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

I'm really pleased to introduce our next speaker from LPL Financial, Matt Audette. Matt, CFO of LPL since joining in 2015. He's really been instrumental in that transformation from a low single-digit organic grower to really posting best-in-class organic growth amongst all the public and private comps that we track. He was -- prior to that, he served as CFO of E*TRADE, where he was a driving force behind the rebuilding of the firm, following a difficult period after the financial crisis. So Matt, really excited to have you. I know it's -- I think you've been here with us at this conference since its inception. So thanks so much for continuing to support it.

Of course, happy to be here.

So probably the best way to place to start, Matt, is just given the challenging macro backdrop. I was really hoping you could just speak to how the business is performing during this period of elevated volatility? And whether it's causing any disruption on the recruiting side and maybe also frame just some of the offsets in the model that you have during a choppier equity market backdrop?

Yes. Yes. I think and maybe starting on that -- on the recruiting point. I think in markets like this, right, where you've got elevated volatility, right? It's very natural for a short period of time, at least for folks to pause, right? And you can imagine that this is where the value prop of being an adviser is clear in these times and other times. And so advisers are spending time with their clients, right? And it's not the best time to then go through the process of transitioning to another firm. And I think when you look at the history of periods of time like this, it doesn't necessarily have a long-term effect, right? It's just more natural that people to slow down, focus on their clients. And then we're in there -- in a period where that's more stable and more comfortable to move at that point. And the same goes for bringing in new accounts on their end, not just recruiting and coming to a firm like us, but their own growth also slows down. Now when you look at our pipelines, right, they continue to build, they are at record levels. So I think the way to think about it is most folks will just shift out their move dates essentially but not really change their ultimate decision to move. It's just more about when, right? So I think that is very natural to see in an environment like this, and we are seeing that. Now on the business model of natural hedges, right, I think what you expect to have happen in an environment like this is happening. So we're performing as expected. And I think the dynamics are the obvious flow-through of as equity markets are down, the effect on client assets, right, come down with those mark-to-markets. But what you typically see is an offset that -- an offset to that with increases in cash balances and increasing in trading activity levels. And we're seeing both of those things, right? So I think the model is functioning as expected. I don't have to highlight to you or probably anybody else on this call, but also the expectation for interest rates going up likely next week, I think, puts a financial return and an improvement of a financial return on that cash that folks go to in the short term. Now I think maybe just to get a little bit of specific to February, we haven't released our February metrics. But as since we're sitting here in March, we're pretty close to finalizing those results. And I think the results we're seeing are exactly as expected in the environment that I just described, right? So when you think about organic growth, it's slowing down a bit, right? We were at 6% in January. So that's likely to slow in February. So I think something in the -- with a 5 handle on it. On the cash sweep side and what -- and maybe a little bit of a context first, what you typically see in a Q1 is that cash build from Q4, right, the tax planning and rebalancing at the end of the year, the dividends and interest at peak in the month of December. You usually see that going back into the market in Q1. And what we saw from our January metrics, which we already released is cash actually continued to build in 2022 by $1 billion in January, we saw another $2 billion in February. So just through the first 2 months of the year, you're seeing cash balances increased by $3 billion, and it's really connected to that dynamic we were talking about before. So I just headline it, Steve. Our model is performing as you would expect in this environment and the natural hedges are kicking in.

That's great. Well, maybe just looking beyond some of the near-term macro headwinds, in the last couple of years have certainly been very constructive with record organic growth across the entire wealth complex. But again, you guys have really been at the head of the class. You also guided recently to the organic growth running in the upper half of your recent range of 7% to 13%. What we have noticed that you guys have been willing to provide those bookends, many of your competitors have not. And just wanted to get some perspective, Matt, as to what gives you that confidence level that you can sustain that higher run rate organic growth?

