Riding the Storm Out

Riding the Storm Out

Raymond James took a more

conservative path years ago when times were better and that has paid off.

finance by Dave Szymanski | Tampa Bay Editor

You won't find Tom James gloating - even though the financial market turmoil has meant the migration of some good advisers and their clients to his solid Raymond James Financial firm.

This month has seen the failure of Wall Street investment institutions, in stark contrast to his profitable St. Petersburg financial services firm.

Sure, James, chief executive officer and chairman of Raymond James, is proud of his company. He knows the conservatively-managed Raymond James is positioned to withstand economic and market challenges. But James calls the Merrill Lynch-Lehman Brothers developments a "tragedy for the industry."

Lehman Brothers Holdings, a Wall Street institution, filed for protection from creditors under Chapter 11 in U.S. Bankruptcy Court. Chapter 11 allows a company to reorganize its finances and remain in business.

Merrill Lynch is selling itself to Bank of America, a commercial and retail bank. Washington Mutual is selling the banking part of its business to J.P. Morgan. These are examples of what can happen when risk-management controls are not properly used, James says.

Because of its steady approach and disciplined management, Raymond James has used leverage sparingly in its growth strategy.

When it has been used, it applied conservative principles and rules. In addition, the firm has almost no direct exposure to the subprime business that affected the markets and many other financial organizations.

Amid the undertow of grim financial news from New York this month, there's three significant pieces of Raymond James history that may have been forgotten.

They explain why Raymond James is still standing, strong.

• One, although they are tweaked, the policies in place at Raymond James Bank, the subsidiary that loans money to consumers and businesses, were created when the bank was born 15 years ago. A decision was made prior to 1993 to not do subprime loans, the risky home loans that were securitized and got Lehman and other firms in trouble.

• Two, the decision by Raymond James to convert its bank from a thrift to a commercial bank, reported this month, has been planned for four years, far earlier than the recent tumult on Wall Street.

• Three, some of the funds from Raymond James' financial advisory business can be moved to Raymond James Bank, where the bank can make strong loans and reap interest income. The company is structured so one side of the business helps another.

So Raymond James Financial, the holding company, and Raymond James Bank, its subsidiary, are not being reactive. There was no smoke-filled war-room decision, or hurried conference calls with lawyers this year. These were policies.

Raymond James Bank is changing to a commercial bank not because it is being forced to or because it is in trouble. It is doing it so it can make more commercial loans and strengthen its future.

A thrift, which is what Raymond James Bank is now, has to do 60% of its business in residential loans, according to federal regulations. A commercial bank has no such restriction.

And before, during and after this transition, Raymond James will still buy and sell stocks and bonds through its private client business.

"The policies were written in a very conservative way," says Steve Raney, president and CEO of Raymond James Bank.

That's not to say Raymond James doesn't have problem loans. It does, Raney admits. But they were clearly the right policies.

"We're not trying to hit a home run here," Raney says. "We are very frugal with capital and lending practices."

In its move to a commercial bank, hopefully in 2009, Raymond James will join Goldman Sachs Group and Morgan Stanley.

But Raymond James says the conversion will have little impact on the way it does business.

Morgan Stanley and Goldman Sachs - the last two independent major U.S. investment banks - received approval recently to convert into bank holding companies.

"It's an unfortunate misperception that Goldman Sachs, Morgan Stanley and now Raymond James are fundamentally changing their business models," James says. "In fact, these changes are more form than substance in that regard."

Standing alone

Bob James, Tom's father, started the business in 1962. Last year, it celebrated its 45th anniversary, complete with an official Raymond James Financial Day declaration from the St. Petersburg mayor. The milestone made Raymond James one of the oldest still-operating major Tampa Bay area companies.

But usually, Raymond James remains low key. That's why people in the investment community find it worthy to note that of all the major brokerages in the country, Raymond James is one of the few, if not the only, that has not had to post any writedowns because of the subprime mortgage mess.

"Part of this is so complicated, these loans were meant to be turned into securities," Raney says. "The problem is if you dug into these loans, these were loans to people who couldn't afford the home."

What ultimately made Raymond James not follow the crowd at the time? A lot of study and an aversion to risk, the company says.

How did that decision turn out? During the beginning of the recent economic boom, in 2003, Raymond James earned $86.3 million on revenue of $1.4 billion.

Flash forward: In 2007, Raymond James' earnings were $250 million on revenue of $2.61 billion.

