Regional Outlook
 

FEDERAL DEPOSIT INSURANCE CORPORATION FOURTH QUARTER 1999 

FDIC
 

Memphis
 

Region
 

Division of
 

Insurance
 

Gary L. Beasley,
 

Regional Manager
 

Harry W. John,
 

Regional Economist
 

Robert L. Burns,
 

Senior Financial
 

Analyst
 

F. Miguel Hasty,
 

Financial Analyst
 

In Focus This Quarter 

◆ Economic Conditions and Emerging Risks in Banking—This article provides an 

overview of economic conditions and banking industry trends, with a primary focus on 

potential risks to insured depository institutions. 

● Indicators of Industry Performance—The reported financial condition of insured banks 

and thrifts is strong. However, despite projected growth in earnings, bank and thrift 

stocks underperformed the broader market through October 1999. See page 3. 

● Economic Conditions—The economy remains generally strong, and the outlook calls 

for continued growth. Growth is likely to slow, however, in order to correct financial 

imbalances that have developed as a result of a rapid creation of household and commercial credit and borrowing from abroad. There is a threat that the adjustment process 

could be a volatile one. See page 4. 

● Emerging Risks in Banking—Rising indebtedness on the part of businesses and households raises concerns about future loan performance. Industry responses to intense competition have created greater credit, market, and operational risks. See page 8. 

Consumer Lending—Banks and thrifts are becoming increasingly involved in subprime
 

consumer lending, which has raised some supervisory concerns. See page 8.
 

Commercial and Industrial Lending—Signs of deterioration in corporate credit quality
 

can be found in rising loss rates, slower profit growth, and rising corporate bond defaults.
 

At the same time, banks are expanding their lending to heavily indebted companies in
 

the syndicated loan market. See page 11.
 

Commercial Real Estate and Construction Lending—Loans for real estate construction
 

and development are growing rapidly. Despite an uptick in commercial vacancy rates,
 

loan losses remain low. See page 12.
 

Agricultural Lending—Low commodity prices are hurting farm operating incomes, but
 

widespread effects on farm banks have yet to materialize. See page 13.
 

Funding and Interest Rate Risk—Lagging deposit growth has led to a greater reliance
 

on more volatile, market-based funding, and some institutions are taking on greater
 

interest rate risk to maintain loan growth. See page 14.
 

By the Analysis Branch Staff 

Regional Perspectives 

◆ Economic and Banking Conditions—The Region’s economy continues to underperform that of the nation. Payroll employment growth has slowed sharply with job losses in the 

manufacturing and energy sectors. The agricultural sector continues to deteriorate as the 

Region’s important rice and cotton crops experience substantial price declines. Banking conditions remain favorable, but weaknesses in net interest margins persist. See page 18. 

◆ New Bank Activity and Performance—Institutions established since the last recession 

represent almost 11 percent of all insured institutions in the Region. New banks’ earning performance has worsened from the middle of this decade, and these newly chartered institutions are taking slightly longer to become profitable than in prior periods. Historically, new 

banks have reported considerably higher failure rates during periods of economic stress than 

established banks have. See page 22. 

By the Memphis Region Staff 

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

Insurance Corporation institutions and financial institution regulators. It is produced for the following eight geographic regions: 

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

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

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

Dallas Region (CO, NM, OK, TX)
 

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

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

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

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

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

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

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

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

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

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

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

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

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

the Federal Deposit Insurance Corporation. 

Chairman Donna Tanoue 

Director, Division of Insurance Arthur J. Murton 

Executive Editor George E. French 

Editors Lynn A. Nejezchleb 

Maureen E. Sweeney 

Ronald L. Spieker 

Publications Manager Teresa J. Franks 

Writer/Editor Kim E. Lowry 
In Focus This Quarter
 

Economic Conditions and 


Emerging Risks in Banking
 

The Division of Insurance periodically assesses conditions in the economy and the banking industry to identify and 

evaluate trends that could adversely affect the performance of insured depository institutions. Overall, conditions in 

the economy and banking industry are favorable at this time. However, signs point to vulnerability in the economy 

and in the banking industry that may make the years ahead much more challenging. Three broad themes emerge from 

this assessment: 

•	 Households’ and businesses’ debt levels are on the rise. Spending by households and businesses is growing faster 

than cash income, resulting in rapidly increasing indebtedness. Consumer spending has been driven, in part, by 

large increases in the net worth associated with stock holdings and home equity. Businesses are restructuring and 

investing in new technologies to raise productivity and cut costs. Both consumer and business spending has been 

assisted by ready access to financing. Rising interest rates or slower economic growth could make debt service 

more difficult for borrowers. 

•	 Intense competition in banking is driving business strategies. Competitive pressures have affected nearly every 

facet of the banking business. These pressures are evident in net interest margins, which have suffered from tighter 

loan pricing and higher funding costs. To maintain profits, some institutions are lending to less creditworthy borrowers, expanding into new or higher-yielding activities, creating more complex balance sheet structures, or cutting costs. These strategies may lead to greater credit, market, and operational risks. 

•	 The currently benign economic environment is vulnerable to rapid deterioration in the event of financial market 

instability. During the 1990s, we have witnessed recurring, and perhaps more frequent, episodes of financial market turbulence. Recent episodes have arisen mainly overseas and have had little adverse effect on U.S. economic 

activity. However, the current economic expansion is closely tied to the ready availability of market-based financing for households and businesses and to wealth generated with the help of rising stock prices and falling interest 

rates. For this reason, the currently strong economic outlook may be subject to sudden deterioration in the event 

of market shocks that sharply raise interest rates or lower stock prices. 

The analysis that follows explores these themes in more detail in the following sections: 1) indicators of industry performance, 2) economic conditions, and 3) emerging risks in banking. 

Indicators of Industry Performance 

Industry Financial Performance Is Strong and a decline in provision expense. However, the majority of the decline in net earnings resulted from a $1.5 

According to reported financial information, the bank- billion loss posted by one large bank. 

ing and thrift industries are performing well. As summarized in the FDIC Quarterly Banking Profile, The low overall level of net loan losses has been a key 

second quarter 1999, both the commercial banking and contributor to strong industry performance. Chart 1 

thrift industries report near-record earnings, strong cap- (next page) shows that the average net loan loss ratio for 

ital levels, and manageable volumes of problem assets the industry has been low and stable in recent years. 

and loan losses. Return on assets (ROA) for all insured Similarly, the range between the worst and best 5 perinstitutions in the second quarter was 1.21 percent and cent of net loan loss ratios has narrowed considerably 

return on equity (ROE) was 14.07 percent. ROA and since the early 1990s. More than 95 percent of insured 

ROE were down slightly from the first quarter despite institutions reported a net loan loss ratio of less than 1 

improvement in the industry net interest margin (NIM) percent in 1998, continuing a five-year trend. 

Memphis Regional Outlook 3	 Fourth Quarter 1999 
In Focus This Quarter
 

CHART 1 

Overview 

ings per share is projected to be 16.9 percent for pubBank Stocks Underperform Despite 

Projected Earnings Growth 

Analysts expect continued earnings growth for banks 

and thrifts in 1999 and 2000. Median growth in earnThe Range of Loan Losses for FDIC-Insured 

Institutions Has Been Stable Recently 

* For institutions with at least 10 percent of assets invested in loans. 

Source: FDIC Bank and Thrift Call Reports (Research Information System) 

–1.0 

0.0 

1.0 

2.0 

3.0 

4.0 

5.0 

6.0 

’84 ’86 ’88 ’90 ’92 ’94 ’96 ’98 

Net Loan Loss Ratio (percent)* 

95th Percentile 

Mean 5th Percentile 

licly traded banks and 19.4 percent for publicly traded 

thrifts for 1999.1 Ratings agencies also view the industry positively. The ratio of upgrades to downgrades for 

ratings issued by Moody’s Investors Service improved 

in the second quarter, with nine companies receiving 

upgrades versus four receiving downgrades. 

Nonetheless, bank and thrift stocks have underperformed the broader market in the first three quarters of 

1999. The SNL Securities Bank Stock Index, which 

tracks more than 450 publicly traded commercial banks, 

declined 6.7 percent between January 1 and September 

30, 1999. The SNL Securities Thrift Stock Index, 

which tracks the performance of about 350 publicly 

traded thrifts, fell 13.7 percent during the same period. 

By contrast, the Standard & Poor’s (S&P) 500 index 

gained 4.6 percent. Analysts cite rising interest rates, 

concerns about problems with corporate credit quality, 

and a decline in bank merger activity as reasons for the 

recent performance of bank and thrift stocks. 

Economic Conditions
 

The U.S. economy has remained generally strong during 

1999, the ninth year of the current economic expansion. 

If growth continues through February 2000—as most 

analysts expect—this expansion will become the 

longest in U.S. history. What is also remarkable about 

this business cycle expansion is the fact that the highest 

rates of growth have occurred during the past two years, 

1997 and 1998. Even as growth has accelerated with 

unemployment declining to 4.2 percent, wage and price 

inflation has remained unusually subdued. While low 

inflation has helped prolong the expansion, it has 

imposed intense price competition on a wide range of 

industries. The currently positive economic outlook is 

subject to possible sudden deterioration in the event of 

financial market shocks that could raise financing costs, 

reduce the availability of financing, or destroy investor 

wealth. 

Commodity Industries Have 

Faced Pricing Pressures 

One disadvantage of low inflation during this expansion 

has been that firms in certain commodity industries 

have suffered from falling prices. Profit margins have 

declined in agriculture, mining, and some manufacturing sectors because of weak or negative revenue growth 

during 1997 and 1998.2 Firms operating in these industries have aggressively cut costs to preserve profit 

margins. Nonetheless, profit growth has been flat or 

negative for a large proportion of S&P 500 firms in the 

mining, textiles, chemicals, iron and steel, and oil and 

gas sectors since 1997. In response, some firms in these 

industries have chosen to consolidate through mergers. 

According to Mergerstat, the dollar volume of merger 

and acquisition transactions involving U.S. firms was a 

record $1.2 trillion in 1998, more than 80 percent above 

1997 levels. 

Business Investment Is Outpacing Cash Flow 

Analysts recently have become concerned about 

increasing levels of debt on corporate balance sheets. 

1 Based on estimates as of November 4, 1999, for 98 commercial 

banks and 33 thrifts that have at least five analyst estimates. 

2 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). 

