Stifel Financial Corp. (NYSE:SF)
Q3 2008 Earnings Call Transcript
November 3, 2008 16:30 pm ET
James M. Zemlyak - Executive Vice President and Chief Financial Officer
Ronald Kruszewski - Chairman, Chief Executive Officer, President
Joel Jeffrey - KBW
Good afternoon. My name is Berneil and I will be your conference operator today. At this time, I would like to welcome everyone to the 2008, Third Quarter’s Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). Thank you.
I would now like to turn the call over to Mr. Zemlyak, Chief Financial Officer of Stifel Financial. Please go ahead sir.
James M. Zemlyak - Executive Vice President and Chief Financial Officer
Thank you, operator. Good afternoon, everyone. This is Jim Zemlyak, CFO of Stifel Financial Corp. I would like to welcome everyone to our conference call today to discuss our third quarter and 2008 year-to-date results. Please note that this conference call is being recorded. If you’d like a copy of today's presentation you may download the slides or view it on www.stifel.com.
Before we begin today's call, I would like to remind listeners that this presentation may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not statements of fact or guarantees of performance. They are subject to risks, uncertainties, and other factors that may cause actual future results to differ materially from those discussed in the statements.
To supplement our financial statements presented in accordance with GAAP, we use certain non-GAAP measures of financial performance and liquidity. These non-GAAP measures should only be considered together with the company's GAAP results. And finally, for a discussion of risks and uncertainties in our business, please see the business factors affecting the company and the financial services industry in the company's Annual Report on Form 10-K and MD&A results in the company's quarterly reports on Form 10-Q.
With that, I would like to turn the call over to Chairman, CEO, and President, of Stifel Financial Mr. Ron Kruszewski.
Ronald Kruszewski - Chairman, Chief Executive Officer, President
Thanks Jim. Welcome everyone. Let's get started by saying that we are pleased to report another very good quarter, especially in light of the certainly unprecedented market events and the turmoil that these times are presenting us with almost endless opportunity to continue to grow our franchise.
I say that recognizing that even though business has been very good and growth has been very good, I note, as I'm sure everyone on this call knows, that we just completed one of the worst months in the history of the Dow, down somewhat 14, the S&P down 17, NASDAQ almost 18% for the month. And certainly that can have a chilling effect on activity when clients open their statements. That said, business has been very good.
With respect to the third quarter of 2008, again I remind everyone that if you want to view our slides, they are online, and I'm going to outline my remarks in conjunction with the slides. So, first of all, with the third quarter, we are pleased to report record net revenues per quarter, an all-time record of almost 219 million up 20% from the comparable quarter of 2007. Revenue growth and Private Client, Equity Capital Markets and our small bank was offset by investment banking witnesses and certainly our Fixed Income Group had a big – a lot to say that 20% increase.
Our GAAP net income was 12.8 million or $0.46 a diluted share up 59%. Core net income which is how we have been in measuring our progress totaled $0.60 per diluted share, which was 17% over the comparable quarter. Core earnings, pretax margin 13%. We have had margin compression, both as a result of a subdued activity on the banking side and plus a lot of growth, additions of offices. I will talk about that in a moment.
Our annualized return on average equity was 14%, I say that with -- we only employed about three times leverage to achieve those results. And during the quarter and frankly at the end of the quarter, we successfully completed a public offering of a million 1,495,000 shares at $45 a share. We think that offering was very timely.
With respect to year-to-date again record nine month revenues of almost 640 million up 16% compared to 2007. Again our Private Client Group had record revenue of 11% Fixed Income record revenue of 185%.
Our GAAP net income was $1.44 up on 115%. Book value totaled $22.21 which was up 22% and core net income for the nine months was $1.88 a share, which is up 11%. Again pretax margins 13%, return on average equity 15%. All things considered in this market I think congratulations to a number of my partners at the firm for just truly very remarkable and balanced results.
If you turn the page, you look at the income statement. Again I have talked about most of the things on here, and we’ll talk a little bit about the balance that allowed us to achieve record revenue and 20% quarter-over-quarter over growth, but all in all, nothing really unusual.
If you took a look at our growth strategy, we just think that the disruption in the Private Client market present significant opportunities. Yes, Wachovia with Wells Fargo, Merril, [BA Bay], Lehman, Bear Stearns, there is just literally thousands of financial advisors that are considering their future. And it is just a lot of opportunity for a firm like ours.
On the Capital Markets side, the Wall Street principal business model is certainly under a lot of scrutiny. We view the deleveraging as something we have noticed. The deleveraging has resulted in less emphasis on the capital side of the business, which has driven our client service model.
The turmoil is fantastic in terms of our ability to hire talent in our Capital Markets platform. And many firms are retooling their business models to deal with the Fed being a Federal Reserve regulated holding company, and we have already been under that regime for nearly two years. So our model is ready to go with respect to what I think will be the new regulatory framework to financial services.
