Raymond James Financial Inc (RJF) — Q4 2019 Earnings Call Transcript

Great. Thanks, Kristie. Good morning, everyone. Today marks the 90th anniversary of Black Thursday, the beginning of the Great Depression. It's amazing if we look back and look at the development of the financial markets and the resiliency of the U.S. economy over that period of time. Today, you're also going to be witnessing another momentous event, as the longest-serving CFO in the S&P 500 is going to have its last official quarterly earnings call. So after I talk about our results for the fourth quarter and the fiscal year, I'll turn it over to our legendary CFO to provide more details on the financials, before I discuss the outlook and open it up for questions. First, I'm going to remind you of the backdrop going into this fiscal year. We came off a record year in 2018, and almost all measures were very, very strong. We entered the year thinking interest rates would be on their way up, which gave us stress tests that rates would go up into the future, and we thought the markets could be challenging. They were, in the first quarter, as rates rose, and it was a very soft, tough quarter. Interest rates went up, which drove a lot of momentum, then interest rates came down and the market went down, but the market went up. We had tariffs on. We had tariffs off. We had increased competition both in the recruiting market and transition assistance, and through that, we really delivered another record year. Overall, I'm pleased with our results in the fiscal fourth quarter and the fiscal year. Business metrics were strong, and I'm encouraged by the solid performance in a number of key areas during the quarter, which included record quarterly net revenue of $2.02 billion. We crossed the $2 billion mark for the first time, which increased 70% over prior year's fiscal quarter and increased 5% over the preceding quarter. Revenue growth this quarter was driven largely by higher Private Client Group assets and fee-based accounts, strong quarterly assessment banking revenues, and a solid performance for both our fixed income capital markets business and tax credit fund business. We generated record quarterly earnings per diluted share of $1.86 or $2 on a non-GAAP adjusted basis for the $19 million goodwill impairment associated with our Canadian capital markets business. Despite this impairment, which was due to challenging market environments in Canada, we remain fully committed to growing our capital markets business in Canada, thanks to our strong financial advisor retention and recruiting results. We ended the fiscal year with records for client assets under administration of $838.3 billion, Private Client Group fee-based assets under administration of $409.1 billion, total Private Client Group financial advisors of 8,011, and net loans of Raymond James Bank at $20.9 billion. All key fundamental drivers of our business. Annualized return on total equity for the quarter was 16.2% or 17.3% on a non-GAAP basis, adjusted for the aforementioned goodwill impairment. While it isn't a metric that we’ve historically used, starting in the first quarter of fiscal 2020, we'll begin reporting the return on tangible common equity, ROTCE, whether we agree with the metric or not, even though we don't have preferred equity, but it seems that all other financial companies are now reporting that metric as well. If you look at what we discussed at our Analyst and Investor Day in June, adjusted return on tangible equity on an annualized basis at that time was about 180 basis points higher than our adjusted return on equity, which should be in the range of what the impact would be this quarter as well. During the fiscal year, we had record net revenue of $7.74 billion, increased by 6%, net income of $103 billion, increasing by 21%, and adjusted net income of $1.07 billion, which increased by 11% over fiscal 2018. Earnings per diluted share of $17.17 increased by 25%, and adjusted earnings per diluted share of $7.40 increased by 14% over fiscal 2018. Notably and really an accomplishment, all four of our core business segments generated record net revenues, and three of the four generated record pretax income during the fiscal year. If you adjust for the non-GAAP items during the year, the Capital Markets segments would have also generated an annual pretax income record, so really a strong performance across all four of our core businesses. The return on equity for the year was 16.2% or 16.7% on an adjusted basis, which is near the top of our range between 16% and 17%, and a really fantastic result given the tough start to the fiscal year and our very strong capital position. Speaking to capital, we were active in deploying capital this year, repurchasing 9.83 million shares for $752 million at an average price of $76.50 per share. This represents just over 6.5% of the shares outstanding at the beginning of the year and combined with dividends, we returned approximately $945 million to shareholders during the fiscal year. Even with these actions, our capital ratios remain healthy with a total capital ratio of 25.8% and a Tier 1 leverage ratio of 15.7% at the end of the year, giving us ample flexibility for the future. Now let me briefly describe the segment results. In the Private Client Group, we generated record net revenue of $1.38 billion for the quarter and $5.36 billion for the fiscal year. We had another fantastic year of retaining and recruiting advisors. On a net basis, we added nearly 200 advisors during the fiscal year, which includes those advisers recruited and those lost due to retirements. On a gross recruited basis, our Private Client Group domestic had its second-best year just behind 2018, with advisors joining the fiscal year with nearly $300 million of trailing 12 production and $43.5 billion of assets under administration at the prior firms. This is an excellent result, especially given the slow start to the year and the increasing competitive environment. While many firms increased their transition assistance and bet on cash balances at the beginning of the year, we remained disciplined and still had an outstanding recruiting year. While higher short-term net interest rates and cash spreads were a tailwind throughout most of the fiscal year, that benefit was partially offset by a decline in total clients' domestic cash sweep balances during the fiscal year, as clients increased their allocations to other investments. As you know, the two rate cuts in our fourth quarter will likely be a significant headwind that will work through during fiscal 2020, which Jeff will explain in more detail. Capital Markets finished the fiscal year with a strong fourth quarter, given investment banking results and strong quarters for fixed income capital markets and the tax credit business, which offset the continued weakness in equity brokerage revenue. The segment finished the year with record net revenues of $1.8 billion, up 12% from fiscal 2018. The segment's pretax income of $110 million was up 21% over fiscal 2018, despite a $19 million goodwill impairment in the fourth quarter and a $15 million loss associated with the sale related to our research sales and trading of European equities in the first quarter. As I’ve said, we remain committed to the Canadian Capital Markets business and continue making long-term investments to expand our banking and sales and trading capabilities in Canada. Last year, we operated in a very small portion of the Canadian life sciences space and chose not to participate in the underwriting of cannabis firms. Whereas the underwriting space for cannabis was very strong, it was the most significant part of the market last year, the subsequent market performance has been weak as the associated market index is down close to 40% over the last six months. Once again, we maintained a long-term view in our decision-making process. In the Asset Management segment, we generated record net revenues and pretax income for both the fourth quarter and fiscal year. Financial assets under management at the end of the fiscal year were $143.1 billion, an increase of 2% over September 2018 and flat compared to June 2019. Overall, the growth in financial assets under management continues to be largely driven by equity market appreciation and positive inflows associated with the increased utilization of fee-based accounts in the Private Client Group segment, which has more than offset the outflows experienced by Carillon Tower Advisers given the extremely challenging market environment for actively managed products. Last but certainly not least, Raymond James Bank generated record net revenues and pretax income for the fiscal year. Record net loans of $20.9 billion grew 7% over last year's September. The growth of loans continues to be focused heavily on residential mortgages and security-based loans, so the Private Client Group as well as commercial and industrial sectors. While the bank's net interest margin for the fiscal year was 3.32%, this improved by 10 basis points from fiscal 2018, lower short-term interest rates including the two rate cuts during the quarter, caused net interest margin to decline during the quarter. Most importantly, the credit quality of the loan portfolio remains solid, and we remained extremely diligent with any new loans we add to our balance sheet. Overall, I believe we had a very strong quarter and fiscal year. Now I'll turn it over to Jeff to provide some more color on the financial results and then I will provide some more comments on the outlook. Jeff?

