U.S. Trust Buy Vaults Schwab Into Finance's Wealthy-Client Hot Spot

Charles Schwab (SCH Quote), broker to the masses, may be paying through the nose in its $2.7 billion acquisition of elite private bank U.S. Trust (UTC Quote).

But the lofty price tag, which carries a 60% premium to U.S. Trust's closing price Wednesday, signals just how far financial firms will go to stay ahead in the ultracompetitive race to manage assets for the wealthy individuals who make up most of U.S. Trust's client base. U.S. Trust and Schwab say they aim to gain an edge by satisfying the evolving needs of a wealth class that, in addition to traditional wealth-management services, desires the autonomy provided by a tech-savvy online broker.

One fact was central to the creation of this deal and will be paramount in its success or failure: Managing money for the superrich pays high returns, and clients are often loyal. As a result, a wide range of financial institutions are keen to get into this sector. That could pressure returns.

Where the Money Is

"All the dogs want to chew on the same bone," says Mark Davis, head of research for the (BANCX Quote)Bank Stock Group fund, which owns shares in U.S. Trust. Private banking "is an incredibly tough environment, as everyone's chasing the same client group."

Players crowding into this market range from venerable old institutions like U.S. Trust to much larger trust-focused banks like Mellon Financial (MEL Quote) and upmarket brokers like Goldman Sachs (GS Quote). Also trying to get into the mix: Internet concerns such as myCFO.com, recently established by Jim Clark, founder of Netscape and Internet health-care company Healtheon/WebMD (HLTH Quote).

This harsh competition can perhaps be detected in U.S. Trust's performance last year, which hurt its stock price, perhaps making the bank more susceptible to overtures from the likes of Schwab, whose better-performing shares have split three times in recent years. The bank lost some $4.5 billion in assets at its Campbell Cowperthwaite division when some employees left, taking clients with them. In addition, assets growth at U.S. Trust was relatively weak in the third quarter, analysts pointed out, although assets under management picked up strongly in 1999's fourth quarter and rose to $73.8 billion, which is 20.2% above the level of a year earlier. "U.S. Trust did have some troubles and that may have made it a buyout target," adds Davis. (U.S. Trust didn't comment.)

Ahead of the Pack

On the other hand, with Schwab, U.S. Trust has a much better chance of staying ahead in an age of cyberinvesting, says Adam Levy, an analyst for the (FSFSX Quote)Invesco Financial fund. "U.S. Trust is a great company, but the only problem is that, as its clients become younger, they want to become more self-directed," Levy says, adding that Schwab can provide the tools for do-it-yourself investing. (Invesco Financial owns Schwab but has no position in U.S. Trust.)

It's also hard to see a raft of other institutions doing mergers like the Schwab-U.S. Trust linkup, or eroding any advantage the two may have gained with Thursday's move.

First, there's a shortage of New Era financial companies of Schwab's size and reputation. As for traditional banks, they aren't in a position to pay such a high acquisition premium as Schwab, since their stocks tend not to be as highly valued as the online broker's: Schwab, trading at 45 times 2000 earnings forecast by First Call/Thomson Financial, has a powerful acquisition currency. By contrast, Old Era financial institutions, as represented by the KBW Bank Index, are trading at 12.6 times 2000 profits.

However, Internet start-ups like myCFO.com may be better placed to compete with Schwab-U.S. Trust. At any rate, myCFO.com is not seeing the merger as a threat. "This merger is yet further validation of this vastly underserved market of high net-worth individuals," says Art Shaw, chief executive of myCFO.com.