Independent advisors might find some New Year’s cheer in knowing that bank brokerages continue to lag their full-service brokerage and wirehouse competitors because of their operational and distribution inefficiencies. And the majority of banks aren’t embracing fee-based models, a service lapse that bodes well for independent planners.
A new report by Cerulli Associates, The State of the Bank Brokerage Industry, forecasts that “the window of opportunity” for bank brokerages is close to slamming shut, and that to stay in the game, banks must remedy their shortcomings posthaste.
Banks’ biggest snafus are their failure to integrate distribution structures, sales practices, systems, and operations across business lines, says Boston-based Cerulli. As the competitive landscape changes, full-service brokerage firms, insurance companies, and discount brokers are adding traditional banking services more rapidly than banks are adopting brokerage and fee-based services.
Jean Sullivan, who co-authored the report with fellow Cerulli consultant Rachael Malatesta, says that while “banks have made progress in positioning themselves more strongly within the brokerage industry,” their infrastructure woes will stymie further improvement. “Oftentimes banks have multiple distribution arms. How do they coordinate between them? How do they capture a customer’s information into a single database? How do they integrate the back office?”
The mid-tier banks, with assets from $5 billion to $70 billion, are the most threatened because they haven’t acquired broker/dealers like the Citibanks, and they lack the niche presence of the community banks. The mid-tier banks suffer “credibility issues. They haven’t been able to acquire their way into those markets because of lack of capital, and sometimes they still face a conflict internally of how they should transition into non-bank business lines,” Sullivan says.
While some of the nation’s large banks have embraced fee-based services, some of the regional banks still need to move in that direction, she says. “They have to work out all the issues relatively quickly because of the changes that have happened within the competitive landscape due to deregulation.”
Another challenge is developing competitive compensation schemes, especially with regard to the bank brokerage channel, Sullivan says, which applies mainly to brokers who are situated in the bank branches. “Brokerage firms are now offering, and have been offering, traditional banking products that will strike at the heart of the banks’ core customer constituency, which is the middle market,” Sullivan says. “Brokerage firms are implementing scalable advice models and are moving down market and offering better compensation models.” Cerulli estimates banks pay reps 32% of gross commissions, while brokerage firms pay 40%.
If you’ve followed the banks’ path to offer fee-based and brokerage services, you’ve noticed that the majority of banks have been struggling with the aforementioned conundrums for a while now. Banks move at a snail’s pace in modifying their behavior because their competitive psyche is still ruled by regulation. As Beth Morrow, senior industry analyst for financial services at Ernst & Young in New York, notes, change is slow in these “highly structured bureaucracies. Banks, and insurance companies as well, have been regulatory-focused for decades; historically, they have been run by regulation, rather than by market forces; they have not been market-focused or market-responsive,” she says. “They are becoming more market responsive, but they in no way respond to the market with the speed at which your average consumer company responds to the market. That is because competition has always been regulated in these highly structured organizations.”
Banks’ slow pace in adopting new habits, particularly their neglect of fee-based services, is a good sign for independent planners. “The RIAs have a stranglehold on the fee-based business, and are actually well-positioned in that marketplace,” Sullivan says. “We think banks have an opportunity to expand into the fee-based arena, and they haven’t done so yet.” Banks’ biggest obstacles, she says, are training their reps to understand fee-based business practices, and finding a program that best suits their customer segments.
Mike Mortensen, president and CEO of PNC Brokerage in Pittsburgh, says another mistake that banks, and other financial services companies, are making is applying financial planning to every customer. “What some financial services companies have done to themselves is say, ‘Financial planning makes a lot of sense, let’s lead with that for every customer,’ but it doesn’t really match up to what the customer wants,” he says. “Not all of [PNC's] customers need full-service financial planning. You still get folks who come in and just want to do a transaction–’I've got some GE stock I want to sell’–but for those looking for investment advice, we have investment planning software we use across the board consistently.” He says PNC strives to provide “quality financial planning that customers will appreciate and are willing to pay for.”
