CHAPTER 16 THRIFT INSTITUTIONS AND FINANCE COMPANIES Copyright© 2012 John Wiley & Sons, Inc.

2 Institutions Covered Thrift Institutions Savings Associations (or S&Ls) Savings Banks Credit Unions Finance Companies Copyright© 2012 John Wiley & Sons, Inc.

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4 Historical Origins of Thrifts Mutual Savings Banks were developed in the 1800s because commercial banks did not serve the needs of small savers. Eventually Mutual Savings Banks invested most of their deposits in mortgage loans. Mutual Savings and Loan Associations and Building Societies were also started in the 1800s by groups of people who pooled their savings so that each would eventually be able to acquire a house. Copyright© 2012 John Wiley & Sons, Inc.

5 Recent History of Thrifts Stockholder owned savings and loan associations were relatively uncommon until the late 1970s and 1980s when pressure to attract more capital encouraged many S&Ls to convert to stock form. Stock S&Ls outnumber mutual S&Ls today. Assets of stock S&Ls are many times as large as the assets of mutual S&Ls. Copyright© 2012 John Wiley & Sons, Inc.

6 Exhibit 16.3A: Number of Savings Institutions Copyright© 2012 John Wiley & Sons, Inc.

7 Exhibit 16.3B: Assets of Savings Institutions Copyright© 2012 John Wiley & Sons, Inc.

8 Thrift Crisis of the 1980s Classic model of thrift management involved a negative maturity gap: Short-to-medium term fixed-rate savings deposits financing and Medium-to-long-term fixed-rate mortgages. Thus the sharp interest rate increases of the early 1980s decimated the industry. The problem was compounded by unsound lending practices and other forms of mismanagement. Copyright© 2012 John Wiley & Sons, Inc.

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10 Copyright© 2012 John Wiley & Sons, Inc.

11 Regulation of Savings Institutions Savings bank regulators— Federal regulator: Office of Thrift Supervision->OCC Insurer: FDIC Savings association (S&L) regulators— Federal regulator: OTS->OCC Insurer: FDIC State regulators also charter and supervise thrifts Federal Home Loan Banks: 12 regional Federal Home Loan Banks empowered to borrow in capital markets and make loans (called “advances”) to thrifts in their regions. Copyright© 2012 John Wiley & Sons, Inc.

12 Assets of Thrifts Residential mortgages still main asset because of tax break. Other loan types more well-represented now than in past because of deregulation. Liquidity management comparable to commercial banks. “OREO”—Other Real Estate Owned—acquired in foreclosures. Copyright© 2012 John Wiley & Sons, Inc.

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14 Liabilities of Thrifts Deposits are key, but deposit types are much more varied today. Advances from FHLB are most important non-deposit sources of funds. Fed funds present but less important as either source or use compared to banks. Copyright© 2012 John Wiley & Sons, Inc.

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16 Capital Accounts, Standards & Terms analogous to banks Tier 1/ Tier 2 Risk-weighting of assets Minimum ratios Thrift capital has risen sharply since 1989 Copyright© 2012 John Wiley & Sons, Inc.

17 Copyright© 2012 John Wiley & Sons, Inc.

18 Income, Expenses, & Performance Structure of income statement comparable to banks Net Interest Margin about 3% deposit rates have fallen more rapidly than mortgage rates institutions take much less interest rate risk than they used to Provision for loan losses reflects sounder lending practices. Industry ROAA averages around 1.2%; ROAE around 13%. Copyright© 2012 John Wiley & Sons, Inc.

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21 Copyright© 2012 John Wiley & Sons, Inc.

22 Credit Unions Mutual institutions organized much like a club with each member (share owner) having a vote to elect the board of directors. Membership requires a common bond (e.g., same employer, church, trade association). Credit Union assets have grown steadily in recent years. Copyright© 2012 John Wiley & Sons, Inc.

