The coronavirus is poised to slash earnings across wealth management, but it may also open up opportunities for some firms if their highly leveraged rivals stumble in an increasingly difficult business environment.
It’s yet another sign of how this public health crisis is upending corporate strategies and changing the industry.
The outbreak marks a “fundamental credit challenge” to independent broker-dealers such as LPL Financial, Cetera Financial Group, Advisor Group and, indeed, most firms, according to a March 20 report by Moody’s analyst Fadi Abdel Massih.
His report came after another one by S&P Global Ratings, which also warned about the threats posed by the pandemic and assessed firms’ altered positions in light of recent events. Well-capitalized incumbents can press an advantage over smaller rivals with higher leverage, as tumbling interest rates and stock values hit the industry with a double whammy.
Fed rate cuts reducing cash sweeps and equity losses hurting client assets are “a major setback for U.S. retail brokers,” S&P said in a March 18 report.
While large BDs can tap their scale and infrastructure, the macroeconomic turmoil will trigger firms to action by pushing down their annual EBITDA by as much as 25% to 50%, the S&P report estimated. LPL’s fixed-rate cash deposits give it some buffer, though, the ratings agencies say. Cetera is finding expense and revenue offsets even as it expands its service capacity, according to the firm.
The fallout spans “almost every single company in the securities and broker-dealer space,” according to Massih. His report argues that firms with stronger balance sheets and credit ratings will use them to recruit advisors and acquire other firms.
“The wealth management business remains attractive because it has the advisory revenue component, which is recurring by nature,” Massih says. “Some companies will be less flexible than others, and they might be ripe to be acquired by larger players.”
Regardless, “as long as the situation is still fluid,” he adds, “companies will have a difficult time forecasting revenue.”
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Accounting firms Crowe LLP and BKD LLP released year-end tax-planning guides Wednesday, during a time of great uncertainty over future tax changes in the midst of the novel coronavirus pandemic and the upcoming election.
Revenue dropped 6 percent as the pandemic triggered economic shutdowns across the country, according to data from 44 states compiled by the Urban Institute.
Industry outlook negative
Veteran IBD recruiter Jon Henschen agrees with the assessment, noting that the coronavirus impact on wealth management depends on the length and depth of the economic correction.
Some firms may put technology improvements and other projects on hold. They may cut back on services too.“We will likely see layoffs of staff as cash flow diminishes, and for those that have a substantial portion of their cash flow devoted to servicing junk bond payments, layoffs will come sooner and be more pronounced,” Henschen said in an email.
Private equity firms had been in a “buying frenzy” in recent years, snapping up BDs and other wealth managers, according to Carolyn Armitage, managing director of investment bank and consulting firm Echelon Partners. Low interest rates and available capital made the deals prudent, she says. Highly leveraged IBDs should now make plans in case of a prolonged crisis.
“Other firms who are better capitalized like an LPL may be more willing to be aggressive in this marketplace and try to gain market share as others pull back,” Armitage says.
S&P designated Cetera parent Aretec Group, Advisor Group and Kestra Financial’s debt-issuing entity — the three IBDs involved in the sector’s largest recent private equity deals — on “CreditWatch with negative implications.”
The S&P 500 Index has regained some of its value to go above 2,600 after Congress moved swiftly to pass the $2-trillion stimulus last week. However, the rating agency calculated expected losses of 10% to 15% of each of the firms’ EBITDA, if the index ended the year at its March 18 level of 2,400. The Fed rate cut could slash their EBITDA by a “massive” 15% to 35%, S&P adds.
Some BDs “have already started implementing cost-cutting measures, but it is unlikely, in our view, that the mitigating measures could absorb the full scale of EBITDA likely losses,” S&P wrote. The agency’s “central scenario” predicts that their leverage and debt interest coverage will “deteriorate from 2019 to levels that may not be consistent with the current ratings.”
The perennial contender won the top spot in J.D. Power’s annual survey as the coronavirus makes brand and advisor trust even more important to the industry.
Wealth management impact by the numbers
Some brokerage executives aren’t expressing concern about the flurry of ratings actions. Among those who are unfazed is Kestra CEO James Poer, an outspoken advocate for the sector’s use of PE capital structures like the backing of his 2,500-advisor firm by Warburg Pincus and earlier investor Stone Point Capital. Poer issued an email statement.
Kestra “is not highly leveraged, enjoys a strong balance sheet and is financially equipped to manage through the current environment,” Poer said. (In the latest available estimates, Kestra’s adjusted debt-to-EBITDA of 6x was lower than that of Cetera’s parent [6.5x] and Advisor Group [7-to-7.5x; 8x], but far higher than publicly traded LPL’s ratio of 2x.)
