Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION THIRD QUARTER 1999 

FDIC
 

New York
 

Region
 

Division of
 

Insurance
 

Kathy R. Kalser,
 

Regional Manager
 

Norman Gertner,
 

Regional Economist
 

Karen A. Wigder,
 

Senior Financial
 

Analyst
 

Alexander J.G.
 

Gilchrist,
 

Economic Analyst
 

In Focus This Quarter 

◆ Falling Prices in Commodities and Manufacturing Pose Continuing 

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

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

industries that produce standardized products and face global competition, mostly 

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

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

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

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

persist. See page 3. 

By Richard A. Brown and Alan Deaton 

◆ Shifting Funding Trends Pose Challenges for Community Banks— 

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

traditional measures of liquidity and liability composition for commercial banks 

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

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

toward greater reliance on nondeposit funding continues, liability management 

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

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

By Allen Puwalski and Brian Kenner 

Regional Perspectives 

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

the Region is strong; unemployment rates in most of the states are better than the 

national average. Banks and thrifts continue to report healthy financial conditions, 

although community banks’ bottom lines continue to be affected by tight interest 

margins. Also, as funding sources shift away from deposits, interest margins could 

be affected, and asset and liability management may become more challenging. See 

page 18. 

◆ Earnings Variability Is Increasing—An influx of new banks and competitive pressures felt by community banks are contributing to increasing profit variability among the Region’s financial institutions. A concern is that insured 

institutions will attempt to mitigate the effects of weaker performance by engaging 

in riskier funding and lending strategies. See page 20. 

◆ Some Key Industries Face Increased Risk Levels—The chemical, gaming, health care, and steel industries are important to various parts of the Region 

and are facing increasing levels of risk because of pricing pressures, heightened 

competition, and global economic forces affecting supply and demand. See page 22. 

By the New York Region Staff 

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

Insurance Corporation for the following eight geographic regions: 

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

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

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

Dallas Region (CO, NM, OK, TX)
 

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

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

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

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

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

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

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

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

Region’s Regional Outlook, please call Kathy Kalser at (212) 704-1308 or send an e-mail to 

kkalser@fdic.gov. 

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

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

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

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

the Federal Deposit Insurance Corporation. 

Chairman Donna Tanoue 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Publications Manager Teresa J. Franks 
In Focus This Quarter
 

Falling Prices in Commodities and Manufacturing 


Pose Continuing Risks to Credit Quality
 

•	 Prices have fallen sharply across a wide range of 

commodities and manufactured goods. 

•	 Signs of stress are apparent in some industry 

sectors. 

•	 These trends are contributing to rising credit risk 

for insured institutions. 

•	 Effects on local economies and community banks 

could grow if low prices persist. 

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

Economic activity grew in 1998 at an inflation-adjusted 

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

and extend the expansion into its ninth consecutive year. 

However, one downside of low inflation has been that 

firms in certain commodity industries have encountered 

slow or negative growth in revenues because of the low 

prices they receive for their products. 

Commodity industries are defined in this article as a 

collection of agricultural, mining, and manufacturing 

industries that produce standardized products and face 

global competition, mostly on the basis of price. Since 

the beginning of 1997, price weakness has extended 

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

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

become apparent. 

The potential importance of problems in commodity 

industries to the FDIC was illustrated by the banking 

problems related to oil and agriculture during the 1980s 

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

FDIC Division of Research and Statistics, regional 

economic dislocations related to declining farmland 

values and declining oil prices contributed to large 

increases in credit losses and the eventual failure of 

hundreds of federally insured banks and thrifts. The 

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

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

1980s—but exposures to commodity industries remain 

important for many insured institutions. 

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

industry-sector problems are important in banking. It 

takes a high-level approach, emphasizing the economic 

fundamentals that are driving prices across the economy 

while ignoring many of the industry-specific factors 

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

on bank credit quality if they persist through 1999 and 

beyond. 

Prices Have Been Declining across a Range 

of Commodities and Manufactured Goods 

Low inflation has been a boon for consumer spending 

and business investment during the economic expansion 

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

Index had risen at an annualized rate of less than 2.0 

percent for 8 consecutive quarters and at an annualized 

rate of less than 4.0 percent for 

33 consecutive quarters. The 

prices of many popular and 

essential consumer goods— 

from computers to gasoline— 

have generally fallen throughout 

the decade, even as the prices of 

most services continue to rise 

steadily. Businesses, too, have 

benefited from the ability to 

purchase goods cheaply, as well as from the generally 

low interest rates that have accompanied low inflation. 

The declining average wholesale price of goods is 

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

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

components since the beginning of 1997. The PPI 

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

the beginning of 1997 has been led by falling prices for 

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

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

declines for 26 consecutive months through May 1999. 

New York Regional Outlook 3	 Third Quarter 1999 
In Focus This Quarter
 

CHART 1	 CHART 2 

Widespread Pricing Pressures Are Evident in the 

Components of the Producer Price Index 

Percent Change in Selected Components of the Producer Price 

Index, January 1997 to May 1999 

–45 

–40 

–35 

–30 

–25 

–20 

–15 

–10 

–5 

0 

Agricultural Prices Are Down Sharply Since 1997 

Percent Change in Reported Price Between 

January 1997 and May 1999 

Source: Wall Street Journal (Haver Analytics) 

Cotton 

Corn 

Hogs 

Wheat 

10 

5 

0 

–5 

–10 

–15 

–20 

–25 

–30 

–35 

–40 

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

Iron & SteelPetroleumProductsMining 

3.3 

–4.0 

0.6 –1.9 –2.5 –2.5 

–10.0 

–19.8 

–33.2 

Although they are only indirectly included in the PPI 

numbers, the prices of several important agricultural 

commodities have also fallen substantially. Chart 2 

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

percent since January 1997, with the price of corn, 

hogs, and cotton also registering double-digit rates of 

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

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

wheat, and cotton continued to decline through May 

1999. 

Reasons for Broad-Based Commodity 

Price Weakness 

Pricing trends in disparate industries such as electronics 

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

industry-specific factors. For example, weather patterns 

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

the demand for a product or its cost of production, 

thereby influencing its market price. For example, 

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

silicon wafers—have significantly increased production 

yields in that industry during the 1990s.1 

However, the pervasiveness of recent price declines 

across a wide range of commodities and manufactured 

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

Surveys, May 27, 1999, p. 4. 

goods suggests that a number of common factors are 

driving prices lower: 

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

Disinflation has profoundly altered the expectations 

of investors, consumers, and businesses, and in the 

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

result, commodities have lost much of their appeal 

as a hedge against inflation. This has contributed to 

a decline of more than 50 percent in the price of 

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

power they must continually cut costs to remain 

competitive. 

•	 Overcapacity because of large-scale investment. 

Global investment in productive capacity accelerated 

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

firms have implemented new technologies and 

moved their operations closer to their markets or to 

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

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

facilities in the emerging markets of Asia and Latin 

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

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

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

November 1998, pp. 28–31. 

New York Regional Outlook 4	 Third Quarter 1999 
In Focus This Quarter
 

could exceed demand by more than 20 million units 

annually by 2000.3 A similar situation has developed 

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

and 1996, contributing to a glut of memory chips and 

plunging prices.4 

•	 Curtailed global demand in the wake of emerging 

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

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

demand for new cars in Korea fell by 50 percent in 

1998.5 Asia received approximately 30 percent of 

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

demand since then has contributed to a sharp decline 

in global grain prices. The slowdown of economic 

activity in crisis countries and the resulting decline 

in their demand for imports is only one factor that 

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

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

its currency experience a reduction in the price of 

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

businesses that sell their goods in global markets. 

