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

Good afternoon, everyone. Let's get started. This is Craig Siegenthaler from Credit Suisse, and it's my pleasure to introduce Matt Audette from LPL. Matt is the firm's Chief Financial Officer and responsible for LPL's core financial functions, including financial planning and analysis, treasury, corporate development and investor relations. Prior to joining LPL in 2015, Matt was the CFO at E*TRADE and spent 16 years there. Matt, thanks for joining us.

Yes, no problem. Thanks for having me.

So for those of you who don't know LPLA, it's a purely independent broker-dealer platform that has one objective: to help independent financial advisers. Unlike peers, it doesn't offer proprietary investment products. And LPL has been expanding its offering into new channels, which has significantly increased its addressable market.

Let's begin the fireside. Matt, to start off, can you walk us through LPL's growth strategy? And we really like it how you break it down into the 3 buckets: new store sales, same-store sales and retention.

Yes, sure, Craig. No problem. I think when we look at growth, and I think you look at the last few years, I think we're excited about the growth, organic growth and prospects. And if you look at the last few years from being at 3% organic growth in 2018 to 5% in '19 to 7% last year, I think we're just we're excited about the trends and really the potential to improve it from here. I think looking at it in the channels that you described, right, so it started with new store, which is really about bringing advisers to LPL. And I think there's just -- and that's probably been a big part of our growth the last few years when you think about the traditional markets that we're in, that kind of traditional independent broker-dealer and advisory space. And then on top of that, the financial institutions, M&T and BMO being 2 larger names that we recently signed agreements with. And then you add to that the new markets that we've entered, and I suspect we'll get into that a little bit, Craig, from the SWS model, which really helps bring breakaway advisers to independents. And as well as our employee model, that's an independent-focused and -minded employee model, all the way to the RIA markets. There's just a lot of opportunity to really drive growth. And with the majority of that growth coming in the last few years from just that first independent channel, there's a lot of opportunity there. I think you then look at same store, right? So think about that as the advisers that are with LPL now and how they're able to grow, right, and how we're focused on positioning them and helping them grow. And you've got things from the -- everything we do on the technology side that's really focused on putting them in a position to be efficient and spend more time with their clients, whether they're existing clients and improving the wallet share there, or bringing in new clients to their practice. And you look at things like business solutions, which is really focused on making and then putting an adviser in a position to be the most -- have the most efficient small business they can have in an integrated way. So it's -- there's a lot of good things happening. I think everything -- and then you add to that all the things that we do to really improve the value prop to attract these new advisers, and all the things that we're doing to help existing advisers be more efficient and grow. I think those things also lead to improvements in a strong retention rate. So collectively, Craig, I think we're really excited about the growth that we've had. But I think we're even more excited if we execute on the things that I just touched on lightly here. The opportunity to drive even further growth from here is there.

So last year was a record year for organic growth at LPL. And you finished the year also on a strong note in December. How does this momentum carry on into 2021?

Yes. And probably just building on the things that I just walked through, right? I think we've got a lot of momentum going into '21. I think if you just take the run rate that we came out of '20 with, so that 7%, 7.5% organic growth if we were to simply maintain that; and then you add the 2 large banks that are going to come on board this year, M&T and BMO; you're starting to get to low double-digit organic growth. So it's pretty good momentum. I think when you click down a little bit, just to highlight some of the opportunities there. And just there's traditional markets, there you look back at last year, we drove a record level of recruiting in an environment where fewer and fewer advisers are changing firms, right? We refer to that as churn. But you had really almost record low churn in our space while we had record recruiting, right? So you put those 2 things together. And what that tells you is our market share is growing to the best levels really that we've had in a long time. So I think if you can -- we can continue that momentum, I think that excites us. You add to that the bank opportunities and really following M&T and BMO. I think we've been in that space for a long time. But when you're able to have large institutions like that who are not really outsourcing before, right, they've decided to outsource to us, it can help generate some more conversations. As that, that's a $1 trillion market with 1/3 of that market not really outsourced. And from our perspective, we think that's something that could be efficient and productive for them to do. So I think that gives us some confidence long term about momentum. Those things are long sales cycles, so maybe not necessarily in 2021, but momentum going forward nonetheless. And then you add to that the new channels. SWS, we really started last year. We had 5 teams, 1 billion of AUM. And I think that's something by the nature of that model that we're new to that space. And we're starting to establish ourselves. We're starting to have a brand and a reputation there, starting to have the teams that have joined us start to recommend other folks to us. So you've got some building momentum there. And similar to employee, it's a little earlier in its development. But we just had our first commitment to that new channel as well. So you put it all together, I think we're -- the momentum to us looks good for '21. And we're excited to see what we can deliver.

