Raymond James Financial Inc (RJF) — Q1 2023 Earnings Call Transcript

Good afternoon, everyone, and thank you for joining us. We appreciate your time and interest in Raymond James Financial. With us on the call today are Paul Reilly, Chair and Chief Executive Officer; and Paul Shoukry, Chief Financial Officer. The presentation being reviewed today is available on Raymond James' Investor Relations website. Following the prepared remarks, the operator will open the line for questions. Calling your attention to Slide 2. Please note certain statements made during this call may constitute forward-looking statements. These statements include, but are not limited to, information concerning future strategic objectives, business prospects, financial results, anticipated timing and benefits of our acquisitions and our level of success in integrating acquired businesses, divestitures, anticipated results of litigation and regulatory developments or general economic conditions. In addition, words such as may, will, could, anticipates, expects, believes or continue or a negative of such terms or other comparable terminology as well as any other statements that necessarily depend on future events are intended to identify forward-looking statements. Please note that there can be no assurance that actual results will not differ materially from those expressed in the forward-looking statements. We urge you to consider the risks described in our most recent Form 10-K and subsequent Forms 10-Q and Forms 8-K, which are available on our Investor Relations website. During today's call, we will 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 schedules accompanying our press release and presentation. With that, I'd like to turn the call over to Chair and CEO, Paul Reilly. Paul?

Good afternoon and thank you for joining us today. Although there is a lot of disappointment for us in the Bucks' playoff game and even more disappointment for me, as Paul Shoukry's Bulldogs won the National Championship, Raymond James came through again with another solid performance. During a volatile and challenging market environment, we generated strong quarterly results, including record net income available to common shareholders of $507 million, an annualized return on common equity of 21.3%, and an annualized adjusted return on tangible common equity of 26.1%. Once again, these results highlight the value of having diverse and complementary businesses. Record Private Client Group results were driven by robust organic growth, along with the strong expansion of net interest margins in the Bank segment and yields on the RJBDP balances at third-party banks in the PCG segment, offsetting market-driven declines experienced through the Capital Markets businesses. As demonstrated this quarter, with the sharp increase in net interest income and RJBDP fees, we have been and remain well positioned for a continued rise in short-term interest rates with diverse and ample funding sources, a high concentration of floating-rate assets, and strong balance sheet flexibility given solid capital ratios. Turning now to the results starting on Slide 4. In the first fiscal quarter, the firm reported net revenues of $2.79 billion, record pretax income of $652 million, and record net income available to common shareholders of $507 million or $2.30 per diluted share. Excluding expenses related to acquisitions and the favorable impact of a $32 million insurance settlement received during the quarter, adjusted net income available to common shareholders was $505 million or $2.29 per diluted share. Quarterly net revenues were flat compared to the prior year quarter and down 2% compared to the preceding quarter, largely driven by the benefit of higher short-term interest rates on net interest income and RJBDP fees from third-party banks, offset by the market-driven declines in investment banking revenues and asset management and related administrative fees. Record quarterly net income available to common shareholders increased 14% over the prior year's fiscal first quarter, largely due to higher net interest income and RJBDP fees from third-party banks. And as I mentioned earlier, we generated very strong returns, with an annualized return on common equity of 21.3% and an annualized adjusted return on tangible common equity of 26.1%. Impressive results, especially given the challenging market conditions and our strong capital position. Moving on to Slide 5. We ended the quarter with total client assets under administration of $1.17 trillion, PCG assets, and fee-based accounts of $633 billion and financial assets under management of $186 billion. With our unwavering focus on retaining, supporting, and attracting high-quality financial advisers, PCG consistently generates strong organic growth. We ended the quarter with nearly 8,700 financial advisers and generated domestic net new assets of $23 billion in the quarter, representing a 9.8% annualized growth rate on beginning of the period domestic PCG assets. Net new assets were strong this quarter and also helped by the seasonally high interest and dividends received in December. Over the trailing 12-month period, we generated net new asset growth of 7.3% of domestic PCG assets at the beginning of the period. During the same 12-month period, we recruited to our domestic independent contractor and employee channels financial advisers with nearly $300 million of trailing 12-month production and approximately $40 billion of client assets at their previous firms. Total clients' domestic cash sweep balances declined 10% to $60 billion, representing 5.9% of domestic PCG assets under administration. The domestic suite balances represent our lowest cost deposits as we have yet to utilize enhanced yield savings accounts to attract cash deposits. Total bank loans grew 2% sequentially to a record $44 billion, reflecting growth at both Raymond James Bank and TriState Capital Bank. Moving to Slide 6. The Private Client Group generated record results with quarterly net revenues of $2.06 billion and pretax income of $434 million. Asset-based revenues declined; however, the segment's results were lifted by the benefit from higher short-term interest rates, including increased yields on RJBDP fees from third-party banks and the Bank segment. The Capital Markets segment generated quarterly net revenues of $295 million and a pretax loss of $16 million. Capital Markets revenues declined 52% compared to the record-setting results in the prior year and quarter, mostly driven by lower investment banking revenues, largely due to the volatile and uncertain markets. The Asset Management segment generated pretax income of $80 million on net revenues of $207 million. The decreases in net revenue and pretax income were largely attributable to lower financial assets under management as the net inflows to fee-based accounts in the Private Client Group were offset by a year-over-year fixed income and equity markets decline. The Bank segment generated record quarterly net revenues of $508 million and pretax income of $136 million. Net revenue growth was primarily due to higher loan balances and significant expansion of the bank's net interest margin to 3.36% for the quarter, up 144 basis points over a year ago quarter and 45 basis points from the preceding quarter, reflecting the flexible and floating rate nature of our balance sheet.

