Federal Deposit Insurance Corporation
 

FDIC
 

Banking
 Review
 Winter 1995

Vol. 8, No. 1

Con Convveerrted Ne ted New England Sa w England Savings Banks vings Banks 

Cutbacks in Construction L Cutbacks in Construction Lending ending 

RRecent De ecent Devvelopments elopments 

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Federal Deposit Insurance Corporation 

FDIC
 

Banking


Review
 

Winter 1995 

Vol. 8, No. 1 

Chairman 

Ricki R. Tigert 

Division of Research 

and Statistics, 

Director 

Wm. Roger Watson 

Deputy Director 

Arthur J. Murton 

Editor 

George E. French 

Editorial Committee 

Frederick S. Carns
 

James L. Freund
 

Detta Voesar
 

Managing Editors 

James L. Freund
 

Detta Voesar
 

Readers 

Matthew T. Billett
 

Christine E. Blair
 

Richard A. Brown
 

Gary S. Fissel
 

David S. Holland
 

John P. O'Keefe
 

Editorial Secretary 

Cathy Wright 

Design and Production 

Geri Bonebrake 

The views expressed are those 

of the authors and do not necessarily reflect official positions 

of the Federal Deposit Insurance Corporation. Articles may 

be reprinted or abstracted if the 

FDIC Banking Review and 

author(s) are credited. Please 

provide the FDIC's Division of 

Research and Statistics with a 

copy of any publications containing reprinted material. 

Single-copy subscriptions are 

available to the public free of 

charge. Requests for subscriptions, back issues or address 

changes should be mailed to: 

FDIC Banking Review, Office of 

Corporate Communications, 

Federal Deposit Insurance 

Corporation, 550 17th Street, 

Room 6061, N.W., Washington, D.C. 20429. 

Understanding the Experience of Converted New England 

Savings Banks 

by Jennifer L. Eccles and John P. O'Keefe page 1 

The authors summarize the environment surrounding New England savings 

banks in the 1980s, motivations for mutual-to-stock conversion, and the strategies 

employed by savings banks after conversion. The financial performance of 

converted savings banks is compared with that of non-converted mutual savings 

banks in the region, and asset growth rates necessary to produce a sufficient return to 

investors are estimated. The authors conclude that growth rates required by the 

New England converted savings banks were high. Because rapid growth can be 

risky, such fundamental changes in a bank's operating strategy require careful 

planning and execution in order to be successful. 

Recent Cutbacks in Construction Lending at BIF-Insured 

Depository Institutions 

by James L. Freund and Maureen C. Crowley page 19 

One of the most discussed aspects of the “credit crunch” of the 1990-1992 period 

was the sharp decline in construction lending at BIF-insured depository 

institutions. This article examines construction lending during that period. The 

authors show that the banks that cut back most aggressively had a heavy 

commitment to such lending in the late 1980s and/or were experiencing general 

earnings or capital problems. In contrast, various tests designed to capture the 

influence of real-estate market developments that might affect the demand for 

construction loans did not help to explain lending patterns. 

Recent Developments Affecting Depository Institutions 

by Benjamin B. Christopher page 31 

This regular feature of the FDIC Banking Review contains information on regulatory 

agency actions, state legislation and regulation, and articles and studies pertinent to 

banking and deposit insurance issues. 
Converted New England Savings Banks 

Understanding the Experience

of Converted New England

Savings Banks * by Jennifer L. Eccles and John P. O'Keefe

Banking industry performance year-end 1989; 17 of the 41 were The capital raised by converting

and failure rates since the converted savings banks. The 17 con- savings banks should have served as a

mid-1980s have followed a verted savings banksthatfailed repre­ cushion when the economy fell into

pattern that is tied closely to regional sented 22 percent ofthe total number * Executive Assistant to the Director, Of- economic conditions. The pattern be- of savings banks that converted to fice of Federal Housing Enterprise Oversight gins with increases in bank loan con- stock form between 1984 and 1990 (formerly of the FDIC) and Financial Econocentrations in areas related to a and the remaining 24 savings banks mist, Division of Research and Statistics, FDIC, 

respectively. The views expressed do not nec­ region's growth, followed by deteriora­ that failed represented 7.5 percent of

essarily reflect official positions of the FDIC or tion in asset quality, earnings, and all other savings banks. the OFHEO. The authors thank Jane Coburn 

capital when regional recessions ap­ While many of the FDIC's Division of Research and Statis- studies of the causes of

pear. Moreover, tics for outstanding research assistance. The rapid growth in bank bank failures have looked at the rela­ authors also would like to thank our other col- assets often accompanies the shifts in tionships among asset growth, portfo­ leagues in the FDIC's Division of Research portfolio composition. lio composition and bank-failure rates, and Statistics, participants at the 1993 annual 

meetings of the Financial Management Asso- These events were repeated by fi­ few studies have examined the influ­ ciation, Larry Cordell of Freddie Mac, and John nancial institutions in New England.1 ence of a related eventin NewEngland Stone at the FDIC for helpful suggestions. FiWhen the regional economy expanded, in the 1980s: the large influx of capital nally, the authors would like to thank Al Tamany nenbaum of Advest, Inc. and Matt Billett at the financial institutions grew rap- resulting from the conversion of many FDIC for help in obtaining data. idly, through increased lending (par­ mutual savings banks to stock form.3

1 New England is defined as Connecticut, ticularly in commercial real estate) There was a dramatic increase in the Maine, Massachusetts, New Hampshire, and/or acquisitions. The subsequent number of conversions in New Eng- Rhode Island and Vermont. 

collapse in real-estate prices, com- land in the mid- to late 1980s, with a 2 The 41 savings banks include five coopbined with a regional recession during majority (48) of the conversions of erative banks and two federal savings banks. 

the late 1980s and early 1990s, led to state-chartered savings banks to stock 3 Another indicator of the influx of new 

capital into a region is bank chartering activity. the demise of numerous New England form occurring in 1986.

In New England, the number of new commer­ banks. The total capital raised by con­ cial and savings banks chartered annually inBetween creased from one in 1980 to a peak of 26 in January 1, 1990 and verted savings banks in Massachusetts

1987, and averaged 19 annually from 1985 March 31, 1994, 88 FDIC-insured alone in 1986 was approximately $1.1 through 1991. This rate exceeded the average 

banks failed in New England, includ­ billion — enough capital to support a annual rate of seven new charters issued being a large number of converted sav­ 17.5 percent increase in the state's tween 1970 through 1984. Of the 171 New 

England banks chartered since 1980, 29 (17 ings banks. Of these 88 failures, 47 banking assets, assuming a 4.8 percent percent) failed. In all other regions, 419 of 

were commercial banks and 41 were capitalization rate on the additional as­ 4,534 (nine percent) of de novo banks failed 

savings banks. The 47 commercial sets (the capitalization rate of the larg­ since 1980. 

banks represented 17 percent of the est bank in Massachusetts at that 4 Stated differently, the largest bank in 

Massachusetts could have nearly doubled in 276 commercial banks operating in time).4 The total capital increase asso­ size with the $1.1 billion capital injection. At New England at year-end 1989. The ciated with all New England savings year-end 1986, the largest bank in Massachu41 savings banks2 accounted for ten banks' conversions between 1984 and setts was the First National Bank of Boston, 

with assets of $25.1 billion and equity capital of percent of the 396 savings banks at 1990 was approximately $2.4 billion.

$1.2 billion (4.8 percent capitalization). 

1 
FDIC Banking Review 

recession. Yet, as noted above, those

savings banksthat converted between

1984 and 1990 had a higher failure

rate than other savings banks and

commercial banks. This paper examines why this discrepancy occurred.

The introduction of common equity required management at converted savings banks to be

accountable to a new constituency —

the shareholder. As part of that duty,

management had a fiduciary responsibility to enhance shareholder value

and generate an adequate return to investors. Capital raised during conversion led to high capitalization rates

that reduced returns on equity. To increase returns on equity, management

at newly converted savings banks had

several options. The primary strategy

employed was to leverage the bank by

growing assets. This could be accomplished by growth in the loan or investment portfolio, or by acquisition

of another institution. Other possible

strategies included engaging in stock

repurchase programs, increasing the

dividend payout rate, or improving

earnings by increasing efficiencies

and, therefore, lowering noninterest

expense.

Despite the use ofthese strategies,

many converted savings banks were

unable to earn competitive returns on

equity. By the late 1980s, certain

shareholder groups began to express

their concerns about the low returns

on equity. While management grappled with shareholder issues, the regional economy moved into a

recession. The equity “cushion” secured by converted savings banks

eroded as losses mounted, and ultimately proved to be insufficient to

prevent the failure of many institutions.

This paper firstreviewsthe experience of New England savings banks

that converted in the 1980s. Topicsto

be discussed include the environment

surrounding New England savings

banks at that time, motivations for

mutual-to-stock conversion, and the

sequence of events following the rush

of conversions. As part of this review,

the strategies employed by converted

savings banks are examined. The

financial performance of converted

savings banksis comparedwith that of

non-converted mutual savings banks

in the region.

Next, this paper examines shareholders' expectations of expected

earnings growth rates (net income to

common shareholders) for converted

savings banks. These earnings expectations subsequently are related to

banks' financial condition and the regional economy to make inferences

about shareholders' expectations regarding banks' strategic plans.

The paper concludesthat high asset growth rates were required by

the New England converted savings

banks in order to generate adequate

returns on equity for stockholders.

However, as has been demonstrated

by previous examples of bank failures, rapid growth can be risky. The

experience of converted New England savings banks suggests that a

fundamental change in a bank's

strategy requires careful planning

and execution in order to be successful. These lessons are particularly

relevant now, given the large

number of mutual savings institutions that have been converting to

stock form recently.

Background: New England 

Savings Banks 

What Are Savings Banks?

There are two characteristics of

savings banks that deserve consideration before engaging in a review of the

environment surrounding New England savings banksin the 1980s. First,

the historical origins and functions of

savings banks were quite different

from those of commercial banks and

savings associations. For these reasons, savings banks were issued a

unique charter type by bank regulators.

Savings banks originated in Europe

as philanthropic institutions, as an attempt to offer the working class a

mechanism for saving and investing

funds.5 The first savings bank in the

United States was chartered in 1816.

While the number of savings banks

has grown over the years, the charter

has not been permitted in all states.6

State-chartered savings banks operated in 19 states as of December 31,

1993.7

Historically, state-chartered savings banks have been given broader

lending and investment powers than

savings and loan associations. Nevertheless, in recent years, savings banks

have tended to have a balance sheet

that more closely resembled a savings

and loan association than a commercial bank. Savings banks have tended

to concentrate their assets in longterm assets such as mortgages, rather

than shorter-term loans such as commercial and industrial loans, yet their

liability structure has tended to be

weighted toward shorter-term funds

such as deposits.8

The second point is that in New

England, and in most other regions,

savings banks have been predominantly mutual form.9 Mutual form

impliesthatthere are no stockholders

ofthe institution. The primary implications ofthisform of organization are

two-fold. First, itis not possible to approach the capital markets for additional equity because the mutual has

not issued any equity stock; hence, all

equity-financed asset growth must be

5 For a detailed history of savings banking in 

the United States, see Ornstein (1985) or 

Golembe and Holland (1986). 

6 Savings banks were all state-chartered 

until 1978, at which time mutual savings banks 

were permitted to convert to federal charters by 

The Financial Institutions Regulatory and Interest Rate Control Act of 1978. 

7 Source: Division of Research and Statistics, FDIC. 

8 Legislative changes involving expanded 

investment powers for banks and thrifts over 

the past 15 years have tended to blur the differences among savings banks, savings and loan associations, and commercial banks. 

9 The proportion of mutual-form savings 

banks in New England rose from 70 percent to 

75 percent between year-ends 1988 and 1993. 

Nationally, the proportion of mutual-form savings banks rose from 66 percent to 72 percent 

over this same interval. This rise was due, in 

part, to higher failure rates among stock-form 

savings banks. 

2 
Converted New England Savings Banks 

funded by retained earnings. Second,

the control exerted over management

is more limited with mutual ownership.10

The Changing Environment

The financial-servicesindustry has

been transformed significantly over

the past 20 years. Two important

factors that affected the savings

bank industry were the economy and

banking-related legislation and regulation. In particular, the rising

interest-rate environment of the

1980s precipitated many changes in

the industry. When interest ratesrose

significantly in the early 1980s, the

subsequent asset/liability mismatch

caused net interest margins to shrink

dramatically. As a result, numerous

thrift institutions sustained heavy

losses and severe depletion of capital.11 At the same time, deposit

interest-rate ceilings imposed by

Regulation Q created a disintermediation out of the banking system and

into alternative but higher-yielding

investments.

In response to these problems, legislation in the early 1980swas enacted

to remove interest-rate ceilings12 and

to expand the powers of thrift institutions.13 These laws were intended to

help depository institutions evolve

with the changing economy and compete with other financial institutions.

New England states were on the leading edge ofreform initiatives, allowing

institutions to offer negotiable orders

of withdrawal (NOW) accounts in

1972, and granting state-chartered

savings banks a fair amount of latitude

with respect to powers by the early

1980s:

Of the six New England states,

Massachusetts has done the most

to expand the powers of its statechartered thrifts. As ofJuly 1, 1983,

state-chartered mutual savings

banks and cooperative banks in

Massachusetts will have the same

powers as commercial banks. In

Vermont,savings banks may offer all

services offered by commercial

banks except trust services. Maine

and New Hampshire have granted

state-chartered thrifts parity with

federal thrifts in most product

Table 1
 

New England Savings Banks
 

($ Millions)
 

Capital Capital 

Number of Ratio Ratio 

Year Conversions Assets Before After 

1985 5 $1,507 5.55% 12.70% 

1986 48 $16,222 6.60% 16.77% 

1987 14 $3,140 6.19% 14.04% 

1988 5 $1,332 7.73% 11.56% 

lines, and have established more

liberal lending limits for commercial, industrial and commercial real

estate loans. Connecticut legislated approximate equality between federal and state thrifts,

while Rhode Island has expanded

thrift powers only in the area of consumer loans. The banking situation

in Rhode Island is unique, however,

since all state-chartered thrifts own

commercial bank subsidiaries.14

The Flurry of Conversions

New England states also authorized the conversion of mutual savings

banks to stock form. New Hampshire

allowed savings banks to convert beginning in 1969, with Maine following

in 1975, Vermont in 1981, Connecticut and Rhode Island in 1983, and

Massachusetts in 1985.15

The majority of conversions occurred in 1986, immediately following

the 1985 authorization of conversions

in Massachusetts. Table 1 shows the

year of conversion, number of converted savings banks per year, total assets of converted savings banks as of

the quarter-end after conversion, and

median capital ratios as of the quarterends immediately before and after

conversion. As seen in Table 1, these

conversions increased book capitalization rates dramatically.

The Economic Boom

While authorized powers were expanded and mutuals were permitted

to convert, the regional economy was

heating up. In the 1980s, New England sustained a decade of strong economic growth. This growth increased

the demand for bank lending, and created a rich environment for sustained

growth at depository institutions.

This growth-oriented environment is

seen in the following graphs. Figure 1

shows the growth in nonagricultural

employment for the New England region plotted against the national

growth rate for 1981 through 1993.

For every year between 1983 and

1987, except 1985,the rate of employment growth in New England exceeded the national average. This

trend is also evident in Figure 2 —

growth in Gross State Product versus

GDP growth. Office vacancy rates in

Boston and Hartford were low in the

early 1980s, as shown in Figure 3.16

Builders responded accordingly, as

seen in the growth in office stock

shown in Figure 4.

Interstate Banking and
 

Acquisitions
 

While the booming economy provided incentives for growth in loan

portfolios, another legislative development allowed banks to expand

10 For a discussion of agency conflicts at mutual and stock institutions, see Cordell, MacDonald, and Wohar (1993), or Dunham (1985). 

11 In the 1970s, savings and loan associations 

were permitted to convert to stock form as a 

means of recapitalization. See Williams, Fleck, 

and Comizio (1987). 

12 The Depository Institutions Deregulation and Monetary Control Act of 1980. 

13 The Garn-St Germain Depository Institutions Act of 1982. 

14 FDIC (1983). 

15 Source: Conference of State Bank Supervisors. 

16DataareavailableforBoston andHartford, 

two large New England metropolitan areas. 

3 
 

 

FDIC Banking Review 

Figure 1 across state lines. In 1975, Maine

Growth in Nonagricultural Employment became the firststate to adopt nationNew England vs. National wide interstate banking. The provi- Percent 

sion, effective in 1978, required the 8 

states in which acquiring banks were

located to have a reciprocal interstate 6 banking agreement. The reciprocity

provision was dropped by Maine in

4 1983, and all ofthe state'slargest commercial banks were acquired by 2 emerging regional banks such as Bank

of New England, KeyBanks, Fleet, 0 and Norstar. Massachusetts and

Rhode Island allowed regional inter­

-2 state banking in 1983, with Connecticut following suit in 1984, and New

-4 Hampshire and Vermont in 1987. By

1990, all New England states had

-6 adopted nationwide interstate bank­ 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 19911992 1993 

ing.

Source: Commerce Department Given these new acquisition powers and the strong economy, New Figure 2 England depository institutions Real Growth Rate in Gross State Product embarked on a wave of acquisitions. (Constant 1987 Dollars) Recently-converted savings banks be- Percent 

New England National 

came excellent targets for those seek- 10 

ing to expand into new markets.

Table 2 shows the number of transac- 8 

tions announced between 1986 and

1990 involving the acquisition of sav- 6 

ings banks, as well as the median

4 transaction ratios. Savings banks that

were acquired during this frenzy 2 rewarded existing shareholders amply,

as institutions were sold at attractive 0 premiums to current market prices

and well above initial offering -2 

prices.17 Of the 44 transactions announced between 1986 and 1990, 13 -4 

involved an interstate acquisition.18

Acquisition multiples tended to decrease after the stock market crashed

in October 1987. Multiples and the

Table 2 number of acquisitions declined as

Announced Acquisitions of New England 

Stock Savings Banks (Median Values) 

17 The transaction price announced per Price/ Premium Number 

share was typically at a premium of 40 to 60 per- Price/ Book Paid for of Deals 

cent above the currently traded price. Of the 21 Year Earnings Value Depositsa Announced 

deals announced for which data are available, 1986 14.7x 163% 5.03% 6 

the premium of the acquisition price to initial 1987 Q1-Q3 19.2x 129% 4.82% 8 offering price ranged from a low of two percent 

to 193 percent, with a median value of 90 per­ 1987 Q4 13.9x 120% 4.61% 5 

cent. (Sources: Lyons, Zomback & Ostrowski 1988 18.8x 123% 4.46% 12 

and The Center for Research in Security Prices, 1989 23.0x 105% 2.04% 8 University of Chicago.) 18 1990 28.7x 90% -1.78% 5 There were 49 commercial bank transactions announced between 1986 and 1990, 19 of a Transaction price as a percentage of total deposits of acquired institution. 

which involved interstate acquisitions. Source: Lyons, Zomback & Ostrowski. 

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 

Source: Commerce Department 

New England National 

4 
 

 

Office V

Figure 

acanc

3

y Rate

Figure 4

Growth in Office Stock

Converted New England Savings Banks 

Percent 

30 

Percent 

Figure 3
 

Office Vacancy Rate
 

Figure 4
 

Growth in Office Stock
 

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 

Source: CB Commercial Torto Wheaton Research 

25 

20 

15 

10 

5 

0 

Boston Hartford 

20 

institutions began to suffer from asset

quality problems in the late 1980s.

Motivations for Conversion 

What were the motivationsfor conversion? First, many savings banks

welcomed an additional source of

capital. Once converted, an institution would have access to the equity

markets — an option not available to

mutual institutions. Forsome institutions, the asset/liability mismatch environment of the late 1970s depleted

capital levels, and a public stock offering represented a faster means of

obtaining capital than earnings retention. Many banks that chose to convert had lower pre-conversion capitalization ratesthan peerswho did not

convert.19

Capital injections and improved

access to capital markets would be

necessary also for banks with strategic

growth plans. The booming New

England economy fostered a widespread perception among bank management teams that there were

tremendous growth opportunities,

and asset growth was necessary in order to remain competitive. An institution dependent solely on internal

capital generation such as a mutual

Source: CB Commercial Torto Wheaton Research 

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 

0 

5 

10 

15 

31 Large Markets Boston Hartford 

savings bank would not have as much

flexibility to expand its balance sheet

or make acquisitions as an institution

with access to external capital markets (a stock savings bank). Limitations on the amount of debt allowed

to be counted as capital for regulatory

purposes, along with the difficulty of

tapping the debt markets as a mutual,

made this alternative capital generation option less useful.

Financial rewards for stockholders

were another motivator, and depositors and management could become

stockholders.20 An institution that

convertedwould have the potentialto

pay dividends, to experience appreciation in its stock price, and to sell

out to an acquirer at a change-ofcontrol price representing a premium

to the current share price. A mutual

savings bank did not have the ability

to offer these financial rewards to depositors and management. Rather, for

mutuals, including mergers of mutuals, rewards to depositors would have

to come through interest and noninterest cost savings, if any. In mergers

of mutuals, management could only

be rewarded through salaries and

benefits.21

Conversion offered a new set of

financial incentives for employees, in

terms of additional forms of remuneration. For management, there were

stock options; Employee Stock Own19 For a sample of 54 savings banks that converted to stock form, the median capital-toassets ratio averaged 6.78 percent over the four 

quarters prior to conversion. A comparison 

group of 54 peer banks, however, had average 

capitalization of 8.05 percent over the same period (see Figure 5). 20 In some mutual-to-stock conversions, 

certain insider abuses involving self-dealing or 

excessive management remuneration have 

been prevalent. The FDIC has been concerned about such abuses, and on June 13, 

1994, published a Proposed Rule on Mutual-toStock Conversions and a Notice and Request 

for Comment on how the conversion process 

should be changed. This is not the focus of this 

paper. See Federal Deposit Insurance Corporation, 12 CFR Part 333, Mutual-to-Stock Conversions of State Nonmember Savings Banks, 

FederalRegister, Vol 59, No. 112, June 13, 1994. 21 A mutual savings bank was not acquired 

in the traditional sense because there were no 

shares outstanding to be acquired. 

5 
FDIC Banking Review 

ership Plans (ESOPs) were available

for all employees. These incentives

were considered beneficial in attracting and retaining the best employees,

especially in a tight labor market such

as that experienced by New England

in the 1980s.22 Senior management

would have additional responsibilities

and challengeswith respectto managing a publicly held entity.

Finally, the markets were receptive. The stock market was generally

strong, and the underwriters were

successful in placing the new issues

with investors.23

There were several disadvantages 

to conversion. A primary disadvantage 

was the necessary fundamental realignment of management responsibilities. After conversion, senior 

management, in its capacity as fiduciary, would have to report to and work 

in the interests of the shareholders. As 

a result, senior management faced increased monitoring by being under 

the scrutiny of shareholders and analysts. The strategies employed by a 

mutual savings bank could no longer 

apply. While increased monitoring 

could have beneficial results — improved efficiencies at the savings 

banks — as discussed later, noninterest expense ratios did not improve in 

the case of converted New England 

savings banks. 

Stockholder scrutiny resulted in a 

“loss” of management control and an 

overall change in corporate culture. 

The possibility existed for an outside 

group, unhappy with the performance 

of existing management, to force a 

change of control and an ouster of existing management via a proxy fight. 

Additionally, there were increased reporting requirements associated with 

being a stock institution, including filings with the Securities and Exchange 

Commission. 

Moreover, conversions added substantial equity capital, thereby decreasing returns on equity (ROE).

The ROE dilution encouraged bank

managements to adopt strategies to

bolster shareholder returns. It was

not clear at the time of conversion

that low shareholder returns and the

implementation of strategies to improve returns would be a significant

problem for managements.

Post-Conversion Strategies 

The conversion process that savings banks were required to follow by

bank regulators could force bank management to add more capital than

might be needed. In short, converting

savings banks were required to issue

common stock in amounts based upon

the appraised net worth of the bank.

For details on the conversion process

see Dunham (1985). The increase in

capitalratios after conversion resulted

in a proportional decrease in returns

on equity. Management at converted

savings banks engaged in several

strategies to improve returns on equity. The primary strategy employed

was asset growth, including growth in

the loan and investment portfolios.

This strategy will be analyzed in the

next section.

Alternative strategies employed

included stock repurchase programs,

increasing the dividend-payout rate,

and/or improving earnings by increasing efficiencies and therefore lowering noninterest expense. The evidence suggests that these strategies

were not utilized extensively by converted savings banks.

Prior to conversion, mutual savings

bankslacked stockholdersto whom to

pay dividends. Therefore, after conversion, dividend policies had to be

established. State regulatory restrictions on dividend payouts typically

prohibit an institution from impairing

its capitalsurplus account and/orlimit

a savings bank to pay dividends from

current earnings only. These restrictions effectively limited the use of

dividend payouts as a serious leveraging tool.

A review of the 54 converted savings banks’ dividend policy showsthat

dividend rates did increse during the

post-conversion period. The converted banks' median quarterly dividend rate (stock dividends as a

percent of net income) increased

from 14.4 percent four quarters after

conversion to 31 percent eight quarters after conversion. Dividend rates

peaked at 32.8 percent ten quarters

after conversion.24

Analysis of the converted savings

banks' noninterest operating expense

indicates no improvement in operating efficiency occurred in the postconversion period. Total noninterest

expense includes salaries and employee compensation, expense on

premises and fixed assets, and all

other noninterest expense. The median total noninterest operating expense of the converted savings banks

had an average annualized value of

2.14 percent of assets for the four

quarters prior to conversion. Postconversion noninterest expense ratios

were comparable, averaging 2.16 percent, 2.09 percent, and 2.15 percent

for the first, second, and third years

after conversion. Moreover, tests of

the statistical significance of differences in converted and peer banks'

operating expense ratios indicated

they were not significantly different.25

Finally, stock repurchases were another means available to converted

savings banks to reduce their capital

ratios and offset ROE dilution. Stock

repurchases are subject to approval at

the state and federal levels because

the strategy involves a direct reduction in capital. Analysis ofthe trend in

net sales, conversions, and retirements of capital stock revealed that

only 8.5 percent of converted savings

22 The average unemployment rate for the 

six New England states in the finance, insurance and real-estate industries declined from 

2.82 percent in 1984 to 0.93 percent in 1988, 

then rose to 5.68 percent in 1991. This unemployment rate remained relatively high in recent years, at 4.35 and 3.70 percent in 1992 and 

1993. (Source: Geographic Profile of Employment

and Unemployment, U.S. Department of Labor, 

Bureau of Labor Statistics.) 23 See, for example, Zweig (1986). 24 The dividend rates cited here are based 

upon quarterly net income and dividend expenditures. 25 Specifically, no statistically significant 

difference in the mean operating expense ratios for converted and peer banks was found for 

most of the post-conversion period at the 95 

percent confidence level. 

6 
 

Figure 5

Median Capital-to-Assets Ratios

The 54 Converted New England Savings Banks

Converted New England Savings Banks 

banks engaged in net stock repurchases or retirements. The majority

of converted savings banks (67.9 percent) had no net stock sales or retirements in the three-year period

subsequent to conversion, while 23.6

percent of converted banks had net

stock sales. It is important to note,

however, that the average quarterly

net stock sales in the post-conversion

period were relatively small (about

0.06 percent of assets) compared to

the average net stock repurchases and

retirements (about 0.20 percent of assets).26·

Post-Conversion Financial 

Trends 

Sample 

In order to investigate the motives

and strategies behind mutual-tostock conversions, the post-conversion financial performance of a sample

of converted New England savings

banks was studied. Approximately 77

New England savings banks converted from mutual to stock form between 1984 and 1992.27 Of these 77

banks, a group of 54 banks had sufficient financial information for the

analysis. Specifically, the financial

condition of the banks was obtained

over a period four quarters prior to

conversion and 12 quarters subsequent to conversion, thereby allowing

the sample to include the majority of

conversions that occurred during the

peak year of conversions, 1986.28

In order to learn whether the performance of the sample of converted

banks differed materially from that of

other banksin the region, a peer group

of nonconverted (mutual form) savings banks was selected for analysis.

The peer group consisted of other

NewEngland banks ofsimilarsize and

timing of financial data asthe group of

converted banks.29 Because financial

trends were presented in terms of an

abstract time measure, i.e., the

number of quartersfrom conversion, a

given quarter actually consists of data

for converted banks from several different calendar periods. Therefore,

each converted bank's peer was selected to be another New England

bank of similar size with contemporaneous financial data.

Financial Performance

As shown in Figure 5 and Table 1,

conversions typically increased the

book equity capitalization of banks

substantially. For the 54 converted

New England savings banks, the median capital-to-assets ratio increased

from 6.69 percent one quarter prior to

conversion to 15.91 percent upon conversion.

Figure 6 shows that converted savings

banks' returns on assets (ROAs) improved from being less than those of

peers priorto conversion to rates comparable to those of peers after conversion. The improvement in ROA was

primarily due to increased net interest margins. Converted savings

banks' interest expense declined after

conversion due to the increased capitalization (lower proportion of assets

funded by interest-bearing liabilities).

In addition, interest income increased

after conversion, primarily because of

Figure 5
 

Median Capital-to-Assets Ratios
 

The 54 Converted New England Savings Banks
 

Percent 

18 

16 

14 

12 

10 

8 

6 

There are beneficial aspects to increased capitalization. All other factors held constant, an increase in

capitalization improves the stability

of earnings and reduces the risk of insolvency over the business cycle.30

26 The average stock sales, conversions and 

retirements used were actual quarterly net additions. 

27 It is difficult to obtain a precise count of 

the number of conversions because complete 

records of conversions were not maintained by 

federal bank regulators. 

28 These 54 converted savings banks were 

relatively small in asset size: 33 had assets under $300 million and only two had assets over $1 

billion at the time of conversion. In addition, 

most of the 54 banks were in Massachusetts 

(24) and Connecticut (17). Finally, nine of the 

54 banks failed as of year-end 1993. 

Converted Savings Banks 

Mutual-Form Peer Banks 

-4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 

Number of Quarters from Conversion 

increases in loans (see Appendix A for

details on profitability trends). Despite this improvement in ROAs, converted banks' ROEs (Figure 7)

generally remained less than those of

peer banks for two years subsequent

29 Because the converted banks changed 

size substantially during the analysis period, 

peers of comparable asset size were paired 

with converted banks over time. To allow for 

these and other changes, a converted bank 

may have its peer replaced two or more times 

during the analysis period. This resulted in 

the selection of a group of 59 mutual-form 

peer banks, 54 of which are paired with the 

converted banks at a given point in time. 30 A tenet of corporate finance (not proven 

here) is that as the proportion of equity finance 

a firm uses increases, the stability of earnings 

per share of equity is improved, all other 

things being equal. 

