Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION FOURTH QUARTER 1998 

FDIC
 

Atlanta
 

Region
 

Division of
 

Insurance
 

Jack M.W. Phelps,
 

Regional Manager
 

Scott C. Hughes,
 

Regional Economist
 

Pamela R. Stallings,
 

Financial Analyst
 

W. Brian Bowling,
 

Financial Analyst
 

In Focus This Quarter 

◆ Merger and Acquisition Activity in the U.S. Banking Industry: 

Trends and Rationale—The size and value of recent mergers and acquisitions 

(M&A) in the banking industry have received much attention, yet the activity is a 

continuation of a longer-term trend and is one aspect of a broader national and global wave of business mergers. For banks, deregulation, competitive pressures, market 

valuations, synergistic opportunities, technology, globalization, and managerial 

incentives are among important drivers of the trend. By identifying the rationale and 

incentives for bank M&A activity, industry participants can better understand and 

evaluate the risks and challenges facing merged institutions. See page 5. 

By Steven E. Cunningham, John F. Sherman 

◆ Risks and Challenges for Consolidating Institutions—M&A activity 

creates significant challenges for bank managers, including combining management 

teams, integrating technology, realizing the benefits of diversification, and maximizing operating economies. As premiums paid in bank M&A deals have escalated, 

some industry observers have questioned whether the promised benefits of the transactions can be realized. Institutions in the process of integrating an acquired entity 

may be especially vulnerable to a downturn in the economy. See page 11. 

By John F. Sherman 

◆ Industry Consolidation Presents Unique Risks and Challenges for 

Community Banks—Industry consolidation has created competitive challenges 

for small banks and highlights traditional obstacles related to operating scale and 

scope. Aside from merging with or selling to competitors, some small banks are 

addressing consolidation challenges by outsourcing business functions, expanding the 

use of nondeposit funding sources, partnering with other banks and nonbanks, capitalizing on personalized service, and focusing on niche markets. While these adaptive 

strategies may help community banks meet the challenges of industry consolidation, 

they potentially complicate these institutions’ operations and risk profiles. See page 14. 

By Steven E. Cunningham 

Regional Perspectives 

◆ Region’s Economic and Banking Conditions—Economic growth in 

the Atlanta Region continues to outperform the nation...a number of factors, 

however, including the impact of the Asian crisis, have combined to slow 

growth...insured institutions are benefiting from the Region’s continued growth, 

reporting strong earnings, solid asset quality, and high capital levels...returns were 

strong across asset sizes, but many institutions are being affected by declining net 

interest margins. See page 19. 

◆ Structural Transformation in the New South—The Greenville, South 

Carolina, metropolitan area reflects the emergence of the “New South” or “New 

Economy”...growth is being driven by an influx of high-tech and informationdriven industries...gains in new industries have resulted in higher levels of economic diversification, tighter labor markets, and steady population growth...one 

drawback may be that the local economy could become more susceptible to national or international shocks. Greenville’s insured institution landscape is reflective of 

the area’s growth...a hallmark of this change has been an increase in number of 

newly chartered banks. See page 23. By Atlanta 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 Atlanta 

Region’s Regional Outlook, please call Jack Phelps at (404) 817-2590 or send an e-mail to 

jphelps@fdic.gov. 

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

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

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

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

the Federal Deposit Insurance Corporation. 

Chairman Donna Tanoue 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Publications Manager Teresa J. Franks 
To the Reader:
 

The Regional Outlook is intended to enhance readers’ understanding of risks and trends affecting FDIC-insured
 

institutions. The editorial staff welcomes the comments of any reader who is willing to take a few minutes to
 

complete the attached survey. Return the survey in the enclosed envelope or fax to (202) 898-8636.
 

You may also access the survey through the FDIC Internet site at www.fdic.gov. FDIC employees may take the
 

survey via the DOI homepage on the FDICnet.
 

All feedback is confidential. Thank you for your time and thought.
 

Sincerely,
 

George French 

Executive Editor 

The Regional Outlook has three In Focus articles that address national issues and a Regional Perspectives article 

that analyzes the economic and banking conditions in each of the eight FDIC supervisory regions. 

0 

No 

Opinion 

1 

Strongly 

Disagree 

2 

Disagree 

3 

Agree 

4 

Strongly 

Agree 

1 The In Focus articles improve my understanding of risks 

affecting the financial institutions of interest to me. 

2 The Regional Perspectives article improves my understanding 

of risks affecting the financial institutions of interest to me. 

3 The Regional Perspectives article is relevant to my geographic 

area of interest. 

4 How would you prefer the geographic boundaries be delineated? 

by the FDIC’s eight supervisory regions—Atlanta, Boston, Chicago, Dallas, Kansas City, Memphis, 

New York, and San Francisco (current format) 

by a smaller geographic location, such as ______________________________________________________ 

by a larger geographic boundary, such as ______________________________________________________ 

5 The length of the In Focus section is 

just right too long too short 

6 The length of the Regional Perspectives article is 

just right too long too short 

7 What other topics would you like to see in future editions? 

8 Additional comments and suggestions 

9 I am affiliated with: 

FDIC Financial institution 

Federal regulatory agency (non-FDIC) State banking department 

Other __________________________________________________________________________________ 
In Focus This Quarter
 

Merger and Acquisition Activity in the U.S. Banking
 

Industry: Trends and Rationale
 

•	 The size and value of recent mergers and acquisitions in the banking industry have received much 

attention, yet the activity is a continuation of a 

longer-term trend and is one aspect of a broader 

national and global wave of business mergers. 

•	 Deregulation, competitive pressures, market valuations, synergistic opportunities, technology, globalization, and managerial incentives are among 

the important drivers of bank merger and acquisition activity. 

•	 By identifying the rationale and incentives 

for bank merger and acquisition activity, industry participants can better understand and evaluate the risks and challenges facing merged 

institutions. 

Merger and acquisition (M&A) activity among banking 

companies is changing the industry’s structure. The 

number of insured commercial banks in the United 

States, which held relatively steady during the FDIC’s 

first 51 years of existence, has declined by one-third 

since year-end 1984, resulting in just under 9,000 commercial banks at the end of the second quarter of 1998. 

The number of banking organizations (bank holding 

companies, independent banks, and thrifts) also has 

declined precipitously since the mid-1980s. 

The recent flurry in M&A activity by banking companies has attracted significant attention as the magnitude 

of transactions has escalated. As shown in Chart 1, the 

announced values of bank mergers have increased 

sharply in recent years. However, increased consolidation activity is not unique to the banking industry: The 

United States is now experiencing the fifth major wave 

of business M&A in this century, which is in turn part 

of an unprecedented level of worldwide M&A activity. 

According to data from Mergerstat, the value of M&A 

deals announced for all U.S. industries during the first 

half of 1998, measured both absolutely and as a percentage of nominal gross domestic product, exceeded 

the value of announced transactions for any full calendar year on record. 

The factors that have contributed to this activity, including the availability of capital, technological change, and 

CHART 1 

Values of Announced Bank Mergers 

Increased Sharply during 1998 

450 $250 

400 

350 $200 

300 

250 $150 

200 

$100 

150 

100 $50 

50 

0 

Number of Announced

 Deals (left axis) 

Total Announced 

Deal Values (right axis) 

’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 1H98 

($ Billions) 

Year 

Source: SNL Securities 

globalization, are particularly important to the banking 

industry. Indeed, according to data from SNL Securities, the announced values of banking M&A have 

accounted for roughly one-third of all U.S. merger 

activity for the first half of 1998, exceeding any full calendar year percentage since the data have been collected (1989). This article will briefly describe the factors 

that are driving M&A activity in banking. 

Why Are Banks Merging? 

Deregulation 

Historically, state regulations and boundaries dictated 

the structure of commercial banking in the United 

States. Not until the 1980s did most states remove or 

substantially relax intrastate branching restrictions. 

Subsequently, the Riegle-Neal Interstate Banking and 

Branching Act removed most remaining restrictions to 

interstate expansion—restrictions that had been significantly liberalized by a 1985 U.S. Supreme Court decision (Northeast Bancorp v. The Board of Governors of 

the Federal Reserve System) that upheld the ability of 

states to reduce restrictions on entry by out-of-state 

holding companies.1 As recently as January 1994 only 

10 commercial banks owning 30 branches operated 

across state lines. By early 1998, 165 institutions owned 

12,694 interstate branches.2 

1 “Interstate Banking—The Past, Present and Future,” FDIC Banking
 

Review, Fall 1996.
 2 Figures provided by the FDIC’s Division of Research and Statistics.
 

Atlanta Regional Outlook 5	 Fourth Quarter 1998 
In Focus This Quarter
 

There is some evidence that the recent increase in 

expansion and branching opportunities arising from 

deregulation has led to improved efficiencies and profitability, both from M&A activity and from intracompany consolidation of bank subsidiaries by 

multibank holding companies. In addition, the recent 

easing of Federal Reserve Board restrictions governing 

Section 20 securities underwriting subsidiaries of bank 

holding companies and favorable bank operating subCHART 2 

Commercial Bank Profitabilty Has Improved 

While Revenue Growth Rates Are Declining 

14 

12 

10 

Percent 

8 

6 

1940s 1950s 1960s 1970s 1980s 1990s 

sidiary rule interpretations by the Office of the Comptroller of the Currency have made expansions into new 

lines of business and mergers across financial sectors 

more feasible. For example, according to data provided 

by SNL Securities, since the beginning of 1997, 47 

banking companies have purchased investment banking 

units, investment advisors, or broker-dealers. 

Increasing Competition 

Significant changes in the competitive environment also 

have contributed to the trend in bank M&A activity. 

One way to consider competition in an industry is 

through the “industry life cycle” framework. In this 

framework, an industry is generally categorized into 

one of four stages—start-up, rapid growth, mature, or 

decline. In each stage, firms are likely to take certain 

actions in response to the competitive environment. As 

discussed below, banking best fits the criteria for an 

industry in the mature stage. These criteria include 

declining revenue growth, improving profitability, 

increasing competition, and a shortage of investment 

opportunities relative to the amount of capital being 

generated. 

As shown in Chart 2, over the long term, commercial 

banks have experienced the declining trend in revenue 

growth and the improving trend in profitability that 

characterize a mature industry. The average annual revenue growth rate by decade, adjusted for inflation, has 

declined since the 1960s. Profitability, as measured by 

the average annual return on equity by decade, has 

steadily improved since the 1940s, with the exception of 

the crisis period of the 1980s. 

Competition in a mature industry often intensifies as 

competitors focus on sustaining market share as revenue growth rates slow. In banking, recent changes in 

the operating environment have stimulated a dramatic 

increase in competition. Specifically, barriers to entry 

into the industry have fallen: Capital is plentiful, experienced managerial talent is available (as a result of the 

many mergers), and regulatory restrictions have been 

relaxed. Technological and financial innovations also 

4
 

2
 

0
 

Return on Equity Revenue Growth (Inflation Adjusted) 

Source: FDIC Historical Statistics on Banking 

are influencing how banks compete by enabling them to 

manage disparate operations with broader product 

arrays more efficiently. Moreover, as a result of intensifying nonbank competition and continuing evolution in 

distribution systems, some banking services have come 

to resemble commodities. Consequently, brand loyalty 

appears to be declining and banks are experiencing 

reduced influence over pricing. 

