Finance 129

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Finance 129

• Chapter 2
• Depository Institutions

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Depository Institutions

• Main criteria is that a significant portion of
  the firms funds come from customer deposits.
• Examples include
• Commercial Banks
• Savings and Loans
• Credit Unions

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Recent Trends

• The 1990s ended with the Fin Modernization Act
  (1999).
• From the end of the 1990s to present there has
  been a wave of mergers and acquisitions in the
  industry.
• The increased business services that Depository
  Institutions are now allowed to offer has created
  a desire for larger less regional institutions.

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Largest Depository Institutions, Dec 31, 2003 by
total assets (billions)

• Dom
• Assets Assets Dep
• J.P Morgan Chase 1009 11.11 6.61
• Bank of America 870 9.58 9.82
• Citigroup 796 8.77 3.47
• Wells Fargo 380 4.19 4.62
• Wachovia Corp 362 3.99 4.09
• Washington Mutual 276 3.04 3.23
• US Bancorp 192 2.12 2.19
• National City Corp 132 1.45 1.17
• SunTrust 125 1.37 1.47
• ABN ARMCO 107 1.18 0.87

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Traditional Services

• Depository Institutions have been traditionally
  been subject to a large amount of regulation that
  restricted their actions.
• Main business functions
• Main overlap with other FIs has been in Savings
  products That has changed dramatically in the
  last 10 years.

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Competition among FIs
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Key Regulatory Legislation

• National Currency and Bank Acts (1863-64)
• Set up system of federally chartering banks
  through US Treas Dept. or Comptroller of
  Currency or Administrator of National Banks
• Comptroller of the Currency examines all
  nationally chartered banks every 12 to 18 months
• Established pledging requirements for owners
  equity

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Key Regulatory Legislation

• The Federal Reserve Act (1913)
• Established the Federal Reserve System as a
  lender of last resort
• Established network to clear and collect checks

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Key Legislation

• McFadden Act (1927)
• National banks allowed branches in their original
  city.
• Branching across state lines forbidden unless
  allowed by state law
• Liberalized banks underwriting activities and
  allowed underwriting of corporate stocks and
  bonds

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Legislation (continued)...

• 1933 Glass-Steagall
• Separates securities and banking activities
• Prohibited commercial banks from most
  underwriting of securities. 4 exceptions Munis,
  US govt, Private Placement and Real Estate Loans.
  Fear of conflict of interest

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Legislation (continued)...

• Bank Holding Company Act and subsequent
  amendments (1956 1966 and 1970)
• Specifies permissible activities and regulation
  by Fed Res of Bank Holding Cos.
• Bank Holding Companies must request Fed Approval
• Cos with 2 or more banks must register with Fed
  Res and file financial statements and submit to
  Fed Res review of their books
• 1970 Amendments to the Bank Holding Company Act
  Extension to one-bank holding companies

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Legislation (continued)...

• 1970 International Banking Act Regulated foreign
  bank branches and agencies in USA
• 1980 Depository Institutions Deregulation and
  Monetary Control Act
• Phased out interest rate ceilings imposed by
  Regulation Q
• Goal was to make SLs, credit unions and other
  nonbank depository institutions more competitive.

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Legislation (continued)

• Depository Institutions Act (1982) Garn-St.
  Germain Depository Institutions Act)
• Allowed all federally supervised depository
  Institutions to sell deposit accounts equivalent
  to Money market mutual fund accounts
• Loan limits were liberalized for national banks,
  allowed lending of up to 15 of their capital
• FDIC could arrange mergers across state lines for
  failing institutions
• Competitive Equality in Banking Act (1987)
• Redefined bank to limit growth of nonbank banks.

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Legislation (continued)

• Financial Institutions Reform Recovery and
  Enforcement Act (1989)
• Imposed restrictions on investment activities
• Replaced FSLIC with FDIC-SAIF
• Replaced FHLB with Office of Thrift Supervision
• Created Resolution Trust Corporation

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Legislation (continued)

• 1991 FDIC Improvement Act
• Fear of FDIC insolvency by end of 1991
• Ordered new measurement scale for describing
  financial condition of depository institution and
  when in violation to take prompt corrective
  action
• Risk-based deposit insurance premiums

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Legislation (continued)

• Riegle-Neal Interstate Banking and Branching
  Efficiency Act (1994)
• Permits BHCs to acquire banks in other states.
• Invalidates some restrictive state laws.
• Permits BHCs to convert out-of-state subsidiary
  banks to branches of single interstate bank.
• Newly chartered branches permitted interstate if
  allowed by state law.

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1999 Financial Services Modernization Act

• Financial Services Modernization Act
• Allowed banks, insurance companies, and
  securities firms to enter each others business
  areas
• Provided for state regulation of insurance
• Streamlined regulation of BHCs
• Prohibited FDIC assistance to affiliates and
  subsidiaries of banks and savings institutions
• Provided for national treatment of foreign banks
• ATM fees must be clearly disclosed
• Federal Crime to steal account information

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Structural Changes
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Unresolved Issues

• Does regulatory approval limit the ability of
  banks to respond to new markets?
• Will functional regulation work (can regulatory
  agencies work together?)
• Can and will countries work together as
  institutions become more global?

