Chris Koegel - LPL Financial Holdings, Inc. Mark Stephen Casady - LPL Financial Holdings, Inc. Dan Hogan Arnold - LPL Financial Holdings, Inc. Matthew J. Audette - LPL Financial Holdings, Inc..

Chris Charles Shutler - William Blair & Co. LLC Chris M. Harris - Wells Fargo Securities LLC Steven Chubak - Nomura Instinet William Raymond Katz - Citigroup Global Markets, Inc. Devin P. Ryan - JMP Securities LLC Conor Fitzgerald - Goldman Sachs & Co. Kenneth B. Worthington - JPMorgan Securities LLC Alex Kramm - UBS Securities LLC.

Good day, ladies and gentlemen, and welcome to the LPL Financial Holdings Fourth Quarter and Full Year 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Mr. Chris Koegel, Senior Vice President and Head of Investor Relations. Sir, you may begin..

Thank you, Tekia. Good afternoon and welcome to the LPL Financial fourth quarter 2016 earnings conference call. On the call today are Mark Casady, our Chairman; Dan Arnold, our President and CEO; and Matt Audette, our CFO. Mark, Dan, and Matt will offer introductory remarks, and then we will open the call for questions.

We ask that each analyst limit their questions to one question and one follow-up. Please note that we have posted our earnings release and supplementary files on the Events & Presentations section of the Investor Relations page on lpl.com.

Before turning the call over to Mark, I'd like to note that comments made during this conference call may include certain forward-looking statements concerning such topics as our future revenue, expenses, and other financial and operating results; improvements in our risk management and compliance capabilities; the regulatory environment and its expected impact on us; industry growth and trends; our business strategy and plans; as well as other opportunities we foresee.

Underpinning these forward-looking statements are certain risks and uncertainties.

We refer our listeners to the Safe Harbor disclosures contained in the earnings release and our latest SEC filings to appreciate those factors that may cause actual, financial or operating results or the timing of matters to differ from those contemplated in such forward-looking statements.

In addition, comments during this call will include certain non-GAAP financial measures governed by SEC Regulation G. For a reconciliation and discussion of these measures, please refer to our earnings press release. With that, I'll turn the call over to Mark..

Thank you, Chris, and thank you to everyone for joining today's call. Before turning the call over to Dan and Matt, I want to offer a few opening remarks. Following a tough start to 2016, we had our best recruiting year ever.

We strengthened our service experience, made ClientWorks available to all of our advisors, and made significant progress on DOL fiduciary rule implementation, and we combined strong asset and gross profit growth with disciplined expense management to grow earnings per share by 22%.

As I reflect back over my 14 years at LPL, I feel fortunate to be part of the growth and transformation of our business. The infrastructure and risk management investments we have made over the last few years provide a solid foundation to drive the next phase of growth for LPL.

It was in thinking about this next phase ahead that I decided the timing was right to retire now. I am grateful to close out my career at LPL with a year that has been a high note in many ways.

With so much progress made, I can't help but be optimistic about the road ahead for LPL, even more so because the company is in the experienced and capable hands of Dan Arnold. I've known Dan for more than 10 years in his role as President, CFO, and Head of Strategy at LPL. Before that, he built his prior broker-dealer, UVEST, into a market leader.

Over the years, I've come to respect and admire Dan's passion for serving advisors and institutions, his sharp intellect and phenomenal work ethic, and his exceptional drive to win in the marketplace. We've also built a strong management team with deep experience in the financial services industry.

You can see the positive impact these leaders are having on our performance in our service and technology improvements, lower risk profile, and expense trajectory. With the business momentum we have and under the leadership of Dan and our seasoned management team, LPL is well positioned for the growth phase ahead.

With that, I will turn the call over to Dan..

Thank you, Mark. I'm grateful for your 14 years of leadership at LPL. It's been truly an honor to serve on your team, and I wish you the very best in retirement. It's great to be back speaking with everyone on the call today.

I'm energized to lead LPL as we deliver a great experience for advisors and their clients, an engaging environment for our employees and long-term value for our shareholders. We had a strong year in 2016 despite some challenges in the environment.

We stayed focused on priorities that matter most to our advisors, such as improving the advisor experience by enhancing our service, delivering new technology, and evolving our product and platform solutions. We did this by expanding and strengthening our service organization and rolling out our ClientWorks technology platform to all of our advisors.

We also reduced pricing on our centrally-managed advisory platforms to drive adoption, and we introduced our No Transaction Fee platform for our rep-driven advisory solution. We also created our Deposit Cash Account, or DCA, which now has over $4 billion of client cash in FDIC insured accounts.

These business enhancements help us to better serve advisors and their clients while also improving our financial outcomes. The progress we've made throughout 2016 helped us to build momentum and increase our pace of growth as we moved through the year.

Total assets at year-end were $509 billion, up 7% from the prior year, and our advisor base grew by 323. The fourth quarter was our strongest growth quarter of the year with net new advisory assets of $4.8 billion and net new advisors of 192.

Our full year production retention finished at 97%, excluding the impact of an institutional client that we previously announced was acquired and departed in September. Our assets also continued to shift towards advisory, which made up 42% of our total assets at the end of the year.

This asset growth and ongoing shift to advisory contributed to our full year gross profit of $1.4 billion, up 3% from the prior year. So 2016 was a good year for growth. Our focus on expense management in 2016 enabled us to make significant business investments while also lowering expense growth.

As a result, we kept our full year core G&A growth below 1% and total G&A was down slightly. This low expense growth created operating leverage which drove EBITDA and EPS growth well above gross profit growth. EBITDA was $508 million, up 12% year-over-year and earnings per share was $2.13, up 22% year-over-year.

