chapter 21 savings institutions and credit unions

CHAPTER

21 Savings Institutions andCredit Unions

Copyright© 2002 Thomson Publishing. All rights reserved.

•Savings & Loans Associations (S&Ls)• (e.g. the late great WaMu, Countrywide Financial, and

IndyMac, Belmount Federal S&L) http://www.belmontfederal.com/

•Savings Banks • (e.g. Jewett City Savings Bank, CT) http://www.jcsbank.com/index.php

Thrifts or Savings Institutions

http://www.belmontfederal.com/

http://www.belmontfederal.com/

http://www.jcsbank.com/index.php


Background on Savings Institutions

Savings institutions have federal or state charters

Mutual ownership means the institution is owned by its depositors

Mutual-to-stock conversions are popular Characteristics of stock ownership

Manager/owners have greater potential to benefit Opportunity to increase capital But more susceptible to unfriendly takeovers


Background on Savings Institutions

Savings banks have characteristics similar to S&Ls Mutual and stock ownership State or federal charter

Key differences between S&Ls and savings banks is that savings banks Are concentrated in the northeastern U.S. Have traditionally had more diverse asset

investments


Number of Mutual and Stock Savings Banks

Source: FDIC

WaMu, the largest S&L

in 2008, switched

from mutual to stock in

1983


Assets of Mutual and Stock Savings Institutions

Source: FDIC


Uses of Funds

Real estate loans (mortgages) are the primary asset of savings institutions

But consumer and commercial loans are of increasing


Sources of Funds

Largest source is deposits which include: Checking and Passbook savings Certificates of deposit

Consumer Jumbo

Money market accounts Usually some borrowed funds


Sources of Funds


Thrift Operations


Regulation of Savings Institutions

Regulators assess savings institutions using criteria similar to those used to evaluate commercial banks Capital adequacy Asset composition Management Earnings Liquidity Sensitivity

Regulators conduct on-site examinations


Number of Problem Thrifts (based on CAMELS)


Savings and Loan Crisis of 1980s

During the 1980s many S&Ls failed Reasons for failure

High interest rates and inflation in late 70s early 80s Real estate and oil collapse in the Southwest Regulation (Reg Q) caused disintermediation and liquidity crisis Deregulation

Allowed risky investments (junk bonds, etc.) Allowed risky loans (especially, commercial real estate)

Moral hazard from raising deposit insurance from $40,000 to $100,000 Caused careless and poor management (3-6-3 rule)

Fraud (15% of losses) and bad management Lobbying (politics, senators and representatives) Failure to close bad banks quickly Inadequate accounting rules for capital and investments


Savings and Loan Crisis of 1980s

Bailout of savings institutions was financed from several sources including Sale of failed S&L assets Taxpayers

Cost $153 billion, $124 billion from U.S. taxpayers or about $700 per man/woman/child.

Surviving S&Ls Easily most expensive financial crisis to that time Positive impact of the bailout

Stronger capital positions Higher asset quality More consolidation


Savings and Loan Crisis of 2008

Savings institutions have generally performed well after recovering from the 1980s. But in 2008, many failed.

Washington Mutual On Sept. 15, WaMu received a credit rating agency downgrade. It’s stock dropped to $2/share, when it had

been $45 a year earlier. During the next nine days, the largest bank run in history occurred, with customers pulling $17B out, which was 9% of deposits.

On Sept. 25, 2008, WaMu, the largest S&L, failed with $328B in assets. Chase Bank purchased WaMu on Sept. 26 for $1.9B, a steal of a deal, resulting in a lawsuit by WaMu’s former shareholders.

WaMu’s strategy was to be the “Wal-Mart of banks” and cater to lower and middle-class customers who other banks viewed as risky. As a result, WaMu invested heavily in subprime mortgages, with teaser rates.

Seattle-based WaMu was chartered the same year as the State of Washington, 1889 Before its collapse, WaMu was the sixth largest “bank” in the U.S. Its failure is the largest of “bank” type

institutional failure in U.S. history

Countrywide Financial Used an aggressive strategy to approve subprime mortgages. Many of these loans defaulted in 2007. In

January 2008, Countrywide Financial was acquired by Bank of America.

