Jul 24, 2008
Operator
Ladies and gentlemen, thank you for standing by, and welcome to the Raymond James Financial Analysts Conference Call. At this time, all lines are in a listen-only mode.
Later we'll conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions].
I would now like to turn the conference over to our host, Mr. Tom James.
Please go ahead, sir.
Thomas A. James
Thank you very much. Good morning everyone.
It's a pleasure as usual to talk to you a little bit about the quarterly results this quarter and third quarter. Of course our comparisons are good relative to the rest of the Street.
I wouldn't say that, if we were eliminating the conditions of the market that they would be satisfactory to us. But I'll have more to say about that later as I try to kind of look at some sort of a normalization hypothetic to get some sort of feel of how management would judge we are doing, which I think publicly has some more value than just looking at stale numbers.
As we of course reported, our net revenues did achieve a new record at $742 million for the quarter, we actually had a slight decline in gross revenues. If you look at securities commissions, the major number, you see a 5% increase over last year's comparable quarter.
I would tell you that, almost were more than all of that essentially or all of that is derived from increase in mainly fixed income institutional commissions. But both institutional categories were up over last year's comparisons.
Two factors, on the equity side, we continue to have very good activity and are being rewarded for our research. On the fixed income side, we've seen more activity, hedge funds, other large buyers that are looking for good opportunities in the marketplace.
And as I reported to you before, we have a major effort underway to distinguish securitized tools from each other so that we can give good recommendations to clients about how to upgrade their portfolios or they are looking at the bottom fish to be able to acquire once and have more opportunity for price appreciation. And that's going on very well.
And in addition, we've had some pretty substantial additions to the sales force but they wouldn't have impacted these numbers very much. We've added 12 or 13 fixed income salesmen just in our Memphis office during the last quarter as a result of Bear Stearns as a deal with JPMorgan where they have actually backed out of some areas that they are in on a regional basis because of overlap or strategic differences at the corporation.
But also, there are some problematic situations at some of the other broker-dealers that are present in that market as there are in other marketplaces. Again, editorializing on those commission numbers, I would say that RJA continues to do very well.
As a result of its recruiting, we have positive recruiting picking up momentum in RJFS. But the continued drip drip of bad information in the marketplace does have some impact on the retail commission flow.
So the Private Client Group is actually doing extremely well in my view in light of the backdrop. I hope that conditions will improve, they obviously have in just the recent past, but the sub-prime crisis really isn't totally over, real estate prices are still in decline mode.
There is a chance that we really do fall off the table with a real recession of some magnitude. I really don't care whether you call it a recession or don't call it a recession if it's mainly flat.
But the only way we increase numbers as either through productivity enhancement, which is unlikely if we have that kind of a market environment or with additional new salespeople which I suspect is continuing a pace, I don't foresee any real changes in terms of that activity, we continue to add to both sales forces fairly rapid fashion with a large number of the spending time in what we call Home Office visits by prospects who visit here. So, the color there is good and even RJ Limited is adding sales people and we're doing fairly well in the UK also.
So I expect to see some growth there over time. So, I'm happy with that.
When you look at interest, the... you still have the impact of lower rates and of somewhat lower spreads whenever you have lower rates, they are lower than we would have anticipated I would tell you in our own projections, here spreads are down from where we would expect them to be but our volume is once again of cash deposits at the firm is growing, not just at the bank, but at the broker-dealer as people continue to join the firm as new clients, as new FAs come on or as a...
just have chosen us as their service provider. And then net trading profits were up for the quarter.
This is a reflection of the fact here in at least the last two quarters, we've seen a pickup in terms of profitability of fixed income trading that is offsetting the continuing losses that you have for execution facilitation for the institutional equity side of the business. So this is back to more normal type conditions for us.
There are great opportunities out there, and actually ours... our results are somewhat curtailed by the fact as you might guess we have continued to be conservative in terms of inventory positions reflecting some concern with the lenders markets as they seem to still be leery of having outstanding balances at the end of a quarter or even the end of a month, because they're trying to work on perception in terms of lowering their leverage ratios, even at the very large banks which you wouldn't think would be that impacted but the fact is instructions are clearly reduced outstanding balances at reporting periods.
So, you should be aware that that's still going on. There was a pretty large increase in other quarter-to-quarter comparisons, I don't really have any specific detail for that.
I have some, but I haven't really even analyzed that, and it's too hard to call these things quarter-to-quarter on other anyway. So when you look at the net revenues as I said, those were record level, that is impressive in this time frame.
We continue to have a somewhat higher commission compensation type expense increase on the form level than we have in commissions and fees. That would be troubling, except for the fact that you have to recognize that the continuing rapid rate of recruiting tends to increase the non-direct payout compensation factors, and so we've had slight escalation in terms of the total payout rates inclusive of all benefits and indirect costs of compensation.
Communication and information processing is reasonably well controlled. We've had big increases in occupancy costs and equipment costs, those reflect loss in [ph] new offices year-over-year, more actually than probably I would like to see, but the opportunities are so good in terms of number of recruits that are available in the marketplace.
We've been more aggressive than perhaps our plan. As I mentioned on the recruiting front, just to give you for example, in RJA we've already reached our objectives for new recruits for the year with the quarter less.
