This financial and calendar year 2018 will be forever marked by the Royal Commission.
Forte made commentary in July on the Royal Commission – Special Market Commentary Post Royal Commission >
It is our normal process to record and comment on all M&A activity in the reporting period but given the transformational shock waves we as an industry are experiencing, any commentary on individual transactions would only be peripheral to the real subject matter.
The exploratory themes of this paper are:
- The immediateimpact of the Royal Commission
- The continuing and accelerating adviser migrations
- Dover Financial Planning demise
- FASEA and their impact on the industry
- Grandfathered revenue
- Recent Transactions
- Current Valuations
- The Future
I recently spoke to a U.S.A FPA study tour and from an outsider looking in, it would be logical to assume as an industry we would be strong and vibrant, given the state of the equity markets and the economy we have enjoyed.
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- All Ords is at a 10-year high
- Australian economy grew 3.4% last financial year
- Australian economy continues to enjoy 27 years of positive economic growth
But I suspect many business owners are also feeling somewhat complacent and enjoying asset and profit growth buoyed by market performance without paying much attention to how there has been little organic growth from new client engagement.
We need to explore current developments to give us some perception ofwhat is happening across the whole industry and how it will likely shape our future.
Royal and Productivity Commission
- AMP Chairperson and board members resign
- AMP share price fell 42% from Jan18 to May 18
- AMP to face two class actions of $2 Billion.
- Immediate tightening of lending policies
- Banks looking at interest serviceability of 7%p.a.
- Productivity Commission recommendations forremoval of trail on mortgages
- Mortgage industry at risk with a move to fee for service and loss of ongoing brokerage
- Misconduct of banks in business loans, farmers, aboriginal loans
- Royal Commission Lawyers recommend criminal charges against AMP, CBA, and NAB
- Colonial First State admit to charging dead people – aware since 2015
- CBA admitted to 15,000 criminal breaches by failing to move 15,000 accounts to low fee no commission accounts
- NAB potentially to be charged for misleading and deceptive conduct by MCL trustee NULIS by failing to tell clients they did not need to pay fees without service
- NAB admitted breaking the law 84 times between 2014 and 2017 by failing toadvise ASIC of fees for no service
- NAB is paying back $90 million to 300,000 super members
- I00F and AMP accused of breaking super laws
- I00F may have engaged in misleading and deceptive conduct
- Australian Securities and Investments Commission (ASIC) told the Royal Commission that $260 million had been refunded by the Big 4 banks and AMP so far, however total cost could be more than $1 billion
- ASIC to be imbedded within big 4 banks and AMP
- ASIC to receive an additional $70 million funding
- Possible new regulator – ASIC and the Australian Prudential Regulation Authority (APRA) are accused of not being tough enough.
Mortgage Broking Industry
The mortgage industry has been immediately impacted byaperfectstorm of events. All major cities are witnessing declining property valuations given the tightening of credit. Some commentators are nominating the impact to be as much as 40% less acceptance of borrowers in comparison to last year. Household savings ratio declined 1% in June quarter – the lowest level since 2007; and banks are starting to move interest rates up citing the cost of funds.
- There were 34 recommendations, 11 of which were directly related to mortgage brokering loans
- Recommendation for the banning of ongoing commission.
- The productivity commission recognizes that upfronts may increase
- Upfront fees in Australia now up from 0.3% to 0.7%
- Upfront fees in Canada is 1.1%
The great risk to mortgage brokers is the potential treatment of ongoing revenue being deemed payments for no service or at the very least conflicted. If this approach is legislated, we would expect grandfathering but the right to recurring revenue is being challenged and as such so are business valuations previously priced at 2 to 2.5 times Recurring Revenue. Current pricing has moved into the unknown with Forte having not facilitating a single mortgage sale this calendar year.
We have a $1.6 trillion mortgage market with the average ongoing commission at 0.15%p.a. = $2.4B of ongoing revenue. The mortgage broking industry represents approx. 50% of home loans or $1.2B of revenue is at risk.
At a minimum,it can be expected that bonus payments will be out-lawed and best interest requirements will be introduced. We will likely see the introduction of client or user pay fees only with no payment from providers.