Thank you, Paul. Starting with consolidated revenues on Slide 8. Quarterly net revenues of $2.79 billion were flat year-over-year and declined 2% sequentially. Asset management and related administrative fees declined 10% compared to the prior year quarter and 4% compared to the preceding quarter, in line with the guidance we provided on last quarter's call based on lower fee-based assets at the end of the preceding quarter due to the equity market declines. This quarter, fee-based assets grew 8%. This growth should provide a tailwind for asset management and related administrative fees, which we expect to increase 5% to 6% in the fiscal second quarter, reflecting two fewer billable days. Brokerage revenues of $484 million declined 13% compared to the prior year's fiscal first quarter and grew 1% over the preceding quarter. The year-over-year decline was largely due to lower fixed income and equity brokerage revenues in the Capital Markets segment, as well as lower asset-based trail revenues in PCG. I'll discuss account and service fees and net interest income shortly. In a much more difficult market environment than we anticipated on last quarter's call, investment banking revenues of $141 million declined 67% compared to the record set in the prior year quarter and 35% compared to the preceding quarter. Despite a healthy pipeline and good engagement levels, there remains a lot of uncertainty in the pace and timing of deal closings given the heightened market volatility. At this point, it is too difficult to say when conditions will become conducive to increased activity. Other revenues of $44 million declined 45% sequentially, primarily due to lower revenues in the affordable housing investments business, which was seasonally high in the preceding quarter. Moving to Slide 9. Clients' domestic cash sweep balances ended the quarter at $60.4 billion, down 10% compared to the preceding quarter and representing 5.9% of domestic PCG client assets. The sweep balance declines were experienced in the Client Interest Program at the broker-dealer, as well as with third-party banks. As of last Friday, these balances have declined to just under $57 billion, reflecting the quarterly fee payments of approximately $1.1 billion paid in January, as well as additional cash sorting activity during the month. The Raymond James Bank Deposit Sweep Program continues to be a relatively low-cost source of funding, and TriState Capital Bank adds an independent deposit franchise, providing a more diversified funding base. And as we have seen deposits decline significantly across the entire financial system, we realize even greater value in having multiple funding sources. To that end, we are also in the process of launching an enhanced yield savings program for our Private Client Group clients. Turning to Slide 10. Combined net interest income and RJBDP fees from third-party banks was $723 million, up 253% over the prior year's fiscal first quarter and 19% over the preceding quarter. This strong growth reflects the immediate impact from higher short-term rates, given the limited duration and high concentration of floating-rate assets on our balance sheet. Our long-standing approach has been to maintain a high concentration of floating-rate assets, which is proving to be a significant tailwind in this rising rate environment. The bank's net interest margin shown on the bottom portion of the slide increased 45 basis points sequentially to 3.36% for the quarter. And the average yield on RJBDP balances with third-party banks increased 87 basis points to 2.72%. Both the NIM and the average yield on RJBDP balances increased more than we expected on last quarter's call, as the deposit beta on the last rate increase was closer to 15%. The spot NIM for the Bank segment is currently close to 3.5%, and the spot yield on RJBDP balances is approximately 3.2%. So we currently expect continued near-term tailwinds for net interest income and related fees despite the ongoing cash sorting activity. The anticipated rate increases should also help. But remember, there are two fewer days in the second fiscal quarter. While we still have sweep balances with third-party banks that could be redeployed to the Bank segment, longer term, if rates stabilize at these levels, we expect the bank's NIM will be impacted by the mix of deposits, anticipating a larger portion of higher-cost deposits being utilized to fund future balance sheet growth. While we are pleased to see the significant NIM expansion, as we have said in the past, we have always prioritized net interest income over net interest margin. And our goal is to continue growing net interest income as we deliberately grow the balance sheet over time. Moving to consolidated expenses on Slide 11. Beginning with our largest expense, compensation. The total compensation ratio for the quarter was 62.3%, nearly flat from the preceding quarter. The adjusted compensation ratio was 61.7% during the quarter. Despite lower Capital Markets revenues, the compensation ratio largely reflects the significant benefit from higher net interest income and RJBDP fees from third-party banks. As a reminder, the impact of salary increases effective on January 1 and the reset of payroll taxes at the beginning of the calendar year will be reflected in the fiscal second quarter. Non-compensation expenses of $398 million decreased 13% sequentially. Adjusting for acquisition-related non-compensation expenses of $11 million and the favorable impact received of $32 million, both included in our non-GAAP earnings adjustments, non-compensation expenses were $419 million during the quarter. The bank loan provision for credit losses of $14 million in the quarter primarily reflects changes to macroeconomic assumptions used in the CECL models as well as modest loan growth. I'm proud of our continued disciplined management of expenses exhibited again this quarter, where we remain focused on investing in growth and ensuring high service levels for advisers and their clients. Given the benefits from higher short-term interest rates, we expect to maintain our compensation ratio well below 66%, as it has been around 62% over the past two quarters, even with much lower revenues in the Capital Markets segment this quarter. Non-compensation expenses, excluding provision for credit losses and the aforementioned non-GAAP adjustments, are still expected to be around $1.7 billion for the fiscal year. Slide 12 shows the pretax margin trend over the past five quarters. In the fiscal first quarter, we generated a pretax margin of 23.4%, a very strong result, highlighting the benefit of our diversified business model, the upside we preserve, the higher short-term interest rates, and our consistent focus on being disciplined on expenses. Similar to my comments on the compensation ratio, given the interest rate tailwinds, we currently believe we are well positioned to continue delivering pretax margins above the previously disclosed 19% to 20% target. However, given the cash sorting dynamics as well as interest rate and market uncertainty, we believe it is premature to formally update our targets in this volatile environment. On Slide 13, at quarter end, total assets were $77 billion, a 5% sequential decrease, primarily reflecting the decline in Client Interest Program cash balances. The reduction of balance sheet assets helped increase the Tier 1 leverage ratio during the quarter. Liquidity and capital remained very strong. RJF corporate cash at the parent ended the quarter at $2 billion, well above our $1.2 billion target. The Tier 1 leverage ratio of 11.3% and the total capital ratio of 21.5% are both more than double the regulatory requirements to be well capitalized. Our capital levels continue to provide significant flexibility to continue being opportunistic and invest in growth. The effective tax rate for the quarter was 21.9%, reflecting a tax benefit recognized for share-based compensation that vested during the period. Going forward, we still believe 24% to 25% is an appropriate estimate to use in your models. Slide 14 provides a summary of our capital actions over the past five quarters. In December, the Board of Directors increased the quarterly cash dividend on common shares 24% to $0.42 per share and authorized share repurchases of up to $1.5 billion, replacing the previous authorization of $1 billion. During the fiscal first quarter, the firm repurchased 1.29 million shares of common stock for $138 million at an average price of $106 per share. As of January 25, 2023, $1.4 billion remained available under the Board's approved common stock repurchase authorization. Since the closing of the TriState acquisition, on June 1 through January 25, we have repurchased approximately 3 million common shares for $300 million or approximately $100 per share under the Board authorization. We remain committed to offset the share issuance associated with the acquisition of TriState as well as share-based compensation dilution and still expect to achieve our objective of repurchasing $1 billion of shares in fiscal 2023. But of course, we will continue to closely monitor market conditions and other capital needs as we plan for these repurchases over the coming quarters. Lastly, on Slide 15, we provide key credit metrics for our Bank segment, which includes Raymond James Bank and TriState Capital Bank. The credit quality of the loan portfolio remains healthy. Criticized loans as a percentage of total loans held for investment ended the quarter at 1.01%. The bank loan allowance for credit losses as a percentage of total loans held for investment ended the quarter at 0.92%, down from 1.18% at December 2021, nearly flat sequentially. The year-over-year decline in the bank loan allowance for credit losses as a percentage of total loans held for investment reflects the higher proportion of securities-based loans, largely due to the acquisition of TriState Capital Bank. Securities-based loans, which account for approximately 34% of our bank loan portfolio, are generally collateralized by marketable securities and typically do not require an allowance for credit losses. The bank allowance for credit losses on corporate loans as a percentage of corporate loans held for investment was 1.64% at quarter end. We believe this represents an appropriate reserve, but we are continuing to closely monitor any impacts of inflation, supply chain constraints, and a potential recession on our corporate loan portfolio. Now I'll turn the call back over to Paul Reilly to discuss our outlook. Paul?

