View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

FEDERAL RESERVE BANK OF RICH M O N D

MONTHLY
REVIEW
Bank Investment in Municipals
Fifth D istrict Skiing
Equipm ent Leasing
The Fifth D istrict




Municipal Bond Portfolios
of Commercial Banks
Since the “ credit crunch” of 1966 the financial
press has followed very closely the volume of new
debt flotations as one indicator of tightness in fi­
nancial markets. The tremendous volume of such
securities in the last year and a half has been un­
precedented, contributing in large part to recent
record-high interest rates. The volume of new
issues of municipals has been especially heavy during
this period, although a pattern of steadily rising state
and local government financing has existed for a
number of years. Since W orld W ar II, new issues
of long-term municipals have increased nearly ten­
fold, from $1.2 billion in 1946 to $11.1 billion in
1966. Between 1956 and 1966 total state and local
government securities outstanding rose from $47.4
billion to $104.8 billion.
Role of Commercial Banks C om m ercial banks
have been the principal investors in this rapidly ex­
panded volume of municipals. From 1946 through
1966 holdings of municipals by all banks rose from
$4.3 billion to $41.4 billion. The most rapid ex­
pansion has occurred in the past decade. Begin­
ning in 1962, banks began to aggressively seek
time and savings deposits through the issuance of
certificates of deposit, and they were aided in their
efforts by several upward revisions of the Federal
Reserve’s Regulation Q, which sets interest rates
on time and savings deposits. They were highly
successful. Over $20 billion of C D ’s are now out­
standing, and the increased level of deposits has
led to heavy investment in municipals. During the
past ten years, the increase in the dollar value of
all-bank holdings of municipal issues has accounted
for close to 90% of the increase in total bank se­
curity holdings. As a result, the ratio of municipals
to total securities in bank portfolios rose from 16.1%
in 1956 to 35.3% in 1966. In the latter year, com ­
mercial banks absorbed over 65% of the $5.6 billion
net increase in municipal bonds outstanding (new
issues minus retirements).
The growing size of municipal bond portfolios has
not been the only change in commercial banks’
role in the municipals market. In the past ten years
2



the maturity structure of these municipal portfolios
also has undergone a metamorphosis. Moreover,
enlarged dealership and underwriting activities have
marked the ascension of commercial banks to their
pre-eminent position in the municipals market.
Postwar Decade [T h is section draws on Roland
I. Robinson’s Postwar Market for State and Local
Government Securities.] The municipal segment of
member bank portfolios grew markedly in the post­
war decade. During this period the gross volume of
new municipal issues accounted for about one-seventh
to one-ninth of all long-term funds raised in the
capital markets. From 1946 through 1956 member
bank holdings of municipal obligations rose from
$3.3 billion to $10.5 billion, an annual rate of in­
crease of 11.1%.
At the end of W orld W ar II commercial bank
portfolios were heavily loaded with United States
Government obligations. Following the war these
security holdings declined and the volume of loans
outstanding increased. From 1946 through 1956
member bank holdings of Government securities fell
from about $72 billion to $48 billion. A t the same
time total loans rose from about $23 billion to $78
billion. In an absolute sense the growth in loans
far exceeded the $7.2 billion increase in municipal
bond holdings of member banks, but the 11.7% an­
nual rate of growth in loans only slightly exceeded
the 11.1% annual growth in municipal holdings
for the period.
The expansion of bank holdings of municipals is
attributable largely to two factors. First, the supply
of new issues grew rapidly as state and local gov­
ernments increasingly entered the market in order
to finance growing programs and facilities. Adding
to the immediate postwar needs of local governments
were many public construction projects which had
been deferred during the war. Second, high incometax rates and the exemption of interest income on
municipal bonds from Federal income taxes com ­
bined to enhance the attractiveness of municipal
issues.
Tax advantages accruing to commercial banks

