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

Right. Right. That's totally fair. Another offering that you guys have rolled out in recent years would be the Business Solutions side grown at an impressive clip, right, double-digit year-on-year sort of growth rates. What have been the key drivers of the growth? And is it some of the offerings resonating more so than others? And what do you think is the ultimate revenue opportunity there, is it a penetration rate, like what do you think?

Yes. Well, I think when you look at Business Solutions, right, they are focused on helping an adviser run their small business. And when you look at the amount of money they're spending to do that, right? When you just look at our advisers, they spend over $1 billion a year in local-level services, right? So if you think of the ultimate addressable market, right, you're not going to get all of that. But if you think of the ultimate addressable market, it's the money that they're spending to run their own small business, right? So that -- I think that's how we look at the market. I think when we click down to our execution on that, and it's really about figuring out are there solutions where we've got a value prop that where we can provide a solution to help them do that, right? And we're not necessarily positioned to help with every single possible thing that someone does in a small business. But I think what we found through developing these solutions and continuing to iterate and have them in pilots and incubation that the more we look, the more we feel like we've got a value prop, and we're able to offer it. So we're now up to 7 solutions that we offer overall. We've got 3 more in pilot phase right now. And then some more that we're incubating and some ideas that we're effectively kicking around. So I think there's a lot of opportunity here. And the reaction to it, I think as you noted in the question, has been great and kind of connected to the growth of folks that are using it. And if you look at the end of Q2, we were around 2,100 subscribers that's more than double a year ago. And when you look at the solutions, just to click down on it, it's kind of centered in 2 categories. The first is where firms will typically have a person doing something. We call that our professional services. And that's a CFO, a Head of Marketing or an ad, right, those 3 solutions. And I think that's where we hope to bring a capability and a knowledge using CFO as an example of taking the skills and knowledge that we have and know as a large public company and really putting together a team that can serve someone running a small business and bring that knowledge to them. I think the other category we refer to is business optimizers, they're almost a little bit of things where we're bringing a capability or a value that isn't necessarily associated with a person and maybe something where it's kind of difficult to get elsewhere. And I think a good example of that is our Assurance Plan. And this is 1 of the business solutions. It was, I think, the 6th business solution that we launched. And this is really about succession planning and protecting the value of an adviser's business if something unexpected happens, and they're no longer able to run their practice, right, long-term disability or an unfortunate passing away. And I think when you think about an adviser practice and in a moment in time where all of a sudden, the adviser can no longer serve their clients. If you don't have a plan or an ability to quickly do something with that business, you can imagine as a client and your adviser is no longer available and you don't hear anything or nothing happens, you may quickly move your business elsewhere. So what we've brought, I think, is a pretty compelling solution with the assurance plan where if you're -- if something happens, you're no longer able to serve your practice permanently, we will immediately buy that practice for a guaranteed price, one. Two, we'll then go market it for sale. And if the sale of that practice is higher than the minimum price we pay, will also provide those proceeds to the adviser or to their estate. And I think when you -- just the protection and the peace of mind that comes from that, I think we've seen is resonating really, really well. And it's hard to get that type of solution elsewhere in the market. So I think that's just, I think, an example of 1 that has resonated really well and we're solving the need that really matters to our clients. And I think that's what resonates across Business Solutions. If we can solve something that matters to them and position them to be able to either more effectively or more efficiently or even both run their practice, then I think we've got something here that can grow and grow well over the long term.

It might be too early to know this. But as I was sitting here thinking about you particularly described in the Assurance Plan and the service, have you done enough of those to know how the customer behavior is? Like is there an engagement that you need to have in order to ensure that the book of business, by the time you're able to market it, hasn't seen customer attrition and whatnot because of that development?

Yes. So we -- there's an onboarding process to make sure there's a connection. And then we've had -- it's a relatively small data set, but we've had a handful of these plans become necessary to use, meaning that events occurred where we had to go into action. And I would tell you, in that relatively small data set, the value proposition has played out really well. We purchased it very, very quickly. It was sold to another adviser, typically an LPL adviser very, very quickly for a higher price. And the clients got to a new home very quickly and the adviser or the advisers of states got the value for the practice, they had spent their lives building, right? So it's really been a win-win on both sides. So relatively small data set, but I think it's worked out really well.

Great. Nice. Shifting gears a little bit and maybe talking a bit about cash dynamics and the monetization of cash balances. One of the pieces of pushback that I get sometimes when I recommend LPL stock to investors is that as your cash monetization sort of model works, you're relying on bank demand for the deposits, right? And there are some investors who believe that, that's a weakness in the rate leverage versus other firms. So from your perspective, what does that argument miss when you consider the benefit of the LPL model versus a bank holding company?