Thank you, Paul. As I said at the start of the call, I'm pleased with our results and our ability to generate record earnings during what continues to be a very volatile market. And while there are many uncertainties, we believe we're well positioned to drive growth over the long term across all our businesses. In the Private Client Group, next quarter's results will be favorably impacted by the expected 5% to 6% sequential increase in asset management and related administrative fees. Additionally, the segment will continue to benefit from higher short-term interest rates, as described by Paul. Focusing more on the long term, I am optimistic we will continue delivering industry-leading growth as current and prospective advisers are attracted to our client-focused values and leading technology and production solutions. In the Capital Markets segment, while M&A pipelines remain healthy, the pace and timing of closings will be heavily influenced by market conditions. And in the fixed income space, depository clients are experiencing declining deposit balances and have less cash available for investing in securities, putting pressure on our brokerage activity. However, SumRidge, with its rapidly evolving fixed income and trading technology marketplace, enhances our position as this business typically benefits from elevated rate volatility. Over the long term, we are well positioned across Capital Markets for growth given the investments we have made over the past five years, which have significantly increased our productive capacity and market share. In the Asset Management segment, financial assets under management are starting the fiscal second quarter up 7% compared to the preceding quarter, which should provide a tailwind to revenues if markets remain conducive. We remain confident that the strong growth of assets in fee-based accounts in the Private Client Group segment will drive long-term growth of financial assets under management. In addition, we expect Raymond James investment management, which generated modest net inflows this quarter, to help drive further growth through increased scale, distribution, operational, and marketing synergies. And the Bank segment is well positioned for rising short-term interest rates and has ample capital to grow the balance sheet prudently. However, in an increasing rate environment, loan growth will face headwinds until rates stabilize and borrowers adjust to a new normal in the cost of borrowings. Additionally, as cash sorting has continued in the sweep program, we expect to increase the focus on funding the growth of the bank's balance sheet with higher costs, diversified sources over the long term. Currently, we have sweep balances at third-party banks that could be redeployed to the Bank segment. However, the past has also taught us that cash sweep balances can decrease or increase rapidly depending on market conditions. Importantly, the credit quality of the Bank segment's loan portfolio remains strong, and we are closely watching economic conditions relating to the lending portfolio. In just a short period since the closing of the acquisition of TriState Capital, I am very pleased with their performance. Staying true to TriState's independent operating model, including remaining a separately chartered bank with its own client relationships. This model, coupled with our strong capital, should foster its ongoing growth. It's no accident that our businesses are positioned well for future growth. It is a result of our steady focus on making decisions for the long term, especially in volatile and uncertain market conditions. We are well positioned for the continued rise in short-term interest rates with diverse funding sources, solid loan growth, high concentration of floating rate assets, and ample balance sheet flexibility given the solid capital ratios, which are all well in excess of regulatory requirements. Finally, in these uncertain times is when clients need trusted advice the most. And I want to thank our advisers and associates for their unwavering dedication to providing excellent service to their clients each and every day. Our strong results are a direct reflection of your contributions. So thank you very much to all of you. With that, operator, will you please open it up for questions?