The final criterion for a mature industry, a shortage of 

investment opportunities relative to the level of capital 

being generated (“excess capital”), as discussed below, 

has become an obstacle for banks. Although generating 

and retaining capital increase the level of protection 

from insolvency risk for depositors and the FDIC, rising capital levels without a corresponding increase in 

profitability reduce returns on equity and, thus, returns 

to shareholders. Attempts to increase assets relative to 

equity capital in an industry with excess capital also 

can be undesirable because competition drives the yield 

on available investments to levels that either dilute current earnings or fail to compensate adequately for the 

amount of risk taken. (See “Bank Earnings: Competitive Pressures and Risks,” Regional Outlook, Fourth 

Quarter 1997.) Alternatives for managing capital in 

such an environment include dividends, share repurchases, and M&A transactions; banks have pursued all 

three. 

Commercial bank cash dividend payments have reached 

record levels in the 1990s. In fact, the level of earnings 

retained over the past two years (26 percent in 1996 and 

28 percent in 1997) was the lowest during a noncrisis 

period since the FDIC’s inception (see Chart 3). A large 

percentage of these dividend payments is made to bank 

Atlanta Regional Outlook 6 Fourth Quarter 1998 
In Focus This Quarter
 

CHART 3 

Commercial Banks Are Retaining a Smaller Share 

of Earnings than during Any Other Profitable Period 

35 37 39 41 43 45 47 49 51 53 55 57 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 

Year 

Note: Negative 285 percent rate in 1987 shown as zero. 

Source: FDIC Historical Statistics on Banking 

$ Billions

Percent 

Percent of Earnings Retained (left axis) 

Cash Dividends Declared (right axis) 

80 

70 

60 

50 

40 

30 

20 

10 

0 

45 

40 

35 

30 

25 

20 

15 

10 

5 

0 

holding companies, which, in turn, use the funds to 

repurchase common stock—another means of reducing 

book capital, increasing financial leverage, and improving return on equity. According to data compiled by 

Keefe, Bruyette & Woods, Inc., share repurchases by the 

top 25 banking organizations increased in each quarter 

during 1995 and 1996 and reached an all-time high of 

$11.5 billion in the first quarter of 1997, but have 

declined steadily since then. There are at least two likely reasons for this trend. First, the continued escalation 

in share prices through the first half of 1998 made 

repurchases more expensive. Second, as share prices 

increase, the “pooling of interests” method of accounting for a merger becomes more attractive; however, it 

carries certain Securities and Exchange Commission 

restrictions on share repurchases both before and after 

the transaction. Therefore, as values rise, institutions 

considering future mergers are less likely to initiate 

repurchase programs. 

The third capital management alternative, M&A, offers 

potential benefits to both parties to the transaction. 

M&A may permit acquirers to deploy excess capital 

while improving earnings through operating and financial economies, diversification of revenues and 

geographic exposures, and greater management 

expertise. M&A also can provide 

access to new products—a common objective of competitors in 

mature industries. For institutions 

acquired through a purchase transaction in which ownership rights 

are relinquished, mergers provide 

a means of returning capital to 

shareholders rather than attempting to remain independent in an increasingly competitive environment. 

Market Valuations 

The increased market values commercial banking companies have experienced through the first half of 1998 

played a major role in recent M&A activity, as common 

stock increasingly has been used as “currency” in transactions, especially the largest mergers. More valuable 

stock allows banks to issue fewer shares to execute 

mergers, which reduces the potential dilutive effects to 

shareholders. Through mid-April 1998, the amount of 

cash used to fund all U.S. business mergers (13.4 percent) had reached the lowest point in ten years.3 Similarly, the aggregate cash amount of announced bank 

deal values through the first half of 1998 was less than 

1 percent and reflects a steady decline since 1994. There 

appears to be a strong relationship between bank stock 

valuations and the level of cash committed in bank 

M&A activity since 1991 (see Chart 4), although this 

relationship is obviously influenced by large, stockbased mergers. 

Record earnings, positive market assessments of earnings quality and stability, and continued consolidation 

expectations sparked the upward trend in bank stocks 

through June 1998. The value of the SNL Bank Index, 

which is composed of publicly traded banking companies, quadrupled between January 1990 and June 1998 

and far outstripped gains in the broader S&P 500 over 

the same period. The result was a rise in bank stock 

prices as a multiple of earnings per share (the price3 As reported by the Wall Street Journal, April 16, 1998, p. C1. 

CHART 4 

5 

10 

15 

20 

25 

30 

’91 ’92 ’93 ’94 ’95 ’96 ’97 1H98 

SNL Bank Index 

Price-Earnings Ratio* Percentage of 

Cash Used in 

All Bank M&A 

* Price-Earnings Ratio = stock price of index members to previous 12 months’ 

earnings weighted by market capitalization. 

Source: SNL Securities 

As Market Valuations Have Increased, 

Cash Usage in Bank Mergers Has Declined 

Price-Earnings Ratio,

% Cash 

0 

Year 

Atlanta Regional Outlook 7 Fourth Quarter 1998 
In Focus This Quarter
 

earnings ratio) both absolutely and relative to the S&P 

500. For example, according to the price-earnings ratio 

for the SNL Bank Index, at year-end 1994, investors 

paid $9.76 per dollar of bank earnings; on June 30, 

1998, investors paid $22.88 per dollar of earnings. Over 

the same period, the price-earnings ratio of the SNL 

Bank Index relative to the S&P 500 increased from 65 

percent to 79 percent. 

From a corporate finance perspective, firms create 

wealth for shareholders by generating returns on invested long-term debt and equity capital that exceed their 

combined cost. Since long-term debt is used less in 

banking than in other industries, Credit Suisse/First 

Boston uses return on equity less the cost of equity capital as a proxy for measuring wealth generation by 

banks.4 As shown in Chart 5, over the long term, 

increases in the price-earnings ratio for banks relative to 

that for the S&P 500 tends to track with the banking 

industry’s ability to generate returns on equity in excess 

of the cost of equity capital. Through 1997, high levels 

of industry profitability, low market interest rates, and 

market expectations of more stable long-term industry 

earnings had driven the spread between the return on 

and cost of equity capital to unprecedented levels. 

Following the strong performance through the first half 

of 1998, the SNL Bank Index lost 21 percent of its value 

during the third quarter of 1998 (all during the month of 

August) because of concerns about corporate earnings, 

international exposures, the flat yield curve, and the ability of banking companies to expand market-sensitive 

4 “Value-Based Analysis of Banks,” Credit Suisse/First Boston, Equity Research—Americas, June 4, 1998. 

CHART 5 

revenues. Over the same period, the S&P 500 declined 

only 10 percent. Likely in response to relatively poor 

stock market conditions, only 75 bank mergers were 

announced during the third quarter of 1998— a 30 percent decline from the second quarter—with over half 

announced during July. According to SNL Securities, 

only 32 bank mergers were announced in August and 

September 1998, the lowest number for any two-month 

period since March and April 1997, when 31 mergers 

were announced. The August 1998 decline in the SNL 

Bank Index was the largest monthly decline since a 7 

percent drop in March 1997. In addition, the average 

price-earnings ratio for the index relative to the S&P 500 

during third-quarter 1998 was the lowest in eight quarters. Consistent with the aforementioned relationship 

between bank stock valuations and the level of cash committed to bank M&A activity, the amount of cash committed to mergers in September increased significantly. 

Synergistic Opportunities 

A primary motive for M&A activity is to increase the 

value of the combined company by creating synergies. 

In other words, through some combination of cost cutting and revenue growth, M&A can produce additional 

wealth for shareholders of the combined company 

beyond what the companies operating independently 

could generate. Although each transaction has unique 

characteristics, most bank M&A generate additional 

value from some combination of operating economies, 

diversification of revenues and geographic exposures, 

financial economies, and transfer of management 

expertise. 

Operating economies are achieved by eliminating overlapping administrative functions and infrastructure as 

Atlanta Regional Outlook 8 Fourth Quarter 1998 

Bank Stock Values Relative to the Broader Market 

Reflect Ability to Generate Equity Returns in Excess of Costs 

0 

20 

40 

100 

120 

–14.0 

–12.0 

–10.0 

–8.0 

–6.0 

–4.0 

–2.0 

0.0 

2.0 

4.0 

80 

60 

Year 

’55 ’58 ’61 ’64 ’67 ’70 ’73 ’76 ’79 ’82 ’85 ’88 ’91 ’94 ’97 

Return on Equity Less Estimated Cost of Equity (right axis) 

Bank Price-Earnings Ratio Relative to S&P 500 (left axis) 

Source: Credit Suisse/First Boston Percent

Percent 
In Focus This Quarter
 

well as by using existing distribution networks to crosssell products and services to generate revenue gains. 

However, the degree to which these benefits materialize 

will depend on the specific characteristics of the merger partners and their markets. For example, a review of 

48 banking company mergers from 1995 through the 

first half of 1998, where the seller held more than $1 

billion in assets, revealed estimated cost savings that 

increased with the degree of market overlap (see Chart 

6). Expected cost savings should translate into an 

increase in a firm’s value. This appears to be the case in 

this sample, as the median price paid by acquirers as a 

multiple of the target’s previous 12 months’ earnings 

increased with the level of expected cost savings. 

Although perceived cost savings have contributed to 

bank M&A activity, whether the gains actually materialize hinges on execution, as discussed in “Risks and 

Challenges for Consolidating Institutions” in this 

issue. 

Whereas mergers in overlapping markets provide 

opportunities for cost cutting, value creation from revenue enhancements is more likely to materialize in 

M&A transactions across markets and industries. Such 

mergers can be expected to lead to increased diversification of revenues and geographic exposures. These 

expectations may be driving the recent trend in acquisitions of investment banking units and brokerage houses 

by banking companies. As traditional interest-spread 

income has stagnated, many institutions have focused 

on expanding noninterest sources of revenue. At June 

30, 1998, noninterest income made up 40 percent of net 

operating revenue (net interest income plus noninterest 

income) for all commercial banks, compared with only 

25 percent in 1984. Similarly, geographic expansion can 

CHART 6 

In-Market Overlapping Out-of-Market 

Median Estimated 

Cost Savings (left axis) 

Estimated Cost Savings and Pricing for Bank 

Mergers Are Tied to the Degree of Market Overlap 

Source: SNL Securities 

Multiple of Median Price Paid by 

Acquirer to Seller’s Previous 

12 Months Earnings (right axis) 

0% 

5% 

10% 

15% 

20% 

25% 

30% 

35% 

40% 

16 

17 

18 

19 

20 

21 

22 

reduce a firm’s dependency on local, undiversified 

economies. Supporting this notion, a May 1998 working paper by the Federal Reserve Bank of Philadelphia 

found that economic benefits are strongest for banks 

engaged in interstate expansion, especially for mergers 

that diversify macroeconomic exposures.5 

As an institution’s size increases through M&A activity, 

financial economies may result from greater access to 

nondeposit funding alternatives as well as traded and 

over-the-counter off-balance-sheet financial instruments. As of June 30, 1998, commercial banks with 

assets less than $1 billion funded approximately 80 percent of assets with domestic deposits, compared with 

roughly 50 percent for commercial banks with assets 

greater than $1 billion—reflecting how funding flexibility and accessibility increase with scale. Access to 

money and capital markets is enhanced for larger institutions through potentially lower transaction costs and 

increased coverage by securities analysts and rating 

agencies. For the same reasons, large banks are also the 

primary users of off-balance-sheet financial derivatives. 

