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Many US banks are investing in their wealth management businesses to generate fee-based revenues and broaden client relationships. Given their often subscale starting points, as well as the technology and talent required to win, these banks are considering M&A to accelerate their wealth management ambitions. In particular, they are looking at the fast-growing segment of registered investment advisory firms (RIAs) for opportunities.
About the authors
This article was a collaborative effort by Pooneh Baghai, John Euart, Vlad Golyk, John Kelleher, and Jimmy Zhao.
Whether and how to get involved will depend on a bank’s starting point and ambitions. To guide banks interested in the RIA sector, we summarize three key topics:
- the market conditions and forces propelling the rapid growth of the RIA segment and, in turn, the rise in acquisition multiples
- ways that banks can add value as strategic acquirers
- questions that bank executives should answer to inform their RIA strategy
RIA assets and acquisition multiples have been rising fast
RIAs have been the fastest-growing category in the US wealth management market—achieving 12 percent annual growth in assets since 2016, versus 7 percent for all other traditional advisor-centric models (excluding direct brokerages and robo- and remote-advisory offerings). Unlike some other traditional advisor-centric wealth management models, these independent firms focus primarily on providing advisory services (earning recurring fees paid by clients), and not on selling brokerage products with commissions and product-based revenues.1RIAs may contract with a broker-dealer to book products with commissions (i.e., hybrid RIAs), but advisory fees typically make up 90 to 100 percent of their business.
Observers on the sidelines typically admire the overall growth rates, but they miss two underlying dynamics that are reshaping the RIA landscape:
- Consolidation at the top. The largest RIAs are approaching institutional scale, with 15 retail-oriented RIAs eclipsing $20 billion in client assets in 2020, up from eight firms in 2016. The average size for the ten largest RIAs grew 2.4 times during this period.
- Fragmentation at the bottom (and middle). Growth in the number of RIAs is accelerating. More than 2,000 of today’s 6,000 retail-focused RIAs were created since 2016, and about 700 new RIAs are started each year. New RIAs are growing in team size, as larger advisors and teams break away from brokerage firms. (The average wirehouse breakaway in 2020 had twice the assets of those in 2016.)
Unsurprisingly, these trends have sparked interest among financial sponsors. Three-quarters of Barron’s 2020 Top 20 RIAs are now owned partly or wholly by private-equity firms or other financial institutions. These investors are betting on three tailwinds for growth: continued advisor movement, strong client retention, and profitability of the model.
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The movement of advisors to RIAs is still accelerating
Over 1,600 advisors join the RIA channel (independent broker-dealers and banks) annually, launching about 700 new firms and bringing with them roughly $180 billion in client assets.2Form 5500 ADV filings; US RIA marketplace 2020, Cerulli & Associates, cerulli.com. Conventional industry thinking holds that advisors leave brokers and banks to keep more of their revenues. However, higher payouts have been available for decades and cannot fully explain the recent acceleration of the trend. Three additional factors contribute to ongoing advisor movement:
- Aging advisors are looking at the RIA channel as the best way to monetize their business. Half of all client assets in the RIA channel are handled by advisors over 55 years old. RIAs are an attractive destination for such advisors: RIA acquisition multiples for top advisors (those with books over $1 billion) are two to three times higher than retire-in-place incentives at broker-dealers (Exhibit 1).
- Advisors believe they can grow more quickly outside of broker-dealers, and the rewards for growth are greater. A majority of breakaways cite growth opportunities as a major factor in their decisions.3US RIA marketplace 2020, Cerulli & Associates, cerulli.com. Moreover, we find that advisors perceive broker-dealers as having lagging internal referral programs (for example, compared with those of RIA custodians) and subpar marketing support versus what they can source independently.
- Technology and services firms, working in conjunction with the major custodians, have lowered barriers for advisors to launch their own firms. Advisors believe they can procure similar or better technology and services than what is provided by legacy broker-dealers, as growth in wealthtech solutions enables advisors to replace core broker-dealer technology for about five basis points of assets annually. Over 80 percent of advisors who are considering leaving a broker or bank cite flexibility to choose technology as a moderate or major factor.4US RIA marketplace 2020, Cerulli & Associates, cerulli.com.
