Stifel Financial Corp. (NYSE:SF)
Q2 2016 Earnings Conference Call
August 2, 2016 5:00 PM ET
James Zemlyak – Chief Financial Officer
Ronald Kruszewski – Chairman and Chief Executive Officer
Christian Bolu – Credit Suisse
Steven Chubak – Nomura
Conor Fitzgerald – Goldman Sachs
Chris Harris – Wells Fargo
Devin Ryan – JMP Securities
Good evening. My name is Christy and I'll be your conference operator today. At this time, I would like to welcome everyone to the Stifel Financial Corp Second Quarter 2016 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there'll be a question-and-answer session. [Operator Instructions] Thank you.
I would now to turn the call over to Jim Zemlyak, you may begin.
Thank you, Christy. Good afternoon. This is Jim Zemlyak, CFO of Stifel. I would like to welcome everyone to our conference call today to discuss our second quarter 2016 financial results. Please note that this conference call is recorded. If you'd like a copy of today's presentation, you may download the slides from our website at www.stifel.com.
Before we begin today's call, I'd like to remind the 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 may include statements regarding, among other things, our ability to successfully integrate acquired companies or branch offices and financial advisors; general economic, political, regulatory and market conditions; the investment banking and brokerage industries; our objectives and results; and also may include our belief regarding the effects of various regulatory matters, legal proceedings, management expectations, our liquidity and funding sources, counterparty credit risks or other similar matters.
As such, 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 may use certain non-GAAP measures of financial performance and liquidity. These non-GAAP measures should only be considered together with the GAAP results. To the extent we discuss non-GAAP measures; the reconciliation to GAAP is available on our website.
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 of the quarterly reports on 10-Q.
I will now turn the call over to the Chairman and CEO of Stifel, Ron Kruszewski.
Jim, you all right?
Thanks. Sit right next to me, I assure you as well. Thanks, Jim, and good afternoon, everyone – have some water.
Thank you, everyone, and thank you for taking time to listen to our second quarter 2016 results. Earlier this afternoon we released our press release with our second quarter results and posted a slide deck on our website.
First, I'll run through our financial results for the quarter, as well as the continued progress we made in growing our balance sheet. I will then discuss some of the key questions impacting our business such as non-core expense runoff, the Department of Labor Rule, our recent asset sale and capital rate before opening up the call to questions.
So with that, let's start off with my opening comments and some of the highlights for the quarter. We're pleased with the results in the second quarter as we posted a second consecutive quarter of record revenue and increased adjusted EPS by 21% sequentially despite unless an ideal market environment.
The diversity of our business model was again illustrated by a rebound in investment banking activity and growth in our bank which more than offset the sequential decline in brokerage revenue from the first quarter's record level.
Although the market environment remains challenged at macro level advanced in the first half of 2016 led spikes and volatility that weighed on investor and corporate activity, we believe that Stifel remains well positioned to capitalize as markets improve.
In the past month we have pulled off the lower margin legacy businesses from the Sterne Agee acquisition, raised preferred equity and refinanced higher cost debt. These actions have further strengthened our already strong balance sheet to facilitate our continuous efforts to optimize our capital base and increase shareholder returns.
In terms of the results from the second quarter, total net revenue for the quarter was a record 652 million, up 5% sequentially and 9% year-over-year. Much of the growth was driven by a rebound in the institutional group that generated revenue of 261 million, up 8% sequentially.
The higher institutional revenues were the results of a 43% sequential rebound in advisory revenue and a 25% sequential pickup and capital raising which more than offset 7% decline in institutional brokerage revenue.
Additionally, our Global Wealth Management business posted another record revenue quarter of 386 million, up 2% sequentially and 12% year-over-year. Brokerage revenues slowed following a strong first quarter but revenue growth benefited from balance sheet growth at the bank and improved syndicate activity.
More specifically, revenue in Stifel Bank & Trust was up 5% sequentially and 36% over 2015 due to both higher short-term rates and balance sheet growth. Assets as a holding company level increased to $15.2 billion at the end of the quarter and are up 50% from the same period a year ago.
So overall revenues are up 9%, but EPS on a core basis declined 3% -- these are on a year-over-year – to $0.69. The decline from the same period a year ago was due to headwinds that included weaker commissions, lower underwriting revenue, a higher comp ratio and increased bad debt expense, again, all as compared to the second quarter of 2015.
Since the end of the first quarter, we have repurchased 600,000 shares of stock. In May, we completed the acquisition of ISM. In June, we announced the sale of the legacy correspondent clearing, an independent business of Sterne, Agee. In July, we raised $150 million in preferred equity, issued $200 million of our 4.25 senior notes and redeemed $115 million of the 5.375 baby bonds. So we've been pretty busy.
