Earnings Call Transcript - RJF Q1 2021

Operator, Operator

Good morning and welcome to Raymond James Financial's First Quarter Fiscal 2021 Earnings Call. This call is being recorded and will be available for replay on the company's Investor Relations website. Now, I will turn it over to Kristie Waugh, Vice President of Investor Relations at Raymond James Financial.

Kristie Waugh, Vice President, Investor Relations

Good morning everyone and thank you for joining us. We appreciate your time and interest in Raymond James Financial. With us on the call today are Paul Reilly, Chairman and Chief Executive Officer and Paul Shoukry, Chief Financial Officer. The presentation being reviewed this morning is available on Raymond James Investor Relations website. Following the prepared remarks, the operator will open the line for questions. Please note, certain statements made during this call may constitute forward looking statements. These statements include but are not limited to, information concerning future strategic objectives, business prospects, financial results, anticipated results of litigation and regulatory development, impact of COVID-19 pandemic or general economic conditions. In addition, words such as believe, expects, could and would as well as any other statement that necessarily depends on future events are intended to identify forward-looking statements. Please note that there can be no assurance that actual results will not differ materially from those expressed in the forward-looking statements. We urge you to consider the risks described in our most recent Form 10-K, which is available on our Investor Relations website. During today's call, we will also use certain non-GAAP financial measures to provide information pertinent to our management's view of ongoing business performance. A reconciliation of these non-GAAP measures to the most comparable GAAP measures may be found in the schedule accompanying our press release and presentation. With that, I'm happy to turn it over to Chairman and CEO, Paul Reilly. Paul?

