Trusts, Except Educational, Religious, and Charitable

SIC 6733

Industry report:

The trust industry is comprised of companies that manage trust funds and foundations, excluding those whose beneficiaries are educational, religious, and charitable organizations.

Industry Snapshot

Many banks and brokerages served the trust needs of personally wealthy and institutional customers in the early 2010s--though not as many as a few years previously. Many banks and other financial institutions failed during the financial crisis of the late 2000s. Basically, in an effort to stimulate a lagging economy in 2001, the Federal Reserve began cutting interest rates, which in turn stimulated the housing market. The number of houses sold and the prices of houses rose dramatically in 2002. Many of these mortgages were packaged and sold as bundled securities to investors. The resulting profitability of mortgages encouraged banks to loosen lending standards and grant mortgages to even more consumers, including those with little or questionable credit. In addition, exporting much of the risk of mortgages to investors freed up capital for banks, and they offered very low adjustable rate mortgages (ARMs). However, in 2006, the housing market stalled, and interest rates started to rise as the prices of houses fell. Many of the ARMs granted earlier started to be reset at higher rates, resulting in large increases in many Americans' house payment. Thousands of Americans were not able to make this higher payment and defaulted on their loans. Foreclosures rose to record levels, and many banks were forced to close their doors. In 2008, 25 banks failed in 2008. In 2009, this figure rose to 140, and in 2010, 146 had failed by mid-November. Many of the banks that did survive incurred huge losses. Overall, according to an analysis by Hoover's, "Deep exposure to subprime mortgages and mortgage-backed securities caused bank failures, government takeovers, and involuntary mergers." In 2010, as stated by Hoover's, "Although the financial climate has improved, slow demand for loans and increased government regulation may result in a long recovery period for the banking industry." This "increased government regulation" came in the form of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which proposed sweeping changes in the financial services sector of the U.S. economy.

Wealth management services had become very popular during the early twenty-first century. Trusts were seen as a way to protect large amounts of money as more of the substantially wealthy considered the stock market too risky. The uncertain future of Social Security also had baby boomers looking for ways to protect their money. By 2020, trillions of dollars of wealth are expected to change hands from generation to generation. Many institutions require customers to set minimum trust amounts between $400,000 and $1 million.

Organization and Structure

A trust is a tool that an individual or institution uses to transfer property to a beneficiary. The entity that grants the property is called the trustor. The trustor gives the property to the trustee, who is charged with the task of disbursing the property to a beneficiary according to the instructions of the trustor. One advantage that a trust has over a simple gift is that the trustor can exercise control over the disposition of the property over time, providing stipulations that must be adhered to even after an individual trustor has died or an institution acting as trustor has dissolved. A second and perhaps more important advantage is that trusts can often be used to minimize tax burdens incurred when transferring wealth.

Trustee Duties and Benefits.
Although trust companies and banks expect to make a profit by acting as trustees, they have a legal responsibility to act in the best interest of the beneficiary and the trustor and to conduct their activities with skill and care. Responsibilities include protecting trust assets from attack by outside parties, dispensing property to beneficiaries, investing trust assets in a prudent manner; keeping accurate records, and accounting to the beneficiary as specified by the trustor.

In return for their services, trustees are compensated by one of several methods. One pricing schedule delegates a percentage of the market value of assets under management to a trust account. Under this arrangement, trustees typically charge from 0.1 to 0.5 percent, and in some cases as much as 1 percent per year of the total value of assets in the trust. For example, a $2 million trust fund might yield $5,000, or 0.25 percent, in annual fees.

Similarly, some trustees charge a "gross income receipts fee," which is a percentage of income collected from interest and dividends on the account. For instance, if the trustee earned interest and dividends of $50,000 by investing account assets for a period of one year, the trustee might receive 5 percent of those proceeds, or $2,500. In addition to these charges, some trustees charge minimum annual management fees and activity fees for special services.