So let me get a little more granular and go through our revenue and segment results. We increased net revenues again sequentially and annually. The improved sequential results were the results of improved investment banking revenue. Improvement in this line item augmented continued improvement in Asset Management revenue and net interest income, which both increased sequentially and annually.
Both Global Wealth Management and Institutional benefited from improved investment banking results and our recent acquisitions as well as our increased balance sheet. Total investment banking revenues of $133 million increased 32% sequentially and offset a sequential decline in brokerage revenue from the record levels that we achieved in the first quarter. We continue to generate strong fixed income brokerage result, despite a pullback from the first quarter level.
Turning to the next slide. Our Global Wealth Management segment continues to benefit from our recent acquisitions as well as growth in the balance sheet and revenue of $386 million. These growth initiatives have helped maintain a relatively flat brokerage and asset management revenues sequentially but resulted in year-over-year growth of 8 and 21%, respectively.
Net interest income was the largest driver of growth, both sequentially and year-over-year, as we added $1.1 billion of assets to the bank's balance sheet during the quarter. Total advisors were 2,838 at the end of the quarter. That would also include 540 independent advisors that were included in the sale of the legacy Sterne Agee business.
Total client assets reached almost $238 billion, but this includes again about 11.5 billion of assets that are included in the Sterne Agee sale. Fee based assets totaled 65.6 billion, up 3% sequentially and 13% year-over-year. There is some geography things some of the analysts may note and that we re-classed some of these assets into fee-based assets, and that something that we can talk about in questions and answers if there's any questions on that.
The increased revenue and sequential declines in both comp and non-comp expenses resulted in the global wealth pre-tax operating margin of 27.2% which is up 250 basis points.
On the next slide we look at the results of Stifel Bank & Trust which benefited from both an asset as we continue to conservatively lever our balance sheet. Total bagged assets are now 9.4 billion, increased 14% sequentially, to almost double from one year ago. Bank loan of 4.6 billion increased 23% sequentially primarily due to growth in residential mortgage loans.
Investment securities total 4.6 billion and highlights that despite the flattening of the yield curve in the quarter we've been able to grow this portfolio with reasonable yield, up more than 2%, duration of approximately two years and certainly solid credit quality. Even in the current rate environment we continue to be able to grow the bank by investing in loans for security that generate a 15% return on equity inclusive of our interest rate hedges.
Consequently, the current market environment is not impacting our strategy. But NIM at the bank declined 12 basis points sequentially to 236 basis points. The decline of the NIM is attributable to an increased investment, security-based loans and mortgage loans as well as increased Agency MBS holdings.
The loans carry lower yields and in terms of the Agency MBS portfolio we experienced faster prepayment speed that led to increased amortization expense which of course impacts our NIM. Additionally, the nim was negatively impacted in many ways we had rapid asset growth and as a result we funded it with an increased level of federal home loan bank deposits, which we did repay at the end of the quarter with our sweep deposits. But this increase by a funding to a federal home loan bank funding accounted for about six basis points in the decline of our NIM. Again, those have been substantially repaid by core deposits. The provision expense in the quarter declined to 1.8 million from 4.4 million in the prior quarter, but it's up 1.4 million compared to 2015. Really the additional reserve is primarily due to loan growth and that's to be expected as we grow the balance sheet. The percentage of reserves to loan declined in the quarter, it was really driven by residential mortgage growth security-based loan, they carry lower provisions for that asset class.
Net NPL and NPA ratios in the quarter were 80 basis points from 37 basis points respectively up from 63 and 28 basis points in the first quarter. The increase was due to a single loan that was placed in non-accrual status.
Moving to the next slide. Our institutional group generated $261 million net revenue up 8% sequentially, again, due to stronger investment banking revenue, more specifically due to strong advisory and equity underwriting revenue. They each increased 43% versus the first quarter. Not saying much as it relates to the first quarter, it was a difficult quarter but we did as the industry – sequential improvement in both advisory and equity underwriting.
The stronger investment banking revenues help to more than offset sequential decline in brokerage revenue from the record level we achieved in the first quarter of 2016. The improved revenues in the quarter and lower comp ratio drove off 410 basis points sequential improvement in the segment pre-tax margin which came in at 16.2%.
On slide eight, we look more closely at some of the components of institutional revenue. Our business benefited from less market volatility in the second quarter than what we experienced in the first quarter, except really at the end of the quarter we did see volatility with related to the Brexit vote. The increased business benefited advisory or stability, if you will, benefited advisory and the underwriting business and more than offset less active trading markets.
As both equity and corporate bond buyouts decline, our quarterly fixed income brokerage revenue was $81 million for the quarter and was down 3% sequentially but up to 50% year-over-year due primarily to our stern acquisition.