from holding municipal bonds are based upon
several characteristics of tax law. Some institu­
tions and funds are fully or partially tax exempt
per se. This advantage reduces their attraction to
the relatively low yields of tax-exempt municipal
securities. Commercial banks, however, are subject
to the full corporate tax rate on income, in part
accounting for their large holdings of municipals.
Furthermore, the tax exemption feature is available
only on municipal securities. In 1941 the Federal
Government withdrew the privilege of tax exemption
existing for certain of its debt issues, and between
1941 and 1945 the volume of these tax-exempt se­
curities outstanding fell from about $5 billion to
$196 million, giving municipal issues a virtual
monopoly on the privilege. Since 1960 municipal
bonds have been the only tax-exempt security
available in the capital markets. Finally, the de­
velopment of the system of “ tax swaps” in 1953
enhanced commercial banks’ participation in the
municipals market. For purposes of computing net
taxable income, tax laws permitted banks to charge
any net of capital losses over capital gains on sales
of securities against current income. Since the long­
term capital gains tax is 25% , banks in high incometax brackets have been encouraged to make large
sales of securities in years of declining prices in
order to charge the losses against their income. The
proceeds for the sales are almost immediately em­
ployed to purchase other securities, thus the name,
“ swaps.” W hile certain other groups can arrange
swaps for tax advantages, banks have been the
largest users of the technique, and although municipal
securities are not considered the best tax-swap in­
strument, the volume of secondary market transac­
tions in municipals probably has been increased by
bank swapping.
The maturity structure of banks’ municipal port­
folios shortened slightly during the postwar decade.
Intermediate-term obligations were increasingly fea­
tured, predominantly at the expense of issues due
beyond ten years. Between 1947 and 1956 the per­
centage of municipal holdings in one-to-five year
maturities grew from 29.8% to 34.5% and the
portion in five-to-ten year issues rose from 25.8%
to 29.9% . Meanwhile, long-term issues were de­
clining from 26.2% of the total to 20.1% .
Although the pattern currently seems to be chang­
ing, banks in the past have usually held municipal
securities until maturity, not choosing to meet im­
mediate cash needs by liquidation prior to maturity.
Indeed, in the early years after the war the market
for municipals was not large enough or developed
enough to permit rapid liquidation in all cases. This



philosophy of portfolio management at least in part
explains the decline of long-term holdings relative to
shorter-term issues. W ith the tremendous increase
in high-yielding loans in the late 1940’s and early
1950’s, commercial banks did not want to be tied
in to these securities for long periods if more at­
tractive investments were available. Thus, given
their approach to liquidation, banks chose to invest
in intermediate-term maturities.
Period 1956 to Present M unicipal financing in
the past ten years has undergone considerable growth
and sophistication. Volume has continued to rise;
yields, as measured by the Bond B uyer’s 20-Bond
Index, have ranged from just below 2.50% early in
1956 to as high as 4.33% in October of this year;
and various marketing techniques now abound, as
witnessed in large numbers of revenue and industrial
revenue issues, and various term and serial forms
of the bonds. A s seen in the first chart, the growth
of municipal bonds outstanding from 1956 to 1966
was accompanied by a sharp redistribution of owner­
ship to commercial banks. There has, however, been
little change in the division of the total between local
government offerings and state government offer­
ings. The former account for about three-fourths
of all municipal bonds.

O W N ER SH IP OF M U N IC IP A L SECURITIES
$ B illio n
45
I n d iv id u a ls
C o m m e r c ia l B a n k s
40

In s u ra n c e C o m p a n ie s
S ta te & L o c a l F u n d s
C o r p o r a tio n s

35

O th e rs

30

25

20

15

10

5

0
1956
S o u rc e :

196 6

T h e B o n d B u y e r.

3

M A T U R IT Y STRUCTURE OF M U N IC IP A L B O N D PORTFOLIOS
M EM B E R B A N K S
$ B illio n

1956
1967
A ll M e m b e r

1956 1967
R eserve C ity

Banks

1956
1967
C o u n tr y

B a nks
9

W it h in

1967

1956 1967
C h ic a g o

1956
19 6 7
F ift h D is tr ic t

g f 1-5 Y e a rs

□

5 - 1 0 Y e a rs

Q O ver

10 Y e a rs

B o a rd o f G o v e r n o r s o f th e F e d e ra l R e serve S y s te m .

A s the municipals market has grown, the market­
ability of municipal issues has naturally increased.
Both a cause and effect of this greater marketability
has been a change in commercial banks’ investment
practices in handling their municipal bond portfolios.
When conditions in the markets warrant, banks now
liquidate municipals before maturity in favor of
other investments or for cash needs. The mutation
is manifest in the pronounced change over the past ten
years in the maturity structure of municipal portfolios
of all classes and groups of member banks.
Maturity Patterns
T h e average m aturity of
municipal bond holdings of all member banks has
lengthened rather markedly in the past decade, as
seen in the second chart. Member bank ownership
of long-term municipal securities, those due in over
ten years, has grown from 20.1% of total municipal
holdings in 1956 to almost one-third of the total in
1967. In absolute terms, the increase has been from
just over $2 billion in 1956 to nearly $12 billion in
Emphasizing the lengthening of the average

maturity is the volume of issues due beyond 20 years.
These currently comprise more than one-fourth of
member banks’ holdings of long-term municipals.
The relative growth of long-term holdings has
4



1956 1967
N e w Y o rk

B anks
1 Year
S o u rc e :

1967.

