* Wealth management leads other units in profit, revenue
* Adviser count falls modestly, production per broker rises
* Seeks to buy all of Smith Barney as soon as possible
By Jed Horowitz
NEW YORK, Jan 18 (Reuters) - Morgan Stanley executives made good on their promise to reap earnings from the bank's burgeoning wealth management business, reporting on Friday that profit margins in the business soared in the fourth quarter.
The New York-based bank's global wealth management group provided more revenue and pretax earnings in the quarter than the investment banking and asset management divisions, and proved more profitable than many analysts expected.
Morgan Stanley has made a bigger bet on retail investors than its major rivals by buying most of Citigroup's Smith Barney brokerage. Revenue from the unit's brokers was up 8 percent to $3.46 billion in the fourth quarter, while profit after distributions to Citigroup soared 111 percent to $277 million.
Pretax income in the group, which focuses primarily on households that keep at least $1 million at the brokerage, more than doubled from a year earlier and from the third quarter, to $581 million. Morgan Stanley as a whole reported pretax income of $859 million, and $481 million after taxes, following a loss of more than $1 million a year earlier.
Most noticeable in wealth management was a leap in pretax profit margin to 17 percent from 7 percent a year earlier, surprising some analysts who forecast the company would have trouble meeting its target of a mid-teen margin by mid-2013.
Morgan Stanley Chief Executive James Gorman's effort to lift the key metric out of single digits has been stymied by four years of near-zero interest rates. When Morgan Stanley bought an initial 51 percent stake in Smith Barney in 2009, he forecast the profit margin would rise to 20 percent.
"We didn't anticipate a very difficult market," Gorman said in a conference call with analysts on Friday. "We didn't anticipate a zero interest rate."
Costs of $80 million to $100 million a quarter for the integration of Smith Barney also have hurt profits.
Wealth management's margin soared in the fourth quarter because the integration is over, asset fees rose, and compensation fell, Gorman and Chief Financial Officer Ruth Porat said on the conference call. A slight rise in pay in the current quarter and fewer revenue-generating trading days will probably lower profit margins, but a 15 percent rate is sustainable, with a move into the high teens "in the future," they said.
Gorman, who hopes to buy the 35 percent of Smith Barney still controlled by Citigroup this year, is betting that investors will reward his emphasis on the stable business of selling and managing investments to the wealthy to counter more volatile returns from trading and raising money for corporations.
"Once you put it on the railway track it will always run," he said of wealth management in a CNBC interview.
Advisers to the very wealthy can generate additional revenue by selling clients and their businesses investment banking services and personal loans, Gorman said, noting that the loans will be funded by Citi deposits that transfer with the Smith Barney acquisition. Just 5 percent of Morgan Stanley clients now borrow from the company, compared with about 10 percent at its peer brokerages, "because historically this hasn't been a strategic focus for us," Porat said on the conference call.
Morgan Stanley kept its brokerage headcount relatively flat during the fourth quarter. It ended 2012 with 16,780 advisers worldwide, 49 fewer than three months earlier and down 732 from the end of 2011.
Bank of America Corp's Merrill Lynch wealth unit said on Thursday that its brokerage count fell by 371 advisers during the fourth quarter to 14,917.
Morgan Stanley spokesman James Wiggins said most brokers who left the bank were "underperforming advisers."
But according to broker moves tracked by Reuters, in 2012, at least 243 veteran advisers who managed more than $39.2 billion in assets left Morgan Stanley, including several teams that managed more than $1 billion. Reuters tracks the moves of brokers or teams managing $100 million or more in client assets.
Both Morgan Stanley and Merrill Lynch said their efforts to hold onto their most productive brokers were bearing fruit.
In the fourth quarter, annualized revenue per broker at Morgan Stanley climbed 12.5 percent from a year earlier to $824,000. At Merrill Lynch, it rose 7.6 percent to $935,000.
For years, big brokerage firms have been paying multimillion-dollar bonuses to recruit top brokers from one another, but Gorman said that the recruiting wars are slowing.
Retail investors who have fled from stocks and riskier assets because of uncertainty over the global economy and budget problems in Washington also appear to be "re-engaging," Gorman said. "The more progress we have on the fiscal front, the more confident investors will be to get out there and invest," he told analysts.
Large brokerage firms including Merrill and Charles Schwab Corp reported huge flows of assets into brokerage accounts in the second half of 2012, but restrained trading. Morgan Stanley said its total client assets in wealth management at year-end were up 8 percent from a year earlier to $1.8 trillion, with 32 percent in fee-based accounts that produce revenue whether or not clients trade. In the fourth quarter, Morgan Stanley generated $3.7 billion in fees from such clients.
Morgan Stanley as a whole beat analysts' profit forecasts, combining the strong wealth results with rising trading revenue and falling compensation costs. Its shares were up 7.5 percent to $22.31 in afternoon trading on the New York Stock Exchange.