February 21, 2024

One of the themes that came out of the recent bank reporting season is the effort that the UK-focused high street banks are putting into diversifying their businesses, by adding wealth management expertise where mortgages and commercial lending had previously been dominant.
If the current highly restricted balance sheet model of UK banking is the long-term result of the financial crisis – an outcome that many will say is welcome relief for taxpayers who paid for the banks to be rescued – then another outcome of that crisis is the urgent need to add high quality earnings to a bank’s core business. This is where wealth managers have a real attraction for the UK’s big banks.
Quilter (QLT) is the latest wealth manager to attract the interest of major banks, with reports that Natwest (NWG) is considering a full-scale takeover bid. While obviously neither company will comment on such speculation, and it could just be silly season chatter as the City goes to the beach for August, the inherent plausibility of such an approach is related as much to the long-term issues facing the major UK-focused banks, as with the merits of any potential bid itself. Predictably, Quilter, whose results we cover this week, saw its share price jump by 15 per cent on the report. In short, investors are betting that the need for banks to diversify their revenues will see more wealth managers acquired – as the long-term holders of Brewin Dolphin, after its sale to the Royal Bank of Canada (CA:RY) earlier this year, can testify.
The pandemic highlighted two long-term trends for the banks, one short, one long. In the short term, the pandemic pushed up corporate liquidity as companies saved cash by cutting dividends and finding operational cost savings. That led to lower demand for corporate loans at the same time as mortgage lending is trending downwards because of recession fears and rapidly rising interest rates. According to the latest figures from the Financial Conduct Authority (FCA), mortgage lending in the first quarter of 2022 fell by 7.5 per cent, year on year, to £76.9bn – although lending that has already been agreed was stable. This seems to confirm predictions that a slowdown in the lending mortgage market is taking shape this year.  
Fundamentally, banks’ profitability is determined as much by external economic factors as their own actions, but some trends are indicative of how the business model has changed over time. For example, the Bank of England’s own figures show that interest income reached a peak of 80 per cent of bank revenues in 1980 and has been declining ever since from a combination of lowered interest rates and banks adding new business functions that rely on fees, rather than lending.
Take Lloyd’s Banking (LLOY) as a representative example of the trend away from lending in the sector. The last half-year results showed the Black Horse had a net interest income that was around 59 per cent of total revenue, despite sitting on a gigantic open mortgage book of £297bn. In other words, the banks need to diversify because the exposure to the core business of lending is now so large that potentially negative macro effects have much greater impact on the bottom line. It is fair to say that this trend is largely confined to the likes of Natwest and Lloyd’s. Barclay’s (BARC) and HSBC (HSBA) already have diversified wealth manager businesses as part of their corporate structure.
One reason that pure-play wealth managers are attractive to larger financial institutions is the fees that investors charge for the privilege of a manager looking after their money. Annual charges of 1 per cent, or more, are not uncommon, plus there are additional fees for services such as share dealing or financial planning. 
While savvy retail investors will probably avoid the charges that rack up with wealth managers over time, many people are simply content to pay for a bona fide wealth manager to do all the work and to stick with that relationship for many years. And it is this combination of high fee levels and basic inertia that is the major attraction for the banks.
The sector’s operating margin varies according to the type of service and provider, with big names easily generating 40 per cent margins, or more. The low capital cost base of the typical manager is another attraction, as this means its operations can be easily integrated into the corporate structure of the acquiring bank without adding vast amounts of physical infrastructure.
In addition, the sector is relatively fragmented, with many mid-tier listed firms such as Rathbones (RAT) and Brooks Macdonald (BRK) sitting alongside a much larger pool of unlisted wealth managers, who have lots of high-value specialisms in retirement planning or ethical investment. In short, the sector is ripe for consolidation and, with interest rates only heading up, the major banks will have the capital to go shopping.
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