By Michael Wursthorn
Wall Street brokerages are pushing customers to take out
billions of dollars in loans backed by stocks and bonds, a trend
that yields lucrative fees for the firms but poses risks for
borrowers.
Executives at Morgan Stanley earlier this month highlighted
these loans to individuals as a big growth area and revenue driver,
saying the loans helped expand the bank's overall wealth lending by
about $3.5 billion, or 6%, in the second quarter. On Thursday,
Goldman Sachs Group Inc. took a step toward growing its
securities-based lending business through a new partnership with
Fidelity Investments.
For brokerages, these so-called securities-backed loans have
become a reliable source of revenue in the years since the
financial crisis as firms have begun moving away from a business
model of charging commissions for trading to a system of fees based
on assets under management. The loans themselves help brokers
retain these assets because customers don't have to sell stocks and
other securities when they need cash. These loans have also become
a big factor in brokers' compensation.
Clients, in turn, are able to borrow money at relatively low
interest rates because the loans are secured.
But they could be left in the lurch if markets tank and the
value of that collateral shrinks, prompting the bank to demand loan
repayment. If a margin call isn't met, the securities backing the
loans are sold and the borrower is responsible for any remaining
balance.
These arrangements are structured to benefit the brokerage, with
the client shouldering virtually all the risk, critics say. And
these loan products are often pushed without regard to whether
clients even need them, they add. Regulators are also taking
notice.
Several Merrill Lynch brokers said they have asked longstanding
clients to open securities-backed lines of credit to help them hit
bonus hurdles, assuring that clients wouldn't need to use it or pay
any fees for opening it. Merrill brokers receive ongoing payments
for getting clients to tap credit lines, and those loan balances
contribute to year-end bonus calculations, people familiar with
matter said.
Brokerage executives have said the longer a client has one of
these loans tied to their account, the more likely they are to use
it.
"We were dramatically pushed to put these on all of our client
accounts, " said Steven Dudash, a former Merrill Lynch broker who
has been managing his own investment-advisory firm since 2014.
"Whenever you're product-pushing, it's not in the client's best
interest."
Merrill representatives say its brokers offer these loans to
clients in a responsible manner, including disclosing the risks and
fees.
"If people need the money, they should sell securities," said
Terrance Odean, a professor of finance at the Haas School of
Business at University of California, Berkeley. "It's very risky to
take a leveraged position in the market, and I don't think people
are thinking about it that way."
A major concern of critics is that the boom in securities-backed
lending has coincided with what is now the second-longest bull
market on record in the U.S. They worry that investors, nearly a
decade removed from the financial crisis, have become less wary of
debt backed by investments as stock markets keep rising.
If U.S. markets fell 10%, Mr. Odean and others predict that
firms would make margin calls on some accounts.
As of the end of last year, clients of Bank of America Corp.'s
wealth unit, which includes Merrill Lynch and private bank U.S.
Trust, had some $40 billion in such loans outstanding, up 140% from
2010. Morgan Stanley's customers had $30 billion in these loans,
more than double from 2013. UBS Group AG and Wells Fargo & Co.
also have made billions in such loans, people familiar with those
banks said.
"The real story for us...has been in the wealth business as we
continue to increase our penetration of our client base with
lending products," Morgan Stanley's finance chief, Jonathan Pruzan,
said while discussing earnings this month, adding that the bank
expects more clients to take out loans in the months ahead. "That's
been a real key driver of our wealth business."
The growth of securities-backed loans has increasingly drawn the
attention of regulators, who have questioned the brokerages'
marketing and sales efforts as well as the suitability of the
loans.
Merrill opened more than 121,000 such loan accounts between 2010
and 2014 with more than $85 billion in total credit extended,
according to a Financial Industry Regulatory Authority settlement
order last year. In the matter, Finra alleged that Merrill didn't
fully explain the risks of securities-backed loans and used risky
or concentrated investments as collateral.
Merrill settled its case without admitting or denying the
allegations. Merrill reported its securities-lending oversight
lapses to Finra initially and cooperated with the regulator's
inquiry, according to Merrill representatives. The representatives
added that the firm has improved its procedures around how the
loans are supervised.
Massachusetts' securities watchdog last year accused Morgan
Stanley of developing a sales program that encouraged brokers to
pitch these loans regardless of whether clients needed them.
Brokers involved in the incentive program were given scripts
coaching them to offer securities-backed loans to clients who said
they needed to pay taxes or cover expenses for a wedding or a
graduation party, or if they mentioned "purchasing a luxury item
like a car or yacht," according to the regulator.
"It's not healthy for the industry," said William Galvin,
Massachusetts' top securities regulator, who has been investigating
how firms motivate brokers to push these loans. Brokerages "should
be more concerned about this," he said, "but they're in favor of
competition and seeing who can get more loans."
Morgan Stanley agreed to a $1 million settlement with the
regulator in April without admitting or denying wrongdoing. A
Morgan Stanley spokesman said Massachusetts found no evidence that
any clients were harmed or that any of the loans were unsuitable or
unauthorized. "We have taken steps to strengthen and clarify our
policies and controls around such initiatives," the spokesman
said.
Write to Michael Wursthorn at Michael.Wursthorn@wsj.com
(END) Dow Jones Newswires
July 27, 2017 05:44 ET (09:44 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.
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