Posts tagged ‘investment banks’

Opening the Broker Departure Floodgates

Even though the equity markets have rebounded massively, investors remain in a sour mood in light of sluggish domestic economic headlines. Technology, for example High Frequency Trading (HFT – read more), along with the harsh realities of financial regulatory reform is creating profit growth challenges for the global financial gargantuans. More specifically, the floodgates have sprung open with respect to broker departures from the big four brokerage firms.

According to Bloomberg, more than 7,300 brokers have left the four largest full-service brokerage firms (Merrill Lynch [BAC], Morgan Stanley Smith Barney [MS], UBS Wealth Management [UBS], and Wells Fargo Advisors [WFC]) since the beginning of 2009. But the brokers have not floated away quietly – more than $1 trillion in assets have fled these major brokerage firms and followed the brokers to their new employers.  

Several factors have led to the deluge of departures of bodies and bucks:

1)      Mergers: The financial crisis triggered an all-out economic assault on the brokerage firm industry. A subsequent game of musical chairs resulted in the marriage of disparate cultures (e.g., B of A-Merrill; Morgan Stanley-Smith Barney; Wells Fargo-Wachovia). Not only did the clashing cultures rub brokers the wrong way, but the surviving executives were left with redundant and unproductive brokers to cut.   

2)      Heightened Recruiting: With a shrinking pie and less growth comes more fierce competition. The discount brokerage firms have realized the Darwinian challenges and reacted to them accordingly. Take TD Ameritrade (AMTD) for example. In the first seven months of 2010, the discount brokerage firm added 212 independent advisers to its network, a +44% increase over the previous year. Charles Schwab Corp. (SCHW) with its network of 6,000 independent advisers is also ratcheting up its efforts to poach brokers away from the large brokerage firms.

3)      Economics: Would you like 40-50% of profits generated from new clients, or 80-100%? In many instances, the broker from the large branded institution funnels the majority of the commissions to the mother-ship. Sure, the broker receives back-office, marketing, and branding support, but some brokers are now asking themselves is the brand an asset or liability? Wall Street has gotten a large black eye and it will take time to heal their corporate images…if they ever manage to succeed at all.

4)      Customer Choice: Lastly, and most importantly, customers are voting with their dollars. As I have indicated in the past, I strongly believe the current system is structurally flawed (see Financial Sharks article). Financial institutions craft incentives designed to line the pockets of brokers (salespeople) and prioritize corporate profits over client wealth creation and preservation. The existing failed industry structure is based upon smoke, mirrors, opacity, and small print. Many independent, fee-only advisors are structuring financial relationships that align with portfolio performance and make transparency a top priority. Customers appreciate these benefits and are shifting dollars away from the brokerage firms.

See More Bloomberg Video

LPL Loving IPO Life

If you are having a difficult time processing the magnitude of this investment advice shift, then consider the $4.4 billion estimated value being placed on the planned IPO (Initial Public Offering) of LPL Financial, the independent brokerage firm of 12,000+ financial advisors. LPL serves as a conduit for legacy brokers to become independent, and still allow them to benefit from an array of ala carte support services. Growth has been strong too – over the last decade the advisor count at LPL has more than tripled and assets under their umbrella now exceed $250 billion.

The Wall Street broker floodgates have opened, so unless regulatory changes are enacted, the old flawed way of doing things will require a life support raft. If not, independent, fee-only advisors like Sidoxia Capital Management will benefit from the current sinking migration of brokers.

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

http://www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in BAC, MS, UBS, WFC, AMTD, SCHW, LPL Financial or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

November 15, 2010 at 12:17 am Leave a comment

California Checking Under the Derivatives Hood

[tweetmeme source=”WadeSlome” only_single=false https://investingcaffeine.com/2010/04/11/california-checking-under-the-derivatives-hood/%5D

Bill Lockyer, California’s State Treasurer, is in charge of driving “The Golden State’s” budget, but as he maneuvers the finances, he is hearing some strange knocks and pings as it relates to the pricing of Credit Default Swaps (CDS) on California debt obligations. CDSs, like virtually all derivatives, can either be used to speculate or hedge (see also, Einhorn CDS and Financial Engineering articles), so the existence of strange noises does not necessarily indicate foul play or problems that cannot be fixed.

Checking Under the Banks’ Hoods

 At the heart of the CDS markets lie the major investment banks, so that is where Lockyer is looking under the hood and requesting information on the role the banks are playing in the municipal bond CDS market. Specifically, Lockyer has sent letters requesting information from Bank of America – Merrill Lynch (BAC), Barclays, Citigroup (C), Goldman Sachs (GS), JP Morgan (JPM),and Morgan Stanley (MS). California pays the banks millions of dollars every year to market bonds on behalf of the state. The I-banks operate in some way like a car dealership – the state produces the cars (bonds) and the banks buy the bonds and resell them to buyers/investors.

