Boom in Securities-Based Lending Lifts Wirehouses, Sparks Concerns over Risk
As investors pile on margin debt, wirehouses are cheering the loan growth they have seen on their balance sheet, but some investor advocates and analysts worry about what comes next.
That figure, which includes retail as well as institutional prime brokerage loans, has been expanding thanks to a confluence of factors, including low interest rates and high market valuations that have upped investors’ appetite to collateralize their portfolio.
The results are also showing up in loan balances at bank-owned wirehouse firms, which have been pushing securities-based lending as a way to cross-sell wealthy retail customers and generate non-compensable revenue that isn’t shared with their advisors.
Morgan Stanley Wealth Management reported that margin loan balances rose 180% year over year to $26.6 billion in this year’s first quarter. The balance, which includes around $3 billion in securities-based non-purpose loans that cannot be used to buy more securities, was throttled by the fourth quarter acquisition of online broker E*Trade Financial.
On its first quarter earnings call, Morgan Stanley Chief Financial Officer Jonathan Pruzan touted “tailwinds” that were helping propel “nice loan growth in margin lending.”
Bank of America reported that securities-based lending specifically increased year-over-year by $5 billion–or 12.5%–to $45 billion in its global wealth and investment management group, which includes Merrill Lynch Wealth Management, Bank of America Private Bank and Merrill Edge consumer investments.
UBS Wealth Americas and Wells Fargo do not segregate specific securities-based loan balances from overall totals. But UBS said that all loans increased 7% over the previous quarter to $78 billion, driven by $5.5 billion in net new loans, which were identified as mostly either margin-account, or non-purpose securities-based lending.
Wells Fargo’s total loan balances were up 4% to $80.8 billion in the first quarter, which Chief Financial Officer Michael P. Santomassimo said on an earnings call was “largely due to customer demand for securities-based lending offerings.”
“Serving our clients’ lending needs is a strong growth opportunity,” a Wells Fargo Advisors spokeswoman said in a statement.
Rates for margin loans vary widely. Merrill Lynch charges 10.875% on loans under $5,000, Morgan Stanley’s E*Trade platform, 11% on the same amount, but both wirehouses lower their rates as clients’ borrowing increases–each dropping rates to 7.5% on loans of $1,000,000 or more, all figures according to InvestorJunkie.com’s 2021 rankings.
While securities-based loans are a boon for firms in the good times, they risk exacerbating losses or prompting margin calls if stocks drop significantly, said Tyler Gellasch, the executive director at Healthy Markets & Trust, an investor advocacy firm.
“Obviously, that could go the other way,” he said about the booming equity markets. “There is leveraging and sky-high valuations in nearly every asset class. It’s hard to truly contemplate in any really clear way what that means for risk, other than it is just unnerving.”
His remarks echoed a concern raised by Morgan Stanley’s Chief Investment Officer, Lisa Shalett, who highlighted the Finra loan stats in her weekly investment strategy letter on May 3 as a worrying sign for the broader market, which has generally seen margin loans peak before earlier crashes such as the dot-com bubble and the housing crisis.
“Margin debt on the stocks in the S&P 500 Index has grown in excess of 70% this past year, a level which in the past has signaled market downturns,” she writes.
To be sure, margin loan balances correspond to market values since customers have more collateral to post when markets are higher.
Finra rules and Regulation T of the Federal Reserve Board also limit how much brokerages’ clients may borrow based on their securities holdings. Finra, which listed securities-backed lending as a compliance examination priority in 2018, set a maximum of 75% of a stock’s value for non-purpose loans.
The Federal Reserve’s Regulation T limits investors to borrowing only up to 50% of the purchase price of securities for margin loans.
Still, some registered investment advisors tell customers it’s generally not worth risking your portfolio with margin debt.
William Jeter, an advisor with Abacus Planning Group, an RIA in Columbia, S.C, said some of his clients may open securities-based borrowing accounts for unexpected or temporary spending needs—such as bridge loans—but he generally advises against it and advises strongly against them using borrowed money to buy more stocks.
“We do not use margin accounts to juice returns, we’re fortunate enough to have clients that are in strong financial positions, and they do not need to jeopardize their security for slightly more return,” Jeter, whose firm manages more than $1.3 billion and custodies its client assets with Charles Schwab, added.
Ross Gerber of Gerber Kawasaki Wealth and Investment Management said non-purpose loans can be good to help keep clients in the market while making large purchases but worried that margin loans were too risky of a tool for many customers.
“It’s sort of the job of an advisor to make sure clients don’t borrow too much and put themselves in a position where they have to be forced to sell securities,” said Gerber, co-founder and president of his Santa Monica, California-based RIA, which oversees $1.8 billion in client assets.