Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION SECOND QUARTER 2000 

FDIC
 

Memphis
 

Region
 

Division of
 

Insurance
 

Gary L. Beasley,
 

Regional Manager
 

Harry W. John,
 

Regional Economist
 

Robert L. Burns,
 

Senior Financial
 

Analyst
 

F. Miguel Hasty,
 

Financial Analyst
 

Regional Perspectives 

◆ Economic and Banking Conditions—Employment gains in 1999 were centered in the urban-based service sector with the rural-based manufacturing sector 

reporting job losses. See page 3. 

◆ Agriculture in the Mississippi Delta May Struggle—With a third consecutive year of low commodity prices, farm financial conditions in the Region may 

deteriorate. Farmers in the Mississippi Delta are expected to be among the most 

severely affected. See page 6. 

◆ Uncertainties Rise for the Region’s Tobacco Economy—Recent changes 

in the tobacco sector, primarily sharply lower demand, could affect farmers and 

communities dependent on tobacco production. See page 9. 

By the Memphis Region Staff 

In Focus This Quarter 

◆ Banking Risk in the New Economy—This article summarizes current economic conditions, with a primary focus on potential risks to insured depository 

institutions. It explores the implications of long-term trends that have led to the 

New Economy. Recent high rates of economic growth with low inflation have been 

made possible by increases in productivity arising from new technologies, higher 

investment spending by businesses, and large-scale industrial restructuring. Underlying these trends has been a financial environment that has largely accommodated 

the growing borrowing needs of consumers and businesses. Market-based financing, 

provided in large part through securitizations and mutual funds, has made capital 

readily available to start-up “new economy” firms as well as mature companies that 

seek to merge or restructure. Despite the clear benefits of market-based financing 

in supporting economic activity, there are also concerns. A recurrence of financial 

market turmoil, such as that experienced in fall 1998, has the potential to quickly 

change the currently positive economic outlook to one that is far more challenging. 

Detail is provided on commercial credit quality, market sources of revenue, and 

other risks to watch in banking. See page 15. 

By the Analysis Branch 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 as an information source on banking and economic issues for insured 

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

geographic regions: 

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

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

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

Dallas Region (CO, NM, OK, TX)
 

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

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

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

San Francisco Region (AK, 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. For 

more information or to provide comments or suggestions about the Memphis Region’s Regional 

Outlook, please call Gary Beasley at (901) 821-5234 or send an e-mail to gbeasley@fdic.gov. 

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

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

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

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

the Federal Deposit Insurance Corporation. 

Chairman Donna Tanoue 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Writer/Editor Kim E. Lowry 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Richard A. Brown 

Ronald L. Spieker 

Publications Manager Teresa J. Franks 
Regional Perspectives
 

Economic and Banking Conditions
 

•	 Although moderating, employment growth led to the lowest unemployment rate of the decade at year-end 

1999. 

•	 Urban areas are outperforming their rural counterparts on the strength of the services sector. 

•	 Banking conditions remain favorable; growth, although slowing, remains concentrated in commercial 

lending. 

Memphis Region’s Unemployment Rate 

Is the Lowest in a Decade 

The Memphis Region experienced generally favorable 

economic conditions during 1999, although employment growth lagged the nation for the fourth consecutive year, and some sectors outperformed others. The 

Region’s average unemployment rate of 4.5 percent in 

1999 is the lowest in a decade and only slightly above 

the national average of 4.2 percent. 

More than 130,000 new jobs were added to the Region’s 

workforce in 1999, an increase in total employment of 

1.5 percent. The services sector added more people to 

employment rolls than any other sector in the Region, 

followed by retail trade (see Chart 1). Growth in these 

sectors reflects the ongoing strength of the booming 

national economy and robust consumer spending. 

CHART 1 

Source: Bureau of Labor Statistics 

New Jobs in 1999 (000s) 

Job Gains Are Concentrated in the 

Services and Retail Trade Sectors 

–40 0 40 80 

Services 

Retail Trade 

Durable Goods 

Others 

Nondurable Goods 

–20 20 60 

The Region’s manufacturing sector lost jobs in 1999, 

with the decline in nondurable goods manufacturing 

continuing a longer-term trend (see Chart 2). Durable 

goods manufacturers continued to add jobs, benefiting 

from strong housing and commercial building markets. In addition, strong consumer spending stimulated 

the transportation equipment sector, boosting regional 

car, light truck, and auto parts producers. These gains 

were more than offset by weakness in nondurable manufacturing, however. In this segment, apparel and textile manufacturers accounted for more than one-third 

of all job losses, with chemicals and allied products 

and textile mill products companies accounting for a 

smaller share. Nondurable manufacturing job losses 

were concentrated in Tennessee, which accounted for 

over 50 percent of the decline in the Region’s total 

nondurable jobs, and to a lesser extent Kentucky and 

Mississippi. 

CHART 2 

Durable Manufacturing Gains Are Offset 

by Nondurable Losses 

1,000 

Durable Goods 

800 

600 

Nondurable Goods 

400 

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

Source: Bureau of Labor Statistics Number Employed (000s) 

Memphis Regional Outlook 3	 Second Quarter 2000 
Regional Perspectives
 

Disparities Grow between Urban and 

Rural Areas 

The strength in urban-concentrated services employment compared with weaknesses in rural-based manufacturing (see Charts 3 and 4) has contributed to a 

growing economic disparity between urban and rural 

areas. While metropolitan areas reported an average 

unemployment rate of approximately 3.5 percent at 

year-end 1999, the average unemployment rate for 

rural counties was 5.4 percent. Furthermore, slightly 

over 10 percent of the Region’s rural counties reported 

an unemployment rate that was more than double the 

national rate at year-end 1999.1 Likewise, urban areas 

have reported much stronger job growth during the 

previous five years. This is a reversal from the first 

half of the 1990s, when rural areas reported robust job 

growth. Per capita income levels in urban areas also 

have risen much more rapidly than in rural areas in 

recent years. 

Many people in the rural labor force depend on the 

manufacturing sector because of the relatively lower 

skill level required compared with the technical skills 

needed for many service-sector jobs. These lowerskilled, labor-intensive jobs historically have been a significant source of economic opportunities for many 

rural area residents. In recent years, however, plant closures, particularly in the apparel and textiles industry, 

have resulted in an increasing number of layoffs in rural 

areas. 

CHART 3 

Urban Areas Benefit from the Strong 

Services Sector... 

Retail Trade 

(13%) 

Services 

(21%) Other
 

(57%)
 

Manufacturing 

(9%) 

Source: Bureau of Labor Statistics 

1 Bureau of Labor Statistics, seasonally adjusted. 

The outlook for the apparel and textile industry is not 

favorable. Although industry analysts expect job losses 

to moderate after the weaker plants cease operations, 

producers will continue to move facilities offshore to 

take advantage of lower wages. The industry followed a 

similar trend decades earlier when it relocated from 

New England to the South to reduce labor costs. Continued plant closures and job losses could exacerbate 

already poor economic conditions in these rural areas, 

many of which also face poor agricultural conditions. 

Moreover, ongoing plant closures in many rural areas 

and continued economic vitality in metropolitan areas, 

spurred by strength in the services, retail, and construction sectors, will likely widen the gulf between rural and 

urban areas. 

The disparity between urban and rural areas of the 

Region also is apparent in bank growth. Over the previous three years, banks headquartered in metropolitan 

areas2 reported much stronger loan and core deposit 

growth than their counterparts in rural areas. Average 

annual growth during the period in both categories was 

approximately 65 percent higher in urban institutions. 

Insured Financial Institution Performance 

Remains Favorable 

The Region’s banks and thrifts reported generally favorable financial conditions at year-end 1999. Capital 

levels remain strong. Asset quality indicators remain 

CHART 4 

...While Rural Counties Are More 

Dependent on Manufacturing 

Retail Trade 

(13%) 

Services 

(15%) 

Other 

(54%) 

Manufacturing 

(18%) 

Source: Bureau of Labor Statistics 

2 This merger-adjusted analysis included only institutions with less 

than $500 million in total assets that were in operation for the entire 

period reviewed. 

Memphis Regional Outlook 4 Second Quarter 2000 
Regional Perspectives
 

generally positive, although some deterioration 

occurred in agricultural production loans, with continuing weaknesses in the sector. Earnings performance 

trends at year-end, although slightly lower than year-ago 

levels, showed some improvement over results reported 

in previous quarters. The median return-on-assets ratio 

among the Region’s financial institutions in 1999 was 

down 5 basis points to 1.10 percent. 

Overall asset growth among the Region’s institutions 

slowed in 1999, although aggregate loan growth moderated only slightly. The modest slowing in loan growth 

was driven by slower growth among larger institutions 

in the Region. Institutions with less than $500 million 

in total assets reported accelerating loan growth. 

Strong demand for commercial real estate and commercial and industrial loans continued to drive growth 

among institutions of all asset sizes (see Memphis 

Regional Perspectives, first quarter 2000). Conversely, 

residential loan originations slowed with rising interest 

rates. 

Memphis Region Staff 

Memphis Regional Outlook 5 Second Quarter 2000 
Regional Perspectives
 

Agriculture in the Mississippi Delta May Struggle
 

• Nationally, low commodity prices continue to plague the farm sector. 

• The outlook for agriculture in the Mississippi Delta is more pessimistic than the outlook for the nation. 

• The Region’s agricultural lenders face potentially greater concern about credit quality in 2000 and 2001. 

The Farm Sector Faces Continued Weaknesses 

Many segments of the nation’s agricultural sector will 

likely experience a third consecutive year of sustained 

low commodity prices in 2000 that will further stress 

farm financial conditions. The U.S. Department of 

Agriculture (USDA) projects net cash income for the 

farm sector to drop $9.3 billion in 1999 to a total of 

$49.7 billion. This projection, if realized, would be 

approximately 10 percent below the average for 

1990–99 and the lowest level since 1986. 

The projected drop in farm income is not evenly distributed across all farm sectors or all farm geographies. 