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

economies may soon begin to recover. However, the 

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

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

and businesses that participate in commodity industries 

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

Signs of Stress Are Showing 

for Affected Industry Sectors 

As commodity prices continue to stagnate, signs of 

stress are emerging among firms in the commodity 

industries. A long-term trend toward reduced levels of 

employment in manufacturing has accelerated in the 

midst of the current economic expansion. Chart 3 shows 

that employment levels declined in a wide range of 

commodity industries in the 24 months ending in May 

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

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

5 Barbara McClellan (1998).
 

CHART 3 

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

Employment Levels Have Declined across a Wide 

Range of Commodity and Manufacturing Sectors 

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

of payroll employment in agriculture and agricultural services 

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

Electronics and Semiconductors 

Textiles 

Autos 

Primary Metals/Iron and Steel 

Chemicals 

Oil and Gas 

Mining 

Lumber and Paper 

Agriculture* 

–20 –15 –10 –5 0 

1999. The total manufacturing sector lost more than 

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

jobs were lost in the mining sector, which includes oil 

and gas extraction. The trend toward lower levels of 

employment in mining and manufacturing not only 

reflects pricing pressures but also attempts by firms in 

these sectors to maintain profitability by investing in 

labor-saving technologies. 

The profit picture has begun to deteriorate as well for 

firms operating in commodity industries. Four-quarter 

trailing earnings through March 1999 for oil-sector 

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

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

earnings of steel firms fell by almost 32 percent. The 

losses experienced by firms in some of these industrial 

sectors extended to the farm sector as well, where net 

CHART 4 

–50 –40 –30 –20 –10 0 10 20 

Agriculture* 

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

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

Earnings Have Declined across a Wide Range 

of Commodity and Manufacturing Sectors 

Oil and Gas 

* 1998 percent change in net farm income 

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

Lumber and Paper 

Mining 

Chemicals 

Primary Metals/Iron and Steel 

Autos 

Textiles 

Electronics and Semiconductors 

New York Regional Outlook 5	 Third Quarter 1999 
In Focus This Quarter
 

incomes fell by more than 7 percent in 1998, according 

to the U.S. Department of Agriculture. 

Affected Industries Have Found Ways to Cope 

with Pricing Pressures Thus Far 

Despite the signs of stress in industries where prices are 

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

have shown themselves to be fairly resilient thus far in 

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

to keep their operations running even if they were not 

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

Practices shows that 29 percent of FDIC-supervised 

agricultural lenders reported at least a moderate 

increase in carryover debt during the six-month period 

ending in March 1999, compared with only 10 percent 

in March 1998. Although the use of carryover debt is 

not an uncommon practice in agriculture, it indicates 

that low prices and declining subsidies have contributed 

to financial stress for farmers. 

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

Chart 5 follows trends in annual total revenue and costs 

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

commodity industries. It shows that growth in revenue 

and costs slowed noticeably in 1997. Both revenue and 

costs in these sectors declined in 1998, illustrating that 

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

sector is further illustrated by a steady decline in the 

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

CHART 5 

U.S. Corporations Operating in 

Commodity Industries Have Trimmed 

Costs to Offset Falling Revenue* 

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

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

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

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

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

Source: Bureau of the Census (Haver Analytics) 

1992 1993 1994 1995 1996 1997 1998 

Billions of Dollars 

Costs 

Revenues 

1,250 

1,450 

1,650 

1,850 

2,050 

2,250 

by the first quarter of 1999. Falling unit labor costs 

means that the productivity of manufacturing workers is 

rising faster than the cost of their services. This trend 

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

Cost savings and industry consolidation have been 

accomplished in part through mergers. According to 

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

trillion in 1998, an increase of more than 80 percent 

from 1997 levels. Both the number and dollar volume of 

mergers announced in 1998 far exceeded the volumes 

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

of the largest mergers announced in 1998 involved 

firms looking for ways to increase market share and cut 

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

Exxon-Mobil transaction announced in December 

1998. Furthermore, merger activity recorded in early 

1999 suggests that total merger volume for the year 

could exceed the record pace of a year ago. 

Industries plagued by oversupply and weak prices 

require consolidation to reduce capacity and improve 

profit margins. Mergers and acquisitions represent a 

fairly orderly way for firms operating in a troubled 

industry to consolidate on their own terms. Bankruptcy 

filings are an alternative means for severely troubled 

firms to reduce capacity and achieve consolidation 

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

employment (such as those documented in Chart 3). 

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

preferable to a disorderly shakeout of firms through 

bankruptcies. 

Recent favorable capital market conditions have 

allowed firms in troubled industries to consolidate 

through mergers. Acquisitions are sometimes financed 

through corporate borrowings or, more commonly, by 

swapping equity shares that have been rising in value 

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

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

and leveraged lending related to mergers and acquisitions reached a 

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

market for that period. 

New York Regional Outlook 6 Third Quarter 1999 
In Focus This Quarter
 

orderly process, associated with record-high merger and 

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

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

financial market conditions characterized by sharply 

higher interest rates, lower stock values, or both could 

inhibit the ability of businesses to restructure and retool 

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

bankruptcies and losses to lenders. 

Signs Point to Rising Credit Risk 

in the Commodity Industries 

In dollar terms, the largest commercial bank exposures 

to the commodity industries are in the portfolios of 

large banks. Chart 6 provides an estimated breakdown 

of the aggregate exposure of insured institutions to 

commodity industries based on corporate balance sheet 

information collected by the Bureau of the Census.7 The 

chart shows that the aggregate exposure of the bank and 

thrift industries to these sectors is approximately $206 

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

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

CHART 6 

Commodity Industries Make Up
 

Over One-Quarter of Bank C&I Loans
 

to Corporate Borrowers
 

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

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

Electronics 

4.2% 

Chemicals* 

9.5% All Other 

73.5% Textiles
 

1.2%
 

Iron & Steel 

1.1% 

Automobiles 

1.7% 

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

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

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

Bureau of the Census. 

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

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

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

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

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

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

to firms operating in the manufacturing sector. 

A rough indicator of recent trends in the credit risk 

associated with bank loans to commodity industries can 

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

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

for firms operating in commodity industries compared 

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

chart shows that while the median EDF for commodity 

industries has consistently exceeded the median for all 

other firms in the recent past, this difference has 

widened appreciably since the middle of 1998. Over the 

past year, the median EDF for commodity industries has 

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

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

increased probability of default among firms operating 

in commodity industries. 

8 KMV’s proprietary calculation for EDF is based on 1) the current 

market value of the firm, 2) the structure of the firm’s current obligations, and 3) the vulnerability of the firm to large changes in market 

value. 

CHART 7 

The Default Risk of Firms Operating 

in Commodity Industries Has 

Risen over the Past Year 

Median Expected Default Frequency (EDF)* 

(Probability that a Firm Will Default on Bond 

Obligations within One Year) 

KMV’s proprietary calculation for EDF is based on 1) the current market value of the firm, 

2) the structure of the firm’s current obligations, and 3) the vulnerability of the firm to large 

changes in market value. 

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

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

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

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

products; and textiles. 

Source: KMV Corporation 

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

Firms in Other Industry Sectors 

Firms in Commodity Industries 

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

New York Regional Outlook 7 Third Quarter 1999 
In Focus This Quarter
 

Effects on Local Economies and 

the Banks That Operate in Them 

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

heavily on these sectors for employment and income. In 

the 1980s, problems in the agricultural and oil sectors 

kicked off a “rolling recession” that spread through the 

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

to the failure of hundreds of FDIC-insured banks 

between 1984 and 1990.9 Similarly, declining oil prices 

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

insured banks and thrifts in Texas, Oklahoma, 

Louisiana, and other states, while the attempts of some 

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

problems can affect local economies and bank credit 

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

significant lag between the onset of industry-sector 

problems and the emergence of performance problems 

9 Federal Deposit Insurance Corporation, Division of Research and
 

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

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


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

index.html.
 

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


and 9.
 

TABLE 1 

in the banking industry. Although banks with direct 

credit exposures to a troubled industry are likely to be 

affected first, virtually all banks that operate in areas 

that are heavily dependent on a troubled sector will 

eventually have to contend with the indirect effects on 

the local economy. 

