Kestra’s debt is soaring. How will that affect its advisor recruiting?

16:01 17 March in In the News by rafferty

March 16, 2023

Kestra Holdings nearly doubled its debt and interest payments on those liabilities after adding a new private equity investor last year, a new ratings agency report found.

The company’s debt load jumped 87% over 14 months to around $850 million, and the service payments alone will soar by the same percentage in 2023 — compared to the 12 months that ended in the third quarter — to $84 million, according to a March 8 “credit opinion” report by Moody’s Investors Service.

At the end of last September, the Austin, Texas-based independent wealth management company received a minority investment of undisclosed size from private equity firm Oak Hill Capital buying Stone Point Capital’s stake and joining majority Kestra owner Warburg Pincus. As part of a December issuance of debt notes, Kestra also picked up an equity investment of $5 million from Dallas-based real estate holding company Crescent Partners, Moody’s noted.

Differences in credit grades can give higher-rated firms an advantage in their competitive recruiting fights for top advisor talent, according to recruiter Jon Henschen of Henschen & Associates. While wealth management is sometimes seen as relatively recession-proof, worries about an economic downturn are simmering.

Firms like Kestra have gained a reputation in recent years for recruiting with big bonuses upfront, then offering cut-rate service and staffing levels to save expenses in order to boost the private equity firms’ profits, Henschen said in an email.

“We are entering an economic environment where broker-dealers should be cutting debt, not raising it,” Henschen said, adding that “all hell will break loose” if a market correction forces down Kestra’s cash flow due to the lower advisory fees tied to asset values.

Henschen said that many broker-dealers “are operating in normalcy bias, having not lived through serious market corrections or forgetting what it was like. For those that seek out battle-hardened broker-dealer models (low debt, profitable, quality staffing levels, low compliance risk, long-term focus), when the tide goes out, they won’t be found swimming naked.”

Kestra CEO James Poer said in a statement that “Our company remains in strong financial condition. We have a healthy balance sheet and continue to grow earnings. We are pleased with our financial performance relative to our debt, which we proactively manage on an ongoing basis.” The company declined to make executives available to discuss the Moody’s report.

Roughly 2,400 independent planners with $122 billion in client assets use Kestra’s brokerages and registered investment advisory firms — Kestra Financial, wirehouse breakaway channel Kestra Private Wealth Services, RIA M&A arm Bluespring Wealth Partners and midsize wealth management company Grove Point Financial.

Despite the elevated debt and higher costs for interest payments, Moody’s predicts Kestra’s leverage will fall significantly this year. By the end of the year, the ratio of debt to adjusted EBITDA will tumble to 7.3, down from 10.1 for the 12 months that ended in the third quarter of 2022. A further drop below 6.5 could help lead to an upgrade, like the one that Cetera, with its latest ratio at 5.8, got from the ratings agency.

But a move above 7.5 could prompt a downgrade from its rating of nearly the last four years under Warburg’s ownership, along with a “shift or deterioration in financial policy to further favor shareholders,” according to Moody’s.

The “governance” section of a part of the report on Kestra’s ESG rating speaks to some of the concerns voiced by Henschen, the recruiter. Kestra has “highly negative” governance risks, according to Moody’s.

Private equity firms put their profits ahead of the best interests of advisors and their clients, Henschen said. One former wirehouse broker who joined a private equity-backed firm recently told Henschen that there was “zero help” from the firm during the transition, which left the tasks involved with transferring the business entirely to the advisor. The process ended up taking eight months to a year, according to Henschen.

“What it boils down to is financial engineering where, on one hand, they offer more in transition money to attract advisors to join but, with the other hand, they make cuts in other areas such as staffing levels or technology improvements,” he said. “We have repeatedly found [leveraged buyout] PE firms to be habitual liars when it comes to staffing and service. This is where recruiting narratives and reality diverge.”