MEMPHIS -- If imitation is the sincerest form of flattery, then Jim Hughes is feeling very flattered these days.
Mr. Hughes, executive vice president in charge of the highly profitable bond division at First Tennessee National Corp., tells of the time a competitor duplicated a proposal the bank had made to a customer.
"They just basically photocopied it and just put their letterhead at the top of the page," he said. "They didn't realize that our telephone numbers were still at the bottom of the page."
Chuckling, he added: "We got several calls from that."
There is good reason why competitors are willing to plagiarize. First Tennessee's bond division today advises one in four banks nationally on portfolio management.
Big Contributor to Profits
Last year, the unit generated $29.5 million in pretax profits, up from $9.5 million in 1990. That amounted to 15.6% of holding company profits and a return on assets of 5.66% - nearly five times that of the core bank.
Analysts believe that investors do not fully appreciate the potency of the bond division.
"It is kind of the engine of the company, and they really haven't had a misstep in the five or six years that I've been following them," said Peter W. Tuz, banking analyst at Morgan, Keegan & Co. in Memphis.
"It seems to be given very little value by the marketplace. It may be that it's a more difficult income stream to understand, and it is maybe a little more volatile business."
Indeed, he said that rising rates and the hunger for capital may slow demand for securities as banks try to book more loans. To counter that pressure, First Tennessee has been expanding its customer base and increasing support services.
Effort to Diversify
"We've been trying to get enough diversification so that when the demand from banks falls off, we can maintain our revenue stream," said Mr. Hughes.
With earnings due out next week, he predicted the bank would show slight growth in the bond division even though increased loan demand has sapped some demand for securities.
The story of how First Tennessee got to where it is dates back to the early 1980s. Like scores of banks, the Memphis-based company for years sold bonds to correspondents across the South. But in 1982, the company launched a strategy to take the business national.
The company added accountants and other support staff to build up the services that First Tennessee would offer banks beyond the traditional day-to-day transactions that many institutional bond salesmen peddle.
Today the management consulting services include everything from financial analysis to basic asset/liability management with advice on tax and regulatory compliance issues.
"We are working with banks and their investment policies, and we want to go much farther than just selling them bonds," said Mr. Hughes. "Being a bank helps us understand what other banks face."
So, as part of the cost of buying and selling securities from First Tennessee, customers - many of them community banks - get plenty of advice, comparisons, and investment options.
For instance, the company uses call data to show a customer how its portfolio management compares with the bank's hand-picked peer group. The results are eye-poppping color graphics that stream from a battery of laser printers at the division's Memphis headquarters.
"They can look at this and clearly understand what they are doing and what the fellow across the street is doing," said Frank Gusmus Jr., senior vice president of the bond division.
Portfolio's Maturity Gauged
One of the most impressive techniques First Tennessee uses is a model to show the expected maturity of the entire securities portfolio. While that is simple for an investment of tax-free municipal bond with clear call dates and terms, it is more ambiguous for riskier collateralized mortgage obligations.
With an idea of how the portfolio will likely mature, the customer is better able to plot an investment strategy. For First Tennessee, the information also provides a guide to opportunities to sell securities in the future
The strategy has clear bottomline implications. Even though many banks buy securities from several sources, the company wants to increase its share of the business by knowing more about its customers.
"Right now we get anywhere from 5% to 90% of a bank's business," said Mr. Hughes. "We think this [approach] does increase our slice of the pie."
Today, he says, banks are buying mostly conservative taxables - largely government agencies - with a three- to five-year duration. To meet that need, First Tennessee has invested in underwriting such issues, ranking sixth among underwriters last year as book-running manager for $5.1 billion in agency deals.
The conservative approach is not reserved for its underwriting. First Tennessee does not deal in off-balance-sheet activity.
The bank also does not engage in the practice of inventory selling, where brokers base recommendations on what they hold rather than what the customer may need.
That approach may pay off over the longer term. One competitor, who asked not to be identified, says First Tennessee has built such a strong relationship with its banks that some won't buy from another firm without first talking to their adviser in Memphis.
"I called one bank where I've done some good business and offered them bonds and there will be a long pause and they say, 'Well, let me call my guy at First Tennessee and see what he says,'" the bond salesman said. "That's loyalty."