Memphis Regional Outlook 4 Fourth Quarter 1999 
In Focus This Quarter
 

Chart 2 tracks the steady growth of fixed investment by 

U.S. corporations during the current expansion. It also 

shows, however, that growth in cash flow available to 

finance investment has slowed in recent years. This 

“financing gap” has grown steadily, reaching a record 

$86 billion in 1998. 

As a result, corporations must finance an increasing 

portion of investment spending by issuing either net 

new equity or net new debt. In recent years, firms have 

overwhelmingly chosen debt financing. Net issuance of 

corporate debt was $219 billion in 1998, while corporations repurchased equity shares on net for the sixth 

straight year. Corporate borrowing has also continued 

at a brisk pace; domestic commercial and industrial 

(C&I) lending rose by 12.5 percent in the year ending 

June 1999. 

A widening financing gap and increasing debt levels 

could pose future problems if there are adverse 

changes in the financial environment. For example, a 

sharp rise in interest rates would increase the debt burden of businesses, hurt their profitability, and impair 

their creditworthiness. Under such a scenario, firms 

might decide to curtail their capital expenditures, 

which would tend to reduce the rate of growth in the 

rest of the economy. 

Consumer Spending 

Continues to Grow 

Strong growth in consumer spending continues to propel the economic expansion. Spending has accelerated 

in recent quarters, in contrast to previous expansions 

when the strongest growth in consumer spending 

occurred early in the recovery. One factor supporting 

the robust pace of spending is housing activity. Singlefamily housing starts rose to an annualized rate of 

more than 1.3 million units in fourth quarter 1998 and 

have remained near that level through third quarter 

1999. Existing home sales also have maintained a 

record pace of 5.3 million units on an annualized basis 

during the second and third quarters. Low mortgage 

interest rates and real income gains have combined to 

push housing affordability to its highest level in many 

years.3 

3 The housing affordability index published by the National Association of Realtors equals 100 when the median family income qualifies 

for an 80 percent mortgage on a median-priced existing singlefamily home. The value of the index as of the third quarter of 1999 

was 127.1. 

CHART 2 

The Financing Gap Has Widened 

for Nonfinancial Corporations 

Source: Federal Reserve Board (Haver Analytics) 

100 

200 

300 

400 

500 

600 

700 

800 

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

Billions of Dollars 

Capital Expenditures 

“Financing Gap” 

Cash Flow 

Rapid growth in consumer spending also warrants 

attention. Despite the highest rates of real income 

growth in nine years, consumer spending has grown 

more quickly than disposable personal income. The 

divergence in growth has resulted in a falling personal 

savings rate, which reached a record low in 1999.4 The 

recent decline in the personal savings rate continues a 

trend that has been under way for more than a decade 

(see Chart 3, next page).5 

Analysts cannot fully explain the reasons for the falling 

savings rate, although the “wealth effect” associated 

with the accumulation of capital gains by households is 

believed to be a significant factor. Since 1995, the total 

value of equities, mutual funds, and pension funds 

owned by households has risen by $6.8 trillion, while 

the value of owner-occupied housing net of mortgage 

debt has increased by $812 billion. This accumulation 

of wealth apparently has emboldened consumers to 

spend, as evidenced by data that show aggregate spend4 Personal savings is calculated as the difference between disposable 

personal income (DPI, or total income net of taxes) and consumption 

expenditures. The personal savings rate is equal to personal savings 

divided by DPI. It should be noted that capital gains, even when realized, are not included as income in this calculation, although taxes 

paid on capital gains are deducted from DPI. Consequently, largescale realization of capital gains by households will tend to push 

down the personal savings rate. 

5 The Bureau of Economic Analysis, which tabulates the personal 

savings rate, has recently revised its methodology, leading to a large 

revision in the savings rate data. Earlier estimates reported the personal savings rate to be around negative 1 percent, suggesting that 

households were spending more than their disposable (after-tax) 

income. Revised estimates show that the savings rate for the third 

quarter of 1999 was 2.1 percent. Although higher than previously 

reported, the revised personal savings rate data continue to show a 

downward trend similar to earlier savings rate estimates. 

Memphis Regional Outlook 5 Fourth Quarter 1999 
In Focus This Quarter
 

CHART 3 

Strong Consumer Spending Has Been 

Accompanied by a Falling Personal Savings Rate 

Source: Bureau of Economic Analysis (Haver Analytics) 

0.0 

2.0 

4.0 

6.0 

8.0 

1Q92 1Q93 1Q94 1Q95 1Q96 1Q97 1Q98 

0.0 

2.0 

4.0 

6.0 

8.0 

10.0 

Personal Savings Rate 

(Percent) 

Personal Consumption Spending 

(Percent change from year ago) 

1Q99 

ing growth exceeding income growth. For the most part, 

when consumers have chosen to convert capital gains to 

spendable cash, they have done so by borrowing—often 

against the equity in their homes or their 401(k) 

accounts. 

The increasing indebtedness of consumers could substantially raise the costs of debt service relative to 

income, especially if interest rates rise or income 

growth slows. Moreover, analysts express concerns 

about a reversal of the wealth effect if there is a significant and sustained decline in equity prices. Any resulting decline in consumer confidence could substantially 

slow the pace of consumer spending, leading to a 

reduced pace of economic growth. 

CHART 4 

The Growing Private Deficit Raises Concerns 

Taken together, the sum of annual net borrowing by 

businesses and households has been referred to as the 

“private deficit.” During the late 1990s, as the combined 

budget of federal, state, and local governments moved 

from deficit to surplus, the private deficit rose sharply; 

between 1996 and 1998, it nearly doubled from $550 

billion to $1.02 trillion (see Chart 4). 

The private deficit was financed from three sources in 

1998. One source was the $73 billion surplus in the 

government sector, the first surplus in 28 years. The 

largest portion of the 1998 private deficit was financed 

by the creation of credit by the domestic financial sector and by an inflow of foreign capital. The rapid creation of credit raises concerns about credit quality, an 

issue that is explored in more detail under Emerging 

Risks in Banking, below. Dependence on foreign capital 

raises questions about what might happen if the foreign 

sector becomes less willing to export capital to the 

United States. 

Recovery Abroad Is Changing 

the Terms of Trade 

During the past three years, the U.S. economy has experienced consistently strong growth with low inflation, 

while the economies of some of its major trading partners have grown more slowly or not at all. Japan was 

mired in its worst recession in decades, while a number 

of countries in Asia, Latin America, and Eastern Europe 

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

Flow of Net Sectoral Lending (lending less borrowing), 

in Billions of Dollars 

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

Source: Federal Reserve Board (Haver Analytics) 

–1200 

–600 

0 

600 

1200 

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

Foreign Sector 

Domestic Financial Sector 

Nonfinancial Business 

Households 

Government 

Memphis Regional Outlook 6 Fourth Quarter 1999 
In Focus This Quarter
 

have experienced the harsh fallout resulting from financial market and exchange rate crises. The euro-zone 

economies, Germany and France in particular, have 

grown slowly following the imposition of tight fiscal 

and monetary policies in advance of the introduction of 

the euro on January 1, 1999. 

The net effect of this disparity in growth rates has been 

a growing U.S. trade deficit. The deficit rose by 57 percent in 1998 to $164.3 billion, reflecting a small decline 

in exports and a 5 percent increase in imports. The 

adverse effects of the trade deficit on the U.S. economy 

have been felt primarily by the commodity industries— 

farming, mining, and basic manufacturing. In addition, 

the large trade deficit has resulted in the transfer of billions of dollars to foreign investors. During 1997 and 

1998, many foreign investors used their excess dollars 

to purchase dollar-denominated stocks and bonds. This 

inflow of capital helped keep U.S. equity and bond 

prices high, while pushing up the value of the dollar. 

A global economic recovery during the first three quarters of 1999 has led to higher demand for investment 

capital outside the United States. The International 

Monetary Fund estimates that growth in the global 

economy will increase from 2.5 percent in 1998 to 3.0 

percent in 1999 and 3.5 percent in 2000.6 Foreign 

investors, in anticipation of stronger growth and greater 

investment opportunities abroad, have started to convert 

excess dollar holdings to other currencies, including the 

yen and euro. This change in investment strategy has put 

downward pressure on the value of the dollar. Between 

July and September 1999, the dollar lost approximately 

10 percent of its value against the yen. 

A falling dollar will likely contribute to a recovery of 

U.S. exports in coming months. The index of export 

orders compiled by the National Association of Purchasing Managers points to future growth in shipments 

abroad. The index has signaled growing export orders 

for nine months through October 1999. As Chart 5 

shows, increasing export orders tend to lead the actual 

rise in exports by several months. 

A lower dollar could also place upward pressure on U.S. 

inflation and interest rates. A steady decline in the dollar would make foreign goods more expensive, while 

higher export demand would raise manufacturing output at a time when U.S. labor markets are very tight. The 

prices of several important industrial commodities have 

6 International Monetary Fund, World Economic Outlook, October 

1999. 

CHART 5 

U.S. Exports Fell in 1998, but Rising 

Orders Point to Growth in 1999 

Source: Bureau of the Census; National Association of Purchasing Managers 

(NAPM) (Haver Analytics) 

–10 

–5 

0 

5 

10 

15 

20 

’93 ’94 ’95 ’96 ’97 ’98 ’99 

40 

45 

50 

55 

60 

65 

70 

U.S. Export Growth 

(Percent change from year ago) 

NAPM Export Orders Diffusion Index 

(Greater than 50 signals expansion) 

risen in dollar terms during 1999, led by a doubling in 

the price of oil during the first nine months of 1999. 

Domestically, the producer price index has risen by 

approximately 4 percent since the beginning of the year 

following a two-year decline, reflecting an increase in 

oil and intermediate goods prices. 

Interest rates have risen in step with renewed concerns 

about inflation. The constant maturity yield on 10-year 

Treasury bonds increased by approximately 140 basis 

points in the year ending October 1999, while the Federal Reserve instituted two 25-basis point increases in 

short-term rates during the summer of 1999. 

The Economic Outlook Calls 

for Continued Growth 

One scenario for the year ahead is that the U.S. economy will continue to grow at much the same rate as it 

has during the past few years. As discussed above, 

however, continued rapid growth would lead to even 

greater imbalances in the domestic economy and in the 

foreign sector. For this reason, most economists do not 

believe that rapid growth can continue indefinitely. 

Instead, analysts suggest two possible scenarios for the 

economy. 

The Blue Chip Economic Indicators consensus outlook for the U.S. economy calls for a “soft landing.” 

