THRIFT OPERATIONS

1
THRIFT OPERATIONS

• CHAPTER 21

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BACKGROUND ON SAVINGS INSTITUTIONS

• SL are dominant form of this type of depository
  institution Savings Bank is other
• California had the Largest SL (Downey ? US Bank)
• New York has the largest SB (Dime, 1864)
• Chartered by OTS (Federal banks) or State
  commissions
• OTC is oversight body for federally chartered
  banks
• Mutual (depositor owned) or Stock (investor
  owned)
• Deposit insurance provided by DIF organized from
  merger of SAIF and BIF, 2006

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SOURCES OF FUNDSRHS of Balance Sheet
(Liabilities)

• Deposits SB 72, SL76
• 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)

4
SOURCES OF FUNDSRHS of Balance Sheet
(Liabilities)

• Capital Markets SB 23, SL23
• Mutual borrowing via repo agreements or from the
  FHLBB
• Stock selling of equity
• Capital SB5, SL2
• 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

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

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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)

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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

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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 lt 1.00, bank has a interest rate
  risk exposure in need of hedging Degree of
  interest-rate sensitivity is measured using
  Duration

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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

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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

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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)

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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

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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

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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

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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?
• How did the Financial Institutions Reform,
  Recovery and Enforcement Act change the
  regulatory environment of savings banks?
• What are the essential reasons for an interest
  rate swap?

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HOMEWORK QUESTIONS

• How does the swap work?
• In what ways do credit unions differ from SL?
• What agency is responsible for credit union
  oversight?
• Who insures credit union deposits?
• What types of risk do credit unions face?
• Do credit unions have an advantage over SL? any
  disadvantages?