Quarterly Analyst Conference Call – Text Summary
Highlights of Raymond James Financial, Inc. Analyst Conference Call, January 20, 2011
Conference Leader: Paul Reilly CEO
Paul Reilly welcomed everyone: “We are here in St. Petersburg and I hope the day is reflective of our earnings – we are bright, sunny and 70 degrees, much like most of you are enjoying I’m sure. I have in the room, Jeff Julien, CFO, who will present, as well as Jennifer Ackart, Controller, Steve Raney, President of RJ Bank, and Paul Matecki, General Counsel. I’m going to start with a brief overview on a segment basis and then turn it over to Jeff who will go into more detailed numbers after which we’ll open it up for questions.”
I think the overall message is this is a strong quarter even after some one-time adjustments. We had record net revenues and record net income, even without the historic non-bank interest earnings that our industry has normally enjoyed. If you really look at it, there are two factors driving that. First, that the firm is well positioned and even in the downturn, we continued to recruit and grow and add to our team. The second factor is that we’ve had a positive market and because of that growth and positioning, we are able to really take advantage of the market and drive these results. All the business units participated and I would like to cover the highlights of those business units and then turn it over to Jeff.
In our Private Client Group, we had record assets under administration of $262 billion, a result of both market improvement and the historic recruiting we’ve done to continue to bring more financial advisors into the firm. Average productivity of advisors, depending on the channel, is up 3-4%, versus the preceding quarter and with good cost control, our margins expanded where we are now in double digits. On a 5% revenue increase, we had a pre-tax contribution increase of 18%. Our advisor count was essentially flat and the backlog of recruiting inquiries is rising again. As I’m sure you saw, Registered Rep rated us as number one in advisor satisfaction. We believe this is giving us more inquiries from folks looking to move to Raymond James. The next segment to cover is Capital Markets, both good news and a little bit of noise flowing through the segment. Revenue was up 12%, but there was a decrease in the contribution. Deal volume was very good, but we have a hard time giving you an apples-to-apples comparison – we reflected US lead-managed to 12 from 5, but one of the issues is related to size. What is a lead-managed deal? What’s our participation? It may reflect direction, but it is hard to use those numbers as a multiple. Canada also had a very strong quarter with 14 versus 6. M&A activity, not just the underwriting, continues to be very strong. On the negative side, we had a decrease in trading profits as a result of Fixed Income owning some municipal inventory that went the wrong way in November and December. This brought the trading profits down for the quarter, although that seems to have corrected in January. We also had some compensation accrual reversals that, overall for the firm, were not out of line, but Equity Capital Markets actually went the other way. We also had a product which we call Best Picks, which is sold heavily in Europe, where the commissions are higher, driving success for our European institutional independent contractors and consequently, drove the commission expense ratio up a little. Overall, the first quarter had some numbers that make the quarter a little more difficult to read for Capital Markets. We also announced the Howe Barnes acquisition, which we believe is a great fit for our firm with approximately 120 associates. This acquisition fits Raymond James very well culturally, and our Financial Institutions Equity Capital Markets practice which we think will help us continue to penetrate our financial institutions business and be synergistic to our existing business. Pat DeLacey, who heads our financial institutions business there and is going to Co-Head with Dan Coughlin, is a big advocate of the acquisition. We have offices very close together in Chicago and people are excited about the additions to the team. Additionally, there is also a lot of synergies with our Fixed Income Group. We’ve been growing our financial institutions fixed income practice, headquartered in Memphis, and we’ve added a number of people. The synergies between our Equity Capital Markets and Fixed Income groups should be very, very strong. We also have about 20 financial advisors who are part of the definitive merger agreement that we hope will be joining us and make a good addition to the Private Client Group. One of our fastest growing recruiting segments in PCG is our Financial Institutions Division and we think this will help us in that area. Again, we believe it is a great cultural fit that we look for here at Raymond James, along the lines of the Lane Berry acquisition.
Looking at Asset Management, had record AUM (excluding money market funds) of $33.4 billion and again, assets were driven by the market but strong net inflows, especially on the institutional side, produced great results. That business has very strong leverage so on a 14% increase in revenue we had a 35% increase on the contribution side. We do have a little bit of one-time $3.2 million in performance fees for the quarter that Jeff may address, but we had $3.6 million last year at the same time. So, while fees may be a little higher for the quarter, versus a normal run rate, they are not unusual as compared to a year ago.
Focusing on Raymond James Bank, they experienced a 16% increase in revenue, driving a 70% increase in contribution. Our loan production was strong, indeed our best residential mortgage month in production. We also had good commercial production and it is still a very competitive market for good credits. Even though spreads may be tightening a little bit on new loans, we are replacing loans with lower spreads that are running off. The story here for the Bank is really the run-off, as people pay down loans and that rate is still staying high and when that comes down we should be adding to our loan balances in the Bank. Continued credit quality improvement is another factor, in both the industry and here at Raymond James. We’ve had well managed credit vis-a-vie our industry and you are seeing several upgrades flow through in this quarter.
That is the highlights of our four major segments and I’m going to now turn it over to Jeff and then return to discuss what I think the outlook looks like.