In comparison, in 2003 Morgan Stanley earned $3.7 billion on revenue of $34.9 billion. In 2007, net income at Morgan Stanley was $3.2 billion on revenue of $28 billion.

Net income for the second quarter at Morgan Stanley was $1.02 billion, a decrease of 60% percent from the second quarter of fiscal 2007. For the first six months of fiscal 2008, net income was $2.5 billion, a 51% percent decrease from a year ago.

At Lehman Brothers, for fiscal 2003, profit increased 74% to $1.69 billion while revenues rose 40% to a record $8.6 billion.

In 2007, Lehman earnings rose 5% to a record $4.2 billion, while revenues increased 10% to a record $19.3 billion.

However, for the second quarter ended May 31, Lehman posted a net loss of $2.8 billion compared to net income of $1.3 billion for the second quarter of fiscal 2007. For the first half of fiscal 2008, the firm reported a net loss of $2.3 billion, compared to net income of $2.4 billion for the first half of fiscal 2007.

For the first six months of fiscal 2008, Lehman reported net revenues of $2.8 billion, compared to $10.6 billion for the first half of fiscal 2007.

If you were a shareholder who invested in Raymond James stock at the start of the boom, in 2003, when the stock was $15.83 a share, the value of your stock would be $30.45 a share today, a 68% increase.

The same investment in Morgan Stanley would have been $48.38 a share in December 2003. Morgan Stanley stock recently closed at $24.75 a share this month.

At Lehman, company stock was worth $71.60 a share in May 2003. Lehman stock recently closed at 29 cents a share this month.

A conservative bank

Raney describes the strategy of Raymond James Bank this way: "It is extremely conservatively managed." But he adds that isn't the only conservative U.S. thrift.

"We weren't the only ones," he says. "We just like to make very strong loans to strong borrowers."

That means sacrifice. At times, it has given up higher net interest spread for better credit quality. There was more margin and profit to be made short term with the interest spread, but it passed that up.

Today, after what has happened on Wall Street, everyone has gotten religion. There are no more subprime loans, Raney says. No lenders are doing it.

Subprime is related to the credit profile of the borrower and how banks document the loan. Some used the term "no doc" loans, meaning there is no documentation of income required.

So lenders made single-family home loans to people with lower credit scores.

"There's been a lot of discussion about problem mortgage loans," Raney says. "We've been thankfully immune from that. We're not totally without credit problems, but we didn't have weak loans."

Tom James was chairman of Raymond James Bank until January 2007. After that, Jeff Julian, chief financial officer of Raymond James Financial, became chair. James remains chairman and CEO of the holding company.

Raney has been able to serve consumers and businesses, but it wanted to do more commercial loans and not be constrained to limiting itself to only 40% non-residential.

"We really have been able to manage through it," Raney says. "We also knew in 2009 we were going to convert. Goldman Sachs and Morgan Stanley are doing it for other reasons."

Business as usual

While Raymond James Bank transitions, other functions will continue. For example, people can still buy and sell stocks through Raymond James as always.

"None of our businesses in the bank are being changed at all," Raney says. "All the investment banking activity will continue to exist exactly like it has now. All we were doing is positioning the bank so it is not bound by this (commercial lending) limit. It is enhancing what we do."

Raymond James Financial is the St. Petersburg-based holding company for all of the activities under it. It is a diversified financial services firm.

Broken out, it has four businesses:

• Raymond James Bank, which makes up about 15% of revenues;

• The private client group, which is the brokerage and brings in about 60% of revenues;

• The capital markets business, which is investment banking and fixed income selling bonds and doing municipal finance, which makes up about 15% of revenue;

• The asset management business, which manages assets for the firm's clients and other firms' clients, on a fee basis, which makes up about 10%.

Raymond James Bank is rapidly growing and becoming a bigger revenue generator, Raney says. Part of that is because the company announced a plan to move client cash balances and capital from the parent company to the bank for lending.

The turmoil on Wall Street has worried Raymond James, but it has helped in one way: A number of quality financial advisors have left other firms and come to Raymond James, bringing their clients. Some of the client assets are in cash. Raymond James can use the cash for lending.

"Although it has been very tumultuous, it's been also good for us," Raney says. "We get more customers."

Of the company's $220 billion under management in the private client group, about $18 billion is available in cash.

REVIEW SUMMARY

Company: Raymond James Financial

Industry: Investment and commercial banking

Key: The diligent use of risk management controls, minimal use of leverage and the decision not to invest in lucrative but risky subprime loans.

