States like New Hampshire and South Dakota report robust interest from wealth managers, family offices and other advisors looking to offer their clients the benefits of an in-house trust company as a hedge against possible FINRA oversight of advisors and more restrictions on how advisory firms can make money.

State chartered trust companies can do everything an SEC-registered advisor can do, plus serve as trustee and custodian. These privileges were given to both banks and trust companies with the enactment of the National Bank Act.

After a rocky year in the markets, high-net-worth clients are on the move — and advisors looking for a competitive edge are hunting whatever it takes to give those investors everything they want.

And what those investors want, according to the experts, is an easy way to pass their wealth on to future generations as securely and efficiently as possible. In other words, they want an advisor who can help them set up and fund trust funds.

“Clients are constantly seeking greater certainty over the safety, disposition and management of their assets,” says Bob Ellis, a consultant at Fast Track Advisors.

By creating their own captive trust companies, wealth advisors more strongly retain clients.”

That’s the logic that’s driven dozens of advisors to start trust companies across the country in the last few years, with the lion’s share going to the states that combine investor-friendly statutes with advisor-friendly regulatory environments.

South Dakota alone gained about a half dozen public trust companies last year, with more applications in the pipeline. Nevada, Delaware and other top-tier jurisdictions have also been big winners in what research firm Cerulli Associates calculates is a decade-long boom in trust company creation.

“Interest seems to be on the uptick,” says Mark Purpura, chair of Delaware’s state bar association’s banking committee.

“I currently have several trust company formations in the pipeline.”

Becoming the trust advisor

Advisors have gotten so hungry for information on this topic that the Trust Advisor is running an in-depth webinar in two weeks. (Register here.)

But all this interest is really business as usual, says former Nevada banking commissioner Scott Walshaw, who — like Purpura and Ellis — will be a panelist.

“The motives haven’t changed much,” he explains. “What’s changed is that there is more opportunity for people to open trust companies now than ever before.”

Wealth managers still see a trust charter as a way to differentiate themselves in the marketplace, tempt new clients and keep old ones from straying.

After all, everybody in the business claims he or she offers “financial planning,” but only 15% even support plain vanilla trust funds, much less have what it takes to run dynastic trusts, asset protection trusts or other specialized vehicles.

And while many of the 15% are content to refer their clients to a third-party provider, Bob Ellis says your AUM gets a lot stickier when you do it yourself.

“Advisors are seeking to ensure that the strategies they develop for their best clients can’t be easily unwound in favor of the next hot product or manager,” he says.

The right trust arrangement can keep the assets on your platform not only for the life of your client, but for generations to come — or even forever.

Location, location, location

In theory, an advisor who wants to start a trust company can gamble everything on a federal charter or find a state that offers the right combination of flexibility, tax breaks and regulatory oversight.

But because states vary widely in terms of the types of trust they allow — much less how hard they make it to apply for a charter — most of the capital has flowed into a few exceptionally trust-friendly jurisdictions.

In these states, the barriers to entry are not as high as many advisors might think.

Nevada and Delaware, for example, generally want to see around $1 million in capital on a trust application. South Dakota will work with applicants who have as little as $200,000 on hand.

As a result, even advisors who used to be content to hand off their trust business to a third-party provider are considering taking that business back in-house.

“If you have a big enough clientele to invest the capital, forming a new trust company makes financial sense,” Scott Walshaw says.

“You’re reducing the lines of communication your clients have to deal with and keeping tighter control over the fee structure and the expense side of things,” he adds. “You can decide what to pass along to your clients, or what not to pass along.”

For example, advisor-run trust companies are well within their rights to charge an administration fee — often 25 to 75 basis points — on the trust assets.

That fee would be hard to negotiate in a third-party relationship, but advisors with their own trust company have complete control over how the money flows.

The advisor can absorb the entire cost of running the account, pass it all on to the client or come up with any arrangement in between.

These accounts can be surprisingly profitable in their own right, by the way. Some states charge supervision fees of barely 6 basis points a year, giving operationally nimble firms plenty of room to make money.

Does a trust company make sense for you?

The traditional breakpoint for thinking about adding a trust company to an existing advisory business is at around $100 million in AUM.

