Raymond James Financial Inc. F4Q08 (Qtr End 09/22/08) Earnings Call Transcript

Oct.25.08 | About: Raymond James (RJF)

Raymond James Financial Inc. (NYSE:RJF)

F4Q08 Earnings Call

October 22, 2008 8:15 am ET


Thomas James – Chairman and Chief Executive Officer

Steven Raney – President, Chief Executive Officer of Raymond James Bank

Jeffrey Julien – Chief Financial Officer and Senior Vice President of Finance


Joel Jeffrey - KBW

Devin Ryan - Sandler O’Neill


Welcome to the Raymond James Financial fourth quarter earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given at that time. (Operator Instructions) And your host and speaker, Tom James.

Thomas James

Thank you very much. Welcome to the year-end quarter earnings release conference call for analysts. I think we have a large group that have joined us this morning indicating that we have some other than analysts that are listening in to this call. I welcome you all also.

As you know, we reported a down quarter compared to last year. My reaction is I was waiting for someone to ask me the question yesterday about why it was down. I was going to reply that we didn’t want to embarrass our peer group by reporting earnings that were equal to last year. But I will have some explanation to you the principal causes here so that you can understand the difference between this quarter and last year.

But if I might, I would chide you a little, at least the analysts present, because at the end of the second month of the quarter I thought we telegraphed pretty well that finally this market trauma that we were experiencing was beginning to impact the Private Client Group in terms of client activity in the stock market.

The institutional activity has remained at high levels, but the individual activity had slowed in spite of the additions that we continue to experience to our sales force, which I’ll give you some more details on.

I think that’s understandable if you just think about your own reaction to the market declines, the shock that has gone on here when you have a market down 32% year-to-date on a calendar basis. That’s a little traumatic for the average client.

I can tell you in the number of letters, calls, et cetera, that I receive directly from financial advisors and clients, you should understand that this is a time when people are really worried about their retirements; they’re worried about any net worth that they’ve accumulated, and on some of these tremendous down days, we’ve actually had clients that have liquidated.

Fortunately, our financial advisors here in the recent timeframe have done a good job of trying to help the clients establish some discipline with respect to remembering that these times you don’t want to get out at the bottom because that gets you the worst of all possible results when you miss any recoveries and you only participated in the downside.

None of us know where this market is going. I listened to the Elliott Wave Theorist this morning on CNBC say that maybe 4,500 wasn’t low enough. My response to that is I don’t share that feeling, and I might give you that perspective.

I actually think that these programs that have been announced by the government, the intervention with various individual financial institutions, in my opinion, has been done very well under the circumstances of battlefield conditions.

The rapidity with which the government has acted is certainly different than any prior periods like this. There’s a lot of liquidity in the system and now we have commodity price erosion. Just the energy price decline will add fuel to a recovery.

Unfortunately in this world, all of us are used to real-time news and we tend to expect everything to happen overnight. I can tell you the money from the government’s $700 billion program has not begun to wend its way through the system as yet.

Until that happens you aren’t going to see the recovery. You may see more stability from a lessening of concern on the part of participants because emotion plays a very large part in this whole environment in which we’re involved.

I would say while we certainly have seen some of this financial services malaise spread into other industries and impact those of us in the industry that basically kept our hands generally clean of some of the activities that have resulted in these losses that everyone is being impacted to some degree now.

Yet certain parts of the economy are really relatively strong. What’s happening now is that you have people realizing that there is this spreading through the economy, and you see companies like all of ours, speaking to the analysts out there, spending time on cost control in their budgets for 2009; trying to determine what can be put off in terms of capital expenditures, et cetera, and that’s now occurring in other industries.

We will see some slowdown, but I think that the infusions of all this money into the marketplace will actually speed the recovery, abnormally contrasted to past events like this ‘73, ‘74, 1929 through ‘32, when a lot of the mistakes were really made in terms of more conservative government policies following declines instead of this much positive intervention.

We actually had a flat net revenue quarter, and I focus on net revenues just because of the gross interest impact with rates coming down during the period. And that is outstanding in light of what I just told you with respect to activity.

If you look at commissions and fees, they were off 2% in the quarter and that’s in spite of the fact that institutional volume was up. So you essentially see a period where the Private Client Group is beginning to be impacted, as you can see from looking at our numbers by segment.

But if you look going back, and the reason I included my own comments to the prior quarter you can see a 7% decline in the securities commissions, which is a pretty dramatic change quarter-to-quarter.

