Raymond James Financial Inc (RJF) — Q4 2016 Earnings Call Transcript

Thank you, Raquel and good morning. I thank all of you for joining the call. As always, we appreciate your time and interest in Raymond James Financial. 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 their prepared remarks, they will ask the operator to open the line for questions. Certain statements made during this call may constitute forward-looking statements. Forward-looking statements include, but are not limited to, information concerning future strategic objectives, business prospects, financial results, market conditions, acquisitions, our ability to successfully recruit and integrate financial advisors, anticipate results of litigation and regulatory developments, or general economic conditions. In addition, words such as believes, expects, anticipates, plans, and future or other conditional verbs, such as will, may, could and would, as well as any other statements that necessarily depend on future events are intended to identify forward-looking statements. Please note that forward-looking statements are subject to risks and there can be no assurance that actual results will not differ materially from those expressed in those forward-looking statements. We urge you to consider the risks described in our most recent Form 10-K and subsequent Forms 10-Q which are available on our website. During today's call, we'll also use certain non-GAAP financial measures to provide information pertinent to our management's view on ongoing business performance. These non-GAAP measures should be read in conjunction with and not as a replacement for the corresponding GAAP measures. A reconciliation of these non-GAAP measures to the most comparable GAAP measures may be found in the schedule accompanying our press release. So with that, I will turn the call over to Paul Reilly, CEO of Raymond James Financial. Paul?

Good morning, Paul, thank you. Kind of a very interesting year if you'd asked me in the first or second quarter if we were going to finish on record. I would have said, with assets down at the start of the year in a tough market, oil prices plunging, and the underwriting market almost freezing up, I would have been very surprised. So needless to say, we're very pleased about the record quarter and record fiscal year. We achieved this remarkably in an unremarkable fashion with just a relentless following up of a long-term implementation strategy. Tom celebrated his 50th year at Raymond James, and he constantly reminds us that our mission is to focus on the well-being of our clients, assist advisors in helping clients achieve their financial objectives, and to make all our decisions for the long term. Looking at this year, there is nothing in particular that stood out, except all divisions had record revenue. This year, our record revenue and profits were achieved while we underwent robust recruiting. The integration of three groups that joined our family; the Deutsche Bank U.S. Private Client Service Unit that we've rebranded as Alex Brown, a division of Raymond James, added capability in the northeastern expansion of our ultra-high net worth capabilities. 3Macs, a firm actually older than the country of Canada, has joined us after almost a 200-year partnership, bringing us great advisors and some multi-language capabilities, as well as back office capability in Canada. The company is expanding our M&A capability in Europe with Mel's group. The implementation of a world-class AML system in a very short order on our platform; new client and advisor technology allowing advisors to do all their work on their iPhone or iPads, such unique technology. So this year was achieved really by our associates, who accomplished all this; we don't talk much about the Austin, Texas people, but we ought to thank them. Throughout all of this, not only did they achieve the above, but they kept the outstanding service levels to our clients and advisors that drive our retention and satisfaction, so they really deserve the credit for this year. First, I want to cover our fiscal year-end highlights. I'm going to turn over to Jeff, and he is going to cover the quarter and certain line items. Then I'll discuss the performance in some of the segments and our outlook in those segments. We achieved record annual net revenue of $5.4 billion, up 4% over last year's record. That was driven by annual net revenue records in all four of our core operating segments. Record annual net income of $529.54 million or $3.65 per diluted share. Again, this was driven by record profit in our capital market segment and RJ Bank, and still the second best year of pre-tax profits for both, the private client group and asset management group combined, which generated this record by less than $5 million. So it really was a good year for everyone. The record diluted EPS of $3.65 for the year represents a 6% growth over fiscal 2015. On an adjusted basis, if you take out the $41 million of acquisition-related expenses, our non-GAAP net income of $556.3 million or $3.84 per diluted share represents a 12% growth over the fiscal 2015 diluted EPS. We ended the year with several new records and key operating metrics which should bode well for revenue going forward. Helped by the aforementioned acquisitions, we hit some of these records, but I also wanted you to note that even without the acquisitions, our organic growth alone would have achieved records in most of these segments that drive our forward revenue. Record client assets under administration of $604.4 billion, a 26% year-over-year increase; again augmented by roughly $50 billion of client assets brought over from Alex Brown and 3Macs. Even if you exclude those additional assets, our client assets under administration would have grown roughly 15% on a year-over-year basis, which reflects our solid organic growth. We had a record number of private client group financial advisors, totaling 7,146; a net increase of 550 over the last year, augmented by approximately 265 advisors added through the acquisitions we talked about. We are proud of this result because we've retained approximately 90% of the Alex Brown team and nearly 100% of the 3Macs advisors. So during the year, on an organic basis, even if you excluded those, we added 285 advisors during the year. That, combined with our low regrettable attrition, which remained below 1% in all of our divisions, drove advisor growth. Record financial assets under management of $77 billion, up 18% over the last year, lifted by our asset management group, which exclusively serves clients in our private client group. Record net loans of Raymond James Bank of $15.2 billion, which is up 17% over September 2015. More importantly, a lot of that growth this year was supported by strengths in our client relationships in our private client group and capital market segments, such as securities-based loans, residential mortgages, commercial real estate loans, and tax-exempt loans. So with those highlights, I'll now turn it over to Jeff to talk about the record quarter, and although it was almost half driven by tax benefits, the other half was driven by solid operating trends. So Jeff?

