Wall Street, searching for a fresh burst of growth, is going all-in on Main Street.
The latest effort on this front came this past week when Morgan Stanley (ticker: MS) unveiled a $13 billion all-stock deal to buy E*Trade Financial (ETFC), signaling that the elite Wall Street bank will compete aggressively for retail banking and brokerage customers. The combined entity will have revenue of $44 billion, eight million customer accounts, and $3.1 trillion of client assets.
While the deal represents the biggest acquisition by a Wall Street bank in a decade, rivals have similar ambitions to capture new business from individual retail investors. Goldman Sachs Group (GS) has been investing heavily in its online bank, Marcus, among other initiatives. Begun in 2016, Marcus now has $60 billion in deposits and generated $860 million of revenue in 2019.
Bank of America (BAC) and JPMorgan Chase (JPM), meanwhile, have launched discount brokerage platforms, bringing in millions of new customers. JPMorgan is offering $2,000 as a signing bonus for new clients who bring in at least $250,000.
Behind the push: Banks are searching for new avenues of growth after being curbed by post-financial-crisis regulation. Trading profits—once a boon for banks like Morgan Stanley and Goldman Sachs—have become less reliable as these banks have had to contend with higher capital-reserve requirements and intensified regulatory oversight since the crisis. Goldman reported that its global markets business, which houses trading, earned just a 7% return on equity last year, while tying up half of the bank’s capital.
Revenue from retail banking and advisory tends to be stickier and more predictable than trading and investment banking. And mass-affluent customers are now viewed as prime prospects for higher-end wealth management, even coming with an acronym: Henry (high earner, not rich yet).
By the Numbers: Client Assets
How banks and brokers rank on individual-investor assets under management.
*Assumes combination | **Discretionary assets | Source: Company Reports
Given the tougher regulations on trading and stricter capital requirements, Wall Street banks have found it difficult to merge in their core areas. Regulators are likely to be wary of deals that would concentrate more assets in firms that pose systemic financial risk. Bank of America and JPMorgan are now so large that they would face pushback from regulators and politicians if they tried to make a major banking acquisition.
Tacking on retail banking and brokerage assets may not invite as much scrutiny. Morgan Stanley CEO James Gorman said that the bank expects to win approval for the E*Trade deal in the fourth quarter and that there is no regulatory input on the structure of the deal.
“We believe it’s straightforward to add to businesses we’re already in, which doesn’t require more capital or balance-sheet intensity,” he said. “It should be attractive from a regulatory perspective, but ultimately it’s up to the regulators.”
All told, the deal gives Morgan Stanley scale across a variety of businesses. “There are numerous financial positives to the transaction,” Gorman said. E*Trade’s pretax profit margins are over 40%, he pointed out, and will lift Morgan’s wealth management margins above 30%. And E*Trade will lift Morgan’s deposit base to over $200 billion. “They have seven million clients, which gives us access to seven million more investors, which we love,” he said.
E*Trade brings a few other prized assets to Morgan Stanley. Included in its $360 billion of client assets are $56 billion in cash deposits—a low-cost, stable funding source that Morgan Stanley can transform into interest income for its bottom line. Morgan Stanley could even turn E*Trade Bank into a full-service online bank, going up against Schwab Bank and others in digital financial services. Additionally, E*Trade’s technology platform is considered one of the best for individual traders, and it can be a pipeline to attract brokerage and advisory customers.
E*Trade’s crown jewel may not be its brokerage platform. Rather, it’s the $300 billion in stock-plan assets that the firm oversees (managing accounts for corporate executives and others who receive grants and options from employers). Morgan Stanley is also a major player in stock-plan servicing with 2.7 million participants, mainly through its acquisition last year of Solium Capital. Combined, Morgan Stanley and E*Trade will have $580 billion in stock-plan assets with 4.6 million clients—many of them prospects to convert into advisory and brokerage customers.
“This is a huge opportunity for us to be a player in all three channels: workplace, direct, and advisory,” Gorman, who orchestrated the deal, said in an interview with Barron’s. “It solidifies us in workplace and gets us into direct digital in a big way. We’re not messing around.”
E*Trade does come with a few skeletons. Morgan paid a 31% premium to E*Trade’s closing price before the deal was announced. It will dilute Morgan’s tangible book value by 10%, said Sandler O’Neill analyst Richard Repetto, partly because E*Trade has so much goodwill on its books from prior acquisitions. Analysts also expect earnings per share to be diluted by the increased stock issuance. Moreover, E*Trade was building out an advisory platform through its acquisition of Trust Company of America, an effort that conflicts with Morgan Stanley’s in-house ranks of nearly 16,000 advisors.
Whether Morgan Stanley is overpaying and whether the stock will benefit are debatable. The deal should make Morgan less capital-intensive, improve margins, and give it a presence in fast-growing digital retail channels. Morgan Stanley is counting on $400 million in savings to the combined firm’s cost structure and expects the deal to add to earnings in 2023.
