Extradordinary & Obscure

Extradordinary & Obscure

Despite a regulatory jungle, Theresa Schefstad took a strange animal - a thrift owned by a securities brokerage - and tamed it. Raymond James Bank now wants more commercial loans.

By Francis X. Gilpin

Associate Editor

Raymond James Financial Inc. has a bank. A savings bank, to be precise. This may come as a surprise to some. After all, Raymond James Bank has just one branch. It's down the street from the Raymond James headquarters in St. Petersburg's Carillon office park.

But Raymond James Chairman Thomas A. James knows he has a savings bank. If for no other reason than Raymond James Bank contributed 7% of the holding company's pretax income for the latest quarter.

Overshadowed by bigger and better-known corporate siblings in fields such as securities research and investment banking, Raymond James Bank may have the most interesting story of all the subsidiaries.

The savings bank was born of a decade of frustration for the holding company. When Raymond James went public in 1983, the company intended to use some of the proceeds to buy a commercial bank. But it couldn't. Regulators wouldn't allow it.

Not until 1994, when Raymond James hired a refugee from the late Tampa Bay Buccaneers owner Hugh F. Culverhouse's former bank, did Tom James finally get his bank. A woman named Theresa J. Schefstad, familiar with the conflicted cultures of banking and securities work, made it happen.

Raymond James Bank turned a profit in its first year - and would have even without the large initial capitalization that regulators required of its parent. Schefstad is still president and chief executive.

The savings bank was the first in America to be entirely owned by a brokerage. That novelty and others have worn off, though, as Congress felled the last of the Depression-era barriers to bankers selling stocks in 1999.

Today, Raymond James Bank both benefits from and suffers for being the federally insured resting spot for the retirement savings of tens of thousands of Raymond James clients.

How it started

Raymond James executives thought they had found their opening into retail banking in 1991 when they entered into an agreement to acquire a Pinellas County thrift. But regulatory inertia snuffed out the deal.

Theresa Schefstad arrived two years later. Schefstad came from Coast Bank, a troubled savings and loan in Sarasota that Culverhouse recast into a successful commercial bank before selling it to SunTrust Banks Inc. in 1992.

Schefstad, who had been executive vice president in charge of Coast's consumer, commercial, marketing and retail divisions, decided to find another place to build on her 17 years of banking experience. She had started at the bottom, while still in high school, as a check-filer for the old Southeast Bank in her hometown of Orlando.

"I've always tried to be a different banker," says Schefstad. "Avoid the herd mentality."

She looked like a good fit for Raymond James, vying to be the first financial services firm to own a thrift. Along with her banking background, Schefstad had become licensed to broker securities and mortgages, as well as become a certified financial planner, in the early 1980s. She thought repeal of the Glass-Steagall Act, the congressional ban on banks selling securities, was imminent. "I was 20 years too early," says Schefstad, with a laugh.

"The opportunity for me was, if I obtained the charter, I got my own shop. So that's how I came to Raymond James. I'm the traditional banker but educated in the investment division of the bank."

Upon moving up to St. Petersburg, Schefstad changed her new employer's approach. A Raymond James bank needed to be able to serve customers in all 50 states - at that time, more via telephone than the Internet. She decided to go after a federal charter, instead of a state one.

She had the perfect vehicle. The Resolution Trust Corp. was trying to get what it could for taxpayers by auctioning off the salvageable assets of failed Sun Belt thrifts. "By working with the RTC, as a federal institution, it provided some state pre-emptions that we could not obtain if we had filed a state charter," she says.

That was important because Raymond James has an insurance subsidiary. Some states bar companies from operating banking and insurance units under the same corporate umbrella.

But Raymond James was otherwise free to jump into consumer lending, even then. "Glass-Steagall never pertained to thrifts. An investment bank could own a thrift. They couldn't own a bank," says Schefstad. "So we never needed the repeal of Glass-Steagall to have an institution, if we were willing to take a thrift charter."

Two down, one to go

Raymond James had to get the blessing of three government agencies - the RTC, the Office of Thrift Supervision and the Federal Deposit Insurance Corp.

