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An article in the May issue of the Business Review surveyed Philadelphia’s status as a center for corporate headquarters. For years the region has ranked high among metropolitan areas as a head quarters complex. The article, however, pointed to a number of signs that the area’s headquarters leadership was beginning to wane. Given many possible reasons for a home-office decline, we have taken a closer look at one of the suspected causes. PHILADELPHIA’S DESIRE TO ACQUIRE by Elizabeth R. Deutermann Headquarters of corporations are an economic CHART 1 asset to a community. Every sign of decline in PHILADELPHIA’S ACQUISITIONS EXCEED ITS LOSSES, 1955-1966 these nerve centers of corporate control is of great concern to a region’s business fraternity. Philadelphia’s fraternity is no exception. Recently, indications have emerged which show Philadelphia is slipping behind its com petitors as a center of corporate headquarters.1 The obvious question is why. If one were to sur vey local business leaders, a single factor would 1966 1965 1964 1963 1962 1961 1960 1959 1958 carry considerable weight; that is, headquarters 1957 are vanishing as corporations sell themselves to 1956 companies headquartered outside of the region.2 And, it is said, the selling exceeds buying by local headquarters of companies outside of the region. The result is a loss of headquarters. In other words, local acquisitions of firms outside the region are not keeping pace with outside acquisitions of firms in the Delaware Valley. So 1955 0 50 100 150 200 250 300 Number of Acquisitions, Cumulated Sources: Federal Trade Commission, Federal Reserve Bank of Philadelphia. to find that Philadelphia is a net gainer in this era of merger fever. During the past 12 years (1955-1966) firms headquartered in Philadelphia goes local thinking. acquired more corporations from outside of the region than they lost to the rest of the nation.3 The balance sheet Philadelphia headquarters acquired 306 corpo rations from cities and towns outside of the Dela It may therefore come as somewhat of a surprise 15ee “ H eadquarters: Centers o f Corporate Control,” Business Review, Federal R eserve Bank o f Philadelphia, M a y, 1967. 2 Philadelphia, throughout this article, refers to the eight-county Philadelphia Standard M etropolitan Area. It includes the counties o f B ucks, Chester, Delaware, M ontgom ery, and Philadelphia in P ennsylvania; and the counties of Burlington, Camden, and G loucester in N ew Jersey. B U S IN E S S R E V IE W ware Valley. Over the same time span 233 Phila delphia-based headquarters were acquired by companies outside of the region.' In terms of sheer numbers, Philadelphia’s desire to acquire resulted in 73 net acquisitions. (See Chart 1 ). 3 Full acquisitions only, as opposed to partial, are in cluded in these comparisons. is produced in the Department of Research. Evan B. Alderfer is Editorial Consultant. Donald R. Hulmes prepared the layout and artwork. The authors will be glad to receive comments on their articles. Requests for http://fraser.stlouisfed.org/ additional copies should be addressed to Bank and Public Relations, Federal Reserve Bank of Philadelphia, Philadelphia, Pennsylvania Federal Reserve Bank of St. Louis 19101. business review At the source CHART 3 Industries, nationally or locally, are convention ACQUISITION GAINS AND LOSSES IN MANUFACTURING, 1955-1966 ally grouped into the four sectors shown in Chart 2. From the chart we see which sectors Major Contributors to the Loss were responsible for the net gain in acquisitions, (Net Change in Firms) — 15 — 10 — 5 and to what degree. Of these four major sectors, Major Contributors to the Gain 10 (Net Change in Firms) 15 20 25 30 I I------1 CHEMICALS ELECTRICAL MACHINERY only wholesale and retail trade combined chalked up a net loss. Manufacturing corporations of the INSTRUMENTS TRANSPORTATION EQUIPMENT PETROLEUM region were primarily responsible for the total PRINTING net gain in acquisitions. APPAREL Chart 2 also points to the relative importance of manufacturing in the region’s merger activity. Of all local acquisitions over the past 12 years, three-fourths of the acquirers and of the ac quirees were manufacturing corporations. While manufacturing is responsible for this region’s net acquisition success, a few important TOBACCO MACHINERY | PAPER | MISCELLANEOUS | PRIMARY METALS STONE, CLAY, GLASS ORDNANCE FOOD TEXTILES LUMBER manufacturing industries have provided the real strength. Within the manufacturing sector, over RUBBER, PLASTICS half of the major industries experienced a net FURNITURE loss to the region through the acquisition route. On the other hand, as can be seen in Chart 3, eight other industries more than compensated for FABRICATED METALS LEATHER Sources: Federal Trade Commission, Federal Reserve Bank of Philadelphia. the larger loss group. The net gain in acquisi tions by the chemical industry alone almost off CHART 2 set the total impact of the losers. Along with MANUFACTURING LEADS IN ACQUISITION ACTIVITY, 1955-1966 Net Change in Acquisitions Who Acquired? Who Was Acquired? Percentage Distribution chemicals, the electrical machinery and instru ment industries stand out as the area’s acquisition activists. What’s it worth? Merger head-counting has documented a total net gain in acquisitions to the Philadelphia metropolitan area. Similarly, such head-counting has demonstrated a