Senate Banking, Housing and Urban Affairs Committee


Hearing on H.R.10 - "The Financial Services Act of 1998"
(Second Hearing in a Series)

Prepared Testimony of Mr. William A. Fitzgerald
Chairman and CEO
Commercial Federal Bank

9:30 a.m., Thursday, June 18, 1998

I am William A. Fitzgerald, chairman and CEO of Commercial Federal Bank of Omaha, Nebraska. Commercial Federal is an $8.9 billion asset institution headquartered in Nebraska, with operations in Arizona, Colorado, Iowa, Kansas, Minnesota, Missouri, and Oklahoma. I also serve as second vice chairman of America's Community Bankers. I am here today to present the association's views on financial modernization and H.R. 10. ACB is the national trade association for 2,000 savings and community financial institutions and related business firms. The industry has more than $1 trillion in assets, 253,000 employees and 14,500 offices. ACB members have diverse business strategies based on consumer financial services, housing finance, and community development.

As a progressive voice for more competitive banking and financial services, ACB seeks to preserve the flexibility of the thrift charter and holding company structure, while improving the bank charter. This will provide maximum choice for all financial firms, enabling them to adapt to the needs of their customers and communities.

The Changing Role of Banking

The share of consumer assets that banks and thrifts hold has decreased over the years. In the past, consumers typically did a vast majority of their financial business with banks and thrifts. They now use a wider variety of financial services, including insurance and securities products and mutual funds, to meet many of their day to day and long-term financial needs. At the same time, many securities and insurance firms offer almost every banking product, one way or another.

Despite these changes, consumers, homebuyers, students, and small businesses still rely, to a great extent, on depository institutions to meet their credit needs and as a secure place to keep their savings. However, the ability of banks and thrifts to provide these essential services is weakened by the legal restrictions on their ability to offer the full range of financial products that their customers demand. This is especially troubling, because now that the era of big government is over, our reliance on the private sector to provide affordable credit is key to economic growth and vitality.

Banks and thrifts are a crucial source of credit for economic development purposes, providing loans to business, state and local government, and consumers. If banks and thrifts are weakened by competitive inequities, they will be less able to play their vital role in private-sector economic development. While true financial modernization legislation would strengthen the banks and thrifts, its ultimate purpose is not to bolster any particular financial sector, but to ensure that all parts of the economy have access to the credit, investment, and deposit services they need.

Competing Industries or Different Business Options?

ACB believes that the public interest would be best served if all financial firms had the choice to include in their corporate family firms that offer the services of a bank, thrift, insurance company, securities firm, or mutual fund. Such ability to choose would improve competitiveness and increase the public's access to financial services.

H.R. 10 takes a fundamentally mistaken approach to financial modernization. Rather than seeking to improve the public's access to financial services, it seeks to mediate among various sectors. Policy makers should recognize that we are moving toward an integrated financial industry with a variety of options that can be offered by all financial firms. For example, the thrift charter ­ with its focus on consumer and home finance ­ is available for use in a wide variety of business structures. Hundreds of thrifts are in the mutual form of organization, while many have converted to stock form. Some are owned by diversified financial firms, and others by bank holding companies. A small number of commercial firms have thrift affiliates within unitary holding companies. Finally, hundreds of stock thrifts operate in non-diversified unitary holding companies.

Mutual funds provide a similar example. In recent years all types of financial firms, including banks, have become involved in the mutual fund sector. It is neither a question of a bank or insurer "getting into" the mutual fund business, nor one of a mutual fund "getting into banking" or "getting into insurance." Mutual funds, like thrifts, are simply another business option available to any firm that believes it can best serve its customers' financial needs by offering mutual funds.

This approach would leave ample room for functional regulation. Thrifts and mutual funds provide good examples of how this already works. The thrift regulator supervises the thrift and ensures it meets its responsibilities as a thrift, regardless of its other affiliations. Similarly, virtually any firm may provide mutual fund services, as long as the mutual fund meets its statutory and regulatory requirements.

Another section of our testimony includes our views on specific provisions in H.R. 10. However, even if these provisions are improved, ACB believes that the bill's approach is fundamentally flawed. Unless Congress recognizes that it is dealing with one industry ­ the financial industry ­ rather than a series of competing industries that need to be protected from one another, it will assume the role of referee. Instead, Congress should set the rules of the road and allow the marketplace ­ with appropriate safety and soundness requirements and investor protections ­ to determine the services each firm can offer.

