LPL Financial Q1 2023 Earnings Call Transcript

Quartr
Provided by Quartr
April 27, 2023

There are 12 speakers on the call.

Operator

Afternoon, and thank you for joining the Q1 2023 Earnings Conference Call for LPL Financial Holdings Incorporated. Joining the call today are our President and Chief Executive Officer, Dan Arnold and Chief Financial Officer and Head of Business Operations, Matt Audette. Dan and Matt will offer introductory remarks and then the call will be open for questions. The company would appreciate if analysts would limit themselves to one question and one follow-up each. The company has posted its earnings press release and supplementary information on the Investor Relations section of the company's website investor.

Operator

Lpl.com. Today's call will include forward looking statements, including statements about LPL Financial's future financial and operating results, outlook, business strategies and plans as well as other opportunities and potential risks that management foresees. Such forward looking statements reflect management's current estimates or beliefs and are subject to known and unknown risks and uncertainties that may cause actual results or the timing of events to differ materially from those expressed or implied in such forward looking statements. For more information about such Risks and uncertainties, the company refers listeners to the disclosure set forth under the caption Forward Looking Statements in the earnings press release, as well as the risk factors and other disclosures contained in the company's recent filings with the Securities and Exchange Commission. During the call, the company will also discuss certain non GAAP financial measures.

Operator

For a reconciliation of non GAAP financial measures to the comparable GAAP figures, please refer to the company's earnings release, which can be found at investor. Lpl.com. With that, I would now turn the call over to Mr. Arnold.

Speaker 1

Thank you, Latonya, and thanks to everyone for joining our call today. Over the past quarter, our advisors continued to help their Clients navigate through market volatility and macroeconomic uncertainty. In doing so, they reinforce the value of their advice and collectively helped millions of Americans continue to pursue their financial goals and aspirations. We thank them for the important work And remain focused on our mission, taking care of our advisors, they can take care of their clients. Now as we look at the marketplace, we continue to experience The growing appeal of our model due to the combination of our robust and future rich platform, stability and scale of our industry leading model and capacity and commitment to invest.

Speaker 1

As a result, we continue to make solid progress toward our vision of becoming the leader across the advisor mediated market. In that spirit, we will continue to focus on helping advisors and enterprises Solve challenges and capitalize on opportunities better than anyone else and thereby serving as the most appealing player in the industry. With respect to our performance, we delivered another quarter of solid results, while also continuing to make progress On the execution of our strategic plan, I'll review both of these areas starting with our Q1 business results. In the quarter, total assets increased to $1,200,000,000,000 as continued solid organic growth was complemented by higher equity markets. With respect to organic growth, 1st quarter organic net new assets were $21,000,000,000 representing 7.5% annualized growth.

Speaker 1

This contributed to organic net new assets over the past 12 months of $99,000,000,000 representing approximately a 9% organic growth. Recruited assets were $13,000,000,000 in Q1, bringing our total for the trailing 12 months to 85,000,000,000 These results were driven by the ongoing enhancements to our model and our expanded adjustable market. Looking at same store sales, our advisors remain focused in serving their clients and delivering a differentiated experience. As a result, our advisors are both winning new clients and expanding wallet share with existing clients. A combination that drove a sequential improvement in same store sales in Q1.

Speaker 1

This increase occurred across all of our affiliation models, led by solid growth in our enterprise chain. With respect to retention, we continue to enhance the advisor experience Through the delivery of new capabilities and technology as well as the evolution of our service and operations. As a result, asset retention for the Q1 was approximately 99% 98% over the last 12 months. Our Q1 business results led to solid financial outcomes of $4.49 of adjusted EPS, which is more than double our level from a year ago. Let's now turn to the progress we made on our strategic plan.

Speaker 1

Now as a reminder, our long term vision is to become the leader across the advisor center market, which for us, since being the best empowering advisors and enterprises to deliver great advice to their clients and to be great operators of the business. And to bring this vision to life, We are providing the capabilities and solutions to help our advisors deliver personalized advice and planning experiences to their clients. And at the same time, through human driven technology enabled solutions and expertise, we are supporting advisors in their efforts to be extraordinary business owners. Doing this well gives us a sustainable path to industry leadership across the advisor experience, organic growth and market share. As we look ahead, we continue to see both the growing demand for advice and increasing appeal of receiving that advice We believe that our strategy positions us well to capitalize on these key structural trends.

Speaker 1

Now to execute on our strategy, we organize our work around 2 primary categories, horizontal expansion, where we look to expand the ways that advisors and enterprises can affiliate such that we can compete for all 300,000 advisors in the marketplace. And vertical integration, where we focus on providing capabilities to solve for a broader spectrum of advisor needs And in doing so, create durable differentiated value. Now while our strategy has not changed, we will use the framework of Horizontal expansion and vertical integration to review our strategic agenda. This structure is an evolution of our strategic plays framework You can see how the strategic plays map to this new orientation within our investor presentation. With that as context, let's start with our efforts Around horizontal expansion.