The financial transaction doesn’t necessarily stop there, because the banks can further pad their profits by selling and making markets in credit default swaps. After the state issues bonds, speculators can then pay the banks to place bets on whether the cars (bonds) fail (default), or investors can also buy insurance from the banks in the form of swaps. As you can probably surmise, there is the potential for conflicts of interest between the state and the banks, which partly explains why Lockyer is conducting his due diligence.

California…the Next Greece or Kazakhstan?

As the housing market came crashing down, credit default swaps were at the center of financial institution collapses and the billions made by John Paulson (see also the Gutsiest Trade Ever). More recently, CDSs were cited as negative contributors to the Greek financial crisis. Lockyer tries to deflect California comparisons with Greece by stating the European country’s budget deficit is 13 times larger than California’s (as % of GDP) and the foreign country’s accumulated debt is 25 times larger on GDP basis as well (read California’s Debt Hole story).

Beyond making sure the profit rules of the game are not stacked against California, Lockyer wants to understand what he perceives as a mispricing in the default risk of California debt obligations. He is worried that the state’s borrowing costs on future bond issues could be artificially escalated because he says the credit default swaps “wrongly brand our bonds as a greater risk than those issued by such nations as Kazakhstan, Croatia, Bulgaria and Thailand.”

Clarity on these issues is important because the state is exploring the expansion into taxable municipal bonds. The government has been subsidizing taxable munis, termed Build America Bonds (BABs), to stimulate the economy and bring down borrowing costs for municipalities. According to Thomson Reuters, BABS accounted for approximately 26% of overall muni bond issuance ($25.8 billion) in the first quarter.

If California were a car, I’m not sure how much cash they would get for their clunker ($16 billion budget deficit), but I tip my hat to State Treasurer Lockyer for holding the investment banks’ feet to the fire. All investors and financial product consumers stand to benefit by looking under the hood of their financial institution and asking tough questions.

Read Full Financial Times Article on California CDS Market 

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper. 

*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct positions in BAC, C, GS, JPM, and MS or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

April 11, 2010 at 11:26 pm Leave a comment

Now You See It, Now You Don’t: TARP

Magic

Elizabeth Warren,  who oversees the TARP (Troubled Asset Relief Program), along with being  the Chair on the Congressional Oversight Panel and a professor at the Harvard Law School, goes out on a limb and candidly states, “ We not only don’t know [where the TARP money is], Maria, we’re not ever going to know.”

Ms. Warren is quick to blame former Treasury Secretary Henry “Hank” Paulson for not implementing accountability for the TARP funds handed to the large commercial and investment banks (see my earlier TARP article). How do you prove the money handed over to the banks was used for  non-lending activities, such as marketing, compensation, television advertising, dividends, acquisitions or other corporate purposes other than lending? The short answer…you can’t! Even if TARP capital tracking was instituted, I think it would have been a fruitless effort since even legitimate use of the TARP funds would only free up additional capital for other suboptimal purposes. If my mom gave me $100 while I was struggling for money in college and told me to use it for food – well I, like a good chunk of students, would have eaten anyways without the handout. The windfall $100 bailout would likely be used for a guys trip to Las Vegas or some Laker basketball tickets. The banks will certainly lend, but not at the same pre-Lehman bankruptcy levels, regardless of whether TARP tracking was instituted or not. Ms. Warren correctly points out that regulators are speaking out of both sides of their mouths. The government wants banks to lend more (which reduces the bank’s capital base) and also raise their sickly reserve levels at the same time.

See TARP commentary on CNBC video interview at minute 2:48

Maria Bartiromo also probes the topic of executive pay compensation given a recent Congressional proposal that  TARP recipients cut salaries of the top 25 executives by -90%. Seems like a reasonable request given the circumstances. However, having the government force banks into making bad loans is probably not the right answer. This stance will only force the banks to take higher loan deliquency provisions and recognize more potential writedowns in the future. Eventually the Fed will cut interest rates paid to banks on the reserves held at the central bank, thereby invcentivizing the banks to take advantage of the steeper yield curve and make handsome spreads on loans.

Until then, some of the banks will sit patiently on their TARP capital (not lending) while Ms. Warren and government officials will wonder how the billions of TARP bailouts magically disappeared.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management and its clients had a direct position in VFH and BAC shares at the time this article was originally posted. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

October 23, 2009 at 2:00 am Leave a comment


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