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Industrial Loan Companies: Where Banking and Commerce Meet BY J AMES R. BARTH,TONG LI,APANARD ANGKINAND, YUAN-HSIN CHIANG AND LI LI Should commercial firms be prohibited from owning banking institutions? Should the United States remain the only G20 country opposed to the “mixing of banking and com- merce”? These questions have assumed new urgency as the Dodd Frank Act of July 2010 imposed a moratorium on the commercial ownership of industrial loan companies (ILCs), which was the last remaining entry point for commercial firms into banking. This paper specifically examines the role of ILCs in America’s financial system from its beginnings in 1910 to the present. Special attention is paid to the performance of commercially owned ILCs prior to, during and after the most recent financial crisis. The examination is based upon both survey data and Federal Deposit Insurance Corporation (FDIC) data, which represents a database of the ILC industry that is the most comprehensive one available to date. The paper also reviews the laws and regulations regarding the mixing of banking and commerce, and discusses the advantages and disadvantages of allowing commercial ownership of banks. JEL Classification : G18, G21, G28. I. INTRODUCTION After the financial crisis of 2007–2009, Washington responded (as it always does) by passing legislation that is supposed to prevent the next calamity. The latest effort, the voluminous Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), weighs in at more than 2,000 pages—a whopping 20 times longer than the law establishing the Federal Reserve System. Buried within this mammoth piece of legislation, and little noticed by the public and the press, are nine specific mentions of “industrial loan companies” or “industrial banks,” financial institutions that are probably a mystery to most Americans. They may not be household names, but industrial loan companies (ILCs), or industrial banks, have been around for a century; they actually pre-date the estab- lishment of the Federal Reserve in 1913. Their names are a nod to their original mission, which was lending to industrial workers who had difficulty obtaining credit elsewhere. Over time, ILCs evolved right along with the financial mar- ketplace, expanding their customer base. Today they are more modern financial institutions offering a greater variety of financial services (although some still cater to a narrower group of customers than the typical commercial bank). Corresponding author: Tong “Cindy” Li, Ph.D. Economist Milken Institute 1250 Fourth Street, Phone: 310 570 4655, Fax: 310 570 4625, [email protected] C 2012 New York University Salomon Center and Wiley Periodicals, Inc.

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Page 1: Industrial Loan Companies: Where Banking and Commerce Meetwebhome.auburn.edu/~barthjr/publications/2012/Check... · 2012-01-18 · Industrial Loan Companies: Where Banking and Commerce

Industrial Loan Companies: Where Bankingand Commerce Meet

BY JAMES R. BARTH, TONG LI, APANARD ANGKINAND,YUAN-HSIN CHIANG AND LI LI

Should commercial firms be prohibited from owning banking institutions? Should theUnited States remain the only G20 country opposed to the “mixing of banking and com-merce”? These questions have assumed new urgency as the Dodd Frank Act of July 2010imposed a moratorium on the commercial ownership of industrial loan companies (ILCs),which was the last remaining entry point for commercial firms into banking. This paperspecifically examines the role of ILCs in America’s financial system from its beginningsin 1910 to the present. Special attention is paid to the performance of commercially ownedILCs prior to, during and after the most recent financial crisis. The examination is basedupon both survey data and Federal Deposit Insurance Corporation (FDIC) data, whichrepresents a database of the ILC industry that is the most comprehensive one availableto date. The paper also reviews the laws and regulations regarding the mixing of bankingand commerce, and discusses the advantages and disadvantages of allowing commercialownership of banks.

JEL Classification : G18, G21, G28.

I. INTRODUCTION

After the financial crisis of 2007–2009, Washington responded (as it always does)by passing legislation that is supposed to prevent the next calamity. The latesteffort, the voluminous Dodd-Frank Wall Street Reform and Consumer ProtectionAct (Dodd-Frank Act), weighs in at more than 2,000 pages—a whopping 20 timeslonger than the law establishing the Federal Reserve System.

Buried within this mammoth piece of legislation, and little noticed by thepublic and the press, are nine specific mentions of “industrial loan companies”or “industrial banks,” financial institutions that are probably a mystery to mostAmericans.

They may not be household names, but industrial loan companies (ILCs), orindustrial banks, have been around for a century; they actually pre-date the estab-lishment of the Federal Reserve in 1913. Their names are a nod to their originalmission, which was lending to industrial workers who had difficulty obtainingcredit elsewhere. Over time, ILCs evolved right along with the financial mar-ketplace, expanding their customer base. Today they are more modern financialinstitutions offering a greater variety of financial services (although some stillcater to a narrower group of customers than the typical commercial bank).

Corresponding author: Tong “Cindy” Li, Ph.D. Economist Milken Institute 1250 Fourth Street, Phone: 310 5704655, Fax: 310 570 4625, [email protected]

C© 2012 New York University Salomon Center and Wiley Periodicals, Inc.

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2 James R. Barth et al.

If the term does ring familiar to the public today, it’s likely because they recall aflurry of news coverage back in 2005, when Wal-Mart filed an application to charteran industrial loan company and applied for federal deposit insurance. Other com-mercial firms like BMW, Toyota, General Electric, and Harley-Davidson alreadyowned ILCs, but Wal-Mart’s application aroused a wave of heated opposition. TheFDIC declared a moratorium on new applications in 2006 and held public hear-ings on the Wal-Mart proposal—the first time in the agency’s 78-year history thatsuch proceedings had been held. The controversy was eventually defused whenWal-Mart withdrew its application for federal deposit insurance in 2007, beforethe FDIC ever ruled on its application.

So what does this have to do with the Dodd-Frank Act? For starters, the actplaced another three-year moratorium on new charters for commercially ownedILCs. It also required the Government Accountability Office (GAO) to issue areport assessing the role and regulation of ILCs.

This paper provides our appraisal of the role industrial loan companies haveplayed over time in the U.S. economy, paying particular attention to the ownershipof ILCs by commercial firms. Figure 1 provides a brief timeline of the industry’sdevelopment, which has been shaped by legislation and regulation that will bediscussed in greater detail in the sections that follow. We will also analyze the sizeand performance of ILCs relative to the banking industry, and carefully examine thedifferences between ILCs that are owned by commercial firms versus those ownedby financial firms. The oversight of these institutions, especially as compared tobank regulation, will also be an important part of our evaluation as we considerthe question of whether commercially owned ILCs represent a greater potentialrisk to the financial system than non-commercially owned banks.

II. A CENTURY-OLD INDUSTRY

A BRIEF HISTORY OF ILCs

A century ago, in 1910, a new financial industry was born in Norfolk, VA., whenan entrepreneur by the name of Arthur J. Morris founded an institution called theFidelity Savings & Trust Company. Its basic purpose was to provide loans to low-and moderate-income industrial workers who had stable jobs but little access tobank credit.

At the time, commercial banks primarily catered to businesses, while savingsand loan associations largely focused on home loans. (There were also mutualsavings banks, but these institutions were largely confined to the New Englandstates.) This situation provided an ideal opening for a new type of financial institu-tion geared toward an underserved market. Loans extended by these institutions toworkers, moreover, were not typical of the day; instead of being made on the basisof available collateral, they relied on recommendations from two creditworthyindividuals who knew the workers.1 In addition, the new institutions initially

1Some state laws limited the size of loans by industrial loan companies, unlike those of com-mercial banks and savings and loans. As Saulnier (1940) points out, for example, Arizona and

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Industrial Loan Companies 3

Arthur J. Morris opens the first ILC in Norfolk, Virginia (1910)

FDIC insuresthe deposits of 29 ILCs (1934)

1910 1920 1930 1940 1950 1960 1970 19901980 2000 2010

Garn-St Germain Depository Institutions Act makes all ILCs eligible for FDIC insurance, which ends the case-by-case approval process (1982)

ILCs are exempted from the Bank Holding Company Act, which prohibits any affiliation between commercial entities and banks. (1956) The Act imposes anti-tying restrictions on ILCs, their owners and affiliates. (1970)

Competitive Equality Banking Act requires all deposit-taking ILCs to obtain FDIC insurance. An ILC controlled by a non-BHC company can not offer demand deposits unless its assets are less than $100 million or it has not been acquired after August 10, 1987. Also, ILCs with more than $100 million in assets cannot offer commercial checking accounts (1987)

FDIC imposes a six-month moratorium on new ILC applications and acquiring existing ILCs (July 2006). The moratorium is later extended through January 31, 2008

The Dodd-Frank Act imposes another three-year moratorium on commercially owned ILCs. Also, parent companies of ILCs are required to serve as a source of strength (July 2010)

All transactions between ILCs and their affiliates are subject to Sections 23A (1933) and 23B (1987) of the Federal Reserve Act

Gramm-Leach-Bliley Act allows mixing commercial banking with investment banking, securities, and insurance but not commerce. However, ILCs are exempt from this Act (1999)

1930Number: 103Total assets: $143 million

1983Number: 135Total assets:$4 billion

2005Number: 96Total assets: $161 billion

1920Number: 87Total assets: $31 million

1938Number: 142Total assets: $151 million

2000Number: 90Total assets: $93 billion

1960Number: 239Total assets: $198 million

1970Number: 177Total assets: $470 million

1995Number: 55Total assets: $12 billion

Q2 2010*Number: 89Total assets: $132 billion

Note: Sections 23A and 23B of the Federal Reserve Act impose restrictions on variousfinancial transactions between a bank and its subsidiaries with an affiliate. Section 23Aplaces restrictions on the amount of transactions relative to the amount of a bank’s capital,while 23B places restrictions such that the transactions must be based on terms and condi-tions that would be comparable with or involving nonaffiliated companies.Sources: Saulnier (1940), state regulatory authorities, FDIC, Milken Institute.∗Based on available data, there were 39 active depository ILCs and 50 active non-depositoryILCs as of June 2010. “Total assets” in this case refers to the 39 active depository ILCs.

Figure 1: An ILC industry timeline.

funded themselves by issuing investment certificates rather than offering deposits.Since their primary customers were industrial workers, these institutions havebeen known ever since as either “industrial loan companies” or “industrial banks.”

Arthur J. Morris decided at the outset to try to copyright his particular type ofinstitution as a “Morris Plan” company.2 In subsequent years, he busied himselfoverseeing the establishment of these institutions in cities around the country, allwith the words “Morris Plan” in their titles and billed as members of the “MorrisPlan” system. But Morris never obtained that long-sought copyright for his lendingmodel. As a result, similar institutions that did not join his system sprouted upin various states, calling themselves industrial banking companies, industrial loanand thrift companies, and industrial loan associations.

These variations in names largely came about to comply with various statechartering and licensing laws under which financial institutions were allowed

Pennsylvania limited their loans to $1,000, while Colorado and Rhode Island limited the size to$5,000.2It has been reported that the “Morris Plan” was originated by a Mr. Stein as early as 1898. He is saidto have established the first such company, the Merchants-Mechanics Savings Association, in NewportNews, Va., in 1901. There is documentation that a judge held that there are “vital difference” betweenthe Morris and Stein plans; see The Survey (1915) and (1916).

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4 James R. Barth et al.

to operate.3 This early confusion has complicated the task of determining theexact number and assets of these institutions over a long period of time. Ofcourse, even though these institutions were quite similar in overall orientation,they sometimes offered a different mix of services to a different mix of customers.To simplify matters, we will refer to them simply as industrial loan companies(ILCs) throughout this paper.4

Throughout their existence, ILCs have always been state-chartered or -licensedinstitutions that make loans and offer their customers deposits, investment cer-tificates, or both. In their early years, some states prohibited ILCs from offeringdeposits, which meant they had little choice but to offer investment certificatesto individuals to obtain funding for making loans. In other states, however, ILCswere allowed to offer either deposits or certificates, or both.

The legal restrictions on the sources of funding available to ILCs in various statesis depicted in Table 1, which provides selected financial information on 142 ILCsoperating in 15 states in 1938. It shows that in some states, these institutions onlyoffered deposits; in others, they only offered investment certificates; and in stillother states, they offered both types of products to their customers. Most tended torely mainly on one type of funding in addition to owner-contributed equity capital.The Table shows, for example, that for ILCs in Nebraska, investment certificateswere virtually the only source of funding besides equity capital. By contrast,ILCs in New York relied almost entirely on deposits in addition to equity capital.Today, there are still non-depository ILCs that do not offer deposit accounts fortheir customers. All depository ILCs, which do offer deposit accounts, are nowFDIC-insured institutions.

The ILC industry has never been very large in terms of either number ofinstitutions or total assets, and it has always been dwarfed by the banking industry,as Figure 2 shows.

In 1920, for example, there were 87 ILCs with $31 million in total assets—but in that same year, there were some 30,000 commercial banks holding nearly$50 billion in total assets. Both the number and total assets of ILCs increasedfor several decades thereafter. During the 1930s, there were more than a hundredin operation. The Great Depression was a pivotal period for ILCs: While bankswere failing in large numbers, ILCs, despite their relatively small role in the creditmarkets, became the leading providers of consumer credit to workers. From 1934to 1938, total assets and loans at ILCs grew by 65% and 81%, respectively, whileassets and loans at commercial banks grew by only 22% and 9%, respectively. Inaddition, loans accounted for 74% of the assets of ILCs over this period, whereasfor commercial banks this figure is 29%.5 (As we will discuss later, ILCs reprisedthis role as an important source of credit during the most recent financial crisis.)

3See Saulnier (1940). Also, in some states like Minnesota, state law prohibited industrial loan compa-nies from using the word “banking” in their titles.4The Dodd-Frank Act of 2010, as noted earlier, refers to these institutions as both industrial loancompanies and industrial banks.5These calculations are based on data from Saulnier (1940).

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Industrial Loan Companies 5

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6 James R. Barth et al.

0

50

100

150

200

250

300

19401954196819821996 Q2 2010

Number of ILCs

0

400

800

1,200

1,600

2,000

2,400

1940 1950 1960 1970 1980

Total assets, 1940 to 1980

US$ millions

0

50

100

150

200

250

300

1980 1990 2000 Q2 2010

US$ billions

Total assets, 1980 to Q2 2010

Sources: State regulatory authorities, Milken Institute.

Figure 2: ILCs by number and total assets, 1940 to Q2 2010.

Figure 2 shows the size of the ILC industry from 1940 to mid-2010, basedon available data from state regulatory authorities.6 ILCs grew rapidly after the1930s, eventually reaching a high of 254 institutions with $408 million in assetsin 1966 (still relatively small when compared to more than 13,000 commercialbanks with $403 billion in assets in that same year). After 1966, the number ofILCs declined steadily to 130 in 1977, before increasing again to 155 in 1983.Once again, the number then declined, falling to 78 ILCs in the second quarter of2010.7

In terms of total assets, as shown in Figure 2, ILCs grew sharply from$3.8 billion in 1983 to $9 billion a decade later and eventually an all-time highof $270 billion in 2007, before declining to $122 billion in the second quarter of2010.8 (This decline was almost entirely due to some fairly large ILCs convertingto bank charters in response to the financial crisis.)

As of mid-2010, there were 39 depository ILCs with $132 billion in total assets.9

These institutions represent about 0.5% of the total number of insured institutionsand roughly 1% of the total deposits as well as the total assets of all the insured

6This data includes both depository and non-depository ILCs. The data for all FDIC-insured depositoryILCs that we could publicly obtain was only available starting in 2000. However, we were able toobtain data for currently active depository ILCs starting in 1992.7This number does not include 11 ILCs in California and Hawaii because those state regulatoryauthorities did not provide data for the second quarter of 2010. However, we were able to include these11 ILCs based upon data from the FDIC.8There is a difference in number and total assets for ILCs when obtaining data from the FDIC ascompared to the state regulatory authorities. These differences are due to 1) the inclusion of non-depository ILCs in data provided by the state regulatory authorities; 2) not all states with ILCssupplying information; and 3) other relatively minor issues involving the time period in which ILCsbecome inactive.9We are unable to obtain any financial information on non-depository ILCs. Almost all of the papertherefore focuses on depository ILCs, which is most appropriate since these are the institutions thathave access to the federal safety net.

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Industrial Loan Companies 7

Utah56%

California26%

Nevada10%

Hawaii2%

Indiana2%

Minnesota2%

Total number=39

Utah77%

Nevada15%

California7%

Hawaii1%

Indiana<1%

Minnesota<1%

Total assets=$131.7 billion

Note: This excludes ILCs that do not take deposits.Sources: FDIC, Milken Institute.

Figure 3: State distribution of ILCs by number and assets, Q2 2010.

institutions. Commercial banks are by far the most dominant institutions in termsof number, assets, and deposits. This striking imbalance further helps explain whyso few people are aware of the existence of ILCs as compared to commercialbanks or even savings institutions.

In the early years of the ILC industry, at least 40 states chartered or licenseddepository and/or non-depository ILCs. During the past decade, however, thisnumber declined to seven states. And as of mid-2010, only six states still hadactive FDIC-insured ILCs. This situation is due to the enactment of the CompetitiveEquality Banking Act (CEBA) of 1987. CEBA specifies that only ILCs charteredin states that had in effect or under consideration a statute requiring ILCs to beFDIC-insured as of March 5, 1987, were exempt from the definition of “bank” inthe Bank Holding Company Act (BHCA). This means that only ILCs charteredin “grandfathered” states, as determined by the Federal Reserve, are eligible forthe ILC exemption from the BHCA. Until 2009 there were seven such states, butthe last ILC in Colorado became inactive that year.10 There are currently only sixgrandfathered states with active depository ILCs.

Utah ranks a clear first in both number of institutions and total assets throughoutthe entire decade. California ranks second in number of institutions over theperiod.11 It also ranked second in terms of total assets in the first half of thedecade, but was supplanted by Nevada in the second half.

Figure 3, which shows the ranking of the states as of the second quarter of2010, illustrates Utah’s dominance in the ILC industry. California is home toapproximately a quarter of ILCs, but accounts for only 7% of the total assets of

10See GAO (2005). In this report, it is noted that at the time of the CEBA exemption, there weresix states that qualified (California, Colorado, Hawaii, Minnesota, Nevada, and Utah). However, anILC that was already in existence prior to the law in Indiana obtained FDIC insurance in 1990 and,apparently, the Federal Reserve considered Indiana to also be a grandfathered state.11Some of these ILCs were quite similar in their operations to finance companies.

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8 James R. Barth et al.

General Motors acquires a small

ILC, Horizon Thrift in Utah, and

changes its name to GMAC Capital

Corp. It becomes the first

commercially owned FDIC-

insured ILC (1988)

GMAC Automotive Bank changes name to GMAC Bank (2006)

GMAC Bank is renamed Ally Bank shortly before it converts to

a commercial bank (2009)

GMAC Commercial

Mortgage Bank is established

(2003)

GMAC Automotive Bank is established

(2004)

GMAC Commercial Mortgage Bank becomes a financial ILC after General Motors sells

majority shares to a private equity consortium in April. It then changes its name to Capmark

Bank in May (2006)

Although its parent company, Capmark Financial Group Inc., files for bankruptcy in 2009,

Capmark Bank still is an active financial ILC (2010)

Another GM-owned ILC, Escrow Bank USA, founded in 1999, is voluntarily closed.

GMAC Capital Corp. sells its

ILC to Franklin Templeton Credit

Corp. (1995)

2010500200028891

BMW Bank of North America

(1999)

Target Bank (2004)

Toyota Financial Savings Bank (2004)

EnerBank by CMS Energy (2002)

Volkswagen Bank USA, founded in 2002, is voluntarily closed (2007)

Volvo Commercial Credit Corp. of Utah, established in 2002, changes its name to Proficio Bank and converts to a commercial bank (2007)

Eaglemark Savings Bank by Harley-Davidson (1997)

First Electronic Bank by Fry’s Electronics (2000)

After Gramm-Leach-Bliley Act, commercial entities that still want to engage in financial activities obtain

ILC charters (1999)

GE Capital Financial (1993)

The Pitney Bowes Bank (2000)

Wal-Mart tries to acquire an ILC in California. However, the state passes a law

prohibiting commercial firms from acquiring/opening ILCs (2002)

Wal-Mart tries to open

another ILC in Utah (2005)

Wal-Mart withdraws its

FDIC application

(2007)

Transportation Alliance Bank by Flying J (1998)

Sears acquires an ILC charter but it remains

inactive for years (1991)

AT&T Universal Financial

is founded (1992)

AT&T sells its ILC charter to Citigroup, which uses it to establish a financial ILC

(1998)

Daimler Chrysler applies in 2005 then withdraws

(2009)Ford applies for an ILC, but still pending (2006)

Note: The upper half focuses on General Motors and its ILC subsidiaries. The light greyshade represents currently active commercially owned ILCs as of June 2010.Sources: Various media reports, FDIC, Milken Institute.

