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April 22, 2015 News » Cover Story

Bank On It 

Thanks to luck and a loophole, Utah is an unlikely hub for the nation's industrial banks

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If you live in New York City and want to become the owner/operator of a yellow taxi cab, you would have to buy one of the city's 13,437 taxi "medallions," a coveted permit issued by the government that can cost up to $1 million.

Coming up with a million bucks isn't easy—even for a cabbie. Fortunately, taxicab medallions, like other big-ticket items in life, can be financed. And one of the places hopeful cabbies turn for financing is Medallion Bank, located at 1100 E. 6600 South in Murray.

Or, maybe you live in Michigan and your electricity bill arrives each month from CMS Energy Corp., a public utility that provides electricity to around six million of the state's 10 million residents, and you want to lower that monthly power bill by installing new double-paned windows and solar panels.

A loan for these upgrades could be obtained from CMS's own bank, EnerBank USA, located at 1245 Brickyard Road in Salt Lake City.

These two banks, along with 16 others located in Utah, are known as industrial banks, a niche form of banking that has existed for more than a century, and has clung to life through a narrow exemption in federal banking law that allows commercial entities to own banks. Through a sequence of circumstances, random good timing and some political lobbying, Utah has become the near exclusive home for these institutions.

With the heft of its industrial banks, which are also known as Industrial Loan Corporations (ILCs), Utah has emerged as a marquee state for financial services. According to statistics compiled by the Utah Department of Financial Institutions, which regulates industrial banks and other state-chartered banks, the Beehive State is the fourth-largest center for state-chartered banking in the nation, with $277 billion in assets anchored within its borders. Only New York, Massachusetts and California top Utah on this list. $143 billion of these assets are in ILCs held by corporations, like General Electric, Target and the Flying J truck-stop chain.

click to enlarge Industrial-bank cheerleader Frank Pignanelli: “Everybody in Utah seems to be enjoying the ride with them.”
  • Industrial-bank cheerleader Frank Pignanelli: “Everybody in Utah seems to be enjoying the ride with them.”

What these banks are and how they operate, though, isn't widely known outside of financial and political circles. In the past decade, the state of Utah and the lobbying firm Foxley & Pignanelli have become the largest cheerleaders for this arm of the banking industry, which according to Frank Pignanelli—a lobbyist, executive director of the National Association of Industrial Bankers and former Democratic legislator—directly and indirectly support thousands of jobs throughout the state.

But, outside of a handful of current and former state regulators, attorneys and the nonprofit community, it isn't easy to find anyone who knows that these banks exist. And it's even harder to find anyone who cares that they exist.

"The only people that have ever said anything bad to me were outside the state, and they didn't know what they were talking about," says Pignanelli, who agreed to an interview at the state Capitol during a break from his lobbying duties during the legislative session. "Everyone in Utah seems to be enjoying the ride with them."

click to enlarge Attorney George Sutton: Utah has built “credibility in the marketplace.”
  • Attorney George Sutton: Utah has built “credibility in the marketplace.”

Blind-Ass Utah Luck: A History
Utah didn't set out to become the capital of industrial banking. It just happened that way.

Industrial banks got their start in the early 20th century, when industrial workers wanted to borrow money but found it difficult to do so from traditional banks. Seeing a need, titans of industry began issuing loans to workers.

As American banking laws evolved, one nuance in particular differentiated the United States from much of the world: the idea that banking must be severed from commerce, a concept that was cemented into law in 1956 with passage of the Bank Holding Company Act. Conventional U.S. banking wisdom holds that a corporation, if allowed to own a bank, could undermine the safety and soundness of its bank by overborrowing or encouraging irresponsible lending to close allies. Industrial banks, though, existed in Utah prior to the establishment of this prohibition and were grandfathered in. To this day, Utah's industrial-bank charter is exempt from the Bank Holding Company Act.

