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Unitary Thrift Holding Company Worry is Overdrawn

Arguments Against Diversified Firms' Ownership Of Savings Institutions Can Be Discredited
The National Law Journal, Volume 21, Number 37,
May 10, 1999
by A. Patrick Doyle

FINANCIAL MODERNIZATION legislation pending before both houses of Congress contains a provision restricting the activities of savings-and-loan holding companies that acquire savings institutions after a grandfather date. The effect of this provision is to restrict ownership of savings institutions to companies engaged in finance-related activities.
The policy end cited most often in support of the legislation is to prevent the "unfettered mixing of banking and commerce" that many say results when thrifts are owned by diversified companies. [FN1] Other concerns include safety and soundness issues and the expansion of a loophole in the law. [FN2] These policy concerns do not justify imposing activity restrictions on diversified companies.
Under current law, any company, regardless of its activities, may acquire a single savings institution if the prospective subsidiary satisfies the qualified thrift lender (QTL) test. [FN3] Financial modernization legislation that recently passed the Senate Committee on Banking and Finance and the House Committee on Banking and Financial Services would impose activity restrictions on companies that acquire savings institutions.
Certain grandfathered unitary thrift holding companies could continue to engage in unrestricted activities. Such a company, however, could not sell the savings institution to another company unless the grandfathered company itself was sold and continued to control the savings institution.[FN4]
This and similar provisions to limit diversified companies' ownership of savings institutions have been circulating in Congress for several years. The impetus behind such limitations seems to be the increasing number of companies that have sought approval from the Office of Thrift Supervision (OTS) to charter or acquire savings institutions.
Since early 1997, for example, approximately 140 applications to acquire savings institutions have been filed by companies. More than half have been approved by the OTS. [FN5] Companies acquiring savings institutions include traditional insurers, such as AllState Insurance Co., The Hartford Group and State Farm Mutual Automobile Insurance Co.; and securities firms, such as Merrill Lynch & Co. Inc. and A.G. Edwards Inc. Applications are pending from companies that engage in both insurance and securities activities, such as American Express Co.; and other companies, such as General Electric Co. and Ford Motor Co.
Mixing Banking and Commerce
The most common argument for limiting diversified companies' ownership of savings institutions is that such ownership impermissibly permits a blending of banking and commerce. The American Bankers' Association, for example, has stated that current law "continues to permit the world's largest holding companies to own a sizable group of financial services providers -- grandfather thrifts -- and engage in the unfettered mixing of banking and commerce." [FN6]
Federal Reserve Board Chairman Alan Greenspan voiced similar concern in testimony to Congress: "Failure to close [the unitary savings-and-loan loophole] would allow the conflicts inherent in banking and commerce combinations to further develop in our economy, and complicate efforts to create a fair and level playing field for all financial service providers." [FN7] These arguments are exaggerated, given the restrictions on savings institutions' activities and the financial modernization legislation's proposed expansion of permissible activities of bank holding companies to those in which many unitary thrift holding companies already engage.
Traditionally, the danger of mixing banking and commerce has been portrayed as the risk that a commercial company owning a financial institution could increase its economic power by controlling provision of credit to itself and other companies, such as through commercial lending. [FN8] This concern appears exaggerated in the context of holding company ownership of savings institutions, as savings institutions historically have been barred from engaging in broad-scale commercial lending.
Savings institutions' activities were broadened in the 1980s to include some limited commercial lending powers, but "basket limits" were imposed to preserve their primary character as retail mortgage-lending institutions. [FN9] Under these limits, as now in effect, a savings institution can engage in mortgage lending without limit and consumer lending of up to 35% of its assets, but it can engage in commercial lending of only up to 10% of its assets (with an additional 10% for small-business loans).
The QTL Test
The imposition of the QTL test in 1987 further limited savings institutions' ability to make commercial loans. Under the test, savings institutions must hold at least 65% of their assets in housing and related loans, and certain consumer loans and investments. [FN10] If a savings institution fails to comply, its parent holding company, among other things, must register as a bank holding company -- and be subject to activity restrictions imposed on such companies -- within one year of such failure.