Figure 4: A timeline for commercially owned ILCs.

these institutions. In contrast, only 10% of the ILCs are located in Nevada, but itsshare of total assets increased from less than 4% in 2000 to slightly more than 15%in the second quarter of 2010. Utah and Nevada are by far the two most importantstates for the ILC industry today.

TWO OWNERSHIP TYPES: FINANCIALLY OWNED AND COMMERCIALLY OWNED

Throughout the industry’s history, most ILCs were either stand-alone entities ortheir parents were financial firms. In 1988, however, General Motors acquiredan ILC charter. From this point forward, there have been two ownership models:Financially owned ILCs are those owned by financial firms, while commerciallyowned ILCs are those owned by commercial firms. According to the Dodd-FrankAct, a company is a “commercial firm” if “the annual gross revenues derived bythe company and all of its affiliates from activities that are financial in nature and,if applicable, from the ownership or control of one or more insured depositoryinstitutions, represent less than 15% of the consolidated annual gross revenues ofthe company.”

A timeline showing some of the developments in the commercial segment ofthe ILC industry is provided in Figure 4. It shows that there have been entriesand exits from this segment of the industry since the first such institution wasestablished; nine commercially owned ILCs remained active as of June 2010. Thefigure also shows that while there are very few commercially owned ILCs, there

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Industrial Loan Companies 9

0102030405060708090

100Colorado

Minnesota

Indiana

Hawaii

Nevada

California

Utah

Percent of total institutions

0102030405060708090

100Colorado

Minnesota

Indiana

Hawaii

California

Nevada

Utah

Percent of total assets

Note: This excludes ILCs that do not take deposits. If an ILC has no parent, it is classifiedas a financially owned ILC.Sources: FDIC, Milken Institute.

Figure 5: State distribution of financially owned ILCs by number and assets,2000 to Q2 2010.

is clearly a variety of commercial parents, ranging from automobile companies toretailers to transportation companies to a motorcycle manufacturer.

From 2000 to the second quarter of 2010, financially owned ILCs have domi-nated commercially owned ILCs with respect to both the number of institutionsand total assets. As of mid-2010, financially owned ILCs accounted for 86% ofthe total assets and commercially owned ILCs accounted for the remaining 14%.In 2008, the commercially owned ILCs accounted for their largest share of assets,at nearly 25%. However, the conversion of GMAC Bank to a commercial bankled to a decline in share of total assets of this type of ILC in the subsequent twoyears. In terms of numbers, the financially owned ILCs also accounted for roughlythree-fourths to four-fifths of all ILCs for nearly the entire decade.

Information on the distribution of financially owned ILCs among the differ-ent states in which they are chartered is provided in Figure 5 with Utah againdominating the list. The total assets of all financially owned ILCs increased from$82 billion in 2000 to a high of $228 billion in 2007, before declining to $113 bil-lion in mid-2010. Almost all of this decrease occurred at financially owned ILCslocated in Utah and was due to the conversion of several ILCs to commercial banksduring the financial crisis, after the parent companies registered as Bank HoldingCompanies (BHCs). The only state in which there was a significant increase inILC assets was Nevada, which saw its share of the total assets of financially ownedILCs increase from less than 4% in 2007 to slightly more than 17% in the secondquarter of 2010. In terms of number of all financially owned ILCs, there was anincrease from 33 institutions to a high of 41 institutions in 2005 and 2006 beforedeclining to 30 institutions in the second quarter of 2010. Colorado was the onlystate among seven that began the decade with some industry representation butended without a single active institution. As of Q2 2010, Utah accounts for roughlythree-quarters of the total assets of financially owned ILCs and half of the numberof all financially owned ILCs. California is second in terms of share of numberand Nevada is second in terms of share of assets of these institutions.

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10 James R. Barth et al.

0102030405060708090

100

Nevada

Utah

Percent of total institutions

0102030405060708090

100

Nevada

Utah

Percent of total assets

Note: This excludes ILCs that do not take deposits.Sources: FDIC, Milken Institute.

Figure 6: State distribution of commercially owned ILCs by number and assets,2000 to Q2 2010.

-3

-2

-1

0

1

2

3

4

5

6

7

FinanciallyownedILCs

Commerciallyowned ILCs

Returnon assets, percent

-20

-15

-10

-5

0

5

10

15

20

25

Financially owned ILCs

Commercially owned ILCs

Returnon equity, percent

0

5

10

15

20

25

30

35

40

Commercially owned ILCs

Financially owned ILCs

Equity to asset ratio, percent

Sources: FDIC, Milken Institute.

Figure 7: Financially and commercially owned ILCs: Financial performance,2000 to Q2 2010.

Figure 6 shows that there were only two states in which there were activecommercially owned ILCs over the past decade: Nevada and Utah. The vastmajority (95%) of the assets were held by commercially owned ILCs charteredin Utah as of June 2010. The same is true of the number of commercially ownedILCs, with Utah accounting for just short of 80% of all these institutions. Thetotal assets of commercially owned ILCs increased from $4 billion in 2000 to $19billion in the second quarter of 2010. The biggest jump in assets occurred from2007 to 2008, when the increase was $18 billion, which was accounted for by GECapital Financial Inc. and BMW Bank of North America.

In comparing the financial performance of commercially and financially ownedILCs, Figure 7 shows the return on assets (ROA) and return on equity (ROE), aswell as the equity capital–to–total asset ratio for these two types of institutions.Through almost the entire decade, commercially owned ILCs remained bettercapitalized than financially owned ILCs. In the second quarter of 2010, however,both types had roughly the same equity capital–to–total asset ratio. In addition,

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Industrial Loan Companies 11

commercially owned ILCs performed far better in terms of ROA. In the earlypart of the decade, their performance was slightly below that of financially ownedILCs in terms of ROE, but that trend changed after 2007. However, the betterperformance of the financially owned ILCs in terms of ROE in the early part ofthe decade was due to the fact that they held less capital relative to their assets ascompared to their commercially owned counterparts.

Tables 2 and 3 provide additional information about the 30 financially ownedILCs and nine commercially owned ILCs that operated as of the second quarterof 2010. Though they began with a fairly narrow scope of business and customerbase in their formative years, ILCs have evolved over time to become a modernfinancial industry offering a wider range of products and services to a morediverse group of customers. Clearly, however, the individual ILCs differ not onlyin type of ownership but also in terms of the specific products and servicesoffered as well as their customer mix. Financially owned ILCs have $55 million inassets per employee, while commercially owned ILCs have $30 million in assetsper employee (by contrast, all FDIC-insured institutions have $6.5 million inassets per employee). The three largest ILCs are all financially owned (AmericanExpress Centurion Bank, UBS Bank USA, and USAA Savings Bank).12 Thesethree institutions account for slightly more than half of the total assets of the ILCindustry. It is also interesting to note it’s not readily apparent from the names ofthese institutions that they are ILCs.

III. REGULATION OF ILCS

LEGISLATIVE DEVELOPMENTS

ILCs essentially operated like local consumer finance companies during their earlyyears; they were not deemed important competitors for banks. But things startedto change when the FDIC was established in 1934 in response to numerous bankruns and associated failures. The FDIC decided to insure the thrift certificates of29 industrial loan companies that year and later added ILCs to the ranks of insuredfinancial institutions on a case-by-case basis. The Banking Act of 1935 also madeILCs eligible for membership in the Federal Reserve System. As a result, fourILCs located in Illinois, Michigan, North Carolina, and Ohio were members asof 1940.13 Over time, more states began allowing ILCs to offer both demand andtime deposits. Then, with the passage of the Garn-St Germain Act in 1982, alldeposit-taking ILCs became eligible for federal deposit insurance. And five years

12We were told that American Express established its ILC in Utah due to the fact that there were manymissionaries who spoke a variety of languages that were useful to the firm given its worldwideoperations. We were also told that USAA Savings Bank was established in Nevada because itsimmediate parent was a savings and loan operating in Texas and therefore subject to interest rateceilings that became binding in a high inflationary period. These ceilings were not applicable for itsILC in Nevada.13See Saulnier (1940).

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12 James R. Barth et al.

Tabl

e2:

Sele

cted

info

rmat

ion

oncu

rren

tly

acti

vefi

nanc

ially

owne

dIL

Cs,

Q2

2010

Dat

eTo

tal

Reg

iste

red

hold

ing

Dat

eF

DIC

-N

umbe

rof

asse

tsD

escr

ipti

onof

com

pany

:U

ltim

ate

Nam

eSt

ate

foun

ded

insu

red

empl

oyee

s(U

S$M

)bu

sine

sslin

eim

med

iate

pare

ntpa

rent

Am

eric

anE

xpre

ssU

T3/

203/

2074

29,9

92A

broa

dra

nge

ofA

mer

ican

Exp

ress

Am

eric

anE

xpre

ssC

entu

rion

Ban

k19

8919

89fi

nanc

ialp

rodu

cts,

incl

udin

gcr

edit

card

san

dco

nsum

ertr

avel

serv

ices

Tra

velR

elat

edSe

rvic

esC

ompa

nyIn

c.

Com

pany

UB

SB

ank

USA

UT

9/15

9/15

5228

,979

Abr

oad

rang

eof

UB

SA

mer

ica

Inc.

UB

SA

G20

0320

03fi

nanc

ials

ervi

ces

USA

ASa

ving

sN

V10

/19/

276

13,7

64Fi

nanc

ials

ervi

ces,

USA

AFe

dera

lU

nite

dSe

rvic

esB

ank

1997

∗19

96pr

imar

ilyse

rvin

gth

em

ilita

ry,v

eter

ans,

and

thei

rfa

mili

es

Savi

ngs

Ban

kA

utom

obile

Ass

ocia

tion

(USA

A)

Cap

mar

kB

ank∗

∗U

T4/

14/

113

79,

533

Fina

ncia

lser

vice

sto

Cap

mar

kFi

nanc

ial

Gen

eral

Mot

ors

2003

2003

inve

stor

sin

com

mer

cial

real

esta

te–r

elat

edas

sets

Gro

upIn

c.C

o.,p

riva

teeq

uity

cons

ortiu

mSa

llie

Mae

Ban

kU

T11

/28

11/2

831

7,37

3E

duca

tion

loan

sto

SLM

Cor

p.SL

MC

orp.

2005

2005

stud

ents

and

thei

rfa

mili

es

(Con

tinu

ed)

Page 13: Industrial Loan Companies: Where Banking and Commerce Meetwebhome.auburn.edu/~barthjr/publications/2012/Check... · 2012-01-18 · Industrial Loan Companies: Where Banking and Commerce

Industrial Loan Companies 13

Tabl

e2:

(Con

tinu

ed)

Dat

eTo

tal

Reg

iste

red

hold

ing

Dat

eF

DIC

-N

umbe

rof

asse

tsD

escr

ipti

onof

com

pany

:U

ltim

ate

Nam

eSt

ate

foun

ded

insu

red

empl

oyee

s(U

S$M

)bu

sine

sslin

eim

med

iate

pare

ntpa

rent

Cap

italS

ourc

eB

ank

CA

7/25

7/25

340

5,77

8Fi

nanc

ials

ervi

ces

Cap

italS

ourc

eIn

c.C

apita

lSou

rce

Inc.

2008

2008

Bea

lBan

kN

evad

aN

V8/

28/

278

5,54

4Fi

nanc

ials

ervi

ces

with

Bea

lFin

anci

alC

orp.

Bea

lFin

anci

al20

0420

04sp

ecia

lizat

ion

inpu

rcha

sing

loan

san

dpo

rtfo

lios

oflo

ans

inth

ese

cond

ary

mar

ket

Cor

p.

Woo

dlan

dsU

T8/

248/

2427

3,21

3C

omm

erci

al/in

dust

rial

Leh

man

Bro

ther

sL

ehm

anB

roth

ers

Com

mer

cial

Ban

k20

0520

05lo

ans,

com

mer

cial

real

esta

telo

ans,

and

war

ehou

selin

esof

cred

it.

Ban

corp

Inc.

Hol

ding

s

Opt

umH

ealth

Ban

kU

T7/

217/

2188

1,44

1Fi

nanc

ialp

rodu

cts

and

Opt

umFi

nanc

ial

Uni

tedH

ealth

Inc.

2003

2003

serv

ices

toin

divi

dual

san

dfa

mili

esto

pay

for

heal

thca

re

Serv

ices

Inc.

Gro

upIn

c.

(Con

tinu

ed)

Page 14: Industrial Loan Companies: Where Banking and Commerce Meetwebhome.auburn.edu/~barthjr/publications/2012/Check... · 2012-01-18 · Industrial Loan Companies: Where Banking and Commerce

14 James R. Barth et al.

Tabl

e2:

(Con

tinu

ed)

Dat

eTo

tal

Reg

iste

red

hold

ing

Dat

eF

DIC

-N

umbe

rof

asse

tsD

escr

ipti

onof

com

pany

:U

ltim

ate

Nam

eSt

ate

foun

ded

insu

red

empl

oyee

s(U

S$M

)bu

sine

sslin

eim

med

iate

pare

ntpa

rent

Mer

rick

Ban

kU

T9/

229/

2213

21,

038

Loa

nsfo

rbo

atan

dR

VC

ardW

orks

Inc

Car

dWor

ksL

PC

orpo

ratio

n19

9719

97cu

stom

ers

Wri

ghtE

xpre

ssU

T6/

16/

132

968

Paym

entp

roce

ssin

gW

righ

tExp

ress

Cor

p.W

righ

tExp

ress

Fina

ncia

lSe

rvic

esC

orp.

1998

1998

and

flee

tand

corp

orat

ech

arge

card

sto

the

U.S

.co

mm

erci

alan

dgo

vern

men

tveh

icle

flee

tind

ustr

y

Cor

p.

Cen

tenn

ialB

ank

CA

10/2

511

/321

812

Mul

tifam

ilyO

rang

eC

ount

yL

andA

mer

ica

1979

1998

HU

D/F

HA

223(

f)lo

anpr

oduc

tB

anco

rpFi

nanc

ialG

roup

Inc.

Fire

side

Ban

kC

A12

/31

10/5

400

787

Non

-pri

me

auto

mob

ileU

nitr

inIn

c.an

dU

nitr

inIn

c.19

5019

84lo

ans

Fire

side

Secu

ritie

sC

orp.

Fina

nce

Fact

ors

HI

5/14

6/4

129

620

Fina

ncia

lser

vice

sto

Fina

nce

Ent

erpr

ises

Fina

nce

Ent

erpr

ises

Ltd

.H

I19

5219

84lo

calc

omm

uniti

esL

td.

Ltd

.

(Con

tinu

ed)

Page 15: Industrial Loan Companies: Where Banking and Commerce Meetwebhome.auburn.edu/~barthjr/publications/2012/Check... · 2012-01-18 · Industrial Loan Companies: Where Banking and Commerce

Industrial Loan Companies 15

Tabl

e2:

(Con

tinu

ed)

Dat

eTo

tal

Reg

iste

red

hold

ing

Dat

eF

DIC

-N

umbe

rof

asse

tsD

escr

ipti

onof

com

pany

:U

ltim

ate

Nam

eSt

ate

foun

ded

insu

red

empl

oyee

s(U

S$M

)bu

sine

sslin

eim

med

iate

pare

ntpa

rent

Med

allio

nB

ank

UT

12/2

212

/22

2952

7R

ecre

atio

n,he

alth

Med

allio

nFi

nanc

ial

Med

allio

n20

0320

03ca

re,a

ndta

xim

edal

lion

loan

sC

orp.

Fina

ncia

lCor

p.

Wor

ldFi

nanc

ial

UT

12/1

12/1

847

7C

redi

tcar

dan

dbi

lling

Alli

ance

Dat

aSy

stem

sA

llian

ceD

ata

Cap

italB

ank

2003

2003

billi

ngac

coun

tst

atem

ents

and

com

mer

cial

lend

ing

for

busi

ness

es

Cor

p.Sy

stem

sC

orp.

Com

mun

ityC

A10

/19/

1051

383

Aw

ide

rang

eof

loan

TE

LA

CU

TE

LA

CU

Com

mer

ceB

ank

1976

1985

prod

ucts

and

depo

sit

acco

unts

Firs

tSec

urity

CA

3/31

6/28

1434

7L

oans

secu

red

byFi

rstA

mer

ican

Firs

tAm

eric

anB

usin

ess

Ban

k19

8819

89co

mm

erci

alpr

oper

tyin

Sout

hern

Cal

ifor

nia

Fina

ncia

lCor

p.Fi

nanc

ialC

orp.

Cir

cle

Ban

kC

A1/

221/

2255

307

Pers

onal

and

Cir

cle

Ban

corp

Cir

cle

Ban

corp

1990

1990

com

mer

cial

fina

ncia

lser

vice

s

(Con

tinu

ed)

Page 16: Industrial Loan Companies: Where Banking and Commerce Meetwebhome.auburn.edu/~barthjr/publications/2012/Check... · 2012-01-18 · Industrial Loan Companies: Where Banking and Commerce

16 James R. Barth et al.

Tabl

e2:

(Con

tinu

ed)

Dat

eTo

tal

Reg

iste

red

hold

ing

Dat

eF

DIC

-N

umbe

rof

asse

tsD

escr

ipti

onof

com

pany

:U

ltim

ate

Nam

eSt

ate

foun

ded

insu

red

empl

oyee

s(U

S$M

)bu

sine

sslin

eim

med

iate

pare

ntpa

rent

Cel

ticB

ank

UT

3/1

3/1

4722

8B

usin

ess

loan

s,re

alC

eltic

Inve

stm

entI

nc.

Cel

ticIn

vest

men

t20

0120

01es

tate

loan

s,as

set-

base

dle

ndin

g,an

deq

uip-

men

t/con

stru

ctio

nfi

nanc

ing

Inc.

Bal

boa

Thr

ifta

ndC

A12

/11

7/3

7619

8Fi

nanc

ials

ervi

ces,

Haf

ifB

anco

rpIn

c.H

afif

Ban

corp

Inc.

Loa

nA

ssoc

iatio

n19

8019

86in

clud

ing

savi

ngs

and

inve

stm

ent

prod

ucts

,res

iden

tial

loan

s,co

mm

erci

allo

ans,

auto

mob

ilefi

nanc

ing,

and

mor

eG

olde

nSe

curi

tyC

A12

/92/

2520

165

Fina

ncia

lser

vice

sN

oaf

filia

tion

No

affi

liatio

nB

ank

1982

1986

incl

udin

gsa

ving

san

din

vest

men

tpr

oduc

ts,r

esid

entia

llo

ans,

cons

truc

tion

loan

s,an

dm

ore.

(Con

tinu

ed)

Page 17: Industrial Loan Companies: Where Banking and Commerce Meetwebhome.auburn.edu/~barthjr/publications/2012/Check... · 2012-01-18 · Industrial Loan Companies: Where Banking and Commerce

Industrial Loan Companies 17

Tabl

e2:

(Con

tinu

ed)

Dat

eTo

tal

Reg

iste

red

hold

ing

Dat

eF

DIC

-N

umbe

rof

asse

tsD

escr

ipti

onof

com

pany

:U

ltim

ate

Nam

eSt

ate

foun

ded

insu

red

empl

oyee

s(U

S$M

)bu

sine

sslin

eim

med

iate

pare

ntpa

rent

Fina

nce

&T

hrif

tC

A7/

912

/17

105

120

Pers

onal

loan

san

dF&

TFi

nanc

ial

F&T

Fina

ncia

lC

ompa

ny19

2519

84au

tolo

ans

Serv

ices

Inc.

Serv

ices

Inc.

Web

Ban

k∗∗∗

UT

5/15

5/15

2068

Loa

nsan

dcr

edit

card

sSt

eelP

artn

ers

IIL

PSt

eelP

artn

ers

1997

1997

Loa

nsan

dcr

edit

card

sSt

eelP

artn

ers

IIL

PH

oldi

ngs

LP

The

Mor

ris

Plan

IN7/

273/

2321

64C

onsu

mer

lend

ing

Firs

tFin

anci

alC

orp.

Firs

tFin

anci

alC

ompa

nyof

Terr

eH

aute

Inc.

1962

1990

Cor

p.

