Stifel Financial Q3 2023 Earnings Call Transcript

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October 25, 2023

There are 8 speakers on the call.

Operator

Good day, and welcome to the Stifel Financial Third Quarter Financial Results Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Joel Jeffrey, Head of Investor Relations. Please go ahead.

Speaker 1

Thank you, operator. I'd like to welcome everyone to Stifel Financial's 3rd quarter conference call. I'm joined on the call today by our Chairman and CEO, Ron Krzyzewski Our Co Presidents, Victor Nizi and Jim Zemlyak and our CFO, Jim Marischen. Earlier this morning, we issued an earnings release and posted a slide deck and financial supplement to our website, which I would note that some of the numbers that we state throughout our presentation This audio cast is copyrighted material of Stifel Financial Corp. And may I will now turn the call over to our Chairman and CEO, Ron Przyzewski.

Speaker 2

Thanks, Joel. To our guests, good morning and thank you for taking the time to listen to our Q3 conference call. Let me start by saying that given the market conditions and what I consider to be one time extraordinary non recurring legal expenses, Stifel generated a solid quarter. Our operating results of $1,050,000,000 in net revenue and $1.18 of operating EPS, Excluding the aforementioned legal reserves are essentially the same as our numbers last quarter and in the Q3 of 2022. I will address the legal reserves momentarily, but frankly, our results over the past 7 quarters can be summarized by Increased wealth management and NII offset by institutional decline, which result from subdued industry wide activity.

Speaker 2

As such, I feel like I'm stuck in the movie Groundhog Day, where Bill Murray's character wakes up and experiences the same day over and over. So thankfully, my alarm doesn't wake me up each morning to the song, I've Got You Babe. But seriously, since the end of 2021, It feels like every quarter we talk about the optimism for near term results based on green shoots in investment banking activity, the potential For delayed M and A deals to finally close, the market stability when the Fed stops raising rates and then cuts and declining cash sorting. Look, we are well positioned when institutional conditions improve. However, when these conditions actually do improve is open for debate.

Speaker 2

History tells us that while the catalysts for improvement vary, my experience has been that institutional activity tends to improve slowly And then ramps up suddenly. Of course, we cannot control market conditions, but there are things we do control, such as Recruiting high quality advisors in our Wealth Management business, maintaining the high levels of support as illustrated by our number one ranking by JD Power for employee advisor satisfaction, increasing our relevancy to our institutional clients that we can capitalize on the eventual market Controlling our expenses in an inflationary environment while building our brand recognition, managing balance sheet growth and liquidity And strategically deploying excess capital. In today's environment, this has been accomplished primarily through share repurchases, dividend increases And investments in our business. With this approach in mind, I would highlight that our Board of Directors has improved an increased share repurchase authorization of 10,000,000 shares, which brings our total authorization to 14,200,000 shares. Lastly, as we've always We continue to look at potential acquisitions, but in the current environment, they are less attractive, particularly in a market with a 5% risk free rate.

Speaker 2

Moving on to Slide 2. On the variance table to consensus estimates, we've highlighted our results that include the impact of the non recurring legal charges we accrued during the quarter. Given the impact on our bottom line, I'll address this item first. The $67,000,000 in legal charges was Primarily the result of the SEC's industry wide review of off channel communication. While this matter is not yet settled, We believe that we are properly accrued.

Speaker 2

Additionally, we have reserved from some smaller legal items as well. The impact of the non deductibility of the SEC matter negatively impacted our tax rate. All said, The after tax impact of these legal matters was $0.58 per share. In terms of revenue, the $28,000,000 shortfall to expectations It was almost entirely due to lower investment banking revenue as we continue to see delays in deal closings In advisory and both equity underwriting and public finance activity was slow given market volatility and of course higher rates. Our transactional revenue was ahead of The Street by $5,000,000 as Wealth Management revenues were higher than estimates and Asset Management revenue came in $3,000,000 above the Street.

