Raymond James Financial Inc. (NYSE:RJF)
F1Q10 Earnings Call
January 21, 2010 8:15 am ET
Tom James - Chairman & Chief Executive Officer
Paul Reilly – President, Raymond James Financial
Chet Helck - Chief Operating Officer
Jeff Julien - Chief Financial Officer
Steve Raney - President
Jennifer Ackart - Controller & Chief Numbers Person
Daniel Harris – Goldman Sachs
Devin Ryan - Sandler O’Neill
Christopher Nolan – Maxim Group
Steve Stelmach - FBR
Hugh Miller - Sidoti
Joel Jeffrey - KBW
Welcome everyone to the quarterly analyst conference call. (Operator Instructions) Mr. James you may begin.
Thank you and welcome everyone. Angel we appreciate your introduction. We think it is quite appropriate that we would have help from above for our industry after what we have been through for the last two years.
The quarter, just making some introductory comments if I might, to think about things here and I think that is important I think what I would say is we expected slow improvement in the economy generally as a backdrop for whatever our performance would be. We probably didn’t expect quite as rapid an increase in stock market values as we have experienced which has led many commentators to suggest that certainly the risk of corrections or consolidations in the marketplace is present. Present. I think I agree with that but I do think the general economy is like Byron [Ween] estimated.
It might surprise some people in 2010 in terms of improvement. The consumer will take a little longer which means that generally speaking unemployment while it might start down here in the second half is going to be slow to recover. I think small business and even big business has a “show me” attitude about what is going on in terms of where they ought to capital expenditures and whether they ought to add to their employment base or not.
So it is not going to be one of these really exciting, V-based recoveries but on the other hand the trends will be generally up. So I think that our numbers kind of reflect that and our business is reflecting that about which I will comment when we get into it. I guess theme one I would make to you because of the market improvement client assets are up dramatically from a combination of all that good early recruiting we did and pure market appreciation we are at record levels of client levels in-house here. We call it assets under administration. I think that is a very favorable trend for future results.
You are beginning to see client activity slowly begin to increase, reflecting all those general comments about the economy but it is slower than you would have anticipated by the degree of recovery in the market. That surprises some people. Fortunately we have a pretty large fee-based revenue content so you can sort of expect that quarter-to-quarter comparisons here should be good. Certainly we know assets under management here whether it is wrap fee or whether it is pure asset management those balances as you can see in our monthly reports have continued to trend upwards which means that revenues in this particular quarter because of our billing-forward policy should be continuing to increase.
Sequential improvement is what I would see in the PCG related activities going forward here which obviously impacts the asset management numbers. The capital market kinds of activity you are seeing in the marketplace, while the transaction volume is high the percentage participation on all of these overnight deals that are occurring tend to be smaller unless you happen to be the lead manager and unfortunately pure IPO activity isn’t up enough to influence our lead managed statistics very much. So everybody looked at these kinds of numbers and we were discussing yesterday here amongst ourselves what indicators could we give you on a monthly basis that could be more useful than just transaction numbers.
It isn’t easy to address this issue. So most of that activity levels both here and Canada can come from smaller participations and underwritings. Don’t be surprised. As the market improves, if it does indeed, you will see increased activity in lead managed transaction as the private equity firms begin to try to get more liquidity into their successful investment holdings and just generally people are more inclined to sell public stock because price levels have increased. A higher mathematics type observation.
While it is nice to report an up quarter over last year, I think you quite properly those of you have already commented on our release are also noting the sequential activity that is going on there. The only comment I would make in that area that is probably useful for you to think about is actually on those comp expenses remember if bank contributions are particularly large and equity capital markets are particularly large comp ratios go up because it is coming from our PCG segment principally and we have already reduced expenses on the asset management side of the ledger.
So you are seeing great operating leverage and their profit numbers as their assets go up but they have actually been able to manage improvement even against periods of similar asset bases in prior years. That is kind of my general comment.
I would tell you I am pleased that the results are reflecting kind of the general trends we have estimated here about what might happen. That is as much luck as forecasting skill when you start dealing with calling market prices and levels and even directions you obviously are subject to a high degree of error. On the other hand I think it is positive to reflect on what is going on here because you see some good base trends.
I didn’t really mention some of some of those bank trends but I will when we get there. Steve Raney, our President who is with us of the Bank I am sure will be called upon to elaborate on these results.
So let me begin by just saying that it has been very difficult to increase net revenues at a meaningful level. That is similar to the rest of the industry, by the way, in the US economy. It has been a little more intractable than I might have expected but you have to dissect the income statement again to come back and say where do you see the vibrancy? Where do you see the return? The private client commissions and fees I would focus on because they were up 15.5%. That is a dramatic kind of growth in these comparisons and they were up over last year.
On a total commission fee you don’t see the kind of total growth at these levels. It is a little bit lower but still up sequentially 7% and up 12% year-over-year. The reason for that is basically that institutional commissions are down slightly in fixed income, still above the kinds of levels that one might anticipate because we benefited from some of the uncertainty and illiquidity in the markets in prior periods that it is getting better now which is good for the market but not necessarily good for spreads or good for pure volume of transactions.
On the equity side, the equity institutional business is still lackluster even in our European operations because of the weakness of the dollar amongst other things. You know, when people begin to think that the dollar is going to strengthen I think you will see some favorable numbers there.
Generally speaking with the exception of these comp lines, noninterest expenses have been in good shape. We are benefiting from that. I do want to keep pressure on management to watch this because unless we start seeing dramatic recoveries in some of these retractably slow recover revenue lines you don’t want to ramp up too much.
Generally speaking net income before all these adjustments that the accountants are slapping on us for unvested share results, $49 million was actually very good contrasted to the $61 million last year and up from $43 million in the immediately preceding quarter so it was a 14% type increase there which led us to the $0.39 diluted earnings versus $0.50 and versus $0.35 from the sequential prior quarter.