7 
 

 

Figure 6

Median Return on Assets (Annualized)

The 54 Converted New England Savings Banks

Figure 7

Median Return on Equity (Annualized)

The 54 Converted New England Savings Banks

Number of Quarters from Conversion

-4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12

18

16

14

12

10

8

6

4

Percent

Number of Quarters from Conversion

Mutual-Form Peer Banks

Converted Savings Banks

Figure 7

Median Return on Equity (Annualized)

The 54 Converted New England Savings Banks

FDIC Banking Review 

Figure 6
 

Median Return on Assets (Annualized)
 

The 54 Converted New England Savings Banks
 

Percent 

1.6 

1.4 

1.2 

1 

0.8 

0.6 

0.4 

Converted Savings Banks 

Mutual-Form Peer Banks 

-4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 

Table 3
 

The 54 Converted New England Savings Banks:
 

Quarterly Changes in Asset Composition
 

(As a Percent of Total Assets in Prior Quarter)
 

to conversions. High post-conversion

capitalization rates were a primary

cause of converted savings banks' poor

returns on equity capital.

It is unlikely that the managements of converted banks sought additional capital solely for the purpose

of risk-reduction. Indeed, Figure 8

shows that managements acted

quickly to try to offset the dilution of

returns on equity by decreasing capitalization rates through leveraged asset growth. Figure 8 presents trends

in the median quarterly asset growth

rates of converted banks and the peer

group. Among converted banks, asset

growth rates rose dramatically upon

conversion, rising to a median quarterly rate of 13.8 percent. This reflects the fact that the additional

capital was used to support asset

growth rather than to reduce liabilities. To see this, one can partition asset growth into the portions funded

by increasesin debt (deposit and nondeposit liabilities) and equity capital.

In the quarter prior to conversion, the

quarterly asset growth for the combined assets of the 54 converted

banks was 13.38 percent. The converted banks' proportional liability

and equity capital growth rates during

this same interval were 1.28 and 12.1

percent, respectively.

In the conversion quarter approximately 54 percent of the asset growth

occurred in liquid assets (cash balances and securities) and 41 percent

in loans (Table 3). Subsequent asset

growth among converted banks remained high for the two-year period

following conversion. Nearly all ofthe

converted banks' asset growth in

quarters 1 through 12 was achieved

through additional lending, although

several savings banks nearly doubled

in size by acquiring othersavings banks.

Loan growth fell during quarters 7

through 12 as the regional economy

slid into recession.3� The vast majority of converted banks' loan growth

31 As shown in Table 1, a large portion of the 

conversions occurred in 1986. Indeed, 67 percent of the 54 conversions followed here occurred in 1986. Consequently, the average loan 

growth rates three years after conversions generally reflect activity in 1989. 

Quarter from Conversion 

Asset Portfolio Item 0 1 2 3 4 

Cash Balances Due 0.53% -0.05% -0.43% 0.22% 0.15% 

Securities 3.45 1.17 0.42 0.27 0.80 

Federal Funds Sold 3.74 -3.74 -0.48 -0.47 -0.26 

Net Loans and Leases 5.53 5.52 4.83 4.64 3.64 

Trade Account Assets 0.00 0.00 0.03 -0.01 0.02 

Premises 0.05 0.04 0.07 0.01 0.08 

Real-Estate Owned 0.02 0.00 0.02 0.03 -0.05 

All Other Assets 0.06 0.17 0.15 0.25 0.17 

Total Asset Growth 13.38% 3.11% 4.61% 4.94% 4.55% 

8 
 

 

 

Figure 8

Median Asset Growth Rates (Quarterly)

The 54 Converted New England Savings Banks

Number of Quarters from Conversion

Number of Quarters from Conversion

Median Construction and Land Development Loans

The 54 Converted New England Savings Banks

Converted Savings Banks 

Mutual-Form Peer Banks 

Converted Savings Banks 

Mutual-Form Peer Banks 

Converted Savings Banks 

Mutual-Form Peer Banks 

Converted New England Savings Banks 

was in traditional real-estate lending

for residential dwellings. However,

converted banks also increased lendFigure 8 

Median Asset Growth Rates (Quarterly) 

The 54 Converted New England Savings Banks 

ing in nontraditional areas as well. In Percent 

particular, converted banks increased 16 

concentrations in construction and

land development loans to a greater 14 

extent than peer banks (Figure 10). 12 

Figures 8 through 10 indicate that 10 

converted savings banks had different

post-conversion growth and portfolio 8 

strategies than mutual-form peer banks. 6 

Appendix A presents data on the statistical significance of these differences. 4 

Those tests showed that the converted 2 

savings banks' capitalization rates

changed over time, moving from rates

significantly lower than those of peer

0 

-4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 

banks prior to conversion to postconversion rates significantly higher

than those of peer banks (see Appendix A, Table 4).

Figure 9 Figure 9 

Median Growth in Total Loans (Quarterly) Median Growth in Total Loans (Quarterly) 

The 54 Converted New England Savings Banks The 54 Converted New England Savings Banks 

Converted savings banks' post- Percent 

conversion loan growth also exceeded 10 

that of peer banks for a brief period after conversion. However, asset and 8 

loan growth rates of converted banks

returned to levels similar to those of 6 

peers by about 18 months after conversion. Finally, converted savings banks 4 

increased concentrations in construction and land development loans sig­ 2 

nificantly above those of peer banks in

the post-conversion period. These re­ 0 

sults suggest that converted savings

banks had more-aggressive post­ -2 

conversion growth and portfolio strate­ -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 

gies than mutual-form peer banks. It

should be pointed out that very similar

results were obtained for different sam- Figure 10 

ples of mutual-form peer banks. Median Construction and Land Development Loans Figure 10

Therefore, it is felt that these results The 54 Converted New England Savings Banks 

are fairly robust with respect to the Percent of Assets 

choice of peer banks. 6 

Converted savings banks funded asset growth primarily with liabilities in 5 

order to decrease capitalization rates

and leverage earnings, but they were 4 

unable to match asset growth rates with

deposit growth. Competition for 3 

deposits is seen in Figure 11, which

shows the spread between the average 2 

rate for 6-month and 1-year certificates

of deposit in the Boston market and 1 

the Bank Rate Monitor national

average rate. The Boston market rate 0 

exceeded the national average rate for -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 

most of the late 1980s. Number of Quarters from Conversion 

9 
 

 

Annual Effective Yield Spread

Boston vs. National

Figure 11

Figure 12

Median High Cost Liabilities

The 54 Converted New England Savings Banks

FDIC Banking Review 

Figure 11 

Annual Effective Yield Spread 

Percent Boston vs. National 

0.8 

0.6 

0.4 

0.2 

0 

-0.2 

-0.4 

Source: Bank Rate Monitor 

As a result, converted savings banks

altered their liability composition in

the post-conversion period. Converted

savings banksincreasedtheirreliance on

nondeposit liabilities, primarily

through the reported item “other

borrowed money.”32 Forthe sample of

54 converted savings banks, the median ratio of other borrowed money to

total liabilities rose from 2.45 percent

to 11.06 percent in the three-year period subsequent to conversion.33 In contrast, for the mutual-form peer banks

the median ratio of other borrowed

money to liabilities remained fairly

steady, varying between zero percent

and 0.2 percent for the same period.

Six-Month CD 

One-Year CD 

1986 1987 1988 1989 1990 1991 1992 1993 

In the three-year period after conversion, the converted savings banks had 

an average quarterly asset growth rate 

of just over three percent, with 66 percent of that average growth financed 

by deposits and 35 percent funded 

with nondeposit liabilities.34 

Figure 12 shows that converted savings banks also increased their reliance

upon high-costliabilities and did so to a

greater extent than their peers. Highcost liabilities are defined as brokered

deposits plus time deposits of $100,000

or more. For the sample of 54 converted savings banks, the median ratio

of high-costliabilitiesto total liabilities

rose from 3.17 percent to 8.18 percent

over the three-year period subsequent

Figure 12
 

Median High-Cost Liabilities
 

The 54 Converted New England Savings Banks
 

Percent of Liabilities 

10 

8 

6 

4 

2 

0 

Converted Savings Banks 

Mutual-Form Peer Banks 

-4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 

Number of Quarters from Conversion 

to conversion. For the comparison

group of mutual-form peer banks, the

high-costliabilitiesratio rose from 2.95

percent to 5.97 percent over the same

period. Statistical tests of the significance of differences in liability

composition between converted banks

and the comparison group of mutualform peers (not presented here) indicate that the differences in the two

groups' reliance upon other borrowed

money and high-costfundswere statistically significant at the 95 percent

confidence level over most of the preand post-conversion periods.

The reliance upon nontraditional

sources of funding, such as high-cost

deposits, by converted savings banks

to fund asset growth hasimportantimplications. These changes in liability

composition indicate thatthe converted

savings banks were unable to expand

their core deposit franchise quickly

enough to support loan growth.3�

32 The funding category “other borrowed 

money” is used in the Reports of Condition 

and Income that banks are required to file with 

federal bank regulators. 33 Banks only report the total value of 

“other borrowed money” and not its components. Other borrowed money includes items 

such as Federal Home Loan Bank (FHLB) advances, borrowings on a bank's own promissory 

notes, and borrowings from Federal Reserve 

Banks. Additional data supplied by the Federal Home Loan Bank of Boston were available 

on advances for 25 of the 54 converted savings 

banks between 1986 and 1993. For these 25 

banks, advances as a percent of total liabilities 

increased from 5.45 percent to 12.28 percent between year-ends 1986 and 1988. For these same 

25 banks, advances usage generally fell after 

December 1988, and was 7.49 percent of liabilities at year-end 1993. However, because 

advances data were not available for all 54 

banks in our sample, it is not clear whether advances usage was the cause for the increase in 

other borrowed money. 34 Stated differently, the average quarterly 

asset growth rate for the converted savings 

banks was 3.03 percent between quarters 1 and 

12. Over this same period, average deposit 

growth was 1.99 percent of assets and nondeposit liability growth was 1.05 percent of assets. While some equity financing was used, 

the average value was negligible during this 

period. 35 Core deposits commonly refer to a 

bank's stable deposit base. These deposits 

come from depositors who seek traditional 

banking services and are not as sensitive to deposit interest rates as those depositors who are 

not as concerned with banking services. Core 

deposits generally are defined as demand and 

other transaction accounts plus savings deposits of $100,000 or less. Core deposits are considered low-cost and have low volatility. 

10 
Converted New England Savings Banks 

Required Growth Rates 

So far we have seen that converted

savings banks' ROEs after conversion

were substantially below those of their

peer mutual savings banks. Investors

may tolerate lower ROEs in exchange

for the risk-reducing effect of a higher

level of capitalization, and converted

savings banks generally had much

higher capital ratios than their peers.

However, the post-conversion growth

ofthese institutionssuggests that management attempted to increase ROEs

and reduce capital ratios. This section

uses a simple approachtodetermine the

rate of leveraged asset growth that

would have been required to achieve

the same ROEs as existed prior to conversion, had asset growth been the sole

strategy adopted. To do this, the target ROE is related to the banks' underlying profit rate on assets (ROA)

and existing capitalization rate. By

definition, the ROE equals the product of the ROA and the inverse of the

capital-to-assets ratio (equity multiplier). That is,

Net Income Assets ROE = ( ) * ( ) Assets Capital

In the pre-conversion period (during

quarters -4 to -1), the average ROE

among both peer and converted banks

was approximately 15 percent.36 The

overall profitrate on assets, ROA, averaged one percentforthe converted savings banks in the year prior to

conversion. Assuming converted banks

expected this average ROA to persist,

the banks would have needed to reduce equity capitalization from an average rate of 16 percent (at conversion)

to 6.7 percent in order to achieve an

ROEof 15 percent.37 Thisreduction in

capitalization could be achieved with

various rates of asset growth over a long

or short period. For example, target

capitalization and ROE could be met

with a compound annual leveraged asset growth rate of 15.5 percent for six

years, or 19 percent for five years. The

median annual asset growth ratesshown

in Figure 6 averaged 12 percent over

the two-year period subsequent to conversions. As mentioned previously, lower

capitalization rates decrease the stability of earnings per share of common

stock. Therefore, banks' knowingly accept more risk when leveraging earnings.

It appearsthatmany convertedbanks

were following a strategy of leveraged

asset growth over a period in excess of

six years as a way to leverage earnings.

The 12 percent median growth ratewas

high relative to the 7.71 percent average

asset growth rate among all FDIC-insured

savings banks between 1986 and 1988.

Epilogue 

Managements at converted New

England savings banks focused on leveraged asset growth to improve the

rate of return on equity, which was a

key measure of performance for the

banks' new constituency, the shareholder. However, managements soon

were required to confront a new issue:

small groups of vocal, hostile shareholders. The booming market for converted thrifts had attracted a newset of

investors. While mostsavings banks had

converted via community offerings

that placed the majority of stock in the

hands of local depositors (and management), non-local or outside investors

began to increase their stock holdings

of converted savings banks. These investorssought to take advantage of the

strong acquisitions market. Often,

these groups accumulated sufficient

stock in a given institution to solicit a

board seat or otherwise influence managementin an effortto elicitthe sale of

the institution. Sale often was viewed

as the best way to maximize shareholder

value, particularly given the difficulty in

raising returns on equity to levels acceptable to shareholders.

In certain cases, management's attention was diverted from running the

institution to staving off proxy fights

and hostile takeover attempts, and

implementing “poison pills” such as

shareholder rights plans.38 Moreover,

profitability declined among both converted and peer banks over the sample

period,reflecting thewidespread problems resulting from the softening of

New England real-estate markets, as

well as a regional recession in the later

quarters, and increased competition

for depositsto fund the high rates of asset growth. Had the regional economy

continued to expand, greater asset

growth might have been possible.

Moreover, if net interest margins and

overall profitability had remained high,

less asset growthwould have been necessary to increase or at least maintain

ROEs.

Conclusion 

The experience of the converted

New England savings banks has useful

lessons for bankers and bank regulators. High capitalization rates alone do

not provide protection against failure.

In fact, this study finds that the high

capitalization rates achieved upon conversion to stock form led managements to engage in rapid asset growth.

When this occurs, additional risk is

borne through rapid loan growth and

credit quality may suffer. This wasthe

case forthe group of 54 converted New

England savings banks; their net loan

and lease charge-offs increased from a

median annual rate of 0.007 percent of

assets one quarter prior to conversion

to 0.110 percent of assets 12 quarters

after conversion.39 Finally, if strategic

growth plans are not well-thought-out,

the bank increasingly may become reliant upon volatile, high-costliabilities.

Conversion to stock form resultsin a

fundamental change in the nature of an

institution. Bank managements need to

have well-defined strategic plans, particularly when planning to expand operations. If growth plans are ill-timed

or notsupportable given market opportunities, severe difficulties may be encountered. This study has shown that

the sample of New England converted

savings banksfaced these problems and

suffered as a result.

36 ROEs of publicly traded commercial 

banks during the mid-1980s tended to be in 

the range of 13 to 15 percent. See Keefe, Bruyette & Woods, Inc., Peer Bank Averages. 37 Some improvement in ROA after conversion may occur with the reduction in total 

interest expense associated with increased 

capitalization. 38 There were five proxy fights involving 

New England savings banks between 1988 and 

1990. Source: D.F. King & Co., Inc. 39 Statistical tests of the difference between converted and mutual-form peer savings banks' net loan and lease charge-off rates 

showed that the converted banks' rates were 

significantly higher than those of the peer 

banks eight quarters after conversion (at the 95 

percent confidence level). Moreover, converted banks' net loan and lease charge-off 

rates remained significantly higher than those 

of peer banks during the entire third year after 

conversion. 

11 
FDIC Banking Review 

APPENDIX A
 

Statistical Significance Tests 

This appendix looks at the statistical significance of the differences between converted savings banks' and 

peer banks' financial performance. 

Specifically, peer banks' financial ratios were subtracted from those of 

converted savings banks on a quarterly basis. The mean differences in 

the two groups' financial ratios were 

obtained. Next, the Student's “t” statistics were computed to test the hypothesis that the mean differences in 

the financial ratios were not significantly different from zero. Tables 

4, 5, and 6 present both the mean differences in financial ratios and the associated Student's t statistics. The 

same mutual-form peer bank group 

used in the figures is used in Tables 4, 

5, and 6. A Student's t statistic of 1.96 

or greater means that the mean differences in the financial ratios are statistically different from zero at the 95 

percent confidence level. Mean differences in financial ratios greater 

than zero result when the converted 

banks' mean ratios are greater than 

those of peer banks, and vice versa

when mean differences are negative. 

Table 4 shows that the converted 

savings banks' capitalization rates increased from pre-conversion rates significantly lower than those of peer 

banks to post-conversion rates significantly higher than those of peer 

banks. Converted savings banks' 

post-conversion asset and loan growth 

rates were significantly higher than 

those of peer banks for a brief period 

after conversion. Converted savings 

banks' concentrations of construction 

and land development loans were significantly greater than those of peer 

banks in the post-conversion period. 

As stated before, these results generally held for different peer groups. 

Tables 5 and 6 present information 

on converted and peer banks' earnings. Table 5 shows that converted 

savings banks' ROAs were significantly less than those of peers prior to 

conversion but, in general, were not 

significantly different than peers' 

ROAs after conversion. Converted 

banks' ROEs generally remained significantly less than those of peers for 

two years subsequent to conversions. 

talization, i.e., a reduction in the proportion of assets financed with deposits and debt capital. This reduction in 

total debt was enough to offset converted banks' increased reliance upon 

Table 4
 

Comparison of the 54 Converted and Peer Banks'
 

Balance-Sheet Activity
 

Mean Ratio Differences (t Statistics), Quarterly Growth Rates
 

Number of Construction 

Quarters from Capital/ Asset Loan Loans/ 

Conversion Assets Growth Growth Assets 

-4 -1.54 0.60 -0.08 1.06 

(-4.44) (1.38) (-0.12) (2.11) 

-3 -1.41 1.63 1.02 0.60 

(-4.48) (0.79) (0.61) (1.06) 

-2 -1.47 -0.23 0.94 0.94 

(-4.45) (-0.49) (1.25) (1.73) 

-1 -1.81 1.50 -0.38 1.21 

(-5.46) (1.77) (-0.44) (2.09) 

0 7.47 9.82 2.88 0.78 

(10.43) (8.13) (3.35) (1.30) 

1 6.95 0.84 5.50 1.50 

(10.18) (1.24) (6.92) (2.41) 

2 6.40 2.27 3.16 1.67 

(9.50) (2.84) (2.78) (2.63) 

3 5.72 2.42 2.59 1.58 

(8.52) (2.98) (3.33) (2.59) 

4 5.75 0.67 0.89 1.08 

(9.96) (0.69) (0.99) (1.55) 

5 4.87 1.70 1.96 2.30 

(8.88) (2.67) (2.87) (2.89) 

6 4.18 3.08 2.38 2.70 

(7.25) (2.30) (1.73) (4.06) 

7 3.98 0.39 -0.56 3.05 

(6.80) (0.59) (-0.80) (3.95) 

8 3.49 1.80 1.38 2.77 

(5.80) (1.28) (0.79) (3.49) 

9 3.25 1.28 2.56 1.95 

(5.47) (0.91) (0.88) (2.36) 

10 3.03 0.51 0.93 2.12 

(5.27) (0.47) (0.85) (2.86) 

11 2.19 -2.00 -1.09 2.44 

(3.77) (-3.80) (-1.56) (3.50) 

12 1.80 -0.59 -1.59 1.47 

(3.29) (-0.98) (-2.66) (1.88) 

Table 6 shows that converted 

banks were able to earn very favorable 

net interest margins (NIMs) after 

conversion to stock form. This was 

due to declines in interest expense, as 

well as increases in interest income. 

Interest expense declined primarily 

because of the increase in equity capihigh-cost funding (see Figure 12) in 

the post-conversion period. The increase in interest income was attributable to the large increases in loans 

after conversion. Prior to year-end 

1987, banks were able to treat all 

fees and points associated with loans 

as part of current interest and fee 

12 
Converted New England Savings Banks 

Table 5 Table 6 

Comparison of the Converted and Peer Comparison of the Converted and Peer Banks' 

Banks' Profitability Income and Expenses 

Mean Ratio Differences (t Statistics), Mean Annualized Differences in Rates 

Annualized Profit Rates as a Percent of Assets (t Statistics) 

Number of Number of 

Quarters from Return on Return on Q uarters from Net Interest Loss Net Noninterest 

Conversion Assets Equity Conversion Margins Provisions Income 

-4 -0.29 -0.02 -4 0.02 0.12 0.06 

(-2.38) (-0.01) (0.11) (1.77) (0.55) 

-3 -0.02 3.55 -3 -0.12 0.05 0.11 

(-0.13) (1.86) (-0.84) (1.39) (0.81) 

-2 -0.32 -1.94 -2 -0.04 0.05 0.07 

(-2.09) (-0.92) (-0.33) (2.59) (0.65) 

-1 -0.42 -4.06 -1 0.05 0.05 0.17 

(-2.45) (-1.43) (0.34) (1.86) (1.99) 

0 -0.03 -6.18 0 0.09 0.02 -0.04 

(-0.33) (-6.21) (0.51) (0.75) (-0.25) 

1 0.13 -5.05 1 0.55 0.03 0.21 

(1.51) (-5.44) (4.95) (1.20) (2.11) 

2 0.005 -5.26 2 0.33 0.04 0.06 

(0.03) (-4.54) (2.52) (1.73) (0.59) 

3 -0.09 -5.41 3 0.22 0.21 0.01 

(-0.52) (-3.97) (1.40) (1.38) (0.10) 

4 -0.08 -5.95 4 0.34 0.30 -0.003 

(-0.44) (-2.68) (2.32) (1.60) (-0.03) 

5 0.07 -2.47 5 0.29 0.07 0.01 

(0.59) (-2.21) (2.87) (0.89) (0.14) 

6 -0.11 -3.01 6 0.24 0.10 -0.01 

(-0.44) (-1.68) (2.45) (0.94) (-0.06) 

7 -0.28 -6.41 7 0.33 0.36 0.17 

(-1.43) (-2.48) (3.71) (2.33) (1.81) 

8 -0.29 -4.82 8 0.22 0.44 0.11 

(-1.34) (-2.43) (1.97) (2.11) (1.10) 

9 -0.55 -9.10 9 0.34 0.80 0.25 

(-1.49) (-1.84) (2.71) (2.31) (1.51) 

10 -0.46 -7.84 10 0.09 0.47 0.21 

(-2.36) (-2.95) (1.04) (3.25) (1.50) 

11 -2.06 -1426.06* 11 -0.005 1.83 0.35 

(-1.84) (-1.01) (-0.04) (1.87) (1.60) 

12 -0.70 -8.78 12 0.08 0.60 0.22 

(-2.28) (-1.69) (0.79) (2.11) (1.52) 

* This large value resulted from one converted bank's ROE. 

income (interest income).40 Because the majority of conversions in the sample occurred in 

1986, the large increases in real-estate loans 

subsequent to conversions generated high fee 

income for mortgage lenders. 

40 The treatment of fee income on loans changed with 

Financial Accounting Standards Board Statement 91 

(FASB-91), Accounting for Nonrefundable Fees and Costs 

Associated with Originating or Acquiring Loans and Indirect Costs of Leases. FASB-91 required banks to amortize 

most of the fee income associated with mortgage lending. 

13 
 

 

Figure 13

Median Common Stock Returns (Annualized)

Converted New England Savings Banks

Number of Quarters from Conversion

Figure 14

Median Expected Earnings Growth Rates (Annualized)

Converted New England Savings Banks

FDIC Banking Review 

Required Returns to Common 

Stockholders 

Expected Earnings Growth 

Estimates 

The previous sections looked at 

the strategies used by the converted 

savings banks to improve profitability 

(ROEs). We were able to determine, 

ex post, that strategic plans focused 

upon leveraged asset growth. It also 

would be interesting to know what 

shareholders' ex ante expectations 

were regarding strategic plans and the 

effect of those plans upon bank earnings. This section used market data 

on converted banks' common stock 

prices along with their financial data 

(income statements and balance 

sheets) to address these questions. 

First, share prices and financial statements were used to obtain estimates 

of expected earnings growth rates, i.e., 

expected growth rates in net income 

to common stockholders. Second, 

these expected earnings growth rates 

were related to banks' profitability 

and asset levels in order to make inferences about expected asset growth 

rates. The methodology used to obtain expected earnings growth rates is 

that presented by Ben-Horim and 

Callen (1989). The results of that 

analysis are presented next, followed by a description of the BenHorim and Callen methodology. 

41 Daily stock returns over a three-year period subsequent to conversions were available for 

24 of the institutions in the original group of 54 

converted savings banks. Daily returns were 

compounded to obtain actual quarterly returns. 

The median quarterly returns were then compounded to obtain annualized values. 

42 It should be noted that a portion of the 

poor post-conversion return performance may 

be due to the general stock market “crash” of 

October 1987. Although the October 1987 market crash would explain poor returns for yearend 1987, poor performance in other periods 

should be determined primarily by bank performance. 

APPENDIX B 

Expected Earnings Growth 

Rates 

Shareholders' expectations of future earnings are generally reflected in 

common share prices and returns. As 

shown in Figure 13, converted banks' 

common stock returns fell soon after 

conversion. Figure 13 presents the 

trend in the median return on common 

shares of a sample of 24 converted 

New England savings banks. The 24 

savings banks were selected from the 

54 banks used in the financial trend 

analysis.41 Initially, the performance 

of converted savings banks appeared 

attractive. However, returns dropped 

quickly after conversion and remained 

poor for most of the post-conversion 

period shown in Figure 13.42 

The poor earnings expectations 

were reflected in estimates of expected earnings growth rates. Figure 

14 shows the trends in expected earnings growth rates for a small group of 

converted savings banks. This group 

is a subset of the 24 converted banks 

whose share returns are shown in Figure 13. Earnings data were not available for all 24 banks in every quarter, 

but were available for seven of the 

Figure 13
 

Median Common Stock Returns (Annualized)
 

Converted New England Savings Banks
 

Percent 

20 

10 

0 

-10 

-20 

-30 

-40 

24 Converted Savings Banks 

0 1 2 3 4 5 6 7 8 9 10 11 12 

Figure 14
 

Median Expected Earnings Growth Rates (Annualized)
 

Converted New England Savings Banks
 

Percent 

8 

6 

4 

2 

0 

Number of Quarters from Conversion 

7 Converted Savings Banks 

0 1 2 3 4 5 6 7 8 9 10 11 12 

14 
Converted New England Savings Banks 

original 24 banks. As Figure 14 

shows, the expected earnings growth 

rates for this group declined over the 

post-conversion period. 

Expected Asset Growth Rates 

In order to relate the expected 

earnings growth rates to expectations 

about converted banks' asset growth 

strategies, one can look at the relationships between overall profitability, asset growth, and resulting 

earnings growth. While there is no 

formal model for relating earnings expectations to banks' strategic plans, 

inferences were made based upon 

bank performance. The expected total earnings as of the end of the period 

can be expressed as the product of the 

expected return on end-of-period assets (ROA), and the end-of-period asset level.43 

E = (ROA ) * (Assets ) 1 1 1 

If the overall profit rate on bank assets (ROA) is expected to remain constant over time, then the expected 

earnings growth rate will be the same 

as that for total assets. If, however, 

the ROA is expected to decline, then 

the expected earnings growth rate 

will be less than that for assets.44 This 

latter situation can explain the declining expected earnings growth rates 

observed in Figure 14. 

The declining expected earnings 

growth rates shown in Figure 14 are in 

agreement with the relatively high asset growth rates in Figure 6. To see 

this more clearly, consider the following example. Suppose a bank's ROA 

declines from 0.8 percent to 0.7 percent. Suppose also that the bank's 

43 The return on assets can be defined as 

the ratio of net income to either average assets 

for the period or end-of-period assets. Average 

assets are the preferred denominator, because 

an average asset value is more reflective of the 

asset level which existed over the period to 

generate earnings. Period-end assets are used 

in this paper in order to simplify the discussion. 

Moreover, because quarterly data are used, the 

difference between period-end and average asset levels should not be large. 

44 For infinitesimally small changes in ROA 

and assets, the percentage change in earnings 

will equal the sum of the percentage changes in 

ROA and assets. 

assets increase from $100 million to 

$120 million over the period. This 

would result in an asset growth rate of 

20 percent, yet the earnings growth 

rate is only five percent. If, however, 

assets had increased to only $110 million (ten percent), the earnings 

growth rate would be -3.8 percent. 

Therefore, the trends in expected 

earnings growth rates shown in Figure 14 are consistent with the hypothesis that shareholders anticipated 

moderate leveraged asset growth to 

offset a portion of the adverse impact 

that weakening ROAs had upon earnings growth rates. 

Overall profitability among both 

converted and peer savings banks did 

decline in the late 1980s and early 

1990s (see Figure 6). We do not have 

estimates of expected ROAs, nor expected asset growth. However, it 

seems reasonable to expect that 

shareholders of the converted savings 

banks were aware of the need for leveraged asset growth to bolster profit 

rates on equity capital (ROEs). In addition, shareholders also should have 

been aware of the adverse impact of 

the regional recession, as well as the 

weakening real-estate market upon 

savings banks' overall profitability. 

Therefore, if ROAs were expected to 

decline, the expected growth rates in 

earnings for a given quarter would be 

less than the expected growth rates in 

total assets. 

Estimating Expected
 

Earnings Growth
 

Standard economic theory states 

that market value of any financial 

claim is equal to the present discounted value of the stream of earnings the claim is expected to generate. 

The discount rate used to value expected earnings can alternatively be 

thought of as investors' required rate 

of return or the firm's funding cost. 

Because actual earnings may differ 

from expectations, the required rate 

of return is also an expected rate of return. Given an expected earnings 

stream, investors in debt or equity instruments adjust market prices so that 

the instrument will yield the required 

rate of return. The cost of common 

equity capital is, therefore, the discount rate that investors use to value 

expected dividends. Equation 1 

gives the standard expression for the 

present value of a firm's stock. To 

simplify the presentation a firm index 

is not used in equation 1, leaving implicit the knowledge that all terms 

vary across firms. 

In this equation, V0 is the current 

market share price of a firm's common 

stock, dt is the expected value, at time 

1, of dividends to be received at time 

t, and kt is the expected rate of return 

on the firm's stock over period t-1 

to t. 