Our net revenue declined modestly. Sequentially our fixed income business continues to benefit from our recent acquisitions and represented 60% of our institutional brokerage revenues in the second quarter of 2016. We continue to increase market share in both investment-grade and high-yield, while also gaining traction in our new emerging market business.
Institutional equities revenue up $55 million declined 12% versus the strong first quarter of 2016 and was relatively in line with the 15% decline in industry wide average daily volume during the quarter. As I said in the past, the diversity of Stifel business model is a tremendous asset and the rebound in our investment banking business is an illustration of this.
Advisory revenues totaled 68 million and was up 20 million from the first quarter of 2016 which was the strongest quarters since the fourth quarter of 2014. Improve performance driven by overall increased activity as we do not have one single large fee throughout the second quarter, unlike the first quarter when we benefited from a large fee tied to the micro Simi deal.
As far as our pipeline, it remains solid as we continue to see decent activity from text to consumer sector. ECM equity underwriting revenue was 27 million and was up 42%, but again, very weak first quarter of 2016. While we are pleased with the improved performance, a note that year over year equity underwriting is still down 46%. The number of U.S. equity offerings increased 50% sequentially and is down nearly 30% from the second quarter of 2015.
The number of IPOs rebounded to 33 from nine in the first quarter it’s still which has that first quarter than the slowest quarter since the first quarter of 2009. While it remains difficult to predict near-term issue windows, our pipeline continues to build with quality issues preparing to excess the market. So overall, for equity underwriting, we continue to believe that despite the improvement there is still significant upside in this business for us as market improves.
In terms of our debt capital markets business, we continue to see very solid results in our public finance business as Stifel ranked number one in a number of issues-ish underwritten in the first half of the year nationwide.
Next we will move on to our expenses. So I can walk through both compensation and non-comp expense as well as the reconciliation of our non-GAAP results to our GAAP results. We are presenting this slide differently this quarter to better illustrate the non-GAAP charges we incur, as we get closer to the vast majority of these charges coming off of our books.
Adjusted compensation expense, up $410 million was up 4%. The quarterly increase was mostly due to higher revenue as our comp ratio was 62.8% which declined from 63.6% in the first quarter. It is actually the low the midpoint of our targeted range of 62 to 64 and as we continue to grow the balance sheet and if Investment Banking revenue continues to improve we would expect to see the comp ratio decline as these revenues carry a higher margin. But we continue to be comfortable with our prior guidance of 62% to 64% as it relates to compensation.
Non-comp OpEx came in at 158 million, up 2% sequentially at the high end of our forecasted range, 153 to 158. The ratio in terms of expenses to revenue was 24.2%, down from 25% in the prior quarter. Sequentially the increase was mostly attributable to higher travel for most expenses as well as elevated expenses on the litigation side and increased FDIC insurance cost.
While -- I just want to caution that legal expenses generally are lumpy and can move around. In terms of the reconciliation or GAAP results the vast majority of the adjustments that we make, the expense items are primarily the result -- but they are all the result of acquisition and much of that is related to how we look at purchase -- the way we purchase company. The total expense adjustment for a quarter was 68.1 million with 50 million related to comp, and $18 million related to non-comp.
In terms of our outlook for the third quarter of 2016, we think it relates to non-comp OpEx. We think at a range of 155 to 165 as appropriate to 155 to 165 million, but low end of the range accounts for the for the cost savings from Sterne Agee's sale and the higher-end accounts are the potential of the more volatile items which would be again increased loan loss provisions and any legal expenses which again tend to be more volatile.
This is a pretty good segue into slide 11 that provides further details on specific deals tied or non-GAAP charges. I've consistently said that our long-term approach to acquisitions was with structured transaction that maximize both associate retention and tax efficiency which we believe we have achieved in each of these transactions. The total charges as we forecast for the quarter were 69 million, it was lower than what we talked about. But that was because of stock based comp for Barclays will be fully realized both in this quarter and next quarter. And that have to do with timing issues associated with informing employees after the final dollar amount of the grant. So, net-net about $24 million of the charges that we expected this quarter will occur in the third quarter of 2016.
After 2017, I would note, that we have no further non-GAAP charges associated with this transaction or frankly any transactions on our books now as core and GAAP come together and start to come together a lot in fourth quarter but totally comes together at the end of 2017, actually the first quarter of 2018.
I would also note that is a function of the sale of the Sterne Agee businesses, some of the expected charges that we had in the third quarter of 2016 were realized in the second quarter of 2016.
