June 13, 2009

Take It Away, 2009 Please!

By Howard J. Stock, BANK INVESTMENT CONSULTANT

Who isn't happy to see the back of 2008? It started out badly on the back of the subprime crisis that began in the fall of 2007 and managed to get spectacularly worse when catastrophic third-quarter 2008 financial results poured in, sending many of the biggest financial services firms straight down the crapper.

I remember the shock and disbelief when on a Friday evening the bartender at my local watering hole told me Wachovia had collapsed. Wachovia? Surely he meant Washington Mutual, said a Wall Street trader I was talking to at a party on Saturday. But the bartender had been right: One moment Wachovia was the white knight ready to snatch WaMu from the jaws of death, and the next, the nation’s No. 3 bank itself had fallen afoul of an asset class that in hindsight seems ludicrously risky. Who would be reckless enough to bet billions of dollars on mortgages lent to people who can’t pay them? Every big name in financial services, apparently, and investors are as mad as all hell about it.

The question is, where do we go from here?

Without wishing to be too gloomy, the next year is going to be tough for advisors. Ken Kehrer, director of consulting firm Kehrer-LIMRA in Princeton, N.J., sums it up: “What’s an advisor to do? How can he encourage clients not to cash out their holdings when all the advisor’s advice is proving wrong? Advisors are still sticking to theories, the experience and wisdom of the profession, while clients are losing confidence in them. We’re all waiting for a comeback, but in the meantime financial advisors just look foolish. The tenets of diversification and rebalancing are shaken.”

Managing Expectations

It’s small consolation that this is a crisis of confidence for everyone. As the former head of global wealth management at Citigroup, Sallie Krawcheck, said at BIC’s Women’s Forum in July, “If you’re not worried, you’re asleep.” No one really knows what’s going to happen from one minute to the next and no one knows when it will end. The current consensus is pointing to anywhere from the end of the first quarter to early 2010, which could mean staying the course for another year, reassuring existing clients and grabbing new ones where you can. It’s not going to be easy. And at the same time as you're trying to calm clients, your own business may be shifting under your feet as the biggest banks digest their acquisitions and the smaller banks try to accommodate a growing client base (see “Small Talk,” at left).

One thing to bear in mind is that the needs of clients and prospects haven’t changed just because the market has-they still need to retire and put their kids through college. Sure, the conversations are more difficult now that everyone’s problems are magnified, but financial consultants must man up, says Heywood Sloane, managing director of the Bank Insurance and Securities Association (BISA). “Advisors can either do these people a service or they can run and hide. Those advisors who choose to help will be remembered when all this is over.”

In the meantime, advisors can add value to client conversations by explaining the problem as it evolves. For example, Sloane says, market volatility unseen since the Great Depression is driven partly by the fact that no one knows what anything is supposed to cost at the moment and so every purchase is a gut reaction, an emotional response that makes the markets unpredictable. “Once we discover a price it will clear the market, but it’ll be scary getting there,” he says.

That price could emerge anywhere, but Sloane postulates that the housing market is the simplest to value. While investors are frozen in the headlights of volatility, people don’t stop having children or needing a place to raise them. Current and anticipated foreclosures are forcing housing prices down and eventually the cost of a house gets low enough that a prospective homeowner feels he or she has to buy it now in case the price goes up again. At that point, assuming that banks are lending, a price is set, against which the prices of other goods are established. Homebuyers then purchase appliances and furniture, and retailers replenish their inventories from manufacturers. Thus the economy reboots.

That’s obviously a greatly simplified version of the eventual turnaround, but simplifying such concepts can help investors conceptualize what needs to happen and since people usually fear the unknown, such information can be very reassuring. “Until we get a net decline in population, there will always be an increase in demand for resources, so the housing market will stabilize at some point,” Sloane says. “You can help clients understand their options going forward by helping them gain knowledge.”

The Job Market

There should be enough bank jobs to go around for bank reps. “Banks will definitely hire more financial advisors,” says Chip Roame, managing principal of consulting firm Tiburon Advisors in Tiburon, Calif. But don’t be surprised if support services shrink as banks struggle to cut costs, warns Howard Diamond, managing director at recruiting firm Diamond Consultants in Chester, N.J. “Banks are cutting back on support staff, tech people and call center staff, and that may have an impact on client servicing.”