LC

AB

ank

Cor

p.U

T1/

261/

267

53Fu

llse

rvic

ele

asin

gL

ease

Cor

pora

tion

ofL

ease

Cor

pora

tion

2006

2006

com

pany

Am

eric

aof

Am

eric

aA

DB

Ban

kU

T8/

18/

115

49Fi

nanc

ein

sura

nce

Lea

vitt

Gro

upA

genc

yL

eavi

ttG

roup

2005

2005

prem

ium

sA

ssoc

iatio

nL

LC

Ent

erpr

ises

AR

CU

SB

ank

UT

9/9

9/9

440

Fina

ncia

ladv

isor

y,A

RC

US

Fina

ncia

lW

ellP

oint

Inc.

2008

2008

pers

onal

cred

it,H

SAac

coun

tsH

oldi

ngC

orp.

(Con

tinu

ed)

Page 18: Industrial Loan Companies: Where Banking and Commerce Meetwebhome.auburn.edu/~barthjr/publications/2012/Check... · 2012-01-18 · Industrial Loan Companies: Where Banking and Commerce

18 James R. Barth et al.

Tabl

e2:

(Con

tinu

ed)

Dat

eTo

tal

Reg

iste

red

hold

ing

Dat

eF

DIC

-N

umbe

rof

asse

tsD

escr

ipti

onof

com

pany

:U

ltim

ate

Nam

eSt

ate

foun

ded

insu

red

empl

oyee

s(U

S$M

)bu

sine

sslin

eim

med

iate

pare

ntpa

rent

Ran

cho

Sant

aFe

CA

1/2

12/1

715

36C

onsu

mer

lend

ing

Sem

perv

erde

Hol

ding

Sem

perv

erde

Thr

ift&

Loa

nA

ssoc

iatio

n19

8219

84C

o.In

c.H

oldi

ngC

ompa

nyIn

c.M

inne

sota

Firs

tM

N1/

18/

714

29C

onsu

mer

loan

san

dM

inne

sota

Thr

iftC

o.M

inne

sota

Thr

ift

Cre

dit&

Savi

ngs

Inc.

1956

1986

hom

em

ortg

age

Com

pany

Sour

ces:

FDIC

,com

pany

web

site

s,M

ilken

Inst

itute

.∗ U

SAA

Savi

ngs

Ban

kw

ases

tabl

ishe

das

acr

edit

card

bank

and

licen

sed

asan

indu

stri

allo

anco

mpa

nyin

1997

acco

rdin

gto

stat

ere

gula

tory

auth

oriti

es.

∗∗C

apm

ark

Ban

kis

cate

gori

zed

asa

fina

ncia

llyow

ned

ILC

afte

r20

06.

Cur

rent

lyits

imm

edia

tepa

rent

,C

apm

ark

Fina

ncia

lG

roup

Inc.

,is

inba

nkru

ptcy

proc

eedi

ngs.

∗∗∗ W

ebB

ank

info

rmed

usth

atit

shou

ldbe

cons

ider

eda

com

mer

cial

lyow

ned

ILC

rath

erth

ana

fina

ncia

llyow

ned

ILC

beca

use

itspa

rent

isa

cong

lom

erat

ew

ithco

ntro

lling

busi

ness

inte

rest

sin

anu

mbe

rof

diff

eren

tin

dust

ries

,in

clud

ing

fina

ncia

l,in

dust

rial

,an

dot

hers

.H

owev

er,

sinc

ein

suff

icie

ntda

taw

ere

avai

labl

eto

usre

gard

ing

diff

eren

tsou

rces

ofre

venu

e,an

dot

hers

have

clas

sifi

edW

ebB

ank

asa

fina

ncia

llyow

ned

ILC

,we

have

also

done

soin

this

pape

r.

Page 19: Industrial Loan Companies: Where Banking and Commerce Meetwebhome.auburn.edu/~barthjr/publications/2012/Check... · 2012-01-18 · Industrial Loan Companies: Where Banking and Commerce

Industrial Loan Companies 19

Tabl

e3:

Sele

cted

info

rmat

ion

oncu

rren

tly

acti

veco

mm

erci

ally

owne

dIL

Cs,

Q2

2010

Dat

eTo

tal

Reg

iste

red

FD

IC-

Num

ber

ofas

sets

Des

crip

tion

ofho

ldin

gco

mpa

ny-

Nam

eSt

ate

Dat

ein

sure

dem

ploy

ees

(US$

M.)

busi

ness

line

imm

edia

tepa

rent

Ult

imat

epa

rent

BM

WB

ank

ofU

T11

/12

11/1

233

8,17

0Fi

nanc

ials

ervi

ces

for

BM

WFi

nanc

ial

BM

WA

GN

orth

Am

eric

a19

9919

99B

MW

cust

omer

sSe

rvic

esN

AL

LC

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20 James R. Barth et al.

Tabl

e3:

(Con

tinu

ed)

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Reg

iste

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ials

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ial

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c.

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lem

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kw

ases

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ishe

din

1997

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chan

ged

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niza

tion

type

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ean

indu

stri

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anco

mpa

nyin

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.So

urce

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IC,c

ompa

nyw

ebsi

tes,

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enIn

stitu

te.

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Industrial Loan Companies 21

later, the Competitive Equality Banking Act required all depository ILCs to obtainFDIC insurance.14 Today, as noted earlier, there are two types of ILCs: depositoryand non-depository institutions. As of mid-2010, there were 39 depository ILCsand 50 non-depository ILCs.15

From the outset, ILCs, being state-chartered financial institutions, have alwaysbeen regulated by the states in which they are chartered. After the establishmentof the FDIC, however, depository ILCs that acquired FDIC insurance also cameunder the supervision of the FDIC. As a result, the FDIC has the authority toexamine any affiliate of any insured depository institution, including the parentcompany. This authority applies to ILCs, so that the FDIC is able to determinethe relationship between the ILC and its parent as well as the effect of such arelationship on the ILC.16 Moreover, regulatory authorities in California, Nevada,and Utah have the authority to conduct examinations of both the parents andaffiliates of ILCs.

In addition, ILCs are subject to Sections 23A and 23B of the Federal ReserveAct, which restrict transactions among ILCs, affiliates, and parents. More specif-ically, ILCs are prohibited from extending significant loans to their parent oraffiliates or from offering them on preferential or non-market terms. Lastly, Utahand the FDIC require a majority of ILC board members to be outside directorsunaffiliated with the parent companies.

The parents of ILCs are not subject to Federal Reserve oversight because theyare not bank holding companies. In particular, the parent of an ILC is exemptfrom the definition of a bank holding company in the Bank Holding CompanyAct (BHCA) so long as the ILC satisfies at least one of the following conditions:(1) the institution does not accept demand deposits, (2) the institution’s total assetsare less than $100,000,000, or (3) control of the institution has not been acquiredby any company after August 10, 1987. Of the 39 active ILCs as of mid-2010,nine of these institutions had less that $100 million in total assets. This includestwo of the commercially owned ILCs (see Tables 2 and 3).17

14However, that act did bar ILCs from offering demand deposits unless their assets were less than $100million or an ILC had been acquired before the law was enacted.15The FDIC only provides information on depository ILCs, but the data is quite difficult to obtainfrom the FDIC website; only for a limited number of recent years are shown. A list of ILCs is also notavailable from the FDIC website.16West (2004).17According to the Section 2(c)(2)(H) of the Bank Holding Company Act:(H) An industrial loan company, industrial bank, or other similar institution which is–(i) an institution organized under the laws of a State which, on March 5, 1987, had in effect or had underconsideration in such State’s legislature a statute which required or would require such institution toobtain insurance under the Federal Deposit Insurance Act–(I) which does not accept demand deposits that the depositor may withdraw by check or similar meansfor payment to third parties;(II) which has total assets of less than $100,000,000; or(III) the control of which is not acquired by any company after the date of the enactment of theCompetitive Equality Amendments of 1987; or(ii) an institution which does not, directly, indirectly, or through an affiliate, engage in any activity inwhich it was not lawfully engaged as of March 5, 1987, except that this subparagraph shall cease to

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22 James R. Barth et al.

REGULATORY BARRIERS TO COMMERCIAL COMPANIES OWNING BANKING INSTITUTIONS

Banks did not seem very concerned about competition from ILCs for a long time—not even in 1988, when the first commercial firm acquired an ILC charter.18 Fromthen on, a variety of different types of commercial firms acquired or formed ILCs,including such companies as BMW, General Electric, Target, Pitney Bowes andHarley-Davidson, without generating a controversy.

The banking industry began to focus on competition from ILCs when thoseILCs owned by Merrill Lynch and Morgan Stanley began to grow dramaticallyby providing insured deposits to their customers. This led to a controversy overinterest-bearing business checking accounts and proposals to prevent ILCs fromoffering such accounts. But it was Wal-Mart’s attempt to enter this market thatcreated a real storm.

Wal-Mart made its first move in this arena in 1999, when it tried to acquire asmall savings and loan in Oklahoma. But the Gramm-Leach-Bliley Act, whichprohibited the mixing of banking and commerce, took effect that year, and Wal-Mart missed the deadline for such an acquisition. In 2001, it then tried to partnerwith Toronto-Dominion Bank USA to buy a thrift institution, but the Office ofThrift Supervision (OTS) denied its application. A year later, Wal-Mart tried yetagain to purchase an ILC, this time in California, but the state quickly passed alaw prohibiting such an acquisition.

Finally, in 2005, Wal-Mart filed an application with the Utah Department ofFinancial Institutions and the FDIC to establish a federally insured ILC. The stateof Utah approved the application for a charter, but the FDIC did not approve the ap-plication for deposit insurance. Instead, the FDIC placed a six-month moratoriumon all industrial loan company applications in July 2006.19 In January 2007 themoratorium was extended by the FDIC for an additional year for ILCs that wouldbe owned or controlled by commercial companies.20,21 Prior to the moratorium,

apply to any institution which permits any overdraft (including any intraday overdraft), or which incursany such overdraft in such institution’s account at a Federal Reserve bank, on behalf of an affiliateif such overdraft is not the result of an inadvertent computer or accounting error that is beyond thecontrol of both the institution and the affiliate.18It might be noted that ILCs had an advantage over commercial banks because they were not subjectto Regulation Q; thus the ownership of ILCs provided an option when competing with money marketfunds after 1975, when interest rates rose. An additional advantage was that ILCs, unlike bank holdingcompanies, were not blocked from going nationwide with their operations.19In November 2007, the FDIC granted an exception to the moratorium when it approved an applicationby a consortium of investors to acquire GMAC Automotive Bank, an ILC in Utah. At the same time,Utah approved the change of control and name change of this ILC to GMAC Bank. According to FDICchairman Sheila C. Bair, “The FDIC Board decided to act on this notice during the moratorium to avoidthe potential for substantial interference with a major restructuring by General Motors Corporation.”See http://www.fdic.gov/news/news/press/2006/pr06103.html, last accessed on December 27, 2010.20According to Bovenzi (2007), “At the time that the initial moratorium expired on January 31, 2007,eight ILC deposit insurance applications and one change in bank control notice were pending beforethe FDIC.”21Subsequent to the moratorium, JC Flowers in December 2007 withdrew its application to acquireSallie Mae Bank, Home Depot in January 2008 withdrew its application to acquire EnerBank USA,and Chrysler Financial in June 2009 withdrew its application for FDIC insurance.

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Industrial Loan Companies 23

2010000209910891

Colorado, Hawaii, Iowa, Nebraska and Utah establish state-level private insurance funds to insure deposits of ILCs in order to compete with commercial banks. However, after CEBA requires federal insurance for ILCs, these funds suffer multi-million-dollar deficiencies due to a rapid loss of memberships and consequently fail. Also, many privately-insured ILCs are unable to obtain FDIC insurance and subsequently fail during 1986-1989.

Utah imposes a moratorium on de novo ILC charters (1986-1997) Utah changes the

name of ILCs to industrial banks

(2004)

Wal-Mart’s ILC application is granted in Utah, though it will later be withdrawn in 2007 due to the FDIC moratorium (2005) Advanta Bank fails

and Utah’s bank regulator appoints the FDIC as receiver (2010)

Nevada starts to license ILCs, which are classified under the thrift charter (1997) By 2007, California, Colorado, Illinois, Iowa,

Kansas, Maine, Maryland, Missouri, Oklahoma, Texas, Wisconsin, Virginia, andVermont have passed laws restricting the operation of ILCs to various degrees

California The Department of Financial Institutions is

established, and the authority to license ILCs is transferred

from the Department of Corporations (1997)

California Deposit-taking ILCs are now called industrial banks, which

are permitted to engage in all activities of commercial banks,

except accepting demand deposits (2000)

Wal-Mart tries to acquire an ILC in California. In response, the state prohibits commercial firms from acquiring or opening ILCs (2002)

The last ILC in Colorado ceases operation (2009)

Iowa no longer has active depository ILCs (2005)

The last ILC in Michigan ceases operation (1984)

Nebraska discontinues chartering ILCs (2003)

The last ILC in North Carolina is acquired by a bank (1997)

West Virginia discontinues chartering ILCs (1996)

Other

States

Utah and

California

Fremont Investment & Loan, an ILC

located in California, closes voluntarily and

liquidates its assets (2008)

Sources: State regulatory authorities, Milken Institute.

Figure 8: A timeline of recent state-level events regarding ILCs.

the FDIC held two public hearings in April 2006 on Wal-Mart’s deposit insuranceapplication. In response to its request for public comments, the FDIC receivedmore than 12,600 comment letters, mostly opposing the approval of Wal-Mart’srequest.

Many banks opposed Wal-Mart’s entry into this market, fearing that such abehemoth would use the ILC to establish branches in all its stores throughout thecountry and eventually offer a full line of banking services. They were not placatedby Wal-Mart’s statement that it only wanted to own such an institution to reducethe transaction costs it was incurring by paying banks to process credit card, debitcard, and electronic check transactions in its stores. Wal-Mart eventually withdrewits application in March 2007, before the end of the moratorium and before anydecision had been made by the FDIC. But we find that by 2007, California,Colorado, Illinois, Iowa, Kansas, Maine, Maryland, Missouri, Oklahoma, Texas,Wisconsin, Virginia, and Vermont had passed legislation restricting to variousdegrees the operation of ILCs.22 (See Figure 8 for information on state-levelindustry developments during the past three decades.)

At the time of the moratoriums, the FDIC acknowledged that commerciallyowned ILCs had not caused serious problems to date but pledged to closely monitorthe existing ones. It further stated that “ . . . the FDIC determined that it is appro-priate to provide Congress with a reasonable period to consider the developments

22Wal-Mart Watch, “Wal-Mart’s Industrial Loan Company Talking Points,” http://walmartwatch.com/img/documents/ILC.pdf. This article refers to six states that prohibited commercial firms from owningILCs in 2006. Two states had prohibited such ownership before 2006. Also, see Falanga (2007).

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24 James R. Barth et al.

Box 1: The Dodd-Frank Wall Street Reform and Consumer Protection Act

Impact on ILCs in three areas:1. Three-year moratorium and study of exemption to BHC Act2. Requires a parent company to serve as a source of strength for ILCs3. Subject to deposit concentration cap on interstate mergers and acquisitionsinvolving all insured depository institutions

The Dodd-Frank reform bill requires the GAO to provide information on ILCs inthe following areas:1. Identify the types and number of institutions2. Generally describe the size and geographic locations of the institutions3. Determine the extent to which the institutions are held by holding companiesthat are commercial firms4. Determine whether the institutions have any affiliates that are commercial firms5. Identify the federal banking agency responsible for the supervision of theinstitutions6. Determine the adequacy of the federal bank regulatory framework, includingany restrictions (including limitations on affiliate transactions or cross-marketing)that apply to transactions between an institution, the holding company of theinstitution, and any other affiliate of the institution7. Evaluate the potential consequences of subjecting the institutions to therequirements of the BHC Act, including the availability and allocation of credit,the stability of the financial system and the economy, safe and sound operation,and the impact on the types of activities in which such institutions and the holdingcompanies of such institutions may engage.

in the ILC industry and, if necessary, to make revisions to existing statutory author-ity. Even though the FDIC has authority to act on any particular application, notice,or request involving an ILC, the FDIC . . . believes that congressional resolutionof these issues is preferable.”23

Since the Dodd-Frank Act requires a GAO study of the ILC industry, Congresswill have an opportunity once this study is completed to decide whether it wishesto take any legislative action that would change the nature of the industry. Theexact requirements for the study are summarized in box 1.

The opposition by some banks to ILCs has largely been focused on commercialownership. It should be emphasized that not all banks are opposed to ILCs, whethercommercially owned or not. In addition to some of the banks, other critics areopposed to commercial firms owning any federally insured depository institutions(not just ILCs).

Given such opposition, it is instructive to note that throughout most of U.S.history, commercial firms could own any type of banking institution, be it acommercial bank, savings and loan association, or an industrial loan company.

23See Bovenzi (2007).

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Industrial Loan Companies 25

As far back as 1799, New York State allowed Aaron Burr to use the surpluscapital in a water company that he owned to establish a bank—which ultimatelybecame JPMorgan Chase. During the Great Depression, moreover, the federalgovernment asked Henry Ford to convert a portion of his car company’s depositsat Manufacturers National Bank of Detroit into stock to prevent its collapse. Herefused, but his son Edsel subsequently recapitalized the bank with his own funds.General Motors, for its part, injected capital into the National Bank of Detroit tosave it from insolvency during this turbulent period.24

It is also interesting to know that Marriner Stoddard Eccles, who became the firstchairman of the re-organized Federal Reserve Board during the 1930s, was, priorto his appointment, “president and owner of 26 banks and one trust company, vicepresident of one of the largest sugar companies in the country, president of a mul-tistate diary concern, president of the large Intermountain construction companyand one of the builders of the Boulder Dam, among many other enterprises.”25

The BHCA of 1956, however, started to change ownership flexibility by pro-hibiting commercial firms from owning more than one bank. The first federallaw restricting ownership of a bank, it prohibited any entity directly or indi-rectly engaged in any activity other than banking (and closely related prod-ucts and services) from owning more than one bank. According to the FDIC(1987):

“[T]he primary purpose underlying [BHCA]’s passage was fear of monopolistic controlin the banking industry. Federal regulators and independent bankers lobbied Congressfor over twenty years to pass more restrictive bank holding company legislation, but itwasn’t until the Transamerica case was lost by the Federal Reserve Board that legislationwas approved. . . . Transamerica controlled 46 banks, in addition to owning a largepercentage of Bank of America. The Federal Reserve Board charged that Transamericawas in violation of the Clayton Antitrust Act by monopolizing commercial banking inthe states of California, Oregon, Nevada, Washington and Arizona. In 1952, the Boardordered Transamerica to divest itself of all its bank stock, except for Bank of America,within two years.”

As a result of the prohibition on establishing multi-bank holding companies, thenumber of one-bank holding companies increased dramatically until 1970, asshown in Table 4. Before 1956, there were only 83 one-bank holding companies.But between 1956 and 1970, an additional 1,235 one-bank holding companieswere established. In the latter year, the BHCA was amended to bar commercialfirms from owning even one bank.

The story does not end here, however, because commercial firms could stillown savings and loans. But around the same time, the Savings and Loan HoldingCompany Act of 1967 imposed restrictions on commercial firm ownership of thistype of banking institution, too. Similar to the BHCA of 1956, the act prohibited

24Time (1933).25“How Marriner Eccles Saved America,” The Salt Lake Tribune, January 17, 2011.

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26 James R. Barth et al.

Tabl

e4:

Num

ber

ofon

e-ba

nkho

ldin

gco

mpa

nyfo

rmat

ions

By

date

offo

rmat

ion

for

orga

niza

tions

regi

ster

edas

ofD

ecem

ber

31,1

970∗

Typ

eof

Bef

ore

1956

to19

60to

1966

toJu

ne19

68to

Num

ber

ofTo

tala

sset

sof

all

com

pany

∗∗19

5619

6019

66Ju

ne19

68D

ec.1

970

com

pani

esco

mpa

nies

(US$

mill

ions

)

Ban

king

only

1112

3534

160

252

$929

Clo

sely

rela

ted

108

7955

173

325

$2,9

02N

otcl

osel

yre

late

d58

3217

210

934

471

5$4

2,31

9Fo

reig

n3

14

27

17$3

2,80

0N

otcl

assi

fiab

le∗∗

∗1

-1

16

9$4

55To

tal

8353

291

201

690

1,31

8$7

9,40

4

Sour

ce:F

eder

alR

eser

ve(1

972)

.∗ E

xclu

des

34ho

ldin

gco

mpa

nies

that

subm

itted

late

regi

stra

tion

stat

emen

ts.