∞ d t 1) V0 = ∑ t t = 1	 (1 + kt ) 

Equation 1 permits a firm's required returns to vary over time. 

While this may be theoretically appealing, the analysis is greatly simplified if one assumes a constant 

discount rate over time. This constant rate would be an average of the 

time-dependent rates. Even with 

this simplification, it is not possible to 

obtain estimates of the required rate 

of return from equation 1 without 

knowledge of the expected dividend 

stream. If one assumes, for simplicity, 

that dividends (earnings) grow at a 

constant expected rate, g, equation 1 

is further simplified as equations 2 

and 3. 

∞ d 0 (1 + g) t 

2) V0 = ∑ 

t = 1 (1 + k) t 

or 

d1 3)	 V = 0 (k g − ) 

From equation 3, one obtains the 

common expression (equation 4) for 

the required return on common equity capital as the sum of the expected dividend yield plus expected 

growth rate in earnings. 

d1 4) k = + g V0 

Estimation of equation 4 is made 

difficult by the need to project not 

only next period's earnings and divi15 
FDIC Banking Review 

dends, but also the future growth rate 

in earnings. Ben-Horim and Callen 

(1989) show that it is possible to avoid 

the need to estimate g by introducing 

stock market data on firm value into 

equation 4. Specifically, Ben-Horim 

and Callen introduce Tobin's q, the 

ratio of the market value of a firm to 

the replacement cost of its assets 

(equation 5). 

V0 + D0 5) q = RC 

In equation 5, the market value of 

the firm is defined as the sum of the 

present value of common stock plus 

the present value of all other claims on 

the firm's earnings and assets (preferred stock and debt, denoted D0). 

The replacement cost of assets is denoted as RC. If factor markets are 

competitive, replacement costs will 

equal the present value of the expected earnings generated by assets. 

In order to simplify the analysis further, Ben-Horim and Callen assume 

that any invested capital will earn a 

constant expected rate of return, r. 

Under these assumptions, factor markets value firm assets in the same way 

one would a perpetuity. Thus, the replacement cost of assets is equal to the 

ratio of expected total earnings in the 

next period, E1, to r. Under these assumptions Tobin's q for the levered 

firm can be rewritten as: 

V0	 + D0 6) q = E1 + D0 r 

Ben-Horim and Callen next introduce the firm's dividend and internal 

investment decisions into the analysis 

by assuming that the firm reinvests a 

constant proportion of earnings, b, 

each period. It is easy to show that 

with this reinvestment policy, the expected growth rate in earnings, g, 

equals the product of the retention 

rate times the expected rate of return 

on invested capital, i.e., br. Under 

these assumptions, the required rate 

of return on equity capital can be expressed as a function of the firm's expected earnings, reinvestment rate, 

and the rate of return on invested 

capital. 

( ) 1 − b E 7) k = 1 + br 

V0 

Rewriting r in terms of Tobin's q, 

equation 7 becomes: 

(1 − bE ) E q 8) k = 1 + b 1 ( ) V V + D (1 − q) 0 0 0 

or 

bqV0 E1 9) k = [ 1 − b + ] V 0	 0 + D (1 − q) V0 

Ben-Horim and Callen state that 

estimation of required returns using 

equation 9 is made easier by the fact 

that one can avoid estimation of 

growth in earnings by using information on current market values, replacement costs, and earnings. This 

is clearly seen in the expression for 

the growth rate implied by equation 

9. 

bq 10)	 g = (E1 ) 

V0 + D0 (1 − q) 

Because the expected value of 

earnings in the next period equals 

this period's earnings times one plus 

the growth rate, equation 10 simplifies to: 

g	 bq 11)	 = (E ) (1 + g ) 0 V0 + D0 (1 − q) 

One may, therefore, solve for the 

growth rate in earnings implied by 

equation 10 using current market information. 

16 
Converted New England Savings Banks 

REFERENCES 

Baer, Herbert and John McElravey. “Capital Adequacy and the Growth of U.S. Banks.” Federal Reserve Bank of Chicago Working Paper (June 1992). 

Ben-Horim, Moshe and Jeffrey L. Callen. “The Cost of Capital, Macaulay's Duration, and Tobin's q.” The Journal of Financial Research Vol. 12, No. 2 (Summer 1989): 143-56. 

Boyd, John H. and Stanley L. Graham. “Investigating the Banking Consolidation Trend.” 

Federal Reserve Bank of Minneapolis Quarterly Review (Spring 1991): 3-15. 

Browne, Lynne E. “Why New England Went the Way of Texas Rather Than California.” Federal Reserve Bank of Boston New England Economic Review (January/February 1992): 23-41. 

Cordell, Lawrence R., Gregor D. MacDonald, and Mark E. Wohar. “Corporate Ownership and 

the Thrift Crisis.” Journal of Law and Economics (October 1993): 719-56. 

Dunham, Constance R. “Mutual-to-Stock Conversions by Thrifts: Implications for Soundness.” Federal Reserve Bank of Boston New England Economic Review (January/February 

1985): 31-45. 

Federal Deposit Insurance Corporation. Mutual Savings Banks (Working Paper), April 1983. 

Furlong, Frederick T. “Capital Regulation and Bank Lending.” Federal Reserve Bank of San 

Francisco Economic Review No. 3 (1992): 23-33. 

Golembe, Carter and David S. Holland. Federal Regulation of Banking, 1986-1987. Golembe Associates, Inc., Washington, DC, 1986. 

Hancock, Diana and James A. Wilcox. “Real Estate Lending, Real Estate Losses, and Bank 

Capital.” A paper presented at the Annual Meetings of the American Economic Association (1993). 

Keeley, Michael C. “Deposit Insurance, Risk, and Market Power in Banking.” American Economic Review Vol. 80, No. 5 (1990): 1183-1200. 

Klock, Mark, Clifford F. Thies, and Christopher F. Baum. “Tobin's q and Measurement Error: 

Caveat Investigator.” Journal of Economics and Business Vol. 43 (1991): 241-52. 

Lindenberg, Eric B. and Stephen A. Ross. “Tobin's q Ratio and Industrial Organization.” Journal of Business Vol. 54, No. 1 (1981): 1-32. 

O'Keefe, John P. “Profitability in Commercial Banking, 1976 -1992.” A study prepared for the 

Commerce, Consumer and Monetary Affairs Subcommittee of the Committee on Government Operations. U.S. House of Representatives (September 1993). 

O'Keefe, John P. “The Texas Banking Crisis: Causes and Consequences, 1980 - 1989.” FDIC 

Banking Review Vol. 3, No. 2 (Winter 1990). 

Ornstein, Franklin H. Savings Banking: An Industry in Change. Reston, VA: Reston Publishing 

Company, 1985. 

Simons, Katerina. “Mutual-to-Stock Conversions by New England Savings Banks: Where Has 

All the Money Gone?” Federal Reserve Bank of Boston New England Economic Review 

(March/April 1992): 45-53. 

Simons, Katerina. “New England Banks and the Texas Experience.” Federal Reserve Bank of 

Boston New England Economic Review (September/October 1990): 55-62. 

Sinkey, Joseph F. Commercial Bank Financial Management in the Financial Services Industry. Third 

Edition. New York: Macmillian Publishing Company, 1989. 

Williams, Julie L., J. Larry Fleck, and V. Gerard Comizio. “Mutual-to-Stock Conversions: New 

Capitalization Opportunities and Post-Conversion Control Developments.” United States 

League of Savings Institutions Legal Bulletin, May 1987. 

Zweig, Phillip L. “Depositors Flock to Thrifts in Northeast, Hoping for the Right to Buy Their 

Shares.” The Wall Street Journal, June 3, 1986. 

17 
Cutbacks in Construction Lending

Recent Cutbacks in 

Construction Lending 

at BIF-Insured 

Depository Institutions 

by James L. Freund and Maureen C. Crowley* 

The topic of the “credit tomer relationships with local finan­ creased rapidly from just under $40

crunch” received consider­ cial institutions have been important billion at year-end 1980 to nearly $150

able attention during the in ensuring a timely flow of such billion at year-end 1989. Because

early 1990s. As a result, several initia­ credit. Thus, any disruption in con- construction cost increases were relatives aimed at eliminating regulatory struction credit from banks is likely to tively modest during the period, this

disincentives to lending were put in be difficult to replace in the short run. increase represented a substantial rise

place. For example, documentation This in real activity funded. During the article documents the sharp requirementsrecently were reduced to next three years, however, such cred­ decline in aggregate construction

the legal minimum for loans to small its fell by 45 percent, to just over $80 lending on the books of BIF-insured

and medium-sized businesses. Also, billion at the end of 1992. While con- institutions during the 1990-1992

examiners and bankers were encour­ struction costs moderated in the early period. Lending patterns varied

aged to emphasize the character and widely 1990s, most of the decline repre­ across regions and between

general reputation of borrowers when sented a decrease in projectsfunded.2 categories of banks. A regression

considering such credits.1 In the aca­ analysis is presented that quantified

demic arena, several studies have Individual Bank Data the relative importance of the differexamined the recent portfolio adjust­ ent factors that determined whether The study utilized data from indiments of insured financial institutions an institution’s construction loan port­ vidual bank Reports of Condition and

to identify possible financial and/or folio was shrinking. An institution’s Income (Call Reports) to examine the

regulatory constraints to the flow of profitability, capital position, and re- rapid decline in construction lending credit. For instance, Hancock and cent experience with construction from the second quarter of 1990

Wilcox (1992) studied permanentsin- lending were the strongest factors in

gle-family and commercial loans. determining whether, and by how

Peek and Rosengren (1993) examined much, lending was cut back. In con­ * James L. Freund is Chief of the Financial

“bank dependent loans,” and Bizer trast, various tests to capture the and Industry Analysis Section and Maureen C.

Crowley was a financial analyst in the FDIC’s (1993) analyzed commercial and in- influence of real-estate market devel- Division of Research and Statistics. dustrial loans, as well as “100 percent opments that might affect demand 1 See Inter-Agency Policy Statement on Credit risk-weight” loans. factors did not yield statistically sig- Availability, FDIC, PR 20-93. Joint release

This nificant results. 3/10/93. article reports on the role of

BIF-insured 2 The non-residential fixed-investment im­ commercial and savings plicit price deflator (1987=100) rose 14 percent banks in the provision of construction The Recent Decline in between 1982-1991; the implicit price deflator

and development credit to the real- Construction and for residential investment grew 31 percent durestate industry. Insured depositories ing the same period. Non-residential investtraditionally have been a key source Development Lending ment prices actually declined one percent from

1991-1992, and residential investment prices for construction and development As shown in Figure 1, construction rose only 1.4 percent in that period. Data are credit, especially for small builders loans on the books of BIF-insured from the Bureau of Economic Statistics, U.S.

and developers. Established cus­ commercial and savings banks in- Department of Commerce.

19
FDIC Banking Review

Figure 1 

Construction Loans Held by BIF-Insured Institutions 

(End-of-Period Balance: 1980-1992:Q4) 

$ Billions 

160 

140 

120 

100 

80 

60 

40 

20 

1980 1982 1984 1986 1988 1990 1992 

through the third quarter of 1992.

The study included banksin continuous operation that had construction

loans on their books at either the beginning or the end of the designated

period. Because the study focused on

the amount of credit supplied by the

banking system as a whole, institutions that were involved in mergers

during the period were included in

Figure 2 

Median Change in Construction Loans Held by 

BIF-Insured Institutions in Continuous Operation 

(1990:Q1-1992:Q3) 

Percent of Institutions 

40 

30 

20 

10 

0
 

-50 to -100 -25 to -50 0 to -25 0 to 25 25 to 50 50 to 100 >100
 

Percent Change in Construction Loans Held
 

-

the sample. A merger-adjustment

procedure was used in which construction loans for currently-operating, BIF-insured institutions that

acquired another bank or a thrift were

compared to the sum of such loans at

their constituent institutions at the

beginning of the period. Both unassisted mergers and acquisitions of

failed banks and thrifts during the

period were included.

The Call Report data have two

limitations. First, direct data on net

credit extensions are not available.

Thus, construction lending activity

must be estimated by subtracting the

stock of loans at the end of a period

from that atthe beginning, and adding

back any charge-offs taken during the

period.3 A second drawback is that

the data do not separate commercial

and residential construction lending.

Given those caveats, Figure 2

shows while aggregate bank lending

declined, not every bank cut back on

construction lending. Indeed, both

ends of the distribution were highly

populated, with high proportions

of banks experiencing both sharp increases and decreases during the

period. Overall, 46 percent of BIFinsured commercial and savings

banks experienced a decline in construction credit; the remaining 54 percent had a higher volume ofsuch loans

in 1992:Q3 than in 1990:Q1.

Banks with Reduced Construction Loans. The more than 4,400 institutions that had reduced adjusted

construction credits outstanding at

the end of the period were typically

larger banks with relatively heavy initial concentrations of such lending.

These banks (and the institutions

3 Charge-offs are accounting adjustmentsto

a period-end balance sheet that reduce a bank’s

loan balances in recognition that the loan is

likely to default. If this adjustment is not

added back in, calculated net credit extensions

would be understated. Adjustments were not

made for other factors affecting changes in the

stock of loans on the books over any period —

net loan sales and writedowns of loan balances

atforeclosure —because data do not exist atthe

necessary level of detail.

20
Cutbacks in Construction Lending

they acquired) accounted for 85 percent of total construction lending in

early 1990. By the end of the period

under study construction loans on

their books, after adjustment for

charge-offs, had dropped by $64 billion. Twenty-one large banks accounted for a large portion of the total

reduction. Each of these institutions

experienced a reduction of $500 million or more during the period; the

decline in construction lending at

these institutions totaled $24 billion.

The subsequent failure of institutionsthat played key rolesin construction loan markets in 1990 had a

significant influence on declines in

overall lending. Commercial banks

and savings banksthat were operating

in 1992 absorbed 418 failed thrifts and

banks during the period under study.

The median change in construction

credit for the combined institutions

was -48 percent. These institutions

accounted for 40 percent ($25 billion)

of the overall decline in construction

lending.

Banks with Increased Construction Lending. Over half of the BIFinsured institutions that were making

construction loans in the third quarter

of 1992 had more loan volume on their

Figure 3 

Change in Construction Loans at BIF-Insured Institutions 

by Region 

(1990:Q1-1992:Q3) 

Median Percent Change In Construction Loans Held 

Percent 

60 

40 

20 

0 

-20 

-40 Northeast Southeast Central Midwest Southwest West 

Proportion of Institutions with Reduced Construction Lending 

Percent 

60 

40 

20 

0 Northeast Southeast Central Midwest Southwest West 

books (after adjustment for chargeoffs) than in early 1990. More than

3,000 banks at least doubled their

lending during that period — 1,000 of

these institutions had construction

loans on their books in 1992 that were

not in the market three years earlier.

Banks with a higher volume of construction loans on their books accounted for $8.6 billion in increased

construction lending. This increase

was dwarfed, however, by the $64 billion decline in construction lending

among institutions that cut back.

Characteristics of Gainers 

and Losers 

Both popular discussions and academic work have focused on several

key factors in discussing lending

changes at banks during the so-called

“credit crunch” period. Figures 3

through 5, which illustrate some of

these factors, show that lending behavior was anything but uniform.

Figure 3 shows regional differences.4 Commercial and savings

banks in the Northeast experienced a

sharp decline in construction loans on

their books. The median change in

adjusted construction loans in the

Northeast was -35 percent, and twothirds of the institutions experienced

declines. In the Southwest the median change was -3 percent. At least

half of the banks in all other regions

increased construction lending. In

fact, in the Central and Midwest regionsthe median change exceeded 40

percent. Itshould be noted, however,

4 The regional definitions are as follows:

Northeast - Connecticut, Delaware, District

of Columbia, Maine, Maryland, Massachusetts,

New Hampshire, New Jersey, New York, Pennsylvania, Puerto Rico, Rhode Island, Vermont.

Southeast - Alabama, Florida, Georgia, Mississippi, North Carolina, South Carolina, Tennessee, Virginia, West Virginia.

Central - Illinois, Indiana, Kentucky, Michigan, Ohio, Wisconsin.

Midwest - Iowa, Kansas, Minnesota, Missouri,

Nebraska, North Dakota, South Dakota.

Southwest - Arkansas, Louisiana, New Mexico, Oklahoma, Texas.

West - Alaska, Arizona, California, Colorado,

Hawaii, Idaho, Montana, Nevada, Oregon,

Pacific Islands, Utah, Washington, Wyoming.

21
that a significant proportion of the institutions in all regions also recorded

declines (lower panel, Figure 3).

Figure 4 illustrates the oftenobserved notion that capitalshortages

act generally as a deterrent to lending

— and particularly to riskier credits

such as construction loans. The median change among the 300 institutions in the sample that had less than

4 percent equity capital in 1990:Q1

was -39 percent. About 2,500 banks

with initial capital-to-asset ratios

between 4 percent and 7 percent had

a median change in construction loans

held of -9 percent. Many well-capitalized institutions increased construction loan portfolios sharply. Among

the 6,400 banks with initial capital

ratios between 7 percent and 15 percent, the median change was a positive 23 percent. Half of the banks

with capital in excess of 15 percent

more than doubled their lending.

Banks with heavy concentrations

of real-estate lending in early 1990 —

and those with high proportions of

delinquent real-estate loans — subsequently were likely to cut back on

construction lending. For the 4,000

banks that started the period with

more than 30 percent of their portfolios in real-estate assets, the median

change was -3 percent. In contrast,

the 181 banks that had less than 5

percent of their assets in real-estate

lending as of 1990:Q1 aggressively

pursued construction loans, with half

of these institutions more than tripling their holdings by 1992:Q3 (Figure 5).

The collapse of many commercial

real-estate markets and mounting

economic difficulties saddled many

banks with problem real-estate loans

in early 1990. As shown in Figure 6,

the median change in construction

lending for banks reporting no problem real-estate loans (90 days or more

past due or in nonaccrual status) was

an increase of 38 percent.5 In contrast, institutions in the sample (representing just over 30 percent of total

assets) with more than 5 percent of

their real-estate loans in difficulty reduced their construction lending

sharply during the period. At the extreme, those banks reporting 15 percent or more of their real-estate loan

portfolio as troubled had a median

change of -39 percent. Even among

the best-capitalized institutions at

least 40 percent of the institutions cut

back during the 1990-1992 period.

A Model of Bank 

Construction Lending 

A model was constructed to identify, and determine the relative importance of, the various influences on

construction lending at BIF-insured

institutions in the early 1990s. The

model was based on the premise that

banks allocate a desired share of their

portfolio to construction loans, given

their level of assets. Because it is not

possible to adjust an institution’s portfolio instantaneously, only part of the

desired adjustment of construction

loans on the books is likely to be made

during any given period.

Proportion of Institutions with Reduced Holdings 

of Construction Loans 

Percent of Institutions 

0 

20 

40 

60 

80 

Equity as a Percent of Total Assets 1990:Q1 

<0 0-2 2-4 4-7 7-15 > 15 

-100 

-50 

0 

50 

100 

Median Percent Change In Construction Loans Held 

Percent 

<0 0-2 2-4 4-7 7-15 > 15 

Figure 4 

Change in Construction Loans at BIF-Insured Institutions 

by Equity Capital 

(1990:Q1-1992:Q3) 

5 Nonperforming loans are classified as 90

days or more past due if they are well-secured

and in process of collection. Otherwise, their

status must be designated as nonaccrual.

FDIC Banking Review

22
Cutbacks in Construction Lending

Figure 5 

Change in Construction Loans at
 

BIF-Insured Institutions,
 

by Initial Real-Estate Lending Concentration
 

(1990:Q1-1992:Q3) 

Median Percent Change In Construction Loans Held 

Percent 

300 

200 

100 

0 

< 5 5-10 10-20 20-30 > 30 

Proportion of Institutions with Reduced Holdings 

of Construction Loans Percent of Institutions 

50 

40 

30 

20 

<5 5-10 10-20 20-30 > 30 

Real-Estate Loans as a Percent of Total Assets 1990:Q1 

Thus, the construction loans (CL) on the books at the

end of any given period, after adjustment for charge-offs,

are likely to be the last period’s stock of such loans plus or

minus a fraction, β, of the difference between today’s

desired level (CL*) and last period’s actual level:

(1) CLt = CLt−1 +β(CL∗

t − CLt−1 ) 

The desired stock of construction loans in period t is

posited to be a target proportion of total assets. The target

proportion is addressed in this study, while the level of

assets is taken as given. Thus,

(2) CL∗

t = (CLt ⁄ ASSETSt ) ∗ (ASSETSt ) 

Given the focus of this study on explaining changes in

lending, equation (4) was derived by substituting equation

(2) into equation (1) and rearranging termsin equation (3).

After scaling the results, equation (5) explains the change

in construction loans during a period relative to assets at

the end of the period. It is posited that in any period the

Figure 6 

Change in Construction Loans at
 

BIF-Insured Institutions,
 

by Initial Troubled Real-Estate Loans Held
 

Median Percent Change in Construction Loans Held Percent 

40 

20 

0 

-20 

-40 

-60 

0 0-1 1-5 5-10 10-15 > 15 

Proportion of Institutions with Reduced Holdings of 

Construction Loans 

Percent of Institutions 

60 

40 

20 

0 

0 0-1 1-5 5-10 10-15 > 15 

Percent of Troubled Real-Estate Loans 1990:Q1 

relative change in construction lending is: 1) positively

related to that period’s desired portfolio concentration in

construction lending and 2) negatively related to last

period’s construction loans relative to today’s level of total

assets.

(3) CLt = CLt−1 + β(CLt ⁄ ASSETSt)

∗ (ASSETSt)−βCLt−1

(4) CLt − CLt−1 = β(CLt ⁄ ASSETSt)

∗ (ASSETSt)−βCLt−1

(CLt−CLt−1) ∗ (5) = β(CLt ⁄ ASSETSt) − β(CLt−1 ⁄ ASSETSt) ASSETSt

Afully specified model of the target proportion of assets

allocated to construction loans would incorporate the returns and risks to construction lending relative to all other

assets. This paper estimates a reduced-form approach to

identifying the major influences on the desired role of

construction lending in bank portfolios.

23
FDIC Banking Review

Several characteristics of a bank

and its portfolio are likely to have

affected a bank’s desired construction

loan portfolio during the early 1990s.

First, a bank’s capital position is a key

determinant of its ability and willingness to book relatively risky assets

such as construction loans.6 On the

one hand, the better the initial capital

position of the bank, the more

likely that it would be willing and

able to take on relatively risky investments such as construction lending.

On the other hand, poorly capitalized

banks may decide they should take

chancesto “gamble” their way back to

health — the well-known “moral

hazard” argument. Studies conducted at the FDIC suggest that the

effect of capital positions on lending

also can be tempered by the profitability of the bank.7 For instance, highly capitalized banks

that are temporarily experiencing

earnings problems may lend lessaggressively than profitable, highly

capitalized institutions.

Second, many have argued that the

adverse developments in real-estate

marketsin the late 1980sled to a negative perception regarding real-estate

investmentsin the early 1990s. Thus,

institutions with high concentrations

of construction loans in the early

1990s reportedly were under pressure

— from existing stockholders, potential sources of new capital, and/or

regulators — to reduce their concentrations of such loans regardless of

other economic factors. In addition,

institutionsthat had a high proportion

of nonperforming real-estate loans

would be less inclined, ceteris paribus,

to make new construction loans.

In order to understand the “credit

crunch,” it is important to separate

restricted supply of credit from lower

demand. Lack of data is a serious

obstacle to identifying shifts in demand for construction loans. Nonetheless, this paper attempts to

identify local economic conditions

that should affect banks’ construction

loan portfolios. Because construction

loans for residential and commercial

projects are combined in the bank

data, developments likely to affect loan demand in both sectors of real-estate

markets were included.

These factors were incorporated into equation (5), yielding the following

relationship:

(CLt −CLt−1) (6) ASSETSt

+ α0

+ α(CAPITAL ⁄ ASSETS) 1 t−1

+ α(AVERAGE RETURN ON ASSETS) 2 t, t−1

− α(CL ⁄ ASSETS) 3 t−1

− α(NONPERFORMING REAL−ESTATE LOANS) 4 t−1

+ α(CONTEMPORANEOUS REAL−ESTATE 5

DEMAND INDICATORS) t, t-1

− β(CLt−1 ⁄ ASSETSt

) 

+μ 

Empirical Tests 

The estimation of the equation was

complicated by two factors regarding the final term, (CLt-1/ASSETSt),

which was introduced into the model

when the first difference/partial adjustment framework was adopted. First,

the equation also includes a term to

capture the independent negative influence of high concentrations of construction lending in the initial period.

Because the two terms are likely to be

highly collinear, the initial concentration variable was omitted. It is likely

that the remaining term will capture

some of the influence of the omitted

variable. Second, the fact that the final

term is imbedded, arithmetically, in

the dependent variable suggests that

contemporaneous correlation may be a

problem, thereby further complicating the interpretation of the results.

Moreover, the equation that was

estimated added several independent

variablesto the basic modelto account

for non-economic factors. First, a

dummy variable was added to identify

institutions that acquired a failed

bank or thrift during the period. Because the data were adjusted for mergers, this variable should identify any

negative effect on the combined entity’s portfolio resulting from the unwillingness of the acquirer to assume

the failed institution’s construction

loans. Acquirers often choose not to

take all of the assets of a failed institution. Second, a set of dummy variables was included to distinguish

among charter types of the BIFinsured institutions. If, as some have

claimed, supervisory pressure acted

to discourage real-estate lending, any

differences among federal regulatory

agencies with regard to such actions

would be identified by these variables.

Because a dummy variable for FDICsupervised savings banks was omitted, the included dummy variables

measure regulator-specific differences relative to savings banks.

Because it is virtually impossible to

isolate the relevant market areas a bank

serves for construction lending, two

basic tests were conducted. First, the

model was tested for all banks that

were active during the period

1990:Q1 to 1992:Q3, without regard

6 Hancock and Wilcox, in particular, discuss

the role of capital position thoroughly.

7 For a discussion of the interaction between

profitability, capital position, and loan growth,

see O’Keefe (1993).

24
Cutbacks in Construction Lending

to specific real-estate market influences that might differentially affect

demand for construction loans. Second, a subset was selected consisting

of institutionsthat were located in the

50 major metropolitan areas for which

detailed data on both residential and

commercial real-estate markets were

available.

All Banks. The results explaining

the change in construction lending

between 1990:Q1 and 1992:Q3 for the

9,563 BIF-insured depository institutions that were active construction

lenders are reported in Table 1. The

dependent variable was the change in

construction loans on an institution’s

books, after adding back charge-offs,

divided by total assets in 1992:Q3.8

As for the independent variables,

profitability was measured by the average return on assets during the entire period. Troubled real-estate

lending at a bank was captured by the

proportion of real-estate loans in

1990:Q1 that was either 90 days or

more past due or in nonaccrual status.

The lag term initially was measured

as the ratio of construction loans on

the books in 1990:Q1 to total assets in

1992:Q3.

The capital position of a bank was

entered as the equity capital-to-total

assets ratio as of 1990:Q1. Subsequent

tests used an estimate of each institution’s surplus or deficit capital position relative to its leverage capital

requirement.9 The estimated required

level was based on the bank’s overall

CAMEL rating and general guidelinesfollowed by examiners at federal

bank regulatory agencies on the corresponding capital needed. While both

measures yielded significant results,

the latter variable was somewhat

stronger. Thus, only the results for

the capital surplus variable are reported here.10

The basic results are reported in

line (1) of Table 1. Standard errors are

reported below each coefficient. As

hypothesized, both profitability and

capital positions had significant, positive effects on construction lending.

Banks with problem real-estate assets

were lesslikely to increase holdings of

such loans.

The acquisition of a failed bank or

thrift during the period was associated

with subsequent cutbacks in construction lending, after adjusting for

the effects of the merger. Also noteworthy was the relative effect of different regulators. Statistical tests

suggest the coefficient for national

banks was significantly lower than for

Table 1 

both state member and nonmember

banks, but the coefficients for the

two regulators of state banks were

not significantly different from each

other.

Large reductions in subsequent

construction lending were statistically

correlated with high initial holdings of

construction loans. The .57 coefficient represented a reasonable partial

adjustment factor. However, this

variable, assuggested above, also captured the independent, negative

effect of high initial holdings of construction loans in a period of severe

difficulty for such assets. The rather

high adjusted R2 was greatly influenced by the inclusion of this very

significant variable and by its probable role in contemporaneous correlation in the estimated equation.

8 Direct data on such charge-offs are available for construction loans, starting in 1991.

The adjustment factor for the three quarters of

1990 understudy was estimated by applying the

ratio of construction loan charge-offs to total

real-estate charge-offs in 1991 to total real-estate charge-offs during 1990.

9 As calculated by John O’Keefe of the

FDIC’s staff.

10 For a more detailed discussion of measures of a bank’s capital position relative to its

“desired level” or target level,see Hancock and

Wilcox (1992).

Changes in Construction Lending: Full Sample Results 

Troubled 

Capital Real-Estate 

Constant 

Surplus 

Deficita Avg. 

ROAb Loansa (%) 

(1) 0.006e

(0.001)

+0.02e

(0.002)

+0.08e

(0.01)

-0.07e

(0.006)

(2) -0.011e

(0.002)

+0.03e

(0.003)

+0.28e

(0.01)

-0.09e

(0.01)

(3) -0.011e

(0.002)

+0.03e

(0.003)

+0.28e

(0.01)

-0.10e

(0.01)

(4) -0.006e

(0.002)

+0.03e

(0.01)

+0.28e

(0.01)

-0.10e

(0.01)

a 90:Q1

b 90:Q2-92:Q3

c 92:Q3

d Dummy variables specification

e Significant at 99 percent confidence level

f Significant at 90 percent confidence level

Observations = 9,563

Lag/Concentration Charter Typed Regiond 

Const. Greater Less Acquired State, State, 

Loansa

/ Than Than 

Assetsc .10d .01d Failed Inst.d Nat. Fed NonBank Member Member 

SouthWest West Adj. 

R2 

-0.57e — — -0.004e +0.004e +0.008e +0.006e — — .56

(0.006)

— -0.068e +0.004f

(0.001)

-0.008e

(0.001) (0.002) (0.001)

+0.004e +0.008e +0.005e — — .28

(0.004) (0.001) (0.001) (0.002) (0.002) (0.002)

— -0.071e +0.005e -0.008e +0.001 +0.005e +0.003f +0.004e +0.013e .29

(0.002) (0.001) (0.002)

— 0.068e +0.004e

(0.002)

-0.008e

(0.002) (0.002) (0.001)

+0.0004 +0.004f +0.002

(0.001)

— — .28

(0.002) (0.001) (0.002) (0.0020) (0.002) (0.002) (0.001)

25
FDIC Banking Review

Table 2 

Changes in Construction Lending: Additional Hypotheses 

Lag/Concentration Charter Typec Regionc Camel Ratingc 

Troubled 

Capital Real-Estate Greater Less Acquired State, State, Avg. Incr. 