Speaker 2

Net interest income came $2,000,000 below Street estimate primarily due to cash sorting, which I note and I've been saying has In terms of expenses, excluding the impact of the $67,000,000 in legal charges, Much of the difference in non comp expenses versus expectations was tied to higher provision expense, which Jim will discuss later. Moving on to Slide 3, I want to focus on the strength and growth of our Wealth Management franchise. The 3rd quarter represented our 11th Consecutive quarter of record net revenue in Wealth Management. Since 2015, Global Wealth Management revenue has increased more than 120%, The percentage of recurring revenues increased from 47% to 78%. This level of growth has been the result of our strategy Our substantial recruiting efforts are illustrated by the fact that over the past 5 years, we have recruited nearly 670 financial advisors with cumulative trailing 12 month production of approximately $430,000,000 I would also highlight that year to date, we've increased the number of recruited advisors By 34%.

Speaker 2

As I mentioned earlier, a vital component to our recruiting strategy has been the advisor friendly culture at people as well as the industry leading level of service we provide. This strategy has been validated by the growth The number of our advisors and our number one ranking in the most recent J. D. Power survey of overall employee advisor satisfaction. This level of recognition has resulted in increased inbound calls from potential recruits.

Speaker 2

And as I look out over the next few quarters, I anticipate that we will See continued strength in recruiting. So the bottom line is that our Global Wealth Management business continues to be a meaningful growth driver despite More challenging market conditions for our overall business. While we remain very well positioned to capitalize on the eventual rebound in Investment Banking, Our growth in wealth management will continue to enable Stifel to generate relatively stable returns. Now let me turn the call over to Jim Marishin to discuss our most recent quarterly results.

Speaker 3

Thanks, Ryan, and good morning, everyone. Looking at the details of our Q3 results on Slide 4, our revenue of $1,050,000,000 was

Speaker 2

flat year on year.

Speaker 3

Compared to the same period a year ago, we saw growth in net interest income, client facilitation and trading, which was offset by declines in advisory and to a lesser degree underwriting. While revenue was essentially flat, Our bottom line was negatively impacted by higher non compensation expenses tied to the legal charges that Rob referenced earlier. Moving on to our segment results. Global Wealth Management revenue increased 10% to a record 769,000,000 Our pre tax margins were 39%. During the quarter, we added a total of 36 advisors, Including 24 experienced advisors with trailing 12 month production of more than $24,000,000 We ended the quarter With fee based assets of $151,000,000,000 and total client assets of 412,000,000,000 Sequential declines were due to lower equity markets as our net new assets grew in the mid single digits during the quarter.

Speaker 1

Moving on

Speaker 3

to slide 6, where we highlight the solid trends in our bank subsidiary. Total deposits increased both sequentially and year on year, Primarily as a result of increased wealth management deposits. As we highlighted last quarter, cash sorting continues to slow and sweep deposits are stabilizing. While we continue to believe that the vast majority of cash sorting is behind us, if the yield curve remains inverted, we expect to see inflows into smart rate, Money Market Funds and Short Term Treasuries. Given the movements within cash products, along with the timing of the last Fed rate increase, This resulted in the modest sequential decline in NII to $285,000,000 In terms of our expectations for the 4th quarter, As we are not projecting any balance sheet growth and given some expectation for additional cash sorting activity, we project net interest income in the 4th quarter to be in a range of $270,000,000 to $280,000,000 Our credit metrics and reserve profile remains strong.

Speaker 3

The non performing asset ratio stands at 17 basis points and charge offs were essentially 0. Our credit loss provision totaled $10,000,000 for the quarter And our consolidated allowance to total loans ratio was 85 basis points. I would reiterate what I said last quarter And only 1% of our loan portfolio is comprised of office CRE exposures or only 9 loans, which are primarily Class A space With average LTVs of approximately 44%. Lastly, our balance sheet continues to be well capitalized. Tier 1 Leveraged Capital Decreased 30 Basis Points Sequentially TO 10.8%.