Yes. I mean, well, I think the book ends are really grounded in what we've been able to deliver, right? The 7% on the low end is what we delivered in 2020. And then the 13% on the high end is what we're able to deliver last year. And I think when we look at the drivers of that growth and kind of how and where we would, in a year, would be positioned within those bookends. I think there's 2 things that kind of -- that move the needle primarily there. And the first is when you think about a period of time where you can land at that kind of upper half of that range, you're in an environment where the macro is supportive and conducive to advisers being comfortable changing firms, meaning it's conducive to recruiting. And then from a channel standpoint, it's probably a year where we've been able to bring on a large financial institution, right, M&T and BMO in 2021, as an example. And then CUNA that we have set up to join this year, right? So I think when you look at the conditions that would lead to the lower end of that range, right, it's just -- it's kind of the opposite, right? You would be in a period with macro headwinds, right, not unlike we're sitting in today and then probably no sizable financial institutions coming, right? So I think those are the things I would highlight that kind of move you around in the range. Now what's kind of foundational in supporting all of that is our value proposition and the core driver of the growth from things like delivering a great client experience for our advisers, making sure we're investing in and delivering the capabilities that matter to them and help them grow their practices. And then the services that we offer, right, Business Solutions being a prime example that helps them run their practices and gives them more time to focus on the wealth management side of their business. And like that's really the engine that drives all of this. And I think maybe back to your question and looking specifically at 2022, right? I think the macro we're in at this very moment as we just talked about in your prior question, is a lot different than it was when we talked about it in our last earnings call, right? So 1 month, 1.5 months ago. And I think if those conditions just persist like we were just talking about, there could be a shift in timing of that growth. And if it shifts for a long period of time, it could impact the year. If it ends up being relatively temporary, right, it may just be a 1 quarter is lower and the next quarter, it starts to increase if things are more calm on the macro side. So I think that's a dynamic I would highlight that's new. But still, overall, I think we feel very comfortable that the value prop is going to drive growth over the long term. When you look at 2022, we're on track to have CUNA joined by the middle of this year, which in and of itself is around 3% organic growth just from them joining. So I think we feel good, Steve, and just making sure you connect the macro in right now, and we'll have to see how that plays out.

Well, maybe let's unpack some of the individual channels when thinking about that organic growth algorithm. When we analyze some of the U5 filings, it's pretty clear that you're continuing to take share from the wirehouses but the majority of new advisers and assets have continued to come from other competitors within that independent broker-dealer channel or your traditional market. With the private equity sponsored roll-ups in particular, really being the biggest share donors. I was hoping you could speak to how you're positioned competitively versus some of those PE-sponsored IBDs in particular? And how do you see the competitive landscape evolving within that channel over the next few years?

Well, and I think it's just building on what we're just talking about. I think when you get to the core of how you're winning share or I like the share donor moniker you just described to some folks. I have to use that one. But I think it gets back to the value proposition, right? So if you're delivering a set of capabilities that helps them grow their own business, right? If you got a service experience that's better than they have at their current firm. If you invest in technology in a way that delivers capabilities for them that's going to matter, right? And when you look at the different ways to affiliate, right, the expansion of our models, right, gives advisers more choice when they come to us versus a firm that they were at maybe limited that choice to have access to things like business solutions to help them actually run their practice, so they can spend more time on being a wealth management. Like those are all things that really help drive that growth. And I think if you pivot to some firms that aren't able to provide that, right? I think they're going to really struggle to grow. And I think specifically to the share donors that you mentioned, right? I think the feedback we get from advisers that join us from those firms is that those places struggle to match the value prop that we're offering, right? So I think our -- what we need to do is continue to invest in that, continue to drive the best experience for advisers. And I think over the long-term, if we can do that, I think we can continue to win and continue to grow our share.

That's great. And Matt, the other part of the organic growth algorithm that you spent some time talking about is the bank channel. Certainly, been a big contributor in recent years. And I was hoping you could just speak to the value prop that you're offering the bank partner where it makes more sense for some of these smaller banks to partner with you versus go at it alone?

