Just about everyone agrees that small and midsize banks have to consider offering mutual funds to their customers. But choosing the right partner can be difficult, even bewildering.

More than 400 companies are vying for the chance to sell mutual funds and other investments to bank customers, according to a recent survey by American Brokerage Consultants Inc., a St. Petersburg, Fla., company that helps banks select brokerage partners.

The field ranges from large companies that serve hundreds of banks and dominate the business to small ones with just two or three clients.

"That surprised the hell out of me, and I'm in this business every day," said Richard A. Ayotte, the company's managing partner. "These guys are getting literally stacks of marketing materials from dozens of third-party marketers."

An Attractive Market

Small wonder. Banks have a vast customer base and an extensive delivery system that is the envy of the brokerage industry. And bank customers, hungry for attractive returns, are clamoring for investment alternatives to CDs.

But relatively few banks are positioned to capture a share of the burgeoning demand for brokerage products.

Mr. Ayotte estimates that only 1,200 of the 7,600 banks with assets between $50 million and $10 billion have contracts with outside vendors who sell mutual funds to bank customers face-to-face. Another 1,800 have only halfhearted arrangements - such as referring customers to brokers' toll-free phone services.

Industry experts say change is on the horizon.

A Need to Compete

"The fact of the matter is, consumers are going to buy mutual funds," said Robert Kniejski, group executive for product marketing, Wachovia Trust Services, Winston-Salem, N.C. "So from a competitive standpoint, you have to have something to offer them."

Fortunately for the banks, they are in the driver's seat. Most third-party providers can and will set up anything from a turnkey operation where they provide everything, including staff, to a customized program that prepares the bank's own employees to sell mutual funds.

"We can do as much or as little for them as they require," said D. Mark Olson, president and chief executive of Invest Financial Corp., a Tampa, Fla. unit of Kemper Financial Companies Inc., Chicago.

In the face of intense competition for their business. hundreds of bankers have managed to sift through the choices.

Check on Reputations

One time-honored way to begin is to talk to your peers about their strategies. Find out about the reputation of the companies that are asking for your business.

"You can create a nightmare if you don't narrow it down by prescreening," said one executive, who didn't want to be named.

Among the touchstones of quality to look for:

* Financial strength. "You don't want to offer a company's products and then run into problems down the road," said James M. Bedard, assistant vice president for retail marketing, Manufacturers and Traders Trust Co., Buffalo, N.Y. "That could impact your customers."

* A wide range of top-notch investment products, and the ability to mix-and-match products that are right for your customers.

* Extensive training and marketing support. This is especially crucial for banks that envision a third-party alliance as a stepping stone to running the business themselves.

"We intend to be successful," said David Sullivan, vice president of investments, American Trust and Savings Bank, Dubuque, Iowa. "And after finding that we are, we intend to become a registered broker-dealer."

* An impeccable track record of compliance with the battery of federal and state securities laws. "Although it is legally [the vendor's] problem, if it takes place in my branches, I worry about it," said Richard C. Kane, president and CEO, Bank Leumi Trust Co., New York.

Emphasis on Service

But the overriding consideration should be good customer service.

Letting another company do business with your customers is a huge step, and "you've got to be comfortable with it," said Mr. Sullivan of American Trust.

Indeed, while most beginners hand over the entire brokerage management job to a third-party firm, some balk at that option.

"I have no interest in that whatsoever," said James R. Murphy, chairman and chief executive of Texarkana National Bank in Texas. "Our bank is 105 years old, and we got there by taking care of our customers."

He also rejected a more modest approach of stationing outside salesmen in branches.

"No way. I wanted total control over our brokers," he said.

A Composite Approach

Mr. Murphy ultimately hired three brokers of his own, but brought in Invest Financial Corp. to provide a product menu, set up accounting systems, clear transactions, and help with marketing.

Indeed, most bankers say providing the best possible service to customers outweighs every other consideration - including the fee structure.

