For banks in corporate finance, this has been a year of remodeling.
Prompted by the Federal Reserve Board's relaxation of rules governing bank securities operations, five large banks are acquiring securities firms. Less obvious are the moves being made by many regional banks.
Since January, eight banks have asked the Fed for either initial or additional securities underwriting powers. Banc One Corp. and First Union Corp. are among the banks applying for Tier 2 powers, while banks such as BOK Financial Corp. and Crestar Financial Corp. are just getting started with Tier 1 powers.
More applications to create so-called section 20 units are expected in the months to come-especially if the Fed further loosens the rules.
The central bank has a proposal pending that would repeal more than a dozen firewalls governing everything from capital requirements to the marketing activities of section 20 units.
It's been 10 years since the Fed first allowed banks to set up securities underwriting units under a loophole in section 20 of the 1933 Glass-Steagall Act. Since 1987, 44 banks have created securities units, usually gaining Tier 1 powers first, which include municipal securities underwriting and dealing and asset securitization. After gaining experience, banks apply for Tier 2 powers, which permit corporate debt and equity underwriting and dealing.
Initially, the Fed only allowed banks to earn 5% of the revenue in their securities affiliates from the new powers. In 1989 the income limit was hiked to 10%. Late last year the Fed raised it again, this time to 25%.
The higher cap, which took effect March 6, made it practical for regional banks to actively use their section 20 units and made it possible for the industry's biggest players to buy investment banks.
In many respects the old rule stopped regional banks from entering the business "because they couldn't be assured of a steady stream of eligible revenue to support the ineligible activities," said Paul Dimmick, executive vice president of capital markets at Mellon Bank. "Now with the ceiling raised, more regional banks can form section 20s."
Mr. Dimmick said the Pittsburgh-based bank is starting to line up people and resources to expand its securities activities.
"The ability of a Bankers Trust to buy an Alex. Brown or a NationsBank to buy a Montgomery (Securities) is driven entirely by two principal Fed changes last year," said Robert L. Tortoriello, a partner specializing in bank capital markets activities at the Cleary, Gottlieb, Steen & Hamilton law firm in New York.
The second change also made it easier for banks to stay within the 25% income limit. The Fed decided to reclassify interest income on securities that banks have long been allowed to own, such as commercial paper. No longer would that revenue count toward the amount of income a section 20 can receive from its securities underwriting activities.
The change reduced so-called "ineligible revenue" at various section 20 units between 19% and 79%, according to Mr. Tortoriello.
This makes managing income limits easier by not only reducing ineligible income, but at same time adding to eligible income. Bankers used to spend a fair amount of time and resources managing the income limit. Now that time can be used to grow business.
"The biggest change in our business is that we've been able to decrease the size of our matchbook because we no longer have the need to generate eligible income from sources which are not strictly part of our day-to-day business," said Howard Curlett, president of First Union Capital Markets.
Previously, most banks had to keep a large matchbook to make certain their eligible to ineligible ratio remained within the limits.
"We have recently been given equity authority and have announced a program for building that business," Mr. Curlett added. "Our ability to proceed with that has been made easier by the change in the ineligible income ratio."
Susan Evans, chairman and chief executive officer of Citicorp Securities Inc., said the 10% limit was a business constraint.
"We almost had to turn away business to stay under the 10% (limit)," she said.
While the Fed has gradually eased the rules governing bank securities activities, Congress continues to debate an outright repeal of the Glass- Steagall Act separating commercial and investment banking.
The House Banking Committee approved a bill June 20 that would permit banks, securities, and insurance firms to buy each other. The legislation is scheduled for another vote by the House Commerce Committee next month and could reach the House floor this fall.