Wells Fargo banking analyst Mike Mayo downgraded Morgan Stanley shares to Equal Weight from Overweight in the wake of the transaction, calling it “value-destroying.” “Morgan Stanley is paying a hefty price for a company that isn’t best in class and is sensitive to both the stock market and interest rates,” Mayo told Barron’s. “It’s strategically risky and financially dilutive and comes at a suspect time. We’re not calling a top in the market, but there is record retail engagement.”
Gorman, however, says E*Trade will improve Morgan’s return on tangible common equity—a measure of profitability. He says E*Trade’s advisory platform is relatively small. Morgan Stanley trades at just 10 times earnings versus a multiple of 18 for Schwab, implying that it is sharply undervalued.
And Gorman isn’t fazed by the 6% selloff in the stock since the deal was announced. “I take a much longer-term view on dilution and impact on the stock,” he said. “I’m focusing on long-term growth, and this materially enhances it.”
While Morgan Stanley has steadily moved deeper into wealth management in the years since the financial crisis, Goldman Sachs has deepened its efforts only recently. At its first-ever investor day last month, Goldman Sachs acknowledged that it was starting its business with a “blank slate…no legacy technology, no retail bank branches.”
Goldman, however, sees a big chance to grab some share. Its private wealth management business garners roughly $3.5 billion in revenue annually, yet has only 3% of global market share. Gaining just half of a percentage point more market share, by hiring more advisors, would bring in an additional $650 million, management said last month. (For perspective, Goldman’s total revenue was $36.6 billion in 2019.)
“ This is a huge opportunity for us to be a player in all three channels: workplace, direct, and advisory. We’re not messing around. ”
Goldman’s Marcus platform has garnered the most attention in its retail push. In its three years, Marcus has grown rapidly. Over the next five years, Goldman hopes deposits and loans will exceed $125 billion and $20 billion, respectively, up from $60 billion and $7 billion.
At a recent investor day, Goldman CFO Stephen Scherr said that “more consistent and durable revenues” would help drive the bank’s return on equity to more than 13% by 2023. It was 10% in 2019. “The path to achieving these targets will not be linear, top-line growth may vary, new initiatives may take longer,” Scherr said, referring in part to Marcus and its credit card with Apple. “They will not only be revenue-accretive, but will contribute to a more stable fee-based revenue, based on more static expenses.”
JPMorgan runs one of the largest private banks with $1.5 trillion in assets, and it has also built out a lesser-known group of businesses that cater to U.S. retail investors. These businesses—the bank’s digital platform, You Invest; J.P. Morgan Securities (which includes the former Bear Stearns brokerage business); and 4,000 financial advisors working largely out 3,500 bank branches—were grouped under a U.S. Wealth Management umbrella in December with $400 billion in assets.
JPMorgan believes it now “has the ability to serve every client in whatever way they would like to invest—self-directed, digitally, or with advisors in branches.
For its part, Bank of America has expanded the wealth management platform that it acquired more than a decade ago with deals for U.S. Trust in 2007 and Merrill Lynch during the 2008 financial crisis.
While Morgan Stanley is buying a major player in the online brokerage business, Bank of America built one over the past decade with Merrill Edge, its online brokerage platform, and the newer and smaller Merrill Guided Investing that offers professionally managed investment strategies. Together, these businesses had $240 billion of client assets at the end of 2019, two-thirds the total of E*Trade.
Bank of America’s traditional brokerage business, Merrill Lynch Global Wealth Management, has $2.6 trillion in client assets, and Bank of America Private Bank has almost $500 billion. The bank has 3,000 financial advisors in 4,300 branches.
The Morgan Stanley/E*Trade merger won’t change any of the underlying dynamics in the industry. Fee pressures are rampant in trading commissions, funds, and asset management. The brokers are also increasingly at the mercy of interest rates. The lower they go, the more their interest income and profits decline, forcing them to recoup revenue in other areas, reduce costs, or scale back on capital expenditures. And Vanguard Group, although not a big player in retail brokerage, is developing a new low-cost robo service and using its enormous scale to scoop up more fund assets.
Fintech advances, meanwhile, are both a threat and an opportunity for Wall Street. They make it possible to launch online banking and brokerage services that can reach millions of new customers, but also give upstarts like Robinhood the ability to compete with established players.
The Banking Business
The country’s biggest banks, seeking to stoke growth, are building out their wealth management businesses and pursuing individual investors. (To view all columns of the table, use the scroll bar at the bottom of the table.)
E=Estimate
Sources: Bloomberg; company reports
Brokerages such as Charles Schwab (SCHW) and Fidelity Investments say they welcome the competition created by the deal. But there is little doubt they will face a more formidable rival in a combination of E*Trade and Morgan Stanley.
If other brokerages are worrying about the merger, they aren’t saying so publicly. “It’s good news for me,” said Thomas Peterffy, chairman of Interactive Brokers Group (IBKR), whose move this past fall to cut commissions sparked the race to zero. “It’s going to be easier to draw a distinction among fewer firms.” Mergers of this magnitude usually result in attrition of clients and advisors, he added, opening doors to swoop in and poach assets.
Schwab declined to comment on the merger.
