雷蒙詹姆斯金融 (RJF) 2020 Q4 法說會逐字稿

Good morning, and welcome to Raymond James Financial's Fourth Quarter and Fiscal Year 2020 Earnings Call. This call is being recorded and will be available for replay on the company's Investor Relations website.

Now I will turn it over to Kristie Waugh, Vice President of Investor Relations at Raymond James Financial.

Good morning. Thank you for joining us. I appreciate your time and interest in Raymond James Financial. With us on the call today are Paul Reilly, Chairman and Chief Executive Officer; and Paul Shoukry, Chief Financial Officer.

The presentation being reviewed this morning is available on Raymond James' Investor Relations website. Following the prepared remarks, the operator will open the line for questions. 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 results of litigation and regulatory developments, impacts of the COVID-19 pandemic or general economic conditions.

In addition, words such as believes, expects, could and would 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 the forward-looking statements. We urge you to consider the risks described in our most recent Form 10-K and subsequent forms 10-Q, which are available on our 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'm happy to turn the call over to Paul Reilly, Chairman and CEO of Raymond James Financial. Paul?

Thanks, Kristie, and good morning, everyone. Thank you for joining us today. Fiscal year 2020 brought some incredible challenges, what a year. In many ways, I'm glad to get it behind us. First, we have the unfolding of the COVID-19 pandemic. Everyone started working from home almost overnight. We experienced social unrest in our country. Uncertain economic outlooks. A presidential and congressional election and a reduction in force, which is extremely rare at Raymond James.

On the other hand, while this year was one of my more difficult years in my career, in many ways, it was also more rewarding because of the way our associates and advisers came together to respond to the crisis, really reinforced our unique culture at Raymond James.

We kept true to our guiding principles, our core values of conservatism, looking long term and focusing on serving our clients. That resulted in great growth even during this period of time, and recruiting was very strong. Net new assets, great retention, all resulted in record client assets under administration. So I want to take this opportunity to say thank you. Thank you to all of our associates and advisers for their tremendous contributions and their unwavering commitment to serving their clients.

Now let me turn to the financials, starting on Slide 3. In the fiscal fourth quarter, the firm reported net revenues of $2.08 billion, net income of $209 million and earnings per diluted share of $1.50. Excluding expenses of $46 million associated with the reduction of workforce and a $7 million loss associated with the pending disposition of certain noncore operations in France, adjusted quarterly net income was $249 million and adjusted earnings per diluted share was $1.78.

Return on equity was 11.9% and adjusted return on tangible common equity was 15.3%. Quarterly net revenues grew 3% over the prior year's period and 13% over the preceding quarter, primarily driven by higher asset management and related administrative fees, strong fixed income brokerage revenues and record investment banking revenues, which were partially offset by the negative impact of lower short-term interest rates.

Quarterly expenses were higher due mainly to compensation expense associated with higher compensation compensable revenues and reduction in workforce expense incurred during this quarter.

While the loan loss provision was higher on a year-over-year basis, it declined significantly from the preceding 2 quarters as the economy and economic conditions tended to stabilize and credit quality of the loan portfolio remained resilient. But given the high degree of market uncertainty, we still wanted to be prudent in adding to our reserves.

Looking at the fiscal year 2020 results on Slide 4, we generated record net revenues of nearly $8 billion, but lower short-term interest rates and higher loan loss reserves caused the net income to decline to $818 million.

On an adjusted basis, net income was $585 million, down 20% compared to the adjusted net income in fiscal 2019. Record revenues grew over the prior year as the continued growth of client assets, along with record fixed income brokerage and investment banking revenues, offset the negative impact of lower interest rates. We generated record revenues in the Private Client Group, Capital Markets and Asset Management segments during the fiscal year, reinforcing the value of having diverse and complementary businesses.

Moving on to Slide 5. We ended the quarter and fiscal year with period-end records for total client assets under administration of $930 billion, Private Client Group assets and fee-based accounts of $475 billion and financial assets under management of $153 billion. The strong client asset growth was predominantly driven by equity market appreciation and our continued success in recruiting and retaining financial advisers across all of our affiliation options.

During the fiscal year, we had a net increase of 228 financial advisers to end with a record number of 8,239, a solid result, particularly given delays in recruiting and onboarding of advisers during the onset of the COVID-19 crisis.

During the fiscal year, financial advisers was over $275 million of trailing 12 production and approximately $49 billion of assets at their prior firms affiliated with Raymond James domestically. That includes recruiting results during the fourth quarter of $82 million of trailing 12 production and $13.8 billion of assets at their prior firms, which was by far our best quarter for recruiting during the fiscal year.

As for our net organic growth results in the Private Client Group during the year, we generated domestic PCG net new assets of $49 billion, representing 6.5% of domestic PCG client assets at the beginning of the year. Based on what we've seen, we believe this to be amongst the very best in our industry even including the e-brokers who benefited from the surge of day and online trading during the year.

Looking forward, we are continuing to experience strong recruiting activity across all of our affiliation options as we enter fiscal year 2021. At the quarter end, net bank loans were $21.2 billion, as growth of loans to the PCG clients was offset by a decline in corporate loans.

Moving to the segment results on Slide 6. The Private Client Group generated quarterly net revenues of $1.39 billion and pretax income of $125 million. Quarterly net revenues grew by 12% over the preceding quarter, predominantly driven by higher asset management and related administrative fees, reflecting higher assets and fee-based accounts, which will continue to be a tailwind for the first quarter of fiscal 2021. This strong revenue growth helped PCG's pretax income grew 37% sequentially. And although it was down 13% on a year-over-year basis, primarily due to the negative impact of lower short-term interest rates.

