A federal court decision that limits national bank sales of insurance outside of small towns to credit-related products is "troublesome," but could set the stage for the reversal of two long-standing appeals court decisions contrary to existing precedent that the industry has wanted to attack for some time, sources said.

The decision Judge June Green handed down March 23 says national bank insurance sales are limited to small towns unless they are credit-related, and also says the Comptroller of the Currency exceeded its authority in declaring crop insurance a "credit-related" product.

Staffers at the OCC said the agency would appeal the ruling.

The decision was based on two precedents, set in 1968 and 1989. The courts held that Sec. 92 of the National Bank Act, which says that, "in addition to all other powers" banks are allowed to sell all types of insurance from offices in places of 5,000 or fewer, is an implied bar on national bank insurance sales outside of small towns.

Acting Comptroller Julie Williams had based her interpretation allowing Iowa national banks to sell crop insurance on another provision of the National Bank Act, Sec. 24(7th), the incidental powers clause. In approving the Iowa banks’ application, Williams had ruled that sale of such insurance is part of, or incidental, to the business of banking. But, in her decision, Green said that ruling "appears limited to a certain type of insurance known as ‘credit life’ and does not purport to stand for the notion that Sec. 24 (7th) can be used to authorize the sale of all insurance by national banks everywhere." But, she said, "crop insurance protects the farmer, not the lender, and is therefore not credit-related."

But David Roderer, a Washington banking lawyer, calls the decision "troublesome," and contrary to the Supreme Court’s 1995 ruling that the Comptroller has the authority under the incidental powers clause to reinterpret the National Bank Act to fit changing market conditions affecting national banks.

While troublesome, Roderer said, the Green decision allows banks and the Comptroller an opportunity to have appeals courts revisit the two older decisions, which the banking industry universally believes are contrary to the 1995 precedent.

Internal credit reporting procedures used by some banks could be the first step in new initiatives aimed at protecting consumer financial privacy, according to an advisory released to institutions by the Office of the Comptroller of the Currency last week.

The advisory is notable because rather than providing clear, enforceable rules, the "guidelines" are meant only as a general map for how banks should proceed in providing financial information to affiliates to use in cross-marketing of products, according to several industry lawyers. The issue is white-hot, with Democrats in both the House and Senate introducing legislation to deal with it.

And, last October, three Republican members of the House Banking Committee, Reps. Doug Bereuter, Neb., Bill McCollum, Fla., and Richard Baker, La., wrote a letter to acting Comptroller of the Currency Julie Williams asking the agency to "go slowly" before amending its rules. The three had proposed legislation several years ago that would limit the ability of the government to restrict use of financial data.

One industry lawyer said the industry is "particularly pleased" that the new advisory doesn’t take the form of any mandatory directive, nor does it impose any new credit reporting burdens on banks. "There is no question that this issue will be tacked on to financial modernization legislation this year. It lends itself to being a political football."

The advisory interprets the 1996 amendments to the Fair Credit Reporting Act (FCRA), which made it easier for banks to exchange customer data with affiliates, including payment history and length of time the customers have held the credit cards. The only restrictions imposed under the 1996 law are that companies clearly and conspicuously disclose to customers that such information may be shared among affiliates, and customers are given the opportunity to "opt out" of the information sharing.

The OCC’s advisory letter is intended to help national banks develop privacy programs by providing specific examples of how other banks are effectively implementing an opt-out program. The advisory letter emphasizes that the examples provided are not examination standards, nor are they the only examples of how a bank can comply with FCRA

Banks are not yet in the elite company of financial services firms in terms of managing customers, but the circle may be broken soon, and by community banks, no less.

A report by technology analyst Meridien Research, released last week, shows the evolution of Enterprise Customer Management (ECM) at 500 large global financial institutions in four stages, with banks lagging in the highest class of integration.

