Raymond James Financial Inc (RJF) — Q1 2018 Earnings Call Transcript

Thank you, Tamara. Good morning, and thank you all for joining us on this call. We appreciate your time and interest in Raymond James Financial. After I read the following disclosure, I will turn the call over to Paul Reilly, our Chairman and 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, acquisitions, anticipated results of litigation and regulatory developments. In addition, words such as believes, expects, will, could and would that necessarily depend on future events are intended to identify forward-looking statements. Please note 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 statements. We urge you to consider the risks described in our most recent Form 10-K, which is 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 of ongoing business performance. A reconciliation of these non-GAAP measures to the most comparable GAAP measures may be found in the schedule accompanying our press release. With that, I'll turn the call over to Paul Reilly, Chairman and CEO of Raymond James Financial. Paul?

Great. Thanks, Paul, and good morning, everyone. Well, this earnings release marks our 120th consecutive quarter of profitability, so 30 years of quarterly profitability. That's a quarter since Black Monday, when we had a small loss because Tom kept the retail trading desk open to help clients. So it's a big benchmark for us. It shows long-term performance. And as we work towards our 121st consecutive quarter, it's comforting to know that the federal government has funded itself all the way until February 8. But despite what happens in the markets, we seem to be able to perform based on our kind of overall long-term strategic outlook. We're pleased with the results this quarter. Private Client Group, Asset Management and the bank all had record net quarterly revenues and pretax income. The Capital Markets' quarter was disappointing but as we’ll speak about a little later, I think a lot of that was really timing related. For the quarter, we had record quarterly net revenue of $173 billion, up 16% over a year ago and 2% on the preceding quarter. And quarterly net income of $118.8 million, down 19% or 39% sequentially but really affected by the estimated discrete tax impact of $117 million. If you exclude that tax impact and the $4 million related to acquisition expenses, our adjusted net income of $238.8 million or $1.61 per diluted share was up 33% from a year ago and 9% sequentially. Quarterly annualized ROE of 8.4% and adjusted quarterly annualized ROE of 16.8%, which is really very good considering our low leverage and strong capital position. Maybe more importantly for the business, our quarter ended with records in all of our key business drivers, record number of financial advisers, record assets under administration of $727.2 billion, record assets under management of $130.3 billion and record net loans at the bank of $17.7 billion. As you look to the segment, Private Client Group, as I already said, had a record quarterly net revenue and pretax, really driven by just continued retention of our advisers and very solid recruiting momentum. We continue with our growth in fee-based assets. And before we get too carried away, we had a little help from the markets and interest rates with the vibrant equity market and tax law change. But with that, our fee-based assets accounts grew 32% year-over-year and 8% sequentially, and our client assets under administration up 46% over a year ago. So all very strong numbers. Although year-over-year cash is still down, we had a nice sequential uptick in client cash at $44.3 billion, which has also helped drive interest earnings, as Jeff will talk more about. Asset management record quarterly revenue up 32% year-over-year and 15% sequentially, record pretax profits of 37% year-over-year and 18% sequentially, again, all strong numbers. And that's a combination of organic growth, increased private client penetration, rising markets and inflows, and of course, the Scout and Reams acquisition, which added $27 billion to our AUM. We're thrilled to welcome Scout and Reams to our Carillon Towers Associates, which is now comprised of Eagle, ClariVest, Cougar and Scout and Reams. The bank had record net revenues and pretax, as stated earlier, really driven by net record loans of $17.7 billion, up 12% year-over-year and 4% sequentially. And this growth was diversified against our residential mortgage, SBL and tax-exempt loans. It's good growth across the board. More importantly, the credit quality continues to improve. Credit size loans were down 11% really due to payoffs. The bank's NIM down to 308, 3 bps down, but Jeff will talk about it. A lot of this was really attributed to the tax law change and cash balances. Capital Markets was a very difficult quarter. Net revenue is down 7% year-over-year, 18% sequentially. Pretax down 78% year-over-year and 89% sequentially. The year-over-year decline has been really a lot of it challenged institutional, fixed income and equity commissions. That's been due to the whole industry. We had low volatility and a flattening yield curve. Sequentially, though, the numbers were really driven by investment banking being down, particularly M&A. We had a very strong September 30 quarter and they tend to average out. And a lot of the, we think, the underperformance is really just timing of closing, so the M&A tends to be a very lumpy business. So overall, good results, we believe, strong performance. I'll talk a little bit about the outlook for those segments after Jeff goes through a little detail in some of the numbers.