Weaknesses are centered in crop production, with 

receipts forecast to be the lowest since 1994. As discussed later in this article, the USDA projects farm 

income in the Mississippi Delta and eastern Kentucky 

and Tennessee to be among the hardest hit in the nation. 

Estimated farm income for 2000 could be revised 

upward by any additional emergency funding approved 

by the federal government.3 Government assistance, 

including emergency funding, was crucial in stabilizing 

farm incomes in 1998 and 1999. Direct payments to 

farmers in 1999 were the largest in history, in both nominal and real terms. 

Some Macroeconomic Trends May Add to 

Farmers’ Financial Stress in 2000 

Overall economic conditions remain positive, but two 

trends may further stress farm financial conditions. 

Interest rates and fuel prices, both significant costs for 

farmers, rose during 1999 and the first quarter of 

2000. 

3 The current forecast does include emergency funding that was previously appropriated as well as estimated transition payments under 

the Federal Agricultural Improvement and Reform Act of 1996 and 

projected loan deficiency payments. 

Although interest rates remain relatively low, borrowing 

costs have climbed as the Federal Reserve increased the 

Federal Funds rate by 100 basis points in 1999. With 

continued emphasis on curbing inflationary pressures, 

the Federal Reserve raised rates an additional 25 basis 

points in the first quarter of 2000. As new production 

loans are made at higher rates and as real estate loans 

reprice on renewal, interest expenses and debt service 

requirements for farmers will rise. Higher interest rates 

may also negatively affect farmland values, which tend 

to be inversely correlated with changes in interest rates 

in much the same way as other income-producing real 

estate. 

Fuel costs also have climbed. Domestic 

oil prices have soared from under $12 per 

barrel at the beginning of 1999 to almost 

$30 per barrel at the beginning of the 

planting season in 2000. Although fuel 

costs are a smaller component of total 

expenses than interest expense, at approximately 4 percent of cash expenses, the dramatic spike 

in prices will negatively affect net farm income. 

Problems for Memphis Region Farmers 

Are Likely to Worsen 

The financial condition of the Region’s farmers is 

weakening. The USDA projects that the Mississippi 

Portal and the Eastern Uplands4 of the Memphis Region 

will be among the most adversely affected areas of the 

nation in 2000 and 2001. Concerns in the Eastern 

Uplands largely relate to changes in the tobacco sector, 

discussed more fully in the Regional Perspectives article “Uncertainties Rise for the Region’s Tobacco Economy.” Potential problems in the Mississippi Portal stem 

4 The Mississippi Portal is a resource region defined by the USDA to 

include Mississippi, Louisiana, western Tennessee, and much of 

Arkansas. The Eastern Uplands are defined to include eastern Tennessee and eastern Kentucky. 

Memphis Regional Outlook 6 Second Quarter 2000 
Regional Perspectives
 

from the heavy concentration of cotton, rice, and soybean production in the area and financial stress resulting from the combination of low commodity prices, 

disease, and poor growing conditions in recent years. 

Specifically, the USDA projects the following: 

•	 The Mississippi Portal will experience the largest 

drop in average net cash income in the nation over 

the next two years, with expected declines of 39 percent in 2000 and an additional 30 percent in 2001. 

•	 Along with the Southeast, the Mississippi Portal will 

report the largest increase in the number of farms 

with negative cash flows. 

•	 Twenty percent of farm businesses in the Mississippi Portal will experience debt repayment difficulties 

in 2000, which would represent a substantial 

increase from prior years and the highest level anywhere in the nation. 

Weather also is a perpetual concern for the agricultural 

sector. Moisture levels in some southern states, 

Louisiana in particular, were extremely low at the 

beginning of the year. This delayed some plantings and 

forced a rotation in some areas from corn to soybeans 

and cotton, which are planted roughly one month later, 

as farmers waited for rain. Long-term weather forecasts 

project dry growing conditions in the area to persist 

throughout 2000. 

Credit Weaknesses Emerge in Agricultural 

Production Lending 

Weaknesses in agriculture have led to rising credit concerns in the Region. One indicator of potential credit 

problems in the agricultural sector is the increasing 

level of carryover debt—annual crop production loans 

that cannot be repaid because of cash flow shortages 

and that are “carried over” into the following year’s crop 

production loan. Historically, prolonged periods of 

increased carryover debt preceded periods of sharply 

higher loan losses. As shown in Chart 5, examiners5 

5 FDIC, Report on Underwriting Practices. Determined from underwriting surveys completed with examinations of FDIC-supervised 

banks. The information shown in Chart 5 represents the percentage of 

agricultural lenders examined during the preceding six months at 

which the level of carryover debt had increased from the previous 

examination. 

CHART 5 

Carryover Debt Levels Are Rising at 

FDIC-Supervised Banks 

Source: FDIC Underwriting Surveys 

12 

26 

32 

42 

0 

10 

20 

30 

40 

50 

Mar ’98 Sep ’98 Mar ’99 Sep ’99 

Percentage of Examinations

with Higher Carryover 

throughout the nation are encountering more agricultural lenders with either moderate or sharp increases in 

carryover debt. 

Total agricultural past-due loans and loan loss rates in 

the Region have risen only modestly over the previous 

two years; however, production loan performance measures are cause for greater concern. Among banks with 

agricultural loan exposure,6 agricultural production loan 

past-due levels and loss rates grew steadily in 1998 and 

1999, compared with averages reported over the previous five years (see Table 1, next page). This deterioration in agricultural production credits is largely masked 

by improvement in agricultural real estate loan performance when viewing total agricultural past-due and 

loan loss rates. 

A combination of factors contributes to the stronger 

performance of farm real estate loans. Some borrowers, 

especially small farmers, have greater incentive to 

remain current on farmland real estate loans, as the 

mortgages often include their homes. More important, 

in the Mississippi Delta, the owner of farmland is often 

not the person who farms the land. Leasing arrangements are common and sharecropping is still used in 

some areas, and landowners are likely ensuring that 

lease payments are received before other payments are 

made from farm cash flows. Also, many landowners not 

actively engaged in farming have other sources of 

income that can be applied toward debt service on farm6 Calculated on a merger-adjusted basis for a constant group of 290 

banks in the Memphis Region with more than 10 percent of loans in 

agricultural loans. 

Memphis Regional Outlook 7	 Second Quarter 2000 
Regional Perspectives
 

TABLE 1 

Agricultural Past-Due Loans and 

Loan Losses Rise at Banks with 

Agricultural Loan Exposure 

1993–97 1998 1999 

TOTAL AGRICULTURAL 

LOANS 

PAST-DUE RATIO 2.06 2.31 2.11 

GROSS LOSSES RATIO 0.26 0.25 0.29 

AGRICULTURAL 

PRODUCTION LOANS 

PAST-DUE RATIO 2.14 2.56 2.69 

GROSS LOSSES RATIO 0.40 0.48 0.56 

AGRICULTURAL REAL 

ESTATE LOANS 

PAST-DUE RATIO 2.00 2.10 1.68 

GROSS LOSSES RATIO 0.13 0.05 0.07 

Source: Bank Call Reports 

land. As a result, weak commodity prices may not 

immediately affect all farmland owners. 

However, the longer depressed crop prices persist, the 

more likely it is that lease values for farmland will 

weaken. A sustained decline in lease prices would likely lead to a drop in land values. The growing number of 

farmers either voluntarily leaving the sector because of 

poor economic prospects or being forced to exit through 

liquidation also may pressure farmland values. If lease 

income or land values weaken, the performance of farm 

real estate loans could follow the same trends currently 

exhibited by agricultural production loans. 

Risks to Agricultural Lenders Are Likely to Rise 

Agricultural loan problems could worsen in 2000 and 

2001 as farm conditions in the Mississippi Delta deteriorate. Current negative trends underscore the need for 

strong loan portfolio management. Underwriting standards will take on added importance as lenders receive 

an increasing number of loan applications from 

less creditworthy borrowers. Banks’ credit administration and loan review functions may require additional 

attention if existing loan portfolios experience rising 

delinquencies. 

Lenders in many Mississippi Delta communities face 

additional economic and demographic hurdles. With 

off-farm employment opportunities a major factor in 

the continuing economic viability for many smaller 

farms, weaknesses in manufacturing sector employment may stress some rural communities. Also, many 

areas in the Mississippi Delta are losing population as 

people move to more economically vibrant areas of the 

nation. These trends could eventually have significant 

structural implications for many Mississippi Delta 

communities and the financial institutions serving 

them. 

Memphis Region Staff 

Memphis Regional Outlook 8 Second Quarter 2000 
Regional Perspectives
 

Uncertainties Rise for the Region’s Tobacco Economy
 

•	 Many rural areas in Kentucky and Tennessee remain dependent on tobacco, a sector under considerable 

external pressure. 

•	 Recent events point to a potential decline in the tobacco farm economy. 

•	 Banks in tobacco-dependent areas face potential credit quality problems, strategic planning issues, and 

funding concerns. 

While agricultural lenders throughout the nation face 

considerable anxiety over the outlook for farming, perhaps the greatest degree of uncertainty exists in the 

tobacco sector, and nowhere is this more apparent than 

in Kentucky and Tennessee. As with agriculture generally, these uncertainties affect not just farmers, but 

also their communities and banks operating in these 

communities. 

Three major changes related to tobacco farming 

occurred in the first quarter of 2000. Two have significant implications for the entire tobacco farming sector, while the third affects only the Region’s tobacco 

growers. 

•	 On February 1, 2000, the USDA announced a historic reduction in the amount of tobacco that can be 

sold over the next year. 

•	 In early February 2000, tobacco product manufacturers proposed a pilot program for direct contracting 

between growers and manufacturers. 

•	 In mid-January 2000, farmers in Kentucky considered measures that could significantly change where 

tobacco is grown in the state. 

