Institutions Ch 14 (Done)

Other Lending Institutions: Savings Institutions, Credit Unions, and Finance Companies

Main financial service provided by savings institutions, credit unions, and finance companies is lending

1. Savings institutions (SIs) were created in the early 1800s in response to commercial banks’ concentration on serving the needs of business (commercial) enterprises rather than the needs of individuals requiring borrowed funds to purchase homes 

2. Credit unions are nonprofit depository institutions mutually organized and owned by their members (depositors)

   • Have historically focused on consumer loans funded with member deposits

3. Finance companies provide such services as consumer lending, business lending, and mortgage financing

   • Primary function is to make loans to individuals and businesses

Savings institutions (SIs)

_______________________ were created in the early 1800s in response to commercial banks’ concentration on serving the needs of business (commercial) enterprises rather than the needs of individuals requiring borrowed funds to purchase homes

Credit unions

_______________ are nonprofit depository institutions mutually organized and owned by their members (depositors)

• Have historically focused on consumer loans funded with member deposits

Finance companies

___________________ provide such services as consumer lending, business lending, and mortgage financing

• Primary function is to make loans to individuals and businesses

Comprise two groups of DIs:

1. Savings associations 

2. Savings banks

Savings associations were historically referred to as savings and loans (S&Ls) associations

• Historically most savings institutions were established as mutual organizations (in which the depositors are the legal owners of the institution and no stock is issued)

Grouped separately from commercial banks, though they generally perform similar services

• Concentrate on residential mortgage lending

The S&L Crisis of 1982-1992

In the mid-1980s, real estate and land prices in Texas and the Southwest collapsed, which was followed by economic downturns in the Northeast and Western states of the U.S.

regulatory forbearance

FSLIC practiced a policy of ___________________ 

• An alarming number (919) of savings institution failures occurred in the 1984-1993 period, peaking at 325 in 1989, alongside a rapid decline in asset growth of the industry

Financial Institutions Reform Recovery, and Enforcement Act (FIRREA) of 1989 abolished the FSLIC and created SAIF

• Strengthened capital requirements and constrained non-mortgage-related asset investment powers under QTL test

FDIC Improvement Act of 1991

___________________________ introduced risk-based deposit insurance premiums and a prompt corrective action policy

As a result of closing weak savings institutions and strengthening capital requirements, the industry is now significantly smaller in terms of both numbers and asset size

• Number of savings institutions decreased from 3,677 in 1989 to 2,262 in 1993 (by 38%) 

• Assets decreased from $1.427 trillion to $1.001 trillion (by 30%) between 1989 and 1993, respectively

number of savings institutions

By 2021, the ______________________ continued to decrease to 608 and the industry’s assets had slightly increased to $1.524 trillion

Balance Sheets and Recent Trends of Savings Institutions 

Assets

• QTL qualifying assets were 72.4% of portfolio assets in 2021

  • Family residential loans (20.2%) and mortgage-backed securities (44.8%) represent 64.9% of assets, while credit card loans were 7.5% of assets

• Loans secured by real estate amounted to 29.2% of assets (compared to 22.2% at commercial banks)

• Commercial and industrial loans were only 3.1% of assets (compared to 9.8% at commercial banks)

• Loans to individuals amounted to 9.0% of assets (compared to 7.9% at commercial banks)

Balance Sheets and Recent Trends of Savings Institutions

Liabilities

• Transaction accounts and small time and savings deposits are the predominant source of funds, with total deposits accounting for 84.7% of total liabilities and net worth in 2021

Balance Sheets and Recent Trends of Savings Institutions

Net worth amounted to 9.7% in 2021

Office of the Comptroller of the Currency (OCC)

• In 1989, FIRREA established the Office of Thrift Supervision (OTS)

  • OTS chartered (and examined) all federal savings institutions and supervised the holding companies of savings institutions

• Wall Street Reform and Consumer Protection Act of 2010 mandated the consolidation of the OTS and the OCC, and now the OCC regulates both national banks and federal savings institutions

FDIC

• Also established in 1989 under FIRREA

• In the wake of the FSLIC insolvency, the FDIC oversaw and managed the Savings Association Insurance Fund (SAIF)

• FDIC merged the SAIF and the Bank Insurance Fund (BIF) in 2007 to form the Deposit Insurance Fund (DIF)

Other regulators

(i.e., state regulators)

Savings institutions had record profits in the mid- to late 1990s, as interest rates remained low and the U.S. economy prospered

• 1999: $10.7 billion in net income (NI) and an annualized ROA of 1.00%

Downturn in the U.S. economy resulted in a decline in savings institutions’ profitability in 2000

• 2000: ROA and ROE fell slightly to 0.92% and 11.14%, respectively

In the early 2000s, the industry’s net interest margins rose

• 2001-2003: ROA and ROE rose to record levels each year 

In the late 2000s, U.S. economy experienced strongest recession since the Great Depression

• 2008: NI was -$8.6 billion, the first negative earnings year since 1991

As economy improved in second half of 2009 through 2013, so did performance, and the trend continued into 2010

• 2021: ROA was 1.11% and ROE was 11.30%

Credit unions (CUs)

___________________ are nonprofit depository institutions mutually organized and owned by their members (depositors)

First established in the early 1900s as self-help organizations

• Members were expected to deposit savings in the CU, and these funds were lent only to other members

CUs are prohibited from serving the general public; members are required to have a common bond of occupation, association, or cover a well-defined neighborhood, community or rural district

• E.g., university-affiliated CUs, police CUs, etc.