Thanks, Paul, and good morning, everyone. I'm glad to report that the variances from the consensus model were generally minor, with a few exceptions this quarter, and only one item showed a negative variance. This clarity should help you understand our story better. On the main figures, our headline numbers for securities commissions and fees were in line with expectations. We recorded modest fees, mainly due to transaction-based volume, and our institutional segments performed slightly better compared to the previous quarter. Overall, fee-based asset disclosures were close to our expectations. The negative variance that has been highlighted by several speakers is in the investment banking line, which saw a 50% decrease sequentially, marking a weak quarter across almost all divisions in Capital Markets. More details on this line item can be found in the press release. If we look back at last year, we had a similar start, indicating some possible seasonality at play. This follows a notably strong September quarter for us, and the current slowdown appears sequential. Our press release mentions that the issue is not about activity levels, but rather about the timing of revenue recognition for individual transactions. Referring to expenses, specifically on Page 5 of the press release, we see that costs related to communication and information processing were lower than our previous guidance. We anticipate these will trend upward on a quarterly basis for the remainder of the year, maintaining our guidance of high 80s million per quarter. This past quarter, the lower numbers were affected by the timing of the implementation of new systems, and we still believe the high 80s is a reasonable figure for modeling. Another expense that exceeded expectations was business development, influenced by the timing of our advertising flights and seasonal recruiting activities around the holidays. Additionally, we had no major conferences this quarter compared to others. We continue to estimate the business development expense will range from high 30s to $40 million per quarter, despite this quarter being lower than that estimate. Another expense that came in under projections was the bank loan loss provision. We experienced nearly $700 million in net loan growth this quarter. With our reserve just over 1%, one might expect a loan loss provision of about $7 million. However, that did not occur because we received payoffs on 5 or 6 criticized loans during the quarter, which helped to release a significant amount of reserves. You can observe this reflected in the decline of criticized loans and assets. I believe modeling net loan growth at 1% remains a reasonable approach. The topic of income taxes is significant. The consensus model we had was before any adjustments, and we communicated in an 8-K on January 11 how it would apply to us for the year using a blended federal statutory rate of 24.5%. Our actual effective rate for the quarter was adjusted to 24.1%, which is relatively low. While the federal rate is 24.5%, additional state taxes apply. I would estimate that 28% is the appropriate blended rate for the remainder of this fiscal year. The lower rate this quarter was primarily due to our ongoing COLI gains observed over the past year. Furthermore, in our first fiscal quarter, we benefit from equity compensation, which, although less favorable than when rates were at 35%, will still contribute about $10 million in the December quarter. As for a one-time charge we previously estimated at $120 million, the current estimate is $117 million, depending on when certain deferred items are realized. This year, these would be realized at a higher rate compared to next fiscal year, when we anticipate being at a 21% federal statutory rate. The revised estimate of $117 million includes just over $100 million associated with revaluating our deferred tax asset, particularly regarding deferred compensation and the bank loan loss provision, with minor contributions from legal provisions and foreign repatriation from our Canadian subsidiary. For modeling purposes this year, I would estimate 28%, and for next fiscal year going forward, a blended rate of around 25% would be prudent, adjusted for factors such as COLI and other potential circumstances. A few additional points: you may notice on the P&L that we no longer have a line item for clearance and floor brokerage. This was a minor figure, not necessarily required in our broker-dealer financials, so we have combined it into other line items. Investment advisory fees, as Paul mentioned regarding the Scout, Reams acquisition that closed in mid-November, contributed around $9 million to investment advisory revenues for the December quarter. You might project around $18 million a quarter from that based on current asset levels, which may have a slight dilutive effect on the asset management segment margin, but not significantly. This aligns with our earlier guidance of $70 million to $75 million annually related to that transaction. We also achieved a record net interest income of $192 million for the quarter, with the deposit beta receiving significant attention. It is important to clarify that our discussion about deposit beta pertains to about $24 billion of the $44 billion mentioned by Paul. Additionally, $2 billion is in various money market funds, with the remainder swept to Raymond James Bank, which reflects separately in the bank's net interest margin. We are primarily discussing direct earnings on the $24 billion, part of which comprises service fees from external banks that we have discussed before, impacting the P&L. Since the December rate hike, we have raised rates for clients twice, resulting in a weighted average increase of just under 10 basis points. This has consequently increased our retained spread to around 130 basis points on that $24 billion. Our competitors are making frequent but minor rate adjustments. Without any further hikes in March or June, I predict some compressions may occur. However, if additional hikes do occur, we may benefit from a lag effect, maintaining our rate. For the time being, we are enjoying a historically high but potentially unsustainable spread on these cash balances. The RJ Bank net interest margin computation has been clarified in the press release on Page 9, addressing frequent inquiries about this metric. Both a slight increase in client rates and higher average cash balances due to preparation for loan growth and securities portfolio expansion contributed to this. Additionally, the revaluation of the taxable equivalent yield for the tax-exempt portfolio was a significant factor affecting NIM. This is clearly presented in the table. The comp ratio for the quarter was 66.8%, slightly better than our 67% target, yet worse than the previous quarter. This was primarily driven by the embedded compensation in Capital Markets, which lacked revenue production this quarter and consequently had a higher comp ratio, thereby impacting the overall firm. If Capital Markets sees normal activity, we expect a reduction back to the low 66s, like in the prior quarter. In previous quarters, we mentioned making grid adjustments to the Private Client Group, but their benefit was negligible this quarter. Since we began implementing this adjustment several quarters ago, there has been bracket creep for many productive employees, mainly due to strong market performance, which diminished the expected benefits from the adjustment. Therefore, while we did not see a direct enhancement in the ratio, it could have been worse without the change. On Page 8 of the press release, Paul highlighted an ROE of 16.8%, the highest I've seen in a long time, with an adjusted pretax margin of 18.3%. Both metrics benefited from interest rate spreads and, in the case of ROE, from the tax rate. We will refine our targets in this area now that the Tax Act has been enacted and will provide updates afterward regarding its impact on our business segments, including tax credit bonds and municipal bonds affecting tax-exempt lending at the bank. It's important to note that the capital ratios have modestly declined at both the holding company and bank due to our asset growth of over $1.2 billion this quarter without matching capital growth because of the discrete tax charge previously mentioned. Looking ahead, I don't expect this trend to continue, especially with a lower tax rate. Lastly, I want to draw attention to the footnote regarding the increase in financial advisers. Last year, we adjusted our adviser counts, reducing them by about 100 from predominantly non-producing roles. This quarter, we reversed that with adjustments for another division, adding back advisers who met specific production criteria. We aim to present a realistic number of full-time producing advisers rather than inflating the figures. This quarter saw decent recruiting, although the employee side experienced above-average retirements and transitions, resulting in flat numbers. On the contractor side, however, we had a strong recruiting quarter with about 70 new advisers. Lastly, our recurring revenue percentage for the quarter reached an all-time high of 73.9%, thanks in part to lower investment banking revenues. This means a significant portion of our total revenues comes from recurring sources. I will now turn it back to Paul for his outlook comments.