Over the years, a number of safeguards have been put in place to ensure that industrial banks aren't undermined by their parent companies. Chief among them are prohibitions that restrict the direction in which money can flow. This means that a holding company such as General Electric—which has a Utah-chartered industrial bank—cannot receive financing from its bank, but it can funnel cash into the bank. (General Electric announced on April 10 that it intended to sell portions of its banking operations. A G.E. spokesperson declined to comment on whether the company's Utah-based operations, which has $22.6 billion in assets, would be impacted.)

This fact, industrial-bank advocates say, stands as proof that corporate profits can and should capitalize banks and float credit to consumers. Far from being a point of weakness, Pignanelli says, corporate ownership is one of the ILC system's strengths, and should be encouraged and embraced by the rest of the nation.

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The industrial-banking world really began to gather steam in 1982, when a new law, the Garn-St. Germain Depository Institutions Act, named after former Utah Republican Sen. Jake Garn, allowed industrial banks to apply for insurance from the Federal Deposit Insurance Corporation (FDIC). In 1987, the Competitive Equality in Banking Act (CEBA) narrowed the field of industrial banks substantially by requiring that states have laws either on the books or under consideration stipulating that industrial banks carry FDIC insurance.

Utah was among seven states that fit into this category.

Around this same time, Pignanelli and his partner, Doug Foxley, arrived on the scene. As Pignanelli tells it, he was approached by several industrial banks, and recalls being told that if Utah laws could be tailored to their needs, industrial banks could become a $100 billion industry within a decade.

Pignanelli says he set out to change the laws, and the industry blossomed. Scores of laws relating to Utah's financial institutions were altered during the 1990s, but it's unclear which specific laws were responsible for generating rapid growth in the industrial banking community. "They predicted that we could be within $100 billion within 10 years if we changed the laws, and we'd become a center of finance for the country," Pignanelli says. "And they were wrong. It wasn't $100 billion in 10 years; it was like $100 billion in like two years. All of a sudden, all of these companies said, 'This is the place to do banking.'"

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Industrial-Bank Heaven
In the early 2000s, industrial banks started popping up in Utah at a rapid clip. In the past decade, 31 different industrial banks have done business here.

In addition to benefits derived from corporate ownership, industrial banks enjoy another perk: being exempt from the Bank Holding Company Act. By operating outside of the act, the parent companies of industrial banks aren't regulated by the Federal Reserve. Instead, the FDIC and, largely, Utah's Department of Financial Services, regulate them.

"State regulators are very firm, but they're very fair," Pignanelli says. "They tend to be viewed as a little more responsive as to where the economy is and things like that."

Darryle Rude, chief examiner with the Utah Department of Financial Institutions, says that state regulation is "less onerous" than federal oversight. Federal Reserve oversight, Rude says, "would be like you going to get your driver's license renewed once every three years, but instead of going to the DMV, you also had to go to Sandy City or Salt Lake County to get that same license from two other people. It's just the process of dealing with another regulator and another bureaucracy."

While there might be some tangible benefits to keeping the Federal Reserve off of a bank's back, according to George Sutton, former commissioner of the Utah Department of Financial Institutions, lack of oversight by the Federal Reserve is not what fueled the growth of these banks.

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Sutton is now an attorney representing roughly half of the state's industrial banks. During the rapid rise of industrial banks in the early 2000s, Sutton says, he was on the phone for an hour each day fielding calls from companies across the country contemplating entering the banking business.

Utah had earned itself a sterling reputation as a good place—and, by then, one of the few places—to set up these sorts of banking shops, Sutton says. "It's really a matter not of changing your laws, but building that kind of credibility in the marketplace," he says. "That's what brings the business."

During this heyday, all kinds of banks were opening in Utah. Some of the first, Pignanelli says, were AT&T Universal Card, GE Capital Bank and Federal Express Centurion. Scores of banks—such as BMW Bank, Pitney Bowes Bank, Sallie Mae Bank, Target Bank and Comenity Capital Bank, to name a few, followed suit.

