Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION FIRST QUARTER 2000 

FDIC
 

New York
 

Region
 

Division of
 

Insurance
 

Kathy R. Kalser,
 

Regional Manager
 

Norman Gertner,
 

Regional Economist
 

Alexander J.G.
 

Gilchrist,
 

Economic Analyst
 

In Focus This Quarter 

◆ Recent Trends Raise Concerns about the Future of Business Credit 

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

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

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

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

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

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

By Arlinda Sothoron, Alan Deaton 

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

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

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

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

highly exposed to international markets, suggesting that economic conditions 

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

profitability. See page 11. 

By Paul C. Bishop 

Regional Perspectives 

◆ Region’s Economic and Banking Conditions—The Region’s economy is 

healthy, although employment growth is beginning to slow. Major economic drivers, 

including Wall Street, new high-tech industries, and commercial real estate, were 

highly profitable in 1999. Insured institutions reported generally sound financial 

conditions in the third quarter of 1999, although profitability measures reflected 

competitive pressures on bank margins. Asset quality measures improved in most 

loan segments. However, commercial and industrial loans showed slight weakening, 

primarily at the Region’s larger banks. See page 18. 

◆ Noninterest Income Has Grown in Importance—As banks have 

attempted to diversify income sources, enhance profitability, and mitigate pressures 

on net interest margins, noninterest income has become a more significant contributor to bank earnings. Noninterest income now represents half of operating income 

at the Region’s banks. Higher noninterest income reflects increased fees from traditional banking services such as ATM use and credit cards. In addition, banks have 

expanded into new activities, including trading, investment advisory, and insurance 

sales, which may be more susceptible to changes in financial market conditions than 

traditional bank services. See page 22. 

◆ The Region Is Again Losing Manufacturing Jobs—Despite the 

Region’s robust economy, the manufacturing sector is continuing to lose jobs. These 

losses are attributed, in part, to higher energy prices, which hinder expansion by 

existing manufacturing companies and make the New York Region a less attractive 

site for new manufacturing. See page 24. 

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

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

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

geographic regions: 

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

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

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

Dallas Region (CO, NM, OK, TX)
 

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

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

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

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

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

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

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

For more information or to provide comments or suggestions about the New York Region’s Regional Outlook, please call Kathy Kalser at (212) 704-1308 or send an e-mail to kkalser@fdic.gov. 

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

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

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

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

the Federal Deposit Insurance Corporation. 

Chairman Donna Tanoue 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Writer/Editor Kim E. Lowry 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Richard A. Brown 

Steven E. Cunningham 

Ronald L. Spieker 

Publications Manager Teresa J. Franks 
In Focus This Quarter
 

Recent Trends Raise Concerns about the Future of
 

Business Credit Quality
 

•	 C&I loan portfolios have been growing rapidly 

during this economic expansion. 

•	 Indicators of weakening corporate credit quality 

have begun to appear, including higher C&I loan 

losses and rising corporate bond defaults. 

•	 The future of business credit quality will depend 

on the economy and on underwriting practices. 

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

largest and fastest-growing segments of lending at 

insured institutions. As of the third quarter of 1999, 

C&I loans comprised 24 percent of total loans and 

leases held by FDIC-insured institutions, up from 21 

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

grown primarily because of strong loan demand driven 

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

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

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

when the economy eventually weakens. 

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

about the future of credit quality at insured institutions. 

This article examines the factors that have contributed 

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

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

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

continued strength of the domestic economy. The future 

of C&I credit quality will ultimately be determined by 

trends in underwriting and corporate debt levels, along 

with the performance of the U.S. economy. 

C&I Loan Growth Has Accelerated 

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

by almost 9 percent during the 12 months ending in 

September 1999, down somewhat from a 13.4 percent 

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

CHART 1 

Commercial and Industrial (C&I) 

Loans Are Growing at a Faster Rate 

than Total Loans and Leases 

Loan Growth 

Rate (%) C&I Loans 

15 

10 

5 

0 

–5 

–10 

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

Source: FDIC Research Information System 

Total Loans 

and Leases 

’86 ’88 ’90 ’92 ’94 ’96 ’98 

loans and leases at insured institutions grew by only 7 

percent in the 12 months ending in September 1999. 

C&I loans accounted for approximately 29 percent of 

all net new loans booked during the 12 months ending 

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

Syndicated lending played a major role in C&I loan 

growth during the 1990s. As intense competition and a 

narrowing of financial institutions’ net interest margins 

have encouraged lenders to seek additional sources of 

revenue, larger institutions have become increasingly 

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

in 1997, when originations totaled some $1.1 trillion 

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

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

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

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

lending is very attractive to lending institutions because 

of the generous fee income associated with leveraged 

originations. Leveraged loan originations grew to $320 

billion in 1999, partly because of the continued rapid 

pace of corporate mergers in 1999.2 

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

January 10, 2000.
 

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

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

New York Regional Outlook 3	 First Quarter 2000 
In Focus This Quarter
 

Most of the C&I loan growth among insured institutions 

since 1997 has been concentrated in loans to domestic 

borrowers. C&I loans held in foreign offices declined 

following the Asian economic crisis and the Russian 

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

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

percent while C&I loans held in foreign offices 

declined by almost 6 percent. 

Is This Rapid Loan Growth a Cause 

for Concern? 

The effect of rapid loan growth on subsequent credit 

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

recent study by the Federal Reserve Bank of Kansas 

City found that high rates of loan growth in the early 

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

however, that relatively high loan growth rates in the 

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

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

crisis of the 1980s were generally more likely to have 

grown their loan portfolios aggressively than banks that 

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

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

future. The future course of industry loan losses 

depends on many factors, including the condition of the 

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

The Condition of the Economy 

Is an Important Driver of C&I Loan Growth 

Recent economic conditions have been particularly 

conducive to rapid growth in domestic C&I lending. 

Business investment has expanded at double-digit 

annual rates as firms have invested in new technologies 

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

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

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

Second quarter 1999. 


4 Federal Deposit Insurance Corporation, Division of Research and
 

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

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

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

CHART 2 

Syndicated Loan Originations Rebounded 

in 1999 after Falling from Record Levels 

Source: Loan Pricing Corporation 

Syndicated Loan Originations

 ($ Billions) 

0 

200 

400 

600 

800 

1,000 

1,200 

’95 ’96 ’97 ’98 ’99 

economy to grow at a relatively rapid pace with low 

inflation. Strong growth in real wages has helped boost 

the consumer confidence index to an all-time high of 

144 in January 2000. Robust consumer demand for 

goods and services has kept business profits growing, 

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

loan charge-off rates have remained at record lows of 

less than 0.5 percent since 1994. Recently, however, 

despite a continuation of generally favorable conditions 

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

loan portfolios. 

Evidence from Financial Institutions Points 

to a Weakening in Business Credit Quality 

Despite strong business conditions and generally good 

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

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

in September 1999 were 63 percent higher than during 

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

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

Similarly, noncurrent C&I loans as of September 1999 

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

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

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

all C&I loans in nonaccrual status. 

New York Regional Outlook 4 First Quarter 2000 
In Focus This Quarter
 

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

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

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

Interagency Loan Review Reveals Increases 

in Problem Credits from Previously Low Levels 

The results of the 1999 Shared National Credit (SNC) 

review provide another indication of slipping credit 

quality at large commercial banks.6 According to the 

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

review, a level approximately 70 percent higher than that 

reported in 1998. This figure represents 2 percent of the 

$1.8 trillion in drawn and undrawn loan commitments 

reviewed in 1999. By contrast, adversely classified 

assets identified in the 1998 SNC review totaled only 

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

While the level of adversely classified syndicated loans 

remains low, 14 percent of the loans adversely classified 

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

finding, Office of the Comptroller of the Currency 

(OCC) First Senior Deputy Comptroller and Chief 

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

high rate of adversely classified new loans could be 

attributable to the continued effects of loan originations 

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

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

loan portfolios. 

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

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

6 The annual interagency process reviews commercial loans over 

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

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

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

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

Release. October 5, 1999. 

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

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

from Loan Pricing Corporation and Banc of America Securities LLC. 

generated because of covenant relief requests, from 22 

percent of all loan amendments during the last six 

months of 1998 to 45 percent during the first ten 

months of 1999. 

Corporate Bond Defaults Soared in 1999 

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

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

Default rates as a percentage of volumes outstanding (or 

dollar default rates) have trended upward each year 

since 1996, reaching 2.2 percent for all corporate issues 

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

to a rising dollar default rate for speculative-grade 

issues, which peaked in November 1999 at 8.2 percent. 