Differences in the ability of managers to operate institutions efficiently may also provide impetus for acquisitions. As Federal Reserve Board Chairman Alan 

Greenspan noted in recent testimony, “there are considerable differences in the cost efficiencies of banks 

within all bank classes, implying that there is substantial potential for many banks to improve efficiency of 

their operations, perhaps through mergers.”6 Thus, 

managers of more efficient banks may acquire less 

efficient competitors in an attempt to increase the latters’ value through improved management. As shown in 

Chart 7 (next page), the efficiency ratios7 of bank holding companies improved significantly from 1987 to 

1997. However, continued disparities in efficiency 

among companies, as reflected by the upward slope of 

the lines in Chart 7, may offer additional opportunities 

for M&A activity. 

Technology and Globalization 

The application of technology to nearly every aspect 

of banking offers the potential for more streamlined 

oversight, management, and evaluation of far-flung 

5 The Dollars and Sense of Bank Consolidation, Working Paper No.
 

98-10,The Federal Reserve Bank of Philadelphia.
 

6 Testimony before the Committee on the Judiciary, U.S. Senate, June
 

16, 1998.
 

7 The efficiency ratio is calculated by dividing noninterest expense by
 

the sum of net interest income and noninterest income. The ratio can
 

be interpreted as the cost to generate each dollar of revenue.
 

Atlanta Regional Outlook 9 Fourth Quarter 1998 
In Focus This Quarter
 

CHART 7 

100% 

80% 

60% 

40% 

20% 

Efficiency Ratios* 

Most Efficient 

Institution 

* The efficiency ratio is noninterest expense divided by the sum of net interest 

income and noninterest income. 

Bank Efficiency Has Improved, but Differences 

among Institutions May Provide Merger Incentives 

Bank Holding Companies Continuously Operating from 1987 to 1997 

Least Efficient 

Institution 

Source: Federal Reserve Board Y-9 Reports, adapted from an analysis 

by McKinsey & Company. 

1987 

1997 

operations both domestically and internationally. 

Consequently, technology can facilitate merger activity. 

Moreover, some insured institutions may turn to mergers with compliant partners as a solution to Year 2000 

computer problems. 

In a June 1997 speech to the Institute for International 

Economics, Deputy Treasury Secretary Lawrence Summers credited information and communication technologies as a contributing factor to the trilliondollar-a-day volume of cross-border capital flows.8 

Although the number of insured branches of foreign 

banks and the number of foreign offices of insured 

domestic banks have both declined in recent years, 

increasingly interconnected financial markets, firms, 

and customers have heightened the potential for competition across borders and continents. 

The scale, scope, and structure of many foreign competitors may promote combinations by U.S. institutions 

looking to enhance competitiveness in the global arena. 

Approval of proposed large mergers announced in early 

1998 will elevate several U.S. banking companies to 

banking’s global elite in terms of assets and market capitalization. Mergers among large European financial 

institutions in anticipation of the European economic 

and monetary union may spur U.S. multinational banks 

to consider strategic mergers across financial sectors. 

8 “Promoting Global Financial Stability: The G-7 Agenda,” delivered 

to the Institute for International Economics, June 12, 1997. 

Management Incentives 

Other factors that may drive M&A activity are related to 

managers’ compensation, special reward structures, and 

job security. Industry observers have noted that executive salaries are highly correlated with company size 

and revenues. Some analysts have noted that compensation of bank executives rises as assets expand, regardless of the source of the expansion. Bear, Stearns & 

Company opined in June 1998 that bank mergers would 

continue partly because “executive compensation in 

banking is correlating more with asset size than with 

any other financial performance measure.” 

Special reward structures also may influence acquisition programs. Large salary increases and special merger bonuses have been observed recently for executives 

of large acquiring banking companies. Amassed stock 

holdings and options may offer significant wealth for managers who 

decide to sell. Additionally, managers may take actions to lessen the 

likelihood of takeover and the corresponding probability of job loss. 

Such defensive managers may 

undertake acquisitions to avoid having their own banks targeted for 

purchase. 

Summary and Conclusions 

By identifying the rationale and incentives for bank 

M&A activity, regulators and industry participants can 

better understand and evaluate the risks and challenges 

facing merged institutions. The recent wave of banking 

industry M&A activity has been stimulated by a number 

of factors, including deregulation, increasing competition, market valuations, synergistic opportunities, technology and globalization, and management incentives. 

Although the pace of M&A activity may slow in the 

short term due to such factors as a stock market downturn or concern about Year 2000 implementation issues, 

the presence of multiple drivers will likely extend the 

consolidation trend well into the future. 

Steven E. Cunningham, CFA, Senior Financial Analyst 

scunningham@fdic.gov 

John F. Sherman, CFA, Senior Financial Analyst 

jsherman@fdic.gov 

Atlanta Regional Outlook 10 Fourth Quarter 1998 
In Focus This Quarter
 

Risks and Challenges for Consolidating Institutions
 

•	 Bank merger and acquisition (M&A) activity creates significant challenges for bank managers, 

including combining management teams, integrating technology, realizing the benefits of diversification, and maximizing operating economies. 

•	 As premiums paid in M&A transactions have 

escalated, some industry observers have raised 

concerns over whether the assumptions concerning potential earnings and strategic benefits can 

be realized. 

•	 Institutions in the process of integrating an 

acquired entity are likely to be especially vulnerable to a downturn in the economy. 

Merging institutions are under great pressure to execute 

the combination smoothly and realize its anticipated 

benefits. On the basis of anticipated earnings improvement and other strategic benefits, M&A deals are often 

executed at premiums substantially above recent market 

prices. As a result, financial market participants closely 

scrutinize post-merger results. Senior management of 

the merged entities, who typically are instrumental in 

convincing shareholders to agree to the transaction, are 

responsible for ensuring that expectations are realized. 

Entities that have demonstrated a proficiency at executing mergers have been regarded favorably by the capital 

markets. For some organizations, merging has effectively become a line of business. Alternatively, those that 

struggle after a merger may experience poor financial 

performance and could potentially become targets for 

acquisition themselves. 

Execution Risk 

The term “execution risk” often is applied to potential 

obstacles to integrating merging institutions. According 

to some analysts, execution risks are the primary risk in 

these combinations. These risks stem from a variety of 

uncertainties that arise following a merger: Can the new 

institution combine its management teams, integrate 

technological systems, realize the benefits of diversification, and maximize operating economies, all without 

interrupting services? Each of these uncertainties, summarized below, presents significant challenges to bank 

managers. 

Management 

Combining the management teams of consolidating 

companies is a critical first step in the transition 

process. Lines of reporting and authority must be delineated, and compensation arrangements coordinated and 

aligned with corporate goals. All of this must be accomplished without alienating critical personnel. The most 

difficult aspect may involve intangible cultural differences. A recent poll by Hewitt Associates1 of human 

resource managers of 218 large U.S. companies identified integrating organizational cultures as the “top challenge” in mergers. While some level of turnover must be 

expected, losses of key personnel and interruptions in 

service can result in dissatisfied customers, which in 

turn can lead to poor financial performance. 

Technology 

Technological advances often are 

identified as the single greatest 

enabler of the wave of bank consolidation; however, smoothly 

integrating existing systems and 

maximizing potential benefits of 

technology can be difficult. A 

Federal Reserve Board2 study of 

nine recent mergers concluded that the most frequent 

and serious problem merging institutions encountered 

was unexpected difficulty in integrating data processing 

systems and operations. The faster systems can be consolidated, the sooner cost savings can be realized; however, disruptions in service or breakdowns in control 

mechanisms may be less likely with a more measured 

integration timetable. Rather than attempting to integrate existing, sometimes incompatible systems, many 

merger partners have chosen to maintain parallel operations while integrating data processing systems over 

time. Year 2000 compliance efforts add yet another layer 

of complexity to these endeavors. 

Diversification 

M&A transactions provide an opportunity to diversify 

risk exposures, thereby potentially decreasing earnings 

volatility and moderating the effect of economic down1 “Career Tracks: Personnel Execs: Toughest Job in Mergers Is Blending.” American Banker, August 10, 1998, p. 6. 2 “The Efficiency Effects of Bank Mergers: An Overview of Case 

Studies of Nine Mergers.” Journal of Banking & Finance, March 

1998, vol. 22, no. 3, pp. 273–291. 

Atlanta Regional Outlook 11	 Fourth Quarter 1998 
In Focus This Quarter
 

turns on an institution’s performance. However, diversification creates added complexity for bank managers. 

They may have little practical experience with new 

product lines or new geographic markets and as a result 

they may not fully understand the risks involved in these 

new areas. 

CHART 1 

Many of the Most Acquisitive Banking Companies 

Have Underperformed the Universe of Bank Stocks 

(March 31, 1993–March 31, 1998) 

550 ◆ Total Assets Greater Than $20B 

Total Return (Percent) 

Total Assets between $5B and $20B 

450 Total Assets Less Than $5B 

Operating Economies 

The degree to which anticipated operating economies 

are realized hinges on management’s ability to carry out 

multiple objectives. To achieve anticipated revenue 

enhancements, managers of consolidating institutions 

350 

250 SNL All Bank Index = 249.4% 

150 

have attempted to promote a culture of cross-selling 50 

20 30 40 50 60 70 80 90 

new and existing products to a broader customer base in 

new markets, often through new distribution networks. 

At the same time, they have sought to reduce expenses 

by eliminating redundant administrative functions. 

Underlying these efforts is the need to establish strong 

internal controls and develop appropriate risk management systems. 

Are Expectations Unreasonable? 

As premiums paid to carry out M&A transactions have 

escalated, some industry analysts have viewed the 

assumptions regarding the expected earnings and strategic benefits as aggressive, raising uncertainty as to 

whether these benefits can be realized. Shares of banking organizations that have been active acquirers have 

not necessarily outperformed the universe of bank 

stocks, even before the recent market volatility. According to BankINVESTOR, for the five-year period ending March 31, 1998, most of the returns of the most 

acquisitive banking organizations across three separate 

size categories lagged the SNL Bank Index (Chart 1). 

This lag may be due to investor concerns about whether 

and to what extent the anticipated benefits of merger 

activity will be realized. For example, the assumed benefits related to economies of scale and diversification 

may be overoptimistic. 