IndyMac (Independent National Mortgage Corp): suffered major losses on its $32 billion portfolio of mortgages and was acquired by OneWest Bank in Feb/10, after IndyMac declared Ch. 7 bankruptcy


Credit Unions

CREDIT UNIONS


Background of Credit Unions

Credit Unions (CUs) are nonprofit, mutual, cooperative organizations, which operate like a club

First CU was in Germany, where old farmers loaned to young ones; first CU in the U.S. was St. Mary’s in NH in 1909.

Members have a common bond, with the followings affiliations: 80% are employer-based (Boeing, Navy, etc.) 10% are association-based (religion, trade association, trade unions, etc.) 10% are residentially-based (people who live in a certain area) Some credit unions have a mixture of the above in their common bonds

There are about 7,800 CUs in the U.S. with approximately 90 million members. Most are small, with a few exceptions (e.g. the Navy FCU, Boeing FCU, with assets > $1B)

Although there are more CUs than banks, total assets of CUs are less than one tenth the amount in commercial banks


Ownership of Credit Unions

Owned by depositors as a mutual cooperative. If a credit union were to shut-down, the building/land

would be sold and the proceeds sent to depositors Credit unions do not issue stock, but they have share

accounts, with a min. par value (e.g. $25) Deposits are called shares, and the interest paid is

called dividends. Because they are nonprofits, CU income is exempt

from income tax Like banks, CUs can be either federally or state

chartered


Objectives of Credit Unions

Satisfy their members Offer good interest on share deposits Offer loans to members at good rates

What should happen to the earnings that the CU accumulates? Offer higher rates on deposits Offer lower rates on loans Give rebates as Christmas presents to owners Expand services


Advantages of Credit Unions

Advantages of credit unions Members/owners are like a family and your name and face is known

(you’re not just a number) CUs pay no federal income taxes, which means that banks hate CUs, since

they are gov’t subsidized competition) See http://bankerspank.com Because CU pay no tax, they should be able to offer better rates CUs typically charge much lower fees than banks CUs are exempt from anti-trust laws CUs have lower operating costs due to volunteers CUs have a powerful grass-roots lobby and trade associations

http://bankerspank.com/


Disadvantages of Credit Unions

Limited diversification Based around one employer, or one region so has

concentrated default risk Limited liquidity

Cannot attract deposits like banks can, since you have to meet the common bond to open an account

Management Concerns Internal controls—separation of duties Volunteers vs. professionals

Small Entities Difficult to attain scale economies


CU Sources and Uses of Funds


Sources of Credit Union Funds

CUs obtain most funds through share deposit accounts Similar to passbook savings Insured up by NCUSIF up to $250,000

CUs also offer share certificates Compete with CDs from commercial banks

Checking accounts are called share drafts Compete with NOW and other bank checking

accounts


Sources of Credit Union Funds

If CUs need funds temporarily, they can borrow from other credit unions or from the Central Liquidity Facility (CLF) Acts as a lender for CUs much like the Fed’s discount

window for banks CLF is an emergency lending fund that is part of a larger

internal system called the Corporate Credit Union Network, which is a “credit union for credit unions”

CLF’s or Corporate Credit Unions are in big trouble and have needed capital infusions because they invested in sub-prime mortgages!

The primary source of capital for CUs is retained earnings


Uses of Credit Union Funds

CUs use the majority of funds for loans to members Automobiles, motorcycles, motorhomes, airplanes Home improvements Personal expenses Some CUs offer mortgages

CUs also invest in safe securities CDs of banks U.S. Treasury and Agency bonds


Regulation of Credit Unions

Federally-chartered CUs are supervised and regulated by the National Credit Union Administration (NCUA) www.ncua.gov. NCUA is composed of three board members

appointed by the U.S. President It grants and revokes Federal charters and examines the

financial condition of Federal credit unions

State chartered CU are under state supervision (DFI in Wash.) http://www.dfi.wa.gov/

http://www.ncua.gov/

http://www.dfi.wa.gov/



Risk assessment NCUA examiners compare CU ratios with industry

norms to identify problems Employ the CAMEL system much like FDIC

examiners Capital, assets, management, earnings, and liquidity Assign each CU into a risk category ranging from Code 1

