Clearing firms face client defections

Securities clearing firms such as Bank of New York Mellon Corp’s Pershing LLC and Fidelity Investments’ National Financial Services LLC are likely to suffer collateral damage from the financial-markets cataclysm that has felled several big banks and brokers, according to securities industry executives and consultants.

Pershing grabbed some unwanted end-of-year headlines when Vanguard Brokerage Services, the discount-brokerage arm of The Vanguard Group Inc. of Malvern, Pa., told customers that it will take its clearing in-house later this year.

It isn’t unusual for securities firms to become self-clearing once they achieve a critical mass of trading volume that justifies the technology costs needed to maintain a clearing operation.

But Vanguard’s decision to leave Pershing now, after clearing through the Jersey City, N.J.-based firm since 1998 and after years of weighing the move, is a sign that brokerage firms are accelerating efforts to cut costs as well as using the economic and financial crisis to pressure their partners and vendors for cost reductions.

LOOKING WITHIN

Boston-based NFS, which is thought to be the second-largest correspondent clearing firm after Pershing, is likely to be hit even harder in the short term. Two of its biggest clients — the brokerage arms of JPMorgan Chase & Co. and Bank of America Corp. the second- and third-largest banks, respectively, by market value in the United States — are widely expected to internalize their clearing this year.

JPMorgan absorbed a clearing business when it took over the mortgage-scarred Bear Stearns Cos. Inc. last June, and bank executives at the time said that Bear’s clearing and related prime brokerage businesses were major attractions. Both firms are based in New York.

The bank’s Chase Investment Services Corp. brokerage group is planning to convert to the in-house clearing unit later this year, according to several people at and outside the bank. They declined to speak for attribution until the arrangement is formalized.

Exacerbating the likely loss for the Fidelity unit is JPMorgan’s acquisition of bankrupt Washington Mutual Inc. last fall. The Seattle-based bank’s small brokerage arm, WaMu Investments Inc., clears through NFS.

A JPMorgan spokesman said that the WaMu and Chase brokerage operations are being integrated but declined to comment about whether or when they would move their clearing in-house.

BofA looms as an even larger loss for NFS. The Charlotte, N.C.-based banking giant’s brokerage unit, Banc of America Investment Services Inc., is thought to be NFS’ first- or second-largest client, ac-cording to a former NFS employee and two other clearing industry officials.

BofA, however, just completed its purchase of New York-based Merrill Lynch & Co. Inc., whose clearing division is likely to add its sister company to its client roster. Last summer, Broadcort & Merrill Lynch Professional Clearing Corp. hired John Tyers, a former Bear Stearns clearing executive, as president, saying he would help the firm solicit business from independent advisers, as well as from its more traditional target audience of broker-dealers.

As of the end of September, Banc of America Investment Services had just under 2,000 investment advisers servicing more than one million accounts. Bringing fees for processing trades and billing for those accounts in-house is likely, in light of BofA’s campaign to cut some $7 billion of costs by integrating Merrill Lynch’s operations, analysts said.

A Merrill spokeswoman referred questions about Broadcort to BofA.

“We are still relatively early in our transition process with Merrill Lynch, with many decisions and announcements to come,” said Jon Goldstein, a BofA spokesman.

NFS’ combined annual revenue from BofA, JPMorgan Chase and Washington Mutual is likely to range between $100 million and $200 million, including fees for funds and other products that go beyond transactions, billing and other more traditional clearing services, said a former NFS official who asked not to be identified because he continues to work with the firm, and others in the clearing industry.

Steve Austin, a spokesman for privately held Fidelity and NFS, said that the firms don’t comment on client matters or revenue.

NEW QUERIES

NFS has more than 300 clients among banks, broker-dealers and insurance firms and has seen inquiries about clearing surge by 40% since the beginning of the year, he said. Mr. Austin declined to say whether the queries have resulted in new business but said that NFS “continues to win clients and strengthen relationships” because of Fidelity’s strong reputation

There is little doubt, however, that revenue throughout the clearing industry is under pressure and that there isn’t a surge of newly registered broker-dealers to pick up the slack.

Clearing firms make their biggest profits by acting as banks to clients of securities firms, financing their purchases of stocks and other securities. Margin account balances that reflect this activity have been steadily declining in the brokerage industry, along with the interest rates that lenders charge.

At the same time, clearing firms must continually invest in technology upgrades to assure that their account processing and other back-office systems are reliable, further squeezing their profit margins.

“You’ve lost a significant number of top client firms; there’s very little organic growth from new firms, and margin balances are way down,” said Matt Bienfang, senior research director at TowerGroup, a consulting firm in Needham, Mass.

That means that profitability gains in the near future will depend on top clearing firms diversifying into related businesses such as prime-brokerage executions services for hedge funds and raiding each others’ clients, as well as those of smaller competitors, he said. Clearing firm officials say that raiding clients is difficult because a shift of clearing firms is a painstaking and often involves disruptions for brokerage firms’ clients.

Meanwhile, the clearing firm universe is changing.

Wachovia Corp. of Charlotte, N.C., was purchased for $12.7 billion this month by San Francisco-based Wells Fargo & Co. Wachovia owns First Clearing Correspondent Services, which clears for its internal brokerage operations and some other firms, but officials of the bank and of Wells declined to discuss plans for the unit under the new ownership.

E-mail Jed Horowitz at [email protected].