Raymond James Financial, Inc. F2Q09 (Qtr End 3/31/09) Earnings Call Transcript

Apr.23.09 | About: Raymond James (RJF)

Raymond James Financial, Inc. (NYSE:RJF)

F2Q09 Earnings Call

April 23, 2009 9:15 am ET

Executives

Tom James - Chairman and CEO

Jennifer Ackart - Controller and CAO

Steve Raney - President and CEO, Raymond James Bank

Jeffrey Julien - CFO

Analysts

Joel Jeffrey - Keefe, Bruyette & Woods

Daniel Harris - Goldman Sachs

Devin Ryan - Sandler O'Neill & Partners LP

Steve Stelmach - Friedman, Billings, Ramsey Group, Inc.

[Jim Margerd - Rainier]

Douglas Sipkin - Pali Research

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the quarterly analyst conference call. (Operator Instructions)

I would now like to turn the conference over to Tom James. Please go ahead.

Tom James

Good morning, everyone. I welcome you all to the second quarter analyst conference call.

We have with us Chet Helck, our COO, Jeff Julien, our CFO, Jennifer Ackart, our Controller, Steve Raney, the President of Raymond James Bank, and of course corporate counsel is sitting in on the meeting to ensure that we all comply with appropriate disclosure regulations.

It's a pleasure to join you this morning, although it's not been a very pleasant or it wasn't a very pleasant quarter in the March quarter given the environment that existed. We have, as you're well aware, continued to give input with respect to changes on a monthly basis on some of the key indicators, which obviously led everyone to understand when you look at the securities side of the business that we were suffering from the direct impact of declining values in our client accounts which versus the prior quarter were down substantially, obviously the parallel decline in assets under management that we were handling, and just the malaise of the continuing onslaught of negative information causing clients to be less active such that for the first time.

I would tell you on the securities front we were actually seeing some despondency on the part of financial advisers whose income was being affected but, more importantly, were being affected by the impact on client accounts, which needless to say increases the importance of communication and conversation with clients, but pain and suffering tends to occur. As you're also aware, we have a lot of our income based on fees, so those factors impacted us.

I will get into more detail with each segment, but just for a summary review, although all of you clearly have read the release since I saw your comments already this morning, we obviously suffered a fairly large decrease in net revenues, 15% decline, and, when you include effective gross interest, going to net interest the decrease was even larger at the gross revenue line.

Net income was down 90%, as we indicated in the press release, where we focused a lot on the bank. It largely stems from a change in bank earnings quarter to quarter that obviously were very large, so we'll get more into that later.

The quarter obviously was down a large percentage from the preceding quarter and for the six months, which we all seem to ignore when we get focused on quarterly reports, was off 41% to $0.57 from $0.97 or 42% at the net income level, where we fell from $116 million to $67 million.

So essentially a continued deterioration in the overall securities environment, as I discussed, but that was even paralleled in larger fashion by the continuing decline in the real estate markets where commercial real estate - office buildings, malls, even multi-unit apartment buildings, other large, income-generating real estate - suffered a massive decline in cash flows and valuation resulting from increased cap rates, etc. That impacted a lot of loans at the bank level, as you can see in the write-offs from the larger banks, which we are a microcosm.

As you know, we, as an S&L, have had to have some degree of concentration in real estate even though we've mitigated that, as we've explained to you before, by some fairly liberal accounting practices on the part of the OTS, which has allowed us to count as real estate commercial loans things that you and I might call corporate loans, which leads us to focus on the $1.3 billion whereas a lot of people, especially bloggers writing and hedge funds that are short, etc., to focus on the much larger balance, which they think reflects not large enough losses sustained to date. Well, those are really corporate loans that have a small portion of real estate as collateral so they get counted as real estate loans for reasons that elude me.

So let us just for a minute make some general observations, then, on the financials. Obviously the securities commissions and fees were off substantially in the quarter - 23%.

Investment banking was down, but the investment banking number actually was flat pretty much in the U.S. This results from declines in Canada by and large and also what we include in investment banking revenues, the RJ tax credit. As you might imagine, tax credit revenues have dropped because there aren't very many banks who've been the principal buyers, along with Fannie Mae and Freddie Mac, because there are no profits to offset with tax credits.

And there are obviously more needs for maintaining high levels of liquidity as opposed to investing in things that really are totally illiquid, which has led to some very interesting dynamics, just as an aside, in that business, because the rates of return now have reached levels that I think make this product attractive to other corporate buyers and perhaps even to individual buyers as you can get double-digit internal rates of return on a very safe product resulting from tax credits. And as you know, individuals are almost so sensitized to taxes that they would sooner have tax credits than equivalent returns from other kinds of investments.

So it's, I think, an opportunity that we're looking at and we see some new buyers entering the market along with the re-entry of those profitable institutions that are seeking CRA or other corporate buyers that now are attracted because of those increased returns. But during this particular quarter we had a substantial decline in those revenues, which affects that investment banking line.

Needless to say, the investment advisory fees are directly impacted by the decline in assets under management. While those are stabilized this quarter, a lot of our bills are forward bills, so in other words you bill for the coming quarter based on asset value at the end of the quarter. Last time we did have a substantial decline from September to December, so the prior quarterly revenues are down a lot, and we expect that we will be in a little better shape than our revised forecast had indicated.

Interest rates year-to-year continued to come down, as I mentioned earlier.

Net trading profits, a big positive. Those profits are principally or are almost totally in fixed income - more than totally - but accommodation losses in the institutional side have been managed very well at less than normal percentage levels. So when you look at the overall revenues, while they're down considerably, the impact here on some of these activities is actually positive.

When you go down the expense side you obviously see the variable reduction in compensation commissions in the overall line. You see good control in communications, occupancy, clearance and floor brokerage, business development. So generally we've had a pretty good decrease in expenses.

And what you have to take out of here, in addition to the comp costs, to look at your fixed cost control or your discretionary cost control is the loan loss provision which relates to the bank which was up 575%, so it affects the overall expenses. But if you pull those out, you've got nominal rates of increase in the overall expenses there.

