Sinking in a Sea of Bad Loans

By Janice Castro

The Federal Savings and Loan Insurance Corporation is supposed to be the lifeboat of the thrift industry, but these days the agency itself is in dire need of rescue. Playing its role as the insurer of deposits in savings institutions, the FSLIC has been nearly swamped by adversity. Beset by severe loan losses, 50 of the 3,200 federally insured savings and loan associations and savings banks have either been reorganized or forced by the FSLIC to merge with other institutions this year. As the agency reimburses depositors at collapsed savings and loans and pays out large sums to healthy institutions that agree to absorb weaker ones, it is fast running out of funds. FSLIC officials say its reserves will have shrunk by the end of the year to a precariously low $1 billion, down from $4.6 billion at the end of 1985. The General Accounting Office estimates that the FSLIC will need to give out as much as $22 billion in financial assistance during the next five years.

The insurer had been counting on a lifeline from Congress. The House and Senate passed bills that would have authorized the FSLIC to raise up to $25 billion in the capital markets. But in their rush to adjourn before next week's elections, the lawmakers neglected to reconcile the two different versions of the legislation. Edwin Gray, the chairman of the Federal Home Loan Bank Board, which oversees the FSLIC, had warned the lawmakers that a bailout was urgently needed. Gray said he was "deeply disappointed" by the impasse but vowed that his agency would "do its level best" to manage without the help.

Industry experts think the FSLIC can scrape by until Congress returns in January, and S and L officials insist that depositors are in no danger of losing their money. Says William O'Connell, president of the U.S. League of Savings Institutions: "I don't think there is a crisis. The whole U.S. Government stands behind the deposit-insurance funds."

At the moment, though, the FSLIC is on its own, and the agency has taken several steps in its struggle to stay solvent. For one thing, it has raised the charges it levies on the thrift industry. Besides the basic premiums of $780 million, the agency will assess the industry an additional $1 billion this year. In a more controversial vein, the agency rules governing accounting methods enable thrift institutions to appear stronger than they actually are. For example, S and Ls can stretch out the reporting of losses from mortgage sales. Moreover, 122 S and Ls now count among their assets so-called net-worth certificates, which are little more than Government IOUs that have been handed out by the FSLIC to dress up the balance sheets of troubled institutions. The rules helped Oklahoma-based Frontier Federal Savings & Loan boost its net worth from a negative $44 million to a positive $14 million. The General Accounting Office says that without these accounting gimmicks, 43% of the thrift institutions in the U.S. would be considered insolvent (with fewer assets than liabilities) or nearly so (with a net worth of less than 3% of assets).

Ironically, the woes that confront so many thrift institutions come at a time when the outlook for the industry as a whole is much brighter than it has been in many years. Overall profits are expected to hit a record $6.5 billion this year, a strong rebound from the $4.6 billion loss suffered in 1981. The sharp drop in interest rates since 1981 has been responsible for much of the improvement. The fall in rates has reduced the interest that S and Ls pay to depositors faster than it has lowered the interest that the institutions earn on mortgages.

But while the interest rate trend has been favorable, hundreds of the weakest thrift institutions have been all but overwhelmed by unexpectedly large losses from bad loans. Many of the shakiest institutions are in communities that rely on farming or energy production, which have been deeply depressed. About 31% of the savings associations in Iowa and 43% in Oklahoma are losing money. Just last month, a major oil-patch S and L, Western Savings Association of Dallas, was declared insolvent, and control of its $2 billion in assets was seized by the bank board. It was the third largest thrift industry failure in history.

Many other institutions have run into difficulty by straying into new lines of business during the recent years of financial deregulation, which enabled S and Ls to cut their reliance on home mortgages and expand into riskier fields such as securities trading, commercial loans and real estate developments. Example: Territory Savings & Loan in Seminole, Okla., became insolvent last year, in part because of more than $10 million in losses on securities transactions. In Boynton Beach, Fla., Sunrise Savings & Loan fueled its growth with risky commercial loans on which it could charge high interest rates. Sunrise was reorganized by the bank board last year when its loan portfolio went sour.

Some thrift executives used financial deregulation as an opportunity to become big shots. In the early 1980s, Centennial Savings & Loan of Guerneville, Calif., bought a Cessna company plane, imported a French chef for its executives and invested in projects as diverse as a mushroom farm and a highway construction company. The S and L failed in 1985, and the bank board had to take it over and replace almost all the high-ranking managers. Says Jack Steele, dean of the University of Southern California School of Business Administration and a member of the new board of directors: "The first thing we did when we got in there was sell the airplane and fire the French chef. That was the easy part. The real test will be getting the institution back on its feet."

That is the task that the FSLIC faces with regard to many thrift associations. The agency is likely to meet the challenge, but only with help from Congress in the form of a sizable and swift infusion of cash.

With reporting by Jay Branegan/Washington and Bill Johnson/Los Angeles