U.S. Bust? Culture clash still bedevils Schwab

It was a marriage worthy of a storybook when the discount king from the other side of the tracks won the hand of a financial services blue blood.

But two years into the union, analysts say, Charles Schwab Corp. of San Francisco and U.S. Trust Corp. of New York are struggling to bridge two vastly different cultures.

As a result, U.S. Trust is still doing business the old-fashioned way and getting outmaneuvered for Wall Street’s most coveted clients – those with $10 million and up.

“Old-boy, old-school, laid-back culture meets highly aggressive Wall Street culture, and Wall Street is killing them,” says Stephen Winks, principal of SRConsultant.com in Richmond, Va.

sweet spot

It wasn’t supposed to be this way.

With its position in the sweet spot of the retail market, the New York bastion was expected give down-market Schwab entree to the elite world of money management and keep Schwab’s own nouveau riche clients down on the farm.

Instead, analysts and competitors say, U.S. Trust is entering a critical time in its 150-year history, a make-or-break period that will determine its relevance in a rapidly changing market.

“The world hasn’t passed U.S. Trust by, but they need to be shaken up,” says Mr. Winks. “Trouble is brewing. U.S. Trust needs to turn it around or Schwab needs to come in.”

There are signs that Schwab is doing just that.

Among the most visible departures is marketing chief Michael Stallard, who left U.S. Trust under unexplained circumstances three weeks ago. He had been on board for less than a year.

One analyst suggests that Schwab co-chief executive Charles Schwab is beginning to exert greater control at U.S. Trust and that letting Mr. Stallard go is an early sign of an imminent shake-up.

Two weeks ago, Schwab paid top U.S. Trust executives their retention bonuses. When the golden handcuffs came off, a raft of resumes from U.S. Trust employees hit the market, according to competitors and executive recruiting firms.

The situation suggests that more upheaval is likely, but the extent of the change is unknown.

It’s too early to tell whether the number of employees seeking new jobs constitutes a mass exodus or simply normal post-merger attrition.

No embrace

Meanwhile, U.S. Trust has faded from significance for advisers who keep assets under custody at Schwab Institutional.

At the time of the acquisition, advisers feared U.S. Trust as a competitor. They don’t anymore. But neither have they embraced it and leveraged its expertise as Schwab hoped they would.

Only a handful of Schwab’s independent advisers have taken advantage of the administrative-trustee offering Schwab makes available to them through U.S. Trust, Schwab acknowledges.

For Eileen A. Fahey, managing director of financial institutions at Fitch Inc. in Chicago, declining profitability at U.S. Trust raised a red flag.

“They did have an ugly year, which sort of surprised me,” says Ms. Fahey, one of several analysts who have grown skeptical of the marriage.

Fitch Ratings of New York last month cut U.S. Trust’s long-term debt from A+ to A.

Allison Kellogg, a spokeswoman for U.S. Trust, says the analysts are off base. No one from Fitch even bothered to contact U.S. Trust, she says.

Ms. Kellogg asserts that analysts are misreading U.S. Trust’s tea leaves and, in particular, its efforts to integrate with Schwab.

“I think we’re very happy with the way things are going,” she says. “I think some of what you’re seeing is a misunderstanding of what we were trying to do from the get-go. We said this was a different kind of merger.”

Slight downgrades have been common on Wall Street in 2002; most firms, Schwab included, have suffered the same blow.

With help from its superaffluent clientele, U.S. Trust actually accomplished a rare feat for a financial firm in 2001: It increased its revenue.

“It’s been a great source of stability the past year,” a Schwab spokesman says.

Revenue rose 2%, to $654 million in 2001, from $643 million in 2000.

But Ms. Fahey says she’s concerned about the firm’s low 10% return on equity and the fact that its profits didn’t follow in lockstep with its revenue.

The firm does not disclose net income, but its operating income fell to $112 million in 2001, from $158 million in 2000, a hefty 29% drop.

Ms. Kellogg says that last year’s decline in profitability can be explained partially by the costs of bringing U.S. Trust’s back-office operations in-house and building a new infrastructure to improve compliance.

The firm paid $10 million in fines last year for failing properly to report currency transactions of $10,000 or more.

She adds that the firm posted $93 billion in discretionary assets under management for the first quarter of this year, an increase of 2.2% from $91 billion for the year-earlier quarter.

Meanwhile, the integration with Schwab is yielding tangible improvements, she claims.

For the first five months of this year, U.S. Trust won $600 million in new assets through Schwab branch office referrals, up from $295 million for the same period last year.

At this rate, U.S. Trust anticipates $1.3 billion in referrals for 2002, up 60% from 2001, she says.

Ms. Kellogg says her firm has gotten what it bargained for with Schwab in other ways as well.

For one, it was looking for help in modernizing its technology. U.S. Trust’s radically improved website is proof positive of the success of that effort, she says.

Glen Mathison, spokesman for Schwab, adds that U.S. Trust is valuable to Schwab, too. The unit is playing a big role behind the scenes in creating Schwab’s emerging advice initiative.

Behind the eight ball

Paul Schaeffer, executive vice president of Capital Resource Advisors, a Mill Valley, Calif., consultant to investment firms, says he has heard the industry buzz about U.S. Trust’s post-merger problems.

“I think both of them have challenges to their business models in a highly competitive environment, but both of them have shown a willingness to tackle it,” he says.

The weakness of U.S. Trust’s model, he adds, is that it still operates without an open-architecture approach.

This cuts down on the number of specialized products – such as alternative investments – that it can offer, he says.

Mr. Winks says U.S. Trust was way behind the eight ball before Schwab acquired it, and its efforts to improve have not been adequate to reflect a new world of competitors.

“Now every major brokerage firm has capabilities equal or superior,” he says.

Citigroup-owned Salomon Smith Barney Holdings Inc. in New York is gobbling up market share in Pac-Man fashion.

Ms. Fahey says that U.S. Trust’s problems extend beyond wirehouses vying for its high-end business.

“[U.S. Trust] is fairly small and it hasn’t made the inroads of State Street, Northern Trust or even Brown Brothers,” she says. “You don’t have the geographical breadth or even the product breadth with hedge funds, et cetera.”

Ms. Kellogg counters that criticism of her firm’s business model misses something.

Many customers greatly value the opportunity to communicate directly with their money manager, she says, something that’s rare at the firm’s bigger rivals.

That may be so, but the traditional approach of having portfolio managers interact directly with customers is self-limiting in today’s environment, analysts say.

“Given what Schwab paid, it will require a massive amount of business [for U.S. Trust] to pay its own way,” says David L. Roberts, president and CEO of National Advisors Trust Co., an Overland Park, Kan., company formed by 80 independent advisers.