TRUST, BROKERAGE
AND BUILDING A FEE-BASED BUSINESS
Feature Article
Andrew Singer

ONE OF THE GREAT "mysteries of the universe" is how to integrate brokerage and trust, says Tom Walker, CEO of Members Trust Company, FSB (Tampa, FL). "If you don't do it correctly, you will build silos."

There are many different 'interest groups' within a financial institution—all clamoring for attention when it comes to brokerage and trust: sales reps, the bank, the broker/dealer unit, and the customer.

But "the primary interest needs to be what's in the best interest of the client," says Walker, whose firm wholesales trust services to institutions, primarily credit unions. "The interests of the staff should be last." It helps, too, if a single management team runs both trust and brokerage, he said, speaking at BISA's Community & Regional Bank Forum, held September 8-11, 2007, in St. Louis.

According to Walker, "What doesn't work is if you say, 'Anything more than $250,000 goes to trust,'" or some other arbitrary numerical cutoff. It is better to match the client with the staff person who is best able to help that individual.

Members Trust Company has been in business for about three and a half years, and has 22 trust officers and $500 million in assets under management (AUM). "It is very expensive to do it yourself," he says, referring to small institutions looking to offer trust services.

'Trust is not cheap'

Walker was speaking at one of the conference's breakout sessions, "Providing Trust and Wealth Management Services Through Your Investment Program." Bob McKinney, another speaker at the session, agreed that it can be difficult for a small institution to offer trust services on its own. McKinney is senior vice president of RCB Bank (Claremore, OK), a $1.2 billion institution (assets) that has some $340 million in assets under management, most of it in corporate trust.

"Trust is not cheap" for a bank to implement, said McKinney. It requires staff. "We almost closed our personal trust" division because of the costs.

RCB's answer? Outsource trust. It uses ING Trust, which has some $25 billion in assets under administration. ING Trust "has a wealth of people," says McKinney.

When a potential trust client comes to RCB, the bank expects them to have at least $500,000 in investable assets. But that isn't always the case. "Sometimes you don't know what they have," says McKinney. If, after an interview, the bank rep determines that the client is, indeed, a trust prospect, they refer that client to ING Trust.

RCB Bank has a number of wealthy clients who do not have much in the way of investable assets. Some own ranches. One client, for instance, has a ranch of several thousand acres and many head of cattle. He doesn't have investable assets—but he has land. He also has an adopted son and wants the ranch to continue after his death. He is a prime trust candidate. "These trusts can be $7 million, $8 million," notes McKinney.

With such clients, McKinney's six reps begin the conversation by talking about wealth management—not trust. "The fiduciary part comes later on. We edge them into it." (Many clients don't know much about trusts; indeed, they're sometimes afraid that they'll be signing away their assets if they form a trust.)

One of the great 'mysteries of the universe' is how to integrate brokerage and trust.

—Tom Walker, Members Trust Company

What about trust fees? At Members Trust, client fees are typically between 1.50 percent and 1.75 percent (about 50 to 75 basis points for trust administration, the balance for investment management, he says). McKinney reports something similar. The typical annual fee to the client is between 1.25 percent and 1.50 percent.

Forty to 50 percent of Member Trust's gross revenues go back to the referring credit union, says Walker.

A myth

One prevalent myth regarding trusts, according to Catherine M. Bonneau, president of PrimeVest Financial (St. Cloud, MN), who moderated the conference session, is that "Only the super rich need a corporate trustee."

In recent years, there has been a general decline in estate tax returns, but a dramatic increase in trust tax returns.

How so? "People are still looking to preserve control," says Bonneau. They may have troubled children or "financially challenged" children; there may be divorces or other family problems.

Often, a child is named trustee of an estate, but after a relatively short period of time, the son/daughter trustee says, "I don't want to do this anymore. I want to enjoy family Thanksgiving dinners. I don't want to tell my sister that she can't do this because Mom and Dad said she couldn't," Bonneau recounts. The trustee doesn't want to be filing fiduciary tax returns.

Increasingly, the two core trust activities—administration and investment management—are uncoupled these days. Banks traditionally gave away trust administration and made their money in investment management, notes Bonneau. But with "open architecture"—and more banks outsourcing investment management—that value proposition has changed. "There's a realization dawning that trust fees were undersold," she observes.

Indeed, trust services that are outsourced through the bank's brokerage unit may be the "wave of the future," opined one New York banker in the audience. His Long Island bank used to employ investment advisors for investment management, and lawyers and accountants for trust administration. But that proved too expensive. You can't make money that way, he said.

Building a fee-based business

The movement toward integration of brokerage and trust is closely allied to the emphasis on the part of banks of attracting more fee-based business. Investment reps today are acting more like advisors and consultants, and less like transaction-oriented stockbrokers. This was further explored at a BISA session entitled "Building a Fee-based Business."

Most RIA's sell for somewhere between four and size times adjusted cash flow, says Lally.

David P. Sprague, Eastern divisional vice president for Curian Capital, LLC (Denver), observed that most people think you will lose money in the first year when you convert to fee-based business. "Ninety-five percent of the time, that is not the case."

But that doesn't mean that it is necessarily easy to build a fee-based business. When Senior Financial Consultant David Jackson came to FirstMerit Investment Services (Twinsburg, OH) from Key Bank six years ago, he was generating only $900 per month in recurring business. He was selling primarily variable annuities.

Six years later, he is doing $125,000 in recurring income (annually).

Christopher DiMattio, senior manager at First National Community Bank (Dunmore, PA), a 20-branch bank, said he got into fee-based business "to get paid for what we were doing every day,"—that is, servicing the customer. Among his goals: He wanted to build his trail commissions (he tries to do more B shares than A shares), boost his 401(k) business, and develop more fee-based accounts, like those that Curian offers. He's now close to $200 million in assets under management. (He is one of INVEST Corporation's top reps.)