It was a strong year for our financial performance as well. There's one more point of context on 2016. You may have read that we recently separated from a couple of clients, and while reports were made in the fourth quarter, the advisors and related assets are likely to move in Q1 and Q2. It may be helpful for us to remind you of our principles here.

We allocate our resources to practices where we are best aligned and that make the most use of our services. We believe this will drive the best value for our advisors, their clients, and our shareholders. From time to time, we have relationships that are not a good fit strategically, operationally, or economically.

In these cases, we may come to the mutual conclusion that it is better to part ways, and we wish them well. Matt will give you a sense for the financial impact of these separations in his remarks. Now turning to 2017, our key priorities are growing our core business and executing with excellence.

Each of these priorities has a few elements which I want to elaborate on further. Let me expand on our first priority, growing our core business. We benefit greatly from the growing markets we have chosen to pursue and the scale we have built. We continue to see strong secular trends to independents and greater use of advisory services.

And our scale allows us to invest to support our advisors and win in the marketplace while generating attractive economics. As we work to drive growth, we are focused on continuing to improve the advisor experience and enhancing the strategic capabilities we offer to our advisors and their clients.

As we think about continuing to improve the advisor experience, we know service, technology, and risk management drive the majority of our interactions with advisors. They are critical to creating operational efficiencies that help advisors lower their cost and have more time to serve their clients and grow their businesses.

On the technology front, now that ClientWorks is available to all advisors, it will be the gateway that integrates all the technology we have rolled out over the past couple of years. We believe this will help improve advisors' adoption and their experience and enable them to make their practices more efficient.

We also see further opportunities to leverage automation to improve our service and to use data to proactively anticipate and address advisor and retail client needs. The changing regulatory environment is another critical part of the advisor experience, so let us now discuss how we are helping our advisors navigate regulatory change.

The anticipated implementation of the DOL fiduciary rule has driven significant change, and we have been working to lead the industry with enhanced solutions for advisors and their clients. Our approach has been to preserve choice for investors while supporting our advisors by taking on as much of the implementation work as possible.

We have been working closely with advisors to prepare for changes to products, processes, documentation, and supervision. This proactive approach to implementing the DOL fiduciary rule has been well received by our advisors and helpful to our overall recruiting efforts.

While the work we have done has prepared us for implementation, it now appears the DOL fiduciary rule may be delayed. Regardless of the ultimate timeline or form of the rule, we believe it is important for the industry to pursue a higher standard of care for retail investors.

So we will continue to move forward with many of the previously announced activities and policy changes that we believe are good for advisors and their clients regardless of the outcome of the rule.

For instance, we have already standardized our variable annuity and alternative investment commissions across sponsors, and we are continuing to work on our design for standardized mutual fund commissions. We're also rolling out our Guided Wealth Portfolios automated advice solution this quarter.

Even though the industry may potentially pursue different paths, we feel prepared to help our advisors and institutions navigate the regularly change successfully. We're also focused on enhancing the strategic capabilities we offer advisors and investors.

With most of our asset growth coming through our advisory solutions, we want to streamline and automate processes for our advisors. We also want to differentiate the retail investor experience through more functionality and lower costs.

Consistent with this strategy, as previously announced, we further reduced our centrally managed platform pricing last month.

We also plan to upgrade our advisory capabilities over the coming years by expanding our centrally managed platform options, streamlining workflows to open new accounts and convert brokerage accounts to advisory when appropriate for investors and adding new billing features like house-holding and asset-based transaction pricing.

We believe these actions will drive growth in our core business, particularly at this time when our differentiated capabilities and scale can help us capitalize on industry change. We saw evidence of this with some notable fourth quarter wins.

Beyond recruiting, we believe industry disruption could create opportunities for more attractively priced M&A activity. We look forward to opportunities across this landscape to grow our core business in 2017 and beyond.

Let me now expand on our second priority, executing with excellence, which I would describe as a relentless pursuit of efficiency while instilling quality and innovation across our operations.

Starting with efficiency, we plan to continue to be disciplined on expenses, and this is reflected on our 2017 core G&A outlook of $710 million to $725 million. We believe we can achieve this limited increase in expenses by balancing investments to drive growth with a focus on productivity and efficiency.

These investments including service and technology help LPL and our advisors to improve our operations and be more efficient. At the same time we are managing efficiency, we're also working to drive quality and innovation throughout our operations.

Quality applies to the service and technology we provide our advisors, the solutions we provide retail investors and the experience we provide our employees. We are also focused on innovating by enabling our teams to learn faster, apply what we learn and continuously improve and enhance our business.

To close out my remarks, I'm honored and excited to lead LPL together with a great management team. Their deep industry experience leading world-class operations will be instrumental in helping us succeed in our next phase of growth. We believe our priorities of growing our core business and executing with excellence will position us well for 2017.

If we succeed in delivering on these priorities, we will position our advisors for success, which in turn drives our growth. We believe combining that growth with disciplined expense management will drive operating leverage and create long-term shareholder value. With that, I'll turn the call over to Matt..

a Key Metrics presentation that we have posted to our Investor website. We have taken our key financial results and metrics, and we presented them visually. We hope it makes it easier to digest our results and see trends over time. Let's now turn back to Q4. Our gross profit was $347 million, flat from the prior quarter.

This was primarily driven by higher cash sweep revenues, offset by lower fees from nonrecurring Q3 items. Looking at commissions, they were $423 million, down $8 million or 2% sequentially. This was primarily driven by a $7 million decline in sales commissions mostly due to lower fixed annuity sales.

As for advisory fees, they were $325 million, up $3 million or 1% from Q3. Advisory fees are mostly built off prior quarter balances, so Q3 market growth in recruiting benefited these revenues. Looking ahead to Q1, the pricing reductions to our centrally managed advisory platforms went into effect in January.

