Raymond James Financial, Inc.
Q1 2015 Earnings Call Transcript

Published: 24 Apr 2015

[Operator:]

Good morning and welcome to the earnings call for Raymond James Financial fiscal second-quarter results. My name is Therese and I will be your conference facilitator today. This call is being recorded and will be available on the Company's website. Now, I will turn it over to Paul Shoukry, Head of Investor Relations at Raymond James Financial.

[Paul Shoukry:]

Thanks Therese and good morning. On behalf of our entire leadership team, I just want to thank you all for joining the call this morning. We know this is very busy time of the year for all of you. So, we certainly do not take your time or interest in Raymond James Financial for granted. After I read the following disclosure, I'll turn the call over to Paul Reilly, our Chief Executive Officer and Jeff Julien, our Chief Financial Officer. Following the prepared remarks, that 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 information concerning future strategic objectives, business prospects, anticipated savings, financial results, industry or market conditions, demands for our products, acquisitions, anticipated results of litigation, and regulatory developments; or to mirror a general economic condition. In addition, the words such as believes, expects, anticipates, intends, plans, projects, forecasts, and future are conditional verbs; such as will, make, could, should, and would; as well as other statements that necessarily depends on future events; are intended to identify forward-looking statements. There can be no assurance that actual results will not differ materially from those expressed in the forward-looking statements. We urge you to carefully consider the risks described in our most recent 10-K and subsequent form 10-Q. Which, are available on the SEC's website at SEC.gov. So, with that, I'll turn the call over to Paul Reilly, CEO of Raymond James Financial. Paul.

[Paul Reilly:]

Thanks, Paul and good morning, everyone. Jeff Julien and I are attending our RJFS Independent Advisors conference. A record 4,000 attendees, over 240 training classes; an extremely positive and constructive environment. In fact, we had over 72 recruits attending our conference from other firms. First and foremost, I want to start with up – we believe we've had a very good start for the first 6 months. In fact, a record pace for the first 6 months. Nets – net revenues for the first 6 months of the fiscal year were $2.5 billion and pre-tax income of $383 million both represent the most we've ever generated for the start of our fiscal year in a six-month period. Additionally, I think if you look at our key operating metrics at the end of the quarter, we have a lot of quarter-end records. That includes client assets under administration of $496 billion, financial assets under management of $69 billion and net loans at the bank of $12 billion. These records have been driven by our long-term focus on recruiting and retaining a great group of financial advisors. That shows up in the numbers also, with a record number of financial advisors. We grew to 6,384 at the end of March, which is up 182 from last year's March, and 48 over the preceding quarter. These strong net additions really understate our actual growth and productivity capacity as they come online. Now, I'm going to go over a few numbers before I turn this over to Jeff for more details. We understand this was a noisy quarter, as was our first quarter last year, both due to seasonal and nonrecurring items that Jeff will discuss. We achieved a record quarterly net revenue of $1.29 billion, a 9% increase over the prior year's fiscal second quarter, and a 3% increase over the preceding December quarter. Quarterly net income of $113.5 million, or $0.77 per diluted share. Quarterly net income is up 9% from last March quarter, but down 10% sequentially. Due to those items which I alluded to previously and Jeff will go over. As we told you on the last earnings call, we typically have a difficult March due to seasonal items. This March quarter was no different. Because of some of these items, we think it's important to look at the combined results for the first half of the fiscal year. Where we generated $2.54 billion of net revenues, up 7% over the first half of FY14. And, net income of $240 million, which is up 8% over the first half of FY14. During these first 6 months of the fiscal year, we generated a 15.1 pre-tax margin in this rate environment, which is within our target. And, an annualized return on equity 11.3, below our 12% target in this interest rate environment. But, we still think our target's obtainable. Now, for a quick recap of some of the segments. The private client group; we generated a record net revenue of $871 million, up 7% over the prior year's fiscal second quarter and 3% over the preceding December quarter. Again, this segment was affected. Quarterly net revenue is really attributed to strong advisor retention. Which, along with a – not a lot of appreciation in the market, we had solid improvement in our assets due to our productivity in recruiting. Meanwhile, quarterly pre-tax profits of the segment of $75 million were challenged by the seasonal factors and other items Jeff will explain. Including, FICA, advertising, technology, and other items. But again, if you look at the 6 months of the fiscal year, you'll see reasonable operating leverage. As net revenues for this segment were $1.7 billion, which grew 8%. While, pre-tax income in this segment was $168 million, which grew by 13% over the previous period. At the current levels and quarterly revenues, we believe this segment can certainly generate over a 10% pre-tax margin to net revenue. If we go to the capital markets segment, we generated quarterly net revenue of $235 million, up 6% compared to last year's March quarter, and 1% compared to the preceding December quarter. Quarterly pre-tax income of this segment of $21 million was also challenged by a few items. Which, I'll leave for Jeff to explain later. Actually, based on January and February's results, we would expected a much more challenging quarter for the capital markets segment as investment banking revenues were very soft for the first 2 months, which we highlighted in our operating metrics. However, March surprised us a bit. As investment banking revenues in March were more than double the revenues of January and February combined. The strong March for investment banking was mainly attributable to very strong M&A and very strong public finance deals, where we had 94 in March alone and our tax credit business. Meanwhile, equity underwriting was very weak in this quarter. As the industry experienced a slowdown in both energy and real estate, which have always been strong sectors for us. The resiliency of our investment banking results this quarter, in light of the softness in energy and real estate, really highlighted the investments we made over the last 5 to 7 years to diversify our platform. In fact, much of the strength in M&A was driven by technology sector, which we essentially didn't have one as recent as 5 years ago. We continue to make these type of investments. For example, we've invested in our capabilities in the consumer sector. And, recently have added significant life science sector support, which, this quarter was hit by recruitment guarantees and the bill out expenses of the life science sector, but, we believe is a very strong and good investment for us. I quickly want to discuss institutional commissions in the segment. Equity commissions of $60 million were down year over year and sequentially. Primarily due to lower equity underwritings as we talked about earlier. Meanwhile, fixed income commissions of $75 million were up substantially on both a year-over-year basis and sequential. Our fixed income division had a very strong quarter. Benefiting from significant amount of interest rate volatility during the quarter. Net trading profits were also strong, which is a testament to our agency focus model. Also, remember this quarter had 3fewer business days than last quarter, which impacts our transactional parts of our business. In the asset management segment, asset management reached a record quarter end for financial assets. Under management of $69 billion, which is up 11% from the prior year's March. Quarterly net revenue of $94 billion, up 7% at to last year's March quarter, but down 6%, compared to the preceding quarter. Remember, the preceding quarter benefited from a $5 million performance fee and had 2 more billable days than this quarter. Quarterly pre-tax income of $31 million is up 44% compared to last March quarter, but, down 22% sequentially. But again, you will see there's reasonable operating leverage if you look at the first half of the year. The asset management segment's revenues were up 6% to $194 million and pre-tax income was up 15% to $71 million. Raymond James Bank reached a record of $12.1 billion of net loans, up 20% over last year's March, and 2% over the preceding December. Loan growth – excuse me, loan growth that decelerated this quarter after a very robust December quarter, as we've always said, remain very focused on quality loans, and we're very opportunistic of growing when those loans are available and slowing down when they're not. Record quarterly net revenues of $102.9 million; up 21% over last year's March. And, remember also, the bank was impacted by 2 less days of interest charges versus the previous quarter. This was the second best quarterly pre-tax income for the bank of $71.3 million, which was up an impressive 25%, compared to last year's March quarter. The loan loss provision declined sequentially on slower loan growth. And, net interest margins did improve to 3.09%, which is 12 basis points higher than last year's March quarter. More importantly, our credit quality remains strong, as a total nonperforming assets declined by nearly 22% compared to March's quarter and now represents 55 basis points of total assets, down from 83 basis points a year ago in the March quarter. So overall, a lot of noise, and Jeff will go through some of the expenses that hit this quarter. But, we believe, very good start to the 6 months of the year and the operating metrics that drive our business ended very, very favorably. So, with that, I'll turn it over to Jeff. Jeff.

