Thank you for that introduction. I would like to thank Bob Howell and members of the League for giving my firm and me this opportunity to be with you today.

I have entitled my talk "Out of the Briar patch: The Third Charter in the 21st Century." I came to the first part that title for several reasons, but prime among them was the statement made by many in the industry, addressed to Congressional ears, that they did not want to become a bank. It reminded me of B'rer Rabbit, Joel Chandler Harris' creation, who just did not want to be thrown in that briar patch, please please please. Of course, that is just what he wanted, since it meant his safety. I'll discuss what the second part about the Third Charter in a few minutes.

I am here today to discuss charter options with you, and perhaps a bank will mean safety for your institution. Your consideration of the matter involves planning. It is interesting to see what some of the great figures in history have had to say about it. One of the most intriguing comes from General Eisenhower. He said:

"In preparing for battle I have always found that plans are useless, but planning is indispensable."

Some less historical figures have expressed a similar idea. Two weeks ago I attended a conference put on by the Illinois and Ohio savings institutions. One of their speakers was the Executive Vice President with McDonald's Corporation, the second best known brand name in the world, just after the famous bottle. He said that at his company they have a basic philosophy: they "think like a brand, but act like a retailer."

As a brand, McDonald's does everything it can to preserve and enhance the image of the "McDonald's experience" -- going to McDonald's, not the hamburger itself. They do long term planning for this and move very carefully. This is the "think like a brand" aspect. The retailer side means to be sensitive, day-to-day, to current market conditions and react promptly and flexibly. McDonald's gives substantial authority to each local outlet in order to promote responsibility and flexible reaction to local conditions. Acting like a retailer is a little like General Eisenhower's observation, a plan is useless for the actual struggle, but planning for any eventuality is essential. The retailer does the battling: he defends the brand.

I hope I will be able to assist you with planning. But just as important, I hope you will use this information as part of your decision to promote and enhance the brands you already have -- the essence of your institution. The choice of charter is strategic. And surely you face a battle ahead.

I am going to divide my presentation into two parts: first, I will compare the authorized lending, liability and activities powers of federal savings institutions with the authorized powers of Michigan chartered savings banks. There are other aspects to charters besides lending and deposit taking, of course. These include taxation, corporate governance (which may not be of significance for those of you that are already holding company subsidiaries), choice of holding company structure, bank or thrift, FDIC capital requirements compared to OTS capital requirements, and affiliation restrictions, among other topics. These are proper subjects for the actual, detailed review that you should perform. This more detailed evaluation is part of a package we have developed at Elias Matz for those federal associations interested in pursuing this alternative in greater depth. However, for this morning's purposes, I assume that as managers you want to know what additional competitive advantage the state charter would bestow as compared to federal limitations. What greater flexibility it will give you in defining yourself and in reacting to events. So I have structured and limited my presentation as described.

After the discussion of authorized powers, I will discuss with you, second, what I call the "Third Charter."

Let us first turn to the charter powers you now have as federal associations. Since each of you have a different make up in terms of the powers you actually use, I will assume you have the typical balance sheet profile that we see at our firm, based upon our firm's over twenty five years experience in the field.

Federal and State Powers Compared

Let us now turn to some specific loan categories:

Residential Real Estate Loans. First, maximum limits for residential real estate loans. As a Federal association or savings bank or Michigan chartered savings bank you have unlimited authority to make residential real estate loans under both statutes. The notion of an unlimited lending power is a theoretical concept. In point of fact, you cannot place 100% of your assets in real estate loans, even though neither statute places a limit on residential real estate loans.

The reason for this is that you must have liquidity. So even though the statute does not, in the section on real estate loans, limit you to a certain percentage of assets, since the regulators have the power to require liquidity, and do, the liquidity requirement crowds out the real estate lending. The HOLA establishes a minimum liquidity requirement of 4% and a maximum of 10%, as determined by the OTS director. By contrast, there is no formal statutory or regulatory liquidity requirement for state savings banks. Rather, the FDIC determines liquidity based upon overall operations of the institution. Presumably, if you were meeting liquidity requirements of the OTS before conversion without FDIC objection, you will continue to be meeting liquidity requirements -- at least until your operations change. The Michigan law also contains no liquidity requirement, although liquidity resources are used in determining adequacy of capital.

