Bank trust departments are often overlooked and usually underrated. But through careful management and integration with other bank strategies, they can make a significant contribution to a bank's return on equity.

There are two chief reasons. First, noninterest income is a critical component of a bank's return on equity, and the trust department can make handsome contributions to noninterest income.

Second, there are no regulatory capital requirements for trust departments. Therefore, unlike deposit-based sources of noninterest income, trust departments can grow without putting stress on the bank's capital base.

Yet despite the potential positive effect on return on equity, trust activities remain segregated from the mainstream of banking. Management career paths in trust and banking generally don't converge.

And the "Chinese Wall" -- the requirement for trust officers to put fiduciary responsibility to customers above the bank's welfare -- can cause discord and misunderstanding within the bank. The result has typically been competition rather than cooperation between retail and trust bankers vying for customer relationships.

Furthermore, in many banks, the trust department has not been expected to make any significant contribution to the bank's profitability. Trust departments were simply there to round out bank services to the community.

To determine and achieve the trust department's profit potential, bankers should assess financial risks, current performance, productivity improvement opportunities, revenue enhancements, and service levels.

To prevent unexpected losses and unnecessary expenses, trust risk must first be understood. Examples of the primary financial risks are:

* A court judgment for improper discharge of fiduciary duties.

* Expense of defending against litigation.

* Government fines or penalties for regulatory violations.

* Reimbursement to accounts resulting from mismanagement

* Loss of fees because of errors or poor collection practices.

* Increased operating expenses arising from managerial errors and lack of expertise. Losses from fiduciary activities can be disproportionately large when compared with trust income.

For example, there are a number of trust departments that have recently spent over $100,000 each to reimburse paying-agency accounts for misplaced or destroyed canceled coupons.

Disputes over liability for selection of an insurance carrier to provide coverage under a Voluntary Employee Benefit Plan cost one Midwest bank more than $1 million in legal fees.

There are four essential fiduciary risk-control steps:

* Hire qualified managers and staff, and require ongoing training.

* Develop detailed and effective trust policies and procedures to ensure safe day-to-day operations.

* Establish internal audit programs to evaluate risk controls rather than just verifying the accuracy of transactions and records.

* Require senior bank management to monitor potential high-risk areas.

To determine the current exposure in your trust department, review all existing primary risk control measures by asking the following questions:

* Do you have the right quality and quantity of staff in place?

* Are your policies and procedures complete. in writing, and are updates issued promptly?

* Are all of the issues raised in audits addressed completely and timely?

Review any previous financial losses to determine if corrective action has been taken.

The fact that expense information on trust departments is not publicly available makes the development of peer performance standards difficult.

A 1989 study by BEI Golembe found that 64% of trust departments with less than $2.5 billion in trust assets under administration said they believed that a minimum of 30% to 39% pre-tax profit margin defined a high-performing trust department.

In the same survey, among those with more than $2.5 billion in trust assets, 28.5% believed that a 40% pretax profit margin was a minimum for a high-performing trust department, while 32.1% set the threshold at 30% to 39%.

Almost without regard to size, when trust performance is viewed from the perspective of what is possible (as opposed to what is simply average), a 40% pretax return on gross fiduciary revenues (including credit for balances) is both attainable and realistic.

Evaluating Expenses

The general guidelines below are offered to assist banks in evaluating the performance of their trust departments. They should be adjusted to fit each bank's situation.

For example, occupancy expense may be significantly below the guidelines if the bank premises are fully depreciated.

Personnel expense may be higher if service is delivered through individual trust branches rather than from a central location. And computer systems and support services may be inappropriate and the expense correspondingly high.

To achieve a 40% pretax profit margin on their trust operations, banks may have to re-examine past strategic and tactical decisions that had significant impact on cost structure.

Increased revenue will not improve profitability if expenses increase proportionately to revenue increases. All new accounts, therefore, must be reviewed to determine if they will improve the overall profitability of the department. If the profitability goal is 40%, fixed and variable costs to service new accounts cannot exceed 60% of the fee.

Improving Productivity

By comparing work loads and observing the daily routines and work habits of the staff, waste can be identified. One common example is preparing control reports that aren't needed.

Examine all activities and tasks to determine if they are essential to the overall mission of the bank. Inefficient, redundant and unproductive activities can be identified by asking the right questions. For example:

* For whom are you making copies of this report? What will they use it for?

* Why are you filing quarterly accounting statements?

* Why are you mailing trade confirmations?

* Why are you handling proxy materials?

* If everyone has terminals on their desks, why are you printing daily reports for them?

Challenge the historic and traditional reasons for doing things the way they have always been done.

What fees should you be charging?

A few trust departments aim to collect total fees equal to 1% of total trust assets under administration (exclusive of corporate trust assets).

Many competitors outside banking, however, have conditioned the market to much higher fees.

Most asset management brokerage accounts, for example. carry fees of 3% of total assets. As a result, investment advisers, mutual funds. and asset management brokerage account revenues have increased over the last few years at a faster rate than revenues from bank trust accounts.

Inroads made into the trust market by these nonbank providers sharply demonstrates the importance of the client's perception. Many brokers and investment advisers actually provide fewer services for their higher fees, but they do a superior job explaining and selling the benefits of their services.

When analyzing your trust department fees. Compare competitive fees schedules, but also analyze total revenues actually collected. Determine if fee waivers are excessive, and if fees are collected on time.

Measuring Service

There are two simple measurements of service levels. The first is the number of new accounts referred by satisfied customers. The second is the existence of quality controls and performance measurement systems within the department.

To ensure superior service, establish standards that are frequently communicated, measured, and tracked by the staff. The good news is that the best source of new trust business is your current trust customer base. Actual, as well as perceived, benefits create customer satisfaction. Only by monitoring and meeting the customer's expectations can your trust organization complete in today's environment.

Mr. Koch is a Pittsburg-based vice president and Mr. Schaefer a Dallas-based managing director for BEI Golembe, a bank consulting company in Dallas.

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