Speaker 3

Even when incorporating the unrealized losses in our bond portfolio, Our Tier 1 capital ratio remains strong at 10.2%. On the next slide, I'll discuss our institutional group. Total revenue for the segment was $257,000,000 in the 3rd quarter. Firm wide Investment Banking revenue totaled $147,000,000 As a result, we're impacted by both lower capital raising revenue and the continued delays in M and A closings. Advisory revenue was $97,000,000 which represented an increase of 11% sequentially.

Speaker 3

Although this remains a difficult M and A environment, We've seen some signs of life in industry wide announcements and our pipelines have improved when we ended the 2nd quarter. That being said, the timing of that improvement will very much be market dependent. Equity revenues totaled $68,000,000 in the quarter As an increase in transactional revenue was offset by lower underwriting activity. Equity transactional revenue totaled $47,000,000 Up modestly both sequentially and year on year, which compares favorably to modest declines in industry wide trading volumes For both periods, as we continue to see traction on our electronic offerings as well as strong engagement with our high touch trading and best in class research. Fixed income generated net revenue of $92,000,000 in the quarter as lower public finance activity offset relatively flat transactional revenue compared to the Q2.

Speaker 3

We continue to be a leader in the municipal underwriting business as we rank number 1 in the number of negotiated transactions as our market share was nearly 14% for the 1st 3 quarters of the year. On the next slide, We go through expenses. Our comp to revenue ratio in the Q3 was 58%, which was in line with our forecast for the second half of the year. Non compensation operating expenses excluding the credit loss provision and expenses related to investment banking transactions totaled approximately 302,000,000 Our non comp OpEx as a percentage of revenue was 28.9%. Excluding the legal charges we referenced earlier, Our non comp OpEx as a percentage of revenue totaled 22.6%.

Speaker 3

The effective tax rate during the quarter Came in at 37.7%. Again, the higher tax rate was primarily due to the non deductibility of legal expenses. Before I turn the call back over to Ron, let me discuss our capital position. We have approximately $300,000,000 of excess capital based on a 10% Tier 1 leverage target. Additionally, we continue to generate substantial amount of excess cash As illustrated by our annualized year to date net income of $450,000,000 We remain focused on generating strong risk adjusted returns when deploying capital And we've done this through reinvesting the business, making acquisitions as well as through share repurchases.

Speaker 3

Given the uncertainty in the market and our discounted valuation, So far this year, we have primarily deployed excess capital through share repurchases. In the 3rd quarter, We repurchased 1,900,000 shares. I note that through 3 quarters in 2023, We've deployed more capital into share repurchases than any of the past 5 full years. Absent any assumption for additional share repurchases And assuming a stable stock price, we expect the 4th quarter fully diluted share count to be 111,800,000 shares.

Speaker 1

And with that, I'll turn the call back over

Speaker 2

to Ron. Thanks, Jim. So let me conclude by talking about how we are positioned And what I believe the potential of our franchise is. Needless to say, our current institutional business is not To put institutional Weakness into perspective, annualized industry wide 2023 U. S.

Speaker 2

Equity Capital Markets Fee revenue is down nearly 80% from 2021 and M and A fee revenue is down 50%. In short, while we don't need activity levels to return to record levels, we do not expect this institutional environment to be the new norm in any shape or form. On that note, I also want to be clear that when it comes to expenses, we are not going to blink at the bottom and try to generate near term operating leverage by significant reduction The vast majority of our operating leverage will come from the scale of our business with markets return. I'm not going to try to predict when markets will turn, but I want to highlight that we are in fact well positioned. I regularly get asked the question, what does people look like when market conditions normalize?

Speaker 2

I'm not offering up long term guidance. I think all you need to do is look at our combination of historical growth rates as well as increased scale and operating leverage. Under these assumptions, we believe that net revenue of $5,200,000,000 and EPS of approximately $8 per share is reasonable. Now you can all do the math, but this is essentially based on continued, if not modestly accelerated growth in Wealth Management, NII of approximately $1,100,000,000 to $1,200,000,000 based on a combination of balance sheet growth and changes in NIM Institutional revenue of $1,700,000 to $1,800,000 and consistent or modestly higher share repurchase activity. I want to highlight this as I recognize the value created for our shareholders by share repurchases at the current price level and valuation, Particularly when compared to what I believe our potential is.