Surplus Avg. Loansa Than Than Failed Nat. Fed Non- South- Camel Camel Adj. 

Constant Deficita ROAb (%) .10c .01c Inst.c Bank Member Member West West Rating Rating f R2 

(1) -0.024d +0.03 +0.40d

(0.005) (0.05) (0.06)

(2) -0.008d +0.03d +0.24d

(0.002) (0.003) (0.01)

(3) -0.024d +0.05d +0.35d

(0.003) (0.01) (0.02)

-0.09d

(0.03)

-0.10d

(0.01)

-0.11d

(0.01)

-0.050d +0.010e -0.006e

(0.005) (0.005) (0.004)

-0.073d +0.004d -0.003

(0.002) (0.001) (0.002)

-0.067d +0.005d —

(0.002) (0.001) (0.002)

a 90:Q1

b 90:Q2-92:Q3

c Dummy variables specification

d Significant at 99 percent confidence level

e Significant at 90 percent confidence level

f 1990-1992

Observations: Equation (1): Assets >$1 Billion ... 401

Equation (2): Assets <500 Million ... 8,892

-0.002 +0.008 +0.014d

(0.005) (0.006) (0.006)

+0.001 +0.006d +0.003e

(0.002) (0.002) (0.002)

-0.003 +0.005d +0.002e

(0.002) (0.002) (0.001)

Equation (3): No mergers ... 8,346

To mitigate this problem, the initial construction loan variable was replaced by two dummy variables to

capture the high and low ends of the

distribution of the variable. The

high-concentration dummy identified all institutions with initial construction loans to current assets of ten

percent or more (463 institutions with

total assets of $300 billion). The lowconcentration dummy marked banks

with less than one percent of total

assets in construction loans (5,221 institutions with total assets of $800 billion). The results of this alternative

specification are reported in Table 1,

row 2. As expected, high initial levels

of construction loans were associated

with subsequent reductions, while

the opposite was true for banks with

low concentrations. The change in

specification increased the importance of the economic factors captured in the other coefficients; the

sign on the constant term reversed.

The explanatory power of the model

declined significantly, with the adjusted R2 falling to .28.

A set of regional dummy variables

also was included to capture broad

differences in economic conditions influencing construction lending. In the

tests discussed below, specific local

market conditions were examined in

areas in which suitable data existed.

When dummy variables were included

in the equation, only the coefficientsfor

the Southwest and the West were statistically significant. The positive signs

no doubt reflected the emerging recovery in many Southwestern states during

the early 1990sfrom their difficultiesin

the mid-1980s, and the heavy building

in key California markets in the early

1990s that led to current problems in

commercial real-estate markets. An

alternative specification in which

dummy variables were included for

only these two regions is reported in

Table 1, row 4. In neither specification did the addition of the regional

dummy variables appreciably improve

the explanatory power ofthe equation.

Other Hypotheses. Several “credit

crunch” studies have focused on a limited number of large banks. The considerable number of smaller banks

thatincreased their construction lending suggests that this approach would

be incompletewhenstudying construction lending. A variable capturing the

size of the institution was tested to see

if scale were a factor, but it was found

to be insignificant (notshown). Table

2 reports the results of alternative

tests in which the basic model was

applied separately to large banks with

initial assets over $1 billion (row 1),

+0.021 +0.009e

(0.007) (0.005)

+0.003e +0.013e

(0.001) (0.001)

+0.001e +0.011d

(0.001) (0.001)

— — .48

— — .25

+0.005d +0.004d .27

(0.001)

and small banks with initial assets of

less than $500 million (row 2).

The most notable differences for

large banks are the lack ofsignificance

of initial capital position and the increased importance of profitability.

The results also suggest that differentials among charter types are more important among large banks. When

only larger institutions were considered, lending at national banks was

not significantly different than at the

omitted savings banks. In fact, in this

test only state nonmember banks had

significantly more construction lending. The negative effects of high initial construction loan holdings were

smaller for large banks, but the positive effect on subsequent construction lending for banks with low initial

lending also wasstronger.11The results

11 An inspection of those banks with the

highest increases in construction lending suggested that a number of large banks that were

aggressive construction lenders were predominantly foreign-owned. To the extent that such

institutions respond to corporate needs of customers in their home country, they would not

be affected by the same forces as domestic institutions. However, when a dummy variable

was entered to distinguish the 136 banks in the

sample that had at least 25 percent foreign ownership, it was statistically significant but negative.

26
Cutbacks in Construction Lending

for small banks were similar to the

overall sample results.

It is possible that the influence of

regulators on banks’ construction

lending would be exerted directly in

the form of pressure notto make these

types of loans. Bizer (1993) believes,

alternatively, that the primary channel through which such regulatory

pressure is exerted is by downgrading

the supervisory classification of the

institution that results from an unfavorable bank examination — the summary composite CAMEL rating for

banks. To test for this effect, both the

initial CAMEL rating of the bank and a

dummy variable that took the value of

1 if the institution was downgraded

during the period between 1990:Q1

and 1992:Q3 were included in the

model.12 In general, it might be expected that banks with either a high

initial CAMEL rating or those “downgraded” (poorly-performing institutions) might be reticent about taking

on new construction credits in a

risky real-estate environment. On

the other hand, a positive coefficient

would suggest that a “moral hazard”

problem caused poorly-managed institutions to engage in riskier lending and/or that better-managed

banks chose not to make such loans

given the troubled real-estate environment.

The results are shown in Table 2,

row 3. Both low initial ratings and

“downgradings” in ratings were associated with higher construction lending. These results do not support the

Bizer hypothesis concerning the

dampening effect of examinations on

lending. Of course, in the case of ratings changes, the increase in lending

could have caused the poorer review.

Alternatively, it has been argued

that regulatory enforcement actions

that inhibited construction lending

were triggered by extremely poor

capital positions.13 To test this hypothesis, institutions with capital

deficits or capital that exceeded their

estimated leverage requirement by

one percent or less in early 1990 were

identified. When tested in conjunction with the model as specified, a

dummy variable denoting those

banks did not have a significant effect

on construction lending.

Geographic Demand Factors. To

fully assess the significance of deteriorating financial conditions or regulatory actionsthat might have affected

the availability of credit, account must

be taken of real-estate market conditions that affected the demand for

such loans. Unfortunately, it is impossible to define the geographic market areas for a given period for a given

type of bank loan — primarily because information does not exist on

the extent and location of out-of-area

lending.

Some earlier studies attempted to

address this problem by grouping

statesinto broad regions. In thisstudy

the opposite approach was attempted.

Instead of attempting to match demand indicators to banks, the model

was applied to banks located in the 50

major real-estate markets for which

the best commercial real-estate data

existed. Data from Torto/Wheaton

Research collected by CB Commercial were utilized for office-building

and industrial-building activity, and

from F.W. Dodge for retail markets.

About 2,200 BIF-insured institutions located in the 50 major markets

in 1992:Q3 were studied.

Differential demand for commercial construction loans was measured

by the weighted average percentage

growth in occupied floor space across

three categories of commercialreal estate — office, industrial, and retail —

in each market during the 1990-1992

period. A similar weighted average of

vacancy rates in 1990 also was used to

gauge differential market conditions.14 The percentage change in

newly issued permits for residential

construction was used to measure

geographic differences in demand for

housing construction credit.15

The test results are presented in

Table 3. Results are reported in row

1 for the basic model applied to the

smaller sample; the results were quite

similar to the full sample of all banks

nationwide. When initial construction lending was included, all variables were still significant. However,

the coefficient on the initial capital

position of the bank was larger. The

dummy variables for charter type no

longer were substantially different

from each other. Results are presented in row 2 for the basic model

using dummy variables for initial construction loan holdings to avoid contemporaneous correlation problems.

The importance of initial capital position was enhanced in this specification, but the charter-type dummy

variables were insignificant. All other

variables were barely changed from

the basic results nationwide.

The results of adding the marketspecific real-estate variables are

shown in Table 3, row 3. New construction lending at banks rose more

rapidly in markets in which newly issued permits for residential construction were the strongest. This result

held when it was tested in conjunction with the measures of commercial

activity or when tested alone. Surprisingly, high commercial vacancy

rates and lack of growth in occupied

commercial floorspace across markets

were not associated with cutbacks in

construction lending. Tests isolating

markets with the highest and lowest

vacancy rates and the highest and lowest growth in demand — when tested

separately or in conjunction with one

12 CAMEL ratings are at least partially determined by some of the financial measures

used in the equation. However, the rating presumably also reflects other aspects of a bank’s

performance and, thus, may well have an independent effect.

13 Peek and Rosengren (1993) argue that

regulatory enforcement actions spurred by low

capital were key to cutbacks in lending.

14 Both variables were weighted by the relative importance of the categories of commercial

real estate in new construction in the market in

question during the period under observation.

15 No comprehensive measure of market

disequilibrium in housing markets is available.

Newly issued permits were used as a measure

of differential demand for construction loans.

While permits are usually issued well in advance

of the actual bank construction lending, for a

period as long as that under observation, this

measure runs the risk of simultaneity between

the independent and dependent variables.

27
FDIC Banking Review

Table 3 

Changes in Construction Lending: The Influence of Local Real-Estate Market Conditions 

Lag/Concentration Local Demand Charter Typed 

Troubled Occup. 

Capital Real-Estate Const. Greater Less Comm. Comm. Res. Acquired State, State, 

Constant 

Surplus 

Deficita Avg. 

ROAb Loansa 

(%) 

Loansa

/ 

Assetsc Than 

.10d Than .01d Space (% Chg.) 

Vac. 

Rate 

Permits 

(% Chg.) 

Failed 

Inst. 

Nat. 

Bank 

Fed 

Member 

NonMember Adj. 

R2 

(1) 0.009e +0.05e +0.21e

(0.004) (0.01) (0.03)

(2) -0.009f +0.07e +0.54e

(0.005) (0.01) (0.04)

(3)	 -0.031e +0.07e +0.54e

(0.008) (0.001) (0.04)

-0.13e

(0.02)

-0.23e

(0.02)

-0.25e

(0.02)

a 90:Q1

b 90:Q2-92:Q3

c 92:Q3

d Dummy variables specification

e Significant at 99 percent confidence level

f Significant at 90 percent confidence level

Observations = 2,192

another — were similarly unsuccessful.16

Table 4 presents some sample statistics illustrating the reason underlying the lack of success of the

commercial real-estate variables. It

divides the sample into the highest

and lowest quartiles with respect to

construction loan growth. Banks with

declines in construction lending were

located typically in areas where residential building was declining. The

banks with the highest growth in construction lending were located in metropolitan areas where residential

permits rose 13 percent, on average,

during the 1990-1992 period. In the

case of commercial indicators, however, little difference was apparent

16 Different markets are likely to have different amounts of vacancy space even in market

equilibrium, due to differences in land costs,

varying transportation costs within the region,

and whether the local real-estate market is

growing or shrinking. In an attempt to account

for such differences, excess supply in commercial real-estate markets during the period under

observation was measured as the difference between the average vacancy rate during the 1980­

1990 period and the rate during the first quarter

of 1990. Even in this re-specified form the

variable continued to be statistically significant

with the wrong sign. In addition, lagged vacancy rates were tested in recognition that loans

on the books respond to cutbacks in new construction lending only after existing commitments were funded. This specification did not

improve the results either.

-0.62e — — — — —

(0.01)

— 	 -0.07e +0.007e — — —

(0.004) (0.003)

— 	 -0.06e +0.007e -0.003f +0.002e +0.005e

(0.04) (0.003) (0.002) (0.001) (0.003)

between market trends and bank construction lending.

The lack ofsuccess of the commercial market variables may reflect

specification problems. One explanation is that demand for commercial

construction credit did not increase in

those markets with growing local demand for commercial space and relatively low vacancy rates. These areas

may have had no new construction

because developers continued to be

discouraged by excess supply conditions elsewhere in the country. HowTable 4 

Real-Estate Market Characteristics and Changes 

in Construction Lending 

High Low 

Construction Construction 

Variable Loan Growth Loan Growth All Other 

Observations 535 497 1,159

Mean Change in Construction

Loansa / Assetsb +3.6% -7.9% -0.4%

Mean Percent Change

Occupied Commercial +0.9% 0.8% +0.7%

Floor Space

Composite Commercial 11.2% 10.8% 10.7%

Vacancy Rate

Mean Percent Change in

Newly Issued Residential

Building Permits 13.1% ~1.6% 11.5%

a 90:Q1-92:Q3

b 92:Q3

-0.005f +0.012e +0.012e

(0.003) (0.004) (0.004)

-0.008f +0.005 +0.007

(0.005) (0.005) (0.006)

-0.009† +0.006 +0.008

(0.005) (0.006) (0.006)

+0.012e .68

(0.004)

+0.003 .34

(0.005)

+0.005 .34

(0.006)

ever, this explanation is not borne out

by data available on new commercial

permits. These data show that commercial construction in many areas,

especially the Southwestern states,

rose during the study period.

Another explanation is that banks

were funding primarily residential construction activity, leaving commercial

construction lending to others. Given

the problems that thrifts and insurance companies were experiencing at

that time, this explanation also seems

unlikely. Moreover, data collected by

28
Cutbacks in Construction Lending

HUD on new-construction loan commitments by commercial banks suggest that over 40 percent of total

construction lending during the period under study was for non-residential projects.17

Finally, the underlying problem

may have been that out-of-area lending at many banks may have weakened the link betweenlocal commercial

activity and lending. Non-local lending is more likely with respect to large

commercial projects than with many

residential projects, which are typically smaller in scale. One test of this

hypothesis is to separate large banks

from small ones. Presumably, larger

banks have a broader geographic

reach. However, a variety of testslimiting the sample to banks in three asset-size categories — less than $1

billion, $500 million, and $100 million

— failed to yield significantly different results.

Conclusion 

While the term “credit crunch”

typically refers to a general restriction

of lending, construction loan funding

activity during the 1990-1992 period

varied widely among BIF-insured

commercial and savings banks. Although construction lending declined

sharply at many large institutions, a

large number of smaller institutions

rapidly increased their lending during

the period. The key variables influencing construction lending activity

included capital position, past degree

of concentration in — and success

with — construction lending, and

profitability during the period.

As has been the case in other studies, attempts to isolate the effects of

reduced loan demand on the decline

in construction credit proved difficult.

Differences in the health of local

housing markets were significant in

explaining lending patterns among

depository institutions, but the same

linkage did not hold for commercial

real-estate market conditions. Because

commercial projects are often large

and the funding market more national

in scope, “out-of-area” lending is

probably more importantthan forresidential construction credit. Unfortunately, no data exist on the geographic

pattern of banks’ construction lending. Without that information, it is

impossible to match lending data

with commercial real-estate market

indicators in a meaningful way.

No attempt was made to address

directly the issue of whether regulators “caused” the credit crunch.

Everything else being equal, the various tests showed some differences

among institutions supervised by different regulators, suggesting that policy enforcement may have had a small

effect on lending practices. However,

the evidence did not suggest that adverse changes in supervisory ratings

negatively affected construction lending. Moreover, variablestesting for an

additional negative effect of bank location in New England and for very

weak capital positions, that would

trigger supervisory actions, added little explanatory power. These results

were not consistent with the hypothesisthat unusualregulatory pressure on

weakened institutions in New England during the period may have affected lending in that region in an

important and unique way.

The results suggest that bank

regulators seeking to apply policies

that were aimed to alleviate the

“credit crunch” were faced with a

trade-off. Many institutions were increasing their lending in the 1990­

1992 period. Large banks that had

dominated the construction loan market in the late-1980s and were already

holding considerable volumes of

problem credits cut back the most.

Attempts to maintain the flow of

credit to real-estate developers had to,

by sheer force of numbers, include

these institutions. However, safetyand-soundness considerations suggested that tighter underwriting

standards and less concentration in

construction lending were prudent

steps to maintain — or restore — the

health of the institutions and the deposit insurance funds.

17 See Survey of Mortgage Lending Activity, Table 13, U.S. Department of Housing and Urban

Development,Office ofFinancialManagement,

various issues.

29
FDIC Banking Review

REFERENCES 

Bizer, David S. Regulatory Discretion and the Credit Crunch. (Unpublished Manuscript.) 1993.

Hancock, Diana and Wilcox, James A. Real Estate Lending, Real Estate Loans, and Bank

Capital. Paper presented at the American Urban Economics and Real Estate Association

Meetings, Anaheim, CA, January 1993.

O’Keefe, John P. Profitability in Commercial Banking, 1976-1992. A study prepared for the

Commerce, Consumer and Monetary Affairs Subcommittee of the Committee on Government Operations. U.S. House of Representatives, September 1993.

Peek, Joe and Rosengren, E. “Bank Regulation and the Credit Crunch.” Federal Reserve

Bank of Boston Working Paper, No. 93-2.

30
Recent Developments

Recent Developments

Affecting Depository

Institutions

by Benjamin B. Christopher*

Regulatory Agency Actions sured institution. The invoices for pervision (OTS) issued a joint stateeach quarterly period would be based ment on retail sales of mutual fund

Inter-Agency Actions on the quarterly Report of Condition and other nondeposit investment

Thefederalbankand provided by each financial institution products by federally insured finan- thriftregulatory for the immediately preceding quar­ cial institutions. The statement su­ agencies are engaging in joint or coorditer. persedes the guidance previously nated efforts in a number of regulatory issued by each of the four agencies, areas that are mentioned specifically in Each payment would be made via

and results in the agencies operating thisissueoftheReview, amongwhichare the Automated Clearing House (ACH)

under the same inter-agency state- retail sales of non-deposit investment network in the form of a direct debit

products, savings bank mutual-to-stock initiated by the FDIC. The first quar­ ment for the provision of mutual fund

conversions, depository institution man­ terly payment would be made approxi­ and other investment services. The

agement interlocks, Community Rein­ mately 32 days before the current statement applies to insured deposivestment Act enforcement, prevention semiannual payment date; the second tory institutions selling at retail, either

of discrimination in lending, and ac- quarterlypaymentwouldbemadeabout directly or indirectly, a mutual fund or

counting practices. For full information 60daysafterthecurrentsemiannualpay- other nondeposit investment product.

on the inter-agency actions included in ment date. Banks and thrifts recommending or

this issue, reference is necessary to the selling such products should ensure The FDIC believes that the propages devoted to each of the agencies that customers are fully informed that posed amendments would result in a

and the Federal Financial Institutions more the products: (1) are not FDIC-in­ efficient collection process, and

Examination Council. sured, (2) are not deposits or other would reduce regulatory burden on inobligations of the institution and are sured institutions. The amendments Federal Deposit Insurance not guaranteed by the institution, and also would clarify the obligation of ac- Corporation (3) involve investment risks, including quiring institutions to pay assessments

possible loss of principal. These disclo­ Deposit on deposits assumed from institutions InsuranceAssessments

sures should be conspicuous and pre­ terminating their insured status; and The FDIC will seek comments on woulddelete sented in a clear and concise manner. fromtheassessmentsregu­ issues related to the way deposit insur­ lation the existing references to experiance premiums are calculated and colence factors, which are not available for lected. Currently, each insured

use after 1994. FIL-45-94, FDIC, 6/16/94; FR, institution determines its assessment 6/10, p. 29965.

premiumamountsemiannuallyandsubmits payment to the FDIC. Under the RetailSales ofNondeposit

*Benjamin B. Christopher is a financial proposal, the FDIC would determine InvestmentProducts

economist in the FDIC’s Division of Research

the assessment premium on a quarterly The Office of the Comptroller of the and Statistics.

basis and send four quarterly invoices Currency (OCC), FDIC, the Board of Reference sources: American Banker (AB); (two of which would become the semi- Governors of the Federal Reserve Sys- Wall Street Journal (WSJ); BNA’s Banking Report

annual Certified Statements) to the in­ tem (FRB) and the Office of Thrift Su­ (BBR); and Federal Register (FR).

31
FDIC Banking Review

The agenciessaid thattellersshould

not qualify customers, make specific

recommendations about nondeposit

investments, or accept orders. Among a

number of other things that banks and

thriftsshould do to minimize the possibility of customer confusion are: when

a customer opens an investment account, obtain a signed statement acknowledging that the disclosures have

beenreceivedandunderstood;separate

physically the investment sales areas

from the deposit-taking areas; and ensurethatinvestmentsalespersonnel are

properly qualified and trained. FIL-9-94,

FDIC, 2/17/94; “Inter-Agency Statement on Retail

Sales of Nondeposit Investment Products,” FRB,

FDIC, OCC, OTS, 2/15/94.

SavingsBankMutual-to-Stock

Conversions

The FDIC adopted an interim rule,

effective February 15, 1994, that will

enable the agency to formally review

and, if necessary, prevent unfair or unsafe conversions of FDIC-supervised

savings banks from mutual to stock

form of ownership.

Among the FDIC’s concerns are

that, in some cases, insiders may set the

stock offering price well below the true

value of the institution, or they may

obtainmore thanafairshareofthestock

subscription. Excessive compensation

packages also are of concern. Underthe

interim rule, an FDIC-supervised

state-chartered savings bank must provide the appropriate FDIC regional office with advance notice of its plans to

convert from mutual to stock form as

well as copies of all application and disclosure materials. The FDIC has 60

days from the receipt of a complete

notice to review the conversion plan

before it can be consummated, although the agency can extend the review period for another 60 days. A

proposed conversion could not be

consummated if the FDIC objects

within the allotted time. If the FDIC

notifies the savings bank that it has no

objection to the transaction or if the

FDIC does not respond within the allotted time, the conversion may be

completed. This interim rule departs

from the FDIC’s past practice of suggesting to other federal orstate regulators that modifications be made in a

conversion plan. PR-7-94, FDIC, 2/8/94;

PR-3-94, 1/28; FR, 2/15/94, p. 7194; 2/1/94, p.

4712.

FDIC-insured mutual state-chartered savings banks that are not members of the Federal Reserve System

would be required under a proposed

rule to comply with new substantive

provisionswhenproposingtoconvertto

the stock form of ownership. The proposed requirements are similar to the

OTS’ regulations which were revised

recently. Currently and during the pendency of this proposed rulemaking, the

FDIC will continue to use the case-bycase procedure under the interim rule

(see above) in reviewing notices of proposed conversions of state savings

banks. The proposed rule would require (among other things): the submission of a full appraisal report,

including a complete and detailed description of the elements that make up

an appraisal report and justification for

the methodology employed; a depositor vote on all mutual-to-stock conversions of state savings banks; that stock

options (if any) be granted at no lower

thanthemarketpriceatwhichthestock

is trading at the time of grant; that the

subscription offering provide a reference to eligible depositors and othersin

the bank’s “local community”;the submission of a business plan, including in

part, a detailed discussion of how management intends to deploy the capital

raised through the sale of stock in the

conversion; and a prohibition on stock

repurchases within one year following

the conversion. FR, 6/13/94, p. 30316; FIL39-94, FDIC, 6/13.

Financial Derivatives

FDIC-supervised commercial and

savings banks were notified that the

agency has updated and consolidated

its guidance to examiners and regional

offices regarding the analysis and treatment of financial derivatives, such as

interest-rate swaps, futures and options

contracts. The guidance is applicable

principally to financial institutions that

are “end-users” of derivatives. It focuses on the fundamentalrisks offinancial derivatives and off-balance-sheet

activities, with the expectation that it

will assist examiners in determining

institutions’ potential exposure and in

assessing their risk management practices. FIL-34-94, FDIC, 5/18/94.

BIF Reaches $15.2Billion

The Bank Insurance Fund (BIF) totaled $15.2 billion (unaudited) onMarch

31, 1994, continuing its strong growth

from $13.1 billion at year-end 1993,from

a negative $101 million at the end of

1992, and a negative $6.8 billion in 1991.

TheBIF’srecovery to dateprimarily has

reflected improved underwriting income resulting from greatly reduced

numbers of bank failures(no failures occurred in the first quarter) a drop in the

estimated cost of banks expected to fail

in future periods, and the Corporation’s

cost-control efforts. In 1993, gross revenue to the BIF totaled $6.4 billion (unaudited), including approximately $5.8

billion from assessments, $0.2 billion

from interest on U.S. Treasury obligations, and $0.4billionfromothersources.

Provision for loan losses was a negative

$7.7 billion, and other expenses were

$0.9 billion, resulting in net income of

$13.2 billion to the BIF.

TheratiooftheBIFtoinsureddeposits stood at 0.80 percent at March 31,

1994, up from 0.70 percent at year-end

1993. The FDIC said in its quarterly

statement that the BIF may reach the

recapitalization goal of 1.25 percent as

early as 1996.

The Savings Association Insurance

Fund (SAIF) had net income of $262

millioninthefirstquarterof1994, andon

March 31 the SAIF totaled $1.4 billion

(unaudited), or 0.20 percent of insured

deposits. Revenue to the SAIF in 1993

was $923 million, of which $898 million

was assessments earned. Expenses and

losses for the year amounted to $46 million. The net income of $877 million

increased the balance ofthe SAIFto just

under $1.2 billion at year-end. Financial

Reports, FDIC.

Bank Failures Continue to
 

Decline
 

Eight FDIC-insured banks, with

assets totaling $844.7 million, have

32
Recent Developments

failed in 1994 through July 15, continuing the declining trend in bank

failures. The banks were located in

California (4), Connecticut (2), Massachusetts and Missouri. In 1993,

there were 42 failures of insured institutions, twenty of which were located

in California and ten in Texas.

The number of commercial banks

on the FDIC’s “Problem List” fell for

the ninth consecutive quarter, to 383

as of March 31, 1994, and their assets

declined for the eighth straight quarter, to $53 billion. A year earlier, there

were 671 “problem” banks, with assets amounting to $377 billion. “Problem” savings institutions totaled 118

as of March 31, 1994, representing

5.3 percent of savings institutions in

operation, and their assets were $89

billion, or 8.9 percent of savings institutions’ assets. FDIC Quarterly Banking

Profile, FDIC, Recent Issues; and FDIC Office of

Corporate Communications.

Management Official Interlocks

The FDIC proposed to amend its

regulations that implement the Depository Institution Management Interlocks Act as part of a joint initiative

by the federal bank and thrift regulatory agencies. The Act generally prohibits certain management official

interlocks between unaffiliated depository institutions, depository holding companies, and their affiliates.

The proposal would create limited exemptions to the prohibition on management official interlocks between

certain depository organizations located in the same community or “relevant metropolitan statistical area”

(RMSA). Such interlocks would be

permitted between institutions that

together control only a small percentage of the total deposits in the community or RMSA. FR, 4/20/94, p. 18764;

6/9, p. 29740.

Activities of State-Chartered

Banks and Subsidiaries

The FDIC approved final rules

implementing statutory restrictions

on the activities of insured state banks

and their majority-owned subsidiaries. The new rules were to go into

effect when published in the Federal

Register.

With certain exceptions, the Federal Deposit Insurance Corporation

Improvement Act of 1991 (FDICIA)

prohibits state banks and their majority-owned subsidiaries from conducting activities “as principal” that are

not permitted for national banks.

The bank may, however, engage in an

otherwise prohibited activity if it

meets its minimum capital requirements and the FDIC determines that

the activity does not present a significant risk to the deposit insurance

funds. Under the final rules:

(a) The term “as principal” is defined to exclude agency activities.

Thus, a state bank can, without prior

FDIC consent, operate insurance

agencies, securities brokerage firms,

real-estate agencies, travel agencies,

financial planning services and certain

other agencies if authorized by state

law.

(b) Activities are listed that do not

present a significant risk to the insurance funds and therefore are permissible. Among the activities are those

defined by the FRB as “closely related to banking.”

(c) Application procedures are described for an institution seeking

FDIC consent to continue or begin an

otherwise prohibited activity.

In a related action, state banks that

are members of the SAIF are put under the same restrictions on corporate

activities that apply to BIF-insured

banks. PR-133-93, FDIC, 11/30/93; FR,

12/8/93, pp. 64460, 64462.

Activities and Investments of

State Savings Associations

The FDIC is amending its regulations concerning applications and notices by savings associations. The

amendments conform the definitions

of “significant risk” and “equity security” to other definitions of those

terms in the FDIC’s regulations, and

allow insured state savings associations to conduct activities and make

investments without the FDIC’s

prior approval provided that the activities and/or investments were

found to be permissible for federal

savings associations under an order or

a written interpretation issued by the

OTS. This change also places insured state savings associations on a

par with the treatment accorded insured state banks under the FDIC’s

regulations. The final amendment is

effective December 8, 1993. FR, 12/8/

93, p. 64455.

Receivership Rules:
 

Least-Cost Resolution
 

The FDIC adopted a regulation

required by FDICIA on the least-cost

resolution of failed and failing depository institutionsinsured by theFDIC.

The final rule adds a new Section to

the FDIC’s regulations stating the

prohibition in Section 13(c) of the

FDI Act on taking any action under

thatsection that would have the effect

of increasing losses to any insurance

fund by protecting uninsured depositors or nondepositor creditors of a

failed or failing depository institution.

In addition, the final rule references

the systemic-risk exception to the

prohibition. The final rule also includes the provision of 13(c) which

makes clear that the FDIC is not prohibited from engaging in purchaseand-assumption transactions under

which uninsured deposits may be acquired so long as the loss to the insurance fund on those uninsured

deposits is less than if the institution

had been liquidated and the insured

deposits were paid. The regulation is

effective January 21, 1994. FR, 12/22/93,

p. 67662.

CrossLand Sale Satisfied
 

Least-Cost Mandate
 

A report by the U.S. General Accounting Office (GAO) concludes

that the FDIC’s resolution of the

CrossLand Federal Savings Bank of

Brooklyn, New York, in August 1993,

was in compliance with the least-cost

calculation and documentation requirements of Section 13(c) of the

FDI Act, as amended by FDICIA,

and criteria contained in an earlier report of GAO in July 1992.

CrossLand experienced substantial losses from 1989 through 1991,

resulting from the weak New York

33
FDIC Banking Review

real-estate market and the bank’s concentration in real-estate development

lending. CrossLand’s efforts to replenish its capital as required by its

primary regulator, the OTS, were unsuccessful. The bank, which had $8.7

billion in assets as of December 1991,

was declared insolvent by the OTS on

January 24, 1992.

