As the pricing of all mutual funds becomes more creative and complex, banks are taking a second look at their own funds' pricing. Load funds appear here to stay, but how they are loaded is very much at issue.

Hoping to grow what is already one of the most successful mid-sized bank investment products programs, Premier Bancorp in Baton Rouge, LA, earlier this year conducted extensive consumer surveys. The results were somewhat surprising to the bank's managers.

About half of the respondents said they would be interested in mutual funds with back-end loads, in which fees are levied at some time other than when the shares are purchased. That led the bank to introduce back-end loads, or B shares, on its proprietary funds in early September. "Consumers understand that there is no free lunch, but they want options in how they pay for it," says Richard White, the executive vice president who heads up the program for the $4.9-billion-assets bank, which has $1.4 billion in assets under management in a family of bank funds.

But at Bank of America, managers are sticking to front-end loads for its family of funds, one of the oldest and largest in the nation with $8.4 billion in assets under management. "The last thing a bank wants to be is the price-of-the-month club," contends Debra McGinty-Poteet, senior vice president and managing director of funds management. She believes that "banks should be consistent with their pricing schemes and stick with them for a while."

So goes the debate over pricing bank mutual funds, one that is growing in intensity as the pricing of all mutual funds becomes more creative and more complex. Today, most bank funds carry front-end loads, or A shares, in which the customer pays a fee when the investment is made based on a percentage of the assets invested.

But the proliferation of different loads, or shares, among non-bank funds is prompting banks to re-examine their own fee structures in order to keep their investment products competitive. As back-end loads become more common on non-bank funds, they are catching the eye of bank programs like that of Premier. Banks have even begun to consider level loads, commonly called C or D shares, in which the customer pays a flat percentage each year based on the amount invested.

"Pricing is one of the major issues facing (bank) programs as they mature," says William N. Wade, senior vice president of business development for Essex Corp., a third-party marketing firm that assists banks with their investment products programs. "Ultimately, banks will offer a range of options."

The B Share Trend

In pricing more innovatively, banks are taking their cue from non-bank funds. In addition to their own funds, banks also provide non-bank offerings in an effort to meet any customer investment need. And what banks are discovering through their own broker/dealer subsidiaries is that there is a voracious and growing appetite for pricing other than front-end loads.

Avi Nachmany, an analyst with New York-based Strategic Insight Inc., says that his consulting firm's research shows that fully 40% of all non-bank funds sold through banks now carry back-end loads. "That sends a very strong message to bankers that customers want this option, and that they should consider offering it on their own funds," he says.

And scores of banks are considering it, though only a handful of programs so far have launched back-end load programs. There are good reasons why more banks haven't jumped onto this bandwagon. One is the fear of confusing customers who depend on the bank to offer straightforward advice and pricing, a la the position taken by Bank of America.

Many bankers feel, though, that explaining different fee structures to customers is simply part of being in the investment products business. They have grown accustomed, they say, to bending over backwards to make sure customers understand the products offered. "We have found that a lot of customers really don't know what they want when they first sit down with us," says Premier's White. "There's a lot of explaining to do anyway."

The structure of back-end loads won't be completely alien to bank investment product customers anyway, because they are already accustomed to what are commonly referred to as contingent deferred sales charges on other bank products. Certificates of deposit, for instance, bear hefty penalties for early withdrawal, though the customer pays no fees up front. With back-end loads, investors who stay in the funds for a number of years might also see loads dwindle or expire completely.

But perhaps a bigger problem is that back-end-loaded funds are much more complex for a commercial bank to execute because of financing considerations. When a customer buys into a bank fund with a front-end load, the customer pays the load up front, and the salesperson is paid his or her commission at that time by the bank's distributor.

But when a customer buys into a back-end-loaded fund, there is no fee paid upon the purchase. Nevertheless, the salesperson must be TABULAR DATA OMITTED compensated at the time of the sale. Because banks are prevented by law from the actual distribution of securities or from the financing of that distribution, they cannot ante up the sales commission and be reimbursed later when loads kick in.

Thus, it is up to the bank's third-party distributor to finance the sale of back-end loads, money it will recover through annual 12b-1 distribution and service fees, as well as redemption fees if the customer exits the fund early.