Types of Trusts.
Noncharitable trust accounts managed by banks and trust companies are categorized as either individual or institutional accounts. Individual accounts can be further classified into personal agencies or trusts. Personal agency accounts are different from ordinary trust accounts in that property does not actually change hands. Instead, the trust company simply manages assets under the direction of its client, often acting as a safekeeping agent, custodian, manager, or escrow agent. The company may provide complete investment management and reporting services as well.

Individual trust accounts involve a beneficiary. The trustor establishes an account with a trustee that manages, invests, and distributes the property. Income from the assets is then used to benefit dependents, organizations, children, or other people or entities. The trust may also be used to benefit the trustor. A multitude of trust structures exist allowing a trustor to achieve various tax benefits and to retain varying degrees of control over account assets.

Two types of individual trusts are guardianships and estate settlement accounts. Under a guardianship arrangement, the trustee acts as a guardian of a minor or mental incompetent, caring for the property that benefits that person. Estate settlements, on the other hand, involve securing and valuing a client's assets, distributing assets in accordance with a will, and otherwise representing the client's wishes at death. Individual trusts are also classified as either revocable or irrevocable. Revocable trusts are used to distribute wealth while the grantor is still living and can be amended at any time. In an irrevocable trust, the trustor relinquishes all control over account assets.

Like individual trusts, institutional trusts can also be broken down into agency and trust accounts. Institutional trusts, however, exist to raise capital for businesses, to reward employees, or to provide income for retired employees. The two most common types of corporate agencies are transfer agencies and registrarships. Trustees in these agency relationships serve to transfer and register stocks and bonds.

Under a corporate trust, the trust company acts as a trustee for a group of people that lends money to a corporation through bonds or other obligatory instruments. Employee benefit accounts are another form of corporate trust. These trusts provide full custody services, compliance reporting, investment management, and special record keeping of each participating employee's interest in pension, profit-sharing, and other benefit accounts.

Background and Development

In the United States, the trust business got its start in 1822. That year, Farmer's Fire Insurance and Loan Company of New York became the first institution chartered to engage in the trust business. Besides serving the needs of wealthy individuals, the company pioneered the concept of corporate trusts in 1830, to help raise money for business ventures. Over the next 50 years, the number and types of institutions engaged in the trust business rose rapidly. Most of these entities maintained a separate department that was devoted exclusively to trust services, which was removed from the firm's other business concerns.

In 1906, Congress elected to allow banks to begin engaging in the trust industry. As a result, about 1,300 national banks were offering trust services by 1920. After the Great Depression, the industry was rattled by legislation that essentially restricted institutions other than banks and trust companies from serving as trustees. Legislation also established what became known as the "Chinese Wall," which referred to measures that forbade commercial and trust departments of a bank from sharing customer credit or investment information.

Furthermore, as a result of the ways in which the Depression brought about new attitudes toward saving and investing for the future, the industry began to encompass more diverse segments of the American population. Employee benefit trusts, for example, became popular in the 1940s. Since that time, employee benefit trusts proliferated so rapidly that Congress enacted the Employee Retirement Income Security Act (ERISA) in 1974 to define the responsibilities of trustees managing those funds. By 1986, employee benefit trusts represented more than 40 percent of all U.S. trust assets.

Investments in individual trusts also escalated after the Depression. Wealthy individuals, in particular, increasingly used trusts as a way to invest their savings and to transfer wealth. Increases in tax benefits that allowed trustors to avoid estate and gift taxes also boosted the trust industry.

The 1970s and 1980s.
In the late 1970s and early 1980s the trust industry began to undergo changes caused by a number of economic and regulatory influences. For instance, high interest rates and deregulation of certain sectors of the financial markets prompted trust departments to invest their assets in new instruments. Instead of traditional T-bills and commercial paper, trustees began putting money into certificates of deposit, money market funds, variable-rate notes, and other more risky investments. In addition, a strong economy in the mid-1980s generated an influx of investment dollars, much of which went into trust funds. Between 1980 and 1986, the total amount of money invested in trusts jumped from $571 billion to $1.065 trillion.

