Raymond James Financial, Inc (NYSE:RJF)
Q3 2014 Earnings Conference Call
July 24, 2014 08:15 ET
Paul Shoukry - VP, Finance & IR
Paul Reilly - CEO
Jeff Julien - CFO
Steve Raney - President & CEO, Raymond James Bank
Chris Harris - Wells Fargo
Steven Chubak - Nomura
Jim Mitchell - Buckingham Research
Alex Blostein - Goldman Sachs
Welcome to Raymond James Financial’s Fiscal Third Quarter 2014 Earnings Call. My name is Desean and I will be your conference facilitator today. (Operator Instructions). Now I will turn the call over to Mr. Paul Shoukry Vice President of Finance and Investor Relations at Raymond James Financial.
Good morning. First on behalf of our entire management team just want to thank all of you for joining this morning for fiscal third quarter 2014 earnings call. We certainly do appreciate your time and interest in Raymond James Financial, so thank you. After I read the following disclosure I will turn the call over to Paul Reilly, our Chief Executive Officer and Jeff Julien, our Chief Financial Officer. Following their prepared remarks they will ask the operator to open the line for questions.
Certain statements made during this call may constitute forward-looking statements. Forward-looking statements include information concerning future strategic objectives; business prospects; anticipated savings; financial results, industry or market condition; demand for our products, acquisitions; anticipated results of litigation; and regulatory developments or general economic conditions.
In addition, words such as believes, expects, anticipates, intends, plans, projects, forecasts, and future or conditional verbs such as will, may, could, should and would, as well as any other statement that necessarily depends on future events are intended to identify forward-looking statements.
There can be no assurance that actual results will not differ materially from those expressed in the forward-looking statements. We urge you to carefully consider the risks described in our most recent Form 10-K and subsequent Forms 10-Q, which are available on SECs website at sec.gov.
So with that I will turn the call over Paul Reilly, Chief Executive Officer of Raymond James Financial. Paul?
Thanks Paul. Good morning everyone. Jeff and I and Steve Raney actually are calling you from the beautiful city of Asheville. We have our Summer Development Conference which is the conference for our traditional top advisors, our employee advisors and if you don’t think it's a unique event, us and the advisors and the 700 kids are here Aqualand [ph], I think it's a testament to our family culture that we still have not just spouses and others but also children attending the event. We just finished the Summer Conference for Independent Contractors Conference in Washington, D.C. and again it was fantastic with 2000 people also.
I will now provide a brief overview of our results and Jeff will give you a little more of detail. We achieved many new records in this quarter, net revenue of 1.2 billion, net income of a 122.7 million, earnings per diluted share of $0.85 and client assets under administration of 479 billion all records for us.
Our largest segment, the private client group generated record revenues pretax income this quarter also. So there is a lot to be proud of. However this quarter also benefited from certain favorable items that don’t necessary recur every quarter. The major ones we highlighted were the $8 million in private equity of valuation adjustments and exceptionally strong quarter for tax credit funds the business that tends to be lumpy but having a very good year and a continual beneficial tax rate.
You guys can do the math but even without those numbers we had a very solid operating quarter. Just as we said in the last quarter’s earnings we had many items going against us, we think it's more valuable to look at the three quarters of fiscal year in aggregate to evaluate our performance and quarter-by-quarter because of the noise inherent in any quarter. If you do that you will see we generated a 15% pretax margin on net revenue and delivered 11.9 annualized rate of return against the 12% ROE target in this current interest environment. We think with interest rate changes we told you that the 15% targets in range we get a 100 basis point rise where we get the majority of our benefit in short term interest rates, overnight interest rates which should give us another about a 150 million per year in pretax income.
Meanwhile we think the 12% ROE is very reasonable compared to other firms in our industry especially considering our very conservative capital position, a total capital to risk weighted assets ratio of over 20%. So going back to this quarter we generated record net revenue of 1.2 billion, up 9% compared to last year’s June and 3% over the preceding quarter. Record net income of a 123 million, 46% over the GAAP results in June’s quarter and 33% over the non-GAAP results of last year’s June which did include some adjustments related to expenses associated with the Morgan Keegan acquisition.
