Depository Institutions

1. Depository Institutions

2. Depository Institutions • Main criteria is that a significant portion of the firms funds come from customer deposits. • Examples include: • Commercial Banks • Savings and Loans • Credit Unions

3. Recent Trends • The 1990’s ended with the Fin Modernization Act (1999). • During this time 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.

4. Largest Depository Institutions, Dec 31, 2003 by total assets (billions) $ % %Dom AssetsAssetsDep 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% Source FDIC Future of Banking Study FOB-2004-02.1

5. Traditional Services • Depository Institutions have been traditionally been subject to a large amount of regulation that restricted their actions. • Main business functions: • Consumer and Business Lending • Savings Products • Payment Services • Main overlap with other FI’s has been in Savings products – That has changed dramatically in the last 10 years.

6. Key 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 Banks • Comptroller of the Currency examines all nationally chartered banks every 12 to 18 months • Established pledging requirements for owners equity

7. Key Regulatory Legislation • The Federal Reserve Act (1913) • Established the Federal Reserve System as a lender of last resort • Established network to clear and collect checks

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

9. Legislation (continued)... • 1933 Glass-Steagall: • Separates securities and banking activities • Prohibited commercial banks from most underwriting of securities. 4 exceptions: Munis, US govt, Private Placement and Real Estate Loans. Fear of conflict of interest • Established FDIC • National banks allowed to branch state wide if state chartered banks were allowed to do so.

10. Legislation (continued)... • 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 books • 1970 Amendments to the Bank Holding Company Act: Extension to one-bank holding companies

11. Legislation (continued)... • 1970 International Banking Act: Regulated foreign bank branches and agencies in USA • 1980 Depository Institutions Deregulation and Monetary Control Act • Phased out interest rate ceilings imposed by Regulation Q • Goal was to make S&L’s, credit unions and other nonbank depository institutions more competitive.

12. Legislation (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 accounts • Loan limits were liberalized for national banks, allowed lending of up to 15% of their capital • FDIC could arrange mergers across state lines for failing institutions • Competitive Equality in Banking Act (1987) • Redefined bank to limit growth of nonbank banks.

13. Legislation (continued)… • Financial Institutions Reform Recovery and Enforcement Act (1989) • Imposed restrictions on investment activities • Replaced FSLIC with FDIC-SAIF • Replaced FHLB with Office of Thrift Supervision • Created Resolution Trust Corporation

14. Legislation (continued)… • 1991 FDIC Improvement Act • Fear of FDIC insolvency by end of 1991 • Ordered new measurement scale for describing financial condition of depository institution and when in violation to take “prompt corrective action” • Risk-based deposit insurance premiums • Limited “too big to fail”

15. Legislation (continued)… • 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.

16. 1999 Financial Services Modernization Act • Financial Services Modernization Act • Allowed banks, insurance companies, and securities firms to enter each others’ business areas • Provided for state regulation of insurance • Streamlined regulation of BHCs • Prohibited FDIC assistance to affiliates and subsidiaries of banks and savings institutions • Provided for national treatment of foreign banks • ATM fees must be clearly disclosed • Federal Crime to steal account information

17. Structural Changes FDIC

18. FDIC Institutions Source FDIC

19. Competition among FI’s

20. Unresolved 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?

21. Bank Size (by asset concentration) • Community banks – under $1billion in assets specialize in retail or consumer lending • 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 – Heavy reliance on nondeposit or borrowed funds.

22. Balance Sheet • Assets - four major categories • Cash and deposits held at other institutions • Government and private interest bearing securities • Loans and leases • Misc assets. • Liabilities – two major categories • Deposits • Non deposit borrowing

23. Assets • 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 deposits • Income 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

24. Assets (continued) • Loans • Largest portion of assets form most banks • Includes 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.)

25. Assets (continued) • Federal Funds sold and Securities Purchased under Repurchase agreements • Short term loans… • Customers Liability on Acceptances • A line of credit provided via a letter of credit backing purchases by the customer. • Miscellaneous Assets • Bank buildings, equipment, prepaid insurance etc.