"The challenge, actually, was the FDIC," recalls Schefstad. "Their concern was: Who's this investment company that's going to take insured deposits and be aggressive with them?"

The veteran banker had to convince the FDIC that a financial services outfit could prudently manage a thrift. "The stereotype was that investment companies were not conservative," she says.

Early in the RTC process, Schefstad was outbid by out-of-state banks that considered the thrift liquidator's prices to be the cheapest admission to the lucrative Florida market. Schefstad teamed up with other financial institutions. Their combined bids were still too low. "My next strategy was, I'm going to find one that no institution wants," says Schefstad.

Raymond James bid for an insolvent Jacksonville thrift. But the FDIC was again slow to sign off. With the RTC's deadline approaching, Schefstad got her board to approve a simultaneous bid with a partner bank for a second thrift. The runner-up in the Jacksonville bidding agreed to take the first set of assets if Raymond James won the second bid.

And win it did. Raymond James paid $462,000 for $13.8 million in deposits and three branch offices of the failed Security Federal Savings Association. Schefstad went to work on the FDIC: "I told them we weren't going away. 'So we need to find a way to make this work.' "

The FDIC drove a hard bargain. The deposit-insurer required Raymond James to capitalize the new thrift with $25 million. Typically, an RTC bidder would have had to put in $2 million for such a deposit base.

"We wanted the charter and they set the terms," says Schefstad, who understood the FDIC only wished to protect the taxpayer-backed insurance fund.

How to make money?

Schefstad had to figure out how a thrift could recoup such a big investment. "Obviously, our own business strategy had to quickly change," she says.

First, though, there were a few problems to fix.

The goal all along was for the cash balances in certain types of Raymond James brokerage accounts to be swept into federally insured Raymond James Bank accounts. But Raymond James Bank needed the expressed approval of each and every one of the brokerage clients before accepting their "sweep" funds.

That was a yearlong logistical nightmare. The new thrift's small staff was initially relegated to an old Security Federal branch in Spring Hill, 50 miles north of the Raymond James nerve center.

Schefstad had started in operations at Southeast, before moving up to branch management and then private and corporate banking. Her experience came in handy in 1994 and 1995 as she supervised the merger of functions at Raymond James. Computer experts wrote custom programs so brokerage accounts could interface with savings accounts.

"This was different than just a banking organization, where you have a board of directors that can give you business referrals, and you have a group of lenders and then you go out and buy a canned processing system, and you start your bank and hire your operations," says Schefstad.

Broker-dealers and bankers didn't always understand each other. "Some of it was just the terminology that you have," she says. "They say dividends. We say interest. They say assets. We say liabilities. And there are issues that are more complex than that."

The eventual computing package allows the more than 4,800 brokers - financial adviser is the preferred term at Raymond James - to call up activity data for both accounts of their clients, who receive combined monthly statements. Raymond James preceded Merrill Lynch & Co. Inc. by two years in being the first to provide this client service.

The U.S. Department of Labor posed another obstacle to profitability. The department enforces the Employee Retirement Income Security Act, which precludes those handling tax-advantaged retirement savings from charging more than one fee. The investment advisers were there first, so they got the fee income.

At the end of fiscal 2002, Raymond James Bank had $920 million in assets. About 86% of those assets were cash balances from ERISA and IRA accounts, managed by investment subsidiaries Raymond James & Associates Inc. or Eagle Asset Management Inc., which had been swept into accounts at the savings bank.

Raymond James Bank is left with only one way to profit from the sweep accounts - manage the tricky interest spread on the investment of those surplus retirement savings.

The conversion

Raymond James Bank grew rapidly, thanks to the inflow from brokerage clients. The savings bank had $100 million in assets by the end of the first year.

After introducing regular checking and certificates of deposit, the bank began writing first mortgages because it was the easiest product, regulation-wise, to roll out nationally. Raymond James Bank did it with a staff of eight. Second mortgages were a little dicier, but for not the usual reason. On a national scale, lenders must be careful in states such as Texas, which allow second mortgages only for home improvements and not equity lines of credit.