Thank you, Jeff. The overall market and business confidence is currently high. It's uncertain how long this will last, as various factors may influence it, including government stability and global issues. However, the outlook is positive. We have several favorable factors entering the quarter, and our main drivers are reaching record levels. Adviser and advisory recruitment remain strong. Our assets under administration and under management are expected to lead to increased billings for the quarter. We anticipate continued growth in bank loans, albeit at a more moderate pace. The recent interest rate changes should benefit us in the upcoming quarter, and we will see how things develop thereafter. Regarding the Tax Act, its impact on our company philosophy is minimal and shouldn't come as a surprise to those familiar with Raymond James. Our primary focus continues to be on our clients, advisers, associates, and shareholders. Our strategy remains centered on organic growth and disciplined acquisitions. We are still on the lookout for acquisitions that align with our culture at a reasonable price, and we don't believe the Tax Act alters this approach. Our dividend payout ratio has consistently remained in the 25% to 30% range. The board will review this as we look to the future, but our payout has been stable for many years. Share repurchases have been made selectively when beneficial for the company, and this act is unlikely to change our approach. If we find ourselves unable to effectively deploy capital, we will consider alternative ways to return it, but so far, we believe we can continue on our current path. This long-standing philosophy has been key to our performance, and we see no reason to alter our operational foundation. We haven't announced any significant changes for associates, and we typically look at what other firms have done regarding minimum wage. Most employees received over a 7% increase, and we have established deferred programs for them this year. Last year, we also provided bonuses, especially to those affected in the aftermath of Irma. We will continue to assess our benefit plans based on associate feedback, aiming to ensure fairness without making hasty changes due to new legislation. A noticeable shift we are beginning to observe is in the regulatory tone. We are aware of the DOL delays, and the SEC is collaborating with the DOL and FINRA to develop a more holistic standard aimed at preserving client and adviser choices. It appears that the more stringent aspects of the DOL regulations may not be implemented, with the SEC indicating this is a priority. Regulatory attitudes have softened, shifting towards a more balanced and cost-effective approach. Although it may take time for these changes to filter through the system, we have not seen the recent influx of new regulations that characterized the previous administration. An area of bipartisan support has been the proposal to lift the $50 billion threshold, which would be advantageous for us as we approach it. There has been considerable discussion in the industry regarding the broker protocol, with some firms opting out. However, Raymond James remains a staunch supporter of the broker protocol. We value the adviser-client relationship and believe we should not interfere in that dynamic. This commitment encourages us to enhance our platform, as we focus on being the best option for advisers and their clients. We believe clients have the right to choose their adviser and platform, and it's not our role to disrupt that choice. Therefore, we maintain our strong support for the broker protocol. In closing, the outlook for our Private Client Group is positive, driven by strong adviser growth and a robust pipeline, along with increased fee billings expected in the upcoming quarter. Cash spreads continue to benefit the Private Client Group, and barring major changes, we anticipate a positive uplift in this segment. The same favorable factors are influencing asset management, now bolstered by the addition of Scout and Reams on our platform for a full quarter, with record assets under management expected to benefit performance. Regarding RJ Bank, we foresee disciplined growth. This quarter showcased an unusually high growth rate due to factors like tax-exempt loans as many sought to refinance before tax law changes. While this growth was above average, we intend to uphold our established model and continue pursuing good loans with robust returns. Capital Markets may still experience challenges with institutional commissions, both in equities and fixed income. However, the M&A and equity underwriting sectors appear promising, with a solid backlog anticipated. Thus, we have no reason to adjust our previous guidance for the year. In the near term, public finance, particularly the tax credit business, might face some hurdles before recovery as markets adjust. The balance of supply and demand for tax credits could impact profitability, but we expect these issues to resolve over time, possibly taking another quarter. Overall, we remain optimistic about our long-term outlook. Jeff mentioned our expense ratios, and our guidance on expenses remains unchanged. The compensation ratio was slightly elevated because M&A was down, which affects our compensation payouts. However, we are confident in our position. While we appreciate the current positive market conditions, we are committed to remaining disciplined, understanding that markets can fluctuate. We will take full advantage of this environment while preparing for potential downturns. Now, I'll turn it over to Tamara for questions.

