Prognosis for Ailing Thrifts Takes a Turn for the Better : Bailout: Analysts say last year was the first profitable one for the industry in five years.
Like a patient who has been through radical surgery, the nation’s thrift industry is entering a post-operative phase. The prognosis for the drastically shrunken business is a slow, steady recovery but with a severe relapse looming if the economy doesn’t pick up soon.
The year 1991 is expected to be certified in a few weeks as the first profitable one for the nation’s savings and loans in five years, with four consecutive quarters without a loss for the industry as a whole.
The nation’s chief savings and loan regulator, Office of Thrift Supervision Director Timothy Ryan, is now characterizing the government’s clean-up of the ailing industry as being in “the bottom of the eighth inning.” One recent report by the Washington consulting firm Financial Research Institute described the thrift business as emerging “through a long, dark night into a new dawn.”
“At this point, the industry appears to be in the eye in the storm,” said Dennis Jacobe, the research firm’s managing director. “If things turn up by midyear, then maybe we’ll have stabilized.”
The most recent numbers have been encouraging. Through Oct. 31 of 1991, OTS reported, S&Ls; overall earned more than $1 billion. About 86% of the nation’s thrifts made money in the third quarter, with 75% earning a profit in the first nine months of 1991.
Contrast that trend with the year 1990, when S&Ls; still in private hands lost $2.9 billion. Since 1986, the last full year the thrift industry was profitable, the S&L; industry’s cumulative losses have totaled nearly $30 billion.
Final results for the industry’s performance in 1991 won’t be available until March. But in California, strong fourth-quarter and year-end results have been posted over the past two weeks by such large institutions as the parent firms of World Savings & Loan, Home Savings of America and Great Western Bank.
Part of the reason S&Ls; as a group look healthier is statistical. Federal regulators have seized, liquidated or found buyers for most of the biggest money losers. When that happens, losses stemming from those institutions are no longer counted when the government computes the industry’s overall performance.
Nonetheless, the stronger results being posted now by thrifts reflect a surprisingly good year, caused largely by the sharp fall in interest rates. Thrifts benefit because the drop in the rates homeowners pay on their adjustable-rate mortgages lag behind the drop in the rates that S&Ls; pay depositors.
Some California S&Ls; reported record spreads between what they pay out on deposits and what they take in from homeowners making their mortgage payments. One benefit is that the boost in profits has allowed some thrifts to further bolster the funds they have set aside as a buffer against future losses on real estate loans.
In addition, the aggressive purging of sick S&Ls; by regulators has brought relief for many healthy S&Ls.; That helps healthy thrifts because their ailing competitors, desperate for funds, drive up the cost of funds by offering sky-high rates to depositors.
In an interview, Ryan conceded that he’s much less worried about the industry now than in the past. Giving him comfort, he said, is the growth in the industry’s capital--the financial safety net that protects against losses--from virtually nothing when the S&L; debacle began spiraling out of control in the late 1980s.
“The cushion between the taxpayer and the institutions is on average 5% of the total assets in the industry. That did not exist when the system crashed,” Ryan said.
The S&L; mess stems from loose supervision in the 1980s that allowed thrifts to expand into risky investments such as real estate development and junk bonds. When those investments soured, S&Ls; that bet heavily on them failed and the clean-up job began through the federal Resolution Trust Corp. The number of insolvent thrifts, more than 600 in 1989, dropped to about 100 by the end of October.
It’s unlikely, however, that strong profits in 1991 will make any dent at all in the tab taxpayers will ultimately pay for cleaning up the thrift industry, already estimated at more than $500 billion over the next 40 years. Most of the damage has already been done. What it does mean, however, is that odds are increasing that the problem won’t get a lot worse as many feared last year.
That isn’t to say the entire S&L; business is healthy now. There are still a handful of large S&Ls--four; of them in California--that are having trouble building up an adequate financial cushion to protect against losses. At stake is their future as independent thrifts, and the possibility of sizable losses for taxpayers should their problems deteriorate.