So what I would say there of course just as a generalization is you sort of had a confluence of all the stars of universe in the first quarter last year when we had pretty good loss experienced. We had already slowed down the growth of loans and assets at the bank and generally speaking I wouldn’t say there is a lot that happened to spreads but these factors at the bank led to a record quarter last quarter and one that turned out to be well above average. As you know in the March quarter the commercial real estate market started to get a lot worse and began to see some of that reflected in loan loss provisions.
Not just by us. In a much greater degree at the larger banks. When you look at the bank just for a minute since I brought it up you see that sequential improvement as some of these loss provisions have benefited from offsetting credits as the ratings of some of our loans have improved during the quarter and the actual additions of new loss loans has declined. I would like to think this represents the longer term trend which I believe.
Unfortunately, still as we have cited in past earnings it is hard to forecast what happens quarter-to-quarter with loans. It is hard for us to forecast it will be a nice inclining line of profitability quarter-to-quarter resulting from a lower loan loss provision. I am sure you will have more questions on that front. As you know the bank also shrunk just generally speaking in the quarter and it is way down from last year. Part of that was by design at the beginning and now I would tell you it is like turning around an aircraft carrier.
It is not the easiest thing to do. You give instructions or you turn the wheel but you don’t notice very much of a change for a pretty good period of time. We are working hard to add because that total capital ratio is above 13% which is higher than our target ratio so we are actually trying to grow loans intelligently. You are seeing kind of a market that you probably may not even discern or be aware of where good loans are sort of hard to come by. There is effort on the new originations to actually be in for a lot more than the total loan so your requests are actually being reduced.
You have kind of your normal renewals which are going on and you have a continued, pretty rapid rate of payback either from re-equification of the balance sheet through earnings or public offerings of existing public companies or it is not really from a reluctance I would say on these numbers because we are not reluctant. We are trying to make more loans and we continue to ramp up the effort that we are doing here while maintaining high credit quality standards. You are going to see that throughout the industry. The industry is going to be extremely careful.
But you also see increased bids for home loans in the secondary markets reflecting this demand which means that a lot won’t meet our qualifications for purchase. That doesn’t make it as easy as you might guess to turn around this aircraft carrier. You should be aware of that. Steve certainly is making a major effort with his team to get that accomplished.
I cited some of these comments on the individual segments of the business for you so you would understand this interplay where you have PCG and asset management group improving results. At the same time, at least the year-over-year comparisons, at the bank are down for reasons I just mentioned. Equity capital markets are still a drag on capital markets in general and as I said the fixed income business was down somewhat in the quarter.
So you don’t see the capital markets ramp that we are really expecting yet and I think we are going to see it because we have certainly seen the activity levels in the capital markets committee but as I said we need more of this IPO activity which is sort of a later stage phenomenon that goes on in the marketplace. It is not coming back as fast and the M&A activity, again this is one of those discrete kinds of things that happens quarter-to-quarter that makes it very difficult to try and look at trends on that front.
The other thing I would say about equity capital markets for those of you who look at the quarter-to-quarter comparisons in capital markets sequentially is that traditionally the fourth quarter of the year, that was the September quarter, is sort of replete with activity as a result of everyone rushing to get in all their fee income, making sure everything is booked in real time, etc. which doesn’t necessarily happen in normal quarterly activity.
So we almost always have some burst of investment banking revenues in the September quarter. So that is part of the reason for those results. The only other comment I would make on the capital markets is we have made a pretty good investment in personnel. So the expense levels there are higher than they were a year ago. You typically don’t have a lot of underwriting in the December quarter. You shut down at least for the last three weeks of December.
So you just don’t see the returns on the increased investment yet but I think you are going to see that going forward. In some degree that [drives] public finance market where we have added bankers and where we saw certainly an improvement last year in terms of the activity in this area and I suspect we are going to continue to see improved results as we continue to add people in that particular area.
We have actually questioned even internally here about net interest. What I am going to do is ask Jeff Julien, our CFO, ably supported here by our Comptroller, to respond on net interest. Jeff if you would give some input with all these new bonds we have outstanding and the changes on the money market funds what is really going on here.
On its base I am looking at net interest sequentially from last quarter and on its base net interest was down $7 million. When we tear into that just a little bit as Tom mentioned the interest on our note issuance last quarter added interest expense of about $7 million this quarter and about $3 million the previous quarter. So if I added that back to what we will call interest earnings from operations which is kind of taking that financing activity away just to look at the ongoing run rate of operating earnings, with respect to interest and you get $86 million in the previous quarter and $83 million in the current quarter; still a decline of $3 million which again doesn’t really comport with all the sequential improvement comments we have been making.
If you will remember last quarter we talked about the inception of this multi-bank suite program in the month of September which we completed sometime mid-quarter in the December quarter. That added about $7 million in the December quarter of fee income which is in financial service fees as a line item; not in interest earnings. That recoups some of the spread that has been lost by the interest rate dynamics.
As Tom mentioned last time the magnitude of our earnings from that is going to be offset by our bond interest cost. When I add that $7 million into this quarter just ended we actually get $90 million versus about $87 million. There was a little bit of this in the previous quarter. So we actually did the way we would analyze this have a sequential improvement from those interest earnings and related activities from September to December. Not a huge jump but about $3 million. We like to think that as balances grow that will continue.
Do you see any change in spreads or in terms of client deposits in all of your areas? What is going on here with the improved markets you might think you [might have a lot] of cash.
It has actually run about flat to slightly down. We have had some net investment but we have increased client assets coming into the firm. Another dynamic is we were earning virtually nothing on the billions that we had in our proprietary money market funds. As of today about 2/3 of the taxable funds or about $3 billion has moved into the Bank suite program. That still leaves $1.5 billion in the taxable fund and the balance of that amount in the tax-free fund.
We will be undertaking steps to convert those to a private label share of someone else’s fund to recoup again part of the lost earnings from that activity as well. So that will additionally help going forward. Most of the decline in net interest income as you can imagine is bank related. From last year interest earnings are down $36 million and $28 million because the banks and Steve can comment on spreads there.