Many Areas in the Region Remain 

Dependent on Tobacco 

Domestic tobacco production is concentrated in two 

areas in the southeastern United States, which can be 

subdivided based on the variety of tobacco grown: the 

flue-cured tobacco belt centered in the Carolinas and 

Virginia and the burley tobacco belt in Kentucky and 

Tennessee. North Carolina and Kentucky7 grow the 

majority of the nation’s tobacco—over two-thirds of 

total production in 1998. Tennessee ranks a distant third 

among tobacco-producing states. According to the 

National Agricultural Statistics Service, tobacco contributed $1 billion to the Kentucky economy in 1998 

and approximately one-fourth as much to the Tennessee 

economy (includes indirect effects). 

In both Kentucky and Tennessee, tobacco production is 

concentrated in specific areas (shown in Map 1). In 

7 North Carolina produces slightly more tobacco, but Kentucky is 

more dependent on tobacco. Both states’ economies have similar levels of dependence on agriculture, with Kentucky having a higher concentration of its agriculture in tobacco. In 1998, tobacco cash receipts 

represented 23.5 percent of all farm commodities and 46.8 percent of 

crop cash receipts for Kentucky. 

MAP 1 

1998 Tobacco Production (000 lbs) 

(Star equals tobacco cash receipts 

representing at least 4% of personal income.) 

Tobacco Production Is Concentrated in Eastern 

Kentucky and Northern Tennessee 

Source: U.S. Department of Agriculture 

10,000 and above (5) 

5,000 to 10,000 (41) 

1,000 to 5,000 (74) 

Below 1,000 (95) 

Memphis Regional Outlook 9	 Second Quarter 2000 
Regional Perspectives
 

Kentucky, most tobacco is currently grown in the eastern part of the state. In Tennessee, production is scattered in the eastern part of the state and along the 

northern border. 

The Tobacco Sector Is Declining 

The amount of domestic tobacco produced annually is 

down sharply, in part because of reduced cigarette production (see Chart 6). Cigarette production is also down 

because of slackening domestic demand and declining 

exports. 

Many reasons have been given for the decline in domestic cigarette consumption, including price increases, 

widening restrictions on where smoking is allowed, and 

increased awareness of the links between smoking and 

health problems. The perceived price inelasticity of 

cigarettes is being seriously tested, as recent price 

increases appear to be a major factor in declining consumption. Since January 1998, wholesale prices of cigarettes have risen $1.05 per pack, an almost 80 percent 

increase. The higher prices are a combination of higher 

state and excise taxes and a recovery of costs incurred 

by manufacturers as a result of the November 1998 settlement with state governments. With excise taxes 

scheduled to rise again in 2001, domestic demand may 

continue to slide. 

Exports of cigarettes also are down. Recently, U.S. manufacturers have expanded overseas manufacturing facilities to reduce production costs. Potential savings 

include not only reduced overhead and salary expenses, 

CHART 6 

but also lower input costs, as world tobacco prices are 

considerably lower than domestic prices. 

Increased use of imported tobacco is another factor contributing to declining domestic tobacco cultivation. The 

reduction in tobacco produced annually in recent years 

(shown in Chart 6) is much greater than declines in cigarette production alone would suggest is necessary. 

Domestic cigarettes are a blend of flue-cured, burley, 

and oriental tobacco leaf. Oriental leaf is a special variety grown only in certain overseas locations, and fluecured and burley tobacco is grown primarily in the 

United States. Foreign-grown tobacco of these two varieties can be substituted, however. The share of foreigngrown leaf used in cigarettes produced domestically has 

grown steadily in recent years as U.S. manufacturers 

attempt to reduce costs. 

Dramatic Changes Affect Tobacco Farming 

On February 1, 2000, the USDA announced a third consecutive year of large reductions in the amount of tobacco that growers are allowed to sell, or quotas8 (refer to 

the inset box for description of the quota system). Both 

flue-cured and burley tobacco farmers are affected by 

lower quotas (see Table 2) with burley growers experiencing a larger drop. The cumulative effect of the 1999 

and 2000 quota cuts is a 60 percent drop in the amount 

of burley tobacco that can be sold compared with 1998. 

The quota cut for 2000 represents the largest reduction 

in quotas in the history of the tobacco program, with the 

previous record having been established in 1999. 

The reduction in quotas equates directly to a decline in 

tobacco farm income. Lower tobacco quotas mean that 

individual growers must either (1) produce less tobacco 

or (2) lease other growers’ quotas in order to continue 

TABLE 2 

Source: Economic Research Service, U.S. Department of Agriculture 

Tobacco Production Has Fallen Sharply 

in Recent Years on Lower Demand 

Cigarettes Produced 

Tobacco Produced 

0.6 

0.7 

0.8 

0.9 

1.0 

1.1 

1.2 

1.3 

Cigarettes (billions)

Tobacco (billions of lbs.) 

’89 

500 

600 

700 

800 

900 

1,000 

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

Tobacco Quotas Slashed in Recent 

Years (Annual Percent Change in 

Marketing Quotas) 

1998 1999 2000 

FLUE–CURED –17 –18 –19 

BURLEY –9 –29 –45 

Source: U.S. Department of Agriculture 

8 On February 1, burley quotas were announced; flue-cured quotas for 

2000 were announced in mid-December 1999. 

Memphis Regional Outlook 10 Second Quarter 2000 
Regional Perspectives
 

Tobacco Program: Tobacco marketing quotas are 

designed to stabilize the price for domestically grown 

tobacco by limiting the supply. Marketing quotas are 

set each year to establish the amount of tobacco that 

growers are allowed to sell. The quota level is based 

primarily on announced manufacturers’ purchase 

intentions, the level of existing supply, and export levels, with some limited discretion by the Secretary of 

Agriculture. Each year’s marketing quota is apportioned among holders of base quotas. Base quotas 

were originally assigned to farmers who were growing 

tobacco in the 1930s, according to how much they 

were growing at the time. Quota-holders can, and 

often do, lease quotas to others rather than grow 

tobacco themselves. 

Tobacco that is not purchased by manufacturers is purchased and held by tobacco cooperatives in “pools.” 

As the cooperatives purchase the tobacco using loans 

from the federal government, the pools are frequently 

referred to as “tobacco under loan.” One of the factors 

leading to the record burley quota cuts in 1999 and 

2000 was the growth in the pool. Manufacturers typically attempt to reduce this excess supply and acquire 

inexpensive inputs by purchasing the pools at steeply 

discounted prices. Burley cooperatives declined to sell 

to manufacturers at these significantly discounted 

prices in 1999. Flue-cured pools were sold and the 

flue-cured quota was cut. Although the cut was large, 

it was less severe than the reduction in burley tobacco 

quotas. Many burley farmers and legislators from 

tobacco-producing states are seeking federal disaster 

relief that would allow the cooperatives to eliminate 

the existing pools without having to repay the government loans. Such action would help alleviate some of 

the downward pressure on burley quotas in the near 

term, but the longer-term negative trends, primarily 

waning demand for domestic tobacco, would remain. 

producing the same amount of tobacco. Quota cuts signal either a considerable decline in individual farm revenues or a significant increase in production costs, as 

quota lease prices have risen sharply in response to the 

reduction in quotas. 

The tobacco settlement between cigarette manufacturers and 46 state governments in November 1998 included provisions to help tobacco growers adjust to 

declining tobacco production. The settlement provided 

for funds to be distributed directly to tobacco farmers 

over a 12-year period to help them transition to alternative employment or agricultural production. However, 

the annual tobacco settlement payments to many farmers are so small as to be inconsequential. 

Simultaneous with the announced burley tobacco quota 

cuts in February, Phillip Morris Corporation proposed a 

pilot program for direct contracting between tobacco 

growers and manufacturers that would operate outside 

the current cooperative system. While contracting has 

been used extensively in the production of other agricultural products, tobacco growers have long resisted 

direct contracting. However, emerging problems facing 

the tobacco sector may provide an incentive for farmers 

to discontinue the quota system and adopt direct contracting. Tobacco quota-holders will vote in 2001 to 

retain or discontinue the current tobacco program. 

From a macroeconomic perspective, contracting may 

create a greater concentration of tobacco production in 

fewer farms. Manufacturers may be inclined to contract 

primarily with larger growers, limiting their expenses 

and exposure to a smaller number of farmers. Long 

term, this could lead to a sharp decline in the number of 

smaller tobacco farms.9 

In addition to the complexities surrounding tobacco 

production nationally, Kentucky burley farmers faced 

additional uncertainty as they began planting in 2000. 

In mid-January 2000, Kentucky tobacco quota-holders 

approved a special referendum to allow quotas to be 

leased across county lines anywhere in the state. Previously, burley quotas could be leased to another grower 

only in the county where the base quotas were originally assigned.10 

Although western Kentucky historically has produced 

less tobacco than eastern Kentucky, crop yields are 

much greater in that part of the state and farm sizes tend 

to be larger. If quotas were no longer restricted to county lines, farmers in many eastern counties could begin 

leasing their quotas to western Kentucky farmers. The 

9 The labor-intensive nature of growing tobacco has long served to 

limit the typical size of tobacco farms. However, the high revenue 

potential from even small tobacco operations has maintained the economic viability of these smaller farms. As a result, there are currently almost 45,000 tobacco farms in Kentucky alone, with a typical size 

of just five acres. 

10 An exception has existed for “disaster pounds.” This exception 

allows farmers who lost tobacco crops to weather or disease to lease 

their marketing quotas anywhere in the state at year-end to other 

farmers who may have produced more tobacco (on speculation or 

strong yields) than they were allowed to sell under the quota system. 

Memphis Regional Outlook 11 Second Quarter 2000 
Regional Perspectives
 

migration of tobacco production to the western part of 

the state would be a significant structural shift in the 

state’s agricultural sector and could significantly affect 

communities in eastern Kentucky. 

However, in late March, a federal judge blocked the referendum, because the total number of votes did not represent a majority of eligible votes. Many farmers, 

particularly those in western Kentucky, were preparing 

to plant additional acres by purchasing leases from 

other parts of the state. With that option no longer available, many tobacco growers faced significant lastminute changes in an already difficult season. 

