Savings Institutions, Not Federally Chartered

SIC 6036

Industry report:

This category includes savings and loan associations operating under state charters and savings banks operating under state charters. Both savings and loan associations and savings banks fall under the general term "thrifts." Thrifts are financial institutions that exist primarily to hold retail deposits and make residential mortgage loans. The thrift industry is the second-largest type of financial institution, after commercial banks. Thrifts can be either federally chartered and regulated by the Treasury Department's Office of Thrift Supervision or state-chartered and subject to regulation varying by state. This article discusses state-chartered thrifts and is intended as a supplement to SIC 6035: Savings Institutions, Federally Chartered. Much information pertinent to both federally and state-chartered institutions is included in that article.

Industry Snapshot

In 2009, there were 64 state-chartered thrift institutions in the United States, compared to more than 1,000 in 1989 and almost 2,500 in 1965. These thrifts held $12.03 billion in assets. State-chartered thrifts accounted for about 8 percent of all thrifts regulated by the Office of Thrift Supervision (OTS) and held just 1 percent of all thrift assets.

The declining number of thrifts in the 2000s reflected regulatory changes that prompted some thrifts to become commercial banks. In 2004, 14 state-chartered thrifts converted to community banks, and 7 converted to state-chartered commercial banks. This trend was also the result of a wave of mergers and acquisitions that began in the late 1990s that transformed the nation's entire financial services world. In 2004, 16 state-chartered thrifts were acquired by commercial banks and 5 were acquired by state-chartered commercial banks; 12 merged with other thrifts and three dissolved operations. This trend continued into the late 2000s; in 2009, 10 experienced charter conversions and 12 were acquired by commercial or state savings banks. In addition, 20 thrifts failed, reflecting the dismal state of the U.S. financial services industry overall.

Of all OTS-supervised thrifts in 2009, one- to four-family mortgage originations were responsible for a majority of total mortgage originations, accounting for $224.3 billion of the total $254.2 billion. Predictably, these figures were down significantly from 2006, when they were $553 billion and $642.2 billion, respectively. Despite the waning number of thrift institutions, the industry's level of assets, deposits, and profits exploded in the early 2000s, mainly because of falling interest rates that sparked record levels of mortgage origination and refinancing loans. Unfortunately, the subprime mortgage crisis that occurred later in the decade shut down many savings and loans and crippled the financial services industry in the United States.

Organization and Structure

Thrifts can be classified in three ways: by type of ownership (stock or mutual), by type of institution (savings and loan association or savings bank), and by type of charter (state or federal). The type of ownership and institution is specified in each thrift's charter, and distinctions between the different types of ownership and institutions are discussed in SIC 6035: Savings Institutions, Federally Chartered. The distinctions between the organization and structure of state-chartered versus federal-chartered thrifts are discussed below.
Depository Insurance.
All thrifts, both federal and state, have federal depository insurance. The Federal Deposit Insurance Corporation (FDIC) is the provider of deposit insurance for all depository institutions. The FDIC merged the Bank Insurance Fund (BIF) and the Savings Association Insurance Fund (SAIF) to form the Deposit Insurance Fund (DIF), effective March 31, 2006, pursuant to the provisions in the Federal Deposit Insurance Reform Act of 2005. The BIF and SAIF were effectively abolished with the act. The Federal Deposit Insurance Corporation (FDIC), an independent federal agency, originally was formed to provide depository insurance for commercial banks, but assumed the role of insurance provider for thrifts with the passage of the 1989 bailout law. Savings banks have always been insured by the FDIC; savings and loans were insured by the now defunct Federal Savings and Loan Insurance Corporation (FSLIC) until 1989. The two funds were kept separate to justify higher insurance premiums at the SAIF. A more thorough discussion of depository insurance is found in article SIC 6035: Savings Institutions, Federally Chartered.
In all states, federal deposit insurance coverage is a necessary condition to obtain and keep a state charter. Those state institutions that opt for federal insurance must comply with any rules of the particular insurance fund, but are not subject to most federal regulatory rules in general, with some important exceptions as explained below. That all state-chartered thrifts had federal insurance, a situation that has existed since the 1980s, did not occur by law. Rather, by the 1980s, most individual state-sponsored insurance funds had failed.

State Regulation.
States can regulate many aspects of state-chartered thrifts. For example, California and Texas have each a separate agency that regulates thrifts. In other states, such as New York, thrifts and commercial banks are regulated by the same agency. Historically, states could regulate the kinds of assets thrifts may acquire; however, the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of 1989 forced state regulation to conform more closely with federal requirements pertaining to asset acquisitions.

