Wednesday, February 25, 2009

Thrift Institutions
1.Three categories of Thrift Institutions :
Chapter Overview
Thrift institutions comprise three different groups of Fl s : saving associations, saving banks, and credit unions. Thrift institutions were first created in the early 1800s in response to commercial banks’ concentration on serving the needs of business (commercial) enterprises rather than the needs of individuals requiring borrowed funds to purchase homes. Thus, the first thrifts pooled individual savings and invested them mainly in mortgages and other securities. While today’s thrifts generally perform services similar to commercial banks, they are still grouped separately because they provide important residential mortgage lending and other financial services to households. Figure 12-1 illustrates key asset side differences among the three types of thrift institutions. Historically, savings associations have concentrated primarily on residential mortgages, while savings bank have been operated as more diversified institutions, with a large concentration of residential mortgages assets but holding commercial loans, corporate bonds, and corporate stock as well. Credit unions have historically focused on consumer loans funded with member deposits. Each category of thrift includes federally chartered and state chartered institutions. Table 12-1 shows the number of each type of thrift as of year-end 2001. This chapter reviews these three types of depository institutions. For each group, we examine (1) their size, structure, and composition, (2) their balance sheets and recent trends, (3) their regulators, and (4) recent industry performance.
Savings Associations
Size, Structure , and Composition of the industry
The savings associations industry prospered throughout most of the 20th century. Savings associations were historically referred to as savings and loan (S&L) associations. However, in the 1980s, federally chartered savings banks appeared in the United States. These institutions have the same regulators and regulations as the traditional savings and loans, Together they are referred to as savings associations. These specialized institutions made long-term residential mortgages usually backed by the short-term deposits of small savers. This strategy was successful largely because of the federal Reserve’s policy of smoothing or targeting interest rates, especially in the post World War II period up until the late 1970s (see Chapter 4), and the generally stable and upward-sloping shape of the yield curve of the term structure of interest rates (see Chapter 2). During some periods, such as the early 1960s, the yield curve did slope downward but for most of the post-World War II period, the upward –sloping yield curve meant that the interest rates on savings associations’ 30-year residential mortgages assets exceeded the rates they paid on their short-term deposit liabilities. Moreover, significant shocks to interest rates were generally absent because of the Fed’s policy of interest rate smoothing and the fact that the world’s economies were far less integrated compared with today’s economies.
2. At the end of the slightly fewer than 4,000 savings associations existed, with assets of approximately $0.6 trillion. During the October 1970 to October 1982 period, however, the Federal Reserve radically changed its monetary policy strategy by targeting bank reserves rather than interest rates, in an attempt to lower the underlying rate of inflation ( see Chapter 4 for more details ). The Fed’s restrictive monetary policy actions led to a sudden and dramatic surge in interest rates, with rates on T-bills and bank certificates of deposits rising as high as 16 percent. This increase in short-term rates and the cost of fund had two effects. First, many savings association faced negative interest spreads or net interest margins (interest income minus interest expense divided by earning assets) in funding much of their long-maturity, fixed-rate residential mortgages in their portfolios. For example, a 12 percent 30-year mortgage was having to be funded by a 15 percent 3-month CD. Second, they had to pay more competitive interest rates on deposits to prevent disintermediation and the reinvestment of these funds in money market mutual fund accounts. Their ability to do this was constrained by the Federal Reserve’s Regulation Q ceilings, which limited ( albeit to a lesser extent for saving institutions than commercial banks ) the interest rates that savings associations could pay on the traditional passbook savings account and retail time deposits that small savers held. Thus, many small depositors, especially the more sophisticated, withdrew their funds from savings association deposit accounts (that were paying less than market interest rates because of Regulations Q) and invested directly in unregulated money market mutual fund accounts (where they could earn market interest rates).
Partly to overcome the adverse effects of rising rates and disintermediation on the savings association industry, Congress passed two major acts in the early 1980s revising the permitted scope of savings associations’ activities : the Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980 and the Garn-St. GERMAIN Depository Institutions Act (GSGDIA) of 1982 (see Chapter 14); these expanded savings associations’ deposit-taking and asset investment powers. On the liability side, savings associations were allowed to offer interest-bearing transaction accounts, called NOW accounts, and to issue more market rate-sensitive liabilities such as money market deposit accounts (MMDAs) to limit disintermediation and to compete with mutual funds. On the asset side of the balance sheet, they were allowed to offer floating-or-adjustable-rate mortgages and, to a limited extent, expand into consumer real estate development and commercial lending. Note the structural shifts in savings associations, the new powers created safer and more diversified institutions.