1956 A N D

$ B illio n

occurred at the expense of the intermediate-term, oneto-five and five-to-ten year bonds, especially the
former. These two maturity classifications accounted
for 34.5% and 29.9% , respectively, of member bank
municipal portfolios in 1956, but by 1967 the re­
spective proportions had declined to 25.1% and
24.4% . Remaining virtually unchanged during this
transformation have been short-term holdings, in­
cluding warrants, short-term notes, bills, and other
maturities due within one year. A s a group, these
securities have increased merely from 15.5% to
18.2% of total municipal portfolios.
W ith certain variations, municipal maturity struc­
tures of various classes and groups of banks have
evidenced changes similar to those of member banks
taken as a whole. Reserve city banks have had a
rather more pronounced redistribution from inter­
mediate- to long-term issues.
Long-term bonds
grew from 23.0% of the total portfolio in 1956 to
38.2% in 1967, while over the same period one-tofive year maturities fell from 32.6% to 20.8% of the
reserve city group’s municipal investments.
Country banks also lengthened their average mu­
nicipal maturity but not as noticeably as reserve city
banks, nor even as much as member banks as a
whole. In fact, country banks still have larger per­

centages in the intermediate maturities than in long­
term bonds. In general, country banks are not as
large as reserve city banks and many of them do
not have the market facilities which larger banks
enjoy. In partial consequence of this, they are less
willing to tie up large amounts of funds in long-term
investments. From 1956 to 1967 long-term mu­
nicipal holdings rose from only 16.6% of their
municipal portfolios to a still low 23.6% of the total.
Both of these figures are less than the corresponding
percentages for all member banks and reserve city
banks. The decline in the proportionate holdings of
intermediate issues was similarly less pronounced.
As with the other two classes, the relative decline of
one-to-five year maturities was larger than the drop
in the five-to-ten year issues. This, in part, is evi­
dence of the lengthening maturity structure of mu­
nicipal portfolios. The purchase of long-term issues
results in a large part of the purchases still being
classified as long-term or five-to-ten year investments
at the end of the ten-year period.
The proportion of municipal portfolios classified
as short-term has not differed significantly between
classes of banks. Compared to the changes in inter­
mediate and long-term holdings, the growth in the
percentage of issues held which mature within one
year has been marginal. Over the past ten years
reserve city banks have held larger amounts of tax
warrants, short-term notes, and bills than country
banks, reflecting in part a dependence of municipal
governments on large banks for short-term funds.
Over the past decade country banks have had a
larger part of short-term holdings in regular issues
due within one year than in securities with original
maturities of less than one year. The proportion
represented by the latter, however, has been in­
creasing.
Am ong classes of member banks, New York City
banks have the longest maturity structure. Over
one-half of their municipal investments are due in
more than ten years. In 1956, 29.5% of their mu­
nicipal holdings were due beyond ten years. Their
investments in one-to-five and five-to-ten year ma­
turities have fallen from about 30% in each in 1956
to roughly 13% in each in 1967. The increase of
short-term holdings from 12.2% to 21.1% of the
portfolios of New York banks is largely explained
by the increase in securities with original maturities
of one year or less.
The predominant role of large banks in the mu­
nicipal market is obvious from the size of holdings
of New Y ork City banks and Chicago banks relative
to the municipal investments of all Fifth District
banks. Only in the past decade have Fifth District



banks come to hold a larger dollar value of municipals
than Chicago banks. The maturity structure of Fifth
District banks is very similar to that for all member
banks, but the lengthening of the distribution over
the past decade has been more pronounced than for
all banks. In the Fifth District, maturities due in
over ten years rose from 13.4% of total portfolios
in 1956 to 28.0% in 1967. A t the same time, oneto-five year maturities fell from 44.0% to 28.0% .
Dealer and Underwriter Positions Dealer and
underwriter positions are held in the main by a
relatively small number of large banks. O f over
6,100 member banks in the country, 130 hold posi­
tions as dealers or underwriters. One-half of that
group have deposits over $500 million, and account
for 87.6% of the dollar value of total member bank
positions. Although seemingly small, the number
of banks engaged in dealer and underwriter opera­
tions has been growing with the market in recent
years. In October 1955, only 57 commercial banks
were listed in the Blue List directory of advertisers,
and of those only about 20 seemed to operate con­
tinuously in the national market.
The location of dealer-underwriter banks is fairly
concentrated into certain areas. O f the 130 banks
with dealer-underwriter operations, 95 are reserve
city banks. This group holds over 92% of the $1.4
billion of total dealer and underwriter portfolios.
Fifty-three of the 130 banks are evenly spread
between the New York, Chicago, and San Francisco
districts. These three districts alone account for
63% of total member bank dealer positions. In the
Fifth District, eight banks act as dealers and under­
writers of municipal bonds. In June 1967 they held
about $33 million of bonds in that capacity. These
holdings, 2.3% of all such positions, were equal to
or greater than those of only three other Federal
Reserve Districts.
Year 1967 In the past year com m ercial banks
have continued to be large purchasers of municipal
bonds. For the first three quarters of 1967, the in­
crease in bank holdings of municipals has accounted
for about four-fifths of nearly $11 billion of new
capital raised by local governments. Over the year
banks have made relatively large purchases in the
short-term area. This probably has resulted more
from an effort to rebuild liquidity following the 1966
“ credit crunch” and from postponements by mu­
nicipal governments of long-term financing due to
high interest rates than from any basic change in
investment philosophy. In fact, long-term purchases
have been sizable also.
Joseph C. Ramage

5

A t B e ech M t. th e h ig !
e a s t is p r e p a r e d f o r t l

t lif t - e q u ip e d

s k i s lo p e

w in t e r .

in

'-'w .iTTuS

S e p p K o b e r, f o u n d e r o f th
N o r t h C a r o lin a 's o ld e s t ski a r e a a b o v e M a g g ie
fe a tu r e s u n lim it e d cro ss c o u n tr y s k iin g .

