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Profit Makers
The two most profitable securities firms, Citigroup Inc. and Merrill Lynch & Co., overcame the longest bear market in 50 years by focusing on the wealthiest clients.
By Margaret Popper
Bloomberg News Service
NEW YORK - Citigroup Inc. and Merrill Lynch & Co., the two securities firms with the most brokers serving individual investors, have become the most profitable by corralling the highest fee-paying customers.
Having the most brokers isn't necessarily a prescription for profit because of the costs of maintaining them. Both Citigroup's and Merrill's retail brokerage units have reversed years of lackluster performance by cutting services to their least-affluent clients and raising them for their richest.
"There are three ways to improve the margin in retail," said James Gorman, president of Merrill's global private client group. "You can create revenues that diversify away from equity sales, you can control the costs of having a global office network, and you can improve the quality of your financial advisers. We've done all three."
Brokerages are competing for the fees generated by the $30 trillion in financial assets held by U.S. individuals and non-profit organizations, even as they expand in home and consumer lending. By selling their richest clients a range of products they might offer a small corporation, and sending less-affluent clients to call centers and the Internet, Merrill became more profitable even during the longest bear market in over half a century. Citigroup's brokerage unit tends to shun less-affluent clients altogether.
Citigroup, the world's biggest financial services company, had a 22% pretax margin on its Smith Barney brokerage in the third quarter, compared with 21% in 2002. Merrill, the largest securities firm by capital, boosted the pretax margin on its retail brokerage to 20% in the third quarter of 2003 from 13.9% in 2002.
Broker revenue
Morgan Stanley, the No. 2 securities firm, had a pretax margin of 11% in the full year 2003, compared with 3% in 2002. Margins at the major retail brokerages - the ratios of pretax profit to revenue - averaged about 11% in the 1980s and early '90s, according to Jeff Hack, Smith Barney's chief financial officer.
The 13,400 financial advisers at Merrill generated revenue of about $600,000 each during the quarter ended Sept. 30, while Citigroup's 12,250 brokers had average revenue of $480,000, according to Ruchi Madan, a Smith Barney analyst.
Wachovia Corp., which bought Prudential Financial Inc.'s brokerage last July, had 11,527 brokers at the end of the third quarter. About 3,000 of them aren't certified to sell anything but mutual fund shares. The company has about 6,500 brokers whose duties would be comparable to the average Smith Barney or Merrill broker. Wachovia won't say what revenue per broker is.
Morgan Stanley, whose retail brokerage unit stems from its acquisition by Dean Witter, Discover & Co. in 1997, had about 11,000 brokers with average revenue of $372,000 in the quarter ended Nov. 30, according to Madan.
Wealthy market
Citigroup's Smith Barney, which has about $147 billion in so-called separate accounts - the money they manage for clients with at least $225,000 to invest - and Merrill Lynch, with about $104 billion, dominate the market for wealthy people, according to data compiled by Cerulli Associates, a Boston-based consulting firm. Morgan Stanley ranks third, with $34 billion. UBS AG is fourth with $31 billion, and Wachovia is fifth with $25 billion.
"Our number one priority is to increase our presence in the high net worth category," said John Schaefer, head of Morgan Stanley's brokerage unit. "Given our heritage from Dean Witter and Morgan Stanley private wealth management, we have an above-average share in smaller accounts and ultra-high net worth accounts. We are now focusing on customers with assets of more than $1 million."
Merrill Lynch's stock price rose 10.4% between the end of March 2000, the height of the market, and the close of trading on the New York Stock Exchange on Jan. 9. Citigroup's stock price rose 19.1%. Morgan Stanley's shares fell 31% during this period.
Drag no longer
Merrill Lynch Chief Executive Officer Stanley O'Neal plans to boost profits from asset management and retail brokering, Wall Street's traditional albatross because of the costs of employing brokers and renting offices, to half of the firm's earnings, compared with about 33% now.
"The pure old-fashioned retail business has gone from being a very bad thing to no longer being a drag on performance," said Brad Hintz, an analyst at Sanford C. Bernstein Inc. in New York.
The richest clients pay fees that range from 1.75% to 3% annually on the total sums invested, said analyst Jack Rabun at Cerulli Associates.
At Merrill Lynch, where John Barrett is a senior vice president and wealth management adviser, clients typically have between $5 million and $25 million in family assets. It takes at least $225,000 to get a foot in the door.
Barrett's team of six serves about 100 family and non-profit clients, and has a total of $800 million to $900 million of client assets under management. Bankers typically offer money management advice to several generations in one family. For example, one of Barrett's clients gave his son in prep school an account of $200,000 so he could learn to manage his own money.