Benefits of Scale 

Economies of scale associated with greater size and 

capacity are commonly identified as a potential benefit 

of consolidation. Large banks make substantial capital 

investment in areas such as technology and deliverysystem infrastructures; spreading these costs across a 

larger customer base may lead to greater efficiency. 

However, some observers question whether there is a 

limit to benefits of scale. Federal Reserve Board ChairPercentage of Current Assets Purchased
 

over Past Five Years
 

Source: BankINVESTOR
 

man Alan Greenspan testified before the Senate Judiciary Committee in June 1998 that “there are no clearcut findings that suggest bank mergers uniformly lead 

to efficiency gains. Returns could be muted by large 

company inefficiencies, and their customers may face 

bureaucratic inflexibility.” Perhaps the increased complexity of larger institutions combined with their 

involvement in more nontraditional activities offset the 

advantages of larger scale. 

Benefits of Diversification 

Another common goal of M&A activity is to promote 

diversification of revenue streams. The relaxation of 

regulatory restrictions on geographic expansion and 

permissible activities has made possible new combinations of revenue sources. However, the extent to which 

combining traditional banking with a broader range of 

activities will yield a diversified income stream is not 

yet clear. Industry analysts often point to the declining 

share of total revenues from net interest income as an 

example of improved diversification and potentially less 

volatile earnings. However, others argue that, like 

margin-related income, fee income from activities such 

as mutual fund sales, investment management, and brokerage operations is sensitive to both increasing interest 

rates and deteriorating economic conditions. 

Cost of Capital 

Failure to meet performance expectations following a 

merger can lead to negative market assessments of earnings quality and stability. As creditors and investors 

view an institution’s performance less favorably, they 

Atlanta Regional Outlook 12 Fourth Quarter 1998 
In Focus This Quarter
 

require a higher rate of return on capital markets instruments. While cost of capital always has been important 

for institutions that rely significantly on capital markets 

as a funding source, changes in the competitive environment have made it a critical issue for all banking 

organizations. Technological advances and deregulation 

now permit low-cost competitors to enter previously 

insulated markets. (See “Merger and Acquisition Activity in the U.S. Banking Industry: Trends and Rationale” for a discussion of changes in the competitive 

environment.) Competitors with a lower cost of capital 

often can provide services at a lower price, or they can 

accept similar risks in exchange for a lower expected 

return. Such competition may lead higher-cost competitors to pursue higher-yielding but riskier investment 

alternatives. 

Economic Conditions 

The M&A activity of the past few years has occurred in 

an environment of nearly ideal economic conditions. As 

a result, many of the new business combinations have 

yet to be tested by a downturn in the economy. Until 

these new entities experience a full business (and credit) cycle, the results of the M&A activity cannot be fully 

assessed. 

Regardless of whether the long-term objectives of 

M&A activity are achievable, institutions that are transitioning to a new structure following a merger are likely to be especially vulnerable to deteriorating economic 

conditions. The experience of newly chartered institutions during the 1980s banking crisis is an example of 

deteriorating economic conditions interrupting this 

transition period. According to the FDIC’s recent study, 

History of the Eighties—Lessons for the Future, more 

than 16 percent of institutions chartered during the 

1980s failed by 1994, compared with just 7.6 percent of 

preexisting institutions. The study attributed the high 

failure rate to a combination of “powerful competitive 

pressures to assume greater risk with relative inexperience in a demanding new environment.” The competitive pressures included incentives to “leverage high 

initial capital positions, increase earnings per share, and 

meet stockholder expectations.” Although recently 

merged institutions and newly chartered institutions are 

not identical, today’s merger participants face many of 

the same pressures. 

The percentage of institutions that have recently experienced a structural change is higher today than at any 

other time since the consolidation trend began. Institutions that were chartered or involved in a merger over 

the past three years represent nearly 13 percent of all 

commercial banks and 65 percent of commercial bank 

assets. (See “Industry Consolidation Presents Unique 

Risks and Challenges for Community Banks” for a 

discussion of the trend in newly chartered institutions.) 

As shown in Chart 2, these percentages have increased 

substantially in recent years. Much of the consolidation 

activity is occurring between institutions that have been 

part of the same holding company for extended periods; 

however, even these transactions present integration 

challenges that would be complicated by an economic 

downturn. 

Summary and Conclusions 

While substantial benefits may be derived from bank 

M&A activity, mergers impose heavy demands on bank 

managers and present potential risks to banking organizations, bank investors, and the insurance funds. Bank 

managers face significant challenges associated with 

executing the merger, including combining management teams, integrating technology, realizing the benefits of diversification, and maximizing operating 

economies. Additionally, uncertainty remains as to 

whether merger-related expectations can be fully realized. Finally, the process of integrating two institutions 

is complex and time-consuming. Should this process be 

interrupted by an economic downturn, these institutions 

may be especially vulnerable. 

John F. Sherman, CFA, Senior Financial Analyst 

jsherman@fdic.gov 

CHART 2 

The Share of Institutions That Were Newly
 

Chartered* or Involved in a Merger within the
 

Previous Three Years Is Increasing
 70 14 

60 13 

50 12 

40 

30 

11 

10

 9 

20 8 

10 7 

0 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 1H98 6 

Percent of Commercial Banks 

(right axis) 

Percent of Commercial Bank Assets 

(left axis) 

Year * Includes all de novo institutions 

Source: Bank Call Reports 

Atlanta Regional Outlook 13 Fourth Quarter 1998 
In Focus This Quarter
 

Industry Consolidation Presents Unique Risks and
 

Challenges for Community Banks
 

•	 Industry consolidation has created competitive 

challenges for small banks and highlights traditional obstacles related to operating scale and 

scope. 

•	 Some small banks that are not merging with or 

selling to competitors are addressing consolidation challenges by outsourcing business functions, 

expanding the use of nondeposit funding sources, 

partnering with other banks and nonbanks, capitalizing on personalized service, and focusing on 

niche markets. 

•	 While these adaptive strategies may help community banks meet the challenges of industry consolidation, they potentially complicate the 

operations and risk profiles of these institutions. 

Historically, commercial banking has been characterized by a large number of small institutions operating at 

the community level. Although the number of small, or 

community, banks (defined as those with total assets of 

$500 million or less) has declined significantly since 

consolidation began in the 1980s, they continue to dominate the industry’s demographics. At June 30, 1998, 92 

percent (8,306) of FDIC-insured commercial banks 

held assets of $500 million or less. Approximately 73 

percent of these banks had no holding company or were 

subsidiaries of one-bank holding companies, and more 

than one-third operated only one office. The June 30, 

1997, Summary of Deposits data present more evidence 

of the extent of community banking. On that date, twothirds of all commercial banks operated offices exclusively within a one-county area. 

In terms of demographics, the structure of commercial 

banking continues to reflect the time when state and 

interstate banking and branching restrictions tended to 

limit rivalry in many local markets. However, recent 

changes in the structure, regulation, and operating environment of the financial services sector have affected 

commercial banks, especially smaller community 

banks. Specifically, industry consolidation has created 

new challenges for small banks arising from heightened 

competition and accentuates traditional small bank 

obstacles related to size and scope of operations. 

Competitive Pressures 

In addition to intensifying competitive pressures from 

nonbanks, industry consolidation has heightened competition among commercial banks. According to the 

Federal Reserve Board’s Flow of Funds data, for the 

seven-year period ending on March 31, 1998, commercial banks’ share of total financial assets in the U.S. 

economy declined nearly 6 percentage points to just 

over 20 percent. At the same time that banks are capturing a smaller slice of the financial services pie, mergers, 

acquisitions, and consolidation have set the stage for 

increased competition within the industry. Larger banks 

operating across state lines and in multiple markets via 

branches, mailings, or technology now vie for community bank customers. Moreover, the rebound in new 

bank charters over the past four years, an outgrowth of 

the consolidation trend, has increased the number of 

small bank competitors in many markets. The inaugural 

ABA Community Bank Competitiveness Survey1 in 

1997 reported that small bankers considered other community banks their chief competitors for deposit gathering and all types of lending, and considered large banks 

formidable competitors in commercial and consumer 

lending and deposit gathering. While competition 

among small banks in common markets has existed for 

some time, the emergence of larger institutions as challengers results largely from many of the merger motivators and drivers discussed in “Merger and Acquisition 

Activity in the U.S. Banking Industry: Trends and 

Rationale” in this issue. 

New Chartering Activity 

A secondary effect of industry consolidation, and a 

potential source of increased competition for preexisting community banks, is the recent trend in new bank 

charters. From June 1994 to June 1998, more than 500 

commercial banks were established in 48 states. 

Although rebounding, the annual level of new chartering activity remains well below the peaks of the previous three decades. Industry observers attribute the 

recent increase in new charters to many factors, including the availability of displaced banking talent, strong 

economic growth, potential niche opportunities in mar1 As presented in the ABA Banking Journal, April 1997, p. 55. 

Atlanta Regional Outlook 14	 Fourth Quarter 1998 
Small Banks in Business 4 Years or Less

18%

21%

29%

40%

24%

38% 20%

27%

In Focus This Quarter
 

ket segments underserved by larger banks, and the loss CHART 1 

of local decision making and perceived service gaps as New Chartering Activity Appears to Be Related local banks are acquired by larger banks or are consoli­ to the Number of Banks Sold or Consolidated dated into far-flung multibank companies. in Merger Transactions 

New bank activity is not concentrated in one region of 

the country. However, at the state level there appears to 

be a relationship between new chartering activity and 

the number of institutions sold or consolidated in merger and acquisition transactions (see Chart 1). Forty percent of all banks sold or consolidated and 27 percent of 

new charters from June 1994 to June 1998 were in 

Texas, California, Florida, Illinois, and Georgia. 

As shown in Map 1, ten states currently host a high perNumber of New Commercial Banks40 (June 1994–June 1998) 

IL 35 

30 GA 

25 FL TX CA 

20 

15 

10 

5 

0 

0 50 100 150 200 250 

Number of Banks Sold or Consolidated 

Sources: Bank Call Reports, FDIC Division of Research and Statistics centage of recently established community banks. Many 

of these states have experienced strong economic 

growth during this expansion and have a large number 

of banking offices owned by out-of-state institutions. 

These concentrations are especially noteworthy since 

newly chartered institutions often pursue aggressive 

growth to improve profitability, which may influence 

pricing and terms for competitors within their markets. 

Reflecting the recent surge in new banks, 57 percent of 

the 402 unprofitable commercial banks through the first 

half of 1998 had been in business less than four years, 

up from 17 percent at year-end 1994 (see Chart 2). As 

would be expected, the ten states highlighted in Map 1 

rank among the top in terms of the percentage of small 

banks that were unprofitable during the first half of 

1998. 