The largest mortgage brokers are owned by the big banks. CBA own Aussie and part of Mortgage Choice. Westpac owns Rams. Nab owns Fast, Choice and Plan. Like the Financial Planning industry this control over distribution is being challenged.
Bank Wealth Management and Advice
The above (pg2) is just a recent record of actions and penalties the banks have received over the last few years. The reputational and operational risk has been too much for most if not all as we see the banks ‘consciously decoupling’ from wealth management and advice.
ANZ is to sell OnePath and aligned Dealer Groups (Millennium 3, RI Advice, Financial Services Partners and Elders to IOOF for $975m. ANZ sold its Life Insurance business to Zurich last December for $2.85 Billion.
The Commonwealth Bank announced in April 2018 it would spin off its wealth and investment management business via a new entity CFS Group. CFS will include Colonial First State with $135 Billion Funds Under management (FUM), First State Global Asset Management $207Billion FUM and the advice firms Count Financial, Countplus and Financial Wisdom and also its interestsin Mortgage Choice. Net profit of the combined entities is approx. $500m.
NAB announced it is to list or sell MLC for an anticipated value of $3 Billion. The sale includes Apogee. Godfrey Pembroke to potentially break away and go it alone. NAB to retain their salaried advisers and JB Were. NAB sold 80% of MLC Life to Nippon Life in October 2016 for $2.4 Billion. NAB acquired MLC in 2000 for $4.5B
Westpac/BT have not commentated on the future of Securitor and Magnitude. BT/Westpac has 969 financial advisers within its salaried and aligned dealer groups.
The migration or movement of advisers from one AFSL to another continues to gain momentum with a definitive bias away from the historically larger and especially vertically aligned and/or Bank owned licensees.
The main reasons for the adviser migration are:
- Brand damage to licensee
- Associated reputational damage to practice (direct or inferred)
- A desire to take control of their business and reduce risk
- Perceived and/or real handicaps on their business by the licensee
- The valuebeing provided by the licensee
- Uncertain ownership and future within existing structure
- Reduction in perceived cost of self- licensing and access to specialist consultants
- Access to product and platform for the fulfilmentof fiduciary care and competitive positioning
- Closure of existing AFSL – Dover and one other non- aligned AFSL currently experiencing ASIC action.
Large Advisor Dealer Groups
This movement would be further exacerbated if Buyer Of Last Resort is deemed conflicted.
Data collected from – Bell Potter: Australian Wealth Platforms
One of the beneficiaries of the adviser bank migration was Dover who was until their demise one of the fastest growing Dealer Groups in the country with 408 advisers, $4b FUM and 10,000 plus clients.
- ASIC investigations began in 2017
- Terry McMaster appeared at the Royal Commission on 26thof April
- Notice of closure made on the 9thof June
- Closed 6thof July 2018
- Client Protection Policy profiled by Royal Commission
- Did not comply with its obligations to act efficiently, honestly and fairly
- Did not comply with financial services law
- Did not take reasonable steps to ensure its representative comply with financial services law
- Lacked the organizational competency required to be an AFSL holder
- Terry McMaster is not of good fame and character
- He is likely to contravene a financial services law in the future
- ASIC’s investigation is continuing
Repercussion for Dover advisers
- No longer able to provide advice
- No access to platform/colonial
- No advice fees to be paid
The demise of Dover, regrettably, has had repercussions across all the industry. Advisers within the group have not only had significant disruption to their businesses but also reputational damage. The 400 or so advisers had precious little time to find an alternate licensee, compounded by alternative licensees being mindful of the ASIC microscope following all adviser movement, their inability to undertake appropriate DD’s in the time permitted, PI Insurers concerns, etc. Indeed, presently there are more than 100 advisers yet to find a new home.
The speed of closure was unprecedented and appears excessive to the one nominated issue “client protection” clause, especially as we compare bank breaches and ASIC response. Is there one rule for the big banks and another for non-aligned ?. It will be interesting to see if there where additional issues that have not yet been referenced and validation for actions in the ensuing legal proceedings. All non-aligned Dealers will need to assess if there are new risk factors that need to be considered given this precedence.