∗∗C

lass

ific

atio

nsar

ede

fine

das

follo

ws:

i)ba

nkin

gon

ly:c

ompa

nyis

enga

ged

only

inba

nkin

gac

tiviti

es;i

i)cl

osel

yre

late

d:co

mpa

nyis

enga

ged

inba

nkin

gan

dac

tiviti

esde

term

ined

byth

eFe

dera

lR

eser

veB

oard

ascl

osel

yre

late

dto

bank

ing;

iii)

not

clos

ely

rela

ted:

com

pany

isen

gage

din

activ

ities

othe

rth

anba

nkin

gan

dac

tiviti

esso

lely

rela

ted

toba

nkin

g;iv

)fo

reig

n:co

mpa

nyis

char

tere

din

afo

reig

nco

untr

yan

dde

rive

sat

leas

thal

fof

itsco

nsol

idat

edre

venu

eor

has

atle

asth

alf

ofits

cons

olid

ated

asse

tsou

tsid

eth

eU

nite

dSt

ates

.∗∗

∗ Mai

nly

trus

ts.

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Industrial Loan Companies 27

the commercial ownership of multiple savings and loans through the establishmentof multi-thrift holding companies.

Despite these legislative attempts to block commercial firms’ entry into bank-ing, the door was not entirely closed, since the BHCA defined a bank to be afinancial institution that offered demand deposits and made commercial loans.Based on this definition, a commercial firm could acquire a bank but then ceaseto offer either demand deposits or commercial loans. This indeed happened; suchfederally insured depository institutions became known as “nonbank banks.” Asthe U.S. Treasury Department (1991) stated, “these nonbank banks were attractiveto a wide range of business organizations seeking to capitalize on the efficienciesand ‘synergies’ that come with offering largely complementary services.” By themid-1980s, firms such as General Electric, Textron, ITT, Gulf & Western, JohnHancock, Prudential Bache, American Express, Merrill Lynch, Dreyfus, House-hold, Beneficial, Sears Roebuck, J.C. Penney, McMahan Valley Stores, BankersTrust Corp., Bank of Boston Corp., and others had established nonbank banks.26

In response, Congress passed the Competitive Equality Banking Act (CEBA) in1987. It grandfathered existing nonbank banks (but limited their growth) and pro-hibited the formation of new nonbank banks by expanding the definition of a bankto include any depository institution covered by FDIC insurance.

Table 5 provides a list of nonbank banks as of June 1987 and their status afterbeing grandfathered. Of the 17 nonbank banks that existed in 1987, only two stillexisted as of June 2010. This suggests that once a type of institution is grandfa-thered, the result seems to be the eventual shrinkage, if not total disappearance, ofthat type of institution.

The other track that a commercial firm could take to gain entry into banking wasto become a unitary thrift holding company that only owned a single savings andloan. Given the prohibition on commercial ownership of multiple thrift holdingcompanies, it’s not surprising that there were far more unitary thrift holdingcompanies controlling many more savings and loans than multiple thrift holdingcompanies in 1996 (as Table 6 shows). The Gramm-Leach-Bliley Act of 1999further blocked entry by prohibiting commercial firms from ownership of unitarythrift holding companies. It did, however, grandfather existing companies.

Table 7 shows a list of unitary thrift holding companies as of June 1996 andtheir status as of June 2010. Of the 28 companies, 16 still existed as of June 2010.The largest such company is USAA, the parent of USAA Federal Savings Bank,which in turn is the parent of an ILC.

As Table 8 shows, legislative actions taken by the federal government overthe past 50 years have steadily and consistently blocked entry into banking bycommercial firms. Commercial firms after 1987 and before 1999 had only twochoices: become a unitary thrift holding company or own an ILC. If a commercialfirm became a unitary thrift holding company, however, its subsidiary was subjectto the Qualified Thrift Lender Test, which meant the savings and loan institution

26U.S. Treasury Department (1991).

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28 James R. Barth et al.Ta

ble

5:Se

lect

edF

DIC

-ins

ured

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bank

bank

s”

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nsur

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1987

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in19

93Sh

ears

on/A

mer

ican

Exp

ress

Am

eric

anE

xpre

ssC

entu

rion

Ban

k61

429

,992

(bec

ame

anFD

IC-i

nsur

edIL

Cin

1989

)A

mer

ican

Exp

ress

Co.

Gre

enw

ood

Tru

stC

o.2,

287

59,5

01(n

owD

isco

ver

Ban

k)Se

ars

Roe

buck

&C

o.H

urle

ySt

ate

Ban

k7

Acq

uire

dby

Citi

bank

USA

in01

/200

2Se

ars

Roe

buck

&C

o.C

layt

onB

ank

&T

rust

24M

erge

din

toPN

CB

ank

on8/

21/2

009

Mob

ilC

orp.

City

Loa

nB

ank

598

n.a.

Con

trol

Dat

aC

orp.

Hic

kory

Poin

tBan

k&

Tru

st45

866

(cur

rent

lya

FSB

)A

rche

rD

anie

lsM

idla

nd

Fire

side

Thr

iftC

o.31

776

7(n

owFi

resi

deB

ank,

owne

dby

Uni

trin

)Te

ledy

neIn

c.G

EC

CFi

nanc

ialC

orp.

357

Dep

osits

acce

pted

byFi

rstH

awai

ian

Ban

kon

6/26

/199

5G

ener

alE

lect

ric

Co.

Sour

ces:

FDIC

,Milk

enIn

stitu

te,c

ompa

nyw

ebsi

tes.

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Industrial Loan Companies 29

Table 6: Holding companies that own OTS-regulated thrifts, as ofDecember 31, 1996

Holding Number of Number of Thrift assetscompany type holding companies thrifts owned (US$ billions)

Unitary thrift holdingcompanies

704 515 $467

Multiple thrift holdingcompanies

40 39 $94

Bank holdingcompanies owningthrifts

131 97 $71

Total 875 651 $632

Note: The total does not include 685 independent thrifts, which held $137 billion in assets.Source: Office of Thrift Supervision (1997).

had to hold a relatively high percentage of its loan portfolio in housing-relatedassets. It should not be surprising, then, that not all commercial firms wouldconsider this option desirable. Some, therefore, like General Motors, decided toacquire an ILC. When General Motors did this in 1988, it subsequently changedthe ILC’s name to GMAC Capital Corp.

By 1999, there was only one remaining point of entry: the acquisition orformation of an industrial loan company.27 As already noted, there are cur-rently nine commercially owned and 30 financially owned ILCs. The nine com-mercially owned institutions now account for 14% of the total assets of theILC industry—and this segment could presumably account for even more, ifand when the moratorium on newly chartered commercially owned ILCs islifted.

The concern over commercial firms owning banking institutions presents somestriking contradictions. After all, Bill Gates can own a bank, but Microsoft cannot.Members of the Walton family, moreover, do own a commercial bank (the ArvestBank, with some 200 branches in Arkansas, Oklahoma, Missouri, and Kansas),but Wal-Mart cannot. The company does, however, operate a full-service bankin Mexico and could own banks in most of the foreign jurisdictions in which itoperates. It seems rather paradoxical that an individual can own a bank and acompany, and yet that company itself cannot invest in a bank.

Furthermore, the United States is out of step with most countries around theworld. According to World Bank data, only four of 142 countries surveyed prohibitthe ownership of banks by commercial firms. Most importantly, this restrictsthe ability of the U.S. banking industry to draw upon the substantial equity ofcommercial firms. With options for enlarging its capital base narrowed, the U.S.

27There was also the ownership of a limited, credit-card-only bank charter.

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30 James R. Barth et al.

Tabl

e7:

Div

ersi

fied

unit

ary

thri

ftho

ldin

gco

mpa

nies

and

sele

cted

info

rmat

ion

ofth

eir

thri

ftsu

bsid

iari

es

Thr

ift

asse

ts(U

S$m

illio

ns)

Hol

ding

com

pany

Typ

eof

busi

ness

Thr

ift

nam

eJu

ne19

96Ju

ne20

10N

ote

Aca

cia

Mut

ualL

ife

Insu

ranc

eC

o.In

sura

nce

Aca

cia

Fede

ralS

avin

gsB

ank

516

1,31

4

Am

eric

anM

utua

lH

oldi

ngC

o.L

ife

insu

ranc

eA

mer

usB

ank

1,19

8n.

a.In

activ

e,7/

31/1

998

B.A

.T.I

ndus

trie

sTo

bacc

o,ci

gare

ttes

Firs

tFS&

LA

ofR

oche

ster

7,34

1n.

a.In

activ

e,3/

20/1

997

Car

pent

ers

Pens

ion

Tru

stFu

ndSo

uthe

rnC

alif

orni

aPe

nsio

ntr

ust

Uni

ted

Lab

orB

ank

FSB

7126

0

Clu

bC

orp.

Inte

rnat

iona

lR

esor

tsFr

ankl

inFe

dera

lB

anco

rpFS

B90

0n.

a.In

activ

e,1/

1/19

97

Equ

ityH

oldi

ngs

Ltd

.R

eale

stat

eFi

rsta

teFi

nanc

ialF

A10

3n.

a.In

activ

e,4/

18/1

997

Est

ate

ofB

erni

cePa

uahi

Bis

hop

Non

prof

ited

ucat

ion

Sout

hern

Cal

.FS&

LA

1,69

5n.

a.In

activ

e,11

/13/

2001

Firs

tPac

ific

Inve

stm

ent

Num

erou

sho

ldin

gsU

nite

dSa

ving

sB

ank

1,52

710

,895

Nam

eis

now

Uni

ted

Ltd

.and

Ltd

.II

Com

mer

cial

Ban

kH

awai

ian

Ele

ctri

cIn

dust

ries

Inc.

Publ

icel

ectr

icA

mer

ican

Savi

ngs

Ban

kFS

B3,

413

4,87

5

Her

itage

Mut

ual

Insu

ranc

eW

estla

ndSa

ving

sB

ank

91n.

a.H

erita

geM

utua

lIns

u-In

sura

nce

Co.

SAra

nce

isno

wA

cuity

Hy-

Vee

Food

Stor

esG

roce

ryM

idw

estH

erita

geB

ank

FSB

9714

9

(Con

tinu

ed)

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Industrial Loan Companies 31

Tabl

e7:

(Con

tinu

ed)

Thr

ift

asse

ts(U

S$m

illio

ns)

Hol

ding

com

pany

Typ

eof

busi

ness

Thr

ift

nam

eJu

ne19

96Ju

ne20

10N

ote

Illin

ois

Mut

ualL

ife

&C

asua

ltyC

o.In

sura

nce

Ban

kplu

sFS

B19

0n.

a.In

activ

e,7/

31/2

007

Kra

use

Gen

tleC

orp.

Gas

and

food

Lib

erty

Savi

ngs

Ban

kFS

B77

152

The

Lan

gdal

eC

o.M

anuf

actu

ring

-fo

rest

base

dpr

oduc

ts

Com

mer

cial

Ban

king

Co.

3419

8

Mas

sach

uset

tsSt

ate

Car

pent

ers

Pens

ion

Fund

,Gur

ante

edA

nnui

tyFu

nd

Pens

ion

trus

t/tru

stFi

rstT

rade

Uni

onSa

ving

sB

ank

FSB

286

636

McM

orga

n&

Co.

Man

ages

unio

npe

nsio

nfu

nds

Uni

ted

Lab

orB

ank

FSB

7126

0

The

Mon

ticel

loC

os.,

Inc.

Med

icin

esa

les

Mon

ticel

loB

ank

24n.

a.In

activ

e,9/

15/2

007

PH

MC

orp.

Hom

ebu

ildin

gFi

rstH

eigh

tsB

ank

FSB

252

n.a.

Inac

tive,

9/9/

2005

Paci

fic

Ele

ctri

cW

ire

&C

able

Man

ufac

ture

rPa

cifi

cSo

uthw

estB

ank

1,33

7n.

a.In

activ

e,3/

19/2

001

Prud

entia

lIns

uran

ceC

o.In

sura

nce

The

Prud

entia

lSav

ings

Ban

kFS

B20

41,

957

(Con

tinu

ed)

Page 32: Industrial Loan Companies: Where Banking and Commerce Meetwebhome.auburn.edu/~barthjr/publications/2012/Check... · 2012-01-18 · Industrial Loan Companies: Where Banking and Commerce

32 James R. Barth et al.

Tabl

e7:

(Con

tinu

ed)

Thr

ift

asse

ts(U

S$m

illio

ns)

Hol

ding

com

pany

Typ

eof

busi

ness

Thr

ift

nam

eJu

ne19

96Ju

ne20

10N

ote

Ray

mon

dJa

mes

Fina

ncia

lIn

c.Se

curi

tybr

oker

age

Ray

mon

dJa

mes

Ban

kFS

B19

07,

465

Sout

hwes

tGas

Cor

p.G

astr

ansm

issi

onPr

imer

itB

ank

FSB

1,70

51,

608

Sun

Lif

eA

ssur

ance

Co.

Insu

ranc

eN

ewL

ondo

nT

rust

FSB

289

n.a.

Inac

tive,

10/3

0/19

99Te

mpl

eIn

land

Inc.

Pape

rG

uara

nty

Fede

ralB

ank

FSB

9,15

373

1

USA

AIn

sura

nce

USA

AFe

dera

lSav

ings

Ban

k5,

806

41,7

49

Wat

tsH

ealth

Syst

ems

Inc.

Hea

lthpl

ans

Fam

ilySa

ving

sB

ank

FSB

167

n.a.

Inac

tive,

12/3

1/20

02

Stat

eFa

rmM

utua

lAut

oIn

sura

nce

Co.

∗M

ortg

age

lend

ing

spec

ializ

atio

nSt

ate

Farm

Ban

kFS

B-

15,6

63

Nor

dstr

omIn

c.∗

Cre

dit-

card

spec

ializ

atio

nN

ords

trom

FSB

n.a.

196

Not

e:A

sof

July

9,19

96,t

heO

TS

repo

rted

the

follo

win

gnu

mbe

rof

firs

t-tie

rth

rift

hold

ing

com

pani

es:2

8di

vers

ifie

dun

itary

hold

ing

com

pani

esan

d65

0no

ndiv

ersi

fied

unita

ryho

ldin

gco

mpa

nies

.The

rew

ere

nodi

vers

ifie

dm

ultip

leho

ldin

gco

mpa

nies

and

44no

ndiv

ersi

fied

mul

tiple

hold

ing

com

pani

es.A

dive

rsif

ied

thri

ftho

ldin

gco

mpa

nyis

defi

ned

byst

atut

eas

one

inw

hich

the

subs

idia

rysa

ving

sas

soci

atio

nan

dce

rtai

not

her

fina

ncia

lac

tiviti

esre

pres

entl

ess

than

50%

ofco

nsol

idat

edne

twor

than

dco

nsol

idat

edne

tear

ning

s.So

urce

s:O

CC

,FD

IC,M

ilken

Inst

itute

.∗ N

on-d

iver

sifi

edth

rift

hold

ing

com

pani

es.

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Industrial Loan Companies 33

Tabl

e8:

Leg

isla

tion

proh

ibit

ing

com

mer

cial

owne

rshi

pof

fede

rally

insu

red

depo

sito

ryin

stit

utio

ns

Leg

isla

tion

and

year

proh

ibit

ing

Typ

esof

fede

rally

insu

red

Typ

eof

fede

rally

insu

red

com

mer

cial

owne

rshi

pof

spec

ific

type

sof

inst

itut

ions

that

legi

slat

ion

proh

ibit

sin

stit

utio

nth

atca

nbe

owne

dby

fede

rally

insu

red

depo

sito

ryin

stit

utio

nsco

mm

erci

alfi

rms

toow

na

com

mer

cial

firm

Prio

rto

1956

–A

nyty

peof

depo

sito

ryin

stitu

tion

Ban

kH

oldi

ngC

ompa

nyA

ctof

1956

Indi

vidu

alba

nks

and

mul

tiple

-ban

kho

ldin

g1.

One

-ban

kho

ldin

gco

mpa

nies

com

pani

es2.

Non

bank

bank

s3.

Mul

tiple

thri

ftho

ldin

gco

mpa

nies

4.U

nita

ryth

rift

hold

ing

com

pani

es5.

ILC

sSa

ving

san

dL

oan

Hol

ding

Com

pany

Act

Mul

tiple

thri

ftho

ldin

gco

mpa

nies

1.O

ne-b

ank

hold

ing

com

pani

es(S

LH

CA

)of

1967

2.N

onba

nkba

nks

3.U

nita

ryth

rift

hold

ing

com

pani

es4.

ILC

sB

ank

Hol

ding

Com

pany

Act

Am

endm

ents

ofO

ne-b

ank

hold

ing

com

pani

es(e

xist

ing

1.N

onba

nkba

nks

1970

com

mer

cial

owne

rshi

pgr

andf

athe

red)

2.U

nita

ryth

rift

hold

ing

com

pani

es3.

ILC

sC

ompe

titiv

eE

qual

ityB

anki

ngA

ctof

1987

Non

bank

bank

s(e

xist

ing

com

mer

cial

owne

rshi

p1.

Uni

tary

thri

ftho

ldin

gco

mpa

nies

gran

dfat

here

d)2.

ILC

sG

ram

m-L

each

-Blil

eyA

ctof

1999

Uni

tary

thri

ftho

ldin

gco

mpa

nies

(exi

stin

gco

mm

erci

alow

ners

hip

gran

dfat

here

d)IL

Cs

Dod

d-Fr

ank

Wal

lStr

eetR

efor

man

dC

onsu

mer

Prot

ectio

nA

ctof

2010

Mor

ator

ium

and

GA

Ost

udy

ILC

s

Not

e:U

nles

sa

law

spec

ific

ally

proh

ibits

aco

mm

erci

alfi

rmfr

omow

ning

ade

posi

tory

inst

itutio

n,it

isas

sum

edhe

reth

atsu

chow

ners

hip

isal

low

ed.C

redi

tuni

ons

and

mut

uals

avin

gsan

dlo

ans

are

excl

uded

.So

urce

:Milk

enIn

stitu

te.

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34 James R. Barth et al.

banking industry will find it more challenging to remain a major player in theincreasingly competitive global arena.

Those who have cautioned against allowing commercial firms to own ILCs,or banks more generally, frequently focus on the systemic risks posed by suchentities. They have also raised questions about oversight and the potential forparent companies to use their ILCs for anti-competitive practices. But regulationthat is already in place appears to be adequate to address these concerns.

For example, some observers fear that ILCs may endanger community banks iftheir commercial parents have the size, resources, and will to use predatory pricingto drive local bank competitors out of business. Others have expressed concernsthat ILCs may have incentives to deny credit to their parents’ competitors or theircompetitors’ customers, to provide funds on preferential terms to their commercialparents, and to tie loans inappropriately to purchases of the parents’ products.However, unfair competition and conflicts of interest are prohibited under existingfederal law, giving regulators the authority and the tools to address these issueswithout eliminating an entire industry.

While the sheer size of some of the corporations that might wish to enter thismarket has been a flashpoint in the debate, the Dodd-Frank Act also provides ameans to limit the growth of any company that might pose a systemic risk to theeconomy. And in times of systemic crisis, commercial firms do not gain directaccess to the federal safety net (meaning FDIC insurance and access to the FederalReserve discount window) merely by owning an ILC.

Is systemic risk heightened by the fact that ILCs and their parents are regulatedby the states and the FDIC, rather than the Federal Reserve? Recent history wouldseem to indicate that is not the case; there is no evidence that the Federal Reservehas done or will do a better job than state regulators or the FDIC. (Indeed, inthe most recent financial crisis, the Fed did not do a particularly good job ofoverseeing bank holding companies, while none of the state- and FDIC-regulatedcommercially owned ILCs failed.)