Speaker 1

So this work involves meeting advisors and enterprises where they are in the evolution of the business by creating flexibility in our affiliation models, so they can design the perfect practice for themselves and their clients. As a result, this component of our strategy helps contribute to solid growth in our traditional markets, while also expanding our adjustable markets through our new affiliation models. Our recruiting in traditional markets continue to be a significant source of growth, reaching a new first quarter high of approximately $9,000,000,000 in assets. In the quarter, we continued to increase our win rate And expand the depth and breadth of our pipeline despite advisor movement in the industry remaining at lower levels. With respect to our new affiliation models, strategic wealth, employee and our enhanced RAA offering, we delivered our strongest quarter to date recruiting roughly $3,000,000,000 in assets in Q1.

Speaker 1

In each of these models, we continue to realize growing demand and expanding pipelines, which position them for increased contribution to our organic growth. Looking ahead, we expect to carry this recruiting momentum into Q2 for both our traditional markets and our new affiliation models. And with respect to large enterprises, Today, we announced that BMO will onboard the wealth management business of Bank of the West to our enterprise platform. In addition, we continue to prepare to onboard Commerce. Collectively, these two deals will add approximately $11,000,000,000 of brokerage and advisory assets in the second half of the year.

Speaker 1

Looking ahead, we continue to build our pipeline as demand for our model grows. Now in Q1, we also continue to have success in our traditional banking credit union space, adding approximately $1,000,000,000 of recruited assets in this chain. Now shifting to our vertical integration efforts. Here, we are focused on delivering value added capabilities, services and technology That extend across an advisor's end to end business, all for the purpose of helping them differentiate and win in the marketplace and run thriving business. A core to this part of our strategy is helping advisors deliver their differentiated wisdom, insight and advice, wrapped in an easily accessible and highly personalized experience for the client.

Speaker 1

In that spirit, this quarter, we continue to enhance our advisors' value proposition By introducing new account aggregation capabilities to help advisors consider their clients' holistic financial picture By enriching the end client digital portal through the expansion of customizable self-service capabilities and by evolving our research offerings to include increased market Now in a separate play within our vertical integration strategy, We continue to expand and enhance our services portfolio and

Speaker 2

are

Speaker 1

encouraged by the evolving appeal of our value proposition and the seasoning of this business. As a result of solid demand in Q1, the number of advisors utilizing our service group continued to increase. We ended the quarter at over 3,300 active users, up roughly 30% year over year. Now as we work with advisors to increase the utilization of existing services, we're also continuing to create new services such as our partial book sales solution, where we provide the flexibility for advisors to sell us their smaller accounts with clients They don't necessarily fit their practice, thus creating more capacity for them to focus on managing and growing the business more robust. This service has been received well and we are seeing solid early momentum with growing pipeline of demand.

Speaker 1

Now at the same time, we are seeing good success with our set of services that help solve the industry wide challenge of up to a third of advisors retiring over the next decade. In that spirit, over the past year, we've facilitated Approximately 150 acquisitions among advisors through our M and A solutions program. And since launching our liquidity and Session capability in Q4, we have completed more than 10 of these deals with LPL Advisors and have growing interest both inside and outside In summary, in the Q1, we continued to invest in the value proposition for advisors and their clients, While driving growth and increasing our market leadership. As we look ahead, we remain focused on executing our strategy to help our advisors further differentiate and win in the marketplace and as a result have long term shareholder value. With that, I'll turn the call over to Matt.

Speaker 2

All right. Thank you, Dan. Then I'm glad to speak with everyone on today's call. As we move into 2023, we remain focused on serving our advisors, growing our business and delivering shareholder value. Against the backdrop of market uncertainty, our business performed well as we continue to execute on our strategic priorities.

Speaker 2

In recent years, we've invested in capabilities, Technology and service to enhance the experience of advisors, enterprises and their clients. At the same time, we've maintained a strong balance sheet with significant corporate liquidity and low leverage, positioning us to support our advisors and clients in a range of macro environments. This was most recently recognized by S and P, who upgraded our credit rating earlier this month, establishing us as an investment grade credit with both our rating agencies. By leveraging the investments in our platform and our financial strength, we continue to grow assets organically in both our traditional and new markets, Closed 2 strategic acquisitions, continued our momentum with our liquidity and succession capability and are preparing to onboard Commerce Bank and Bank of the West in the second half of the year. We accomplished all of this while continuing to invest in our industry leading value proposition and delivering record adjusted earnings per share.

Speaker 2

So as we look ahead, we continue to be excited by the opportunities we have to help our advisors differentiate and Wynn in the marketplace. Now let's turn to our Q1 business results. Total advisory and brokerage assets were 1.2 trillion up 6% from Q4 as continued organic growth was complemented by higher equity. Total organic net new assets were $21,000,000,000 or 7.5% annualized growth rate. Our Q1 recruited assets were 13,000,000,000 which prior to large enterprises was a record Q1 of the year.