The Capital Markets segment generated record quarterly net revenues of $410 million and record pretax income of $106 million, a truly amazing quarter for Capital Markets, driven by broad-based strength across fixed income, global equities and investment banking as well as the Raymond James tax credit funds. During the quarter, fixed income brokerage revenues continued to benefit from a high level of client activity, particularly with small and midsized depository clients. Record investment banking revenues were driven by the strength in equity underwriting, M&A and debt underwriting.

The Asset Management segment generated quarterly net revenues of $184 million and record pretax income of $78 million. Record quarterly pretax income was driven by the growth of financial assets under management as equity market appreciation and net inflows into the PCG fee-based accounts more than offset the net outflows for Carillon Tower Associates.

Lastly, Raymond James Bank generated quarterly net revenues of $161 million and pretax income of $33 million. Compared to a year ago quarter, net revenues declined primarily due to lower net interest income as lower short-term interest rates caused net interest margin to decline 121 basis points compared to a year ago period. The quarterly loan loss provision of $45 million increased the allowance for loan losses as a percentage of loans to 1.65%.

On Slide 7, you can see the fiscal year results for all of our segments. The firm's record revenues were driven by record revenues in the Private Client group, Capital Markets and Asset Management segments, a reflection of our attractive organic growth and consistent market share gains across businesses. Additionally, the Capital Markets segment -- management segment generated record annual net pretax income as both segments generated significant operating leverage during the year.

Meanwhile, the pretax income declined in both Private Client Group and Raymond James Bank segments due to lower short-term interest rates and higher loan loss provisions at the bank.

And now for a more detailed review of the financial results, I'll turn the call over to Paul Shoukry. Paul?

Thank you, Paul. I'll begin with consolidated revenues on Slide 9. Record quarterly net revenues of $208 billion grew 3% year-over-year and 13% sequentially. Asset Management fees grew 9% on a year-over-year basis and 16% sequentially, commensurate with the sequential increase in fee-based assets.

Private Client Group assets and fee-based accounts were up 7% during the fiscal fourth quarter, which will provide a tailwind for this line item for the first quarter of fiscal 2021. Consolidated brokerage revenues of $495 million grew 10% over the prior year. This continued strength in fixed income trading helped fuel this growth. For the year, consolidated brokerage revenues were up 8% to almost $2 billion, lifted by strong institutional fixed income brokerage revenues of $421 million, which were up 49% over fiscal 2019.

While the fixed income business is continuing to benefit from high client activity levels, these revenues are inherently difficult to predict. So I think a reasonable assumption for fiscal 2021 is that these brokerage revenues may end up somewhere between the results in fiscal year 2019 and the record achieved in fiscal year 2020. But again, it is highly uncertain and will largely be driven by market conditions throughout the year.

Account and service fees of $140 million declined 22% year-over-year, primarily due to the decrease in RJBDP fees from third-party banks due to lower short-term interest rates, which I'll discuss along with net interest income in more detail on the next 2 slides.

Consolidated investment banking revenues of $222 million grew 41% year-over-year, achieving a record result driven by strong equity underwriting, debt underwriting and M&A advisory revenues. For the fiscal year, we generated record investment banking revenues of $650 million, which were up 9% over the prior year's record, really an amazing result given the high degree of market uncertainty during the year.

While our investment banking pipelines are robust, closings will largely be dependent on conducive markets, which we can't necessarily count on, given we are still in the middle of a global pandemic.

Turning to Other revenues, which were $57 million for the quarter. This line included $12 million of private equity valuation gains, of which approximately $3 million were attributable to noncontrolling interest reflected in Other expenses. Additionally, tax credit fund revenues finished the year with a very strong fiscal fourth quarter.

Moving to Slide 10. Clients' domestic cash rebalances, which are the primary source of funding for our interest-earning assets and the balances with third-party banks that generate RJBDP fees, ended the quarter at $55.6 billion, increasing 7% sequentially and representing 6.7% of domestic PCG claim assets.

On Slide 11, the top chart displays our firm-wide net interest income and RJBDP fees from third-party banks on a combined basis, as these 2 items are directly impacted by changes in short-term interest rates. As you can see, the interest rate cuts have put significant pressure on these revenue streams, which, on a combined basis, are down $143 million compared to the prior year's fiscal fourth quarter. This has had and is expected to continue to have provided significant headwinds for our compensation ratio and pretax margin, particularly as these revenue streams are not directly compensable.

On the bottom of Slide 11, RJ Bank's NIM was 2.09% in the fourth quarter, just below the range we guided to last quarter. The sequential decline in NIM was predominantly caused by the decline in LIBOR as well as a higher concentration of lower-yielding agency-backed securities on the bank's balance sheet. But remember, while the agency-backed securities reduced the bank's NIM, they do represent an increase in spread compared to what we earn off balance sheet with third-party banks. If LIBOR rates have bottomed up, going forward, the bank's NIM should really be impacted more by asset mix and market spreads. So based on what we know now, we are expecting the bank's NIM to be around 2% in fiscal 2021.

On the bottom right portion of the slide, the average yield on RJBDP fees of 33 basis points, while down significantly year-over-year due to the lower short-term interest rates, was flat sequentially. We expect this to remain around 30 basis points in fiscal 2021.

Moving to consolidated expenses on Slide 12. First, compensation expense, which is by far our largest expense. The compensation ratio decreased sequentially from 69.6% to 68.1% during the quarter, primarily due to record revenues in the Capital Markets segment, which had a 56% compensation ratio during the quarter. The year-over-year increase in the compensation ratio was primarily due to the negative impact from lower short-term interest rates, as I explained on the last slide.