Forte Licensing Solutions dealt with many Dover advisers seeking an alternative dealer in June, but Forte could not represent as many as 40 ex Dover businesses as they were below our and the industries minimum size requirements < $100k recurring revenue but with 5 years or more history, all revenue grandfathered, Dealer hoppinghistory, past compliance record, compliance adverse etc.
More than ever, advisers need to do their DD on licensing options and not simply be influenced by pricing or ease of transition. Ask yourself if you have researched your licensee as much as you researched your last holiday. Forte Licensing Solutions undertakes continual research and as a starting point these are some of the questions we ask of a potential new licensee.
Whilst Pricing, Resources/Support Services, APL, Technology, PI Cover, etc. are all important, we also ask the following:
- Compliance history of the Licensee and its’ advisers past or pending issues
- Who controls/owns the license?
- Do they plan on having an “equity event”?
- What is the financial strength of the Licensee?
- What is the Licensee’s position on client ownership and bulk transfers, positive or negative consent?
- In the current environment, what programs and capital do they have in place to manage future change?
- How would you describe the culture?
All advisers, ex Dover or otherwise, should now be hypersensitiveto their Dealer affiliation as their businesses are not only exposed to the lowest common denominator but also the top denominator (i.e. the Licensee). You can be guilty by association irrespective of the quality of an adviser’s business/advice and could find yourself a refugee with closed borders.
It is for these reasons and the reputational cost with the association to the Banks and AMP that we are seeing the growing number of practices moving to small sized Dealer Groups or self- licensing. The smaller sized Dealer Group gives confidence that they have a voice and personal relationships with management and peers.
There is growing momentum regarding the industry becoming fully self- licensed, not unlike the accounting profession. We have become aware of professional groups, outside of the current industry associations, who are giving serious consideration to meeting the Code Monitoring criteria (i.e. an external monitoring body) adding yet more credence to the pathway of self-licensing.
The increasing demand for self-licensing is also being seen by ASIC, from our experience the application process is taking 9 to 12 months to approval. In 2016/17 the previous processing time was approx. 3 months.
In the last few months,we have coached several large $1Billion plus FUM groups and several single practice break-away groups who are simply seeking to de-risk their enterprise value and take individual control of their future. For own licensee aspirants after sourcing their license and having comfort around their ongoing compliance the focus becomes technology and asset management.
Platforms and Asset Management
Whilst my commentary on the industry has been so far rather bleak, there are also winners emerging and the greatest beneficiary of the breakup of the banks’oligopoly other than compliance organisations are the new generation platforms.
We saw the very successful listing of Netwealthand the extraordinary pricing of some of the previously listed platforms (PE’s of 100x) reflecting the expected growth due to the migration of advisers and associated FUM.
Panorama Investment platform announced their reduction of fees to 15bps to come in-line with competitors. We will soon see other incumbents move their pricing as well to maintain competitive positioning to retain FUM.
The interest on cash accounts needs to be considered when looking at total cost as does transactional costs.
The Managed Account industry has seen a 9% rise in the last 6 months to June of $5.389 Billion and in the financial year a rise of 30% or $14.46 Billion for a total industry FUM of $62.43 B as reported by IMAP.
- Exchange Traded Funds (ETF) market opens from $27.2B to $36.2B in last 12 months
- 33% growth
- Over 15 years US $2 Trillion moved globally from active funds to index funds and ETFs
- Globally the ETF market is predicted to grow to $10 Trillion by 2025
Dealer groups and individual self- licensed advisers are continuing to bring asset management in-houseto a degree – many are using independent asset management consultants to assist in portfolio management and ensure best practice and best of breed. The most common approach is having a hub and spokes model with the hub being low-cost index funds or the 5-core risk profile portfolios and the spokes being direct or alternative assets and/or managed funds for alpha with tactical asset allocation.
Many Private Client or Family Office In-houseFund Managers/ Asset Managers are cascading their IP down to select new licensees; an example is DFS Portfolio Services who have an impressive record of benchmark outperformance, with a risk-based objective of maintaining the integrity of risk-profiles of investors.
Vertical Integration is a key focus for the Royal Commission and it is expected/hoped that they will look to the UK experience whereby you can have ownership of two parts but not all three of the value chain of advice, platform and asset management.
