雷蒙詹姆斯金融 (RJF) 2008 Q2 法說會逐字稿

Welcome to quarterly analyst conference call.

At this time, all participants are in a listen-only mode.

Later, we will conduct a question-and-answer session.

Instructions will be given at that time.

(OPERATOR INSTRUCTIONS)

I would now like to turn the conference over to our host, Chairman and CEO, Mr.

Tom James.

Please go ahead.

Thank you very much.

Welcome all of you to the quarterly conference call for the second quarter of our fiscal year.

As I introduced some of the comments in our press release, I would say that we were pleased with the report, but only in light of the conditions in which the financial service industry finds itself now, which all of you know, as well as I know, has impacted particularly the investment banking activity industry-wide.

It's obviously impacted investment advisory fees, as assets under management have declined due to market action, not necessarily net with respect to net sales.

But the fact is generally speaking in this quarter, assets did decline.

As I've reported, there have been some compression in net interest spreads at the broker dealer, in particular that relate specifically to what we pay out in our credit interest program, but also in our bank deposit program, where we match heritage rates.

When rates are rapidly moving down as a result of Fed action, you essentially, if you're matching the heritage rates or looking at a 45-day-type average timeframes so that they don't move down as quickly as what you have to in the overnight investment account for 15c3 balances or for other overnight balances that the Firm has that were uninvested.

You do have that compression.

By the way, just to preclude a future question, in the last two quarters, that's amounted to somewhere between 5 and $7 million a quarter in what our estimates of compression are.

So that if actually rates begin moving up as -- as inflation concern mounts, you will see the reverse factor, not only go back to equilibrium, but actually have some benefit from the move as rates increase.

Of course trading, which we've talked about and you did notice we suffered in this period in terms of net trading profits, most of those bad results actually happened in January and February.

March, there were some recoveries in the fixed income market.

It's been a very difficult time when often the hedges go the same direction as the underlying securities.

But as you probably are aware, our inventories are at low levels because of this and just generally because we don't tend to be very proprietary-trading oriented, where much more support, the commission side of the business.

As you looked at that, the thing I would remind everybody is that retail commission -- I mean gross commissions were up about 15%, commissions and fees, but a lot of that growth actually occurred in the institutional side.

We're still up in retail, as we have consistently been heretofore, probably surprisingly.

It has been surprising to me, I can tell you for sure, because normally in this kind of a market upset with all the negative publicity in the newspapers, you anticipate that the retail investor sits on their hands and avoids major changes in this kind of a period.

Whereas some of the institutions, quite the contrary, are trying to upgrade their mortgage-backed securities investments, buy some of the pools that are very attractive, rid themselves of others.

One of the things that I think we've distinguished ourselves on during the last 18 months is developing the capacity to actually analyze pool underlying instruments.

When you can do that, you really do bring a value-added content to the discussion for clients.

Basically, the run rate of those commissions has been anywhere from two and one-half to three times last year's run rates and commissions and fixed income, and up 30 to, oh, say 30% in the institutional equity side.

That's offset some of the other revenue lines, like investment banking, that is down and the trading results.

That's why the numbers in the segments might look a little better than you might have suspected for the quarter.

I was actually impressed that the overall gross revenues would be up 9% with lower interest rates in the mix.

Then of course net interest -- I mean net revenues actually grew faster because of the decline in interest rates on the gross level changing, which, you know, is not normal given the rate of growth of the bank during this period.

When you looked at that, you had that 9 and 11% increase which amounted to, because of the negative factors, I suggested during those earlier comments, a flat earnings result to last year, and up from last quarter, the immediately preceding quarter, so we've re-reported the $0.50 a share in earnings.

I think this is probably the first manifestation of what we basically have been saying about avoiding subprime because clearly, you don't have any massive write-downs.

There are declines as I pointed out in my comments in the value of the securities.

We've done, as you might guess, we've done a thorough scrubbing in the bank of all securities positions that are held there and essentially, in the publicly traded securities, you essentially have had a market where prime quality mortgage-backed securities have dropped about 10% from the end of the December quarter, maybe slightly less than that, but a lot.

Anything of lower quality during at least the first half period here is --- they have gone to subterranean levels, sometimes not appropriately, but most the time they certainly would have been affected a lot more than the higher quality securities.

While we have a couple of securities that you might not qualify as the normal securities in our portfolio, and that's in the 3% range.

We do have this research that can evaluate these kinds of securities.

The scrubbing process of looking at the public ones.

While the increase from $7 million of market discounts from costs at the end of December went up to $62 million in this period, the quality of the securities hasn't declined at all.

They are all paying fine, and we don't see any problems there.

We don't even see anything that would be called an impairment at this point in those few lower quality securities.

Now, needless to say, if you were looking at banks in general, you would conclude that if you had declines in the public securities portfolio, that you could do some sort of parallel analysis in the individual whole loans.

I would tell you as a general rule, that's correct.

That's why there's a concern currently in the marketplace that while banks have marked all the public securities and the impaired securities down, they haven't marked down some of these securities that aren't yet impaired, as that's the nature of bank accounting.

It tends to spread out the losses on these home loans over a longer period of time.

So there's still more losses to be taken in those bank securities.