To evaluate the extent of local economic effects that 

might have resulted from the recent adverse trends in 

the commodity industries, we have conducted analysis 

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

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

might be affected by these trends; instead, this analysis 

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

commodity industries and determines if these counties 

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

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

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

moderately lower job growth and higher unemployment 

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

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

86,055 for all U.S. counties. 

U.S. Counties Most Concentrated in Commodity Industries 

by 1998 Payroll Employment 

NUMBER OF 

PERCENT OF COUNTIES WITH 

1998 COUNTY EMPLOYMENT 

EMPLOYMENT IN CONCENTRATION STATES WITH THE MOST 

THE INDUSTRY IN 1998 DESIGNATED COUNTIES 

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

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

OIL AND GAS >5 83 TX, OK, LA 

CHEMICALS >5 46 TN, IL, NC, TX 

STEEL >5 70 KY, OH, AR, IN 

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

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

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

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

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

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

New York Regional Outlook 8 Third Quarter 1999 
In Focus This Quarter
 

TABLE 2 

Relative Economic Performance of Counties 

Most Concentrated in Commodity Industries 

1998 AVERAGE 1998 AVERAGE 

EMPLOYMENT GROWTH (%) UNEMPLOYMENT RATE (%) 

AGRICULTURE 1.1 4.8 

LUMBER AND PAPER 1.3 6.9 

OIL AND GAS 1.4 5.6 

CHEMICALS 1.3 6.0 

STEEL 1.7 5.6 

AUTOS 1.8 4.4 

TEXTILES 0.9 5.1 

ELECTRONICS AND SEMICONDUCTORS 1.9 3.7 

Any Commodity Industry 1.3 5.5 

All U.S. Counties 1.6 5.1 

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

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

decades. On the whole, the economic picture did not 

noticeably deteriorate in 1998 for the concentrated 

counties. Average unemployment declined in 1998 for 

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

counties except textile counties. These data indicate that 

while recent problems in the commodity industries 

might be having severe effects in specific areas, these 

problems had not translated into a broader weakening of 

economic performance through the end of 1998. 

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

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

thrifts identified as having at least 25 percent of their 

deposits in at least one of the concentrated counties as 

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

for concentrated counties overall was higher than the 

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

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

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

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

in one or more concentrated counties and meeting all the selection 

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

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

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

indicate that institutions operating in agricultural and 

oil and gas counties tend to have more problem credits 

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

December 1998, the average noncurrent loan ratio 

jumped from 4.8 percent to 6.1 percent for institutions 

operating in agricultural counties, while the average 

ratio rose from 2.7 percent to 3.8 percent for institutions 

operating in oil and gas counties. 

These results indicate that while profitability in 1998 

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

rise in agricultural and oil and gas counties. However, 

because this analysis relies on annual data that extend 

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

test for the local effects of problems in the commodity 

industries. There is every reason to expect these credit 

problems to intensify over time if commodity prices 

remain low.14 These considerations suggest that bankers 

in commodity-dependent counties should continually 

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

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

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

14 For more information on how the agricultural outlook could affect 

FDIC-insured institutions, see the statement of FDIC Chairman 

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

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

speeches/99spchs/spc13apr.html. 

New York Regional Outlook 9 Third Quarter 1999 
In Focus This Quarter
 

TABLE 3 

Relative Financial Performance of Insured Institutions Operating in Counties 

Most Concentrated in Commodity Industries 

NUMBER OF AVERAGE C&I AVERAGE AVERAGE NET 

BANKS WITH AT LOANS PAST DUE NONCURRENT C&I LOAN 

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

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

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

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

AGRICULTURE 416 5.08 6.12 1.58 1.16 

LUMBER AND PAPER 465 3.38 1.89 0.78 1.21 

OIL AND GAS 163 3.44 3.78 1.18 1.29 

CHEMICALS 81 2.47 2.97 0.79 1.18 

STEEL 186 2.53 2.06 0.59 1.08 

AUTOS 341 2.64 2.05 0.66 1.12 

TEXTILES 264 2.91 1.92 0.70 1.10 

ELECTRONICS AND 

SEMICONDUCTORS 107 2.71 2.36 0.68 0.87 

Any Commodity 

Industry 1,915 3.39 3.03 0.93 1.13 

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

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


C&I = Commercial and industrial.
 

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

Information System)
 

monitor their local economy for signs of stress related 

to problems in the commodity industries. 

Conclusion 

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

declining prices. This problem is not solely the result of 

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

stress among firms in these industries are apparent in 

the form of declining levels of employment and slow or 

negative profit growth. However, there are few signs to 

date of any disorderly industry shakeouts involving 

widespread business bankruptcies and losses to lenders. 

Thus far, most firms have managed to cope with 

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

associated with commodity industries may be on the 

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

dependent on these industries showed few signs of a 

widespread deterioration in the performance of their 

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

are signs of rising credit losses among local depository 

institutions in counties with the highest concentrations 

of agriculture and oil and gas extraction. A continuation 

of today’s weak pricing picture in these industries has 

the potential to result in higher credit losses for insured 

institutions during the next few years. 

Richard A. Brown, Chief, 

Economic and Market Trends Section 

Alan Deaton, Economic Analyst 

New York Regional Outlook 10 Third Quarter 1999 
In Focus This Quarter
 

Shifting Funding Trends Pose Challenges 


for Community Banks 


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

asset growth with deposits in today’s marketplace. 

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

sources to meet loan demand. 

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

that have historically relied upon deposits for 

funding and net interest revenues for profitability. 

For the past few years, assets have been expanding 

faster than deposits at many commercial banks. The 

result is an increased reliance on equity and borrowings 

for funding. Since 1992, commercial bank assets have 

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

deposits. Traditional measures of liquidity and funding 

for commercial banks reflected record-low levels of 

deposit funding at year-end 1998. Large commercial 

banks have traditionally made greater use of nondeposit 

funding alternatives. However, many community 

banks,1 which have typically relied more on deposit 

funding, may face liability management challenges as a 

result of shifting funding trends. This article surveys the 

factors influencing the ability of banks to fund loan 

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

trends for community banks. 

Factors Influencing Deposit Funding Trends 

The percentage of commercial bank assets, particularly 

loans, funded with deposits has declined steadily in the 

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

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

level of these industry ratios is heavily influenced by 

larger banks, the trend toward lower deposit funding 

exists for both large banks and community banks and 

points to secular factors that are affecting banks’ ability 

to raise deposits in step with asset growth. 

Trends in Household Wealth Accumulation 

One factor affecting the ability of banks to attract 

deposits is the recent trend in the way households are 

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

capital gains on housing and investments, annual net 

purchases of new financial assets2 by households as a 

percentage of disposable income have actually trended 

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

A falling personal savings rate and fewer purchases of 

financial assets may suggest that households are more 

comfortable consuming a higher percentage of current 

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

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

deposits has been growing more slowly. 

Higher-Yielding Investment Alternatives 

At the same time that households have been setting 

aside less of their current income for savings, the share 

of total new household savings flowing into bank 

deposits has declined in the 1990s as competition from 

higher-yielding alternatives has increased. During the 

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

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

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

CHART 1 

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

Ratios Reflect Reduced Deposit


 Funding for Commercial Banks
 

Recession 

Ratio (%) Deposit-to-Asset Ratio 

90 

85 

80
 

75
 

70
 

65
 

60
 

55
 

50
 

Loan-to-Deposit Ratio 

’70 ’74 ’78 ’82 ’86 ’90 ’94 ’98 

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

New York Regional Outlook 11	 Third Quarter 1999 
In Focus This Quarter
 

CHART 2 

Total Annual Additions* to Financial Assets 

of Households and Nonprofit Organizations 

Have Declined with Personal Savings Rate 

Percentage of Disposable 

Personal Income 

Net Acquisition 

15 

10 

5 

0 

20 

of Financial Assets 

Personal Savings 

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

* Excludes capital gains 

Sources: Federal Reserve Board; Flow of Funds 

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

has flowed into deposits during the 1990s, although an 

increasing proportion has been allocated to deposits in 

recent years. 