The growth of Fintech and Regtech has been accelerated in the last few years as evidenced by this Netwealthdiagram of participants. This is important as we look to the future in a later section of this paper.
2018 Netwealth Advice Tech Report – Alpha Group companion
Financial Adviser Standards and Ethics Authority (FASEA)
- FPA survey of 3393 advisers taken in June 2018 found:
- 35.3% of financial advisers are likely to leave the industry
- 57.9% of those intending to retire due to FASEA have more than 16 years’ experience
- 51% of financial advisers are considering a career change
- 8,700 experienced advisers to leave
- AFA research suggest 16% to 45% (11,000)
- Adviser Ratings found more than 50% to exit (14,000)
- Of most concern regarding FASEA was –
- Time: 86.4%
- Workload: 79.7%
- Cost: 65.8%
- 47% of advisers on ASIC’s register do not have a bachelor’s degree and based on the new minimum education standards imposed by FASEA planners on average will need to study 642 hours with 52% percent facing a minimum of 960 hours or 192 hours per annum, 16 hrs per month, 4 hours per week for the next 5 years as well as looking after their businesses, clients, family and themselves.
The surveys maybe and will likely prove to be knee-jerk emotional reactions but even taking a conservative view we will continue to see advisers leave the industry. But consider this –
- Adviser Ratings found 7,000 advisers have left the industry since 2015
- UBS nominated that 14,724 have exited in last 5 years
The number of exits we have seen over the last 3 to 5 years is equal to what is expected in coming years. Some commentators are saying we will see enterprise values fall as low as 1 times maintainable earnings because of increased supply, but we have seen no variation in valuations over these respective timeframes.
Most mature aged advisers are seeking to retain their businesses and move from face to face roles to General Manager or Chairman like roles, so not all will look to sell but will look to succeed their businesses internally or externally. It would be expected that Responsible Managers will require to meet higher educational standards. However this succession like strategy is difficult to achieve without the right infrastructure, business size, personnel and time. The preferred succession timetable is 5 years so if this is to happen it needs to start now.
Financial Planning Valuations 2017/18
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# Deal structure over 2 years taking into account LIF.
The above 2017/18 pricing is reflective of historical norms with no real changes over the last 15 years of Forte’s transactional history. This reporting period is likely to be remembered as a high- watermark reflecting the sellers’ market experienced over the last 2.5 years with limited supply and excessive demand.
This excessive demand did not lead to price inflation but was largely evident in the terms and conditions that were entered between buyer and seller – higher upfront payments, shorter terms, less buyer freedom to introduce change over the full settlement period.
Currently,the market has gone quiet in regards to both buyers and sellers. Forte’s last experienced this “eye of the storm” sensation in 2013 to 2015 with the Future Of Financial Advice legislation at that time of uncertainty the general theme was “when in doubt stay out”.
Howeverthis hold strategy is more prevalent in the smaller end of town who are risk adverse and debtreliant.
There are a number of transactions that need to be remembered as these will likely prove to be a key indicator to the leaders of the future.
Quadrant Private Equity partnered with Yorkway Capital Partners for a $200m investment to fund Fitzpatricks Private Wealth growth strategy. Fitzpatricks at the time of investment had 75 advisers $7b Funds Under Advice and $1.5B FUM in itsin-houseasset manager Atrium. The management and board are well respected and whilst their vision is internal at the moment it will turn external at some point.
Sequoia Financial Groups acquisition of Interprac with 215 advisers $3b in FUA, $17.5m in insurance premiums. There is cash in the bank and access to debt and equity being a listed group and again with respected leadership reflected by Interprac winning IFA Dealer Group of the year for the second consecutive year.
Easton Groups acquisition of GPS Wealth for $20M in June 2017. GPS at the time was one of the fastest growing Dealer Groups with 123 advisers, 182 limited advice licencesand risk premiums of $36M and FUA of $3.4Billion again with respected leadership and access to cash, equity and debt. The Easton Group also have Merit Wealth and 33% of Haynes Knight in the accounting area. The total number of combined advisers is 574 with 53 at that time in transition moving them into the Top 10 by numbers.
