Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION THIRD QUARTER 1999 

FDIC
 

Atlanta
 

Region
 

Division of
 

Insurance
 

Jack M.W. Phelps,
 

Regional Manager
 

Scott C. Hughes,
 

Regional Economist
 

Pamela R. Stallings,
 

Senior Financial
 

Analyst
 

W. Brian Bowling,
 

Senior Financial
 

Analyst
 

In Focus This Quarter 

◆ Falling Prices in Commodities and Manufacturing Pose Continuing 

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

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

industries that produce standardized products and face global competition, mostly 

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

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

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

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

persist. See page 3. 

By Richard A. Brown and Alan Deaton 

◆ Shifting Funding Trends Pose Challenges for Community Banks— 

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

traditional measures of liquidity and liability composition for commercial banks 

reflected record-low levels of deposit funding at year-end 1998. The need to augment 

lagging deposit growth to meet loan demand has led many community banks to seek 

more wholesale funding sources, particularly borrowings. If the trend toward greater 

reliance on nondeposit funding continues, liability management may become more 

important and more challenging for community banks that have historically relied 

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

By Allen Puwalski and Brian Kenner 

Regional Perspectives 

◆ Agricultural and industrial commodity price declines are adversely 

affecting some Atlanta Region producers—Hog, soybean, and cotton prices 

have fallen sharply in recent years as a result of low inflationary expectations, excess 

productive capacity, and weakened global demand. Lower prices have led to reduced 

farm income and employment in some parts of the Region. Industrial commodities 

such as steel, textiles and apparels, and pulp and paper also have been hurt by a 

strong U.S. dollar and financial turmoil overseas. While the Region’s overall economy remains strong, the troubled agricultural and manufacturing sectors are largely 

concentrated in less diverse rural areas where economic growth has been much slower. Persistent price stagnation could lead to further financial stress in these areas, 

which could negatively affect credit quality at some insured institutions. See page 18. 

◆ Bank funding has changed considerably during this economic 

expansion and differs from previous cycles—Loan demand has outpaced 

deposit growth at Atlanta Region commercial banks since the current economic 

expansion began in 1992. This situation has led to an increase in noncore funding, 

particularly borrowings, at both large and small banks.A more diverse funding mix 

may offer advantages with regard to asset and liability management, but it also raises some new potential risks. Many industry observers believe funding issues represent a major long-term challenge to the industry and one that is likely to affect 

community banks more than large banks. See page 22. 

By Atlanta Region Staff 

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

Insurance Corporation for the following eight geographic regions: 

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

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

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

Dallas Region (CO, NM, OK, TX)
 

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

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

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

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

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

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

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

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

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

jphelps@fdic.gov. 

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

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

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

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

the Federal Deposit Insurance Corporation. 

Chairman Donna Tanoue 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Publications Manager Teresa J. Franks 
In Focus This Quarter
 

Falling Prices in Commodities and Manufacturing 


Pose Continuing Risks to Credit Quality
 

•	 Prices have fallen sharply across a wide range of 

commodities and manufactured goods. 

•	 Signs of stress are apparent in some industry 

sectors. 

•	 These trends are contributing to rising credit risk 

for insured institutions. 

•	 Effects on local economies and community banks 

could grow if low prices persist. 

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

Economic activity grew in 1998 at an inflation-adjusted 

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

and extend the expansion into its ninth consecutive year. 

However, one downside of low inflation has been that 

firms in certain commodity industries have encountered 

slow or negative growth in revenues because of the low 

prices they receive for their products. 

Commodity industries are defined in this article as a 

collection of agricultural, mining, and manufacturing 

industries that produce standardized products and face 

global competition, mostly on the basis of price. Since 

the beginning of 1997, price weakness has extended 

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

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

become apparent. 

The potential importance of problems in commodity 

industries to the FDIC was illustrated by the banking 

problems related to oil and agriculture during the 1980s 

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

FDIC Division of Research and Statistics, regional 

economic dislocations related to declining farmland 

values and declining oil prices contributed to large 

increases in credit losses and the eventual failure of 

hundreds of federally insured banks and thrifts. The 

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

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

1980s—but exposures to commodity industries remain 

important for many insured institutions. 

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

industry-sector problems are important in banking. It 

takes a high-level approach, emphasizing the economic 

fundamentals that are driving prices across the economy 

while ignoring many of the industry-specific factors 

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

on bank credit quality if they persist through 1999 and 

beyond. 

Prices Have Been Declining across a Range 

of Commodities and Manufactured Goods 

Low inflation has been a boon for consumer spending 

and business investment during the economic expansion 

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

Index had risen at an annualized rate of less than 2.0 

percent for 8 consecutive quarters and at an annualized 

rate of less than 4.0 percent for 

33 consecutive quarters. The 

prices of many popular and 

essential consumer goods— 

from computers to gasoline— 

have generally fallen throughout 

the decade, even as the prices of 

most services continue to rise 

steadily. Businesses, too, have 

benefited from the ability to 

purchase goods cheaply, as well as from the generally 

low interest rates that have accompanied low inflation. 

The declining average wholesale price of goods is 

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

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

components since the beginning of 1997. The PPI 

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

the beginning of 1997 has been led by falling prices for 

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

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

declines for 26 consecutive months through May 1999. 

Atlanta Regional Outlook 3	 Third Quarter 1999 
In Focus This Quarter
 

CHART 1	 CHART 2 

Widespread Pricing Pressures Are Evident in the 

Components of the Producer Price Index 

Percent Change in Selected Components of the Producer Price 

Index, January 1997 to May 1999 

–45 

–40 

–35 

–30 

–25 

–20 

–15 

–10 

–5 

0 

Agricultural Prices Are Down Sharply Since 1997 

Percent Change in Reported Price Between 

January 1997 and May 1999 

Source: Wall Street Journal (Haver Analytics) 

Cotton 

Corn 

Hogs 

Wheat 

10 

5 

0 

–5 

–10 

–15 

–20 

–25 

–30 

–35 

–40 

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

Iron & SteelPetroleumProductsMining 

3.3 

–4.0 

0.6 –1.9 –2.5 –2.5 

–10.0 

–19.8 

–33.2 

Although they are only indirectly included in the PPI 

numbers, the prices of several important agricultural 

commodities have also fallen substantially. Chart 2 

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

percent since January 1997, with the price of corn, 

hogs, and cotton also registering double-digit rates of 

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

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

wheat, and cotton continued to decline through May 

1999. 

Reasons for Broad-Based Commodity 

Price Weakness 

Pricing trends in disparate industries such as electronics 

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

industry-specific factors. For example, weather patterns 

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

the demand for a product or its cost of production, 

thereby influencing its market price. For example, 

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

silicon wafers—have significantly increased production 

yields in that industry during the 1990s.1 

However, the pervasiveness of recent price declines 

across a wide range of commodities and manufactured 

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

Surveys, May 27, 1999, p. 4. 

goods suggests that a number of common factors are 

driving prices lower: 

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

Disinflation has profoundly altered the expectations 

of investors, consumers, and businesses, and in the 

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

result, commodities have lost much of their appeal 

as a hedge against inflation. This has contributed to 

a decline of more than 50 percent in the price of 

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

power they must continually cut costs to remain 

competitive. 

•	 Overcapacity because of large-scale investment. 

Global investment in productive capacity accelerated 

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

firms have implemented new technologies and 

moved their operations closer to their markets or to 

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

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

facilities in the emerging markets of Asia and Latin 

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

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

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

November 1998, pp. 28–31. 

Atlanta Regional Outlook 4	 Third Quarter 1999 
In Focus This Quarter
 

could exceed demand by more than 20 million units 

annually by 2000.3 A similar situation has developed 

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

and 1996, contributing to a glut of memory chips and 

plunging prices.4 

•	 Curtailed global demand in the wake of emerging 

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

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

demand for new cars in Korea fell by 50 percent in 

1998.5 Asia received approximately 30 percent of 

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

demand since then has contributed to a sharp decline 

in global grain prices. The slowdown of economic 

activity in crisis countries and the resulting decline 

in their demand for imports is only one factor that 

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

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

its currency experience a reduction in the price of 

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

businesses that sell their goods in global markets. 

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

economies may soon begin to recover. However, the 

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

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

and businesses that participate in commodity industries 

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

Signs of Stress Are Showing 

for Affected Industry Sectors 

As commodity prices continue to stagnate, signs of 

stress are emerging among firms in the commodity 

industries. A long-term trend toward reduced levels of 

employment in manufacturing has accelerated in the 

midst of the current economic expansion. Chart 3 shows 

that employment levels declined in a wide range of 

commodity industries in the 24 months ending in May 

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

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

5 Barbara McClellan (1998).
 

CHART 3 

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

Employment Levels Have Declined across a Wide 

Range of Commodity and Manufacturing Sectors 

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

of payroll employment in agriculture and agricultural services 

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

Electronics and Semiconductors 

Textiles 

Autos 

Primary Metals/Iron and Steel 

Chemicals 

Oil and Gas 

Mining 

Lumber and Paper 

Agriculture* 

–20 –15 –10 –5 0 

1999. The total manufacturing sector lost more than 

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

jobs were lost in the mining sector, which includes oil 

and gas extraction. The trend toward lower levels of 

employment in mining and manufacturing not only 

reflects pricing pressures but also attempts by firms in 

these sectors to maintain profitability by investing in 

labor-saving technologies. 