Speaker 2

This included $3,000,000,000 of recruited assets from our new affiliation, the largest contribution since their launch a few years ago. Looking ahead to Q2, our momentum continues across our traditional independent and new models, and we are on pace to deliver another strong quarter of recruiting. As for our Q1 financial results, The combination of organic growth, rising interest rates and expense discipline led to adjusted EPS of $4.49 the highest in our history. Looking at our top line growth, gross profit reached a new high of 1,020,000,000 up $48,000,000 or 5 percent sequentially. As for the components, commission advisory fees net of payout were 215,000,000 up $43,000,000 from Q4, primarily driven by higher advisory fees and a seasonally lower production bill.

Speaker 2

In Q1, our payout rate was 86.2%, down about 220 basis points from Q4, largely due to the seasonal reset of the production bonus at the beginning of the year as well as a non recurring benefit of approximately 50 basis points realized during the quarter. Looking ahead to Q2, we anticipate our payout rate will increase to approximately 87.5%, primarily driven by the typical seasonal build in the production bonus. With respect to client cash revenue, It was $439,000,000 flat to Q4 as the impact of higher short term interest rates was offset by a sequential decline in balance. Looking at overall client cash balances, they ended the quarter at $55,000,000,000 down $10,000,000,000 driven by record net buying of 37,000,000,000 Within our ICA portfolio, we added $3,000,000,000 of new fixed rate contracts, bringing our fixed rate balances to roughly 55% of the ICA within our target range of 50% to 75%. Our ICA yield averaged 3 20 basis points in the quarter, up 29 basis points from Q4, primarily due to the increases in short term rates.

Speaker 2

As for Q2, based on where interest rates are today and what we've seen with client cash balances so far in April, we expect our ICA yield to remain unchanged at approximately 320 basis. As the full quarter benefit of the Q1 rate hikes is offset by the mix impact of lower floating rate balances. As for service fee revenue, it was $119,000,000 in Q1, down $1,000,000 from Q4, primarily driven by lower conference revenue, offset by seasonal increases in IRA. Looking ahead to Q2, we expect service and fee revenue Roughly flat sequentially. Moving on to Q1 transaction revenue, it was $49,000,000 up $2,000,000 sequentially as trading volume increased slightly.

Speaker 2

Looking ahead to Q2, we expect a seasonal decline of a couple of $1,000,000 Now let's turn to expenses, starting with Core G and A. It was $326,000,000 in Q1. For the full year 2023, we continue to anticipate core G and A to be in a range of $1,335,000,000 to $1,370,000,000 As a reminder, this year we are opportunistically accelerating our investments to support our core business growth, expand our addressable markets and scale our new services. We have also sequenced our spending plans to build gradually through the year, which positions us to be flexible and dynamic depending on how our growth opportunities in the macro evolve from here. To give you a sense of the near term timing of the spend, in Q2, we expect core G and A to be in a range of $330,000,000 to 340,000,000 Moving on to Q1 promotional expense.

Speaker 2

It was $101,000,000 up $17,000,000 sequentially, primarily driven by conference spend as we had 2 of our largest conferences of the year during the quarter. In Q2, we expect promotional to increase to a range of $105,000,000 to $110,000,000 due to increased transition assistance resulting from strong recruiting and large enterprise onboarding as we prepare for Commerce Bank and Bank of the West to join us in the second half of this year. Looking at share based compensation expense, it was $18,000,000 in Q1, up from $12,000,000 in Q4. In Q2, we expect a similar level of expense as the majority of our grants occur in the 1st 2 quarters of the year. Turning to depreciation and amortization.

Speaker 2

It was $56,000,000 in Q1, up $2,000,000 sequentially. We expect it to increase to approximately $60,000,000 next quarter. Regarding capital management, our balance sheet remains strong. We ended Q1 with corporate cash of $234,000,000 down $225,000,000 from Q4 as we closed on 2 acquisitions during the quarter. Our leverage ratio was 1.3 times, down from 1.4 times in Q4, driven by a combination of our continued growth and a higher interest rate environment, both of which have meaningfully improved our earnings power.

Speaker 2

As for capital deployment, our framework remains focused on allocating capital aligned with the returns we generate, Investing in organic growth 1st and foremost, pursuing M and A where appropriate and returning excess capital to shareholders. In Q1, we allocated capital across our entire frame. We continue to invest to drive and support organic. On traditional M and A, we closed on 2 acquisitions for approximately $150,000,000 Within our liquidity and succession offering, We closed 7 deals for around $100,000,000 and we continue to have a solid pipeline. With regards to capital return, We increased our share repurchases to $275,000,000 in Q1.

Speaker 2

We plan to further increase share repurchases in Q2 to approximately $300,000,000 To summarize, our balance sheet is strong and we are well positioned to drive value through our capital allocation plan. In closing, we delivered another quarter of strong business and financial results. As we look forward, we remain excited about the opportunities we see to continue investing to serve our advisors, grow our business and create long term shareholder value. With that operator, please open the call for questions.

Operator

And our first question will come from Steven Chubak of Wolfe Research. Your line is open.

Speaker 3

Hi. Good afternoon, Dan. Good afternoon, Matt. So maybe just kicking things off with a question for Matt on the enterprise channel. Recently, you've seen some really strong recruiting momentum within enterprise.

Speaker 3

I was hoping to get your perspective on whether the recent Stress in the banking space bolsters the case for banks to partner with LPL. And can you help quantify just where the enterprise backlog is today Versus say the start of the year.

