By Lauren Tara LaCapra
NEW YORK, Aug 3 (Reuters) - Early this year, a New York State Lottery winner in Brooklyn approached Morgan Stanley with a problem: he needed to borrow hundreds of thousands of dollars before he collected his prize money.
The man, a Russian immigrant, wanted money to help move his family to a secure location before he redeemed his ticket and possibly became famous, according to people familiar with the matter who spoke on the condition of anonymity. He also wanted advice about what to do with his prize money, which was in the hundreds of thousands of dollars.
The bank's wealth management unit decided to make the loan to win a new customer, a step it is increasingly willing to make as it builds up its brokerage unit.
Making unusual loans is critical for Morgan Stanley. The bank has bet its future in large part on its wealth management business, which produces more stable revenue than the trading unit that nearly wiped out Morgan Stanley during the financial crisis. Providing unconventional loans is a reliable way to win customers, and keep them.
Morgan Stanley is playing catch-up against rivals including JPMorgan Chase & Co, Citigroup Inc, Deutsche Bank AG and Credit Suisse Group AG, which offer loans collateralized by everything from art collections to cases of wine.
Industry sources said they had never heard of a loan against a lottery ticket, though they cited other examples of atypical collateral that other banks have loaned against, including a client in Texas who borrowed against the future offspring of his prize bulls, and a client who borrowed against future ticket sales of a professional sports team he owned.
"We've got 3 million clients, and they've got borrowing needs," Eric Heaton, who runs Morgan Stanley's private bank, said in an interview.
Reuters attempted to track down the Lotto winner by the description provided by sources familiar with the matter but was unable to confirm his identity.
Tailored loans are lucrative for the bank, which can help Morgan Stanley reach its profitability targets for wealth management. Morgan Stanley's pretax profit margin target is 22 percent to 25 percent by the end of next year, compared with a current level of 20.6 percent, assuming interest rates do not rise.
To spearhead Morgan Stanley's efforts to build up what it calls "tailored lending," the bank hired a team from Deutsche Bank led by Marcus Mitchell. Although Morgan Stanley has been making these loans since 2010, it is ramping up its efforts now. It can make more loans now because it received extra deposits when it bought the portion of Citigroup's retail brokerage that it did not already own last year -- Morgan Stanley now has $130 billion of deposits.
Morgan Stanley spent billions of dollars buying the Smith Barney retail brokerage business from Citigroup between 2009 and 2013, and adding it to its own wealth management unit. In public presentations, executives have continually trumpeted the reliable earnings that wealth management offers, as opposed to businesses like trading, where profit can oscillate wildly. Investment management and retail brokerage accounted for about 30 percent to 40 percent of the bank's quarterly revenue in 2007, a figure that grew to more than half in the second quarter of 2014.
As its lending effort has gotten under way over the past year or two, Morgan Stanley has about $2 billion of tailored loans outstanding, which now account for about 5 percent of the total loans outstanding at its wealth management unit.
Heaton and other executives who spoke to Reuters said they expect tailored lending to remain a relatively small sliver of the wealth management unit's loans. Mortgages in contrast account for about a third of loans at the unit. But tailored loans can be much more profitable-- for some, banks can earn 7.5 percentage points more than their funding costs, said one adviser at a rival firm, who spoke on the condition of anonymity. Morgan Stanley said its profits are much lower on the loans.
But even if the bank's margins on these loans are less than 7.5 percent, industry experts said they are likely much higher than margins on mortgages, which tend to be one percentage point or less.
The wider margins on tailored loans come in part because the loans are so unique. Morgan Stanley mitigates its risk by making sure it has access to collateral that can be sold quickly to recoup the cost of the loan, or that loans have a guarantor with enough assets to repay. It hires appraisers to assess the value of assets it is lending against.
Wealth management clients can borrow against one-of-a-kind assets like rare coins, but tailored loans can also be for assets like commercial real estate, which make up about a quarter of Morgan Stanley's tailored loan book. For loans that fall outside of the bank's comfort zone, like auto loans, the bank refers clients to other lenders, Heaton said.
In the case of the lottery winner, while Morgan Stanley executives would not acknowledge having any relationship with such a client, they did stress that the bank usually has ample collateral, and would not rely on expected lottery winnings alone to back a loan.
"We don't chase Lotto winners in hopes of establishing a relationship," said Heaton. "But if there's a client that comes in with a liability need, we'll look at their financial position and see what we can do to help." (Reporting by Lauren Tara LaCapra; Editing by Dan Wilchins and John Pickering)