States can regulate locations of thrift branches, whether thrifts may have branches in other states, and whether branches may exist for out-of-state thrifts. When a state-chartered thrift becomes insolvent, the state may appoint a conservator or receiver to handle the thrift's assets, though disposition of assets may also be carried out by the Federal Resolution Trust Corporation. (See SIC 6035: Savings Institutions, Federally Chartered.)
Since the passage of FIRREA, state-chartered thrifts must meet net worth and capital-to-asset ratio standards identical to federally chartered thrifts. Before the 1989 act, state thrifts did not have to meet any federal standards beyond the few imposed by the FSLIC for those thrifts that chose to obtain deposit insurance there. However, some leeway still exists for state-chartered thrifts, as those that do meet the net worth standards are free to invest deposits in assets that federal thrifts may not or in certain assets to a greater extent than federal thrifts are allowed. However, the FDIC has the right to veto any asset acquisition of state thrifts if it determines that the asset may pose too much risk for the insurance fund. After FIRREA went into effect, there were fewer distinctions between the types of ventures that are permissible for state versus federal thrifts.

Office of Thrift Supervision.
The Office of Thrift (OTS) System, and its predecessor agency, the Federal Home Loan Bank System, is to thrifts what the Federal Reserve is to banks. OTS provides liquidity to federally chartered savings and loans, which must join it, and to any state-chartered institutions that wish to join.

Reserve Requirement.
State-chartered thrifts are also under the same depository regulations of the Federal Reserve System as all other depository institutions (both state and federal, including thrifts) and must hold a certain amount of deposits as reserves. The Federal Reserve imposes this "reserve requirement" as a hedge against bank runs.

Background and Development

Savings and Loans Versus Savings Banks.
Both savings and loan associations and savings banks have their origins in the nineteenth century. Savings and loans were first created primarily with the goal of fostering home ownership among members of the association. Savings banks, by contrast, were designed to encourage thrift and personal savings but also found mortgage lending to be a sound investment of depositor funds. In this way, savings and loan associations and savings banks came to have similar functions, and their differences in the twentieth century stemmed from variances in regulation and chartering.

Chartering and regulation of savings and loans by individual states was all that existed until the creation of the Federal Home Loan Bank System in 1932. From this time, savings and loans could obtain a federal charter and could have either stock or mutual ownership, but savings banks were only state chartered and mutually owned until 1980. After 1932, state savings and loans willing to pay the premiums could receive federal insurance from the Federal Savings and Loan Insurance Corporation (FSLIC). Aside from FSLIC standards, these state thrifts were exempt from federal regulations. Since state-chartered savings and loans historically held a smaller portion of the industry's assets than federal ones, dual regulation sometimes served as a testing ground for new concepts. Because particular states in the 1970s allowed adjustable rate mortgages (ARMs), notably California and Wisconsin, ARMs became popular enough to convince Congress to allow federal thrifts to offer them. State regulations were for the most part little different from federal ones, perhaps slightly more liberal, until federal deregulation in the early 1980s provided inspiration for many states to allow massive experimentation by thrifts with minimal regulation.

The Depository Institutions Deregulation and Monetary Control Act (DIDMCA) of 1980 and the Garn-St. Germain Act of 1982 deregulated federally chartered thrifts. However, these acts had a profound effect on state-chartered thrifts as well. Because federal thrifts were then able to pay higher deposit rates and could invest those deposits in a much wider variety of consumer and commercial loans, state governments had the incentive to deregulate their own thrift industries. In an effort to allow their state-chartered thrifts to remain competitive with the newly deregulated federal thrifts, several states made regulations much more lenient than even the newly eased federal regulations, with Texas and California leading in leniency followed by Florida and Arizona. In California, the state with the largest number of state-chartered thrifts, the Nolan Bill became law at the beginning of 1983, which allowed almost anyone to own a savings and loan, with unlimited deposits and no rules pertaining to how those deposits may be invested. All of these deposits, for a very small premium, were insured by the FSLIC. Other states passed laws almost as lenient.

