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review by the Federal Reserve Bank of Chicago Business Conditions 1967 December Contents The trend of business 2 Farm economy slows 6 Bank mergers A study of Marion County, Indiana 11 Federal Reserve Bank of Chicago THE S in c e late summer, strikes and threatened strikes in major Midwest industries have cast a veil of doubt over confident predic tions that business activity would surge in the fourth quarter. Total employment and industrial production failed to rise in September and October. Retail sales re mained sluggish. And unemployment rose in some areas. October settlements of disputes in three important industries—motor vehicles, con struction machinery and steel hauling—and the likelihood that other negotiations would be resolved without long walkouts opened the way to a renewed upswing. But labor peace is being bought at a high price to be paid in annual instalments for as many as three years to come. Increases in compen sation of 6 percent a year, with much of the gain in current cash income, are far more than the most optimistic projections of gains in output per manhour. Wage gains far in excess of increases in productivity will be illusory. Price tre n d s c lo se ly w a tch e d A poll of purchasing agents a year ago revealed their principal headaches to be broken delivery promises, long lead times and material shortages, in that order, with rising prices fourth. A recent survey shows rising prices as the main problem. These survey results highlight one of the paradoxes of the current situation. Most industries are operating below capacity, overtime has been OF BUSINESS restricted and—except for the effects of strikes and defense priorities— delivery schedules have improved. But the likelihood of an accelerated rise in prices has increased. In October, 65 percent of Chicago pur chasing agents reported paying higher prices for the principal items they buy, with only 1 percent paying lower prices. Only in a few months in the spring of 1966 were larger ratios of increased prices reported. Evidence of inflationary trends in manu facturing has been clouded for the past year Prices of finished goods rose as prices of materials and farm products moved to lower levels percent, 1957-59 = 100 Business Conditions, December 1967 by declines in prices for raw materials, in cluding many farm products. The Government’s spot commodity price index was down to 95 percent of the 195759 average in late October. This was from 102 a year earlier and a peak of 115 in February 1966. Declines in hogs, wheat, hides, rubber, zinc, lead, steel scrap and print cloth all played a part in the down ward movement of this index. The broad wholesale price index, which includes finished and semifinished goods, was lower in September than a year earlier —but only slightly and entirely because of declines in raw materials. But machinery and equipment and consumer nondurable goods (exclusive of food) were up almost 3 percent. Consumer durable goods averaged only 1 percent higher, but appreciable in creases have been announced for appliances, television and hi-fi sets, and a further increase in auto prices is widely expected. The consumer price index, used in granting workers “cost-of-living” increases, was almost 3-percent higher in September than a year earlier, despite a 1-percent de cline for food consumed at home. Food prices had risen sharply in 1966. This year housewives continue to complain about high food prices, and some foods, such as dairy products and citrus fruits, have risen further. But the main increases in the con sumer price index involve commodities and services with large labor inputs. Apparel, restaurant meals and, especially, medical care have increased substantially in 1967. Rents, which had been rising about 1 per cent a year in the early 1960s, increased 2 percent in the year ending in September. Declines in prices of raw materials and agricultural products seem to have run their course for the time being. More and more, therefore, higher prices announced by manufacturers and other suppliers of goods and services will be reflected fully in the total consumer and wholesale price indexes. In October and November, higher prices were posted for stainless steel, sulfuric acid, copper, brass and aluminum products, elec trical equipment, household appliances, TV sets, rapid transit fares, newspapers and polyethylene film. The upward price trend has clearly ac quired strong momentum. But scattered price reductions for processed g o o d s , margins of unused capacity in most indus tries and depressed markets for many raw materials indicate that competitive forces remain at work. Appropriate public policies can reinforce these stabilizing influences of the market place. L a b o r s h o rta g e s p e rsist Estimates of total nonfarm wage and salary employment for all Seventh Federal Reserve District states— Illinois, Indiana, Iowa, Michigan and Wisconsin—and for the nation as a whole show moderate increases in recent months from the levels of a year earlier. Manufacturing employment has been somewhat lower, however, and average work weeks in industries producing durable goods have been reduced sharply since last year. In October 1966, 18 out of 23 major labor markets in the Seventh District were classi fied as having “low unemployment” with less than 3 percent of the labor force seeking work. Five centers were in the “moderate un employment” group with unemployment rates ranging from 3 to 6 percent. Currently, 11 of the District centers are in the low un employment group, 11 are in the moderate unemployment group and one (Kenosha) is classified as having “substantial unemploy ment”—more than 6 percent. Most of the Midwest centers with easier labor markets Federal Reserve Bank of Chicago concentrate on production of motor vehicles or farm machinery. For the United States as a whole, a similar but less pronounced trend developed in the past year. Of 150 major labor markets, 35 percent had low unemployment in