Raymond James Financial Inc (RJF) — Q1 2015 Earnings Call Transcript

Thanks, Therese, and good morning. On behalf of our entire leadership team, I just want to thank you all for joining the call this morning. We know this is a very busy time of the year for all of you. So, we certainly do not take your time or interest in Raymond James Financial for granted. After I read the following disclosure, I'll turn the call over to Paul Reilly, our Chief Executive Officer, and Jeff Julien, our Chief Financial Officer. Following the 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 conditions, demands for our products, acquisitions, anticipated results of litigation, and regulatory developments; or to mirror a general economic condition. In addition, the words such as believes, expects, anticipates, intends, plans, projects, forecasts, and future are conditional verbs; such as will, make, could, should, and would; as well as other statements that necessarily depend 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 10-K and subsequent form 10-Q, which are available on the SEC's website at SEC.gov. So, with that, I'll turn the call over to Paul Reilly, CEO of Raymond James Financial. Paul.

Thanks, Paul, and good morning, everyone. Jeff Julien and I are attending our RJFS Independent Advisors conference. A record 4,000 attendees, over 240 training classes; an extremely positive and constructive environment. In fact, we had over 72 recruits attending our conference from other firms. First and foremost, I want to start with that we believe we've had a very good start for the first 6 months. In fact, a record pace for the first 6 months. Net revenues for the first 6 months of the fiscal year were $2.5 billion and pre-tax income of $383 million both represent the most we've ever generated for the start of our fiscal year in a six-month period. Additionally, I think if you look at our key operating metrics at the end of the quarter, we have a lot of quarter-end records. That includes client assets under administration of $496 billion, financial assets under management of $69 billion and net loans at the bank of $12 billion. These records have been driven by our long-term focus on recruiting and retaining a great group of financial advisors. That shows up in the numbers also, with a record number of financial advisors. We grew to 6,384 at the end of March, which is up 182 from last year's March, and 48 over the preceding quarter. These strong net additions really understate our actual growth and productivity capacity as they come online. Now, I'm going to go over a few numbers before I turn this over to Jeff for more details. We understand this was a noisy quarter, as was our first quarter last year, both due to seasonal and nonrecurring items that Jeff will discuss. We achieved a record quarterly net revenue of $1.29 billion, a 9% increase over the prior year's fiscal second quarter, and a 3% increase over the preceding December quarter. Quarterly net income of $113.5 million, or $0.77 per diluted share. Quarterly net income is up 9% from last March quarter, but down 10% sequentially. Due to those items which I alluded to previously and Jeff will go over. As we told you on the last earnings call, we typically have a difficult March due to seasonal items. This March quarter was no different. Because of some of these items, we think it's important to look at the combined results for the first half of the fiscal year. Where we generated $2.54 billion of net revenues, up 7% over the first half of FY14. And, net income of $240 million, which is up 8% over the first half of FY14. During these first 6 months of the fiscal year, we generated a 15.1 pre-tax margin in this rate environment, which is within our target. And, an annualized return on equity of 11.3, below our 12% target in this interest rate environment. But, we still think our target's obtainable. Now, for a quick recap of some of the segments. The private client group; we generated a record net revenue of $871 million, up 7% over the prior year's fiscal second quarter and 3% over the preceding December quarter. Again, this segment was affected. Quarterly net revenue is really attributed to strong advisor retention. Which, along with a much appreciated market, we had solid improvement in our assets due to our productivity in recruiting. Meanwhile, quarterly pre-tax profits of this segment of $75 million were challenged by the seasonal factors and other items Jeff will explain. Including, FICA, advertising, technology, and other items. But again, if you look at the 6 months of the fiscal year, you'll see reasonable operating leverage. As net revenues for this segment were $1.7 billion, which grew 8%. While, pre-tax income in this segment was $168 million, which grew by 13% over the previous period. At the current levels and quarterly revenues, we believe this segment can certainly generate over a 10% pre-tax margin to net revenue. If we go to the capital markets segment, we generated quarterly net revenue of $235 million, up 6% compared to last year's March quarter, and 1% compared to the preceding December quarter. Quarterly pre-tax income of this segment of $21 million was also challenged by a few items, which I'll leave for Jeff to explain later. Actually, based on January and February's results, we would expect a much more challenging quarter for the capital markets segment as investment banking revenues were very soft for the first 2 months, which we highlighted in our operating metrics. However, March surprised us a bit. As investment banking revenues in March were more than double the revenues of January and February combined. The strong March for investment banking was mainly attributable to very strong M&A and very strong public finance deals, where we had 94 in March alone and our tax credit business. Meanwhile, equity underwriting was very weak in this quarter as the industry experienced a slowdown in both energy and real estate, which have always been strong sectors for us. The resiliency of our investment banking results this quarter, in light of the softness in energy and real estate, really highlighted the investments we made over the last 5 to 7 years to diversify our platform. In fact, much of the strength in M&A was driven by the technology sector, which we essentially didn't have one as recent as 5 years ago. We continue to make these types of investments. For example, we've invested in our capabilities in the consumer sector. And, recently have added significant life science sector support, which, this quarter was hit by recruitment guarantees and the bill-out expenses in the life science sector, but we believe is a very strong and good investment for us. I quickly want to discuss institutional commissions in the segment. Equity commissions of $60 million were down year-over-year and sequentially. Primarily due to lower equity underwritings as we talked about earlier. Meanwhile, fixed income commissions of $75 million were up substantially on both a year-over-year basis and sequential. Our fixed income division had a very strong quarter, benefiting from significant interest rate volatility during the quarter. Net trading profits were also strong, which is a testament to our agency focus model. Also, remember this quarter had 3 fewer business days than last quarter, which impacts our transactional parts of our business. In the asset management segment, asset management reached a record quarter end for financial assets under management of $69 billion, which is up 11% from the prior year's March. Quarterly net revenue of $94 million, up 7% at to last year's March quarter, but down 6% compared to the preceding quarter. Remember, the preceding quarter benefited from a $5 million performance fee and had 2 more billable days than this quarter. Quarterly pre-tax income of $31 million is up 44% compared to last March quarter, but down 22% sequentially. But again, you will see there's reasonable operating leverage if you look at the first half of the year. The asset management segment's revenues were up 6% to $194 million, and pre-tax income was up 15% to $71 million. Raymond James Bank reached a record of $12.1 billion of net loans, up 20% over last year's March, and 2% over the preceding December. Loan growth that decelerated this quarter after a very robust December quarter, as we've always said, we remain very focused on quality loans, and we're very opportunistic of growing when those loans are available and slowing down when they're not. Record quarterly net revenues of $102.9 million; up 21% over last year's March. And, remember also, the bank was impacted by 2 fewer days of interest charges versus the previous quarter. This was the second-best quarterly pre-tax income for the bank of $71.3 million, which was up an impressive 25% compared to last year's March quarter. The loan loss provision declined sequentially on slower loan growth. And, net interest margins did improve to 3.09%, which is 12 basis points higher than last year's March quarter. More importantly, our credit quality remains strong, as total nonperforming assets declined by nearly 22% compared to March's quarter and now represents 55 basis points of total assets, down from 83 basis points a year ago in the March quarter. So overall, a lot of noise, and Jeff will go through some of the expenses that hit this quarter. But, we believe it is a very good start to the 6 months of the year and the operating metrics that drive our business ended very, very favorably. So, with that, I'll turn it over to Jeff. Jeff.