We believe this pricing strategy will drive asset growth and benefit our gross profit over time, as these are some of our most profitable platforms. However, in the near-term, this previously announced price reduction will lower gross profit by approximately $3 million per quarter starting in Q1.

Turning to payout rate, it was 86.4% in Q4, down from 87.2% in Q3. This was mostly due to a lower base payout rate, as advisory fees grew faster than brokerage commissions. As for Q1, advisory production bonuses reset at the start of the year so we expect our payout rate to decline sequentially.

Moving on to asset-based fees, which include sponsor and cash sweep revenues. Sponsor revenues were $95 million, down $2 million from Q3, as average billable assets decreased. As for cash sweep revenues, they were $49 million, up $8 million from Q3.

The growth in cash sweep revenue was primarily due to rising short-term rates, but we also benefited from higher balances which increased to approximately $31 billion, up $2 billion sequentially. Looking at Q4 cash sweep yields, our ICA yield was 73 basis points, up 11 basis points from Q3.

The largest driver of our ICA yield is the Fed Funds effective rate, but we also have some of the portfolio indexed to one-month and three-months LIBOR as well as a small amount of fixed rate balances.

And while Q4 average Fed Funds rates increased 6 basis points sequentially, driven by the mid-December rate hike, average LIBOR rates increased by a greater amount, and this overall increase in short-term rates was the primary driver of the 11 basis point increase in ICA yields in Q4.

As for our money market yield, it was 43 basis points, up 1 basis point sequentially. Higher rates benefited our yield, offset by money market reform which drove balances to lower-yielding government funds at the end of Q3. And our DCA yield was 39 basis points, up 3 basis points sequentially, driven the mid-December Fed Funds target range increase.

Now I want to spend a couple of minutes on our cash sweep yield outlook, starting with ICA. We expect our ICA yield will primarily be a function of short-term interest rates along with the market for retail account deposit rates. With the mid-December Fed rate hike, we saw a portion of that benefit already in Q4 and expect the remainder of it in Q1.

As for market deposit rates, they remained relatively flat following the mid-December 2016 rate hike. So we kept our client deposit rates flat, too. For Q1, assuming no change to the current short-term interest rates or our deposit rate, we anticipate ICA yields in the low-80 basis point range.

For DCA, the revenue we earn is based on a fee per account rather than actual yields, and that fee is based on the Fed Funds target range. Based on the current target range in DCA balances, we anticipate our Q1 DCA yield to be in the low-50 basis point range.

With future rate hikes, we would expect our yield to increase by at least half the pace of the Fed Funds target range. Our max yield works out to be around 130 basis points, so we feel good about our additional upside in DCA revenues from rising rates. For money markets, these are third-party funds, so the product manufacturer controls the rates here.

And if history is a guide, money market rate growth could lag with short-term interest rate growth. We saw this happen following the December 2015 Fed rate hike. So we expect those rates to rise, but it's difficult for us to predict where they will land in Q1. I also want to note that our max money market yield has increased to about 80 basis points.

Now turning to transaction and fee revenues, they were $103 million in Q4, down $6 million or 5% sequentially. Recall that, in Q3, we had $7 million of seasonal conference revenue from Focus and $5 million of non-recurring account termination fees.

Excluding those items, Q4 would've been up $6 million, or 7% sequentially, mostly due to higher transaction volumes. Let's now move on to expenses, starting with core G&A. In Q4, core G&A expense was $181 million, up $6 million from Q3.

This was primarily driven by technology investments, DOL fiduciary rule implementation costs and seasonal items as well as some relocation expenses associated with moving to our new Carolinas campus. Looking at full year core G&A for 2016, we came in at $700 million which was at the low-end of our outlook range.

That is a growth rate of less than 1%, well below growth rates of prior years. Additionally, our 2015 core G&A total of $695 million was an adjusted number. If we look at those results on an unadjusted basis, 2015 core G&A would've been $708 million. So our total core G&A for 2016 was down 1% on a comparable basis.

We were able to achieve these results while continuing to invest in key areas, like service and technology, automation and efficiency, risk management and DOL rule implementation. This reflects a lot of hard work by our teams, and we are proud of these results. As for 2017 expenses, our philosophy has not changed.

We plan to stay disciplined on expenses, prioritizing investments that drive growth and help us to be more productive. Our 2017 core G&A outlook of $710 million to $725 million translates to a modest growth rate consistent with our expense management approach. Moving on to Q4 promotional expenses, they were $36 million, down $7 million sequentially.

Our recruiting success increased transition assistance and we had a seasonal increase in marketing. Both of these items are more than offset by the decline in conference expenses as we had our Focus conference in Q3.

Looking ahead at promotional expenses, I just want to remind you that the majority of our transition assistance is in the form of forgivable loans, and that expense is incurred over time. So our recruiting success in Q4 will lead to a naturally higher transition assistance expense in Q1 even before any additional recruiting.

For some context, I would highlight Q4 transition assistance from loan amortization was $13 million, up $1 million sequentially and $2 million year-over-year. As for Q1 conference expense, we have both our MASTERS and SUMMIT conferences in the first quarter, rather than split between Q1 and Q2 like we had in 2016.

So we anticipate a sequential increase in conference expense of approximately $10 million in Q1. Moving to regulatory-related expenses for Q4, our total was $6 million, up $2 million sequentially. Our full year 2016 regulatory-related expenses were $17 million, half the $34 million we had in 2015.

Looking ahead to 2017, we believe the efforts we have made have lowered our risk profile and that our regulatory-related expenses will be closer to our 2016 total than our 2015 total in the future, but they remain quite difficult to predict, so it's hard to be more precise than that.

Turning to CapEx, we spent $30 million in Q4, a sequential decrease of $11 million. For the full year, we had $128 million of CapEx, including $51 million of investment related to our Carolinas campus and the remaining $77 million was nearly all technology investments.