Gross domestic product is projected to grow at a rate of 

3.8 percent in 1999 with somewhat slower growth of 2.8 

percent in 2000.7 Rising wage pressures, reflecting tight 

7 Blue Chip Economic Indicators, Aspen Publishing, October 10, 

1999. 

Memphis Regional Outlook 7 Fourth Quarter 1999 
In Focus This Quarter
 

labor markets across the nation, and economic recovery 

abroad are expected to increase the risks of higher U.S. 

inflation. Improving growth prospects in the global 

economy may also lead to a stabilization of commodity 

prices, reversing a trend of falling prices that has until 

recently contributed to lower U.S. inflation. In response 

to expectations of higher inflation, medium-term interest rates are also expected to rise modestly. Slower U.S. 

growth and faster expansion abroad would result in a 

rebalancing of global growth that should narrow the 

U.S. trade deficit and reduce downward pressure on the 

dollar. 

Although the consensus forecast calls for continued 

expansion, an alternative scenario suggests the possibility of a steep decline in economic growth leading to a 

“hard landing.” Sharply higher interest rates, in 

response to a weak dollar and an unexpected acceleration of U.S. inflation, could lead to declining capital 

investment and reduced consumer spending. Rising 

interest rates would increase the debt burden for households and businesses even as measures of indebtedness 

are rising. A significant and sustained decline in equity 

prices may occur if investors become pessimistic as the 

economy slows. The response of the world economy to 

a U.S. recession is difficult to assess. As the past several months have shown, growth in the U.S. economy has 

been an important factor in supporting growth abroad. 

If the U.S. economy were to enter a recession, overall 

global growth could also slow, depending on the extent 

to which recoveries in Europe, Asia, and Latin America 

offset any shortfall in U.S. growth. 

Emerging Risks in Banking
 

Overview 

Favorable economic conditions continue to support 

strong loan growth and healthy loan performance 

among insured institutions. Net loss rates remain low 

relative to the early 1990s for almost every major loan 

category except consumer loans. Loss rates in domestic 

commercial loans, previously at low levels, rose modestly during the first half of 1999. Agricultural loan loss 

rates appear likely to rise in the future due to the effects 

of weak commodity prices on farm incomes. Strong 

loan growth and low loan losses have helped banks 

achieve record and near-record high quarterly profits. 

However, rising indebtedness on the part of businesses 

and households raises concerns about future loan performance, particularly if economic conditions were to 

deteriorate or if interest rates were to rise. 

Strategic responses to competitive pressures point to 

greater credit, market, and operational risks for the 

industry. Intense competition has pressured NIMs and 

has encouraged many lenders to seek higher returns by 

lending to less creditworthy borrowers. In order to 

maintain and grow profits, some insured institutions are 

expanding into activities such as subprime consumer 

lending, high loan-to-value mortgage lending, and lending with minimal or no documentation requirements. 

Rapid growth in syndicated lending to leveraged companies also indicates that large commercial lenders have 

increased their tolerance for risk. Competition has made 

funding with deposits more difficult. As a result, some 

institutions are relying increasingly on securitizations 

and more expensive, market-based sources of funds, 

which can alter an institution’s liquidity position, interest rate risk profile, and operational needs. Institutions 

have also responded to competitive pressures by cutting 

costs or merging in an attempt to achieve greater efficiencies. In some cases, deep reductions in operating 

costs support profits at the expense of less effective 

operational controls. 

Consumer Lending 

Household Borrowing Is on the Rise 

Household borrowing is growing rapidly, consistent 

with high reported levels of consumer confidence and 

strong consumer spending. Mortgage debt, which grew 

by 10.4 percent in the second quarter from year-ago 

levels, is the fastest-growing segment of household 

debt (see Chart 6). Mortgage loan growth has been particularly strong, in part because of rising homeownership, the availability of more low-down-payment loans, 

and the use of mortgage loans to consolidate revolving 

debt balances. Nonrevolving debt grew by 7.3 percent 

in the year ending June 1999, largely because of strong 

sales of new cars. In contrast, credit card and other 

revolving debt increased by only 5.7 percent during the 

same period—a much slower rate of growth than during the mid-1990s. 

Memphis Regional Outlook 8 Fourth Quarter 1999 
In Focus This Quarter
 

CHART 6 

Household Borrowing Is on the Rise, 

Led by Increases in Mortgage Debt 

Source: Federal Reserve Board (Haver Analytics) 

–10 

–5 

0 

5 

10 

15 

20 

25 

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

Percent Change from Year Ago 

Nonrevolving 

Home 

Mortgages Revolving 

A Mortgage Refinancing Boom Has Helped 

Consumers Consolidate Debt 

A key component of the recent shift by consumers from 

credit card debt to mortgage debt has been a surge in 

mortgage refinancing in 1998 and early 1999. The 

Mortgage Bankers Association’s Refinancing Index 

peaked at over 4,300 in October 1998, compared with 

an average monthly index value of 527 during 1997.8 

Many households have refinanced their mortgages to 

obtain cash to pay down credit card and other high-cost 

consumer debt, thereby lowering their monthly financial obligations. According to a Freddie Mac survey of 

1998 refinancing transactions, more than 3 million 

homeowners, or 51 percent of all mortgage-refinance 

borrowers, generated net cash proceeds when they refinanced their loans.9 On average, these borrowers cashed 

out 11 percent of the equity in their homes. On the basis 

of this survey, Bank One Corporation estimated that 

cash out refinancing added about $60 billion in cash 

flow to consumer pocketbooks last year. This extra cash 

flow could help explain recent quarterly declines in personal bankruptcy filings, mortgage delinquencies, and 

consumer credit charge-offs.10 Rising interest rates 

appear to have ended this mortgage refinancing boom. 

The lower volume of mortgage refinancings raises ques8 Index is seasonally adjusted where the week of March 16, 1990 =
 

100.
 

9 Survey cited in a study by the Joint Center for Housing Studies at
 

Harvard University, “The State of the Nation’s Housing: 1999.”
 

10 Tristan Mabry, “This Boom, Some Say, Is on the House,” The Wall
 

Street Journal, July 6, 1999.
 

tions about whether consumers again will increase their 

use of credit cards to finance purchases. If so, there may 

be negative consequences for future consumer debt service burdens and consumer credit quality. 

Credit Card Lenders Face Declining Returns 

After several years of rapid growth in the mid-1990s, 

the credit card industry has become characterized by 

overcapacity and declining margins. At the same time, 

the high level of mortgage refinancings and rising 

household incomes have reduced the dependence of 

consumers on credit card debt. Consequently, credit 

card lenders are struggling to maintain volume as consumers pay off their credit card balances more quickly. 

Overcapacity and declining margins have led lenders to 

search aggressively for new ways to increase revenues. 

One method they have adopted is to charge new fees 

that are triggered by cardholder behavior. Lenders are 

now charging fees for inactive accounts, fees to close 

accounts, and even customer service fees. In addition, 

they are reducing grace periods, curtailing leniency 

periods, and imposing higher penalty interest rates. 

According to RAM Research, banks’ income from 

credit card fees has grown 79 percent over the past two 

years, while card interest income rose only 10 percent.11 

Shrinking margins have also prompted consolidation in 

the credit card industry. Today, the top five issuers control about 60 percent of the total managed assets in the 

credit card sector, up from just 35 percent in 1990.12 

Amid this changing competitive 

landscape, credit quality has 

improved. Credit card charge-off 

levels at insured commercial banks 

hit an all-time high of 5.5 percent 

in the third quarter of 1997 but 

have declined steadily to a level of 

4.1 percent in the second quarter of 

1999. This decline has been attributed to tighter underwriting standards, more aggressive collection efforts, 

and extra household cash flow generated through mortgage refinancings. 

11 Miriam Kreinan Souccar, “Consumer Groups Up in Arms Over
 

Card Penalties,” American Banker, February 26, 1999.
 12 James C. Allen, “Tarnished Platinum,” SNL Securities Bank Mergers & Acquisitions, June 1999.
 

Memphis Regional Outlook 9 Fourth Quarter 1999 
In Focus This Quarter
 

Subprime Lenders Have Riskier 

Characteristics than the Industry 

Subprime lending to consumers has grown dramatically in recent years. Subprime mortgage originations 

have grown from 5 percent of the total mortgage market in 1994 to 15 percent in 1997.13 The percentage of 

originations fell somewhat in 1998 to 10 percent—not 

because the volume of subprime mortgage originations 

fell but because the volume of prime mortgage originations was at a record high. In fact, in terms of dollars, 

subprime originations grew by 20 percent from 1997 to 

1998, to $150 billion. That figure is up significantly 

from the $35 billion in subprime originations in 1994. 

Estimates of the size of the subprime automobile loan 

market vary somewhere between $50 billion and $75 

billion, but one source estimates that subprime automobile originations jumped 

from about 8 percent of all 

automobile loan originations 

in 1990 to over 18 percent in 

1998.14 Analysts also have indicated that the subprime 

credit card market is the fastest-growing segment of 

credit card lending today. According to RAM 

Research, subprime receivables are growing 45 percent 

annually, compared with 16 percent or less for other 

segments of credit card lending.15 

Intense competitive pressure has contributed to the 

expansion of bank and thrift participation in subprime 

consumer lending. These loan programs offer higher 

margins than prime consumer lending products and 

have become an attractive alternative for banks and 

thrifts that have experienced shrinking margins in credit cards, mortgage lending, and other consumer product 

types. Moreover, the shakeout in the subprime specialty 

finance industry has provided new opportunities for 

insured depository institutions seeking to enter the subprime lending market. In 1999, several insured depository institutions acquired, or announced plans to 

acquire, a subprime specialty finance company. Bank 

and thrift involvement in subprime lending is expected 

to increase. In fact, some industry analysts predict that 

insured depository institutions with subprime affiliates 

13 The Mortgage Market Statistical Annual for 1999, Inside Mortgage Finance Publications, 1999. 

14 Ron Feldman, An Introduction to Subprime Auto Lending for 

Examiners, Federal Reserve Bank of Minneapolis, April 1998, and 

data supplied by CNW Marketing and Research. 

15 Lisa Fickenscher, “Credit Card Issuers Panning for Gold Among 

Tarnished Credit Histories,” American Banker, October 22, 1998. 

will overtake finance companies as leaders in the subprime industry. 

