Wealth management expenses weigh on Morgan Stanley

By Joseph A. Giannone

NEW YORK (Reuters) - Senior executives at Morgan Stanley <MS.N> expressed impatience with the profitability of the company's retail brokerage business on Thursday, despite reporting progress in the unit's joint venture with Citigroup's <C.N> Smith Barney.

Second-quarter net revenue in the company's global wealth management group climbed 13 percent from a year ago to $3.48 billion on higher asset-management fees and trading gains, but pretax profit margin slipped to 9 percent from 10 percent in the first quarter on higher expenses.

The margin is well below Morgan Stanley Chief Executive James Gorman's target of 20 percent, and far lower than what the bank produces in its trading and asset management groups.

"Margins must improve and do so soon," Gorman told analysts on a conference call Thursday after the company reported much stronger-than-expected earnings companywide.

Pretax income at the unit rose 56 percent from a year earlier to $322 million but fell 7 percent from the first quarter.

Gorman, a former McKinsey consultant who once ran Merrill Lynch's retail brokerage empire, joined Morgan Stanley in 2005 with a mandate to revive an individual investor business that was strongly rooted in the former Dean Witter & Co. branch network.

His deal with Smith Barney two years ago, which includes a right to fully own the joint venture, makes him the only major investment bank executive to bet much of his company's future on retail brokerage.

The global wealth management group generated almost 40 percent of Morgan Stanley's second-quarter revenue, but its expenses are high and broker productivity is uneven.

"The margin isn't where we would like it," Chief Financial Officer Ruth Porat told Reuters in an interview.

The expense issue partly reflects Morgan Stanley's participation in an expensive war to recruit top brokers with guaranteed payouts over several years.

Compensation in the brokerage unit during the second quarter rose 9 percent from a year earlier, eating up 62 cents of every dollar of revenue.

Morgan Stanley Smith Barney remains the largest brokerage with 17,638 financial advisers at the end of June, down from 17,800 three months earlier and a decline from 18,087 a year earlier. The two legacy firms had more than 20,000 when the joint venture agreement was signed in January 2009.

Porat has indicated that the broker count could fall further. "We're focused on insuring that we remove lower-performing financial advisers," Porat said in an interview with Reuters on Thursday. "That's good for clients and that's good for our business."

Gorman told analysts on Thursday that costs will come down once the two brokerage forces in some 800 branches are integrated onto a single technology platform by the middle of 2012.

The quarter generated some good news in the brokerage unit. Advisers are on pace to generate an annualized $785,000 of revenue, the highest since the joint venture was started and 2 percent more than at the end of this year's first quarter.

Client assets as of June 30 climbed 14 percent from a year earlier to $1.71 trillion but were off 1 percent from three months earlier, due in part to tax-season withdrawals. Advisers on average oversaw $97 million of assets, on par with the first quarter and up 17 percent from a year ago.

Profitability, however, trails that of Bank of America's Merrill Lynch <MER.N>. Despite Merrill's smaller brokerage force of 16,241 advisers and client balances of $1.54 trillion, it generated second-quarter revenue of $3.49 billion and its brokers were more productive with annualized average commissions and fees of $894,000.

Morgan Stanley's surging expenses partly reflect its high technology costs as it integrates brokers onto the common platform. The bank incurred $98 million of integration costs during the quarter but said all its legacy brokers are now on the system while Smith Barney brokers will be aboard by the middle of 2012. Integration plans are "very much on track," Porat told analysts.

The company is hoping that the new system will help advisers work more efficiently with their clients, who added just $2.9 billion of net new assets during the quarter. That's down from $11.4 billion in the first quarter and well off the bank's goal of $50 billion a year.

Gorman said that "fee based" accounts are trending in the right direction. The accounts, which generate income regardless of trading activity, grew 29 percent from a year ago to $509 billion, or 30 percent of assets.

Shares of Morgan Stanley, whose earnings soared past analysts' estimates on strong trading results, were up 9.8 percent in afternoon trading Thursday at $23.84 a share.

(Reporting by Joseph A. Giannone; additional reporting by Lauren LaCapra and Knut Engelmann; Editing by John Wallace)

(This story is corrected in paragraph 12 to show comparison periods for decline in broker ranks)