Paul Reilly, Chairman and Chief Executive Officer

Good morning and thank you for joining us today. It's hard to believe it's been almost a year since the COVID-19 pandemic started here in the U.S. And while there is now light at the end of the tunnel, with the vaccine starting to be distributed across the globe, we are still very much in a period of uncertainty and volatility. As painful as the pandemic has been for everyone, I'm very proud of how Raymond James has performed. Who would have predicted when we lost 40% of our earnings to the rate cuts in March that we would be talking about records today. This is a testament not only to the resiliency of the U.S. economy but also to Raymond James, our advisors and their associates. As you can see on Slide 3, our unwavering focus on serving clients resulted in fantastic financial results during the quarter. Starting off fiscal 2021 with record quarterly revenues and earnings, driven by strength across our businesses. In the fiscal first quarter, the firm reported record net revenues of $2.22 billion which were up 11% over the prior year's fiscal first quarter and 7% over the prior record set in the preceding quarter. Record net income of $312 million or $2.23 per diluted share increased 16% over the prior record of net income set a year-ago quarter and 49% over the preceding quarter. Excluding expenses of $2 million associated with the completed acquisition of NWPS Holdings and the pending acquisition of Financo, adjusted quarterly net income was $314 million and adjusted earnings per diluted share was $2.24, both records. Annualized return on equity for the quarter was 17.2% and return on tangible common equity was 19%, impressive results, especially in this near zero rate environment and given our very strong capital position. Record quarterly results were primarily attributable to higher asset management and related administrative fees, record investment banking revenues, strong fixed income brokerage revenues and disciplined expense management, which more than offset the negative impact of lower short-term interest rates on the net interest income and RJBDP fees. The record results and broad-based strength in our businesses in a near-zero rate interest environment, which included record results for capital markets and asset management segments during the quarter, reinforce the value of our diverse and complementary businesses, something that is sometimes under-appreciated in different market cycles. Moving to Slide 4, we ended the quarter with records for total client assets under administration of $1.02 trillion, PCG assets in fee-based accounts of $533 billion and financial assets under management of $170 billion. Client assets crossing the $1 trillion mark for the first time is a testament to the consistent growth that we've achieved by focusing on retaining our existing advisors, while also recruiting high quality financial advisors. And when you step back, this is quite an achievement. In December 2010, we had around $260 billion of client assets. So, we have experienced around a 15% compounded annual growth and essentially quadrupled client assets over a 10-year period and a vast majority of that was organic growth. We ended the quarter with 8,233 financial advisors, a net increase of 173 over the prior year, but a slight net decrease of six sequentially. A flat advisor count is not unusual for this quarter as we typically see an elevated number of retirements at the year-end, where assets are typically retained at Raymond James by their successors. We are still optimistic about all of our recruiting pipelines across our affiliation options, but there are a few trends we are seeing in the industry. On the independent side of the business, we continue to experience strong recruiting activity and we're seeing more interest from both external and internal advisors in the RIA custody affiliation options particularly for much larger teams who have the scale and appetite to assume the regulatory and supervision responsibilities and risks. We have been beneficiaries of this trend in our rebranded RIA and Custody Services division, RCS, and we believe we will continue to benefit from the trend given major consolidation and disruption in the RIA custody industry. However, it's important to note that when an RIA affiliates with RCS, whether it be an internal transfer from our other affiliation option or external additions, we do not count the advisors of the RIA firms in our advisor count, but their assets are still included in client assets under administration. On the employee side, there has been a modest slowdown in recruiting due to the challenges brought on by COVID and also increased competition for experienced advisors where even our regional competitors have significantly increased the recruiting packages. In response to what we are seeing, we have also enhanced our recruiting packages to be more competitive while also ensuring attractive returns to our shareholders. Also impacting advisor count this year, we temporarily decreased the size of our new advisor training class this year by about 35 trainees, allowing us to dedicate more time and attention to new advisors as they seek to overcome the challenges presented by this current virtual environment. While this will negatively impact the growth in advisor count when compared to prior years, when the training class was larger, it really shouldn't have a significant impact on client assets. We believe our recruiting will continue to thrive as advisors are attracted to our supportive culture and client-first value. Looking at recruiting results over the prior four quarters, financial advisors represented nearly $270 million of trailing 12 production and nearly $40 billion of assets at their prior firms affiliated with Raymond James domestically. As for our net organic growth results of the Private Client Group, we generated domestic PCG net new assets of $42 billion over the four quarters ending in December 31, 2020 representing more than 5% of domestic PCG client assets at the beginning of the period and remember, this is net of client fees. We are very pleased with our consistent organic growth, especially given the disruption associated with the COVID-19 pandemic during the year and as you know, we did not benefit from the surge in self-directed online business during the year. Moving to segment results on Slide 5. The Private Client Group generated quarterly net revenues of $1.47 billion and pre-tax income of $140 million. Quarterly net revenues grew 5% over the preceding quarter, predominantly driven by higher asset management and related administrative fees reflecting higher assets in fee-based accounts, which will continue to be a tailwind in the second quarter. This strong revenue growth helped PCG's pre-tax income grow 12% sequentially, although it's still down 8% on a year-over-year basis, primarily due to the negative impact of lower short-term interest rates. Capital Markets segment generated record quarterly net revenues of $452 million and pre-tax income of $129 million, an extraordinary result, a strong quarter for the segment driven by broad-based strength across global equities and investment banking, as well as fixed income. During the quarter record investment banking revenues were driven by record NNA advisory revenues along with continued strength in debt and equity underwriting. Fixed income brokerage revenues were strong as client activity levels remained robust. While we certainly would caution you against annualizing the record results in the capital markets segment this quarter, I do think the results reflect the significant investments we have made to strengthen our platform over the last 10 years and we are continuing to make those investments as I will discuss shortly. The Asset Management segment generated record net revenues of $195 million and pre-tax income of $83 million. Record results were driven by the growth of financial assets under management as equity market appreciation and the net inflows into PCG fee-based accounts more than offset the modest net outflows for Carillon Tower Advisers. Lastly, Raymond James Bank generated quarterly net revenues of $167 million and pre-tax income of $71 million. Compared to a year ago quarter, net revenues declined primarily due to the impact of lower short-term interest rates on net interest income. Sequentially, quarterly net revenues grew 4% as higher asset balances more than offset the seven basis point decline in the bank's net interest margin in the quarter, which was primarily attributable to the growth in the agency MBS portfolio. The credit quality of the bank's portfolio remains healthy with most trends continuing to improve. Non-performing assets remained low at nine basis points of total assets and the amount of criticized loans declined 4% during the quarter. The quarterly bank loan provision for credit losses of $14 million declined sequentially and was driven mostly by macroeconomic model inputs under the CECL methodology, which Paul Shoukry will cover in more detail. Moving to Slide 6; as you've heard me say many times, we remain focused on long-term growth and are committed to deploying excess capital to generate attractive returns to our shareholders. Good examples of that commitment are the two acquisitions we announced during the quarter. The first, which closed in late December is NWPS. NWPS is a provider of retirement plan administration, consulting, actuarial and administrative services based in Seattle, Washington. The addition of NWPS allows Raymond James to expand our retirement services offering, including retirement plan administration services to advisors and clients. Many of our advisors serve clients with small businesses and offering this retirement solution is another attractive way to help advisors develop deeper and stronger relationship with our clients. The second pending acquisition, Financo, is a consumer-focused NNA advisory firm, which allows us to strategically grow our capabilities in an attractive vertical with an industry-leading team. We anticipate this transaction to close in the March or April timeframe. Both of these firms represent great cultural and strategic fit and we're excited about welcoming them to the Raymond James family. While we are not going to discuss the terms of these two transactions in total, over time, these two acquisitions represent consideration, retention and earn-out potential for the sellers of approximately $320 million, so is a meaningful and attractive use of cash and capital. We will continue to actively pursue additional acquisitions that are both a cultural and strategic fit. And now, for a more detailed review of the financial results, I'm going to turn this over to Paul Shoukry. Paul?