Clearly if you marked our portfolio to market, you would have a similar kind of effect, but I would tell you that the actual quality is very high.

I would suggest to you that that ought to give you comfort that the earnings growth that you see in the bank segment is not a harbinger of things that are going to change in the future on the down side, rather that we actually expect those -- growth if those numbers, as I'll discuss here in a minute with segment reporting.

Then I'm just going to take you briefly through all the segments and then come back.

But first, just to round out the quarter, of course, that adds up to the net income for the half of $116 million, down from $119 million, so 3% decline year-to-year, if conditions in the marketplace improve, and I'm not forecasting that.

I can't call short-term markets.

The -- we should be able to match last year's results or improve upon them as some of these negative factors that I mentioned begin to dissipate in the marketplace.

The outlook is actually pretty good.

As I said in my remarks, some of these financial results are going to continue to trickle in negatively, especially in the bank sector.

But eventually here you will see us climbing out of this as the bulk of the bad news is behind us.

Really, it's more dependent now on just how resilient the general economy is in the marketplace.

There are plenty of places that are evidencing strength as you see in some of the own earnings reports that are coming out outside of the financial sector.

I would tell you, I don't think this is going to be a deep recession, if indeed it is a recession.

It really doesn't matter whether the general economy's in recession.

As far as I'm concerned, we've been in a recession in the financial services industry, certainly some people might say depression, at least those that are out of a job.

This is -- there have been a lot of changing scenarios going on here.

When we look at the segments, the private client group had a 5% increase in revenues which is pretty good given the circumstances.

We continue to strongly recruit, and this is the third consecutive quarter of up financial advisors in the United States.

We're also beginning to have a little better recruiting results abroad in Canada and the UK.

I actually think not only are we getting very high quality brokers, but we are continuing to upgrade productivity.

If you look at the productivity figures, our commission results compare favorably, in spite of this downturn in conditions.

Profits were roughly flat.

I would say here, the only reason that they are not up relates more to the cost of new FA recruits.

As you continue to fill up this pipeline of large recruiting that we've been going through now for three or four years, as you know in the financial side you amortize these costs over usually the length of time of the agreements.

While I would argue it ought to be a shorter period, we have trouble winning that argument with accountants.

I think they are, actually they are not making the right decisions about -- because you have some failures.

You have the time value of money.

You got a lot of considerations that I would argue ought to cause a write-off schedule that's somewhat different than what actually occurs in the marketplace.

But those numbers are very good.

There's nothing particularly of surprise in those numbers.

The Capital Markets side, we still have very low equity Capital Markets, investment banking activity in both new issuance and investment banking.

It's somewhat better perhaps than last quarter.

Canada is better than in the U.S., as natural resources are clearly leading the marketplace here.

But we are seeing evidence of some more activity.

When you think about our mix of sectors that we follow, the -- it's clear that things that are income-generative, like energy MLPs and REITs are doing some financing currently which is actually in our power zone.

I think that we're going to see a little increase and then as the market tenor improves, we will see more issuance in the other sectors.

I think we're kind of near the bottom on this side of the business.

As I said on fixed income, while trading has been unusual, the commission rates are terrific.

In addition to that, we are very successfully recruiting institutional fixed income sales people as a result of things like Bear Stearns, upsets at some of the banks that have large fixed income Capital Markets' efforts.

There's some real opportunities in the marketplace.

I actually expect that we may be in for two or three years of improved results in the fixed income area going forward, and a stronger platform for longer term than that.

On the asset management front, while revenues were up 2%, the -- remember a lot of our billings are done on a proforma basis for the quarter.

The -- as a result, we didn't see all the decline in the market values in the March quarter being realized on the revenue line.

But still, there was enough given the prior quarter.

There's also some product mix in here, in terms of the assets we manage, so that the net profits were actually off slightly here.

There's nothing particularly remarkable in those numbers, except that it's aberrant because normally this business is a pretty steady performer on the upside as we have positive net sales and we also benefit from average increases in market value.

I suspect these numbers are going to start looking better going forward.

I know the bank results clearly, when you look at that revenue line in spite of lower interest rates, et cetera, the --- that just reflects the asset growth.

Jeff, how much asset growth have we had in the last 12 months?

22% in the last quarter, but were we double?

No, in the total assets in the bank.

Year- to-year, it's pretty large number.

You see the net interest earnings is mainly volume-related.

Two factors needless to say.

You've got more assets that you're earning revenues on.

And the -- what?

5.1 to 8.3.

5.1 to 8.3, so you're looking at 60% increase.

It's a very large increase.

Where you see even more growth than that is because at that point last year, we weren't as fully invested as we are now, so you've actually -- because we've had good loan activities.

The other factors that might not be immediately apparent to you is that we've been buying very attractive loans.

Even additional pieces of existing loans at discounts to the prices we originally paid, even though the seasoned -- they are more seasoned and perhaps higher quality than they were when we originally participated.

The sales by the large banks of assets, good assets to generate capital and to shrink the balance sheet has been dramatic.

Firms like Citi have sold tremendous amounts of good assets at big discounts.

We've had the opportunity to take advantage of that and grow the bank.

Of course as you grow, you're also spreading your fixed cost base over a much larger asset base.