"If I take one of my best customers and introduce him to a representative who happens to be sitting there in my lobby, and he is treated badly, he is going to think badly of Bank Leumi," said the bank's Mr. Kane.

That's an important consideration, because customer retention, along with fee income, is the primary motivation cited by banks entering the mutual fund business.

"If funds are going to leave us, then we ought to be able to help our customers with the investments and get paid for it," said the American Trust's Mr. Sullivan. "That way our customers don't leave us, too."

Mr. Sullivan has spent the better part of a year looking over third-party firms. He has narrowed his search to seven, and expects the $315 million-asset bank to start selling mutual funds by spring.

Mr. Bedard of M&T Bank advises fellow bankers to make sure the mutual fund company understands that bank customers are more conservative than brokerage customers. Offerings should be tailored accordingly.

"You don't necessarily want to offer high-risk growth mutual funds to a conservative customer base," Mr. Bedard said. "Look for a contractual arrangement where you can build in some approval over the product line." His bank signed on with Boston-based Liberty Financial.

It's worthwhile to ask what a third party can do to help the bank increase its share of the customers' investable funds.

Mr. Sullivan estimated that American Trust's customers, on average, have about 20% of their investable funds on deposit at the bank. He says offering a broader array of investment products could help the bank to capture 50% of those funds.

Another important decision is whether to pay commissions to brokers. Some banks are comfortable with that. Others plainly aren't.

"There's no doubt in my mind that we would make more money if we had our folks on commission," said Mr. Murphy of Texarkana National."but I don't want our customers under that pressure."

An Alternate Route: Starting Your Own Fund

Thinking of launching your own family of mutual funds?

Join the crowd.

So far this year, 21 banks have taken the plunge, bringing the number of so-called proprietary bank fund families to 101, according to Lipper Analytical Services.

What's the attraction? Instead of selling another company's mutual funds, banks can reap higher profits and maintain more control over their customer base by offering home-grown products. That's because banks can manage the investments and collect substantial fees for doing so.

Still, the decision is far from simple. Moving aggressively into the mutual fund business means a major commitment of money and people. And to avoid Glass-Steagall prohibitions, a nonbank has to be brought in to sponsor and distribute the funds.

Here are some basic points banks that experts say you should consider as they weigh the options:

Be realistic. To make a go of it in the mutual fund business, a bank needs investment management expertise, and not every bank has it.

One place to find that expertise: your trust department.

"There are substantial assets already there, and we're managing them exactly the same way," said Paul A. Kampner, senior vice president at LaSalle National Trust, Chicago, which plans to jump-start a family of 16 mutual funds with nearly $1 billion in trust assets.

If you can't say that, proprietary mutual funds may not be for you.

Know the risks. One of the potential pitfalls of running your own fund family is poor investment results.

"The inherent risk that a bank takes in bringing its own funds to the market is that they had darn well better perform," said D. Mark Olson, president and chief executive of Invest Financial Corp., a Tampa, Fla., unit of Kemper Financial Services. Some customers inevitably will hold it against you if their uninsured fund investments disappoint them.

Think critical mass. Will it pay to start a private-label family of funds? Some experts cite this rule of thumb: You need $100 million to make a money-market fund go, and $50 million for an equity fund.

"If you don't think you can get to these numbers, you're probably better off offering someone else's funds," said Robert S. Kniejski, group executive for product marketing and development at Wachovia Trust Services.

Get management's backing. "I can't think of anything more frustrating and less fulfilling than trying to implement this kind of strategy if senior management isn't committed to it," said Thomas Howe, executive vice president of Fleet Investment Services, a subsidiary of Fleet Financial Group, Providence, R.I. "Be sure that you're not going to have to be fighting battles constantly over this."

Spread the wealth. "If branches are afraid of losing deposits, make sure that goals are set to compensate them for referring sales," Mr. Howe said.

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