Tennessee quota-holders had approved a similar rule 

change in their state in the early 1990s. The effect was 

a shift in tobacco cultivation from eastern counties to 

the western part of the state. Although eastern Tennessee still produces a considerable amount of tobacco, 

most eastern tobacco-producing counties shown in Map 

1 have experienced a decline in tobacco production 

since 1993. By contrast, most counties in the northcentral and western portions of the state have reported 

growth in tobacco production during the period. 

Rural Communities Will Be 

Disproportionately Affected 

Lower marketing quotas, direct contracting, and crosscounty quota leasing are all likely to adversely affect 

local economic conditions, but the severity will vary 

greatly. Some major tobacco-producing counties are 

located near metropolitan areas with strong local 

economies. In these areas, reliance on tobacco has 

steadily declined as cities expand over what was previously farmland and as employment opportunities grow. 

By contrast, dependence on tobacco production remains 

high in many rural areas. Map 1 depicts those counties 

with tobacco cash receipts equivalent to 4 percent or 

more of total personal income. Often, these rural communities have only limited opportunities for off-farm 

employment, and many face declining manufacturing 

bases. Textile and apparel employment, in particular, 

declined sharply in the 1990s in Kentucky and Tennessee, dropping from over 90,000 in 1993 to approximately 46,000 at the end of 1999. 

Nicholas County, Kentucky, northeast of Lexington, is 

one rural area facing lost tobacco revenue and a declining manufacturing employment base. The reduction in 

quotas could result in over $5 million in lost revenue for 

the county (tobacco cash receipts were equivalent to 8.7 

percent of total personal income in the county in 1998). 

The largest employer in the county, an apparel manufacturer, closed on December 30, 1999, resulting in 325 

lost jobs, or approximately 10 percent of the county’s 

total employment. This combination of declining farm 

revenue and job layoffs will adversely affect the local 

economy. Nicholas County is just one example of the 

many rural communities in Kentucky and Tennessee 

struggling with similar problems. 

Banks Face Challenges in Coming Years 

Banks operating in tobacco-dependent areas are subject 

to greater uncertainty because of the ongoing upheaval 

in the sector. Potential challenges include elevated credit quality concerns, declining overall loan demand, and 

additional funding pressures. 

Borrowers’ credit quality could deteriorate. With significant reductions in the amount of tobacco that can be 

grown, revenues will drop sharply for most tobacco 

farmers. Some may be unable to generate sufficient 

income to cover expenses and meet debt service 

requirements. Lenders have taken steps to bolster credit quality by acquiring additional collateral or using 

government guaranty programs, but concerns with 

direct lending remain. Also, the credit quality of other 

borrowers, such as downtown merchants, in communities that depend on tobacco dollars could be adversely 

affected. 

With less tobacco likely to be grown by fewer farmers, 

structural changes may occur in the loan portfolios of 

banks that have traditionally loaned directly to tobacco 

growers.11 Nonagricultural loan demand in or near urban 

areas such as Lexington or Louisville has been strong in 

recent years; banks operating in these areas should be 

able to easily replace tobacco loans with commercial, 

consumer, and real estate loans. However, management 

may need to revisit lending strategies and diversification efforts if loan portfolio composition changes significantly with the loss of tobacco-based credits. In 

rural communities, lenders may have limited options 

available for replacing lost tobacco loans in local mar11 Among community banks (those with less than $500 million in total 

assets) operating in tobacco-growing areas of northeastern Kentucky, 

for example, agricultural-related loans represent an average 16 percent of total loans. While other farming activities are present, the 

majority of such loans are related to tobacco. 

Memphis Regional Outlook 12 Second Quarter 2000 
Regional Perspectives
 

kets. In such areas, banks may experience a decline in 

total loans. 

Deposits also could decline with the loss of considerable annual cash flow in some rural counties. This may 

in turn lead to funding complications for community 

banks in those areas. The use of alternative funding 

sources, primarily borrowings from the Federal Home 

Loan Bank, already was increasing among these institutions. Such borrowings often represent a more costly 

source of funding than locally generated core deposits. 

As a result, both liquidity and earnings could be affected. Core deposit growth at community banks headquartered in tobacco-dependent counties12 slowed 

appreciably in 1999 (see Table 3) and was well below 

core deposit growth at community banks located in 

other rural areas in the Region. 

Implications 

The Region’s tobacco farm economy currently is characterized by significant challenges and considerable 

12 Tobacco-dependent counties are those with tobacco cash receipts 

equivalent to 4 percent or more of total personal income; community 

banks are those with less than $500 million in total assets. All growth 

rates are merger-adjusted. 

TABLE 3 

Deposit Growth Slows in 1999 for 

Banks in Tobacco-Dependent Counties 

1997 1998 1999 

LOAN GROWTH 11.0 8.6 9.8 

CORE DEPOSIT GROWTH 5.5 7.3 1.4 

LOANS/DEPOSITS RATIO 76.3 77.7 83.3 

Source: Bank and Thrift Call Reports 

uncertainty. Many financial institutions operating in 

areas that depend on tobacco revenues are faced with 

serious questions about borrowers’ credit quality and 

the economic vitality of their communities, with the 

potential indirect effects perhaps posing the greatest 

challenges. The uncertain outlook for tobacco farming 

will require considerable effort by institution officers 

and directors to properly manage current risks and plan 

for future growth. 

Memphis Region Staff 

Memphis Regional Outlook 13 Second Quarter 2000 
In Focus This Quarter
 

Banking Risk in the New Economy
 

The Division of Insurance periodically assesses conditions in the economy and the banking industry to identify and evaluate trends that could adversely affect the 

performance of insured depository institutions. At this 

time, the banking industry as a whole continues to 

enjoy record profits and solid financial ratios.1 Much of 

the industry’s strength derives from the remarkable performance of the U.S. economy, which has been expanding for the past nine years. This article explores factors 

that have shaped this unusually robust economic environment and discusses how changes in the economy 

may create new types of risks for insured depository 

institutions. 

During 1999, the FDIC reported the first annual loss for 

the Bank Insurance Fund since 1991. This loss primarily resulted from an uptick in unanticipated and highcost bank failures. Some of these failures were 

associated with high-risk activities such as subprime 

lending, and some were related to operational weaknesses and fraud. The emergence of these problems in 

the midst of a strong economic environment raises concerns about how the condition of the banking industry 

might change if economic conditions deteriorate. 

The Longest U.S. Expansion 

In February 2000, the U.S. economy entered its 108th 

month of expansion, making this the longest period of 

uninterrupted growth in U.S. history.2 This recordsetting performance has also been marked by a recent 

acceleration in the rate of real gross domestic product 

(GDP) growth, which has exceeded 4 percent in each 

year since 1997. Meanwhile, price inflation has 

remained relatively subdued. The core inflation rate, 

which excludes the volatile food and energy components, was just 2.1 percent in 1999, the lowest core rate 

since 1965. 

Recent economic conditions have been highly conducive to strong loan growth, low credit losses, and 

record earnings for the banking industry. The important 

1 For a recent summary of financial performance and condition of the 

banking and thrift industries, see the FDIC Quarterly Banking Profile, fourth quarter 1999, http://www2.fdic.gov/qbp/. 2 The chronology of U.S. business cycles is available from the National Bureau of Economic Research, http://www.nber.org/cycles.html. 

question going forward is how long these favorable conditions might last. Is this remarkable economic performance the result of some long-term upward shift in the 

pace of economic activity, or is it the temporary result 

of a few transitory factors? More important, are there 

new and unfamiliar dangers that, at some point, could 

significantly impair banking industry performance? To 

evaluate these questions, we must assess the factors that 

have contributed to recent economic performance and 

think ahead to possible developments that could end this 

expansion. 

What Is the New Economy? 

The term used most often to describe the recent period 

of economic performance has been somewhat controversial: the New Economy. Much of the controversy has 

arisen because people interpret the term in different 

ways. Wall Street analysts use the term to refer to the 

high-technology sectors of the economy, such as computers and software, biotechnology, and especially the 

Internet. Some of these New 

Economy firms have been able to 

raise large amounts of capital and 

command market valuations in 

the tens of billions of dollars well 

in advance of earning a profit or 

even booking significant cash 

revenues. 

Economists tend to employ the term New Economy in a 

slightly different way. To them, it refers to evidence that 

some of the traditional economic relationships have 

changed. For example, intangible assets now appear to 

play a much larger role in the valuation of investments 

than they have in the past.3 Firms in some industries 

now may exhibit increasing returns to scale (rather than 

diminishing returns), reflecting the fact that the value of 

their product rises as it becomes a de facto industry 

standard.4 Individual decision making, too, may be 

changing. Some believe that investors have reduced the 

risk premium they demand to hold equity positions 

3 Nakamura, Leonard. Federal Reserve Bank of Philadelphia. 

July/August 1999. Intangibles: What Put the New in the New Economy? Business Review. http://www.phil.frb.org/files/br/brja99ln.pdf. 4 Brown, William S. March 2000. Market Failure in the New Economy. Journal of Economic Issues, 219–27. 

Memphis Regional Outlook 15 Second Quarter 2000 
In Focus This Quarter
 

because of their perception that holding equity is not, 

after all, substantially riskier than holding debt.5 Such a 

shift in investor attitudes could help explain why the 

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

recently approached all-time highs.6 

Perhaps the most important underlying change in the 

economy is the relationship between high rates of economic growth and changes in inflation. Economists have 

long maintained that rapid growth in economic activity 

has a tendency to lead to excess demand for goods (thereby raising consumer and producer prices) and excess 

demand for labor (thereby raising wage rates). But during 

the late 1990s, as growth accelerated and inflation 

remained low, economists began to reevaluate their 

notions of these trade-offs. Some argued that the low rate 

of inflation during this expansion was the fortunate result 

of temporary factors, such as a strong dollar and low 

energy prices, both of which could diminish or reverse 

direction over time.7 Only a few analysts were so bold as 

to suggest that the fundamental workings of the economy 

had changed in such a way as to allow a sustained period 

of high economic growth with low inflation. 

