Stifel Financial Corp. — Q2 2012 Form 10-Q
Business context and reporting period. Unaudited results cover the three and six months ended June 30, 2012; balance-sheet comparisons are with December 31, 2011. Stifel provides wealth management, institutional brokerage and investment banking, and retail and commercial banking. Unless otherwise noted, financial amounts below are in millions of dollars.
Financial results and position
- Q2 revenue and earnings: Net revenues were $374.4 million, up 4.3% from $358.9 million. Net income was $26.1 million versus $3.4 million; diluted EPS was $0.42 versus $0.05. Pretax margin was 11.7% of net revenues and net margin was 7.0%.
- First half: Net revenues were $774.7 million, up 6.8%; net income was $60.9 million, up 75.0%. Diluted EPS was $0.97 versus $0.55. Pretax margin was 13.3% and net margin 7.9%.
- Revenue mix: Q2 commissions fell 7.9% to $127.4 million; principal transactions rose 14.8% to $91.6 million; investment banking rose 4.6% to $67.4 million; and asset-management and service fees rose 14.6% to $65.3 million. Net interest income increased 16.7% to $17.3 million.
- Costs: Q2 non-interest expenses declined 6.9% to $330.5 million, largely reflecting lower other operating expenses. Compensation was $239.4 million, or 63.9% of net revenues. For the first half, non-interest expenses were nearly flat at $671.6 million; compensation was $494.1 million.
- Cash flow: First-half operating activities used $302.8 million and investing activities used $494.3 million; financing activities provided $1.071 billion. Cash and cash equivalents increased $274.0 million to $441.7 million. Financing inflows primarily reflected higher bank deposits and the senior-note issuance; investing outflows included purchases of available-for-sale and held-to-maturity securities.
- Balance sheet and liquidity: Total assets were $6.139 billion, up 24.0% from year-end; shareholders’ equity was $1.372 billion. Bank deposits grew to $2.777 billion from $2.072 billion, and bank loans, net, rose to $708.9 million. Short-term bank borrowings were $282.0 million. The company reported $175.0 million of senior notes and $82.5 million of trust debentures.
- Capital: Stifel Nicolaus reported $342.4 million of net capital, $329.5 million above its minimum. Stifel Financial and Stifel Bank met the disclosed “well capitalized” thresholds.
Material changes versus the prior period
- First-half revenue gains came from principal transactions (+20.4%), investment banking (+30.2%), asset-management and service fees (+10.0%), and interest revenue; commissions declined 14.7%.
- Management attributed growth to stronger fixed-income trading volumes and tighter credit spreads, public-finance activity, increased M&A advisory revenue, growth in fee-based assets, and expansion at Stifel Bank. Stone & Youngberg, acquired in October 2011, contributed to institutional and public-finance growth.
- The much higher year-over-year earnings also reflect comparison with 2011, which included estimated Wisconsin school-district settlement and litigation costs and merger-related expenses. Management said that excluding those items, other operating expenses increased 11.0% in Q2 and 5.3% for the first half.
- Global Wealth Management Q2 pretax income increased 10.7% to $61.4 million; Institutional Group Q2 pretax income decreased 20.1% to $17.5 million despite slightly higher net revenue, as expenses grew faster. For the first half, Institutional Group pretax income declined 4.8% to $41.3 million.
- In January 2012, the company issued $175 million of 6.70% senior notes due 2022. At June 30, the $50 million committed revolving credit facility was undrawn and expires in December 2012.
Outlook, commentary, risks and unusual items
- Outlook: No numerical earnings or revenue guidance is provided. Management said it plans to pursue revenue growth, recruit experienced financial advisors, diversify capital-markets products, and consider opportunities arising from consolidation among middle-market firms.
- Market and regulatory risks: Management cited European sovereign-debt concerns, unemployment, weaker U.S. economic data, subdued IPO activity, and uncertainty over the U.S. budget as factors weighing on investor and CEO confidence. Results remain sensitive to financial-market activity, trading volumes, interest rates, credit spreads, client assets, and investment-banking demand. Dodd-Frank implementation may increase compliance costs and affect business practices and competition.
- Legal matters: The SEC’s Wisconsin CDO lawsuit remained pending, with a motion to dismiss undecided. Stifel settled the school districts’ related civil suit in March 2012, paying $13.0 million and providing a $9.5 million standby letter of credit subject to conditions; the filing also describes additional potential damages and claims by RBC. A separate $50 million bond-offering dispute was stayed pending a federal jurisdiction decision. The company warned that resolution of litigation could materially affect results in a future period, though it did not expect the matters, based on information then available, to materially harm its overall financial position and results.
- Other commitments and contingencies: TWP estimated customer ARS repurchases of $25.1 million par value over four years, including an estimated $6.2 million in December 2012, assuming no issuer redemptions. Stifel Bank had $330.3 million of loan-origination commitments and $477.0 million of unused credit lines. The company reported $175.3 million of ARS; Level 3 assets totaled $256.2 million and require significant valuation judgment.
- Subsequent event: On August 6, 2012, after quarter-end, Stifel agreed to invest $30 million in Knight Capital preferred stock as part of a $400 million private placement.
- Tax and interest-rate items: The effective tax rate was 40.4% for Q2 and 40.9% for the first half, compared with 11.8% and 36.2% in 2011; 2011 rates benefited from a valuation-allowance release. The filing estimates $9.8 million of hedge-related losses will be reclassified to interest expense over the next 12 months.
Investor verification points
- Reconcile the MD&A statement that cash and cash equivalents available to meet obligations were $421.9 million with the balance sheet and cash-flow statement amounts of $441.7 million.
- Assess how much of the earnings improvement reflects recurring business performance versus the 2011 settlement, litigation, and merger-cost comparison.
- Monitor the Wisconsin SEC and related litigation, the bond-offering claims, and potential exposure beyond recorded reserves or the school-district settlement.
- Review deposit concentration and funding liquidity: deposits include approximately $2.7 billion of Stifel Nicolaus brokerage-customer funds, while some uncommitted credit lines require bank approval for each advance.
- Evaluate credit, valuation, and liquidity exposure in the bank loan and securities portfolios, including Level 3 assets, ARS, and mortgage-loan commitments and repurchase representations.
- Track the senior-note interest burden, the December 2012 revolving-facility renewal, and the use and terms of the Knight Capital investment.