I want to bring to the attention of those who might follow Raymond James (RJF) my response to their earnings call, in which I invite the company to host an analyst day open to all investors, not just selected brokerage firms.
I'm less concerned about publicizing an issue that would help the shorts and more interested in raising an important philosophical issue. In my opinion, RJF is a case study of the arbitrary and unfair nature of how different regulatory rules can result in the massive destruction or preservation of wealth. This fact is of primary concern in this market, where we see major brokerages getting almost wiped out (Bear, Lehman, etc) when they may have similar risk profiles to other companies (RJF) that are also public but don't have to play by the same rules. I think this example speaks well to a constant critique of how regulation via the Fed, Treasury Dept. and SEC can play a role in the current state of credit markets and financials.
First, addressing the nature of the earnings release. Within the first few minutes of RJF’s earnings call yesterday management said they were well aware of the short thesis as posted on some short selling websites. Additionally, they gave the appearance that the earnings call was open to listeners for questions. Unfortunately for share holders and interested investors alike, the conference call was on listen only mode, unless you were one of the select brokerage firms to receive a call in number where you were able to ask questions. Why would a company who has acknowledged that there are short sellers discussing the quality of the bank’s lending, not want to open themselves up for questions? Additionally, antagonizing short sellers by management on the call and not making clear that the calls questioners were a select group of people is if anything a disingenuous.
As those who know the company well will note, RJF has improved their revenues in the face of declining commissions across investment banks on Wall Street. Adding to their increased revenue
Yesterday on CNBC, Raymond James Financial's CEO credited recent earnings strength due in part to the growth of RJBank - an entity inside the brokerage firm, which acts as a lending arm (according to 2007’s 10k, 70% of their loan book is composed of real estate loans, with over 60% of their residential loans are none agency backed loans.)
The company decided to announce earnings on CNBC yesterday evening, where the CEO, Mr. James, announced the company beat expectations with strength attributed to their bank's interest earnings. When asked about the real estate exposure to the bank, he responded by saying, "the majority of our loans are to corporate”. This theme was reiterated on yesterday morning’s conference call. This is misleading and I’ll explain:
Below is a copy RJF’s last 10Q filing, which breaks out each segment (click to enlarge images):
Below is a copy of yesterday’s earning’s press release (take note of the 9th line down – “Corporate & Real Estate Loans”):
When reporting their numbers for press release the company decided to combine corporate loans and commercial real estate loans. Unless loans were reclassified from commercial real estate loans to corporate loans over the quarter, the majority of the company’s loans are real estate related.
As such, according to last quarter’s filing 60% of the residential real estate loans are non-agency loans. According to their press release:
....approximately 90% of the residential loans are fully documented loans to owner-occupant borrowers. More than three-fourths of RJBank’s residential loan portfolio contains adjustable rate mortgages (ARMs) loans with interest-only payments based on a fixed rate for an initial period of the loan, typically 3-5 years.” (page 8, press release)
Given the rapid ramp up in residential real estate lending, which took place at RJBank from 2005 – today, it would seem like much of this ARM paper would just now be coming due. Management on yesterday’s call did confirm that of the non-accrual loans noted above, vintage 2005 paper.
Management has in the past and continued yesterday to advise to the possibility that their real estate loan portfolio may deteriorate accordingly with the housing market; but to date RJF hasn’t experienced the same amount of delinquent payments as the rest of the market – implying their underwriting standards are better.
In yesterday’s press release on page 8 the company writes:
On average, three-fourths of the purchased residential loans are re-underwritten with new credit information and valuations, if warranted, by RJBank staff prior to purchase…
I would have liked to ask management to clarify what this means. It could be read to interpret that RJBank is buying impaired or discounted loans from sellers and after “re-underwriting” them placing the loans on book at par value?
According to the press release, “RJBank experienced some credit quality deterioration in a limited number of corporate credits associated with the Residential Acquisition and Development/Homebuilder industry.”
Note from above that while “total nonperforming loans jumped almost 100% from .21% to 0.54% in the quarter, the companys’ reserves for loan loss and unfunded lending as a % of loans increased only 2 bps, from 1.24% to 1.26% in the quarter.” Management asserted that their loan losses would increase as their book of loans increased; but one would hope not to see deterioration in underwriting standards.
I’m not implying that is the case, rather if I were to speculate I would guess that as vintage 05 and 06 ARM paper resets (2006 is the height of the lending bubble), we may be in for further difficulties from the residential mortgage portfolio. Additionally, the financial deleveraging which begins in the housing market will spread through various industries, corporate default rates have just barely moved and are still at record lows.
Okay this brings me to my next point, and what I view as the fundamental philosophical question surrounding RJF and RJBank – why does RJF, which derives a majority of their income acting as a brokerage firm, use bank reporting standards – thus avoiding mark-to-market risk on their portfolio?
The RJF press releases and SEC filings, RJBank announced in late March that it had increased the write-downs in their CMO portfolio, recognizing deterioration in market value of real estate assets. This was an admission that the real estate assets in the Securities portfolio had to be written down.
In a following earnings call the CEO went on to say, in so many words, that although logically this real estate mark down process should also extend to the bank loan portfolio, there are bank accounting rules that allowed them to not report the loans on a ‘marked-to-market' basis. This forbearance of the accounting rules on mark to market and write-downs might make sense if RJBank actually were run as a normal bank, but in the RJF holding structure the bank is just a "holding pond" (a quote from the CEO in an Earnings call) for assets from the brokerage accounts where RJBank gets basically all its deposits like E*Trade did.
RJBank has no checking or other bank services and only one branch. Does the argument they should get the benefit of bank accounting rules make any sense?
If other brokerages like Bear Stearns (or a Merrill) had used the RJF savings bank subsidiary approach to buy its riskier assets and protect them from write-downs in a massive way like RJF did, then Bear or Merrill may not have had to write down their assets. Does it seem like RJF should get special treatment from regulators or auditors here? This inconsistency in treatment of brokerage structures and the ability of RJF not to mark to market does not make sense from either a regulatory or investor protection standpoint.
I remain disappointed that I didn’t have a chance to clarify any of these questions with the company on their conference call. In conclusion I want to note disappoint and the feeling of deception, given the company’s handling of the earnings call, while we are in such a tumultuous financial/credit environment. Presenting information and not making yourself available for questions only furthers the ability of people to dissent.
Click here to view the CNBC earnings release, yesterday morning's analyst call and the press release referred to in the documents.
Disclosure: Author holds a short position in RJF