Speaker 2

This is a nice segue to discussing how we think about deploying capital As we build toward this level of revenue and earnings, we've always focused on generating the best risk adjusted returns with our capital. And as I look at the opportunities today, the best returns will come from repurchasing our stock, growing our dividend and recruiting productive advisors. We will continue to look at acquisitions, but given higher interest rates, inflation and still continued elevated valuation, This opportunity today is less attractive. So before I turn the call over to the operator for questions, let me close by reiterating that while the near term environment Is uncertain. I'm very optimistic about our longer term outlook and upside.

Speaker 2

And with that, operator, please open the line for questions. Thank

Operator

And we do go to our first line from Steven Chubak with Wolfe Research. Please go ahead.

Speaker 4

Hi, good morning, Ron. Good morning, Jim.

Speaker 3

Good morning. Good morning.

Speaker 4

So wanted to ask you a question on NII and Some of the sweep deposit commentary. The NII resiliency in the 4th quarter, certainly encouraging, You noted you're contemplating some sorting activity in that guidance in the Q4. And I was hoping you could speak to what you're seeing so far in October in terms of sweep deposit trends and whether your NII guide contemplates any seasonal benefit in terms of cash upload from tax loss harvesting?

Speaker 2

We haven't really thought about the seasonal benefit of increasing cash Through tax loss harvesting, I just haven't really thought about that. I think that's a good point. Overall, as we said on other call, Steve, we started our Smart Rate program Along 3 years ago. And what we're seeing is slower, in fact, A lot slower in cash sorting because a lot of it has occurred. The reason that we project Lower and I'll let Jim jump in on this.

Speaker 2

But we don't know what the future holds and the yield curve is significantly inverted And we see a preferred investment for clients to be short term duration fixed income, And that will impact cash sorting. So as we look forward, while we think things have slowed, we want to be conservative when we talk about

Speaker 3

Yes. And to add to that a little bit, the slowing in the Q3 is about the same pace we've seen thus far in the decline in sweep in terms of what we In the Q4 and so we've seen that kind of come to right around 3% of PCG AUM and at some point That level of operational cash can fight against some of the impacts of the inverted yield curve, but that's part of our guidance. The other thing I'd kind of dive into a little bit, If you look at the other deposit line in their supplement, that was down about $85,000,000 sequentially, but we did see some very positive trends In the Venture and Fund Banking Deposit Base, those groups saw inflows of about $300,000,000 in 3Q And that book of deposits now stands at about $1,800,000,000 or about 75% of that balance. That was offset by a decline mainly of additional ICS deposits And so I would also say we've seen a similar pace of deposit growth within the funded venture banking space so far in the Q4 as well.

Speaker 4

That's great. And just for my follow-up on Capital Management, you were pretty clear that Buyback is at least the preferred avenue or for capital deployment relative to M and A and other potential considerations. How should we think about the buyback cadence from here given the strength of your excess capital position? Should we assume the $120,000,000 that you did this quarter Is a reasonable run rate in terms of the go forward?

Speaker 3

I would say it's definitely price dependent, but I think you've seen a step up the buyback cadence over the last few quarters. And at the current prices, I would expect it to be higher.

Speaker 4

Very helpful. Thanks for taking my questions.

Operator

And next we go to Devin Ryan with JMP Securities. Please go ahead.

Speaker 5

Thanks. Good morning, Ron and Jim. How are you? Good morning. I guess, I want to start here on Investment Banking.

Speaker 5

I appreciate The outlook commentary, we obviously track M and A backlogs and equity issuance pretty closely. The fixed income capital raising business is a bit harder for us Follow, and that was actually the biggest, area of delta from our model. And so if I just look at that business, it's less of half Where it was a year ago, at least in Q3, to run rating about $100,000,000 If you go back 2021, you generated $225,000,000 So Just want to kind of dig in a little bit around the intermediate term outlook for that business. And is normalized or something more normal

Speaker 2

Well, certainly depressed. I mean, thank you for reminding me about how depressed it is. But of course, I know that. Look, as I said, this business, we've built capabilities We haven't lost market share. That's small solace to what I'm saying in terms of this in this environment.