They are down from a year ago when we had the record bank quarter. We also had a very strange LIBOR rate. You will remember LIBOR spiked over 4% and we benefited somewhat from that but we had unrealistically and unsustainably high spreads for that quarter as well as very high balances. So we had the best of all worlds. But the spreads are hanging in there pretty well at the bank although our balances are way down and the challenge to that is to grow the loan balances to recapture some of that spread.
Let me come back, we expect rates at some point during this year to begin escalating which will actually have a favorable impact over time for us as it increases because as you know even the private clients where we have a lot of these client assets we have benefited at the bank by the low rates but the private client group essentially hasn’t earned much, as Jeff pointed out, in the general investment of some of these assets. That will get better as rates increase and you will see perhaps not a restoration of the total amount of interest net earnings in the future that we have enjoyed in past periods but you will see a pretty dramatic increase which will help private client margins.
As you know during the quarter the private client margin actually increased dramatically sequentially from the prior quarter which is what we expected to have happen. We expect it to happen more. The reason I say that is essentially the productivity per financial advisor is still about 16-17% beneath where it was a year earlier. The only reason for that is the individual investor isn’t back in full force and the impact of these increased assets hasn’t totally restored the income levels. It is getting there now.
You are going to see kind of built in an increase in product client group margins unless or until you have a correction in stock market values. So the outlook there is good. The other factor that affects private client group which has been the tremendous recruiting in prior periods, actually you saw a slight decrease of total financial advisors at the firm over the last quarter. As you know there are normal factors, I am reminded by our guys, the debt retirement that conjoin with trimming the sales force at year-end for re-registration at the calendar year end.
So essentially we had a number of our smaller offices closed in December and it actually spills over to a smaller degree in January so we have a decline and the rate of new additions is always somewhat less in the holiday season but there is no question that the rate of movement within the industry has slowed mainly because the market is good and brokers spend less time thinking about this when they are making more money and have things to do.
So we are seeing what we call home office visits where financial advisors who come down here and visit us are increasing again. I suspect we are going to see more increase in the loss numbers because of the comment I made about sort of cutting off at the bottom each year. It means that our additions are probably a much higher average productivity than the departures.
So I actually suspect we will be back on positive footing here for the rest of the year adding advisors. That is true in Canada. It is true in the United Kingdom. This is kind of a universal comment on what happens with financial advisor accounts but I think we are just not going to be as an industry as active in moving people around during this year as we were last year. We sort of forecast that which leads me to conclude that we need to have more trainees back in the system which would require some ramp up on our current activity levels.
I think it is really sort of an obligation to the system. It is an obligation to the firm. We have very good records with the ones who survived, which unfortunately is a smaller percentages than one would like to believe it should be. So we have improvement to make there.
As you can see the book value of this company has increased. I think we had some improvement in our public securities at the bank. We had the earnings after dividend addition and you had option exercises that have contributed to that increase in the quarter so we are at $17.58 on book value per share calculation. The margin balances have increased. Pretty much by all measures we are obviously up in financial advisor count over last year.
The health is good at the firm and the outlook for firms like ours that are more agency oriented and deal with private client is actually quite favorable going forward. I think the major part of our business, 60-65% of it is in good health. The asset management part is directly related to those numbers. We are also seeing great net inflows from institutional accounts and from outside broker dealers in total so that we are seeing net growth on a reduced amount of cancellations as the market has been better.
So I am looking forward to a restoration of that business which is a higher margin business here in the succeeding quarters. As I have already said on the capital markets front I expected somewhat lower levels of commission activity and fixed income. I expect equity commissions to begin to increase here unless we have a major correction in the market. I do expect investment banking activity to increase more dramatically unless the market has a shock.
Hopefully I know the trend in the bank will be to increase profitability as we begin to grow assets again and more importantly see more traditional levels of loan loss provisions quarter-to-quarter going forward. The outlook is good.
I do want to add something that is nonspecific just because my irritation level has reached a point where I have to take this steam kettle top off. As you know we are involved in some financial re-regulation that is kind of taking a second consideration to the healthcare legislation. The rhetoric is just beyond comprehension. I really believe that you all have some opportunity and I mean the analyst community to add some kind of realism to this process because this blame mongering that is going on in Congress and by the Administration I find extremely irritating.
That doesn’t mean I don’t believe a lot of the management teams in larger financial institutions and even in some of the smaller banks have earned the ire of the American public, particularly their shareholders, because they have experienced big losses. For lack of risk management control and for not being tight enough in terms of the way they managed these companies. I don’t believe, however, that was generated by a concern for current levels of bonuses the way the government seems to portray this. It is sort of an outrage to me that they do that.
The vast majority of financial service companies while they have been injured by the fallout of everything that has occurred in the marketplace during the last 1.5 to 2 years has made it through here without TARP funds, without direct government assistance and often I might say with a government that sort of ignores their plight and makes no effort to distinguish among the firms that really have kept on operating and doing what they are supposed to be doing with their stocks falling apart in the marketplace because they are put in the same category as those that haven’t done well.
So as one of those firms I would just like to comment that if you think we got through this without being injured it is not true. Our shareholders experienced a large decline at the bottom at least in terms of our share price that is still below highs. So they have been injured by this process. The TARP recipients while they certainly in the large institutions may deserve some of the comments on the management they have paid back the money with interest and with option profit and for the President to comment that the banks need to bear the responsibility for the major problems in the economy, and I mean solely amongst the large 50 of which we are not one, that is an outrage actually I would tell you.
The administration, the Fed by both its fiscal and monetary policy, by its general comments on the economy and not reigning in real estate when we had a clear bubble, not recognizing the risk of increased sub-prime activity and taking action through the bank and S&L regulators by making them tougher on that category of loans, the regulators themselves simply didn’t tighten down the ship with all that is going on around them. The mono line insurance companies that thought they could be just as good at insuring mortgage pools as they were with financial bonds bear responsibility. The rating agencies who seem only to be able to look at the rearview mirror and that is sometimes without the benefit of a clear rear window pane I think all of these groups including the Administration and Treasury activities before the problems developed.
