Stifel Financial Corp. — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011; balance-sheet comparisons are with December 31, 2010. Stifel provides brokerage, securities trading, investment banking and advisory, and banking services. Results include Thomas Weisel Partners Group (TWPG), acquired July 1, 2010, so the year-over-year comparison is not fully like-for-like. Per-share data reflects the April 5, 2011 three-for-two stock split.
Financial results
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Total revenue | $372.9 million | $314.4 million | +18.6% |
| Net revenue | $366.6 million | $312.0 million | +17.5% |
| Income before tax | $50.7 million | $39.6 million | +28.1% |
| Net income | $31.4 million | $23.7 million | +32.3% |
| EPS, basic / diluted | $0.60 / $0.50 | $0.52 / $0.45 | — |
| Operating cash flow | $(252.2) million | $(79.4) million | Greater cash use |
| Investing cash flow | $(211.9) million | $6.4 million | — |
| Financing cash flow | $335.0 million | $56.9 million | — |
Net income was 8.6% of net revenue, compared with 7.6% a year earlier; non-interest expenses were 86.2% of net revenue, down from 87.3%. Compensation and benefits remained the largest expense at $231.2 million, or 63.1% of net revenue, versus 66.1% in Q1 2010.
Balance sheet, funding and liquidity
- Total assets were $4.54 billion, up from $4.21 billion at year-end; shareholders’ equity was $1.29 billion.
- Cash and cash equivalents fell to $124.9 million from $253.5 million. The quarter’s operating cash outflow reflected working-capital movements, including higher trading and other operating assets and lower accrued liabilities. Investing outflows included securities purchases and fixed-asset spending.
- Short-term bank borrowings rose to $299.7 million from $109.6 million. The quarter-end balance carried an average rate of 1.59% and was secured by company-owned securities valued at $343.8 million. The company also reported $30 million outstanding on a $50 million unsecured credit line and $82.5 million of trust debentures.
- Stifel Bank deposits totaled $1.63 billion, principally customer-related deposits. The bank had $136.1 million of unused Federal Home Loan Bank borrowing capacity. Management said it believed available liquid assets, operating funds and financing sources would meet anticipated needs, while noting that access to external financing depends on market and credit conditions.
- Stifel Nicolaus reported $200.6 million of net capital, $188.7 million above its minimum requirement. Stifel Financial and Stifel Bank were reported as well capitalized under applicable regulatory standards.
Material changes and management commentary
- Commissions increased 48.3% to $155.8 million, attributed to higher client assets and productivity. Asset management and service fees rose 40.3% to $57.7 million, reflecting market performance, account growth and TWPG. Investment banking revenue increased 21.0% to $41.4 million, mainly from stronger equity capital raising and the acquisition.
- Principal transactions declined 20.9% to $92.9 million, with management citing challenging fixed-income markets. Municipal underwriting and fixed-income institutional activity were weak; fixed-income capital raising fell 48.6%.
- Global Wealth Management pretax income rose 57.0% to $61.5 million. Institutional Group pretax income fell 22.1% to $21.4 million as expenses grew faster than revenue and activity in fixed-income, equity origination and advisory services was subdued.
- Management’s stated priorities were revenue growth, advisor recruiting, client relationships and product diversification. The filing gives no numerical earnings or revenue guidance and cautions that interim results do not necessarily indicate full-year results.
Risks, contingencies and unusual items
- ARS repurchases: Under a repurchase agreement with state securities authorities, Stifel estimated clients held $62.2 million par value of eligible auction-rate securities at quarter-end and estimated repurchases of $62.0 million par value in the final phase, due by December 31, 2011, assuming no issuer redemptions. Separately, TWP agreed to purchase up to approximately $50 million par value from certain customers under settlement agreements.
- Legal and regulatory matters: The SEC made a preliminary determination to recommend a civil or administrative enforcement action concerning Stifel’s role in CDO investments by five Wisconsin school districts. The company said this was not a formal allegation or evidence of wrongdoing and that it had responded. Related litigation seeks unspecified damages, including treble and punitive damages; Stifel said it intended to defend the claims. It also disclosed a FINRA proceeding involving approximately $15.7 million of ARS; the securities at issue were repurchased at par, while FINRA seeks fines and other relief.
- Investment valuation and credit: $158.1 million of assets measured at fair value were Level 3, involving significant unobservable inputs. The available-for-sale portfolio included $537.9 million fair value of securities below amortized cost. Stifel recorded a $0.4 million credit-related impairment on a held-to-maturity security.
- Other notable items: A valuation-allowance release related to unrealized capital gains helped reduce the effective tax rate to 38.1% from 40.0%. TWPG integration restructuring liabilities were $4.0 million at quarter-end. Management cited Dodd-Frank implementation and changing regulation as potential sources of higher costs and business-model changes.
- Interest-rate, market, credit, operational, legal and regulatory risks remain material. The company noted that litigation outcomes are uncertain and may materially affect results in a future period, even though it did not expect current matters to materially affect financial position based on information then available.
Important facts for investors to verify
- How much of revenue and earnings growth is attributable to TWPG, market movements and organic business growth, and how comparable the prior-period results are.
- Whether the cash decline and negative operating cash flow persist, and how working-capital needs, securities activity and financing affect liquidity.
- Progress and ultimate cost of the ARS repurchase commitments, including the separate TWP customer settlements and the impact of issuer redemptions.
- Developments in the SEC investigation, Wisconsin school-district litigation and FINRA proceeding, including any change to recorded reserves or potential exposure.
- Credit quality and valuation of Level 3 investments and impaired securities, and the effects of interest-rate changes on Stifel Bank’s net interest margin.
- Institutional Group profitability and expense trends, alongside continued advisor recruiting, transition-pay costs and TWPG integration.