Measured as a percentage of all issuers, the default rate 

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

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

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

reported twice as many issuer downgrades as upgrades 

during the fourth quarter of 1999, although the dollar 

volume of upgrades exceeded the dollar volume of 

downgrades by 55 percent.11 

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

Investors Service. October 13, 1999.
 

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

CHART 3 

The Default Rate on Corporate Bonds Has
 

Been Driven by Defaults on Speculative Issues
 

Issuer-Weighted 

Default Rate (%) 

15 All Corporate Issues 

10 

5 

0 

Speculative Issues 

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

Source: Moody’s Investors Service 

New York Regional Outlook 5 First Quarter 2000 
In Focus This Quarter
 

Why Are C&I Loan Losses Increasing 

Amid Strong Economic Growth? 

Several factors have contributed to the current signs of 

deterioration of C&I credit quality in an environment of 

favorable business conditions. These factors include 

global competition and deflationary pressures, an 

increase in corporate debt levels, loosened underwriting 

standards, and a greater appetite for risk. 

Global competition and deflationary pressures 

have squeezed revenues. An era of low inflation and 

intense global price competition has contributed to low 

or negative revenue growth in a number of domestic 

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

losses and corporate bond defaults in these sectors. 

Moody’s noted that the industrial sector, weakened by 

low commodity prices, accounted for 64 percent of all 

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

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

1999 earnings for the iron and steel sector declined 80 

percent from one year earlier after five consecutive 

quarters of negative year-over-year earnings growth. 

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

slowed foreign C&I lending and increased net losses of 

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

1998. However, this adverse trend reversed itself in 

1999, when C&I loans held in domestic offices 

accounted for the majority of losses. 

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

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

growth in corporate debt is partially a result of actions 

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

and rising spending on fixed investments. Capital 

expenditures on fixed investments by businesses have 

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

as evidenced by Chart 4. Cash flow has also been 

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

“financing gap” that reached an annualized level of 

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

Commodities and Manufacturing Pose Continuing Risks to Credit
 

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

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

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

Moody’s Investors Service, January 2000.
 

CHART 4 

The Financing Gap Has Widened

 for Nonfinancial Corporations 

$ Billions “Financing Gap” 

900 

700 

500 

300 

100 

Capital Expenditures Cash Flow 

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

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

Source: Federal Reserve Board (Haver Analytics) 

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

flow has not been available to finance investment, firms 

have turned primarily to debt financing as opposed to 

equity financing. Net new corporate equity issues by 

nonfarm nonfinancial corporations have been negative 

in each year since 1993, while net new corporate bond 

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

billion in 1998. 

Loosened underwriting standards in 1997 and early 

1998 are contributing to current losses. Signs of 

stress in C&I loan portfolios can be partially attributed 

to loosened underwriting standards in 1997 and early 

1998. During 1997 and early 1998, loan underwriting 

standards loosened, accompanied by reduced spreads 

and pricing. In May 1998, the Federal Reserve Board 

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

during early 1998 “a large percentage cut their spreads 

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

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

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

A record number of first-time speculative-grade deals 

were also brought to market during 1997 and early 

1998. The increase in the volume of issuance was itself 

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

have fueled investor demand for additional high-risk 

bonds. However, the Asian crisis during 1997 and the 

Russian debt default during the second half of 1998 

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

New York Regional Outlook 6 First Quarter 2000 
In Focus This Quarter
 

caused new issuance of speculative-grade bonds to slow 

significantly while defaults rose sharply, to a rate of 6 

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

the void by raising originations of highly leveraged 

loans between second-quarter 1998 and fourth-quarter 

1999.15 

Financial markets have evidenced greater risk 

appetite. While the ratio of speculative-grade bond 

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

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

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

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

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

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

during the year ending September 1999 were rated for 

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

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

of corporate bond defaults reflects the looser standards 

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

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

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

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

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

CHART 5 

bond defaults in 1999.19 This relationship is analogous 

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

attributable to weakened underwriting standards in 

1997 and early 1998. 

The Increase in Leveraged Lending Could 

Result in a Riskier Mix in C&I Loan Portfolios 

Leveraged lending comprises an important part of the 

syndicated lending market and generates considerable 

fee income for financial institutions. Leveraged loans 

have grown from 12 percent of total syndicated loan 

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

next page). Leveraged syndicated loan originations grew 

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

seeking higher risk-adjusted returns and lenders were 

seeking higher fees. Paine Webber analysts estimate that 

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

Highly leveraged lending increased to a new record of 

$190 billion in 1999.21 This growth in loan originations 

reflects the current high corporate demand for loans, and 

by definition these loans are being made to borrowers 

with higher-than-normal levels of financial leverage and 

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

higher pricing and higher fees. 

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

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

May 14, 1999.
 

21 Loan Pricing Corporation defines highly leveraged loans as those
 

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

The Composition of the Rated Bond Market Has Shifted

 toward the Lower Part of the Speculative-Grade Issues 

Distribution of Issuer Ratings 

as a Percentage of Total Issuers 

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

Source: Moody's Investors Service 

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

Moody’s Bond Ratings 

January 1998 January 2000 

Investment-Grade Ratings Speculative-Grade Ratings 

0 

2 

4 

6 

8 

10 

12 

New York Regional Outlook 7 First Quarter 2000 
In Focus This Quarter
 

CHART 6 

$ Billions As a Percentage of 

Total Syndicated Loans 

Loans to Leveraged Companies Represent 

a Greater Portion of Syndicated Loans 

Originations of Syndicated Loans to Leveraged Companies 

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

Source: Loan Pricing Corporation 

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

400 

0 

100 

200 

300 

40 

0 

10 

20 

30 

Leveraged lending volumes have recently been partially 

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

activity approached $1.4 trillion in total volume during 

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

media and telecommunications industries, which have 

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

levels in quantity. 

Where Is Business Credit Quality Heading? 

The future direction of business credit quality will be 

influenced by several factors, including the condition of 

the economy, growth in the indebtedness of corporate 

borrowers, exposure to vulnerable industry sectors, the 

interest rate environment, the development of emerging 

markets, and underwriting standards. 

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

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

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

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

noted that excessive credit, attributable to unsustainable 

corporate indebtedness and falling asset values, has 

weakened the financial systems of 20 nations. As for 

credit expansion in the United States, the survey noted 

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

that the ratio of private sector loans outstanding to gross 

domestic product rose from 101 percent in 1995 to 142 

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

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

repayments based on projections that are realizable only 

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

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

domestic economy.24 

Continued growth in corporate indebtedness could 

contribute to increased losses and defaults. The 

growth rate of corporate debt has surpassed the growth 

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

problems if there are adverse changes in the interest rate 

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

a slowdown in revenue growth would reduce the cash 

flow available to service outstanding debt. Under such a 

scenario, business bankruptcies and failures are likely 

to rise, causing increased loan losses and bond defaults. 

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

domestic industries are continuing to experience stress. 

Exposures to weakened industry sectors, such as health 

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

quality at insured institutions. One way to evaluate the 

relative riskiness of firms operating in a given industry 

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

developed a proprietary method of measuring the 

degree of credit risk inherent in corporate borrowers by 

calculating an EDFTM score to estimate the probability 

that a firm will default on its obligations within one 

year.25 Chart 7 diagrams syndicated loan exposures 

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

industry sectors having the highest expected default 

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

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

1999. 

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

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

market value. Multiplying industry originations by median industry 

EDFTM scores provides an estimate of expected default volumes. This 

figure provides a more meaningful measure of aggregate lending risk 

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

industry exposures. 

New York Regional Outlook 8 First Quarter 2000 
 

In Focus This Quarter
 

volume based on the volume of 1999 syndicated loan 

originations. In 1999, loans originated to mortgage 

lenders (including subprime lenders), communications 

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

trade organizations generated the five highest expected 

default volumes among 50 broad industry sector classifications. 

The interest rate environment and refunding risk 

affect the demand for and availability of credit. 

Declining interest yield spreads from 1996 to 1998 

benefited borrowers. As spreads declined, the rate of 

syndicated loan growth increased and refinancing 

activity was high. Increases in spreads since 1998, 

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

have not significantly affected origination volumes, as 

new debt continues to come into the market. Rising 

interest rates and refunding risk particularly affect 

speculative-grade borrowers. Higher interest rates 

would raise businesses’ cost of borrowing, potentially 

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

to new capital markets can become limited. A sharp 

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

obligations. 

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

refinancing the maturing portions of long-term debt. 

