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Chapter FourteenOther Lending Institutions: Savings Institutions, Credit Unions, and Finance Companies

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Overview: Other Lending Institutions

• Savings Associations (1,074 in 2004)– concentrated primarily on residential mortgages

• Savings Banks (339 in 2004)– large concentration of residential mortgages– commercial loans– corporate bonds– corporate stock

• Credit Unions (9,210 in 2004)– consumer loans funded with member deposits

• Finance Companies– Make loans to individuals and businesses

• Savings Associations (1,074 in 2004)– concentrated primarily on residential mortgages

• Savings Banks (339 in 2004)– large concentration of residential mortgages– commercial loans– corporate bonds– corporate stock

• Credit Unions (9,210 in 2004)– consumer loans funded with member deposits

• Finance Companies– Make loans to individuals and businesses

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Savings Associations

• Historically referred to as savings and loan (S&L) associations

• Net interest margin - interest income minus interest expense divided by earning assets

• Disintermediation - withdrawal of deposits from depository institutions to be reinvested elsewhere, e.g., money market mutual funds

• Regulation Q ceiling - an interest ceiling imposed on small savings and time deposits at banks and thrifts until 1986 (continued)

• Historically referred to as savings and loan (S&L) associations

• Net interest margin - interest income minus interest expense divided by earning assets

• Disintermediation - withdrawal of deposits from depository institutions to be reinvested elsewhere, e.g., money market mutual funds

• Regulation Q ceiling - an interest ceiling imposed on small savings and time deposits at banks and thrifts until 1986 (continued)

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• Regulator forbearance - a policy of the FSLIC not to close economically insolvent FIs, allowing them to continue in operation

• Savings institutions - savings association and savings banks combined

• Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of 1989 - abolished the FSLIC and created a new savings association insurance fund (SAIF) under the management of the FDIC

• QTL test- qualified thrift lender test that sets a floor on the mortgage-related assets that thrifts can hold

• Mutual organization - an institution in which the liability holders are also the owners

• Regulator forbearance - a policy of the FSLIC not to close economically insolvent FIs, allowing them to continue in operation

• Savings institutions - savings association and savings banks combined

• Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of 1989 - abolished the FSLIC and created a new savings association insurance fund (SAIF) under the management of the FDIC

• QTL test- qualified thrift lender test that sets a floor on the mortgage-related assets that thrifts can hold

• Mutual organization - an institution in which the liability holders are also the owners

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Balance Sheets of Savings Associations (percentage of total assets and liabilities)

Item 1977 1982 Liabilities Fixed ceiling liabilities 87.3% 22.0%Market ceiling small time deposits 0.0 52.8Discretionary liabilities 8.6 23.2Other liabilities 4.0 2.0

Assets Mortgage assets 86.0 81.1Fixed rate 86.0 74.9Adjustable rate 0.0 6.2Nonmortgage loans 2.3 2.6Cash and investments 9.2 11.2Other assets 2.5 5.1

Item 1977 1982 Liabilities Fixed ceiling liabilities 87.3% 22.0%Market ceiling small time deposits 0.0 52.8Discretionary liabilities 8.6 23.2Other liabilities 4.0 2.0

Assets Mortgage assets 86.0 81.1Fixed rate 86.0 74.9Adjustable rate 0.0 6.2Nonmortgage loans 2.3 2.6Cash and investments 9.2 11.2Other assets 2.5 5.1

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Real Estate Assets of Savings Associations and Savings Banks

13%

3%

5%

5%

25%

49%

MortgageBackedSecuritiesConstruction andLandDevelopmentCommercial RealEstate Loans

MultifamilyResidential

Other assets

FamilyResidential

13%

3%

5%

5%

25%

49%

MortgageBackedSecuritiesConstruction andLandDevelopmentCommercial RealEstate Loans

MultifamilyResidential

Other assets

FamilyResidential

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Savings Banks

• Established as mutual organizations and largely confined to the East Coast and New England states

• Deposits are insured by the FDIC under the Bank Insurance Fund (BIF)

• Have been allowed greater freedom to diversify into corporate bonds and stocks

• Rely more on deposits than savings associations and have fewer borrowed funds

• Established as mutual organizations and largely confined to the East Coast and New England states

• Deposits are insured by the FDIC under the Bank Insurance Fund (BIF)

• Have been allowed greater freedom to diversify into corporate bonds and stocks

• Rely more on deposits than savings associations and have fewer borrowed funds

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Regulators of Savings Institutions