Speaker 2

Yes. I know you said for me, Steven, but I think Dan is chomping at the bit on this.

Speaker 1

Hey, look, Steven, when you have Circumstances of displacement in the marketplace, as you were calling out, that can create challenges and or opportunities And certainly through some of the bank failures in Q1, we think back to 2020 with the pandemic, a much more significant impact on that. I think in the case of the recent bank failures, we didn't necessarily see this disruption Creating short term opportunity because it was very short lived and the impact somewhat muted. That said, I think at times like this, it does reinforce maybe some of the really important elements Of this model, so think about it this way, the value of human centered advice, right, which creates opportunity for advisors As they are providing guidance when folks need it most in times of uncertainty, it certainly helps reinforce the feel of us as a Strategic partner to advisors given our strength and scale and robust capabilities, we sort of end up being a safe haven of quality. And then finally, I think right to your question or the point of your question, it does reinforce our value proposition for enterprises and in particular banks That type of disruption may be a catalyst for exploring different strategic options or alternatives Four different business lines as an example of wealth management.

Speaker 1

And I think, that certainly would create incremental demand as we go forward. Finally, our capital light model allows us to play offense and continue to invest back in the platform in order to enhance and further differentiate our capabilities And others perhaps can't do that in these disruptive markets or displaced markets. So I think we didn't see necessarily opportunity in the short run. I think it does reinforce the attributes of this model and is quite helpful to our long term growth And our positioning in the marketplace where we can kind of turn this change in the market into opportunity Across most disruptive sort of marketplace changes. So I hope that helps.

Speaker 3

No, it's really helpful color, Dan. Matt, I was really just trying to share the wealth, but my follow-up is going to be for Dan here. Just on the traditional independent channel, There is some evidence that recent broker dealer consolidation activity is driving increased advisor churn. And just Given the strong N and A results that we saw in March, how does the recruiting backdrop in the traditional market compare to last year? And do you expect to see an acceleration given some evidence of higher advisor churn?

Speaker 1

Yes. Well, look, I mean, if we look just And Glenn, the Q1 is perhaps jumping off to your question, Stephen. You see the traditional recruiting markets In a solid place for us with $9,000,000,000 in assets and that channel continues to continuously produce solid results It continues to increase over time as the differentiation of our model and our capabilities creates A real appealing alternative to these advisors and quite frankly, the flexibility in our different affiliation models gives them Different sets of sort of problems or challenges to potentially solve for by moving to our platform that they're in a place where they're trying to evolve their practice Depending where they are in the life cycle of their models. So, we certainly think that just as a baseline, We continue to see that part of the market strengthening and its opportunity from a recruiting standpoint. As you look forward to your point around other changes that players in the marketplace in the independent space may be contemplating Or considering that certainly would take the lower baseline of churn we've seen over the last couple of years And obviously create a, what should be a much greater opportunity set anytime we create change in the marketplace and new model That is going to trigger or be a catalyst for advisors to consider their sets of options and alternatives relative to how they practice this business going forward.

Speaker 1

And so, we do believe that if those things occur, that does create more churn in the marketplace and we take our Sealing model, we take the growing capability set of our business development team to do a great job across All of these different affiliation models, and I think we aggressively go play offense Capitalize on that opportunity. So that's kind of how we see the traditional marketplace both now and if things occur in the future, we'll be ready to It's 4 of those possibilities as they may have.

Speaker 3

Very helpful color, Dan. Thanks so much for taking my questions.

Operator

One moment for our next question. And our next question will come from Alexander Blostein of Goldman Sachs. Your line is open.

Speaker 2

Alexander, you better have a good question.

Speaker 4

It's late in the early So whatever it goes. Okay. So you guys announced a pretty sizable win in In the RIA channel, I think a couple of weeks ago, I think it's on the larger size from what we've seen in that kind of affiliation part of your model. So I was curious if you could speak to sort of the key attributes that maybe won the business for you guys and ultimately what does the pipeline look like in that Part of the market and maybe just remind us on sort of the economics in that channel for LPL either in the gross profit ROA terms or else.

Speaker 1

Thanks, Alex. This is Dan. I'll take the first part of that and then I'll flip it to Matt for kind of part 3 of that question. So, first of all, yes, we had a nice win that you referenced a couple of weeks ago that we announced where the team did a great job of attracting CG Advisor Network, which is a new large RAA. And those assets So show up actually in Q2 or the current quarter we're in.

Speaker 1

And look, I think this win does a couple of things. 1st and foremost reinforces the strong work the team is doing to create a really compelling and differentiated solution in this part of the market. A great example perhaps of that is how we're using our services portfolio to give these RIAs access Differentiated tools and resources, they hadn't always had availability to or access to, which are really meant to help them Better operate the businesses as they go forward once on our platform. So that's a great example of how we're building in what I might call a baseline of capability set and differentiation that we think is creating a more robust appeal for this part of the marketplace. I think if you click down specifically on CGA Advisor Network and what were some of the attributes that may be attracted them.