The global private equity group Sargons’ acquisition of Madison Financial group including Wealth Portal, Advice Net and Proactive Portfolio’s in April 2018.
The newly Nasdaq listed US group Focus Financial acquired a Forte represented business and they have a billion-dollar war chest and are very inquisitive in the local market.
Forte also facilitated a sale to AZNGA who have been very active over the last few years.
Forte is currently in a transaction with another Los Angeles based buyer who has a larger strategy, once they have made their beachheador foundation acquisition in December 2018.
Forte last week met with an Australian financial services group that has made minority shareholding investments into top-tier boutique advice groups that will assist acquisition and growth aspirations of partner groups.
Financial Index whilst recently quiet since their 2015 $137m Crowe Horwath acquisition are well positioned to focus externally at some stage.
All listed Australian Financial Service businesses, as well as private equity capital groups, are looking at the landscape and seeing a substantial opportunity with the removal of the banks and as we know when a vacuum is created it is soon filled.
These groups and others are well funded, well managed and optimistic about the future of the industry and while small businesses maybe on the sidelines now there is significant movement and plans being developed by those that seek to make their mark on the largest industry contributing to GDP and has legislated growth in superannuation.
Rowena Orr QC recommendations: (1) ending commissions that were grandfathered or exempted from the 2013 reforms, and (2) ending ongoing service fees, which have replaced commissions and are just as problematic”. (3) She also asked for industry submissions on whether “clients receive any meaningful benefit from ongoing service arrangements”.
- Grandfathered Revenue
- BT, Macquarie and NAB voluntary removed grandfathered commission for internal advisers before legislatively being required to.
- FPA have advocated for a 3-year phase-out period.
Grandfatheredrevenue is being deemed conflicted and the epicentre of no service with fees as profiled by the Royal Commission. In Forte’s travels we are constantly being shown advice being provided to clients who are being serviced with appropriate products and platforms but cannot be moved in their best interests with Centrelink, capital gains tax and cost of new advice considerations. The merits of whether this should be removed or not is moot. When the recommendations come out the government will unlikely have any political appetite to intercede in passing these to legislation. Forte is applying a 2 times multiple to this revenue stream from the previous 3 times that was being paid.
The impact on business will also be the loss of revenue and/or productivity as businesses focus on this revenue stream.
2 & 3. Ongoing Service fees. Choice submission to the RC made the following comments in regards to asset based fees – “bear no relationship to the actual work done by the financial adviser or the quality of the work conducted”. “Asset based fees create conflicts of interest that may encourage the adviser to give poor quality advice. They discourage strategic advice, such as personal debt reduction, like paying down a home loan or credit card, for which the adviser would not earn a fee…”
Many in the industry post FOFA have already moved to a fixed fee structure. Forte places a premium onthose practices with a fixed income stream as the business has protected its revenue and profit from economic or market movement and is only exposed to service continuation and competitive pressure. We recently entered an agreement on a fixed fee business at 3.5 times Recurring Revenue.
Other Royal Commission future change considerations.
- Fixed price for fixed services, non FUM based so no implied bias.
- If use of IMA/MDA full disclosure of total cost to the client.
- “Best of Breed” to be proven with comparison to external like offers.
- Each Dealer/Licensee may need to have 3 solutions – IMA/MDA for wholesale clients. Retail Wrap and Industry Fund for retail and client selects service and product.
- Dealers with own asset management will need to show value for fee.
- Dealer with advice and asset management cannot have ownership of the platform or in anyway be conflicted in the selection of best of breed.
- Can quickly remove and replace managers and platform providers and illustrate “best of Breed”.
“It is not the strongest or the most intelligent who will survive but those who can best manage change”
The medium and longer- term future.
It would be easy and somewhatself- serving as a vendor advocate to be an alarmist, but as a 30-year participant I am reminded that our industry has faced many challenges in the past.
The reason most of us love this industry isthatit is dynamic and often challenging.
The changes envisaged inthis paper are transformational but from a balanced perspective, required given the explosive revelations and breach of trust evidenced.
Not all changes will make sense or serve the public and there will once again be a loss of productivity as businesses change their value proposition and business models just like we had to do for FOFA. Howeverit needs to be remembered that better businesses were built because of FOFA with higher client engagement and in many cases higher profitability.
