The European advisory model of private banking, as opposed to structures in wide use in the US and elsewhere that depend on transaction-based securities brokerage, continues to significantly outstrip its cross-Atlantic peers, based on a range of key performance indicators.
European players as a whole continue to enjoy superior gross and pre-tax margins. Indeed, with their full-service fee-based model, the European players are pulling away from their US rivals.
For example, pure play Swiss bank EFG International posted a gross margin on assets under management (AuM) of a class-beating 123 basis points in the first-half of 2007 (albeit with a slower performance in the third quarter as the subprime crisis unnerved investors). Among the majors, Credit Suisse reported a 116 basis point margin and HSBC 98 basis points. UBS posted a figure of 93 basis points.
Their nearest US rival by this measure, Morgan Stanley, recorded 89 basis points. Merrill Lynch (85), Bank of America (84) and Citigroup (72) trailed the Europeans, according to data compiled by Bear Stearns International. The latest edition of its annual study, by analyst Christopher Wheeler, is widely regarded as one of the most comprehensive research works into the inner finances of the global private banking business.
Credit Suisse, HSBC, UBS and Deutsche Bank have all enjoyed an improvement in their gross margins in recent months. This is despite a greater focus on the ultra high net worth segments, where there is a lower gross margin (generally 55 basis points to 45 basis points) and low cost-income ratio (40 percent or less), the study notes, saying: “However, we believe this improvement in gross margin reflects a continued shift of clients into higher-margin alternative asset classes.”
Ranked by pre-tax margin, HSBC is the class leader at 45.4 percent in the first half of 2007, followed closely by Credit Suisse (41.8 percent). UBS (35.3 percent) and Bank of America (34.5 percent) also perform creditably. If UBS’s lower-margin US wealth management operation is excluded, it could actually top the table with a very impressive pre-tax margin of 49 percent.
As UBS has discovered in managing US wealth, changing the way US wealth management businesses operate is no simple task, the study asserts. “While a greater number of asset-based accounts in Europe helps boost the gross margin, the lack of flexibility of (US) financial adviser compensation is a much thornier issue,” it maintains.
Wealth management compensation in Europe and Asia tends to be calculated on a basis similar to investment banking compensation, taking the form of a salary plus a bonus calculated on a number of performance-related measures. In US wealth management, the benchmark of being paid around 40 percent of attributable revenues remains the norm, and the report says “changing this has proved difficult”.
UBS has been trying to move the compensation of US financial advisers to a greater focus on net new money generated, in an initiative outlined last year; however, it has recently conceded that only 5 percent or so of US financial advisers’ compensation is based on this formula. UBS does remain absolute leader in terms of actual pre-tax profits, with $5.67 billion in the first half of this year. To give a measure of its clout, this is equivalent to nearly 25 percent of the total pre-tax profits of the top ten global private banks.
Merrill Lynch posted pre-tax earnings of $3.71 billion in the period, or just over 16 percent of the top ten banks’ profits.
UBS was also the leader ranked by wealth management revenues. On an annualised basis, it generated turnover of $16.1 billion in first half of 2007. This was equivalent to nearly 21 percent of the revenues generated by the top ten private banks. Merrill was ranked second, with $14.0 billion, for an 18.3 percent share.
In the rankings for adviser productivity, JPMorgan Chase is the class leader. Each of its financial advisers on average managed $324.3 million of client assets in the first half of 2007. This is understood to be a reflection of the ultra-wealthy clients in which the bank specialises, including many family fortunes.
Credit Suisse followed with $247.6 million, while UBS was a distant third at $137.4 million. Ranked by average revenues per financial adviser, Credit Suisse was the easy winner with $2.74 million. JPMorgan Chase recorded a figure of $2.20 million and, again, UBS lagged these leaders with $1.21 million.
Faced with such competitive disadvantage, the US players have been moving to raise their game, often by emulating the advisory model. “The move towards the full-service model and the shift of clients away from traditional transaction-based accounts is accelerating, accompanied by a greater emphasis in serving ultra-high net worth individuals, where the full-service model provides a competitive advantage,” the Wheeler study notes.
Indeed, Bank of America’s acquisition for $3.3 billion of U.S. Trust, with its blue chip client list, confirms the importance wealth managers are placing on the ultra-wealthy segment. Another measure of success in the US wealth market is the growing proportion of asset-based accounts – fee-bearing accounts that produce annuitised revenues. In 2002, the ratio for the larger US-based players was certainly less than 20 percent. Now it has moved up to much higher levels, with Merrill Lynch leading the way at 39 percent. Clearly, the 30 percent of asset-based accounts at UBS put it at a major disadvantage to its great rival, the study notes.
UBS US wealth management effectively earns 61 percent of its revenues from just 30 percent of its AuM, while Merrill Lynch earns 49 percent of its revenues from 39 percent of its AuM. So while UBS US is doing exceptionally well in terms of just under one-third of this AuM, a large proportion of its AuM earns very little. This reinforces why the US wealth managers are trying to shift more assets into fee-based accounts.
Whatever the geographic origin of wealth managers and their business models, most have enjoyed handsome returns from the wealth business amid buoyant markets. Their aggregated annualised first-half 2007 earnings grew some 59 percent to $22.9 billion compared with 2005 levels, as players refined their businesses and extracted leverage from their franchises.
In terms of strategy, wealth managers’ ability to offer high-quality, sought-after product has become an “increasingly important tool in winning clients”, the study observes. Although the development of in-house product, particularly structured product, has continued at a pace, in the past 18 months wealth managers have become more proactive in cementing access to external product.
This has taken a number of forms. Several wealth managers have followed the route established by JPMorgan Chase, which acquired a controlling stake in Highbridge Capital in 2005. However, others have avoided the risks of controlling alternative asset management, an area in which UBS has had a particularly bad experience this year with its Dillon Read hedge fund venture. Instead, they have formed closer links with product providers by forming joint ventures or taking meaningful minority stakes that provide preferential access to product, it notes.
Finally, the Bear Stearns analysis makes interesting reading at a time when many banks are bleeding from their investment banking operations and the subprime crisis, while private banking is vitally providing their continued revenues and profits streams.
Boston Consulting Group has estimated that total worldwide wealth, including mass affluent client assets, has reached almost $100 trillion. If these assets earned a conservative gross margin of 50 basis points, Wheeler observes, then this would yield fees of around $500 billion annually. “This compares to the total revenues generated by the world’s top ten investment banks in 2006 of $193 billion,” he notes.
No wonder private banking is such a priority at so many financial institutions, a trend that can only accelerate if the subprime credit crisis takes several months to resolve. For example, the proportion of group pre-tax profits at UBS represented by high-quality wealth management earnings has risen to 39.0 percent from 36.7 percent of the total. This trend has been replicated at Merrill Lynch (to 30.3 percent from 29.4 percent) and Wachovia (to 16.6 percent from 13.1 percent).
“This is clearly very positive for these banks’ overall valuations, particularly when one considers the valuations placed on asset/wealth managers compared to commercial/investment banks,” Wheeler concludes.