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Stifel Financial Corp. (NYSE:SF)

Q3 2012 Earnings Call

November 5, 2012 8:30 am ET

Executives

James M. Zemlyak – Senior Vice President and Chief Financial Officer

Ronald J. Kruszewski – Chairman, President and Chief Executive Officer

Thomas B. Michaud – President and Chief Executive Officer, KBW, Inc

Analysts

Devin Ryan – Sandler O’Neill & Partners LP

Hugh M. Miller – Sidoti & Co. LLC

Christopher Harris – Wells Fargo Securities, LLC

Patrick O’Shaughnessy – Raymond James

Alexander Blostein – Goldman Sachs

Glenn Schorr – Nomura Securities Co. Ltd.

Judy Delgado – Alpine Associates

Anthony Christopher Reiner – Cantor Fitzgerald & Co.

Christopher Harris – Wells Fargo Securities, LLC

Operator

Good morning. My name is Sara, and I will be your conference operator today. At this time, I would like to welcome everyone to the Stifel Financial Third Quarter Earnings and Merger Announcement with KBW 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)

I would now like to turn the call over to Mr. Jim Zemlyak, CFO. You may begin your conference.

James M. Zemlyak

Thank you, and good morning, operator. Good morning, everyone. This is Jim Zemlyak, CFO of Stifel Financial Corp. I’d like to welcome everyone to our conference call today to discuss two items of importance; number one, our third quarter results, and secondly, our merger agreement with KBW, Inc.

Please note that this conference call is being recorded. If you’d like to follow along with today’s presentation, you may download slides from our website at 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. Slide number 1 of today’s presentation covers this in greater detail. Forward-looking 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 Report on From 10-Q.

With that, I’d like to turn the call over to our Chairman, CEO, and President of Stifel Financial Corp., Ron Kruszewski.

Ronald J. Kruszewski

Thank you, Jim. Good morning, everyone. First of all I’d like to apologize for the delay. We have literally hundreds of people that were calling in and we wanted to have some time to allow people to get out of the queue and onto the call. So we did delay for a moment. But I want to be respectful of all of your time and we will get going. It’s very, very exciting day for people and I think KBW with me as Tom Michaud, who is CEO of KBW. Tom and I are going to talk about what I think is the real exciting news, which is our strategic merger with KBW. But before we get to that, we released earnings this morning.

And so, I thought I would do sort of an abbreviated call on our earnings. I’m very pleased with our third quarter results. It included record net revenues, as well as record net revenues and net income for the first nine months of 2012. Our results highlight the soundness of our balanced business model particularly against the challenging economic backdrop. In the quarter both Global Wealth Management and Institutional Group segment performed well.

And as you will see today, we continue to invest in businesses that expand our client services in which we believe will return shareholder value. Opportunities drive our growth in today’s announcement of our merger with KBW furthers our goal of creating the premier Middle Market Investment Bank with a specialized focus certainly on the financial services industry today.

In the third quarter, the major industries moved higher and the Fed announced their much anticipated QE3 program and investors gained confidence with what is happening in Europe. However, the global growth prospects, pending election, fiscal cliff, concerns all crept back into the market towards the end of the third quarter and have continued today. Given that backdrop, I’m very pleased with our results for the three months, in the third quarter, we have record net revenue of $420 million, was of 26% compared to last year. Results for the quarter include realized and unrealized gains on our investment in Knight Capital of $25.6 million pre-tax to $0.09 per diluted share after-tax.

Excluding Knight revenues of $395 million, or 18% above last year’s third quarter. We recorded net income of $37.7 million, or $0.60 per diluted share, compared to net income of $22.3 million, or $0.35 per share last year, excluding Knight EPS of $0.51, or 46% above the third quarter of last year.

Pre-tax margin improved to 15% and was 13% excluding Knight, that compares to 12% a year ago. For the nine months ended September 30, we posted again record net revenues and net income, net revenues of nearly $1.2 billion, increased 13% as compared to the first nine months of last year. Net income of $98.6 million, or $1.57 per diluted share compared with net income of $57.1 million, or $0.90 per diluted share in the year ago period.

Results for the nine months last year if you recall included a $0.47 per diluted share after-tax charge related to previously disclosed litigation and merger expenses. Pre-tax margins of the first nine months were 14%. The next slide breaks out our sources of revenues. Comparing year-over-year results lower industry volumes, I have continued to put pressure on our commission revenues, which declined 11% to $128 million. Our principal transaction revenues increased 34% to $103 million, that was really due to our strong fixed-income trading volumes and which were further helped by tightening credit spreads.

Investment banking had a great quarter; investment banking revenues increased 94% to nearly $73 million, up from $37.7 million. The year-over-year increase was a result of an increase in both equity and the fixed income capital raising as well as strong advisory revenues due to completing more transactions.

Now, I would like to comment the merger that we announced about this time last year with Stone & Youngberg has contributed nicely to our results and fixed income origination. And I am also pleased to tell you that that merger is fully integrated, everyone is on Board and we are doing a lot of business with respect to the merger. Asset management services fees increased 8% to $62.9 million.

I will now provide details on our segment comparisons for the quarter results in both our Global Wealth Management and Institutional Group were solid. Revenues compared with year ago quarter increased in both segments, Global Wealth was up 15%, our Institutional Group was up 50%. The revenue mix was split 60% from global, the balance of 40% from the Institutional Group. That is an improvement again from the Institutional Group. We did record our Knight gain in our Institutional Group, so that did help. Our Global Wealth operating contribution increased 23% and our Institutional Group’s operating contribution was $33.4 million, which was up significantly over 250% compared to the third quarter of 2011.

On our last earnings call I walked through the impact of our year-to-date investments, which we view as a key component of our strategy to grow the business. I want to update this chart to show both the impact and future potential. Through October 31, we’ve hired a 132 financial advisors and 65 fixed income sales and trading professionals.

