By Michael Wursthorn And AnnaMaria Andriotis
Loans backed by investment portfolios have become a booming
business for Wall Street brokerages. Now the bill is coming
due--for both the banks and their clients.
Some lenders, including Bank of America Corp., are issuing
margin calls to clients after the global market drubbing of the
past week, forcing investors to choose between either putting up
more money or selling some of the securities underlying the
loans.
Banks, meanwhile, are likely to take a hit to a key profit
source if investors pull back from these loans as many expect.
Among the largest firms, Morgan Stanley had $25.3 billion in
securities-based loans outstanding as of June 30, up 37% from a
year earlier. Bank of America, which owns brokerage firm Merrill
Lynch, had $38.6 billion in such loans outstanding as of the end of
June, up 14.2% from the same period last year. And Wells Fargo
& Co. said last month that its wealth unit saw average loans,
including these loans and traditional margin loans, jump 16% to
$59.3 billion from last year.
"Your largest wealth creator for the top end has been inflation
in financial assets. You're now seeing wealth destruction," said
Charles Peabody, a bank analyst at Portales Partners LLC. Even
including Wednesday's stock-market rally, the S&P 500 index is
down 5.8% in the year to date.
Mr. Peabody said he believes profitability in banks'
wealth-management arms will fall in the coming quarters, in part
due to an expected decline in their securities-lending
businesses.
In a securities-based loan, the customer pledges all or part of
a portfolio of stocks, bonds, mutual funds and/or other securities
as collateral. But unlike traditional margin loans, in which the
client uses the credit to buy more securities, the borrowing is for
other purchases such as real estate, a boat or education.
Securities-based loans surged in the years after the financial
crisis as banks retreated from home-equity and other consumer
loans. Amid a yearslong bull market for stocks, the loans offered
something for everyone in the equation: Clients kept their
portfolios intact, financial advisers continued getting fees based
on those assets and banks collected interest revenue from the
loans.
The result was "dangerously high margin balances," said Jeff
Sica, president at Morristown, N.J.-based Circle Squared
Alternative Investments, which oversees $1.5 billion of mostly
alternative investments. He said the products became "the vehicle
of choice for investors looking to get cash for anything." Mr. Sica
and others say the products were aggressively marketed to investors
by banks and brokerages.
While the loans make up a small share of overall bank lending,
the industry's biggest brokerage firms have all reported higher
securities-based loan balances or higher client-loan asset totals,
each quarter for more than two years. Client-loan asset totals
include securities-based loans and margin accounts.
Even before Wednesday's rally, some banks said they were seeing
few margin calls because most portfolios haven't fallen below key
thresholds in relation to loan values.
"When the markets decline, margin calls will rise," said Shannon
Stemm, an analyst at Edward Jones, adding that it is "difficult to
quantify" at what point widespread margin calls would occur.
Bank of America's clients through Merrill Lynch and U.S. Trust
are experiencing margin calls, but the numbers vary day to day,
according to spokesman for the bank. He added the bank allows
Merrill Lynch and U.S. Trust clients to pledge investments in lieu
of down payments for mortgages.
A Morgan Stanley spokeswoman said "it is not an issue for most
borrowers, " but declined to say how frequently margin calls are
being made.
Wells Fargo declined to provide details on recent client margin
calls.
Brokerages prefer to offer these types of loans to clients that
have diversified portfolios of stocks and bonds, according to
lending executives at brokerage firms and analysts. Clients may be
able to borrow only 40% or less of the value of concentrated stock
positions or as much as 80% of a bond portfolio. Interest rates for
these loans are relatively low--from about 2% annually on large
loans secured by multimillion-dollar accounts to around 5% on loans
less than $100,000.
Aaron Schindler, a 51-year-old financial adviser in New York,
holds one of these loans. While he isn't worried about a margin
call just yet, he says he plans to keep a close eye on the
market.
About 18 months ago, he took out a $93,000 loan through
Neuberger Berman, collateralized by about $260,000 worth of stocks
and bonds, and used the proceeds to buy his share in a three-unit
investment property in the Bushwick section of Brooklyn, N.Y. He
says that his portfolio, up about 3% since he took out the loan,
would need to fall 25% before he would worry about a margin
call.
"When you stick to [borrowing] lower numbers, it would take a
significant drop for this to occur," Mr. Schindler said.
Regulators earlier this year had stepped up their scrutiny of
these loans due to their growing popularity at brokerages. Earlier
this year, the Financial Industry Regulatory Authority put
securities-based loans on its so-called watch list for 2015 to get
clarity on how securities-based loans are marketed and the risk the
loans may pose to clients.
"We're paying careful attention to this area," said Susan
Axelrod, head of regulatory affairs for Finra.
Peter Rudegeair contributed to this article.
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(END) Dow Jones Newswires
August 26, 2015 19:16 ET (23:16 GMT)
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