Got it. So Matt, I know you just covered part of the bank channel in the last response. But we wanted to dive a little bit deeper into the bank channel opportunities really after we saw M&T and the BMO transactions in '20. How are other opportunities progressing? And what is your outlook from the bank channel from here?

Yes. So it's we think it's good. I mean I think just a little bit more color on the market opportunity that I touched on, it's a trillion-dollar market. And you can kind of break it down into 1/3s, right? 1/3 is outsource today. We're the dominant player in that space with that leading market share in that space. 1/3 is with institutions that are large enough, we think it's highly unlikely that that would make sense for them where they would consider outsourcing. And then you've got that last 1/3, which are institutions where we think it's -- the value prop is there for them to outsource. And that's where M&T and BMO come in for the recruits coming on board this year. I think when you just look at that channel overall, we've got momentum in that market, right? We've -- you go back to 2019, we had about 5 billion of recruited AUM in that space. You look back just last year, we had 10. M&T and BMO that I've talked about, alone are about 35 billion of assets. So there's some momentum there. I think maybe it would be helpful just to click down a little bit into why we think it makes sense for these banks to outsource, and why an M&T and a BMO would choose to come to somebody like us. And if you think about it, there's a handful of things. Scale is becoming more and more important. And when you look at the size and scale necessary to bring the capabilities to market that are going to be a great value prop, you just need to be larger and larger. And for us sitting at north of 900 billion versus a bank who's much smaller, it just can be challenging to really bring the financial wherewithal forward in that particular product. You then get to client experience, right? The expectations of clients mean that retail clients are getting higher and higher, as they should. So it kind of comes back to the capabilities and value prop that you've got to deliver, not just for the advisers but also for the end clients. Third is I'd highlight is probably advisory capabilities. Like a lot of these businesses really started up and primarily sold on the brokerage side. And as advisory has become a much, much larger part of the business at LPL where now the majority of our AUM is in advisory, the capabilities there are more and more important. And that's where we've done a lot of our investments. So if you're a bank having to think through developing those or connecting with a third party, that might not be the best solution versus coming to somebody like us. Fourth I'd say is just risk, right? The compliance is just becoming more and more complex. And why not outsource to someone who's got expertise and it's a core part of their value prop? Meaning LPL makes a lot of sense. So you add all that up. In order for a financial institution to solve all of those items in a compelling way to have a great value prop, they're going to have to turn their investment dial up in something that I'm sure is quite important for them. But it's not their core business, right? Their core business is banking, and wealth management is in addition to that. So I think that whole environment, Craig, just really triggers, or a catalyst perhaps for banks to think through what is the best way to offer a wealth management or a brokerage and advisory kind of adviser-mediated product to my clients. And I think that's where looking at LPL really comes into play. So we're excited about the opportunities there, and hopefully that gives you a little more color and context as to why.

So another growthy-type question. But in 2020, we watched you expand into the employee channel. We watched you also expand into the RIA channel. Maybe talk about how you did this, and also how this impacted your addressable market.

