For independent broker-dealers, 2011 was a challenge. Mounting technology costs, intense scrutiny and new rules from securities regulators were compounded by record low interest rates, which decimated returns on once-lucrative activities such as margin lending and holding clients' cash.
The environment was further clouded by the downgrading of the U.S. credit rating by Standard & Poor's and concerns over the European debt crisis. Those events sent the market into a free fall last August and spooked investors still troubled by the market's downturn during the 2008-09 credit crisis.
But 2011 proved to be a strong — if not quite stellar — year for many large independent broker-dealers. On average, the largest 25 firms reported an increase in total revenue of 12.3% for the year, although that was below the 16.9% year-over-year increase reported in 2010.
(See the latest revenue rankings.)
The all-important S&P 500 finished 2011 at 1,257.6, at virtually the same point it started the year. But its daily average last year was 1,267.6, an 11.2% increase over its daily average of 1,140 in 2010, according to Capital IQ.
That increase is significant because “fee calculation is a whole strata of data points, typically based on averages,” said Alois Pirker, research director at Aite Group LLC.
Account fees essentially are based on a midpoint over a period of time such as a quarter, he said. “That means the average for the quarter can be higher than the quarter's end.”
“If you just took a snapshot of the S&P 500, year-over-year 2010 was identical to 2011,” said Robert Moore, chief financial officer for LPL Financial LLC, the largest independent broker-dealer, with $3.34 billion last year in total revenue.
“The 2% return [in 2011] is all dividends on the S&P 500, but the daily average of the index was markedly higher than 2010,” said Mr. Moore, who was promoted last week to president and chief operating officer starting May 1. “Firms price assets throughout the year, and the first six months were strong, with accelerated activity.”
Other executives agree that the quarterly timing of charging fees on assets contributed to strong revenue growth.
“We are now so attuned to watching the indexes on the quarters,” said John Rooney, a managing principal with Commonwealth Financial Network. “March 31, June 30, etc., are so important to companies like Commonwealth because we are so tied to the market, for better or worse.”
Mr. Rooney added: “If there are a couple of tough quarters, if the indexes are lower at those dates, you lock in the next quarter's revenue on those dates — if you are overwhelmingly fee-based.”
And most income at Commonwealth Financial Network, the fifth-largest firm, with $646.5 million in total revenue last year, comes from fees, Mr. Rooney noted. Counting 12(b)-1 fees on mutual funds, the firm's client accounts are “close to 75% fee-based,” Mr. Rooney said. “So it's a really big number.”
Ameriprise Financial Services Inc., the second-largest firm, had $2.84 billion in total revenue last year from a “well-mixed business” of asset-based accounts that are charged a fee, along with accounts that are charged the traditional brokerage commission, said Don Froude, president of the Personal Advisers Group at Ameriprise.
“Despite the flat equity market, we still increased our asset-based and transactional revenue,” he said. “The market was flat, but we had a focus on managed money.”
Revenue from fee-based ac-counts increased 14.7% at the firm last year.
STRONG YEAR
With the S&P 500 returning 12% for the first quarter, 2012 could be an equally strong year for revenue growth, if the market can avoid the major pitfalls it encountered last summer, executives said.
“With the market up this much already this year, we could see revenue up substantially in 2012, from 12% to 20%,” said Eric Schwartz, chief executive of Cambridge Investment Research Inc., which produced $396.9 million in total revenue last year, ranking it the 11th-largest independent broker-dealer.
Still, the industry will be sorely tested in 2012.
“A big problem is this darn regulatory environment and where it's going to go,” said Amy Webber, president of Cambridge. “Big broker-dealers will weather this, but there is still a lot of nasty stuff out there.”
Creating new disclosures mandated by the Labor Department for registered representatives who have retirement plans as clients is particularly daunting and potentially dangerous for firms that are not prepared, Ms. Webber said.
“Firms need to get that done by summer,” she said. “That was a big scramble. Some advisers who work at broker-dealers that haven't figured out how to deliver those disclosures will wake up in June and be out of business.”
M&A OUTLOOK
And 2012, like 2011, could prove a significant year for mergers and acquisitions in the independent-broker-dealer industry, executives said.
This year has already seen two sizable deals.
In February, carrier Western & Southern Financial Group said it was selling the assets of its independent broker-dealer, Capital Analysts Inc., to Lincoln Investment Planning Inc.
In January, insurer Genworth Financial Inc. sold its independent-broker-dealer subsidiary to Cetera Financial Group for $78.5 million, plus an earn-out provision.
More firms are up for sale.
Last month, The Hartford Financial Services Group Inc. said it was putting its independent broker-dealer, Woodbury Financial Services Inc., on the block as part of a far-ranging reorganization of its businesses.
TECH PRESSURE
Broker-dealers and registered investment advisers must make investments in technology due to regulatory change, noted Scott Curtis, president of Raymond James Financial Services Inc. That potentially spells trouble for small firms, he said.
“Smaller broker-dealers may struggle to keep up with those changes, and they may consider selling or partnering with a larger organization,” Mr. Curtis said. “That's a pressure that exists for the independent broker-dealers,” he said.
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