Thanks, Paul. Most of the revenue trends this quarter are clear or have already been discussed by Paul, so I will keep my comments on that part of the P&L brief. I want to address asset management and related admin fees, which are up 5% sequentially, aligning with the consensus model, so this is not unexpected. I mention it because it correlates directly with the 5% increase in fee-based assets from the previous quarter. It's nice to see this consistency, as it's our largest revenue item. The 3% growth in fee-based assets in the last quarter should serve as an indicator for this line item in December since a large portion of these accounts have already been billed in advance. The investment banking line slightly exceeded the consensus model, with both M&A and fixed income investment banking contributing to the quarter. Further down the page, other revenues surpassed expectations in our current revenue format, which includes the tax credit fund revenues that demonstrated a strong September quarter, similar to last year. You can find more details on Page 12. Now, regarding expenses, let's discuss compensation. We experienced a higher absolute number than consensus, which is expected because of increased compensable revenues, particularly in investment banking and the tax credit fund area. However, the compensation ratio for the quarter was 65.2%, better than anticipated and below our 66.5% target. In the short term, we do not plan to adjust this target. As revenues from client cash sweep balances decline, a larger portion of our revenues will be compensable, which may squeeze margins. Additionally, our successful recruiting efforts, which have led to near-record levels over the past two years, will impact us in the short term due to the amortization of hiring costs. The 2020 budgeting process is still undergoing adjustments, and we are examining controllable expenses closely given potential headwinds. We expect to provide better guidance on these items next quarter. In terms of non-compensation expenses, the significant sequential increase of 13% includes a $19 million goodwill impairment charge. There was a small rise in occupancy and equipment costs due to various factors, including recurring rental increases. We are currently paying double rent on our office space in Memphis as we transition from downtown to East Memphis. Additionally, we are incurring extra equipment amortization costs. I'd also like to mention the bank's loan loss provision. Although it met consensus, it was a turnaround from the previous quarter's credit. The high provision was driven by several downgrades during the quarter, following the semiannual SNC exam results in September, which led to three downgrades of substantial credits that contributed to an $88 million increase in criticized loans. This situation doesn't point to wider credit issues; it's simply our policy to maintain our ratings when credits are downgraded. Also noteworthy is the simplification of our reporting, as we have combined the non-controlling interest line into other expenses to streamline our disclosure, as it has become an immaterial line item. Now let's shift to net interest. Overall, net interest performed solidly after the Fed's rate cut in July. RJ Bank’s net interest margin fell 7 basis points from 3.37% to 3.30%, mostly due to the rate cut in July leading to spread compression. RJ Bank's earning assets experienced a decline of 19 basis points in yield, while the cost of funds decreased only 13 basis points, resulting in this compression. However, the loan growth for the quarter helped boost net interest earnings quarter-over-quarter. The July rate cut, which influenced two-thirds of this quarter, saw a deposit beta of about 55%. Looking ahead, the deposit beta from any additional rate cuts might be significantly lower, affecting our future results. It’s also important to remember that the bank's loan portfolio is linked to LIBOR, which doesn’t always align with Fed funds movements. Consequently, predicting net interest margin can be challenging. Our estimates suggest that future rate cuts may negatively impact the bank’s net interest margin by about 8 to 10 basis points. Regarding client cash sweep balances, they have stabilized in the $37 billion to $38 billion range. A change of one basis point in spread will affect us by approximately $3.8 million annually. Most of this will show up in accounting service fee revenues instead of interest earnings, as previously mentioned. The strategy moving forward regarding client cash sweep balances will depend on market competition. We continuously strive to remain competitive within peer groups, which include a variety of firms. Finally, examining our annual results, there was a 6% increase in net revenues, with a comp ratio of 65.7%, which is pleasing as it is below our target. Non-comp expense growth was 9%, influenced by non-GAAP adjusted items in our schedules and some accounting gross-ups due to revenue recognition changes earlier in the year. For a clearer comparison of operating results, I encourage you to refer to the annual non-GAAP results on Page 5, which show a pre-tax increase of 7% and a non-GAAP net income rise of 11%. The diluted EPS increased even more at 14%, reflecting the share buybacks conducted throughout the year. Overall, it has been a strong quarter and a successful year. I’ll now hand it back to Paul.