So there's not a problem on that line. As you might expect, all of our departments are focused on expense control, albeit I would tell you that our direction, unlike the normal reaction you often see in New York, is to try to get rid of underperformers and perhaps not fill attrition, but really to try to maintain a stable work force during these periods.

And the need for that policy is underscored by the vast additions that we have made to our sales force year-to-year, which requires a higher level of service because you have more bodies but, more importantly, we require a higher level of service because in these kind of times people are more sensitive  either the clients or the FAs - to service deficiencies, and it's extremely important that you have problem resolution on a very timely basis.

So we would tend, unless we know we have a more permanent decline in revenues, which we don't believe that we're experiencing, if we're looking at something we think will be over in less than a year, we will do these things to tighten up. And we're pretty lean anyway, but the fact is we don't dictate 10% reductions in work force. That makes absolutely no sense to me, those kinds of policies. You have to look at, number one, how do you replace them when business comes back and the cost of that versus the savings on the way out. And you also have to be aware that you can't find these talented people in St. Petersburg, Florida when you need them.

So from our standpoint we tend to be more disciplined in terms of how we go about this process. And in the past, even in '73 - '74 and '87 - '89 and the 2000 - 2002 periods, I would say that we're net beneficiaries of that policy when you look at it in the longer term.

So that's kind of the quick run through. I think it's timing differences and I would ask Jennifer on tax rates since we obviously had a higher tax rate than normal.

Jennifer Ackart

The tax rate is impacted by permanent items such as [inaudible] expense and options, and they just had a great impact in a quarter with lower earnings.

Tom James

Yes. And we experienced that last quarter, too. We would like to not have that impact just because that would indicate that normal profitability has been re-established and we don’t have these kinds of adjustments.

Let me for a minute try to get beneath the surface. I'm going to start with the Private Client Group part of the operation.

We clearly had a substantial decrease in commissions and fees. It was 27.5% in the Private Client Group. Again, that reflects lower asset values, but it also reflects the reticence of investors to transact as much business or make any financial decisions in consistent down periods.

I think we have done a good job in terms of trying to be proactive in generating ideas for our sales force based on the opportunities of the time, which are legion in this kind of scenario, and a lot of money will be made. As a matter of fact, here in the month of March a lot of money was made in rallies just in some securities groups. But we think there are some even better immediate-term opportunities. There are also considerable opportunities in some of the fixed income sectors and some of the other depressed price securities, where we're making efforts to raise additional funds.

We have our research teams in all of our areas, not just individual securities, coordinating to generate a constant flow of good ideas with some new products that we have designed. A lot of fixed income information coming out, closed end information, closed end fund information coming out, etc. So on the general front I would tell you that's going well in spite of the fact we're seeing this decline.

And the best evidence is, contrary to the current politicians' focus, we believe that the kind of meetings that you have - I'm not talking about the chairman's council trips and things like that; I'm talking about these annual development conferences where you bring in a lot of sponsors and meet with all your people and bring your home office people together with your sales forces - we are continuing to have those, though at much-reduced cost levels, for the purpose of maintaining mainly attitude, but also providing this specialty education on the additional products and focus of how to conduct reviews during periods like this, even how to prop up spouses and significant others during down periods like this.

So this is a massive psychological job in addition to a substantive job in terms of generating ideas in the downturn. It gets really into the nitty gritty. And I would tell you the feedback from those meetings has been very positive and the information exchanged, even from peer group members who describe their processes in dealing with this, is kind of where we take our leaders and have them actually be teachers. In the environment, it's been very positive.

I actually think you get far more value than the cost, even if people complain about these. Since we are not the beneficiary of government money, we don't have to stand up to all this, but I would tell you, just as an observation, the complaints about Northern Trust meetings and the tournament that they've run for years, trust companies are highly dependent on serving the really high-end client. They have to differentiate themselves from peer group members in doing this. They have to appear, in terms of brand, to the specific sub segment of the universe, small as it may be, to be able to attract that money. I actually think Northern Trust should have stuck to their guns in terms of really fighting the kinds of comments that were made.

And some of the meetings that have been actually canceled by industry participants probably were net costs to the firm, not just in these terms that I've described but also in real dollars, where you have very large down payments and costs of canceling meetings and then you usually have less obtrusive kind of an event some place but the total cost of the two usually exceeds what would have happened had you gone back and negotiated with the event providers, the vendors, as we have done ahead of time. And by the way, in the case of most of us in the securities business, sponsors pay for these costs anyway in large measure, so it's not as if you're even changing your out-of-pocket dollars.

But you should be aware where you are that some of the populist press is totally out of line in my view. Unfortunately, there are not enough of us that say that publicly.

I would say on the retail side and indeed on the investment banking side Canada has been more impacted by this decline than has Raymond James proper here in the U.S. market and the reason for that is not just the downturn in prices but also the downturn in natural resource pricing. And when you overlay the two, it's extremely difficult to generate the kind of enthusiasm and activities, although I can assure you we're trying to assist our new leadership in Canada in accomplishing this and I think they're working hard to reverse the trends there.

And just as an aside, a lot of these energy prices are down so far, especially in the gas sector, that when you take a little longer-term view, like two or three years, the intermediate term outlook there is very good. I actually am hopeful.

And we've been very successful recruiting there, too. What I should tell you there is on the recruiting year-to-year net - and obviously you prune out low-end producers during periods like this or they prune themselves out - we added 112 net brokers at RJA year-over-year. We have added brokers at RJFS. As a matter of fact, the recent recruiting results have been extremely good. I announced a couple of quarters ago that the inflection point had been reached in terms of stopping our pruning efforts and adding a lot of net advisers. And then in Raymond James Limited we've added considerably to our sales force, principally in our independent contractor operations there. But we're now a material factor relevant to any firms that aren't bank owned in Canada and I foresee good opportunity from that.

