Moody's cites revenue concerns on three large IBDs

The double whammy of the broad sell-off in stocks and sharp declines in interest rates led Moody's Investors Service Inc. to revise or cut its outlooks and ratings last week for three of the largest networks of independent broker-dealers: LPL Financial, Advisor Group and Cetera Financial Group.

Moody's analysis is a harbinger for the entire independent broker-dealer industry. Broker-dealers make money from charging clients fees on assets under management, so the sharp 30% decline in the broad market indices from the recent highs will have a harmful impact on revenues for firms in the near term. Broker-dealers also generate income from the spreads on client cash in margin or cash sweep accounts, so the Fed rate cut of 50 basis points this month is another negative for firms' bottom lines.

Moody's already rated all three broker-dealer networks as below investment grade, or junk. Private equity managers used junk bonds to finance and complete their recent acquisitions of both Cetera Financial and Advisor Group.

In a note last Tuesday, Moody's said that while it maintained LPL's credit rating at Ba2, it changed its outlook on LPL to stable from positive "reflecting our expectation that lower interest rates and asset prices will slow the pace of revenue growth at LPL." Moody's also noted that LPL had lowered its debt levels since they peaked in 2015.

"Our firm’s financial strength and stability remain a differentiator in our industry, and we remain confident in our ability to serve as our advisers’ long-term partner," an LPL spokesperson, Lauren Hoyt-Williams, wrote in an email.

Also last Tuesday, Moody's said that while it was reaffirming the credit rating for Cetera's parent company, Aretec Group Inc., at B3, it changed the company's outlook to negative from stable.

"Aretec's negative outlook reflects a challenging macroeconomic environment which will weigh on the firm's revenue in the form of lower asset-based and advisory fees," according to Moody's. "The negative outlook also reflects the elevated debt level and the increasing probability of deterioration in debt servicing capacity now that interest rates and market levels have declined."

"We are pleased that Moody’s reaffirmed our rating and like all in the financial services sector right now, we understand their caution with the overall economic environment," Jeff Buchheister, Cetera's chief financial officer, wrote in an email.

And last Thursday, Moody's downgraded Advisor Group to B3 from B2 with a negative outlook.

"Although Advisor Group's revenue has benefited from macroeconomic tailwinds between 2017 and 2019, including higher interest rates and strengthened levels of client assets, Advisor Group has also engaged in debt-funded acquisitions, delaying its organic deleveraging during this favorable period," Moody's noted.

“In this economic and market environment, companies across many industries are being put on credit watch, or being downgraded, and as expected, the entire financial services sector is not immune,” said Joe Kuo, spokeperson for Advisor Group.

“Thankfully, we are of sufficient size and have the financial resources to continue to invest” in the company, Mr. Kuo added.