Interest rate fluctuations, mergers and the rumored departure of the state’s longtime banking commissioner dominated the news in the first part of 2003, but according to banking industry professionals in the Bay State, the overall theme for the year was “fiscal crisis.”

Some might consider 2003 a year of battles. Internationally, the United States engaged in a war with Iraq and continued its fight against terrorism while here on the home front, financial services firms were besieged with corporate scandals and intensified the fight against identity theft and predatory lending practices.

In the past 12 months, interest rates fluctuated, refinancing activity skyrocketed then plummeted, and local banks battled real estate investment trust tax paybacks. And all the while the groundwork was being laid for the biggest bank merger in New England history.

While analysts and researchers tracked a slow and steady economic recovery in Massachusetts, bankers and mortgage professionals faced the highs and lows of a much more turbulent ride.

According to one banking insider, the single most threatening issue for the banking industry locally in 2003 was the Gov. Mitt Romney’s proposal to close a corporate tax loophole – and the state’s budget deficit – by seeking close to $150 million from banks that had set up REIT tax shelters, retroactive to 1999.

“The fiscal crisis facing the commonwealth was clearly the dominating issue for 2003,” said Kevin Kiley, executive vice president and chief operating officer for the Massachusetts Bankers Association. “From a banking perspective, we got into things early on with REITs, and we ended up having months of discussions and negotiations with the Department of Revenue that led to an amicable resolution for all banks with REITs.”

After negotiating a compromise, banks paid the Department of Revenue 50 percent of the amount assessed for the 2001 tax year, including interest, and 50 percent of the estimated amount that would have been owed for the 2002 tax year under legislation that was enacted in March 2003.

For the mortgage industry, the fluctuating interest rates kept lenders and brokers guessing. As low rates spurred resurgent refinancing boom in the first half of the year but gave way to higher rates and a renewed focus on purchase mortgages in the second half.

“In 2003, we [mortgage professionals] moved away from the refi business and had to concentrate on back to basics mortgage lending because the saturation in the refi market [created] a slowdown in the market,” said Kevin Cuff, executive director of the Massachusetts Mortgage Bankers Association. “Purchase markets, looking at emerging markets, immigrant markets and things of that nature have become more of a focal point instead of just taking orders from a [busy] refi market.”

The lesson of 2003, according to Cuff: “The refi market isn’t going to drive our industry any longer. The leaders in the industry … realize it’s time to get back to basics and concentrate on the things that got us here, and that’s not the refi boom.”

Kiley said that discussions surrounding funding issues dominated conversations in the state Legislature, but between debating the budget members of the Joint Committee on Banks and Banking heard their fair share of industry-related proposals.

Anti-predatory lending was a much-discussed topic among mortgage professionals and bankers when the Legislature discussed a proposal to make Community Reinvestment Act requirements obligatory for mortgage companies. While the debate around defining “predatory lending” and “subprime lending” is still ongoing, consumer activists and bankers remain in favor of imposing CRA regulations on mortgage companies, while members of the mortgage industry are fervently opposed to the proposed legislation. Now, industry players are in a wait-and-see mode as legislative resolution to the issue is not yet certain

“Predatory, subprime and CRA discussions are all status quo,” said Cuff. “[Mortgage professionals] knew it was coming, we prepared ourselves the best we could, and the Legislature doesn’t know how they want to proceed. That’s evident by them not taking any further [action].”

Identity theft continued to be acknowledged as a top threat to consumers, national lenders Fannie Mae and Freddie Mac came under investigation for fraud and eventually saw their top executives resign, USA Patriot Act legislation was enacted, and after serving almost two decades at the Massachusetts Division of Banks, the industry said goodbye to Commissioner Thomas J. Curry, and in December a new banking commissioner, Stephen L.Antonakes, was named. Curry was named as one of five directors at the Federal Deposit Insurance Corp.

Merge Ahead

But no event made as big an impact on the New England region as the arrival of national powerhouse Bank of America, which announced the acquisition of Boston-based FleetBoston Financial.

While Massachusetts witnessed over a dozen bank mergers during the year, the announcement of the Bank of America acquisition of Fleet was undoubtedly the newsmaker of 2003, heralding the first large-scale push of a national bank into the Northeast market.

The merger announcement on Oct. 27 gives North Carolina-based Bank of America the leading market position in Massachusetts, Rhode Island, Connecticut and New Jersey, as well as a powerful retail platform in New York City, upstate New York, New Hampshire and Maine, all part of Fleet’s banking footprint.

While Massachusetts’ consumers braced for the national conglomerate to enter the market, local banks and credit unions used the pending merger as an opportunity to stress local ties, woo merger-weary customers and increase growth.

“Citizens Bank has had a very good year. Despite challenging economic times, our market share is increasing,” said Thomas Hollister, president and chief executive officer of Citizens Bank Massachusetts, which also played a part in the year’s merger activity, acquiring Cambridgeport Bank and Community National Bank. “We are very pleased to be serving some additional communities that we did not serve before. The Bank of America merger is a significant event, but it makes Citizens Bank the largest local bank and we’ll continue to [impart] old-fashioned service and personal attention to the communities we serve.”

Citizens Bank was the first bank in Massachusetts to formally enhance the company’s military leave policy when the U.S. declared war with Iraq.

While the biggest merger in New England history caused consternation among community development groups, which expressed concern about the loss of a Boston-based giant in Fleet and asked for a local Community Reinvestment Act plan from Bank of America, was also viewed as a blessing for the credit union industry, according to Robert Kimmett, senior vice president of public relations and marketing at the Massachusetts Credit Union League.

“The mergers and the entrance of big banks in 2003 created opportunities for credit unions, and we are looking forward to more of those opportunities and serving more folks in the coming year,” said Kimmett. “We saw what a tremendous impact mergers had on the landscape in 2000, and it created enough turmoil in the marketplace that people became changeable. The big impact was this year’s merger, and now people know what to expect and how to change. 2003 was a year where credit unions were beginning to become more comfortable with their position in the marketplace because of consumer demands.”

Overall, industry experts say 2003 was a year of anticipation for signs of economic recovers punctuated by the ups of strong returns and the downs of negative attention focused on the financial services industry, especially in mutual funds. But banking leaders say banks have positioned themselves well to take advantage of any economic growth that may occur in 2004.

“The banking industry is healthy … bank earnings are driven by interest rates and the economy. Despite a difficult economy and shrinking margins due to interest rates, banks are still doing pretty well,” said Hollister. “I don’t think there is an end state to the banking industry [merger activity]. The customers have the power and if the bigger banks don’t work, the customers will go elsewhere and the customers have exercised their power to do so this year.”

According to Cuff, despite the slowdown in refinance activity the mortgage industry also is poised to benefit from a more productive economy in 2004.

“All trends indicate that the economy is improving and growing. Certainly, the real estate and mortgage market never slowed down from the economy we had in 2003,” said Cuff. “Unemployment never hit dramatic levels – the mortgage industry lost some players, but not in comparison to other industries. I think the mortgage and real estate industry have continued to drive the economy.”

But despite what will or won’t drive the economy back to positive performance levels, local banking industry executives said that the state’s budget woes were the No. 1 story of 2003 and will continue to be watched closely in the coming year.

“The Massachusetts fiscal crisis was the dominating issue of this year’s [legislative] session but it is important to note that Massachusetts was not unique in this situation, and all of us are starting to see a little light at the end of the tunnel,” said Kiley. “People feel the economy is starting to turn and we’re entering 2004 with an optimistic tone. The industry is strong, but we need the economy to bounce back and turn around.”