An early Wall Street description of the New Economy 

appeared in an article released by Goldman Sachs in 

January 1997.8 It describes a number of fundamental 

changes in the economy—driven by global competition 

and advancing technology—that may permit business 

cycle expansions to last longer than they have in the 

past. At the same time, it warned that longer economic 

expansions might have a tendency to contribute to 

greater financial excess and the possibility of more 

severe recessions and more sluggish recoveries. 

If this hypothesis is correct, and an emerging New 

Economy would contribute to longer expansions and 

more severe recessions, there may be implications for 

how banks manage risks. Since the Great Depression, 

U.S. business cycle recessions have not necessarily been 

catalysts for large numbers of bank and thrift failures. 

5 January 24, 2000. Has the Market Gone Mad? Fortune.
 6 September 1999. Earnings: Why They Matter. Money.
 7 Brown, Lynn Elaine. Federal Reserve Bank of New England.
 

May/June 1999. U.S. Economic Performance: Good Fortune, Bubble,
 

or New Era? New England Economic Review. http://www.bos.frb.org/
 

economic/pdf/neer399a.pdf, and Brinner, Roger E. Federal Reserve
 

Bank of New England. January/February 1999. Is Inflation Dead?
 

New England Economic Review. http://www.bos.frb.org/economic/
 

pdf/neer199c.pdf.
 

8 Dudley, William C., and Edward F. McKelvey. January 1997. The
 

Brave New Business Cycle: No Recession in Sight. U.S. Economic
 

Research, Goldman Sachs.
 

During the period from 1983 to 1989, when the U.S. 

economy was in the midst of a long expansion, some 

1,855 insured banks and thrifts failed. This wave of 

failures has been attributed to a variety of factors, 

including severe regional economic downturns, realestate-related problems, stress in the agricultural sector, 

an influx of newly chartered banks and banks that converted charters, and high nominal interest rates.9 However, the potential for significantly more severe national 

recessions would represent largely uncharted territory 

that could cause losses and loss correlations to depart 

from historical norms, posing a new set of risk management challenges for the industry going forward. 

The Productivity Revolution 

As the essential element that links faster economic 

growth and low inflation, productivity growth is the cornerstone of the New Economy. Productivity refers generally to the amount of output that can be obtained from 

a fixed amount of input. Labor productivity is usually 

measured in terms of output per hour. Chart 1 shows 

that output per hour in manufacturing has risen at an 

average annual rate of 4.5 percent during the current 

expansion, compared with rates of just over 2.5 percent 

in the three previous long economic expansions. Moreover, productivity growth accelerated in 1999 to a rate 

of 6.3 percent. Why is productivity growing so fast now 

compared with previous expansions? Even economists 

who believe that economic relationships have fundaCHART 1 

Productivity Has Grown at a Faster Rate in This 

Expansion than in Previous Long Expansions 

Average Year-over-Year Growth 

in Manufacturing Output per Hour 

5.0% 

4.0% 

3.0% 

2.0% 

1.0% 

0.0% 

1961–69 1975–79 1983–90 1991–2000 

Source: Bureau of Labor Statistics (Haver Analytics) 

9 FDIC 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, 16–17. http://www. 

fdic.gov/bank/historical/history/contents.html. 

Memphis Regional Outlook 16 Second Quarter 2000 
In Focus This Quarter
 

mentally changed are hard-pressed to explain why all of 

the factors came together in the late 1990s and not 

before.10 Still, explanations for the increase in productivity tend to focus on three main factors. 

Increased Competition. Expanding global trade during 

the 1980s and 1990s has subjected U.S. firms to new 

competition from around the world. Annual U.S. 

exports of goods and services grew by over 230 percent 

(after inflation) between 1982 and 1999, while imports 

grew by 315 percent. The construction of new production facilities around the world in industries such as 

autos and chemicals has led to excess manufacturing 

capacity that has kept prices low. In other industries, 

including air travel, trucking, telecommunications, and 

banking, competition has been intensified through 

domestic deregulation. Facing intense competitive pressures and a low rate of general price inflation, firms 

cannot rely on annual price increases to help expand 

top-line revenue. Instead, there is pressure to continually cut costs in order to increase earnings. For many 

firms, this means adopting new technologies and new 

ways of organizing operations. 

Expanded Investment. U.S. firms of all sizes have 

invested in new technologies at a rapid pace during this 

expansion. Chart 2 shows that business investment in 

equipment and software represents almost one-quarter 

of total net GDP growth during this expansion, comCHART 2 

Business Investment in Equipment and Software
 

Has Been Robust during This Expansion
 

Average Percent Contribution of Real Investment 

in Durable Equipment and Software 

to Net GDP Growth by Expansion 

25 

20 

15 

10 

5 

0 

1961–69 1975–79 1983–90 1991–99 

Note: GDP = gross domestic product
 

Source: Bureau of Economic Analysis (Haver Analytics)
 

10 One possible explanation is that there is a learning curve for adopting new technologies and that technology diffusion is an inherently 

slow process. David, Paul A. Organization for Economic Cooperation 

and Development. 1991. Computer and Dynamo: The Modern Productivity Paradox in a Not-Too-Distant Mirror. In Technology and 

Productivity: The Challenge for Economic Policy, 315–47. 

pared with around 15 percent or less during previous 

long expansions. While this investment has been motivated by the need to cut costs, it has also been fueled by 

the availability of new computer technologies that have 

fallen in cost over time and by the ready availability of 

financial capital on favorable terms. 

Industrial Restructuring. The third aspect of the productivity revolution is large-scale restructuring in the 

U.S. corporate sector. Chart 3 shows that both the annual number and dollar volume of mergers in the late 

1990s far exceeded the pace of the so-called merger 

mania of the late 1980s. Two classes of firms are leading the new wave of mergers. First, companies in 

mature industries such as oil, autos, and banking are 

faced with excess productive capacity and intense price 

competition. For these firms, mergers are useful in 

expanding market share and removing redundant operations. Second, the largest dollar volume of mergers is in 

some of the most volatile emerging industries, including telecom, media, and the Internet. It is in these sectors of the economy, in particular, where the business 

models are evolving rapidly and where technological 

standards are still being determined. Firms in these 

industries that can grow rapidly through mergers have 

the chance to achieve long-term market dominance in 

what appear to be some of the fastest growing industries 

of the new century. 

The implications of the productivity revolution for the 

banking industry have been decidedly positive. Higher 

productivity has allowed a long expansion and faster 

economic growth with low inflation, all of which are 

conducive to robust financial performance by depository institutions. Higher rates of business investment 

CHART 3 

Note: M&A = merger and acquisition 

Source: Houlihan Lokey’s Mergerstat 

The Volume of Corporate Mergers Set 

Another New Record in 1999 

Number of M&A Deals M&A Deal Value, Billions of Dollars 

’70 ’72 ’74’76’78’80 ’82 ’84’86 ’88 ’90’92’94’96 ’98 

0 

2,000 

4,000 

6,000 

8,000 

10,000 

1,000 

1,200 

1,400 

1,600 

0 

200 

400 

600 

800 

Memphis Regional Outlook 17 Second Quarter 2000 
In Focus This Quarter
 

have generated demand for credit that is supplied, in 

part, by banks and thrifts. Perhaps most important, the 

recent large-scale industrial restructuring has been 

highly supportive of strong business credit quality. This 

process has moved economic resources to more productive uses in an orderly fashion, without the high levels 

of bankruptcies and defaults that often accompany 

industrial restructuring. Given the volumes of corporate 

assets that have changed hands in recent years (more 

than $1.4 trillion in 1999 alone), it is fortunate indeed 

that this restructuring has proceeded in this fashion. 

The Role of the Capital Markets 

A critical factor in heightened business investment and 

restructuring during this expansion has been the 

remarkably favorable conditions in the financial markets. Financial capital has generally been readily available to business borrowers, usually on favorable terms. 

One factor that has held down the cost of capital for 

publicly traded corporations has been sharply rising 

stock prices. Many of these firms have been able to use 

equity shares as a currency with which to finance mergers. Furthermore, existing accounting rules do not 

always require the amortization of good will that comes 

onto the balance sheet as a result of a merger.11 

By far the largest amount of external business financing 

has been debt financing. U.S. nonfinancial corporations 

issued net debt in the amount of $535 billion in 1999 

and repurchased equity shares, on net, for the sixth consecutive year. Businesses have used this debt to purchase capital equipment, finance mergers, and buy back 

equity shares. This increase in debt issuance has not 

been limited to highly rated corporations. Venture capital financing amounted to almost $15 billion in the 

fourth quarter of 1999 alone, with over 60 percent of 

that amount going to Internet firms.12 

Banks have been active participants in nearly every 

facet of this financing activity. Syndicated loan origination volumes rose by 17 percent in 1999 to just over 

$1 trillion, despite relatively high credit costs and facility fees, factors that helped keep total volume below 

1997’s record $1.1 trillion in issuance. Syndicated loans 

to leveraged companies also rose 17 percent in 1999 to 

a record $320 billion. More impressive still was the 

growth in high-yield transactions, which rose nearly 50 

11 April 17, 2000. Techdom’s New Bean-Counting Battle. Business 

Week. 

12 May 2000. Venture financing data are derived from a PriceWaterhouseCoopers/Money Tree survey, as cited in Upside, 43. 

percent in 1999 to $190 billion. It is difficult to determine precisely how much syndicated loan exposure 

resides on the books of insured institutions or, more 

important, how much high-yield exposure is retained by 

commercial banks. Loan Pricing Corporation estimates that 64 percent of high-yield volume in the first 

half of 1999 was retained by banks.13 Insured commercial banks are the dominant originators of syndicated 

loans, with a 79 percent market share of investmentgrade originations and a 56 percent market share of 

non-investment-grade originations in 1999. Commercial banks have also expanded their presence in the venture capital market. For some of the largest banks, 

profits from venture capital operations account for a 

large portion of total earnings. Chase Manhattan reported venture capital investment earnings of $2.3 billion in 

1999, accounting for 22 percent of total net income.14 

Innovation in the capital markets continues to provide 

new and more efficient vehicles for business financing. 

