Stifel Financial Corp. — First Quarter 2016 Form 10-Q
Business context and reporting period
Stifel provides wealth management, institutional brokerage and investment banking, and retail and commercial banking services in the United States and Europe. This unaudited report covers the three months ended March 31, 2016, compared with the three months ended March 31, 2015; balance-sheet comparisons are with December 31, 2015. Amounts below are in U.S. dollars.
Stifel completed its acquisition of global fund placement and advisory firm Eaton Partners on January 4, 2016, funded with cash and common stock. Growth and expenses also reflected the 2015 acquisitions of Barclays and Sterne Agee.
Financial performance and condition
| Metric | Q1 2016 | Q1 2015 or prior balance-sheet date | Change |
|---|---|---|---|
| Total revenue | $634.1 million | $574.0 million | Up 10.5% |
| Net revenue | $620.0 million | $561.0 million | Up 10.5% |
| Income before tax | $43.9 million | $70.1 million | Down 37.3% |
| Net income | $27.1 million | $43.1 million | Down 37.2% |
| Diluted earnings per share | $0.36 | $0.56 | Down |
| Total non-interest expenses | $576.1 million | $490.9 million | Up 17.3% |
| Cash and cash equivalents | $577.4 million | $811.0 million at Dec. 31, 2015 | Down $233.7 million |
| Total assets | $14.2 billion | $13.3 billion at Dec. 31, 2015 | Up 6.7% |
| Total liabilities / shareholders’ equity | $11.8 billion / $2.4 billion | $10.8 billion / $2.5 billion at Dec. 31, 2015 | — |
Net income as a share of net revenue fell to 4.4% from 7.7%; pretax margin fell to 7.1% from 12.5%. Compensation and benefits were $411.1 million, or 66.3% of net revenue, versus $355.7 million, or 63.4%. The effective tax rate was 38.4%, broadly in line with 38.5% a year earlier.
- Revenue mix: Commissions rose 9.8% to $197.9 million; principal transactions rose 20.7% to $120.9 million; asset management and service fees rose 26.9% to $144.5 million; and interest revenue rose 46.9% to $62.8 million. Investment banking declined 19.5% to $100.7 million, and other income fell 38.7% to $7.2 million.
- Interest and margins: Net interest income increased 63.8% to $48.7 million. Stifel Bank’s net interest margin was 2.47%, compared with 2.46% a year earlier. Bank deposits were $7.2 billion, up from $6.6 billion at year-end; bank loans, net, were $3.5 billion, up from $3.1 billion.
- Cash flow: Operating activities used $97.6 million, investing activities used $1.1 billion, and financing activities provided $931.8 million. Investing outflows principally reflected purchases of securities, bank-loan growth, and acquisitions. Financing inflows primarily reflected higher deposits and FHLB advances, partly offset by share repurchases.
- Funding and debt: Borrowings were $827.6 million, up from $237.1 million at year-end, including $500 million of FHLB advances. Senior notes had $750 million principal outstanding ($740.4 million carrying value); trust debentures were $82.5 million. Stifel also had a $100 million committed revolving facility, undrawn at quarter-end, and $980 million of uncommitted secured lines whose availability depends on bank approval and collateral.
- Liquidity and capital: Management reported $6.8 billion of cash and assets readily convertible to cash. It said the company had sufficient liquidity under its firm-wide stress tests; Stifel Bank’s cash and highly liquid investments were approximately 34% of its assets. Stifel and Stifel Bank were categorized as well capitalized. Stifel broker-dealer net capital was $288.4 million, $258.5 million above its minimum.
Material changes versus the prior comparable period
- Revenue growth did not translate into higher earnings: non-interest expenses increased faster than net revenue, with higher compensation, occupancy, communications, and other operating costs. Management attributed cost growth largely to expansion, acquisitions, and added infrastructure.
- Investment banking weakness was concentrated in capital raising: total capital-raising revenue declined 29.5%, including a 47.9% fall in equity capital raising. Advisory fees declined 4.2%. Fixed-income capital raising increased, but did not offset the equity decline.
- Segment pretax income declined in Global Wealth Management to $93.3 million from $98.8 million and in the Institutional Group to $29.2 million from $32.3 million. The Other segment’s pretax loss widened to $78.6 million from $61.1 million, including $26.5 million of acquisition-related non-interest expenses versus $8.0 million.
- Gross bank loans increased to $3.5 billion from $3.2 billion at year-end. Residential real estate loans rose to $730.7 million from $429.1 million. The allowance for loan losses rose to $34.1 million from $29.8 million; impaired loans were $23.0 million versus $1.1 million at year-end.
- Stifel repurchased 2.69 million shares for $91.4 million, at an average $33.98 per share. The Board authorized an additional 5 million shares in February; 8.2 million shares remained authorized at quarter-end.
Outlook, commentary, risks, contingencies, and unusual items
The filing provides no quantified earnings or revenue guidance. Management described a continued focus on revenue growth, recruiting experienced financial advisors, diversifying capital-markets products, and pursuing acquisition opportunities. It cautioned that results depend substantially on financial-market activity and economic conditions, including equity and fixed-income markets, investment banking demand, interest rates, and client assets under management.
- Management identified a challenging municipal underwriting market, including reduced state and local government borrowing and investor reluctance to take longer-dated or higher-risk municipal securities.
- Key risks include market and interest-rate movements, credit and counterparty risk, liquidity and funding availability, regulatory and legal exposure, and operational or control failures. A credit-rating downgrade could raise funding costs, restrict market access, or trigger contractual obligations.
- Stifel uses interest-rate swaps to hedge variable-rate exposures. The swaps had a $952.0 million notional value and a $12.2 million net liability at quarter-end; the filing estimates $5.4 million will be reclassified from accumulated other comprehensive loss to interest expense over the next 12 months. Certain agreements include collateral or default provisions.
- Stifel disclosed ongoing litigation, including an SEC case concerning CDO sales to five Wisconsin school districts, with trial scheduled for September 2016; litigation related to a $50 million Wisconsin bond offering; and the Broyles matter, with trial scheduled for November 2016. The company intends to defend the claims. Management said the ultimate resolution of pending matters was not expected to materially harm overall financial position or results based on currently available information, while acknowledging a matter could materially affect results in a future period.
- The loan-loss allowance depends on estimates and could prove insufficient if assumptions or economic conditions change. At March 31, 97.1% of the loan portfolio was collateralized; $2.0 million of loans were past due, and none were 90 days past due and still accruing.
- Goodwill and intangible-asset purchase-price allocations for Eaton Partners and certain prior acquisitions remained preliminary. Goodwill was $974.3 million at quarter-end, with no impairment recorded in the period.
- Stifel recorded $30.0 million of gross unrealized losses on its investment securities and reported no credit-related other-than-temporary impairment in the quarter. Management attributed the losses to credit spreads and market interest rates and did not expect credit losses based on its assessment.
Important facts for investors to verify
- Whether investment banking, particularly equity capital raising, recovers and whether revenue growth improves earnings as expenses and compensation rise.
- How Eaton Partners and prior acquisitions contribute to recurring revenue, integration costs, goodwill, and future amortization.
- Whether growth in residential real estate and commercial lending, impaired loans, and the allowance for loan losses indicate any deterioration in credit quality.
- The stability and concentration of bank deposits—especially brokerage-affiliated deposits—and the cost and availability of FHLB and other secured funding.
- Developments in the disclosed legal matters, including trial outcomes, reserves, and potential exposure beyond amounts accrued.
- The effects of share repurchases, stock-based compensation, and outstanding unvested awards on cash use and per-share results.