So this is a... that's costly because it involves more front money, more operating expenses, more ACAT expenses, all kinds of costs that are directly attributable to the recruiting process.
But as I said, when you have these upsets in the industry one should take advantage of them. So expenses in total were up at the same rate as net revenues, normally we'd like to see some margin increase, but without having the commissions really up at a higher rate, you're not going to see any margin expansion, is what I would tell you.
And of course, that resulted in a record net income quarter where we almost made $70 million after taxes and resulted in a very good quarter of $0.59 versus $0.57 on a slightly smaller average share outstanding fully diluted base. So, those...
remember we probably purchased almost three million shares in the marketplace. And offsetting that we've had option exercises and issuance of restricted stock for all these recruits that I have just mentioned which is part of the cost element that I described.
Pre-tax margins were good in the quarter at 14.2, after-tax margins at 8.65, those are gross. So if you look at them on net, which is maybe better we were still 9.43 on an after-tax basis which is very good.
And I did mention, the compensation rates which are up somewhat on the gross revenues, which is reflecting some of these issues. But net interest income is up considerably, that's mainly bank-related as we move more balances to the bank, also during this year period.
So you don't see as much of the benefit in PCG as you might have expected to see in this period. And then when you look at rate of return, I mean, the tax rate, it's higher than our normal average projected rates and the reason for that is [inaudible] and we of course have had declines in market price of securities in which the [inaudible] assets are invested.
So this has resulted in this somewhat distorted higher tax rate. Hopefully we get back to some period here in the near future where we get increases quarter-to-quarter and appreciation.
When you look at that... at that quarter and try to look at it on a segment basis as my press release focused on this particular quarter, you see PCG actually with a decline.
That relates again to some unusual factors more than anything else. In compensation expense now, you are impacted by stock price changes during the quarter for unqualified options.
And as a consequence of that, last year's quarter had a $6 million credit and this year's quarter has a $2.3 million expense. So you have an $8 million...
over $8 million swing in that particular cost factor in PCG for independent contractors. And the...
so when you look at that, and we had about $2 million in other costs related to independent contractor cost and we have some unusual costs that again are mainly timing differences in Raymond James Limited. So on the expense side, with no real commission and revenue when you have this kind of increase along with just your general inflation, you're going to have a lower margin.
But this one is distorted in terms of the difference and when you look at the prior quarter, that's reinforced, where I think we had $52 million in contribution versus $56 million last year and then we're $36 million kind of numbers this year. So, I don't expect that to continue, is what I would tell you.
But you are always going to have these factors on a quarter-to-quarter basis, and that resulted in all those taxes. So essentially, you also had a downturn in the asset management group, which reflects the fact that assets are down as a result of the market decline, you've got flat fees, higher costs.
The only reason fees are flat is we earned some performance fees, they are not monumental in our models because we just don't have that many accounts on performance basis. Fees, but the...
that's an unusual thing too, it's normally more consistent grower, but the biggest impact here clearly is, market barriers. And when you think back to PCG, you need to recall that a lot of our income in PCG is related to fees also, so that even our FA gross revenues are directly impacted by the fact that you might have some decline as a result of the market on assets under their management or which they have placed in the control of professionals so that really is the two declining factors, capital markets is up for sort of the reverse reasons that one would expect, equity capital markets continues to be depressed, especially in the investment banking side, the commission volume, as I mentioned, is good there.
But fixed income, which has been a drag for three years is generating near record revenue levels in terms of institutional commissions and generating very good profits. So it's nice to have counter balancing factors in capital markets, but we're clearly not running on all cylinders and that's the point to remember here even though we have achieved some increases and you see relatively good activity in terms of the number of underwritings.
But the fact is, the new issue business itself is about more of an... and the continuing financing which we benefit from in real estate in oil and gas and other energy continues to be reasonably good, and in fact we're getting some lead assignments, M&A activity is okay, it's not great, it's down on an industry basis too.
But our people are very busy. And we are also taking advantage of some of these times again on the recruiting front to add people in our consumer segment in our West Coast offices and we're trying to add internationally for cross-border business and so we're in a lot of discussions, nothing to report there, but we continue to look and I view that as sort of the planning to seed variety and not as something that would generate large immediate revenue associated with it either.
But, again pretty healthy other than equity capital markets, and I've saved the best for last of course, the bank which seems to continue to generate consternation on behalf of certain analysts, I read a report by a shorting service choosing us as the short... and let me just say, empathetically that I can understand why somebody just looking at raw numbers and the growth of the assets at the bank would have a concern that we would be in for a spade of larger write-off and in fact the answer is, sure they are going to be higher if you got much higher balances.
The question is whether they are higher proportionately or not and what I would tell you is, we're still benefiting from the fact that lot of these loans are relatively new, although we bought a lot of our additional loans, which are mainly corporate loans, I want to point out to you, we've added to our whole loan packages in real estate, but we're really not issuing new A&D loans or anything like that. So these are single family home loans by and large and we are being very circumspect in terms of the purchases, as I've pointed out to you before and our reports indicate, we continue to review individual loans when we evaluate packages of loans for purchase, and we reject a very high percentage of the loans we look at even though those with high FICA score.