Maybe to start off, I want to delve deeper into the comments about tax reform and its benefits. It seems like capital is building, and the philosophy remains consistent. The first part of my question is whether you believe this has advanced M&A efforts, which are clearly a priority. Do you think that some elements are now moving closer due to this uncertainty or any other factors? The second part relates to spending. Are you focusing more on any specific projects or technology investments? I'm trying to understand how you plan to allocate some of that spend. Lastly, regarding competition, it appears there's no clear area where the benefits could be eroded. Perhaps lending could be one, but I'm curious if there's anything I might be overlooking in your business.

Yes, Devin, it's important to note that just because we have more capital, we don't feel pressured to spend it. We are consistently evaluating acquisition opportunities through our corporate development team. The acquisitions we've made recently need more time to demonstrate their worth, but we believe they were strategically and culturally aligned. We will continue to search for more opportunities. Having more capital doesn't fundamentally alter our approach; it allows us to consider larger deals, but our strategies remain the same. Our technology investments are strong, and we continually have new ideas for spending in this area. However, our guidance for this year reflects what we can manage effectively. If there are any overspending instances, they may involve consulting services or similar support. We've established a solid technology agenda, and our provided guidance is reliable. Even with lower tax rates, we believe it's essential to maintain the business's core principles. In the coming year or two, as we accumulate capital, we will consider how to best return value to shareholders. Currently, our capital ratios are slightly improving and remaining consistent, and we've identified opportunities for investment to enhance our platform and operations. If we find ourselves unable to do so, we'll develop alternative plans, but I don't anticipate any immediate changes.