• Office of Thrift Supervision - established in 1989 under the FIRREA, charters and examines all federal savings institutions and supervises the holding companies of savings institutions

• The FDIC - oversees, manages SAIF and BIF• SAIF - provides insurance coverage for savings

associations• BIF - provides insurance coverage for savings

banks• Other regulators - state-chartered savings

institutions are regulated by state agencies

• Office of Thrift Supervision - established in 1989 under the FIRREA, charters and examines all federal savings institutions and supervises the holding companies of savings institutions

• The FDIC - oversees, manages SAIF and BIF• SAIF - provides insurance coverage for savings

associations• BIF - provides insurance coverage for savings

banks• Other regulators - state-chartered savings

institutions are regulated by state agencies

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Credit Unions

• Are not-for-profit depository institutions mutually organized and owned by their members (depositors)

• CU member deposits (shares) used to provide loans to other members with earnings from these loans used to pay interest on member deposits

• Tend to hold higher levels of equity than other depository institutions

• Can be federally chartered and regulated by NCUA or state chartered and regulated by the state

• Growth is not the primary goal

• Are not-for-profit depository institutions mutually organized and owned by their members (depositors)

• CU member deposits (shares) used to provide loans to other members with earnings from these loans used to pay interest on member deposits

• Tend to hold higher levels of equity than other depository institutions

• Can be federally chartered and regulated by NCUA or state chartered and regulated by the state

• Growth is not the primary goal

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Composition of Credit Union Loan Portfolio, 2004

30%

13%

6%6%6%

22%

17% First MortgageLoansOther Real EstateLoansOther Loans tomembersCredit CardLoansAll otherUnsecured LoansUsed VehicleLoansNew VehicleLoans

30%

13%

6%6%6%

22%

17% First MortgageLoansOther Real EstateLoansOther Loans tomembersCredit CardLoansAll otherUnsecured LoansUsed VehicleLoansNew VehicleLoans

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Composition of Credit Union Investment Portfolio, 2004

18%

8%

16%

2%

56%

Corp Credit UnionInvestments

Other Investments

Bank and S&LCDs

U.S. GovObligations

Fed AgencySecurities

18%

8%

16%

2%

56%

Corp Credit UnionInvestments

Other Investments

Bank and S&LCDs

U.S. GovObligations

Fed AgencySecurities

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Composition of Credit Union Deposits, 2004

36%

23%1%

9%

19%

12% RegularShares

CDs

OtherDeposits

IRAs andKeoghAccountsMoney MarketShares

Share Drafts

36%

23%1%

9%

19%

12% RegularShares

CDs

OtherDeposits

IRAs andKeoghAccountsMoney MarketShares

Share Drafts

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Finance Company Functions

• Originated during the Depression when General Electric Corp. created GE Capital Corp. to finance appliance sales to cash-strapped customers

• In the late 1950’s, banks became more willing to make installment loans so finance companies branched out into leasing and leveraged buyouts

• Willing to lend to riskier borrowers• Often are directly affiliated with manufacturing • Limited regulation

• Originated during the Depression when General Electric Corp. created GE Capital Corp. to finance appliance sales to cash-strapped customers

• In the late 1950’s, banks became more willing to make installment loans so finance companies branched out into leasing and leveraged buyouts

• Willing to lend to riskier borrowers• Often are directly affiliated with manufacturing • Limited regulation

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Three Major Types of Finance Companies

• Sales finance institutions– finance companies specializing in loans to customers of a

particular retailer or manufacturer (e.g., Ford Motor Credit and Sears Roebuck Acceptance Corp.)

• Personal credit institutions– finance companies specializing in installment and other loans

to consumers (e.g., Household Finance Corp. and American General Finance)

• Business credit institutions– finance companies specializing in business loans, leasing, and

factoring (e.g., CIT Group and Heller Financial)

• Sales finance institutions– finance companies specializing in loans to customers of a

particular retailer or manufacturer (e.g., Ford Motor Credit and Sears Roebuck Acceptance Corp.)

