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98 MONTHLY REVIEW, APRIL 1976 The Business Situation The latest business statistics indicate that the economic recovery is continuing at a fairly vigorous pace. During February, retail sales advanced strongly and industrial pro duction moved up at a moderate rate. The increase in economic activity has been reflected in significant gains in employment, and the unemployment rate eased fur ther to 7.5 percent in March. In the last few months, consumer buying has contributed major strength to the re covery. Consumers have stepped up their purchases of bigticket items, such as automobiles and appliances, putting the economic recovery on a much more solid footing than it was in earlier stages. At the present time, the main weak spot is plant and equipment spending which has failed to show any clear-cut signs of an incipient upturn. Although demand for these investment goods remains weak, the index of leading indicators continues to signal further expansion in the near term. Inflation has slowed markedly at both the retail and wholesale levels in recent months. Consumer prices rose at a 1.4 percent annual rate in February, the lowest in flation rate in over four years. Wholesale prices were also a source of favorable news, as they increased only slightly in March and remained below December levels. To some extent, however, the recent moderation in in flation has reflected declines in the prices of food and energy items, and it would be overly optimistic to extrap olate the recent experience far into the future. Never theless, inflation rates well below the double-digit level appear in prospect. IN DUSTRIAL PRO DUCTION A N D INVENTORIES During February, the Federal Reserve Board’s index of industrial production registered a 0.5 percent increase, the tenth consecutive monthly advance. The February rise was fairly broadly based across industry and market groupings, an encouraging sign that the economic recovery is now on a solid footing. While industrial production in February stood 9.3 percent above the cyclical trough, it still has a way to go before the ground that was lost in the recession is fully recovered. Even at recent robust rates of advance, industrial production would not reach its November 1973 peak until early 1977. In fact, only in the nondurable consumer goods sector has the pre recession peak in output been exceeded. The automotive sector contributed substantially to the industrial output rise of February, and the available in formation suggests that a strong gain also occurred in auto output in March. Auto assemblies were up 200,000 units from the improved February level, reaching an 8.3 million unit seasonally adjusted annual rate in March. In recent months the automotive industry has experienced a dramatic improvement in demand from the depressed level earlier in the recovery. Sales of domestic automobiles, which had been essentially flat from late July to November, have picked up considerably since then. Indeed, in February and March, unit sales of domestic automobiles averaged 8.75 million at an annual rate. This represents a 15 percent advance over November and is the highest sales rate since August 1974. While auto manufacturers have stepped up production by a sizable amount, the increase has not been large enough to match the expansion in sales and auto in ventories have declined. According to industry sources, an inventory stock equal to about 60 days’ supply is regarded as the minimal reserve for the spring selling season. Inven tories have been drawn down well below this level, reach ing about 50 days’ supply at the end of March. It is, therefore, no surprise that the automobile manufacturers reportedly plan to boost their production in the next few months, especially for the larger car models which are in particularly short supply. In other industries as well, inventory building is likely to be a source of upward thrust in the near future. By the end of last year, it seemed that most businesses had run down their once excessive inventories to the point where further reduction might have resulted in interruptions in the productive process as well as in delays on deliveries of finished goods. Indeed, some analysts asserted that the 99 FEDERAL RESERVE BANK OF NEW YORK declines in November and especially in December were unintended, resulting from unexpectedly strong sales. Recent data suggest that some rebuilding of stocks has begun. The book value of business inventories increased $1.2 billion in January, as gains were recorded in the wholesale trade, retail trade, and manufacturing sectors. Yet, despite the sizable accumulation, the inventorysales ratio declined further to a level which is low by his torical standards. February data for the manufacturing sector indicate that nondurables manufacturing inventories continued to increase, while the change in durables manu facturing inventories turned positive for the first time in a year. The February accumulation was modest, however, and inventory-sales ratios decreased further in both du rables and nondurables manufacturing, as shipments con tinued to advance rapidly. As a result, substantial further inventory accumulation is likely to be necessary to bring stocks to a comfortable level. NEW O R D E R S A N D LEADING INDICATORS Led by a 28.8 percent surge in orders for automotive equipment, new orders received by durable goods manu facturers spurted 7.4 percent over the three months ended in February. Orders for nondefense capital goods exhibited a modest 1.1 percent advance over the same period, however, and new orders for machinery and primary metals have shown only moderate momentum. The lag of new orders in these industries is important because past movements in new bookings have tended to be fairly re liable advance indicators of changes in economic activity. The Commerce Department’s composite index of lead ing indicators has resumed its advance following last fall’s sluggish performance, which had caused considerable ap prehension. The index has increased 3 percent since November. Eight component series rose, contributing to February’s 0.8 percent gain, while three components fell. Though the February increase was well below the revised 1.5 percent January spurt, the recent performance of the leading indicators provides corroborating evidence of a near-term continuation of the recovery. disbursements also continued to climb, although the advance was somewhat smaller than in prior months. Over the last three months, wages and salaries have in creased at a robust 11 percent annual rate. The quickening pace of consumption spending that occurred at the end of last year has carried over into the current year. Retail sales had shown comparatively little growth from July to November but have risen strongly since then (see Chart I). In February, total retail sales increased $0.8 billion and were 4.1 percent above the November level. Though the recent gains have been wide spread among the major spending categories— nondurable and durable goods— the rise in spending for durable goods has been most marked. Since November, retail durable sales have advanced 9.3 percent. Looking ahead to coming months, further gains in consumption spending would ap pear to be in the offing. The unemployment picture has brightened considerably, as has the economic outlook in general. Moreover, the heady advance in the stock market in recent months has substantially restored the wealth posi tions of many consumers. These favorable developments may facilitate future sizable increases in consumption out lays, particularly for durable goods. Indeed, according to the latest surveys, there has been a sharp rise in consumer confidence, which is usually associated with willingness to spend. C h a rt I RETAIL SALES S e a s o n a lly a d ju s t e d B illio n s o f d o lla r s P E R S O N A L IN C O M E A N D RETAIL S A L E S In February, personal income rose $12.9 billion, a slightly smaller gain than in the preceding month but one well above that averaged in 1975. A part of the February increase was attributable to a speedup in certain veterans’ benefits, as well as to the receipt of a Federal earned in come tax credit (for calendar 1975) by some low-income households with dependent children. Wage and salary S o u rc e: U n ite d S ta te s D e p a r tm e n t o f C o m m e r c e . B illio n s o f d o lla r s 100 MONTHLY REVIEW, APRIL 1976 RESIDENTIAL CONSTRUCTION AND CAPITAL SPE N D IN G Residential construction activity reportedly rose sharply in February, as housing starts spurted ahead 27 percent on a seasonally adjusted basis. The previous three months had shown declines. It has been suggested, however, that the huge February increase may have been overstated due to the application of standard seasonal adjustment pro cedures. February is typically a cold and wintery month in which residential construction is rather low, so that the reported number of starts is blown up to get seasonally ad justed housing starts, an estimate which eliminates the usual impact of weather in February and permits compar ison with other months. This February, however, the weather was unusually mild in the colder regions of the country and construction occurred at an unusually high rate for that time of the year. Hence, for this February, the usual seasonal factor for housing starts resulted in too high a level of seasonally adjusted starts, thus accounting for the appearance of a February spurt. To the extent that