For Thrifts, It’s the Best of Times--and the Worst of Times

Were the savings and loan industry to be psychoanalyzed these days, chances are excellent that the diagnosis would be acute schizophrenia.

“Never before has there been such a gap between the strong and weak,” says Allan Bortel, a financial analyst at Shearson Lehman Bros.

“It’s going to be a weird year,” says Herschel Rosenthal, a savings and loan executive in Miami.

The reason for these observations is the fact that the once-homogeneous S&L; industry is awash in both profits and problems. The result is a potpourri of good and bad news that has been even the most seasoned S&L; watchers groping for generalizations.

“I’m still trying to figure out how to put the picture together,” says Dennis Jacobe, research director for the U.S. League of Savings Institutions, a Chicago-based trade group.

Industry boosters say the profits are evidence that happy days are here again. S&Ls; have already made more money in the first half of 1985 than in all of 1984 and the outlook for the rest of the year and beyond is just as good if interest rates stay stable.

But doubters fret that the problems are more serious than ever.

More Poor-Quality Loans

Problems with poor-quality loans have jumped so alarmingly in recent months that many question whether the Federal Savings & Loan Insurance Corp., the industry insurance fund known as FSLIC that protects deposits up to $100,000, will survive. Some even worry that the industry itself may already be in the grip of a slow death dance that will end when S&Ls; are absorbed by the commercial banking industry.

What everyone does agree on is that the comfortable old order, where the industry struggled or thrived largely as a group, is gone for good, a casualty of deregulation.

Under the new order, the fat cats are getting fatter, the frail are about to expire and the rest are in limbo. As First Nationwide Savings Chairman Anthony Frank put it, there are the “haves, the could-be-agains and the never-will-bes.”

Industry experts and analysts estimate that 15% of all S&Ls; are robust today, while another 25% are either insolvent or close to it. The other 60% could go either way, depending upon their loan problems and interest rates.

So severe are the differences that while Federal Home Loan Bank Board boasts that S&Ls; are making more money than ever, the Congressional Budget Office warns in its mid-year report that S&Ls; are being “besieged by the increasingly poor quality” of their loan portfolios.

Both agencies are correct.

The nation’s 3,200 FSLIC-insured S&Ls; earned $1.4 billion from April through June, their best quarter in six years, and analysts expect profits for the entire year to be as high as $6 billion. That would shatter the old record of $3.92 billion earned in 1978.

Most Should Profit

The U.S League of Savings Institutions estimates that 90% of the nation’s S&Ls; should make money in the second half of 1985 if interest rates don’t jump sharply. A year ago, that figure stood at about 65%.

“There’s an incredible earnings rebound going on right now,” says Sal Serrantino, an industry consultant in Santa Monica.

Equally valid is the problem-loan concern. Regulators at the Federal Home Loan Bank Board, who oversee almost all the nation’s federally insured savings and loans, now say that bad loans, not high interest rates, are their most formidable challenge.

Billions of dollars in commercial and residential development loans--mostly for condominiums and office buildings--have gone into default due to poor underwriting and a sharp slowdown in inflation that has dampened real estate activity.

The FSLIC, an arm of the Federal Home Loan Bank Board, in turn has the job of cleaning up the loans once the S&Ls; have expired, a costly task that takes years. (That asset portfolio is estimated at about $2.3 billion.)

Last year, the FSLIC fund fell more than 7% to $5.96 billion--its steepest drop ever--and many are predicting the accelerating problems in 1985 mean that it is only a matter of time before the agency is absorbed by the better capitalized Federal Deposit Insurance Corp.

Merger Highly Likely

The possibility of a FSLIC-FDIC merger, which would have to be approved by Congress, is “very high,” concedes one S&L; regulator. (The FDIC insures accounts at most commercial banks and a small number of Eastern savings banks.)

“If the FSLIC can’t keep up with its responsibilities,” said Robert Mueller, president of Morristown, N.J.-based Carteret Savings, “and they don’t seem to be able to, pressure is going to continue to mount for this kind of consolidation,”

The latest official figures show that at the end of 1984, almost 900 S&Ls; failed to meet federal regulatory standards, which require an S&L;’s net worth be kept at a level that is roughly equivalent to 3% of total assets. About 71 of those S&Ls; actually had a negative net worth, meaning that their liabilities exceeded their assets.

So far this year, 33 failing S&Ls; have either been liquidated, merged with healthy institutions or taken over by regulators. That includes eight California-based institutions that have been taken over in the past four months, starting with Beverly Hills Savings in April. The latest--Presidio Savings & Loan Assn. of Porterville--was taken over by the regulators on Wednesday.

In an effort to conserve resources, the FSLIC has kept the eight California institutions open, but has brought in new management teams from other healthy S&Ls; and new boards of directors from the real estate industry. Regulators hope these private-sector experts will identify and dispose of the loan problems more cheaply than overworked FSLIC staff members.