I guess just a couple of quick ones on my end. First, on the buyback. So you repurchased $138 million. It's a bit below the implied $250 million average target. And so I guess the implication is there's going to be a catch up. So I'm just trying to understand the factors that impact the cadence, whether it was being price conscious or were you in blackout through the quarter that we didn't see or maybe any other reasons trying to think about, again, kind of the cadence there.

We're still targeting the $1 billion of repurchases for fiscal 2023, as we've said several times now. And so that obviously means we would have to ratchet that up on an average basis going forward to get to that $1 billion mark. There was a lot of volatility in this particular quarter. And then as you point out, there's always a blackout period. So we were pleased to get $138 million in. But understand that to hit our target going forward, we're going to have to kind of increase that average. But with that being said, a lot can change between now and the end of the fiscal year, so we do monitor market conditions and all the sources and uses that we have for cash and capital at the firm.

Got it. Okay. And just a follow-up here on net interest income in private clients. So that's been obviously very strong, and that came in better than we were looking for. And we see the decline in the kind of the Client Interest Program. And so if you're trying to think about the other drivers there, was the continued strength there driven by margin and just higher margin rates? Or some of your peers had some securities lending that helped as well. So I'm curious if there was any kind of lumpy securities lending in there. Just trying to think about some of the moving parts that's keeping that really strong.

Securities lending was not a driver. Really, it was just the higher yields on both the segregated assets pursuant to the broker-dealer regulations as well as the higher yields on the margin balances. But I will point out going forward, sort of the 'last in, first out' type of cash is really the Client Interest Program cash, and that has declined the most dramatically during this cash sorting cycle. And so we're probably at around $3 billion to $4 billion of those balances today versus sort of the average balance for the quarter of $6 billion. So that would be something you would need to consider, which would partially be offset by the higher rates going forward as well, factoring in a full quarter of last quarter's rate hikes and potential rate hikes this quarter, but something that you would need to factor into your modeling.

Hoping you might be able to just give a little incremental color on the enhanced yield product, where you see the sort of demand coming for that and what the potential kind of rates might be that could be offered to clients.

