Morgan Stanley will buy the rest of its wealth-management joint venture with Citigroup Inc. (C:US) as soon as next week, capping a four-year effort to reshape the investment bank into a more stable firm reliant on the retail-brokerage business.
Morgan Stanley will pay $4.7 billion in cash for the 35 percent of the business it doesn’t already own after receiving regulatory approval, the New York-based company said today in a statement, adding that it will take a $200 million charge in the second quarter related to the purchase. The brokerage will also redeem $2.03 billion of preferred interests owned by Citigroup, according to the statement.
Chief Executive Officer James Gorman, 54, set a price in September with Citigroup to purchase the rest of the brokerage venture, which was created in 2009. Morgan Stanley said in January that the purchase will place demands on an additional $400 million of capital.
“This is a historic day for Morgan Stanley,” Gorman said in the statement. “It is the culmination of a multiyear effort to transform our business model into one that offers stronger shareholder returns and greater stability in volatile markets.”
The Federal Reserve was reviewing the transaction after determining during its annual stress test in March that Morgan Stanley had sufficient capital to move forward. The bank didn’t ask to return additional capital to shareholders through buybacks and dividends this year because of a desire to purchase Citigroup’s stake and own the entire business.
The purchase of the full stake comes a year earlier than scheduled under the original plan, which was revised as part of the price-setting agreement last year. Morgan Stanley (MS:US) completed the integration of the brokerage’s technology platform last July, a year later than it originally laid out. The firm pledged to spend $500 million this year to improve the systems after flaws frustrated employees.
“While we lost a year on the integration, we picked up a year on buying the business, so net-net, I feel terrific about where we are,” Gorman said in an interview. “The business is operating extremely well on that platform, the financial advisers are happy, our clients are well-served, and the business is back to the kind of profitability that we anticipated.”
The joint venture was known as Morgan Stanley Smith Barney until last year, when it was renamed Morgan Stanley Wealth Management. It combined Citigroup’s Smith Barney business with the Dean Witter franchise, and Morgan Stanley took a controlling stake during the financial crisis.
The acquisition has helped make Morgan Stanley’s wealth-management division, led by Greg Fleming, the world’s biggest brokerage, with 16,284 financial advisers and $1.79 trillion in client assets at the end of March. The division accounted for almost half of the bank’s net revenue (MS:US) last year.
Gorman said last week the division can earn a pretax margin of more than 23 percent by 2015 as interest rates and stock markets climb. It can achieve a 20 percent to 22 percent margin absent any changes in the broader markets, he said.
Gorman has staked his strategy in large part on buying all of the brokerage and increasing profitability at the unit. Morgan Stanley has said it will earn about $400 million in the first year from buying the rest of the venture as the company eliminates non-controlling interest payments to New York-based Citigroup and benefits from more retail orders and deposits (MS:US).
The wealth-management division has posted a pretax margin of 17 percent in each of the past two quarters, the highest since the joint venture was formed and ahead of Fleming’s goal of a mid-teens margin by the middle of this year.
The bank has said it can further boost that margin by increasing the number of lending and banking products it sells to individual clients, driving more assets into fee-based managed accounts and getting its investment-bank division to work more closely with the brokerage.
“Every time we do a transaction in banking, capital markets, and every relationship we have in institutional securities, we should use that as an opportunity to showcase what we can do in wealth management for those clients,” Gorman said. “Historically, we haven’t had the strength in wealth management to do that. We clearly have the strength, the muscle to do that now.”
Citigroup said the sale will boost its Basel III Tier 1 common ratio by about 45 basis points, or 0.45 percentage point. The purchase price was equal to the value on Citigroup’s balance sheet (C:US), the New York-based company said in an e-mailed statement. Citigroup wrote down the value of what was then its 49 percent stake by $4.7 billion after agreeing to a final price with Morgan Stanley last year.
Morgan Stanley fell 2.5 percent to $24.53, the third-biggest drop in the 82-company Standard & Poor’s 500 Financials Index, after Bloomberg News reported that U.S. regulators are considering doubling a minimum capital requirement for the largest banks, which could delay plans to return capital to shareholders. The firm’s shares are up 28 percent this year.
“I’m not planning a big celebration yet” over the completion of the Smith Barney deal, Gorman said. “We’ll do that when our stock is where we think it should be.”
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