The FDIC isrequired by statute to

resolve a failed bank in a manner least

costly to the BIF. Immediately upon

CrossLand being declared insolvent,

the FDIC placed the bank in conservatorship, and injected $1.2 billion in

cash to restore capital to the required

level and to strengthen the bank by

reducing its high-cost debt. The

FDIC also hired a chief executive officer to manage CrossLand in conservatorship and approved a business

plan that was designed to return the

bank to operating profitability by

downsizing and stabilizing it. After

considering various alternativesforresolving the conservatorship, inAugust

1993 the FDIC sold the conservatorship — by then the assets were down

to $5.2 billion — through a public

offering.

The report said the process the

FDIC used for the 1993 decision was

well-documented and adequately

supported with cost estimatesfor each

alternative, and that there was much

improvement over the 1992 processin

establishing a conservatorship. In addition, the GAO found no evidence of

significant problems with the management and control of CrossLand

during its operation under FDIC conservatorship. FDIC Sale of CrossLand Conservatorship Satisfied Least-Cost Test, U.S. General

Accounting Office, April 1994.

The FDIC estimated the losses to

the BIF from the CrossLand resolution, as of December 31, 1993, to be

$784.8 million. PR-20-94, FDIC, 3/30/94.

Assistance for Areas Affected by

Earthquake

The FDIC announced a series of

steps to assist the rebuilding in the

area damaged by the earthquake in

Southern California. Guidelines that

the FDIC will send to the banks it

supervises suggest that extending repayment terms, restructuring existing

loans or easing terms for new loans, if

done in a manner consistent with

sound banking practices, can both

contribute to the health of the community and serve the long-term interests of the lending institution. Other

regulatory relief actions include a

temporary waiver of certain real-estate appraisal regulations for the affected areas, and temporary relief

from certain capitalrequirementsif an

already adequately capitalized bank

finds its asset levels increasing due

solely to deposits of insurance proceeds or government assistance funds.

PR-4-94, FDIC, 1/25/94; FDIC Statement,

1/25/94.

See also “Real Estate Appraisal

Exceptions in Major Disaster Areas,”

FR, 2/11/94, p. 6531; OCC, FRB,

FDIC, OTS, and NCUA, reporting

actions pursuant to Section 2 of the

Depository Institutions Disaster Relief Act of 1992 (DIDRA), which

authorizes the federal financial institution regulatory agenciesto make exceptions to statutory and regulatory

requirementsrelating to appraisalsfor

certain transactions.

Treasury Study of Depository

Institutions Disaster Relief

The Department of the Treasury,

in consultation with the federal bank

regulatory agencies, is conducting,

and requesting comments on, a study

of the effectiveness of the federal

banking agencies’ response to recent

disasters. Pursuant to Section 5 of

DIDRA, the study group intends to

complete the study by February 12,

1995, and will submit to Congress a

final report including recommendations for administrative or legislative

action. FR, 6/29/94, p. 33574.

Alternative Dispute Resolution

The FDIC adopted a Statement of

Policy to further its commitment to the

use of Alternative Dispute Resolution

(ADR) for resolving appropriate disputesin a more timely, less-costly manner than litigation or administrative

adjudication. The Statement reiterates the agency’s support of the costeffective use of ADR, including

negotiation, mediation, early neutral

evaluation, neutral expert fact-finding, mini-trials and other hybrid forms

of ADR in appropriate instances; it

does not favor the use of binding arbitration other than as set forth in the

Administration Dispute Resolution

Act of 1990. An ADR Task Force has

been created to design, implement

and coordinate ADR efforts across the

Corporation, and to develop strategies

for educating employees and disputants about ADR options. FR, 3/30/94,

p. 14860.

Establishment and Relocation of

Remote Service Facilities

The FDIC proposed revising its

application and publication requirements for the establishment and relocation of remote service facilities

(RSF), in order to lessen the regulatory burden on state nonmember

banks and state-licensed branches of

foreign banks. Currently, banks desiring to establish an initial RSF must

comply with the requirements in

these respects that are applicable to

the establishment of a “brick and mortar” branch office, while successive

RSFs may be established or relocated

without a formal application. There is

no differentiation based upon the

condition of the applying institution.

The proposal provides that an institution whose most recent Community Reinvestment Act (CRA) rating

is Satisfactory or better may establish

and operate or relocate an RSF by

filing a letter with the appropriate

FDIC regional director containing

certain specified information. Unless

the institution is notified otherwise by

the FDIC within seven days of receipt of the letter, the institution may

establish or relocate the RSF. Existing public notice requirements would

be dispensed with in this case. Other

requirements would apply to an institution not having a CRA rating of Satisfactory or better, including that they

comply with existing notice requirements. Unless the institution is noti34
Recent Developments

fied otherwise within 15 days after

processing of its information letter,

the institution could establish or relocate the RSF. Should a protest be

filed or other objection taken, the institution could not proceed until the

FDIC provides a written notice of approval. FR, 4/26/94, p. 21676.

Disclosure Regarding Deposit

Insurance Coverage

The FDIC proposed that plan administrators of certain retirement and

other employee benefit accounts be

provided timely disclosures about

whether their funds qualify for “passthrough” deposit insurance coverage.

In general, “pass-through” insurance

means that each participant in the account rather than the total account balance, is individually insured up to

$100,000. Under a 1991 law and the

FDIC’s implementing regulations, depositors in certain retirement and other

employee benefit plan accounts are entitled to “pass-through” deposit insurance coverage based, in part, on

whetherthe insuredinstitutionsatisfies

certain capital standards.

Among the types of accounts affected by the proposed rule are 401(k)

retirement accounts, Keogh plan accounts, and corporate pension plan and

profit-sharing plan accounts. Situations

in which an employee benefit plan administrator would receive a notice indicating an institution’s “prompt

corrective action” (PCA) category, and

whether employee benefit plan deposits at the institution would qualify for

“pass-through” insurance coverage, include: (1) when an existing or prospective employee benefit plan depositor

requests the information; (2) when

someone opens an employee benefit

plan account; (3) when the institution

has been informed that its capital category has been reduced to “adequately

capitalized” from “well-capitalized”;

and (4) when the institution’s capital

category has been reduced to a PCA

capital category below “adequately

capitalized,” thus eliminating “passthrough” insurance coverage on additional deposits.

Also, upon request, existing and

prospective employee benefit plan depositors would receive more-detailed

information about the institution’s actual capital ratios. With the exception

of immediate disclosures to depositors of new accounts, the notices

would be provided within two business days. PR-132-93, FDIC, 11/30/93; FR,

12/8/93, p. 64521.

Allowance for Loan and Lease

Losses

The FDIC adopted a Statement of

Policy on allowance for loan and lease

losses (ALLL) as recommended to

the four federal regulators of banks

and saving associations by the

FFIEC. The statement provides

comprehensive guidance on the

maintenance of an adequate ALLL

and an effective loan review system.

It is another step by the agencies to

promote consistency in supervisory

policies among banks and thrifts.

The guidance, which is effective

immediately, explainsthat the ALLL

is designed to absorb estimated credit

losses associated with the loan and

lease portfolio, including binding

commitments to lend. To the extent

not provided for in a separate liability

account, the ALLL should also be

sufficient to absorb estimated credit

losses associated with off-balancesheet credit instruments such as

standby letters of credit. The statement coversthe responsibilities ofthe

board of directors, the institution’s

management, and the examiners.

FIL-89-93, FDIC, 12/21/93; “Inter-Agency Policy

Statement on the Allowance for Loan and Lease

Losses (ALLL),” OCC, FDIC, FRB, OTS, 12/21.

Proposal to Recognize Holding

Gains and Lossesin Tier 1

Capital

The FDIC issued for comment a

proposal to conform its capital definitions for Part 325 leverage and riskbased capital purposes with the

recently issued FASB Statement of Financial Accounting Standards No. 115.

This new accounting standard requires

banks to recognize, as a separate component of stockholders’ equity, the

amount of net unrealized holding gains

and losses on securities held as “available for sale.”

The FFIEC notified all banks in

September that they must adopt the

new FASB 115 accounting standard as

of January 1, 1994, or the beginning of

their first fiscal year thereafter, if later.

Early adoption of this standard is also

permitted for Call Report purposes to

the extent allowable under FASB 115.

The proposed changes would require

institutions to include the FASB 115

capital component for “available for

sale” securities when calculating Tier 1

capitalfor leverage and risk-based capital purposes. The FDIC invited comments on several specific questions.

The proposed capital rule is similar to

rules being developed by the OCC,

FRB, and OTS. FIL-1-94, FDIC, 1/4/94;

FR, 12/29/93, p. 68781; PR-137-93, FDIC,

12/14/93; FR, 4/18/94, p. 18328.

Affordable Housing Pilot
 

Program
 

The FDIC announced a pilot effort

with the Federal National Mortgage

Association that will allow mortgage

lenders to offer favorable financing to

buyers of FDIC Affordable Housing

properties. This pilot program, focusing on propertiesin Massachusetts,furthers the FDIC’s goal to make

residential properties retained from

failed financial institutions available to

low- and moderate-income purchasers.

The FDIC, Fannie Mae and the MassachusettsBankersAssociationhave initiated programs to encourage lending

institutions to participate in this joint

effort. Eligible purchasers can receive a

ten percent credit or grant toward the

purchase of FDIC properties. The

FDICpropertiesmaybepurchasedunder various arrangementsin respect to

the down payment and the payment

of closing costs, with loan-to-value ratios ranging from 85 percent to 95

percent.PR-6-94, FDIC, 2/8/94.

Policy onRisk-BasedCapital:

MultifamilyHousingLoans

Section 618 of the Resolution Trust

Corporation Refinancing, Restructuring, and Improvement Act of 1991

(RTCRRIA) requires the FRB,

FDIC, OCC and OTS to accord a 50

percent risk-weight to multifamily

mortgage loans and related mortgage35
FDIC Banking Review

backed securities meeting certain

specified criteria and gives the agencies discretion to add other prudential

safeguards.

The FDIC amended its risk-based

capital guidelines, effective January

27, 1994, to assign a 50 percent riskweight to loans secured by multifamily residential properties that meet

certain conditions and to any securities collateralized by such loans. At

present, these loans are assigned to

the 100 percent risk-weight category.

The rule should facilitate prudent

lending for multifamily housing purposes. FR, 1/27/94, p. 3779; 3/18, p. 12806.

Securities Disclosure

Section 12 of the Securities Exchange Act of 1934 requires that the

FDIC issue regulations substantially

similar to those of the Securities and

Exchange Commission or publish its

reasons for not doing so. The FDIC

proposed to make itssecurities disclosure requirements for banks with a

class of securities registered under

Section 12 substantially similar to

those of the SEC in regard to: (1)

disclosures of executive compensation; (2) disclosure requirements for

small banks; and (3) proxies and related communications among shareholders. Comment is sought also on

whether the agency should incorporate in its regulations by cross-reference the comparable SEC rules, or

continue to maintain the separate but

substantially similar body of rules.

FIL-36-94, FDIC, 5/20/94; FR, 5/2, p. 22555.

Proposal to Eliminate Planned

Growth Reports

The FDIC proposed to rescind its

regulations that require all insured

banks, exceptinsured bankers’ banks,

to give prior notice of planned rapid

growth that involves the solicitation

and acceptance of fully insured deposits obtained from or through brokers or affiliates, the solicitation of

fully insured deposits outside a bank’s

normal trade area, or secured borrowings, including repurchase agreements. The proposed rescission

would lessen the regulatory burden

on banks that are currently required

also to comply with the FDIC’s brokered deposit regulation and the

prompt corrective action rule, both of

which were designed in part to address the same risks resulting from

rapid growth. FR, 4/5/94, p. 15869.

Finesfor Violations of

Mortgage Disclosure Law

The FDIC has started to impose

fines against lending institutions for

late or inaccurate submissions of data

used by federal regulatorsto check for

possible mortgage loan discrimination. The agency has fined six lenders, in amountsranging from $2,000 to

$4,000, for late submissions of 1992

and 1993 data required by the Home

Mortgage Disclosure Act (HMDA).

Data are required by March 1 each

year from most lenders on their loans

for home purchases, home improvement and refinancing, including the

race, gender, income and property location of the loans and loan applications. Data for each institution and

nationwide aggregate reports are

made publicly available by the agencies. HMDA data for 1992 have been

publicly available since October 1993,

and the 1993 data reports are being

processed for public release later this

year. The FDIC supervises more

than 3,200 of the 9,649 lendersreporting 1993 data. PR-39-94, FDIC, 6/17/94.

Court Rules Against FDIC
 

on Suit Against Bank
 

Officials
 

The U.S. Supreme Court ruled unanimously thatstate law and not federal law governed the conduct of

lawyers representing a failed California thrift. In a Texas case, the Court

declined to review a decision that

held that federal law does not take

precedence overstate statutes of limitation for suing bank directors or officers for wrongdoing. The two

decisions may place at risk an estimated $3 billion in FDIC and RTC

claims.

In a recent article authored by

FDIC Acting Chairman Andrew C.

Hove,Jr., he expressed strong support

for pending federal legislation that

would allow federal regulators to sue

for wrongdoing committed up to five

years before the date of a banking

institution’s failure. The Washington Post,

6/14/94; The New York Times, 7/15/94.

Report on the Savings
 

Association Insurance
 

Fund (SAIF)
 

The Savings Association Insurance

Fund Industry Advisory Committee,

which was established by Congress in

1989, has recommended that the

SAIF and the BIF be merged “assoon

as possible.” The FDIC administers

SAIF, which was created by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989

(FIRREA) to insure savings institutions, replacing the former Federal

Savings and Loan Insurance Corporation (FSLIC).

The Committee’s report states

that if $8 billion in funds authorized

for SAIF by the RTC Completion Act

of 1993 are actually appropriated

when needed, it will at best avoid a

short-term crisis if loss funds are

needed by SAIF. Funds “authorized

and arguably mandated” by FIRREA

have never been provided by the

Treasury.

Among the report’s conclusions are

that an assessment rate disparity between the BIF and SAIF of 13 to 20

basis points likely will occur approximately in 1996, rising to 18 to 20 basis

pointsin 1997. Thisrate disparity will

adversely impact the ability of SAIFinsured institutions to raise capital,

and will result in a pronounced

shrinkage in the SAIF-insured deposits base. A shrinking deposit base,

combined with SAIF’s fixed obligation to pay approximately $770 million per year in interest on Financing

Corporation (FICO) bonds, will reduce available funds to cover future

losses and expenses. FICO was created by the Competitive Equality

Banking Act of 1987 to issue bonds to

recapitalize the FSLIC. Unless the

SAIF is fundamentally restructured,

the report said, it cannot survive, and

the only solution that realistically can

36
Recent Developments

avoid further costs to the taxpayers is

a merger of the two funds. The resulting fund would achieve the statutorily mandated 1.25 percent reserve

ratio in 1997, only one year later than

currently projected for the BIF. By

1998, the assessment rate for all insured institutions would be reduced

to a range of six to nine basis points,

on the assumption of a continuation of

the FICO interest obligation. Report of

the Savings Association Insurance Fund Industry

Advisory Committee, March 1994.

Real-Estate Recovery
 

Is Broadening
 

A substantial improvement in realestate markets across the nation occurred for the second quarter in a row,

according to a survey of real-estate

trends conducted by the FDIC in late

April. The composite index that

measures change in all types of realestate markets rose to 78, up from 73

in the quarter ending in January and

67 in October 1993.

Values of the index above 50 indicate that more respondents believed

conditions were improving than declining, compared to the previous

quarter, while values below 50 indicate the opposite. The surveys,

which began in April 1991, are based

on interviews across the country with

more than 450 senior examiners and

asset managers at federal bank and

thrift regulatory agencies.

Improvement wasreported nationwide in both local housing markets

and in local commercial real estate.

Almost 70 percent of the respondents

saw a strengthening of local housing

markets in the three months ending

in April, while only three percent reported weaker conditions. The improvement in commercial real estate

— almost one half of the respondents

reported improvement and only two

percent saw worsening markets —

was particularly encouraging.

Recovery in regional real-estate

markets was most widespread in the

South, and wasstrong also in the Midwest, continuing the relatively favorable assessments received from these

regions in previous surveys. In California, stable market conditions were

reported by two-thirds of the respondentsfor commercial real estate in the

quarter, though it should be noted

that the 23 percent seeing better conditions in the state was more than

double the ten percent reporting

weaker markets. In January, only one

respondent saw improvement. In

housing markets, 43 percent of California respondents in April believed

markets were better, up from 29 percent in the preceding quarter. In the

West outside of California, stronger

conditions in commercial real-estate

markets were reported by two-thirds

of the respondents, and in housing

markets by three-fourths of respondents. The broadening recovery extended also to the Northeast, where

74 percent of those interviewed saw

improvement in housing markets, up

from 54 percent in January, and 42

percent reported better commercial

real-estate markets, rising from 33

percent in January.

Another positive development was

that for the third consecutive quarter

there was distinct progress nationwide in reducing excessinventories of

commercial real estate. During the

first two years of the survey, not much

reduction was reported. While 65

percent of the respondents in April

still reported an excesssupply in commercial real estate, the figure was

down from 72 percent in January and

82 percent in July 1993. California

lagged here also with 94 percent reporting excessinventoriesin April. In

residential real estate nationally, excess supply conditions were reported

by 29 percent of the respondents, declining from 33 percent in January.

Further evidence of improvement in

housing markets was that 18 percent

of those reporting nationally, and 33

percent in the Midwest, saw “tight”

supply conditions. Survey of Real Estate

Trends, FDIC, April 1994.

Newsletter on Consumer Issues

The FDIC introduced FDIC Consumer News, a quarterly, free newsletter that presents information of

interest to bank customers. The first

issue features a report to help consumers avoid costly mistakes under

the insurance rules, noting the

FDIC’s concerns about the large

number of depositors with funds over

the $100,000 insurance limit, and the

increased number of depositors’ complaints that bank personnel gave them

wrong information about their coverage. The report discusses the new deposit insurance rules that took effect

December 19, 1993. Othertopicsinthe

first issue include federal efforts to

increase lending to low- and moderate-income neighborhoods,newdisclosures for deposit accounts and mutual

funds sold by banks, and a new consumer protection law on unclaimed

funds.

Each issue of the newsletter also

will include the addresses and phone

numbers of the various government

agencies where consumers can get information or other help regarding their

rights under the banking laws. PR-131­

93, FDIC, 11/22/93.

Resolution Trust Corporation

Operations Update

The RTC resolved eight institutions in June, bringing the total

number of resolutionsto 726 since the

inception of the agency in 1989. As of

June 30, 1994, the RTC had 18 institutions remaining in its conservatorship program, all of which are

expected to be resolved by the end of

the third quarter of the year.

Assets under RTC management,

including both conservatorships and

receiverships, amounted to $48 billion at the end of May. The 25 conservatorships held about $16 billion in

gross assets on May 31, 1994. Cash

and securities were 31 percent of

these assets; performing 1-4 family

mortgages, 22 percent; other performing loans, 17 percent; delinquent

loans,seven percent; real estate,three

percent; investments in subsidiaries,

ten percent; and other assets, ten percent. Assets in receivership remaining from the 718 institutions closed by

the RTC amounted to $32 billion on

May 31 (excluding approximately $11

billion in cash, liquid investments,

and accounts receivable accumulated

from receivership collections). Because

37
FDIC Banking Review

many of the relatively marketable assets have been sold before an institution enters a receivership, most of the

assets retained by the RTC in receivership consisted of lower-quality,

less-marketable assets. Thus, real estate and delinquent loansrepresented

40 percent of receivership assets.

Cash, securities, and performing 1-4

family mortgages represented only 18

percent of receivership assets.

From inception through May, the

RTC collected $150 billion from securities, $101 billion from 1-4 family

mortgages, $52 billion from other

mortgages, $29 billion from non-mortgage loans, $16 billion from real estate, and $20 billion from other assets.

Book value asset reductions were

$413 billion, and the RTC recovered

89 percent ($367 billion) on these collections. The RTC has recovered 98

percent from securities, 97 percent

from 1-4 family mortgages, 78 percent

from other mortgages, 90 percent

from non-mortgage loans, 56 percent

from real estate, and 69 percent from

other assets. The RTC also has collected $18.1 billion in receivership income.

As of the end of June 1994, RTC

resolutions had protected 24.1 million

deposit accounts from financial loss.

These accounts had an average account balance of $9,000. The thrifts

closed from the RTC’s inception

through May 31 held $228 billion in

assets at the time of closure. Of this

total, $49 billion, or 21 percent, were

sold to acquirers (after taking into account assets returned to the RTC under put-back provisions of resolution

transactions). Estimated resolution

costs for the 718 closed thrifts totaled

$84.5 billion. This amount represented 32 percent of their total liabilities at the time of resolution. If the

insured deposits of all 718 institutions

had been paid out to depositors, the

estimated resolution costs would have

been $88.4 billion. The $3.9 billion

difference represented the estimated

savings, or premiums, over insureddeposit payout costs. These savings

were equal to two percent of core deposits, represented by deposits with

balances below $80,000.

Since its inception through May

31, 1994, the RTC has obtained $118

billion in funding from external

sources as follows: $50 billion in appropriations under FIRREA, $41 billion in loss funds authorized by 1991

Acts of Congress, and $27 billion in

Federal Financing Bank (FFB) borrowings. The RTC also has obtained

$105 billion in recoveries from receiverships. The RTC Completion Act,

enacted into law on December 17,

1993, authorized the Treasury to provide the RTC with up to $18.3 billion

in loss funds. RTC Review, July 1994.

Improved Returnsin
 

Nonperforming
 

Loan Auction
 

The RTC’s fourth National Nonperforming Loan Auction, held in

Kansas City, Missouri, in April 1994,

provided the highest return the RTC

has received in these auctions, an average of 60 cents per dollar of book

value, compared to 50 cents in the

August 1993 auction. The improvement in recovery is credited to offering smaller-sized, geographically

localized loan packages. An official

said higher returns were obtained by

stratifying loan pools by state, city and

zip code. RTC Investor, June 1994.

Defining a Minority
 

Neighborhood
 

The RTC adopted, and requested

comments on an interim rule that defines “predominantly minority neighborhood” under Section 21 of the

Federal Home Loan Bank Act, as

amended. The interim rule is effective February 24, 1994. Section 21

requires, among other things, that in

considering offers to acquire any insured depository institution, or any

branch of an insured depository institution, located in a predominantly minority neighborhood, the RTC will

give preference to an offer from any

minority individual or minorityowned business, including depository

institutions, over any other offer that

results in the same cost to the Corporation. Section 21 permitsthe RTC to

lease to a minority acquiror, on a rentfree basis, subject to certain conditions, any branch of a failed institution

which is located in a “predominantly

minority neighborhood,” and authorizes the RTC to provide additional

preferences in the form of capital assistance and performing assets. The

interim rule generally defines “predominantly minority neighborhood”

as any U.S. Postal Zip Code geographical area in which 50 percent or

more of the persons residing there are

minorities based upon the most recent Census data. FR, 2/24/94, p. 8842.

“Gross Negligence” Ruled

Necessary to Convict

Directors of Federal Thrifts

The U.S. Court of Appeals in Chicago ruled that the RTC must prove

“gross negligence,” rather than “simple negligence,” to convict 13 former

directors and officers of Concordia

Federal Savings and Loan Association, which failed in 1990. The Court

said that FIRREA established a national gross negligence standard for

directors and officers at nationally

chartered institutions. The Court did

not rule on whether this national

standard preempts state laws. This is

the first such “negligence” case at the

circuit court level to involve a federally chartered institution. Directors of

state-chartered institutions have lost

two cases in two other circuits. AB, 11/

15/93, p. 2.

Court Rules on RTC’s Power to

Subpoena Information

In a case involving officials of two

failed savings institutions, Trustbank

Savings, McLean, VA, and American

Pioneer Savings Bank, Orlando, FL, a

federal appeals court limited the

RTC’s power to issue subpoenas for

personal financial information to persons that the RTC may reasonably

suspect may be liable for the institution’s failure. Personal financial information to determine a potential

defendant’s liability in a savings and

loan failure can be subpoenaed, as can

information necessary to identify attachable assets, or to establish evidence of illegal asset transfersto avoid

restitution payments to the RTC. The

agency cannot subpoena personal

38
Recent Developments

financial information from officials of

failed thrifts for the purpose of deciding whether to sue them. WSJ, 3/23/94,

p. B8; AB, 3/23, p. 3.

Affordable Housing
 

Accomplishments
 

A report on the RTC’s Affordable

Housing Disposition Program shows

that through November 30, 1993,

78,000 dwelling units had been sold

for $1.2 billion. These units consisted

of about 23,900 single-family units,

and 54,100 multifamily units of which

22,500 were solely for low- and very

low-income tenants. Purchasers of

the single-family homes had incomes

averaging approximately $21,900, or

61 percent of the national median income, and they paid an average price

of about $27,400. According to a recent survey of buyers at nationwide

auctions, 40 percent were minorities,

74 percent were first-time buyers, and

13 percent were veterans.

The RTC realized 74 percent of

appraised value for both single-family

and multifamily properties, with an

overall return of 65 percent of book

value. The Silver Lining, RTC, Fall/Winter

1993, p. 10.

Federal Reserve Board

Extensions of Credit by
 

Federal Reserve Banks
 

The FRB adopted amendments,

effective January 30, 1994, to its

Regulation A to implement Section

142 of FDICIA regarding limits on

Federal Reserve Bank credit. Under

Section 142, after December 19, 1993,

the FRB may be financially liable to

the FDIC for certain losses incurred

by the insurance funds administered

by the FDIC. The amendment was

intended to discourage advances to

undercapitalized and critically undercapitalized insured depository institutions, due to a concern that such

advances could lead to increased

losses to the insurance funds.

Among the principal substantive

changes were: placing limitations on

Federal Reserve Bank credit to undercapitalized and critically undercapitalized insured depository

institutions; clarifying the term viable, as it applies to an undercapitalized insured depository institution;

and providing for assessments on the

Federal Reserve Banks for amounts

that the FRB may be required to pay

the FDIC under Section 142. The

final rule provides that a Federal Reserve Bank may make or have outstanding advances to or discounts for

a depository institution that it knows

to be an undercapitalized insured depository institution only: (1) if, in any

120-day period, the advances or discounts are not outstanding for more

than 60 days during which the institution is undercapitalized; (2) during

the 60 days after the receipt of a written certification of viability from the

Chairman of the FRB or the head of

the appropriate federal banking

agency; or (3) after consultation with

the FRB. A Federal Reserve Bank

may make or have outstanding advances to or discounts for an institution that it knows to be a critically

undercapitalized insured depository

institution only during the five-day

period beginning on the date the institution became critically undercapitalized or after consultation with the

FRB. Press Release, FRB, 12/16/93; FR, 12/28,

p. 68509.

Capital Requirementsfor
 

Recourse Arrangements
 

The FRB, OCC, FDIC and OTS

proposed revisions to their risk-based

capital standards regarding regulatory

capital treatment of recourse arrangements and direct credit substitutes

that expose banks, bank holding companies, and thrifts to credit risk. The

joint proposal was developed under

the auspices of the FFIEC. The proposal would allow banks and bank

holding companies to maintain lower

amounts of capital against low-level

recourse transactions. Higher

amounts of risk-based capital would

be required against certain direct

credit substitutes including, for banking organizations, purchased servicing

rights that provide loss protection to

the owners of the loans serviced, and

purchased subordinated intereststhat

absorb the first dollars of losses from

the underlying assets, and, for both

banking organizations and thrifts, certain guarantee-type arrangements

(such as standby letters of credit) provided for third-party assets that absorb the first dollars of losses from

those assets. The OTS is proposing

to change its existing capital regulations only in respect to the capital

requirements for the treatment of

guarantee-type arrangements that absorb first-dollar losses.

In addition, the agencies are publishing a preliminary proposal to use

credit ratings to match the risk-based

capital assessment more closely to an

institution’srelative risk of lossin certain asset securitizations. Press Release,

FRB, 5/25/94; FIL-37-94, FDIC, 5/31; FR,

5/25, p. 27116.

Community Reinvestment Act

The FRB, OCC, FDIC, and OTS

proposed revising their regulations

concerning the Community Reinvestment Act (CRA). The proposed

procedures are designed to emphasize performance rather than process,

to promote consistency in assessments, to permit effective enforcement against institutions with poor

performance, and to reduce unnecessary compliance burden while stimulating improved performance.

The inter-agency proposal would

replace 12 subjective factors now being used to assess an institution’s

CRA performance with three “tests”

using objective, performance-based

standards in the following areas: (1)

lending test: the bank or thrift would

be evaluated on loans made to lowand moderate-income areas as well as

other areas; (2) service test: the institution’s branch locations, their accessibility to low- and moderate-income

areas, and the availability of credit and

other services would be reviewed; (3)

investment test: this analysis would

cover investment in community development programsthat benefit lowand moderate-income areas. The

three tests would apply differently to

different types of institutions; for example, relatively large institutions

(generally those with assets of $250

million or more) would be evaluated

39
FDIC Banking Review

on additional information not now reported regarding the geographic distribution of their consumer, smallbusiness and small-farm loan applications, denials and originations.

Smaller institutions would be evaluated under a streamlined method that

would not include additional data on

the geographic distribution of loans.

As an alternative to the three tests,

each institution could submit a strategic plan that includes measurable

goals for meeting its CRA obligations.

The strategic plan would be open to

public comment and would be subject

to regulatory approval. If the institution failed to meet the goals set forth

in its approved plan, its performance

would be evaluated under the applicable tests or standards described

above. FR, 12/21/93, p. 67466; 2/3/94, p. 5138;

PR-135-93, FDIC, 12/9/93.

Truth in Savings

The FRB is publishing for comment a proposed official staff commentary to its Regulation DD. The

commentary applies and interprets

the requirements of the regulation,

which became effective on June 21,

1993. The proposed commentary incorporates much of the guidance provided when the regulation was

adopted, and addresses also additional

questions.

The purpose of the Truth in Savings Act is to assist consumers in comparing deposit accounts offered by

depository institutions. The Act requiresinstitutionsto disclose fees,the

interest rate, the annual percentage

yield, and other account terms whenever a consumerrequeststhe information and before an account is opened.

Fees and other information also must

be provided on any periodic statement the institution sends to the consumer. Rules are set forth for deposit

account advertisements and advance

notices to account holders of adverse

changes in terms. The Act restricts

how institutions must determine the

account balance on which interest is

calculated. Press Release, FRB, 1/31/94; FR,

2/7/94, p. 5536.