BY THE NUMBERS

RAYMOND JAMES FINANCIAL

BALANCE SHEET

($ in thousands)

ASSETS 6/30/07 6/30/08 % change

Current assets:

Cash and cash equivalents 745,003 669,541 (10%)

Assets segregated by federal regulations 3,749,872 4,121,260 10%

Securities bought under agreements to resell 1,723,172 972,996 (43%)

Securities owned:

Trading securities, fair value 737,850 491,599 (33%)

Available for sale securities, fair value 527,585 619,166 17%

Other investments, fair value 85,160 88,694 4%

Receivables:

Brokerage clients, net 1,708,549 1,965,787 15%

Stock borrowed 1,382,233 1,166,913 (15%)

Bank loans, net 3,427,240 6,680,362 94%

Brokers-dealers, clearing organizations 449,175 141,609 (68%)

Other 299,103 339,150 13%

Investments in real estate partnerships 219,887 222,692 1%

Property and equipment, net 155,055 184,665 19%

Deferred income taxes, net 96,132 112,733 17%

Deposits with clearing organizations 31,350 75,746 141%

Goodwill 62,575 62,575 0%

Prepaid expenses and other assets 261,380 363,700 43%

Total current assets 15,671,201 18,279,188 17%

LIABILITIES & SHAREHOLDERS' EQUITY

Loans payable 552,104 312,904 (43%)

Loans payable related to investments by variable

interest entities in real estate partnerships 114,937 101,197 (12%)

Payables:

Brokerage clients 5,331,386 5,825,439 9%

Stock loaned 1,502,335 1,177,188 (22%)

Bank deposits 5,024,546 7,746,139 54%

Brokers, dealers, clearing organizations 228,101 197,299 (13%)

Trade and other 141,324 186,450 32%

Trading securities sold, not yet purchased 342,919 241,974 (29%)

Securities sold under agreement to repurchase 197,627 88,707 (55%)

Accrued compensation, commissions and benefits 304,538 311,515 2%

Income taxes payable 9,864 3,504 (64%)

Total liabilities 13,749,681 16,192,316 18%

STOCKHOLDERS' EQUITY

Common stock 1,173 1,197 2%

Retained earnings 1,409,498 1,603,478 14%

Shares exchangeable into common stock 3,504 3,504 0%

Additional paid-in capital 262,357 334,091 27%

Accumulated other comprehensive income 19,103 (8,695) (54%)

Total stockholder equity 15,671,201 18,279,188 17%

INCOME STATEMENT 6/30/07 6/30/08 % Change

Revenues:

Securities, commissions and fees 462,047 483,225 5%

Investment banking 51,818 36,236 (30%)

Investment advisory fees 51,754 51,492 (1%)

Interest 191,691 156,935 (18%)

Net trading profits 7,050 11,100 57%

Financial service fees 30,285 31,774 5%

Other 28,108 37,986 35%

Total revenues 822,753 808,748 (2%)

Interest expense 134,093 66,724 (50%)

Net revenues 688,660 742,024 8%

Non-interest expenses:

Compensation, commission and benefits 462,459 490,479 6%

Communications and information processing 28,828 30,899 7%

Occupancy and equipment costs 19,938 26,102 31%

Clearance and floor brokerage 8,180 7,969 (3%)

Business development 22,416 24,527 9%

Investment advisory fees 12,111 12,997 7%

Other 29,156 34,358 18%

Total non-interest expenses 583,133 627,331 8%

Minority interest (4,371) (425) 90%

Income before provision for income taxes 109,898 115,118 5%

Net income 68,353 69,938 2%

Net income per share-basic 0.59 0.60 2%

Net income per share-diluted 0.57 0.59 4%

Weighted avg. common shares outstanding-basic 116,135 115,633 (1%)

Weighted average common shares and

common equivalent shares outstanding-diluted 119,140 118,272 (1%)

Source: Yahoo Finance and Raymond James Financial

at a glance

Raymond James

Financial Inc.

Headquarters: St. Petersburg

Employees: About 4,000 employees in Florida - 3,400 in the Tampa Bay area - and 10,200 employees, affiliated independent contractors and professional partners worldwide.

Market capitalization: $3.65 billion

Stock symbol: RJF (NYSE)

Recent stock price: $30.45

52-week stock price range: $19.38 to $38.25

Price-earnings ratio (trailing 12 months): 14.59

Source: Raymond James Financial and Yahoo Finance