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

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

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

largely of unsecured bank debt, matures in 2001 and 

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

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

Potential growth in new markets presents both 

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

potential growth areas and possible sources of credit 

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

new markets to the loan and bond markets and has 

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

1999. 

CHART 7 

Lending to Some Industries May 

Involve Higher Risk Exposures 

Change in Expected Default FrequencyTM (EDFTM) 

for the 12 Months Ending in December 1999 

6 

8 

–2 0 2 4 6 8 10 12 14 16 18 20

 EDFTM as of December 1999 

1 

2 4 5

3 

6 

7 

9 

10 

4 

2 

0 

–2 

Industry Name and Origination Dollars in Billions:

 1. Communication Services - $234.6

 2. Motor Vehicles and Parts - $133.1

 3. Chemicals and Drugs - $96.1

 4. Retail Trade - $92.1

 5. Wholesale Trade - $46.5

 6. Health Care Services - $42.3

 7. Oil & Gas Extraction - $41.8

 8. Entertainment - $33.5

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

10. Hotels & Lodging Services - $20.2 

Note: Data and bubble size represent total syndicated loan originations
 

for the year ending 1999.
 

Sources: Securities Data Corporation; KMV Credit Monitor®
 

increased market efficiency. The “Internet economy” 

grew 68 percent from the first quarter of 1998 to the 

first quarter of 1999, with annual revenue expected to 

exceed $500 billion in 1999.27 Internet technology has 

improved the efficiency of the syndicated loan markets, 

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

online trading.28 Increased levels of credit risk could 

result from the volatility of Internet stock prices and the 

competitive disadvantage faced by firms that do not 

have an Internet presence but must compete against 

firms that do. 

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

syndicated lending activity in Europe will accelerate 

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

financing needs. In addition, the European high-yield 

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

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

Street Journal. December 6, 1999. 

New York Regional Outlook 9 First Quarter 2000 
In Focus This Quarter
 

cent of the total market.29 Domestic lenders have begun 

to compete for this market but face credit risks because 

the European markets also pose sovereign and foreign 

exchange risk. 

Underwriting Remains the Key to Assessing 

C&I Credit Quality 

The August 1999 OCC Survey of Credit Underwriting 

Practices reported some tightening of commercial loan 

underwriting standards. However, loan officers also 

reported increased embedded risks in commercial loan 

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

1999 Federal Reserve Board Senior Loan Officer 

Opinion Survey on Bank Lending Practices found that 

30 percent of domestic banks reported increasing risk 

premiums, credit line costs, and loan spreads during the 

preceding three months. Loan 

officers cited an uncertain or 

unfavorable economic outlook, 

an expected worsening of industry-specific problems, and a 

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

standards. 

Despite signs of tightening underwriting standards, the 

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

The OCC issued an advisory to banks in May 1999 

warning of potential problems with leveraged lending. 

The OCC stated that highly leveraged corporations 

could be particularly vulnerable to economic weakness 

and may not be able to compete effectively in a rising 

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

November 15, 1999. 

interest rate environment. The OCC also addressed 

reliance on enterprise value loans, which are often used 

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

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

company fails to meet the assumptions underlying these 

estimates, the lender may be subject to considerable 

credit risk. The last interagency SNC review also noted 

instances of inadequate documentation and support for 

enterprise loans.30 

Summary 

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

lending lines at insured institutions. Recent growth in 

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

including a favorable economy, merger and acquisition 

activity, and other sources of high loan demand, strong 

asset quality, aggressive pricing, and attractive fee 

income. While indicators of C&I loan performance 

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

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

strength. Increasing corporate indebtedness, signs of 

corporate stress, and adverse trends in corporate bond 

defaults suggest that an economic downturn could result 

in a much more challenging environment for business 

credit quality. 

By Arlinda Sothoron, Senior Financial Analyst 

Alan Deaton, Economic Analyst 

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

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

New York Regional Outlook 10 First Quarter 2000 
In Focus This Quarter
 

Local Industries in the Global Economy
 

•	 The contribution of international trade to U.S. 

economic activity has risen rapidly during the 

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

recent financial market turmoil in several emerging markets. 

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

trading partners, accounting for approximately 

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

(excluding Japan) also account for a large share 

of U.S. trade. 

•	 The importance of trade at the industry level 

varies widely. The industries most dependent on 

trade, including machinery and transportation 

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

trade. 

The value of goods and services traded on international 

markets has more than doubled during the past decade. 

More goods and services than ever are being shipped 

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

national borders. 

The increasing importance of international trade is 

reflected in different types and levels of exposure to 

international markets. First, total exports and imports 

compared with overall economic activity confirm the 

increasing contribution of trade to the economy as a 

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

markets, although widely varied, is concentrated in a 

small number of countries, namely Canada, Japan, and 

Mexico. Consequently, economic conditions in these 

countries are particularly important in assessing the 

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

Third, the level of exposure to international trade across 

industry sectors varies considerably. Some industries are 

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

conditions in the world economy are an important factor 

in determining the level of sales and profit. The exposure 

to international markets, either through reliance on trade 

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

consideration for lenders seeking to determine a firm’s 

future profitability and financial condition. 

International Trade Is of Growing Importance 

Over the past 30 years, international trade has grown 

more quickly than the economy as a whole. Exports, 

which include both merchandise and services, have 

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

product (GDP) in 1970 to approximately 12 percent 

today. The merchandise component accounts for about 

73 percent of exports and includes manufactured goods, 

agricultural products, and raw materials such as metals 

and oil. The services component of exports, accounting 

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

and educational services. 

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

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

(see Table 1, next page). 

Although trade in services has grown quickly for many 

years, merchandise still accounts for the majority of all 

trade. The dominance of merchandise is attributable, in 

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

With few exceptions, services are generally produced 

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

and cultural barriers. Hospitals, dry cleaners, and movie 

theaters, for example, serve well-defined local markets 

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

this article focuses primarily on the dominant merchandise component. 

U.S. Trade Activity Has Reflected Recent 

Global Economic Turmoil 

Over time, conditions in the international economy have 

become an increasingly important influence on U.S. 

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

increasing volume of imported goods and services 

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

New York Regional Outlook 11	 First Quarter 2000 
In Focus This Quarter
 

TABLE 1 

Merchandise Is the Largest Component of Trade 

DOLLAR VALUE* PERCENT 1999 

(1998, $ MILLIONS) OF TOTAL GROWTH** 

Exports $ 933,910 100.0% 1.8% 

MERCHANDISE 682,138 73.0% 0.8% 

AGRICULTURE AND 

RELATED COMMODITIES 26,603 2.8% –1.8% 

MINERAL COMMODITIES 6,644 0.7% –17.4% 

MANUFACTURED GOODS 593,297 63.5% –0.1% 

OTHER MERCHANDISE 55,593 6.0% 39.5% 

SERVICES 263,662 28.2% 4.3% 

TRAVEL 71,250 7.6% 3.0% 

PASSENGER FARES 19,996 2.1% 2.7% 

ROYALTIES AND LICENSE FEES 36,807 3.9% 4.1% 

FREIGHT AND PORT SERVICES 25,520 2.7% 6.4% 

OTHER SERVICES 110,089 11.8% 5.0% 

ADJUSTMENTS*** (11,890) 

Imports $ 1,098,193 100.0% 10.3% 

MERCHANDISE 907,647 82.6% 10.4% 

AGRICULTURE AND 

RELATED COMMODITIES 22,859 2.1% –2.2% 

MINERAL COMMODITIES 38,619 3.5% 5.6% 

MANUFACTURED GOODS 803,384 73.2% 11.6% 

OTHER MERCHANDISE 42,786 3.9% –0.6% 

SERVICES 181,015 16.5% 9.6% 

TRAVEL 56,105 5.1% 7.2% 

PASSENGER FARES 19,797 1.8% 8.3% 

ROYALTIES AND LICENSE FEES 11,293 1.0% 11.0% 

FREIGHT AND PORT SERVICES 30,460 2.8% 11.4% 

OTHER SERVICES 63,360 5.8% 10.9% 

ADJUSTMENTS*** 9,531 

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

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

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

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

Sources: Bureau of Economic Analysis; Bureau of Census
 

New York Regional Outlook 12 First Quarter 2000 
In Focus This Quarter
 

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

international economy has been buffeted by a series of 

crises that resulted in steep exchange rate depreciations 

for a number of countries and a marked slowdown in 

economic growth in many emerging markets. Although 

the U.S. economy remained surprisingly strong during 

the worst of the emerging markets crises, the fallout 

was evident in the diverging performance of U.S. 

exports and imports over the period. 

