Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION FIRST QUARTER 2000 

FDIC
 

Kansas City
 

Region
 

Division of 

Insurance 

John M. Anderlik, 

Regional Manager 

Jeffrey W. Walser,
 

Regional Economist
 

Christopher
 

J. Sesler,
 

Economic Analyst
 

Troy D. Osborne,
 

Financial Analyst
 

In Focus This Quarter 

◆ Recent Trends Raise Concerns about the Future of Business Credit 

Quality—Commercial and industrial (C&I) lending is one of the largest and 

fastest-growing lending lines at insured institutions. Recent growth in C&I lending 

can be attributed to a strong U.S. economy, increased industrial merger activity, and 

a willingness of lenders to extend credit. While C&I credit quality remains relatively strong, signs of deterioration have recently begun appearing in C&I portfolios 

and in corporate bond defaults. These signs of weakness in commercial credit quality raise concerns because they are appearing during a period of economic strength. 

Business credit quality could deteriorate further in the event of an economic slowdown, higher interest rates, or a loosening of underwriting practices. See page 3. 

By Arlinda Sothoron, Alan Deaton 

◆ Local Industries in the Global Economy—The contribution of international trade to overall U.S. economic activity has been increasing for a number of 

years. Although the United States trades with many nations, most activity is concentrated in a few markets—Canada, Japan, and Mexico. Across a collection of 

industries, there is, however, considerable variation in both the level of exposure to 

export markets and the intensity of import competition.A number of industries are 

highly exposed to international markets, suggesting that economic conditions 

abroad are particularly important in any assessment of future revenue growth or 

profitability. See page 11. 

By Paul C. Bishop 

Regional Perspectives 

◆ Region’s Economic and Banking Conditions—More than half the 

Region’s 618 counties have lost population since 1970, and 84 of the more remote 

counties lost population at an increasing rate in the 1990s. Continuing outmigration threatens the economic viability and health of the banking industry in 

these counties. In the 1990s, insured financial institutions in these counties reported lower asset, loan, and core deposit growth rates, and they will likely continue to 

have difficulty growing loans and core deposits within their geographic markets. 

See page 19. 

By John M. Anderlik, Jeffrey W. Walser, 

Christopher J. Sesler, and Troy D. Osborne 

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

Insurance Corporation as an information source on banking and economic issues for insured 

financial institutions and financial institution regulators. It is produced for the following eight 

geographic regions: 

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

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

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

Dallas Region (CO, NM, OK, TX)
 

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

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

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

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

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

form found on the back cover to the FDIC Public Information Center. Contact the Public 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. For 

more information or to provide comments or suggestions about the Kansas City Region’s Regional Outlook, please call John Anderlik at (816) 234-8198 or send an e-mail to janderlik@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 

Richard A. Brown 

Steven E. Cunningham 

Ronald L. Spieker 

Publications Manager Teresa J. Franks 

Writer/Editor Kim E. Lowry 
In Focus This Quarter
 

Recent Trends Raise Concerns about the Future of
 

Business Credit Quality
 

•	 C&I loan portfolios have been growing rapidly 

during this economic expansion. 

•	 Indicators of weakening corporate credit quality 

have begun to appear, including higher C&I loan 

losses and rising corporate bond defaults. 

•	 The future of business credit quality will depend 

on the economy and on underwriting practices. 

Commercial and industrial (C&I) lending is one of the 

largest and fastest-growing segments of lending at 

insured institutions. As of the third quarter of 1999, 

C&I loans comprised 24 percent of total loans and 

leases held by FDIC-insured institutions, up from 21 

percent at the end of 1995. C&I loan portfolios have 

grown primarily because of strong loan demand driven 

by a long economic expansion during which the indebtedness on corporate balance sheets has expanded rapidly. Even as the economic expansion continues, C&I loan 

charge-offs have begun to trend upward, albeit from historically low levels. By some measures, banks and the 

financial markets appear to be assuming increased levels of risk that could lead to greater C&I loan losses 

when the economy eventually weakens. 

High rates of growth in commercial lending and weakening indicators of C&I credit quality raise concerns 

about the future of credit quality at insured institutions. 

This article examines the factors that have contributed 

to high C&I loan growth rates and discusses the drivers 

that will determine the direction of C&I credit quality in 

the future. While loan performance at insured institutions is relatively good at the present time, signs of deterioration and stress have begun to appear despite the 

continued strength of the domestic economy. The future 

of C&I credit quality will ultimately be determined by 

trends in underwriting and corporate debt levels, along 

with the performance of the U.S. economy. 

C&I Loan Growth Has Accelerated 

C&I loans held by FDIC-insured banks and thrifts grew 

by almost 9 percent during the 12 months ending in 

September 1999, down somewhat from a 13.4 percent 

rate of growth in 1998 (see Chart 1). By contrast, total 

CHART 1 

Commercial and Industrial (C&I) 

Loans Are Growing at a Faster Rate 

than Total Loans and Leases 

Loan Growth 

Rate (%) C&I Loans 

15 

10 

5 

0 

–5 

–10 

Note: 1999 data are annualized based on 3Q99 data. 

Source: FDIC Research Information System 

Total Loans 

and Leases 

’86 ’88 ’90 ’92 ’94 ’96 ’98 

loans and leases at insured institutions grew by only 7 

percent in the 12 months ending in September 1999. 

C&I loans accounted for approximately 29 percent of 

all net new loans booked during the 12 months ending 

in September 1999, while unfunded C&I loan commitments grew by approximately 17 percent to $1.6 trillion. 

Syndicated lending played a major role in C&I loan 

growth during the 1990s. As intense competition and a 

narrowing of financial institutions’ net interest margins 

have encouraged lenders to seek additional sources of 

revenue, larger institutions have become increasingly 

active as loan syndicators and as purchasers of syndicated credits. Syndicated loan volume reached its peak 

in 1997, when originations totaled some $1.1 trillion 

(see Chart 2, next page).1 After falling off in 1998, originations of syndicated loans rose by 17 percent in 1999 

to just over $1.0 trillion. Leveraged loans, in which the 

borrower’s debt-to-equity ratio is significantly higher 

than the industry average, served as a catalyst for syndicated lending growth in 1999, accounting for 32 percent of total syndicated loan originations. Leveraged 

lending is very attractive to lending institutions because 

of the generous fee income associated with leveraged 

originations. Leveraged loan originations grew to $320 

billion in 1999, partly because of the continued rapid 

pace of corporate mergers in 1999.2 

1 LPC Gold Sheets, Vol. XIV, No. 1. Loan Pricing Corporation.
 

January 10, 2000.
 

2 According to Houlihan Lokey’s Mergerstat, total M&A activity set
 

a new record of $1.4 trillion in merger deal value in 1999.
 

Kansas City Regional Outlook 3	 First Quarter 2000 
In Focus This Quarter
 

Most of the C&I loan growth among insured institutions 

since 1997 has been concentrated in loans to domestic 

borrowers. C&I loans held in foreign offices declined 

following the Asian economic crisis and the Russian 

government bond default in 1997 and 1998, respectively, while domestic C&I lending was growing at doubledigit rates. During the 12 months ending in September 

1999, C&I loans held in domestic offices grew 12.2 

percent while C&I loans held in foreign offices 

declined by almost 6 percent. 

Is This Rapid Loan Growth a Cause 

for Concern? 

The effect of rapid loan growth on subsequent credit 

quality has been the subject of a number of articles. A 

recent study by the Federal Reserve Bank of Kansas 

City found that high rates of loan growth in the early 

1980s and early 1990s appeared to be positively correlated with future higher loss rates.3 The study also noted, 

however, that relatively high loan growth rates in the 

late 1980s did not result in sharply higher loss rates. 

Another study by the Federal Deposit Insurance Corporation found that banks that failed during the banking 

crisis of the 1980s were generally more likely to have 

grown their loan portfolios aggressively than banks that 

did not fail.4 But it remains to be seen whether the high 

C&I loan growth rates of today will necessarily contribute to higher losses for insured institutions in the 

future. The future course of industry loan losses 

depends on many factors, including the condition of the 

economy, the interest rate environment, and underwriting standards used in originating C&I credits. 

The Condition of the Economy 

Is an Important Driver of C&I Loan Growth 

Recent economic conditions have been particularly 

conducive to rapid growth in domestic C&I lending. 

Business investment has expanded at double-digit 

annual rates as firms have invested in new technologies 

to raise productivity and keep costs down. These productivity gains have been instrumental in allowing the 

3 William R. Keeton. “Does Faster Loan Growth Lead to Higher Loan
 

Losses?” Economic Review. Federal Reserve Bank of Kansas City.
 

Second quarter 1999. 


4 Federal Deposit Insurance Corporation, Division of Research and
 

Statistics. History of the Eighties: Lessons for the Future. Vol. 1, An
 

Examination of the Banking Crises of the 1980s and Early 1990s.
 

1997. http://www.fdic.gov/bank/historical/history/contents.html.
 

CHART 2 

Syndicated Loan Originations Rebounded 

in 1999 after Falling from Record Levels 

Source: Loan Pricing Corporation 

Syndicated Loan Originations

 ($ Billions) 

0 

200 

400 

600 

800 

1,000 

1,200 

’95 ’96 ’97 ’98 ’99 

economy to grow at a relatively rapid pace with low 

inflation. Strong growth in real wages has helped boost 

the consumer confidence index to an all-time high of 

144 in January 2000. Robust consumer demand for 

goods and services has kept business profits growing, 

further spurring business borrowing to finance inventories, new construction, and fixed assets such as computer networks. Amid all of these favorable trends, C&I 

loan charge-off rates have remained at record lows of 

less than 0.5 percent since 1994. Recently, however, 

despite a continuation of generally favorable conditions 

in the economy and the financial markets, signs of credit quality deterioration have begun to appear in C&I 

loan portfolios. 

Evidence from Financial Institutions Points 

to a Weakening in Business Credit Quality 

Despite strong business conditions and generally good 

asset quality, signs of deterioration in C&I credit quality have begun to appear in bank portfolios. While problem C&I loan levels remain low by historical standards, 

net C&I loan charge-offs during the 12 months ending 

in September 1999 were 63 percent higher than during 

the previous 12-month period. The net C&I loan chargeoff rate rose in the 12 months ending in September 1999 

to 0.5 percent, up from 0.3 percent one year earlier. 

Similarly, noncurrent C&I loans as of September 1999 

rose to $11.2 billion, or 1.2 percent of total C&I loans.5 

In dollar terms, this level of noncurrent loans is 30 percent higher than one year earlier. 

5 Noncurrent C&I loans include C&I loans past-due over 90 days and 

all C&I loans in nonaccrual status. 

Kansas City Regional Outlook 4 First Quarter 2000 
In Focus This Quarter
 

Despite these increases in C&I charge-offs and noncurrent C&I loans, the current industry ratios for these measures remain well below the 1.9 percent and 4.5 percent 

ratios reported during the recession in 1991 for net C&I 

charge-offs and noncurrent C&I loans, respectively. 