Now the same would be true of any other investment. They crowd out your unlimited investments. Probably you have been doing a little too much crowding on your own; liquidity in the high teens in not at all uncommon. The high liquidity is a product of low investment opportunity; so the money is parked in liquidity.

We spoke of maximum limits on residential real estate lending. Is there a minimum requirement? Yes. Even after the changes regarding bad debt recapture -- you must still be an entity entitled to the phase out and meet an asset composition test. When you switch charter you will want to assure yourself that you retain the phase-out treatment on federal tax liability.

Minimums must also be met for reasons other than tax compliance. Again, as with liquidity we must look to other sections of the statute. Both the HOLA and the Michigan Savings Bank Act contain threshold tests that will probably impact on real estate lending and other unlimited powers. As you know, residential real estate loans help an institution qualify for the Qualified Thrift Lender or the "domestic building and loan" test -- since, after the Budget bill yesterday, you can use either test -- and thus avoid commercial bank meltdown. Similarly, the Michigan law imposes a 50% of assets test (or a test devised by the Commissioner), which can be met by loans for domestic residential housing. You will want to compare your present QTL or Internal Revenue Code qualification with the Michigan 50% of assets requirement.

In short, there are minimum requirements in both statutes, and you must apply a pencil to both tests, both in terms of present and projected asset mix. The tests are QTL or IRC for federal associations and a 50% test for Michigan savings banks.

Commercial Mortgage Loans. We turn now to commercial lending authority. The new HOLA limit is 20% of assets, with the amount over 10% only for small business loans. There is additional authority to make real property secured loans up to 400% of capital. Under the Michigan law the power is unlimited as part of a savings bank's general power "to make, sell, purchase [ loans ] for agricultural, business, corporate, or commercial purposes, which are unsecured or secured by liens or interest in personal or real property." For Federal associations a small business loan will help you meet the QTL investment test under the new Budget bill. The same is true for the Michigan 50% test. In both statutes, then, small business lending is encouraged.

Consumer Loans. For Federal associations the limit is 35% of assets, unless it is a credit card loan. If a credit card loan, under the Budget bill, there is no percentage of assets limit. For a Michigan savings bank consumer lending power is unlimited, and is included as part of the general lending authority. Consumer loans help a federal association meet its QTL. All of a Michigan savings bank's consumer loans may be used to meet the 50% test. Both statutes allow significant expansion of credit card operations.

Investment Securities. Both the Federal and Michigan statutory provisions contain unlimited authorities for U.S. government obligations and obligations of FNMA, GNMA and FHLMC.

Corporate Bonds. For a Federal association, up to 35% of assets, inclusive of consumer lending, may be invested in corporate bonds, plus an additional 10% of assets. In other words, consumer loans and corporate debt and commercial paper, in the aggregate, are subject to a 35% of assets limit. In Michigan, these corporate bond investments are unlimited, but subject to creditworthiness and bond liquidity requirements.

Commercial Paper. For short-term corporate obligations in the form of commercial paper, up to 35% of assets, inclusive of consumer lending, may be invested in commercial paper.. In other words, consumer loans and corporate debt and commercial paper, in the aggregate, are subject to a 35% of assets limit. In Michigan, the treatment is the same as for corporate bonds -- unlimited, but subject to creditworthiness and bond liquidity requirements. Similar rules apply to mortgage-backed securities.

The Budget bill will impact investment in corporate debt instruments for Federals. It will take several months to find out just how. The OTS will need to go through rulemaking.

FHLBank Stock. How about membership in the Federal Home Loan Bank? As a Federal association membership is required, as a Michigan savings bank membership is permitted.

Service Corporations. How about service corporation investments? For a federal, the rule is a maximum of 3% of assets. There is a laundry list of permitted activities, and the regulations permit you to apply to engage "incidental" activities. This can be quite a potent authority. I used just this authority when I sought the approval of several federal associations to organize what eventually became Invest, the first federally approved union of banking and securities brokerage activities. In Michigan, the investment is in "service entities", not service corporations. The permissible limit is potentially higher: to the lesser of 5% of assets or 75% of capital and surplus (or of total capital for mutual institutions). Like the Federal system there is a laundry list of activities plus "incidental" test. Again, you will want to compare your business plan against the Michigan list to test conformity.

Alter Ego Corporations. Alter ego corporations? The rules are the same here: no percentage of assets limitation for either charter.

