Good day. And welcome to Stifel Financial Third Quarter 2022 Financial Results Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Joel Jeffrey, Head of Investor Relations at Stifel Financial. Please go ahead..

Thank you, Katie. I'd like to welcome everyone to Stifel Financial's third quarter 2021 financial results conference call. I'm joined on the call today by our Chairman and CEO, Ron Kruszewski; our Co-Presidents, Victor Nesi and Jim Zemlyak; and our CFO, Jim Marischen.

Earlier this morning, we issued our earnings release and posted a slide deck and financial supplement to our website, which can be found on our Investor Relations page at www.stifel.com.

I would note that some of the numbers that we state throughout our presentation are presented on a non-GAAP basis and I would refer to our reconciliation of GAAP to non-GAAP as disclosed in our press release.

I would also remind listeners to refer to our earnings release, financial supplement and our slide presentation for information on forward-looking statements and non-GAAP measures. This audio cast is copyrighted material of Stifel Financial. It may not be duplicated, reproduced or rebroadcast without our consent.

I will now turn the call over to our Chairman and CEO, Ron Kruszewski..

Thanks, Joel. To our guests, good morning, and thank you for taking the time to listen to our third quarter results. Stifel posted a strong quarter as our Global Wealth Management segment generated its seventh consecutive record quarter.

Investments we have made have diversified our revenue sources and continue to enable us to create solid results despite market headwinds. The first nine months, revenues totaled $3.3 billion, with earnings per share of $4.17, and we are on track to record our second strongest annual revenue and earnings per share.

This performance was despite market conditions that included a 25% decline in the S&P 500, nearly nonexistent capital raising activity in subdued trading markets.

Our results prove that our diverse business model is capable of generating consistent top and bottom-line results as well as solid book value growth as our year-to-date tangible book value per share is up 5% and our book value per share increased 3%. Looking at the details of our third quarter results on Slide 2.

Revenue totaled nearly $1.05 billion, and earnings per share came in at $1.29. I would highlight that our pretax margin of almost 21% was our eighth consecutive quarter with operating margins above 20%. Our tangible book value of $29.63 increased by nearly $1 a share sequentially and is up 90% since 2017.

In addition, our return on tangible equity has exceeded 20% in each year since 2017 and is at 21.5% year-to-date on an annualized basis. As we did last quarter, we included a year-on-year revenue bridge to illustrate the changes in revenue in the third quarter of '22 compared to 2021.

Simply, our increase in net interest income was more than offset by about $100 million by the absence of underwriting and reduced trading. Looking at our segments. Global Wealth Management revenue increased 7% to a record $702 million with pretax margins up 40%, an increase of 380 basis points sequentially.

As I noted earlier, the increase in net interest income was the primary driver of revenue growth. While Jim will get into the details of our net interest income later in the presentation, I want to highlight that our third quarter NII was up 86% compared to the prior year's quarter, and year-to-date is up 60%.

We continue to invest in our wealth business through recruiting and improving our technology. We now have hundreds of thousands of accounts using our Wealth Tracker app. Our advisers are using Wealth Tracker to not only deepen their relationships with existing clients and to review relationships holistically, but also to attract new clients to Stifel.

Development of Wealth Tracker is a great example of our fundamental approach to this business. Stifel is an advisor focus firm that offers a platform and culture that enables financial advisers to grow their business without the bureaucracy that plagues many other firms. This adviser-first culture resulted in Stifel being ranked no 2 by J.D.

Powers in their 2022 U.S. Financial Advisor Satisfaction Survey. This is a testament not only to our culture, but to the investments we've made into the business. Our continuous improvement is on display as our J.D. Power ranks have improved every year since 2019.

Importantly, we ranked number one in the survey in three categories, leadership and culture, customer service and marketing.

I would also note that these rankings are based on feedback from the advisers themselves but underscores the quality of the culture we've built here at Stifel, which is a vital aspect of our ability to continue recruiting high-quality advisers. Speaking of recruiting, we added 36 advisers.

I would say that recruiting activity remains strong, but we've seen throughout the year that the pullback in market to slow the actual transition of advisers while also accelerating the retirement of others. As we look forward to more stable markets, we anticipate meaningful increases in recruiting levels.