[Jeff Julien:]

Thanks, Paul. As I've become accustomed to now, I'll start – I will go through some of the line items that give a little more detail on some of the items that affected those lines. Which, I hope will help in the modeling exercises that many of you go through. Commissions and fees were pretty much in line. The noise around that line item, for the last couple quarters, both commission revenues and commission expenses, has to do with the mutual fund adjustment that we've been talking about. By way of reminder, in the December quarter, we took a $10.5 million reduction of revenues, and a corresponding $6 million reduction of comp expense assuming that that would be the amount recouped from financial advisors on commissions that would be reimbursed to clients related to mutual funds that share class issue, whereby, some of the mutual funds that we sell had some, were run – ran specials periodically. Very deep in their prospectuses there were special deals that were available to certain type of plans. It gets very complicated and very easy to miss. And, so, what we had done in December was on an automated basis, went back 5 years, and sort of, took a charge for what we deemed to be the worst-case situation for us in terms of client reimbursements and FA chargebacks. In the most recent quarter, in the middle of February, we made the decision not to charge this back to financial advisors. So, that $6 million reduction in comp expense became a additional comp expense in this quarter. And actually, represents a $12 million swing if you're looking at December versus the March quarter. Further, the $10.5 million estimate that we had reduced commission revenues by in the first quarter, has been refined downward after we scrubbed the accounts for which we're truly eligible, etcetera, that, to about an $8 million number. And, those reimbursements are – to clients are starting this month. So actually, we've benefited by $2.5 million to – by fine-tuning that estimate. So, that was – other than that noise in that line item, it's trended pretty much as all your models have expected. Paul's touched on investment banking in some detail. Also, investment advisory fees, which are down just because of fewer days in the performance fee in the preceding quarter. Interest is in line despite the 2 fewer days. And, the most significant item of note there, of course, is the net interest margin improvement of 5 basis points quarter over quarter at Raymond James Bank. Account and service fees are in line. Paul touched on trading profits. They usually trend pretty much with fixed income commission volumes, which were good last quarter. This most recent quarter as well. In the other revenue line item, with the detail you can see in the press release, the big factor there was a higher than normal gains from private equity investments, about $17 million for the quarter. But about $6 million of that, by way of reminder, is attributable to noncontrolling interest. So, only about $11 million of that to our pre-tax line, for those of you that adjust private equity out of your models. Looking at the expense side, aside from the mutual fund reversal of the chargeback to FAs, which added $6 million in the quarter, Paul mentioned the FICA restart. This is an annual seasonal event for us, of course, and, everybody else that added versus the December quarter about $6 million to our comp expense, as everyone restarts the FICA clock that had surpassed the limits in the prior year. That difference will dwindle, that increment will dwindle over the course of the year, as people continue to hit the limit going forward. And then, information processing

[Paul Reilly:]

Thanks, Jeff. And, I know we're spending a little more time than usual. But, we know we had a little bit of a noisy quarter. In a way, I feel like it's like deja vu over again with same situation we're in the first quarter a year ago. But, if you really go through it all, you look at the first 6 month's numbers; we've had good strong operating results. More importantly, if you look at the factors that really drive our Business and the private client group record assets under administration at the quarter end, record advisors, a great recruiting pipeline; I think we'll continue to still drive and grow our Business. I wish you guys were all here at our conference and you'd see the positive energy from our financial advisors. In the capital market segment, investment banking activity remains robust, particularly in the M&A and public finance. But, we do con – still continue to feel the headwinds in underwriting, especially in the energy and real estate sectors. As we told you, we thought that the energy price fall would impact this sector for a quarter or 2 and be replaced by M&A and increased underwriting. But, we're still working through that transition in the marketplace. But, we got a very very good year and start this year in M&A. Asset management, record assets under adminis – under management, continue to help drive earnings. And, you also remember we announced a $1 billion asset acquisition in early March and were waiting for our final pending regulatory approvals. So, assets should continue to grow. Driven a lot by recruiting and net inflows. Bank, another very strong quarter. Good credit quality and the NIM improvement, the modest NIM improvement, should continue to help drive good numbers. And, finally, we know getting a lot of questions about the Department of Labor's fiduciary standard. We were active in fighting back in the first release in 2010 and now the law, as proposed, is very complex. We are analyzing it internally. As well as, I'm on the board of FSR and SIFMA. Scott Curtis, on FSI with our trade groups. I think were all united. I'm going through the proposals. In fact, there's ongoing discussions right now with labor. So, it's hard to quantify any changes and we're studying it. But, believe, the business we do is very positive for clients. So, with that, I appreciate your patience and we'll finally open it up for questions and answers. So, I'm going to turn it back to Therese.