We had about a 7.5% increase in sales force year-to-year net, so we have good numbers there. And what I can tell you from this end is we can't process any more applicants for positions with us than we are currently seeing. I told you before that there are only a few of us that are really mainly above the fray in terms of major damage to brand, to retirement fund, to the company - which also impacts retirement funds - so that you really have sort of abused the current sales forces at those firms unintentionally, and as a result they tend to want to go somewhere else. And that's understandable in the timeframe.

The front money consideration, the other emoluments that have grown to unheard of proportions have now been reduced to more logical levels and I think it's - I mean much lower than all these numbers that get reported dealing with 150% to 200% plus front end deals when we never did anything like that. But the fact is we are substantially below 100% in our average cost for these recruiting efforts. And, of course, those are based on historical production, which has dropped considerably, too, even for producers that are way above average.

So this is actually a good time to recruit albeit you want to be reasonable in terms of your capital committed to the area, which we do. We budget all of these expenditures. But to just give you some insight in RJA in the first six months of this year we spent our entire budget at a lower cost than we had estimated, so we had to allocate some additional funds for recruiting in the second half at much lower rates.

So while we're slowing that down, you will see some pretty dramatic increases here over the year so far and over the rest of the year in terms of increased occupancy at the branch level because we've really curtailed branch openings. If you have limited amounts of capital you want to commit to this in some logical format, it's clearly best spent in existing space. So we recently had our regional roundtable group meeting and this was a discussion that all of us agreed on in terms of our own approaches as CEOs to the business, so a very positive result.

I've also reported just as an aside that we have been very successful in recruiting, especially in fixed income, on the institutional front, so we have grown those sales forces year-over-year also. So that's important, I think, for you to note that this effort isn't just going on in retail.

Now when you have that kind of revenue decline, however, and you have what I call an amortizing cost base expanded from prior front money expenditures and you put that kind of a decline on the revenue dollars, you substantially drop your contribution to profits from that area. And as you can see in our Private Client Group description of pre-tax income included with the press release, you see an almost 80% decline in pre-tax income. That's not cash flow now, because that money was invested heretofore in that front money, but I would tell you that you have substantially decreased that. We have always invested, probably affecting margins by maybe 20% of total margin, by investing in the frictional costs of growth. So we will continue to do that and I expect we will do fine.

When you look at the Capital Markets numbers in that segment reporting you see that it's pretty flat on the revenue side. Again, there are declines in the ECM area, although the ECM area at RJA was relatively flat with the comparable period last year. So it's really been in Canada and some of these other things that we include in this area.

Other comments on Capital Markets, first, we obviously had pretty good underwriting activity with 10 underwritings domestically, but we only had one in Canada, reflecting my earlier comments. We also had increased restructuring revenues as we have grown that part of our business.

Needless to say, we look for opportunity wherever it exists. There's probably more of that today than has ever existed. And some of the underwriting opportunities are what you would call financial restructuring by increasing equity components in things like REITs and other corporations that can do some things with small stock offerings. You actually see a pretty good level of business currently directed at this effort, where you will see some of these REITs sell off some of their assets with large debt proportionality and raise a little equity capital and, as a result, substantially increase their equity to debt ratios so that not only do they meet covenants even if things get much worse but they really stabilize cash in terms of their operations.

So I suspect you will see more of that going forward. I think you'll see some of this in the energy sector and you may even see some of this in the traditional corporate sector. I actually am hopeful as long as we don't have these massive drops back down to 660 on the averages that - in the S&P, I mean - that would affect us dramatically. So we see pretty good activity there.

On the Asset Management side, assets have dropped. Again, there's some variable components in the way we pay people in this area, but the fact is that the high margins that exist with the assets at levels that did exist are very much impacted when you drop your assets under management as much as have dropped overall at our firm, so this is a large change. There's been substantial cost cutting in those areas to assure profitability even at today's market levels. So there's been positive change on that front that will preserve profitability, but the profits will be much less than we have been experiencing. But again, it's still important that you have sort of the same mission going throughout the organization.

And the performance of our asset managers is still very good relative to their benchmarks. Nobody cares when you're talking about outperforming big downs by 300 basis points. We may get some institutional money, but retail sales fall considerably. And the other thing that happens and has benefited us to some extent is people actually switch a lot of their assets to more fixed income. We do have excellent fixed income management results, so we have had big net growth in our fixed income assets under management and we've even had some wins outside of the firm on this front, which has never been a hallmark of our overall Asset Management operations at Eagle, so I'm actually bullish on that front.

The bank, which garners most of the focus over the last year, where we had a massive ramp up in earnings, actually experienced a loss this quarter. And the unfortunate thing about this is if we look back a couple of years ago, when we would debate with our accountants about levels of reserves, their arguments were always your reserves are too high, you need to cut them back, and our arguments were always you reserve for difficult environments that happen about once every 12 or 15 years in the banking industry like clockwork. You actually can do studies to check all this out.

So virtually we had no bad debt losses for our first 12 years and we still have very low levels of losses in residential real estate, so that's not really a major problem with us, but we've substantially increased the reserves for that area. I think we're at 83 basis points or some number like that now. Steve is reconfirming numbers in that range.

What we have been ramping up are the commercial real estate, which we started probably a year and a half ago when we had the first signs of a few more A&D type loans - and there were only a few - that we reserved for in spite of the fact we started out with loan-to-value ratios in the 50% - 60% range, you still experienced some losses.

And what's happened now of course is other real estate loans, whether they're REIT-related like the one we were a participant in that caused us a $28 million write-off during the quarter, you simply don't know when those occur. So we were actually surprised at the end of the quarter by that write-off. We had already had reserves for it - for some of it, but not a very large amount of it because we didn't anticipate the level of loss percentage that existed, which we think is extraordinarily high - but we would also recognize these are extraordinary times, so the ones that become troubled can have extraordinary losses attached to them.

So we have been increasing reserves in this sector for other individual loans that we can hopefully deduce might have a problem. But again, using historical reference points is imperfect. We look at them. We know the numbers. We tend to try to analyze all of these loans and I think we've done a good job in terms of trying to be in front of the losses. That's why you see our ratio not a whole lot different than the non-performing, I call them reserves; I'm always told they're allowances and provisions. But the fact is we have increased those reserves to a level that offsets roughly 100% of those non-performing loans.

