雷蒙詹姆斯金融 (RJF) 2017 Q1 法說會逐字稿

Good morning, and welcome to the earnings call for Raymond James Financial's fiscal first quarter of 2017. My name is Kayla, and I will be your conference facilitator today. This call is being recorded and will be available on the Company's website. Now, I would like to turn the call over to Paul Shoukry, Head of Investor Relations at Raymond James Financial. Please go ahead.

Thank you, Kayla. Good morning, and thank all of you for joining us on the call this morning. As always, we appreciate your time and interest in Raymond James Financial. After I read the following disclosures, I will turn the call over to Paul Reilly, our Chief Executive Officer; and Jeff Julien, our Chief Financial Officer. Following their prepared remarks, they will ask the operator to open the line for questions.

Certain statements made during this call may constitute forward-looking statements. Forward-looking statements include but are not limited to information concerning future strategic objectives, business prospects, financial results, acquisitions, our ability to successfully recruit and integrate financial advisors, anticipated results of litigation and regulatory developments, or general economic conditions. In addition to words such as believes, expects, plans, and future or conditional verbs, such as will, could, and would, as well as any other statements that necessarily depends on future events are intended to identify forward-looking statements.

Please note that forward-looking statements are subject to risk and 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 is available on our website.

During today's call, we'll also use certain non-GAAP financial measures to provide the information pertinent to our management's view on ongoing business performance. These non-GAAP measures should be read in conjunction with and not a replacement for the corresponding GAAP measures. A reconciliation of these non-GAAP measures to the most comparable GAAP measures may be found in the schedule accompanying our press release. Now, I'll turn the call over to Paul Reilly, CEO of Raymond James Financial. Paul?

Thanks, Paul, and good morning, everyone. Paul told me this morning that we're going to have huge, just really huge crowds on this call. So I don't know if that's based on real facts or alternative facts. But as I read some of the analysis of our release, I want to make sure that we get as clear as we can so everybody's dealing with the real facts here.

First, I am very proud of the quarter and the accomplishments. I think the underlying businesses, maybe save Capital Markets had a tough quarter, have done very, very well. We had record quarterly net revenue of $1.49 billion, up 17% over year-ago quarter (inaudible) sequentially. We had our second-best quarterly net income of $146.6 million, up 38% over last year's quarter and down 15% sequentially, due primarily, a lot of adjustments, but a legal reserve we'll talk about a little bit. And that resulted in $1 per fully diluted share.

During the quarter, we had the Alex. Brown and 3Macs acquisitions close and integrate. They, at Alex. Brown, we're still over 90% of the advisors and 3Macs 100% -- that's an easy one to calculate, had come over, and are with us. If you take out those integration expenses, our adjusted net income was $155.6 million, up 45% from last year's quarter, down 16% sequentially, or $1.07 per fully diluted share.

So we had a lot of positives going on. We had a record quarter of net revenue in Private Client Group, Asset Management, and RJ Bank. And we had record quarterly pretax in both Asset Management and RJ Bank. Maybe more importantly is our key future revenue drivers ended up with new records. Client assets under administration of $116.9 billion (sic - see press release, "$616.9 billion"); financial assets --

616.

116.9 -- did I say a different number?

616.

616. I guess I mispronounced it. $616.9 billion -- thanks, Jeff -- financial assets under management of $79.7 billion; net loans of $15.8 billion; and we have a Fed interest rate hike that really came in December that hasn't really come through the quarter, which should impact us positively next quarter. I think it's just showing a solid execution of our business strategy and our long-term focus.

Two items that hit really the quarter, before I get into the segments that Jeff will cover. First, the [favorable] tax rate of 29% that was really due to stock comp accounting, which he will go into. And a legal reserve. We could have been more explicit, increase, which was a little over $30 million that impacted the quarter the other way. With that, let me get into the segments.

Private Client Group had a record quarter of net revenue of $104 billion, up 19% over a year ago, and 8% sequentially, really driven by organic growth. Recruiting remained very strong, and retention, as well as the 3Macs and Alex. Brown acquisitions. We had quarterly pretax of $74.3 million, up 6%, but down 31% sequentially. Again, legal reserves and some overhead during the Alex. Brown and 3Macs acquisitions.

We had a footnote, but it probably could've been clearer. We ended advisor count at 7,128 advisors, up 441, and it could've appeared, without reading the footnote, that we were down 18. But as the footnote referred to, we actually refined how we counted advisors, and more of the focus on branch managers when they were producing versus non-producing branch managers. And if you really look at apples to apples, we were up 80 in the quarter versus the adjustment that we did in the count. So again, we had a good increase of advisors, up 80 for the quarter.

Client assets under administration, $585.6 billion, up 24% over last year's quarter and 2% sequentially. Private Client Group assets and fee-based accounts actually rose quicker at $240.2 billion, up 26% over last year's quarter and 4% sequentially. So in the tailwinds, both in assets, and again, the Fed interest rate rise in December not really fully impacting that number yet.

If there is a disappointing area, it certainly was Capital Markets. Our net revenues of $233 million were up 3% over a year ago's quarter but down 18% sequentially. Interesting that the number of institutional commissions were -- and trading profits were solid. The institutional commissions had a positive impact over the changes after the Trump election. But investment banking revenues were hit hard, down 42%, primarily with part of it structural, part of it cyclical with the IPO market. It was certainly off last year.

We had some bumps in tax credit, which we'll talk a little bit just with great business and a great backlog, but we also had proposed tax changes after the Trump election where it will take some time to sort out and get through that system. With that impact, really, as a result of that down revenue, the pretax income was $21.4 million, down 15% over a year ago, and down 60% from a record quarter the previous quarter.