And then areas that things might be accounted for differently or some of the benefits could diminish over time?

No, there's discussion about how lending will eventually benefit clients, but I don't think we see that happening just yet. Just as interest rates weren't fully passed on to clients in the industry, we were among the first to increase rates, and others didn't follow suit. Now we find ourselves in the middle or upper middle of the pack. However, I don't observe any urgency regarding loans or any part of our business to give away benefits. We always consider how our employees are treated, and while we have made some adjustments, these will primarily focus on ensuring fairness in compensation to ensure we treat our staff well, which we consistently strive to do. I don't see any significant changes from our management team. We recently held an off-site meeting, and nothing stands out that would lead us to believe we should alter our approach due to any newfound resources at this time.

Got it, okay. And then with respect to the broker protocol, I think Raymond James is pretty clear in its position here. But obviously, the status of the actual protocol seems like it's a little bit fluid here in the firms that are in and/or out of it. And so I'm just curious, now that several or even a few kind of large firms have now backed away, is your appetite to recruit from those firms lower? I know that there's obviously been over time firms that are not in it and you still recruit from them. So I'm just curious kind of does that create more complexity in recruiting at all? Do you still feel confident in kind of playbook to recruit from firms that are not in the protocol?

Yes. I think that there's a number of firms that we recruit from are non-protocol and we just make sure we follow and the advisers are instructed and taught that they have to follow the letter of the rule. And as long as they do that, they're still free to move and their clients can follow them, subject to whatever contracts they have and following protocol. So I think we're just very clear on those folks what it takes to come over, and we've been doing it for years. We disagree that, I think, protocol was really raised by the industry given regulatory concerns on clients have the right to choose their adviser and know where their advisers are going. And I think it's a fundamental right of investors. So we'll see where that develops out and if regulators take a stand on it or not. But we just think it's the right thing to do.

Okay, great. And then just last year, tax credits and debt underwriting, I mean, do you have any sense of how long it could take the markets to adjust tax reform? Do you think it's purely timing or maybe more so for the tax credits business? Do you think it drives a structural change to that market and then trying to think about some of the other inputs, infrastructure if we do kind of move a plan forward here without actually being a catalyst for the debt underwriting side? I'm just trying to think about some of the moving parts.

Yes, I believe there will be a slight change in volume in public finance due to the unavailability of certain elements. However, I don't think this change will be substantial. We have already experienced a slowdown in the tax credit business since discussions about reform began, with uncertainty surrounding the new rate preventing speculation. There is a disconnect between what project developers expect and what banks are willing to accept regarding risk. Now that the rate is established, there will be adjustments to the economics, which may impact our margins and lead to a repricing. As long as there is a need for CRA, these investments were made not based on competition but for CRA purposes and reasonable returns. I expect that as the rates are understood and we move past this period, the business should perform well under the existing regulations.

The first one, I just wanted to zero in on expenses quickly and see if there were any meaningful amount of expenses, whether in comp or some other expense lines that might have essentially been pulled forward into the fourth quarter with the tax reform and that you might not expect to recur.

Yes, there was nothing we did in that regard. Our effective tax rate applies to the entire fiscal year. By the time the law was passed, we were already in a lower rate environment, so we didn’t have the same opportunities as other companies that operate on a calendar year. With expenses as they were, we had no reason to make any adjustments. The rate will remain the same in March or June as it was in the December quarter.

Okay, that makes sense. I have another quick question about MiFID. Now that we are a few weeks into 2018, could you provide an updated perspective on the discussions you are having with clients regarding MiFID II? Also, what do you anticipate the year-over-year impact on the equities business might be?

So I'm not sure we're prepared to really talk about what the impact will be. Certainly, the discussions are there. And certainly, as we've always said, it's not going to be a positive, right? So it's any time you're negotiating and you have something like MiFID, it's a reason to drop what you pay people. So I think it's early. As an overall part of our business, Raymond James as a whole, it's not that big. But certainly, it's not going to be a positive impact. But it's too early to tell you what that's going to be right now.

Okay, understood. Last thing's on CRE. Just looking at the yield decline in the CRE portfolio, was that driven by new loans and a reflection of where the market is today? Or was that decline more from repayment of old loans or roll-off of higher-yielding stuff?