In the nine months ended September 30, our core business, which excludes these investments that I talked about last quarter, generated diluted EPS of $1.73 with a compensation ratio of 62.9 and pre-tax margins of 15.5. The revenues generated by our new investments were approximately $29 million, while total expenses were $45 million. This impacted earnings per share by 15% reducing our margins by a 170 basis points.

I just want to highlight that we worked, not really that we worked to reduce the negative impact, it’s the fact that these investments are coming online. And you can see that in the third quarter the impact was $0.02 versus $0.074 and $0.06 for the first two quarters. And as our investments mature, a lot of it is new offices that we open, we expect them not to not really be a drag on earnings, but to increase our earnings. We have not veered. As you are going to see in a moment, we are going to talk about, we certainly announced veered from our strategy of investing in down cycles. We continue to position the company to take advantage of opportunity.

And with that, I want to turn to our strategic merger with KBW. And I again cannot tell you how excited I am to be able to partner with the preeminent brand in financial services, 50-year old firm that has been a good and tough competitor and one that I am pleased to be able to now say is a good tough competitor but my partner. So, Tom, so let’s take a look at that, I’ll try to get through this pretty quick, give you a sense of how we’ve looked at this and then open this all up to some questions.

So why this combination makes sense? Look, we create the dominant force in financial services, includes equity research, equity, and fixed income sales and trading and investment banking highly complementary on the investment banking, research sales and trading platforms. We do have significant synergies, but we are going to maintain KBW’s premier brand.

The financial institutions, Tom has assured me, is poised to benefit from improving fundamentals. This will also leverage our Global Wealth Management and Capital Markets platform. And this deal is expected to be accretive to Stifel in many ways, not just financially, but across many ways that you can measure accretion to the overall value of our franchise.

So looking Stifel and KBW today, I thought I would sort of introduce KBW and then I will introduce Tom and tell you what he saw in Stifel. But when we look at this transaction with KBW, it’s a leading, it is the leading global investment bank focused exclusively on the financial services industry approximately 448 associates in 10 locations celebrating your 50 year, so congratulation.

But what I like about all this is all the number one advisor in the U.S. financial institutions, number on manager of equity offerings for financial institutions, only boutique with comprehensive research coverage with financial services globally, 390 stocks covered in the U.S., number two best financial sector research firm by Bloomberg. It has the largest FIG specialist sales force globally one that we intend to keep and to, the clients are going to see no change from the services they’ve had. It’s a top 10 trader in the NASDAQ Financial 100. It’s a great firm, Tom.

Thomas B. Michaud

Well, thank you, Ron. Thank you very much for all those nice words about our firm. And thank you as well to everybody who is on the call with us this morning. I have to tell you that we’re very excited about partnering with Stifel Financial. We believe that this is the right deal for our shareholders, for our clients, and for our employees.

And like Ron said, I’d like to tell you a couple of things about Stifel that got us very interested in partnering with them. I think number one is the fact that they’ve been very successful. One of the things we do quite often around KBW is studied stock performance. And if you go back since the time that we went public back in 2006, there is one standout in terms of stock performance, and that’s Stifel Financial. And I think that the company has done right by their shareholders and we’ve been very supportive of the strategy, and we’re delighted to be joining them.

When you look at Stifel, I think something that stands out is their financial consultants where they have over 2,000 financial consultants generating over $1 billion of revenue. That’s a greatest stable base for an investment banking company. Also we love the vision of the company which is to be the leading Middle Market Investment Banking firm in the country. When you think about our expertise, when you get into that mid and small-cap level of financial services it still is very unconsolidated.

And those companies are very much in need of services that now the combined piece at Stifel are going to offer when you think about fixed income, merger advisory services, capital raising as well as just trading their stocks. And many of those mid and small-cap companies also have very heavy retail ownership and we’re very much looking forward to being able to work with those clients and trading the shares of those companies.

Also too, Keith and Stifel have shared a passion for the old-fashioned approach to research, which we think that is very valuable. And we’re excited about the platform at Stifel, which is so broad, combined we’re going to have one of the largest research platforms in the nation.

Also too we’re excited about all the capabilities that have been built in fixed income. We have some fantastic relationships around the financial services industry and we think that we’re going to have a great opportunity to plug into that platform.

Ronald J. Kruszewski

Well, thanks Tom. If you look, as I’ve said on many calls, I think that our business model and turning to the next slide is based on balance, we would like to have that balance to be 55% to 60% Global Wealth Management change as opportunities come. This slide just shows that we’ll go from about 62%, 38 Institutional of about 54%, 46%. And firm is certainly achieving scale in revenues. Our annualized net revenue base on the nine months is over a $1.8 billion. And again I think that the combination from a balanced perspective makes a lot of sense to us.

So let’s go over the summary of the key transaction terms. Stifel will acquire 100% of KBW’s common stock, and importantly and we’ll talk about this. We looked the valuation at $250 million of KBW’s excess capital is estimated to be available to us at closing as it relates to consideration. The KBW’s shareholders will receive $17.50 per share or shareholders that will be $10 in cash, and $7.50 in Stifel’s stock.

You can read the press release. The stock is collared between any of the floating exchange rates. You’ll get $7.50 per share if our weighted-average volume preceding the merger is between $29 and $35. Under $29 and over $35, the exchange ratio becomes fixed. But more of that detail is in the press release, restricted stock that will be really changed for the most part for Stifel stock at $17.50.

Our significant synergies, we’ve already identified them as we do. But there will be very few clients facing changes and our cost savings are principally from redundancies. We’ve assume no revenue enhancements in our financial modeling. Although, I do agree with Tom that I think that there is a lot of capabilities that we’ll bring together and I’m look forward to really building out together our fixed income model, where we’ve been investing.

I’m pleased to welcome Tom to the team. He will be joining the Board with another KBW outside director. Tom will be Chairman and CEO of KBW division. He is actually being a separate legal entity within Stifel. And I think importantly, and this is the point that I want to emphasize to the investors and people that have looked at our deal.

