Morgan Stanley to link Wall Street, Main Street with E-Trade purchase

Michael J. de la Merced, Kate Kelly and Emily Flitter, The New York Times

Posted at Feb 21 2020 08:45 AM

People take photos by the Morgan Stanley building in Times Square in New York City, New York US, Feb. 20, 2020. Brendan McDermid, Reuters

Morgan Stanley is betting its future on Main Street.

The Wall Street giant moved further from its investment banking origins Thursday with an agreement to buy discount brokerage E-Trade for about $13 billion, the biggest takeover by a major American lender since the 2008 global financial crisis.

The addition of E-Trade would allow Morgan Stanley to tap into a new source of revenue: the smaller-volume trades of the country’s so-called mass affluent, people who are wealthy enough to have some savings but not rich enough to buy into hedge funds or seek out a money manager. If it goes through, the deal will put Morgan Stanley, which does not have retail bank branches to draw in new asset-management customers, on firmer footing with competitors like Bank of America and Wells Fargo.

It would also give Morgan Stanley a big share of the market for online trading, an additional 5.2 million customer accounts and $360 billion in assets.

Morgan Stanley’s chief executive, James P. Gorman, said the merger would disrupt neither E-Trade clients nor Morgan Stanley customers, but ultimately result in more services for all.

The deal highlights the increasing convergence of Wall Street and Main Street: Elite bastions of corporate finance are seeking to cater to customers with smaller pocketbooks, and online brokerages that once hoped to overthrow traditional trading houses are instead suffering from a price war that has slashed their profits.

It also reflects a continuing shift in strategy for Morgan Stanley, which long relied on fees from high-finance services like mergers, stock offerings and massive trading desks but has lately embraced steady fees over bigger paydays and bigger risks.

Under Gorman, who has led the bank for a decade, Morgan Stanley has de-emphasized the businesses of jet-setting investment bankers and aggressive Manhattan traders, preferring the predictable and less costly realm of wealth management. It’s a strategy playing out all along Wall Street: In the dozen years since the start of the financial crisis, major financial firms from Credit Suisse to Goldman Sachs have embraced what are considered lower-risk business lines.

“This continues the decade-long transition of our firm to a more balance-sheet-light business mix, emphasizing more durable sources of revenue,” said Gorman, whose most transformative deal at Morgan Stanley before Thursday was its acquisition of Smith Barney’s retail brokerage in 2012.

E-Trade was an enticing target: It has struggled as brokerages slashed fees in a fight that peaked last fall when Charles Schwab eliminated fees for the trading of stocks and exchange-trade funds, and later agreed to buy TD Ameritrade for $26 billion.

Michael McTamney, who researches banks for ratings agency DBRS Morningstar, said the deal accelerated Morgan Stanley’s growth plans. The bank already had a strong high-net-worth client base, he said, and now “they’ll be able to bring in this next generation of wealth via the E-Trade platform.”

If the deal goes through — it needs the approval of E-Trade shareholders and regulators — more than half of Morgan Stanley’s pretax profits will come from wealth and investment management, compared with 26 percent a decade ago.

Morgan Stanley’s $2.7 trillion in assets are largely tied to big companies and wealthy individuals. The E-Trade deal would expand its access to the comparatively well-heeled, a group that encompasses more than 20 million households in the United States.

But Morgan Stanley could face a challenge luring this sort of investor toward its higher-touch investment management services.

Many E-Trade customers manage their own investments because of their intense distaste for the old-fashioned brokerage business. Others are hobbyists, trading a chunk of their retirement portfolios or some mad money. Both types have benefited greatly from decades of price wars that have made it possible for customers to pay nothing to maintain a brokerage account. Morgan Stanley will raise those fees at its peril.

But the addition of E-Trade offers another way to make money from those customers. Morgan Stanley could use the brokerage as the vehicle for delivering other products and services, such as shares of initial public offerings it has underwritten.

In Gorman’s words, the combination would unite Morgan Stanley’s “full-service, adviser-driven model” with E-Trade’s “direct-to-consumer and digital capabilities.”

Morgan Stanley is betting that regulators in Washington will approve what is perhaps the most consequential acquisition by a systemically important American bank — the too-big-to-fail variety of financial institution — since 2008.

Under the Obama administration, officials at the Federal Reserve fretted about the nation’s biggest banks growing through mergers. Daniel Tarullo, a former Fed governor, said in a 2012 speech that the central bank should have a “strong, but not irrebuttable, presumption of denial” for takeovers by America’s banking titans.

But the Fed has become more industry friendly during the Trump administration, particularly with the addition of officials like Vice Chairman Randal K. Quarles, a former bank lawyer who is helping reassess the rules put in place after the financial crisis. The central bank recently approved the combination of BB&T and SunTrust, paving the way for the creation of the sixth-largest US commercial bank.

The acquisition could look attractive to regulators from a financial stability perspective: The deal would infuse the Wall Street bank with stable deposits and reliable revenue streams. But it will also make Morgan Stanley more of a behemoth.

Morgan Stanley doubtless hopes an E-Trade deal goes more smoothly than a past effort to pull in retail clients. Its merger with Dean Witter Reynolds two decades ago foundered amid a clash between Morgan Stanley’s Wall Street aristocrats and Dean Witter’s more down-market brokers. Since then, however, the bank has been steadily shifting toward asset management — one of a number of approaches major banks have been trying to court Main Street.

Morgan Stanley’s traditional rival, Goldman Sachs, created a retail-focused lending arm, Marcus, in 2016 and teamed up with Apple last year to offer a credit card. Last month, Goldman said it intended to expand its retail deposit base to $125 billion, and its consumer loan and card balance to $20 billion, over the next 5 years.

Investors seem to be more taken with Morgan Stanley’s continuing shift than with Goldman’s, at least based on the Wall Street scoreboard of stock prices. Shares in Morgan Stanley have climbed nearly 33 percent over the past 12 months, while those in Goldman have risen about 19 percent.

Late last year, JPMorgan Chase — already known for its enormous banking operations in both the consumer and the institutional areas — established a new platform that is meant to combine financial advisory services within its bank branches with wealth-management and online brokerage offerings.

And Bank of America, whose acquisition of Merrill Lynch during the financial crisis made it a heavyweight in the wealth-management business, has moved to court less-wealthy clients as well.

Under the terms of the deal announced Thursday, Morgan Stanley will buy E-Trade using its own stock. Its offer is worth about $58.74 a share as of Wednesday’s market close, a 30 percent premium on the value of the online brokerage’s shares.

E-Trade’s chief executive, Michael Pizzi, would continue to run the business upon the deal’s closing, which is expected by year’s end.

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