That stage is referred to as enterprise customer management, and is defined by Bill Bradway, research director at Meridien and author of the study, as when an institution is "really engaged in thinking and acting to deliver intimate, personalized and compelling levels of service that create customers for life." He added that the trick has only been pulled off so far by insurance company USAA, and a brokerage firm Charles Schwab.

Bradway said the feat is harder for banks because their businesses are more complex and they have more products to keep track of, requiring more expensive and complex technology.

He added that to reach that level requires a high level of commitment and vision from management that has been in place for a long time, and for large banks that often requires a cultural change from prior organizational philosophies. Bradway said, however, he thinks within the next couple of years a very large commercial bank may qualify for that category. But, he added, smaller banks might be more likely to get to that stage because it is easier to coordinate the activities of 100 employees than 70,000.

"Technology gets you in position to do things, but financial services is still a people business," he said.

The next highest stage, the use of behavior-based interactive marketing, was attained by only 15 out of the 300 banks surveyed. This system allows banks to view the customers against the depth and breadth of relationships–checking accounts, IRAs, mortgage–so the bank staff can use data mining to predict the next service or product the customer might need.

Although the survey is of companies worldwide, Bradway said four U.S. banks make up about 5% of the banks ahead of the game in this stage, Wachovia being one of them (see other Wachovia technology story, p. 3)

Then comes database marketing, which 60%-65% of the banks were using. In this approach, customers are segmented once a month or quarter using demographic and lifestyle data, and the relationships between them and their services are examined. However, it is a cumbersome process for the largest banks, which often have separate core processing systems for financial products ranging from credit cards to IRAs. The number of systems that must be integrated for effective database marketing can easily be 20 and as high as 50, Bradway said. Further, because the examinations are not very frequent, this kind of marketing, which is in its infancy, is not very dynamic. "A lot can happen in a quarter," he said.

The most basic stage is list pulling. For example, lists might be generated of all the CD holders with instruments maturing over the next 60 days, and letters mailed to those customers.

While action on financial modernization legislation is underway in both the House and Senate, the likelihood that such legislation will quickly pass the Congress is fading as more and more roadblocks pop up.

For example, Democrats in both the House and Senate are increasingly demanding that limits be placed on banks’ access to the financial information they have on their customers. Large institutions want to use such information to cross-sell non-banking products based on the income and assets of their banking customers. If major hurdles are placed on access to that information, large bank support for the bill will cease, and it is the large institutions that are primarily supporting the current versions of financial modernization legislation.

At the same time, small commercial banks are demanding that the unitary thrift loophole be closed as the primary price for their support of legislation that mainly benefits large institutions.

Currently, commercial banks can conduct financial businesses through unitary thrifts, but small banks find this unfair competition. Current bills would close this loophole. However, there is broad support in the Congress for the loophole because owners of these institutions are deep-pocketed campaign contributors. And, as the industry has consolidated, many large states, such as Texas, New York and California, see commercial institutions as the only source of capital for new banks in their states. Representatives of these states fear even greater losses of financial institutions if the loophole is closed.

Against that background, there is a belief that provisions in all current versions of the bill outlawing new unitary thrifts will somehow be deleted as the bill moves through the Congress. That would have the effect of having banking trade groups, such as the American Bankers Association and the Independent Community Bankers of America, withdraw support.

In a financial services bulletin last week, analysts at Schwab Capital Markets & Trading Group, based in Washington, warned clients that "congressional limits on thrifts are not certain."

Action will resume on the bill when Congress returns to work from the Easter recess. The Senate leadership has scheduled meetings for next week on how to break the logjam holding up the legislation in that body, and Senate Democrats have reintroduced last year’s bill as their alternative to the current version, which recently passed the Senate Banking Committee on a partisan vote.

Wachovia Corp. is joining the handful of banks striving to equip corporate customers with electronic bill presentment capabilities.

The bank said last week that it had signed a letter of intent with InvoiceLink Corp. to market software that would let its corporate clients send bills over the Internet.