Yes. Well, I think -- yes, I think a couple of things. One, I think when we look at our model and how we drive value in this area. We look at 2 things. One, like first and foremost, is the value prop to our clients, right? In this example, our clients are advisers who are making sure that they're able to offer the products that their clients and the retail investors want. And I think that for us, the question becomes for those products, do you need to be a bank to offer those? Do you need to be a bank to offer cash management capabilities? And the answer is, when you look at the marketplace and how you can have relationships with other banks and integrate their capabilities onto your platform, the answer is no, you don't need to be a bank in our business to offer that. And then I think the second question becomes for the economics of that sweep cash, and maybe this might be the core of your question is what's the best way to generate a return on that, and what's the best return on capital? Holding the deposits on our balance sheet versus holding them on someone else's? And I think when you run the math on that, especially in an interest rate environment where rates are near 0 and the curve is flat, running the math on having a bank, having the capital` requirements of a bank, it's pretty simple and clear what makes more sense from a capital allocation standpoint is the -- is not having the bank. So I think for the investors that are citing that, I'm not sure what they're looking at when -- if they're looking at different math than I am. But I think it's pretty clear that the capital required to have the balance -- the deposits on your balance sheet, combined with the lack of additional return that that's going to generate in an environment like this, it seems very clear to me what the answer is.

Okay. And when we think about the first part of the answer, which I -- actually contains something that I wanted to try to follow up on, you don't -- you flagged that there's really no gap in the offering versus being the bank. One of the things that we've seen more recently amongst wealth management firms, particularly in the past like roughly 18 or some-odd months since the pandemic broke out is a lot of growth in lending for the full-service wealth management firms. Can you talk about how you partner with banks? How you make that -- those types of services available for advisers that want to help out their clients, not only with the left-hand side of their balance sheet, right, but also the liability side, the right-hand side of the balance sheet?

Yes. And I think we've got -- you've got wealth managers and broker-dealers specifically, you've got core products you can offer, margin being the most notable 1 that we offer. We have integration on the SBLOC side, so another type of wealth management lending and offerings. And I think maybe the products and capabilities you're perhaps referencing are the larger firms that have their -- have integrated other retail products or their own retail products, whether it be mortgages or things of that nature. I think that's where we can -- to get our advisers' clients access to mortgage, I think that's something where you can integrate and there's lots of capabilities and firms out there that you can connect to. And I think what that would -- it would put us in the position of making sure that we're providing a compelling experience to go get that product, but the need to actually own the commodity itself, like in this example, the mortgage I don't think that's where the value prop is, right? It's a commodity, and there's so many folks out there that offer that. I think where you can distinguish yourself is in your technology, in your integration and your access to those products. So I think that's where we end up focusing is on that.

Got it. And then when we think about you managing the portfolio, right? You referenced the current rate environment, which we all know is extremely challenging. When you're thinking about managing the ICA portfolio through this type of environment, how do you prioritize near-term yield stabilization versus an opportunity set, which could be a bit down the road when we might be in an environment where we're getting higher rates and therefore, gauging an opportunity cost that's a little bit hard to suss out at this point?

Yes. I think what we're trying to have -- we've got a philosophy that really is grounded in not trying to suggest or demonstrate that we're clairvoyant on interest rates and can pick the moment in time where it makes sense to be variable versus fixed, right, because nobody can do that. And I think what we want to really ground ourselves in is we've got a company and a firm that's got a value prop that supports advisers in running their businesses. And 1 of the things that comes out of that is a small percentage, 4% or 5% of those assets are in cash on average in a given day. And what's the best way to deploy those or invest those in a long-term way? And I think what that brings us back to is our goal on the fixed rate balance side is -- and philosophy is really unchanged. And it's 50% to 75% would be the objective. Of course, you need to be in an environment where there is demand for that, which we're really not in right now. But when that demand returns, I think that range is unchanged. And I think we're -- while we're not going to try and be clairvoyant on rates, we're not going to ignore the general position of rates, meaning if we're in a period like now, and there is demand, I think we would naturally stay closer to the low end of that range. right? We're always going to want to have a pretty laddered portfolio. So any given year, you've got some amount that's maturing. So you're never too far or terribly far from where rates are. But if rates are really low, we'd want to be at the low end of the range. And the opposite, if rates were high and the curve was steep, we'd probably be closer to 75% side of that. So I think that's the that's the approach we have. It is interesting to your point on where rates are. I mean, when you see the curve -- so rates pick up, meaning the curve is steepening because Fed funds really hasn't moved much. You do see people starting to come back to the market, right? We saw that in Q2 and the 10-year got up to that 150, 160 range, we started to see some banks pop their head up and have demand on the fixed rate side, and we were able to put in a small amount, but $600 million in new contracts, and we didn't go out 5 years, which would be our typical focus point. We did 3. But like you saw an opportunity there. And then, of course, rates have gone down from that level then, although I think we're starting to see a little tick up here on the past few weeks on that. So I think it's just an interesting data point that as the yield curve improves and there is economics on the balance sheet side of the banks that demand could start to come back. And I think the same thing on the floating rate side, which is really driven by the massive amount of liquidity in the system. But to your point on the loan side, you're starting to see some trends of where banks are deploying their cash, whether it be the loans starting to pick up that you described or consumer spending starting to pick up, meaning the balances in checking and savings accounts potentially coming down. I mean, just all of that collectively, I think, over time can ultimately lead to demand picking up in this space. But that's just some context on how we see some things. I think back to the core of your question, I think our philosophy there is really unchanged.