It would be an oversimplification to say that deregulation caused savings institutions to fail. Deregulation was a response to the inflation-induced insolvencies of the 1970s, and in the early years of the 1980s, it appeared as if deregulation was helping the industry recover from the previous decade's slump. Yet the facts show that failures of thrifts were more widespread at the state level than at the federal in the mid-1980s, so it can be said that the industry, especially at the state level, grew too fast, accumulating vast quantities of federally insured deposits, which were badly invested without regulation. Deregulation caused a huge increase in new thrift start-ups, mostly at the state level. From 1982 through 1986, some 139 new state charters were granted with only 67 new federal charters. Compared to the new federal thrifts, the new state thrifts had a higher variance of returns on assets, riskier asset portfolios, and were more likely to pay higher than competitive rates on deposits in order to grow more quickly.

Shrinkage of the State-Chartered Segment.
From 1980 to 1986, state-chartered savings and loans declined from 50 percent of all savings and loans to 46 percent then down to 42 percent by 1989. The share of all savings and loan assets held by state-chartered institutions from 1980 to 1986 fell from 44 percent to 36 percent then down to 26 percent by 1989, the level it continued roughly to hold in the mid-1990s. Most of this shift away from state to federal charters happened in the last part of the 1980s because of the realization in the mid-1980s that state-chartered thrifts were more likely to be insolvent. The FIRREA of 1989 reduced the advantages of holding a state charter, leading to more charter flips in the 1990s. Savings banks could not obtain federal charters until 1980, and since the crisis of failures and insurance insolvency did not affect savings banks as harshly, only a handful of savings banks made the switch. Tax law changes in 1996 made it more cost effective for commercial banks to acquire thrifts, and in 1997, a record 77 savings institutions were acquired.

Both state and federal thrifts began recovering in the early 1990s. Lower interest rates and loan refinancing had positive effects on both state and federal thrifts. This led to record profits in the mid-2000s. Even as interest rates began to rise again, thrifts showed stability going into the latter part of the first decade of the twenty-first century. These issues are all discussed in SIC 6035: Savings Institutions, Federally Chartered. At the turn of the twenty-first century there were more than 7,000 state-chartered banks with at least 70 percent having assets under $100 million. As of the early 2000s most state banks were still small community banks.
Charter Flipping.
The rapid switching of state thrifts to federal charters in the mid-1980s resulted from the extra problems of state thrifts. Yet by the early 1990s, some federal thrifts were healthy enough to make the opposite switch. These thrifts tended to be among the healthier and better-capitalized institutions. These healthier thrifts found it possible and advantageous to pursue the few regulatory benefits of a state charter that still existed post-FIRREA. Having met the federal capital-to-assets requirements, these institutions found it advantageous to switch to state charters so that they could invest in a broader variety of assets. By the late 1990s Congress was considering legislation to deregulate the governance of financial services that may be offered by all depository institutions in the areas of securities, insurance, real estate, and similar nonbanking services. President Clinton signed the Gramm-Leach-Bliley Act into law on November 12, 1999. The act was expected to accelerate combinations among banks, brokerages, and insurance companies.

During the mid- to late 1990s many thrifts converted their charters to commercial bank charters. Between 1990 and 1997, some 135 thrifts made this change. This number is astoundingly high considering that only eight thrifts made this change during all of the 1980s, largely due to favorable tax legislation enacted in August of 1996. Also in 1996 there was legislation easing restrictions that allowed commercial banks to qualify for a thrift charter if they wished. This legislation included increasing the amount of credit card loans and student loans a thrift could hold. From 1996 to 1998, some 14 commercial banks converted to savings institutions.

By 2000, there were also an increasing number of community banks, both commercial and thrift. While the total number of community banks in the United States was decreasing due to consolidation, new community banks were proliferating. Independent Community Bankers of America reported in 1999 that the highest number of new or "de novo" community banks formed in nearly a decade, with 205 new charters reported during the year. The last record was in 1989 when 192 new banks were formed.

Since the mid-1980s, the state-chartered portion of the thrift industry has been characterized by a greater rate of insolvencies. Because they were governed by fewer regulatory safeguards than federal thrifts, state thrifts were able to make risky investments with depositors' funds. Throughout the 1990s and early 2000s, the industry saw increasing defection to federal charters among savings and loans, with similar but less widespread charter flipping among savings banks. Between 1990 and 2001, the number of OTS-regulated state-chartered thrifts declined from 850 to 137. The total assets of these state-chartered thrifts declined from $173.3 billion to $24.6 billion over the same period.

