Merrill Lynch, which manages more than $1.6 trillion in private client assets worldwide, plans to set up a concentrated stock strategies div...

Merrill Lynch, which manages more than $1.6 trillion in private client assets worldwide, plans to set up a concentrated stock strategies division in London within the next six months targeting wealthy entrepreneurs looking to diversify their single stock holdings or use them as collateral to borrow. Citigroup, HSBC Republic and JP Morgan Chase say that they are also aggressively pursuing the new market servicing credit among entrepreneurs, estimated to be worth anywhere between $20bn to $50bn. In this Private Client Management feature, William Rhode examines the strategic thinking of these four players who are at the cusp of a new differentiation trend in global private banking.

The new Merrill’s group, which follows the establishment of a similar division by the firm in New York last October, reflects a growing trend within the private banking industry to pursue demand for liquidity from high net worth clients who are concerned that a large percentage of their wealth is tied up in stocks that they are either unable, because of restrictive clauses, or unwilling, because of the stock market downturn, to sell. As a result, several private banks are moving away from traditional investment management services and are placing an increased emphasis on lending and other specialised services to help high net-worth individuals unlock large pools of wealth from concentrated stock holdings.

“It is testimony to the growth potential we see in this business that we are hiring people in the concentrated stock strategies division even as most other banking operations are either laying off people or have hiring freezes in place,” says Doris Meister, head of wealth management services at Merrill Lynch and chief executive officer of Merrill Lynch Trust Company, in New York.

Deutsche Bank Private Bank in the US confirms this trend through the recruitment of several corporate finance professionals and is looking to hire more to help develop credit expertise within its private banking arm, which it still operates under the Bankers Trust name following the German bank’s $10.1bn acquisition of the firm in November 1998. Meanwhile, Adrian Kyriazi, managing director of corporate finance advisory services at HSBC Republic in London says the firm has also hired six corporate finance professionals for a new debt division targeting high net worth clients and is looking to expand into Europe and South America over the next 12 months.

Private bankers say that the trend, which has picked up momentum over the last year and which is currently being pursued by a variety of private banks especially in the US, in part reflects the changing face of the high net worth individual from that of the conservative beneficiary of an inheritance to the more aggressive, Silicon Valley-style entrepreneur.

“Most high net worth individuals these days have earned their wealth as opposed to inherited it,” says Merrill’s Meister. “The stock market bull run during the nineties and the development of restrictive stock option programmes has meant that a lot of individual wealth is today tied up in concentrated stock positions. The challenge is to help those individuals unlock that wealth,” she adds.

Typically that may involve lending money to high net worth clients who need cash and want to use their stock portfolios as collateral but may also include a range of other services. Derivatives, such as collars and prepaid forward contracts, can often help wealthy individuals unlock value from restrictive stock programmes. In addition, the use of exchange funds, where restricted stock holdings are pooled to create fund, can help them diversify. Special investment vehicles can be used for tax harvesting processes, whereby the individual appropriately times the sell off of an underwater stock position to match the sale of profitable positions to minimise capital gains taxes. Finally, trust funds can both meet the philanthropic ambitions of the high net-worth individual as well as deliver significant tax benefits.

“It’s the combination of strategies according to the client’s needs that usually delivers the best results,” says David Berger, first vice president of private finance operations at Merrill Lynch in New York. Private bankers say that demand for these services has increased with volatility in the equity markets and the fact that many rich individuals are seeing their wealth eroded by the stock market downturn.

“Given the dramatic growth in personal wealth and entrepreneurial success over the past decade, our clients have increasingly challenging requirements,” says Leigh Hoagland, managing director and head of Bankers Trust Private Banking Americas Lending within the Deutsche Bank Group in New York. “Addressing these needs successfully requires a convergence of private banking and corporate finance disciplines to successfully analyse all aspects of a loan, including the collateral and the use of proceeds.”

“We find that most entrepreneurial clients want to employ an integrated wealth management strategy to either leverage or liquidate,” says Shom Bhattacharya, the global head of lending at JP Morgan Private Bank, a division of JP Morgan Chase in New York. “Leveraging their assets enables clients to diversify, liquidating means using their stock holdings to access cash quickly so that they can buy a private plane, yacht or anything else.”

“Private banking is becoming much more complex,” says George Blauvelt, executive director of banking and investment finance at Citigroup in New York. “These days, it’s all about providing customized solutions. We are presenting ourselves as a private banking boutique with a commercial bank supermarket to back it up,” he says, adding that Citigroup’s private banking arm recently ran a series of advertisements in the US emphasizing its lending skills to reflect the firm’s new approach.

But the trend isn’t just restricted to concentrated stocks, bankers say. Professionals are being hired to also help structure solutions that enable wealthy individuals to access liquidity using a range of assets, from cross border holdings to art collections. One example might include arranging a life insurance policy for a wealthy Japanese client who wants to use his London property as collateral, Citigroup’s Blauvelt.

“To mitigate the currency risk between a Japanese yen-denominated life insurance policy and a sterling denominated property, we have to arrange a series of currency swap transactions over the life of the policy for our client,” he says, adding that the firm has no immediate plans to hire. “That requires significant derivatives and corporate finance expertise, both relatively new things within the world of private banking.”

The trend toward enhancing credit services for private clients will soon become an important differentiation strategy for industry players. Significantly, given the appeal of these services to younger entrepreneurial clients, private banks can become more involved in the earlier stage of the wealth cycle. “The margins may not always be as attractive as other products, by the trade-off is that the bank gets a broader exposure to the client’s total wealth requirements. The benefits will be the formation of a more durable long-term relationship,” notes Sebastian Dovey, director of Scorpio Partnership, a wealth management strategy think tank in London