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Bank Size (by asset concentration)

• Community banks
• The asset share of banks over 1Billion has
  increased from 63.4 in 1984 to 83.9 in 2000.
• Large banks often have access to cheaper forms of
  cash.
• Money Center Banks

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Balance Sheet

• Assets - four major categories
• Cash and deposits held at other institutions
• Government and private interest bearing
  securities
• Loans and leases
• Misc assets.
• Liabilities two major categories

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Assets

• Cash (Primary Reserves)
• includes vault cash, reserves at the Fed Res,
  deposits at other banks, checks in the process of
  collection. Designed to meet liquidity needs
• Investment Securities
• Liquid portion (Secondary Reserves) ST Govt
  securities, money market securities, commercial
  paper, time deposits
• Income Generating portion Bonds notes and other
  securities (taxable and tax exempt).
• Trading account securities bank serve as a
  security dealer for state, federal and local
  govt obligations. Bank intends to sell these
  prior to maturity

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Assets (continued)

• Loans
• Largest portion of assets form most banks
• Includes consumer, real estate, business, ag
  production, leases and foreign loans.
• Most statements include a gross loan amount and
  an allowance for loan loss (balance is built
  with deductions from current income, when a loan
  is uncollectable then balance is reduced.
  Therefore both the gross account and loss account
  change. And net income is not impacted.)

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Assets (continued)

• Federal Funds sold and Securities Purchased under
  Repurchase agreements
• Short term loans
• Customers Liability on Acceptances
• A line of credit provided via a letter of credit
  backing purchases by the customer.
• Miscellaneous Assets
• Bank buildings, equipment, prepaid insurance etc.

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Assets, of Total Assets
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Type of Loans, of Total
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Loan Portfolios 2000
CI 17.96
Credit Card 1.55
Consumer 10.98
Large Banks
Real Estate 62.77
Other 6.74
Real Estate 39.85
CI 29.38
Small Banks lt1 Billion
Credit Card 7.55
Other 14.10
Consumer 9.12
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Asset Quality QBP 3/31/05
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Liabilities

• Largest portion of liabilities is deposits
• Average ratio of equity to assets 8.49 (91.51
  of asses are financed by some type of debt..)
• Approximately 21 of deposits are transaction
  accounts (checkable deposits that cost little or
  no interest)
• Retail savings and time deposits have been
  declining due to competition form money market
  mutual funds

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Deposits

• Non-interest bearing demand deposits
• Checking accounts with unlimited check writing
• Savings deposits
• NOW accounts
• Money market deposit accounts
• Time deposits

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Liabilities and Equity of Total
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Assets Vs. Liabilities

• Generally liabilities tend to be of shorter
  maturity than assets. This introduces interest
  rate risk and liquidity risk for depository
  institutions.

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Equity

• Usually about 8 to 10 of liabilities and equity
• Generally equity held is close to the minimum
  amount set by regulations

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Income

• Net Interest Income
• Non Interest Income

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Revenues from QBP 3/31/2005
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Recent changes in Interest MarginQBP 3/31/05
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Improving Credit Conditions QBP 3/31/05
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Other Fee Generating Activities

• Trust Services
• Management of estate assets and pension fund
  assets
• Correspondent Banking
• Providing banking services to smaller
  institutions that do not have the staff or
  expertise in those services.

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Other Recent Trends

• 1st quarter 2005 no bank failures 3rd straight
  quarter without a failure 2nd longest streak in
  last 15 years.
• About ½ as many problem institutions compared
  to same time as last year.

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Off - Balance Sheet Activities

• Assets and Liabilities that will appear on the
  balance sheet or income statement if a contingent
  event occurs.
• Motivated by both earnings and regulatory (tax
  avoidance) incentives.

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OBS Activities continued

• Standby Credit Agreements- bank pledges to
  guarantee repayment of a customers loan received
  from a third party
• Interest rate swaps exchange interest payments
  on debt securities with another party
• Financial futures and options
• Loan commitments pledge to lend up to a certain
  amount of funds
• Foreign exchange rate contracts

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Derivative Contracts QBP 3/31/05
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Recent Changes in Home Equity Credit QBP 3/31/05
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Derivative Use

• Use of derivative increased by 4 to 91.9
  Trillion in notional value in the first quarter
  of 2005 (QBP).
• Most of the increase were in interest rate
  derivatives used in trading and in credit
  derivatives.

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Savings Associations

• Primarily deal with household saving and
  mortgages.
• Financing long term mortgages with short term
  deposits has been helped by a traditionally
  upward sloping yield curve.

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SL Regulation

• Traditionally restricted in the type of accounts
  they could offer the regulation in the early
  1980s allowed SLs to become more competitive
  with commercial banks. Most notably the repeal
  of Regulation Q. Also allowed to offer NOW
  accounts and more market sensitive money market
  accounts

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Savings Banks

• Originally organized as a mutual organization
  that also focused on mortgage lending
• Many are now switching to stock ownership

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Credit Unions

• Nonprofit depository institutions that are
  mutually organized.
• Members must belong to a specific similar
  occupation, association or live in a given
  community.