And I would tell you that I would have guessed that we would have had a write-off slightly higher than last quarters for this purpose had we not had this one large situation. In looking at the portfolio I expect, as I've said for the last couple of years, that when you run into bad times you then experience some actual losses, so we expect those numbers to continue. I don't know when exactly. I don't know for how long. I have a feeling that our levels, which are around 240 in this segment of the portfolio - 2.4% - are competitive to the much-larger peer group in terms of their scoop and size. And we're adding and had planned to add at above historical rates to those reserves and we expect we will continue to do that, as I mentioned.

But I would say that when we've done all this stress testing internally that we're fairly comfortable looking forward that these reserves, as I said before, are not only at a pretty good level but when you look at operating earnings in terms of sustaining any additions and all those things, we're as confident as you can be in times like this, which is not very confident because are we going to fall off the cliff or are we reaching an inflection point by year end? I honestly don't know. I tend to think it's closer to the latter than the former.

So we are reserved conservatively, I think, for that kind of environment and, as new problems arise, we will continue take reserves. I think we increased reserves more than some of you thought we would over the whole year in this quarter, so my instructions are at these meetings tell me what your best judgment is right now for what we've got and where we know the problems are and take the reserves now. There's no earnings management going on here. We're trying to stay in front of it, as I mentioned. So I think we're in good shape.

With that, I would tell you that I think you need to take a longer view. That's the point that I left here. These spreads I don't expect to decline back to more normal levels anytime in the near future because the government has every reason to try to generate large operating earnings for the bank structure because that's one of the best ways to improve confidence and to really sustain any losses that have not as yet occurred. So that's why you've seen some positive results at places like Bank of America and Citicorp that really are not probably in line with recent results prior thereto.

But you also see these warnings, as Ken Lewis issued at Bank of America, about look, we expect to see some more loans get in trouble going forward because I think our best estimate was that some of these commercial-type properties probably dropped in value around 25% during the first quarter. You can't have many quarters like that, but the fact is you still are in substantial downward revision and if you're trying to prepare yourself for problems related to that, it's a very difficult job. Prophecy has never been one of my best strengths, so we tend to be conservative. And that's what we're trying to do.

I know a lot of people have always said well, you haven't taken very many write-offs, therefore you're going to have more. I would tell you we haven't taken very many write-offs, therefore relative to everybody else we're going to continue to have lower write-offs than they do. And I still think that's true, but it's not as much fun as it was when we didn't have these for 12 years.

Steve, I don't know what you would like to add specifically in terms of - you might just add before we open it up for questions.

Steve Raney

Sure. Just, you know, continued focus on the commercial real estate sector, as you mentioned, specifically those areas that are tied to consumer spending, retail, gaming, hospitality, those sub sectors in particular are areas of focus, and our credit team is watching that very closely.

I also wanted to highlight I know that - and Tom alluded to this earlier - that our commercial real estate as reported in our regulatory reports and also some of our public filings - our Q and our K - is really not reflective of how I think you, the investors and the analysts that follow us, along with our management team, would view the real estate exposure.

Once again, we have $1.4 billion of commercial real estate exposure compared to about $3.5 billion of what would be called commercial and industrial or corporate loans. So a smaller percentage of our balance sheet is actually tied to commercial real estate than what is reported in our regulatory reports.

That being said, that continues to be our primary focus at this point.

Tom James

But you generally have pretty good diversification of assets in your loans, right, Steve?

Steve Raney

Yes, absolutely. We've got corporate limits on various sectors within not only the commercial real estate space but also our corporate portfolio by industry sector. We have a limit of 5% of total assets, but nothing exceeds 3.9% right now, which the highest is consumer products and services. We are highly diverse across various property types and geographies.

Tom James

With that, Jeff, anything you'd like to add or can I open this up for questions?

Jeffrey Julien

I guess the only comment I'd make is on net interest earnings. We've talked about gross interest and net interest earnings was actually up 33% quarter versus the prior year quarter as a result of some of the increased loan portfolio manifesting itself in operating earnings at the bank.

It was down about $10 million from the prior quarter and that's somewhat reflective of the statement that we made last time saying that we don't expect that very high interest spread at the bank to be sustainable for an extended period of time, and it drifted down 23 basis points this particular quarter. I think we kind of expected that, I would say, to drift lower, not to see a sharp spike down, but to drift a little bit lower as some of the LIBOR loans reset and some of the mortgage pools that we're placing over time are lower mortgage rates than we've seen historically, etc.

So I think you're going to see that continue to drift downward just a little bit over the next couple of quarters but, again, not fall back sharply.

Tom James

Yes. And I would add on that front we have a little bit of a contrarian thing going on here because net interest earnings in the securities side of the business are virtually insignificant currently, when they historically have been large percentages of pre-tax profit so that, as rates rise when we come out of this, while bank earnings may drop, the securities part of the business in net interest will rise.

So when you look at the general results you have to recognize it's comprehending both on the net interest front. We actually absorbed a large decline in net interest earnings at the securities firm over the last couple of years.

Let me open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Joel Jeffrey - Keefe, Bruyette & Woods.

Joel Jeffrey - Keefe, Bruyette & Woods

Just in terms of the bank, can you give us the quarter end tangible equity levels at the bank?

Steve Raney

Sure, Joel. Let me give you all three of our ratios. Total capital to risk-weighted assets was 10.3%. Tier 1 capital to risk-weighted assets is 9%. And Tier 1 to adjusted assets is 7.7%. We had disclosed also yesterday, Joel, that tangible common equity to risk-weighted assets is 7.91%.

Joel Jeffrey - Keefe, Bruyette & Woods

And then in terms of the AFS portfolio and the revaluation of some of the securities due to the accounting change, can you tell me where those are currently marked and what kind of impact that actually had on equity?

Tom James

Let me give a shot at that before Steve because we had thought, based on the early discussions on how this was going to play out, that it would make a material difference because when we run our own stress tests on these securities, we still think that that portfolio, the reserves against there or the market value adjustments on those securities, are much greater, maybe by a factor of 2 or more, than we really expect to experience.