And so those of you who have followed, us you know that I’ve already said that our philosophy is that we only want to do transactions with people that want to them with us. And so in every case, we’ve always asked key people to agree by signing retention agreements that have that really commit them to the combined platform in this case for I think it’s almost 14 months, assuming we close.

And here Tom, we haven’t heard the update yet, but I know we went out to a number of people and…

Thomas B. Michaud

Yeah, 85 of our top colleagues have signed on and have guaranteed the fact that they will be with us for the next 14 months.

Ronald J. Kruszewski

How longer than that, but we’ve kept that to agree to that…

Thomas B. Michaud

Yes, absolutely.

Ronald J. Kruszewski

…and again that speaks to the fact that the top people here today are not listening to people say, what’s going on. They already understand the benefits of this. We’ve explained the benefits of this merger, and we’re going after today. And I’m trilled that’s nearly everyone that we have and congratulations on that.

Again this approval, this customary regulatory approval, this will require obviously KBW shareholder approval. And finally Tom, I want to say that we’re honored to partner with you in continuing your commitment to 9/11. I know the importance that is to your firm and I am certainly honored to partner with you on that.

Thomas B. Michaud

We appreciate that. Thank you very much.

Ronald J. Kruszewski

So looking at the transactions financials, the way you looked at looked at this, and Tom and I have talked about this, I mean frankly KBW is over capitalized. And so we have identified as I’ve said $250 million is really in excess liquidity. And so what we’ve done as we’ve looked at the purchase price growth, but then we’re taking out excess capital of $250 million is really being financed off of their balance sheet.

If you look at it that way, then you’ll see that all the pricing multiples make a lot of sense in deals that have been successful for us in the past. The price to average three year net revenues in both cases is well within what we’ve done in the past. The purchase price stated tangible and adjusted tangible are all very reasonable, and this transaction is accretive both to EPS and book value per share, and I will talk more about what about that.

But it’s important to understand the overcapitalization when we look at valuation. If you look at how we look at this, we will attractive the returns based on conservative modeling. We look at our equity investment. We take our purchase price, we add in our after-tax, we test and we deduct out our excess capital in.

And then we look at what we’re going to use of our balance sheet to right size the equity investment, which we believe is in the $262 million range. It’s about we think our incremental shares will be about 8.9 million shares that we’ll put out. We believe that we’ve looked at revenues between $250 million and $325 million. We’re just trying to be conservative based on trough year for you, and you’re near the $250 million level, but in a difficult year. And we believe that we will have estimated non-comp operating expenses of about $64 million.

So if you look at all of that what we believe is that our expected return on equity will be between 10% and 16%, and we believe that it is approximately 5% to 7% of accretive to EPS. As we’ve done in the past, we identify the cost that need to be eliminated. We will tell you what those are. But once those costs are eliminated we believe that on a core basis, this deal is accretive to earnings per share.

Tom, you’ve told me a number of times that this is the time to invest in financial services. I’d like to welcome your state of mine.

Thomas B. Michaud

Yeah, well, hey we do think there are opportunities, but frankly in most markets there always are good stocks to buy. But we’re excited about some of the trends that are happening in financial services. If you look at the top right part of this chart, you’ll see that for the first time since 2006, financial services stocks are starting to outperform the market, and we think that’s the positive opportunity for us. As you look over the left part of the slide, you can see some of trends that we continue to monitor and to follow. Number one is that the nation still has 7,200 depository oriented institution and we feel there still is a lot of consolidation ahead of us.

The operating environment is quite tough for many banks. Most banks did not saying that interest rates are going to be this low for this along and we think that could be a real strategic catalyst going forward. The credit quality in the industry continues to improve. We had 10 straight quarters of improving non-approval loans, and typically when credit quality is improving in the banking industry that is a leader for more consolidation activity. And also too, the Basel III changes in particular, where banks are down as well as $500 million in asset are now being required to follow many of the Basel requirements, which I think was a surprise to most of the industry.

And then on the bottom right of this chart, you can see what financial investment banking fees typically mean to Wall Street. And like the weighting in the stocks, for example 22% of the Russell 2000 is weighting in financials. Financial services investment banking fees are quite substantial. And we believe on this new platform we’re going to have an enhanced ability to go after many of those fees.

Ronald J. Kruszewski

I believe your comment as I’m excited to do this, I believe the financial services sector is going to significantly rebound and provide tremendous opportunities in investment banking and as an investment sleeve for many of our investors.

So the next slide just looks that our combined platform will be the dominant force in the financial services vertical. And what I’m mostly talk about the slide is just number ones, so I mean, in investment banking number one depository book runner, number one conversion advisor, number one FIG M&A advisor, we will be the most trusted advisor to financial institution.

James M. Zemlyak

And then in equity research, the combined firm is going to have the largest platform for equity research which, again, both of us share the vision that that’s very important, as well as the number one depository equity research coverage. We are going to have a footprint of 427 companies under coverage.

And then in terms of sales and trading, we have invested a lot in developing a specialist sales force which is going to continue to operate under its own brand. And we’ve also invested a lot in trading and market making. We’re going to continue to make a market in a very broad range of stocks, which I think is going to marry up very nicely with the private client business of Stifel.

Ronald J. Kruszewski

That’s right. And as I said our FIG and we see significant growth opportunities in fixed income. We’ve done a major growth initiative for us. We’ve hired, as I said 65 professionals this year and we have a focus before we did this, and I think it’s highly fragmented in the depository space and I’m looking forward to being a major provider of fixed income services to depository.

So if you look, I think I will turn now to our operating strategy. The addition of KBW adheres to our philosophy of building out highly focused specialized business. So within an integrated platform and we’re looking at how and it’s very important that explain on this call that how much we respect and the KBW brand and the specialized sales force and your research.