Jeff Julien: The overarching comment that is most appropriate for this quarter is that with some equity market wind at our back, some of the operating leverage that we’ve been telling people about for years, particularly in this case within PCG and Asset Management, did come home to roost. I’m going to focus on a few statistics that aren’t readily apparent from all of the information we sent out in the press release, but are a pre-cursor to some of the things that will be in the 10-Q when it gets filed. One is the comp ratio that has had a lot of focus, which actually did come down in the quarter. It is not unusual when we have record net revenues, but it did drop below 68%, but still hovering in the high 60s (67.8% this quarter versus 68.4% last quarter). As we pointed out last time, I don’t expect to see any major movement in this as long as our business mix stays similar, until we get some help from interest earnings, which doesn’t have a lot of variable comp associated with it. At that time I would think our comp ratio would possibly drift down a couple hundred basis points from here. Another factor is recurring revenues. Last fiscal year by comparison, our total recurring revenues were 54% of total revenues and for this quarter, not much different at 53%. As we are in a lot of transaction related businesses, it was still a good deal of recurring revenues driving the revenue stream, a lot of fee-based accounts, etc. Paul touched on the Asset Management performance fees and I think that is an important factor to note. It is indicative that our performance has held up very well in asset management, although it does have a tendency to distort the December quarter slightly. Within the commission and fees line of $534 million for the quarter, of that $104 was institutional and $430 was private client group, but equally important to me is that within the PCG, 57% of their $430 million was recurring. That includes fee-based accounts and trails on funds and annuities which is again, indicative of the strong equity market we’ve seen. I also want to touch on net interest income which was $88 million for the quarter, up from $78 million in the preceding quarter. We had been running along in the $75-80 million per quarter range for some time now. As pointed out in the footnotes to the RJ Bank information, there was a correction of an interest accrual at the Bank which effective added $6.4 million to net interest income this particular quarter, so exclusive of that, net interest income was about $81.5 million. That is indicative of two things, one that the Bank is maintaining a high spread and actually slightly growing loans again, thus the Bank had about $3 million in improved interest earnings from last quarter to this quarter. The balance of the increase was in PCG; as you get an upward moving equity market, we start to generally see a slight uptick in margin debits and we have seen that versus a year ago. The Bank interest accrual adjustment added about 9 basis points to the spread for the quarter, but that spread stays quite strong even with that taken out. We had been guiding people toward the 325-330 range for spread and it looks now that given where the market is and the loans we’ve been adding, it is probably going to be nearer to 340 going forward for guidance. Expanding a little bit more on the Bank, the biggest difference between actual and analyst projections, I think was the loan loss provision which came in at a little over $11 million for the quarter, the lowest since March 2008. It has been a while since we’ve seen that and it is equally nice to see the improving credit environment with some loan upgrades that factored into that, but by and large our rate of additional problem loans surfacing has gone down dramatically. Our total criticized loans are down 37% year-over-year and non-performing assets were down $25 million during the quarter, indicating that all the credit metrics are looking better and better as we go quarter after quarter without any major hiccups in the economy. I also want to touch on Bank capital ratios – we did pay a $75 million dividend from the Bank to the Holding Company after receiving regulatory approval to do so. Even after that, the Bank’s risk-based capital ratio at the end of December was 13.2%. To the extent that the Bank keeps generating earnings at these levels, without a lot of net loan growth to need that capital, they may be paying a regular dividend back to the parent company. Lastly, a non-recurring item, that only occurs in the December quarter is that we end up reversing some of the over-accrued bonus pools that we have around the firm. This year the figure was $7.7 million, which served to help the comp ratio of course, and that is similar to the amount it was in the prior year, but obviously that is a factor that won’t be there every quarter. In looking at a run rate, which people focus on, between the adjustment at the Bank and the bonus reversal, it is 5-6 cents of non-recurring type items in this particular quarter, which still even without those two items, would have been a record quarter for us. Where the rubber meets the road in terms of our own analysis of our results is return on equity; for this quarter ROE was 13.9% which is pretty impressive without the help of the traditional interest spreads which would mean somewhere between $80-100 million pre-tax to us when short-term rates have risen by 100 basis points or more. That 13.9% is contrasted to 12.2% last quarter and only 8.3% a year ago, so we are pleased with the magnitude of that number. We certainly would like to be back in our 15%-plus target range, but have been somewhat resigned to the fact that wasn’t going to happen until we return to traditional interest spreads, however, we certainly made good progress toward that goal this quarter.
Paul Reilly: When looking at the outlook for the second quarter of fiscal 2011, the biggest question remains the economy which certainly has a major impact on our business. Our view is that we are in a slow, but choppy, growth phase and we’ll see small corrections as the economy continues to slowly grow and recover. The upside is going to partly be determined by how the economy grows and its impact on the capital markets. We continue to manage costs as 2009 wasn’t that far away so we remember that big corrections can happen and even though we came through that with an 8% return on equity, it wasn’t a time we enjoyed. If you look at the businesses, all of the indicators are positive, so given a fully improving market, I believe we still see a lot of positive momentum off the lower base. In PCG our assets will continue to grow with the markets and I think as clients move into equities, as that trend continues, it should have a positive effect on our business. We’re still very focused on recruiting, but we’re not going to overpay for financial advisors and we tend to be over-cautious in markets where we think people are overpaying. Again, the big driver will be the shift to equities really driving our business. On the Bank side, the loan backlog looks strong and the big question is run-off. We’ll continue to push loan production within our credit limits – we remain very, very focused on credit quality, there is a lot of competition for them and the question is as we continue to book those loans, how much will run off. The credit quality is clearly improving and I think the provisions have improved because the loan quality has improved and I’m not sure what would move that except as we add more loans. Once again, anything can happen to individual credits and given our size, it can affect the provision. In the capital markets, ECM has a solid backlog, both in underwriting and in M&A, Canada has been surprisingly strong and looks to continue to have a good backlog. We’ll continue to recruit to build our ECM business and we believe it has a solid outlook. In fixed income, we had some bumps in the quarter over trading profits, but they look like they are rebounding to more traditional levels. As you know in that market, anything can happen, and that is hard to predict, however, we think it is well managed and well positioned. As for Asset Management, they continue to control costs very well and as long as we continue on in-flows and market improvements, should continue to be positive in our outlook. Overall, if the market improves, we feel very good about our positioning and earnings but we don’t take it for granted. We still have to continue to recruit and build this business which we think we are well positioned to do. We have a strong team and given a reasonable economy and markets we have a positive outlook. With that, we’ll open it up to questions.