It is also important to consider the potential impact of a parent company fail-ure. If this occurs and the ILC subsidiary is largely in the business of financingpurchases from the parent, would the ILC be forced into insolvency? The recordshows this has not been a problem in the past. ILCs, as separately chartered andcapitalized subsidiaries, can continue to operate. In a worst-case scenario, an ILCwith a failing parent would undergo a controlled liquidation with the goals ofpaying depositors (no losses to the FDIC), paying all other creditors in full, andpaying a liquidating dividend to the parent. For instance, when Conseco filedfor bankruptcy, its ILC subsidiary self-liquidated, paid all depositors and otherdebts, and then paid a large dividend to the bankruptcy trustee to pay the par-ent’s creditors. The ILC owned by Lehman Brothers also remained solvent andis self-liquidating despite the bankruptcy of its parent. (According to the latestquarterly reports, in the past two years, it has shrunk from over $6.4 billion inassets to $2.8 billion, has a 26.6% capital ratio, and is earning about 2.4% ROAin the third quarter of 2010.) In two other instances, ILCs owned by companies

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Industrial Loan Companies 35

that were reorganizing under bankruptcy laws continued operating normally underclose regulatory oversight to ensure that the bank’s assets were not used to helprescue the parent. More generally, these examples show that prudent regulationand supervision can prevent (and has prevented) any exploitation of the insuredsubsidiary by the parent when the parent faces financial difficulties.

Given the range of concerns that have been expressed about this little-knowncorner of the banking industry, it is essential to understand exactly how ILCs areregulated. Table 9 compares the powers, ownership forms, and regulatory oversightof ILCs vs. state commercial banks. It shows that ILCs have more restrictions onthe types of deposits they are able to offer, though in most other respects, bothare subject to similar restrictions and oversight. More generally, both ILCs andtheir parent companies are subject to regulation by the bank’s regulators. They areexamined and required to provide reports and other information specified by theregulators. The regulators can issue cease and desist orders, orders of prohibition,and civil money penalties to the parent company and every affiliate that hastransactions with the bank or otherwise influences its operations, all individualsserving as officers or representatives of an affiliate, outside auditors, consultantsand legal counsel, and anyone else that qualifies as an “institution affiliated party”as defined in the Federal Deposit Insurance Act. These powers are comparableto the Federal Reserve’s authority over bank holding companies and financialholding companies.

The primary differences between the regulation of an ILC holding company anda bank holding company is that ILC affiliates can engage in any lawful activitythat does not pose a risk to the bank; ILC regulators do not govern the activitiesof a diversified parent that have no relevance to the bank, such as manufacturingand retail sales operations. The parents of commercially owned ILCs are also nowsubject to serving as sources of strength as a result of the Dodd-Frank Act.

It is important to point out the relative importance of parent companies to theirILCs. Tables 10 and 11 provide information on the ILCs’ assets and equity capitalas a percentage of the parents’ assets and equity capital, respectively, as well asthe ROA and ROE for both the ILCs and their parents. Table 10 shows that theassets of ILCs as a percent of the parents’ assets range from a low of 0.3 to a highof 29.1%, while the ILCs’ equity capital as a percent of the parents’ equity capitalranges from a low of 0.1 to a high of 28.4%. In general, these figures indicate thatto the extent that the parents are financially healthy, they can serve as a source ofstrength for their subsidiary ILCs.

Moreover, parent firms serve as an important source of governance over theirILCs. Commercial firms like BMW, Target, and Toyota clearly do not wish to havetheir brands damaged by inappropriate behavior on the part of their subsidiaryILCs, given their overriding dependency on the products produced by the parents.

While ILCs tend to be dwarfed by their parent companies in terms of assetsand equity capital, the bank subsidiaries of bank holding companies are generallyvital to the overall enterprise. Table 12 shows that the bank subsidiaries of bankholding companies generally account for a relatively large share of the total assets

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36 James R. Barth et al.

Table 9: ILCs vs. state commercial banks: Differences in powers, ownershipform and regulatory oversight

Statecommercial banks ILCs

Ability to offer full range of depositsand loans

Yes Yes∗

Ability to export interest rates Yes YesAbility to branch interstate Yes YesExamination, supervision, and

regulation by FDICYes Yes

FDIC may conduct limited scope examof affiliates

Yes Yes

Federal Reserve Act 23A & 23B,Reg. O, CRA apply (see note)

Yes Yes

Anti-tying restrictions apply Yes YesFull range of enforcement actions can

be applied to the subsidiarydepository institutions if parent failsto maintain adequate capitalization

Yes Yes

Ability to accept demand deposits andcommercial checking accounts

Yes No∗∗

Parent subject to umbrella federaloversight

Yes No∗∗∗

Parent activities generally limited tobanking and financial activities

Yes No

Parent serves as a source of strength Yes Yes,Dodd-Frank Act

makes explicitChartered as a national institution Yes NoChartered as a state institution Yes YesGolden Parachute restrictions apply Yes YesParent could be prohibited from

commencing new activities if asubsidiary depository institution hasa CRA rating that falls belowsatisfactory

Yes No

Parent could be ordered by a federalbanking agency to divest of adepository institution subsidiary ifthe subsidiary become less then wellcapitalized

Yes No

(Continued)

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Industrial Loan Companies 37

Table 9: (Continued)

Statecommercial banks ILCs

Control owners who have caused a lossto a failed institution may be subjectto personal liability

Yes Yes

Cross-guarantee requirement foraffiliates

Yes No

Note: Federal Reserve Act Sections 23A and 23B limit bank transactions with affiliatesand the parent company. Regulation O limits loans to bank insiders and applies to allFDIC-insured institutions. CRA denotes the Community Reinvestment Act.Sources: Adapted from West (2004); Milken Institute.∗Including NOW (negotiable order of withdrawal) accounts. However, ILCs with morethan $100 million in assets cannot accept demand deposits or offer commercial checkingaccounts.∗∗Except those ILCs that have assets of less than $100 million or ILCs that were notacquired after August 10, 1987.∗∗∗Publicly traded parent companies are subject to SEC oversight.

of their parents. In most cases, the reputation of the bank holding companies ishighly dependent upon the reputation of the subsidiary bank, while the reverse istrue for commercially owned ILCs and their parents.

In short, for most bank holding companies, as the financial performance of thebank goes, so goes the parent. This is not the case for commercial firms like BMW,Toyota, and Target that own ILCs.

IV. THE CAPITALIZATION AND PERFORMANCE OF ILCS

It’s clear that ILCs were not responsible for the financial crisis of 2007–2010.After all, these institutions accounted for only a very small portion of the numberand total assets of all financial firms during these years.

Furthermore, most of the FDIC’s deposit insurance protects deposits of non-ILCinstitutions. ILCs accounted for 4.1% or less of all FDIC-insured deposits over thepast decade. As of mid-2010, they accounted for less than 2%. Most of the insureddeposits, moreover, are held by financially owned ILCs, not commercially ownedILCs. If the FDIC had to write a check to all insured depositors to cover losses,the sum going to ILC depositors would be at most $87 billion (assuming all ILCdeposits are FDIC-insured) while the check going to all other depositors wouldbe a daunting sum indeed, at more than $5 trillion. In short, ILCs do not pose aserious threat to the FDIC insurance fund at the present time or in the foreseeablefuture.

Page 38: Industrial Loan Companies: Where Banking and Commerce Meetwebhome.auburn.edu/~barthjr/publications/2012/Check... · 2012-01-18 · Industrial Loan Companies: Where Banking and Commerce

38 James R. Barth et al.

Tabl

e10

:Im

port

ance

ofco

rpor

ate

pare

nts

for

fina

ncia

llyow

ned

ILC

s,Q

220

10

Par

ent

com

pany

ILC

Tota

lE

quit

yIL

Cas

sets

ILC

equi

tyE

quit

yTo

tal

equi

tyca

pita

las

%of

its

as%

ofit

sca

pita

las

sets

capi

tal

toto

tal

RO

AR

OE

Fin

anci

ally

pare

nt’s

pare

nt’s

toto

tal

RO

AR

OE

Par

ent

com

pany

(US$

B)

(US$

B)

asse

ts(%

)(%

)(%

)ow

ned

ILC

Stat

eas

sets

equi

tyas

sets

(%)

(%)

(%)

Lea

vitt

Gro

upn.

a.n.

a.n.

a.n.

a.n.

a.A

DB

Ban

kU

Tn.

a.n.

a.15

.60.

53.

1A

mer

ican

Exp

ress

Co.

143.

814

.510

.12.

523

.3A

mer

ican

Exp

ress

Cen

turi

onB

ank

UT

20.9

35.6

17.2

4.5

24.8

Wel

lPoi

nt50

.223

.847

.410

.222

.0A

RC

US

Ban

kU

T0.

10.

290

.42.

49.

5H

afif

Ban

corp

n.a.

n.a.

n.a.

n.a.

n.a.

Bal

boa

Thr

ifta

ndL

oan

Ass

ocia

tion

CA

n.a.

n.a.

10.1

0.6

6.1

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lFin

anci

alC

orp.

n.a.

n.a.

n.a.

n.a.

n.a.

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lBan

kN

evad

aN

Vn.

a.n.

a.35

.39.

125

.4C

apita

lSou

rce

10.7

2.0

18.4

−5.5

−31.

1C

apita

lSou

rce

Ban

kC

A54

.044

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.2−0

.1−0

.5

Gen

eral

Mot

ors

Co.

,pr

ivat

eeq

uity

cons

ortiu

m

n.a.

n.a.

n.a.

n.a.

n.a.

Cap

mar

kB

ank

UT

n.a.

n.a.

19.0

−6.9

−37.

6

Cel

ticIn

vest

men

tn.

a.n.

a.n.

a.n.

a.n.

a.C

eltic

Ban

kU

Tn.

a.n.

a.11

.21.

412

.9L

andA

mer

ica

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ncia

lGro

up∗

3.3

0.5

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∗n.

a.n.

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ente

nnia

lBan

kC

A24

.417

.110

.30.

65.

9

Cir

cle

Ban

corp

0.3

n.a.

n.a.

n.a.

n.a.

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cle

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kC

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.7n.

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50.

810

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EL

AC

U0.

4n.

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a.C

omm

unity

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mer

ceB

ank

CA

95.8

n.a.

9.3

−0.4

−4.4

(Con

tinu

ed)

Page 39: Industrial Loan Companies: Where Banking and Commerce Meetwebhome.auburn.edu/~barthjr/publications/2012/Check... · 2012-01-18 · Industrial Loan Companies: Where Banking and Commerce

Industrial Loan Companies 39

Tabl

e10

:(C

onti

nued

)

Par

ent

com

pany

ILC

Tota

lE

quit

yIL

Cas

sets

ILC

equi

tyE

quit

yTo

tal

equi

tyca

pita

las

%of

its

as%

ofit

sca

pita

las

sets

capi

tal

toto

tal

RO

AR

OE

Fin

anci

ally

pare

nt’s

pare

nt’s

toto

tal

RO

AR

OE

Par

ent

com

pany

(US$

B)

(US$

B)

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ts(%

)(%

)(%

)ow

ned

ILC

Stat

eas

sets

equi

tyas

sets

(%)

(%)

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F&T

Fina

ncia

lSe

rvic

es0.

10.

0n.

a.n.

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nanc

e&

Thr

ift

Co.

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92.4

81.9

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6.8

Fina

nce

Ent

erpr

ises

n.a.

n.a.

n.a.

n.a.

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Fina

nce

Fact

ors

Ltd

.H

In.

a.n.

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7−1

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1.9

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trin

8.5

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24.3

2.5

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Fire

side

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kC

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311

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24.

5Fi

rstA

mer

ican

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ncia

lCor

p.5.

51.

934

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rstS

ecur

ityB

usin

ess

Ban

kC

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31.

910

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514

.4

No

affi

liatio

nG

olde

nSe

curi

tyB

ank

CA

n.a.

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6.69

−1.0

7−1

5.7

Lea

seC

orp.

ofA

mer

ica

n.a.

n.a.

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AB

ank

Cor

p.U

Tn.

a.n.

a.11

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015

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allio

nFi

nanc

ial

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allio

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ank

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87.8

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n.a.

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dWor

ksL

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erri

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ank

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p.U

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612

.9

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neso

taT

hrif

tCo.

n.a.

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neso

taFi

rst

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dit&

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ngs

Inc.

MN

n.a.

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0.6

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Firs

tFin

anci

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orp.

2.5

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The

Mor

ris

Plan

Com

pany

ofTe

rre

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teIn

c.

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914

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tedH

ealth

Gro

up60

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418

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ptum

Hea

lthB

ank

Inc.

UT

2.4

0.7

11.9

3.1

26.3

(Con

tinu

ed)

Page 40: Industrial Loan Companies: Where Banking and Commerce Meetwebhome.auburn.edu/~barthjr/publications/2012/Check... · 2012-01-18 · Industrial Loan Companies: Where Banking and Commerce

40 James R. Barth et al.

Tabl

e10

:(C

onti

nued

)

Par

ent

com

pany

ILC

Tota

lE

quit

yIL

Cas

sets

ILC

equi

tyE

quit

yTo

tal

equi

tyca

pita

las

%of

its

as%

ofit

sca

pita

las

sets

capi

tal

toto

tal

RO

AR

OE

Fin

anci

ally

pare

nt’s

pare

nt’s

toto

tal

RO

AR

OE

Par

ent

com

pany

(US$

B)

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B)

asse

ts(%

)(%

)(%

)ow

ned

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Stat

eas

sets

equi

tyas

sets

(%)

(%)

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Sem

perv

erde

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ding

Co.

n.a.

n.a.

n.a.

n.a.

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Ran

cho

Sant

aFe

Thr

ift&

Loa

nA

ssoc

.

CA

n.a.

n.a.

71.9

3.0

4.9

SLM

Cor

p.20

7.3

3.7

2.5

0.5

26.7

Salli

eM

aeB

ank

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3.6

35.3

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UB

SA

G1,

353.

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BS

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kU

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T2.

16.

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SAA

n.a.

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ASa

ving

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ank

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lPar

tner

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oldi

ngs

LP

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kU

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024

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man

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ther

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oodl

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mer

cial

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k

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0.5

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aSy

stem

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00.

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ldFi

nanc

ial

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italB

ank

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5.9

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ghtE

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righ

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ncia

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∗ Dat

ais

asof

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;Lan

dAm

eric

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ialG

roup

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dba

nkru

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ovem

ber

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008.

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ehm

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ers

file

dba

nkru

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ber

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urce

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IC;B

loom

berg

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enIn

stitu

te.

Page 41: Industrial Loan Companies: Where Banking and Commerce Meetwebhome.auburn.edu/~barthjr/publications/2012/Check... · 2012-01-18 · Industrial Loan Companies: Where Banking and Commerce

Industrial Loan Companies 41

Tabl

e11

:Im

port

ance

ofco

rpor

ate

pare

nts

toco

mm

erci

ally

owne

dIL

Cs,

Q2

2010

Par

ent

com

pany

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Tota

lE

quit

yIL

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sets

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equi

tyE

quit

yTo

tal

equi

tyca

pita

las

%of

its

as%

ofit

sca

pita

lP

aren

tas

sets

capi

tal

toto

tal

RO

AR

OE

Com

mer

cial

lypa

rent

’spa

rent

’sto

tota

lR

OA

RO

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mpa

ny(U

S$B

)(U

S$B

)as

sets

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owne

dIL

CSt

ate

asse

tseq

uity

asse

ts(%

)(%

)(%

)

BM

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WB

ank

ofN

orth

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eric

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42.

931

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ley-

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agle

mar

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ving

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ank

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SE

nerg

y15

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019

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nerB

ank

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UT

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lect

roni

csn.

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rstE

lect

roni

cB

ank

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n.a.

n.a.

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912

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ital

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ncia

lInc

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9

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kIn

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etC

orp.

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ank

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yota

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ncia

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ving

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ank

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0.3

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nspo

rtat

ion

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ance

Ban

kIn

c.

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29.1

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lass

ets

ofU

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onfi

nanc

ialc

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rate

busi

ness

:$2

7tr

illio

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taln

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orth

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onfi

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rate

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ness

:$1

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illio

n

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owne

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kIn

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ange

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emen

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2010

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urce

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owof

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s,Fe

dera

lRes

erve

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IC,B

loom

berg

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enIn

stitu

te.

Page 42: Industrial Loan Companies: Where Banking and Commerce Meetwebhome.auburn.edu/~barthjr/publications/2012/Check... · 2012-01-18 · Industrial Loan Companies: Where Banking and Commerce

42 James R. Barth et al.Ta

ble

12:

Tota

lass

ets

and

equi

tyof

sele

cted

bank

hold

ing

com

pani

esan

dth

eir

subs

idia

ries

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2010

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ding

com

pany

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IC-i

nsur

edsu

bsid

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ing

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pany

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lN

o.of

Com

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ned

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tal

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kho

ldin

gTo

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nkto

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me

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atio

nas

sets

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tal

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S$B

)ca

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kof

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(Con

tinu

ed)

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Industrial Loan Companies 43

Tabl

e12

:(C

onti

nued

)

Hol

ding

com

pany

FD

IC-i

nsur

edsu

bsid

iari

es%

hold

ing

com

pany

Tota

lN

o.of

Com

bine

dC

ombi

ned

tota

lTo

tal

Ban

kho

ldin

gTo

tal

equi

tyba

nkto

tal

bank

equi

tyTo

tal

equi

tyco

mpa

nyna

me

Loc

atio

nas

sets

capi

tal

subs

idia

ries

asse

ts(U

S$B

)ca

pita

l(U

S$B

)as

sets

capi

tal

Key

Cor

pC

leve

land

,OH

9411

.11

918.

996

.280

.7N

orth

ern

Tru

stC

orp.

Chi

cago

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44 James R. Barth et al.

Table 13: Losses incurred by the FDIC’s deposit insurance fund from failedinstitutions: ILCs vs. all other FDIC-insured institutions, 1986 to 2009

All other ILCs as% of allFDIC-insured other FDIC-

depository insured depositoryILCs institutions institutions

1986–2003Number of failed institutions 21 2,065 1.0%Total assets of failed institutions

(US$ millions)$1,470 $642,575 0.2%

Total loss to the FDIC (US$millions)

$212 $105,309 0.2%

Total loss to total assets of failedinstitutions (%)

14.4% 16.4% –

2004–2009Number of failed institutions 0 172 0%Total assets of failed institutions

(US$ millions)$0 $544,440 0%

Total loss to the FDIC (US$millions)

$0 $57,431 0%

Total loss to total assets of failedinstitutions (%)

– 10.5% –

1986–2009Number of failed institutions 21 2,237 0.9%Total assets of failed institutions

(US$ millions)$1,470 $1,187,104 0.1%

Total loss to the FDIC (US$millions)

$212 $162,740 0.1%

Total loss to total assets of failedinstitutions (%)

14.4% 13.7% –

Sources: FDIC, Milken Institute.

Of course, there have been some failures of ILCs over time. Since 1986, 21ILCs have failed, costing the FDIC $212 million to resolve. But no ILC failedfrom 2004 to 2009, which encompasses the recent financial crisis. Furthermore,none of the failures involved commercially owned ILCs. The two biggest ILCsaccounted for 43% of the total FDIC resolution cost for all failed ILCs over thistime period.

The 21 failed ILCs accounted for 1% of all FDIC-insured depository institutionfailures during this time period, as shown in Table 13. The other 2,237 institutionsthat failed cost the FDIC $163 billion to resolve, while the 21 ILCs cost $212million. In terms of losses relative to assets, the ILCs’ ratio was 14.4% overthe period, as compared to 13.7% for the other institutions. From 2004 to 2009,

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Industrial Loan Companies 45

-60

-40

-20

0

20

40

60

2001 2002 2003 2004 2005 2006 2007 2008 2009 Q2 2010

ILCs

Currently active ILCs

FDIC-insured institutions

Percent change from previous year

Note: Q2 2010 data represents percent change from year-end 2009.Sources: Federal Reserve, FDIC, Milken Institute.

Figure 9: Asset growth for all and only currently active ILCs and FDIC-insuredinstitutions, 2001 to Q2 2010.

however, the ratio for ILCs was 0 because there were no failures, while the ratiofor the other 172 failed institutions was 10.5%.

During the crisis years, some ILCs closed and others were converted to com-mercial banks. Table 14 provides a list of these institutions and shows that after2009, only one ILC failed. This institution, Advanta Bank Corp., was a financiallyowned ILC that provided loans to small businesses; it failed in March 2010 as itsclients suffered the effects of the Great Recession. This institution, like so manyothers, became a victim of the crisis, as its income and capital plummeted. OtherILCs closed or converted to commercial bank charters, contributing to substantialchanges in the assets and loans of the ILC industry during the past several years. Itshould be noted that the charter conversions during the recent crisis were, in mostcases, driven by the parent companies’ conversion to bank holding companies.