ACB had hoped that the Alliance for Financial Modernization ­ which we helped organize ­ would advance proposals consistent with these principles. The Alliance included representatives from virtually every financial sector. While we shared a vision of financial modernization, we ­ like the House of Representatives ­ were unable to reconcile conflicting agendas.

Improving the Bank and Thrift Charters

A linchpin of a modernized financial industry would be improved and more flexible banking and thrift charters. Banks and thrifts must continue to be the primary providers of credit and deposit services to consumers and businesses. To strengthen this role, banks and thrifts need to be able to offer the full range of financial services at any level. H.R. 10 deals with part of this issue by proposing a very broad definition of financial activities that are permissible for financial holding companies.

Expanded holding company authority is helpful, but many institutions ­ particularly smaller ones ­ will find it more economical and efficient to pursue new activities within the depository institution itself or through separately capitalized subsidiaries. They should be able to offer a full range of financial services either in the depository institution itself, through a subsidiary, or through a holding company affiliate based on their business judgment and particular needs. Corporate separation, if needed, can be achieved as effectively using the bank-subsidiary model as with the holding company format. The rules of capitalization and their enforcement ­ not the formal structure ­ are the key factors.

Applying H.R. 10's flexible definition of "financial" to all corporate levels would deal with a number of deficiencies in the current bank and thrift charters and holding company structures, such as:

Bank holding company acquisitions of securities firms are subject to arbitrary limits under the Federal Reserve's section 20 rulings (though those limits have been substantially liberalized);

National banks may sell insurance virtually anywhere, but must do it through an agency located in a place of 5,000 or lesser population;

Bank holding companies may not acquire an insurance underwriter;

The OCC's Part 5 ­ which has the potential to permit a broad range of financial activities in bank subsidiaries ­ will undoubtedly be challenged in lengthy litigation as it is fully implemented; and,

Thrifts may sell insurance only through service corporations or holding company affiliates.

Unitary Thrift Holding Companies and the Thrift Charter

Some are claiming that the ability of thrifts to affiliate with non-bank firms through the unitary thrift holding company is some kind of new "loophole." This is wrong. In 1967 the Savings and Loan Holding Company Amendments continued the long-standing policy permitting a unitary thrift holding company (a company with a single thrift) to engage in any activity that was not detrimental to the thrift's safety and soundness. In contrast, the 1970 Bank Holding Company Act Amendments limited banks to affiliations with firms closely related to banking.

H.R. 10 continues to distinguish between affiliations permitted for banks and thrifts. It requires financial holding companies (FHCs) that own banks to divest their commercial activities. In contrast, unitary thrift holding companies in existence or applied for by March 31, 1998 may retain all their existing activities and add other non-financial activities. (Unfortunately, newly formed thrift holding companies are restricted to activities permitted under today's version of the Bank Holding Company Act; it denies them both the broad affiliation rights available to unitary thrifts and the financial affiliation rights available to FHCs. This issue is discussed in more detail in another section of this testimony.)

Critics of the unitary thrift holding company structure complain that it is an unfair competitor. This is misguided. The bank and thrift charters and their holding companies each have their own strengths and weaknesses. Banking firms enjoy unlimited commercial lending authority and are well suited to conducting overseas business. The thrift charter is well suited to housing and consumer lending; the Qualified Thrift Lender test requires thrifts to devote 65 percent of their assets to home mortgages, consumer, and education lending. In addition, thrifts' commercial loan authority is limited to 10 percent of assets, with an additional 10 percent available to small businesses only. No thrifts operate foreign branches or do foreign lending. The thrift charter is an excellent consumer banking platform, not an unfettered mixture of banking and commerce.

Most significantly, complaints about "unfair competition" ignore the fact that any bank may own and operate a thrift or convert to a thrift charter. Similarly, a thrift may convert to a banking charter. So, any institution may shift charters if it believes that is necessary to be competitive.

While there is increasing interest in the thrift charter, there is no unseemly rush to charter thrifts and thrift holding companies. Office of Thrift Supervision (OTS) Director Seidman has noted that, "The number [of thrifts] leaving OTS jurisdiction still surpass those coming under our supervision." (Speech before the Exchequer Club, January 21, 1998) And, the OTS is closely scrutinizing applications from major firms, such as insurance companies, to ensure that the thrift will be operated safely, soundly, and with full regard to Community Reinvestment Act responsibilities.