Interagency Loan Review Reveals Increases 

in Problem Credits from Previously Low Levels 

The results of the 1999 Shared National Credit (SNC) 

review provide another indication of slipping credit 

quality at large commercial banks.6 According to the 

Federal Reserve Board of Governors, adversely classified syndicated loans rose to $37.4 billion in the 1999 

review, a level approximately 70 percent higher than that 

reported in 1998. This figure represents 2 percent of the 

$1.8 trillion in drawn and undrawn loan commitments 

reviewed in 1999. By contrast, adversely classified 

assets identified in the 1998 SNC review totaled only 

$22 billion, or 1.3 percent of loans reviewed in 1998.7 

While the level of adversely classified syndicated loans 

remains low, 14 percent of the loans adversely classified 

during the 1999 review were loans made to new borrowers since the 1998 SNC review. In reference to this 

finding, Office of the Comptroller of the Currency 

(OCC) First Senior Deputy Comptroller and Chief 

Counsel Julie Williams has noted that “Banks are booking new loans that are weak at their inception.”8 The 

high rate of adversely classified new loans could be 

attributable to the continued effects of loan originations 

made toward the end of a period of loosened underwriting standards in 1997 and early 1998. Alternatively, it 

could indicate a higher-risk credit mix in current C&I 

loan portfolios. 

Signs of corporate stress that may weaken credit quality at insured institutions are also reflected in recent 

Banc of America Securities analysis of publicly available bank loan amendments.9 This study shows a significant increase in the number of loan amendments 

6 The annual interagency process reviews commercial loans over 

$20 million that are shared by three or more participants. 

7 Federal Reserve Board Press Release. November 10, 1999. 

8 “OCC’s Williams Warns of Credit Risk in the Banking System; Calls 

for Bankers to Scrutinize Loan Portfolios More Closely.” OCC Press 

Release. October 5, 1999. 

9 “Leveraged Loans: The Plot Thickens.” Banc of America Securities 

Syndicated Finance Research. November 15, 1999. This loan amendment analysis was completed using only publicly available information 

from Loan Pricing Corporation and Banc of America Securities LLC. 

generated because of covenant relief requests, from 22 

percent of all loan amendments during the last six 

months of 1998 to 45 percent during the first ten 

months of 1999. 

Corporate Bond Defaults Soared in 1999 

Trends in corporate bond defaults also indicate increasing levels of stress in the corporate sector. During 1999, 

147 issuers defaulted on $44.6 billion in long-term debt. 

Default rates as a percentage of volumes outstanding (or 

dollar default rates) have trended upward each year 

since 1996, reaching 2.2 percent for all corporate issues 

at year-end 1999. Much of the increase can be attributed 

to a rising dollar default rate for speculative-grade 

issues, which peaked in November 1999 at 8.2 percent. 

Measured as a percentage of all issuers, the default rate 

for speculative-grade issues rose to a post-1991 high of 

6 percent in September 1999 (see Chart 3). According 

to Moody’s, year-end 1999 default rates improved marginally but are expected to remain high through mid2000.10 In addition, domestic speculative-grade issuers 

reported twice as many issuer downgrades as upgrades 

during the fourth quarter of 1999, although the dollar 

volume of upgrades exceeded the dollar volume of 

downgrades by 55 percent.11 

10 “Corporate Bond Default Rates Highest Since 1991.” Moody’s
 

Investors Service. October 13, 1999.
 

11 “Moody’s Default Rate Pendulum.” Moody’s October 1999 Commentary. Moody’s Investors Service. October 18, 1999.
 

CHART 3 

The Default Rate on Corporate Bonds Has
 

Been Driven by Defaults on Speculative Issues
 

Issuer-Weighted 

Default Rate (%) 

15 All Corporate Issues 

10 

5 

0 

Speculative Issues 

Dec ’89 Dec ’91 Dec ’93 Dec ’95 Dec ’97 Dec ’99 

Source: Moody’s Investors Service 

Kansas City Regional Outlook 5 First Quarter 2000 
In Focus This Quarter
 

Why Are C&I Loan Losses Increasing 

Amid Strong Economic Growth? 

Several factors have contributed to the current signs of 

deterioration of C&I credit quality in an environment of 

favorable business conditions. These factors include 

global competition and deflationary pressures, an 

increase in corporate debt levels, loosened underwriting 

standards, and a greater appetite for risk. 

Global competition and deflationary pressures 

have squeezed revenues. An era of low inflation and 

intense global price competition has contributed to low 

or negative revenue growth in a number of domestic 

industry sectors, particularly commodities and manufacturing.12 The result has been an increase in loan 

losses and corporate bond defaults in these sectors. 

Moody’s noted that the industrial sector, weakened by 

low commodity prices, accounted for 64 percent of all 

defaults in 1999, with the oil and gas, steel, and shipping industries being especially hard-hit.13 For example, 

Standard & Poor’s (S&P) reports that third-quarter 

1999 earnings for the iron and steel sector declined 80 

percent from one year earlier after five consecutive 

quarters of negative year-over-year earnings growth. 

Initially, commodity price declines and the international economic turmoil in 1997 and 1998 resulted in 

slowed foreign C&I lending and increased net losses of 

C&I loans held in foreign offices. These losses accounted for the majority of net C&I loan losses in 1997 and 

1998. However, this adverse trend reversed itself in 

1999, when C&I loans held in domestic offices 

accounted for the majority of losses. 

Corporations are increasingly reliant on debt markets. Increasing levels of debt on corporate balance 

sheets have helped to foster C&I loan growth. The 

growth in corporate debt is partially a result of actions 

taken by firms to improve operating efficiency, including increasing merger and acquisition (M&A) activity 

and rising spending on fixed investments. Capital 

expenditures on fixed investments by businesses have 

increased at a steady rate since the 1990–91 recession, 

as evidenced by Chart 4. Cash flow has also been 

increasing, but at a slower rate, resulting in a growing 

“financing gap” that reached an annualized level of 

12 See also Richard A. Brown and Alan Deaton. “Falling Prices in
 

Commodities and Manufacturing Pose Continuing Risks to Credit
 

Quality.” Regional Outlook, third quarter 1999. http://www.fdic.gov/
 

bank/analytical/regional/ro19993q/na/t3q1999.pdf.
 

13 “Historical Default Rates of Corporate Bond Issuers, 1920–1999.”
 

Moody’s Investors Service, January 2000.
 

CHART 4 

The Financing Gap Has Widened

 for Nonfinancial Corporations 

$ Billions “Financing Gap” 

900 

700 

500 

300 

100 

Capital Expenditures Cash Flow 

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

Note: 1999 data are annualized based on 3Q99 data. 

Source: Federal Reserve Board (Haver Analytics) 

$142 billion in the third quarter of 1999. Where cash 

flow has not been available to finance investment, firms 

have turned primarily to debt financing as opposed to 

equity financing. Net new corporate equity issues by 

nonfarm nonfinancial corporations have been negative 

in each year since 1993, while net new corporate bond 

issuance has increased from $75 billion in 1993 to $219 

billion in 1998. 

Loosened underwriting standards in 1997 and early 

1998 are contributing to current losses. Signs of 

stress in C&I loan portfolios can be partially attributed 

to loosened underwriting standards in 1997 and early 

1998. During 1997 and early 1998, loan underwriting 

standards loosened, accompanied by reduced spreads 

and pricing. In May 1998, the Federal Reserve Board 

Senior Loan Officer Opinion Survey on Bank Lending Practices reported that domestic banks were “generally eager to make loans to businesses” and that 

during early 1998 “a large percentage cut their spreads 

on such loans.” Moody’s describes the second half of the 

1990s as a “mini credit cycle.” The cycle began in 1995, 

when the strong economy, accompanied by falling interest rates and low loan losses and default rates, encouraged investor demand for high-yield bonds and loans.14 

A record number of first-time speculative-grade deals 

were also brought to market during 1997 and early 

1998. The increase in the volume of issuance was itself 

enough to push the default rate lower, which in turn may 

have fueled investor demand for additional high-risk 

bonds. However, the Asian crisis during 1997 and the 

Russian debt default during the second half of 1998 

14 “Default Rate Pendulum.” October 18, 1999. 

Kansas City Regional Outlook 6 First Quarter 2000 
In Focus This Quarter
 

caused new issuance of speculative-grade bonds to slow 

significantly while defaults rose sharply, to a rate of 6 

percent by issuer in September 1999. While speculativegrade bond issuance declined, banks stepped in to fill 

the void by raising originations of highly leveraged 

loans between second-quarter 1998 and fourth-quarter 

1999.15 

Financial markets have evidenced greater risk 

appetite. While the ratio of speculative-grade bond 

issues to total corporate bond issues has remained fairly stable at approximately 40 percent during the past 

decade, the composition of borrowings has shifted substantially. Moody’s reports a shift in the distribution of 

bond issue ratings within the speculative-grade category toward the lower end of the ratings scale (see Chart 

5).16 Evidence of this shift is demonstrated by the fact 

that bonds rated B3 or lower currently comprise approximately 35 percent of all speculative-grade issues, a 

record high and up from 24 percent in 1995.17 Furthermore, almost 50 percent of the issuers that defaulted 

during the year ending September 1999 were rated for 

three years or less.18 This change in the composition of 

ratings has contributed to the current increase in speculative-grade defaults and could affect the future volatility and liquidity of the market. The current high volume 

of corporate bond defaults reflects the looser standards 

in 1997 and 1998 for corporate debt issued by low-rated 

first-time issuers, who accounted for 40 percent of rated 

15 LPC Gold Sheets. January 10, 2000.
 16 Moody’s January 2000 Commentary. January 18, 2000.
 

17 “Refunding Risk for Speculative Grade Borrowers.” Moody’s Special Comment. Moody’s Investors Service. December 15, 1999.
 

18 “Default Rate Pendulum.” October 18, 1999.
 

CHART 5 

bond defaults in 1999.19 This relationship is analogous 

to the current increase in net C&I charge-offs partially 

attributable to weakened underwriting standards in 

1997 and early 1998. 

The Increase in Leveraged Lending Could 

Result in a Riskier Mix in C&I Loan Portfolios 

Leveraged lending comprises an important part of the 

syndicated lending market and generates considerable 

fee income for financial institutions. Leveraged loans 

have grown from 12 percent of total syndicated loan 

originations in 1995 to 32 percent in 1999 (see Chart 6, 

next page). Leveraged syndicated loan originations grew 

19 percent to $320 billion in 1999, as investors were 

seeking higher risk-adjusted returns and lenders were 

seeking higher fees. Paine Webber analysts estimate that 

leveraged lending accounts for over 80 percent of syndicated loan fees and profits earned by loan underwriters.20 

Highly leveraged lending increased to a new record of 

$190 billion in 1999.21 This growth in loan originations 

reflects the current high corporate demand for loans, and 

by definition these loans are being made to borrowers 

with higher-than-normal levels of financial leverage and 

risk. In return for their higher risk profile, leveraged borrowers must compensate financial institutions through 

higher pricing and higher fees. 

19 Moody’s January 2000 Commentary. January 18, 2000.
 

20 “The Biggest Secret of Wall Street.” Paine Webber Equity Research.
 

May 14, 1999.
 

21 Loan Pricing Corporation defines highly leveraged loans as those
 

for which pricing exceeds 250 basis points over LIBOR and generally involves sub-investment-grade credits.
 

The Composition of the Rated Bond Market Has Shifted

 toward the Lower Part of the Speculative-Grade Issues 

Distribution of Issuer Ratings 

as a Percentage of Total Issuers 

Note: Unrated issues of corporate debt fall below the speculative-grade “C” rating. 

Source: Moody's Investors Service 

Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3 Ca C 

Moody’s Bond Ratings 

January 1998 January 2000 

Investment-Grade Ratings Speculative-Grade Ratings 

0 

2 

4 

6 

8 

10 

12 

Kansas City Regional Outlook 7 First Quarter 2000 
In Focus This Quarter
 

CHART 6 

$ Billions As a Percentage of 

Total Syndicated Loans 

Loans to Leveraged Companies Represent 

a Greater Portion of Syndicated Loans 

Originations of Syndicated Loans to Leveraged Companies 

Note: 1999 data are annualized based on 3Q99 data. 