But the actual change here as a result of the conservative approach being recommended by our accounting firm - it really doesn't make a whole lot of difference to us - is that the change in the asset or the revaluation was $18 million only and we're still largely close to where we get market values from IDC and we haven't moved very far to any of these quantitative cap rate kinds of calculations, which was the whole thesis for the revaluation of these assets.

I think that there may be some pushback from the industry, but it seems to be very small now, which probably reflects that you're not going to see much activity in terms of interest on the part of any of the banks in terms of selling off assets. And they certainly don't want to overvalue anything, so they're not pushing against their auditors as hard as I thought they would be. But we're going to have to wait to see how this plays out over a little more time. To us this is a little bit of accounting mumbo jumbo.

I think that we're still undervaluing those portfolios, but we certainly don't want to have anything on our - to me it's kind of like a reserve in net worth.

So, Jeff, you were going to say something?

Jeffrey Julien

We didn't really wholeheartedly adopt 157. I'd say we used it as an additional indicator as to which of the external prices, whether it's a pricing service or a dealer quote, which one made more sense. The only securities that we actually marked to a model were some of the subordinated pieces that had really no other market value provided out there and that’s where the valuation came from. But the vast majority, I would say, we did not mark to discount cash flow model. There's not really very clear guidance on what discount rates to use and stuff like that.

The feedback we're getting is that most financial institutions are tiptoeing into this rather than making some kind of massive revaluation adjustment when it would be at risk to revalue it back partially the other way if more clear guidance comes out and you have to use more onerous discounts.

So I would say we're just tiptoeing in as well as everybody else and I echo Tom's comments. Based on all the stress testing we've done of these securities and if they don't break their coverage, etc., that we think there's still some substantial undervaluation present in that at this point in time, but not based on these third-party quotes being provided in the marketplace today.

Joel Jeffrey - Keefe, Bruyette & Woods

So there's sort of bounce back and the value of the AFS portfolio is really driven by more unrealized gains and [inaudible].

Jeffrey Julien

Joel, just to clarify a couple things. There were two securities declared other than temporarily impaired, a $6.2 million pre-tax earnings impact in the quarter. But the negative mark as of 12/31 was $174 million; now it's going to be in the $155 million range.

And if you're talking about what was the - the balance increase we actually purchased some agency Ginnie Mae securities during the quarter, so it was a zero risk-weighted asset agency paper. So if you're looking at the difference in the available for sale market value, the larger increase was really attributable to some purchase of some new Ginnie securities.

Joel Jeffrey - Keefe, Bruyette & Woods

Okay, not private label?

Jeffrey Julien

Yes.

Joel Jeffrey - Keefe, Bruyette & Woods

And then just lastly, were there any capital downstreams from the parent company or broker to the bank this quarter?

Jeffrey Julien

$10 million.

Operator

Your next question comes from Daniel Harris - Goldman Sachs.

Daniel Harris - Goldman Sachs

I was hoping you could just walk us through a little bit how you think about the re-underwriting standards that you guys have in place with regards to investing in the shared national credit and to some extent what your forward view is or what you can see coming down the pike in terms of delinquencies or non-performing assets given that you're not actually underwriting those loans to the actual end user?

Steve Raney

Dan, we really do re-underwrite the entire line. We have a credit team that does our own - obviously we get information from the lead bank - but we do our own interviews and discussions with the management teams of the borrowers, we use a lot of resources inside the firm if there's existing relationships, which many of them have an existing relationship with the firm. About a third of our corporate portfolio has a relationship with our research or investment banking folks. We go through a full-blown due diligence process and I would argue that our underwriting standards are equal to if not superior to others that are participating in these types of loans.

I would also mention shared national credit is a very broad universe of loans. We're in a very small portion of the total shared national credit population. We get statistical information only on an annual basis and this is dated information that's probably a little over six months old, but last year's shared national credit, 13% of total shared national credits were criticized; ours were 4% as of that date. We will be getting the results of the shared national credit exam in the August/September timeframe, but we would anticipate the loans that we're participating in would continue to fare better from a creditworthiness standpoint than the total shared national credit population. So we continue to feel very good about the way we're going about selecting the clients that we want to do business with.

Tom James

You know, that one-third statistic you used, Steve, is true for people we actually have relationships with, but it's probably more than double that, the companies that we specifically know about and follow because we sort of narrow our focus on any of these loans to areas where we have substantial experience, segments in which we operate. So our knowledge level in the firm generally speaking is high.

The second part of your question, though, is extremely difficult, which is what I reflected in the general comments. We just don't have a clue how many of the individual loans - we expect some more problems in the real estate-related sectors, but I can't tell you which loans. We picked out 10 or 15, I don't know how many, you have now that we have some degree of reserves against already in the major loans. We try to look at them in sub sectors for reserves and constantly review the individual company financials.

Steve, I don't know what you would say to elaborate on that, but we don’t have a crystal ball on this; I wish we did.

Steve Raney

We have reserves against all of our loans, but the ones, Tom, that you're saying are the ones that are in our watch or worst category that we are watching very, very closely on a monthly basis and have been taking substantial additional reserves as indicated in this last quarter.

Tom James

In advance of.

Steve Raney

In advance of, yes. I mean, just to provide a little bit more color on our non-performing loans - the $143 million total - $43 million of the $143 million are residential loans. Then out of the balance of the $100 million of the corporate and commercial real estate, $40 million of the $100 million are actually continuing to paying as agreed, in compliance with their loan agreement, but we've got them in non-accrual status, non-performing status because we are concerned about their long-term prospects to be able to meet their obligation, so we feel like it's prudent to take the payments all to principal at this point that we're receiving.

Daniel Harris - Goldman Sachs

Two thoughts on that. First of all, do you guys, after the initial underwriting standards, have exposure to the actual borrowers or is that through the manager of the loan?