You need to understand that the quality level is very high in those but at the same time I want to point out we have told you before and I'm going to continue to tell you we expect those loans to have some real losses associated with them, certainly on the commercial side where we have a very small exposure in real estate, A&D type loans and in loans to real estate companies, I think we've reported a $127 million, I've got Steve Raney, our bank president. Yes, we have a $110 million in outstandings, but that's a very small percentage of our total portfolio.
So we don't have a lot of big exposure and I would tell you that the loans were well underwritten, and even if we take some of those back into REO, that's owned real estate for those of you that don't use the bank jargon, we, in fact, don't anticipate we're going to have major write-offs from these things relative to the amount of reserves that we've already accumulated on our own portfolio and we don't seem to be developing any problems as of yet on the corporate front. But as I pointed out to you before, we won't really test the quality of our underwriting skill on traditional corporate lending until we have a real recession and a real downturn, sure, you will have isolated instances of companies that have problems when you have as large a portfolio of loans as we have.
But remember that we are making these loans in industries where we have great knowledge inside the company where we know the industries well, we usually know the individual companies well even before we've seen the opportunities, and I think we have the analytical skills to do a very high-quality job in this lending. But as our larger peers have proven even though as they thought they had good lending techniques, you can have losses especially if you get caught up in the euphoria at the time in making loans and trying to be competitive with everyone that offers.
So, now when I tell our FAs at their national conventions that they can expect that we are going to turn down loans for even some of their clients who they think are wealthy, they will understand that number one, we're not taking the risk at the bank and number two, we're going to be competitive, but that doesn't necessarily mean you win every competition on the cost of a loan to the borrower. So, right this minute, they appreciate that point of view, they normally do not, but I would tell you that that's the policy here, our subsidiaries stand on their own two feet in terms of their business practices.
So you've seen a big ramp up. Now, let me just give you one other perspective because I think it's important that you understand that we did ramp this business up rather rapidly but we didn't do it until we had a full complement of lenders that we thought could perform this function participating generally in syndications with a large number of the banks that we know in the industry and again, in the areas where we have expertise.
But we did do it in the secondary market when secondary markets became very attractive, we were able to buy seasoned loans, okay, that actually had experience often were much better quality than they were when they were issued, and we bought them at discounts. So from a timing standpoint, we didn't get in at the market high on all of these securities.
It doesn't mean we don't have some that we would rather issue in today's marketplace, but the fact is, we generally are benefiting from higher spreads on the loans we've got contrasted to our peer groups' portfolios, which I'd like to take great credit for, but I would tell you some of it is a function of timing when we grew the bank. So, we are benefiting from this and at the same time you need to understand while we have these large additions, I think another 12 million during the quarter to our reserves as a result of new loans that are put on incrementally net, the fact is that we've now slowed down that rate relative to the base because we kind of put off some of the sweep changes, we still have a lot of money to move from the broker-dealer to the bank over time that we elect to do so.
Now, the... we also had very good organic growth, still while slowed down for a while during tax season and cash need periods.
The fact is that the continuing growth of cash flow to the firm from new clients and existing clients is higher than we had anticipated and we are getting good organic growth without any sweep changes. So, from the perspective of CEO, manager pays a lot of attention to what it looks like from the 10,000-foot point of view, you need to understand that we are not converting ourselves to a bank.
First, we are... the bank is part of our overall services and it is...
it's goal is to serve our clients as their cash repository, which means that we must run it very conservatively, number one. But number two, we've got a lot of the capital committed to it now and we would like the growth to be nearer to our corporate growth rates so that we maintain the balance of our businesses, which while we may continue to grow at a rate somewhat higher than the rest of the business, certainly in down markets, on average, it isn't going to be a lot more, because we want to keep the amount of capital allocated to that business in line with the amount of capital we are allocating to our other businesses currently, we've pretty much got the balance right.
Now what is the impact of that strategy from a quarter-to-quarter analysis point of view? It's that you don't have as big reserves being created, which means your current profitability is somewhat higher than it would have been and you have sort of a catch-up factor going on where these higher spreads, these higher balances are being reflected now in more gross interest and more net interest at the bank, and a higher ROE now, which is more in line with the long-term objectives that when Jeff first laid out for our analyst projections going forward.
They're probably pretty consistent with those early analysis of where we might be three years into the program. So this is getting more like the steady state although we are still growing, this is more like the steady state business model than that which you've seen before with the rapid ramp-up.
So, you need to understand that when you look at these numbers, so this bank has essentially offset during this particular quarter, some anomalies with respect to expense, but also some weakened segments, the PCG being a little slower than normal in spite of the fact all the engines are running right except for the market and equity capital markets which is going to suffer from this market condition, and tell it is a more appropriate time for issuers to bring stock to market. So, that's the reason that I focused in the press release on the segment analysis, I hope you have some appreciation for the fact there is an overall strategy to how we grow the business, how we manage risk here in our approach to the business and I'll be the last one to tell you that while Maria on CNBC said, yesterday we crushed the competition.
I'd like to take a step back and say, we are a little different business than a lot of the competition and so when you compare us, even to Merrill Lynch who clearly changed its business model to its own detriment during the last couple of years, but if you look at some of these other investment banks with whom the numbers are at least compared, the fact is we are not in the same businesses those guys are, and you need to appreciate the differences and you need to measure the risk. It's not to say we don't have risk, we do have risk, all of our businesses have risk and we certainly have some things...
