STIFEL FINANCIAL CORP annual report, FY2012

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Stifel Financial Corp. — FY 2012 Form 10-K

Reporting period: Fiscal year ended December 31, 2012. The filing also provides unaudited fourth-quarter results. Amounts below are in U.S. dollars; financial figures are generally in millions unless stated otherwise.

Business context

Stifel is a diversified financial services and bank holding company operating through Global Wealth Management, Institutional Group, and Other. Its businesses include private-client brokerage and advice, institutional sales and trading, research, investment banking, and retail and commercial banking. At year-end it reported 5,343 associates, including 2,041 financial advisors, and approximately 1.3 million client accounts.

Financial performance and position

  • Revenue and profit: FY 2012 total revenues were $1.646 billion, up 14.2%; net revenues were $1.613 billion, up 13.8%. Net income rose 64.7% to $138.6 million. Diluted EPS was $2.20, compared with $1.33 in 2011. Reported pre-tax and net income margins were approximately 14.0% and 8.6% of net revenues, respectively.
  • Fourth quarter: Total revenues were $426.4 million and net revenues were $417.8 million; net income was $40.0 million and diluted EPS was $0.63. In Q4 2011, the comparable figures were $363.3 million, $356.9 million, $27.0 million, and $0.43.
  • Revenue mix: Investment banking increased 43.6% to $286.6 million; principal transactions rose 19.0% to $408.5 million; asset management and service fees grew 12.7% to $258.0 million; and net interest income increased 19.1% to $76.4 million. Commissions fell 8.6% to $513.0 million. Other income rose to $70.2 million, including $39.0 million of realized and unrealized gains on the Knight Capital investment.
  • Expenses and margins: Non-interest expenses rose 8.5% to $1.387 billion. Compensation and benefits increased 13.7% to $1.024 billion and equaled 63.5% of net revenues, versus 63.6% in 2011. Other operating expenses declined 21.0% to $120.8 million, mainly because 2011 included approximately $45.5 million of Wisconsin litigation-related expense.
  • Cash flow: Cash and cash equivalents increased $236.3 million to $403.9 million. Operating activities used $264.3 million; investing activities used $1.226 billion, largely reflecting bank securities purchases, acquisitions, and loan growth; financing activities provided $1.725 billion, principally from deposit growth and debt issuance.
  • Balance sheet and liquidity: Total assets increased 40.7% to $6.966 billion; shareholders’ equity was $1.495 billion. The company reported $4.128 billion in cash and assets it classified as readily convertible to cash, including securities. Bank deposits were $3.346 billion, primarily affiliated brokerage deposits. Stifel Bank’s net loans were $815.9 million, and loans held for sale were $214.5 million.
  • Debt and capital: Year-end debt included $175 million of 6.70% senior notes due 2022, $150 million of 5.375% senior notes due 2022, and $59.0 million of non-recourse debt related to East Shore aircraft, in addition to $82.5 million of trust debentures and $304.7 million of short-term bank borrowings. Stifel Nicolaus reported $411.2 million of net capital, $400.7 million above its minimum; Stifel Bank was classified as well capitalized.
  • Credit metrics: Stifel Bank’s loan-loss allowance was $8.1 million, versus $5.3 million a year earlier; provision for loan losses was $3.0 million. Non-accrual loans were $1.8 million at year-end. Approximately 96% of the loan portfolio was collateralized.

Material changes versus 2011

  • Revenue growth reflected stronger public finance and M&A activity, improved fixed-income trading volumes and credit spreads, higher fee-based account assets, and growth at Stifel Bank. Commission revenue nevertheless declined.
  • Global Wealth Management net revenues rose 9.6% to $995.2 million, while pre-tax income increased 13.9% to $268.2 million. Institutional Group net revenues increased 21.9% to $618.5 million and pre-tax income rose 52.0% to $96.2 million.
  • Assets under management in fee-based accounts increased 12.9% to $20.8 billion; the filing attributes about 32% of the increase to net inflows and 68% to market appreciation.
  • Total assets expanded substantially, with growth in bank deposits, securities portfolios, trading inventory, loans, and acquisition-related assets. The company issued $325 million of senior notes during 2012.

Outlook, unusual items, and risks

  • Outlook: No quantitative earnings or revenue guidance is provided. Management describes continued growth as a priority, emphasizing advisor recruitment, client relationships, institutional and investment banking expansion, banking services, and disciplined acquisitions.
  • Acquisitions: Miller Buckfire and East Shore Aircraft were acquired in December 2012. The KBW acquisition closed on February 15, 2013, after year-end; Stifel paid approximately $253 million in cash and issued 6.7 million shares, plus restricted awards to employees. Integration, retention, cost, and execution risks are disclosed.
  • One-time and valuation-sensitive items: The $39.0 million Knight Capital gain materially contributed to 2012 other income. Level 3 assets were $206.8 million, including $163.1 million of auction-rate securities (ARS); valuation relies partly on internal models and unobservable assumptions. The company recognized $0.6 million of credit-related impairment on securities in 2012.
  • Legal matters: The SEC’s Wisconsin school-district CDO lawsuit remained unresolved. Stifel had settled the districts’ related civil claims for $13 million and provided a $9.5 million standby letter of credit; related claims involving RBC continued. Other disclosed matters include litigation over a $50 million tribal bond offering and a tribal-court lawsuit. Management says current reserves and information do not indicate a material adverse effect on financial position, but resolution could materially affect results in a future period.
  • Other principal risks: Market and interest-rate sensitivity, credit and counterparty losses, reliance on funding and affiliated deposits, regulatory and capital requirements, litigation, mortgage repurchase and indemnification exposure, pricing pressure, acquisition integration, operational and cybersecurity disruptions, and employee retention. Management also notes that market conditions and regulatory changes are uncertain.
  • Shareholder returns and controls: No cash dividends were paid in 2012 or 2011, and none were anticipated in the foreseeable future. The board repurchase authorization had 4.0 million shares remaining at year-end. Management and the auditor reported effective internal control over financial reporting; the financial statements received an unqualified audit opinion.

Important facts for investors to verify

  • How much of earnings growth is repeatable without the $39.0 million Knight Capital gain, and how commissions and fixed-income trading perform in subsequent periods.
  • Whether the KBW acquisition delivers expected growth and integration benefits, and its eventual purchase-price allocation, goodwill, and dilution effects.
  • Liquidity quality and funding concentration: distinguish cash from securities and other assets in the $4.128 billion liquidity measure, and monitor reliance on affiliated brokerage deposits.
  • Debt service and refinancing exposure, including the senior notes, short-term borrowings, and debt tied to aircraft lease proceeds.
  • Credit and valuation exposure in Stifel Bank’s growing loan and securities portfolios, including loan-loss reserves, securities-based lending, ARS, and Level 3 valuations.
  • Developments, possible additional costs, and reserve adequacy for the SEC/Wisconsin, tribal bond, and other legal matters.
  • Potential dilution from outstanding stock units and acquisition-related share issuance; the filing reports 15.5 million stock units outstanding at year-end.