Yes, almost everyone is currently offering enhanced yield programs that aren't new. We haven't needed them due to the amount of client cash we've had, but as that decreases, we will start to provide these options. Customers may have accounts with cash, money markets, or insured products, or they might be considering moving their funds. They can achieve a competitive yield without needing to shift their money into money markets or fixed income products. Many firms in the industry are focusing on this, but we haven't had to because of our funding costs. However, we are nearing a point where we will begin offering these products as planned. Competitive rates in the market are currently between 3.75% and 4%, though there are some exceptions. We will ensure we are always positioned well in terms of cash. The good news is that even at these higher rates, we can still maintain a profit margin, and since we mostly have low-yield deposits and very few high-cost deposits, adding some higher-yield options won’t significantly impact our funding costs compared to other institutions.

Great. And then maybe one just on the recruiting environment. Is there anything seasonal kind of about turning the calendar that would be sort of advantageous as it relates to kind of attracting and recruiting advisers? And perhaps if you could also just kind of touch on just any of the dynamics around transition assistance and what you're kind of seeing in the marketplace.

Thank you. For years, everyone has said it is competitive, and it has been competitive for a long time and continues to be so. I believe the competitive landscape remains largely unchanged. The only notable development over the past year is that some third-party RIA aggregators are offering more compensation than other firms to attract advisers. However, we have a very strong backlog. Last year, our employee division set a record, while our independent division was somewhat slower in the first quarter. Although recruiting has been faster in the independent division and somewhat slower in the employee division so far this quarter, we are confident in the backlog, which is very strong in both divisions, especially among large teams. We remain optimistic about our recruiting efforts. Looking at the past few years, we have consistently ranked at the top in terms of net new assets and recruiting.

I wanted to ask a question on cash sorting. Can you comment on the broader trends in cash sorting? We're sort of getting closer to that 5% of client assets that has been a lower end of the range in the past. So is that 5% still a good base for where cash should settle? And how quickly do you think we'd get there?

I think the true answer is that no one really knows. That 5% figure was based on the period from 2016 to 2019. As an industry, we don't have a lot of strong historical benchmarks because even during that time frame, the Fed funds target peaked at 2.5%. Client sensitivity to rates is arguably heightened at today's Fed fund target rate and the yields available on investable cash balances. So while 5% seems reasonable, we are not relying on it potentially being 4%. This is why, as Paul mentioned, we are exploring all the diversified funding sources we can offer our clients that would be attractive to them and also allow us to appreciate the TriState Capital franchise, as they have an independent and diversified funding source as well.

I don't think we focused on determining the lowest points when TriState joined us. When we discussed diversified funding, many wondered why we brought it up, given our record cash deposits. However, we always prepare for these situations. In 2019, we were ready to introduce higher-yielding products since there was little demand for cash, but then we saw a sudden influx of cash deposits. We understand that these dynamics can shift quickly. Cash sorting continues as reported. Whether the bottom is 5% or a bit lower is uncertain. Many of our lower balance deposits, which are significant, have remained very stable. Eventually, the higher deposits will likely find productive uses at current rates, but that impact on the lower balances is minimal, similar to traditional bank accounts. We always prepare for the worst, but outcomes are unpredictable. I hope 5% is the lowest it will go, but we will be ready if it isn’t.

Got it. Okay. Great. And then in terms of deposits, you noted you're allocating more deposits to the bank rather than a third-party bank program. So is there a specific loan-to-deposit ratio or liquidity level that you're thinking about maintaining at a bank? And how should we think about this going forward if cash hoarding continues at the same rate?

Yes. The biggest constraint on that is just sort of the percentage of BDP sweep deposits that we want in our own bank because we always wanted there to be a cushion of balances that are swept to third-party banks in case balances, as Paul said, do decline more rapidly than we expect. So that's really kind of the governing factor. It's roughly at 75% today in terms of the amount of the BDP sweep cash that is going to our own banks. Maybe it will go a little bit higher than that. I mean of the $14 billion to $15 billion of cash with third-party banks, today, a good portion of that could be swapped over to our own bank while still preserving clients' FDIC insurance that we offer them, which is best-in-class in the industry, by the way, as far as we can tell. But we also want to make sure we're being prudent and not exposing ourselves to funding risk by shifting too much over.

Yes. We have ample capital and liquidity. Our primary focus is to support the banks, which is central to our business. The cash sweep acts as a cash overflow and is an important element of our business model. Currently, we are not concerned. We still have options available. However, we have seen instances where some have reached 90% cash, which we find to be a bit too leveraged for our preferences.