That means that you're going to have higher profits also.

So actually I would tell you, I don't think we're finished with the margin improvement.

You know, we're still growing.

We've had good organic growth in deposits.

We're not -- we moved during the quarter one other small sweep group of accounts.

But we have not at all kept pace with the rate that we could have moved other sweeps into the Bank, because we want to have a controlled growth approach to the Bank's growth, both to maintain extremely high quality.

The only reason we grew it at the pace we did over the last year was the quality of loans that were available in the marketplace.

The organic growth, however, has continued to be good.

Again, that ought to be fairly clear.

As people move out of investments.

they tend to have higher cash balances.

They are looking for places to invest.

My comment is while they are in these holding ponds, they are somewhat sensitive to rates.

While many of our competitors have all these tiered rates on their bank deposits, we actually pay higher rates.

We pay market rates for everything, but the very smallest accounts.

But small, I mean really small, $5000 type accounts.

So the fact is that I think this is even an opportunity for us to advertise in the future to attract more of these cash funds.

It could generate more growth from the Bank.

But to be frank, the growth is about as good as we would like it to be at the moment anyway.

We're not forcing that point at all.

As I tried to deal with, again, after the problems that arose from our release not this quarter, but the prior quarter.

While we've had big additions to reserves, in the $12-million range for this quarter, like it was last quarter, which shows another expense.

The fact is that the actual charge-offs that we have have, have been continued to be small.

When I say small, in the range of 0.22%, 22 basis points kind of numbers.

It's a -- they have been low.

I have remarked in the past that we expect them to be higher.

That's why we have higher reserves.

But I do want to point out that our reserve formulas for type of loans, relate a lot to industry norms, as well as our own norms, because it's very hard to separate these things out and tell really what the loan losses might be.

But because of the quality concerns in our individual underwriting methodology, where we're actually buying these packages from people, but looking at every single loan in most cases and certainly in all the corporate loans, where we focus on industries that we understand and companies that we already know.

I do suspect that we will have better than average bank experience over the long run, or we're not as good as we think.

That wouldn't be the first time I have been surprised by our performance in some area or another.

But I can tell you in this area, we have an excellent lending crew.

We use all of our produced research here.

We use all of our contacts and knowledge to be able to evaluate these things.

I actually think we're in good shape.

The fact that we have a lot of loans, as some hedge funds would have had you believe, does not necessarily lead one to the conclusion that there are large losses to take.

As a matter of fact, I would tell you quite the reverse.

I don't understand why people have reached some of these conclusions.

The Bank is doing fine.

Emerging market comparisons were down, largely because of Turkey and also because some of this market malaise has actually slipped into these markets, and so activity levels are down.

As you know, the volatility in emerging markets higher than it is in the developed markets.

I don't expect it to come back really quickly, but on the other hand, I don't expect it makes a whole lot of difference given the size of the operation there.

Proprietary capital, we now have bought two companies in Raymond James Capital.

They are both doing well.

We have installed new CFOs and a CEO in one case.

We will install a CEO in the second company also.

I think they have a lot of opportunity.

But again, this is a small activity on our part, where we budget spending, $50 million a year in this kind of activity in investments of equity.

This is not going to be a monster business of ours, but it is going to be a great adjunct to the investment activity that we have, as is Ballast Point's Venture Capital operation, where we're nearing the end of raising funds for our second fund.

It's gone very well there.

We have excellent results in the venture capital side to-date.

I think that's going well.

Then of course, we make some small investments in outside venture capital funds where we have new business effort underway from our investment banking side.

That's been successful.

I think that's going to continue to generate good results for us.

When I pause and look back at this, I've been somewhat frustrated, as you can tell from some of my remarks, by how much fallout outside of subprime has occurred in the financial services industry as a result of a whole series of factors, not the least of which is poor management and controls at the larger financial service institutions.

But also in rating services and regulatory oversight, where clearly, leaders at either the Treasury or at the Fed could easily have made some negative remarks about the growth of subprime and said, we don't expect to see you originate more than 5 or 10% of your portfolios in subprime.

You would have seen a dramatic change in behavior way back in 2005 or 2006.

It did not happen, and it needs to happen.

I happen to favor most of the provisions or provisions like the provisions that have been issued by our Treasury Secretary.

We really do need to centralize overall financial stability and soundness regulation in the United States.

Obviously, with an election going on, you're not going to see these things moved on quickly.

But if you just make, again, some logical projections about democratic Congress' activities when you have these kinds of problems.

In fact, all legislative response to issues is to try to find solutions which has its own set of problems attendant thereto.

We will probably see at least a major change where a central regulator has that responsibility.

I think that it's important that you are ready for that.

I'm going to make a couple other comments about it in the context of where I thought I would wrap up my comments.

I don't do this as a matter of normal course, but for a long time we haven't really talked about what I call the investment case at Raymond James.

I sit here and l look at these shorts in our stock and I say, what are these people doing.

We've never had this kind of short position.

I realize that we're one of the few plays in the investment industry that you actually can short enough of to make a difference, so that you can become part of a package in shorts.

I don't have anything against shorts, by the way.

I'm not one of these CEOs that think it, you've committed some sort of harassy if you go short a stock or if you have a negative opinion on a company.

