Raymond James Financial Inc (RJF) — Q2 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, Chairman 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 integrating acquired businesses, divestitures, anticipated results of litigation and regulatory developments or economic conditions. In addition, words such as may, will, could, anticipates, expects, believes or continue or negative of such terms as well as any other statement that necessarily depends 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 these 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. Now I'll turn the call over to Chair and CEO, Paul Reilly. Paul?

Good afternoon. Thank you for joining us today. Paul and I are joining you from Orlando, Florida. We have over 4,000 people attending our independent advisors conference. It's great to see such an upbeat mood and people really having a good time getting back together as well as all the other educational sessions we have here. Since our founding over 60 years ago, Raymond James has maintained an unwavering commitment to placing clients first through conservative decision-making that keeps us well positioned over the long term. While remaining focused on the long term has not always been easy or fully appreciated in good times, it has served us very well over time. And it's in times such as these when even the financial system itself is challenged that our philosophy not only carries us through but enables us to thrive. Just a few examples of our differentiated positioning that we have benefited recently from include Tier 1 leverage capital ratio of 11.5%, over 2x the regulatory requirements to be well capitalized. 88% of our bank deposits are FDIC insured, including nearly 95% of Raymond James Bank among the highest in the entire industry, and an A-level rating with all three credit agencies which Fitch reaffirmed in March at the height of the turmoil. A few weeks later, we were able to renew and upsize our 5-year committed revolver with enhanced terms, thanks to the fantastic relationship we have with all of our bank partners. Further, we were able to buy back $350 million of shares at what we believe were attractive prices. And we still have $1.1 billion of capacity remaining under our Board authorization. In times like these, we are reminded of the importance of keeping a long-term client-focused approach and our stakeholders' benefit and appreciate the firm's dedication to placing them first. Now turning to our results. Despite the challenging market and the high market volatility during the first six months of the fiscal year, we generated record net revenues and record earnings. Reviewing second quarter results, starting on Slide 4. The firm reported record quarterly net revenues of $2.9 billion and net income available to common shareholders of $425 million or $1.93 per diluted share. Excluding expenses related to acquisitions, adjusted net income available to common shareholders was $446 million or $2.03 per diluted share. The increase in interest-related revenues driven by short-term interest rates drove significant earnings growth over the prior year. Net revenue increased 7% and net income available to common shareholders grew 32%. And despite the challenging market conditions and our robust capital position, we generated strong returns with annualized return on common equity of 70.3% and annualized adjusted return on tangible common equity of 22.3%. Moving to Slide 5. We ended the quarter with total client assets under administration of $1.2 trillion, PCG assets and fee-based accounts of $666 billion and financial assets under management of $194 billion. With our continued focus on retaining, supporting, and attracting high-quality financial advisors, PCG consistently generates strong organic growth, which is evident again this quarter with domestic net new assets of $21.5 billion, representing an 8.4% annualized growth rate on the beginning of the period domestic PCG assets. During the prior 12 months, we recruited through our domestic independent contractor and employee channels, financial advisors with approximately $275 million of trailing 12 production and nearly $38 billion of client assets at their previous firm. Total clients' domestic sweep and Enhanced Savings Program balances ended the quarter at $52.2 billion, down 14% from December of 2022. The sequential decline reflects the expected cash sorting activity, which was partially offset by the launch of our Enhanced Savings Program. We are pleased with the early success of our Enhanced Savings Program. This product offered the PCG clients the Raymond James Bank is a fantastic option for clients seeking competitive rates while maintaining a high level of FDIC insurance. We believe this product is really unique in the industry and certainly appealing in the current environment. As of this week, Enhanced Savings Program balances have surpassed $4.5 billion. Total bank loans decreased 1% from the preceding quarter to $44 billion, primarily reflecting a modest decline in securities-based loans due to a higher interest rate environment. We will touch on this more later on the call, but we plan to remain very prudent with growing our corporate loans over the next several months given volatile market conditions. Moving to Slide 6. Private Client Group generated record results with quarterly net revenue of $2.14 billion and pre-tax income of $441 million. Year-over-year, asset-based revenues declined due to market declines. However, PCG's results were lifted by the benefit of higher interest rates and interest-related revenues and fees. As Paul Shoukry will explain in more detail, this quarter was negatively impacted by some seasonal expenses as well as elevated legal costs. The Capital Markets segment generated quarterly net revenues of $302 million and a pre-tax loss of $34 million. Revenues declined 27% compared to the prior-year quarter mostly driven by lower investment banking revenues as well as lower fixed income brokerage revenues. The extremely challenging market environment, particularly for investment banking, has strained the near-term profitability of the segment. However, we are focused on managing controllable expenses as near-term revenues are depressed. The Asset Management segment generated pre-tax income of $82 million on net revenues of $216 million. The year-over-year decreases in net revenue and pre-tax income were largely attributable to lower assets and fee-based accounts as net inflows into fee-based accounts into the Private Client Group were offset by market declines. Solid net inflows for Raymond James Investment Management helped boost financial assets under management, which should provide a tailwind in the fiscal third quarter. The Bank segment generated record net revenues of $540 million and pre-tax income of $91 million. Revenue growth was largely due to the continued expansion of the bank's net interest margin to 3.63% for the quarter, up 162 basis points over the year-ago quarter and 27 basis points from the preceding quarter. The NIM expansion reflected the flexible and floating nature of our balance sheet. Although as Paul Shoukry will explain, we do expect some headwinds to NIM, which reached very high levels across the industry over the past couple of months. Looking at the fiscal year-to-date results on Slide 7. We generated record net revenues of $5.66 billion and record net income available to common shareholders of $932 million, up 4% and 21%, respectively, over the prior year's record. Additionally, we generated a strong annualized return on common equity of 19.3% and annualized adjusted return on tangible common equity of 24.2% for the six-month period. On Slide 8, the strength of the PCG and Bank segment for the first half of the year primarily reflects the strong organic growth in PCG and the benefit of higher interest-related revenues, whereas the weaker Capital Markets results reflected the challenging environment for investment banking and brokerage revenues, especially when compared to the record activity levels in the year-ago period. And now I'm going to turn the call over to Paul Shoukry for a more detailed review of the second quarter financials. Paul?