Investment banking, as you can see, suffered, was down 40% compared to last year. This is a carryover to the conditions that have existed all year long as new issue business has declined. You can see from our statistics that the absolute participations, I think there were 17 in the quarter, here and in Canada, which is actually up from last year’s quarter but lot of them were smaller participations.

Although our investment banking activity, because of our involvement especially in real estate, where there’s been equification in some of the rebalance sheets, and energy where there’s been some continuing financing, especially because of discoveries in the Haynesville and Bartlesville Shale, et cetera, which has benefited a lot of the smaller E&P companies in the United States that we serve, has impacted the results positively offsetting some of the decline.

But normally, in this quarter we see a catch-up as all the revenues come in, but there isn’t anything to catch up with during this period because the volume of lead-managed transactions has lessened during the period, and obviously performance of the securities has not been as good in the aftermarkets which has slowed this activity considerably.

When you go further down the line, while investment advisory fees don’t show much decline but remember that a good portion of our investment advisory fees were billed in advance, so actually you won’t see the decline until the first quarter of 2009.

This is because we’ll be billing on September 30 balances which, as you can see from the trends in assets under management, is down in spite of the fact we have continued excellent relative performance statistics and net sales have generally been still positive in spite of the declines through September.

I would tell you in October, with these declines, you should be aware that you did frighten out a lot of investors and I think if you looked across the industry you would find that there were a lot of cancellations of accounts, and people just going totally to cash, which has meant that our cash deposit alternatives have swelled in the months particularly of September and October, which isn’t all good either.

That sounds good, but the impact of that has been during these odd periods that actually you can have some negative interest days when your pay-outs on deposits are higher than you are receiving in overnight rates with the flight to quality.

Once again I think the conclusion that you would reach if you were watching this is that behavior hasn’t really changed so much. When you have massive declines in the market it affects all aspects of our business; albeit on the fee-based business you have more stickiness and you have this lag in terms of fee income relative to the declines in the marketplace.

By the way, just so you could quantify the PCG commission decline activity that I mentioned, I would tell you that if you measured it versus last year it would mean about $0.03. It’s not a major impact yet. We still have reasonably good positive momentum internally, which is offsetting some of this productivity decline of same store FA sales that would be occurring as we enter this period of shock.

A worse factor during the quarter really occurred in September when fixed income trading once again, and this is the second time we’ve had a major shock. We’ve had other periods where all the indices change their relationships, so that any hedging activity at all really becomes negative factor.

Fortunately, our inventories were very small so unlike Jefferies, Piper and others in the business that have reported, we didn’t experience as large an impact as they did, but you essentially had an $18 million trading swing which is $0.04 a share relative to last year’s quarter. Again, this is a major impact.

The other factor that I mentioned was the fact that COLI and BOLI investments on our balance sheet declined in value which means that you have a loss but on a tax basis nothing is deductible, so you end up with a higher tax rate during the quarter than you would have otherwise experienced.

If you look at those tax rates at the bottom of the page there you would see that that impacts us by another couple of cents and you see you get into about a $0.10 change just from those factors and it really impacts everything.

As I’ve mentioned before, the Raymond James tax credit funds, which typically have their biggest quarter in the fourth quarter, actually were relatively uneventful. While we were still profitable in this area for the year, the fact is our normal year-end closing activity ground to a halt.

The reason for that, of course, is there aren’t very many typical buyers for tax credits. Fannie Mae and Freddie Mac are out of the market; the bigger corporations in America from GE through all the major banks no longer have tax problems.

While CRA is an incentive to buy these tax credits, there really aren’t the normal group of buyers that would have made up 75 or 80% of the market. We do have some sales occurring as I speak now. There seems to be some settling of this business in the 7 to 7.5% after-tax internal rate of return pricing for tax credits.

But no one knew what price to pay. While this is a small subsidiary, it really does have its financial results concentrated in this quarter.

The old comments about our business rising and falling with the tide of the markets still remains true. You should have recognized that more than you did in terms of your own adjustments to financials.

I realize that the fact that we’re generally invulnerable to some of the direct costs of sub-prime and credit derivative swaps and all of these activities makes you think that our results might have more stability; and they do in fact have more stability because if you look at the companies that have these activities you will see that they have massive write-offs still occurring while we essentially have avoided it.