During the quarter, we announced a reduction in force, which is something we very seldom do, given our strong culture and the value we place on stability at Raymond James, but the reduction was unfortunately unavoidable, given the significant impact of the unexpected interest rate cuts in March.

All else being equal, we expect a reduction in force to benefit the compensation ratio and consolidated pretax margin by approximately 100 basis points starting in the fiscal first quarter of 2021. However, it is important to remember that the compensation ratio is also impacted by revenue mix, given the different compensation ratios in each one of our segments. PCG has the highest compensation ratio due to the independent contractor channel where advisers receive high payouts because they cover most of their overhead expenses like real estate. The compensation ratio is also impacted by the level of recruiting activity as transition assistance was amortized in the compensation line. For example, this year, adviser transition assistance and retention amortization had an impact of approximately 340 basis points to the firm's overall compensation ratio.

So a lot of moving parts, but given near 0 short-term interest rates, we are confident we can maintain a compensation ratio of 70% or better, especially after the reduction in force, and that's utilizing conservative assumptions relative to the record Capital Markets results we achieved in the fiscal fourth quarter and fiscal year 2020. I will touch a bit more on compensation on the next slide.

On to non-compensation expenses. Non-compensation expenses of $408 million, increased 17% year-over-year as lower business development expenses were more than offset by a higher bank loan loss provision, along with $46 million associated with reduction in workforce expenses and a $7 million loss associated with the pending disposition of certain noncore operations in France. Other expenses also increased during the quarter due to several items hitting during the quarter, including a reserve for state franchise taxes, the aforementioned noncontrolling interest associated with the private equity valuation gains and a couple of other items.

I know many of you may ask what our guidance is for non-compensation expenses in fiscal 2021. Unfortunately, there's just too much uncertainty to provide guidance on that line item. For example, business development expenses and bank loan loss provision expenses are 2 items that will be heavily influenced by the COVID-19 pandemic and the economic recovery throughout the year. What I can tell you is we are extremely focused on managing each and every single one of the controllable expenses while still investing in growth in high service levels for our advisers and their clients.

Turning to Slide 13. There's been a lot of focus on our expense management over the past few years. So we thought it was appropriate to take a minute to reflect on the trend. This chart depicts the year-over-year growth rates of administrative compensation expense in the Private Client Group segment since fiscal year 2016. We highlight this particular expense item because it incorporates the majority of the compensation growth associated with the infrastructure buildup we have been focused on over the past several years, including the majority of technology, operations and risk management and control areas as we fully allocate almost all of these expenses to the businesses and PCG is by far our largest business.

As you can see, after short-term interest rates started increasing at the end of 2015, we have reinvested a large portion of the spread benefit into our businesses to strengthen our platform. About 2 years ago, we told you that we would start decelerating that growth, which you can really see this fiscal year with a 4% growth rate. And after our recent reduction in force, we expect this growth rate to be even lower, maybe even close to flat in fiscal year 2021. And remember, this administrative compensation also includes growth-related expenses like new sales assistants that joined the firm with a recruited adviser. So we hope to see this line grow over time, just as long as we keep it lower than long-term revenue growth.

So this slide really highlights 2 things. First, we use this benefit of higher spreads to reinvest in our business and ensure we have a platform that can support our future growth. And we are glad we took advantage of that window of opportunity as we wouldn't want to be playing catch up with our infrastructure investments in this rate environment. And secondly, the deceleration of these expenses reinforces our long-standing approach to managing controllable expenses, especially during difficult market environments.

Slide 14 shows the pretax margin trend over the past 5 quarters. Pretax margin was 12.3% in the fiscal fourth quarter of 2020 and adjusted pretax margin was 14.9%. Again, I know many of you would want our guidance for this metric, but there's just simply too much of market uncertainty in the midst of this pandemic to give you targets with any level of confidence. But the margins this quarter were obviously boosted by the record Capital Market results as this segment generated a 26% pretax margin, which is a record.

On Slide 15, at the end of fiscal fourth quarter, total assets were approximately $47.5 billion, a 6% sequential increase. This increase was primarily attributable to shifting client assets from third-party banks to Raymond James Bank for the continued purchases of securities. Liquidity is very strong. Cash at the parent was more than $2 billion, of which about $1 billion are excess cash over our conservative targets. But we are intentionally maintaining even more cash than we typically hold given the high degree of market uncertainty. So with cash at the parent of more than $2 billion, a total capital ratio of 25.4% and a Tier 1 leverage ratio of 14.2%, we have substantial amounts of capital and liquidity with plenty of flexibility to be both defensive and opportunistic.

Slide 16 provides a summary of our capital actions over the past 5 quarters. In the fourth quarter, we repurchased approximately 678,000 shares for $50 million, an average price of approximately $73.75 per share. As of October 27, 2020, $487 million remained available under the Board's current share repurchase authorization. In total, over the past 5 quarters, we returned nearly $680 million to shareholders through dividends and repurchases under the Board's authorization. With our strong capital liquidity position, we expect to continue share repurchases of at least $50 million per quarter to offset share-based compensation dilution in fiscal 2021, and we will certainly consider doing more buybacks during the year as well as appropriate.

On the next 2 slides, we provide additional detail on the bank's loan portfolio. Slide 17 provides some detail on Raymond James Bank's asset composition. In the pie chart, you can see we have a really well-diversified portfolio with the focus over the past few years to grow residential mortgages and securities-based loans to Private Client Group clients as well as significantly increase the size of the securities portfolio, which ended the quarter at $7.7 billion or 25% of the bank's total assets. These securities are almost all agency-backed securities. So we have a much more diversified portfolio now than we did before the last financial crisis. The slide also highlights the diversification we have within each segment of the portfolio.