And many breakout wirehouse brokers will be looking around for new homes. They may land in banks, where their expertise, which may have been neglected at the wirehouses, is valued. For example, Merrill Lynch managers are offering advisors who produce at least $1.75 million per year 100% of their production in forgivable loans and deferred cash over seven years, but most of the brokerage’s rising stars who are producing $500,000 or less will get nothing. “We still think banks are a great landing place for disenfranchised wirehouse advisors, such as sub-$500,000 Merrill advisors who aren’t feeling the love right now,” says Diamond. “Many of those are starting to see the bank channel as a great way to go.” Diamond says 139 advisors left Merrill on Nov. 21, the day the retention package was announced, and he expects many more to follow. For a sense of how many, Alois Pirker, senior analyst at Aite Group in Boston, says Merrill’s retention package only applies to 6,000 of the firm’s 16,000 advisors. “Merrill’s second-rate advisors would be considered top producers at other firms, so they’re more likely to move,” he says. Now that they can’t count on signing bonuses, many of these advisors might look for work in the slower-paced, friendlier small-bank market.

Will there be positions for those migrating advisors? The job market overall is holding up well, especially at smaller banks that steered clear of the subprime mortgage and are now reaping the rewards of prudent management with new clients and deposits. “When things shake out I think advisors will look beyond revenues to their own happiness and make more thoughtful decisions about where they move when they change firms,” says Diamond. Some advisors may move just to replenish their own assets. “Golden-handcuff deferred comp plans have come down with stock price, and for advisors who have lost assets, it’s almost fiscally responsible not to at least look at a well-timed move.”

But advisors who were planning their own retirements have to drink the same poison as their clients. Retirement just isn’t an option right now. Even independent advisors who sold their books to banks in order to retire and live off the proceeds are suffering. Now that their assets are reduced and clients might be a flight risk, their books hold less value. Indeed, who’d buy such a risky business? “Many advisors will have to work longer,” says Pirker. “At least as a profession it lends itself to working past retirement age.“

Anxiety Attack

To be sure, the trials of being an advisor right now are enough to make the whole community pine for golf clubs and slippers. “Advisors are set up to call their clients once per quarter. Calling every month or more is not sustainable,” says Alistair Jessiman, managing director of consulting firm Novantas in New York City. “Something has to give, and that’s advisors' physical health in 2009.” (See “De-Stressing Yourself,” page 37.)

Jessiman says most program managers are spending a huge amount of time trying to make their advisors feel good enough to show up for work. “Morale is at an all-time low right now,” he says. “Advisors are trained for it, but they keep having to have these conversations. Seven weeks into the crisis it felt like it had been seven months to me. And I’m not having the same horrible conversation 20 or 30 times a day.”

Advisors’ need for those pep talks isn’t likely to go away either. Many have more equity exposure than their clients do and are suffering worse losses than their clients, Kehrer says. “So they’re being blamed and they’re suffering personally, which is a really tough position to be in.”

It’s hard for advisors to make up for lost assets with new sales when they’re so busy just trying to calm their clients. Even advisors with significant assets in fee-based accounts, who at least have an ongoing relationship with clients, are suffering because those accounts are generating much less revenue than they used to. However, BISA’s Sloane says that the beauty of fee accounts is that at least clients understand that whatever happens to their assets also happens to their advisor’s income.

Economic crises aren't always so pandemic. Bank-based advisors held up quite well compared with wirehouses during the 2001 and 2002 bear market partly because they seemed pure and trustworthy in comparison with Wall Street firms that were implicated in the scandals. In addition, high sales of fixed annuities-bank brokerage’s traditional bread and butter-helped fill the gap left by equity sales. The same thing happened in the first nine months of 2008, but in October, three things changed that: A lot of banks were involved in selling suprime mortgage securities; there’s concern about the stability of annuity underwriters; and consumers lost a lot of wealth in the value of their houses. “Combined, there’s no way bank-based advisors could have been immune to the downturn,” says Kehrer. “We’re hearing October production numbers were awful.” (Exact numbers weren’t available at press time.)

Frighteningly, Matt Bienfang, a senior research director in TowerGroup’s brokerage and wealth management service in Boston, expects some investors will be so upset by their losses, they will take legal action as soon as the first quarter 2009. The cost of defense alone could wipe out some advisors, whether these lawsuits hold water or not. “Consumers are still shell-shocked,” says Bienfang. “But soon the class-action lawsuits will start, and I suspect there will be a lot of arbitration that will end a few careers.” However, he notes that the public is extremely fickle. A rising market could assuage injured parties, just as gas prices falling to roughly $2 a gallon have shelved demand for alternative fuels and gas-efficient cars. “Consumers have an amazing capacity to forget,” says Bienfang. “They’re now out buying cheap Escalades!”