Yes. And I think and even it's not just smaller banks, right? And I guess small is a relative term. But I think in the folks that have been joining us, they're starting to get larger and larger versus our past. And I think the key there, like when you look at it from that institution's perspective, right, they've got a core offering that are banking products and capabilities. And it's very natural to have an extension to the wealth management side of their clients' needs or their clients' balance sheet, if you will. And when you look at that wealth management offering, it's hard to scale and operate that efficiently when it's not your core platform and your core product. And then you pivot to and say, okay, well, in order for me to grow this business, what do I need to do? What investments do I need to make? And I think it's not surprising at those institutions where you've got your core product that's got very compelling business cases, if you will, on investments to make that you're having to choose between your core banking products and the wealth management platform for that investment. And that's I can see at those places, they're going to choose their core product, which makes total sense. And I think that dynamic then leads to a discussion or a thought of was there a more efficient way to do it. And I think that's where when you start to look at outsourcing to us, a lot of folks are starting to see and conclude that, that does make sense, right? Because they're able to get access to the investments in capabilities and service that we've made right, without having to make the investments themselves. They've got the ability to accelerate their own organic growth once they're on those tools and capabilities. Advisory platforms being a key example where a lot of these folks, their core product for a long time was on the brokerage side. And a lot of clients today or retail investors today really want a fee-based product. And that's not something that they've been able to invest in historically. And then you look at the cost model where they're turning their cost for the wealth management platform more into a variable cost model with us. And then maybe the last point I'd highlight is they're getting out of the compliance business or owning the compliance business and they're able to outsource that to us where it's our area of expertise, and they're able to leverage that. So I think the value prop gets really, really exciting. And I think you then add to that having some wins and institutions of the size and scale and sophistication of an M&T, a BMO and then CUNA that's coming on this year, you can naturally imagine how that type of firm is starting to joining us is starting to generate dialogue across the space about whether it makes sense to come join us. And then maybe last point, right, the work that we do to onboard an M&T and BMO and CUNA involves a lot of developing capabilities that we didn't have that are really important to those institutions. And if they're important to those institutions, they're going to be important to other institutions. So it's part of bringing them on is actually improving our capability set even further, which I think makes us really excited about this opportunity.

That's great. And I mean, Matt, you made a strong case for how your value prop is differentiated. I know you guys have leading market share in this space. But maybe you can help for the folks that are listening just size the addressable market, how do you think about the long-term opportunity for LPL?

Yes. I mean it's big, right? I think when you look at the market overall, it's over $1 trillion and growing. And I'd put that market into 3 buckets. First is 1/3 of it, that broadly 1/3 of it that's outsourced today, right? And we've got, as you said, the leading market share there. You've got 1/3 of it that is with a large money center banks, a handful of large money center banks that are so large that it's probably unlikely, not impossible, but unlikely that they would outsource this business just given the size and scale that they have. And then you've got the last 1/3, which is where the -- I think the big opportunity is, which are the financial institutions that haven't outsourced it. And I think from our perspective, for the reasons that we just talked through, we think it would make a lot of sense for them to do so. And I think when you look at kind of building on the earlier point, like when you have the M&Ts and the BMOs and the CUNA has joined, right, that dialogue that occurs with the rest of that, that last 1/3 has really picked up, right? So the pipeline that we have, meaning the dialogue that we're having with firms is at a record high. So I think -- and that kind of pulls us down to the point of when you think about this opportunity in the long-term, it is, from our perspective, a sustainable contributor over the long-term to organic growth in that third slice.

That's great color, Matt. And maybe just for the last piece of that organic growth algorithm, I did want to spend some time just talking about strategic wealth services. But you've already experienced great success with this offering. I think in 2 short years, it's now contributing about 100 basis points to your organic growth rate. What about the SWS offering is really resonating with those wirehouse advisers and you talked about record backlogs. Like are you seeing similar momentum within that channel as well?

Yes. And I think -- and you actually see that some advisers looking to make a move, you're starting to see the wirehouse churn actually increase and meaning the opportunities to have folks come over are actually increasing and improving, which is a nice environment to be in. And I think when you get to the value prop of strategic wealth, and I think maybe a good way to, I think, articulate it is when you look at the traditional IBD model, right, even our traditional platforms. If you go back before the development of our services that support strategic wealth, the offering almost presuppose that you were already independent, right? And if you're independent, we've got a value prop and feel very comfortable and convicted on why you should be with LPL. But if you were at a wirehouse, and you need help getting to independents. And then once you've got to independents, you needed help establishing and running your own small business, but we didn't have a compelling offering there, right? So you had to go out and get a third party to help you do that. And I think that's where strategic wealth came from, which is really taking the compelling traditional IBD model and then adding -- I'll put them in 2 broad categories, but 2 key services, which are one a transition service to bolt get you to independents. And then once you are independent packaging our business solutions to effectively have a management team, right, a CFO, marketing, admin that are there and ready to go to help you run that practice. And that has really been the big differentiator. And I think why -- and you put in the numbers well, why this affiliation model is really starting to grow, right? We now have -- we've recruited over $6 billion to the platform. That's about $1 billion of that this year-to-date. And the other maybe additional exciting thing is now that you're starting to have a critical mass on the platform, you're starting to get those advisers referring new prospects to us, right? So it's just the pipeline itself begins to strengthen in ways that are pretty exciting. So good momentum here, and I think we're excited about the future of strategic wealth.