Challenges of Scale and Scope 

A by-product of industry consolidation is the emerMAP 1 

Some States Host a High Percentage of Banks 

Established in the Past Four Years 

Greater than 15% (10) 

5% to 15% (19) 

Less than 5% (22) 

New Banks as a Percentage of Total 

June 30, 1998 

24% 

16% 

gence of larger institutions. By definition, community CHART 2 

banks operate with relatively less scale than their 

regional, super-regional, and money-center counter- Recently Chartered Small Banks Comprise a 

Higher Proportion of Unprofitable Institutions parts. As a result, small banks have limited ability to 

spread the costs of new investments or operating 

expenses across a broad asset base. This characteristic 

has traditionally forced community banks to spend 

more to generate each dollar of revenue than the rest of 

the industry, as measured by efficiency ratios.2 The 

inability of many community banks to fund large expenditures, such as investments in technology, alternative 

delivery systems, or new business lines, may cause 

2 The efficiency ratio is calculated by dividing noninterest expense by 

Percentage of All Unprofitable Banks 100 

80 

60 

40 

20 

0 

Small Banks in Business More Than 4 Years 

Small Banks in Business 4 Years or Less 

’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 1H98 

Year the sum of net interest income and noninterest income. The ratio can 

Source: Bank Call Reports be interpreted as the cost to generate each dollar of revenue.
 

Atlanta Regional Outlook 15 Fourth Quarter 1998
 
In Focus This Quarter
 

CHART 3 

Small Banks Remain Highly Dependent 

on Spread Income 

55% 

60% 

65% 

70% 

75% 

80% 

85%

Net Interest Income to Net Operating Revenue 

Total Assets Greater 

Than $500M 

Total Assets Less 

Than $500M 

’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 1H98 

Year 

Source: Bank Call Reports 

long-term competitive disadvantages. For example, The 

Tower Group estimates that 70 percent of 1997 information technology (IT) spending by banks was by the 

top 15 institutions.3 Smaller institutions competing with 

larger banks that are investing in technology to improve 

operational efficiency, increase customer convenience, 

or to better identify customer profitability, pricing 

strategies, or cross-selling opportunities may find a 

diminished presence in the marketplace. Consequently, 

small banks may face increasing competition for customers who are attracted to sophisticated pricing, wider 

product arrays, and multiple delivery channels offered 

by competitors. 

Closely related to scale is the issue of scope of operations, both business line and geographic. Community 

banks’ scale may limit their ability to expand into new 

business lines or activities, thereby reducing the degree 

of revenue diversification and resulting in dependence 

on spread income. Since many noninterest sources of 

revenue require scale to economically justify investment, small banks tend to derive a greater percentage 

of net operating revenue from spread income, as shown 

in Chart 3. Also, the limited geographic scope of many 

community banks may result in less loan portfolio 

diversification and greater exposures to local economic downturns. From a portfolio management perspective, lenders with more diverse loan portfolios that can 

spread risks over a broader customer and economic 

base may gain pricing advantages over less diversified 

competitors. 

3 “How Much Do US Banks Spend On Information Technology?,” 

The Tower Group Research Notes, www.towergroup.com. 

How Are Community Banks Addressing 

Consolidation Challenges? 

In response to competitive pressures arising from industry consolidation, community banks, new and old, 

appear to be adapting to meet strategic challenges to 

their long-term viability. Indeed, this summer, Federal 

Reserve Board Chairman Alan Greenspan told the 

Charlotte, North Carolina, Chamber of Commerce that 

“well-managed smaller banks have little to fear from 

technology, deregulation, or consolidation.” Recent surveys and anecdotes reveal that small banks that are not 

selling to or merging with competitors are adjusting 

business practices to cope with the aforementioned 

pressures and challenges. Their strategies include outsourcing business functions, expanding the use of nondeposit funding sources, partnering with other banks 

and nonbanks, emphasizing personalized service, and 

developing niches or specialties. However, as described 

below, while these approaches may help small banks 

meet the challenges of consolidation, they potentially 

complicate the operations and risk profiles of these 

institutions. 

Outsourcing 

A recent survey by Electronic Data Systems Corporation and Bank Earnings International LLP4 found that 

community bankers are more concerned with controlling operating expenses than any other issue. This finding is not surprising given the cost savings expected 

from many recent mergers. The study also revealed that 

banks view IT as the most valuable tool for improving 

day-to-day performance—from controlling expenses to 

increasing fee income. Yet, according to The Tower 

Group, IT budgets as a percentage of total noninterest 

expenses for small banks are typically half of those for 

larger banks.5 As a result, some small banks are turning 

to outside parties to maximize the utility of expenditures, IT and others. 

American Banker recently reported on a trend among 

small banks to outsource the origination of consumer 

loans. The Tower Group noted that third parties handled 

2.7 million noncard, nonmortgage loan applications 

(mostly from small institutions) in 1997, and annual 

outsourced volume growth is projected to average 40 

percent through 2002.6 Vendor networks designed to 

4 American Banker, July 22, 1998, p. 16.
 5 Computerworld, May 25, 1998, p. 20.
 6 “More Banks Handing Off Nitty-Gritty of Consumer Lending,”
 

American Banker, June 12, 1998, p. 1.
 

Atlanta Regional Outlook 16 Fourth Quarter 1998 
In Focus This Quarter
 

enable small banks to reduce hardware and personnel CHART 4 

needs also have emerged and allow for more cost- Small Bank FHLB Membership and efficient processing and cheaper access to customer Borrowing Are Rising information. Many small banks planning Internet-based 

or home banking also are turning to outside experts. 60 Nonborrowing members 

Outsourcing certain business functions may allow for 

greater focus on profitable business lines, less risky 

access to state-of-the-art technology, cost savings, and 

more options for customers. However, these arrangements are not without risk. Indeed, FDIC-insured institutions have experienced difficulties in the past with 

indirect consumer lending, such as auto lending. Moreover, banks that outsource business functions may have 

Percentage of Small Banks


Belonging to the FHLBs


Borrowing members 50 

’93 ’94 ’95 ’96 ’97 2Q98 

40 

30 

20 

10 

less control over those functions and may become overreliant on third-party providers. 

Nondeposit Funding Sources 

As noted above, increasing competition for deposits has 

left some small banks searching for alternative funding 

sources to meet loan demand. On average each year 

from 1993 to 1997, 64 percent of small commercial 

banks experienced loan growth in excess of deposit 

growth. Similarly, six in ten banks responding to the 

1998 ABA Community Bank Competitiveness Survey7 

reported that deposit levels were not keeping pace with 

loan demand. In response, small banks are increasingly 

turning to nondeposit funding sources. From 1993 

through the second quarter of 1998, the percentage of 

small banks using borrowings of any type increased 

from 48 to 56 percent. Over the same period, the percentage of small banks funding with borrowings other 

than overnight funds (Federal funds and repurchase 

agreements) increased from 20 percent to 35 percent, 

and the percentage reporting brokered deposits rose 

from 7 percent to 12 percent. 

The rising number of commercial banks joining the 

Federal Home Loan Bank (FHLB) System in recent 

years, as reflected in Chart 4, is likely a symptom of the 

aforementioned funding trend. At June 30, 1998, nearly 

half of all small banks were FHLB members, compared 

with 21 percent at year-end 1993. On the same date, 90 

percent of FHLB commercial bank members and 87 

percent of FHLB commercial bank borrowers were 

small banks. In addition to providing a backup source of 

liquidity, the FHLB is essentially acting as an intermediary to the capital markets for banks with limited 

access. The relatively limited nondeposit funding 

options available to many small banks may explain their 

7 ABA Banking Journal, February 1998, p. 47. 

0 

Year 

Sources: Bank Call Reports, Federal Housing Finance Board 

increasing reliance on FHLB advances. At June 30, 

1998, approximately 80 percent of small banks’ 

nonovernight borrowings were FHLB advances. 

The increasing liquidity of loan portfolios is becoming 

another funding alternative. Many small banks have 

used participation arrangements to sell off portions of 

loans to correspondent banks or have turned to Fannie 

Mae or Freddie Mac to sell mortgages. The securitization of other loan types also may become increasingly 

appealing as funding shortages persist and market 

opportunities for small banks increase. For example, in 

July 1998, American Banker highlighted the creation 

of a new commercial mortgage conduit established 

specifically to buy loans originated by community 

banks.8 The secondary market for the guaranteed portion of Small Business Administration loans also has 

been cited as a potential source of liquidity. 

Although identifying and expanding the use of 

nondeposit funds may increase the flexibility of small 

banks, their use complicates asset-liability management. While net interest margins for small banks have 

yet to reveal significant compression, recent evidence 

suggests future declines. For example, a recent survey 

conducted by the Federal Reserve Bank of Minneapolis found that 57 percent of small bankers in the upper 

Midwest expect a shift away from deposit funding to 

decrease profitability.9 

8 “Commercial Real Estate: New Conduit Plans to Help Small Banks
 

Enter,” American Banker, July 21, 1998, p. 29.
 9 “Location Influences Community Bank Challenges,” Fedgazzette,
 

Federal Reserve Bank of Minneapolis, July 1998, p. 2.
 

Atlanta Regional Outlook 17 Fourth Quarter 1998 
In Focus This Quarter
 

Partnering 

In an effort to expand revenue sources and attract and 

retain customers, smaller banks are expanding their 

spectrum of products and services through partnerships 

with other entities. The 1998 ABA Community Bank 

Competitiveness Survey found that 10 percent of community banks partnered with other banks in 1997, while 

nearly twice as many have teamed up with nonbanks. 

Over two-thirds of the survey’s respondents considered 

their partnering approach profitable. The leading types 

of arrangements with other banks include loan participations, title insurance, data processing, credit card programs, and mortgage lending. Nonbank partnering has 

been used to expand offerings to customers such as brokerage, insurance, and travel agency services. However, 

like outsourcing, partnering could result in less control 

and overreliance on third parties. 

Service Orientation 

Small banks have long touted personalized service and 

local decision making as a competitive advantage. 

Influenced by the recent wave of merger and acquisition 

activity in the industry, community bankers cited service as an area 

with great opportunity in the 1998 

ABA Community Bank Competitiveness Survey. Indeed, many 

community bankers have publicly 

welcomed consolidation as a 

chance to establish new relationships and attract customers affected by integration problems and personnel shifting at larger acquiring or 

merging banks. 

Establishing prudent relationships with smaller, underserved customers may present opportunities and profits 

for small banks. This may be especially true for small 

business customers, which may not fit more standardized lending models of larger banks yet remain acceptable credit risks. According to the Federal Reserve 

Board’s second-quarter 1998 Survey of Terms of Business Lending, rates on small commercial and industrial 

loans earn the greatest spread of any size business 

loans. Further, a recent survey by PSI Global of small 

business owners in south Florida, which has seen a great 

deal of merger and acquisition activity in recent years, 

found that nearly one-quarter of respondents would 

move their business if their bank was purchased, exemplifying the extent to which small banks may be able to 

use service to capitalize on consolidation activity.10 

Developing Niches or Specialties 

Anecdotal evidence suggests that some small banks are 

specializing in narrow markets and niches. Some analysts and consultants have emphasized that community 

banks should not try to be what they are not, but should 

instead focus on a particular market segment or niche. 