Two failures and 20 closings and conversions occurred in the ILC industryduring the past decade. Despite these changes, Figures 9 and 10 show that the assetsand loans of ILCs grew in every year except 2008 and 2009. (For comparison, wealso include the growth of assets and loans for all FDIC-insured institutions aswell as for the currently active ILCs.) It therefore follows that these institutionsdid not contribute to the recent credit crunch, in contrast to the other FDIC-insuredinstitutions. The lack of growth in assets and loans for all ILCs in 2008 and 2009is almost entirely due to the conversion of a few large ILCs to commercial banks.

Real estate lending was a major factor in the crisis. Using a simple bivari-ate regression model, Figure 11 shows that there is a statistically significantand negative relationship between ROA (and ROE) and the percentage of anILC’s total assets that are accounted for by real estate loans. It is therefore use-ful to compare the percentage of total loans that were real estate–related for all

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46 James R. Barth et al.

Table 14: Closed and converted ILCs, 2007 to 2010

Year-endassets as of the

Industrial loan Inactive inactive date Inactivecompanies State date (US$ millions) type Parent company

Financially owned ILCsMerrill Lynch Bank

USAUT 7/1/2009 67,995 M&A Merrill Lynch

Morgan Stanley Bank UT 9/23/2008 38,530 CB Morgan StanleyGoldman Sachs Bank

USAUT 9/26/2008 21,630 CB Goldman Sachs

Fremont Investment &Loan

CA 7/25/2008 5,657 VC Fremont General Corp.

CIT Bank UT 12/22/2008 3,117 CB CIT GroupAdvanta Bank Corp. UT 3/19/2010 1,526 Failed AdvantaTrust Industrial Bank CO 12/1/2009 798 VC FISERVTamalpais Bank CA 1/30/2009 702 CB Tamalpais BancorpRepublic Bank Inc. UT 5/28/2009 554 CB No affiliationSilvergate Bank CA 2/28/2009 327 CB Silvergate CapitalSecurity Savings Bank NV 2/27/2009 238 M&A Srampede Capital LLC5 Star Bank CO 5/1/2009 157 CB Armed Forces Benefit

AssociationFirst Financial Bank CO 9/19/2007 152 VC First Data Corp.Home Bank of

CaliforniaCA 7/11/2008 148 CB La Jolla Savers and

Mortgage FundMarlin Business Bank UT 1/31/2009 84 CB Marlin Business ServicesHome Loan Industrial

BankCO 6/1/2008 41 CB Home Loan Investment

Co.

Commercially owned ILCsAlly Bank (GMAC

Bank)∗UT 10/1/2009 52,513 CB GM

Volkswagen Bank USA UT 10/26/2007 288 VC Volkswagen AGEscrow Bank USA UT 6/30/2009 2 VC GMVolvo Commercial

Credit Corp. of UtahUT 1/16/2007 3 CB Volvo

∗Ally Bank originally was established on 8/2/2004 as GMAC Automotive Bank; CapmarkBank was originally established on 4/1/2003 as GMAC Commercial Mortgage Bank.Note: VC: Voluntarily closed; CB: Converted to commercial bank. M&A: Merged with oracquired by other institutions.Source: FDIC.

FDIC-insured institutions vs. the percentage for ILCs. Real estate loans accountedfor 61% of total loans for FDIC-insured institutions before the crisis and declinedslightly to 59% after the crisis. But for financially owned ILCs, real estate loansmade up slightly less than one-third of total loans before the crisis, dropping to17% after the crisis, as shown in Figure 12. This decline was mainly due to the clo-sure or conversion of several large financially owned ILCs. Commercially ownedILCs, however, had a very small percentage of real estate loans. Figure 13 shows

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Industrial Loan Companies 47

-50

-40

-30

-20

-10

0

10

20

30

40

2001 2002 2003 2004 2005 2006 2007 2008 2009 Q2 2010

ILCs

Currently active ILCs

FDIC-insured institutions

Percent change from previous year

Note: Q2 2010 data represents percent change from year-end 2009.Sources: Federal Reserve, FDIC, Milken Institute.

Figure 10: Loan growth for all and only currently active ILCs and FDIC-insuredinstitutions, 2001 to Q2 2010.

-15

-10

-5

0

5

10

15

0 50 100RO

A (%

)

Real estate loans to total assets (%)-60

-40

-20

0

20

40

60

80

0 50 100

RO

E (%

)

Real estate loans to total assets (%)

Note: The estimated beta coefficient from a bivariate regression (ROA = α + β Realestate/total assets) is statistically significant at the 5% level for the ROA regression, and atthe 1% level for the ROE regression. The RHS figure does not include the data for the PitneyBowes Bank Inc (its ROE = 148%); excluding this bank does not affect the significancelevel of the estimated coefficient.Sources: FDIC; Milken Institute.

Figure 11: ILCs: Correlation between real estate loans to total assetsand performance, Q2 2010.

that prior to the crisis, only 5% of total loans were real estate loans, while afterthe crisis, the percentage increased to 10%.

General Motors owned three ILCs during the past decade: GMAC Bank (nowAlly Bank), Capmark Bank, and Escrow Bank. The latter was voluntarily closed

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48 James R. Barth et al.

Real estate loans 30%

Commercial and

industrial loans 29%

Consumer loans35%

Other loans6%

Financially owned ILCs: Pre-financial crisis period (2007)

Real estate loans 17%

Commercial and

industrial loans 17%

Consumer loans64%

Other loans2%

Financially owned ILCs: Current period (Q2 2010)

Notes: The data are for aggregate loan compositions of all financially owned ILCs. Thepre-financial crisis period is as of the end of 2007. The data include all active ILCs in agiven year; some of them were closed or became inactive before Q2 2010.Sources: FDIC, Milken Institute.

Figure 12: Financially owned ILCs focused more on consumerand commercial/industrial loans, not real estate.

Real estate loans 5%

Commercial and

industrial loans 52%

Consumer loans43%

Other loans<1%

Commercially owned ILCs: Pre-financial crisis period (2007)

Real estate loans 10%

Commercial and

industrial loans 32%Consumer

loans53%

Other loans5%

Commercially owned ILCs: Current period (Q2 2010)

Note: The data are for the aggregate loan composition of all ILCs. The pre-financial crisisperiod is as of the end of 2007. Based on nine commercially owned ILCs (BMW Bank ofNorth America, GE Capital Financial Inc., Target Bank, Toyota Financial Savings Bank,Eaglemark Savings Bank, EnerBank USA, First Electronic Bank, The Pitney Bowes BankInc., and Transportation Alliance Bank Inc.)Sources: FDIC, Milken Institute.

Figure 13: Commercially owned ILCs largely avoided real estate loans both pre-and post-crisis.

in the summer of 2009. GMAC Bank converted to a commercial bank in late2009, while Capmark was sold in 2006 and is still an active ILC. Both GMACand Capmark Bank became and still remain heavily involved in real estate assets,especially as compared to all the other ILCs.

Of the five major investment banks that existed prior to the financial crisis, twoare still active, two were acquired, and one failed. The one that failed, Lehman

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Industrial Loan Companies 49

Brothers, owned an ILC: Woodlands Commercial Bank in Utah.28 This ILCdid not cause the failure of Lehman Brothers. Furthermore, it was reported thatLehman Brothers transferred $75 million in cash and $200 million in other noncashconsideration to its ILC in December 2010, with plans to sell or liquidate thisinstitution in 2012.29 To this degree, it would appear that the parent of the ILChas been able to serve as a source of strength for its subsidiary, not the otherway around. However, Julie Boyle, CEO of the ILC, stated in a conversation forthis paper that such a transfer of funds would not have been necessary if not foran earlier inappropriate seizure of some of Woodlands’ assets. Furthermore, sheindicated that the ILC relied on mark-to-market accounting, which contributedto a significant decline in the value of the institution’s assets in 2008 but hasbeen subsequently reversed; as markets have improved, the institution is now wellcapitalized.

Some may argue that if Lehman Brothers, the parent of Woodlands, had beensupervised by the Federal Reserve rather than the Securities and Exchange Com-mission (SEC), things would have turned out much better for the subsidiaryILC. However, there is no evidence that granting the Federal Reserve supervisoryauthority over all holding companies that owned a FDIC-insured depository insti-tution would have averted the financial crisis or resulted in fewer bank failures.The SEC, the supervisor of investment banking firms, and the Federal Reservealike supervised institutions that failed during the crisis.

In any event, the Dodd-Frank Act provides greater authority for the FederalReserve to deal with systemically important financial institutions. In addition, theact requires parents of all FDIC-insured depository institutions to serve as a sourceof strength.

As a result of the crisis, there was a change in the composition of the list of thelargest ILCs in the industry. As Table 15 shows, the three largest ILCs in 2007were all converted to commercial banks; by the second quarter of 2010, the threelargest ILCs were much smaller in terms of total assets. However, the five largestinstitutions in 2007 accounted for 73% of the total assets of all ILCs, and in mid-2010, they accounted for a slightly smaller 69%. Although these percentages arequite close to one another, the total assets of the industry declined to $132 billionfrom $264 billion over this period. Lastly, the three largest institutions are allfinancially owned ILCs and account for 55% of the total assets of the industry.

V. IS THE ILC BUSINESS MODEL A GOOD ONE?

The ILC industry has survived for more than a century, so clearly ILCs have beenaccepted in the financial marketplace. As discussed in previous sections, no ILCsfailed during the recent crisis. Moreover, no commercially owned ILC has everfailed.

28Lehman Brothers filed for bankruptcy in December 2008.29Reuters, “Lehman Units’ Refinancing Deals Go Through,” December 3, 2010, http://www.reuters.com/article/idUSN0329600320101203

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50 James R. Barth et al.

Tabl

e15

:B

igge

stIL

Cs:

Pre

-an

dpo

st-f

inan

cial

cris

is20

07Q

220

10

Com

mer

cial

Com

mer

cial

All

real

and

Gro

ssTo

tal

All

real

and

Gro

ssTo

tal

Tota

les

tate

indu

stri

allo

ans

toot

her

Tota

les

tate

indu

stri

allo

ans

toot

her

asse

tsTo

tal

loan

slo

ans

indi

vidu

als

loan

sas

sets

Tota

llo

ans

loan

sin

divi

dual

slo

ans

(US$

B)

empl

oyee

s(U

S$B

)(U

S$B

)(U

S$B

)(U

S$B

)(U

S$B

)em

ploy

ees

(US$

B)

(US$

B)

(US$

B)

(US$

B)

1M

erri

llLy

nch

Ban

k78

.11,

419

10.7

18.0

6.5

1.1

1A

mer

ican

Exp

ress

30.0

740

<0.

113

.1<

0.1

USA

∗C

entu

rion

Ban

k2

Mor

gan

Stan

ley

Ban

k∗35

.175

1.7

10.5

0.7

3.8

2U

BS

Ban

kU

SA29

.052

0.4

7.5

7.9

0.4

3A

llyB

ank

∗ (fo

rmer

ly28

.451

318

.20.

83.

21.

23

USA

ASa

ving

sB

ank

13.8

60

013

.90

GM

AC

Ban

k)4

Am

eric

anE

xpre

ss26

.061

0<

0.1

22.2

0.8

4C

apm

ark

Ban

k9.

513

76.

30

00.

1C

entu

rion

Ban

k5

UB

SB

ank

USA

25.0

42<

0.1

5.2

5.6

0.1

5B

MW

Ban

kof

8.2

330

06.

80

Nor

thA

mer

ica

Sum

ofth

ebi

gges

tfiv

e19

2.7

2,11

030

.634

.538

.36.

9Su

mof

the

bigg

estf

ive

90.4

302

6.8

7.5

41.7

0.5

All

othe

rIL

Cs

71.1

5,83

414

.99.

113

.51.

7A

llot

her

ILC

s41

.22,

371

8.1

8.4

6.9

1.3

Gra

ndto

tal

263.

87,

944

45.5

43.6

51.9

8.6

Gra

ndto

tal

131.

72,

673

14.8

15.8

48.6

1.8

Big

gest

five

(%to

tal)

73.0

26.6

67.3

79.1

73.9

80.0

Big

gest

five

(%to

tal)

68.7

11.3

45.5

47.2

85.8

27.4

Not

e:∗ T

hese

ILC

sar

ecu

rren

tlyin

activ

ebe

caus

eth

eyw

ere

conv

erte

dto

com

mer

cial

bank

s.So

urce

:FD

IC.

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Industrial Loan Companies 51

0

5

10

15

20

25

30

35

40Commercially owned ILCs

Financially owned ILCs

AllFDIC-insured institutions

Equity to asset ratio, percent

Financially owned ILCs (exclude Merrill Lynch Bank USA) -3

-2

-1

0

1

2

3

4

5

6

7

FinanciallyownedILCs

Commerciallyowned ILCs

AllFDIC-insured institutions

Returnon assets, percent

Financially owned ILCs (exclude Merrill Lynch

Bank USA)

-20

-15

-10

-5

0

5

10

15

20

25

Financially ownedILCs

Commerciallyowned ILCs

AllFDIC-insured institutions

Returnon equity, percent

Financially ownedILCs (exclude Merrill Lynch Bank USA)

Sources: FDIC, Milken Institute.

Figure 14: Equity-to-asset ratio and performance ratios of ILCs and allFDIC-insured institutions.

-40

-20

0

20

40

60

80

100

0 5 10 15 20 25

Number of branches

Brokered deposits to total deposits ratio (%)

Note: The estimated Beta coefficient from a regression (brokered deposits to total depositsratio = α + β number of branches) is statistically significant at the 5% level. The figuredoes not include the data for ARCUS Bank, since we cannot access its information on theFDIC website due to expiration of its charter.Sources: FDIC; Milken Institute.

Figure 15: Correlation between number of branches and brokereddeposits–to–total deposits ratio (%), Q2 2010.

It is useful to measure the capitalization and performance of ILCs against allFDIC-insured institutions. Figure 14 shows that over the past decade, both finan-cially and commercially owned ILCs have been better capitalized and performedbetter in terms of ROA and ROE as compared to all FDIC-insured institutions,with the exception of financially owned ILCs in 2008 (and that poor performancewas due to a single ILC, Merrill Lynch Bank USA). The figure shows that withoutthe inclusion of this institution, the remaining financially owned ILCs performedbetter than all FDIC-insured institutions in 2008.

One can also compare ILCs to FDIC-insured institutions based upon more thanjust ROA, ROE, and equity capital–to-asset ratios. This is done in Table 16. The

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52 James R. Barth et al.

Tabl

e16

:D

iffe

rent

perf

orm

ance

mea

sure

sfo

rIL

Cs

and

FD

IC-i

nsur

edin

stit

utio

ns,Q

220

10

Equ

ity

Net

Non

-L

oss

Net

The

num

ber

capi

tal

Eff

icie

ncy

inte

rest

curr

ent

allo

wan

ceto

char

ge-

offs

ofIL

Cs

RO

AR

OE

toas

sets

rati

om

argi

nlo

ans

tono

ncur

rent

tolo

ans

unde

rea

ch(%

)(%

)(%

)(%

)(%

)lo

ans

(%)∗

(%)∗

(%)∗

cate

gory

Perc

enta

geof

ILC

sha

ving

bette

rpe

rfor

man

ceth

an:

All

FDIC

-ins

ured

inst

itutio

ns82

.174

.466

.764

.169

.276

.372

.263

.239

Stat

e-ch

arte

red

inst

itutio

ns84

.684

.666

.769

.274

.469

.266

.756

.439

Com

mer

cial

bank

sA

sset

sle

ssth

an$1

00M

87.5

75.0

75.0

62.5

87.5

75.0

83.3

50.0

8A

sset

s$1

00M

to$3

00M

87.5

87.5

50.0

75.0

62.5

71.4

85.7

28.6

8A

sset

s$3

00M

to$5

00M

80.0

80.0

80.0

80.0

80.0

80.0

80.0

60.0

5A

sset

s$5

00M

to$1

B83

.383

.366

.766

.766

.766

.766

.716

.76

Ass

ets

$1B

to$1

0B77

.877

.888

.910

0.0

44.4

44.4

55.6

66.7

9A

sset

sgr

eate

rth

an$1

0B10

0.0

100.

066

.710

0.0

66.7

100.

010

0.0

33.3

3

Sour

ces:

FDIC

;Milk

enIn

stitu

te.

∗ Dat

afo

rno

ncur

rent

loan

sto

loan

s,lo

ssal

low

ance

tono

ncur

rent

loan

s,an

dne

tch

arge

-off

sto

loan

sar

eon

lyav

aila

ble

for

38,3

6,an

d38

ILC

s,re

spec

tivel

y.

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Industrial Loan Companies 53

Table 17: Safety and soundness measures for ILCs and FDIC-insured insti-tutions, Q2 2010

Capital ratiosProfitability ratios

Equity capital Tier 1 risk-basedto assets capital ratio ROA ROE

Financially ownedILCs

16.5% 20.2% 1.9% 11.2%

Commerciallyowned ILCs

15.1% 14.8% 2.9% 17.6%

All FDIC-insuredinstitutions

11.0% 12.4% 0.6% 5.5%

Sources: FDIC, Milken Institute.

table shows that in terms of ROA, 82% of the ILCs performed better than theaverage of all FDIC-insured institutions; 85% outperformed the average of allstate-chartered institutions. When the ILCs are compared to commercial bankswithin the same size categories, nearly 80% or more of the ILCs came out aheadof their respective FDIC-insured institution size group in terms of ROA. Based onall the other measures, more than half the ILCs performed better than all FDIC-insured institutions and state-chartered institutions. This is not always the casewhen ILCs are compared to commercial banks by size group. In particular, for netinterest margin, noncurrent loans to loans, and charge-offs to loans, ILCs performbetter than commercial banks (except for one size group with respect to net interestmargin and noncurrent loans to loans, and three other size groups with respect tocharge-offs to loans).

Table 17 shows that as of the second quarter of 2010, both types of ILCs werebetter capitalized and had better profitability ratios than FDIC-insured institutions.In particular, commercially owned ILCs had an ROA that was nearly five timesthat of FDIC-insured institutions.

In terms of individual institutions, based on data for the second quarter of2010, more than half of all ILCs ranked in the top 10% of the 7,152 FDIC-insuredinstitutions for return on assets (ROA). Among the nine commercially owned ILCs,eight ranked in the top 10%. The worst-performing ILC was First Electronic Bank,a small institution with $7.1 million in assets. However, it had an equity-to-assetratio of approximately 70% as of mid-2010.

Among all ILCs, only nine of them have 60% or more of their total loans in realestate, while the rest of ILCs either concentrate more heavily on commercial andindustrial loans or consumer loans. However, most of the 39 depository ILCs haveno branches whatsoever. Of the nine institutions with branches, CapitalSourceBank has the largest number of branches, with 23. None of the commerciallyowned ILCs operated with any branches as of mid-2010—so in this way, they donot directly compete with community banks.

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54 James R. Barth et al.Ta

ble

18:

Res

pons

esof

ILC

exec

utiv

esto

our

ques

tion

nair

ere

gard

ing

the

adva

ntag

esof

com

mer

cial

owne

rshi

pof

ILC

s

Res

pond

ent

Adv

anta

ges

ofco

mm

erci

alow

ners

hip

ofIL

Cs

BM

WB

ank

ofN

orth

Am

eric

aIn

stal

lmen

tLoa

nIn

cent

ive

prog

ram

s,fu

ndin

g/liq

uidi

tyop

tions

,com

plet

eco

ntro

lof

loan

unde

rwri

ting,

bran

ding

,cus

tom

erse

rvic

e.E

nerB

ank

USA

We

dono

tper

form

orpr

ovid

ean

yse

rvic

esfo

ror

toth

epa

rent

oran

yot

her

affi

liate

.Our

spec

ializ

edfi

nanc

ial

serv

ices

prod

ucts

(uns

ecur

edco

nsum

erin

stal

lmen

t,sa

me-

as-c

ash

loan

sfo

rho

me

impr

ovem

entp

urpo

ses)

are

rare

lyav

aila

ble

thro

ugh

com

mun

ityor

com

mer

cial

bank

s.O

urho

me

impr

ovem

entl

oans

have

the

follo

win

gde

sira

ble

feat

ures

for

borr

ower

san

dho

me

impr

ovem

entc

ontr

acto

rs:

Bor

row

erad

vant

ages

:Loa

nam

ount

sup

to$5

5,00

0;lo

ans

are

unse

cure

d;pa

ymen

tdef

erra

lper

iods

ofup

to18

mon

ths;

noin

tere

stif

paid

infu

lldu

ring

paym

entd

efer

ralp

erio

d;up

to10

-yea

rre

paym

entt

erm

s;qu

ick

and

easy

loan

byph

one

appl

icat

ion

proc

ess

dire

ctly

with

bank

;qui

cklo

anap

prov

als

–ty

pica

lly10

min

utes

;no

fees

(oth

erth

anla

tepa

ymen

tfee

s);n

opr

epay

men

tpen

alty

;no

defa

ulti

nter

estr

ate;

inte

rest

rate

fixe

dfo

rte

rmof

loan

;100

%fi

nanc

ing

ofho

me

impr

ovem

entp

roje

cts.