All right. That's really great color, Matt. And maybe just switching gears to the expense side and promotional expense, in particular. You guys are seeing really good organic growth momentum, but one of the biggest areas of pushback is this perception that you've had to pay up for that organic growth in the form of higher promo or promotional expense. Have you made any changes to the adviser comp for upfront packages to accelerate that organic growth? And if not, what are just some of the factors that contributed to that meaningful step-up in promo expense?

Yes. I'd pushback on that pushback, Steve, because I think that that's not the case. And I think there's a lot going on that shows up in that expense line. So I'll walk through that, but I think the headline is no. Well, we're not -- it's not a pay up for the growth because the growth is driven by the value prop. That's the number one driver of why someone would change a firm, at least coming to us, right? Because if someone is solely seeking to maximize some sort of payment, well, that's not what we're looking to do. We're looking to have a value prop and a capability set that supports advisers on what they need and to help them. Whatever is important to them, if growth being an example of that, if that's what they want to do. Now when you look at promotional, right, the expense of the line item where those things show up, there's really 3 things going on. And the big one is the costs associated with recruiting. And I think the thing to note there that when you look at the several -- the last several years, our recruiting volume has been growing, right? We're setting new records almost each and every year. And at that same time, the actual TA rates that we're paying, right, which is in basis points of AUM, those have actually gone down. So the expense you're seeing, which is growing is really a function of the sheer volume of recruiting, which has been at record levels, right? That is the driver of the expense, not paying up, if you will, for growth. Now the other 2 things I would highlight that make that -- the trends in that line item a little bit harder to follow is, first, our conference spent, right? And I think not dissimilar from a lot of folks in our space. When you look at what we spend on conferences, 2019 was the last like full year -- full normal year we've had of in-person conferences. And when you went into 2020, like most folks, so you just had very little spend on conferences, right? Whatever you did do was a virtual conference, which was a much, much lower spend. And I think when you look into 2021, we started to ramp back up into in-person conferences, not completely but start to ramp up to it. And our plan for 2022 is to be in-person for the full year, right? So when you think about 2022 will be the first year that is very similar to 2019. So in a period of time where promotional expense, everything else being equal, kind of seemed flat. It was because recruiting volumes were going up, which is a great thing but then it was offset by this COVID dynamic of conferences, which was a temporary thing. And then the last thing to highlight is really the large financial institutions, right, that we were talking about a little bit earlier. The cost to bring on a large financial institution from an overall cost standpoint is similar to a traditional recruit, drive similar, if not better returns, but it shows up a little bit differently, right? The TA is a lot less, right? Your traditional recruit, it's very simple to understand and model. There's a TA rate that's paid, whatever period of time that, that transition assistance is tied to, it's a very simple expense over that period of time. When you're looking at a large financial institution, there's a lot of different things, but it's probably just 3 main categories. The first is TA. They're typically a lot lower. Second is technology. What matters a lot more to these folks, as I was talking about earlier, is making sure that we can mirror and have the capabilities that they have on their platform that are really important to them. And if we don't have that, it will be part of our underwriting and plans to build that technology. And that can show up as an expense at the time you're building it. Some of it can show up as technology that's capitalized and expensed over 3 to 5 years, either way, it's going to show up earlier. And then lastly is just the onboarding assistance. It's almost M&A conversion like when you're bringing 1 of these firms on board, right? So we deploy a lot of teams, a lot of human capital to make that go well, and that's expensed as incurred, right? So when you take a step back, for a large part of our growth, the upfront capital to bring those on to the platform has just shifted into the earlier years, right? And I think if you don't have the context of that dynamic, it may seem like promotional is growing faster than it really is.