Investors are voting with their wallets
RIAs enjoy the highest customer satisfaction of any wealth management model. Therefore, it is no surprise that breakaway advisors manage to retain 70 to 90 percent of client assets during transition.5McKinsey Financial Decision Maker COVID Impact Survey 2020.
RIAs are a profitable business
Average pretax margins for RIAs over the last five years have hovered in the midtwenties, matched by wirehouses and almost twice as high as average pretax margins for other broker-dealers. Top-quartile RIAs typically earn margins around 40 percent.62020 elite RIA study, InvestmentNews, 2020, research.investment.com. This higher profitability is primarily the result of RIAs adopting a payout model different from that of broker-dealers: RIAs much less often use grid-based payout structures and far more often rely on salary-plus-bonus models.
Private-equity investment has increased valuations for at-scale RIAs. Recent transactions were priced approximately 40 percent higher than five years ago, with faster-growing, at-scale RIAs priced at high-teen earnings multiples.7M&A valuation and deal structure: Insights from leading serial acquirers, Fidelity, 2019 and 2020, institutional.fidelity.com. Financial sponsors often view these RIAs as a roll-up platform, where the largest RIAs acquire smaller firms and consolidate the market (making about 200 sub-acquisitions annually).
Still, it’s no surprise that many banks are taking a hard look at RIAs as they look to grow recurring fee-based businesses and deepen client relationships. Quickly achieving scale in wealth management is important for capital investment at many banks, in addition to core retail digitization initiatives and cloud migrations. A case in point is Silicon Valley Bank, which acquired Boston Private for about $900 million. Between the deal announcement and closing (from January to July 2021), the bank added $10 billion in market cap, for a total shareholder return of 43.5 percent, versus about 25 percent for the S&P 500 Financials Sector Index.8Carleton English, “SVB Financial stock is up 57% in 2021: Here’s why Silicon Valley’s favorite bank still has room to grow,” Barron’s, June 8, 2021, barrons.com.
Banks’ buy-or-hold dilemma
Given that, in theory, acquiring an RIA could accelerate banks’ strategies, bank executives are facing a dilemma: Should they buy into the exciting RIA space at high multiples or stay away? Answering this question requires understanding whether a bank can create value relative to financial sponsors and, in turn, be a more competitive bidder.
We believe that, in general, banks have two important revenue growth levers that financial sponsors, who mainly focus on cost levers when underwriting deals, cannot match. The first lever is revenue growth from provision of banking services to the installed high-net-worth (HNW) client base. The second is organic growth acceleration from referrals of existing HNW clients from across commercial and, to a lesser extent, retail banking franchises. Additionally, banks can deploy the same cost levers relied upon by financial buyers.
The service-provider advantage
A fundamental advantage that banks possess is their ability to provide RIAs with banking services—a rapidly growing business with a significant white space. In fact, the share of RIA advisors who offer their clients banking services (such as mortgages, securities-based lending, and cash management) has doubled from 2014 to 2020.9Cerulli & Associates, 2016–20. However, at 7 percent, this share is significantly lower than the 50 percent share of wirehouse advisors, who have been working on banking adoption for over a decade. Importantly, successful banking offerings from wirehouses—unlike their investment offerings—can be built on a closed architecture, maximizing profitability for the wealth managers with affiliated banks.
Banking services among RIA advisors are expected to accelerate further, propelled by client demand (especially from wealthier and younger clients who prefer to consolidate investments and banking) and advancement of digital-first banking solutions, which can be easily integrated into the advisor workflow. For instance, Goldman Sachs’s GS Select offers digital loan origination, Envestnet offers Advisor Credit Exchange, and Orion offers cash management and credit capabilities jointly with Focus Financial.
