In face of pandemic, IBDs proved resilient in 2020
April 26, 2021
By Bruce Kelly, Investment News
Last year, the 25 largest independent broker-dealers reported $26.6 billion in revenue, an increase of 4.3% from 2019. Although financial results were far from spectacular, growth at leading IBDs last year was resilient in the face of the Covid-19 pandemic and the havoc it caused for the broader stock market.
2020 was anything but a typical year for the industry, particularly for service-focused businesses like independent broker-dealers.
Covid-19 caused firms to shut down their offices and send staff home to work. Advisers began learning to click the mute button on Zoom. And adviser recruits stopped flying to distant cities to press the flesh with executives trying to convince them to switch firms.
Although financial results were far from spectacular, growth at leading IBDs last year was resilient in the face of the Covid-19 pandemic and the havoc it caused for the broader stock market.
In 2020, the 25 largest independent broker-dealers reported $26.6 billion in revenue, an increase of 4.3% from 2019, when those same firms reported $25.6 billion in revenue, according to InvestmentNews Research.
That’s about half the increase seen in 2019, when the top 25 IBDs reported growth in revenue from fees, commissions and other sources, primarily interest-rate-sensitive bank products, of 8.3%.
“Covid threw sand in the gears, including no recruits coming in for home office visits,” said John Rooney, a managing principal with Commonwealth Financial Network, which had $1.64 billion in revenue last year, an increase of 5.3% compared to 2019. “We’ve started doing them again and it’s picking up, but 2020 was a tough recruiting year. And right now there’s a natural attrition rate where some older advisers are selling practices.”
“We lost revenue with interest rates dropping last year and the tough second quarter, but after that we had a great year,” said James Poer, president and CEO at Kestra Financial Inc., which posted a 6.5% annual increase in revenue, hitting $607.9 million.
GROWTH MAY BE MISLEADING
That said, revenue growth for independent broker-dealers was off compared to years past. For most of the past 20 years, the leading 25 firms as a group reported revenue growth of close to 10%, although that figure may be a bit misleading, as firms drop in and out of the survey at their own discretion.
For example, the broker-dealers of Cetera Financial Group, some of the most prominent in the industry, stopped reporting two years ago, and Wells Fargo Advisors Financial Network dropped out three years ago.
The list of big independent broker-dealers shrank further as the industry’s consolidation continued last year and into this year. Two top 25 firms have been acquired or agreed to be acquired since December, when LPL Financial said it was buying Waddell & Reed Financial Advisors as part of a larger transaction.
Two months later, Cetera Financial Group Inc. said it was buying Voya Financial Advisors Inc. from its parent, Voya Financial Inc., the latest insurance company to dump its retail wealth management business as a result of risk and the decline in demand for high-commission variable annuities.
Even in the face of the obstacles caused by the pandemic in 2020, the industry hit a milestone: For the first time since InvestmentNews started its survey, the top 25 firms last year reported that fee revenue made up 50% of total revenue on average, with revenue from commissions at 35% and other revenue, primarily generated from interest-rate spreads, of 15%.
That’s almost the mirror opposite of the revenue breakdown for the leading IBDs in 2013, when commissions accounted for 52% of revenue and fees 34%, with so-called “other” revenue at 14%.
The sale of products for commission has faced significant headwinds, industry executives noted, including discount brokers cutting commissions for some trades to zero starting in 2019 and a new regulatory regime from the Securities and Exchange Commission, called Regulation Best Interest.
“Fifty percent fee revenue is a really important milestone, and the pace of change is accelerating as the industry moves to advisory model portfolios and accounts for clients, and away from commissions,” said Rich Steinmeier, managing director and divisional president of business development with LPL Financial, the largest IBD.
“And it’s likely to move faster,” Steinmeier said. “We’ll be talking about 60% of revenues from fees before you know it.”
LPL posted a 4.4% increase in year-over-year revenue to $5.87 billion.
“At the independent broker-dealer, the broker-dealer or commission side of the business is the declining side,” said Dennis Gallant, senior analyst with the Aite Group. “It’s not the part of the business that is driving revenue.”