Lastly, on Slide 18, we provide key credit metrics for Raymond James Bank. During the quarter, we opportunistically sold approximately $340 million of corporate loans at the average selling price of 92% of par value. In total, over the past 2 quarters, we sold nearly $700 million of corporate loans associated with industries we believe are most vulnerable to the COVID-19 pandemic. While we are now much more confident with the remaining corporate loans in our portfolio, we will continue to be opportunistic in selling certain corporate loans but we've also recently resumed being opportunistic and deliberate in investing in new corporate loans that are in sectors that we believe are less negatively impacted by the COVID-19 crisis.

Quarterly net charge-offs of $26 million were all related to the aforementioned loan sales during the quarter. The quarterly loan loss provision of $45 million resulted in the allowance for loan losses as a percentage of total loans to increase to 1.65%. And for the corporate portfolios, the allowance for loan losses as a percentage of C&I loans increased to 2.7% and for CRE loans, it increased to 3.1%. While nonperforming assets remained low at just 10 basis points of total assets in the fourth quarter, the amount of criticized loans increased as we have still been proactive in downgrading loans as we get more information, but we have experienced positive trends with deferrals during the quarter. As of September 30, only 11 of our corporate loans representing 1.7% of balances were on COVID-related deferrals, which was down from 3.1% in the preceding quarter. Similarly, residential mortgages on COVID-related deferrals declined from 2.6% of balances in the preceding quarter to just 1.6% of balances at the end of the quarter.

We implemented CECL on October 1, which we expect will increase our allowances by approximately $40 million to $50 million. With the majority of that increase attributable to recruiting and retention-related loans to financial advisers in PCG, which now require a larger allowance under CECL than it did under the incurred loss method. Going forward, our allowances and provision expenses will be impacted by macroeconomic conditions as well as individual loan performance using the CECL models. And as the surge in COVID cases over the past 2 weeks has reminded us we are not out of the woods yet.

Now I'll turn the call back over to Paul Reilly to discuss our outlook. Paul?

Thank you, Paul. As for our outlook, we are extremely well positioned entering fiscal 2021 with strong capital ratios and quarter end records for client assets and a number of Private Client Group financial advisers. However, we will face continued headwinds from a full year of lower short-term interest rates, and there's still a high degree of uncertainty given the COVID-19 pandemic and upcoming presidential and congressional elections.

In the Private Client Group segment, our financial adviser recruiting pipeline is strong across all of our affiliation options, and the segment is going to benefit by starting the fiscal first quarter of 2021 with a 7% sequential increase of assets in fee-based accounts.

In the Capital Markets segment, investment banking activity levels remain strong, and we're cautiously optimistic so long as the economic conditions don't deteriorate that, that will continue. And in fixed income, brokerage revenues have remained strong thus far in October, but we've set a high bar to keep up with for next year.

In the Asset Management segment, results positively impacted by higher financial assets under management as long as the equity markets remain resilient. And Raymond James Banks will continue to benefit from the attractive growth of mortgages and securities-based loans to PCG clients.

Given the high degree of uncertainty, we'll continue to be conservative and cautious of adding to the corporate loan portfolio, and we will be ready and willing to resume more significant corporate loan growth when the economic outlook is more certain. Our growth priorities remain unchanged. Our top priority is organic growth, which is primarily driven by retaining and recruiting advisers in the Private Client Group. And as I stated earlier, our annual organic PCG domestic net new asset growth of 6.5% in fiscal year 2020 has been best-in-class in the industry despite the COVID-19-related challenges. Additionally, we are continuing to add senior talent in our other businesses, such as investment banking.

We also continue to actively pursue acquisitions. We will still be deliberate and pursue only transactions that are a great cultural fit as well as a strategic and economic benefit. We are entering into more discussions than ever as we see the year-end coming closer and the economic uncertainty that's brought more people to the table.

As Paul Shoukry mentioned, we are still continuing to repurchase shares to offset share-based compensation dilution and are prepared to increase repurchases as appropriate when the economic outlook is clear.

Before we open the line for questions, I want to thank all of our associates and advisers again for their invaluable contributions during these trying times. I'm incredibly proud of our accomplishments and the tireless efforts to support each other and our clients. We are entering fiscal 2021 well positioned in all of our businesses, and we have significant opportunities for continued growth. We have something special here at Raymond James, where we have the scale and scope of services to compete with the largest firms in the industry, while at the same time, having this unique adviser and client-facing culture that's increasingly difficult to find in our industry. As long as we preserve that unique competitive advantage and adviser-centric attitude, I am confident in our ability to generate relatively attractive long-term returns for our shareholders in any market.

With that, operator, I'd like to open it up for questions.

(Operator Instructions) Our first question comes from the line of Manan Gosalia with Morgan Stanley.

I know you don't have any guidance around pretax margins in the near term and even noticed that there's a lot of uncertainty, especially on the noncomp side. But I was wondering if you can help us with where you think you can manage the business once we're past the loan loss cycle, but we still have lower rates? And as you speak to that, maybe you can also talk to what the puts and takes are from 14.9% adjusted margin you had this quarter? And what the headwinds are from your -- I know it's rate and then hiring, but it also sounds like you have some more room on the expense side. So if you can give us more details there.