construction slated for the spring months began early, housing starts in coming months will tend to be somewhat lower than otherwise. Nevertheless, the outlook for resi dential construction continues to improve. Permits to build new housing units advanced 13.3 percent during the first two months of this year. The recovery in this sector has been dramatic, with permits up about 60 percent from their low point of a year ago. Demand will probably improve further, as personal in come continues to rise and fears of layoff recede. In the Federal National Mortgage Association April 5 auction, both government-underwritten and conventional mortgage rates declined. Conventional mortgage rates fell from their October peak of 10.02 percent to 9.05 percent in April, while government-underwritten mortgage rates dropped 1.01 percent over the same period. These factors may contribute to housing demand during coming months. Business fixed investment appears unlikely to con tribute much stimulus in the near term. At present, busi ness firms possess substantial excess capacity. Indeed, the current large overhang of excess productive capacity appears to be the principal factor underlying the pessi mistic response obtained by the recent Commerce Depart ment survey of planned plant and equipment spending. The latest survey, conducted during January and February, indicates that planned business fixed investment expendi tures for 1976 will be 6.5 percent above 1975 levels. Dif ferent sectors exhibit a wide divergence in spending plans. The public utilities plan a 15.4 percent increase in plant and equipment spending, while transportation industries (rail, air, etc.) plan sizable cuts in investment expenditures. The scheduled increase in the manufacturing sector is 8.1 percent— stronger than the total— due to the rapid planned advance of capital spending by the nondurables producers. Overall, however, if this survey is accurate, capital spending in real terms is likely to be up only slightly, if at all. In interpreting the outlook for business capital spend ing, several other points are worth noting. First, low capital spending is common in the early part of a recovery. Typically, production strengthens because of increasing demand, and then firms decide to expand capacity. More over, many firms tend to underpredict the growth of sales during an upturn and therefore underestimate their capac ity requirements. Second, the high backlog of unspent appropriations suggests that there could be a very short lead time to capital spending once businesses decide to go ahead with investment. Third, the costs of financing invest ment are down. Internally generated funds have exhibited a recent surge and, according to the McGraw-Hill survey, pretax business profits are expected to increase an addi tional 18 percent in 1976. Equity financing opportunities have been enhanced by the recent rise in stock prices. And last year’s worries concerning the possibility that Treasury borrowing would crowd out private investment financing seem to have been largely dispelled. Indeed, the interest rate on long-term debt is now slightly lower than at the recession trough. PRICES At both the wholesale and retail levels, inflation has moderated in recent months, in large part because of re duction in food and energy prices. Wholesale prices edged up in March following declines in the previous two months. Prices of farm products and processed foods and feeds were down slightly after four months of siz able drops. With retail food profit margins rather high, some further declines in consumer food prices are likely. Wholesale prices of industrial commodities advanced at a 4.7 percent annual rate which brought the average rate of increase in the first quarter of 1976 to 3.6 percent, a marked improvement from the last half of 1975. Consumer prices rose a modest 0.1 percent in Feb ruary, the best monthly performance in over four years. Overall, the performance of the consumer price in dex during recent months has been quite encouraging (see Chart II). A good part of the recent slowdown in prices, however, is attributable to declines in food prices— a volatile component which is usually not indicative of general price trends— and to declines in energy prices, FEDERAL RESERVE BANK OF NEW YORK C h a r t II CONSUMER PRICES C H AN G E FROM P e rc e n t THREE M O N T H S EARLIER A T A N N U A L R A TE S e a s o n a ll y a d ju s t e d 101 increase over the coming year. The calendar of scheduled union contract negotiations is quite heavy for 1976, and the terms in the new contracts will have an important impact on overall labor costs. LABOR MARKET CONDITIONS Source-. U n ited S tates D e p a rtm e n t o f L ab o r, B u rea u o f L a b o r S tatistics. resulting in part from recent legislation. Excluding these items, the past three months’ experience is somewhat less favorable. For example, consumer commodity prices other than food and energy increased at a rate of 5.5 percent per annum during the three months ended in February, and prices for services advanced at a 10 percent annual pace over this interval. While the favorable behavior of wholesale prices probably augurs well for the consumer price index in the near term, over the longer term inflation may well be more of a problem. One concern is the rate of wage Labor market conditions continued to improve in March. Reflecting the trends in production and sales, nonagricultural employment increased by 191,000, its ninth consecutive month of gain,, and the rate of unem ployment edged down further to 7.5 percent. The March unemployment drop was quite small, as 264,000 new workers entered the labor force looking for work. The extent and duration of joblessness have fallen dramatically. Since last May, employment gains have far outstripped labor force growth, reducing the number of unemployed workers by 1.2 million. Moreover, in recent months, there has been a sharp drop in the number of persons reporting extended unemployment of more than fifteen weeks’ dura tion. Only 2.4 percent of the labor force had been unem ployed for fifteen weeks or longer, according to the March survey, compared with 3.3 percent in December. Improving employment conditions appear to be draw ing previously discouraged persons into the work force, In the third quarter of 1975, the Labor Department estimated that 1.2 million such discouraged workers had decided not to search for jobs, despite desiring work, because they believed no jobs were available; in the first quarter this number averaged 0.9 million. With sales continuing to expand, further employment gains appear certain during coming months. If labor force growth picks up in response to improved employment prospects, however, the unemployment rate may tend to recede more slowly in coming months than it has since May. 102 MONTHLY REVIEW, APRIL 1976 The Money and Bond Markets in March Interest rates in the money and bond markets were about unchanged on balance over March. During the first week of the month, a temporary rise in the Federal funds rate led market participants to believe that the Federal Reserve was moving toward a less accommodative policy stance. In response to this, nearly all short-term and other interest rates increased abruptly. These increases were re versed in trading over the remainder of the month, as market participants decided that their apprehensions were unwarranted. The short-term markets were also bolstered by the uncommon absence of net new issues of Treasury bills in the regular weekly auctions, as nearly all new cash raised by the Treasury during March was obtained in longer term issues. The pattern of long-term interest rate movements was similar to the one followed by short-term rates. The im provement in market sentiment as the month progressed generated good investor demand, and substantial new fi nancing in the Treasury coupon, corporate, and tax-exempt markets was readily accomplished. New issues and trading in the secondary market also appear to have benefited from the report that price increases in February had been modest. In addition, prices of state and local obligations, which had lagged behind during the rally in other sectors, adjusted upward. Reports of progress in resolving the financial problems of certain New York State agencies contributed to the more optimistic outlook. Preliminary estimates indicate that the narrowly defined money stock (MO continued to rise moderately in March. A deceleration in the growth of consumer-type time and savings deposits, however, reduced the rapid expansion of the broadly defined money stock (M 2). Another decline in large negotiable certificates of deposit (CDs) held the bank credit proxy to a small increase. THE M ONEY MARKET AND THE MONETARY AGGREGATES Although the Federal funds rate increased sharply dur ing the first week of March, it soon began to recede to about the levels that have prevailed since shortly after the start of the year. The effective rate on Federal funds averaged 4.84 percent during the month, compared with a 4.77 percent average for February (see Chart I). After rising at the beginning of the month, rates on most money market instruments declined to levels near those prevail ing at the end of the previous month. At the end of March, yields on 90- to 119-day dealer-placed commercial paper were 5 Vs percent, unchanged from the level at the end of February. Rates on 90-day bankers’ acceptances fell by 5 basis points over the month to 5.10 percent. Large nego tiable CDs