CHART B-I-ILLUSTRATION OF UNDERPROVISION FOR BAD DEBTS EXPERIENCE METHOD-RISING

CHART B-II-ILLUSTRATION OF UNDERPROVISION FOR BAD DEBTS EXPERIENCE METHOD RISING

CHART B-III-ILLUSTRATION OF REASONABLE ADDITION TO BAD DEBT RESERVE EXPERIENCE METHOD, 1-YEAR LOANS AND STATIC OTHER FACTORS

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CHART B-IV-ILLUSTRATION OF UNREASONABLE ADDITION TO BAD DEBT RESERVE EXPERIENCE METHOD, 6-YEAR LOAN AND STATIC OTHER FACTORS

2 The 5 percent loss on the replacement loan portfolio at end of yr 6 will be realized over the life of that loan-i.e.. over its 6-yr life and not necessarily in the next year.

STATEMENT OF THE U.S. LEAGUE OF SAVINGS INSTITUTIONS

The U.S. League of Savings Institutions' which represents savings banks and savings and loan institutions with both stock and mutual ownership, appreciates this opportunity to present its views to the Subcommittee in strong support of H.R. 1343 introduced by Cong. Mike Lowry (D-Wash.). This important legislation attempts to rectify an inequitable change in the qualified asset test of savings banks adopted during the conference negotiations on the Economic Recovery Tax Act of 1981 (ERTA).

The change requires a stock savings bank to invest at least 82 percent of their assets in residential real estate, liquidity and certain other assets in order to receive the full benefit of Section 593(b)2-the percentage of taxable income method bad debt deduction. It was 1962 when mutual savings banks were first made eligible for the percentage of taxable income bad debt deduction. Then in the Tax Reform Act of 1969, Congress, believing Section 593(b)(2) had become too generous, cut back this tax benefit for savings banks and savings and loans by 33 percent over a ten-year period.

At the same time Congress was reducing the benefits of Section 593(b)(2), it also reaffirmed the rationale for this important tax benefit-to provide a major source of home mortgage loans.

Under the 1969 Act, the 82 percent investment test which qualified savings and loan institutions for the full 593 tax benefit was expanded to include mutual savings banks at a lower 72 percent qualifying loan level. The reason for the more lenient test for savings banks was due to the broader asset powers already enjoyed by these institutions. By requiring the 72 percent qualifying loan test for mutuals, Congress hoped to encourage greater housing-related residential real estate investment, while at the same time allowing them the investment flexibility necessary to effectively compete in the highly competitive financial marketplace.

Stock savings bank test creates competitive disadvantage

Savings banks have traditionally been limited to a mutual form of ownership. In 1980, Congress gave mutual savings banks the authority to convert to stock ownership. The following year the ERTA law made stock savings banks eligible for Section 593 tax treatment but applied the more rigid 82 percent qualifying asset test

'The U.S. League of Savings Institutions serves more than 3,500 member institutions which make up the $900 billion savings association and savings bank businesses. League membership includes all types of institutions-federal and state-chartered, stock and mutual. The principal officers include: Paul W. Prior, Chairman, New Castle, Indiana; John B. Zellars, Vice Chairman, Atlanta, Georgia; William B. O'Connell, President, Chicago, Illinois; Philip Gasteyer, Executive Director of Washington Operations; and Rita I. Fair, Senior Vice President, Regulatory Operations. League headquarters are at 111 East Wacker Drive, Chicago, Illinois 60601. The Washington Office is located at 1709 New York Avenue, N.W., Washington, D.C. 20006. Telephone: (202) 637-8900.

required by savings and loans. If stock savings banks meet the critical investment test which has been required of their mutual counterparts for the last 15 years, then what justification is there for not according them the same favorable tax treatment?

Equity requires equal treatment between similar institutions. Stock savings banks have the same methods of operation, authority and powers as mutuals. Consequently, there is no inherent structural reason why stock savings banks should be subjected to the more restrictive 82 percent test. Therefore, by subjecting stock savings banks to the restrictive 82 percent qualifying asset test, you place those institutions at a competitive disadvantage vis a vis mutuals. A competitive disadvantage which is based on form rather than substance. By contrast, all savings and loan institutions are required to meet the same 82 percent test whether they're stock or mutual.

