Morgan Stanley’s purchase of discount brokerage E-Trade came just weeks before Covid-19 began its global spread. How will the resulting operations be affected? Jane Monahan reports.

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The US banking sector is changing rapidly as the global spread of Covid-19 brings fears of the devastating loss of human lives and an economic recession. 

In banking terms, 2020 started with a revolutionary deal: Morgan Stanley, the erstwhile pedigree investment bank that traditionally focused on large corporations and the very rich, took its biggest step yet into mainstream retail brokerage, striking an all-share agreement valued at $13bn to buy E-Trade, a digital discount brokerage that pioneered cheap online trading.

The merger, announced in a conference call with investors on February 20, was presented by James Gorman, chairman and chief executive of Morgan Stanley, as a strategic move that he said was vital for the bank’s long-term earnings and growth.

It is not the first transformational move Mr Gorman has made at the bank.

In his decade of leadership, which has encompassed the aftermath of the financial crisis and numerous changes in regulations, he has repositioned the bank, reducing its dependency on more volatile trading revenue and expanding its more reliable, fee-earning wealth management business. The addition of E-Trade represents “a leap forward in this wealth management strategy” and “an extraordinary growth opportunity”, he said, according to Morgan Stanley’s transcript of the call.

“E-Trade’s products, innovation in technology and established brand will help position Morgan Stanley as a top player across the full spectrum of wealth management,” he continued, indicating his tenacity in his quest to buy E-Trade, which he said he had first sought to buy in 2002 when he was an executive at Merrill Lynch.

Long-term gains

Investors on the conference call agreed with the bank’s executives that there was much that they considered positive about the surprising deal. However, they questioned what they considered the high price for the all-share transaction, representing a 30% premium paid by Morgan Stanley on the closing price of E-Trade shares on February 19.

Jonathan Pruzan, chief financial officer and executive vice-president of Morgan Stanley, said that once the deal closes, which is expected at the end of 2020 – subject to the customary regulatory approvals and acceptance by E-Trade shareholders – costs will exceed savings for the first three years of integration. Mr Pruzan acknowledged that in the short term the value of Morgan Stanley shares would suffer a decline, or a dilution, of “about 10%”. 

In the long term, however, the bank’s executives argued that the value of the bank’s franchise and earnings will go up as opportunities for organic growth increase. Morgan Stanley did not provide estimates of what these potential earnings will be when announcing the takeover.

“With hindsight, Morgan Stanley was lucky to have announced the deal when it did, when US stock markets were at an all-time high; and also to have structured it as an all-share, and not a cash, transaction,” says Michael Wong, financial markets analyst at Morningstar Research Services. Spending the latter would have affected Morgan Stanley’s capital ratios, at a time when, just weeks following the deal, big US banks are facing extraordinary challenges to their bottom line.

Drastic measures

Fears of the spread of Covid-19, or coronavirus, greater risks of a US economic downturn and a slump in oil prices all contributed to the ending of an 11-year bull run on US stock exchanges in March. Bank stocks have been particularly badly hit, alongside asset prices.

Added to that, hampering bank profit margins further in an already low-interest-rate environment, the Federal Reserve went ahead with an emergency cut of the benchmark interest rate of half a percentage point on March 3, and a further full percentage point cut on March 15 that left it hovering near zero, in a range between 0% and 0.25%. It also announced new quantitative easing measures that would entail $700bn-worth of asset purchases.

Before the Fed’s emergency measures and the acceleration in the international spread of Covid-19, Morgan Stanley executives were hopeful about the future. On February 20, they talked about the prospect that the more than 5 million brokerage clients of E-Trade – millennials and the moderately well-off – who today are accustomed to investing in shares and funds in a self-directed fashion, will, in a few decades, be wealthy enough and have a sufficiently complex financial situation to become a Morgan Stanley wealth management customer and need a full-service financial adviser.

“We love our financial advisers. We have nearly 16,000 of them,” said Mr Gorman during the conference call. “Our current adviser channel supports established wealth. E-Trade, on the other hand, services the next generation, the pipeline of emerging wealth. Having access to a much younger demographic and acknowledging their demands for digital solutions is critical to the growth of our businesses.”

Catching a trend

Jennifer Butler, a senior director at Corporate Insight, a US financial market research company, says that E-Trade’s digital platform capabilities are state of the art and an example of two trends in the US digital financial market.

First, she says, is that leading digital brokerages and big US banks, such as JPMorgan Chase, Bank of America and Wells Fargo, are increasingly blurring the lines between brokerage and banking models. Second, with a view to providing comprehensive financial management, which allows for more cross-selling of products and services, and is therefore more profitable, big banks are trying to create, or have already established, central platforms with integrated dashboards where customers can see all of their financial accounts in one place and easily move from one financial service or ‘experience’ to another.

“That keeps the customers’ money in-house or within the bank’s digital ecosystem,” says Ms Butler.

Stock plans

E-Trade’s brokerage accounts are already integrated with an array of offerings, including debit cards, online bill payments, mobile cheque deposits, mobile wallet capabilities and savings accounts.

The benefits of the merger for Morgan Stanley do not end there. E-Trade also has an established stock plan business with 4.6 million participants, managing the share compensation plans of executives and employees at thousands of companies. Mr Gorman described it as “a killer business”, which, he said, Morgan Stanley can scale up by combining with a similar, but much smaller, franchise of Canada-based Solium Capital, which Morgan Stanley bought in 2019 for $900m and rebranded as Shareworks. 

Like E-Trade, Shareworks' stock plan management focuses on millennials and salaried employees at thousands of companies, including start-ups such as Stripe and Spotify. The bank plans to merge both businesses in its Morgan Stanley at Work channel.

Ms Butler says one reason why stock plan management is gaining attention is because, with fees for trading stocks and funds shrinking over a long time, and being eliminated altogether in 2019 by Charles Schwab, the biggest digital discount broker – which has also taken over TDAmeritrade, the second largest – “a lot of larger financial institutions and incumbents are looking for new ways to make up for that revenue loss”.  

From the perspective of E-Trade shareholders, becoming part of Morgan Stanley, a big US bank, considerably reduces the uncertainty of continuing alone in such a cut-throat environment, believes Morningstar’s Mr Wong.

On top of this, importantly for Morgan Stanley, which does not have any physical bank branch footprint and obtains most of its funding wholesale, E-Trade brings $56bn of deposits and represents a low-cost, stable source of funding. Goldman Sachs, which also has no branch network, also took a step recently to attract moderately well-off customers, launching a retail digital brand, Marcus, from which base Goldman plans to increase retail deposits to $125bn in five years.

Untapped assets

Against this backdrop, when the deal was announced, Morgan Stanley estimated that once the merger closes there will be opportunities to target a total of $7300bn in assets that it believes are held by both companies’ clients but not yet managed by them, and to incorporate these assets into the bank’s broad wealth management business.

However, Brian Kleinhanzl, managing director of Keefe, Bruyette and Woods, a specialist in financial services, says such assertions raise questions about the deal’s cost.

“[Morgan Stanley executives] talk about the opportunity of assets held away being a target. But they also had pre-deal money held away and you haven’t seen that tremendous organic growth coming from that money,” Mr Kleinhanzl says.

“So I think the challenge is: how this [deal] is going to work organically, and that’s going to take a while to play out. That’s the only way you are going to make this deal work, if you do get future revenue synergies post-deal,” he adds. 

This is a challenge that may now be harder to address as the coronavirus pandemic takes its toll on the US economy.


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