Focus Financial’s plan to weather rising rates

Rising rates may create significant problems for buyers of leveraged RIAs, but Focus Financial Partners says it’s prepared to weather the storm better than most – in part because of its unique status as a listed company.

“Being in the position where we are, the industry leader for what we do, also allows us to have many different moats, one of which is clearly our access to capital with the lowest cost of capital in the industry. “, said Lenny Chang (photo), the head of mergers and acquisitions of the financier RIA.

Focus spent some of the early days of the coronavirus pandemic locking in favorable interest rates on some of its debt. That gamble could pay off now, as the Federal Reserve prepares to hike rates in an effort to curb inflation.

The company’s primary source of debt is a two-tranche $2.4 billion senior term loan, much of which was locked in at the aforementioned favorable price.

Approximately $850 million of the A tranche of this term loan is priced through a series of hedges at 0.62% plus a 200 basis point spread. The remaining $752.6 million of tranche A is at LIBOR + 200 basis points. The $792.4 million B tranche of the Focus term loan is at LIBOR + 250 basis points.

The company’s revolving credit facility, which is its main source of financing for transactions, is priced at SOFR + 175 basis points for the money it has drawn down. Focus pays 50 basis points on the money he did not draw from the revolver; by the end of the second quarter of 2022, Focus had drawn $100 million from the $650 million credit facility.

In total, the company paid a weighted average interest rate of 3.4% on its debt at the end of the second quarter of 2022. Focus paid approximately $19.9 million in interest expense during this quarter and warned that it would have had to pay $11.9 million in additional expenses if LIBOR and SOFR were 300 basis points higher.

“It’s not just about the rates, it’s about the structure, how you can use the money from whoever lends it to you,” Chang said. “I think that bodes very well for a company like ours that has always championed discipline in the types of businesses we do business with.”

Some well-known Focus rivals enjoy relatively similar capital costs.

CI Financial, a Canadian asset manager that is a regular RIA buyer, is also listed on the stock exchange. The Toronto-based company told investors that at the end of the second quarter of 2022, it was paying a weighted average interest rate of 3.63%.

SOFR – the benchmark rate at which banks lend to each other – has soared this year, from 0% at the start of the year to over 3%.

“I think that will really mean a lot to a lot of people,” Chang said. “I think in a market where the cost of capital is going to get harder and harder and much more expensive, that’s going to separate the wheat from the chaff.”

Among buyers grappling with rising costs of capital, “there is going to be a settling of scores,” Chang predicted.

Still, Focus and CI haven’t exactly been immune to market moves this year. With the S&P 500 down 24% in 2022, their shares have plunged 46% and 57% respectively.

“If the market continues to fall or the Fed raises interest rates more than expected, there could be a further decline in earnings,” Oppenheimer analyst Owen Lau wrote in an Oct. 6 note reiterating his rating of “outperformance” on the company. “That said, the age-old trend of breakouts and consolidation remains, which should support FOCS’s long-term growth.”

Additionally, given the dismal performance of Focus shares in 2022, “it seems like the stock has priced in the bad news,” Lau added. “Trading at just ~7x 2023 earnings, the valuation looks attractive to long-term investors.”