Thank you, Paul. Starting on Slide 10. Consolidated net revenues were a record $2.87 billion in the second quarter, up 7% over the prior year and 3% sequentially. Being able to generate record quarterly revenues during a period when Capital Market revenues were so challenged across the industry reinforces the value of having diversified and complementary businesses. Asset Management and related administrative fees declined 11% compared to the prior year quarter and increased 5% sequentially due to the higher assets and fee-based accounts at the end of the preceding quarter, partially offset by fewer billable days in the fiscal second quarter. This quarter, fee-based assets grew 5%, providing a tailwind for Asset Management and related administrative fees in the fiscal third quarter. Brokerage revenues of $496 million declined 12% year-over-year and grew 2% sequentially. This year-over-year decline was largely due to lower asset-based trail revenues in PCG as well as lower fixed income brokerage revenues in the Capital Markets segment. I'll discuss account service fees and net interest income shortly. Investment banking revenues of $154 million declined 34% year-over-year and grew 9% sequentially. As experienced across the industry, M&A revenues were particularly challenged this quarter, declining 37% year-over-year and 15% sequentially. Despite a healthy banking pipeline and solid new business activity, there remains a lot of uncertainty in the pace and timings of deals launching and closing, given the heightened market volatility. It remains too difficult to say when conditions will become conducive to increase investment banking revenues. Moving to Slide 11. Clients' domestic cash sweep and Enhanced Saving Program balances ended the quarter at $52.2 billion, down 14% compared to the preceding quarter and representing 4.9% of domestic PCG client assets. The Enhanced Savings Program added approximately $2.7 billion in new deposits in March as the offering was only open to net new balances until April. A good portion of these new balances were derived from brand-new clients to the firm following the Silicon Valley Bank collapse, highlighting the attractiveness of this product and Raymond James being viewed as a source of strength and stability. As Paul said, the Enhanced Savings Program balances exceeded $4.5 billion this week, continuing to grow nicely and partially offsetting the anticipated decline in sweep balances, largely due to quarterly fee billings in April. So while it's difficult to parse through the disclosures to make sure we're comparing apples to apples, of the handful of peers who have reported thus far, we estimate year-over-year cash sweep declines for those peers were approximately 35% to 45%. This compares to a 35% year-over-year decline in our domestic sweep balances through March. So this dynamic of declining sweep balances has really been experienced at roughly the same order of magnitude for most of the firms in our industry. And as most of you know, we have been expecting, communicating and preparing for the sorting activity for quite some time. Looking forward, we expect additional cash sorting activity, although we believe we are much closer to the end of that dynamic than we are to the beginning if rates settle out near current levels, and the average sweep balance per account over the approximately 3.4 million accounts domestically is now less than $15,000. And we hope to continue to offset any further cash sorting activities through our diversified funding sources, including the Enhanced Savings Program, TriState's deposit franchise and other initiatives. And when the sorting dynamic does stabilize, we would then expect to grow sweep balances given our strong organic growth in PCG. Meanwhile, to be prudent, we would strive to maintain a strong funding cushion of domestic cash swept to third-party banks, not too much lower than where it ended the March quarter. We would also plan to keep elevated cash balances in the Bank segment, which grew from $1.8 billion in December to $5 billion at the end of the fiscal second quarter. While these actions don't optimize net interest margin over the short term, we believe they give us the most flexibility over the long term. Turning to Slide 12. Combined net interest income and RJBDP fees from third-party banks was $731 million, up 226% over the prior year quarter and 1% over the preceding quarter, as a sequential decrease in RJBDP fees from third-party banks was more than offset by higher firm-wide net interest income. The Bank segment net interest margin increased 27 basis points sequentially to 3.63% for the quarter, and the average yield on RJBDP balances with third-party banks increased 53 basis points to 3.25%. Our long-standing approach of maintaining a high concentration of floating rate assets not only helped drive more immediate upside to higher short-term interest rates but also preserve a relatively flexible balance sheet compared to the banks that had much higher concentration of duration risk. Looking forward, we expect combined net interest income and RJBDP fees from third-party banks to decline sequentially in fiscal third quarter due to a decrease in third-party RJBDP fees given the lower average balances with third-party banks. We would also expect the bank segments NIM to contract from the second quarter given the higher level of cash balances we plan to maintain during this volatile period as well as the impact from higher cost diversified funding sources. But as we have always said, instead of focusing on maximizing NIM, we are focused on preserving flexibility and growing net interest income over the long term, which we still believe we are well positioned to do after the cash sorting dynamic is behind us. But near term, we expect headwinds for the net interest income and RJBDP fees for the reasons I just explained. Moving to consolidated expenses on Slide 13. Compensation expense was $1.8 billion, and the total compensation ratio for the quarter was 63.3%. The adjusted compensation ratio was 62.8% during the quarter. The compensation ratio continues to benefit from higher net interest income and RJBDP fees from third-party banks. The sequential increase in compensation reflects higher revenues as well as the impact of salary increases effective on January 1, along with the reset of payroll taxes at the