The profit picture has begun to deteriorate as well for 

firms operating in commodity industries. Four-quarter 

trailing earnings through March 1999 for oil-sector 

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

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

earnings of steel firms fell by almost 32 percent. The 

losses experienced by firms in some of these industrial 

sectors extended to the farm sector as well, where net 

CHART 4 

–50 –40 –30 –20 –10 0 10 20 

Agriculture* 

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

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

Earnings Have Declined across a Wide Range 

of Commodity and Manufacturing Sectors 

Oil and Gas 

* 1998 percent change in net farm income 

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

Lumber and Paper 

Mining 

Chemicals 

Primary Metals/Iron and Steel 

Autos 

Textiles 

Electronics and Semiconductors 

Atlanta Regional Outlook 5	 Third Quarter 1999 
In Focus This Quarter
 

incomes fell by more than 7 percent in 1998, according 

to the U.S. Department of Agriculture. 

Affected Industries Have Found Ways to Cope 

with Pricing Pressures Thus Far 

Despite the signs of stress in industries where prices are 

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

have shown themselves to be fairly resilient thus far in 

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

to keep their operations running even if they were not 

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

Practices shows that 29 percent of FDIC-supervised 

agricultural lenders reported at least a moderate 

increase in carryover debt during the six-month period 

ending in March 1999, compared with only 10 percent 

in March 1998. Although the use of carryover debt is 

not an uncommon practice in agriculture, it indicates 

that low prices and declining subsidies have contributed 

to financial stress for farmers. 

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

Chart 5 follows trends in annual total revenue and costs 

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

commodity industries. It shows that growth in revenue 

and costs slowed noticeably in 1997. Both revenue and 

costs in these sectors declined in 1998, illustrating that 

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

sector is further illustrated by a steady decline in the 

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

CHART 5 

U.S. Corporations Operating in 

Commodity Industries Have Trimmed 

Costs to Offset Falling Revenue* 

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

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

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

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

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

Source: Bureau of the Census (Haver Analytics) 

1992 1993 1994 1995 1996 1997 1998 

Billions of Dollars 

Costs 

Revenues 

1,250 

1,450 

1,650 

1,850 

2,050 

2,250 

by the first quarter of 1999. Falling unit labor costs 

means that the productivity of manufacturing workers is 

rising faster than the cost of their services. This trend 

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

Cost savings and industry consolidation have been 

accomplished in part through mergers. According to 

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

trillion in 1998, an increase of more than 80 percent 

from 1997 levels. Both the number and dollar volume of 

mergers announced in 1998 far exceeded the volumes 

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

of the largest mergers announced in 1998 involved 

firms looking for ways to increase market share and cut 

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

Exxon-Mobil transaction announced in December 

1998. Furthermore, merger activity recorded in early 

1999 suggests that total merger volume for the year 

could exceed the record pace of a year ago. 

Industries plagued by oversupply and weak prices 

require consolidation to reduce capacity and improve 

profit margins. Mergers and acquisitions represent a 

fairly orderly way for firms operating in a troubled 

industry to consolidate on their own terms. Bankruptcy 

filings are an alternative means for severely troubled 

firms to reduce capacity and achieve consolidation 

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

employment (such as those documented in Chart 3). 

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

preferable to a disorderly shakeout of firms through 

bankruptcies. 

Recent favorable capital market conditions have 

allowed firms in troubled industries to consolidate 

through mergers. Acquisitions are sometimes financed 

through corporate borrowings or, more commonly, by 

swapping equity shares that have been rising in value 

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

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

and leveraged lending related to mergers and acquisitions reached a 

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

market for that period. 

Atlanta Regional Outlook 6 Third Quarter 1999 
In Focus This Quarter
 

orderly process, associated with record-high merger and 

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

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

financial market conditions characterized by sharply 

higher interest rates, lower stock values, or both could 

inhibit the ability of businesses to restructure and retool 

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

bankruptcies and losses to lenders. 

Signs Point to Rising Credit Risk 

in the Commodity Industries 

In dollar terms, the largest commercial bank exposures 

to the commodity industries are in the portfolios of 

large banks. Chart 6 provides an estimated breakdown 

of the aggregate exposure of insured institutions to 

commodity industries based on corporate balance sheet 

information collected by the Bureau of the Census.7 The 

chart shows that the aggregate exposure of the bank and 

thrift industries to these sectors is approximately $206 

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

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

CHART 6 

Commodity Industries Make Up
 

Over One-Quarter of Bank C&I Loans
 

to Corporate Borrowers
 

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

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

Electronics 

4.2% 

Chemicals* 

9.5% All Other 

73.5% Textiles
 

1.2%
 

Iron & Steel 

1.1% 

Automobiles 

1.7% 

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

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

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

Bureau of the Census. 

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

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

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

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

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

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

to firms operating in the manufacturing sector. 

A rough indicator of recent trends in the credit risk 

associated with bank loans to commodity industries can 

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

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

for firms operating in commodity industries compared 

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

chart shows that while the median EDF for commodity 

industries has consistently exceeded the median for all 

other firms in the recent past, this difference has 

widened appreciably since the middle of 1998. Over the 

past year, the median EDF for commodity industries has 

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

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

increased probability of default among firms operating 

in commodity industries. 

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

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

value. 

CHART 7 

The Default Risk of Firms Operating 

in Commodity Industries Has 

Risen over the Past Year 

Median Expected Default Frequency (EDF)* 

(Probability that a Firm Will Default on Bond 

Obligations within One Year) 

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

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

changes in market value. 

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

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

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

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

products; and textiles. 

Source: KMV Corporation 

0.0 

0.5 

1.0 

1.5 

2.0 

2.5 

Firms in Other Industry Sectors 

Firms in Commodity Industries 

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

Atlanta Regional Outlook 7 Third Quarter 1999 
In Focus This Quarter
 

Effects on Local Economies and 

the Banks That Operate in Them 

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

heavily on these sectors for employment and income. In 

the 1980s, problems in the agricultural and oil sectors 

kicked off a “rolling recession” that spread through the 

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

to the failure of hundreds of FDIC-insured banks 

between 1984 and 1990.9 Similarly, declining oil prices 

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

insured banks and thrifts in Texas, Oklahoma, 

Louisiana, and other states, while the attempts of some 

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

problems can affect local economies and bank credit 

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

significant lag between the onset of industry-sector 

problems and the emergence of performance problems 

9 Federal Deposit Insurance Corporation, Division of Research and
 

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

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


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

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


and 9.
 

TABLE 1 

in the banking industry. Although banks with direct 

credit exposures to a troubled industry are likely to be 

affected first, virtually all banks that operate in areas 

that are heavily dependent on a troubled sector will 

eventually have to contend with the indirect effects on 

the local economy. 

To evaluate the extent of local economic effects that 

might have resulted from the recent adverse trends in 

the commodity industries, we have conducted analysis 

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

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

might be affected by these trends; instead, this analysis 

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

commodity industries and determines if these counties 

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

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

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

moderately lower job growth and higher unemployment 

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

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

86,055 for all U.S. counties. 

U.S. Counties Most Concentrated in Commodity Industries 

by 1998 Payroll Employment 

NUMBER OF 

PERCENT OF COUNTIES WITH 

1998 COUNTY EMPLOYMENT 

EMPLOYMENT IN CONCENTRATION STATES WITH THE MOST 

THE INDUSTRY IN 1998 DESIGNATED COUNTIES 

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

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

OIL AND GAS >5 83 TX, OK, LA 

CHEMICALS >5 46 TN, IL, NC, TX 

STEEL >5 70 KY, OH, AR, IN 

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

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

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

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

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

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

Atlanta Regional Outlook 8 Third Quarter 1999 
In Focus This Quarter
 

TABLE 2 

Relative Economic Performance of Counties 

Most Concentrated in Commodity Industries 

1998 AVERAGE 1998 AVERAGE 

EMPLOYMENT GROWTH (%) UNEMPLOYMENT RATE (%) 

AGRICULTURE 1.1 4.8 

LUMBER AND PAPER 1.3 6.9 

OIL AND GAS 1.4 5.6 

CHEMICALS 1.3 6.0 

STEEL 1.7 5.6 

AUTOS 1.8 4.4 

TEXTILES 0.9 5.1 

ELECTRONICS AND SEMICONDUCTORS 1.9 3.7 

Any Commodity Industry 1.3 5.5 

All U.S. Counties 1.6 5.1 

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

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

decades. On the whole, the economic picture did not 

noticeably deteriorate in 1998 for the concentrated 

counties. Average unemployment declined in 1998 for 

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

counties except textile counties. These data indicate that 

while recent problems in the commodity industries 

might be having severe effects in specific areas, these 

problems had not translated into a broader weakening of 

economic performance through the end of 1998. 