Thanks, Paul. As Paul mentioned, we had a record revenue quarter, $1.46 billion, up 9% compared to last year's fourth quarter and 7% compared to the preceding quarter. This revenue growth was really across the board; all four of our core operating segments had record quarterly revenues in the September quarter. Furthermore, three of our four segments, private client group, capital markets, and the bank, all generated record quarterly pre-tax profits. So a very strong quarter. Net income was $171.7 million, or $1.19 per diluted share. That represents a 35% growth over last year's fourth quarter and 37% over the preceding quarter. On a non-GAAP basis, a headline number that people are talking about, the adjusted net income of $185 million was $1.28 per diluted share, which is a 38% increase over the preceding quarter. Obviously, the $1.28 far exceeded everybody's expectations, including our own. Let me touch on some of the major variances from the consensus model that really drove that feat. On the revenue side, the biggest line item that varied from everyone's expectations was the strength of the investment banking revenues. That was really a combination of several businesses; we seem to have a tradition of having strong Septembers in a lot of these businesses, and this year was no exception. M&A, equity underwritings both picked up, and our tax credit fund business, which is also in that line item, had a phenomenal quarter with a lot of syndications closing in the quarter. So while we have room to improve on the institutional equity side, the other cylinders were all firing pretty well. We have a good pipeline in most of the businesses, but I'd be surprised if we stay at that level in terms of equity capital market activity next year, but that one’s a hard one to predict, as you all know. Interestingly, almost all the other revenue items were ahead of the consensus numbers, but all by mid-single-digit type percentages, so nothing else really blew the cover off the ball on the revenue side other than investment banking. Let me talk about a couple of the other line items and give you a little help in terms of what we see going forward. On our biggest line item, the commission and fees line, you can see in the release, our assets in fee-based accounts ended the quarter at $231 billion, which is a 12% increase over the preceding quarter. A lot of that came from the acquisitions that we made, so that obviously helped that increase. That certainly is going to provide a good tailwind for the security commissions and fees going forward. But all those are not going to manifest themselves as a large percentage increase in fees; we think that the billings in October versus the preceding quarter were up about 9% to 10%. So a good start on that line item for the quarter. Similarly, the increase in assets under management of 7% sequentially provides a boost for the investment advisory fees as well. Let me touch on net interest for a moment; in the release, you can see the increase in secured client lending ended the quarter at $4.3 billion, about $800 million higher than the preceding quarter. About $75 million of that was organic growth, and the rest was really all attributable to the increase in margin loans that came from the Alex Brown transaction. Most of that was driven by the strength of the bank and its growth. Going forward, it looks like net interest will pick up about $30 million of net interest next year from the Alex Brown related cash to customer cash balances and margin balances. We're also expecting to have some continued bank growth with the NIM somewhere in the current range, and we're guessing somewhere between 10% and 15% growth in the bank. So all those things will lead us to some nice continued growth in the net interest income line item. If we're fortunate enough to get a rate increase, which is being rumored more strongly all the time, any rate increase we're projecting would add somewhere