beginning of the calendar year. We are very pleased to generate a 62.8% adjusted compensation ratio given these factors and the extremely challenging market environment in Capital Markets. Non-compensation expenses of $496 million increased 25% sequentially. Adjusting for acquisition-related non-compensation expenses and the favorable settlement received in the fiscal first quarter, which are all included in our non-GAAP earning adjustments, non-compensation expenses grew 16% during the quarter. This increase was largely driven by higher legal and regulatory costs including an unfavorable arbitration award totaling $20 million, along with higher communication and information processing expenses, which reflect continued technology investments and the seasonal impact of year-end mailing. The bank loan provision for credit losses for the quarter of $28 million largely reflects the charge-off of a C&I loan that has been challenged for several quarters as well as higher allowances in the CRE portfolio. I'll discuss more related to the credit quality of the Bank segment shortly. In summary, we remain focused on managing expenses while continuing to invest in growth and ensuring high service levels for advisors and their clients. While there has been some noise with elevated legal and regulatory expenses this quarter and there are always some seasonal expenses that hit in the first calendar quarter of the year, none of the non-compensation expenses are coming in too much differently than we expected when we last provided guidance for the fiscal year. But legal and regulatory expenses are inherently difficult to predict. Slide 14 shows the pre-tax margin trend over the past five quarters. In the current quarter, we generated a pre-tax margin of 19.4% and adjusted pre-tax margin of 20.4%, a strong result given the industry-wide challenges impacting Capital Markets. On Slide 15. At quarter end, total assets were $79 billion, a 3% sequential increase largely reflecting the $3.2 billion increase of cash balances in the Bank segment during the quarter. Liquidity and capital remains very strong. RJF corporate cash at the parent ended the quarter at $1.8 billion, well above our $1.2 billion target. Our Tier 1 leverage ratio of 11.5% and total capital ratio of 21.4% are both more than double the regulatory requirements to be well capitalized. The 11.5% Tier 1 leverage ratio reflects $1 billion of excess capital above our conservative 10% target, which would still be 2x the regulatory requirements to be well capitalized. Our capital levels continue to provide significant flexibility to continue being opportunistic and invest in growth. We were pleased to have our A- credit rating reaffirmed by Fitch in mid-March. In the announcement, Fitch cited the firm's strong capital cushion, significant deposit funding and access to unsecured debt markets, among other drivers as the reason for the rating. Also in April, we renewed our revolving credit facility and expanded it from $500 million to $750 million. A strong balance sheet and long-standing relationships with our banking partners enabled us to upsize the 5-year committed corporate revolver with enhanced terms to further strengthen our contingent liquidity sources. The ability to execute this facility in a challenging market environment is a testament to our long-term conservative approach. I know many of our bankers are listening on this call, so I'd like to thank all of you for your continued support and partnership. We also have other significant sources of contingent funding. For example, just to be proactive, given the market uncertainty in March, we increased our FHLB borrowings in the Bank segment by only $500 million from December 31 to March 31. And given our strong cash position, we've already paid $200 million of that down in April. That leaves us with more than $9 billion of FHLB capacity in the Bank segment. Slide 16 provides a summary of our capital actions over the past five quarters. During the fiscal second quarter, the firm repurchased 3.75 million shares of common stock for $350 million at an average price of $93 per share. As of April 26, approximately $1.1 billion remained available under the Board's approved common stock repurchase authorization. And we currently intend on continuing our planned repurchases as we discussed previously, particularly as this market volatility has provided attractive opportunities for us, and we don't plan on using as much capital to support balance sheet growth over the next 3 to 6 months. Lastly, on Slide 17, we provide key credit metrics for the Bank segment, which includes Raymond James Bank and TriState Capital Bank. The credit quality loan portfolio remains healthy. Criticized loans as a percentage of total loans held for investment ended the quarter at just 0.92%. The bank loan allowance for credit losses as a percentage of total loans held for investment ended the quarter at 0.94%. The bank loan allowance for credit losses on corporate loans as a percentage of corporate loans held for investment was 1.67% at quarter end. We believe this represents an appropriate reserve but we are continuing to closely monitor any impacts of inflation, supply chain constraints, higher interest rates and a potential recession on our corporate loan portfolio. I know there's been a lot of attention on commercial real estate across the industry, given the challenges with property value and interest rates. So let me briefly cover our portfolio. Across the Bank segment, we have CRE and REIT loans approximately $8.8 billion, which represents 20% of our total loans. Our office portfolio is only 17% of these real estate loans. So our office portfolio only represents approximately 3.5% of the Bank segment's total loans. Based on the underwriting and origination along with the most recent appraisals, the average loan-to-value of this office portfolio is somewhere around 60%, which is probably a little bit higher now, given pressure on valuations in the industry, but still providing us a lot of cushion on this portfolio on average. Overall, we have deliberately limited the exposure to office real estate, and we underwrote office loans with what we believe are conservative criteria, but we continue to monitor each loan closely given the industry-wide challenges. Now I'll turn the call back over to Paul Reilly to discuss our outlook. Paul?