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

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

thrifts identified as having at least 25 percent of their 

deposits in at least one of the concentrated counties as 

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

for concentrated counties overall was higher than the 

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

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

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

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

in one or more concentrated counties and meeting all the selection 

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

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

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

indicate that institutions operating in agricultural and 

oil and gas counties tend to have more problem credits 

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

December 1998, the average noncurrent loan ratio 

jumped from 4.8 percent to 6.1 percent for institutions 

operating in agricultural counties, while the average 

ratio rose from 2.7 percent to 3.8 percent for institutions 

operating in oil and gas counties. 

These results indicate that while profitability in 1998 

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

rise in agricultural and oil and gas counties. However, 

because this analysis relies on annual data that extend 

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

test for the local effects of problems in the commodity 

industries. There is every reason to expect these credit 

problems to intensify over time if commodity prices 

remain low.14 These considerations suggest that bankers 

in commodity-dependent counties should continually 

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

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

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

14 For more information on how the agricultural outlook could affect 

FDIC-insured institutions, see the statement of FDIC Chairman 

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

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

speeches/99spchs/spc13apr.html. 

Atlanta Regional Outlook 9 Third Quarter 1999 
In Focus This Quarter
 

TABLE 3 

Relative Financial Performance of Insured Institutions Operating in Counties 

Most Concentrated in Commodity Industries 

NUMBER OF AVERAGE C&I AVERAGE AVERAGE NET 

BANKS WITH AT LOANS PAST DUE NONCURRENT C&I LOAN 

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

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

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

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

AGRICULTURE 416 5.08 6.12 1.58 1.16 

LUMBER AND PAPER 465 3.38 1.89 0.78 1.21 

OIL AND GAS 163 3.44 3.78 1.18 1.29 

CHEMICALS 81 2.47 2.97 0.79 1.18 

STEEL 186 2.53 2.06 0.59 1.08 

AUTOS 341 2.64 2.05 0.66 1.12 

TEXTILES 264 2.91 1.92 0.70 1.10 

ELECTRONICS AND 

SEMICONDUCTORS 107 2.71 2.36 0.68 0.87 

Any Commodity 

Industry 1,915 3.39 3.03 0.93 1.13 

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

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


C&I = Commercial and industrial.
 

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

Information System)
 

monitor their local economy for signs of stress related 

to problems in the commodity industries. 

Conclusion 

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

declining prices. This problem is not solely the result of 

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

stress among firms in these industries are apparent in 

the form of declining levels of employment and slow or 

negative profit growth. However, there are few signs to 

date of any disorderly industry shakeouts involving 

widespread business bankruptcies and losses to lenders. 

Thus far, most firms have managed to cope with 

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

associated with commodity industries may be on the 

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

dependent on these industries showed few signs of a 

widespread deterioration in the performance of their 

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

are signs of rising credit losses among local depository 

institutions in counties with the highest concentrations 

of agriculture and oil and gas extraction. A continuation 

of today’s weak pricing picture in these industries has 

the potential to result in higher credit losses for insured 

institutions during the next few years. 

Richard A. Brown, Chief, 

Economic and Market Trends Section 

Alan Deaton, Economic Analyst 

Atlanta Regional Outlook 10 Third Quarter 1999 
In Focus This Quarter
 

Shifting Funding Trends Pose Challenges 


for Community Banks 


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

asset growth with deposits in today’s marketplace. 

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

sources to meet loan demand. 

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

that have historically relied upon deposits for 

funding and net interest revenues for profitability. 

For the past few years, assets have been expanding 

faster than deposits at many commercial banks. The 

result is an increased reliance on equity and borrowings 

for funding. Since 1992, commercial bank assets have 

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

deposits. Traditional measures of liquidity and funding 

for commercial banks reflected record-low levels of 

deposit funding at year-end 1998. Large commercial 

banks have traditionally made greater use of nondeposit 

funding alternatives. However, many community 

banks,1 which have typically relied more on deposit 

funding, may face liability management challenges as a 

result of shifting funding trends. This article surveys the 

factors influencing the ability of banks to fund loan 

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

trends for community banks. 

Factors Influencing Deposit Funding Trends 

The percentage of commercial bank assets, particularly 

loans, funded with deposits has declined steadily in the 

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

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

level of these industry ratios is heavily influenced by 

larger banks, the trend toward lower deposit funding 

exists for both large banks and community banks and 

points to secular factors that are affecting banks’ ability 

to raise deposits in step with asset growth. 

Trends in Household Wealth Accumulation 

One factor affecting the ability of banks to attract 

deposits is the recent trend in the way households are 

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

capital gains on housing and investments, annual net 

purchases of new financial assets2 by households as a 

percentage of disposable income have actually trended 

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

A falling personal savings rate and fewer purchases of 

financial assets may suggest that households are more 

comfortable consuming a higher percentage of current 

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

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

deposits has been growing more slowly. 

Higher-Yielding Investment Alternatives 

At the same time that households have been setting 

aside less of their current income for savings, the share 

of total new household savings flowing into bank 

deposits has declined in the 1990s as competition from 

higher-yielding alternatives has increased. During the 

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

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

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

CHART 1 

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

Ratios Reflect Reduced Deposit


 Funding for Commercial Banks
 

Recession 

Ratio (%) Deposit-to-Asset Ratio 

90 

85 

80
 

75
 

70
 

65
 

60
 

55
 

50
 

Loan-to-Deposit Ratio 

’70 ’74 ’78 ’82 ’86 ’90 ’94 ’98 

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

Atlanta Regional Outlook 11	 Third Quarter 1999 
In Focus This Quarter
 

CHART 2 

Total Annual Additions* to Financial Assets 

of Households and Nonprofit Organizations 

Have Declined with Personal Savings Rate 

Percentage of Disposable 

Personal Income 

Net Acquisition 

15 

10 

5 

0 

20 

of Financial Assets 

Personal Savings 

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

* Excludes capital gains 

Sources: Federal Reserve Board; Flow of Funds 

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

has flowed into deposits during the 1990s, although an 

increasing proportion has been allocated to deposits in 

recent years. 

Not only do banks face intensifying competition from 

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

respondents in Grant Thornton’s 1999 Sixth Annual 

Survey of Community Bank Executives,3 but they also 

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

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

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

CHART 3 

face increasing competition from mutual funds and 

other nonbank financial service providers, such as credit unions. 

Mutual Funds. Increasingly, consumers are pursuing 

higher yields by investing in mutual funds. Beyond 

yields, however, many mutual fund companies also are 

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

check writing, automated teller machine cards, and 

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

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

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

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

prices, other measures indicate a shifting preference for 

mutual funds as a savings vehicle. For example, data 

from the Investment Company Institute show that net 

inflows into mutual funds have exceeded net increases 

in insured institution deposit accounts in all but three 

quarters during this economic expansion. Moreover, the 

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

increases in deposits for all FDIC-insured institutions. 

Credit Unions. In addition to mutual funds, credit 

unions also are formidable competitors for consumer 

savings. Membership in credit unions has increased 

more than 20 percent over the past decade, while 

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

1990 1998 

U.S. Government 

Securities
 

7%
 

Equities, Bonds, 

and 

Commercial 

Paper 44% 

Money Market 

Fund Shares 

5% 

Mutual Fund
 

Shares
 

6%
 

Bank Deposits 

(excl. Foreign) 

38% 

Money Market Mutual Fund 

Fund Shares Shares 

7% 22% 

Equities, Bonds, Bank Deposits 

and Commercial (excl. Foreign) 

Paper 35% 30% 

U.S. Government 

Securities
 

6%
 

Source: Federal Reserve Board 

Atlanta Regional Outlook 12 Third Quarter 1999 
In Focus This Quarter
 

cent.4 Credit unions also offer federal insurance on share 

accounts as well as competitive rates on comparable 

deposit-type vehicles relative to other types of financial 

institutions. For example, according to information from 

the National Credit Union Association, on average, 

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

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

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

certificates over the 12 months ending May 1999 were 

consistently higher than rates offered by banks or thrifts 

and approached retail rates offered by brokerages. 

Demographic Shifts 

Some analysts maintain that rural community banks 

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

of Kansas City, rural bankers perceive that sluggish 

deposit growth is at least partially attributable to the 

migration of deposits to cities as urban-dwelling heirs 

of rural depositors relocate funds. While evidence for 

this deposit migration remains anecdotal, economists at 

the Federal Reserve Bank of Kansas City indicate that 

the demographic shift is still in process, and its full 

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

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

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

CHART 4 

Bank One-Year CD Rates Have Recently Lagged
 

Those Offered by Competitors
 

Average Retail Rates Offered for 

One-Year Certificates (%) 

6.0 

3.0 

3.5 

4.0 

4.5 

5.0 

5.5 

Thrifts 

Credit Unions 

Banks 

Brokerages 

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

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

Sources: BanxQuote and Bank Rate Monitor 

savings in banks than their rural counterparts do.5 This 

trend poses additional consequences for bank deposits 

as rural populations migrate to suburban areas. 