Primary objective is to satisfy depository and borrowing needs of members

Earnings of CUs are not taxed, given they are nonprofits

• May offer higher interest rates on deposits and charge lower rates on some types of loans compared to banks and savings institutions

Most numerous of all depository institutions

• 4,760 CUs in 2022

• 135.3 million members

Less affected by the crises that affected commercial banks and savings institutions in the 1980s and late 2000s

• Traditionally, more than 40% of their assets have been in small (less than $10,000) consumer loans, which are funded by member deposits

• Relatively matched credit risk and maturity in the asset and liability portfolios left CUs less exposed to credit and interest rate risk 

Nation’s credit union system consists of three tiers:

1. U.S. Central Credit Union is the top tier

   • Provides investment and liquidity services to corporate CUs

2. Corporate credit unions comprise the middle tier at the state or regional level

   • FIs cooperatively owned by their member CUs

   • As of June 2022, there were 11 corporate CUs with assets of $32 billion

   • Serve members by investing and lending excess funds that member CUs place with them

   • Provide automated settlement, securities safekeeping, data processing, accounting, and payment services

3. Local level credit unions make up the bottom tier

U.S. Central Credit Union is the top tier

• Provides investment and liquidity services to corporate CUs

Corporate credit unions comprise the middle tier at the state or regional level

• FIs cooperatively owned by their member CUs

• As of June 2022, there were 11 corporate CUs with assets of $32 billion

• Serve members by investing and lending excess funds that member CUs place with them

• Provide automated settlement, securities safekeeping, data processing, accounting, and payment services

Local level

___________ credit unions make up the bottom tier

In recent years, CUs have expanded their services to compete with CBs and SIs

• Now offer mortgages, credit lines, and mobile banking

• Some offer business and commercial loans to their employer groups

Bankers claim that CUs unfairly compete with small banks that have historically been the major lender in small towns and local communities

• Banking industry filed two lawsuits in 1997 aimed to restrict the growing competitive threat from CUs 

• In 1998, the Supreme Court sided with the banking industry

  • Later that year, Congress quickly passed a bill that sided with CUs

• As of December 2022, 4,760 CUs had assets of $2.17 trillion compared to $192.8 billion in assets in 1988 

• CUs tend to be very small, with an average asset size of $455 million in 2022, compared to $5,408 million for banks

Balance Sheets and Recent Trends of Credit Unions

Assets

• 34.2% of assets are in the form of small consumer loans and another 26.7% are in the form of 1-4 family home mortgages

• Investment securities made up 22.0% of total assets in 2021

Balance Sheets and Recent Trends of Credit Unions

Liabilities

• 86.8% of total funding came from member deposits in 2021

CUs hold lower levels of equity than other DIs

• CUs’ capital-to-assets ratio was 10.3% in 2021 

As of 2022, 64.6% of CUs were federally chartered and subject to National Credit Union Administration (NCUA) regulation, an independent federal agency that charters, supervises, examines, and insured the nation’s CUs 

• Accounts for 51.0% of the total membership and 49.3% of total assets

• Through its insurance fund, the National Credit Union Share Insurance Fund (NCUSIF), NCUA provides deposit insurance guarantees of up to $250,000 for insured state and federal credit unions

  • NCUSIF covers 98% of all credit union deposits

member credit unions

NCUSIF’s reserves come entirely from premiums paid by ______________ 

CU industry has grown in asset size in the 1990s and 2000s

Larger CUs generally outperform small CUs

• Largest CUs experienced ROA of .95% in 2022, while ROA for the smallest CUs was 0.14%

• Smaller CUs generally have a smaller and less diversified customer base and higher overhead expenses per dollar of assets

Given the mutual-ownership status of this industry, growth in ROA is not necessarily the primary goal of CUs

• As long as capital or equity levels are sufficient to protect a CU against unexpected losses on its credit portfolio as well as other financial and operational risks, this nonprofit industry has a primary goal of serving the deposit and lending needs of its members

There are three major types of finance companies (FCs):

1. Sales finance institutions specialize in making loans to customers of a specific retailer or manufacturer

   • E.g., Ford Motor Credit and Toyota Motor Credit

2. Personal credit institutions specialize in making installment and other loans to consumers

   • E.g., HSBC Finance Corp. and Synchrony Financial

3. Business credit institutions provide financing to corporations, especially through equipment leasing and factoring, in which the finance company purchases accounts receivable from corporate customers at a discount from face value and the finance company assumes the responsibility for collecting the accounts receivable

