The last 18 months have brought once unthinkable changes to the financial services landscape; the carnage may have forever altered the way in which registered reps think about their relationships with their firms. How the mighty have fallen — Merrill Lynch limped into a shotgun wedding and the once-swaggering Lehman Bros. and Bear Stearns failed. Over this past decade, many other firms have changed hands as well (albeit for other reasons) — RBC owns Dain Rauscher, UBS owns McDonald Investments, Wachovia Securities is now part of Wells Fargo, as is AG Edwards. For the retail rep, the perception that bigger is better, or at least safer, isn't as comforting as it once was. What's an FA of a publicly traded company to do? Go long? Short? What?
The problems of the big names have benefitted smaller firms, who, now, in contrast to the past, seem like a safer and more stable place to hang a shingle. About 25,000 reps switched b/ds last year, and only around half stayed within the “wirehouse” channel, according to Discovery Database. Of course, the Merrills and UBSs of the world have been forcing out FAs producing under $300,000 or so recently. Still, average reps are beginning to migrate to these firms in greater numbers than in the past. Discovery Database recently began tracking broker movement (in late 2008), and it says that, while the data are incomplete, the ties that bind (deferred comp) have been broken. To sweeten the transition, some IBDs, who don't normally offer forgivable loans, have been offering “transition assistance.”
It's all about gathering assets, of course. So we thought we would take a look at a few publicly traded b/ds and custodians from an equity analyst point of view. For example, we wondered: Does this trend (improved asset gathering) make them attractive investments? With the financial sector on a tear since the March lows, driven largely by macroeconomic trends, does it make sense to consider these stocks as long-term investments, as a way to play the potential growth of retail financial services?
Buy Or Sell Your Company Stock?
First, let's put the trend in perspective. Most advisors felt the pain of the bursting of the credit bubble, a problem retail FAs did not cause; and their attitude towards their firms changed accordingly. Several recent surveys make it clear that there is a fair amount of disgruntlement amongst reps. In December, this magazine published a survey of FA satisfaction with their firms and it was not pretty, for the most part. In November, a Schwab survey of 200 FAs at full service firms found that 59 percent regarded the idea of going independent as appealing, but most (56 percent) wanted to join an existing firm rather than creating their own RIA or b/d.
TD Ameritrade, for example, is capitalizing on the credit crisis. “Our pipeline has been chock full for the last year, and now we are seeing those relationships being consummated,” says Brian Stimpfl, managing director of Advisor Advocacy for TD Ameritrade. In the current quarter ending Dec. 30, three times the number of RIAs have joined TD compared to the previous quarter, and the number of “breakaway brokers is up 32 percent over last year's quarter,” he says. Stimpfl notes that 72 percent of new assets at TD have come from full commission channels over the last six months, as RIAs are attracting new business from former wirehouse clients.
Still, the overall FA movement to TD is not huge. With 4,000 RIAs currently, TD has roughly the same number of reps it had at the time of TD's acquisition of Ameritrade four years ago, suggesting that big changes have yet to be realized. But Stimpfl is confident that TD will continue to attract new FAs since, like its rivals, TD staff can help in the transition — the managerial and organizational concerns that sometimes dissuade FAs from going indie. TD has improved its product offerings to position itself as a beneficiary of the migration away from wirehouses. “The most important thing an RIA gets from his custodian?” Stimpfl asks. “Reps want services, white glove. TD Ameritrade, more than others, helps with practice management and consulting, partnering with advisors to help them build better businesses.” Stimpfl says TD has “focused on, this year specifically, offering consulting [services], through our sales and consulting team, 12 consultants and sales force of 70. Our Roadmap product, a technology platform that allows our consultants to scale these services to 4,000 current advisors, helps advisors run their businesses,” says Stimpfl.
Again, despite the destruction of Wall Street, the number of advisors switching firms from wirehouses to smaller b/ds and hybrid custodians remains small in the overall scheme of the industry. (Yet, undoubtedly bigger than ever before.) “Advisors are not leaving wirehouses in droves the way so many write and speak about the issue,” says Chip Roame of Tiburon Strategic Advisors, a leading industry consultant. “We calculate that 600 to 800 successful brokers left the wirehouses in the last year. That's a significant number but not relative to the 90,000 brokers still at the wires and regional firms.” Discovery estimates that the “breakaway broker” number for 2009 is almost double Roame's estimate.
Despite the changes in the landscape, many reps are choosing to stay with wirehouses, for a number of reasons. For one, if you don't want to go indie, your choices are limited. And some FAs simply are willing to accept a lower payout for the back office and managerial support that national brands offer. The best time to leave is still influenced by many factors besides changes in control of the current firm. “The rep needs to feel his clients will go with him, his firm won't tie him up in court, and that he has a plan in place,” says Roame.