Not only do banks face intensifying competition from 

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

respondents in Grant Thornton’s 1999 Sixth Annual 

Survey of Community Bank Executives,3 but they also 

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

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

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

CHART 3 

face increasing competition from mutual funds and 

other nonbank financial service providers, such as credit unions. 

Mutual Funds. Increasingly, consumers are pursuing 

higher yields by investing in mutual funds. Beyond 

yields, however, many mutual fund companies also are 

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

check writing, automated teller machine cards, and 

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

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

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

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

prices, other measures indicate a shifting preference for 

mutual funds as a savings vehicle. For example, data 

from the Investment Company Institute show that net 

inflows into mutual funds have exceeded net increases 

in insured institution deposit accounts in all but three 

quarters during this economic expansion. Moreover, the 

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

increases in deposits for all FDIC-insured institutions. 

Credit Unions. In addition to mutual funds, credit 

unions also are formidable competitors for consumer 

savings. Membership in credit unions has increased 

more than 20 percent over the past decade, while 

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

1990 1998 

U.S. Government 

Securities
 

7%
 

Equities, Bonds, 

and 

Commercial 

Paper 44% 

Money Market 

Fund Shares 

5% 

Mutual Fund
 

Shares
 

6%
 

Bank Deposits 

(excl. Foreign) 

38% 

Money Market Mutual Fund 

Fund Shares Shares 

7% 22% 

Equities, Bonds, Bank Deposits 

and Commercial (excl. Foreign) 

Paper 35% 30% 

U.S. Government 

Securities
 

6%
 

Source: Federal Reserve Board 

New York Regional Outlook 12 Third Quarter 1999 
In Focus This Quarter
 

cent.4 Credit unions also offer federal insurance on share 

accounts as well as competitive rates on comparable 

deposit-type vehicles relative to other types of financial 

institutions. For example, according to information from 

the National Credit Union Association, on average, 

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

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

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

certificates over the 12 months ending May 1999 were 

consistently higher than rates offered by banks or thrifts 

and approached retail rates offered by brokerages. 

Demographic Shifts 

Some analysts maintain that rural community banks 

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

of Kansas City, rural bankers perceive that sluggish 

deposit growth is at least partially attributable to the 

migration of deposits to cities as urban-dwelling heirs 

of rural depositors relocate funds. While evidence for 

this deposit migration remains anecdotal, economists at 

the Federal Reserve Bank of Kansas City indicate that 

the demographic shift is still in process, and its full 

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

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

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

CHART 4 

Bank One-Year CD Rates Have Recently Lagged
 

Those Offered by Competitors
 

Average Retail Rates Offered for 

One-Year Certificates (%) 

6.0 

3.0 

3.5 

4.0 

4.5 

5.0 

5.5 

Thrifts 

Credit Unions 

Banks 

Brokerages 

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

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

Sources: BanxQuote and Bank Rate Monitor 

savings in banks than their rural counterparts do.5 This 

trend poses additional consequences for bank deposits 

as rural populations migrate to suburban areas. 

Community Bank Funding Trends 

Community banks traditionally rely more heavily upon 

core deposit funding than larger banks do. For example, 

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

community bank assets were funded with core deposits 

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

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

deposits. This difference in liability structures reflects 

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

While large banks have responded to factors influencing deposit 

growth by making greater use of 

alternative funding sources, 

funding options for community 

banks tend to be more limited. 

Because of high fixed costs, community banks may find 

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

“Industry Consolidation Presents Unique Risks and 

Challenges for Community Banks,” Regional Outlook, 

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

The need to augment lagging deposit growth to meet 

loan demand has led many community banks to acquire 

more noncore funds. These funds include time deposits 

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

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

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

banks exceeded that threshold. Moreover, over the same 

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

as total deposits less time deposits greater than 

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

community banks declined each quarter. 

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

Rural Banks Facing Increased Funding Pressures? Evidence from 

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

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

New York Regional Outlook 13 Third Quarter 1999 
In Focus This Quarter
 

CHART 5 

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

Large Banks Community Banks 

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

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

Source: Bank Call Reports (Research Information System) 

Other 

Domestic 

Deposits 

7% 

Borrowings 

16% 

Other 

Liabilities 

12% 

Equity and 

Subordinated 

Debt 

9% 

Core 

Deposits 

43% 

Foreign 

Deposits 

13% 

Other Domestic 

Deposits 

11% 

Borrowings 

6% 

Other 

Liabilities 

1% 

Equity and 

Subordinated Debt 

10% 

Core 

Deposits 

72% 

As community banks’ use of noncore funds has 

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

demand notes, and mortgages (collectively referred to 

as borrowings). After adjusting for mergers, borrowings 

funded 12 percent of new community bank asset growth 

from 1992 through 1998—three times more than the 

percentage of new asset growth funded by borrowings 

from 1985 to 1990. Possibly reflecting a shift toward 

greater acceptance of wholesale funding by community 

bankers, growth in borrowings has been largely driven 

by increased use of nonovernight borrowings,6 which 

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

community banks reporting nonovernight borrowings 

has doubled in the 1990s. This trend coincides with 

growing community bank membership in the Federal 

Home Loan Bank (FHLB) system and increasing use of 

FHLB borrowings. 

Federal Home Loan Bank Membership 

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

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

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

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

advances outstanding for community banks grew by 

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

6 Nonovernight borrowings are defined here as all borrowings other 

than federal funds purchased and repurchase agreements. 

FHLB advances represented approximately 80 percent 

of all nonovernight borrowings for community banks. 

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

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

growth, and leverage capital to maintain or boost 

returns on equity. Recent surveys indicate that FHLB 

advances will continue to have a role in community 

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

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

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

advances in 1999. Similarly, the American Bankers 

Association’s 1999 Community Bank Competitiveness 

CHART 6 

’97 

0 

10 

20 

30 

40 

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

The Percentage of Community Banks Reporting 

Nonovernight Borrowings* Is Rising 

Community Banks 

Reporting Nonovernight 

Borrowings (%) 

* Includes all borrowings other than federal funds purchased and repurchase 

agreements 

Source: Bank Call Reports (FDIC Research Information System) 

New York Regional Outlook 14 Third Quarter 1999 
In Focus This Quarter
 

Survey7 reported that FHLB advances are the preferred 

nontraditional funding product. In addition, legislative 

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

$500 million, significantly increasing access to FHLB 

advances for smaller banks in rural areas. 

Implications of Funding Trends 

for Community Banks 

According to community banker opinion surveys, the 

trend toward greater reliance on noncore or alternative 

funding sources appears likely to continue. Grant 

Thornton’s 1999 Annual Survey of Community Bank 

Executives found that 75 percent of community bankers 

expect funding with core deposits to be more difficult in 

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

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

funding from deposits five years from now. Liability 

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

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

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

asset growth and net interest income for profitability. 

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

associated with wholesale funding sources. As shown in 

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

repurchase agreements, subordinated notes, and FHLB 

advances, have traditionally exceeded the interest cost 

of core deposits for commercial banks. Therefore, as 

institutions that have typically relied upon core deposits 

increase the use of nondeposit sources, funding costs 

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

interest margins (NIMs) may be pressured. 

To some extent bank managers may be able to offset the 

higher interest costs of wholesale funding strategy by 

improving efficiency through greater management of 

overhead expenses and increases in noninterest income. 

However, community banks face challenges to their 

ability to increase noninterest income (see “Industry 

Consolidation Presents Unique Risks and Challenges 

CHART 7 

Subordinated Debt 

FHLB Advances 

0 

1 

2 

3 

4 

5 

6 

7 

8 

’93 ’94 ’95 ’96 ’97 ’98 

Reported Interest Cost for Commercial Banks (%) 

Nondeposit Alternatives Have Typically Cost 

More than Core Deposits 

Federal Funds 

Core Deposits* 

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

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

deposits greater than $100,000. 