I have made clear before that I believe that the Fed and Treasury earned kudos for their recovery from the problem but we didn’t need to have the problem develop at this level. If we had just used existing regulatory power, some foresight, some more sensitivity to changing numbers we wouldn’t have experienced anything as bad during this period. For that you ought to start out with some moderation in what kind of activities are taking place in the regulatory front.
I want to point out I have been involved with the financial services roundtable, financial services regulatory activity since prior to all of the problems developing when we warned everybody without anybody listening that Fannie Mae and Freddie were train wrecks ready to happy with very limited equity capital when their stock prices were high and they could have easily raised more equity capital but for some unintelligible reason their own management kept lobbying for maintaining high degrees of leverage made no effort to protect itself from the increasing probability that the firms might be destroyed in some sort of a real estate revaluation when they could have fixed that easily and the government could have prodded them to do it and they should have instead of agreeing the whole time.
I get really sick of some of our politicians playing “holier than thou” positions when they in fact were very active participants in insuring none of that happened. Then blaming the banks for what happened that has occurred over decades in the auto industry, the terrible management of risk in AIG which I would argue with a benefit of retrospect that we shouldn’t have saved even though we would have had a domino effect and I understand why Treasury and Fed were worried about it.
Those losses and some of the guarantees that were made, I will tell you all these transactions that occurred were done with the benefit of contracts. There was no comment about having additional costs assessed retroactively based on participation. I find that un-American. I think this whole behavior is very unfortunate because we shouldn’t be focused on blame. We should all be about restoring the jobs in this country. We should all be about fixing the system rules where they need to be fixed. They are all pointing out we are fighting the Consumer Protection Agency because we are trying to hurt consumers.
That is the biggest bunch of nonsense I have ever heard. The fact is, we have been arguing for four years we ought to have an oversight agency that looks at systemic risk, that looks at risk of entire holding companies as opposed to individual elements of the holding company and we ask Treasury and the Fed and we sent these reports to Congress and all the regulators to take action in this area. Whether it is the Fed that does this or whether it is some new body really isn’t as important as we actually have this global oversight activity going on here more aggressively than we have in the past coordinating all the efforts, looking at the financials holistically going forward.
We asked for that. So it wasn’t just for the Fed and Fannie Mae. We asked for national charters for the large companies in these activities so that regulation wouldn’t be done by state regulators who don’t even understand what derivative risk is or how swaps work. It is inexcusable that in this day and age that we don’t have a national regulatory system. We don’t have a national charter for insurance companies. We do have some bank regulations but you could make it clearer for large holding companies that you had this form of regulations and certainly that applies to the brokerage industry as well.
We had areas that were unregulated. We commented on those whether it is mortgage brokers or other areas of business that could easily be added to existing regulators. There should be consolidation, not additions, to regulators. The FDC, the CFDC should be merged. The OTS and the OTC should be merged. It doesn’t take a genius. I didn’t need to be a business school graduate or experienced either 73 or 74 or the recent market declines we had to make these evaluations.
We have all known this for some time and yet we can’t get the politicians to cooperate to invoke the right kind of regulation here to fix these problems. After all, since 1934, 1933 and 1940 we have had major changes in the products we sell and the way we conduct business. As much as I liked [Glass eagle] and supported it during its existence I would tell you that you shouldn’t go back on [glass eagle]. You don’t need to limit the size of bank growth. You need to limit leverage. You need to have a real regulatory oversight. You need to have adequate resources given to those regulators. The SEC didn’t even have new product oversight until last quarter. That is unbelievable.
So we had registrations of leveraged ETS coming out and listed on major exchanges, the New York Stock Exchange, without someone understanding whether these leveraged ETSs worked as advertised or not. It is unforgiveable is what I would tell you. We have seen regulators go after us that sold the ARS securities when in fact I would tell you based on past experience, based on ratings, based on everything we knew without the impact of the perfect storm that we all have hopefully survived in total that you would have never had them go bad just the way you wouldn’t have had the commercial paper market fail or the securitized mortgage backed market fail or generally have a collapse of the global securities markets.
What are the regulators doing? They are spending their time going back and blaming everybody when they didn’t even take the time to develop appropriate disclosure for secondary trading rules. I find this obnoxious. It is very unfortunate that everyone doesn’t take their share of the blame and we are looking for a scapegoat to blame all this on. We need to get refocused going forward here. I think if we do that we can become very globally competitive again instead of losing market share but that is going to take a senior agency that I mentioned or some other vehicle for the industry and regulators to cooperate to develop competitive, global, up to date, technologically capable systems to beat our global competitors.
Because if you think that developed Europe and especially Asia are going to stand by as they accumulate all these positive cash flows in Asia and not try to grab bigger parts of the financial markets you are sorely misled. Excuse me for ranting on this subject but somebody has to because no one seems to be doing this. I think it is our responsibility as participants in the industry to do that.
With those comments I will open it up for questions.
Question and Answer Session
(Operator Instructions) The first question comes from the line of Daniel Harris – Goldman Sachs.
Daniel Harris – Goldman Sachs
You mentioned earlier in the call the decision at some point to start growing the loans at the bank. I was wondering as you think about that where you see the most opportunity. Is it in residential or is it in the commercial and CRE space where you see you might grow loans going forward?
As you see over the last three quarters and this most recent quarter our loan portfolio was down about $140 million following two quarters where we were down roughly $500 million. So the activity levels in terms of us growing the portfolio, that effort really started in earnest at the end of the September quarter but as you know it takes a little while to build that momentum up. We did 18 transactions in our corporate portfolio that represented about $200 million of new funded loans.
The residential business has been a little bit more challenging where we moved from an environment where there were a lot more sellers than there were buyers. That dynamic has changed. We are actively looking for some new channels for some new residential loans. We have a couple of things that are closing this quarter but we are also not going to sacrifice credit quality for just putting on new loans for the sake of doing that.
