Another Good Year for the Brokerage Industry

We’ve already heard about what a great year 2006 was for Wall Street, with securities industry firms ringing in some of the best revenues and profits in years. But fourth-quarter earnings reports are just now rolling in, and they’re even better than expected. And it’s not just Wall Street’s investment-banking divisions that are reeling it in—retail brokerage contributed its share of bounty, too.

We’ve already heard about what a great year 2006 was for Wall Street, with securities industry firms ringing in some of the best revenues and profits in years. But fourth-quarter earnings reports are just now rolling in, and they’re even better than expected. And it’s not just Wall Street’s investment-banking divisions that are reeling it in—retail brokerage contributed its share of the bounty, too.

“The broker/dealers [Merrill Lynch, Morgan Stanley, Goldman Sachs, Lehman Brothers and Bear Stearns] went on a great run in 2006…peer group revenues were up nearly 30 percent, and the stocks increased by 40 percent, easily trouncing a 14 percent move in the S&P 500,” wrote Sandler O’Neill analyst Jeff Harte in a Jan. 12 research note. And that was even before he got a glimpse of earnings releases from Merrill Lynch, Citigroup and Wachovia over the past two weeks.

Merrill Lynch, which reported earnings on Jan. 18, smashed analysts’ full-year consensus expectations by $0.54 per share, with a fourth-quarter finale driven by underwriting gains, strong trading revenues and “surprising strength in its wealth-management business.” As of the fourth quarter, the global private client group and the global investment management group (which includes revenues from Black Rock and several alternative-investment products) are now lumped together as one: Global Wealth Management.

Merrill’s private client group racked up $11.6 billion in full-year revenues, up 11 percent versus 2005, and full-year pretax earnings of $2.7 billion, a 23 percent increase from the previous year. Additionally, Merrill padded its already comfortable lead over its wirehouse peers in most retail brokerage measurements: client assets ($1.63 trillion); financial advisors (up 5 percent, to 15,580); revenues per advisor, ($793,000, according to CIBC World Markets analyst Michael Mayo); net new assets, ($61 billion in 2006); and a pretax profit margin of 22.5 percent for 2006. Shareholders have benefited as well—the firm’s stock price increased 37 percent in 2006.

Citigroup had a solid fourth quarter as well, beating consensus expectations by a penny. Expenses were the talk of the day as CEO Chuck Prince promised to reign in costs and boost operating leverage. He ousted wealth-management head Todd Thomson (who, according to published reports, had a habit of loosely spending the company’s money). Taking his place will be Sallie Krawcheck, the current CFO and former head of the unit. COO Bob Druskin will run wealth management until a CFO is found to replace Krawcheck.

Despite the noise, full-year earnings at Smith Barney were up 15 percent, to $1 billion from $871 million in 2005. And full-year revenues were up 20 percent, to $8.16 billion from $6.8 billion in 2005. The number of financial advisors increased only 2 percent in 2006, to 13,143, but renewed recruiting efforts and advertising campaigns could give hiring a boost. Additionally, revenue per advisor reached $667,000 in the fourth quarter, an 18 percent improvement from the same time last year. Client assets increased 9 percent in 2006, to $1.23 trillion from $1.13 trillion at the end of 2005. However, net new client asset flows stagnated to $9 billion in 2006, down from $28 billion in 2005. Smith Barney’s pretax profit margin dipped to 19 percent in 2006, down from 22 percent in 2005.

Morgan Stanley, which released earnings Dec. 19, had a very good fourth quarter to cap a solid 2006. Investors are happy about the firm’s performance, and the stock increased 45 percent. In its global wealth management unit, full-year pretax earnings were $509 million, up 22 percent from last year, excluding the $198 million benefit the firm received in 2005 from the World Trade Center insurance settlement. Full-year revenues, driven by net interest revenues from the bank-deposit sweep program and higher revenues on fee-based products, were up 10 percent, to $5.5 billion. Client assets grew 11 percent in 2006, to $686 billion with $8.5 billion in net new client assets on the year, a dramatic turnaround compared to the $2.7 billion net outflow the retail unit recorded in 2005. The number of financial advisors decreased 16 percent in 2006, to 8,030 from 9,526 in 2005, as the firm continues to cut loose primarily lower-end producers. Remarkably, reps at the firm now average $720,000 in annual revenue and $85 million in assets, according to analysts.

Wachovia, who reported earnings Jan. 23, just beat consensus earnings per-share estimates by a penny. While the stock price was up only 9 percent in 2006, analysts feel good about the firm’s prospects: “We are encouraged by management’s positive outlook for 2007 and the apparently strong momentum in all lines of business,” wrote Morgan Keegan analyst Evan Momios in a research note. Wachovia does not compile full-year comparisons, but its fourth quarter was impressive: In the capital-management group, retail brokerage services’ pretax earnings were up 34 percent, to $222 million from $166 million at the same time last year. Total revenues in the unit were up 14 percent, to $1.3 billion from $1.18 billion in the fourth quarter of 2005. The retail unit’s pretax profit margin for the quarter was 26 percent, tops among its brokerage peers. A Wachovia spokesman said the firm does not disclose net new asset flows, but total client assets were $760 billion—which, as of the second quarter, includes some mutual fund assets—an 11 percent increase from the fourth quarter of 2005. Wachovia’s network of financial advisors inched up 1 percent, to 8,091, in 2006.

UBS, the only wirehouse yet to report earnings for the final quarter of 2006, reports on Feb. 12.

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