I reported to you on Turkey in the past telling you that I thought there was a good chance we would end up closing down in Turkey if anything were closer to that than before, we have taken the appropriate reserves for that already in the past to be prepared for that action. To be frank, the regulatory and government policy that the legal systems there that are acting [inaudible] to a foreign corporation operating there, and it's really difficult to operate intelligently.
So, I suspect we'll close that down. That's dirt on us even if it's not going to impact our earnings and to be frank, what bothers me the most is we have a lot of good people there whose lives will be impacted by this although they are so good they'll all get jobs, but the...
it's painful to me to reach a conclusion like that in the marketplace, but sometimes you need to make decisions like that. The...
we have a interesting situation developing with one of our recent corporate proprietary purchases, [inaudible] which relates to prior acts by the past management that where there are some claims by the government that the prior owner violated its own agreement and the government has taken upon itself to take some acts against us even though we are a new corporation after a mass asset purchase, which in my view is totally inappropriate but the fact is that and we don't know what we are going to do with that purchase. So we have the right under certain conditions to take actions or a recession, or damages and we're evaluating all those alternatives.
So, we don't have any reserves taken for any of that because we still think there is a very strong likelihood that whatever happens we'll emerge unscathed except for bruise, pride and a lot of time expended, and legal fees on that. But these things happen and I would be the last one to claim that we have all the expertise to avoid every single risk.
I love all the accolades when they come, but for heaven's sake keep in mind that we'll have our day in the -- up above the water with people throwing balls trying to knock us down. So, just some comments with respect to that.
Obviously when you look at it on a year-to-date basis for the nine months, we continue to have net revenues up 10%, we have net income about almost flat down 1% from last year. I personally believe that's outstanding performance under the circumstances and the weaknesses in the certain segments that I mentioned.
If this condition continues the way we are operating in the marketplace, and I don't mean the last week, I would suspect that it will impact the Private Client Group and it will impact Capital Markets. But if, in fact, we're looking at the end of real estate problems somewhere 12 months out, I would say mid 2009, we should pretty well have completely digested the problems from the meltdown.
You could see a market at the beginning of the calendar year discounting all that activity, if it is not doing so already. And it's very hard to ascertain what the longer-term direction is, but clearly a thousand points ago, you saw the kinds of feelings where you're trying to make a bottom in the marketplace.
And so, I tend to take a longer view anyway. All I can tell you is that we are certainly a much stronger company relative to where we were a year ago when all of us started than we were then.
And that means that when we come out of this market decline, I think we will see some well above the average growth rates in terms of revenues and profit growth assuming we can't find some other potholes to manage to run over in the industry which seems to be the best of some of our participants. And perhaps we are going to even have a more sensible updated modern regulatory system to deal with some of the challenges in the industry going forward, because the biggest fear I have is systemic as an industry, some of the regulatory risk, some of the inter-relationships business-to-business, etcetera, and that's why members of our management, Chet Helck in Sifma [ph], Dick Averitt in various independent contractor groups and I, in the Financial Services Roundtable are spending a great deal of time trying to work on these industry issues to try to see if we can forge a more practical and foreseeing regulatory structure working jointly with regulators as opposed to this enforcement mentality that seems to exist all the time as a way to make new rules, etcetera.
It's not a good way to handle problems, and if we don't plan together, we're not going to maintain our global competitive advantages. So, I think that's important.
One final comment and then we'll open to questions, and that's that, one of the things that we got to remind is, in spite of the fact that we have a very strong balance sheet where our assets, lot of them are either at the bank or they are cash deposits at the broker-dealer with offsetting 15 C-3 deposits etcetera, meaning we don't have a lot of real leverage at the company. I was shaken by the behavior of some of these large institutions, and we have gone back to look at restructuring our balance sheet through developing some term loans as well as backup lines of credit, committed lines of credit, and as Jamie Dimon has often reminded me there is no such thing as an uncommitted line of credit and nearest I can say is with the exception of JP Morgan and Wells Fargo and a few other people that have acted like they are committed, even when they are uncommitted, he's right and so we're putting ourselves in a position to essentially be able to take more advantage of this market, we would have bought more stock back had we been in a position to assure ourselves that credit would be available and you have to understand when you look at this that a year earlier, the banks were calling us clamoring for us to draw down our lines to borrow money against all these assets and we never had anything borrowed.
And so now when we had an opportunity to use money intelligently to buy back the best investment that I could find that I understand at very low prices, we did indeed get to $20 a share. I...
and there are opportunities in the marketplace, both within our existing units and on an acquisition basis, we need to have some dry powder for those opportunities. So we've completely revisited it, the structure and Jeff Julien, our CFO is involved in restructuring this debt and we have a lot of friends in the banking industry who stand ready to join our group.
So, the cost will be a little higher now than they were a year ago, because people figured out there are more risks in financial services than they thought. Now I would argue that we should have proven that they aren’t with us, but they tend to throw the same net over the industry, so...
but I think that's the thing that probably has kept Lehman Brothers above water in this downturn even with its high leverage because of its debt structure for which I commend Dick Fuld. But these are strange times, they teach lessons, these things do happen, they happen infrequently but we need to be prepared for them and certainly we want to take advantage of the opportunities that are presented in these times.
So it's extremely important that we act judiciously to restructure. And with that, I invite you to ask questions.