Subprime lending poses entirely new challenges in risk 

management for insured institutions. Not only are 

expected credit losses higher than for prime consumer 

lending, but a number of factors suggest that losses are 

also less predictable: 

•	 Subprime borrowers are more likely to default than 

prime borrowers and may be more vulnerable to 

economic shocks, such as a recession. Borrowers’ 

previous credit problems suggest that they have 

limited financial resources to withstand economic 

difficulties. 

•	 Credit-scoring and pricing models used to underwrite subprime loans are untested in a recession. 

Analysts have noted that credit-scoring models 

are less effective in predicting the likelihood of 

default for subprime borrowers than they are for 

prime borrowers. 

•	 Operational risks are greater in subprime lending. 

Because defaults occur sooner and more often than 

in prime lending, subprime portfolios require a 

greater investment in servicing and collections 

resources. Subprime lenders run a greater risk that 

these resources could become severely strained if the 

level of defaults is not correctly anticipated. 

•	 Liquidity risks are greater in subprime lending. 

Some large-volume subprime lenders heavily depend 

on the ability to securitize and sell loans to the secondary market. But investor demand for paper 

backed by subprime loans may be volatile, as was 

demonstrated during the financial market turmoil of 

late 1998. A number of nonbank subprime lenders 

experienced a liquidity crunch as a result of that market turmoil, and several opted for—or were forced 

into—bankruptcy.16 

•	 Reputation, legal, and compliance risks also are 

important for subprime lenders. Subprime lenders 

generally run a greater risk of violating, or being 

accused of violating, consumer protection laws or 

regulations. The public perception of subprime 

16 Dominic DiNapoli and Ron Greenspan, “The Next Industry Crisis 

Could Be Even Bigger,” American Banker, June 15, 1999. 

Memphis Regional Outlook 10	 Fourth Quarter 1999 
In Focus This Quarter
 

lenders could be tarnished if a recession were to 

result in substantially higher default rates. 

The growing involvement by insured depository institutions in subprime lending has raised significant concerns for bank and thrift supervisors. To address those 

concerns, FDIC Chairman Donna Tanoue recently 

announced that the FDIC will propose to the other federal financial institution regulators that insured depository institutions with concentrations in subprime 

lending be held to higher minimum capital requirements than the current rules dictate.17 The FDIC proposal includes a common supervisory definition of 

subprime lending and ties capital adequacy to the types 

and levels of risks that individual subprime lenders have 

in their portfolios. This proposal will be shared with 

other federal regulators to refine a final approach. 

Commercial and Industrial Lending 

Commercial and Industrial Loan 

Losses Have Been on the Rise 

Insured institutions continue to accommodate the credit needs of business borrowers. Domestic C&I loans 

grew almost 12.5 percent during the year ending in June 

1999 and accounted for 40 percent of all net new loans 

booked during that period. 

Although commercial loan losses are low, there are 

signs that credit quality in C&I portfolios is deteriorating. Net domestic C&I charge-offs during the first half 

of 1999 more than doubled from 1998 levels, while 

noncurrent domestic C&I loans rose by 26 percent. 

Examiners also have reported increasing problems in 

commercial portfolios. The Office of the Comptroller 

of the Currency recently reported that the dollar volume of classified and special-mention Shared National 

Credits rose 70 percent during a recent annual review.18 

Slower profit growth and rising corporate bond defaults 

also point toward somewhat weaker business credit 

17 FDIC Chairman Donna Tanoue in a speech before America’s Community Bankers, Orlando, Florida, November 2, 1999 (http://www. 

fdic.gov/news/news/speeches/chairman/sp02Nov99.html). 

18 “OCC Says Big Commercial Loans Suffering from Lax Underwriting,” American Banker, October 6, 1999, p. 1. The shared national 

credit program is a cooperative interagency program to review large 

credits held at several institutions. Loans subject to review include 

commitments in excess of $20 million that are shared among three or 

more participating lenders. 

quality. While corporate profits grew by an average of 

15 percent per year between 1993 and 1996, economists 

polled by Blue Chip Economic Indicators project 

growth of 6.7 percent for all of 1999, followed by 

growth of only 3.5 percent in 2000.19 Standard & Poor’s 

reported that 55 rated issuers defaulted on $20.5 billion 

in debt during the first six months of 1999.20 This pace 

of defaults is already nearly double levels experienced 

in the first half of 1998 and does not include more 

recent large defaults such as Iridium and Daewoo 

Group. Approximately 85 percent of the defaults that 

occurred during the first half of 1999 were among 

speculative-grade issuers. According to Moody’s, junk 

bond defaults rose to 5.8 percent of issues outstanding 

during the 12 months ending in September 1999, the 

highest level since 1991. 

Rising Losses May Be Attributable 

to Loose Underwriting 

Analysts attribute the recent deterioration in commercial credit quality to weak underwriting standards in 

the corporate debt markets during 1997 and early 

1998.21 Bank underwriting was reported to be particularly accommodating at that time. The Federal Reserve 

Board reported in its May 1998 Senior Loan Officer 

Opinion Survey on Bank Lending Practices 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.” Subsequently, the November 1998 Survey reported a “broad 

tightening of business lending practices” associated 

with the financial market turmoil in progress at that 

time. However, regulators have continued to express 

concern about the assumptions underlying bank lending decisions. A Supervision and Regulation Letter 

sent by the Federal Reserve Board of Governors to its 

examiners in September 1999 noted the recent tightening of standards, but stated that “certain deeper issues 

remain,” which relate mainly to overoptimistic 

assumptions about the future repayment capacity of 

business borrowers.22 

19 Blue Chip Economic Indicators, Aspen Publishing, October 10,
 

1999.
 

20 “Defaults Soar in First Half 1999,” Standard & Poor’s, August 12,
 

1999.
 

21 See, for example, “Under Boom Economy, Strain Over Debt,” The
 

Wall Street Journal, August 18, 1999, Section C, p. 1. 
 22 SR 99-23, September 28, 1999. “Recent Trends in Bank Lending
 

Standards for Commercial Loans” (http://www.federalreserve.gov/
 

boarddocs/SRLETTERS/1999/SR9923.HTM).
 

Memphis Regional Outlook 11 Fourth Quarter 1999 
In Focus This Quarter
 

Leveraged Lending Has Been the Predominant 

Type of Syndicated Lending 

Banks appear to be taking on more risk in the syndicated loan market by expanding their lending to heavily indebted companies. During the first half of 1999, 

leveraged lending was the fastest-growing segment of 

syndicated commercial lending.23 While overall syndicated loan volume was down slightly compared with 

the first half of 1998, syndicated lending to leveraged 

companies rose $7 billion, or 5 percent, on the strength 

of a record volume of “highly leveraged loans.”24 As 

shown in Chart 7, loans to leveraged companies are 

making up a growing proportion of syndicated loan 

originations. 

Factors driving growth in leveraged lending include a 

high volume of corporate mergers and acquisitions, 

increasing investor demand for higher-yielding loans, 

and a shift in preference for loans over bonds by highyield issuers.25 While bank syndicators pass a large volume of these loans along to nonbank investors, a 

23 Syndicated loans are credits extended to large or medium-sized corporate borrowers that are originated by a group, or syndicate, of 

lenders. One type of syndicated lending is leveraged lending, in 

which the borrower’s debt-to-equity ratio is significantly higher than 

the industry average. Loan Pricing Corporation defines “leveraged 

loans” as those for which pricing exceeds 125 basis points over 

LIBOR. 

24 Loan Pricing Corporation defines “highly leveraged loans” as those 

for which pricing exceeds 225 basis points over LIBOR. 

25 According to Mergerstat, the value of mergers and acquisitions 

(M&A) was almost $400 billion during second-quarter 1999. According to Loan Pricing Corporation, syndicated loans originated in the 

second quarter to finance M&A activity totaled some $69 billion—a 

43 percent increase over issuance in the first quarter. 

CHART 7 

Loans to Leveraged Companies
 

Are Making Up A Greater Proportion of
 

Syndicated Loan Originations
 

Originations of Syndicated Loans to Leveraged Companies
 

As a Percentage of Total Syndicated Loans Dollars in Billions 

32% 

350 

300 

60 

50 

250 40 

200 

30 150 

20 100 

10 50 

0 

’90 ’92 ’94 ’96 ’98 ’99:1H* 

0 

* First half, annualized 

Source: Loan Pricing Corporation 

substantial portion of these credits remains on bank balance sheets. Loan Pricing Corporation has reported 

that as much as 64 percent of the value of “highly leveraged” loans originated in the first half of 1999 was 

retained by banks.26 

Commercial Real Estate 

and Construction Lending 

Construction Loan Volume Continues to Rise 

Loans for real estate construction and development 

(C&D) represent one of the fastest-growing segments of 

bank balance sheets, increasing 24 percent during the 

year ending June 1999. Compared with construction 

activity in the mid-1990s, spending on new commercial 

construction has shifted somewhat away from the industrial and retail markets and toward office and hotel construction. Residential construction growth was also 

strong during the first half of 1999, with single-family 

completions increasing 17 percent from a year ago. In 

the midst of this growth in loan volume, loss rates and 

past-due ratios for construction and development loans 

remain very low by historical standards, as indicated in 

Chart 8. 

Office Vacancy Rates Are Rising 

in Many Top Markets 

In previously published reports, Division of Insurance 

analysts identified nine metropolitan real estate markets 

where rapid development threatened to produce nearterm oversupply conditions.27 These cities were identified based on the pace of current construction activity, 

commercial space demand indicators, and independent 

market analysts’ projections. Six of the metropolitan 

areas identified—Atlanta, Phoenix, Orlando, Portland, 

Dallas, and Nashville—subsequently experienced large 

increases in office vacancy rates during the first half of 

1999. These areas have also experienced reduced 

employment growth and slowing net in-migration. 

Higher vacancy rates are often accompanied by slower 

26 “Junk Loan Market Is Feeling the Pinch of Oversupply and Rising 

Interest Rates,” The Wall Street Journal, September 13, 1999. 27 Steven K. Burton, “Commercial Developments Still Hot in Many 

Major Markets, but Slower Growth May Be Ahead,” Regional 

Outlook, First Quarter 1999 (http://www.fdic.gov/bank/analytical/ 

regional/ro19991q/na/infocus2.html) and “Ranking the Risk of 

Overbuilding in Commercial Real Estate Markets,” Bank Trends, 

FDIC Division of Insurance, October 1998 (http://www.fdic.gov/ 

bank/analytical/bank/bt9807.html). 

