Westside thrift expects to be first state S&L to become a bank since the feds intervened.

Westside thrift expects to be first state S&L to become a bank since the feds intervened

The head of a West Los Angeles-based thrift indicated last week that his institution is about to become the first savings and loan association in California to be converted to a commercial bank since the passage of the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) last August.

Joe Borda, chairman and CEO of Westside Savings & Loan, said approval from the California Department of Banking is imminent.

The Office of Thrift Administration (OTS) has already approved of Westside's conversion.

Conversions of S&Ls to banks have so far taken place in Florida, Georgia and Ohio.

Three other California thrifts currently have applications pending. They include Eastern Savings Bank, based in Alhambra; Frontier Savings & Loan, Redondo Beach; and Mother Lode Savings Bank, Sacramento.

Many other institutions are taking a hard look at the option, according to Norman Katz, managing partner at MCS Associates, an Irvine-based consulting division of Grant Thornton.

Besides overcoming the stigma attached to being an S&L these days, these institutions hope that by converting to banks they could have broader investment powers and greater access to capital markets.

Keith Holmes, a partner at the Century City law firm, Fried, King, Holmes & August, predicted with no changes in the law, roughly 10 California thrifts would convert to banks by the end of the year.

One impediment, particularly applicable to the larger, more established S&Ls, is the tax effects of converting. Thrifts for a long time were allowed to take reserves for bad debt under a formula far in excess of their actual bad debt experience. Banks, on the other hand, have never enjoyed such tax subsidies. Therefore, to convert, thrifts will have to pay taxes on the aggregate amount they set aside over the years for bad debt reserves net of actual bad debt write-offs, Katz explained. In tax parlance, this tax on a past tax benefit is called "recapture."

A potential bad debt reserve recapture is not an important factor to Westside and other young S&Ls because the percent of income that they could set aside for bad debt reserves has become less in recent years. Westside was organized in 1984.

Currently the U.S. House of Representatives' Ways and Means Committee has a bill under consideration to eliminate the bad debt reserve recapture for institutions with assets under $500 million and to lighten the recapture for larger thrifts, Holmes said.

If such a bill is passed, Holmes estimates there would be 30 conversions in California by the end of the year.

Because the recapture will have little impact on Westside's tax liability and bottom line, Westside will incur no significant costs in the transition, Borda said. Contrary to popular belief, no entry or exit fee kicks in unless there is a change in insurance funds, and FIRREA permits ex-thrift banks to continue operating under the Savings Association Insurance Fund, known as SAIF.

Although SAIF carries assessments that are almost double those of the Bank Insurance Fund (BIF), the new banks would be no worse off by staying in SAIF than they would be if they had not converted, Katz observed. Paying the higher SAIF assessments may generally be preferable to changing funds because the combined exit and entry fee would be 1.7 percent of deposits. For $100 million of deposits, the new bank would pay $1.7 million. "The bank would have to work very hard to make up that amount," said Barry Rubens, CEO of Santa Monica-based California Research Corp.

Borda said he intends to stay in SAIF for at least five years.

Converting, among other things, will permit the institutions to avoid the qualified thrift lender test, which many S&Ls regard as onerous. Converting also avoids restrictive loan-to-one-borrower limitations. As banks, these companies would face fewer restrictions on how they allocate their assets, Katz pointed out.

Borda also expects his cost of funds to go down because the investment community perceives commercial banks as "better security" than S&Ls.

From their membership in the Federal Home Loan Bank, S&Ls can fund loans with long-term advances, a source of funds unavailable to banks. Borda said, however, that Westside never utilized such advances.

As a bank, Westside will have to meet higher capital standards currently imposed on banks. Banks must have core capital of 6 percent of assets, whereas S&Ls only need 3 percent.

In reviewing applications to become banks the Banking Department also looks at the institution's business plan and chances of success as a bank, according to Holmes. The department will look at management and the institution's recent operating history, he added. "If the S&L has lost money for a few years, it could have a problem converting," Holmes suggested.

As a bank the former thrift will have to divest any non-conforming assets and liabilities within six months, Holmes indicated.

Among those are long-term Federal Home Loan Bank advances, and doing so may trigger prepayment penalties, Holmes mentioned.

One other factor is the shareholder profile. The banking department has a policy of rejecting applications if there is to be a sole or majority shareholder, even though such a prohibition does not prevent one person from buying all the stock of an existing bank. If the thrift has a majority shareholder, the Banking Department will require that shareholder to lower his interest to below 50 percent within a few years, Holmes said.

The rationale for the policy against majority ownership is to avoid having an institution in the pocket of one individual, who may then be tempted to use the bank's resources for his own personal ends, to the detriment of depositors. Dispersed ownership may, it is believed, provide some checks to this sort of personal opportunism.

Besides converting to banks, there is a wave of state-chartered S&Ls applying for federal thrift charters. Since February a total of 17 California S&Ls have taken that step, and the applications of three to become national associations were approved in March and April.

The sudden impetus to become federally chartered comes from FIRREA. The thrift bail-out statute eliminated the broader real estate investment powers state-chartered institutions had enjoyed, said Kathy Wedeking, senior vice president at the California League of Savings Institutions.