net gain in manufacturing acquisitions. But we beg an important question. What is this regional gain worth in dollars and cents? For all sectors of the economy, we just don’t — 20 L Sources: Federal Trade Commission, Federal Reserve Bank of Philadelphia. know. But for the most important one, manu facturing, we do. And unfortunately the numer- 3 business review ical gain in manufacturing acquisitions has re of manufacturing companies in this region were sulted in a monetary loss. (See Chart 4.) being purchased by headquarters outside of the Historically, manufacturing has provided the Delaware Valley. But the smaller number of base for the region’s economy. It supports the firms this region lost was worth more in terms area’s service industries. In Philadelphia it gen of production. Net numbers of acquisitions ran erates more jobs than any other sector. And now counter to their net value. we see that it is responsible for over three-fourths Through the merger process, Philadelphia- of the region’s acquisition activity. These factors give added significance to a net acquisition gain headquartered firms lost 18 per cent more than they gained in control over manufacturing, as in manufacturing which produced a dollars-andcents loss to the region. measured by value added. This region’s head quarters acquired manufacturing headquarters from outside of the area whose firms generated $392 million worth of new production. But now Over the past 12 years, headquarters of manu facturers in Philadelphia acquired companies outside of the region which, through their pro look at the other side of the ledger, as shown in new control over that production— measured as Chart 4. During the same time period, local man ufacturing headquarters which had been respon sible for $461 million worth of new production value added. At the same time, a fewer number merged into companies outside of the region.4 duction, added to the nation’s gross national product. This gave Philadelphia headquarters As a result of the acquisition process, Phila delphia was a net loser of corporate control over productive activity to the tune of $70 million in CHART A THE GAIN IN ACQUISITIONS RESULTED IN A DOLLARS AND CENTS LOSS Value Added by Manufacturing Headquarters, 1955 to 1966 Gain Loss value added. This is the value of the 18 per cent net loss experienced by Philadelphia home offices in control over manufacturing activity since 1955. Letting in some air To this point, we have been considering Phila delphia’s acquisition and merger experience in a relative vacuum. Unfortunately, comparable information on other metropolitan areas does not exist. However, using the national experience as a backdrop may shed some light on Philadel phia’s acquisitive economy. For example, of all acquisitions in the United States and in Philadelphia over the past dozen years, the same four sectors of the economy were relatively important. That is, for both the nation * In the vernacular, if a com pany buys, it “ acquires” ; if it was bought, it “ m erged” ! 4 business review and the region, manufacturing corporations were the leading acquirers. They were followed, in order, by services, trade, and mining. The United States in microcosm? Philadelphia has frequently been referred to as a “ miniature United States” with respect to its industrial struc CHART 5 PERCENTAGE DISTRIBUTION OF ACQUIRED MANUFACTURING AND MINING FIRMS BY INDUSTRY OF ACQUIRING MANUFACTURING FIRM, 1955-1966 Percentage ture— and rightly so. But is this also true in terms of its acquisitive industries? For the bulk of this region’s manufacturing in dustries the answer is yes, as can be seen in Chart 5. For most of the 20 major manufactur ing industries there is very little difference in the preeminence of Philadelphia acquirers and the nation’s as a whole. There are, however, a few very important exceptions. In spite of the similarities in the industrial make-up of the region and the nation, the food, nonelectrical machinery, and transportation equipment industries are much more merger- Sources: Federal Trade Commission, Federal Reserve Bank of Philadelphia. minded nationally than locally. But on the other hand, chemical, electrical machinery, and in strument corporations in Philadelphia have “ smelling like a rose.” Yet, recalling the net been more aggressive national counterparts. Part of the answer to this paradox may be found in the size of regional firms which have been most merger-minded. Size, in general, is acquisitors than their The fact that Philadelphia corporations have had the highest acquisition rates in the three industries noted above should lend considerable strength to the economy. This can be seen by value lost, the rose looks a bit wilted. a very important factor in who acquires whom. The larger corporation seeking growth through acquisitions usually buys out a smaller firm. Of again comparing the nation’s experience with course there are occasions in which an ant swal the region’s. The manufacturing firms acquired lows an anteater. But the incidence is rare. by local headquarters over the past 12 years are Chart 6 graphically depicts this size bias of in industries which are expected to be rapid- acquiring firms. During the past 12 years, both growth industries in the future. On the average, nationally and regionally, the great majority of United States corporations are buying up com manufacturing firms acquired were bought by panies in industries