In 2017, we anticipated facilities-related CapEx to be mostly maintenance, and therefore, a small fraction of the 2016 total. At the same time, we plan to increase technology investments to enhance our advisory and digital capabilities, drive growth, and increase efficiency.

Taken together, we expect total 2017 CapEx to be down slightly from our 2016 levels. Turning to taxes, our tax rate for Q4 was 36% as we benefited from the release of some state tax reserves.

Going forward, we expect our tax rate to be in the upper 39% range prior to any unique items which may occur from time to time in the tax area, so there could be some variability here, especially on a quarterly basis. Next, let's turn to capital management.

Our Q4 credit agreement net leverage ratio finished at 3.4 times, down from 3.6 times in the prior quarter. Last quarter, we lowered our target leverage to a range of 3.25 times to 3.5 times, and we were able to reach that range through earnings growth.

Going forward, we are maintaining our target range as we feel it is the right mix of balance sheet strength and flexibility to deploy capital as opportunities arise. Just note that we could stretch slightly above the range or float below it depending on the capital deployment options we see at the time.

Next, let's talk about our debt structure going forward. We feel good about our current structure, but I would note that the credit environment has improved, so we are actively monitoring the markets and making sure we are prepared to take advantage of opportunities should they materialize.

We are also prepared to deploy capital into good growth options, whether organic recruiting or attractive M&A, and we continue to view our stock as an attractive buy at the levels it has been trading recently. In closing, we are pleased to have delivered strong business and financial results in Q4 and for 2016.

We remain focused on growing assets and gross profit while also managing expenses to create operating leverage. We are pleased that this worked well this year, converting a 3% increase in gross profit into 12% EBITDA growth and 22% EPS growth. And to echo Dan's comments, we could not have done this without Mark's thoughtful leadership and steady hand.

Looking ahead, I'm excited to work with Dan on LPL's next phase as we seek to drive growth, stay disciplined on expenses, and create long-term value for our shareholders. With that, operator, please open the call for questions..

Our first question comes from Chris Shutler with William Blair. Your line is now open..

Hey, guys. Good afternoon..

Hey, Chris..

So first, congrats, Dan, on the new role. I guess first question is on fees. Your average corporate advisory fee today I think is just over 100 basis points, we obviously all know that there's a couple guys out there that are closer to 30 basis points – Schwab and Vanguard, in particular – with some of their new solutions.

So there seems to be increasing talk around the industry around fees, capping fees, discrete fees for different services like financial plans.

So with all that in mind, do you feel like the gap between that roughly 30 basis points and your 100 basis points is too large? Or – you talked earlier about what all you're doing to reduce fees for the end client, but just how do you think about that gap? Thanks..

Thanks, Chris. So, yeah, I think you've got to look at the holistic marketplace and look at the segments of potential end investors, and certainly there's a group of end investors that either were historically discount-oriented trading clients and/or smaller clients who may be looking for a purely digital experience.

And there's a certain price point out there, as you say, in the 30 basis point range where you can interface and get some simplified asset allocation support and help, and certainly, there's a price point in that range.

You see variances in the 30 basis point to 50 basis point range depending on what you wrap around that in terms of additional service or support.

That is one of the reasons why we are rolling out a robust solution to ensure that our advisors, should they have the opportunity to serve that segment of the marketplace, have a competitive tool that, from a capability and a price point standpoint, to provide that type of value.

And I would say potentially differentiate their value by wrapping around at a local level their support and service to that digital experience. And so, I think that's how you address that segment of the marketplace.

There is still a segment that is in need of more complex financial planning, more sophisticated and complex advice that runs a gambit of everything from asset allocation/portfolio construction to financial planning to even just helping one manage through the ups and downs and the emotions of a career or a desire to achieve a lifetime of goals and objectives.

And so, I think in that case there's a different price point in the marketplace for that. And I think that's where you see more of 100 basis points range, if you will. And there's certain variances into how that's packaged and how that's offered into the marketplace.

And we still think there's a certainly viable place for that type of broad-based value and certainly pricing.

That said, I think it's fair to consider that as the marketplace moves forward with new technology, certainly puts pricing pressure on advisors' practices, and that's why we've constantly got to work to help enhance their value proposition, enhance the value of their advice and the emphasis on their advice such that it creates and helps them either sustain that pricing point or enables them efficiencies in their practice to lower the price point and increase the scalability of their practice..

Okay. Thanks.

And then just on a different note, Matt, the core G&A guide for 2017 which I know has not changed, at $710 million to $725 million, what would cause you guys to be at the lower versus upper end?.

Yeah, Chris. And I think that kind of building on a few of the points that Dan made, I mean we're focused on a combination of investing in the business for growth, whether it be capabilities, advisor experience, and delivering on productivity and efficiency. And those are the two things that really drive overall core G&A.

So I think if we ended up landing on the lower end, it would be a combination of our productivity and efficiency. We exceeded our goals. Or in a rigorous approach to make sure that the investments we're making to improve the advisor experience and other items, and that we made some judgment calls based on what the returns were on those.

So I think what I'd take away from it is we have a rigorous process to think through every dollar we spend because we know it's shareholders' money and we want to create value..

Okay. Thank you..

Thank you. Our next question comes from Chris Harris with Wells Fargo. Your line is now open..

Thanks. Hey, guys. So we all know that commissions are down a fair amount the last few years as is advisor productivity.

Really this seems like not too big of a deal if advisors are successfully transitioning to advisory, but I'm wondering, do you have some advisors that are having difficulty making this transition? And if so, can they make the model work at this level of productivity?.

Yeah. So, Chris, let me answer that one for you. Again, I think you've got to look at the spectrum of the advisors out in the marketplace and then also considering what they've been managing through over, call it, the past couple of years.