   • E.g., IBM Credit and John Deere Financial Services

Sales finance institutions

_______________________ specialize in making loans to customers of a specific retailer or manufacturer

• E.g., Ford Motor Credit and Toyota Motor Credit

Personal credit institutions

___________________________ specialize in making installment and other loans to consumers

• E.g., HSBC Finance Corp. and Synchrony Financial

Business credit institutions

_________________________ provide financing to corporations, especially through equipment leasing and factoring, in which the finance company purchases accounts receivable from corporate customers at a discount from face value and the finance company assumes the responsibility for collecting the accounts receivable

• E.g., IBM Credit and John Deere Financial Services

In 2021, the finance company industry assets stood at $1,448.8 billion

FC industry is highly concentrated

• Large firms with assets of $20 billion or more account for more than 71% of its assets

• Many of the largest FCs tend to be wholly owned or captive subsidiaries of major manufacturing companies

• Major role of captive finance company, a finance company wholly owned by a parent corporation, is to provide financing for the purchase of products manufactured by the parent

  • E.g., Ford Motor Credit provides financing for Ford Motor Company cars

captive finance company

Major role of _________________ , a finance company wholly owned by a parent corporation, is to provide financing for the purchase of products manufactured by the parent

Balance Sheets of FCs: Assets

• Business and consumer loans (called accounts receivable) represent 78.5% of total assets

  • Motor vehicle loans and leases are traditional the major type of consumer loan (72.5% of consumer loan portfolio in 2021)

  • FCs generally charge higher rates for consumer loans because they generally attract riskier customers than commercial banks

    • Individuals may obtain a mortgage from a subprime lender FC, a finance company that lends to high-risk customers

    • A few loan shark FCs prey on desperate consumers, charging exorbitant rates as high as 30% or more per year

    • Payday lenders provide short-term cash advances that are often due when borrowers receive their next paycheck

• Real estate loans are 7.2% of total assets

subprime lender

Individuals may obtain a mortgage from a _________________FC, a finance company that lends to high-risk customers

loan shark

A few ______________ FCs prey on desperate consumers, charging exorbitant rates as high as 30% or more per year

Residential and commercial mortgages have become a major component in FCs asset portfolio

• Home equity loans allow customers to borrow on a line of credit secured with a second mortgage on their home

• FCs mortgage portfolios also include securitized mortgage assets, mortgages packaged and used as assets backing secondary market securities

• FCs earn income when they continue to service the original mortgage (in addition to income from securitizing mortgage assets) via mortgage servicing

Home equity loans

__________________ allow customers to borrow on a line of credit secured with a second mortgage on their home

securitized mortgage assets

FCs mortgage portfolios also include ______________________, mortgages packaged and used as assets backing secondary market securities

mortgage servicing

FCs earn income when they continue to service the original mortgage (in addition to income from securitizing mortgage assets) via ___________________ 

Business loans represent 31.2% of the loan portfolio of FCs

• Major subcategories of business loans are retail and wholesale motor vehicle loans and leases (21.2% of all business loans in 2021), equipment loans (56.9%), and other business loans (21.9%)

Balance Sheets of FCs:
Liabilities and Equity

• FCs cannot accept deposits; rather, they rely primarily on bank loans, short-term commercial paper, and other debt instruments to finance assets

  • In 2021, bank loans were $169.9 billion (11.7% of total assets); 

  • Commercial paper was $41.3 billion (2.9%); and

  • Other debt (due to parent holding companies and notes, bonds, and debentures) totaled $832.6 billion (60.3%)

• Total capital comprised $258.2 billion (17.8% of total assets)

Problems arose in the FC industry in the mid- and late-2000s with the crash of the market for subprime mortgage loans

• Many FCs saw sharply lower equity values

As the U.S. economy improved in the late 2000s and early 2010s, the FC industry improved as well

• In the mid-2010s, industry median ROE rose to 9.33%, up from 6.61% during the height of the crisis

• For business credit institutions ROE rose to 13.73%, up from 5.31% during the height of the crisis

• Industry assets were $1.82 trillion in the mid-2010s, up from $1.59 trillion during the crisis

$1.4 trillion to $1.5 trillion range

In the late 2010s, industry assets have been declining back to the ________________________

• FCs are financial intermediaries that borrow funds so as to profit on the different between the rates paid on borrowed funds and those charged on loans

• FCs may be subject to state-imposed usury ceilings on the maximum loan rates assigned to individual customers

• Regulated to the extent to which they can collect on delinquent loans (e.g., legal mechanisms to be followed)

• Because FCs do not accept deposits, they are not subject to extensive oversight by federal and state regulators, as are banks or thrifts

• Heavy borrowers in the capital markets and do not enjoy the same regulatory “safety net” as banks

• Overall, regulatory oversight of this industry is relatively light

Unlike the U.S., savings institutions and cooperative banks (similar to CUs in the U.S.) in Europe were created in the 19^th century to channel individuals’ savings into the continent’s commercial industry

• Majority of savings institutions in Europe are mutuals (owned by local officials, religious organizations, unions, and deposit holders)

Two features that all savings banks in Europe have in common:

1. Focus on savings and savings mobilization

2. Clear regional and even local focus

• Nonbank FI lending has increased in importance over the past decade

• While the financial crisis affected the operations of FCs, they still remained a major part of the financial sector worldwide