Apologies for a two-parter, but it is related. So I'm hoping to just better understand the balance sheet strategy for you guys from here. So on the one hand, Paul, you talked about slowing loan growth in this environment. And then at the same time, you're talking about launching an enhanced yield product on the deposit side, despite the fact that you have lots of liquidity in third-party bank deposit sweep still. So maybe help me understand how much of that $18 billion third-party bank is ultimately sweepable to your bank. How big the enhanced yield program you think ultimately will be for you guys over the next 12 months? And how are you thinking about the overall growth at the bank in terms of the growth in assets?

Yes. The growth in the bank is ultimately driven by client demand. As Paul mentioned, client demand is facing challenges due to changing interest rates. We anticipate these challenges will persist until clients adapt to the new interest rate environment. However, we are committed not to pursue growth aggressively or venture into asset classes that don't align with our clients' needs when demand naturally slows down given the current rate situation. Regarding funding, we want to prepare for the future since one quarter doesn't indicate a trend. Our goal is to support our clients, whether it's in one, two, or five years. Therefore, we are focused on diversifying and strengthening our funding sources to ensure we have sufficient resources when client demand returns. We are confident it will return, although we can't predict when or how quickly. This approach reflects our long-term strategy rather than responding to short-term fluctuations.

In terms of the amount, we don't have a specific figure. What we do is activate the program to start raising funds, and we can always expedite this by informing more clients, enhancing our marketing efforts, or adjusting our rates according to the market competition. There are many ways to accelerate the process, and we have the option to slow it down or halt it entirely. However, none of these actions can be taken until we initiate the program. We have the technology operational and tested, and now we're preparing to expand it. If necessary, we will extend it to a wider range of adviser segments. If we find that our needs exceed expectations and cash flows decrease, we will either slow down or stop the initiative. It's about being ready. The same applies to TriState, which also has external funding sources. We advised to be prepared to activate these options, ensure availability, and gauge interest. If needed, we will adopt a more aggressive approach, but if not, we can simply cease operations. It's a matter of finding the right balance. If we had a clear idea of how much cash we need, we would communicate that. We have an understanding of our funding requirements, although we tend to operate based on models and speculation. Ultimately, the reality is that we don't know for certain, so our goal is to remain adaptable.

Also appreciate you moving back the conference call tonight. Just following up on sort of this last line of questioning. As you think about earning asset growth, can you grow that in an environment where there's sorting and mixed loan demand? And if it does grow, could you talk a little bit about the sort of decision-making between loan growth and the investment securities portfolio?

Currently, in a more challenging and uncertain funding environment, we are focusing on our clients' demands and funding needs rather than our securities portfolio, similar to how we previously prioritized the securities portfolio when managing excess client cash balances. Our balance sheet is mainly designed to serve our clients, which sets us apart from many of our competitors. We genuinely prioritize client demand on both the asset and funding sides. Regarding future loan growth, as Paul mentioned, we are uncertain about what it will be. We won't be pushing for growth aggressively, but we will continue to ensure our advisers provide outstanding advice to their clients. If clients need mortgages, securities-based loans, or if our corporate clients engage in mergers and acquisitions requiring financing, we aim to support them.

Okay. And then just a follow-up. Maybe switch back to capital for a moment. Obviously, you said a pretty strong capital position, as you both have mentioned. Can you update us on what your latest thinking is on where you'd like to have that Tier 1 leverage ratio settle out? And I think you've mentioned a couple of times of opportunities to deploy your capital. Will you be able to buy back the full $1 billion? Or is it a function of potential M&A? And if you're interested in M&A, where might you be looking?

Yes, let me address your question. We prefer organic growth because it is sustained, substantial, and provides consistent net new assets. Even without acquisitions in the PCG space, we are still experiencing growth. However, we are open to acquisitions if the right opportunities arise, though we cannot predict when those might happen. In recent years, there were doubts about our commitment, but we successfully closed three deals relatively quickly. Currently, our balance sheet maintains a Tier 1 target of 10%, which we have consistently met. This target has increased, partly due to earnings and also because of a reduction in the corporate balance sheet. As cash has increased, our ratio has improved without significant changes. We remain committed to achieving the $1 billion target mentioned by Paul, and while we partially met it this quarter, we recognize the need to be more aggressive to fully reach that goal. Regarding other capital opportunities, if a strong acquisition opportunity were to arise requiring substantial capital, we might consider reallocating from buybacks. However, we have no such opportunities at this time, so it remains a theoretical discussion. Our primary focus right now is on our commitment to achieving that $1 billion target.

Paul, could you share your thoughts on net interest income? Considering the average Fed funds, there might be an increase, possibly close to 90 basis points in the first quarter compared to the fourth. However, we also have a change in the deposit mix and higher spot net interest margin as we head into the first quarter. How should we view net interest margin and net interest income in the first quarter? You mentioned your goal to grow net interest income; do you see that happening consistently, or should we anticipate that the negative mix shift might impact net interest income growth after the first quarter? I'm curious about your perspective, whether it's for the first quarter or the full year.