Questions and Answers:
Q1 - Devin Ryan - Sandler O’Neill: I’m trying to reconcile the strength in the commission and fee line, it looks like if you look at just the month of December alone, it was a record. Given that a lot of fees are built up front and that industry trading activity levels tend to fall off a bit during that month, I’m trying to figure out what happened in December and why it was such a strong month.
Jeff Julien: Versus the preceding quarter, there was a $16 million increase in institutional commission, largely driven by the number of syndicate participations and equity underwriting activity, as well as our Best Picks that drove $5 million in commissions. The balance was in PCG on the strength of a rising market. You know we had a jump start when the fee billings on Oct. 1 were about 5-6% higher from July 1 billings. We have that same dynamic going forward where we have about 10% higher market billings Jan. 1 than Oct. 1 and again, it is as Paul mentioned, clients shifting back to equities. While nowhere near the levels that they were three years ago in terms of household ownership of equities, but that drives a lot of business in funds where we get bigger trails and some of the managed accounts, etc. I think it is the manifestation of some of the unused capacity within PCG as the market recovered.
Paul Reilly: I think people focused on trying to compare the commission lines to a lot of the institutional business. A lot of this is driven by PCG, the movement to equities, and certainly underwriting in the syndicate business.
Jeff Julien: There is nothing unusual in the quarter, beyond our analyst Best Picks which is a $5 million type item. (See response to Q5).
Q2 - Devin Ryan - Sandler O’Neill: And that means you got paid for that in December? Again, I’m just trying to understand December.
Jeff Julien: It is only in December of each year for the picks for the coming year.
Q3 - Devin Ryan - Sandler O’Neill: I understand the SEC is going to deliver a report to Congress tomorrow on the results of recommendations related to the study that will outline the extent to which broker-dealers are going to be held to a fiduciary standard. I just wanted to get any early insights you might be expecting?
Paul Reilly: I think it is still pretty well unknown and is a moving controversy between registered investment advisors and our industry and what defines what. It gets down to what regulator and what rules are going to come down from whom. Our take on all of this legislation is that it shouldn’t dramatically change our business or positioning, but it is going to increase compliance costs. I think that will be the net result and whether that protects investors long-term or not will be left to others. I think it’s important to look at not just when the positions come out, but when the rules do and what they mean.
Q4 - Devin Ryan - Sandler O’Neill: Lastly, on non-comp expenses, outside of the Bank loan loss provision, they increased 6%, in my take, it just looks like higher business activity levels and higher revenues probably drove that, but is there anything unusual in there or anything else I should be looking at?
Paul Reilly: I don’t think so, Jeff?
Jeff Julien: No, looking down the line items, it can’t be a big dollar number. There is nothing unusual in those numbers.
Q5 - Hugh Miller – Sidoti: I just want to follow up with a question on how strong the December commissions were in the month? Would you say that there was year-end tax loss planning and maybe some harvesting there of tax losses that were kind of driving up December commissions relative to November and the prior few months, or is it really just related to the Best Picks and shift into equities by retail investors?
Jeff Julien: I don’t think we see a big seasonality in terms of a year-end tax transaction related movement. I think it was, and again, this is somewhat the explanation in September as well, a busy underwriting calendar in the month. We also had higher trails than expected by $3 million and $5.5 million from the Best Picks deal.
Paul Reilly: We’ve looked through it, Hugh, and we didn’t see any unusual items other than those mentioned. Again, I think the underwriting business calendar does impact it and we had a very strong month and I believe the big movement for us is always the PCG movement to equities does push it there, but we can’t point to anything else that looks unusual.
Q6 - Hugh Miller – Sidoti: You had also mentioned in the presentation that you were seeing broker production levels up 3-4% on a sequential basis. Is that right and where would you say they are relative to historical norms?
Paul Reilly: We’re getting closer. They’re not there yet, but I think we have a number of factors such as in our recruiting over the last few years, we’ve recruited much higher producing financial advisors. As you look at productivity, the headcount is relatively flat, but if you look at the average production level per financial advisor, it is getting higher. We’re getting closer to that historic level, but we still have some room.
Jeff Julien: To give you some definition, in RJA the employee side, I think we peaked, if I remember right, at about $515,000 average gross and we are currently back up to $490,000. As Paul said, we’re getting close and we’ve got on average, people with a higher trailing 12 than we had when we set the previous record. So there is still some room to run, but it is getting back toward records for us.
Q7 - Hugh Miller – Sidoti: You mentioned the pick-up in some competition on the recruiting side and that you are not going to go out there and pay for advisors above what you are comfortable with. Given the potential for competition to remain somewhat high, how confident are you with the company’s ability in Fiscal 2011 and beyond to grow advisor headcount?
Paul Reilly: Our goal is to grow advisor headcount and I believe we can and probably will for the year. Our view that we reiterate all the time, is we target 15% revenue growth in the PCG segment using a factor of three items, recruiting up 5%, a 5% increase in productivity and the market up 5%. In 2009, we had no market and no productivity so we relied on recruiting; this year we’re getting a lot of help from the market and productivity, but recruiting is down. We’re not going to do uneconomic deals to make the numbers look better short-term. We’ve ridden through the cycle and it’s been historic Raymond James and I have no intention at all of changing that. If people want to do uneconomic deals, we’re not going to participate and we’ll wait until, as the recruiting market always does, times become economic again. Having said that, our inquiries, if you look at January, are way up. Now that’s very early in the recruiting cycle, but we think we’re doing the right thing and we’ll continue to recruit and try to grow the headcount and think we can, but I just don’t know how much.