At that level, the required starting cash can represent a year or two of the revenue those client accounts throw off — and it can take another year or two before the operation runs in the black.

For those a little lower down the food chain, there are always trust companies dedicated to directed trusts.

These arrangements keep the advisor in control of the way the assets are invested while taking on the work of administering the trusts themselves.

And while it hasn’t been tried yet, Walshaw is intrigued at the notion that several smaller advisory firms might team up to “share” a captive trust company.

“Get three or four friends together, and you might be able to do it,” he says.

Scott Martin, senior editor, The Trust Advisor

Permalink: http://thetrustadvisor.com/news/trust-charters

President Obama signed sweeping changes to  federal financial regulation this week, signaling perhaps the Democrats’ last major legislative victory before the midterm elections in November.

After over a year of bickering about everything from toasters to options trading, the financial reform bill is now a reality and the 20-year-old Office of Thrift Supervision’s days are numbered.

Starting next summer, the OTS will fold into the Office of the Comptroller of the Currency, which will take over supervision of about 745 thrift-structured lenders, trust companies and other institutions. Click here to request an Excel listing of all 745 OTS thrift institutions.

But, what won’t be folding anywhere are the existing powers thrifts have to operate in all 50 states.  They will, however, have to comply with new, more stringent capital rules regarding problem loans.

According to the OTS and the new rules,  no new national thrift charters will be issued anymore.

“We are changing regulators but still have a valid thrift charter,” explains Art Sims, president of Davidson Trust, which got an OTS charter in 2000. “That is not going away.”

With a year to consider their options, holders of national thrift charters are mulling their next moves carefully, Sims says. Some are considering asking the OCC to convert them into banks, but Davidson at least will probably stay right where it is.

No reason to change?

As Sims points out, these institutions went down the thrift route in the first place because the distinct advantages that operating model offered outweighed the downside.

Everyone I talked to while putting this story together told me that the OTS unified holding company rules made it easier to branch out. As long as you didn’t break any state statutes, all you really needed was a national thrift charter and you could set up remote offices instantaneously.

“It was a distinct advantage,” says Scott Walshaw, regulatory advisor of Advisors Institutional Services. “Presuming the regulatory provisions those charters are operating under right now are grandfathered, it will continue to be an advantage.”

One reason Davidson Trust went with the OTS when it was picking a charter was because the thrift system let it operate under the same rules wherever it chose to do business.

That uniformity has saved endless headaches as the company serves the customers of its corporate parent, the Davidson Companies, which does business in 15 states beyond its native Montana.

If anything, people who have worked with both OTS and OCC charters say that the national thrift charter is now not only an endangered species but a hot commodity.

“The people who are holding those federal charters will have a distinct valuable asset,” Walshaw says.

State charters are in play

Other OTS-chartered trust companies are weighing their choice as well.

One source close to an OTS trust bank–talking on condition of confidentiality–tells me that the institution started making plans to move to a state trust charter back in June in order to avoid having to deal with the overhaul.

For industry giants that, like Northern Trust, already have both thrift and banking charters, there is no reason to switch. If anything, having one less regulator to deal with simply streamlines the compliance process.

More locally focused players may find the idea of dealing with the OCC a little daunting, especially if rumors that the bank regulators are going to get stricter on thrifts come true.

Right or wrong, the OTS had a reputation for being a bit more lenient with reserves and the way it priced non-performing assets.

Since the old savings & loans had most of their portfolios tied up in real estate, a more flexible regulatory model made sense—at least in theory. But a lot of today’s thrift-chartered lenders are carrying a lot of bad debt on their books that might have passed OTS muster but not the OCC.

These lenders may be looking at converting to a state charter. In the new environment, the FDIC will still regulate state thrifts and the various state watchdogs will supervise trust companies.

Scott Walshaw wouldn’t be surprised if state thrift charters make a comeback as both new and established lenders opt for local regulation. For trust companies, of course, leverage and non-performing loans are both non-issues.

A nationally chartered trust company would probably find moving to state regulation to be more of a step backward than just going across to the OCC, Art Sims believes.