These products were first marketed through the bank, then by the financial advisers and finally region-by-region throughout the country, starting with the Southeast. "We are a very conservative institution," says Schefstad.

Next, Raymond James Bank started doing commercial loans. The savings bank now offers commercial loans in all 50 states. The minimum is $3 million. Raymond James Bank often teams with a local bank more familiar with the area where the borrower is working.

In hindsight, however, Schefstad thinks Raymond James Bank could have shifted assets into bigger moneymakers faster.

With ERISA accounts, Raymond James Bank prices products to the benefit of the depositor. Those deposit rates are revised weekly. Meanwhile, on the asset side of the balance sheet, loan rates are more static.

"It's difficult to find loans that you can find weekly re-pricing," says Schefstad. "So, as we've grown today, what we try to do is shift from cash to investments to residential purchases to commercial lending. Each of those has higher yield, each with higher risks, obviously. The conversion of the balance sheet, if we could have had that taken place even two years ahead of our cycle of where we are, I believe our numbers would have met our strategic objectives sooner.

"It's a challenge for management," says Schefstad. "We're very challenged keeping that interest-rate risk balanced."

Raymond James Bank purchases collateralized mortgage obligations. But CMO packages currently have an average life of two years. The savings bank looks for pools of securities backed by mortgages with rates that are typically fixed for no more than three to five years.

"We attempt to find adjustable portfolios to better match our shorter-term deposits, such as five-one and three-one adjustable mortgages," says Schefstad.

Swap meet

Not all thrifts still act like a thrift, Schefstad contends. "When you look at a thrift, you really have to understand its numbers," she says. "There are some plain vanilla thrifts out there still doing mortgage lending. And you have some others. I call ourselves a hybrid thrift, for a lot of reasons. We're about a billion (dollars in assets). Somebody would say that's a community-sized bank. But we're sitting here buying $10 million syndicate pieces or $50 million home-loan pools or working with our investment bankers."

And there are interest-rate swaps, more associated with commercial banks. Schefstad's thrift uses them to manage its exposure to fluctuations in the variable rates it must pay for the retirement-account funding. The swaps allow the bank to get variable interest-rate income while making fixed interest-rate payments, creating the equivalent of fixed-rate funding.

In 2002, when interest rates dropped, Schefstad says the swaps ended up burning the savings bank. Interest and revenue expense dropped by 38%. But so did revenue by 36%, although pre-tax income increased after a 2001 decline.

"Now we had no choice but to engage in swaps because the upside risk was worse," says Schefstad, who notes that regulators closely watch equity ratios in hybrid thrifts like hers. "You sit here and say, our earnings in '02 could have been fabulous. It could have been great because of the interest rate drop, if we hadn't swapped."

Had rates gone the other way, however, she says the damage to the thrift's capital position would have been intolerable. "When we go to buy these packages, you have to be careful not necessarily to forecast the market," says Schefstad. "You give up some profitability to avoid the risk."

Raymond James Financial Chairman Tom James, who also chairs the bank board, understands. "He expects a certain return from the investment (that) the holding company (makes) in the brokerage side of the business and the bank, a lesser return, because our bank is going to take lesser risk."

Her executive team, which includes another veteran Florida banker in Chief Credit Officer William C. Beiler, is not sure who their institutional peers are. "It's very much a challenge who to compare yourself with," says Schefstad.

Nevertheless, Raymond James Bank's return-on-equity was 8.35% for 2002, compared to an average of 7.32% for 19 other OTS-regulated institutions in the Southeast with a minimum of $750 million in assets.

This fiscal year, as rates dipped for a while and mortgage refinances kept surging until recently, Raymond James Bank has not had to do as much hedging. "Because we have had huge pre-payments, we have not had to do any more swaps," says Schefstad. "We have a remaining swap balance because these other loans have paid off so quickly." The bank was party to $90 million in swap deals, as of June 27.

Raymond James Bank has saved on the cost of swap brokers. And the savings bank originated more residential and commercial mortgages, while purchasing more home loans, in the first six months of this fiscal year than in all 12 months of fiscal 2002.