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

generally flat, reflecting the sluggish pace of growth in 

several important U.S. export markets. Export prices 

fell by 4 percent over the period in response to weak 

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

agricultural products, basic manufactured goods, and 

commodities faced rapidly deteriorating conditions in 

several important overseas markets. For example, the 

value of merchandise exports to the Pacific Rim fell by 

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

recent financial market turmoil in the region. 

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

however, reflecting both strong demand for imported 

goods and falling prices. In fact, average import prices 

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

time, competition from imports limited the pricing 

power of domestic producers that compete with goods 

produced abroad. Although producers that compete 

with cheaper imports experienced adverse effects on 

profitability, consumers and firms that purchased 

goods from abroad generally benefited from falling 

import prices.1 

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

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

which reached a record $26.5 billion in November, has 

raised concerns among analysts about the vulnerability 

of the dollar. Faster growth abroad or a slowdown in 

U.S. growth could convince foreign investors to 

increase purchases of assets outside the United States, 

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

severity and speed of a sell-off, heightened financial 

market volatility and rising U.S. import prices could 

result. Although potentially many forces are at work in 

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

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

CHART 1 

U.S. Import Growth Has Accelerated 

while Exports Remain Flat 

$ Billions 

350 

300 

250 

200 

150 

100 

Imports 

Exports 

1992 1993 1994 1995 1996 1997 1998 1999 

Source: Bureau of Economic Analysis 

such a scenario, rising inflation or a falling dollar may 

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

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

changes in the prices of either imports or exports would 

result in both positive and negative effects on firms’ 

costs, revenue, and profitability.2 

Most U.S. Trade Is Concentrated 

in a Few Foreign Markets 

Because the United States trades with most nations, 

economic conditions abroad are one of the critical 

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

the strength of the markets to which exporters ship 

their goods. Consequently, economic weakness 

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

Economic conditions abroad also influence the level 

of import competition that U.S. firms experience. 

Foreign firms facing slack demand in their own 

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

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

measured against a trade-weighted basket of currencies. The 

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

costly on world markets and contributed to financial stress among 

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

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

of the 1980s. 

New York Regional Outlook 13 First Quarter 2000 
In Focus This Quarter
 

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

more effectively with U.S. producers.3 

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

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

for more than 40 percent of merchandise exports and 

imports. Asia (excluding Japan) and Western Europe 

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

and a broadly similar share of imports. Central and 

South America, despite proximity to the United States, 

account for less than 10 percent of exports and only 

5 percent of imports (see Chart 2). 

The United States has routinely run a trade deficit with 

its largest trading partners. The trade deficit with 

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

$18.8 billion during the same period. The trade 

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

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

of 1999. 

The Importance of Trade Varies 

among Industries 

The level of export activity or the intensity of import 

competition also varies across industries. Besides the 

overall dollar volume of exports, industries differ in the 

proportion of total production that is exported. 

Although some industries, such as leather products, 

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

exports, exports from this industry make up a large 

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

such as this, conditions in export markets are important 

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

Industries also differ in the share of total spending 

devoted to imports. Imports account for a relatively 

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

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

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

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

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

expand market share and recoup current losses in the future when 

prices rebound. 

CHART 2 

Canada Is the Largest U.S. Trading Partner 

(1Q99 through 3Q99, ranked by exports) 

Eastern Europe 

Africa 

Central/South America 

Japan 

Mexico 

Asia (excluding Japan) 

Western Europe 

Canada 

Source: Bureau of Census 

–250 

$ Billions 

–150 –50 50 150 250 

Imports Exports 

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

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

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

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

pricing environment and, by extension, the revenue and 

profit growth of domestic firms. 

For the purposes of this article, industries can be 

assigned to one of three broad categories depending on 

their exposure to international markets either through 

exports or through the intensity of import competition. 

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

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

contrast, some industries are highly exposed through 

their reliance on export markets, through competition 

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

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

performance. Industries not part of either group, or 

Moderately Exposed Industries, face some competition 

from abroad and may earn a relatively small amount of 

revenue from export markets. 

To gauge these differences more fully, a measure 

of exposure to international markets was calculated for 

a set of 26 industries (20 manufacturing industries, 

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

New York Regional Outlook 14 First Quarter 2000 
In Focus This Quarter
 

TABLE 2 

Industry Exposure to International Trade 

IMPORT SHARE OF U.S. CONSUMPTION 

LOW MEDIUM HIGH 

EXPORT 

SHARE OF U.S. PRODUCTION 

LOW 

PRINTING AND PUBLISHING 

FOOD PRODUCTS 

LUMBER AND WOOD 

PRODUCTS 

PETROLEUM AND COAL 

PRODUCTS 

AGRICULTURAL SERVICES, 

FORESTRY, AND FISHING 

FURNITURE AND FIXTURES 

OIL AND GAS EXTRACTION 

MEDIUM 

COAL MINING 

TOBACCO PRODUCTS 

NONMETALLIC MINERALS, 

EXCEPT FUELS 

FABRICATED METAL 

PRODUCTS 

METAL MINING 

PAPER AND ALLIED 

PRODUCTS 

TEXTILE MILL PRODUCTS 

STONE, CLAY, AND 

GLASS PRODUCTS 

RUBBER AND PLASTIC 

PRODUCTS 

PRIMARY METAL INDUSTRIES 

MISCELLANEOUS MANUFACTURING INDUSTRIES 

APPAREL PRODUCTS 

HIGH 

FARM PRODUCTS CHEMICALS AND ALLIED 

PRODUCTS 

INSTRUMENTS AND 

RELATED PRODUCTS 

TRANSPORTATION 

EQUIPMENT 

INDUSTRIAL MACHINERY 

AND EQUIPMENT 

ELECTRONIC EQUIPMENT 

LEATHER AND LEATHER 

PRODUCTS 

Highly Exposed Industries 

Moderately Exposed Industries 

Less Exposed Industries 

summarizes the results of the assessment.4 Each row 

shows industries that have high, medium, or low 

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

production in a particular industry that is exported. 

Each industry was ranked by this measure, with the 7 

highest industries placed in the High category, the 7 

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

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

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

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

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

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

imports divided by inflation-adjusted domestic production less 

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

latest industry-level production data available. 

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

relatively low proportion of production in the printing 

and publishing, lumber and wood products, and oil and 

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

industries is exported. 

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

distribution where 50 percent of the industries are assigned to the 

Medium category, with the remaining 50 percent evenly allocated 

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

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

New York Regional Outlook 15 First Quarter 2000 
In Focus This Quarter
 

The industries in each column are categorized by the 

share of U.S. consumption expenditures in a particular 

industry that are satisfied by imports. Again, the Low 

and High categories each include 7 industries, and the 

Medium category includes the remaining 12 industries.6 

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

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

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

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

import competition. These industries—transportation 

equipment, industrial machinery, electronic equipment, 

and leather products—account for slightly less than half 

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

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

U.S. international trade. 

Using the terminology introduced above, Highly 

Exposed Industries are defined as those assigned to 

either of the High categories; industries in this group 

either are very reliant on export markets or face high 

levels of import competition. Less Exposed Industries 

are defined as those that have little exposure to either 

export markets or import competition; they are shown 

in the upper left cell in the Low classification. The 

remaining industries are defined as Moderately 

Exposed Industries. 

Chart 3 illustrates the distribution of establishments in 

each of the three categories by Region.8 Among the 

6 Breakpoints for the distribution of industries by import share of 

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

than 25 percent. 

7 Although not directly included in the analysis, most domestically 

produced services also have minimal reliance on export markets and 

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

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

mining, and agriculture account for the majority of imports and 

exports. 

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

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

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

County Business Patterns (Bureau of Census, 1997). 

CHART 3 

Atlanta Boston Chicago Dallas Kansas Memphis New San 

City York Francisco 

Number of Establishments* Classified by 

International Trade Exposure by Region 

0 

10,000 

20,000 

30,000 

40,000 

50,000 

60,000 

FDIC Region 

Source: Bureau of Census, 1997 County Business Patterns Database 

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

Highly Exposed Industries 

Moderately Exposed 

Industries 

Less Exposed Industries 

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

Atlanta, Chicago, and San Francisco have the greatest 

number of establishments in this category. The Chicago 

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

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

most service-sector, construction, and government 

enterprises, while not part of this analysis, could be 

classified as Less Exposed.10 

Although this analysis highlights the varying level of 

direct exposure to international markets, industries also 

may be exposed through a less direct secondary channel. 

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

example, the rubber and plastics industry produces 

goods that are used in the manufacture and assembly of 

transportation equipment, a Highly Exposed Industry. 