[Operator:]

[Operator instructions]. And your first question comes from the line of Devin Ryan with JMP Securities.

[Devin Ryan:]

Hey, good morning.

[Paul Reilly:]

Good morning, Devin.

[Devin Ryan:]

A question on the bank. If I look at just the overall, kind of, deposits. And then, kind of, think about the deposits of third-party banks. I mean, I know that you guys, you want to have the bank balance within the platform and grow, kind of, with the firm. But, when I look at the capital base of the firm, capital looks strong. You have excess capital. Then you have significant deposits at third-party banks. And so, yes, I would think the spread pickup from moving some of those deposits onto the balance sheet would be pretty significant. So, just let me get your thoughts there? Is that an opportunity? And, some of you guys would, maybe, look to do? Just given that, I think, from earnings standpoint it could be pretty powerful.

[Paul Reilly:]

Yes, Devin, I think that there's a lot of things we know we could do to improve earnings. And, it goes even taking some fixed rate risk in securities; minimal. We could grow the bank. But, we've had a philosophy to target the bank about 35% of capital and no more than 40. We think it's important for our advisors and for our shareholders to understand we're not a bank first. So, we're a private client group that has strong banking and asset management backing to it. So, sure, we could deploy more capital. I think the bank's done a great job of investing in its assets, its loans, and its good risk return basis. But, our view so far is, we want to keep it within those capital ratios. We have an opportunity to grow. We haven't told Steve not to grow, because we certainly have a little more capital room. But, we're not going to be overly aggressive in it either. So, we're going to stick to our model right now.

[Devin Ryan:]

Great, thanks.

[Jeff Julien:]

Kind of makes sense. The bank's not intentionally slowing down just because of that constraint. They lend when they find good opportunities to participate in credits that meet are – that meet our quality standards and our return standards. And, that gets lumpy. You saw it really big in the first quarter and you saw it slow down a lot this quarter.

[Paul Reilly:]

So, you're right. It has room to grow, and we've told them to grow if they find good quality loans. And, I think, we're – as we find good loans and we're opportunistic, we add them. And, when it's not there, we slow it down. And, it has room both within our internal capital allocations and certainly our client cash. Which again, we limit to 50% of our client cash in the bank as another control and diversification tool. But, they have room under both. But, we won't let it get out of hand.

[Devin Ryan:]

Got it. Thanks for so much the update there. And then, just with respect to the NIM in the bank. You had a nice step up sequentially. Was that mix-driven? Or, what drove that? And then, just, kind of, thinking about the outlook for the NIM. Just giving some of the moving parts around mix versus what we're sitting in rates today? That would be helpful.

[Steven Raney:]

Devin, this is Steve Raney. Good morning. It was primarily driven by NIM increase in our corporate lending book of business. I would say that, yes, the outlook I would say is probably stable for the next few quarters within a small range up or down. But, I would say the outlook would be pretty stable at this point.

[Devin Ryan:]

Okay. Great. And then, just lastly, within investment banking it sounds like the backlog feels pretty good. And, just, kind of, within the businesses there. How is M&A, maybe, specifically today? And, how does that backlog feel? And then, with public finance it sounds like it turned on toward the end of last quarter. So, what drove that? And, is that, kind of, theme carrying into this quarter?

[Paul Reilly:]

Yes, I'd first – in investment banking, I think, certainly, kind of, underwriting business has been tough across the board. Especially for us, where we're strong in energy and real estate. But, the other sectors have done well. In M&A it's been across the board, but, particularly in tech and tech services, an extremely good quarter. Late March quarter actually, where it produced a lot of the results. I think people forget sometimes, in public finance, we're a top ten underwriter. I think one poll said 8 and one poll said 9, with total credit to lead. So, we are – it's a significant business force. That business was very slow in January and February. The March turn on had to do with, I think, first, in that business, you get a lot of, because of the holidays at year end. Financing typically slows in January. That carried over longer into February. But, we're getting the refinancing part of that business is turned on during some rate volatility. So, we're – the refi part of public finance has been absent in the last year. That turned on and a lot of deals happened quickly. So, so far we see the movement short term. Here we are into early April. Good activity in both of those. But, as you all know, that's a lumpy business that's hard to predict. Both of those. But, we feel pretty good about the backlog. Sure.

[Devin Ryan:]

Great. Thanks for taking my questions.

[Paul Reilly:]

Sure.

[Operator:]

Thank you. Your next question comes from Hugh Miller with Macquarie.

[Hugh Miller:]

Hey, morning.

[Paul Reilly:]

Hello, Hugh.

[Hugh Miller:]

I appreciate the insight that you guys gave on the fiduciary standard. Was wondering if you could just give us a little more detail on a few areas to help us, kind of, frame some things up? With regard to the percentage of your, kind of, advisors that are RIAs. That are, kind of, already adhering to that standard? And, some color, maybe if you can, on – you could give us in detail on the fee-based assets? But also, can you give us any sense as to how much of those are qualified? And, any rough sense, on historically, the type of revenue you typically tend to generate from IRA rollovers in those types of things?

[Paul Reilly:]

\First, let's answer it in 2 parts. The standard, we have an awful lot of our advisors that have their own RIAs, or, in our RIAs. But, that's not actually even the issue. I know that publicly it's been the issue. If you look at the definition of exemption and level fee payments and disclosures, it's pretty complex right now. So, I think hopefully in this comment period, and working with the Department of Labor, we can get things that are clear. Because, it's not that clear the way it's written. So, we're working through those right now and that's, it's – that's hard to tell. So, it's not as simple. If it's as simple as having an RIA, we'd have a lot of people exempt. But, it's not that simple in terms of level fees, products, what qualifies in an exemption, what doesn't. And, that's what I think the industry's trying to work through. In terms of assets, Jeff?

