The merging of the savings and loan industry

The Merging of the Savings and Loan Industry

Changes in the number of savings and loan associations (S&Ls) from year to year occur for four reasons: (1) voluntary, supervisory, and FSLIC-assisted mergers; (2) new charters; (3) member terminations; and (4) defaulted (liquidated) associations. Mergers account for the vast majority of changes in industry size. This article explores historical merger trends with emphasis on the 1980-1983 period and describes the major. characteristics of each type of merger.

Historical Trends

The number of Federal Home Loan Bank (FHLB) member institutions reached a peak of 5,053 in 1965 and has declined steadily each year since then, with the exception of 1978 and 1980 when some mutual savings bank additions boosted the membership totals slightly. Although the rate of S&L merger activity has varied widely from year to year, it has at least exceeded the pace of newly chartered and liquidated S&Ls since 1965.

Adverse economic conditions lead to an increased number of mergers. Table 1, which depicts S&L merger activity from 1970 to 1983, illustrates that the years 1971-1972, 1975, and 1981-1983 were peak merger periods and these years correspond with recessionary periods. Previous research indicates that an approximately one-year time lag may occur between cyclical declines and peak S&L merger activity.1 After eleven months of merger activity in 1983, however, the consolidation of the S&L industry has been reduced to a crawl compared with the two previous years.

1 Kaplan, Smith and Associates, Inc., Study of Mergers Involving Savings and Loan Associations (Washington, DC), 1981.

The total number of annual mergers more than doubled from 1979 to 1980 from 51 to 117. By year-end 1981, the number of annual mergers increased nearly threefold to 315. The merger approval rate was 7.42 percent (number of mergers as a percent of FHLB members) in 1981. In 1982, this rate was 10.55 percent, which is the highest annual rate ever experienced by the industry. After eleven months in 1983, the merger approval rate had dropped to 3.43 percent, which is slightly more than the then record-breaking level of 3 percent in 1975.

A breakdown of the type of merger activity experienced by the S&L industry is shown in Table 2.

On average, voluntary mergers accounted for 65 percent of all mergers from 1980 to November 1983. Approximately 24 percent and 11 percent of all mergers were supervisory and FSLIC-assisted, respectively, during the same period.

The percentage of voluntary to total mergers declined from a high of 77 percent in 1980 to a low of 51 percent in 1982. At the same time, supervisory and FSLIC-assisted mergers grew rapidly as a percentage of total merger activity. Supervisory mergers equalled 15 percent of total activity in 1980, jumping to 39 percent; FSLIC-assisted mergers rose from almost 8 percent in 1980 to over 10 percent in 1982 and 17 percent thus far in 1983. In addition, the total assets of disappearing supervisory and FSLIC-assisted institutions rose sharply, indicating that a number of the assisted cases involved large institutions. In 1982, for example. FSLIC-assisted disappearing institutions accounted for one-third or $24 billion of the total disappearing assets with only 13 percent of the total number of disappearing S&Ls.

Merger Characteristics

This section provides major characteristics of acquiring and acquired institutions involved in three types of mergers: voluntary, supervisory, and FSLIC-assisted. A profile for each type of merger is analyzed by charter type, asset size, and various financial ratios, including measures of asset quality, liability structure, and profitability. Also, some geographic distribution information is provided for each merger type. Tables 3-5 summarize these merger characteristics for 1980 to 1982, respectively. Table 6 provides a breakdown by Federal Home Loan Bank district of merger types for the same period.

Voluntary Mergers

Historically, voluntary mergers have accounted for the majority of all S&L merger activity. An average of 75 percent of all mergers in 1980 and 1981 were voluntary in nature. Only 51 percent of mergers in 1982 were voluntary but, after eleven months in 1983, this figure rose to 61 percent. Not surprisingly, the characteristics of acquiring and acquired institutions involved in voluntary mergers show much similarity, except in asset size. In general, acquiring S&Ls tend to be larger than acquired institutions in voluntary mergers. In 1981, 177 or 76 percent of the 234 acquiring institutions had assets greater than $100 million, while 159 or 68 percent of the acquired institutions had assets less than $100 million.