The primary market right now is still very light but we are very active with all potential participants that we have been doing business with and once again we have really kind of started turning that aircraft carrier around as Tom alluded to. We would think we would be roughly flat to trying to be up slightly this quarter. I would tell you the activity in the capital markets we were notified this week of a couple of payoffs and pay down’s we are getting as a result of borrowers accessing the high yield market.
So once again we are not going to sacrifice quality just for the sake of putting loans on but we do think we will be able to eventually grow the loan portfolio in the next few quarters.
Before you go off that subject there is one other item you need to consider here. We still have this application and the convert to a commercial bank from a S&L which the government has chosen to move very slowly with and has concerns about ARS activity and things like that but no problems with respect to the quality of the bank activities or the financial stability of the holding company and results or anything like that. There is no real incentive for a regulator to approve anything that has any risk associated with it of making a mistake in an environment like the one we have been through.
While you can empathize with them a little bit even though it is frustrating from our standpoint because it caused us to again go through this gross up activity at the end of September that we described to you. So part of the problem is if we are going to have to continue to comply with OTS regulation it is important that we do add more residential mortgage loans here and so that will affect our judgment too.
It isn’t just where are things available that meet our quality and return standards because we are going to be guided by what goes on there. I wish I could be more definitive but this is outside our control. I don’t know what is going to happen there.
Daniel Harris – Goldman Sachs
Staying within the bank but moving over to the securities portfolios as you look out to March or April with the government cash back involvement in the mortgage market how do you think about your securities portfolio? I think most of it is agency MBS. Does that change your view in terms of maturity or type of security you are borrowing or how you are thinking about the mix of securities and loans?
We really haven’t been buying any securities. There have been a couple of Jennie Mae and agency bonds we have bought over the last 12 months but in the December quarter we didn’t buy any new securities at all. The private label portion of our securities portfolio continues to get paid down on a monthly basis and as Tom mentioned we have had some improvement in that negative mark-to-market by about $20 million in the December quarter.
In terms of the impact of the GSEs pulling back their purchases and support of the mortgage market I don’t think that is going to have a lot of impact on our existing portfolio. Right now we are really more interested in deploying our liquidity into loans. I’m not sure exactly how that is going to play out.
Daniel Harris – Goldman Sachs
As you look forward here to the spring and potential transition how are you thinking about any changes going forward for the firm or do you think it is just still the same business strategy we have had for the last few years?
I have got Paul Reilly in here also who is will be replacing me as CEO on May 1 and increasingly is involved in all of the activities here on a management level. All I can say from my standpoint is the transition thus far has gone extremely well. In terms of his rapid learning curve and in terms of all of our business activities, in terms of his continuing to manifest and understanding for as well as an endorsement of the general values and policies we have here at the business. It is interesting that for the first time since we have stopped worrying about survival you are seeing demand for the use of our existing capital again and we are having to go through some of these decisions about do we invest more in Latin America, how aggressive are we on the recruiting front and we are going to deal with all of these things in our long-range planning meeting in February of our Board of Directors which is always fun.
We definitely get a divergence of opinions represented at these meetings. We actually have an operating committee meeting later today. These kinds of discussions are ongoing. I would tell you from my standpoint I don’t see a lot of changes but things will be done differently. That is sort of what happens when you change CEO. I think the basic precepts are going to continue to be followed. We certainly share amongst all our senior management team a view that there is tremendous opportunity in our business not only to restore rates of return on equity that we have enjoyed in the past and get back some of the operating margins we had but also to capture share in almost every single one of these businesses. I know Steve certainly shares the fact that we would like to return to a little more normal banking environment where people spend a lot more time worried about adding new loans than they are about protecting the value of existing ones. So we have a lot of that but Paul is here so I will ask Paul to comment if he has anything to add.
Let me briefly say that first I am here because I believe in the strategy, direction and really the values of the firm. As I tell people internally the biggest difference on May 1st is it will be the day after April 30th. This isn’t about drastic changes. It is maybe about tweaks or looking at different things a little bit differently but we share the same values and direction.
Tom and I consistently agree on 90% automatically. Then we debate that and he has certainly got a lot of experience and I will continue to lean on that too as we continue past.
The next question comes from the line of Devin Ryan - Sandler O’Neill.
Devin Ryan - Sandler O’Neill
I believe you said that productivity per financial advisor is down 16-17%. Can you quantify or qualify how much of that is related to the new hires that haven’t ramped up yet? What I am trying to get a sense of is there a large amount of revenues from more recent hires that isn’t reflected yet in the results?
As you compare year-over-year the only comment I would make to you is that we had a lot of new hires in prior periods too. So I would say the quality of the hires we are making hasn’t declined. So we are still adding above average producers in general at the firm with the exception perhaps of the [fit] division where we have these brokers in banks who tend to range all over in production but I would say on average you have a little lower production in some of those positions. I don’t think that is really the major factor. Certainly we had some built in ramp from the hires over the last year that still will be ongoing this year. I really think this is just a major deficit in terms of recovering the levels that existed on prior assets.
Since the asset levels have recovered to a large degree I actually think that we have a great opportunity to see that difference recovered here within the next 12 months. That is a substantial increase in commission activity by itself without some increment from new hires or them reestablishing prior productivity levels.
Chet is here too and he is still running all the retail operations. Chet you are probably the best one to comment on this.
I agree, the late productivity is more impacted by continued fear in the marketplace on the part of retail investors. People are starting to get their legs under them again and some confidence but there is still a great deal of apprehension about a second leg down or some double dip or some other impact that would put them through another decline in asset values and there is fear out there. Consequently there are large cash reserves building. There are people waiting to see what is going to happen. The commission part of our business has not recovered anywhere nearly as robustly as the fee part of our business has.
So we have that to look forward to and I think with the increased productivity potential of the people we have recruited which is much higher than our averages were before. There is a great deal of leverage built into our system.