If you look at the next slide, as we outline our 2008 growth, it has been a year of tremendous growth. Added 140 new financial advisors, 21 offices through the end of September in Equity Capital Markets, some 58 people, including 38 professionals in investment Banking, over 50 professionals in Fixed Income; a lot of additions in public finance and continued growth in our bank.
The market turmoil simply equals opportunity. We have, as this next chart shows, we have one of the fastest-growing private wealth management businesses in the industry. Year-over-year, consistent growth in our Private Client revenues, financial advisors and branches. On the research side, today our equity research domestically in terms of domestic research is the sixth largest research department in the US, and we are the second largest provider of small cap coverage, according to StarMine in both of those charts.
If you look at our revenue source, again pretty much similar to what it was in the second quarter. Strong growth in commissions, a very strong year-over-year and quarter-over-quarter growth in principal transactions, which offset decline in Investment Banking. Nice increase, 12% for the quarter, 26% for the year in fee business, resulting, as you can see, driving a 20% quarterly increase in revenue, 16% for the year.
For the last three calls, I have gotten questions on principal transactions. I figured I would just throw a slide into this presentation to at least show where it comes from. This slide will show that our principal transactions have been driven. Taxable debt, as you can see for the quarter, more than doubled. That is again driven by our Fixed Income, for the most part, our Fixed Income Capital Markets business.
Our tax-exempt business is again nearly doubled. Our equities business up almost 100%, and again, these are all principal transactions. The main thing here is there is always I think a lot of confusion about principal transactions. This is a slow business for us that we do on a principal basis, primarily in the Fixed Income market versus on an agency basis. But it does not mean that we're taking really additional risk. It is the way that we're executing the trade. Again, though, at the end of it, most of the increase in principal transaction is driven by our Fixed Income Capital Markets business.
The other thing I think noteworthy for the quarter and the nine months is depicted on the next slide, which is the volatility of our investment account. For the quarter we had about 3 million of a loss in the investment compared to about 1 million gain last year, so 4 million swing in the investment account.
Nearly half of that was in our deferred comp account, and this is somewhat arcane accounting in my opinion in that this is the investments that we hold for our associates in their deferred comp plans. It is unvested in the way the accounting rules work. You need to book the change in that value up or down, and then you change your amortization to compensation expense going forward. So this can work both ways. And this, as you can see, last year we were up about 800,000, and we're down 1.9 million. But it does impact reported results.
Obviously our New York Stock Exchange Euronext stock was down for the year almost $1 million. Our cap though, which is our private equity fund, had mark-to-market losses for the quarter of about $0.5 million. And then other investments down about 1.25 million. So you can see I just want to point out the volatility in that investment account, a lot of this is unrealized.
If you want to know what we have in investments, the bottom of the slide will show you that the deferred compensation hedge is around $26 million, a little bit about $26 million in treasuries and then the investments is another $26 million. So there’s not a lot of exposure here and really it’s down to $26 million, which is our investment in partnerships, our investments in financial stocks, et cetera. But the volatility of nearly $4 million for the quarter and $6.5 million year-to-date, I think, was significant enough to talk about.
The next slide just shows our balance of revenue. I think that again it’s important to have private client and capital markets, fixed income, offsetting weaknesses in equity we think their model is well positioned. Now when we have weathered the storm, but positioning as well going forward.
If you look at the segment, total revenue is up 20%. Revenues increased in each verticals and margins improved in three out of the four operating segments. You can look at the detail here, but for the quarter to see Equity Capital Market is up 33%, again Fixed Income are not enough good things I can say about that segment both in the quarter and this year, up 139% for the quarter and up 185% for the year. But you will also see increased margins in profitability. So all in all, pretty solid performance all things considered across all of our businesses.
If you quickly look at the Private Client Group, you will see that 1% increase in revenues result in about a 3% decline in our contribution the way we look at it. That again for the quarter that is the result of a lot of our expansion. Year-to-date pretty consistent, 11% increase in revenues driving a 15% increase in contribution, but we’ve added a lot of offices.
In fact the next slide was something I thought we should talk about for a moment. What we try to do on this slide is show our new branch. When we looked at trailing 12 new branches and what we have recorded. And I do want to note that some management estimates and some of these numbers we noted from the slide, but I think you will get the point here that the way we look at it, these new branches so far have generated $10 million in revenue and after you get through the one-time expenses in transition pay, we have lost $5.3 million over the last 12 months on the new branches that we opened in the last 12 months.
But importantly, if you look at it on a pro forma basis and what we did here was we looked at the expected production for the people we have hired and we apply our standard targets internally as to what we drive for, and you will see that we would expect $40 million of revenues generating almost $11 million of contribution before transition pay, which we would estimate at 12%. Net-net, we look at the investment in these new branches to over time go from a $5.3 million loss to a $6.3 million profit. And that’s what we have been doing for the last decade and it’s just – we are doing more of it now and as I said, this is going to, in the short run, compress margin.