maturing in ninety days traded in the second ary market at 5.23 percent at the end of the period, an increase of 3 basis points over the month. Member bank borrowings from the Federal Reserve fluctuated around frictional levels (see Table I), as the discount rate re mained above the rate on Federal funds. Business demand for bank loans continued to exhibit the weakness which has been characteristic throughout the current recovery. Over the five statement weeks ended March 31, commercial and industrial loans at large com mercial banks fell by $1,676 million. For comparable periods in the preceding two years, these loans showed an average increase of about $4 billion. The demand for business loans has also been unusually sluggish relative to the early stages of past business upturns. In February, business loans at all commercial banks (seasonally adjusted and including loans sold to affiliates) were about 2 percent below their level in April 1975, about the beginning of the economic recovery. At the same stage of the previous four recoveries, these loans exceeded levels at their respective troughs by a range of 2 V2 to 5 percent. The unusually long lag in the response of loans to the current economic upswing is accounted for, in part, by more rapid advances in corporate liquidity and slower growth in inventories (which are usually financed by bank loans) than has been experienced in other recoveries. Preliminary data indicate that the faster growth in M 1 that began in February continued during March. Over the four weeks ended March 24, Mx—private demand deposits plus currency outside commercial banks— advanced at a seasonally adjusted annual rate of 5.3 percent from its FEDERAL RESERVE BANK OF NEW YORK 103 C h a rt I SELECTED INTEREST RATES J a n u a ry -M a rc h P e rc e n t M ONEY J a n u a ry N o te : 1976 M A R K E T RA TE S F eb ru a ry BOND M a rc h J a n u a ry MARKET Y IE L D S F e b ru a ry P e rc e n t M a rc h D a t a a r e s h o w n fo r b u s in e s s d a y s o n ly . M O N E Y M A R K E T RATES Q U O T E D : s t a n d a r d A a a - r a t e d b o n d o f a t le a s t t w e n t y y e a r s ' m a tu rity ; d a ily a v e r a g e s o f P rim e c o m m e rc ia l lo a n ra te a t m o st m a jo r b a n k s ; o f f e r in g r a te s (q u o te d in te rm s o f r a te o f d is c o u n t) on 9 0 - to 1 1 9 - d a y p rim e c o m m e r c ia l y ie ld s on s e a s o n e d A a a - r a t e d c o r p o r a te b o n d s ,- d a i l y a v e r a g e s o f y ie ld s on p a p e r q u o te d b y th r e e o f th e fiv e d e a le r s t h a t r e p o r t t h e ir r a te s , o r th e m id p o in t o f lo n g -te rm G o v e r n m e n t s e c u ritie s (b o n d s d u e o r c a lla b le in ten y e a r s o r m o re ) th e r a n g e q u o te d if no c o n s e n s u s is a v a i la b l e ; th e e f f e c tiv e r a t e on F e d e r a l fu n d s a n d on G o v e r n m e n t s e c u ritie s d u e in th r e e to fiv e y e a r s , c o m p u te d on th e b a s is (th e r a te m o st r e p r e s e n t a t iv e o f th e t r a n s a c tio n s e x e c u te d ); clo s in g b id r a te s (q u o te d in te rm s o f r a t e o f d is co u n t) on n e w e s t o u ts t a n d in g th r e e -m o n t h T re a s u ry b ills . y e a r t a x - e x e m p t b o n d s (c a r r y in g M o o d y 's ra tin g s o f A a a , A a , A , a n d B a a ). B O N D M A R K E T YIELD S Q U O T E D : Y ie ld s on n e w A a a - r a t e d p u b lic u t ilit y b o n d s a r e b a s e d on p ric e s a s k e d b y u n d e r w r itin g s y n d ic a te s , a d ju s t e d to m a k e th e m e q u iv a l e n t to a level over the previous four weeks, bringing growth over the four weeks ended fifty-two weeks earlier to 4.9 percent (see Chart II). As a consequence of sharp decelerations in time and savings deposits in March, however, growth in M2— Mi plus these deposits— was somewhat more modest than in recent months. Compared with its average level in the previous four weeks, M2 in the first four weeks of March grew at an 8.5 percent rate. This brought the growth rate from the four weeks ended fifty-two weeks ear lier to 9.3 percent. After a moderate increase in February, the bank credit proxy— total member bank deposits subject to reserve requirements plus certain nondeposit sources of funds— resumed its recent lackluster performance and o f c lo s in g b id p ric e s ; T h u rs d a y a v e r a g e s o f y ie ld s on tw e n t y s e a s o n e d tw e n ty- Sources-. F e d e r a l R e s e rv e B a n k o f N e w Y o rk , B o a rd o f G o v e r n o r s o f th e F e d e r a l R e s e rv e S y s te m , M o o d y 's In v e s to rs S e rv ic e , In c ., a n d T h e B o n d B u y e r. rose by only 0.3 percent above its level over the previous four-week period, as large negotiable CDs continued to decline sharply in response to the weak demand for bank loans. THE GOVERNM ENT SECURITIES MARKET Interest rates on United States Treasury bills during March were little changed from February, although they sustained a sharp increase at the beginning of March before gradually returning to earlier levels. According to market observers, the initial increases represented a sharp reaction to the temporary rise in the Federal funds rate 104 MONTHLY REVIEW, APRIL 1976 Table I FACTORS TENDING TO INCREASE OR DECREASE MEMBER BANK RESERVES, MARCH 1976 In m illions of dollars; (-)-) denotes increase and (—) decrease in excess reserves Changes in daily averages— week ended Net changes Factors March 3 March 10 March 17 March 31 March 24 “ M arket” factors M em ber b an k req u ired re serv e s. . + 93 + 396 — 235 + 80 — 384 — 50 O p eratin g tr a n s a c tio n s —|—466 816 G o ld a n d fo r eig n a cc o u n t .......... + 3 ,2 3 9 — 165 — 3,894 + 1 ,4 9 3 + 1 ,1 3 9 + — 144 — — 411 — 1 ,269 + 3 ,2 7 9 477 375 +995 + 2 ,7 4 3 + 1 ,1 9 6 — 2,929 + 1 ,2 7 4 — 34 + 24 + 26 — 5 + 21 4-3 8 3 — 306 __ 880 — 585 + 600 — 63 + 301 — 366 + 2 + 10 -1-559 + 3 ,6 3 5 _ 400 — 3,814 + 1 ,1 0 9 + 1 ,0 8 9 — 93 — 4,051 + 427 + 3 ,5 4 3 — 1,002 — 1,176 + 32 — 788 — 116 O ther F e d e r a l R eserve Direct Federal Reserve credit transactions O pen m ark et o p era tio n s (s u b to ta l) .................................................. O utright h o ld in g s : +334 — 2,090 + 1 ,2 0 3 + 1 ,0 9 3 — 492 ................... __ 25 — 36 — — — 14 F e d e r a l a gen cy o b lig a tio n s . . . . +254 + 42 T reasu ry se c u r itie s ........................ B a n k e r s ’ a cc ep ta n ces 20 56 + 48 — 151 + 296 R e p u rc h a se ag re em e n ts: __767 — 1,502 — 646 + 2 ,0 9 0 ................... +138 — 379 — 101 + 191 + 98 — F e d e r a l ag en cy o b lig a tio n s . . . . — 27 — 86 — 9 + 225 — 17 + 86 M em b er b an k b orrow in gs ................. — 64 — 37 — 6 +1 36 — 40 __ 111 154 T reasu ry s e c u r itie s ........................ B a n k e r s ’ a cc ep ta n ces S e a s o n a l b orrow in gs’!" ................... __ 2 53 2 188 + 730 + 3 .7 3 2 — 855 — 559 — + 254 + 530 + 151 + 115 + ....................................................... __ 36 — 3,937 + 537 Excess reservest§ ............................ +523 — + 137 302 — 1,402 + +122 T o ta l 577 + ... O th er F e d e r a l R eserve a s s e t s t s— 82 1 Monthly averagesll Daily average levels Member bank: T o ta l reserves, in c lu d in g v a u lt c a s h t§ ........................................... 34,094 33,396 33,768 33,606 34,244 33,822 R e q u ired reserves .................................. 33,677 33,281 33,516 33,436 33,820 33,546 E x c e s s reserves § .................................... 417 115 252 170 424 276 84 47 41 77 37 57 ................... 8 8 8 8 10 8 N on borrow ed reserves ........................ 34,010 33,349 33,727 33,529 34,207 33,764 — 26 175 9 6 67 46 T o ta l b orrow in gs .................................. S e a s o n a l b o rro w in g s! N e t carry-over, ex c ess or d e fic it (— ) H ........................................... N o te : B e c a u s e o f ro u n d in g , figu res do n o t n e c e s s a r ily a d d to to ta ls . * I n c lu d e s ch a n g es in T reasu ry cu rren cy a n d cash , t In c lu d e d in to ta l m em b er b an k borrow in gs. I n c lu d e s a s s e ts d e n o m in a te d in fo r eig n cu rren cies. § A d ju ste d to in c lu d e w aivers o f p e n a ltie s for reserve d e ficie n c ie s in a cc o rd a n c e w ith th e R e g u la tio n D ch a n g e effec tiv e N ovem b er 19, 1975. II A verage for five w eek s en d ed M arch 31, 1976. H N o t reflected in d a ta above. t early in the month. As a consequence, 52-week bills were sold in the regular auction on March 3 at an average yield of 6.01 percent, 44 basis points higher than rates obtained at the auction four weeks earlier (see Table II). After upward rate pressures in the money market disappeared, however, the average yield on 52-week bills auctioned at the end of the month fell to 5.78 percent. At the last regu lar auction in March of three- and six-month bills, average yields were 4.93 percent and 5.33 percent, respectively, up 6 and 12 basis points from average yields on February 23. For the first month in a year and a half, little new cash was raised by the Treasury in these short-term issues. Rates on most bill issues ended March unchanged to 20 basis points below levels at the end of the previous month. Yields on Treasury coupon issues ended March slightly below those prevailing at the end of February, as the market was bolstered by the announcement of a low infla tion rate in February. The Treasury continued efforts during March