between $12 million and $15 million pretax per quarter for us. Of course, that's dependent upon how much gets passed through to clients, but for sensitivity, every basis point means about $4 million. Now let me turn to the expense side; the compensation ratio for the quarter was a very nice 65.9%, much lower than it has been recently and lower than expectations due largely to the revenue mix in that quarter. The compensation ratio for the overall year was 67.1%, which was nicely below our target of 68%. We would be happy to repeat that in fiscal '17. We are not necessarily going to lower our compensation target of 68%, but perhaps we have some soft expectations that we do better if we can continue to grow revenues, but there are other things that are coming into play next year. I would tell you that our guidance would be something like 10% higher, somewhere in the $7 million to $80 million range per quarter, and the biggest driver of that is the systems work that is already underway related to the DOL rule, which is due to take effect in the middle of fiscal '17 for us. The provision for losses on bank loans was only $1.2 million for the quarter, much lower than expectations; that loan growth was just over $400 million. We have some downgrades during the quarter, but the increase in criticized loans was offset by nice pay-downs and pay-offs, particularly in the more harshly criticized energy space. The legal and regulatory expenses that we've seen over the past quarters have been a little elevated; that continues to be the case, and we'll call it a new normal for now within the regulatory environment we're in. Acquisitions-related expenses were about $19.4 million for the quarter and $40.7 million for the year, most of those related to Alex Brown. We expect those incremental costs to be complete by the end of the March quarter. The biggest variance in the quarter, which you all have noted in your early comments, was that abnormally low effective tax rate of 27.4% for the quarter. The three biggest factors related to tax benefits associated with the planned divestitures of our Latin American businesses. We have been providing for taxes on repatriation of earnings from those entities, but that will not be happening now. Thus, we had to reverse that tax. We had a great quarter on the firm's corporate-owned life insurance portfolio, closing in on $300 million in size, which had a little over a 4% return for the quarter. That one will continue to impact us in both directions going forward, but long-term, it's certainly beneficial to us. We generated a pre-tax margin of 17.5% on a non-GAAP basis, well over our 16% target. My guess is right now we would probably leave that target intact as we feel pretty comfortable at that 16% target for all of fiscal '17. Just a couple of other points, and I'll turn it back to Paul. One is the weighted average shares; that's having an impact on EPS, it's lower this year's fourth quarter than last year's, given the share buyback we did in the January/February timeframe where we purchased about 3.2 million shares for $145 million. We saw total assets for the quarter increase by $2.8 billion; the major factors being our $800 million bond issue, $700 million of growth in the bank, and the client cash balances and margin loans brought onto our balance sheet from the Alex Brown and 3Macs transactions. We do not expect that rate of growth for the overall balance sheet on a quarterly basis going forward; this was an abnormally big jump. Overall, our capital ratios remain strong, and we are well over the comfort level. Moving forward, we have decided to modestly increase the bank's securities portfolio—agency mortgage-backed securities primarily, with a duration of less than three years. This will improve the bank’s earnings and return on equity while maintaining liquidity. With that, I will turn it back over to Paul to discuss the year-end results and some macro trends.

