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April 8) 1977 Housing Specialists Households are now spending more out of income) and thus are beginning to slow down their flow of funds into the nation's thrift institutions. Yet savings flows are still immense in relation to past historical patterns. No one expects a repetition of the 1976 experience) when net savings at savings-andloan associations rose 18 percent above the 1975 record to a nev.' peak of $46 billion) but most observers believe that heavy inflows of funds will continue to support a strong upturn in housing activity. Indeed) there is no question about the immediate future) since commitments for future mortgage lending were 38 percent higher in February than a year earlier. l\tiaill1taill1 Bng predominance The S&L's remain the nation's housing specialists)with $323 billion in mortgage debtoutstanding at yearend 1 976-up 14 percent for the year. The thrifts hope to maintain their strong position) with the help of Congress' expected extension of interest-rate ceiling on savings deposits-a move which would allow them to retain the one-quarter percent differential over commercial-bank rates. Although Congress last year shelved financial-reform proposals that would have permitted S&L's to expand outside the mortgage-lending field) the thrifts continue to argue for expanded lending powers while testing new ways of stabilizing flows of funds into housing. The very substantial (albeit reduced) savings flows reflect the fact that S&L rates still represent the best game in town for household and other savers.For more than a year) rates on Treasury bills and other short-term money-market instruments have remained almost consistently below the 51;4-percent S&L passbook rate. Rate spreads between longer-term governments and S&L certificates also have favored the latter. Given the recent signs of tightening in market rates) S&L'smay be under less pressure than they were in late 1976to reduce their cost of funds. At that time) the large supply of funds-along with increased commercial-bank activity in mortgage markets-put downward pressure on mortgage rates. In the face of a heavy savings inflow) the thrifts tried to maintain a viable spread between the rates they were charging for mortgages and the rates they were paying for savings) primarily by marginal measures rather than by basic rate reductions. Many S&L's eliminated their longest-dated certificates and raised minimum deposits on intermediate-maturity certificates. A few even reduced rates on passbook accounts) but soon scrambled back to higher ground when the market failed to follow them. Protection through VRM's Whatever their feeling about the direction of rates in the short term) (continued on page 2) Opinions expressed in this newsietter do not necessarily reflect the views of the rnanagement of the Federal Reserve Bank of San Francisco, nor of the Board of Governors of the Federal Reserve System. thrift industry leaders have shown increased interest in protecting themselves against the long-term threat of inflation through new types of mortgage contracts. The most common of these is the variable interest-rate mortgage-the VIR or VRM-under which the rate charged varies over the life of the instrument (within prescribed limits) in line with some index of the mortgagor's cost of funds. The instrument is designed to reduce the likelihood of disintermediationthat is, to assure continued availability of lendable funds-during periods of high interest rates. Because the VRM shifts some of the interest-rate risk formerly borne solely by the mortgagor to the mortgagee, some regu latory agencies are hesitant to permit them. For example, Federally chartered S&l's are not yet able to offer them to their customers. In California, however, eighteen state-chartered S&L's, along with two major commercial banks, have been offering VRM's for more than a year. Roughly two-thirds of the total lending by S&l's offering VRM's has been in this type of mortgage, with the two banks reporting somewhat lower figures. Terms vary among offering institutions, but most permit refinancing with no prepayment penalty in the event of an upward adjustment in the variable mortgage rate. California institutions tie their variable rate to the weighted cost of funds paid by California members 2 of the Federal Home Loan Bank System.Available semi-annually with a lag, this index has fluctuated narrowly over the past two years, never dropping the ten basis points which (under state law) would call for a mortgage rate reduction. (Over the second half of 1976,the California indexed rate rose from 6.382percent to 6.394 percent.) In contrast, one Massachusettsinstitution reduced its mortgage rate by 25 basis points (one-quarter percentage point) last October when the index used in that state permitted such a reduction. Proteduon through GN M A Federal support will remain a major feature of the 1977 mortgage market, following 1976's15.5-percent increase (to.