Thanks, Paul. As I've become accustomed to now, I'll start – I will go through some of the line items that give a little more detail on some of the items that affected those lines. Which, I hope will help in the modeling exercises that many of you go through. Commissions and fees were pretty much in line. The noise around that line item, for the last couple quarters, both commission revenues and commission expenses, has to do with the mutual fund adjustment that we've been talking about. By way of reminder, in the December quarter, we took a $10.5 million reduction of revenues, and a corresponding $6 million reduction of comp expense assuming that that would be the amount recouped from financial advisors on commissions that would be reimbursed to clients related to mutual funds that share class issue, whereby, some of the mutual funds that we sell had some specials periodically. Very deep in their prospectuses there were special deals that were available to certain types of plans. It gets very complicated and very easy to miss. And, so, what we had done in December was on an automated basis, went back 5 years, and took a charge for what we deemed to be the worst-case situation for us in terms of client reimbursements and FA chargebacks. In the most recent quarter, in the middle of February, we made the decision not to charge this back to financial advisors. So, that $6 million reduction in comp expense became an additional comp expense in this quarter. And actually, represents a $12 million swing if you're looking at December versus the March quarter. Further, the $10.5 million estimate that we had reduced commission revenues by in the first quarter has been refined downward after we scrubbed the accounts for which we're truly eligible, etcetera, to about an $8 million number. And, those reimbursements are to clients are starting this month. So actually, we've benefited by $2.5 million by fine-tuning that estimate. So, that was – other than that noise in that line item, it's trended pretty much as all your models have expected. Paul's touched on investment banking in some detail. Also, investment advisory fees, which are down just because of fewer days in the performance fee in the preceding quarter. Interest is in line despite the 2 fewer days. And, the most significant item of note there, of course, is the net interest margin improvement of 5 basis points quarter-over-quarter at Raymond James Bank. Account and service fees are in line. Paul touched on trading profits. They usually trend pretty much with fixed income commission volumes, which were good last quarter. This most recent quarter as well. In the other revenue line item, with the detail you can see in the press release, the big factor there was a higher than normal gains from private equity investments, about $17 million for the quarter. But about $6 million of that, by way of reminder, is attributable to noncontrolling interest. So, only about $11 million of that goes to our pre-tax line, for those of you that adjust private equity out of your models. Looking at the expense side, aside from the mutual fund reversal of the chargeback to FAs, which added $6 million in the quarter, Paul mentioned the FICA restart. This is an annual seasonal event for us, of course, and, as with everybody else, that added versus the December quarter about $6 million to our comp expense, as everyone restarts the FICA clock that had surpassed the limits in the prior year. That difference will dwindle over the course of the year, as people continue to hit the limit going forward. And then, information processing: we have some seasonality in that line as well. We had this discussion last year. The annual printing and mailing of our 13th statement for our capital access, which is our cash management accounts, all the 1099s for all of our clients at the end of the year, our annual reports and proxies, our annual meeting's in this quarter, etc. When you add all that together, that effort in total, is about $2.5 million that hits in this quarter every year. In addition to that, in this line item, we had, what I would call a more normal run rate for IT projects; projects that involved additional consultant charges, consultant fees. We had some programs come online, so we started some amortization and maintenance fees, etc. Some of it was a little bit of a snowball that caught up a little from the first quarter. So, for these 2 line items particularly, the comp line item and the information processing line, I would encourage you to look at the six-month average run rate for those 2 items. And, for the six months, the comp ratio is 67.8%. So, for the six-month period, we're pretty much in line with our goals. And, for the 6 months on the information processing, it's averaged about $63 million per quarter, which is in line with the low-to-mid 60s guidance that we've been steering you toward here for some time. And, I think again, both those represent more realistic run rates for us at this point in time. I will note that there was a slight reclassification last quarter that affected the information processing. And, the other side of it was the admin line, by about $3 million, where some of the capitalized IT costs, which, really, our developers' time, was capitalized out of IT costs and should have been capitalized out of compensation. So, we did adjust that: just made a reclass between those 2 lines to get them comparable to our current presentation. Occupancy and equipment's