Great. Thanks, Jeff. I appreciate your comments and the insights you've provided over the years. Tom and I, and Jeff isn’t really going anywhere; he gets to keep the CFO role, but we’ll have his services at least for another year as he helps us through the transition. So as Jeff has explained, we are in the middle of our budgeting process and looking at expenses. I do want to point out the magnitude. Jeff talked about our non-comp expenses being up 9%. But if you look at the two non-GAAP items that we discussed and the impact of the accounting change that grossed up expenses, that accounted for $65 million of the $110 million increase, so over half of the increase was really accounting-related. I think that people may have missed that in the market. They talk about our expense growth, but if you do the math, it’s significantly less than the actual dollar spent. Going forward, we are still focused as a growth company and we are still recruiting. We historically have done very well in down markets in recruiting if that comes. We continue to recruit for long-term growth, and there’s just more expense associated with that. But we’re certainly looking at the non-controllable expenses. We do have some visibility entering this next quarter, even though, with interest rates proposed cuts, it certainly makes it difficult right now to figure out where we’re going to be for the year. The private client group assets and fee-based accounts, as Jeff talked about, increased 3% for the quarter and that should reflect in the asset management related administrative fees for the first quarter of 2020 as those assets are primarily pulled in advance. Speaking of those billings, while client cash balances have shown some signs of stabilization over the past three months, our balance just declined in October, and that's really due to the fact that we bill; only bill, they come out to client's accounts in cash generally. So that was the impact of the billing in October. What we see is even more impactful is the basis point cut in our rate at the end of our fiscal fourth quarter, as Jeff talked about, which isn’t really fully reflected yet, because it was at the end of the quarter and that will impact 2020. On a positive note, our financial advisor recruiting activity remains very active across our affiliation options. This is not a numeric metric, but I can’t remember seeing so many $5 million to $10 million teams in the pipeline. Again, I think it shows the strengthening of our platform, even with our disciplined transition assistance approach. Our M&A pipeline is robust. I know the market forecast has been down, but we have several large key deals that we hope will close, and I think bode well for M&A at least how we can see it today. You never know in that market, but the outlook for fixed income business is still very positive. We expect continued rate volatility in 2020. Raymond James Bank enters the quarter with fiscal year with record loan balances and solid credit metrics. While the only negative financial implications of lower interest rates, many of you do, there are some positives. I do think that the spread difference between cash sweeps and money markets has caused a lot of money to go out of cash and into money market instruments. Appropriately, as that spread comes in to more historical levels, the premium for FDIC-insured sweep balances should close enough, but I think total yield for cash balances. Although, we may give it up at return rates or return to more normal states long-term, and more rational pricing, I think this is going to be a long-term positive for the market. Hopefully, it will also establish more rational pricing in the market on transitional systems and other packages, but there always seems to be some aggression in the market. A lot of you have asked about e-brokers cutting their commission to zero. As you all know, we do not have a direct channel, so there’s no impact there. On the advisory side of our business, we think this move really reflects the RIA custody segment catching up with the full-service segment. That’s the vast majority of our fee-based accounts today do not have transaction fees. As for our growing and significantly smaller but important RIA custody business, we did announce that we will follow the e-brokers, but that impacts us pretty marginally—around $6 million to $7 million of annual transaction fees to the firms. With that being said, all these actions always remind us there will be price pressure in our business just as there's in all industries, which means we will have to continue to make investments in resources to help our advisors add value and strengthen their client relationships while also looking for investments to make us more efficient on the cost side. This is exactly what we’ve been focused on. Before I open for questions, I want to thank the associates and advisors for contributing to another great year. They really generate the revenue and the great client relationships we have. We’re a people business, and our success simply would not be possible without our client-focused advisors and associates that support them every day. With that, Calandra, I’m going to turn it over to you and open up the line for questions.