So a quick view by segment, the private client group segment generated record revenues and pretax income as I’ve said driven by record levels of assets under administration which reached 454 million client assets under administration. 454 billion in the segment. Net revenues of a 187 million grew 10% over a year ago, June quarter and 1% over the preceding quarter. The revenue growth has really being led by a growth in assets and fee based account in the private client group which now accounts for 37% of our client assets in that segment as equity and fixed income activity in the segment remains tough [ph].
Despite the rising equity markets we think that many clients are still waiting on the sidelines although our average cash balances even to our historic mean per client are down. Those shows that the advantage of our recurring revenues now has reached 70% of total revenues this segment. Another thing we’re very proud of is that the advisor front, we continue to be extremely effective in retaining and recruiting the highest quality advisors. During the quarter we added 49 new net advisors growing our total count to 6251.
Activity levels which we measure by home offices it's a leading indicator for recruiting are still robust. We expect the trend to continue as deals -- retention deals from other firms till the financial crisis burn off.
I also have to talk about the profitability of these segments since pretax income of 81.5 million grew 39% over last year’s June quarter and reached a new record. The segment is benefited from operating leverage and discipline expense management which has enabled us to hit our 10% pretax margin on net revenue for the quarter sooner than expected. We previously had told you by the end of the fourth quarter.
I know that sometimes people get confused on our pre-margin target of 7% it seems much lower than our competitors but then Dennis [ph] explained at our Analyst Day, almost all of it’s a trigger to just different economic -- not the economic measure but how we count the beans. So for example most of our peers would include their bank earnings in their segment. Raymond James Bank is not included in our private client group nor is our asset management which is accounted for separately.
Now turning to capital market segment we generated net revenue of 237 million and pretax income of 28 million for the quarter representing 11.8% pretax margin. That’s below our 15% target but given the fixed income environment with head winds and the trading activity which is being tapped in the equity capital markets. We don’t expect much improvement in the short term until -- especially in fixed income we need rising rates and/or interest rate volatility to really generate more activity there.
On the equity capital markets division underwriting revenues grew 24% on year-on-year basis and 17% sequentially. A lot of that is driven by Canada but really offset by weaker M&A markets in the segment for us in this quarter. The M&A activity was softer than last quarter although our backlog still appears very strong and building.
It's really the same story this quarter for our fixed income division, low interest rates and low volatility continue to drag on commissions were down 22% from last year’s June quarter.
So I don’t expect much upside in the short term for fixed income again until rates start to move. Probably the big surprise to many was the number in capital markets for our tax credit fund business. It is a lump business as syndication fees increased by more than $10 million over the preceding quarter but you know we account before this deals close and we just had a good closing quarter especially in the month of June.
The asset management segment continues to benefit from record levels of assets under management, we reached a record of 65.3 billion this quarter, an impressive 25% over last year. Net revenues of 91 million grew 19% over the prior year and pretax of 31.3 million grew 31% over the prior year. This business should continue to perform well because of net inflows partly of the market but also because it's a strong private client group recruiting.
Raymond James Bank, it's going to generate strong results. Total net loans of 10.4 billion, grew 19% over prior year and 3% over the preceding quarter driven by growth in the C&I and securities based loan portfolios. Compared to the preceding quarter, the bank’s net interest income in the quarter was almost completely offset by higher loan loss provisions which is due to grow not the issues. I know a lot of you are concerned about the OCCs annual review of our Shared National Credit Portfolio and you can see by the release that we had very good results. The review reinforced that the vast majority of our loans were in great condition and we had additional provision expense of 1.6 million compared to 5.6 million in the prior year.
The bank also experienced a few positive items this quarter, (indiscernible) pretax results by about $8 million which Jeff will explain in a little more detail. So with that overview of the segments I’m going to let Jeff get into some details into the line items. Jeff?
Thanks Paul. I know that we typically talk about segments but all of you do models and we report obviously in line items on the P&L. So sometimes it's a little difficult to translate the segment info into the line item. So I thought this time we would -- I would walk down some of the line items as they deferred from the -- what we put together which is a consensus of your models those of you who that are the kind of not to supply them -- we actually do a consensus by line item so we can see where we’re not giving enough guidance or color and then we can help explain some of the differences. By the way I guess we’re doing pretty well at it because about half the line items are within a $1 million of the consensus to actual. So we seem to be doing something pretty much right.