Yes, Ann, it's Steve Raney. Yes, it's kind of the normal flow. I would say, there's been maybe more pressure in commercial real estate in terms of spreads that the market is demanding now. And as you know, we have a lot of clients that are REITs that tend to be lower price than the project finance loans and our loan growth in REITs was a little bit higher in the quarter. So it was repayments of prior loans. Jeff cited that we had a couple of criticized loans that were in the commercial real estate category that paid off in full and then replaced with new loans at lower spreads.

So was hoping to dig in a little bit more and early clarify some of the tax guidance on the 25%. And Jeff, I know that the 21% federal rate, the state and local has run on average on an adjusted basis for the lower deduction about 3% to 4%. So it tells us that you're essentially assuming no benefit from additional tax credits, which is since a lot of the benefits appear to have been preserved even with the change in the tax law, whether it's things such as low-income housing credits, I'm just wondering what level of future credits do you think would be reasonable to assume going forward and to what extent is that contemplated in your tax guidance.

Yes, we have factors that can influence the rate in both directions. As I mentioned, we benefit from the equity compensation provision in the December quarter each year, which will affect that rate. The COLI can also fluctuate depending on the equity markets. The new law has both positive and negative aspects; for instance, there are some clawbacks related to the lower rate, and we are losing some deductions for meals and entertainment. Next fiscal year, not this year, we will see an impact from executive compensation going forward. Additionally, since our bank exceeds $10 billion, we will face a phaseout of some FDIC premium deductibility. Thus, the situation is more complex than just changing the rate. We are also uncertain about market trends concerning COLI, but we feel we have a good grasp on the other elements. The guidance I’m providing on the weighted average statutory rate takes these factors into account. The greatest variability will come from our COLI portfolio, which is about $300 million, and its performance each quarter. Generally, if the markets remain relatively stable, the impact shouldn't be significant. All these considerations help us estimate the rate for modeling in the future.

Great. It's extremely helpful. I had a follow-up just relating to some of the discussion around capital management priorities. As I think back to, it was 1Q '16, when your stock was trading at north of a 20% discount to the market. You guys got pretty aggressive and actually bought back shares. I know it's a very different environment then. But just looking at the improvement in your earnings profile, you're actually trading on a tax-adjusted basis, just taking your new guidance at an even higher discount today. And I'm wondering, what valuation levels are your guys looking at when considering the potential for additional share repurchase? I'm just trying to understand some of the dynamics given the pace of capital build that we're expected to see, what we should be expecting and the bank growth targets you've already outlined, whether you guys might have more appetite to actually initiate a share repurchase program.

So once again, I think the discounts you're referring to are related to the S&P, not the financials. We view share repurchases as opportunistic and based on where we can earn a return, rather than as a way to manage capital or a short-term strategy to utilize earnings. Everything we do is focused on the long term. We recognize the new rules have been implemented and understand their implications. If the markets don't change, we can't assume they will continue to be favorable and generate extra profits. We will assess our position as we move forward, including our growth and acquisition opportunities. If we find ways to effectively use the capital, we will, but otherwise, we will consider other options. We are not in a hurry to make changes, and our strategy remains unchanged, although we may have slightly more capital to work with now. The speculation that we will buy shares simply because we have more capital does not align with our long-standing philosophy. We've faced pressure to repurchase shares in the past and were praised for our choices when we waited, but now there is criticism for not acting quickly. We will maintain our philosophy, as we believe our long-term growth and outperformance stem from this approach, rather than focusing on immediate short-term gains. You will see the same behavior from us as we continue to navigate the situation.

And just one final one from me on the deposit beta commentary. I'm just trying to parse it a bit since I know you guys have tended to be fairly conservative in terms of some of the guidance that you've given. I mean, it looks like the messaging, though, from your peers has suggested that the positive beta from here should track more in line with historical levels. They've cited somewhere in the range of 50% to 60%. It felt like with some of the remarks, that essentially the competitive dynamics are really going to dictate or anchor what you guys do on the deposit side. Not necessarily relying on what we've seen historically in the last rate cycle. I mean, is that a fair reasonable expectation? So long as competitors are running within that range, that you guys aren't going to deviate materially from that?

