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CHAPTER 21 Savings Institutions and Credit Unions.

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1 CHAPTER 21 Savings Institutions and Credit Unions

2 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) Savings Banks (e.g. Jewett City Savings Bank, CT) Thrifts or Savings Institutions

3 Copyright© 2002 Thomson Publishing. All rights reserved. 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

4 Copyright© 2002 Thomson Publishing. All rights reserved. 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

5 Copyright© 2002 Thomson Publishing. All rights reserved. Number of Mutual and Stock Savings Banks Source: FDIC WaMu, the largest S&L in 2008, switched from mutual to stock in 1983

6 Copyright© 2002 Thomson Publishing. All rights reserved. Assets of Mutual and Stock Savings Institutions Source: FDIC

7 Copyright© 2002 Thomson Publishing. All rights reserved. Uses of Funds  Real estate loans (mortgages) are the primary asset of savings institutions  But consumer and commercial loans are of increasing

8 Copyright© 2002 Thomson Publishing. All rights reserved.

9 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

10 Copyright© 2002 Thomson Publishing. All rights reserved. Sources of Funds

11 Copyright© 2002 Thomson Publishing. All rights reserved. Thrift Operations

12 Copyright© 2002 Thomson Publishing. All rights reserved. Thrift Operations

13 Copyright© 2002 Thomson Publishing. All rights reserved. Thrift Operations

14 Copyright© 2002 Thomson Publishing. All rights reserved. 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

15 Copyright© 2002 Thomson Publishing. All rights reserved. Number of Problem Thrifts (based on CAMELS)

16 Copyright© 2002 Thomson Publishing. All rights reserved. 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

17 Copyright© 2002 Thomson Publishing. All rights reserved. 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

18 Copyright© 2002 Thomson Publishing. All rights reserved. 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 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

19 Copyright© 2002 Thomson Publishing. All rights reserved. Credit Unions n CREDIT UNIONS

20 Copyright© 2002 Thomson Publishing. All rights reserved. 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  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

21 Copyright© 2002 Thomson Publishing. All rights reserved. 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

22 Copyright© 2002 Thomson Publishing. All rights reserved. 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

23 Copyright© 2002 Thomson Publishing. All rights reserved. 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 See  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

24 Copyright© 2002 Thomson Publishing. All rights reserved. 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

25 Copyright© 2002 Thomson Publishing. All rights reserved. CU Sources and Uses of Funds

26 Copyright© 2002 Thomson Publishing. All rights reserved. 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

27 Copyright© 2002 Thomson Publishing. All rights reserved. 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

28 Copyright© 2002 Thomson Publishing. All rights reserved. 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

29 Copyright© 2002 Thomson Publishing. All rights reserved. Regulation of Credit Unions  Federally-chartered CUs are supervised and regulated by the National Credit Union Administration (NCUA)  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.)

30 Copyright© 2002 Thomson Publishing. All rights reserved. Regulation of Credit Unions  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

31 Copyright© 2002 Thomson Publishing. All rights reserved. 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.November

32 Copyright© 2002 Thomson Publishing. All rights reserved. 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

33 Copyright© 2002 Thomson Publishing. All rights reserved. Financial Crisis Lowers CAMEL Scores

34 Copyright© 2002 Thomson Publishing. All rights reserved. # of CU with CAMEL Scores 4-5

35 Copyright© 2002 Thomson Publishing. All rights reserved. # of CU Failures (latest Sept/12)

36 Copyright© 2002 Thomson Publishing. All rights reserved. Regulation of Credit Unions  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

37 Copyright© 2002 Thomson Publishing. All rights reserved. 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

38 Copyright© 2002 Thomson Publishing. All rights reserved. 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

39 Copyright© 2002 Thomson Publishing. All rights reserved. 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

40 Copyright© 2002 Thomson Publishing. All rights reserved. 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

41 Copyright© 2002 Thomson Publishing. All rights reserved. Performance of CUs

42 Copyright© 2002 Thomson Publishing. All rights reserved. Performance of CUs

43 Copyright© 2002 Thomson Publishing. All rights reserved. Performance of CUs

44 Copyright© 2002 Thomson Publishing. All rights reserved. Performance of CUs


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