with slower growth expecta companies with assets of $10 million or more. tions. The logical conclusion is that our past acquisition activity (1955-1966) has been head ing in the right direction— heading for growth. But as the chart shows, a higher proportion of manufacturing firms in the nation were acquired Value revisited. Both in terms of numbers of more than was the case in Philadelphia. This net acquisitions and the industrial composition of fact gains added significance in light of Phila delphia’s high concentration of corporations of what was acquired, the region should come off by corporations with assets of $100 million or 5 business review this size relative to the nation as a whole. The the firms they acquired from outside of the region data suggest that the region’s corporations in the were smaller than their Philadelphia buyers. top bracket are not quite so actively acquisitive Merger myopia as their counterparts elsewhere. Firms acquired by Philadelphia corporations Why has the Philadelphia business community, with assets in the $10 million to $50 million along with similar groups in other major metro range were also less heavily concentrated than politan areas, been so quick to blame the loss of was the case nationally. However, local corpora tions between these two top groups exhibited a headquarters on acquisitions? More specifically, greater acquisition tendency than did their na why has it assumed that a gain in net acquisi tions would improve the region’s headquarters’ tional counterparts. (See Chart 6 ). In summary, position? it is at the top of the scale— from $10 million in assets upward— where the big firms are more actively acquiring the smaller ones. And it is here that the nation’s acquisition rate exceeds that of Probably because of some confusion about the relationship between acquisitions and head quarters. Suppose we see a bold newspaper head line noting that a Dallas-headquartered firm has the Philadelphia region. Since the general tendency is for the larger acquired firm to acquire the smaller, the lower half of about the expected damage to the local economy Chart 6 suggests one possible reason for the — in the loss of local decision-making, services region’s gain in numbers and loss in value. Small corporations in this region are the most acquisi purchased, plant and equipment put in place, and tive relative to the national trend. Our het is that a large Philadelphia-headquartered firm. From past experience we may generalize employment.4 Therefore fear of a net loss in acquisitions generates fear of a net loss in head quarters. Shouldn’t the same process work in reverse ? CHART 6 Unfortunately for Philadelphia it does not. DISTRIBUTION OF ACQUIRED MANUFACTURING AND MINING FIRMS BY ASSET SIZE OF ACQUIRING FIRMS, 1955-1966 The net gain in acquisitions experienced here over the past 12 years does not imply a net gain in headquarters. For example, if this region’s Assets of Acquiring Corporations (Millions of Dollars) headquarters made 30 acquisitions and in the same year only one corporation in the region was purchased by a company headquartered in, say, New York, the area would have a net acquisition figure of 29. Nevertheless, it would have lost a headquarters. The 29 acquisitions would have enlarged this area’s existing homebased corporations, but the acquisitions would not have added any new headquarters to Phila delphia’s economy., Relating headquarters to acquisitions can lead 0 10 20 30 Percentage of Acquired Firms Sources: Federal Trade Commission, Federal Reserve Bank of Philadelphia. 6 40 4S ee footn ote 1. business review to other points of confusion if we are not cau the Old Philadelphia Development Corporation, tious. For instance, a net loss through acquisi for example, to create a prestige headquarters tions could be indicative of a prospering econ center around Independence Mall is a move in the right direction. In addition, personal contacts omy. Firms seeking acquisitions usually are not looking for “ dogs.” In general, they want to buy can be one of the most valuable means of at companies with good products, customers, growth traction not now fully utilized. Presidents and potential, and talented management— or what board members of Philadelphia corporations are ever may be needed to aid their present corporate often the first to know, through their private structures to become more profitable. pipelines, when a headquarters is seeking a new To take another important example, the loss of site. The sales talents of these men can be put to corporate headquarters may be confused with the health of the regional economy in general. good use in selling the region as the right one for headquarters’ relocation. There is no proof that a company acquired in a And finally there is a basic job to be done in region will make any less contribution to the educating existing Philadelphia-headquartered firms on the acquisition process. Of course, local economy after the merger than before it. whether the acquisition route is the best one for Corrective lenses expansion is a decision each corporation has to Nevertheless, business and civic leaders in Phila make in light of its own situation. However, a delphia, and other major metropolitan areas, growth company with an active acquisition policy know headquarters are a special kind of asset to their communities. In the Philadelphia area, one and program will probably grow still faster than