For a small but significant group, however, whose earnings and shareholders’ capital was being eroded in traditional areas of asset and liability business, the new regulations meant the opportunity to take more asset side risks which, if they paid off, could return the institution to profitability. However, in the mid-1980s, real estate and land prices in Texas and the Southwest collapsed. This was followed by economic downturns in the Northeast and Western states of the United States. Many borrowers with mortgage loans issued by savings associations in these areas defaulted. In other words, the risks incurred by many of these institutions did not pay off. This risk-taking behavior was accentuated by the policies of the federal insurer of savings associations deposits, FSLIC. It chose not to close capital-depleted, economically insolvent savings associations (a policy of regulator forbearance) and to maintain deposit insurance premium assessments independent of the risk taken by the institutions (see Chapter 14). As a result, an alarming number (1,248) of savings association failures occurred in the 1982-1992 period (peaking at 316 in 1989), alongside a rapid decline in asset growth of the industry. Figure 12-2 shows the number of failures, mergers, and new charters of savings institutions (savings associations and savings banks combined) from 1984 through 2001. Notice the large number of failures from 1987 through 1992 and the decline in the number of new charters.
In the 1980s, the large number of savings association failures depleted the resources of the FSLIC to such an extent that by 1989 it was massively insolvent. For example, between 1980 and 1988, 514 thrifts failed, at an estimated cost of $42.3 billion. Moreover, between 1989 and 1992 an additional 734 thrifts failed, at a cost of $78 billion. As a result, Congress passed an additional piece of legislation: the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of 1989. This legislation abolished the FSLIC and created a new savings association insurance fund (SAIF) under the management of he FDIC (with the help of a $100 billion infusion of funds by the U.S. government). FIRREA also replaced he Federal Home Loan Bank Board with the Office of Thrift Supervision (OTS) as the main regulator of federally chartered savings associations. In addition, the act created the Resolution Trust Corporation (RTC) to close and liquidated the most insolvent savings institutions. The FIRREA also strengthened the capital requirements of savings associations and constrained their non-mortgage-related asset investment powers under a revised qualified thrift lender test, or QTL test (discussed below). Following FIRREA, Congress further enacted the Federal Deposit Insurance Corporation Improvement Act (FDICIA). The FDICIA of 1991 introduced risk-based deposit insurance premiums (starting in 1993) in an attempt to limit excessive risk taking by savings association owners. It also introduced a prompt corrective action (PCA) policy, such that regulators could close thrifts and banks faster (see Chapter 14). In particular, if a savings association’s ratio of its owners’ equity capital to its assets fell below 2 percent, it had to be closed down or recapitalized within three months.
As a result of closing weak savings associations and strengthening their capital requirements, the industry is now significantly smaller both in terms of numbers and asset size. Specifically, the number of savings associations decreased from 2,600 in 1989 to 1,176 in 2001 (by 55 percent) and asset have decreased from $1.2 trillion to $906 billion (by 24 percent) over the same period.
Balance Sheets and Recent Trends
Even in its new smaller state, the future viability of the savings association industry in traditional mortgage lending areas is a matter of debate. This is due partly to intense competition for mortgages from other financial institutions such as commercial banks and specialized mortgage bankers. It is also due to the securitization of mortgages into mortgage-backed security pools by government-sponsored enterprises, which we discuss in Chapters 7 and 25. In addition, long-term mortgage lending exposes FIs ti significant credit, interest rate, and liquidity risks.
