Wall Street needs you to borrow against your stock


Wall Street brokerages are pushing customers to take out billions of dollars in loans backed by stocks and bonds, a trend that yields lucrative fees for the firms but poses risks for borrowers.

Executives at Morgan Stanley earlier this month highlighted these loans to individuals as a big growth area and revenue driver, saying the loans helped expand the bank's overall wealth lending by about $3.5 billion, or 6%, in the second quarter. On Thursday, Goldman Sachs Group Inc. took a step toward growing its securities-based lending business through a new partnership with Fidelity Investments.

For brokerages, these so-called securities-backed loans have become a reliable source of revenue in the years since the financial crisis as firms have begun moving away from a business model of charging commissions for trading to a system of fees based on assets under management. The loans themselves help brokers retain these assets because customers don't have to sell stocks and other securities when they need cash. These loans have also become a big factor in brokers' compensation.

Clients, in turn, are able to borrow money at relatively low interest rates because the loans are secured.

But they could be left in the lurch if markets tank and the value of that collateral shrinks, prompting the bank to demand loan repayment. If a margin call isn't met, the securities backing the loans are sold and the borrower is responsible for any remaining balance.

These arrangements are structured to benefit the brokerage, with the client shouldering virtually all the risk, critics say. And these loan products are often pushed without regard to whether clients even need them, they add. Regulators are also taking notice.

Several Merrill Lynch brokers said they have asked longstanding clients to open securities-backed lines of credit to help them hit bonus hurdles, assuring that clients wouldn't need to use it or pay any fees for opening it. Merrill brokers receive ongoing payments for getting clients to tap credit lines, and those loan balances contribute to year-end bonus calculations, people familiar with matter said.

Brokerage executives have said the longer a client has one of these loans tied to their account, the more likely they are to use it.

"We were dramatically pushed to put these on all of our client accounts, " said Steven Dudash, a former Merrill Lynch broker who has been managing his own investment-advisory firm since 2014. "Whenever you're product-pushing, it's not in the client's best interest."

Merrill representatives say its brokers offer these loans to clients in a responsible manner, including disclosing the risks and fees.

"If people need the money, they should sell securities," said Terrance Odean, a professor of finance at the Haas School of Business at University of California, Berkeley. "It's very risky to take a leveraged position in the market, and I don't think people are thinking about it that way."

A major concern of critics is that the boom in securities-backed lending has coincided with what is now the second-longest bull market on record in the U.S. They worry that investors, nearly a decade removed from the financial crisis, have become less wary of debt backed by investments as stock markets keep rising.

If U.S. markets fell 10%, Mr. Odean and others predict that firms would make margin calls on some accounts.

As of the end of last year, clients of Bank of America Corp.'s wealth unit, which includes Merrill Lynch and private bank U.S. Trust, had some $40 billion in such loans outstanding, up 140% from 2010. Morgan Stanley's customers had $30 billion in these loans, more than double from 2013. UBS Group AG and Wells Fargo & Co. also have made billions in such loans, people familiar with those banks said.

"The real story for us...has been in the wealth business as we continue to increase our penetration of our client base with lending products," Morgan Stanley's finance chief, Jonathan Pruzan, said while discussing earnings this month, adding that the bank expects more clients to take out loans in the months ahead. "That's been a real key driver of our wealth business."

The growth of securities-backed loans has increasingly drawn the attention of regulators, who have questioned the brokerages' marketing and sales efforts as well as the suitability of the loans.

Merrill opened more than 121,000 such loan accounts between 2010 and 2014 with more than $85 billion in total credit extended, according to a Financial Industry Regulatory Authority settlement order last year. In the matter, Finra alleged that Merrill didn't fully explain the risks of securities-backed loans and used risky or concentrated investments as collateral.

Merrill settled its case without admitting or denying the allegations. Merrill reported its securities-lending oversight lapses to Finra initially and cooperated with the regulator's inquiry, according to Merrill representatives. The representatives added that the firm has improved its procedures around how the loans are supervised.

Massachusetts' securities watchdog last year accused Morgan Stanley of developing a sales program that encouraged brokers to pitch these loans regardless of whether clients needed them. Brokers involved in the incentive program were given scripts coaching them to offer securities-backed loans to clients who said they needed to pay taxes or cover expenses for a wedding or a graduation party, or if they mentioned "purchasing a luxury item like a car or yacht," according to the regulator.

"It's not healthy for the industry," said William Galvin, Massachusetts' top securities regulator, who has been investigating how firms motivate brokers to push these loans. Brokerages "should be more concerned about this," he said, "but they're in favor of competition and seeing who can get more loans."

Morgan Stanley agreed to a $1 million settlement with the regulator in April without admitting or denying wrongdoing. A Morgan Stanley spokesman said Massachusetts found no evidence that any clients were harmed or that any of the loans were unsuitable or unauthorized. "We have taken steps to strengthen and clarify our policies and controls around such initiatives," the spokesman said.

Write to Michael Wursthorn at Michael.Wursthorn@wsj.com