drake drake university fin 129 finance 129 chapter 2 depository institutions

DrakeDRAKE UNIVERSITY

Fin 129

Finance 129

Chapter 2

Depository Institutions

DrakeDrake University

Fin 129Depository Institutions

Main criteria is that a significant portion of the firms funds come from customer deposits.

Examples include:Commercial Banks Savings and LoansCredit Unions


Fin 129Recent Trends

The 1990’s ended with the Fin Modernization Act (1999).From the end of the 1990’s 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.

Source FDIC Future of Banking Study FOB-2004-02.1


Fin 129

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%


Fin 129Traditional 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 FI’s has been in Savings products – That has changed dramatically in the last 10 years.


Fin 129Competition among FI’s

Payment Savings Fiduciary Insurance

Services Products Services Bus Cons Equity Debt Risk Mgmt

Depository Institutions X X X X X

Insurance Companies X x X

Finance Companies x X

Securities Firms X X X X

Pension Funds X

Mutual Funds X

Depository Institutions X X X X X X X X

Insurance Companies X X X X X X X X

Finance Companies X X X X X x x X

Securities Firms X X X X X X X X

Pension Funds X X X X

Mutual Funds X X X X

UnderwritingLending

1950

2000

Products Sold by US

Financial Institutions


Fin 129Key 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 BanksComptroller of the Currency examines all nationally chartered banks every 12 to 18 monthsEstablished pledging requirements for owners equity


Fin 129Key Regulatory Legislation

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


Fin 129Key Legislation

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


Fin 129Legislation (continued)...

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



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 Co’s with 2 or more banks must register with Fed Res and file financial statements and submit to Fed Res review of their books1970 Amendments to the Bank Holding Company Act: Extension to one-bank holding companies



1970 International Banking Act: Regulated foreign bank branches and agencies in USA1980 Depository Institutions Deregulation and Monetary Control Act

Phased out interest rate ceilings imposed by Regulation QGoal was to make S&L’s, credit unions and other nonbank depository institutions more competitive.


Fin 129Legislation (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 accountsLoan limits were liberalized for national banks, allowed lending of up to 15% of their capitalFDIC could arrange mergers across state lines for failing institutions

Competitive Equality in Banking Act (1987)Redefined bank to limit growth of nonbank banks.



Financial Institutions Reform Recovery and Enforcement Act (1989)

Imposed restrictions on investment activitiesReplaced FSLIC with FDIC-SAIFReplaced FHLB with Office of Thrift SupervisionCreated Resolution Trust Corporation



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



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.


Fin 129

1999 Financial Services Modernization Act

Financial Services Modernization ActAllowed banks, insurance companies, and securities firms to enter each others’ business areasProvided for state regulation of insuranceStreamlined regulation of BHCsProhibited FDIC assistance to affiliates and subsidiaries of banks and savings institutionsProvided for national treatment of foreign banksATM fees must be clearly disclosedFederal Crime to steal account information

FDIC


Fin 129Structural Changes

http://www2.fdic.gov/hsob/SelectRpt.asp?EntryTyp=10

0

100

200

300

400

500

600

700

1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

# o

f F

DIC

In

sti

tiu

tio

ns

New Charters + Conversions Unassisted Mergers Total Instituions


Fin 129Unresolved 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?


Fin 129

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 –


Fin 129Balance Sheet

Assets - four major categoriesCash and deposits held at other institutionsGovernment and private interest bearing securitiesLoans and leasesMisc assets.

Liabilities – two major categories


Fin 129Assets

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 Gov’t securities, money market securities, commercial paper, time depositsIncome 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 gov’t obligations. Bank intends to sell these prior to maturity


Fin 129Assets (continued)

LoansLargest portion of assets form most banksIncludes 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.)


Fin 129Assets (continued)

Federal Funds sold and Securities Purchased under Repurchase agreements

Short term loans…

Customers Liability on AcceptancesA line of credit provided via a letter of credit backing purchases by the customer.

Miscellaneous AssetsBank buildings, equipment, prepaid insurance etc.

FDIC


Fin 129Assets, % of Total Assets

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

1935 1942 1949 1956 1963 1970 1977 1984 1991 1998

Total Loans Investment Securities Cash

Federal Reserve Board


Fin 129Type of Loans, % of Total

0

0.1

0.2

0.3

0.4

0.5

0.6

1940 1950 1960 1970 1980 1990 2000Sec by Real Estate Dep Inst Ag ProdC & I Individuals State & LocalOther

Federal Reserve Board


Fin 129Loan Portfolios 2000

Real Estate62.77%

C&I17.96% Credit Card 1.55%

Consumer 10.98%

Other 6.74%

RealEstate39.85%

C&I29.38%

Credit Card7.55%Other

14.10%Consumer 9.12%

Large Banks

Small Banks<$1 Billion


Fin 129Asset Quality QBP 3/31/05


Fin 129Liabilities

Largest portion of liabilities is depositsAverage 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


Fin 129Deposits

Non-interest bearing demand depositsChecking accounts with unlimited check writing

Savings depositsNOW accounts

Money market deposit accounts

Time deposits

FDIC


Fin 129

Liabilities and Equity% of Total

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

90.00%

100.00%

1935 1945 1955 1965 1975 1985 1995 2005

deposits borrowed funds total equity


Fin 129Assets Vs. Liabilities

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


Fin 129Equity

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


Fin 129Income

Net Interest Income

Non Interest Income


Fin 129

Revenues from QBP 3/31/2005


Fin 129

Recent changes in Interest Margin

QBP 3/31/05


Fin 129

Improving Credit Conditions QBP 3/31/05


Fin 129

Other Fee Generating Activities

Trust ServicesManagement of estate assets and pension fund assets

Correspondent BankingProviding banking services to smaller institutions that do not have the staff or expertise in those services.


Fin 129Other 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.


Fin 129Off - 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.


Fin 129OBS Activities continued

Standby Credit Agreements- bank pledges to guarantee repayment of a customers’ loan received from a third partyInterest rate swaps – exchange interest payments on debt securities with another partyFinancial futures and optionsLoan commitments – pledge to lend up to a certain amount of fundsForeign exchange rate contracts


Fin 129

Derivative Contracts QBP 3/31/05


Fin 129

Recent Changes in Home Equity Credit QBP 3/31/05


Fin 129Derivative 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.


Fin 129Savings 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.


Fin 129S&L Regulation

Traditionally restricted in the type of accounts they could offer the regulation in the early 1980’s allowed S&L’s 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


Fin 129Savings Banks

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


Fin 129Credit Unions

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

drake drake university fin 129 finance 129 chapter 2 depository institutions

Documents

drake drake university

fis slide

fin modernization act

fed res of bank

owners equity slide

chartering banks

chartered banks

bank acts