Everything was chugging along just fine, and assets skyrocketed to a 2007 peak of $223 billion. Then, in 2005, the world's largest retailer, a politically polarizing giant named Walmart, applied to become a Utah charted industrial bank.

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The Big Bad Wolf
Plenty of stories have been written about Walmart and the destruction it has wrought on small businesses with its aisles of cheap goods stored in acres of neon-lighted consumer warehouses.

The same fear that might sweep across the face of a small-town grocer upon hearing that a Walmart is breaking ground on the outskirts of town also gripped the nation's community-banking industry when it found out Walmart had set its sights on banking in Utah. If Walmart were allowed to enter the banking industry, would it wipe out America's small-town banks?

National banking associations and even the Federal Reserve raised this concern, contending that the inability of federal watchdogs to regulate parent companies of industrial banks presented a "blind spot" that, if left unchecked, could rain chaos on the nation's financial sector.

In testimony before the House Subcommittee on Financial Institutions and Consumer Credit in July 2006, Scott G. Alvarez, general counsel of the board of the Federal Reserve, said the rapid expansion of industrial banks created a potentially unfair opportunity for corporations to gain access to the federal banking safety net. He urged Congress to either close the Bank Holding Company Act exemption that permitted industrial banks to exist, or to create rules that would allow other banks to operate in a similar fashion—meaning their parent companies could be involved in commerce.

"If Congress does not address the ILC exception, the nation's policies on banking and commerce and the supervisory framework for corporate owners of insured banks are in danger of being decided for Congress through the expansion of this loophole by individual firms acting in their own self-interest," Alvarez said. "The board believes that the decisions on these important policies, which influence the structure and resiliency of our financial system and economy, should be made by Congress, acting in the public interest, and then applied to all organizations in a competitively equitable manner."

Another important issue raised by Alvarez was the close ties industrial banks have to their parent companies. The parent company of a typical bank that accepts deposits at a drive-thru window and offers lollipops to children is watched closely by the Federal Reserve to ensure no actions are taken to jeopardize the soundness of the bank.

But in the case of an industrial bank owned by a company like BMW, Target or General Electric, the Federal Reserve has no authority to peer in on the books.

While officials in Washington, D.C., and banking associations across the country were sweating over industrial banks, bankers in Utah were left scratching their heads over the controversy.

Howard Headlee, president of the Utah Bankers Association, says his counterparts across the country were acting out of fears surrounding an industry that they knew nothing about. "We understand what the industrial bank charter can and cannot do, and we understood the risk they were responding to was not real," Headlee says of the national uproar surrounding Walmart's bid to enter banking.

While Alvarez and other regulators raised concerns over the perception that a parent company could, through poor lending practices to itself or its affiliates, undermine a federally insured bank, Headlee says these scenarios were unlikely, and remain so. He says the flow of capital from a bank to its parent company would run afoul of a pair of long-established FDIC rules pertaining to industrial banks.

And, rather than weaken the bank, Headlee says the close relationship that an industrial bank has with its parent company can come in handy in times of distress. "The positive thing about it that people overlook is that these parents—like General Electric, CMS Energy, Pitney Bowes, United Health Group—they can recapitalize these banks overnight," Headlee says.

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Indeed, many of the fears surrounding Walmart's banking bid appear to have been unfounded. Like other industrial banks, Walmart would have been prohibited from opening branches in its stores. Its primary function would most likely have been similar to that of Utah-based Target Bank, which issues and processes credit-card transactions.

Nevertheless, Walmart's application sparked massive interest in Washington, D.C. Hearings were held, and thousands of comments poured in to the FDIC, most critical of Walmart's plan. In 2006, in the midst of this controversy, the FDIC placed a moratorium on the issuance of new industrial-bank charters.

As the Walmart controversy worked itself out (the retailer eventually forfeited its application in 2007), the tidal wave that became the Great Recession was just about to sweep the nation. Many states, wary of Walmart's bid for a bank, passed tighter restrictions on banking charters, and industrial banks became further entrenched in Utah.