In short, basket limits and the QTL test severely restrict a savings institution from engaging in large-scale commercial lending activities, unless the parent holding company is prepared to accept restrictions on its activities. Thus, a diversified company like Microsoft Corp. could acquire a savings institution, but the subsidiary, in essence, would be limited to retail consumer lending activities, such as mortgage, home equity and consumer lending -- areas in which it is difficult, if not impossible, to amass economic power.
Indeed, a review of the types of applications filed by diversified companies with the OTS indicates that they want to own savings institutions to offer retail rather than commercial banking services. For example, the savings institution chartered by The Principal Financial Group offers retail consumer loans to the public. [FN11] Many other companies, such as Nationwide Mutual Insurance Co., A.G. Edwards Inc. and TIAA Board Overseers, have sought to acquire savings institutions to offer specialized trust services to customers seeking a wide variety of financial and investment products from a single source.
If any of these companies were to expand its subsidiary's commercial lending activities in an effort to exert economic power, the company's power itself would be checked by activity restrictions similar to those imposed on a bank holding company -- the very intent of the proposed legislation. Therefore, under current law, the risk of a diversified company improperly mixing banking and commerce through ownership of a savings institution appears remote.
Safety and Soundness
Another common argument is that diversified companies' ownership of savings institutions raises safety and soundness issues. The Independent Bankers Association of America, for example, has expressed concern that such ownership lets companies engage without limit in riskier ventures, such as real estate development and investment activities, than those of bank holding companies. [FN12]
This argument had more validity when savings-and-loan holding companies faced fewer restrictions. Before 1959, federal law did not address the corporate ownership of savings institutions, although some diversified companies had owned savings institutions since as early as 1945. [FN13] A 1960 study by the Federal Home Loan Bank Board (the predecessor to the OTS) found that the absence of regulation allowed such companies to evade laws governing thrift operations and to use thrifts to serve the holding companies' needs at the thrifts' expense. [FN14]
To address these concerns, Congress enacted the Savings and Loan Holding Company Act of 1967 (SLHCA), which imposed comprehensive registration, examination and supervision requirements on savings and loan holding companies. [FN15] In doing so, Congress rejected proposals to restrict holding company ownership of savings institutions, opting to permit continued ownership of a single institution by a diversified company.
The SLHCA prevented potential conflicts of interest and other abuses by restricting certain transactions between savings institutions and their affiliates, requiring holding companies controlling two or more savings institutions to divest activities unrelated to the institutions' business, and controlling the amount of debt that could be incurred by certain savings and loan holding companies. [FN16]
To further wall off a savings institution from its parent holding company, the Financial Institutions Reform, Recovery and Enforcement Act of 1989 [FN17] imposed affiliate transaction restrictions tougher than those applicable to transactions between banks and their parent holding companies. Under these restrictions, a savings institution cannot lend funds to any affiliate engaged in activities not permissible for a bank holding company. Transactions with other affiliates became subject to the same restrictions applicable to banks under SS 23A and 23B of the Federal Reserve Act. [FN18]
The OTS also imposes conditions on diversified companies to prevent abuse. For example, it prohibits more than 60% of a saving institution's directors from serving as officers or employees of its holding company or any of its affiliates. With respect to securities company applicants, the OTS requires the savings institution to be operated separately from the broker-dealer affiliate, including having completely separate officers and a majority of different directors, and to adhere to requirements barring conflicts of interest and corporate opportunity.
These statutory and regulatory restrictions reduce the risk of a diversified company's using a savings subsidiary to fund risky activities. Data indicate that these restrictions are effective. As of 1997, there were more than 100 unitary thrift holding companies engaged in nonbanking activities.[FN19] At that time, the OTS noted that it had not "detected any systemic problems that arise from the scope of permissible activities of thrift holding companies and their affiliates." Of nearly 900 enforcement actions initiated between 1993 and 1997, only three involved diversified holding companies.
Indeed, rather than raising safety and soundness issues, diversified companies seem to have contributed to the health of the thrift industry. OTS Director Ellen Seidman recently testified that during the thrift crisis, diversified companies infused more than $3 billion into the industry. [FN20] Thus, the risk that diversified companies' continued ownership of savings institutions will cause these institutions to be operated in an unsafe and unsound manner appears no greater than, and perhaps less than, that associated with banks and their holding companies.