And then second of all, how should we think about - I know that you're saying that your loans are criticized about a third as much as - I think 13% for the total to 4% what you're seeing - but how do we think about that chargeoff rate versus what the government's going to say with regards to commercial and credit when it releases its stress test results some time in the next few weeks?

Steve Raney

Well, all of our exposure would be directly to the borrower. We don't have any exposure to the agent or lead bank. When we're extending credit in these participations, we have the exposure to the borrower and not the lead bank.

In terms of the stress test, I'm not sure, in terms of chargeoff rates - we're going through and have been working extensively on our own stress tests and coming up with a variety of different assumptions that we're putting against our portfolio.

Tom, I know, as you alluded to in the earnings announcement, the earnings that are going to be generated over the intermediate term in the bank we still feel confident are going to keep the bank in a well capitalized status despite the fact that we know we're going to continue to have chargeoffs and problems and additional reserves that we're going to need to take against these loans that we have concern over.

Tom James

We didn't need to add the $10 million.

Steve Raney

Yes, we would have stayed well capitalized without the $10 million, the question that Joel asked about, the additional capital into the bank.

Tom James

I think, Steve, if I understood his question, he was saying do we talk to some of those individual clients who are borrowing from us and obviously, given the earlier comments, we talk all the time with borrowers that we already know. There are some that we did the reviews on but we don't know as well, and I would classify the one that we took the loss on as one of those, which is increasing our focus on the list that we don't have as much knowledge on to start with.

Daniel Harris - Goldman Sachs

On residential origination, some of your peers have noted that we're at record levels, refis are enormous and even primary mortgages, because of foreclosure sales. What are you guys seeing in terms of the residential backlog? And then I know you've talked about sort of slowing down the pace of loan origination, but how do you think about that in the current environment?

Steve Raney

And you saw that our loans were in effect flat quarter-over-quarter and I would anticipate that being the case, at least over the next few quarters.

Dan, you may remember that actual originated residential business is a relatively small part of the bank's operation. That being said, that business is very robust right now. Our own originated residential portfolio has performed exceedingly well, better than any other asset class, really, that the bank has. Once again, these are loans that we're extending only to clients of Raymond James. But that business is very robust given the current rate environment and we're continuing to be very active in that space.

What we've not been as aggressive on here recently is actually buying pools of mortgage loans originated by [break in audio] institution, so I think that that will continue to be the mandate, at least over the next few quarters.

Operator

Your next question comes from Devin Ryan - Sandler O'Neill & Partners LP.

Devin Ryan - Sandler O'Neill & Partners LP

You guys spoke about the residential portfolio some here and it sounded reasonably comfortable with what your seeing, the way I read it, but the loans 30 days past due had a pretty good jump in the quarter so would you expect that the level of deterioration that we kind of saw this past quarter would continue to rise going forward, particularly as unemployment rises, or how shall we think about that portfolio?

Steve Raney

And I know, Devin, that increase from 130 basis points over 30 days to 221 was a significant jump quarter-over-quarter. And Tom alluded to it earlier - we have 84 basis points of reserves against our residential portfolio. We almost doubled the level of reserves this quarter. That was part of the $75 million in provision expense.

In light of the increase in past dues that we seeing, it's really hard to predict what we think the past due trends are going to be and the loss rate.

Tom James

Loss rates are up, so we had to adjust for both.

Steve Raney

I would tell you the way that we're doing our probability of default and loss given default in that portfolio I think are very conservative and we've got adequate reserves based on our current past due statistics.

Despite the fact that our past dues increased dramatically, in reviewing a lot of data from a variety of different financial institutions, our mortgage portfolio continues to perform exceedingly well. There's a lot of transparency regarding past due information at these other institutions in their mortgage portfolio and literally we cannot find another institution that's reported of any significance or size that has past due statistics as favorable as ours.

Devin Ryan - Sandler O'Neill & Partners LP

And that being said, that's a big increase quarter-over-quarter.

Tom James

But remember the rationale there. If you remember where our principal purchases were from, we bought a lot of outside whole loan packages which, again, we pruned considerably as I mentioned before, but we bought them from other financial institutions like our own, you know, Morgan Stanley, Merrill Lynch. So they had similar profiles, the borrowers had similar profiles to us, and where they didn't, we pruned them. So we weren't just willy nilly buying all kinds of pools that prima facie had higher returns. We were actually taking ourselves through a higher-quality screening process.

Steve Raney

Tom, we re-underwrite every loan as if it's new, even though we're buying it from somebody else.

Devin Ryan - Sandler O'Neill & Partners LP

And then just in the corporate loan portfolio, what percentage is to REITs?

Steve Raney

Out of the $1.4 billion, Devin, about $700 million of the $1.4 billion is to REITs. And that's, as you can imagine, every property type virtually - apartments, office, hotels, every property type, retail.

Tom James

And again, they're the ones that you would find higher ratings from our analysts on than the general group.

Devin Ryan - Sandler O'Neill & Partners LP

And just a general question here. How do you guys balance the task of preserving capital in this environment with obviously the opportunity to hire and build your business?

Tom James

You're asking the $64 question. I would tell you, you know, look, Devin, I'm an old guy, so I've been through 40 years of this stuff and I've run through '73 - '74. And in periods like this if you were looking at signage in front of you, the one that said preserve capital, maintain viability and survive is about 40 times brighter than the one beside it that says take advantage of opportunities.

That being said, I would tell you that we still are generating enough cash flow that we can invest further in adding financial advisers, which has been our prime addition, but we are also adding people in equity capital markets, we're adding people in fixed income. So we're taking this opportunity - public finance is an area where we've added a lot of people - we're taking this opportunity to invest some money.

And by the way, the cost, as I said, with retail financial advisers is down. It's even down further in some of these other spaces. We're upgrading analysts. We're doing all the kinds of things that we would normally do as if we weren't impacted, although I would tell you that if we tried to just meet supply here on the financial adviser front, we might be able to hire 250 more financial advisers just in Raymond James & Associates in the second half of this year. Well, we're not going to do that because physically we couldn't begin to process all that. And we have very good activity in our independent contractor firm, which has much lower levels of transition investment.

