Unique Asset Survey: Findings & Recommendations

a feature article appearing in the June 2014 (Issue No. 583) issue of the ABA Trust Letter, published by the American Bankers Association

Trust institutions have long known their best customers own unique assets such as real estate, closely-held businesses and mineral interests, and recognize these assets are often very valuable. But until August 2012 when the Office of the Comptroller of the Currency published its Unique and Hard-to-Value Assets Handbook, there was no trust industry standard detailing what was expected of institutions holding them.

Now there is. In a nutshell the Handbook says trust institutions have two primary unique asset responsibilities: to manage them properly and to value them accurately.

The Handbook's publication is focusing the trust industry's attention on unique assets like never before. Banks are taking a fresh look at how they are managing the unique assets they already hold, and those they expect to accept going forward. Naturally they are curious to know how their practices compare to their peers, so spardata Value Advisors and the Fiduciary and Investment Risk Management Association, Inc. (FIRMA™) decided to conduct a survey detailing unique asset practices prevailing in the trust industry today.

Over a seven month period 45 banks with total trust assets ranging from $4 million to $151 billion (average of $9.0 billion; median of $1.9 billion) participated in the Unique Asset Survey. The final report is a candid and straightforward presentation of our findings, observations and recommendations. This article highlights three key findings. There are many more but due to space limitations this article does not discuss them. The Survey may be purchased from FIRMA for $149 ($99 to FIRMA members): email amy@thefirma.org or call 678-565-6211 or visit www.thefirma.org.

Exhibit 1

Who Owns Unique Assets?

The Internal Revenue Service conducts ongoing studies of Federal estate tax returns. Since only estates worth $5 million or more must file estate tax returns, these studies paint an interesting and often surprising picture of the assets owned by America's most affluent citizens.

Among estates filing estate tax returns in 2012, the dominant asset class owned was liquid assets such as stocks, bonds and mutual funds (shown in red on Exhibit 1). No surprise there. But what is surprising is that liquid assets comprised only about half of the assets (46% of smaller estates, 52% of larger ones). What about the other half?

Real estate is a reasonable guess and a correct one. The affluent do own real estate (shown in blue on Exhibit 1): 25% of assets in the smallest estates down to just 10% of assets in the largest ones. But another 29%-38% of the assets in estates filed in 2012 (shown in green) consisted of other types of unique assets including private equity investments, hedge funds, closely-held stock (often in family-owned businesses), limited partnerships, oil, gas and mineral interests, insurance and collectibles.

Assuming estate assets are representative of assets owned by affluent individuals generally, the main takeaway is that unique assets represent 48% to 54% of the assets of high net worth individuals. Unique assets equal liquid assets in importance, yet the Survey reveals they are treated as an afterthought by the trust industry.

Three Key Findings

While the Survey asked dozens of questions and drew many conclusions, three in particular are worth highlighting.

Exhibit 2

1. Banks hold fewer unique assets than expected. The Internal Revenue Service analysis of estate tax returns noted above suggests unique assets comprise roughly half of the assets of high net worth individuals. However the Survey revealed the unique assets held by the surveyed banks represent far less than one-half of their total trust assets. In both managed and directed accounts, unique assets are a dramatically under-represented asset class.

The Survey's authors think this phenomenon is likely due to (i) banks lacking the expertise to manage and value unique assets so they shy away from accepting them; or if they possess the expertise (ii) the unique asset services they offer are not what their customers want, or (iii) the banks may be marketing their services ineffectively. Whatever the reason, growth-minded banks should view unique assets as an opportunity to gather assets and grow fee income.

2. Most banks appear to treat unique assets as an accommodation, not a profit center. 90% of the surveyed banks - a shockingly high percentage, in the Survey authors' view - seem to view unique assets not as a business intended to make a profit but as an accommodation. These banks appear to have accepted their customers' unique assets not because they wanted to but because they were forced to in order to win the competition for their customers' liquid assets.

These banks are in a pickle. Having accepted their customers' unique assets, the Handbook expects them to manage the assets properly and value them accurately. Yet the 90% appear to provide few (if any) services their customers find valuable, fail to cover their costs (let alone earn a profit), and do little to mitigate their risk exposure. Perhaps it is an overstatement to say this is a crisis but if it is not yet a crisis, it is at least a serious problem.

In sharp contrast, roughly 10% of the banks surveyed seem to be managing their customers' unique assets effectively in the sense they

  1. offer services their customers find valuable and are willing to pay for;
  2. meet or exceed the standards described in the Handbook; and
  3. charge sufficient fees to cover their costs and generate a reasonable profit.

3. Examiner focus varies by agency (and even among examiners within same agency). While Federal and state trust examiners collectively identified a wide range of unique asset problems at the 45 surveyed banks, each bank typically reported its examiner focused on just one or two issues (i.e. stale prices or arbitrary prices or poor documentation or inconsistent treatment of similar assets), and furthermore the issues focused on (and the corrections requested) seemed to vary from examiner to examiner and/or from year to year.

Banks and their unique asset-owning customers would benefit if trust examiners from the various Federal and state agencies (and especially examiners within the same agency) focused on two or three issues at a time, and clearly stated what banks should do to correct any deficiencies.

Recommendations

Trust institutions should never forget their high net worth customers own both liquid and unique assets. Profit opportunities exist for banks willing to manage and value both. Banks lacking unique asset expertise should consider either building the capability or buying it. Those with sufficient scale may opt to hire staff with the requisite expertise; smaller banks (or large banks dipping their toes in this pond) may prefer to acquire the necessary expertise using unique asset service providers.

The Survey's single most alarming finding is that 90% of banks seem to consider holding unique assets not as a business but as an accommodation forced on them in order to win control of a customer's more attractive liquid assets. It is very likely that many banks among the 90% would rather belong to the 10%. What prevents them may not be a lack of desire but rather a lack of know-how. Unless someone at their bank happened to have worked at one of the 10% banks, they may have no resource that can point the way.

To that end spardata and FIRMA believe the trust industry would benefit by having an Unique Asset Road Map consisting of case studies telling the stories of a large national bank, a regional bank and a small community bank, each of which belong to the 10%. The document will describe:

  • each bank's practices back when belonged to the 90%;
  • who or what was the initial spark that motivated it to start on the path to change;
  • how it got buy-in from key stakeholders along the way;
  • what obstacles appeared and how those obstacles were conquered; and finally
  • the rewards the bank now enjoys for having made the journey.

The Road Map is being prepared now and is scheduled to be available in the fall of 2014. Bankers who would like to know when the Road Map becomes available for purchase should send an email expressing their interest to bdavidson@spardata.com.

About the author

Brad Davidson is President of spardata Business Valuation Experts of Baltimore Maryland and is a recognized expert in the valuations field. Organizations which have invited Davidson to lecture include the Internal Revenue Service, the Securities and Exchange Commission, the North American Securities Administrators Association, the Department of Labor, the Federal Financial Institution Examination Council, the Federal Reserve, the Michigan Bankers Association, the Virginia Bankers Association and the American Society of Pension Actuaries. spardata has been cited on numerous occasions by the Wall Street Journal, the Washington Post and other publications. You may contact him at bdavidson@spardata.com or 240-553-1100 x107.

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