That's fine with me.

That's your job.

That's what you're paid to do.

I recognize that happens.

But I do want to make sure that everyone understands what is really going on here.

When you look at these results, I would tell you it all relates back to our overall business strategy.

If you think about these, the issues that I would discuss generally in talking to shareholders, we've got a very diversified business space.

We are private client group oriented which is good.

Distribution tends to not have the volatility in it that a lot of other parts of our business do.

The -- but the -- that means that you can have situations where fixed income offsets results in equity Capital Markets.

Or retail does well when equity Capital Markets doesn't do well.

Asset management continues to grow a pace with your ability as a distributor and your outside sales.

The second part of the model is since, at least I and many of senior management at this Firm, still remember down markets in the early '70s, in '87 and '89 and 2000 through 2002.

All of these periods, we've always had a very conservative business model here where risk management is key.

I chaired the compliance and standards committee that meets once a month and looks at every problem in the Firm, and in the market generally, and tries to device strategies to avoid systemic problems arising or continuing.

We've always had a very conservative balance sheet in terms of our approach to the business, only to be subject to some of the same comments from lenders about, well, we're not going to lend to financial service companies in this market.

Fortunately, we don't have to borrow much money.

But the fact is, that it's inappropriate.

People are are not making the distinction among firms in our industry that are risk-oriented.

I don't have to tell you who those are, but you can look at 30 and 35 times leverage ratios.

When you look at ours, even our ---10 times, or 9 or 10 times ratio is way overstated just because we got the deposits in the Firm with offset by 15c3 deposits.

And most -- the rest of it's in the Bank.

The base business is really not leveraged, and I would say to a fault actually.

If anything, we have been so conservative in these things, we haven't quite maximized ROE.

The limited leverage, the agency nature of most of our business, and the fact that we just don't reach for the extra basis points.

We don't recommend to our clients they do that either.

People forget about what you always assume.

When you have markets like this, you get reminded that it's extremely important that this is a fundamental tenant in your overall business strategy.

The third thing, of course, is the multiple distribution platforms.

Chad Helck has been sort of the spokesman for us in terms of all of the models we offer to recruit financial advisors and other distributors to our platform.

We got the employee-based activities, the independent contractor-based activities, the bank financial advisor activities, and advisory activities, and we have active correspondent activities going on currently, recruiting business into our Firm.

That affords the perspective financial advisor the flexibility, not only to choose the distribution channel that he or she wishes currently, but to have the opportunity to move amongst those alternatives long-term.

You see this in the strong recruiting and retention that we have.

Of course, that is augmented by the fact that we have stayed independent and largely problem-free relative to our competition.

When you look out there and you talk about big acquisitions or brokers that have worked forever for CitiGroup or for some -- UBS or some other large firm that's now owned by a bank.

And they see problems at the bank and there's bad publicity, it causes upset and you have movement.

I would tell you that, that's a tremendous opportunity for us.

The fourth thing I would say is that small and mid-cap markets, as a result of all this consolidation, all of the Capital Markets' activities are kind of --- created a void here in these smaller corporate and smaller municipal markets.

Big firms have difficulty making money in a lot of these activities.

Just as an example that may not come immediately to your mind, municipal finance, public finance, the fact is that the current problems that exist and ill liquidity in the market are reminding people maybe they shouldn't use swaps in their financings.

That means you'll be going back to basics.

And I can assure you without swap profits, you're not going to see major firms out in the hinterlands.

Things auger well for our type of business model.

There are a few really independent securities firms left in the marketplace, so there aren't many places to go.

The ones that are around are good ones, so it's not that we don't have some competition.

We do.

But I would tell you we're going to attract a lot of people from the major firms.

The sixth thing I would say, is that we still can grow at 15 to 20% per year without substantial leverage.

I mean everybody arguing that you have to have 35-times leverage to generate this kind of revenue and profits that have occurred at the major investment banks, is just not true.

We can continue to earn 15 to 20% ROEs going forward on average.

Sure, we're affected by markets, but this is a good model to have.

It's a sound model.

The conservative management is easier to sleep at night than a lot of these other models.

And believe me, the financial advisors in the marketplace appreciate some of this now.

They may not have appreciated it before.

They may have taken for granted that everything was good, because numbers generally were up for almost 20 years in the marketplace.

But the fact is, that's not the way our business works.

It is subject to both cyclical activity and to great traumatic events.

You want to avoid traumatic events.

That's a big part of our strategy.

The final thing I would say is, at least our stock, and I don't normally say this, just so you understand, our stock is inexpensive.

I mean it's inexpensive enough that it triggered our own stock purchase mechanisms.

It has initiated a lot of purchase activity among our associate employee base.

When I meet with my own associates, when the market is -- our stock is near highs, you will always hear me tell people, look, don't bet a lot on the Company in a market when things are overpriced.

I mean you have to pay attention to where the market is when you buy stocks.

Quite the contrary today, I recommend that you can purchase our stock.

Just to give you an example of that, we have our own CEO group of what we used to affectionately call the regional firm group, which today is more vestages of firms that used to be free-standing regional firms.

But we still meet and share a lot of ideas.

