Another Ticking Time Bomb——-Wall Street Loans Collateralized By Stocks & Bonds

By MICHAEL WURSTHORN and ANNAMARIA ANDRIOTIS at The Wall Street Journal

Loans backed by investment portfolios have become a booming business for Wall Street brokerages. Now the bill is coming due—for both the banks and their clients.

Some lenders, including Bank of America Corp., are issuing margin calls to clients after the global market drubbing of the past week, forcing investors to choose between either putting up more money or selling some of the securities underlying the loans.

Banks, meanwhile, are likely to take a hit to a key profit source if investors pull back from these loans as many expect.

Among the largest firms, Morgan Stanley had $25.3 billion in securities-based loans outstanding as of June 30, up 37% from a year earlier. Bank of America, which owns brokerage firm Merrill Lynch, had $38.6 billion in such loans outstanding as of the end of June, up 14.2% from the same period last year. And Wells Fargo Co. said last month that its wealth unit saw average loans, including these loans and traditional margin loans, jump 16% to $59.3 billion from last year.

“Your largest wealth creator for the top end has been inflation in financial assets. You’re now seeing wealth destruction,” said Charles Peabody, a bank analyst at Portales Partners LLC. Even including Wednesday’s stock-market rally, the SP 500 index is down 5.8% in the year to date.

Mr. Peabody said he believes profitability in banks’ wealth-management arms will fall in the coming quarters, in part due to an expected decline in their securities-lending businesses.

In a securities-based loan, the customer pledges all or part of a portfolio of stocks, bonds, mutual funds and/or other securities as collateral. But unlike traditional margin loans, in which the client uses the credit to buy more securities, the borrowing is for other purchases such as real estate, a

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