While offering banking services is becoming easier for independent RIAs, banks have an advantage on the profitability of such services, as they already possess the required infrastructure and can provide banking services to advisors and their clients directly (and will not need to share revenues with intermediaries such as wealth technology platforms). Deeper penetration of banking will also lead to stickier and deeper relationships with clients, creating a virtuous cycle as advisors look to offer these services to other clients. However, banks can achieve these gains only by offering competitive rates on banking products versus those of third parties. RIA advisors will often seek the best deals for their clients, even if banking does not fall under the fiduciary umbrella.
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The high-net-worth-client advantage
Banks possess another advantage over private-equity buyers—their significant but as yet untapped HNW client bases. According to Finalta by McKinsey data, many banks have attempted to start wealth relationships with those clients through captive broker-dealers but achieved limited success; top-quartile penetration at regional banks reaches just 15 to 20 percent. Their success has been held back by a combination of internal barriers—disjointed and siloed businesses that fail to attract top industry talent—and the perception among HNW clients that banks are not strong investors. Many banks thus find themselves with more potential clients than they can successfully capture.
A strong process for lead identification and an institutional referral process can significantly accelerate the growth trajectory of an acquired RIA. Success requires training frontline commercial and retail bankers focused on private clients, deploying data and analytics to identify clients, and carefully managing channel conflicts with existing wealth offerings. Lessons can be drawn from custodians, who have been referring as much as $40 billion per year from their HNW and ultra-HNW clients to a preferred list of RIAs.
Credible lead generation would help differentiate banks from a crowded field of would-be buyers. Independent advisors have demonstrated great willingness to pay for referrals, using tactics such as buying leads from digital marketing affiliates (Smartasset, for example) with a one-to-two-year payback or paying up to 25 basis points of assets annually to custodians for referred clients. Importantly, credible lead generation can be a more reliable long-term advantage than reliance on referrals from third parties.
The value creation potential
Successfully capturing revenue synergies from banking and referrals can lead to significant incremental value creation, which allows banks to bid more competitively for RIAs. To quantify the value creation potential, McKinsey has developed a “fair-value model” for RIAs based on the detailed P&Ls of RIAs’ historical performance. We have examined two different types of RIAs: top-quartile performers and those in the other three quartiles in terms of their EBITDA margins (averaging 40 percent and 16 percent, respectively).
Our financial modeling suggests that through active ownership—banking revenue synergies and client referrals—banks can increase the value of an RIA by 19 to 35 percent and add approximately three turns to EBITDA multiple accretion (Exhibit 2). This significant value creation sets bank buyers apart from financial sponsors, who typically underwrite deals based on value creation from cost synergies alone.
2
Seven questions to answer
As banks start exploring inorganic opportunities in the RIA space, their executives should be prepared to answer seven critical questions:
- How do we position ourselves as the most attractive buyer in the environment where high-performing RIAs have multiple strategic and financial-sponsor bidders?
- What markers of culture must be in place for an RIA to ensure a strong cultural fit? Markers of culture could be community focus, customer experience focus, diversity, and track record on environmental, social, and governance issues, for example.
- What is the optimal governance for an acquired RIA? This would balance independence and flexibility with bank risk and performance management rigor.
- What digital, data, and analytics capabilities do we need to put in place to realize revenue synergies (for example, from banking integration or identifying client leads), and how can we accelerate deployment of these capabilities (for example, by partnering with fintech)?
- How should the client referral process to RIAs be designed to ensure positive client experience and high success rates?
- What field training, engagement, and support do we need so we can accelerate the timeline to capturing revenue synergies?
- Beyond achieving the organic synergy opportunity, how can we scale our acquisition by making the acquired RIA an attractive destination for advisors we recruit and for follow-on acquisitions?
For banks aiming to expand their fee revenues and profits by building wealth management franchises, M&A of RIAs can provide an attractive path with an accelerated timeline, versus investing in organic growth of existing operations. As active and strategic acquirers, banks have potential to add value in unique ways, partially offsetting risks associated with elevated valuations. Therefore, bank executives should not simply forgo the attractive RIA M&A landscape due to the strong competition. Instead, they should carefully analyze this opportunity, taking into account their bank’s other uses of capital, its readiness to capture revenue synergies, the governance required for the acquired RIA to be successful, and the cultural fit between the firms.
