Remember the bear market? Remember how ugly that was, in 2002 and 2003, when the securities industry was lopping off employees and in a general state of defense? We can’t either. The post-bubble good times just keep on getting better. The first quarter of 2007 was the best ever in terms of revenue growth for the securities industry. The performance even tops the first quarter of 2000.
“For the industry as a whole, it’s a quarterly record,” says a veteran industry economist, who for professional reasons, asked that his name be withheld. (The industry data hasn’t been formally released, but is imminent.) The retail brokerage units of securities firms, by and large, are doing well, but the record growth is being driven by: Proprietary trading gains, merger-and-acquisition activity and “other corporate financial advisory,” which is mostly structured derivative products, says the economist. The firms riding the growth wave in those categories are primarily the industry’s largest. Indeed the top 25 firms account for 80 percent of the earnings gains in those three categories, says the economist; the stellar first-quarter results at the major wirehouse firms would suggest as much.
Merrill: Uneasy Lies The Head That Wears The Crown
Merrill Lynch had a “terrific” first quarter in the words of CEO Stan O’Neal. But, alas, it’s tough being Number One. Analysts weren’t so impressed by one of Merrill’s business units: the private client group. “Somewhat disappointing” was the way CIBC World Markets analyst Kenneth Worthington described the private client division in a research note. UBS’ Glenn Schorr said GPC’s results were “not bad, but nothing to write home about.” Total revenues in GPC were $3.14 billion, up 11 percent from $2.8 billion in the year ago quarter. Pre-tax profit was $842 million, up 133 percent from $361 million in the year ago quarter. (Just think: Net doubled and yet analysts were still carping!) Total client assets at the firm are now $1.65 trillion, up 10 percent from $1.5 trillion in the first quarter of last year. The unit’s profit margin rebounded to 24.7 percent in the quarter, up from 12.3 percent last year, and Merrill’s 15,930 advisors brought in a substantial $16 billion in net new assets. That said, CIBC’s Worthington thinks Merrill could be losing some of its dominance: “We notice that both Morgan Stanley and Citi had higher increases in their fee-based revenues and Morgan Stanley had a notable increase in net new assets which made us question whether Merrill had been losing some market share, especially to Morgan Stanley, in private client.” Merrill’s stock is down nearly 3 percent through May 1st.
Morgan Stanley: The Turnaround
Morgan Stanley is officially the industry’s turnaround story. Keefe Bruyette & Woods analyst Lauren Smith has added the firm to her “Best Ideas List.” In his remarks, CEO John Mack cheered the firms first quarter as having “delivered its highest revenues since 2000.” Smith thinks the firm has plenty of room left to run. “While Global Wealth Management has made great strides in improving profitability and returns under new leadership, we believe momentum here is accelerating.” Total revenue in GWM was $1.5 billion in the first quarter, up 18 percent from $1.26 billion last year. Pre-tax income was $220 million, up 1,466 percent (yes, really) from $15 million at the same time last year. The unit’s profit margin was 15 percent, up from 1 percent a year ago, and total client assets were $690 billion, up 11 percent from the first quarter of last year. Mack’s push to cut low-end producers and hire rain-making replacements is working nicely: Morgan Stanley reports average annualized revenue per rep and assets per rep in the first quarter to be $748,000 and $86 million, a stark contrast to the first quarter of last year’s $552,000 and $70 million per rep. That puts the firm solidly in 2nd place in those categories, behind only Merrill Lynch.
Smith Barney: Cost Control
Smith Barney had a solid first quarter as well but the brokerage unit’s success was overshadowed by record revenue growth in larger businesses, its fixed income and equity markets, and investment banking and transaction services. Also taking analyst attention was the progress of cost cutting measures being implemented by new COO Bob Druskin, the “expense czar,” who most recently orchestrated the laying off of 17,000 Citi employees, saving the company an estimated $2 billion in operational expenses. Smith Barney saw total revenues climb 13 percent in the first quarter to $2.25 billion from $1.99 billion in the first quarter of last year. Revenue growth was driven by a 17 percent increase in fee-based and net interest revenues, “reflecting a continued shift to fee-based advisory products and services.” Pre-tax profits were $522 million, up an impressive 96 percent from $266 million last year. The unit’s pre-tax profit margin bounced back to 23 percent in the quarter, up from 13 percent at the same time last year. Total client assets are now $1.28 trillion, up 9 percent from $1.17 trillion last year. The firm’s 13,009 financial advisors produced $697,000 in annualized revenue, a 17 percent increase from last year, and brought in $7 billion in net new client assets compared to $3 billion in the first quarter of last year.
Wachovia: Growing Quietly
Wachovia’s Capital Management Group, which includes retail brokerage and asset management, has quietly become a contender among the wirehouses. Total revenues in the first quarter of this year were $1.72 billion, up 17 percent from $1.47 billion in the same period last year. Total income in the quarter was $304 million, up 42 percent from $214 million last year. The firm has been aggressively hiring top producers too and advisor headcount is now 8,166, up 3 percent from 7,926 in the first quarter of last year. The unit’s total client assets were $773 billion in the first quarter, a 12 percent increase from $689 billion last year; management claims 60 percent-plus of revenues are now recurring. Capital Management enjoys a brokerage industry-best 29 percent pre-tax profit margin. Earnings aside, Wachovia brokerage execs see the industry changing soon in one fundamental way for reps: how they get paid. CIBC analyst Meredith Whitney writes in a May 1st research note that Capital Management Group president David Carroll, and group CFO Irene Esteves, believe “longer term…the structure of the U.S. brokerage business will move closer to what we call the ‘Swissie’ model of salary and bonus versus the more traditional ‘Grid’ model of sales commissions structure.”
The newest entrant to the U.S. brokerage arena, UBS, files its earnings on May 3rd, but if analyst predictions are correct, it will match—and exceed in some cases—the success of its wirehouse peers. CIBC’s Whitney predicts total revenues for the quarter to be $1.35 billion, up 11 percent from last year, and pre-tax earnings to be $175.5 million, a 14 percent increase from last year. Most surprising, Whitney expects Wealth Management US to bring in $21.18 billion in net new client assets, a 189 percent increase from last year. “In Wealth Management US, we expect revenues to grow by 11 percent from a year ago to CHF 1.6 billion…We believe that [the brokerage unit] will begin to reap benefits from its hefty spending, aided by its recent bolt-on acquisitions [brokerage units of Piper Jaffray and McDonald Investments].” If UBS meets expectations it will round out a stellar performance for the brokerage industry, one that our unnamed economist thinks is likely to continue, for a little while anyway: “Short of China [stocks] tanking again but this time not recovering, the success of these firms is likely to continue through the 3rd quarter.”