Certainly, there has been headwinds on the commissions business whether that be the uncertainty around the regulatory environment, whether that be certain sentiment around that type of brokerage account or certain product types within that spectrum.

And so, I think some of that headwind is cyclical in nature and I think the industry or I'll say in particular LPL in terms of standardizing certain commissions and creating an economic construct around those products take down some of that negative sentiment and certainly create a more appealing solution for the investor.

So I think those things help as advisor continues to use those types of solutions in helping and supporting investors achieving their goals and objectives. I also think the uncertainty around the regulatory environment created a significant headwind that we don't think sustains itself with clarity of both solutions and of the guidelines.

I think you will see a rebasing, if you will, in terms of healthy mix and utilization of both advisory and brokerage and where that's been skewed heavily towards advisory in the last year, year and a half.

We believe that mix will sustain itself somewhere around two-thirds advisory, a third brokerage and I think that also will be helpful as you go forward when you think about productivity on commissions. And so when you think about our advisors and 42% of our assets being in advisory and 60% in brokerage but most of the new flows going to advisory.

I think, on average, you could see where some help, if you will, on the other side of those headwinds from brokerage would support productivity in the advisors practice.

I also think there's administrative work as they pivot and make adjustments relative to the regulatory environment adjusting their practices to a more significant use of advisory solutions than brokerage and that can have some short-term headwind on productivity as you're working on and allocating your time perhaps in a different way than you would in a more normalized time where you could allocate more time to gathering successfully new assets.

All that said, I think if you look at the underlying success that they've had in attracting new assets in the advisory solutions, it tells you that their practices and their solutions are still appealing and still attractive in terms of both the value they provide to the investor as well as how competitively they're priced.

So we still have great confidence that the independent model is the optimal way to deliver and provide advice and our seasoned financial professionals at a local level have a great opportunity to differentiate themselves and continue to win going forward..

Got you. Thank you..

Thank you. Our next question comes from Steven Chubak with Nomura Instinet. Your line is now open..

Hi. Good afternoon. So I wanted to kick things off with a question on recruitment. So the net new advisor adds in the quarter were quite impressive.

I just wanted to get a sense as to how the backlog of new recruits is shaping up and also how the election and possible DOL delays have maybe impacted the backlog or advisors' mindsets in terms of the timing for when they would consider a move..

Yeah. So maybe there's a couple of questions there. Let me field the DOL one first and perhaps that will also help you with your first question. If not, please ask it again..

Sure..

So I mean, clearly the – if you think about the DOL, we actually believe that the industry will adopt a new fiduciary standard or rule. So it's more around not if but when. And we believe that that change will certainly lead to disruption in the industry, which one then would logically expect to see consolidation and advisor churn come from that.

And so, we continue to be poised and ready for that time and that opportunity.

That said, I think if you look back at fourth quarter, it still reinforces that we have a great model and we're winning in the marketplace, both in terms of the net new assets and advisors and we feel good about that momentum that we have coming out of fourth quarter, going into first quarter.

We feel good about the pipeline that we have and we are focused on executing our plan. We shared with you in our remarks that our strategy is built – one of the elements is built around growing in our core markets and we have a plan that we are clearly focused on making sure that we execute as we go throughout the year..

Thanks, Dan. And, Matt, maybe switching over to you. Just appreciated some of your remarks on the capital management priorities that you outlined.

One of the interesting elements that we've been hearing more about is the possibility that you could evaluate your debt stack and the Term B loans carry a spread of around 350 basis points, 400 basis points above LIBOR. You mentioned possibly exploring a refinancing on that front.

And I just want to get a sense as to where those loans trade today or at what level you could refinance, and then just bigger picture, how you rank the capital management priorities that you outlined..

Yeah. Sure, Steven. So I think on the debt markets, as you can imagine, we monitor them quite closely. I mean, as I said in the remarks and in your question, they are quite attractive right now. So I think there's definitely an opportunity to reduce the cost of our current structure. I think you quoted our rates correctly there.

But there's also an opportunity to think longer term whether it's moving at our maturities, diversifying our funding sources, improving liquidity even further. So I think there's a host of choices out there. Some of them could be less P&L benefit in the short-term but better P&L benefit in the longer term depending on the type of structure out there.

So I think the key I would leave you with here is that we're monitoring it just to make sure we can take advantage of if there is an opportunity and I think you've summarized the opportunity well.

I think on your second question, just building on from a capital allocation priority standpoint, it really is grounded and centered in having balance sheet strength and having the ability to deploy capital, drive value for shareholders.

And I think on the balance sheet strength side, the key is we want to have a strong balance sheet that supports our business growth, doesn't distract from our business growth. Right? And we've had a little bit of that a year ago. Sitting here today, we've lowered our target leverage range to 3.25 times to 3.5 times.

Our view is that's the leverage ratio that helps support business growth. And we got there in Q4 through earnings growth with no debt pay down. So I think just that gives us more confidence to deploy our excess capital. Now when we're deploying it, I'd focus in on two areas.

First and foremost, investing in it to grow the business and just thinking about the things that we're able to do in Q4, whether it be advisor loans for our recruiting or our investments in technology or CapEx.

Like, those are two big areas where, if we look at our total spend in 2016, they were record high years, and our plans for 2017 are to improve those even further. Spend more in technology and if we're successful in growing recruiting, we'd end up spending more in recruiting.

So I think investments in the business is key but just as important as returning capital to shareholders. As I said in the prepared remarks, we view our stock as an attractive buy versus our view of intrinsic value. So I think there's a lot of choices here.

Maybe I'd close it with just highlighting we've got $0.5 billion of cash sitting on the balance sheet. Our target of cash to maintain is more around $200 million. So I think there's about $300 million to deploy just using our targets. And that's how we think about it.

So hopefully that helps you understand where we are and, of course, I will update you next quarter on what we've done..