Thanks, Jeff. I know there is a lot to go over on the annual call, but I'll try to get through this as quickly as possible. Let me start with the Private Client Group segment, which achieved record annual net revenue of $3.62 billion, which is 3% over fiscal 2015. Note that it’s the second-best pre-tax profit of $340.6 million, down just $2 million from last year's record. Driven by strong advisor recruiting, it was a record year for independent advisor recruiting, with the employee group likely being the second best year. We saw very strong organic growth; this isn’t solely due to acquisitions. The Private Client Group segment also benefited from higher assets and fee-based accounts during the year, as well as higher fees earned on cash balances in the Raymond James Bank deposit program following the increased rates last December. However, revenues were negatively impacted by declines in transactional revenues, especially in new issue credits, really attributable to the market slowdown in underwritings. We think we’ll see a continuation in fee-based accounts, especially with the implications of the DOL rule. The revenue growth of 3% was lower than our asset growth during that transition year and we should note that we also had elevated regulatory expenses in the Private Client Group segment for the year, which Jeff talked about, continuing into the fourth quarter. Our capital markets generated record annual net revenues of $999.9 million, a pre-tax profit of $139.2 million, up really 30% over 2015; driven by record revenues in our fixed income division and record revenues through agreements in tax credits. Our fixed income division had a fantastic year, with institutional fixed income commissions up 11%, and net trading profits actually increasing 57% this year to $92 million. I want to note that we didn't have the same explosive growth that the big banks experienced in the fourth quarter; we've been very steady through the year. Offsetting some of the strength in fixed income and tax credits was the performance in the equity capital markets division, as equity revenues were down 27% from last year; actually a little better than the overall market. Fortunately, M&A had a strong fourth quarter, resulting in M&A revenues being only down 8% from last year's record. Additionally, we're happy to welcome a new company to the Raymond James family, expanding our cross-border M&A activity. The asset management segment generated record annual net revenues of $404.3 million, up 3% over last year, with a second-best pre-tax profit of $132.2 million, down 2% from last year's record. Financial assets under management hit $77 billion, which is up 18% over the last year. The asset management division has continued to benefit from growth in the Private Client Group segment, as well as increased utilization of our fee-based accounts. At the end of September, fee-based assets and PCG totaled $231 billion, up 29% over 2015, representing about 40% of our total client assets in PCG. Eagle was challenged by institutional net outflows this year, with continued focus on augmenting our portfolio management sales team. The bank recorded annual net revenues of $494 million, a 19% increase over last year, with annual pre-tax income of $337.3 million, 21% over fiscal 2015. The record results for the bank were fueled by strong loan growth, with net loans ending at $15.2 billion, up 17%. The bank's net interest margin for the year was relatively stable at 3.04% compared to 3.07% for the previous year. Our credit quality of the loan portfolio remained very solid through the fiscal year despite increased provisions taken earlier. Overall, a fantastic year with record revenues and profits. ROE for the year is 11.3% on a GAAP basis and 11.8% on a non-GAAP basis, which we're very pleased with, especially given that our capital ratios have stayed over 20% throughout the year. The outlook certainly has political and economic regulatory uncertainties with DOL guidelines. But in the private client group, the records in assets bode well for a good start to the year; both in client assets under administration and the balances in our cash suite programs. We're excited about the high-quality advisors and people from the Alex Brown and 3Macs acquisitions. We don't expect those to be big contributors to profits this year, as we will be very deliberate in our integrations. We also have about $35 million of additional retention from Alex Brown running through the P&L this coming year, and we expect legal and regulatory expenses to remain elevated as we comply with DOL and other regulations. We also expect to continue to offer commission-based accounts to comply with the rules. In the capital markets segment, we're cautiously optimistic about investment banking, as it has been a hard year for everyone in the market. Our fixed income business had a record fiscal 2016, largely held up by trading profits. The asset management segment is expected to see continued growth as we grow our number of advisors and increase utilization of fee-based accounts. Raymond James Bank is in position to continue to grow, expecting a slight expansion of the NIM as we invest some of our cash, and we think the bank is in very good shape. So in closing, we're entering 2017 with a lot of uncertainties, but we are convinced that if we continue to focus on our mission of helping our clients and advisors in this challenging environment, we'll continue to deliver good results. With that, I'll turn it back to the operator and open it up for questions. Raquel?