“That 50% fee revenue figure is a reflection of what clients want, which is ongoing advice about their portfolios,” said Evamarie Schoenborn, president and CEO of Northwestern Mutual Wealth Management Company. Northwestern Mutual’s broker-dealer posted a 12.3% increase in total firm revenue to $1.5 billion. “It’s not surprising we’re at this inflection.”
THE HYPE ABOUT FEES
The retail securities industry has spent the better part of the last two decades declaring that it was inexorably moving to charging clients fees, like registered investment advisers, instead of commissions.
Now that hype about fees looks to be turning into a reality. Many consider revenue from fees more attractive to firms because it is steadier, more dependable and less affected by the whims of the broader market and brokers pumping products for commissions.
“To show 4.3% growth in 2020 in spite of shutdowns, isolation and a period of market upheaval shows our industry to be quite resilient,” said Jon Henschen, an independent recruiter. “A large part of that resilience is the ever-increasing portion of our business that is advisory-focused, which holds up better in turbulent market swings.”
Last year’s volatility definitely posed a challenge. The S&P 500 stock index hit record highs on Feb. 19 but days later markets started falling worldwide as fear of Covid-19 spread. On March 23, the S&P 500 hit its low for the year, having posted a stunning decline of 34% over that time.
The broader market soon recovered after the U.S. government signed record stimulus packages into law, with the S&P 500 and Dow Jones Industrial Average posting record highs repeatedly over the remainder of the year. For the entire 12 months of 2020, the S&P 500 returned 18.4%, with dividends.
NOT SO NIMBLE
Not all firms were able to bounce back nimbly from the market’s ups and downs last year. For example, three large broker-dealers under the umbrella of the Advisor Group Inc., which acquired Ladenburg Thalmann Financial Services Inc. last year, saw declines in revenue. Last year, Royal Alliance Associates Inc.’s revenue declined 2.6% to $936.4 million, while SagePoint Financial Inc.’s dropped 6.8% to $387.4 million and FSC Securities Corp. posted a revenue drop of 18% to $237.1 million.
An Advisor Group Inc. executive shrugged off those results. “Advisor Group is very pleased with our strong 2020 results,” Greg Cornick, Advisor Group’s president of advice and wealth management, wrote in an email.
That included one of the IBD’s best recruiting years, better-than-projected adviser retention, expansion of its senior management team, and the launch of growth-oriented offerings for advisers, Cornick wrote.
“When we were in the middle of the market downturn last February and March, we would have been thrilled to know that we would eventually rebound to the levels of growth that we eventually did,” said Jodie Papike, president of Cross-Search, another recruiter for independent broker-dealers and RIAs. “But the firms with negative growth numbers suffered not only the negative downdraft of the broad market but were unable to recruit as well as the competition, and some also lost big teams.”
Last year also saw a sharp drop in interest rates after the Federal Reserve slashed rates for short-term borrowing to almost zero in March in response to the economic crisis caused by the pandemic. That undoubtedly hurt some firms, and it was bad news for the securities industry as a whole, which charges clients interest for borrowing on margin and captures the interest rate spread on the cash clients hold in money market accounts.
The broader securities industry and, specifically, independent broker-dealers have felt the crunch in revenue caused by near-zero interest rates before. In the wake of the 2008 and 2009 credit crisis, the Federal Reserve dropped rates close to zero to stimulate the economy. It took several years for the Fed to shift and slowly raise rates again.
Last year’s rate cut hurt firms’ top lines and will undoubtedly continue to create pressure this year and into the foreseeable future. Ameriprise Financial Services Inc., for example, reported a 31.5% decline of “other” revenue last year, to $708.6 million.
An Ameriprise spokesperson declined to comment.
“The dirty secret of the broker-dealer world in general is that a significant amount of pure profitability comes from money market funds and interest-rate spreads,” said Danny Sarch, an industry recruiter. “When interest rates spiked a few years ago, profitability went through the roof.”
