FREDRIC J. FORSTER : Back to Home Base for S&Ls; : Bailout Is for Depositors, Not Firms, Says Thrift Leader

Created during the Depression as a separate financial industry to foster home ownership, savings and loans have been re-created more in the image of their banking counterparts under the S&L; legislation signed recently by President Bush.

Many S&Ls;, including some of the 35 in Orange County, are not expected to survive the process because they will not be able to meet tough new standards for capital, an institution’s final reserve against losses. Others will have to revamp their business strategies to comply with new restrictions.

Like many thrift leaders, Fredric J. Forster, president of Newport Balboa Savings in Newport Beach, has been studying provisions of the new legislation.

Forster, 45, is a director of the Federal Home Loan Bank of San Francisco, which, among other duties, provides loans to S&Ls.; He has also been active in the California League of Savings Institutions, where he is a member of the industry trade group’s legislative committee.

He has presided over Newport Balboa Savings, which is expected to have nearly $1 billion in assets by the end of the year, since it was formed 10 years ago. He spoke recently with Times staff writer James S. Granelli about some of the effects the new law will have on S&L; customers and on the institutions themselves.

Q. The new savings and loan law has been termed an “S&L; bailout.” Is that appropriate?

A. It seems to me the concept of government bailout implies the U.S. government stepping in and saving companies. That’s not what’s going on here, and that’s not what’s been going on for some time. We’re dealing with a set of circumstances where literally thousands of companies are going to disappear, maybe hundreds of thousands of stockholders will lose their investments in these companies, tens of thousands of employees will lose their jobs. That’s not a bailout to me. In my mind, what’s going on here, is the government simply making whole their promise to protect depositors, which is what the deposit insurance system is all about. That’s my concern. There’s been a lot of coverage that uses the words “S&L; bailout.” It’s not an S&L; bailout, it’s a bailout of the depositors and the government’s relation to them.

Q. Does it also signal the beginning of the end of the industry?

A. That’s a point of a lot of debate. I think that the industry as we knew it and know it is already gone. I would guess that over the next decade, you will see a blending of the banking and savings and loan industries such that it becomes pretty much one in terms of financial institutions. They will have very similar powers and authorities and abilities to do various things. At that point, there’s a positive aspect, in a sense, because if everybody’s pretty much the same, then you become what you choose to become. And rather than calling it a savings and loan, you may be a financial institution that happens to focus on home lending. Nothing wrong with that. In a way, you’re letting your market determine who you are rather than your charter. And I view that as healthy.

Q. Overall, what is the bill intended to do besides bail out depositors?

A. It has a lot of the flavor of “never again.” The government doesn’t want this mess to occur again. And that implies a lot of restructuring--tougher capital standards, sharper penalties for people who stray--to try to protect the deposit insurance fund, that really is the other main focus to the bill.

Q. Will one of the effects of the law be to stabilize, or lower, interest rates paid to customers for their deposits?

A. There’s no product that’s been invented that doesn’t respond to the forces of supply and demand. That’s true for oil and it’s true for interest rates. And it’s the same kind of forces at work. So when you extract from the marketplace a segment of the people who are competing for deposits, you’d expect the rates to--what our view is not stabilize but--normalize. I think we’ve had an abnormal situation for the last few years as the brain-dead S&Ls; have aggressively competed for deposits. They are entities that shouldn’t have been there in the first place. And if you pull them out, you’re going to get a more normal situation with regard to depositors.

Q. By the same token, would the law effectively push up mortgage rates, especially on adjustable-rate mortgages?

A. You might see more rational behavior in the methodology for establishing rates and terms for home mortgages. That might occur. It might not in the sense that there are other pressures. Particularly, the new risked-based capital regulations might make it more advantageous for banks to participate in home lending. (The S&L; legislation sets out two tests for levels of capital, but it leaves to regulators the task of designing a third, even tougher test based on the risks inherent in S&L; loan and investment portfolios.) That could bring more competitors into a business that’s already very competitive. And when competition becomes very aggressive, anything can happen. I’m much less certain about where home rates are going than other people seem to be. Other people seem to say rates are going to go up because fewer people are offering home loans. I don’t necessarily see that as a conclusion.