" 'If you make a mistake with $200,000, that's fixable,' " Barrett quoted the father as saying. " 'We don't want him to make those mistakes with $200 million.' " One of Barrett's colleagues, Nancy Bello, calls the son to talk about his investments during study halls.
Barrett's group also provides services typically offered to corporations or institutional investors, including calling in Merrill's unit that structures specialized contracts such as options and swaps to lower the risks to a portfolio. "We have clients with concentrated positions in securities because 95% of their wealth is in stock options from their own company," Barrett said.
Phone service
Barrett will also offer clients mortgage terms that aren't available to most consumers and don't meet the standards of U.S. federal lending agencies Fannie Mae and Freddie Mac. Clients can construct whatever kind of repayment schedule suits them, including making payments only from their yearly bonuses.
When the accounts are under $50,000, Merrill sends clients to its Internet site or directs them to a phone service called the Financial Advisory Center. Accounts between $50,000 and $100,000 are assigned via the phone service to a dedicated team of brokers who handle a larger number of clients with less sophisticated needs than Barrett's clients have.
"The Financial Advisory Center aligns the level of service with the level of client need," Gorman said. "Clients receive attention and advice in a cost effective manner." As client assets grow they may become eligible for a referral to a full-time broker in a local branch office.
Merrill is a passive, minority investor in Bloomberg LP, the parent of Bloomberg News.
Smith Barney uses the resources of its parent to gain market share among the wealthiest clients. Citigroup, which will have profits of about $17.6 billion this year, made about a tenth of that from Smith Barney, run by Sallie Krawcheck.
Wealthy Smith Barney clients have access to anything Citigroup has to offer, including financing of personal aircraft, fine art appraisals, jumbo mortgages and insurance.
"There isn't a financial service or product that a client can't find somewhere in Citigroup," said Charlie Johnston, director of Smith Barney's U.S. branch system, which has 525 offices.
Johnston described one of his customers, with a net worth of about $200 million, as a chief executive of a mid-sized company that had just gone public. The client received advice on estate planning, a mortgage for his vacation home and a personal line of credit, as well as an interview with the top Citigroup investment banker in his industry to discuss his capital raising needs and his company's stock option plan.
Top pay
"Smith Barney has a staggering amount of cash flow and capital and the money to put into good people, marketing and product development," said Richard Bove, senior financial services analyst at Hoefer & Arnett Inc. "Sallie (Krawcheck) has the best resources, and that's why she's been able to join the ranks of Merrill Lynch in managed accounts."
Smith Barney consciously eschewed customers who wanted to pay less for trades during the stock market boom of the late '90s, said Hack, who's also chief operating officer of Smith Barney's Private Client Group. "We decided if we were going to be in the affluent market, we didn't want to associate Smith Barney's name with discount brokers," he said.
Sanford Weill, former Citigroup chief executive, always insisted that his brokers be among the best paid in the business because that's how to get high net worth clients, Hack said,, adding, "Even though Sandy had a reputation for being expense conscious, it's no accident we have a very competitive payout."
Top Smith Barney brokers can keep just over 50% of the revenue they generate, Hack said. By contrast, top Morgan Stanley brokers can keep at most 42% of the revenue they generate, according to Madan at Smith Barney.
Stock-selling kiosks
Morgan Stanley's predecessor firm, Dean Witter, used to install stock-selling kiosks in Sears Roebuck & Co. stores. Now the firm is also trying to shift its focus to the rich. Retail head Schaefer cut the brokerage force by 23% from a peak of 14,342 in the third quarter of 2001.
"The brokers that were let go were typically brokers with low-asset transaction-based accounts that had relatively long length of service," Madan wrote last month.
Morgan Stanley has revamped its training program to teach brokers how to snare wealthy customers. About 700 financial advisers have already received training on how to serve clients with assets between $1 million and $10 million. Another 800 are slated to receive this training.
During its fiscal year ending in November, Morgan Stanley's retail brokerage generated $454 million in pretax profit, more than four times the $109 million of pretax profit the year before. The division's net revenues declined 1% to $4.017 billion from $4.069 billion during this period.
"Morgan Stanley's retail side is transitioning away from its old Dean Witter clients and refocusing on more affluent clients, more akin to Merrill's client base," said David Bruns, a New York-based money manager at Federated Investors Inc., which oversees about $185 billion in assets and owns 3.5 million Morgan Stanley shares. "Retail should be showing improvement as they transfer from their current strategy."
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