Paul Shoukry, Chief Financial Officer

Thank you, Paul. I'll begin with consolidated revenues on slide 8. Record quarterly net revenues of $2.22 billion grew 11% year-over-year and 7% sequentially. Asset management fees grew 12% on a year-over-year basis and 6% sequentially, commensurate with the growth of fee-based assets. Private Client Group assets in fee-based accounts were up 12% during the fiscal first quarter, which will provide a tailwind for this line item for the second quarter of fiscal 2021. However, given fewer billable days in the March quarter, I would expect asset management fees in PCG to increase about 10% sequentially. Consolidated brokerage revenues of $528 million grew 15% over the prior year and represented a record. These revenues are inherently difficult to predict, but our clients are still engaged in both the Private Client Group and capital markets segments given the current market and interest rate environment. Account and service fees of $145 million declined 19% year-over-year, almost entirely due to the decrease in RJBDP fees from third party banks due to lower short-term interest rates, which I will discuss along with net interest income in more detail on the next two slides. Consolidated investment banking revenues of $261 million grew 85% year-over-year and 18% sequentially, achieving a record result driven by record NNA advisory revenues and strong debt and equity underwriting. Based on the pipeline and activity levels, we anticipate second quarter to be healthy, but not as strong as the remarkable results achieved in the first quarter. As you all know, these revenues are very difficult to predict, but for the rest of the fiscal year, we would be very pleased to achieve the pace of the average quarterly investment banking revenues from the annual record we set in fiscal 2020 which would be roughly $160 to $165 million per quarter on average. Turning to other revenues, which were $56 million for the quarter, this line included $24 million of private equity valuation gains during the quarter, of which approximately $10 million were attributable to non-controlling interest reflected in other expenses. Moving to Slide 9, client domestic cash sweep balances ended the quarter at a record $61.6 billion, increasing 11% sequentially and representing 6.7% of domestic PCG client assets. As we continue to experience growing cash balances and less demand from third party banks, more client cash is being held in the Client Interest Program at the broker-dealer. You can see those balances grew to $8.8 billion and most of that growth has been used to purchase short-term treasuries to meet the associated reserve requirement. Over time, that cash could be redeployed to our bank or third party banks as capacity becomes available which would hopefully earn a higher spread than we currently earn on short term treasuries. On Slide 10 the top chart displays our firm wide net interest income and RJBDP fees from third party banks on a combined basis. Related, based on your feedback, we have updated our net interest table in the earnings release to incorporate all of the firm's interest earning assets and liabilities instead of those balances for just Raymond James Bank. We hope you find this update helpful and, as always, we thank you for your suggestion to continue enhancing our disclosures. As you can see on Slide 10, while lower rates have put significant pressure on these revenues since the Fed rate cuts in March 2020, we did experience a slight uptick in these revenues sequentially, helped by the aforementioned growth in client cash balances and higher asset balances at Raymond James Bank, which more than offset the sequential NIM compression you see on the bottom left portion of this slide. Given prepayment speeds of higher-yielding securities and mortgages, we would expect the Bank's NIM to decline another 10 basis points or so throughout the year. However, we are hoping that growth in the bank's earning assets will more than offset the NIM compression and result in continued growth of the firm's net interest income. I will provide a bit more color on the bank's balance sheet growth in a few slides. Moving to consolidated expenses on slide 11, first, compensation expense, which is by far our largest expense, the compensation ratio decreased sequentially from 68.1% to 67.5% during the quarter, primarily due to record revenues in the Capital Markets segment, which had a 56% compensation ratio during the quarter and the benefit from the private equity valuation gain, which doesn't have direct compensation associated with it. As we said last quarter, given the near-zero short-term interest rates and the successful implementation of the expense initiative we announced last quarter, we are confident we can maintain a compensation ratio of 70% or better, which we still believe is an appropriate target. And as we experienced this quarter, very strong capital markets results in any particular quarter could result in a compensation ratio below 70%. Non-compensation expenses of $323 million increased $24 million or 8% compared to last year's first quarter and almost all of that increase could be explained by the $14 million bank loan provision for credit losses compared to the $2 million benefit in the year ago period and $13 million of non-controlling interest in other expenses, much of which offsets a portion of the $24 million private equity valuation gain reflected in other revenues. As we explained and as you can see in these results, we have been very focused on the disciplined management of all compensation and non-compensation related expenses, while still investing in growth and ensuring high service levels for advisors and the clients. Slide 12 shows the pretax margin trend over the past five quarters. Pre-tax margin was 18% in the fiscal first quarter of 2021, which was boosted by the record capital markets results as that segment generated a record 29% pre-tax margin. Last quarter, we talked about generating a 14% to 15% pre-tax margin on the consolidated basis in this near-zero interest rate environment, which again we believe is still a reasonable target. But as we experienced this quarter, there is upside to the margins when the capital markets results are so strong. On Slide 13, at the end of fiscal first quarter, total assets were approximately $53.7 billion, a 13% sequential increase reflecting the dynamic I explained earlier, with growth in client cash balances and associated reserves at the broker-dealer. This growth of client cash balances on the balance sheet caused our Tier 1 leverage ratio to decrease to 12.9%, which is still well above the regulatory requirement. Liquidity remains very strong with $1.8 billion of cash at the parent, leaving us with plenty of flexibility to be both defensive and opportunistic. Slide 14 provides a summary of our capital actions over the past five quarters. In December, in addition to increasing the quarterly dividend 5% to $0.39 per share, the Board of Directors authorized share repurchases above $750 million, which replaced the previous authorization and $740 million remains available under the new authorization. In the first quarter, we repurchased approximately 108,000 shares for $10 million, an average price of approximately $92.80 per share. This fell short of our $50 million quarterly target which we plan on making up for in the subsequent quarters as we are committed to repurchasing at least $200 million to offset share-based compensation dilution during the fiscal year. One thing many of you have asked us to be more explicit on is our plans for deploying capital, which is something we hope to discuss with you in much more detail at our Analyst Investor Day tentatively planned to be held virtually in May. But at a high level, what I would share with you now is that our goal is to manage down the firm's Tier 1 leverage ratio closer to 10% over time through a combination of balance sheet growth, primarily at the bank as well as more deliberate deployment of capital through a combination of organic growth, acquisitions and share repurchases. We are not ready to share specific timeline to achieve this objective and doing so in the middle of a pandemic is probably not the best time to do so, but I want to be clear that we are fully committed to managing our capital levels, balancing our objectives and optimizing returns to shareholders while ensuring significant balance sheet flexibility and conservatism. On the next two slides, we provide additional detail on the bank's loan portfolio, starting on slide 15 with some detail on Raymond James Bank asset composition. In the pie chart, you can see we broke out CRE and REIT loans into separate categories with the implementation of CECL this quarter. The only other thing I would point out on this slide is we have a very well-diversified balance sheet at the bank. The bank's total assets grew 3% sequentially, led by 4% growth in the bank's loan portfolio, about 60% of which was attributable to securities-based loans to Private Client Group clients. We have decelerated the growth of the securities portfolio at the bank and we will likely continue to do so over the near term as spreads for agency mortgage-backed securities have gotten extremely tight. Meanwhile we have resumed growth in certain sectors in the corporate loan portfolio that we believe are less directly exposed to the COVID-19 pandemic. Lastly, on Slide 16, we provide key credit metrics for Raymond James Bank. First, let me briefly discuss CECL. We implemented CECL on October 1, which increased our allowances by approximately $45 million. With the majority of that increase attributable to recruiting and retention related loans to financial advisors in the Private Client Group segment, which now require a larger allowance under CECL than under the incurred loss method. About $10 million of that day one impact was related to outstanding bank loans, and remember all $45 million hit the balance sheet directly and did not go through the P&L. We had no charge-offs in the quarter. The quarterly bank loan provision for credit losses was $14 million, largely attributable to the macroeconomic model inputs we use from our third party vendor which assumed a greater decline in commercial real estate prices in the near term with a longer recovery period, resulting in higher allowances for the CRE portfolio from 3.25% to 4.2% at the end of the quarter. The bank loan allowance for credit losses as a percent of total loans ended the quarter at 1.71%. So, we believe we are adequately reserved but that could change rapidly if economic conditions deteriorate. But currently, we are pleased with the credit quality and the positive trends we are seeing with the loan portfolio and the broader economy. Now, I will turn the call back over to Paul Reilly, to discuss our outlook. Paul?

