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Banks Eat From Hands of the Filthy Rich

Lauren Tara LaCapra

As banks shave down on money-losing housing business, they're also tapping into a lucrative, high-growth area: private-wealth management.

Low- and middle-income families are buckling under the pressures of debt burdens, declining home values, high costs and a weak job market. They have little excess money to throw onto banks' profit margins. On the other hand, the Astors, Rockefellers and Vanderbilts of the world may have lost some wealth amid the market turmoil, but they're still rich.

These clients want to protect and expand their wealth for generations to come, which can translate into a long-term relationship with their investment advisors. Furthermore, the market for private-wealth clients has grown -- both in the U.S. and abroad -- as baby boomers look to invest their assets wisely and emerging economies spawn new prosperity.

An annual survey by Euromoney found that private-wealth assets under management more than doubled last year, to $7.6 trillion from $3.34 trillion in 2006, pushing the industry's profit from such business up 44%. While Europe and North America comprised nearly 80% of the assets under management, the fastest profit-growth areas were China (135%), Russia (88%) and India (84%).

"There's no doubt that banks love providing an array of services ... to wealthy clients, because of the fat fee revenue they can earn," says Philip van Doorn, senior banking analyst for TheStreet.com. "Fee revenue always holds up, where banks' traditional business of earning money on interest-rate spreads is more risky."

"Prestige is also a factor," he adds.

However, commercial banks trying to gain market share in this highly competitive area face challenges in several areas, including reputation, integration and investment strategy.

Tough Competition

High-net-worth individuals tend to invest their assets with trusted local consultants or longstanding institutions whose reputations precede them. That makes it difficult for commercial banks with tacky ad campaigns and thousands of branches to gain an edge: The rich want white-glove treatment from respected, high-brow advisors, not an ATM card from the McDonald's of the banking world.

"If you won the PowerBall or came into a lot of money, you'd go to U.S. Trust or go to JPMorgan to have a very stuffy old person help you," van Doorn says.

Building a private-wealth division from scratch would be incredibly difficult and have little chance of success. Instead, over the past decade, banks have opted to acquire well-known firms.

Citi(C Quote) swallowed Smith Barney in 1998. UBS(UBS Quote) engulfed Paine Webber in 2000. Wachovia(WB Quote) scooped up a majority stake in several Prudential units -- including its private-client business -- in 2003. And, most important, Bank of America(BAC Quote) became the U.S. private-wealth juggernaut with its $3.3 billion acquisition of U.S. Trust last year.

BofA's move pushed it ahead of its top competitors, Citi and JPMorgan Chase(JPM Quote), in terms of private-wealth clients and managed assets. But the integration has shown some signs of stress.

Instead of keeping the U.S. Trust brand, BofA opted to change its name to the awkwardly phrased "U.S. Trust, Bank of America Private Wealth Management." Many top-level U.S. Trust executives departed, including CEO Peter Scaturro, who was replaced by his No. 2 officer, Frances Aldrich Sevilla-Sacasa.

It is unclear whether BofA has lost or gained wealthy clients from the transition. Recent quarterly results from its wealth-management division reflect the acquisitions of U.S. Trust and LaSalle and the sale of Marisco, which all occurred within the last year. Still, BofA spokesman John Yiannacopoulos called U.S. Trust a "growth driver," noting that its first-quarter income grew 31% from the year-ago period.

Each level of wealth wants a different set of services. Those with hundreds of thousands are still building their fortunes -- they want to be millionaires. Millionaires are still accumulating wealth, but have more complicated finances, with illiquid assets and qualified investments. They are also starting to consider future generations. The mega-wealthy -- with hundreds of millions or billions -- want a full-service approach with an entire office of advisors. Finances span several family branches and generations.

Scaturro reportedly left his role at U.S. Trust due to clashes with Bank of America managers over how to run the business. One "key point of contention" was whether to offer the same products to all customers, regardless of income bracket, the Wall Street Journal reported last July.

Yiannacopoulos says the bank offers personalized service for each individual client. In-house experts offer trust and estate planning, alternative investments, philanthropy assistance and management of specialty assets like farm and ranch land, oil and gas property and commercial real estate.

"At all times, but particularly during times of heightened market volatility and uncertainty, we believe that a customized, comprehensive and up-to-date approach to asset allocation makes excellent sense for most investors," Yiannacopoulos wrote in an email. "A well-conceived asset allocation is attuned and responsive to the specific needs and objectives of each client."

Even so, it will be tough for BofA and its commercial competitors to beat out so-called "single-family offices," or SFOs, to gain ultra-wealthy clients. SFOs provide one-stop shopping for not just investments, but an array of other "concierge" services, according to Raphael Amit, a professor at the University of Pennsylvania's Wharton School. Those services include hiring staff, guiding philanthropy efforts, overseeing education, encouraging family "unity" and managing homes, boats, planes and cars. Some even provide psychologists.