V a lle y

(U th e rn p ro fe s s ii
ig e n a t H o t S p ri

ski s c h o o l, d e m o n s tr a te s g e l
[OGtEBAY PARK

CHESTNU* RIDGE
HGHTS

SNA^TOY MOUNTAIN

^W>_NEE-

WEISS KNOB J
SPA HElVETIAjjC
5|CCOONSKIN PARK/

\

»KI BRYCE
jksKYLINtfy

iTHE HOMESTEAD
KNOB]

SEVEN DEVILS
BEECH MOUNT^IH^I ; 5|C HOUND EARS
^BLOWING ROCK

3^
*

jjCCATALOOCHEE

8s LH
WM F

S k ie rs m a rv e l a t th e b e a u t *
of a

H ound

T h is is B w y l jP v ir g i n ia , J

E a rs M t. t r a i l. •

not N ew

E n g la n d .
5^CS>!I RESORTS

S n o w g u n s a t B a sye e n h a n c e
■

th e w i n t e r w o n d e r la n d .

I

o n th e S o u th e ri
s k i sc e n e — S e p p K o b e r a n d
le a d , m e ta l s k i d« ■ elo p e r— m e e t a t H o t S p rin g s .

T h a t b liz z a r d

b lo w in g




at

B lo w in g

Rock

is

re a l.

W e s te rn




tre n d

fr o m

seem

to

g re e n

snow

b u s in e s s ."

to w h ite

in d ic a te

to

th a t th e re

g re e n , th is

is " n o

w o u ld

b u sin e ss

>|< P ra c tic a lly a ll o f th e

EQUIP

lik e

re s o rts

a re lo c a te d in th e re g io n d e s ig n a te d b y th e P re si­
d e n t as A p p a la c h ia , a n a re a w ith h ig h u n e m p lo y ­
m e n t a n d lo w in c o m e .

T he e x te n s iv e c o n s tru c tio n

n e ce ssa ry f o r b u ild in g th e slo pe s a n d th e p e rso n s
re q u ire d

to

m a in ta in

th e

re s o rts

m ake

s k iin g

D ix ie a b o o n to th e u n e m p lo y e d , a n d , w it h
m oney

c o m in g

econom y.

in to

th e

re a l

The

e s ta te

a re a s ,

a

boost

in

new

to

d e v e lo p m e n ts

th e

w h ic h

h a v e b lo s s o m e d as a n a d ju n c t to th e re s o rts a re
no s m a ll fa c to r .
f o r b u ild in g
th e p u b lic ity
im p ro v e d
out

C h a le ts f o r sa le o r re n t a n d lo ts

c lu s te r a r o u n d th e ski a re a s .

W h ile

p u t o u t b y m a n y o f th e re so rts ha s

th e ir

bum per

sum m er

stic k e rs

s u m m e r" a n d

bu sin ess,

r e a d in g

"T H IN K

th e y

" h e lp

S N O W ."

s till

pass

s ta m p
It w a s

out
th o s e

w h o w e re r e a lly th in k in g s n o w w h o fo u n d h o w to
tu r n

a ll th a t w h it e

in to g re e n

(m o n e y ).

The d e ­

v e lo p e rs o f th e s n o w g u n m a d e th e s n o w f a ll u p s id e
down

and

m ade

it a ll

p o s s ib le .

W ith

th e

r ig h t

c o m b in a tio n o f c o m p re s s e d a ir a n d w a te r e je c te d
a t b e lo w

fr e e z in g

te m p e ra tu re s , as

m u ch

as

10

in che s o f s n o w , t a ilo r e d to th e s k ie rs ' ne ed s, ca n
be la id on a s lo p e o v e r n ig h t.

The e q u ip m e n t h a s

p ro v e d so succe ssful in th e s u n n y s o u th la n d
m ost o f

th e

n o rth e rn

and

som e

of

th e

th a t

w e s te rn

re s o rts a re in s ta llin g s n o w g u n s as in s u ra n c e a g a in s t
n a tu re 's u n p r e d ic t a b ilit y .
in d u s tr y schusses t o w a r d

>|< W h ile th e U. S. ski
th e b illio n

d o lla r m a rk ,

a s iz a b le p o r tio n o f th e t r a d e is b e in g a c q u ire d b y
th e

D is tric t's o n ly e q u ip m e n t a n d

fa c tu r e r .