October, compared with 44 percent a year earlier. The proportion of insured workers receiv ing unemployment compensation is higher than last year in all District states, but the rates generally remain well below the level for similar periods before 1965. Moreover, all District states continue to report ratios lower than the nationwide averages. Also, un employment was increased temporarily in the early fall by indirect effects of strikes. Re sumption of full-scale auto production will reduce unemployment in some centers. Many personnel managers remain uncon vinced that labor markets are easier than a year ago, and some insist that recruiting prob- Labor costs per unit of output and prices of manufactured goods have risen sharply percent, 1957-59 =100 cents per dollar of sales lems have become more acute. Responses to help-wanted ads have been poor, and some companies have increased use of other devices —such as ads on public conveyances, appeals for employees to aid in recruiting, and direct mail and blind telephone calls to private homes— all of which tend to seek out people working somewhere else. Married women and potential moonlighters have been at tracted to jobs with hours and other condi tions tailored to individual circumstances. Labor shortages have been aggravated by requirements of the Armed Forces and by the large proportion of young men attending burgeoning universities. Most of these stu dents must pursue a full-time academic pro gram to maintain their draft-exempt status. Premium salary offers to those with advanced degrees also tend to extend schooling. The availability of labor has been further reduced by longer vacations and a trend toward early retirement encouraged by liberalization of public and private pension programs. Demand for skilled workers—all of the building trades, the metalworking trades, en gineers, computer programmers, draftsmen and other technicians—exceeds supply al most everywhere. The Department of Defense recently assigned a number of enlisted men with machinist training to the Rock Island, Illinois, arsenal after a request to the union failed to yield enough workers. The shortage of skilled or trainable work ers is compounded by the tendency of em ployers to hire promising applicants or to retain workers when they are not really re quired. Such labor hoarding is characteristic of tight labor markets. An overall view suggests that production in the Midwest will be limited in the months ahead by labor availability rather than plant capacity and supplies of raw materials. Heavy demand for workers largely explains the rapid Business Conditions, December 1967 rise in wages and salaries, whether collective bargaining is involved or not. C a p ita l o u tla y s to rise Private surveys have indicated that busi ness outlays on new plant and equipment will rise about 5 percent in 1968. Equipment prices and construction costs are expected to rise about the same proportion, however, so little if any real increase in purchases of plant and equipment is expected. Outlays for this year are expected to be up 2 or 3 percent from last year’s record total, or slightly less than the increase in prices. Surveys of plant and equipment investment intentions taken in the fall may differ appreci ably from actual results because some plans are not yet complete and others may be either stepped up or slowed down as circumstances determine. Nevertheless, recent surveys con firm views Midwest equipment producers have expressed for several months: that although their new orders have revived from the slump in the first half, the uptrend has not been vigorous. Analysts for some companies foresee years of comparatively dull business before a new boom in capital expenditures develops. Underuse of capacity, reduced pro fits, high borrowing costs and the likelihood of a corporate tax increase—all these are cited as restraining forces. Plant and equipment expenditures rose more than 15 percent a year in 1963-66—a sustained expansion without precedent. In 1966, these outlays amounted to 8.2 percent of output of all goods and services—up from 6.6 percent in 1963. The ratio may be about 7.9 percent in 1967 and, according to recent surveys, only slightly less in 1968. The equipment portion of capital expendi tures has held up much better in the last year than the construction portion. In 1966 and 1967, purchases of producers’ durable equip ment (including some types not covered in plant and equipment surveys) amounted to about 7 percent of total output, a record ratio equaled only once since World War II. Plant and equipment expenditures will be high in 1968, even if current projections are not revised upward. These outlays have shown wide fluctuations in the past and virtual stability at the crest of a boom is no mean achievement. Nevertheless, because of the importance of the production of machin ery and equipment in the Seventh District— the area produces a third of the nation’s total with a sixth of its population—this District will not lead the expected uptrend in the gen eral economy in 1968 as it did in 1963-66. Lo o kin g to 1 9 6 8 Projections of total economic activity for 1968 have begun to cluster in the 840 to 850 billion dollar range—up 7 to 8 percent from the 785 billion total expected for 1967. Price increases are widely expected to account for 3 percent or more of the rise in spending. A year ago, economic forecasts ranged widely—from 750 to 800 billion dollars— and straddled actual results. The more ex pansive forecasts of a year ago failed to fore see the drastic inventory adjustment in the first half of 1967. The pessimists, while anti cipating the inventory adjustment, expected a much greater and more extended impact on final demand than actually developed. Economic forecasts of trends well in the future obviously must be used with caution, even when they show a high degree of uni formity. Nevertheless, policy must be formu lated and implemented on the best advice available. Currently, there is widespread agreement that the coming year will