Standard & Poor’s Ratings Services has assigned credit ratings to brokerage firm Raymond James Financial Inc., noting that the outlook for the firm is stable.

The rating agency says that the ratings on RJF “reflect the benefits and risks inherent in its [predominant] distribution force, the independent contractor channel, the influence of its retail brokerage business on overall company performance, and the high correlation of its earnings to equity market dynamics.”

“RJF’s good fiscal yearend revenue and earnings growth and its conservative balance sheet also support the current rating,” it notes.

The firm says that RJF’s independent contractor channel (which is also growing in Canada) is a competitive advantage, which drives its growth and profitability. “The benefits include a low fixed-cost, higher-margin distribution model that attracts productive talent, supports growth, and better protects RJF in down markets given its more variable cost structure,” it says. “However, this cost structure challenges the profit potential in up-markets compared to those of other retail brokers that have predominately employee-based models and/or fixed-cost structures.”

S&P reports that the independent contractor business model, which accounts for over 80% of RJF’s total sales force, is less expensive to operate than the employee advisor model. “Thus, RJF has lower supporting fixed costs and therefore reallocates revenue in the form of compensation with payouts that exceed those of the competition. In addition, the entrepreneurial nature of the model attracts new, highly productive contractors and thus supports RJF’s headcount and revenue growth,” it says.

However, it also notes there is more risk in using the independent contractor model. “Inherent in this entrepreneurial-type model is the lower level, relative to the employee model, of management control, which exposes the company to potentially adverse actions of independent contractors. RJF works to manage and mitigate this risk through its automated and manual daily compliance systems, which are thorough for both the independent contractors and employee advisors,” it reports.

Also significant to the rating are RJF’s capital levels, “which are strong given its balance-sheet structure, and its liquidity, which is sufficient given that its balance sheet is self-funding and that RJF does not need to access capital markets for short-term borrowings”. It reports that trading risk is minimal, and although the firm faces regulatory and litigation issues, “these risks are being managed and have not imposed any apparent reputational damage”.

“The company is expected to continue deriving competitive advantages by leveraging the higher-margin, variable cost structure of its independent advisor model and by successfully executing its recruiting strategy, which attracts experienced talent from traditional firms because of the increased autonomy and increased commission capture offered,” S&P predicts. “Expansion of the independent channel could support margins to a point, thus providing continued earnings protection against stagnant equity markets. Further support to margins would result from the continued growth of RJF’s asset management business, which had benefited from growth in assets and recognition of well-performing funds. Additionally, RJF is expected to continue expanding its investment banking business, which recently hit record new issue levels.”