We got Jeff Julien, our CFO; we got Chet Helck, our Chief Operating Officer; we've got Steve Raney, Head of our Bank; we got Jennifer Ackart, who I like to say is our financial chauffeur, and any answers that we're supposed to know that we don't, we will refer to her. So any questions you have, we would love to entertain.
Question and Answer
Operator
[Operator Instructions]. Our first question comes from the line of Lee Matheson with K.J.
Harrison & Partners. Please go ahead.
Lee Matheson
Hi, good morning guys.
Thomas A. James
Good morning, Lee.
Lee Matheson
Just a couple of quick things. In terms of...
on the private client group and the addition of these advisors, can you give me some sort of update in terms of where the upfront payments are trending either what you guys paid for to bring these guys over or what the general industry is looking like and ended that up in the last 36 months?
Thomas A. James
No, I'd say, actually maybe up slightly... it would be up on an average at our firm only because we are recruiting people with higher average gross production.
So if you're looking in the teams with multibillion-dollar production, we would be somewhat over 100%, it might be 110%, it might be 120%, average is still somewhere between 60% and 100% upfront. We prefer to use some good portion of that in stock.
The industry is still higher, the firms that have net outflows are somewhat frantic in an effort to maintain positive count. And so you see them making large offers which is...
the people that take those offers under the circumstances are going to pay for it, because some of these reputations have been besmirched at these firms and it isn't going to be easy. We are benefiting from the fact that we stayed out of the fray here.
So... but all firms again I'm going to add a degree, it seems as if all firms think everybody else is higher than they are.
So, I would prefer to say that what we can do and we certainly can recruit with our current levels. We have productivity growth still going on at both firms in spite of all these factors that I've mentioned.
That's why I say, I think we're a little bit vulnerable, but that also augurs well for rate of return on investment because the key here is to make sure that you are making wise investments and not buying production on its way down as opposed to production on its way up. So...
Lee Matheson
Absolutely, from a balance sheet aspect, what... I mean, I don't know if you guys are really...
but can you give us an idea what non-bank cash level was at the quarter-end?
Thomas A. James
I will defer to Jeff and Jennifer on that. Jeff says [inaudible] as he is pulling out another book of financial data that he thinks it was around 200 million and with...
what kind of borrowing... 400 million.
Jeffrey P. Julien
But a lot of that is in sub where we wouldn't really call it readily investable or available for dividend of the parent.
Lee Matheson
Right.
Jeffrey P. Julien
In terms of true parent-free cash, as Tom mentioned earlier, we've, without reducing the capitalization levels of some of our subs, we substantially deployed our free cash at this point in time.
Lee Matheson
I am sorry, can you just reiterate the share buyback program, what the activity was under that ?
Jeffrey P. Julien
It was next to nominal this quarter, no open market purchase to speak of at all.
Lee Matheson
I see. Okay.
Thomas A. James
Remember, our discipline is somewhat different than other people, we don't do it on a consistent basis.
Lee Matheson
Right.
Thomas A. James
We buy it when we think the multiple of book and earnings are low and very attractive over a longer term viewpoint, and that's why I say we had a real opportunity, we could have bought a lot more back which if we had had more free cash and hadn't been successfully deploying it in our proprietary capital activities and in the bank, the main part in the bank, of course, we would have bought more stock.
Lee Matheson
Fair enough. And then just one last one on...
just in terms of, you guys are scouting maybe for acquisitions looking at some of the publicly traded and mid-market investment banks, they are all trading substantially over tangible book value, I mean, is there an opportunity for you guys to go in and beef up in areas that you find attractive in geographies you feel attractive in that space? And also on the asset management division, bolting some things on to heritage or doing lift-outs there, can you just comment on those?
Thomas A. James
Yes. On the part of the broker-dealers, yes, I'm well aware of the comment you just made about some of the smaller investment banks out there that are...
have reasonably good franchises, unfortunately you can't just bolt them on, you've got some overlap. So, when you do your analysis, you have to decide what earnings power are you really adding when you do this.
You also need to be prepared to sustain some current losses during a period of inactivity. So, heretofore, that's about as far as I can go, when we got into these analysis, we've had a little difficulty with our own staff being real comfortable with wanting to go through the process of making these evaluations of current and external staff, and instead of adding one plus one, adding up with one-and-a-half instead of two.
It's... they don't really like the process, but it's certainly a possibility given the current market and it's not something that we are not looking at.
I mean, we are evaluating potential opportunities in that space, but we haven't done any more than that currently. We have talked to some of the smaller boutiques that really do have the attributes of bolt-ons that should have lower price expectations.
But to-date, haven't shown to you know except those kinds of prices, but look if this goes on a little longer in the capital markets, I would suspect we can do that. In the meantime though probably it's at least equally as opportunistic for us to take some of these individuals that are either still with places they are nervous about or who have been cut back as a result of some of these sort of gross across-the-board cuts, that have gone on especially with some of the younger associates that have a tremendous potential.
On the Asset Management side, we continue to be very active in looking at companies. We recently participated in a process and came in second.
So the... in very close bid form on prices we are...
Lee Matheson
In the retail mutual funds space? Sorry, in the retail mutual funds space?
Thomas A. James
No, it was in the portfolio management individual accounts space.
Lee Matheson
Okay, yes.