There are about 1,000 SFOs around the world, according to Amit's research. They service clients with at least $100 million in assets, though more than half are worth more than $1 billion. Each SFO costs about $3 million a year to operate, but families consider the outlays worthwhile because of the holistic approach.

While banks can be successful at managing money, they're not necessarily skilled at making hors d'oeuvres and organizing trust circles at family events. That means they must lure in new wealth with the right investment strategy and tailor service for each level of wealth.

West Egg Investor, East Egg Strategy

Wealth management falls into two categories, according to Richard Marston, another Wharton professor who specializes in the topic. The first "old trust-company" model has a few in-house portfolio managers who oversee investments in traditional stocks and bonds. The second "modern institutional" model farms out investing to well-known, aggressive managers at various firms. They tend toward cutting-edge investment vehicles, large-cap growth stocks in the U.S. and emerging stocks overseas.

Once upon a time, the old trust-company model worked fine -- high net-worth clients wanted to build and maintain their wealth at a reasonable pace and make sure it would last for generations to come. Newfangled investment strategies lacked style and grace.

Then cash began flooding in from new technologies, emerging markets and nouveau investment vehicles themselves. The Astors, Rockefellers and Vanderbilts -- the old money of The Great Gatsby's East Egg -- still exist, but the rich-client rolodex now includes the Larry Pages and Sergey Brins of the world. The Google(GOOG Quote) founders sit alongside other corporate stars and Wall Street titans who made their riches through innovation, leveraged buyouts, hedge funds, commodities, emerging markets, derivatives, mortgage-backed securities and other exotic investment vehicles, on Gatsby's fictional West Egg, home to the nouveau rich.

"The top thing is to gain the investor's confidence that you can handle his money, her money in a sensible way," says Marston. "But I would think that one of the strongest points of an advisor would be that they're not going to keep everything in-house but consider the best investment managers, wherever they are."

Still, with the collapse of the housing market, the decline of several well-known hedge funds and the downcast economic state all pegged to an over-exuberance about risk, investors have taken cover in safer assets. It's unclear how banks will lure in new, cosmopolitan wealth: Promises of safety and stability or promises of high risk and high returns?

Banks that choose the first option will have to determine whether West Egg investors will accept such an East Egg strategy. Banks that promise high returns instead must figure out how to deliver them in today's risk-averse market.

Formulating Success

Many banks will be forced to take a multi-tiered approach. Wealthy clients are split across the board with what they want, depending on not just their income bracket, but their age, personality, lifestyle and values, Marston says.

"Families that I know about aren't changing their asset allocation because we're in a slumping economy -- they're not letting short-term market movements disturb their long-term plans," he adds. "But lots of families are flailing all over the place, changing strategies, trying to decide where the market is going to go -- when it's gonna go up, when it's gonna go down -- and that type of client is really hard to deal with."

A look at first-quarter results of a few major banks provides some clues about what strategies are working best as the market regains its footing.

UBS outsources all of its private-client investments to managers outside the firm. However, the respected Swiss entity posted billions in losses from the market turmoil that began last fall. Its wealthy clients fled as they started to see weak returns and lost confidence in the bank's ability to weather the storm.

The bank faced net new-money outflows of 12.8 billion Swiss francs from its private-client business in the first quarter, compared with net inflows of 52.8 billion francs a year earlier. Its reputation was especially battered in its home country of Switzerland, which has a particularly competitive banking landscape.

"This takes time to recover, so it will clearly take a while," CEO Marcel Rohner said during a conference call. "It's hard to say, but the more quickly we return to more normalized levels of activity, and the more quickly we reduce our risk exposures and are back on track, the more quickly we will recover."

In contrast, JPMorgan -- which has been championed for its relatively strong performance amid the recent market tumult -- had 9% higher revenue from its private-client operations during the same period. The bank received lower fees as performance waned, but CFO Mike Cavanagh called cash in-flows "tremendous."

JPMorgan will also gain some private-wealth clients from its acquisition of Bear Stearns.

Wells Fargo(WFC Quote), which has been handling Americans' money since the gold rush, reported double-digit growth in revenue and profit from its wealth-management business last quarter.

The bank is catering to ultra-wealthy clients who want a full-service approach. It recently started offering family retreats, on-call psychologists and a think tank dedicated to issues that affect the rich, as part of a new "family wealth group." Wells Fargo's outline of the group also emphasizes its risk-management skills.

"Traditional financial firms and family offices tend to focus only on the wealth," says Michael Cole, executive vice president of the group. "Our goal is to assist families in aligning their wealth and their values," he later adds.

On the other hand, Wachovia is honing in on the "affluent" segment. The company expanded its scope last year to include clients with at least $250,000 in investable assets, even if they are held outside the bank. Wachovia notes in its business plan that households with that threshold of wealth or more represent 83% of U.S. riches -- a large market to tap into.

Though Wachovia swung to a hefty first-quarter loss, earnings from its wealth-management business rose 10% "as asset gathering overcame market depreciation."