Stifel Financial Corp. — Q3 2014 Form 10-Q
Business context and reporting period
Stifel is a financial-services and bank holding company with wealth management, institutional brokerage and investment banking, and banking operations. This unaudited filing covers the quarter and nine months ended September 30, 2014; balance-sheet comparisons are with December 31, 2013. Results include acquisitions of De La Rosa (April 2014) and Oriel Securities (July 2014). Stifel completed its acquisition of Legg Mason Investment Counsel & Trust Co. on November 7, after quarter-end.
Key financial metrics
Amounts below are in millions except per-share data and percentages. The filing reports interim results; they are not necessarily indicative of full-year results.
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net revenues | $523.5 | $478.6 | $1,630.3 | $1,410.9 |
| Income before tax, continuing operations | $65.8 | $31.0 | $221.4 | $107.2 |
| Net income, including discontinued operations | $39.9 | $69.7 | $130.9 | $113.7 |
| Diluted EPS | $0.52 | $0.93 | $1.72 | $1.56 |
| Non-interest expenses | $457.7 | $447.6 | $1,408.9 | $1,303.7 |
| Operating cash flow | Not presented quarterly | $(54.3) | $433.1 |
- Q3 net revenues rose 9.4%; nine-month net revenues rose 15.6%. Q3 pretax income more than doubled, while nine-month pretax income rose 106.5%.
- Q3 net income fell 42.7%, despite higher pretax income, principally because 2013 included a $43.9 million income-tax benefit related to the SN Canada investment; Q3 2014 recorded $25.7 million of tax expense. The effective tax rate was 39.0% in Q3 2014.
- Q3 non-interest expenses increased 2.2%, slower than net-revenue growth. Non-interest expenses were 87.4% of net revenues, versus 93.5% a year earlier. Q3 pretax margin was 12.6%, versus 6.5%.
- Revenue drivers included investment banking (up 29.4% in Q3), asset management and service fees (up 26.0%), and net interest income (up 48.1%). Other income fell 63.2%; principal transactions fell 10.8% as fixed-income institutional brokerage volumes declined.
- For the first nine months, investment banking rose 36.2%, asset management and service fees 26.3%, and net interest income 67.4%. Management attributed fee growth to higher assets under management, and net-interest growth principally to Stifel Bank asset growth.
- At September 30, total assets were $9.33 billion, cash and cash equivalents $535.1 million, and shareholders’ equity $2.24 billion. Bank loans, net, were $1.87 billion, up from $1.40 billion at year-end; bank deposits were $4.55 billion, down from $4.66 billion.
- Debt included $625.0 million of senior notes, $82.5 million of trust debentures, and $49.8 million of short-term bank borrowings. Senior notes increased by $300 million following issuance of 4.25% notes due 2024 in July.
- Nine-month cash declined $181.4 million to $535.1 million. Investing activities used $181.2 million, mainly reflecting bank-loan growth; financing activities provided $59.8 million. Stifel reported $5.12 billion of cash and assets readily convertible to cash, though some assets were pledged or otherwise subject to restrictions.
Material changes and management commentary
- Global Wealth Management Q3 net revenues increased 15.5% and pretax income 30.4%. Growth in fee-based assets, bank interest revenue, and commissions offset weaker principal transactions. Fee-based account assets rose 26.0% year over year to $32.0 billion at June 30; the filing attributes 43.7% of that increase to net inflows and 56.3% to market appreciation.
- Institutional Group Q3 net revenues increased 4.9%, but pretax income decreased 15.7% to $29.5 million as expenses rose 9.1% and brokerage volumes weakened. Nine-month net revenues and pretax income increased 21.4% and 24.9%, respectively.
- Management said it intends to pursue organic growth, recruit experienced financial advisors, diversify capital-markets products, and consider acquisition opportunities. It provided no quantified earnings or revenue guidance.
- Oriel-related and other nonrecurring/merger expenses reduced continuing-operations net income by $8.6 million after tax in Q3 and $18.3 million for the nine months. The filing also records a $6.8 million pretax noncash Oriel retention-award charge in compensation expense.
Outlook, risks, and contingencies
- Results remain sensitive to market activity, trading volumes, interest rates, assets under management, and investment-banking issuance and deal flow. Management described municipal underwriting as challenging, citing reduced government debt issuance and investor reluctance toward longer-dated or higher-risk municipal securities.
- Liquidity and funding risks include dependence on subsidiary earnings and distributions, market access, secured financing, and customer deposits. The $100 million committed revolving credit facility expired in December 2014; it was undrawn and covenants were met at September 30. The $680 million of uncommitted secured lines remained subject to bank approval and available collateral.
- Stifel reported strong regulatory capital at quarter-end: Stifel Nicolaus had $339.4 million of net capital, $326.4 million above its minimum; Stifel Bank’s total risk-based capital ratio was 13.9% and it was categorized as well capitalized.
- Legal matters include the SEC lawsuit concerning CDO sales to Wisconsin school districts, related claims involving RBC, and bond-related litigation involving tribal entities and other parties. The company said it intends to defend the claims and does not expect currently known matters to materially affect financial position or results overall, but acknowledged that resolution could materially affect results in a future period. Loss estimates are difficult to determine.
- Other exposures include possible repurchases of up to $16.3 million par value of auction-rate securities under customer settlement agreements, $34.5 million of commitments to fund investments, loan-originination commitments, and guarantees and repurchase obligations relating to mortgage loans sold. The company reported no credit-related other-than-temporary impairment on securities in the quarter or nine-month period.
- Fair-value estimates for Level 3 assets involve significant unobservable inputs. Level 3 assets were $177.8 million at quarter-end, including auction-rate securities and private or partnership investments. The annual goodwill impairment test completed July 31 found no impairment; purchase-price allocations for DLR and Oriel were preliminary.
Important facts for investors to verify
- Separate the strong pretax improvement from reported Q3 net-income and EPS declines; verify the effect of the unusual 2013 tax benefit and 2014 acquisition-related costs.
- Assess whether growth in investment banking, fee-based assets, and bank lending can persist, and monitor lower trading volumes and principal-transaction revenue.
- Review cash conversion and liquidity: operating cash flow was negative for the nine months, cash declined, and portions of liquid assets were pledged or collateralized.
- Track loan growth, credit quality, and allowance adequacy: the allowance was $19.0 million, nonaccrual loans were $3.6 million, and commercial and industrial lending expanded materially.
- Monitor acquisition integration, the subsequent LMIC transaction, the December 2014 credit-facility expiry, and material litigation developments and potential loss exposure.