LPL Financial Holdings Inc. (LPLA) Earnings Call Transcript & Summary

Good afternoon and welcome to the Virtual Wolfe FinTech Forum Fireside Chat with LPL Financial, hosted by Wolfe's senior analyst covering diversified banks and brokers, Steven Chubak. [Operator Instructions] And now I hand the call over to Steven.

Thanks, Ellen. Hello, everyone, and welcome back to the afternoon session. I'm very excited, as Ellen noted, to introduce our next company, LPL Financial. And joining us virtually is their CFO, Matt Audette. Just quickly in terms of background, Matt joined LPL Financial in 2015 to take the CFO reins. And since he joined forces with CEO, Dan Arnold, the company has delivered leading shareholder returns, generated best-in-class revenue and EPS growth and has really become the premier player in independent broker-dealer space. So Matt, thanks again for joining.

All right. Thanks, Steven. Happy to be here.

So I know everyone on the webcast is eager to hear what you have to say on the macro. But first, I wanted to discuss the February monthly metrics, which you released yesterday after the close. Now it's interesting, despite the challenging equity backdrop, you saw a meaningful acceleration in organic growth, NNA coming in above 7%. I was hoping if you can give us some color on the trends you saw in February that supported such a strong results. And then at least indicate how things are tracking so far in March as both the market and rate volatility has persisted?

Sure. I mean I think when you look at our recent trends in organic growth, you go back a few years ago, we were growing at 1%. You look at last year, it was in the 4%, kind of 5%. And now our best 2 months ever were January and February, with February, to your point, being at 7.5%. I mean I think you're just starting to see the benefits and the power of our strategy, right, which has really been focused on serving advisers so they can serve their clients. So things like the capabilities that we're delivering, the investments in technology, the development of things to help them manage their practices, like business solutions, the centrally managed capabilities where they can outsource investment management to us. I mean those things are -- and I know you've heard me say it over and over, but those things really, really matter, right? And our ability to invest in those things, like in increasing the investments in our technology portfolio and all the things that matter to advisers, I think you're just starting to get a taste of the organic growth that we can generate, if we do that well and we serve advisers well. So I think we're excited to see that start to come through. I think now when you look at March, I think March is at -- to state the incredible obvious, right, the macro volatility has been the theme of the month so far. And I think what you see in our business is what you would expect to see which -- and I'll speak to that through cash balances, right? When you see volatility in equity markets go down, you typically see advisers position their clients more in cash. And the opposite when markets go up. And I think this one is -- and I think we're there again today, right? It's like the Dow moves 1,000 points every day. It's a matter of whether it's up or down, and it's going back and forth. So it's hard to predict, of course, what's going to happen volatility-wise from here, but the headline I'd leave you with is when markets are down, you would expect to see cash balances go up and vice versa when they go up.

So I think you touched on the cash dynamics, Matt. It really opens the door at least to address the elephant in the room, which is the rate outlook. And in recent years, you've taken the necessary steps, extending the duration on client cash, really in an effort to reduce your overall sensitivity to the short end. Now certainly, it feels pressured given what we're seeing in terms of the curve dynamics. But with the Fed futures now pricing in 0 rates by midyear, a 10-year now sitting around 80 basis points, if these low rate levels persist, how will that impact reinvestment rates, just on the fixed side? And how should we think about the ICA yield trajectory, if it persists for an extended period?