[Jeff Julien:]

Yes, I mean, our retirement plan assets in our firm are about 35% of our assets. And, which I believe that includes IRAs. Is that right, Paul?

[Paul Shoukry:]

Yes, about 35 to 40% our retirement plan assets. Actually, it's a little bit higher than that within fee-based accounts. It's about 45% of our assets in fee-based accounts are retirement assets.

[Jeff Julien:]

I don't think that's a statistic you'll find much different than –

[Paul Reilly:]

Anyone, yes.

[Jeff Julien:]

Well, may be different than Ameritrade.

[Paul Reilly:]

Yes.

[Jeff Julien:]

Or, something like that. But, not much different than most full-service firms that focus on financial planning.

[Hugh Miller:]

Okay, yes, that's very helpful. And then, as we look at, kind of, the asset management business. Do you have a sense of, kind of, the percentage of the assets that are in qualified accounts?

[Paul Reilly:]

I don't that, I don't think we know that one offhand. But, I will tell you that the early reads on that, that actually that we get some benefit, some restrictions of – in that area. In IRAs and what you can sell. But, if you read again, the best you can read the DOL standard, we may actually may even get some relief and some opportunity in that area. And, again it's just too early to speculate. It's – the law is 800 pages. It's very complex. And, people are still trying to go through and understand it. And, I think even the department's trying to understand the implications and what all this means. So, we're studying it like crazy.

[Jeff Julien:]

We have a whole committee doing that.

[Paul Reilly:]

Yes, but, it's too early to really give you an impact. If we had a clearer picture, we would.

[Hugh Miller:]

Okay. Well, that's certainly helpful; the color you've given there. And then, just a question or 2 at the bank. I think you started to talk about, maybe, some of the energy credits and things like that and getting ahead of this – the SNC exam. But, is that what's driving, kind of, the uptick we saw in classified assets? Just, kind of, adjusting things ahead? Or, are you seeing any changes in credit trends? That are, maybe, low level, but it's not rising to an MPA? But, that you're making some adjustments?

[Paul Reilly:]

Yes, Hugh, the increase in criticized loans was attributable to downgrading 3of our energy names. And, us proactively, and we think wisely, adding reserves against those names. So, the exposure still remains a very low. It's less than 3% of total assets are in the energy sector. And, the vast majority, 75% of our energy exposure is really not related to – it's not as sensitive to the volatility of oil and gas prices. It's more midstream-oriented related to exposure. So, but, continue to watch every name very closely and monitor that portfolio actively.

[Jeff Julien:]

The percentage may have moved, but if you look at dollars, it's not much. It's in a normal fluctuation. So, I think, there's nothing underlying that we're worried about, that's driven any increase there. Is just our normal credit process and trying to be conservative and doing the best job we can at estimating that. And, trying never to be behind the curve.

[Hugh Miller:]

That's helpful; that's helpful. And then, as we look at, kind of, the deceleration in loan growth. If you could just give us any color between the resi portfolio and the corporate portfolio? And, I guess as we look at things from a spread basis, we have seen, kind of, a nice improvement in credit spreads in both investment-grade and high-yield in late last year and into this year. Any color as to how we should be thinking about that in terms of your willingness to, kind of, go out there and put capital to work?

[Steven Raney:]

Yes, we have seen improvements in the marketplace pushing back and credit takers like us and institutional investors in this market are finally having a little bit more discipline as it relates to the returns they're looking for. That being said, I would say as reflected in this quarter. Loan volumes, I would say broadly in the corporate sector in particular, were down. There's not as much deal flow right now. And, as Paul and Jeff alluded to. As you well know, we've been very prudent and not really changing our credit standards at all. So, I think you'll see us, really, not making any significant changes to our approach. We've got latitude to run in place and even shrink if we needed to. If there weren't opportunities, so.

[Jeff Julien:]

Hey Hugh, and this is the one we've been terrible at guidance, because we just don't know. We've seen when we say it's slowing down, we all of a sudden, like the December quarter, we had a huge quarter. So, we just – we're very focused when the markets are right and we get the right credits, we act. And, when they're not, we slow down. So, it's a hard one to tell you how we really – where we see it going because it can open up like a spigot and it can slow down in terms of the things that we're interested in lending on.

[Q- Hugh Miller:]

All right, that's helpful. Thank you so much.

[Paul Reilly:]

Thank you.

[Operator:]

Thank you. Your next question comes from Chris Harris with Wells Fargo.

[Chris Harris:]

Thanks, hello guys.

[Paul Reilly:]

Hello, Chris.

[Chris Harris:]

Surprise, a few questions on DOL. Wondering if you guys could help us out. Maybe, not getting into the law specifically. But, if we just think about your advisor force overall. How does the behavior differ between your advisors that are operating under fiduciary versus those that are not? And, I know one is – tend to be a little more fee-oriented and the other is commission-based. But, anything you can kind of help us out with, with regards to how they run their practices differently? The different products that are in those 2 categories would be helpful.

[Paul Reilly:]

Here's the hardest thing Chris. First, I wish I could tell you that one's one and one's the other. And, those operating our fiduciary are different than the commission volley. We believe that our job is to put the client first. It's been one of our – it's the center of our core values. It always is. To say that just because your fee-based, it's better for clients, when a commission is cheaper. Especially, in small accounts. In fact, there's anti-churning regulations where we're not supposed to charge a fixed fee when we're not giving a lot of advice. It's cheaper for the client to be commission-based. So, this whole thing of fiduciary, what does it mean under the standards? And, that's really the question. Whether it's under the 40 act or it is this fiduciary standards proposed now. I – we all believe it's in the best interest of the clients. So, just because your fee-based doesn't mean you automatically do what's in the best interest of clients. Madoff was fee-based IRA. But, so, that's the hard thing here. So, it's – at one extreme you could say everybody who's doing commission base is going to have to go to some wrap fee level, commission charge. Frankly, that wouldn't be good for a lot of clients. And frankly, for small accounts, it probably is cheaper not to have them. Better for the client if that's forced. But, they're going to lose access to advice. Short term, it may impact, as we – our accounts. But, frankly, a lot of those accounts aren't profitable for us either. We do them as an accommodation to our clients, friends of our clients, or relatives, and to our financial advisors. So, although we may have some juggling around, and it may hit revenue. The expense part, we might be better off. So, this thing gets so complicated and everybody wants to simplify it. Until we get through the rules, the regulations, and what do these exemptions really mean, it's so hard to give guidance. It really is. So, I wish I could answer. But, I think the headline from the administration of DOL is

[Chris Harris:]

Okay, that – now helpful. The other kind of question I had on this topic, have you guys disclosed? Or, can you disclose the amount of revenue-sharing payments that you generate on a recurring basis?