one relying on internal growth alone. Con goal of such leaders is to increase the region’s stature as a corporate headquarters center. This summated acquisitions will not create a new means adding new headquarters to the economy stem out-migration of headquarters. and holding on to those the area already has. headquarters are acquisition-minded and see tan To accomplish this, community encouragement of the generation of new firms in the region is essential. Each new company born in the area is gible results in growing control over corporate headquarters in the region but they may well If local wealth, they are less apt to be merger-minded. They will be seeking sellers, not buyers. automatically a headquarters. If the community A locally headquartered company which is lends support to the company’s initial internal not in such a mood might mull over Chart 5. growth, the firm may well find its next step Is its own industry a vigorously acquiring one to speed growth is through acquisitions. Never nationally? If so, how does its corporate acquisi theless, as the “ urge to merge” moves yearly to tion program compare? Or does it even have new peaks, some headquarters inevitably will such a program? Does it need one at its par be lost. But to minimize this loss, each new com ticular stage of development? Only the individ pany should consider including in its manage ual company can answer. But it is folly to avoid ment tool kit the skills of acquiring, as a hedge the questions. against being acquired. In stemming the tide of headquarters out Second, the community can work to attract re migration by way of acquisitions, two groups of locating corporate headquarters. Endeavors of Philadelphia home offices, in particular, might 7 business review assess their acquisitive attitudes relative to their terms of financial strength, which are not pulling growth their weight as acquirers. requirements. They are corporations which have assets either between $10 million and $50 million or over $100 million. (See Chart 6.) They are companies which can best afford to be in the acquisition game. Because of size they can bring greater control over cor porate wealth into the region. And they are the most important groups of local headquarters, in Acquisitions do not bring corporate head quarters to a region. But they do add to local control over corporate decision-making and na tional wealth. In contrast, acquisitions by “ out siders” reduce the number of home offices in a region. One prerequisite in preventing the loss of corporate headquarters from Philadelphia is a powerful desire to acquire. APPENDIX We are indebted to the Bureau of Economics of the Federal Trade Commission (FTC) for pro was recorded by the FTC, one of the most diffi cult tasks was determining the headquarters lo viding the basic data for this article. The Com cation by metropolitan area. Another problem in mission maintains records on acquisitions which volved measuring the value of acquisitions. While it obtains primarily from Moody s Industrials asset data were virtually complete for acquiring (semi-weekly), Standard Corporation Records firms, both asset and sales data from the FTC (daily), the Wall Street journal, the Journal of were sketchy for corporations acquired. There Commerce, the New York Times, and Dun and fore, in order to estimate value added for each Bradstreet. Corporations recorded in the FTC corporation merger file include all manufacturing and min the manufacturing file, the average value added ing industries, wholesale and retail trade, and by United States corporations in each four-digit contract construction but only selected services, transportation, and financial, real-estate and in Standard Industrial Classification Manual for surance companies. (as opposed to establishment) in industry was computed, as classified by the the years 1958 and 1963 (the most recent Cen Detailed data on acquisitions by acquiring and sus years). Data for 1958 were used for acqui acquired companies are unpublished. They were sitions during the period 1955 to 1959, and made available to us by the Commission, with data for 1963 for the years 1960 to 1966. The the stipulation that there would he no corpora basic information may be obtained from the U. S. tion disclosure. The information was first recorded by us on a Department of Commerce, Bureau of the Census, Census of Manufactures, 1963, Vol. III. company basis from the Commission’s I.B.M. The FTC merger data include both consum cards. Data not available on the cards were mated and pending or proposed acquisitions. obtained from numerous industry sources, in The Bank staff chose only verified consummated cluding FTC files, by the staff of the Federal acquisitions for analysis. The staff also used only Reserve Bank of Philadelphia. “ full” as opposed to “ partial” acquisitions in preparing data for this article. Full acquisitions Although the home state of the corporation 8 business review include those for which more than 50 per cent Statistics of Output, Employment, and Produc of the assets or stock of a company was acquired. tivity: U. S. Economy and Selected Industries, References in the article to projected growth 1947-1985, National Economic Projection Series, rates of industries are based on studies of the Report No. 65-1, N.P.A., Washington, D. C., National Planning Association. (See Revised 1965.) DEPOSIT VARIABILITY: A BANKER’S HEADACHE by Hugh Chairnoff Deposit