pretty much in line. Clearance and floor brokerage; we had in there a $3 million catch-up adjustment. It relates to several years worth of clearing charges that were paid to – on foreign clearing, clearing our foreign branches, at least, to our clearing agent. But, the other side of it got hung up on the balance sheet and when the – an account reconciliation jarred that one loose. And, it's – so it's about $3 million one-time charge here to catch that up. Like I said, it relates to several years' worth of charges. Business development is a little high. It's a – Paul mentioned the advertising expenses. What we have an annual budget for advertising and branding expenses, particularly, television advertising and we really don't know at the beginning of the year which quarter we're going to buy air time. But, we bought a significant amount in the March quarter. Which, will again, even out over the course of the year, because we will not exceed our budget over the course of the year. And, that hit in the other segment for now. Over the rest of the year, it's allocated out to the other segments ratably. So, but it's – for now, it affected the other segment. The other thing that's affecting business development is this very robust recruiting activity. When you're having the success that we are currently in recruiting, there are a lot of exit fees that are being paid on behalf of FAs, whose clients get charged an exit fee by the broker/dealer that they're coming from. There are a lot of costs associated with flying people down; home office visits. We're starting amortizations of all the hiring deals, etc. So, I mean, a whole lot of costs, which are good costs. I mean, it's an investment we're happy to make, as it – given that we're in a sweet spot for recruiting. Investment advisory, sub-advisory fees are in line. Paul mentioned the loan-loss provision. It was – generally reflects our loan growth. We had a modest amount of additional provision for some downgrades, a couple in, a couple additional steps down in some energy names. Additionally, we're trying to get prepared for the SNC exam results here in the June quarter. We like to get in front of that as much as we can. If you remember last year, that was a fairly modest impact on us. Last year, less than $2 million, and we're hopeful that we do as well this year when we get the results in late June. Other expense was in line. Tax rate was in line. We didn't have a lot of Coley gains. The market was relatively flat. The equity market was relatively flat for the quarter, at least the S&P. Noncontrolling interest for what you'd expect. The – Paul's talked on the pre-tax margins. Again, this is – since these quarters have so much jostling between them, it's better to look at the six-month period. Again, 15.1% margin versus 14.6% a year ago. And, the comp ratio, I already mentioned, a year-to-date 67.8 versus 68.5 last year. I will mention our capital ratios that you can see. Now, we now have 4 that we're displaying instead of three. As this is the first period we're reporting under Basel III. I will mention that there are at least a couple items, mainly private equity, that gets treated a little more harshly under Basel III than it did under the prior methodology. That could impact our capital ratios negatively. There are also a number of items that are not clear to us yet. How they need to be treated, that could impact these ratios positively. We have portrayed what we think are the most conservative ratios, because that's what we do. So, any of these items that we get clarity on in terms of risk weightings, etc., over the course of the next couple months, we will reflect that appropriately in the June quarter and that you may see an uptick in the capital ratios from what we've displayed here. But, that remains to be seen. We had a higher share count by about a million shares. What happens is, I think we talked about this last year as well, the December quarter is by far our largest quarter of the year in terms of RSU equity awards to employees and retention awards to financial advisors that are done in shares etc. So, that's – this is the time of year that you'll see the spike in the outstanding shares. So, at the end of the day, if you look at all the things I've talked about, and we've talked about, well, what's really not going to recur in the next couple quarters? Well, this $6 million increase in FICA will diminish. It will eventually, go away here toward the later part of the year. We certainly won't have another $6 million reversal of the FA chargeback. I don't think we're going to have another short quarter, best I can tell. We should not have another $2.5 million of printing and mailing for 1099s. We should not have another $3 million clearing adjustment in equity capital markets. And, I already told you, we won't have more accelerated advertising, in that we're not going to exceed our budget. So, we have a lot of expenses that hit some seasonal, some self-inflicted wounds, that should not play a part going forward. But, for all those reasons, we again still think that the 6 months is a pretty good representation of how we did during this six-month period. But, in that six-month period every year we've got these seasonal factors. The shorter quarter, the printing and mailing costs, the FICA restart; all those things. That would lead you to think that, perhaps, all things equal, that the next quarter won't have those charges and might be better.