So the combination of those factors means that we are committing less, we are watching closely and budgeting the capital expenses, but we're getting a lot more for the dollar spent and we're still maintaining some growth. So that's sort of the picture.

I don't know how much faster we would go if we were unfettered. It's certainly not more than 50% more, I don't think. We wouldn't go double just because we couldn't process them all. We've already recruited this year 100% of what we recruited last year and last year was a great year. Last year was the best year we'd ever had.

So, you know, how fast can you ramp up? I mean, it creates all kinds of strains on the organization. We've got a big transition team that does all of this work. We don't have that much stress in some of these other areas, nor do we have the need to add as many individuals, so we're more unfettered in the area if we see a really good investment banker team, pick it up, the really good micro team or fixed income sales group or whatever. So we're continuing to maintain those conversations.

Operator

Your next question comes from Steve Stelmach - Friedman, Billings, Ramsey Group, Inc.

Steve Stelmach - Friedman, Billings, Ramsey Group, Inc.

I just want to circle back on an answer you gave with regards to the shared national credit. You mentioned nationwide 13% are criticized; you're somewhere on the 4% number.

Steve Raney

And that was from last year's data, Steve. That, once again, is dated - August or September of last year.

Steve Stelmach - Friedman, Billings, Ramsey Group, Inc.

I guess the question is how much of that 4% is based on your credit selection versus the fact that your assets have grown and it's going to take awhile for credit experience to sort of catch up? You know, credit tends to lag asset growth, right?

Tom James

I would normally agree with that if we weren't in the heavy stress environment today that we are in. I mean, admittedly you can have, you know, over time you can develop more problems in a corporation because you're further away from the environment that was analyzed.

But the fact is we're staying at the upper end of the quality of companies in each segment and, again, we're restricting ourselves to the segments about which we have knowledge and we see a lot of opportunity. So when you do that you're just by your sort of asset allocation decision making, I think, a real differential in terms of the problems you're going to experience. And the main reason we're experiencing the level of problems even that we have is the fact that we had to have some real estate focus based on the fact we were an S&L. So we did have a higher percentage of real estate. Given a free hand in terms of this asset allocation, we might have even had more corporate loans than we had relative to the real estate.

But, again, we think we understand real estate, including those of us that aren't necessarily [break in audio]. We have development experience at the firm, we've syndicated billions of dollars worth of real estate, so we have a lot of knowledge here on that front.

Steve Stelmach - Friedman, Billings, Ramsey Group, Inc.

And so I guess the argument is you're not going to regress to the mean of that 13%, but somewhere between 4% and 13% is probably reasonable?

Steve Raney

That 13% will be substantially higher when we get the results in August or September and our 4% will be higher. It already is. We already know, you know, our criticized loans have increased. We will be substantially less than the net average.

Steve Stelmach - Friedman, Billings, Ramsey Group, Inc.

And then just lastly, you mentioned the stress test. Can you just give us some parameters of what you guys had in the back of your mind in terms of stress test? I know it's probably more art than science, but [inaudible] were unemployment, GDP, what the environment is. What's your definition of stress?

Tom James

I think we're in a stress test, aren't we?

Steve Stelmach - Friedman, Billings, Ramsey Group, Inc.

I think we all agree on that.

Steve Raney

Steve, we're actually still finalizing some work and plan on sharing in greater detail at the end of next week with the analysts the results of that test, including what our stress test assumptions are for probability of default by asset class - residential loans, corporate loans, commercial real estate loans, and the severities associated with those. I think that's probably even more relevant than what the underlying GDP and unemployment numbers are. It's really almost loan by loan.

Operator

Your next question comes from [Jim Margerd - Rainier].

Jim Margerd - Rainier

Could you tell us a little bit more, give us a little bit more detail about how many loans do you have in the bank portfolio that are over, let's say, $20 million discrete loans, either, you know, [inaudible] credits or other, and how many over $15 million?

Steve Raney

I don't have that broken down that way, but just kind of a general comment. That was 257 corporate borrowers that comprised that portfolio and that includes our commercial real estate borrowers as well. I would say 50% to 60% of them are over $20 million in total exposure. Not all of that is outstanding; we've got revolving lines of credit that aren't fully funded. But in terms of our exposure level I would say 50% are north of $20 million.

Jim Margerd - Rainier

And are those made up of multiple loans or are those to one single borrower?

Steve Raney

Well, it may be multiple loans to the same borrower, but I'm giving it to you on kind of a borrower-by-borrower basis.

Operator

Your next question comes from Douglas Sipkin - Pali Research.

Douglas Sipkin - Pali Research

I just wanted to follow up on a couple of things. I guess to the first point about the commercial real estate, just help us understand how in the 10-Q or the SEC filing it's listed close to $4 billion, but obviously you guys are indicating that it's just $1.4 billion, so can you reconcile the difference between those two numbers.

Jeffrey Julien

The thrift regulators allow us to call loans commercial real estate loans if we have some real estate in our pool of collateral along with other assets that we may be securing ourselves with. So there are a lot of companies that may have a corporate headquarters or some buildings that are part of their operation, but you and I would look at that - we're calling that a commercial real estate loan in our regulatory reporting and in our public filings, but the reality is that's really a loan that's not really tied to the commercial real estate. It's really tied to the [break in audio] of the underlying borrower.

Douglas Sipkin - Pali Research

So I should really be thinking about the $1.4 billion. I guess that's a better number.

Jeffrey Julien

That is correct, yes. That's where the repayment source of the loan and the use of the proceeds of the loan was really for the buildings and the underlying repayment source is from rental income from that property.

Douglas Sipkin - Pali Research

So then my next question would be I know you guys actually provided both the breakdown where you did provide the commercial real estate balance and you also provided the allowance in the filing. Can you give us an idea of what the allowance is on that $1.4 billion?

Jeffrey Julien

Doug, I do not have it broken out that way. It's going to be, as we cited earlier, 2.41% of the total of those two, the commercial real estate and the corporate loans. That total, 2.41% of that is the loan loss reserve. I would say that a higher percentage of that against our real estate just knowing we've got more of our criticized loans and we typically take higher reserves against our real estate exposures anyway. I don't have that number off the top of my head, though.