Community Bank Funding Trends 

Community banks traditionally rely more heavily upon 

core deposit funding than larger banks do. For example, 

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

community bank assets were funded with core deposits 

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

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

deposits. This difference in liability structures reflects 

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

While large banks have responded to factors influencing deposit 

growth by making greater use of 

alternative funding sources, 

funding options for community 

banks tend to be more limited. 

Because of high fixed costs, community banks may find 

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

“Industry Consolidation Presents Unique Risks and 

Challenges for Community Banks,” Regional Outlook, 

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

The need to augment lagging deposit growth to meet 

loan demand has led many community banks to acquire 

more noncore funds. These funds include time deposits 

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

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

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

banks exceeded that threshold. Moreover, over the same 

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

as total deposits less time deposits greater than 

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

community banks declined each quarter. 

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

Rural Banks Facing Increased Funding Pressures? Evidence from 

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

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

Atlanta Regional Outlook 13 Third Quarter 1999 
In Focus This Quarter
 

CHART 5 

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

Large Banks Community Banks 

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

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

Source: Bank Call Reports (Research Information System) 

Other 

Domestic 

Deposits 

7% 

Borrowings 

16% 

Other 

Liabilities 

12% 

Equity and 

Subordinated 

Debt 

9% 

Core 

Deposits 

43% 

Foreign 

Deposits 

13% 

Other Domestic 

Deposits 

11% 

Borrowings 

6% 

Other 

Liabilities 

1% 

Equity and 

Subordinated Debt 

10% 

Core 

Deposits 

72% 

As community banks’ use of noncore funds has 

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

demand notes, and mortgages (collectively referred to 

as borrowings). After adjusting for mergers, borrowings 

funded 12 percent of new community bank asset growth 

from 1992 through 1998—three times more than the 

percentage of new asset growth funded by borrowings 

from 1985 to 1990. Possibly reflecting a shift toward 

greater acceptance of wholesale funding by community 

bankers, growth in borrowings has been largely driven 

by increased use of nonovernight borrowings,6 which 

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

community banks reporting nonovernight borrowings 

has doubled in the 1990s. This trend coincides with 

growing community bank membership in the Federal 

Home Loan Bank (FHLB) system and increasing use of 

FHLB borrowings. 

Federal Home Loan Bank Membership 

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

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

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

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

advances outstanding for community banks grew by 

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

6 Nonovernight borrowings are defined here as all borrowings other 

than federal funds purchased and repurchase agreements. 

FHLB advances represented approximately 80 percent 

of all nonovernight borrowings for community banks. 

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

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

growth, and leverage capital to maintain or boost 

returns on equity. Recent surveys indicate that FHLB 

advances will continue to have a role in community 

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

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

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

advances in 1999. Similarly, the American Bankers 

Association’s 1999 Community Bank Competitiveness 

CHART 6 

’97 

0 

10 

20 

30 

40 

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

The Percentage of Community Banks Reporting 

Nonovernight Borrowings* Is Rising 

Community Banks 

Reporting Nonovernight 

Borrowings (%) 

* Includes all borrowings other than federal funds purchased and repurchase 

agreements 

Source: Bank Call Reports (FDIC Research Information System) 

Atlanta Regional Outlook 14 Third Quarter 1999 
In Focus This Quarter
 

Survey7 reported that FHLB advances are the preferred 

nontraditional funding product. In addition, legislative 

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

$500 million, significantly increasing access to FHLB 

advances for smaller banks in rural areas. 

Implications of Funding Trends 

for Community Banks 

According to community banker opinion surveys, the 

trend toward greater reliance on noncore or alternative 

funding sources appears likely to continue. Grant 

Thornton’s 1999 Annual Survey of Community Bank 

Executives found that 75 percent of community bankers 

expect funding with core deposits to be more difficult in 

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

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

funding from deposits five years from now. Liability 

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

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

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

asset growth and net interest income for profitability. 

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

associated with wholesale funding sources. As shown in 

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

repurchase agreements, subordinated notes, and FHLB 

advances, have traditionally exceeded the interest cost 

of core deposits for commercial banks. Therefore, as 

institutions that have typically relied upon core deposits 

increase the use of nondeposit sources, funding costs 

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

interest margins (NIMs) may be pressured. 

To some extent bank managers may be able to offset the 

higher interest costs of wholesale funding strategy by 

improving efficiency through greater management of 

overhead expenses and increases in noninterest income. 

However, community banks face challenges to their 

ability to increase noninterest income (see “Industry 

Consolidation Presents Unique Risks and Challenges 

CHART 7 

Subordinated Debt 

FHLB Advances 

0 

1 

2 

3 

4 

5 

6 

7 

8 

’93 ’94 ’95 ’96 ’97 ’98 

Reported Interest Cost for Commercial Banks (%) 

Nondeposit Alternatives Have Typically Cost 

More than Core Deposits 

Federal Funds 

Core Deposits* 

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

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

deposits greater than $100,000. 

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

Home Loan Bank (FHLB) System Annual Reports 

’ 

for Community Banks,” Regional Outlook, Fourth 

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

banks are unable to fully offset higher funding costs 

with increases in noninterest income or reductions in 

noninterest expenses, overall profitability could suffer. 

Community bankers in the upper Midwest expressed 

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

percent of respondents expect the shift away from 

deposit funding to decrease bank profitability.8 As bank 

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

increase asset yields by pursuing additional portfolio 

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

higher asset yields. 

Funding challenges also could alter the liquidity and 

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

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

liquidity strains or exposures to changing interest rate 

environments. Strategies that result in the pledging of 

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

adversely affect a bank’s relative liquidity or interest 

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

nondeposit funding sources. For instance, some FHLB 

advances may contain embedded options that required 

greater expertise and attention to policies and practices 

that, if not managed properly, could lead to undesirable 

outcomes if interest rates change adversely. 

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

Atlanta Regional Outlook 15 Third Quarter 1999 
In Focus This Quarter
 

Differences between Community Banks with 

High and Low Levels of Core Deposit Funding 

To evaluate how a shift from a core deposit funding 

strategy might change the profile of a community bank, 

TABLE 1 

performance and condition measures for community 

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

funding. Table 1 compares 1998 funding, earnings, and 

asset performance measures for these community bank 

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

ALL COMMUNITY BANK COMMUNITY BANK 

COMMUNITY BANKS1 AGRICULTURAL LENDERS2 COMMERCIAL LENDERS3 

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

DEPOSIT DEPOSIT DEPOSIT DEPOSIT DEPOSIT DEPOSIT 

FUNDING4 FUNDING4 FUNDING FUNDING FUNDING FUNDING 

Selected Aggregate Measures 

NUMBER OF BANKS IN GROUP 405 405 106 51 126 185 

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

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

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

Selected Median Liquidity and Funding Measures (%) 

1998 GROWTH IN TOTAL ASSETS 9.02 11.16 5.96 6.42 12.75 18.50 

1998 GROWTH IN TOTAL DEPOSITS 9.74 8.79 6.40 5.31 13.56 11.93 

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

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

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

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

BORROWINGS TO TOTAL ASSETS RATIO 0 9.58 0 4.15 0 8.55 

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

Selected Median Performance Ratios (%) 

RETURN ON EQUITY 12.65 10.19 11.10 10.93 14.49 9.52 

RETURN ON ASSETS 1.07 1.04 1.01 1.19 1.10 0.92 

NET INTEREST MARGIN 4.76 4.03 4.51 3.98 5.25 4.22 

GROSS EARNING ASSET YIELD5 8.17 8.02 8.24 7.89 8.45 8.26 

COST OF FUNDING EARNING ASSETS6 3.33 4.07 3.74 4.05 3.21 4.05 

NONINTEREST INCOME TO AVERAGE ASSETS 0.76 0.61 0.59 0.44 1.01 0.64 

NONINTEREST EXPENSE TO AVERAGE ASSETS 3.49 2.90 3.23 2.40 3.99 3.12 

EFFICIENCY RATIO7 69.01 63.68 68.59 57.48 68.99 67.00 

Selected Median Credit Quality Measures (%) 

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

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

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

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

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

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

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

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

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

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

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

of all community banks.
 

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

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

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

FHLB = Federal Home Loan Bank
 

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


Atlanta Regional Outlook 16 Third Quarter 1999 
In Focus This Quarter
 

groups. High core deposit funders are defined as those 

community banks with core deposit-to-asset ratios in 

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

1998. Low core deposit funders are those community 

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

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

combined make up roughly 60 percent of each of the 

total community bank funding groups. 