I would tell you we are still seeing some move of assets to fixed income in spite of the fact you would have thought the market performance would have gotten a lot of our people back into equity. I would say that a number of our elderly clients, and I can relate to them because I am one of them, the fact is they are looking at those assets and they are saying gee I don’t know if I want to go through the probability that one of these could happen again in my lifetime now that I am 65. Consequently I am going to move more assets to fixed income because I was really under-diversified by demand. I would tell you the clients define that because of prior performance. Now a 10-year period of no real increase or equity value you have to sit back and say to yourself, I would say by the way being a friend that means the next 10 years are going to be good.
That’s right. They would conclude that I may only live five more years and even if I live 10 years I don’t want to go through another one of these gyrations. I sort of empathize with that point of view. I know what has happened historically and that is people will continue to invest in equities. I will remind everybody that we forget too soon. When you look back last March there wasn’t a real market for a lot of equity. I always described the behavior of what the stocks were doing as a safe and freefall, falling off the top of a building. There was no way to interrupt it. There was no logic to it other than physical laws. No one should have pushed it off of the roof of the building.
The fact is when you see that, that is what causes people uncertainty because they realize it wasn’t rational what happened and they don’t want to be subject to that.
Devin Ryan - Sandler O’Neill
You had commented that the bank appears to be on the road to higher profit. Maybe there is some lumpiness in the provisions going forward but can I extrapolate from your comment that it is your expectation the provisions going forward on average should be lower than what we saw this quarter? Essentially no big surprises in volatility or above normal in any one quarter.
Just a couple of additional points on that. In residential loans we did have an increase in past dues but it was relatively nominal in the aggregate about $1 million in terms of loan balances being higher in terms of our past due. The percentage looks a little bit higher in terms of past dues to total loan as a result of loan balance declines but just so you know the less than 90 day past dues in the residential portfolio are actually down quarter-over-quarter so these loans we would like to think are working their way through the pike.
We are continuing to be very cautious in the residential portfolio in terms of another leg down or a double dip in housing. On the corporate side of our portfolio we saw pretty marked improvement across the board but we still remain extremely cautious on commercial real estate. Out of all of this the new deals we did in the quarter out of the 18 I think two were real estate related. So predominately corporate, commercial or industrial focused at this point.
All that being said we know over the last 4-5 quarters we have been very aggressive in terms of how we are reserving and charging loans off. As Tom mentioned we would like to think we are starting to head into a more normalized environment. But we are also not here to predict what the next few quarters are going to look like because as you know our portfolio and loan loss reserves and charge offs can be lumpy just given the large nature of some of our credit exposures, particularly in our corporate portfolio.
A great example of [inaudible]. I am really proud of you Steve.
The next question comes from the line of Christopher Nolan – Maxim Group.
Christopher Nolan – Maxim Group
The decline in non-performing assets from the prior quarter was that mostly seen in the commercial real estate portfolio or brokered or what?
We actually had an increase in residential non-performers of a little over $10 million so the corporate and commercial real estate portfolio in terms of the non-performers actually were down quite a bit. We were down roughly the total reduction was a little over $20 million in non-performing reduction. It was pretty broad. We had some pay downs and one of our commercial real estate loans actually paid off entirely that was non-performing. We had some upgrades of some loans both one corporate loan that was non-performing was put back on accrual status and we have had a couple of upgrades in the commercial real estate portfolio that were upgraded as well.
We did have some charge off’s that lowered the balance of non-performing loans so all of those things factored together resulted in a net reduction in non-performers [inaudible] commercial real estate space though.
Christopher Nolan – Maxim Group
As a follow-up did the regulatory changes in terms of recognition of non-performers where the loan is performing but the underlying collateral is worth less than the loan…NPA growth from one quarter to the next?
That had no impact on our results.
Christopher Nolan – Maxim Group
Positive or negative do you see any sort of impact from the proposed Obama tax on financial institutions? I am saying benefit from the standpoint you see some talent coming over from the larger banks to Raymond James? I know you commented at length on it and I am completely sympathetic with it. I am just trying to get it more distilled.
I really don’t think that it is large enough to impact that very much. It is more of the comp issues and the disaffection that has grown amongst employees, not just financial advisors, with the large institutions that didn’t perform not just because they were large but because the performance was subpar during this period and certainly didn’t conform to their prior opinion that they were situated on a lot of stability.
In fact they may have been on rocks of stability but the seawater was rising. So I think there is some of that still going on. They are not really convinced of the commitment in some of these institutions is at the level it ought to be and that some of the institutions have totally lost credibility. I won’t specifically mention them but if you look at where you have the biggest outflows of financial advisors you might get a feel for that.
It is also true in the investment banking and public financials at those firms. They have similar levels of discontent arising from the performance. It is just that now that things have stabilized and it looks like a vast majority of firms have gotten rid of TARP, and that is in this special class of those who would be competitors to us. There is just not going to be as much movement but there will continue to be net loss from those firms during this coming year. That is not to say there will be.
They are going to start worrying next about margins in their different business units when they get past the survival mentality also. You may see continued activity in terms of exiting certain businesses or you may see a board of directors in some foreign country sitting down and saying we really don’t want to be in that business. We don’t understand that business very well. We haven’t had very good managers in the business. We want out. We would certainly benefit from of that if that happened.
The next question comes from the line of Steve Stelmach – FBR.
Steve Stelmach - FBR
Could you circle back on your thoughts on financial regulatory reform. I wasn’t real clear where you stood on the issue. I appreciate the candor.
I am for financial reform by the way. I really am. That is the point I was making. I appreciate the one liner though. We need more of those now.
Steve Stelmach - FBR
On the bank margins the banks have [been] a little higher clearly than last year. [inaudible] a little higher or by some higher margin. At this point what do we need to see to get that margin to at least stabilize? Is it short term rates or are we looking for something else?
Just making sure we are on the same page in terms of our reported results here because it may have got lost there, our net interest spreads over the last couple of quarters have actually been very stable. When you take out the effect of the excess cash balances that are in the bank that started in the September quarter and then continued on in the December quarter. We have that excess cash now outside of Raymond James bank and in the other banks that are in the multi-bank suite program. So you take all that out our net interest spreads were roughly 3.37% last quarter and that was one basis point higher than the prior quarter.