Real Estate Investments. Of course for both Federal associations, by legal interpretation of the Office of General Counsel as an implied power, and for Michigan Savings Banks by express statutory provision, institutions may hold real estate as a result of foreclosure or kindred proceedings. As for other situations, for Federal associations real estate investments are limited. Investments may be made for offices and related facilities, but such investments may not exceed the association's total capital. Michigan savings banks can invest less for offices and related facilities. The limit is 2/3 of total capital of association. However, acquisition, development and construction lending with incidental real estate purchases, may be made up to 10% of assets. This is a much more liberal treatment than has ever been available to federal associations. Both classes of institutions could presumably own real estate in leases with nominal "lessors" that are the financial equivalent of loans. In addition, by using a "service entity" a Michigan Savings Bank can acquire real estate for offices of a person that owns an interest in the savings bank or for offices and related facilities and for rental or sale.

Personal Property. Personal property investment is much more liberal than real estate investment for both classes of institutions, with Michigan having the edge. Federal institutions can invest in personal property for rental or sale up to 10% of assets. A Michigan savings bank can acquire personal property for the purpose of leasing without limit. Personal property acquired for other purposes is limited to 20% of capital and surplus.

Venture Capital Investments. How about other types of venture capital type investments? Federal association equity investments are generally limited to service corporations and alter-ego companies; they do not have a general power to make equity investments. Michigan savings banks are permitted to make "venture capital investments" including investments "in equity securities of a professional investor" engaged in such investments; limited to 10% of capital. Such investments, like other investments, would be subject to FDIC oversight and review.

Let us now turn briefly to the liability side.

Deposits. Federal associations may have deposit, share, or other accounts, including demand deposits. Michigan savings banks have broad power to "engage in the business of banking", which would include deposit taking. There is even a specific provision permitting the payment of interest on demand deposits unless restricted by federal law (which it is -- the only remnant of Regulation Q).

Other Borrowings. As for other borrowings, both types of institutions have broad power to borrow.

Grandfathered Loans and Activities. The subject of grandfathering of investments is critical for obvious reasons. No one would wish to change charter and be subject to a forced sale of an asset. The Michigan Act contains authorization for federal associations converting to state charter "to retain and carry" assets of the federal association not permitted for the state savings bank. There is no mention of grandfathering of activities, so this is an item that should be checked with the Bureau of Financial Institutions. The Michigan law does not paint the institution into a corner, later reconversion to federal charter is permitted.

Branching. Branching for federal associations is permitted nationwide, if the association meets the Internal Revenue Code definition of "domestic building and loan association." For Michigan savings banks branching is permitted nationwide.

Real Estate Brokerage. In the area of activities, one of the most interesting new powers contained in the Michigan law is the power to conduct full, third party brokerage activity. Federal associations may not engage in this activity either at the association or at the service corporation level. The Michigan law also permits the acquisition of real estate brokers. As you are all aware, one of the aspects of concentration of resources is loss of sources of business. Real estate brokers may steer business to larger competitors. This legislation makes it possible for an institution to acquire a real estate brokerage business and rejuvenate lending activity in the process.

Insurance Agency. Another attractive feature of the Michigan law is the power to engage at the bank or subsidiary level as an insurance agency. Federal associations have this power, but only through service corporation subsidiaries.

The Third Charter

I would now like to discuss what I shall term the "Third Charter." The Third Charter is one of several entirely new phenomena to come out of the thrift crisis. Other new phenomena are a product of the move toward reform that began with the Hunt Commission in the 1970's, but traces its roots to reforms proposed by Carter Glass in the 1930's to safeguard the nation's banking system. I am speaking now of the imminent advent of nationwide branching, which begins in the middle of next year. Carter Glass favored nationwide branching, because it distributed risk among many communities.

But what is this Third Charter I am talking about? Simply put, after 1991 the FDIC became a de facto chartering authority. This power is the source of the third charter. As you know, one type of charter is the federal charter of thrifts or of banks. Another type of charter is the one granted by the states; we are discussing the savings bank charter today. The third charter was added by Congress in FIRREA for state savings associations and in FDICIA for insured state banks. It is the charter crafted by the FDIC and lies in between the two other types.