We have two main principles. First, we are committed to being competitive and fair to our clients. Currently, there's a belief that demand for cash may eventually rise, leading to more competitive rates. It's uncertain when this might happen, and while the difference between client deposits and alternatives is widening, interest rate markets will also become competitive. It's speculative to assume we will simply give away half of any future increases. Historically, when rates were much higher, competition was intense. Therefore, we are taking a cautious approach in our guidance. We don't know what the future holds, and we're not in a rush to be the highest payer. We are being thoughtful and competitive but also want to maintain fairness.

We may have to go back a bit in time to answer this question. But wonder if you guys could help us understand what the environment was like for adviser recruiting prior to the broker protocol. And I think getting that perspective would help us try to gauge what things might look like if protocol were to dissolve for some reason.

That's a good question. The environment has changed significantly over time, and our firm has evolved as well. Given our current size and scale, we attract individuals leaving larger firms more than we did in the past. While we did recruit back then, it was not to the extent we do now. The market is fundamentally different today. It's challenging to draw direct comparisons. We can examine our recruitment efforts from non-protocol firms now, and it appears that this has not created any obstacles. I'm not sure I would be inclined to consider our approach in a different context. This is an interesting topic that warrants further discussion, as the times have changed, our firm has changed, and the market has changed as well. There were 60 firms that took us public, and only eight remain, none of which are in the Private Client Group business. The market is dynamic. While I don't have a definitive answer at the moment, I can say our recruitment pipeline looks very promising.

Got you, okay. And then another sort of related question I was wondering about, firms that make the decision to get out of protocol restrict adviser and client movement. Do you think that ultimately might be able to be challenged under fiduciary standards?

I believe we have raised the issue and recognized that regulators are examining it. Clients have a fundamental right to know where their adviser is and to choose their advisers, whether they decide to leave us or join us. Regulators were considering this when the industry introduced the protocol. We are certainly advocating for this matter to be addressed. It's important to clarify what clients' rights are. I find it hard to believe that clients wouldn't want to know where their adviser goes or feel they should have the right to choose. It’s a fundamental right for investors. We'll see how this unfolds and whether regulators take a position on it, but we believe it's the right thing to do.

A couple of tactical questions, a lot of the big picture questions already asked. As you think about the interplay on the business for the NIM, just wondering if could give us sort of an update on how you sort of think the NIM plays out over the next couple of quarters as you potentially redeploy some of the pickup of cash you may have gotten from the strong growth in the business.

I believe the net interest margin will return to the range of 3.10% to 3.20% that we previously indicated, assuming no significant changes. We'll benefit from a full quarter reflecting the rate hike in December, which will positively impact the bank. As for the Tax Act, I haven't observed any specific impact on loan rates at this time, but perhaps Steve can provide additional insights.

Yes. Bill, we haven't noticed anything yet. Obviously, it's still early days in terms of spread compression that I would attribute to that. I mean, we've seen credit spreads obviously come in quite a bit over the last couple of years, so just given a lot of demand for loans, but I would not attribute any changes here recently to any of the tax law changes nor is our strategy changing in terms of the types of credits that we're going to pursue nor do we expect to have a lot higher average cash balance than we had this past quarter, nor do we expect to expand the securities portfolio aggressively in the face of rate hikes. So those won't be factors that drag on it particularly going forward either.

Okay. I want to revisit capital management. With the tax reform, it seems like the company's return on equity will improve even if the markets stabilize from past growth. It's clear that you're going to accumulate a significant amount of capital. Are there spending decisions that you have been postponing that might increase? Your prepared comments didn't suggest anything about technology. I'm trying to understand the relationship between capital generation and the company's returns.

I believe that if the markets perform well, we have a chance to generate capital. We will consider strategic acquisitions, but right now, our primary use of capital is likely for recruitment, which has significantly impacted our metrics. We expect this trend to continue, and we are not currently considering any external opportunities. Our technology spending is quite substantial, and we have various initiatives underway. However, due to limitations in capacity and the interdependence of our systems, I’m unsure how much we can accelerate this process. While we have available funds, I don't think it's wise to spend them just for the sake of it, as this could negatively impact our return on equity. We need to ensure that any spending is beneficial and, at this moment, I don’t see any particular area where we could effectively utilize additional funds outside of earnings. If we identify a good opportunity, we will act on it, but none are evident to me right now.