Q8 - Hugh Miller – Sidoti: My last question is in regards to the Bank. You mentioned that you are seeing a pick-up in interest in loan originations at the Bank and obviously, the headwind is the run-off in the portfolio. Can you just talk about if there are certain loan types that you are seeing more of an interest in at the Bank at this point?
Steve Raney: We highlighted that we had a pretty significant increase in our commercial and industrial loans versus commercial real estate in the quarter. We actually grew that segment of our business almost $200 million in outstandings during the quarter. Within the C&I bucket, it has been across a wide cross-section of industries, with no one or two industries really driving that. It’s been very broad, although it does align itself well with our business units inside investment banking, such as energy, health care, REITS, as well as some of the other industry groups we’re focused on, telecommunications and some consumer areas. The residential business has been very challenging. Paul mentioned that we had the largest quarter in the Bank’s history in terms of loan closings on the origination side. We are actively trying to grow our own originations in the mortgage banking area. We’ve purchased some pools, but it’s been relatively small as we’ve been disciplined with our approach to that business. We are not willing to buy pools of loans without strong buy-back language. I think that over time, you are going to see a higher percentage of the Bank’s balance sheet in C&I commercial loans versus commercial real estate and residential real estate.
Q9 - Joel Jeffrey – KBW: In terms of the growth in other revenues, can you tell us what was driving that?
Jeff Julien: There is an anomaly when we have OTTI costs at the Bank, they are a contra-revenue item and they were a lot lower this quarter, so that obviously makes the other revenue number higher. The other thing is that we continue to convert more and more mutual fund families to the Omnibus arrangement that we have. We get paid much more per account than we do in the previous networking-type arrangement. That will continue to grow as we continue to convert more funds. That is a recurring type item that will be there going forward. For the quarter, it was about $3.5 million.
Q10 - Joel Jeffrey – KBW: So, this low $30 million number is a decent way to think about the “other” line going forward?
Jeff Julien: It looks like it at this point. There is nothing particularly unusual. Proprietary capital goes up and down, a little lumpy, but wasn’t a big deal this quarter but can be. On a run rate, probably 30ish is reasonable.
Q11 - Joel Jeffrey – KBW: In Investment Banking, can you give us a revenue breakdown between M&A and what you did on the underwriting side?
Jeff Julien: Domestically, it was about $17 million of each for this quarter and within Canada, it was about $16 million, but I don’t have the breakdown between the two. They are more weighted to underwriting, so overall it is probably 60/40 underwriting to M&A.
Q12 - Joel Jeffrey – KBW: Lastly, can you give us a sense for how much of the increase in AUM came from, in-flows versus market appreciation?
Jeff Julien: There was about $1.9 billion of net in-flows.
Q13 - Joel Jeffrey – KBW: So similar to what we saw last quarter?
Jeff Julien: Probably a little stronger than the preceding quarter. We had a lot more market help this quarter, but we also had help in the month of September. Market appreciation this quarter was $4 billion, but I don’t have last quarter’s details in front of me.
Q14 - Daniel Harris – Goldman Sachs: I would like to come back to one of the questions posed earlier, about the trajectory of the quarter on the commission line. It looked like the December month, not the quarter was really, really strong. Was that really driven by the activity in the municipal market? I know that was really volatile and it seems like some of the volumes that we could track were very high. Can you put some color on that?
Paul Reilly: We received a lot of mutual fund trails, more than we had accrued for, around the end of the quarter. Then you have underwriting activity and Best Picks, so there is some lumpiness at the end of the quarter.
Jeff Julien: With respect to trails, we try to accrue them, but end up estimating because we don’t really know what those will end up being. We get quarterly payments for those toward the end of the month and they’ve been more than we had accrued for the last two quarters. That added about $3 million above and beyond what our accrual rate was in the December month. We also mentioned that we had a strong underwriting month in terms of number of transactions and not all as lead, but those that we participate in as well. That drives a lot of volume both institutionally and PCG and then the Best Picks that is done in December for the coming year was about a $5 million commission number as well. Those three things all happened in December.
Q15 - Daniel Harris – Goldman Sachs: Coming back to your late-year announcement of the Howe Barnes deal, what was it about that transaction that really attracted you to it? How did that actually come about and should we be looking for you to be doing smaller things on the securities side, outside of this? I know you’ve been thinking more on the asset management side in the recent past.
Paul Reilly: As we look at growth, given our size, we are great believers in organic growth, so we’ll continue to recruit one-by-one because as you do that you are pretty comfortable that people are joining you for the right reasons and that there is a good cultural fit. Having said that, I think we are also getting much more proactive and talking about a corporate development function, where we look for what I call niche acquisitions. The Howe Barnes acquisition, again, added to our financial institutions base, a place that we have a decent practice, but certainly not at the levels of some of our other practices in terms of size and scope. So it added great capability. This was actually introduced to us through PCG by talking with some of their advisors. It was just a great fit. Again, our fixed income folks are great supporters of the transaction because of the synergy. We’ll continue to look for, hopefully more systematically, niche acquisitions, which I would also consider the Lane Berry acquisition which really helped us out in our M&A practice. Now, Howe Barnes will give us more critical mass in our financial institutions group with great people. We’ll look at other areas in all of our businesses that we can add to. Again, we’re not a big believer in large acquisions because of the costs, the cultural implications, the integration challenges, etc. Niche acquisitions we would hope to do more of if we can find them, if the culture fits and if the price is reasonable. If we hit those criteria and they fit the strategy, then hopefully, we’ll do more of them.
