Morgan Stanley said it will buy the rest of its wealth-management joint venture with Citigroup Inc by the end of the month, completing a deal started during the financial crisis that was designed to stabilize both banks.
Morgan Stanley will pay $4.7 billion for Citigroup's remaining 35 percent stake in the joint venture that the two banks set up in 2009. It is also paying about $2 billion to redeem Citigroup's preferred securities.
In an interview, Chief Executive James Gorman said the deal has given investors more assurance about Morgan Stanley's business model, with a reliable stream of income from wealth management helping to offset volatility in trading and investment banking.
"You come in every day and know approximately how much money you're going to make," he said.
Gorman has wanted to expand Morgan Stanley's retail brokerage business since 2006, when he joined the bank as chief operating officer for wealth management.
Gorman's first order of business was to evaluate whether Morgan Stanley should fix its barely profitable wealth management group or sell it. He told John Mack, then the bank's chief executive, that the wealth management unit could earn profit margins of 20 percent or more - 10 times its margins at the time.
His forecast had a caveat, though: to become that profitable, the wealth management business would not only have to become more efficient, but also double its size by buying a large competitor, like Citigroup's Smith Barney or UBS's wealth management unit.
The financial crisis was still some time away, and Mack was focused on bolstering bond trading, where Morgan Stanley had lagged Wall Street rivals. In lieu of an acquisition, Gorman began fixing the wealth business by cutting costs, until an opportunity presented itself a few years later.
On January 13, 2009, Morgan Stanley and Citigroup announced a deal that would eventually leave Morgan Stanley owning Smith Barney. The transaction was designed to provide extra capital to Citigroup, and give Morgan Stanley stable revenue after it was hit by $9.4 billion in losses on subprime mortgage bets.
But it was not a straightforward acquisition: the two banks agreed to put certain wealth-management businesses into a joint venture, with Morgan Stanley holding a 51 percent stake. Morgan Stanley planned to buy additional slices over the next five years, at prices to be determined later.
The two banks sparred last summer over the value of the joint venture. But in September they agreed that Morgan Stanley would buy the rest of the business faster than previously planned, pending regulatory approval, at an overall valuation of $13.5 billion. Analysts widely considered the deal a bargain for Morgan Stanley.
Citigroup said with the completion of the deal, a key measure of its stability, the Basel III tier 1 common ratio, will rise by 0.45 percentage points.
Morgan Stanley needed to clear two regulatory hurdles to finish the deal. In March, the U.S. Federal Reserve approved Morgan Stanley's plan to use capital to buy the final stake. Friday's announcement pertained to a "process approval" by regulators including the Fed and the Office of the Comptroller of the Currency, as required by the 2010 Dodd-Frank law.
Morgan Stanley Wealth Management is the largest U.S. brokerage by adviser headcount and client assets. The business will have at least $138 billion in deposits by 2015, according to Morgan Stanley, which could put it among the top 10 banks by deposits in the United States.
The deal is expected to close by June 28. The bank will take a $200 million hit against capital in the second quarter related to the difference between the purchase price and its carrying value for the remainder of the business.
Last year, Morgan Stanley's wealth management business, which includes its share of the joint venture, delivered $13.5 billion in net revenue, or 44 percent of its overall adjusted net revenue.
Analysts expect wealth management to make up more than half of Morgan Stanley's revenue over time.
(Reporting by Lauren Tara LaCapra in New York; additional reporting by Dan Wilchins in New York and Tanya Agrawal in Bangalore; Editing by Jeffrey Benkoe and Phil Berlowitz)