Douglas Sipkin - Pali Research

So that 2.4 is coverage on what? I'm a little confused.

Jeffrey Julien

If you added the $1.4 billion and the $3.5 billion together.

Douglas Sipkin - Pali Research

And the $3.5 billion is just corporate?

Jeffrey Julien

Yes, that's correct.

Douglas Sipkin - Pali Research

Okay, so your coverage on basically commercial is 2.4?

Jeffrey Julien

Yes. And it's 84 basis points on the residential portfolio.

Douglas Sipkin - Pali Research

And then maybe just a broader question and I know you guys have given us an indication that you feel comfortable and obviously the market is very volatile, but just as recently as last month you guys had indicated that you felt very comfortable with the credit quality. Again, it does look like March was sort of an inflection point, but what's going to give us comfort that something like that can't happen again?

Tom James

Look, one loan occurring in the last month really caused the size of this to be much larger than we expected, and it probably had an impact on us in terms of also reassessing other similar loans. So consequently we're small enough when you have 250 loans outstanding that a couple of loans in a quarter can have a major impact and that's why we say we try to identify them very early and set up reserves if we think there are any problems with any of the loans.

But I've got no clue. We may have none this quarter. We may have two more. I mean, I don't know, even though we've provided for a number of additional ones than we've already experienced.

Generally speaking these things take awhile to occur. You don't go out and make a settlement with somebody on a loan. I'm not sure looking at the overall settlement on the loan that we did have whether it was good, bad or indifferent, and we spent a lot of time looking at it. But normally you would have expected that whole process on that one loan to take maybe nine months or a year and a half to take.

And a normal bank in that situation I think would be reserving more if it became clear over the period that the amount of potential loss to that particular loan was rising. Our attitude is a little bit more front end loaded than that. We tend to look at it and say now where would you really feel comfortable knowing everything you know about what's happening in the space, what's happening to this individual company, what's happening to this individual project, and so what would you reserve for as opposed to saying okay, this is a Level 15 and you need to take 10% against it.

And I know it's hard to quantify what I just said, but it is an approach that we take in looking at this because what you find in these real stress tests that we're undergoing is that specific loans caused the major problem and all the historical norms for different conditions of ratings don't really apply very well and you need to take some larger provisions against loans that you know are at risk.

Douglas Sipkin - Pali Research

A question for Steve. Obviously it's early in the quarter so things can change. $25 million provision to $75 million, can you give us sort of a rough range - I know it's predicated on what you guys see the credit quality looking like - how should we be thinking about that expense for the next couple of quarters?

Steve Raney

That's a really tough question and we don’t have a lot of clarity on that on a look-forward basis. That is the biggest challenge right now.

Tom James

We wish we knew the answer to that question. I mean, I guess what you're saying is there's been [break in audio] that could be in that range for the next couple of quarters?

Yes, Doug, you know, from the earlier comments that we look at over the next 12 months and look at operating earnings rates and what loss experiences are, that conclusion is a realistic conclusion based on our already given sort of best guess. In the shorter period you take, the more risk there is that you're wrong. And if we're in a period right now, as it appeared in the first quarter, where you're having a major revision of valuation in this commercial real estate sector, you could have it bunch in the next quarter. I just don't know.

So our best guess is over a little longer term we feel pretty comfortable, but in these very short periods - and we obviously know another month now, but we don't know what's going to happen in the next two months.

Douglas Sipkin - Pali Research

In terms of - back to Steve - I know on that $1.4 billion I guess you're probably not going to have the level of non-performers on that, are you?

Steve Raney

There's $100 million of total non-performers in our corporate portfolio, and I think maybe 100% of them are in the commercial real estate space. I'm trying to think. There's 9 borrowers in that $100 million and I believe all of them are in the commercial real estate space. I don't believe we have one - we may have one company, one of the nine. Yes, one of the nine is in our corporate portfolio versus commercial real estate.

Douglas Sipkin - Pali Research

Switching gears, any update on auction rate securities? Have you guys been able to work down the balances on your own? Is there a plan in progress in place to deal with the situation or it's sort of just going to roll off over time?

Tom James

We had some pretty significant roll off, as you may be aware of, as a result of buybacks by about three of the closed-end issuers of preferreds, which have reduced balances. We have a plan which is being initiated by Nuveen for all of its holders to try to serially go through each of their trusts and refinance the auction rate securities. And as you are probably aware, I mean, it's probably $530 million now of our, say, $830 or $850 million that are currently outstanding after the last buybacks this month. I've just had a whole series of them in client accounts I know about.

Douglas Sipkin - Pali Research

So - I'm sorry - $850 million is outstanding, but $500 million of that $850 million you feel like there's real good potential it can get refinanced out?

Tom James

Yes, over the next nine months I would say. We'll find out. We'll have a better answer to that at the end of this quarter when we see how the initial transactions are received.

Douglas Sipkin - Pali Research

And then any update - and I've talked a little bit about this with your guys - but any update on the TARP application and whether or not you guys are even going to proceed with that now? I think you had said you were looking for $200 - $300 million of preferred?

Tom James

My personal view currently is that we probably aren't going to get - we wouldn't accept TARP funds, but we're still in process and so we're not making a decision by policy until we see the acceptance and look at the offer and see where we are at the moment in time. Remember, we're also proceeding in our conversion to a bank holding company, which would open up the door for an application for the temporary loan guarantee program.

So I guess I would tell you, all things being equal, if we had everything at the table in front of us we wouldn't take TARP funds and we would take those. We may not take TARP funds at all given the current liquidity of the firm. But we just don't know and I don't see any reason to commit.

Operator

Thank you. And there are no further questions in queue at this time, gentlemen.

Tom James

Thank you very much for joining us this quarter. Hopefully we'll be reporting numbers more akin to those we've reported in the past next quarter. Thank you very much.

Operator

Thank you. And, ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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