Thomas A. James
But we're looking in all spaces, so what I would tell you is that I really do anticipate that we will see some opportunities. Again we needed to bolster the balance sheet to take advantage of this, also before I would have felt comfortable right now certainly writing a check for more than $100 billion for something.
Smaller acquisitions are different or stock acquisitions or larger deals are different. I would...
I [inaudible] there may be some other larger institutional owners that may still be considering perhaps withdrawing from various spaces that might be of interest to us.
Lee Matheson
Okay, excellent. Okay, well, thanks guys.
Thomas A. James
There is opportunity and we are spending time looking at things.
Lee Matheson
Great, thanks Tom.
Thomas A. James
Thanks Lee.
Operator
And next we have a question from the line of Doug Sipkin with Wachovia. Please go ahead
Douglas Sipkin
Yes, hi, good morning everyone. Just a bunch of questions.
Thomas A. James
How are you doing, Doug?
Douglas Sipkin
I'm doing all right. Wachovia's stock was up 28% yesterday.
So the first good day in a long time. Hope it lasts.
Thomas A. James
[inaudible] little point was that?
Douglas Sipkin
All right, hey, come on, don't rain on my parade. A couple of quick questions.
On the retail business looking at on the segment basis retail revenues, and you might have explained this and I apologize if I missed it. The 20 some odd million drop in retail revenues, I mean, can you talk a little bit more about what drove that?
I mean, I know retail is softer but maybe the dynamic of the spreads compressing?
Thomas A. James
Yes, part of it is the interest that I mentioned. We moved some assets out of broker-dealer into the bank, about $550 million.
In addition, the spread compression from about 60 basis points to 40 basis points during the quarter. Are you talking to gross?
Yes, if you're looking at gross, you need to understand that just the rate differential will drive you down.
Douglas Sipkin
Can you talk a little bit about that dynamic and what would be a better environment for sort of the spreads and retail?
Thomas A. James
Well, that factor, just the net interest spreads. Yes, Jeff I'll just defer it to you.
Jeffrey P. Julien
What would be a better environment, I think that the answer to that is going to be when rates start rising a little there seems to be... this happened before back in '01 to '03 time frame when rates got back down into drill bit sizes.
We saw some compression on spreads because just the absolute of the percentage differential in rates, there's some psychology to the differential. I mean 50 basis points doesn't sound like that big a difference when you're talking about the difference between 6.5 and 7.
But when you're talking about the difference between 1.5 and 1, it's a huge percentage difference. So, with rates at this lower level, we're going to...
we see some compression in spread. We see it in the stock loan business as well, it's not just in the customer cash versus overnight investment side.
Douglas Sipkin
I was just under the impression that you guys are going to see a little bit of a bounce back this quarter because of the fact that the Fed cut so much...
Jeffrey P. Julien
And we did, that is one to the degree we thought it would be. And even as we sit here today, the spread that we...
the most common spread we look at in the broker-dealer is between a customer cash deposit and the overnight rate we're able to invest that at, which has historically been about a 65 basis point spread, today it's sitting at about 40.
Douglas Sipkin
So, I guess in an environment of rising interest rates, that dynamic would benefit you?
Jeffrey P. Julien
That's correct.
Douglas Sipkin
Okay.
Jeffrey P. Julien
Shorter and longer term.
Douglas Sipkin
Yes, second point, I mean the non-comp moved up quite a bit this quarter. Tom had mentioned quite a bit of expense related to retail brokerage, hiring new offices, etcetera.
Any color around... I mean obviously I know some of this is tied to revenues, but would you characterize $137 million as sort of a little bit of an outlier or more sort of new realistic type of rate given the revenue base, well talking non-comp?
Jeffrey P. Julien
Non-comp, not interest. I would say that there is nothing...
that's large, abnormal. Yes, the options which would...
maybe taking them up...
Jennifer Ackart
No, there wasn't anything particularly large...
Thomas A. James
I think that's probably where we are. The...
again as I said, if you're running at an inflation rate of 4% to 6% depending on aberrational kinds of things that go on quarter-to-quarter, you ought to get more growth in commissions and fees in these levels to have any margin expansion. That's been typical of our model when we're in...
I always say that it's costing at least 200 basis points at the current rate of growth that we have, and maybe more. So, you need to understand that we are making that investment in the future, and so I suspect that the operating costs are going to be about where you see them.
But I'm excited about the additions. You need to understand that this recruiting activity, when I say that it's good, it's not just good, it's about as many office visits as we can basically handle and we are talking to a lot of people...
a lot of people in the pipeline, and I think this is going to continue, but it does bring with it incremental expense.
Douglas Sipkin
Okay.
Jeffrey P. Julien
Back to first question, let's put some numbers to it on the decline in Private Client Group gross revenues. From this year's quarter to last year's was $37 million of that decline of the $27 million decline was related to the gross interest rates.
Douglas Sipkin
Okay.
Jeffrey P. Julien
Net interest was relatively flat year-to-year in the segment, but the gross interest because of the rate declines were a big part of that.
Douglas Sipkin
Sure, well, that's helpful. Can you talk just a little bit more on the bank and let me speak to [inaudible], looking at the sort of net interest margins for the quarter, pretty consistent to even some of the larger banks, 3.09% on earning assets.
