Other Lending Institutions: Savings Institutions, Credit Unions, and Finance Companies

8-1McGraw-Hill/IrwinChapter FourteenOther Lending Institutions: Savings Institutions, Credit Unions, and Finance Companies14-2McGraw-Hill/IrwinSavings Institutions (SIs)Historically referred to as Savings and Loans (S&Ls)Savings banks (SBs) appeared in the 1980sSpecialize in long-term residential mortgages, which are usually financed with short-term deposits of small saversFaced a huge crisis during the 1982-1992 period that saw over half of all SIs fail14-3McGraw-Hill/IrwinThe S&L Crisis of 1982-1992Some 4,000 SIs existed at the end of the 1970sBy 2007, only 1,257 SIs existThe Federal Reserve radically changed its monetary policy during October 1979 to October 1982targeted reserves rather than interest ratesled to sudden surge in interest ratesmany SIs faced negative spreadsSIs lost depositors because of Regulation Q14-4McGraw-Hill/IrwinThe S&L Crisis of 1982-1992Depository Institutions Deregulations and Monetary Control Act (DIDMCA) of 1980 and Garn-St. Germain Depository Institutions Act (GSGDIA) of 1982 addressed the crisisallowed interest-bearing transaction accountsallowed SIs to offer floating- or adjustable-rate mortgagesallowed expansion into real estate development and commercial lendingsome SIs chose to invest in the junk bond market and suffered large losses when the junk bond market collapsed in the mid-1980s14-5McGraw-Hill/IrwinThe S&L Crisis of 1982-1992Real estate and land prices collapsed in many areas of the U.S. in the mid-1980smany mortgages defaulted as a resultThe Federal Savings and Loan Insurance Corporation (FSLIC) had a policy of regulatory forbearancei.e., its policy was to not close economically insolvent FIs, allowing them to continue to operate1,248 SIs failed in the 1982 to 1992 periodthe FSLIC became massively insolvent as a result14-6McGraw-Hill/IrwinThe S&L Crisis of 1982-1992The Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of 1989abolished the FSLICcreated a new Savings Association Insurance Fund (SAIF) that was put under the management of the Federal Deposit Insurance Corporation (FDIC)replaced the Federal Home Loan Bank Board with the Office of Thrift Supervision (OTS)created the Resolution Trust Corporation (RTC) to close and liquidate insolvent SIsthe Qualified Thrift Lender Test (QTL) sets a floor on the mortgage-related assets that thrifts must hold (currently at 65%)introduced Prompt Corrective Action (PCA), which mandates that regulators must close problem banks and thrifts faster14-7McGraw-Hill/IrwinSI Balance Sheets (2007)Mortgages and mortgage backed securities (MBSs) represent 73.2% of total assetscompares to 33.7% for commercial banksCommercial loans represent 3.9% of total assetscompares to 11.7% for commercial banksConsumer loans represent 5.0% of total assetscompares to 8.4% for commercial banksCash and investment securities represent 10.1% of total assetscompares to 32.3% for commercial banks14-8McGraw-Hill/IrwinSI Balance Sheets (2007)Transaction accounts and small time deposits are the predominant source of funds for SIstotal deposits account for 65.9% of total liabilities and net worthThe second most important source of funds is borrowings from the 12 Federal Home Loan Banks (FHLBs)Net worth is the book value of the equity holders’ capital contribution11.9% compares to 10.1% for commercial banksmost SIs were historically mutual organizationsmany have switched to stock charters in order to more easily attract capital investment14-9McGraw-Hill/IrwinRegulation of SIsThe primary regulator of nationally chartered SIs is the Office of Thrift Supervision (OTS)established in 1989 under the FIRREAState agencies regulate state chartered SIsThe FDIC oversees the deposit insurance fund of SIsthe Savings Association Insurance Fund (SAIF) from 1989 to 2007the Deposit Insurance Fund (DIF) since January 200714-10McGraw-Hill/IrwinRecent Trends for SIsExperienced record profits in the mid- to late-1990s as interest rates were low and the U.S. economy prosperedLike commercial banks, SIs experienced substantial consolidation in the 1990The downturn in the U.S. economy eroded SIs’ profitability in 2000The subprime mortgage crisis of the mid-2000s has hit SIs quite hard14-11McGraw-Hill/IrwinCredit Unions (CUs)Not-for-profit depository institutions mutually organized and owned by their members (depositors)First established in the early 1900s as self-help organizationsmembers deposit savings and the funds are lent to other membersCUs are prohibited from serving the general public—i.e., members are required to have a common bond of occupation, association, etc.Because CUs are not-for-profit, their earnings are not taxedoffer higher interest rates than commercial banks on depositscharge lower interest rates than commercial banks on loans14-12McGraw-Hill/IrwinCredit Unions (CUs)Most numerous of all depository institutions: 8,329 CUs in 2007Less affected by the crisis of the 1980s that hit SIs and CBs hardtraditionally, more than 40% of their assets are in small consumer loansloans are funded with depositstend to hold large amounts of government securities as assetshold small amounts of residential mortgages14-13McGraw-Hill/IrwinCredit Unions (CUs)National credit union system consists of three tiersU.S. Central Credit Union is the top tierprovides investment and liquidity services to Corporate CUs34 Corporate Credit Unions comprise the middle tier at the state or regional levelcooperatively owned by their member CUsserve members by investing and lending excess funds