1. Drake DRAKE UNIVERSITY Fin 129 Finance 129 Chapter 2 Depository Institutions

2. Drake Drake University Fin 129 Depository Institutions Main criteria is that a significant portion of the firms funds come from customer deposits. Examples include: Commercial Banks Savings and Loans Credit Unions

3. Drake Drake University Fin 129 Recent Trends The 1990’s ended with the Fin Modernization Act (1999). From the end of the 1990’s to present there has been a wave of mergers and acquisitions in the industry. The increased business services that Depository Institutions are now allowed to offer has created a desire for larger less regional institutions.

4. Drake Drake University Fin 129 Source FDIC Future of Banking Study FOB-2004-02.1 Largest Depository Institutions, Dec 31, 2003 by total assets (billions) $ % %Dom AssetsAssets Dep J.P Morgan Chase$100911.11%6.61% Bank of America $8709.58%9.82% Citigroup $7968.77%3.47% Wells Fargo $3804.19%4.62% Wachovia Corp $3623.99%4.09% Washington Mutual $2763.04%3.23% US Bancorp $1922.12%2.19% National City Corp $1321.45%1.17% SunTrust $1251.37%1.47% ABN ARMCO $1071.18%0.87%

5. Drake Drake University Fin 129 Traditional Services Depository Institutions have been traditionally been subject to a large amount of regulation that restricted their actions. Main business functions: Main overlap with other FI’s has been in Savings products – That has changed dramatically in the last 10 years.

6. Drake Drake University Fin 129 Competition among FI’s

7. Drake Drake University Fin 129 Key Regulatory Legislation National Currency and Bank Acts (1863-64) Set up system of federally chartering banks through US Treas Dept. or Comptroller of Currency or Administrator of National Banks Comptroller of the Currency examines all nationally chartered banks every 12 to 18 months Established pledging requirements for owners equity

8. Drake Drake University Fin 129 Key Regulatory Legislation The Federal Reserve Act (1913) Established the Federal Reserve System as a lender of last resort Established network to clear and collect checks

9. Drake Drake University Fin 129 Key Legislation McFadden Act (1927) National banks allowed branches in their original city. Branching across state lines forbidden unless allowed by state law Liberalized banks’ underwriting activities and allowed underwriting of corporate stocks and bonds

10. Drake Drake University Fin 129 Legislation (continued)... 1933 Glass-Steagall: Separates securities and banking activities Prohibited commercial banks from most underwriting of securities. 4 exceptions: Munis, US govt, Private Placement and Real Estate Loans. Fear of conflict of interest

11. Drake Drake University Fin 129 Legislation (continued)... Bank Holding Company Act and subsequent amendments (1956 1966 and 1970) Specifies permissible activities and regulation by Fed Res of Bank Holding Cos. Bank Holding Companies must request Fed Approval Co’s with 2 or more banks must register with Fed Res and file financial statements and submit to Fed Res review of their books 1970 Amendments to the Bank Holding Company Act: Extension to one-bank holding companies

12. Drake Drake University Fin 129 Legislation (continued)... 1970 International Banking Act: Regulated foreign bank branches and agencies in USA 1980 Depository Institutions Deregulation and Monetary Control Act Phased out interest rate ceilings imposed by Regulation Q Goal was to make S&L’s, credit unions and other nonbank depository institutions more competitive.

13. Drake Drake University Fin 129 Legislation (continued)… Depository Institutions Act (1982) Garn-St. Germain Depository Institutions Act) Allowed all federally supervised depository Institutions to sell deposit accounts equivalent to Money market mutual fund accounts Loan limits were liberalized for national banks, allowed lending of up to 15% of their capital FDIC could arrange mergers across state lines for failing institutions Competitive Equality in Banking Act (1987) Redefined bank to limit growth of nonbank banks.

14. Drake Drake University Fin 129 Legislation (continued)… Financial Institutions Reform Recovery and Enforcement Act (1989) Imposed restrictions on investment activities Replaced FSLIC with FDIC-SAIF Replaced FHLB with Office of Thrift Supervision Created Resolution Trust Corporation

15. Drake Drake University Fin 129 Legislation (continued)… 1991 FDIC Improvement Act Fear of FDIC insolvency by end of 1991 Ordered new measurement scale for describing financial condition of depository institution and when in violation to take “prompt corrective action” Risk-based deposit insurance premiums

16. Drake Drake University Fin 129 Legislation (continued)… Riegle-Neal Interstate Banking and Branching Efficiency Act (1994) Permits BHCs to acquire banks in other states. Invalidates some restrictive state laws. Permits BHCs to convert out-of-state subsidiary banks to branches of single interstate bank. Newly chartered branches permitted interstate if allowed by state law.

17. Drake Drake University Fin 129 1999 Financial Services Modernization Act Financial Services Modernization Act Allowed banks, insurance companies, and securities firms to enter each others’ business areas Provided for state regulation of insurance Streamlined regulation of BHCs Prohibited FDIC assistance to affiliates and subsidiaries of banks and savings institutions Provided for national treatment of foreign banks ATM fees must be clearly disclosed Federal Crime to steal account information

18. Drake Drake University Fin 129 FDIC Structural Changes http://www2.fdic.gov/hsob/SelectRpt.asp?EntryTyp=10

19. Drake Drake University Fin 129 Unresolved Issues Does regulatory approval limit the ability of banks to respond to new markets? Will functional regulation work (can regulatory agencies work together?) Can and will countries work together as institutions become more global?

