Despite a stock market decline, the largest independent broker-dealers turned in another stellar year in 2018, with revenue for the top 25 firms participating in an InvestmentNews survey reaching $25.5 billion, a 14.7% increase over 2017.
The 2018 increase comes on the heels of a 13.1% increase in revenue in 2017. Both years bested the 10.45% average annual increase the 25 biggest firms have attained since InvestmentNews began tracking revenue growth in 2004.
[The increase in revenue might have been even higher if Wells Fargo Financial Advisors Network, one of the 10 largest firms in the industry, had participated in this year's survey, as it had in the past.]
Last year's strong results came despite the market sell-off that panicked many advisers and their clients in the last quarter of 2018. In the final three months of the year, the S&P 500 dropped 14% and the Dow Jones Industrial Average plunged 11.8%, wiping out the prior nine months' gains. For the year, the S&P 500 and Dow were down 6.2% and 5.6%, respectively, their biggest annual declines since the 2008 credit crisis and Wall Street's collapse.
IBDs were largely able to side-step the impact of the sharp downturn in the last quarter because of the way they bill clients. Firms typically bill before the start of the quarter; that means they charged clients for the fourth quarter at the end of September, when levels of client assets were still high and before the sell-off was recorded on broker-dealer ledgers. That means broker-dealers recorded the impact of the market sell-off during the first quarter of this year.
"We book the fourth quarter on the end of September valuations," said John Rooney, managing principal of Commonwealth Financial Network. "The end of December billing [for the first quarter] was pretty weak."
But any concern of a prolonged market slide evaporated as the first quarter of 2019 played out, with the S&P 500 rallying by almost 14%.
And yet, those looking for signs of a potential recession could find evidence, perhaps most notably with the recent inversion of the yield curve.
"Everyone's fear of recession goes up when the yield curve flirts with an inversion," Mr. Rooney said.
A historically accurate indicator of recession, inversion occurs when long-term interest rates drop below those of shorter-term bonds. On March 22, the yield on the benchmark 10-year Treasury note fell to 2.42%, dropping below rates on three-month bills for the first time since July 2007, according to Bloomberg.
"We'll watch how the yield curve moves for the rest of the year," Mr. Rooney said.
Last year's market swoon may have helped larger broker-dealers with an eye on acquisitions. Owners of small or mid-size firms, those with fewer than 500 registered reps, might believe the end of the 10-year bull market is near and may feel that now is a good time to sell their businesses, executives and industry recruiters said. Add in the continued increasing cost of technology and of keeping up with regulation, and 2019 looks more than ever like a buyers' market for IBDs.
"We are moving into an environment of seeing more transaction volume in the broker-dealer and RIA space," said Richard Steinmeier, managing director and head of business development at LPL Financial, the industry's largest player. "Folks are seeing that we may be at the end of the bull run and looking at the sustainability of their businesses."
"We will be one of the players to look at the right types of opportunistic acquisitions," Mr. Steinmeier said. "Many more of them are likely to face challenges and the lack of scale in the near term."
Big brokerage deals
That would continue the M&A trend of the past few years as large brokers started realizing revenue gains from consolidation. LPL Financial bought the four broker-dealers of the National Planning Holdings network in the second half of 2017, and last year that acquisition showed its financial impact. LPL reported close to $5.2 billion in revenues for 2018, a 21.2% increase compared with the year before.
Last June, Advisor Group purchased Signator Investors and rolled that firm into Royal Alliance Associates Inc., the network's largest broker-dealer. Royal Alliance reported $603.9 million in revenue last year, an increase of 24.8%.
Meanwhile, even those not buying firms benefited from mergers, as they saw it as an opportunity to recruit brokers and advisers whose firms were changing hands.
"We benefited from industry consolidation, with many people choosing Securities America after their B-D was acquired," said Jim Nagengast, CEO of Securities America Inc. The firm's top line increased by close to $166 million, or 26%.
Increased short-term interest rates also helped the bottom line at many firms. Brokerages make money when rates go up, from increased spreads on money market accounts, cash sweep accounts and margin lending. The federal funds rate climbed by 100 basis points over 2018 and ended the year at 2.5%.
That coincided with a new business initiative for at least one firm. Amy Webber, CEO of one of the industry's largest firms, Cambridge Investment Research Inc., partnered with a firm to build its own cash sweep program instead of relying on what its clearing firm offered.
Insurance owners lag
Insurance company-owned B-Ds, formerly significant players, continued to lag the industry, with many posting results below the group's average. Those firms have not been as nimble as their peers in making acquisitions, investing in technology or paying more to attract new recruits.
"The firms that are having success are offering more creative business solutions than just being an IBD," said Jodie Papike, president of Cross-Search, an industry recruiter. She pointed to firms that are developing a registered investment advisory channel for those advisers who want to drop their securities license and become a fee-only business. "Broker-dealers didn't do that in the past," she said. "Now they are targeting a huge market."
Firms also are still shaking off anxiety, fear and increased business expenses caused by the Department of Labor's fiduciary rule, which essentially died last year in federal court.
"Firms are more calm today because they are not expecting such a prescriptive approach" under the Securities and Exchange Commission's proposed Regulation Best Interest, said Scott Curtis, president of Raymond James' private client group. "With Reg BI, the focus is on the client's best interest. Firms will still need evidence of that, but it's believed or perceived to be more manageable."
Continuing a trend in the securities industry, fee revenue for the top 25 firms continued rising at a rate faster than commission revenue. Charging steady fees for assets under management rather than commissions is widely regarded as a more desirable form of business in retail wealth management.
According to InvestmentNews data, the top 25 IBDs last year produced close to $11.7 billion in revenue from fees, $9.5 billion from commissions and $4.4 billion from other business lines. The previous year, those totals, respectively, were $10.2 billion, $9.2 billion and $3.8 billion.