What we are seeing right now that is going on, the incremental business we are doing in the corporate portfolio is actually accretive to margins but as Tom mentioned we are seeing more demand than there is supply. We have seen where we were for many quarters where there were very high LIBOR floors with much higher spreads we are seeing that start to come in just slightly and we are seeing more buyers and therefore our allocations in the primary deal will be cut back.
Still that being said the incremental business we are doing is actually a net positive to spreads in the corporate portfolio. On the residential side it has been somewhat stable but maybe slightly down in terms of loans that are coming up for reset. They are coming off of their initial 5-year fixed rate period and then they are resetting to the reset rate which is slightly lower than what it was before. The net/net of that is we think our margins are going to be somewhat stable. In the bank we would be negatively impacted by rising short-term rates but I think that would be offset at the rest of the firm. It is not a big impact though because most of our assets are floating rate and we would benefit in the corporate portfolio it really wouldn’t be an impact. It would impact our residential portfolio from rising rates.
I would conclude that absent all the problems in the economy the fact is what we are doing and you can look at it on an individual loan basis all the way through just generally what is going on in loan classes, etc. the rates of return on equity currently are not where they ought to be given anything like these spreads. So as you see some normalization occur if that is the correct outlook you are going to see higher rates of return on equity and Steve certainly likes double digits. He gets real fired up. There is a lot of latent potential on that front as well as from ramping up lending balances.
Steve Stelmach - FBR
On capital allocation the bank I think began higher capital last year. It seems like you are pretty close to where you want to be in terms of capital. Incremental capital, where do you think it goes? Is it on the retail side? Institutional? Back to the bank?
Well I didn’t mention our proprietary activity. We expect to be making some transactions on the proprietary front as the demand or capital, so we continue to look at outside private equity investments as part of our overall rate of return kind of investing but also assisting in the investment banking activities we have got. So there is some demand from that sector of the business and I would tell you we are seeing pretty good transactions. So potential transactions.
I think there is going to be good opportunity there for us. As a practical matter as you know we limit our capital allocation to those kinds of assets unlike some of our higher learning institutions did prior to the market decline and then the illiquidity they are now bemoaning. I think we are going to continue to have some demand there and on that front where we will put some money. I think we are going to have enough capital generated from retained earnings and from existing sources. That $300 million addition was actually a good idea. It wasn’t just totally for a buffer fund in the event of continuing difficult times.
I think we have enough capital actually to allocate things like additional foreign offices if we decide to do that or to make a smaller firm acquisition. There is certainly bank lines out there we are not even bothering currently to utilize that we could utilize or new ones we could establish for specific purposes in the event we want to do something. We have been told that by some of our banks. So I don’t really see a shortage of capital. It is just we are going to be tough. If you look, for example, at the merchant markets at these levels you have to be a little concerned that if there is a decline anywhere as China recently indicated there is reason for concern in some of those markets that have run up a lot. We have to be very careful in terms of how we deploy capital even where we think we see great opportunity. We are not going to be just rushing off a cliff to do these things.
We are looking at a lot of things again though and it will be subject, as I said, to the long-range planning meeting. I think a lot of the recovery, for example, in PCG, doesn’t really require capital commitment of anything like what we have been making over the last couple of years. So I think we are going to be fine.
The next question comes from the line of Hugh Miller – Sidoti.
Hugh Miller - Sidoti
Do you know what the cost implications at the bank from the expected rise in OREO properties you alluded to in the press release?
It is still a relatively small and manageable number of properties that are currently in non-performing that will be working their way into foreclosure and into OREO. It is a manageable number. I don’t have a figure for you. It shouldn’t be a huge impact to our overall earnings and we have budgeted and are planning for an increase in OREO expense both in the actual ongoing management of those properties and also as we have seen in the past we have taken some charges, we didn’t have any write down of OREO in the December quarter but we have had a write down of OREO properties in prior periods. So we are factoring that into our operation.
Hugh Miller - Sidoti
I know there was a question asked before about provision levels on a go-forward basis. I was wondering if you could talk a bit about barring any type of double dip in the economy and with where we are yet you are still cautious on the CRE cycle as we move forward but how comfortable you are with the notion that September’s NPA levels could represent a peak as we look back a year from now?
Absent having a lumpy…we could have a couple of loans go on non-accrual that could be a big number and have another spike. Obviously we don’t feel like we have anything like that identified or has already been put on non-accrual. We are still at risk for having something like that fall out of bed, so to speak, and have to be put on non-performing and it still could impact the numbers and as I mentioned we did have $10 million increase in non-performers in our residential portfolio. I think there is still some risk we could have an increase so it is hard for me to handicap what that is going to look like going forward. Obviously we would like to think we have seen the peak in the September quarter but that may not be the case.
Hugh Miller - Sidoti
With regard to the equity capital markets business, obviously you have been doing some opportunistic hiring. It seems as though you are positive on the outlook with regard to increased activity as we head further into 2010. Can you talk about I guess following the hiring you have done how you feel about the opportunity to not only benefit from any increase in activity but also just maybe gaining some market share as we move forward?
On the equity capital markets front clearly there aren’t as many players in the small and mid cap space. As activity picks up generally the big funds will be less apt to participate in some of these smaller transactions they have been involved in lately and then they just sort of go away after the deal. It is sort of incredible what happens in these time frames.
I think if you look at our SBU groups with our largest businesses being energy, real estate, financial services, we have a pretty good healthcare practice, these are going to be vibrant areas for additional finance going forward and we are trying to expand our consumer presence and some of the other activities which we think are mainly [inaudible] currently that will pick up. So I actually think we have a good chance to increase the space and our market share if the market is as attractive as it is now and you see the private equity firms where we have a massive effort in terms of calling on that marketplace, etc. for IPOs and just generally we are seeing people…I had somebody in my office this week who made an appointment to come in to ask me how the equity markets were working and what his timeframe ought to be and where his hurdle rate of activity needed to be to do a public offering.