Speaker 2

In fact, I believe The way we measure, we've gained market share. So I don't really want to put numbers You know what the normalized overall Equity Capital Market revenue will be When it rebounds, that's a hard thing to do. I certainly don't believe this is the new normal at all of about $100,000,000 when you're talking about $100,000,000 talking about equity revenue. So we priced an IPO last night, a lead left IPO, which Felt good. I don't think we haven't done that in a while.

Speaker 2

And when these markets, I've said this, I've said it in my Remarks. Markets like this tend to improve slowly And then suddenly, okay. And suddenly, there's a lot to do. I the potential for that suddenly is there because I See and talk to a lot of clients that have a lot to do in their capital stacks. I'm just going to be reluctant to Try to put a timeframe on it, which might be the most optimistic thing I'm saying because I feel that once I quit predicting when things are going to rebound, it's going to be closer To that moment.

Speaker 5

Understood. Got it. Okay. Thanks, Ron. Appreciate it.

Speaker 5

So follow-up Here, just on CRE, so provision obviously ticked up a little bit. I know it's a small portion of the balance sheet and the allowance looks healthy, but how do you guys feel about that portfolio right now? And anything else that you might need to do there? Thanks.

Speaker 3

I would kind of maybe starting with the top down across the entire loan book, we feel pretty good. The portfolio was down probably $140,000,000 $150,000,000 in the quarter mainly in Fund Banking, but the vast majority of that portfolio 70 plus percent Mortgage, Fund Banking, SPLs, CRE is only $1,500,000,000 Obviously, the reserves did tick up on there. We are continuing to watch that space, but it is a relatively modest exposure for us. And if you think about in the grand scheme of things, a $10,000,000 provision, Given the size of our portfolio, not something that we view as a concerning trend. Non performing loans only less than $40,000,000 past due loans at $16,000,000 We feel pretty good overall on the credit profile of the bank.

Speaker 5

Okay, perfect. Thanks so much guys.

Operator

Our next question or comment comes from the line of Alex Blostein with Goldman Sachs. Please go ahead.

Speaker 6

Hey, guys. Good morning. Thanks for the question. Good

Speaker 3

morning, Alex.

Speaker 6

Hello. So first, just a follow-up to maybe Steve's questions around Deposit and the Suite Deposit Trends. Your monthly commentary seemed to have suggested that the deposit trends and the outflows Improved in September, I think you said they were up in September versus August. Today's results seem to be a little bit more muted. So maybe just kind of the cadence of Deposit sweep trends over the course of the quarter.

Speaker 6

And then I guess relative to the $11,000,000,000 of sweep deposits and balance sheet, I guess call it about $600,000,000 in third party Where do things stand today? And does that include the sort of the monthly billing dynamic?

Speaker 3

Yes. So I would say at a high level, the inflows and outflows within the sweep program can be lumpy on a day to day basis. We just happen to see a decent sized outflow on pretty much the last day quarter, which accounted for the discrepancy between those two dates. As I mentioned earlier, the suite program and the decline we've seen there Over the basically the 1st month of Q4, it basically matched the cadence of decline you saw during the Q3. So we have not seen an increase on there.

Speaker 3

It was just some lumpiness over a particular few days.

Speaker 6

Got it. Okay. A little bit bigger picture question. So Wealth Management continues to do nicely here. I think you guys said mid single digit organic growth and net new asset growth In the Q3, Ron, you alluded to really strong pipeline and I guess there's maybe a mix shift occurring as well with the PEP advisors you're bringing in.

Speaker 6

So As you look a little bit further out, what do you see as a reasonable net new asset growth for this business for you guys? And then The assets that are coming in, can you give us a sense of how much is going into sweep deposits as a percentage of client assets? In other words, In line with kind of firm wide average or more kind of balances disproportionately go to higher yielding options? Thanks.