Wachovia is the first customer of InvoiceLink, which aims to let billers bypass the services of companies such as Checkfree Corp. and TransPoint, which consolidate bills from multiple corporations at a single Web site.

InvoiceLink said it intends to market its software primarily through banks. It has directly signed up one biller, North State Telephone of High Point, N.C.

"There is tremendous attention on the part of corporate customers to look to banks as a channel for bill payment and presentment,"said Larry Hoskins, vice president for treasury services at Wachovia. "A company like InvoiceLink is working toward banks’ facilitating that."

At least two other banks are taking a similar tack. Using software developed in-house, Chase Manhattan Corp. and First Union Corp. intend to help their corporate clients present bills electronically to retail customers.

Aiming for the business-to-business market, PNC Bank and Northern Trust have developed software to let their large corporate customers send bills electronically to smaller business trading partners.

Wachovia’s announcement, made by its corporate side, comes just days after the retail side said it would test TransPoint, the bill presentment service of Microsoft Corp., First Data Corp., and Citigroup (see FMR 3/29/99, p.3). The pilot would let 100 of Wachovia’s on-line banking customers gain access to their bills over the Internet.

With InvoiceLink, large billers can let retail customers opt to receive bills at the biller’s site, their bank’s site, or an Internet portal site. Billers basically invite the portals and banks to come and get the billing information free of charge.

The procedure contrasts with Checkfree’s and Transpoint’s consolidator model, which requires billers to send customer billing information to their sites. Consumers then tap into the billing information directly at the TransPoint or Checkfree sites, or through their bank’s site.

"With the market vying for Checkfree alternatives, creative upstarts like InvoiceLink will be an attractive choice for billers and banks," Avivah Litan, research director of GartnerGroup, wrote in a recent report.

With InvoiceLink, customers control the timing and size of their payments, using technology on which InvoiceLink expects to garner a patent.

Now that bank customers can move their money, pay their bills and get approved for a credit card on-line, they’ll soon be able to have mortgages instantly approved over the Internet, right? Probably not.

Right now, the only bank that has the technology to originate loans other than credit cards on-line, in real time, without having to call or write the customer back, is Bank of Montreal, according to Laura Starita, a specialist in Internet banking at the GartnerGroup.

She explained that the Canadian giant has made a massive investment in time and money in a behemoth data warehousing system with a decision support tool. It can take data on a customer from several different places in the bank, analyze it and decide how much risk the bank wants to expose itself to when the customer, or potential customer, asks for the loan.

For example, a customer might ask for a $100,000 loan. If the bank has already issued a credit card and a small business loan to the customer, it might only have the appetite for $80,000 of exposure. The bank could send back the request, saying it only wants to lend $80,000, or it could approve the entire loan, she said.

In a report issued December, the GartnerGroup noted that the Bank of Montreal can approve loans for existing customers as well as new customers online. Starita said, however, that approving mortgage loans in real time is a ways off for several reasons. One inhibitor, she said, is that legally a mortgage loan needs a hard signature. Another barrier to widespread use is that most banks do not have data warehousing technology because it is expensive and difficult to set up. But the big stumbling block, Starita noted, is the loss of the personal touch.

"Culturally, they’re not ready to take on the risk of automating the process. As soon as you automate the process, you give the customer the ability to price shop, which drives them into a model of making decisions not on the basis of a relationship with you, but who is providing the best deal. (Banks) want as much as possible to facilitate the early stages of the process, perhaps the prospecting part of it, or the early stages of the approval portion. But in terms of closing or the end result, they want to make that a face-to-face communication."

She said, however, that despite all of these reasons, she expects the leaders in on-line transactional banking, such as BankAmerica, which has a data warehousing system, or Fleet Financial, First Union and Wells Fargo, to improve their automated loan approval ability greatly over the next 12 to 18 months. At that point, the mortgage loan could all be done on-line, save getting the signature.

Theodore Iacobuzio, senior analyst at the Tower Group, disagreed that mortgages will be completed in real time, on-line, except for the signature. He said that mortgages are compliance-heavy and inherently need paper–reams of it.