The Third Charter is based and builds upon the state charter. It affects every aspect of your authorized conduct of business, with no exception. It is no broader than your state charter. But at the same time, it mirrors and takes as its foundation the charter and powers of national banks as set out in statute and by interpretation of the Comptroller of the Currency. If you were a state chartered savings association instead of a state chartered savings bank, the charter would mirror the federal savings charter.

One way to visualize the Third Charter is that it always stands on the state charter as a base, but it always narrower at the top. It is like a cone with a plane through it, as you may remember from geometry. The plane does not rest on the point, because if it did, national banks would have no investment or activity powers. Instead it cuts through the cone somewhere. It is flat at the top and may or may not extend all the way down to the base. The surface area at the top represents the equity investment powers of the charter. These investment powers are no greater than for a national bank. The broader volume underneath consists only of non-equity investments and of activities. There are no equity investments below the flat surface at the top. The volume below consists of all permitted state activity as agent, all permitted national activities as principal, and some, but not all, permitted state activities as principal.

This Third Charter is different for each state.

The FDIC is a de facto chartering authority, because it decides what powers you, as state chartered entities, may have. It makes these decisions under very broad guidelines. All state chartered banks and thrifts now have this Third Charter, whether they know it or not.

This new arrangement of federal and state affairs has profound implications for banking in the 1990's and beyond. There is no dual system. There is a system of federalized cones all over the country, a kind of invasion of the charter snatchers. This is true, right now. The first of the invaders floated down from the sky in the dark of night on December 9, 1992, when the FDIC implemented FDICIA. The rest followed a year later on December 8, 1993. There they sit, limiting your charter powers, each one different for every state.

This is not only structurally odd to look at and difficult visualize; it is an unprecedented concentration of banking power in a federal agency -- with veto power over the sovereign states. These vetoes, mind you, will emanate from mere staff interpretations at the OCC, or at the FDIC, interpreting OCC interpretations. The Federal Courts under Article III of our Constitution do not have such power to overturn state statutes. Why it is simply breathtaking. It might even be illegal. No one has challenged this new dispersal of federal power yet.

Equity Investments

Now let's take a closer look. First, equity investments. Under Section 24 of the FDIA, no state chartered bank, including a state chartered savings bank, may make an equity investment unless a national bank may do the same. There are some limited exceptions to this rule. The equity investment limit is both as to type and as to amount. The investment limitation is absolute; the FDIC may not carve out exceptions on its own motion even though a particular investment may be perfectly safe and sound, and the state bank proposing to make it is in excellent financial health. Put another way, institutions cannot apply to make investments impermissible for a national bank.

What are permissible equity investments for national banks? The list is always expanding as Congress changes the National Bank Act, in fact, just yesterday certain changes were made to the investment powers of national banks in the Budget Bill. They also expand as the OCC issues its interpretations, and presumably as the FDIC issues its interpretations of OCC interpretations. But to provide some idea, the list includes: (1) Bank Service Corporations in an amount equal to 10% of paid-in and unimpaired capital and surplus and not more than 5% of total assets. (2) Community Development Corporations up to 2% of capital and surplus for any one CDC and 5% in the aggregate. (3) Equity Securities taken DPC. (4) Stock of FNMA and FHLMC and investment in mortgage related securities. (5) Municipal Parking lots (true!). Over thirty types of investments have been identified so far by the FDIC.

The list of national bank equity investments does not include personal property held for sale. Thus some of the personal property powers granted by the Michigan law will not be available at the bank level. Presumably personal property may be acquired for leasing that is the functional equivalent of a financing -- this investment is not on the FDIC's list, but has been approved by the OCC in interpretations.

Again, ADC lending that takes on the character of an equity investment will probably be forbidden by the FDIC even though permitted by the Michigan Act. This is not on the FDIC's list of permissible equity investments for national banks.

The list could go on. You will need to make an inventory of what you have now as equity investments, and what you want to do in the future. You will need to see whether you fall on the top surface of that cone -- the permissible equity investments of national banks.

How about "service entities" and "alter ego" corporations? This leads us to the most significant exception to the investment rule. Under the FDIC law a state bank may invest in a majority owned subsidiary even though a national bank may not. For example, a state bank could invest in a wholly owned subsidiary that engages in activities as principal that are prohibited for a national bank. If the subsidiary is majority owned, we must look at its activities. If the subsidiary is not majority owned, there is no exception, it is an equity investment, and authority for it must be found in the National Bank Act.