It appears the refinancing craze will bring mixed blessings to Raymond James Bank for the fiscal year ending this month. Through the first nine months, revenues were down almost 6%. That includes a $282,000 decline for the third quarter, which the holding company in a recent regulatory filing blamed entirely on lower rates. But pre-tax income moved up, as the bank better managed the interest rate spread with its expanding loan portfolio.

Raymond James Bank gets a C+ on Weiss Ratings Inc.'s A-to-E scale. The Palm Beach Gardens research firm considers that an average or fair score.

Weiss bank analyst David Proko says Raymond James Bank's loan quality appears good. Since its portfolio is expanding, that means underwriting standards must be solid.

Proko says Raymond James Bank's return-on-assets could be higher. But at least this indicator of the thrift's ability to profit from its lending and investing activities has been consistent.

"Raymond James Bank is what you see lots of times when an investment company buys a bank," says Proko. "There's already a strong philosophy in place and the bank is just a tool to facilitate that."

What the future holds

Since the rugged birth of Raymond James Bank, regulators have gotten slightly less discomforted by unconventional approaches. A few financial institutions, including NetBank, do business entirely in cyberspace. But Schefstad says hers will continue to maintain at least one physical address, though probably not more.

"When we're presented with opportunities for branch networking, we do look at them," she says, "sometimes more in-depth than others, sometimes presenting them to the board to challenge our strategy of what our niche is." The board has yet to bite.

Besides, opening more branches would make Raymond James Bank less attractive to other banks looking to fill out profitable syndication deals. "We've been very successful partnershiping with other institutions because we don't have a brick-and-mortar on every corner," says Schefstad. "We're not in competition with them in obtaining that business."

Doing more commercial business is definitely on the radar screen of Schefstad, who is pushing Raymond James Bank toward $2 billion in assets. That could entail a new rapprochement with regulators.

"Our limitation is the thrift industry, again going back to its core purpose of lending for mortgage financing for housing," says Schefstad. "There are commercial loan limits for thrifts that we cannot exceed. So, if we are going to continue to seek commercial corporate business, we have to monitor the regulatory limitations as a thrift and determine if there are other alternative charters that are more appropriate for our strategy."

THERESA J. SCHEFSTAD

Title: President, chief executive officer and director, Raymond James Bank.

Age: 45.

Hometown: Clearwater.

Personal: Single.

Education: B.S., finance (minor in computer science), 1980, University of Central Florida; completed Advanced Banking Program, 1988, Darden Graduate School of Business, University of Virginia

Favorite book: "I can't sit long enough to read a book."

Country & western song that describes her life: "I'm In A Hurry (And I Don't Know Why)," by Alabama. The confessed workaholic says: "It's just the way I am. People tell me, slow down and smell the roses, and I want to plant the bush."

Selling the Bank

Raymond James Bank owes much of its growth to the mutually beneficial relationship it has established with financial advisers working elsewhere in the Raymond James empire.

"The bank's philosophy is we view the financial advisers as our clients," says CEO Theresa J. Schefstad. "They choose whether to sell our products to their clients."

The thrift makes a lifestyle pitch to the internal clients, the FAs. Raymond James Bank customers generally need a bank before they need investment advice. When thrift customers are ready, however, Raymond James Bank won't forget the FAs. "We can introduce them to new clients," she says.

In turn, Raymond James Bank can help protect against investment customer defections. "We are here to keep their clients out of traditional banks, where they'll be cross-sold brokerage products," says Schefstad.

As for their own cross-selling, the FAs don't worry so much anymore about Raymond James Bank turning down one of their clients for a loan, according to Schefstad. The thrift does its best to steer rejected brokerage customers to another loan product they can afford, she says.

Raymond James Bank FSB at a glance 1997 2002

Total assets $372,373,000 $868,505,000

Net loans and leases $23,392,000$497,556,000

Total liabilities $344,380,000$804,664,000

Total deposits$335,755,000$735,529,000

Net income$1,049,000 $5,136,000

Return on equity3.89%8.35%

Return on assets0.33%0.59%

Efficiency ratio62.31%42.33%

Net interest margin1.52%1.73%

Source: FDIC