This comparison reveals several differences. First, a 

tradeoff between heavy reliance on core funding and 

asset growth is evident. Median measures for the groups 

indicate that the typical bank that relies less on core 

deposit funding is larger and growing faster than the 

typical bank in the high core funding group. Second, 

less core deposit funding appears to be associated with 

a lower NIM, primarily the result of higher funding 

costs. However, overall profitability 

is similar between the groups 

mainly because of a lower ratio 

of overhead expenses to average assets for the low core 

funders. These characteristics are also evident across 

the agricultural and commercial specialists groups. 

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

higher asset yields resulting from increased portfolio 

risk are not evident, median measures for each low core 

funding group reflect higher levels of noncurrent loans 

and higher growth in nonperforming assets and net loan 

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

greater than 25 percent. 

part. For example, the median growth in nonperforming 

assets for commercial lending specialists with less 

reliance upon core deposits was nearly 24 percent in 

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

Summary and Conclusions 

Commercial banks have been experiencing a long-term 

trend toward lower deposit funding of loans and assets. 

Increasing competition among banks and from thrifts, 

nonbanks, and higher-yielding investment alternatives 

has made it more difficult and expensive for some 

banks to attract deposits in step with asset growth. 

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

(especially those located in areas characterized by 

aggressive competition and slow deposit growth), better 

matching of asset cash flows, and greater flexibility in 

asset-liability management, they also may pose certain 

risks. To some extent community banks may be able to 

manage noninterest expense and noninterest income to 

offset the relative increase in interest expense incurred 

to acquire nondeposit funding sources. However, if 

overall profitability suffers, banks may be tempted to 

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

may become more challenging for community banks 

that have historically relied upon deposits for funding 

and net interest revenues for profitability. In addition, 

the complexity of some nondeposit funding sources 

requires greater expertise and attention to policies and 

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

Allen Puwalski, Senior Financial Analyst 

Brian Kenner, Financial Analyst 

Atlanta Regional Outlook 17 Third Quarter 1999 
Regional Perspectives
 

Regional Perspectives
 

•	 Sustained agricultural and industrial commodity price weakness could adversely affect the Atlanta Region. 

Hogs, soybeans, and cotton are among the Region’s farm commodities that have witnessed significant price 

pressures in recent years. 

•	 In the industrial markets, steel, textiles and apparel, and pulp and paper producers experienced the effects 

of increased imports and weak export demand because of the strength of the dollar and the Asian economic 

crisis. 

•	 The disparity between loan and deposit growth during this economic expansion has resulted in an increase 

in borrowings at banks in the Region. Longer-term trends suggest that factors other than the business cycle 

may be affecting bank funding. 

Commodity Price Weakness Could Affect the Atlanta Region’s Economy
 

Price weakness in agricultural and industrial commodities markets is due to a number of factors, including low 

inflationary expectations, overcapacity resulting from 

excess investment, and curtailed global demand in the 

wake of emerging-market crises. For further analysis, see 

Falling Prices in Commodities and Manufacturing Pose 

Continuing Risks to Credit Quality, page 3. If sustained, 

commodity price weakness could adversely affect the 

Atlanta Region’s economy, given the importance of agriculture and manufacturing in the Region. 

Overall economic growth in the Atlanta Region remains 

strong. In April 1999, employment in the Region was up 

3.0 percent compared to the national increase of 2.3 percent. However, most gains were occurring in larger metropolitan areas, which have greater economic diversity. 

Rural and smaller metropolitan areas—where many of 

the industries facing price pressures are located—saw 

less pronounced growth. Persistent price stagnation 

could lead to further layoffs in manufacturing and 

financial stress on the Region’s farmers, and could ultimately affect credit quality. 

that in the fourth quarter of 1998, nominal farm income 

did rise, but this likely was the result of the approval of 

an additional $6 billion in federal farm aid in October 

1998.) Declines in agriculture income can have a ripple 

effect on rural communities as farmers scale back consumption and purchases of farm equipment. Long-term 

price declines also could affect farmers’ ability to service loans and ultimately could pressure farmland values, which are often used as collateral for loans. In the 

Atlanta Region, hog farming, soybeans, and cotton, all 

economically important sectors of agriculture, have 

experienced price declines. 

Hog farming has seen dramatic growth in the Atlanta 

Region in recent years, with every state in the Region 

CHART 1 

The Nation’s Farm Income and Agriculture Prices 

Have Moved Together in Recent Years 

120 50

Farm Price Index (1990–92=100)

Farm Proprietors’ Income with 

Inventory Valuation Adjustment 

and Capital Consumption Adjustment 

(Seasonally Adjusted Annual Rate), right axis 

Prices Received by Farmers: 

All Farm Products, left axis 

1Q	 

110 40

Farm Income ($ Billions) 

115 45

Agricultural Prices Continue to Decline 

Agriculture commodity prices have been declining 

since 1996. In the first quarter of 1999, prices for all 

farm products were down 5.2 percent from one year earlier and were 21 percent below their peak in the third 

105 

100 

95 

90 

2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q

quarter of 1996. According to Bureau of Economic ’96 ’96 ’96 ’96 ’97 ’97 ’97 ’97 ’98 ’98 ’98 ’98 ’99 

Analysis data, this decline in agriculture prices has been Source: U.S. Department of Agriculture, Bureau of Economic Analysis (Haver 

Analytics) paralleled by a drop in farm income (Chart 1). (Note 

Atlanta Regional Outlook 18 Third Quarter 1999 

35 

30 

25 

20 
Regional Perspectives
 

now engaged in the industry. The industry is most heavily concentrated in North Carolina, which accounted 

for 15.7 percent of the nation’s hog and pig inventory in 

1997; North Carolina inventories have tripled over the 

past 10 years, according to the U.S. Department of 

Agriculture (USDA). 

Considerable media attention was given to the dramatic 

hog price declines in late 1998. In December, hog prices 

stood at $13.79/cwt,1 less than half the level at the end 

of the third quarter of 1998 and the lowest level in more 

than three decades. Most analysts give hog farmers a 

break-even price of around $35/cwt. The dip has been 

transitory, however, as prices rebounded to nearly 

$37/cwt by May 1999. The recent volatility in hog 

prices likely was an aberration, as the pork industry was 

coming off a period of high production while slaughterhouse capacity was at low levels and thus unable to 

process pigs quickly. In that case, the recent sharp drop 

and recovery in prices, though causing short-term pain 

for the industry, may not affect hog farmers in the 

future. 

Despite the recent rebound, hog prices remain well 

below the year-ago level and below the long-term trend 

(Chart 2). According to data from the Wall Street Journal, since July 1988, the trend in hog prices has been 

slightly negative. Many analysts attribute the downward 

trend to structural changes in the industry. Technological and organizational (vertical integration and contracting) changes have resulted in a trend toward larger 

farms and greater specialization. Economies of scale 

1 cwt = 100 pounds. 

CHART 2 

Hog Prices Rebound but Remain 

that the larger farms enjoy have placed downward pressure on hog prices over the long term and may make it 

increasingly difficult for smaller producers to compete. 

Recent short-term price declines may have exacerbated 

competitive pressures on smaller producers. 

In recent years, supply and demand shifts have resulted 

in downward pressure on soybean prices. The United 

States and other nations, such as Brazil, have seen 

bumper crops, while the crisis in Asia has crimped 

demand. In May 1999, soybean prices fell to 

$4.53/bushel (Chart 3), down nearly 30 percent from 

one year earlier to their lowest level in more than 20 

years. According to the USDA, U.S. soybean production 

in 1999 may reach record levels, which may offset any 

improvement in Asian demand and lead to continued 

price weakness. The USDA forecasts soybean prices to 

level off at $4.35/bushel in 2000. In the longer term, 

U.S. farmers may face further global competition as foreign acreage and yields climb. In April 1999, a buyers’ 

group in North Carolina contracted to purchase 75,000 

tons of soybeans from Brazil for use as feed. According 

to a recent Wall Street Journal article, Brazil, seeing 

surging agricultural exports because of its recently 

devalued currency, may be able to open several million 

acres of land for soybean farming in its western savanna. The Atlanta Region’s soybean production is concentrated near coastal areas, particularly in eastern portions 

of the Carolinas. 

Price weakness persists in the cotton market. In May 

1999, the price of cotton was 56 cents/lb., down nearly 14 

percent from one year earlier and down nearly 50 percent 

from its previous peak in the summer of 1995 (Chart 3). 