Great. Good morning, everyone.

Hey Devin.

Maybe start where you left off, Paul, just on the competitive dynamics and some of the pricing changes we’ve recently seen here. I guess first, maybe I just missed it at the end of the year, but did you actually quantify the impact of the pricing change that you're making on the RIA side? I guess that's number one. Number two, what other areas are you seeing within kind of the financial advice part of the business, if you will, that potentially could come under pressure? Are you seeing any areas of pressure? We've recently seen UBS cut fees on SMAs. I'm curious if there's any other areas as we're kind of constantly in this competitive environment where your pricing seems to come under pressure, I'm not sure if there's anything else you would point to.

Yes, it is obviously not clear enough, but it was $7 million to $8 million, the RIA revenue impact to the firm on those transactions for equities and ETFs. So $7 million to $8 million firm-wide is the impact. Yes, we always see competitive pressure, Devin, whether it's been moving to ETFs, the industry moving mutual funds to ETFs, whether it's pressure on advisory fees. UBS’ announcement wasn't clear; a few years ago, they unbundled between what the advisor charged and what the firm charged. I don't know if it's a re-bundling, so we’re going to have to see more, but there are always people pushing that dynamic and we’ve been going through that for years; it’s not new. I can say the advisor fees have held very, very steady, and it’s pushed us to be more efficient. I think that's the advantage of scale as we've gotten larger; that we can deal with some of that. But certainly if that continues long-term and Reg BI will be out in June, we’ll see the impacts of that. Over the longer-term, if that dynamic continues, people have to remember there are three parties impacted by changes: the client, the advisor, and us. It has to be fair with the client; they’re the advisor, and then we have to be in business to operate. I think you always have to look at that dynamic. Right now, we feel pretty good. Industry dynamics change; we’ll have to change with them. I don’t think that’s a new dynamic. It’s just interesting during these periods of time. It will also be interesting as firms who have been dependent on transaction fees, but especially where most of their earnings or more than all their earnings come from interest, dependent on that reaction. So we've certainly benefited from them, but I think we're a little more diversified in that. So we watch, we think through them, but I don’t see any short-term call to action, but we’re watching closely.

Okay, great, color. Thanks, Paul. And just to follow-up on kind of the recruiting strength in the quarter, obviously good to see and heard the commentary around I guess the backlogs. I mean with this pent-up demand, did that just kind of come through in the quarter or was there something else that changed where maybe there’s a reacceleration? I’m trying to dig into that a little bit more. And then also, you guys have been opening a lot of new offices, and that has led to at least some of the expense growth. So I’m also just curious at what point you maybe see that slowing, and ultimately, I think that would be good for operating margin potential. Just trying to think about that piece as well.