to meet its cash needs for the first half of 1976 by offering a variety of new coupon issues. On March 5, $2 billion of new cash was obtained by the auction of four-year notes at a 7.54 percent average rate. On March 18, $3 billion of two-year notes was sold to raise $700 million in new cash at an average yield of 6.76 percent. An additional $2.5 billion of SS^-m onth notes was sold to raise new cash on March 24 at an average return of 7.38 percent. These securities were well re ceived. Many market observers expect the reliance placed by the Treasury on longer term issues in March to continue throughout 1976, since the average maturity of the debt declined substantially in 1975 and since the Congress has increased the volume of long-term Treasury bonds exempt from a 4^4 percent interest ceiling and has extended the allowable maturity of note issues (which are not subject to a rate ceiling) from seven to ten years. Rates in the market for Federal agency securities were little changed in generally light trading and re mained quite close to those on Treasury issues. Early in the month, the Government National Mortgage Associa tion (GNMA) auctioned two issues to raise $300 million of new money. The yield on $200 million of 7V4 percent and $100 million of IV 2 percent thirty-year modified pass-through securities was 8.47 percent. Later in March, GNMA borrowed additional funds by auction ing $239.3 million of IVk percent and IV 2 percent modified pass-through securities priced to yield 8.23 per cent. The Farm Credit Banks sold $1,613.6 million of new bonds to replace $1,196.5 million of bonds maturing April 1 and to raise $417.1 million of new cash. This financing was composed of $499.6 million of six-month Banks for Cooperatives bonds yielding 5.80 percent, FEDERAL RESERVE BANK OF NEW YORK $753.5 million of nine-month Federal Intermediate Credit Banks (FICB) bonds yielding 6.1 percent, and $360.5 million of ten-year FICB bonds returning 7.95 percent. The Federal National Mortgage Association offered $400 million of four-year debentures and $300 million of 9 Viyear debentures toward the end of the month. These securities were enthusiastically received at yields of 7.375 percent and 7.9 percent, respectively, and immediately traded at premiums in the resale market. Table II AVERAGE ISSUING RATES AT REGULAR TREASURY BILL AUCTIONS* In percent Weekly auction dates— March 1976 M a tu rity March 1 C h a rt II GROWTH OF SELECTED MONEY STOCK MEASURES S e a s o n a lly a d ju s te d a n n u a l ra te s P e rc e n t N o te : P e rc e n t G ro w th ra te s a r e c o m p u te d on th e b as is o f fo u r-w e e k a v e r a g e s o f d a ily fig u re s fo r p e rio d s e n d e d in th e s ta te m e n t w e e k p lo tte d , 13 w e e k s e a rlie r a n d 5 2 w e e k s e a r lie r . T h e la te s t sta te m en t w e e k p lo tte d is M a rc h 2 4 , 19 76 . M l - C u rre n c y plus a d ju s te d d e m a n d d e p o s its h e ld b y th e p u blic. M 2 = M l plus c o m m e rc ia l b a n k s a vin g s a n d tim e d e p o s its h e ld b y th e p u b lic , less n e g o tia b le c e rtific a te s o f d e p o s it issued in d e n o m in a tio n s o f $ 1 0 0 ,0 0 0 o r m o re. So u rc e: B o a rd o f G o v e rn o rs o f th e F e d e ra l R es erv e System . March 8 March 15 March 22 March 29 T h r ee-m o n th 5.258 5.060 4.981 4.8 9 0 4.929 S ix -m o n th 5.724 5.487 5.459 5.. 283 5.327 .. OTHER SECURITIES M A R K ETS Yields on corporate bonds ended March about un changed from the end of February. Early in the month, interest rate expectations and additions to the schedule of new financing precipitated an increase in rates on sea soned corporate issues. The market improved, however, in trading activity during the remainder of the month, as it became evident that a tighter monetary policy had not emerged, as a period of less new issue activity approached, 105 Monthly auction dates— January-March 1976 F ifty - tw o w eek s * ......................................... January 7 February 4 March 3 5.578 5 .5 7 2 6.010 March 31 I n te r e s t ra tes on b ills are q u o ted in term s o f a 3 6 0 -d a y year, w ith th e d isc o u n ts from p ar a s th e retu rn on th e fa c e a m o u n t of th e b ills p a y a b le a t m a tu r ity . B o n d y ie ld eq u iv a le n ts, r e la te d to th e a m o u n t a c tu a lly in v e sted , w o u ld be s lig h tly h igh er. and as inflation in February appeared quite modest despite continued strength in the economic recovery. Yields on tax-exempt bonds declined, on balance, following reports of progress toward resolution of New York State’s short term financing needs. While new borrowing through corporate debt was very substantial during March, investors appeared willing to acquire longer term issues— albeit at somewhat higher yields than had been required in February. A return of 8.70 percent was available on $200 million of thirty-year Aa-rated industrial debentures, 25 basis points higher than a similar issue in February. In sales of Aaa-rated debentures, $300 million of forty-year telephone debt provided an 8.56 percent return and $300 million of thirtyyear industrial obligations yielded 8.57 percent. These yields were about 25 basis points above issues distributed a month earlier. Though the volume of tax-exempt financing was,jrlso heavy in March, yields on most issues trading tn the sec ondary market declined somewhat. In the largest general obligation issue on record, Massachusetts sold $535 mil lion of 25-year bonds rated A -l by Moody’s and AA by Standard & Poor’s. The yield provided by these bonds was 9 percent, and the underwriting was oversubscribed. Cali fornia offered $100 million of Aaa-rated serial bonds at yields from 3.4 percent in 1978 to 5.7 percent in 2002. These aggressively priced bonds met with considerable sales resistance. Other sizable offerings included Penn- MONTHLY REVIEW, APRIL 1976 106 sylvania’s $110 million of bonds, with yields ranging from 3.25 percent in 1976 to 7.05 percent in 1995, and Con necticut’s $100 million issue priced to yield 3.8 percent in 1977 to 6.75 percent in 1996. Both issues were also rated A -l/A A and were well received. The tax-exempt market was buoyed during March by reports of progress in New York State’s efforts to assemble a $2.6 billion package to allow four state construction finance agencies to avert a potential default in March and to finish their ongoing construction projects over the next thirty months. In par ticular, this development contributed to the strong perfor mance of Municipal Assistance Corporation issues during the month. The Bond Buyer index of twenty bond yields on twenty-year tax-exempt bonds fell 29 basis points to 6.69 percent. The Blue List of dealers’ advertised inventories rose by $47 million to close the month at $749 million. Per Jacobsson Foundation Lecture The Per Jacobsson Foundation in Washington, D.C., has made available to the Federal Reserve Bank of New York a limited number of copies of the 1975 lecture on international monetary affairs. The Foundation sponsors annual lectures on this topic by recognized authorities in honor of the former Managing Director of the International Monetary Fund, who died in 1963. The twelfth lecture in this series was given on August 31, 1975 in the International Monetary Fund Building in Washington, D.C. Alfred Hayes, former President of the Federal Reserve Bank of New York, presented a paper entitled “Emerging Arrangements in International Payments— Public and Private”. Commentaries on the subject and on his paper were offered by Khodadad Farmanfarmaian, Chairman of the Board of the Bank Sanaye Iran, by Carlos Massad, consultant to the United Nations Economic Commission for Latin America, and by Claudio Segre, President of the Cie. Europeenne de Placements, Paris. This Bank will mail copies of the lecture without charge to readers of the Monthly Review who have an interest in international monetary affairs. Requests should be addressed to the Public Information Department, Federal Reserve Bank of New York, 33 Liberty Street, New York, N.Y. 10045. FEDERAL RESERVE BANK OF NEW YORK 107 Banking Structure in New York State: Progress and Prospects By J u d it h B e r r y K u n r e u t h e r * The structure of commercial banking in New York State has undergone a quiet revolution in less than a decade. The possibilities for statewide banking through branching and bank holding company acquisitions have brought all the state’s banking markets within the range of new competi tive influences. These developments, which have con tributed to an improved level of financial services to the public, could not have taken place without the substantial liberalization of state restrictions on branching and the granting of authority for bank holding companies to operate in the state. Moreover, the growth of the bank holding company movement has opened new channels of competition through diversification by New York organi zations in bank-related activities in New York State, as well as in other states across the nation, and through the entry of out-of-state bank holding companies into financial markets in this state. New York State has been in the forefront of the swing toward freer competition in local and regional banking markets across the nation. While a strengthening of com petition throughout the state could be expected to benefit the public interest, those urging the relaxation of legal bar riers to competition in New York State had to contend with the concerns of those who feared the possible domination of banking by the state’s largest organizations. Thus far, these fears have not been borne out. It will, of course, take some time to appraise the full impact of statewide branching and the bank holding company movement on banking structure in New York State. Present indications The provisions of the state’s branch banking amend ments of 1971 became fully effective on January 1, 1976, following a 4Vi-year transition period.1 Beginning this * The author is an economist in the Banking Studies Depart ment of the Federal Reserve Bank of New York. She wishes to acknowledge the valuable comments provided by her colleagues in the Banking Studies Department. 