Again, the bank has been a major contributor during this activity to profitability. The comparisons on the bank segment are very positive. I have Steve Raney with us if we have more detailed questions later on, but while we have more non-accrual loans, they really still reside in the specific sector of acquisition development type activities and are focused in five loans, three of which are still paying, although two of those are paying from interest reserves.

As a result we put them in non-accrual status when we think there’s a chance we might have a principal issue and we take losses to mark down to market actual charge-offs against those loans and we put them on non-accrual and the interest payments we get just go to principal reduction.

Effectively, you have the vast majority of those outstanding loans resulting from that activity whereas we have about 45 or 46 individual real-estate loans that are in non-accrual status. They don’t amount to much. It’s about $17 million.

When we’ve had to foreclose on these properties, so far we’ve experienced an average of 15% value decline. As you know, some of the stronger areas have actually recovered a little bit in terms of real-estate sales due to the declining prices that these things are being offered at.

Depending on the quality and location of the real estate you really get different activity. But when you take that number of loans and you relate it to the 6500 individual loans we have, it’s really a non-factor; and what I had tried to explain to you before was that this very detailed due diligence review, loan-by-loan, that we go through on even residential loans has really proven to be a saving grace contrasted to other lenders on the banking front.

The negative factors aren’t so large, and I would also remind you that we have larger than ever spreads in the normal corporate lending part of the business and that has offset a lot of this.

The spreads are large and in fact the loans that we buy today, we buy at ever-increasing rates and Jeff Julien who’s also with us, our CFO, and Jennifer Ackart, our Controller, would tell you that our bank is actually performing probably a little above budget in terms of ROE statistics, with an ROE by itself of over 15% during 2008.

A positive in spite of the fact that some of the trends, as you would expect, are finally moving slightly negatively; and we expected this, I have warned you of this in past periods that as we’ve grown these loan balances, the absolute numbers of non-accrual or delinquency loans is going to grow and we expect that to continue for another few quarters, but we still don’t think it’s going to be any kind of a major factor.

In fact, as we put more money to work here going forward, we will have very good spreads on rates currently for loans that are in the market. There’s simply nobody out there yet making these loans except at very attractive margins and that bodes well for us in the coming year in the bank.

While you’re looking at overall operations in the bank, it’s certainly become a larger percentage of our profits. If you look at the segment results, things look good from that side of the business and I’m actually positive there going forward.

In terms of the other businesses, my outlook would be for two to three quarters you’re going to have lackluster results as people regain confidence in the market and we try to establish a baseline in our overall bottoming out process in the market, and this volatility then will slow somewhat.

But you always need to remember that when we suffer these major declines, and I would add 1987 to the prior periods that I mentioned, the experience has been that we lose a small percentage of investors, period, and then it takes a while for those that have gone to cash, or even those that are investing new dollars, to begin to move them back to equities.

They tend to move them to fixed income products, especially if there’s some that have reasonably high yields relative to the yields available in equities. That doesn’t mean there aren’t places in the market, like the MLPs have reached, that don’t have high returns today.

There are many conservative ones that do indeed have high returns, so there are places to invest, but the individual investor is going to be reluctant to do this and it’s going to take a strong pitch on the part of the financial advisors to actually encourage them to participate in the recovery as it develops in the stock market.

We, on the other hand, who might have had cash during this period as I did myself, tend to be earlier investors in these declines, which can be painful at first, but in the light of day, five years later, looks like it can be a very positive factor.

That’s the quarter. The year should give you a little better perspective on how we have performed relative to the industry and when you look at the results with $1.97 in earnings versus $2.11 last year, that’s actually a very small shortfall giving the scenario that I just described for the prior year in the market and the more traumatic period that those of us in the financial services industry have actually experienced.

You can almost go to all those lines I’ve talked about and draw immediate parallels and indirect impacts from problems at the major institutions. One that I mentioned in my remarks was the total lack of credit lines on an unsecured basis available to financial service companies by peer lenders.

Actually, policies from some of the major banks like Wells Fargo are that they are currently not making unsecured loans to anybody in our industry.

Foreign banks are pretty much in the same school and other banks, depending on their own cash needs, have been impacted in that process. You might conclude from looking at that, if you can operate without any of those lines, you are a pretty stable organization, and that’s certainly true.

But the impact of this has actually trickled down again to the rest of industry, where loans for new borrowers, for borrowers in small and medium-sized companies that have normally depended on these lines are not available for renewal and the lenders are over-scrutinizing results, expecting downturns and being very cautious.

