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Mod 4 Savings and Loans and The Mortgage Markets
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Using the Harvard Business Case Study, Savings & Loans and the Mortgage Markets, answer the following questions by creating and submitting a Word document. Your answers should be a maximum of 1 page per question.
1. What are the similarities and differences of the problems encountered by the S&L industry and the more recent problems of the mortgage / housing industry?
2. The US government has created several agencies – the FHA, FHLB, Fannie Mae, Freddie Mac, Ginnie Mae – to provide assistance to the housing market and essentially took over Fannie and Freddie in mid-2008 to assure that it could continue to operate. Why has this sector attracted so much attention and assistance?
3. What policy actions and changes to the marketplace undermined a solid position of savings and loans in the 1970s? Could the effects of these changes have been anticipated and foreseen?
4. Many actions were taken by Congress and regulators to try to address the weakening position of savings and loans. Why were these not effective?
Tags: US government Financial Markets and Institutions Mortgage Markets Savings Loans SL industry
712_module_4_compiled.pdf
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2019/4/11 Module 4 Compiled Module 4 – Compiled Content The following are all pages from the module linked as a single file suitable for printing or saving for offline viewing. Please note that this compilation will not include popup pages, and some animations or images may not work. Module 4 Study Guide and Deliverables Lecture Financial Institutions: Commercial Topics: Banking Operations and Regulations Bank Management and Profitability Readings: Madura: Ch. 17, 18, 19, 20, 21, HBS #1, and HBS#2 Discussions: 4: Bank Consolidation Initial post due by Wednesday, April 10 at 11:59 PM ET Reply posts due by Sunday, April 14 at 11:59 PM ET Activities: Case Study #1 Savings & Loans & the Mortgage Market due by Sunday, April 14 at 11:59 PM ET Week 4 Introduction msm_ad712_13_su2_bchambers_w04 is displayed here Download Banks and Thrifts Commercial banks are the most pervasive of all financial institutions. We’ll here distinguish commercial banks, and the financial intermediary services they offer, from investment banks and other financial services entities. Essentially, we’ll focus on the services they offer in terms of deposit accounts with the size and maturity characteristics desired by savers and on repackaging the funds received from deposits to provide loans of the size and maturity desired by borrowers. Background of U.S. Banking https://learn.bu.edu/bbcswebdav/pid-6629017-dt-content-rid-25349100_1/courses/19sprgmetad712_o2/course/module_04/ad712_W04_Print… 1/40 2019/4/11 Module 4 Compiled The U.S. market features a huge number of banks, approximately 5,300 in number, while in most countries, the market is dominated by just a handful of banks. The U.S. phenomenon has interesting historical roots, but even in the U.S., the largest banks – Bank of America, JP Morgan Chase, Wells Fargo, etc. – play a dominant role. The bank system is continuing to consolidate. Interstate regulations were changed in 1994 to allow banks more freedom to acquire banks across state lines. Competition among banks increased, and banks needed to become more efficient as a means of survival. Acquisitions were a convenient method to grow quickly. The number of banks today (about 5,300) is about one-third the number existing in 1985. The largest 100 banks now represent more than 80% of all bank assets. The following two tables highlight some of the largest institutions, both worldwide and in the U.S. It’s notable that only two U.S. institutions are among the dozen largest banks worldwide. Most of the largest U.S. banks are well-known names (after taking mergers into account). World’s Largest Banks – 06/30/2015 Rank Bank Total Assets (US$ B) 1 ICBC, China 3,616.39 2 China Construction Bank, China 2,939.15 3 Agricultural Bank of China , China 2,816.60 4 Bank of China, China 2,629.31 5 HSBC Holdings , UK 2,571.71 6 JP Morgan Chase &Co. 2,449.60 7 BNP Paribas 2,400.04 8 Mitsubishi UFJ Financial , Japan 2,323.24 9 Bank of America 10 Credit Agricole Group 1,911.27 11 Deutsche Bank 1,901.37 12 Barclays PLC 1,882.67 13 Citigroup Inc 1,829.37 14 Wells Fargo 1,720.62 15 Japan Post Bank 1,701.60 16 China Development Bank 1613.2* 17 Mizuho Financial Group 1,563.88 18 Sumitomo Mitsui Financial Group 1,526.98 19 Societe General 1,525.76 20 Royal Bank of Scotland Group 1,517.66 2,149.03 *As of 12/31/2014 Source: relbanks.com https://learn.bu.edu/bbcswebdav/pid-6629017-dt-content-rid-25349100_1/courses/19sprgmetad712_o2/course/module_04/ad712_W04_Print… 2/40 2019/4/11 Module 4 Compiled Largest US Bank Holding Companies – 06/30/2015 Bank Holding Company 1 JPMorgan Chase & Consol Domestic Assets Assets (Mil $) (Mil $) Pct Pct Domestic Cumulative Assets Assets Domestic Branches 2,118,442 1,618,423 175 79 5,511 2 BofA Corp. 1,606,232 1,519,921 95 26 4,854 3 Wells Fargo and Co. 1,553,871 1,506,535 97 37 6,222 4 Citigroup 1,336,201 742,469 56 46 794 414,002 412,728 100 49 3,217 343,630 340,088 99 52 2,741 