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

Home Loan Bank (FHLB) System Annual Reports 

’ 

for Community Banks,” Regional Outlook, Fourth 

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

banks are unable to fully offset higher funding costs 

with increases in noninterest income or reductions in 

noninterest expenses, overall profitability could suffer. 

Community bankers in the upper Midwest expressed 

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

percent of respondents expect the shift away from 

deposit funding to decrease bank profitability.8 As bank 

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

increase asset yields by pursuing additional portfolio 

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

higher asset yields. 

Funding challenges also could alter the liquidity and 

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

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

liquidity strains or exposures to changing interest rate 

environments. Strategies that result in the pledging of 

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

adversely affect a bank’s relative liquidity or interest 

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

nondeposit funding sources. For instance, some FHLB 

advances may contain embedded options that required 

greater expertise and attention to policies and practices 

that, if not managed properly, could lead to undesirable 

outcomes if interest rates change adversely. 

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

New York Regional Outlook 15 Third Quarter 1999 
In Focus This Quarter
 

Differences between Community Banks with 

High and Low Levels of Core Deposit Funding 

To evaluate how a shift from a core deposit funding 

strategy might change the profile of a community bank, 

TABLE 1 

performance and condition measures for community 

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

funding. Table 1 compares 1998 funding, earnings, and 

asset performance measures for these community bank 

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

ALL COMMUNITY BANK COMMUNITY BANK 

COMMUNITY BANKS1 AGRICULTURAL LENDERS2 COMMERCIAL LENDERS3 

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

DEPOSIT DEPOSIT DEPOSIT DEPOSIT DEPOSIT DEPOSIT 

FUNDING4 FUNDING4 FUNDING FUNDING FUNDING FUNDING 

Selected Aggregate Measures 

NUMBER OF BANKS IN GROUP 405 405 106 51 126 185 

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

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

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

Selected Median Liquidity and Funding Measures (%) 

1998 GROWTH IN TOTAL ASSETS 9.02 11.16 5.96 6.42 12.75 18.50 

1998 GROWTH IN TOTAL DEPOSITS 9.74 8.79 6.40 5.31 13.56 11.93 

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

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

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

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

BORROWINGS TO TOTAL ASSETS RATIO 0 9.58 0 4.15 0 8.55 

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

Selected Median Performance Ratios (%) 

RETURN ON EQUITY 12.65 10.19 11.10 10.93 14.49 9.52 

RETURN ON ASSETS 1.07 1.04 1.01 1.19 1.10 0.92 

NET INTEREST MARGIN 4.76 4.03 4.51 3.98 5.25 4.22 

GROSS EARNING ASSET YIELD5 8.17 8.02 8.24 7.89 8.45 8.26 

COST OF FUNDING EARNING ASSETS6 3.33 4.07 3.74 4.05 3.21 4.05 

NONINTEREST INCOME TO AVERAGE ASSETS 0.76 0.61 0.59 0.44 1.01 0.64 

NONINTEREST EXPENSE TO AVERAGE ASSETS 3.49 2.90 3.23 2.40 3.99 3.12 

EFFICIENCY RATIO7 69.01 63.68 68.59 57.48 68.99 67.00 

Selected Median Credit Quality Measures (%) 

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

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

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

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

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

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

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

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

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

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

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

of all community banks.
 

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

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

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

FHLB = Federal Home Loan Bank
 

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


New York Regional Outlook 16 Third Quarter 1999 
In Focus This Quarter
 

groups. High core deposit funders are defined as those 

community banks with core deposit-to-asset ratios in 

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

1998. Low core deposit funders are those community 

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

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

combined make up roughly 60 percent of each of the 

total community bank funding groups. 

This comparison reveals several differences. First, a 

tradeoff between heavy reliance on core funding and 

asset growth is evident. Median measures for the groups 

indicate that the typical bank that relies less on core 

deposit funding is larger and growing faster than the 

typical bank in the high core funding group. Second, 

less core deposit funding appears to be associated with 

a lower NIM, primarily the result of higher funding 

costs. However, overall profitability 

is similar between the groups 

mainly because of a lower ratio 

of overhead expenses to average assets for the low core 

funders. These characteristics are also evident across 

the agricultural and commercial specialists groups. 

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

higher asset yields resulting from increased portfolio 

risk are not evident, median measures for each low core 

funding group reflect higher levels of noncurrent loans 

and higher growth in nonperforming assets and net loan 

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

greater than 25 percent. 

part. For example, the median growth in nonperforming 

assets for commercial lending specialists with less 

reliance upon core deposits was nearly 24 percent in 

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

Summary and Conclusions 

Commercial banks have been experiencing a long-term 

trend toward lower deposit funding of loans and assets. 

Increasing competition among banks and from thrifts, 

nonbanks, and higher-yielding investment alternatives 

has made it more difficult and expensive for some 

banks to attract deposits in step with asset growth. 

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

(especially those located in areas characterized by 

aggressive competition and slow deposit growth), better 

matching of asset cash flows, and greater flexibility in 

asset-liability management, they also may pose certain 

risks. To some extent community banks may be able to 

manage noninterest expense and noninterest income to 

offset the relative increase in interest expense incurred 

to acquire nondeposit funding sources. However, if 

overall profitability suffers, banks may be tempted to 

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

may become more challenging for community banks 

that have historically relied upon deposits for funding 

and net interest revenues for profitability. In addition, 

the complexity of some nondeposit funding sources 

requires greater expertise and attention to policies and 

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

Allen Puwalski, Senior Financial Analyst 

Brian Kenner, Financial Analyst 

New York Regional Outlook 17 Third Quarter 1999 
Regional Perspectives
 

Regional Perspectives
 

• The Region’s growing economy has stimulated strong and sustained employment growth; unemployment 

rates in many counties are at their lowest points in this decade. 

•	 Financial institutions in the Region continue to report healthy financial conditions, although the variability 

of earnings across institutions is increasing. 

•	 Key industries in the Region, such as chemicals, gaming, health care, and steel, face growing risks because 

of industry consolidation, reduced demand for exports, and stiffer competition. 

•	 Consistent with national trends, the Region’s financial institutions are relying less on core deposits and 

more on alternative sources of funding. While this practice may have some benefits, it does raise some new 

issues regarding asset and liability management. 

Overview of Economic Conditions
 

Employment Levels Continue to Rise 

With the nation and Region enjoying rapid economic 

growth, employment levels in the Region continue to 

rise. Between the first quarters of 1998 and 1999, 

337,000 new jobs were added to the Region’s employment base, a growth rate of 1.7 percent. Although 

employment levels in the nation rose at a somewhat 

faster 2.2 percent rate over the same time, this period 

marked more than six consecutive years of job growth 

in the Region (see Chart 1). Delaware remains the 

fastest-growing state in the Region, adding jobs primarily in the finance and business service sectors. Between 

CHART 1 

Employment Has Grown in the Region 

for More than Six Straight Years 

’90 

4 

3 

2 

1 

0 

–1 

–2 

–3 

–4 

’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 

Percent 

Change 

* 1999 represents the first quarter only. 

Source: Bureau of Labor Statistics 

U.S. Region

’99* 

the first quarters of 1998 and 1999, employment levels 

in Delaware rose 3.4 percent. Job growth in Pennsylvania, at 1.2 percent, was the slowest among the states 

in the Region. Its employment growth has been sluggish for the past two years, perhaps partially because of 

continued consolidation in the manufacturing sector as 

well as weak population growth in the northern and 

western parts of the state. Year-over-year employment 

growth rates in Maryland, New Jersey, and New York 

ranged between 1.8 percent and 2.5 percent as of 

March 31, 1999, reflecting gains in business services 

and technology-related industries. 

In contrast to the mainland economies, employment in 

Puerto Rico declined from the first quarter of 1998 to 

the first quarter of 1999. Figures from the Bureau of 

Labor Statistics show that employment levels fell by 

over 7,000 jobs, about 1 percent, over that period. 