Although industry assets under management continued to climb throughout 1987, trustees began to suffer in the late 1980s. The Tax Reform Act (TRA) of 1986, for instance, increased paperwork for trustees and created some confusion, serving to discourage the use of trusts and estates as devices to accumulate wealth. The act's provisions also added to the already rising costs associated with managing trusts.

The TRA and other regulatory measures, in addition to the recession of the late 1980s, began exerting downward pressure on trust department profit margins. Investment in trust funds slowed in the late 1980s at the same time that investment returns were shrinking. Even a massive industry investment in labor-saving technology during the 1980s was not enough to buoy profits for many companies. Between 1987 and 1989, the number of trust companies dropped from 6,285 to 4,283, and total employment fell from 32,491 to 25,853. The total payroll of those companies also fell from $666 million to $574 million. At this time, approximately $229 billion in employee benefit trusts and $342 billion in other types of trusts were being managed by trust companies.

The decline in the growth of funds invested in trusts reflected a recessed economy in the late 1980s that persisted into the early 1990s. Contributing to the decline was competition for U.S. investment dollars between banks, trust companies, and other financial institutions. In addition, trust departments at all financial institutions were facing rising management costs, the threat of federal tax laws that could potentially diminish some benefits associated with trust funds, and decreased investment returns caused by the recession. Although employment in the industry remained below its peak levels of the late 1980s, the flow of money into noncharitable trusts showed an increase in the mid- to late 1990s as the U.S. economy experienced unprecedented growth.

In the 1990s, the trust industry was facing the promise of asset growth throughout the decade. The most important reason was the increased amount of personal saving by aging baby boomers and their need to arrange means to transfer wealth, which was likely to elevate opportunities available to trust companies and banks. The trust industry grew in importance in the late 1980s and 1990s, as well, because service fees from trusts had become an important stream of revenue for many banks that were suffering losses on loan portfolios.

Despite the expectation of a recovery in the industry, trustees were still struggling to maintain profits in an increasingly competitive marketplace. Mutual funds, defined-benefit contribution plans like the 401(k), and other investment vehicles were competing for investment dollars that might otherwise go to banks and trust companies. Trust departments were also battling rising costs associated with reporting, accounting, and investment activities.

However, Congress passed the Taxpayer Relief Act of 1997 that raised the amount of total assets permitted in a trust without tax penalty to $1 million by 2006. The passage of this legislation was expected to cause some to use trusts more in estate planning.

Cutting Costs.
To remain competitive and sustain profit margins, most banks and trust departments continued their efforts to reduce administrative costs, improve investment performance, and improve service in the 1990s. The most potent weapon to cut costs was new technology. In addition, many trustees were actively marketing their services for the first time, rather than waiting for business to come to them. Some banks, for instance, were giving their trust officers specific client-contact goals that encouraged them to initiate new business.

Another important change that many trust departments were experimenting with was performance-based incentives for investment personnel. Indeed, some trust departments were realizing productivity gains by linking the performance of their investments to portfolio managers' compensation. Trustees were also achieving savings by grouping accounts with similar investment objectives, allowing them to operate more efficiently and to obtain leverage in their investment purchases and sales.

Cost-cutting efforts were likely paying off, according to one study conducted by the American Bankers' Association. The study indicated that commercial bank trust departments outperformed nonbank investment managers over a ten-year period ending in 1992. The study showed that bank trusts produced higher yields than mutual funds, insurance companies, and equity fund advisors. Furthermore, bank trusts exhibited more consistent results, according to the study, because they had lower risk profiles.

After the dot-com and telecommunications bust during the late 1990s and recession of the early 2000s, trusts increased in popularity as wealthy individuals and institutions looked for ways to shield their funds from an uncertain stock market. Although the economy improved and the stock market rebounded by the mid-2000s, trust divisions became integral parts of the wealth management systems of many banks and brokerages. In 2005 Fidelity Investments announced the creation of a separate entity to provide services to institutional trust clients and other nonmutual fund businesses.