CHART 3 

Soybean and Cotton Prices Continue to Decline 

$0 

$10 

$20 

$30 

$40 

$50 

$60 

$70

Hog Price: Iowa–South Minnesota Avg

($/cwt) 

Hog Price 

Trend: 1988–1999 

May 

’99 

Jul 

’88 

Jul 

’89 

Jul 

’90 

Jul 

’91 

Jul 

’92 

Jul 

’93 

Jul 

’94 

Jul 

’95 

Jul 

’96 

Jul 

’97 

Jul 

’98 

Below Long-Term Trend 

Jan Jul Jan Jul Jan Jul Jan Jul Jan May 

’95 ’95 ’96 ’96 ’97 ’97 ’98 ’98 ’99 ’99 

Cotton Price (cents/lb)

Soybean Price ($/bu) 

Price: Cotton, 1-1/16", Avg 7 Mkts (cents/lb) 

Price: Soybeans, #1 Yellow: Central IL ($/bu) 

120 

0 

20 

40 

60 

80 

100 

0 

2 

4 

6 

8 

10 

12 

Source: Wall Street Journal (Haver Analytics) Source: Wall Street Journal, Journal of Commerce (Haver Analytics) 

Atlanta Regional Outlook 19 Third Quarter 1999 
Regional Perspectives
 

Despite weak prices that are near or at the break-even CHART 4 

point, the USDA anticipates that farmers nationwide will Industrial Commodity Prices Remain Below 1995 continue to shift into cotton as competing crops are Peaks, Particularly in the Steel Industry 

expected to bring lower prices. Cotton farming in the 120 

Atlanta Region exists in all states except West Virginia, 

with production concentrated in Alabama, Georgia, and 

North Carolina. In 1998, poor weather and low prices 

aggravated the financial situation of many farmers in the 

Region, particularly in South Georgia. 

Potential implications for insured institutions will 

Price Index, 1995/01=100 110 

100 

90 

80 

70 

60 

Paper and Allied Products 

Textiles 

Scrap Steel 

depend on the magnitude and duration of the price 

declines in agriculture. If recent price declines prove to 

be transitory, many farmers may be able to meet current 

obligations by placing crops under marketing loans or 

having lenders capitalize interest on debt, according to 

a recent report from the College of Agricultural, Consumer, and Environmental Sciences at the University 

of Illinois at Urbana-Champaign. However, if the 

nation’s agricultural sector has entered a prolonged period of price stagnation, especially if it is accompanied by 

declines in farm property values, farm credit quality 

could deteriorate. In the Atlanta Region, agricultural 

credit risk is most heavily concentrated in Georgia, 

where 28 of the Region’s 39 agriculture banks, with 

$1.6 billion in assets, are located. (For a detailed discussion of agriculture in the Atlanta Region, see Atlanta 

Regional Outlook, First Quarter 1998.) 

Industrial Commodity Prices Are Also Declining 

A strong U.S. dollar and economic and financial turmoil 

overseas have depressed prices for several key industrial 

commodities produced in the Atlanta Region. Many 

Asian and Latin American nations are in a lingering 

recession that has depressed consumption and may have created a 

dependence on export trade as a 

means of recovery. The U.S. economy is among the few displaying 

strong growth, resulting in a severe 

and growing imbalance between 

imports and exports in the steel, textile and apparel, and paper and allied products markets. 

The American steel industry was restructured in the 

1980s, and as a result of major capital investments, productivity was enhanced, but thousands of jobs were lost. 

The steel industry is now experiencing a challenge from 

foreign imports. Recently, steel imports reached record 

levels, and prices have declined sharply (see Chart 4). 

U.S. manufacturers claim profits have suffered as they 

50 

Jan Jul Jan Jul Jan Jul Jan Jul Jan May 

’95 ’95 ’96 ’96 ’97 ’97 ’98 ’98 ’99 ’99 

Source: Journal of Commerce, Department of Labor (Haver Analytics) 

compete with imports sold at prices well below the cost 

of production. According to Curtis H. Barnette, president and chief executive officer of Bethlehem Steel 

Corporation, the surge in steel imports has caused over 

10,000 layoffs and an increase in the number of steel 

laborers working reduced hours or receiving reduced 

pay incentives. The growing trade imbalance within the 

industry has resulted in substantial production cuts, lost 

or cancelled orders, and significant price declines. 

Although the volume of imported steel has dropped 

slightly in recent months, the levels remain well above 

those prior to the collapse of many Asian economies, 

and industry recovery is expected to be slow. 

Weirton Steel, West Virginia’s second largest private 

employer, laid off about 25 percent of its workforce 

(1,000 workers) last Christmas as a result of increasing 

losses. The company has sustained $41.5 million in 

losses since steel imports began flooding U.S. markets. 

However, the Associated Press reported that increased 

demand for tin-plated steel in recent months has 

brought about the recall of nearly half the displaced 

workers. Some steel producers in Alabama and North 

Carolina have adopted “no layoff ” policies to preserve 

loyalty and motivate their workforce; however, such 

practices may have resulted in lower wages through the 

reduction or elimination of bonuses and overtime. 

Weekly wage rates generally have declined in Alabama, 

Georgia, Virginia, and West Virginia over year-ago levels, and average weekly work hours of steelworkers in 

the Atlanta Region have declined in all states, with the 

sharpest declines occurring in Virginia and West Virginia. Fewer work hours and lower wages may increase 

the likelihood that consumer credit quality in these 

areas will deteriorate. 

Foreign economic turmoil has hastened the ongoing 

secular decline in the textile and apparel industries. The 

Atlanta Regional Outlook 20 Third Quarter 1999 
Regional Perspectives
 

Asian crisis has been particularly troublesome for 

apparel producers, as lower incomes and currency 

depreciation have left Asian consumers with less money 

to purchase U.S. merchandise. Currency depreciation 

also has led to deep discounting by Asian producers in 

an effort to keep their factories operating. The Journal 

of Commerce reported that U.S. exporters expected 

sales to Japan to exceed $1 billion in 1998, but instead 

sales declined nearly 30 percent to $675 million, of 

which $424 million was attributed to the apparel industry. The U.S. Department of Labor reported that apparel prices fell 1.5 percent last year, leading U.S. 

manufacturers to move some operations to Mexico and 

the Caribbean, where labor is less expensive. 

The Atlanta Region produces nearly 23 percent of all 

apparel manufactured in the United States, with North 

Carolina, Georgia, and Alabama having the largest 

concentration of apparel-related employment. (For a 

detailed discussion of the textiles and apparel industries 

in the Atlanta Region, see Atlanta Regional Outlook, 

Second Quarter 1998.) Apparel jobs are leaving Georgia faster than any other state in the South, according to 

the Atlanta Business Chronicle. Within the past year, 

plant closings and layoffs have cost nearly 1,500 jobs in 

both Georgia and Alabama, as well as several hundred 

in North Carolina. Displaced workers throughout the 

Region are increasingly seeking public assistance, as 

their efforts to find work have resulted in lower paying 

jobs, according to Harris Ryanor, southern regional 

director of the Union of Needletrades, Industrial and 

Textile Employees in Union City, Georgia. 

While the Asian crisis has resulted in decreased exports 

for most commodities, strong domestic demand has 

provided some measure of stability to certain sectors of 

the textile industry. Textile manufacturers in the Atlanta 

Region account for over 72 percent of all textile jobs in 

the nation. A strong housing market has increased sales 

for carpet and fabrics used in home furnishings and has 

kept prices relatively stable. A slowdown in home sales 

and construction could disrupt this demand, however. 

Since 1995, nearly 44,000 jobs in the Atlanta Region 

have been eliminated in the textile industry. North Carolina, Georgia, and South Carolina have the highest 

concentration of industry workers. Textile job losses 

have been especially high in the production of synthetic fabrics, where Asian competition has been strongest. 

Prices of some fabric categories have declined by as 

much as 40 percent. All states within the Region have 

seen an increase in job losses in the textile industry; 

however, the Carolinas have experienced the greatest 

number of layoffs. 

Weakness in the Asian and Latin American economies 

has reduced demand for paper and allied products, which 

has driven down prices. 

Exports of pulp and paper 

to Asia have deteriorated in 

recent years, partly because 

of weaker currencies relative to the U.S. dollar but 

also because of structural 

changes brought about by 

increased automation and 

modernization of paper mills throughout the world. 

Greater efficiency and lower demand have resulted in 

moderately high pulp inventory levels. Low-cost paper 

mills, particularly in Asian countries, are reducing overcapacity by offering products in U.S. markets at reduced 

prices, making it difficult for U.S. companies to compete. 

The U.S. Industry and Trade Outlook ’99 reports that 

pulp exports represented slightly less than 55 percent of 

the volume of all U.S. market pulp shipments in 1998— 

the lowest market share this decade. The pulp and paper 

industry is vital to many areas of the Atlanta Region, with 

Georgia and Alabama having the highest exposure. As a 

result of global pressures, plant shutdowns and layoffs 

have become common throughout the Region. (For a 

detailed discussion of the pulp and paper industry in the 

Atlanta Region, see Atlanta Regional Outlook, Third 

Quarter 1998.) Some analysts expect the pulp market to 

start rebounding soon because of the slow improvement 

in economic conditions in Asia. 