Hom

eim

prov

emen

tcon

trac

tor

adva

ntag

es:P

rove

nsa

les

and

mar

ketin

gto

olth

atre

sults

inm

ore

lead

s,hi

gher

clos

era

tes,

and

larg

erpr

ojec

tsiz

es;g

reat

way

todi

ffer

entia

teco

ntra

ctor

from

com

petit

ors;

noad

min

istr

ativ

ebu

rden

–cu

stom

erde

als

dire

ctly

with

bank

;qui

cklo

anby

phon

eap

plic

atio

npr

oces

sfo

rcu

stom

er,d

irec

tlyw

ithba

nk-

typi

cally

10m

inut

es;a

sour

ceof

unse

cure

dw

orki

ngca

pita

lfor

cont

ract

ors

–sm

allf

amily

-ow

ned

busi

ness

es(5

0%of

loan

amou

ntca

nbe

adva

nced

toco

ntra

ctor

upfr

ont)

;hig

hap

plic

atio

nap

prov

alan

dcu

stom

ersa

tisfa

ctio

nra

tes;

cont

ract

orkn

ows

the

cust

omer

has

aw

ayto

pay.

Firs

tEle

ctro

nic

Ban

kT

hepr

ivat

e-la

belc

redi

tcar

dpr

ogra

mFi

rstE

lect

roni

cB

ank

runs

for

itspa

rent

coul

dbe

run

byot

her

bank

s.H

owev

er,b

anks

have

ahi

stor

yof

aggr

essi

vely

ente

ring

and

then

rapi

dly

exiti

ng,o

rdr

amat

ical

lysc

alin

gba

ckon

,cer

tain

busi

ness

es,i

nclu

ding

priv

ate-

labe

lcre

ditc

ards

.Unf

ortu

nate

lyth

eyha

vea

habi

tof

exiti

ngor

scal

ing

back

atth

ew

orst

poss

ible

time

–w

hen

cred

itis

need

edm

ost.

Thi

sis

just

wha

twe

have

witn

esse

ddu

ring

this

fina

ncia

lcri

sis.

Indu

stri

alba

nks

inge

nera

l,an

dFi

rstE

lect

roni

cB

ank

inpa

rtic

ular

,hav

ehi

stor

ical

lybe

enth

ere

topr

ovid

efi

nanc

ing

for

our

pare

nts’

cust

omer

sw

hen

trad

ition

alba

nks

have

(Con

tinu

ed)

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Industrial Loan Companies 55

Tabl

e18

:(C

onti

nued

)

Res

pond

ent

Adv

anta

ges

ofco

mm

erci

alow

ners

hip

ofIL

Cs

retr

ench

ed.W

ehe

lpke

epth

eec

onom

ygo

ing

bypr

ovid

ing

cred

itw

hen

othe

rsca

n’to

rw

on’t

.Ibe

lieve

that

,be

side

sbe

ing

seen

asa

sour

ceof

prof

it,in

dust

rial

bank

sca

nbe

view

edas

anin

sura

nce

play

onth

epa

rtof

thei

rco

rpor

ate

pare

nts

–in

sura

nce

that

cred

itw

illbe

avai

labl

eso

that

thei

rcu

stom

ers

can

purc

hase

the

pare

nts’

prod

ucts

even

iftr

aditi

onal

bank

sw

on’t

lend

.G

EC

apita

lFin

anci

alIn

c.G

EC

apita

lFin

anci

alIn

c.is

anal

tern

ativ

eso

urce

ofco

mm

erci

alle

ndin

gan

dle

asin

gfi

nanc

ing

tom

id-m

arke

tcu

stom

ers;

prim

arily

infr

anch

ise

fina

ncin

g,eq

uipm

entf

inan

cing

,and

corp

orat

ele

ndin

gto

mid

-siz

edbu

sine

sses

.M

edal

lion

Ban

kT

heIL

Cch

arte

ral

low

sth

epa

rent

flex

ibili

tyin

havi

ngso

me

nonf

inan

cial

activ

ityan

dst

illow

na

bank

.The

ycu

rren

tlyw

ould

qual

ify

asa

fina

ncia

llyow

ned

ILC

pare

ntbu

tals

oow

nan

adve

rtis

ing

agen

cy.

Opt

umH

ealth

Ban

kIn

c.O

ptum

Hea

lthB

ank

isa

who

llyow

ned

subs

idia

ryof

Uni

ted

Hea

lthG

roup

that

prov

ides

heal

thsa

ving

sac

coun

tsan

dot

her

heal

th-r

elat

edba

nkin

gse

rvic

esto

mor

eth

an1

mill

ion

indi

vidu

als.

The

indu

stri

alba

nkch

arte

ral

low

sth

eba

nkto

bepa

rtof

the

fina

ncia

lser

vice

sdi

visi

onof

Opt

umH

ealth

,ahe

alth

and

wel

lnes

sco

mpa

nyse

rvic

ing

mor

eth

an60

mill

ion

peop

le.I

nad

ditio

nto

help

ing

indi

vidu

als

and

fam

ilies

save

for

thei

rou

t-of

-poc

keth

ealth

-car

eex

pens

es,w

epr

oces

ses

elec

tron

iche

alth

care

clai

mpa

ymen

ts,i

ssue

Mas

terC

ard

card

sth

atfa

cilit

ate

the

use

ofFl

exib

leSp

endi

ngan

dH

ealth

Rei

mbu

rsem

entA

rran

gem

ents

,an

dpr

ovid

esp

ecia

lized

cred

itto

the

heal

th-c

are

com

mun

ity.T

hepr

oduc

tsan

dse

rvic

espr

ovid

edby

Opt

umH

ealth

Ban

ksi

mpl

ify

and

low

erth

eco

stof

heal

thca

re.

Targ

etB

ank

By

inte

grat

ing

with

the

com

mer

cial

reta

ilpa

rent

,we

can

offe

rcr

edit

toen

titie

sth

atca

n’tg

etit

else

whe

re(i

.e.,

it’s

notp

rofi

tabl

efo

roth

ers

tose

rve)

.Tar

getB

ank

offe

rs“c

lose

dlo

op”

com

mer

cial

cred

it,i.e

.,a

com

mer

cial

cred

itca

rdus

able

only

atTa

rget

stor

es.O

urcu

stom

erba

seis

pred

omin

antly

gove

rnm

enta

idag

enci

es,

nonp

rofi

ts,a

ndsc

hool

s;as

gove

rnm

ente

ntiti

esan

dno

npro

fits

,the

y’re

typi

cally

prec

lude

dfr

ompa

ying

inte

rest

and

late

fees

,so

the

cred

itex

tens

ion

isef

fect

ivel

yfr

ee,s

ave

the

inte

rcha

nge,

whi

chTa

rget

stor

espa

yto

Targ

etB

ank

(rig

htpo

cket

,lef

tpoc

keta

ccou

ntin

gfo

rth

epa

rent

com

pany

).T

hepa

rent

can

affo

rdto

(Con

tinu

ed)

Page 56: Industrial Loan Companies: Where Banking and Commerce Meetwebhome.auburn.edu/~barthjr/publications/2012/Check... · 2012-01-18 · Industrial Loan Companies: Where Banking and Commerce

56 James R. Barth et al.

Tabl

e18

:(C

onti

nued

)

Res

pond

ent

Adv

anta

ges

ofco

mm

erci

alow

ners

hip

ofIL

Cs

doth

is,b

ecau

seth

ecr

edit

exte

nsio

nm

eets

aco

mm

unity

serv

ice

obje

ctiv

efo

rth

eco

mpa

ny,a

nddr

ives

reta

ilsa

les.

Als

o,op

erat

iona

lly,m

any

ofth

ese

entit

ies

prov

ide

aid

oras

sist

ance

tofa

mili

esin

need

–th

eba

nk,

inte

grat

edw

ithth

ere

taile

r,ca

nho

nor

vouc

her

prog

ram

sfr

omth

ese

aid

agen

cies

,allo

win

ga

fam

ilyto

take

anag

ency

vouc

her

into

aTa

rget

Stor

eto

purc

hase

the

food

and

clot

hing

they

need

,but

prec

lude

the

purc

hase

ofbe

eran

del

ectr

onic

sor

othe

rag

ency

-dir

ecte

dno

nper

mis

sibl

eite

ms,

and

then

that

purc

hase

isbi

lled

agai

nstt

heag

ency

’scr

edit

acco

untw

ithth

eba

nk.F

rom

aco

stto

serv

e,an

dop

erat

iona

lpro

cess

,the

bank

-ret

aile

rin

tegr

atio

nis

the

only

mea

nsto

mak

eth

ispo

ssib

le.

The

Pitn

eyB

owes

Ban

kIn

c.A

com

mer

cial

bank

coul

dpr

ovid

eth

ese

rvic

es,b

utno

othe

rch

arte

ris

avai

labl

eto

the

pare

nt.

Toyo

taFi

nanc

ial

Savi

ngs

Ban

kT

here

are

nose

rvic

esan

ILC

can

offe

rth

atca

nnot

beof

fere

dby

aco

mm

erci

alba

nk.T

hebe

nefi

tto

the

pare

ntis

that

they

getd

irec

tcon

trol

over

prod

ucts

offe

red,

and

100%

ofth

epr

ofits

from

prod

ucts

asop

pose

dto

ash

arin

gag

reem

entw

itha

com

mer

cial

bank

(i.e

.,ha

ving

asu

bsid

iary

offe

ring

the

prod

ucts

asop

pose

dto

anex

tern

alpa

rtne

r).

Tra

nspo

rtat

ion

Alli

ance

Ban

kIn

c.A

llow

sou

rpa

rent

thro

ugh

the

ILC

toof

fer

fina

ncia

lpro

duct

san

dse

rvic

esto

itscu

stom

erba

se.

Wri

ghtE

xpre

ssFi

nanc

ialS

ervi

ces

Cor

p.

Pare

ntco

mpa

nyca

now

nth

eba

nkw

ithou

tcre

atin

ga

bank

hold

ing

com

pany

.Dis

adva

ntag

eis

inin

abili

tyto

issu

eD

DA

acco

unts

and

limita

tions

onex

pand

ing

nonf

inan

cial

com

pone

nts

atpa

rent

leve

l.

Sour

ces:

Res

pond

ents

ofin

dust

rial

loan

com

pani

es,M

ilken

Inst

itute

.

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Industrial Loan Companies 57

Table 19: Total revenues for financially owned ILCs and their parents,Q2 2010

Total Total %revenue Financially revenue parent

Parent company (US$B) owned ILC State (US$M) company

Leavitt Group Private ADB Bank UT 1.6 n.a.American Express

Co.14.7 American Express

Centurion BankUT 2,764.2 18.8

WellPoint 29.6 ARCUS Bank UT 1.7 <0.1Hafif Bancorp Private Balboa Thrift and

Loan AssociationCA 10.1 n.a.

Beal FinancialCorp.

Unlisted Beal Bank Nevada NV 328.6 n.a.

CapitalSource 0.4 CapitalSource Bank CA 175.6 48.6General Motors

Company,private equityconsortium

n.a. Capmark Bank UT 199.4 n.a.

Celtic Investment Private Celtic Bank UT 16.1 n.a.LandAmerica

Financial GroupDelisted Centennial Bank CA 20.0 n.a.

Circle Bancorp Private Circle Bank CA 9.1 n.a.TELACU Private Community

Commerce BankCA 11.2 n.a.

F&T FinancialServices

Private Finance & ThriftCo.

CA 9.1 n.a.

Finance Enterprises Private Finance FactorsLtd.

HI 12.8 n.a.

Unitrin 1.3 Fireside Bank CA 58.2 4.4First American

Financial Corp.2.0 First Security

Business BankCA 7.3 0.4

No affiliation - Golden SecurityBank

CA 5.0 n.a.

Lease Corp. ofAmerica

Private LCA Bank Corp. UT 3.4 n.a.

MedallionFinancial

<0.1 Medallion Bank UT 23.5 n.a.

CardWorks LP Private Merrick BankCorp.

UT 132.2 n.a.

Minnesota ThriftCo.

Private Minnesota FirstCredit & SavingsInc.

MN 1.2 n.a.

First FinancialCorp.

0.1 The Morris PlanCompany ofTerre Haute Inc.

IN 4.0 5.1

(Continued)

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58 James R. Barth et al.

Table 19: (Continued)

Total Total %revenue Financially revenue parent

Parent company (US$B) owned ILC State (US$M) company

UnitedHealthGroup

46.5 OptumHealth BankInc.

UT 57.1 0.1

SemperverdeHolding Co.

Private Rancho Santa FeThrift & LoanAssociation

CA 3.0 n.a.

SLM Corp. 3.5 Sallie Mae Bank UT 222.3 6.4UBS AG 26.4 UBS Bank USA UT 237.6 0.9USAA Private USAA Savings

BankNV 780.1 n.a.

Steel PartnersHoldings LP

Private WebBank UT 4.5 n.a.

Lehman BrothersHoldings

n.a. WoodlandsCommercialBank

UT 89.3 n.a.

Alliance DataSystems

1.3 World FinancialCapital Bank

UT 48.3 3.6

Wright Express 0.2 Wright ExpressFinancialServices Corp.

UT 148.5 84.7

Notes: Total revenue for ILCs is the sum of total interest and noninterest income.Sources: FDIC, Bloomberg, Milken Institute.

Figure 15 shows more clearly that there is a significantly negative relationshipbetween the percentage of total deposits accounted for by brokered deposits andthe number of branches at the ILCs. Brokered deposits have become the primaryfunding source for institutions with few or no branches. Indeed, for some ILCs,brokered deposits are the only deposits on the balance sheet and, in some cases,the single most important funding source other than equity. Since ILCs with morethan $100 million in assets are not permitted to offer demand deposit accounts orcommercial checking accounts, brokered deposits are vital to these institutions.Furthermore, all the commercially owned ILCs conduct business on a nationalscale even though they have no branches. It is therefore impractical and not costeffective to raise retail deposits only in the markets in which their sole office islocated. Attempts to do so would clearly put undue stress on community banksthat raise retail deposits through their branch networks in these markets.30

30It should be noted that the FDIC does charge a premium for brokered deposits and also requires ahigher level of capital (“well capitalized” versus “adequately capitalized”). Also, brokered depositsare a very reliable and efficient source of funding for ILCs as brokered deposits are not subject to earlyredemption except in the case of death or certified mental incompetency of the depositor. Most are

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Industrial Loan Companies 59

Table 20: Commercially owned ILCs account for a small share of theirparents’ total revenue, Q2 2010

Total Total %revenue Commercially revenue parent

Parent company (US$B) owned ILC State (US$M) company

BMW AG 36.8 BMW Bank ofNorth America

UT 325.5 0.89

Harley-Davidson 2.5 Eaglemark SavingsBank

NV 7.4 0.29

CMS Energy 3.3 EnerBank USA UT 16.7 0.51Fry’s Electronics n.a. First Electronic

BankUT 3.0 n.a.

GE 73.4 GE CapitalFinancial Inc.

UT 391.1 0.53

Pitney Bowes 2.7 The Pitney BowesBank Inc.

UT 74.0 2.80

Target Corp. 31.1 Target Bank UT 3.6 0.01Toyota 111.2 Toyota Financial

Savings BankNV 44.7 0.04

Flying J n.a. TransportationAlliance BankInc.

UT 36.4 n.a.

Notes: Flying J Inc. is a private company (and is being restructured under Chapter 11);Fry’s Electronics is a private company. Total revenue for ILCs is the sum of total interestand noninterest income.Sources: FDIC, Bloomberg, Milken Institute.

POTENTIAL BENEFITS OF ILCs

The fact that ILCs exist is per se evidence that they provide potential benefits toboth their customers and owners. However, it is important to distinguish betweenfinancially owned ILCs and commercially owned ILCs. The loan composition ofboth commercially and financially owned ILCs reveal that it is not possible todistinguish the type of ownership simply based on the composition of the loanportfolio. All one can say is that the average loan-to-asset ratios for both types ofILCs are nearly identical, and the weighted average ratios show that commerciallyowned ILCs have a larger share of loans than the financially owned ILCs.

Financially owned ILCs are in many respects quite similar to other bankinginstitutions. Since their parents are financial firms, they could become financialholding companies by converting their ILCs to commercial banks. In this sense,there appears to be nothing particularly unique about financially owned ILCsas compared to commercial banks. However, both financially and commercially

issued in $1,000 increments. All of the record-keeping at the depositor level is accomplished by thedeposit broker.

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60 James R. Barth et al.

owned ILCs are state-chartered rather than federally chartered, which is not thecase for commercial banks.

Apart from that difference, it is largely the fact that some ILCs are owned bycommercial firms that is truly unique today. The parents of these ILCs cannotconvert their ILCs to commercial banks and at the same time themselves becomefinancial holding companies. The only way for these commercial firms to currentlyown a banking institution is to continue owning their ILCs.

The business model associated with commercial ILCs has multiple characteris-tics that contribute to their stability:

• Marketing advantages and economies of scale. Many ILCs serve the lowest-risk parts of a broader financial operation. The bank obtains its businesswith little or no marketing cost and often only makes loans selected from abroad pool of applicants. Even if the broader pool is affected in an economicdownturn, it may have little impact on the loans made by the bank.

• Geographical risk reduction. Most ILCs serve specialized customer groupsspread across the nation, which helps reduce risk through geographical diver-sification. Access to such a large market is extremely difficult for a bank notowned by a large diversified parent.

• Capital. In times of stress, a diversified parent may be in a better position toprovide capital support to a bank subsidiary than a banking holding companywhose assets consist almost entirely of a bank subsidiary.

• Informational efficiencies. An ILC parent engaged in multiple business linesmay be better able to identify underserved markets and opportunities toprovide banking services to customers of the parent. This information mayenable the institution to make better loan decisions than traditional banks,to provide other financial services that are desired by the customers of theparent firm, and to make credit available when it is not readily availableelsewhere. For example, the ILC owned by Harley-Davidson is in a muchbetter position to assess the collateral value of a motorcycle than a typicalbank. Transportation Alliance Bank, because of its affiliation with thecompany operating truck stops nationwide, is better positioned to serve thebanking needs of long-haul truckers.

• Governance. The parent company of an ILC provides an additional and im-portant source of governance. It would not want its subsidiary institution todamage its reputation, especially if the subsidiary ILC is small in relation tothe parent.

To elicit more information, we sent surveys to all ILCs. We asked each ofthem to identify what they considered to be the advantages to the parent of suchownership. Twelve of the 39 ILCs responded to our survey; their responses areprovided in Table 18.

It is useful to also examine the contribution of the revenue generated by the ILCsto the total revenue of their parent companies. Tables 19 and 20 show the share of

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Industrial Loan Companies 61

Tabl

e21

:Se

lect

edst

udie

son

the

mix

ing

ofba

nkin

gan

dco

mm

erce

Aut

hor

Pur

pose

Fin

ding

Hau

bric

han

dSa

ntos

(200

5)T

heau

thor

sex

amin

eth

ead

vant

ages

and

disa

dvan

tage

sof

mix

ing

bank

ing

and

com

mer

ceus

ing

the

“liq

uidi

ty”

appr

oach

tofi

nanc

iali

nter

med

iatio

n.

The

auth

ors

exte

ndpr

evio

usre

sear

chon

asse

tliq

uida

tion

and

argu

eth

atm

ixin

gba

nkin

gan

dco

mm

erce

incr

ease

sa

bank

’sef

fici

ency

indi

spos

ing

ofde

faul

ted

loan

sby

crea

ting

anin

tern

alm

arke

t.H

uert

as(1

988)

The

auth

ordi

scus

ses

whe

ther

bank

ing

and

com

mer

cesh

ould

bepe

rmitt

edto

cont

inue

tom

ix,a

ndif

so,h

owth

issh

ould

bedo

nean

dw

hatr

egul

atio

nsm

aybe

requ

ired

.