Turning to the next slide there is an update of the slide we showed last quarter that focuses on the convergence of our core and GAAP EPS as a current deal related expenses runoff. GAAP EPS was impacted in 2015 as we not only have legacy deals coming to an end but the impact of two large acquisitions Sterne Agee and Barclays. This resulted in a $1.24 share differential between core and GAAP EPS.
In the first half of 2016, we have incurred $0.78 of GAAP charges, barring further acquisitions, as I have said we expected GAAP charges to substantially wind down beginning in the second half of 2016.
So, if you look at the impact of these deal related charges, compared to current consensus estimates for 2017, our GAAP EPS could effectively double in 2017 from 2016. We remain highly focused on integrating our current acquisitions in the most accretive ways possible. This was illustrated by the recent sale of Sterne Agee.
Over the past year, we analyzed how to integrate these businesses into Stifel. Our analysis indicated that the risk adjusted returns didn't make sense for us given the changes in the regulatory environment in the lower margins, really coupled with the lower margins generated in these businesses.
Our focus on integration doesn't preclude us from doing another acquisition if the economics would be compelling, but we felt it was the best use of shareholder capital to do this divestiture.
On the next side we quickly review the balance sheet and our repurchase activity, total assets continue to increase in the quarter. I think we said that we would achieve over 15 billion by this summer. I think we said that last year, and we came in at 15.2 billion as we continue to use our excess capital conservatively lever the balance sheet. Interest earning assets averaged 11.4 billion during the quarter; it's up 63% from one year ago.
Firm-wide NIM was 171 basis points. I've already talked about the decline in NIM and I would say that the same reasons are true here firm-wide is in the bank. One thing that I want to mention was the change to the chart on this slide. We increase the level of historical IDA in the slide as we believe that some of the revenue attributable in the past should've been attributable to specific aspects. So the adjustment here drove a decline in NIM.
As we continue to refine our disclosure, we believe this will better reflect what's going on in the balance sheet. We continue to maintain strong capital ratios despite the growth in our balance sheet. As you can see our tier one risk weighted assets improve in the quarter despite the asset growth as we continue to focus on CMBS and security-based loans that carry much lower risk weighting.
In terms of rate sensitivity, we see modest benefit from the 25 basis point December increase in Fed funds due to some of our loans that are tied to 90 day LIBOR, but the impact to our financial from this with material and we are maintaining our guidance of $66 million of incremental pre-tax income annually from a 100 basis point increase in Fed fund rates. We currently have 7.6 million shares remaining on our existing authorization.
As I said we purchase 600,000 shares to the state from the first quarter. In the last few slides before we take Q&A I want to touch on a few of the more important topics to Stifel in the near-term. We will continue the opportunistic in repurchasing shares. We continue to believe that utilizing our excess capital increases leverage in our balance sheet also offers very attractive returns. We've used the bar chart here for the past four earnings releases. First is the way illustrate how we manage our balance sheet as we invest in infrastructure and preparation for costing the $10 billion threshold and more recently to show how rapidly we have been able to grow asset while effectively managing risk.
Our balance sheet as I said is over 15 billion. We added 1.2 billion during the quarter. Our risk weighting, asset density declined, and so overall I think that – what that show is that we've been able to do what we said with the balance sheet.
So subsequent events and industry issues, as I said, we closed the sale of Sterne Agee, we issued 150 million of non-cumulative preferred shares, we can cut the effective way to optimize our balance sheet. We issue $200 million of senior debt while recalling 150 million of our 5 3/8 senior debt.
So with that, let me conclude by saying I'm happy with our results in the first half despite the challenging market condition. I believe we continue to operate well below our capacity and that our shares remain meaningfully undervalued.
So with that, I appreciate you taking the time to listen our call and your interest in Stifel, and operator with that, I'll take questions.
[Operator Instructions] Your first question comes from the line of Christian Bolu from Credit Suisse. Your line is open.
Good afternoon, Ron. Thanks for taking my question.
Just a couple of questions on the bank. On the investments securities line, I think you mentioned you're getting about 2% type yields on asset that have about two-year duration. Just give us a bit more detail on what you're invested in?
And then just talk also about the credit dynamics in the loan book, really, really strong loan growth but I believe loan losses were actually down. So, just a bit of dynamics there and how should we think about progressing going forward?
I think, what we've been doing is what we've been doing in the past. We – our portfolio consists of agency MBS/CLO corporate bond. We've purchased some securities and we purchase some loans, all of which are at attractive risk adjusted returns.
I think some of that question can be in some of the cases I believe that when you purchase loan, purchasing them at effectively fair value versus originating where you put some provision on. But that's not that material, but we have overall what you'll see is, what we've always said in the bank is that we believe that with our low funding base and our efficient model, we can generate 50% ROEs by not taking a lot of risk and that's evident in our NIM.