I mean, can that go higher or is that a function of just the paper you guys are putting on at the better prices, I mean, where do you see that going if it can continue to move up?
Steven Raney
Doug, good morning, it's Steve. How are you doing?
Douglas Sipkin
Pretty good, how are you, Steve?
Steven Raney
That was the function of a couple of things, if you remember, at the very beginning of March, so you didn't see the full impact of this last quarter. In the March quarter-end, we'd changed the pricing methodology that we're using in the bank on the Raymond James Bank deposit program.
If you remember, we had determined that the benchmark, one of the main benchmarks that we're using contained a lot of money market funds that had riskier assets in them. And we didn't feel like that was appropriate given the profile of the bank and the FDIC insurance.
So, we made that change at the very beginning of March. So you have the full impact of that pricing differential in this quarter, the June quarter-end.
And then also couple that with, as you know, the assets that we have been adding, we've been able to put on new assets at better spreads. I would say that, I don't think that that level is sustainable, I would say that, that's probably 20 to 30 basis points higher than what I would say is more long-term sustainable, although we are obviously going to ride this as long as we can.
Douglas Sipkin
Okay.
Jeffrey P. Julien
There are two other... I would say that there are two other things that happened during the quarter that make it non-sustainable.
One is, I think we had a very artificially high LIBOR relative to our cost of funding, and I mean firstly all of our commercial portfolios keep off of LIBOR and that differential between that and Fed funds rates accrue to us, a very big gap relative to historic norms. And secondly, the Fed continued to cut rates during the quarter.
As you know, we have about $2.2 billion of residential loans that are in that five year fixed rate period before they put the floating rate and our cost of funding those dropped as the Fed contained the lower rates. We won't see that anymore, we don't think we'll see continued lowering going forward.
So those are two other factors that I think Steve and I and the bank folks kind of think that a sustainable rate is somewhere closer to 2.5 to 2.75 based on what we've got in place today.
Douglas Sipkin
Okay. Could you just chime in on the credit quality obviously I don't think it's a surprise non-accruals jumped a good amount, but I don't know if that relates to some of the developmental stuff or that's just general normal seasoning and any expectations for where that sort of non-accrual and non-performing percentage can go to over a time period?
Jeffrey P. Julien
Sure. Doug, that...
as you know when you are starting from the real low base that can be very lumpy and affected by a handful of names. We did add some corporate loans to the non-accruals that were some larger loans that we had had in non-accrual before that were almost exclusively the residential loans.
So that... and almost all of that the increase was related to residential acquisition and development homed over type loans, also the charge-offs in the quarter related to the same credits.
So, in addition to some residential loans, about $3.5 million of the $5 million that we had in charge-offs was related to our corporate portfolio with about $1.5 million in charge-offs on our residential portfolio. All the...
and that and the non-accruals are related to one another. In terms of looking out, I would anticipate some additional loans going into non-accrual status, we have an increase in our watch loans and increase in categories of credit size loans that are not in non-accrual status now, but I would...
we would expect some increase in that, just given continued softness, particularly in this residential acquisition and development space, which we've quantified for you. We have a total outstanding of $110 million in that industry segment.
That number has come down by about a third over the last 12 months or so. We're not adding anything more in that space, but we are very fortunate we have a very small percentage of the bank's balance sheet devoted to that industry segment.
Douglas Sipkin
Okay. And then just finally, question around just the balance sheet.
If I understood the comments around excess cap, I mean, let's just say hypothetically and let's hope this doesn't happen, mortgage gets crushed again, stock was back to $21, $22, you guys not have the same amount of capital to buy back like you did in the first quarter?
Thomas A. James
Yes, that's correct.
Douglas Sipkin
I mean...
Thomas A. James
When we complete the... we have about the same amount and we're not devoid of credit and cash.
I mean we have about $100 million, but it's drawn on our credit lines. But...
so that we could actually use for that today, but Tom was as I'm sure about to say, once we put in place the term debt here in the next, hopefully 30 to 45 days, that will be... we will have taken what I call a belt-and-suspenders approach, we're going to have excess cash on the balance sheet, as well as credit lines just backing that up, and then we would be in a position.
Today, we could still buy $60 or $80 or $100 million stock if that opportunity arose, but then we would be very stretched.
Douglas Sipkin
I got you. And again, I guess that's just a function of growing the bank and the buyback in the first quarter.
Thomas A. James
Yes, the bank... those are the two big factors, yes.
Douglas Sipkin
Okay. Great, thanks.
Operator
[Operator Instructions]. And we have a question from the line of William Tanona with Goldman Sachs.
Please go ahead.
William Tanona
Hi, good morning everyone.
Thomas A. James
Hi, Bill, good morning.
William Tanona
Just to kind of follow-up and focus on the bank again, obviously that's the hot button for you guys over the last couple of quarters. As you look at the charge-offs, I mean obviously increased charge-offs are going to be a cost of doing business for the bank.
But just trying to get an understanding in terms of, of those charge-offs or of the charge-offs that we saw this quarter, when would those loans actually put on?
Thomas A. James
Once again, about $1.5 million of them were residential loans, Bill. We're going to see kind of that as a normal flow, I would think.
Those particular loans, I actually don't have the origination dates on those particular loans, that one is roughly seven loans that made up that $1.5 million. The other three loans that in our corporate portfolio that comprise the remaining $3.5 million were all originated in the '05 time frame and one loan was in early '06.