Thanks, Jeff. And, I know we're spending a little more time than usual. But, we know we had a little bit of a noisy quarter. In a way, I feel like it's like déjà vu again with the same situation we're in the first quarter a year ago. But, if you really go through it all, you look at the first 6 month's numbers; we've had good strong operating results. More importantly, if you look at the factors that really drive our business and the private client group record assets under administration at the quarter end, record advisors, a great recruiting pipeline; I think we'll continue to still drive and grow our business. I wish you guys were all here at our conference and you'd see the positive energy from our financial advisors. In the capital market segment, investment banking activity remains robust, particularly in the M&A and public finance. But, we do continue to feel the headwinds in underwriting, especially in the energy and real estate sectors. As we told you, we thought that the energy price fall would impact this sector for a quarter or 2 and be replaced by M&A and increased underwriting. But, we're still working through that transition in the marketplace. But, we got a very good year and start this year in M&A. Asset management, record assets under management, continue to help drive earnings. And, you also remember we announced a $1 billion asset acquisition in early March and we're waiting for our final pending regulatory approvals. So, assets should continue to grow, driven a lot by recruiting and net inflows. Bank, another very strong quarter. Good credit quality and the NIM improvement, the modest NIM improvement should continue to help drive good numbers. And, finally, we know getting a lot of questions about the Department of Labor's fiduciary standard. We were active in fighting back in the first release in 2010 and now the law, as proposed, is very complex. We are analyzing it internally. As well as, I'm on the board of FSR and SIFMA. Scott Curtis, on FSI with our trade groups. I think we’re all united. I’m going through the proposals. In fact, there's ongoing discussions right now with labor. So, it's hard to quantify any changes and we're studying it. But, believe, the business we do is very positive for clients. So, with that, I appreciate your patience and we'll finally open it up for questions and answers. So, I'm going to turn it back to Therese.