20. Drake Drake University Fin 129 Bank Size (by asset concentration) Community banks – The asset share of banks over $1Billion has increased from 63.4% in 1984 to 83.9% in 2000. Large banks often have access to cheaper forms of cash. Money Center Banks –

21. Drake Drake University Fin 129 Balance Sheet Assets - four major categories Cash and deposits held at other institutions Government and private interest bearing securities Loans and leases Misc assets. Liabilities – two major categories

22. Drake Drake University Fin 129 Assets Cash (Primary Reserves) – includes vault cash, reserves at the Fed Res, deposits at other banks, checks in the process of collection. Designed to meet liquidity needs Investment Securities Liquid portion (Secondary Reserves) – ST Gov’t securities, money market securities, commercial paper, time deposits Income Generating portion – Bonds notes and other securities (taxable and tax exempt). Trading account securities – bank serve as a security dealer for state, federal and local gov’t obligations. Bank intends to sell these prior to maturity

23. Drake Drake University Fin 129 Assets (continued) Loans Largest portion of assets form most banks Includes consumer, real estate, business, ag production, leases and foreign loans. Most statements include a gross loan amount and an allowance for loan loss (balance is built with deductions from current income, when a loan is uncollectable then balance is reduced. Therefore both the gross account and loss account change. And net income is not impacted.)

24. Drake Drake University Fin 129 Assets (continued) Federal Funds sold and Securities Purchased under Repurchase agreements Short term loans… Customers Liability on Acceptances A line of credit provided via a letter of credit backing purchases by the customer. Miscellaneous Assets Bank buildings, equipment, prepaid insurance etc.

25. Drake Drake University Fin 129 FDIC Assets, % of Total Assets

26. Drake Drake University Fin 129 Federal Reserve Board Type of Loans, % of Total

27. Drake Drake University Fin 129 Federal Reserve Board Loan Portfolios 2000 Real Estate 62.77% C&I 17.96% Credit Card 1.55% Consumer 10.98% Other 6.74% Real Estate 39.85% C&I 29.38% Credit Card 7.55% Other 14.10% Consumer 9.12% Large Banks Small Banks <$1 Billion

28. Drake Drake University Fin 129 Asset Quality QBP 3/31/05

29. Drake Drake University Fin 129 Liabilities Largest portion of liabilities is deposits Average ratio of equity to assets = 8.49% (91.51% of asses are financed by some type of debt..) Approximately 21% of deposits are transaction accounts (checkable deposits that cost little or no interest) Retail savings and time deposits have been declining due to competition form money market mutual funds

30. Drake Drake University Fin 129 Deposits Non-interest bearing demand deposits Checking accounts with unlimited check writing Savings deposits NOW accounts Money market deposit accounts Time deposits

31. Drake Drake University Fin 129 FDIC Liabilities and Equity % of Total

32. Drake Drake University Fin 129 Assets Vs. Liabilities Generally liabilities tend to be of shorter maturity than assets. This introduces interest rate risk and liquidity risk for depository institutions.

33. Drake Drake University Fin 129 Equity Usually about 8 to 10 % of liabilities and equity Generally equity held is close to the minimum amount set by regulations

34. Drake Drake University Fin 129 Income Net Interest Income Non Interest Income

35. Drake Drake University Fin 129 Revenues from QBP 3/31/2005

36. Drake Drake University Fin 129 Recent changes in Interest Margin QBP 3/31/05

37. Drake Drake University Fin 129 Improving Credit Conditions QBP 3/31/05

38. Drake Drake University Fin 129 Other Fee Generating Activities Trust Services Management of estate assets and pension fund assets Correspondent Banking Providing banking services to smaller institutions that do not have the staff or expertise in those services.

39. Drake Drake University Fin 129 Other Recent Trends 1 st quarter 2005 no bank failures – 3 rd straight quarter without a failure – 2 nd longest streak in last 15 years. About ½ as many “problem institutions” compared to same time as last year.

40. Drake Drake University Fin 129 Off - Balance Sheet Activities Assets and Liabilities that will appear on the balance sheet or income statement if a contingent event occurs. Motivated by both earnings and regulatory (tax avoidance) incentives.

41. Drake Drake University Fin 129 OBS Activities continued Standby Credit Agreements- bank pledges to guarantee repayment of a customers’ loan received from a third party Interest rate swaps – exchange interest payments on debt securities with another party Financial futures and options Loan commitments – pledge to lend up to a certain amount of funds Foreign exchange rate contracts

42. Drake Drake University Fin 129 Derivative Contracts QBP 3/31/05

43. Drake Drake University Fin 129 Recent Changes in Home Equity Credit QBP 3/31/05

44. Drake Drake University Fin 129 Derivative Use Use of derivative increased by 4% to $91.9 Trillion in notional value in the first quarter of 2005 (QBP). Most of the increase were in interest rate derivatives used in trading and in credit derivatives.

45. Drake Drake University Fin 129 Savings Associations Primarily deal with household saving and mortgages. Financing long term mortgages with short term deposits has been helped by a traditionally upward sloping yield curve.

46. Drake Drake University Fin 129 S&L Regulation Traditionally restricted in the type of accounts they could offer the regulation in the early 1980’s allowed S&L’s to become more competitive with commercial banks. Most notably the repeal of Regulation Q. Also allowed to offer NOW accounts and more market sensitive money market accounts

47. Drake Drake University Fin 129 Savings Banks Originally organized as a mutual organization that also focused on mortgage lending Many are now switching to stock ownership

48. Drake Drake University Fin 129 Credit Unions Nonprofit depository institutions that are mutually organized. Members must belong to a specific similar occupation, association or live in a given community.