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

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

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

remaining Regions, the percentages vary between 25 percent and 35 

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

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

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

(Boston Region) of total establishments. 

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

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

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

not 26 as in Table 2. 

New York Regional Outlook 16 First Quarter 2000 
In Focus This Quarter
 

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

These supplier industries are also vulnerable to import 

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

markets for its products, may switch from a domestic 

supplier of rubber products to a cheaper foreign supplier 

if a favorable price differential emerges. Therefore, 

assessing the exposure of industries to either exports or 

imports requires consideration of any secondary linkages 

between suppliers and purchasers of industry products. 

Summary 

The contribution of international trade to overall U.S. 

economic activity has been increasing for a number of 

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

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

growth resulting from both slumping international 

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

Import growth has continued unabated, largely because 

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

trade deficit. The effects of import and export growth 

on particular industries vary because of differing levels 

of reliance on export markets and the extent of import 

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

conditions. Lenders should be aware that for firms in 

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

both imports and exports, largely determine pricing, 

revenue growth, and profitability. 

Paul C. Bishop 

Senior Financial Economist 

New York Regional Outlook 17 First Quarter 2000 
Regional Perspectives
 

Regional Perspectives
 

•	 Although the Region’s economy remains healthy, employment growth has become sluggish, suggesting the 

possibility of less vigorous economic gains in the near future. 

•	 Despite competitive pressures, the Region’s banks reported generally sound financial conditions as higher 

noninterest income offset erosion in the average net interest margin. Credit quality measures improved for 

most loan segments, except commercial and industrial loans, which showed slight deterioration at larger 

banks. 

•	 Noninterest income is expected to increase as banks look for ways to augment earnings and improve performance measures. As noninterest income becomes a more significant contributor to bank profitability, 

analysis of the quality and stability of these income sources becomes more critical. 

•	 The Region’s manufacturing sector, previously benefiting from the general economic expansion, is once 

again losing jobs. Analysts have cited higher energy costs as a major factor that discourages manufacturing 

relocations and expansions in the Region. 

Region’s Economic and Banking Conditions 

Region’s Economy Is Healthy, although 

Employment Growth Is Beginning to Slow 

The New York Region’s economy remains prosperous, 

with new jobs being created, incomes growing, and, 

according to surveys of consumer confidence, consumers upbeat about future economic prospects. The 

major economic drivers of the Region, which include 

Wall Street, new high-tech industries, and commercial 

real estate, were highly profitable in 1999. In many 

respects, the Region has recovered fully from the recession of the early 1990s, which was particularly harmful 

to the local economy with large numbers of layoffs. In 

contrast, these days, labor shortages are more common 

than layoffs. Economists’ expectations for continued 

economic growth into the near future are high. 

Although the Region’s economy is healthy, employment 

growth has slowed. The Region added 286,000 jobs 

between the third quarters of 1998 and 1999, a 1.3 percent growth rate. While the increase represents 

respectable growth based on historical trends, it is less 

than the 2.2 percent growth rate attained by the nation 

over the same period and the 1.8 percent rate achieved 

by the Region between the third quarters of 1997 and 

1998. Over the past several quarters, the rate of job 

growth has been gradually declining, and the gap 

between employment gains in the Region versus the 

nation has been widening (see Chart 1). Analysts traditionally associate the Region’s slower job growth with 

several factors, including more expensive labor, higher 

energy costs, less space to build new office buildings or 

factories, and higher taxes. Limited population growth 

and, more recently, labor shortages also have been cited 

as impediments to job growth in the Region. 

Employment gains have been leveling off in almost all 

of the Region’s states and the Commonwealth of Puerto Rico. Delaware, the perennial job-growth leader in 

the Region, remained strong at 2.9 percent annual 

growth between the third quarters of 1998 and 1999. In 

CHART 1 

Note: Growth rates are quarterly year-over-year percent changes. 

Source: Bureau of Labor Statistics. 

Region’s Employment Growth Rate Is 

Slowing Compared with the Nation’s 

Percent Change 

New York Region 

U.S. 

1.0 

1.5 

2.0 

2.5 

3.0 

1Q972Q973Q974Q971Q982Q983Q984Q981Q992Q993Q99 

New York Regional Outlook 18	 First Quarter 2000 
Regional Perspectives
 

Maryland, New Jersey, and New York, however, job 

gains slowed, ranging between 1.6 and 1.75 percent, 

down from 2 percent or more in each state.1 The largest 

drop in the Region was in Pennsylvania, where 

employment growth slipped to below 0.5 percent 

between the third quarters of 1998 and 1999 from 

almost 1.75 percent a year earlier. Losses in manufacturing employment, particularly in industries related to 

steel production, apparel, textiles, transportation, electronic equipment, and industrial machinery, contributed 

to the slower employment growth. In particular, Pennsylvania’s steel producers have been hurt by weak prices 

stemming from economic slowdowns that began in Asia 

in 1998. Subsequent economic recessions in Asia, 

Brazil, and Russia depressed demand for steel exports, 

resulting in lower prices and profits. Despite some economic turnaround in Asia and Brazil, it is too soon to 

assess whether the Region’s steel manufacturers will 

benefit from any short-term recovery in steel prices. 

Pennsylvania’s overall employment slowdown has been 

particularly noticeable in the Harrisburg area, which 

between 1994 and 1998 was one of the fastest-growing 

locations for new jobs in the state. In 1999, however, job 

growth abated, primarily because of losses in the manufacturing and government sectors and limited growth in 

business services jobs. Consolidation and layoffs at 

Tyco International, a large manufacturer of electronic 

equipment in the Harrisburg area, are responsible for 

many of the job losses. Although it has begun to rise, 

Harrisburg’s unemployment rate still remains below the 

state average of 4.4 percent and the national average of 

4.2 percent in third quarter 1999. 

A loss in the number of manufacturing jobs also has 

been noted in Puerto Rico. The gradual phaseout of federal tax incentives has discouraged investment and hurt 

the manufacturing sector over the past three years. Manufacturing employment declined by 5.2 percent between 

the third quarters of 1998 and 1999, which tops the previous-year decline of 3.6 percent. This decline has contributed to flat overall employment growth through the 

first three quarters of 1999. Despite reduced job growth, 

the Puerto Rican economy is expected to expand 

because of increases in other sectors such as tourism and 

construction. Declines in manufacturing-sector jobs also 

have been occurring in New Jersey and New York, where 

losses in textiles, chemicals, and apparel, as well as steel 

and primary metal production, have been reported. 

1 Annual employment growth is measured on a current quarter over 

prior year’s quarter. 

Employment growth in the Region’s finance, insurance, 

and real estate (FIRE) industries as well as the service 

sector—industries that over time have become more 

vital to the Region’s economic well-being—also has 

slowed. Higher interest rates and consolidations may be 

reasons that FIRE-sector companies are paring down 

hiring plans. At the same time, employment in some 

companies that provide service support to the FIRE sector may be slowing as well. Reported labor shortages in 

computer-related and high-tech industries also may be 

limiting job growth. Press reports suggest that labor 

force constraints are crimping companies’ hiring plans, 

particularly in the rapidly growing BaltimoreWashington, D.C., high-tech sector. 

Region’s Established Banks Report Healthy 

Conditions, but Competitive Pressures Remain 

Following the strong economy, the New York Region’s 

banks reported generally healthy financial conditions 

in the third quarter of 1999, although profitability measures reflected competitive pressures on bank margins. 

The average return on assets (ROA) for the Region’s 

banks (excluding banks that have been in operation less 

than three years) slightly improved, to 1.15 percent in 

the third quarter of 1999 from 1.13 percent reported one 

year ago. While competition from banks and other 

financial service providers hindered interest income 

growth, increased noninterest income offset the effect 

of narrowing net interest margins (NIMs) on bank earnings. In the third quarter of 1999, the average NIM at 

the Region’s established banks2 declined to 3.94 percent 

from 4.04 percent one year ago. The decline occurred in 

spite of the widening spread between short- and longterm treasuries,3 a trend that can be beneficial to banks. 

Noninterest income, however, increased from 1.64 percent of average earning assets in third quarter 1998 to 

2.57 percent in third quarter 1999. Despite preparations 

for the year 2000, the Region’s banks controlled 

expense growth, as the average efficiency ratio,4 the 

ratio of an institution’s operating or overhead expenses 

to operating income, remained at approximately 64 

percent. 

2 Established banks are defined as banks that were in existence prior 

to September 30, 1996. New banks are discussed separately because 

of the increasing number of new banks in the Region and because 

new banks have different performance characteristics than established 

banks. 