Employment growth has been hindered by the gradual 

phase-out of tax provisions favorable to investment, 

which, in turn, has resulted in declines in manufacturing 

and local government employment. Nonetheless, Puerto 

Rico’s 13 percent unemployment rate was the lowest in 

the decade, although it was still substantially higher 

than the national average. 

Rising employment levels have driven many state 

unemployment rates down to their lowest points in the 

decade. Except for New York, unemployment rates for 

all the Region’s states were at or below the U.S. average 

in the first quarter of 1999. Most counties surrounding 

New York Regional Outlook 18	 Third Quarter 1999 
Regional Perspectives
 

the Region’s major eastern cities had lower unemployment rates than the U.S. average (see Map 1). Counties 

in eastern New York, southeastern Pennsylvania, western New Jersey, central Maryland, and northern 

Delaware have experienced very strong job growth over 

the past several years. These counties enjoy unemployment rates below 3 percent and are considered to be at 

full employment levels, leading to some reports of labor 

shortages. Apparently, counties surrounding, but still 

anchored to, the central cities have benefited more than 

outlying counties from the economic expansion. The 

former generally offer lower business costs, more land, 

and less congestion than the cities, yet they are close 

enough to access the cities’ large populations, port facilities, and business markets. 

Unemployment rates generally are higher in areas that 

are more reliant on manufacturing industries. 

Economies in many parts of northern and western New 

York and Pennsylvania are dependent on industries such 

as apparel and textiles, which have been consolidating 

and relocating to lower-cost areas for many years. More 

recently, manufacturers in the Region have been slowed 

by the economic recessions in Asia and Latin America 

as well as Europe’s weak economy. This combination of 

factors has hampered employment growth where these 

industries are concentrated. 

The Stronger Economy Has 

Boosted the Housing Market 

After several years of little activity, the stronger economy and job expansion coupled with low mortgage rates 

and rising consumer confidence have stimulated the 

housing markets in many parts of the Region. Most 

notable is Maryland, where existing home sales surged 

almost 28 percent in 1998, compared with the 14 percent national average. New Jersey experienced a 13 percent gain and New York a 9 percent gain. Pennsylvania 

trailed with only a 1 percent gain. The positive economic conditions also have boosted new construction of 

single-family units. Nationally, the number of permits 

for new single-family homes rose 12 percent in 1998. 

In the Region, the number of permits for new singleMAP 1 

Tightest Labor Markets Surround 

Major Eastern Cities 

Lower unemployment rates than 

U.S. average 

Higher unemployment rates than 

U.S. average 

New York City 

Philadelphia 

Baltimore 

Washington, DC 

Source: Bureau of Labor Statistics 

family homes also rose 12 percent, with the largest gain 

(17 percent) occurring in New York. Permit data for 

single-family homes can change quickly over a year and 

are sensitive to changes in interest rates, employment, 

and weather conditions. Nonetheless, first-quarter 1999 

data show a continuation of these positive trends. 

Housing prices across the Region also have risen, 

reflecting strong demand. According to the Office of 

Federal Enterprise Housing Oversight, housing prices 

in the Region’s states rose by 2 to 5 percent between 

the fourth quarters of 1997 and 1998. The hottest markets were in Long Island, where price increases were 

in the double digits in the fourth quarter of 1998 and 

the first quarter of 1999, and Bergen and Passaic 

counties in New Jersey.1 Houses in upstate New York, 

particularly around Buffalo, Rochester, and Syracuse, 

have experienced less price appreciation. In general, 

however, the stronger housing market has boosted 

demand for new home mortgages, refinancings, and 

home equity loans and has been positive news for 

insured financial institutions. 

1 Data provided by National Association of Realtors. 

New York Regional Outlook 19 Third Quarter 1999 
Regional Perspectives
 

Bank Performance Remains Strong, but Earnings Variability Is Increasing
 

The Region’s Banks and Thrifts Continue to 

Report Healthy Financial Conditions 

The Region’s banks and thrifts reported generally 

healthy financial conditions in the first quarter of 1999. 

The Region’s average return on assets (ROA) was 0.94 

percent, compared with 1.06 percent in the first quarter 

of 1998 and 0.88 percent in the first quarter of 1997. 

The average net interest margin (NIM) declined to 3.91 

percent in the first quarter of 1999, compared with 4.10 

percent a year earlier and 4.21 percent two years earlier. 

The average reported leverage capital ratio remained 

strong, rising 90 basis points over the first-quarter 1998 

figure. Aggregate past-due ratios continued to decline, 

reflecting improvement in almost all loan categories, 

with the exception of commercial and industrial loans 

and credit card loans, which both saw a modest rise in 

past-due levels from year-earlier figures. Credit card 

portfolios, which recently have had the highest past-due 

and charge-off rates, registered a slight rise in aggregate 

past-due rates from year-earlier levels. Charge-offs on 

credit card loans were 4.68 percent in the first quarter of 

1999, the second quarter in a row and only the second 

time since December 31, 1996, that the figure was 

below 5.0 percent. However, the rise in past-dues, 

although slight, suggests that charge-off levels are 

unlikely to fall significantly over the next few quarters. 

Community banks (or small banks, defined here as 

banks with total assets less than $250 million), which 

make up more than half of the Region’s banks, reported 

lower average ROA numbers than their larger counterparts (see Chart 2). In the first quarter of 1999, community banks had an average ROA of 0.68 percent, 

compared with 1.24 percent for larger institutions. 

Community bank figures are affected by the lower average ROAs of savings institutions (0.63 percent) and new 

banks (negative 2.05 percent). When new banks are 

excluded,2 the average ROA for community banks 

improves to 0.94 percent, which is still 30 basis points 

lower than that of larger banks, but again is negatively 

affected by savings institutions. Although all banks have 

faced narrowing interest margins in the past few years, 

community banks have less noninterest revenue to bolster the bottom line. Further, community banks’ 

expenses as a percentage of earning assets are higher 

than those of larger institutions. These factors result in 

2 New banks are defined as banks that have been insured within the 

last three calendar years, i.e., that opened on or after January 1, 1996. 

CHART 2 

Source: Bank and Thrift Call Reports. Data as of March 31, 1999. 

Small Banks Underperform Larger Ones 

6 

5 

4 

3 

2 

1 

0 

Return 

on 

Assets 

Percent 

Banks with assets 

over $250M 

Banks with assets 

under $250M 

Net 

Interest 

Margin 

Noninterest 

Income/ 

Earning 

Assets 

Noninterest 

Expense/ 

Earning 

Assets 

poorer efficiency ratios3 for community banks and hinder earnings performance. For more information on the 

challenges facing community banks, see Community 

Banks Hurt by Tighter Margins, Higher Costs in the 

New York Regional Outlook, Fourth Quarter 1998. 

Earnings Variability Is Increasing 

The stable aggregate profitability reported over the past 

several years masks an increasing variation in profitability among the Region’s financial institutions. In 

the past five years, the Region’s median ROA, excluding outliers,4 has shown little fluctuation, ranging from 

0.94 percent to 1.03 percent. However, the variation in 

profitability across the Region’s institutions, as measured by the distribution of ROAs at various points in 

time, is at its widest since 1991 (see Chart 3). In 1996, 

when the distribution showed the lowest variability, 

ROAs ranged from negative 0.52 percent to 2.41 percent. As of March 31, 1999, ROAs ranged from negative 

2.57 percent to 2.76 percent. 

Among many factors that could be influencing the 

increasing dispersion of ROA figures, one is the growing number of new banks in the Region. New banks 

3 The efficiency ratio is defined as noninterest expense divided by the 

sum of net interest income and noninterest income. 

4 This analysis excludes the top and bottom 2.5 percent of banks with 

the highest and lowest ROAs, which are considered outliers that 

would unduly skew the analysis. They are excluded from all analyses 

in this section unless specifically noted. 