Thank you, Paul. And as I said at the start of the call, I'm pleased with our results for the first 6 months of fiscal 2023 and our ability to generate record earnings during what continues to be a very volatile market. And while there is still a lot of near-term economic uncertainty, we are in a position of strength, and I believe we are well positioned to drive growth over the long term across all of our businesses. In the Private Client Group, next quarter results will be favorably impacted by the 5% sequential increase of assets in fee-based accounts. However, we do expect to have some headwinds from lower RJBDP fees from third-party banks, given lower average balances. Focusing more on the long term, I'm optimistic we will continue delivering industry-leading growth as current and prospective advisors are attracted to our client-focused values and our leading technology and product solutions. For example, in our current advisor recruiting pipeline, we have several commitments from teams with $5 million to $20 million of annual production. In the Capital Markets segment, while M&A pipelines remain healthy and engagement levels are good, the pace and timing of launching and closing transactions will be challenged until market conditions stabilize. 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 enhances our position as this business typically benefits from elevated rate volatility and has produced excellent results since joining us. While we expect continued industry-wide challenges over the next couple of quarters, over the long term, we are well positioned across the capital markets business for growth given the investments we made over the past 5 years, which have significantly increased our productive capacity and market share. We will continue to prudently manage expenses in these businesses as the near-term revenues continue to come under pressure. Obviously, we will take more significant actions if the industry headwinds prove to be more long term. In the Asset Management segment, financial assets under management are starting the fiscal third quarter, up 5% compared to the preceding quarter, which should provide a tailwind to revenues if markets remain conducive throughout the fiscal third quarter. We remain confident that 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 solid net inflows this quarter to help drive further growth through increased scale, distribution, operational and marketing synergies. In the Bank segment, our focus over the next several months will continue to be fortifying the balance sheet with diversified funding sources. While we'll continue to support our PCG clients when their demand for loans eventually recover, we will be very prudent in growing corporate loans given market uncertainty. We believe there will be more attractive opportunities in the future as spreads widen to reflect the higher cost of funding and our higher premium required for credit risk across the entire banking industry. And just as we did during uncertain market environments in the past, we have been and will continue to be opportunistic in selling certain loans to further derisk the corporate portfolio, especially when we believe the secondary market prices do not fully reflect the downside risk. So overall, our approach to the Bank segment over the next 3 to 6 months is to build as much dry powder as possible for what we believe will be a more attractive and opportunistic environment for loan growth in fiscal 2024. In closing, we believe we are well positioned with strong prospects for future growth and ample cash and liquidity. Uncertain times like these are when clients need trusted advice the most. And I want to thank our advisors and their associates for their continued perseverance and dedication to providing excellent service to their clients each and every day. The strength and stability of our firm is a direct reflection of your commitment. So thank you all for all you do. And with that, operator, that concludes my remarks, and we'll open up the line for questions.