Source: Loan Pricing Corporation 

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

400 

0 

100 

200 

300 

40 

0 

10 

20 

30 

Leveraged lending volumes have recently been partially 

driven by M&A lending, which comprised over 30 percent of the total syndicated loan market in 1999. M&A 

activity approached $1.4 trillion in total volume during 

1999, increasing the demand for capital and driving corporations to the loan market.22 Approximately 22 percent of leveraged loans originated in 1998 were to the 

media and telecommunications industries, which have 

experienced significant levels of M&A activity.23 Leveraged buyout activity contributed an additional 15 percent to leveraged lending volumes, surpassing 1998 

levels in quantity. 

Where Is Business Credit Quality Heading? 

The future direction of business credit quality will be 

influenced by several factors, including the condition of 

the economy, growth in the indebtedness of corporate 

borrowers, exposure to vulnerable industry sectors, the 

interest rate environment, the development of emerging 

markets, and underwriting standards. 

Economic growth will remain an important determinant of credit quality. Should economic growth slow 

and corporate profits decline, the demand for C&I loans 

is likely to fall, and problem asset levels are likely to 

rise. A recent S&P survey of global credit conditions 

noted that excessive credit, attributable to unsustainable 

corporate indebtedness and falling asset values, has 

weakened the financial systems of 20 nations. As for 

credit expansion in the United States, the survey noted 

22 Houlihan Lokey’s Mergerstat. www.mergerstat.com. 23 “The Biggest Secret of Wall Street.” May 14, 1999. 

that the ratio of private sector loans outstanding to gross 

domestic product rose from 101 percent in 1995 to 142 

percent in 1999. S&P also noted evidence that banks’ 

C&I loan portfolios may be relying too heavily on loan 

repayments based on projections that are realizable only 

if the current economic expansion continues. S&P estimates that 5 to 15 percent of bank loans could default 

should the United States experience a significant downturn in the stock market leading to a hard landing for the 

domestic economy.24 

Continued growth in corporate indebtedness could 

contribute to increased losses and defaults. The 

growth rate of corporate debt has surpassed the growth 

rate of the economy in each year since 1994. A widening financing gap and increasing debt levels could pose 

problems if there are adverse changes in the interest rate 

environment or if corporate revenue growth slows. Rising rates will increase the costs of servicing debt, while 

a slowdown in revenue growth would reduce the cash 

flow available to service outstanding debt. Under such a 

scenario, business bankruptcies and failures are likely 

to rise, causing increased loan losses and bond defaults. 

Lending to some industries involves high-risk exposures. Despite the strength of the U.S. economy, some 

domestic industries are continuing to experience stress. 

Exposures to weakened industry sectors, such as health 

care and oil and gas, could negatively affect C&I credit 

quality at insured institutions. One way to evaluate the 

relative riskiness of firms operating in a given industry 

is through KMV Corporation’s® Expected Default FrequencyTM (EDFTM) analysis. KMV Corporation® has 

developed a proprietary method of measuring the 

degree of credit risk inherent in corporate borrowers by 

calculating an EDFTM score to estimate the probability 

that a firm will default on its obligations within one 

year.25 Chart 7 diagrams syndicated loan exposures 

along with December 1999 EDFTM scores and the direction of change since December 1998. This chart illustrates one measure of the risk associated with the 10 

industry sectors having the highest expected default 

24 “Global Financial System Stress: The Weak, the Vulnerable, and 

Those Limping Toward Recovery.” Standard & Poor’s. December 17, 

1999. 

25 KMV’s® proprietary calculation for EDFTM is based on (1) the current market value of the firm, (2) the structure of the firm’s current 

obligations, and (3) the vulnerability of the firm to large changes in 

market value. Multiplying industry originations by median industry 

EDFTM scores provides an estimate of expected default volumes. This 

figure provides a more meaningful measure of aggregate lending risk 

exposure than pure origination volumes alone and can be used to rank 

industry exposures. 

Kansas City Regional Outlook 8 First Quarter 2000 
 

In Focus This Quarter
 

volume based on the volume of 1999 syndicated loan 

originations. In 1999, loans originated to mortgage 

lenders (including subprime lenders), communications 

firms, oil and gas firms, health care firms, and retail 

trade organizations generated the five highest expected 

default volumes among 50 broad industry sector classifications. 

The interest rate environment and refunding risk 

affect the demand for and availability of credit. 

Declining interest yield spreads from 1996 to 1998 

benefited borrowers. As spreads declined, the rate of 

syndicated loan growth increased and refinancing 

activity was high. Increases in spreads since 1998, 

along with higher interest rates, have caused refinancing activity to slow significantly. However, rising rates 

have not significantly affected origination volumes, as 

new debt continues to come into the market. Rising 

interest rates and refunding risk particularly affect 

speculative-grade borrowers. Higher interest rates 

would raise businesses’ cost of borrowing, potentially 

decreasing the demand for business credit and impairing borrowers’ ability to repay their debts. Once a corporation’s debt service ability is compromised, access 

to new capital markets can become limited. A sharp 

rise in interest rates would particularly impair the ability of highly leveraged firms to repay floating-rate debt 

obligations. 

Refunding risk continues to be a concern for speculative-grade borrowers as they face potential problems 

refinancing the maturing portions of long-term debt. 

The current tightening of terms in the C&I market and 

increasing default rates heighten refunding risk to borrowers. Rising interest rates or limited access to secondary markets could also increase refunding risk. This 

situation could continue to be problematic, since a rising volume of speculative-grade borrowings, consisting 

largely of unsecured bank debt, matures in 2001 and 

2002. Specifically, $64 billion in speculative-grade debt 

matures in 2001 and 2002, and approximately 63 percent of the debt is unsecured.26 

Potential growth in new markets presents both 

opportunities and challenges. The Internet and European syndicated loan markets represent both future 

potential growth areas and possible sources of credit 

risk for C&I lenders. The Internet has introduced large 

new markets to the loan and bond markets and has 

26 “Refunding Risk for Speculative Grade Borrowers.” December 15, 

1999. 

CHART 7 

Lending to Some Industries May 

Involve Higher Risk Exposures 

Change in Expected Default FrequencyTM (EDFTM) 

for the 12 Months Ending in December 1999 

6 

8 

–2 0 2 4 6 8 10 12 14 16 18 20

 EDFTM as of December 1999 

1 

2 4 5

3 

6 

7 

9 

10 

4 

2 

0 

–2 

Industry Name and Origination Dollars in Billions:

 1. Communication Services - $234.6

 2. Motor Vehicles and Parts - $133.1

 3. Chemicals and Drugs - $96.1

 4. Retail Trade - $92.1

 5. Wholesale Trade - $46.5

 6. Health Care Services - $42.3

 7. Oil & Gas Extraction - $41.8

 8. Entertainment - $33.5

 9. Mortgage Lenders and Mortage-Backed Securities - $20.2 

10. Hotels & Lodging Services - $20.2 

Note: Data and bubble size represent total syndicated loan originations
 

for the year ending 1999.
 

Sources: Securities Data Corporation; KMV Credit Monitor®
 

increased market efficiency. The “Internet economy” 

grew 68 percent from the first quarter of 1998 to the 

first quarter of 1999, with annual revenue expected to 

exceed $500 billion in 1999.27 Internet technology has 

improved the efficiency of the syndicated loan markets, 

with recent changes including the development of public price reporting, credit ratings, and Internet sites for 

online trading.28 Increased levels of credit risk could 

result from the volatility of Internet stock prices and the 

competitive disadvantage faced by firms that do not 

have an Internet presence but must compete against 

firms that do. 

While the majority of syndicated loan financing currently occurs in the United States, analysts predict that 

syndicated lending activity in Europe will accelerate 

significantly because of increased cross-border competition generated by the introduction of the euro and new 

financing needs. In addition, the European high-yield 

bond market is still developing but produced $6.8 billion of volume in the third quarter of 1999, or 61 per27 “Internet Indicators.” The Center for Research in Electronic Commerce at the University of Texas Graduate School of Business. October 27, 1999. 

28 “Syndicated Loan Market Soars as Efficiency Increases.” The Wall 

Street Journal. December 6, 1999. 

Kansas City Regional Outlook 9 First Quarter 2000 
In Focus This Quarter
 

cent of the total market.29 Domestic lenders have begun 

to compete for this market but face credit risks because 

the European markets also pose sovereign and foreign 

exchange risk. 

Underwriting Remains the Key to Assessing 

C&I Credit Quality 

The August 1999 OCC Survey of Credit Underwriting 

Practices reported some tightening of commercial loan 

underwriting standards. However, loan officers also 

reported increased embedded risks in commercial loan 

portfolios for the fifth consecutive year. Survey respondents attributed the increased risks to weakened underwriting standards in previous years. The November 

1999 Federal Reserve Board Senior Loan Officer 

Opinion Survey on Bank Lending Practices found that 

30 percent of domestic banks reported increasing risk 

premiums, credit line costs, and loan spreads during the 

preceding three months. Loan 

officers cited an uncertain or 

unfavorable economic outlook, 

an expected worsening of industry-specific problems, and a 

reduced tolerance for risk as reasons for tightening C&I lending 

standards. 

Despite signs of tightening underwriting standards, the 

mix of credits appears to be riskier than in recent times. 

The OCC issued an advisory to banks in May 1999 

warning of potential problems with leveraged lending. 

The OCC stated that highly leveraged corporations 

could be particularly vulnerable to economic weakness 

and may not be able to compete effectively in a rising 

29 LPC Gold Sheets, Vol. XII, No. 44. Loan Pricing Corporation. 

November 15, 1999. 

interest rate environment. The OCC also addressed 

reliance on enterprise value loans, which are often used 

to support leveraged lending. Enterprise values are calculations based on projections of the future income of a 

firm. If such estimates are overly optimistic, or if the 

company fails to meet the assumptions underlying these 

estimates, the lender may be subject to considerable 

credit risk. The last interagency SNC review also noted 

instances of inadequate documentation and support for 

enterprise loans.30 

Summary 

C&I lending is one of the largest and fastest growing 

lending lines at insured institutions. Recent growth in 

C&I lending can be attributed to a number of factors, 

including a favorable economy, merger and acquisition 

activity, and other sources of high loan demand, strong 

asset quality, aggressive pricing, and attractive fee 

income. While indicators of C&I loan performance 

remain generally strong, signs of deterioration in commercial credit quality have begun to surface. These 

signs are cause for some concern because they are surfacing during a period of remarkable economic 

strength. Increasing corporate indebtedness, signs of 

corporate stress, and adverse trends in corporate bond 

defaults suggest that an economic downturn could result 

in a much more challenging environment for business 

credit quality. 

By Arlinda Sothoron, Senior Financial Analyst 

Alan Deaton, Economic Analyst 

30 Remarks by OCC First Senior Deputy Comptroller and Chief Counsel Julie L. Williams before the Robert Morris Associates Conference 

on Lending and Credit Risk Management, October 5, 1999. 

Kansas City Regional Outlook 10 First Quarter 2000 
In Focus This Quarter
 

Local Industries in the Global Economy
 

•	 The contribution of international trade to U.S. 

economic activity has risen rapidly during the 

past decade. The U.S. economy has been increasingly influenced by conditions abroad, such as the 

recent financial market turmoil in several emerging markets. 

•	 Canada, Japan, and Mexico are the largest U.S. 

trading partners, accounting for approximately 

40 percent of U.S. trade. Western Europe and Asia 

(excluding Japan) also account for a large share 

of U.S. trade. 

•	 The importance of trade at the industry level 

varies widely. The industries most dependent on 

trade, including machinery and transportation 

equipment, also account for a large share of U.S. 

trade. 