The markets have also influenced our transactional and asset management revenues. Regardless, we ended the quarter with fee-based asset of $136 million and total client assets of $365 billion. Speaking of growth, our net new assets increased 6% in both the third quarter and over the trailing 12-months.

On the next slide, you see some of the longer-term trends within our Global Wealth franchise. As I mentioned earlier, we continue to see the benefits of investing this business through recruiting and bank growth, which has not only led to revenue growth, but also a significant increase in the percentage of recurring revenue.

For the quarter and a foundation of our long-term strategy, 16 experienced advisers joined Stifel as their firm of choice, choosing us because of our friendly culture, expansive products, industry-leading yet simple and fair compensation plans and excellent technology. These new advisers brought trailing 12-month production of $14 million.

Since the beginning of 2019, we've recruited nearly 500 advisers to our platform, a total trailing 12-month productivity of more than $350 million. Our recruiting pipeline remains strong, and we are encouraged by the traction we are gaining in the independent channel.

One of the many benefits of our increased NII is the increased percentage of recurring revenue, which adds to greater stability and predictability of results. Our recurring revenue reached 75% for the first nine months of the year, which surpassed our previous full year high by 900 basis points.

We achieved this high watermark while generating record revenue in this segment. What makes it more impressive is that we do this in light of the fact that our asset management revenues, which accounts for the majority of our recurring revenue, has been impacted by market valuations.

We grew our loan portfolio by $1.7 billion during the quarter, up 9% sequentially. Total firm-wide assets on September 30 were $37.6 billion, up $3.6 billion year-to-date. Starting in November, we will publish monthly metrics for wealth management.

This will include commentary on our business during the month as well as metrics such as total client assets, fee-based assets, client cash balances and total loans. We believe that by updating the Street on a monthly basis, we can have better align expectations with our quarterly results. Moving on to our Institutional Group.

We built a diversified business that has made us more relevant to our clients, and we are well positioned for future growth when the operating environment stabilizes. As always, we'll also look to continue for additional growth opportunities. In the quarter, revenue was $339 million.

Year-to-date, revenue was $1.2 billion, led by record advisory revenue and represented our second strongest first nine months, only trailing last year. However, the 75% decline in capital raising activity across the industry and the reduction of sequential trading volumes have more than offset the strength of our advisory business.

Investment banking revenue totaled $222 million. I'll focus on advisory business for the remainder of this slide and discuss our underwriting business on the following slide. Advisory revenue of $167 million, while an acceptable result, was negatively impacted by delays in deal closing.

I'd particularly highlight the impact that we've seen in our financials vertical as regulators have slowed approval of bank transactions, including a few of our deals. While we believe these deals should close in the fourth quarter, of course, cannot be certain. Looking at advisory fees and other business verticals.

We had a relatively strong quarter as we saw strength in the U.S. M&A market, particularly in technology, health care, consumer and real estate as well as restructuring. Additionally, we have increased the number of high fee assignments as we continue to deepen our relationships with our clients.

Overall, while closings have slowed, we continue to see positive signs in our business as client engagement remains high, and our investment banking pipelines remain solid. On the next slide, we look at the remainder of our institutional business, looking through the lens of equities and fixed income.

Fixed income generated net revenue of $101 million in the quarter and posted our third highest revenue for the first three quarters of the year. Our equity business was down 50%, again, due primarily to the industry-wide drop in capital raising. Fixed income transactional revenue totaled $74 million, with lower activity in our rates business.

Our bank clients continue to face a lack of liquidity on their balance sheet as they contend with lower deposit levels, which has resulted in lower trading activity in their investment portfolio. Fixed income capital raising came in at $27 million.

The sequential decline was due in part to a slowdown in industry-wide public finance volumes, which, for the record, were down 16%. As interest rates have risen, refunding transactions have essentially ceased, and new money bond volume is still being impacted by the unspent federal ARPA funds.