Hey, good morning.

Good morning, Devin.

A question on the bank. If I look at just the overall, kind of, deposits. And then, kind of, think about the deposits of third-party banks. I mean, I know that you guys, you want to have the bank balance within the platform and grow, kind of, with the firm. But, when I look at the capital base of the firm, capital looks strong. You have excess capital. Then you have significant deposits at third-party banks. And so, yes, I would think the spread pickup from moving some of those deposits onto the balance sheet would be pretty significant. So, just let me get your thoughts there? Is that an opportunity? And, some of you guys would, maybe, look to do? Just given that, I think, from an earnings standpoint it could be pretty powerful.

Yes, Devin, I think that there's a lot of things we know we could do to improve earnings. And, it goes even taking some fixed rate risk in securities; minimal. We could grow the bank. But, we've had a philosophy to target the bank about 35% of capital and no more than 40. We think it's important for our advisors and for our shareholders to understand we're not a bank first. So, we're a private client group that has strong banking and asset management backing to it. So, sure, we could deploy more capital. I think the bank's done a great job of investing in its assets, its loans, and its good risk return basis. But our view so far is, we want to keep it within those capital ratios. We have an opportunity to grow. We haven't told Steve not to grow, because we certainly have a little more capital room. But, we're not going to be overly aggressive in it either. So, we're going to stick to our model right now.

Great, thanks.

Kind of makes sense. The bank's not intentionally slowing down just because of that constraint. They lend when they find good opportunities to participate in credits that meet our quality standards and our return standards. And, that gets lumpy. You saw it really big in the first quarter and you saw it slow down a lot this quarter.

So, you're right. It has room to grow, and we've told them to grow if they find good quality loans. And, I think, as we find good loans and we're opportunistic, we add them. And, when it's not there, we slow it down. And, it has room both within our internal capital allocations and certainly our client cash. Which again, we limit to 50% of our client cash in the bank as another control and diversification tool. But, they have room under both. But, we won't let it get out of hand.

Got it. Thanks for so much the update there. And then, just with respect to the NIM in the bank. You had a nice step up sequentially. Was that mix-driven? Or, what drove that? And then, just, kind of, thinking about the outlook for the NIM. Just giving some of the moving parts around mix versus what we're sitting in rates today? That would be helpful.

Devin, this is Steve Raney. Good morning. It was primarily driven by NIM increase in our corporate lending book of business. I would say that, yes, the outlook I would say is probably stable for the next few quarters within a small range up or down. But, I would say the outlook would be pretty stable at this point.

Okay. Great. And then, just lastly, within investment banking, it sounds like the backlog feels pretty good. And just, kind of, within the businesses there. How is M&A, maybe, specifically today? And, how does that backlog feel? And then, with public finance it sounds like it turned on toward the end of last quarter. So, what drove that? And, is that, kind of, theme carrying into this quarter?

Yes, I’d first – in investment banking, I think, certainly, kind of, underwriting business has been tough across the board. Especially for us, where we're strong in energy and real estate. But, the other sectors have done well. In M&A it's been across the board, but, particularly in tech and tech services, an extremely good quarter. Late March quarter actually produced a lot of the results. I think people forget sometimes, in public finance, we're a top ten underwriter. I think one poll said 8 and one poll said 9, with total credit to lead. So, we are – it's a significant business for us. That business was very slow in January and February. The March turn on had to do with, I think, first, in that business, you get a lot of downtime because of the holidays at year-end. Financing typically slows in January. That carried over longer into February. But, we're getting the refinancing part of that business has turned on during some rate volatility. So, the refi part of public finance has been absent in the last year. That turned on and a lot of deals happened quickly. So, so far we see the movement short-term. Here we are into early April. Good activity in both of those. But, as you all know, that's a lumpy business that's hard to predict. Both of those. But, we feel pretty good about the backlog. Sure.

Great. Thanks for taking my questions.

Sure.

Hey, morning.

Hello, Hugh.

I appreciate the insight that you guys gave on the fiduciary standard. Was wondering if you could just give us a little more detail on a few areas to help us, kind of, frame some things up? With regard to the percentage of your, kind of, advisors that are RIAs. That are, kind of, already adhering to that standard? And, some color, maybe if you can, on – you could give us in detail on the fee-based assets? But also, can you give us any sense as to how much of those are qualified? And, any rough sense, on historically, the type of revenue you typically tend to generate from IRA rollovers in those types of things?

First, let's answer it in 2 parts. The standard, we have an awful lot of our advisors that have their own RIAs, or, in our RIAs. But, that's not actually even the issue. I know that publicly it's been the issue. If you look at the definition of exemption and level fee payments and disclosures, it's pretty complex right now. So, I think hopefully in this comment period, and working with the Department of Labor, we can get things that are clear. Because, it's not that clear the way it's written. So, we're working through those right now and that's, it's – that's hard to tell. So, it's not as simple. If it's as simple as having an RIA, we'd have a lot of people exempt. But, it's not that simple in terms of level fees, products, what qualifies in an exemption, what doesn't. And, that's what I think the industry's trying to work through. In terms of assets, Jeff?

