Stifel Financial Corp. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017; comparisons are with the corresponding 2016 periods unless otherwise noted. Stifel operates in wealth management and brokerage, institutional trading and investment banking, and retail and commercial banking. It completed its acquisition of City Securities on January 3, 2017, funded with cash and common stock.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net revenues | $725.6 million | $652.1 million | $1,401.2 million | $1,272.1 million |
| Income before taxes | $83.2 million | $15.8 million | $162.2 million | $59.7 million |
| Net income | $52.8 million | $9.8 million | $118.3 million | $36.8 million |
| Net income available to common shareholders | $50.5 million | $9.8 million | $113.6 million | $36.8 million |
| Diluted EPS | $0.63 | $0.13 | $1.41 | $0.48 |
| Pretax margin on net revenues | 11.5% | 2.4% | 11.6% | 4.7% |
Q2 net revenues rose 11.3%; six-month net revenues rose 10.1%. Growth reflected higher investment banking, asset management and service fees, and net interest income. Brokerage revenues declined, as did other income. Total non-interest expenses increased 1.0% in Q2 and 2.2% for the six months; compensation and benefits were 62.5% and 63.5% of net revenues, respectively, down from 70.5% and 68.5%.
- Investment banking: Up 39.2% in Q2 to $185.3 million and 33.5% for six months to $312.1 million, supported by capital raising and advisory activity.
- Asset management and service fees: Up 19.6% in Q2 to $172.9 million and 16.1% for six months to $335.7 million. Fee-based account assets, including Asset Management, were $79.2 billion, up 20.9% year over year.
- Net interest income: Up 90.3% in Q2 to $92.3 million and 82.4% for six months to $177.4 million, primarily reflecting growth in Stifel Bank interest-earning assets and higher yields.
- Brokerage revenues: Down 13.1% in Q2 to $268.0 million and 10.7% for six months to $560.1 million. Management cited lower agency activity, trading volumes, volatility, and a flatter yield curve.
- Segments: Global Wealth Management Q2 net revenues rose 17.1% to $452.0 million and pretax income rose 45.9% to $153.2 million. Institutional Group net revenues rose 5.8% to $276.2 million and pretax income rose 24.7% to $52.9 million; investment banking gains more than offset weaker brokerage. Other segment reported a $122.9 million Q2 pretax loss.
Cash flow, balance sheet, debt, and liquidity
At June 30, 2017, total assets were $19.5 billion, up 2.1% from year-end 2016; total liabilities were $16.7 billion and shareholders’ equity was $2.85 billion. Cash and cash equivalents were $678.1 million, down from $912.9 million at December 31, 2016.
- Six-month cash flows: Operating activities provided $610.9 million, versus $432.0 million used in the prior-year period. Investing activities used $1.13 billion; financing activities provided $276.0 million. Cash declined by $234.9 million over the period.
- Funding and debt: Bank deposits were $12.05 billion; Federal Home Loan Bank advances were $790 million; senior notes were $796.3 million net of issuance costs (principal of $800 million, with maturities in 2020 and 2024); other borrowings were $105 million. The $200 million revolving credit facility had no advances outstanding, and the company reported compliance with its covenants.
- Liquidity: The company reported $9.44 billion of cash and assets readily convertible to cash, with average stated conversion periods of one to ten days for listed asset categories. Stifel Bank’s cash and highly liquid investments were approximately 22% of its assets. Management said firm-wide stress tests showed sufficient liquidity for modeled current and contingent funding obligations.
- Capital: Stifel and Stifel Bank were classified as well capitalized. Stifel broker-dealer had $276.3 million of net capital, $245.0 million above its minimum requirement. The company reported a 10.3% Tier 1 leverage ratio; Stifel Bank reported 7.2%.
- Credit: Net bank loans were $6.16 billion, up from $5.59 billion at year-end; the loan-loss allowance increased to $54.2 million from $45.2 million. Impaired loans were $14.4 million, including $9.2 million of troubled debt restructurings. Management reported 98.2% of the loan portfolio was collateralized.
Material changes, outlook, and risks
- Stifel adopted new stock-compensation accounting guidance in January 2017. A $17.1 million excess tax benefit was recognized in the six-month income tax provision, affecting comparability; the six-month effective tax rate was 27.1%, versus 38.3% in 2016. Q2 effective tax rate was 36.5%, versus 38.1%.
- Management provided no specific numerical earnings or revenue guidance. It described a strategy focused on organic growth, recruiting experienced financial advisors, expanding capital-markets capabilities, and pursuing suitable acquisition opportunities.
- Management cautioned that results are sensitive to financial-market activity, trading volumes and volatility, interest rates and yield curves, investment-banking demand, and client assets under management. It also cited a challenging municipal underwriting market and extensive, evolving financial-services regulation.
- Other operating expenses rose 25.4% in Q2; management cited increased legal and FDIC insurance expenses and Stifel Bank loan-loss provisions. The six-month provision for loan losses and advisor advances was $10.8 million, compared with $6.6 million.
- Legal proceedings include the Broyles matter, alleging losses exceeding $200 million in connection with a CDO, and a related individual-investor action seeking approximately $90 million. Stifel is contesting the claims; management said ultimate resolution was not expected to materially affect financial position and results overall, while acknowledging a matter could materially affect results in a future period. The filing states outcomes and potential losses are difficult to predict.
- Off-balance-sheet exposures include $213.2 million of loan-origination commitments, $90.2 million of standby letters of credit, and $559.9 million of unused credit lines. The filing also describes mortgage-loan repurchase and securities-clearing guarantees; the latter’s potential liability is not quantifiable, though payment was considered remote.
- Management reported no recognized subsequent events requiring adjustment. Disclosure controls were assessed as effective, with no material quarterly change in internal control over financial reporting.
Most important facts for investors to verify
- How much of the earnings increase is sustainable versus the $17.1 million stock-compensation tax benefit and the unusually low prior-year comparison?
- Whether investment-banking growth and asset-management fee gains continue, and whether weaker brokerage revenues stabilize.
- Credit quality, loan-loss allowance adequacy, and the pace and risk profile of Stifel Bank’s loan and deposit growth.
- Cash use, funding mix, collateral availability, and liquidity sensitivity to deposit withdrawals or reduced secured-funding access.
- Developments in the Broyles and other legal matters, including any change in reasonably estimable exposure or reserves.
- Integration and final purchase-price allocation for City Securities, and the ongoing costs of acquisitions, advisor recruiting, and stock-based compensation.