And so what we are looking at here and we are trying to show a slide somewhat busy, so we look at how we look at our business. First of all, our Global Wealth Management business we’ve talked about at equal private client in our banking trust, our bank today is almost $3.5 billion, but that is revenue of about $1 billion. And then if you look at the way we will look at our Institutional Group, you can pick up in two ways. Our Middle Market experts that Stifel has in all of our research but not in Fed and it’s about $600 million business between fixed income and equities, it will continue doing what it’s always done and what we are now going to add to that and we’re going to combine the best of Stifel and we have very good research in FIG and investment banking and in trading. We’re going to combine that and merge that into what will be the KBW brand within Stifel.

And so, it will have a separate sales force. We’ll frankly have two morning calls that will be separate and you will be servicing your clients and we’re going to run very hard together and FIG will be one integrated, timely integrated firm on the, obviously on the back office. But as from a client facing perspective, we are going to maintain your brand and what you felt over 50 years, and we are very excited, as we said we see that as the $250 million to $325 million.

This deal simply leverages our platform, we think were approaching integration right. We think that we’re not going to integrate away the best of what KBW is about. So we think that maintaining the culture in brand of KBW is important. KBW will become, as I said, the financial institutions brand for Stifel, the best performers of both teams joined together drive our future growth.

We will keep KBW research separate and the equity sales force will be maintained. The KBW existing sales force will be responsible for all FIG sales coverage and will integrate KBW’s fixed income expertise, which is impressive into our substantial platform. And I think that we thought a lot about this and as you know, we at Stifel take integration very seriously, and we’ve thought about it.

I will quickly go through these again. We will be the largest provider of research on a combined basis and we’re number one provider of research in technology transportation REIT and now we’re number one in FIG. We’re the number two provider of small cap equity, the FIG research coverage is very impresses, 427 company’s number one, and big equities number one in depository. You can see the pie chart. Looking at trading, aging we combined and we’re now distancing ourselves in the middle market banks as number two in trading volume, and this firms are equity research platform. Again we’re not only writing research for trading very well.

If you look at our investment bank, we in all managed equity offerings since 2005, we moved from 12 to 7 and impressively on book run equity offerings in our sort of what we focus on, which is the middle market, we have defined as less than $500 million in market cap in 2005. We go from nine 9 to 2. We share that focus on small cap stocks and that is impressive. Tom, you’re going to be CEO of what I think is the dominant force in financial services, and walk us through a couple of these rankings.

Thomas B. Michaud

Sure, Ron. What you showed in our prior slide is how the firms going to be moving up into the book runner position. And typically when you’re in the book runner position, your opportunity for fee is three to five times of the size if you’re in a co-manager position, plus the opportunity to trade the shares in the after market close. And so we’re excited about this transaction, because we think would be broader capabilities and in particular, the private client business, we’re going to have a chance to continue to move up.

And also when you look at the combined efforts in our banking department, which includes some of the Ryan Beck staff, the historic Ryan Beck staff and the Stifel staff, we’re going to have a very broad coverage effort. And then with the skills that we have, we think we’re also going to be more competitive in the higher end mid-cap space as well to compete for REIT managed business.

And as you can see, we have a very good footprint together, weather it’s been the bank IPO book runner space where we have had the number one position and now we can see Stifel had a very strong position as well, and combined we have a great league table standing.

When you look at FIG IPO and follow on book runner since 2005, not just the depositories, you’ll see that we also have a very good footprint there. So it’s not just banks in financials. And then when you look at advisory work, on the top right, KBW had been the number one advisor and now with the folks who contributed to Stifel’s effort, we think we’re going to be able to have an even stronger present there.

And then both firms are very committed to the conversion business. Our firm had been the number one firm in terms of number of conversion of conversions, yet Stifel had been the number one firm in terms of dollars amount of proceed. And so when you put the two firms together and both teams are going to continue to work this for us. We think we’re going to have a very credible effort. We also continue to pay attention to the credit union industry, which I don’t believe it has started its conversion activity yet like it may in the feature. So that’s another opportunity for the two firms combined.

On the next page, you can just see the mix between the two firms, both in terms of M&A and capital market. And what you’ll find is in the M&A business consolidation in the banking industry has been more popular that it has been in the other areas of FIG, but churn off we do complement each other. And we’re very excited about what we can do together in capital markets. The banking industry has very much recapitalized itself, and so we think that maybe from a mix perspective it will be a lot more capital raising in others sectors of financials and we think given the track record of both firms, we’re going to have a great footprint in that business as well.

Ronald J. Kruszewski

Again, fixed income, I said their expertise will be integrated under our platform. This has been a major growth initiative. Our client trade volumes approaching $300 billion widespread coverage with a sales team of over 200 professionals. We have the core of products and again combining with your expertise and your relationship on the depository side, this is going to, while we haven’t built in any revenue enhancements this is one that I certainly believe is one that we will achieve, and it also this will leverage our global wealth management platform, with 2,000 advisors, $130 billion in client assets this helps with their research what they can do all the deal this is very, very nice.

So last is I believe Tom and with you and I can just tell the way we work together, put the deal together that we’re going to integrate this in the manner that we have integrated other deal. That’s evidenced by the fact that you’ve had all of the people that have signed under this deal, and if you look at our transaction over the past, starting with Legg Mason Capital Markets, Ryan Beck, our bank Butler, Wick, UBS branches, Thomas Weisel, last year Stone & Youngberg and today KBW, each merger prior to this one has been accretive to Stifel’s retention extremely high.

You can see that we have integrated these while increasing our stock price and you can see that when you started of this, the revenues have grown from $260 million to nearly $1.6 billion without counting UN. And not only this integration help but importantly half of our growth has been through acquisitions, the other half has been organic because the mergers in and among themselves create opportunity to have organic growth. I believe that the way we operated to this point, KBW will equal the success that we’ve had in integration and that this will be a successful deal and we’re going to be a dominant player in the marketplace and I look forward to that.

So with that, it was pretty long, and we are very excited about it and we hope all of you on the call are excited about it and we will take some questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Devin Ryan from Sandler O’Neill. Your line is open.

Devin Ryan – Sandler O’Neill & Partners LP

Hey good morning guys, how are you doing?