see: • Relatively full utilization of resources— especially manpower—with real gains in output limited to about 5 percent 5 Federal Reserve Bank of Chicago • All major sectors of the economy—private and public—following increasing or (at worst) leveling trends • Wage settlements in excess of productivity gains constituting both a cause and an effect of inflationary pressures • The general price level under upward pres sure and likely to rise at least 3 percent— maybe more without additional restraints • The need for moderation of the rate of credit growth, including the Federal deficit • Continued need for a rise in tax rates in lieu of a general (but unlikely) reduction in total Government outlays. The record rise in the economy since early 1961—almost seven years—has been sus tained despite hesitations in late 1962 and early 1967. Growth in consumer and nonde fense Government outlays has continued in the face of a sharp rise in military outlays since mid-1965. In the past two and one-half years further expansion on an orderly basis has been increasingly threatened by strength ened inflationary pressures. Relieving these pressures in a manner consistent with sus tained expansion and maximum possible free dom of market forces to allocate resources must be a prime national objective for 1968. Farm economy slows 6 arm prices declined this year, dipping well below the high level reached in 1966. In October, the index of prices farmers received for all commodities stood about 6 percent below that for a year ago. Livestock prices dropped sharply, especially the price of hogs. Poultry and egg prices also averaged well below levels for the previous year. On the other hand, dairy products bolstered by high er support prices averaged near the 1966 level. Crop prices, in the early part of the year, were generally above the 1966 level, but as demand weakened and prospects for a record harvest became more certain, these too sank sharply. Government payments to farmers declined also— about 6 percent from the 3.3 billion dollars in 1966. The combination of lower prices and reduced Government payments held gross farm income a half billion dollars short of the record 49.7 billion dollars reached last year. Higher prices for most production items and larger purchases of these items boosted total farm costs more than a billion dollars and diminished net farm Farm commodity prices recover but continue below a year before . . . percent, 1957-59=100 1966 1 96 7 Business Conditions, December 1967 income to about 14.8 billion dollars— 10 per cent less than the 16.4 billion realized in 1966. Except for 1966, however, this was still the highest since the early 1950s. A major factor in farm price and income trends has been the weakening of the export demand for U. S. products. Exports in the first three quarters totaled about 4.6 billion dollars. This was about 6 percent less than for the same period a year before and the first decline in exports in several years. The weakening of export demand was especially important in price developments for feed grains, wheat, soybeans and other commodities dependent on foreign outlets for large parts of total sales. Feed grain exports lagged by nearly a third behind those for 1966. Foreign shipments of wheat were about a fourth lower. Soybean exports, on the other hand, exceeded the previous year’s level, but by less than expected. Domestic demand for most agricultural commodities remained strong, reflecting high levels of employment and personal income. Price changes of farm commodities dependent primarily on the domestic market were, . . . causing incomes to decline billion dollars Total farm exports lag behind a year ago million dollars, January through September 0 1,000 2,000 3,0 0 0 4,0 0 0 5,000 therefore, associated largely with changes in supply. The lower price levels for meat animals and poultry are prime examples. Pork supplies rose 9 percent, and supplies of beef increased about 2 percent. Similarly, broiler and turkey supplies were 4 and 12 percent higher, respectively. Despite the decline in commodity prices and farm income, agriculture’s financial bal ance sheet was more favorable than a year ago. Preliminary estimates indicate that the value of farmers’ assets increased about 4 percent to around 281 billion dollars in 1967, and although farm debt also continued to rise rapidly, farmers’ equities reached a record high—about 3 percent more than last year. Farm borrowings, estimated at 48.6 billion dollars, rose about 4.1 billion from the 1966 level. The increase in loans outstanding secured by mortgages on farm real estate lagged behind that of other recent years, even though land prices rose further. Nonrealestate loans, on the other hand, jumped about 2.4 billion dollars— a record increase. The 7 Federal Reserve Bank of Chicago increase probably reflects a number of forces, including the cost of producing large crops, the downward drift of commodity prices and the upward drift of prices paid for equipment and supplies. The general economic climate in which farmers will operate in 1968 is expected to be more buoyant than that of 1967. Prospec tive increases in economic activity, employ ment and wage rates point to further advances in consumer income. Advances will be sub stantial, even if income taxes are increased. Domestic demand is, therefore, expected to increase further, and expenditures for food are expected to increase 4 percent or more— about in line with the increase for 1967. Foreign demand for farm commodities will also probably strengthen from last year. Sup plies of farm products going into 1968 are large, however, and farmers using new tech- Farm debt continues rise b illion dollars 50 r proj. I9 6 0 1961 1962 Note.' As of January I. 1963 1964 1965 1966 1967 1968 nologies and improved practices are likely to keep production at a high level, despite Government efforts to curtail it. In this setting, the Department of Agricul ture concluded at its annual outlook confer ence in November that farmers’ cash receipts in 