EUR 850.00 For Business Accounts Only

Morningstar | Tailwind of Higher Interest Rates for Raymond James Is Abating; Shares Fairly Valued

Raymond James reported multiple records in its fiscal second quarter ending in March, but like other investment-services firms, tailwinds are abating. The company reported net income to common shareholders of $261 million, or a record $1.81 per diluted share, on $1.86 billion of net revenue. Net revenue increased 3% from the previous year, and net income increased 7%. The increase in net revenue primarily came from net interest income, up 22% to $249 million, and investment banking, up 41% to $163 million, while the main detractor was brokerage revenue that fell 13% to $442 million. Somewhat surprisingly, brokerage in the company's struggling institutional trading business was flat, and the large decrease came from brokerage revenue in the wealth management business. Wealth management firms have been decreasing commission-based business over the previous several years (Raymond James' fee-based wealth management assets are now about 50% of total client assets compared with less than 40% in 2015) so part of the decline is due to business mix, while the rest of the decline is from lower market volatility. Overall, return on equity for the company was 16.7% in the quarter, so even if earnings growth is slow, the company is still generating healthy returns. We don't anticipate making a material change to our $100 fair value estimate for no-moat Raymond James and assess shares as being fairly valued.

A main driver of earnings at Raymond James and other investment-services firms over the previous years that is slowing is interest-rate-related revenue. While net interest income increased 22% from the previous year, it only increased 2.5% sequentially. Fee income from third-party banks increased 18% sequentially to $80 million, due to the December hike in the federal-funds rate, but it should be more flat going forward, since the Federal Reserve is likely done raising interest rates this year, maybe for the whole economic cycle.

Like other firms, Raymond James' management remains cautious on its interest-rate-related revenue. Domestic client cash sweep balances decreased to 5.5% of client assets in the quarter from 6.8% in the December quarter and 6.2% from a year ago. The wealth management business' client cash balance is the main driver of Raymond James' bank's net interest income and third-party bank fees. There's also been an increase in client cash in less profitable money market funds, 10% in the quarter compared with 5% a year ago, as clients move cash to the higher-yielding option. Raymond James' management, along with other management teams, is playing down the ability to grow net interest margins. Without further fed-fund rate increases or a steepening yield curve, Raymond James can only get net interest margin expansion from shifting to more loans from securities. Given that about 80% of the company's bank assets are already loans, it doesn't have as much potential to increase its net interest margin with this shift as other wealth management firms. In a flat interest-rate environment, deposit pricing could creep up that would then compress net interest margins.

For our recent analysis of deposit costs and net interest margins, please see our December 2018 Financial Services Observer, "The Return of the Bank: Net Interest Margins Reach a Turning Point."