Stock savings bank test inconsistent with 1969 Reform Act

The 82 percent savings bank test is also inconsistent with the 1969 Tax Reform Act which established the asset test distinction between savings banks and savings and loans based on traditional differences in investment powers and loan portfolios, not their form of ownership. H.R. 1343 corrects this inequitable distinction and the U.S. League supports this result.

Stock savings bank test discourages conversion

The 82 percent qualifying test also acts as a disincentive to stock conversion at a time when many undercapitalized mutuals are exploring ways to attract new sources of capital.

The thrift industry has been devastated in recent years by high interest rates. Their traditional long-term low-yielding residential mortgage loan protfolios, generated under Sec. 593(b)(2), have undermined the ability of thrifts to quickly and profitably adapt to today's high interest rate environment. This growing pressure from high interest rates has caused thrifts to experience the largest number of failures and forced mergers since the depression years. Also the enactment of federal programs, like the net worth certificate program in 1982, which bolsters the net worth of weakened thrifts, have been most helpful to the struggling thrift industry.

Unfortunately, high interest rates are not a passing phenomenon but are expected to continue to plague the business recovery for the foreseeable future. In response to this bleak economic forecast, the U.S. League believes it's appropriate to reduce the investment restrictions of stock savings banks and work to strengthen their net worth and captital base. An important way of achieving this is by providing a stock conversion option which doesn't inhibit savings bank investment alternatives. Consequently, the League supports changing Section 593(b)(2) as proposed in H.R. 1343 because it corrects the arbitrary distinction that the current tax code creates between mutual and stock savings banks, thereby eliminating a major impediment to stock conversion.

The 82 percent test also stiffles savings and loan investment flexibility

Just as stock savings banks should not be bridled with new investment restrictions in this period of shrinking earnings and high interest costs, the 82 percent savings and loan qualified asset test imposes an outdated mortgage investment standard which should be eased. The 82 percent qualified asset test for savings and loans was first applied after the Revenue Act of 1962. It was an investment standard developed during the economic stability of the early 1960's and was appropriate for its time, reflecting stable interest rates, low inflation and a strong demand for housing. Since 1962, housing finance has certainly undergone dramatic changes including sharp interest rate increases, additional mortgage competitors and new innovative mortgage instruments. The 82 percent test, first applied in the stable economic period of the 1960's, is no longer an appropriate standard for the 1980's. The rigid mortgage investment percentage of Section 593(b)(2) discourages alternative investment opportunities specifically enacted in 1982 for the purpose of strengthening the capital position of thrift institutions-so that they remain viable in the future to perform their role as the nation's principal source of home mortgage credit.

Savings and loans have performed their special home lending function with great distinction over the years. The tax incentive provided by Sec. 593(b)(2) has been principally responsible for directing over $645 billion of savings and loan assets into qualifying loans (Sec. 7701(a)(19)(C)). No less than 85 percent of federally-insured savings and loan institutions maintain $564 billion or over 72 percent of their assets in these qualifying loans. The savings and loan business is proud of their record of providing homeownership opportunity to America for the past one-hundred and fifty years and is committed to continuing this important task in the years ahead.

Now after 22 years and tremendous upheaval in the financial marketplace, it is time to revise the 82 percent standard to a more realistic mortgage investment level consistent with new limited, but broadened powers. If this change were made, savings and loans would be in a better position to strengthen net worth and improve capitalization, making them more active and productive mortgage lenders. The U.S. League strongly recommends that the lower savings bank test (72 percent test) be applied to all thrifts.

Federal policy should encourage viable competitive thrifts

Two years ago Congress enacted major financial institutions legislation which granted new but limited investment authority for thrift institutions. This landmark Garn-St Germain legislation narrowed, but by no means eliminated, the distinctions within the U.S. financial community.

The underlying federal policy of the Garn-St Germain legislation was to improve the competitiveness and thus the viability of thrifts. Consequently, relaxing the restrictive and outdated savings and loan qualified asset test is clearly in concert with the policy enunciated in the Garn-St Germain Act of making savings and loans stronger financial competitors and more productive home lenders. Savings and loan institutions want to continue their traditional commitment to housing finance, but realize that today's volatile interest rate savings will demand additional investment flexibility for institutions to remain viable, healthy and productive mortgage lenders. Therefore, the U.S. League proposes that the 72 percent qualified asset test should apply to all thrifts whether they be savings banks or savings and loans, mutuals or stocks.

The U.S. League of Savings Institutions appreciates the opportunity to present is views on this important issue contained in H.R. 1343.