Sure. And I'd add the SWS model to that, Craig, too. I mean that was the first area that we really expanded into, with employee following it. I think when you look at that collectively, it really tripled our addressable market. You look at the traditional channels, right, the adviser and the bank channels, those are call them in the 4 trillion zone. And then you add the market, that opportunity that we have being in these new models, and you bring that closer to 13 trillion, right? So you're tripling the addressable market. And I think just maybe click down a little bit on that, right, and just using the SWS model as an example, right, why we really didn't have access in a big way to that market, like those are folks that are moving from an employee model, typically a wirehouse, into independents. And when you look at our historical value prop, it really was designed under the presumption that somebody was already independent. Or if you were on the outside looking in, I think that's a conclusion you would probably draw even though we had -- even though we were focused on helping there. It just wasn't as strong as a value prop for someone who has had a -- pick a large wirehouse name. And didn't have a clear path on how they get to independents and "How do I set up my own shop? How do I get real estate?" Like things like that. So I think that's where the SWS model comes in and really helps, one, get an adviser to independents. But then at the same time once they are independent, and these folks are used to being wealth managers, not small business owners, helps them also run their small business through our business solutions which come along with that platform. So I mean that was the first one, and I think the one that we're really starting to help -- to develop the brand and reputation that that's a -- LPL is a destination and is a choice for someone looking to go independent. On the employee, so in your question, Craig, on the employee side, it's very similar to SWS and for all the same reasons that someone wants to go independent, right? They want to own their own clients. They want to manage products and distribute products that make sense for the clients versus having a house product, if you will, that you need to distribute. They want to keep more of the economics they generate, meaning they pay out higher. But they want to do all -- they want all of that, but they don't want to run their own small business. And I think that's where employee models largely didn't check those boxes, right, that I just walked through. So I think that's why we're excited about the independent employee model that we put together. We just had our first commitment to join the model. So you then kind of think of how SWS has tracked along, and think of employee right behind it in a similar way if we're successful. So we're excited, excited about it, Craig.

Excellent. So something else that we saw last year, you acquired Waddell & Reed's wealth management business, in a transaction that actually Macquarie acquired their bigger asset management business. What attracted you to this business? And can you just remind us of the earnings accretion opportunity?

Yes, definitely. And we signed in December, and I think we're looking to close mid- this year. But I think the -- what attracted to us was really when you look at the quality of the adviser base from -- looking from the outside in, but having had a decent number of Waddell & Reed advisers come join LPL just through a normal recruiting process, I think what we saw is just really a quality group of advisers that culturally really fit in well at LPL. And so when you see that from the recruiting side, I think -- and there's an opportunity to do some M&A at that firm. I think that really is what excited about us -- excited us about the opportunity. Now on the accretion side, right, so I think when we announced that deal a few months ago, our expectations, at least from a modeling standpoint, were retaining 70% of the AUM. And with all the cost and things to support that on our platform, our estimate is about a $50 million run rate EBITDA accretion opportunity. Now that being said, since then, our recruiting has already gotten up to 80%. So it's already above what we'd assumed in the models. And then the markets have increased. So the AUM that we're recruiting from has gone from 63 billion to 70 billion, right? So the opportunity set is getting larger and larger. And we'll update that EBITDA accretion opportunity as we get as we get closer to close or next quarter. But I think the headline and takeaway is really great property, meaning advisers and employees, right? We're going to be bringing on some employees from Waddell & Reed as well in a Kansas City operations center. And also a great partner with Macquarie on the asset management side. So overall really, really good transaction. And I think on the financial side, things are looking better than we initially thought.

Great. Now moving on to client cash. For those of us that are new to the LPL story, can you remind us what you do with client cash? And also, how has this allowed you to over-earn peers through your ICA allocation to fixed-rate contracts?

Sure. So we're -- I think the key is we're self-clearing, right? So when we're directing and managing client sweep cash, we're the ones connecting to and placing those deposits with banks. Versus if you're not self-clearing, the firm doing the clearing is doing that. So I think it puts us in a position to really -- when you think of the overall economics that get shared amongst different firms, like we're keeping a larger percent of those economics. It also allows us to really put some duration and some stability into that earning stream as well. Meaning having fixed rate contracts with some tenor with those third-party banks. So I think conceptually, that's what it allows us to do. And our strategy is really focused on doing just that, using the ability to fix out the deposits and really create steady earnings stream. Meaning reducing sensitivity to short-term interest rates. And you saw us do a fair bit of that in kind of late 2018 and '19. Prior to the COVID-driven reduction in interest rates, we moved about 12 billion of deposits or about 40% of our sweep deposits into fixed contracts. And I think that positioned us really, if you march through 2020, to really be in a place where our earnings were more stable. It allowed us to continue to invest in the platform. And in a period of time where I could imagine folks that were 100% floating on the cash sweep side, maybe they didn't have the financial wherewithal to do that. So I think it all comes back to being able to deliver a value prop that's really, really good for advisers. And stability in cash sweep is one of those things.