By default, many small banks depend on their customers’ local businesses and, through local expertise, 

may be better at serving specific industries than their 

larger competitors. However, a narrow focus may 

reduce portfolio diversification and could lead to 

greater exposures during an economic downturn. 

Summary and Conclusions 

Small banks are facing heightened competitive pressures from larger, merged institutions and from new 

banks. Their ability to respond to these pressures is 

restricted by traditional scale and scope limitations. 

Community banks are addressing these challenges by 

outsourcing business functions, utilizing nondeposit 

funding sources, partnering with other banks and nonbanks to diversify revenues and widen customer 

options, capitalizing on personalized service, and developing niches or specialties. While these strategies may 

help community banks meet the challenges of industry 

consolidation, they potentially complicate the operations and risk profiles of these institutions. 

Steven E. Cunningham, CFA, Senior Financial Analyst 

scunningham@fdic.gov 

10 South Florida Business Journal, May 22, 1998, p. 6. 

Atlanta Regional Outlook 18 Fourth Quarter 1998 
Regular Feature
 

Regional Perspectives
 

•	 Economic growth in the Atlanta Region continues to outperform that of the nation, but a number of factors, 

including the impact of the Asian crisis, have combined to slow growth. 

•	 Insured institutions are benefiting from the Atlanta Region’s continued economic success, reporting strong 

earnings, solid asset quality, and high capital levels. The Region’s commercial banks reported an aggregate 

return on assets of 1.22 percent in the second quarter. 

•	 The Greenville, South Carolina, metropolitan area reflects the emergence of the “New South” or “New 

Economy,” where growth is shifting from older industries, such as textiles and apparel, to high-tech and 

information-driven industries. The “New Economy” may offset the secular decline in older industries but 

may introduce new risks related to the altered relationship between the metropolitan area and the domestic and global economies. 

•	 Greenville’s insured institution landscape has changed over the past several years, reflecting the area’s 

growth. A hallmark of this change has been an increase in de novo activity. 

Region’s Economic and Banking Conditions 

The Atlanta Region’s economy continues to outperform 

that of the nation. Employment growth for the Region 

stood at 3.1 percent in the second quarter. Although still 

nearly one-half a percentage point above the national 

average, growth was slightly lower than in the fourth 

quarter of 1997 and the first quarter of 1998. Insured 

institutions are benefiting from the Region’s economic 

success, reporting strong earnings, solid asset quality, 

and high capital levels. Atlanta Region commercial 

banks reported an aggregate return on assets (ROA) of 

1.22 percent in the second quarter, down slightly from 

the same period in 1997 but in line with the national 

average. Returns were strong across asset sizes, 

although large banks generally outperformed smaller 

banks (see Chart 1, next page). Thrifts also reported a 

lower ROA than a year ago, at 0.76 percent. However, if 

restructuring losses at the Region’s largest thrift and sizable losses at an upstart Internet-based thrift are excluded, the adjusted return of 1.01 percent was only slightly 

below the national thrift average for the quarter. A flattening of the yield curve and increasing competition 

continue to erode bank and thrift net interest margins, 

but large banks have, for the most part, been able to offset margin compression by expanding non-interest (feegenerating) business lines. 

Despite its strong overall economy, weakening international markets are beginning to affect many of the 

Region’s prominent industries. Falling demand from 

global markets, industry consolidation, and vulnerability to cyclical fluctuations have accelerated the secular 

decline in the textile and apparel industries. Likewise, 

pulp and paper manufacturers in the Region have felt 

the strain of increased global competition, while the 

steel industry has suffered as the Asian economic crisis 

has increased imports and decreased exports. The 

Region’s agricultural producers are being affected by a 

number of circumstances, including increasing global 

production, trade pressures, falling commodity prices, 

and devastating weather-related crop losses, all at a time 

when federal subsidy programs are being phased out. 

Reduced income and employment in any of these industries could affect the Region’s insured institutions, particularly in the less economically diverse rural areas. 

South Carolina’s job growth continued to rise in the 

second quarter of 1998, eclipsing Florida’s gains by a 

full percentage point. South Carolina’s strong performance is partially attributable to its success in attracting 

tourism. Tourism-related industries, particularly in 

coastal areas such as Charleston, Myrtle Beach, and 

Hilton Head, grew by 9.4 percent in 1997, and even 

stronger gains are expected in 1998, according to Mark 

Vitner, an economist at First Union. Likewise, construction employment has been strong in the state, rising 

7 percent in the past year. Single-family construction is 

at record levels, and the pace of commercial construction 

has picked up as well. Nearly $5.5 billion in new industrial capital investments announced in 1997 are just 

beginning to be built out. The performance of South 

Atlanta Regional Outlook 19	 Fourth Quarter 1998 
Regular Feature Regional Perspectives
 

CHART 1 CHART 2 

Large Banks Outperformed Small Banks 

in the Second Quarter, but Performance 

Was Strong across Asset Sizes 

Region 

Second-Quarter Earnings Were above 

1997 Levels for Most States in the Atlanta Region 

% Return on Assets (ROA) 

0.00 0.25 0.50 0.75 1.00 1.25 1.50 1.75 2.00 2.25 2.50 

Atlanta Region, 1997Q2 

Atlanta Region, 1998Q2 

Source: Bank Call Reports 

Second Quarter 1998 

Second Quarter 1997 AL 

FL 

GA 

NC 

SC 

VA 

WV 

2Q 1998 

Under $100M $1B to 

$100M to $1B $10B 

Source: Bank Call Reports % Return on Assets 

Over 

$10B 

Region 

2Q 1997 

U.S. 

2Q 1998 

2.00 

1.75 

1.50 

1.25 

1.00 

0.75 

0.50 

0.25 

0.00 

Carolina’s insured institutions reflects the state’s thriving 

economy, as banks and thrifts reported second-quarter 

ROAs of 1.46 percent and 1.15 percent, respectively, 

both exceeding the Regional and national averages (see 

Chart 2). South Carolina institutions, as a group, are 

very well capitalized, and asset quality remains solid. 

However, growth in metropolitan areas such as 

Greenville (discussed below) and Columbia has been 

accompanied by a rise in commercial and industrial 

(C&I) lending exposure, and although current risks are 

low, such credits could be affected negatively by an economic slowdown. Institutions in agricultural areas could 

see some near-term economic slowing and possible 

credit quality deterioration as farm incomes decline as a 

result of the summer drought. 

Florida’s economy continues to outpace that of the 

nation, with job growth of 3.7 percent in the second 

quarter of 1998. The state’s economy continues to grow 

despite the year’s floods, tornadoes, drought, and wildfires. A drop in summer tourism as a result of wildfires 

dealt a temporary economic blow to the state, but that 

industry is expected to rebound quickly. Pulp and paper 

are less likely to recover in the short term, because premature harvesting in response to drought and wildfires 

has increased the market supply of timber and pushed 

prices lower. Asian economic turmoil has taken an additional toll on the pulp and paper industry in the form of 

an increased supply of cheap imports and reduced 

export demand. 

Despite recent setbacks in tourism and pulp and paper, 

Florida’s banks performed reasonably well in the second 

quarter. The aggregate ROA of 2.29 percent was inflated by merger accounting at the state’s largest bank, however. Small banks posted the lowest returns (0.78 percent), as overhead costs continued to weigh on that 

group. Falling net interest margins hurt both large and 

small institutions during the quarter. Thrifts, despite 

reducing overhead considerably since the second quarter of 1997, posted their lowest ROA in five quarters at 

0.86 percent. A steady quarterly decline in the net interest margin has contributed greatly to the lower thrift 

returns. Competitive pressures are likely to intensify for 

Florida institutions in the future as more large out-ofstate banks aggressively enter this attractive and growing market. Also, insured institutions in areas where 

economic growth and development activity have been 

the strongest, such as Miami and Orlando, have seen 

higher rates of growth in commercial lending. Although 

credit quality is not currently a concern, these products 

would react negatively to a slowdown in the state’s 

tourism industry (Orlando) or to further weakening in 

the Latin American markets (Miami). 

Georgia’s economy remains strong: Year-over-year job 

growth of 3.5 percent in the second quarter of 1998 continued to outpace that of the nation. However, a number 

of factors may be coalescing to weaken the state’s performance. Tight labor markets may slow the Atlanta 

metropolitan area’s economic expansion as employers 

find it increasingly difficult to locate qualified workers. 

In addition, the Asian crisis continues to affect Georgia’s apparel and paper industries. The state’s apparel 

employment has declined by 15 percent in the past year 

and by 50 percent over the past three years. Pulp and 

paper producers are finding it difficult to compete as 

Asian countries dump excess capacity on the market at 

discounted prices. Stone Container Corporation, the 

state’s latest casualty of the Asian crisis, announced in 

Atlanta Regional Outlook 20 Fourth Quarter 1998 
Regular Feature Regional Perspectives
 

September that it would lay off 400 employees because 

of weakness in international markets. 

Georgia’s banks have not yet shown any significant negative effects from the current situation; rather, they 

reported second-quarter earnings sharply higher than 

those of a year ago, with an ROA of 1.41 percent. 

Thrifts, constrained by high overhead expenses, underperformed their peers in the Region and nation in the 

quarter, despite posting their highest return in four quarters. However, when the losses of one Internet-based 

institution are excluded, Georgia’s aggregate thrift ROA 

rises from a dismal 0.45 percent to a solid 1.06 percent. 

Current measures reflect strong asset quality among 

Georgia’s banks and thrifts, but risks may be increasing 

at institutions in metropolitan areas—specifically 

Atlanta—that report construction and development 

(C&D) loan exposures well above levels in the Region 

and nation. Although capital and reserves also have 

increased in metro Atlanta, it is important to note that 

institutions with similar credit concentrations have 

struggled in past economic downturns. Meanwhile, concentrations of agricultural credit could pose a risk to 

institutions in south Georgia, particularly around the 

Albany area, whose sizable agricultural sector was devastated by heavy spring rains and the summer drought. 

Albany’s job growth already has stalled, pushing the 

metro area’s unemployment rate to a four-year high of 9 

percent in August 1998. 

Alabama’s economic expansion continued in the second quarter of 1998, albeit at its slowest pace since the 

end of 1991, with employment levels up 1 percent from 

a year earlier. Weaknesses in the state’s economy are 

mostly concentrated in the manufacturing and mining 

sectors. Within manufacturing, older industries such as 

pulp and paper, textiles and apparel, and metals have 

continued to see losses, particularly as overseas competition has intensified and the U.S. dollar has remained 

strong. Losses in these sectors have been partially offset, however, by growth in newer industries such as 

automobile manufacturing. Growth in other sectors also 

has helped keep the economy going. 