For example, issuance of asset-backed securities totaled 

$346 billion in 1999, up from only $50 billion in 1990. 

In this ongoing revolution in finance, market-based 

intermediaries, such as mutual funds and asset pools, 

have assumed an increasing role in the credit markets. 

Chart 4 shows that net holdings of credit market instruments by mutual funds, government-sponsored enterprises, and asset pools exceeded the debt held by 

depository institutions for the first time in 1997. 

CHART 4 

Market-based Lending Is Becoming More 

Important as a Source of Business Financing 

Share of Total Net 

Credit Market Lending1 

70% 

60% 

50% 

40% 

30% 

20% 

10% 

0% 

Market-based Lenders3 

Depository Institutions2 

’60 ’63 ’66 ’69 ’72 ’75 ’78 ’81 ’84 ’87 ’90 ’93 ’96 ’99 

1 Total net credit market lending is defined as net holdings of open-market paper,
 

government and municipal securities, corporate and foreign bonds, mortgages,
 

and other loans.
 

2 Depository institutions include commercial banks, savings institutions, and credit
 

unions.
 

3 Market-based lenders include mutual funds, closed-end funds, government-


sponsored enterprises, and asset pools.
 

Sources: Federal Reserve Board (Haver Analytics); Regional Financial Associates
 

13 September 13, 1999. Junk Loan Market Is Feeling the Pinch of 

Oversupply and Rising Interest Rates. The Wall Street Journal. 14 April 3, 2000.What’s Really Driving Banks’ Profits. Business Week. 

Memphis Regional Outlook 18 Second Quarter 2000 
In Focus This Quarter
 

While the expansion in market-based financing has 

made credit more available to business and consumer 

borrowers, it also creates some concerns. One issue is 

the susceptibility of the financial markets to periodic 

bouts of turmoil. These episodes, such as the one triggered by the Russian government bond default and the 

near-failure of the Long Term Capital Management 

hedge fund in the fall of 1998, can result in the interruption of capital flows even to creditworthy borrowers. 

During the 1998 episode, private yield spreads widened 

sharply as investors sought the safety of U.S. Treasury 

securities. Some companies that had planned to issue 

debt to the markets during that period were unable to do 

so. For companies whose business models depend heavily on a continuous supply of liquidity from the financial markets, the effects of these episodes can be 

catastrophic. For example, the relatively short-lived 

episode of financial turmoil during late 1998 resulted in 

significant liquidity problems for a number of commercial mortgage firms. Nomura, Lehman Brothers, CS 

First Boston, and others incurred losses, while Criimi 

Mae, Inc., was forced to declare bankruptcy. 

Because market-based financing has played such a large 

role in facilitating the orderly restructuring of the U.S. 

economy through mergers and the formation of new 

businesses, a recurrence of financial market turmoil 

could contribute to the end of the current expansion. 

Moreover, such an event could have serious consequences for business credit quality. A prolonged interruption of market-based financing could, in this very 

competitive economic environment, prevent businesses 

from restructuring themselves through mergers and 

deprive them of capital needed to invest in cost-cutting 

technologies. The loss of financial flexibility would 

leave businesses much more vulnerable to the effects of 

CHART 5 

competition and could result in more firms seeking 

bankruptcy protection. Such a scenario has the potential 

to bring about a significant increase in charge-off rates 

for business lenders. 

Financial Imbalances 

Another concern that arises from increased dependence 

on market-based financing is that it may contribute to 

the emergence of financial imbalances in the economy. 

These imbalances could, in turn, increase the potential 

for financial market turmoil as a result of some unforeseen shock to the markets. 

As recently as 1993, the public deficit was near the top 

of the list of economists’ concerns about the U.S. economy. During that year, the combined deficit of the federal, state, and local government sectors exceeded $300 

billion. However, on the strength of a long economic 

expansion, lower interest rates, and lower federal spending on defense, the consolidated government sector 

posted its second consecutive surplus in 1999 (Chart 5). 

As the government has moved from deficit to surplus, 

households and businesses have continued to borrow 

hundreds of billions of dollars every year. Taken together, the annual net borrowing of businesses and households has been referred to as the “private deficit.” In 

1999, the private deficit narrowed to $913 billion from 

a record $1.02 trillion the year before. Although this private borrowing indicates confidence on the part of consumers and businesses about future prospects, it also 

raises concerns about the ability to service debt if interest costs rise or if incomes level off or decline. 

Memphis Regional Outlook 19 Second Quarter 2000 

Flow of Net Sectoral Lending 

(Lending Less Borrowing), 

in Billions of Dollars Domestic Financial Sector 

Note: “Nonfinancial business” includes farm and nonfarm, corporate and noncorporate businesses. 

Source: Federal Reserve Board (Haver Analytics) 

Net Borrowing by Businesses and Households Represents a Growing “Private Deficit” 

–1,200 

–900 

–600 

–300 

0 

300 

600 

900 

1,200 

Foreign Sector 

Nonfinancial Business 

Households 

Government 

’80 ’81 ’82 ’83 ’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 
In Focus This Quarter
 

The largest part of the private deficit was again 

financed in 1999 by domestic financial institutions 

($649 billion) and an inflow of capital from abroad 

($207 billion). Both of these sources of financing are 

potential causes for concern. The rapid expansion in 

credit created by the financial sector raises questions 

about credit quality. Financial institutions theoretically 

serve as the gatekeepers of the economy, financing only 

the most creditworthy projects and rejecting those that 

are not viable. The sheer volume of credit extended to 

businesses and households—almost $1.4 trillion in new 

net lending over the past two years—raises the possibility that underwriting has become more lax and that 

average credit quality is slipping. (See the inset box on 

page 17 for a discussion of recent trends in commercial 

credit quality.) 

Reliance on inflows of foreign capital raises a different 

set of issues. The fact that the U.S. economy has been 

growing significantly faster than the economies of its 

major trading partners has contributed to a U.S. trade 

deficit that reached $268 billion in 1999 and could 

exceed $300 billion in 2000. This deficit puts hundreds 

of billions of dollars annually in the hands of foreign 

investors. As long as foreign investors largely choose to 

reinvest their excess dollars in U.S. factories and financial instruments, as has been the case in recent years, 

the United States can continue to enjoy a strong dollar 

and relatively low inflation and low interest rates. However, if foreign investors should choose to invest elsewhere, they must sell their dollars in foreign exchange 

markets. Doing so would put downward pressure on the 

dollar and upward pressure on U.S. inflation and interest rates. 

Recent Shocks to the U.S. Economy 

Despite the potential for a declining dollar as a result of 

U.S. reliance on foreign capital, other adverse developments have confronted the U.S. economy over the past 

year. The two factors of most consequence to the macroeconomic outlook have been rising energy costs and rising interest rates. These trends have played a role in 

recent equity market volatility that may have implications for the future direction of the economy. 

Rising Energy Prices. After declining to a low of 

around $10 per barrel in December 1998, oil prices have 

risen dramatically over the past year and a half. The spot 

price per barrel of West Texas Intermediate crude 

peaked in March 2000 at just under $30 before declining slightly in April. The rapid increase in oil prices during 1999 was sparked by a cutback in output by oilproducing nations that was instituted just as global economic growth was recovering from the crisis of 1998. 

The OPEC nations and other major oil producers 

reached a new agreement in March 2000 that provides 

for a production increase of some 1.5 million barrels a 

day. But, because demand is rising and gasoline inventories remain lean, analysts do not look for a significant 

decline in gasoline prices in the near term.15 

The effects of higher oil prices on the U.S. economy at 

this time are uncertain. According to some estimates, 

the economy is only half as dependent on oil as it was 

25 years ago, when the United States was experiencing 

the effects of its first “oil shock.”16 Still, higher oil 

prices were responsible for nearly all the increase in 

consumer price inflation during 1999. While year-overyear growth in the Consumer Price Index rose from 1.6 

percent in December 1998 to 2.7 percent in December 

1999, the core rate of inflation (excluding food and 

energy items) actually fell. The question now is whether 

higher energy prices will be passed along to the rest of 

the economy through rising wage and price demands 

during the remainder of 2000. 

Rising Interest Rates. From low points at the end of 

1998, both short-term and long-term interest rates have 

risen substantially, contributing to a higher cost of debt 

service for businesses and households. At the short end 

of the yield curve, the Federal Reserve (the Fed) raised 

the Federal Funds rate six times between June 1999 and 

May 2000, for a total increase of 175 basis points. 

While part of this increase merely reversed the reduction in rates that took place in late 1998, the Fed also 

voiced concerns that inflationary pressures might be 

emerging because of continued rapid U.S. economic 

growth. Given the stated commitment of the Federal 

Reserve to price stability, most analysts expect the Fed 

to continue to push short-term rates higher until growth 

in the economy slows to a more sustainable pace.17 

Bond markets also pushed up long-term interest rates 

during this period. The yield on the ten-year Treasury 

15 Energy Information Agency (U.S. Department of Energy). April
 

2000. Short-Term Energy Outlook. http://www.eia.doe.gov/emeu/
 

steo/pub/contents.html.
 

16 March 11, 2000. Fueling Inflation? The Economist.
 17 See, for example, U.S. House of Representatives. February 17,
 

2000. Testimony of Chairman Alan Greenspan Before the Committee
 

on Banking and Financial Services. http://www.federalreserve.gov/
 

boarddocs/hh/2000/February/Testimony.htm.
 