Additionally, we had lower activity in our taxable debt capital markets business. Looking at public finance business. Stifel has increased its market share, which we calculate based on the total number of transactions of approximately 15%, up from 13% in 2021. Equity transactional revenue totaled $46 million, up modestly from the prior quarter.

The increase compares favorably to industry-wide volumes that were down 12%. Overall, we see increased engagement in electronic trading. Also, we generated modest trading profits compared to trading losses that we discussed last quarter. In terms of equity underwriting, Stifel's activity is really no different than what's happening industry-wide.

However, I do believe that this business will rebound as many transactions are delayed as opposed to being canceled, and we have seen some green shoots from the technology and health care verticals. And with that, let me turn the call over to our CFO, Jim Marischen..

Thanks, Ron, and good morning, everyone. I'll start by addressing net interest income. NII was up 25% sequentially to $244 million and came in at the high end of our guidance. The growth was driven by a 40-basis point increase in our bank NIM to 328 basis points and a 5% increase in our interest-earning assets.

We continue to see further upside from the recent Fed fund increases. We anticipate that the 75 basis point increases that occurred in July and September will further benefit our fourth quarter results. As such, we project net interest income in the fourth quarter in a range of $290 million to $300 million and a bank NIM of 375 to 385 basis points.

Based on our fourth quarter NII guidance, we expect our full year NII to be between $885 million and $895 million. Year-to-date, we've increased our average interest-earning assets by nearly $6 billion, which is at the high end of our full year guidance. As such, we expect limited balance sheet growth in the fourth quarter.

I'll address our 2023 expectations on our fourth quarter call. But as I said last quarter, we anticipate exiting 2022 with a full year NII run rate of $1.2 billion. Thus far, through the current interest rate cycle, we've experienced a 38% deposit beta, which is consistent with our original guidance range of 25% to 50%. Moving on to the next slide.

I'll quickly review the bank's loan and investment portfolios. We ended the quarter with total of $21 billion, which was up approximately $1.7 billion from the prior quarter. Our commercial portfolio increased by $1.4 billion, with particular strength in the fund banking and industrial sectors.

On the consumer side, our mortgage portfolio increased by $400 million, while our securities-based loan portfolio fell by $200 million. Moving on to the investment portfolio. Total investment book value decreased by approximately $40 million sequentially, most of which was driven by portfolio amortization and maturities. Turning to credit metrics.

Our credit loss provision totaled $6.5 million. Loan growth in residential mortgages and fund banking were a primary driver. And given their lower expected loss levels, our allowance to total loans ratio declined to 70 basis points. Overall, our credit metrics remain very strong.

Our nonperforming assets as a percentage of total assets were four basis points, while our nonperforming loans were five basis points. Moving on to capital and liquidity. Our risk-based and leverage capital ratios remained strong at 17% and 11.1%, respectively. The modest decrease in our capital ratios were the result of loan growth.

Our funding base increased modestly in the third quarter, and PCG client cash, which consists of sweep deposits and smart rate deposits, were essentially flat at $26 billion, and I would note, have increased since quarter end. The products that we launched in order to keep client cash within Stifel have proved successful.

And consequently, we have not been as impacted by many of the recent cash sorting trends in the industry. Specifically, our smart rate program is approximately $4.7 billion in deposits, up from approximately $1.5 billion as of the time of our last earnings call.

These are yield-seeking deposits that would have historically gone into third-party money market funds. It's products like this that have enabled us to grow our balance sheet without reliance on wholesale funding. As I stated earlier, we'll likely see limited balance sheet growth in the fourth quarter.

As we think about future growth, much of that will be driven by growth in assets from adviser recruiting, and we can potentially tap into some of the $6 billion in additional money market fund balances. On the next slide, we go through expenses.

Our comp-to-revenue ratio of 58% was down 10 basis points sequentially as the benefits from increased NII contributions have been partially offset by slower institutional activity.

Non-compensation operating expenses, excluding the credit loss provision and expenses related to investment banking transactions, totaled approximately $209 million, which is flat sequentially. This represented 20% of our net revenue.

While the absolute amount of our non-comp operating expenses was in line with our expectations, it came in above our guidance as a percentage of revenue due to lower-than-expected revenue. The effective tax rate during the quarter came in at 26.5%, which was above our guidance due to our forward operations.