"CRA requirements can’t be done on-line. Insurance requirements–you have to have a house inspected–it may never be done on-line (in real time). Paper is not going to go away," he said.

Starita cautioned that although banks could soon have the ability to automate loans, it doesn’t mean people will be extinct. "BankAmerica might start the process electronically but hit a glitch because of something odd about a credit report, so then they might have to get a loan officer involved. Just because they can do it doesn’t neccessarily mean they do."

A rush of banks is scurrying to set up tax shelters they think may be in danger under the proposed federal budget.

Real Estate Investment Trusts (REITs) are under fire in the federal budget proposal for the second year in a row, as the Clinton Administration tries to help states collect taxes from wily banks that have found a dodge.

While the biggest banks in the country have already jumped on the bandwagon, many of the rest are also looking to do so, according to accountants who have noticed a recent flurry of activity. Stephe Lawson, president and CEO of $1 billion-asset Cape Cod Bank and Trust Company, said he decided to make the change after hearing positive things from a peer group, and the obvious: a tax savings of six figures.

Bankers put a portion of their loan portfolio into a state-chartered REIT their company wholly owns, converting interest income into dividend income. In many states, REIT dividends are taxed little or not at all, to eliminate double taxation of corporations.

In this year’s budget proposal, the Obama Administration is seeking to limit one company’s ownership of a REIT to 50%, making it harder for banks to use it as a tax shelter. Perhaps the reason the proposal has not received much public attention is that the big banks have already taken advantage of the structure, which most likely would be grandfathered if the bill passed. Another reason is that the proposal is not among the 16 corporate tax shelters Clinton officially declared fair game–it raises no tax revenue at the federal level. It merely helps out states, some of whom have been hit hard by the loss of tax revenue from banks.

Capitol Hill watchers consider the measure’s passage a 50-50 shot at best. A few pointed to the fact that this is the second round for the proposal.

"This is not something unknown to states and it is not something the states could not change in their own laws. There is no need for federal legislation," said Chuck Wheeler, a partner at KPMG Peat Marwick. KPMG is widely credited with inventing the strategy and pushing it hard to banks whenever applicable oeven in some states where it was unclear it would work.

For example, in Massachusetts there is a 95% dividend deduction. But, the law was only clarified so that banks were certain the strategy would work at the beginning of this year. The big players have already set up REITs, but community banks, which were waiting for the law to become clearer, are just now getting to the task.

Explaining the benefit, Andrew Wilson, the tax partner in charge of Grant Thornton’s Boston office, said that if a Massachusetts bank has $100 million of loans, with an average interest income of 7%, and has a REIT, it would pay tax on around $350,000 in dividends through the REIT, rather than the much higher tax on the $7 million of interest income.

He said the strategy could still work, even if the proposed provision passed–which many observers consider a 50-50 shot at best–but it would be tricky. He said to get around the 50% ownership limit, three banks would have to be brought together. He noted that most competitors would probably not want to do business together–even to save a load of cash.

First Tennessee National Corp.’s strategy to grow its fee-income business is moving ahead with plans to transform its nationwide chain of mortgage offices into financial centers, adding insurance, credit card and brokerage services, to solidify customer loyalty and boost profitability.

"We’ve got one-product customers and we want to make them five-, six, seven-product customers. The more products you can get a customer to use and you do a good job on, then they’ll stay with you. Then they start recommending other customers to you," said Ralph Horn, First Tennessee’s Chairman and CEO.

The $18.7-billion-asset bank concluded several years ago that while being a good, solid commercial bank was key, it would also need to have a healthy fee-income franchise to prosper and to give shareholder value. That it has done, building a nationwide Dallas-based retail mortgage origination empire that ranks in the top ten in the country, a capital markets group that is the top underwriter of agency securities and can claim 30% of all banks in the country as customers, and a booming transaction processing business, ranking 11th nationwide.