One myth about trusts: 'Only the super rich need a corporate trustee,'

—Catherine Bonneau, PrimeVest

DiMattio's bank does not have a trust department. But he had no qualms about going right to the top when it came to leads. "Have meetings with your top commercial lenders," he advises. They can help gather "collateral accounts (assets used as collateral for loans)," for instance. "That's the best place to start your fee-based business." A bank like First National will manage those collateral assets for one percent, versus the two percent that the wirehouse or local stockbroker often charges.

DiMattio doesn't charge his clients much—only 25 to 50 basis points per account, typically. He thinks that's only right "because I didn't get that client on my own." Many accounts are the result of bank referrals.

DiMattio has one full-time licensed person working for him, as well as a full-time administrative person. He places his larger accounts in the Curian product—accounts of $1 million or more, for instance; he charges those clients only 25 basis points, typically.

Fees are always a concern. DiMattio says that his "biggest" fear is that he will have his quarterly meeting with a client, and the customer will ask: "Why am I paying so much for this?"

He admits that his fees are "probably low." Still, "I'm competitive with just about everyone." With some other products, like ETFs (exchange traded funds)—which he uses a lot—he charges 50 basis points, typically.

Not for everyone

"Fee-based business isn't for everyone," says DiMattio. You have to really serve your clients.

FirstMerit Bank is the largest asset manager in the Akron, Ohio area. Jackson often gets accounts that FirstMerit's asset management group doesn't want to deal with because they are too small—those with $175,000, for instance. "A trust officer just doesn't want to deal with this."

That said, "a lot of registered reps don't want to buy into it," he observes. Of FirstMerit's 43 financial consultants, only eight or nine have sold a fee-based product, says Jackson. Many don't seem to be comfortable with such products. They also wonder whether they will be with the bank long enough to reap the rewards. "Am I even going to be here in two or three years?" They don't want to leave business behind when they depart.

Jackson typically charges his clients 115 basis points. He crafts the portfolios himself, often using America Funds A shares, among other products. When Jackson started, (as noted) his best month was $900 in fee-based business. Now it's $24,000 per month. It took him more than three years to build up his fee-based business.

Support from senior management is crucial if bank reps are going to sell fee-based products, says Jackson. The bank may need to fashion special compensation arrangements, such as advancing some compensation. "Otherwise, a lot of people won't do it."

When DiMattio began, "I set goals for myself. 'I want to bring in $10 million a year in fee-based business.'" He would encourage other reps to set goals, as well.

Acquiring RIAs

Admittedly, a fee-based business can take a long time to build. That is why many banks have opted for the acquisition route—purchasing independent registered investment advisory firms (RIAs).

Trust services that are outsourced through the bank's brokerage unit may be the 'save of the future,' opined one New York Banker in the audience.

Banks were responsible for half of all RIA acquisitions last year, says Paul Lally, President of Gladstone Associates, LLC (Conshocken, PA) and speaker at another BISA session on acquiring RIAs. With a problematic yield curve, it's been more difficult for banks to make money the traditional way—by making loans. Many have been looking for alternative sources of income.

There are some 19,500 financial advisor firms in the U.S., Lally says. Why are they looking to sell out to banks? More than half of all independent advisors are now over 50, and succession planning plays an increasingly prominent role in their thinking. Many have reached a glass ceiling in their careers. They're not likely to grow the business dramatically by themselves. "Succession planning is driving this," says Lally. (Indeed, in a recent survey, "independent reps rated the importance of the succession planning issue a 7.3 out of 10," with 10 being most important), notes Lally.

There are other factors, too. Credit is a big issue for many RIA clients. Banks, obviously, are well positioned to service these clients' credit needs.

That doesn't mean that banks are model acquirers, however. Sellers approach them—not the other way around. That's one reason that banks have a bad record when it comes to integrating RIA purchases—"they're reactive," says Lally.

Typically, "someone in the bank falls in love" with the target firm. But then, two years later, that executive has left the bank. So what happens to the acquisition?

That's why it's important to have the more-senior executives in the bank on board, noted James Quinlan, executive vice president for Beneficial Savings Bank (Philadelphia), another speaker at the session.

Of First Merit's 42 financial consultants, only eight or nine have sold a fee-based product, says Jackson. Many don't seem to be comfortable with such products.

There are key questions to consider prior to any acquisition, adds Quinlan. If a bank already has an investment product platform—Charles Schwab, say—how will it integrate that with the new RIA?

The number of suitable acquisition candidates may be lower than anticipated, too. A community bank in southeastern Pennsylvania may find only a handful of RIAs that fit its target profile, Quinlan observes.

What about valuation? Fee-based firms traditionally trade at about 2.1 times recurring revenues, notes Lally. But this is just a rule of thumb. In truth, valuation is more art than science, he adds. It's often more useful to look at adjusted cash flow when making such determinations. RIAs with $50 in AUM often trade at four times the adjusted cash flow. Firms with $100 million in AUM often trade at five times the adjusted cash flow.

Overall, most RIAs sell for somewhere between four and six times the adjusted cash flow, says Lally, who adds that adjusted cash flow is typically 40-60 percent of revenues at well-run firms.

A bank should expect to put 40 percent down in any deal, but no payout should extend longer than five years because of tax reasons. (Most deals require RIA principals to meet long-term incentive targets in order to realize the deal's full value.) Most acquisitions take between five to six months to complete, somewhat longer than is often assumed.

Valuation is obviously a critical element in the success equation. "Unrealistic valuation expectations are the number-one reason that deals don't work," says Lally. If the seller has unrealistic expectations, he advises banks to walk away from the deal.