There are many variables to consider. As we enter our fiscal second quarter, we have a spot rate of 3.5% for the bank's net interest margin. This figure does not account for any potential benefits from future rate hikes. Additionally, the bank’s portfolio has grown by 2%, with assets also increasing by 2% sequentially. Even with two fewer days in the second quarter compared to the first quarter, we still believe we can grow net interest income overall in the second quarter. However, this growth may be partially offset by a decline in the BDP fees due to lower balances. We expect the average balances to decrease by about 20% to 25% as we've allocated a larger portion of the funds to the Bank segment, but we will have a higher spread on those balances. We're starting the quarter with a spot rate of 3.2%, which is an improvement over the average yield of 2.7% that we experienced during the first quarter.

I think also is we'd have to really hustle on raising high-cost deposits, which could be significant enough to have a huge impact on that number in the shorter term. But obviously, if the cash dynamic and sorting continues, that will start impacting as we raise. So we'll just have to see how that goes.

Right. Okay. And maybe just as a follow-up, on admin comp and PCG was up, I think, 21% year-over-year, 7% sequentially. Is that a new run rate? Or is there some intersegment? Because I did notice that the comp and benefits line in Corporate, Other was down 20-plus percent. Was there some kind of shifting of those costs among segments? Or is that just a higher upward pressure in that line?

Yes, Jim, I would say that comparing the first quarter to the fourth quarter can be a bit misleading because we make adjustments to the bonus and benefit accruals in the fourth quarter to reflect the actual fiscal year results, and then we reset those in the first quarter. For instance, last year, the PCG admin compensation was around an 11% increase at this time. Therefore, there's quite a bit of variation when comparing sequentially. Additionally, we have acquisitions, such as the Charles Stanley acquisition for the entire quarter this year in PCG, along with overall growth in the PCG business. Looking ahead to the second quarter, we will see the effects of the payroll tax reset as we begin the calendar year. Moreover, we will also experience the impact of salary increases effective January 1. This year's salary increases were considerable. As always, we aim to share in the firm's success with our associates who contribute to that success. Given the inflationary environment and our strong results in the fiscal year, we were generous in providing salary increases, which will be fully reflected in the second quarter.

I have a question regarding the current forward curve and market expectations for the Fed to start cutting rates by the end of 2023 and into 2024. Could you provide insights on deposit betas in a declining Fed funds environment? In the previous rate cycle, adjustments on yields and betas during the initial cuts in 2019 were relatively high and helped support the bank's net interest margin. Is it reasonable to consider that last cycle as a reliable reference for how you might adjust your deposit rates this time around?

We are still struggling to accurately determine the deposit betas in this upward cycle, making it challenging to predict what they will be in a different cycle. This depends on the competitive landscape and several other factors at play. For instance, during the last rate cycle, we saw increases in cash balances due to the pandemic. Consequently, when rates were cut, we did not have a funding requirement; instead, we needed to find ways to allocate the excess cash. This situation may not be replicated when rates drop again. Each cycle is distinct, making comparisons difficult. Many believe that the deposit betas will decrease in a manner similar to their increase, but we cannot be certain about that.

Okay. I have a follow-up regarding the net loan growth in the quarter. Could you help us understand some of the dynamics by loan category? It appears that demand for small business loans has been somewhat softer, while there is still solid demand for mortgages despite the challenging environment. Given the remainder of this fiscal year, where should we anticipate the main source of loan growth to emerge from? Should we expect the slower demand for small business loans to continue in the near term?

Yes, we do provide the detailed end-of-period loans in the supplement, so it may be somewhat hidden there. I understand we have a lot of materials, but there are additional details available. However, you're correct that the SBL balances declined sequentially. This was largely due to significant repayments as interest rates increased dramatically over the past three to six months. Residential mortgages, on the other hand, rose, mainly because many were already in progress before the quarter began. As you know, the mortgage process takes time due to underwriting and closing. Looking ahead, it's difficult to predict the dynamics, as it will depend on client demand. We anticipate headwinds for growth across all loan categories, both floating and fixed, until rates stabilize and clients adapt to the new normal. The fixed rates have also risen, although we don't engage much in that area. Mortgages, in particular, are a category where borrowers are still adjusting to interest rates between 5.5% and 6.5%, compared to just 3% to 3.5% one and a half years ago. This represents a significant change in a short timeframe.

I understand you've mentioned this a few times, but I still have some confusion and would like to ask a follow-up. Paul, you often discuss the liquidity in the balance sheet, and we can definitely see your liquidity on the asset side. I'm not completely clear on why there is a need to raise higher-cost funding through this enhanced yield program when you could allow some of the assets to run off, especially the easily replaceable ones like securities. Could you clarify that for me? Also, we've noticed some competitors launching similar products recently, which has led to a significant shift towards higher-cost funding. Do you have any estimates or rough ideas about how much of that shift you might experience in your own deposit base?