Running down the line items quickly, securities commissions and fees are -- we are pretty much right online and you’ve the detail in the press release on page nine and you can see it's the usual mixture that we have had so far this year which has been a steady improvement in private client group offset by some more difficult times in the capital markets commissions and this trended during the monthly operating specific releases, so no big difference there. Investment banking line, we did better than year consensus projections. As Paul mentioned it's primarily driven by the Raymond James tax credit fund syndication business $10 million swing from last quarter to this quarter.
Excluding that investment banking revenues were pretty flat maybe down slightly which again on page nine is detailed where you can see underwriting revenues up and M&A actually down slightly from last quarter. Investment advisory fees didn’t -- we came in below your expectations. One of the things I guess we didn’t do very well at because we didn’t mention it last quarter is if there was a couple of million dollar performance fee in Canada that came in the March quarter that was -- came in and then -- a bunch of it was paid out as subadvisory fees. Couple of million dollars total. So it was kind of an in and out on both sides of the P&L but that distorted last quarter a little bit. We spent most of the time last quarter talking about the difference because of the performance fee in the December quarter but this factor obviously makes the difference in looking at June to March. So we’re taking that couple million dollars out that -- annual fee.
It was more in-line both on the revenue and the subadvisory expense side. Interest we were just slightly below projections. Paul mentioned client cash balances, actually -- versus a year ago our cash balances are up about 75 million -- sorry our total client assets are up about $75 billion but our cash balances are actually lower than they were a year ago. They were 8.4% of assets a year ago, they are down to 7.1% now. So clients are certainly a little more invested in lease holding less cash here or in short term cash equivalent such as CDs or very short term bonds and other things for the time being.
Account and service fees were pretty much in-line trading, Paul already addressed. In the other revenue line we did better, obviously driven by the private equity valuations and other factor in there compared to last quarter at least is one of the (indiscernible) items at the bank that drove their gain and there were really two items at the bank level while net interest -- a net interest improvement of 3 million was roughly offset by a $3 million higher provision for loan losses. There were two items that’s changed quarter-to-quarter that has caused the bank to have a pretty dramatic improvement.
One was in the March quarter, there was a foreign exchange loss and in this quarter there was a foreign exchange gain. We still hold $30 million to $40 million of loans in the U.S. bank that are dominated in Canadian dollars that we so far have not hedged, so that’s been a little bit of a volatile item but from quarter-to-quarter about a $4 million swing and the other item that’s in there has to do with a charge and a liability related to unfunded loan commitments which is not part of the provision in loan loss reserve but it is part of the P&L as a charge and it's in other liability account.
There was one particularly large item that was a special mentioned credit that still was not in covenant violation and we had taken a bigger charge in March related to the potential of them drawing on that line and us having to take a reserve provision at that time, turns out that loan either we are no longer are in that credit. We sold that loan out in the June quarter, it was about a 1.7 million charge in March and we reversed that in June. So that’s about $3.5 million. So those two items make up the vast majority of the bank’s swing. But going back to line items the foreign exchange part and also the reversal discredit charge are in this other revenue line. I’m sorry the reversal charge and other expense, my apologies.
On the expense side compensation, we’re pretty much in-line with everybody’s expectations a little higher maybe because of revenues were higher and we did achieve the 68% comp ratio for the quarter but I guess people can say while it was only because of some of these extraneous revenue factors like proprietary capital and things like that. So we probably on an operating basis weren’t quite there but we still have that as our objective for our run-rate in the fourth quarter to get to that 68% total comp ratio, we’re getting very, very close.
Data comp you remember last quarter we talked about some seasonal factors such as the mailing of 1099s in that an unusual item which was a move to a new data center in Denver. Most of you had adjusted that correctly and it actually came in a little better than your projections and probably our expectations as well. We had some projections wrap up early in the quarter so we got ended some of the consulting agreements and things but my guess is those will be replaced with other projects going forward. So I would say we’re still kind of guiding for the mid-60s per quarter on that which is where you had us this quarter.
Occupancy clearance and flow [ph] brokerage business development were all right in line with year consensus. Investment subadvisory fees I talked about the loan loss provision we talked about, now we’re down just to other expense which a lot of which is and there is a detail of this of course of page nine in the press release as well. It has to do with the consolidated tax credit partnerships, a lot of those losses come in there every quarter now it's not a once a year thing, we’re going to have a number like that in our expenses most of which comes out through non-controlling interest which is another line item that was pretty fair off from where the consensus chart was.
So you can see that was about almost all the $12 million expense from these partnerships came out through non-controlling interest.
