Kestra Holdings nearly doubled its debt and interest payments on those liabilities after adding a new private equity investor last year, a new ratings agency report found.
The company's debt load jumped 87% over 14 months to around $850 million, and the service payments alone will soar by the same percentage in 2023 — compared to the 12 months that ended in the third quarter — to $84 million, according to a March 8 "credit opinion" report
At the end of last September, the Austin, Texas-based independent wealth management company
"Kestra's credit profile is constrained by its high leverage and low profitability, but benefits from strong revenue and [earnings before interest, depreciation and amortization (EBITDA)] growth driven by M&A and advisor recruiting," Moody's analyst Gabrial Hack wrote. Earnings before interest, taxes, depreciation and amortization are a common measure of profitability.
"Kestra has favorable recurring revenue streams and has grown its client assets over the past three years resulting in higher EBITDA and cash flow generation," Hack wrote. "These positive trends are offset by the higher debt balance and interest burden associated with debt issuances."
Moody's has assigned a "junk," or non-investment grade, rating of "B3" to Kestra's debt, the same mark at rival
Differences in credit grades can give higher-rated firms an advantage in their competitive recruiting fights for top advisor talent, according to recruiter Jon Henschen of
Firms like Kestra have gained a reputation in recent years for recruiting with big bonuses upfront, then offering cut-rate service and staffing levels to save expenses in order to boost the private equity firms' profits, Henschen said in an email.
"We are entering an economic environment where broker-dealers should be cutting debt, not raising it," Henschen said, adding that "all hell will break loose" if a market correction forces down Kestra's cash flow due to the lower advisory fees tied to asset values.
Henschen said that many broker-dealers "are operating in normalcy bias, having not lived through serious market corrections or forgetting what it was like. For those that seek out battle-hardened broker-dealer models (low debt, profitable, quality staffing levels, low compliance risk, long-term focus), when the tide goes out, they won't be found swimming naked."
Kestra CEO James Poer said in a statement that "Our company remains in strong financial condition. We have a healthy balance sheet and continue to grow earnings. We are pleased with our financial performance relative to our debt, which we proactively manage on an ongoing basis." The company declined to make executives available to discuss the Moody's report.
Roughly 2,400 independent planners with $122 billion in client assets use Kestra's brokerages and registered investment advisory firms — Kestra Financial, wirehouse breakaway channel Kestra Private Wealth Services, RIA M&A arm Bluespring Wealth Partners and midsize wealth management company Grove Point Financial.
Kestra Financial and Rockville, Maryland-based Grove Point generated $878.5 million in combined revenue in 2021, the latest year available in
That growth will cost Kestra, though, due to the higher expenses associated with supervising more advisors under the industry's strict regulatory scrutiny, according to Moody's. The ratings agency cited Bluespring's M&A deals as driving the "bulk" of its growth, although Hack noted Kestra has been successful in recruiting advisor teams, too.
"Kestra's recruiting strategy has generally been prudent and focused on attracting higher-producing advisors as well as those serving a significant portion of their client base in an advisory capacity," he wrote. "These recruiting standards will not only benefit the firm's revenue profile in the form of recurring revenue, but also reduce potential risks of compliance issues that could arise from hiring less experienced lower-producing advisors and advisors who are more reliant on generating transactional commission-based revenue from the sale of complex products."
Client cash, which has
"However, lower dependence on cash-sweep revenue supports Kestra's credit profile during periods of low interest rates," the report said. "Kestra also has a substantial amount of floating rate debt, which will carry high interest expense in higher-rate environments."
Despite the elevated debt and higher costs for interest payments, Moody's predicts Kestra's leverage will fall significantly this year. By the end of the year, the ratio of debt to adjusted EBITDA will tumble to 7.3, down from 10.1 for the 12 months that ended in the third quarter of 2022. A further drop below 6.5 could help lead to an upgrade, like the one that Cetera,
But a move above 7.5 could prompt a downgrade from its rating of nearly the last four years under Warburg's ownership, along with a "shift or deterioration in financial policy to further favor shareholders," according to Moody's.
The "governance" section of a part of the report on Kestra's ESG rating speaks to some of the concerns voiced by Henschen, the recruiter. Kestra has "highly negative" governance risks, according to Moody's.
"The firm's private equity ownership structure has led to aggressive financial and strategic policies evidenced by a high tolerance for maintaining elevated debt leverage in the normal course of business and making significant debt-funded shareholder distributions," Hack wrote.
"The firm's financial strategy involves seeking growth through debt-funded M&A," he added. "The experienced management team has been successful in executing its business strategy, but this is offset by reduced financial flexibility due to its aggressive financial policy. Kestra's private equity sponsor Warburg Pincus has effective control of the company and there is no independent oversight at the board level."
Private equity firms put their profits ahead of the best interests of advisors and their clients, Henschen said. One former wirehouse broker who joined a private equity-backed firm recently told Henschen that there was "zero help" from the firm during the transition, which left the tasks involved with transferring the business entirely to the advisor. The process ended up taking eight months to a year, according to Henschen.
"What it boils down to is financial engineering where, on one hand, they offer more in transition money to attract advisors to join but, with the other hand, they make cuts in other areas such as staffing levels or technology improvements," he said. "We have repeatedly found [leveraged buyout] PE firms to be habitual liars when it comes to staffing and service. This is where recruiting narratives and reality diverge."