Extremely helpful. Thanks, Matt, for the detail..

You bet..

Thank you. Our next question comes from William Katz with Citigroup. Your line is now open..

Okay. Thank you very much. And, Mark, best of luck. Dan, best of luck. And Matt, thanks for the extra disclosure. Really appreciate all of that. I'd like to start with that and if I look at this supplement on page five, what I'm sort of struck by is the EBIT ROA and also the underlying expense that you have on that.

As you think forward, if rates don't improve from here, how do you think about the catalyst to driving greater overall profitability?.

Yeah, sure, Bill. I mean I think that chart that you're looking at does and I think it really captures a proof point for success in our overall strategy. It's just showing our overall asset base and our gross profit ROA and our expenses in those basis points.

So I think when I go back to a lot of things that Dan talked about in the prepared remarks, just growing our core business whether it be capitalizing on the growing market that we're in, improving the advisor experience, enhancing our capabilities, all of those things are going to lead to growth in the core business and, at the same time, executing with excellence, which is driving those efficiencies.

I think, ultimately, what the proof points that we get on that page is an increase in an operating leverage which improves the spread between the orange and the green line. So hopefully, that additional disclosure was helpful to you because we think that's the long-term proof point of success for us..

We can follow up offline, because I'm not seeing the same trend you're seeing there. The other question I have for you is that you'd mentioned that your max yield on money markets is now 80 basis points, and I think some of your competitors are probably a little bit less than 60 basis points.

And when you have a fair amount of pricing pressure on active management was 3 basis points, 5 basis points, 10 basis points for some equity fixed income mandates, how sustainable is that money market yield looking ahead?.

Yeah, sure. I think on the follow-up, Bill, it's probably not much follow-up needed. I was articulating what success would look like in the future. I wasn't describing the trends on the chart, so hopefully that helped ground why we think that chart's important.

I think on the cap, if you go back to where our cap on the money market funds, we had about $8 billion in there. It was about 50 basis points. About half of those funds went into the new DCA account which is a great account that gives the investors, in those accounts and with their retail retirement cash, access to FDIC insurance.

The cap on those particular funds happen to be lower, so the 80 basis points is really is the cap that were on the funds that remained in money market. So the cap didn't really change. It was just a weighted average of a bunch of funds, and that's the cap on the funds that were there.

So I think it hasn't moved, and I think when you look at what we're earning currently on money markets, we're talking probably a couple rate movements and then we'll be at about at the cap..

All right. Thank you very much..

Thank you. Our next question comes from Devin Ryan with JMP Securities. Your line is now open..

Hey, thanks. Good evening, everyone..

Hi, Devin..

Hi, there..

First question here just a couple lines within the commission bucket. Your mutual fund commissions declined a bit sequentially. I'm curious if that was a function of customers selling in the year-end? I think we saw that from some of your peers, and suspect maybe that helped the cash balances. So I'm curious if I'm reading that correctly.

And then just the decline in fixed annuity commissions – what's going on there? If you can provide and perspective, it would be helpful..

Yeah. I'll start with the mutual funds. I think Dan will probably take the fixed annuities. I think on the mutual funds side, I think when we look at trailing commissions overall, which I think maybe is where you're focused, we've seen a nice slow and small but steady increase in VAs and then an offsetting decline in mutual funds.

And I'd probably say two things there. One, keep in mind from the institutional client that departed, it was primarily brokerage assets, right? And the effect of that shows up on the commission side. And then second, just some context. Even the Q4 decline in mutual funds – those numbers are still above the Q1 and Q2 levels this year.

So maybe a little bit of a decline versus Q3 but still at a relatively reasonable level.

And then, Dan, on fixed annuities?.

Yeah. With respect to fixed annuities, there's two primary drivers. I think certainly you had growing headwinds throughout the year on fixed annuities as it relates to the uncertainty in the regulatory environment, more specifically with respect to the DOL rule, and so that certainly was a headwind that built as you went throughout the year.

So that's some of that sequential transition down in fixed annuity commissions.

The other and probably bigger driver is – and we see this, I don't know, maybe pretty consistently every year – where certain big product sponsors will have reached the amount of asset flows they wanted in those certain product categories at the end of third quarter, early fourth quarter, and they'll begin to dial back the desire for those asset flows.

So whether that comes in the form of reduction in commissions, changing of rates or even just stopping accepting new flows, that many times is an overlay in the fourth quarter relative to fixed annuities. And we certainly saw that occur with at least one carrier if not several more. So those are probably the biggest drivers of that shift..

Got it. Okay. That's very helpful. And then second question here. Just last year at the Investor Day, you guys spoke about, one, potential 2017 initiative as moving into the pure RIA custodian business just as an extension of the hybrid model where you've had a lot of success.

Clearly, this is a scaled business, and you guys need to find some areas where LPL can differentiate.

But I'm curious if you can provide any update around how you're thinking about this? Is this still an opportunity for this year?.

Yeah. We're still focused on our core markets, which is of course the traditional IBD market, your institution market, and your hybrid RIA solution. Today our hybrid RIA solution is a way to differentiate with respect to those advisors that want to run their own advisory solution.

We do have, because of that hybrid solution, a number of advisors that have gone pure RIA as just a way of evolving their practice, but today we are not actively or currently positioning ourselves, or investing in differentiating relative to an entry into that market.

We see good opportunity in the IBD space and in the hybrid markets, and we believe that, from a strategic standpoint, investing in capabilities that further differentiate ourselves in those markets are going to drive the best returns and the best shareholder value and continue to drive growth in the organization..

Got it. Okay. Thank you very much, guys..

Thank you. Our next question comes from Conor Fitzgerald with Goldman Sachs. Your line is now open..

Good evening. I just wanted to get your thoughts on how you expect competition to evolve given the industry as a whole is seeing improved profitability with higher rates.