Since the non-wirehouse firms are so much smaller (measured by assets), their businesses can be greatly enhanced by movement of even a small numbers of reps. “If 600 brokers with $500 million in assets under management each leave the wirehouse channel, that is $30 billion of AUM moving,” Roame says. “Schwab is the largest beneficiary of this movement, and it already has $500 billion in assets, but for Fidelity, TD Ameritrade and LPL, who have assets of $200 billion in total, this could be huge.”
Hybrids Are Growing
Many observers think the trend will continue — even after bad news about wirehouse stability fades from the headlines. “We have seen a lot of advisors breaking off on their own, but we are seeing breakaway brokers joining existing firms, and we have seen evidence of that, with the average RIA office growing from 1.7 individuals to over 2 per firm,” says Scott Smith, senior analyst with Cerulli Associates. He estimates the net loss in 2008 in the advisor channel, was 1,000 out of 50,000. “We project a loss in assets in wirehouse market share from 48 percent at the end of 2008, to 41 percent by the end of 2012, making the wirehouse players still the largest in terms of market share, but definitely ‘smaller giants.’ We see that driven by changes in headcount. Wirehouses had 18 percent of advisors; we see that falling to 14 percent, with losses to RIA and other dually registered firms. The most growth is in the dually registered model, going from 5 percent in 2008 to 12 percent in 2012. The firms that stand to benefit most would be the RIA custodians Schwab, Fidelity and TD.”
LPL has begun to focus on the ranks of the dually registered. The bigger regionals, such as Stifel and Raymond James, will also benefit, says Smith. You can see this trend clearly in the stock of Stifel. Shares have tripled since the beginning of 2007, a rare feat in this industry. In its most recent quarter, ended on Sept. 30, revenues reached $289 million, up 32 percent from the prior year's numbers; assets in fee-based client accounts grew 23 percent, benefitting from an improvement in market conditions. Stifel's global wealth management division saw revenues of $157 million, up 34 percent in a year, as Stifel completed an acquisition of a UBS unit and added in total 583 FAs (roughly half coming from acquisitions).
Raymond James, meanwhile, has seen its stock decline roughly 20 percent, from $30 to around $24 today, in the same time frame. But Raymond James has also benefitted from the unrest amongst FAs, and enjoyed record recruitment in its most recent fiscal year, ended Sept 30, 2009. The firm recruited 219 reps in its full service channel (Raymond James & Associates), compared favorably to a three-year average annual pick up of approximately 150 FAs. “From the late summer 2008 market downturn to the end of our fiscal 2009 year, we grew total assets 15 percent from Sept. 2008 to Sept. 2009 despite a market meltdown, almost unheard of in the industry, says Dennis Zank, president of Raymond James & Associates.
With 90 percent of its new reps coming from the largest five wirehouses, Zank believes that recent retention efforts announced by the likes of UBS and others is evidence of how strong this trend is. Despite improved retention efforts by his competitors, Zank remains optimistic about Raymond James' ability to attract reps. “I have great confidence that the big firms will find ways to aggravate — advisors and branch consolidations, management changes, compensation changes, there is always something that seems to upset financial advisors,” Zank says.
So what can a rep make of the stocks of the independent b/ds and custodians? Certainly, they are less encumbered (and embarrassed) by the financial distress and toxic assets that stung many of the larger firms. But that alone does not make the stocks a buy today. Some investors and analysts are still skeptical that the smaller brokerages and RIA platforms can continue to grow at 2009 rates. KBW, a respected financial services boutique and investment bank, recently cut earnings estimates at TD, noting that daily transactions are still running below management guidance; it also observed that lower rates hurt the firm's traditional banking branch business. KBW now expects 2010 earnings per share to be $1.16, and $1.55 per share in 2011. Schwab, on the other hand, was recently launched with an overweight at Morgan Stanley, which believes the firm's asset gathering is going well and that rising rates will soon help the firm's earnings. Deutsche Bank also raised its price target from $18 to $25 per share.
At the recent price of $19, that puts TD at 12 times 2011 estimates — fair value if TD reaches those numbers, but riskier if it doesn't. Raymond James at $24, also trades at roughly 12 times 2011 estimates, while Stifel trades at 17 times 2011 estimates, the result of a cleaner balance sheet and stronger growth rates.
ETrade, on the other hand, is the clear loser in the group, with a stock languishing at $1.67, the result of severe financial distress related to purchases of toxic mortgage securities during the housing bubble, and the subsequent refinancing that left its shareholders with diluted stakes. Volumes there are declining, down 22 percent from last year in the November month, and analysts do not expect the firm to be profitable in the current year.
Schwab, TD, Raymond James and Stifel will all continue to benefit from asset gathering, fueled in part by the likely continued and accelerating movement of reps from wirehouses. Schwab and Raymond James are probably the best stocks to play this trend — their valuations are reasonable, although certainly not cheap after the market's huge run this year, and their businesses are the most levered to advisor movement; TD has a traditional banking business and ETrade seems to be in too much turmoil to attract new advisors currently. Stifel is also well positioned, but the stock's valuation recently seems to reflect much of the potential good news.