Speaker 1

1, our very advisor centered model, I think coupled with innovative technology that they can create integrated workflows for driving efficiency in their practice. And finally, in the flexibility of our solution to handle all of their assets in a more integrated way on one platform. And so At a high level, those were probably some of the bigger attributes that they were attracted to. And so look, I think as we look forward overall, we're really excited about the The momentum is building in this model. We have a number of new clients that have joined us so far this year as we referenced in the In Q1, and certainly there's more opportunities that are progressing in the pipeline.

Speaker 1

So we'll continue to invest The capabilities here as we see this is a very attractive market to create that differentiated model and continue to contribute and accelerate both. So, hopefully that gives you a little color on both that particular affiliation model and then specifically with CG Advisor Network.

Speaker 2

And then Alexander, on the economics, I mean, it's not too dissimilar From the enterprise channel or the large financial institutions where on the RIA side, it would typically have a lower gross profit ROA. But the costs and specifically the acquisition costs are also lower. We'll underwrite TA to return. So you get to a bottom line Margin and economics that are compelling and similar to the rest of the business, but you have that dynamic similar to what you have on the large enterprise side.

Speaker 5

Okay, great. Thank you. For my second, maybe I'll ask a less insightful question. Can we talk just about cash? I think you guys gave the ICA yield of $320,000,000 for Q2, but maybe just an update on where cash stands today and the composition.

Speaker 5

And also just around the philosophy, you guys kind of Starting on this journey of putting extensions in a couple of years ago, you're north of 50% now. Clearly, the volatility in cash balances has been something we have to look for the last 6 to 9 months. So as the environment continues to be sort of uncertain, Do you guys anticipate to continue to extend and add more fixed balances or you find yourself in a pretty good place here?

Speaker 2

Yes. So I think so on April, and I'll give Some color on cash balances and maybe just how we're seeing organic growth, pull through in April as well. And I think when you look at Cash bound, both of those things are as a reminder, which I'm sure you know, but there's I'll remind anyways, there's 2 key seasonal factors For April that I'll hit 1st and 1st and foremost is the tax impact, right? It's tax month. Annual taxes for our clients usually impact cash as well as NNA by about $1,500,000,000 And in addition, given its month 1 of the quarter, advisory fees primarily come out in that 1st month as well, which is around $1,000,000,000 So those two seasonal factors would reduce cash by around $2,500,000,000 everything else being equal.

Speaker 2

That in addition to that, we've continued to see strong levels of investor engagement, but the pace of cash balance declines has continued to moderate. So when you look at the incremental decline in April beyond the seasonal factors, it's about $800,000,000 So if you look at the first 4 months of this year, the cash balance declines really peaked in January and have moderated each month since. And when you take those seasonal factors into account, The April decline is the smallest decline so far this year. So you put all that together, that puts cash sweep balances just above around $51,000,000,000 where we sit today. On your point on fixing out the ICA balances, I think the premise of the question summarized it well.

Speaker 2

We've got a target range of 50% to 75%. With the $3,000,000,000 that we did put on this quarter, We're now within that range of 55%. And I think I like where we are. I think we feel well positioned. And of course, we'll monitor the environment from here.

Speaker 2

And if things evolve where we think it makes sense to put on more fixed, the environment there has gotten Quite constructive and we feel good about our ability to do that if it makes sense. But where we sit today in this market, I think we feel well positioned where we are.

Speaker 5

Perfect. Thanks very much.

Operator

And one moment for our next question. And our next question will come from Jeff Schmitt of William Blair. Your line is open.

Speaker 6

Hi, good afternoon. Just another one on the cash balances. So I think they're around 4.6% of Client assets in the quarter. I understand you were saying that the pace kind of slowed, but appears to be driven by really strong sort of buy sell activity. Are we approaching a level that you think even if the markets remain strong, it won't move below?

Speaker 6

Like I think it bottomed at 4.3% in 2019. Is that sort of a good support level?

Speaker 2

Yes, I think a few things. I think the headline answer is yes, from a support level. I think the best the thing that we look at Here, which I think you were referencing is really history is the best guide here and getting at, is there a natural amount of cash that sits And it accounts to manage it and to do things like facilitate rebalancing, facilitate paying advisory fees, Customer withdrawals, all so you don't so an advisor is not forced to make a trade that they would otherwise not make a trade that's still listed, those things. So When you look at our history, as you highlighted, when we've gotten to a place where advisors have their clients fully deployed into the marketplace, which has happened Several times in our history, you usually see it get down to that around 4% level. So history tells us That's the zone and we're not seeing anything in this environment that causes us to think anything different.

Speaker 6

Okay. And then on core organic growth, I think you guided into the mid to low teens, kind of reiterated that view. What does that assume on interest rates? And would that Change, I guess, if the Fed paused, hikes are even started cutting in the back half of the year. How variable, I guess, is that assumption?

Speaker 2

Yes. Well, I think as I commented on the prepared remarks, right, we have prepared our spending plans So if we think there is a reason to pause or adjust, we certainly have that ability. I think we would be very deliberate about that. I think the investments that we're making, we think drive long term value of the firm. We've got our balance sheet positioned quite well to be able to do that.