Q16 - Michael Lipper – Lipper Advisory Services: Thinking long-term, assuming for the moment that you don’t do any foreign acquisitions, at what point will your international activities be a meaningful contribution to your earnings? I’m thinking along the lines of looking out 5 years, would they be 10%, 20% after some normalized period out there?
Paul Reilly: If you look at institutional sales, at $30 million gross they are already a factor in our business. We will continue to look at growing our business in Europe organically and in South America. Having said that, if you look at the real number drivers, international may become more important, but we have plenty of opportunity in North America in the U.S. and Canada and those numbers will continue to be the predominant growth numbers even as we invest more in Europe and South America.
Jeff Julien: Let’s assume for the moment, you are not considering Canada as international, as we clearly have a big commitment there, I would say that Europe is already a material factor in our institutional business. We have several independent contractor sales offices over there and some trading and research operations. What you see in our segment presentation as emerging markets is a small number and if that is what you are referring to, we go a little more cautiously into the emerging markets space than we do into the developed markets. If the opportunities don’t present themselves, that may never become a meaningful part of our business.
Q17 - Michael Lipper – Lipper Advisory Services: Would it be useful at some point to, at least in your commentary, aggregate your international activities and for the moment include Canada, your institutional sales overseas, as well as the office space activities.
Paul Reilly: I believe it is in the 10-K – revenues are broken out by country.
Q18 - Michael Lipper – Lipper Advisory Services: By country, but is that by where the client is, or where the office is?
Jeff Julien: That is reflected by where we are located, our salesperson or producer is located.
Q19 - Steve Stelmach – FBR: On the interest rate activities Jeff, you mentioned $80-100 million in pre-tax leverage as a higher rate, which has been mentioned for a few quarters. Margin balances are up 12% year-over-year, are you seeing any sort of incremental benefits in those higher margin balances yet, or is the level of absolute rates just not really moving the needle yet on the brokerage side?
Jeff Julien: To the extent that margin debits increase, just as bank loans would increase, then we’ll see some increased interest earnings from that, but when I talk about the $80-100 million, I’m really talking about the spread on client cash balances. That dynamic hasn’t changed and we haven’t seen cash balances change much, if anything they’ve increased a little bit. We haven’t seen a big massive deployment back into the market with cash balances. The reason I give a range is because it depends on how much is in cash at any given point in time. To the extent that loan balances at either the Bank or the brokerage firm increase, that will definitely benefit interest earnings even without any change in rates.
Q20 - Steve Stelmach – FBR: On the Bank, is it fair to say that you are liability sensitive?
Steve Raney: We would characterize it that we’re going more asset sensitive in terms of that business mix. We are funding the portfolio predominantly with floating rate deposits. We do have almost all of the corporate loans at a floating rate, the residential loans are almost exclusively 5/1 adjustable rate loans that typically have a 3 to 3 ½ year average life. We do have some interest rate risk, but it is relatively low and manageable. We’ve done some hedging in the past and we monitor that very closely on a monthly basis in a very formal approach to the interest rate risk management.
Paul Reilly: People need to remember the flexibility we have in the Bank on the funding side. We can adjust deposits almost overnight, while most institutions have to worry about that, we have the luxury of being able to sweep deposits into the Bank or into other banks through our bank sweep program.
Jeff Julien: I see quarterly interest earnings hovering around this $80-85 million range for awhile until either balances take a huge jump in terms of loan balances, or until interest rates start moving. Then we’ll get back over the $100 million per quarter where we had peaked before.
Q21 - Steve Stelmach – FBR: That’s even with your Bank’s 340 basis points of net interest margin?
Jeff Julien: Yes.
Q22 - Doug Sipkin – Ticonderoga: I want to come back to the provision expense, maybe Steve could chime in a little bit, obviously a bigger drop-off than I expected. How did you get there from where you were running at? The loan balances did grow a little bit, so I’m just trying to get the sense of how we get this decline this quarter and what the outlook is right now?
Steve Raney: To reconcile that back for you, we had a low number of downgrades relative to upgrades. We did resolve some of our largest problems loans and actually, our largest non-performing loan was resolved during the quarter. We had another problem loan that was fully paid in the quarter that freed up reserves. In effect, our charge-offs and our additions to reserves off-set each other approximately. It was really a reflection of improving credit trends across the board and our residential portfolio has really stabilized the last couple of quarters. We haven’t seen dramatic improvements, but the improvements have been nominally better the last couple of quarters. All of those factors led to the lowest provision expense in a couple of years.
Q23 - Doug Sipkin – Ticonderoga: For Paul, it seems like you have to be blind not to see that you guys are doing better in investment banking. How much of that is hires, how much is finding better leverage points between the commercial bank and the investment bank, how much is the environment?
Paul Reilly: I think it is a little bit of everything. We continue to hire, such as the Lane Berry acquisition in M&A which is starting to really come to fruition and that always takes time, both between the market and the integration. We got some very good people and we’re starting to get some pay-off. We’ve also continued to hire bankers and the market has been pretty strong in sectors we are strong in, such as REITs, downstream energy, and the health care businesses which have continued to produce very, very well. Also, as the recovery in capital markets opens up more to the middle market companies, it is also going to benefit us. It is a bit hard for us to compete on Fortune 100 business, but as you know the market continues to open up and allow more companies in, and we become a stronger and stronger player in terms of being able to be the lead book runner on deals. It is all of these factors and I think the outlook looks good, give that the markets stay open and continue to trend up, it should be a good outlook.