Ronald J. Kruszewski

Hi, Devin.

Thomas B. Michaud

Good morning.

Devin Ryan – Sandler O’Neill & Partners LP

So you guys are obviously very experienced acquirers and historically you’ve have bought this that I was there not hitting at their full revenue potential when you do. So in the revenue assumptions that you gave of $250 million to $325 million that you’re calling conservative and based on trough years, can you speak a little bit to why are you doing the deal now kind of with the business hitting kind of a trough revenues, and then if that does represents something closer to trough in your view, can you give a sense of what you think is maybe a more normal level or how we should think about that?

Ronald J. Kruszewski

Well, Devon, I think the slide answers that we are not going to go and to Tom, there are years when you get over $400 million of revenue.

Devin Ryan – Sandler O’Neill & Partners LP

Correct.

Ronald J. Kruszewski

Recently of 10, look I don’t think there is any question that’s been difficult capital market environment not just in big, but across the board. Why now? It is the premier brand of financial services. It’s not like there’s 10 KBW, there is one KBW. This opportunity presented itself, presented itself in a manner which is like other transactions that we have done and now is a good time.

Devin Ryan – Sandler O’Neill & Partners LP

Okay, thank you, and then just wanted to get a little more color on the cost saves and if I’m looking at the detail that you have provided correctly the $64 million of incremental operating costs, mentioned in a slide back that would seem to imply that you’re cutting KBW’s current non-comp expense base in half, so just want to get a better sense of what the big areas of the reductions are going to come from, if you have a timeline for extracting those and then any additional color on maybe the size of charges that would be taken between now and then?

Ronald J. Kruszewski

We were working at the other way, because I think it’s difficult to say, what cost saves are since there has been a lot of reduction that Tom has done to right size the cost base to the lower revenue. So we were given to you a different way, we were telling you that you could take your estimate for our non-comp operating expenses and add $64 million, and that’s across the broad swap of areas of communication, all the public company expenses that you have, which are tremendous obviously back office clearings is a big number in terms of that there are some charges that (inaudible) tracks leases there will be some, I think we’ll update more of that in future calls and so what exactly that is, but I’m confident on the $64 million of incremental OpEx, Devin.

Devin Ryan – Sandler O’Neill & Partners LP

Okay, great. And then lastly, did you guys give a closing date, I may have missed that?

Ronald J. Kruszewski

As soon as we can, but it requires things that are out of our hands in terms of shareholders we have other documents we need to file, but I’m looking forward to get these things closed and having a great 2013 together.

Devin Ryan – Sandler O’Neill & Partners LP

Okay, great. Thanks for answering my questions. I’ll hop back in the queue.

Operator

Your next question comes from the line of Hugh Miller from Sidoti & Co. Your line is open.

Hugh M. Miller – Sidoti & Co. LLC

Hi, just a question about the rationale for I guess keeping the franchise as an independent subsidiary, which I think it will be different than how you guys have structured things in the past?

Ronald J. Kruszewski

Absolutely different and just we, I’m not sure that any of our integrations have been cookie-cutter, we look at each of them individually with an eye toward maintaining client service, and in this case it should be clear certainly to anyone that does business with KBW the importance of maintaining the brand in the specialized sales force in the sales and trading. It was obvious to me and so to integrate the sales force for example, would really not been very smart, so we are not going to do that in other cases think it has a very unique protocol. I think we know that and we have been thinking and I know a number of firms have tried to establish a big protocol, but the way to do it is the way we are going to do it.

Hugh M. Miller – Sidoti & Co. LLC

Okay, and I guess KBW also had announced that there are exiting their Asian operations, I was wondering I guess how much of a factor I guess this particular transaction had on that decision, I guess as it does add a little bit of stability with the retail segment, which is reduces some of the volatility in the business environment, I was just wondering kind of the thought process for now deciding to kind of move away from that expansion?

Thomas B. Michaud

I think there were two reasons for that, I think the first is how challenging the cash equity market is in the Asian market. We were the only specialist firm to be executing that strategy there, and while we were watching volumes really declined significantly and it was our judgment that this was not going to be a shot term. Now we were very, very excited about the quality of the product we had, but the activity frankly just wasn’t there and we felt that it was going to remain in a loss position for the near-term horizon and that wasn’t acceptable at this time. We are very excited about other parts of our international operations in Europe, where we have been there since 2004. We’ve got scale there. We have some very highly rated analysts in that market and so we’re going to be more focused on that market as well as on our home market where we think there is a lot of opportunity as well.

Hugh M. Miller – Sidoti & Co. LLC

Okay. And last question I had Tom, on the earnings that you guys did announce in the third quarter obviously showing some challenges in the core business in both the commissions, but also the investment banking area, I was just wondering what the conversation of the clients are about what kind of get things kick started for consolidation within the regional banking space or M&A and also seeing that underwriting, the potential for underwriting that really pickup. Where we stand now with the cycle and what kind of gets that ball rolling here in the near-term?

Thomas B. Michaud

M&A activity is definitely picking up, we can see it all of our bankers are busy in the depository space. The number of deals that we’ve announced year-over-year is up. And I think really what it is, like I said earlier, it’s the length of time that we are in this low interest rate environment. And a lot of banks are really being squeezed in their net interest income, which is typically two-thirds of their revenue. And I think that’s causing a lot of banks to think about taking costs savings out and combining with potentially a larger institution. Also, what’s really interesting is that, we’ve been studying where is the sweet spot in banking right now and we have found that the $5 billion to $10 billion banks are the most profitable banks in the industry right now, and they are also the most highly valued.

And so we think in that sweet spot, you can see banks around that asset size executing a lot of consolidation. With regards to capital raising, there still, I think there is about 290 banks that still have TARP preferred or some type of TARP instrument. And we are getting closer to the recast moment in the interest rates in those of preferreds. And so we are seeing more activity.