Yes. Like you said, a lot of moving parts. Obviously, the record result in Capital Markets, which generated, I think, a 26% margin, certainly lifted the firm's overall margins and that's just a high bar going forward. And then business development expenses, obviously, still subdued given the COVID-19 pandemic and the provisions are elevated. Hopefully, they're elevated. Hopefully, they get better going forward as we have more economic certainty. So a lot of puts and takes, which is why it's hard to give you guidance here near term. What I can tell you is if you look historically at our pretax margin, last time we were in a kind of near 0 rate environment. We were generating roughly a 15%-type pretax margin. Now we're entering this period with higher recruiting results coming into this period. So that leads to higher transition assistance amortization. I think the impact of that relative to that period of time is about 100 basis points. So we're not really ready to give targets yet. But if you just do that math, it gets you to about a 14% to 15%-type pretax margin. But again, that could be 2 years out, I mean, depending on market conditions.

Yes. I think the other challenge is Private Client Group will have tailwinds with a 7% start in their asset base into the quarter. But obviously, Capital Markets had very, very strong results and especially when you go to a quarter, I mean, Capital Markets is lumpy by nature, closings are lumpy by nature. So it's just challenging to come with a number. But again, we're razor focused on expenses. We've operated in that 14% to 15% margin when we had no help from interest rates, not that many years ago, so in the same team. So we're focused on managing our expenses and on growth. So it's just hard to give guidance given pandemic may impact loan loss reserves, which will certainly impact the numbers or company continue to operate in our portfolio, they won't be elevated. So it's just too difficult to give the number.

Got it. And then maybe on the security side, you added about $2 billion to your securities book this quarter. But at the same time, it looks like deposits at both third-party banks and RJF Bank were up quite substantially in the quarter. So you're getting a fair amount of deposit growth. Do you have some sort of target amount that you are comfortable holding in securities? And can you talk a little bit about how you're thinking about the duration risk if the long end of the curve moves up for there?

Yes. I think we still want to be more exposed to the short end of the curve than the long end of the curve, just given the floating rate nature of our deposits. So we did grow security substantially. But if you think about our balance sheet priorities in terms of where we want to grow the bank, the first priority would be growing loans to Private Client Group clients both mortgages and securities-based loans really because it has two-pronged benefit. The first is it helps us strengthen -- our adviser strengthen their relationships with their clients with really what's a competitive mortgage and securities-based loan offering. And it's also -- it also generates a very good risk-adjusted return for the bank. So it's sort of a win-win, which is why that's the highest priority and fortunately has been growing pretty consistently at an attractive rate.

Our second priority typically is growing the corporate loan portfolio. But obviously, given the pandemic that we're in the midst of, we've actually been selling loans, as you know. And we're going to be very selective in adding new loans that are less exposed to the COVID-19 pandemic.

And then really, our third priority is growing the securities, particularly now when the incremental yield you get for the duration exchange is paltry relative to the risk return trade-off. So we're going to do that all in the context of trying to keep the bank's stand-alone Tier 1 leverage ratio at around 7.5%, give or take, which is where it is now after we've grown the securities portfolio right around 7.5%.

Now we could always -- we have a lot more capital. We have a 14% ratio at the firm overall. So we could always contribute more capital to the bank if 1 of those 3 categories of assets at the bank generate higher volumes at attractive risk-adjusted returns. So that's kind of how we're thinking about it. So while we have a lot of capital and cash capacity to grow the bank more rapidly, given where we are in the midst of this COVID-19 pandemic, I think we're going to be very patient in deploying that capacity.

So it sounds like you would end up -- sorry, go on.

Go ahead.

I was just saying so...

Go ahead.

So it sounds like you would end up growing the securities book just in line with the cash inflows that you're getting from clients?

It's probably oversimplification. I think we'll just grow it to sort of as we have excess capacity to grow the bank's balance sheet relative to the loan growth.

Up next, we have a question from the line of Steven Chubak with Wolfe Research.

This is Michael Anagnostakis filling in for Steven. Congrats on the great quarter. I just wanted to start off with 1 on the expense savings opportunity. I guess my question is, based on the expense actions you're taking, assuming some normalization of activity, how should we think about efficiency levels or how we're going to see that impact flow through the expense run rate? And should we expect a slower pace of expense growth from here?

Yes. I think what I said in my prepared remarks was that the reduction in the workforce would benefit the compensation ratio and the pretax margin, all else being equal, which it never is, but all else being equal, it'd benefit those 2 metrics by about 100 basis points starting in the fiscal first quarter of 2021.

I think that certainly, the difference is you saw the expense chart that Paul talked about earlier. So we're managing expenses very tightly. So it certainly, we see this year on an apples-to-apples basis, that growth, as Paul said, could be near 0. So we're managing it very tightly now. If the economy opens up and there's more the business development and conferences, certainly, that will impact expenses. But I think as you can see the expenses of managing down even before the pandemic by the results last year and the expense from the reduction in force really benefit starting this quarter. So I think you're going to see tighter -- much tighter business expense management given the environment just as we did years ago in a 0-rate environment.

All right. Great. My follow-up, maybe just pivoting over to M&A. We've seen continued consolidation in the Asset Management space. Could you give some color around your appetite for potentially doing a deal in that space or maybe other areas?

Yes, I think our priorities on M&A haven't changed. First is, we focused on the Private Client Group. It's an area of where -- it's our main business, but there aren't a lot of opportunities generally in that space that move the needle and our type of wealth management business, but certainly are active there and are proactive reaching out. And then it is the same, we've continued to grow that business organically through recruiting and through strategic niche acquisitions and certainly are looking there. And Asset Management is also an area we've looked to add to the products and opportunities.

So those are the areas we focused on, but we're open parts to any parts that actually improve our businesses and strategically will have a long-term impact. We aren't looking at deals for size. So there's been (inaudible) periods in the market. It's really just a, I call it, financial engineering or lower revenue or adviser or we're looking at really staying true to our core businesses and growing on expanding our service offerings, not just being bigger for bigger sake.