About

tw e n t y

y e a rs

a p p a re l m a n u ­

ago

in

th e

s m a ll

to w n o f T im o n iu m , M a r y la n d , w ith som e b o r r o w e d
m oney and

a

d re a m , a n

a ir c r a f t

e n g in e e r fr o m

Equipment leasing is a time-honored practice in
American industry. For many years, machinery has
been leased to users by manufacturers so they could
retain control over maintenance and replacement and
assure satisfactory service.
Sometimes the lease
arrangement has been used to avoid local property
taxes or to take advantage of other tax considera­
tions. Frequently, users have leased equipment to
avoid tying up scarce capital or going into debt.
Lessees have acquired almost every type of equip­
ment in this manner— automobiles, trucks, office
equipment, manufacturing machinery, and recently,
multi-million dollar jet aircraft.
Equipment is
available on lease not only from manufacturers and
regular suppliers, but also from leasing companies,
and in recent years, from commercial banks.

In

almost every undertaking involving the use of pro­
ductive goods, leasing is now an alternative to buying
and sometimes a more attractive alternative.
Types of Leases

E quipm ent leases are often

classified as “ operating leases,” sometimes known as
maintenance or service leases, and “ financial leases.”
The operating lease is used when the lessee does
not want to buy the equipment, but only wants to
use it.

He may prefer not to buy either because he

B a ltim o re la u n c h e d a p ro je c t w h ic h re v o lu tio n iz e d

needs the equipment only for a limited time or

s k iin g

because he would prefer to have the lessor maintain

and

bu sin ess.

d e v e lo p e d
A d a p t in g

in to

a

m u lti- m illio n

e n g in e e rin g

d o lla r

p rin c ip a ls ,

he

it.

This type of lease usually involves payments

w h ic h

which add up to less than the price of the equipment

w a s to b e c o m e th e c rite r io n b y w h ic h a ll o th e r skis

over the term of the lease, and the leased property

b u ilt

th e

s im p le

" a lu m in u m - s a n d w ic h "

ski

h a v e sin ce be e n ju d g e d , if sales fig u r e s a lo n e a re

is reclaimed at the expiration of the lease.

used as a b a sis.

He p u t th e s k iin g w o r ld o n m e ta l.

the lessor agrees to provide maintenance or service

O f a ll th e h ig h q u a lit y skis sold to d a y , 8 0 % a r e

over the term of the lease or to replace the equipment

m e ta l.

if it should become defective.

T h ro u g h d iv e r s ific a tio n

in to p ro d u c tio n o f

q u a lit y lin e a p p a r e l a n d re s e a rc h in to th e d e v e lo p ­
m e n t o f fib e rg la s s a n d p la s tic s f o r e q u ip m e n t, he
c o n tin u e s as a le a d e r in th e ski in d u s try .

F rom

a ll in d ic a tio n s th e F ifth D is tric t is m a k in g a w id e
s itz m a r k o n th e ski scene. W ith a n e s tim a te d 5 m il­
lio n s k ie rs in th e U. S., th e s o u th e rn e n tre p re n e u rs

Usually

In the case of an

automobile or truck lease, for example, the lessor
would generally be required to maintain the vehicle
in good repair and provide tires, batteries, and other
parts, but not gas and oil.
The financial lease resembles more closely the

a re m a k in g m o u n ta in s o u t o f m o g u ls a n d e x p e c tin g

purchase of goods on an instalment basis.

th e m to b r in g in a t le a s t t h e ir s h a re o f c o ld cash .

such a lease is non-cancellable for its entire term, and




P a tr ic ia

G.

A b e r n a th y

Usually

payments will total more than the price of the equip-

MENT

LEASING

ment. The agreement frequently provides for the
lessee to take possession of the equipment at the
termination of the lease after paying an additional
nominal fee. The financial lease is used when the
lessee actually wants to acquire the property, but
when a lease offers some advantage over an instal­
ment purchase, such as a lower down payment or
reduced tax liability.
Leasing vs. Purchasing Leasing in one form or
the other frequently provides advantages over out­
right purchasing. Many smaller businesses find such
an arrangement a useful substitute for a loan. The
lease may in effect provide 100% financing and on
a longer-term basis than any available loan. Some­
times a lease is available to an individual or com ­
pany who, as a result of a poor credit rating, would
be

Government auditors are aware

of this discrepancy, however, and now apparently
treat lease payments and similar costs on a com ­
parable basis.
Some firms find leasing preferable to purchasing
on credit because it minimizes the amount of debt
appearing on the balance sheet.