We just announced the deal couple of weeks ago for a client in North Carolina, where they did an exchange, they raised capital, they sold net assets, and so there still is going to be a lot of that restructuring work going on. But I’m getting more excited is away from the depositories and its capital raising in the specialty finances space, where you still have the $10 trillion of mortgages in the country, $7 trillion of them are in some capacity backed by the government.

And that’s going to have to change over time and there is going to be a lot of evolution in the mortgage industry. So we are spending a lot of time outside of depositories thinking that there is going to be a lot of capital raising there. And I think with our combination, with the private client business that we are now going to have access to and some of the other products in the combined company, we’re eager to participate more in that space.

Hugh M. Miller – Sidoti & Co. LLC

Great. Thank you for the color.

Ronald J. Kruszewski

Yeah.

Operator

Your next question comes from the line of Chris Harris from Wells Fargo Securities. Your line is open.

Christopher Harris – Wells Fargo Securities, LLC

Good morning, guys.

Ronald J. Kruszewski

Good morning.

James M. Zemlyak

Hey, Chris.

Christopher Harris – Wells Fargo Securities, LLC

I want to come back to the expenses synergies we are expecting here. Just to get a little bit more detail, could give guys give us the actual dollar amount of costs you expect to come out of the combined business both comp and non-comp?

Thomas B. Michaud

Well, again come out of, add $64 million to our expense base, okay. If you want a sense of a comp to revenue you can use 50%, 57%, 58%. And so when you do that, you can back into your own whatever base you want to start with as to what the cost base. I don’t approach it that way, because you never know from where you spot it. And I look at what is it going to cost to maintain this business on our platform and what comps to revenue including that includes the fixed comp that we are going to need above the professional comp so to speak. So, it’s a backwards ways of answering your question, but I gave you the two numbers.

Christopher Harris – Wells Fargo Securities, LLC

Okay. So just to make sure I’m understanding here fully, it doesn’t sound like, there is going to be really a tremendous amount of if any head count reduction as a result of this deal, is that a fair assumption to be made?

Ronald J. Kruszewski

Well, certainly, look, there is always some redundancies, all right. But, KBW today is not operating under a 58% comp to revenue model, they are not operating at $64 million of the non-comp OpEx. So I think there are significant savings and as I said, when you run those numbers, we believe our return on equity investment is from 10% to 16%.

Christopher Harris – Wells Fargo Securities, LLC

Okay. So with the head count reduction what do you guys see the most redundancy, where do you think, we’ll see some staff reductions, what areas of the firm, and then is it going to be more concentrated on the KBW side, or is it going to be potentially Stifel head count reduction as well?

James M. Zemlyak

I think it’s going to be less so on the customer facing side when you look at the mix over time, I mean, I feel comfortable saying that. And we’ve already done a lot of work together at thinking about who is going to be customer facing and what particular spots. So we think that there will be less there.

Christopher Harris – Wells Fargo Securities, LLC

Okay. Last question then for me, really for you, Tom. Wondering why do this deal from a KBW perspective at only a 7% premium if we are at a trough level of revenues right now for you guys?

James M. Zemlyak

Well, I think there are two things to that. I think number one is, as our Board voted unanimously in favor of this transaction, because we believe it’s fair to the shareholders. And I think that that’s the first reason. The second reason is that, we think there is more to come. We are excited about this combination and it’s interesting, because we do think there are catalysts around the corner. And the question is, we’ve just expanded our product suite of things that we can do, and I think our market share is going to go up. And the more time we spent with Ron the more we felt that we were stronger and better off together than KBW approaching those opportunities by their selves with a smaller product set than we now have.

Ronald J. Kruszewski

We are going to be again, I answer that question from my perspective. We are better together and I look forward to that.

Christopher Harris – Wells Fargo Securities, LLC

Okay, guys. Thanks.

Operator

Your next question comes from the line of Patrick O’Shaughnessy from Raymond James. Your line is open.

Patrick O’Shaughnessy – Raymond James

Hey, good morning, guys.

James M. Zemlyak

Good morning.

Ronald J. Kruszewski

Good morning.

Patrick O’Shaughnessy – Raymond James

Can you kind of allow me to the process if you are able to talk about how the merger came to be, have you guys been talking about this for few quarters, did it just come up recently? And if you can, if there is any sort of competitive bidding process?

Ronald J. Kruszewski

Look, I mean at this point that will all be disclosed in the proxy, I don’t think we are in a position to talk about that now, fair enough.

Patrick O’Shaughnessy – Raymond James

Okay, fair enough. The second question I have is Ron for the cash component that you guys are paying for the deal, I think from slide 16, it’s just that, some of that’s coming from cash borrowings. Can you just walk me through, how much of that cash is coming from your balance sheet, if you’re going to have to take on additional debt to pay for this or how you are thinking about that?

Ronald J. Kruszewski

Yeah, look, I think we’re well capitalized and we believe that between the cash on KBW’s balance sheet and our excess liquidity that we on Stifel, we don’t think we really have to do anything to fund this deal.

Patrick O’Shaughnessy – Raymond James

Okay.

Ronald J. Kruszewski

In terms of access in the capital market.

Patrick O’Shaughnessy – Raymond James

Okay, that’s helpful, thanks. And then the last one if I could, so Ron, you talked about kind of your ideal business mix is probably 55% retail, 45% institutional and you kind of add that with this deal on a pro forma basis. Do we expect that you guys will still look for M&A for this, or do you kind of say, what, this is what we are going to look like and now we are just going to try to execute?

Ronald J. Kruszewski

Well, look, this is what we look like and we are going to execute. And I’ve always said that 60, 40 what tends to happen is if opportunities come along and it changes that mix. So, we have a vision to build and I think we are getting there, the premier Middle Market Investment Bank. This was an opportunity that we felt we had to do, we are going to achieve that goal. We are going to make this work, the integration will obviously consume some of our time and energy, and maybe are looking around for the next opportunity. But we expect to get this done, I don’t think this integration is really that difficult at all especially considering how we’re approaching it.

