STIFEL FINANCIAL CORP quarterly report, Q2 FY2010

Business context and reporting period

Stifel Financial Corp. is a diversified financial-services firm operating in retail brokerage, securities trading, investment banking and advisory, and banking. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2010; comparisons are with the corresponding 2009 periods. Balance-sheet comparisons are with December 31, 2009.

Financial performance and position

• Net revenue rose 25.4% in Q2 and 32.9% for the first half; net income rose 33.5% and 54.7%, respectively. Compensation and benefits were 66.1% of net revenues in both 2010 periods, down from 67.3% in 2009.
• Revenue growth reflected higher commissions, asset-management fees and investment banking, plus expansion and the 2009 UBS branch acquisition. Q2 principal-transaction revenue was nearly flat; fixed-income institutional brokerage weakened.
• At June 30, total assets were $3.37 billion, cash and cash equivalents $262.7 million, and shareholders’ equity $927.1 million. Bank deposits were $1.26 billion; short-term bank borrowings were $163.9 million, up from $90.8 million at year-end. Trust debentures totaled $82.5 million.
• For the six months, operating cash flow was positive $23.7 million, investing cash flow negative $198.9 million, and financing cash flow positive $276.2 million; cash increased $100.9 million. Financing inflows included higher deposits and bank borrowings.
• Stifel reported strong regulatory capital: the parent’s total risk-based capital ratio was 39.4% and Stifel Bank’s was 15.7%; management said both were well capitalized.

Changes, outlook and notable items

• Global Wealth Management drove growth: first-half net revenues rose 58.9% to $399.4 million and pretax income rose 92.6% to $79.6 million. Institutional Group first-half net revenues rose 3.2% to $237.9 million, while Q2 pretax income declined 3.4% to $30.8 million.
• The Thomas Weisel Partners Group acquisition closed July 1, 2010, after quarter-end. Stifel issued approximately 3.72 million shares and restricted stock units for estimated consideration of $276 million. Preliminary estimated excess purchase price over net assets was $112 million; allocation remained subject to completion. Q2 acquisition transaction costs were about $5 million before tax.
• On August 3, the Board modified deferred-compensation vesting terms; the change accelerated noncash compensation expense and was expected to result in an after-tax charge of approximately $104.8 million. This is a subsequent event, not a June 30 period expense.
• Other unusual items included a $2.1 million gain from conversion of a Chicago Board of Exchange membership and a $0.4 million pretax loss on a bank-branch sale. The company also recorded $3.1 million of merger-related employee termination accruals and expected further integration costs.
• No specific earnings or revenue guidance is provided. Management emphasized continued growth and recruiting, while cautioning that results are unpredictable and sensitive to market activity. It described Q2 markets as volatile, with tighter bid-offer spreads and challenging fixed-income conditions.
• Risks include market and interest-rate volatility, credit and liquidity exposure, dependence on recruiting and retention, regulatory capital constraints, and legal matters. The ARS repurchase program was scheduled to continue through 2011; estimated remaining client repurchases were $20.1 million through 2010 and $67.2 million by year-end 2011, subject to redemptions and estimates.
• The company disclosed SEC, FINRA and state inquiries concerning auction-rate securities and CDO transactions, plus litigation brought by Wisconsin school districts relating to $200 million of CDO investments. Stifel disputed the allegations; it said ultimate resolution could affect results in a future period, though it did not expect a material adverse effect on financial position.

Important facts for investors to verify

1. How the TWPG acquisition’s final purchase-price allocation, integration costs and operating results compare with the preliminary estimates.
2. The amount and timing of the deferred-compensation charge and its effect on reported earnings and future compensation expense.
3. Whether revenue gains persist if fixed-income brokerage remains weak or broader market conditions deteriorate.
4. Actual ARS repurchases, redemptions and related liabilities versus management’s estimates, and developments in the related investigations and litigation.
5. Deposit stability, funding needs, collateral requirements and regulatory capital after the acquisition and share repurchases.