Since the major portion of the S&L industry (76 percent) has mutual charters, it is not surprising that 72 percent of acquiring and 62 percent of acquired S&Ls involved in voluntary mergers have federal or state mutual charters. Most of the remaining charters involved in voluntary mergers are held by state stock S&Ls.

Financial ratios for the acquiring and acquired institutions vary little in terms of asset quality, liability structure, and profitability. The variation that exists may be largely attributed to the relative sizes of the institutions involved. In 1981, for example, the median ratio of jumbo certificates to total assets was 3.15 percent for acquiring S&Ls and 2.77 percent for acquired institutions. Smaller S&Ls typically do not attract, nor do they seek, jumbo deposits (certificates over $100,000). In terms of profitability, smaller S&Ls may have slightly higher operating expenses than larger S&Ls (1.49 percent to 1.43 percent in 1981), but these differences may be expected to disappear because of increased economies of scale after the merger. Also, since small S&Ls tend not to have jumbo certificates (which pay market rates since there is no ceiling on these accounts), their overall cost of money is lower than larger S&Ls (9.7 percent to 9.79 percent in 1981).

Voluntary merger activity has been most prevalent in the following Federal Home Loan Bank districts: Fourth District (Atlanta Bank), with jurisdiction over Alabama, District of Columbia, Florida, Georgia, Maryland, North Carolina, South Carolina, and Virginia); Fifth District (Cincinnati Bank), with jurisdiction over Kentucky, Ohio, and Tennessee; Seventh District (Chicago Bank), with jurisdiction over Illinois and Wisconsin; and the Ninth District (Dallas Bank), with jurisdiction over Arkansas, Louisiana, Mississippi, New Mexico, and Texas. (See Table 6.) These regions, particularly the states of Florida, Georgia, and Illinois, also account for the majority of the supervisory and FSLIC-assisted mergers. These states are particularly vexatious spots for S&Ls due to past restrictive state laws, including limited branching laws, and usury ceilings. High merger rates in these regions indicate that some consolidation of the industry is needed in order to overcome the harm imposed by past restrictions.

Supervisory Mergers

Institutions whose net worth to total assets ratio hovers around the three percent legal regulatory requirement qualify for a supervisory merger assistance by the Federal Home Loan Bank Board's Office of Examinations and Supervision (OES). Mergers in this category accounted for 15 percent, 19 percent, and 39 percent of total merger activity in 1980, 1981, and 1982, respectively. Twenty-two percent of 1983 mergers, through November, have been supervisory. The charter type and asset size trends noted for voluntry mergers are similar for supervisory mergers. In 1981, 74 percent of the acquiring and acquired institutions were federal or state mutuals, and the remaining charter types are almost all state stock charter types. Forty-five S&Ls or 83 percent of the acquiring institutions had assets greater than $100 million, while 44 S&Ls or 82 percent of the acquired institutions had assets less than $100 million. Thus, larger institutions tend to acquire smaller S&Ls in supervisory cases.

The financial ratios indicate that acquiring S&Ls have substantially better performance levels than the institutions they acquire. The median net worth to total assets in 1981 ratio, for example, was 4.54 percent for acquiring S&Ls and only 0.9 percent for those acquired. Other profitability measures show similar trends during this period.

The cause of the acquired institutions' problems are not readily discernible as a group from Tables 3-5. Further analysis is needed to determine more precisely why these institutions have low net income and net worth levels relative to acquiring S&Ls. The answer may well be a combination of delinquent mortgages; reliance on other borrowing, including jumbo certificates; higher cost of money; and other problems associated with low-yielding mortgage portfolios, high interest rates, and their relatively small size.