Q. S&L; customers who also are taxpayers are going to get hit with several whammies, then. They’re going to end up paying for a large part of this cleanup, they’re possibly going to pay higher rates for mortgages and probably earn lower rates on their deposits. That sounds like bad news. What is the good news in the law?

A. I think the good news is that it’s not going to happen again. I really do believe that a lot of the excessive activity is going to be squeezed out of the business, and you’re not going to see that kind of behavior in the future. I think the risk to the insurance fund after this bill goes into effect is materially, dramatically different from the way it was before. Keep in mind that it can be argued that the abnormal, very high deposit rates that have existed over the last three or four years and the aggressive teaser rates for mortgage programs could be viewed as windfalls for the consumer.

Q. Various provisions of the law seem to make it a little tougher to operate as an S&L.; What would some of the major concerns about the law be from the industry point of view?

A. Clearly, capital is a core issue. It’s unclear to me how many players in the business today are going to be able to respond to the requirements for additional capital. There’s been a lot of attention on good will and the 1.5% and 3% (capital to asset) levels. That’s just the beginning. Risked-based capital is going to take the levels to 6% or 8%, and we’ve got some major, major hurdles to get over as an industry. It is that fact that I think will force a lot of mergers and a lot of liquidations to occur. That, I think, is the biggest impact on the industry.

Q. Several reports suggest that at least 1,000 S&Ls; are going to need new capital. Will they be able to find it, and where will they be able to find it?

A. I would guess they won’t be able to find it. And that’s simply a guess. Every single company is going to have to wrestle with that issue itself. Newport Balboa Savings is in a very unusual position in that we’re owned by a much larger company, ITT Financial Corp., and we simply have access to capital. It’s a decision, it’s not a strategic issue, and the decision is to keep the company well-capitalized and safe. That’s the good news. The bad news is that these are smart, capable people. They want a return on their capital, and so the pressure is there to make the company perform. But for companies that don’t have that kind of choice, it’s going to be a tough, tough road. There are many companies that are going to get the capital, either because the ownership is such that they’ll simply fork it over to stay in the business or because they’re not so far from the goals that they can stretch and make it. Others will not be so fortunate; they will have to seek other ways to get out of the situation.

Q. We’ve got more than 2,900 S&Ls; in the nation. Do you see half of them gone in five years through merger, closure or sale?

A. I’m truly not qualified to respond to that question. That number wouldn’t surprise me, but I haven’t done any kind of study to indicate what that would be.

Q. What business does the law leave for S&Ls;?

A. It leaves them with the business they’ve always been in--that is, the focus on supporting residential lending both for home ownership and also for apartment loans. It leaves them with the reason they were created for in the first place. That doesn’t strike me as a bad thing.

Q. But many savings and loan executives claim that they can’t make money simply on mortgage lending alone.

A. That is yet to be determined. Nobody knows the answer. But it’s clear to me that with potentially lower deposit rates, with more rational behavior in the way home loans are termed, the chances of being successful in that business in the future are higher than they were in the past. So it is unclear to me why people would absolutely conclude that there’s no way for S&Ls; to survive or thrive in that kind of business. I think it can be very successful.

Q. One of the first provisions of the bill that was well-publicized back in February was the increase in premiums for deposit insurance. Will some S&Ls; have trouble trying to pay those increased premiums?

A. It’s a matter of degree. There are so many parts in this play, so many different aspects. That is one that clearly has a negative impact on the potential profitability of business. It could be irrelevant, for instance, in comparison to more favorable terms in the kinds of loans that are made. There are many potential offsets. I am not describing that as a great thing. I’m not happy about the premium change, but it’s not permanent. I think that it was unavoidable.