3 Column (1) of Table 12-3 shows the balance sheet for the savings association industry at year-end 2001. On this balance sheet, mortgages and mortgage-backed securities (securitized pools of mortgages) represent 73.42 percent of total assets. This compares to 35.44 percent in commercial banks. Figure 12-3 shows the distribution of mortgage-related assets for all savings institutions (savings associations and savings bank) as of December 2001. As noted earlier, the FIRREA uses the QTL test to establish a minimum holding of 65 percent in mortgage-related assets for savings associations. Reflecting the enhanced lending powers established under the 1980 DIDMCA and 1982 GSGDIA, commercial loans and consumer loans amounted to 2.71 and 6.20 percent of savings association assets, respectively, compared to 14.96 percent and 9.61 percent at commercial banks. Finally, savings associations are required to hold cash and investment securities for liquidity purposes and to meet regulator-imposed reserve requirements (see Chapter 14). In December 2001, cash and investment securities (U.S. Treasury securities and federal agency obligations; federal funds and repos; and bonds, notes, debentures, and other securities) holding amounted to 10.95 percent of total assets compared to 33.36 percent at commercial banks.
4 On the liability side of the balance sheet, small time and savings deposits are still the predominant source of funds, with total deposits accounting for 60.74 percent of total liabilities and net worth. This compares to 66.85 percent at commercial banks. The second most important source of funds is borrowing from the 12 Federal Home Loan Banks (FHLBs), which the institutions themselves own. Because of their size and government-sponsored status, FHLBs have access to the wholesale capital market for notes and bonds and can relend the funds borrowed in these markets to savings associations at a small markup over wholesale cost. Other borrowed funds include repurchase agreements and direct federal fund borrowings.
Finally, net worth is the book value of the equity holders’ capital contribution; it amounted to 8.21 percent in 2001. This compares to 9.09 percent at commercial banks. Historically, most savings associations (and saving banks) were established as mutual organizations (in which the depositors are the legal owners of the institution and no stock is issued). As a mutual organization, member deposits represent the equity of the savings association. Since there are no stockholders, and thus no demand for equity investment returns, mutual organizations are generally less risky than stock-chartered organizations—mutual savings association managers can concentrate on low-risk investments and the prevention of failure rather than higher risk investments needed to produce higher required returns on stockholders’ investments. However, through time many savings associations (and savings banks) have switched from mutual to stock charters (in which the holders of the stock or equity are the legal owners of the institution rather than depositors as under the mutual charter). This is mainly because stock ownership allows savings institutions to attract capital investment from outside stockholders beyond levels achievable at a mutual institution. Figure 12-4 shows this trend in mutual versus stock charters and asset size for savings institutions from 1988 through 2001.
In May 2002, the Office of Thrift Supervision (OTS) proposed new rules that would increase the documentation required when a mutually chartered organization applies for conversion to a stock charter. The new rule would require the thrift to demonstrate a need for new capital, instead of merely explaining how the new capital would be deployed. The institution would also be asked to describe its experience with growth and expansion into other business lines, and demonstrate that it would be able to achieve a reasonable return on equity. These changes are expected to reduce the number of mutual thrifts converting to stock charters.
Savings Banks
Size, Structure, and Composition of the Industry
Traditionally, savings banks were established as mutual organizations in states that permit such organizations. These states were largely confined to the East Coast—for example, New York, New Jersey, and the New England states. As a result, savings banks (unlike savings associations) were not affected by the oil-based economic ups and downs of Texas and the Southwest in the 1980s. The crash in New England real estate values in 1990-1991 presented equally troubling problems for this group, however. Indeed, many of the failures of savings institutions (see Figure 12-2) were of savings banks rather than savings associations. As a result, like savings associations, savings banks have decreased in both size and number. In December 2001, 357 savings banks had $393 billion In assets: $248 billion of their deposits are insured by the FDIC under the BIF (Bank Insurance Fund). FDIC insurance under the BIF is just one characteristic that distinguishes savings banks from savings associations, whose deposits are insured under by the FDIC under the SAIF (Savings Association Insurance Fund).
Balance Sheets and Recent Trends
Notice the major similarities and differences between savings associations and savings banks in Table 12-3, which shows their respective assets and liabilities as of year-end 2001. Savings banks (in the second column of Table 12-3)have a heavy concentration (73.72 percent) of mortgage loans and mortgage-backed securities (MBSs). This is slightly more than the savings associations’ 73.42 percent in these assets and much more than commercial banks (35.44 percent). Over the years, savings banks have been allowed greater freedom to diversify into corporate bonds and stocks; their holdings in these assets are 7.50 percent compared to 2.21 percent for savings associations. On the liability side, the major difference is that savings banks generally (although this was not the case in 2001, as shown in Table 12-3) rely less heavily on deposits than savings associations and therefore savings banks have fewer borrowed funds. Finally, the ratio of the book value of net worth to total assets for savings banks stood at 8.96 percent (compared to 8.21 percent for savings associations and 9.09 percent for commercial banks) in 2001.