Paul Reilly, Chairman and Chief Executive Officer

Thanks, Paul. As for our outlook, we remain well positioned entering the second fiscal quarter with strong capital ratios and record client assets. However, we'll continue to face headwinds from a full year of lower short-term interest rates and there is still a high degree of uncertainty given the COVID-19 pandemic and the rollout of the vaccine and a new administration. In the Private Client Group segment, while the recruiting environment is extremely competitive and we faced some challenges in a largely virtual environment, our advisor recruiting pipeline is strong across all of our affiliation options. And the segment is going to benefit by starting the fiscal second quarter with strong sequential growth in fee-based accounts. Private Client Group fee-based assets were up 12% which would be a good tailwind and result in a 10% increase in the associated revenues. In the capital markets segment, there is still a significant amount of economic uncertainty due to the ongoing COVID-19 pandemic. However, the investment banking pipeline is currently strong and we expect fixed income brokerage results to remain elevated, given the current interest rate and economic conditions. In the Asset Management segment results will be positively impacted by the 11% increase in assets under management but those assets are billed throughout the quarter. At Raymond James Bank, we should continue to benefit from the attractive growth of securities-based loans and mortgages of the PCG clients. And as we decelerate the growth of the securities portfolio, we are cautiously adding to corporate loans in the less COVID impacted sectors. We continue to focus on long-term growth and our priorities remain unchanged. Our top priority is serving clients and we're focused on organic growth, which is primarily driven by retaining and recruiting advisors in the Private Client Group. Additionally, we're continuing to add senior talent in our other businesses such as investment banking. As you observed this quarter, we will continue to actively pursue acquisitions. But we are still focused on being deliberate and only pursuing transactions that have a great cultural and strategic fit and at prices that can deliver attractive returns to our shareholders. We started fiscal 2021 with very strong results and I believe we are well positioned to drive profitable growth in the coming quarters across all of our businesses. But we are also fully aware that we are still in the middle of a global health pandemic and we should all be prepared for much more economic turbulence and market volatility over the next several months. With that, operator, could you please open the line for questions.

Operator, Operator

Thank you. The first question comes from Manan Gosalia of Morgan Stanley. Please go ahead.

Manan Gosalia, Analyst, Morgan Stanley

Hi, good morning. Maybe a question on the PCG segment. How should we think about the compensation ratio in that segment? I mean, I know the last quarter was about 100 basis points positive for the pre-tax margin, but I guess when we look at the compensation of that segment, it was pretty flat versus the last quarter. So were there any factors that are maybe masking that 100 basis point improvement here?