26. Assets, % of Total Assets www.FDIC.gov

27. Loans, % of Total Loans FDIC

28. Loan Portfolios 2000 Real Estate 62.77% Real Estate 39.85% FDIC

29. Liabilities • Largest portion of liabilities is deposits • Average 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

30. Deposits • Non-interest bearing demand deposits • Checking accounts with unlimited check writing • Savings deposits • NOW accounts • Held only by individuals and nonprofit institutions pay interest and permit checks • Money market deposit accounts • Limited check writing ability and can pay interest • Time deposits • CD’s with fixed maturity and interest rate

31. Liabilities, % of Total Fedral Reserve Board

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

33. Equity • Usually about 8 to 10 % of liabilities and equity • Generally equity held is close to the minimum amount set by regulations

34. Off - 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 • Expose the bank to added risk, but do not show up on traditional financial reports.

35. OBS Activities continued • Standby Credit Agreements- bank pledges to guarantee repayment of a customers’ loan received from a third party • Interest rate swaps – exchange interest payments on debt securities with another party • Financial futures and options • Loan commitments – pledge to lend up to a certain amount of funds • Foreign exchange rate contracts

36. Other Fee Generating Activities • Trust Services • Management of estate assets and pension fund assets • Correspondent Banking • Providing banking services to smaller institutions that do not have the staff or expertise in those services.

37. Savings 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.

38. S&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

39. Savings Banks • Originally organized as a mutual organization that also focused on mortgage lending • Many are now switching to stock ownership

40. Credit Unions • Nonprofit depository institutions that are mutually organized. • Members must belong to a specific similar occupation, association or live in a given community. • Earnings are designated to paying higher rates of return on deposits and to charging lower rates of interest on loans.

41. Financial Analysis ofDepository Institutions Finance 129 Drake University

42. Basic Financial Statements • Report of Condition • Balance Sheet • Report of Income • Income Statement • Funds Flow Statement • Sources and Uses of Funds • Statement of Stockholders Equity

43. Financial Outputs (uses of Bank Funds or Assets) Cash (primary reserves) Liquid Security Holdings (secondary Reserves) Investments in Securities Loans Consumer Real Estate Ag Fin Institutions Mics Loans Misc Financial Inputs (Sources of Funds or Liabilities and Owners Equity) Deposits from Public Demand NOW’s Money markets Savings Time Nondeposit Borrowings Equity Capital Stock Surplus Retained Earnings Capital reserves Balance Sheet

44. Balance Sheet continued • As with any balance sheet Assets = Liabilities + Owners Equity or Accumulated uses Accumulated sources of bank funds of bank funds =

45. Balance Sheet Components Assets • The Cash Account • includes: Cash in the vault, deposits with other banks, cash items in the process of collection and reserve accounts with the Federal Reserve • Traditionally banks attempt to keep this account as low as possible • Primary reserves since it is banks first line of defense against withdrawls

46. Balance Sheet Components Assets • Investment Securities: the liquid portion • Short term government securities and money market instruments • secondary reserves • Investment Securities Income Generating Portion • Taxable and nontaxable • Can be recorded at original cost or market value or the lower of the two • trading account securities

47. Balance Sheet Components Assets • Loans • Largest Asset • Generally broken down by purpose of loans • Gross loans -- total of all outstanding • Allowance for Loan losses (ALL account) • PLL on income statement • Gross minus ALL = Net Loans • Allocated Transfer Risks • Unearned Discounts

48. Balance Sheet Components Assets • ALL account • often divided into two sections, specific reserves, and general reserves • Tax reform Act of 1986 • only loans actually declared uncollectable can be expensed through the ALL accounts • decreased use of ALL accounts • Permanent capital

49. Balance Sheet Components Assets • Federal Funds Sold and Securities Purchased under Resale Agreements • Customers liability Acceptances • Misc Assets

50. Balance Sheet Components Liabilities • Deposits • Noninterest bearing • Savings • NOW accounts • Money Market Accounts • Time Deposits • Borrowings from Nondeposit sources • Capital Accounts