23 Crucial differences from other depository institutions Always and strictly mutually owned; organized like clubs. Common-bond membership/exemption from antitrust constraints. Most common bonds are occupational. Others are associational/fraternal or residential. Not-for-profit and therefore tax-exempt. Expected to concentrate on smaller consumer loans. Copyright© 2012 John Wiley & Sons, Inc.

24 Credit Union Regulation Regulated by the National Credit Union Administration (NCUA). Deposits are insured by the National Credit Union Share Insurance Fund (NCUSIF). Liquidity is provided by the Credit Liquidity Facility (CLF). Copyright© 2012 John Wiley & Sons, Inc.

25 Credit Union Assets Credit union member loans constitute bulk of CU assets. Other assets include cash and investments. Copyright© 2012 John Wiley & Sons, Inc.

26 Credit Union Liabilities Regular share accounts are like savings accounts. Share certificates are time deposits like CDs, and have become a more important source of funds. Share drafts are CU interest-bearing checking accounts. Net worth includes reserves and undivided earnings. Copyright© 2012 John Wiley & Sons, Inc.

27 Credit Union Developments Small credit unions are merging or liquidating. Credit unions are adopting new technologies, especially larger credit unions. Funds flows are becoming increasingly coordinated. Corporate central credit unions - correspondent banking for credit unions. Powerful trade associations/lobbying groups: CUNA and NAFCU. Copyright© 2012 John Wiley & Sons, Inc.

Trends in Credit Unions 28 Copyright© 2012 John Wiley & Sons, Inc.

Selected Ratios for Credit Unions, Dec. 31, Copyright© 2012 John Wiley & Sons, Inc.

Credit Union Assets, Dec. 31, Copyright© 2012 John Wiley & Sons, Inc.

Credit Union Liabilities, Dec. 31, Copyright© 2012 John Wiley & Sons, Inc.

32 Finance Companies Lenders to businesses and consumers who are higher risk borrowers. Highly leveraged; borrowing funds from banks and the open market. Most larger finance companies are now subsidiaries of bank and financial holding companies. Many "non-bank" banks or consumer banks are similar to finance companies. Finance companies are diverse and adaptive to changing needs. Copyright© 2012 John Wiley & Sons, Inc.

Types of Finance Companies Captive sales finance companies help finance goods sold by their parent companies. The largest finance companies are sales finance companies that are captives of major retailers and auto manufacturers that help finance sales of their parents’ goods. Other large finance companies are large factoring finance companies. Consumer finance companies are independent lenders that largely make personal loans to consumers. 33 Copyright© 2012 John Wiley & Sons, Inc.

34 Finance Company Assets Investment securities, real assets, cash, and deposits represent a small percent of assets. Consumer receivables (loans): Personal loans; Automobile credit; Mobile home credit; Revolving Consumer Installment Credit; Other Consumer Installment Credit. Real Estate Lending (second mortgages) is the fastest growing area of finance company lending. Copyright© 2012 John Wiley & Sons, Inc.

35 Finance Company Assets, cont. Business credit -- area of growth in recent years: Wholesale paper -- loans to finance inventories. "Floor plan" is a type of wholesale paper. Retail paper -- purchase of consumer sales (loan) contracts from retailers. Lease paper -- leasing business equipment and consumer durables. Commercial accounts receivable financing. Factoring -- the purchase of accounts receivables. Copyright© 2012 John Wiley & Sons, Inc.

36 Liabilities and Net Worth Net worth: highly leveraged Net worth level directly related to riskiness of loan portfolio Debt: Bank debt Commercial paper Transfer credit from parent companies Long-term debt when rates are low Copyright© 2012 John Wiley & Sons, Inc.

37 Regulation of Finance Companies Consumer protection more than safety and soundness Interest rate ceilings on loans, but phased out in most states Debt collection practices Branching, chartering, and merger restrictions Truth-in-lending (Regulation Z) Bankruptcy protections Copyright© 2012 John Wiley & Sons, Inc.

38 Finance Company Developments Securitization Shift toward business credit Shift toward second mortgage lending Growth of leasing Growth of home equity credit lines Decline in small finance companies Copyright© 2012 John Wiley & Sons, Inc.