Asset Management, record net revenues, $114.1 million, up 14% from a year ago's quarter, 7% sequentially. Record pretax income of $41.9 million, up 26% over a year ago's quarter and 19% sequentially. Ended with record assets under management, as I said previously, of $79.7 billion. This is driven by the growth of the advisors; certainly, equity market appreciations; and even some net positives, small net positive flows for Carillon Tower Associates, Eagle.

Under the Bank, record net revenues, $138 million, up 27% over last year's quarter and 3% sequentially. Record pretax income of $104.1 million, up 58% over last year's quarter and 7% sequentially. Really driven by across-the-board balance loan growth and consistent net income margins. We had record net loans of $15.8 billion, up 15% over last year's quarter and 4% sequentially. And credit quality really improved between payoffs and even selling some criticized loans, where we were -- criticized loans were down 18% from a year ago's quarter and 26% sequentially. So, overall, very pleased with the Bank results and really very pleased with the first fiscal quarter. With that, I will turn it over to Jeff and have him get into some details.

Thanks, Paul. Let me talk about some of the line items and the variances from what we'll call the consensus model that you all have provided to us. Actually, our biggest revenue line item, the commissions and fees, were pretty close. We did a little better as we had a little better quarter in terms of commissionable product sales than were anticipated, but all in all, it was very close. And I'd say you all did a very good job of anticipating the impact of a full quarter of Alex. Brown and 3Macs on that line item.

Investment banking was the biggest miss in terms of percentage for the quarter. There's detail in the press release that shows the weakness and underwriting, M&A, and the tax credit funds business compared to the preceding quarter particularly. Those businesses are all are a little lumpy, as you all know. And as Paul mentioned, we think that the businesses have a lot of upside from this current quarter, but December is a seasonably weak quarter anyway. But this was a little bit weaker than we had expected as well.

Account and service fees, we were a little higher than the model. And what that really reflects is the immediate impact of the interest rate hike on the bank deposit program and the fees we received from the banks participating in that program. It was a little over $3 million impact for the quarter.

Trading profits, I know we steered you downward in our operating statistics releases during the quarter on fixed-income trading profits. Indeed, in November, post-election, when we had a rate spike, trading days were very difficult there. But they had a very, very good December, which pulled them out. And for the quarter, the $20 million that we showed was a fair amount above the consensus that you all ended up with and that we steered you toward.

Other revenues, as, again, there's detail in the press release showing a private equity valuation gain for the quarter of about $10.6 million, which, those also are lumpy and we don't know when to expect it, but some of the private equity fund of funds and things that we are still owners of had valuation gains, along with the rise in the stock market during the quarter. On the expense side, comp was reasonably close. I will point out that our comp ratio for the quarter was 67.4%, so comfortably under our 68% target that we're still operating under.

Communication information processing was a little lower than we had been guiding you toward. I think we're giving guidance in the $75 million to $80 million a quarter, and I think that we will reiterate that guidance for the balance of the year. This quarter was unusually light. A lot of it had to do with the timing of when projects come on-stream and begin amortizing and when -- how much of the project work is being capitalized versus expense and things like that. That's a little hard for us to predict with great accuracy, but I think the $75 million to $80 million is probably still a pretty good number. And if we don't spend the IT resources on regulatory, we'll find other things to use them for. We have a long list of items that are requesting attention. So I don't think it will go down even if regulatory demands abate somewhat.

Investment sub-advisory fees, interestingly, were higher than you had projected, and the real reason for that is the wrap fee-based assets that were brought in from Alex. Brown, particularly. They already had relationships with outside managers, and a lot of them were already on our platform and some we added. So they came over, mapped over just directly and stayed with those outside managers. So a lot of those fee-based assets that came over continued to use outside managers, as opposed to our proprietary managers, so that's what gives rise to the outside manager sub-advisory expense.

The bank loan loss provision, a credit for the quarter in the face of $618 million of net loan growth in the quarter. It does look unusual. Paul pointed out the declining criticized loans. We had payoffs, pay-downs, and some sales, actually, of some of our criticized loans during the quarter, as well as one nice recovery that we had previously charged off. That, again, I'd say that's us getting ahead of the game somewhat. But a lot of those things came home to roost in the December quarter, and so all of those things were enough to overcome the provision that would've been associated with the $618 million of net loan growth in the quarter to give rise to a small credit.

The other expense we've talked about, that Paul mentioned, is some significant legal reserves in there this quarter. We hope that's a nonrecurring thing, but we always have legal reserves of some magnitude, but this was a particularly large quarter for that.

Paul mentioned the tax rate of 29%. I assume, as the analyst community at least is aware of the change in equity accounting for the -- I will call it the windfall that you get when equity awards are deductible, when they vest, as opposed to when you start amortizing with your books from [grant date] forward. But then they're deductible when they vest, and typically, that's five years later, typically for us. The stock's higher than it was at grant price, so you have a bigger tax deduction than you have run through your book expense over that time, and that gives rise to this tax windfall. In the past, that amount was simply a credit to book value, a credit to equity. But now, the guidance is to -- that, that will run through the tax provision, because it truly is less taxes that you will pay in the quarter that the vesting occurs. So most of our awards are made at the end of the fiscal year, in the November time frame, and typically, like I mentioned, have five-year vests associated with them.

So the amount -- it will typically be a December quarter phenomenon for us to see this tax benefit, as long as the stock price is higher than it was five years earlier. This year, it was a particularly big number because of the stock price versus where it was five years ago. If the stock price were not to move from where it is today for the next couple of years, that number would be about a $10 million-type tax benefit in the next two years, in the December quarter. But a lot of it depends both on the stock price, and it also depends on how many units are outstanding, based on who's still with us at that time, but turnover has not been a big factor here.