Memphis Regional Outlook 12 Fourth Quarter 1999 
In Focus This Quarter
 

CHART 8 

Construction Loan Volume Continues to Rise, 

but Problem Loans Remain Low 

* First half 

Source: FDIC Bank and Thrift Call Reports (Research Information System) 

Construction and Development Loans 

0 

75 

150 

225 

’84 ’87 ’90 ’93 ’96 ’99:1H* 

0 

2 

4 

6 

8 

10 

12 

14 

Percent Nonaccrual Rate 

(Right Scale) 

Loss Rate 

(Right Scale) 

Volume in billions of dollars 

(Left Scale) 

rental-rate growth, which may lead to lower real estate 

values. For example, Atlanta’s vacancy rate rose 1.5 percentage points to 10.3 percent, while growth in rental 

rates slowed noticeably from the pace of the previous 

three years.28 

Surveys Suggest Tighter Standards 

in Commercial Real Estate Lending 

Evaluations of bank loan underwriting suggest a recent 

tightening of lending standards for commercial real 

estate loans. The August 1999 Federal Reserve Board 

Senior Loan Officer Opinion Survey reported a net 

tightening of commercial real estate underwriting standards, continuing a trend begun in late 1998. The 

FDIC’s March 1999 Report on Underwriting Practices 

also found fewer instances of risky lending practices 

with respect to commercial real estate and construction 

lending than in prior reports. The FDIC’s September 

Report showed no significant changes in lending 

standards. 

The FDIC also recently published the findings of a targeted evaluation of the underwriting practices of banks 

operating in three of the fastest-growing metropolitan 

areas in the country—Atlanta, Dallas, and Las Vegas.29 

Results indicated that competition was generally driving 

pricing margins down to very low levels, particularly 

28 Vacancy rates and rental growth rates were obtained from REIS 

Reports. 

29 Steven K. Burton, “Recent Trends in Construction Lending Practices,” Bank Trends, FDIC Division of Insurance, July 1999 (http:// 

www.fdic.gov/bank/analytical/bank/bt9901.pdf). 

compared with the 1980s. In some instances, lenders 

have responded to competitive pressures by making 

structural concessions on loan-to-value, cash equity, 

and recourse terms, particularly for large borrowers. 

However, underwriting standards generally have not 

been as aggressive as practices observed in the 1980s. 

Agricultural Lending 

Low Commodity Prices Stress 

the Agriculture Industry 

Low prices for wheat, corn, hogs, cotton, and oilseeds 

are creating financial difficulties for farmers in the 

nation’s midsection. Several consecutive years of high 

worldwide production have resulted in large inventories 

of grains and oilseeds, which have depressed prices. 

Prices not only have fallen from mid-1990s levels, but 

are also low by historical standards. The United States 

Department of Agriculture (USDA) forecasts for 2000 

show little likelihood of improvement in prices.30 

The financial outlook for significant portions of the 

farm sector has deteriorated. The USDA projects that 

farm income from operations will decline by around 15 

percent in 1999 from year-ago levels. However, total net 

farm income is projected to decline less 

than 1 percent. A projected $16.6 billion in government payments is expected to make up most of the difference 

between operating income and total net 

income.31 Legislation passed in October 

1998 provides for $8.7 billion in emergency aid to affected farmers. 

Farm Banks Continue 

to Perform Well Overall 

Despite the difficulties created by low farm prices, the 

overall financial condition of the 2,250 FDIC-insured 

farm banks continues to be strong.32 Farm banks reported an annualized ROA of 1.21 percent and an equity 

capital-to-assets ratio of 10.5 percent at mid-year 

30 “World Agricultural Supply and Demand Estimates,” USDA, October 10, 1999. 

31 “Potential Impacts of an Agricultural Aid Package,” Agricultural 

Outlook, USDA, September 1999. 32 Farm banks are defined by the FDIC as those with over 25 percent 

of their loans in agricultural production or secured by agricultural real 

estate. 

Memphis Regional Outlook 13 Fourth Quarter 1999 
In Focus This Quarter
 

1999.33 Loan loss reserves, which stood at 1.58 percent 

of total loans in June, remain high compared to historical levels. Loan performance at farm banks also appears 

to be strong at this time. Total past-due loans made up 

just 2.66 percent of total loans at farm banks in June, a 

level that is only 9 basis points higher than a year ago. 

Moreover, this increase in past-due loans is attributable 

entirely to nonagricultural loans; the level of past-due 

farm loans has not risen over the past 12 months. At the 

same time, higher-than-average nonperforming loan 

levels have been reported by farm banks in the upper 

Midwest and the South. 

There are reasons to believe, however, that it will take 

time for financial distress among farm producers to 

significantly affect loan performance at farm banks. 

One such reason is the increasing use of carryover debt 

to restructure and extend operating loans that cannot 

be fully retired by borrowers during the current crop 

year. The most recent Survey of Agricultural Credit 

Conditions conducted by the Federal Reserve Bank of 

Kansas City indicated an increase in the use of agricultural carryover debt by Tenth District banks.34 

An increase in carryover debt was also noted in 

the FDIC’s March 1999 Report on Underwriting 

Practices, which indicated that almost one-third 

of FDIC-supervised farm banks experienced at least 

a “moderate” increase in agricultural carryover debt 

during the preceding six-month period.35 Although the 

use of carryover debt is not an uncommon practice in 

agricultural lending, it can be a leading indicator of 

declining loan performance. Chart 9 shows that 

increases in carryover debt by Tenth District farm 

banks in 1995 preceded increased loan losses during 

1996. 

33 Twenty-three percent of insured farm banks have adopted a Subchapter S designation since 1997, when banks were first allowed to 

take advantage of the favorable tax treatment available under this section of the Internal Revenue Service code. Because of the effects of 

this tax treatment on reported profitability, farm bank ROA levels 

may not be comparable with ratios from prior periods. 

34 Survey of Agricultural Credit Conditions, Federal Reserve Bank of 

Kansas City, June 29, 1999 (http://www.kc.frb.org/PUBLICAT/ 

RED/PDF/2q99AgCrPress.pdf). The Tenth District comprises significant agricultural areas in Colorado, Kansas, Nebraska, Oklahoma, 

Wyoming, northern New Mexico, and western Missouri. 

35 John M. Anderlik and Jeffrey W. Walser, “Agricultural Sector 

Under Stress: The 1980s and Today,” Kansas City Regional Outlook, 

Third Quarter 1999 (http://www.fdic.gov/bank/analytical/regional/ 

ro19993q/kc/k3q1999.pdf). 

CHART 9 

Rising Levels of Carryover Debt Suggest Future 

Increases in Loan Losses at Farm Banks 

Reports (Research Information System) 

Source: Federal Reserve Bank of Kansas City; FDIC Bank and Thrift Call 

–30% 

–10% 

10% 

30% 

50% 

1Q89 2Q90 3Q91 4Q92 1Q94 2Q95 3Q96 4Q97 1Q99 

–1.0% 

–0.5% 

0.0% 

0.5% 

1.0% 

1.5% 

Net Percentage Reporting 

Higher Agricultural Loan 

Renewals and Extensions 

Moving 4-quarter 

Charge-Off Rate

 (percent) 

Agricultural Production Loans 

(right scale) 

Funding and Interest Rate Risk 

Lagging Deposit Growth Has Led to Greater 

Reliance on Market-Based Funding 

For most of the 1990s, banking industry asset growth 

has outstripped growth in deposits, creating greater 

reliance on more expensive and less stable marketbased sources of funding. The trend in the loan-todeposit ratio for commercial banks, which reached a 

record high of almost 90 percent at June 30, 1999, 

reflects this shift. Deposit growth has not kept pace with 

asset growth, in part because of a low rate of personal 

savings by households and competition for depositor 

funds from higher-yielding investment alternatives and 

nonbanks. Lagging deposit growth is particularly 

important for community banks because these institutions traditionally rely more heavily on deposits to fund 

assets than do larger banks.36 Greater dependence on 

market-based funding can alter the liquidity and interest 

rate risk positions of institutions and may require 

heightened attention to, and expertise regarding, assetliability policies and procedures. 

Growth in Securitization Affects Underwriting 

and the Structure of Bank Balance Sheets 

Banks, and nonbanks in particular, continue to employ 

the securitization market to fund lending activities. 

36 Allen Puwalski and Brian Kenner, “Shifting Funding Trends Pose 

Challenges for Community Banks,” Regional Outlook, Third Quarter 

1999 (http://www.fdic.gov/bank/analytical/regional/ro19993q/na/ 

t3q1999.pdf). 

Memphis Regional Outlook 14 Fourth Quarter 1999 
In Focus This Quarter
 

Issuance of asset-backed securities and commercial 

mortgage-backed securities (CMBS) totaled $223 billion through the first six months of 1999, and is on pace 

for another record year. Including participation through 

credit card companies and CMBS conduit programs, 

bank-related issuance amounted to about 25 percent of 

total issuance in 1998, a decline from 1997 levels. 

Although insured institutions are not dominant players, 

growth in the securitization market can influence loan 

underwriting practices and the structure of bank balance 

sheets. 

The securitization market competes to originate loans 

that could be made by insured institutions. This competition may tend to erode underwriting standards if securitizers ease terms to maintain sufficient volume to 

support lending pipelines. Recent trends indicate that 

this competition has intensified. For example, market 

observers note that the subordination levels in the 

CMBS market have been declining, which allows securitizers to increase lending volume for a given level of 

capital.37 

When banks do securitize, it is not always clear how 

much risk is transferred. The issue of credit risk transference by commonly used securitization structures 

continues to receive attention from the markets and rating agencies. For example, many analysts agree that 

revolving structures, such as those used to securitize 

credit cards, eliminate only the most catastrophic credit 

risks for issuers.38 In addition, assets created by gain-onsale accounting rules when loans are securitized can be 

37 Securitizations are often structured in tranches such that a subordinated security bears the credit risk for a senior piece. The relative 

size of the subordinated piece affects not only funding costs for the 

issuer, but also the amount of effective leverage achievable through 

securitization. 

38 A common feature of a revolving securitization structure is the provision for an “early amortization.” When a triggering event occurs, 

such as a negative three-month average excess spread, all available 

cash flows are used to pay off bondholder principal. This event causes receivables related to the deteriorating accounts to remain on the 

balance sheet of the issuer. Unless the deterioration in account credit 

quality is very rapid and severe, the bondholders will be repaid completely, and the credit risk will be borne by the issuer. 

volatile and can lead to unstable earnings and capital if 

not properly controlled and administered. 

Banks and Thrifts Appear Increasingly 

Vulnerable to Rising Interest Rates 

Potentially volatile liabilities and long-term assets 

have been growing as a percentage of banking assets. 