Q24 - Doug Sipkin – Ticonderoga: ROE just below 14%. I know you raised the dividend last quarter, you did an acquisition. It does start to feel like you guys are using that excess a little bit more. Should we continue to think that both on acquisitions, that buybacks haven’t historically been that big of a focus unless the stock got a lot lower. Can you update us on that?
Paul Reilly: As you know, we’ve had a pretty consistent dividend payout policy which is up to the board. You are right that we are not big on stock buybacks unless we feel there is no other use for money. We would like to systematically do deals like Howe Barnes and Lane Berry, if we could find them. We’re going to put processes in place to hopefully do more, but we are very, very disciplined in terms of fit, we’re not going to do it just to force some growth number. We are very focused on that ROE and I think with any help from interest rates, it would be over 15% this quarter. Outside of that, we’re going to stick to the fundamentals. Hopefully, we’ll do more deals like Howe Barnes, but I can’t say we have many in the pipeline. We happen to look at a lot last year and found one we closed on and we’ll continue to more systematically look and if we find them, we’ll close on them.
Q25 - Doug Sipkin – Ticonderoga: It also seems like non-comp expenses seem to be pretty well under control. Just generally with the revenue levels you probably expect to see a little bit more, are you guys doing some internal things to get more efficient, track things a little bit better to save a buck here, a buck there where it adds up to on the non-comp side?
Paul Reilly: We do that every day.
Jeff Julien: I would say that we are very sensitized to it after what we’ve gone through the last couple of years. We don’t have a lot of fat in the organization, and never really have. I believe what we are seeing here is a reluctance to build expenses to meet those revenue levels. We are making sure expenditures are really very, very necessary before we undertake them.
Paul Reilly: If you look at expense levels, we have bolstered IT spending a little bit. We are very focused on where we spend money on things that are critical and we try to keep tight on the operations side, yet, if you look at advisor satisfaction, people rate us as unusually high in service. We try to manage costs and even in the downturn we didn’t cut the support areas in order to keep our service levels high. We tend to be more level, but even in up markets, we tend to watch our costs too because we know markets come down. As Jeff said, you’ll see the comp ratios, without interest increases, hopefully down a little with volume, but if the businesses grow that are less comp sensitive that will bring the comp ration down to more historic levels.
Jeff Julien: As well as all the other expense ratios as there aren’t many ratios that don’t improve with improved interest spreads.
Paul Reilly: But, we have very little control over that.
There being no further questions, the conference call ended.
Highlights of Raymond James Financial, Inc. Analyst Conference Call, October 21, 2010
Conference Leader: Paul Reilly CEO
Paul Reilly welcomed everyone: “There are two pieces of good news to start the call; first the company and our earnings are much stronger than my voice this morning and secondly, it’s rare when you have a company where you can go to the bench and get a replacement for the starter who has more experience than the starter. Since my voice won’t hold out through this call I am going to turn it over to Tom James who will lead the call this morning”.
Chairman James began by introducing everyone who was present for the call which included Jeff Julien, CFO, Steve Raney, President of RJ Bank, Jennifer Ackart, Controller, Paul Matecki, General Counsel and Chet Helck, COO.
As Mr. James announced on CNBC, we had record quarterly net revenues. We had $748 million in net revenues, which was a 12% increase from last year’s fourth quarter. Expenses were well contained with a 6% increase, which has the bank loan loss provision in it not interest expenses. In general, costs continued to be well managed as they do generally for corporate America, although we have been doing a lot of hiring. As you can see, that generates most of the increase in expenses during the quarter. As a result, net income per common share beat the $043 estimate coming in at $0.55 up from $0.35 last year and $0.48 in the immediately prior quarter. Pre-tax margins were 13.8%. After tax margins on net revenues were 9.23%. Our compensation ratio stays relatively high, especially on net revenues, but you must remember to consider the high payout for independent contractors. If the compensation ratio were adjusted to employee FA compensation rates for independent contractors, it would have been 60.6%. If you are trying to compare us to a normal employee based firm, our comparisons are favorable. We did benefit from the corporate tax rate where we had a 34.4% effective tax rate. This is due to tax credits from our low income housing operations, tax credits from education charitable contributes we make in Florida (which gets the state tax credits as well as deduction on the federal level) and a non-taxable gain in our COLI portfolio. When you look at this number and you spread it across the year, the tax rate is 37%, which is a pretty good run rate figure. The results were very good for the quarter, even better than we anticipated under the circumstances, as our base businesses performed well. The fact is we were driven again by Private Client Group, where we had a 113% increase in pre-tax income. Capital Markets results were very good for the quarter, up 36% and that comes from a resurgence in Fixed Income in the fourth quarter as well as reasonably active ECM calendar and good M&A activity. As you can see in the press release, we included only lead managed underwriting data and took out the co-managed total where in today’s era the economics are low. We have good lead managed activity still focused in the real estate, mainly REIT sector, in energy, MLPs, financial services and health care transactions. We have had M&A activity pretty much across the board. We would have expected this due to a lot of hiring. The hiring has also been across the board and we have continued to recruit good brokers, but the rate of recruitment is about 35% of last year’s activity level because of all the high retention payments that were made by other firms early this year or late last year. This has really slowed down the pace.
Looking at Asset Management, the recovery has mirrored the increase in assets under management which increased from $25 to $30 billion year to year. We have had good results in both net sales and in market appreciation. Raymond James Bank also had very good comparability in the quarter. More importantly from our standpoint, with pre-tax income up 163% we see moderation and hopefully bottoming on the loan loss reserve provisions. Next year we hope to begin to see some improvement in those numbers and we are beginning to see a bottoming on the overall loan balance.
The other activity is generally flat, not a big impact on overall results.