Yes, I mean, our retirement plan assets in our firm are about 35% of our assets. And, which I believe that includes IRAs. Is that right, Paul?

Yes, about 35% to 40% our retirement plan assets. Actually, it's a little bit higher than that within fee-based accounts. It's about 45% of our assets in fee-based accounts are retirement assets.

I don't think that's a statistic you'll find much different than anyone.

Yes.

Okay, yes, that's very helpful. And then, as we look at, kind of, the asset management business. Do you have a sense of, kind of, the percentage of the assets that are in qualified accounts?

I don't have that; I don't think we know that one offhand. But, I will tell you that the early reads on that, that actually that we get some benefit, some restrictions of – in that area. In IRAs and what you can sell. But, if you read again, the best you can read the DOL standard, we may actually even get some relief and some opportunity in that area. And, again it's just too early to speculate. It's – the law is 800 pages. It's very complex. And, people are still trying to go through and understand it. And, I think even the department's trying to understand the implications and what all this means. So, we're studying it like crazy.

We have a whole committee doing that.

Yes, but, it's too early to really give you an impact. If we had a clearer picture, we would.

Okay. Well, that's certainly helpful; the color you've given there. And then, just a question or 2 at the bank. I think you started to talk about, maybe, some of the energy credits and things like that and getting ahead of this – the SNC exam. But, is that what's driving, kind of, the uptick we saw in classified assets? Just, kind of, adjusting things ahead? Or, are you seeing any changes in credit trends? That are, maybe, low level, but it's not rising to an MPA? But, that you're making some adjustments?

Yes, Hugh, the increase in criticized loans was attributable to downgrading 3 of our energy names. And us proactively, and we think wisely, adding reserves against those names. So, the exposure still remains very low. It's less than 3% of total assets are in the energy sector. And, the vast majority, 75% of our energy exposure is really not related to – it's not as sensitive to the volatility of oil and gas prices. It's more midstream-oriented related to exposure. So, but, we continue to watch every name very closely and monitor that portfolio actively.

The percentage may have moved, but if you look at dollars, it's not much. It's a normal fluctuation. So, I think there's nothing underlying that we're worried about that's driven any increase there. It's just our normal credit process and trying to be conservative and doing the best job we can at estimating that. And, trying never to be behind the curve.

That's helpful; that's helpful. And then, as we look at, kind of, the deceleration in loan growth. If you could just give us any color between the residential portfolio and the corporate portfolio? And, I guess as we look at things from a spread basis, we have seen, kind of, a nice improvement in credit spreads in both investment-grade and high-yield in late last year and into this year. Any color as to how we should be thinking about that in terms of your willingness to, kind of, go out there and put capital to work?

Yes, we have seen improvements in the marketplace pushing back and credit takers like us and institutional investors in this market are finally having a little bit more discipline as it relates to the returns they're looking for. That being said, I would say as reflected in this quarter. Loan volumes, I would say broadly in the corporate sector in particular, were down. There's not as much deal flow right now. And, as Paul and Jeff alluded to. As you well know, we've been very prudent and not really changing our credit standards at all. So, I think you'll see us, really, not making any significant changes to our approach. We've got latitude to run in place and even shrink if we needed to. If there weren't opportunities, so.

Hey Hugh, and this is the one we've been terrible at guidance because we just don't know. We've seen when we say it's slowing down, we all of a sudden, like the December quarter, we had a huge quarter. So, we're just – we're very focused when the markets are right and we get the right credits, we act. And, when they're not, we slow down. So, it's a hard one to tell you how we really – where we see it going because it can open up like a spigot and it can slow down in terms of the things that we're interested in lending on.

All right, that's helpful. Thank you so much.

Thank you.

Thanks, hello guys.

Hello, Chris.

Surprise, a few questions on DOL. Wondering if you guys could help us out. Maybe, not getting into the law specifically. But, if we just think about your advisor force overall. How does the behavior differ between your advisors that are operating under fiduciary versus those that are not? And I know one is tend to be a little more fee-oriented and the other is commission-based. But, anything you can kind of help us out with, with regards to how they run their practices differently? The different products that are in those 2 categories would be helpful.

