Building on an unprecedented melding last year of the banking, securities, and insurance industries, 1998 is shaping up to be the year of the financial conglomerate.

"The marketplace is demanding a convergence of the industries," said Steven Ollenburg, president of Principal Bank, the newly chartered thrift owned by Principal Mutual Insurance Co. "The financial services industry has to figure out a way to do it. There isn't much of an option."

Consumers want the lower prices and added convenience associated with financial supermarkets, said Howard L. McMillan Jr., president and chief operating officer of Deposit Guaranty Corp., Jackson, Miss. And, he said, banks are well positioned to deliver.

"It is not like we are moving into businesses we don't know anything about," Mr. McMillan said. "These are not uncharted waters. Many banks now are in the securities and insurance businesses."

Nine large commercial banks, capitalizing on regulatory changes, acquired prominent securities firms in 1997. At the same time, insurance and securities firms have seized on the thrift charter as a means of entering the consumer banking and trust businesses, flooding the government with applications.

Last year was also the first full year since the Supreme Court stripped away state laws that blocked bank insurance sales. Since then, negotiations for mergers and joint ventures between banks and insurers have skyrocketed.

According to a survey by Risk Management Services, the number of banks that sell insurance policies beyond credit life increased to 28% last year from 23% in 1996. Paul A. Buse, a consultant at the firm, said he expects half of all banks to be selling insurance by yearend.

Conglomerates, however, have a rocky history in this country. Few industrial conglomerates from the 1960s still exist. Also, American Express Co. and Sears, Roebuck and Co. were unable in the 1980s to successfully combine retail brokerage, credit card lending, and insurance sales.

"I'm not convinced that conglomerates will prove any more successful in the financial services sector than they have in the industrial sector," said Karen Shaw Petrou, president of the industry consulting firm ISD/Shaw Inc.

"Banking is a different kind of risk taking than brokerage or insurance," said Diane M. Casey, national director of financial services at accounting giant Grant Thornton. "The question is whether you can blend them together."

David E.A. Carson, chairman and chief executive officer of People's Bank, Bridgeport, Conn., said financial conglomerates must excel in all three businesses to be successful. "That is a very real challenge," he said. "Not many institutions have done it."

He said one of the few successful conglomerates is USAA, San Antonio, a diversified financial services company that combines a thrift's retail banking services with securities and insurance sales.

Others are more optimistic that the three industries can merge successfully. "There isn't necessarily a connection between someone who shops for tires at Sears and needs financial services," said Donald R. Mengedoth, chairman and president of Community First Bancshares. "But when someone walks into a bank, they are looking for financial services. There is a natural tie-in."

Richard B. Roberts, who retired Dec. 31 as treasurer of Wachovia Corp., said all distinctions between the three sectors could evaporate if Congress finally eliminates the Glass-Steagall Act. "It is going to take a cooperative spirit between the regulatory and legislative functions to go get it all melded together," Mr. Roberts said.

Prospects for legislative reform, however, appear bleak. Efforts to pass a reform bill failed last year because of disagreements over bank insurance and securities sales. Those disputes have not been resolved.

"I'd be surprised to see legislation go through the Senate," said Kenneth Guenther, executive vice president of the Independent Bankers Association of America.

Mr. Guenther also questioned whether legislative reforms would help the industry. "What more could be needed? The convergence is already moving forward," he said. "Why give it a further push?"

But Larry LaRocco, executive director of the ABA Securities Association, said a complete repeal of the separation of commercial and investment banking is crucial for U.S. financial companies to compete globally. "Right now we are working with a patchwork of laws," he said. "If we are truly the leaders of the global market, then we need modern laws."

House Banking Committee leaders vowed to continue pushing for reform. "We have to move ahead, or we are abdicating our legislative responsibilities," said Marge Roukema, chairman of House Banking's financial institutions subcommittee. "We shouldn't hand over our legislative job to regulators. That invites trouble."

House Banking Chairman Jim Leach said he is encouraged by a recent uptick in support from community bankers, who fear insurance companies will use newly acquired thrift charters to muscle into the banking business. "I sense an increasing consensus on the theoretical basis for modernization," he said. "There is a growing recognition that ... lack of legislation is the worst of all worlds."

Even without legislative change, last year witnessed a variety of unprecedented deals. Leading the charge was Travelers Group, the insurance giant that chartered a federal thrift and acquired Salomon Bros.

Also grabbing headlines were mergers between Bankers Trust New York Corp. and Alex. Brown Inc.; NationsBank Corp. and Montgomery Securities; First Union Corp. and Wheat First Butcher Singer Inc.; BankAmerica Corp. and Robertson Stephens; and U.S. Bancorp and Piper Jaffray Cos.

The unprecedented wave of mergers between commercial and investment banks began when the Federal Reserve Board more than doubled to 25% the amount of revenue section 20 units may derive from underwriting and dealing in corporate securities. This freed holding companies to pursue securities firms. The Fed also approved six new section 20 units last year and gave five permission to underwrite corporate securities.

Louis A. Schmidt Jr., managing director of First Union Capital Markets, said the new revenue cap is high enough that his customers never need to use a brokerage house again for their underwriting needs. "Instead of having to deal with a truncated capability in a bank and a truncated capability in a securities firm, a customer can have a complete menu of financial services," he said.

Insurance and securities firms began their long-expected move into banking by applying for 13 federal thrift charters. The Office of Thrift Supervision awarded charters to three insurers-Principal, Travelers, and Reliastar Financial Corp.

"Banks have been selling insurance for a long time," Principal's Mr. Ollenburg said. "All the insurers are trying to do is sell bank products."

Going forward, observers expect the Office of the Comptroller of the Currency to decide whether banks may use operating subsidiaries to develop real estate, a business the industry currently may not enter.

They also expected to see continued consolidation in the banking industry and more mergers among banks, insurers, and securities firms.

Bert Ely, president of Ely & Co., a consulting firm in Alexandria, Va., said small, regional securities firms are especially tempting for takeovers. Potential targets include McDonald & Company Securities Inc. in Cleveland, Robinson-Humphrey Co. in Atlanta, Roucher Co. in Dallas, and Stifel Nicolaus & Co. in St. Louis.

Richard J. Barrett, managing director at UBS Securities in New York, said he expects large U.S. banks and foreign banks will bid aggressively for securities firms, including some of the industry's leaders such as Goldman, Sachs & Co. and Merrill Lynch & Co.

"It used to be that big fish looked for small fish," Mr. Barrett said. "But the watchword for 1998 is that you cannot exclude anyone from your list anymore.

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