5. Regulators of Savings Institutions
The three main regulators of savings institutions are the Office of Thrift Supervision (OTS), the FDIC, and state regulators.
The Office of Thrift Supervision. Established in 1989 under the FIRREA, this office charters and examines all federal savings institutions. It also supervises the holding companies of savings institutions.
The FDIC. The FDIC oversees and managers the Savings Association Insurance Fund (SAIF), which was established in 1989 under the FIRREA in the weak of FSLIC insolvency. The SAIF provides insurance coverage for savings associations. Savings banks are insured under the FDIC’s Bank Insurance Fund (BIF) and are thus also subject to supervision and examination by the FDIC.
Other Regulators. State chartered savings institutions are regulated by state agencies—for example, the Office of Banks and Real Estate in Illinois—rather than the OTS.
6 Savings Association and Savings Bank Recent Performance
Like Commercial banks, savings institutions (savings associations and savings banks) experienced record profits in the mid-to late 1990s as interest rates (and thus the cost of funds to savings institutions) remained low and the U.S. economy (and thus the demand for loans) prospered. The result was an increase in the spread between interest income and interest expense for savings institutions and consequently an increase in net income. Despite an economic slowdown in the United States in the early 2000s, savings institutions continued to earn record profits. Figure 12-5 reports ROAs and ROEs for the industry from 1988 through December 2001. In the fourth quarter of 2001, savings institutions reported a record $3.8 billion in net income and the highest ever annualized ROA of 1.16 percent (this compares to an ROA of 1.13 percent over the same period for commercial banks—see Chapter 11). For the entire year 2001, savings institutions earned a record $13.3 billion in profits, with an ROA of 1.08 percent (the highest since 1946). The industry’s net interest margins rose in response to a steeper yield curve: the cost of funding earning assets declined by only 46 basis points. However, noncurrent loans (those with an interest payment over 90 days past due) as a percent of total loans rose to above 0.6 percent and net charge-offs in 2001 were almost twice those in 2000. Equity capital as a percent of total assets was 8.44 percent, down from its all time high of 8.94 percent in 1998, largely due to rapid asset growth by these banks. Table 12-4 presents several performance ratios for the industry for 1989 and 1993 through 2001.
Like the commercial banking industry, savings institutions have experienced substantial consolidation in the 1990s. For example, the 1998 acquisition of H.F. Ahmanson & Co. by Washington Mutual Inc. for almost $10 billion was the fourth largest bank/thrift merger completed in 1998. Washington mutual was the third largest savings institution in the United States early in 1997, while Ahmanson was the largest savings institution. In 1997, Washington Mutual bought Great Western to become the largest thrift in the country. Then, in March 1998, Washington Mutual bought Ahmanson to combine the two largest U.S. thrifts. In December 2001, Washington Mutual (the largest savings institution in the United States) had total assets at $223 billion, ranking seventh of all depository institutions (banks and thrifts). Table 12-5 shows the industry consolidation in number and asset size over the period 1992-2001. Notice that over this period, the biggest savings institutions (over $5 billion) grew in number from 29 to 44 and their control of industry assets grew from 32.3 percent to 63.7 percent.
Larger savings institutions have also enjoyed superior profitability compared to smaller savings institutions. The 576 small thrifts (with assets less than $100 million) had an average annualized ROA of 0.64 percent for the year 2001, while the larger (stock-owned) institutions reported an ROA of 1.17 percent. One major reason for this size-based difference in ROA is that larger savings institutions (unlike money center banks relative to smaller commercial banks) have virtually no asset investments or offices in foreign markets and countries and have consequently not suffered from recent crises in emerging markets and countries like Argentina that have so harmed the profitability of some money center banks. Despite the recent resurgence of this industry, as discussed in In the News box 12-1, its future is still uncertain.