I'm wondering if you're planning on investing more given some of the revenue benefit you're seeing from rates, and getting more aggressive in terms of competing for growth? Or on the other hand, are you seeing any competitors make any changes where the behavior could impact LPL?.

Yeah. We're always actively monitoring the environment and assessing changes whether that be from competitors or something else in the marketplace, and then reflecting on those changes and how we think about our own strategy.

And I think that the hypothesis around as rates go up, do firms take some of that economic gain that comes from that, and reinvest to try to drive value in a different way or an accelerated way is certainly a possibility. I think as you look across the spectrum, it is for all of us who have that opportunity.

And so, as much as anything I don't think it's a game-changer as much as it's simply just on a relative basis; you look at that opportunity to drive additional economics, and can you push that economics back into the business to help accelerate growth, profitable growth, I should say, that creates shareholder value? And that's how we look at it.

I think as we look at the spectrum of opportunity, we see a great deal of ways of which to differentiate ourselves in the IBD space. We've sized that market for you before that's roughly $2.3 trillion in assets.

You've got another $2 trillion in the hybrid marketplace, and as we continue to expand our own economics we've been clear that part of our strategy is to grow. Growing that strategy comes with some investment enhancing our capabilities and we certainly see that as an opportunity for ourselves..

That's helpful. Thank you.

And then maybe the bigger picture on deposit rates, I'm just curious how much below competitors your deposit rates would have to be before you thought it could be a competitive issue? Just wondering if there is a breakpoint where, at lower rates, hurt your ability to recruit? And then maybe a similar line of question, but the other side of the coin, if you were paying 25 basis points or 50 basis points above peers, do you think that would give you a completive advantage? I'm just trying to get a sense of how much sensitivity there is around this?.

Yeah. I think if you look over the spectrum of our cash balances, and then you average out what that average holding is per investor, it's roughly in the $8,000 to $10,000 range.

And thus, it tends to be monies that are simply in an account more for convenience in either handling fees, or just giving them some flexibility with respect to a low amount of cash in an account as opposed to maybe in other industry competitors' books of business where they may have more significant investors who have big cash balances and have some active investment management strategy around that cash.

And so given that, a profile, I think our investors tend to be a lot less price sensitive relative to these deposits and thus, whether you move the dial up or down, we historically have not seen it matter much at all with respect to our overall balances.

And so, I think that's one of those places where, as Matt said, we simply think about those and we'll watch the market as those rates move and be strategic relative to our moves based on what the marketplace does..

That's helpful. Thank you..

Thank you. Our next question comes from Ken Worthington with JPMorgan. Your line is now open..

Hi. Good afternoon. Thanks for taking my questions. I guess both on DOL, one of the implications of DOL was the migration from upfront commissions to more recurring trailers, which was going to have an impact on the timing of your revenue generation.

If DOL rules are not mandatory, to what extent does this revenue mix change still migrate in that direction? Like you mentioned that the changes to, I think, the annuity commissions were sort of baked here on the path for mutual funds.

Does the rollback of the DOL rules take pressure off kind of that mix change from upfront to recurring?.

Yeah. So, first of all, I think the standardization of the commissions and where you took complexity out and tried to reduce conflict, and just improve the transparency of the fees is a really good thing and probably helps, quite frankly, a greater utilization of brokerage solutions going forward, and is certainly better for the investor.

And so, I do believe most of those changes across the industry will stick, and thus you have a baseline going forward with respect to think about those commissions and how they relate, then, to the price of an advisory solution. And I think, in all cases, we continue to see advisors.

As I've said before, use brokerage one-third of the time and two-thirds of the time use advisory solutions, at least at LPL.

And so if you use that as a baseline, I think that given the fact that that historically is a slightly different mix than what we've seen, but a building mix, you don't get as much of this big shift or cliff in a year-over-year in terms of the revenue or the economics that are generated in the short run.

Definitely there is a shift that happens when you go from upfront to more reoccurring over time. But I think just the trajectory or the transition that's occurred sort of smooths that out, if you will. I think at the same time, though, you've got other trends going on that have different implications as well.

As you move more off-platform assets to on-platform assets, you have a different shift in economics, because when they're on-platform we provide more value. We're able to charge for that value, and we get better economics. And so you also see some of that trend going on at the same time.

It's a long-winded way of say you've got multiple different things of which to consider when you ultimately contemplate what's the gross profit impact in the short run that occurs because of the DOL. That said, if the DOL is not required and forced in the short run, we ultimately think that it will be some fiduciary rule that will occur.

But let's just say that that's pushed out for some time. I think these trends will continue. I think you're going to see off-platform assets moving on-platform. It's an easier, more efficient way for an advisor to manage their practice.

You're going to see the trend to advisory where appropriate for the investor because I think many advisors are evolving and shifting their value proposition to providing ongoing advice. And, so it makes sense that you would continue to make that transition.

So I think those dynamics aren't materially different, whether or not you have a date and time where it's applicable, you'll continue to see them. Perhaps, if you rolled out and said here's when the date's applicable, you might have some impact post that – the first year post that.

But again, we think it's muted because the trend's already occurring and it's sort of spreading out that impact..

Okay. And then just one more on DOL. One of the other implications was expected to be a pretty meaningful shrinkage of the list of product providers on your platform and others as well.

Does the postponement or elimination kind of reduce the need to shrink the list, like does the list stay the same or does the list still shrink kind of dramatically here given that, to some extent, the horse is out of the barn?.

Yeah. So I think if you look at the DOL, right, we've been actively working from a strategy that says we want to make sure that we comply with the rules so there are certain changes associated with that. We want to help advisors manage through that transition and that change curve so there are certain changes that occur with that.