Got it. Yes. And actually, it's interesting that you brought up the curve steepening because that was 1 of the things that I had thought about reflecting on the second quarter call. The -- once I caught my breath, that is, I remember that day, being rather dizzying as far as the number of companies that we're reporting. But the -- with the curve steepening, was it purely the idea as far as demand goes? Because when we look at like the loan-to-deposit ratio in the banking system, it's really low. And even if we go back to the last time you guys were able to deploy some of these fixed rate instruments. It's not necessarily that like the loan-to-deposit ratio got back to where it was. It just sort of ticked up modestly, and it seemed like that led to some demand. So are the indicators, the loan growth as you referenced? And is the steepness of the yield curve enough for banks to want deposits? Or is it more that the steepening yield curve is like indicative of velocity and improving in the economy, and therefore, they want to have some dry powder?

Yes. I think where we are right now, it's just -- it's really a technical market, which means it's whatever is specific to that particular bank and their liquidity needs or the instance of fixed rates, their asset liability management focus and needs. That's what's driving it. And I think if you get to a place where someone sees -- a fixed rate deposit is a very efficient vehicle to one, get deposits, but two, to really manage -- do their asset liability management as opposed to going out and paying money for swaps or interest rate caps and floors and things of that nature. You see them pop up when there's some steepness to the curve, if the curve is flat, it's not necessarily as good of a vehicle because they can't really deploy them and make the economics on their side. So I think just in this environment, there's such little demand, I think the early moves that ultimately could return us to a more normalized environment, they may return some banks more quickly than others, right? It just depends on their particular balance sheet and needs.

Okay. That makes sense. And shifting gears a little bit on the expense side. First half of '21, core G&A, excluding Waddell, right, up about 7% year-over-year, consistent with the outlook of 5.5% to 8%. But as we see organic growth running at this really attractive elevated rate versus history, should we continue to assume mid-single, mid- to upper single-digit growth there in that line going forward? Or might there be upside if the organic growth remains this good? It's obviously a good problem to have.

Yes, agreed. Yes, I think when you just look at the investments, right, we're trying to do and focused on 2 things: One, drive organic growth, but at the same time, deliver operating leverage, right? I think it's -- we're -- most companies are aimed to do the same -- to do that, right? You don't want to drive organic growth and then spend it all to support that. So we try and balance that well. I think we've been -- when you look at the numbers that you were just quoting, I think we've been able to do that. And it's because the investments are working, right? It's not only capabilities, but it's also the service and support teams to support the new clients that we're bringing on, we want to make sure that we're supporting them in a way that really allows the value prop to resonate. And when you're delivering double-digit organic growth like we are this year, so far. And even when you look into next year, if you get a good kind of traditional base rate continuing and you add on even CUNA joining, you can see a path to over 10% again next year. So I think when we look at that and come back to the investments necessary to support that growth, we're going to have the same philosophy that we have now, which is we want to both deliver operating leverage, but also really invest at the levels necessary to support our clients. And those are dual objectives and 1 is not more important than the other, other than if we're not supporting our clients, maybe hedge it to that side, then the operating leverage doesn't really matter because at its core, we've got to support our clients very well. So I think you take all that to and say, okay, well, if we're in a scenario where our core G&A growth rates are drifting up above what we had recently, well that would be because we are delivering organic growth that is compelling. So I think it's -- as to your point, I think a good problem to have, but ultimately, organic growth levels, I mean that's what we're spending to drive. So if there's more organic growth over time, there could be more expense growth, but there should also be operating leverage that comes with that.

Yes. Okay. Makes sense. It's perfectly logical. And then last 1 for me because we only got a couple of minutes here on capital. So you guys have recently closed some of the bigger deals and working on the integration at this point. But do those -- you got CUNA still coming, some of those ongoing acquisitions and integrations that limit further large M&A? Or was the restarting the buyback an attempt to try to signal that if the -- if another attractive deal does present itself, you'd be in the market?

Yes. I think our framework here is probably the best way to answer that. I think we look at organic growth as the highest returning place to deploy capital. We aim to deploy capital there first. M&A second, although M&A opportunities are always hard to predict and then third, returning capital to shareholders. And I think I wouldn't infer any signal from restarting the buyback other than what we talked about, which is we had 3 large capital allocation events, if you will, above and beyond our core business or core recruiting that was growing at record levels. Meaning M&T, BMO and then the onboarding of Waddell & Reed. And I think we wanted to be very deliberate about getting on the other side of those things to make sure that we had an opportunity to assess the organic growth opportunities, which remain compelling to assess the M&A environment and then be able to assess the ability to buy back shares if that made sense to do. And I think when you look at our plans, we certainly think it does. So I think -- but the key here is really that framework is not static. It's dynamic. And if we see different opportunities on any 1 of those fronts, then we'll adjust based on the opportunities and the returns that they generate.

All right. That makes a lot of sense. And that takes us to the end of the time. So Matt, I really want to thank you for participating with us here this afternoon, this morning on [indiscernible] your time. And hopefully, next year, we can do it in person.

Sounds good. Thanks for having me.

Take care.