Yes. So when you look at the portfolio today, so the ICA portfolio, we've got about $12 billion in fixed rate balances, right? So that's about half the size of the portfolio or 50%. And we moved into those, to your point on the strategy, really to reduce the impact of movements in short-term interest rates. And we moved into those primarily at the end of '18 and then another step-up in the second half of '19. So you look at when we did that, the average rates on those contracts, it's roughly in the 280 basis point range. So when you look at that strategy, so our focus was in moving into fixed rate contracts. Think about it as the 5-year point of the curve, but at the same time, it was to be a laddered portfolio, right? So when we move into those contracts, we're focused on having -- each and every year, having a bit of that portfolio mature, so you never have a big event coming where you're going to have some large maturity. You would have a maturity each year that you're just reinvesting in those rates. And then you're really reducing the interest rate sensitivity. So that's what we've done. I think when you look at just such the dramatic movements in rates or the presumption that rates are going to be near 0 and you compare that to that 280 basis points, I think the -- from a reinvestment risk standpoint, the primary period is the time where that would be the largest or not for 3 or 4 years, just given that we had recently moved into that. So it's not a near term event. I would just emphasize, we do have a laddered portfolio where a bit comes out each year. So I think that helps you on the math. I mean the thing that I would really highlight from a strategic perspective is we go back to kind of the first question on organic growth and what we saw in February. And when we think about what is a driver of that growth, right, the stability of our earnings matters to our clients. The strength of our balance sheets matters to our clients, right? So that positioning ourselves to be able to really absorb, I think, better than most in our space, right, our leverage being at the low end of our range at 2x. And while we -- while there is interest rate sensitivity to having $12 billion of fixed rate contracts, that really is a stabilizer that I think can help drive organic growth over the long-term and has been one of the drivers of the organic growth we're seeing right now.

Very helpful color, Matt. And it's interesting that you bring that up because there is a tendency for some investors to analyze the rate and market sensitivity dynamics in a vacuum. And I was hoping you could just speak to what are some of the offsets in the model that should alleviate those pressures from declining rates in markets? And maybe what are some of the other factors that are differentiating yourself relative to the retail broker and maybe some of your independent broker-dealer peers?

Yes. I think when you -- especially when you think about on the retail broker side, when you look at us, we're really just a single line of business focused on serving advisers, right? So when you start to think about all the different things that you could have exposure on in an environment like this, most of them we don't have, right? We don't have a bank with credit exposure, or a bank with mortgages that have prepayment risk. We don't have a capital markets group, where you get variability in those earnings and a host of other risks to run any of that. I think what we do have, and a little bit we're talking about and what we're seeing on volatility is when the markets are down, are natural hedges in the model, right? So when you have equity markets going down, you would typically see client cash balances go up. When you have volatility in the markets, you would see trading revenues go up. So I think those are some pretty natural hedges. Those are natural hedges in the model that I think help create a stable earnings stream. And I would just repeat what I said before, those differences matter so much to our clients, right? They are small businesses and the firm that they affiliate with, being a stable place, being a place that doesn't have as many risks as some of the -- when you say our independent competitors who -- most of them are subscale, very -- few of them had the capability to fix out deposits the way we did. Many of them have leverage or debt levels that are well above us and not as positioned as -- in a position of strength like we are. All of those things are really important to a small business in choosing where they affiliate. So I think that's just -- it gives you a little bit of color on why we position ourselves there. And why I think the business model we're in and the space that we're in, we're positioned to grow well over the long term when you compare us to some of our direct peers.

And so Matt, as we dig a little bit deeper into that and just think about the recruiting backdrop, given some of the recent macro developments, we have seen in prior periods, at least the pace of recruiting slow when there's outsized and sustained volatility. I'm just wondering in light of the recent developments that we're experiencing now, on how that's impacting your ability to recruit, if at all?

Yes. I think that you -- as a headline point, I think our recruiting is strong, right? Q4 was a record level of recruiting. I think what we look at right now, folks are still coming and still joining LPL. So I think overall recruiting is quite strong. I think the -- to your point, it is natural. When you just think about where an adviser is going to spend their time in a period like this, where they're going to spend the time talking to their clients, right? So a simple example if someone was going to come in to do a meeting with us, a typical meeting before they join to go through the technology, to go through centrally managed platforms, et cetera. On periods like this and days like today, they may be doing -- talking to their clients as opposed to doing that. Now when you look back at historical periods of volatility, hindsight would tell you that's just a temporary delay, right? I think when -- let's just -- if you look at Q4 of '18, which was the last kind of big period of volatility, well, what happened after that, 2019 was a record year of recruiting. So I think that's the key thing to keep in mind. There can be a natural timing delay. But I think from a recruiting standpoint, in general, and maybe just to emphasize a little bit on the strength of our position in our balance sheet, when we start to think about returning to normal, if you will, even if that normal is still a low interest rate environment, then you just start to think about how -- who are we competing against? And who are we recruiting from in an environment like that? And then you start to click down and say, okay, we're going to have a stronger balance sheet. We're going to have a better ability to invest. We're going to have a better ability to support those clients and the things that are important to them. So I think maybe a capstone way or summary, which says, I think our value proposition just shines even more if we're able to continue to invest in capabilities and deliver what's important for clients over the long term.

