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Are FAs Begging for Strife with Securities-Backed Loans?

July 28, 2017

Securities-backed loans have been great for boosting the bottom line at financial services firms in recent years, but critics say they’re of far less benefit to wealth management clients, the Wall Street Journal writes. Regulators are also increasingly going after hard-sell tactics of such lending products, according to the paper.

Loans backed by stocks and bonds have become a stable source of revenue for brokerages as more of them move away from commission- to asset-based fee models, the Journal writes. Merrill Lynch and U.S. Trust, which comprise the wealth management division of Bank of America, had $40 billion in such loans as of the end of 2016 — more than double the balance in 2010, according to the paper. Morgan Stanley had $30 billion, meanwhile, more than double from just four years ago, the Journal writes. Wells Fargo and UBS also have billions of dollars in such loans, people familiar with the firms tell the paper. Goldman Sachs is now in the game as well, partnering with Fidelity to grow securities-based loans.

The loans are also a boon for brokers because their clients don’t need to sell the securities in their accounts to obtain the necessary funds, the paper writes. At Merrill, outstanding loan balances can count towards a broker's year-end bonus and advisors typically earn continuing payments when they convince clients to tap credit lines, the Journal reports, citing an unnamed source familiar with the matter.

But securities-backed loans could be very risky for clients, the Journal writes. While clients can typically get the loans at low interest rates because they’re secured, they can end up on the hook if the market falls, according to the paper. When the collateral for the loan drops, banks may demand a loan repayment, the sale of the securities and repayment of outstanding balances, the Journal writes.

In case of a 10% market drop, firms would start making margin calls on some accounts, Terrance Odean, a professor of finance at the Haas School of Business at the University of California, Berkeley, and others tell the Journal.

What’s more, brokerages often push these loans on clients who don’t even need them, critics tell the paper. Several Merrill Lynch brokers, for example, tell the Journal they’ve asked clients to take out the loans so they could hit their bonus targets. Steven Dudash, a former Merrill Lynch broker who went independent in 2014, tells the paper advisors at the wirehouse were “dramatically pushed” to encourage all of their clients to take out such loans. Representatives for Merrill Lynch tell the Journal that the loans are offered with disclosures of risks and fees and that the brokers push them “in a responsible manner.”

Regulators are increasingly scrutinizing the practice, meanwhile, according to the paper. Finra settled with Merrill Lynch last year when the self-regulator alleged the wirehouse had failed to adequately explain the risks of such loans, the Journal writes.

A spokeswoman for Merrill Lynch tells FA-IQ that following a comprehensive internal review of the wirehouse's loan management accounts, the firm had self-reported to Finra some potential issues it had found with its supervision.

"We cooperated fully with Finra’s inquiry and have strengthened our controls and procedures to the regulator’s satisfaction," she says.

In entering into the settlement, Merrill Lynch made no admissions of wrongdoing but believed it was in the best interests of the firm and its clients to resolve these matters, according to the firm's spokeswoman.

And Massachusetts’ top securities regulator settled with Morgan Stanley last year to the tune of $1 million, alleging the firm’s brokers were encouraged to push the loans regardless of whether clients needed them, the paper writes.

A spokesman for Morgan Stanley tells the Journal the regulator didn’t find evidence of any harm to clients, and the firm has since clarified its policies and control measures over the sale of securities-backed loans.

By Alex Padalka
  • To read the Wall Street Journal article cited in this story, click here.