Atlanta Regional Outlook 21 Third Quarter 1999 
Regional Perspectives
 

Funding Issues Affect Commercial Banks in the Atlanta Region
 

Bank funding has changed considerably in the 1990s 

(see Shifting Funding Trends Pose Challenges for 

Community Banks, page 11). Change has been driven, 

in part, by cyclical factors since the current economic 

expansion began in 1992, but there are differences in 

the way the industry is funded when compared with previous expansions. Most notably, loan growth has 

increased relative to deposit growth more than in past 

cycles. This situation has contributed to a shift away 

from traditional core2 deposits toward alternative funding sources such as noncore3 deposits and borrowings.4 

This analysis examines funding changes at banks in the 

Atlanta Region, the factors driving those changes, and 

potential risks. 

Deposits have declined steadily as a percentage of 

assets at commercial banks in the Atlanta Region since 

the current economic expansion began in 1992 (see 

Chart 5). This trend has been consistent across large and 

small banks. It is not uncommon for loan demand to 

outstrip deposit growth during cyclical expansions, but, 

as Chart 5 shows, such a sharp and sustained decline in 

2 Core deposits include all transaction, savings, and money market 

deposits, as well as time deposits less than $100,000. Core deposits typically are viewed as a stable source of funding for insured institutions. 

3 Noncore deposits include time deposits over $100,000, foreign 

deposits, and deposits placed through a broker. These are considered 

more volatile than core deposits. 

4 Borrowings include federal funds purchased, securities sold under 

agreements to repurchase, demand notes issued to the U.S. Treasury, 

mortgages and capitalized lease obligations, and any other borrowed 

money. 

CHART 5 

Deposit Funding at Atlanta Region Commercial 

Banks Has Fallen during This Economic 

Expansion 

Deposits to Assets 

Source: Bank Call Reports 

60% 

70% 

80% 

90% 

Commercial Banks 

with Assets over 

$1 Billion 

Down 4 

Percentage Points 

Down 14 

Percentage Points 

’84 ’86 ’88 ’90 ’92 ’94 ’96 ’98 

Commercial Banks 

with Assets under 

$1 Billion Recession 

deposits relative to assets did not occur during the previous expansion in the 1980s. This shift suggests that 

factors other than the business cycle are influencing 

bank funding decisions. As discussed below, the move 

from deposits to borrowings appears to be occurring 

both from necessity, as competition from nonbank 

financial services providers has slowed bank deposit 

growth, and opportunity, as funding alternatives available to banks have increased. 

Competition from Nonbank Financial Services 

Providers Is Affecting Insured Institution 

Deposit Growth 

The slowdown in bank deposit growth has resulted, in 

part, from increased competition from nonbank financial services providers, such as mutual funds and, to a 

lesser extent, credit unions. Unquestionably, high 

returns in the financial markets have helped the mutual 

fund industry garner a substantial and growing share of 

each household dollar in the 1990s. Fund flow data suggest that there has been a demographic shift from a 

“saver” to an “investor” focus in recent years, as individuals are placing a larger share of their financial 

assets in the capital markets rather than in insured bank 

deposits. 

The Investment Company Institute5 (ICI) reports that 

net new cash flow into mutual funds (equity, bond, and 

money market funds) reached a record $477 billion in 

1998, surpassing the previous record of $374 billion set 

in 1997. Moreover, during the five-year period from 

1994 to 1998, nearly $1.5 trillion of new money flowed 

into mutual funds, compared with only $300 billion a 

decade earlier from 1984 to 1988 (a 400 percent 

increase). Mutual fund penetration also has grown 

steadily, as 44 percent of all U.S. households held mutual fund investments in 1998 compared with 24 percent 

10 years earlier. It is likely that growth in the mutual 

fund sector, to some extent, is coming at the expense of 

the banking industry. Banks in the Atlanta Region may 

face even stronger competition with mutual funds relative to their out-of-region peers, as ICI demographic 

statistics show the nation’s highest concentration of 

mutual fund ownership to be in the southern states. 

5 The Investment Company Institute, based in Washington, D.C., is 

the national association of the mutual fund investment industry. 

Atlanta Regional Outlook 22 Third Quarter 1999 
Regional Perspectives
 

Nonbank financial services providers have been successful in capturing market share during the 1990s. 

Chart 6 shows, at the national level, the growth in total 

funds held by various financial services providers 

(banks and thrifts, mutual funds, and credit unions) 

from 1991 to 1998, as reported in the Federal Reserve 

Board’s Flow of Funds data. The chart illustrates how 

successful insured institution competitors have been in 

increasing their share of the nation’s financial assets. 

Equity and bond mutual funds have been the big winners; their asset volume has grown nearly fivefold since 

1991. Meanwhile, money market mutual fund assets 

(perhaps the closest substitute to insured institution core 

deposits) have risen by 150 percent since 1991. In fact, 

money market funds took in more new investment dollars ($235 billion) than bond and equity funds combined in 1998. (The increased flow into money market 

mutual funds in 1998 may have been a “flight to quality” surrounding the equity and bond market declines 

that occurred in the third quarter.) 

Credit union deposits also have grown at a faster rate 

than bank deposits in the 1990s. Chart 6 shows that 

credit union deposits grew nearly 60 percent from 1991 

to 1998, compared with only 14 percent for bank and 

thrift deposits. As indicated by the bold line on Chart 6, 

slow deposit growth has led insured institutions to rely 

increasingly on borrowings to meet funding needs since 

1992. Regional Flow of Funds data are not available, 

but Call Report data suggest that deposit and borrowing trends at insured institutions in the Atlanta Region 

are similar to the national trends. 

The mutual fund industry now holds the largest share of 

financial assets. Chart 7 presents the Federal Reserve 

CHART 6 

Growth of Insured Institution Deposits Lags 

Competition and Leads to Increased Borrowings 

Index 

500 

450 

471 Bond & Equity 

Mutual Funds 

400 

350 Insured Institution 

328 Borrowings 300 

Money Market 250 249 Mutual Funds 

200 Credit Union 

150 158 Deposits 

114 Insured Institution 100 Domestic Deposits

50 

Note: Insured institutions include U.S.-chartered commercial banks, savings and 

loan associations, mutual savings banks, and federal savings banks 

Source: FRB Board of Governors, Flow of Funds Accounts of the United States 1991 Stock = 100 

’91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 

Board’s Flow of Funds data in dollars rather than as an 

index. As seen in the chart, insured institutions were 

losing deposit volume to competitors from 1991 until 

about 1994 (consistent with the 14 percent increase in 

total deposits from 1991 to 1998 shown in the previous 

chart). That equates to an average annual growth of 1.85 

percent, which was less than the average interest being 

credited on deposits over that period. Chart 7 also shows 

that dollars held by the mutual fund industry actually 

eclipsed total bank and thrift deposits in 1996 and that 

the gap has continued to widen. Finally, it is important 

to note that credit union deposits, despite their strong 

growth in recent years, remain nominal relative to total 

deposits held by banks and thrifts. 

Bank Funding Has Diversified as More 

Alternatives Have Become Available 

Consistent with the national trend, banks in the Atlanta 

Region are relying more on borrowings to meet their 

funding needs. Chart 8 (next page) breaks down each 

new dollar of funding raised by commercial banks in the 

Region in 1998 into its components—core deposits, 

noncore deposits, borrowings, and equity—and compares that to the composition of new funds in 1988. Borrowings represented a much larger share of new funds 

in 1998 than in 1988 at both large and small banks in the 

Region. The increase in borrowings primarily offset a 

decline in large time deposits at both groups of banks, 

although large time deposits still make up the bulk of 

community bank noncore funding in the Region. Both 

groups, meanwhile, funded a larger portion of their 

asset growth with equity rather than interest-bearing liabilities in 1998 than in 1988, which is consistent with 

CHART 7 

Note: Insured institutions include U.S.-chartered commercial banks, savings 

and loan associations, mutual savings banks, and federal savings banks. 

Source: FRB Board of Governors, Flow of Funds Accounts of the United States 

Mutual Fund Dollars Outstrip 

Insured Institution Deposits 

0 

1,000 

2,000 

3,000 

4,000 

5,000 

$ Billions 

1991 

Insured Institution Domestic Deposits 

Bond & 

Equity Mutual Funds 

Money Market Mutual Funds 

All Mutual Funds 

Credit Union Deposits 

1992 1993 1994 1995 1996 1997 1998 

Atlanta Regional Outlook 23 Third Quarter 1999 
Regional Perspectives
 

CHART 8 

Borrowings Increase as a Share of New Dollar
 

Funding at Atlanta Region Commercial Banks
 

Commercial Banks Commercial Banks 

under $1 Billion over $1 Billion 

1988 1998 1988 1998 

Percent of New Funds

100 

75 

50 

25 

0 

–25 

Basis Points 

Collapses; Long-Term Capital 

Management Meltdown 

Persian Gulf 

War Begins 

Mexican Peso Devaluation 

Orange County Bankruptcy 

Southeast Asian Economic 

Crisis Begins 

Recession 

Trend 

Negotiable 6-Month Bank CD Rate (Secondary Market) 

Less 6-Month T-Bill Yield (Constant Maturity) 

Equity 

63% 61% 

23% 

10% 

6% 

19% 

8% 10% 

71% 71% 

18% 13% 

4% 8% 

8% 9% 

Borrowings 

Noncore Deposits 

Core Deposits 

Source: Bank Call Reports 

generally higher equity levels across the industry in the 

1990s. It is important to note that, while core deposits 

were essentially unchanged as a percent of new funding 

in 1998 compared with 1988, core deposits have 

declined relative to assets at both large and small banks 

in the Region over the past 10 years. 