So, I don't – there is nothing really that change in the quarter other than the fact that as I said previously, we had really throttled our growth for a few years and this is just indicating that we can grow and grow with acceptable return on equity.
Okay. I only ask because I guess, the yields a little higher than somewhat we have comparison, but I hear you. Maybe just on how you pay or how you compensate on bank related earnings? I guess, the comp ratio is higher year-over-year thus by the significant increase in interest revenues. So how do you think about compensation for that line?
I -- that's a fair question. I mean, compensation is all things being equal, if we were operating what I felt was more full capacity of the investment bank, which we're not. I mean, I'm very pleased with record revenue, but we'll tell you that in this environment all things being equal. I'm actually disappointed with where our revenue is.
We've had – it's a very difficult environment and despite our record revenue, we can be higher. So, as we have left revenue, our expense ratio might otherwise be higher. Of course, net interest income, which carries a much lower comp rates will drive a bit lower. So I don't -- I can't give you the components, but I understand what you're asking and if we were operating at a more what I would view, robust environment on the non-interest income, the operating revenue side, our comp ratio would be lower.
Okay. And then just trying to understand how much more of the potential balance sheet side, we know you target on the 18 billion, but just -- can you just let us know how much client cash you still have off balance sheet today?
Well, at this point, without giving -- I would say that we have more than we can deploy right now, okay. I mean, to get to 18 billion and we've obviously looking forward, but we have customer deposit core's as I view with our – it's our clients sweep deposits. We have more than we can utilize right now, Christian.
Okay. And just my final question maybe just have taken a step back on acquisitions, when do you look at the contribution of maybe Sterne and Barclays post-acquisition, maybe any lessons learned or does it in any way change the way you think about M&A going forward?
No. I would say that, as I have said in the Sterne deal. As I have said at the time we did the deal. We wanted the traditional branch offices. We wanted the fixed income of businesses that really supplemented and improved our credit business. We did not want the mortgage business. We sold it. We did not want the institutional equity business. We sold it. And we looked at the independent clearing with optionality.
Since we have done that deal some things have changed on the regulatory front that have changed our overall view towards those businesses. We sold them well within our models to how we value them. So I don't know that I am not sure what was learned.
I think what you can take away and what our investors can take away from this is that we evaluate all of our businesses on risk-adjusted returns. We are not looking just to grow for growth's sake.
If we don't think a business that fits our core objectives we will do what we have done in the past and that is in this case we divested of that business. As I have said, the potential of the Department of Labor of Rule I think has sort of a disproportionate impact potentially on the independent business and that certainly weighed into our thought process plus the business was needed restructuring with what we had was a low margin business.
So we just felt that with everything we were doing we would be better to redeploy the capital and this transaction is accretive to what we're doing going forward. As it relates to Barclays, that's a great transaction. Almost all of that transaction is the purchase price is in compensation expense.
Some people don't like that we transaction – do things by doing compensation expense instead of purchase price, but that's how we do it and we would do it again, so that effectively the purchase price is retentive over eight to nine years and the only thing that I've learned from that transaction as I would like to do it again.
Okay. I guess maybe just – do you have a number for what the – when you look at the contribution today of those deals what the risk adjusted returns are?
Of course we do and I think that while I don't have them here you can go back and when we did the Sterne Agee deal we showed the contribution and what we expected on our risk adjusted – return on investment, return on Investment including any non-GAAP charges that we had. We include that in our investment.
I would say that as I said of Sterne Agee the fixed income and traditional wealth management businesses are performing very good on a relevant basis. The markets are difficult and obviously we divested the businesses that we did. We also disclosed our effective purchase price of Barclays which included what we paid to seller and what we paid for retention.
In stock-based comp that's running through, you can go back and look at that slide. I would say that business is performing with the exception that there and elsewhere the, the calendar – the equity calendar, the last thereof of the syndicate has impacted the same-store sales that you will both in that business and overall on Stifel but that's more market driven than it is any client engagement or any other performance issues, I just that there are very little going on in equity capital market.
Okay. I appreciate the detail. That's it. Thank you.
Our next question comes from the line of Steven Chubak from Nomura. Your line is open.
Hi, good afternoon.
Ron, just had a follow-up relating to Christians earlier question about some of the NIM guidance and recognized there are a lot of different moving parts to this quarter. But I'm just wondering how we should think about the NIM outlook or trajectory based on the current forward curve given that the FHLB deposits have been repaid and assuming that some of the other variables you mentioned the 2% reinvestment yield and the targeted 50-50 mix of loans versus securities you talked about before is maintained.