A debt to a supplier

or a loan payable is clearly a liability, but in the past
large amounts of equipment have been leased with
no evidence of indebtedness appearing in the firm’s
statement of condition. In recent years, however,
it has become more common to make some reference
to leases, either in a footnote on the balance sheet or
as a liability representing the sum of future pay­
ments due. The American Institute of Certified

equivalent

Public Accountants, after a study of accounting
principles related to leasing, issued a policy state­

Leasing may also provide a hedge against

ment holding that leases which in effect are instal­

unable to

size.

by borrowed funds.

obsolescence.

qualify

for

a loan

of

Rapidly advancing technology con­

ment purchases should be treated as purchases, and

tinually provides new and better machines, but as

should appear on the books as such.

a result, today’s mechanical marvel may be to­

should be noted on the balance sheet, with sufficient

m orrow’s white elephant.

T o avoid being stuck

Other leases

information available to indicate the true financial

with outdated equipment, the user may prefer to

position of the firm.

lease machines for relatively short periods of time,

recommended accounting procedures in some in­

replacing those which have been by-passed by later
developments. The lessor must, of course, charge

stances would dilute or eliminate the advantages
of leasing.

fees which will cover the depreciation of his assets,

Recent developments in Federal tax laws have re­

Strict adherence to these

but the user of the machinery is saved the problem

moved some of the advantages of equipment leasing

of justifying new purchases, establishing a high rate

and in some instances, added others.

of depreciation for tax purposes, and marketing the

depreciation allowances may make leasing less at­

outdated equipment.

tractive to the lessee, in that the depreciation de­

Accelerated

For a time, the way in which many government

duction may exceed the deduction for rental pay­

contracts were handled provided an incentive to

ments under a lease agreement for several years

lease equipment.

Under contracts negotiated on a

cost-plus basis, the practice in many instances was

after the acquisition of an asset.

But the 7 % in­

vestment tax credit now provided under the Internal

to allow lease payments in full as costs, but to dis­

Revenue Code may offer benefits to both the lessor

allow interest payments on borrowed funds.

and lessee.

De­

The credit may be claimed by either,

preciation allowances also had to be related to the

but of course not both.

life of the equipment, rather than to the life of the

credit, he may give the lessee some of the benefit

contract.

in the form of lower rental payments.

A s a result, many defense contractors

It the lessor claims the tax
This has the

found it more profitable to lease equipment than to

effect of spreading the benefit of the tax credit over

buy it, especially when its purchase was financed

a period of years for the lessee.




9

In some instances, the lessor has claimed the tax
credit because the lessee could not take full ad­
vantage of it under the law, and then passed on
some of the benefit to the lessee.

For example,

when a major airline placed a multi-million dollar
aircraft order, it could not benefit directly from the
tax credit because companies can deduct the cost of
new equipment from their tax bills only up to
$25,000 a year plus 25% of the company’s tax lia­
bility above $25,000.

The airline had heavy ex­

penditures but a small tax liability, and so instead
of buying the planes outright, it leased them from
a syndicate of banks which could take full advantage
of the tax credit and share the benefit with the air­
line in the form of lower financing costs.
Leasing by Banks

Com m ercial banks have fi­

nanced equipment leasing for many years.

Some of

the oldest leasing companies have relied upon banks
for

operating funds,

and banks have frequently

looked upon such companies as attractive borrowers
with highly acceptable collateral.

Bank interest in

lease financing was no doubt stimulated somewhat
when the amendment of Regulation Q on Janu­
ary 1, 1962, resulted in a substantially larger amount
of funds available for intermediate and long-term in­
vestment.

But bank entry into direct leasing dates

from the Comptroller of the Currency’s letter of
March 13, 1963, to the presidents of all national
banks, in which he ruled that direct leasing of equip­
ment constitutes “ legal and proper banking activities
for National Banks.”

A number of state banking

commissions subsequently granted permission for
banks under their jurisdiction to engage in direct
leasing.

Some

of the larger banks

immediately

moved into the field, and the dollar volume of bank
equipment leases quickly reached substantial pro­
portions.
Banks have found many compelling reasons to en­
gage in direct equipment leasing, but the strongest,
apparently, is customer demand.

Bank customers,

noting the advantages of leasing cited above, have
asked their banks to purchase equipment on their
behalf. Banks have strong incentives to accommodate
their customers whenever possible, especially when
such accommodation brings respectable earnings, and
lessees have been willing to pay rates resulting in
attractive yields.
Few banks, however, are in a
position to offer leases comparable to those of large
equipment manufacturers and suppliers. Since banks
do not produce the equipment they lease and have
10




no facilities for servicing it, they generally do not
provide operating leases. Their activities are con­
fined primarily to financial leases, similar in some
respects to instalment or term loans. Financial
leases frequently do not yield the tax benefits of an
operating lease to the lessee, and the lessor does not
claim equipment having a substantial residual value
at the termination of the lease, but they still offer
advantages for both parties. The lessee may abtain
100% financing, may improve the appearance of
his financial statements, and in some instances may
derive a tax advantage. The bank may be able to
acquire business which otherwise would be lost, and
may sometimes earn a higher yield.
Leases do not necessarily bring higher net returns
than loans, however. Unless a bank handles enough
leases to establish routines for processing them, costs
may be considerably higher than loan costs, and may
more than offset the difference in rates. The risk
factor apparently is about the same as for a com­
parable loan. The risk of default is essentially the
same in each instance. It depends on the ability of
the borrower or lessee to pay, not on the type of
instrument involved. In the event of default, the
lessor, on the one hand, may have some advantage
over the lender if the receiver rules that rental pay­
ments must be continued during the period of re­
ceivership.