However, the traditional trust industry continued to face significant challenges According to American Banker, in the mid-2000s, only 4 percent of the ultra-rich (with investable assets in excess of $5 million) considered a trust department as their primary financial adviser for their wealth. Most turned to brokers and financial managers. According to American Banker's survey, respondents retained 54 percent of their wealth in trusts, but most were managed by a family member or an attorney. Less than one-third used an institutional trust as trustee.

The financial crisis of the late 2000s had an impact on all aspects of the money management industry. On the regulatory front, debates abounded regarding the role of the Gramm-Leach-Bliley Act of 1999, which first allowed mergers between investment and commercial banks. In addition, the industry faced the implications of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Passed in 2010, the act called for a sweeping reform of the entire U.S. financial services sector.

Current Conditions

By late 2010, the U.S. residential mortgage-backed securities market had $8.9 trillion in outstanding debt. According to a November 2010 Investment Dealers' Digest article, "Even after the credit crisis, mortgage bonds reside in all kinds of portfolios from banks and pension funds to foreign governments and central banks." As a result, many of the changes that were occurring in the trust industry in 2010 related to transparency and reporting requirements. Although the effects of the Dodd-Frank Act were as yet to be realized in late 2010, the trust industry was sure to find itself closely examined by both the public and the federal government in the coming years.

According to Dun & Bradstreet, in 2010 17,592 establishments were engaged in the management of the funds of trusts and foundations organized for purposes other than religious, educational, charitable, or nonprofit research. Together these firms employed 54,486 people and generated $16.2 billion in annual revenues in 2009.

Industry Leaders

In 2007 the Bank of New York--on its third attempt at purchasing former industry leader Mellon Financial Corporation--finally succeeded, creating The Bank of New York Mellon Corp. The New York-based company reported $8.2 billion in revenues in 2009. Other major players that managed to hang on to their hats during the financial meltdown of the late 2000s included Northern Trust Corp., located in Chicago. Founded in 1889, by 2010 Northern Trust had 85 offices in 20 states and about 12 countries. The firm reported revenues of $4.1 billion in 2009. State Street Corporation of Boston was another leader in the trust and custody business. In 2003 State Street sold its private asset management business to U.S. Trust and its corporate trust business to U.S. Bank N.A. State Street continued to offer trust and money management services around the world and reported revenues of $8.4 billion in 2009. Some of the largest banks in the country were also involved in the trust segment of the financial services industry. One of these was Wells Fargo & Co. of San Francisco, which doubled its size when it bought Wachovia Services in 2008. Wells Fargo reported overall revenues of $98.6 billion in 2009. Citigroup Inc. of New York restructured after losing more than $90 billion in mortgage-backed securities and other investments in the late 2000s and reported sales of more than $108 billion in 2009. Other industry leaders included New York-based JP Morgan & Chase Co., with revenues of $115 billion. Finally, Deutsche Bank Securities Inc., located in New York and the U.S. arm of the German giant Deutsche Bank, recorded sales of $7.5 billion in 2009.

Research and Technology

Advanced computer systems and information technology had become a vital link to survival for many trustees by the mid-2000s. By implementing labor-saving information systems, trustees reduced costs, eliminating errors, and improving the efficiency of their reporting operations. The systems were used to maintain inventories of account assets, determine when and to whom disbursements should be paid, calculate dividend payments, print checks, and handle tax accounting and reporting tasks.

For trust departments that wanted the advantages of high technology without having to manage the investment and implementation, outsourcing became a popular option beginning in the 1990s. By outsourcing many of their trust operations to third party vendors, trustees reaped the benefits of automated accounting, control, and reporting systems that were completely integrated with their investment and customer service activities. Many trust departments were quickly reducing operations costs by 15 percent to 40 percent, while at the same time having more predictable and less-risky cost outlays that would be required by in-house automation.

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