Despite transitions in Alabama’s economy, the state’s 

banking sector has maintained very stable performance 

in recent years. In fact, banks’ aggregate ROA has 

remained within a 14-basis-point range over the past 12 

quarters. The second-quarter 1998 ROA of 1.23 percent 

was in line with averages in the Region and nation, and 

performance was comparable across asset sizes, with 

the largest and smallest peer group returns varying by 

only 5 basis points. Thrifts, aided by securities gains and 

lower reserve provisions, reported higher earnings than 

a year ago (0.86 percent ROA), although they were 

below the national average. Alabama was the only state 

in the Atlanta Region to show an increase in past-due 

loans at both banks and thrifts during the past year, 

which may reflect the continuing declines in some of 

the state’s larger industries, including textiles and apparel and pulp and paper. Moreover, some rural Alabama 

institutions report high and increasing levels of C&I 

loan exposure, despite the ongoing deterioration in 

these dominant industries. This trend may indicate that 

exposure to the troubled industries is growing or that 

out-of-market lending activity is rising, either of which 

could have credit risk implications. Additional challenges may face rural institutions in the state’s southeast 

corner, where spring flooding and a summer drought 

substantially affected crop production. 

Economic growth in Virginia 

1998, with employment rising 

at high levels in the second quarter of 

continued 

nearly 3 percent from a year 

earlier. Gains have been concentrated mostly along the “Golden Crescent,” which 

arcs from northern Virginia through Richmond and 

over to Norfolk. In this area, strong population growth, 

high-tech manufacturing, business services, software 

engineering, and construction activity have fueled economic expansion. The area is not immune to global 

forces, however: Richmond recently suffered a setback 

with Motorola’s indefinite postponement of construction of a large semiconductor manufacturing facility. 

Outside the arc, gains have been less robust, as losses in 

textiles and apparel continue to constrain growth in 

many rural areas. 

A strong economy has benefited Virginia’s banking sector, which posted a second-quarter ROA of 1.59 percent, 

above the averages for the Region and nation and well 

above the banking sector’s average for the same period 

in 1997. Performance was solid across asset sizes, in 

part thanks to the state’s overall favorable economic 

environment. Virginia’s thrift performance also 

improved from a year ago and compares favorably with 

those of the Region and nation when the losses of one 

large institution are excluded. Asset quality remains 

strong, but repayment capacities may become strained 

for institutions in agricultural areas as a result of the 

summer drought and, more recently, Hurricane Bonnie. 

Some counties have estimated storm damage of up to 60 

percent of tobacco, 55 percent of corn, and 25 percent 

Atlanta Regional Outlook 21 Fourth Quarter 1998 
Regular Feature Regional Perspectives
 

of cotton and soybean crops. Meanwhile, strong growth 

and development in metropolitan areas such as Norfolk 

and northern Virginia are not yet being reflected in 

higher C&D loan exposures. Declining office vacancy 

rates are fueling higher levels of construction in northern Virginia. 

North Carolina’s economic expansion continued in the 

second quarter of 1998, but the pace of growth may be 

slowing. During the quarter, the state’s workforce grew 

2.5 percent from a year earlier, marking the first time 

that the state’s job growth had fallen below the national 

average growth rate since 1991. As in other areas of the 

Atlanta Region, some of the weakness in the economy 

can be traced to job losses in manufacturing, particularly textiles and apparel. Growth in the retail sector has 

been tepid as well. Steel is another of the state’s industries that faces emerging risks from abroad. Nucor Corporation, for example, pressured by an increasing 

supply of cheap foreign imports, recently cut steel 

prices by $20, to $270/ton. (Steel was selling for 

$350/ton a year ago.) Finally, as in most states in the 

Region, a summer drought and a general decline in 

commodity prices have adversely affected North Carolina’s agricultural producers. 

One sector of North Carolina’s economy that continues 

to show strong growth is financial services. The state is 

clearly the banking center of the Atlanta Region, claiming 55 percent of the Region’s bank and thrift assets in 

the second quarter of 1998. A drop in ROA from the 

year-ago second quarter, from 1.27 percent to 0.88 percent, can be explained largely by two factors. First, 

acquisition-related charges reduced the earnings of one 

bank that accounts for 38 percent of the state’s total 

banking assets. Second, small banks (under $100 million) reported a negative aggregate return primarily 

because most banks in that group were chartered within the past three years and have not yet reached sustainable profitability. Although erratic or even negative 

earnings are not unusual for new institutions, history 

has shown that an economic slowdown can disrupt the 

growth and earnings patterns of young institutions, particularly if larger, more established banks compete 

aggressively on product pricing to garner or protect 

market share. North Carolina’s relatively large thrift 

sector performed reasonably well in the quarter, 

although margin compression and a slight rise in overhead spending held returns below the year-ago level at 

0.95 percent. While current reported asset quality is 

strong at North Carolina’s banks and thrifts, the growing pressures on industries mentioned above could 

affect credit quality at institutions actively serving these 

industries or related borrowers. 

West Virginia’s economic performance remains erratic, 

with year-over-year job growth fluctuating between 

1 and 2 percent over the past three years. Nonetheless, 

continued job growth and a rise in out-migration helped 

push the state’s jobless rate down to 4.4 percent in the 

second quarter in 1998 — the lowest level since early 

1970. Despite its recent gains, West Virginia’s economy 

is not immune to global developments. For example, 

some areas of the state are highly dependent on steel 

production, and steel scrap prices have fallen more than 

10 percent in the past year. Also, coal-producing counties could face increasing pressure, as slumping Asian 

demand and strong oil production from exporting countries have steadily depressed energy prices. 

West Virginia’s banks have enjoyed the state’s gradual 

economic expansion, reporting strong and stable profitability over the past several quarters; however, the second-quarter ROA of 2.08 percent was inflated by 

nontraditional operations at one institution and nonrecurring items at another. Small banks reported lower 

second-quarter returns than a year ago, largely because 

of net interest margin compression, while large banks 

were able to offset margin declines with higher noninterest income. Asset quality has improved from a year 

ago, but delinquency and charge-off rates still exceed 

those for the Region as a whole. Thrifts, like banks, 

have been hurt by falling net interest margins, which 

contributed to a 21-basis-point drop in ROA (to 0.72 

percent) from the second quarter of 1997. Thrifts’ 

reported capital remains high, however, and despite a 

slight rise in charge-offs in the second quarter, reported 

asset quality is generally solid. 

Atlanta Regional Outlook 22 Fourth Quarter 1998 
Regular Feature Regional Perspectives
 

Structural Transformation in the New South
 

Greenville-Spartanburg-Anderson 

Metropolitan Area May Face New 

and Old Risks in the Future 

In many ways, the Greenville-SpartanburgAnderson, South Carolina, metropolitan statistical 

area (Greenville MSA) embodies what some describe as 

the “New South” or the “New Economy,” where an 

influx of high-tech and information-driven industries is 

replacing a shrinking manufacturing base. Gains in new 

industries have resulted in higher levels of economic 

diversification, tighter labor markets, and steady population growth. One drawback, however, is that the local 

economy could become more susceptible to national or 

international shocks. Furthermore, although economic 

changes are occurring, the continued strong presence of 

textiles and apparel still poses a significant risk to the 

Greenville metropolitan economy. The New Economy 

may offset the secular decline in these industries but 

may introduce new risks related to the altered relationship between the metropolitan area and the domestic 

and global economies. 

The Greenville economy has undergone a significant 

structural transformation over the past several years. 

This process accelerated during the 1990s, as investment in new industries, particularly automobile manufacturing, occurred and losses in the critical textiles and 

apparel industries increased. Not only is the industrial 

mix changing, the economy is moving away from 

dependence on manufacturing toward services and 

retailing. These shifts will change how the metropolitan 

area is affected by future economic downturns. 

Greenville’s insured institution landscape also has 

changed over the past several years, reflecting the area’s 

growth. For example, from 1985 through the first half 

of 1998, the Greenville MSA lost seven insured institutions to consolidation but gained ten new charters, 

resulting in a net addition of three institutions. Although 

some new charters (mostly in the 1980s) resulted from 

corporate reorganizations rather than new market 

entrants, six de novo institutions were chartered in the 

1990s. In fact, nearly one in four institutions headquartered within the Greenville MSA has opened since 

1990. An increase in de novo activity is consistent with 

steady economic expansion. 

Greenville’s Historical Development Based 

Primarily on Textiles and Apparel 

Historically, the manufacturing sector, particularly textiles and apparels, has dictated Greenville’s economic 

performance. In 1970, nearly one in four jobs in the 

metropolitan area was in these industries. Their presence had shrunk somewhat by 1980 but still accounted 

for almost 20 percent of total employment. Manufacturing as a whole accounted for 37 percent of all jobs in 

1980—rubber, plastics, and industrial and commercial 

machinery production had a significant presence as 

well. Nationally that year, approximately 22 percent of 

jobs were in manufacturing. An economy that relies 

heavily on manufacturing, especially a single industry, 

is often highly cyclical. In the past four recessions 

(1973–1975, 1980, 1981–1982, and 1990–1991), 

employment losses were felt more acutely in the 

Greenville metropolitan area than at the national level 

on a monthly year-over-year percentage basis. 

Aggregated bank data were unavailable before 1984, 

but, as Table 1 (next page) suggests, Greenville’s 

insured institutions performed reasonably well during 

the mid- to late 1980s despite the ongoing decline in 

textiles and apparel that was occurring during that 

time. Institutions in the MSA, as a group, maintained 

reasonably strong profitability, increased capital ratios, 

and reported very low levels of past-due and chargedoff loans. Asset quality did weaken somewhat during 

the recessionary period of 1991; however, profitability 

and capitalization measures continued to strengthen. 

The ability of Greenville’s insured institutions to perform well during the recession left them in a favorable 

position to benefit from the economic expansion that 

followed. 

Gains in the 1990s Driven by New Industries 

In the 1990s, growing overseas competition and rising 

levels of automation contributed to faster erosion in the 

textiles and apparel industries in the Greenville MSA, 

as well as the entire Region (see Atlanta Regional Outlook, second quarter 1998, for a discussion of the textiles and apparel industries). International trade 

agreements have contributed to some of the losses as 

Atlanta Regional Outlook 23 Fourth Quarter 1998 
Regular Feature Regional Perspectives
 

well. While the 1980s saw steady or slightly rising job 

levels in textiles and apparel in the Greenville metro 

area, these industries have lost more than 13,000 workers in the past eight years. 

Despite those losses, economic growth in the Greenville 

MSA has remained comparable to the national average 

throughout the 1990s. Much of the growth resulted 

from aggressive state and local government efforts to 

lure relocating industries by offering tax incentives and 

promoting the area’s low wage rates, low levels of 

unionization, and low land costs, as well as its location 

along Interstate 85 between Atlanta and Charlotte. 

These efforts attracted billions of dollars of investment 

to South Carolina’s economy, much of it in the 

Greenville MSA. Perhaps the zenith of the recruitment 

effort was BMW’s decision to build its Z3 Roadster 

assembly plant in the metropolitan area. The plant, 

opened in 1992, employs 2,000 workers. Whereas the 

average annual salary in the textiles and apparel industries was $26,252 in 1996, the average worker in 

Greenville’s transportation equipment industry earned 

$46,824. In addition to direct hires, the BMW plant has 

had a cascade effect, attracting the company’s first- and 

second-tier suppliers to the area. Existing manufacturers such as Hitachi also have expanded their area operations. Employment gains in these new industries have 

helped offset losses in textiles and apparel. 