Adviser migration will continue, and the “independent” community will no longer be a minority but the preeminent provider and advocate for the consumer.
The to be listed aligned groups will need to have financial services professionals managing the business not bankers. The banks have been found to be unworthy custodians of Australians futures, but the next generation of leaders will know not to sacrifice client outcomes at the altar of shareholder interests. In the future shareholders will be rewarded by growth as trust is restored.
The move to individual licensing like accountants makes sense as we become more personally accountable and not relying on a big brother to ensure governance and oversight. I believe we will see the creation of super boutiques and brands who are well capitalised and well managed, much like we see in the accounting industry with the Big 4. I have identified a few well positioned groups above but there will be other local and international well branded and capitalised groups to fill the vacuum left by the banks.
Taking off my rose-coloured glasses for a moment there will be casualties and it will be those that cannot change. FASEA will challenge valuations as supply increases as we see the largest hand-over from baby boomer founders to the next generation. Age demographics always dictated this was to happen FASEA has just set a timeline. Whether this hand over will be orderly or not and valuations of a lifetime of work impaired or destroyed is yet to be seen.
We may well see the removal of Recurring Revenue in a buyers’ market as the primary valuation methodology and a focus on Adjusted EBIT being the determinate of value. My concern is for the businesses operating at the industry average EBIT to Gross revenue of 20%. An example best illustrates my point. Assume a $500k Gross Revenue business with $400k Recurring Revenue and $100k EBIT. Today it is worth $1.2m on a 3 times Recurring revenue basis, if a 6 times EBIT multiple was adopted the value would be $600k a 50% devaluation.
To maintain future value, you need to operate at a 40% sustainable EBIT level or $200k profit x 6 = $1.2m
The move to profitability is not just by changing supply and demand but also because of the margin compression being experienced through the whole value chain which diminishes the synergy benefits that was once easily achieved.
How-ever this requirement for increased profitability has never been so achievable in our current environment as evidenced by the proliferation of technology providers (see Netwealthwheel above). Just moving to an MDA enhances back office efficiencies and client outcomes let alone further adoption of technologies enhancing client communication, education and engagement.
Forte launched our third service offer to the market through Forte Consulting Solutions which assists businesses to grow. Forte has sourced subject matter experts in practice management, HR, marketing, social media, compliance and corporate governance. We have partnered with legal, accounting, PI providers, cashflow lenders, workflow and revenue software providers, web designers and others to assist in all growth in all key areas.
Profitable businesses are always going to be desired and technology is the great enabler. Those that do not have the energy or desire to innovate should move forward their exit dates – to be brutally honest – grow or go to capture current value.
We are not seeing this move to EBIT valuations for all businesses yet. Buyers are looking at what profit they can derive from the revenue. FASEA may not be the value destroyer some buyers expect when we look to the number of advisers who have left our industry (14,724) in the last 5 years similar to the number expected to leave in the next 5 years, yet no price reduction was experienced over this period. The total industry number has been relatively constant with new entrants replacing exiting advisers. Over the last 5 years we have been attracting new talent and hopefully providing the next generation of buyers/successors and leaders. This new generation also require and seek succession with the mentorship that a CEO/ chairperson can provide.
Greater barriers to entry are affirming to price. New well capitalised buyers are evident, and others will come. For all current participants,there is the need for growth with rising production costs yet little organic growth being experienced. Debt is still cheap, latest transaction saw 6% cashflow lending rate and capital is available. All the banks are lending with Macquarie taking leadership from NAB.
I recently attended the Alpha Conference in Darwin and I was encouraged by the succession success stories of businesses I had known in my BDM days at First State some 20 years ago. I meet the new generation owners and they told similar stories of happyretired founders, re-engineered and revigorated businesses being led by young progressive owners who embraced technology whilst retaining the culture of client service and advocacy.
In summary when change is evoked it is the human condition to experience fear – and that fear is tangible at the moment, as is the anger. But let’s take a breath; see where we have come from and understand where we are going and plan accordingly.
Overall it is not going to be easy, but my glass is half full.