3 Treasury spread is measured as the yield on the ten-year Treasury 

bill minus the yield on the six-month Treasury bill. 

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

sum of net interest income and noninterest income. 

New York Regional Outlook 19 First Quarter 2000 
Regional Perspectives
 

Asset quality measures improved in most loan categories. Past-due loans as a percentage of total loans in 

the Region declined slightly, from 2.5 percent to 2.4 

percent, between the third quarters of 1998 and 1999. 

Delinquency rates were down for the credit card, commercial real estate, and consumer loan portfolios. However, the commercial and industrial (C&I) past-due ratio 

increased slightly over the past two years. Reported 

aggregate charge-off rates on the Region’s loans have 

tracked, on a lagged basis, improvements in the 

Region’s delinquency ratios. Aided by a declining rate 

of personal bankruptcy filings in the nation and a 

vibrant economy, the charge-off rate on the Region’s 

credit card loans decreased to 5.16 percent in the third 

quarter of 1999, down from 5.90 percent reported in 

third quarter 1998. The charge-off rate on the Region’s 

other major loan categories also improved from a year 

ago. Charge-offs on the Region’s C&I loans, however, 

increased from 0.46 percent in the third quarter of 1998 

to 0.75 percent in the third quarter of 1999. 

While asset quality measures depict improved credit 

quality, the ratio of reserve coverage to noncurrent loans 

reported by the Region’s banks has declined gradually 

and was below the average for the nation. Reserves to 

total noncurrent loans reached 133 percent as of September 30, 1999, compared with 146 percent one year 

ago and 180 percent for commercial banks nationwide.5 

Lower reserve coverage ratios could result in higher 

provisions by the Region’s banks should loan quality 

deteriorate significantly because of either underwriting 

deficiencies or a slowing economy. 

Aided by increased noninterest income, 

the Region’s established community 

banks6 reported a higher average ROA of 

1.08 percent in the third quarter of 1999 

compared with 1.01 percent one year 

ago. Community banks did not escape 

the effects of increasing competition for 

loans, as interest income as a percentage 

of average earning assets declined from the same period a year ago and is at its lowest point in five years. 

Higher noninterest income, which increased to 5.55 percent of average earning assets in the third quarter of 

1999 compared with 2.19 percent in the same period 

one year ago, bolstered community banks’ earnings. 

5 FDIC Quarterly Banking Profile, third quarter 1999.
 6 Established community banks are defined as banks with less than
 

$100 million in assets that were in existence prior to September 30,
 

1996.
 

Community banks reported slightly higher operating 

expenses as measured by the average efficiency ratio, 

which rose from 71.3 percent to 73.2 percent between 

the third quarters of 1998 and 1999. In other words, 

established community banks spent approximately 73 

cents to earn one dollar of income in the third quarter of 

1999, compared with an average of just over 64 cents 

for all established banks in the Region. Community 

banks typically have higher (less favorable) efficiency 

ratios because they cannot achieve economies of scale 

(i.e., spread costs over a large revenue base) to the same 

extent as larger banks. (See “Bank Performance 

Remains Strong, but Earnings Variability Is Increasing,” Regional Outlook, Third Quarter 1999.) 

New Bank Formation Continues in the Region 

The increasing number of new banks,7 primarily in New 

Jersey and Pennsylvania, is driving down the average 

ROA for new banks in the Region. As of September 30, 

1999, there were 67 new banks in the Region, compared 

with 37 one year earlier. New banks represented 7.5 percent of the Region’s banks, the highest percentage in the 

1990s. During the third quarter of 1999, the average 

ROA for the Region’s new banks was negative 2.76 percent, compared with negative 1.47 percent one year ago. 

The higher percentage of banks in operation less than 

one year has skewed the average ROA reported by the 

Region’s new banks. As of September 30, 1999, approximately 58 percent of the Region’s new banks had been 

in operation less than one year, the largest share in the 

decade. However, the average ROA for banks that were 

between one and three years old was better (less negative) than that of their newer counterparts. 

New banks typically report lower earnings in the initial 

years as bank management grows its clientele and 

develops businesses. To compensate for the impact of 

losses during the first few years of a bank’s existence, 

new banks are required to have higher capital levels 

than their established counterparts. Although the 

Region’s new banks reported substantially lower average ROAs than established banks, the group’s capital 

ratio averaged 30.2 percent over the past two years, 

almost three times the average capital ratio of the 

Region’s established banks. While most of the Region’s 

new banks are located in strong local economies, they 

also face increasing competition for loans and deposits. 

7 New banks are defined as banks formed since September 30, 1996. 

New York Regional Outlook 20 First Quarter 2000 
Regional Perspectives
 

(For additional information on new bank formation in 

the New York Region, see “New Bank Activity Occurs 

in Clusters” in Regional Outlook, Fourth Quarter 

1999.) 

C&I Loans at Larger Banks Inch Up, 

but Credit Quality Shows Slight Weakening 

While the dollar amount of C&I loans outstanding at the 

Region’s banks increased almost 76 percent over the 

past five years, C&I loans increased only slightly as a 

percentage of total assets (see Chart 2). Among banks 

with assets greater than $1 billion, C&I loans increased 

from 14 percent of assets in the third quarter of 1998 to 

15 percent in the third quarter of 1999.8 Large banks are 

more active in certain segments of the C&I market, such 

as syndicated and leveraged lending, which have 

increased substantially in the past year. Increased syndicated lending activity may be contributing to C&I loan 

growth in the Region, as several of the Region’s money 

center banks accounted for almost half of the syndicated lending volume in 1999.9 Large banks also have been 

more active in the securitization of commercial loans. 

As competition for commercial loans has driven down 

spreads, some larger banks have packaged and sold C&I 

loans to improve profitability margins. Loans that are 

securitized are generally recorded as sold but are not 

reported on the balance sheet. 

Recent underwriting surveys conducted by the Federal 

Reserve Board and the Federal Deposit Insurance 

Corporation have identified changes over the past two 

years in C&I underwriting. A November 1997 Federal 

Reserve Board Senior Loan Officer Opinion Survey 

noted that intense competition forced many banks to 

ease terms and standards on C&I loans during that 

year; however, more recent surveys, in August and 

November 1999, stated that during the first half of 

1999, banks had subsequently tightened C&I underwriting standards. 

Credit quality measures for the Region’s C&I loans 

reflect the trends noted in the recent underwriting surveys. Following several years of improvement in credit 

quality measures, there are some recent signs of deteri8 Securitized C&I loans that have been packaged and sold by institutions are not included in this amount.
 

9 Moyer, Liz, and B. Chase. “A Dominated Syndicated Loan Market,”
 

American Banker, January 4, 2000.
 

CHART 2 

Source: Bank and Thrift Call Reports, as of Sept. 30 each year. 

C&I Loans as a Percentage of Assets

 Have Increased Slightly in the Region 

C&I Loans 

(Left Axis) 

C&I Loans to Assets 

(Right Axis) 

$ Millions Percent 

18 

1999 

100 

150 

200 

250 

300 

350 

6 

8 

10 

12 

14 

16 

1990

19911992199319941995199619971998 

oration in the quality of the Region’s C&I loans, primarily in large banks. The average past-due ratio on 

C&I loans reported by the Region’s large banks 

increased slightly, from 1.8 percent to 2.1 percent 

between the third quarters of 1998 and 1999 (see Chart 

3, next page). This deterioration may reflect the credit 

quality of the loans booked during the past two years, 

when banks were reportedly more aggressive in underwriting commercial loans. The C&I past-due ratios 

reported by the Region’s community banks (those with 

assets less than $100 million) and midsize banks (those 

with assets between $100 million and $1 billion), however, were stable or improved, reflecting healthy economic conditions throughout many parts of the Region. 

The C&I charge-off ratio among the Region’s large and 

midsize banks tracked the C&I past-due ratio: after 

several years of decline, charge-offs ticked up in the 

past two years. However, the ratios remain at relatively 

low levels. The Region’s community banks showed 

improvement in the C&I charge-off rate (see Chart 4, 

next page). 

Although some experts expect the economic expansion 

to continue, any slowdown in the nation’s or Region’s 

economy could contribute to deterioration of C&I loan 

performance. In fact, the results of the Federal Reserve 

Board’s August 1999 Senior Loan Officer Opinion 

Survey on Bank Lending Practices showed that onethird of respondents believed that their C&I portfolios 

have become more sensitive to periods of economic 

weakness. Specific concerns include borrowers’ 

increased financial leverage and narrower profit margins. Furthermore, the increase in lower-quality syndicated loans, such as leveraged loans, which now 

account for almost 45 percent of total syndicated 

New York Regional Outlook 21 First Quarter 2000 
Regional Perspectives
 

CHART 3 CHART 4 

Source: Bank and Thrift Call Reports. Mature banks as of Sept. 30 each year. 