You can see why the government is endeavoring to infuse capital to encourage them to put money to work, to turn around the mentality that develops. I think that’s true.

I think that it’s important for all of us to develop a longer-term perspective and that’s why it’s important that you look at the yearly results. It really isn’t bad to have a 13% ROE overall in a year like the one we just experienced.

I wish I could have reported that in 1975 when we came out of the downturns in the marketplace. We were indeed profitable every month after the market turned in October of 1974, but the fact is the rates of return, in spite of the fact we had very little equity, were still small. During the down period we actually experienced actual losses.

So, when you see the stability afforded by the great diversification in our industry now, and I’m talking about the private client group industry when I say that, because there aren’t many of us left. We’re really sole practitioners, two-thirds of our business coming directly and indirectly from this activity.

This is still a profitable business and we can still perform reasonably well. When you take the longer-term view and you look at a book value of 16, 18, we’re now selling at less than one and a half times book, which given outlook that I have described to you for the coming six to nine months, if you’re a short-termer, isn’t real exciting, but in a longer-term viewpoint is very attractive.

While I see some downturn in the asset management business with the $33 billion down from a $37 billion kind of number, we actually have all of the underlying factors still very positive; two 10-year track records in our small and mid cap areas that are four star and five star kinds of performance now, and very good recent relevant performance almost across all of our fund and SMA-type managers.

Nobody pays any attention to that, by the way, when they have absolute losses until the market turns and people get positive. But the fact is that the performance is there. As people begin to re-enter the market this is a very attractive alternative.

Our net sales have still remained positive; highly positive outside the firm on platform sales, et cetera. I think the outlook for activity, while next year won’t be any barnburner, the underlying factors are very positive.

On the private client group front, the biggest factor you should pay attention to is the actual activity in our people counts, which have been outstanding; remain outstanding.

We substantially increased the number of financial advisors here in the fourth quarter, which is extremely positive, and for the year comparisons have added substantially across the 5,000 type accounts.

On our financial advisors, we’ve had big growth in Canada. We’ve had good growth in all of our broker dealers here recently. The outlook is very positive going forward.

I had totaled those for you. When you look at the three that we released we had 5,045 financial advisors versus 4,758 last September, and only 4,913 in the immediately prior quarter.

You can see we have never seen the activity of financial advisors searching for a new home. We have never seen a large number of Merrill Lynch financial advisors looking to join another firm.

These are not small advisors. These are a lot of financial advisors with over half a billion dollars in assets that are looking for homes where there’s stability, where things operate the way they’re used to, and they’ve been shaken by the experience of seeing the major firms fall by the wayside during 2008.

I think we had 57 home office visits in just our employee based firm with similar higher activity in the month of October scheduled. That kind of activity puts us strained to even talk to the people.

I know that our independent contractor operation decided to go outside the home office with a team and go to the West Coast where we probably have less participation in terms of the broad number of financial advisors than we do here.

They went out there for a short weekend and met with about 30 financial advisors and took the team there, because we could actually reach more people by doing that than we were by having people fly in.

When people come here, the great advantage is the normal wire house firms sees the same support that they see at the major firms, if not more here. We have very competitive payout schedules with the independent contractor firms; but more important to them we have the capacity to provide the same kinds of service that they’re used to where they came from with a very positive attitude from all of our service people here at the home office. This is a very positive kind of number.

If you go down to our proprietary activity where our two companies that we now own a good part of, operate, both of them are operating well. The companies that are available in the marketplace to buy today are available at much lower multiples of EBITDA.

In our venture capital subsidiary, we are now seeing more opportunities for high quality companies in second and third stage financings that are extremely attractive. We have successfully raised a new fund for them. We have surpassed our objective of $125 billion for these small and mid cap type companies located in the Southeast and Southwest.

That new business is performing well and contributed positively to our results this year. This is exactly the kind of time, when venture capital funds and buyout funds can’t raise money, that you should be investing in those activities because the opportunity in this space is excellent.

I mentioned tax credit being down, but some of the major competitors of ours have exited the business, which means that we will have a larger share of this business and I assure you the government is soon going to be saying how do we stimulate low income housing construction, because the current plans are simply not generating any new activity.

They’re going to give added incentive to buyers; they’re going to provide more lending; they’re going to do something and they’re going to do it relatively soon. That business has a very good outlook for us.

