Independent broker-dealers hit a wall

As commission revenue continued its decline in 2016 and headwinds from regulators stiffened, the independent broker-dealer industry hit a wall, with the top 25 firms — those with roughly $250 million and more in total revenue — collectively reporting a year-over-year decline in revenue of 1.3%.

It’s the first time the industry has had an annual drop in revenue since the dog days of the credit crisis and stock market crash of 2008 and 2009. At that time, InvestmentNews reported year-over-year declines in total revenue of 2.1% and 10.3%, respectively, for the top 25 firms.

Just eight of the top 25 independent broker-dealers posted revenue growth in 2016: Ameriprise Financial Services Inc., Raymond James Financial Services Inc., Commonwealth Financial Network, Wells Fargo Advisors Financial Network, Cambridge Investment Research Inc., Royal Alliance Associates Inc., Signator Investors Inc. and Securian Financial Services Inc.

Meanwhile, the firms that ranked 26th to 50th fared even worse. Those firms reported from $87.8 million to $249.8 million in total revenue, and as a group they saw sales decline 3.8% in 2016 when compared to a year earlier. Only seven of those firms reported positive revenue growth last year: Lincoln Investment Planning, CUNA Brokerage Services Inc., Centaurus Financial Inc., Summit Brokerage Services Inc., United Planners Financial Services, KMS Financial Services Inc. and J.W. Cole Financial Inc.

InvestmentNews has been tracking the financials of the leading independent broker-dealers since 2003 and charting an annual assessment of the industry’s growth since 2004. Over that 13-year period, growth averaged 10% per year.

Despite the recent faltering in commissions, the independent broker-dealer industry has seen robust growth for more than a decade. Over that 13-year period, the top 25 firms have seen total annual revenues increase more than 160%, from $7.7 billion to $20.2 billion.

Large IBDs such as Ameriprise, LPL Financial and Raymond James spent millions of dollars in 2016 to prepare to comply with the Department of Labor’s fiduciary rule for retirement accounts. By wide consensus, the new rule has sharply slowed down the sale of high-commission products including variable annuities and nontraded real estate investment trusts — bread and butter products for many IBDs and their advisers.

The fiduciary rule implementation has been delayed until June 9.

2017 LOOKS BUMPY

If 2016 was tough, this year also has its hurdles. “The uncertainty and transition of the business will add up to make another challenging year for IBDs,” said Joel Marks, an industry consultant and long-time senior executive at leading independent broker-dealers. “We are transitioning into a fiduciary world, however you define it. The DOL rule is the uncertainty. If they didn’t prepare for it, smaller firms, those with less than $150 million in annual revenue, just got a reprieve. And a lot of them are praying the deadline for implementation keeps getting extended.”

The decline in revenue came despite an end-of-the-year surge in stocks following the election of President Donald J. Trump, who the securities industry widely believed would push a pro-growth business agenda of deregulation, tax cuts and spending on infrastructure — good news for stocks. After a sharp 10% decline at the start of last year, the S&P 500 finished 2016 with a total return, including dividends, of 11.96%.

(More: InvestmentNews Broker-dealer Data Center for full data and profiles)

“Despite the rising tide of the market, revenues were challenged,” Mr. Marks said. “Small firms are having a challenge in revenue growth, both organically or through recruiting.”

Commission revenue declined 8% for the top 50 IBDs, falling to $11 billion in 2016 from $11.9 billion a year earlier. The positive news for firms was the increase in fee revenue, which rose 2.9% for the top 50 firms, reaching almost $9.3 billion in 2016 compared to $9 billion a year earlier.

“2016 wasn’t a true downturn in the classic sense, but the market was flat for 18 months and the economy had limited growth,” said Eric Schwartz, chairman of Cambridge Investment Research, which saw its total revenue increase 1.9% to $711.5 million in 2016.

“Twenty years ago, if an IBD was not growing 20% per year, you were an also- ran,” Mr. Schwartz said. “The industry may still grow, but it won’t be as diverse, particularly with the number of insurance companies leaving the business.”

Others were more sanguine about the prospects for the remainder of the year, particularly given the election of Mr. Trump.

“What is different right now is that the macro backdrop improved greatly in November with the election,” said Dan Arnold, president and CEO of LPL Financial, which saw a year-over-year decline in total revenue of 5.4% “We’ve seen investor sentiment improve. We see advisers now being very optimistic about being able to grow their practices. We haven’t seen that much optimism in the prior three to four years.”

MISLEADING RESULTS

Mr. Arnold was quick to note that LPL’s top-line results can be misleading in assessing the firm’s growth. Revenues from hybrid advisers do not contribute to top-line numbers; rather, they are accounted for as “other revenues” and contribute to gross profits, which were up 2.7% at LPL in 2016.

“Our thinking is that better sentiment will lead to improved asset flows to advisers this year versus in prior years, although it’s still too early to know how that will play out,” he said. “If investor sentiment is better, that sets up conditions for existing advisers to grow their businesses better.”

The recent rise in interest rates has some in the industry more confident about 2017.

“Interest revenue was up dramatically,” said Scott Curtis, president of Raymond James, which posted an increase in revenue of 3.4% in its fiscal 2016, which ended in September.

“Fee-based assets are up 25%, and that reflects the move we’ve seen more toward fee-based in response to the Department of Labor’s fiduciary rule,” he said. “Clients are moving out of certain commission accounts, and the DOL accelerated that.”

“For the rest of the calendar year, I’m optimistic with asset levels where they are today,” said Mr. Curtis. “They are at milestone levels for Raymond James Financial Services and the rest of the firm, and that bodes well for fee levels in the upcoming quarter.”

The Advisor Group, a network of four firms — Royal Alliance Associates Inc., SagePoint Financial Inc., FSC Securities Corp. and Woodbury Financial Services — is seeing a clear shift to fee-based advisory business, with advisers steering what would have been clients’ direct mutual fund purchases to advisory accounts, said CEO Jamie Price.

“What was on the commission line for mutual funds is now on the fee line for advisory,” Mr. Price said. “For sure that’s happening, at least in Advisor Group. For the rest of the year, I think you’re going to see a continued shift into new advisory business.”

With commissions drying up, consolidation is coming, executives said.

“In 10 to 15 years, you will see half the advisers in this business leave,” said John Rooney, managing principal with Commonwealth Financial Network, which saw its revenue grow 6.1%, to close to $1.1 billion, in 2016.

“The industry is trending from needing four advisers producing $150,000 in gross revenue toward needing one $600,000 producer with a staff,” he said. “People most likely dropping out of the business are in the range of producing $150,000 to $200,000 in gross dealer concession. That’s a much more challenging way, a much harder row to hoe to become an institutionalized financial planning firm.”