• Personal credit institutions– finance companies specializing in installment and other loans

to consumers (e.g., Household Finance Corp. and American General Finance)

• Business credit institutions– finance companies specializing in business loans, leasing, and

factoring (e.g., CIT Group and Heller Financial)

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Assets of U.S. Finance Companies(September 30, 2004) ($Bn)

Accounts receivable gross ……… $1,354.7 77.6% Consumer …………………………. 462.6 26.5 Business …………………………… 598.3 34.3 Real estate …………………………. 293.8 16.8Less reserves for unearned income …… (75.1) (4.3)Less reserves for losses ………………. (20.9) (1.2)Accounts receivable net ………………. 1,258.7 72.1All other ………………………………. 487.1 27.9

Total Assets $1,745.8 100.0

Accounts receivable gross ……… $1,354.7 77.6% Consumer …………………………. 462.6 26.5 Business …………………………… 598.3 34.3 Real estate …………………………. 293.8 16.8Less reserves for unearned income …… (75.1) (4.3)Less reserves for losses ………………. (20.9) (1.2)Accounts receivable net ………………. 1,258.7 72.1All other ………………………………. 487.1 27.9

Total Assets $1,745.8 100.0

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Liabilities of U.S. Finance Companies(September 30, 2004) ($Bn)

Bank loans …………………………… $ 64.1 3.7%Commercial paper ……………………. 150.8 8.7Debt due to parent ……………………. 112.3 6.4Debt not elsewhere classified ………… 768.8 44.0All other liabilities ……………………. 415.9 23.8Capital, surplus, undivided profits ……. 233.9 13.4

Total Liabilities $1,745.8 100.0

Bank loans …………………………… $ 64.1 3.7%Commercial paper ……………………. 150.8 8.7Debt due to parent ……………………. 112.3 6.4Debt not elsewhere classified ………… 768.8 44.0All other liabilities ……………………. 415.9 23.8Capital, surplus, undivided profits ……. 233.9 13.4

Total Liabilities $1,745.8 100.0

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Balance Sheet

• Assets– Business and consumer loans (called accounts

receivable) and real estate loans• Liabilities and equity

– FCs cannot accept deposits, so they rely heavily on issuing short-term commercial paper and other debt instruments (longer-term notes and bonds) to finance assets

• Assets– Business and consumer loans (called accounts

receivable) and real estate loans• Liabilities and equity

– FCs cannot accept deposits, so they rely heavily on issuing short-term commercial paper and other debt instruments (longer-term notes and bonds) to finance assets

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Finance Company Assets, 2004

32.2

24.5

13.2

30.1Business Loans

Consumer Loans

Real Estate Loans

Other Assets

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Consumer Loans

• Motor vehicle loans and leases are the major type of consumer loan (80.4% in 2001)

• Subprime lender - a finance company that lends to high-risk customers

• Loan sharks - subprime lenders that charge unfairly exorbitant rates to desperate, subprime borrowers

• Other consumer loans (19.6% in 2001)– personal cash loans

– mobile home loans

– loans for consumer goods

• Motor vehicle loans and leases are the major type of consumer loan (80.4% in 2001)

• Subprime lender - a finance company that lends to high-risk customers

• Loan sharks - subprime lenders that charge unfairly exorbitant rates to desperate, subprime borrowers

• Other consumer loans (19.6% in 2001)– personal cash loans

– mobile home loans

– loans for consumer goods

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Mortgages

• Residential and commercial mortgages have become a major component of finance companies’ assets

• Often issued to riskier borrowers and charge a higher interest rate for that risk

• Securitized mortgage assets: mortgages packaged and used as assets backing secondary market securities

• Bad debt expense and administrative costs of home equity loans are lower and have become a very attractive product for finance companies

• Residential and commercial mortgages have become a major component of finance companies’ assets

• Often issued to riskier borrowers and charge a higher interest rate for that risk

• Securitized mortgage assets: mortgages packaged and used as assets backing secondary market securities

• Bad debt expense and administrative costs of home equity loans are lower and have become a very attractive product for finance companies

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Business Loans

• Represent the largest portion of the loan portfolio• Several advantages over commercial banks offered to

small-business customers– they are not subject to regulations that restrict the type of

products and services– do not accept deposits so no bank regulators– have substantial industry and product expertise– more willing to accept risky customers– generally have lower overheads

• Business lending also includes equipment loans or leasing, purchase accounts receivable, small farm loans, wholesale loans/leases of mobile homes

• Represent the largest portion of the loan portfolio• Several advantages over commercial banks offered to

small-business customers– they are not subject to regulations that restrict the type of

products and services– do not accept deposits so no bank regulators– have substantial industry and product expertise– more willing to accept risky customers– generally have lower overheads

• Business lending also includes equipment loans or leasing, purchase accounts receivable, small farm loans, wholesale loans/leases of mobile homes