U.S. banks' wealth management profit engine seen stalling

By Elizabeth Dilts

NEW YORK (Reuters) - Big U.S. banks looking to wealth management to shore up their profits may have to wait for another year according to analysts, who expect market volatility to keep the business subdued throughout 2016.

For years, wealth management has been banks' crown jewel - a source of high margins and growth in an increasingly challenging regulatory and market environment. But lately that jewel has been losing its luster. The biggest U.S. wealth managers have been reporting slower profit growth and slipping margins in recent quarters as confusion about markets' direction sapped demand for their services in favor of safe assets, such as cash.

Now, as banks kick off second-quarter reporting this week, analysts expect more weakness this year, citing uncertainty related to Britain's June 23 decision to leave the European Union, U.S. elections and the Federal Reserve's policy.

"The market instability from Brexit will definitely put pressure on (wealth management) goals," said Stephen Biggar, head of financial services equity research at Argus.

On Friday, Barclays analysts cut second-quarter earnings estimates for Morgan Stanley based partially on an expectation of "below trend growth" in wealth management. They also expect lower revenues at wealth units of Bank of America Corp and Wells Fargo & Co.

"Banks promised investors wealth management (returns), and the business has just been meh," said Ryan Caldwell, chief investment officer of Chiron Investment Management LLC in Kansas City, which invests in bank stocks.

Profit margins at the wealth management arms of UBS and Morgan Stanley fell 16 percentage points and 1 point respectively in the first quarter over the same quarter last year. Wells Fargo Advisors' net income fell 14 percent last quarter over the previous year, according to financial reports.

Barclays projects that Morgan Stanley's margins will stay at around 21 percent in the second quarter.

Until conditions improve, "investors are going to be wondering how banks are going to drive returns," Caldwell added.

Faced with market volatility and uncertainty, investors have amassed their largest cash pile since 2001 and equity holdings are at a four-year low, according to a Bank of America Merrill Lynch study released in mid-June. That trend hurts wealth managers' ability to generate fee income from managing clients' assets.

The weakened wealth business leaves banks scrambling to generate profits as they have to contend with low interest rates, weak loan demand, poor trading conditions, a dearth of investment banking activity and escalating regulatory costs.

Banks have long touted wealth management as a remedy - a source of a steady stream of fees from a growing pool of assets.

Top executives have also promised investors fat margins from the business, betting that wealth clients will come to them for other financial services, like loans.

"We decided it was very important to add ballast to our institution to give us protection during a period of downside," Morgan Stanley CEO James Gorman said in June. "Wealth and asset management business is now almost exactly 50 percent of our firm revenues."

Gorman has promised the wealth business will bring pre-tax profit margins of 25 percent by next year. Last quarter, however, Morgan Stanley struggled to reach a 21 percent margin and analysts doubt such lofty goals are within reach anytime soon.

Compliance costs are another concern. The Labor Department estimates that a rule it issued in April will cost the wealth management industry between $10 and $31 billion in technology, legal counsel, training and new sales policy fees over the first decade.

That comes on top of routine compliance expenses, including fines issued by the Financial Industry Regulatory Authority or the U.S. Securities and Exchange Commission, which have been cracking down on risky behavior.

"Wealth management fees are under pressure and regulators are looking at these (businesses) with more scrutiny," said Ryan Kelley, portfolio manager of the Hennessy Large and Small Cap Financial Funds in Novato, California, which invests in bank stocks.

(Reporting By Elizabeth Dilts, additional reporting by Olivia Oran in New York; Editing by Lauren Tara LaCapra and Tomasz Janowski)

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