Few products have raised the banking industry's hopes as high as the latest hot retail offerings: mutual funds and annuities.
But experts say the desired payoff - a steady stream of fee income that matches or exceeds banks' traditional spread income - could take years to materialize.
And the income from fee-based investments may not be sustainable unless banks make basic changes in the way they manage their business and generate earning.
After years of resistance, many banks have begun to view fee income as a cornerstone of future profit-ability. That doesn't necessarily mean it will be a quick earnings fix. Total noninterest income, though up 12% this year, was only one-fifth of the $194 billion in interest income earned in the aggregate by all insured commercial banks during the first nine months of this year, according to the Federal Deposit Insurance Corp.
There can be little doubt that banks need to offer mutual funds - or risk losing longstanding customer relationships, core deposits, and earnings, said George Salem, banking analyst at Prudential Securities Inc.
But "we're a couple of years away from knowing" whether fees generated by sales of alternative products will have much impact on earnings, Mr. Salem said.
One reason: Banks are still in the early stages of the costly process of staffing up, buying software and computer systems, and marketing the new products.
"I don't think [the investment products are] big enough anywhere to make a difference right now," Mr. Salem said. "This is such a permanent change in the business that the planning horizon is five to 10 years instead of five or six months." But in a recent research report, Mr. Salem made his long-term vision clear: He called mutual funds "the bank deposits of the 1990s."
Inexperienced but Enthused
To date, bankers have but a sketchy track record selling such nontraditional products, often lumped under the catch-all tag "alternative investments." Nevertheless, they are unmistakably upbeat about the prospects.
"Even with minimal involvement, we see this as one of the great fee-income opportunities for banks in the future," said Christopher L. Williston, president and chief executive of the Independent Bankers Association of Texas.
A recent study of 116 super community banks - multibank holding companies with at least $300 million in assets - showed a widespread expectation of growth in "alternative" earnings streams.
In the survey by BDO Seidman and American Banker, top executives were asked their three biggest income sources. For 1992, at least three out of four named transaction accounts, trust banking, and loans. Brokerage was listed by 15%; annuities, by only 9%.
Income Changes Expected
But looking five years out, the bankers' answers became more diversified. Trust was named by 80%; loans, by 54%; transaction accounts, 47%; annuities, 39%; brokerage, 28%; and insurance, 24%.
Why the optimism?
As consumers become more financially sophisticated, they are demanding a wider array of services than banks historically have offered. But while brokerage houses and mutual fund providers have the product advantage, banks own the customers.
The vast majority of consumers at all income levels identify a commercial bank as their principal financial relationship, and research shows they have more trust in a depository institution than in its competitors.
If banks can capitalize on that trust and loyalty, they would be in line to earn mutual fund commissions of 1% to 5% of sales. And the mutual fund business, with assets of more than $1.6 trillion today, is expected to double or even triple in size by the end of the century.
Whether bankers - novices in the business - can get their share of that growing pie, and profitably, are different matters.
"You have to anticipate that it will take five years to build a sizable [mutual] fund organization with good economies of scale," said Avi Nachmany, a partner at Strategic Insight, a consulting firm in New York.
The few banks that have been at the business more than a year or two are reluctant to discuss profits openly.
Fund Unit Turns Profitable
Chase Manhattan Corp., which celebrated the fifth anniversary of its $3 billion-asset Vista family of funds in September, said the unit was in the black for the first time during 1992.
"The first four years were investment years," said Paul W. Klug, the Chase vice president who oversees the mutual fund business. "Now, that investment is starting to pay a good profit."
He described the profits as "significant" but declined to be more specific. He noted, however, that the mutual fund business is considered so promising that it is "on the radar screen" of Chase's chief executive officer, Thomas Labrecque. Chase president Arthur Ryan attends Vista board meetings.
Mr. Nachmany, the mutual fund consultant, also pointed to Citicorp's Citibank, which is said to have sold $2 billion in mutual funds in 1992.
A Useful Piece of Change
"If they did, they just made $40 million or $50 million on sales commissions," he said, assuming that the bank's share of commissions came to a conservative 2% of sales.
Community banks, like First Bank and Trust Co. of Aurora, Neb., are getting into the act, too.
David Laferla, vice president of the $85 million-asset bank, said mutual funds and annuities have become a big part of the business. "We've had to change our mindset quite a bit," he said.
First Bank and Trust began offering the products in early October through a program run by Community Assets Management, a consortium of small banks. Sales are running 40% ahead of projections.
Fearing a Market Slump
Still, Mr. Laferla is anything but sanguine about the business. "You're exposing your very best customers to a product that does not necessarily work like a CD.
"Let's see how they make it through an 800-point drop in the Dow," he said. "There could be some squirming about that."
John Backlund, president of Community Assets Management, is an unabashed believer in alternative products. But he sometimes worries that some banks are panicking and moving in too soon.
"It kind of reminds me of sitting in the stands at a major league baseball game and saying, |Gee, that looks easy,'" Mr. Backlund said. "It's a whole lot harder when you have that ball coming right at you."
A Relationship Saver
He advises banks to look at alternative products as a tool for cementing customer relationships. "I don't know anybody who doesn't think these products are here to stay," Mr. Backlund said. "We think banks can add 15 to 20 basis points or more to their return on assets."
Rolland Johannsen, a senior partner at Furash & Co., is another big fan.
"We think a well-designed program can have a pretty quick effect of as much as 10 basis points on assets," the Washington-based consultant said.
But having said that, he added: "A lot of banks have just looked at it as the flavor of the month." They tend to overlook the need for "a fundamental shift in their earnings dynamic."
A major challenge is to change the organizational structure so that "the trust department and the private bank and the retail branch network can work easily together," Mr. Johannsen said.
Banks will also need to take a closer look at how they measure performance and must make sure they have accounting systems able to track the new business.
The profit potential is enticing.
In 1991, pretax operating margins averaged 33% at 11 publicly traded mutual fund companies in a study done by Mr. Nachmany of Strategic Insight. Average return on equity was 22%.
Competition Could Limit Fees
Nevertheless, the consultant added, "banks are coming very late into a very competitive, intense environment." Market-share wars are putting pressure on the very fees that now look so juicy, he said.
One thing that could work against some banks is a tendency to be timid about pricing.
"It's the trust department mentality - you don't fully account for the costs of providing the services to customers over time," Mr. Nachmany said. "That could make it very difficult for an organization to make money even [when achieving] economies of scale."
There is, however, wide agreement on one point: Mutual funds are here to stay. And in a big shift in bankers' traditional mentality, they are giving up the conviction that alternative products necessarily threaten the deposit base.
For years, bankers were worried about deposit disintermediation," said Mr. Johannsen. "Now, most of them are starting to realize that the real threat is disintermediation of customers."