management is a complicated affair. Bankers know there is nothing in the world to THE VARIABILITY INDEX assure them that deposit inflows will match de Bankers measure variability in terms of dollars and cents. However, in order to show that some bankers face more of a variability problem than other banks, we need to abstract from dollars and cents. In this way, the factors determining variability can be examined. The variability index compares the average fluctuation of deposits to the average level of deposits during a given period of time. Because of some mathematical quirks, computation of the variability index is somewhat complicated. If we were to average only the actual fluctua tions of deposits (both positive and negative), the result would be zero— falsely implying no variability. Therefore, we must square each of the fluctuations from the average. The sum of the squared fluctuations divided by the number of fluctuations during the period is the average squared fluctuation. This number has little mean ing for us because variability then would be measured in terms of squared dollars. So, we take the square root of the average squared fluc tuation— the average fluctuation. The average fluctuation is not a completely fair measure of variability. Larger banks will have a higher average fluctuation simply because they are larger banks. A $1 million fluctuation to a $1 billion bank is likely to be less worrisome than a $750,000 fluctuation to a $500 million bank. Yet, the average fluctuation will be higher at the larger bank— indicating relatively more variability posit outflows. The more frequent or the larger the fluctuations of deposits around their average level, the higher the variability of deposits and the bigger the headache for bankers. If bankers know the nature and extent of de posit variability, they can gauge the time for lending and investing, the period for which funds can be committed, and the limitations variability place on their choices among different types of assets. Consequently, bankers will be better able to resolve the ever-present conflict between profitability and safety. Thus, the more bankers know about their deposit variability, the better they are able to serve their communities, their depositors, and their stockholders. We found that deposits do not fluctuate to the same extent for all banks. In this article we examine some of the factors that cause some banks to experience less deposit variability than others.1 l This article is based on an analysis of bi-w eekly d e posit data o f a sample of 122 m em ber banks in the Third Federal R eserve D istrict for 1965. 9 business review at the larger bank. Thus, we must take one more step to arrive at the index of variability. It is to compare the aver age fluctuation to average deposits. The ratio of the average fluctuation to average deposits dur ing a given period of time is our index of vari ability.* * For th e m a th e m a tic a lly in clin e d , th e fo llo w in g n o ta tion s m ay be helpful: X Xi n *1 Sx, Z ( x t)2/n A verage d e p o s its fo r the period A c tu a l d ep osits, i = 1......... n N u m b e r o f o b s e rv a tio n s in th e period F lu ctu a tio n of a ctu a l fro m average d e p o s its (Xi - X) Sum o f th e in d iv id u a l flu c tu a tio n s fro m average d e p o s its — e q u a l to zero Ave rage sq u a re d flu c tu a tio n V2(x,)*/n The average flu c tu a tio n V Z (x ,) * / n T h e index o f v a ria b ility DEPOSIT VARIABILITY: A CROSS-SECTIONAL VIEW Variability is not turnover The more familiar concept of deposit turnover should not be confused with deposit variability. There are no inherent reasons for the two con cepts to be related. Demand deposit turnover measures deposit activity and sometimes it is used as a proxy for economic activity. Turnover expresses the relationship between total debits and average deposits for a given time period. Deposit variability, on the other hand, measures the extent of fluctuations of deposits from their average during a given period of time. Fragmentary evidence in the Third Federal Reserve District suggests the lack of any rela tionship between deposit turnover and variability. The evidence indicates that high or low deposit turnover can be associated with the same degree of deposit variability. does tend to be greater for smaller banks than for larger banks. A 1 per cent increase in average For all 122 banks in the study, the average bi weekly fluctuation of deposits amounted to 2.2 per cent of the average level of deposits.2 But as Chart 1 shows, larger banks generally ex perienced less deposit variability than smaller banks. For example, banks with deposits of less In 1965, larger banks generally experienced less deposit vari ability than smaller banks . . . CHART 1 INDEX OF TOTAL DEPOSIT VARIABILITY RELATED TO BANK SIZE Variability Index than $5 million had an average deposit fluctua tion of 2.4 per cent; banks with deposits of $20 million or more had an average fluctuation of only 1.9 per cent of the average level of deposits. Deposit variability does not change much when the average level of total deposits changes. Thus, if the ratio of time deposits to total de posits does not change, a 1 per cent increase in average deposits would reduce deposit variability by less than 1 per cent.3 The impact, however, Less than 5 5 10 10-20 20-100 Over 100 Bank Size (Millions of Dollars) 122 Banks 2 These data have been adjusted for trend. ! The sensitivity o f the index of total deposit variability was estimated at the mean values o f the independent variables of the follow ing linear regression : Std. D ev. — Total D eposits = $804.97 -|- $13.34 (A v g . Total D eposits) — $11.95 (T im e D eposit P rop ortion ). ($522.46) ($ 4 7 .1 1 ) ($ 0 .5 5 ) ($ 3 .4 6 ) A d ju sted R " — 0.85. The regression is significant at the 1 % level. The figures in parentheses are the standard errors. 