Here's the hardest thing Chris. First, I wish I could tell you that one's one and one's the other. And, those operating our fiduciary are different from the commission volley. We believe that our job is to put the client first. It's been one of our – it's the center of our core values. It always is. To say that just because you're fee-based, it's better for clients, when a commission is cheaper. Especially, in small accounts. In fact, there's anti-churning regulations where we're not supposed to charge a fixed fee when we're not giving a lot of advice. It's cheaper for the client to be commission-based. So, this whole thing of fiduciary, what does it mean under the standards? And, that's really the question. Whether it's under the 40 act or it is this fiduciary standards proposed now. I – we all believe it's in the best interest of the clients. So, just because you're fee-based doesn't mean you automatically do what's in the best interest of clients. Madoff was fee-based IRA. But, so, that's the hard thing here. So, it's – at one extreme you could say everybody who's doing commission base is going to have to go to some wrap fee level, commission charge. Frankly, that wouldn't be good for a lot of clients. And frankly, for small accounts, it probably is cheaper not to have them. Better for the client if that's forced. But, they're going to lose access to advice. Short term, it may impact, as we – our accounts. But, frankly, a lot of those accounts aren't profitable for us either. We do them as an accommodation to our clients, friends of our clients, or relatives, and to our financial advisors. So, although we may have some juggling around, and it may hit revenue. The expense part, we might be better off. So, this thing gets so complicated and everybody wants to simplify it. Until we get through the rules, the regulations, and what do these exemptions really mean, it's so hard to give guidance. It really is. So, I wish I could answer. But, I think the headline from the administration of DOL is: fee-based is good, commission is bad. Well, we can show you hundreds of thousands of accounts where that's not true. So, we're just going to have to see where this ends up.

Okay, that – now helpful. The other kind of question I had on this topic, have you guys disclosed? Or, can you disclose the amount of revenue-sharing payments that you generate on a recurring basis?

Revenue sharing from?

Chris, we have a line in the queue that we provide that just shows what we earn from mutual fund companies of – all types of fees and revenues we earn from mutual fund companies in the private client group segment. But, again, going back to Paul's comments, we're not even sure that those fees would actually be totally impacted by the new proposal. As we kind of go through it and look through all the exemptions. So, we haven't disclosed an estimate of what portion of those fees we think would actually be impacted is, because we don't know what that estimate would be. So, until we get more guidance on that item, you can kind of reference that line item in the queue under the private client group segment. That's probably as good a number as any for you to look at.

Okay, great. I'll check that out. And then, real quick, a question on the numbers this quarter. Jeff, thanks a lot for walking through all those expense items. Just one follow up on that. It seems like a lot of those discrete items were in PCG. Yet, you had a pretty decent drop off in the capital markets margin this quarter. I know you had the $3 million item that impacted the numbers there. But, was there anything else to call out in capital markets while you saw a bit of drop off there in the margin?

Well, you see the investment, actually, in the new practices was, kind of, a light number all in between recruiting fees, guarantees, startup costs. And, you also – it's, as our business shifts and we look and estimate comp, we're better as we get to the end of the year in that business to get better estimates at the end of the quarter. So again, it had a lot of shifting pieces in it. But, there's certainly those 2 pieces, that on a smaller business, that had an impact on the bottom line.

Great. Thank you.

Oh yes, the other one is – I'm sorry, as Jeff just pointed out to me, is, the other impact is Canada has had a very difficult market. Not just for us, for everybody. And, the results there have been, from a bottom line standpoint, haven't been positive. So, and that's across the board. Even with our competitors, because it's a commodity, energy-based market. So, those numbers have dragged down significantly too this quarter. That's the other big factor.

It does. Thank you.

Hello. This is actually Ryan Bailey filling in for Bill. I just had a quick question on margins and ROE targets. And, how we should think about that going forward? And, kind of, what might be the main drivers there? Thank you.

Yes, we're – for the moment we're sticking with for the year that to exceed 15% margin. We would like to hit 12% ROE. We know we're behind that, even for the first 6 months here. Still, our 12% ROE goal, in this particular interest rate environment. As we get into the 2016 budgeting process, we're going to be revisiting the targets for margins in all of our businesses. As well as the overall firm. And, when we arrive at those, we'll make them more public. But, for this fiscal year we haven't shifted in the middle of the year here because we don't expect any change in interest rates either.

Okay. Great. Thank you.

Good morning, guys.

Hello, Christian.

Hello. Just a broader question on expenses. Ignoring the ins and outs of this quarter, expense efficiency just seems to be a recurrent theme for you. And, I think some of your other peers. Just curious if there's anything in your pertinent environment that's driving this? Is there increased competition that's driving higher marketing spend? Or, is the rise of robo-advisors filling in the need to, just, improve technology capabilities?