Consistent with reduced deposit funding by insured 

institutions, more market-based and potentially volatile 

liabilities have been supporting an increasing proportion of banking assets in recent years (see Chart 10).39 

At the same time, the lengthening maturity of insured 

institution mortgage portfolios has increased the percentage of total bank assets with maturities or repricing 

frequencies of greater than five years. This trend in 

mortgage portfolios is primarily responsible for the 

thrift industry’s increasing interest rate sensitivity. 

According to the Office of Thrift Supervision’s Quarterly Review of Interest Rate Risk, interest rate sensitivity for the median thrift rose in the second quarter of 

1999 for the third consecutive quarter. 

39 Volatile liabilities include borrowings, federal funds purchased, 

repurchase agreements, jumbo certificates of deposit, foreign 

deposits, and trading liabilities. 

CHART 10 

Long-Term Assets and Volatile Liabilities
 

Have Been Growing as a Percentage
 

of Total Assets
 

Percentage of 

Total Assets 

35 

30 

25 

20 

15 

10 

Volatile Liabilities 

Long-Term Assets 

2Q92 2Q93 2Q94 2Q95 2Q96 2Q97 2Q98 2Q99 

Note: Long-term assets have a maturity or repricing frequency of greater than
 

five years.
 

Source: FDIC Bank and Thrift Call Reports (Research Information System)
 

Memphis Regional Outlook 15 Fourth Quarter 1999 
In Focus This Quarter
 

Operational Risks 

Insured banks and thrifts face numerous business- and 

process-oriented operational risks on a daily basis. At 

the same time, recent industry developments and bank 

failures have highlighted the importance of maintaining 

strong operations. The Basle Committee on Banking 

Supervision reported in late 1998 that “awareness of 

operational risk among bank boards and senior management is increasing.”40 

The competitive environment and shareholder expectations have led many insured institutions to search for 

greater efficiency by cutting costs. In some cases, deep 

cuts in overhead expenses may weaken the effectiveness 

of operating and monitoring systems as well as internal 

controls. Anecdotal evidence from banking regulators 

suggests that internal control and recordkeeping weaknesses are on the rise. Moreover, industry consolidation 

and new business activities are creating bigger, more 

complex, and more decentralized operating environments, especially for the largest institutions. These 

issues are important since operational weaknesses may 

leave institutions more vulnerable to adverse economic 

conditions, insider abuse, or fraud. 

Implications 

This article has summarized the generally favorable current condition of the U.S. economy and banking industry. The economy is in the ninth year of a remarkable 

economic expansion that has been conducive to a high 

level of financial performance on the part of the banking industry. There are, nonetheless, areas of vulnerability that could contribute to a less favorable economic 

environment and less robust financial performance for 

insured institutions in the future. 

One issue raised by this report is rising indebtedness on 

the part of households and businesses, which represents 

a growing private deficit. Rising interest rates could 

40 “Operational Risk Management,” Basle Committee on Banking 

Supervision, September 1998 (http://www.bis.org/publ/bcbs42.pdf). 

increase the debt service burden for consumers and 

businesses, making them more vulnerable to a slowing 

economy. An increasing private deficit is problematic 

also because the two major sources of financing—foreign capital inflows and domestic credit creation—have 

the potential to create problems for the economy and for 

lenders. Dependence on foreign capital makes U.S. 

inflation and interest rates highly subject to changes in 

the decisions of foreign investors and the value of the 

dollar. The rapid pace of credit creation by the financial 

sector threatens to impair credit quality. The intuition 

that loose underwriting standards can lead to credit 

quality problems is supported by recent signs of rising 

credit losses in a strong economy. 

The second issue that cuts across this report is the effect 

that competition is having on banking strategies and 

exposures to credit, market, and operational risks. There 

has been an increase in lending to less creditworthy borrowers, including subprime consumer borrowers and 

leveraged corporate borrowers. There is also evidence 

that institutions are pursuing asset-liability structures 

with higher levels of interest rate risk to maintain loan 

growth and meet funding needs. Finally, some of the 

innovations banks have used to counter competitive 

pressures may introduce new risks associated with complex accounting valuations, weakening internal controls, and the need for more intensive loan servicing. 

The third issue is the increasing potential for financial 

market instability, which leaves the economy and the 

banking system vulnerable to sudden shocks. Events 

from fall 1998 showed some of the more damaging 

aspects of these crises, as market-based financing went 

from abundance to scarcity virtually overnight. The 

financial imbalances associated with the rapid creation 

of credit and borrowing from abroad not only create the 

need for the economy to slow down eventually, but also 

threaten to make that adjustment process a 

volatile one. Financial market shocks 

could quickly alter the confidence of 

consumers and businesses and their 

access to financing. Such instability 

could end the current expansion and 

expose underlying weaknesses in 

bank risk-management practices. 

Memphis Regional Outlook 16 Fourth Quarter 1999 
In Focus This Quarter
 

This article was prepared and coordinated by the staff of the Analysis Branch of the Division of Insurance. Contributions and feedback from analysts across the Division were essential to its completion. 

Maureen E. Sweeney, Associate Director 

Paul C. Bishop, Senior Financial Economist 

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

Steven K. Burton, Senior Banking Analyst 

Steven E. Cunningham, Chief, Financial Institutions Section 

Alan Deaton, Economic Analyst 

Diane Ellis, Senior Financial Analyst 

Brian Kenner, Financial Analyst 

Allen Puwalski, Senior Financial Analyst 

Arlinda Sothoron, Senior Financial Analyst 

Jack Taylor, Senior Financial Analyst 

Memphis Regional Outlook 17 Fourth Quarter 1999 
Regional Perspectives
 

Regional Perspectives
 

•	 The Region’s economy continues to underperform the nation’s economy because of declining manufacturing employment and weaknesses in the agricultural sector. Conditions in the agricultural sector worsened 

considerably in 1999. 

•	 Insured institutions reported healthy financial conditions and strong loan growth, although earnings 

performance continues to decline. Asset quality indicators remain positive; however, agricultural and 

commercial lenders reported slightly higher past-due levels. 

•	 New bank activity is increasing, with almost 11 percent of the Region’s existing banks established since the 

previous economic downturn in 1991. Earning performance of new banks appears to have weakened in 

recent years. 

Overview of Economic Conditions 

Employment Growth Slows 

The Region’s economic activity remains sluggish 

relative to the nation’s, as measured by nonagricultural 

payroll employment growth. Total job growth has 

dropped sharply since mid-1998 (see Chart 1). 

Although regional job creation has trailed the nation’s 

since 1996, the divergence in performance widened 

considerably in the past nine months. Second-quarter 

employment growth for the Region’s states was below 

the national average, although considerable variability 

was reported among states (see Table 1). 

Kentucky reported the strongest year-over-year job 

growth in the Region, driven by solid gains in all sectors 

except nondurable manufacturing. In Arkansas, 

employment growth slowed moderately as a result of 

continued job losses in manufacturing. Arkansas 

remains highly dependent on manufacturing with 22.3 

percent of total employment in the sector, compared with 

14.4 percent nationally. 

Mississippi reported the fewest new jobs, with little 

gain reported from one year ago. Modest gains in the 

construction and government sectors were offset by 

continued losses in manufacturing, especially in the 

apparel and textile industry. In the service sector, gains 

in hotel and casino employment were offset by losses in 

the state’s health care industry. 

TABLE 1 

CHART 1 

Regional Employment Growth Has Dropped 

Sharply since Midyear 1998 

Source: Bureau of Labor Statistics, Payroll Establishment Survey Year-over-Year Job Growth (%) 

0 

1 

2 

3 

4 

5 

1999 

Memphis Region 

Nation 

1993 1994 1995 1996 1997 1998 

Employment Growth Is Lower 

throughout the Region 

2Q98 2Q99 

(%) (%) 

ARKANSAS 1.7 1.2 

KENTUCKY 2.5 2.1 

LOUISIANA 2.8 1.1 

MISSISSIPPI 2.6 0.1 

TENNESSEE 2.0 1.2 

REGION 2.6 1.2 

NATION 2.3 2.2 

Source: Bureau of Labor Statistics, Payroll Establishment Survey, year-over-year growth 

Memphis Regional Outlook 18	 Fourth Quarter 1999 
Regional Perspectives
 

Job growth continued to slow in Tennessee as well, 

influenced by losses in manufacturing and overall labor 

market tightness. Manufacturing industry payrolls are 

declining at an increasing pace as the state’s apparel and 

textile firms continue their flight from the United States 

for lower-cost overseas locations. While these job losses 

were more than offset by gains in the construction, retail 

trade, and service sectors, the rate of growth in the retail 

and service sectors declined. Despite the slowdown in 

the manufacturing and services industries, job creation 

continues to exceed the number of people entering the 

workforce, with Tennessee reporting the lowest unemployment rate among the Region’s states. The unemployment rate in Tennessee fell from 4.3 percent in 

second quarter 1998 to 3.7 percent in second-quarter 

1999. Although generally a positive development, the 

declining unemployment rate may constrain future economic growth because of a shortage of workers. 

Louisiana’s job growth at 1.1 percent slowed appreciably from one year ago, primarily because of job losses 

in the energy sector. The state’s mining segment shed 

almost 6,000 jobs from June 1998 to June 1999. 

Although petroleum prices recovered in the first half of 

1999, energy-sector employment has been slow to 

respond and the extraction segment of the industry continues to lose jobs. Recent increases in the number of 

operating oil rigs could signal an end to these extraction job losses. However, employment in the sector 

remains at risk from further cost-cutting measures and 

consolidation. 

The Region’s lackluster payroll employment growth 

may not fully describe the current slowing in economic 

conditions, as the farm sector is not included in these 

statistics. Problems in this sector, described more fully 

below, are worsening. In addition to lower expected 

agricultural revenues, current conditions could result in 

an exodus of people from farming. 

Agricultural Sector Conditions Worsen 

The outlook for much of the agricultural sector is 

becoming increasingly unfavorable. Several factors are 

creating additional pressure on an already-stressed farm 

economy, including: 

•	 a second year of adverse growing conditions in some 

areas; 

•	 continued low prices for soybeans and corn; and 

•	 the collapse in prices for the Region’s important rice 

and cotton crops. 