Paul Reilly, Chairman and Chief Executive Officer

The biggest driver is really just the growth in the production to advisors. That's going to have roughly a 75% payout associated with it. So that's going to be your biggest driver of compensation in the PCG segment. As per the administrative compensation in the PCG segment, as we said on the call last quarter, we expected that to be relatively flat when we were on the call last quarter, but the one driver there would be some of the benefits that grow with profitability across the firm. So that's what we're really focusing on managing is the administrative compensation in the PCG segment and that's what would reflect the benefit from the expense initiatives we announced last quarter.

Manan Gosalia, Analyst, Morgan Stanley

Got it. And then on the capital return front. I appreciate the update on how you're thinking about capital return and I realize you can't give a timeline, but in the past you mentioned 1.8 times book value threshold as a level that you're looking at for doing more buybacks. Can you give us an update on how you're thinking about that now, and would you maybe consider buying back at a higher level, if the stock stays above that level in the absence of any acquisition opportunities?

Paul Shoukry, Chief Financial Officer

Yes, we're going to later roll out a more definitive capital plan to managing Tier 1 back to 10% over time. We've committed to the $200 million buybacks a year just to manage equity based dilution at any price and then the other will be more opportunistic. So we'll just have to see that out now. The only caution on the opportunistic part is we'd like to see the pandemic and vaccines controlled; we don't know that yet. So, we'll be a little cautious on that part, but we'll be a little more opportunistic outside of that $200 million more programmatic buyback.

Manan Gosalia, Analyst, Morgan Stanley

Got it. Thank you.

Operator, Operator

Thank you. The next question comes from Devin Ryan of JMP Securities, please go ahead.

Devin Ryan, Analyst, JMP Securities

Thanks, good morning everyone.

Paul Reilly, Chairman and Chief Executive Officer

Hey, Devin.

Paul Shoukry, Chief Financial Officer

Good morning, Devin.

Devin Ryan, Analyst, JMP Securities

First question here, just on the recruiting commentary and outlook. Obviously, you guys have been alluding to some increased competition in recent months. So I just want to dig in a little bit, because it seems like over time recruiting competition kind of ebbs and flows. And so I'm kind of curious, what do you think is driving that right now and I guess I just want to make sure that I understand the full message here. I guess my takeaway is that independent advisor recruiting is still very strong and that's the expectation on the employee side, pricing has become more competitive, but it sounds like Raymond James is already increasing kind of pricing competitiveness. So, should we expect that the recruiting on the employee side will remain active but just cost a bit more or I guess what should we be taking away here?

Paul Reilly, Chairman and Chief Executive Officer

We've had a very robust recruiting history and certainly on the employee side as people look to grow their Private Client Group businesses the gap just got bigger and bigger where I think that people even wanting to join saw the economic gap was too big. When we analyzed that, we found that by upping our competitiveness modestly we don't have to match every offer, we've proven that over history, but being more competitive because of the environment makes sense. What we offer advisors, we can still provide a good return and if interest rate spreads widen again in the future, those recruiting deals from our standpoint will even be better. So, we've become more aggressive. Yes, there is a little bit of lag, but we think we can get it going. We did decrease the advisor class during the pandemic and as we ramp back up the training, which we expect to once we exit the total virtual environment, that will help also. So again, last year we had good recruiting stats in the quarter but it isn't unusual if you go back to the year before that it was flattish. I think we're up to record recruiting here, so we'll get it back on track. We also need to provide better numbers because advisors in the RIA channel we don't count in the advisor count, so you're not really seeing overall recruiting even though their assets are in the asset numbers. We're going to work on how to give you a better metric on that too, so you can compare it more apples to apples as channels may shift over time.

Devin Ryan, Analyst, JMP Securities

Okay, that's really good color. Thank you, Paul. And then just a follow-up here on capital as well. Appreciate the update there. Is there any way you can just help refresh us how to think about the capacity — the bank growth or the size of the bank within Raymond James. I appreciate that you're going to be opportunistic and can't really give a timeline of expanding the bank balance sheet, but how should we think about based on whether it's third-party bank deposit and client interest program, the capacity to fund growth or the size of the bank within the overall firm, how are you guys thinking about maybe the upper band of capacity without giving us a timeline of exactly how you'll get there?

Paul Reilly, Chairman and Chief Executive Officer

We would love to continue growing the bank and we have, as you can see with the cash at third party banks and CIP at the broker-dealer, a lot of funding capacity and plenty of capital capacity to grow the bank. So the biggest constraint now is just finding assets with good risk-adjusted returns over a long period of time. The way we're thinking about balance sheet growth overall as a firm, which includes that most of the growth in the balance sheet would come from the bank going forward, is that Tier 1 leverage ratio that Paul mentioned, which we hope to target around 10% and take that ratio down to somewhere around 10% over time. It could go under 10% if we're just accommodating client cash balances and investing it in parking at the Fed or investing in treasuries, but on a more normalized basis, I think 10% is a conservative place to be at the holding company overall. And so that's how we're thinking about the bank growth. Some of the metrics in the past that we shared with you around the percentage of equity and percentage of cash balances were established when we were primarily a corporate loan bank. Those metrics were intended to contain the size of the corporate credit exposure to our overall balance sheet. Now that we have agency mortgage-backed securities and we have securities-based loans and mortgages to Private Client Group clients, some of those metrics aren't as relevant as they were five years ago. So, that is going to be part of the discussion that we hope to share more details with you on at our upcoming Analyst Investor Day.