So those are the line items. Some other points I'd like to mention from a big-picture standpoint, and I've read the comments that have come out starting last night. I'd say that, generally, they're pretty on point. I'd say if you try to strip out all the noise that we had in the quarter with the tax benefit, with the unusually high legal provision, with the bank loan loss provision being a credit, with the PE gain and all those type of things, I think that your comments are right. We're not too far off from where the consensus was on what you'd call an operating run-rate basis. But as I'll talk about in a minute, we sure have a lot of tailwinds going into the next quarter.

Other ratios I'll mention that are in the press release, the pretax margin non-GAAP was 14.7%, well below our target. But obviously, that relates to the legal provisions taken during the quarter. Otherwise, we might have been closer or above our target there. The non-GAAP ROE was 12.4% for the quarter, which we think is acceptable, given the climate. But, again, that was -- included the offset of all these factors I mentioned before.

Shareholders equity, by the way, crossed $5 billion for the first time. It's a little bit of a milestone there for us. And I will point out that our capital ratios all improved slightly during the quarter, as we had earnings and equity credits that -- from other stock compensation expense and other things that affect equity that grew faster than our total assets did.

So, going forward, a couple comments. The impact of the rate hike, as I mentioned, it was a little over $3 million in the December quarter. There is a little bit of guesswork still in terms of going forward, but at this point in time, based on what we are seeing in the competitors and the rates on money market funds, et cetera, I am anticipating above and beyond the December quarter an additional $15 million to $18 million to pretax earnings, split between interest earnings and the account and service fees. We have raised rates to clients, once since that rate hike, and I'm guessing we will probably do so again during the quarter some time, but how far and how fast is the unknown.

Going into the March quarter, we do have some headwinds. I know we mentioned this last year, we do have a FICA reset that's typically cost us somewhere between $8 million and $10 million versus December, the March quarter to December quarter, and then that number drifts down lower throughout the year as people get over the FICA limit. We're guessing that, that will have a negative impact on comp expense in March.

We also have all of our year-end mailings of 1099s, our annual reports, et cetera, et cetera, and that number was -- somewhere between all the printing and mailing costs for that was somewhere around $2 million, and that will hit in the communication info processing line. We do anticipate about another $5 million to $10 million of integration costs from the acquisitions we've done. And then we are hopeful that the numbers going forward will be so immaterial that we'll stop using that line item after the March quarter. But that should be about the number to wrap up Alex. Brown and 3Macs.

And lastly, we mentioned the tailwinds on the fee-based assets and those are disclosed as well. The billings in the March quarter -- billings in January were somewhere around 4% higher than they were in October. That's certainly a good starting point for the commissions and fees going forward into the March quarter. Those are my comments I wanted to point out, so with that, I'll turn it back to Paul.

Great, thanks, Jeff. Let me give just a little bit of outlook on where we see the businesses for the quarter. First, the Private Client Group will continually be driven by strong recruiting and strong retention. We always focus on retention first. The fact that we're not filling holes because people like the Firm and stay here is the utmost importance to us, and that helps us recruiting, our recruiting pipeline, and results are continuing to be very, very strong, as we've been a destination for people over these last couple of years. So that, combined with the record client assets starting the quarter that Jeff talked about and the rising short-term interest rates last quarter should be very, very positive.

As Jeff talked about, our communication and technology lines will be there. We continue to invest in people and technologies. And some things we don't spend a lot of time talking about is our capabilities. Our advisors can do most of their things on their iPhones through industry-leading apps today. We'll announce really what we're doing on the client side. We had a plan three years ago, but everyone seems to be going robo, robo, robo. But we believe that electronic delivery to clients has always been our plans, and we'll talk about how we're addressing that this week. And I believe we have a very good, solid technology platform going forward. We continue to add solutions for -- on loans and other products and high net worth solutions. So we continue to invest in our Private Client Group business and the outlook looks very strong.

Capital Markets are headwinds and tailwinds. Fixed income and public finance have done very well, well positioned. A preliminary look at public finance shows that certainly in the top 10, maybe number 8, in full credit [delayed] and underwritings last year, doing very, very well. The problem and the challenge in that business is that is a business with inventory and rising interest rates. There is a bias that inventory hurts you. So we can hedge part of it; some of it we can't. The quick turn and the credit quality and the movement of that inventory remains very, very important. It's easier in downward markets for trading profit than it is in upward markets, but I believe they continue to do a good job.

Equity underwriting came off a very slow quarter, so it should be up this quarter. But there's some challenges, both structurally in that market, is more competition and more book runners and syndicate members in terms of share of fees for that type of business. M&A backlog looks good, but it's a lumpy business. So we can't tell you which quarter that will fall in. The tax credit business, we believe we're the largest underwriter of tax credit deals now. Our backlog's very good, but certainly proposed tax law changes certainly have an impact on a business that sells both really, based on CRA credits to banks, and effective after-tax yield off of tax credits, so that has created some repricing and I think some slowness last quarter. We feel very good about that business, but there might be a little bit of interim challenge here as that gets repriced. But it looks good.

Asset Management, very strong. Recruiting and retention continue to give us strong asset close, and the market certainly has been in our favor. The trend has been to move to more to fee-based accounts, which has also has helped that business. So the record assets under management is a big positive going into the quarter, and I think that our net recruiting should continue to help drive that business.

RJ Bank continues to do well, solid disciplined loan growth. We've had growth over CNN, mortgage, and our tax-exempt lending. Certainly we're always cautious about the credit environment. It's been very constructive lately, but we've seen good and bad credit cycles. We've been through it, so we stay very diligent on what we're adding to the portfolio and the management of the loan portfolio. Again, our focus is when we like the credits, we will continue to grow. And if the market moves away from us, we will slow it down.

Net-net, I think our forward drivers all appear positive with record AUA, assets under administration, record assets under management, record net loans and the Fed interest rate changes should all add positive momentum for the quarters. Certainly, the FICA statement mailings, 1099s, and all those first-quarter expenses will come through, which will be a drag. Although, we weren't planning on building any walls, we were looking at building a building for expansion. And we ended up buying three buildings on our campus to expand our growing needs, which have a little bit of an impact but not huge.