320,204 213,405 67 54 3 8 State Street Corp. 289,425 223,099 77 56 2 9 Capital One FC 255,291 255,203 100 58 843 235,030 235,030 100 59 1,310 190,500 186,678 98 61 231 12 BB&T Corp. 186,643 186,462 100 62 1,902 13 SUNTRUST Bank 184,223 184,223 100 63 1,466 14 Fifth Third BC 139,250 138,532 99 66 1,349 15 Morgan Stanley 126,643 126,643 100 66 0 16 Goldman Sachs Group 122,681 122,681 100 67 1 Co. 5 U S Bank Corp. 6 7 PNC Financial Services Group Bank of NY Mellon Corp. TD US P & C Holdings 10 / Toronto Dominion Bank 11 HSBC North America Holdings https://learn.bu.edu/bbcswebdav/pid-6629017-dt-content-rid-25349100_1/courses/19sprgmetad712_o2/course/module_04/ad712_W04_Print… 3/40 2019/4/11 Module 4 Compiled 17 Regions FC 120,932 120,932 100 68 1,628 18 Northern Trust Corp. 119,600 87,560 73 69 68 113,525 113,202 100 70 388 106,948 106,948 100 71 843 19 20 MUFG Amers Holds Corp Citizens Financial Group Source: Federal Reserve Historically in the U.S., anyone could establish a bank. Thousands of individuals (the wealthiest man in town) set up a bank. Because of weakness and lack of standards, many banks failed during various crises, most often due to a run on the bank. This resulted in the loss of retail deposits which obviously became a political issue. Many communities also viewed (and still do) having a bank as a sign of prestige and a key agent for economic development of the area. Consequently, politicians have been very protective of local banks. Strong populist fear of the monopolistic power of large financial institutions also engendered restrictions on how big banks could be, limiting number of branches, etc. Some states even forbade banks from opening branches at all (creating “unitary banks”, such as Continental Illinois). Such concerns also help explain the over-protection afforded to savings and loans and are still evident in regulations such as the Community Reinvestment Act: “The CRA was enacted in 1977 to prevent redlining and to encourage banks and thrifts to help meet the credit needs of all segments of their communities, including low- and moderate-income neighborhoods. It extends and clarifies the longstanding expectation that banks will serve the convenience and needs of their local communities.” Office of the Comptroller of the Currency Bank Participation in Financial Conglomerates Some commercial banks have acquired other types of financial service firms or are owned by bank holding companies which also control other financial entities. Conglomerates are composed of various units offering specialized services. This is a fairly new phenomenon arising primarily over the past 30 years. The Financial Services Modernization Act gave banks and other financial service firms more freedom to merge, without having to divest some of the financial services that they acquired. The Act allowed financial institutions to offer a diversified set of financial services. Recent discussion about the so-called “Volcker Rule” explored imposing limitations on bank size and functions. There are certainly some benefits of diversified services to individuals and firms as well as to the firms themselves. Individuals and firms have various financial needs that they can now satisfy with one individual institution. But perhaps the greater advantage of conglomerates is to the institutions themselves. Financial institutions can reduce their reliance on the demand for any single service they offer and this may result in less risk for the institution. The units of a https://learn.bu.edu/bbcswebdav/pid-6629017-dt-content-rid-25349100_1/courses/19sprgmetad712_o2/course/module_04/ad712_W04_Print… 4/40 2019/4/11 Module 4 Compiled financial conglomerate may generate some new business just because they offer convenience to clients who already rely on its other services. However, to date, few real benefits have been realized from the “supermarket” approach, and some have moved to at least trim the number of lines of business in which they participate. For example, Citibank spun off its Travelers Insurance unit. The Bank Balance Sheet The following is an explanation of a bank’s balance sheet: The composition of US Banks’ balance sheets for the periods from 1991 to 2015 follows: https://learn.bu.edu/bbcswebdav/pid-6629017-dt-content-rid-25349100_1/courses/19sprgmetad712_o2/course/module_04/ad712_W04_Print… 5/40 2019/4/11 Module 4 Compiled The source of most of a bank’s funds is various types of deposit accounts. Transaction deposits include demand deposit accounts (checking account), offered to customers who desire to write checks as well as negotiable order of withdrawal (NOW) accounts, that provide checking services as well as pay interest but require a larger minimum balance. Increasingly, both deposits and other transactions are done electronically. About two-thirds of all employees in the U.S. have direct deposit accounts and more than 60 percent of bank customers use ATMs. Debit cards and preauthorized debits can be used for recurring monthly payments. Until 1986, Regulation Q restricted the interest rate banks could offer on passbook savings, reserving such saving accounts for savings and loan companies. Further, ceilings prevented commercial banks from competing for funds during periods of higher