I hopped on a minute late, but I had a question just on the net interest income outlook. I just want to make sure I understood the commentary. So is the expectation that it's going to take a near-term step back and then can grow off of whatever that new base is? Or Paul, are you saying that you'll kind of resume growth off of the fiscal second quarter level? And I guess related, I heard that you're going to operate, I think, with higher reserves. So just how much of a drag is that? And I guess, what would make you comfortable bringing that down?

Well, I'll let the other Paul go through the NIM. But I don't think we anticipate right now higher reserves. I mean, reserve cash, maybe we'll be carrying a little more cash, but I don't know which reserve you're referring to, so.

Yes. I was referring to the cash reserves, just the cash.

There's more cash in the bank. Go ahead, Paul. I'll let...

We have increased our cash balances at the bank due to the volatility in March, which we consider a prudent decision. We ended the quarter with an increase of about $5 billion, bringing our total cash at the Bank segment to $5 billion. While this is a drag on net interest margin because the cash earns close to 5%, compared to approximately 7% on the new loans being added to the book, we believe this is a necessary measure given the current conditions. Looking ahead, we expect a decrease in net interest income and BDP fees when evaluated together. We plan to maintain our cash swept to third-party banks at around the current level of $9 billion, as this provides a comfortable cushion and ensures clients receive maximum FDIC insurance, which is particularly important right now. Even with $9 billion, we anticipate average balances to decrease by about 25% sequentially, which will also lead to a 25% reduction in fees, depending on interest rates and other factors. Additionally, the net interest income will be impacted by having higher cash balances and the increased funding costs we introduced with the Enhanced Savings Program in March. Overall, we expect a sequential decline of around 10%. As we begin to grow the balances from this point, it should offer a solid starting point for the future.

Got it. Okay. Great insight. I would like to follow up on the same topic, specifically regarding the Enhanced Savings Program. It seems like you're experiencing some positive results there. I'm assuming it's still relatively early in terms of advisor engagement. I would like to discuss the expectations for growth in this area. Could advisors potentially be more proactive in directing their customers' cash into this program soon, given it's a new initiative? Might this impact the rates on the liability side, or do you have data indicating that most of the yield-seeking cash has already been withdrawn from the accounts?

Yes, I would tell you, when we look at sort of the trends, it looks like a lot of the sorting activity, the higher yield seeking activity has occurred. When we rolled out the Enhanced Savings Program in March, it was actually to new money to the firm until we expanded it in April to certain security sales and new money to the bank. But we raised $2.7 billion of brand new flows to the firm during the month of March. Most of it was mid-March strength of banking turmoil. So we were pleased to see that those cash balances come in. But even there we're close to $5 billion today of these balances, that represents roughly 10% of the sweep and enhanced yield savings balances whereas most of our peers are at 50% of their balances being an enhanced yield savings. So our relative cost of funds when you look at those two balances together is still very attractive even though we've been able to be more generous to clients on the sweep balances in terms of passing on rates via the suits as well. So we feel like we're well positioned. And right now, what we're really hoping to do is a lot of clients hold money market fund positions and would prefer to have FDIC insurance. And so a lot of those balances now are moving to the enhanced yield savings, which we think is really a win-win for the clients in the firm.