[Steven Raney:]

Revenue sharing from?

[Jeff Julien:]

Chris, we have a line in the queue that we provide that just shows what we earn from mutual fund companies of – all types of fees and revenues we earn from mutual fund companies in the private client group segment. But, again, going back to Paul's comments, we're not even sure that those fees would actually be totally impacted by the new proposal. As we, kind of, go through it and look through all the exemptions. So, we haven't disclosed a estimate of what portion of those fees we think would actually be impacted is, because we don't know what that estimate would be. So, until we get more guidance on that item, you can kind of reference that line item in the queue under the private client group segment. That's probably as good a number as any for you to look at.

[Chris Harris:]

Okay, great. I'll check that out. And then, real quick, a question on the numbers this quarter. Jeff, thanks a lot for walking through all those expense items. Just one follow up on that. It seems like a lot of those discrete items were in PCG. Yet, you had a pretty decent drop off in the capital markets margin this quarter. I know you had the $3 million item that impacted the numbers there. But, was there anything else to call out in capital markets while you saw a bit of drop off there in the margin?

[Paul Reilly:]

Well, you see the investment, actually, in the new practices was, kind of, a light number all in between recruiting fees, guarantees, startup costs. And, you also – it's, as our business shifts and we look and estimate comp, we're better as we get to the end of the year in that business to get better estimates at the end of the quarter. So again, it had a lot of shifting pieces in it. But, there's certainly those 2 pieces, that on a smaller business, that had an impact on the bottom line.

[Chris Harris:]

Great. Thank you.

[Paul Reilly:]

Oh yes, the other one is – I'm sorry, as Jeff just pointed out to me, is, the other impact is Canada has had a very difficult market. Not just for us, for everybody. And, the results there have been, from a bottom line standpoint, haven't been positive. So, and that's across the board. Even with our competitors, because it's a commodity, energy-based market. So, those numbers have dragged down significantly too this quarter. That's the other big factor.

[Operator:]

Okay. Does that complete your question?

[Chris Harris:]

It does. Thank you.

[Operator:]

Thank you. Your next question comes from Bill Katz with Citi.

[Ryan Bailey:]

Hello. This is actually Ryan Bailey filling in for Bill. I just had a quick question on margins and ROE targets. And, how we should think about that going forward? And, kind of, what might be the main drive with there? Thank you.

[Paul Reilly:]

Yes, we're – for the moment we're sticking with for the year that to exceed 15% margin. We would like to hit 12% ROE. We know we're behind that, even for the first 6 months here. Still, our 12% ROE goal, in this particular interest rate environment. As we get into the 2016 budgeting process, we're going to be revisiting the targets for margins in all of our businesses. As well as the overall firm. And, when we arrive at those, we'll make them more public. But, for this fiscal year we haven't shifted in the middle of the year here because we don't expect any change in interest rates either.

[Ryan Bailey:]

Okay. Great. Thank you.

[Operator:]

Thank you. Your next question comes from Christian Bolu with Credit Suisse.

[Christian Bolu:]

Good morning, guys.

[Paul Reilly:]

Hello, Christian.

[Christian Bolu:]

Hello. Just a broader question on expenses. Ignoring the ins and outs of this quarter, expense efficiency just seems to be a recurrent theme for you. And, I think some of your other peers. Just curious if there's anything in your pertinent environment that's driving this? Is there increased competition that's driving higher marketing spend? Or, is the rise of robo-advisors fill in the need to, just, improve technology capabilities?

[Paul Reilly:]

I don't think the robo-advisor factor is certainly topical, but not impacting our business really at all. So, I think we've been running under our technology and investment run rate, which has helped drive our recruiting. Because, we have a extremely competitive platform in technology now and we continue to advance it. But, we've told you it's low-to-mid 60s as a run rate. And, we believe as a run rate average, that's what we're going to come in this quarter. The marketing, our budget for the year, is the same budget we've had all year. It's just lumpy. We just had a bigger expenses quarter because we run them in flights. We don't run all year round and it just happened to hit this quarter. So, I don't think anything in the expense. Sure, we run high levels of back office support. We always have. It's part of our model. But, I don't anything's fundamentally changed. And, if you look at the first 6 month run rates and what we've given as guidance, we don't see anything that's fundamentally different. It's just a – we got a lot of hits this quarter.

[Jeff Julien:]

Yes, I'd say Chris, and even over comparing this to a year ago or 2 years ago or anything else. That, we have – we're bigger. So, we have some increased absolute expenses. But, the only area I'd say that disproportionately has increased in expenses has been compliance and regulatory. Which, is obviously mainly in the admin side of the P&L comp expense, but.

[Paul Reilly:]

We're not alone and that.

[Jeff Julien:]

Yes.

[Christian Bolu:]

Okay. That's fair.

[Jeff Julien:]

I don't see anything fundamental in the other expense line items that are responsive to anything in the environment.

[Christian Bolu:]

Okay. That's fair. Just switching over to, kind of, M&A and acquisitions for you. I know you've been clear that asset management is a priority. You did the Koger deal, but that was fairly small. I'm just curious as to what's holding back, you guys pulling the trigger on the bigger deals? Is it that you just haven't found the right targets? Or, price or just something else?

[Paul Reilly:]

Yes, we're very clear that our strategy is, first, has to have a cultural hit. Secondly, it's strategic fit. And, third, has to be at a fair price. And, the hardest filter is the first one. A lot of the companies that we're interested in, because they share our culture and, we think our values and background, are private and not for sale. So, that's problematic. But, we believe a number of those companies will go through owner, founder transitions. So, we stay close to them. So, we continue to talk to a lot of people. We stay very close. We're very active. We're very desirous of doing something. But, they have to fit the criteria. So, I'll tell you, we're more and more active and we talk on more and more deals and upwards. But, we're very disciplined on spending cash.