William Tanona
Okay. So that's helpful, pretty seasoned in terms of that the portfolio not some of the newer stuff that you guys have been adding.
I guess in following up on Doug's question in terms of the non-performing loans, I mean, where ultimately, as you guys are continuing to build this out as the bank continues to mature. What do you think is the right level in terms of non-performing loans given your mix of business?
Thomas A. James
Yes, that's a hard number, Bill to anticipate on, we're obviously looking at past due pipeline information on our residential portfolio. Although we...
the 90 day plus loans in the residential portfolio have increased, if you look through the pipeline at even loans that are less than 30 days, that number has actually gotten lower in the last quarter. In that industry segment, we do continue to see some softening in this particular, this residential acquisition and development portfolio, really almost with that exception that entire portfolio is at least on our watch list and it's...
I would say it's a little bit up in the air in terms of what's ultimately going to happen to all of those names, I would anticipate some of those names deteriorating further and some of those names even winding up in our non-accrual status, all of those loans have some level of collateral support, but as you can tell that happened with these charge-offs this last quarter, what we're going through the evaluation of our collateral position, when a loan is going 90 days past due or the borrowers having problems, we have seen material deterioration in the collateral values, and then we're getting new appraisals and discounting that further. So, using that map I would anticipate some additional charge-offs and larger non-accruals particularly in that one industry segment.
William Tanona
Okay, that's helpful. And then I guess on the reserves, I know you're obviously restricted in terms of the reserve built that you can ultimately do.
But where do you ultimately think you're going to feel comfortable in terms of reserves to the kind of loans. If I look at your reserve and kind of compare it to a lot of the other banks, you guys seem to be at the lower end of that range, just wondering whether or not you anticipate kind of building that reserve up as this portfolio continues to grow?
Jeffrey P. Julien
One thing that's, sometimes hard to compare institutions in terms of the asset mix. We don't have any consumer loans, no credit cards, no auto loans, and typically have higher reserves associated with them.
Our residential loans had a certain reserve going in that tends to be a more homogeneous product offering and asset, our corporate loans based on the risk profile of each individual loan when we book it, it varies it could swing by almost a 100 basis points based on the risk profile of that transaction. We actually feel like we've been pretty conservative in the way we reserved against these certain assets, and we've also been very proactive in downgrading loans, early on in the process and when we're downgrading loans, we are actually taking additional reserves against that particular asset through that process.
So, we... we have seen an increase in reserves over the last five quarters, that's really been a reflection of the credit, some of the credit deterioration really changed the methodology, we haven't really seen the evidence of a need to change the methodology and feel comfortable that we got really the reserves adequately covered and pretty conservative that now a little over $85 million in total reserves.
Thomas A. James
Yes, just adding color to that. Most of the questions from our auditor are still dealing with the fact that our reserves are too high.
So, our outside auditors should be chastened in their approach to what reserves are necessary in the banking industry, at the moment still are not convinced that we're not over reserves. So, you...
we'll find out, but Steve pointed out to you and I hope you got a feel of essentially the residential loans are nominal, way below industry averages in terms of... and we do have a lot of history with a lot of those loans over a period of time.
The A&D loans, [inaudible] to mark them down the instant that there is any question about any problems dealing with them and we do anticipate that a couple other of those loans will have some sort of loss exposure. But again they do have good assets, I mean it isn't like they don't have good assets.
So, it's not like we're going to have any fire sales in those areas. So, I'm...
I feel more than confident without any problems in the corporate sector that we have far more reserves than we need. If we have some problems in the corporate sector, I still think our methodology is appropriate based on experience in industry factors even in recessionary times.
So, I'm pretty confident that we're well reserved, we don't need to have any massive changes in our write-off strategy.
Jeffrey P. Julien
Bill, one other thing that happened this last quarter, we had our regulatory exam that was effective as of March 31st using those balances. And they went through a rigorous process, as you can imagine on credit quality, actually we're dealing 50 plus loans, including all of our watch and worse [ph] loans, and also really went through a validation on our loan loss reserve methodology, and really kind of confirmed that we were using...
they validated that our approach was accurate and somewhat conservative.
William Tanona
Okay, well that's hopeful color. And I guess just finally on the bank obviously saw a pretty big jump in consumer loans this quarter, looks like it increased about $77 million.
Just if you could provide some color as to was that one transaction or what was driving that big jump in the consumer corporate portfolio?
Jeffrey P. Julien
That was related to a couple of corporate loan transactions. One was a soft drink company and the other is a [inaudible] company that provides services to theme parks and sports facilities and catering business.
So once again, I know those two businesses don't necessarily seem that related to one another, but we are putting it in the consumer products category in our industry concentration disclosures.
William Tanona
Okay. Thank you.
Thomas A. James
Sure.
Operator
And speakers please go ahead with any closing remarks, no one else in queue at this time.
Thomas A. James
I want to thank all of you for spending so long with us this morning. I look forward to seeing you again next quarter and let's hope this market continues to have more favorable conditions.
Thank you very much.
Operator
Ladies and gentlemen, that does conclude the conference for today. Thank you for your participation and thank you for using AT&T Executive Teleconference Service.
You may now disconnect.