1968 probably will rise from the level of the previous year. Larger Government pay ments—primarily for feed grains—are ex pected to boost gross income past the record 50 billion dollar mark. But with the unrelent ing upward movement in production expen ses, total net farm income will probably be held near the 14.8 billion dollar estimate for 1967. Livestock production is likely to be stimu lated by the more favorable relationship between livestock prices and feed costs. But because of the time required to expand opera tions, total meat supplies may be only mod erately greater than the 1967 record level. Cattle slaughter and beef production are expected to be maintained near this year’s levels. Marketings of fed cattle will probably continue larger in the first half of 1968 than in 1967, reflecting the larger number of cattle on feed last fall that will be reaching market weights after the turn of the year. Marketings of fed animals in the second half of 1968 will depend largely on the availability of feeder animals. Current estimates point to fewer cattle being available at the beginning of 1968, but some observers, recognizing the possible error in such estimates, point out that there could be enough to keep fed cattle marketings above 1967 levels for most of 1968. Cow slaughter, which has been running well under a year ago, is expected to continue lower as beef herds are expanded and dairy herds culled less rigorously. This, with small er calf slaughter, would probably hold total beef output near the 1967 level. As a result, Business Conditions, December 1967 beef prices will probably average higher than this year, since the demand for beef is apt to be strengthened further by gains in population and personal income and by further increases in preference for beef over other meats. Hog production can be expected to rise moderately as farmers respond to the current ly favorable relationship between prices of hogs and corn. The level of hog marketings in 1968 is less certain, however. A Depart ment of Agriculture survey of Com Belt farmers in September showed a 2-percent reduction in the number of sows farrowing between June and next February. This would point to smaller hog marketings through much of 1968. But similar farrowing esti mates failed to provide accurate clues to actual marketings in 1967. Furthermore, re duced production would be contrary to past experience. Producers have usually re sponded to sharp increases in feed grain production and lower feed prices by increas ing production. Also, sow slaughter has run below year-ago levels in recent months, indicating that an expansion in production may be underway. The extent of the expan sion will be reflected in increased slaughter and lower prices, especially late in the year. The expansion in poultry production that has been underway for the past several years may slow some in 1968 because of the low returns received in 1967, especially for turkeys. Prices of turkeys were the lowest since 1961 and well under the cost of produc tion much of the year. Although feed costs are expected to be lower in 1968, a cutback in production is indicated. This would allow prices to recover. Broiler producers, on the other hand, will probably continue increasing output in 1968, but not as rapidly as this year. Even so, 1968 prices may average a little higher than those for this year. Milk production will total close to the 120 Dairy product inventory rises sharply as consumption falls billion pounds 1961 1962 1963 1964 1965 1966 1967* * Estimated billion pounds produced in 1967. Prices farmers receive for milk will average close to 1967 levels, assuming no change in Federal support of dairy prices. However, consump tion of dairy products at these high prices is again expected to fall short of production. This, of course, will again make it necessary for the Commodity Credit Corporation to remove large quantities of dairy products from normal market channels to maintain prices at support levels. The crop situation has changed dramati cally from that in the fall of 1966. Faced with rapidly declining grain supplies and expecting sharply increasing demands, the Government encouraged expansion of production in 1967 through a series of program changes. Farm ers responded by planting 18 million more acres to crops. This, combined with favorable weather, resulted in the largest harvest ever recorded. Feed grain production rose nearly 18 mil lion tons from the near-record 1966 output. 9 Federal Reserve Bank of Chicago Although both domestic and foreign demand are expected to pick up from the reduced levels of the past year, total use is almost cer tain to fall below the 1967 crop output. The result will be the first buildup in carryover stocks since 1963. Wheat supplies are also much higher, reflecting a record harvest, curtailed export shipments and reduced domestic use. While wheat use is expected to be more than last year, it will not be as great as the 1967 crop. Thus, the wheat carryover will also increase, reversing a seven-year decline. Similarly, a slower rate of increase in soy bean use and export, coupled with another record crop, resulted in total supplies of more than a billion bushels—far more than is ex pected to be needed, even allowing for some increase in demand. Because of the resumed buildup in grain stocks and the depressing effect these supplies have had on farm prices, a number of actions Expanded acreage and record yields boost feed grain production millions tons per acre Soybean supplies reach record levels million bushels have been taken, or are expected to be taken, to curtail crop output in 1968. The Govern ment’s recently announced feed grain pro gram for 1968 provides for reinstatement of the farmer’s option to idle more acreage than the minimum required to participate in the program. This would probably reduce feed grain acreage 10 million acres or so. Also, the wheat program for next year reduces the na tional wheat allotment from 68.2 million to 59.3 million acres. With prospects of 12 to 