Devin Ryan, Analyst, JMP Securities

Okay, great. Thanks, Paul. That was what I was getting at, so, appreciate it.

Operator, Operator

Thank you. The next question comes from Craig Siegenthaler of Credit Suisse. Please go ahead.

Analyst (filling in for Craig), Analyst, Credit Suisse

Good morning. I'm filling in for Craig. I just wanted to follow up on the balance sheet commentary and we want to know what kind of macroeconomic trends you're seeing and how those are making you more comfortable growing Raymond James Bank over the near term.

Paul Shoukry, Chief Financial Officer

I think it's certainly sector by sector. As you know, we are pretty aggressive on selling COVID-exposed loans, and so that kind of shrunk the balance sheet a little bit relative to what it could grow. But we have tracked other non-COVID related areas and how the economies performed even in near lockdowns in places, and we're pretty comfortable in a lot of those sectors and so those are the sectors we're looking at growing. We've also looked at the spread on MBS securities and they're just not attractive right now, so we're looking at higher grade corporate loans also to get a better spread with shorter duration. When you buy a three-year A corporate loan in a well-run company in a non-COVID segment versus a treasury that's not yielding anything, the economics can be better. So we're looking at those opportunities. We're comfortable with the bank and the lending team. We have a lot of capacity, so as we've gone through this part of the pandemic, even though there's uncertainty, we're getting more comfortable with lending in areas and that's kind of opened that back up.

Analyst (filling in for Craig), Analyst, Credit Suisse

Thank you.

Operator, Operator

Thank you. The next question comes from Steven Chubak of Wolfe Research. Please go ahead.

Steven Chubak, Analyst, Wolfe Research

Hi, good morning.

Paul Reilly, Chairman and Chief Executive Officer

Hey, Steven.

Steven Chubak, Analyst, Wolfe Research

I wanted to start off with a question on the capital markets outlook. Coming off a record year for fixed brokerage, activity appears elevated. Are these elevated levels something you view as sustainable? Mr. Shoukry, you alluded to a $160 million to $165 million run rate for investment banking on average. Should we infer from your remarks that this base level is consistent with your view of normalized activity and what you believe is readily achievable within the investment banking segment?

Paul Shoukry, Chief Financial Officer

I'll answer the second part first. I wish projecting investment banking revenues was more scientific. I think it's more hypothetical. On a going-forward basis, if we averaged $165 million of investment banking revenues a quarter then that would sort of match the record we set last fiscal year. So, is there upside to that as we saw this quarter — yes, there is upside. And we are growing the platform; Paul mentioned the Financo acquisition, which we hope will close and we've hired a lot of other senior MDs, so we have a pretty powerful investment banking platform. I think you saw the potential of that this quarter, but we just want to caution the street against annualizing this quarter.

Paul Reilly, Chairman and Chief Executive Officer

It's one of the difficult things — if you talk to us or to peers in the industry, everyone was surprised at how robust this quarter was. It's not that we didn't have good backlog. Coming off a quarter like this, you ask what the next quarter looks like. Backlogs are very good and activity is very high but you hate to keep predicting a repeat of this quarter when it's an all-time record. Industry-wide it was very strong. So can it continue? Yes, but that would be a guess. We try to give numbers we're comfortable with; it doesn't mean we can't beat them. We just don't want to mislead by annualizing a record quarter.

Steven Chubak, Analyst, Wolfe Research

We're dealing with the same struggles.

Paul Reilly, Chairman and Chief Executive Officer

I think the fixed income market dynamics have been favorable and that usually won't shut off unless there's a major event. But NNA is still strong, so it's hard to give a firm forecast. We try to be realistic and hope to do better.

Paul Shoukry, Chief Financial Officer

Maybe a little additional color: the debt underwriting business was also near record this quarter. Our public finance business finished the calendar year in the top 10 in the country and the pipelines there looked good as well. So we have a very strong public finance franchise, which will also contribute to the results.

Steven Chubak, Analyst, Wolfe Research

Thanks. And on my follow-up, relating to organic growth and NNA. I appreciate the nuance around recruiting and the different channels. You quoted a net new asset figure of about 5% organic growth. Slightly below the 6 to 7 you recorded over the last two years. As you look ahead, given heightened competition within the employee channel, what piece of NNA growth are you comfortable underwriting or we should contemplate in the near to intermediate term?

Paul Shoukry, Chief Financial Officer

I'll let Paul talk about the competitive dynamics. As far as the NNA metric goes, that 5% was for the year; the fourth quarter for almost all firms in our industry can be seasonally high because of dividend and interest reinvestment. Quarter-to-quarter that number can change because the baseline rolls forward. We're still pleased with the 5% organic growth and remember that is net of commission and fees in the Private Client Group the way we account for it.

