ch14

1. Financial Institutions
Course Code 456413
by
Dr. Muath Asmar
An-Najah National University
Faculty of Graduate Studies

2. Chapter Fourteen
Other Lending
Institutions: Savings
Institutions, Credit
Unions, and Finance
Companies
Copyright © 2022 McGraw-Hill. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill.

3. Other Lending Institutions
 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
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4. Savings Institutions (SIs)
 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
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5. 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.
 FSLIC practiced a policy of regulatory forbearance
 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
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6. The S&L Crisis of 1982-1992
(Continued)
 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
 By 2019, the number of savings institutions continued to
decrease to 659 and the industry’s assets had slightly
increased to $1.154 trillion
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7. Structural Changes in the Number
of Savings Institutions, 1984-2016
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8. Balance Sheets and Recent
Trends of Savings Institutions
 Assets
 QTL qualifying assets were 71% of portfolio assets in 2019
 Mortgages (28.1%) and mortgage-backed securities (32.3%) represented
60.4% of assets, while credit card loans were 10.6% of assets
 Loans secured by real estate amounted to 38.5% of assets
(compared to 27.1% at commercial banks)
 Commercial and industrial loans were only 3.8% of assets
(compared to 11.8% at commercial banks)
 Loans to individuals amounted to 12.3% of assets (compared to
9.9% at commercial banks)
 Liabilities
 Transaction accounts and small time and savings deposits are the
predominant source of funds, with total deposits accounting for
79.8% of total liabilities and net worth in 2019
 Net worth amounted to 10.8% in 2019
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9. Assets and Liabilities of Savings
Institutions, 2019
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10. Regulators of Savings Institutions
1. 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
2. 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)
3. Other regulators (i.e., state regulators)
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11. Savings Institutions Recent
Performance
 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
 2019: ROA was 1.36% and ROE was 12.41%
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12. Selected Indicators for U.S. Savings
Institutions, 1989 through 2019
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13. U.S. Saving Institution Asset
Concentration, 1992 versus 2019
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14. Credit Unions (CUs)
 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
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15. Comparison of Average Savings,
Deposits, and Loan Rates at CUs
and Banks, December 27, 2019
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16. Credit Unions (CUs)
(Continued)
 Most numerous of all depository institutions
 5,236 CUs in 2019
 120.4 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
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17. Credit Unions (CUs)
(Concluded)
 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 2019, there were 11 corporate CUs with assets of
$23 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
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18. Credit Union (CU) Trends
 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
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19. Balance Sheets and Recent
Trends of Credit Unions
 As of 2019, 5,236 CUs had assets of $1.57 trillion compared to
$192.8 billion in assets in 1988
 CUs tend to be very small, with an average asset size of $299
million in 2019, compared to $3,601.6 million for banks
 Assets
 28.5% of assets are in the form of small consumer loans and another
30.7% are in the form of 1-4 family home mortgages
 Investment securities made up 16.8% of total assets in 2019
 Liabilities
 84.2% of total funding came from member deposits in 2019
 CUs hold lower levels of equity than other DIs
 CUs’ capital-to-assets ratio was 11.4% in 2019
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20. Assets and Liabilities of Credit
Unions, 2019
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21. Composition of Credit Union
Deposits
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22. Credit Union Regulators
 As of 2019, 63.7% of CUs were federally chartered and
subject to regulation by the National Credit Union
Administration (NCUA), an independent federal agency that
charters, supervises, examines, and insured the nation’s CUs
 Accounts for 51.5% of the total membership and 49.9% 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
 NCUSIF’s reserves come entirely from premiums paid by
member credit unions
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23. Credit Union Industry
Performance
 CU industry has grown in asset size in the 1990s and 2000s
 Larger CUs generally outperform small CUs
 Largest CUs experienced ROA of 1.04% in 2019, while ROA for
the smallest CUs was 0.30%
 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
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24. Return on Assets for Credit
Unions, 1993 through 2019
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25. Finance Companies (FCs)
 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 Global Financing and GE Capital Global Holdings
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26. Finance Companies (FCs)
(Continued)
 In 2019, the finance company industry assets stood at
$1,503.6 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
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27. Assets and Liabilities of U.S.
Finance Companies, December 2019
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28. Balance Sheets of FCs: Assets
 Business and consumer loans (called accounts receivable)
represent 79.2% of total assets
 Motor vehicle loans and leases are traditional the major type of
consumer loan (70.3% of consumer loan portfolio in 2019)
 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 7.8% of total assets
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29. Balance Sheets of FCs: Assets
(Continued)
 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
 Business loans represent 31.4% of the loan portfolio of FCs
 Major subcategories of business loans are retail and wholesale motor
vehicle loans and leases (29.4% of all business loans in 2019),
equipment loans (50.9%), and other business loans (19.7%)
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30. 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 2019, bank loans were $153.6 billion (10.2% of total
assets);
 Commercial paper was $62.8 billion (4.2%); and
 Other debt (due to parent holding companies and notes,
bonds, and debentures) totaled $1,030.1 billion (68.5%)
 Total capital comprised $257.0 billion (17.1% of total
assets)
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31. Industry Performance for FCs
 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
 In the late 2010s, industry assets have been declining back
to the $1.4 trillion to $1.5 trillion range
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32. Regulation
 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
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33. Global Issues
 Unlike the U.S., savings institutions and cooperative banks
(similar to CUs in the U.S.) in Europe were created in the 19th
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
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