Maybe just a first question on the leverage ratio, obviously, sitting at 11.5%. Just curious whether you still feel that 10% target to a good level to think about as a near-term target, especially with the macro environment and kind of the uncertainty that we're facing with the macro right now?

Yes. That's the hard one to peg with tests like happening today in the press, even we're going to be more cautious until the industry is sorting down and kind of a level field. We think that the 10% is a good target. But in the short term, we're probably not going to be overaggressive to it, especially if we're not growing the bank aggressively. We don't think that's the smart move right now. We will continue to let SBL balances and mortgage our client balances fund those, those are the priority. We're not sure it's a good time to get into the increasing the corporate side of the lending right now just because of the market. So shorter term, I think the capital ratio is going to be over the 10%, but we're not going to change the goal, but during the volatility like we've seen with today's news and other things, we're going to be cautious to pretty comfortable the market settled down.

The only thing I would add to that is a lot of other banks have to worry about the impact of unrealized losses on their securities portfolio. And we have some of those as well, obviously. But I think we would be north of 10%, even if we factored in all of those losses because we kept duration relatively contained on our balance sheet. So we're in a position of strength when you look at our capital ratios and feel like we have a lot of flexibility.

Great. I have a follow-up question regarding your current stock price. In the first quarter, you increased your buyback. Can you compare your stock's current valuation to any M&A opportunities you might be seeing? It would be helpful if you could elaborate on these opportunities and indicate which segments you believe present the most potential, especially in light of recent developments in the banking sector.

We have effectively maintained close relationships with potential candidates for joining our firm, particularly in the M&A and private client sectors. Some opportunities may be complicated or affected by pricing issues, but discussions that had previously stalled are starting to resume. However, adjustments are necessary for both buyers and sellers to align with market expectations. As we've mentioned, we do not anticipate a significant increase in M&A volume in the near term until the market stabilizes. We believe lending needs to recover, which is contingent upon interest rates settling down and market participants adjusting to that environment. Nevertheless, we remain optimistic about future M&A opportunities. We have sufficient liquidity and a strong balance sheet to capitalize on these prospects, as we typically do during downturns. Ultimately, our ability to seize these opportunities will depend on the dynamics between buyers, sellers, and various market factors.

So can we start with the outlook for NII. If I heard you correctly, I think you guys have gotten to down 10% from wide NII. Can you help with some of the underlying assumptions in terms of NIM from wide and maybe how are you thinking about the ultimate amount of cash that you need to run with on the balance sheet? And obviously, it would be helpful to know what you're assuming for interest rates for the second quarter, underpinning the 10% decline?

Yes, the 10% decline includes the BDP fees as well. It's a combined basis as shown in the presentation, which factors in the 25 basis point increase that the market is anticipating in May. Regarding the cash we intend to maintain on the bank's balance sheet, we plan to hold more than what we might typically need during these volatile times, just to remain prudent. As Paul mentioned, we're being intentional in growing corporate loans and are also being opportunistic in selling them. Therefore, we don't expect much growth on the balance sheet during this period of volatility. For instance, we've already sold over $400 million of corporate loans rated lower from a credit perspective and managed to secure nearly par value for those loans, despite having higher marks on them prior. We don't think the market is fully accounting for the potential downside risk on certain loans. So, as we've done in past volatile periods, we're being opportunistic while building up our capital and funding reserves to accelerate growth when opportunities become more favorable.

Got you. Okay. Yes. Combined makes a lot more sense. I appreciate that. My second question was around non-comp expenses. And I appreciate that you guys think this is close to what you were budgeting for. But if we look at non-comp ex provisions and backing out the $20 million of the arbitration fee, it looks like it was up almost $30 million sequentially. So maybe help us reconcile what's driving the growth? And just given your outlook for effectively peak rates revenues in a challenging capital markets backdrop, when should we expect you guys to become a little bit more aggressive on cost savings initiatives?

