As ultra-low interest rates, a challenging economy and fee pressure weigh on the financial services industry, broker-dealers Advisor Group and Cetera Financial Group face magnified risks, according to credit ratings agencies and recruiter Jon Henschen, president of Henschen & Associates.
The heavy debt held by these two BDs, which are owned by private equity firms, limits their options in the event of a severe market downturn and constrains their ability to serve their advisors, Henschen says. The firms, for their part, say that they have strategies in place to manage their debt and that private equity ownership has its advantages.
Advisor Group Ratings
In Fitch’s most recent report on Advisor Group, the ratings service affirmed the broker-dealer’s long-term Issuer Default Rating of B- that had been downgraded from B in March, while maintaining the negative outlook it provided in March that was downgraded from stable.
Advisor Group’s ratings are “constrained by high leverage levels, weak interest coverage, low margins and competitive dynamics within the independent wealth management sector,” Fitch said.
“Additional rating constraints include the relatively high reliance on transactional revenues and Advisor Group’s private equity ownership, which introduces a degree of uncertainty over the company’s future financial policies and a potential for more opportunistic growth strategies,” Fitch stated.
The continuing negative outlook, meanwhile, “reflects Fitch’s view that the challenging economic environment, including lower for longer interest rates, may prevent Advisor Group from achieving projected profitability levels over the next 12-18 months, resulting in higher leverage and weaker interest coverage for an extended period,” according to the firm.
The negative outlook also “reflects uncertainties surrounding Advisor Group’s ability to achieve planned cost reductions associated with” the BD’s acquisition of Ladenburg Thalmann, finalized in February, Fitch said.
Fitch’s perspective hasn’t changed since the recent review in November, so the drivers and sensitivities outlined in the firm’s Nov. 10 press release remain current, Evgeny Konovalov, director of financial institutions at Fitch Ratings, said Monday.
Similarly, Moody’s downgraded Advisor Group’s Corporate Family Rating (or CFR) to B3 from B2 with a negative outlook in March.
Although Advisor Group’s acquisition of Ladenburg “helped it expand its scale, it has also substantially worsened its debt leverage, and the risks of operating at higher leverage are magnified in the existing challenging macroeconomic environment,” Moody’s said in an April report.
Cetera’s Negative Outlook
Moody’s in March affirmed its CFR of B3 for Aretec Group, Cetera’s holding company, while changing its outlook to negative from stable, just as Fitch did with Advisor Group.
The B3 CFR “reflects its weak profitability and debt servicing capacity, with elevated levels of debt,” Moody’s said. The negative outlook, meanwhile, “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 for Aretec also “reflects the elevated debt level and the increasing probability of deterioration in debt servicing capacity now that interest rates and market levels have declined,” Moody’s said.
Moody’s maintained its B3 rating and negative outlook for Aretec Group in a Nov. 30 report. This rating is part of the non-investment-grade range for credit, often referred to “speculative,” “high yield” or “junk” bonds.
Leveraged Buyout Risks
Henschen, a recruiter for broker-dealer reps, told ThinkAdvisor in a recent phone interview he had concerns with leveraged buyouts in general.
Since 2018, with Genstar Capital’s purchase of the Cetera BDs, “LBO private equity has made its entry,” Henschen said in a 2020 white paper. And “there are a number of similarities between the Cetera and the Advisor Group LBO purchases, and an accompanying number of risk factors for the advisors,” the white paper noted.
(The private equity firm Reverence Capital bought a 75% stake in Advisor Group in 2019.)