10 business review deposits at a $1 million bank seems to have a and local governments, and nonbank financial greater impact on deposit variability than the institutions (with an average fluctuation of about same percentage increase at a $10 million or $20 6 per cent of the average level of this type of million bank, though the impact still is relatively deposit). Accounts of different types of indi small. For banks with about $80 million in de viduals, businesses, state and local governments, posits or more, increases in the average deposit and nonbank financial institutions also are not level virtually have no impact on deposit vari equally variable. How stable a banker’s deposit ability. structure will be very much depends on the All this suggests that deposit variability can character of the accounts in this category as be reduced, though not much, simply by increas well. Thus, variability cannot be reduced merely ing the level of deposits. But there is another by increasing deposits indiscriminately. major consideration. Some types of deposits are much less stable than others. For example, Chart 2 compares the variability indexes of The anatomy of lower variability— the case of demand deposits As Chart 3 shows, larger banks generally ex Increasing the deposit level may not reduce variability be perience less demand deposit variability than cause some types of deposits are more unstable than others... do smaller banks. Lower variability is achieved CHART 2 despite the fact that larger banks generally have VARIABILITY OF DEMAND DEPOSITS BY TYPE a larger proportion of more unstable types of demand deposits such as interbank and U.S. Government deposits. One reason is that vari OTHER DEMAND DEPOSITS* ability of the important catch-all category of U.S. GOVERNMENT DEMAND DEPOSITS demand deposits also is lower at larger banks. DEPOSITS DUE TO OTHER COMMERCIAL BANKS 1 --------------- 1 --------------- 1 --------------- 1 ---------------I_________ I_________ I _________ 0 .10 .20 .30 .40 .50 .60 .70 Variability Index •Includes deposits of individuals, businesses, state and local governments, and nonbank financial institutions. Larger banks generally experienced less demand deposit var iability than smaller banks. . . three broad categories of demand deposits. De CHART 3 posits due to domestic commercial banks— inter DEMAND DEPOSIT VARIABILITY RELATED TO BANK SIZE bank demand deposits— are a very unstable source of demand deposits (the average fluctu Variability Index ation of these deposits was 64 per cent of the average level of interbank deposits). Deposits of the United States Government are consider ably more stable than interbank deposits (the average fluctuation was about 45 per cent of the average level of these deposits), but they are considerably less stable than the total of all other types of demand deposits, a catch-all cate Less than 5 gory that includes individuals, businesses, state 5-10 10-20 20-100 Over 100 Bank Size (Millions of Dollars) 122 Banks 11 business review One reason for lower variability at larger banks was that deposits of a ll types of customers except other commercial banks and the U.S. Government tended to be more stable at larger banks . . . CHART 4 we computed the weighted average index of deposit variability over the three broad cate gories of demand deposits— interbank, U.S. Gov ernment and all other— from the sample of 122 member banks. We then computed the ratio of VARIABILITY OF OTHER DEMAND DEPOSITS RELATED TO DEPOSIT SIZE* the weighted average index to the actual index for total demand deposits. Because of the likeli Variability Index hood that deposit flows may offset one another to some extent, this ratio will be equal to or greater than unity. Thus, the higher this ratio, the greater is the extent of offsetting flows among deposit accounts. As shown in Chart 5, the bigger the bank, the greater the extent of offsetting deposit flows.5 Offsetting deposit flows— // . In addition to the likelihood that deposit flows from different Bank Size (Millions of Dollars) •Includes all demand deposits except U.S. Government and interbank deposits. parts of the accounts will be offsetting, trans Chart 4 bears this out.4 Another reason seems actions among depositors of the same bank may to be that there are more chances for deposit tend to be greater at larger banks than at smaller flows to offset one another at a larger hank than at a smaller bank. Offsetting deposit flows— /. During a given period, a bank will experience inflows that off set, at least to some extent, outflows. Though deposit accounts, groups, may individually function and independently in of small one BThese results are som ew hat biased because the pro portion o f interbank and U .S. Governm ent deposits tends to be significant mainly at larger banks. H ow ever, it would seem that similar results would have been o b tained if it were possible to segregate other types of demand deposits. Another reason was that chances