interest rates. Time deposits are deposits that cannot be withdrawn until a specified maturity date. Retail certificates of deposit (CDs) require a specified minimum amount of funds to be deposited for a specified period of time. Annualized interest rates and maturity types vary among banks and there is no organized secondary market, so depositors will normally forgo a portion of their interest as a penalty for early withdrawal. Negotiable certificates of deposit (NCDs) are offered by some large banks to corporations. They typically have shortterm maturities and require a minimum deposit of $100,000. They can be sold but generally do not have a secondary market. Money mark et deposit accounts (MMDAs) were created with the Garn-St. Germain Act of 1982. They differ from conventional time deposits in that they do not specify a maturity, so they are more liquid than retail CDs and provide limited check-writing ability, but they normally pay a lower rate than retail CDs. Wholesale Sources of Bank Funds TBanks actively borrow (and lend) funds to each others. These are termed Fed Funds, which, despite the name, have no direct government involvement whatsoever. Federal funds purchased represent a liability to the borrowing banks and an asset to the lending bank that provides them. Loans in the federal funds market are typically for one to seven days. https://learn.bu.edu/bbcswebdav/pid-6629017-dt-content-rid-25349100_1/courses/19sprgmetad712_o2/course/module_04/ad712_W04_Print… 6/40 2019/4/11 Module 4 Compiled The intent of federal funds transactions is to correct short-term fund imbalances experienced by banks. The interest rate charged in the federal funds market is the federal funds rate, and each loan is negotiated between the participating banks. The rate is typically between 0.25% and 1.00 % above the T-bill rate. Banks are able to borrow from the Federal Reserve banks through the discount window. The interest rate charged on loans from the Federal Reserve banks is the discount rate. Loans from the discount window are commonly from one day to a few weeks, and they are mainly used to resolve a temporary shortage of funds. Banks commonly borrow in the federal funds market instead of the discount window because the Fed may disapprove of continuous borrowing by a bank. A repurchase agreement (repo) represents the sale of securities by one party to another with an agreement to repurchase the securities at a specified date and price. Banks use repos as a source of funds when they need funds just for a few days. The bank sells some government securities to a corporation and buys back those securities later. Repo transactions are negotiated and carried out through a telecommunications network connecting large banks, corporations, government securities dealers, and federal funds brokers. Repo transactions are typically in blocks of $1 million, and the repo yield is slightly less than the federal funds rate. Banks issue medium-term notes bonds to provide longer-term sources of funds. Common purchasers of bank bonds are households and various financial institutions. Banks finance less with bonds than other corporations, since they hold few long-term assets; so any longer-term borrowing may create a funding mismatch (we’ll discuss that later in this lecture). Pricing Deposits Deposits constitute the bulk of a bank’s source of loanable funds. Thus pricing these liabilities – “how high a rate will we offer?” – represents a significant policy decision by the bank. The bank must make this decision in a competitive environment and must offer depositors high enough rates to attract and retain a stable deposit base. Nevertheless, it must maintain a spread between the cost of funds and the return on funds (interest margin). Competition puts pressure on the “spread” from both sides – the bank may have to charge lower rates on loans while paying higher rates on deposits. Bank Capital (Equity) Bank capital represents funds attained through the issuance of stock or through retained earnings, and it represents the equity or net worth of the bank. Especially for regulatory purposes, banks distinguish different types of capital. According to Basel III conventions, Common Equity Tier 1 capital) results from issuing common or preferred stock or retained earnings and Accumulated Other Comprehensive Income. Additional Tier 1 capital includes perpetual preferred stock , bank -issued Small Business Lending Fund and TARP instruments. Tier 2 Capital includes allowances for loan and lease losses up to 1.25 percent of risk-weighted assets, qualifying preferred stock, subordinated debt. RiskWeighted Assets (RWA) are determined by two approaches, the standardized one for smaller community banks and the advanced approach used by large institutions. (https://www.fdic.gov/regulations/safety/manual/section2-1.pdf) Banks generally avoid issuing new stock because it dilutes the ownership of the bank and reduces reported EPS. “In 2009, the Committee introduced a set of revisions to the Basel II market risk framework to address the most pressing deficiencies.” Capital levels will be much more closely tied to actual risk exposure of the bank, its own default and recovery experience, as well as operation