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October 6, 2011

Resolution Trust Corporation, History May be Repeating

The two decades that followed the end of World War II were the most robust periods of growth experienced by the S&L industry. As millions of servicemen returned we experienced a dramatic increase in our population which spurred a home building boom.  After the 1940s S&Ls provided most of the financing for this expansion.¹ Within…

Resolution Trust Corporation, History May be Repeating

The two decades that followed the end of World War II were the most robust periods of growth experienced by the S&L industry. As millions of servicemen returned we experienced a dramatic increase in our population which spurred a home building boom.  After the 1940s S&Ls provided most of the financing for this expansion.¹

Within the industry there was stiff competition for new deposits as deposit accounts were the lifeline of the business. In an effort to lure new deposits and spurred by an increase in competition, S&L’s waged rate wars with one another, promising hefty interest on new deposits. These rate wars became so severe that in 1966 the government set limits on savings rates. As interest rates rose depositors would withdraw their funds from the S&Ls and place their money in more competitive investments that kept pace with inflation.

In response to these economic conditions, S&L managers came up with several “innovations,” such as alternative mortgage instruments and interest-bearing checking accounts as a way to retain funds and generate lending business. Despite growth generated from the additional business lines, there were still clear signs that the industry was headed for hardship.

In 1979, the financial health of the S&L industry was challenged by a return of high interest rates and inflation. In response, Congress acted on deregulating the thrift industry. The deregulation not only allowed thrifts to offer a wider array of savings products, but also significantly expanded their lending authority. These changes were intended to allow S&Ls to “grow” out of their problems.

The deregulation of S&Ls gave these organizations many of the same capabilities as banks, without the same regulations. S&Ls quickly moved under federal charter which effectively backed their potential losses with US tax payer dollars at a time when their core business was under severe pressure.  By insuring the risk, the government guaranteed that desperate S&L owners and managers would engage in ever more risky investments, knowing that if they were successful, the institution would be saved, and if unsuccessful, their depositors would still be bailed out by Uncle Sam. Simply stated, the S&Ls took on riskier assets, particularly land and developments.

When the real estate market crashed, the S&Ls went with it. In an effort to take advantage of the real estate boom (outstanding US mortgage loans 1976: $700 billion – 1980: $1.5 trillion) and high interest rates of the late 1970s and early 1980s, many S&Ls lent far more money than was prudent, and explored risky ventures which many S&Ls were not qualified to assess. At the same time, the US Government passed the Tax Reform of 1986 which led to a precipitous decline in real estate values.

As a result of poor initial regulation and the subsequent inability to effectively deregulate the industry while properly managing risk, many S&Ls became insolvent. As each S&L began to fail deposits were transferred to healthy institutions and assets were transferred to the Resolution Trust Corporation for liquidation.

The Resolution Trust Corporation (RTC) was a United States Government-owned asset management company charged with liquidating assets (primarily real estate-related assets, including mortgage loans) that had been assets of S&Ls declared insolvent. Between 1989 and mid-1995, the RTC closed or otherwise resolved 747 S&Ls with total assets of $394 billion. ² As the RTC took possession of assets for the purposes of liquidation private investors were attracted to bid because they had a unique window of opportunity to acquire quality assets at depressed values. Because of the negative stigma at the time regarding real estate assets and the fear in the general market surrounding economic uncertainty, buyers of RTC assets realized unprecedented returns. To ensure the US taxpayer participated on any upside the RTC retained an equity ownership position in these pools which ultimately helped recover a large part of the big tax payer bailout when the assets appreciated in value which they did.  The federal government sold off bank debt at cents on the dollar in auctions and buyers, mainly large investment firms, who were able to cure the loans reaped generous returns.

By 1995, the S&L crisis abated and the agency was folded into the Federal Deposit Insurance Corporation, which Congress created during the Great Depression to regulate banks and protect the accounts of customers when they fail.

Fast Forward to today and the current environment and the story outlined above looks all too familiar. The increase in home ownership from 2005-2008 can be traced to the explosion of the Residential Mortgage Backed Securities (RMBS) market during the same time period.

Banks and mortgage brokers originated home loans, packaged them into massive securitized pools and sold them to investors in the form of bonds. Because few of the originators intended on holding the loans on their own balance sheets and Wall Street’s insatiable appetite for yield, underwriting became increasingly lax. Home buyers that had no business qualifying for high leverage financing were finding it easy to access. As capital flooded in to the residential mortgage space home values continued to rise and low interest-high leverage loans only helped to catalyze the process.

Because Wall Street was hungry for yield, these exotic mortgage products carried adjustable rates which hiked interest rates over a defined period of time over the life of the loan. Increasingly borrowers were not capable of meeting their mortgage obligations and were falling behind on payments. As defaults began to mount, RMBS investors became spooked about the quality of the bonds they were holding and the inherent risk they had assumed. A complete dislocation of the capital markets ensued as a once very liquid market froze over-night. Because the market had no way to evaluate the risk associated with the paper investors held, values plummeted. Every major financial institution was exposed to the RMBS market in some fashion and as the value of the investments began to sink loses began to mount sending shock waves through the capital markets.

350+ banks have been shut down since 2008…size of circle represents value of assets at time of closure.

The fall-out of the credit crisis has led to the failure of many regional banks. 25 banks failed in 2008, 140 in 2009 and 158 in 2010.

Today’s procedure for bank failures is not too different than it was in the RTC days. When banks fail deposits are moved to healthy institutions and assets of the failed banks are moved to the FDIC who is responsible, as was the RTC, for the liquidation of these assets. Sound familiar? Today’s opportunity is not unlike that of the late 1980’s and early 1990’s. The FDIC, now responsible for the timely liquidation of assets held by failed banks, is attempting to entice risk-adverse investors back in to the market by selling assets at severely depressed prices, financing acquisitions and insuring loses. Once again investors are faced with a once in a cycle opportunity to capitalize on market dislocation created by a confluence of failures.

For more information on this article or to schedule a free consultation, please contact the South Coast Office.

Posted by Chris



Citations / Disclosures: This article is strictly for educational purposes and not intended as an offer to buy or sell securities.  Such offers are made through a sponsor’s Private Placement Memorandum.1-Wall Street Journal – Tracking the Nation’s Bank Failures  2-The Bank Implode Meter  3-FDIC –Federal Deposit Insurance Corporation  4-The New York Times- Resolution Trust Corporation

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