CHAPTER

21
Thrift
Operations
Chapter Objectives

 Describe the key sources and uses of funds for

savings institutions
 Evaluate the exposure of savings institutions
to various types of risk
 Describe the savings and loan crisis and its
resolution
Background on Savings Institutions

The term thrift institution (or savings institution)

is normally used to refer to a depository
institution that specializes in mortgage lending.
Characteristics of stock ownership
• Manager/owners have greater potential to benefit
• Opportunity to increase capital
• More susceptible to unfriendly takeovers
Sources of Funds

 Deposits can include:

• Passbook savings
• Certificates of deposit
 Consumer

• Money market accounts

Sources of Funds

 Borrowed funds are an added source of funds

 Sources of borrowed funds include
• Federal funds
• The Federal Reserve’s discount window
• Repurchase agreements
 Long-term sources
• Mortgage-backed securities
• Subordinated debentures
Sources of Funds

 Capital is composed of retained earnings and

funds from issuing stock
• If earnings are strong, capital increases via
retained earnings
• Regulators set minimum capital standards
 Capital is a source of funds
 Serves to maintain confidence in institution
Sources of Funds

 Mortgage-backed securities are issued by

larger institutions to obtain funds
• Other institutions/investors purchase mortgage-
backed securities
• Thrift earns origination fee and may continue to
service the mortgages
• Prepayment risks exist if mortgages are repaid or
prior to their maturity
• Provides liquidity for thrift for reinvestment in
mortgages
Uses of Funds

 Cash and due from accounts

• Satisfies reserve requirements for checking
services - enforced by the Central bank
• Meets liquidity needs if customers decide to
withdraw funds
• Correspondent accounts are cash balances at other
institutions maintained in return for various
services
• Due from accounts assist in the check clearing
process
Uses of Funds

 Mortgages are the primary asset of savings

institutions
 Characteristics of mortgages at savings institutions
• Long-term maturities—15 and 30 year maturities
• Can be prepaid by borrowers
• Most are for homes or multifamily dwellings
• Standardized contracts that can be sold in the secondary
market
• Credit risk and interest rate risk assumed with mortgages
Uses of Funds

 Mortgaged-backed securities may be

purchased
• Receives interest and principal from pool of
mortgages
• Risks include:
 Credit risk
 Price risk
 Prepayment risk– especially when interest rates fall
Uses of Funds

 Other securities include Treasury and

corporate bonds
• Savings banks hold a greater proportion of
securities as compared to savings and loans
• Past investments in junk bonds or high-risk bonds
created problems that led to a regulatory response
Uses of Funds

 Consumer and commercial loans are of

increasing importance on the asset side of the
balance sheet
• This can reduce SIs heavy exposure to mortgage
loans.
• Making corporate & consumer loans & reducing the
concentration of mortgage loans affects overall risk
• Interest rate risk is reduced
• Credit risk increases
Uses of Funds

 Other uses of funds

• Reverse Repurchase agreements—securities
purchased under agreement to resell
• Savings institutions can provide temporary
financing to other institutions through the use of
repurchase agreements.
• Federal funds sold
Both methods allow them to efficiently use funds that they
will have available for only a short period of time.
Exposure to Risk

 Liquidity risk exists because institutions use

short-term liabilities to fund longer-term
assets
• If deposits are not sufficient, institutions obtain
funds from financial market sources for short-term
 Repurchase agreements
 Federal funds/ Interbank borrowing

• Sell marketable assets in exchange for cash

 Treasurysecurities
 Mortgages
Exposure to Risk

 Credit or default risk

• Mortgages represent the primary asset, they are
the main reason for credit risk at SIs.
• To manage the risk savings institutions
 Performcredit analysis
 Geographically diversify their loans
Exposure to Risk

 Interest rate risk

• Commonly measured by the gap or difference
between rate-sensitive assets and liabilities
• Regulators monitor interest rate risk assumed by
savings institutions