Finally, our average fully diluted share count came in below our guidance due to our lower share price. We currently have approximately 10.3 million shares remaining on our share repurchase authorization.

Absent any assumption for additional share repurchases and assuming a stable stock price, we'd expect the fourth quarter fully diluted share count to be116.8 million shares. Before I turn the presentation back to Ron, I wanted to give some additional color on our expectations for the fourth quarter and the full year.

The market so far this year haven't rebounded as much as we had expected. And as a result, we now forecast net revenue to come in at the low end of last quarter's guidance for 2022 despite continued strength in our net interest income. So by definition, if our revenues are down, this puts pressure on our expense ratios.

As such, we expect our comp ratio to come in at the high end of our prior guidance. Our non-comp expenses have essentially been in line with our initial forecast, but due to lower revenues, we've increased our expectations for operating non-compensation ratio to 18% to 20%. And with that, I'll turn the call back to Ron..

Thanks, Jim. Look, it's been a tough year as financial conditions have tightened significantly, and market returns have been dismal pretty much regardless of asset class. Yet, I am optimistic. We have built a strong and balanced business, which remains well positioned to gain market share and deliver for our shareholders and associates alike.

Let's not lose sight of the fact that Stifel is having its second-best year, with operating margins and return on tangible common equity both exceeding 20% and very strong credit and capital metrics.

As Jim detailed, we anticipate net interest income back to 2022 with a run rate of $1.2 billion, assuming -- and assuming -- that assumes no growth in interest-earning assets. It is noteworthy that NII totaled only $500 million for all of 2021.

We will continue to build our wealth management business through strategic investments and a continued focus on recruiting. Everyone is concerned about the state of the institutional business, and I see this as a business that will continue with strong growth, and we will look back at 2022 as a difficult, yet temporary operating environment.

As we have often stated, our strategy is to use our excess capital in a variety of ways to benefit our shareholders. At different moments in the cycle in order to effectively deploy capital, we may elect organic growth, acquisitions, increased dividends or share repurchase.

At this point, it is our expectation given the economic outlook that our asset-light growth is likely to slow.

So given our high level of profitability, the fact that our capital ratios are well above our target levels and the fact that we will slow our balance sheet growth, it is likely that our capital deployment will focus more on dividend increases and share repurchases and, if appropriate, acquisitions.

With that, operator, please open the line for questions..

[Operator Instructions] We'll take our first question from Steven Chubak with Wolfe Research..

Hey, good morning, Ron and Jim. Hey, it's Michael [Inaudible] for Steven. Good morning. So I guess starting off on the maybe cash sorting here. I was just trying to dig into the numbers here a little bit more. I guess you've rolled out the smart program. That has been an attractive way to retain deposits.

How much of that yield-seeking activity have you seen thus far? And maybe if you could provide any thoughts around the incremental behavior you may see as cash continues to migrate into that program. You had also noted 40% to 50% betas in the NII guidance.

I guess is that a through-the-cycle expectation? Or is that on further rate hikes? So just trying to think about the trajectory of deposits and the incremental deposit costs there..

Yes. I'll let Jim -- you could start with this, Jim..

Yes. So we talked about smart rate program at the end of the quarter had $4.7 billion, and it's increased some since then. We have seen some additional cash sorting. But I think most of what we've seen is the decline in the Sweep Program has ended up being retained via smart rates. So we're able to retain those deposits.

And when we think about the total deposit beta here and the asset yields, we're getting, we're able to generate a return that it makes sense to continue to capture those deposits. We ended the quarter with -- if you look at, like I said, in the end-of-period book yield on our bonds and our loan portfolio, it was north of 475 basis points.

And inherent, what we talked about a 38% deposit beta through the end of the period, so ignore the lag, you're at about 114 basis point cost of funds. And so if you think about, yes, do we think the deposit beta will go up from here? Yes, we do.

We still feel over the life that we're comfortable of saying somewhere between the 25% and 50% deposit beta. And as we look forward, we've tried to illustrate some of the impact of that on the 2023 results. And I think without growth and the ability to retain those deposits, it's pretty impactful..

