Chapter Fourteen Other Lending Institutions Savings Institutions Credit

Chapter Fourteen Other Lending Institutions: Savings Institutions, Credit Unions, and Finance Companies Mc. Graw-Hill/Irwin 8 -1 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

Savings Institutions (SIs) • Historically referred to as Savings and Loans (S&Ls) • Savings banks (SBs) appeared in the 1980 s • Specialize in long-term residential mortgages, which are usually financed with short-term deposits of small savers • Faced a huge crisis during the 1982 -1992 period that saw over half of all SIs fail Mc. Graw-Hill/Irwin 14 -2 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

The S&L Crisis of 1982 -1992 • Some 4, 000 SIs existed at the end of the 1970 s • By 2007, only 1, 257 SIs exist • The Federal Reserve radically changed its monetary policy during October 1979 to October 1982 – – targeted reserves rather than interest rates led to sudden surge in interest rates many SIs faced negative spreads SIs lost depositors because of Regulation Q Mc. Graw-Hill/Irwin 14 -3 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

The S&L Crisis of 1982 -1992 • Depository Institutions Deregulations and Monetary Control Act (DIDMCA) of 1980 and Garn-St. Germain Depository Institutions Act (GSGDIA) of 1982 addressed the crisis – allowed interest-bearing transaction accounts – allowed SIs to offer floating- or adjustable-rate mortgages – allowed expansion into real estate development and commercial lending – some SIs chose to invest in the junk bond market and suffered large losses when the junk bond market collapsed in the mid 1980 s Mc. Graw-Hill/Irwin 14 -4 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

The S&L Crisis of 1982 -1992 • Real estate and land prices collapsed in many areas of the U. S. in the mid-1980 s – many mortgages defaulted as a result • The Federal Savings and Loan Insurance Corporation (FSLIC) had a policy of regulatory forbearance – i. e. , its policy was to not close economically insolvent FIs, allowing them to continue to operate • 1, 248 SIs failed in the 1982 to 1992 period – the FSLIC became massively insolvent as a result Mc. Graw-Hill/Irwin 14 -5 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

The S&L Crisis of 1982 -1992 • The Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of 1989 – abolished the FSLIC – created 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 SIs – the 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 faster Mc. Graw-Hill/Irwin 14 -6 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

SI Balance Sheets (2007) • Mortgages and mortgage backed securities (MBSs) represent 73. 2% of total assets – compares to 33. 7% for commercial banks • Commercial loans represent 3. 9% of total assets – compares to 11. 7% for commercial banks • Consumer loans represent 5. 0% of total assets – compares to 8. 4% for commercial banks • Cash and investment securities represent 10. 1% of total assets – compares to 32. 3% for commercial banks Mc. Graw-Hill/Irwin 14 -7 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

SI Balance Sheets (2007) • Transaction accounts and small time deposits are the predominant source of funds for SIs – total deposits account for 65. 9% of total liabilities and net worth • The 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 contribution – 11. 9% compares to 10. 1% for commercial banks – most SIs were historically mutual organizations – many have switched to stock charters in order to more easily attract capital investment Mc. Graw-Hill/Irwin 14 -8 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

Regulation of SIs • The primary regulator of nationally chartered SIs is the Office of Thrift Supervision (OTS) – established in 1989 under the FIRREA • State agencies regulate state chartered SIs • The FDIC oversees the deposit insurance fund of SIs – the Savings Association Insurance Fund (SAIF) from 1989 to 2007 – the Deposit Insurance Fund (DIF) since January 2007 Mc. Graw-Hill/Irwin 14 -9 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

Recent Trends for SIs • Experienced record profits in the mid- to late 1990 s as interest rates were low and the U. S. economy prospered • Like commercial banks, SIs experienced substantial consolidation in the 1990 • The downturn in the U. S. economy eroded SIs’ profitability in 2000 • The subprime mortgage crisis of the mid-2000 s has hit SIs quite hard Mc. Graw-Hill/Irwin 14 -10 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

Credit Unions (CUs) • Not-for-profit depository institutions mutually organized and owned by their members (depositors) • First established in the early 1900 s as self-help organizations – members deposit savings and the funds are lent to other members • CUs 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 taxed – offer higher interest rates than commercial banks on deposits – charge lower interest rates than commercial banks on loans Mc. Graw-Hill/Irwin 14 -11 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

Credit Unions (CUs) • Most numerous of all depository institutions: 8, 329 CUs in 2007 • Less affected by the crisis of the 1980 s that hit SIs and CBs hard – traditionally, more than 40% of their assets are in small consumer loans – loans are funded with deposits – tend to hold large amounts of government securities as assets – hold small amounts of residential mortgages Mc. Graw-Hill/Irwin 14 -12 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