We're very helpful to each other in the industry, as trade groups should be.

But one of the things we do for fun is we have an investment competition where the CEOs put up their favorite stocks.

This year, for the first time, because I thought this was a first-time opportunity, I recommended our own stock.

Just so you understand, I used to write all the research around here in the early parts of the Firm.

I was the first portfolio manager in our investment advisory business.

I have some experience with stocks and last year I won the CEO contest for the best performing security with a good energy stock.

I can tell you that when I say this, I really believe it.

It's not that I can't be wrong.

I can be wrong, because none of us know the outside market activity.

But when I sit here and I see rating agencies give higher quality ratings to large investment banks with 35 times leverage versus a firm like ours, I wonder what they eat in the morning that's got all that peyote in it.

To me, it's absolutely unbelievable.

We've got some problems to deal with on an industry basis, but the Firm is doing quite well.

We're glad to answer any questions you have.

I appreciate your attendance.

Oh, I do want to remark on one other thing.

I also described our auction-rate securities issue, where we essentially have -- did you get a final number?

Yes, $1.9 billion in auction rate securities outstanding, about 800 million of which are mainly new vein perpetual preferred, muni-based auction rates.

The $800 million are muni-based and those are beginning to be refinanced out.

The majority of those -- they almost all have premium rates.

But those with very high premium rates make up a minority of that, although the rate differentials are probably large enough to encourage refinancing on the vast majority of all those.

Those things are beginning to happen.

The rest are taxable closed-in fund perpetual preferreds.

Those are beginning to be taken out as we speak here.

Over the next 6 months, I expect to see a lot of this gone.

We have provided financing for these securities as have a number of firms in the financial services industry.

We're not loaning 90 or 100%.

We're loaning 50% on those securities.

The vast majority of our clients who own these have plenty of other assets.

They are only a part of their cash holdings.

It's still very small related to all of our cash deposits.

Just so you understand, our confirms always included a risk statement that auction rates securities were subject to auction risk, and that they might fail.

Then you would have a liquidity problem.

As a practical matter, there aren't many collateral problems in any of these securities.

They are well secured.

It's really just the fact that the structure had a fundamental flaw, at least the perpetual preferreds do.

You need to have a term period in those securities.

A number of us in the industry are working to solve this at both the trade group level and at individual firm levels with the product sponsors to quote, encourage, end quote, their rapid action in dealing with these issues.

I suspect that this is going to get better.

I mentioned the margin.

Actually, the amount of margin that we have issued on these securities is relatively small.

Even at tax time when you would expect the maximum demand for liquidity.

I think they are generally owned by people that can afford to own them, not in all cases.

We have been included in the class action suit with 19 firms.

But I think when you get into the distinguishing features, like our confirm and the fact that they are carried in a separate category on our client statement, that you would see substantial difference in how we deal with these issues contrasted to outside firms.

The loans that are being made are being made through the Bank, not through the brokerage firm.

Although there has been some loosening of the rules with respect to loans at the broker dealers, some of the terms that are set up are very limiting.

It's almost hard to interpret how some of them interact, so we have avoided that to date.

We obviously don't want a lot of ill-liquid securities in the broker dealer anyway.

But the fact is, we're not going to have a lot of them in the Bank either.

The -- we haven't had much demand as yet for that, but this is a problem for the industry.

It's a shame this happened.

Again, this is one of those, what can go wrong analysis that all of us didn't pay enough attention to, even though we paid enough in our compliances standards meeting at the time we originated them to make sure we had special warnings with respect to their purchase.

Unfortunately, not all of our financial advisors may be as circumspect as we are in terms of these general warnings.

It's not that there may not be some liability, but I really think these things are generally money-good.

We're going to work our way through these as an industry.

I do want to preempt your comments there, too, because I think we're doing all the right stuff.

I don't think that maybe the analysts and the journalists have fully understood some of the issues presented in here, and how you deal with them, and the differences amongst all the securities.

Although the level of knowledge seems to be increasing at some of the --- in some of the newspapers, as I can tell the quality of writing has improved with respect to the facts.

With that, I would like to open it up to questions.

(OPERATOR INSTRUCTIONS) We have a question from Lee Matheson with KJ Harrison and Partners.

Please go ahead.

Thanks.

Hi, guys.

Just have a couple of quick questions on the -- first of all, on the write-down that you took on the available for sale securities.

It looks like it's about 10% of the gross amount you're carrying at the amount you're carrying at the Bank.

Of the amount of the available for sale, how much of that was agency versus non-agency paper?

I'll let Jeff respond to the question on those securities.

The write-down there is really mark to market that goes direct to the equity side.

It's not an earnings write-down.

As we said, we don't see even a --- any material risk at all in terms of actual loss in those securities.

Sure.

Were these particularly long-dated, or what -- like a big move.

They are two-year average life.

Three-year?

Two.

Two-year, okay.

Yes.

Okay.

I think agency, I think at the call reported like $300 million was agency.

That sounds right.

Yes.

Okay.

So presumably, the non-agency fell substantially more than the 10%?

Yes.

Okay.

Was it any particular exposure?

I think we're at about an 8.5% or 9% total write-down.

So that's correct.

Okay.

There was no particular exposure to a non-agency issuer that we should know about?