Greenville may be emerging as a regional retailing center as well. The retail sector has seen annual job growth 

in excess of 3.5 percent since 1994, and retail space 

construction activity has increased gradually since 

TABLE 1 

1993. Absorption has remained steady, however, and the 

divergence between supply and demand has resulted in 

a rise in retail vacancy rates to a seasonally adjusted 

14.3 percent in the first quarter of 1998 (see Chart 3). 

Nonetheless, there is continued optimism about the 

market’s retail potential. According to F.W. Dodge, the 

metropolitan area had over 10 million square feet 

of retail space in the planning stages as of June 1998. 

In comparison, the Charlotte metropolitan area had 

about 5.5 million square feet in the planning stages. 

Greenville’s residential markets have been active as 

well. Job, income, and population growth, combined 

with low mortgage rates, have fueled demand for new 

housing over the past few years. Permit issuance in the 

metropolitan area reflects the sustained level of 

demand: The number of units authorized has remained 

above 6,000 since 1994. Through June 1998, however, 

total year-to-date permit issuance was down 5 percent 

from year-ago levels, owing entirely to declines in multifamily permitting. The trend toward homeownership 

may be the result of low mortgage rates, which encourage homebuying. In any case, the decline in multifamily issuance may help prevent any major overbuilding in 

Greenville’s residential markets. 

As Greenville emerged from the 1991 recession, area 

institutions saw past-due and charge-off measures moderate. Credit quality improvements were accompanied 

by steady asset growth and solid gains in earnings and 

capital (see Table 1). Greenville’s economic expansion, 

as well as its industrial diversification, generally has 

helped improve the risk profile of insured institutions. 

Specifically, the aggregate equity-to-assets ratio for 

Greenville’s Insured Community Institutions* Are Benefiting from the Area’s New Economy 

MEDIAN C&I CRE NET C&I CRE 

ASSET LOANS LOANS ALLL PAST PAST LOAN LOAN LOAN 

INSTITUTIONS SIZE TO TO TO PAST DUE DUE CHARGE­ CHARGE­ CHARGE­ EQUITY 

IN ($ IN ASSETS ASSETS LOANS DUE C&I CRE OFFS OFFS OFFS TO 

YEAR MSA 000S) (%) (%) (%) LOANS LOANS LOANS (%) (%) (%) ROA ASSETS 

1998Q2 23 88,246 8.63 7.28 0.89 1.60 1.37 0.85 0.06 0.02 0.00 1.13 13.03 

1997 26 89,558 9.62 8,76 0.87 1.77 2.59 1.07 0.12 0.50 0.01 1.08 12.16 

1995 23 92,982 6.23 7.20 0.87 1.51 1.17 1.87 0.06 0.17 (0.05) 1.11 10.94 

1993 24 77,772 8.87 10.87 0.99 1.67 0.96 0.99 0.17 0.28 0.14 1.19 9.76 

1991 24 65,859 9.59 8.03 0.92 2.29 2.05 2.10 0.31 0.92 0.33 0.81 8.37 

1989 23 55,521 9.81 5.93 0.66 0.95 2.06 — 0.23 0.79 — 0.73 8.07 

1987 20 53,544 9.61 4.71 0.62 0.94 1.52 — 0.11 0.28 — 0.92 7.22 

1985 21 55,197 6.64 5.85 0.34 0.43 1.10 — 0.10 0.60 — 0.88 4.04 

* Includes all insured institutions headquartered in the Greenville, South Carolina, metropolitan statistical area (MSA) with assets under
 

$1 billion.
 

Past dues include all loans delinquent 30 days or more or on nonaccrual.
 

C&I = commercial and industrial loans.
 

CRE = commercial real estate loans.
 

ALLL = Allowance for loan and lease losses.
 

ROA = Return on assets, annualized for 1998Q2.
 

Source: Bank and Thrift Call Reports 


Atlanta Regional Outlook 24 Fourth Quarter 1998 
Regular Features Regional Perspectives
 

CHART 3 

1990 

* Seasonally adjusted annual rate 

Greenville’s Retail Vacancy Rates May Stabilize

 but Remain in the Double Digits 

3,000 

2,500 

2,000 

1,500 

1,000 

500 

0 

Source: F.W. Dodge Real Estate Analysis and Planning Service Retail Space (000s sq. ft.)

Vacancy Rate (%) 

18 

15 

12 

9 

6 

3 

0 

1991199219931994199519961997

1998Q1* 

New Completions 

Absorption 

Vacancy Rate 

community institutions (those with assets less than 

$1 billion) in the MSA has increased steadily since the 

mid-1980s and is well above the state average. Asset 

returns in the 1990s have been much higher than in the 

1980s, loss reserves have increased relative to loans, 

and delinquencies and charge-offs have remained at low 

levels. The vibrancy of the Greenville market is evidenced further by the fact that all six of the new institutions chartered in the MSA during the 1990s, including 

four that have opened since the beginning of 1996, were 

profitable in the first half of 1998. 

Although current measures reflect a very healthy financial sector, the risk exposure of some Greenville institutions may be increasing. For instance, while there has 

been no significant or sustained rise in aggregate C&I 

or commercial real estate (CRE) exposure in the MSA 

for community institutions, the number with concentrated exposure in these products has increased. Nine 

institutions had C&I exposures of 15 percent or more of 

assets in 1997, up from six in 1991 and five in 1987. 

Seven institutions had at least 15 percent of assets in 

CRE loans in 1997, compared with just three in 1991 

and one in 1987. The aggregate exposure changes considerably when two institutions headquartered in the 

MSA with assets over $1 billion are included: Aggregate C&I exposure rises from 8.6 percent to 9.4 percent 

of assets, and CRE exposure jumps from 7.3 percent to 

15.9 percent. This fact may indicate that Greenville’s 

growth is being financed more by large, statewide institutions than by smaller, in-market participants. But, 

because these institutions have sizable operations outside the Greenville MSA, it is difficult to determine 

how much of their exposure actually is concentrated 

within the MSA. In addition to the two large Greenville 

banks, some regional and super-regional banks also 

maintain a strong presence in the Greenville market. 

According to the latest Summary of Deposits data, 

institutions with assets over $1 billion, including 

regionals and super-regionals headquartered outside the 

MSA, held more than 70 percent of the deposits in 

Greenville County and had nearly a 50 percent market 

share in Spartanburg and Anderson counties. 

Regarding C&D lending, both aggregate and individual 

institution exposures have remained relatively low 

despite an increase in residential and other development 

activity. For community banks headquartered in the 

Greenville MSA, aggregate C&D lending over the past 

few years has remained steady at around 5 percent of 

assets, which is only slightly above the national average 

for metropolitan institutions. This ratio does not change 

significantly when institutions with assets over $1 billion are included. 

The fact that community banks, as a group, have not 

taken on excessive levels of concentrated lending exposure may bode well in the event of an economic downturn. Moreover, the larger banks that appear to be more 

actively funding the area’s growth and development are 

likely to have greater geographic and loan product 

diversification, which should improve their ability to 

withstand any future volatility in the Greenville market. 

Even the ‘New’ Greenville 

MSA Economy Faces Risk 

The greatest source of growth to 

the Greenville metropolitan area 

during the 1990s has been corporate investment and relocation. 

Conversely, the greatest risk the 

area faces may be a reduction in 

the pace of investment. A selling 

point Greenville has used to 

attract corporate relocation is the 

availability of inexpensive labor. 

With a 2.2 percent unemployment rate in the second quarter 

of 1998, labor has become scarce. Rapid growth in the 

metropolitan area’s labor force has been critical to satisfying the demand for new workers. Demographics may 

contribute to Greenville’s labor shortages, as economic 

growth elsewhere in the nation may be discouraging inmigration. In 1997, net in-migration to the metropolitan 

area fell to 6,487, down 2,000 from a year earlier. ConAtlanta Regional Outlook 25 Fourth Quarter 1998 
Regular Feature Regional Perspectives
 

sequently, the MSA’s population growth slipped to 1.0 

percent. While on par with that of the nation, the MSA’s 

population growth is at its lowest level since 1986. The 

lack of adequate infrastructure development became a 

barrier to further growth, particularly in Anderson 

County. Tight labor markets and high demand for new 

space may raise the cost of doing business, thus eroding 

Greenville’s competitive edge in attracting and retaining 

corporate relocation. 

Corporate investment in the Greenville MSA in the 

1990s has diversified the local economy and attracted 

migrating job seekers. As a result, the character of the 

MSA has changed significantly since the last economic 

downturn. How the “new” economy will fare during any 

future recession remains uncertain. The shift toward 

service employment may help insulate the economy 

from the effects of a downturn as this sector typically 

displays less volatility over the business cycle. However, the economy still remains highly dependent on the 

textiles and apparel industries, which account for 

approximately 40,000 of the MSA’s 460,000 jobs. 

Recent strength in the U.S. dollar could further aggravate losses in these industries as domestic manufacturers face pricing competition from abroad. 

In contrast to weakness in textiles and apparel, growth 

has been strong in the metropolitan area’s nascent transportation equipment industry. However, employment in 

the sector currently accounts for just 5 percent of total 

manufacturing employment or approximately 6,700 

jobs. Gains are expected to continue, especially with 

BMW’s recently announced plans to begin assembly of 

sport utility vehicles in the MSA. Nonetheless, since the 

rising importance of automotive production in the area 

postdates the 1990–1991 recession, the local economy 

has not yet experienced the effects of an economic 

downturn in the automotive industry, which is prone to 

large cyclical swings. 

Just as the Greenville economy faces new and different 

risks, insured institutions also face new challenges. 

Managers of insured institutions must recognize and 

be knowledgeable of the differing characteristics of 

Greenville’s new industries. For example, when evaluating credit quality, events that affect the automotive 

industry now must be considered on a scale similar to 

those affecting textiles and apparel. Also, as the level 

and volatility of income and employment in Greenville’s 

new industries is likely to differ from textiles and apparel, loans advanced to these industries and related 

borrowers may react differently during an economic 

downturn. These risks may be higher for de novo institutions, which may lack the financial flexibility (riskbearing capacity), local market expertise, and pricing 

power of their larger, more established competitors. 

The economic transformations of the 1990s are not 

unique to the Greenville MSA, but rather may be indicative of a trend in the Atlanta Region. In Tuscaloosa, 

Alabama, for example, the rise of transportation equipment production is having a significant impact on local 

economies. Florence, South Carolina, may share similar experiences in the future with the location of a new 

Honda facility. Finally, as more metropolitan areas see 

corporate relocation and investment as a possible economic panacea, Greenville may face more intense competition for corporate relocation in the future. 

Atlanta Region Staff 

Atlanta Regional Outlook 26 Fourth Quarter 1998 
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