Thrifts & Loans Moving Into Mainstream, Observers Say : They Lend Where Other Firms Would Fear to Tread

Robert Bickford never expected to see a physician show up at his Heritage Thrift & Loan in Brea looking for an emergency loan.

But the Irvine doctor who walked in the door six years ago explained that he had filed for bankruptcy and that his credit was shot. He was willing to pay the higher interest rate that thrifts typically charge if he could just qualify for a loan.

“There wasn’t a bank or savings and loan that would lend to him,” said Bickford, president of Heritage. “We sat down with him and found out what was going on.”

It turned out that the doctor had participated in a group medical practice that fell apart because its financial operations were poorly administered, Bickford said. The company went bankrupt, and each of the doctors filed for personal bankruptcy.

“He needed money just to get himself back on his feet and operating as a doctor again,” Bickford said.

While the bankruptcy raised obvious questions about the doctor’s creditworthiness, Heritage executives reviewed his credit history, his character, his available collateral and his capacity to repay the loan.

The doctor got his loan--at an interest rate several percentage points higher than banks would charge--and he got back on his feet.

Traditional Role Exemplified

The incident exemplifies the traditional role of thrifts as lenders of last resort.

Long viewed as “hard money” lenders--institutions that expect to acquire the collateral backing loans because of typically high numbers of defaults--California’s 55 thrift and loans are shedding that image and trying to become lenders of first choice.

“You just don’t take an application on a piece of paper and act on it. You find out what the customer’s doing. You get his side of it,” Bickford said. “Banks and S&Ls; don’t have the time to do that.”

Though the tiny industry attracts only 1% of the state’s $300 billion in deposits, it has gained new lending and depository powers and is seeking more middle-market customers, thrift executives and industry consultants said.

For the first time, thrifts began offering 30-year mortgage loans this month. That ability was one of the last remaining lending powers needed to break down traditional barriers between thrifts and their competitors in the banking and savings and loan industries.

Customers still may pay thrifts several percentage points more in interest, especially for riskier loans, but they get quicker service and more flexible terms in return, executives said. More importantly, they often get loans that no one else would provide.

“Fastest-Growing Industry”

“The thrift and loan business is the fastest-growing industry--on a percentage basis--of any financial industry in California,” said Edward Carpenter, a Costa Mesa financial institutions consultant. And thrifts generally outperform banks and S&Ls; by posting significantly higher rates of return.

The higher returns, he said, are prompting more investors to apply for charters to open new thrifts, much as they did during the 4-year period between 1979 and 1983 when about 30 thrifts were licensed.

“The figures show that this is a high-velocity industry,” said Carpenter, who has helped to license more than 80% of the thrifts chartered since 1975. “These companies have proved very attractive to outside investors and other companies.”

Entry into the business also is relatively low cost. Under state and regulatory laws, new thrifts need only $1.25 million in capital to open their doors, though regulators may require a little more in certain situations. Investors, by law, need to come up with $3 million in capital to open a bank or an S&L.;

Increasing interest in thrifts, however, already is creating a backlash.

Some industry leaders are warning that the market is not big enough for more players and that a rush to open thrifts could push the industry into the same kind of financial quagmire that banks and S&Ls; are only now emerging from. In the early 1980s, the financial-services market was flooded with new banks and S&Ls;, many of which could not survive in the economic downturn that hit the state at the same time.

Thrift and loans are something of a hybrid between banks and finance companies, which do not accept deposits and are not regulated. Thrifts could get hurt during an economic downturn, some bankers argue, because their riskier loans would be the first to go sour.

But Carpenter and thrift executives pointed out that most thrift loans are backed by solid collateral, while banks often lend money simply on personal credit.

At the state Department of Corporations, the primary thrift regulator, officials have recorded a respectable 8% increase in total industry assets to $2.7 billion at the end of September, from $2.5 billion a year earlier.

“It’s a solid industry, but we’re not growing by leaps and bounds,” said Dale Lucas, one of the agency’s chief examiners for thrifts.

The thrift industry was born more than 70 years ago, the child of industrial banking laws passed by many states, including California. Those laws recognized a need for institutions that would provide blue-collar workers with a place to obtain loans they could not get at banks or building and loans, the predecessors of today’s savings and loans.

Thrifts specialize in making short-term, high-interest loans for automobiles, boats and junior mortgages, and in providing small commercial loans and equipment leasing to business customers.

Some Called Industrial Banks

The terminology can get confusing, especially since S&Ls; are sometimes called thrifts. While 22 states still have industrial banking laws, most of them call their institutions industrial banks or even savings banks. Only California’s are commonly called thrift and loans.

Until 1984, deposits at California’s thrifts were insured up to $50,000 per account through the privately financed Thrift Guaranty Fund.

But the failure of Western Community Money Center in Walnut Creek that year prompted the California Legislature to require that all thrifts obtain insurance from the Federal Deposit Insurance Corp. by July 1, 1990. FDIC insures funds up to $100,000 per account, and the agency is backed by the full faith and credit of the federal government.