1 For a discussion of the history of banking legislation and regulatory developments in New York State prior to 1971, see Karen Kidder, “Bank Expansion in New York State: The 1971 Statewide Branching Law”; Monthly Review (Federal Reserve Bank of New York, November 1971), pages 266-74. are that the controlled entry of the state’s largest banking organizations into regional and local markets, under regulatory standards designed to promote a healthy competitive environment, has served the public interest by contributing to improvements in the quality and quantity of financial services available to the public. Multibank holding companies have assumed increased importance in the state’s banking structure since the pas sage of the landmark Federal Bank Holding Company Act Amendments of 1970. They have enabled banking organi zations both to expand statewide through acquisition of footholds or de novo banks and to engage in nonbanking activities. The liberalization of the state’s branch banking law, leading to statewide branching in January 1976, now provides the state’s banking organizations with added scope to improve their efficiency and services to the public. A few large organizations have already consolidated their affiliates into statewide branch systems. Banking organiza tions are likely to be digesting and adjusting to these devel opments for some time to come. This article reviews the major structural changes that have occurred in the past five years and their significance for the further evolution of banking in New York State. EXPA NSION THROUGH BRANCHING 108 MONTHLY REVIEW, APRIL 1976 year, the new law eliminated the previous nine banking districts, which had served to limit the extent of branch banking within the state except for the authority granted to New York City banks to branch into neighboring Nassau and Westchester counties and for banks in those counties to enter New York City. The effect of this change is to authorize statewide branching. A second change was a reduction of the degree of homeoffice protection afforded independent banks in the state’s major cities. Prior to 1971, entry by outside banks through branching was precluded in a community that had a popu lation of one million or less and was the headquarters of an independent bank (i.e., a bank not affiliated with a bank holding company). New York City was the only major city in the state not eligible for home-office protection un der the population ceiling, although by the end of 1971 a few other major cities could be entered by outside banks since all banks headquarterd in those cities were affiliated with bank holding companies. The 1971 amendments re duced the population ceiling for home-office-protected communities to 75,000 in January 1972 and then lowered it again to 50,000 as of January 1976. These changes re moved home-office protection from several large cities that still were the headquarters of independent banks. In ad dition, a provision that limited to one the number of de novo banks a bank holding company could establish in each district expired, as did a provision that allowed a newly chartered bank to open only two branches a year until it had been chartered for five years, except that none could be opened during its first year of operation. At the same time, the prohibition on the acquisition by a bank holding company of a newly chartered bank in a homeoffice-protected community remains intact. The 1971 relaxation of the branching law contributed to further heavy branching activity in most of the state’s major banking markets, where branch banking had already taken root firmly in response to oppor tunities within each of the former nine banking districts. During 1971-75, an average of 149 de novo branches per year were established by New York State banks, a substantial increase over the average of 93 branches per year established during the previous five years. At the end of 1975, 73 percent of the banks in the state operated branch banking systems, up from 40 percent in 1960, and about 97 percent of the deposits outside New York City were controlled by banks operating branch systems. Table I indicates the growth of branch offices and related changes in New York’s banking structure between 1950 and 1975. BANK HOLDING C O M P A N Y EX PA N SIO N Table I SUMMARY OF BANKING STRUCTURE CHANGES IN N E W Y O RK STATE 1950 1960 1970 1975 N um ber of com m ercial banks ................................. 635 403 296 276 Independent banks ......................................................... 625 384 230 157 Holding com pany banks .............................................. 10 19 66 119 N um ber of branch offices* ........................................ 755 1,368 2,407 3,253 Category N um ber of bank holding com panies! .................... 4 8 26 32 N um ber of m ultibank holding com panies ........... 2 3 8 15 Percentage cf state deposits held by m ultibank holding com panies ................................................ 3 5 24 81 Percentage of state deposits held by one-bank holding companies ......................................................... t t 62 13 N um ber of bank mergers§ ........................................ - 239 130 46 N um ber of new banks§ .............................................. — 11 27 26 N ote: All data are for the year-end, except 1950 and 1960 deposit data which are for June 30. * N et figure reflecting de novo branches, branch closings, and other changes in bank office status. Excludes foreign branches and m ilitary facilities. t Includes only holding com panies with bank subsidiaries operating in New York State. %Less than 1 percent. § Refers to num ber consum m ated during periods 1951-60, 1961-70, and 1971-75. Sources: Federal bank-regulatory agencies and P o lk’s Bankers Encyclopedia (Septem ber 1950 and 1960). The bank holding company movement in New York State dates back to 1929, when Marine Midland Banks, Inc. began operating as a multibank holding company. Three large New York City organizations (Charter New York Corporation, The Bank of New York Company, Inc., and Bankers Trust New York Corporation) commenced operations as multibank holding companies in the middle or late 1960’s as did two smaller upstate organizations (Lincoln First Banks Inc. and Security New York State Corporation). Most of the large organizations in the state, however, did not form holding companies until the late 1960’s, and then chose to operate as one-bank holding companies. This enabled them to engage in nonbank ac tivities without being subject to regulation under the Bank Holding Company Act of 1956, which applied only to multibank organizations. At the end of 1970, eighteen of the twenty-six holding companies operating banks in New York State were one-bank companies. Passage of the 1970 amendments to the Bank Holding Company Act brought one-bank and multibank holding companies under the same Federal regulation, thereby eliminating the advantages of the one-bank company. It FEDERAL RESERVE BANK OF NEW YORK 109 Table II TWENTY LARGEST BANKING ORGANIZATIONS IN NEW YORK STATE Consolidated total deposits of organization* Share of New York State deposits held at domestic offices M illions of dollars Percent Banking organization Number of domestic bank affiliates Citicorp, New Y ork City ...................................................................................... 45,163 15.4 7t The Chase M an h attan C orporation, New Y ork City ................................... 33,948 15.2 9 M anufacturers H anover C orporation, New Y ork City .............................. 23,428 12.3 6 C hem ical New Y ork C orporation, New Y ork City .................................... 19,516 10.1 7 B ankers T rust New Y ork C orporation, New Y ork City ........................ 16,956 8.2 9 J. P. M organ & Co., Inc., New Y ork City ....................................................... 19,954 7.5 1 M arine M idland Banks, Inc., Buffalo ............................................................. 9,658 5.5 10t C harter New Y ork C orporation, New Y ork City .......................................... 9,856 5.5 15 The Bank of New Y ork Com pany, Inc., New Y ork City ........................... 3,710 2.4 8t C .I.T. Financial C orporation, New Y ork City ............................................. 2,462 1.7 1 Lincoln F irst Banks Inc., R ochester ................................................................ 2,147 1.7 5 E uropean-A m erican B ank & T rust Company, New Y ork City ............... 2,144 1.4 1 F irst C om m ercial Banks Inc., A lbany .............................................................. 1,376 1.1 5 U nited B ank C orporation of New Y ork, A lbany ........................................ 1,305 1.0 3 The B ank of Tokyo, Tokyo, Jap a n J .................................................................... 