So Matt, you alluded to the fact that you have a differentiated value prop. It supports continued organic growth momentum, why are you differentiated relative to peers. I guess in that same vein, how should we be thinking about it more from an M&A context? Do you foresee any changes just in the M&A landscape, given those recent -- given the recent macro pressures and the weaker balance sheet positioning for some of your competitors?

Yes. When you look at our space, right, it's -- especially our traditional markets, right? It is a highly fragmented space. So there is a handful of larger players that are PE owned, with a lot of leverage on their balance sheet. But the vast majority of our space are just really small, think $5 billion, $10 billion, $15 billion, $20 billion AUM shops, where you've got to -- you put yourself in their shoes, it's going to be tough in an environment like this, to really serve their clients in a way that's competitive with folks like us, right? And so I think when you look at that from an M&A standpoint, I think if we stay in an environment like this, you think it would be biased for more consolidation in our traditional markets. So -- and I think our lens on that, our view on that really is the same approach we've had, which was we will stay disciplined. And we'll focus on things that -- or opportunities that come our way or things that come to market from, is it a strategic fit? Are we -- do we have the operational capacity to bring it on in that moment? And then I think, perhaps, most importantly, right now, financially, does the price make sense? And we'll continue to have that discipline. I think the thing -- maybe last point I would emphasize and something that is, I think, a really cool part of our model and our industry, in general, is when M&A happens, you can win either way, right? If you're the winning bid on a deal, well, that's great. And you've got consolidation. You've got growth. If you're not, there's typically at those firms, especially when you've got a value proposition that we have, there are opportunities to recruit out of those firms that are going through a change, right? And you look at our recruiting over the last year or 2 and you can see the names of the larger practices that we release, and a lot of those names are from firms that went through some sort of ownership change. So there's a way to win either way. So I think long term, there's opportunities there.

Okay, great. And Matt, maybe it's good time just to shift gears and talk about some of the strategic growth priorities. If I look over the past 3 and 5 years, your shares have meaningfully outperformed the peer set and while some of that lift has been a function of rate and market tailwinds, you've also done a nice job of just evolving into more of an organic growth story. I was hoping you could outline some of the changes you've implemented just to achieve or execute on that transformation. And how are you prioritizing growth initiatives as we look out over the next 3 to 5 years?

Yes. So maybe just quickly to -- a quick repeat of that organic growth, right? So a few years ago, we were in the 1% range. Last year, it was 4%. This year, 6% with the month of February at 7.5%. So that's really been that growth. And I think the things we're doing to drive that, it's all about -- I don't want to sound repetitive, Steven, but it's all about producing and creating capabilities for advisers so they can serve their clients, right? So our investments, delivering those capabilities, investments in technology, the investments in service, right, to make that service experience something that's efficient. Strengthening our business development team and performance, right? They're quite effective at not only highlighting our value prop to folks, but also helping them get on board, right? It's not an easy thing to do in the independent space or it could be an unknown or an uncertain thing for an adviser and having a firm that can walk you through that transition process and do it well is important. And then maybe perhaps what resonates a lot today is having a strong and stable balance sheet, right? As small business, you want to be affiliated with somebody and supported by somebody that can support you through times like this and is able to invest in you through times like this. So I think that's what's really driven the growth. And I think those things will -- when you think about the next 3 years, I think continuing everything I just said, right, but then I think adding on top of that, it's really about expanding our addressable markets, right? So our traditional markets, which is where we -- all our growth has come from or the growth that I was highlighting, that's about -- I'll round up here, of about $5 trillion in assets as a market. And when we look at where we're expanding, so the premium offering, which we're in market with now and the employee offering, which we're in market in effect through acquisition, but developing the organic product as we speak, when you add those 2 models, then that addressable market goes from $5 trillion to more like $15 trillion. So really, when you think about the next 3 years, right, competing effectively for that, I think, is where we're focused. It can be in that big opportunity. The second is our service experience, right? So it's a big part of our -- when you think about strategically, the 3 big things we're doing, this is a core of it. And it's number two. And just having an industry-leading service experience that really -- again, really, really matters to service advisers and position them to be able to spend the majority of their time with their clients, I think, is a key differentiator. And then third, which may be the most -- if we do this well, I think it might be the most differentiating part of the value proposition, is helping advisers actually run their business, right? I think when you look at the independent space, historically, not just us, just over the last 5, 10 years, like most of the investments and capabilities and where people spend their time was helping advisers manage their clients. Very little time and attention, at least in the IBDs, was spent on actually helping them run their business, right? So this is things like business solutions, where if they need to go out and find and hire an admin, right? We've got that as a product to help them do that. They have to go find a CFO. We help them do that. Or we have a CFO for them, right? So I think that area, again, when you think about over the next 3 years and even beyond, if we do that successfully, I think it's -- when you put that together with the service experience and the capabilities in those addressable markets, I'm excited. I mean, hopefully, it comes across my tone about the long-term ability to grow. And if you put on top of that, I know it's not fun now to look at where interest rates are, but you put on top of that an environment where our direct competitors in this traditional space are challenged to invest at the levels that we can, I get pretty excited about the opportunity.