15 million acres being withdrawn from production, crop output will probably be less next year. This is expected to allow the liquidation of grain stocks to be resumed— assuming strong domestic and foreign de mand— and to allow grain prices to strengthen in the latter part of 1968. Current large supplies, however, are apt to hold grain prices substantially below the 1967 level during most of 1968. In the longer run, the outlook for agri culture continues to be dominated by the ability of farmers to produce more than domestic and world markets can absorb at Business Conditions, December 1967 current prices. The continuing challenge to farmers— and to the officials that formulate and administer farm programs—will be to adjust the amount of resources used in agri cultural production to the amounts that will provide the output required by consumers. Achieving a desirable balance is not easy. While rising demand and restricted produc tion in the early 1960s culminated in sharply reduced supplies and higher prices in 1966, the boost in production in 1967 resulted in a swing to excess supplies and sharply de clining prices. Hopefully, the situation in 1968 will bring a swing to greater stability. Bank mergers A study of Marion County, Indiana* JN ^erg ers—a postwar movement in all in dustries—have accounted for nearly 3,000 banks disappearing as separate businesses since 1945. This article describes the factors underlying postwar bank mergers in Marion County, Indiana—the Indianapolis area. Marion County offers a striking example of the merger movement in banking. Of the 21 banks in the county in 1945, 15 were absorbed by other banks by 1960. During that time, the proportion of deposits held by the three largest Indianapolis banks grew from 67 to 96 percent. No effort is made here to evaluate the ef fects of the mergers on banking competition and service in the Indianapolis area. Instead, the article describes the forces that initiated and facilitated Marion County mergers. Information for the study—obtained from official reports, interviews with officers, direc tors and shareholders of banks involved in mergers and from documents pertaining to merger agreements—indicated that merger *This article is based on a study conducted by Peter W. Bacon for a doctoral dissertation at Indi ana University. The study was conducted while Mr. Bacon was a research fellow at the Federal Reserve Bank of Chicago. He is now assistant pro fessor of finance at Southern Illinois University. activities of the absorbing banks reflected basic forces at work in the economy, in bank ing and the legal environment. G ro w th of o u tlyin g a r e a s The economy of Marion County changed markedly after World War II, the most not able change being the growth of outlying areas. From 1950 to 1960, the population of Indianapolis increased only 11.5 percent, compared with 78 percent for the rest of the county. As new markets for banking services opened in outlying areas, growth-minded Indianapolis bankers wanted to tap them. And because the location of these markets precluded plans to serve them from down town offices and because Indiana allowed countywide branch banking, bankers in the city began reaching out to the new markets through branches. Branches could be established by setting up new offices or by acquiring existing banks for operation as branches. Acquisition of an ex isting bank was often the more attractive alternative, for several reasons: • The existing bank was already a going con cern, with customers, an established 11 Federal Reserve Bank of Chicago location and employees familiar with the markets— all of which helped reduce the problems and expenses of setting up a branch. • Information on the bank to be acquired provided a firm basis for estimating poten tial business—which reduced the uncer tainties that would have accompanied an all-new branch. • Acquisition of an existing bank eliminated a potential competitor—which boosted the share of the market that could be obtained. The drive for branches to reach new mar kets was probably the most important factor underlying the merger activities of large In dianapolis banks. G ro w th of r e ta il b a n k in g Growth of markets in the outlying areas coincided with the growing interest of Indi anapolis bankers in retail banking—in pro viding consumer credit and obtaining savings accounts and small demand deposits. Several of the large Indianapolis banks had long been “wholesalers of credit,” dealing mostly with businesses, smaller banks and wealthy indi viduals. But after the war, at least three important developments made it clear that the future growth of these banks depended on their reaching customers with small ac counts. One was the absorption of many Marion County businesses into national organizations and the financial needs of these companies suddenly being met by sources in other cities.1 Another was the slow growth of de mand deposits, which had not kept pace with economic activity. To counter this, several Indianapolis banks followed the nationwide 12 The Chicago Federal Reserve Bank noted in its 1956 Annual Report that Indianapolis had experi enced more mergers of local businesses into nation al companies than “almost any other big city” (page 7). trend by aggressively seeking savings de posits. This required offices located conven iently to homes, shops and places of employ ment.2 Still another development was the growing importance of instalment lending that stim ulated Marion County mergers. Often the best way of expanding, and in some cases initiat ing, consumer credit departments was by merging with other banks. Growth in the size of companies served by Marion County banks, the increased com plexity of services required by customers and the rising costs of bank operations were also factors underlying the mergers. Many bankers believed that these needs could be met most effectively by achieving rapid growth in the size of their bank and that this could be done only by merging with other banks in the area. P e rm issive n