Stifel Financial Corp. — Q1 2014 Form 10-Q
Business context and period. Stifel is a financial services and bank holding company, with wealth management, institutional brokerage and investment banking, and banking operations. This unaudited report covers the three months ended March 31, 2014; comparisons are with Q1 2013 unless otherwise noted. Stifel Canada’s discontinued operations are reported separately.
Financial performance and position
Amounts below are in millions of dollars except per-share data and percentages.
| Metric | Q1 2014 | Q1 2013 / prior date | Change |
|---|---|---|---|
| Total revenues | $555.4 | $449.2 | +23.6% |
| Net revenues | $546.7 | $438.6 | +24.7% |
| Income before tax, continuing operations | $78.1 | $23.7 | +230.2% |
| Income from continuing operations | $48.0 | $14.9 | +221.2% |
| Net income, including discontinued operations | $47.4 | $14.6 | +224.1% |
| Diluted EPS | $0.63 | $0.21 | Up $0.42 |
| Operating cash flow | $(338.3) | $56.4 | Changed to use |
- Revenue drivers: Investment banking rose 72.0% to $132.3 million, asset management and service fees rose 29.4% to $89.2 million, principal transactions rose 17.9% to $126.5 million, and commissions rose 9.3% to $159.4 million. Net interest income increased 77.8% to $34.2 million. Other income fell 74.5% to $5.2 million.
- Profitability and costs: Pretax continuing-operations margin was 14.3% of net revenues, versus 5.4%; net income margin was 8.7%, versus 3.3%. Non-interest expense increased 12.9% to $468.6 million, slower than net revenue growth. Compensation and benefits were $346.8 million, or 63.4% of net revenues, compared with 71.8% a year earlier.
- Segments: Global Wealth Management net revenues were $297.2 million (+11.3%) and pretax income was $79.7 million (+14.6%). Institutional Group net revenues were $250.0 million (+44.2%) and pretax income was $45.6 million (+61.6%). Other reported a pretax loss of $47.2 million, improved from a $74.1 million loss.
- Balance sheet at March 31: Total assets were $9.388 billion, up from $9.009 billion at year-end 2013; shareholders’ equity was $2.100 billion, up from $2.059 billion. Cash and cash equivalents were $525.4 million, down from $716.6 million. Stifel reported $5.585 billion of cash and assets considered readily convertible to cash.
- Funding and debt: Short-term bank borrowings were $414.9 million, compared with $55.7 million at year-end, and were secured by company-owned securities. Senior notes totaled $325.0 million and trust debentures $82.5 million. Bank deposits were $4.605 billion, down from $4.663 billion. The company had no advances on its $100 million committed revolving facility and reported covenant compliance; the facility expires in December 2014.
- Cash flow: Investing activities used $146.3 million, mainly reflecting securities purchases and bank loan growth; financing activities provided $293.1 million, primarily from short-term borrowings. Cash decreased $191.2 million during the quarter. The filing attributes operating cash use mainly to movements in operating assets and liabilities.
- Banking and capital indicators: Stifel Bank loans, net of allowance, were $1.498 billion. The allowance for loan losses was $14.1 million; non-accrual loans were $1.3 million, and 96.9% of the loan portfolio was collateralized. Stifel Nicolaus reported net capital of $345.7 million, $332.7 million above its minimum; Stifel Financial and Stifel Bank exceeded the stated “well capitalized” thresholds.
Material changes, outlook, and risks
- Management attributed growth to improved M&A and capital-raising activity, increased assets in fee-based accounts, higher institutional trading volumes, and growth in Stifel Bank’s interest-earning assets. Fee-based account assets reached $28.433 billion, up 34.7% from March 2013; management attributed 33.8% of the increase to net inflows and 66.2% to market appreciation.
- Management identified $4.1 million of after-tax non-recurring and merger-related expenses in Q1 2014, reducing continuing-operations income by about $0.06 per diluted share. Q1 2013 included a $30.6 million pretax non-cash charge for KBW-related retention stock awards. The 2013 comparison also benefited from a Knight Capital investment gain, contributing to the year-over-year decline in other income.
- After quarter-end, Stifel completed its acquisition of De La Rosa & Co. on April 3, 2014, and on May 8 entered an agreement to acquire London-based Oriel Securities. The filing describes strategic aims but provides no earnings or financial guidance.
- Management noted sensitivity to market activity, securities prices, trading volumes, interest rates, investment banking demand, and client assets. It also cited municipal underwriting challenges, regulatory change including Dodd-Frank, funding-market access, credit and operational risks, and the possibility that legal matters could materially affect results in a future period.
- Significant legal matters include SEC and school-district litigation involving Wisconsin CDO transactions, disputes relating to a $50 million tribal bond offering, and a separate tribal-court matter. The company says it intends to defend the claims; outcomes and potential losses are uncertain. It also estimated that certain customers may tender $18.3 million par value of auction-rate securities for repurchase over two years, assuming no issuer redemptions.
- The company reported no credit-related other-than-temporary impairment on securities in Q1. Level 3 fair-value assets were $224.5 million; valuations rely in part on unobservable inputs and management estimates. Interest-rate derivatives had an $8.3 million net liability termination value, with $24.0 million of cash collateral posted.
Important facts for investors to verify
- Whether investment banking, trading, and fee-based asset growth can be sustained, and how much depended on market appreciation or unusually strong transaction activity.
- The quality and liquidity of securities and investments, including Level 3 assets, auction-rate securities, and securities pledged as collateral; verify valuation assumptions and redemption experience.
- The causes and likely persistence of negative operating cash flow, the sharp increase in period-end short-term borrowing, and the availability and terms of secured and committed funding.
- The economics, integration costs, and funding implications of the De La Rosa acquisition and proposed Oriel acquisition, as well as the timing and amount of advisor transition-pay amortization.
- Developments in the disclosed litigation and customer ARS repurchase commitments, including whether estimated reserves or exposures change.
- Future loan growth, credit quality, allowance adequacy, and regulatory capital and liquidity at both the parent and bank subsidiaries.