In the early 2000s, a weak economy boosted the number of troubled loans as a percentage of total assets at both federally chartered and state-chartered thrifts; however, this figure was below 1 percent in 2002. In fact, as the recession deepened, interest rates plunged, and return on assets for thrifts began to climb, reaching 1.07 percent, their highest level since the mid-1950s, in 2001. Net income for the industry as a whole grew 27 percent to a record $10.2 billion in 2001 as lower interest rates fueled record mortgage refinancing levels, as well as increased new mortgage loan originations. Because one- to four-family mortgages accounted for more than 50 percent of the thrift industry's assets, the rock-bottom interest rates that bolstered both new home mortgages and existing mortgage refinancing also fueled growth for thrifts.

Despite controversy surrounding efforts by nonfinancial companies to secure thrift charters, these firms continued to apply for thrift charters in the late 1990s and early 2000s. Between 1997 and 2001, insurance companies accounted for 53 percent of all nonbank institutions applying for thrift charters. Securities brokers accounted for 18 percent. The total number of new thrift charters peaked in 1998 at 89 and fell to 17 by 2001.

The rapid decline of the number of state-chartered thrifts was indicative, industry proponents argued, of an unfair playing field between state-chartered institutions and federally chartered institutions. In the late 1990s, the Office of the Comptroller of the Currency put into place new rules that provided national banks broad protection from the imposition of state laws. The ruling was designed to allow for consistent business operations within the national banking system, many of whose members operate locations in multiple states. Barbara Rehm noted in American Banker in April 2004: "Until 1980 state-chartered thrifts outnumbered those with federal charters--2,009 to 1,984. But then the state charter began a slow, steady decline as the Office of Thrift Supervision (and its predecessor) promoted the federal charter's power to preempt state laws."

With fewer than 85 state-chartered institutions in 2006, the state-chartered thrifts industry hardly made up the thriving industry they once were. However, the state-chartered thrifts that remained fared well during the first half of the 2000s, bolstered by historically low interest rates and a robust mortgage industry. Net income for the entire thrift industry in 2006 totaled $15.89 billion, down 3 percent from a record $16.4 billion in 2005.

Historic low loan default rates also helped the industry as the low interest rates combined with a stable economy to ease pressure on consumers in the mid-2000s. However, loan delinquencies and foreclosures rose dramatically in 2007 as ARM loans adjusted upward. Even so, the industry's capital position remained strong with the equity capital ratio at a record 10.71 percent of total assets in 2006. Because thrifts are so dependent on the mortgage industry, any changes in the interest rate and overall economy can significantly affect thrifts' performance. Although the largest federal thrifts had the means to grow and diversify through mergers and acquisitions, smaller state-chartered thrifts did not have the same resources at hand. As a result, growth in the industry was limited to say the least.

Current Conditions

The profitability of the mid-2000s came to an abrupt halt in 2007, as interest rates rose, housing prices declined, and the U.S. economy headed downward. Many Americans who had obtained a low-interest adjustable rate mortgage (ARM) earlier in the decade found their house payments rising by several hundred dollars as their low rate expired and a new, much higher interest rate was applied to their mortgages. At the same time, unemployment was increasing and the country was heading into a recession that many compared to the Great Depression of the 1930s. As consumers defaulted on their home loans, and the number of foreclosures reached record highs, thrifts found themselves in a quandary. According to the OTS, thrifts sustained net losses of $649 million in 2007 and $15.8 billion in 2008. Net charge-offs for all loans at OTS-regulated thrifts topped 2 percent in 2008, and in 2009 more than 5 percent of consumer loans were charged off.

Increased profits in the last two quarters of 2009 brought the figures up for the year, and by the end of 2009 the thrift industry was back to breaking even, with industry profitability reported as 0.00 percent. However, more challenges were ahead for the industry. Some of these came in the form of the Dodd-Frank Wall Street Reform and Consumer Protection Act, passed on July 21, 2010. The act called for merging the thrift industry regulator, the OTS, into the Office of the Comptroller of the Currency (OCC), as well as a myriad of other changes to the financial industry. Under the new rules, state-chartered thrifts will be supervised by the FDIC, whereas the Federal Reserve will have supervisory and rulemaking authority over these thrifts. The act also included substantial new penalties for thrifts who do not meet their qualified thrift lender (QTL) test, which served as incentive for thrifts to switch to a commercial bank charter. According to many, the thrift industry was on its last legs. As stated by William Longbrake of the University of Maryland in The New York Times in July 2010: "It's going to be increasingly difficult to say that there's any true thrift industry any longer."

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