The Merrill Revolution

One of the biggest trends to watch in 2009 will be how BofA begins to integrate the massive Merrill Lynch. Tiburon’s Roame doesn’t expect any great synergies in the near future, but about five years out, if it works, he says the merger could raise the bar for bank brokerage across the board. Aite’s Pirker says, “Merrill will come into BofA with a lot of high-quality products, such as SMAs, and the Merrill philosophy will be rolled out across BofA’s entire brokerage operation, which will put competitive pressure on other banks.”

Of course there’s a high risk of losing customers when two cultures clash. Banks like BofA view investment services as mutual funds for the masses, while wirehouse bosses are used to providing high-touch service for the high net worth. In the past, Merrill has been dismissive of $100,000 clients, requiring its advisors to relegate them to a call center, while BofA has a late-fee, overdraft-fee model that collects little amounts along the way, says Pirker. “That’s very different to how Merrill does business and could disgruntle a lot of its clients.” BISA’s Sloane predicts that the merger will work if the two cultures are kept independent unless they’re cross-referring business when clients need it. “But if it’s ‘My way or the highway,’ it won’t work,” he says. “The whole model must be customer driven.” So far, it seems U.S. Trust has survived its merger with BofA because it’s been more or less autonomous.

TowerGroup’s Beinfang believes that synergies will grow over time. “BofA does a good job at the sub-$100,000 level, but it hasn’t been able to sell well above that asset level,” he says. “As Merrill learns to come down market to build a feeder channel to get those clients to come up as their assets grow, BofA will need to nurture those relationships, which it’s good at."

Wells Fargo’s integration of Wachovia’s massive securities operation should be somewhat easier because they’re of a similar mindset. Wachovia already had a three-way structure that doesn’t need to be altered, since Wells Fargo hasn’t had much of a brokerage operation until now. “It’s a good fit and I was happy Citi didn’t get its hands on Wachovia,” Pirker says. “The deal would have left Wachovia’s brokerage business behind and the great job it has done integrating banking and brokerage would have been lost, which would have been a pity.”

Sink or Swim?

Smaller banks that had no part in the subprime fiasco, what Jessiman calls “survivor banks,” have a bright future, particularly with billions in taxpayer dollars now available to help strong banks buy up weaker ones. “If you’re a survivor bank, why not take TARP money to free up capital to grow your business?” he says. “This is a great time to be a winner. Just put your battle gear on and go for it. Community banks that know what they’re doing are going to have a heck of a year.”

That appears to be PNC’s plan in its acquisition of NatCity. Indeed second-tier regional banks like PNC that weren’t involved directly in subprime mortgages are gaining new assets, “This is the biggest influx of new business they’ve had in five years,” Jessiman says.

But like everything else these days, there’s a hitch. “Opening new investment accounts is very laborious when you figure in the time it takes for the initial financial plan. How can an advisor do that and call existing clients at the same time?” he asks. The answer is there’s no choice.

In short, there’s no easy solution to these myriad problems for the foreseeable future, but there are ways to survive sanely. One of them, says Sloane, is to “keep a sense of humor. That doesn't mean this isn’t serious, but if you can keep up morale while helping clients, that’s a huge positive.”

Small Talk

Consumers lost a lot of confidence in large banks in 2008, and who can blame them? But those bad mega-apples haven’t tainted the whole industry - small banks, community banks and credit unions will maintain high levels of consumer trust going into 2009, according to a report by TNS, a New York-based market information group.

“Big banks used to be seen as stable and reliable,” says Trish Dorsey, senior vice president of brand and communications at TNS. “But now smaller banks that weren't exposed to subprime are coming out of this looking much better.”

More than half of the 1,000 heads of households polled say their confidence in large banks waned over the fourth quarter, but the same number of people say that isn't so for small banks and credit unions. In fact, one-fifth of respondents say their perception of smaller financial institutions has improved.

The question is, how can small banks capitalize on this market driven advantage? Dorsey counsels a back-to-basics approach to marketing. “Messages of conspicuous consumption and wealth are not going to go down well right now,” she says.

Messaging has to be sensitive. For example, Citigroup’s “Live Richly” campaign obvious has no place in this market and it would be ridiculous to continue with it, so the financial services firm shelved the campaign in favor of its older “Citi Never Sleeps” campaign, a message that implies a watchdog-like vigilance.

Communications that emphasize a bank’s trustworthiness, both rational and emotional, are what the doctor ordered. “On the rational side are expectations of reliability, but the emotional side wants to feel safe, protected,” Dorsey says. “The degree to which you can communicate to both sides is where the power is.”