(low risk) to Code 5 (high risk) Less than 10 percent of CUs in Codes 4 or 5 Alerts examiners to CUs experiencing problems


Secret CAMELs

The disclosure of the CAMEL score at the credit union of former NCUA Board nominee Carla Decker has resulted in the ban of a board member there by the NCUA.The agency on Wednesday said it has banned James Talbert, a former board and supervisory member at the 11,000-member, $46 million District of Columbia Employees Federal Credit Union, from any further participation in the affairs of a federally insured financial institution.An exam report and CAMEL rating from the credit union was leaked in early November prompting an NCUA investigation.

http://www.cutimes.com/2011/11/08/ncua-board-nominees-credit-union-is-high-strategic


SECU Discloses CAMEL Scorehttp://www.cutimes.com/2011/10/12/secu-discloses-camel-score The CEO at the nation’s second-largest credit union said his institution doesn’t need to hide its CAMEL score and that perhaps others shouldn’t either.After clearing it with state regulators, the $23 billion State Employees’ Credit Union of North Carolina announced that it has a CAMEL score of 2 on a scale of 1 to 5, where 1 is the best.SECU said it sought permission from the N.C. Credit Union Division to disclose its individual CAMEL score, which are confidential, and the 2 score was in its June 30 audit report from state regulators.It’s all about transparency and reform, says the CEO of the 1.7 million-member institution. “Shining a little sun under the rock never hurt anyone,” Jim Blaine told Credit Union Times on Thursday. “If a credit union has a problem with its CAMEL rating being revealed, perhaps there’s a deeper problem there, something going on that managers need to address and members need to know about.”Blaine said that he thought such information should be publicly available on a routine basis, but added, “That’s up to individual credit unions and the regulators to decide.”

Disclosing CAMEL Scores

http://www.cutimes.com/2011/10/12/secu-discloses-camel-score

http://www.cutimes.com/2011/10/12/secu-discloses-camel-score


Financial Crisis Lowers CAMEL Scores


# of CU with CAMEL Scores 4-5


# of CU Failures (latest Sept/12)



Capital requirements for Federal credit unions Federal CUs have capital requirements of 8

percent of risk-weighted assets, 4 percent of primary capital (retained earnings and reserves) and 4 percent of secondary capital

CUs are regulated with respect to the types of services they can offer Now able to offer mortgages and can sell mortgages

they originate State-chartered credit unions are regulated by

state agencies


Insurance for Credit Unions

Insured by the National Credit Union Share Insurance Fund (NCUSIF) (1970) Administered by NCUA 90 percent of CUs are insured by NCUSIF—all

Federal CUs and most state CUs Credit unions contribute annual insurance

premiums of 1/10 of one percent of share deposits Provides for up to $250k of deposit insurance CU failure rates have been much lower than for

banks and savings institutions, due to better regulation and higher capital


Credit Union Exposure to Risk

Liquidity risk (usually more than most banks) Localized depositors (not broad source of funds) Unanticipated surge of withdrawals can affect a small CU Short-term solution: borrow from the Central Liquidity

Facility But CUs cannot borrow from the Federal Reserve

Credit risk (usually more than banks) Concentration of loans to local members, many of whom may

be employed by same employer, or live in the same geographic area – this means less diversification than banks

But most CU loans are secured by collateral Common concern: volunteer employees may not conduct a

thorough credit analysis of loan applicants


Credit Union Exposure to Risk

Interest rate risk (usually less than banks) More insulated from interest rate risk than banks Assets (consumer loan and investment) maturities

are typically short term (5 yrs or less), matching the short-term liabilities

Because of the similarity in maturity in both assets and liabilities, the net interest margin has been fairly stable for CUs


Performance of Credit Unions

CUs have been more profitable in the last two decades due to growth of CU assets and increased efficiency

CUs have been merging More diversified member base Achieve economies of scale Offer a variety of new products such as traveler's

checks, money orders, credit cards, and insurance


Performance of CUs

chapter 21 savings institutions and credit unions

Documents

thomson publishing

fdic slide

increasing slide

stock savings banks

sources of funds slide

borrowed funds slide

savings loans associations

onsite examinations