When it Began, the credit crisis had little to do with retail brokerage. After all, the fixed income departments were the ones who made the bad mortgage bets that have since unraveled, resulting in a pileup of more than $200 billion dollars in write-downs and hundreds of billions more to come. In fact, last year the wealth management divisions of the big-name brokerages were humming. Take Merrill Lynch, which posted a $10 billion loss in the fourth quarter of 2007, the result of a $16 billion write-down on the value of its collateralized-debt obligation (CDO) exposure and home loan portfolios. It was the firm's worst quarter in its 94-year history, and the second of three consecutive quarterly losses (so far). But hidden inside that horrendous quarterly report was some good news: The global wealth management unit capped its best year ever in terms of sales, with $3.6 billion in net revenues and $80 billion in net new client assets — its largest haul since 2000.
But it has been nearly a year now, and the credit-related losses continue — as does the relentless press coverage of it all — and the retail brokers at every wirehouse have been feeling a residual effect of the write-downs and losses brought on by tanking debt products either created, bought or sold by colleagues in other business lines. Net new client assets — with the exception of Morgan Stanley — have slowed significantly at the wirehouse firms in the past two quarters (see charts on p. 38 and p. 40). Contrast that to the RIA divisions at Schwab and Fidelity, where assets continue to rush in.
In short, the Merrill bull has been tattooed — as have the brands at all the other big firms. (We don't mean to single out Merrill.) And now (judging from first-quarter reports) the credit crisis seems to be hurting wirehouse retail brokerage operations, too. The collapse of the auction-rate securities market has made many retail advisors look foolish — especially given how complacent many advisors (and their firms) had become about the risk inherent in the Dutch auctions. The ARS market is mortally wounded but its death throes will likely play on in court.
There were other embarrassing missteps as well. Hedge fund blowups at Citi, UBS, Bear and Goldman have caused tens of millions in losses among advisors' high-net-worth clients, a situation Citi is trying to improve by offering to cover some of the losses. It's easy to see why some clients are angry at their brokers and the firms they work for. It really does seem as though Wall Street firms stagger from one mistake to another every few years, backing up the truck and loading up on a profitable product or strategy until it doesn't work anymore. And then firms clean up by finding people to blame — and firing them.
This time, though, some well-known heads were lopped off, from division chiefs to CEOs, including Merrill's Stanley O'Neal, Citi's Charles Prince, and both UBS' Peter Wuffli and the firm's chairman, Marcel Ospel. John Mack, CEO of the comparatively successful Morgan Stanley, was even a target for replacement by a band of activist investors — though they didn't succeed. It's easy to see why some advisors are angry too — and are leaving their firms. With bad news swirling both in the markets and at their firms, but with top producers still in high demand, it's a good time to move. According to reps and recruiters, some top reps are taking advantage of exceptional recruiting packages now, when their firms are getting shellacked in the press. The bad press gives advisors an easy explanation for departure with clients. One Smith Barney rep says his firm has lost a lot of top reps because they bet big on the return of Citi's stock price, even borrowing heavily on margin. When these big bets went bad, they sought out upfront recruiting pay to replace their investment losses. (For those who aren't in dire financial straits, it's still easier to move when company shares and deferred comp are in the toilet as they are at every firm.) According to reps we've talked to, some clients have also withdrawn some assets — moved them to the family trust bank, for example — or left entirely. They're fed up — like many of the brokers — with the failures and scandals involving the firms they trusted to manage their money. Client asset are migrating to RIAs (see chart on p. 43). One UBS rep points to the ARS-market collapse as a catalyst: “That really created, I think, a deep resentment for firm products,” he says.
How will all of this impact these firms and their brands? Will the past nine months amount to a stain that fades after a few months or years, like the investment banking research scandal? Or, as some argue, have the disruptions and screw-ups at the wirehouses, combined with a shifting advisor business model to fees and open architecture, lessened the appeal of working for a firm with a big financial brand?
Peter Kurer, the former UBS chief counsel who replaced an embarrassed Marcel Ospel as chairman of the board in April, publicly recognized the damage done to the brand he's now in charge of restoring. “We shouldn't fool ourselves,” he told the Financial Times in mid-April. “We cannot pretend there has been no reputational damage.” In May the firm announced a huge $10 billion loss in the first quarter, and write-downs at the firm now total $38 billion. The firm also announced the terms of a $16 billion dollar rights issue, one of the largest in European history, to repair its ailing balance sheet. Additionally, net new client assets across all of UBS' wealth management operations totaled $5.3 billion in the first quarter, compared to nearly $30 billion in the previous quarter. Speaking about the severe slowdown in inflows, Marco Suter, UBS's CFO, echoed his boss, saying it was a reflection “no doubt, of the reputational damage we have sustained.”