Yeah. Well, I would think that – I would that as we continue to grow I would think that 50-50 as it becomes more loans and NIM will expand by definition and I would say that as it relates to this quarter, all I will really say is, I believe the NIM was compressed this quarter for the reasons I gave you, and looking forward, I would expect it to go back to what it was more historically and that historical NIM is reflective of our loan funding costs, our hedged strategy and our conservative viewpoint both on loans and on investment.
But for the quarter they were factors which I have discussed that compressed the NIM by 13 basis points, if I remember what I said and as I said 6 of that was – that we had a lot of growth and we ended up funding to some of that growth with advanced, to Sweep deposits, although we did move those Sweep deposits towards the end of the quarter. Not an immediate switch but from funding perspective. So I think, look I think the NIM was compressed and it will go back to more historical levels and I think we will continue to grow our balance sheet.
Got it. And thinking about the capacity to onboard some additional deposit, I know you were speaking about that earlier, I noted that given some of the capital constraints that might preclude you from doing so, but thinking about optimizing your capital structure and the fact that you guys actually issued some qualifying preferreds in the quarter, how are you thinking about optimizing that mix of common versus preferred's? And would you may be use the additional preferred issuance as a vehicle for expanding balance sheet, possibly beyond that $18 billion interim target.
Look. First of all I don't think I said we were constrained. I want to be clear, I didn't mean to imply, if I did that we were constrained in balance sheet growth by our capital ratios. And in fact, we are not at our target level what happens with that is that, first of all as it relates to that growth we're generating a lot of cash. We are generating a lot of earnings and we have a lot of deposit.
So I can see if you put all of those together, we are not constraint with balance sheet growth. The flipside of that is to the extent that we decide that a better use of capital as repurchase shares that obviously impacts our capital clearly. But we have been growing and I don't feel constrained by the capital ratios at this point, nor do I feel constrained by funding constraints.
As it relates to the preferred it is really pretty simple math and that as we continue to leverage and if you look at it just from a perspective of whether or not we have repurchased shares or we use that preferred which is tier one capital, as you know, when we look at our capital structure, we just need to beat the hurdle rate of preferred interest rate. And so, we believe that that preferred with that coupon helps us leverage our ROE to come in. So, it is really just a component of tier one capital. And it is a way to trade, if you will returns on tier one capital which we believe will be above the fixed change yield on the preferred.
Got it. And just one more follow-up for me – actually maybe switching gears for a moment to the fixed income side. You managed to put together a string of two to three really solid quarters in a row, the fee is running in that $75 million to $85 million a quarter range. And I am just wondering whether that's – is a reasonable expectation going forward. But also, how we should think about seasonality in your business since, I know, it's quite a bit different just in terms of the mix and how much flow versus derivative compared to some of your ballots racket peers?
Yeah. Well first, we have never been really a manufacturer and a – where we are driving revenues through securitization and buying and packaging and doing that. Our business is a more traditional by servicing clients business. I view the fixed income market and a lot of people who question it the way I look at it. The fixed income market has expanded substantially. Just look at corporate issuance over the last four to five years. Corporate bond outstanding are what up 400% yet the industry is reducing capacity to service that. We have a talented group of people across the spectrum of both race and credit.
And at one point sort of the tailwind of declining rates might be replaced and eventually hopefully will be replaced with rates rise. But the need for having what we built when the flow is reversed, the company is issuing bond fund buy that's easy, bond fund sell and you got to place that that's going to enhance what we have built on the sales and trading sites. So we like what we've done and we put some good quarters together. I think it's a highly fragmented market where people are pulling back and so we like our prospects.
As it relates to muni finance, a little bit different story, muni finance because of their rates, muni finance is a business that many could argue if near cyclical high because of refinancing activity.
I certainly wouldn't argue with that. But as I look forward, what I see is the potential for policy-decision at the Fed level which encourages to various means, infrastructures spend I think that's actually everyone saying that and so to the extent infrastructure spend may then help the muni finance business as refi by definition go away. So overall I think our fixed income business is in great shape. We have great business. We're gaining market share. We don't take a lot of risks.
Thanks Ron, for the helpful detail. Appreciate it.
You are welcome.
Your next question comes from the line of Conor Fitzgerald from Goldman Sachs. Your line is open.
Good afternoon. Thanks for taking my questions. First, I appreciate the new breakdown you gave on the adjustments on the expense side, but hoping you can elaborate on a couple of items. One, just what exactly are the duplicate costs in compensation? And then on that same topic is why have duplicate costs for non-comp grown quarter-over-quarter, just appreciate some clarity on both of those?
Yes, well, as we disclosed the biggest item is the stock-based comp that the way we structure transactions is that when we determine a value for a deal, and you have to go back and look at our analysis of Barclays that I don't have it in front of me now.
