Black ink at last for the thrifts.
IN THE MARCH QUARTER OF 1991, for the first time in four years, the private-sector portion of the savings and loan industry - those companies not in the hands of the government - showed a profit, aggregating $627 million. In addition, the number of private-sector thrifts, which includes both savings banks and savings and loans, showing a profit rose to 1,936, or 85 percent of the group, from 1,808 or 72 percent in December 1989, and 1,769 or 76 percent in December 1990.
While there are seasonal factors in thrift earnings - the incidence of loan loss reserving is often heaviest at year-end - the improvement in industry earnings in the most recent quarter has been substantial. It has reflected a drop in loss provisioning from $1.7 billion in the December 1990 quarter to $1.1 billion in March 1991, the taking over of money-losing companies by the government, and a substantial improvement in net interest income as deposit and borrowing costs have declined faster than interest income for many thrifts.
Obviously, the March 1991 data are still tentative and the data from the June quarter will not be reported until the end of September. The Office of Thrift Supervision (OTS) has a nasty habit of revising income for a period downward in subsequent releases as laggard associations file, or correct, their regulatory reports or as examiners carve out more loss reserves from their beleaguered charges. In addition, the OTS changed its reporting form in March 1990, temporarily causing confusion and errors in the preparation of the numbers by managers. The fourth quarter 1990 loss originally was reported at $965 million, but the OTS later revised it to $1,488 million. We reckon that the revision only adds emphasis to the profit improvement shown this year.
Let's take the earnings figures for what they purport to show and draw some conclusions about where the industry is going.
1. DURING THE LAST 18 MONTHS, the number of savings and loans not in government hands has fallen 12 percent, from 2,597 to 2,283. Assets of these companies have declined from $1,159 billion to $971 billion, or by 16 percent. While the number of companies has dropped, the number of "dead" savings and loans (those in what the OTS classifies as Group Four, the lowest quality) has declined even faster, from 377 in December 1989 to 164 in March 1991. The assets of these companies have come down from $261 billion to $102 billion.
In fact, conditions have improved to the point where the OTS has begun to categorize Group Three companies (the next least healthy group of savings and loans) into good, indifferent, and bad. Assuming that the 61 "bad" companies in Group Three ultimately are candidates for interment, we now appear to have a fairly good handle on the future size of the industry - say about 2,050 companies. Obviously, this number could dwindle because of mergers and acquisitions.
2. THE PROFITABILITY OF COMPANIES in Group One is being well maintained and that of Group Two actually has increased during the last 12 months. In each case, the ratio of tangible capital to tangible assets seems adequate, at 6.6 percent for Group One and 5 percent for Group Two. The latter, incidentally, has moved up from 4 percent at midyear 1990.
In contrast, Group Three still is operating at a loss ($210 million in the March 1991 quarter). Its tangible capital ratio, however, has climbed to 2.5 percent (regulations call for 1.5 percent) and the probable burial of the "bad" component of Group Three companies should increase this number considerably.
We believe that the private sector of the savings and loan industry will continue to show a profit in future quarters and that such profit will grow, assuming that the Resolution Trust Corporation continues to bury the dead (some say "shoot the wounded"), that interest rates behave, and that the economy does not slide back into recession.
The aggregate industry return on equity, however, remains unsatisfactory, and there is little margin for error by managers. Capital requirements are increasing, partly because of the increments in tangible and risk-based capital called for under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA, or the Bush Plan), and partly because of the new core capital requirements under which most savings and loans will have to show a core capital ratio of between 4 and 5 percent of assets (as against the former 3 percent). Nor should we forget the punitive instincts of savings and loan examiners, whose passion for requiring the setting up of loan loss reserves is likely to be rekindled if the economy turns down.
3. A NUMBER OF OBSERVERS HAVE pretty well written down or off the future role that thrifts will play in the financial structure of the United States. Their thinking is that thrifts will be taken over by commercial banks and that the punitive terms of FIRREA have doomed thrifts to a profitless future. Their thinking also takes into account what some feel is a hostile attitude in Congress.
To date, most of the savings and loans taken over by banks have been wards of the RTC - in other words, dead. Even though some bank acquirers have asset quality and capital problems of their own, the attraction of being able to leave assets of dubious quality with the government while scooping up deposits has proved to be strong. It remains to be seen whether the taking over of healthy and increasingly profitable thrifts will be as easy, or as attractive to buyers, as the RTC-variety of dead savings and loan acquisition has been to date.