The institutional business, when I talk about recruitment, you need to understand that I am not just talking about retail sales people. Our institutional sales forces have swelled as a result of the availability of Lehman, Bear Stearns, UBS sales people.

As you know, UBS exited the municipal marketplace. We also have picked up public financed producers from them and others during this period.

Just to cite one example, when Bear Stearns sold to JPM, they had an overlap of depository institutional salesmen which were principally based in Memphis. We recruited 25 new people to our already existing Memphis office and took over the old Bear Stearns space, so that we now have 40 institutional sales people in that market.

I meet with a lot of these high-end producers when they come here and I’ve never been busier. Chet Helck, our COO who’s here, also is having these meetings with advisors from all parts of the business and these professionals. The outlook for our business is extremely good.

On the financing side, since I brought that up; you should know that we believe that we will be eligible, even though we have an S&L holding company, for the guarantees on unsecured capital. We don’t know that yet, but we’ve had conversations with various governmental officials about this. It appears that we can get that.

That’s not the preferred capital I am talking about; we will be eligible for that, certainly, if we decide to get it, to use it. However, if we get this eligibility for the savings and loan holding company the way we expect, we will be able to have government guaranteed three-and-a- half year financing for $250 million of unsecured, which is actually more than we had before, because they used 125% factor of what you had on September 30.

That would be beneficial for us and what that would enable us to do in conjunction with a new revolver financing and perhaps some term debt at the longer end of five to seven years, which we are currently under discussions with some insurance companies on, which is the reason why I said the preferred stock may not be as attractive.

The combination of those would give us more than adequate capital to conduct any operations in addition to what we already have, if we decide to take advantage of some of these opportunities to expand further either by adding additional people at a higher rate or by acquiring some of the variously available companies in our industry.

This is one of those opportune times for companies that are stable, that do have good programs and platforms, to really take advantage of the times. I think you see it happening at JPMorgan; you see it happening at Wells Fargo, and Bank of America with Merrill’s acquisition, in spite of the fact they probably didn’t need to pay that much, in the long-term view it’ll be a very good purchase for them.

While we think we’re going to acquire a number of their salesmen, that doesn’t mean that we are going to somehow diminish the overall value of the Merrill Lynch franchise. The same can be said of our competitors that are left in the business.

As usual, when you have these downturns, the opportunities really burgeon, and a firm like ours can take advantage of lot of that and we already have. When you look at these margins, when we’re rolling our sales forces and our investment bankers counts and our institutional sales counts, that impinges on our margins.

We normally experience 1.5 to 2% margin erosion due to the growth that we normally expect. When we have an opportunity like this, which we believe will benefit us, perhaps not immediately, but certainly in the intermediate to long-terms, we actually will spend more at the same time we’re cutting other costs.

The fact is, it may look like we’re not controlling expenses as well as we might otherwise do, but I can assure you that all of our managers are trying to operate more efficiently. But this is not going to be one of the areas where we’re trying to be totally efficient.

While we try to control growth, we are going to take advantages of special opportunities in the market at reduced front-end money; often, for some of these institutional-type hires, with no front-end money and limited salary guarantee levels, et cetera. We’re going to grow, and we’re going to add these people intelligently because the need for financing when we come out of this is going to be dramatic.

You might say that someone of my age that’s been in this business this long might be more conservative and being very careful at this point, and I would tell you we have been very careful and so we have the opportunity to take on a little risk here in order to grow at advancing rates during this timeframe.

When we come out of this timeframe, we are going to do extremely well. As I said, I think that six to nine months from now, and none of us are seers, none of know for sure when that’s going to occur, but I do know that we’re going to be a stronger firm, certainly relative to whatever our peers are when we come out of this period, and I think that our shareholders will be well rewarded.

With that, since I’ve got all this talent here at the table with me on detail and I know you have some additional questions with respect to some of these operations, I’m going to open it up for questions.

Question-and-Answer Session


(Operator Instructions) Our first question is from the line of Devin Ryan - Sandler O’Neill.

Devin Ryan - Sandler O’Neill

Can you remind us approximately what percentage of client assets are equity related, and are you seeing actual outflows in client assets just given that the volatile markets or the declines are still primarily related to the equity market declines?

Thomas James

Actually we’re seeing net inflows, because of the recruiting again. I just reviewed last night the number of new accounts moving into the firm versus those being delivered out. We’ve maintained about a 2.25 to 2.50 to 1 ratio. It’s largely from recruiting and the acquisition of accounts by existing financial advisors.