Some area farmers again suffered from dry growing 

conditions. While the lower Mississippi Delta states 

reported more severe weather-related problems in 1998, 

Tennessee and Kentucky reported worse conditions in 

1999. Both states were designated for disaster relief in 

late summer. Despite lower expected production in 

these and other southeastern states, strong nationwide 

production forecasts have kept prices relatively low. 

Prices for soybeans and corn remain extremely low for 

a second consecutive year and below break-even levels 

for most producers. Soybean prices reached 27-year 

lows in July before recovering somewhat in late summer 

on weather-related concerns. The oversupply resulting 

from high yields and production both nationally and 

worldwide in recent years is driving the low prices. 

Chart 2 demonstrates the inverse relationship between 

commodity prices and existing supply, using soybeans 

as an example. The current situation for corn, cotton, 

and rice is similar. 

Prices are unlikely to improve substantially in the near 

term absent a supply shock. U.S. farmers can be expected to plant high soybean acreage in 2000, as the level of 

crop loan deficiency payments should decline only 

slightly next year. Loan deficiency payments represent 

minimum amounts subject to a cap that farmers can 

receive on crops placed into the program based on average price levels over several preceding years. Thus, 

these payments maintain a relatively stable price floor 

for most domestic producers. While lower prices may 

discourage competing producers in other areas of the 

CHART 2

 Soybean Prices Fall as Supplies Grow 

* Denotes estimate 

Source: USDA, Wall Street Journal 

’90–’94 

avg. 

8.0 

Bushels (millions)

$/bushel 

’95 ’96 ’97 ’98 ’99* 

4.0 

6.0 

0 

100 

200 

300 

400 

500 

Production 

Price 

Memphis Regional Outlook 19	 Fourth Quarter 1999 
Regional Perspectives
 

world, the late summer price rally may harm U.S. farmers by encouraging more fall planting by South American growers, thus exacerbating oversupply problems. 

A substantial price decline for cotton and rice in 1999 

may severely affect area farmers. Prices for both commodities were high relative to other crops throughout 

much of 1998 and provided some stability to farm cash 

flows suffering from low prices for soybeans, corn, and 

winter wheat. As a result, Memphis Region farmers 

increased cotton acreage by 16 percent during 1999. 

The resulting large expected increase in production, 

continued modest demand, and high existing stocks 

have led to a slump in prices. Late summer cotton prices 

were down over 25 percent from the prior year. In a similar situation, rice production, both nationally and in the 

Region,1 is forecast to reach record levels in 1999. As a 

result, the average price for the crop is expected to end 

1999 between $5.50 and $6.00 per hundredweight compared with an average price of $8.80 per hundredweight 

in 1998. 

Current farm problems are not limited to weather and 

commodity prices, however, as rising interest rates also 

may hurt the sector. Farm cash flows in 1998 were aided 

by a significant drop in average loan rates. While interest rates remain relatively low, the increase in rates since 

June 1999 will place additional stress on farm financial 

conditions as interest costs and debt service requirements rise. Higher interest rates could also adversely 

affect farmland values. With cash flows and property 

1 Three states in the Memphis Region (Arkansas, Louisiana, and Mississippi) are expected to produce more than 68 percent of the nation’s 

rice crop in 1999. 

values likely to be negatively influenced by higher rates, 

some farmers may find refinancing more difficult. 

Performance of the Region’s agricultural lenders is 

being affected by the unfavorable conditions in the sector. During the first six months of 1999, agricultural 

loan losses were up somewhat from levels reported during the same period in 1997 and 1998. As a result, provision expenses increased (see Table 2), contributing to 

a decline in return on assets (ROA). 

Agricultural lenders face growing credit concerns. 

Aggregate past-due loans were reported at 3.2 percent 

on June 30, 1999. While this ratio suggests that past-due 

loan levels remain manageable, it does represent a moderate increase from levels reported one year ago. Many 

lenders are minimizing potential losses by acquiring 

additional collateral or obtaining government guarantees on renewed or reworked loans and encouraging 

farmers to use subordinated borrowing sources such as 

chemical companies. However, agricultural lenders and 

their communities remain dependent on a farm sector 

that is currently in decline. 

TABLE 2 

Credit Concerns Affect Earnings 

Performance of Insured Agricultural 

Lenders 

1997 1998 1999 

RETURN ON ASSETS 1.40 1.31 1.12 

PROVISIONS/LOANS 0.24 0.30 0.44 

Source: Bank and Thrift Call Reports, annualized 

from June 30 each year 

Memphis Regional Outlook 20 Fourth Quarter 1999 
Regional Perspectives
 

Overview of Banking Conditions 


Banking Conditions Remain Favorable 

The Region’s banks and thrifts reported generally 

healthy financial conditions through the second quarter 

of 1999, although earnings performance measures 

remain below year-ago levels. The average ROA ratio 

for the first six months of 1999 was 0.99 percent, down 

19 basis points from the same period in 1998. The major 

factor contributing to lower earnings was a falling average net interest margin, which declined to 4.21 percent 

from 4.40 percent. Increasing competition for loans and 

funding sources contributed to the decline in margins. 

Other financial ratios reflect improvement over results 

reported in the first six months of 1998. Average leverage capital ratios were slightly higher at 11.36 percent 

compared with 11.14 percent at the end of the second 

quarter of 1998. Second-quarter 1999 reported slightly 

improved asset quality over one year ago as past-due 

loans declined to an average 2.69 percent of total loans. 

The Region’s slowing economic growth has not yet 

affected the reported asset quality of insured financial 

institutions, although some bank groups reported modest increases in past-due ratios. 

Agricultural and commercial lenders are the primary 

bank and thrift groups to report higher past-due loan 

ratios from one year ago (see Chart 3). The same factors 

affecting aggregate past-due ratios at agricultural 

lenders are likely influencing the slight increase in pastCHART 3 

due ratios at other nonspecialized banks, many of which 

operate in agriculturally dependent areas. 

Commercial and Industrial Loan 

Levels Are Growing 

Commercial and industrial (C&I) loans continue to 

drive loan growth in the Region and represent an 

increasing share of bank and thrift loan portfolios. 

Aggregate C&I loans have grown at double-digit rates 

since 1994, exceeding overall loan growth (see Chart 4). 

While much of this increase has been driven by institutions with more than $500 million in total assets, smaller banks also report considerable growth in commercial 

credits. As a result, C&I credits are increasing as a share 

of loans, rising from an average 13.31 percent of total 

loans two years ago to 14.11 percent as of June 30, 

1999. Factors contributing to this growth will be discussed further in the Memphis Regional Outlook, First 

Quarter 2000. 

C&I loan asset quality indicators remain favorable. 

While aggregate past-due C&I loans have risen somewhat since mid-year 1997, this ratio is heavily influenced by higher past-due ratios at some of the Region’s 

larger financial institutions. C&I loan past-due ratios 

for banks with under $500 million in assets as of June 

30, 1999, are slightly lower than at the same period in 

both 1997 and 1998. 

CHART 4 

Aggregate Past-Due Loans Rise
 

at Agricultural and Commercial Lenders
 

Percent of Loans

Past-Due 3.5 June 1998 June 1999 3.0 

2.5 

2.0 

1.5 

1.0 

0.5 

0.0 Agricultural Commercial Consumer Mortgage Other Small 

Lenders Lenders Lenders Lenders Nonspecialized 

(112) (358) (56) (90) Banks (350) 

Commercial and Industrial (C&I) 

Growth Outpaces Total Loan Growth 

* Growth from June 30, 1998, to June 30, 1999 

Source: Bank and Thrift Call Reports 

Overall Loan Growth 

Annual C&I Loan Growth 

Year-over-Year Growth (%) 

–12 

–8 

–4 

0 

4 

8 

12 

16 

1991 1992 1993 1994 1995 1996 1997 1998 1999* 

Note: Agricultural Lenders = agricultural production plus farm real estate 

loans > 25 percent of total loans. 

Commercial Lenders = consumer and industrial loans plus commercial real estate 

loans > 25 percent of total loans. 

Consumer Lenders = one- to four-family mortgage loans plus loans to 

individuals > 50 percent of total assets. 

Mortgage Lenders = one- to four-family mortgage loans plus mortgage-backed 

securities > 50 percent of assets. 

Excludes a limited number of small specialized (57) and large nonspecialized 

(8) banks.
 

Source: Bank and Thrift Call Reports
 

Memphis Regional Outlook 21 Fourth Quarter 1999 
Regional Perspectives
 

Results of recent underwriting surveys2 are consistent 

with current favorable asset quality indicators, but note 

some concern in the event of an economic downturn. 

These surveys suggest that C&I underwriting standards 

have remained fairly stable since late 1998. Interestingly, one-third of the banks surveyed by the Federal 

Reserve Board in August 1999 stated their C&I loan 

portfolios have become more sensitive to periods of 

economic weakness. This sensitivity was most often 

attributed to borrowers’ increased financial leverage, 

borrowers’ narrowing profit margins, and previous easing of credit standards. If these findings are consistent 

2 Surveys reviewed include the August 1999 Federal Reserve Board 

Senior Loan Officer Opinion Survey on Bank Lending Practices 

and the FDIC Report on Underwriting Practices for the period ending March 1999. 

across geographies, the Region’s economic slowdown 

may begin to affect commercial loan portfolios. 

New banks3 report much higher concentrations of C&I 

loans, with an average 21 percent of total loans in C&I 

loans as of June 30, 1999, than do established institutions. Such high concentrations are likely attributable to 

the relative ease of bringing in business credit lines compared with more specialized commercial real estate 

underwriting or more labor-intensive creation of a retail 

customer base for consumer and residential mortgage 

loans. The considerable increase in new bank activity in 

the Region, discussed below, could heighten competition 

for business loans and pressure underwriting standards. 

3 For purposes of this article, new banks are those established within 

the preceding three years. 

New Bank Activity and Performance
 

New Bank Formation Remains High 

Although the pace of new bank and thrift formation 

cooled slightly in 1998 from the prior year, activity rose 

sharply during the first half of 1999. Twenty-one new 

insured institutions were established through the first 

six months of 1999, exceeding all of 1998 (see Chart 5). 

Through September 1, 1999, six additional banks 

received regulatory approval to open, with ten more 

new bank charter applications pending approval. If 

these applications are approved, the Region would experience a record number of new bank openings in 1999. 