But we said that of that deal that they would stocks-based compensation of approximately $60 million that we would instead of giving to the seller, we would give to our new partners and then we run that through a fact-based comp as a charge. So that's the stock base comp. Let me look in the slide, are you asking on the slide about the duplicate comp, the $3.3 million?
Yes, $3.3 million.
Yes. That's really related to the Sterne business which we were converting. So we had duplicate comp for running to operations centers that we built in the purchase price, but then we expect it to go away. You won't see that going forward. You won't see that going forward anymore. We still that business so that's gone.
Okay. And then just that's what drove the increase in the non-comp, business line the 113? The same Sterne business?
Yes. Again, if you look, this is consistent and will be consistent, we projected these costs and those were the expenses that were acquisition related that we are intended to go away as we fully integrated those businesses and the fact that. In this case, we changed our mind as related to these last businesses and we sold them so they go back away.
Okay. Got it. And then maybe a two part question, maybe just help on the modeling. But could you give us a little bit sense of exactly better sense of exactly when you expect the Sterne correspondent business clearing, the sale to close in 3Q?
Okay. So following up on that, if I back out some of the non-comp costs from that – you are saying that was not included in core? So your core 150 eight of the adjusted non-comp did not include anything from Q2 perspective from the correspondent business?
Well, no, again. What we do, what we do is that we look at, as I've said on a core basis with what we expected to keep after we eliminated the duplicate expenses, the Sterne business contributed about $100 million of revenue and was marginally profitable on a quarter basis. It was a low-margin business and so we haven't disclosed what the non-comp OpEx in that business was. But I'm telling you that it was marginally profitable.
And we do disclose the non-comp expenses that primarily relates to the duplicate operating center that we were going to close. And so going forward I would say that you will be on a quarterly basis of about $25 million in revenue go away, a little bit, a very little core profitability, but more than offset by the fact that we had capital deployed down there and we will redeploy that capital net, net the sum of all of that's accretive .
Okay. Thanks, that's actually very helpful. And then just following up on the guidance for non-comp expenses on a quarter basis, next quarter to be in the -- I think if I heard you right 155 to 165 range. Can you just talk about what's driving the quarter-over-quarter increase?
Well, we are at 158, right and I think that if you look at these things and there are items, as I said, there is items that can fluctuate that are not is easily predictable. Take loan loss provisions depending on how and what you do in C&I loans and how that runs through non-core expenses or provision. So I am comfortable with a range. We have a little bit of downside because we do save some expenses on Sterne and we have an upside but, I would rather have a little bit more of range here than trying to have more precision where precision does not exist, and that's that. So I'm trying to give you the best I can.
Okay. Appreciate the color. Thanks for taking my questions.
Our next question comes from the line of Chris Harris from Wells Fargo. Your line is open.
Hey, good evening. Question about the bank, we haven't really seen a full credit cycle there yet. I think you guys had less than $200 million or so of loans there back in 2007. So really just wondering how you feel like the bank is positioned if we do get a turn and the cycle. And then in particular, I would like to hear how your C&I loan book is positioned for that kind of environment.
Well I think that as evidenced again by the NIM and where we take credit risks, I think we are well positioned. We went through a pretty severe energy cycle here as one, so it isn't that we haven't had any credit events since 2009. We positioned the bank to be very high quality both our investment portfolio is very heavily weighted toward agency type portfolios. So, you know, hopefully take great credit risk and the U.S. government is AAA, and then we hedged interest rate risk and so that's how we look at it and we have been consistent on that. The C&I book, as I look at it, we have grown, we have been over – we grow from 200 million to 9 billion, and we've had the bank for nearly eight years. So there is some history there.
I think we are well positioned. I am not going to give out a prediction on that. I'll look at our NPLs and our nonperforming assets and look at it historically, and you know that's what we would like to believe, but I am not sure what the next credit cycle or credit crisis is going to look like, so I am not going to try to predict it. But I believe relatively we have a very conservative balance sheet.
Got you. Okay. And then in the advisory business, if we just look at your productivity ratios, they are down quite a lot year-on-year. And it is just not Stifel phenomenon, this is sort of happening everywhere, and a lot of the explanation we've getting is sort of market oriented reasons, but I'm wondering if you could expand on that? Whether you think that's the only reason or whether you think so the regulatory overhang with the DOL is having an impact on the advisor productivity business. You just look at the numbers and you have to go all the way back to 2009 to see this kind of productivity numbers. So it just seems like really a pretty big overhang just from recent market events, so maybe you could expand a little on that.