e ss of re g u la tio n s Banking is a profit-seeking business. From that standpoint, postwar mergers in Marion County can be viewed as responses of com peting banks to the changing demands and unfolding opportunities of a dynamic econ omy. But banking is also a regulated industry, and the mergers of Marion County banks also reflected what was permissible under the statutes and regulatory policies then in effect. Before the Bank Merger Act of 1960, the legal climate was extremely favorable for bank mergers. Under some conditions, mergers were consummated without prior review by Federal agencies. And even when the statutes gave an agency the power of ap proval over a merger, they did not specify the factors to be considered in the decision. There is also substantial evidence to sug2 Studies conducted recently by the Federal Re serve Bank of Chicago show a strong tendency for customers to use the nearest bank. This makes con veniently located offices essential to consumeroriented banking. Business Conditions, December 1967 gest that the discretionary standards applied by some agencies were not very restrictive. From 1950 to 1958, for example, the Comp troller of the Currency approved 731 mergers and disapproved only 35. Furthermore, Federal antitrust laws were not used to prevent bank mergers until very recent years. Since the Supreme Court deci sion in United States v Philadelphia National Bank in 1963, mergers have been restrained partly by fear of costly law suits. The branch banking laws of Indiana also provided a strong incentive for bank mergers. Banks could establish branches in their city and any other city in the county that was not the home office of another bank. This law was significant for a couple of reasons. For one thing, absorbing banks were allowed to operate acquired banks as branch offices. This provided an incentive to merge that bankers would not have had if branch banking had been prohibited. For another, the “home office protection” provision of the law effectively closed six rapidly growing Marion County communities to the establish ment of de novo branches by “outside” banks. There were only two ways an outside bank could establish branches in these towns: either by absorbing the existing bank or by waiting until another bank absorbed it. Five of the six banks protected by the home office provision were absorbed by merger. The a cq u ire d b a n k s But why were the stockholders and man agers of 15 Marion County banks willing to give up control of their banks? In three cases, the acquired banks had been affiliated with their acquiring banks for many years. In these cases, the mergers were simply logical extensions of existing associa tions undertaken to achieve the benefits already discussed. In two other cases, it was hard to distin guish the absorbed from absorbing banks. One merger— a large retail bank and a large wholesale bank of about the same size—was undertaken so the combined banks could serve the banking needs of the entire com munity, instead of only segments of it. The other— also two large downtown banks— resulted from the death of the chairman of the board of one bank and the appointment of the president of the other to fill the vacancy. Other considerations in the merger included prospects for increased operating efficiencies through the introduction of data processing, more effective competition with the largest bank in the city and the use the combined bank could make of the two main offices, which were next door to each other. The question applies more meaningfully to the elimination of small banks. In 11 years, 10 of the county’s small independent banks were absorbed into larger Indianapolis banks. The sm all a cq u ire d b a n k s A failure to compete that left them behind in growth, earnings and service to the com munity is sometimes suggested as the reason for the absorption of many commercial banks. Most of the small banks absorbed in Marion County were operating as profitably as their absorbing banks, had above average growth rates and comparable loan-to-deposit and capital-to-deposit ratios. Nevertheless, there is much to suggest that many of them were less efficient than the larger absorbing banks —that they were profitable largely because of higher charges, lower salaries and lower occupancy expenses, all conditions that could not be continued indefinitely. Interest rates on loans and service charges on demand deposits were above average at many of the banks. More important, the profitability ratios of these small banks did 13 Federal Reserve Bank of Chicago 14 not adequately reflect a number of prospec tive costs—costs the banks could not post pone much longer. The most important of these costs were competitive salaries and fringe benefits for management. Salaries of officers in the ab sorbed banks were, on the average, 44 per cent less than salaries paid officers of the absorbing banks. Even though many people working for themselves are satisfied with less income than they would be working for someone else, yearly incomes of several of the bank presidents were not comparable with those of even junior officers in the larger banks. And none of the ten small banks had retirement or hospitalization programs. Most of the banks operated in obsolete, overcrowded, poorly located or otherwise inadequate facilities. Absorbing banks had to renovate or replace the offices of seven of the acquired banks. Many operating procedures were also in adequate. Up-to-date credit files were almost nonexistent. It was reported nearly impossi ble to borrow from one bank when the presi dent was not there, because “he had all the credit information in his head.” Modern methods of record keeping and even “safe keeping” were seldom used. A former direc tor of one bank complained, “There were no files, and paper was lying all over the place. The operations were at best confusing.” One bank operated its safe deposit facilities on a “one-key” basis, with the president holding the only key. The usual practice requires two keys, one