Horn proudly cites statistics that rank the Memphis-based bank in the top ten banks in country for earnings-per-share growth, one of the top returnon-equity companies, with a 22.7% ROE for 1998, and one of the top-five fee income producers–64% of revenues–among commercial banks. About half the company’s bottom line comes from fee income businesses, and about half from being the top commercial bank in Tennessee. It has the number one market share in four of the state’s five metro areas.

Now Horn wants to take the company’s non-retail banking customers who are scattered all over the country–the mortgage holders–and strengthen those relationships, leveraging them into credit card, insurance and brokerage services relationships. Part of the plan to do this is the recently-embarked upon re-branding campaign to give one name and image to the company’s nine mortgage banks, credit card and other products. The bank hopes the new name, First Horizon, will smooth over reservations that a satisfied mortgage borrower, at, for example, the company’s Emerald mortgage company in Seattle, might have with a First Tennessee credit card. The new tagline, "All Things Financial," also aims to get customers thinking of the company as the place for all their financial needs.

Horn’s plan is to transform several of the company’s 167 mortgage offices in 32 states into financial centers by the end of the year, with the company’s employees taking over roles as insurance agents and brokers. He said so far the company has begun an "aggressive" strategy of marketing insurance to the current customer base and has registered 200 bank employees as insurance agents. The firm may have to hire more brokers outside of Tennessee to staff the new financial centers, but hopes to fill the posts with more of its current employees. Horn said he can see maybe 20-25 addtional offices opened in the U.S. by the time the plan is completely carried out.

Another way the bank plans to leverage its existing customer base is with its six-month-old Internet bank, which will also move to the First Horizon brand. The idea is to extend the financial center concept and garner current mortgage customers or credit card customers as retail bank customers. "We plan to access our customers and allow them to access us," Horn said.

Although the Internet bank is accessible through the main First Tennessee site, Horn said he doesn’t plan to do any mass marketing campaigns, which would be too expensive. Nor does he expect to garner many customers who are altogether new to the company through Web traffic, although they would certainly be welcome. Although the Internet bank is under First Tennessee now, as it goes nationwide, depending on state laws, it will probably have to set up as a separate subsidiary under the holding company.

Now the bank has 525,000 commercial bank customers in Tennessee, and another 500,000 customers from other businesses. Horn said he hopes the latter will catch up to the former by year-end.

He added that in the company’s commercial banking base, First Tennessee, which operates primarily out of its home state with a branch or two in Mississippi and Arkansas, currently gets two-thirds of its new customers from current customer referrals.

Another big part of the company strategy is pampering the customer. A statistic Horn is keen to point out is the firm’s 97%-98% customer retention rate. The flip side of the pamper-the-customer strategy is the company’s focus on keeping employees happy and turnover low, which has gained the bank the rank of 14th best company to work for in the country from Fortune magazine. Horn said a big part of keeping customers happy is keeping employees happy and worry-free.

Part of helping the employees to focus on their tasks and carry out the strategy of keeping customers is achieved, he said, by letting everyone in the company know that the bank will stay independent and that they needn’t worry about being taken over, or merged with another bank. "We don’t buy banks," Horn said simply, explaining that the revenue growth generated by the retail bank side of the company is all done internally. The company does not, however, have a moratorium on acquisition of fee-based companies, such as mortgage lenders. Horn stressed that the company’s superior average annual return to stockholders of 32% over the last five years, plus a 15.2% revenue growth over the decade, means the company has been doing something right.

"We don’t want to change that by being involved in a lot of merger activity." In addition, the employees are all shareholders themselves, which is another incentive to keep focused on the company’s customer-centered strategy.

"We’re a niche player. we’re not trying to cover the world. We just want to be a great bank."

The House Banking Committee reported out its version of financial modernization legislation late March 23, and the House Parliamentarian apparently granted the House committee a 45-day sequential referral to May 14, obviously slowing the momentum for the bill its supporters are trying to create.

