As the outlook on the U.S. equity markets and the overall economy continues to change, so too does the outlook for the brokerage industry. And for many firms, the outlook is trending down.
Rating agency Moody’s Investors Service downgraded its outlook from stable to negative for Advisor Group and Cetera Financial, two of the largest independent broker/dealer networks in the industry; Advisor Group’s debt was also downgraded. The rating agency also lowered its outlook on LPL from positive to stable. Raymond James was an outlier in the group, with Moody’s affirming its stable outlook for the company.
The ratings agency attributed its downgrades of Advisor Group and Aretec (Cetera’s holding company) to the Federal Reserve’s cut in interest rates earlier this month, which would eat into these firms’ profitability. For both, it said the “negative outlook reflects a challenging macroeconomic environment which will weigh on the firm's revenue in the form of lower asset-based and advisory fees.”
The negative outlook also reflects higher debt levels at these firms. The capacity to service that debt will also likely be impacted, as interest rates and markets decline, Moody’s said.
“The rating affirmation by Moody's reflects the confidence that the agency has in Cetera’s organic growth strategy and the strength of our private equity owners, Genstar," said Jeff Buchheister, chief financial officer of Cetera, in a statement. "Market volatility and the Federal Reserve Board’s cut to the federal funds target rate impacts a large part of the financial services industry like banking and brokerage that rely on interest income as part of their revenue profiles. We understand that the shift to a negative outlook is a conservative decision to flag that there is greater risk in the sector than there was before. We are working closely with Moody’s to communicate the mitigating expense measures and revenue strategies that we are putting in place to offset deteriorating market conditions.”
Advisor Group just recently closed on its deal to acquire Ladenburg Thalmann, creating one of the largest IBD networks in the industry, with about 11,300 advisors and over $450 billion in client assets. But that acquisition was debt-funded.
“Moody's expects the recent market volatility, combined with lower short-term interest rates, to delay Advisor Group's path of organic deleveraging that was originally anticipated following the acquisition of Ladenburg Thalmann, a credit negative,” the report said. “Moody's also said the full and timely achievement of the extensive planned post-acquisition synergies will be more difficult for Advisor Group to achieve in the challenging operating environment that currently exists, pertaining to the coronavirus pandemic.”
“In this economic and market environment, companies across many industries are being put on credit watch, or being downgraded, and as expected, the entire financial services sector is not immune,” said Joseph Kuo, a spokesperson for Advisor Group. “Thankfully, 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.”
While Moody’s affirmed the credit ratings for LPL Financial, it revised its outlook from positive to stable, citing the potential impact of lower interest rates and asset prices on the firm’s revenue growth.
“However, Moody's said the firm's credit profile remains well positioned at its current rating levels because of a number of credit positive strategic and financial policies that LPL has adopted over the last two years,” the report said. “In third quarter of 2018, LPL's management started moving client cash balances into fixed-rate contracts (generally with an average duration of around four years). As of fourth quarter 2019, LPL had around 50% of its deposits in fixed rates and plans to move more deposits into fixed contracts raising its target range to 50-75%. The strategy will benefit the firm's profitability now that five cuts have taken place since July 2019.”
"Our mission is to take care of our advisors so they can take care of their clients, and we remain committed to our advisors during this time of disruption," said Lauren Hoyt-Williams, a spokeswoman for LPL. "The firm’s financial strength and stability remain a differentiator in our industry, making it possible for us to continue investing in the service, technology and resources advisors need to keep moving their businesses forward."
The outlook on Raymond James did not change, with Moody’s affirming its stable outlook due to the firm’s financial performance and stress resilience. The firm’s financial flexibility, in particular, will be a big strength in a market downturn.
“This financial flexibility is important, Moody's noted, since the coronavirus pandemic is causing profound economic, societal, operational and other shocks,” the report said. “Moody's expects that Raymond James's diversified revenue streams, flexible cost structure, and low leverage (inclusive of the new notes being issued) will allow the firm to quickly recover its pre-tax margin, leverage and coverage at levels that are still consistent with its current ratings.”
A spokeswoman for the firm declined to comment.
"Our long-term focus has helped us achieve 128 consecutive quarters – 32 years – of profitability, even through the 2008/2009 financial crisis," wrote Chairman and CEO Paul Reilly, in a letter to clients. "Because of our historically conservative management approach, including recent emphasis on cost management to offset an anticipated slowdown, we are well-positioned to not only make it through these troubling times, but emerge stronger, just as we have through prior market disruptions."
Earlier this week, Goldman Sachs analyst Alexander Blostein issued a buy recommendation for LPL, which he says is one of the "most underappreciated growth stories" in the industry. He believes the firm’s shares are undervalued and that recruiting activity and net new assets should rebound later this year in the wake of the coronavirus hit. Blostein downgraded shares of Raymond James Financial from neutral to sell, arguing that the firm’s revenue streams are cyclical and likely to face pressure amid market swings.