The tax rate -- I know we have been guiding you a little higher than it's been because we don’t typically project a 5% a quarter market increase. We have been experiencing that and so we have been benefiting from the corporate owned life insurance appreciation that’s a non-taxable gain to us. So in a rising market perhaps you could if you want to be precise back to that a little bit into the tax rate. It's been about a 1% - 1.25% boast to us so far in the tax rate this year, it's running about $7 million a quarter. We got about $200 million in corporate owned life insurance, it's not all in equities. So it's not all impacted by that but it's been about 7 million a quarters so far this year.
A couple of other things I will point out, we’re frequently asked about the asset mix. We have seen a shift from a year ago. Equities were a little under half of our client positions a year ago, they are up to about 53% now and that’s 5 percentage point increase came about 4% on a fixed income and 1% out of cash as I mentioned earlier. I would also like to point out that our firm wide recurring revenues for the quarter were over 62%, for the year-to-date they are 61% and so we’re nicely over that 60% plateau. I’m not sure if I would say we like to stay -- we would like to grow it or not because if it shrinks back under 50 it's because we had a whole lot of transactional revenues and that’s not necessarily a bad thing if there is a really active trading environment or investment banking environment.
And lastly I just point out that it was nice to see our shareholders equity top to $4 billion mark for the first time.
With those comments I will turn it back to Paul.
Thanks Jeff and just wanted to make a few comments before I open it up for questions. First maybe the preempt question I know will come on kind of our targets. I think once as I have said earlier we think that 15% margin and the 12% ROE targets are good targets for now in this operating environment. Certainly we’re affected by the market. People have been waiting for market correction for a while and it may or may not come and for us it depends when it comes, if it comes in the middle of a quarter and rebounds it doesn’t have a lot of impact, it's on quarter end and it has more impact.
But we’re well positioned and we think these targets are good targets given this interest rate environment, until interest rates move I guess if they move. We’re maintaining kind of that outlook. Our private client group business is really been doing extremely well, I’m proud not just for the recruiting but more importantly the retention. We’re getting great retention coming from both of these conferences, the spirit of our advisors are very, very high and a part of it is the market is good, people are happy but a lot of it is -- they are very happy with all our investments in technology and our continued high level support people just believe the firm is really helping them with their business which is kind of our model.
We believe that that’s kind of our unique position that we have advisors continue to move to what we call independence and whether they are independent or the employee channel we give our advisors a lot of freedom to practice business the way they want within our guidelines and as deals on the wire houses [ph] tend to burn off and our recruiting pipeline stays very robust. So we expect this recruiting continues to grow, and in the decent market that -- the private client group business should do very, very well.
The capital markets business is kind of the tail on the other side that certainly over the (indiscernible) commissions challenged across the industry. We have been in underwriting certainly you know one of the segments that we’re really strong and do well, we do well. When the segments we don’t participate and do well we don’t participate as much which I would say has been in the last quarter or two. We have had good syndicate activity but not high this quarter what I call lead activity. Although July has been so far a good month.
Fixed income, like I say you know I got an A franchise, I would say an A plus franchise operating in a D market until volatility and rates move, they are doing a good job of double-digit margins and really one of the toughest markets you could have. So I’m proud of what they have done and our public finance service we have actually continued to look to recruit in this tough down market as we are solidly in the Top 10, I think we’re number eight year-to-date in the lead tables in our public finance. I’m proud of that group.
Asset management, because of inflows partly because of the recruiting and the market increase our year should be pretty well set, they should have another good quarter since a lot of their assets are already built in advance. So they should have another solid quarter. And the banks continue to perform well. The challenge for us is we have been very clear to the bank. If you can find loans that need our conservative underwriting standards that are reasonable yield continue to grow and if you can’t don’t make loans, and they have been very good so far in finding good credits that meet our standards. And this market is unpredictable but the banks have done a great job.
So overall we’re in a good position. Proud of what we have done, I think this quarter I would characterize as not as good as it looks but very good, where last quarter we told you it was better than it looked and I think the average if you look at nine months running. So I think if you look at our first nine months operating and average it out you can see that -- I think that’s our operating level and feel very, very comfortable about where we’re.
So with that operator I would like to open it up to questions.
(Operator Instructions) Your first question comes from Chris Harris from Wells Fargo.