Annual results were also very good. Assets under management are up significantly and the assets under administration for our clients are up to record levels of $249 billion, which was a very substantial increase over last year. That record is a good indicator of near-term fees and commissions.
The outlook for the first quarter of fiscal 2011, while clearly somewhat dependent upon whatever the markets are going to do, looks good on all fronts except for net interest. In looking at the year we still had net income up 49% to $228 million and reported $1.83, up from $1.25, which was a 47% increase. I started this year by saying this moderate economic activity and slow recovery would not enable us to have the typical v-shaped bottom type effect on earnings that we normally experience coming out of a recession. That was maybe a little overly pessimistic but we did it without a lot of revenue growth. You can’t maintain that, so we want to see more revenue growth and the challenge that Paul has made to our operating committee and our senior managers is to really focus on the sectors of the business where the most opportunity is and try to identify drivers of future growth. I think that effort is well under way here. We continue to look at opportunities, both internally and externally, that give us an opportunity for more growth going forward. I think the outlook for the financial services industry is improving even at the banks, that will have some residual losses in the coming periods. You do see that the bank earnings are up which is largely from lower provisions and some are actually removing reserves from the balance sheet into earnings. That is not taking place here. The numbers at our bank are actual generation of earnings and the reason we are frustrated with the lack of growth is that we have ample capital to support larger loan balances, which would generate higher net interest earnings and higher earnings.
I would say we are running on most cylinders. A remaining problem is the auction rate securities. We have continued to be somewhat frustrated by the slow pace of Nuveen’s buybacks, especially with respect to the issues in which we have the largest interest. They continue to be committed to buying their issues back. We are down to around $580 million of ARSs outstanding. We would have hoped that we would soon be out of the Nuveen issues so we would be down to less than $200 million outstanding. It’s going to take longer. We have been in negotiations with regulators to try to reach a solution but we haven’t gotten there yet. We are hopeful to get there soon. We are dedicated to the shareholders and we need to make sure that we do the right things for the company and don’t take unwise risk in the event of a second leg down in the economy which could put us in a cash shortage.
I have noticed that the analysts have all forecasted continued increases in earnings next year. Based on some of the factors I gave you, that’s a reasonable conclusion to reach.
The Bank Holding Company application is still in limbo because they are waiting until they complete the merger of the OTS and OCC. The fed has already essentially assumed control of Holding Company regulation and is having very active conversations with all members of our senior management team trying to figure out what we do. We have been notified that they will have two full time people assigned to our account. They are doing a much better job on risk management at the Holding Company level now. I look forward to working with them, hopefully as a bank instead of as a savings and loan, which caused us to gross-up again on September 30th to meet the S&L requirements.
Questions and Answers:
Devin Ryan - Sandler O’Neill:
I just wanted to drill down some more in the commissions and fees line. Obviously you bucked the industry trend in September with a record month. Is FA productivity really ramping with the new additions or was the bigger drivers the mix of your revenues?
Tom James:
The fee bases are being very positively impacted but the regular commission levels are up too or you would not have the kind of increase in PCG commissions, which were up 12%. The institutional equity commissions are still somewhat lackluster but fixed income picked up from recent quarters albeit not at the levels of last year. I think it’s mainly productivity enhancement.
Jeff Julien:
An additional factor is that we re-evaluated our accrual for mutual fund trails and made a one-time catch-up adjustment of $18 million in September, which inflated commission revenues. This did not have much bottom line impact after payouts, bonus pools and taxes, only about $0.01 per share in the quarter.
Devin Ryan - Sandler O’Neill:
With certain items within FINRA that are open ended, like the SECs interpretation of the fiduciary duty language, as time passes are you getting any more clarity on the regulators are thinking about?
Tom James:
They are somewhere past “we don’t have a clue” but not very far. This is a very complex area. The regulators are way behind the times of what is really going on in the relationship of financial advisors to their client. To make some kind of distinction between registered FA and FA in general is really not quite correct anymore. We don’t have a problem as financial planners with someone defining higher levels of fiduciary responsibility on the part of FAs.
Devin Ryan - Sandler O’Neill:
On the bank side with some of the credit trends improving, on the residential side especially, would it be reasonable to assume some reserve releases in the near future?
Steve Raney:
I don’t know about any substantial reduction in reserves. We are seeing some improvement in credit trends and see some moderation, although problem assets are still at escalated levels. This is the first reduction in the residential past dues since the December 2007 quarter. We have also seen four consecutive quarters of declining charge-offs on our portfolio. Our corporate portfolio has actually performed very well.
Tom James:
Remember we are going to have the same conservative attitude about reserve levels that we do everywhere else in the firm.
Hugh Miller – Sidoti:
Did you see some advisors trying to generate business in September ahead of the fiscal year end to achieve production?
Tom James:
Even excluding the aforementioned accrual adjustment, September was a good month compared to other months. There was much more underwriting activity, which does drive some increased commissions.
Hugh Miller – Sidoti:
I was under the assumption that a good portion of the fee based commissions were generated off of the June 30th balances for the quarter. Am I overlooking something?
Jeff Julien:
It’s about a 60 / 20 / 20 for managed business. Sixty percent of assets are upfront, 20% are on average over the quarter and 20%, particularly the institutional accounts, are in arrears. I would say in September the two biggest drivers of commission revenues were the level of capital markets activity and just the general upward trend in the market.
Hugh Miller – Sidoti:
In regards to the bank and some of the changes you are seeing what LTV metrics on the portfolio are you seeing now?