Continuing on, we now have a question from the line of Bill Katz with Citigroup.

First question, just maybe staying on the capital management fee for a moment. You mentioned that you obviously have a lot of firepower in the balance sheet and that you've looked to sort of pick up buyback as sort of things improve. Could you give us a sense of what milestones you might be looking at, at the macroeconomic level to sort of get that comfort? Or perhaps some kind of valuation metric of your own stock that we can monitor to sort of see or anticipate something more than just the offset of stock-based comp dilution?

I mean that's a very complex question. So I mean, in terms of we've long term have talked about customer valuation metrics as we've looked to repurchase. The difference right now is the environmental outlook, which is hard to see. So there's a lot of -- there's also a lot of negative implications looks where regulators look harder on share repurchases and so it does, I'll call it, public interest in share repurchases.

So we're at a time right now where as we look at wave 2, which is obviously hitting the country is when do we think we're through that. And that we want capital, not just for defensive purposes, but we also believe that there is a more difficult economic time, as we've seen this period drag out a little longer, more interest in people doing things. So that's going to be a judgment call. I'd -- it's not clear what's going to happen in these next couple of quarters with the pandemic. And so until we get a view on that, that we think we can get solid economic returns off that, we're going to hold back to make sure that we have plenty of capital to be both defensive and offensive. So I can't give you a clear answer on that.

Okay. That's helpful, nonetheless. And then maybe just a follow-up question for either you or Paul. Just in term -- I appreciate all the guidance around expenses where you can. Given your very strong recruiting pipeline, I appreciate that this is a very fluid fiscal year for you. The business development costs in this particular quarter, is this a fair run rate relative to the recruitment pipeline? Or is there some potential lift in that given the very strong recruitment pipeline that you're speaking to?

Yes. I mean, the business development costs are down 50%. I think year-over-year it just reflects a lack of travel, client-related activity relative to normal activity levels. So I would expect as we get through the COVID crisis for business development costs to expenses to get much closer to where they were, maybe even going back to the first quarter of the fiscal year, even with that elevated recruiting. But again, it will depend on how much recruiting we do going forward. But I would say this -- certainly, this quarter's number was very low.

And a lot of that too, there are big numbers and conferences and things that have been postponed, but we don't see really coming certainly. We've moved back everything through the first half of the year. But our Chairman's reward trips, our educational conferences are important to us and our culture, but those will resume at some point, but we don't see them coming in these next few quarters. And truth is, in recruiting, we have a lot of different recruiting. We have a lot of commitments that have pushed back joining dates because of COVID. And when that breaks through, I think we'd expect still a very, very robust recruiting, but I don't think that recruiting line in itself is a big driver of short-term business development expenses.

Next, we have a question from the line of Chris Harris with Wells Fargo.

So really strong quarter for investment banking. You highlighted that. Can you guys maybe unpack the drivers for us a little bit more and really just kind of interested to know like how broad based the strength is that you're seeing in investment banking or whether it's somewhat concentrated in a handful of transactions? And then how are you feeling about the sustainability of the revenues that you're seeing in I-banking?

I can just tell you it's been pretty broad based. Our largest groups, tech services and real estate have continued to perform well and continue to perform well. And I think their backlogs are very strong as well as banking across all of our sectors, as you can see from the industry is up. So I would say our top-performing sectors have continued to outperform, and the other sectors are having good years also. So it's pretty broad based. And if you look at backlog for -- backlog is not any good. Unless the deal closes, it's very, very strong. So again, we've seen deals shut off and we've seen deals accelerate. And I don't know if there'll be a rush at the end of the year, if there's presidential and congressional changes and anticipated tax rate changes, whether that rushes deals to close at year-end. But -- so it's just hard to tell, but I can just tell you the activities is broad based.

Okay. Great. And just a quick follow-up for Paul Shoukry. I know there's a lot of moving parts to the loan portfolio. You want to be selective with C&I, but you could potentially see some growth in other areas. Maybe you'll sell some more loans, maybe not. Given all of that, could we potentially see growth in the loan portfolio for fiscal '21?

I think it's possible, especially depending on the growth in the Private Client Group loans. Securities-based loans, I think we hope to still continue growing at over 10% and the mortgage growth has been pretty strong as well. So that's certainly possible. I think what we're trying to do going forward is if you look at the slide that shows the combined interest -- net interest income and the BDP fees from third-party banks, because you have to really look at it on a combined basis.

What we're hoping is that this quarter -- I hate to call it a trough because you never know, but certainly, the short-term rates has sort of been fully reflected in the loan portfolio, all the floating rate loans, almost all of them have reset. And so we hope to grow that number from this point forward, assuming cash balances remain relatively resilient at the current levels. So that's the hope. But again, if we don't grow loans this year as much as we can, given our capacity for cash and capital capacity, then that will just give us more dry powder for the next year.

And we're going to grow loans when we're -- especially the corporate loans when we're comfortable with the sort of economic environment and the lack of certainty -- there's less uncertainty than there is now. And we're looking at this. We're making long-term decisions. So if it takes 2 years to get to that level of comfort, then we'll have more dry powder then, and that rate of growth will be higher then if we don't grow it as much this year. So we're going to be patient and make the best decisions based on what we know in the economic environment.

We are starting to see some core growth opportunities that look like decent spreads and some floors and some -- you go through cycles. And so whether that continues or strengthens, I don't know. But again, I agree with Paul, we're going to be cautious on those. We are staying in the flow and looking at those opportunities.