All right. That's great color, Matt. And look, it certainly sounds like a lot of that growth in promo is good expense as one might call it. We actually had a couple of questions that were submitted just on the topic of the expense outlook. And with inflationary pressures continuing to intensify, I was hoping you could just speak to your confidence around managing that core G&A expense within that 7% to 9.5% band that you're targeting for this year. And if we do see a significant windfall from higher rates, how much of that benefit should we expect to fall to the bottom line versus maybe get redeployed back into the business?

Yes. Well, I think the primary driver of where we land on that expense guidance is really going to be the investments we're making to drive and support organic growth, right? I think that's probably the key driver. I think from an interest rate standpoint, I don't -- we don't expect interest rates and the path of interest rates to be a meaningful factor, especially early in the cycle, right? When early in the rate cycle, we would expect those economics really to fall to the bottom line and improve margin. And I think once you get past that, right, when you get deeper into the rate cycle, I think then we just go back to our capital allocation framework and see what's the highest and best use for those additional funds and how to deploy it. And I think where we focus on and where we look first is things that can drive even more organic growth, right? It would be things like additional capabilities, right? Can we go deeper on our -- down our priority list of capabilities that matter for advisers? Is there an opportunity to provide an even more differentiated service experience? Are there additional services that we would accelerate offering on the Business Solutions side or the planning and advice side that we just want? So it's things like that, that we would think through. There's also M&A, right? Is there an opportunity to accelerate capabilities that instead of building it going out and buying something, which we've done in the past or are there growth acquisitions that with compelling returns that are even now more compelling and that we're interested in. And then, of course, returning capital to shareholders, right? So we would go through that framework. And I would just emphasize the environments can change very quickly. So we'll be on top of that and adjust our plans if it makes sense. But I think the core of your question, those early increases in the cycle, they're likely to fall to the bottom line.

That's great. And maybe just sticking to the topic of asset sensitivity. I think one of the elements that's still most underappreciated about your business is the fact that the earnings upside from future hikes exceeds even some of the most rate-sensitive call it, traditional banks, by mid of your ability to monetize client cash will depend on bank demand for those deposits. And I was hoping you could just give us an update, Matt, on ICA demand from third-party banks, how that's tracking? And how do you see it evolving once the Fed begins tightening or draining the system of excess liquidity?

Yes. I would say sitting here today, right, it is feeling a bit better. And I would emphasize it is still quite challenged overall. But I think the direction we're heading is one that is improving. And why do I say that, right? The dialogues that we're having with banks are picking up, right? It's not remotely close to where it was pre-COVID, but I think when -- even when we think about a month or 2 ago versus today, we're having more dialogue, which is good, right? You never know what that dialogue is going to lead to, but the early indicators are there. I think the other thing to note on this, and it's probably a short-term dynamic, but building on where we started this conversation is just what's going on with the macro environment and the cash balances that are billed, right? That's a very good natural hedge in the model, but for a system that has a lot of liquidity in it already, that dynamic could lead to maybe a little bit of a delay in demand returning. But again, that feels like a short-term positioning issue and as opposed to longer term, where that demand is certainly starting to pick up. I think the things that will drive it, I think the biggest factor you hit on is the Fed, right, not only raising rates, but I think shrinking their balance sheet is probably the most notable thing or the biggest driver that they could do because that's effectively cash that they have in the system sitting on the very banks that would come to us for suite. I think things like -- any other things that are going to reduce the cash amounts that are in the system, consumer spending being an example; loan balance is going up, which can also create demand. So I think those are the factors that would likely drive it. And overall, again, still headline point here is it remains challenging, but there's some early indicators of demand picking up.

And Matt, you guys do have a great track record of like optimizing some of those ICA yields and just looking at the composition of those cash balances today, you have about 30% or $16 billion that's parked in what are maybe very low-yielding money market funds. If the Fed does, in fact, begin to tighten more aggressively, how would you look to optimize the deployment of those balances?

Yes. And I think maybe just a little bit of color on how those balances get there first, right? And those are over full balances, meaning we've got our ICA structured up in a waterfall of banks to go first. And when we're in a scenario where the amount of ICA we have exceeds the bank capacity, it's got to go to another product, right? And that other product is -- are the money markets. So kind of back to what we were just talking about, right? If and when that demand starts to return, it's somewhat automated mechanism when now those cash balances would come out of money markets and go back to ICA when that capacity is there, right? And I think then once things are in ICA, I think our approach would be very similar to what we've talked about in the past of being very deliberate and focused on managing a mix of fixed and variable contracts kind of consistent with what we've talked about previously.