Credit Unions (CUs) • National credit union system consists of three tiers – U. S. Central Credit Union is the top tier • provides investment and liquidity services to Corporate CUs – 34 Corporate Credit Unions comprise the middle tier at the state or regional level • cooperatively owned by their member CUs • serve members by investing and lending excess funds that member CUs place with them • provide settlement services, securities safekeeping, etc. – individual credit unions make up the bottom tier Mc. Graw-Hill/Irwin 14 -13 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

Credit Unions (CUs) • Recently CUs have expanded their services to compete with CBs and SIs – many have converted to a common charter to expand their customer base – now offer mortgages, credit lines, and ATMs – some offer business and commercial loans to their employer groups • Banking industry challenged CU expansion in 1997 – Supreme Court sided with the banking industry – Congress quickly passed a bill that sided with CUs Mc. Graw-Hill/Irwin 14 -14 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

CU Balance Sheets (2007) • Total assets of all CUs is less than the total assets of the single largest commercial bank – total assets of all CUs is $748. 3 billion – total assets of Citigroup alone is $2, 358. 3 billion • Consumer loans represent 31. 8% of total assets – compares to 8. 4% at CBs and 5. 0% at SIs • Home mortgages represent 40. 2% of total assets – compares to 33. 7% at CBs and 73. 2% at SIs • Investment securities represent 18. 1% of total assets – compares to 27. 9% at CBs and 8. 0% at SIs – 54. 7% of the investment portfolio is in U. S. government or federal agency securities Mc. Graw-Hill/Irwin 14 -15 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

CU Balance Sheets (2007) • 86. 3% of total funding comes from member deposits – compares to 65. 9% for CBs and 61. 1% for SIs – share draft transaction accounts account for 36. 0% of all CU deposits – certificates of deposit (CDs) account for 22. 8% of all CU deposits – money market deposit accounts (MMDAs) account for 18. 4% of CU deposits – share accounts account for 13. 0% of CU deposits • CU equity is the accumulation of past earnings that is “owned” collectively by member depositors Mc. Graw-Hill/Irwin 14 -16 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

CU Regulators and Performance • 62. 1% of CUs are federally chartered – regulated 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 level • Assets grew by more than 10% annually from 1999 to 2007 • Membership increased from 63. 6 million to 90. 2 million from 1999 to 2007 • ROA decreased from 1999 to 2007, but not a huge concern as CUs are not-for-profit organizations Mc. Graw-Hill/Irwin 14 -17 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

Finance Companies (FCs) • There are three major types of finance companies (FCs) – sales finance institutions specialize in loans to customers of a particular retailer or manufacturer – personal credit institutions specialize in installment and other loans to consumer – business credit institutions specialize in business loans, especially through factoring • factoring is the process of purchasing accounts receivables from corporations, usually with no recourse to the seller should the receivables go bad Mc. Graw-Hill/Irwin 14 -18 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

Finance Companies (FCs) • Industry assets were $2, 159. 7 billion in 2007 • FC industry is highly concentrated – the 20 largest FCs account for more than 75% of industry assets – many 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. Mc. Graw-Hill/Irwin 14 -19 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

Balance Sheets of FCs (2007) • Business and consumer loans (called accounts receivables) represent 54. 0% of total assets • Consumer loans include motor vehicle loans and leases and other loans, which are often at higher interest rates than CBs because FCs lend to riskier customers – subprime lenders are FCs that lend to high risk customers – loan sharks are subprime lenders that charge unfairly exorbitant rates to desperate subprime borrowers – payday lenders provide short-term cash advances that are often due when borrowers receive their next paycheck Mc. Graw-Hill/Irwin 14 -20 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

Balance 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 offer – do not accept deposits—accordingly, bank-type regulators do not monitor their behavior – often have substantial industry and product expertise – are more willing to accept risky customers – generally have lower overhead than CBs Mc. Graw-Hill/Irwin 14 -21 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

Balance Sheets of FCs (2007) • Real estate loans represent 26. 1% of total assets – second 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 home – securitized mortgage assets are mortgages purchased and used as assets backing secondary market securities – mortgage 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 vehicles Mc. Graw-Hill/Irwin 14 -22 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

FC Performance and Regulators • Problems arose in the FC industry in the mid-2000 s with the crash of the market for subprime mortgage loans – many FCs saw sharply lower equity values • FCs are subject to state imposed usury ceilings • Because FCs do not accept deposits, they are not subject to the extensive oversight that CBs, SIs, and CUs are • FCs signal their safety and soundness to investors with higher capital-to-assets ratios Mc. Graw-Hill/Irwin 14 -23 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved

Global Issues • Unlike the U. S. , SIs in Europe traditionally catered to the commercial industry • The majority of SIs in Europe are mutually owned • SIs worldwide are quite small compared to CBs • Nonbank FI lending has increased in both Latin America and in Europe in the last decade • Postal SIs exist in about 30 countries throughout the world, mostly in Europe – operate virtually as full-service banks – many post offices have savings products linked to stock markets Mc. Graw-Hill/Irwin 14 -24 © 2009, The Mc. Graw-Hill Companies, All Rights Reserved