Any decline we have in what we call assets under administration as related to the market decline. In fact this new inflow of money has offset a lot of the market decline, not just in managed assets, but in non-managed assets.

We have been working for years on improving asset allocation throughout our sales force and you’ve seen some of that reflected in our client base, and apart from those that I described that had moved out of the market from managed assets or from unmanaged fee-based programs, which is small relative to the total group, it’s still larger than you would normally see.

I think during the year we still were more like 14 or 15% erosion out of managed accounts in terms of cancels – 10 to 14%, which is a low average, relatively speaking, especially in a down market.

The opportunity here is that the base has grown, it’s just that, unfortunately, the assets have depreciated in value. I can’t give you off the top of my head. I don’t know if anybody here knows.

Unidentified Executive

There’s a lot of packaged products in there that’s hard to...

Thomas James

We’d see just a mutual fund number. We don’t know how much of that would be in PEMCO and other fixed income alternatives that Templeton-type assets.

Unidentified Executive

We believe it’s heavily weighted towards equity versus fixed income alternatives and other types of asset classes. For our own benchmarking, we tend to estimate somewhere in the two-thirds to three-quarter equity totals for large groups of clients, but because of the packaged products, it’s hard to be precise.

Devin Ryan - Sandler O’Neill

That’s actually helpful. And just given the more recently recruited FAs and it sounds like that they’re typically larger on average than maybe the existing FAs; how long does it take for them to actually become accretive to results on average?

Thomas James

That’s a good question. The answer varies dependent on whether you open a new office, those individual FAs go into the new office; and what we have done recently, we’ve actually decreased the total package sizes.

We have moved more of the retention front-end money to a not exactly front-end money status, where really in the second and third year you get additions to the base amount, which start a new period of amortization.

Effectively you might give a broker 50% upfront and allow that broker, depending on the performance of his production over the next two years to move up to 80 in total production. But you’re not going to pay money based on 12-months of historical gross, when we know that the future gross is probably going to be down just because of the market environment.

We actually have made those adjustments, and anybody that isn’t doing that now, the answer is it’s going to be at least three to five years until they make money on their deals. I think in our case, I would expect these bigger brokers, who tend to maintain productivity much better than smaller brokers in these timeframes, that we’ll be accretive in the second year.

Devin Ryan - Sandler O’Neill

Sure, okay. And in terms of share repurchases, it seems like every time the stock has traded down to around one and a half times book value or in that range, you’ve been out there repurchasing shares. So just with the stock, you’ve been trading a little bit below that, I just want to get your thoughts here on the repurchase program?

Thomas James

The last couple of times that the stock has moved down to this level; our quiet period, which we respect as a company, so we haven’t been active in those particular timeframes.

Because of the current condition of the financial markets, we have been extremely conservative marshaling cash. We don’t want to be in a position if we have some special opportunity that we couldn’t turn around and invest 50 or $100 million.

We’re less apt to do purchases at this moment than we normally are, but if the stock obviously moved down considerably from this point again, as it has once or twice in the immediate past three to six months, we would use some of these new lines that we are obtaining.

As you can see from our release, we have adequate collateral lines for all of our inventories; that’s not really a problem. The reason you need some of these lines on operating basis are simply for delayed settlements, unusual situations in terms of cash flow in and cash flow out that require more free cash to operate; it’s not a net capital related issue.

As the situation begins to clarify here and some of these new lines are put in place, we would once again be positively predisposed to utilizing the existing purchase authority that our board has granted us to repurchase stock.

It’s been our history to try to time these purchases at lower end prices, which has actually been extremely positive for us over the long run. You are quite correct in pointing out the current pricing timing is very good, and as I said if we see any further decline and some opportunities here, we probably will take a good look at participating again.

But again, you need to understand that the prime directive today is to keep powder dry.

Devin Ryan - Sandler O’Neill

Okay. I’m going to hop back into queue. Thanks for taking my questions.


Our next question is from the line of Joel Jeffrey - KBW.

Joel Jeffrey - KBW

Can you give us an update on your client’s auction rate securities positions?

Thomas James

It’s a $1.1 billion in total and about $950 million in liquid securities. Actually, some the securities have become liquid in our trading, some of the municipal ones. We’ve had a few repurchases from some of the closed end funds recently, but they are related mainly to violations of covenants with respect to coverage in things like convertible bonds, and some of the international equity closed end funds and things like that.

