Do fee-based services have an edge? (June 2008)

NEXT MONTH'S MAGAZINE

Editorial content organized by topic

Sponsored content from industry partners

PRODUCT/CONTRACT ANNOUNCEMENTS
Latest offerings by category

JOB BOARD

Articles submitted by industry partners

DIGITAL EDITION ARCHIVE

Online Edition

Do fee-based services have an edge? (June 2008)

The markets tend to reward them with higher valuations than traditional banks. Two analysts explain what creates the edge.

By Bill Streeter, editor-in-chief, This e-mail address is being protected from spam bots, you need JavaScript enabled to view it

ABA WEALTH MANAGEMENT & TRUST CONFERENCE

Two analysts give views on what creates value in the world of trust and asset management

Baby boomers may be the best thing in years for some bank stock prices. At ABA’s Wealth Management and Trust Conference this spring, analyst Gerard Cassidy made the case that the market rewards fee-based banks—banks such as Bank of New York/Mellon that emphasize asset management, trust, custody, and other fiduciary services—with higher price/earnings multiples than traditional spread lenders.

Cassidy, bank analyst and managing director for RBC Capital Markets, explained how fee-based banks have latched onto the changing demographics particularly well. In a nutshell, as baby boomers move into their 60s in enormous numbers, the wealth they have amassed or inherited needs managing (Exhibit 1). This is not just a gift for banks, however. Cassidy said that already there is intense competition in the wealth management field from hedge funds, family offices, and many other players, but he predicted a shakeout would winnow the field going forward. And even though capital markets’ fees have fallen recently, he said, fiduciary business will continue to grow steadily (Exhibit 2, p. 8).

After sketching out the favorable scenario for fee-based banks, Cassidy and another analyst, Robert Lee, commented on what approaches and best practices stand out among the banks that operate in these businesses—Northern Trust and The Bank of New York/Mellon being two that Cassidy mentioned.

Their success, he said, results in large part from superior client service. This, in turn, is a function of technology and well-trained people. Fee-based banks invest more in technology than traditional banks, he suggested.

Skip the style box
Robert Lee, managing director for Keefe, Bruyette & Woods, believes that a solutions-based business model is superior for the financial advisory/asset management business. In contrast to the popular “style-box” models [grids used for asset allocation and risk-return analyses], the solutions approach, said Lee, promotes “stickiness” of assets and helps generate more profits from existing customers. A solutions-based model combines various products and services to meet a client’s objectives. “It takes [the focus] away from performance, per se,” said Lee, “and looks at the client more holistically.

Over time, Lee predicted, more and more advisory firms will migrate away from the style-box model. “If you do solutions-based business right, you don’t even need open architecture,” he added, referring to the practice of offering investment products managed by others versus offering proprietary products.

Lee cited AllianceBernstein’s private client business as an example of a solutions-based provider that succeeds with a completely closed (proprietary) architecture. The company has high-margin, extremely sticky, very wealthy individuals as clients, said Lee, and is excellent at working with these clients and setting objectives. The strategy works for AllianceBernstein, he said, because it has a very broad range of investment capabilities. But Lee emphasized that the model per se isn’t the critical success factor. Not all companies can do what Alliance does, he said, yet they can succeed using a more “open” approach.

“At the end of the day,” said Lee, “It’s really stickiness of assets that drives profitability.” If open architecture is done properly, he continued, you get very sticky assets. Even if the organization is not earning the whole fee, if it keeps the assets, it will have much better profitability [than if the assets move elsewhere]. Plus, it may not have to carry the whole overhead of an investment staff, and all the processing behind it.

“When I look at a company,” said Lee, “what I’m looking at are the characteristics of that particular company and how they execute on them—and their ability to sustain earnings. Open architecture or a proprietary model in and of themselves to me doesn’t mean one [company] is more highly valued than another. It’s about what you do well, and where you add value.”

“The only thing I would add to that,” Cassidy chimed in, “is, if the buyer of a proprietary shop thought that after the purchase it would switch over to open architecture, that may make them less valuable because the transition period for doing that is not easy.”

Organic: better but harder
In response to an audience question about creating value when price competition is so intense, Cassidy acknowledged that it is a challenge to grow organically. The companies that have managed to do it the best, he said, are those whose clients use more than one product.

“You know how challenging it is to win new customers,” added Cassidy.

He pointed to the old U.S. Trust (now part of Bank of America) as one of the most successful of the fee-based banks at creating value using a “multiple hook” strategy—essentially, cross-selling. Over time, he said, the bank would line up an array of products for a given customer—estate planning, tax planning, investments, etc.—so that the bank was not just managing money, because there will always be down markets when investment performance suffers.

Broadening his answer beyond just fee-based banking, Cassidy said that New Jersey’s Commerce Bank (soon to be TD Commerce Bank following its merger with TD Banknorth) was very good at organic growth. Commerce had a culture unique to a bank, he said, almost like that of a revival meeting. It created some emotion that ran right from the top of the organization to the bottom.

“You need that sort of commitment to have organic growth,” said Cassidy. “For trust banks, management must also provide the tools you need to grow faster than the competition.”

Another questioner asked the two analysts whether Wall Street had a general preference for organic growth versus growth by acquisition.

“The markets pay up for organic growth,” said Cassidy. “Organic is less risky. Acquisitions always have a risk element to them.” Integration may not go smoothly or the price may be dilutive, for example.

“If we can see high-single-digit organic growth, on top of acquisitions or market growth, that’s very positive,” said Cassidy. He noted, however, that it’s hard for outsiders to separate organic growth from market growth without management breaking it out, and some managements don’t like to do that.

Cassidy expected to see more acquisitions in the trust and asset management field.

Lee agreed, but added that there is unlikely to be big BNY/Mellon type acquisitions again any time soon. “The nature of acquisitions will mostly be incremental,” he said referring both to geographic increments and to specific asset management capabilities.

Insurance, a tough fit
When asked if any fee-based banks have successfully integrated insurance services into their trust or other fiduciary product lineup, Lee responded: “None come to mind!”

The analyst, who used to cover life insurance companies, said the big broker/dealers have been selling annuities for years, but many of them still struggle with it. Lee said, that’s because insurance products, including annuities, are complex and difficult to understand. He also said that relative to most asset management products, insurance products are considered to be expensive.

For all those reasons, said Lee, it has been difficult for financial advisors to successfully incorporate insurance products. BJ

The electronic version of this article available at: http://lb.ec2.nxtbook.com/nxtbooks/sb/ababj0608/index.php?startid=6