The value of goods and services traded on international 

markets has more than doubled during the past decade. 

More goods and services than ever are being shipped 

abroad and imported from all parts of the globe. Consequently, U.S. economic activity is increasingly influenced by the flow of goods, services, and capital across 

national borders. 

The increasing importance of international trade is 

reflected in different types and levels of exposure to 

international markets. First, total exports and imports 

compared with overall economic activity confirm the 

increasing contribution of trade to the economy as a 

whole. Second, the amount of U.S. trade with foreign 

markets, although widely varied, is concentrated in a 

small number of countries, namely Canada, Japan, and 

Mexico. Consequently, economic conditions in these 

countries are particularly important in assessing the 

influence of global economic conditions on U.S. trade. 

Third, the level of exposure to international trade across 

industry sectors varies considerably. Some industries are 

not influenced greatly by activity in international markets, while for other, more trade-dependent industries, 

conditions in the world economy are an important factor 

in determining the level of sales and profit. The exposure 

to international markets, either through reliance on trade 

with particular countries or via industries with a significant exposure to international markets, is an important 

consideration for lenders seeking to determine a firm’s 

future profitability and financial condition. 

International Trade Is of Growing Importance 

Over the past 30 years, international trade has grown 

more quickly than the economy as a whole. Exports, 

which include both merchandise and services, have 

risen from less than 5 percent of U.S. gross domestic 

product (GDP) in 1970 to approximately 12 percent 

today. The merchandise component accounts for about 

73 percent of exports and includes manufactured goods, 

agricultural products, and raw materials such as metals 

and oil. The services component of exports, accounting 

for about 28 percent of total exports, includes travel services, passenger fares, royalties, freight and port services, and a number of smaller sectors such as financial 

and educational services. 

Imports also account for a growing share of U.S. consumption of goods and services, exceeding 15 percent 

of U.S. GDP in 1999, up from 6 percent in 1970. Merchandise is the largest component of imports, accounting for 83 percent, while services account for 17 percent 

(see Table 1, next page). 

Although trade in services has grown quickly for many 

years, merchandise still accounts for the majority of all 

trade. The dominance of merchandise is attributable, in 

part, to the difficulty of trading many types of services. 

With few exceptions, services are generally produced 

and consumed within a local market because they cannot be transported easily and are subject to language 

and cultural barriers. Hospitals, dry cleaners, and movie 

theaters, for example, serve well-defined local markets 

and produce products that cannot be traded competitively on international markets. Although trade in services such as travel continues to grow, the remainder of 

this article focuses primarily on the dominant merchandise component. 

U.S. Trade Activity Has Reflected Recent 

Global Economic Turmoil 

Over time, conditions in the international economy have 

become an increasingly important influence on U.S. 

growth, since a rising share of all domestically produced goods and services is sold abroad. Similarly, an 

increasing volume of imported goods and services 

implies a higher level of competition for domestic producers that compete directly with imports. 

Kansas City Regional Outlook 11	 First Quarter 2000 
In Focus This Quarter
 

TABLE 1 

Merchandise Is the Largest Component of Trade 

DOLLAR VALUE* PERCENT 1999 

(1998, $ MILLIONS) OF TOTAL GROWTH** 

Exports $ 933,910 100.0% 1.8% 

MERCHANDISE 682,138 73.0% 0.8% 

AGRICULTURE AND 

RELATED COMMODITIES 26,603 2.8% –1.8% 

MINERAL COMMODITIES 6,644 0.7% –17.4% 

MANUFACTURED GOODS 593,297 63.5% –0.1% 

OTHER MERCHANDISE 55,593 6.0% 39.5% 

SERVICES 263,662 28.2% 4.3% 

TRAVEL 71,250 7.6% 3.0% 

PASSENGER FARES 19,996 2.1% 2.7% 

ROYALTIES AND LICENSE FEES 36,807 3.9% 4.1% 

FREIGHT AND PORT SERVICES 25,520 2.7% 6.4% 

OTHER SERVICES 110,089 11.8% 5.0% 

ADJUSTMENTS*** (11,890) 

Imports $ 1,098,193 100.0% 10.3% 

MERCHANDISE 907,647 82.6% 10.4% 

AGRICULTURE AND 

RELATED COMMODITIES 22,859 2.1% –2.2% 

MINERAL COMMODITIES 38,619 3.5% 5.6% 

MANUFACTURED GOODS 803,384 73.2% 11.6% 

OTHER MERCHANDISE 42,786 3.9% –0.6% 

SERVICES 181,015 16.5% 9.6% 

TRAVEL 56,105 5.1% 7.2% 

PASSENGER FARES 19,797 1.8% 8.3% 

ROYALTIES AND LICENSE FEES 11,293 1.0% 11.0% 

FREIGHT AND PORT SERVICES 30,460 2.8% 11.4% 

OTHER SERVICES 63,360 5.8% 10.9% 

ADJUSTMENTS*** 9,531 

* Sum of components may not equal total due to rounding.
 

** First three quarters of 1999 versus first three quarters of 1998.
 

*** Because of different methods of estimating the merchandise and services components of trade, an adjustment
 

term is necessary. Consequently, percentages may not sum to 100.
 

Sources: Bureau of Economic Analysis; Bureau of Census
 

Kansas City Regional Outlook 12 First Quarter 2000 
In Focus This Quarter
 

During the past two and a half years, for example, the 

international economy has been buffeted by a series of 

crises that resulted in steep exchange rate depreciations 

for a number of countries and a marked slowdown in 

economic growth in many emerging markets. Although 

the U.S. economy remained surprisingly strong during 

the worst of the emerging markets crises, the fallout 

was evident in the diverging performance of U.S. 

exports and imports over the period. 

From mid-1997 through mid-1999, U.S. exports were 

generally flat, reflecting the sluggish pace of growth in 

several important U.S. export markets. Export prices 

fell by 4 percent over the period in response to weak 

demand for U.S. exports. In particular, exporters of 

agricultural products, basic manufactured goods, and 

commodities faced rapidly deteriorating conditions in 

several important overseas markets. For example, the 

value of merchandise exports to the Pacific Rim fell by 

15 percent during the first six months of 1999 compared with the same period in 1997 because of the 

recent financial market turmoil in the region. 

U.S. imports continued to grow during the period, 

however, reflecting both strong demand for imported 

goods and falling prices. In fact, average import prices 

fell by 5 percent between 1997 and 1999. At the same 

time, competition from imports limited the pricing 

power of domestic producers that compete with goods 

produced abroad. Although producers that compete 

with cheaper imports experienced adverse effects on 

profitability, consumers and firms that purchased 

goods from abroad generally benefited from falling 

import prices.1 

The slowdown in U.S. export activity and the acceleration of import growth have resulted in an increasing 

trade imbalance (see Chart 1). The U.S. trade deficit, 

which reached a record $26.5 billion in November, has 

raised concerns among analysts about the vulnerability 

of the dollar. Faster growth abroad or a slowdown in 

U.S. growth could convince foreign investors to 

increase purchases of assets outside the United States, 

resulting in a sell-off of the dollar. Depending on the 

severity and speed of a sell-off, heightened financial 

market volatility and rising U.S. import prices could 

result. Although potentially many forces are at work in 

1 Weak import prices are a factor cited by analysts to explain the 

benign performance of U.S. inflation during the past few years. 

CHART 1 

U.S. Import Growth Has Accelerated 

while Exports Remain Flat 

$ Billions 

350 

300 

250 

200 

150 

100 

Imports 

Exports 

1992 1993 1994 1995 1996 1997 1998 1999 

Source: Bureau of Economic Analysis 

such a scenario, rising inflation or a falling dollar may 

ultimately result in higher interest rates and slower U.S. 

growth. The extent to which U.S. trade would be affected by such a scenario is difficult to assess, since 

changes in the prices of either imports or exports would 

result in both positive and negative effects on firms’ 

costs, revenue, and profitability.2 

Most U.S. Trade Is Concentrated 

in a Few Foreign Markets 

Because the United States trades with most nations, 

economic conditions abroad are one of the critical 

factors that determine the growth of U.S. trade. Foreign demand for U.S. goods and services depends on 

the strength of the markets to which exporters ship 

their goods. Consequently, economic weakness 

abroad often results in slower U.S. export growth. 

Economic conditions abroad also influence the level 

of import competition that U.S. firms experience. 

Foreign firms facing slack demand in their own 

domestic markets, much like manufacturers in Southeast Asia during the recent market turmoil, may 

2 During the early 1980s, the dollar rose by roughly 50 percent, as 

measured against a trade-weighted basket of currencies. The 

increase in the value of the dollar made U.S. exports much more 

costly on world markets and contributed to financial stress among 

export-dependent manufacturers and agriculture producers. Beginning in mid-1985 the dollar fell sharply, back to its pre-appreciation 

level. The resulting improvement in U.S. competitiveness contributed to robust growth in U.S. exports that lasted during the rest 

of the 1980s. 

Kansas City Regional Outlook 13 First Quarter 2000 
In Focus This Quarter
 

reduce prices of their U.S.-bound goods to compete 

more effectively with U.S. producers.3 

Although the U.S. trades with many nations, a large 

share of U.S. trade is concentrated among a small number of countries. Canada, Mexico, and Japan account 

for more than 40 percent of merchandise exports and 

imports. Asia (excluding Japan) and Western Europe 

each account for just over 20 percent of U.S. exports 

and a broadly similar share of imports. Central and 

South America, despite proximity to the United States, 

account for less than 10 percent of exports and only 

5 percent of imports (see Chart 2). 

The United States has routinely run a trade deficit with 

its largest trading partners. The trade deficit with 

Canada was $22.8 billion through the first three quarters of 1999. The trade deficit with Mexico topped 

$18.8 billion during the same period. The trade 

deficits with Japan and China, by far the two largest at 

$53.4 billion and $49.4 billion, respectively, accounted for approximately 40 percent of the total U.S. merchandise trade deficit through the first three quarters 

of 1999. 

The Importance of Trade Varies 

among Industries 

The level of export activity or the intensity of import 

competition also varies across industries. Besides the 

overall dollar volume of exports, industries differ in the 

proportion of total production that is exported. 

Although some industries, such as leather products, 

account for a relatively small share of total U.S. 

exports, exports from this industry make up a large 

share of all U.S. leather goods production. In cases 

such as this, conditions in export markets are important 

for producers even if total export sales from a particular industry are small. 

Industries also differ in the share of total spending 

devoted to imports. Imports account for a relatively 

3 From the perspective of a foreign exporter, increased sales of goods 

abroad, even at reduced prices, may be a preferred strategy to offset 

lower sales within its own weaker domestic market. A foreign steel 

mill facing weak sales in its home market may choose to sell its output below cost on the world market if it can still cover its fixed costs 

of operation. There also may be an incentive to maintain or even 

expand market share and recoup current losses in the future when 

prices rebound. 

CHART 2 

Canada Is the Largest U.S. Trading Partner 

(1Q99 through 3Q99, ranked by exports) 

Eastern Europe 

Africa 

Central/South America 

Japan 

Mexico 

Asia (excluding Japan) 

Western Europe 

Canada 

Source: Bureau of Census 

–250 

$ Billions 

–150 –50 50 150 250 

Imports Exports 

small portion of all domestic spending on farm products such as grains and livestock, for example, while 

imports account for a relatively large share of all U.S. 

oil consumption. These differences expose U.S. industries to varying levels of competition from abroad. In 

industries characterized by high levels of import competition, import prices may largely shape the domestic 

pricing environment and, by extension, the revenue and 

profit growth of domestic firms. 