C&I Past-Dues Are Moderate, but... 

Percent 1994

19951996199719981999 

Large 

Medium 

Community 

0.0 

1.5 

3.0 

4.5 

6.0 

7.5 

Source: Bank and Thrift Call Reports. Mature banks as of Sept. 30 each year. 

Percent 

...Large and Medium Bank’s 

Charge-Off Rates Are Inching Up 

199419951996199719981999 

1.5 

0.0 

0.5 

1.0 

Community 

Medium 

Large 

lending volume,10 could have adverse effects on C&I 

credit quality measures. For more information on 

trends in commercial and industrial loans, see the 

“In Focus” article in this issue. 

Noninterest Income Grows in Importance 

Traditionally, insured institutions have relied on interest income from loans and securities to generate the 

bulk of their operating income; fees and service 

charges were usually supplemental. In the past five 

years, however, increased competition for loans and 

deposits between banks and other financial providers, 

including investment banks, brokerage companies, and 

insurance firms, has pressured bank interest margins 

and market share. In response, banks have attempted to 

diversify income sources, enhance profitability measures, and mitigate pressures on NIMs by generating 

more noninterest income. 

The growth of noninterest income11 results from 

increased fees from traditional banking services as well 

as expansion by banks into new services. Banks are 

generating more income from traditional banking 

activities, such as charges on deposit accounts and 

10 “Spotting for the Market,” The Investment Dealer’s Digest, December 6, 1999. 

11 Noninterest income, as defined by the Consolidated Reports of 

Condition and Income (Call Reports), includes trading income, fiduciary income, service charges on deposit accounts, other fee income, 

and all other noninterest income. Gains on the sale of investment 

securities are accounted for separately and not included in this discussion of noninterest income. 

credit cards and fees for mortgage servicing and loan 

commitments, which generally are more insulated from 

changes in economic conditions or financial market 

instability. For example, automated teller machines 

(ATMs) have been a source of fee income for insured 

institutions for years; however, banks have initiated 

new charges for ATM use, including fees for noncustomer use and charges for the use of another institution’s ATM (referred to as a “foreign fee”). According 

to CNNfn,12 a recent Public Interest Research Group 

survey found that the number of banks imposing ATM 

fees climbed 31 percent in 1998, with 93 percent of all 

banks now surcharging non-account-holders. Higher 

noninterest income also has resulted from increased 

bank involvement in activities that are more susceptible 

to changes in financial markets such as trading activities, investment advisory services, and the sale of life 

insurance products. 

Increased reliance on noninterest income has occurred 

nationwide as noninterest income climbed from 29 percent of operating income13 to 36 percent over the five 

years ending September 30, 1999.14 In the Region, noninterest income has increased from 39 percent to 50 

percent of operating income over the same period, as 

the growth of noninterest income has outpaced that of 

interest income.15 The larger proportion of noninterest 

income to operating income reported by the Region’s 

12 Jacoby, Nicole. “Keeping Bank Costs in Check,” CNNfn, May 3,
 

1999.
 

13 Operating income is defined as net interest income plus noninterest
 

income.
 

14 Excluding banks in the Region.
 

15 On a merger-adjusted basis.
 

New York Regional Outlook 22 First Quarter 2000 
Regional Perspectives
 

banks reflects in part the broad scope and national 

presence of the Region’s larger banks and credit card 

specialists.16 

Because of size, market reach, and the types of products 

offered, the Region’s larger banks (those with assets 

over $10 billion) have historically stood at the forefront 

of revenue diversification and generation of noninterest 

income. The larger banks, excluding credit card banks, 

accounted for approximately 70 percent of total noninterest income as well as two-thirds of all fees and 

income from trust activities, trading revenue, and mutual fund and annuity sales generated in the Region during the third quarter of 1999. Noninterest income 

constituted approximately 55 percent of the operating 

income for the Region’s larger banks in the third quarter of 1999, up from 43 percent five years ago. 

Increased syndicated lending has contributed to greater 

levels of fee income reported by large banks. According 

to Paine Webber Equity Research,17 syndicated lending 

generates more fees than any other type of underwriting 

activity. The report estimates that syndicated lending 

generates almost $6 billion in fees to banks annually, 

ranking it as the highest fee-generating business in 

investment banking. The report also states that syndicated lending is one of the fastest-growing markets for 

banks, increasing an estimated 15 percent per year. Periods of economic instability or reduced merger activity, 

however, could lessen demand for syndicated loans and 

pressure fees earned by banks in this market segment. 

Trading revenue also is an important source of noninterest income to the Region’s larger banks, ranking second behind fee income. As of September 30, 1999, 

trading revenue contributed 19 percent of total noninterest income to banks with assets over $10 billion. 

Noninterest income from trading includes income from 

interest rate, foreign exchange, equity, and commodity 

contracts. As is the case with syndicated lending, revenue from bank trading activities can be vulnerable to 

fluctuations in global financial markets. 

The contribution of noninterest income is more significant in the Region’s credit card specialists than in its 

larger banks. In the third quarter of 1999, 72 percent of 

16 Credit card specialists are defined as banks that have 50 percent of 

assets in loans and 50 percent of loans as credit card loans. 

17 Madan, Ruchi. “The Biggest Secret of Wall Street,” Paine Webber 

Equity Research, May 14, 1999. 

operating income for the Region’s nine credit card specialists came from noninterest income, compared with 

55 percent during the same period five years ago. Credit card banks historically have generated a greater 

amount of fees and service charges than traditional bank 

lenders. As credit card lenders have saturated consumers with solicitations, credit card specialists have 

competed for market share by offering low-rate cards 

and other incentives such as mileage rewards and rebate 

programs. To offset the effect of lower yields earned on 

these “teaser” rate offers, many lenders increased service fees. According to industry reports, late and overlimit fees have increased the most in the past few years, 

with late fees currently averaging $24.02, up from 

$11.97 five years ago, and the average over-limit fees 

increasing to $23.44 from $12.57 in the same period.18 

Many major issuers also reduced their late payment 

grace period from 14 to 0 days, resulting in borrowers 

being subject to late fees sooner. Some credit card 

issuers have even instituted charges for closing an 

account and for general customer service. 

The expansion into subprime lending is another factor 

contributing to the growth of noninterest income. Some 

credit card banks, along with other insured and nonbank 

lenders, are making loans to subprime borrowers more 

accessible than in prior years. Subprime loans, which 

are offered to borrowers who are considered to have 

weaker credit histories, typically generate more fees 

than loans to borrowers who have better credit quality 

characteristics. Subprime loans typically incur more 

late charges, insufficient fund charges, and escrow 

charges than nonsubprime loans. Recent entrants in 

subprime lending have benefited from a strong economy; however, revenue from subprime loans, including 

interest and noninterest income, may prove to be less 

significant during weaker economic environments. 

Growth in Noninterest Income 

Is Not Limited to Larger Banks 

Increased reliance on noninterest income is not limited 

to the Region’s credit card specialists and larger banks. 

The Region’s midsize banks (those with assets between 

$100 million and $1 billion) have reported a higher proportion of noninterest income to operating income in 

recent years. Noninterest income increased from 17 percent of operating income in third quarter 1994 to 28 per18 Jacoby, Nicole. “Picking a Credit Card,” CNNfn, July 21, 1999. 

New York Regional Outlook 23 First Quarter 2000 
Regional Perspectives
 

cent in third quarter 1999.19 This segment of the 

Region’s banks reported “other noninterest income”20 as 

their main source of noninterest income. 

While some types of “other” noninterest income are 

generated by ongoing operations, such as data processing services and rental income, others are derived from 

a merger or restructuring of an institution’s balance 

sheet or operations. Barring a continuous stream of 

mergers or restructuring, the amount of income generated from this source is limited. 

Gains from the sale of securitized assets are another 

example of “other” noninterest income that is sensitive 

to changes in financial markets. During the past year, 

several financial providers, primarily subprime lenders, 

reported substantial losses resulting from decreases in 

the value of gains recorded on securitizations because 

of changes in market conditions, primarily interest 

rates. As a result of these losses, some subprime lenders 

that relied almost exclusively on gains from securitizations for earnings have been forced to merge or cease 

operations. 