Activities

Activities comprise the volume of material underneath the permitted surface of equity investments. First, as to activities as agent, there is no federal charter limitation. Agent activities are determined by state law. What is an activity "as agent?" It is an activity not conducted "as principal." And what is that? An activity is considered to be conducted "as principal" if conducted other than as agent for a customer, is conducted other than in a brokerage, custodial, advisory, trustee, or administrative capacity. Examples of activities as principal are: real estate development, insurance underwriting, issuing annuities and securities underwriting.

Second, if the activity is as principal, then it may be engaged in without permission from the FDIC if a national bank may do the same, either at the parent bank or at the subsidiary level. What activities are permitted for a national bank as principal? (1) Sales of bankers' acceptances. (2) Finder and servicer of loans. (3) Sale of fixed rate and variable annuities. (4) Engaging in arbitrage activities. (5) Engaging in automobile leasing through a subsidiary. (6) Placing of third-party commercial paper. (7) Establishing a credit card bank as a subsidiary. (8) Sale of credit life insurance. (9) Equipment and Personal Property Leasing. Well in excess of 100 activities have been identified. Again, this category was recently expanded as part of the Budget bill. Notice that the VALIC Supreme Court decision of last December, which you probably have heard about, validates a Comptroller decision that national banks can sell insurance products, as agent, it does nothing to expand the as principal authority of national banks. VALIC did not say that national banks could underwrite insurance.

Third, if the activity is as principal and the activity is not permitted for a national bank, then FDIC permission must be sought to engage in the activity. The applying bank must meet the applicable minimum capital requirement, and it must demonstrate to the FDIC that "as principal" activity does not pose a significant risk to the affected insurance fund. The one exception to this rule is that the FDIC may not approve insurance underwriting beyond the authority of national banks.

But wait. What is an "activity?" Is it just things such as selling insurance as agent? No. An "activity" is, and I quote, "the authorized conduct of business by an insured state bank." It is everything. It includes acquiring or retaining an investment other than an equity investment. Here is what the FDIC said:

Several comments expressed concern that the definition [of activity] as proposed would sweep so broadly that nearly everything a bank does is made subject to the regulation. ¼ [T]hese comments did not suggest any way to narrow the definition.

Activity encompasses everything, or almost everything. However, the FDIC has stated that it will not impose national bank limitations on state banks with respect to loans to one borrower, insider loans, interest rate ceilings, restrictions on shared management, or minimum number of directors. "Activity" encompasses non-equity investments such as corporate bonds and commercial paper. These would be "as principal" investments in most cases, and, under the FDIC's interpretation are not subject to an amount limitation, but are subject to a type limitation. The rule is that non-equity investments may be invested in if the type of investment is permitted for a national bank. State banks can invest more than permitted for national banks and need seek no permission to do so. This will mean that all the lending authority I described earlier will be permitted, except for ADC lending that would be accounted for as an equity investment.

With respect to equity investments of a subsidiary (which are shield by the investment in majority owned subsidiary rule) they to are treated as "activities." So to the question "when is an equity investment not an equity investment?" the answer may be given: "when the equity investment is made by a majority owned subsidiary."

Applying this to the Michigan powers, this will mean that impermissible equity investments should be made through a majority owned subsidiary after receiving permission from the FDIC to do so under its approval of activities powers. This is not a bad result from a Federal standpoint (especially if the FDIC approves the application). It makes hash of the dual system, of course.

Summary and Conclusions

I hope I have convinced you of three things:

First, the state powers of savings banks are broader than those of Federal associations. They are also more certain. It should also be easier to get questions answered, because your regulator is close by.

Second, there is a Third Charter that is a blend of Federal and State charters administered by the FDIC; the dual banking system as you know it no longer exists.

Third, the system is not free of complexity. If you venture off the national bank reservation, you will have to seek FDIC approval. Some things you simply cannot do, even if state law allowed it.

I believe the FDIC will do its best to administer the new structure in as unabrasive a manner as possible and will seek to expedite treatment. The regulation itself contains a number of practical accommodations that time has not permitted me to discuss.

Will you escape from the briar patch if you leap into state charter?

The question is one of thinking like a brand or advance planning for battle. The state charter deserves your most serious consideration. It can fit into your own vision for the future of your institution. It provides plenty of flexibility. Suitably armed and well prepared, you can deal with the federal government. Thank you.