For the purposes of this article, industries can be 

assigned to one of three broad categories depending on 

their exposure to international markets either through 

exports or through the intensity of import competition. 

Firms in Less Exposed Industries are not directly influenced by conditions in the global markets. Export markets are not a particularly important source of revenue, 

and imports are a negligible share of all domestic consumption of goods produced by these industries. In 

contrast, some industries are highly exposed through 

their reliance on export markets, through competition 

from imports, or in some cases, through both. For firms 

in these Highly Exposed Industries, conditions in international markets are clearly one of the important factors influencing current and prospective financial 

performance. Industries not part of either group, or 

Moderately Exposed Industries, face some competition 

from abroad and may earn a relatively small amount of 

revenue from export markets. 

To gauge these differences more fully, a measure 

of exposure to international markets was calculated for 

a set of 26 industries (20 manufacturing industries, 

4 mining industries, and 2 agriculture sectors). Table 2 

Kansas City Regional Outlook 14 First Quarter 2000 
In Focus This Quarter
 

TABLE 2 

Industry Exposure to International Trade 

IMPORT SHARE OF U.S. CONSUMPTION 

LOW MEDIUM HIGH 

EXPORT 

SHARE OF U.S. PRODUCTION 

LOW 

PRINTING AND PUBLISHING 

FOOD PRODUCTS 

LUMBER AND WOOD 

PRODUCTS 

PETROLEUM AND COAL 

PRODUCTS 

AGRICULTURAL SERVICES, 

FORESTRY, AND FISHING 

FURNITURE AND FIXTURES 

OIL AND GAS EXTRACTION 

MEDIUM 

COAL MINING 

TOBACCO PRODUCTS 

NONMETALLIC MINERALS, 

EXCEPT FUELS 

FABRICATED METAL 

PRODUCTS 

METAL MINING 

PAPER AND ALLIED 

PRODUCTS 

TEXTILE MILL PRODUCTS 

STONE, CLAY, AND 

GLASS PRODUCTS 

RUBBER AND PLASTIC 

PRODUCTS 

PRIMARY METAL INDUSTRIES 

MISCELLANEOUS MANUFACTURING INDUSTRIES 

APPAREL PRODUCTS 

HIGH 

FARM PRODUCTS CHEMICALS AND ALLIED 

PRODUCTS 

INSTRUMENTS AND 

RELATED PRODUCTS 

TRANSPORTATION 

EQUIPMENT 

INDUSTRIAL MACHINERY 

AND EQUIPMENT 

ELECTRONIC EQUIPMENT 

LEATHER AND LEATHER 

PRODUCTS 

Highly Exposed Industries 

Moderately Exposed Industries 

Less Exposed Industries 

summarizes the results of the assessment.4 Each row 

shows industries that have high, medium, or low 

reliance on export markets, defined as the share of U.S. 

production in a particular industry that is exported. 

Each industry was ranked by this measure, with the 7 

highest industries placed in the High category, the 7 

lowest in the Low category, and the remaining 12 in the 

4 Export share of production (rows in Table 2) was calculated as the 

ratio of inflation-adjusted exports at the industry level divided by 

inflation-adjusted production in that industry (Gross Output by Industry from the Bureau of Economic Analysis was used as a measure of 

industry production). The import share of consumption (columns in 

Table 2) was calculated as the share of inflation-adjusted industry 

imports divided by inflation-adjusted domestic production less 

exports plus imports. All calculations were based on 1997 data, the 

latest industry-level production data available. 

Medium category.5 Table 2 shows, for example, that a 

relatively low proportion of production in the printing 

and publishing, lumber and wood products, and oil and 

gas extraction industries is exported. In contrast, a relatively high percentage of production in the farm products sector, chemicals, and transportation equipment 

industries is exported. 

5 This allocation, while completely arbitrary, roughly corresponds to a 

distribution where 50 percent of the industries are assigned to the 

Medium category, with the remaining 50 percent evenly allocated 

between the High and Low categories. Breakpoints for the distribution of industries by export share of production were as follows: Low: 

less than 7 percent; High: greater than 13 percent. 

Kansas City Regional Outlook 15 First Quarter 2000 
In Focus This Quarter
 

The industries in each column are categorized by the 

share of U.S. consumption expenditures in a particular 

industry that are satisfied by imports. Again, the Low 

and High categories each include 7 industries, and the 

Medium category includes the remaining 12 industries.6 

On the basis of this analysis, for example, a relatively 

low share of U.S. consumption of food, fabricated metals, and farm products is imported. In contrast, a large 

share of U.S. consumption of oil, apparel, and electronic equipment is imported.7 

As shown in the lower right cell of the table, four industries are highly exposed to both export markets and 

import competition. These industries—transportation 

equipment, industrial machinery, electronic equipment, 

and leather products—account for slightly less than half 

of total U.S. exports and a similar percentage of total 

U.S. imports. Not only are these industries more closely tied to international markets than most other industries examined, but they also account for a large share of 

U.S. international trade. 

Using the terminology introduced above, Highly 

Exposed Industries are defined as those assigned to 

either of the High categories; industries in this group 

either are very reliant on export markets or face high 

levels of import competition. Less Exposed Industries 

are defined as those that have little exposure to either 

export markets or import competition; they are shown 

in the upper left cell in the Low classification. The 

remaining industries are defined as Moderately 

Exposed Industries. 

Chart 3 illustrates the distribution of establishments in 

each of the three categories by Region.8 Among the 

6 Breakpoints for the distribution of industries by import share of 

consumption were as follows: Low: less than 9 percent; High: greater 

than 25 percent. 

7 Although not directly included in the analysis, most domestically 

produced services also have minimal reliance on export markets and 

face little import competition. Retail trade, construction, local transportation services, and government, for example, all operate in relatively sheltered markets and are dependent on the health of the local 

economy. Particular firms may engage in high levels of international activity in tradable services such as travel, but manufacturing, 

mining, and agriculture account for the majority of imports and 

exports. 

8 An establishment is defined as a single physical location at which 

business is conducted or services or industrial operations are performed. It is not necessarily identical with a company or enterprise, 

which may consist of one or more establishments. Data are from 

County Business Patterns (Bureau of Census, 1997). 

CHART 3 

Atlanta Boston Chicago Dallas Kansas Memphis New San 

City York Francisco 

Number of Establishments* Classified by 

International Trade Exposure by Region 

0 

10,000 

20,000 

30,000 

40,000 

50,000 

60,000 

FDIC Region 

Source: Bureau of Census, 1997 County Business Patterns Database 

*An establishment is a single physical location at which business is conducted. 

Highly Exposed Industries 

Moderately Exposed 

Industries 

Less Exposed Industries 

group of industries analyzed, most are in the Moderately Exposed Industries category. Of the FDIC Regions, 

Atlanta, Chicago, and San Francisco have the greatest 

number of establishments in this category. The Chicago 

and San Francisco Regions lead in the number of establishments in the Highly Exposed Industries group, followed by the New York and Dallas Regions.9 Less 

Exposed Industries account for a relatively small number of establishments. As suggested above, however, 

most service-sector, construction, and government 

enterprises, while not part of this analysis, could be 

classified as Less Exposed.10 

Although this analysis highlights the varying level of 

direct exposure to international markets, industries also 

may be exposed through a less direct secondary channel. 

Several industries, although not highly exposed themselves, are suppliers to Highly Exposed Industries. For 

example, the rubber and plastics industry produces 

goods that are used in the manufacture and assembly of 

transportation equipment, a Highly Exposed Industry. 

9 An alternative way of analyzing the establishment data is to calculate the percentage of all establishments across the 25 industries that 

are in Highly Exposed Industries. On the basis of this calculation, the 

Dallas Region ranks highest at 42 percent because of the large number of establishments engaged in oil and gas extraction. For the 

remaining Regions, the percentages vary between 25 percent and 35 

percent. Across all industries (including services and other sectors not 

part of this analysis), the percentage of Highly Exposed Industries in 

each Region ranges from 1.7 percent (Atlanta Region) to 3.4 percent 

(Boston Region) of total establishments. 

10 These data do not include a count of establishments in the farm 

products sector (Standard Industrial Code (SIC) 01 and SIC 02). 

Therefore, 25 industries are represented in the establishment data, and 

not 26 as in Table 2. 

Kansas City Regional Outlook 16 First Quarter 2000 
In Focus This Quarter
 

Consequently, conditions in export markets for transportation equipment are of particular interest for manufacturers of certain types of rubber and plastic products. 

These supplier industries are also vulnerable to import 

competition through this secondary exposure to international markets. A transportation equipment manufacturer, in response to heightened competition in international 

markets for its products, may switch from a domestic 

supplier of rubber products to a cheaper foreign supplier 

if a favorable price differential emerges. Therefore, 

assessing the exposure of industries to either exports or 

imports requires consideration of any secondary linkages 

between suppliers and purchasers of industry products. 

Summary 

The contribution of international trade to overall U.S. 

economic activity has been increasing for a number of 

years. The growing significance of trade has been highlighted by the recent series of economic and financial 

crises across the globe. One result of recent global economic turmoil has been a slowdown in U.S. export 

growth resulting from both slumping international 

demand for U.S. goods and services and weak prices. 

Import growth has continued unabated, largely because 

of strong U.S. growth, leading to a rapidly widening 

trade deficit. The effects of import and export growth 

on particular industries vary because of differing levels 

of reliance on export markets and the extent of import 

competition. This analysis suggests that several industries are highly exposed to changing global economic 

conditions. Lenders should be aware that for firms in 

these industries, changes in global economic conditions, including demand for U.S. exports and prices of 

both imports and exports, largely determine pricing, 

revenue growth, and profitability. 

Paul C. Bishop 

Senior Financial Economist 

Kansas City Regional Outlook 17 First Quarter 2000 
Regional Perspectives
 

Banking Scorecard
 

In the aggregate, as of September 30, 1999, the Region’s farm banks1 continued to report sound conditions. 

Earnings remained strong and contributed to adequate capital levels. Despite continued low commodity prices, 

problem loans remain manageable and reserve levels provide a cushion against potential loan problems. Funding is a concern as farm banks continue to have problems increasing core deposits and are turning instead to 

noncore funds to support asset growth. Noncore funds, such as large time deposits, Federal Home Loan Bank 

borrowings, and brokered deposits, typically are more expensive and volatile than core deposits. Increased interest expenses, coupled with increased loan competition and changing asset compositions, have put moderate 

pressure on net interest margins. 

Record government payments to farmers helped maintain farm banks’ relatively low levels of problem loans in 

1999. However, given the continued expectation of low commodity prices, farm banks could see a significant 

increase in past-due loans in 2000. 

Source: Bank Call Reports 

The Region’s Farm Banks 

Continue to Post Strong Earnings 

Return on Assets (%) 

Sept: ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 

U.S. 

KC Region 

1.4 

1.2 

1.0 

0.8 

Net Interest Margin (%) 

Increasing Competition, Coupled with Declining 

Loan Volumes, Is Compressing Margins 

KC Region 

U.S. 

Sept: ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 

4.6 

4.4 

4.2 

4.0 

3.8 

As Core Deposit Bases Wither, Noncore 

Funding Sources Increase in Significance 

Percentage of Assets

Percentage of Assets 

Sept: ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 

Core 

Deposits 

(left axis) 

Noncore 

Funds 

(right axis) 

20 

16 

12 

8 

4 

84 

80 

76 

72 

68 

Past-Due Loan Levels Are Low 

and Reserves Remain Strong 

Percentage of Total Loans

Noncurrent 

Loans 

Sept: ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 

Loans Past-Due 

30–89 Days 

Loan Loss 

Reserves 

5.0 

4.0 

3.0 

2.0 

1.0 

0.0 

1 Farm banks are defined as FDIC-insured financial institutions whose agricultural operating loans and real estate loans secured by real 

estate make up at least 25 percent of total loans. 