Memphis Regional Outlook 20 Second Quarter 2000 
In Focus This Quarter
 

As Commercial Credit Quality 

Indicators Slip, Trends in Commercial 

Lending Come to the Forefront 

Commercial lending, which includes both commercial 

and industrial (C&I) and commercial real estate (CRE) 

loans, represents the greatest source of credit risk to 

insured institutions and the deposit insurance funds. C&I 

loan growth continued to be strong in 1999, although it 

did moderate from 1998 levels, and recent underwriting 

surveys have reported a slight tightening of terms.18 Nevertheless, there are signs that commercial credit quality is 

deteriorating.19 Most notably, as seen in Chart 6, C&I loan 

charge-off rates, corporate bond defaults, and corporate 

bond rating downgrades relative to upgrades have all 

been trending upward recently. For example, C&I loan 

loss rates rose to 0.56 percent of total loans in 1999, nearly double the rate of loss experienced in 1997. Although 

C&I loan loss levels are well below historical highs experienced throughout the 1980s and early 1990s, these signs 

of credit quality deterioration are occurring despite 

extremely favorable economic conditions. 

At least three factors have contributed to weakening in 

corporate credit quality. First, corporate indebtedness has 

been rising, as businesses have been spending to increase 

productivity, cut costs, repurchase equity, and finance 

mergers and acquisitions. The second factor relates to a 

greater risk appetite in the financial markets. For example, originations of leveraged syndicated loans—in particular, highly leveraged loans—have tripled over the past 

five years. Finally, stresses within industry sectors hard 

hit by structural changes, global competition, and deflationary pressures have resulted in challenges for 

borrowers. 

Construction and development (C&D) lending continues 

to be one of the fastest growing segments of banks’ loan 

portfolios, while loss rates among CRE and C&D loans 

remain extremely low. However, there are indications 

that conditions could be worsening in some markets. In 

particular, as shown in Chart 7, strong office completions and construction activity have begun to outpace 

absorptions and are projected to continue to do so over 

the next several years. Moreover, these trends have 

implications for vacancy rates. The national office 

vacancy rate moved higher during 1999 for the first time 

since 1991 and is projected to climb higher. 

In addition, some local CRE markets continue to show 

signs of overbuilding. Last year, the FDIC’s Division of 

Insurance identified nine markets in which the pace of 

construction activity threatened to outstrip demand for at 

least two property sectors.20 Seven of these nine markets 

reported an increase in office vacancy rates in 1999. 

CHART 6 

0.0 

1.0 

2.0 

3.0 

4.0 

’84 ’85 ’86 ’87 ’88 ’89 ’90 ’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 

0.0 

1.0 

2.0 

3.0 

4.0 

5.0 

Note: C&I = commercial and industrial 

Source: Moody’s; Bank and Thrift Call Reports (Research Information System) 

Deteriorating Indicators Suggest Weakening 

Business Credit Quality 

Insured Institution C&I 

Charge-off Rate 

Corporate Bond 

Default Rate 

Bond Ratings 

Downgrades to 

Upgrades (columns) 

18 Both the 1999 Senior Loan Officer Opinion Survey (Federal 

Reserve Board) and 1999 Survey of Credit Underwriting Practices 

(Office of the Comptroller of the Currency) point to more stringent 

C&I loan terms since the latter part of 1998. This tightening follows a four-year period of easing C&I loan standards and predominantly reflects an increase in loan pricing. 

19 For additional detail, see Sothoron, Arlinda, and Alan Deaton. 

FDIC Division of Insurance. First quarter 2000. Recent Trends 

Raise Concerns about the Future of Business Credit Quality. 

Regional Outlook. http://www.fdic.gov/bank/analytical/regional/ 

ro20001q/na/Infocus1.html. 

20 These markets are Charlotte, Orlando, Salt Lake City, Dallas, Las 

Vegas, Phoenix, Nashville, Atlanta, and Portland. See Burton, 

Steve. FDIC Division of Insurance. First quarter 1999. Commercial Development Still Hot in Many Major Markets, But Slower 

Growth May Be Ahead. Regional Outlook. http://www.fdic.gov/ 

bank/analytical/regional/ro19991/na/Infocus2.html. 

CHART 7 

0 

20,000 

40,000 

60,000 

80,000 

100,000 

120,000 

140,000 

’78 ’80 ’82 ’84 ’86 ’88 ’90 ’92 ’94 ’96 ’98 ’00 ’02 ’04 

0% 

5% 

10% 

15% 

20% 

Source: CB Commercial/Torto Wheaton Research 

U.S. Office Vacancies Rose Last Year 

for the First Time since 1991 

Completions, Absorption 

(000 sq. ft.) Vacancy

 Rate 

Completions 

Absorption 

Projected

Actual 

Memphis Regional Outlook 21 Second Quarter 2000
 
In Focus This Quarter
 

note rose from a low of 4.5 percent in October 1998 to 

6.5 percent by May 2000. Analysts have cited renewed 

demand for credit by a recovering world economy as 

well as concerns about inflation arising from the 

increase in energy prices as factors behind the rise in 

long-term rates. 

Higher energy costs and higher interest rates do not 

appear to have significantly slowed the pace of U.S. 

economic activity during the first quarter of 2000. The 

preliminary estimate of real gross domestic product 

growth during the quarter was 5.4 percent—a slowdown 

from the 7.3 percent rate of the fourth quarter of 1999 

but still well above what is considered a sustainable 

pace. Home construction, usually a sector that is particularly sensitive to movements in long-term interest 

rates, has remained surprisingly resilient. Still confident 

of their future prospects, homebuyers have increasingly 

turned to adjustable-rate mortgages to avoid some of the 

immediate costs of higher fixed mortgage rates. 

As for the business sector, higher costs for energy and 

debt service are most significantly affecting “Old Economy” firms that purchase commodity inputs and carry 

significant debt on their balance sheets. Airline companies in the S&P 500, for example, posted a year-overyear decline of 27 percent in net income from 

continuing operations during the first quarter of 2000.21 

Analysts have argued that New Economy firms, by contrast, are less vulnerable to recent economic shocks 

because they tend to carry little debt and consume relatively little energy. 

Equity Market Volatility. The notion that New Economy 

firms are less vulnerable to the effects of higher energy 

costs and higher interest rates may be one of the reasons 

that equity shares of firms in the technology sector 

began to dramatically outperform the broader market, 

beginning around the middle of 1999. Chart 8 shows 

that the technology-heavy NASDAQ index performed 

more or less in tandem with the Dow Jones Industrial 

Average between the end of 1996 and the middle of 

1999, but thereafter the NASDAQ soared far ahead of 

the Dow. Between October 1, 1999, and February 29, 

2000, the NASDAQ rose by 72 percent while the Dow 

declined by 4 percent. Moreover, this striking divergence between the equity returns of Old and New Economy companies was not limited to the U.S. markets. 

Parallel trends were observed in Europe, Japan, Korea, 

21 Bloomberg. The S&P 500 airline industry is composed of AMR 

Corp., Delta Air Lines, Southwest Airlines, and U.S. Airways Group. 

CHART 8 

and Hong Kong. The similarity in performance of the 

high-tech sectors across three continents suggests a 

worldwide flow of liquidity from investors to the shares 

of technology firms. 

However, emerging concerns about the technology sector contributed to significant volatility in technology 

0 

50 

100 

150 

200 

250 

300 

350 

400 

4Q96 4Q97 4Q98 4Q99 

Source: Bloomberg 

Tech Stocks Have, Until Recently, Far 

Outperformed “Old Economy” Stocks Worldwide 

January 1997 = 100 

United States 

NASDAQ 

DJIA 

May 12, 2000 

0 

200 

400 

600 

800 

1,000 

4Q96 4Q97 4Q98 4Q99 

Source: Bloomberg 

January 1997 = 100 

EASDAQ 

Bloomberg European 500 

May 12, 2000 

Europe 

0 

50 

100 

150 

200 

250 

300 

January 1997 = 100 

Japan 

4Q96 4Q97 4Q98 4Q99 

Source: Bloomberg 

JASDAQ 

Nikkei 225 

May 12, 2000 

Memphis Regional Outlook 22 Second Quarter 2000 
In Focus This Quarter
 

shares during March and April 2000. The NASDAQ 

index lost 30 percent of its value between March 10 and 

May 12, 2000. Analysts cited the Justice Department 

finding against Microsoft and doubts about the ultimate 

profitability of business-to-consumer Internet firms as 

two factors in the sell-off. 

Equity market volatility also poses a threat to the economic outlook. One concern is the so-called “wealth 

effect” that a declining stock market may have on consumer spending. Since 1995, rising stock prices have 

helped raise the market value of equities held by U.S. 

households, plus their holdings of mutual funds, by 

some $5.7 trillion. This windfall is an important reason 

that households have continued to reduce annual personal savings (to just 2.4 percent of disposable income 

in 1999) and increase spending on homes, autos, and 

other consumer goods. Although it is uncertain what 

effect a prolonged stock market correction might have 

on consumer spending, the potential wealth effect has 

surely grown as more households hold a higher percentage of wealth in corporate equities and mutual fund 

shares. (See the inset box at right for a discussion of 

how financial market volatility could affect banks.) 

The Economic Outlook 

Despite the effects of rising energy costs, increasing 

interest rates, and equity market volatility, the U.S. 

economy continues to grow at a robust pace. The consensus forecast of 50 corporate economists surveyed by 

the May 1999 Blue Chip Economic Indicators suggests 

that the economy will grow by 4.7 percent in 2000, 

while consumer prices are projected to rise by 3.0 percent from 1999 levels. Short-term interest rates are projected to rise only slightly by year-end from early May 

levels. In short, the consensus forecast indicates that the 

New Economy formula of rapid economic growth combined with low inflation will continue for the foreseeable future. If actual events conform to this forecast, the 

result will likely be another year of generally low loan 

losses and solid earnings for much of the banking 

industry. (See the inset box on the following page for a 

discussion of other risks to watch in banking.) 

Clearly, risks are associated with the economic outlook. 

Recently, higher oil prices and higher interest rates have 

been the most visible signs of trouble for the economy. 

New Economy companies may be less vulnerable to 

these effects, but even these firms have experienced a 

sharp decrease in equity valuations as investors reevalFinancial Market Volatility Could 

Pare Earnings for Banks Most 

Reliant on Market Sources of 

Revenue 

FDIC-insured banks are deriving an increasing proportion of earnings from noninterest sources (see 

Chart 9), particularly market-sensitive sources of revenue. This is especially true for larger institutions. 