1,286 1.0 1 F irst Em pire State C orporation, Buffalo ........................................................ 1,238 1.0 3t R epublic New Y ork C orporation, New Y ork City ................................... 1,215 0.8 1 Security New Y ork State C orporation, R ochester .................................... 793 0.6 9 LITC O C orporation of New York, G arden City ......................................... 504 0.4 1 U nited States T rust Company, New Y ork City ........................................... 468 0.4 1 N ote: All data are for D ecem ber 31, 1975. * Figures include deposits held at both domestic and foreign offices. t B ank affiliates of these holding com panies were m erged into one or two subsidiaries in January 1976. t Includes only deposits of B ank of Tokyo T ru st Com pany, New Y ork City. is not surprising, therefore, that soon afterward the state’s four largest banking organizations, which had been one-bank holding companies, sought to expand by acquiring bank subsidiaries across the state. As indicated in Table II, thirteen of the twenty largest banking organi zations in the state had established statewide banking oper ations through holding company affiliates as of the end of 1975. By that time, the number of holding companies operating in New York State had increased to thirty-two, and fifteen of them were multibank organizations. (Two of these holding companies merged their respective bank subsidiaries into one bank in January 1976.) The share of state deposits held by all bank holding companies rose to about 94 percent from 86 percent over the five-year period. CHANGES IN THE NUMBER AND AFFILIATION OF BANKS IN t h e s t a t e . The slowing of bank merger activity in New York State between 1970 and 1975 reflected a diminish ing number of potential proposals that could satisfy regu latory standards. As a result, the total number of com mercial banks in the state declined only slightly to 276 between 1970 and 1975. At the same time, the stimulus to multibank organizations by the Bank Holding Company Act Amendments of 1970 resulted in a jump in the num ber of banks affiliated with bank holding companies in the state. The number of such affiliates increased from 66 in 1970 to 119 in 1975. INCREASED COMPETITION While bank mergers and acquisitions by bank holding companies contributed to a reduction in the number of 110 MONTHLY REVIEW, APRIL 1976 nonaffiliated banking institutions serving the state as a whole, the move to statewide banking furthered the entry of new competitors into attractive local and regional mar kets. The large New York City-based organizations, having very substantial resources at their command, were, of course, in a position to respond to the pull of opportunities in upstate banking markets. As a result, the number of banking institutions operating in many of the state’s bank ing markets increased. Many communities that previously were served only by locally oriented institutions now have access to the services of some of the state’s largest and most diversified banking organizations.2 In 1970, as noted above, only Charter New York Corporation, The Bank of New York Company, Inc., and Bankers Trust New York Corporation had upstate affili ates. By 1975, virtually all the major New York City bank holding companies had gained representation in the major upstate markets of Albany, Buffalo, Rochester and Syra cuse.3 Yet, the deposits accounted for by the large New York City organizations in upstate banking markets are quite modest. For example, as of December 31, 1975, the seven large New York City holding companies with state wide operations accounted for about 22 percent of the deposits held by New York State banks in offices outside New York City. The four largest New York City holding companies alone accounted for only 4 percent of such deposits, holding as little as 1.4 percent of deposits in the Buffalo market and at most 5.5 percent of deposits in the Albany market.4 The deposits of the upstate affiliates of New York City holding companies acquired since 1971 amount, on average, to about $29 million. It is indeed no accident that the penetration of upstate banking markets by the large New York City bank holding companies has not gone very far. A significant restraining 2 Seven New York City organizations are now represented in upstate markets: Citicorp, The Chase Manhattan Corporation, Manufacturers Hanover Corporation, Chemical New York Cor poration, Bankers Trust New York Corporation, Charter New York Corporation, and The Bank of New York Company, Inc. 3 A few of the seven large New York City organizations op erating in major upstate markets do not have affiliates in every one of these markets. Charter New York Corporation is not represented in the Buffalo market; The Bank of New York Com pany, Inc. has no affiliate in the Rochester market; and Manu facturers Hanover Corporation and Bankers Trust New York Corporation are not represented in the Syracuse market. 4 These four organizations are Citicorp, The Chase Manhattan Corporation, Manufacturers Hanover Corporation, and Chemical New York Corporation. Market deposit shares of these organiza tions in the Buffalo and Albany markets are as of June 30, 1974. influence has been Federal and state regulatory policy, which forecloses any acquisition that would pose a threat to the competitive health of the market involved. More over, following the relaxation of the state branching law through the 1971 amendments, the New York State Bank ing Department established regulatory guidelines to pro vide for an orderly transition of new entry by the New York City holding companies into upstate markets. The Banking Department’s policy centered on two criteria for the upstate acquisitions of New York City holding com panies. First, these organizations would be permitted to acquire only de novo banks or small footholds. Second, the number of branches established annually by foothold acquisitions would be subject to branch limits similar to those applying to newly chartered banks. Besides these regulatory limits on the establishment of foothold positions in new markets, the natural obstacles to the penetration of new markets, such as the difficulty of changing established banking relationships and overcoming customer inertia, have served to limit the possibilities for these organizations to exert much market leverage. Table III MEASURES OF CONCENTRATION IN SELECTED METROPOLITAN BANKING MARKETS IN NEW YORK STATE Number of banks Three-bank concentration ra tio * Relevant area Concentration Indexf Percent 1970 1974 1970 1974 1970 1974 A lbany m arket^ .... 15 18 56.0 50.0 .140 .129 Buffalo m arket ..... 10 15 94.3 92.2 .372 .349 R ochester m arket .... 17 15 82.0 77.8 .258 .245 Syracuse m arket 10 14 74.5 71.1 .227 .210 1972 1974 1972 1974 1972 1974 M etropolitan New Y ork m arket§.. 113 117 45.1 47.5 .098 .100 New Y ork State ... 287 280 40.0 43.4 II II N ote: D a ta are for June 30 and reflect deposits held in dom estic offices. * Sum of the m arket shares held by the three largest banks in the m arket, f H erfindahl Index. Equals the sum of the squared m arket shares held by all banks in the m arket. V alue of 1 im plies perfect monopoly. $ D eposit shares of the A lbany banks do not include their holdings of state governm ent deposits. § E arlier years not readily available. II N ot readily available. Source: F ederal D eposit Insurance C orporation. FEDERAL RESERVE BANK OF NEW YORK It should be noted that the possibilities for freer compe tition in New York State have inspired some new incur sions by upstate organizations into the downstate markets. For example, First Commercial Banks Inc., Albany, United Bank Corporation of New York, Albany, and First Empire State Corporation, Buffalo, have acquired bank subsidiaries in the metropolitan New York area and other downstate markets. While such new entry could not be expected to have much immediate effect in the large New York market, it does serve to illustrate that competitive influences seldom operate only in one direction. The entry into local banking markets by banking in stitutions not previously represented has tended to re duce the concentration of banking resources in a num ber of the state’s largest banking markets. Both the three-bank concentration ratio and a frequently used in dex of concentration that is sensitive to changes in the market shares of all market participants (the Herfindahl Index) indicate that there has been a slight reduction in concentration in each of the four upstate metropolitan markets where most new entry has occurred (see Table III). At the same time, concentration has risen slightly over the past few years in the metropolitan New York market. However, with over 100 banking organizations, ranging from very small local institutions to some of the largest banks in the country, competition for retail and wholesale banking business remains quite keen in that market. PER F O R M A N C E OF NEW U P ST A T E E N T R A N T S Analysis of income and expenses of New York City organizations that have entered upstate markets since 1971 provides significant insight into the nature of the impact that their entry has had to date, the problems that they face in penetrating markets outside New York City, and the efforts they are exerting to enlarge this part of their business. Table IV shows for the years 1974 and 1975 the average operating ratios of eleven member bank affiliates of the major New York City holding companies that entered