Continuing on, our next question comes from the line of Jim Mitchell with Seaport Global.

Maybe just a question on the recruiting a little bit more detail, if you could just sort of share where you're seeing the growth? It does seem broad based, but is there any kind of geographic concentration? Is it mostly from the wirehouses still? And maybe a little bit of an update on sort of the West Coast, where I think you've been -- have the least amount of penetration, how has that been going in terms of ramping that up?

So the color on recruiting, we look and recruiting is great across all of our affiliation options from employee independent to the RA channel. So we've been very pleased that the growth in all 3. I'd say recruiting has been broad based as much as we focus Southwest, where we continue to gain momentum. There's still a lot of recruiting going in places where we're strong, like the Midwest and other areas. So it's a very broad based. The wirehouses continue to be the primary contributor to our recruiting pipeline, although there are other firms where we, through periods of time, also get, but it's mainly wirehouse driven. And if the recruiting outlook looks very, very good and committed (inaudible) that pipeline looks very strong. And again, a part of that is due to deferrals, especially in the employee channels. Our approaches have been closed. They're open now, but a lot of the folks during that period of time didn't want to move into a closed branch. So the employees lagged a little bit to independent channel during this last year, but we're seeing activity across all the channels there.

Okay. That's helpful. And maybe just on -- second question on the investment banking business. Obviously, it's a strong, pipeline strong. Is that an area that you're investing in to grow? Or is this just kind of reaping a good environment? I'm just trying to get a sense of what you think of sort of the organic or market share growth that you might be targeting in across investment banking?

I'm sorry if you guys haven't noticed the investment because there's a lot of focus on growing the M&A business, acquiring a firm in Europe, which has done terrific a few years ago. That's really added to our cross-border, adding a lot of very, very senior bankers in health care and other areas and looking at boutiques and tuck-ins. And -- so I think both the environment is good. You can see that through earnings releases by everybody, but the reason that our numbers are so good is we've invested in the bankers that have made a big difference. So -- and we'll continue to, so especially in M&A, where we are probably undersized given our size and our great Capital Market strength. We'll continue to invest, particularly in that area. And hopefully, given the rest of the business and our good research, we can continue to grow that.

Continuing on, our next question comes from Devin Ryan with JMP Securities.

Most have been asked here, but just a couple of kind of cleanup. So first 1 on just the election next week and trying to think about some of the considerations to the extent there's an administration change. And I appreciate there's a lot of nuance in terms of what happens there. But are there any regulatory items that you're kind of focused on in an administration change? Whether it be the potential for more onerous rule relative to the SEC's Reg BI. I'm not sure if the DOL could reinsert itself for that, if that's at all in the conversation or states, specifically you could feel more emboldened to disrupt kind of where the industry has been moving towards. So I'm curious if there's any kind of chatter of that? And then just more broadly, thinking about the potential for higher tax rates and any businesses that you guys feel like that could impact for you?

Yes. So Devin, it's even complicated. So first, the world always seems to turn when parties change. So despite the changes and we have to -- we all compete in the same environment. So we feel very comfortable competing in whatever that environment is. So I think that if there is a congressional and presidential party change, that certainly taxes are the ones that will be. I mean, I think in most businesses shouldn't have a huge impact. Businesses will go on. Our tax credit business will probably benefit from it.

The higher the tax rate, more value of those credits. And I think low-income housing will still be a target for the administration. So I think relative, unless tax rates go totally crazy that the world will go on.

So regulatory, we always monitor regulatory change. And even with what is considered a business-friendly White House, we've had some pretty big regulatory changes with Reg BI. And so I think you're talking about matters of degree. And could there be tweaks to that? Yes, it doesn't look like the #1 platform (inaudible) nominee is regulatory reform. So it really more counts that who's put into the laws office and a number of the key ones are the people are in those positions for a couple of years even after the elections that usually set the tone on enforcement and other things.

So I don't think there's going to be a short-term impact, no matter what the election is. Longer term, certainly, there could be. So I think it's all speculation. We were -- the states we -- you always worry about individual states because it makes the business very complex, but most of those changes have (inaudible) not come forward that have had major impacts to our business. So it's been unknown but we'll compete in whatever the environment is and whatever the rules are.

Okay. And just a follow-up here, just want to bring together the expense conversation and just make sure that we're fully appreciating kind of all moving parts. So I guess, first and foremost, is the valuation that you guys referenced last quarter, is that now complete with all of the changes and some of the detail that you provided here, and then obviously, the reduction in force? Or are there more things that you're looking at internally that could also move the needle on the expense trajectory from this point? And then also, I just want to make sure that it doesn't feel like there's probably any big revenue considerations from the curve? I just want to make sure that we're understanding that as well.

So I'd say that, first, the major ones that you're referring, we're not planning anymore. So last time we really had any kind of reduction in force was after '09. And after the couple of years after the Morgan Keegan acquisition where we had a small one, but we waited a couple of years trying to make -- get everybody employed. So I think that's behind us. So there's nothing of that size. But we are managing infrastructure spend, technology spend that you go across the board, we are still looking at how do we get more efficient and continue to bring in costs. We have a big service initiative going on, as we believe we have high service levels, but we want to increase those. From an adviser standpoint, we'll look at areas not to become better at service, but be more efficient, which is a longer-term project. So we're all over expenses, but there's no big needle movers as the reduction in force was.

And our next question comes from the line of Kyle Voigt with KBW.

Maybe first, just on the AFS portfolio. Wondering if you could help us understand where current reinvestment rates are with an average 3-year duration that's still sitting just under 100 basis points? And secondly, when or if you're able to start opportunistic buybacks later this year, does that change your desire to allocate capital to growing that AFS portfolio at this pace?