That's great. And I did want to ask you on the decision to potentially sometime down the road maybe become a bank holding company. I know prior to joining LPL, you had a lot of experience running a regulated bank, a CFO of E*TRADE. I know you've been on the record saying you have no interest in building a bank at LPL. There are a lot of negatives, whether it's the regulatory burden, the amount of capital consumption that you would need just to support client cash on balance sheet. While the decision to become a bank might not make sense today at your current scale, just given the strong pace of organic cash growth, is there a level of client cash where maybe operating as a bank would be accretive to earnings, could be value enhancing for shareholders?

Yes. Well, I think with the center of that question for us and for me is really getting back to clients and what we're delivering to them, right? So the core of that -- answering that question is, are we in a position to deliver the products and the capabilities that matter to advisers and their clients, right? And when you click down and say, okay, do you need a bank charter to do that, right? And I think the way the marketplace works is we have options to deliver those products and capabilities without having to be a bank and you can integrate them, the cash management capabilities of our existing suite as an example and even on the lending side with integrating a mortgage offering and things of that nature. You don't have to be a bank to do that. And so then the second question becomes, I think what you're asking is when you think about it from just a return on capital standpoint, it is the return on capital specific to holding deposits on our balance sheet versus someone else's. And I think the math on that is very clear. And the return on capital of having a bank, if you're just focused on monetizing deposits, when you can place them on somebody else's bank, it's just -- it's not compelling to say not accretive, right? And so it's just not a good use of capital. And I think that's our view. And I think that's why it makes sense to be where we are. But to your question, right, I think that this is something -- it's not a dogma, right? It's not something that we've just decided and don't look at. I think we make sure that we understand what's happening in the environment that are, for whatever reason, if some dynamic that's led us to that conclusion changes, whatever that may be, our size, the regulatory environment, whatever it could be, I would tell you, we'd be in a position to understand that, understand that math changing and then act accordingly. So that's not where we are now. I think where we are now is we like where we go.

That's great. And I think we have time for one more question here, Matt. And I know a few people have submitted questions on the topic of M&A. If I think 6 years ago, you announced a large-scale acquisition of NPH. At that point in time, I think believe you retained 60% of the advisers. This past year, you did another large-scale acquisition of Waddell and retain more than 90% of the advisers, which really just speaks to the progress that you become a destination of choice within the wealth ecosystem. And how does that improve retention following the Waddell deal impact the M&A calculus as you evaluate other potential transactions? And has that favorable experience at least changed your appetite or willingness to transact?

Well, I think the key thing there, if we think about those 2 transactions, right, I think as a firm, the process of onboarding and integrating an acquisition like that, we're just much better today than we were in the past, right? Whether it be from the team that does this, from recruiting to onboarding, everybody involved is just more seasoned. They've had more experience doing it, and we brought in talent -- more talent that can do this really, really well. And then on the technology side, we've just -- we've invested in a lot of capabilities that make the process smoother, right? So you've got better and more talent and better and more capabilities to make that happen and get a better result. Now the other thing that I think is really important here is the nature of the firm that you're acquiring is a big, big driver of it, right? They can be very different, right? While Waddell & Reed is a great firm, it's a single centered culture with advisers who have been there for a very, very long time versus if you're doing an acquisition of something that is more of a holding company that has several different broker-dealers or firms underneath it, like NPH was where they're not really as connected to the mothership, if you will. And in an acquisition, it's very natural for those folks to look more at their options. So I think that the nature of the firm can be very different. And when you're approaching M&A, right, the core of your question, right, what matters is what you assume in your purchase price. And I think we would both factor in the fact that we're better at doing this, but at the same time, different firms you're going to have different expectations of what you can drive there. So I think those are the 2 things that would really drive it. And so depending on the opportunity, we'd apply that.

That's great. Well, I know we're a minute over now, Matt. So I appreciate the additional time. Always great to hear your perspectives on the wealth management landscape, and nice to see that the momentum in the business continues. With that, next up, we have Sightline Payments. We're down we'll be doing a fireside. Thanks so much for joining, everyone, and have a great rest of your day.

Take care.