Speaker 2

But if we do get an environment where the investments don't make sense or it does mean we need to pause, we would. But I think sitting here today, I think we still feel quite comfortable that The 12% to 15% this year makes sense, given the investments that we're making and the results that we think that will follow.

Speaker 7

Okay. Thank you.

Operator

One moment for our next question. And our next question will come from Kyle Boyer of KBW. Your line is open.

Speaker 8

Hey, good evening. A couple of follow ups for me. The first is on Alex's RIA question. I believe CG was previously using TDA for custody. And with the Schwab and Ameritrade integration Over the next year, I think primarily in Q3, I'm just wondering, are you viewing that migration as Potential catalyst for putting more RIA assets in motion, and are you targeting that as an opportunity to continue to have success in that channel?

Speaker 1

Much like we mentioned With regard to our traditional markets, that is certainly a change in the market because it could be a catalyst for advisors looking Different options and alternatives. And certainly, we believe that that is a contributor to Ongoing potential demand, as not only we leave up to that transition, but even post that transition. I think in terms of step function change and significant change management efforts, sometimes on the other side of those, they We don't always look what the advisors would have expected the interest hire they wanted. And so I think that opportunity set extends Before the transition and potentially after it relative to that potential opportunity set. And I think what we're trying to do is just build Capable and appealing alternative that will structurally be attractive and create great opportunities for the advisors See it on our platform.

Speaker 1

To the extent we can do that, I think that differentiated value with the Willingness and need to potentially look around at other options creates an interesting opportunity. That's what we're trying to play into.

Speaker 8

Great. Thank you. And then a second follow-up is on the ICA. On the fixed rate side, I think a lot of the demand generally Comes from larger banks that may have seen deposit inflows through the recent banking crisis. But in terms of that demand, I think you just noted that there were very I guess, can you just provide a little bit more color on what you're seeing In terms of how constructive those trends are and maybe quantifying that?

Speaker 2

Sure. I mean, at a headline level, I The appetite of the demand for ICA balances overall, whether it be fixed or floating is well in excess of what we have to deploy, right? So I think when we Our balances were able to pull on both sides. I think on the fixed rate side, we're just now positioned where we want to be, and we're able to do that, during the quarter. I think Maybe to put some data behind it and where you could probably see it move in the marketplace itself is really on the variable rate side.

Speaker 2

And I think that we're placing those deposits. We're starting in if you look in the current quarter or the current market, Those are now being placed at Fed Funds plus 15 to 25 basis points. That was about a spread of 10 to 15 last quarter and compares to kind of flat to negative during the pandemic. So maybe that's probably the best place to focus on where you can see that demand for these deposits really showing up.

Speaker 4

Great. Thank you.

Operator

And one moment for our next question. Our next question will be coming from Michael Cyprys of Morgan Stanley. Your line is open, Michael.

Speaker 9

Hi, good evening. Thanks for taking the question. Maybe if you could circle back to brokerage, NNA strength there, quite robust, 5.5% or so organic annualized. It's up meaningfully from a year ago. So I was hoping you might be able to elaborate on what's driving

Speaker 1

Let me take that. There's a couple of maybe primary drivers. As you say, you see some growth year on year if we issue that as And I think, one of the drivers would be we're in a rate environment that we hadn't seen for 15, 16, 17 years. And in some cases, advisors' opportunity to serve their clients and meet their needs in this rate environment leads to products That have maybe a utilization that is more appealing or easier to use as a brokerage structure than an advisory. So You see some of that accruing, where they're saying that that might be a community or some type of bond treasury, etcetera.

Speaker 1

The other thing that I think that you see driving that growth is also the some of the mix in these larger enterprise They have a higher mix of brokerage than advisory, and certainly different than our typical mix of roughly 50 2 53 percent advisory. And so when we transition those folks in, obviously, that has a shorter term influence in the mix. We see that as an opportunity. Once they get to our platform, it's much more appealing and robust advisory platform that has more interest in pricing to the end client. We do see those as opportunities for them and as a catalyst to shift their mix over time More towards advisory.

Speaker 1

That's what's causing that. Those are the primary drivers that you're on their ship.

Speaker 9

Great. Thank you. Very helpful. And then just as a follow-up question. If we look at the gross profit ROA prior to the client cash that also showed a very nice improvement year on year.

Speaker 9

It has been pretty steady in this 19 to 20 basis point range for some time. So I

Speaker 4

guess what do you see as some

Speaker 9

of the biggest opportunities to expand that over time, the gross profit ROA prior to client cash? What might be the 2 to 3 biggest drivers of expansion over the next couple of years. Where do you see some potential partial offsets? And ultimately, what level do you think this could ultimately achieve?

Speaker 2

Yes, Michael. I mean, I think that what I'd emphasize is really the overall growth opportunities that we have for gross profit itself, Right. Things that we've talked a lot about on this call, but our overall organic growth, bringing in and recruiting Larger advisors, the enterprise channel, which drives gross profit growth, but actually has a lower gross profit ROA. Like all of those things, Adding in our service and fee revenues and services group, those things all drive growth there. And I think the key thing I would highlight from an ROA standpoint is As we become a larger and more diversified firm for both offerings and revenue drivers, they're just not all asset driven.