This scenario isn't a cheap one for the distributors. If a bank sells $500 million a year in back-end-loaded shares, for instance, the distributor would have to come up with $20 million in financing to cover an average 4% sales commission. Though some distributors can handle the financing themselves, most turn to other banks for the money.

Citicorp, for instance, provided financing for third-party distributor Concord Holding Co.'s back-end load program for Chase Manhattan Corp., which has pulled in $260 million in B share sales since last November. The deal was structured so that Citi is repaid with the assets from the sale of the cash flows from Concord's 12b-1 fees.

Concord did, however, choose to finance Barnett's back-end-load program itself, as the commissions involved are not expected to be as great as those generated by the Chase program.

The danger to the financing entities--the institution loaning money to the distributor and the distributor as the entity that advances the commissions--is that 12b-1 fees are based on the value of the assets invested in the funds. If the fund value tanks, the distributor's 12b-1 fees shrink. For the bank, there is relatively little risk, though. It comes primarily in the form of the distributor running into financing problems, which could disrupt bank sales.

Observers believe that most bank fund programs will begin offering back-end loads, now that a few banks have untangled the thorny financing problems. "There is a definite trend toward back-end load funds," says Tony Psilos, president of Hibernia Investment Securities Inc., which has $580 million in assets in the bank's family of funds, which include A and B shares. Adds Tom Johnson, head of retail banking at Barnett Banks: "From an accounting standpoint, front-end loads are a little cleaner, but banks are clearly seeing a trend toward back-end loads."

Psilos, Johnson and others also say they are seeing increasing interest in level loads, a pricing structure McGinty-Poteet dismisses as "another pay-as-you-go scheme." Adds Concord executive vice president Joe Kissel: "Some are saying that wrap fees are definitely the future for banks," referring to programs in which consumers pay a flat annual fee for a bundle of products which are loaded in a number of ways.

That bundle of products, for instance, might include a credit card that carries no annual fee, a front-loaded mutual fund and other retail products. Instead of paying individual prices, the customer would pay a flat rate for a group of products.

Loads in a No-load World

What's abundantly clear at this point in the evolution of bank funds is that one pricing option won't be no-loads, even as non-bank no-load funds increase in popularity. Banks do, in fact, offer the no-load option to their customers through the sale of third-party funds, programs which complement their own fund offerings. But doing away with fees on their proprietary funds is not economically viable at this time for a number of reasons.

The primary motivation for sticking with loaded funds is simple: Banks can't make money in this business with no-load funds. "Different channels of distribution will accommodate different load structures," says Johnson at Barnett, which has $3.3 billion in assets under management in the bank's own funds. "If a customer wants to order a fund using an 800-number, he should get a price break because that distribution channel is much more efficient."

But that's never been the customer base banks have sought to tap into. Banks seeded their own funds with money converted from their trust departments, and they've grown those funds by first going to their own retail customers. And conventional wisdom has it that customers inclined to buy funds through banks are more conservative and require more hand-holding than investors who feel confident simply placing an order over the phone. No-load funds "carry a very different set of dynamics," says McGinty-Poteet.

Indeed, banks have sought to differentiate themselves in the investment business by helping customers choose the right vehicles. For that advice, banks are generally charging 3.5% to 5.5% of the assets invested, which covers not only the investment management expertise inherent in running the funds, but also the fees paid to the third-party distributors.

Economic reality dictates that banks must charge loads, but an additional consideration is maintaining their reputation as advisors. Most bankers believe that the wire-house approach to selling funds would not enhance the niche they've carved out in this business. "Many retail investors are still looking for good, unbiased advice, and they see banks as offering that," says Essex's Wade.

Still, these customers are growing more sophisticated in making investment decisions, and banks are recognizing that by offering a wider array of products and pricing. "If you're in this business, you've got to look at all kinds of pricing," says Kissel.

For banks to become more than marginal players in the investment products business, they must at some point in the future venture outside their own retail base to grow funds. And that prospect virtually ensures that they will eventually be targeting customers who are more sophisticated buyers than their present customer base. When that time comes, the bank that has developed a comprehensive lineup of products will likely be the most successful.

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