[Christian Bolu:]

Okay. And then, just a follow up question on this long-term operating margins for you guys, for the firm. We can do the math in terms of, like, how much margins should improve as rates rise. But, just curious, is there a natural level at which, kind of, margins max out for you? Just given competitive forces that should come into play as, maybe, as rates rise?

[Jeff Julien:]

Sure. I mean, it's – your margins definitely are not going to be rising forever. So, given our current mix of businesses. Once we get the benefit of interest rate lift, and we will get some modest benefits of scale in some of the businesses over time. But, it won't be as material as the impact of interest rates. So, I've – if, a couple hundred basis points from here in terms of margin, is probably a realistic cap. Given the dynamics and businesses that we're in today. The world can change on a dime, but we don't anticipate that.

[Christian Bolu:]

Okay, fair. And then, just lastly for me. I apologize if I missed this one in the earlier remarks, but an investment advisory fee line. I think revenues there were up, kind of, 3% year over year. Which, kind of, lagged significantly the pace of AUM goals. It just seems like it was more like 11%. Do you have any color on what was driving that, kind of, revenue lag while if it to AUM?

[Jeff Julien:]

Yes, it's been a pretty – if you look at the components of our assets, which I think are disclosed in the queue in chart form. The components of our AUM, you'll see that the growth has come in what we would call our lower fee type products. Which, the most of – a lot of, large part of the growth has come in the lower fee products. Predominantly, the product we call, "Freedom." There's a Freedom in our Freedom UMA, which are managed mutual fund portfolios. And, given the significant costs embedded in mutual funds already, we don't feel like we can layer on a particularly large charge on top of that to manage that. So, that's where a lot of the growth has come from and it's a very low fee relative to, say, a separate managed account where you're managing equities.

[Christian Bolu:]

That's perfect. Thank you very much.

[Operator:]

Thank you and that completes your question?

[Christian Bolu:]

Yes, it does.

[Operator:]

Thank you. Your next question comes from Jim Mitchell with Buckingham.

[Jim Mitchell:]

Hey. Good morning.

[Paul Reilly:]

Morning.

[Jim Mitchell:]

Maybe, just on the growth in fee-based assets. You guys were up, I think, 4.7% quarter over quarter. That seemed quite a bit stronger from mark – versus the market impact. Can you – I know you guys don't just disclose flows into fee-based assets. But, is that a fair assumption? Or, was there something unusual on the promo market impact? Or, is that just reflective of the higher recruiting in the assets coming over? And, quite a bit of it was net new assets?

[Paul Reilly:]

It's recruiting. It's net at new assets. We've had net asset inflows and we've – just recruiting is very very strong, and that drives asset management also.

[Jeff Julien:]

And, a lot of it's billed in advance, obviously. So, that'll be a good harbinger for next quarter.

[Jim Mitchell:]

Right that should be priced in next quarter? Okay. And then, maybe just another stab at the fiduciary duty. Just maybe, bigger picture. Obviously, there's a lot of moving parts. We don't know how it's going to play out. But, if there's some pressure on some revenue stream that says, hey, this is not allowed under a fiduciary standard. I mean, just big picture, do you guys feel that you have pricing power to maintain pricing regardless of what an individual revenue stream may fall away on the way side? Can you reprice somewhere else? Or, do you feel like this is a – if there is some impact on a particular revenue stream that you won't be able to make it up?

[Paul Reilly:]

It – that's kind of hard to say. I would say overall, if you look at where we are in terms of size and distribution power, that we should be able to. If one source of payment goes down and we have to change it, you would assume that, I don't know in the short term. But, over time, it's going to even out. And, in the worst parts of the law, you would say we'd have to get rid of some accounts and assets because they're not cost-effective. On the other hand, those accounts are not profitable to us, in general anyway. So, it's really hard to tell the net income. I do think, that at the end of the day, it's a very competitive market. We have a valuable franchise and distribution. And, I think people are going to pay us fairly to access that. But, I don't how it's going to look.

[Jim Mitchell:]

Okay, no, I appreciate that color. Thanks.

[Operator:]

Thank you. Your next question comes from Douglas Sipkin with Susquehanna

[Douglas Sipkin:]

Thank you and good morning to all. Just had a couple of questions here. First, I figured I'd add that I'm pretty sure I know the answer I'm going to get. I'm looking at your record results for the first 6 months. Yet, your ROEs, kind of, to trend down. And, it just feels like the logical thing to do, is maybe, shrink the equity somewhat. And, I know you guys are not hip to doing buybacks. But, I still struggle with, why you guys wouldn't, at a minimum, just buy back the dissolution from new awards. It seems like a pretty common practice in the industry to do that. Just doing that alone could probably – would've shrunk the share count couple million shares over the last year-and-a-half. So, I'm just curious, are you guys are considering that, given a little bit of pressure showing now on the ROE?

[Paul Reilly:]

Yes, I don't think it's – philosophically, a year ago, the board's position was that we felt we could deploy the capital and that a nominal share buyback was really kind of a false signal. We knew it pacify people, but it really didn't move the needle but 1 or 2% in the deployment of capital to be stronger. I think we reported after the last board meeting, that it was an item that was under further discussion. And, I think an item that will be looked at again. We've told you guys and our shareholders, our job isn't to hoard capital. We don't do it. In fact, our – holdbacks on our compensation each year as a management team are RSUs. Half of that holdback is indexed to ROE targets. So, we're not incented to hoard capital for the heck of it. We're trying to do what's best for our shareholders and how we think we can use it. So, the topic and discussion of the board is not dead. I'm sure it'll come back up and if we can't find uses for the capital, we will look at ways of returning it. So, I think it's a fair question, Doug. I'm surprised it took so long to come up. But, maybe we had enough operating expense questions, that it took a little longer to hit this time. But, it's a fair question and we are looking at.