Chris Harris - Wells Fargo
Great quarter for recruiting, you kind of talked about that a little bit. Just wondering Paul, you guys are getting the benefit of some of these legacy retention bonuses rolling off, based on your conversations, based on the flow you’re seeing how long do you expect that trend to kind of persist. Is this something that could go on for quite a long while or is this maybe something that might be just kind of a quarter or two benefit?
Remember what Tom said and Tom is the master of phrases and openings. So when recruiting close down we just wait for some of the big competitors to do something else stupid which does makes sense for them but sometimes the advisors don’t like what they do is the institutionalization of their business but banks tend to look at doing more products direct, relationships direct, we seem to get the benefit also. So I think there is an awful lot of people still because the merger activity is pretty fresh that grew up in firms like ours that don’t like that kind of operating environment that tend to become and I’m sure the big banks own firms from their strategy it makes sense because they are trying to institutionalize and maybe overtime they will get the advisors that fit their business and their business model but I think we will continue to be the beneficiaries for a fairly decent period of time here.
I think that’s probably caused a little bit of a way generally when the markets are as good as they have been lately, you don’t see a lot of movement. So that’s probably what’s driving some of that but as the markets ever do slowdown that just shows that what the potential is here because we’re really in a pretty sweet spot. I have been talking to a lot of managers and regional managers here at this conference and they say it's just a little bit out of the ordinary, how many incoming calls we’re getting from people because they like the story, they like the stability, they like that we’re a private client group focused firm, they like to own their book. You know they like all the things that we have talked about as our differentiating features and I think that is sustainable the market environment and all is what’s going to change.
And the other thing is that if you look at our record year results ’09 and we were just kind of a haven. We were the firm out of the news and a terrible market, right? So this has been a very, very good market for advisors. So to get this kind of flow, most advisors don’t want to upset their business when it's doing very, very well. I think it's just showing that there are lot of people searching a platform like ours.
Chris Harris - Wells Fargo
Maybe just if I can ask a follow-up question or two on margins and I appreciate you guys already gave us a lot of color there. As it relates to the bank Jeff, you called out a few items. Is it safe to assume then that under reasonable set of circumstances that the bank margin might drift back down from the level we’re at now and any comment you could maybe give us about potentially extra cost you guys might have to absorb when your bank trips to $10 billion asset threshold?
We’re over 10 billion now. We’re actually over 12 billion and subject to all of the regulatory changes once we go over that 10 billion. So that’s really in effect now but we have I would say over the last few years added to compliance and audit and oversight, you being some of those regulatory changes but it's not a material difference at the bank. It's clearly inside our Raymond James Financial, we have had to add expenses being a bank holding company. We have added two risk management in that enterprise as well. So but really I would say in general a lot of those expenses are already kind of in our numbers over the last couple of years. In terms of net interest margins we continue to see some pressure on margins and as Paul indicated we’re not under any pressure to grow loans just for the sake of growing loans and we have been even more selective on credits particularly it's not meeting our return hurdle.
That said as we provided our comments in the past I would expect some slight net interest margin compression to continue over the next few quarters. It was down a 9 basis points this last quarter. I would say the bulk of that is in our corporate lending area, most of the other areas there maybe some slight deterioration in net interest margin but it's primarily in our corporate lending and commercial real estate book. But frankly we’re just passing on deals where we don’t think that the net interest spread that we’re being offered is commensurate with the type of credit they were extending.
So my only add to that is that in looking at the new production we’re not really doing much new production at rates that would compress this what’s happening is even if the new production is at steady rates or steady spreads, the fact is that older loans are what are running off or are being refinanced. So you still have -- that's what is driving it down. It's not the new production coming out of lower and lower rates going forward.
I would mention, we shared a line item in our numbers, our supplemental information on the bank that I have mentioned to you in the past but we have gotten into the tax lending business. The net interest margins are actually on a tax equivalent basis, are actually a little bit higher but without the tax adjustment that will potentially have a negative impact on our net interest margin. That business is just under a $100 million and outstanding as of the end of June. So it's still relatively small but a growing part of the bank now.
Chris Harris - Wells Fargo
Steve if I can maybe get you to kind of identity a number for us or maybe a range what would you say that the bottoming of the NIM, what that number might look like assuming kind of rates don’t change from here?
We have been provided some guidance I would say maybe over the course of next couple of quarters, maybe another 15 to 20 basis points.