The last thing that I know people are going to ask about, the Department of Labor. All indications are that the administration is moving to certainly suspend the rule, delay it, and maybe rewrite it. So we have moved and continue to move to be in compliance, should we have to be. I would say the indications today is that rule will be delayed and, if you ask me to guess, more likely changed. I do believe, even though it was well intended that there are some issues that really impact clients and the ability for clients to get advice. And we certainly welcome at least an improvement to the rule and maybe a different approach to it. But we'll find out more as the administration continues to sign many orders, it looks like, in the last week. So with that, I appreciate you joining the call, and I'm going to turn it over to Kayla for questions.

Thank you.

(Operator Instructions)

Devin Ryan, JMP Securities.

You increased the securities portfolio in the Bank, which was discussed last quarter, but capital just continued to build throughout the quarter. How should we think about the trajectory of maybe continuing to do that in the Bank? And any other thoughts around capital utilization that you can provide would be helpful. Thanks.

There's multiple fronts. We're continuing to, over time, build the securities portfolio and that plan hasn't changed, we continue to buy more securities. Again, we're conservative and have kept the duration very, very short.

We do go have a board off-site in a month, in February, and we will discuss capital deployment at that meeting, whether it be to the Bank and some of the opportunities. And also, we continue to look at potential acquisitions. I think of we're very disciplined. We focus, really, in M&A space, where we did in acquisition in Europe for a merger -- for an M&A business, and have looked at other opportunities.

And we've looked in Asset Management. Even though we know the market's challenged, we believe there are certain segments of the business that Asset Management is still valued and we continue to analyze those. So we keep looking at capital deployment but also for the right opportunities.

Just to be clear, Devin, growing the securities portfolio on the Bank is not particularly capital intensive. The kind of securities we're buying are governments and agencies, typically, that are 20% risk weighted and don't require a whole lot of capital. Growing the loan portfolio more quickly and other things would be more capital intensive.

Understood. Thanks very much. And then, within account and service fees, some upside that you spoke through. But when we look at the Alex. Brown and the 3Macs deal, are those being optimized yet in terms of how they're running through account and service fees?

Meaning, do all the customer cash balances that were brought on from those deals, are they already deployed into third-party bank sweeps? Or is there any upside from third-party mutual funds or manufacturers just around the omnibus fees or things like that? I'm just trying to think about if there is a tailwind maybe still to come from those acquisitions in that line?

Not on the balances. The balances we deployed pretty quickly into the sweep programs and other vehicles. So the assets are pretty much -- that part of it's optimized at this point in time.

I don't think there's a lot to be gained there. The gain going forward is going to be from rate changes and spreads not from further deployment of assets.

And as you look at those businesses, I remind you, because of the amount of retention where all of the advisors really coming over have retention on both of those deals, that it's really not going to help PCG margins. It's going to challenge them in the short term.

But from a firms standpoint, certainly the cash and very active lending business and very high net worth clients, it's going to have a positive impact on that side. So Alex. Brown is really settled in now and is starting their recruiting to fill up their offices. So it's is going to take some time, as we said, during the acquisition to really make it accretive.

This type of conversion we did here, we mapped all the wrap fee account, mapped over to our asset management platform and the cash mapped over to sweep programs. It wasn't as though we were bringing it on advisor by advisor and they had to make a bunch of elections and then things moved after the fact. This was all done pretty much at conversion day in September.

Got it. Okay, that's helpful. And then just last quick one here. So appreciate the color on the legal reserve. I know that can bounce around quarter to quarter, but there's always some level, as you mentioned. How should we think about -- how much of it was incremental, would you say, relative to what's normal? I'm just trying to think about it from a modeling perspective, given that there's always something in there.

A lot of it is driven by a particular issue, but that rise, we said $30 million was what we call above normal. That doesn't mean there can't be other charges or other cases or issues that come from time to time. But that's certainly, most of that incremental rise was above what I'd call historical. But we expect run rates, but there are challenges and that can bounce up and down.

Okay. I will hop back in queue. Thanks a lot, guys.

Steven Chubak, Nomura.

Jeff, on the last call, you had spoken of a 17% margin benchmark or expectation with the benefit of the December rate hike. Clearly this quarter, you fell a bit short, in part because of the timing of the hike and also the elevated legal charge. I was wondering, given some of the tailwinds that you highlighted in your prepared remarks, whether 17% was still the appropriate jumping off point or benchmark we should be contemplating for the remainder of this year?

I don't remember -- I remember we were at 16% I remember at the last half of last year was our target. You're saying with this rate hike we would be at 17%?

Yes, that's exactly right. The guidance was 16% without the rate hike, and then, about 100-basis-point benefit when you saw the benefit of the rate hike in December, which ultimately materialized.

But the rate hike in December barely hit the numbers in the quarter.

Yes, you're asking --

I'm thinking about the remainder of the year.

I don't think that's an unreasonable goal. There are a lot of factors at play, obviously, and the market being the biggest one. But based on where everything is right now, again, this quarter would've been significantly different without the elevated legal charges, which is a pretax item. But we had some other things going the other way, as well, like the bank loan loss provision and private equity gain. So, but it wouldn't have been way off.

With this additional rate hike, if it really adds $15 million to $20 million per quarter going forward, and if we get equity capital markets and tax credit funds and others back to what we call more normalized margins and levels, do I think that's attainable this year? Absolutely. Absolutely.

Do I think that I would take it to the bank? There are too many things that can happen to be that certain about it. But based on the dynamics of what we've got in place, absolutely. That's a reasonable target.