Interestingly, most of the major firms that have recently applied for thrift charters are primarily devoted to financial services. H.R. 10 itself would permit any financial firm to affiliate with full service commercial banks. Even commercial applicants ­ e.g. GE Capital and Ford ­ are seeking to convert banks or financial firms they already own into thrifts.

In any case, ACB believes that the danger of mixing banking and commerce is overstated. However, those who have such concerns with respect to banks should not have the same concern about providing thrifts with more flexible affiliation options. While banks and thrifts have many common features ­ deposit insurance, capital requirements, and strict safety and soundness regulation, to name three ­ clear differences remain. Banks enjoy unlimited commercial lending authority, which raises concerns that ­ if affiliated with commercial firms ­ those banks could misuse that authority. In contrast, thrift's commercial lending authority is strictly limited, as indicated earlier. Further, thrifts must meet a qualified thrift lender test that requires them to devote a substantial share of their assets to home mortgages, consumer loans, or student loans. As OTS Director Seidman has pointed out in a recent interview, "having a depository institution where only 10% of the assets can be in unrestricted commercial loans ­ and anything more up to 20% must be in small business loans ­ is not exactly how you create a keiretsu." (USBanker, March, 1998, p. 42)

Given these differences between the asset powers of banks and thrifts, Congress should reaffirm holding companies' competitive choice: if you wish to maintain a substantial commitment to your commercial business, you may only affiliate with a thrift and you must maintain its commitment to housing and consumer lending. You must also abide by its limitation on commercial loans. On the other hand, if a bank's commercial lending authority is critical to your business plan, then your commercial affiliations must be limited. This presents firms with a trade off between two desirable business options rather than a one-size-fits-all government dictate.

Congress should not be misled by fear mongering claims that unitary thrift holding companies pose any special risks. According to Treasury Undersecretary John Hawke, "there is no history of problems attributable to the unitary holding company format." (Speech before the Association of American Law Schools, January 8, 1998). OTS Director Seidman made a similar point just two weeks later regarding commercial affiliations, saying that, "So far, our experience with the relationship between a commercial or major financial entity and a subsidiary or affiliated thrift has been good, and devoid of any serious problems," (Speech before the Exchequer Club, January 21, 1998). Nevertheless, in recent testimony Director Seidman indicated that the OTS will examine whether the agency should increase is regulatory oversight of these holding companies to supplement its careful supervision of all transactions between thrifts and their holding companies.

Of course, regardless of the type of holding company regulation, all depository institutions must adhere to the same statutory capital, prompt corrective action, regulatory restrictions, and supervisory standards. Bank and thrift regulators must ensure that activity at the holding company level will not increase risk to the depository institution or to the FDIC.

Dual Banking & Dual Chartering ­ Increasing Market Choice

The thrift industry strongly supports the system of dual chartering, providing for both state and federal chartering of banks and thrifts. It leads to a creative tension between state and national chartering authorities, which is the primary value of the dual banking system. ACB sees a similar value in the creative tension between the banking and thrift charters, one that is adding to business and consumer choice.

One element of that creative tension is the ability of diverse companies to affiliate with thrifts. Most recent thrift applications by these companies have been for federally chartered institutions. However, a state-chartered savings bank may also become a "unitary" if it agrees to meet the qualified thrift lender test under the Home Owners' Loan Act. As a result, thrift holding companies for state-chartered savings banks may also expand into diverse businesses.

While there has been a recent spate of interest in federal thrift charters, hundreds of federal thrifts have converted to state charters since 1989. Many were responding to state-initiated improvements in banking charters. States have enacted modernized savings bank laws, improved existing state charters, or provided parity among all state charter types.

Last year, Maine provided the latest example of an improved banking charter available to all depository institutions in the state. Maine's commercial banks and thrifts now operate under a universal bank charter that permits them to engage in the full range of financial activity, providing the tools that enable them to compete in a dynamic banking environment. In addition, Maine's depository institutions may affiliate with any firm, though this flexibility is still limited by federal restrictions.