Obviously as Tom mentioned, there's a small fraction that are not AAA.

Not that ratings have the same credibility that they used to.

That has suffered a greater percentage write-down.

But again, we've looked through it on security-by-security basis.

They still seem to have adequate credit protection, very high quality borrowers, very -- you know.

Okay.

-- delinquent rate, delinquency rates, et cetera.

The only way that the pricing can be justified in the market right now is if people expect things to get a whole heck of a lot worse, even from where they are today.

Okay.

Then just a second question, which is just looking at the residential mortgage loan book at the Bank.

You guys say you're not reaching for that extra basis points.

I'm wondering what the yield pickup is on these sort of deferred amortization, residential mortgages versus just going with the traditional immediate amortization.

Obviously, there's got to be some incentive for you to do that.

Just wondering if you could walk us through the thinking there.

The incentive for the interest only is that's predominately the product that's being sold in the marketplace right now.

The only experience, about 6% -- amortization the first five years of a 30-year amortization schedule anyway.

It's not that we're --- either seeing dramatically lower payments by going interest-only, nor that we're picking up just -- we're not doing it because of the income play.

We're doing it because of availability of product in the market.

We have, again, with all of the screens and scrubs we do on the residential mortgage pools, we have equally good credit profile there, as we do on the commercial side in terms of superior statistics to the industry averages.

I mean when you guys look at it and you see, there's obviously nonconforming then.

What -- I mean are you comfortable with the $650 million of available-for-sale NBS as sort of a liquidity pool, because obviously ---

That, plus $1.3 billion in overnight reverse repos that are awaiting to be deployed into loans as well.

Okay.

That are on the bank's books also.

The answer is, yes, that's why they are in available for sale.

It's a holding location that if eventually we need the liquidity for any reason, whether it's because loan demand has picked up or whether it's because deposit withdrawals.

We also have a substantial line of credit at the Fed, secured by our loan portfolio that we could draw upon if it were an opportunity, in an opportune time to liquidate securities, such as today.

Sure, sure.

We have ample sources of liquidity at the bank.

That's not a concern for us.

Okay.

Then just on the deposit-gathering side of the bank, is there any concentration risk within that?

Is there any one office, RJ office or advisor or anything like that, that represents an inordinary amount of the $7 billion in deposits?

No.

It is a broad cross section of our client base.

Certain types of accounts such as custodial accounts, et cetera, are exclusively using the Bank.

It's more by account type than it is by any kind of office.

I mean this is -- well, it's not technically viewed totally as a core deposit.

This is a substantial portion of our cash at the Firm.

We have about $18 billion in client cash balances at our Firm with now about $7.5 billion at the Bank.

We have the ability, as Tom mentioned, to do other types of sweep moves if we -- at such time as we're ready for it at the Bank, to increase the deposits there.

We've had to consider these core deposits.

I've been here closing in on 25 years this summer.

Every year I've been here, I think client cash balances have increased.

We have never actually had a down year in cash balances, but we do not view these as hot money or at any kind of risk for around the Bank or anything like that.

Okay, great.

Thanks a lot, guys.

Good quarter.

(OPERATOR INSTRUCTIONS) We have one from the line of Joel Jeffrey with KBW.

Please go ahead.

Good morning.

Good morning.

Hi, Joel.

Can you guys talk a little bit about the compensation expense and how that could be impacted by that $6 million you referenced in the release?

It was impacted by that.

I mean the fact is that accounting rules require a mark to market treatment on equity compensation instruments issued to independent contractors.

We have a, not a significant, but a significant enough, a reward mechanism for independent contractor financial advisors in past years, where they have received options.

We also used some options and/or restricted shares in the recruiting process for independent contractors.

As one of the anomalies of our stock price dropping, we actual --- those, when mark to market.

Those options and restricted shares became worth significantly less.

It actually reduced compensation expense by about $6 million in the quarter.

It's actually 180 from our normal experience, quarter-to-quarter.

The stock had normally gone up.

We actually, in past quarters, have assumed large amounts of increased compensation expense during these periods.

Whereas if you were using a qualified type mechanism, which you can't use with independent contractors, but if you did, you would have put yourself in a position where you took a write-down on the value of the optionality at the time of issuance.

I would tell you, that there is no fundamental difference between how we use them with independent contractors and how we use them with employees.

And then actually, the treatment ought to be the same.

This is one of these rules that derived to stop companies from giving stock compensation to contractors of a nature that provide some vendor service to the company, when they didn't have cash and so they paid with stock.

Actually it's -- I don't think it was ever intended to work the way it's working here.

I actually believe they ought to change the policy.

The policy's wrong.

But for the moment, this is just the way it works.

As long as the stock price goes up, we have increased compensation expense and if we have one period where you give some of it back, the way we did last quarter, you can give it back.

In the nature of our reporting, we make attempts to try to get you back to understanding operating result line and try to make sure that these anomalies that occur, and they are not really anomalies, but these things that don't happen quarter by quarter, that we make you aware of them so you can factor them into your earnings estimates, et cetera.

We are sensitive to the fluctuations caused by this, however.

We're taking steps to substantially limit the amount of equity incentives used for contractors going forward.