Equity Capital Markets, we are looking at that segment again quarter-over-quarter 33% increase in revenue. On the investment banking side, I do think that this number was a strong quarter for investment banking, again all things considered, up sequentially and up year-over-year, up 9% year-over-year within this segment. So very nice quarter, about 20% margins and again a good quarter. The investment banking business however does still feels shaky debt markets a number of things. There is a lot of things on our plate, but there is a lot of things that require some market cooperation to get it. So I caution people on that going forward.
Turning to the slide, turning our look to fixed income, again phenomenal performance, 30% plus margins, 140% increase in revenue for the quarter, driving over a four-fold increase and contribution of $12 million. A lot of investment in people and in area that we have seen tremendous amount of interest in joining our platform including in the future, social business that certainly the markets have been kind to this business from where we approach it, but it’s a business that I feel we have gained real market share.
The bank ended with 327 million of assets almost flat line assets for the last few quarters and the bank in fact is growing at all because of our – some of our clients have chose to sweep some of the deposits and insure it into our bank, which causes balance sheet growth, but we have been very measured in our loans. We don’t feel that the bank, in this environment has something that we need to grow on the balance sheet. We are doing a lot of servicing of our clients in the mortgage side. We have a tremendous mortgage team. We have added a lot of associates. But the bank as you can see from some of these ratios are non-performing loans are at 0.09%. Again we acquired a small very conservative run bank and in these markets we have not been aggressive, but the bank.
The next couple of slides -- to reconcile our GAAP to core earnings, slide 19, just shows core to GAAP and the acquisition related expense, I have talked about this every quarter was $0.14 for the quarter taking our GAAP down to $0.46.
Page 20 of the slide shows our actual results for Q1 to Q3, we have also estimated that these expenses are about $6.5 million they were 6,506 million for the quarter. We estimate it to be 6.5 million in Q4. And importantly in 2009, as I have said for three years, this concept of core to GAAP goes away.
Looking at the balance sheet assets, we little blipped on our balance sheet, mostly a lot of unsettled trays caused our broker dealer receivables to go up somewhat a couple of hundred million dollars at the end of the quarter, so you will see our assets were $2 billion. It’s not that high today. If you look at our total capitalization of 660 million, 565 million of equity and 95 of trust-preferred, to drive a capitalization or our definition of leveraged ratios were about 3 to 1, book value growing nicely its 20 to 21. Capital structure again, well capitalized, you will see in our Q, no significant additions to Level 3 assets, all in all pretty conservative.
Finally, just looking at other financial data, you will note the growth and associates, locations, advisors, a number of good growth trends. So with that operator, I will be glad to take any questions.
(Operator Instructions). Your first question comes from the line of Joel Jeffrey.
Hi guys, how are you? Just a quick question. Going back to the slide, where you talk about the new branches and going from losses to gains on a pro forma basis. How long do you expect that to take?
You know, we liked to get the preliminary contribution of loss to break even pretty quick, you need to really focus on those one time expenses of $3 million that are the front end costs of opening a branch. A cap these, litigation if we have and things like that. So that goes away pretty fast, as it relates to new branches. The ramping up for the branches, generally you know, a year, two years, it depends on market. But, I will really give the timeframe, I am not going to do it now, but I am just try to show why when we open new branches, we take some margin compression, but we think we are building the value in the company.
Okay. And then in terms of the business really looked like it took off, in terms of equity capital markets, does that something we think is sustainable for the near future or is that just sort of function of the volatility we have seen in the markets off late?
I think its sustainable impact, in fact I did kind of – I wanted to get through these slides, but I had a lot here and I think did gross over that. If you look at that in the equity capital markets, I think it is phenomenal, and I was on page 15 that our focus, our cash equities business quarter over quarter is up 45%, Joel and year-over-year 36%. So our research driven advise service model we think is gaining sustainable market share.
Okay. And then in terms of on the investment banking side, advisory revenues were a little higher than what we were looking for. Was there anything behind that, anything in particular, or just a strong pipeline?
You know, I think it was -- you know, that business can be lumpy and it was. We have a strong pipeline. It is difficult to predict when things will close. So again, that market is volatile and uncertain, and it was -- we got some things done in the third quarter. But I do caution everyone that things that we have in the pipeline that could close this quarter simply could not close for reasons that are going to be market-driven versus deal-driven. And so I think it is -- it was a nice performance considering the market, but that tends to be a lumpy line item.
Sure. Okay. And then lastly, in terms of performance sort of quarter to date for the fourth quarter, have you seen the retail investor pulled back by the volatility in the markets? Have you seen the institutional business continue to sort of thrive as it has? Any update there?
Well, business has been good. I mean -- but as I started the call, you know the business is good, but I always give get cautious when business is good in down markets. Alright? And I just had to leave it at that. So I don't want to get too far over my skis in talking about where we are going for the quarter. But our October flow business was quite healthy. But the markets were very volatile, as you know.
Well. Good, thanks for taking my questions.
(Operator Instructions). There are no questions at this time.
Thank you, operator. Everyone, may you have a good quarter and a happy holiday, and we will see everyone in what I hope will be a good final quarterly update and year update in February of 2009. Thank you very much.
This concludes today's conference call. You may now disconnect.
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