Yes. So I think in the short term, you've got two dynamics. As we grow and open offices, that is cost. And leases renew, especially in the big markets right now, may be cyclically at a peak, maybe they continue, but when those renew, that adds cost pressure to it. As we grow in major markets and need more space, that certainly has moved against us, but that comes and goes in the cycle. I don’t see any relief in that part of the cycle. Again, we believe that the franchise value of recruiting great advisors is key to what we do. So that part I don't see much relief to. We just have to be more efficient at the back-office side, and that's what we're managing. A lot of our expense growth, if you look at it, half of the expense growth, over half was accounting-related—I'll call it, between our investments in technology beefing up our compliance, supervision, and services. I mean, I think the expense growth is pretty reasonable, given the growth we've had.

Got it. In terms of just the recruiting, kind of the pretty material acceleration, any other color you could provide there if something else that’s happening?

Yes. I think that last year you saw that the recruiting was kind of flattish from the first quarter, which I think if you go back historically, a lot of people stayed for their bonuses and things through the year-end. And we just got used, for a couple of years, we had people come anyway, right. After the year-end and bonuses, it’s a more logical time for people to move, and the pipeline has been strong. We’re seeing many people we thought would even join in the fourth quarter just for transition timing for their businesses, which is what they should do—to do what’s best for their business—move into the next quarter. So we’ve – I can’t tell you what we said in the beginning was that we thought it would accelerate, and I’d say we delivered. The backlog isn’t any different whatsoever. It’s very, very strong. So I can’t cite anything. I get that businesspeople don’t leave for fun. They are leaving something to join something. We just have to be that great platform that people want to come to. If they’re unsatisfied where they are, we know we’ve been the receiver of that.

Got it. Great, thank you very much.

Thank you.

Hi, good morning. This is Brian Wu on for Bill Katz. Thank you for taking the question. Can you give a sense of the client cash mix between purchase money market funds versus holding cash since you guys discontinued the money market sweep option? And how has that trended particularly in this declining rate backdrop?

So we haven't reported on with some money market is certainly a lot of the cash movement, but we reported sweeps in cash, pure cash, in our system. A lot of the movement has been in the money markets.

Got it. And then it looks like client cash after declining quarter has ticked up in September. You mentioned it stabilized. Any update you can provide on client cash trends in October?

Only as Paul reported that we have the fee billings come out at the beginning of each quarter, which causes a hiccup in the downward direction and then it generally rebuilds over the course of the quarter to accommodate those fee billings in the next quarter. So that was the same dynamic that we reported last quarter that we saw in July that we obviously saw it again for the billings in October. It’s down now versus where it was at the end of the year because of those billings, which are a little over $800 million now for us as a firm. So it’s down now because of that. It will generally, if it follows history, rebuild over the course of the quarter through recruiting and through repositioning those accounts to be in a position to accommodate the billing in the next quarter.

Our feeling is that we’re entering a stabilized kind of platform. Money market rates tend to come down a little slower because they buy securities; it takes a while for them to mature and then invest in the new lower rates. As those rates continue to come down, we think that pressure is going to ease as that spread narrows.

Got it. Thank you for taking my question.

Okay.

Thanks. Good morning, everyone.

Craig.

Hi, Craig.

And Jeff, just wanted to congratulate you again for the 30 plus years and wish you the best for the next step.

Thank you, sir.

So I had a follow-up to the first set of questions on recruiting. Have you seen any changes in the composition of the incoming advisers in terms of where they're coming from and the sizes of their books of business? And I'm especially looking on a near-term basis where we saw this reacceleration.

Yes. Again, I think the reacceleration has been steady through the pipeline. The average advisor continues to be higher; we’re seeing much larger teams through the pipeline. It doesn’t mean they’ll all join us, but the pipeline is very, very strong, and the size is quite big. We just announced a big team that joined us last quarter. It's almost $6 million in production. We have a number of those teams in the pipeline in the $5 million to $10 million range. Hopefully, we'll be able to recruit them. There are also very, very good advisors that are in the $0.5 million range, and they’re very profitable and do a great job with their clients. So we are looking to recruit across the platform, but we are getting much bigger teams, I think in general right now anyway.

Thanks, Paul. Just as my fault here with RJF stock now well above the average levels of where you’ve purchased over the last year. I just wanted to see if we could get an update on your appetite for buybacks but also M&A in the future. Can you remind us roughly how much excess capital you currently hold?