And then there are certain product innovation that has occurred in order to help our advisors in both expanding their capability set, lower the cost to the investor and that shows up as a differentiation for them and certainly I think an opportunity from an innovation standpoint. So that's the principles of which we've used to approach this.

If you look at the spectrum of that work, rule or no rule, we will still pursue many of those things that we believe are in the best interest of the advisor and the investor and so I think that enables our advisors to continue to get some of the best of what we've been working on and they get the benefit of it or the investor gets the benefit of it.

I think the nice thing about that is, is that without a hard and fast timeframe, it gives us a little bit more time to continue to enrich those solutions as well as gives us a little flexibility as to how we roll them out.

All that said, to answer your question, I think one of the things that you've got to consider is, what is the spectrum of investment options and alternatives that you make? And with or without the rule, it's fair to ask the question, do you get a point of diminishing returns with so many different product providers, and is there some consideration just from the spirit of it's the right thing to do? With respect to the rule, does that cause you to think about still maintaining choice but a more rationalized level of choice? Sure it does.

And I think we will continue to be thoughtful about that but without a hard and fast rule, it gives us a bit more time to be thoughtful about that and assess our considerations.

So that's where just the patience and trying to get clarity on when the rule will be applicable, if so, and in what form, helps us to think about the exact sort of breadth of product offering..

Okay. Great. Thank you so much..

Thank you. Our next question comes from Alex Kramm with UBS. Your line is now open..

Yes. Hey. Good evening, everyone. Just a couple of things here just to close out I guess. On the ICA fees, Matt, thanks for the guidance in the low-80 basis points I guess you said. Just – can you just tell me why you're seeing that? I mean, if I look at – let's put it this way, if I look at Fed Funds we're up about 21 basis points quarter-over-quarter.

If I look at LIBOR, we're up 11 basis points quarter-over-quarter. You're basically saying you're going to see a 9 basis point, 10 basis point increase here in the next – if things stay like they are right now. So it seems like a little bit of a disconnect.

So either it's some of the rate moves that you've seen already in the fourth quarter or maybe you're sharing a little bit more. Like maybe just talk through how those dynamics work exactly..

Yeah, sure. It's not the sharings; we kept our retail deposit rates flat. You hit on it. So there's a bit of the increase in rates that are in our Q4 results. So if you look at the 73 basis points in Q4, that's up 11 basis points from Q3. And it's a mix of the primary index for our sweep accounts.

I'm just going to use the ICA accounts, so the nearly $23 billion is Fed Funds. But we do have balances on one month LIBOR, we do have balances on three months LIBOR, and those were up in Q4.

So I think even though the rate hike was at the end of the quarter, there's only two weeks of that benefit to the extent they're tied to one month LIBOR, still on the short end of the curve a little bit of that benefit was in Q4.

So I think if you take the low-80 basis points and just make it simple and say that's 10 basis points, so 73 basis points to 83 basis points and you look at the benefit in Q4 combined with the benefit in Q1, you're kind of getting to that 20 basis point to 25 basis point range, and in Fed Funds at least where it's been trading moved up about 20 basis points, 21 basis points so far, not the full 25 basis points yet.

So that's a bit detailed but that's how we came to our thinking..

Yeah. That seems fair. Thanks for clearing that up. And then secondly, I guess I want to come back to what Bill asked earlier but not really asking about that chart. But one of the things that I track and I don't know if you look at it is the asset-based fees minus the sweep fees.

So basically the core asset-based fees over your overall assets and that's something about like 7.5 basis points right now. And the interesting thing that is over the last five years or so, that number has consistently moved higher but then in 2016 that really collapsed and it started coming down like a decent amount.

So I read that as, hey, maybe some of these pricing changes you have made have actually weighed on the asset-based fees a decent amount.

So the question is now with maybe some of that you're done with because maybe DOL is not as much of a headwind anymore; do you think the trend of those asset-based fees in relation to assets under management or an administration will start increasing again? Or are we not through with that yet?.

Yeah, so, let me take a stab at that. I think that there's a couple of dynamics going on. One, the asset-based fees, historically, were moving up, because we had a structural shift going on, and that we were expanding the support of our omnibus processing for our advisory accounts and balances.

And so, that created a natural lift from 2013 to 2015 from that structural shift. That was completed in 2015, so you lost that accelerant, if you will, in 2016.

And then, I think, the other – so, your point, that's part of what's going on in 2016 – and then, I think, some of the trend throughout the year across those asset balances, down, reflect just a mix shift in business that's going on, whether that's the certain use of different product types.

I think it also reflects some mix shift in the active versus passive management, as well. So those were, I think, the underlying dynamics around the trend in that number..

So how do you think about it going forward then, which is the core of the question? Sorry..

Yeah, sorry. So I think, with respect to the number without the tailwind in place, then you're left with the standpoint of saying, well, we believe we'll continue to grow assets. Net new assets will help contribute positively towards that number. And feel good about that, and you get a good mix across brokerage and advisory.

They both contribute to that. You do get some headwind with respect to your rep-directed advisory platforms when there's a shift from active to passive management with respect to those asset balances.

And again, I think what we've done for our advisory platforms we're creating great solutions on a centrally-managed basis that create additional value for those advisors. And we can obviously get paid for that solution. So they have access, if you will, to either active or passive, and still pay us for the incremental value that we're providing.

So that's one of the ways of which we offset or support sort of that transition of using passive, but still creating value in economics from it..

All right. That's helpful. Thank you very much..

Thank you. That concludes our question and answer session for today. I would like to turn the conference back over to Mr. Dan Arnold, President and Chief Executive Officer, for any closing remarks..

Yeah. So thank you all for joining our call today. We certainly appreciate it. And I am excited to lead LPL in 2017. We look forward to focusing on executing our plans and continuing to deliver results, and share with you our thoughts around those as we go forward. Thank you..

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day..