Alright, and maybe just focusing on the NII contribution again, Jeff, you mentioned on the last call in terms of the Alex. Brown guidance, $30 million benefit for the full year. On a quarterized basis just should have added $7.5 million on top of the significant sequential uptick that we saw in loans and securities.

Now, I was hoping you could speak to some of the factors that may have dampened the pace of NII growth, since it only increased about $7 million this quarter, and maybe how we should be thinking about the jumping-off point as some of those benefits show through in the March quarter.

Sorry, what increased 7?

I think, Steven, when you talk about the guidance for the Alex. Brown contribution, you have to look at both the NII and the account and service fees. For the cash that swept off the balance sheet to third-party banks, that's going to impact account and service fees not net interest income, so.

Okay, so it was a $30 million rate benefit, which shows up in both. Got it.

That's still accurate.

Okay. Understood. Last one from me, and might be a better question too, for Steve. But just given the duration profile of the securities book, can you remind us what's the net yield tick up that you're getting on the securities today, given the steepening of the curve versus what you're earning on the cash sweep?

Yes, hi Steven, Steve Raney. It's about 100 basis points. It's obviously, security specific. Some are a little lower, and some are a little bit more, but right now, it's about 100 basis points. That negatively impacts our reported net interest margin percentage, but obviously increases our interest earnings.

Okay, and how much excess capacity do you have at the Bank in terms of the internal binding constraints that you think about, whether it be liquidity or some of the capital ratios to actually support continued bank growth? I know you've, Jeff, actually mentioned it wasn't capital-intensive. But tier-one leverage is also another constraint you have to manage too. And was hoping you could maybe quantify that excess that's available to support future growth lines?

$5 billion to $6 billion?

Yes, it's a big number because of the risk weighting, Steven.

We have a higher capacity, but it hasn't been what we've agreed to go on. We're going to review it at the Board meeting, but we're well short of $2 billion, I think, in our goal, and -- but the capacity is probably $5 billion to $6 billion.

Thanks for taking my questions. Thank you.

Christian Bolu, Credit Suisse.

Good morning, Paul. Good morning, Jeff. Firstly, Paul, congratulations on the announcement that you will be taking over as Chairman. As you think about taking over this role, curious what it means for how the firm is managed?

I don't think there's a lot of difference. I have Tom setting next to me and he's --

He can't say what he really thinks.

Tom continues to do what he's done, is harp on client focus and what we're doing. He's a great sounding board. So I actually think it's a genius move by Tom to give me more work, but he still gets to get around and do what he did before. So it's been a team effort, and I don't think that will change.

So Tom is spending a little more time in his museum and stuff, but he's in the office every day. The dynamics, this has been a shift since 2009 from the day Tom has asked me to come in to slowly moving stuff over, and I think that we'll see still a slow move.

Hopefully, five years from now, you'll be asking me the same question, it's just a more natural transition. So it's all hands on deck and it is been a transition that's been happening over seven years, and I think almost a textbook one so far where this is what I think good succession planning does. And I will have to go through that at some point too, and hope that I can do it half as well as he has. I don't see any dramatic change, and certainly not in strategy or anything else.

Okay. Got it. And then just on Alex. Brown, maybe a progress update on how the integration is going. And then more specifically, how far are you along, just getting towards that 10% margin target?

So Alex. Brown, we're not projecting a 10% margin target for a while. It's really due to a number of factors. First, and it's something we've talked about, whether we should publish acquisition retention and give you guys more insight. We have -- every one of those advisors is on a retention package.

Without that, you'd have good margins. With that, you really eats up the margins. So it's going to be a long process over a number of years for that part of the business to hit those targets.

Certainly, there are some bigger swings in parts of that business on when transactional volumes come out because of the semi-institutional, ultra high net worth, family office type of business. That has impacts when that type of business is up.

And we've got to recruit and fill the branches. We had to move out of a relocation or split locations, and we added room for recruiting. We're just -- recruiting takes a while and we're going to get people through the pipeline.

So you shouldn't look at that business in the short term having the margins. We've looked at as a long-term, strategic investment. And we want it to be profitable. We don't do things we don't think we're going to make money on, but we've got a lot of work to do still to get it there.

We've talked before that it's not going to be accretive to the PCG segment, but you've got to understand that they've brought significant assets into the Asset Management segment. They've also introduced loans of all types to our Bank. So they're radiating throughout the rest of the organization, even if those results aren't measured specifically in the Private Client Group.

That's fair.

In terms of the integration, the only thing that's really left of magnitude is I think they have one or two more real estate moves that they have to accomplish, that they were given a period of time post-close to vacate certain premises, currently, Deutsche Bank owned or leased.

So net-net, I think we're a little better certainly in retention than we thought we would be. Revenue was maybe a little more challenged, given last year, because of the markets and syndicate, and everything else. But I think we're probably ahead on the people side, and everything's coming along. It's just these integrations take a few years to get up and running, and Morgan Keegan was no different and it's been accretive. And we've got work to do on Alex. Brown. Great group of people. I think they're settling in well and we just need to keep working at it.

Great, thanks for all of the color. And then just a follow up from a question that's been asked a number of times on the potential for you to grow the AFS book of the Bank. Just, can you just help us with how to think about how much excess capital you have at the total firm level? Should we think about it as tier-one leverage or a risk-based capital as a constraint? And then, maybe any numbers in terms of the minimum ratios you would want to run the format?

Christian, this is a debate that I think a lot of people -- our view of excess capital is different than most. This is in the broker-dealer space versus financials. There's a lot more liquidity, risk, and demands. And so we tend to keep extra liquidity, and it looks dumb until you hit a 2009 or a bottle period; then you look smarter than you are. We're just conservative in the space.

The Bank certainly has leverage in the securities portfolio of leverage capital just because the capital charge is low. Both regulators like the liquidity in the securities portfolio because they believe it's a secure type of environment. And because they're agencies -- government-oriented and short term, we're less concerned about that investment than we would be if they were longer term or more risky securities.