risk. https://learn.bu.edu/bbcswebdav/pid-6629017-dt-content-rid-25349100_1/courses/19sprgmetad712_o2/course/module_04/ad712_W04_Print… 7/40 2019/4/11 Module 4 Compiled “FDIC-supervised institutions must maintain the following minimum capital ratios. These requirements are identical to those for national and state member banks. Common equity tier 1 capital to total risk-weighted assets ratio of 4.5 percent, Tier 1 capital to total risk-weighted assets ratio of 6 percent, Total capital to total risk-weighted assets ratio of 8 percent, and Tier 1 capital to average total assets ratio (tier 1 leverage ratio) of 4 percent.” (https://www.fdic.gov/regulations/safety/manual/section2-1.pdf) Bank Assets Banks typically hold a combination of cash and securities as well as various types of loans on their balance sheets. Banks are required by the Fed to hold some cash as reserves, to maintain liquidity and accommodate withdrawal requests. Banks only hold as much cash as necessary because cash does not earn interest. Loans are the main use of bank funds. These take a wide range of forms to accommodate different borrower needs. Types of business loans include work ing capital loans that are designed to support ongoing business operations. An informal line of credit allows the business to borrow up to a specified amount within a specified period of time and may take the form of a revolving credit loan which obligates the bank to offer up to some specified maximum amount of funds over a specified period of time. The term revolvers refers to the fact that they may be drawn down, repaid, drawn down again, etc. Term loans are used to finance the purchase of fixed assets. Term loans are often amortized so that the borrower makes fixed payments. Alternatively, if the loan principal is paid off in one balloon payment, it is a bullet loan. Both working capital and term loans require the posting of collateral and other protective covenants. A direct lease loan involves purchasing the assets and leasing them to the firm. Larger loans may prove to be too large for a single bank to fund itself. Consequently, several banks pool their available funds in a loan participation. One of the banks serves as the lead bank, and other banks supply funds that are channeled to the borrower. The lead bank receives fees for servicing the loan in addition to its share of interest payments. All participating banks are exposed to credit risk. A loan syndication is a similar arrangement, although the individual shares in the loan may subsequently be resold in the secondary market. Typical consumer loans include installment loans, used to finance purchases of cars and household products. Banks are also the principal provider of credit card loans. The interest rate charged on credit card loans and personal loans is typically much higher than the cost of funds, but credit card loans also entail a higher risk of default. State regulators can impose usury laws to restrict the maximum rate of interest charged by banks. Banks have always provided significant financing for commercial real estate, but, following the decline of the savings and loan sector, they expanded their position in residential real estate significantly. For residential real estate, the maturity on a mortgage is typically 15 to 30 years with the loans typically backed by a first lien (first mortgage) on the residence purchased. Banks provide some commercial real estate loans to finance commercial development as well as their ongoing ownership. Securities Banks purchase Treasury securities and government agency securities. Government agency securities can be sold in the secondary market, but they have a less active market than Treasury securities. In general, they are not a direct https://learn.bu.edu/bbcswebdav/pid-6629017-dt-content-rid-25349100_1/courses/19sprgmetad712_o2/course/module_04/ad712_W04_Print… 8/40 2019/4/11 Module 4 Compiled obligation of the federal government and are commonly issued by federal agencies such as Freddie Mac or Fannie Mae. Note that since the “conservatorship” of Fannie and Freddie in 2008, their obligations do carry a direct guarantee. Banks also purchase investment-grade corporate and municipal securities. These holdings can vary significantly in importance over time since the securities offer a lower expected return than the loans they provide. On the other hand, they offer more liquidity and are subject to lower default risk than loans. During weak economic conditions when firms are unwilling to expand, banks extend fewer loans and increase their purchases of securities. Federal funds sold represent funds that have been lent out will be returned at a specified time with interest. Small banks are common providers of funds in the federal funds market. Similarly, with repurchase agreements, banks can act as the lender on a repo by purchasing a corporation’s holdings of Treasury securities. Banks generally maintain a relatively low level of fixed assets, consisting of the bank premises and the large IT infrastructure needed to conduct their business operations. Pricing of Loans and Other Services As with any business, the pricing of its products is a critical aspect of its operations. For a bank, it invol …
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