Schwab’s acquistion of U.S. Trust casts shadow on advisers

Charles Schwab Corp. is about to welcome a new addition, and it’s already inciting sibling rivalry.

In the wake of the San Francisco brokerage’s announcement this week that it is acquiring U.S. Trust Corp. for a hefty $2.73 billion, many advisers who use the No. 1 online discount broker say the merger would pose a direct threat to their livelihoods.

“We’ve always seen Schwab as being on our team and as an extension of our practice; now they’ll be seen as a direct competitor,” says Coral Gables, Fla., planner Harold Evensky of Evensky Katz & Brown.

Mr. Evensky is a former member of Schwab’s institutional advisory board and uses the brokerage as a clearing agent.

Though he’s unwilling to move his accounts just yet, he is thinking about finding alternatives to handle back-office details.

Still, John Philip Coghlan, who heads the Schwab Institutional adviser unit, says investment advisers have little to fear.

If anything, the new entity will be a boon to financial advisers who have increasingly wealthy clients and require trust services, he says.

“It’s a solution that people have been asking us for quite some time,” he says. “Advisers have been asking us for help with that.”

At a time when the wirehouses are encroaching on Schwab’s discount business, the deal is part of Schwab’s effort to recast itself as a full-service brokerage on a par with Merrill Lynch & Co. Inc. and Morgan Stanley Dean Witter & Co.

More important, it’s a grab for the assets of very wealthy people, whose business offers higher profit margins.

Those clients have long eluded Schwab because of its down-market image. Its average account size is $100,000. U.S. Trust, by comparison, has a more attractive $7 million average account size.

For its part, U.S. Trust is gaining technology to help lower its costs and drive new business.

Schwab says it would prefer to handle fewer and larger accounts. At the same time, it is a leader in hand-holding novices through their first investment experiences.

That leaves Schwab advisers, who mainly serve the less-profitable middle market, at sea.

stress factor increases

“This may stress Schwab’s relationship with investment managers,” says Bruce White, also a former advisory board member, who oversees $800 million in Pasadena, Calif.

Mr. White adds, “We’re not as profitable to them as we used to be.”

Indeed, their clients don’t bring big-ticket accounts to the table, and don’t rely on Schwab for all their financial needs.

“The middle market is still a danger zone for Schwab,” agrees John Payne, an analyst with Cerulli Associates of Boston. “If they appear too much like a full-service broker, it will alienate the registered investment advisers.”

Schwab’s risk of offending advisers appears to be a calculated one.

It refused to break out the figures, but analysts estimate that advisers’ assets represent about 30% of $725 billion housed at Schwab, which generates about 15% of its profits.

Although previous years’ figures are unavailable, that percentage has stagnated recently, Mr. Payne says.

In contrast, private banking has a more stable fee-based income stream. And U.S. Trust, even though significantly smaller at $86 billion in assets, had a 1999 after-tax profit margin almost identical to Schwab’s — 14.3% vs. 14.9%.

Particularly vexing to advisers is that U.S. Trust will be listed on Schwab’s Adviser Source referral service.

By using Schwab’s technology, U.S. Trust will be able to provide its services at a lower cost and make them available to more clients, a move that could also cut into the advisers’ business.

Even advisers who are uneasy say they can see benefits to the new deal.

Marilyn Capelli Dimitroff, a Bloomfield Hills, Mich. planner, says none of her clients have walked out because Schwab lacks trust services. In addition, the deal allows advisers to offer lending services.

Even so, Ms. Capelli Dimitroff says she’s wary as well. “There will be new competition, but there would have been competition anyway.”

“Merrill Lynch is going after investment advisers [business] much more [than Schwab],” says Amy Butte, an analyst who covers Schwab for Bear Stearns Cos. in New York. “In some ways it gives registered investment advisers more tools.”

And when wealthy clients seek services, “it isn’t Schwab that’s taking the hit, it’s the advisers,” Ms. Butte says.

Still, Mr. Evensky contends that few advisers have a need for trust services that they’re unable to get on their own. Further, Schwab is “prepared to forgo advisers for more opportunity in the high-net-worth market,” he says.

Mr. Coghlan sent e-mails to advisers early Thursday morning and then had a conference call with the advisory board. On Friday, he held another conference call with the firm’s 800 largest advisers. And Mr. Coghlan has been named to head the committee overseeing the adoption process.

“It’s meaningful that I am head of the execution and synergy,” he says.