FSLIC-Assisted Mergers

After the Federal Home Loan Bank Board has exhausted supervisory merger possibilities, the FSLIC resolves the problem case using the most appropriate combination of assistance, including purchase of assets, loans, contributions, and notes. A balance is sought between protecting the Insurance Fund with the least costly solution and ensuring the long-run viability of the institution. The financial trends observed in supervisory merger cases are more exaggerated in FSLIC-assisted mergers because the acquired institution is clearly experiencing severe financial problems.

Charter type and asset size trends are similar (with one exception noted below) to both voluntary and supervisory merger activity. Federal and state mutuals account for the majority (60 percent of acquiring and 89 percent of acquired) of transactions with state and federal stock accounting for the remainder. In terms of asset size, 22 S&Ls or 82 percent of acquiring institutions have assets greater than $100 million. Of the acquired institutions, 12 or 44 percent have assets less than $100 million and 15 or 56 percent have assets of $100 million or greater. This is a deviation from voluntary and supervisory merger asset size pattern, indicating that some large institutions are acquired by equally large (or larger) S&Ls.

As noted previously, financial ratios for acquired institutions show significant deterioration in absolute terms as well as relative to acquiring institutions. Median net worth levels averaged -0.08 percent in 1981, compared with 5.06 percent for the acquiring institution. Net income ratios were also very poor (-1.95 versus -0.24) in 1981.

In 1981 and 1982, the FSLIC utilized "Phoenix' transactions with primarily note (income capital certificate) assistance to the acquiring institution. The Phoenix program involves the merging of two or more weak or defaulting institutions that the FSLIC hopes will achieve operating economics of scale until permanent solutions are found, such as an interstate acquisition or internal recapitalization. Thus, acquired and acquiring FSLIC-assisted merger statistics are distorted towards poor financial performance making it necessary to separate Phoenx transactions from total assisted mergers in Tables 4 and 5.

After exclusion of Phoenix transactions, FSLIC-assisted acquiring institutions show good asset quality, liability structure, and profitability trends in 1981. Profitability of acquirers, however, drops below the regulatory minimum net worth level of 3 percent to 2.7 percent in 1982. Also, in 1982, the acquirers' cost of money and borrowing ratios are higher than voluntary and supervisory acquirers. This is probably due to worsening economic conditions in 1982 when interest rates reached record-breaking high points.

Conclusion

The shrinking of the S&L industry and consolidation of its financial assets, as a result of the most recent economic recession, have been dramatic. Since 1980, the number of institutions has contracted nearly 20 percent from 4,250 in January 1980 to 3,433 at the end of November 1983. Although merger activity will continue in the immediate future, particularly in supervisory and FSLIC-assisted cases, the rapid and record-breaking pace of the 1981-1982 period is unlikely to persist if economic conditions remain relatively flat and stable.

Futher deregulatory actions may cause merger activity to accelerate. If the breakdown of interstate banking restrictions and blurring of lines between banking and commerce were to occur, firms may find voluntary consolidation more attractive. These are issues that are being addressed by the regulators and the Congress, although no legislative action that may encourage further consolidation of the S&L industry is likely to be forthcoming in the immediate future.

Volatile and high interest and inflation rates largely plunged the thrift industry into a fight for survival, unprecedented since the Great Depression. This shrinkage has had an overriding benefit in that the S&L industry, now leaner and financially stronger, should be better prepared for the inevitable next economic crisis.

Table: Savings and Loan Association Merger Activity: 1970-1983

Table: Type of S&L Merger Activity: 1980-1983

Table: Characteristics of Federal Home Loan Bank System Members Approved for Merger in 1980 Classified by Type of Merger

Table: Characteristics of Federal Home Loan Bank System Members Approved for Merger in 1981 Classified by Type of Merger

Table: Characteristics of Federal Home Loan Bank System Members Approved for Merger in 1982 Classified by Type of Merger

Table: Summary of Merger Activity of Federal Home Loan Bank Members (1980-1982)

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