“A state charter can entail more effort and more cost to keep up with the state regulator, much less rethink what a change would mean for every location where you do business,” he explains. “It is less likely that people who have already committed to a national charter are going to want to go back to a state charter.”

When the rubber hits the road

As anyone who deals with regulators knows, all of this is still largely hypothetical.

OTS spokeswoman Janet Frank was able to point The Trust Advisor readers to the two sections of the 2,300-page Dodd-Frank rules that affect trust companies (here and here), but she admits that as yet nothing is set in stone.

“So much is up in the air right now and there are so many moving parts,” she says. “Guidance will be coming out as appropriate to tell our trust companies how the transfer will work, but I don’t know how or when that guidance will move.”

While the OTS is currently scheduled to disappear next July, Congress has the option to extend its life another six months if the transition bogs down. This means that an institution may not even deal with the OCC until 2012 at the earliest.

By that point, the OCC, OTS and the Federal Reserve should have had plenty of time to sit down and come up with a system for affected trust companies to follow.

“Naturally, I would hope they do it soon in order to eliminate uncertainty and give people time to rethink their business plan,” Scott Walshaw says. “But it could take two years for the dust to settle, and in the meantime it’s anybody’s guess.”

Scott Martin, contributing editor, The Trust Advisor Blog. Steven Maimes contributed to the research and the editing.

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Permalink: http://thetrustadvisor.com/news/ots

Experts recommend wealth managers conduct due diligence before sending a client to a bank’s trust dept.

With 700 banks still on the FDIC’s secret “problem list” and banks getting shut down on almost a weekly basis, the financial sector is still in its worst shape since the early 1990s.

But until recently, relatively few people worried what would happen if fiduciaries started failing along with banks.

FDIC spokeswoman LaJuan Williams-Young told me, advisors recommending a bank to hold client assets should be on guard.

The good news is that no federally insured financial institution with the legal power to operate as a trust company failed in either 2008 or 2009. However, this year five banks with trust assets have been taken over by the FDIC.

“There are definitely banks that have considerable problems and some of them have trust departments,” she said.

She wouldn’t single out any trust banks in particular, but said the ones the regulators have their eyes on generally have a lot of problem loans and a track record of enforcement actions against them.

Cracking the Code

L. Scott Walshaw, Nevada’s former banking commissioner and regulatory advisor with Advisors Institutional, says sending a client to a bank that wind ups failing can affect the relationship. It’s better to do some homework. Figuring out which banks are in bad shape can be a matter of “reading the tea leaves,” but he gave me more specific pointers for spotting serious trouble ahead of time.

While most of the steps leading up to the FDIC taking a bank over are hidden from the public, a bank usually gets an official cease and desist order—usually a last warning to clean up its lending habits and beef up its balance sheet. If it fails to comply or improve on its own, it’s a strong candidate for getting sold off.

These orders are part of the public record, so anyone can check the FDIC website to see whether a bank’s condition has deteriorated to that point. So far this year, 40 banks have gotten the orders, but only 7 have had trust departments: Cowlitz Bank in Longview, WA; First Security Bank & Trust in Norton, KS; State Bank of Burnettsville in Burnettsville, IN; Clarke County State Bank in Osceola, IA; Security State Bank in Scott City, KS; Bank of Smithtown in Smithtown, NY; and Citizens Union Bank of Shelbyville in Shelbyville, KY.

All have relatively small trust departments. The biggest, Cowlitz Bank, has a total of $70 million in fiduciary assets.

Knowing the Risks

When a federally insured fiduciary fails, its trust accounts are currently protected up to $250,000 per qualified beneficiary, LaJuan Williams-Young at the FDIC says.

While that may scare some advisors whose clients have put millions of dollars in stock or real estate into trust at a weak bank, it may not necessarily be a big deal, Scott Walshaw told me.

That’s because the FDIC insurance limit only applies to products issued by the bank that failed. Certificates of deposit held within the trust account are subject to the $250,000 limit. Stocks and real estate aren’t.

As long as the assets are managed properly and your clients’ trust bank is FDIC-insured, Walshaw says, it won’t matter whether it fails or not. The fiduciary assets simply roll over to the financial institution that takes it over and, as Walshaw puts it, “Nobody’s even going to get a haircut.”

