By Matthias Rieker
The increased number of investors borrowing against the value of
their portfolios has caught the eye of Wall Street's
self-regulator.
At banks and brokerages, securities lending has become more
popular with customers who use the low-interest-rate loans to
purchase everything from homes to luxury items such as yachts at a
time when credit has been tight.
The Financial Industry Regulatory Authority said on Tuesday that
it has put such lending on its watch list for 2015, questioning how
the securities-backed lines of credit are marketed and the risk the
loans pose to customers.
Richard Ketchum, Finra's chairman and chief executive, said
securities-backed lending has in some ways replaced home-equity and
other consumer loans in popularity after the financial crisis. "Any
time you see leverage increase in a variety of ways...that
increases risk for investors," he said.
Banks are pushing their wealth-management divisions to get their
clients to take out more of the loans against their growing
portfolios. rather than investors selling their securities to raise
to cash. "That's exactly the risk we are focused on," Mr. Ketchum
said.
The securities-backed loans "carry significant credit and call
risk," the regulator said. "In addition, they are difficult to
value, have longer settlement time than other investments and are
relatively illiquid."
Meanwhile, funds consisting primarily of floating-rate bank
loans and alternative mutual funds are also new on Finra's radar
screen, the regulator said in its 2015 broker examination priority
letter. Finra urged brokers to be more transparent about each
fund's individual strategies rather than considering them as a
general investment category.
"We are concerned that this is a bit of an accident waiting to
happen," Mr. Ketchum said about alternative investments. "The area
is complex" given that fund managers have substantial discretion
and fees are high.
It is too early to determine whether investors already have
invested too much in alternatives, he said: "But the risk of
concentration is there."
Securities-backed lending hasn't been much of a disciplinary
issue, but Finra is concerned about the increase in loan volumes as
consumer loans are harder to get following the financial crisis and
as investors look at other assets to leverage, Mr. Ketchum
said.
"What asset has grown considerably for the last six years? That
would be equity securities," he said. "But equity securities and
portfolios can fluctuate a great deal, and with that can come the
risk."
At the same time, many brokerages have increased incentives for
its advisers to offer securities-based loans to clients. Bank of
America Corp's Merrill Lynch, one of the largest securities lenders
according to data from SNL Financial, told its 14,000 advisers it
would at least double the base payouts for new assets this year,
including loans. Others, like UBS Wealth Management Americas and
Wells Fargo Advisors, are employing similar tactics around
advisers' compensation.
The efforts has been paying off. The industry's largest
brokerage firms all reported bigger client-loan asset totals in the
third quarter, which includes debt products like securities-based
loans and margin accounts.
Morgan Stanley, for example, reported $48 billion in client
liabilities, up 33% from same period a year earlier. UBS said its
U.S. unit saw a 4% year-over-year increase in securities-backed
lending.
Spokespeople for Wells Fargo and Merrill Lynch weren't
immediately available for comment. And those for Morgan Stanley and
UBS declined to comment.
Several financial advisers and executives at the major
brokerages have played down the lending risk. "We're not offering
these products to put clients into a more risky position," said one
Wells Fargo adviser who's based in the Northeast.
Securities-based loans aren't like margin loans--that is, they
can't be used to buy more securities. But like margin loans, banks
can call securities-backed loans when the markets and the value of
the securities used as collateral fall, or demand more securities
to collateralize the loan, moves that can ultimately hurt
borrowers.
That was the case in Puerto Rico, where the falling value of
closed-end bond funds led to investor losses. The U.S. commercial
banking unit of UBS AG had also made non-purpose loans to Puerto
Rican brokerage clients backed by such bond funds, and lawyers for
those investors allege the loans compounded the damage to their
clients when the bank called those loans.
In some cases, UBS brokers may have used the loans to buy more
bond funds for customers, the island's bank regulator said in
October. Puerto Rico's Commission of Financial Institutions ordered
UBS to pay $5.2 million in fines and restitution over the bank's
sales practices.
Finra said it estimates it levied $127 million in fines and
brought 1,365 disciplinary actions against firms and brokers last
year. That's almost double the $65 million Finra fined in 2013, but
disciplinary actions in 2014 were down 11% from the prior year.
The regulator said it ordered firms and brokers to pay $32.3
million in restitution to harmed customers, more than triple the
$9.5 million in restitution ordered in 2013.
Michael Wursthorn
contributed to this article.
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