Slowly but steadily, banks are building revenues from investment products.

In the first nine months of 1997, banks reported $2.4 billion of fee income from selling and servicing mutual funds and annuities, according to data from the Federal Deposit Insurance Corp.

That's up a notch from the $2.3 billion banks collected from these activities in all of 1996, and strongly ahead of the $1.7 billion posted in 1995.

Large banks with the most active fund operations say they are pleased with their progress, though they are loath to discuss profits in detail.

"We've been in the business for 10 years, and it is a profitable enterprise for us," said Sarah E. Jones, president of Chase Global Mutual Funds, a unit of Chase Manhattan Corp., New York. "Mutual funds generate a significant amount of revenue for the corporation."

One reason for banks' reticence may be that investment products remain but a tiny sliver of the revenue picture at most banks. Only a handful generate enough income from these activities to warrant a separate line item in their earnings reports. Among them: Mellon Bank Corp. and First Union Corp.

According to the FDIC, investment product revenues in the year to date equaled 0.73% of banks' gross operating income. But those ratios have been climbing strongly since the FDIC began tracking the data. In 1995, these fees equaled 0.44% of banks' gross operating income; in 1996, 0.58%.

For the biggest banks-with more than $10 billion of assets-the ratio was 0.97% in the first nine months of this year, up from 0.60% in 1995, and 0.78% in 1996.

Banks make their money on investment products in two key ways.

For managing the money in so-called proprietary mutual funds, banks can collect advisory fees ranging from 0.1% to more than 1% of assets. Banks now manage $608 billion in mutual funds, about one-seventh of the $4.4 trillion in all mutual funds.

Banks also reap commissions for selling funds and annuities, ranging from 4% to 8% of the amount invested. The FDIC data showed banks' gross sales of stock and bond mutual funds and annuities jumped to $22.2 billion in the third quarter, up 46% from the year-earlier period. This figure, however, does not reflect redemptions and exchanges.

Some observers maintain that most banks are progressing so slowly in mutual funds that it will never become a meaningful contributor to profits.

Many of 110-plus banks that manage mutual funds do so purely for defensive reasons-they want to keep customers from taking investment dollars elsewhere, said George A. Bicher, bank analyst at BT Alex. Brown, New York.

The real value of the fund business for banks, he said, is that it can help them deepen customer relationships. "I don't think the amount of contribution (to profits) is important."

But bankers said they see real profit potential. "Any company that has asset management and the distribution of funds has the ability to be quite profitable," said Ms. Jones of Chase.

The company's third-quarter income statement shows $338 million in trust, custody, and investment management fees-14.3% of noninterest revenue. But Chase doesn't break out mutual fund fees; they are embedded in the total.

Mellon Bank Corp.-arguably the most successful bank in the fund business-has had to do some retooling to boost profits.

When Mellon bought Dreyfus Corp. in 1994, the mutual fund company was known chiefly for its bond funds. Under Mellon, Dreyfus has been remaking itself into an equity shop. By managing equity funds, Dreyfus can command richer fees than it reaps from bond funds.

"To maintain market share, you have to have a significant equity base," said Lawrence S. Kash, a vice chairman of the Pittsburgh-based banking company. "There is no sales process in the world that is going to keep your market share up there if you do not have assets that are going up in value."

Stock funds now make up 22% of Dreyfus' $84 billion of assets, up from 10% three years ago.

In the third quarter, Mellon's fees from mutual fund management totaled $97 million, up 14% from the year-earlier period. The bank also earned $34 million from mutual fund custody and administration, up 31% from last year's third quarter.

Aside from managing funds, banks also make money from selling funds managed by others. Some observers expect sales of third-party funds to grow in importance for banks.

A recent Bank Securities Association study of 20 leading banks showed that while sales of bank-managed mutual funds rose in the third quarter, sales of third-party funds rose faster. Proprietary fund sales accounted for 13% of bank fund revenues, down from 18% in last year's third quarter.

"The problem banks face in getting a bigger share of that business is the brand recognition that some of these other funds have," said Kenneth Kehrer, a Princeton, N.J.-based consultant who conducted the study.

But bankers may not be willing to let their own mutual funds take a back seat.

Proprietary funds account for 30% of sales at Union Bank of California, up from 22% last year, said Gregory Knopf, managing director of the mutual fund division. He anticipates boosting that figure to 50% next year.

"We continue to increase share as our brokerage unit continues to increase sales," Mr. Knopf said. "We've now started to delete certain fund families from our list that we initially thought we needed."

The $6 billion-asset Highmark Funds family is part of Union's trust and private financial services group, which contributes 8% of total revenue, Mr. Knopf said.

In its efforts to sell mutual funds, Mr. Knopf said, the bank has penetrated about 2% of its customer base of one million households, and it has stepped up its marketing efforts. Two-thirds of the Highmark Funds' assets are from institutional investors, the balance from retail investors.

Others see a wide range of outcomes for banks in the mutual fund business.

Some banks' mutual fund operations are throwing off hefty profits- margins of "30% to 40% are not unheard of in banking," said Kenneth Hoffman, president of Optima Group, Fairfield, Conn.

"The question is, can they increase the size of those operations to the point where the dollar contribution is meaningful in a very large organization-can they become a more important contributor to total bank revenue and profit?"

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