We're finding other instruments and other ways to compensate them, so we minimize this fluctuation going forward.

Would there have been -- had that $6 million been included, would there have been any kind of offset from an increase in share count?

No.

It would be related to really where the stock price is.

If it weren't there, it would mean the stock price were higher.

If you just think through what's happening, essentially if a stock doubles over the period of holding radically, and it were a five-year option, you would be amortizing the increase as you went through the five-year period as incremental compensation expense.

Whereas if you had a qualified plan, you would have taken the option value into consideration.

Or you wouldn't have any.

It wouldn't related to any revenue production or anything else.

It was strictly related to the stock price movement.

Okay.

Then, can you give us a breakdown of the investment banking revenue?

M&A versus underwriting?

Yes.

I can.

For the quarter?

Yes, please.

For the quarter, M&A -- well, domestic M&A was about $7.8 million.

Underwriting fees, domestically again, were about 3.8.

And -- Canada in total was about 7.3.

I don't have a breakdown between M&A and underwriting.

I think it's substantially underwriting fees.

Roughly 10, 10 underwriting and 8 M&A, something like that.

Then we had -- the one that kind of surprised me at least, had to do with our tax credit fund, real estate syndication of tax credit housing properties, which had about a $6 million revenue in the quarter.

Which is a business that's a little bit lumpy, depending on when they close funds and some seasonality to it as well.

As well as the state of some of their normal buyers which have been Fannie Mae, Freddie Mac, some of the big banks and big insurance companies, et cetera.

That business is slowing down.

They don't have any earnings to shelter.

The -- so that's why the surprise.

But the fact is that we had carry-over from prior periods effectively as the funds are employed in new properties where you have commitments that haven't yet been executed.

That's what happened in the first half.

But we expect a slowdown in the second half.

That market is basically more opened for the moment while people are trying to figure out what rate of tax credit return is going to be required in this market and where the new buyers are going to be allowing insurance companies, et cetera, to utilize the credits.

We actually, from our budgeting standpoint, had budgeted very low actual revenues for the entire year.

The first half is not reflective of that, but this is not a major line item in our overall firm either.

Okay.

Great.

Then just lastly, can you just cover what the total buybacks for the quarter were and if there's anything remaining on the authorization?

We repurchased about 2.8 million shares for $60 million which in equity, nicely negated our earnings for the quarter.

He means balance sheet net addition to equity.

The --- Shouldn't negate our entire equity.

We exhausted our authorization that had been outstanding for several years.

It started back I think the 6, 7 years ago, they authorized $75 million.

Even in the 2000 to 2002 dip in market, and we -- our stock only dipped for about a week during that timeframe.

So we are not able even --- we did not choose to use the authorization even then.

However, when it got down to these prices, we got a lot more aggressive.

We exhausted that authorization and had a special board meeting which you should have seen a press release about.

Which basically reinstated a new $75 million authorization which we've not really made any dent at all in yet.

We honor the timing ---

Blackout period.

Blackout periods even for our own purchases, even though I'm not sure we have to.

We do do that.

That's part of the reason.

Our average price was around 22.5 for those shares that we repurchased.

Great.

Thanks so much.

Okay, Joel.

And next, we have a question from Doug Sipkin with Wachovia.

Please go ahead.

Yes.

Thanks.

Good morning.

Just a couple of questions here.

First off, you had mentioned, I think Tom, you had given the number on the net interest adverse impact from the Fed cuts.

$5 to 7 million a quarter, that doesn't -- does that fall straight to the bottom line pretax?

Or is there some cost associated with that?

No.

That's an increased expense during the last two quarters.

Increased expense.

Okay.

Or if you think about it, it's results in understated --- Profits from the normal ---

-- tax line.

Yes.

I'm sorry.

I didn't get that.

It would fall substantially to the pretax line.

No, there aren't --- no new expenses would have been ---

There might be general bonus accruals, stuff like that related to it, but substantially it falls to the pretax line.

Perfect.

That's very helpful.

Secondly, and I think someone might have asked this already and maybe I missed it.

But the yield in the bank, whether it be on the margin or the spread has gone up quite dramatically.

I'm just trying to figure out what is that attributable to?

Is it just the higher rates that you put on?

The higher --- the lower prices that you were able to get in the last couple quarters?

Or is there some other dynamic there?

That's part of it.

There are really two at play, I guess.

Actually three, one going the wrong way, but.

We added a net $1 billion in loans in the December quarter.

Obviously, we were getting the interest earnings impact from those and about 70% of those were in the commercial world.

At much better spread than we had been seeing historically, so that, plus the additional -- we had about $0.5 billion dollars in this March quarter.

We had some earnings from those as well, as, again, the prices and yields continue to be very favorable relative to where we've been historically.

You definitely had a manifestation of interest earnings from all the loans added.

The second thing is, as the Fed continued to cut rates, as you know, we have a $2.3-billion portfolio of residential mortgage security, residential mortgages on the bank's books, substantially all 51 ARMS.

Even though they have a very short average life, they are in the fixed-rate period of that five, five/one.

As mortgage rates have not been dramatically affected, there hasn't been a flurry of refinances or repayments, and as our cost of financing those has dropped.