I would say 270 (multiple speakers). We don’t have any economics to support that.
So far we have been able to use loan growth offsetting NIM compression to keep earnings flat. We don’t know -- our production has been good.
Yes it's interesting. They are embedded in the net interest margin, it's fee recognition. The March quarter for example we had an exponentially high fee recognition quarter where loans were paying off where we had unamortized fees that we took into income that actually kind of artificially inflated net interest margin in the March quarter relative to the June quarter. So that can contribute a couple of basis points. But as Jeff said I think -- you kind of bottoming it out 270 or maybe even little bit higher than that is probably a reasonable number for us to expect over the next few quarters.
Your next question comes from Steven Chubak with Nomura.
Steven Chubak – Nomura
So Steve, I think I’m not ready to let you off the hook just yet. I do have a follow-up question on expectations from loan growth and what I’m trying to do is reconcile -- some of the comments you had made in actually the last monthly metrics release highlighting a reduced level of -- or increased risk aversion within the commercial or C&I space given the deals that were coming across and I wanted to -- I just wanted to understand what our expectation should be for loan growth particularly within that channel going forward and maybe if you can give some context on the other channels as well, that will be really helpful.
Every time we give you guidance on loan growth, it goes the other way. So Steven -- going down. It's so hard to get visibility and we look credit by credit; so with that it's just -- I wish we could give you guidance but it's basically on the flow. If we like the loans we will participate. If we don’t, we don’t. So go ahead Steve.
I was -- up that we diversified the business over the last few years. As you know we are doing business in Canada. That business is growing actually a little bit more rapidly than our U.S. business. I mentioned the tax exempt business, the business that we weren’t in six months ago that we’re now in. We do some project finance infrastructure type lending. Obviously we have got a commercial real estate business as well that we have selectively grown. So we have got a lot of different businesses and obviously a lot of different industries inside of our peer commercial and industrial portfolio, energy, healthcare, technology, consumer, a variety of different industry. So in those businesses they don’t all run the same and they are -- some of them are counter cyclical with each other and we have been able to pick and choose across this broad spectrum.
We have been able to grow the C&I book, we have got the tax exempt business now growing. Growing our residential business and our securities based lending business will go through a $1 billion and outstanding this quarter. So we have got a lot of different businesses that can contribute to being able to selectively grow. As you saw we grew loans 3% this last quarter. I think that growth in the 2% to 3% range per quarter is an achievable number given that all of our businesses that we’re in. But as Paul mentioned if -- in one or two quarters if there not enough deal flow that we liked, it's in our sweet spot from a credit selection standpoint then we can run flat or shrink the bank potentially.
Steven Chubak – Nomura
Okay. Then moving over to the expense side of the bank. It's a follow-up to one of Chris’s question’s. If excluding the provision we actually saw the core expense come down – it's pretty meaningfully to 24 million versus 28 million last quarter and I just want to get a sense as to whether there is an seasonality that’s driving that decline and it seems as though you have already invested in terms of regulatory and compliance or have made the necessary investment. So how should we think about that expense run-rate going forward from a modeling perspective.
I know Jeff mentioned before the foreign exchange as well as the other revenue --
Steven Chubak – Nomura
I guess just on the expense side.
Yes I mean we have --
That provision for the --
The unfunded -- that was a big number, it was almost $4 million change right there in terms of our unfunded commitments. We have a reserve for unfunded commitments, the unfunded portion of lines of credit. We have a credit size loan that actually we exited in the June quarter so in effect released unfunded reserves that had a material impact to that line item. So our true expense run-rate is relatively stable. There is no seasonality to it.
But the trough is probably in between the last two quarters or maybe trending a little more towards the March quarter actually.
Steven Chubak – Nomura
And I guess switching gears and moving over the investment banking side. the business that show growth in the quarter, the pace of growth has wide [ph] some of the results that we have seen at your bulge bracket [ph] peer and looking at the M&A business specifically and maybe taking Paul’s comment and constructive comments I should say on the M&A backlog into consideration here. It does appear as though that the recent M&A surge has been concentrated in larger deals and I wanted to see if this is potentially limiting your participation in the recovery that we’re seeing.
