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Chapter FourteenOther Lending Institutions

Chapter Outline

1. Other categories

2. Savings institutions: Savings Associations and Savings Banks

3. Credit union

4. C&L crisis

5. Finance Company

1. Other categories

2. Savings institutions: Savings Associations and Savings Banks

3. Credit union

4. C&L crisis

5. Finance Company

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1. 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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Composition of the Industry

Saving associations

(1, 074*) (SAIF**) Individuals

(TA = $1,123,981m)

Saving Institutions

Savings Banks Individuals

(339*) (BIF**)

(TA = $508,614m)

Corporations

Credit Unions(9,210*) (NCUSIF**) Individuals(TA = $648,700m)

Saving associations

(1, 074*) (SAIF**) Individuals

(TA = $1,123,981m)

Saving Institutions

Savings Banks Individuals

(339*) (BIF**)

(TA = $508,614m)

Corporations

Credit Unions(9,210*) (NCUSIF**) Individuals(TA = $648,700m)

Consumer loans

Deposits

Deposits

Deposits

Deposits

Residential mortgages

Residential mortgages

Commercial loans

* - Number of institutions in 2004** - InsurerSAIF – the Savings Association Insurance Fund BIF – the Bank Insurance FundNCUSIF – the National Credit Union Share Insurance Fund

2. Savings Associations

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

• Assets concentrated in real estate loans

• Liabilities concentrated in retail CDs

• Can be either mutually owned or shareholder owned

• Deposits insured by FDIC – SAIF

• Regulators: Office of Thrift Supervision (OTS)

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

• Assets concentrated in real estate loans

• Liabilities concentrated in retail CDs

• Can be either mutually owned or shareholder owned

• Deposits insured by FDIC – SAIF

• Regulators: Office of Thrift Supervision (OTS)

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)

• Historically 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)

• Historically 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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Real Estate Assets of Savings Associations and Savings Banks (2004)

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

Regulators of Savings Institutions

• The 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

• The 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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3. Credit Unions

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

• Funding almost totally from 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• Deposits insured by the NCUSIF• Exempt from corporate taxes• Growth is not the primary goal

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

• Funding almost totally from 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• Deposits insured by the NCUSIF• Exempt from corporate taxes• 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

4. S&L Crisis

• 1930s Basic Regulatory Structure put in place.– S&Ls limited to fixed rate mortgage loans– Deposit Insurance with fixed premium– Deposits insured by FSLIC– Deposit rate ceilings (Regulation Q)

• 1970s - Fluctuating and increasing interest rates lead to deposit outflows

• 1930s Basic Regulatory Structure put in place.– S&Ls limited to fixed rate mortgage loans– Deposit Insurance with fixed premium– Deposits insured by FSLIC– Deposit rate ceilings (Regulation Q)

• 1970s - Fluctuating and increasing interest rates lead to deposit outflows

S&L Crisis

• Initial response - Deregulation – removed deposit rate ceilings– lessened investment restrictions– raised insurance ceiling to $100,000 from $40,000

• Record high interest rates in early 80s lead to losses – Many S&Ls economically insolvent– FSLIC economically insolvent

• Initial response - Deregulation – removed deposit rate ceilings– lessened investment restrictions– raised insurance ceiling to $100,000 from $40,000

• Record high interest rates in early 80s lead to losses – Many S&Ls economically insolvent– FSLIC economically insolvent

S&L Crisis

• Next response - regulatory forbearance – Allow insolvent S&Ls to continue in operation rather

than close them down– FSLIC did not have sufficient funds to close

insolvent S&Ls and payoff depositors – Hoped the problems would go away

• Next response - regulatory forbearance – Allow insolvent S&Ls to continue in operation rather

than close them down– FSLIC did not have sufficient funds to close

insolvent S&Ls and payoff depositors – Hoped the problems would go away

S&L Crisis

• S&Ls attempt to “grow out of the problem”– commercial real estate loans

– junk bonds

– brokered deposits

• Increased the moral hazard because an operating but insolvent S&L, a zombie S&L, has nothing to lose by taking on greater risk

• Zombie S&Ls attracted deposits away from healthy S&L's by offering higher interest rates

• FSLIC fund was bankrupt by the end of 1986

• S&Ls attempt to “grow out of the problem”– commercial real estate loans

– junk bonds

– brokered deposits

• Increased the moral hazard because an operating but insolvent S&L, a zombie S&L, has nothing to lose by taking on greater risk

• Zombie S&Ls attracted deposits away from healthy S&L's by offering higher interest rates

• FSLIC fund was bankrupt by the end of 1986

S&L Crisis

• Next Response – re-regulation (Financial Institutions Reform, Recovery, and Enforcement Act, 1989) – Zombie thrifts finally closed– New supervisory agency (Office of Thrift

Supervision)– Insurance moved to FDIC– Higher capital standards – Risk based capital and risk based deposit insurance

premiums– Investment restrictions

• Next Response – re-regulation (Financial Institutions Reform, Recovery, and Enforcement Act, 1989) – Zombie thrifts finally closed– New supervisory agency (Office of Thrift

Supervision)– Insurance moved to FDIC– Higher capital standards – Risk based capital and risk based deposit insurance

premiums– Investment restrictions

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5. 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