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THRIFT OPERATIONS

THRIFT OPERATIONS. CHAPTER 21. BACKGROUND ON SAVINGS INSTITUTIONS. S&L are dominant form of this type of depository institution; Savings Bank is other California had the Largest S&L (Downey → US Bank) New York has the largest SB (Dime, 1864)

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THRIFT OPERATIONS

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  1. THRIFT OPERATIONS CHAPTER 21 Dr David P Echevarria

  2. BACKGROUND ON SAVINGS INSTITUTIONS • S&L are dominant form of this type of depository institution; Savings Bank is other • California had the Largest S&L (Downey → US Bank) • New York has the largest SB (Dime, 1864) • Chartered by OTS (Federal banks) or State commissions • OTS is oversight body for federally chartered banks • Mutual (depositor owned) or Stock (investor owned) • Deposit insurance provided by FDIC Dr David P Echevarria

  3. SOURCES OF FUNDSRHS of Balance Sheet (Liabilities) • Deposits; SB = 72%, S&L=76% • Pass-book savings (traditional) • Money Market Deposit Accounts (Garn-St. Germaine Act, 1982) • Certificates of Deposit (higher rates than pass-book, penalty for early withdrawal) • NOW accounts ( DIDMCA, 1980) Dr David P Echevarria

  4. SOURCES OF FUNDSRHS of Balance Sheet (Liabilities) • Capital Markets; SB = 23%, S&L=23% • Mutual; borrowing via repo agreements or from the FHLBB • Stock; selling of equity • Capital; SB=5%, S&L=2% • Retained earnings and common stock (for non-mutual) • Earnings a function of the spread (Loan rate - rate paid to depositors) • Size of capital base important factor in ability to weather financial storms Dr David P Echevarria

  5. USES OF FUNDSLHS of Balance Sheet (Assets) • Cash and Investments • Service depositor withdrawal demands • Portion of required reserves held as cash • Mortgages • Single most important asset and source of risk • Preference for fully collateralized loans Dr David P Echevarria

  6. USES OF FUNDSLHS of Balance Sheet (Assets) • Mortgage-Backed Securities • Package and sell to individual and institutional investors • Retain servicing of loan on fee-basis • Consumer and Commercial Loans • Automobiles for consumers (collateralized) • Commercial Real Estate (ditto) • Other Uses of Funds (Repos) Dr David P Echevarria

  7. RISK MANAGEMENT • Liquidity Risk: savings institutions typically have • Short-term liabilities • Long-term assets • Default Risk; dealing with non-performing loans • Narrow capital base and thin margins makes banks sensitive to non-performing loans • Managing Default Risk is a function of managing the credit policy • Interest Rate Risk; managing impact of interest rate volatility • Fluctuations in the values of the asset portfolio and its liabilities • Assets tend to have fixed rates; liabilities tend to be subject to variable rates Dr David P Echevarria

  8. RISK MANAGEMENT • Net Interest Margin = (Interest Revenues - Interest Expenses) / Assets Note that IR - IE reflects the spread; the spread is not stable, hence the risk Computing the GAP = Rate-sensitive assets (uses) - Rate-sensitive liabilities (sources) • GAP Ratio = $ value of rate-sensitive assets / $ value of rate-sensitive liabilities • When ratio ≥ 1.00 bank is okay • When ratio is < 1.00, bank has a interest rate risk exposure in need of hedging Degree of interest-rate sensitivity is measured using Duration Dr David P Echevarria

  9. RISK MANAGEMENT • Managing Interest Rate Risk • Adjustable-Rate Mortgages (ARMS); variable rate assets • Financial Futures Contracts; • Short positions hedge fixed-rate loans • As interest rates rise, profits on hedge offsets losses on fixed rate loans • Interest Rate Swaps; exchanging fixed for floating rate instruments • Mortgages tend to be fixed rate, rates paid to depositors tend to vary w/market • Obtaining the interest flow of floating rate instruments help to manage sensitivity • Interest Rate Caps; maximum rate to be paid as market rates change over time Dr David P Echevarria

  10. CREDIT UNIONS • Affinity Bond; i.e., Navy Federal Credit Union (multi-national in scope) • More than 10,000 CU in US; Many have less than $100 Million in assets • Objectives Of Credit Unions; provide loans to those who might otherwise be unable • Obtain funds at a reasonable cost from depositors • Members own the CU and vote for officers of the unions and for all rule making • May be Federal or state chartered • Principal Regulatory body is the NCUA; 6 regional offices report to 3 member board • Grant and revoke charters • Examines financial condition • State chartered institutions insured by NCUA subject to oversight Dr David P Echevarria

  11. SOURCES AND USES OF CREDIT UNION FUNDS • Savings deposits and Share Draft accounts form the principal sources • Loans to members are the main use of funds. Also have Lines of Credit, Mortgages, • CD's and money market accounts • Profits are paid out to members as interest on their average balances • Temporary funds may be obtained from the Central Liquidity Facility (CLF) Dr David P Echevarria

  12. CREDIT UNION RISK EXPOSURE • Liquidity Risk; high levels of withdrawals may create cash flow problems • Default Risk; most loans are consumer type and generally collateralized • Interest Rate Risk; assets and liabilities are both rate sensitive and correlated. Therefore, this is not a source of concern to CU Dr David P Echevarria

  13. HOMEWORK QUESTIONS • Describe the asset, liability, and equity structure of depository institutions • What federal legislation helped savings institutions become more competitive? • What particular problems do banks face from; liquidity risk? Default risk? Interest-rate risk? (Details are what count here.) • Why is the capital (or equity) position of a depository institution important? • What are the essential reasons for an interest rate swap? Dr David P Echevarria

  14. HOMEWORK QUESTIONS • How does the swap work? • In what ways do credit unions differ from S&L? • What agency is responsible for credit union oversight? • Who insures credit union deposits? • Do credit unions have any advantages over S&Ls? any disadvantages? Dr David P Echevarria

  15. SAVINGS AND LOAN CRISIS • Reasons for Failure; • Non-performing loans leading to forced liquidations and resulting losses • Losses on poor investments; junk bonds, commercial real estate • Bank management fraud and embezzlement; long list of "players." • Provisions of FIRREA (1989); Financial Inst. Reform, Recovery & Enforcement Act • Increased authority over state chartered institutions • Abolished FSLIC and FHLBB. FDIC reorganized into BIF, SAIF divisions • Created the RTC and Office of Thrift Supervision • Permitted Bank Holding Companies (BHC) to acquire healthy thrifts • Stiffened penalties for fraud and embezzlement • Created the Federal Housing Finance Board to oversee 12 FHL Banks • Required regulators to develop and enforce minimum standards for property appraisal • Lowered tax benefits to acquirers of failed or failing thrifts Dr David P Echevarria

  16. SAVINGS AND LOAN CRISIS • Provisions of FDICIA (1991); Federal Deposit Insurance Corp. Improvement Act • Deposit insurance premiums based on riskiness of institution • Detailed rules for the conduct of federal regulators • Increased borrowing authority for FDIC and reserve requirements • Established a "tripwire" system for early problem detection • Expanded FDIC authority over foreign bank expansion and termination's in US required foreign banks to obtain insurance • Restricted activities of state chartered thrifts to those permitted to federally chartered thrifts Dr David P Echevarria

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