Love Those Commissions
Mortensen says he agrees that banks haven’t embraced fee-based services, but for many banks it’s a matter of economics. “Certainly there is the internal politics and infrastructure [problem], but some of it is just plain scale,” he says. And banks are often loath to give up the revenues generated by a commission model, he says. “I think people view [commissions versus fees] as one or the other; it’s not. You are going to need to have what you have today in terms of offering mutual funds, equities, and bonds via commission. [Financial and investment planning] is just an additional product set. Even if you’re not doing financial planning, customers would much rather pay you for your services via a fee arrangement than paying a transaction for a trade.”
Since independent planners are so far ahead of the majority of banks in the fee-based area, they should eliminate banks as competitors, right? Not really. As Mortensen can attest, “Banks, in general, plan on playing a larger role in [the fee-based] area.” And Cerulli’s Sullivan says it is precisely the mid-tier and large regional banks–like PNC–and to a lesser extent national banks that independent advisors should keep an eye on. “Because RIAs have a local presence, it could be the regional banks that present a challenge to them. People are more familiar with regional banks than the national banks that, to some extent, have lacked the regional presence,” she says. “First Union [now Wachovia] is really a broad, nationally based financial institution; they have moved away from their regional roots.”
Ernst & Young’s Morrow concedes there are exceptions to the rule in the banking and even insurance industries (particularly Northwestern Mutual, which she says has successful financial advisors), that have nailed down brokerage and fee-based services, and could become a nuisance to planners. But Morrow says planners’ independence and trusted bonds with clients put them in almost impenetrable territory. “I would find it very hard for anybody to threaten independent planners now because they have on their side something huge, and that’s independence.” She says financial advisors within the brokerage arena are achieving more independence because it’s the only way they can compete with independent advisors.
The popular notion has always been that banks have an advantage because they can draw from an established customer base to cross-sell products. As Mortensen says, “A lot of the folks that we deal with who are traditional bank customers aren’t really comfortable going to wirehouses or even to fee-based planners. They are more comfortable talking to their bank.” He says this affords PNC the opportunity to “not so much take away business from planners, but instead to offer [financial planning] services to a part of the public that doesn’t have it today but would really benefit from it.” So to capture more revenue and loyal customers, Mortensen says PNC needs to better “identify customers’ needs and provide solutions.”
Satisfying the customer is a concept that has become lost in the banking world, Morrow says. And banks, she says, are making yet another mistake by assuming that they own the customer. “In a bank, the bank is considered to own the customer. In a brokerage house, people know that the financial advisor owns the customer.” She says if customers were asked, “Because you have a checking account and fixed annuity with a bank, should you buy a mutual fund there?’ I think you would find distinctly different answers.” Banks will continue to irk customers, because unlike independent advisors, she says, banks “do not focus on the customer; they don’t find out what the customer needs or wants; and they don’t run the bank in order to make the customer happy. How often have they made you happy? And how often have they screwed up your life? I really believe that of all the institutions that aggravate people, banks are way up at the top.”
Morrow says she believes banks won’t “become an overwhelming force in brokerage, unless the bank buys a brokerage that already exists and runs it on a hands-off basis. That tends to be more promising.”
Even PNC’s Mortensen admires the independent planner’s business model, and plans to emulate as many services as he can from a group that he considers competitors. “I like the fee approach; I think it puts the best interest of the customer very directly aligned with the advisor and the firm,” he says. “I like the breadth of services [independent advisors] are trying to provide, and they are really trying to capture a significant share of the customer’s wallet. I like the fact that they can go out and choose from the best investment providers. And I like that it’s a very relationship-based approach.”
In the end, Morrow believes the fiercest competition will take place among “the brokerage houses, the asset managers, the mutual fund companies, and the independent advisors.” But keep your eyes on the banks, too. They’re watching you.