In the worst case scenario, he says, the FDIC will simply liquidate the bank and turn insured cash and other assets back to the outside trustee, who now needs to find a new trust company.

“Other than perhaps the inconvenience of having to move from one institution to another—which is normally done for you by the FDIC—that’s it,” he told me. “There’s really little if any risk to the beneficiaries as long as the limits are satisfied.”

However, some experts warn that failure to satisfy the limits does expose advisors to some degree of reputation risk if the bank fails.

According to a report the Virginia State Bar Association did a few years ago, lawyers may not be immediately liable if trust assets are lost in a bank failure; after all, there are hundreds of non-FDIC-insured trust companies out there, and some legal precedent for holding the advisor blameless when those companies go under.

Still, James Barr, the association’s ethics counsel, warned Virginia lawyers that leaving even a small part of their clients’ assets in weak banks outside the FDIC’s protection can damage their reputation and isn’t really good practice.

“Regardless of possible malpractice or disciplinary exposure, good lawyers take reasonable measures to prevent or mitigate financial loss to clients,” he said.

Trusts not the Problem

In any event, banks with trust departments tend to be more stable than those that focus exclusively on lending. Nobody I talked to had ever heard of a trust department dragging down a bank.

Usually, it’s the other way around, says Mike Heller, president of a company called Veribanc, which provides independent bank safety ratings.

“Most of the FDIC-insured trust companies have a much broader portfolio,” he told me. “I don’t know of a single bank that’s failed because of the trust department.”

For Northern Trust and other huge trust banks that analyst Dick Bove at Rochdale Securities covers, the trust business itself is not part of the problem. The big risk to worry about is litigation, he says.

“Unless the bank gets sued for things that have to do with trust activity, the trust department isn’t really in a position to create risk,” he told me. “If anything, trust accounts can help a bank weather the credit cycle by giving them earnings when the lending market does poorly.”

Scott Martin, contributing editor, The Trust Advisor Blog. Steven Maimes contributed to the research and editing.

Permalink: http://thetrustadvisor.com/news/fdic

Private trust companies or family trust companies cater to ultra-high-net-worth individuals with at least $100 million in investable assets. These trust companies which have been set up by families to avoid the necessity of using third-party trust companies and who have special assets such as closely held family businesses, real estate or partnership interests or don’t feel comfortable handing over their assets either to an individual or to a big trust company to manage.

Private trust companies often have boards set up with various committees that enable family members from many generations of branches to be involved in managing the family’s wealth.

Private trust companies launches hit a peak in 2007 with 4 launches and when they were chronicled in a Wall Street Journal article; Wall Street Journal; Matters of Trust: Super-rich Setup Companies. According to the WSJ story, private trust companies have been promoted by private trust company expert John P. C. Duncan, a Chicago lawyer. Duncan reported, in 2007, that the numbers have increased because more trust lawyers have touted their benefits.

TRUST COMPANY TRENDS

South Dakota public trust company start-ups have surged this year. Last month, The Trust Advisor reported an increase in start-ups nationwide including South Dakota. With five launches completed and several other now awaiting filing, 2009 will likely become a record year for the State.

SHIFT TO NEVADA?

Perhaps the reason for the decline in South Dakota is that many trust lawyers are waiting for a new Nevada law to become effective October 1, 2009,  Nevada SB-310 which permits private family trust companies to be setup without special licensing and without regulatory capital. Previously, Nevada required private trust companies to have $300,000 of regulatory capital.

Earlier this year, Duncan testified at a Nevada State Senate Hearing in support of SB-310, endorsing higher capital requirements for public institutions and no licensing or capital requirements for private family trust companies.

L. Scott Walshaw, Nevada’s former banking commissioner and regulatory advisor with Garrison Institutional said, “It’s too early to determine that the decline in South Dakota is a definite trend. There is not enough data to statistically validate any conclusions.”

Walshaw added, “Besides the year is not over and there could be ten filings before the end of the year. As for the shift to Nevada no one knows how many new trust companies will be incorporated under SB-310.”