The Walmart controversy kicked up enough dust in Congress that even after Walmart gave up its quest for an industrial-bank charter, the FDIC extended the moratorium on new industrial banks through early 2008.

By then, the country was being strangled by the Great Recession, and new industrial bank charters, and all other state banking charters, were put on hold. This state of affairs continues across the nation to this day, Pignanelli says.

But while the rest of the banking industry was mired in controversy during the Great Recession, Headlee says Utah's industrial banks were some of the strongest in the banking sector.

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One example of this was Lehman Brothers, which up until 2011, operated a Utah industrial bank called Woodlands Commercial bank. Even as Lehman Brothers went belly up, Woodlands slowly self-liquidated, inching down from a 2008 peak of $6.8 billion in assets to $1.6 billion before closing for good in 2011.

"Industrial banks are the safest and soundest institutions in the country. In terms of capital and everything else, they are safe and sound," Pignanelli says. "Lehman burned to the ground. What was the one asset left standing? Their industrial bank."

One industrial bank, though, did fail. Advanta Bank Corp.—which, at the time of its closing, had $1.5 billion in assets—was shuttered in 2009. The bank, located in Draper, issued credit cards to small businesses. Its closure cost the FDIC, and taxpayers, $635.6 million.

Even though Utah's industrial banks remained on relatively sturdy ground during the Great Recession, the state still saw shrinkage in the industry. Some of the state's largest industrial banks, including Goldman Sachs and Morgan Stanley, elected to shutter their industrial bank charters in favor of a national charter. This allowed these banks to more easily receive Troubled Asset Relief Program (TARP) funding.

"I think Walmart really put a blanket over the industry for a while," Sutton says, referring to the political dissonance the retailer sparked in Washington, D.C., which led to the moratoriums being placed on new industrial bank charters. "And then the recession came along, and that's the problem we've got right now."

An Attack From Washington
In the wake of the Great Recession, the federal government went to work trying to identify exactly what had occured in order to prevent it from happening again. These efforts were spun into the hulking Dodd-Frank Act, a 2,000-page document that implemented a wealth of new banking laws.

One of the laws that Pignanelli says nearly found its way into the document would have placed an outright prohibition on the charter, driving a stake through industrial banking's heart. Sutton was one of those lobbying on behalf of industrial banks. "We were able to head off all of the legislation that would have permanently eliminated the charter," he says.

Rather than kill industrial banking, the Dodd-Frank Act directed the Government Accountability Office to conduct a study on the banks, the exception they operate under and the strength of the regulatory system.

But instead of waiting around for the GAO study, Pignanelli says he urged Utah to conduct its own study to show just how sweet industrial banking is to the state's economy.

To accomplish this, Pignanelli's National Association of Industrial Bankers reached out to the Governor's Office of Economic Development (GOED), which lures business to Utah primarily by granting hundreds of millions of dollars in corporate tax breaks. In September 2009, the GOED board considered spending $100,000 of taxpayer money on a study, but balked. According to the minutes from the meeting, board members were concerned that they would toss public money away, only to have the federal government turn around and alter the laws anyway.

But five months later, the board took up the matter again, voting unanimously to give a $100,000 "economic opportunity" grant to the Economic Development Corporation of Utah to petition a study. At this meeting, board members heard first-hand from Louise Kelly, president of the Utah Association of Financial Services and president of EnerBank USA, about the impacts industrial banks have on the local economy.

According to minutes from the meeting, Kelly told the board that industrial banks provided 1,000 local jobs, some with salaries that reach $400,000.

The presentation, according to the minutes, was summed up this way: "If the ILC charter can be protected and expanded nationally, Utah will benefit. Utah has positioned itself as the leader of the ILC industry. Utah has a competitive advantage in securing a portion of the estimated $1 trillion in unused private capital due to our state's past experience with the industry."