[Douglas Sipkin:]

Yes, okay, no, that's great to hear and I appreciate the color on the targets related to stock awards and things like that. That's very helpful. Secondly, so, obviously, great run with the recruiting. You're seeing it in the fee-based accounts. You're seeing it in FAs. You're obviously, you're seeing it in some the front-end costs. I mean, it's been a couple of quarters with this. So, looking out 6 months. I mean, are we still on this toward pace here? Or, are you guys sensing, maybe, there's a little bit of flatlining of the recruiting? I mean, it still looks like you guys are winning advisors and your pipeline of new people coming in is pretty good. But, I'm just curious to get your pulse?

[Paul Reilly:]

Yes, right now I remind our people, don't believe the press everyone's writing about us. Because, they're going to write other stuff someday. So, but the truth is our recruiting's going great. We've been one of those firms that have just been attractive to advisors. Pipeline's very strong. It's lumpy. We have a lot of people that like to change after year end. Just like in other places. After their bonuses and things. But, having said that, if you look at the pace of – in summer months it slows down a little bit typically. But the pace and the backlog are very very strong. And, our discussions aren't, are they going to fall off? It's, maybe we should even increase our recruiting sales force more and take advantage of the position we're in. So, the six-month year end outlook is very very good. But, we know these things don't go forever. And, just like good markets don't go forever. So, we're trying to take advantage of it while we can. And, also to make sure our FAs are very very happy here and that we keep continue with high support level. So, and retention is the key. I think our real net recruiting's really good. But, the nice thing about the firm is we don't have to chase a dark hole that a lot of firms have to chase with advisors leaving. Our regret attrition stays low and that's a big focus for us too. So, the outlook is still good.

[Douglas Sipkin:]

Great. That's helpful. And then shifting gears. So, I've been very encouraged to see the fixed income commissions start to show a little bit of life. 2 consecutive quarters of sequential improvement. I mean, just curious, digging a little deeper into that marketplace. I mean, as you get the sense that this quarter here in March was kind of an anomaly? Given the rate volatility? Or, are you maybe, picking up that there's a little bit of a sustainable trend improvement that may be coming about in this market? Because I know there was a point in time where this was doing $80, $90 million in quarterly revenues a quarter now, obviously still a long ways away from that. But, the last 2 quarters have seen a real nice uptick. So, I'm just curious, is there more there? Or, is it just too hard to call?

[Paul Reilly:]

I'd say the trend has continued so far. Certainly, at the last few years we always wondered every quarter if it was the bottom, but, it wasn't. As people stop trading, and certainly the 2 big drivers of the fixed income business there, is rate volatility and slope of the yield curve. So, if the Fed raises short-term rates and we have a flat yield curve at 2% from 1 day to 30 years, it wouldn't be good for the business. If there's volatility and speculation on that, it's good for the business. So far, that momentum has kept up and it's nice to see for us that institutional commissions have picked up and there's activity and that's continued so far. So, how long it lasts is a function of volatility in the markets and what happens with the rates. We've got a great team though. We've got a really – I've told our team in the last 2 years we had an A+ team working in a D market. And, I think when a business is really terrible and you can stay at double-digit margins, you're doing really well and they've done a good job.

[Douglas Sipkin:]

Great. And then, just the last question and I know it's been hit on today, the fiduciary standard. I'll maybe, try to approach it from a different perspective. Can you, maybe, just shed a little bit of light on the philosophy of your guys' advisor business? And, some of the products that you have historically, sort of, shied away from? Because, I think that, maybe, provide a good framework of sort of, how the business has been run for a long time period, rather than, sort of, focusing on, obviously what's going to be some compliance headaches from a potential.

[Paul Reilly:]

The philosophy of this firm way before me is to be very conservative in client product. And, then every new product is to say, the first green isn't what we make. Is it good for the advis – for the client? Does it give returns compared to other things existing in the market? Is the risk less for the return? And, is it explainable? So, very early on, the firm was a pioneer in requiring, in variable annuities, to lower the front-end fees. In fact, firms had to manufacture those products specifically for us because we didn't want the upfront loads. And, pricing of the riders and everything had to be fair. It wasn't about the firm. It was the client. Our non-traded REITs. We've stayed out of that market. It's not that we think all non-traded REITs are bad, but, we look at liquidity versus return and the valuations of – and we said it's not worth it for clients. You looked at closed-end funds. We have very strict leverage ratios. It doesn't mean there's a lot of great product that we won't sell. But, we said, hey, the leverage in the return isn't worth the yield enhancement. So, that's always been our philosophy and it's been the philosophy in the products and the things we sell. Now having said that, I think for a lot of accounts, commissions are a lot better for small accounts than a continuing fee. And, at the heart of this fiduciary standard, commissions are bad, isn't fair. And, that's the heart of the debate. Now, we can all find examples in the industry and all of our firms where there's always the 1% bad actors. But, you shouldn't penalize all the really great people that are doing the right thing for clients. We should get after those folks as an industry and as regulators to make sure we penalize the misbehaviors and take care of those clients. Instead of just messing up the whole industry. Which, honestly, I believe will leave millions of people without advice and that they're getting today. So, that's the heart of the debate. So, and we're still in it and we're continuing to work with the DOL. The great thing is all the trade groups are in line on this. And, we don't have a split between the custodial firms and the broker/dealers. And, then we all, kind of, agree on this approach and we'll see where it ends up.

[Douglas Sipkin:]

Great. Thanks for answering all that.

[Paul Reilly:]

Thank you.

[Operator:]

Thank you. Your next question comes from Joel Jeffrey with KBW.

[Joel Jeffrey:]

Hey, good morning, guys.

[Paul Reilly:]

Hello, Joel.

[Joel Jeffrey:]

Just a follow-up to Doug's first question. I mean, in thinking about, potentially, buybacks. Just curious as to how much you guys believe you have in excess capital? Not just necessarily above what's required by regulators. But, what you see in terms of operating the business currently?

[Paul Reilly:]

It depends how you look at it. There's probably a couple hundred million, 200 to 300, if you really go through it. But, we also have a bond issue coming due next year. And, people could say, well, why don't you just refinance in these low rates? We tend to be very anti-debt. Again, not just for our clients. We keep the same philosophy for ourself. And, so when we look at that, that's kind of the excess level. And, it doesn't mean that we couldn't do a much larger transaction in a good asset management business and take on some more debt and use our equity. So, we're not adverse to it for the right situation. But, we kind of, view that as, kind of, the excess real capital that we have today.