Kansas City Regional Outlook 18 First Quarter 2000 
Regional Perspectives
 

Regional Perspectives
 

•	 Economic conditions in the Region remain strong; however, the actions of some large firms may adversely 

affect the Region’s labor market. 

•	 More than half of the Region’s counties have lost population since 1970, and of those counties, almost onequarter are losing population at an increasing rate. Agricultural consolidation and population density 

trends are driving these population outflows. 

•	 Insured institutions in rural counties that have lost population since 1970 have reported slower asset, loan, 

and deposit growth than institutions in counties with growing populations. Key differences also exist in loan 

composition and funding strategies. 

•	 If rural depopulation continues, many banks and thrifts may eventually be located in counties with inadequate population bases, a situation that could lead to consolidation among rural banks or increased risktaking to maintain loan and deposit bases. 

Overview of Economic and Banking Conditions 

Overall, the Region’s economy remains sound heading 

into 2000 as it continues to expand moderately with little inflation. Labor market analysts expect that 

increased activity in export markets will strengthen the 

Region’s manufacturing sector, especially durable 

goods. Commercial real estate conditions remain strong 

although construction and housing markets have 

slowed. Consumer spending is robust, and significantly 

higher oil and natural gas prices have generated 

renewed drilling activity in the Region. 

Despite generally strong economic conditions, areas of 

weakness exist. For example, the Region’s economy has 

slowed considerably since 1998 as measured by net new 

jobs created. Consistent with the nation, the year-overyear total nonfarm employment growth rate continued 

to slow and was 1.1 percent as of October 1999. The 

Region’s unemployment rate is extremely low, below 

3 percent, compared with the national rate of 4.1 percent. Labor market tightness and slower employment 

growth could continue into 2000. 

In addition, the Region’s labor market may be affected 

significantly by the actions of certain large firms. The 

announced merger between Sprint Corporation, 

Kansas City’s largest employer, and MCI WorldCom 

Inc. may affect the Kansas City metropolitan area. 

Pending Federal Communications Commission and 

U.S. Department of Justice approval, the new company, WorldCom Inc., will be based in Clinton, Mississippi, with extensive operations at MCI WorldCom’s 

new campus near Washington, D.C. As a result of the 

merger, Sprint could see employment reductions in its 

long-distance operations and divestitures in its localtelephone operations. Sprint’s legal, finance, regulatory, and administrative divisions in Kansas City could 

be vulnerable as well. 

The AlliedSignal Inc. and Honeywell Inc. merger was 

completed on December 1, 1999. The merger will affect 

the Minneapolis-St. Paul metropolitan area, since Honeywell’s Minneapolis headquarters will be moved to the 

new company’s Morristown, New Jersey, headquarters. 

The integration of the two companies is estimated to be 

completed by mid-year 2000 and is expected to result in 

a loss of 1,000 to 1,500 jobs in the Minneapolis-St. Paul 

area. These job eliminations began at year-end 1999 and 

will be completed by year-end 2000. 

Boeing Company, the world’s leading aircraft manufacturer, continues to implement workforce reductions. 

Boeing Wichita, with 21,600 workers at year-end 1998, 

projects year-end 1999 employment at 16,900. Layoffs 

are expected to continue, although at a declining rate, 

throughout 2000. In May 1999, Boeing announced that 

as many as 7,000 jobs, or 35 percent of the workforce, 

would be eliminated by mid-2001 at its St. Louis facility because of a lack of orders for the F-15 military aircraft. The aerospace industry disproportionately affects 

the St. Louis economy because of high average salaries 

and numerous support industries that generate significant secondary economic activity. 

Kansas City Regional Outlook 19	 First Quarter 2000 
Regional Perspectives
 

In addition, the Region’s agricultural sector continues to 

be hampered by low commodity prices. Moreover, rural 

depopulation is adding to stress in rural areas. This article examines how rural depopulation trends are affecting 

the Region’s rural economy and the banking industry. 

Depopulation Threatens the Viability 

of Many of the Region’s Rural Counties 

As seen in Map 1, 367 of the Kansas City Region’s 618 

counties have lost population since the 1970 Census. 

While this trend has been evident for several decades, a 

significant subset of the Region’s counties is losing population at an increasing rate. According to the U.S. Census Bureau’s 1998 County Population Estimates, 94 

counties in the Region lost population at a greater rate in 

the 1990s than in the previous two decades. Of these 94 

counties, 84 are rural counties not adjacent to metropolitan areas. 

This article segments the Region’s 402 rural counties, 

nonadjacent to metropolitan statistical areas (MSAs), 

into three types: the 84 counties with “accelerating 

declining” populations (AD counties); the 209 counties 

that are losing population but not at an increasing rate 

(Other Declining counties), and the 109 counties with 

increasing population (Growing counties).1 This article 

examines why many of the Region’s rural counties have 

lost population since 1970 and why some counties are 

losing population at an increasing rate. It also discusses 

likely future scenarios for the economic development of 

AD counties and Other Declining counties and assesses 

risks to FDIC-insured financial institutions headquartered in these counties as of June 30, 1999. 

Why Are Many Rural Counties Losing Population? 

Population trends in the Region are part of the larger 

story of rural-to-urban migration that has occurred 

throughout our nation’s history. At the beginning of the 

twentieth century, 40 percent of the U.S. population lived 

on farms, but this percentage had declined to less than 

3 percent by the 1990 Census.2 Farm population has 

declined as farmers have adopted new capital-intensive 

technologies, leading to a surplus of farm labor and sub1 AD counties are those that have lost population since 1970 but at a 

faster rate in the 1990s than from 1970 to 1989. Other Declining 

counties have lost population since 1970 but did not experience an 

increased rate of decline in the 1990s. Growing counties have gained 

population since 1970. 

2 Lorraine Garkovich. Population and Community in Rural America. 

1989. Westport, CT: Greenwood Press. p. 98. 

MAP 1 

Source: U.S. Census Bureau, 1998 County Estimates 

Population since 1970 

Other Declining 

A Majority of the Region’s Counties 

Have Lost Population since 1970 

Growing 

Accelerated Declining 

sequent outmigration from rural areas.3 Because of the 

relative importance of agriculture in the Region, the 

implications of rural-to-urban migration are significant. 

Over time, farms have declined in number and 

increased in size. In the Region, the number of farms 

has declined from 573,000 in 1974 to 438,000 in 1997, 

while over the same period the average farm has grown 

from 477 acres to 597 acres. These aggregate statistics 

actually understate consolidation in the sector, as they 

are based on the U.S. Department of Agriculture’s 

(USDA) broad definition of a farm, which includes all 

operations with more than $1,000 in sales. Farms with 

annual sales over $100,000 have seen much greater 

declines in numbers. 

As farms become larger and more technologically 

sophisticated, their reliance on the local rural economy 

often diminishes. Larger farms tend to buy inputs, 

including financial resources, from more distant, larger 

firms that can provide more services at a lower cost. 

Ongoing industrialization in many agricultural sectors 

weakens farms’ connections to local rural economies.4 

As seen in the hog industry in Iowa, Minnesota, 

and more recently Kansas, large integrators have supplied many of the inputs, including working capital 

3 Don E. Albrecht and Steve H. Murdock. The Sociology of Agriculture: An Ecological Perspective. 1990. Ames: Iowa State University
 

Press. p. 87.
 

4 Mark Drabenstott and Tim R. Smith. “The Changing Economy of
 

the Rural Heartland.” Economic Forces Shaping the Rural Heartland.
 

Federal Reserve Bank of Kansas City. April 1996.
 

Kansas City Regional Outlook 20 First Quarter 2000 
Regional Perspectives
 

to local growers, often to the detriment of competing 

local suppliers.5 

Many of the Region’s demographic characteristics can be 

understood in relation to the importance of agriculture. 

Population densities in the United States are typically low 

in areas that are dependent on agriculture.6 This is especially true in the Kansas City Region, where the major 

products are field crops, such as corn, soybeans, and 

wheat, that are raised on large tracts of land. According to 

the 1997 Census of Agriculture, 80 percent of the 

Region’s land area is used for farming, compared with the 

national share of 41 percent. Consequently, the Region’s 

population distribution differs significantly from the 

U.S. average. According to 1998 Census estimates, the 

Region’s population density was 36.8 people per square 

mile, compared with a national average of 76.4 per 

square mile. Of the Region’s seven states, only Missouri, 

a state with the major MSAs of St. Louis and Kansas 

City, has a density greater than the national average. 

Why Are Some Counties Losing Population 

at a Faster Rate than Others? 

Table 1 presents some of the relevant characteristics of 

the three types of rural counties, nonadjacent to MSAs, 

in the Region, categorized by population trends. The 

data identify several factors that distinguish AD, Other 

5 Mark Drabenstott. “This Little Piggy Went to Market: Will the New
 

Pork Industry Call the Heartland Home?” Economic Review. Federal
 

Reserve Bank of Kansas City. Third quarter 1998. p. 98. 


6 Albrecht and Murdock. p. 152.
 

TABLE 1 

Declining, and Growing counties. First, AD counties are 

smallest in average population size, with more than half 

reporting populations of fewer than 5,000. The population data clearly suggest a relationship between county 

size and the tendency to have an accelerating population 

decline. Of the 280 counties that had populations of less 

than 10,000 in 1990, 23 percent were AD counties by 

1998. Of the 131 counties with fewer than 5,000 people 

in 1990, 31 percent were in the AD category, and of the 

counties with fewer than 3,000 people, 38 percent fell 

into the AD category. 

Outmigration is another important characteristic that distinguishes AD counties from Other Declining and Growing counties. Table 1 shows that in the 1990s, AD counties 

lost 7.3 percent of their 1990 population, presumably 

because of better employment opportunities in more economically robust rural or metropolitan counties. Outmigration was 2.1 percent in Other Declining counties, 

while Growing counties gained 1.9 percent in the 1990s. 

The exodus of working-age people has, in turn, adversely affected the demographic characteristics of the counties they left. As Table 1 shows, AD counties are 

characterized by a disproportionate number of elderly 

people; 19.0 percent of the population in these counties 

is older than 65, compared with a national figure of 13.3 

percent. The outmigration of younger people from the 

sparsely populated counties also affects the population 

growth rate by reducing the rate of natural increase. On 

average, more people died than were born in AD and 

Other Declining counties during the 1990s. People in 

Rural Counties with Declining Populations Differ from 

Counties with Growing Populations 

RURAL, NONADJACENT COUNTIES 

OTHER METRO AND 

AD DECLINING GROWING ADJACENT 

COUNTIES COUNTIES COUNTIES COUNTIES 

NUMBER OF COUNTIES 84 209 109 216 

AVERAGE POPULATION 

(1998 ESTIMATE) 7,195 9,331 20,434 64,411 

PROPORTION OF COUNTIES WITH 

FEWER THAN 5,000 PEOPLE 51% 36% 8% 4% 

NET MIGRATION IN THE 1990S –7.3% –2.1% 1.9% 1.3% 

NATURAL INCREASE IN THE 1990S –0.1% –0.1% 3.5% 5.2% 

PROPORTION OLDER THAN 65 19.0% 18.9% 14.6% 12.4% 

Note: “AD” counties refer to “accelerating declining” counties. 