‘Two-Stage Process’

It is part of a “two-stage process,” explains industry consultant Jim Croft, a former regulator. “First, there is the emergency treatment where you stop the bleeding, apply the tourniquet and set the bones. Then, for those who can’t be saved, you comfort them into liquidation. You send the others into the long-term care unit.”

On the plus side, the national environment has been kind for a change, as interest rates have accelerated a decline that began about a year ago. Lower interest rates mean higher profits because they reduce what S&Ls; must pay depositors for their savings.

Today, short-term interest rates are about 3 percentage points below last summer’s level and show no signs of sharp upward movements--good news for an industry that has been rocked by record failures, depositor panics and regulatory upheaval in the past five years.

Though overshadowed by more dramatic events, the positive signs are clearly evident.

In addition to lower interest rates and higher profits, loan demand has been satisfactory, rapid growth has been curbed dramatically and the use of of volatile jumbo certificates of deposit has greatly diminished, regulators say.

(Fast growth is dangerous because it often leads to sloppy lending, they say, while large, uninsured CDs are unstable because those deposits are the first to leave a financial institution in times of trouble.)

The impact has been particularly evident at the huge California-based savings and loans that dominate the industry.

Record Earnings

The parent company of Home Savings of America, for example, earned slightly more money in the second quarter--$55.3 million--than it did all last year. Great Western, Glendale Federal, CalFed and Home Fed of San Diego were some of the large S&Ls; reporting record quarterly earnings.

What’s more, the profit picture would have been even brighter were it not for a special regulatory assessment that will reduce industry profits by as much as $1 billion in 1985. That money is being used to shore up the FSLIC fund.

Industry analysts also say the large institutions have benefited from diversification, which has broadened their profit base, and by making adjustable-rate mortgage loans, which lessens interest-rate sensitivity.

But many S&Ls--particularly; ones that are the “could-be-agains”--remain vulnerable to rises in interest rates because they’re still making too many fixed-rate loans. It was these kinds of loans that caused horrendous losses in 1981 and 1982 when soaring interest rates turned the loans into money-losers. (Unlike a fixed-rate loan, payments on adjustable mortgages move up or down based on interest-rate movements.)

“If interest rates rise, the losses will recur because many S&Ls; have done little to address their interest-rate sensitivity.” according to the Congressional Budget Office report. “Thus, S&Ls; not only remain highly sensitive to interest rate movements but are now besieged by the increasingly poor credit quality of many of their assets.”

Industry Resistance

Any attempt to deal with the asset-quality problem by merging the FSLIC with the FDIC will likely meet fierce resistance because S&Ls; leaders believe the regulatory bureaucracy keeps their institutions apart from commercials banks.

Some also question whether such a merger will do any good.

“Merging the two (insurance funds) doesn’t solve anything,” says Joseph F. Humphrey, chief economist of the Federal Home Loan Bank of San Francisco. “It doesn’t get at the bad assets on the books.”

The asset problems spring largely from the broader lending powers allowed by 1982 deregulation legislation passed by Congress. Lured by large loan fees and the chance to bounce back from heavy losses in 1981 and 1982, savings and loans jumped into big-time commercial and residential development lending and joint-venture deals that were far riskier than their traditional mainstay of single-family mortgages.

“There was tremendous naivete on the part of the lenders over what the lending process was all about,” says Del Mar-based real estate consultant Sanford Goodkin. “They were all trying to be Tarzan and swing on the vines, but the vines turned out to be snakes.”

San Mateo-based Bell Savings, for example, had a healthy regulatory net worth of nearly 3.5% at the end of 1984, according to figures from the Federal Home Loan Bank of San Francisco. However, the financial institution was taken over in July because problem real estate loans wiped out its net worth.

Concern Over Deficits

Many also worry what will happen to interest rates if the huge federal budget deficits continue unchecked. A repeat of 1981 and 1982, when high rates forced hundreds of S&Ls; out of business, would be a disaster, most experts agree.

Some also fear that the S&L; industry, which was founded during the Depression as a means of maintaining a steady source of mortgage money for homeowners, is losing its reason for being because expanded powers have made thrifts so similar to commercial banks. Today, customers can go to either a bank or an S&L; for consumer loans, checking accounts and commercial loans.

Jay Janis, a former Federal Home Loan Bank Board chairman, tried to dramatize the long-term dangers to the industry in a “fantasy” look-forward paper that he wrote as an addendum to a speech he gave to the Senate Banking, Housing and Urban Affairs Committee in late July.

Imagine the year 1994, Janis wrote, and 90% of the industry has gone out of business in the past nine years, leaving only 300 S&Ls; left. The industry shrinkage has been hastened by sustained bouts of high interest rates, continued imprudent lending practices and the loss of industry clout through a FDIC-FSLIC merger. So feeble and obsolete has the industry become that a bill before Congress proposes to eliminate the differences between commercial banks and S&Ls.;

The scenario isn’t that far-fetched, Janis says in a phone interview. “I took the worst case,” he says, “but I really believe something like that could happen.”