New York Regional Outlook 20 Third Quarter 1999 
Regional Perspectives
 

CHART 3 all community banks (intense competition and narrowROA Variability in the Region Increases 

Percent 

4
 

3
 

2
 

1
 

0
 

–1
 

–2
 

–3
 

–4
 

–5
 

Median 

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

Source: Bank and Thrift Call Reports. Data are for March 31 of each year. 

typically show weaker earnings performance in their 

formative years because of high initial start-up costs relative to their small asset base. In the first quarter of 

1999, new banks made up 3.4 percent of all banks in the 

Region, compared with an average of 1.7 percent in the 

previous five years (see Table 1). Further, these new 

banks are underperforming new banks of past years. 

The increased number of new banks (especially the 

number of banks that are less than a year old) and their 

poorer performance skews the group’s performance 

downward. For example, 52 percent of new banks had 

negative ROAs in the first quarter of 1999, compared 

with an average of 13 percent of new banks over the previous five years. New banks made up 41 percent of all 

banks with negative ROAs as of March 31, 1999, compared with an average of 10 percent in the five previous 

years. Also, 86 percent of new banks have ROAs below 

the median for the Region, which is significantly higher than in prior years. The sheer volume of start-ups, 

which have always faced significant initial costs but 

must now deal with additional pressures experienced by 

TABLE 1 

ing NIMs), may partly explain the increased variation in 

profitability. 

Another reason for the Region’s increasing dispersion 

of earnings is the relatively poorer recent performance 

of established community banks (banks more than three 

years old with assets under $250 million). Excluding 

the new banks, 82 percent of the Region’s banks that 

had negative ROAs were community banks. This figure 

compares with 52 percent in 1994 and 73 percent in 

1996. 

Comparing the established small banks with negative 

ROAs in 1996 with those in 1999 sheds some light on 

the difficulties facing smaller institutions today. In the 

first quarter of 1996, the average ROA for this group 

was negative 0.21 percent. In the first quarter of 1999, 

the average ROA for the group was negative 0.78 percent. Over that period, average NIMs fell from 4.04 percent to 3.44 percent, primarily because of a decline in 

interest income. The group experienced a decrease in 

the ratio of interest income to earning assets of over 50 

basis points, while the average cost of funds increased 

slightly. Further, although noninterest income has been 

rising, noninterest expenses have been rising even 

faster, hurting efficiency ratios. 

The number of unprofitable institutions appears to be 

rising despite generally favorable economic conditions 

and a lack of higher loan loss provisions. The relatively 

flat yield curve during 1998 and fierce industry competition combined have resulted in slimmer margins and 

weaker efficiency ratios. This situation at least partly 

explains why the range of profitability is increasing and, 

in particular, why earnings at the poorest-performing 

institutions have weakened further. 

The Influx of New Banks* May Be Affecting the Region’s ROA Variability 

PERCENTAGE OF: 1994 1995 1996 1997 1998 1999 

NEW BANKS TO TOTAL BANKS 1.3 1.5 1.7 2.3 1.8 3.4 

NEW BANKS WITH NEGATIVE ROAS 14.0 13.0 12.0 5.0 19.0 52.0 

BANKS WITH NEGATIVE ROAS 

THAT ARE NEW BANKS 8.0 10.0 9.0 8.0 17.0 41.0 

NEW BANKS THAT HAVE ROAS 

BELOW THE MEDIAN ROA 50.0 56.0 71.0 52.0 50.0 86.0 

* New banks are defined as banks that opened within the previous three calendar years from the date shown.
 

Note: All data are as of March 31 of the year indicated.
 

Source: Bank and Thrift Call Reports
 

New York Regional Outlook 21 Third Quarter 1999 
Regional Perspectives
 

The major concern for regulators is that insured institu- performing institutions are generally much better capitions may combat falling margins by employing riskier talized and burdened with fewer problem assets than 

funding and lending strategies. These concerns are mit- their counterparts of the 1980s. 

igated somewhat by the fact that today’s poorerKey Industries in the Region Face Growing Risks
 

In both the nation and the Region, several key industries, such as chemicals, gaming, health care, and steel, 

are facing increasing risks. Pricing pressures, heightened competition, and global economic forces affecting 

supply and demand are among the factors affecting 

these industries. See Falling Prices in Commodities 

and Manufacturing Pose Continuing Risks to Credit 

Quality for a detailed discussion of many of these risks. 

Chemicals 

According to Standard and Poor’s, the chemicals 

industry accounts for almost 12 percent of the value of 

all U.S. manufacturing and is its largest domestic 

exporting sector. The Region has 285,000 chemical 

industry jobs, more than one-fourth of the nation’s total 

employment in the industry. Delaware and New Jersey 

had the highest concentrations of chemical industry 

employment, at 5.5 percent and 2.5 percent of each 

state’s total employment, respectively, in 1998. These 

figures compare with less than 1 percent of total 

employment for the nation. 

Employment in the chemicals industry in Delaware has 

been declining since 1990, when it was almost 10 percent of the employment base. More recently, the industry has been vulnerable to declining exports and lower 

prices resulting from weak economies in Brazil and 

parts of Asia. This vulnerability has resulted in continuing consolidations and job restructurings. Just recently, 

DuPont announced layoffs because of pricing pressure 

and reduced demand. Although there is some evidence 

that the Asian and Brazilian economies are rebounding, 

chemical exports to those countries from the Region’s 

manufacturers are expected to remain weak in the near 

term.5 In addition, the chemicals industry, which uses 

5 Forecast by Standard and Poor’s. 

large amounts of oil and other petrochemical products, 

is vulnerable to rising oil prices. Any significant 

increases in energy expenses could pressure chemical 

producers to cut costs or consolidate further. 

Gaming Casinos 

Behind Nevada, New Jersey has the highest number of 

large casino-hotels in the nation. With 12 casino-hotels 

and 1.1 million square feet of casino space, the Atlantic 

City casino-hotel industry is the 

largest single contributor to the 

state’s tourist economy. In 1997, 

visitors spent $3.6 billion in 

Atlantic City’s casinos, 15 percent of all the state’s tourist dollars. In 1998, gaming revenues 

totaled $4 billion. 

Because of its reliance on casino activity, the outlook 

for the local economy is becoming increasingly unclear. 

Competition for the gambling dollar has intensified; 

Indian reservations in Connecticut, slot machines at 

racetracks in Delaware, gaming boats cruising from 

New York, and even the growth of Las Vegas all threaten Atlantic City’s prospects. Its heavy reliance on gambling means that Atlantic City is highly susceptible to an 

economic downturn, when spending on tourism and 

entertainment usually decline. 

Additionally, in spite of the boost to the local economy 

by area resorts, the growth in gaming activity has not 

brought substantial economic relief to the central city. 

Even though casino activity adds 48,000 jobs to Atlantic 

City’s economy, unemployment rates remain higher in 

Atlantic City than the rest of the state. Further, casino 

expansion, which helped the local construction industry 

in the past, slowed in 1998. City leaders hope that a 

New York Regional Outlook 22 Third Quarter 1999 
Regional Perspectives
 

combination of attractions will add to the gambling dollars and boost the local economy. Therefore, they plan 

to add hotel rooms, improve infrastructure and transportation, and build more tourist attractions and commercial facilities. 

Health Care 

The health care industry is the largest single component 

of the U.S. economy. The Health Care Financing 

Administration forecasts that spending on health care 

will rise from 13.6 percent of the gross domestic product to almost 17 percent within the next ten years. In 

recent years, the nation’s highly fragmented health care 

system has undergone major cost-containment and 

restructuring efforts. Nonetheless, in both the Region 

and the nation, health care employment had been a 

growing share of total employment, although in recent 

years growth has leveled off. Health care employment 

represents almost 8 percent of jobs in the nation and 

close to 9 percent in the Region. Employment concentrations higher than 8 percent are found in Maryland, 

New Jersey, New York, and especially Pennsylvania, 

where one out of every ten jobs is in health care. 