Good morning. Maybe just starting on the deal while I appreciate some of the comments but obviously there are a lot of moving parts. We're hearing from some that they're looking to apply kind of the fiduciary requirements across all brokerage assets; and then others are talking about going to level commissions for similar products. I appreciate you're going to offer choice, but I'm curious where you stand on those? Additionally, you’d spoken about the overtime here, renegotiation that could occur with product manufacturers, just around the economics of the sale. I’m curious if any of those have already occurred and how you see the economics changing?

From an advisory standpoint, we will be using leveled fees in those accounts. We'll have to move there on fee-based accounts for our independent contractors. We believe that the economic impact, if any, will be pushed off into the next fiscal year as we get through this transition. The DOL is going to release answers to the questions they've talked about releasing in the summer, which we expect to impact our response. We fully expect to offer a range of options for advisors to help their clients.

Got it. Okay, that's helpful. And maybe regarding the increase in the securities portfolio in the bank, some people would like to see that you're moving in that direction. I'm curious if you can put in more context around how much more you look to expand that? And then just in terms of the economics, I assume it's coming from the third-party bank deposits, so I'm just starting to think about the net benefit there?

Yes, we think the overall securities portfolio will grow by about $400 million, with an aim to increase it to about $1 billion over the course of the year. In terms of the economics, we're earning a little over 50 basis points from the banks we have programmed. By redeploying that cash into the securities portfolio, we're aiming to pick up about 100 basis points.

We're staying mainly with agencies in the short term, which should provide stability in the portfolio's performance.

As a reminder, we have a mix of corporate loans with LIBOR floors; about $4 billion of our corporate loans. They need to exceed 100 basis points in LIBOR before we'd really gain on that. We're also looking at the 30-day and 90-day LIBOR based loans, and those are showing more increase in the 90-day rate over the last year.

Got it. And just one last quick one here; just on FA recruiting. You still seem to have some good momentum. I'm just curious, is that shifting at all with the uncertainty around DOL, where FAs may be waiting to make a move or even consider slowing down? Just trying to gather perspective on the revenue implications.

Surprisingly not. We’ve expected to see some slowdown, but we haven’t experienced that. The pipeline is robust, and while this month's activity is typically slower, our backlog is strong. So far, we have not noticed any slowdown as we get closer.

Got it. Okay, thank you guys for taking my questions, and congratulations on the strong quarter.

Thank you.

Thank you. The margin in private client; I thought it was particularly good. It sounds like you still have some elevated legal expenses running through there. Can you talk a little bit about how the margins were so good? And related to that, is Alex Brown coming through at a higher margin; maybe providing some advances?

Unfortunately, Alex Brown, actually for the month, has impacted our performance as amortization starts hitting. Overall, it's not expected to provide a big contribution to margins because it's more of a breakeven business for us on internal accounting. However, we have great advisors, and that will generate productive activity both in the bank and other initiatives.

We experienced a lot higher fee billings compared to the preceding quarter, which increased our margins. Also, some of the interest spread benefits from balances during that time supported the margins. Our general outlook is to see potential margin targets between the 10% and 11% range.

Very good, thank you.

Good morning, guys. Quick question; on your commentary of rate sensitivity, if you gauge a 25 basis point increase, you mentioned that about $4 million per basis point, estimating a total of about $100 million if you capture that. How should we think about that?

That’s exactly right. Our cash balances in loan are currently around $43 billion, which was $34 billion a year ago. This means our sensitivity is higher. The $12 million to $15 million per quarter we project with a 25 basis point increase is partially from what we expect to be a reduction from fees based on competitive pressures. We're trying to be fair to clients.

Fair enough. Regarding your pre-tax margin guidance of 16%; is this relying on an improvement in banking, which tends to be higher margin?

Yes, we're expecting improvements across all three of our core segments, given the strong growth and acquisition results. We're optimistic about overall results across the business.

Okay, great. Thank you very much.

Good morning. Just one on DOL; I know you mentioned continuing the migration towards the fee-based accounts. One of your competitors when they stopped offering commission-based retirement accounts offered fee relief to customers that had sticker shock coming from that transition. Do you think that's something you would consider implementing to help migrate customers over to that channel?

We don't want to force anyone under any platforms, nor manipulate the pricing in a way to incentivize transition. It's important for us to retain the flexibility for clients and advisors and ensure they receive the service they expect. Our strategy is to provide options.

Got it. And regarding the 16% pre-tax margin guidance, can you help us understand what you are assuming for interest rates? If we did get a Fed hike in December, how would that impact that assumption?

If we got the benefit of another 25 basis points to the Fed rate, we believe we would see an increase in our pre-tax margin. The projections here reflect the sensitivity to interest rate movements.

That's very helpful. Thanks for taking my questions.

First, thank you all. We appreciate your taking the time to follow us. With a lot of earnings coming out last week and this week, we will continue to focus on the long-term and talk to you next quarter. Thank you very much.