STIFEL FINANCIAL CORP quarterly report, Q2 FY2016

Stifel Financial Corp. — Q2 2016 Form 10-Q

Business context and reporting period. Stifel is a diversified financial-services and bank holding company, operating in wealth management, institutional brokerage and investment banking, and banking. This filing covers the quarter and six months ended June 30, 2016; interim results are unaudited. The company completed acquisitions of Eaton Partners in January and ISM Capital in May 2016.

Financial performance and position

Metric	Q2 2016	Q2 2015	Six months 2016	Six months 2015
Net revenues	$652.1 million	$597.8 million	$1,272.1 million	$1,158.7 million
Net income	$9.8 million	$20.9 million	$36.8 million	$64.0 million
Diluted EPS	$0.13	$0.27	$0.48	$0.82
Net income / net revenues	1.5%	3.5%	2.9%	5.5%
Net interest income	$48.5 million	$33.8 million	$97.2 million	$63.5 million

• Revenue growth reflected higher principal transactions, asset management and service fees, and interest income. Investment banking revenue declined 17.3% in Q2 and 18.1% for the half, largely due to lower capital-raising activity. Q2 commissions were nearly flat.
• Non-interest expenses rose 13.7% in Q2 and 15.4% for the half, faster than net revenue growth. Compensation and benefits were $460.0 million in Q2 and $871.1 million for the half.
• At June 30, total assets were $15.39 billion, up from $13.33 billion at year-end 2015; shareholders’ equity was $2.49 billion, essentially unchanged. Bank loans, net, were $4.17 billion, compared with $3.14 billion at year-end; bank deposits were $7.88 billion, compared with $6.64 billion.
• Cash and cash equivalents were $364.1 million, down from $811.0 million at year-end. For the six months, operating activities used $432.0 million, investing activities used $2.19 billion, and financing activities provided $2.18 billion.
• Funding obligations included $865.0 million of Federal Home Loan Bank advances, $335.2 million of borrowings, $740.8 million of senior notes, and $67.5 million of trust debentures. These figures exclude bank deposits and other operating liabilities. The company reported $100 million available under its committed revolving facility, with no advances outstanding.

Material changes and unusual items

• Q2 net income fell 53.2% despite 9.1% growth in net revenue; first-half net income fell 42.4%. A major expense item was a $36.0 million Q2 compensation charge after the company removed continuing-service requirements on certain Barclays employee restricted stock awards.
• Other income included a $5.6 million gain from extinguishing $15 million of trust debentures. The company repurchased $95.1 million of common stock, or 2.8 million shares, during the first half.
• Bank-loan growth and higher investment securities drove a substantial increase in investing cash use. Cash flows were also supported by increased deposits and FHLB advances.
• After quarter-end, Stifel completed the sale of Sterne Agee’s legacy independent brokerage and clearing businesses for approximately $50 million; the related assets and liabilities were classified as held for sale at June 30. The legacy RIA sale was expected to close in Q3.
• On July 11, 2016, the company priced an additional $200 million of 4.25% senior notes due 2024 and issued $150 million of 6.25% non-cumulative perpetual preferred stock. The filing says note proceeds were intended to repay the 2012 senior notes and for general corporate purposes. Two term loans reported at quarter-end were paid off in July.

Outlook, commentary, and risks

• No numerical earnings or revenue guidance is provided. Management said it would pursue revenue growth through advisor recruitment, client relationships, product diversification, and selective acquisitions.
• Management described results as highly dependent on U.S. equity and fixed-income markets, trading activity, investment banking demand, interest rates, and client assets. It noted a challenging municipal underwriting market and investor reluctance toward longer-dated municipal securities and credit or liquidity risk.
• Liquidity stress testing indicated sufficient resources to meet modeled current and contingent obligations at June 30; Stifel Bank reported cash and highly liquid investments equal to approximately 37% of its assets. However, the filing cautions that market disruption, reduced funding access, collateral calls, deposit withdrawals, or a credit-rating downgrade could pressure liquidity. Uncommitted secured lines require lender approval for each advance.
• Stifel reported that it and its bank were well capitalized. Stifel broker-dealer net capital was $268.3 million, $236.4 million above its minimum; Stifel Bank’s reported total capital ratio was 14.5%.
• Credit risks include loan growth and concentrations, collateral values, and a higher level of impaired loans: $35.1 million at June 30 versus $1.1 million at December 31, 2015. The allowance for loan losses was $35.9 million; management cautioned that estimates could prove insufficient.
• The company faces ongoing litigation and regulatory matters, including the SEC/Wisconsin school-district CDO case, with trial scheduled for September 2016, and the EDC bond matter, with trial phases scheduled for October 2016 and January 2017. Management said ultimate outcomes are uncertain and could materially affect results in a future period, although it did not expect a material adverse effect on financial position and results based on information then available.

Most important facts for investors to verify

• Whether the $36 million award-modification charge and other acquisition-related costs are nonrecurring, and how ongoing compensation and expense growth affect margins.
• Whether asset-management growth and stronger trading and net interest income can offset persistently weaker investment banking and capital-raising revenues.
• The quality and performance of the rapidly expanded bank-loan portfolio, especially impaired commercial loans, and the adequacy of the loan-loss allowance.
• Cash and liquidity trends, deposit stability, collateral availability, and the cost and availability of FHLB, secured-line, and other financing.
• Final purchase-price allocations for Eaton Partners and ISM, completion and proceeds of the Sterne Agee disposals, and the effect of the July debt and preferred-stock issuances.
• Developments in the disclosed litigation and regulatory cases, and any resulting changes to reserves or operating results.