Paul Reilly, Chairman and Chief Executive Officer

On recruiting, we've been better than we've been in a decade, and we've had quarters where channels ebb and flow. We continue to attract advisors because of our platform, culture and technology. We may have been a little slow to react during the pandemic but we've adjusted our packages and expect recruiting to remain strong. We will provide better metrics over time, particularly to capture RIA channel movement so you can compare apples to apples.

Operator, Operator

Thank you. The next question comes from Alex Blostein of Goldman Sachs. Please go ahead.

Alex Blostein, Analyst, Goldman Sachs

Hey, good morning everybody. Thanks for the question. Paul, I was hoping you could dig into the RIA and the custody platform a little bit more. One, can you give us a sense for the assets on that platform now and how much that's been contributing to your NNA over the last year? And bigger picture, what is the competitive advantage that differentiates you versus peers in this part of the market? From an economics perspective, how should we think about the revenue yield or the operating income yield on those assets aside from the cash related revenues — are there other fees we should contemplate as that part of the business grows?

Paul Reilly, Chairman and Chief Executive Officer

It's complex and multi-faceted and one reason we'll try to provide better metrics at Investor Day. Historically, much of the economics in that business has included trading fees and interest spreads; trading fees have declined and interest spreads are currently compressed so economics are a bit challenged near-term. Our competitive advantage is that we can offer a full platform with custody, integrated systems, access to our bank products like lending, and broader services and support that many independent custodians do not provide. We can serve turnkey RIAs as well as those who use third-party platforms. We believe we have strong service centers and infrastructure and that positions us well. The RIA custody trend is long-term and we expect to be competitive in that space. We have a lot of growth ahead and will scale over time.

Alex Blostein, Analyst, Goldman Sachs

Great. And then my follow up is around expenses. Paul, you gave updated thoughts around the comp rate and that you expect 70% or better. Can you talk about non-comp expense outlook excluding provisions? You guys have been running a little over $300 million this quarter and last quarter on those lines, again excluding credit provisions. How do you envision that evolving through the rest of the fiscal year and to what extent will higher recruiting TA packages push that number higher? Just trying to get a framework to think about it for the rest of the year. Thanks.

Paul Reilly, Chairman and Chief Executive Officer

I don't think the higher transition assistance packages will move the non-compensation line materially; those show up in compensation as they amortize. We were around $323 million this quarter, which is roughly the level we expect, and that included some non-controlling interest expense. The harder-to-project items are business development expenses, which are down year-over-year as travel and conferences have been curtailed. We'll see how travel recovers, but in the short term we're focused on disciplined management of controllable non-comp items. Some line items will grow naturally with business growth, for example, sub-advisory fees grow with fee-based assets in PCG, which were up 12% sequentially. Overall, discretionary spending remains tightly managed.

Paul Shoukry, Chief Financial Officer

In the shorter term, non-comp items will be well managed. The question becomes when the environment opens up for conferences and in-person events, we'll see some rise, but short term we don't have many conferences scheduled and it may take a while before people are comfortable traveling and gathering. It might be next calendar year before you really see a pickup there. We're managing these expenses very closely and plan to continue doing so, while adding people tied to growth in the business.

Paul Reilly, Chairman and Chief Executive Officer

One other comment: the first fiscal quarter has some seasonal factors — fewer billable days impacts interest and asset management billings, and there's a payroll tax reset and higher mailings which show up in communication and information processing. So quarter-to-quarter comparisons will reflect some seasonality as well as the disciplined expense management Paul described.

Alex Blostein, Analyst, Goldman Sachs

Great, thanks very much.

Operator, Operator

Thank you. The next question comes from Chris Harris with Wells Fargo. Please go ahead.

Chris Harris, Analyst, Wells Fargo

Great, thanks guys. Another one on the competitive environment for advisors. How does what you're seeing in the marketplace today compare to history — is this about as competitive as you've seen it or more like the middle of the road? And are you a little surprised about how competitive it is getting given where interest rates are?

Paul Reilly, Chairman and Chief Executive Officer

It's always been competitive. We've always had outliers where one or two firms offer outsized packages. What's different is it has become a little more broad-based with more regional firms increasing offers. When we dug into the economics, even though some packages are large, we believe with appropriate structuring they can still deliver acceptable returns to us, especially if spreads improve in the future. We were a bit behind the market in recent quarters and have adjusted. Recruiting remains strong overall; it's just down from a recent series of records. We've navigated these cycles before and have rebounded, and I remain optimistic.

Chris Harris, Analyst, Wells Fargo

Quick follow-up for Paul Shoukry. You highlighted additional downside to the NIM as we progress through the fiscal year. I'm guessing that's all coming from the AFS portfolio. Once we get toward the end of the fiscal year, is it fair to say we're probably close to bottoming on the NIM based on where interest rates are today?

Paul Shoukry, Chief Financial Officer

Yes, it's mostly the agency mortgage-backed securities portfolio. We're seeing prepayment speeds accelerate as clients refinance mortgages, and with the Fed purchasing a large amount of securities, spreads have tightened meaningfully. If rates don't change, the yield on that portfolio could bottom out at current levels, which is why we decelerated growth in that portfolio this quarter and plan to run in place near-term until spreads improve.