So Matt, let's touch on a couple of those. I guess, first, with the premium model that you cited. One of the things that you noted recently is that there's a pretty healthy backlog of firms that are interested in joining. I'm just wondering if the model proves to be successful, are the barriers to entry particularly high for another independent competitor to replicate it and launch something similar? And how should we think about the timing for when it could become a material contributor to revenues or assets?

Yes. So just -- so maybe I'll start with just a reminder of what we're doing. When you think about the premium model and where it's resonating, it's really folks that are kind of wirehouse or employee models that are moving to independents. And I think when you look historically in that space, like we didn't really have a capability to help get someone from point a to point b, right, to get them to independents. And if you are one of those folks, you'd typically go out and you'd hire a firm to help get you to independents, and then that would help you get to a custodian, you would start to have to piece together all these different capabilities yourself. And then over time, once you've kind of figured out how to be independent and how to run things, then you may make a choice, okay, now that I'm here, what is the firm that I want to be at. And a lot of times, we would -- those folks would come to LPL. And that's why you see us recruit and our recruiting come from the independent space. So when you get to what the employee model is and why we think it's resonating in the marketplace or we getting good feedback is, it's taking all the capabilities, all the positives that I talked through on our existing model and packaging that with support to help get you to independents, right? To help you start your own practice, right? And then when you have your own practice, bundling those capabilities that help you run that practice, right? Business solutions as an example. So you get all of that as part of that program. So as I describe all that, right, and to answer your question of, would it be easy for someone to replicate that, I think it will be hard, right? I think that question says, can someone replicate our integrated offering? Can they replicate our business solutions? And I think that would be tough. And I think when you look at what we put together and the feedback we're getting in market and reactions to it, I think we've hit on something that could be compelling. Now second part of your question. So when can it be a material contributor? I mean that's something that I think when I -- I'd speak about it in the long term. When you look at the addressable market that we really haven't been competing in and when you look at the product that we're putting together, I'm excited about the long-term growth prospects and contribution from this channel, right? The pace at which that occurs and when and how it flows in, that's hard to predict. So what I do feel good about is the model we put together is resonating in the market. And if we execute it well, I think we can grow from it.

And along those same lines, Matt, you also touched on the Virtual Business Solutions and that's something where -- or an area where the pace of adoption has actually been very strong over a short time frame since it's been launched. I was hoping for those a little bit less familiar, since it is an area where your value prop is very differentiated, I was hoping you could speak to what some of those capabilities are. And with fewer than 5% of your adviser base actually utilizing this product, how much runway for growth is there within your core adviser base at the moment?