Yes. And then I would just add from a client behavior perspective, I think we've always said we've been consistent that we felt in this cycle that cash sorting would ultimately be greater than what we've seen in the past. I mean, look, the one year is at 4.60, and effective Fed funds is at 3.08.

And so to -- in our case, we're sitting here with which is what the question should be is what is our total cost of funds. That's about 1.14. And that's the real question. We see our NIM -- our margins actually expanding even with the cash sorting that we're anticipating. So that's how I would do it.

But it's different this time around in terms of the alternatives that clients face for idle cash..

Got it. That's extremely helpful. I guess pivoting to the institutional side, I just wanted to dig into the FIC business a little bit more.

Understanding that business is different from the bulge bracket in terms of mix, a bit surprised to see fees in that business come down on a year-over-year basis following that Vining Sparks deal that you guys completed.

Given that the Fed balance sheet hasn't begun shrinking at this juncture, should we expect that business to continue to come in from here? And maybe you could just speak to some of the drivers of that decline in a little bit greater detail, that would be great. Thank you..

Sure. Well, the fixed income, there's -- you could think of it as really three of the business that we do. One is our capital raising on fixed income. And I spoke to what's been going on in public finance.

Frankly, taxable underwriting like equity underwriting has been very slow in terms of debt activity with corporations not really engaging that much in the capital raising side. Look, our rates business is a big business for us. Our rates business is dominated by depository institutions.

And I've said these issues with deposits and liquidity of banks impact bank's portfolio. So we've seen that slow. I don't see that turning on a dime, but I think we're near the lows of that activity. And then, of course, the credit business has been impacted just as credit wide have really spread, especially what's going on in the high-yield market.

So for us, that business -- I think the results have been pretty good. I see it getting better from here. We're near the low than we are at the top, sure. But for us, we don't also, we don't participate in commodities and currencies like our bigger brethren do.

And there's been a lot of activity and a lot of volatility that has driven those results, which we don't do..

We'll take our next question from Devin Ryan with JMP Securities..

Good morning. How are you guys? Doing great, excellent. Maybe first one here for Jim. Just coming back to the balance sheet and maybe focusing on the asset side a bit. So clearly appreciate the dynamics around growth from here.

Is there any room or opportunity to be opportunistic around just optimization on the asset side? Or do you guys like the current mix? Just curious if there's any places where you can maybe pick up some more spread by recalibrating that a little bit..

So I think there's always opportunities for optimization. And I think you look at both the loan and the bond portfolio, there's opportunities in both.

I think where it's going to be limited due is more so of how we're generating deposits to support that, but there's a number of different lending verticals across fund banking, various different C&I channels that offer pretty attractive yields today.

And you think about on the bond side as well, CLOs are being priced anywhere from, it so offers to plus 2.10 to 3.50. And so from a yield perspective, those offer some pretty attractive yields compared to where we're at today..

Okay. Appreciate that. And then a quick follow-up here on the GWM commissions. Just want to parse that a little bit.

Is the decline that we've been seeing in the last several quarters, is that primarily just driven by lower trailing commissions, just kind of the mark-to-market on what's already kind of in the book? Or is that just a lot more subdued engagement? I'm just trying to think about if markets come back versus engagement coming back..

I think a good portion of that is being driven by just lower client engagement. There is some fund placement business that goes on through that transactional line that has been slowed as well, and that's impacted the results from retail transactional results..

Yes. I think that's consistent across the industry. And Devin, I want to go back a little bit to your question about growth in the balance sheet. We've been growing our balance sheet quite large. We've grown loans through nine months, 25%. And we see demand. There are remixing opportunities.

It's just in this environment where we are -- or everyone's talking about potential recession. Forecasts are changing. And we did this a few years ago.

Our belief is that with the cash that we're generating, which is substantial cash, the math has changed on whether or not that cash is better deployed back to shareholders, especially our stock prices relative to growth and in the current environment.

So that's really the message, is that it's an opportunity to remix the balance sheet, but it's also where is the best investment for the substantial amount of cash that we're generating, frankly, on a daily basis..