Aff

iliat

ions

betw

een

bank

ing

and

com

mer

ceha

vebe

enco

mm

onth

roug

hout

Am

eric

anhi

stor

y.T

heau

thor

argu

esth

atm

ixin

gba

nkin

gan

dco

mm

erce

isbe

nefi

cial

and

fair

tocu

stom

ers,

and

does

notj

eopa

rdiz

eth

esa

fety

ofco

nsum

erde

posi

tsor

thre

aten

the

stab

ility

ofth

epa

ymen

tsys

tem

.Con

sequ

ently

,the

find

ing

isth

atth

em

ixin

gof

bank

ing

and

com

mer

cesh

ould

bepe

rmitt

ed.

Kra

iner

(200

0)T

heau

thor

disc

usse

spo

tent

ialb

enef

itsan

dco

sts

ofba

nkin

gan

dco

mm

erce

affi

liatio

ns.

The

auth

orco

nclu

des

that

the

bene

fits

ofIL

Cs

wou

ldbe

inth

efo

rmof

enha

nced

effi

cien

cy,b

oth

oper

atio

nala

ndin

form

atio

nal.

The

sebe

nefi

tsar

elik

ely

togr

owbe

caus

eof

chan

ges

inte

chno

logy

.The

auth

oral

sono

tes

that

cost

sof

bank

ing

and

com

mer

cial

affi

liatio

nsar

elik

ely

tobe

felt

ona

smal

lsca

le.

Hau

bric

han

dSa

ntos

(200

3)T

heau

thor

sin

vest

igat

eth

ehi

stor

yof

bank

ing

and

com

mer

cein

the

U.S

.by

cons

ider

ing

the

two-

way

inte

rloc

king

that

take

spl

ace

betw

een

bank

san

dco

mm

erci

alfi

rms.

The

exte

nsiv

elin

kage

sbe

twee

nba

nkin

gan

dco

mm

erce

have

chan

ged

with

shif

ting

defi

nitio

nsof

“ban

k”an

dch

angi

ngm

etho

dsof

“con

trol

.”It

issh

own

that

regu

latio

nspe

rse

dono

tel

imin

ate

thes

elin

kage

s.Fu

rthe

rmor

e,it

ispo

inte

dou

ttha

t“at

times

polit

ical

pres

sure

sha

vefo

rced

bank

ing

and

com

mer

ceap

art;

attim

esec

onom

icpr

essu

reha

spu

shed

them

toge

ther

.”

(Con

tinu

ed)

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62 James R. Barth et al.Ta

ble

21:

(Con

tinu

ed)

Aut

hor

Pur

pose

Fin

ding

Bla

ir(2

004)

The

auth

orex

amin

estw

odo

min

antv

iew

son

the

sepa

ratio

nof

bank

ing

and

com

mer

ceby

pres

entin

gits

pote

ntia

lben

efits

and

risk

sfr

omth

epu

blic

polic

ype

rspe

ctiv

e.

•A

lthou

ghth

ecu

rren

tpro

hibi

tions

onco

rpor

ate

owne

rshi

pof

bank

sar

eju

stif

ied

onth

egr

ound

sth

atba

nkin

gan

dco

mm

erce

have

alw

ays

been

sepa

rate

,the

reis

noev

iden

ceof

alo

ng-t

erm

sepa

ratio

nin

U.S

.ban

king

hist

ory.

Ext

ensi

velin

ksbe

twee

nba

nkin

gan

dco

mm

erce

have

exis

ted

and

cont

inue

toex

ist.

•D

espi

teth

epo

tent

ialr

isks

ofm

ixin

gba

nkin

gan

dco

mm

erce

,the

evid

ence

sugg

ests

that

with

adeq

uate

safe

guar

dsin

plac

e,th

eca

refu

lmix

ing

ofba

nkin

gan

dco

mm

erce

can

yiel

dbe

nefi

tsw

ithou

texc

essi

veri

sk.

Ras

kovi

ch(2

008)

The

auth

orev

alua

tes

the

maj

orar

gum

ents

ofm

ixin

gof

bank

ing

and

com

mer

ceby

rela

ting

each

ofth

ose

argu

men

tsw

ithex

istin

gth

eore

tical

and

empi

rica

lres

earc

h.

The

auth

orco

nclu

des

that

maj

orco

ncer

nsth

atha

vebe

enra

ised

are

theo

retic

ally

wea

kor

lack

empi

rica

lsup

port

.

Bar

th,C

apri

o,an

dL

evin

e(2

001,

2006

a)

The

auth

ors

exam

ine

the

effe

ctof

regu

latio

nan

dow

ners

hip

onba

nkpe

rfor

man

cean

dst

abili

tyus

ing

acr

oss-

coun

try

empi

rica

lan

alys

is.

The

auth

ors

cons

truc

tam

easu

reof

mix

ing

bank

ing

and

com

mer

ceba

sed

the

abili

tyof

nonf

inan

cial

firm

sto

own

and

cont

rol

com

mer

cial

bank

san

dvi

ceve

rsa

for

each

coun

try

inth

esa

mpl

e.T

heau

thor

sfi

ndno

sign

ific

antr

elat

ions

hip

betw

een

the

mea

sure

sof

mix

ing

bank

ing

and

com

mer

cean

dth

ele

velo

fba

nkin

gse

ctor

deve

lopm

ento

rth

ede

gree

ofin

dust

rial

com

petit

ion.

The

yal

sofi

ndth

atco

untr

ies

that

rest

rict

bank

sfr

omow

ning

nonf

inan

cial

firm

sar

em

ore

likel

yto

expe

rien

cea

bank

ing

cris

is.T

hey

conc

lude

that

som

eof

the

maj

orre

ason

sfo

rre

stri

ctin

gth

em

ixin

gof

bank

ing

and

com

mer

ce–t

ore

duce

fina

ncia

lfra

gilit

yor

topr

omot

efi

nanc

iald

evel

opm

ent–

are

not

supp

orte

dby

empi

rica

levi

denc

e.

(Con

tinu

ed)

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Industrial Loan Companies 63Ta

ble

21:

(Con

tinu

ed)

Aut

hor

Pur

pose

Fin

ding

Bys

trom

(200

4)T

heau

thor

estim

ates

the

prob

abili

tyof

syst

emic

bank

ing

cris

esus

ing

asa

mpl

eof

diff

eren

tcou

ntri

es,a

ndex

amin

esho

wit

can

beex

plai

ned

byva

riou

sin

stitu

tiona

lfac

tors

.

Incl

uded

inth

elis

tof

inst

itutio

nalf

acto

ris

anin

dex

ofre

gula

tory

rest

rict

ion,

and

bank

sow

ning

nonf

inan

cial

firm

sar

eam

ong

one

ofth

eva

riab

les

used

toco

nstr

uctt

his

inde

x.T

hepa

per’

sem

piri

cal

find

ings

show

that

the

prob

abili

tyof

bank

failu

reis

syst

emat

ical

lyhi

gher

inco

untr

ies

with

mor

ere

gula

tory

rest

rict

ions

.W

all,

Rei

cher

t,an

dL

iang

(200

8aan

d20

08b)

The

auth

ors

asse

ssth

epo

tent

ialp

ract

ical

effe

cts

ofin

tegr

atin

gba

nkin

gan

dco

mm

erce

usin

gec

onom

icth

eory

,pas

tex

peri

ence

with

dere

gula

tion,

and

obse

rved

cros

s-in

dust

ryco

mbi

natio

ns.

•E

cono

mic

theo

rysu

gges

tsth

atjo

intc

orpo

rate

owne

rshi

pof

bank

san

dco

mm

erci

alfi

rms

has

seve

ralp

oten

tialb

enef

its,i

nclu

ding

econ

omie

sof

scal

ean

dsc

ope,

incr

ease

din

tern

alca

pita

lmar

kets

,an

ddi

vers

ific

atio

n.T

hese

bene

fits

offs

etco

sts

asso

ciat

edw

ithso

me

com

bina

tions

ofba

nkin

gan

dco

mm

erci

alfi

rms.

•E

mpi

rica

lana

lysi

sof

the

pote

ntia

lgai

nsis

cond

ucte

dfo

rth

esp

ecif

icca

seof

Wal

-Mar

tacq

uiri

nga

bank

.The

auth

ors

find

that

ifW

al-M

arto

wne

da

bank

with

anea

rnin

gsdi

stri

butio

nsi

mila

rto

that

ofth

eav

erag

eU

.S.b

ank,

itw

ould

gene

rate

am

odes

tdec

line

inav

erag

eR

OE

butw

itha

redu

ctio

nin

risk

that

wou

ldbe

two

toth

ree

times

asla

rge.

•U

sing

empi

rica

lmet

hodo

logi

esan

din

dust

ry-l

evel

fina

ncia

ldat

afr

omIn

tern

alR

even

ueSe

rvic

eco

rpor

ate

inco

me

tax

filin

gto

exam

ine

gain

sfr

ompo

rtfo

liodi

vers

ific

atio

n,th

eau

thor

sfi

ndth

atba

nks

affi

liatin

gw

ithno

nban

king

activ

ities

(per

mitt

edby

the

Gra

mm

-Lea

ch-B

liley

Act

of19

99)

prov

ides

pote

ntia

lgai

nfr

omdi

vers

ific

atio

n.A

ngki

nand

(200

9)U

sing

acr

oss-

sect

iona

lstu

dy,t

heau

thor

inve

stig

ates

the

impa

ctof

bank

regu

latio

nson

the

seve

rity

ofba

nkin

gcr

ises

.

The

auth

orfi

nds

that

the

decl

ine

inec

onom

icac

tivity

follo

win

ga

bank

ing

cris

isw

illbe

less

seve

refo

rth

ose

coun

trie

sw

ithfe

wer

rest

rict

ions

onba

nkac

tiviti

es,i

nclu

ding

bank

sow

ning

nonf

inan

cial

firm

san

dvi

ceve

rsa.

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64 James R. Barth et al.

the parents’ total revenue that is accounted for by financially and commerciallyowned ILCs, respectively.

As seen in Table 19, 16 of the parents of the financially owned ILCs are privatecompanies (one financially owned ILC has no parent) and therefore their revenuedata are not publicly available. For the 12 financially owned ILCs for which dataare available, the percentage of the parent companies’ revenue accounted for bythe subsidiary ILCs ranges from a low of less than 0.1% to a high of 123%.

In the case of commercially owned ILCs, as shown in Table 20, two of theparents of these ILCs are private companies. For the seven parent companies forwhich data are available, their subsidiary ILCs in every case account for less than3% of the parents’ total revenue. This suggests that parent firms are not dependenton their ILCs as a significant source of revenue but rather as complements to theirprimary business model. These data also seem to indicate that the parents wouldhave no incentive to exploit their ILCs in an inappropriate manner, since the onlyresult would be reputational damage in addition to adverse actions taken by theregulatory authorities.

In addition, it might be noted that financially owned ILCs had net incomeof $322,156 per employee and commercially owned ILCs had a net income of$404,989 per employee for 2009. In comparison, all FDIC-insured institutionshad a net income of $4,723 per employee.

In addition, Table 21 lists some of the academic studies that have examined theissue of mixing banking and commerce, along with their findings. They presentno evidence that the ownership of ILCs by commercial firms is unsound policyor that whatever risks might exist cannot be contained by appropriate regulation.In addition, according to the FDIC (1987), “the public policy implication of [thisstudy’s major] conclusion is that . . . the Bank Holding Company Act . . . should beabolished.”

VI. CONCLUSION

ILCs survived the Great Depression and, indeed, increased their loans throughoutthe period—a role they reprised during the most recent financial crisis.

But today the ILC industry is being studied by the GAO, as mandated by theDodd-Frank Act. This is certainly appropriate given the concerns surroundingILCs. But to reiterate: No commercially owned ILC has ever failed, and ILCshave performed well over the years—better, in many respects, than most otherFDIC-insured institutions.

There is simply no evidence that the U.S. financial system and economy wouldbe on sounder footing if diversified firms were prohibited from owning ILCs, andthis kind of empirical evidence should be required before acting on calls for anychange in the ILC industry (especially its abolition through repeal of the currentexemption for ILC owners in the BHCA).

Many of the diversified companies that would wish to enter this industry haveexpertise, resources, capital, and perhaps even established credit businesses to

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Industrial Loan Companies 65

contribute to a bank, both during the start-up phase and over time. As the U.S. Trea-sury Department (1991) pointed out, “the development of these broadly diversifiedfirms has often proven beneficial to the economy at large, and financial marketsin particular. Most important has been the ability and willingness of such firmsto strengthen the capital positions of their financial services subsidiaries. . . . Thestability brought to the financial markets in this way is a net benefit to the economyoverall.”

During the most recent financial crisis, ILCs provided credit when other fi-nancial institutions were unable or unwilling to do so (due to a lack of liquidityor capital). If the ILC industry is allowed to grow, it may be able to tap intonew sources of capital from companies that are otherwise prohibited from own-ing a bank by the BHCA. The total net worth of U.S. non-financial corporatebusinesses was $13 trillion as of mid-2010. If even a small percentage of this cap-ital were invested in ILCs, it could contribute to an expansion in the availabilityof credit, a development that could have wider ramifications for U.S. economicgrowth.

Furthermore, U.S. financial institutions now compete in a global marketplace.The vast majority of countries around the world allow the mixing of banking andcommerce, leaving the United States out of step with international norms. Thissuggests that legislators, regulators, and other officials should be careful not to putU.S. financial institutions at a competitive disadvantage.

VII. BIBLIOGRAPHY

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Ashcraft, A. B. 2008. “Are bank holding companies a source of strength to theirbanking subsidiaries?” Journal of Money, Credit and Banking 40:273–294.

Baradaran, M. 2010. “The ILC and the reconstruction of U.S. banking.” SouthernMethodist University Law Review 63:101.

Barth, J. R., and M. A. Regalia. 1988. “The evolving role of regulation in thesavings and loan industry.” Pp. 113–191 in The Financial Services Revolution:Policy Directions for the Future, eds. C. England and T. F. Huertas. Boston:Kluwer Academic Press.

Barth, J. R., R. D. Brumbaugh Jr., and G. Yago. 1997. “Breaching the wallsbetween banking & commerce.” Banking Strategies, July 1.

Barth, J. R., R. D. Brumbaugh Jr., and J. A. Wilcox. 2000. “Glass-Steagall re-pealed: Market forces compel a new bank legal structure.” Journal of EconomicPerspectives 14:2:191–204.

Barth, J. R., G. Caprio Jr., and R. Levine. 2001. “Banking systems aroundthe globe: Do regulation and ownership affect performance and stability?”Pp. 31–88 in Financial Supervision and Regulation: What Works and WhatDoesn’t? eds. F. Mishkin. New York: National Bureau of Economic Research.

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Barth, J. R., G. Caprio Jr., and R. Levine. 2006a. Rethinking Bank Regulation: TillAngels Govern. Cambridge, MA: Cambridge University Press.

Barth, J. R., L. Goldberg, D. E. Nolle, and G. Yago. 2006b. “Financial supervisionand crisis management: United States experience and lessons for emergingmarket economies.” Pp. 379–459 in Regulatory Reforms in the Age of FinancialConsolidation: The Emerging Market Economy and Advanced Countries, eds.L. J. Cho and J. K. Kim. Seoul, Korea: Tiger Press.

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Blair, C. 2004. “The mixing of banking and commerce: Current policy issues.”FDIC Banking Review 16:4:97–120.

Bovenzi, J. F. 2007. Testimony on industrial loan companies before Senate Com-mittee on Banking, Housing, and Urban Affairs. October 4.

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Federal Deposit Insurance Corporation. 1987. Mandate for Change: Restructuringthe Banking Industry. Washington, D.C.: FDIC.

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VIII. NOTES ON CONTRIBUTORS/ACKNOWLEDGMENTS

James R. Barth is the Lowder Eminent Scholar in Finance at Auburn Universityand the senior finance fellow at the Milken Institute. His research focuses onfinancial institutions and capital markets, both domestic and global, with specialemphasis on regulatory issues. An appointee of Presidents Ronald Reagan andGeorge H.W. Bush, Barth was chief economist of the Office of Thrift Supervisionand previously the Federal Home Loan Bank Board. He has also held the positionsof professor of economics at George Washington University, associate director ofthe economics program at the National Science Foundation, and Shaw FoundationProfessor of Banking and Finance at Nanyang Technological University. He hasbeen a visiting scholar at the U.S. Congressional Budget Office, the FederalReserve Bank of Atlanta, the Office of the Comptroller of the Currency and theWorld Bank. He has authored more than 200 articles in professional journals andhas co-authored and co-edited several books, including The Rise and Fall of the

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U.S. Mortgage and Credit Markets: A Comprehensive Analysis of the Meltdown,China’s Emerging Markets: Challenges and Opportunities, The Great Savings andLoan Debacle, The Reform of Federal Deposit Insurance, and Rethinking BankRegulation: Till Angels Govern.

Tong (Cindy) Li is a research economist in the Financial Research Group at theMilken Institute. She specializes in the U.S. mortgage market, international capitalmarkets, banking regulations, and the Chinese economy. Li has authored and co-authored dozens of reports, papers, and articles. Her research work has beenpublished in academic journals and presented at major academic and regulatorconferences. She is a co-author of The Rise and Fall of the U.S. Mortgage andCredit Markets: A Comprehensive Analysis of the Meltdown and the author ofFinancial Institutions in China: A Study on Formal and Informal Credits. Shecurrently serves on the editorial board of Bank and Banking Systems. Li hasbeen interviewed by such major media outlets as China’s Phoenix Television andChina Youth Daily. She received her Ph.D. in economics from the Universityof California, Riverside, with research focused on microfinance and economicdevelopment, and special emphasis on China. She received a bachelor’s degree ininternational finance from Peking University.

Apanard (Penny) Angkinand is a senior research analyst in the Financial Re-search Group at the Milken Institute. Her research focuses on financial institutions,open economy macroeconomics, emerging market economies, and financial crises.Her work has been published in the Journal of International Money and Finance,International Review of Finance, Open Economies Review, The Journal of Inter-national Financial Markets, Institutions & Money, and the International Journalof Economics and Finance. Prior to joining the Institute, Angkinand was an as-sistant professor of economics at the University of Illinois at Springfield. Whilecompleting her Ph.D., she also held visiting scholar positions at the ClaremontInstitute for Economic Policy Studies and the Freeman Program in Asian PoliticalEconomy at the Claremont Colleges as well as a lecturer of economics at PitzerCollege and the University of Redlands. Angkinand received a Ph.D. in economicsfrom Claremont Graduate University.

Yuan-Hsin (Rita) Chiang is a research analyst in the Financial Research Group.She co-authored a Milken Institute report on industrial loan companies that ana-lyzes this unique financial industry from various aspects, including its historicaldevelopment, business model, economic impacts and the prospects for its survivalunder current financial reforms. Chiang has a range of research interests includingmacroeconomics, international money and finance, political economy, social net-work analysis, and strategic business modeling. She is completing her interfielddoctoral degree at the Claremont Graduate University, with empirical researchrevealing the impacts government capacity has on attracting foreign investmentsto local regions in China. At the National Taiwan University, she received a

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master’s degree in political economy, with research focused on the differencesin institutional frameworks among Asian central banks. She also received herbachelor’s degree in political science from National Taiwan University.

Li Li is a research analyst in the Financial Research Group at the Milken Institute.Her areas of expertise include affordable housing, cost-benefit analysis of publictransportation programs, and financial markets. She received a master’s degree inpublic policy from the University of Southern California with special focus onfinance and business economics. She has a bachelor’s degree in computer sciencefrom Zhejiang University, China.

This paper is a shorter version of a report by the authors, who very much appre-ciate funding provided by the Economic Development Corporation of Utah, theNevada Commission on Economic Development and the Milken Institute. Helpfulcomments were received from various state regulators, executives of industrialloan companies, and other individuals with extensive knowledge regarding the in-dustry. In this regard, special thanks are due to Paul Allred, Kelvin Anderson, DaleBronson, Matthew Browning, William J. Donnelly, Doug Foxley, Michael Jones,John B. Kemp, Edward Leary, Aimee McConkie, Neil Milner, Frank Pignanelli,Darryle Rude, Frank Salinger, Raymond Specht, George Sutton, and particularlyLouise Kelly. However, all the views expressed in this paper are those of theauthors. The authors also thank Lisa Renaud for the excellent editorial work andvaluable comments.