The Region’s community banks (those with assets less 

than $100 million) also have increased reliance on noninterest income, from just under 15 percent of operating income during the third quarter of 1994 to almost 

32 percent during third quarter 1999.21 Fee income represented the largest share of community banks’ noninterest income. According to the American Bankers 

Association (ABA), a 1999 Community Bank Competitiveness Survey found that mortgage and trust fees 

were a significant source of fee income (22 and 17 percent, respectively) for community banks.22 Like their 

larger brethren, community banks are earning more 

fees from traditional banking activities and developing 

new fee-based businesses. For example, sales of nondeposit investment products such as mutual funds and 

annuities have augmented community banks’ earnings. 

According to a recent report in the ABA Banking Journal, community banks that sell nondeposit investment 

products are more successful than regional or money 

center banks at realizing profits from these products 

and penetrating their deposit base. Community banks’ 

19 Excluding credit card specialists.
 

20 The Call Report definition of “other noninterest income” includes
 

data processing fees, net gain on sale of assets such as buildings and
 

branches, and rental income.
 

21 Excluding credit card specialists.
 

22 “The Income Picture: Shifts and Surprises,” ABA Banking Journal,
 

February 1999.
 

income from the sale of nondeposit products could 

decline if confidence in the stock market erodes or 

other financial intermediaries expand their presence 

into local communities. 

Implications for Insured Institutions 

The benefits to insured institutions of earning higher 

levels of noninterest income are numerous. Noninterest 

income has helped strengthen banks’ earnings while 

mitigating the effect of narrowing interest margins on 

profitability. Higher fee income, in part, reflects the 

successful expansion by banks into new markets and 

products, which strengthens the banks’ market share 

while diversifying income. Furthermore, noninterest 

income enhances an institution’s return on assets and 

equity, because service-based income does not require 

capital reserves. In addition, noninterest income generally is not subject to credit quality concerns, as is interest income on loans and securities. 

Insured institutions’ emphasis on noninterest income is 

expected to continue as banks look for ways to augment 

earnings and improve performance measures; however, 

increased competition from other financial services 

providers and fluctuations in the financial markets may 

hinder future growth. Some types of noninterest income 

may be more susceptible to changes in market conditions than more traditional bank products. Increased 

competition among banks and nonbank financial 

providers also could influence banks’ ability to generate 

noninterest income. The enactment of the GrammLeach-Bliley Act, which expands permissible bank 

activities such as investment banking and insurance 

activities and permits mergers between insured institutions and other financial providers, may intensify competition for banking products and services. As 

noninterest income becomes a more significant contributor to bank profitability, the analysis by banks of the 

quality and stability of these income sources becomes 

more critical. 

The Region’s Higher Costs Have 

Hurt the Manufacturing Sector 

The Region’s manufacturing sector has been contracting 

for decades (see Chart 5). After World War II, manufacturing industries gradually began to exit the Region for 

lower labor-cost areas of the South and overseas. 

Throughout the 1970s and 1980s, declines in the 

New York Regional Outlook 24 First Quarter 2000 
Regional Perspectives
 

CHART 5 

Note: Represents year-over-year percentage change. 

Source: Bureau of Labor Statistics 

Regional Manufacturing Employment May Have Resumed Its Long-Term Decline... 

–10 

1981 1985 1990 1995 1999 

–8 

–6 

–4 

–2 

0 

2 

4 

Region’s manufacturing sector, including the fabricated 

metal, machinery, furniture, textiles, and transportation 

equipment industries, were particularly severe. In the 

1990s, job declines in the Region reflected downsizings 

and major restructurings in defense-related firms, pharmaceuticals companies, and a number of prominent 

manufacturers, including Xerox, IBM, and Kodak, 

whose losses contributed to the Region’s severe recession. These restructurings, however, increased productivity of the Region’s manufacturing sector by 30 

percent between 1990 and 1997, improving these firms’ 

competitive position in the global market (see Chart 6). 

In the late 1990s, employment levels began to rise. 

Crises in Asia, Brazil, and Russia, however, reduced 

worldwide demand for manufactured goods from the 

United States and the Region, resulting in a decline in 

manufacturing employment beginning in third quarter 

1999 through year-end. 

Region’s Large Cities Pay High Electricity Rates 

Higher electricity rates as well as higher labor costs 

have been particularly burdensome to businesses in 

the Region. A recent study by the New York City 

Comptroller’s Office found that electricity costs in 

many of the Region’s cities are among the highest 

in the United States.23 New York City’s residential 

23 New York City Office of the Comptroller. Economic Notes: The 

High Price of New York City Power, September 1999. 

electrical rates ranked the highest of any major U.S. 

city, even after factoring in state and local taxes. Moreover, Philadelphia was ranked second and Pittsburgh 

and Washington, D.C., were in the top ten. On the commercial side, the picture was no better. Every major 

city24 in the Region ranks among the U.S. cities paying 

the highest dollar per kilowatt-hour. Higher rates can 

be attributed to the local utilities’ cost of doing business. These utilities face limited access to less expensive hydroelectric power or the inability to burn cheap 

coal because of local air quality restrictions. The 

24 Major cities include Baltimore, New York City, Pittsburgh, Philadelphia, and Washington, D.C. 

CHART 6 

...but Productivity Is Up 30 Percent since 1990 

Note: Productivity is measured by dividing gross state product by the number of 

employees. Data from 1997 are the most recent available and exclude Puerto 

Rico. 

Source: Bureau of Labor Statistics, National Income and Product Accounts. 

80 

100 

120 

140 

Productivity Index 

1990 1991 1992 1993 1994 1995 1996 1997

New York Regional Outlook 25 First Quarter 2000 
Regional Perspectives
 

Comptroller’s report also cites high local and state utility taxes as well as high administrative costs as contributing to the costs of energy production. 

Some States Are More Vulnerable 

to Oil Price Hikes 

The Region’s energy costs have been driven even higher 

with the increase in oil prices since last year. In December 1998, the cost of benchmark West Texas intermediate oil stood at $11.28 per barrel. Agreements by the 

Organization of Petroleum Exporting Countries, 

however, had driven the price to $26.08 per barrel by 

December 1999, an increase of over 130 percent. 

Despite the increase, oil has become less important to 

the economy than it was in the 1970s, as the economy 

moves toward services and away from manufacturing. A 

recent article in the Wall Street Journal said that many 

of the nation’s companies have learned to protect themselves from oil-price swings by diversifying fuel sources 

and developing new energy-saving technologies,25 thus 

also helping to shield the nation’s and Region’s 

economies from higher prices. 

Petroleum, nevertheless, represents the largest single 

energy source in both the Region and the nation, 

accounting for approximately 40 percent of all energy 

use (see Chart 7). In Delaware, Maryland, and New 

Jersey, petroleum dependency is higher, representing 

25 Liesman, Steve, and Jacob Schlesinger. “Blunted Spike: The Price 

of Oil Has Doubled This Year; So Where’s the Recession?,” The Wall 

Street Journal, December 15, 1999. 

CHART 7 

Petroleum Is the Primary Source 

of Energy in the Region and Nation 

Other Rest of United States 

Biomass 

Hydroelectricity New York Region 

Nuclear 

Petroleum 

Natural Gas 

Coal 

0 10 20 30 40 50 

Share of Energy Use (%) 

Source: U.S. Department of Energy 

over 55 percent of all energy use in Delaware and New 

Jersey and over 43 percent of all energy use in Maryland. Delaware and New Jersey are very dependent on 

petrochemical products for their chemicals industries, 

and increases in oil prices could hinder future economic growth. Increases in oil prices, like additional taxes, 

increase production costs. Delaware, Maryland, and 

New Jersey businesses could suffer a competitive disadvantage if oil prices remain high. 

Kathy Kalser, Regional Manager 

Norman Gertner, Regional Economist 

Alexander Gilchrist, Economic Analyst 

Special thanks to Mark Otero, Intern 

George Small, Examiner 

New York Regional Outlook 26 First Quarter 2000 
✁
 

Subscription Form
 

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

Institution Name ______________________________________________________________ 

Contact Person ______________________________________________________________ 

Telephone ______________________________________________________________ 

Street Address ______________________________________________________________ 

City, State, Zip Code ______________________________________________________________ 

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

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

Washington, D.C. 20434 

Fax Number (202) 416-2076 

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

Atlanta _________ Dallas _________ New York _________ National _________ 

Boston _________ Kansas City _________ San Francisco _________ All _________ 

Chicago _________ Memphis _________ 

Federal Deposit Insurance Corporation 

Washington, DC 20429-9990 

OFFICIAL BUSINESS 

PENALTY FOR PRIVATE USE, $300 

BULK RATE
 

MAIL
 

Postage &
 

Fees Paid
 

FDIC
 

Permit No. G-36