Industry executives and analysts agree the most troubled institution now is the parent of HomeFed Bank in San Diego, a thrift that was staggered last year by losses on commercial real estate projects. The most likely scenario is a government seizure or a sale to a bank or thrift via a government-assisted deal. Under either scenario, deposits up to $100,000 will remain protected under the federal government’s deposit insurance program.
Also under the gun is CalFed, parent of California Federal Bank. Government regulators have proposed that it pump $375 million into the thrift by midyear, an action that has been interpreted as a means to force the institution to find a buyer on its own or agree to a government-assisted sale. Industry sources said Ryan, the government’s thrift regulator, met with CalFed’s directors last Monday in Los Angeles, although they added that the dispute between the company and regulators remains unresolved for now.
Two others facing pressure, albeit less than CalFed and HomeFed, are the parent firms of Glendale Federal Bank in Glendale and Coast Federal Bank in Los Angeles. Both institutions have undergone a sweeping overhaul of their operations, although it is unclear whether the changes will be enough to ensure their continued independence.
The S&L; industry that remains today is a much smaller one, with institutions that are increasingly looking like banks. The number of thrifts in private hands has fallen by nearly 1,200 over the past five years to about 2,100 today. Dominating the S&L; business today are stronger, healthier players that did not stray from making home loans.
“They are getting rid of more and more of the weak institutions, and that’s good. When you strip out the losses, then the good part of the industry is able to come through more. But what you end up with is a substantially shrunken industry,” said Bert Ely, an Alexandria, Va.-based banking and thrift consultant.
The economy continues to be a wild card. A recovery will solidify the industry’s comeback, and President Bush’s proposals to spark home buying could help even more. But continued economic sluggishness could cause marginal thrifts to fail. Delinquencies on home loans in California have been rising at some major thrifts, and the prospect of further cuts in defense spending bodes ill for lenders. But most analysts don’t see an outright plunge in housing prices.
“California is still not out of the woods, but people don’t believe housing prices will collapse,” said Peter Treadway, a thrift analyst with Smith Barney, Harris Upham & Co. in New York.
Although thrifts are benefiting from the lower interest rates caused by Fed actions to pump up the economy, some new problems are emerging. The lower rates on certificates of deposit are prompting some people to shop around for investments that will yield more. In addition, thrifts could start to feel a financial squeeze later this year if interest rates bottom out because the gap between what they receive from home-loan payments and what they pay out to depositors will inevitably shrink.
Moreover, the adjustable-rate mortgages, or ARMs, that thrifts have pushed since the early 1980s are unpopular with home buyers now because people would rather lock in fixed-rate mortgages at today’s low rates. Lower rates also have triggered a wave of refinancing as well as heated competition from mortgage bankers who make fixed-rate loans.
This development has triggered concerns that California thrifts whose chief business is making ARMs will see their loan business shrink. But thrift executives believe that the development is temporary, and that ARMs will return to popularity once interest rates bottom out and rise again.
“When fixed rates become very popular, people predict the demise of adjustable mortgages. But every time rates bottom out and rise, fixed-rate lenders seem to disappear,” said Great Western Chief Executive James F. Montgomery.
ARMs are generally more lucrative to S&Ls.; In most cases, large thrifts such as Great Western sell what fixed-rate mortgages they make to buyers of home loans such as Fannie Mae because they don’t want those loans on their books should interest rates climb again.
The flurry of fixed-rate lending by S&Ls; is raising concerns that smaller thrifts will forget the lessons learned when inflation was high in the early 1980s. In those days, S&Ls;, stuck with low-rate mortgages on their books, paid out more to depositors than they took in from mortgage payments.
“My big concern would be that people are forgetting the lessons of the past,” said Herbert M. Sandler, chairman of Golden West Financial, the Oakland-based parent of World Savings.