And we’ll either do something or we’ll do nothing depending on the next opportunity how it presents itself and how it fits into our goal of doing this. I’ve always said, we are not looking to just get larger, we are looking to get better, this deal makes us better.

Patrick O’Shaughnessy – Raymond James

Great. Thank you.

Operator

Your next question comes from the line of Alex Blostein from Goldman Sachs. Your line is open.

Alexander Blostein – Goldman Sachs

Thanks, good morning, everybody. Ron, I wanted to follow up just one more on expenses, because it just feels like, there is still some outstanding questions here. On the comp that you provided, so 57 to 58, you’re talking about the overall from comp rate that includes Wealth Management business?

Ronald J. Kruszewski

No, I’m saying what I said was, I’m trying to answer the question that as you take, if you look at how I looked at KBW across the revenue spectrum and you apply that comp free show and $64 million of OpEx you can kind of get in, you can figure out, how I get to 10% to 16% ROE, and that should allow you based on whatever your models are determine what the level of assumed cost base are both in cash and in non-cash. It is approaching and bottoms up instead of top down.

Alexander Blostein – Goldman Sachs

Got it. Okay yeah because you guys and capital markets are right now running a little bit north of 60%, I’ll break KBW is 65%, 66% so that’s I guess okay I guess that is the question? Second point is I guess on a strategy part you guys have been quite successful growing the bank and that has been very accretive way for you guys to earnings, what does this deal do I guess to your ability to deploy capital to the growth of the bank. Do you think it’s going to slow over time or what’s kind of the decent run rate for growth there, now.

Thomas B. Michaud

I don’t think that does anything to are the balanced approach that we’ve done with building the bank. We understand we have a capital plan, we’re generating earnings. We create earnings both through the way we compensate people with equity, we create capital and earnings and looking forward we even with this transaction, we are well capitalized, and so I don’t see that, it’s certainly doesn’t make me think we can’t continue to build the bank, but we’ve built the bank in a balanced fashion and that will continue.

Alexander Blostein – Goldman Sachs

Okay, and then I guess going along the lines of strategy here, this deals certainly puts you I guess a little bit more on the institutional investment banking camp versus more of a wealth management camp, great business but clearly more volatile business, so from a multiple perspective, the way you guys think about the stock, how did that I guess playing to your decision to do this deal since it feels like the blended multiple in the business, probably should be a little less than the Stifel multiple preview.

Thomas B. Michaud

Well that’s your opinion and I respect that, but it’s we are building a firm to that will look back and we want to be a firm that emerge from the meltdown in financial services in 2008 and 2009 and that firm is a balanced investment bank with private clients and investment banking and this deal, and this ability to partner with the premier financial institution boutique was compelling, and I think institutional business is quite rebound and when it rebounds, I think you will see significant additions to our earnings and to our margins. So this thing will go, but when it’s good, it’s very good. So we just looked at it and said, this fits the vision of the firm we’re trying to build, and therefore we execute it, and certainly we’re (inaudible). But what does it mean to my earnings multiple. I think it has value and I don’t necessarily worry with the fact that it is the lower multiple.

Alexander Blostein – Goldman Sachs

Got it, fair enough. And then sorry, just last one on the timing. I guess you guys don’t have the certain date for closing, but do you have an expected date, so that we can start thinking about these numbers flowing through in the models?

Ronald J. Kruszewski

Yeah, look I’d like to think it would be early 2013.

Alexander Blostein – Goldman Sachs

Gotcha, great. Thanks so much.

Ronald J. Kruszewski

Joel Jeffrey from KBW asking a question and we’re with Joel.

Alexander Blostein – Goldman Sachs

Yeah, exactly.

Ronald J. Kruszewski

Okay. Go ahead Operator.

Operator

Your next question comes from the line of Glenn Schorr from Nomura. Your lien is open.

Glenn Schorr – Nomura Securities Co. Ltd.

Hi, thanks very much. Couple quickies, in the 85 people on the retention that have signed retention agreements, I just want to make sure I got the understanding. So that would take care of comp for 2012 and 2013. I’m just curious what the total dollar amount is and what that included in the purchase price?

Ronald J. Kruszewski

Yes, I mean, we did retention with stock, the way we often look at this, there were some things that needed to do. You’ll see some charges that go through with respect to that. But we always view that as a purchase price in that, and therefore when you look the way we looked at our return on equity investment, you’ll see a line where we add the after-tax cost retention to purchase price. Those shares we then build into our 8.9 million incremental shares that we’ll have outstanding and we throw it all in as purchase price. And so that’s all baked into these numbers.

Glenn Schorr – Nomura Securities Co. Ltd.

Perfect, thank you. On the slide 17, when you talked about financial is always being a big part of the revenue share and I agree it’s going to go up, I’m curious if you going to cross action to see what is produced by to say the big parts of financial services versus the small medium part that you tend to dominate, and if that has an impact on the acquisition, if you are able to as a larger firm stream, go upstream if you will? And I have a follow on, on that.

James M. Zemlyak

Our strategy had been to move upstream, but that doesn’t mean to the nation’s biggest bank. So that is a very competitive space, particularly for underwriting, particularly for a debt capital market. But there still are some very large regional banks that are below that the big universal banks are the biggest super regional banks. And I think that we’re going to be more competitive in that space now, because of this partnership.

Ronald J. Kruszewski

But I think we can see it upstream.

James M. Zemlyak

That’s right, yes, definitely. We’ll be more competitive together than individual.

Ronald J. Kruszewski

But look credit conditions are improving. You’re going to see, I believe you’re going to see catalyst to drive a lot of capital markets and advisory transactions with the overall, as we come out of this crisis. And I believe that in general is the rising tide that’s going to raise all ships including this. But with our additional capabilities combined with KBW, I believe that our ability are sort of our target range is bigger.

Glenn Schorr – Nomura Securities Co. Ltd.

I appreciate. Last one is and I agree with most of your points at low rates and everything else you mentioned driving activity. The one question I have, I don’t know this is for Tom or not, but how important would certain SIFI buffers and certain asset level cut-offs be or has it been in getting banks to transact and get larger if they don’t know what kind of capital charge comes along with being let’s just call it the next size are?