$117 billion) in mortgages underwritten or insured by federal programs. Direct subsidy programs for housing are due to double this year under the new administration's budget, but the biggest assistshould come indirectly from secondary-market support programs, such as the pass-through bonds developed by the Government National Mortgage Association (GNMA). Under this system, a mortgage issuer assemblesa pool of VA and FHA loans bearing the same interest rate and similar maturity and converts them into a GNMA security, thus freeing up funds to be reinvested in new mortgages. In late 1976, about 500 firms were active in the GNMA marketpredominantly mortgage-banking companies which specialize in the origination of VA and FHA mortgages. During the year, outstanding issuesof pass-through bonds jumped from $18 billion to almost $31 billion. Becauseof their government sponsorship and efficient packaging, they could be marketed at a rate 50 basis points below the rate on the underlying mortgagesand in consequence have become popular with managers of pension funds and trust funds, as well as private individuals able to afford the $25,000 price per security. In fact, the general successof passthrough bonds has led some lenders to try to extend this technique to pools of conventional mortgages. Altogether, thrift institutions appear to be in rather good shape to finance the 1.8 million units (or more) which the housing industry plans to build this year. Of course, there could be trouble later on if savings flows slow down in response to rising market interest rates. But any development of that type would also tend to speed the thrift industry's adoption of new mortgage instruments geared to offset the impact of inflation on S&L balance sheets. joan Walsh Note to Subscribers Reply cards were recently sent to all subscribers of this publication and responses are presently being used to compile a current mailing list. please return your card promptly if you wish to continue receiving the publication. If you did not receive a card, contact the Public Information Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120,phone (415)544-2184. 3 uOl13U!4SBM. 4Bln • uo13cuO BpBAaN BPI • .04 !!BMBH • B!UJOJ!lB:) BUOZPV .. B)jSBIV 0 c5I c5I BANKING DATA-TWELfTH FEDERAL RESERVE DISTRICT (Dollar amounts in millions) SelectedAssetsand Liabilities LargeCommercial Banks Amount Outstanding Change from 3/23/77 3/16/77 Changefrom year ago Dollar Percent + 7.47 + 6,537 + 10.37 + 6,738 + 528 + 58.67 + 3.45 + 783 + 13.04 + 2,559 + 14.97 + 1,619 Loans(gross,adjusted)and investments* 93,996 - 835 Loans(gross,adjusted)-total 71,723 - 529 Security loans 1,428 - 268 + 63 Commercial and industrial 23,509 + 47 Real estate 22,182 Consumerinstalment 12,434 + 30 + 94 - 3.81 U.S.Treasurysecurities 9,361 - 371 + 170 + 1.33 Other securities 12,912 - 400 + 6.61 Deposits(lesscash items)-total* 93,199 + 5,782 - 646 + 8.10 26,037 + 1,952 Demand deposits(adjusted) - 745 19 U.S.Government deposits 224 - 7.82 - 768 Time deposits-total* + 660 + 3,277 + 5.30 65,129 Statesand political subdivisions 5,344 41 - 827 - 13.40 31,658 + 25.09 Savings deposits + 132 + 6,350 Other time depositst 26,027 + 522 - 1,874 - 6.72 Largenegotiable CD's 9,458 + 529 - 3,237 - 25.50 Comparable Weekly Averages Week ended Week ended year-agoperiod of Daily Figures 3/23/77 3/16/77 Member Bank Resee,zt! Position + 73 Excess Reserves (+)/Deficiency (-) + 48 + 25 Borrowings 2 50 1 + 71 Net free(+)lNet borrowed (-) 2 + 24 FederalFunds-Seven LargeBanks Interbank Federalfund transactions + 1,287 Net purchases(+)/Net sales(-) + 117 + 79 Transactions with U.S.security dealers + 461 + 25 Net loans(+)/Net borrowings (-) + 147 *Includes items not shown separately.tlndividuals, partnershipsand corporations. Editorial commentsmay be addressed the editor (William Burke) or to the author•••. to Information on this and other publications can be obtained by calling or writing the Public Information Section, federal ReserveBank of San Fran-Cisco, O. Box 7702, San Francisco94120. P. Phone(415)
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