7 Credit Unions
Credit Union (CUs) are not-for-profit depository institutions mutually organized and owned by their members (depositors). Credit unions were first established in the United States in the early 1900s as self-help organizations intended to alleviate widespread poverty. The first credit unions were organized in the Northeast, initially in Massachusetts. Members paid an entrance fee and put up funds to purchase at least one deposit share. Members were expected to deposit their savings in the CU, and these funds were lent only to other members.
This limit in the customer base of CUs continues today as, unlike commercial banks and savings institutions, CUs are prohibited from serving the general public. Rather, in organizing a credit union, members are required to have a common bond of occupation (e.g., police CUs), association (e.g., university-affiliated CUs), or cover a well-defined neighborhood, community, or rural district. CUs may, however, have multiple groups with more than one type of membership. Each credit union decides the common bond requirements (i.e., which groups it will serve) with the approval of the appropriate regulator (see below). To join a credit union individuals must then be a member of the approved group(s).
The primary objective of credit unions is to satisfy the depository and borrowing needs of their members. CU number deposits (called shares, representing ownership stakes in the CU) are used to provide loans to other members in need of funds. Earnings from these loans are used to pay interest on member deposits. Because credit unions are not-for-profit organizations., their earnings are not taxed. This tax-exempt status allows CUs to offer higher rates on deposits and charge lower rates in some types of loans compared to banks and savings institutions, whose earnings are taxable.
Size, Structure, and Composition of the Industry
Credit unions are the most numerous of the institutions (9,984 in 2001) that compose the depository institutions segment of the FI industry. (Figure 12-6 shows the number of credit unions, their total assets, and number of members from 1993 through 2001.) Moreover, CUs were less affected by the crisis that affected commercial banks and savings institutions in the 1980s. This is because traditionally more than 40 percent of their assets have been in small consumer loans, often for amounts less than $10,000, which are funded mainly by member deposits. This combination of relatively matched credit risk and maturity in the asset and liability portfolios left credit unions less exposed to credit and interest rate risk than commercial banks and savings institutions. In addition, CUs tend to hold large amounts of government securities (almost 20 percent of their assets in 2001) and relatively small amounts of residential mortgages. CUs’ lending activities are funded mainly by deposits contributed by their almost 80 million members.
The nation’s credit union system consists of three distinct tiers: the top tier at the national level (U.S. Central Credit Union); the middle tier at the state or regional level (corporate credit unions); and the bottom tier at the local level (credit unions). Figure 12-7 illustrates this structure, with the services conducted between various entities identified via arrows. Corporate credit unions are financial institutions that are cooperatively owned by their member credit unions. The 34 corporate credit unions serve their members primarily by investing and lending excess funds (unloaned deposits) that member credit unions place with them. Additional services provided by corporate credit unions include automated settlement, securities safekeeping, data processing, accounting, and payment services. As of 2001, credit unions had over $19 billion (3.9 percent of total assets) invested in corporate credit unions. The U.S. Central Credit Union serves as a “corporate’s corporate” – providing investment and liquidity services to corporate credit unions. The central Credit Union acts as a corporate credit unions’ main provider of liquidity. It invest their surplus funds and provides financial services and operational support.
In recent years, to attract and keep customers, CUs have expanded their services to compete with commercial banks and savings institutions. For example, many CUs now offer mortgages, credit lines, and automated teller machines. Some credit unions also offer business and commercial loans to their employer groups. For example, in the late 1990s, AWANE (Automotive Wholesalers Association of New England) Credit Union’s business loans represented 13.6 percent of its lending and the CU participated actively in the Small Business Administration loan programs, which enabled it to sell a portion of those loans. In addition, commercial real estate lending accounted for 29.5 percent of AWANE’s total lending.
As CUs have expanded in membership, size and services, bankers claim that CUs unfairly compete with small banks that have historically been the major lender in small towns and local communities. For example, the American Bankers Association claimed that the tax exemption for CUs gives them the equivalent of a $1 billion a year subsidy. The response of the Credit Union National Association (CUNA) is that any cost to taxpayers from CUs’ tax-exempt status is more than passed on to their members and society at large through favorable interest rates on deposits and loans. For example, CUNA estimates that the benefits of CU membership can range from $200 to $500 a year per member or, with almost 70 million members, a benefit of $14 billion to $35 billion per year.

No comments:

Post a Comment