Source: U.S. Census, 1998 County Estimates 

Kansas City Regional Outlook 21 First Quarter 2000 
Regional Perspectives
 

their childbearing years are those most likely to leave 

the sparsely populated counties in search of other 

opportunities, leading to a lower birth rate, while the 

disproportionately high population of elderly leads to a 

higher death rate. 

Population density most clearly distinguishes AD counties from other county types. As seen in Chart 1, which 

compares the population densities of the Region’s three 

categories of rural nonadjacent counties, AD counties 

have an average population density considerably less 

than even that of Other Declining counties. 

Many demographers argue that communities whose populations fall below a critical mass are destined for irreversible decline, as the local economies no longer have 

sufficient human resources to maintain viability.7 Given 

their low population bases and densities, some AD counties may already exhibit these characteristics. Counties 

with very low population bases often face difficulties 

maintaining infrastructure and public services. Smaller 

rural counties also face increasing difficulty maintaining 

a full range of government services, such as education, 

utilities, public roads, and health care.8 The per capita 

cost of providing these services is high in areas with low 

population density, where relatively few people must 

share the fixed costs associated with such investments. 

As such, areas of low population density may face a 

vicious circle as residents attempt to maintain an infrastructure to support the current level of economic activ7 Harlow A. Hyde. “Slow Death in the Great Plains.” Atlantic Monthly. June 1997. p. 45.
 8 Thomas D. Rowley. “Sustaining the Great Plains,” Rural Development Perspective. Vol. 13. June 1998. p. 4.
 

CHART 1 

AD Counties Have Barely Half the Population
 

Density of Other Declining Counties
 

Population per Square Mile 

25.0 23.3 

20.0 

15.0 

10.0 

5.0 

0.0 

AD Other Declining Growing 

6.9 

12.0 

Source: U.S. Census Bureau, 1998 County Estimates 

ity. However, as cost per capita increases, many communities are unable to maintain or develop the infrastructure necessary to attract new economic activity.9 

The demographic data discussed above suggest that the 

Region’s AD counties may be facing irreversible 

decline. While the population of the majority of the 

Region’s counties has long been in decline, AD counties 

are most in danger of losing their viability. 

Accelerated Depopulation More Prevalent 

in the Western Half of the Region 

Within the Region, there are substantial differences 

between the western states (North Dakota, South 

Dakota, Nebraska, and Kansas) and the eastern states 

(Minnesota, Iowa, and Missouri). As shown in Table 2, 

the western states’ population densities are less than 

those of the eastern states. Much of this difference can 

be explained by variation in the nature and productivity 

of the agricultural sector. 

Population densities depend, in part, on the productive 

capacity of the land and the ability of the local economy 

to support other kinds of activity. In a state such as 

Iowa, for example, the land is very fertile and the weather patterns usually result in high productivity. In such 

areas of high productivity per acre, farm sizes are relatively small and rural farm populations relatively large. 

These areas usually support a diverse range of nonagricultural activities. In the Northern Great Plains, by contrast, the land and weather are less conducive to 

consistently high levels of productivity, resulting in 

larger farms and sparser rural populations.10 As seen in 

Table 2, according to data from the USDA, in 1998 cash 

receipts per acre for Iowa farms were more than four 

times those of farms in North Dakota and South Dakota. To compensate for this disparity, the average farm in 

the Northern Plains is more than four times as large as 

a farm in Iowa. Nebraska and Kansas in the Southern 

Plains fall between these extremes, partly because of the 

effects of irrigation technology. 

In summary, rural depopulation trends, although occurring slowly, are important and may be irreversible. The 

next section examines how rural depopulation trends 

have affected the performance of insured financial institutions headquartered in declining counties. 

9 Mark Drabenstott, Mark Henry, and Lynn Gibson. “Rural Economic Policy Choice.” Economic Review. Federal Reserve Bank of Kansas
 

City. January 1987. p. 41.
 

10 Albrecht and Murdock. p. 153.
 

Kansas City Regional Outlook 22 First Quarter 2000 
Regional Perspectives
 

TABLE 2 

The Population Structure of the Region’s Western States 

Differs Considerably from That of Its Eastern States 

WESTERN STATES EASTERN STATES 

ND SD KS NE MN IA MO US 

POPULATION PER SQUARE MILE 9.3 9.7 32.1 21.6 59.4 51.2 78.9 76.4 

AGRICULTURAL CASH 

RECEIPTS PER ACRE (DOLLARS) 76 79 169 194 295 353 162 211 

FARM SIZE IN ACRES 1,290 1,418 748 885 354 343 292 487 

PERCENTAGE OF LAND IN FARMS 89% 91% 88% 93% 51% 87% 65% 41% 

Source: U.S. Census of Agriculture, 1997 

Banking Analysis—Rural Depopulation 

Has Affected Bank Performance 

Banking statistics show that institutions located in rural 

counties with declining populations grew assets, loans, 

and deposits more slowly in the 1990s than institutions 

located in counties with increasing populations. Institutions in AD counties reported even slower growth rates. 

In addition, institutions in declining counties have significantly different loan compositions and funding 

strategies than institutions in growing counties. 

Types of Institutions in Rural, Nonadjacent Counties 

This article examines the performance of “community 

institutions,” which we define as all FDIC-insured institutions with less than $250 million in total assets as of 

September 30, 1999.11 As of that date, there were 189 

community institutions in AD counties with total assets 

of $8.96 billion, 589 community institutions in Other 

Declining counties with total assets of $29.48 billion, 

and 347 community institutions in Growing counties 

with total assets of $22.74 billion. In total, rural nonadjacent counties in the Region that have lost population 

since 1970 (referring to both AD and Other Declining 

counties) headquarter 778 community institutions with 

11 In looking at banking activity in the Region’s rural, nonadjacent 

counties, it is important to examine institutions that conduct a majority of business in the counties in which they are headquartered. Otherwise, institutions’ reported results, which are shown entirely as 

occurring in their headquarters’ counties, may reflect economic activity outside their home counties. To determine if economic activity 

was centered in institutions’ home counties, branch data as of June 30, 

1998 (the most recent branch data available) were examined. The 

1,125 institutions with less than $250 million in assets in the Region’s 

rural, nonadjacent counties had 76.4 percent of branches in the same 

county as their headquarters. By contrast, the 35 institutions in those 

counties with assets of more than $250 million had 29.1 percent of 

their branches in the same county as their headquarters. 

total assets of $38.44 billion, plus 12 noncommunity 

institutions with total assets of $4.95 billion. 

Not surprisingly, because rural depopulation has largely 

been driven by consolidation in the agricultural sector, 

a large percentage of community institutions in AD and 

Other Declining counties are farm banks.12 In fact, as 

shown in Table 3 (next page), over 86 percent of community institutions in AD and Other Declining counties 

are farm banks. In Growing counties, which are far less 

dependent on agriculture than declining counties, just 

over half of community institutions are farm banks. 

Community institutions in AD and Other Declining 

counties also have a greater concentration in farm lending13 than do institutions in Growing counties. AD county institutions show the highest aggregate level of farm 

loan concentrations (46.6 percent), and many institutions in these counties have much higher concentrations 

than the aggregate figure. 

Growth 

Because declining population means dwindling bases of 

potential borrowers and depositors, growth rates14 for 

total assets, loans, and deposits in AD and Declining 

county institutions have been lower than in Growing 

county institutions. This disparity in total asset growth 

rates can be seen in Chart 2 (next page). Not surprisingly, AD county community institutions showed the lowest 

cumulative asset growth of 42.7 percent over the decade, 

or 3.7 percent annually. Other Declining county commu12 Farm banks are defined by the FDIC as institutions that have farm 

operating loans or loans secured by farm real estate of over 25 percent 

of total loans. 

13 Farm loans consist of loans made for agricultural production and 

loans secured by agricultural real estate. 

14 All growth rates cited in this article were computed on a mergeradjusted basis. 

Kansas City Regional Outlook 23 First Quarter 2000 
Regional Perspectives
 

TABLE 3 

AD and Other Declining County Institutions 

Are Heavily Concentrated in Farm Lending 

RURAL, NONADJACENT COUNTIES 

AD OTHER DECLINING GROWING 

COUNTIES COUNTIES COUNTIES 

NUMBER OF COUNTIES 84 209 109 

NUMBER OF COMMUNITY INSTITUTIONS 189 589 347 

NUMBER OF FARM BANKS 163 507 185 

% OF INSTITUTIONS THAT ARE FARM BANKS 86.2% 86.1% 53.3% 

% OF FARM LOANS TO TOTAL LOANS 46.6% 42.1% 26.0% 

Note: “Farm Banks” are institutions with at least 25 percent of loans in farm operating loans or loans secured by 

farm real estate. 

Source: Bank and Thrift Call Reports, 1999 

CHART 2 

Community Institutions in AD and Other 

Declining Counties Report Slower 

Rates of Asset Growth 

Assets (1989 = 100) 

Source: Bank and Thrift Call Reports 

Sept. 

100 

120 

140 

160 

180 

’99’98’97’96’95’94’93’92’91’90’89 

Growing 

Counties 

Other 

Declining 

Counties 

AD Counties 

nity institutions did not fare much better, growing assets 

by 46.8 percent over the decade, or 4.0 percent annually. 

Community institutions in Growing counties reported 

asset growth of 71.5 percent, or 5.7 percent per year. 

Loan growth was similar to total asset growth, but the 

differences between community institutions in the three 

county types were not as pronounced. AD county community institutions increased loans by 7.0 percent per 

year in the 1990s, while Other Declining community 

institutions increased loans at 7.3 percent. Growing 

county institutions reported loan growth of 8.1 percent 

per year. 

The three county types are differentiated to a greater 

degree by the deposit growth rate. Community institution deposits grew by an annualized rate of just 2.9 percent in AD counties and 3.2 percent in Other Declining 

counties, while Growing county community institutions 

grew deposits by 5.0 percent. Deposit growth is 

addressed in more detail in the funding section of this 

article. 

Going beyond the cumulative 1990s growth figures, in 

every year this decade community institutions in Growing counties grew assets and deposits to a greater extent 

than did community institutions in AD counties. In 

addition, in all but one year during this decade, AD 

community institutions reported slower loan growth 

than Growing county institutions. 

Loan Composition 

As seen in Table 4, there are key differences in loan composition between institutions in AD counties and Growing 

counties. Because AD and Other Declining counties are 

overwhelmingly agricultural, community institutions headquartered there have high concentrations in farm loans. AD 

county community institutions show even higher concentrations in farm lending than institutions in Other Declining counties. With less dependence on agriculture, 

institutions in Growing counties report much lower levels 

of farm loans. Since community institutions in AD and 

Other Declining counties have higher levels of farm lending than institutions in Growing counties, they have significantly lower levels of other loans. For example, they make 

significantly fewer single-family residential loans, an 

important fact because these loans generally carry much 

less risk than other types of loans. However, they also 

make fewer commercial real estate loans, which can carry 

higher levels of risk than other loans. 

Kansas City Regional Outlook 24 First Quarter 2000 
Regional Perspectives
 

TABLE 4 

Declining County Institutions Report More Farm Loans, 

Fewer Residential Loans than Do Growing County Institutions 

% OF TOTAL LOANS AS OF 9/30/99 

COMMUNITY INSTITUTIONS IN: 

AD OTHER DECLINING GROWING 

LOAN TYPE COUNTIES COUNTIES COUNTIES 

LOANS SECURED BY REAL ESTATE 41.4 46.0 54.5 

CONSTRUCTION/DEVELOPMENT 1.6 1.6 2.6 

COMMERCIAL REAL ESTATE 7.1 8.4 12.7 

1–4-FAMILY RESIDENTIAL 16.9 20.2 28.1 

5+ FAMILY RESIDENTIAL 0.8 0.7 1.3 

HOME EQUITY 0.4 0.6 0.8 

FARMLAND 14.7 14.6 9.0 

COMMERCIAL AND INDUSTRIAL 14.0 14.1 14.6 

INDIVIDUAL 9.5 10.5 12.4 

FARM PRODUCTION 31.9 27.5 17.0 

OTHER LOANS 3.2 1.9 1.5 

Total 100.0 100.0 100.0 

Source: Bank and Thrift Call Reports as of 9/30/99 

AD and Other Declining county institutions’ reliance on 

agricultural lending results in greater exposure to both 

long-term and short-term agricultural-sector problems. 