Well, the excess capital is always a subjective question, but I do think first that we have been committed to purchasing dilution on a regular basis and opportunistically buy in the market. I don’t think that’s changed. You would see we raised our threshold, given the tax act and our excess liquidity, so we were probably more aggressive than we’ve done historically. But I think the guidance we’ve given is still we will buy dilution and then be aggressive when we think there’s an opportunity. On the M&A front, I can tell you, all I can tell you is we've been very active. It’s a very interesting cycle right now. There’s a lot more firms talking about maybe doing something, but they seem to be looking at this last year's environment as if it’s going to continue for the next 10 years. So if you discount interest rates, if you discount what you think the market may be involved in and all that, the pricing has led to a number of places where those things didn’t transact, not just for us. We’re going to stay very active, very connected, and be very disciplined. So we are very active on the M&A side, but again, we’re not going to do something just to be bigger. It has to make us better, so it has to be strategic. It has to fit our culture, and then we have to be able to provide a good return for shareholders. With all of that, I’d say it’s been a frustrating year; we’ve had some very good opportunities that didn’t transact anywhere because the pricing to us just wasn't realistic. We’ll stay active, and I think that’s the advantage. If there is a downturn and certainly downward interest rates will put pressure, it’s been a great tailwind for the whole industry. That tightening may give us more opportunities, but we’re still on it. I can’t tell you again with this type of market when we can do something, but we’re very active.

Thanks, Paul.

Hey, good morning.

Hey, Steve.

So, Jeff, congrats. Enjoy the well-deserved R&R. Paul, I wanted to start off with a question on the industry pricing changes. Appreciate a lot of the commentary you gave in addressing some of the pricing developments on the SMA side at UBS. I was hoping you can quantify your direct exposure that third-party and internal SMAs and how you think this change may impact the fees on this particular product?

Again, we have significant assets in our advisory accounts. So it’s both internal management and third-party sub-advisors. I think UBS’ announcement isn’t very clear, whether they're just re-bundling, whether advisers are sharing on that or what's going on. It’s hard for me to comment on that. If you look overtime, there’s always been pressure on those advisory accounts and the fees that we and third-party managers charge. It’s very competitive. It would impact us if we lower these. But we’ve continually—since I've been here, I don't know how many times we’ve lowered fees in those accounts to be more competitive. The good news is our scale has grown significantly, so it’s been pressure, but with size, it’s still a growth area for us. Again, UBS’s announcement for us, I have no idea. The impact is how that change is going to be passed to the advisor and client, and that wasn't announced at all. If it’s a re-bundling, it could have no impact. If it’s charged to the advisor, it has a different impact. If they’re going to eat it all and the advisor, client and shared as a more significant impact. But I have no idea what that is right now. I wish I could be more clear; I just don't know. We are looking at it, and it's just a couple of day-old announcement.

Recognizing we're still waiting additional color on that context is certainly quite helpful. I had a question on some of the developments ahead of the upcoming election. There's been lots of focus on election risk for financials and given some of Warren's momentum. What her agenda can mean for the group recognizing that the legislative hurdles for the DOL could potentially be much lower. I was hoping you could just give some perspective on whether you think it's reasonable for to be repurposed, especially given the implementation of Reg BI and how you're thinking about that potential threat or have you made sufficient changes already to your business model, you're already pretty well prepared.

There are multiple answers. First, the DOL will come back. I mean, we've been told that the Department of Labor is looking for an October type of announcement. If you remember, Reg BI specifically talked about the DOL. Our belief is that the – I have no idea, but our belief is the SEC and the DOL had long talks to ensure that what the SEC proposed aligns with the DOL proposal. Some of BI already signals some of the stuff that you'd have to do with DOL type of accounts. I don’t think the DOL portion will be significant. I think Reg BI is, in a lot of ways, harder than the DOL because the DOLs – here’s what you have to do; here’s what you can’t do, and it’s easy to program for it. Now, I think it was bad for advisors and flexibility. The best interest standard says, hey, make sure you're putting clients first and disclose everything. As you do that, you got a little harder from a judgment standpoint, but I actually think the standards align more. It gives flexibility to say, yes, you can do this; just make sure it’s in the best interest of your client. Certainly, I think all firms will be better positioned if a DOL type of administration goes back. We’d be closer because a lot of those elements would have already been programmed in, especially on disclosure, which is hard to argue against and document why you made decisions is also hard to argue against. The DOL will definitely add a lot more stops, making it hard for commission-based accounts and other things. The industry will be better off; there will be pressure on the regulatory landscape. Many of the people in regulatory seats terms do go on for a few years after the next elections. There’ll be pressure, but it’ll be harder to do it by appointment. It’ll have to go through regulation, and my guess is we'll have a divided Congress no matter what. Who knows? But we’ll react to it. I can't predict. Certain candidates, if they look like they have an opportunity to be the next president, would be a lot more disruptive than others. But I can’t do anything about that. I only have one vote.