Only 19 thrifts have yet to comply with the FDIC insurance requirement. They include four Orange County institutions--Centennial in Fountain Valley, North American in Corona del Mar, Savers in Laguna Hills and Chase Manhattan of California, a Newport Beach thrift that still has a loan portfolio but no longer takes deposits.

Thomas Cunningham, executive vice president of the Thrift Guaranty Fund, said he expects that the 19 thrifts will either obtain FDIC insurance by the 1990 deadline or merge with other institutions.

FDIC regulations are strict, but the confidence the public has in the agency usually allows FDIC-insured institutions to acquire deposits at lower interest rates.

While industrial banks are a stagnant or fading industry in many areas of the country, they are booming in California and six other states where FDIC insurance is required, Carpenter said.

The Department of Corporations has 15 applications pending for approval of new thrifts, and the numbers should go up soon.

Carpenter said at least five more thrifts--including First Commercial Thrift in Costa Mesa--have been approved and are getting ready to open. In addition, he said, eight other groups are working with him to prepare applications for thrift charters, and those applications should be filed within 90 days.

Since 1970, a total of 80 thrifts have operated in California. Of that total, four failed, including Orange Coast Thrift in Los Alamitos in 1986. Three were converted to banks or S&Ls--including; Western Financial Savings Bank in Orange--18 were merged into other institutions and 22 have new investors in control.

But a previous wave of thrift start-ups ended in 1982 when investors turned to banks and savings associations to take advantage of deregulation, which gave expanded investment powers to banks and S&Ls.;

Thrift powers have expanded gradually since then, although the institutions have shown little interest in some of the new opportunities available to them. For example, nearly all thrifts have shunned interest-bearing checking accounts, even though they are now able to offer them.

More Inquiries About Mergers

In addition to the applications for new thrifts, thrift executives are getting more inquiries about mergers and acquisitions.

“I get calls from (prospective) investors all the time,” Cunningham said. “It makes a lot more sense to buy an existing one than to start one up.”

Murray Zoota, president of Investors Thrift in Orange, added: “There’s been more activity recently than in the last three or four years.”

Michael McGuire, president of Citizens Thrift in Tustin, said he has been receiving a number of telephone calls and letters asking if Citizens is for sale. He believes that there is enough potential customer demand in California to support at least 20 new thrifts.

“It’s just a matter of being able to find niches in the market where your services can best be utilized,” he said.

But some leaders in financial services believe that Carpenter and others are stirring up a false fervor for thrifts. They contend that the industry is being set up for a fall like the downturns that devastated banks and S&Ls; in the early 1980s, when high interest rates and a real estate bust caused many institutions to fail.

“There are people out there promoting thrift and loans as the wave of the future,” said Gary Findley, a Brea lawyer who represents financial institutions.

“We went through it all a few years ago,” Findley said. “But it’s a hit-or-miss situation. Some applications don’t get approved, or some that do get approved turn out bad. It’s a very competitive industry. It’s tough for me to believe that many are going to make it.”

Van Rhebeck, president of First Fidelity Thrift in Irvine, said he does not think a rush to open new thrifts will occur. Besides, he added, “I don’t really see too many people who are qualified.”

Still, available records indicate that most thrifts are consistent money-makers, a characteristic that tends to catch the eye of potential owners.

$140 Million in Assets

First Fidelity, for instance, had $140 million in assets at the end of 1987, making it, along with Investors Thrift, one of Orange County’s two biggest thrifts. First Fidelity expects to post a $3.1-million profit for 1987--well in excess of what banks of comparable size typically generate, said its president, Van Rhebeck.

Its return on equity--a standard measure of performance and profitability--was 45.4% in 1986. The most profitable bank in the world, the Bank of Stockholm, had a 34.6% return on equity that year, Carpenter said. Executives at banks and S&Ls; usually figure they have done well if they can achieve a 15% return.

One of the keys to the money-making abilities of thrifts is that they typically enjoy a wider profit margin, also known as the spread. The margin is the difference between the interest rate a company earns on loans and investments and the rate it pays on deposits and borrowings.

The average spread--before administrative expenses--for Orange County’s 42 banks in 1986 was 5.37%. The county’s 33 S&Ls; operated on a 3.87% margin that year. But the 14 county-based thrifts had an average spread of 10.42%, Carpenter said.

First Fidelity enjoyed the highest spread at 16.67%, while Chase Manhattan of California Thrift Corp. had the lowest at 6%. Chase, owned by New York’s Chase Manhattan Corp., still has loans on its books but no longer takes deposits.

Such spreads help even tiny thrifts like Citizens, with $44.8 million in assets at the end of the year, post annual earnings of $1.2 million.

Thrift executives cite a number of reasons for the ability of thrifts to enjoy big margins and high profitability:

- Thrifts operate with lower overhead and in less expensive quarters. “How many banks with $44 million in assets have seven branches? None that I know of,” said McGuire about Citizens’ operations.

- Thrifts are short-term lenders, so they get their money back with interest in three to five years. That way, they avoid major long-term interest rate fluctuations that could force them to pay more for deposits than they yield from their loans. That is what happened to long-term lenders such as banks and S&Ls; in the early 1980s when interest rates skyrocketed.