That just demonstrates to me anecdotally that we are beginning to come out of this very quiet period and while it is still a little fragile just because it is hard to tell whether you are going to have a correction here or not, I actually think we are going to see a pretty good ramp up in business for all these firms in this business and we are in a particularly good place. When you look at our retail distribution which is more important than a lot of firms advertise in terms of who you want to have own your stock in an initial offering, or who will own your stock because of the interest or the type of security and European institutional sales and US institutional sales and global research we are building we are seeing underwriting assignments in Brazil and Argentina. I think that we are in a good place. Canada is going to pick up on the investment banking front too.
I think the business has changed a little bit currently so when those big firms going down and doing these transactions including five or six co-managers and maybe having two senior lead managers or so that makes for a very small percentage allocations at the co-manager levels. That is hurting us more and that change has hurt us more than about anything I would tell you. It is not because people don’t respect our research in our business. Quite the contrary. I expect our institutional conference in March to be sort of record levels of interest and participation.
I think there is a lot of opportunity but we are at that kind of position where you are in between making it to another plateau in terms of levels of investment banking activity and we earned that on our research base but we haven’t yet earned that in terms of direct competition for the underwriting assignments. That is what is going to be the differentiating factor going forward. We have to do better. We will do better.
The next question comes from the line of Joel Jeffrey – KBW.
Joel Jeffrey - KBW
In terms of the fewer opportunities you are seeing on the commercial loan purchases, is that really being driven by larger banks generating fewer loans at this time or is it just more competition for the loans?
I would say more the former than the latter. But we have had our allocations cut down on several deals we have done in the last few months quite substantially in terms of us committing 25 and getting 12 but the deal flow is slower right now kind of in our sweet spot in terms of credit quality. Once again we are hoping that the overall economic environment and capital markets will continue to fuel M&A activity and therefore deal flow for us. There are opportunities in the secondary market. We have added to certain positions and taken on a few new things in the secondary market but as Tom alluded to earlier prices have moved up substantially kind of across the broad senior loan market probably 30 points in the last 12 months.
Arising like a phoenix is the high yield bond market and public securities and the fact is as you might expect a number of borrowers are concerned about having too much commitment to bank loans that have shorter terms when they can go out further with less terms and conditions and the good ones qualify to do that. The fact is some of these companies are quality credit, the DD type credit quality companies, but often because of size and not because of quality of the company. They are looking at this and saying maybe it is worthwhile to pay the premium to get the term commitment and have more flexibility with respect to using banks and future financings.
Rates haven’t been terribly…LIBOR is 100 basis points plus 400 you are looking at a floating rate of 5% or something like that.
If you go out even like we did and do an 8 or an 8.50 that is not much premium to pay for that much more freedom. I think that is part of the cause. I also really believe and you need to keep this in mind that the companies have really battened down the hatches. They have cut costs and gotten rid of employees. They have improved their balance sheets and they can pay back bank lines even if they intend to go back into the bank markets when things pick up. So we had some of that happening right now too. You add that to the natural disinclination of any financial institution to make a loan that has any risk associated with it, real risk of non-payment, you are not going to get a lot of it. I would not blame it all on banks not making loans. They are not making loans because demand is declining too. As we see business pick up that will reverse. I expect that to happen but it is not going to be an overnight process.
I would also add I think we have talked about this before that about 1/3 of our corporate borrowers have an institutional relationship with the firm either research and/or equity capital markets. In the December quarter about 75% of the deals we did were actually with firm clients. You will probably see that percentage of our borrowers that have another relationship with the firm increase over time. We think that is obviously good client selection tool and we won’t be exclusively doing that but it will be a larger percentage of our new business will be other relationships with the firm.
In fairness that also reflects the fact that issuers are more sensitive to trying to make relationships with people who have equity offering capability and also can join that with lending capability and looking to maintain a group of relationships that are all similarly capable so they don’t have to maintain ten relationships. They are more sure that those financial providers stay on top of the stocks, the right research and are just as sensitive to making sure the overall capital balances are right at the firm as the issuer is.
So I think that is going on all over the world and it certainly hasn’t slowed down as a result of what we have just been through.
Joel Jeffrey - KBW
As a follow-up to that, given what you said about the relationship aspect of this and I realize this could be a complete seat change in strategy but would you ever consider building out a [inaudible] capability to take care of this?
Oh yes. We have talked about that on numerous occasions. That is mainly a consequence of what size we are in and what new products or processes we are adding at the bank. That is in the foreseeable future I would tell you. We would do some of that for our client base. It is almost competitively necessary that we begin to consider doing that.
Joel Jeffrey - KBW
Lastly, when you talked about the impact of higher interest rates on the private client business and the increase in net interest income how should we think about that falling to the bottom line? Would the comp ratio on client go down or is this sort of all factored into the advisor’s comp rate?
I don’t think the comp ratio would change too much. The advisors share modestly and some of the advisors and some of the products share some of the interest spread but that is not going to impact the comp ratio too much. We are trying to get our hands around better sensitivity analysis of interest rates but the positive impact on the private client group would be more than the negative impact on the bank of a modest rise in interest rates. So we think that the first couple of raises would be a net positive to the overall firm although again we have again a positive on one hand and a negative on another segment so it wouldn’t be as dramatic as it would have been in the past before we had the bank.
I actually think that where you are going to see comp ratio go down a little bit is mainly in the GNA section of the PCG as the productivity levels are restored and indeed they increase above prior levels. That will lower some of the overall costs but it is not going to be a tremendously large factor from either source I would tell you.
There are no further questions at this time.
We would like to thank all of you for participating. We look forward again to continuing seeing manifestations of the overall longer term trends that we are forecasting will occur here. Thanks so much. If you agree with some of the comments I made don’t be afraid to get on the pulpit. Thanks very much.
This does conclude the conference. You may now disconnect.
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