I think two areas, in the banking areas our flagship practices historically have been reach downstream energy because of the MLP business. Healthcare, bull markets and bioscience or industrial or stuff we don’t compete as much because those aren’t our strongest spots and we’re building out some space in consumer and others right now. So on the banking side when banking activity in our sectors do well we outperform and when they are in the other sectors we probably underperform the market just because that’s not our sweet spot and the same on M&A. I think our M&A backlog is good but you’re right on -- the headline numbers are very, very big or very big deals and they tend to hit the money centered banks and the very, very large M&A firms.
So as those big deals headlines come or market share is going to be down because we don’t participate in those.
Steven Chubak – Nomura
And then just one final one from me on the trading profits line. I suppose given the subdued volatility we have seen in fixed income markets, the revenue stream there has actually been quite resilient and I argue it's really back to trend that we have seen at some of your larger peers and I was hoping you could explain the factors that are driving that resilience. I would have expected that higher volatility backdrop would in fact be better for that business but we have also seen some favorable inventory marks particularly in the month of June and want to get a better sense of -- maybe whether that provides some incremental support.
I would say there are few things happening and which is, we -- part of the acquisition strategy of Morgan-Keegan was that we had a good fixed income department -- we had a great fixed income department and I will tell you they are better than we thought. The inventory -- the reason we can get still good trading profits on our inventories because it just turns and that the profits are just little pieces of lots of transactions. They have a very good sales force. We don’t keep inventory long and all, we turn it rapidly and it's just a very, very good management and sure you know rates come in a little bit and we make more money because whatever we’re holding is more valuable but we do hedge a lot of the pieces of it. When hedges work without big movements in certain areas and so they continue to consistently perform and rates come in on some months it does better but they have consistently every month, the exception was last June, a year ago when everyone got it and everyone -- we did a lot less and traditionally carried bigger inventories than our competitors.
They just do a good job of turning it, hedging it, moving it and it's been pretty consistent. It's been consistent for a number of quarters but that’s what I say we have an A franchise in a D market. I don’t see in the short term that changing much. Now if we get steep rise in rates that will probably hurt us.
If the commission volume grows in the institutional fixed income side you will see trading profits grow with it as there will be more transactions.
And we just don’t like this gradual growth, and if it steep rises we can get a hurt a little bit inventory valuation but it's well managed and I think well hedged and they just do a good job.
Your next question comes from Jim Mitchell with Buckingham Research.
Jim Mitchell - Buckingham Research
I just want to follow-up on you mentioned the capital ratio is improving and I know you talked about it in your Investor Day about looking at both on acquisitions and asset management. Do you have any color? Do you see any opportunities out there? Or is it still? You haven't really seen a deal? Are you struggling to find acquisitions? Just want to get a sense of if you feel I guess more optimistic or less about the prospects of adding on to the asset management business or other acquisitions?
Yes. I would say the acquisition areas we have highlighted are both asset management and M&A opportunities both in North America and Europe. I would say I’m more optimistic and I think it's a market where there are a lot of people in businesses that we like that are willing to talk but it's hard to handicap. We have a screen on culture and we have found people with the right culture but a lot of those cultures are independent and typically independent firms don’t trade. So it's a longer term process, so discussions are good and if we get the right firm who is willing to join us and join the team we will do something. If we can’t you know -- it is very lumpy.
So I would say I’m more optimistic just because there is more activity and I’m more optimistic but I can’t give you any guidance or probability or timing.
Jim Mitchell - Buckingham Research
And maybe just on the wealth management side, it appears like if I can back into some numbers that flows in your fee based assets continue to be very strong and can you just help me think through is that a conscious effort on your part to move more assets into fee based versus more traditional commission based or is that just more of a demand from your client base, it's that’s where they are putting their money into more and more into the fee based account. So just want to make sure I know if it's sort of push or pull on that front.
Yes we don’t, with our FAs we let them choose the kind of business but I would say a lot of it is driven by the recruiting that we tend to -- a lot of the big teams that we recruit tend to be more fee based and it's interesting that before we got a $1 million team that was a big deal now, we are talking to $5 million and $6 million teams and a lot of those tend to be fee based businesses. So I think that’s driving a lot of the numbers. We see a lot of the more traditional Morgan-Keegan advisors also who are more transaction based slowly moving to little more fee based, that’s helped some in those numbers but I think a lot of it's driven by recruiting.