We've had a windfall, if you will, on the spread relative to financing the five/one ARM portfolio.

Having said that, we are very sensitive to the fact that this works the other way, if and when the rates --- if -- when, I should say, rates hit bottom and turn around and go the other way.

We're actively evaluating hedge mechanisms, et cetera, to mitigate, partially mitigate that effect when interest rates turn around.

But for now, it's been a big windfall for us.

Okay.

Then just a couple of more.

Can you give us sort of an outlook of how we should be thinking about loan growth going forward, and obviously, the provision expense, attach that.

I may be getting the sense that you guys are thinking that's going to start to slow a little bit, given the rapid growth and also a lot of the sweeps that have already taken place.

Any color on how we should maybe be thinking about it?

I know provision was $19 million, $12 million, and then almost $13 million.

Obviously, I know you guys are going to be opportunist.

But could you put any boundaries around how we should be thinking about provision expense?

At least as it relates to new loans going forward?

Well, some of that's dependent on what the marketplace is.

If the market -- assuming that attractive loans continue to be available in the marketplace, we are probably going to try to manage going forward to maybe a 25 to 30%-type growth in the bank in total assets.

Which would imply if we keep the same ratios, maybe just slightly more than that in terms of loan growth percentage.

You might see $2-billion type increase in net loans.

$0.5 billion a quarter, something on that nature is kind of where we're targeting for the next 12 months, but again, it's subject to a lot of things.

If a lot of opportunities present themselves, we may try to take advantage of them.

If the market really tightens, we might go even slower than that.

We have some control over the sweep steps.

We don't have a lot of control over the organic growth, which is coming in from new FA recruiting and, and/or people sitting out from the market for a period of time, et cetera.

That's really been fueling our growth more than these sweeps steps has.

We kind of see the bank growing at 2, $2.5-type billion in the next 12 months.

We'll probably put 80% of that to work in loans.

Okay.

In terms of the --- I think Tom mentioned this, the deferred compensation expense that you recognize as you run through --- I guess deferrals on the FA side.

Given that you guys have done a lot of recruiting, I mean can we be thinking about that maybe slowing down at some point in the future?

Or is it something that's going to just kind of be the same impact on the earnings number, pretty much consistently going forward?

I'm just thinking maybe because there is a lot of hiring done, maybe have higher deferrals right now than you normally would otherwise.

I would make the reverse argument, actually, that we're still filling up the pipeline in terms of amortization.

Because if you have now, say, an average of seven years of contracts outstanding on FAs.

That as you amortize the front money over the seven-year period, that means it takes seven years to fill up the pool at the higher rates of FA acquisition that we've had for the last three and a half or four years.

We've got a few more years to go.

The -- what the offsetting factors are that we have continued to have after the first year downturn in production in a transfer, which averages probably 15 or 20%, we have continued productivity growth in the newly-acquired FAs that were brought in during that period.

Then they offset the rate of acquisition.

The only thing that would achieve the result that you're talking about is, number one, of course, it we keep going at the same absolute rate.

I find it hard to go much faster.

It will slow down relative to the base of total production.

If the --- if it becomes more difficult to recruit, as indeed it ought to, in the marketplace because of retention programs, you may see less movement in the future.

At least, that's what the impact of compensation plans would indicate.

It would mean that there would be less activity out there someplace.

But right now, I see the reverse.

I actually see more activity as brokers are moving away from problems into other situations.

But I suspect with fewer firms recruiting and with all these retention agreements, somewhere out there after things settle down in the marketplace, there will be less movement.

Then, you will indeed see this slow.

It's a little complicated.

The overall impact of this, since it has so many offsetting factors in it.

But you could see a basis point or two of increase, max over the next three years.

It may be mitigated by some of these other circumstances that I mentioned.

It isn't going to be a major deal because it's smaller as a percentage of total commission generation as we increase the sales force.

But I don't see it going away here in the near term.

Great.

Then just finally, you had mentioned that --- I guess the underwriting and slash-backing environment was starting to show a little bit of signs.

Maybe can you characterize that by month?

In the sense --- just from my rough glance, it looks like April you guys had done a couple of things, might have another one in the pipe for this week.

Would you characterize April being better than March?

Or you just don't think about it that way?

Yes.

It's not significant enough to comment.

Month-to-month, you're erratic, number one.

But number two, what you're seeing is some more lead-managed activity in these areas that we call our sweet spots.

I expect to see some slow ramp here.

But if we don't get a better market for new issues, it's not going to immediately go away.

I suspect more that you're going to have a slow increase here in terms of activity levels.

It's still not going to be a great year.

I can't comment on what next year's going to be like yet, until we figure out what this general economy really does.

But I see some improvement, but I don't see it being the halcyon days of the recent past.

Okay.

And M&A activity, I do expect will increase a little bit, soon as financing ill-liquidity straightens itself out.

Great.

Thanks a lot.

It's not a big deal for them.

At this time, there are no further questions in queue.

Please continue.

Well, I want to thank all of you again for attending.

Sorry we took so long this morning.

I hope you have a good day.

We'll see you next quarter.

Thank you.

Thank you.

That does conclude our conference for today.

Thank you for your participation and for using AT&T executive teleconference.

You may now disconnect.