An illegitimate loophole?
The final argument often made for prohibiting diversified companies from owning savings institutions is that such ownership is a legal loophole that should be closed. This implies that such ownership is illegitimate and that the only valid ownership of savings institutions is by bank holding companies or companies that conform their activities to those permissible for bank holding companies.
Diversified companies' ownership of savings institutions, however, appears to be the result of a thoroughly considered policy judgment by Congress, carefully retained over 40 years of statutory amendments to the SLHCA, despite attempts to prohibit it. In fact, in the 1980s, when there was evidence of abuse by holding companies, Congress did not impose activity restrictions on unitary thrift holding companies or limit their ability to own thrifts. Rather, it addressed the issue by walling off the savings institution from the holding company by prohibiting certain affiliate transactions and restricting all others.
Arguments in support of eliminating diversified companies' ownership of thrifts appear to be addressed adequately by existing federal law. Diversified companies that operate savings institutions do not and cannot engage in "unfettered mixing of banking and commerce." In addition, any safety and soundness risks associated with such ownership appear to be the same as those associated with banks and their holding companies.
The real issue is whether these companies have an unfair advantage over bank holding companies. Bank holding companies, however, have capital sufficient to invest in consumer banking.
Moreover, given the recent expansion of their activity in the securities area via regulatory order, and given their proposed expansion into insurance and other areas via financial modernization legislation, they will be able to offer the same services as most unitary thrift holding companies.

FN1. Steve Cocheo, "A Closer Look at Unitary Thrifts," ABA Banking Journal, Oct. 1, 1998, at 66.
FN2. Jeffrey Marshall, "Taking Another Road into Banking," U.S. Banker, December 1998 at 38.
FN3. 12 U.S.C. 1467a(c)(3).
FN4. H.R. 10, 106th Cong., 1st Sess. S 401; S. [undesignated], 106th Cong., 1st Sess. S 601 (1999).
FN5. OTS, Applications for New Thrift Charters Detail (Jan. 1, 1997-Feb. 4, 1999).
FN6. Cocheo, supra, n.1 at 66 (citing Summer 1998 ABA position paper supporting restricting commercial firms from owning banking institutions through unitary thrift holding companies).
FN7. Statement by Alan Greenspan before Committee on Banking, Housing and Urban Affairs, U.S. Senate, June 17, 1998.
FN8. Statement by Henry C. Wallich before Subcommittee on Commerce, Consumer and Monetary Affairs of the Committee on Government Operations, U.S. House of Representatives, June 25, 1980.
FN9. Garn-St. Germain Depository Institutions Act of 1982, SS 321-335, 96 Stat. 1469, 1499-1505 (1982) (currently codified at 12 U.S.C. 1464(c)).
FN10. Competitive Equality Banking Act of 1987, Pub. L. 100-86 S 104 (1987).
FN11. The Principal Mutual Life Ins. Co., OTS Order No. 97-114 (Nov. 14, 1997).
FN12. Marshall, supra, n.2, at 42. A savings institution itself may engage, to a limited extent, in real estate development activities through a service corporation subsidiary. An institution's investment in all such subsidiaries, however, generally is limited to 2% of its assets (with an additional 1% available for community, inner-city and community development purposes). 12 C.F.R. 559.5(a).
FN13. Report of Federal Home Loan Bank Board on Savings and Loan Holding Companies (May 31, 1960) at 6. The first savings institutions were organized in mutual form. By 1945, there were 14 savings-and-loan holding companies, including All-State Insurance, Nationwide Corp. and National American Insurance Co.
FN14. Savings and Loan Holding Companies: Hearings on S. 1542 before the Senate Committee on Banking and Commerce, 90th Cong., 1st Sess. at 26 (1967) (statement of John E. Horne).
FN15. P.L. 90-255 (1968).
FN16. Id., at S 408(d).
FN17. Pub. L. No. 101-73, 103 Stat. 183 (1989).
FN18. Pub. L. No. 63-43, 38 Stat. 251 (1913).
FN19. OTS, Holding Companies in the Thrift Industry (April 1997) at 8.
FN20. Dean Anason, "Compromise in the House Reform Legislation," American Banker, Feb. 16, 1999 at 2.

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