- Thrifts tend to find niches--automobile lending or home-improvement loans--and stay away from businesses with which they are unfamiliar. Though they have authority to offer such high overhead items as interest checking accounts and lines of credit, only a few of the largest thrifts do. And those offering 30-year loans, such as Citizens, are selling them quickly in the secondary market.

- Thrifts typically investigate loan applicants more thoroughly and place less reliance than banks and S&Ls; on making sure loan applicants score enough points in every category, such as creditworthiness and strength of collateral. “People aren’t numbers to me. If you use a score card, you miss their true capabilities,” said Richard Salvetta, president of South Coast Thrift in Santa Ana. If a customer comes up short in some categories, thrifts will still make the loans if the collateral or the ability to repay is strong, he said.

Unique Industry Niche

Though thrifts occupy a unique industry niche, their style has been crimped somewhat by the FDIC. The agency’s bank auditors “don’t have any separate instructions on how to audit thrifts,” McGuire said, and FDIC regulations are forcing thrifts to act more like commercial banks.

First Fidelity’s Rhebeck and others disdain the “hard money” operations of old. They contend that they now offer competitive rates on ordinary loans and that higher rates simply reflect the fact that the loans they make tend to be riskier.

“I believe that when people want to borrow money, they want it now,” Rhebeck said. “They don’t want to borrow it two months from now.”

An emphasis on service is a strong selling point for thrifts.

“The market place is very much the same, though it’s expanded to white-collar workers, too, on the same premise--people who can’t get loans from banks or S&Ls;,” said Robert Bickford of Heritage Thrift.

Bickford cites as an example the once-bankrupt doctor that Heritage helped get back in business.

After paying off that first loan, Bickford said, the doctor made Heritage his first choice about 18 months ago when he took out a $100,000 business loan. The thrift’s collateral was a first trust deed on the doctor’s home.

According to Bickford, the doctor said he was willing to pay one or two percentage points more for the new loan because Heritage had helped him when he was down and out.

“That’s what thrifts are all about,” Bickford said.

COUNTY-BASED THRIFT & LOANS RANKED BY ASSETS Assets at Sept. 30, 1987, and 9-month results for the thrift & loans based in Orange County, as compiled by Edward Carpenter & Associates Inc., Costa Mesa.

Assets Deposits Loans Capital (millions) (millions) (millions) (millions) First Fidelity* $123.9 $115.3 $98.8 $7.5 Investors* 117.8 106.5 114.3 7.7 Liberty** 12.7 11.1 9.0 1.5 South Coast* 43.4 39.5 35.5 3.2 Citizens* 40.8 36.8 36.3 3.5 Heritage* 35.1 32.0 32.5 2.6 Assured* 33.4 30.4 29.7 2.9 Huntington Pacific* 25.8 21.6 21.5 2.7 Centennial 25.1 22.4 16.0 2.6 Tustin 22.2 20.5 18.0 1.6 Franklin* 21.0 19.4 17.6 1.3 North American 11.2 10.1 9.3 .96 Freedom* 6.9 5.4 5.6 1.2 Savers 6.7 7.6 7.6 1.2 Chase Manhattan 1.7 0.0 1.5 1.6 TOTALS $527.7 $478.6 $453.2 $42.06

9-Month ***Spread Profit (Loss) Percent (thousands) First Fidelity* 16.67 $2,374 Investors* 7.2 906 Liberty** 7.2 12 South Coast* 9.03 625 Citizens* 9.54 822 Heritage* 7.52 108 Assured* 8.44 627 Huntington Pacific* 9.53 136 Centennial 14.72 265 Tustin 9.03 105 Franklin* 8.46 (56) North American 9.42 53 Freedom* 9.35 97 Savers 10.34 (157) Chase Manhattan 6.0 45 TOTALS 10.42 $5,962

* Deposits insured by Federal Deposit Insurance Corp.

** Investors Thrift purchased the failed Whittier Thrift in August, 1987, changed its name to Liberty and operates it as a subsidiary.

*** Average loan yields minus cost of deposits.

Source: Edward Carpenter & Associates Inc.

COMPARISONS OF FINANCIAL INSTITUTIONS

Thrift & Loan Bank Required Minimum Capital $1.25 million $3 million Ratio, Deposits to Capital 20-1 14-1 Interest-bearing and Interest-bearing non-interest bearing Deposit Instruments checking account checking accounts Passbook savings Passbook savings Certificate of deposit Certificate of deposit Deposit Insurance FDIC (required by 1991) FDIC Total Loans % of Deposits 100% 70% Business Types of Loans Consumer All types Some real estate Spread** 10.42% 5.37%

Savings & Loan Required Minimum Capital $3 million Ratio, Deposits to Capital *33-1 Interest-bearing Deposit Instruments checking account Passbook savings Certificate of deposit Deposit Insurance FSLIC Total Loans % of Deposits 100% Primarily real estate Types of Loans (Percentage can’t fall below 60%) Spread** 3.87%

* Proposed U.S. law would require 20-1 ratio by 1991.

** Average loan yields minus cost of deposits for Orange County institutions.

Source: Edward Carpenter & Associates Inc.