Yes, Kyle, you're right on with your kind of estimate on the yield. It's right around -- or just under 1% for sort of the 3-year-type duration. And in terms of the decision whether to buy back shares or grow the portfolio, we have enough capital, frankly, to do both if we are comfortable doing both. So we have a lot of capacity and flexibility and certainly the ability to do both, just as we have been over the last couple of years.

Got it. And just on the cash balances, I mean, those continued to grow quite nicely. Just wondering if you can just provide an update maybe on a long-term target for the percentage of those balances? Or how you're thinking about the percentage of those balances that you're comfortable migrating to the balance sheet over time?

Yes. I mean, I think -- again, a lot of variables in terms of the capital, the returns that we're getting on the assets that we're funding with the cash. And frankly, what the demand is from third-party banks, which was very high in March when these banks were seeing revolver draws, they needed the cash to cover those draws. And since then, a lot of those revolver draws have been paid back and, yes, the banking system is generally flushed with cash right now. So we are on a net basis seeing -- some banks still want that cash. But on a net basis, the demand is diminishing. So that's really the benefit of having a bank in our business as it gives us a lot of flexibility. And the demand from third-party banks continue to diminish and things continue to recover in the economy, and we have good risk-adjusted returns on the assets that the bank can invest in, then we would be comfortable putting a large portion of those cash balances on the balance sheet, so long as it doesn't compromise the client's ability to get the maximum FDIC coverage. We're one of the few firms that offer up to $3 million for a joint account of FDIC coverage through our waterfall program. And so it gives us a lot of flexibility to continue growing the balance sheet.

Yes. And then lastly from me, and I'll leave it there. Just a really a clean-up question on reduction in force. Should we expect any additional onetime charges this quarter? And I know you said it will impact the admin line within PCG. Just wondering what are those segments we could see some level of impact on the competition?

Yes, we took the vast, vast majority of the associated expense in that $46 million this quarter. So I don't think that there'll be any meaningful numbers kind of going forward related to the reduction in force in terms of costs. And then in terms of -- PCG is our largest business. Most of the support cost, control cost, risk management cost gets allocated to PCG. But I think what you -- the reduction was fairly broad based in terms of the businesses. So I think you'll just see it on a consolidated basis in the administrative compensation line item in each business, but Private Client Group business is by far the largest consumer of that administrative expense.

And our final question comes from the line of Chris Allen with Compass Point.

Two quick ones. One, I'm wondering if the -- if you've seen any changes in the competitiveness of the recruiting environment, just given some of the commentary we've heard from some of the big banks. And anecdotally, it sounds like some of them get a little more aggressive on packages, wondering if you're seeing any change there?

Yes. I'd say that, first, everyone -- since I've been in this job, everybody asked that question. It's always competitive, right? So sometimes the players change, sometimes even people say they're getting out of the market with recruiting, they get out for a quarter or 2 and they're right back in. So it's always been competitive. And firms change are firms that have done better, who paying a lot of money relative to what we pay for transition assistance. And I think we've kind of kept our great balance of being fair to the people coming over and having them come over for the environment. So we get outbid sometimes, yes, but that's not new for us. But what we believe is we offer the best home and the best tools and the best platform. So it's competitive out there, it's -- and sometimes it's more competitive. In the independent channels, people get aggressive. The employee channel, I think, in this last quarter or 2, people have really kind of been more aggressive in what they're willing to pay, and we continue to sell our long-term value proposition. So it's always competitive, and we've done pretty good at this for a long time now. So we're keeping our focus and very happy with the great teams we're bringing in.

Got it. And just another quick one. It's on the news article just in terms of you're reorganizing the trusted divisions, combining the broker-dealer and hybrid R&A across the units. I'm just wondering if that was done is looking more -- to be more offensive, just given the mergers with Schwab, Ameritrade and Morgan Stanley E*TRADE, just in terms of the opportunity around R&A custodial? Any color there would be helpful.

Yes. So it's our focus for growth for us and we've had that division for a long time. We felt that eventually with enough regulatory change, I think BI was one that acceleration of movement, which we saw before June 30 and somewhat slowing down now. But RA channel has been the fastest-growing percentage-wise in the industry for a long time. So the move was really just to consolidate the scale of the businesses, the custodial business, and they're much more related than they're not. So we want to combine to make sure that we have more size and scale to focus on that for management there.

I'll now turn the presentation back to Mr. Reilly to continue for his concluding remarks.

Well, thank you all for joining us. So we know it's hard. Your jobs are like ours, predicting what's going to happen. Remember, a lot of years where we could just kind of draw a line and look at trends and be pretty much tell you what was going to happen, and certainly that's not this environment right now. So look, we'll try to give you as much guidance as we can when we think we can see it. We don't want to make up numbers or make up things to just to help you put in a model that don't have a base. So I think with the outlook, it's more difficult.

Having said that, I think you can see the commitment to expense reduction that we've talked about. You can see it coming through last year. It's certainly better this year. And we are really focused on growth. We've still been focused on growth. And the one thing, if you really manage your expenses and continue to grow, you get pretty good financial results. So we think long term, we're doing the right thing. We've got the focus. And as we get more clarity, we'll try to give it to you and hopefully have an Analyst Day soon, where we can give you good -- better targets than we could in the middle of this hopefully, not a bad second wave of the pandemic. But thank you all for joining us, and we'll talk to you next quarter.

Thank you. And that does conclude the conference call for today. We thank you all for your participation and ask that you please disconnect your lines. Thank you once again. Be well.