How long until it heals? In his April interview with the Financial Times, Kurer said, “Experience says it goes away after two to three years.”
That may be about right. History has shown investors do have short memories when it comes to the shenanigans of Wall Street's big name players. Some think they'll forgive and forget even sooner than that. Punk Ziegel analyst Dick Bove covers many of the wirehouse firms, and dismisses the idea of a permanent hit to the reputations of the embattled brands. “Reputational risk doesn't exist,” he says. “This is nothing but another example of a dreary down cycle in this industry. It's not unique; it's not special. It happens.”
He mentions Merrill's harrowing year in public relations back in 2002 as a case in point. Merrill suffered a PR triple whammy that year: It was hit with a $100 million fine from the SEC for its part in the research investment banking conflicts-of-interest scandal, it was involved in the Martha Stewart insider-trading case involving one of its brokers, Peter Bocanovic, and 96 Merrill employees were implicated by a Senate subcommittee for investing in Enron CFO Andrew Fastow's shell games. “By 2003, who remembered?” asks Bove. (Stewart was ultimately convicted — not of insider trading, but obstruction; Bocanovic was permanently expelled from the industry.) Brad Hintz, an analyst at Sanford Bernstein, concurs, saying any damage to the reputations of the firms over sub-prime losses would be “small in comparison to the research scandal.”
Naturally, others disagree. One of them is Michael Robinson, the former public affairs and policy chief for the SEC under former SEC Chairman Harvey Pitt. He thinks the big Wall Street firms have done more damage to their reputations in the past year than in the “last several decades.” Robinson saw up close the effects of the investment banking and research scandal in 2001 and 2002, and says many firms won't escape unscathed this time, even if collusion and outright fraud aren't uncovered. Neither will advisors — it doesn't matter if you didn't sell your client a proprietary hedge fund that blew up or an auction-rate security that went illiquid overnight. “It's your affiliation, not your specific job,” says Robinson. “Ever lose your luggage? You protest to the first airline staff person you meet — you don't go looking for baggage handlers.”
Now a senior vice president at Levick Strategic Communications, a Washington, D.C.-based PR, marketing and crisis management firm, Robinson says this time is different from the research scandal because the overall mood of the country is worse — and for good reason. After all, 2002 was the beginning of the credit bubble; this is the end. Not only has your house lost a chunk of its paper value, but the prices of gasoline and food are shooting up. Meanwhile, this is all being played out on a backdrop of war and the usual election-year snipping about how bad everything is because of the other party. The result: According to a New York Times/CBS poll, 81 percent of Americans think the country is headed in the wrong direction. It probably couldn't be a worse time for Wall Street to be on the front page of newspapers and featured on the nightly news for its apparently greedy mistakes.
Just as Democratic presidential candidates Hillary Clinton and Barack Obama were rounding the final stretch of the primary by pumping up their populist rhetoric, ousted Merrill Lynch and Citi CEOs Stanley O'Neal and Charles Prince were appearing before Congress (on T.V.) to explain why they deserved $40 million and $161 million, respectively, in compensation for 2007 while the companies they ran did so poorly that year (see charts on p. 40 and p. 43). In short, it makes for easy eat-the-rich rhetoric that plays well in some precincts. (See Clinton's early May trashing of Wall Street in her “money brokers” speech, where she blamed the financial community for causing the recession.)
A Boon For RIAs?