Such a ruling may be forthcoming if

the business continues to operate, using the leased
equipment.

A lender in similar circumstances might

have to wait until a reorganization has been com­
pleted or some other statement has been reached.
On the other hand, the lender has the advantage over
the lessor in that a lender qualifies as a general
creditor, and may qualify for the payment of any
unsatisfied balance after the disposal of equipment
used as collateral, whereas the lessor can only re­
claim the equipment in the event of a default on a
lease.

H e has no claim as a general creditor.

For many banks, the departure from traditional
banking practices inherent in direct leasing are great
enough to discourage them from entering the field.
They have found, however, that close affiliation with
a nonbank leasing company may offer them the op­
portunity to meet the demands of their customers
through traditional channels.

The lessee leases the

equipment from the leasing company, and the leas­
ing company discounts the lease with the bank. Then
the customer has his equipment, the bank has its
loan, and the problems involved in making and
servicing direct leases are avoided.
Harmon H . Haymes

ft

THE FIFTH DISTRICT

j K

AGRICULTURAL OUTLOOK FOR 1968
Domestic demand for farm products will expand
further; exports are expected to continue at a high
level; farm output will remain h ig h ; production ex­
penses will continue to increase; and net farm income
will probably equal the reduced level of 1967. This,
in a nutshell, is the national outlook for agriculture
in 1968 as seen by top economists of the U. S. De­
partment of Agriculture.
In appraising the agricultural outlook for the year
ahead, U S D A ’s analysts assumed that general
economic activity in 1968 would expand further and
at a somewhat faster pace than in 1967. They also
assumed average growing conditions and took into
consideration the probable effects of changes in the
farm programs for cotton, corn, sorghum grains,
and wheat.
M ore detailed forecasts of the Department of
Agriculture are given below.
Farm Prices, Costs, and Income Farm prices in
1968 promise to show some improvement over the
reduced levels of 1967, primarily because of pros­
pects for higher prices for livestock and livestock
products. Expectations point to a decrease in grain
production and a sizable increase in cotton produc­
tion, but overall crop output in 1968 will probably
show little change from that in 1967. Though gains
are unlikely to be big, output of livestock products
is expected to at least equal the record production
of 1967.
Farm production expenses in 1968 will probably
increase by another $1 billion, the same as in 1967.
Prices paid for production items of nonfarm origin
will likely continue their upward trend. Overhead
items such as real estate taxes, interest payments,
and depreciation charges will be sharply higher.
Feed and fertilizer usage will likely increase, and
wage rates will be higher.
Both cash receipts from farm marketings and
Government payments to farmers are expected to in­
crease in 1968.

These gains will likely boost the

nation’s realized gross farm income to a new record
high of slightly more than $50 billion.

But the con­

tinued rise in production expenses may largely offset
the gain, and realized net farm income will probably
remain at the 1967 level of about $14^4 billion. This



would be sharply lower than the near-record $16.4
billion in 1966 but well above all other years since
1952. Realized net income per farm and after-tax in­
come of farm people seem likely to increase, however.
Supply and Demand Conditions There is co n ­
siderable variation in the 1967-68 supply situation of
the various farm products. Supplies of soybeans,
peanuts, and the “ free” supplies of feed grains are
at record levels. Supplies of most kinds of tobacco
have been adjusted downward toward a better
balance with requirements.
Cotton supplies are
significantly lower, but wheat supplies are larger.
Little change is expected in the supply of total crop
food products.
Demand for farm products, both at home and in
foreign markets, is expected to continue strong in
1968. Here at home, a further expansion in economic
activity and the accompanying increases in employ­
ment and wage rates indicate a continued rise in
disposable personal income. Gains in consumer
buying power will also be accompanied by a growing
population. W ith rising incomes and retail food
prices 2 % to 3% higher, expenditures for food will
probably climb some 3% to 5% higher in 1968.
The percentage of income spent for food will likely
remain about the same as the 17.7% in 1967,
however.
United States agricultural exports during fiscal
year 1968 appear to be headed toward $6.7 billion,
the same as two years ago and close to last year’s
record of $6.8 billion. Sales for dollars are expected
to reach $5.1 billion, also near last year’s record dollar
sales of $5.2 billion. W hile the value of farm exports
will be near last year’s level, the volume of products
shipped will likely be higher.
Outlook for Commodities B rief review s o f h igh ­
lights in the outlook for major Fifth District com ­
modities fo llo w :
Poultry and E g g s : Prospects for 1968 point to
a slight decline in egg production, a small increase in
broiler production, and fewer turkeys. The moderate
cutbacks indicated for production of eggs and turkeys
and the smaller gain in prospect for broiler output
reflect producers’ response to lower prices and higher
production costs in 1967.
11