Yes. The first two quarters tend to be a bit uneven regarding non-compensation expenses. If we consider the combined figures, excluding acquisition-related costs and the loan loss provision which informed our guidance, it was approximately $830 million for the first half of the year. This actually trends lower than the $1.7 billion guidance I provided for non-comp expenses, not including the provision. We're not changing that guidance for now since, apart from legal and regulatory issues—which are inherently unpredictable—and a $20 million arbitration award we didn't foresee this quarter, most of the other line items align with what we had forecasted when we issued that guidance. However, if circumstances change in the next six months of the fiscal year, we will definitely update you all.

I believe that comparison appears larger due to the $30 million recovery in the last quarter which we adjusted non-GAAP. However, we think they are aligned. Yes, legal fees have increased, and that settlement was higher, but that is somewhat variable. We believe the run rate and the guidance are still reasonable based on our observations.

And with that being said, while it's coming in line with what we expected, we're also given the market environment going to be very deliberate in managing all those expenses while still investing in growth in high service levels.

Maybe stepping back and perhaps it's just too soon tell. As you think about some of the structural changes that may evolve for the banking industry on the other side of the banking collapse and maybe your early-stage conversation with the regulators, how do you see the evolution for regulatory capital or leverage ratios. Does that affect your 10% bogey? And then maybe how you think about long-term growth in earning assets and NIM associated with that.

First, regarding capital, I believe that even at 10%, we are in a strong position compared to our competitors. We still consider that to be a very conservative target. I don't foresee any regulations that would come close to affecting that figure, so we have a buffer. We are not concerned about capital. Given the current environment, we've been focusing on liquidity, which is why we introduced the Enhanced Savings Program. We're pleased that even after the quarter, we managed to pay our $1.2 billion in Asset Management fees from those funds, alongside tax payments that typically exceed $1 billion. Our cash balances remain stable. In terms of liquidity, the main consideration is how much we need to raise in higher-yielding programs, but we feel confident about our liquidity without having to utilize our FHLB advances or our $9 billion buffer. As for investing in growth assets within the bank, we will take a cautious approach. We won't be overly aggressive, but if we see suitable opportunities or M&A prospects, we'll pursue them. Given the challenging banking environment, rising interest rates, and predictions of a potential recession, we believe this is not the right time to aggressively grow corporate loans. Therefore, our growth plans for the next quarter do not involve significantly expanding the balance sheet.

I think you asked a question about the future NIM prospects for the industry. And I think the banking industry is pretty efficient. The good news is we already have a very conservative level of capital. So I think we're well, as Paul said, well positioned for those changes. But to the extent the capital rules do change or increase and certainly the cost of the average deposit in the industry as all the big banks were saying, even the largest banks are saying that's increasing as well, then you would expect all else being equal for spreads to expand across the industry to preserve a reasonable NIM and a reasonable return on equity for the industry. And so to the extent that we can be patient now and wait for more attractive opportunities at least a more stable environment, we think that will serve our shareholders well over the long term.

If you consider the industry in recent years, deposits have been very cheap and rates are increasing. However, the spreads have not met historical expectations, based on the types of loans being issued. In this cautious environment with higher funding costs, we anticipate that spreads will widen. While we cannot specify when this will occur, we believe it is likely to happen, which is why we intend to be more cautious with our balance sheet in the upcoming quarter or two as we monitor market developments. In previous instances, such as when we sold off COVID-related loans, we demonstrated that we can quickly expand our balance sheet. Our primary concern is ensuring that we proceed wisely within the right market conditions.

Understood. Just a quick follow-up and just a jumping one point there. As you think about maybe Paul, Sui you could just unpack, I think I understand the difference between the sort of the bank versus the third-party sweep impact, but maybe unpack maybe where you are on a spot basis for the NIM? And as you think about this year, how to think about maybe earning asset levels, can I hear a couple of different things those cautious loan growth, maybe some runoff in the corporate loan portfolio sales, maybe some shrinkage on the investment securities book, how to think about maybe framing where the end of the year might be in terms of your associated with that.