for deposit flows to offset one another seem to be greater at larger banks . . . another, in the aggregate they are likely to be CHART 5 somewhat interlocking. Thus, while a bank may RATIO OF WEIGHTED AVERAGE DEMAND DEPOSIT VARIABILITY TO ACTUAL DEMAND DEPOSIT VARIABILITY be experiencing deposit outflows from one or more segments of its accounts, it may be likely Ratio to experience deposit inflows from one or more other segments. As a consequence, demand de 1.6 posit variability actually will be less than the average variability of each of the components. To test for this type of offsetting deposit flow, 1.4 1.2 4Larger banks ordinarily offer a wider variety of serv ices than smaller banks. Because o f this, it m ay be that greater stability o f private demand deposits at larger banks partly results from larger idle balances maintained by depositors as com pensation for services received. 12 Less than 5 5-10 10 20 20-100 Bank Size (Millions of Dollars) Over 100 business review banks. There are a number of reasons why this Deposit variability is sensitive to changes in may occur. For example, larger banks tend to the proportion of time deposits in the deposit have a much larger number of accounts. Also, structure. In fact, deposit variability is more they tend to cover a broader geographical area sensitive to changes in the time deposit propor than smaller banks. As a result, transactions tion than it is to changes in the average level among depositors of larger banks may tend to of deposits. A 1 per cent increase in the time occur more frequently than at smaller hanks. deposit proportion is accompanied, on average, So, if Depositor A writes a check to Depositor B, by a 1.28 per cent decrease in deposit variability. and Depositor B has his account at the same bank The same percentage increase in the average credited for the full amount, this transaction has level of total deposits would bring a less than 1 no effect on variability of deposits, since the com per cent reduction in the index of deposit vari bined balance of Depositors A and B has not ability. changed. If one can imagine a world in which Actually, sensitivity of deposit variability to there was only one bank, it would be a world changes in the time deposit proportion depends almost without deposit variability because all on the level of the time deposit proportion. For transactions (except for those involving currency) example, for banks whose time deposits are less would be among depositors of the same bank. In summary, some hanks experience less vari than 50 per cent of total deposits, a 1 per cent ability than other banks because they have proc companied by a less than 1 per cent reduction esses working for them that tend to reduce the frequency and magnitude of deposit fluctuations. in variability. But for banks with time deposits IMPACT OF TIME DEPOSITS ON VARIABILITY0 Time deposits are less variable than demand deposits. Variability of time deposits for the increase in the time deposit proportion is ac in excess of 50 per cent of total deposits, the percentage drop in variability will be greater than the percentage change in the time deposit proportion. Thus, the higher the time deposit proportion, the lower the variability of total de posits as shown in Chart 6. sample of Third District hanks averaged 1.5 per cent of the average level of time deposits (after adjustment for trend). In contrast, vari V ariability of time deposits tends to be lower at banks with a higher proportion of time, deposits in the deposit structure . . . ability of demand deposits averaged 6.3 per cent CHART 6 of the average level of demand deposits. Thus, TOTAL DEPOSIT VARIABILITY RELATED TO THE TIME DEPOSIT PROPORTION the presence of time deposits has a salutary effect on total deposit variability (also adjusted for Variability Index time trend). Lower variability of time deposits is especially important to many smaller banks since much of their growth over the last decade has resulted from time deposits. 0 Throughout this article, time deposits include all interest-bearing deposits from regular passbook accounts to large-denomination certificates o f deposit. 13 business review The impact of time deposits on total deposit variability manifests itself in another way. Time Time deposits had more of an impact on total deposit vari ability o f smaller banks . . . deposit variability tends to decline as the time CHART 7 deposit proportion rises. Because smaller banks DEMAND DEPOSIT VARIABILITY COMPARED TO TOTAL DEPOSIT VARIABILITY tend to have a higher time deposit proportion, Variability Index they tend to benefit more from the presence of time deposits. Table 1 shows that the percen tage of banks with a time deposit proportion of 60 per cent or more is higher for smaller banks than it is for larger banks. As a result, the im pact of time deposits on total deposit variability tends to be greater for smaller banks. On Chart 7, the number at the top of each pair of bars is the ratio of the index of total deposit variabil ity to the index of demand deposit variability. The lower this ratio the greater the impact of time deposits on total variability. For banks with deposits of $20 million or less, total deposit deposits, smaller banks and larger banks would variability is less than 35 per cent of demand have had even greater differences in deposit deposit variability. On the other hand, total de variability.7 posit variability is a