Michigan took another approach in 1995, creating a state savings bank charter. The charter was designed to give Michigan's thrift industry ­ all federally chartered at the time ­ a state option that would allow them to maintain their home lending focus. Other states have taken similar approaches to improve the flexibility of their charters.

As discussed elsewhere in this testimony, the federal thrift charter has its own unique strengths. For example, it is particularly attractive to institutions seeking to operate in more than one state. In 1978, the Supreme Court determined that the Federal thrift regulator could establish uniform nationwide rules governing the sale of financial products by federal thrifts. The OTS and its predecessor have used this authority primarily to enable thrifts to offer traditional loan and deposit products under uniform federal standards. All thrifts, not just those in unitary holding companies, use these standards to offer products economically to millions of consumers.

Thrift regulators have used their preemption authority judiciously. For example, though federal law explicitly permits thrifts to sell insurance, the OTS has not sought to preempt state laws that prevent federal thrifts from using that authority; subsidiaries of Federal thrifts must be separately capitalized and meet state licensing requirements.

The Office of Comptroller of the Currency (OCC) has continuously sought ways to make national banks more competitive. The OCC's new Part 5 rule ­ permitting national bank subsidiaries to offer new services ­ is just one of a decades' long line of decisions designed to make national banks more competitive. In a string of four 9-0 decisions the Supreme Court has supported the OCC's rulings. Despite these improvements in the national charter, thousands of commercial banks have remained state-chartered.

In summary, every chartering authority ­ the Office of Thrift Supervision, the Comptroller of the Currency, and each state ­ is working to ensure that their institutions can meet consumer and business needs in an increasingly competitive marketplace. Despite the inevitable differences among the charters, all FDIC-insured depository institutions ­ savings associations, savings banks, and commercial banks ­ must meet the same strict capital and supervisory standards. In both 1989 and 1991, Congress removed much of the regulators' discretion that had permitted some institutions to remain open after their capital fell to dangerously low levels. Under prompt corrective action requirements, a regulator must impose increasingly strict requirements for undercapitalized institutions and must close institutions if they fall below two percent capital. This ensures that stockholders, not depositors or the FDIC, will bear most or all of the risk of failure. The differences among charters, tempered by strict safety and soundness requirements, allow for improved services to customers and communities under safe and sound conditions and keep the nation's financial system diverse and competitive in every market.

The Thrift Charter in Action

The thrift industry remains a critical component of housing finance. According to the Office of Thrift Supervision, thrifts originated more than $59 billion in single-family mortgages during the first quarter of 1998, more than double the $28 billion in the first quarter of 1997. (OTS Press Release, June 3, 1998) And, the industry devotes more of its capital to housing finance than does the banking industry. Every $1.00 of thrift capital supports $6.05 in home mortgages, plus an additional $2.06 in mortgage originations held by investors. By contrast, every $1.00 at a commercial bank supports $1.72 in home mortgages and just 54 cents in mortgage originations. (OTS & FDIC Call Reports) The OTS has found that the home lending commitment of thrifts extends across the industry. For example, thrifts owned by firms engaged in non-banking activities hold "more of their assets in mortgage loans and related securities ­ 73.7 percent ­ than the thrift industry average ­ 70.6 percent." (OTS Background Paper, Holding Companies in the Thrift Industry, January, 1998; emphasis added) Banks have only 32.6 percent of their assets in mortgage loans and related securities.

Real Estate Development

Thrifts' real estate activities are not confined to housing loans. Through their service corporations, they also develop real estate, including acquiring property and constructing homes and commercial buildings. For example, Financial Federal Trust & Savings Bank of Olympia Fields, Illinois ­ through its real estate development subsidiary, Financial Properties -- renews middle-income housing in mature Midwestern communities. That renewal strengthens the tax base, revitalizes the home building sector, and gives new hope to those who aspire to own their own homes.

In another instance, a $70 million Texas institution, Dalhart Federal S&L Association, has been prudently developing real estate since 1971 ­ and survived the Southwest real estate collapse of the mid-1980s. Although a small institution, Dalhart Federal has constructed and sold a number of new single-family homes ­ recently averaging about 10 each year ­ providing clear benefits to its rural community.

To address any concerns that might arise concerning the safety of real estate development, Congress acted in 1989 to require that all real estate development activities be conducted in a separately capitalized service corporation. The service corporation capital must be deducted from that of the savings association, no more than three percent of assets can be reinvested in the service corporation, and at least one percent must be used for community development activities.

