Stifel Financial Corp. — Q1 2013 Form 10-Q
Business context and reporting period
Stifel is a financial services and bank holding company spanning retail brokerage, securities trading, investment banking and advisory, and retail and commercial banking. This unaudited filing covers the three months ended March 31, 2013; comparable results are for Q1 2012. Balance-sheet comparisons are with December 31, 2012.
Key financial results
| Metric | Q1 2013 | Q1 2012 / prior year-end |
|---|---|---|
| Total revenue | $453.2 million | $409.3 million |
| Net revenue | $441.8 million | $400.3 million |
| Income before tax | $23.3 million | $59.3 million |
| Net income | $14.6 million | $34.8 million |
| Diluted EPS | $0.21 | $0.55 |
| Operating cash flow | $56.4 million | $(189.8) million |
| Cash and cash equivalents | $573.7 million | $403.9 million |
| Total assets | $8.13 billion | $6.97 billion |
| Shareholders’ equity | $1.90 billion | $1.49 billion |
- Net revenue grew 10.4%, while net income fell 58.0%. Net margin was 3.3%, versus 8.7%; pretax margin was 5.3%, versus 14.8%.
- Commissions increased 20.6% to $148.6 million; investment banking rose 11.3% to $78.4 million, led by advisory fees; asset management and service fees increased 13.3% to $68.9 million. Principal transactions declined 7.7% to $107.2 million.
- Non-interest expenses rose 22.7% to $418.4 million. Compensation and benefits increased 24.0% to $315.7 million; compensation equaled 71.5% of net revenue, versus 63.6% a year earlier. Excluding retention awards and merger-related expenses, management reported a ratio of 63.8%.
- Net interest income increased 13.2% to $18.4 million. Stifel Bank’s net interest margin declined to 1.91% from 2.25%, as average asset yields fell despite growth in interest-earning assets.
- Cash flow from investing was $(379.3) million, including the KBW acquisition and investment-security purchases; financing provided $493.7 million, principally from short-term borrowings and higher bank deposits. Cash increased $169.7 million during the quarter.
Material changes and acquisition
Stifel completed its acquisition of KBW, Inc. on February 15, 2013, adding a financial-services-focused investment bank. Consideration was approximately $601.9 million: $253.0 million cash, $262.7 million of common stock, and $86.2 million fair value of replacement restricted awards. Stifel issued 6.7 million common shares and 2.2 million restricted awards. The preliminary purchase accounting recorded $307.9 million of goodwill; allocation remained subject to finalization. Goodwill rose to $730.0 million from $419.4 million at year-end.
Management attributed the earnings decline in part to $30.6 million of noncash retention-stock expense and merger-related costs. Together, these and other identified nonrecurring items reduced net income by $25.3 million after tax, or $0.37 per diluted share. Q1 results also included Miller Buckfire, acquired in December 2012. Segment pretax income was $69.5 million for Global Wealth Management, $28.1 million for Institutional Group, and a $74.3 million loss for Other.
Debt, liquidity, risks and outlook
- At March 31, short-term bank borrowings were $569.8 million, up from $304.7 million at year-end; corporate debt was $380.9 million, including $325.0 million of senior notes and $55.9 million of non-recourse debt. Trust debentures were an additional $82.5 million. Bank deposits totaled $3.56 billion.
- Stifel reported $4.78 billion in cash and assets considered readily convertible to cash, while noting collateralized assets and funding needs. The $100 million revolving credit facility was fully drawn, at 2.7%, and the company reported compliance with its covenants; it expires in December 2013. The bank also had $554.2 million of unused Federal Home Loan Bank borrowing capacity.
- Stifel and Stifel Bank exceeded regulatory capital requirements. Stifel Nicolaus reported $320.5 million net capital, $308.3 million above its minimum. The filing reported the bank as well capitalized.
- Management identified sensitivity to financial-market activity, interest rates, credit and liquidity conditions, regulatory change, and legal and operational risks. Municipal underwriting conditions were described as challenging; equity and fixed-income market activity directly affects results. Management stated that liquidity resources were expected to meet present and anticipated needs, but gave no numerical earnings or revenue guidance.
- Legal matters include the SEC/Wisconsin school-district CDO litigation, bond-related litigation involving Saybrook and tribal parties, and a tribal lawsuit. Stifel reported a March 2013 adverse Canadian court decision awarding Stifel Nicolaus Canada approximately $16 million plus interest and costs; the subsidiary is appealing and said it believes reserves are adequate. Management cautioned that litigation outcomes could materially affect results in a future period.
- Other exposures include possible repurchases of up to $18.3 million par value of auction-rate securities over three years under customer settlements, and $196.0 million of bank loan-origination commitments. The filing also describes derivative counterparty and collateral provisions, short-sale exposure, and valuation uncertainty in Level 3 assets.
Management’s stated strategy is continued growth through recruiting financial advisors, expanding capital-markets capabilities, and pursuing selective acquisitions. These statements are not quantified financial guidance. Disclosure controls were reported effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- How much of the earnings decline is attributable to one-time acquisition and retention charges, and what recurring expense and profitability levels follow integration?
- Whether KBW integration delivers expected synergies, and how final purchase-price allocation affects goodwill and intangible assets.
- Trends in compensation as a share of revenue, advisory and capital-raising activity, principal-trading revenue, and the bank’s net interest margin.
- Funding and liquidity resilience, including reliance on brokerage-affiliated deposits, short-term secured borrowing, collateral availability, and the December 2013 credit-facility expiration.
- Developments and potential financial exposure in the disclosed litigation, particularly the appealed $16 million Canadian judgment and the CDO and bond cases.
- Credit quality, loan-loss allowance adequacy, Level 3 valuation assumptions, and potential ARS repurchase obligations.