This $100,000 was put to use, and in April 2011, the Milken Institute, a nonpartisan think tank in California, delivered a 169-page study that told the nation exactly what Utah wanted it to hear about its industrial banks.

"There is simply no evidence that the U.S. financial system and the economy would be on sounder footing if diversified firms were prohibited from owning ILCs, and this kind of empirical evidence should be required before acting on calls for change in the ILC industry (especially its abolition through repeal of the current exemptions for ILC owners ...)" the report concludes.

Pignanelli puts it this way: "We were able to use the study not only to deflect any negative things, but we were also able to use it to tell our story in Washington," he says. "Now we've gone from playing defense. We're now playing offense."

Community Benefits
Like commercial banks, industrial banks must contribute the equivalent of 1 percent of their total assets to the Community Reinvestment Act, which pumps some of that money back into the communities where the banks are based.

Over the years, Pignanelli says, industrial banks have given vast sums of money to Utah's nonprofit community, primarily through investments in affordable-housing projects.

The Community Development Corporation of Utah is one of the recipients of industrial banking money. Darin Brush, the CDC's executive director, says that over the past decade the CDC has built or remodeled 300 single-family homes, nearly all of which have been touched by money from the industrial banking sector.

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In addition to outright grants from industrial banks, which Brush says total hundreds of thousands of dollars, CDC receives low-interest loans from various industrial banks, including a revolving $15 million line of credit.

"I've got to tell you," Brush says. "We couldn't do our work without them. We just couldn't."

Kathy Ricci, executive director of the Utah Microenterprise Loan Fund, tells a similar story. In the past two decades, her organization has given more than 800 loans to small-business owners that, because of bad credit or other circumstances, wouldn't qualify for regular bank loans.

Although Ricci says she receives funding from Salt Lake City and Salt Lake County, the majority of the $13 million in loans she's divvied out have been contributed by banks.

"If it were not for CRA, I doubt that we would exist," Ricci says. "And that would be 800-plus businesses that would not have gotten start-up or growth funding, many of which are still out there doing business and hiring people. Utah is actually very lucky to have the industrial banks."

Banks, Ricci says, have significant leeway in how to allocate CRA funds, and are also bound by strict federal guidelines. As a result, quantifying and tracing the dollars into local arteries is an opaque process. But looking at each of the banks individually provides a picture of how much money is flowing into the communities that host these banks.

Julie Buchholz, GE Capital Bank's CRA officer, said through a spokesperson that GE would contribute more than $100 million in loans, investments, grants and technical assistance to Utahns in 2015. Between 2009 and 2014, Buchholz says GE issued $156.9 million in community-redevelopment loans, gave $2.6 million in grants and invested $165.1 million in securities and funds targeting in Utah.

In January 2014, Buchholz says GE gave the CDC a $2 million revolving line of credit, which she says has provided housing for 15 families.

But more than anything, industrial banks offer their services nationwide, exporting credit and Utah's unique banking laws to other states.

A bank's assets are primarily its loans, and its liabilities are deposits. This means that Utah is home to $143 billion in consumer loans and credit-card debt.

That Restoration Hardware credit card you maxed out last Christmas buying ornate candle holders for your cousins, and the Ann Taylor, J-Jill and Pier 1 Imports cards that fatten your wallet are all made possible by Comenity Capital Bank, located at 2855 E. Cottonwood Parkway, Suite 100.

That metered postage on the bills you receive in the mail was probably printed by a postage machine made by Pitney Bowes, which, thanks to Utah's industrial bank charter, offers postage on credit (City Weekly's credit account with Pitney Bowes is assessed at a 22-percent interest charge).

And that time you visited New York City and took a yellow cab? Well, chances are, the driver took out a substantial loan from Medallion Bank just to be able to drive you to the bar.

"They're chartered in Utah. Their assets are parked here, but they're serving millions of Americans elsewhere," Pignanelli says. "It's a great economic model for Utah."

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