Speaker 2

Especially in that service and fee revenue side, the growth that we've had in the large enterprise channel will show up as lower gross profit ROA, even though we're serving and supporting those clients in a way that can drive compelling margin. So I think it's less about the ROA from a basis standpoint, it's really about the key drivers of our model that can drive a gross profit growth over time.

Speaker 9

Great. Thank you.

Operator

One moment for our next question. And our next question comes from Brennan Hawken of UBS. Your line is open Brennan.

Speaker 4

Thanks. Good afternoon. Thanks for taking the question. Matt, we'd love to circle back to the comments that you made about Again, the prior level of cash as a percent of client assets would work as a trough this cycle. We've seen other firms, You laid out a few of the reasons for that, the need to have advisors catching the dividends and need for Some baseline of cash, but we've seen that other wealth management firms that have very similar business models, cash as a percentage of client assets Go below prior cycles trough.

Speaker 4

So I guess I'm just curious as to what gives you the confidence that that trough is going to hold rather A simple understanding that we're in a higher for longer and therefore prior Trends might end up just being a bit different here. Isn't that fair too?

Speaker 2

Yes. Well, I think Brennan, there's always Scenarios where things could play out differently. But I think from our standpoint, history is the best guide, right? And I think from our business model, which I know You've heard us talk through a bunch, but the cash balances as a starting point are relatively small, and they are transactional or operational in nature. We've got a long term average of around 5%, or 7,000 per account.

Speaker 2

And when you look at that history, The primary factor that has moved those balances up and down is really based on the markets and where and how advisors have their clients deployed. And to your point on when that's when those balances come down, it's typically come down to that 4%. We've seen it several times, most recently in 2021, as the markets really recovered post the onset of the pandemic. So that's what we're looking at. And I think it's a combination of the size of the balance

Speaker 4

Okay. All right. That's fair. And just a ticky tacky one to follow-up. The Yield on the money market sweeps has sort of seemed to compress a bit from where it was about a year ago.

Speaker 4

I had always thought of those as more or less fixed. Is there some sort of mix dynamic that's happening where something is causing that to Compress and how should we be thinking about that going forward? I know it's a small impact, just kind of curious.

Speaker 2

Yes, I think well, in recent periods, It's come up a little bit. You're referring to perhaps few years ago, is that what you're looking at?

Speaker 4

No, the average yield in basis points On the money market sweep, it was 30 this quarter, it was 32 prior quarter and then 38 in the 3rd quarter 2018.

Speaker 2

Okay. Yes, I just okay. So I put all those in a relatively similar zone, meaning not moving around a lot. Whenever you do see movement there, it's more about the mix. Is there at different firms, different paths, there's nothing from a pricing standpoint going on there.

Speaker 2

And as you said, the balances there are really small. So it's usually a mix of guidance. Great. Thanks. Yes.

Speaker 2

You bet.

Operator

One moment for our next question. Our next question will come from Craig Siegenthaler of Bank of America, your line is open.

Speaker 10

Thanks. Good afternoon. So We saw that annuity sales were up a lot. I think commissions were up 52% year on year. I'm curious, Why type of annuities are the clients buying?

Speaker 10

And have you seen an increase in surrenders of older annuities just given the wide gap

Speaker 1

Yes. I think The short answer to your question is what I said earlier that this in this rate environment that we haven't seen for an extended period of time, there's an opportunity to use fixed annuities as a Tunedee to use fixed annuities as a way to help people with their desires around yield Or yield that leads to lifetime income. And that opportunity has largely been Muted for an extended period of time. And so in because of that, it's not surrenders Exchanges from prior annuities, I think you would have seen that coming or being forced to come out of variable annuities that were set up and created for a different And so this is typically new money that has opportunity to find higher yields, with the pent up demand for those higher yields that I think well positioned and suited to support their long term income needs in retirement. So that's the primary driver of that.

Speaker 10

Thank you. And just one question on your advisory relationships. But What percentage of LPL Advisors with advisory relationships charge fees on total client AUA Versus net client AOA after backing out client cash.

Speaker 1

Yes. Well, so first of all, there's limits to the amount of cash that someone can hold for A period of time within an advisory account or they're required to either put that money to work Or move those assets out of that advisory account. So that's your control relative to high amounts Cash inside advisory accounts. That said, their cash that they use inside of the account if at appropriate levels as we talked about before It is part of the fee that is charged.

Speaker 10

Thank you, Dan.

Operator

One moment for our next question. And our next question will come from Michael Cho of JPMorgan. Michael, your line is open.

Speaker 7

Hi, good afternoon, Dan. Thanks for taking my question. I just wanted to follow-up on capital allocation again. I mean, you mentioned The leverage continues to tick lower and you got $4,000,000,000 of firepower. If you think about the inorganic bucket, just given the changing Backdrop and across macro and banking and I realize just that nothing kind of near term changes from recruiting or partnerships, but I mean are there any segments or channels So you might be focused on more when you think about organic just as LPL's firepower just continues to grow.