The FRB decided not to preempt

Wisconsin’s truth-in-savings law, because the state law is not inconsistent

with the federal statute. FR, 5/10/94, p.

24032; AB, 5/12/94, p. 9.

The FRB proposed new rules,

which among other things, would

have the effect of producing an annual

percentage yield (APY) that reflects

the time value of money.

The FRB withdrew other proposed amendments to the regulation

that would have required an internal

rate of return formula to calculate the

APY. The withdrawal was based on

considerations of cost and regulatory

burden. Press Release, FRB, 5/4/94; FR, 5/11,

p. 24376.

Truth in Lending: Depository

Institutions Disaster Relief

The FRB granted temporary relief

from certain provisions of Regulation

Z governing waivers by consumers of

the right to rescind certain home-secured loans, so that borrowers in disaster-affected communities in

California can gain easier access to

loan funds for emergency purposes.

Consumers’ use of preprinted forms

to waive the right of rescission is permitted, if the home securing the extension of credit is located in the

disaster area. A consumer must still

provide the creditor with a signed,

dated waiver statement that a personal financial emergency exists.

The FRB’s order is effective 2/11/94

and expires on 10/31/94. The FRB

acted under provisions of DIDRA,

which temporarily authorizes the

FRB to make exceptionsto the Truth

in Lending Act and Regulation Z for

transactions in an area the President

has declared to be a major disaster

area. FR, 2/11/94, p. 6532.

Equal Credit Opportunity:
 

Appraisals
 

The FRB revised its Regulation B

to implement amendments to the

Equal Credit Opportunity Act contained in FDICIA. The law provides

credit applicants with a right to receive copies of appraisal reports. The

regulation is amended to provide alternative methods of compliance with

the law. For creditors that do not

automatically provide copies of appraisalreports,the regulation includes

limits on when an applicant may request (and a creditor must provide) a

copy of an appraisal report, and a requirement that applicants be notified

of the right to receive a copy. The

final rule applies to applications for

credit to be secured by a lien on a

residential structure containing 1-4

family units. The effective date is

12/14/93, and compliance is optional

until 6/14/94. FR, 12/16/93, p. 65657; FIL12-94, FDIC, 2/28/94.

Loansto Officers and Directors

The FRB approved a final rule, to

be effective February 18, 1994,

amending several provisions of its

Regulation O. An interim rule is

made permanent that increases the

aggregate lending limit for small, adequately capitalized banks from 100

percent of a bank’s unimpaired capital

and surplus to 200 percent. Other

amendments are designed to reduce

the burden and complexity of the

regulation. Press Release, FRB, 2/18/94; FR,

11/23/93, p. 61803; 2/24/94, p. 8831.

Public Welfare Investments

The FRB proposed amending its

Regulation H, implementing Section

6 of DIDRA, to permit state member

banks to make certain public welfare

investments withoutspecificFRB approval, and other public welfare investments with specific approval.

The aggregate of the bank’s public

welfare investments must not exceed

the sum of five percent of the bank’s

capital stock paid in and unimpaired

and five percent of its unimpaired surplus. The FRB may waive this limit

on a case-by-case basis, and permit

such investments up to ten percent of

capital stock and surplus as described

above. Also, the FRB must limit a

bank’s investments in any one project.

The proposed rule identifies

classes of public welfare investments

that do not require FRB approval,

leaving less-common investments and

investments of more than five percent

of a bank’s capital subject to case-bycase review. Other requirements regarding public welfare investments

40
Recent Developments

without FRB approval include that

the bank must be at least adequately

capitalized and rated a composite

CAMEL “1” or “2,” and the bank

must not be subject to any written

agreement, cease and desist order,

capital directive, or prompt corrective

action directive. FR, 5/26/94, p. 27247.

Bank Investmentsin Premises

Effective July 5, 1994, the FRB is

amending its Regulation H to allow a

state member bank that meets certain

conditions to invest in its premises an

amount up to 50 percent of its Tier 1

capital without obtaining specific approval. Such an investment in premises generally should not cause

significant risk to a bank which is

well-capitalized, israted CAMEL “1”

or “2,” and is not subject to any written agreement, cease and desist order,

or capital directive. This action will

significantly reduce the number of applications to invest in bank premises

that are filed with the FRB and will

thereby reduce regulatory burden.

The amendment does not affect state

member banks’ ability to invest in

bank premises, without conditions,

up to the amount of their capitalstock

account. FR, 6/3/94, p. 28761.

Approval to Underwrite
 

Equities
 

The FRB granted approval for

Chase Manhattan Corp., through a

wholly owned subsidiary, to underwrite and deal in all types of equity

securities, including common stock,

on a limited basis worldwide. Commercial banks are prohibited in general by the Glass-Steagall Act from

engaging in investment banking activities, however Section 20 of the Act

permits limited securities underwriting and dealing by banks. The FRB’s

rules do not allow a bank holding company’s Section 20 subsidiary to derive

more than ten percent of it grossrevenue from underwriting and dealing in

bank-ineligible securities over any

two-year period. The Chase subsidiary also is subject to the recordkeeping, reporting, fiduciary standards,

and other requirements of the Securities Exchange Act, the Securities and

Exchange Commission, and the National Association of Securities Dealers. BBR, 6/13/94, p. 1022.

Alternative Test Proposed for

Section 20 Compliance

The FRB proposed an alternative

to the current test used to measure

whether a Section 20 subsidiary is in

compliance with the “engaged principally” criterion of Section 20 of the

Glass-Steagall Act. Section 20 prohibits a member bank from being affiliated with a company that is

“engaged principally” in underwriting and dealing in ineligible securities. The current test is based on the

revenue earned from ineligible securities activities relative to the total

revenue of the Section 20 subsidiary.

Comments are requested on whether

asset values or sales volume data, or a

combination of both measures,should

be used as a new alternative test. Press

Release, FRB, 7/6/94; FR, 7/12, p. 35516.

Anti-Tying Rules Are Eased

The FRB granted approval for a

brokerage subsidiary of First Union

Corp., Charlotte, NC, to give price

discounts on stock and bond commissionsto retail customers who maintain

required minimum balances in deposit accounts.

The Glass-Steagall Act requires

holding companies to maintain stringent barriers between their securities

and commercial banking activities.

Anti-tying rules of the Bank Holding

Company Act prohibit banks from requiring customers to purchase one

service in order to receive another.

The FRB used its authority under the

BHC Act to grant exceptions if they

serve the public interest. The FRB

allowed a tie-in in 1990 when it permitted banks to offer price reductions

on credit cards issued to their established customers. The agency said it

could cancel the approval if anticompetitive practices should develop. AB,

12/28/93, p. 1.

The FRBproposed thatthe exception granted to First Union Corporation (see above) be made available to

bank holding companies generally,

thus avoiding the need for action on

individual requests. The proposed

amendments to Regulation Y would

also permit discounts on any traditional bank product if the customer

obtains another traditional bank product from an affiliate of the bank. Press

Release, FRB, 3/11/94; FR, 3/16, p. 12202.

Home Mortgage Disclosure

The FRB is proposing several

changesto its Regulation C to provide

for earlier availability to the public of

disclosure statements required by the

Home Mortgage Disclosure Act of

1975, and to improve the quality of

the data. Amendments to the Act in

1992 provided that starting with the

HMDA reports for calendar year

1994, disclosure statements for individual lenders should be available to

the public by July 1 of the following

year, and that aggregate tables should

be available atthe central depositories

by September 1. Among the proposed changes, lenders would be required to submit their data by

February 1 instead of March 1. Another proposal is for reporting in machine-readable format, which should

also improve data quality. Institutions also would be required to keep

their loan application registers current

during the year as data are being collected. FR, 6/13/94, p. 30310.

BHC Subsidiary Can Offer

Career Counseling Services

The FRB approved an application

from Comerica, Inc. under which

Comerica of Detroit, MI would provide career counseling services

through a Detroitsubsidiary to banks,

thrifts, bank and thrift holding companies, and their subsidiaries. The

approval covers persons currently employed in, recently displaced from, or

seeking employment in these organizations, and to employed persons in

financially related positions in other

kinds of organizations, and those

seeking such positions. BBR, 11/15/93, p.

754.

Investmentsin Community
 

Corporations Approved
 

The FRB gave approval forseveral

state member banks to invest in the

West Virginia Bankers Association

41
FDIC Banking Review

Community Development Corp., a

for-profit corporation which will promote small-business development.

Other banks may participate if they

are adequately capitalized and not

subject to any formal enforcement actions. Investments will be limited to

two percent of a bank’s capital and

surplus. The OCC gave similar permission last December to national

banks. It was not until DIDRA that

individual banks were explicitly

authorized to make investments in

community development corporations, although bank holding companies already had this authority. About

75 banking companies are involved in

these projects, increasingly through

multibank consortia. AB, 5/6/94, p. 3.

Charging for Examinations of

U.S. Offices of Foreign

Banks

The FRB proposed to amend its

regulations relating to the activities of

foreign banking organizations in the

U.S. to implement provisions of the

Foreign Bank Supervision Enhancement Act of 1991 requiring the FRB

to charge foreign banks for the cost of

examinations of their branches, agencies, and representative offices in the

U.S. The amount charged would be

the number of examiner hours, times

an hourly rate. For branches and

agencies, examiner hours would be

determined by applying a formula

based on the branch’s or agency’s

characteristics. For representative offices, the actual recorded examiner

hours would be used. FR, 12/15/93, p.

65560.

Revisionsto Payments System

Risk-Reduction Program

The FRB adopted changes to its

Policy Statement on Payments System Risk, involving the procedures

that depository institutions must use

if they choose to complete a self-assessment to establish a daylight overdraft net debit cap. First, effective for

self-assessments performed on or afterJanuary 1, 1995, depository institutions must evaluate their operating

controls and contingency procedures

in addition to the three existing components of the self-assessment

(creditworthiness, intraday funds

management and control, and customer credit policies and controls).

Second, depository institutions will

use a “Creditworthiness Matrix” to

determine their overall creditworthiness rating, except in certain limited

circumstances.

The FRB is eliminating the requirement that branches and agencies

of foreign banks provide information

on U.S. funding capability and discount window eligible collateral for

use in determining their daylight

overdraft net debit caps. FR, 1/20/94, p.

3104.

Payments System Risk Policy

The FRB will assess a penalty fee,

effective April 14, 1994, on the average daily daylight overdrafts in Federal Reserve accounts incurred by

bankers’ banks that do not maintain

reserves, Edge and agreement corporations, and limited-purpose trust

companies. The rate for the daylight

overdraft penalty fee is equal to the

regular daylight overdraft rate applicable to other institutions plus 100

basis points, quoted on a 24-hour basis,for a 360-day year, and adjusted for

the length of the Fedwire operating

day. The penalty fee should create an

incentive for institutions that do not

have regular discount window access

to avoid incurring daylight overdrafts

in Federal Reserve accounts. FR,

2/24/94, p. 8977.

Risk-Based Capital: Netting

Arrangements

The FRB and OCC issued a joint

proposal that would amend the agencies’ risk-based capital guidelines to

recognize the risk-reducing benefits

of netting arrangements. A proposed

revision to the Basle Accord would

allow the recognition of such netting

arrangements.

Under the proposal, institutions

would be permitted to net, for riskbased capital purposes, the current

exposures of interest- and exchangerate contracts subject to qualifying bilateral netting contracts. Institutions

would be allowed to net positive and

negative mark-to-market values of

rate contracts in determining the current exposure portion of creditequivalent amounts of such contracts

to be included in risk-weighted assets. Press Release, FRB, 5/18/94; FR, 5/20, p.

26456.

Netting Eligibility for Financial

Institutions

The FRB approved a final rule,

effective March 7, 1994, concerning

the definition of “financial institution” in Section 402 of FDICIA.

The Act validates netting contracts

among financial institutions. Parties

to a netting contract agree that they

will pay or receive the net, rather

than the gross, payment due under

the netting contract. The Act provides certainty that netting contracts

will be enforced, even in the event

of the insolvency of one of the parties. Press Release, FRB, 2/1/94; FR, 2/2, p.

4780.

Protections Under Electronic

Payments of Benefits

The FRB adopted amendments to

its Regulation E in order to accord recipients ofbenefits,suchasfoodstamps

and Supplemental Security Income,

much the same protections that are

available to other users of electronic

payment mechanisms. Electronic

benefit transfer (EBT) programs involvethe issuance ofplastic accesscards

and personal identification numbers to

benefit recipients. Benefits can be accessed through automated teller machine (ATMs) and point of sale

terminals. The EBT amendments call

for general application of the rules on

liability forunauthorizedtransfers, error

resolution, and most other provisions.

Mandatory compliance was set for

March 1, 1997, asrequested by a federal

EBT task force that represents all the

majorfederal agencieswithbenefitprograms. Press Release, FRB, 2/24/94.

Proposal to Expand Fedwire

Funds Transfer Format

The FRB proposed expanding, by

late 1996, the Fedwire funds transfer

format and the adoption of a more

comprehensive set of data elements.

An expanded format would improve

42
Recent Developments

efficiency in the payments mechanism by reducing the need for manual

intervention when processing and

posting transfers. Also, truncation of

payment-related information would

be minimized when forwarding payment orders through Fedwire that

were received via other large-value

transfer systems, such as the Clearing

House Interbank Financial Telecommunications (SWIFT). Comments

are requested on the benefits and

costs to depository institutions, to

their customers, and to the overall

payments mechanism, from the proposal. FR, 12/1/93, p. 63366.

Office of the Comptroller of

the Currency

Bank Capital: Risks From

Credit Concentration and

Nontraditional Activities

The OCC, FRB, FDIC and OTS

proposed a rule,to implement Section

305 of FDICIA, amending their riskbased capital standards by explicitly

identifying concentration of credit

risk and certain risks arising from nontraditional activities, as well as an institution’s ability to manage these

risks, as important factors in assessing

an institution’s overall capital adequacy.

While it is not feasible at this time

to quantify the risk related to concentrations of credit for use in a formulabased capital calculation, techniques

do exist to identify broad classes of

concentrations and to recognize significant exposures. Institutions with

significant levels of concentrations of

credit risk should hold capital above

the regulatory minimums. Risks

posed by nontraditional activities will

be taken into account by ensuring

that, as members ofthe industry begin

to engage in, or significantly expand

their participation in, a nontraditional

activity, the risks of that activity are

promptly analyzed and the activity is

given appropriate capital treatment.

Section 305 requires the agencies to

review their capital standards biennially to determine whether those

standards are sufficient to facilitate

prompt corrective action under Section 38 of FDICIA. Should, however,

a nontraditional activity evolve rapidly in the industry, it promptly will

be reviewed for proper treatment under risk-based capital.FR, 2/22/94, p.

8420; FIL-15-94, FDIC, 2/25.

Deferred Tax Assets

The OCC proposed to amend its

capital adequacy rules to limit the

amount of certain deferred tax assets

that may be included in a national

bank’s Tier 1 capital for risk-based

and leverage capital purposes. The

proposal was developed jointly by the

OCC, FRB, FDIC, and OTS to respond to the Financial Accounting

Standards Board’s Statement of

Standards No. 109, which was issued

in February 1992. The proposed

amendment is expected to increase

the amount of net deferred tax assets

that a national bank may include

when computing its regulatory capital. FR, 12/23/93, p. 68065.

Guidance on Derivatives

The OCC issued a guidance covering a wide range of issues that were

addressed in a policy statement on

derivatives adopted by the agency in

the Fall of 1993. Among the provisions, the statement requires banks

selling derivatives as agents to ensure

that their products are appropriate for

buyers. The earlier statement had

dealt only with banks as principals.

The new statement emphasizes that

senior management must approve derivative products that present new

risks to banks. It relaxes an earlier

requirement that a bank credit officer

must approve each derivatives transaction,to state that after a broad policy

is established, other officials can approve derivatives transactions.

The statement says that “factors

that are considered in determining a

bank’s overall capital adequacy include the quality of the bank’s riskmanagement systems, and exposure

to credit concentrations, as well as liquidity, interest-rate, market, legal

and operational risks . . . banks with

deficient risk-management practices

or significant individual or aggregate

risk exposures will be expected to

hold capital above the regulatory

minimums.” Bulletin 94-31, OCC, 5/10/94;

WSJ, 5/10.

Disclosuresin Mutual Fund

Sales

The OCC announced that in response to an interest expressed by a

number of national banks in having

the agency review disclosure materials they use in sales of mutual fund

and annuity products, the agency is

offering the opportunity for a onetime review of these disclosure materials. After an initial contact by an

OCC examiner, banks will send in

brochures, advertising copy or other

promotional materials they wish to

have reviewed, following the completion of which the bank will be contacted regarding the materials. Letter to

National Banks, OCC, 5/4/94.

Real-Estate Appraisals

Effective June 7, 1994, the four

federal regulators of banks and thrifts

adopted rules, pursuant to Title XI of

FIRREA, on real-estate appraisals

that are intended to reduce costs and

encourage lending without diminishing safe-and-sound banking practices.

The revised rules: (a) increase the

threshold level to $250,000, from

$100,000, for loans that require a realestate appraisal by a certified or licensed appraiser; (b) exempt from the

appraisal requirements businessloans

of $1 million or less where the sale or

rental of real estate is not the primary

source of repayment; (c) expand and

clarify other exemptions from appraisal requirements,such asthose for

renewals of existing loans, and loans

that qualify for sale or are guaranteed

by a U.S. government agency or government-sponsored agency; and (d)

reduce and simplify the standards for

conducting required appraisals, relying more on industry standards. FIL41-94, FDIC, 6/8/94; FR, 6/7, p. 29482.

Inter-Agency Statement on

Discrimination in Lending

Federal agencies that are responsible for enforcing fair lending laws

adopted a uniform policy statement

on discrimination in lending. The

guidance addresses what constitutes

43
FDIC Banking Review

lending discrimination under the Fair

Housing Act (FHA) and the Equal

Credit Opportunity Act (ECOA), including specifically such areas as what

the agencies consider in determining

if lending discrimination exists; what

steps lenders might take to prevent

discriminatory lending practices; and

what lending patterns will be referred

to the Department of Justice for investigation. The ECOA prohibits discrimination in credit transactions

generally, while the FHA prohibits

discrimination in residential real-estate-related transactions.

The statement notes that the

courts have recognized three methods

of proof of lending discrimination under the ECOA and the FHA: (a)

“Overt evidence of discrimination,”

when a lender blatantly discriminates

on a prohibited basis; (b) evidence of

“disparate treatment,” when a lender

treats applicants differently based on

one of the prohibited factors (such as

race, national origin, sex, etc.); and (c)

evidence of “disparate impact,” when

a lender applies a practice uniformly

to all applicants but the practice has a

discriminatory effect on a prohibited

basis and is not justified by business

necessity.

Questions and answers, and specific examples, are provided to assist

lenders in respect to what constitutes

discriminatory lending in the agencies’ statement. “Inter-Agency Policy Statement on Discrimination in Lending,” OCC, FRB,

FDIC, OTS (and other agencies), 3/8/94; FR,

4/15/94, p. 18266; FIL-29-94, FDIC, 4/29.

“Retirement CD” Is Permitted

The OCC issued a “no-objection”

letter that permits a Montana bank to

offer a “Retirement CD” which combines features of a traditional certificate of deposit with certain payment

terms and tax advantages of an annuity contract. Customers may open a

Retirement CD account with a minimum initial deposit of $5,000, and

may make subsequent deposits once

a year, each of not less than $1,000.

When opening an account the customer chooses a maturity date, with a

minimum term of one year. They can

elect to receive up to two-thirds of the

account balance in a lump sum at maturity, and any amount which is notso

received will be used as the basis for

equal monthly lifetime payments to

the customer. In respect to the Retirement CD as an annuity for income

tax purposes, income taxesreportedly

are deferred until the time of withdrawal. The certificate pays a fixed

rate of interest up to the first five

years, after which the interest rate is

adjusted at the bank’s sole discretion

without reference to any independent

index. However, the issuing bank

guarantees that the interest rate will

never fall below three percent per

year. One condition that the OCC

specified in its approval was that the

bank should hedge its payment obligations; another was that the bank

make full and accurate disclosures to

its customers.

The FDIC has said the CD is a

deposit for deposit insurance purposes, but emphasized that under no

circumstances would FDIC insurance

extend to the bank’s commitment to

make lifetime payments, and that this

fact should be clearly and conspicuously stated by the bank. AB, 5/13/94, p.

3; Public Letter, FDIC, 5/12.

Small-Bank Examination
 

Program to Reduce
 

Paperwork
 

Under a program of the OCC now

set to apply only to community banks,

but which might be extended in part

to larger banks, qualifying institutions

that meet certain criteria will be subject to examination procedures requiring less documentation than is

currently needed. Their paperwork

requirements, especially in preparing

for an examination, would be reduced. An official said the program

generally would cover banks having

assets of less than $100 million,

though banks with assets up to $1

billion also might qualify. A qualifying institution would have a rating of

“1” or “2” in the 5-point CAMEL

scale, and generally would not be

heavily involved in nontraditional

products, such as mutual funds,

annuities, or complex commercial

real-estate loans. However, banks

involved with mutual funds or annuities could qualify if they meet other

criteria. AB, 7/8/94, p. 1; Bulletin 94-40, OCC,

6/20.

Banks’ Acquisitions of Mutual

Fund Companies Approved

The OCC gave approval for Mellon Bank Corp. to acquire Dreyfus

Corp., the nation’s sixth-largest mutual fund company. Among the conditions imposed on the approval,

Dreyfus is required to obtain OCC

approval before beginning any new

business activities, and Mellon Bank

is prohibited in most circumstances

from lending to Dreyfus. Other conditions described by observers as “unusually detailed” require Mellon to

submit plans to the agency detailing

the post-acquisition management reporting structure, and explaining how

the holding company will oversee

Dreyfus’ audit and compliance activities. When the transaction is completed, Mellon’s mutual fund assets

will increase from $3.7 billion to $71

billion, raising it to fifth place among

mutual fund management companies.

AB, 5/5/94, p. 1.

The OCC approved an application

for First Union National Bank, Charlotte, NC, to acquire Lieber & Co.,

Purchase, NY, which advises and

services 15 mutual funds in the Evergreen group with assets of about $3.2

billion. In an unusual move, the OCC

had asked for public comment on both

of the above acquisitions. WSJ, 2/24/94, p.

A4; 4/18.

The FRB approved the MellonDreyfus acquisition, effective June

22, 1994. In regard to the Truepenny

Corp., a Dreyfus non-bank subsidiary

which through another subsidiary partially owns a waterfront redevelopment project in New York City, the

approval requires that Mellon’s involvement in the project be terminated at the end of its first phase,

estimated at about seven years, in

order to comply with Regulation Y.

Technically the project does not meet

the community development investment criteria of the regulation, because it does not provide direct

44
Recent Developments

benefits primarily to low- and moderate-income persons. Press Release, FRB,

6/22/94; BBR, 6/27, p. 1108.

LendingLimits

The OCC proposed to revise its

rules governing national bank lending

limits, this being the first of a series of

proposals intended to simplify the

agency’s regulations and reduce compliance costs. The revisions would

clarify the scope and application of

the lending limits, and update the

rules to address frequently-asked

questions and incorporate significant

OCC interpretations of the lending

limits. In addition, the revisions

would simplify calculation of the

lending limits by relying primarily on

quarterly Call Report information,

and revise the definition of capital and

surplus upon which lending limits are

based to rely on capital components

that a bank must already calculate for

Call Report purposes. A new exception would be added to the lending

limits to allow a bank to advance

funds to renew and complete funding

a loan commitment under circumstances where the additional advance

will protect the position of the bank.

FR, 2/11/94, p. 6593.

Interstate Branching

A ruling by the OCC will enable

NationsBank Corp. to merge two

branching systems in Maryland and

the District of Columbia. Federal law

generally prohibits operating a single

branch system across state lines, however, the approval was granted under

a federal statute that allows banks to

move their headquarters anywhere

within 30 miles from the town or city

where the bank was originally chartered. The headquarters of American Security Bank NA would be

moved from DC to a suburb, Silver

Spring, MD, and American, retaining

its branches in DC, would be merged

with Baltimore-based Maryland National Bank. Both of the branching

organizations were acquired by NationsBank last year.

In a similar case that would result

in interstate branching between New

Jersey and Pennsylvania, the OCC in

January granted approval for First Fidelity Bank, NA in Pennsylvania, to

move its main office to Salem, New

Jersey, and then merge with First Fidelity Bank, NA, New Jersey.

Legislation that would allow interstate branching is pending in Congress and in state legislatures

including Georgia, Virginia and Florida. WSJ, 2/7/94, p. B3C; BBR, 1/17, p. 116;

2/14, p. 306.

Fair Housing Home Loan
 

Data System
 

The OCC issued a final rule, effective June 20, 1994, amending its Fair

Housing Home Loan Data System

(FHHLDS). The rule enhances the

OCC’s ability to use data collected

under HMDA in fair lending examinations and reduces recordkeeping

requirements on national banks that

are currently required to maintain duplicative information under both the

FHHLDS and HMDA. The final

rule replaces the current FHHLDS

monthly recordkeeping requirement

with the HMDA Loan/Application

Registers already maintained by national banks, which will be required to

be updated quarterly. All national

banks subject to the HMDA, including those banks not subject to the

FHHLDS, will be required to maintain information on the HMDA

Loan/Application Registers on a quarterly basis. National banks that are

not subject to the HMDA requirements will continue to be subject to

the original FHHLDS recordkeeping

requirement, which will be updated

quarterly under this final rule. FR,

5/20/94, p. 26411.

National Bank in Delaware

May Charge Late Feesto

Out-of-State Customers

The Colorado Court of Appeals

ruled that national banks are allowed

under the National Bank Act to

charge late fees based on the law of

the state where the bank is located,

even if the fees are not permitted in

the customer’s state (Copeland v.

MBNA America, N.A., 5/26/94).

MBNA, a national bank located in

Delaware, issues Visa and MasterCard credit cardsto customers nationwide. The Court found that under

the Act as interpreted by the courts,

interest includes late fees, and it supported MBNA’s argument that it may

export the interest rate which is permitted in Delaware, including the late

fees the state allows, to customers in

other states. BBR, 6/13/94, p. 1033.

NationalBankConsolidations

withFederalSavings

Associations

The OCC is adopting final procedures for national banks to follow in

merging or consolidating with federal

savings associations. These transactions were authorized in Title V of

FDICIA. To the extent appropriate,

the procedures parallel the longstanding statutory and regulatory procedures governing mergers and

consolidations between national

banks and state-chartered financial

institutions. Effective: May 2, 1994.

FR, 5/2/94, p. 22497.

Restrictions on Banks’

Insurance Activities Upheld

A U.S. District Court in Florida

upheld a ruling by the State Banking

Commissioner that bars Barnett

Banks of Marion County, NA from

selling insurance through a newly acquired agency. A state statute prohibits bank subsidiaries or affiliates of

bank holding companies from insurance agency activities. Barnett argued that Section 92 of the National

Bank Act as interpreted by the OCC

permits banks to sell insurance in

towns with a population up to 5,000.

The Court found an express intent to

preemptstate insurance laws notto be

present in Section 92, and thus the

matter is determined by the provisions of the McCarran-Ferguson Act

which leave insurance regulation and

taxation to the states. Barnett has appealed the ruling to the U.S. Circuit

Court of Appeals for the Eleventh

Circuit. BBR, 12/13/93, p. 934.

Business Contracting Outreach

Program

The OCC proposed a rule for the

adoption of a Minority-, Women- and

Individuals with Disabilities-Owned

Business Contracting Outreach Program. The intention is to ensure that

45
Recent Developments

business concerns owned and controlled by those groups are provided the

opportunity to participate in the

agency’s contracting process. This

action, with respect to the minorityand women-owned businesses, is required by FIRREA, and inclusion of

individuals with disabilities is consistent with the intent of the Rehabilitation Act of 1973 as amended. The

OCC’s activities include (a) targeting

appropriate firms for participation in

the program; (b) participating in business promotion events comprised of

or attended by MWOB and IDOB

firms to explain OCC contracting opportunities;(c) ensuring thattheOCC

contracting staff understands and actively promotes this program; and (d)

registering MWOB and IDOB firms

in the OCC’s database to facilitate

their participation in the competitive

procurement process for OCC contracts. Ownership and control requirements are specified in the

proposal that each prospective

MWOB or IDOB must demonstrate

that it meets in order to participate in

the program. FR, 11/10/93, p. 59686.

Bank Investmentsin

Community Development

Corporations

The OCC amended itsregulations

concerning national bank investments in community development

corporations (CDCs) and community

development projects, effective December 31, 1993, to implement Section 6 of DIDRA. Among the

amendments, adequately capitalized

national banks with assets of $250 million or less would be exempt from

required prior OCC approvalfor CDC

and CD project investments, and can

self-certify single investments up to

five percent of their unimpaired capital and surplus. For national banks

with assets of more than $250 million,

self-certification of individual investments would be permitted up to the

lesser of two percent of unimpaired

capital and surplus, or $10 million. Investments that exceed either of those

limits would require OCC approval.

The ceiling on bank investments in

CDCs and CD projects is raised from

five percent of unimpaired capital and

surplus to ten percent on a case-bycase basis, subject to a determination

by the OCC that there is no significant

risk to the deposit insurance fund.

The OCC said its action will reduce

regulatory burdens associated with

CDC and CD project investments, in a

manner that will not endanger banks’

safety and soundness, and is intended

to promote economic growth and

investments in low- and moderateincome areas and underserved rural

communities. FR, 12/27/93, p. 68464; BBR,

1/3/94, p. 8.

PublicationofCRARatings

A new monthly publication, The

CRA Report, will include a listing of

Community Reinvestment Act ratings,

and for banks rated less than “satisfactory” the full text of their evaluations.

CRA ratings of national banks will continue to be released monthly in the

OCC’s Weekly Bulletin and Interpretations and Actions. BBR, 1/10/94, p. 54.

Office of Thrift Supervision

ConversionsFromMutualto

StockForm

The OTS is amending its regulations governing mutual-to-stock

conversions of insured savings associations. Among the changes, the

amendments revise and clarify the appraisal standards; prohibit the use of

“running” proxies by managements

of converting associations; provide

stock purchase priority to long-term

depositors, and require a stock purchase preference for eligible depositors

residing in the association’s local community. Also, the amendments prohibit management stock benefit plans

in a conversion; prohibit merger conversions except in supervisory situations; lengthen the conversion

public comment period; require associations to submit business plans for

all conversions; prohibit the repurchase of a converted association’s

stock within one year of conversion;

and make publicly available preliminary conversion proxy materials.