So, yes, do we have room? Yes, in our capital base, but it's not as extreme as I think other people think.

I think that from a regulatory perspective, the tier-one leverage ratio would be the one that trips first. But we've got internal constraints that we've talked about before that would trip even earlier, the percentage of firm capital that we have want to have allocated to the banking segment, as well as the percentage of client cash deposits that we want in our own institutions. So those would actually trip even before the regulatory ratios would trip.

And then just maybe just quick, can you remind us, you said there is a client cash internal target. Can you just remind me what that is? And for the Bank, I think you talked about one-third of capital being at the Bank. But as you're moving towards things like securities, which have a very low risk weighting, does that -- is there a potential for that constraint to change in any way?

I think there is a chance there, but, again, we'll be discussing it at the Board meeting, what the appropriate allocations are.

Our constraint, we've got a little over $40 billion in the Bank sweep program, and we don't want more than half of that going to our own Bank, our banks currently a little under $15 billion. So we've got $5 billion of runway in that constraint.

Perfect. Well, it seems like a very important Board meeting ahead.

They're all good and challenging. I don't see drastic changes, but I think the discussions and the challenges are all good. Again, if you -- this is the balance. Certainly, a lot of things we could do to raise earnings very quickly in the short term; I'm not sure it's good for shareholders in the long term.

So we keep that balance of making sure that we've looked at acquisitions and other things that would make the numbers look very good short term. But we ask ourselves long term, is it a good return for shareholders. And we're reminded all the time, it's not our money. We're investing other peoples' money.

Some of it is, because we're shareholders, but we try to keep that balance. The Board is challenging us, but it's very productive. And I mainly look forward to our off-site. It is a lot of work and a lot of challenging, but it's very good discussions.

Great, thank you so much for all the color.

Conor Fitzgerald with Goldman Sachs.

A two-part question on corporate tax reform. First, just when thinking about your sensitivity to lower corporate tax rates, should we be thinking about that having a one-for-one flow-through on the year tax rate?

And then two, if we do get corporate tax reform, how should we think about that impacting competition in your industry? Some management teams have indicated they think the vast majority of the benefit would be competed away. But just be curious for your thoughts on if you think there'd be increased competition in your space and if some of the benefit of lower tax rates could be computed away.

I know a lot of people have said they think that if we had lower tax rates, it will pass it through the loan spreads. I don't know if that's the case. We're certainly more diversified than that. A 10% drop in the tax rate's, what, $90 million, Jeff, somewhere in there? If you just did some math, somewhere in that range. So I don't know what gets arbitrated away or not.

Certainly, our loan portfolio is a piece of our business, an important one. It's a big number, but it's certainly diversified across the businesses. A lot of people focus on the rate, but how you define net income, taxable income's important too and what deductions are there and not there. So there's a lot.

First, they got to get it through Congress. And secondly, we don't know what it is, but people focus on the headline rates.

And there's impact on some of our businesses. Tax credit funds, there's tax-exempt lending at the bank, there's municipal bond trading that -- all those businesses will be impacted.

Differently, yes. And you got the one-time net charge for deferred tax assets too. So there's -- it's a pretty complicated topic. Until we see more, it's hard for us to define. So honestly, we look at that, but we spend most of our time making sure we're running our core business as well. And the things that we don't have in control, we worry less about, although we do look at what the impact would be.

As we sit here today, if they were to lower rates effective immediately by 10 percentage points from 35 to 25, our deferred tax asset revaluation would offset most of our first-year benefit from the lower rates. Then we'd obviously benefit pretty much on a straight pass-through basis going forward depending on the impact on our businesses.

That's helpful color. Thank you. And then on the $15 million to $18 million of growth from the Fed hike, are you still assuming the same deposit [bid], in that 40% to 50% range? Or have you changed your assumptions there?

No, we've changed it to a little lower, just pay out to clients than our ultimate original target of a 60/40 split. We're basing that pretty much on what we're seeing in the competition.

Our strategy there is to stay at the top of the group, and we are there already. No one else has moved since the Fed rate hike. Maybe one other party has moved, but the rest have straight 1s and 2s all the way down in terms of basis points, what they're paying to clients at all levels. At least their advertised rates.

We moved twice from the old rate move, the first rate move and once now from this one where our lowest rate is comparable to government money market fund rates. And if there are higher cash balances, or higher client relationship balances, I should say, within our system, then the rates scale up from there.

At some point -- I think it's just a very front-loaded game, which is not how we thought it was going to be. And so, we're recovering our -- most of our spread before we start passing it through to clients at this point in time.

Candidly, that may be the new model. Firms may end up keeping more of the interest spread to help pay for regulatory, compliance, legal, these other costs, IT, that are out there. It may just be a new dynamic in the model from what was in place prior to the economic crisis back in 2008 and 2009. That was -- we may be in a little bit different environment, but.

So the answer to your question, long-winded answer, but it is yes, we are changing that, and we are expecting to keep a little bit more of the spread then we had originally intended.

Although, it hasn't changed our long-term philosophic view of sharing with clients. I think the question, over time, is how do you get there? What happens to money market funds, given all of the things that have happened to money market funds? What happens to rates? What happens to future regulation if some that regulation comes off, money market funds make it more competitive and rates go up.

So there's a lot of dynamics that'll impact it, but we ultimately believe that we have responsibility to share with clients. But we also want to be also competitive in the rise and be deliberate in our raises. So I think that we're through a transition right now for this year.

That's helpful. Just a quick follow-up on that. If your deposit rates are materially higher than peers, do you view that as giving you a competitive advantage?

Recruiting-wise, hard to say. We're talking about basis points here. We're not talking about huge dollars on a per-account basis. I don't think it gives us a huge competitive advantage in the recruiting world, and it certainly puts us at a slight economic disadvantage. I don't think it's -- it's not something that recruiters lead with, let's put it that way.