We have not seen the follow through by firms like Nuveen or PEMCO in terms of stepping up these, merely because of the instability in the marketplace. The rates certainly would justify repurchases.

I think what’s going to happen here is either the auction rates are going to be financeable somehow through government assistance, or the issuers are going to have more pressure on them at the same time we see more liquidity in the marketplace allowing financing alternatives to proceed, so that the auction rate securities issue goes away in the next 9 to 12 months.

Joel Jeffrey - KBW

Are you seeing any increased pressure from clients in terms of trying to unlock that and how would be dealing with that?

Thomas James

We have always provided margin lending to our clients that want to borrow on these securities that have emergency needs, and actually the demands for that have been very low.

We have a few arbitrations with clients that are ongoing, but that’s all. We have been very open in terms of describing the issues that are posed to us, and other firms of our size who don’t have access to the federal window to buy these back, plus the issue of not having any capital credit for any purchases directly into the firm. I think our clients are pretty aware of this.

We wouldn’t have had any problem at all were if not for some of the larger firms that did have access to the window, who had other violations with respect to employees getting out at the same time they were selling auction rate securities to clients; inside information that caused suppression of research reports, activity like that. We don’t have any instances of that.

We weren’t auction market makers in any major sense of that word. While we did do some business in between period dates, we really didn’t do much. We didn’t have much inventory ourselves at all.

This is a problem that I think is going to go away. The regulators are still being unreasonable in their demands in terms of having this happen, because they simply don’t understand how the process works, number one.

Number two, this was one of the first manifestations of this perfect storm caused by sub-prime and related credit issues, and to be frank, this is absolute nonsense. If I had been Chairman of the SEC, I’d have slammed the New York Attorney General for this activity, and I think it’s not only been unfair, it’s been unreasonable.

In our case, we have very clear warnings on our confirms about the inability of auctions leading to illiquidity in the marketplace, and we do have separate categories on our clients’ statements. This has been nothing, to some of the members of the industries who didn’t participate in some of these kinds of activities I described, short of extortion.

Some of those guys could look at the remediation of that as positive, because they could buy these assets in at positive spreads and finance them at the window at 1.5 or 2%. Some of those programs really haven’t triggered yet.

They announced that they were happening in January and in April, and hopefully by then more of this will have gone away as we get this increased liquidity for borrowing in the marketplace, and this would be a fairly safe utilization so long as you stay out of the scholarship student loan activities, which have some problems associated with them that are special.

A wise lender actually could make some good money in this business. If the government doesn’t do it themselves, which I would suspect would actually be beneficial to them because they’re trying to get credit into some of these same institutions that have announced buybacks. What are they going to do with those?

If they could get them refinanced some way and off their balance sheets, it would actually improve the credit conditions at those institutions just the way the direct infusions of capital would. I would think that’d be a good alternative.

Joel Jeffrey - KBW

Okay. And can you just give us a little more detail on the necessity of a tri-party repo agreement between RJN and Raymond James Bank and why the $300 million is necessary as opposed to the $78 million that was talked about in the footnotes?

Jeffrey Julien

As we talked about, that was mirroring a bank exemption that was permitted to allow affiliated institutions to provide secured financing only supported by collateral permitted under Reg W where that type of lending had become less available in the marketplace.

We have not even used our bank facility at all yet, not even the $78 million. We put it in place as a contingency backstop when the darkest days of September were upon us. We didn’t even know if committed lenders were going to live up to their commitments at one point in time.

As it turns out, the availability of those lines has continued apace. We are in the process of putting other committed lines in place with other lenders such that when the $300 million ability runs out, if it does, or if it’s not extended at the end of January, that’ll be a somewhat non-event.

We don’t carry large inventories, as you know, Joel. We’re carrying $200 to $300 million at this point in time in terms of financeable inventories. So, we don’t really need $1 billion worth of secured lines.

But we’d like to comfortably have enough secured lines in place that when the bank line goes away, it will be a non-event. As Tom pointed out, secured lending is available in the marketplace under fairly conservative collateral requirements and margin requirements, et cetera. But it’s the unsecured lending that has really totally dried up.

Joel Jeffrey - KBW

Okay, great. And then just lastly, given what’s going on with the decline in the economy and then concerns about commercial real estate, is there any thought about reconsidering your strategy at the bank in terms of aggressively pursuing commercial loans?