The shift from large time deposits to borrowings seen in 

Chart 8 may be related to an increase in the relative cost 

of large time deposits over the past few years. Chart 9 

shows that, at the national level, the spread between negotiable (over $100,000) bank certificates of deposit and a 

benchmark six-month U.S. Treasury bill has increased 

since 1994. This is notable in that, according to a 1990 

report by Citicorp entitled Interest Rate Spreads Analysis: Managing and Reducing Rate Exposures, this 

spread normally narrows during periods of recovery and 

economic stability. As seen in the chart, the spread has 

widened as expected during periods of economic uncertainty, such as the recession in 1990 and the Russian bond 

market collapse last year. But the fact that the spread has 

been increasing despite stable economic growth may signal that banks relying on this type of noncore funding 

must pay higher rates in response to increased competition from within the banking industry and from nonbank 

financial services providers. 

In addition to competitive factors, the industry’s shift 

from deposits to borrowings may be a result of greater 

access to borrowed funds. The increase in borrowings 

by both large and small banks in the Atlanta Region has 

coincided with commercial banks gaining access to the 

Federal Home Loan Bank (FHLB) system with the passage of the Financial Institutions Reform, Recovery, and 

Enforcement Act of 1989. As shown in Chart 10, memCHART 9 

The Cost of Bank Certificates of Deposit Has
 

Increased Relative to Treasury Bill Yields during
 

This Economic Expansion
 

Russian Bond Market 

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

January 

Source: Federal Reserve Bank of St. Louis, Federal Reserve Economic Data 

(Monthly Averages) 

bership in and advances from the FHLB system have 

been popular among Atlanta Region banks. From 1993 

(earliest available data) to 1998, the number of commercial banks in the Atlanta Region that were members 

of the FHLB system more than doubled, from 310 to 

725. Moreover, outstanding advances increased more 

than tenfold, from $2 billion to $23 billion, over that 

period. FHLB penetration within the Region has grown 

steadily as well, as membership has increased from one 

in five banks (21 percent) in 1993 to nearly two of every 

three banks (63 percent) in 1998. As of year-end 1998, 

72 percent of banks in the Region with assets over $1 

billion were FHLB members, with advances totaling 

$20 billion. Community bank membership stood at 63 

percent at year-end, and advances totaled $3.3 billion. 

Community bank membership is likely to continue to 

CHART 10 

Federal Home Loan Bank (FHLB) Membership 

and Borrowings Have Increased at Atlanta Region 

Commercial Banks 

2,000 

1,750 

1,500 

1,250 

1,000 

750 

500 

250 

0 

1993 1994 1995

FHLB Borrowings (Billions) 

1996 1997 1998 

Number and Percentage of Commercial 

Banks in the Region That Are FHLB Members 

Number of Commercial 

Banks in the Region 

$25 

$20 

$15 

$10 

$5 

$0 21% 32% 39% 47% 55% 63% 

Source: Bank Call Reports, Federal Housing Finance Board 

Atlanta Regional Outlook 24 Third Quarter 1999 
Regional Perspectives
 

grow, as the Federal Housing Finance Board amended 

its membership requirements in 1998 to allow rural 

banks with assets under $500 million to use combination business or farm properties on which a residence is 

located to qualify for FHLB membership. 

As the Region’s overall funding mix has diversified to 

include more borrowings, the composition of core 

deposits also has changed. Chart 11 compares the composition of new core deposits raised by community 

banks in the Atlanta Region in 1998 with that of 1988. 

Small time deposits, normally a staple of community 

bank funding, fell sharply from 71 percent of new core 

funds in 1988 to 27 percent in 1998. This decrease is 

consistent with balance sheet data for community 

banks in the Region, which show that small time 

deposits have declined as a percentage of assets since 

the late 1980s. This decline may be related to strong 

growth in the mutual fund sector, as some consumers 

might view mutual funds and small time deposits as 

interchangeable products. Also, the fact that savings 

and money market deposit accounts represent a larger 

share of new core funds now than in 1988 may imply a 

“liquidity preference” on the part of depositors to hold 

nonmaturity deposits rather than time deposits, given 

today’s low interest rate environment. Large banks 

exhibit trends similar to those shown in Chart 11, the 

only exception being that transaction accounts have 

declined at large banks while representing a higher perCHART 11 

New Core Funding Has Shifted away from 

Small Time Deposits over the Past Decade 

at Atlanta Region Community Banks 

1988 1998 

Small Time Transaction Transaction Deposits (27%) (37%)

(23%) 

Savings and
 

Money Market
 

Deposit Accounts
 Small Time Savings and (6%) Money Market 

Deposit Accounts 

(36%) 

Deposits (71%) 

Note: Pie represents the composition of new core deposit flows during 

the year and not the existing balance sheet composition. Community 

banks are defined as insured commercial banks with assets less than 

$1 billion and in operation at least three years. Large banks exhibit 

similar trends. 

Source: Bank Call Reports 

centage of small bank core funding. Transaction 

accounts, while free of interest costs, can be expensive 

to maintain depending on transaction frequency, average account balance, and the channel (electronic, automated teller machine, or teller window) customers use 

to make transactions. 

The Community Bank Funding Challenge 

Community banks may face greater funding challenges 

than their larger counterparts. A 1998 survey conducted 

by the American Bankers Association found that 4 of 10 

community bankers reported core deposit growth lagging 

loan demand. In addition, a 1999 Grant Thornton survey 

showed that three of four community bankers believe 

core funding will be a greater challenge three years from 

now. Factors that could constrain community bank funding relative to large banks include limited access to the 

capital markets, a smaller geographic presence from 

which to solicit deposits, and slower rural population 

growth. According to an article in the June 7, 1999, 

American Banker, some small banks are soliciting outof-market deposits to meet loan demand because core 

deposit growth is insufficient. This strategy could 

increase interest costs, however, and because many community banks have limited fee income opportunities, they 

are structurally more reliant than larger banks on spread 

income from taking deposits and making loans. 

Other factors that might affect community banks over the 

longer term include convergence toward national, rather 

than local, market pricing as a result of advances in technology. A number of community banks enjoy some pricing power in their local markets, but consumers’ ability to 

shop markets nationally and move money more quickly 

at lower costs could pressure pricing spreads at certain 

institutions. Ultimately, this could lead to more volatility 

in core deposits, which currently fund 72 percent of the 

Region’s community bank assets (compared with 54 percent for large banks). A less stable core deposit base 

would heighten the need for alternative funding sources, 

which are limited for many small banks. In a recent issue 

of SNL Securities’ Bank Investor, L. Bud Baker, CEO of 

Wachovia Corporation, alluded to these concerns: 

“...there is no such thing any longer as a core deposit... 

you are going to be able to go on the Internet and find the 

best price for your money...and you can move your 

money with the punch of a button.” 

Atlanta Regional Outlook 25 Third Quarter 1999 
Regional Perspectives
 

Risk Implications of Funding Changes 

A more diverse funding mix can offer benefits with 

regard to pricing and balance sheet management, but a 

shift from core to noncore funding is not without new 

potential risks. With net interest margins already pressured by pricing competition and a flattened yield 

curve, there is some concern that the higher interest 

costs normally associated with noncore funding could 

lead to more risk taking (credit risk or interest rate risk) 

in search of higher asset yields. That risk may be tempered somewhat by the fact that the noninterest cost of 

gathering wholesale funds can be less than that of retail 

funds. The move from core to noncore funding also may 

have liability-side liquidity implications. As banks turn 

more attention to alternative funding, there may be less 

focus on retail deposit gathering. This raises the question of whether banks could recapture deposit share lost 

to competitors, such as mutual funds or credit unions, in 

the event that financial market turmoil or credit quality 

concerns unexpectedly diminish alternative funding. 

Many industry observers believe that the funding challenges facing banks are long term rather than cyclical. 

Thus, the issues discussed here will only add to the 

complexity of asset and liability management going forward. Maintaining a cost structure consistent with the 

mix of retail and wholesale funding will be critical for 

banks to continue to grow without sacrificing profitability. Regardless of how funds are acquired in the 

future, insured institution managers must allocate those 

funds in a manner that can achieve earnings and growth 

objectives without subjecting institutions to undue credit, interest rate, or liquidity risks. 

Atlanta Region Staff 

Atlanta Regional Outlook 26 Third Quarter 1999 
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