Fair enough. Although it is a vote in Florida. I could make sure, it gets counted. Just one more for me, Jeff, just to clean up a question on the NII geography. Certainly good momentum this quarter. Looks like the beat was in the corporate other catchall segment. I was hoping you can discuss what contributed to some of the strength there. Just trying to gauge the sustainability of that NII momentum.

That kind of jumped off the page with us too. I’m going to let our Treasurer, who we've asked to look into that, address that since you're going to need to get used to hearing his voice in the future anyway. I'll let Paul Shoukry talk to that one.

I think, Steve, is already sick of my voice. Some of the geography, Steve, is really attributable to rounding when you're dealing with such small numbers from quarter to quarter. The other segment showed that it was up $9 million sequentially through interest income; more than half of that was attributable to rounding, believe it or not, just when you're dealing with such small numbers. But the remaining portion was due to higher cash balances sequentially. They were up at the parent company around $300 million on average quarter-to-quarter. We really didn't see the negative impact of the interest rates just given the timing of the cuts. So that will be reflected on those balances next quarter.

Very helpful, Paul, and Paul, thanks very much for taking my questions.

Thanks guys. So we've seen pay rates on deposits come down quite a bit across the industry and your firm as well, and you've already highlighted that. Is there a point though where you might decide, hey, you know what, we need to be a little bit more generous with these pay rates if we want to grow cash balances a little bit more? Or is that not really under consideration at this point?

I think we look at it this way. We would obviously like funding by cash balances. To the extent that spreads come in, the negative is spreads came in. The positive is the delta between cash sweep, FDIC insured, and the premium that you may give up in money market will narrow. We think that may lead to a natural cause for people to stay in the FDIC insured. We think that may grow. Being led by the firm, the number one thing is liquidity. We will look into raising higher rates if we needed liquidity, third party funding in the bank. We’ve tested our CD program, and it worked just fine; we’re going to test other measures just to make sure liquidity is there. But that’s all at a much higher rate, and that would compress NIM if we needed it. Right now, we don’t, but you don’t—everyone assumes you don’t. We've always been more conservative in how we funded the bank, so the cash drop has not impacted our operations, again at that point. You just need to make sure that we have access to third party funds, but it would be at a higher cost. We are looking at it, but I would call it more as a contingency. You may see us raise some money just to test that, but right now, it’s not a big driver of our cash program in our minds, certainly not in the short term.

Okay, got it. I did want to ask you one question on your margins. At the last Investor Day, I think you guys talked big picture—the margins are generally flattish, revenues growing in line with expenses or expenses growing in line with revenues. If we cut the Fed again in the December quarter and we have kind of like a formal equity market for your fiscal year 2020, do you think that outlook is still achievable?

I think as we look, Chris, honestly, the more interest rate cuts, certainly that impacts top line and, frankly, bottom line. We don’t pay anything on that, right? That’s going to compress margins, and even if revenue grows, it will be compensable revenue. We’re paying 65% or 66%, whatever the number is this quarter; next quarter on that. The comp ratio will go up as you go from non-compensable to compensable, and margins will come down because you can’t make up non-comp expenses; you can’t make up that difference. The only way you do that is by changing your grid, and that’s a major effort which we have to do; we’ll do if that’s the right thing to balance for the business. It’s not a short term fix. So interest rate cuts are going to impact anyone who's interest-rate-sensitive.

Got you. Okay, thank you.

Hey. Hi, guys. Good morning. Just one question around expenses, I think Paul, to your point around non-comp growth this year being really impacted by a couple of accounting changes and charges. If you backed us out, I guess you guys would have been in the closer to mid-single digit growth in non-comp expenses for fiscal 2019. I understand that you guys are still early in the budgeting process, but assuming a similar level of investment continues, is that a more reasonable way to think about non-comp expense growth in June 2020? Thanks.

I would say, yes, it is something we’re going to manage. I do think we're not an e-broker. I mean, we will have recruiting expenses. We’ll have raises — if you looked at the marketplaces, those are 3% this year across the board, which you multiply that across our system. You have technology investment that certainly isn't going down; you've got some embedded growth. Even when you manage all those other expenses, if you're recruiting, the good way is to make us all look good is to stop recruiting. A lot of those expenses will go away. I don’t want to hand over the business someday to a successor who has a business that's not viable and growing. We’re going to continue to grow, and that will drive expenses. It's probably the last two years; it’s probably been 50 basis points. It shouldn’t just impact the comp ratio, just from amortization. The more we recruit, that number will grow over time. We plan to continue to recruit. We had a number in 2009; we had our record recruiting year until last year. This year we beat it. But in downturns, we recruit now, and it may not look good in the numbers during the downturn, but it certainly looked good, when I came out of it and drove really a decade of great performance. So yes, it’s not going to go away. We’re going to manage it as well as we can, but it’s not going away.

