STIFEL FINANCIAL CORP quarterly report, Q3 FY2016

Stifel Financial Corp. — Q3 2016 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2016; comparisons are with the corresponding 2015 periods unless otherwise noted. Stifel is a diversified financial-services and bank holding company, operating in wealth management, institutional brokerage and investment banking, and banking.

Financial performance

Metric	Q3 2016	Q3 2015	Nine months 2016	Nine months 2015
Net revenues	$642.0 million	$591.6 million	$1,914.1 million	$1,750.3 million
Income before taxes	$28.0 million	$22.3 million	$87.7 million	$130.5 million
Net income	$17.8 million	$17.2 million	$54.6 million	$81.2 million
Net income available to common shareholders	$16.3 million	$17.2 million	$53.1 million	$81.2 million
Diluted EPS	$0.21	$0.22	$0.69	$1.04
Pre-tax margin on net revenues	4.4%	3.8%	4.6%	7.5%

Q3 net revenues rose 8.5%, while net income increased 3.7%; diluted EPS declined as preferred dividends and share dilution affected per-share results. Year-to-date net revenues rose 9.4%, but net income fell 32.7%. Total non-interest expenses increased 7.9% in Q3 and 12.8% year to date, with year-to-date expense growth outpacing revenue growth.

Revenue mix: Q3 principal transactions rose 22.4%, investment banking 21.9%, asset management and service fees 10.4%, and interest revenue 72.6%; commissions fell 11.8% and other income fell 51.4%. Nine-month principal transactions rose 29.3%, asset management and service fees 18.9%, and interest revenue 56.6%; investment banking declined 5.4% and commissions declined 1.9%.
Profitability drivers: Management attributed revenue growth principally to higher fee-based assets, principal transactions, advisory activity, and growth in Stifel Bank’s interest-earning assets. Q3 advisory fees rose 73.5%, offsetting lower capital-raising revenue. Year-to-date investment banking was lower because capital raising declined, despite higher advisory fees.
Cash flow: Operating activities used $227.1 million in the first nine months, investing activities used $3.8 billion, and financing activities provided $3.9 billion. Cash and cash equivalents decreased $136.0 million to $675.1 million.

Financial position, debt, and liquidity

At September 30, 2016, total assets were $17.2 billion, compared with $13.3 billion at December 31, 2015; shareholders’ equity was $2.69 billion, versus $2.49 billion.
Bank loans, net, increased to $4.96 billion from $3.14 billion; deposits rose to $9.89 billion from $6.64 billion. Available-for-sale securities increased to $3.15 billion from $1.63 billion. Management reported $8.13 billion in cash and assets readily convertible to cash.
Reported debt and borrowing balances included $795.8 million of senior notes, $500.0 million of Federal Home Loan Bank advances, $234.2 million of borrowings, and $67.5 million of trust debentures. The company issued $200 million of additional 4.25% senior notes due 2024 and redeemed $150 million of 5.375% notes due 2022 during July.
The company issued $150 million of 6.25% non-cumulative perpetual preferred stock in July. Q3 and nine-month preferred dividends were $1.6 million.
Stifel Financial and Stifel Bank were classified as well capitalized. Their reported common equity Tier 1 ratios were 19.5% and 13.7%, respectively. Stifel broker-dealer reported net capital of $295.5 million, $261.4 million above its minimum requirement.

Material changes and unusual items

Stifel acquired Eaton Partners in January and ISM Capital in May 2016. It sold Sterne Agee’s legacy independent brokerage and clearing businesses in July and its legacy RIA business in August, for approximately $50 million in cash consideration.
Accelerated expense recognition for certain Barclays employee restricted stock units contributed $22.6 million of compensation expense in Q3 and $58.6 million in the first nine months. Management cited this, higher variable compensation, and growth-related costs among the drivers of expense increases.
Other income included a $5.6 million gain on extinguishment of trust debentures. Redemption of the 5.375% senior notes also resulted in a debt-issuance-cost write-off; the filing reports $3.0 million of this in interest expense.
The company repurchased $113.5 million of common stock, or 3.4 million shares, during the first nine months. At September 30, 7.4 million shares remained authorized for repurchase.
Loan growth was accompanied by an increase in the allowance for loan losses to $39.1 million from $29.8 million at year-end. Individually impaired loans were $28.3 million, including $9.8 million of troubled debt restructurings, compared with $1.1 million of impaired loans at December 31, 2015. The filing states that 97.6% of the loan portfolio was collateralized.

Outlook, commentary, and risks

The filing provides no specific earnings or revenue guidance. Management described continued priorities of attracting experienced financial advisors, expanding capital-markets capabilities, growing client relationships, and pursuing selective acquisitions.
Management emphasized that results are sensitive to market activity, volatility, interest rates, investment-banking demand, client assets, and funding conditions. It also noted challenging municipal underwriting conditions and investor reluctance to assume longer-dated municipal, credit, or liquidity risk.
The SEC’s civil case concerning CDO sales to five Wisconsin school districts had a tentative settlement announced to the court, subject to SEC approval. The company said it could affect income-tax provision by approximately $9 million because of potential non-deductibility. The filing also describes other litigation, including the Lac du Flambeau bond matter and the Broyles/Collybus CDO case; outcomes remain uncertain.
Liquidity risks include reliance on customer deposits and secured funding, potential reduced access to credit or capital markets, collateral calls, and the possibility that uncommitted credit lines may not be available when requested. The company reported sufficient liquidity under its stress tests at quarter-end.
Interest-rate swaps had a $10.6 million net liability fair value; $17.6 million of cash collateral had been posted. Derivative agreements include default, equity, creditworthiness, and regulatory-capital triggers that could require collateralization or settlement.
Management reported effective disclosure controls and procedures and no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

Whether the tentative SEC settlement receives approval, its final terms, and the resulting tax and financial-statement impact.
Whether loan growth—particularly residential real estate and commercial lending—translates into higher delinquencies, impaired loans, provisions, or charge-offs.
Whether deposit growth and access to secured and uncommitted funding remain sufficient to support the expanded bank balance sheet and liquidity needs.
Whether revenue diversification and growth in advisory, fee-based, and interest income can offset weaker commissions and capital raising, while controlling compensation and acquisition-related costs.
The final purchase accounting for Eaton Partners and ISM, and the continuing costs and benefits of acquisitions and the Sterne Agee business disposals.