[Joel Jeffrey:]

Okay. And then, when you talked about, clearly, the negative impact to the underwriting business tied to what's going on in energy markets for you guys. Do you also see that on a go forward basis, kind of, plying out in terms of equity-based commissions from the institutional side of the business?

[Paul Reilly:]

Yes, I don't know if I can make that call. There's certainly been a lot of activity and speculation in the equity mark – in the energy markets of people making bets that oil's going down and oil's going up. So if – and clients, we have a lot of people that have gotten in.

[Jeff Julien:]

But, our commission base is pretty broad.

[Paul Reilly:]

Yes.

[Jeff Julien:]

I mean, they're buying a lot of sectors, not just energy. And to – low energy prices are good for a lot of other sectors. So, that – it definitely – the equity commissions were down. But, that was just related to the underwriting activity. Maybe, underwriting activity'll pick up in some of the other sectors that are beneficiaries. Others that are beneficiaries.

[Paul Reilly:]

And, so, the commission drop is, as Jeff pointed out, as I said in my remarks is really underwriting driven. There's nothing else fundamentally. So, if you took out those factors, it would – there wouldn't have really been a decline.

[Joel Jeffrey:]

Okay.

[Jeff Julien:]

And we're adding SVUs and we were just continuing to build out, both consumer and life sciences to help augment some of the underwriting activity of the firm.

[Joel Jeffrey:]

Okay. And then, Jeff, I think you mentioned that there were some items on your balance sheet that you could get better, potentially better risk-weighted treatment under Basel IIi. Can you just talk a little bit about what those might be?

[Jeff Julien:]

We're, there – it's kind of hard to go into detail at this point in time. But, there's some pretty significant pots of assets that it's unclear to us just exactly how they're supposed to be treated. And, we've asked for regulatory guidance. And, like I said, we've treated them all as though they're the most heavily. But, I don't want to get into any of the details right now. Until we get the regulatory guidance. It won't – I mean, it's not going to move the ratio 10,000 basis points. It might move it 100 basis points.

[Paul Reilly:]

Again, we think we've taken a very conservative approach overall. I believe we have some of upside on that.

[Joel Jeffrey:]

Okay. And then, just lastly, for me. I apologize if you guys touched on this earlier. But, in terms of the impact on the fewer number of business days on the investment advisory revenue line. Can you just talk about how that impacts the actual billing of the client?

[Jeff Julien:]

The client gets billed based on the number of days in the quarter over 365. So, we're getting a lower fee in that quarter from clients. Given it's 90 days, instead of 92 or 92 or 91, which the others are for that quarter. And, that into the investment advisory fee line item. And, obviously, it affects interest earnings as well at the bank, which is done on a daily basis. So 2.2% fewer relative to December quarter. It's the same as last year's March though.

[Joel Jeffrey:]

And, do you have a – do you know specifically how much on a revenue basis that actually impacted the number this quarter?

[Jeff Julien:]

I don't have an exact figure. I don't have an exact figure on that note. I'm sorry.

[Joel Jeffrey:]

Okay. Thanks for taking my questions.

[Paul Reilly:]

Thank you.

[Operator:]

Thank you. And your next question comes from Chris Allen with Evercore.

[Chris Allen:]

Morning, guys.

[Paul Reilly:]

Hey.

[Chris Allen:]

Apologies if these were already asked. I joined the call a little bit late. But, I was just wondering, the business development increase in the sequential basis. How much was due to recruiting related and how much was due to an ad spend increase? I'm just trying to break it down.

[Paul Reilly:]

This is to development; how much recruiting versus?

[Jeff Julien:]

Oh, the advertising spike was, called a spike, was between $4.5 million versus a normalized run rate. So, I would say it was a little bit slanted toward that. Because recruiting's been active for a while. But, I'd say it was a little bit more slanted toward the TV air time purchases. To the tune of $4 to $4.5 million. Something in that range.

[Chris Allen:]

Got it, okay. And then, in the asset management segment, pre-tax margins were down in the year-over-year basis. Even though you see nice revenue growth, nice AUM growth. I'm just wondering if you could give any color there? What's driving that and whether that could, it – the trajectory there could change?

[Paul Reilly:]

Well, that relates to the shift in, to the lower fee products that I, that was talked about earlier. If, maybe you weren't on the call then. But, if you just look at the – a mix of where the assets in the – are being held, it's – there's been a bit of a shift to some of the lower fee products to us. Particularly, the Freedom account products. Which, again, as I mentioned, were, are mutual – managed mutual fund portfolios that have pretty high embedded costs already in the underlying mutual funds. So, we add a fairly modest margin on top of that.

[Jeff Julien:]

But, Chris, if you look at the first 2 quarters compared. First half of the fiscal year versus the last fiscal year, the margin improved from 33.6% to 36.6%. So, there was about a 300 basis point improvement in margin on a year-over-year basis. If you look at the first 6 months, which is important to do because of the noise you may have in any 1 quarter that can really impact their margins given their revenue base. So, there is operating leverage occurring, as Paul mentioned in his opening remarks.

[Chris Allen:]

Got it. Thanks, guys.

[Operator:]

Okay, thank you. At this time, I'm not showing any further questions.

[Paul Reilly:]

Well, thank you all for joining us. We know it was a difficult quarter. I wish we could give better guidance as these – as this quarter happens. It's the same thing as last year. Net strong, we think, start to the year. Our best first 6 month start ever. We've gotten, if you look at the key indicators of our business, recruiting, FA count, assets under administration, assets under management, net bank loans, all at quarterly, kind of, records. And, so, that's going to position us well for the next quarter. And, we have to fight in this environment like everyone else to bring it in. So, I – just make sure that when you look at the quarter and, kind of, normalize the expenses, I think the six-month run rate is a good proxy for that. So, thank you for attending us. We know on a busy day here with a lot of calls. And, we'll talk to you soon. Thank you, Therese.

[Operator:]

You're welcome. And, ladies and gentlemen, thank you for joining today's conference. And, thank you for your participation. That does conclude the conference. You may now disconnect.