And there to point out, there are a couple of expenses that are really somewhat out of our control, such as legal reserves, which depend on what happens with that, and regulatory issues and bank loan loss provision being another one. It’s subject to whatever happens in those particular areas. Those are very difficult to budget, although they've been within a range; they’re very difficult to pinpoint anytime over a year or such. Those can go either direction from this year to next.

I’ll just say that the CEO is there in our control, but there are long-term cyclical impacts. If we make good loans and get good people, we allow a lot less of those. But I think we’re in good shape.

Maybe we could just talk a little bit about fee-based asset flows, if I—not that you disclose them, but we can take a stab back in our market impact. If I look at flows this year or 2019, they seem to be down, probably still solid but down very strong from a year ago. Maybe cut in half in terms of the annualized growth. How much—I’m just trying to unpack that—how much of that has been the slowdown in recruiting at the beginning of the year versus a tough equity market versus a slowdown in sort of migration from brokerage to fee-based? I know there's a lot of moving parts there, but maybe you can help us think about the pace of flows, how that trajectory has been and where it could go with accelerating recruiting.

Yes. I’ll just make a couple of comments on that, Jim. First of all, I think that last year was an abnormal year before they killed the DOL rule. There was a, as you know, a huge movement over to fee-based. For us, that happened for the first nine months of last year in a pretty big way. That has definitely slowed down to some extent. But having said that, we’re still recruiting advisors that use our fee-based platforms to a large extent. We still see migration from our existing advisors to fee-based just at a slower rate. That’s why you see the growth of fee-based assets outstripping the growth of the market, with the S&P up one and fee-based assets up three this most recent quarter, because we continue to see both those dynamics still in play.

Okay. So you would think last year was a lot of it or a good chunk of it was driven by just sort of that migration.

Yes, last year and the year before probably were both heavily DOL driven.

And we think about the new recruits, it looks like it was more in the employee channel versus the independent contractor channel. Where, I guess geographically, is that coming from, and does that help the margin a little bit, because it's in the employee channel instead of the more fixed margin independent contractor?

So the employee channel had a very good last few quarters, where the independent, who's been really leading recruiting the last couple of years, had a little bit of slowdown, but not much. I would call it, it’s episodic. Both channels are recruiting very well. I think economically, we’ve had a big bull run, so independence look really good. If you get a little tougher market environment, the employee channel looks a lot safer. Some advisors just like, they want to work with clients and they don't want to worry about turning on the lights and paying bills and others want to feel like they own their business every day. So, although we tell all the advisors they do, I wouldn’t call it one versus the other. I think they’re both robust, and their pipelines have a lot of strength. I couldn't explain why the independent has been a little higher and the employees have picked up. I do think some of that's big teams. Geographically, it's all over; we’re doing better in the Northeast, pushing harder in the West. We’re gaining ground, but we've got a lot of markets in the west. I wish I could give you more of a definitive answer—that's the color, but I’d say it’s too short to say that people switched to an employee of a cycle.

Okay. I guess generator cost in California will have to go up for Raymond James.

Yes.

All right. Thanks for the color. And Jeff, good luck on retirement, hope your golf game improves.

Thanks, Jim.

Jeff, you're not off the hook for another year, he’s saying. He still has a little more time that maybe a little more freedom, but we’ll have his services both at the bank and as an advisor, helping Paul through that transition. I want to thank you all for the call. I do think that a lot of people, the recruiting numbers are big numbers, but if you look at $300 million in assets and I made production the trailing 12, those $40 plus billion in assets, it’s like a Morgan Keegan. I’m sorry, Alex Brown acquisition just on organic recruiting. We believe that’s a great way of growth. We get to pick advisor by advisor. I still think it’s the biggest testament to the underlying platform is that, and the fact that they’re generally joining us for less checks and sometimes significantly less checks than they get at other places. We’ll continue to push. I think the fundamentals are great from both advisor and platform standpoint, but the fundamentals are very difficult from an interest rate standpoint, and the markets will be the markets, especially coming to an election here. So appreciate you joining the call and we’ll talk to you soon.