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5 Trends Impacting LPL’s Results & IBD Space

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LPL Financial (LPLA) shared its second-quarter earnings late last week, reporting higher net income but flat sales.

While it says it is making “significant progress” on the compliance and regulatory fronts, it also admits to grappling with slower sales commissions and decreased cash sweep revenue, which fell 9% in the period, as well as going through a series of executive changes.

Looking ahead, though, the independent broker-dealer sees five opportunities/challenges that will impact its business–as well as that of rival IBDs–in 2016.

Naturally, its executives tend to put a positive spin on where the company is headed, noting that profit margins remain about 30%. But, like the volatile investment market its 14,100 affiliated reps operate in, the financial-service industry is full of unexpected turbulence caused by fickle regulators and other factors.

Here are five of the complex dynamics influencing LPL’s financial results in the short term.

Advisor retention and recruiting are “bumpy” and “lumpy” processes.

1. Advisor retention and recruiting are “bumpy” and “lumpy” processes.

According to Chairman & CEO Mark Casady, who spoke with equity analysts on a conference call on Wednesday after the IBD released its second-quarter results, LPL had a net gain of 32 advisors in the period. For the past 12 months, it has added 290, which is roughly 24 a month on average.

“While production retention continued to be high, we had an uptick in advisor departures during the quarter due to low producers leaving our system,” Casady explained.

This means reps with average fees & commissions of $20,000.

“So they’re very small producers, and therefore good to have out of the system … [with] all due respect to them, and we just had an abnormal bump in those [departing] … for the quarter,” he added.

While LPL is “seeing an uptick in recruiting,” according to Casady, “… it’s lumpy, in terms of when it shows up and lumpy depending on when we decide to take advisors out, as happened in the second quarter.”

Alternative sales are under pressure.

2. Alternative sales are under pressure.

The uncertain macroeconomic environment in the quarter “was a challenge,” Casady said, which “reduced brokerage activity across the industry.”

He said this was the case across mutual funds, fixed and variable annuities and alternative investments. “More specifically low interest rates both constrained annuity sales and limited cash sweep revenues,” Casady added.

Plus, a “maturing real estate cycle and a lack of liquidity events pressured alternative investment sales across the industry as well as ours. We expect continued softness in sales commissions on the third quarter due to the same factors,” he cautioned.

“All the three horsemen [funds, annuities and alts], pardon the expression, of commissioned sales are down, and we’re seeing this across the industry,” Casady stated. The most-recent period, he says, “felt a little bit like 2012, when we had tax uncertainty that affected commissions as well.”

Nonetheless, the chairman and CEO insists the firm is upbeat given the flows it is experiencing in its advisory products overall.

Compliance is complex – and costly.

3. Compliance is complex – and costly.

LPL, which spent $36 million on regulatory charges in 2014, has added nearly 400 employees to its compliance, legal and control staff. As a result, the IBD “tracked several areas of exposure generally involving the thoroughness or completeness of our processes and systems of supervision and surveillance of several complex products,” according to Casady.

He adds that the firm’s regulatory charges “are unpredictable quarter to quarter,” but that it believes it has incurred “the majority of the cost of these issues and have the compliance infrastructure to mitigate future exceptions, which should lead to meaningfully lower annual regulatory charges beginning in 2016.”

As for the expected fiduciary standard being hammered out by the Department of Labor, LPL should have the “scale and flexibility” to adjust. Its assessment is that the current proposal’s restriction on alternative investment sales, for instance, would have an impact “of 2% or less” on its pre-tax profit, Casady explains.

The company adds that it expects its 2015 regulatory to be lower than in 2014 and that its 2016 expenses in this area should “be meaningfully lower than the elevated levels seen in 2014 and 2015,” according to interim CFO Tom Lux.

It's tough to balance technology investments and lower fees.

4. It’s tough to balance technology investments and lower fees.

In 2016, LPL intends to “meaningfully lower” certain pricing on its largest platform, which it hopes will help advisors boost business in return and, thus, make up for lower revenues it collects from them (tied to the lower fees).

It’s also working with a third-party on an automated-advice (i.e. robo) tool, so advisors can reach out in more ways to millennial, multi-generational families and clients with smaller amounts of funds to invest.

“We will also be waiving our IRA maintenance fee on two of our centrally managed advisory platforms,” Casady said. This move should give it “additional flexibility” in implementing the pending DOL rule.

Funding these technology investments is coming from “new services and programs and a more efficient use of resources elsewhere,” according to Lux.

The company says that, on a net basis, the new technology spending could have an annual pre-tax profit impact “of less than $5 million” next year.

As some firms fight headwinds, LPL will pick them up.

5. As some firms fight headwinds, LPL will pick them up.

Curian Capital, for instance is shutting down its third-party asset manager. That means LPL-affiliated reps could move $1.3 billion to $1.5 billion of assets onto its platforms.

“If we were to capture just roughly 50% of those assets,” said Casady, “that by itself would overwhelm any of the price changes at all. So it’s an economically sound strategy for us to pass that scale along. It’s also a better mix shift for us in terms of moving assets of a client’s overall portfolio from brokerage to advisory, and within advisory, to the centrally balanced platforms, which are our highest profit margin platforms in advisory even after these changes.”

And there could be movement from smaller financial firms shutting down their BDs and selling to LPL, the executive says. “Zions is actually a good example on the banking side; it is deciding to get out of the brokerage setup they had and transfer their advisors to us, using our broker-dealers. So we see lots of opportunity for that growth as a result of that increased complexity in managing these businesses.”

 – See related ThinkAdvisor story: DOL Tackles Key Fiduciary Plan Proposals at Hearings.