That would doom efforts to deal with the bill in May on the House floor, as optimists had sought. And, in the Senate, Sen. Phil Gramm, R-Texas, chairman of the Senate Banking Committee, told lobbyists at the second meeting in a week that Sen. Trent Lott, R-Miss., majority leader, had asked to meet with him, and Sens. Tom Daschle, D-S.D., minority leader, and Paul Sarbanes, D-Md., ranking minority member of the Senate banking panel, when Congress returns in April.

The purpose of the meeting, Gramm said, is to see what could be done to resuscitate Gramm’s version of the bill. His bill was passed 9-7 on a partisan vote in the Senate Banking Committee, and, as a result, had not been reported out of the committee as of March 25.

The ostensible objection of Democrats is Gramm’s efforts to water down the Community Reinvestment Act mandates imposed on banks. President Clinton wrote a letter promising a veto of the bill based on the CRA provisions in Gramm’s bill even before the panel voted on it.

But that is just the beginning of the bill’s problems. While not directly linked, signals from the Clinton administration are that it will demand that Congress improve financial privacy protections as part of a package of consumer protection provisions it supports. That would virtually end banking industry support for the bill, because ability to use its customer base to market non-banking products is one of the key reasons money center banks are still supporting the bill. In fact, at a meeting of bank lobbyists earlier this month, the Washington lobbyist for Chase Manhattan Bank specifically linked his institution’s support for financial modernization legislation to Congress’s ability to maintain current provisions on financial privacy.

American Banker/Bond Buyer Despite all the shouting about e-commerce, electronically-driven financial services are still at a very early stage of their development, according to an official of a wholesale bank in the forefront of serving a full range of financial services providers.

A key component of providing that service is allowing the customer, whether a consumer, a company, a regulator or another financial services provider, to keep track of its money at all times, said Dale Carleton, vice chairman, State Street Corp.

Carleton was among a group representing regulators, academics and private industry who testified on the impact of technology on the delivery of financial services March 25 before the capital markets, securities and government-sponsored enterprises subcommittee of the House Banking Committee.

The most sobering testimony was by Arthur Murton, director, Division of Insurance, for the FDIC.

He said consolidation of the banking industry is blurring the distinction between financial services providers in general, but especially between banks and thrifts. And, he said, the consolidation is creating "megabanks." This has resulted in a concentration of assets and deposits in the country’s largest institutions. Specifically, he said, just seven banking companies hold 25% of domestic deposits.

Technological change is a key driver of this consolidation, he said, but that poses some risks to the FDIC as the deposit insurer. The deposit insurance funds face larger potential losses from the failure of a single large consolidated institution, he said.

"Larger institutions also are more complex and tend to be involved in more non-traditional activities," Murton said. "Very large banks also pose challenges when they are in danger of failing, both because of systemic concerns and because of the operational difficulty the FDIC would face in resolving them."

One key change of electronic banking is that it is spurring growth in cross-border investing, Carleton said. Another is that, "All over the world, finance is becoming oriented toward securities markets. Government control of industry is giving way to private ownership," Carleton said. "Closely owned enterprises that for decades have depended upon relationships with local commercial banks are increasingly going to global markets for finance capital."

Carleton made two other points. In the quest to achieve this end-toend information management and to be a trusted provider of financial information to the markets, a corporate culture of risk management and expertise is critical, he said. By risk management, "we mean traditional market and transaction risk, as well as information risk," he said. "Markets simply will not function unless all market participants have faith in the quality and veracity of the information on which their decisions are based."

At the same time, Carleton said, "The electronic delivery of financial services and information promises great things for U.S. and world capital markets." For example, the development of automated trading systems could enable even more efficient securities trading than is possible today–and more efficient allocation of capital by enabling investors to execute trades that are inhibited today by existing market structures. "Another benefit could be to reduce intra-day volatility by allowing a greater number of intended trades to take place more rapidly and efficiently."