Just wanted to ask on the cash buildup in the bank, just a little sense around how quickly you think you can get the extra $350 million deployed. And if you just comment on what type of reinvestment yields you're seeing in your securities portfolio today.

We can manage the growth easily with the securities portfolio. That could certainly support our growth for about a quarter. We don't have a specific target. We're just trying to keep up with the growth in our loan activity. As Paul mentioned, this was an unusually high growth quarter. I wouldn't suggest annualizing the loan growth for this specific quarter.

I would say low double digits. A target of 10% to 12% would be great for us over the next 12 months. In terms of the yields we're looking at in the securities portfolio right now, they're around the 2.75% range. We plan to keep our duration relatively short on the securities.

Yes. The reason it didn't grow much last quarter is that we are maintaining a short position. There are significant pay-downs in the portfolio every quarter. Consequently, on a net basis, it might be a bit challenging, especially if we reduce our buying slightly while facing increasing interest rates.

As a reminder, everything we're doing is agency-backed. No credit risk in the securities portfolio.

And the average life is generally a little over three years.

And Paul, appreciate your commentary around no obvious sources for tax reform to get computed away. But what about your appetite for growth or recruiting? Like most businesses, you obviously think about decisions when you're hiring somebody partly on an after-tax return basis or earn-back basis. It just seems like mathematically, at least, a lower tax rate should increase your upside for growth or at least what you're willing to pay the recruited advisers. Do you think that flows through at all?

Our pipeline is very strong. Like anything else, we can drive growth but also make poor decisions. We're focused on return on equity. As an investor, I would prefer a higher return rather than seeing money spent unnecessarily. We plan to concentrate on areas that provide good returns. Most advisers are compensated based on their previous 12 months, so we need to consider market conditions. Will the market continue to grow robustly over the next seven years while we recover that return? We can increase our offers and create models to demonstrate that it’s a valuable investment. However, because we intentionally do not offer the highest transition assistance, we may lose some individuals, but this helps us attract those who truly want to align with our values. We believe our compensation is fair and, although it lags behind many competitors, we are experiencing growth. We see no reason for a fundamental change. If return goes up slightly due to transition assistance, we won't automatically raise it just because of that. Any increase will be because we consider it a sound investment and necessary for competitiveness. We are not looking to squander savings, but we are open to investing when we identify strong opportunities.

That's helpful. And then, sorry, just one last one for me. Total capital this quarter was 23.4% versus kind of the 20% target. If I'm interpreting your commentary around the call, we should just think about that as 20% being the target, but when times are good, you're perfectly happy running with excess for some unspecified period of time?

I believe that part of our consistent returns and stability over 120 quarters is due to maintaining higher capital levels. We are often compared to banks, but our capital model differs significantly from theirs. Capital does not directly translate to cash, and our cash business is much more volatile, requiring reserves for challenging periods. We are comfortable operating in the high teens. While we have a conservative target, we could also be in the high teens if suitable investment opportunities arise. However, we won’t take on more debt just for the sake of it; we will wait for long-term opportunities that align with our strategy. We're not in a hurry. It’s also important to note that excess capital does not benefit our balance sheet. People tend to forget that the executive team is also evaluated based on performance. Part of our bonuses is tied to equity and an ROE-adjusted return where we focus on profitability. While we could pursue actions to boost ROE, we prefer to act in the firm’s best interest and maintain the right balance. In prosperous times, we often get asked when we will buy back shares, but we see no reason to alter our long-term perspective, which has been successful. We will consider acquisitions and investments that make sense when the opportunities arise, but we won't make changes based on short-term events. We will remain cautious and will assess how the markets develop. If we find ourselves with surplus cash, we will take appropriate action, but we aren't prepared to declare a shift in our approach at this time.

Right. Well, thank you. Again, I feel very good about our quarter, our positioning and our markets. Certainly, the Tax Act and changes, you've asked a lot of questions on it. We're digesting it too, but we're going to do it very thoughtfully, and like I think we've always done is invest long-term for shareholders. And certainly, the markets look very constructive in the future, but we also get concerned when comments overall get pretty euphoric because that's usually when some bad things could happen in the market. So we don't take our eye off the ball what happens if markets go down. It's great they're expanding. We hope they do for a long time for our clients and for us. But we're going to keep to take a balanced view and just do the best we can to manage the business. So appreciate your time this morning, and look forward to talking to you next quarter.