that member CUs place with themprovide settlement services, securities safekeeping, etc.individual credit unions make up the bottom tier14-14McGraw-Hill/IrwinCredit Unions (CUs)Recently CUs have expanded their services to compete with CBs and SIsmany have converted to a common charter to expand their customer basenow offer mortgages, credit lines, and ATMssome offer business and commercial loans to their employer groupsBanking industry challenged CU expansion in 1997Supreme Court sided with the banking industryCongress quickly passed a bill that sided with CUs14-15McGraw-Hill/IrwinCU Balance Sheets (2007)Total assets of all CUs is less than the total assets of the single largest commercial banktotal assets of all CUs is $748.3 billiontotal assets of Citigroup alone is $2,358.3 billionConsumer loans represent 31.8% of total assetscompares to 8.4% at CBs and 5.0% at SIsHome mortgages represent 40.2% of total assetscompares to 33.7% at CBs and 73.2% at SIsInvestment securities represent 18.1% of total assetscompares to 27.9% at CBs and 8.0% at SIs54.7% of the investment portfolio is in U.S. government or federal agency securities14-16McGraw-Hill/IrwinCU Balance Sheets (2007)86.3% of total funding comes from member depositscompares to 65.9% for CBs and 61.1% for SIs share draft transaction accounts account for 36.0% of all CU depositscertificates of deposit (CDs) account for 22.8% of all CU depositsmoney market deposit accounts (MMDAs) account for 18.4% of CU depositsshare accounts account for 13.0% of CU depositsCU equity is the accumulation of past earnings that is “owned” collectively by member depositors14-17McGraw-Hill/IrwinCU Regulators and Performance62.1% of CUs are federally charteredregulated by the National Credit Union Administration (NCUA)deposit insurance is provided by the National Credit Union Share Insurance Fund (NCUSIF)Remaining CUS are regulated at the state levelAssets grew by more than 10% annually from 1999 to 2007Membership increased from 63.6 million to 90.2 million from 1999 to 2007ROA decreased from 1999 to 2007, but not a huge concern as CUs are not-for-profit organizations14-18McGraw-Hill/IrwinFinance Companies (FCs)There are three major types of finance companies (FCs)sales finance institutions specialize in loans to customers of a particular retailer or manufacturerpersonal credit institutions specialize in installment and other loans to consumerbusiness credit institutions specialize in business loans, especially through factoringfactoring is the process of purchasing accounts receivables from corporations, usually with no recourse to the seller should the receivables go bad14-19McGraw-Hill/IrwinFinance Companies (FCs)Industry assets were $2,159.7 billion in 2007FC industry is highly concentratedthe 20 largest FCs account for more than 75% of industry assetsmany of the largest FCs are captive subsidiaries (i.e., wholly owned subsidiaries of parent corporations)GMAC Commercial Mortgage Corp., a FC subsidiary of General Motors Acceptance Corp. (GMAC), is the largest business unit of General Motors and is the largest commercial lender in the U.S.14-20McGraw-Hill/IrwinBalance Sheets of FCs (2007)Business and consumer loans (called accounts receivables) represent 54.0% of total assetsConsumer loans include motor vehicle loans and leases and other loans, which are often at higher interest rates than CBs because FCs lend to riskier customerssubprime lenders are FCs that lend to high risk customersloan sharks are subprime lenders that charge unfairly exorbitant rates to desperate subprime borrowerspayday lenders provide short-term cash advances that are often due when borrowers receive their next paycheck14-21McGraw-Hill/IrwinBalance Sheets of FCs (2007)FCs often have advantages over CBs with respect to business loans because FCs:are not subject to regulations that restrict the type of products and services they can offerdo not accept deposits—accordingly, bank-type regulators do not monitor their behavioroften have substantial industry and product expertiseare more willing to accept risky customersgenerally have lower overhead than CBs14-22McGraw-Hill/IrwinBalance Sheets of FCs (2007)Real estate loans represent 26.1% of total assetssecond mortgages are in the form of home equity loans, i.e., loans that let customers borrow on a line of credit secured with a second mortgage on their homesecuritized mortgage assets are mortgages purchased and used as assets backing secondary market securitiesmortgage servicing is a fee-related activity whereby the flow of mortgage repayments is collected and passed on to investors in whole mortgage loan packages or securitization vehicles14-23McGraw-Hill/IrwinFC Performance and RegulatorsProblems arose in the FC industry in the mid-2000s with the crash of the market for subprime mortgage loansmany FCs saw sharply lower equity valuesFCs are subject to state imposed usury ceilingsBecause FCs do not accept deposits, they are not subject to the extensive oversight that CBs, SIs, and CUs areFCs signal their safety and soundness to investors with higher capital-to-assets ratios14-24McGraw-Hill/IrwinGlobal IssuesUnlike the U.S., SIs in Europe traditionally catered to the commercial industryThe majority of SIs in Europe are mutually ownedSIs worldwide are quite small compared to CBsNonbank FI lending has increased in both Latin America and in Europe in the last decadePostal SIs exist in about 30 countries throughout the world, mostly in Europeoperate virtually as full-service banksmany post offices have savings products linked to stock markets