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Morgan Stanley amps up lending to boost wealth margins

The corporate logo of financial firm Morgan Stanley is pictured on a building in San Diego, California September 24, 2013. REUTERS/Mike Blake

By Lauren Tara LaCapra

NEW YORK (Reuters) - Just a few years ago, Morgan Stanley (MS) lacked the expertise, infrastructure or desire to do a lot of lending, but today it is making a big push into loans to bridge a profit gap with rivals.

Morgan Stanley's brokerage business historically focused on helping clients invest in stocks and bonds, leaving lending to competitors like Citigroup (NYS:C) with bigger retail banking operations.

But lending is a key source of revenue in the brokerage business now. Interest rates are near zero, which weighs on the returns that brokerages can earn from investing client deposits in securities. By making more loans instead, Morgan Stanley could generate an extra $300 million of annual profit by one analyst's estimate.

Morgan Stanley is behind its competitors. For every dollar of client deposits, Morgan Stanley makes just 55 cents of loans, far less than the 70 to 80 cents that rivals banks make in their brokerage businesses. Its profit margins are weaker than other major brokerages.

To expand its lending book, it has been hiring hundreds of bankers, underwriters and back-office staff to help push everything from mortgages to stock loans. It is also marketing its loan offerings to clients more aggressively, and changing the bonus structure to encourage brokers to lend more.

The bank wants to lend 70 percent of its deposits by 2015, and 90 percent over the long term. Morgan Stanley's management wants to build the bank's loans across investment banking and trading as well, but wealth management is a big part of the buildout.

"We want to be able to provide good advice on both sides of the balance sheet - not just investments but also lending," said Shelley O'Connor, chief executive of Morgan Stanley's private bank. "You want to be the quarterback for what the client needs financially."

O'Connor and Eric Heaton, who is president of both the private bank and Morgan Stanley Bank NA, are tasked with getting the lending operation into full swing, and recently spoke with Reuters about their plans.

The wealth division has become much more important to Morgan Stanley under the leadership of Chief Executive James Gorman. In the wake of the financial crisis, Morgan Stanley agreed to buy Citigroup's Smith Barney business over time and merge it with its own wealth management unit, a process that began in 2009 and is slated to end in 2015.

Wealth now accounts for more than half of Morgan Stanley's revenue and its pretax profit margin rose to 18 percent in the first nine months of this year, compared with 5 percent for all of 2009.

Despite that progress, Morgan Stanley Wealth Management is still underperforming major rivals. Bank of America's wealth business has delivered a pretax margin of 26 percent so far this year, while Wells Fargo & Co's (WFC) Wells Fargo Advisors is at 20 percent and Swiss rival UBS AG (UBSN.VX) reported a 31 percent pretax margin year-to-date.

Analysts say a big part of that gap pertains to Morgan Stanley's newcomer status in lending. UBS analyst Brennan Hawken estimates Morgan Stanley will take in another $300 million in annual pretax income if it can lend out 70 percent of its deposits.


Lending has become a significant component of Morgan Stanley Wealth Management's annual "growth" bonuses, which reward advisers for growing assets, loan balances and overall revenue. Under the new plan for 2014, advisers can earn up to $202,500 for loan growth, up from $127,500 in 2013.

Advisors are also rewarded on a staggered scale for individual loans. For example, they can earn 50 basis points for the first three mortgages they initiate, then 65 basis points for the next four to six mortgages, and 75 basis points for mortgages beyond that. In dollar terms, that equates to $2,500, $3,250 and $3,750 for each $500,000 worth of mortgage debt, respectively.

O'Connor and Heaton are hoping the sweeter lending bonuses will get more advisers to warm to lending. A little more than half of the firm's 16,500 financial advisers have loaned money to a client. The executives aim to get that figure to somewhere in the high-70s to mid-80s over the next two years.

O'Connor and Heaton have so far hired 160 private bankers to work with advisers on growing their loan books, along with staff to handle underwriting, risk-management and back-office functions. They plan to add more bankers to the payroll in coming years as the lending operation grows, O'Connor said.

The bank is also working to get more clients to think of Morgan Stanley as a lender. Only 5 percent of Morgan Stanley's wealth clients have a loan from the bank. O'Connor and Heaton want to double that figure, and will early next year roll out new applications for mobile banking, bill payments and account management.

Brad Hintz, an analyst with Bernstein Research, said Wall Street banks have tried to gain a stronger foothold in lending many times to disastrous ends because brokers and investment bankers are incentivized to generate income by lending but do not have appropriate risk-management protocol in place. He cited Merrill Lynch's push into small-business lending in the early 2000s, which led to big losses when Gorman was a top executive there.

"This may be a remake of a movie we saw once before," said Hintz.

Morgan Stanley executives say they are not allowing bankers and brokers to issue loans willy-nilly to boost returns.

Chief Financial Officer Ruth Porat said in September that loans must adhere to "board-level underwriting criteria" and Heaton said that all loans are priced so that Morgan Stanley earns returns in excess of its cost of capital, and is wary about taking on duration risk for long-term loans.

Morgan Stanley spokesman James Wiggins said the losses at Merrill Lynch stemmed from loans made to small-business owners outside of the firm's existing client base, and were concentrated among building contractors. "We want to be very clear that this is NOT the kind of lending we are doing at MS Wealth Management," Wiggins said in an email.


Most of Morgan Stanley Wealth Management's loans come from securities-based lending, which uses clients' investment portfolios as collateral. If a client fails to pay, Morgan Stanley can seize and liquidate the assets, though executives said that rarely happens.

This type of lending can also deliver new assets. One adviser recalled a recent instance in which Morgan Stanley beat out JPMorgan Chase & Co (JPM) for a $60 million securities-based loan by offering a better rate. The client had to deliver more than $100 million worth of assets for the loan, because Morgan Stanley Wealth Management typically lends against roughly 50 percent of a client's holdings.

While O'Connor deals with loans to wealth clients and other banking services, Heaton also oversees Morgan Stanley's expansion of loans to institutional securities clients. Underwriting staff must sign off on any loan before it is approved. Those staff report into the risk-management division headed by Chief Risk Officer Keishi Hotsuki.

"We've got support from the top of the house to continue doing this in a measured way," said Heaton. "We're not racing to get it all out the door next year."

(Editing by Tiffany Wu and Tim Dobbyn)