Paul Reilly, Chairman and Chief Executive Officer

The good news is our capital and liquidity positions give us flexibility. We're a growth company and want to grow the bank across several segments. We've come through what we hope is the worst of the pandemic in great shape and feel more comfortable looking forward. We plan to grow the bank in SBLs, mortgages and corporate lending where appropriate.

Operator, Operator

Thank you. The next question comes from Jim Mitchell of Seaport Global. Please go ahead.

Jim Mitchell, Analyst, Seaport Global

Hey, good morning guys. Maybe we could dig into the MD business a bit. It's been an area of focus and investment and obviously big surprise strength this quarter. Can you give us some metrics that we can think about — number of MDs, growth rate in MDs, what's driving the growth and how we can model it better?

Paul Reilly, Chairman and Chief Executive Officer

It's not just headcount. We've tried various metrics including underwriting number of MDs, but the business is driven by the productivity of MDs, deal sizes and vertical strength. Our investment in senior talent and building vertical franchises is driving stronger production. Historically, no single metric has tracked reliably quarter-to-quarter given cyclical deal flow. We'll review disclosures ahead of Analyst Day to see if there are clearer metrics we can provide to help you model this better.

Jim Mitchell, Analyst, Seaport Global

Got it. Maybe on the comp ratio, when you talk about 70% or lower, is that assuming that average quarterly run rate in investment banking? How should we think about that target for the year versus the 67.5% in the first quarter? Are you assuming the $160 to $165 million run rate?

Paul Reilly, Chairman and Chief Executive Officer

Yes, it's primarily driven by revenue mix. Asset management fee growth in PCG has about a 75% payout associated with it. So if capital markets revenues remain as strong as this quarter, the overall comp ratio can be lower. The comp ratio target reflects our view of revenue mix; the biggest driver of moving below 70% is very strong capital markets results in a quarter.

Jim Mitchell, Analyst, Seaport Global

Okay, all right, thanks.

Operator, Operator

Thank you. The next question comes from Kyle Voigt of KBW. Please go ahead.

Kyle Voigt, Analyst, KBW

Hi, good morning. Thank you. Most of my questions have been asked and answered. I guess maybe a follow-up for Paul, you just spoke that the agency MBS book is pressured. Any color on how much more pressure we should expect on refinance loan yields through the remainder of the year given prepayment trends?

Paul Shoukry, Chief Financial Officer

We see a lot of refinance activity, which is good for clients but continues to pressure yields in that area. That pressure is real, but not to the same extent as the agency MBS portfolio. We're focused on growing corporate loan balances opportunistically to offset NIM compression and grow net interest income through asset growth.

Paul Reilly, Chairman and Chief Executive Officer

We're feeling much better than this time last year. With our capital and liquidity, we have flexibility to pursue growth where risk-adjusted returns make sense. The mortgage market looks like it's bottoming and securities-based lending continues to be attractive for clients and for us.

Paul Shoukry, Chief Financial Officer

Yes, we're feeling really good compared to this time last year.

Operator, Operator

Thank you. And our final question comes from Bill Katz of Citigroup. Please go ahead.

Bill Katz, Analyst, Citigroup

Thank you for taking the questions this morning. Going back to the acquisitions, you mentioned consideration and earn-outs. Can you help us think through how to model earnings accretion or ROE impact against that payout as a first question?

Paul Reilly, Chairman and Chief Executive Officer

We don't do things for short-term accretion. We evaluate transactions for long-term growth and cultural fit. Some acquisitions carry intangibles, transition compensation and integration costs that can affect near-term P&L but we expect attractive long-term returns. These two deals are structured with that longer-term perspective and while we are very positive on both, don't expect material short-term accretion.

Bill Katz, Analyst, Citigroup

Okay, that's helpful. And broadly on M&A priorities, how are you thinking about focus areas from here — would it be asset management or scaling further in private client, or other areas?

Paul Reilly, Chairman and Chief Executive Officer

Our priorities haven't changed. We look at private client opportunities, but there aren't many that fit culturally or at attractive prices; organic recruiting has been the engine for PCG growth. We're also focused on strategic add-ons such as the retirement plan administration and other service businesses that help advisors and clients and can be monetized. Technology and service-driven acquisitions that enhance client and advisor value are also areas of interest. We're deliberate but active and will deploy capital when the fit and returns are right.

Bill Katz, Analyst, Citigroup

Thank you.

Paul Shoukry, Chief Financial Officer

I don't think we have any more questions.

Paul Reilly, Chairman and Chief Executive Officer

Well, great. I appreciate you all joining us on the call and certainly a strong quarter for us and again we're very optimistic in terms of the fundamentals. I don't know what will happen with the market, but hopefully this pandemic gets behind us and we feel optimistic about Raymond James. And just remember that our area is the home of championship teams — we have the Stanley Cup champion, the baseball runner-up and World Series champions and Raymond James Stadium, where we are playing for the NFL Championship; so thank you.

Operator, Operator

Thank you. That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Thank you and have a good day.