Chapter Fourteen

1. Chapter Fourteen Other Lending Institutions: Savings Institutions, Credit Unions, and Finance Companies McGraw-Hill/Irwin

2. Overview: Other Lending Institutions • Savings Associations (1,074 in 2004) • concentrated primarily on residential mortgages • Savings Banks (339 in 2004) • large concentration of residential mortgages • commercial loans • corporate bonds • corporate stock • Credit Unions (9,210 in 2004) • consumer loans funded with member deposits • Finance Companies • Make loans to individuals and businesses McGraw-Hill/Irwin

3. Savings Associations • Historically referred to as savings and loan (S&L) associations • Net interest margin - interest income minus interest expense divided by earning assets • Disintermediation - withdrawal of deposits from depository institutions to be reinvested elsewhere, e.g., money market mutual funds • Regulation Q ceiling - an interest ceiling imposed on small savings and time deposits at banks and thrifts until 1986 (continued) McGraw-Hill/Irwin

4. Regulator forbearance - a policy of the FSLIC not to close economically insolvent FIs, allowing them to continue in operation • Savings institutions - savings association and savings banks combined • Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of 1989 - abolished the FSLIC and created a new savings association insurance fund (SAIF) under the management of the FDIC • QTL test- qualified thrift lender test that sets a floor on the mortgage-related assets that thrifts can hold (65%) • Mutual organization - an institution in which the liability holders are also the owners (majority of savings banks and associations) McGraw-Hill/Irwin

5. Savings Banks • Established as mutual organizations and largely confined to the East Coast and New England states • Deposits are insured by the FDIC under the Bank Insurance Fund (BIF) • Have been allowed greater freedom to diversify into corporate bonds and stocks • Rely more on deposits than savings associations and have fewer borrowed funds McGraw-Hill/Irwin

6. Regulators of Savings Institutions • Office of Thrift Supervision - established in 1989 under the FIRREA, charters and examines all federal savings institutions and supervises the holding companies of savings institutions • The FDIC - oversees, manages SAIF and BIF • SAIF - provides insurance coverage for savings associations • BIF - provides insurance coverage for savings banks • Other regulators - state-chartered savings institutions are regulated by state agencies McGraw-Hill/Irwin

7. Credit Unions • Are not-for-profit depository institutions mutually organized and owned by their members (depositors) • CU member deposits (shares) used to provide loans to other members with earnings from these loans used to pay interest on member deposits • Tend to hold higher levels of equity than other depository institutions • Can be federally chartered and regulated by NCUA or state chartered and regulated by the state • Growth is not the primary goal McGraw-Hill/Irwin

8. Finance Company Functions • Originated during the Depression when General Electric Corp. created GE Capital Corp. to finance appliance sales to cash-strapped customers • In the late 1950’s, banks became more willing to make installment loans so finance companies branched out into leasing and leveraged buyouts • Willing to lend to riskier borrowers • Often are directly affiliated with manufacturing • Limited regulation McGraw-Hill/Irwin

9. Three Major Types of Finance Companies • Sales finance institutions • finance companies specializing in loans to customers of a particular retailer or manufacturer (e.g., Ford Motor Credit and Sears Roebuck Acceptance Corp.) • Personal credit institutions • finance companies specializing in installment and other loans to consumers (e.g., Household Finance Corp. and American General Finance) • Business credit institutions • finance companies specializing in business loans, leasing, and factoring (e.g., CIT Group and Heller Financial) McGraw-Hill/Irwin

10. Balance Sheet • Assets • Business and consumer loans (called accounts receivable) and real estate loans • Liabilities and equity • FCs cannot accept deposits, so they rely heavily on issuing short-term commercial paper and other debt instruments (longer-term notes and bonds) to finance assets McGraw-Hill/Irwin

11. Consumer Loans • Motor vehicle loans and leases are the major type of consumer loan (80.4% in 2001) • Subprime lender - a finance company that lends to high-risk customers • Loan sharks - subprime lenders that charge unfairly exorbitant rates to desperate, subprime borrowers • Other consumer loans (19.6% in 2001) • personal cash loans • mobile home loans • loans for consumer goods McGraw-Hill/Irwin

12. Mortgages • Residential and commercial mortgages have become a major component of finance companies’ assets • Often issued to riskier borrowers and charge a higher interest rate for that risk • Securitized mortgage assets: mortgages packaged and used as assets backing secondary market securities • Bad debt expense and administrative costs of home equity loans are lower and have become a very attractive product for finance companies McGraw-Hill/Irwin

13. Business Loans • Represent the largest portion of the loan portfolio • Several advantages over commercial banks offered to small-business customers • they are not subject to regulations that restrict the type of products and services • do not accept deposits so no bank regulators • have substantial industry and product expertise • more willing to accept risky customers • generally have lower overheads • Business lending also includes equipment loans or leasing, purchase accounts receivable, small farm loans, wholesale loans/leases of mobile homes McGraw-Hill/Irwin