There may be somewhat less competition from red
meats in 1968, and this could strengthen the demand
for poultry. Broiler and egg prices may average
the same the first half of 1968 as in 1967 but are
likely to average moderately above the relatively low
levels of 1967 during the last six months. Turkey
prices through the first half of 1968 will likely average
below a year earlier, but if production is cut back as
anticipated, they may average a little above 1967 the
last half of the year.
M eat A nim als: Livestock farmers are expected
to produce about the same amount of red meat in
1968 as in 1967. Fed beef output probably will be
larger than in 1967 and may just about offset a
further decline in cow slaughter. Fed cattle prices
for the year as a whole may average a little higher
than in 1967.
H og slaughter during the first six months of 1968
may be about the same or slightly smaller than a
year earlier. H og prices during the period are ex­
pected to be about the same as a year ago. H og
slaughter and prices later in 1968 will depend chiefly
on the size of next spring’s pig crop. A ny sizable in­
crease would likely result in a sharp decline in prices.
Dairy P rod u cts: Milk production in 1968 is ex­
pected to be about the same as in 1967. Gains in
output per cow will likely offset the continued decline
in milk cow numbers. Total use of milk may rise
since both commercial sales and Government dona­
tions of purchased dairy products are expected to in­
crease. The farm price of milk may average near
the 1967 average, provided dairy supports and Fed­
eral milk marketing order provisions continue at
1967 levels, and cash receipts from dairying will
probably change little from the record $5.8 billion
received in 1967.
T oba cco: Supplies of most kinds of tobacco have
been adjusted downward toward a better balance with
requirements. The national flue-cured marketing
quota for 1968 is essentially the same as in 1967.
Over marketings of the 1967 crop are expected to
exceed undermarketings, and the adjustments to take
this into account will reduce the 1968 total of in­
dividual farm quotas below 1967. Marketing quotas
for burley, Maryland, fire-cured, dark air-cured, and
certain cigar tobaccos will be announced by Feb­
ruary 1. The overall support levels for 1968 tobacco
will be 4 % higher than in 1967 if the parity index
the rest of the year remains at its October level.
United States production and consumption of
cigarettes rose to new record levels in 1967. The
number of cigarettes smoked per capita also increased
and was second only to 1963. A further modest in­
crease in cigarette consumption is expected in 1968.
Digitized for12
FRASER


United States exports of unmanufactured tobacco
in 1966-67 were nearly one-third above 1965-66 and
the largest since 1919-20.
Tobacco exports in
1967-68 may be slightly below the 47-year high of
1966-67 but well above other recent years. The un­
certainty of the political situation in Rhodesia, the
world’s second largest exporter of flue-cured prior
to United Nations economic sanctions against its
tobacco, continues to cloud the outlook for United
States tobacco exports.
Cotton-. This year’s small cotton crop and con­
tinued relatively large disappearance point to another
sharp reduction in cotton stocks. Stocks may fall
to around 6^4 million bales by next August. This
would be Sy2 million less than last August and more
than 10 million below the record high stocks of
nearly 17 million bales on August 1, 1966. D o­
mestic mill consumption in 1967-68 is expected to
be a little over 9 million bales. Our cotton exports
will likely be about as large as last year’s 4.7
million bales.
The 1968 cotton program is designed to increase
production and to encourage production of a higher
proportion of medium and longer staples.
Soybeans and P ean u ts: Soybean supplies for the
1967-68 marketing year are estimated at a record
I.1 billion bushels, 12% above a year earlier. Soy­
bean usage is expected to increase at a faster rate
than last year, however. Domestic use may rise as
high as 600 million bushels compared with 551 mil­
lion in 1966-67. Soybean exports may increase to
around 280 to 300 million bushels in comparison with
257 million last season. Despite prospective in­
creases in exports and domestic crush, the carryover
into 1968-69 will probably be \/2 times the 91 million
l
bushels at the beginning of this year. Soybean
prices at harvesttime averaged slightly below the
support rate of $2.50 per bushel. They are expected
to return to the support level later in the season.
Peanut supplies in 1967-68 are also estimated to
be at a record level, about 3% above a year earlier.
Total edible consumption is expected to increase, and
peanut exports may be about the same as last year,
but they will face larger competitive world supplies.
Prices of peanuts are expected to average around
II.4 cents per pound, a little above last year.
Sada L.Clarke

PHOTO
C a r o lin a

C a r ib b e a n

C o rp .,

CREDITS
N o rth

C a r o lin a

D e p t,

of

C o n s e r v a tio n a n d D e v e lo p m e n t, B ry c e 's M o u n t a in Re­
s o rt, In c ., D e e p C re e k L a k e - G a r r e tt C o u n ty P ro m o tio n
C o u n c il, T h e H o m e s te a d .