Fidelity’s head of brokerage, Ram Subramaniam, said the deal validates the firm’s multipronged revenue strategy: “We’re in all the businesses that this deal purportedly brings together.”
The chest-thumping is warranted to some extent. Schwab and Fidelity have spent years expanding their revenue base and spreading it out across retail, brokerage, advisory, custodial, and retirement services. The firms have come to dominate retail brokerage—Fidelity has more than 30 million brokerage accounts, and a combined Schwab/ Ameritrade would have nearly 25 million, well above the 5.2 million accounts at E*Trade.
Office Space
Part of E*Trade’s appeal for Morgan Stanley is its stock-plan assets. Here are the numbers:
Size of E*Trade’s stock-plan business managing accounts for executives who receive stock grants and options
Size of Morgan Stanley’s stock-plan servicing business
Fidelity and Schwab are established in online banking, cash management, mobile apps, and digital advice—all growth areas in retail financial services. Schwab’s deal for TD Ameritrade Holding (AMTD), announced last November, will give it more scale and resources to gather assets and build out its advisory and custody businesses.
E*Trade was struggling before Morgan Stanley arrived. The discount broker was hit hard by the loss of equity trading commissions. The company had run an 18-month “strategic review” that ended in late 2018, triggering speculation that it might sell. And it would have been a good time—commissions and interest rates were higher and E*Trade’s stock fetched a higher price and valuation.
Gorman said that he moved opportunistically to make a deal for E*Trade and that the firm was open to it after Schwab acquired Ameritrade.
It’s also clear that standalone brokerages don’t stand much chance in a deflationary pricing climate. Brokerages have been cutting prices for years, and they hit rock bottom when Schwab and others went to zero on equity trading commissions. That left many discount brokerages bleeding for revenue, hammered their stocks, and made them vulnerable to takeovers, paving the way for Schwab to buy Ameritrade and Morgan Stanley to scoop up E*Trade.
The deal highlights the way Wall Street is going after “share of wallet” for mass-affluent customers. Morgan Stanley and E*Trade clients have $7.3 trillion in assets held away from their firms. Buckingham Research analyst James Mitchell sees an opportunity for Morgan/E*Trade to capture $2.1 trillion of those assets.
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He also sees an opportunity to accelerate deposit growth with digital banking, through E*Trade’s checking and online bill-paying service. “Essentially, Morgan Stanley is building a vertically integrated wealth management business that should provide scale, better client penetration, and more limited attrition,” Mitchell wrote.
Wall Street’s so-called wirehouse brokerages are battling an exodus of advisors to independent firms, and they have come around to the economics of direct relationships with retail clients. Advisors at a wirehouse, with their own client base, get a cut of asset-based fees, but brokerages like Schwab that employ financial planners or build relationships with clients through digital advice keep much more of the revenue for the firm.
“The direct-to-consumer business is more profitable and less capital-intensive than traditional advisory,” said Shirl Penney, CEO of Dynasty Financial Partners, a financial advisor network.
None of this will happen overnight, and the merger could pave the way for other brokers to win over clients and assets. E*Trade had laid out an aggressive plan to go after Schwab and Ameritrade clients, Wells Fargo analyst Christopher Harris wrote. Now that E*Trade is getting acquired, it is unlikely to be as aggressive.
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The acquisition should be a “net positive” for Schwab and Ameritrade with respect to asset flows, and there could be near-term opportunity for Fidelity to pick up market share, Harris wrote. “Recent e-broker transactions are not signaling much confidence in the standalone business models.”
Indeed, financial results from the brokers illustrate how tough it’s getting to boost revenue and profit. Nearly two thirds of E*Trade’s $2.9 billion in revenue last year came from interest income on cash deposits. Commission-based revenue declined, while fees and services charges increased modestly. E*Trade reported $3.86 in earnings per share last year, down from $3.90 in 2018.
Customers may reap benefits from the price competition and asset-gathering blitz coming from Wall Street and other firms. Discount brokerage clients are no longer paying commissions to trade stocks, and banks are offering substantial bonuses for clients to switch. The more scale the banks and brokers achieve, the more they can lower fees (theoretically) and invest in fintech apps and services, ultimately benefiting consumers.
But some advisors worry that all the price competition and the “race to zero” is creating incentives for brokers to increase revenue in other areas and steer clients into high-fee products. “These are for-profit organizations that aren’t looking to race to zero,” says Michael Nathanson, head of Colony Group, an advisory firm. “What kind of business models will they introduce to replace the revenue they’re losing from commissions? What concerns me is that we don’t know what’s coming down the road.”
Carleton English contributed to this article.
Write to Daren Fonda at daren.fonda@barrons.com and Andrew Bary at andrew.bary@barrons.com
https://news.google.com/__i/rss/rd/articles/CBMiZWh0dHBzOi8vd3d3LmJhcnJvbnMuY29tL2FydGljbGVzL3doYXQtbW9yZ2FuLXN0YW5sZXlzLWUtdHJhZGUtZGVhbC1zYXlzLWFib3V0LXdhbGwtc3RyZWV0LTUxNTgyMzM4NTQw0gEA?oc=5
2020-02-22 02:29:00Z
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