CHART 5 

Regional New Bank Activity Climbs 

* Six months only 

Source: Bank and Thrift Call Reports 

8.0 

7.0 

6.0 

5.0 

4.0 

3.0 

2.0 

1.0 

0.0 

Percent of Existing Banks 

Not only are the numbers of new banks established during this economic expansion surpassing prior periods, 

new banks represent a higher portion of the Region’s 

existing banks than at any other time in the previous 30 

years. Among other areas of the nation, only the southeastern United States and the West Coast report higher 

levels of new banks relative to existing banks. Almost 

11 percent of the Region’s insured institutions have 

been established since 1991 and have not experienced 

an economic downturn. 

Factors Influencing New Bank Formation 

Several factors may be contributing to the rising level of 

new banks, including: 

•	 record industry profitability in the mid-1990s; 

•	 strength and longevity of the current economic 

expansion; and 

•	 significant industry consolidation in recent years. 

However, a recent study by the FDIC’s Division of 

Research and Statistics4 concluded that the correlation 

between industry consolidation and new bank formation 

4 Steven Seelig and Timothy Critchfield, FDIC Division of Research 

and Statistics, “Determinants of De Novo Entry In Banking,” 1999. 

New Banks

30 

25 

20 

15 

10 

5 

0 

Share of Banks 

New Banks 

1991 1992 1993 1994 1995 1996 1997 1998 1999* 

Memphis Regional Outlook 22	 Fourth Quarter 1999 
Regional Perspectives
 

may be less of a factor than previously thought, at least 

in the same market areas. This study reviewed new bank 

activity in metropolitan markets from 1995 through 

1997 and found that acquisitions tended to correlate 

negatively with new bank formation. In the Memphis 

Region, new bank formation appears to be more closely linked to local economic conditions and the level of 

competition for banking services. 

As shown in Map 1, pockets of new bank formation are 

clustered in or around metropolitan areas. Almost 60 

percent of banks established since June 30, 1996, are 

located in metropolitan areas. One explanation for this 

is that metropolitan areas are characterized by larger 

and more diversified economies. In addition, many metropolitan areas have enjoyed greater economic prosperity during this expansion, which may be attractive to 

new bank entrants. 

The three largest metropolitan areas in Tennessee are 

home to multiple new banks, thanks in large part to 

these cities’ strong economies in the mid-1990s. The 

Memphis metropolitan area has experienced the greatest number of new banks. Eight banks opened since 

June 30, 1996; one new bank charter was approved but 

has not yet opened; and two new bank applications are 

pending. Three banks also have opened in both 

Nashville and Knoxville in the past three years. These 

MAP 1 

New Bank Formation Is Concentrated 

in Metropolitan Statistical Areas (MSAs) 

(as of June 30, 1999) Lexington MSA 

Memphis MSA 

Little Rock MSA 

Baton Rouge MSA 

Houma MSA 

Nashville MSA 

Louisville MSA 

New Banks (Total = 74) 

Source: FDIC Research Information System 

Monroe 

MSA 

three cities, particularly Memphis and Nashville, have 

been major drivers in Tennessee’s economy and have 

reported strong employment and income growth 

throughout much of the decade. Opportunity to provide 

banking services also appears favorable in these metropolitan areas. The core counties in these metropolitan 

areas, Shelby, Davidson, and Knox counties, reported 

the three highest market shares of the state’s total 

deposits among Tennessee’s 95 counties. 

Other metropolitan areas with significant new bank 

activity include Lexington, Kentucky, with six new 

banks opened since June 30, 1996, and Baton Rouge, 

Louisiana, with four new banks. These cities continue to 

lead their states in economic development. 

One measure of both economic strength and banking 

opportunity is the ratio of personal income to the number of bank branches in a market. A relatively low ratio 

of personal income per branch indicates that a market 

may be saturated with banking services or may hold 

more limited opportunity for banking services. As a 

result, the market may be a less desirable location for a 

new bank. A relatively high ratio of personal income per 

branch indicates that a new banking entrant has ample 

opportunity to attract customers. 

Most of the Region’s new banks opened in counties with 

relatively high levels of personal income in relation to 

the number of branch banking offices. Eighty percent of 

the new banks chartered in the past three years were 

opened in counties that reported a higher than median 

level of personal income to bank branches on June 30, 

1996. Areas with multiple new bank openings over the 

past three years all reported significantly higher than 

normal levels of personal income to bank branches. For 

example, Shelby County, at the center of the Memphis 

metropolitan area, reported the highest level of personal income to branches in the Region on June 30, 1996, 

more than double the Region’s average. More new 

banks have opened in this county than in any area in the 

Region since that time. 

New Bank Financial Performance 

New banks typically report operating losses followed by 

gradual improvement in profitability. Weak initial earnings performance is attributable in part to high start-up 

costs and overhead expenses relative to a smaller earning assets base. Even after at least one complete year of 

operation, new banks in the Memphis Region reported 

Memphis Regional Outlook 23 Fourth Quarter 1999 
1988

1989199019911992199319941995199619971998

1999* 

Regional Perspectives
 

a median ROA one-third of that reported by established CHART 6 

banks (using data as of June 30, 1999). Higher interest New Bank Earnings Have Weakened since 1996 expense as well as higher overhead expense (see Table 

1.4 3) contributed to the lower ROA. The higher reported 

interest expense to earning assets ratio is attributed to a 

greater reliance on higher-cost noncore funding, such as 

large certificates of deposit. 

New banks take time to grow into their initial overhead 

and replace higher cost funding with more stable 

deposits. A 1996 Office of the Comptroller of the CurMedian Return on Assets

1.2 Established Banks 

New Banks 

1.0 

0.8 

0.6 

0.4 

0.2 

rency study5 found that while new banks report rapid 0.0 improvement in profitability during the first three years 

of operation, these institutions do not attain levels of 

profitability enjoyed by established banks for an aver­ * Through June 30, 1999 

Source: Bank and Thrift Call Reports age of nine years. 

The rate of new institutions’ initial earnings improvement appears to be slowing. Nationally, new banks’ 

median ROA during the third year of operation (see 

inset box) declined in recent years from impressive levels established in the mid-1990s (see Chart 6). This 

trend suggests that the climate for new bank earnings 

performance has worsened since the middle of this 

decade. Despite the recent decline in new bank ROAs, 

earnings levels are slightly above those reported prior to 

the 1990 to 1991 recession. 

Consistent with banks’ declining profitability in the 

third year of operation, new banks in the Memphis 

Region are taking slightly longer to reach breakeven 

than in prior periods. Banks established between 1995 

and 1997 on average required six quarters of operation 

before reaching breakeven. By comparison, banks 

5 Robert DeYoung and Iftekhar Hasan, Office of the Comptroller of 

the Currency, “The Performance of De Novo Commercial Banks: A 

Profit Efficiency Approach,” Journal of Banking and Finance, 

1998. 

TABLE 3 

established during the previous expansion (1983 to 

1989) reached profitability in four quarters on average. 

This trend is likely being influenced by growing competition from other financial service providers in the 

1990s. 

New institutions also report a lower allowance for loan 

and lease losses than reported by established institutions. As of June 30, 1999, the median allowance for 

new banks in operation for at least one year was 1.06 

percent of total loans, compared with 1.25 percent for 

established institutions. The lower allowance level may 

be cause for concern as new banks report higher concentrations in loan types that historically have demonstrated higher risk of loss, such as C&I loans. 

New Banks May Be More Susceptible 

to Economic Downturns 

New banks in the Region failed at considerably higher 

rates during periods of economic stress than have estabNew Bank Earnings Analysis 

For purposes of comparison, this analysis reviews 

the reported earnings of commercial banks established within the preceding three years of each 

report date, but only after two complete calendar 

years of operation. This analysis includes more than 

1,500 institutions. New banks’ earnings performance in the Memphis Region generally mirrors 

national trends but is not displayed because of the 

limited number of observations in certain years. 

New Banks Report Higher Interest 

Costs as well as Higher Overhead 

(AS % OF NEW ESTABLISHED 

EARNING ASSETS) BANKS BANKS 

INTEREST INCOME 8.15 7.89 

INTEREST EXPENSE 4.10 3.69 

OVERHEAD EXPENSE 4.00 3.07 

NONINTEREST EXPENSE 0.61 0.74 

Source: Bank and Thrift Call Reports; as of June 30, 

1999 

Memphis Regional Outlook 24 Fourth Quarter 1999 
Regional Perspectives
 

lished banks, based on a review of bank failures from 

1980 to 1992, a period encompassing three recessions. 

From 1980 to 1992, 17.7 percent of banks chartered 

during or immediately preceding the period6 failed, 

more than double the failure rate for established banks. 

The failure rate for established banks during the same 

time was 7.7 percent. In other words, more recently 

established institutions represented 21 percent of total 

bank failures during the period while constituting only 

10 percent of banks. 

The higher failure rates may be attributable to various 

factors. Many new banks hold concentrations of higher 

risk assets, such as C&I loans. This was particularly true 

during the 1980s. Also, anecdotal evidence suggests 

that new institutions’ loan portfolios often include a disproportionately high number of unseasoned borrowers 

that have not experienced economic downturns. Another factor contributing to the higher failure rate is new 

banks’ lower earnings performance. New banks’ profitability remains below that of established banks for 

several years, and, as a result, lower earnings levels provide a more limited cushion to absorb credit losses. 

Memphis Region Staff 

6 This analysis incorporated banks established between January 1, 

1977, and December 31, 1989, three years prior to the beginning and 

ending dates of the period reviewed. 

New Bank Facts 

A review of the 74 new banks established in the 

Region since June 30, 1996, reveals the following: 

•	 Most new banks are commercial lenders. 

Thirty-eight, or 51.4 percent of all new banks, 

are in the Commercial Lender Bank Group (institutions with 25 percent or more of total assets in 

C&I loans or commercial real estate loans). 

•	 Some new banks quickly establish branch networks. Thirteen new banks have established at 

least one branch in addition to a headquarters 

location, with five new banks having two or 

more branches. As branch offices often represent excess capacity for new banks, profitability 

in such institutions may be depressed in the first 

years of operation. However, branches may help 

maturing new banks attract low-cost deposits. 

•	 Some new banks are part of multibank holding 

companies. Eleven new banks, roughly 15 percent of the new banks in the Region, are associated with multibank holding companies. This 

operating structure may provide some stability 

during the formative years and serve as a cushion as these institutions mature. 

•	 New banks do not appear to be embracing new 

technology. Only 8 of 74 new banks have Internet websites and only six have transactional 

Internet sites. New banks may be reluctant to 

offer Internet banking services because of startup and maintenance costs and the fact that they 

often have limited staff resources. 

Memphis Regional Outlook 25	 Fourth Quarter 1999 
✁
 

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