders 

Report Higher Loan-to-Deposit Levels 

90 

80 

70 

60 

50 

40 

Loan-to-Deposit Ratio (%) 

Source: Bank and Thrift Call Reports 

1995 

Agriculture Mortgage Other Small 

Nonspecialized 

1998 

Commercial 

Funding by Business Specialization 

Earnings performance differed considerably between 

the two groups of institutions. While both groups 

reported similar ratios of interest income to average 

earning assets, the low core funding group reported 

considerably higher interest expenses. These higher cost 

liabilities have resulted in a lower average net interest 

margin for these institutions. Since 1992, the average 

net interest margin of the low core funding group has 

ranged between 40 and 50 basis points below that of 

other institutions. While institutions with lower core 

funding levels reported lower average overhead expenses than other institutions, the reduced costs did not 

entirely offset lower margins. As a result, average 

returns on assets for institutions with low core funding 

levels have ranged between 10 and 20 basis points 

below those of other institutions in recent years. While 

Table 3 displays only 1998 performance, similar results 

were reported in recent years. 

Funding Trends Implications 

The performance of the low core funding group may 

have implications for the entire banking industry if current funding trends continue. The increasing reliance on 

noncore funding sources is likely contributing to the 

recent declines in net interest margins described in the 

“Banking Overview” section of this article. As the use 

of noncore funding continues to grow, banks and thrifts 

may face additional pressure on margins. The potential 

for lower net interest margins also raises a concern that 

some institutions may seek higher returns on assets, 

which could involve accepting higher levels of credit or 

interest rate risk. 

Although core and noncore funding definitions are easy 

to apply, the distinction between these two categories 

is becoming increasingly blurred. Noncore funding 

Memphis Regional Outlook 24 Third Quarter 1999 
Regional Perspectives
 

Banks with Low Core Funding Levels 

Report Lower Earnings 

TABLE 3 

CORE FUNDING/ 70% OR MORE THAN 

TOTAL LIABILITY LESS 70% 

NUMBER OF BANKS 125 850 

AVG. INTEREST 8.14 8.29 

INCOME/EARNING 

ASSETS 

AVG. INTEREST 4.16 3.85 

EXPENSE/EARNING 

ASSETS 

AVG. NET INTEREST 3.98 4.44 

MARGIN 

AVG. RETURN 0.97 1.17 

ON ASSETS 

Some Institutions Face Near-Term 

Funding Considerations 

The current agricultural situation discussed in the 

“Economic Overview” suggests that higher carryover debt is likely next year, which could affect 

agricultural lenders’ funding needs in 2000. Most 

agricultural lenders have borrowing arrangements 

in place to accommodate increases in seasonal loan 

demand. High levels of carryover debt that could 

take several years to be repaid may require more 

than just seasonal funding, however. Institutions 

that expect significant carryover may need to make 

arrangements to replace seasonal funding sources 

with longer-term funding for these loans. As 

described in the “Funding by Business Specialization” box, many agricultural lenders appear to 

retain considerable flexibility in accommodating 

higher levels of longer-term loans and may not 

require additional funding. 

Institutions should also be well prepared for possible short-term funding complications arising from 

year 2000 (Y2K) concerns. Some customers may 

choose to withdraw higher-than-normal levels of 

cash immediately before January 1, 2000, as a precaution against potential disruptions in any form of 

services, financial or otherwise. Institutions should 

be educating their customers about Y2K preparedness as well as planning to meet these potential 

withdrawals. 

Note: Excludes banks established within past three
 

years.
 

Source: Bank and Thrift Call Reports; 1998 results
 

shown. 


sources have traditionally been considered both more 

volatile and expensive to obtain than core funding. 

While this is true in general, individual institutions may 

be able to utilize noncore funding sources to lower costs 

or better match asset and liability maturities. 

Changing funding trends and consumer preferences are 

likely to contribute to greater volatility in funding and 

increase most institutions’ sensitivity to market conditions. These factors in turn require greater effort by 

institution officers and directors to properly manage 

both liquidity and interest rate risk. 

Memphis Region Staff 

Memphis Regional Outlook 25 Third Quarter 1999 
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