Yes. So those solutions are -- I touched on a couple of them just a minute ago. But they are -- when you think about it, it is -- the core of the offering is how do we help an adviser run the small business. And the 4 offerings that we have on there are, an administrative assistant, a CFO, a marketing head and then help with your technology needs. That's not really a person, it's more just helping with your technology needs. And I think -- and when you think about it, right? So just a couple of examples, right? I'm going to go -- use admin as an example, where I'm going to go hire an admin in my local market, may or may not be a financial services expert from the admin side, if you will, probably not an LPL expert. I've got to manage their vacation. I've got to manage some sick time. I've got to manage the turnover, and it's tough. And it's not cheap versus if we've got an admin that's in our -- one of our main offices and can support you and they know the LPL systems, they know financial services, if they're out sick or on vacation, we can plug another person in. So you always have that right support. So I think just a taste of -- or an example of why we think these resonate so well. Now when you look at how many we have, right? So if you think about the last couple of years, they've really been about kind of piloting and testing which of these solutions really resonated and then making sure we're developing a solution and getting the feedback through those pilots and iterating to make sure we've got a product that hits the mark. And I think that's really what the last couple of years have been about and now we have grown to the 650 subscribers on the -- to your point, on the less than 5% of our advisers. So I think about where we could go from here, right? When you just think about the solution and think about how many advisers would this be helpful to or what this would matter to, to make their lives better, I think that market is quite large. Now whether the pace at which those folks see that value prop and sign up for it, again, that stuff is hard to predict. But I think what we're confident is the value props there. And now we've got to work through folks and make sure they understand what that value prop is and understand that's an investment in their business that can help them get more efficient. So we'll update along the way, right? We put metrics out on how that growth is going. But I think the headline I'd leave you with is just long term, we think the value prop is there, and we're going to keep focused on making sure we can articulate it and grow.

And so Matt, as we think about the need to balance the investment to support some of the product innovation and newer initiatives versus the current business. This year, you guided to a higher step-up in expense, core G&A growth in the range of 5.5% to 8%. But one of the things that you did note is that a large portion of that, about 50%, is actually allocated towards newer growth opportunities. And as you think about the optimal mix of run the bank or broker -- sorry, definitely not bank, run the broker versus grow the broker, what is the optimal mix in your view? And how should people also think about it in the context of a tougher macro about your ability to maybe rein in spending?

Yes. And I even -- the way I'd characterize it is, I mean, our core G&A growth is really primarily focused on organic growth overall, right? So to your point, about half of it, I'd say, as investments in our traditional markets, right? But those are the traditional markets that are driving the growth, like we talked about in our February metrics, right? So those are investments in our capabilities and technology and the service experience. And that's really driving the growth you're seeing right now. The other half, to your point, is investment to expand those markets, right? So it's investments in that premium model, investments to develop the employee model, investments to scale business solutions. So I would just emphasize that those are both growth as opposed to the classic kind of run, which doesn't apply growth. Now -- so a couple of things to highlight. So I think the variability of those investments. So our guidance for the year of core G&A growth of 5.5% to 8%, the primary driver of the variability in that number is variable comp and that's variable comp tied to organic growth. So meaning, if the organic growth for some reason doesn't come because of the macro and then variable comp would be adjusted for that and automatically reflect that. So I'd just keep that in mind. Now when I think about just the macro overall, right, and our ability to adjust spending, we absolutely have that, right? If you look at -- so go back to 2016, is probably a good year to look at for the last time. There was somewhat of a prolonged macro downturn, and what we did in response to that. And we kept our core G&A relatively flat that year. The thing I would emphasize, though, is we continued to invest, right? We invested. We grew our technology spend that year. I mean -- and we funded those investments with productivity and efficiency elsewhere. So I think that's just an example we could do that. Now I think where we are now, right? And when we think about our philosophy, right, and how we drive growth over the long term, I think these are moments that in hindsight could be moments where these are some of the best investments you can make, right? Investments to drive capabilities, drive things that support advisers in a time where it's really, really important to them. And perhaps in a time when they're looking across the marketplace where others aren't doing the same. So when I take a step back and say, look, if there's an environment where, just given the macro and given the downturn, that it makes the most sense to pull back investments, well, then we would do that. But if there's an environment where we look at the benefit of pulling back those investments versus the benefit of continuing to invest because these are things that will drive growth, well, then I think we would think long and hard before pulling those investments and be thoughtful about it. So we'll be balanced. I just wanted to emphasize that the growth aspects of this and how we could distinguish ourselves against smaller players that may not be able to do the same.