upstate markets after 1971.5 The sample covers affiliates operating in the four major upstate 111 banking markets— Albany, Buffalo, Rochester and Syra cuse. To determine whether the operating experience of the new entrants differed markedly from banks already established in the relevant markets as well as throughout the state, the average operating ratios of these affiliates were compared with those of twenty-five other member banks headquartered in the same four upstate markets and not affiliated with New York City holding companies, and with the average ratios of all member banks in the Second Federal Reserve District having deposits of $10 million$50 million. The latter range included the average size of the New York City affiliates under study. The broad sample of Second District banks included about 130 banks. One of the striking features of these comparisons is that virtually all of the eleven upstate affiliates of the large New York City organizations under study have not achieved profitable operations since their affiliation.0 The losses incurred, on average, by the eleven member bank affiliates in 1974 and 1975 reflect several factors on the expense side of their income statements. Both salary and wage expenses as well as net occupancy expenses of the New York City affiliates were significantly larger, measured as a percentage of total operating income, than those of other banks in the markets in which they operate. These expenses also were significantly larger than those of other banks of comparable size in the Second Federal Reserve District. Net charge-offs on loans also were relatively high. The in crease in provisions for loan losses from 1974 to 1975 contributed heavily to a deterioration of the New York City affiliates’ ratios of net income to total assets, though this was only one factor in the overall unprofitability of the banks. The New York City affiliates also showed signif icantly higher interest expenses on time and savings de posits. The relatively high operating expenses appear to be at the root of the New York City affiliates’ unprofit ability, since their return on loans either exceeded or approximated those of the banks headquartered upstate and the Second District member bank group. It should be recognized that the operating experience of the New York City affiliates is generally typical of de novo banks attempting to penetrate markets of estab lished competitors. Such penetration is not easily achieved. The relatively high occupancy and salary expense probably indicates the opening of many new offices that have not yet produced sufficient business to become profitable as well 5 The operating ratios, which are expressed in percentages, are derived from Reports of Income and Reports of Condition filed regularly by banks with the Federal bank-regulatory agencies. Be cause of data limitations, the sample excludes a few bank holding 6 Only one of the eleven affiliates achieved profitable operations company affiliates that are not members of the Federal Reserve in 1974, and none were profitable in 1975. System. MONTHLY REVIEW, APRIL 1976 112 as the expense of attracting experienced personnel. The high interest paid on time deposits suggests not only higher rates offered on such deposits, but also greater reliance on high-cost deposit sources of funds, in part necessitated by the difficulty of penetrating established deposit markets. Since the growth of the New York City affiliates took place after 1971, most of their time deposits have been acquired during a period of relatively high interest rates. The New York City affiliates also show significant differences in the composition of their loan portfolios in comparison with the upstate-headquartered organizations. Roughly 40 percent of the New York affiliates’ gross loans Table IV A N A LY SIS O F SE LE C T ED O PE R A T IN G D A T A O F F E D E R A L R E SE R V E M E M B E R BA N K S L O C A T E D IN T H E A LB A N Y , B U F F A L O , R O C H E ST E R , A N D SY R A C U SE B A N K IN G M A R K ET S 11 upstate affiliates of 4 largest New York City holding companies* Selected averages 1974 25 banks headquartered upstatef 1975 1974 Second Federal Reserve D istrict member banks w ith deposits of $10 m illio n-$ 50 m illion 1974 (130 banks) 1975 (126 banks) 3 2 2 .lt 25.0$ 24.9 1975 M illions of dollars Total deposits per bank ............................................................................. 25.2 18.8 330.0$ Percent Time and savings deposits to total deposits ..................................... | 55.3 52.4 Total capital accounts and reserves to total assets .............................. 15.4 10.8 63 .8§ 63.9$ 63.6§ 8.8$ 8.9 9.0§ 9.0$ 62.5 Income ratios: N et income to equity capital including all reserves ............................... -1 0 .5 - 1 9 .3 6.2§ 7.9§ 6.0§ 2.4§ N et income to total assets .............................................................................. — 1.6 — 1.7 0.6§ 0.7§ 0.6§ 0.3§ Service charges on deposit accounts to total operating income .......... 1.5 1.9 2.9§ 3.1§ 3.0§ 3.2$ Return on loans (interest and fees to gross loans) ................................. 11.2 10.2 9.5§ 8 .9 | 9.8§ N et losses (—) or recoveries (+ ) on loans to gross loans .................... - 0.8 - 1.8 — 0.8 — 0.4§ — 0.5 9.1 — 0.7 Expense ratios: Salaries and wages to to tal operating income ............................................ 35.8 41.8 17.7§ 18.6§ 19.0§ 21.2§ N et occupancy expense to to tal operating income ................................... 12.7 15.8 4.4§ 5.0§ 4.2§ 5.2§ In terest on time and savings deposits to total time deposits ................ 7.6 6.1 6.0§ 5.4§ 5.9§ 5.3§ T o tal operating expenses to total assets ......................................................... 11.9 11.5 6.7§ 6.4§ 6.8§ 6.8§ Total operating expenses to to tal operating income ............................... 147.0 157.4 90.4§ 87.6§ 91.6§ 9 7 .1§ 59.4 58.9$ 57.7$ 36.9§ 37.2§ 36.8§ Loan ratios: G ross loans to total assets ................................................................................ 65.6 64.9 60.1 R eal estate loans to gross loans ...................................................................... 21.4 22.3 36.2§ Loans to farm ers to gross loans ..................................................................... 0.7 0.6 1.4 1.6 2.4 2.5 C om m ercial and industrial loans to gross loans ..................................... 38.7 43.7 21.4§ 21.4§ 20.8§ 20.4§ C onsum er loans to individuals to gross loans ............................................ 17.2 20.4 31.2§ 31.9§ 27.0§ 27.4 N ote: Significance of the observed differences betw een banks is m easured here by a statistic reflecting the difference in m eans fo r the two groups divided by a m easure of the variability w ithin the groups. * Affiliates of C iticorp, The Chase M an h attan C orporation, C hem ical New Y ork C orporation, and M anufacturers H anover C orporation. t Includes independent banks and affiliates of holding com panies headquartered upstate; excludes banks in first group as well as affiliates of The B ank of New Y ork Com pany, Inc., B ankers T rust N ew Y ork C orporation, and C harter New Y ork C orporation. D ifference from 11 affiliates significant at 95 percent level. § Difference from 11 affiliates significant at 99 percent level. t FEDERAL RESERVE BANK OF NEW YORK were commercial and industrial loans, compared with about 20 percent for the upstate-headquartered banks. In contrast, the percentage of the affiliates’ loan port folios in real estate loans and consumer loans was signif icantly lower than for the upstate banks. The relatively heavier concentration of the New York affiliates in com mercial as opposed to retail lending in part reflects the relatively greater expertise of the New York banking organizations in commercial lending, but probably also reflects the difficulty of new banks in penetrating retail banking markets already served by substantial local bank ing organizations. Comparison of the New York affiliates with the broader sample of member banks shows very similar results. Thus far, the operating experience of the affiliates of New York City organizations entering upstate markets after 1971 shows that their entry has been limited in scope and achieved at considerable expense. Although additional expansion can be expected in response to opportunities for growth in New York State, there clearly is a need for these banks to strengthen their existing financial positions at these relatively new points of entry. Several organizations have in fact announced plans to close branches that have not proved profitable. STATEW IDE BANKING— VIA A FFIL IA T E S OR B R A N C H E S ? The recent liberalization of New York’s branching law is not expected to lead to a surge in branch activity or many additional statewide banks, since most organizations that seek statewide representation probably have already done so through a holding company system. The ability of banks to branch without geographical restrictions does, however, have a number of implications for New York’s banking structure. Independent banks operating on the fringes of the previous banking district boundaries may serve their customers throughout economically integrated areas through branching. Further, bank holding compa nies now operating statewide through subsidiaries can evaluate the advantages of consolidating their operations into a single banking institution. One consideration influencing a holding company to continue operating