Business Context and Reporting Period
LPL Financial Holdings Inc. is an independent broker-dealer and investment-advisory platform serving financial advisors and institutions through technology, custody, clearing, compliance, research and practice-management services. This unaudited Form 10-Q covers the three and six months ended June 30, 2020, compared with the corresponding 2019 periods. Results were materially influenced by COVID-19, market volatility and sharply lower interest rates.
Key Financial Metrics
| Metric | Q2 2020 | Q2 2019 | Change |
|---|---|---|---|
| Net revenues | $1,366.7 million | $1,389.8 million | (1.7%) |
| Pre-tax income | $137.3 million | $195.1 million | (29.6%) |
| Net income | $101.7 million | $146.1 million | (30.4%) |
| Diluted EPS | $1.27 | $1.71 | (25.7%) |
| Gross profit | $488.2 million | $535.7 million | (8.9%) |
| Gross profit as a percentage of revenue | 35.7% | 38.5% | (280 bps) |
| Effective tax rate | 25.9% | 25.1% | Up 80 bps |
For the six months ended June 30, 2020, net revenues were $2,830.1 million, up 2.5%; pre-tax income was $344.9 million, down 13.5%; net income was $257.3 million, down 14.7%; diluted EPS was $3.19, down from $3.50; and gross profit was $1,063.8 million, down 2.5%.
- Q2 advisory revenue increased 8.7% to $523.4 million, while commission revenue decreased 10.8% to $427.5 million and asset-based revenue decreased 14.4% to $247.1 million.
- Client cash revenue declined as lower interest rates more than offset higher average client cash balances. Average client cash balances increased to $46.1 billion from $29.9 billion.
- Transaction and fee revenue increased 1.0% to $119.5 million, primarily due to higher trading activity during market volatility.
- Operating expenses increased 3.7% to $1,203.1 million, driven principally by compensation, promotional, technology-related occupancy and equipment costs, and brokerage, clearing and exchange fees.
- Six-month operating cash flow was $338.1 million, compared with cash used in operations of $54.4 million in the prior-year period. Capital expenditures were $71.9 million.
- Cash, cash equivalents and restricted cash totaled $1,489.7 million at June 30, 2020, compared with $1,161.3 million at June 30, 2019.
- Long-term borrowings, net, were $2,349.6 million at June 30, 2020. The earliest principal maturity of long-term borrowings is in 2025; revolving facilities mature in 2024.
- LPL Financial had regulatory net capital of $121.5 million versus a $9.6 million minimum requirement. The company reported compliance with its debt covenants, including a 2.03 leverage ratio versus a maximum of 5.00 and 9.24 interest coverage versus a minimum of 3.00.
Material Changes Versus the Prior Comparable Period
- Advisory assets increased 15% to $375.3 billion, while brokerage assets increased 2% to $386.4 billion. Total brokerage and advisory assets served increased 8% to $761.7 billion.
- Six-month net new assets increased to $27.3 billion from $11.9 billion, including $23.4 billion of net new advisory assets versus $12.7 billion previously.
- Q2 net new assets were $13.0 billion, including $10.2 billion of advisory assets and $2.8 billion of brokerage assets, compared with $6.2 billion, $7.5 billion and an outflow of $1.3 billion, respectively, in Q2 2019.
- Commission revenue was pressured by lower annuity, mutual fund and fixed-income sales and lower trailing commissions following the first-quarter market decline. Equity sales and transaction volumes increased.
- Asset-based revenue decreased primarily because of lower client cash program revenue. Management expects the pressure from low interest rates to continue through the remainder of 2020.
- The company suspended share repurchases in mid-March 2020. It repurchased $150.0 million of stock during the first quarter and paid $39.5 million of dividends during the first six months. A $0.25-per-share dividend was declared on July 28, 2020.
- The company acquired Allen & Company in August 2019 and paid the remaining $10.0 million contingent consideration in February 2020. Asset purchase agreements for Lucia Securities and E.K. Riley Investments were expected to close in the second half of 2020.
Outlook, Commentary, Risks and Unusual Items
The filing does not provide formal financial guidance. Management stated that operating cash flow, available credit and other funding sources are expected to satisfy working-capital, obligation and capital-expenditure needs for the foreseeable future, including reasonably likely stress scenarios involving a sustained market downturn and continued low interest rates.
- COVID-19 remains the principal uncertainty. A prolonged market downturn could reduce advisory, asset-based and trailing-commission revenue, while sustained low rates could further reduce client cash revenue.
- The company shifted a substantial majority of employees to remote work and implemented continuity, distancing, cleaning and vendor-monitoring measures. The filing warns that these measures may not prevent operational interruptions, cybersecurity incidents or service-level deterioration.
- Regulation BI procedures were implemented by June 30, 2020. Continuing changes involving Regulation BI, the Department of Labor fiduciary rule and state standards of conduct may increase compliance costs, litigation exposure and product or pricing constraints.
- Regulatory and legal reserves include matters considered probable and reasonably estimable. The historical blue-sky settlement involved $26.4 million of fines covered by captive-insurance reserves; customer remediation was substantially complete and was not expected to be material. Future losses could exceed accruals and insurance.
- Client margin loans totaled approximately $327.4 million and were collateralized by securities with a fair value of approximately $458.3 million. Clearing guarantees and other client-related commitments could expose the company to losses, although management considers the likelihood of payments under clearing guarantees remote.
- The company adopted the current expected credit loss standard on January 1, 2020; management reported no material impact on recognition of credit losses.
Most Important Facts to Verify
- Whether market levels, advisor recruiting and net new assets sustain advisory-asset growth and future advisory revenue.
- The pace and durability of lower client cash revenue under the low-rate environment, including bank-counterparty fee negotiations.
- COVID-19 effects on market values, trading volumes, remote operations, cybersecurity, vendors and advisor productivity.
- Progress and financial impact of the Lucia Securities and E.K. Riley Investments transactions.
- Debt maturity, refinancing and covenant capacity, including the effects of floating-rate debt and the expected LIBOR transition.
- Potential regulatory, litigation, customer-remediation and captive-insurance exposures beyond recorded reserves.
- Continuation of the quarterly dividend and the timing or resumption of share repurchases, which remain subject to board approval, liquidity needs and debt restrictions.