I don't think the robo-advisor factor is certainly topical, but not impacting our business really at all. So, I think we've been running under our technology and investment run rate, which has helped drive our recruiting. Because, we have an extremely competitive platform in technology now, and we continue to advance it. But, we've told you it's low-to-mid 60s as a run rate. And, we believe as a run rate average, that's what we're going to come in this quarter. The marketing, our budget for the year, is the same budget we've had all year. It's just lumpy. We just had a bigger expenses quarter because we run them in flights. We don't run all year round and it just happened to hit this quarter. So, I don't think anything in the expense. Sure, we run high levels of back office support. We always have. It's part of our model. But, I don't think anything's fundamentally changed. And, if you look at the first 6-month run rates and what we've given as guidance, we don't see anything that's fundamentally different. It's just a – we got a lot of hits this quarter.

Yes, I'd say Christian, and even over comparing this to a year ago or 2 years ago or anything else. That, we have – we're bigger. So, we have some increased absolute expenses. But, the only area I'd say that disproportionately has increased in expenses has been compliance and regulatory. Which, is obviously mainly in the admin side of the P&L comp expense, but.

We're not alone in that.

Yes.

Okay. That's fair.

I don't see anything fundamental in the other expense line items that are responsive to anything in the environment.

Okay. That's fair. Just switching over to, kind of, M&A and acquisitions for you. I know you've been clear that asset management is a priority. You did the Koger deal, but that was fairly small. I'm just curious as to what's holding back, you guys pulling the trigger on the bigger deals? Is it that you just haven't found the right targets? Or price or just something else?

Yes, we're very clear that our strategy is, first, has to have a cultural hit. Secondly, it's a strategic fit. And, third, it has to be at a fair price. And, the hardest filter is the first one. A lot of the companies that we're interested in, because they share our culture and, we think our values and background, are private and not for sale. So, that's problematic. But, we believe a number of those companies will go through owner, founder transitions. So, we stay close to them. So, we continue to talk to a lot of people. We stay very close. We're very active. We're very desirous of doing something. But, they have to fit the criteria. So, I'll tell you, we're more and more active and we talk on more and more deals and upwards. But, we're very disciplined on spending cash.

Okay. And then, just a follow up question on this long-term operating margins for you guys, for the firm. We can do the math in terms of, like, how much margins should improve as rates rise. But, just curious, is there a natural level at which, kind of, margins max out for you? Just given competitive forces that should come into play as, maybe, as rates rise?

Sure. I mean, your margins definitely are not going to be rising forever. So, given our current mix of businesses. Once we get the benefit of interest rate lift, and we will get some modest benefits of scale in some of the businesses over time. But, it won't be as material as the impact of interest rates. So, I've – if, a couple hundred basis points from here in terms of margin is probably a realistic cap. Given the dynamics and businesses that we're in today. The world can change on a dime, but we don't anticipate that.

Okay, fair. And then, just lastly for me. I apologize if I missed this one in the earlier remarks, but an investment advisory fee line. I think revenues there were up, kind of, 3% year over year. Which, kind of, lagged significantly the pace of AUM goals. It just seems like it was more like 11%. Do you have any color on what was driving that, kind of, revenue lag while if it to AUM?

Yes, it's been a pretty – if you look at the components of our assets, which I think are disclosed in the queue in chart form. The components of our AUM, you'll see that the growth has come in what we would call our lower fee type products. Which, the most of – a lot of, large part of the growth has come in the lower fee products. Predominantly, the product we call, "Freedom." There's a Freedom in our Freedom UMA, which are managed mutual fund portfolios. And, given the significant costs embedded in mutual funds already, we don't feel like we can layer on a particularly large charge on top of that to manage that. So, that's where a lot of the growth has come from and it's a very low fee relative to, say, a separate managed account where you're managing equities.

That's perfect. Thank you very much.

Well, thank you all for joining us. We know it was a difficult quarter. I wish we could give better guidance as these – as this quarter happens. It's the same thing as last year. Net strong, we think, start to the year. Our best first 6 month start ever. We've gotten, if you look at the key indicators of our business, recruiting, FA count, assets under administration, assets under management, net bank loans, all at quarterly, kind of, records. And, so, that's going to position us well for the next quarter. And, we have to fight in this environment like everyone else to bring it in. So, I just make sure that when you look at the quarter and, kind of, normalize the expenses, I think the six-month run rate is a good proxy for that. So, thank you for attending us. We know on a busy day here with a lot of calls. And, we'll talk to you soon. Thank you, Therese.