Thomas B. Michaud

Yeah, I think first of all I think the nation’s biggest banks are probably not going to be the banks involved in consolidation. In particular, you’ve got a lot of the universal banks that are already above the deposit cap. So I don’t think they will be buyers of the depositories.

But it’s interesting because what we’re finding is that at the $10 billion mark, there is an additional level of regulation that kicks in. What we hear a lot from these managements is that if they’re going to go through $10 billion, their belief is that leveraging that additional regulatory cost over a bigger footprint in asset base and earnings stream is a worthy thing to do.

So we’ve seen some banks, when they pierce these levels that they want to keep going. And I think that $5 billion to $10 billion range that I spoke about earlier that we believe its happening is that you’re big enough to leverage your regulatory costs, when you get into that space, and you’re also think enough to have a broader range of products. And when you’re below that space, it’s harder to do both of those things. So I think that this regulatory transition that we’re in is going to play an important role in consolidation. I hope that answers your question?

Glenn Schorr – Nomura Securities Co. Ltd.

It does, thank you.

Operator

Your next question comes from the line of Judy Delgado from Alpine Associates. Your line is open.

Judy Delgado – Alpine Associates

Yes, thank you. Most of our questions have been answered. Could you detail what regulatory approvals in particular are required for merger closing?

Ronald J. Kruszewski

Yeah, for us we obviously in more notice in asset regulators to improve everything, but the regulatory, we have FINRA and we have the Fed. We’ll get those, we obviously have Hart-Scott, which we don’t anticipate any problem. And probably the biggest thing is the shareholder approvals.

Judy Delgado – Alpine Associates

Thank you. Can you also just detail the stock collar for shareholders, the expectation perhaps, if there are any walk away prices of protection for Stifel in this transaction?

Thomas B. Michaud

There is a collar and there is not any other than customary merger provisions as it relates to termination. Our shares float between 25 and 35 and then it will become fit after than. So the deal value fluctuates about 35 and below and 29 and so some of the volatility in the share count is within the range. Is that make sense to you?

Judy Delgado – Alpine Associates

Yes, thank you.

Operator

Your next question comes from the line of Tony Reiner from Cantor Fitzgerald. Your line is open.

Anthony Christopher Reiner – Cantor Fitzgerald & Co.

Congrats on the deal guys, another good deal. Can you just go through, I would just ask as far as regulatory approvals. What exacts states you need to get approval to get before you close this thing if any? What individual states do you need as far as regulatory approvals if any?

Ronald J. Kruszewski

None, I’m aware of.

Anthony Christopher Reiner – Cantor Fitzgerald & Co.

Okay, in you approval stuff like that?

Ronald J. Kruszewski

In approvals, look I don’t want it in any way discount the need for anyone that can ask any questions. But my understanding is no state specific FINRA will obviously review this transaction to improve. But we don’t see anything here unusual at all.

Anthony Christopher Reiner – Cantor Fitzgerald & Co.

And what about any foreign approvals in UK, Hong-Kong anything?

Ronald J. Kruszewski

No, we have the FSA of the regulators will look at our combined and look at our capital plans. But again I think we’ve done conservatively, I don’t anticipate any issues.

Anthony Christopher Reiner – Cantor Fitzgerald & Co.

That wasn’t my phone. Yeah, I’m pretty sure. Okay, I appreciate it. Thanks so much.

Ronald J. Kruszewski

Okay, thanks.

Operator

Your next question comes from the line of Chris Harris from Wells Fargo Securities. Your line is open.

Christopher Harris – Wells Fargo Securities, LLC

Thanks for the follow-ups here guys. Two quick ones, one of the revenue range for KBW $250 million to $325 million that you guys lay out on slide 16. I assume those numbers that you have there that kind of takes a new account potential staffing reductions we might see? And I’m just kind of curious is to how or how you think you can maintain that level of revenue at KBW if there are some head count reduction?

Thomas B. Michaud

Look, with the client facing businesses, the people that generate revenue at KBW and the people at Stifel in the FIG practice are you know we’re keeping those people. We are not talking about any reduction for the people that face our clients and provide that service. So and I never view cuts that cut revenue as synergistic.

Christopher Harris – Wells Fargo Securities, LLC

So you might after this deal is done you could conceivably have just take the world of analysts, for instance, you could conceivably have two analysts covering the exact same stocks just because one is on a KBW side and the other is on Stifel side?

Ronald J. Kruszewski

Well, no, that’s a good question to clarify that I mean we’re obviously have a plan to have a research product that combines the best of what we are doing, but that I am glad to point that out because I don’t want there to be confusion on that. On the stifle side and we cover 1,000, we will have 1,000 names anyway or close to that outside of FIG, we will not have a FIG coverage. So there will not be Stifel analyst that is covering a FIG name. All of the FIG business will be done under the KBW banner and brand and the KBW sales force will be the specialized sales force that markets that research products. So we’re not going to have two analysts imagine that what if we had conflicting opinions that would be interesting. But we are not doing that.

Christopher Harris – Wells Fargo Securities, LLC

Okay thank you.

Operator

And with no further questions in queue, I turn the call back over to Mr. Kruszewski for closing remarks.

Ronald J. Kruszewski

Well I would like to close by again I am pleased with our quarter. I think that while that was very good news, it is overshadowed by the great news of welcoming our new partner from KBW. We look forward to getting out and seeing our clients and talking to people Tom?

Thomas B. Michaud

Yes, thank you Ron. We’re delighted to be partnering with Stifel and we think that like I said earlier, we think this is the right deal for our shareholders, for our clients, and for our employees. And we look forward to working with Ron to build the premier Middle Market Invest Bank.

Ronald J. Kruszewski

With that, thanking for you time, your questions, and participation and we look forward to updating you in the future. Thank you.

Operator

And this concludes today’s conference call you may now disconnect.

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