Yes, but I would say the intangible part is our advisors and our retention is viewed on an environment of being fair to them and their clients. So I agree that, we don't say we're paying 2 more basis points; your medium accounts brings people over. But I do think the attitude of fairness and equity to advisors and clients is a big reason people stay here. And that isn't -- it isn't just that; it's a piece of it and that story is a piece of it. We try to be very balanced, And we're not way ahead of the market, but we're ahead for that reason.

Thanks for taking my questions.

Chris Harris, Wells Fargo.

Thanks. Hi, guys.

Hi Chris.

Are you guys seeing much of a behavioral change among your private client customers following the election? And, really, just trying to wonder whether we could see some better activity rates, better sales cycle if there's an uptick in confidence here?

It might be too early to tell. I'd say people are optimistic and scared at the same time. The only thing we could see is a little bit more movement to fee-based accounts. So I think -- I can't tell you, certainly, there's been better equity flows if you look at mutual funds, not just us, certainly since the election, it's early to tell, have been positive versus -- more positive versus the previous trends, but I think it's still early days.

Yes, I'd say only a very slight hinge that would risk on, but it's not a significant shift.

Got it. Okay. And then in capital markets, you sound like you guys are a little positive, bullish about the pipeline. But when you speak to your commercial customers, are you getting the sense that activity levels could potentially be delayed somewhat if you've got companies wanting to wait to see what changes will occur with tax and regulatory reform? Or was really the election the big unknowable, and now that's behind us, potentially, we should see activity pick up, depending on, obviously, what the markets do?

I'll tell you, in M&A activity, we haven't seen a big impact. It seems like it's still going well. I think the biggest challenge, if you look at structural challenge in the market, is just the rise of private equity and companies thinking the regulatory burden's too much to go public. And the private equity versus IPO market, when you look at the, what was it, 12-year cyclical low or something in IPOs has been impacted.

When you get companies as big as SnapChat and Facebook waiting until they get their valuations before they go public, it's just the private equity is a lower-cost, less visible alternative. I think that's impacted the IPOs.

The other thing that's impacted secondaries is the balance sheet and bought deals. So it makes it much more difficult to compete, so I think the share of the market has gone down because of that.

We're bullish. I think we're saying off the December number, we think there's a positive trend as we have already been a book runner in a couple of IPOs. We see something in the pipeline, but I don't know how robust that business is, what the impact's going to be.

I do think that regulatory change, if and when it's coming, if it favors capital formation, if it takes regulation off of IPOs and stuff, may help that market. But that remains to be seen. I think that part of the reform hasn't come up. It's after tax rates, the wall, and all sorts of other stuff that seem to be in front of that, but that discussion will come.

Thank you.

Ann Dai, KBW.

I was hoping to dig a little deeper on the DOL and just look behind the scenes on some of the changes that are happening as you work towards compliance. Can you outline some of the more meaningful changes that you've made lately to product structure, commission structure, and, really, any pricing in anticipation of the rule?

I'm not at liberty to talk about those changes. We've highlighted some potential ones to advisors, but, frankly, we're waiting really on the rule, if it's coming or not, before we pull the trigger on them.

I believe that there are some things in the rule -- in looking at the rule, we said we could do this better or this make sense or other parts that we think it's just a burden to clients and will take away advice. And frankly, we are waiting.

So just as we've been slow to announce our changes, not because we didn't want to tell people what we were doing, but we certainly didn't want clients and our advisors to go through the pain of doing things to undue it. We're lucky, maybe, but so far we've been right. We're still not ready to push that out to advisors until we know.

I think there's more reason to believe that it's going to be delayed, so we are waiting to see, first, if there's a delay. Although we're teed up to go if there isn't. And secondly, if there is a delay and the rule is reviewed and changes are made, we certainly don't want advisors to make changes they didn't have to make or to go back and undo them with clients. We are in an analysis mode, which we've been in for a long time.

Okay. Thanks for the color. The other thing was just on loan growth. You continue to grow loans at a nice pace during the quarter. I think it was maybe the last earnings call when you had given some guidance around expecting that growth to moderate over the next couple of years, or maybe just not continue at the pace it had been.

So was there any impact from Alex. Brown this quarter on loans? And if you could just give us an update on your thoughts around the next year or so, year or two, and if that guidance has changed?

Ann, I would say, looking out, we would still think low double digits, 10% to 12% would be a good annualized run rate. Our product suite is just changed ever so slightly. We are doing some larger mortgage loans to ultra high net worth clients, not only in the Alex. Brown channel, but in general, we've been recruiting more productive advisors that are dealing with larger families or more wealthy families. And so that product has changed just ever so slightly.

The loan growth over this last quarter around 4%. Once again, it's a little bit opportunistic. The corporate loan market, in particular, is the most volatile part of the business. We've seen periods when -- and right now, as a matter of fact, since the election, the corporate market has gotten extremely aggressive. We have seen some repricings. The secondary markets have moved up probably 100 basis points in price.

So we've taken other periods when there's been a pullback to be more aggressive, when we think rates and the risk relative to those rates are more attractive. But in general, I think 10% to 12% is a good number going forward.

Thank you so much.

Jim Mitchell, Buckingham Research.

Good morning, guys. Maybe just a quick follow up on -- can you just give us the total number of client cash balances at this point? Have we seen any material change?

Yes, grand total is about $46 billion. But there's a fair amount of that, $5 billion or $6 billion in various types of state-specific money market funds and things like that. And then there's about $40 billion in the bank sweep.

Okay, and the deposits, how should we think about the deposits in the bank?

Deposits in the bank right now are about $15 billion from the bank sweep program. They'll to continue to draw on those balances as -- to support the growth of the loan and/or securities portfolio going --

Okay. So that's embedded in the $40 billion?