The interim final rule is effective

May 3, 1994, and public comments

were requested. FR, 5/3/94, p. 22725.

The OTS announced on January 31,

1994, that it wassuspending the acceptance of applications involving merger

conversions of mutual savings associations under its supervision, the moratorium to remain in effect while OTS

reviews its regulations governing these

conversions. Merger conversions are

transactions in which a mutual savings

association is merged into another entity, and the value of the mutual is converted into the stock of the acquirer.

Standard conversions, in contrast, are

thosebywhichmutualthrifts convertto

stock ownership without a merger or

acquisition being part of the transaction. NEWS, OTS, 1/31/94.

CharterConversionsDenied on

“ConvenienceandNeeds”

Criteria

The OTS denied applications of

four savings associations to convert to

state-chartered savings banks because

they have failed to serve the convenience and needs of their respective

communities or to satisfactorily carry

out their responsibilities under CRA.

These are the first denials by OTS of

applications for such conversions.

Three New Jersey thrifts — Pulaski

Savings Bank, SLA, Springfield; Gibraltar Savings Bank, SLA, Mendham;

and United Roosevelt Savings and

Loan Association, Carteret — received

“needsto improve” ratings on their last

two CRA compliance examinations

conducted by OTS, including the most

recent in 1993. An Ohio institution —

The Mayflower Savings & Loan

Company, Groesbeck — received

the same rating on its last compliance exam, in late 1992. The institutions range in size from the $60

million-asset Mayflower to the

$160 million-asset (approximate)

Pulaski. NEWS, OTS, 2/18/94.

Acquisition ofControl ofSavings

Associations

The OTS proposed to incorporate

into its rules the provisions of Section

46
FDIC Banking Review

211 of FDICIA, which amended the

Home Owners’ Loan Act to require

that the OTS, in reviewing a holding

company application to acquire a savings association, consider the competence, experience, and integrity of the

officers, directors, and principalshareholders of the proposed acquirors and

the savings association to be acquired.

Under Section 211, OTS must deny

an application if the company fails to

provide adequate assurances that the

company will make available such information on the operations or activities

of the company, or any affiliate, as OTS

requires. In addition, the OTS must

deny anapplicationby any foreignbank

that is not subject to comprehensive

supervision or regulation on a consolidated basis by the appropriate authorities in the home country of the foreign

bank. FR, 11/23/93, p. 61850; 6/2/94, p. 28468.

Capital Standards

The OTS issued a final regulation

making its capital treatment of intangible assets consistent with rules previously adopted by the other federal

banking agencies. The new rule also

implements a statutory requirement

on the valuation of purchased mortgage servicing rights (PMSRs) mandated by FDICIA. Among the

changes under the new rule, PMSRs

and purchased credit-card relationships (PCCRs) may be included in

thrifts’ core capital up to 50 percent of

core capital. Previously, thrifts could

not include PCCRs in their capital.

These two types of intangible assets

must be valued at the lower of 90

percent of fair market value calculated at least quarterly or 100 percent

of remaining unamortized book value.

A grandfather provision permits savings associations to continue to include the same amount of PMSRs

that they have for the past several

years. The new OTS rule disallows

any new core deposit intangibles

(CDIs)from counting as capital. However, the OTS will grandfather CDIs

resulting from prior transactions or

those under firm contract when the

rule goesinto effect on March 4, 1994.

NEWS, OTS, 2/2/94; FR, 2/2, p. 4785.

The OTS proposed amending its

minimum regulatory capital regulations by revising the definition of

“common stockholders’ equity,” in

order to incorporate a recent change in

generally accepted accounting principles (GAAP), made by Statement of

Financial Accounting Standards No.

115. The agency solicited comments

particularly on certain questions with

reference to SFAS 115, among which

are: If unrealized gains and losses are

included in regulatory capital,

whether these gains and lossesshould

be included in core capital for purposes of the leverage ratio requirement or the risk-based capital

requirement; or included in supplementary capital for purposes of the

risk-based capital requirement. Section 4 of the Home Owners’ Loan Act

of 1933 requires the OTS to prescribe

accounting standards that incorporate

GAAP to the same extent as used for

regulatory purposes by the federal

banking agencies. The proposal is

similar to amendments the other federal banking agencies have proposed.

FR, 6/22/94, p. 32143.

The OTS proposed amending its

risk-based capital standards to recognize the risk-reducing benefits of

netting arrangements. Savings associations would be permitted to net, for

risk-based capital purposes, interestand exchange-rate contractssubject to

legally enforceable bilateral netting

contracts that meet certain criteria.

The amendments parallel recent

amendments proposed by the FRB

and OCC. The proposed amendments

would allow thrift institutions to net

positive and negative mark-to-market

values of rate contractsin determining

the current exposure portion of the

credit-equivalent amount of such contracts to be included in risk-weighted

assets. FR, 6/14/94, p. 30538.

Annual Independent Audits

The OTS proposed amending its

annual independent audit rules for

savings associations to conform to

those applicable to other federally insured depository institutions. Under

Section 112 of FDICIA, the FDIC

requires annual audits of insured depository institutions with total assets

of $500 million or more. The OTS

proposes to eliminate its annual independent audit requirement, and to

adoptthe requirementsin theFDIC’s

final rule forsavings associations. The

OTS proposes also to retain the

authority to require independent

audits of small savings associations if

advisable for purposes of safety and

soundness. FR, 3/22/94, p. 13461.

Authority to Provide Postal
 

Services
 

The OTS said in a legal memorandum that federal savings associations

may provide the same postal services

that are authorized for national banks.

These services appear to be limited

to: selling stamps and other postal

supplies; accepting matter for mailing; selling parcel insurance as agent

for the U.S. Postal Service; accepting

registered mail; and issuing money orders. A federal savings association offering these services must observe the

appropriate rules of the U.S. Postal

Service. The books and records of the

postal operation must be kept separate from the records of other operations of the savings association and

will be subject to inspection both by

the OTS and the U.S. Postal Service.

Legal Division Memorandum, OTS, 3/24/94.

CAMEL Rating System

The OTS is amending its regulations, effective April 19, 1994, to

reflect the conversion from the

MACRO to the CAMEL (capital

adequacy, asset quality, management, earnings and liquidity) rating

system. The change will reduce regulatory burden by using the same rating system employed by the other

federal banking regulatory agencies,

and will improve consistency with regard to risk-related assessments and

joint examinations. The OTS expects that virtually no practical effect

on savings associations will result

from this change. FR, 4/19/94, p. 18474.

47
Recent Developments

Release of Unpublished
 

Information
 

The OTS proposed to amend its

regulations pertaining to release of

unpublished agency information that

would include, in certain circumstances, records that are exempt from

disclosure under the Freedom of Information Act (FOIA). The proposed

regulation does not apply to requests

for records that are required to be disclosed under FOIA. The proposal describes in detail the procedures that

requesters must follow in seeking the

release of unpublished information,

and the criteria on which OTS will

evaluate requestsfor thisinformation.

FR, 12/9/93, p. 64695.

Federal Financial

Institutions Examination

Council

Accounting forSecurities
 

Activities
 

The FFIEC issued an interim revision to its existing guidance on the

accounting and reporting for securities and the holding of mortgage

derivatives that addresses the relationship between a policy statement

adopted by the federal banking and

thrift supervisory agencies, effective

February 10, 1992, and the Financial

Accounting Standards Board’s Statement No. 115, issued in May 1993.

Banks must adopt the FASB Statement for their Reports of Condition

and Income for fiscal years beginning

after December 15, 1993. The interim

revision to the policy statement: (a)

removes the regulatory reporting requirement that “nonhigh-risk mortgage securities” that later become

“high-risk” must be redesignated as

held-for-sale or trading; (b) instructs

examiners to consider any unrecognized net depreciation in held-to-maturity high-risk mortgage securities

when they evaluate the adequacy of

an institution’s capital; (c) reiterates

that mortgage derivative products

that are high-risk when acquired shall

not be reported in regulatory reports

as held-to-maturity securities at amortized cost; and (d) explains that, for

banks and thrifts, examiners may seek

divestiture of high-risk mortgage securities that do not reduce interest-rate

risk when the examiners determine

that continued ownership of these securities represents an undue safetyand-soundness risk to the institution.

The revision also identifies certain

factors that provide evidence of this

risk.FIL-25-94,FDIC, 4/21/94; “InterimRevision

to the Supervisory Policy Statement on Securities Activities,” FFIEC, 4/15.

Accounting forLoan
 

Impairment
 

The FFIEC is seeking public comment on certain implementation issues

arising from the Financial Accounting

Standards Board (FASB) Statement

No. 114, which will be effective for

fiscal years beginning after December

15, 1994. Under the federal banking

and thrift agencies’ capital rules, general allowancesfor loan and lease losses

are included inTier 2 capital,subjectto

certain limits, but specific allowances

are not eligible for inclusion in regulatory capital. Comments are asked to

address whether the portion of an institution’s allowance established under

the Statement should be reported and

considered as a specific allowance or a

general allowance. Statement No. 114

contains provisions that describe how a

creditor should recognize income on

impaired loans. However, the FASB

recently proposed to replace these provisions with one allowing creditors to

use existing methods of income recognition. Among the issues on which the

FFIEC is requesting comment are

whether the regulatory nonaccrual

standards should be retained, and the

expected effect of FASB 114 on the

level of institutions’ allowancesfor loan

losses. Press Release, FFIEC, 5/13/94; FIL-35­

94, 5/23; FR, 5/17, 25656.

Electronic ImagingSystemRisks

The FFIEC issued a statement to

alert the senior management of each

FFIEC member agency and all examining personnel to the risks associated

with electronic imaging systems in

financial institutions. Electronic imaging systems are defined asthe technology used to capture, index, store and

retrieve electronic images of paper

documents. Many of the traditional

audit and security controls for paperbased systems may be reduced or

absent in electronic document workflow. New controls must be developed

and designed into the automated process to ensure that information in image

files cannot be altered, erased or lost.

Risk areas that management should

address when installing imaging systems, and that examiners should be

aware of when examining an institution’s controls over imaging systems,

are discussed. Press Release, FFIEC, 12/20/93;

FIL-13-94, FDIC, 2/25/94.

RiskManagementSeminars

The FFIEC will conduct two Risk

Management Planning Seminars in

1994, in response to FIRREA which

specifies that the Council “develop

and administer training seminars in

risk management for its employees

and the employees of financial institutions.” The seminars for top bank

officials and directors will emphasize

the development of policies and procedures to control risk. A seminar to

be held in Houston, Texas, will be

aimed at insured financial institutions

of all sizes, while a seminar in New

York City will focus on financial institutions that are larger than $500 million. Press Release, FFIEC, 12/13/93.

FairLendingSeminars

The FFIEC will conduct three fair

lending seminars in 1994 for chief executive officers of financial institutions. The goal of the seminars is to

assist top management of the institutions in better understanding fair

lending issues and instituting policies

that ensure nondiscriminatory lending practices. Among the topics to be

discussed at each seminar are the fair

lending priorities of the agency principals and the initiatives underway to

carry them out, the role of the Justice

Department and the Department of

Housing and Urban Development in

enforcing the fair lending laws, and

ways by which institutions have improved their fair lending. The agencies encourage attendance at these

one-day seminars by a member of an

48
FDIC Banking Review

institution’s executive management

team. PR-23-94,FFIEC,4/5/94.

Federal HousingFinance Board

AdvancestoCapital-Deficient

Members

The FHFB is amending itsregulations, effective February 22, 1994, to

incorporate requirements governing

secured loans (called advances) made

by the Federal Home Loan Banks to

capital-deficient members. The final

rule prohibits Bank lending to tangibly insolvent members, except at the

request of the appropriate federal

regulator or insurer, and restricts the

Banks from lending to other capitaldeficient members whose use of Bank

advances has been prohibited by the

appropriate federal regulator or insurer. In addition, the final rule providesthat aBank may allow a member

to assume advances held by a nonmember if the advances had previously been extended by the Bank to

another of its members.FR,1/20/94,p.2945.

National Credit Union

Administration

Organization and Operation of

Federal Credit Unions

The NCUA adopted a final interpretive ruling and policy statement

(IRPS), effective July 5, 1994, following a proposal issued in July 1993.

The proposed IRPS was designed to:

(a) update policies on low-income

credit unions; (b) streamline the charter application process; (c) address

credit unions undergoing corporate

and military unit restructuring; (d)

clarify NCUA policy on the “operational area” requirement for select

group expansions; and (e) make certain other minor or technical changes.

To provide expanded credit union

service to low-income persons the

IRPS: (a) permits chartering associational low-income federal credit

unions, where the association is organized solely for the purpose of

providing credit union service to lowincome persons; (b) permits a low-income federal credit union, whether

associational or community based, to

include in its charter, occupational,

associational, and community common bond groups, without regard to

location; and (c) permits a federal

credit union of any type to include

low-income groups in its field of

membership, without regard to the

group’s location, either by forming an

association which is organized solely

for the purpose of providing such

service or by including a community

group which could be the basis for

chartering a low-income credit union.

The Board will institute special reporting requirements and special examination procedures for any credit

union including a low-income group

in its field of membership to ensure

that adequate credit union services are

provided to all personsin the community.

The NCUA determined also that

federal credit unions of all types need

additional flexibility when faced with

distress situations such as significant

corporate or military restructurings.

Thus, the final IRPS: (a) permits federal credit unions of all types to apply

for designation as a “distressed federal credit union” and to do so regardless of whether they are converting to

community charter; (b) permits federal credit unions with such designations to add occupational and

associational groups to their fields of

membership regardless of location.

Controls over the process include a

comprehensive review by the NCUA

Board prior to initial designation;

groups must request service in order

to be added to a distressed credit

union’s field of membership; the regional director must approve all expansion requests; and normal overlap

procedures will apply. FR, 6/3/94, p. 29066.

ApprovalGreatlyEnlargesCU’s

PotentialMembership

In what appears to be the largest

single potential membership expansion, the NCUA granted approval for

Communicators Federal Credit Union,

Houston, TX, whose members are

mostly local telephone and supermarket workers, to expand its field of

membership to include all retirees

and senior citizens living within a 25­

mile radius of Houston. The $97 million-asset credit union would have its

potential membership enlarged to

over 20 times its current 28,035 members. The three largest expansion approvals last year also primarily involved

adding senior citizens groups. AB, 4/15/

94, p. 9.

Mergersand Insurance
 

Conversions
 

The NCUA proposed amendments

to clarify thatitsregulations on mergers,

voluntary termination and insurance

conversion apply not only to federally

insured credit unions converting to

non-federally insured credit unions,

but those converting to any institution

that is not insured by the National

Credit Union Share Insurance Fund

(NCUSIF). The amendmentswillprovide NCUA with clear authority to

prevent abusesin connection with conversions, involving the agency’s authority to require membership votes, to

monitor the fairness of those votes, and

to ensure thatthe transaction ishandled

in the best interests of the members of

the NCUSIF. FR, 6/30/94, p. 33702.

Mutual Fund Investments

An NCUA letter to federal credit

unions notes that the proliferation of

mutual funds, the increasing complexity of mutual fund investments,

and often rapid changes in fund portfolios have made it more difficult for

credit unions to determine if an individual mutualfund is permissible, and

to monitor funds’ investments and investment transactions. For these reasons, and to eliminate examiner

inconsistency, the NCUA is taking

the position that an FCU may invest

in a mutual fund only when the prospectus indicates that the fund’s

authority is strictly limited to investments and investment transactions

that are legal for FCUs. Thus, a fund

authorized to purchase Collateralized

Mortgage Obligations (CMOs) and

Real-Estate Mortgage Investment

Conduits (REMICs) without restriction is an impermissible investment

49
Recent Developments

for FCUs, even though the FCU has

evidence that the fund purchases only

securities passing the high-risk securities test. The policy issuance is effective January 1, 1995. Letter to Credit

Unions, No. 150, NCUA, 12/93.

Nonmember and Public Unit

Accounts

The NCUA amended its regulations, effective June 20, 1994, to

change the amount of nonmember

and public unit accounts that a credit

union may maintain, without awaiver,

to 20 percent of total shares or $1.5

million, whichever is greater. Credit

unions accepting nonmember and

public unit accounts in excess of 20

percent of total shares are still required to develop a written plan and

send it to the Regional Director. FR,

5/19/94, p. 26101.

Corporate Credit Unions

Noting that many corporate credit

unions are closely tied to credit union

leagues or trade associations through

interlocking boards of directors or

common management, the NCUA requested comment on whether to require that a corporate credit union’s

board of directors be independently

elected by its members,thatthe board

represent primarily the interests of

those members that are credit unions,

and that management report only to

the corporate credit union’s board of

directors.

The corporate credit union system

consists of 44 corporate credit unions

serving the nation’s 13,000 natural

person credit unions, with the U.S.

Central Credit Union in turn serving

the corporate credit unions. The corporate credit union system provides

liquidity, investment, and payment

services to credit unions. As of December 31, 1993, the 44 corporate

credit unions held about $41 billion in

assets, half of which was reinvested in

shares in U.S. Central. FR, 4/19/94, p.

18503.

Credit Unions Examined for

Loan Bias

The NCUA said that data reported

under HMDA for 1992 indicated that

some credit unions are rejecting minority mortgage applicants at higher

rates than non-minorities, and that

those with the highest denial rates in

the HMDA data would be given special examinations. The NCUA advised credit unions to review their

lending policies and procedures to

“ensure that the service and credit

needs of all members are provided by

their credit unionsin a completely fair

and nondiscriminatory way.” The

denial rate, according to the HMDA

data, for all mortgage applicants is

much lower than at other institutions:

in 1992, the overall denial rate at CUs

was 9.8 percent, compared to 15.7 percent for all other mortgage lenders.

But the denial rate was 19.7 percent

for black applicants, 16.6 percent for

Hispanics, and 13.6 percent for Native Americans, compared to 7.7 percent for whites. AB, 1/14/94, p. 8.

Truth in Savings

The NCUA extended the date for

compliance with its Truth in Savings

regulation, to March 31, 1995 for

credit unions of an asset size between

$500,000 and $1 million as of December 31, 1993, that are not automated,

and to June 30, 1995 for credit unions

of lessthan $500,000 that are not automated. The compliance date for all

other credit unionsremainsJanuary 1,

1995.

The Truth in Savings Act (Title II

of FDICIA) required the NCUA to

issue implementing regulations for

credit unions. The agency published

a regulation on September 27, 1993.

The regulation is effective January 1,

1995, except for some requirements

not effective until approved by the

Office of Management and Budget.

The Act and regulation require credit

unions to disclose fees, dividend and

interest rates and other terms concerning share and deposit accounts,

and limit the methods by which credit

unions determine the balance on

which dividends are calculated. FR,

3/22/94, p. 13435.

Legal Opinion on Interstate
 

Export of Interest Rates
 

The NCUA, in an interpretive letter, addressed the authority of federally insured, state-chartered credit

unions to export to other states the

late charges allowed under the laws of

the state where the credit union is

located. It concludes that the credit

unions have this authority regardless

of any prohibition or limitation by the

state where members reside. Late

charges, the statement said, are included within the meaning of the

term “interest” in Section 523 of the

Depository Institutions Deregulation

and Monetary Control Act of 1980

(DIDMCA), and this statutory provision preempts all state law limitations

in the member’s state of residence on

the interest which may be charged by

a state-chartered, federally insured

credit union. Interpretive Letter, NCUA,

4/11/94.

Incentive Pay Plans

The NCUA requested comments

on whether to change its rule that

prohibits federally insured credit unions from providing incentive pay

plans to certain employees related to

the credit union’s lending activities.

Under Section 701 of the agency’s

rules, federal credit unions are barred

from making any loan or extending

any line of credit if, either directly or

indirectly, any commission, fee, or

other compensation is to be received

by the credit union’s directors, senior

management, loan officers, or any

immediate family members of such

individuals, in connection with underwriting,insuring,servicing,orcollecting

the loan or line of credit. The regulation does not restrict the payment of

non-commission salary to employees.

While an official in charge of lending

may not receive compensation tied to

the performance of the loan department,the agencyhastaken theposition

that a chief executive officer’s compensation may be tied to the overall performance of the credit union, part of

which is based on its loan activities.

FR, 3/15/94, p. 11937.

State Legislation and

Regulation

DisclosurestoBankCustomers

California: More than 90 percent of

banks in the state are obtaining signed

50
FDIC Banking Review

disclosure acknowledgements from

customers who purchase mutual

funds, according to a survey by the

California Bankers Association. The

survey covered about ten percent of

the membership of the Association.

Such matters as mutual funds’ lack of

federal deposit insurance, and investment risks, are covered in the customer statements. AB, 1/18/94, p. 8.

CustomersGivenTrialPeriod on

Annuities

California: Legislation that became

effective on January 1, 1994, provides

for a “trial” period of 30 days on the

purchase of annuities and life insurance

by persons over age 60 during which

they can cancel the contracts and have

all premiums returned. Previously, the

institutionsthatsell these products had

been granting a ten-day “free-look” period. The new legislation poses problems to sellers of variable annuities

because of the market fluctuations in

the underlying investment securities

for the annuities contracts. AB, 1/24/94, p.

13.

SellingAnnuitiesPermitted
 

forBanks
 

Colorado: New legislation allows

banks, bank holding companies, and

their subsidiaries and affiliates to sell

fixed- and variable-rate annuities.

The statute requires that the seller

receive written acknowledgment

from the purchaser that the annuity

involves investment risk that is not

FDIC-insured. BBR, 6/6/94, p. 991.

Restraints onCreditCards

Eased

Colorado: The Governor signed a

bill that eliminates prohibitions on

credit-card fees and allows returnedcheck fees of up to $20, sets a minimum interest charge of up to 50 cents,

and lets state-chartered institutions export fees and rates. Existing regulations

limit the annual percentage rate (APR)

on credit cards to 21 percent with, and

18 percent without, a grace period. The

new law reflects federal regulations in

requiring that a credit card’s APR be

conspicuously displayed. AB, 5/25/94, p.

12.

Maine: The Governorsigned legislation containing several provisions

aimed toward reversing losses of

credit-card jobs to other states. Among

the changes, it eliminates the 18 percent ceiling on annual rates and also a

$12 maximum on annual fees, replaces

a prohibition on late fees with a maximum fee, and for the 25-day grace

period allows immediate calculation of

interest for customers with an unpaid

balance. Existing restrictionsthat were

unchanged includeprohibitions on: fee

charged to cardholders who exceed

their credit limit, returned-check

charges, and charges by companies for

attorney’s fees during disputes. BBR,

4/18/94, p. 705; 6/6, p. 991.

InterstateBanking

Florida: The Governor is expected to sign legislation that allows, on a

reciprocal basis, banking organizations

in other states to acquire Florida-based

banks, and permits Florida banks to

make similar out-of-state acquisitions.

The legislation would be effective May

1, 1995, and would take the state out of

the Southeast regional banking compact. Virginia, and the Georgia legislature, passed similar bills earlier this

year, and North Carolina enacted a

law in 1993, to be effective July 1,

1996.

Interstate banking and branching

legislation nowbeing considered by the

Congress would largely supersede the

various regional banking networks. AB,

4/4/94, p. 7; BBR, 4/4, p. 622.

HousingAgency toEstablish
 

Bank
 

Florida: The State Comptroller

approved an application by Dade

County’s Housing Finance Authority

to establish a bank to provide home

mortgages to low-income County

residents. An official of the Authority noted that of 46 local banks asked

recently to participate in a lending

program, only one agreed to commit

any funds. The Authority’s mortgages

are small, typically ranging from

$25,000 to $50,000. The bank will not

offerchecking accounts, but will provide savings accounts, and expects to

package quantities of low-interest

loans into securities that could be sold

to pension funds, university endowments and other investors seeking socially conscious investments. The Miami

Herald and Knight-Ridder/Tribune Business News,

12/8/93.

MutualFundSalesGuidelines

Illinois: The Commissioners of

Banks and Trust Companies adopted

specific guidelines for state-chartered

banks’ sales of mutual funds. The

guidelines, which closely follow

guidelines issued by federal regulators, require that institutions disclose

that a mutual fund investment is not

a deposit, is not insured by the FDIC,

and that the investment involves

risks. Among other provisions are that

personnel involved in soliciting or

selling mutual funds should be

trained for these activities, that the

sales areas for mutual funds should be

separate from deposit-taking areas,

and that banks should not market

mutual funds under names identical

to the bank’s name. BBR, 3/28/94, p. 586.

AllCreditUnionsinStateAre

Insured

Massachusetts: All state-chartered

credit unions in the state are now covered by federal deposit insurance, the

National Credit Union Administration

said. Since the private share insurance

crisis in Rhode Island, and the conversion process beginning in early 1991,

a total of 124 credit unions, with assets

of more than $3.6 billion, have applied

for federal coverage, and of these the

NCUA approved 106 for insurance.

The remaining institutions have

merged or closed. BBR, 4/25/94, p. 750.

Limit on Cleanup Liability
 

Overturned
 

Michigan: The U.S. Court of

Appeals for the District of Columbia

ruled that the Environmental Protection Agency lacked statutory

authority to issue its regulation under

which a lender is notliable for cleanup

costs when it does not participate in

the management of the property.

The decision came in a suit brought

by the State of Michigan and the

51
Recent Developments

Chemical Manufacturers Association

to overturn the EPA rule. Shortly before the decision,the ClintonAdministration introduced a Superfund

reauthorization bill that would provide environmental liability protection to lenders and also authorize the

EPA to issue such rules. AB, 2/10/94,

p. 1.

CourtApprovesBank’sPurchase

of InsuranceAgency

Michigan: A decision of the Michigan Supreme Court permits a bank

service company to purchase an insurance agency (Ludington Service Corp.

v. Michigan, 1/25/94). The Court upheld a ruling by an appeals court that

overturned the disapproval of the transaction by state insurance regulators.

Legislation now being considered in

the state legislature would give financial institutions broad authority to sell

various kinds of insurance. BBR, 2/7/94,

p. 253.

UnannouncedBank
 

Examinations
 

Nebraska: The Department of

Banking will begin conducting a limited number of unannounced examinations of randomly selected state banks.

Currently,theDepartmentprovides advanced notice of several days to banks

scheduled for examination. Northwestern

Financial Review, 4/23/94, p. 31.

Interest-RateDeregulation,

ConsumerProtectionsEnacted

New York: A new law eliminatesthe

sunset provisions in a 1980 statute that

removed interest-rate ceilings, and deregulatesfees on credit cards and consumer installment loans. Other key

provisions of the legislation that apply

to banking institutionsinclude: requiring them to provide basic banking

services, including low-cost checking

and savings accounts; prohibiting

them from engaging in “geographic”

discrimination; and requiring them to

report their loan activity regarding

small businesses and farms. In addition, a toll-free number is established

at the New York Banking Department

to provide consumers with interestrate and other information; and two

quasi-public companies are created to

make loans to small businesses, especially those in economically depressed

areas. BBR, 2/7/94, p. 245; AB, 2/4, p. 14.

Power toSellAnnuities

NewYork: The state’s highest court,

the Court of Appeals, affirmed that

state-chartered banks can sell annuities. The court agreed with the Banking Department that annuities are

similar to other investment products

sold by banks, such as certificates of

deposit. In some states, banks are not

allowed to sell annuities which are

regarded as insurance products. The

OCC has authorized national banksto

sell annuities, but the power remains

unclear because of legal challenges at

both the state and federal levels.

WSJ, 3/31/94, p. A2; AB, 3/31, p. 12.

Reverse Mortgage Loans

New York: The Banking Board

adopted regulations applicable to reverse mortgage loans. The loans enable persons aged over 60 to access

the equity in their homes. Among the

provisions, loans are limited to 80 percent of the anticipated value of the

real property at maturity. Investment

in reverse mortgage loansislimited to

ten percent of the lender’s capital,

undivided profits and surplus. AB,

4/11/94, p. 9; BBR, 4/11, p. 658.

Stock Payment Disallowed in

Mutual Conversion

New York: Officials of Greenpoint

Savings Bank and others were required by state regulators, because of

failure to obtain a fair appraisal of the

thrift, to forego $40 million in stock

benefits from a planned initial public

offering in a conversion of Greenpoint

from a mutual to stock form of organization.

Last Fall the state issued a proposal to tighten conversion regulations by requiring outside review of

executive compensation and two appraisals of the converting institution’s

net worth. AB, 1/26/94, p. 1.

Fiduciary Powersfor Foreign

Banks

New York: The Banking Department adopted rules, effective May 18,

1994, providing authority for foreign

banking corporations to engage in

fiduciary activities, and setting up application procedures for the institutions to obtain permission to change

their name, and for a license to establish a representative office, branch or

agency. BBR, 5/30/94, p. 959.

State Bank Powers

Oklahoma: Revisions of the Banking Code give state banks automatic

parity with national banks in respect

to bank powers. The Banking Board

is no longer required to adopt a regulation before a state bank may exercise a power conferred upon national

banks. Oklahoma Banker, 5/13/94, p. 9.

Protection of Compliance
 

Review Documents
 

Oklahoma: Amendments to the

Banking Code provide a framework

within which banks may establish

compliance review committees, the

findings of which are protected from

discovery in civilsuits brought against

the bank. While the underlying data

used by the compliance committee

may still be discoverable and admissible, the data compilations and conclusions will be protected and kept

confidential. Without this protection, many banks were hesitant to

conduct rigorous internal reviews of

compliance practicesfor fear the findings could be used against them. This

legislation will not provide confidentiality for compliance review

documents which relate to fraud committed by an insider of the institution. Oklahoma Banker, 5/13/94, p. 9.

Branching Restrictions

Oklahoma: New legislation has

reinstated restrictions on branching

by state-chartered savings and loan

associations which terminated on

July 1, 1993, equalizing the branching

powers of state-chartered banks and

savings and loans, until July 1, 1996.

It closes the “Mississippi loophole”

that has enabled national banks in

other states to establish de novo

branches despite statutory restrictions on such branching by state

banks. Oklahoma Banker, 4/15/94, p. 1.

52
FDIC Banking Review

Thrift Drops Deposit Insurance

Oklahoma: Home Savings and

Loan Association, Oklahoma City, a

$15 million-asset state-chartered institution, has dropped its deposit insurance, and plans to pass on to

customers its savings on premiums,

offering higher interest rates on deposit accounts. Home Savings is the

second small thrift in the state to have

recently dropped its deposit insurance. Oklahoma is one of the few

states that do not require state-chartered depository institutions to have

FDIC insurance. AB, 5/11/94, p. 3.

Law Barring Home-Equity
 

Loans Overturned
 

Texas: A panel of the Fifth U.S.