After Moody’s affirmed Aretec’s “B3” rating but revised its outlook to “negative” from stable, Cetera posted statements on its website. The company also referred Financial Planning to earlier comments by CEO Adam Antoniades describing the Genstar Capital-backed firm’s approach of finding “the right private equity partner with the right investment thesis.”
Cetera has shared its “mitigating expense measures and revenue strategies” with Moody’s in the face of conditions affecting “a large part” of the financial services, according to CFO Jeff Buchheister. Still, Antoniades says the network of five IBDs with 8,000 advisors is bulking up services, providing online training and rolling out new tech to support them.
“First and foremost our focus right now is on our advisors and institutions and helping them navigate the impact of a global pandemic that is unprecedented in our time,” Antoniades says.
Publicly traded rivals can point to credit ratings that are several rungs higher, though. LPL, at the upper end of non-investment grade issuers, has also expanded services to advisors in the pandemic. Moody’s (“Ba2”) and S&P (“BB+”) affirmed the 16,500-advisor firm’s ratings, though Moody’s altered the firm’s outlook to “stable” from “positive” and S&P changed it to “negative.”
LPL’s move starting in 2018 to convert about 50% of its client cash deposits to fixed-rate deposits gave the firm a hedge in its sweep revenue. There have been five rate cuts by the Fed since last July.
The firm’s leverage “could slightly exceed 3x” if interest rates and equities remain at their current level for the whole year, giving it “ample cushion” up to 5x under its revolving debt covenant, according to S&P.
“Against this backdrop, we believe LPL Holdings is less vulnerable than peers to a deterioration of market conditions,” the four S&P analysts said.
In an email, spokeswoman Lauren Hoyt-Williams said the firm is “solely” focused on supporting LPL advisors so they can serve their clients, and it remains committed to them as their long-term partner during the disruptive crisis.
“The firm’s financial strength and stability remain a differentiator in our industry,” she said in a statement. “They make it possible for us to continue investing in the service, technology and resources advisors need to keep moving their businesses forward.”
The CEO of Raymond James, another publicly traded firm, sent a message on March 17 to 8,000 advisors and their clients noting that the firm has $1 billion in cash and an investment-grade credit rating from S&P of “BBB+”. On March 26, Moody’s affirmed Raymond James at “Baa1,” citing its “diversified revenue streams, flexible cost structure, and low leverage.”
The ratings agency gave the company’s new issue of $500 million worth of senior unsecured notes due in 2030 the same rating. In the memo, Reilly said that the firm has canceled its conferences, eliminated business travel and reduced in-person contact through remote work.
“We know times of instability are when we best earn clients’ trust, and we are here to be a strong, reliable partner through the current volatility and beyond,” Reilly said. “I personally do not take lightly my responsibility as a leader of a large organization. And I do not take lightly our responsibility as a firm.”
Downgrades of Advisor Group
At another end of the leverage range, Advisor Group remains the only IBD to receive downgrades this year. A month before the Reverence Capital Partners-backed firm closed its acquisition of Ladenburg Thalmann’s for $1.3 billion, S&P dropped its rating to “B” from “B+” but kept the firm’s outlook as “stable.” The nine-IBD network grew to 11,500 advisors in the deal.
Moody’s downgraded Advisor Group to “B3” from “B2” on March 19, and S&P’s current review of the issuer means that it could downgrade the firm again in the next few weeks. Advisor Group “has their hands full” with integrating Ladenburg into a new parent firm, but it has a “very strong management team” with experience carrying out such tasks, Massih says.
In an emailed statement, Advisor Group spokesman Joseph Kuo said that recent ratings actions have shown the impact of the health and economic crisis at “companies across many industries.”
“Thankfully,” he added, “we are of sufficient size and have the financial resources to continue to invest in the tools, human capital and platforms necessary to fully support our financial advisors, particularly in this period of time when their advice and counsel is needed most by their clients.”
In examining its credit ratings for Advisor Group, Cetera and Kestra, S&P says it will be taking into account the firms’ debt covenants and mitigating responses alongside the macro impacts. LPL could also receive a downgrade in the next year if its leverage goes above 3x or it has less excess liquidity. An upgrade for LPL in that timeframe is only “a remote possibility,” S&P says.
The agencies had been raising warning signs relating to BDs even before the coronavirus pandemic. Moody’s Massih revised the outlook for retail brokers to “negative” from “stable” in December, based on interest rates, leverage and the “the credit negative move to zero commissions.”
It doesn’t mean there are only dire prospects for the firms, though. Financial advisors and retirement planning remain central to the equation, Massih’s report says. While the crisis will be tough for some firms to navigate, the turmoil could also enable them to retain advisors.
“There will be a lot of focus on recruiting,” Massih says. “However, during volatile times, advisors tend to be cautious and not necessarily looking to change jobs."
