A federal appeals court ruled yesterday that banking companies can issue commercial paper for clients, opening the way for banks to compete with stockbrokers in the lucrative financing of short-term business loans.
In a 2-to-1 decision, the Court of Appeals for the District of Columbia overturned a lower court's ruling that Bankers Trust Co. of New York could not sell commercial paper because such sales violate federal laws separating the securities and the banking businesses.
A spokesman for the Securities Industry Association -- the trade organization for brokers -- said that it expects to ask the entire nine-judge court to review the issue because the decision was split.
Commercial paper essentially is a corporate IOU, a promissory note sold by companies to raise cash generally for periods of from 30 to 90 days. Corporations raise much of their short-term cash in the commercial paper market because interest rates are usually lower than what banks charge them.
The appeals court ruled that the commercial paper sold by Bankers Trust is not a security and therefore not covered by federal securities laws. The court said that, because Bankers Trust does not underwrite the sales in the conventional way (by buying the paper from the client and then re-selling it to others), its activities do not violate the law.
Financial companies -- such as banks and auto finance firms like General Motors Acceptance Corp. -- have been major issuers of commercial paper for years, but nonfinancial companies have become major issuers during the last few years. According to the Federal Reserve Board, nonfinancial businesses had nearly $60 billion of commercial paper outstanding at the end of September.
Some banks and big issuers such as GMAC sell their own commercial paper directly to purchasers, but many other companies sell paper through dealers, who charge a fee for their service.
A.G. Becker, which brought suit against the Federal Reserve Board over the Bankers Trust operation, is one of the biggest underwriters of commercial paper.
If yesterday's decision is upheld, a number of other bank holding companies are prepared to start selling commercial paper for clients, industry sources said. The companies that own Citibank, Morgan Guaranty and Bank of America reportedly have mapped out strategies to enter the commercial paper market.
"If the banks come in, it won't increase the amount of commercial paper issued, but it will increase competition and probably lower the profits brokerage firms now earn by selling commercial paper for clients," said one industry source.
Banks long have complained that brokers have been permitted to enter the banking industry but that bankers can't enter the securities industry. If the decision stands, the rush of banks into a domain once clearly defined as brokerage business will represent one further erosion of the once seemingly sacrosanct division between commercial banking and the securities business.