higher proportion of de mand deposit variability for banks with deposits DIVERSITY AND DEPOSIT VARIABILITY of $20 million or more. Thus, the presence of Differences in variability between banks seem time deposits had a greater impact on total to result mainly from differences in deposit variability at smaller banks than at larger banks. structure. Banks with more broadly based de If it were not for different proportions of time posit structures seem to experience less deposit variability. Diversity of deposits is a nice thing, if you TABLE 1 PERCENTAGE OF BANKS WITH A TIME DEPOSIT PROPORTION OF 60 PER CENT OR MORE BY SIZE GROUP* Size Group (in Millions) Percentage of Total in Group Total Banks in Group Less than $5 $5- $10 $10- $20 $20-$100 $100 or more 78% 72 77 52 33 35 32 29 20 6 From sample of 122 banks in the Third Federal Reserve District. 14 can get it. That is why bankers suffer headaches from managing deposits. Diversity has so many manifestations that deposit management is com7 The benefits o f time deposits can be illusory. For e x ample, bidding for time deposits m ay induce customers holding idle demand deposits to switch. Such a process will have no impact on variability but it will increase the cost of the deposit structure. It also is important to recognize that the decision to increase the time deposit proportion should not be based solely on its impact on variability. T hese are interestbearing deposits. Bankers must be able to em ploy these funds profitably with due consideration for risk. The benefits arising from reduced variability, though positive, may not be sufficient to reward bankers for acquiring interest-bearing deposits. business review plicated. Moreover, not all types of diversity may Without knowledge of the nature of variability produce the results desired. For example, a bank of different types of deposits and different de in an area dominated by a single industry or positors, planning by bankers always will be firm may find it difficult to achieve diversity. a more precarious task than it needs to be. The behavior of a few accounts will likely domi Though the banker is devoting increased atten nate the entire deposit structure. Sometimes bank tion to his deposit structure, more knowledge ers have sought to acquire a large number of would prove equally useful since so many of his relatively small accounts without sufficient knowl problems emanate from the nature of his de edge to compare the high costs of acquiring and posits. A greater understanding of deposit be handling such accounts with the potential bene havior, including the factors that contribute to fits including possible loan business. For some banks, diversity is an oft-dreamed of, though lower deposit variability, can contribute to better planning and, hence, to more efficient bank oper impractical goal. ation. THIRD DISTRICT MEMBER BANKERS If you would like to know how the variability of your deposit structure compares to the average for banks of similar size in the Third District, please write to the author on your bank's letter head. We regret that this analysis can be made available only to Third District member banks. 15 FOR THE R E C O R D BILLIONS $ INDEX Third Federal Reserve District Per cent change July 1967 from SUM M ARY mo. ago CONSTRUCTION** ........... COAL PRODUCTION ......... BANKING (All member banks) Deposits ......................... Loans ............................ Investments.................... U.S. Govt, securities .... Other ............................ Check payments***........ MEMBER BANKS, 3RD F.R.D. United States Per cent change MANUFACTURING Production ..................... Electric power consumed Man-hours, total* ........ Employment, total .......... • • • year ago 7 mos. 1967 from year ago July 1967 from mo. ago - 2 - 1 - 1 — 1 -2 9 -1 8 + 1 - 5 0 — l - 8 - 5 + + + + — 2 3 1 l 5 1 7 year ago - 2 Manufacturing 7 mos. 1967 from year ago Employment Metropolitan olallSllCdl Areas* Payrolls Check Payments** Total Deposits*** Per cent change July 1967 from LO C A L C H A N G ES Per cent change July 1967 from Per cent change July 1967 from Per cent change July 1967 from mo. ago + + + + + + 10 9 9 3 17 7t + + + + + 7 9 4 4 14 7t Wilmington .... -1 0 -1 4 + 2 + 8 - 4 + 7 Trenton .......... — 4 ot + 3t ‘ Production workers only “ Value of contracts “ ‘ Adjusted for seasonal variation + 3* year ago + 2 0 + 4 + 6 + 1 + 1 + + + + + + 9 6 13 10 16 14 0 0 0 + 3 mo. ago year ago 0 - 3 + 1 +25 -1 4 0 + 8 + 1 + 4 + 4 - mo. ago ago year + + + + + + 6 6 8 2 14 12 1 - 3 0 - 5 +11 +58 + 5 + 18 - 1 0 - 1 + 3 + 10 0 + 5 0 + 2 + 5 - 9 + 11 0 + 10 - 5 - - + 2 + 2 + 2 + 6 0 + 10 + 2 — 5 - 4 + 1 + 6 2 + 2 0 + 2 + 7 + 2 + 7 - 1 + 1 + 11 + 3 + 12 - + 6 + 1 +11 0 - Lancaster ........ + 8 Lehigh Valley .. - 0 + 3 115 SMSA’s ^Philadelphia 1 1 - 3 9 - 1 - 1 1 - Reading .......... - 1 - 2 0 + 4 Philadelphia.... 1 0 Altoona ........... 9 - 1 + 2 + 2 + 12 +13 +25 + 4 +10 Wilkes-Barre .... - 3 - 4 - 2 + 2 + 3 + 7 + 2 + 10 York ............... - 1 - 1 - 1 + 5 + 3 + 1 + 1 + 4 Scranton ......... PRICES Wholesale....................... Consumer ....................... mo. ago Atlantic City .... Harrisburg ...... 3 2 4 6 2 5f year ago + 1 Johnstown ...... + + + + + + Banking ‘ Not restricted to corporate limits of cities but covers areas of one or more counties. “ All commercial banks. Adjusted for seasonal variation. ‘ “ Member banks only. Last Wednesday of the month.
@FedFRASER