It's difficult to predict our future, as we've experienced significant changes in the past couple of months, and we can certainly expect more changes in the next six months. We will continue to support our clients in the Private Client Group business. Currently, half of our loans are securities-based loans and mortgages, and if demand increases over the next six months, we want to be ready. Demand has been impacted by the rising interest rates, but it may return as clients adjust to the new rate environment. As for corporate loans, we will adopt a more cautious approach to growth until we have more confidence in the risk-adjusted returns. Regarding our net interest margin, we anticipate some pressure due to higher cash balances and increased funding costs. Our disciplined approach to funding has been beneficial, as we only have 10% of our sweep and enhanced yield savings balances in the enhanced yield savings program, while many competitors have 40% to 50%. This gives us room to grow those balances, but it will also put pressure on our net interest margin. We estimate a potential pressure of about 20 to 30 basis points in the upcoming quarter, depending on future rate increases. This is attributed to the higher funding sources and the elevated cash balances we plan to maintain on our balance sheet.

Can you explain what occurred with cash sorting in March? I ask this because your press release last month mentioned that cash balances as of March '21 were approximately $51 billion. It seems that around $1.5 billion was withdrawn in the last week, excluding the Enhanced Savings Program. Can you share what you were hearing from financial advisors and customers during that time? Additionally, what gives you confidence that this will decelerate moving forward?

Yes. To summarize our current status, we ended the quarter with sweep balances and Enhanced Saving Program balances at $52.2 billion. Today, we are just around $52 billion in Enhanced Saving Program balances, which reflects our quarterly fee billing of over $1.2 billion and annual income tax payments. We feel confident that the sorting dynamic is nearing its conclusion, as the average cash per account in the sweep program is currently about $15,000, marking a low point based on historical data. While we believe we are closer to the end of this trend, we cannot predict how much longer it will last. In the meantime, we will continue to provide attractive products for our clients that offer good yields and strong FDIC coverage to maintain robust deposit balances.

And I think you asked the FA reaction there has been, look, their job was to invest idle cash and they put it in money markets, and they didn't leave the system. They put it in money markets and they put it in treasuries, CDs to get yields and they said just give us the yield. We like the program. So once we roll it out, we've had money flowing in. And so our job is to manage just how much of it we really need. It's in the system. We have a very good product, and we're just going to have to balance that given operations. We feel very comfortable at our levels right now. And with the reserves we have on top that we really haven't touched. So I think it's going to be just the process of managing how much of the higher cost funds you need given the movement in the market.

One other important metric related to this topic is the aggregate deposit data since rates began to rise. It is essential to consider both the sweep program and the Enhanced Saving Program balances. Currently, the aggregate deposit beta for us has only been between 25% and 30%. Based on what we have observed, there is a much higher mix of higher-cost funding at this time. This is despite us being more generous to our clients in the sweep program compared to most competitors. Consequently, if we need to increase some incremental higher-cost deposits, the 25% to 30% aggregate deposit beta is much lower than we all anticipated at this stage in the cycle. Therefore, we have considerable capacity and flexibility to add higher-cost funding while still achieving attractive returns.

That's helpful. And maybe as a related question then. Can you talk about the percentages on the third-party bank fee rates from here as we think over the next few quarters? So after the Fed stops hiking rates, I'm assuming that deposit betas will continue to rise and be a drag. But I guess, at the same time, the demand for these deposits will also likely be strong. Is there some offset from the 12.5 basis points or so of spread that you make on that portfolio?

There's no doubt there's a significant demand for deposits in the system. Banks are eager for cash, so the key issue is what will happen with interest rates. Given this demand, you would expect the spread to increase. If the Federal Reserve stops raising rates or if we see a recession causing cash to flow back into traditional deposit programs, we predict that those spreads would indeed increase, but we aren't experiencing that at this moment. Looking ahead a year, we feel more optimistic compared to the next quarter because we've been in a very dynamic market since March.

It sounds like if balances are relatively flat, third-party bank fees should also be relatively flat beyond the second quarter?

You need to consider the average; the average balances will decrease by 25% even if they remain the same as they were at the end of the quarter. However, the key factor will be the balances, as they will have a greater impact than the spread we earn from the third-party banks, which is the simplest way to explain it. Yes. That's what we believe. Just take it as it comes, and we'll keep it as long as we believe it needs to stay that way and adjust as per the condition. Try to stay within the balance we have. Yes, and as we continue managing cash and reserves, we still need to be really mindful of how much we bring in versus what we need on the business side.

Yes. Good. Thank you all for joining us. I know you're all busy, given all the dynamics in the market. So obviously, an uncertain market. But again, I think the conservative way we run the firm really puts us in good shape. We are at our conference with 4,000 advisors here and they're pretty excited. So it's nice to be here. Thanks for joining us, and we'll talk to you all soon.