The future role of thrifts in the U.S. financial structure currently is clouded by the fact that we are in a recession, and, in the case of some real estate markets, a depression. The fact that many thrifts are downsizing in an effort to conserve their capital and to conform their loan portfolios to the dictates of FIRREA also has led to cutbacks in making loans. Nor has regulatory stringency been limited to thrifts. Many commercial banks have sharply cut back their lending for real estate construction and income property. This, together with the adverse effects of the Tax Reform Act of 1986, which made income property less attractive to investors, and a surfeit of office space and apartments in various parts of the country, has produced a dearth of funds for even the most worthwhile projects.
Over time, however, it seems certain that this slowing in lending will be corrected as past excesses are worked off. We are still a growing nation, and even depressions do not last forever.
Will the thrift share of the home lending market recover? I believe it will, and that the thrift of the future will continue to play a major role as a conduit of housing funds, perhaps as a community bank or as a mortgage banker.
In the past, thrifts have made a continuing commitment to housing. In contrast, many commercial banks have jumped in and out of the mortgage market, depending on the demand for business loans. Today, the role of government-sponsored enterprises such as the Federal National Mortgage Association (FNMA) or the Federal Home Loan Mortgage Corporation (FHLMC) has changed the balance of power. But these companies do not originate mortgages; they only package them into mortgage-backed securities or, in the case of the FNMA, hold them in portfolio. Thus, traditionally, the important source of thrift competition for loan originators has come from mortgage bankers who offer mortgages to homeowners strictly with a view to reselling them.
Today, a number of large thrifts are active in mortgage banking, buying or originating mortgages for resale in the secondary market. Furthermore, other, often smaller, companies have bought or established mortgage company subsidiaries of their own, thus enabling them to tap the secondary market and to turn over their loan portfolios more rapidly. This provides the added advantage of allowing them to keep the yields on their portfolios at levels closer to current rates, and to broaden their offerings to mortgagors to include fixed-rate as well as adjustable-rate instruments. The fixed-rate portion of their originations is what typically is offered for resale.
I predict that the savings and loan of the future will be a quasi-mortgage banker, selling its product directly to other lenders or a community bank. The community bank concept is appealing because this type of institution usually has close ties to its local operating area. It offers consumer loans and personal service and often can compete effectively against larger institutions where decisions are made at (distant) headquarters.
The savings and loan name may change - indeed, many savings and loans already have renamed themselves banks - but they will continue to fulfill an important function in the housing market as originators of home loans.
4. AN OFTEN USED, ALBEIT ACCURATE, cliche regarding the thrift industry is that "capital is king." Let's turn this phrase around and say that, for the thrift industry, "the inability to raise or maintain capital is destitution." For the past several years, thrifts have wallowed in a sea of red ink, resulting in large part from write-downs and writeoffs of loans and real estate holdings that have sapped their capital. The public markets for capital have been closed to all but a tiny handful of companies. And regulators have contributed to capital depletion by redefining and greatly expanding the classifications of non-performing assets.
We began this article by noting that savings and loans were in the black in March 1991 for the first time in four years. This provides some hope that capital erosion is slowing. A cessation of further downturns in the real estate market, if it occurs, will help even more and, in time, as confidence is restored, give the industry broader access to public capital markets.
But what about the future attitudes and actions of regulators? For thrifts, as well as any closely regulated financial service company, the changes in the ground rules from Washington during the last 10 years have made survival difficult. As recently as July of 1991, Congress was in the mids of considering major changes in the regulatory structure for financial service companies, prompted in part by an administrative proposal (the Brady Bill) to overhaul the supervisory agencies and to bolster deposit insurance funds. Absent greater continuity and perhaps easing of regulation, the thrift industry will continue to be buffeted by drastic and rapidly changing requirements to which many companies may be unable to adapt.
Stability of regulation and supervision by Washington is long overdue. It's time to cease enacting stop-gap measures and put in place a carefully thought out structure that will work. It's time to stop messing around.
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|Title Annotation:||Management Strategy; optimistic outlook for the savings and loan industry|
|Author:||Peltz, Henry S.|
|Date:||Sep 1, 1991|
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