Steve Raney:
Many of our corporate loans are not tied to real estate so the LTV dynamic is a little different on that sector of the portfolio. Over the last couple of years we have made some changes to our underwriting criteria and our LTVs have come down some. We have always underwritten to a very conservative standard and even despite that we still have loans that are over 100% loan to value in the residential portfolio given the significant price deprecation throughout the country. The loans we have originated over the past couple of years have been at very conservative LTVs and are performing well.
Jeff Julien:
The LTVs are still in the 60% type of range but are on very depressed “V’s”.
Hugh Miller – Sidoti:
Are you getting to the point where charge-offs will continue to trend lower?
Steve Raney:
The recent business is reserved at a lower level than what our current portfolio reserve level is. There may be some very minor relief this year if all goes according to plan.
Daniel Harris – Goldman Sachs:
In thinking about the recruiting environment, what activity levels are you expecting in the next 12 months?
Tom James:
We are comfortable growing at the rate we have been growing but we are used to higher rates of new FAs acquisitions so we have big business development efforts. Our Home Office Visits statistics are increasing. The people that are interested in moving are tending to take longer to convert again.
Joel Jeffrey – KBW:
What was driving the net trading profits?
Tom James:
This was a much better quarter for fixed income.
Joel Jeffrey – KBW:
In terms of the investment banking side of the business can you give us a breakdown of how much came out of M&A, and how much came out of ECM underwriting activity?
Jeff Julien:
M&A fees for the quarter were $20 million.
Joel Jeffrey – KBW:
Is there anything specific you are looking for in growth opportunities?
Tom James:
There is nothing far enough along to announce as an acquisition potential. On the asset management side we are still looking for lift outs and small acquisitions in several specific product areas. I would say the same in ECM and Fixed Income.
Joel Jeffrey – KBW:
Is there one business within Raymond James that might have potential for outside growth than any other?
Tom James:
I have always thought asset management was the easiest one to grow, it’s just difficult to identify superior track records that are reliable.
Doug Sipkin – Ticonderoga:
What percentage of the fees and commissions are fees vs. commissions? What percentage of the fee number is priced on beginning assets?
Tom James:
You need to separate out the institutional commissions from the retail commissions. Retail revenues are roughly 51% fee based and 49% commission based.
Jeff Julien:
You need to understand what is in recurring fees. It is not just asset management. There are trails, C shares, recurring payments and other things that go into the recurring stream.
Doug Sipkin – Ticonderoga:
The margin balances in retail jumped a lot. Does this help?
Tom James:
That helps a lot. The fact is that the spread on margin accounts is very good. If the balances continue to escalate as they have, both domestically and internationally, we will begin to see bigger spreads.
Doug Sipkin – Ticonderoga:
Is the bank going to continue to operate with the large cushion of capital, or is there a plan next year to give some back to the parent?
Steve Raney:
We do have more cushion than we need. We would like to grow into using some of it but consideration has been given to sending some money back to the parent company during fiscal 2011.
Doug Sipkin – Ticonderoga:
What is the roadmap to get your ROE back into the mid double digits?
Tom James:
We would certainly like to have the $80 to $120 million of additional interest profit that we are currently missing due to the extremely low interest rate environment. That largely comes from the retail side of the business and that would get us back to our historical contribution margins in the PCG group. The next biggest component is a general expansion of productivity.
Steve Stelmach – FBR:
Do you expect provision expense to be lower on both a percent of asset basis and dollar amounts?
Steve Raney:
I would think on a percentage of assets during the course of the year it would just come down slightly.
Steve Stelmach – FBR:
What is driving the jump in Equity Markets pre-tax margin?
Tom James:
Trading, investment banking fees and M&A fees.
Jeff Julien:
They basically replaced commission income as compared to the prior quarter.
Steve Stelmach – FBR:
Is increasing your marketing an effort to try off-set the tough recruiting environment?
Tom James:
It’s the marketing cycle. We have gone through three years where we haven’t changed our theme approach to advertising. We did that because times were tough and we were watching margins during the down-turn. It was an appropriate time for us to initiate a new marketing campaign.
Chet Helck:
Our approach to marketing costs has been remarkably consistent. We did dial it back for cost savings reasons in the last couple of years and held off in developing any new materials because of the cost.
Michael Lipper – Lipper Advisors:
What are the current dynamics for the securities lending business?
Tom James:
The nature of the business has changed considerably. We used to do a lot of non box lending (matched book) which really doesn’t exist much anymore in the industry. It’s now mainly out of the box. The box here is good because we have a lot of smaller companies that tend to be less available to borrow some of these stocks. You can still earn some margin on that. The general margins shrink in relationship to absolute interest rates so we don’t earn the same kind of margin in this type of period we would earn in a higher interest rate environment.
Hugh Miller – Sidoti:
Are you seeing a less risk adverse sentiment from some of your clients that are working with the FA as opposed to the person who is doing it themselves?
Chet Helck:
I think most good financial advisors are taking a very prudent balanced approach by putting more emphasis on asset allocation than maybe they traditionally did. That would tend to steer more clients toward equities at this juncture. We continue to be concerned about the flows in to fixed income and the risk in the retail markets of these low interest rates the clients are exposed to.
Hugh Miller – Sidoti:
In prior conversations we have talked about how the majority of margin loans are more for other types of borrowing as opposed to actually investing in securities. Is that still the case and if so, what is causing people now to borrow more?
Tom James:
Those who took a risk near the bottom of the market and profited a lot, and who are more investment leverage oriented, are continuing to do that. The vast majority of our margin accounts are really intelligent sources of borrowing at lower rates for other purposes.
Joel Jeffrey – KBW:
Of the $380 million of loan production on the commercial side, are they anything different than what you were buying in the past?
Steve Raney:
Very similar. They were 100% Commercial and Industrial except for a few REIT loans.
There being no further questions, the conference call ended.