Q. Is there a likelihood that that cost will be passed on to customers?

A. The price of a mortgage or a deposit, as measured by the rate on either side, is very much a function of the marketplace. It isn’t necessarily a function of cost. The market determines, because of the laws of supply and demand, what those prices are. You then apply the costs that go with the business and you end up with (profit) margins that either are acceptable or unacceptable to the companies in that business. For those who find those margins unacceptable, they get out of the business. Either they’re forced to or they choose to. And the result is you end up with a different kind of competitive environment where you are able to pay less for deposits or get more for mortgages so that the margins become whole again. To me, I see a self-correcting process at work here. Conceivably, the most important part of this bill is that it’s removing a lot of constraints that have existed for a decade on letting the marketplace make those kinds of decisions. Those constraints exist because companies that shouldn’t have been in the marketplace are still there, and they’re there because of the inability of the Federal Savings and Loan Insurance Corp. to pay the bill. So I think it’s too simplistic to think of it as an additional cost that will be passed on to the customer. Maybe it will, maybe it won’t.

Q. At the same time S&Ls; are paying higher insurance premiums and trying to raise capital, they find that some of their business strategies are being restricted. One is the ban on trading in high-yield corporate bonds, otherwise known as junk bonds. Has any S&L; ever lost money on junk bond trading?

A. To the best of my knowledge, no S&L; lost a penny in investments in junk bonds. To me, that’s not the issue. There’s an interesting philosophical difference between proving something is a bad idea versus looking through what’s really going on and saying, “Is this the right thing to do.” And that’s where I come down on this issue. I don’t think it’s a matter of whether they’re good investments or not. I think that there are S&Ls; in California that invest in junk bonds that have magnificent expertise in the handling of those kinds of risks, and have done a marvelous job. Columbia (Savings & Loan in Beverly Hills), in particular, comes to mind. But that doesn’t mean it’s the right thing to do. That’s a separate question. It just does not seem to me to be appropriate for federally insured deposits to be invested in those kind of securities. Some people think differently.

Q. There’s another argument against junk bond trading.

A. The other argument, of course, is that conceivably they haven’t been tested yet. You get a real sharp recession, you might get some losses. I don’t have to go that far to reach a conclusion. I think that it’s appropriate for S&Ls; not to be in that business because it’s not the right thing to do. It strikes me as the wrong place to be with federally insured deposits.

Q. What are the opportunities for S&Ls; under the new law?

A. To me, the opportunity is for those entities that do have access to capital, as we do. There will be growth opportunities and, because we can grow when others may be restricted from growth, they will be chances for us to acquire asset and/or deposit relationships that might not otherwise be available without the shrinkage occurring in the rest of the business. That to me is a tremendous opportunity.

Q. Does that mean you’ll likely look for acquisitions?

A. We have no current plans to acquire other companies.

Q. S&Ls; now will be subjected to banking standards in regulatory examinations. What effect will that have on S&Ls;?

A. Beats me. We don’t know what we’re facing. I would suspect that many of the same people who have examined the company in the past may well be involved in examining the company in the future. But they will have different bosses, who will establish different standards of performance. We are attentive, shall we say, to that issue. How it sorts out, I’ll let you know when it happens.

Q. Does the new law provide enough money to do the job, or will more be needed?

A. Well, I read what you read. There are people who say that it’s going to take more later. I think the job will be harder if major S&Ls; are permitted to withdraw from the system and switch over to the Federal Deposit Insurance Corp. and pay lower premiums. I don’t blame them for trying, either. It just makes good business sense to try to lower your money costs.

Q. You do see the day eventually when the deposit insurance funds for banks and S&Ls; are no longer separate.

A. To me the distinction under the bill is as much art as it is substance. From the U.S. Congress’ perspective, it’s all income. And from the U.S. Congress’ perspective, repairing the damage is all expense. And whether there are separate pots or one pot, from the taxpayers’ perspective, isn’t so critical. My instinct tells me that in 10 years, there will be no difference in the funds or in the institutions. Everybody will be able to do the same things and have the same access to the same things. Basically, it’s a merger through time rather than legislation that the distinction between financial institutions will be so minimal as to be distinctions without a material difference.