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BirdsEye View

achieving scale in the wealth management space

Wealth management, and investment management in particular is a scalable business. It takes one person to manage $10 of large cap equities. That very same person can manage perhaps $1B of such equities. So fixed cost is high, and variable cost is lower.

As banks search for sources of fee income and growth, they are mindful of the fact that the largest generation in history is Gen Y, and those Y'ers are approaching 30, getting ready to buy a home and start building wealth. At the same time, Boomers are retiring and beginning to transfer wealth. The opportunities in Private Banking and Wealth Management are growing, and so is banks' interest in the space.

Many bank CEOs are disheartened with the business, since the top line is typically very high but the bottom line quite skinny. They struggle to find the magic formula to improve contribution margin. That's where growth, again, comes to the forefront.

Unfortunately, growing the business organically is a long and arduous process. Customer acquisition is difficult and the sales cycle long. Dislodging customers from competitors is doubly difficult; average customer retention among our forum members in this space approaches 95%. The dilemma: how to grow the business rapidly enough to achieve significant scale economies, which are essential to improve profitability and contribution margin. The immediate answer  acquisitions.

M&A activity involving private client services continues to grow around the globe, as players in the financial services industry realize the potential embedded in this space. As Aaron Dorr of Sandler, O'Neill tells me, global M&A activity has increased 20% in the past two years. Buyers view private wealth management as one of the most attractive growth opportunities in the asset management industry. Transaction number and volumes grew significantly since 2010, from $157B Assets Under Management (AUM) to $245B in 2013, from 22 deals to 47. Historically, asset managers and banks have been the most active buyers. Banks acquisitions of Wealth Management businesses now constitute a very small percentage of the transaction volume, whereas asset managers and others account for the majority of the deals. Not a single US bank acquired a wealth manager in 2013, the first time on record. US banks were also absent as buyers of institutional and retail fund businesses. Asset managers accounted for 60% of the former deal volume, and 78% of the latter.

Interestingly, deal size has been relatively small and quite digestible by community banks. In 2013 median AUM transacted for private client deals was $1.2B, 20% less than 2012 and almost half of the median in 2010. This makes sense, as smaller RIAs (Registered Investment Advisors) look for larger firms to partner with.

There are four types of buyers competing to acquire wealth management businesses today:

  1. Diversified asset managers looking to enhance scale, leverage their research capabilities and diversify earnings with the more stable income streams of the wealth management earnings

  2. Broker dealers and other private client businesses who are looking to add products and services to their offering suite to increase share of wallet of existing customers, expand geographic footprint and, again, achieve greater earnings stability.

  3. Private wealth management holding companies, often funded by private equity firms, looking for scale and greater operational efficiency by centralizing middle office and administrative functions.

  4. Banks, looking to deepen penetration in their footprint and enhancing their product offering.

As you think through your acquisition strategy, keep a couple of topics in mind:

  1. Business due diligence.

    There are several key diligence items that will influence both the attractiveness and valuation of a private wealth management business:

    • Assets under management vs. assets under advisement or administration.

      • AUM are valued substantially higher than assets under advisement or administration, given the markedly wider profit margins associated with AUM.

    • Growth of client base.

      • New client generation, as mentioned above, is among the most challenging elements of private wealth management, so firms with a strong history of organic growth command premium multiples.

    • Size and scalability of platform.

      • Larger, established businesses with developed, scalable platforms gain higher valuations due to the opportunity to leverage infrastructure and achieve efficiencies

    • Length of client relationship and retention.

      • Long-term clients predict greater retention post-acquisition

    • Investment results and strength of product offerings.

      • Investment performance is a strong predictor of future growth and client retention. However, given the importance of service in determining client satisfaction, service trumps all, especially in the retail business

    • Social issues.

      • Asset management companies have unique cultures that play a key role in their success. Their branding, compensation and governance are quite different from banks' activities. Changing any of those in a meaningful way to mirror the bank's culture is likely to destroy the asset you just paid a premium for. If executive management doesn't have the stomach for the compensation levels inherent in the business, they should not buy these companies, especially since the assets go down the elevator every day.

        At the same time, RIAs and other forms aren't as sensitive to the type of regulations banks are subjected to. They are quite adapt at complying with SEC regulations and other regulatory bodies, but the specific requirements of the Fed, OCC etc. aren't something they had to deal with. Their ability to adopt and execute those regulatory constraints is key to success and needs to be understood and communicated in advance.

  2. Transaction structure.

    Purchases of asset managers require greater structuring than bank deals.

    • Upfront vs. contingent consideration.

      • The majority of asset management acquisitions utilize earn-outs, unlike bank transactions where total consideration is paid at closing.

    • Employee retention and incentives

      • Incentive programs are often established to ensure on-going employee motivation and retention as well as a longer-term horizon for value building.

    • Governance

      • There are two possible models most often utilized: integrated models generally provide greater synergies but may not be welcomed by management teams who are seeking to preserve their autonomy; the risk profile of the bank is also altered by this model, vs. the affiliate model.

Your wealth management business is a perfect complement to the rest of your business. It can be an important product suite to serve your entire client base, and can be extremely profitable without being a capital hog. But growth is difficult, and growth is essential to scale economics and operational efficiencies. It is my hope that 2014 will see more bank deals in this space than in the past, and certainly more than in 2013!