Thomas James

I don’t like to use the word commercial loans. I like to use real estate related lending and that would be development oriented as opposed to general mortgages, and use corporate lending.

On the corporate lending side, I would tell you that so far we really haven’t had any problem loans. We have a couple that we have rated at some of the lower quality levels, but actually the companies are performing quite well with respect to coverage in terms of EBITDA performance.

Where we think our big advantage is, is understanding the individual corporations. We can invest with management teams that we know, with businesses that we understand, and industries that we have great internal knowledge about.

As you know, we have announced that we had intended prior to all this to convert to a bank, which would make us a bank holding company. We still intend to do that. We would love to do it sooner than later in the event that some other future timeframe has problems with liquidity so that we have the availability of the Fed window ourselves directly.

From a business strategy, we had to go through this, I will describe it as Mickey Mouse from my perspective, dynamic of pumping money into the bank and then investing it overnight in real estate related short-term securities, then taking it right back out to meet a requirement which is a fully permissible activity, and in fact was supported with the regulators who didn’t want us to cease becoming an S&L.

We really should do it anyway, because our business is much more corporate related. We understand how to buy good real estate mortgages and are still doing it. But in the interest of diversification we will always maintain participation in different forms of loans.

We will always have allocation within the corporate side of the portfolio. But the fact is we’re going to have larger amounts in corporate loans than we do in real estate related loans.

In the commercial real estate end of the business, we will continue to be extremely cautious. I want to remind you that the total size of that lending was less than 1% of our balance sheet. We will continue to exercise caution.

I have done development myself. As a matter of fact, this firm at one-time had a subsidiary that was in the homebuilding and townhouse-type building operation. I know what the risks are in down periods and so I don’t like A&D loans.

I certainly don’t like them if you’re not receiving 700 basis points over. As you may recall, we were getting a 150 over in the banking industry to do some of this financing for the bigger developers. We don’t really have any intention of being a major player in that kind of activity anytime where you’re not paid to do it. The outlook isn’t so rosy.

It was clear by the way; when you see investors paying down payments and flipping them, that there’s a lot of risk in the real estate marketplace. That’s when you exit. We had actually really pulled back from these activities two years earlier.

We don’t have nearly as much exposure as our other compatriots, especially in Florida, California, Texas, and Nevada. Our bank is kind of rock-solid compared to the rest of the industry.

Jeffrey Julien

Joel, let me give you a couple of other reasons; the answer to your question is no, we don’t plan to alter our strategy going forward.

Besides from the internal knowledge base with research and investment banking of these companies and industry, historically the corporate commercial loans side has been more profitable than the residential mortgage side, not always true given some of the pricing anomalies in the market today, but historically, that’s been true.

We certainly want to put ourselves in a position to take advantage of that if normality returns to spreads there.

Another factor is availability. In case you hadn’t noticed, there are fewer mortgages being originated today than in the past. There are also fewer corporate loans available today. But availability swings back and forth, and again we need to be in a position to go where the goods are if we’re in a growth mode and have cash to put to work, and that may be more on the corporate side than it is on the residential side at any point in time.

One of the most important factors to me is that the corporate loans are all floating rate as opposed to the 5/1 type ARMs that we typically buy in the residential portfolio, which is a much better match interest rate risk-wise to our bank’s balance sheet, where all the deposits virtually are floating rate.

Steven Raney

Just to provide a few numbers for you. As of September 30, our corporate and real estate lending portfolio was about $4.6 billion in outstandings. Approximately $3 billion of that were corporate loans. About $1.6 billion in commercial real estate.

Also included in that $1.6 billion is our loans to REITs. So of that $1.6 billion, a little bit less than $100 million were in the residential acquisition and development in homebuilder space. That gives you a little bit more diversification and color for the size of the portfolio as of September 30.

Joel Jeffrey - KBW

Great. Thanks for taking my questions.


(Operator Instructions) At this time, we have no additional questions in queue.

Thomas James

I want to thank you very much for spending the time with us this morning. All of us look forward to a period when market conditions are rosier, but this is the kind of environment when I think the good management teams will prove their worth for analysts.

We look forward to continuing to generate relatively good results as we go forward into 2009. We look forward to talking to you in the near future, certainly at the next quarterly call. Thank you very much for participating.


Ladies and gentlemen, that does conclude your conference. We do thank you for joining and for using AT&T executive teleconference. You may now disconnect. Have a good day.

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