Thanks for that, Matt. And as we think about capital management, in particular, one of the questions that was submitted of, I was hoping for an update, at least on your capital management priorities. And to what extent do the recent changes in the macro, and in particular, your share price, at least, influence that strategy or maybe your appetite to do more buyback?

Yes, I think our capital allocation approach and philosophy doesn't change, right? When you lay out the 3 primary areas that we invest in, organic growth, we see as the first and foremost area to invest because it drives the most value and the returns are the highest. And I think that is unchanged. And if you kind of take the answer -- my answer to the last question, you might say, it's even more important right now. M&A if it's a fit, especially financially, meaning from a return lens, is second. And I think capital returns remain important, right? Our historical practice has been a pretty consistent dividend with share repurchases augmenting that. And I think what we -- our philosophy is really always to be dynamic based on the environment we're in and to allocate capital to where it can drive the most growth, all surrounded by a balance sheet that is strong and can support the organic growth. So I would just emphasize all of that. In our share repurchase plans, we've always said is we'll be dynamic based on the environment we're in. I think at this very moment, we think our stock is -- and capital returns is at good place to deploy capital. If that environment changes, then we would change at that time. But where we sit today, we think it's a good buy.

And Matt, maybe just since you touched on a lot of really important growth drivers for your business. I wanted to ask just a more theoretical question on valuation. Our FinTech Forum does tilt heavily towards growth companies. It feels like a lot of investors have at least pigeonholed LPL into that rate-sensitive broker category. And then looking at all the changes you cited in terms of what you've implemented over the years and it feels like you're much more business or solutions-oriented, whether it's heavy digital investment, product innovation, strong organic growth and just reducing that overall macro and credit sensitivity. And do you see LPL at least as a company that's evolving into more of a solutions firm versus a broker-dealer. Maybe how do you get the investment community to maybe recognize that a bit more?

Yes. I mean I think the way you described it -- well, you described it well, right? When you just look at what we do, right, what our value prop is, is providing capabilities and solutions to advisers, right? So it's all about things -- it's all about those -- developing those capabilities. A lot of that is through technology. Things like just digitizing the workflows and where they spend their day and where they spend their time on whether it's proposals to new clients or the process to open a new account or essentially manage platforms, where they're managing their clients' money and so on and so on. So I think that is what we do. That is where the value prop is from an investor lens. I spent a lot of time on highlighting that. And I think that -- and we'll keep doing that. But I think your description is a good one, and we're providing solutions to advisers to position them well to succeed.

And so, Matt, one of the other questions that was submitted, just quickly, is just on white labeling of solutions. Just given the strong pace of adoption of your centrally managed platform, some of the virtual solutions that you're offering, is this something that, over the long term, you could potentially market as a white label offering, maybe what are some of the biggest hurdles, if any, to just simply going down that path?

Yes. I think when you look at these capabilities resonating with our advisers, there's no reason it has to be limited to just folks that were on our platform. So I think when you say that the long-term opportunity to do that, I think it's certainly there. I think when -- what's preventing us from doing that or how do we prioritize that, when you come back and look at the things that we invest and the things that we do and it kind of gets into what I think that the team here is really good about is when you list out the opportunities we have to drive value and to drive growth it's a long list. And I think we spend a lot of time prioritizing that list to make sure we're doing the highest returning in the best items first. So it's all about the sequencing. And I think when we look at the opportunities in front of us from a capability set with folks on our platform or to bring folks to our platform, that's just a really large opportunity. But I think we're -- to your point on the long term, that certainly could be an opportunity down the road.

Great. Well, Matt, thanks again for joining us virtually. Obviously, a lot of exciting developments, but it's nice to see that your value prop continues to resonate. We look forward to, hopefully, having you participate with us again next year just ideally in person and maybe we'll talk even more about the strategic priorities. And hopefully, we'll be in an environment where we can touch a little bit less on the macro. Thanks again. We really appreciate you being here. And next on the agenda, everyone, we have the CEO of Paysafe. He's presenting, and that should kick off in about 4 minutes. Thank you all for listening. Stay safe and wash your hands.