One segment of the advice business is leveraging the bad news from the wirehouses, and recruiting and gathering assets: the RIAs. While net new assets slowed to a trickle or flowed out of the wirehouse firms (except for Morgan Stanley, which has been on a roll) in the first quarter, the two kingpin RIA platform providers — Schwab Institutional and Fidelity Institutional Wealth Services — have been raking in net new assets at an astonishingly fast rate. Raymond James, with its five different business model offerings, is also benefitting from hard times at the wirehouses. According to an April 28 research note from Fox-Pitt Kelton analyst, David Trone, “Raymond James is seeing unprecedented interest from non-competitors FAs, who are disappointed with their parent firms due to the write-downs, bad press, etc.” Is it possible Americans have a growing preference for independent financial advice? According to a Fidelity survey of Americans with at least $1 million in investable assets conducted in April, the use of independent advisors grew to 26 percent this year, up from 22 percent last year. Additionally, the survey — which did not identify Fidelity as the sponsor — found that the percentage of respondents' investable assets held by independent advisors grew to 71 percent this year, compared to 56 percent in 2007. Indeed, Fidelity convincingly overtook Merrill as the largest financial services firm in the first quarter of 2008, with $1.9 trillion of total client assets. Charles Schwab Corp., with more than $1.4 trillion of client assets, is right on Merrill's heels.
And the past year has provided firms like Schwab, Fidelity, TD Ameritrade and Pershing with marketing leverage, not just with clients seeking safe haven for their assets, but advisors, too. “It's true, most wirehouse advisors are still at the wirehouses,” laughs Barnaby Grist, managing director of Schwab's business consulting and the man in charge of recruiting wirehouse FAs. But there has been a lot of interest lately in the independent world — 2,000 phone calls from advisors in the first quarter inquiring about independence, up 40 percent from last year, he says. And a lot of movement (relative to past years), too: In 2007, 114 wirehouse advisors with $9.2 billion in assets joined Schwab Institutional. Grist expects to easily eclipse both of those numbers this year — the more important one, the asset figure, he says, will likely be topped as early as June.
The turmoil on Wall Street has presented a golden opportunity for independent investment advisors to crow about their no-conflicts-of-interest advisory model as well. “Is your financial advisor a fiduciary?” The answer might well be “yes,” since many wirehouse advisors are now dually registered. But it's a question financial planners and their organizations — like NAPFA and the FPA — have effectively used to win new clients. It's also a message the public is hearing more, too. On April 26, in the “Your Money” section of The New York Times, there was a story titled, “Pick a Planner Who Can Spell Fiduciary.” The story, which ran in what is arguably one of the top three newspapers in the country, implored its readers to give this legal term, and this question, extra weight in evaluating potential advisors — no doubt a good thing for RIAs.
“I think the reputational risk advisors face because of the things their firms do is probably growing,” says Chip Roame, founder of Tiburon Strategic Advisors, a financial services consultancy. “As the years go by advisors are going more to fee-based, which means fewer in-house products,” he says. With firms like Schwab and Fidelity and others offering access to top-notch technology, research and managers, more advisors will question their need to be at a wirehouse, says Roame. “As a result, with fewer reasons for staying, the scandals and failures of the firm will mean more and more each year.”
Robinson, the crisis management expert at Levick Strategic Communications, says firms are making a big mistake if they ignore the power of reputation. He says it is one of the most important, yet difficult, concepts for people and organizations to grasp, but has real value. “It's hard to measure and monetize, but it's the reason you pay more for certain products,” he says. “It allows you to hire the best people, it lowers your cost of capital, it allows you to partner with the best. It attracts new business, and it helps you attract and retain the best employees,” Robinson says. “Therefore, protecting it is critical.”
Investors have punished the big firms for losses.
|Full Year 2007 Net Income||CDO 1Q 2008 Net Income||Market Cap 1Q 2007/stock price end of earnings day||Market Cap 1Q 2008/stock price end of earnings day|
|Merrill Lynch||-$7.8 billion||-$2.0 billion||$81 billion/$87.67||$49 billion/$46.39|
|UBS||-4.0 billion||-10.9 billion||123 billion/63.43||63 billion/33.77|
|Morgan Stanley||3.2 billion||-1.5 billion||61 billion/66.0||54 billion/43.20|
|Wachovia||6.3 billion||-708 .0 million||100 billion/51.95||58 billion/25.55|
|Citigroup/SB||3.6 billion||-5.1 billion||247 billion/49.91||135 billion/24.79|
|Source: Company reports|
THE RACE FOR ASSETS (BILLIONS)
The RIA custodians continue to set a pace the wires can't keep up with.
|Firm||Net New Assets 4Q' 07||Net New Assets 1Q' 08||Net New Assets Full-year 2007||Total Client Assets as of 1Q' 08|
|Fidelity Inst. Wealth Services||31.3||14.6||96.5||350|
|Source: Company reports|