Court of Appeals, reversing a lower

court, ruled that federal laws and

regulations preempt a state law that

prohibits most home-equity loans.

Under the homestead provisions of

the state’s constitution, liens on

homes are unenforceable, except for

loans to cover home purchases, taxes

or improvements. WSJ, 5/6/94, p. A4.

Banking Department Receives

Accreditation

Texas: The Department of Banking became the 29th state banking

department to be accredited by the

Conference of State Bank Supervisors. The Departmentsupervises 514

state-chartered banks with more than

$43 billion in assets. Texas Banking, 5/94,

p. 13.

Bank and Thrift

Performance

Insured Banks Earned $12.4

Billion in First Quarter

The FDIC reported that insured

commercial banks earned $11.1 billion in the first quarter of 1994 (preliminary), an amount little changed

from the last quarter of 1993, and

about $400 million below the record

level set in the third quarter of last

year. For the year 1993, the banks

earned $43.4 billion. Net operating

income reached a new quarterly record of $10.7 billion. Lower loan-loss

provisions and overhead expense, as

well as increased noninterest income,

were the principal factors contributing to the record operating earningsin

the quarter. Net interest margins narrowed for the fifth consecutive quarter, as asset yields declined more

rapidly than average funding costs.

The average net interest margin in

the first quarter was 4.26 percent,

down from 4.40 percent in the last

quarter of 1993, and from 4.67 percent

in the last quarter of 1992.

Commercial banks’ total assets

grew by $137 billion in the first quarter, to $3,843.2 billion. This included

a $99-billion increase in the quarter in

banks’ trading account assets which

resulted from changes in accounting

for on-balance-sheet amounts associated with certain off-balance-sheet

derivatives contracts. The only loan

categories having strong growth in the

quarter were commercial and industrial loans, which increased by $10.6

billion, and consumer installment

loans, up by $5.7 billion. Commercial

and industrial loans now have had two

consecutive quarters ofstrong growth.

Noncurrent loans at commercial

banks declined for the twelfth consecutive quarter, to $40.3 billion,

down from $42.7 billion at year-end

1993, and from the peak level of $83.3

billion in the first quarter of 1991.

Commercial banks’ loan-loss provisions and loan charge-offs were the

lowest quarterly amounts since the

mid-1980s. The ratio of equity capital

to total assets was 7.83 percent, down

from 8.01 percent at year-end 1993.

Insured private-sector savings institutions earned $1.3 billion in the

first quarter of 1994 (preliminary),

representing a decline of $365 million

from the previous quarter. Earnings

for the year 1993 were slightly under

$6.9 billion. Over 94 percent of all

savings institutions reported positive

net income in the first quarter. In the

quarter the effects on earnings from

lower loan-loss provisions, reduced

overhead expense and higher net

interest income were offset by large

losses related to balance-sheet restructurings by a few large institutions. Average profitability was virtually unchanged from the previous

quarter at institutions with less than

$5 billion in assets. The average net

interest margin was 3.41 percent, almost unchanged from the 3.39 percent in the fourth quarter, but down

from 3.51 percent a year ago.

Assets of savings institutions decreased in the quarter by $4.1 billion,

to $996.7 billion. Total real-estate

loans fell by $12 billion in the first

quarter, due largely to a drop in home

mortgages. Mortgage-backed securities increased by $7 billion, and now

represent 21 percent of all thrift assets.

Savings institutions’ troubled assets fell from 2.10 percent of total industry assets to 1.96 percent during

the quarter. A year ago, troubled assets represented 3.02 percent of all

industry assets. Net charge-offs of

nearly $800 million contributed to a

$571-million decline in noncurrent

loans during the quarter. Noncurrent

real-estate loansfell to 2.05 percent of

total real-estate loans from 2.09 percent a year ago. Institutions in the

Northeast and West regions continue

to have the highest noncurrent realestate loan rates, at 2.75 and 2.47 percent, respectively. For the rest of the

U.S., the average noncurrent rate is

0.89 percent. Equity capital grew by

$971 million during the quarter, raising the average core capital “leverage” ratio to 7.55 percent at the end of

March, and marking the fourteenth

straight quarterly rise in this ratio.

Seventeen savings institutions

with $7 billion in assets either were

acquired by commercial banks or

switched to commercial bank charters in the first quarter. During the

same time, 28 mutual savings institutions with $18 billion in assets

converted to stock organizations.

Mutuals now account for 48 percent of

all savings institutions and hold 20

percent of the industry’s assets. FDIC

Quarterly Banking Profile, Fourth Quarter 1993;

First Quarter 1994.

53
Recent Developments

Fair Lending Rated Highly
 

Burdensome Rule
 

The compliance rules rated most

often by respondents in a recent survey to be among the most burdensome were the Fair Lending statutes,

followed by the Community Reinvestment Act and the Real Estate Settlement Procedures Act. Fair lending

examinations encompass the Home

Mortgage Disclosure Act, the Equal

Credit Opportunity Act, and the Fair

Housing Act. Compliance examinations are perceived as becoming

longer, more detailed, and more reliant on statistical analysis. The American Banker surveyed 80 compliance

officers, and of the institutions represented, 59 percent had more than $1

billion in assets, 12 percent were between $300 million and $1 billion, and

29 percent were under $300 million.

Compliance areas in which the responses suggested some progress included more involvement by senior

managements in compliance, an improvement in respect to positive attitudes on the part of compliance

officers about their jobs, more participation by men in areas of compliance

responsibilities where women are still

dominant, and expanding compliance

sensitivity more widely throughout

the bank. AB, 6/30/94, p. 16.

Electronic Delivery Systems

Replace Branches

A study sponsored by the BankAdministration Institute concludes that

20 percent of existing bank branches

will likely be closed by the end of

the decade, as cash machines, home

banking, and various electronic delivery systems continue to gain

popularity with consumers. Fiftyseven percent of banking transactions already are taking place

outside traditional branches, according to the study. Information from

more than 35,000 accounts at ten

major banks also indicate wide regional variations in the extent of

branching. The Midwest, for example, is said to be relatively underserved by bank offices. In general,

the older, rural, and small-town residents tend to favor branches, while

the younger, urban bank customers

prefer�cash machines,�telephones and

computers�for�financial�transactions.

The rapid increase in branches in

supermarkets has resulted in another

estimate that 5,000 such branches will

be operating in the U.S. by the year

2000. This would be more than double the 2,100 in-store branches currently in operation and seven times

the 1989 total of 675. Supermarket

branches are seen as having advantages over conventional branches in

usually being far less expensive to

build and maintain, and also they enable banks to better penetrate retail

markets in many cases. AB, 11/22/93, p.

1; 1/27/94, p. 18; 2/16, p. 15.

Usage of Direct Deposit
 

Increasing
 

The number of employees being

paid by direct deposit has tripled in

the past five years to 35 percent of all

employees in the U.S. at year-end

1993, according to the National Automated Clearing House Association.

Over 56 percent of recipients of Social Security benefits receive their

payments by direct deposit. AB, 3/29/94,

p. 14.

Bounced-CheckFees Excessive,

Deposit Interest Rates

Too Low, CFA Says

The Consumer Federation of

America charged that banks are

“gouging” customers on bouncedcheck fees, receiving $4.35 billion in

fees on bounced checks in 1992, over

six times more than the direct cost of

$685 million. The costs consisted of

$581 million in processing expenses

and $104 million in losses on uncollected checks. The $3.67 billion difference between the fees received

and costs for bounced checks represented 11 percent of the industry’s

earnings of $32.2 billion in the year.

An American Bankers Association

spokesman said the amount of fees on

bounced checks reflects cost recoupment and also the industry’s effort to

deter the activity. In addition, quantification of all of the costs related to

bounced checks is difficult.

Large banks, those with assets exceeding $1 billion, had the highest

bounced-check fee markup, 971 percent of costs, according to the CFA’s

study. Banksin the $300 million to $1

billion range showed a 469 percent

markup, and smaller banks, 315 percent. AB, 12/10/93, p. 1.

Banks have not increased their

rates paid on money-market accounts

and NOW accounts, and have started

to raise CD rates only since February,

according to a CFA report, although

money-market fund rates and Treasury-bill rates have been rising for the

past year. The reportsaysthat if commercial banks had paid money-market fund rates on their money-market

accounts, and paid 6-month Treasurybill rates on their CDs, consumers

would have received an additional $500

million in interest in April 1994, and $3

billion more in the twelve months ending in April. BBR, 5/9/94, p. 824.

State’sBanksWillCutFees,

ReduceAccountRestrictions

Through the efforts of the Massachusetts Community and Banking

Council, formed in 1990 and funded

by the state Bankers Association, more

than 140 banks have agreed to charge

nomorethan$3permonthfor checking

and $1 a month for savings accounts.

Deposit accounts can be opened with

only a $10 deposit, and checking accounts will offer eight free withdrawals

a month. The banks also have agreed

on identification requirements that are

easier for customers. Those who cannot present a credit card or a driver’s

license will be able to use utility bills,

for example, as identification. The account changestake effectimmediately.

AB, 6/29/94, p. 5.

BanksMayRequireMore

Information toHelpReduce

BadLoans

By mid-1994 many bankers may be

asking their prospective business borrowers to supply more information,

using a 20-page form developed by

the American Institute of Certified

Public Accountants. The new form

would seek much more extensive and

54
FDIC Banking Review

detailed information than businesses

usually have supplied in the past.

This would include, for example, the

company’s five largest customers and

suppliers and credit terms and limits

for each, the company’s plans for ownership succession, and much more information on accounting policies.

Businesses would be likely to strongly

object to some of the disclosures and

small businesses in particular would

not be able to meet some of the requirements without the additional expense of hiring an outside accountant.

WSJ, 12/16/93.

Environmental Trade Group

Formed

The Environmental Bankers Association has been formed by 25 banks

with a mission of helping to protect

banks from environmental risk and

liability. An official said the Association is not a lobbying organization,

and willfocus on assisting banksinternally in managing their environmental policies. Immediate goals

include developing model environmental policies, preparing a member

roster listing areas of specialization,

establishing a member information

clearinghouse, proposing bank examination protocol, and creating standards for evaluating consultants.

Membership in the trade association

is open to all banks. AB, 3/31/94, p. 9.

Credit Unions’ Assets Now
 

Over $300 Billion
 

Membership in U.S. credit unions

reached 67.6 million at the end of

May 1994, according to estimates released by the Credit Union National

Association, representing a gain of

about 5.8 percent since year-end

1992. Membership in credit unionsin

the U.S. has more than doubled since

1975. Credit unions’ assets grew to an

estimated $300.6 billion in May, up by

4.8 percent from year-end 1993, and

11.4 percent from 1992. The 1993

total was about 36 percent of total

savings and loan assets and eight percent of commercial bank assets.

The estimated number of credit

unions at the end of May was 12,789,

down from 12,960 at year-end 1993.

Of the latter total, 6,031 had assets of

more than $5 million, and 574 had

over $100 million in assets. CUNA

notes that once a credit union reaches

the $5 million size, their customers

require and can support more extensive services such as share drafts,

IRAs, larger consumer loans, automated teller access and credit cards.

At year-end 1993, for example, the

percentages of credit unions having

assets of $5 million to $10 million, and

those over $100 million (in brackets)

offering these services were as follows: share drafts, 66.1 (97.5); IRAs,

68.9 (98.4); ATM cards, 27.7 (97.3);

and credit cards, 42.8 (94.9). It may be

noted that almost 80 percent of the

employees of the $5-10 million group

of credit unions were part-time workers or volunteers. Credit Union Reports,

CUNA.

Recent Articles and Studies

Large Banks’ Role in Banking

Crisis

This article, by John H. Boyd and

Mark Gertler, concludes that in the

banking crisis in the 1980s, banks

with the largest assets contributed

disproportionately to the losses. This

resulted from a combination of circumstances involving deregulation

and financial innovations that led to

increased competition in the industry

and regulatory actions that tended to

subsidize risk-taking by large banks

more than small banks. Large banks

benefitted from a “too big to fail” policy in ways that ranged from favored

treatment at the Federal Reserve’s

discount window to direct subsidies.

One of the undesirable results of this

policy on the part of the federal bank

regulators was to create a nontechnical incentive for banks to become

large.

In support of their thesis, the

authors examine first the potential

sources of loan losses. The losses in

the 1980s were caused to a substantial

extent by regional factors, for example, in the Southwest the collapse of

oil prices, and real-estate prices on the

East and West Coasts. But after allowing for regional conditions, it is shown

that the large banks still performed

below the industry mean. One measure is the larger banks’ relatively low

capital-to-asset ratios in the period.

Up to a certain asset size, a negative

relationship between this ratio and a

bank’s size might be explained by diversification gains and increased access to purchased money markets as a

bank grows larger. However, the ratio

is found here to decline markedly

with size well beyond the point that

might be explained by economies of

scale, and in particular a significant

decline above the $10 billion level is

noted. Other measures of portfolio

risk are presented to indicate that

large banksfollowed higher-risk practices than could be explained by scale

economies.

The authors are against any “sweeping withdrawal” of the safety net.

They are skeptical about the benefits

of mergers of large banks that would

create even larger institutions. Newly

adopted regulatory capital standards

are viewed as having a beneficial effect of forcing banksto internalize the

costs of their portfolio decisions. Under FDICIA, not allowing a large bank

to fail requires the concurrence of

bank regulators and the Secretary of

the Treasury. Other provisions of the

Act restrict discount window lending

as a means of keeping troubled banks

in operation, and impose restrictions

on interbank lending to undercapitalized banks. Quarterly Review, Federal Reserve

Bank of Minneapolis, Winter 1994, pp. 2-21.

Competition in the Credit-Card

Industry

Until about two years ago, creditcard interest rates in the U.S. had remained stable at about 18 percent for

a number of years, although during

this period there were large fluctuations in the costs of funds to lenders.

Wide interest margins in the industry

gave rise to Congressional concern

about the adequacy of price competition among credit-card issuers. The

U.S. General Accounting Office conducted a study of the credit-card

55
Recent Developments

industry between May 1992 and October 1993 focusing on the competitiveness aspects of the industry, and

discussing various policy options.

It can be argued that the structure

of the credit-card industry provides

for adequate competition among card

issuers. The industry has about 6,000

issuers, who set their own interest

rates and other pricing terms, and

there are another 14,000 “participating institutions.” VISA and MasterCard permit virtually any federally

insured depository institution to join

and issue their credit cards. The industry’s concentration level, as measured by the Herfindahl-Hirshman

Index (HHI) estimated to be less than

565 (values of less than 1,000 are consideredtobeunconcentrated),suggests

that the industry should be quite competitive.

Another viewpointisthat the largest

card issuers have dominated the creditcard industry and have conformed to

each other’s interest-rate and pricing

decisions. The evidence, the report

says,doesnot appeartosuggestthat any

one card issuer has acted as a dominant

price leader. There is some evidence

that these issuers have not engaged in

tacit coordinationwhereinfirmswillnot

necessarily match a price increase by

otherfirmsin themarketbutwillmatch

a price decrease — a situation that generally results in stable pricing. Examples given are reductions in interest

rates by some large card issuers in the

past that were not matched by rival

firms.

The reasonswhy credit-cardinterest

rates were stable and industry earnings

were high during the 1980s can be explained by differences between creditcard and other types of lending.

Credit-card lending isriskier than most

other lending activities. Average annual charge-off rates for VISA and

MasterCard members from 1981

through 1993 consistently exceeded

the average charge-off rates for commercial bank lending in the same period; in 1993, the charge-off rate for

credit-card lending was more than five

times the charge-off rate for all bank

lending. Operating costs as a percentage of total lending costs are relatively

high for credit-card lending, while

funding costs are relatively low, thus

changes in funding costs will tend to

be less influential in shaping creditcard interest rates.

When an industry is experiencing

strong growth, as the credit-card industry wasin the 1980s,firmsin thatindustry are not forced to compete as much

on price to maintain their marketshares

and have satisfactory earnings. Moreover, the credit-card industry was not

under competitive pressures caused by

cardholder behavior in the 1980s. Traditionally, shopping by cardholders for

lower interest rates has not been a

strong characteristic of the industry.

Consumers often do not respond to offers of cards with lower interest rates

because of the search and switching

coststhatwouldbe entailed. Cardholders with high credit-card balances and

low incomes may find it particularly

difficult to switch issuers.

Evidence from the early 1990s indicates that consumers have become increasingly concerned about credit-card

debt and interest rates. In the past few

years, improved information about interestrates andother credit-cardpricing

terms has been made available to consumers willing to shop for credit cards.

The better information is attributable

in large measure to the Fair Credit and

Charge Card Disclosure Act of 1988,

which, among other provisions, requires card issuers to provide readilyunderstandable information in all card

solicitations about their interest rates,

annualfees, and graceperiods. TheAct

also requires the Federal Reserve to

collect data on credit-card price and

availability from a broad sample of financial institutions offering credit-card

services, this information to be made

publicly available, and reported to Congress semiannually.

The report concludes that the U.S.

credit-card industry should continue to

be closely monitored to determine

whether the evidences of increased

competition will be sustained. The

report recommends that the Federal

Reserve collect additional information, in particular data on the range of

interest rates that issuers offer to cardholders. More information is needed

for assessing the extent to which cardholders are benefitting from lower card

interest rates, how these rates affect

industry earnings, and the short- and

long-term impacts of competitive developments within the industry. U.S.

Credit-Card Industry, U.S. General Accounting Office,

April 1994.

PreservingMinorityOwnership

ofFinancial Institutions

This U.S. Government Accounting

Office report examines actions taken

by the Department of the Treasury,

FDIC, RTC, and OTS to satisfy the requirements of Section 308 of FIRREA,

and Section 403 of RTCRRIA, which

were designed to preserve minority

ownership of financial institutions and

provide assistance for minority-owned

institutions and minority investors with

acquiring failed institutions.

The FDIC’s approach to preserving minority-owned banks is described

in terms of maintaining the condition

of existing minority-owned banks

(MOBs) through the regular supervisory process. Actions include making

available training, education, and technical assistance in Call Report preparation, consumer affairs and civil rights,

and accounting. In July 1993, the

agency reiterated that, as required by

statute, when resolving failed MOBs,

bids from qualified minority-owned

financial institutions (MOFIs) nationwide are to be generally sought before bids from nonminority-owned

financial institutions (NMOFIs). While

the FDIC generally solicits bids from

qualified MOFIs nationwide during

its marketing efforts,the actualselection

of the winning bidder is determined by

the least-cost approach. In some cases

state law restrictions on interstate acquisitions of failed or failing MOFIs

may be overridden for the benefit of

minority acquirers but not for the

benefit of nonminority acquirers. The

FDIC has established a national list

of potential minority bidders for use in

identifying and contacting minority investors and MOFIs that are interested

56
FDIC Banking Review

in acquiring failed institutions. The

agency has provided assistance in several casesto individualMOBs. In September 1992, agency officialsstated they

would not ordinarily approve a transaction that allows a troubled institution to

acquire a failedinstitutionbecauseofthe

risk involved. One case was approved

because the MOB’s financial condition

had improved. The agency also hassupported several MOBs by using informal

enforcement actions to communicate

bank problemsidentified during the examination.

FDIC-supervised MOBs increased

from 42 in December 1989 to 52 as of

March 31, 1993. From August 1989 to

July 2,1993, 11MOBsfailed, andintheir

resolution the FDIC preserved the minority ownership of two,sold six to nonminorities, and closed three with

payoffs to depositors. MOBs also acquired five failed NMOBs. Total assets of MOBs increased from

approximately $5 billion at the end of

1989 to about $8 billion in March

1993.

The decline in minority-owned

thrifts (MOTs) was not as dramatic as

the decline in nonminority-owned

thrifts (NMOTs): between December 1989 and March 31, 1993, MOTs

were reduced by 27 percent from 56

to 41, while the number of NMOTs

fell by 31 percent from 2,541 to 1,761.

The decrease in assets held by MOTs

was not as dramatic as the decrease in

assets of NMOTs. MOTs’ assets fell

from $7 billion at the end of 1991 to

$6 billion at the end of 1992, but by

the end of the first quarter of 1993

had returned to the level of nearly $7

billion. Assets of NMOTs in the

same period declined from $870 billion to $729 billion.

The RTC’s approach to preserving

the minority ownership of financial

institutions includes extending preferences to bidders of the same ethnicity as the previous owners of the failed

MOT. The RTC had registered, as

of September 14, 1993, 297 minority

investors or MOFIs for its list of potential bidders. RTC also offers interim capital assistance, in the form of

loans, to successful minority bidders

to facilitate the acquisition of institutions. The amount of such assistance

is limited to two-thirds of the minimum capital required by the chartering and regulatory agencies, and is

subject to repayment within two

years. In April 1992, the RTC

amended its minority preference

resolution guidelines to comply with

Section 403 of RTCRRIA which provides for assisting minority investors

or institutions with acquiring failed

NMOTs. When no acceptable bids

are received for failed NMOIs, the

agency may accept bidsfrom minority

investors or institutions and may provide interim capital assistance.

As of May 18, 1993, the RTC had

provided over $7 million in interim

capital assistance to six minority investors or institutions. Since its inception in August 1989 through May

18, 1993, the RTC had resolved 26 of

the 29 failed MOTs. Minority ownership was preserved in 12 of the 26

resolutions. Nine of the remaining

14 failed MOTs were acquired by

NMOIs because no acceptable proposals were received from minorities.

However, the thrifts remained in

their previous locations and continue

to serve the community. Finally, the

RTC closed five MOTs because no

qualified minority or nonminority

group expressed an interest in acquiring them.

Minority trade associations and executives of MOFIs expressed mixed

evaluations of the effectiveness of

the regulatory agencies’ programs.

Some said the FDIC and OTS should

provide their examiners with more

training on the unique circumstances

of the minority-owned banking community and its practices; also, the

agenciesshould not use the same procedures to examine smaller institutions’ loan portfolios that are used for

larger banks. One suggestion was

that an FDIC-managed fund should

be established to allocate capital to

MOFIsthat are attempting to acquire

an institution that is about to fail.

Assistance would be in the form of a

loan to the acquirer. Another suggestion was that the RTC extend preference to minority groups when

considering offers to acquire nonminority-owned institutions or branches

located in minority communities. An

OTS policy requiring $2 million in

capital for new owners to acquire a

failed thrift was said to be too restrictive.

The report said that neither the

FDIC nor OTS had evaluated their

minority-ownership program’s effectiveness, and officials at the agencies

say their focus has been on implementation rather than evaluation of their

programs. Periodically surveying

MOFIs to assess the effectiveness

of current approaches is essential

given the goals of the legislation

and mixed views of the minority

institution community regarding

the agencies’ efforts, the GAO stated.

March 31, 1993 

Supervised Minority-Owned Institutions 

FDIC OTS 

African-American 22 17

Asian-American 17 13

Hispanic-American 11 11

Native-American 2 —

Total 52 41 

Total Assets

($ billions) 8.32 6.51

Assets of Largest

Institution ($ billions) 1.54 1.79

Assets of Largest Five

Institutions ($ billions) 4.98 3.57

“Minority-Owned Financial Institutions — Status

of Federal Efforts to Preserve Minority Ownership,”

U.S. Government Accounting Office, November

1993.

Interstate Banking: Effects of

Deregulation

This report by the U.S. General

Accounting Office analyzes the potential impact of further deregulation

of interstate banking and branching,

focusing on the effects on the structure of the banking industry, the risks

to the safety and soundness of the

industry, and other implications.

Among the specific topics included

are the legal and regulatory factors

57
Recent Developments

that will affect the response to a federal nationwide banking and branching law, and antitrust considerations.

Under the McFadden Act of 1927,

national banks are allowed to branch

anywhere in a state if such branching

is allowed under the state law for

banks chartered in thatstate. The Act

generally prohibits interstate branching by member banks of the Federal

Reserve System. State law governs

interstate branching by state-chartered nonmember banks. New York,

Oregon, Alaska, and North Carolina

permit reciprocal interstate branching, but except for a few minor cases,

no interstate branching has been allowed to date. The Douglas Amendment to the Bank Holding Company

Act of 1956 permits bank holding

companies to establish and acquire a

bank in another state, provided such

action is specifically permitted by the

state the bank holding company

wants to enter. Almost every state

now has some statutory provision for

such interstate banking, subject to

varying restrictions and conditions.

Over time, revisions of state laws

have contributed to a substantial increase in interstate banking. By early

1993, all but two states, Montana and

Hawaii, permitted some form of interstate banking. Thirty-four states and

the District of Columbia permit bank

holding companies to enter from any

state, either on a reciprocal or nonreciprocal basis. The remaining 14

states (as of 11/93) restricted interstate entry to bank holding companies

from their own geographic region.

Before states relaxed their interstate

banking laws, bank holding companies were free to expand interstate

through their nonbank subsidiaries,

and banks also could cross state borders by establishing insured nonbank

banks, Edge Act Corporations, and

loan production offices. The Garn-St

Germain Act of 1982 and the Competitive Equality Banking Act of 1987

authorized the interstate acquisition

of failed banks and thrifts.

At year-end 1992, a majority ofU.S.

banking assets were owned by 190

banking companies that operate bank

subsidiaries in more than one state.

Approximately two-thirds of these

assets were held in the banking companies’ headquarters states, and onethird were held out-of-state. The

nonbank activities of bank holding

companies gave some larger banking

companies a physical presence in virtually every state. In 16 states and

DC, more than 40 percent of each of

the states’ bank assets are owned by

banking companies headquartered

out-of-state. In all except 13 states,

more than ten percent of each of the

states’ bank assets are owned by outof-state banking organizations.

Increased interstate banking is

found to have contributed to a substantial consolidation of the U.S.

banking industry and led to an increase in overall industry concentration. From December 1986 to

December 1992, the number of independent banking companies in the

U.S. declined almost 20 percent, from

10,620 to 8,794, while the percentage

of banking assets controlled by the

three largest banking companies — a

measure of overall industry concentration — increased from 12.8 percent

to 14.4 percent. This increase understates the relative importance of the

larger banking companies, because

they are the main holders of off-balance-sheet accounts excluded from

the calculations. However, the study

finds no direct relationship between

increased interstate banking and

changes in the state and local concentration levels of the three largest

banking companies. The average

concentration levels of the three largest banking companies in local banking markets did not change between

1980 and 1991. Increased interstate

banking does not necessarily mean a

reduced role for smaller banks. Between 1986 and 1992, banks with assets of less than $1 billion, measured

in 1992 dollars, maintained a national

market share of about 20 percent and

increased their market share in nine

of the 16 states with a relatively large

amount of interstate banking.

The study concludes that removing federal interstate banking and

branching restrictions would further

encourage the growth of larger, more

geographically diversified banking

companies. The effects on interstate

banking would depend on the extent

to which state banking laws are overridden, actions of the state and federal

regulators, and business decisions.

While increased interstate banking is

leading to increased national and regional concentrations of assets, concentration at the state and local levels

increases only as a result of mergers

and acquisitions among banksthat are

in the same states or local markets.

Removing interstate banking and

branching restrictions could benefit

the safety and soundness ofthe industry, the regulatory process, and many

bank customers. However, the removal of such restrictions poses risks

as well. The risks can be minimized

if interstate expansion is restricted to

well-managed and well-capitalized

banks, and if the early closure and

safety-and-soundness provisions of

FDICIA are properly implemented.

Risks to the quality and availability of

banking services can best be minimized by ensuring that markets remain competitive through vigilant

antitrust enforcement, and that laws

and regulations governing credit

availability are adequately enforced.

While interstate banking offers potential benefits to banks and the

banking system from reduced costs,

expanded market opportunities, and

greater diversification of risks, the extent that these benefits are realized

depends largely on how well banks

are managed. Interstate Banking — Benefits

and Risks of Removing Regulatory Restrictions,

U.S. General Accounting Office, November 1993.

Banking Concentration Stable

in Most Western Statesin

1980s

Thisstudy by Elizabeth Laderman

examinesthe effect that banking consolidation, including such mergers as

those between Bank of America and

Security Pacific National Bank, and

Wells Fargo Bank and Crocker National Bank, had on concentration of

banking markets in the West from

1982 through 1992.

58
FDIC Banking Review

Antitrust analysis of bank mergers

by the regulatory agencies and Department of Justice focuses mainly on

the effects on the structure of local

banking markets, using as a measure

the Herfindahl-Hirschman Index

(HHI). Thisindex is computed asthe

sum of the squares of the percent market shares of bank deposits of the

competitors in the local market. Under DOJ guidelines, a bank merger

that increases the HHI in a local market by 200 points and results in an

index of atleast 1800 would raise competitive concerns. Deposits of savings institutions are included with a

weight of 50 percent in calculating the

HHI of local banking markets. The

guidelines have resulted in merged

banks being required to divest banking offices to reduce the effects on

market concentration, and even to

denials of merger applications.

Within the Twelfth Federal Reserve District, consisting of Alaska,

Arizona, California, Hawaii, Idaho,

Nevada, Oregon, Utah, and Washington, this study delineates 243 local

banking markets. Statewide average

HHIs were calculated by multiplying

the HHI in each market by a marketspecific weighting factor, which is

the deposits in that market divided

by the sum of all deposits in all local

markets in the state, and adding up

all the weighted HHIs for the state.

The study finds that, for the most

part, bank consolidation has occurred

along with stable or decreasing local

market concentration, and this holds

true in both metropolitan and rural

markets. Even California, with two of

the largest bank mergers, showed a

net decline in weighted average

HHIs. In Arizona and Nevada, the

HHIs declined by 370 points and 989

points, respectively. The two states

with increases in the HHI were

Alaska and Hawaii. In Alaska the

HHI rose by 183, mostly because of

the largest bank’s acquisitions as approved by regulators of several of the

mid-sized banksin the state that were

in weak financial condition. Hawaii

had an increase of 709, in part because

the largest bank in the state acquired

a fairly large savings and loan association.

One factor in the stable or declining HHI in most of the western states

isthe increase in the number of banks

in some local banking markets,

through entry of new banks and

branches of existing banks. From

1982 to 1992, 67 local banking markets saw increases in the number of

banks. For example, new entry

played an important role in the decline in the HHI in both Arizona and

Nevada. Another factor is the “dynamics” of competition in local markets, where an “evening out” of

market shares suggests that small

banks have provided a competitive

check on larger banks. Competitors

may be able to attract customers from

merged institutions because they

close branches or otherwise change

bank practices, which has happened

in some interstate as well as intrastate

acquisitions. Following some of the

larger mergers in particular, competitors have undertaken aggressive promotional campaigns aimed at

attracting the customers of merged or

acquired institutions. Weekly Letter, Federal Reserve Bank of San Francisco, 1/28/94.

59