Transcript Chapter 21 PowerPoint

THRIFT OPERATIONS
CHAPTER 21
All Rights Reserved
Dr David P Echevarria
1
BACKGROUND ON SAVINGS
INSTITUTIONS
A. S&L are dominant form of this type of depository
institution; Savings Bank is other
1. California had the Largest S&L (Downey → US Bank)
2. New York had the largest SB (Dime, 1864)
B. Chartered by OTS (Office of Thrift Supervision –
xxx Federal Credit Union) or State commissions
1. OTS is oversight body for federally chartered banks
2. Mutual (depositor owned) or Stock (investor owned)
3. Deposit insurance provided by FDIC
All Rights Reserved
Dr David P Echevarria
2
SOURCES OF FUNDS
RHS of Balance Sheet (Liabilities)
A. Deposits; SB = 72%, S&L=76%
1. Pass-book savings (traditional)
2. Money Market Deposit Accounts (Garn-St.
Germaine Act, 1982)
3. Certificates of Deposit (higher rates than passbook, penalty for early withdrawal)
4. NOW accounts ( DIDMCA, 1980)
All Rights Reserved
Dr David P Echevarria
3
SOURCES OF FUNDS
RHS of Balance Sheet (Liabilities)
B. Capital Markets; SB = 23%, S&L=23%
1. Mutual; borrowing via repo agreements or from the
FHLBB
2. Stock; selling of equity
C. Capital; SB=5%, S&L=2%
1. Retained earnings and common stock (for non-mutual)
2. Earnings a function of the spread (Loan rate - rate paid to
depositors)
3. Size of capital base important factor in ability to weather
financial storms
All Rights Reserved
Dr David P Echevarria
4
USES OF FUNDS
LHS of Balance Sheet (Assets)
A. Cash and Investments
1. Service depositor withdrawal demands
2. Portion of required reserves held as cash
B. Mortgages
1. Single most important asset and source of risk
2. Preference for fully collateralized loans
All Rights Reserved
Dr David P Echevarria
5
USES OF FUNDS
LHS of Balance Sheet (Assets)
C. Mortgage-Backed Securities
1. Package and sell to individual and institutional
investors
2. Retain servicing of loan on fee-basis
D. Consumer and Commercial Loans
1. Automobiles for consumers (collateralized)
2. Commercial Real Estate (ditto)
E. Other Uses of Funds (Repos)
All Rights Reserved
Dr David P Echevarria
6
RISK MANAGEMENT
A.
Liquidity Risk: savings institutions typically have
1.
2.
B.
Default Risk; dealing with non-performing loans
1.
2.
C.
Short-term liabilities
Long-term assets
Narrow capital base and thin margins makes banks sensitive to nonperforming loans
Managing Default Risk is a function of managing the credit policy
Interest Rate Risk; managing impact of interest rate
volatility
1.
2.
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
All Rights Reserved
Dr David P Echevarria
7
RISK MANAGEMENT
3. 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)
4. GAP Ratio = $ value of rate-sensitive assets / $ value of
rate-sensitive liabilities
1.
2.
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
All Rights Reserved
Dr David P Echevarria
8
RISK MANAGEMENT
D. Managing Interest Rate Risk
1. Adjustable-Rate Mortgages (ARMS); variable rate assets
2. Financial Futures Contracts;
a.
b.
Short positions hedge fixed-rate loans
As interest rates rise, profits on hedge offsets losses on fixed rate
loans
3. Interest Rate Swaps; exchanging fixed for floating rate
instruments
a.
b.
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
4. Interest Rate Caps; maximum rate to be paid as market
rates change over time
All Rights Reserved
Dr David P Echevarria
9
CREDIT UNIONS
A.
B.
C.
D.
E.
F.
G.
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
1.
2.
3.
H.
Grant and revoke charters
Examines financial condition
State chartered institutions insured by NCUA subject to oversight
Share accts insured by NCUA SIF ($250K max)
All Rights Reserved
Dr David P Echevarria
10
SOURCES AND USES OF CREDIT
UNION FUNDS
A. Savings deposits and Share Draft accounts
form the principal sources
B. Loans to members are the main use of funds.
Also have Lines of Credit, Mortgages,
C. CD's and money market accounts
D. Profits are paid out to members as interest on
their average balances
E. Temporary funds may be obtained from the
Central Liquidity Facility (CLF)
All Rights Reserved
Dr David P Echevarria
11
CREDIT UNION RISK EXPOSURE
A. Liquidity Risk; high levels of withdrawals
may create cash flow problems
B. Default Risk; most loans are consumer type
and generally collateralized
C. Interest Rate Risk; assets and liabilities are
both rate sensitive and correlated. Therefore,
this is not a source of concern to CU
All Rights Reserved
Dr David P Echevarria
12
SAVINGS AND LOAN CRISIS
A.
Reasons for Failure;
1.
2.
3.
B.
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
1.
2.
3.
4.
5.
6.
7.
8.
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
All Rights Reserved
Dr David P Echevarria
13
SAVINGS AND LOAN CRISIS
C.
Provisions of FDICIA (1991); Federal Deposit Insurance
Corp. Improvement Act
1.
2.
3.
4.
5.
6.
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
All Rights Reserved
Dr David P Echevarria
14
HOMEWORK QUESTIONS
A.
B.
C.
D.
E.
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?
All Rights Reserved
Dr David P Echevarria
15
HOMEWORK QUESTIONS
F. How does the swap work?
G. In what ways do credit unions differ from S&L?
H. What agency is responsible for credit union
oversight?
I. Who insures credit union deposits?
J. Do credit unions have any advantages over S&Ls?
any disadvantages?
All Rights Reserved
Dr David P Echevarria
16