Yes. Correct. That's part of the $40 billion, correct.

Do you still think we should think about every basis point's around $4 million at the short end?

$4 million per year, yes. About $1 million per quarter.

And that was always guidance around the short. Does the steepening yield curve give you any additional upside in NII in the bank, particularly [throughout] securities book?

Possibly. I mean not -- I wouldn't say materially from that. I wouldn't' vary it materially from the previous guidance based on that.

Okay. Maybe just a broader picture. It seems like you guys, if I try to take a stab at market impact, you had very strong growth in fee-based assets. Can you, A, discuss what's the geography of that? How much is maybe just transitioning from brokerage accounts to fee-based versus net growth from current customers, new customers? And how you think about the recruiting dynamic in those flows going forward?

I think that part of it is recruiting certainly large -- our recruiting has gotten larger [FAs], and they tend to have more fee-based in their platforms. So that impacts it.

The other thing, and maybe part of this is DOLs, we've had a lot of other smaller accounts or advisors as we looked at the rules, just that they were getting out-of-commission accounts because the look at the BIC and everything else is that they just decided it would be easier to manage in our fee-based platforms. We did open up a smaller account solution, fee-based to help advisors. And there's been a lot of net movement there too. It's just -- it is across the board.

The geography and the financials, if there's a shift from a commission-based account to a fee-based account is that most of the revenue says in the same line item. It's in the commission and fees line item to the advisor. There's a small piece when it goes to a wrap fee account that goes to the Asset Management segment for the administration of the account.

In terms of the overall magnitude, it just depends on what the account was generating on a commission basis versus what the fee is that's assigned to that account. But geographically, not a big change in the statements. But since you brought that up, we will point out that we did also set a record high for recurring revenues this quarter at 68.75%. So closing in on 70% of our revenues that we would call recurring fee-type revenues.

Great. And as we look at the recruiting pipeline, you mentioned it's still very strong. How long do you think this is -- I think you've been growing FA head count for close to 5% plus for the last year or two. Do you think you still have that kind of momentum?

There seems to be -- it's hard to recruit at those levels. And certainly, they've been supplemented by not huge acquisitions but meaningful, both with Alex. Brown and 3Macs joining us.

But recruiting pipeline looks very good, and there seems to be a changing landscape every year or two. Or one or two firms where people are unhappy with the circumstances there, whether it be strategy or movements in their grid or pushing out of small accounts or something where it always seems we've got a large flow. And it is continuing right now. So, do we think it happens forever? No. There's are cycles, but it still looks very good for this year.

I would say that my net growth of 350 headcount, without acquisitions, just through brick-by-brick recruiting and training programs, I think would be a little bit of a stretch for us. But that's a lot of bodies to recruit, but it's certainly is doable.

Okay, well, thanks for all of your help. Thanks.

Hugh Miller, Macquarie.

Just wanted to follow-up on the prior conversation just on the recruiting side of things. Was wondering if you could just give us a little bit of color on just the overall level right now of competition with upfront money, things like that? And if we get into an environment where we get more relaxed regulatory climate, would you anticipate an uptick in that competition, or would you think maybe some of the larger peers would divert capital to other business lines, and we wouldn't see that type of scenario?

I can't tell you what other people would do. I can tell you what the market dynamic has been. Ironically, we've all historically, especially versus larger firms, offered less front money transition assistance.

With the DOL proposed rule, most of the major firms drop their back-end bonuses, which was the significant delta between ours and theirs. We haven't changed ours, so in a way, we've become more competitive. We've always based ours on what we thought was a fair, reasonable return to the firm, and fair to the advisor. So we've been very competitive.

There's some indications they may be raising theirs a little more, but I think it's below where it was a year ago. But this is a highly competitive market. Always has been a highly competitive market and continues to be.

So right now, I think that the dynamics are still positive in our favor, based on technology, kind of a cultural -- the culture we've created here, and so we still have a lot of net demand. I don't know how that changes.

Last year, we certainly -- you could make more money going to other firms up front. We certainly weren't the highest, but we did pretty well. It's a positive -- we lose some people that we would like to get, but net-net, people come for the right reasons when they're not coming just for the check, they're for the environment. And I think it's a -- it gives a positive bias to the people we're trying to recruit.

That's certainly fair, and that's very helpful. And then one other question. Just, in terms of, obviously, we're very focused on the potential for changes and with DOL. As you look out on things, are there other regulatory changes that could be meaningful for your business if there were some changes on the horizon? I don't anticipate Volcker would be much of a difference for you guys, but are there any other things that we should be keeping an eye on in terms of any type of enhancement?

I think that certainly all regulation has an impact. First, we should be regulated. We're a regulatory -- we're in an industry that has other people's money, and regulation is not negative. I think the amount and type is important. We get a lot of discussions about regulatory enforcement where there's not rules or interpretation of rules. So I think anytime there's clarity, it makes it better for everybody, and some of that reform would be helpful. Volcker does have some positive impacts, and it certainly changes to Dodd-Frank for private equity and investments to all sorts of things. Not as big as us, as other people.

So the regulatory cost has continued to go up for everyone. If that moderates, that would be a positive. But regulation won't and shouldn't go away. We do believe that maybe there are areas that should be modified, and DOL is one, again, that I believe was well intended but missed the mark, and will hurt clients and advice. And that's one example and there some in other areas too.

Thank you very much.

At this time, there are no further questions.

Great. Well I appreciate everyone joining the call today. I hope we could give you a little more clarity than maybe we did in the release on some of the numbers. We're very positive on the future and where we stand today and look forward to talking to you next quarter. Thank you.

Thank you. Ladies and gentlemen, that does conclude today's conference call. We thank you for you participation and ask that you please disconnect your line.