Insurance & Investments

The thrift industry offers insurance services, both through their service corporations and through holding company affiliates. A savings association in Montana kept open the only independent insurance agency in town by using its service corporation authority. If that institution had not stepped in, the agency would likely have had to close.

In Virginia, Acacia Federal Savings Bank and its holding company, the Acacia Group, is developing the concept of full service customer delivery by combining lending, insurance, and investment services. Similarly, Chesterfield Savings of Chicago has been offering investment and annuity products for many years.

Savings banks in Connecticut, Massachusetts, and New York provide low-cost savings bank life insurance to their customers. Some 1,112,000 policy holders benefit from this convenient and valuable service.

Trust Services

Several financial firms have sought thrift charters to enable them to offer trust services to their securities and insurance customers. A major retail securities firm, Edward Jones, plans to offer the trust services of Boone National S&L Association throughout its network of over 4,000 offices. Many more traditional thrifts have been offering trust services for a number of years.

Bank Holding Companies

Bank holding companies of all sizes recognize the value of the thrift charter. For years, Citicorp has conducted all of its retail banking operations outside New York through its thrift, Citibank, FSB. Citicorp calls the federal thrift charter "the premier legal vehicle for extending consumer and mortgage credit on a multistate or nationwide basis." Treasury Undersecretary Hawke agrees, saying earlier this year that, "The federal thrift charter is fabulous.For anybody doing a nationwide consumer finance-type business, a federally chartered thrift is ideal." (emphasis added) Recently, the president and CEO of State Financial Services Corp. of Hales Corners, Wisconsin, Michael J. Falbo, explained why he plans to maintain a recent thrift acquisition as a separate affiliate, telling the American Banker newspaper that, "Adding a thrift charter provides us with a great deal of flexibility." (June 4, 1998) OTS statistics indicate that approximately 15 percent of federal savings associations operated within holding companies are in bank holding company structures.

The Strength of the Thrift Charter

The most recent OTS report on thrift earnings demonstrates that the savings industry remains a major force in the financial services sector and a bulwark of housing finance. The nation's 1,195 OTS-supervised thrifts earned $1.87 billion in the first quarter of this year (a first quarter record and the second highest in industry history). The industry's capital increased to a record 8.40 percent. Upon releasing these figures, OTS Director Seidman said that, "The industry's underlying strength, especially its high capital levels, puts it in a good position to respond effectively to future changes in the business climate." (OTS Press Release, June 3, 1998)

Every segment of the thrift industry shares in its robust condition. According to the OTS press release, "All but one of the 1,195 OTS-supervised thrifts met or exceeded minimum capital requirements, and 1,116, or 98 percent, were in the highest capital category ­ well capitalized ­ at the end of March."

Similarly, the thrifts' primary insurance fund, the FDIC's Savings Association Insurance Fund (SAIF), is in a very strong position. The strength and flexibility of the thrift charter helped make it possible for the industry to make a special payment of $4.5 billion (equal to nearly a year's earnings) into the SAIF in the fall of 1996, bringing the fund to the statutory target of 1.25 percent of insured deposits. By December 31, 1998, the FDIC projects that SAIF could hold an amount equal to 1.45 percent of insured deposits ­ well above its statutory requirement.

While SAIF and its commercial bank counterpart, the Bank Insurance Fund, are both at or near historically high levels, independent studies have shown that a combined fund would be stronger than either standing alone. ACB strongly recommends that the funds be merged, regardless of the outcome of the financial modernization legislation. But let me be perfectly clear, the thrift industry will not agree to reduce the strength and flexibility of its charter and holding company structure in exchange for a merger of the funds.





Comments on H.R. 10

The following are ACB's specific comments on H.R. 10 as it passed the House:

Thrifts

Before it passed H.R. 10, the full House wisely struck committee language that would have eliminated the thrift charter ­ provisions that had barely survived a motion to strike in the Banking Committee. Even so, the remaining thrift holding company provisions do unjustified damage to firms that have not yet formed holding companies, while stigmatizing those that applied before an arbitrary cutoff date.