Yes. No, really appreciate that and makes sense, and I think people will like to see buybacks here. So thank you..

[Operator Instructions] We'll take our next question from Alex Blostein with Goldman Sachs..

Hey, guys. Good morning. Hey, so just another one on the balance sheet for you guys. So if you look at the loan mix, Stifel has a fairly outsized balance with PE and venture capital commitments -- capital commitment lines.

How does that business perform in this environment? And as you think about any risk of sort of paydowns in those balances or any other kind of loan buckets that you have as you look out into 2023.

So should we be thinking of that as an incremental headwind to loan growth, and therefore, you'd have to remix in the securities portfolio? I know you mentioned CLOs.

And maybe as a follow-up to that, obviously, the yield curve is flat, but the absolute level of yield is reasonably attractive, especially if, I guess, if you believe the forward curve and that we'll get rate cuts at some point of time in the next 12 to 18 months.

So any appetite to extend duration to lock in some of these wider spreads?.

Well, the first question, there's two questions there. The first question around fund banking. And look, I think it's a good question as to the growth in that business considering capital raises, that's all tied together.

Those loans come off of PE firms actually raising our capital and then taking those commitments and prefunding them sort of with the banks, that's what we and other banks do. What I would say to you, as we sit here today, we don't really view that as a risk if prepayments exist because we do have a lot of home demand.

And so if anything, we'd see a pickup in yield. Those are great loans, but -- or they're not our highest yielding loans. They're very safe so as we look at them. But I think it's a great question. I don't view that as a headwind. If that prepayment would occur, we would be remixing our balance sheet and our loan portfolio and with equally quality assets.

So that's not the issue. With respect to duration, it's a great question. And I think that, like we do everything, we'll probably have some balance in that. I think it makes some sense to extend some duration here, but -- and we saw with our friends over in Britain, if you do everything all at once, that doesn't always end very well.

And so I don't see us completely changing our duration here. But it makes some sense to extend duration incrementally here, for sure..

Yes. Great. And then just a follow-up to your discussion earlier about sort of capital returns. And obviously, it sounds like there's an appetite for a bigger buyback. You guys have always been opportunistic, of course, on the M&A front as well.

So if there are opportunities to do deals, especially some of the other players might be a little bit more pressured, any sense of which way you will be sort of pivoting, whether it's on the institutional side or the wealth side or maybe the asset management side, again, presumably nothing imminent? But if you were to consider M&A, what part of the model would be more interesting to do deals right now?.

Yes. Well, I think that we're allocating certainly, and it's an efficient capital allocation model, but we're allocating to recruiting. Our recruiting is strong.

A number of the things that we have done have made that a very attractive area for us to put investment, and you're going to see us really focusing on building wealth management through recruiting. On the other acquisition front, we've been focusing on advisory type businesses.

So capital-light type businesses, and that would certainly be on the advisory front on the institutional side. That said, there's always a lot of opportunities that present themselves in markets like this. What I would say on balance is that if you think about it, we grew our assets so far about $4 billion. That's $400 million of use of capital.

As we slow that, that's capital that can be used for deployment back to shareholders. And frankly, our stock price, where it sits today, is a very attractive alternative for our excess capital..

And maybe another couple of numbers around there. You think -- we've been -- we've had trailing 12 net income of around $700 million. We pay out about $185 million in common preferred dividends. So you can think about the excess there. And on top of that, you have about $400 million in excess of, like, a Tier 1 leverage target.

So that kind of gives you some additional numbers around where we have excess capital to deploy..

Yes. And we've been growing, Alex, and we've been deploying our capital, as I said, $4 billion of growth. But one of the best investments I see out there right now has a similar effect. So that's how I see it..

With no additional questions in queue, I'd like to turn the call back over to our speakers for any additional or closing remarks..

Well, I appreciate everyone joining in this month of October. We look forward to reporting on our fourth quarter late January, and we'll give everyone a look forward into 2023. But with that, thank you for your time and attention and look forward to communicating again. Thank you..

Thank you. And that will conclude today's call. We appreciate your participation..