held by the bank and the other by the customer. Most of the small banks made no aggres sive effort to attract new business, and few of their officers recalled doing any advertising. A typical comment was, “We were there and if you wanted to come in, fine.” Directors of one bank did not consider a sign outside the banking office necessary. The chairman of the board of a large downtown bank that eventually absorbed this small bank described driving up and down the main street of the little town looking for the bank. After stopping to ask where the bank was, he learned it was in the Masonic Hall. These are descriptions of banks that failed to adjust to changing conditions. One can only guess how much longer they would have operated profitably. Salaries for suitable man agement replacements, fringe benefits for employees, and plant modernization and mechanization are all costs successful banks must pay to achieve continued growth and prosperity. Too often, they were costs that seemed to dismay owners and managers of the small Marion County banks. C o n ce n tra tio n of o w n e rsh ip The stock of the ten small absorbed banks was closely held. In only two banks did the directors, officers and their families own less than 50 percent of the outstanding shares. This concentration of ownership facilitated mergers in two ways: 1) by allowing merger decisions to be made by small groups of peo ple with the same interests, it increased the probability that terms could be worked out to the satisfaction of all and 2) by creating a problem of ownership succession. In organizations with a wide distribution of stock in small lots, the decision of a small group of shareholders to dispose of their holdings is seldom important. But the situa tion is different in an organization with a small number of large shareholders. In such a situation, shareholders often find a merger brings them the best price for their holdings. Problem of m a n a g e m e n t succession The ages and tenures of the managers of the small absorbed banks made management Business Conditions, December 1967 succession a problem. Five of the ten presi dents were more than 65 years old, and only three were less than 60. More than half the officers were more than 60, and only 12 per cent were less than 40. Of the 39 officers for whom information was available, nearly half had been with their banks more than 20 years and only five had served less than six years. At least five of the mergers can be attri buted to chief officers wanting either to retire or reduce their activities and the realization that their banks had no one to take over. The only bank that reported having tried to attract a new president was unsuccessful—primarily because of the low salary it offered. T a ilo re d m e rg e rs A useful distinction can be made between factors initiating a bank merger and those facilitating it. Many of the characteristics of the small absorbed banks were facilitating factors—the kind that set the stage. Factors initiating mergers were the attrac tive prices and terms offered by absorbing banks. In most cases, the merger agreements were tailor-made to meet the wishes and needs of owners and managers. The terms offered usually provided increases in book value, dividends, salaries and needed pension benefits, as well as other accommodations to meet the wishes of individual shareholders. Although book value provides only an approximation of the real value of a bank’s stock, shareholders of the absorbed banks indicated that they evaluated the attractive ness of merger offers by comparing the price offered with the book value of their stock holdings. As a result of their merger deci sions, they received substantial premiums over book value, either in cash or book value per share in the merged bank. For every dollar of book value they gave up, they re ceived, on the average, $1.56 in cash or book value of the stock in the combined bank. This premium was apparently far more than that paid shareholders of absorbed banks in most areas. A study of bank mergers in the Third Federal Reserve District (Philadel phia) in 1946-54, showed that shareholders of absorbed banks were typically paid $1.05 per dollar of book value. Owners of seven banks absorbed in ex changes of stock (as opposed to cash pur chases) were also influenced in their deci sions to merge by the expectation of substan tial increases in dividend income. Sharehold ers of these banks averaged $2.88 in cash dividends in the two years after merger for each dollar they received in the two years before merger. To have matched the dividends their share holders received in the combined banks, the absorbed banks would have had to increase their payouts for the two years before the mergers by 190 percent. The dividends re ceived by stockholders of two absorbed banks in the two years after their mergers were more than the total after-tax incomes of their banks for the two years before the mergers. Merger decisions of five banks were in fluenced by promises of substantial salary in creases to bank officers. Immediate yearly salary increases for the leading officers of these banks ranged from $1,500 to $5,580— from 25 to 126 percent. The decision to merge at each of these banks was apparently influenced by these salary increases. All the officers and employees of the absorbed banks that received employment with the absorbing banks were also brought under retirement programs. This, too, was an important factor in the decisions to merge— since most of the absorbed banks had not provided retirement benefits and most man agement personnel were approaching what are usually retirement ages. 15 Federal Reserve Bank of Chicago Officers of three small absorbed banks operated insurance agencies that had supple mented their bank salaries before the mergers. In each case, the absorbing bank allowed the officer to retain his agency. Officers of several banks reported that their directors were reluctant to merge be cause they did not want to give up the prestige and pleasure of being bank