Jim Mitchell - Buckingham Research
And with the recruiting, seems like you’re being flat for about the last year, you ticked up about 1% in net asset advisors outstanding. What sort of the -- how long does it take to sort of get them ramped up once they come on. Is it pretty immediate? Is it a couple of quarters until you see the full impact of the new hires, just want to get a sense of the timing?
We say the full book is over a year so the first two quarters I think a good chunk of the book moves over. So a couple of quarters to get a bulk of it maybe a year to get them back up and running. So that’s not the lead time, so that should continue to drive results.
Your next question comes from Alex Blostein with Goldman Sachs.
Alex Blostein - Goldman Sachs
First question I guess on the retail business, clearly you guys are retention levels are good and asset gathering is very strong. I was wondering if you can comment on the retail activity trends in the quarter at all because it looks like when you look at just the PCG Commissions, They were up about 1% sequentially presumably majority of that is endured just higher market values and higher asset values. So can you talk a little bit I guess about the level of activity within the channel?
I think the results are driven partly kind of recruiting in the market but the truth is that the transaction level is down just like it is in fixed income and ECM over the (indiscernible). So if you look at the whole market transaction business is down, it was true in PCG. So the 1% growth was net so the fee based business was actually up and it was brought down by lower transactional business. So this environment I think our competitors that are more transactional based will have lower results just because the activity in the market is down and our model has been continues to perform in this environment.
Alex Blostein - Goldman Sachs
And I guess at the Investor Day you guys pointed out the fact that the amount of retail cash or so in side lines, it's quite low towards the low end in historical ranges and it's the same kind of dynamic we have seen with some of the other retail -- brokers. Do you see that drawn down still happening over the course of the quarter or do you think we have kind of dropped out and those will be more challenging to find kind of incremental dollars for retail investors to sort of put to work?
If you look at the shifts, the shift has been two equities. We have had a pretty good shift to equity really over the last year. A lot of it is out of fixed income and as Jeff mentioned it's some out of cash. I think there is more activity because it's hard to tell in our numbers but I think cash is down, it's steeper or tighter earnings 1 or 0 bps wherever they were and I’m not sure all that money, part of the equity growth has been the market growth so the share changes. I think people are just putting using short term bond funds and other vehicles. I can’t prove it. The part money because I want more of a yield. So, I can’t tell how much -- there has certainly been some move to equities but I’m sure if it's dramatic as it looks and I’m not sure if the drop in cash is as dramatic as it looks.
And this is the problem with -- anytime somebody fixes something in an environment and escapes the government and interest rates you get all sorts of behaviors that are hard to figure out. So the rate protection comes off and you see the market normalize. So a good question, but it's difficult to answer accurately.
Alex Blostein - Goldman Sachs
The last one for me is just I want to follow-up on Steve’s question around the fixed income trading, the way I’m trying to guess characterize it is we have been in a -- to your point a D type of environment in fixed income trading for quite some time. You guys are not alone at it, your fixed income commissions have been kind of like in the low $60 run-rate for the last fourth quarters or so. I was wondering if you were just to think about no inventory marks, no big changes in interest rates, is this effectively kind of like the trough level of activity that we could expect. If you just kind of show up and turn the lights on like that’s kind of the amount of run-rate revenue you think the business is capable of generating without the environment getting better?
Yes we hope so. First our guys work really hard, so we just turn the lights on. They work hard to generate that and work hard to keep the relationships and I think whereas the trough, we have thought so for a couple of quarters but it's going down a little bit. You know we get some really good days and then it flattens back out. So I think we’re at this run-rate level until something happens in the market. I don’t think it will deteriorate much from here. I think we’re probably at a trough level. I already hate to say that because something happens that you don’t anticipate but I think this has been a tough environment, they are doing good job and I think this is kind of the run-rate so if something happens in the commission.
At this time there are no further questions.
Okay. Well thanks very much. I think in summary we’re very pleased with the operating results of the quarter. I think it shows strong underlying businesses especially crowded [ph] dynamics in the private client group and I know that sometimes due to last year people said, well, where is the results? We’re kind of low steady long term producer and I think it's showing up in private client group and as the management, of course we’re subject to market fluctuations like anything but I think our model is strong. Hopefully we will get some rate movement which I think will help both -- will help all the capital markets business and activity flows but feel good about where we’re going. We’re well positioned and we will continue chugging along. So appreciate your time this morning and we will talk to you soon.
Thank you. Ladies and gentlemen this concludes today’s conference call. You may now disconnect.
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