The attractions of wealth managers

One of the themes that emerged from the recent banking reporting season is the effort that major UK-focused banks are making to diversify their businesses, adding wealth management expertise to banks where mortgages and commercial loans were once dominant. If the current very tight balance sheet pattern of UK banks is the long-term result of the financial crisis – a result which many would say is a welcome relief for the taxpayers who paid for the bailout of the banks – then another result of this crisis is the urgent need to add high quality income to a bank’s core business. This is where wealth managers have real appeal for the big UK banks.

Quilting (QLR) is the latest wealth manager to attract the interest of major banks, with reports that Natwest (NWG) is considering a full-scale takeover bid. While obviously neither company is commenting on such speculation, and it’s just silly chatter during the season as the city heads to the beach in August, the inherent plausibility of such an approach is as much linked to the long-term problems faced by the main players in the United Kingdom. targeted banks, as for the merits of any potential offer itself. Predictably, Quilter, whose earnings we’re covering this week, saw its stock price jump 15% in the report. In short, investors are betting that the need for banks to diversify their income will result in the acquisition of more wealth managers – like the long-term holders of Brewin Dolphin, after it was sold to the Royal Bank of Canada (CA:RY) earlier this year, can testify.

Lack of interest income and loans

The pandemic has highlighted two long-term trends for banks, one short-term, one long-term. In the short term, the pandemic has increased corporate cash as companies have saved money by cutting dividends and saving on operational costs. This has led to lower demand for business loans as mortgages tend to fall due to recession fears and rapidly rising interest rates. According to the latest figures from the Financial Conduct Authority (FCA), mortgage lending in the first quarter of 2022 fell 7.5%, year-on-year, to £76.9bn – although loans already agreed were flat . This seems to confirm forecasts that a slowdown in the mortgage market is looming this year.

Fundamentally, the profitability of banks is determined as much by external economic factors as by their own actions, but certain trends are indicative of the evolution of the economic model over time. For example, the Bank of England’s own figures show that interest income peaked at 80% of banking income in 1980 and has been declining ever since under the combined effect of falling interest rates. interest and the addition by banks of new commercial functions based on commissions, rather than lending.

Take Lloyd’s Banking (LLOY) as a representative example of the lending trend in the industry. Last half-year results showed the Black Horse had net interest income which accounted for around 59% of total income, despite a massive open mortgage portfolio of £297billion. In other words, banks need to diversify because the exposure to the core lending business is now so large that potentially negative macroeconomic effects have a much bigger impact on the bottom line. It’s fair to say that this trend is largely confined to companies like Natwest and Lloyd’s. Barclay’s (BARC) and HSBC (HSBA) already have diversified wealth management activities as part of their business structure.

Why wealth managers?

One of the reasons pure wealth managers are attractive to large financial institutions is the fees investors charge for the privilege of a manager looking after their money. Annual fees of 1% or more are not uncommon, plus additional expenses for things like “stock trading” or “financial planning.” While many savvy retail investors will likely avoid the fees that accrue with wealth managers over time, many people are content to simply pay for a bona fide wealth manager to do all the work and maintain that relationship for many years. And it is this combination of high fee levels and basic inertia that is the main attraction for banks.

The industry’s operating margin varies by type of service and provider, with the big names easily generating margins of 40% or more. Another attraction is the typical manager’s low cost of capital, which means that its operations can be easily integrated into the acquiring bank’s corporate structure without adding large amounts of physical infrastructure.

In addition, the sector is relatively fragmented, with medium-sized listed companies such as Rathbones (RAT), Where Brooks Macdonald (BRK) being representative of a much larger pool of unlisted asset managers, who have many high value-added specialties in terms of pensions or ethical investment. In short, the sector is ripe for further consolidation and, with interest rates only rising, the big banks will have the capital to shop around.

Dolores W. Simon