According to Deutsche Banc Alex. Brown, the 18 

most active generators of market-sensitive sources of 

revenue earned over 25 percent of net operating revenue from these potentially volatile business lines.22 

While market-sensitive sources help to diversify revenue streams, they can also introduce increased 

income volatility in the event of financial market turbulence. Deutsche Banc Alex. Brown also reports that 

for those 18 banks that generated the largest amounts 

of market-sensitive revenues during the third quarter 

of 1998, the share of total revenue derived from 

market-sensitive sources declined from 23 percent to 

13 percent. Thus, a more sustained downward trend in 

the financial markets could particularly affect the 

earnings of large banking companies that rely heavily 

on income from sources such as venture capital, asset 

management and brokerage services, and investment 

banking. 

CHART 9 

15 

30 

45 

60 

75 

90 

1970s 1980s 1990s 

Noninterest Revenues Account for a Growing 

Share of Bank Net Operating Revenue 

Percentage of Net Operating Revenue* 

* Net operating revenue is the sum of net interest income and 

noninterest income. 

Sources: FDIC Historical Statistics on Banking; FDIC Quarterly Banking 

Profile 

Net Interest Income Noninterest Income 

0 

22 Net operating revenue is the sum of interest income and 

noninterest income less interest expense. According to 

Deutsche Banc Alex. Brown, these companies are Bank of 

America Corporation; Bank of New York Company, Inc.; 

Bank One Corporation; Bank Boston; BB&T Corporation; 

Chase Manhattan Corporation; Citigroup, Inc.; First Union 

Corporation; FleetBoston Financial; JP Morgan; KeyCorp; 

Mellon Financial Corporation; National City Corporation; 

PNC Bank Corp.; SunTrust Banks, Inc.; US Bancorp; 

Wachovia Corporation; and Wells Fargo & Company. 

Memphis Regional Outlook 23 Second Quarter 2000 
In Focus This Quarter
 

Other Risks to Watch in Banking
 

Subprime Lending 

•	 Subprime consumer loan portfolios contributed to 

the large losses associated with recent high-cost 

bank failures. During 1999, the FDIC reported the 

first annual loss for the Bank Insurance Fund since 

1991. The loss was primarily the result of an uptick in 

unanticipated and high-cost bank failures. FDICinsured institutions with at least 20 percent of Tier 1 

capital in subprime loans accounted for 6 of the 13 

bank failures that occurred between January 1998 and 

March 2000. Fraud and inappropriate accounting for 

residuals also played a role in some of these failures.23 

•	 Subprime lending remains an area of concern. 

Insured depository institutions that engage in subprime lending represent a disproportionate share of 

problem institutions. Of the 79 banks and thrifts on 

the problem bank list as of year-end 1999, 21 percent 

were institutions with at least 20 percent of their Tier 

1 capital in subprime loans.24 

Agricultural Lending 

•	 While a majority of agricultural institutions remain 

relatively strong, external conditions have put pressure on some agricultural producers. Many agricultural areas are experiencing low commodity prices as 

well as weather- and disease-related problems. Strong 

global competition and high worldwide production 

over the past several years have resulted in increasing 

inventories of many crops and poor prospects for a 

price turnaround in the near term. Moreover, in spite 

of record government farm payments in 1999, the 

U.S. Department of Agriculture projects that in the 

year 2000 one in four farms will not cover cash 

expenses, up to 20 percent of farmers will experience 

repayment problems, and 5 percent of farmers will be 

“vulnerable.”25 

23 See Puwalski, Allen. FDIC Division of Insurance. Second 

quarter 1998. Gain-on-Sale Accounting Can Result in Unstable 

Capital Ratios and Volatile Earnings. Regional Outlook. http:// 

fdic01/division/doi/outlook/2q1998/atlanta/infocus1.html. 

24 The problem bank list includes all insured depository institutions rated a composite “4” or “5.” 

25 “Vulnerable,” as defined by the U.S. Department of Agriculture 

Economic Research Service, applies to institutions that have 

debt/asset ratios above 0.40 and negative income such that they 

cannot meet current expenses or reduce existing indebtedness. 

•	 Some signs point to growing stress for agricultural 

institutions. Forty-two percent of FDIC-supervised 

banks active in agricultural lending showed a moderate or sharp increase in the level of carryover debt 

during third quarter 1999, compared with just 26 percent during third quarter 1998.26 In addition, net loan 

loss rates for agricultural production loans increased 

in 1999 to the highest level since 1991. However, at 

0.32 percent, the 1999 net loss rate is just one-tenth 

the rate experienced during the height of the agricultural crisis of the mid-1980s.27 

Operational Risk 

•	 Operational risks are becoming more prominent in 

the banking industry. Driven by consolidation and 

expansion into new product lines and markets, financial institutions are seeing an increase in operational 

complexity. Operational risk encompasses a host of 

factors not related to credit or market activities, 

including risks associated with processing transactions, legal liability, fraud, strategic missteps, and 

internal control weaknesses. Operational risks tend to 

be more pronounced when institutions engage in 

rapid growth, far-flung operations, and complex business processes. 

•	 Greater attention is being paid to operational risks 

in the financial industry. Recently, analysts have 

noted that the pressure to meet ambitious postmerger 

earnings predictions can result in cost-cutting measures that jeopardize the comprehensiveness and 

integrity of risk-management systems. In addition, 

the role that fraud has played in recent bank problems 

and failures reinforces the importance of adequate 

internal controls and audit procedures. The significance of operational risks to financial institutions has 

been noted in industry surveys and informationsharing efforts among financial firms.28 NetRisk Inc., 

a Greenwich, Connecticut, consulting firm, recently 

estimated that operational losses among financial 

institutions have exceeded $40 billion over the past 

five years. 

26 September 1999. FDIC Report on Underwriting Practices. 27 See Anderlik, John M., and Jeffrey W. Walser. FDIC Division of 

Insurance. Third quarter 1999. Agricultural Sector Under Stress: 

The 1980s and Today. Regional Outlook. http://www.fdic.gov/ 

bank/analytical/regional/ro19993q/kc/agricult.html. 

28 For additional detail, see March 2000. Operational Risk: The 

Next Frontier. RMA/PricewaterhouseCoopers Survey. April 6, 

2000. Tech Bytes: Banks Join Forces Against Operational Risk. 

American Banker. 

Memphis Regional Outlook 24	 Second Quarter 2000 
In Focus This Quarter
 

uate the long-term prospects. Equity market volatility 

threatens to dampen consumer confidence and the ability of businesses to continue to merge, restructure, and 

invest. 

The economy has become particularly dependent on 

financing delivered through the capital markets. In this 

more permissive financial environment, rising debt levels and greater dependence on foreign capital have 

emerged as financial imbalances that may contribute to 

future problems for the economy. Businesses and 

households with high levels of debt are more vulnerable 

to problems if interest rates continue to rise or income 

growth falters. Rapid credit creation by the domestic 

financial sector suggests the possibility of lax credit 

underwriting standards. Reliance on foreign capital 

raises concerns about what would happen to the value of 

the dollar and to domestic inflation if foreign investors 

decide to invest elsewhere. 

Some analysts suggest that the New Economy, driven by 

increased productivity, heightened competition, and 

robust investment, may be characterized by longer 

expansions. Financial market imbalances may, however, 

contribute to deeper recessions and more sluggish 

recoveries compared with earlier business cycles. 

For the banking industry, it is clear that a recession 

would mean slower loan growth, deteriorating credit 

quality, and impaired profitability. But the biggest 

threat to the banking industry is a recession that is tied 

to disruptions in the financial markets. The ready availability of financing to start new businesses and restructure old businesses has been key to the New Economy. 

The process by which businesses have invested and 

restructured in response to competition has been orderly from the perspective of bank creditors. If this 

process should be disrupted, we could see a much more 

disorderly process, with more bankruptcies and higher 

losses to lenders. 

This article was prepared and coordinated by the management and staff of the Analysis Branch of the Division of 

Insurance. Contributions and feedback from analysts across the Division were essential to its completion. 

Maureen E. Sweeney, Associate Director 

Paul C. Bishop, Senior Financial Economist 

Richard A. Brown, Chief, Economic and Market Trends Section 

Steve Burton, Senior Banking Analyst 

Steven C. Cunningham, formerly Chief, Financial Institutions Section 

Alan Deaton, Economic Analyst 

Diane Ellis, formerly Senior Financial Analyst 

Mary L. Garner, Senior Financial Analyst 

Brian Kenner, Financial Analyst 

Thomas A. Murray, Senior Financial Analyst 

Allen Puwalski, Senior Financial Analyst 

Arlinda Sothoron, Senior Financial Analyst 

Ronald Spieker, Chief, Regional Programs and Bank Analysis 

Memphis Regional Outlook 25 Second Quarter 2000 
✁
 

Subscription Form
 

To obtain a subscription to the FDIC Regional Outlook, please print or type the following information: 

Institution Name __________________________________________________________________________ 

Contact Person __________________________________________________________________________ 

Telephone __________________________________________________________________________ 

Street Address __________________________________________________________________________ 

City, State, Zip Code __________________________________________________________________________ 

Please fax or mail this order form to:	 FDIC Public Information Center 

801 17th Street, N.W., Room 100 

Washington, D.C. 20434 

Fax Number (202) 416-2076 

Please indicate below each Region’s issue you wish to receive: 

Atlanta _________ Dallas _________ New York _________ National _________ 

Boston _________ Kansas City _________ San Francisco _________ All _________ 

Chicago _________ Memphis _________ 

Federal Deposit Insurance Corporation 

Washington, DC 20429-9990 

OFFICIAL BUSINESS 

PENALTY FOR PRIVATE USE, $300 

BULK RATE
 

MAIL
 

Postage &
 

Fees Paid
 

FDIC
 

Permit No. G-36