"We'll Take the Money Now": A Focus on Short-Term Results Has Kept Banks from Embracing Fee-Based Wrap and Separate-Accounts Business. (Securities Sales)

Banks have been slow to follow the shift of nonbank securities firms from traditional transaction business--selling stocks, bonds, mutual funds and annuities for sales commissions-to such fee-based business as mutual fund wrap accounts and separate account asset management services. According to the 2000 Report on Production and Earnings of Registered Representatives, recently released by the Securities Industry Association, fee-based business accounted for 20.1% of retail securities firms' revenue in 2000, up from 18.2% in 1999. Meanwhile, fee-based business accounted for just 0.8% of the typical bank investment services program's revenue, according to the 2000 Kehrer-Essex Bank Investment Program Benchmarking Study. While that was an improvement over the 1999 level of 0.6%, banks' fee-based business lags light years behind their regional broker/dealer and wire house competitors, as shown in Exhibit 1. And banks may actually be losing interest. This past year only 38% of the banks participating in the annual Kebrer Bank Investment & Insurance Services Compensation Study actively sold wrap mutual fund accounts, down from 43% in 2000 and 50% in 1999 (Exhibit 2). Many industry analysts join nonbank competitors in believing that traditional transaction business will continue to shrink, and that fee-based products offer the best platform to demonstrate the value of the advisor. Revenue today, not tomorrow We have identified three principal reasons why banks lag behind in capturing fee business. The first is the potential for shortfalls in short-term revenue and earnings as a broker shifts sales from up-front commission products to level load products. When a broker advises a customer to invest in a mutual fund wrap account or a separate account investment instead of a traditional mutual fund or annuity, the broker is foregoing a share (typically about a third) of the up-front sales compensation of 3.5 to 6%. The sales compensation on the fee-based product is typically Ito 1.5% a year. Thus the broker and the bank investment services unit both are conceptually cannibalizing some of this year's sales to build up an annuity over time. Depending on the pricing of the wrap account and the sales compensation on the traditional investment with up-front commissions, it takes three to five years before the cumulative asset-based income exceeds the foregone up-front income from traditional sales commissions. Beyond this breakeven level, the asset-based income in subsequent years is very attractive, both for i ts growing size and relative predictability. In many ways, it is a growing annuity for the bank, thc broker/dealer, and the broker. For its part, the bank tends to be pressing hard to achieve the current quarter's earnings, and keeps raising its earnings goal for its retail investment services unit. Sure, the bank likes the asset-based income in a pro forma of a mature wrap and separate accounts business, but it is a rare bank that can sacrifice short term revenue to get there. Bank management asks, Why should we bc building up an annuity for the bank that acquires us, if we don't meet our earnings numbers? Consequently, the bank tends not to encourage its broker/dealer to focus on fee-based business, and the broker/dealer in turn does not encourage the broker. The head of the bank's investment services unit asks, Why should I be building up an annuity for the person who will be sitting at this desk if I don't deliver my earnings targets? To be sure, some nonbank security firms that were pioneers in marketing fee-based investments had an advantage over banks and other firms that are now eyeing the business. The annual asset fees on the early products were much higher than they are today, often reaching 3%. The choice between 4% today and 2 or 3% a year for the life of the investment is not as difficult as 1 or 1. …