The health care sector continues to adjust to the challenges of managed care. With only about half of the 

population belonging to managed care plans, additional 

managed care growth is expected over the next decade. 

This factor, combined with continued pressure to lower 

prices and reduced government health benefits, is 

expected to pose increased risks for the industry. In July 

1998, Pennsylvania’s largest nonprofit health care system, the Allegheny Education and Research Foundation, 

filed for bankruptcy protection. The bankruptcy is troubling because it evidences the fragility of the health care 

system. More than half of New Jersey’s hospitals operated at a deficit in 1998, according to a survey by the 

New Jersey Hospital Association. Even the most fiscally fit medical centers are facing tightening revenues and 

escalating expenses. As a result, risks to the health care 

industry may increase for the foreseeable future. 

Steel 

Although positive revenue growth 

prevailed in the first half of 1998,6 the 

U.S. steel industry came under 

tremendous pressure in the second 

half. Depressed economic conditions 

in Latin America, Asia, and Russia led to a sharp 

increase in lower-priced imports from those regions and 

curtailed exports to them. As a result, prices fell, production dropped, and overcapacity increased. All told, 

higher foreign imports, lower exports, and the strike at 

General Motors lowered revenue and profits and 

sparked a round of downsizing in the industry. 

Almost 14 percent of the nation’s employees in the primary and fabricated metal industries (which include 

steel and aluminum production) are employed in the 

Region. Employment concentrations are highest in western Pennsylvania, the home of the USX-US Steel Group, 

the nation’s largest steel producer. While the number of 

employees in the metals industry has been declining 

since the mid-1970s, rates of decline slowed to a trickle 

in 1996 and 1997. Between the first quarters of 1998 and 

1999, however, employment levels were down 4.6 percent. The metals industry (specifically steel) is no longer 

the centerpiece of Pennsylvania’s economy; the service 

and finance sectors are far more important to the state’s 

employment base than during the heyday of the industry. 

Nonetheless, the industry still accounts for 3 percent of 

the state’s total employment, compared with 1.8 percent 

of the nation’s. 

U.S. steel companies face several risks that may continue to hurt their profitability and possibly result in 

additional cost-cutting efforts, consolidation, and downsizing, thereby threatening local economies of counties 

still dependent on steel production. Excess domestic and 

global capacity and weak currencies relative to the U.S. 

dollar in emerging markets could result in significant 

price pressures for some time to come. 

6 Standard and Poor’s. 

New York Regional Outlook 23 Third Quarter 1999 
Regional Perspectives
 

Banks’ Funding Sources Shift
 

Competition for consumers’ financial assets, both 

within the banking industry and from brokerages, 

insurance companies, and credit unions, has impeded 

core deposit growth. As consumers put more of their 

savings into stocks, mutual funds, and other higheryielding assets, the banking industry is faced with 

deposit growth that is lagging behind loan demand. As 

a result, alternative funding sources are becoming 

increasingly important (see Shifting Funding Trends 

Pose Challenges for Community Banks for detailed 

background information on national funding trends). 

Consistent with national trends, the Region’s banks 

have become more reliant on noncore deposits and 

other borrowings in this decade, a trend that is likely to 

continue as competition for financial assets intensifies. 

Large Banks Show Greater Shifts 

than Small Ones 

The Region’s average loan-to-deposit (LTD) ratio has 

not changed significantly in this decade. However, the 

LTD ratio for large banks (those with over $1 billion in 

total assets) has trended upward. Large banks reported 

an average LTD ratio of 101 percent on March 31, 1999, 

up from a low of 82 percent on March 31, 1992. Chart 

4 shows the change in the distribution of LTDs for large 

banks from March 31, 1992, to March 31, 1999. The 

percentage of large banks that have LTD ratios above 80 

percent has risen from 57 percent to 73 percent. 

The Region’s banks are relying less on core deposits7 

and more on other sources of funding (see Chart 5). 

Core deposits for all institutions in the Region totaled 

68 percent of assets on March 31, 1999, compared with 

a high of 77 percent in 1992 and 1993. Differences in 

the ratio of core deposits to assets between small and 

large institutions reflect the smaller banks’ traditional 

reliance on core deposits for funding, although that 

reliance is weakening. In large banks, the ratio of core 

deposits to assets was down to 52 percent on March 31, 

1999, compared with 64 percent in 1992. This ratio has 

fallen in smaller banks as well, but it still remains much 

higher than for larger banks. Small banks had an average ratio of 71 percent in the first quarter of 1999, down 

from a high of 80 percent in 1992. The most significant 

growth in noncore funding has come from borrowings, 

including Federal Home Loan Bank advances. 

Financial institutions also are relying more heavily on 

the capital markets as a source of funding. Large banks 

in particular have been using securitization as a financial management tool, although smaller banks are starting to tap the public markets as well. Consumer loans 

are the asset securitized most often; for example, in this 

7 While the distinction between core and noncore funding has become 

blurred, core deposits are still considered generally more stable than 

noncore funding. Core deposits are defined as the sum of Call Report 

items for demand deposits, all NOW and automatic transfer service 

accounts, money market deposit accounts, other savings, and time 

deposits under $100,000. 

CHART 4 CHART 5 

Large Banks Show Increase in 

Loan-to-Deposit Ratios 

60 

30 

25 

20 

15 

10 

5 

0 

% of Banks within Each Range 

80 100 120

Source: Bank and Thrift Call Reports for institutions with total assets over $1 billion. 

3/99 

40 

3/92 

Loan-to-Deposit Ratio Ranges (%) 

Funding Sources Shift 

% of Assets % of Assets 

26 78 

24 76 

22 

20 

74 

18 72 

16 70 

14 68 

12 

10 66 

8 64 

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

Note: Data are for March 31 of each year. 

Source: Bank and Thrift Call Reports. 

Noncore Funding 

(left axis) 

Core Deposits 

(right axis) 

New York Regional Outlook 24 Third Quarter 1999 
Regional Perspectives
 

Region, credit card securitizations reached $119 billion 

in the first quarter of 1999, up 54 percent from three 

years earlier. 

Implications 

Although the increasing availability of noncore funding 

sources may add more flexibility to banks’ asset and liability management strategies, such strategies could 

entail new risks. An analysis of banks that were heavy 

users of noncore funding8 from 1994 through 1998 

shows one possible drawback. Over the five-year 

period, this group had an average ratio of interest 

expenses as a percentage of earning assets that was 51 

basis points higher than that of the core users (those 

with a ratio of core deposits to liabilities greater than 70 

percent). This group offset the higher expenses with 

higher yields on earning assets, so that overall earnings 

performance (in terms of ROA) was comparable with 

that of the core users. Higher yields, however, could 

mean the banks are using riskier assets to improve their 

8 Heavy users of noncore funding are defined as banks, excluding new 

banks, with a ratio of noncore funding sources to total liabilities of 

greater than 30 percent. 

margins. Noncore users have much 

higher LTD ratios: over the same 

five years, LTD ratios for noncore 

users averaged 115 percent, versus 

70 percent for core users. Further, 

higher interest expenses could be 

worrisome if the current interest rate 

environment shifts. The potential for 

decreased profitability raises the concern that some 

institutions may respond by venturing into higher-risk 

business strategies. 

Banks may face other risks as they use more noncore 

funding sources. The reliance on capital markets and 

other public sources of funding exposes banks to 

increased market risk; they are likely to be more affected by changes in market sentiment and availability of 

funds. This situation makes it more difficult to manage 

bank balance sheets, since outside factors influence 

banks’ ability to execute planned strategies. Market 

forces could increase the volatility in funding and make 

management of liquidity and interest rate risk more difficult. In short, it is likely that as core deposits become 

more difficult to attract, the management of liquidity and 

interest rate risks will become increasingly important. 

The New York Region Staff 

New York Regional Outlook 25 Third Quarter 1999 
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