Speaker 7

And then just relatedly, just terms of the new liquidity and succession offering, it looks like you're having some good success there with the growing pipeline. I mean, can you just remind us how much Capital, are we looking to allocate there, and maybe just capacity for a number of deals annually or dollar amount, but just, yes, if you can just provide an update there. Thanks.

Speaker 2

Sure. I'll start with liquidity in succession. I mean, I think that if you look at what we did in the quarter, I think it's a good guide And the opportunity here, the focus here from a capital standpoint is it's relatively small, right? We're deploying capital Using disciplined return thresholds, which usually leads to purchase multiples in the 6 to 8 times EBITDA zone, The size of the deals are usually relatively small in the $10,000,000 to $20,000,000 range. So it's less a big use of capital and it's more about really the capability that we're that we built there to help transition practices to the next generation.

Speaker 2

So that's the key for the offering. I think on your main I think on your first question, make sure we got it as far as the opportunity set in the interest in the From an M and A standpoint, I mean, I think when you just look at where we have participated as a company, It's across several channels, but anything that would really accelerate our strategy, whether it be in our advancing in our traditional markets, Expanding into newer markets, so the employee channel is an example that we did. And if we can do so in a way that just matches our strategy So we've got the operational capacity to do it really well and then it meets our disciplined financial hurdles. I I think that's how we'd be interested from an M and A standpoint. Dan, anything you want to add?

Speaker 1

No. We also look Always at capabilities, at the interesting capabilities that will accelerate our strategy and create A better opportunity with interesting returns versus building them ourselves or renting them, we are always open for exploring that too. So that's just the only other element of M and A that I might

Speaker 7

Okay, great. Thank you for that. And then just a quick follow-up On the G and A, I mean, Matt, you talked about some flexibility throughout the year, just given how things kind of shake out in the big Good. I guess, are there any certain projects or initiatives that you'd call out That again, that's my call in terms of the accelerated investments where you may pause if the environment changes No, later in the year?

Speaker 2

Not particularly. Maybe just to emphasize the construct And how we built up to the 12% to 15%. I mean, I think that from a prioritization standpoint, we're investing 1st and foremost to support the core business, right? And each of those categories is about a 4% to 5% growth in the year. The second category is really about expanding our markets and scaling our new services.

Speaker 2

And then that third category is really being opportunistic given the environment to accelerate So if we are pulling back, it would be more in that it would be first in that third category, which is less about the specific initiative and more about, We're just doing some things that we would have otherwise have waited until 2024 over beyond.

Operator

Okay, great. Thank you so much. And our last question will come from Bill Katz of Credit Suisse. Your line is open.

Speaker 11

Okay. Thank you very much for taking the questions tonight. Just Just coming back to the opportunity to sort of fix up versus flow. So it sounds like the 55% is about where you want to be. And I certainly understand that you've done a great job of managing through the rate cycle in the past.

Speaker 11

But to play devil's advocate for a moment, if you look at the forward curve And it's pointing to a pretty, pretty sharp reduction, if you will. And you think that the sorting is sort of coming to a conclusion and the cash balances are So on the stabilized, why not try and fix out a bit more just to reduce some of the risk to earnings in 2024 and 2025?

Speaker 2

Yes, Bill. I mean, I think when we form that target range of 50% to 75%, I mean, it was contemplated that would be the range want to be in a range of interest rate environments. And it's not about being clairvoyant on rates and picking exactly when and how and what Percentage to do, it's about increasing the stability of our earnings. And I think we like where we're positioned in that range. I'm not saying we're going to sit there forever.

Speaker 2

That's how we feel today. If the environment changes or the dynamic changes, we'll adjust. But I think we really like where we're positioned right now.

Speaker 11

Okay. That's helpful. And then just coming back to capital for a moment. Thank you for the guidance on buyback into new quarter. But if I take that And your dividend, it looks like the payout ratio on sort of consensus numbers for the quarter, plus or minus some updates from today, is almost 80%, 90%.

Speaker 11

And when I look at your corporate cash, that number ex the $200,000,000 bogey that you normally like to keep Handy, it leaves very little incremental liquidity. So as you think about inorganic opportunities, liquidity succession another use of cash. How do you think about the interplay between free cash flow deployment and balance sheet leverage, particularly given the macro backdrop?

Speaker 2

Yes. Well, I think the key thing there, Bill, is we'll manage liquidity based on our leverage ratio, right? So we're below the low end of our target range of 1.5 to 2.5. So we think about liquidity capacity across all three areas, right? Investing for organic growth, M and A and returning capital Shareholders, we feel well positioned that we're at that we're below the low end of that range.

Speaker 2

So that's where we manage that and we feel good where we are.

Speaker 7

Thank you, guys.

Operator

And I'm showing no further questions. I would now like to turn the conference back to Dan for closing remarks.

Speaker 1

Hey, thanks. And I just want to thank everyone for taking the time to join us this afternoon. We certainly appreciate your investment and time. We look forward to speaking with you again next quarter.

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Earnings Conference Call
LPL Financial Q1 2023
00:00 / 00:00