a number of separate banking affiliates centers on the belief that bank customers prefer to patron ize an institution with a local identity, which is manifested in part through a local board of directors. Further, in creased reserve requirements that usually result from the merging of several affiliates places a cost on consolidation. On the other hand, consolidation could enable an organi zation to implement more uniform policies throughout 113 all of its offices. Significant economies could be achieved by some organizations in such areas as portfolio and li quidity management, compliance with reporting require ments, data services, and check clearing. Also, a smoother and more efficient movement of funds by a holding com pany system could be facilitated by merging its affiliates. Such movements of funds can be impeded by the limits imposed by Section 23A of the Federal Reserve Act. This section restricts the movement of funds (interestbearing deposits, loans, and Federal funds) from one member bank or insured affiliate to another affiliate to 10 percent of the former’s capital (including reserves), and to all affiliates to a total of 20 percent of that bank’s capital. Moreover, such loans must be secured by acceptable col lateral, which ranges from 100 percent to 120 percent of the value of the loan depending on the nature of the col lateral. While these constraints were designed to protect banks from undue extensions of credit to ailing affiliates, they can under some circumstances impede intra-holding company flows of funds that serve legitimate economic needs, such as those involved in large seasonal shifts in loan demand within a holding company system. Bank holding companies that are constrained by these or other factors may decide to avail themselves of the advantages of a consolidated statewide branch system. Marine Midland Banks, Inc. and The Bank of New York Company, Inc. merged all of their respective affiliates in January 1976, and The Chase Manhattan Corporation has initiated a program to consolidate all of its affiliates into a single bank through a series of mergers. First Empire State Corporation also has announced plans to merge its two bank affiliates into one bank. Citicorp, on the other hand, has restructured its operations by forming an upstate and a downstate affiliate. Additional consolida tions are to be expected, but the course chosen by the state’s holding companies undoubtedly will vary, depend ing on the perception by management of their best op portunities for achieving efficient operations. C O M P E T I T I O N IN B A N K - R E L A T E D A C T I V I T I E S The growth of the bank holding company movement in New York State has added a new dimension to the provision of financial services in the state and in the na tion. The state’s large bank holding companies all have subsidiaries that engage in a range of permissible bankrelated activities, such as mortgage banking, consumer finance, personal and real property leasing, factoring, and commercial financing to name a few of the more impor tant nonbank activities engaged in by bank holding com panies. Entry into these activities has been permitted in MONTHLY REVIEW, APRIL 1976 114 B A N K -R E L A T E D A C T IV IT IE S P E R F O R M E D IN N E W Y O R K STATE B Y O U T S ID E B A N K H O L D IN G C O M P A N IE S financial needs of individuals and businesses. Map I pro vides an indication of outside bank holding company rep resentation in the state. The diversity and far-flung scope of bank holding company activities in permissible nonbank fields make it difficult to appraise their overall impact on competition. Nonetheless, there are grounds for believing that bank holding company expansion in New York State as well as in the nation has added to the quality and quantity of fi nancial services available to the public and, in some in stances, may have contributed to the reduced cost of these services. Most of the out-of-state acquisitions by New York bank holding companies have been in areas where they were not previously represented. As shown in Map II, New York State bank holding companies have entered markets in about forty states in the nation, including New York. Moreover, the size of the subsidiaries in terms of assets seems well below levels that might raise concern over undue concentrations of economic power. Note: State of origin and number of bank holding companies involved ir shown alongside symbols. Placement of symbols on map do not indicc CONCLUDING R E M A R K S Banking structure in New York State has adjusted substantially, but smoothly, in response to major changes enacted in Federal and New York State banking laws. These changes have ushered in statewide banking and accordance with the provisions of the Bank Holding have given an important forward thrust to the bank Company Act of 1956, as amended, which requires that holding company movement. As a result, banks have the performance of the activity be in the public interest.7 been encouraged to compete more widely and to im Although most of the New York organizations have prove the efficiency of their operations. Such competi substantial operations in New York State, they are not tion, however, seems not to have affected adversely the limited by state boundaries, since the Bank Holding Com state’s well-managed independent banks. The experience pany Act places no geographic restrictions on the per of the New York City affiliates in upstate markets indi formance of approved nonbank activities. Many upstate cates that local banks have remained profitable in the face holding companies also have acquired or formed nonbank of entry of the state’s largest institutions and should con subsidiaries that operate in financial markets both in and tinue serving their local communities on a profitable basis. outside New York State. Moreover, thirty-two out-of-state Banking organizations in New York can expect several bank holding companies, representing thirteen states in the additional challenges in the years ahead. Increased com nation, own some twenty nonbank subsidiaries and petition could come from thrift institutions and from twenty-two Edge Act corporations in New York. Entry the possible expansion by banks across state lines. More into New York State’s financial markets by these or over, wider use of electronic funds transfer facilities could ganizations has added to the flexibility of the state’s bring further changes in banking practices. Thrift institutions in New York State have actively financial structure and has enhanced its ability to meet the sought expanded powers, most notably the authority to offer checking accounts, and legislation to permit this activity has been introduced in the state legislature. While the entry of thrift institutions into the area of payments services in principle could be expected to result in im 7 For an analysis of the public interest aspects o f bank holding proved services to the public, the granting of such powers company acquisitions under Section 4 ( c ) ( 8 ) . see Michael A. lessee and Steven A. Seelig, “An Analysis o f the Public Benefits without ensuring competitive equality in other areas of Test of the Bank Holding Company Act”, Monthly Review (Fed banking regulation, such as deposit rate ceilings and eral Reserve Bank of New York, June 1974), pages 151-62. 115 FEDERAL RESERVE BANK OF NEW YORK reserve requirements, could create an undesirable im balance in the competitive position of institutions doing essentially the same type of business. Over the long run, such imbalances contribute to inefficiencies by causing an allocation of financial resources for regulatory rather than economic reasons. Competitive opportunities also could be enhanced if banks were allowed to enter large out-of-state metro politan banking markets. A proposal along these lines was announced last month by New York State Superintendent of Banks Heimann, who suggested that banks from other states be allowed, on a reciprocal basis, to make bank acquisitions in New York metropolitan areas having a population of 1.5 million or more. Enactment of Super intendent Heimann’s proposal would represent a signifi cant step toward interstate competition in banking via branches or affiliates located across state lines. The wider introduction of electronic payments systems by the banking industry in transactions with the public promises new flexibility for both small and large banks in meeting the needs of their customers. The investment out lays needed for such facilities are modest, compared with the expense of opening full-service branches, and there may in time be opportunities for banks of all sizes to participate in electronic facilities through pooling arrange ments. Such technological improvements could be expected to contribute to greater efficiency in banking and, there fore, to reduced costs of financial services to the public. M ap II OUT-OF-STATE EXPAN SION IN BANK-RELATED ACTIVITIES BY SELECTED NEW YO RK BANK H O LDIN G COM PANIES ■w 'i t KEY: J Consumer finance C D Data processing ^ Edge Act Corporation Factoring and commercial finance 4^ \ — !/ I m IO . /£ *■ ■ - • ' - ‘ I \ ">li> Insurance underwriting [3 Investment and economic advising A The Chase Manhattan Corporation V C-ticorp. f~l Manfacturers Hanover Corporation ^ Chemical New York Corporation ^ Marine Midland Banks, Inc # A Charter New York Corporation JPMorgan & Co., Inc. O Bankers Trust New York Corporation
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