Look. Think that – I don't know what numbers you are looking at. I don't know how you are calculating it. But what I will say to you is that if you look at what we've disclosed, one of the things for us and one of the reasons we looked at it, is the average productivity in the independent business was significantly below the traditional business. So, you know, the increase that you saw as it related to the Sterne independence and the number of people we added, and then we have said that we sort of – we divested of relative to the $25 million quarterly revenue that I gave you is going to give you a big chunk of what you are talking about.
DOL is really not having an impact. I think that that rule is still being digested. There's – as it relates to getting down to the advisor level, I doubt that there would be very many firms at all that would say that the DOL is impacting productivity at the advisor level, because they're not even know – knowing about some of the things that are going to be done. It's – we're like everyone, well along in our analysis and have plans. But I don't believe that impacted advisor productivity or client engagement in any measurable way at all.
And overall, though, I would tell you that if the industry and maybe us, if you looked at it, if average production in traditional is down to 5% to 8%, 9%, that's reflective of the market. And know that's sort of year-over-year. I don't really know what it was back and I believe that productivity certainly up compared 2010. But I would look at your numbers after you exclude the independent contractor impact on productivity per advisor.
Okay. Helpful. Thank you.
Our last question comes from the line of Devin Ryan from JMP Securities. Your line is open.
Hey. Good evening, Ron. How are you?
Maybe one here on Brexit. Obviously, the U.K. and Europe are smaller businesses for Stifel today, but you've done a couple acquisitions over there with Oriel and ISM in recent years. So just trying to think about – is that an area that as maybe your peers are not investing or retrenching where it kind of in your contrarian way may actually look to get bigger? Or is it just a backdrop where you say, we're actually happy that Europe, or U.K. is not a bigger driver of our overall business, usual account over the next year or couple of years?
Dev, I hesitate to even ever say that I like to grow when other people aren't growing. That doesn't seem to be path of the comment. But I do and we are contrarian. And I view – my view on Brexit is, first of all, is it even going to happened, and we can leave that for other people in terms of what it actually means in both, article – the article and actually do it, I think there's a lot going on over there. What it means for is interesting and that – what is means for us is that our business and one of which is ISM, Oriel, Knight and our distribution, primarily to a lot of U.K. accounts to the UK and to London in particular. So to the extent that Brexit overall causes a decline in economic activity in the UK in and of itself, that's our biggest impact is because we're focused on that but the other, the way I look at it and what I keep hearing from everyone and that would be really don't look at London as a passport into Europe and we don't have a bunch of people sitting in London that are really doing business elsewhere. What I think might happen is that there may be some real opportunity for us as people consider what they are going to do their.
So it's not a big business for us. It's profitable but net-net I would look at that market as actually from where I sit today, I would look at it as more opportunity than something I would be concerned about.
Got it. That's helpful. And then just on the DOL, I understand complicated rule and still being digested and I know we're still waiting from some kind of follow-up clarification from the DOL, but you spoke to having plans. And so just trying to think about we're getting to a point where I suspect we're going to start to see real action from companies, we haven't seen heck a lot of yet. So I'm not sure if you can share anything else around kind of what you are thinking about is the next steps internally, and then if there is any you can share around what are those plans entail? That would be very helpful.
You know, Devin, I am not, I am really not prepared to at least discuss on an earnings call, you know, execution and implementation plans around DOL other than to say you know we've got teams looking at this. We're contact with many industry participants. You know more lawyers than I can count in some cases. It's a complicated rule that the devil is always in the details when you start looking at these things. And I think we in the industry are digesting it, I feel that we do have a plan that will provide our clients and our advisors the ability to properly navigate this rule when it's required to be done so which is you know April and then many of the rules in many ways in January of 2018. So I would tell you I am confident with our strategy. I'm confident with our position, but specifics, I am not prepared to talk about.
Okay. I figured I would try. Thanks a lot, Ron. Appreciate it.
There are no further questions in queue at this time. I will turn the call back over to our presenters for any closing remarks.
Okay, well, I would say that all things considered, what we have talked about at the end of last year which was that we would like all of our shareholders to look at us as we continued and levered our balance sheet. You will see the earnings potential that we have today, despite the fact that I still believe that the overall market environment is quite challenging, that our revenue potential for what we built is higher.
I still believe that you will see the continued earnings power of the company as markets improve. And even as they are today, they certainly are acceptable. But we will continue to properly lever our balance sheet. We will continue to effectively look at our capital levels both from a share repurchase and leveraging perspective.
We have shown how and we will continue to show how our core and our – I mean, our adjusted and our GAAP numbers come together. And we will continue to do what we've done for a long time which is to build a premier investment bank and wealth management firm and that is our strategy. And I thank you for your interest. And look forward to talking to you next quarter. Have a good evening.
Ladies and gentlemen this does conclude today's conference call. Thank you for joining us today. You may now disconnect you lines.
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