Speaker 2

Look, I think the growth is as we said this quarter, I think Mid single digit growth is reasonable and is what I would say, ask to try to project That growth. As it relates just overall to recruiting, Just our recruiting pipeline, what I most encourage about it is the quality and Frankly, the fact that we have large teams that are really talking to us that we haven't had in the past. So we've had That's the biggest thing is quality and the level of the teams that are joining us. I'm not sure that I see any difference in the ACAD Accounts as to what's in sweep or what goes into our smart rate. I think I would note though that one of the things that is notable to me is the amount of cash that we have in bills, Less than 1 year, which is up almost approaching probably $10,000,000,000 And that's where When you talk about cash sorting, it's not just between our sweep and our smart rate.

Speaker 2

It's the fact that today, The trade that everyone likes to talk about is, well, I don't know what I want to do, so buy me a 6 month treasury. And we've seen a lot of that. But the good news is that money is not going, it hasn't left. It's just geographically somewhere else on our balance sheet and Yes, client asked. So, that's I don't know if you have anything to add to that, Jim.

Speaker 3

I don't think that covered it.

Speaker 2

All right. Thank you very much.

Operator

We go next to the line of Brennan Hawken with UBS. Please go ahead.

Speaker 7

Good morning. Thanks for taking my questions.

Speaker 2

Hi, Brad. I

Speaker 3

wanted to start with

Speaker 7

The fact that the credit, well, appreciating that it's small as a percentage of assets and loans, It like more than tripled in the quarter. So could you talk about What drove that? And the outlook, please? Thank you.

Speaker 3

Yes. So I would maybe starting with the outlook. I think we feel good about that portfolio. We have very, very loan to cost. We talked a little bit about some of the loan to values on the prepared remarks in the call.

Speaker 3

You'll see in some of the detail in the 10 Q, there was probably $5,000,000 or $6,000,000 specific reserve on one credit. We feel that, totally addresses That particular credit in terms of a reserve and that's really what drove a lot of the underlying build that you're talking about within CRE.

Speaker 7

Okay. Thanks for that. And I guess when we sit there and think about All the green shoots narrative. It's been a little hard to keep track of because it seems like there was a lot of optimism around The green shoots started in about May. Here in the past month or so, we've heard, it come off And so or maybe moderate a bit and pull back.

Speaker 7

Are you seeing that are the higher rates On the long end of the curve, constraining maybe some of that optimism on the margin, how would you characterize the recent

Speaker 2

I think look, I think, you're now going to hear Things like term premium and it won't be just a short term rate, what's the 10 year doing? I mean, the overall interest rate environment clearly Has an impact on activity and on confidence and frankly, Many of the pundits will disagree on whether short term rates are going to 6 or go to 4. And all of that uncertainty just mutes activity. I know it as a participant in the marketplace in our own M and A activity, we haven't we did a deal a year, 2 to 3 deal a year for almost 19 years and we haven't done 1 in 2. So I think it's all of that together.

Speaker 2

If you remember when you talk about green shoes, there was a Time when the forward curve predicted that the first cut in the short term rates would be this December. That wasn't that long ago and that certainly has moved out. So I don't want to try to predict When the markets will turn, what I do want to say is that we've built a great franchise and we're maintaining it And we believe that we will get our fair share of business when the markets improve. I'm just not going to venture a guess as to when.

Speaker 7

No, I totally appreciate that, Ron, and venturing a guest in this environment has been super challenging. I'm actually not asking for What I'm asking for is what's been happening since maybe early September in the past roughly month. Have you noticed any changes in the dialogue An engagement or not really?

Speaker 2

Not really. Like I said, we did price an IPO Last night that used to be a lot more commonplace. So that's just that was maybe even idiosyncratic in itself. So Not really. I think the environment has stayed pretty consistent.

Speaker 2

Okay, great. Thanks for the color.

Operator

We now turn the floor to Ron Krzyzewski for closing remarks.

Speaker 2

Thank you, operator. Everyone, I look forward to Bringing everyone up to date on our year end results in January, and I do look forward to not waking up to Groundhog Day. So with that, have a great day. Thank you.

Operator

Thank you. This does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time.

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Stifel Financial Q3 2023
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