Under the adopted version of H.R. 10, unitary thrifts applied for after March 31 could not use their full existing affiliation rights. In fact, these new holding companies may not even use the financial holding company powers granted under the bill's new section 6 of the Bank Holding Company Act. Instead, they are generally relegated to the "closely related to banking" powers under the old section 4(c) of that Act. ACB urges the Senate to strike the thrift holding company restrictions in H.R. 10 completely. However, the anomaly created for new thrift holding companies should, at a minimum, be corrected by clarifying that thrift holding companies may use all the financial powers that H.R. 10 would grant to bank holding companies.

As indicated, H.R. 10 is particularly unfair to firms that have not formed holding companies, while appearing to give an advantage to those who have. This freezes a dynamic sector of the financial industry at a single point in time ­ March 31, 1998 ­ ignoring the rapid changes the industry is experiencing. Today, about 140 new unitary holding companies are formed every year, and a like number are dissolved. Even though over 800 unitary holding companies exist today, they must be allowed to change and restructure as required by the dynamics of the marketplace.

Limitations on the entry of new thrift holding companies are unsound public policy and are a significant step backward for companies that might form thrift holding companies in the future. Not only do they lose the potential for unitary affiliations, they are not even provided the financial holding company powers that the bill grants to bank holding companies.

It would be far better for Congress to simply leave the full unitary holding company option in place for those companies that chose to qualify for it by maintaining the requisite housing and consumer lending commitment.

FHLBank System

While H.R. 10 contains many flaws that prevent it from being true financial modernization, Title I, subtitle G provides a very positive basis for modernizing the Federal Home Loan Bank system. These provisions will benefit commercial banks and thrifts, as well as depository institutions that are small community based lenders. Although there has been some disagreement about a few of the sections, such as investment authority, the subtitle does include vital elements that must be a part of any FHLBank system legislation considered: equalized membership rules and a capital structure flexibly set within a risk-based framework. S. 1423, a bill that this committee held hearings on, also addresses these important issues and addresses most of the concerns raised with the FHLBank system provisions in H.R. 10.

Commercial & Savings Banks

The OCC has identified a number of areas where H.R. 10 scales back national banks' insurance powers or significantly restricts how national banks may sell insurance. These cutbacks and restrictions could have severe effects on state-chartered banks that operate under parity statutes.

H.R. 10 places severe limitations on the activities of national bank subsidiaries under the OCC's Part 5 regulation. This regulation permits national banks to apply to offer through a subsidiary new financial products incidental to banking. H.R. 10 would limit subsidiaries to agency activities, such as insurance and securities sales. That would deny financial firms the flexibility to offer many new financial products, such as insurance and securities underwriting, through the corporate structure that is often the most efficient and effective for them and their customers. This is a dramatic step away from financial modernization.

Non-bank firms

Unfortunately, the House voted to eliminate the commercial activities basket for new financial holding companies. This provision was important to many primarily financial firms that engage in a limited amount of non-financial activities. The loss of this flexibility makes the continuation of the full unitary thrift affiliation powers that much more important.

These provisions ­ the elimination of new unitary thrift affiliation authority, the failure to extend financial holding company authority to thrifts, the cutback on national bank insurance and operating subsidiary authority, and the elimination of the modest commercial basket ­ all show how H.R. 10 still fails to meet the true test of modernization. In too many cases, each half-step forward is accompanied by two steps backward.

Risk to Public Companies

The financial holding company provisions pose particular concerns to publicly held companies. Each depository institutions affiliated with FHCs must:

The Federal Reserve may order divestiture of the new FHC activities if an affiliated depository institution fails to meet any of these requirements. While each of these requirements have positive features, whether a given institution meets all of them is subject to interpretation by individual examiners. And, the requirement to offer low-cost basic banking accounts is entirely new. Congress should be careful to avoid some of the experiences under the Community Reinvestment Act ­ a seemingly simple statute ­ which led to significant compliance costs.

Conclusion

True financial modernization legislation would strengthen private sector mechanisms that provide credit and other critical financial services. It would expand, not reduce, choices for financial firms by improving the bank charter, while maintaining the thrift charter and holding company structure as an option for firms that wish to pursue a housing and consumer focus. Unfortunately, the House-passed version of H.R. 10 fails to meet that test. It is too focused on dividing turf among competing financial industry segments, rather than permitting firms to use all the tools available to best serve their customers and communities. The Senate can do better.


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