directors. Many of the board members had served 20 years or more, and strong friendships were evident within the boards. To help overcome their reluctance and avoid any loss of customers in the community, the absorbing banks estab lished the boards of several absorbed banks as advisory boards to the directors of the acquiring banks. Information on nine of the ten small banks absorbed showed merger decisions were in fluenced by provisions that officers and most of the other personnel would be retained, though this probably also indicates that ab sorbing banks recognized the value of keep ing familiar faces in local offices. Five mergers left former presidents of the absorbed banks as vice presidents of absorbed banks and branch managers of their previous ly independent banking offices. In three mergers, the presidents of the absorbed banks voluntarily retired and a senior officer of the absorbed bank was made branch manager. In another case, the president of the absorbed bank would have become chairman of the board had he not died before the merger agreement took effect. It appears that many officers of the small absorbed banks enjoyed the best of two worlds. They received substantial increases in salaries, nearly all became eligible for re tirement benefits and insurance programs, and they were able to continue as managers of the banking offices where they had spent so many years. Conclusion No two mergers were alike. But regardless of the considerations that made each differ ent, the bank mergers in Marion County re flected basic changes in the banking environ ment—changes in the local economy and the distribution of economic activity, in the de mand for banking services and the kind of services demanded, in the sources of funds available to banks and in the technology of banking itself. The mergers were undertaken for the most part to put absorbing banks in stronger posi tions to serve their customers, to compete in new patterns of banking and to continue their growth and remain profitable. Many of the smaller banks, on the other hand, did not have the resources, including the staff and facilities, to cope with changing conditions. The same forces that led larger banks to undertake mergers made smaller banks will ing candidates for absorption. B U S IN E S S C O N D IT IO N S is p u b lish e d m o n th ly b y the F e d e ra l R e se rve B a n k o f C h ic a g o . G e o rg e W . C lo o s w a s p rim a rily resp o n sib le fo r the a rtic le "T h e tre n d o f b u s in e s s ," R ob y L. S lo a n fo r " F a rm econo m y s lo w s " a n d Peter W . B acon fo r " B a n k m e rg e rs ." S u b scrip tio n s to B u sin e ss C o n d itio n s a re a v a ila b le to th e p u b lic w ith o u t ch a rg e . Fo r in fo rm a tio n co n ce rning b u lk m a il in g s, a d d re ss in q u irie s to the F e d e ra l R e se rve B a n k o f C h ic a g o , C h ic a g o , Illin o is 6 0 6 9 0 . 16 A rticle s m a y be rep rin te d p ro vid e d source is cre d ite d . Business Conditions a review by the Federal Reserve Bank of Chicago In d e x fo r th e y e a r 1967 Month Pages A g ricu ltu re an d farm fin a n ce 1966 farm loan survey Most banks extend credit to agriculture, some have inadequate funds and small loan limits. . . . Larger loans, longer maturities, higher interest ra te s............................................ Fewer but larger borrowers use more credit........... Farm economy slo w s................................................ Meat supply to diminish............................................ Shifts in District farming Strong rise in grain production................................ May 11-16 August September December June 8-16 5-11 6-11 13-16 October 11-16 November 10-16 B a n k structu re an d m a rk e ts A new banking system? Broader powers proposed for savings banks and S & L s.................................... Bank markets and services Summary of three surveys of bank customers. . . . Bank mergers A study of Marion County, Indiana....................... Competition in banking The issues............................................................... What is known? What is the evidence?................... May 6-10 December 11-16 January February 8-16 7-16 Month Pages C red it an d fin a n ce Bank credit cards Stampede in the Midwest.................................. Federal funds How banks use the m ark et............................. Instalment loans Profitability varies............................................ . . . Ownership of Federal debt Private holdings decline............ Profile of savings deposit rates'. . ... “Special” checking service grows more general. . . . . Trends mbanking and finance "Money and credit growth resumed................... Trends in banking and finance Corporate security issues.................................. Trends in banking and finance Income of District banks in 1966..................... Trends in banking and finance What’s happened to liquidity?......................... 6-9 2-11 March July July March 8-14 14-16 13-16 2-8 2-7 2-6 May 3-5 August 2-7 Economic conditions Defense activity in the M idw est......................... Homebuilding upsurge continues......................... New findings on consumer finances Closer look at the well-to-do........................... The trend of business The outlook for 1967 ...................................... The trend of business Declines hit Midwest industries..................... The trend of business Stage set for renewed expansion..................... The trend of business Inventory adjustment completed..................... The trend of business Inflationary pressures and labor shortages . . . . July November June 9-12 6-9 10-13 2-6 April 2-6 June 2-6 2-5 2-6 In te rn a tio n a l econom ic cond itions Banking goes international.................................. The diminishing trade surplus............................. U. S. wealth abroad.............................................. January September 7-16 3-8 12-16
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