Yes, Brennan, we are continuing to allow the securities portfolio to run off. Much of the growth over the past two years has been related to accommodating client cash balances on the balance sheet. We have built that up well beyond our liquidity targets at Raymond James Bank. Therefore, our funding approach is quite comprehensive. We are also, as Paul mentioned, ensuring that we are prepared on multiple fronts regarding funding. The enhanced yield savings program is starting with a relatively small amount compared to our overall funding requirements. However, as Paul pointed out, we want to make sure that all these sources are activated and functioning so that we can gauge their capabilities and demand. We are learning from this process, and if necessary, we can pursue additional balances through various strategies. But it is challenging to do that if the program isn't even activated.

I am not aware of other institutions that don't utilize CDs or enhanced yield products. They have been actively raising funds. Due to our floating rate balance sheet and our notably high liquidity, both on our balance sheet and in client cash, we haven't needed to take similar actions, which has significantly contributed to our earnings. We could assume that our resources will be sufficient indefinitely, or we can initiate these programs in case demand declines more than the industry anticipates, ensuring we remain well-funded. The reason we are starting these initiatives is as a precaution. If additional funding becomes necessary, we will accelerate the programs. It wouldn't be wise to wait until we urgently need these solutions and do not have any programs established. Many other firms have lacked this flexibility and have had to act aggressively. We have the advantage of flexibility, but as always, we are focused on long-term planning, ensuring these programs are ready to implement. The effectiveness of these programs is confirmed when we actively execute them, collect deposits, and manage operations effectively. From there, we can adjust our approach as needed.

The only additional point I would make is that there is a lot of concern regarding the shift in product mix, which is understandable. However, it's important to note that cash is still being actively managed. We offer the top purchase money market fund platform in the industry, available to clients of any size. It's not that cash is being moved to other higher-yielding options, and financial advisers assist their clients with these choices. To the extent that we can provide a compelling product on our balance sheet that aligns with clients' needs, there are still some concerns about money market funds, primarily because their performance has been lackluster in recent cycles. Therefore, we must provide an FDIC-insured product, which retains funding on our balance sheet while generating a better spread than if it were allocated to those other options—this could be mutually beneficial. That is our perspective on the situation as well.

Yes. Sure. Sure. Totally get you on the substitutes being broadly available. And any sense of your expectations for magnitude of how big this program could be?

No, because it really, frankly, depends on the levers that we pull, right? We have levers around the rate we offer, the size or the count that we limit it to, the size of the deposit, etc. So as Paul said, most of our competitors have already come out with it and had to be aggressive because in the last couple of years, they deployed almost all of their deposits to fund balance sheet growth. We always said, and we took a lot of criticism for it a year or so ago, that we wanted to keep that cash very flexible. And so we don't have the same acute pressures on funding that they have had over the past six months. And so we're able to be more deliberate in sort of figuring out the right balance for clients and for the firm.

I have one last question regarding Capital Markets, specifically about the profitability, or lack of it, in this quarter. I understand that one quarter isn't indicative of a trend. You reported a pretax loss in that segment, and I would like to understand how you plan to manage expenses and compensation given the challenging investment banking environment, especially considering that this is a frequently asked question. The pretax margin was strong for the firm, and the compensation ratio was well managed overall. However, you didn't experience positive compensation leverage this quarter, much of which was impacted by Capital Markets. Any insights you could share on this would be greatly appreciated.

The Capital Markets have been challenging for everyone. One reason is that we did not have a strong quarter. Additionally, unlike many other firms, we do not have any unallocated overhead. While some firms experienced lower results, they have their overhead allocated to specific segments, leading to a fully loaded profit and loss statement, unlike our situation. This quarter was affected by both mergers and acquisitions and the current slowdown in underwriting. Our fixed income business also faced difficulties due to cash dynamics at third-party banks. We will continue with our usual approach, which includes a very variable compensation structure. Although we have raised our bonus bases, they remain lower than many other companies, and we have taken significant pay cuts in the past. Our compensation structure will address these issues, and we'll evaluate our business for necessary adjustments. The positive aspect is that we have been conservative corporately; we have hired many people but still have open positions, and we are being cautious with our hiring to retain essential staff during these cycles. We do not plan on implementing significant layoffs like some other firms.

Thank you for joining us. Overall, while not many companies are reporting record net income to shareholders this quarter, it reflects the strength of our model. However, we acknowledge the uncertainties ahead. We anticipate your questions and are committed to our capital repurchase plans, with the only condition being if we encounter opportunities that could enhance shareholder value. Regarding cash management, we can run forecasts and provide answers based on those, but our experience shows results can vary. Therefore, we intend to raise as much cash as necessary to support the business without raising it unnecessarily. So far, this approach has proven effective. Thanks again for joining the call, and I look forward to speaking with you soon.