New Year Looks Fine for Thrifts

1987 could be the most profitable year ever for the savings and loan industry, surpassing even the record $4.8 billion in after-tax profits the industry posted in 1986.

The profits of California savings and loans accounted for almost one-third of that total.

Savings and loan performance should be strong in 1987 because the industry has moved further to restructure its balance sheet, with a higher percentage of assets in adjustable rate mortgages. Thus, the savings and loans are less susceptible to interest-rate risk. In addition, their cost of funds is lower because of cost-cutting and more efficient management.

Moreover, loan losses are becoming less of a problem in the industry due to the healthy housing and real estate market in most parts of the country. Another factor helping the industry is that the limitations on growth, which have been set by the Federal Home Loan Bank Board, have caused savings and loans to be more careful in their lending since they are restricted on the total amount they can lend.

Last year was a record lending year, particularly for those thrifts in California, Arizona and Nevada--the 11th District of the Federal Home Loan Bank system.

Through the end of October, these lenders had closed $70.2 billion in loans, compared to $60 billion for all of 1985, which was at that time a record. While 1987 should be another good year, it will be difficult to surpass 1986.

Refinancings accounted for one-third to one-half of the 1986 lending, and they should continue strong at least through the first half of 1987, as long as mortgage interest rates remain in the 10% range.

The surprising trend of 1986 was the popularity of the adjustable-rate mortgage, which, by the end of the third quarter, accounted for 70% of the mortgage loans in the 11th District and 40% nationwide.

When mortgage interest rates tumbled, consumers initially rushed to get fixed-rate loans. For several reasons, that soon changed, however, particularly in the West.

First, California lenders have made variable-rate mortgages since the mid-1970s, so consumers here are more familiar with them.

Second, since Westerners are more mobile, they like the adjustables, with their lower origination fees and initial interest rates.

Third, consumers favor adjustables mortgages because they do not have a prepayment penalty, as do most fixed-rate loans.

Fourth, the most common adjustable mortgage in the 11th District is indexed to the 11th District cost of funds, which is a more stable index than the Treasury security indexes commonly used elsewhere.

Lastly, many savings and loans in the West have aggressively marketed adjustable mortgages because they recognize that this is the key to their long-term stability.

During 1986, the consolidation in the industry continued as healthy savings and loans acquired weaker ones and merged with other healthy thrifts.

A new trend was the breakdown of the regulators’ ban on interstate mergers involving two healthy savings and loans. More of these mergers will probably happen in 1987.

The major regulatory issue of 1986--the recapitalization of the Federal Savings and Loan Insurance Corp.--was not resolved by Congress. This year, it stands a better chance of happening.

FSLIC, which insures depositor accounts up to $100,000, has been drained by the rash of failures in the savings and loan industry.

Sen. William Proxmire (D-Wis.), the expected new chairman of the Senate Banking Committee, favors linking recapitalization to limitations on savings and loans’ direct investment in real estate and equity securities.

With two new members on the Federal Home Loan Bank Board, it is unclear what direction the board will take on several issues confronting the industry, such as whether to extend limitations on direct investment in real estate.

Another important subject is what to do with the large number of “sick” savings and loans operated under the management consignment program. Through this program, a “healthy” savings and loan sends in management to operate the “sick” thrift. The problem is how long the healthy savings and loans can afford the loss of some of their best managers.

The 1986 tax reform legislation added a new wrinkle to real estate lending with the creation of the Remic, or real estate mortgage investment conduit. Remics are a compromise between a collateralized mortgage obligation and a traditional mortgage-backed security. What is important about Remics is that they address one of the major issues in designing mortgage-backed securities--the legal structure for transferring payment from the mortgagor to the investor.

With a Remic, cash flows from a pool of mortgages can be rearranged into an almost infinite series of variations without forcing double taxation, which was a problem with many CMOs.

The creation of the Remic means that the investment banking community will play a more important role in the mortgage market, which will force savings and loans to offer more competitive rates.