Prices for the Region’s primary commodities—corn, 

wheat, soybeans, and hogs—are at very low levels and are 

not expected to improve in the near term. Low prices have 

resulted in declining farm incomes over the past couple 

of years, and many farmers, especially those with higherthan-average levels of debt, are experiencing some loan 

repayment problems. Community institutions in AD 

counties are reporting the most significant loan quality 

problems, with an aggregate past-due ratio of 2.9 percent 

of total loans, with 1.6 percent of total loans being noncurrent. By contrast, community institutions in Growing 

counties have total past-due loans of just 2.3 percent of 

total loans, with 1.1 percent of those being noncurrent. 

Interestingly, community institutions in Other Declining 

counties have low levels of problem loans—2.2 percent—even though, like AD counties, they headquarter 

many farm banks. This disparity probably occurs because 

23 of the Region’s 84 AD counties are in North Dakota, 

where farmers are in particularly bad shape because of 

years of low prices and reduced production. Farm banks 

in North Dakota as a whole are experiencing the highest 

aggregate level of past-due loans in the Region. 

Funding 

Funding, especially regarding growth in core deposits, 

differs widely among AD, Other Declining, and Growing counties. Core deposits, which are stable funds that 

include non-interest-bearing, savings, and money market deposit accounts, as well as time deposits of less 

than $100,000, have traditionally been the backbone of 

community institutions’ funding.15 Core deposits are 

generally less expensive and less sensitive to interest 

rates than nontraditional funds such as large time 

deposits, brokered deposits, and Federal Home Loan 

Bank (FHLB) advances. 

Deteriorating depositor bases have caused community 

institutions in AD and Other Declining counties to 

report much slower core deposit growth in the 1990s 

than institutions in Growing counties. Chart 3 (next 

page) illustrates the disparity in cumulative core 

deposit growth during this decade. Community institutions in AD and Other Declining counties grew core 

deposits by just 2.4 and 2.6 percent per year, respectively, while institutions in Growing counties reported 

15 Core deposits funded over 80 percent of rural community institutions’ assets, regardless of county type, at year-end 1989. 

Kansas City Regional Outlook 25 First Quarter 2000 
Regional Perspectives
 

CHART 3 

Community Institutions in AD and Other Declining 

Counties Have Slower Core Deposit Growth 

Assets (1989 = 100) 

100 

120 

140 

160 

Growing 

Counties 

Other 

Declining 

Counties 

AD Counties 

’99’98’97’96’95’94’93’92’91’90’89 

Sept. Source: Bank and Thrift Call Reports 

growth in core deposits of 4.5 percent per year. The low 

core deposit growth reported by AD and Other Declining county institutions suggests that they did not even 

retain the accrued interest on core deposits over the 

past decade. 

In response to slower rates of core deposit growth, community institutions in all three county types have developed several strategies. First, as is the case in any 

prolonged economic expansion, banks liquidated securities and invested the funds in higher yielding loans. 

Institutions in AD and Other Declining counties (combined) began the decade with a loan-to-asset (LTA) ratio 

of 46.3 percent and securities-to-assets (STA) ratio of 

40.1 percent. By September 30, 1999, these institutions’ 

aggregate LTA ratio had increased to 62.4 percent, 

while their STA ratio had declined to 29.1 percent. 

TABLE 5 

Growing county institutions began the decade with far 

higher levels of loans and lower levels of total assets, 

and moderately shifted between securities and loans, 

reaching LTA and STA ratios of 64.3 and 26.9 percent, 

respectively. 

In addition to liquidating securities portfolios, community institutions increased reliance on nontraditional 

funds in place of traditional core deposits. Table 5 

shows how community institutions in AD, Other 

Declining, and Growing counties shifted reliance from 

core deposits to nontraditional funding sources in the 

1990s. Of these nontraditional sources, community 

institutions in all three county types continue to rely 

heavily on large time deposits, but have increasingly 

been relying on borrowings during this decade. This 

trend toward increased reliance on nontraditional funds 

is consistent among AD, Other Declining, and Growing 

counties. The difference is that institutions in Growing 

counties appear to be using nontraditional funds to grow 

asset bases, while institutions in AD and Other Declining counties are using them without experiencing the 

same level of asset growth. 

Most borrowings reported by community banks refer to 

advances from the FHLB, and such advances are 

becoming an integral part of many community institutions’ funding strategies. However, until recently commercial banks needed a sizable portfolio of residential 

mortgage assets to join the FHLB system. As a result, 

many small banks, including most farm banks, did not 

qualify to become members. Because of their large farm 

loan portfolios, only 88 of 189 (46.6 percent) AD county community institutions were members of the FHLB 

Community Institutions in Rural Counties, Nonadjacent to MSAs, 

Are Relying More on Noncore Funding 

AD COUNTY OTHER DECLINING GROWING COUNTY 

COMMUNITY COUNTY COMMUNITY COMMUNITY 

INSTITUTIONS INSTITUTIONS INSTITUTIONS 

FUNDING TYPE AS % OF ASSETS 9/99 12/89 9/99 12/89 9/99 12/89 

CORE DEPOSITS 71.6 81.5 73.0 83.5 72.5 80.9 

BROKERED DEPOSITS 0.7 0.0 0.6 0.2 0.7 0.1 

TIME DEPOSITS GREATER 

THAN $100,000 10.4 7.5 8.9 5.6 10.1 7.7 

OTHER BORROWINGS 6.1 0.8 6.1 0.7 6.6 2.1 

TOTAL NONCORE FUNDING 17.2 8.3 15.7 6.5 17.4 9.9 

Sources: Bank and Thrift Call Reports; USDA (for county codes) 

Kansas City Regional Outlook 26 First Quarter 2000 
Regional Perspectives
 

as of September 30, 1999. On the other hand, community institutions in Other Declining and Growing counties showed FHLB membership of 52.1 and 59.4 

percent, respectively. 

An analysis of FHLB membership suggests that some 

community institutions in the Region’s rural counties 

have the opportunity to make more loans but may be 

constrained by funding—namely, lack of core deposit 

growth. For example, the FHLB is a primary source of 

funding for many institutions. However, segmenting 

banks that are FHLB members from those that are not 

shows differing growth rates, even among community 

institutions within each of the three county types. As 

shown in Table 6, AD county institutions that are not 

FHLB members grew total assets by 34.5 percent in the 

1990s, while AD county institutions that are FHLB 

members grew assets by 47.4 percent. The difference 

lies in loan growth: AD county FHLB members outgrew their non-FHLB counterparts 98.0 percent to 81.7 

percent. Likewise, Other Declining county FHLB members grew loans much faster than their non-FHLB counterparts. The data indicate that FHLB membership may 

have enabled some institutions to make more loans and 

grow asset bases. 

Looking Ahead 

The Region’s rural depopulation trends may not be 

reversible. Agricultural consolidation is expected to 

continue; as a result, many rural areas will continue to 

see larger farms and lower population levels. AD counties, some of which may have fallen below a critical 

TABLE 6 

population level already, are likely to continue to experience significant depopulation. Other Declining counties could also see continued depopulation, and counties 

that depopulate below the critical point may also see 

accelerated outflows. 

Rural depopulation has affected many of the Region’s 

community banks. Most important, institutions in areas 

of declining populations have found it difficult to grow 

asset and core deposit bases. Institutions, particularly 

those in AD counties, have experienced problems growing loans and core deposits. Given the likelihood of 

continued population outflows, what does the long term 

hold for institutions in troubled counties? 

First, these institutions will likely experience continued 

problems growing loans and core deposits, which could 

be exacerbated if population declines quicken. As farms 

continue to consolidate, their lending needs will escalate. Since community institutions are constrained by 

lending limits and prudent loan concentration standards, they may not be able to service these large farms’ 

credit needs. In response, many community institutions 

are using participation agreements to divide large loans, 

but at some point large farms may find it cheaper or 

easier to deal with larger banks or input suppliers in 

more populated areas. A common and perhaps reasonable response to dwindling borrower bases may be for 

community institutions to expand their geographic lending areas or expand into new lending products. Such 

actions could heighten institutions’ credit-risk levels if 

management lacks the expertise to enter new markets or 

make new types of loans. 

FHLB Member Community Institutions in Declining Counties Grew 

Their Assets and Loans Faster than Non-FHLB Institutions 

COMMUNITY INSTITUTION GROWTH IN 1990S (%) 

FHLB MEMBER?/COUNTY TYPE ASSETS LOANS DEPOSITS CORE DEPOSITS 

YES / ACCELERATING DECLINING 47.4 98.0 33.6 27.0 

NO / ACCELERATING DECLINING 34.5 81.7 29.3 23.3 

YES / OTHER DECLINING 55.2 107.7 41.1 33.5 

NO / OTHER DECLINING 32.0 81.4 25.5 20.4 

YES / GROWING 69.8 112.1 57.1 48.7 

NO / GROWING 76.0 119.5 71.5 66.2 

Note: Growth rates are merger adjusted and for the period of 12/31/89 to 9/30/99. 

Sources: Bank and Thrift Call Reports; Federal Home Loan Bank (FHLB) 

Kansas City Regional Outlook 27 First Quarter 2000 
Regional Perspectives
 

In addition, most institutions in areas of declining population are likely to have trouble growing core deposits 

into the future. Core deposit levels are driven by local 

depositor bases, and as these bases shrink, so may core 

deposits. As a result, community institutions in counties 

with declining populations likely will continue to 

increase their reliance on nontraditional funding sources. 

For example, institutions may turn to the FHLB for longterm funding or try to attract large time deposits through 

an active money desk operation or an Internet site. At 

least in the short term, demand for FHLB advances may 

increase significantly as a result of the enactment of the 

Gramm-Leach-Bliley Act. This legislation, signed by 

President Clinton on November 12, 1999, will enable 

most banks to join the FHLB system, eliminating prior 

restrictions based on the size of institutions’ residential 

mortgage loan portfolios. In addition, the Act allows 

farm loans and small business loans to be used as collateral for advances in addition to residential mortgage 

loans. These changes, at least in the short term, should 

alleviate some of the funding constraints many community institutions are experiencing. In the long term, a 

continued shift into nontraditional funding could pose 

greater risk to earnings through higher rates paid and 

could require more active management of interest rate 

and liquidity risks if such funds are unstable.16 

Perhaps the long-term result of depopulation in the 

Region is that the banking industry in rural areas will 

consolidate. This consolidation could result in institutions in counties of declining population becoming 

small branches of institutions in more economically 

robust counties. However, it is also possible that institutions in these areas will increase the level of risk in their 

loan portfolios or funding strategies. 

John M. Anderlik, Regional Manager 

Jeffrey W. Walser, Regional Economist 

Christopher J. Sesler, Economic Analyst 

Troy D. Osborne, Financial Analyst 

16 For a detailed discussion of these risks, refer to “Shifting Funding 

Trends Pose Challenges for Community Banks,” Regional Outlook, 

third quarter 1999. 

Kansas City Regional Outlook 28 First Quarter 2000 
✁
 

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