Stifel Financial Corp. (NYSE:SF) Q4 2022 Earnings Call Transcript

Stifel Financial Corp. (NYSE:SF) Q4 2022 Earnings Call Transcript January 27, 2023

Operator: Good day, and welcome to the Stifel Financial Fourth Quarter 2022 Financial Results Conference Call. Today’s conference is being recorded. At this time, I’d like to turn the conference over to Joel Jeffrey. Please go ahead.

Joel Jeffrey: Thank you, Justin. I’d like to welcome everyone to Stifel Financial’s fourth quarter and full-year 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 an earnings release and posted a slide deck and financial supplement to our website, which can be found on the 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. 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 and may not be duplicated, reproduced or rebroadcast without the consent of Stifel Financial Corp. I will now turn the call over to our Chairman and CEO, Ron Kruszewski.

Ronald Kruszewski: Thanks, Joel. To our guests, good morning, and thank you for taking the time to listen to our fourth quarter and full-year results conference call. 2022 represented Stifel’s 132nd year in business, and represented our second best annual results as our balanced business model enabled us to deliver return-on-tangible common equity of 22%. Simply stated, Stifel performed as we expected with our more stable Global Wealth Management business, offsetting declines in our institutional segment. As is well reported, 2022 represented a difficult operating environment characterized by persistent inflation and rapid central bank tightening, which put pressure on equity valuations illustrated by a 19% decline in the S&P 500.

The pressure on asset valuations was broad-based and in the case of high-growth technology companies, dramatic. The complex and volatile environment, including the highest inflation in 40 years and significant geopolitical turmoil had a chilling effect on capital raising and related strategic activity, impacting our institutional business worldwide. Despite this volatility, Stifel revenues totaled $4.4 billion with earnings per share of $5.74. Additionally, we increased our book value by 6% and our tangible book value by 9%. Global Wealth recorded record revenue and record profitability and our institutional business despite a difficult year when compared to 2021 was approximately the same as 2020, which represented record revenue at that time.

Again, these results are a testament to the diversity of our business model and our long-term strategy of continually reinvesting for growth. On the basis of our 2022 results and our belief in consistently increasing our dividend, I’m happy to announce that our Board of Directors has approved a 20% increase to our common dividend, which will now total annually $1.44 per share or $0.36 per quarter. Moving to Slide 2. We review the significant growth in our business since 2015. Even with the difficult operating environment in 2022, our growth has been stellar. Net revenue was up 86%, net interest income up nearly 600%, advisory revenue up 300% and earnings per share increased more than 350%. Further, comparing our 2022 results to 2020, our growth story is equally clear.

We have increased net revenue by 17%. Net interest income nearly doubled, advisory revenue was up 67% and earnings per share grew 26%. You’ve heard me say a thousand times, but I remind you again, Stifel is a growth company and we will continue to reinvest in our business as it has been instrumental in our long history of consistent profitable growth. Our focus on long-term growth is a key factor in reaching our strategic objectives. Over the past 25 years, Stifel has grown from a small Regional Wealth Management firm to a premier Global Wealth Management and investment bank. As I look to the future, we will continue to grow both our business segments by redeploying our substantial excess capital with the goal of generating the best risk-adjusted returns.

For our Wealth Management franchise, this means continuing to recruit high-quality financial advisers that choose to make Stifel their firm of choice due to our adviser-friendly culture, expands the product suite, excellent technology and industry-leading yet simple and fair compensation systems. Since 2018, we’ve added more than 500 financial advisers with trailing 12-month production levels that total more than $350 million. As you’ve heard me say before, we believe that we can reach $1 trillion in total client assets through a combination of strong recruiting, net new asset growth and market appreciation. This growth will not only help us grow our private client asset base, but increase our deposit base at our bank and further expand our bank balance sheet, which has been a significant contributor to our top and bottom line growth.

Speaking of the bank, we are pleased with both our net interest income and expanding net interest margin. As Jim will expand on later in this presentation, we believe our net interest will increase nearly 40% next year with our net interest margin expanding to between 4.05% and 4.25%. We have accomplished this because of our focus on building an asset-sensitive balance sheet over the past several years of near-zero short-term rates. This asset strategy has allowed people to offer competitive saving type accounts and pass more of the rate increases to our clients. A particular note is our bank’s Smart Rate program, this high-yield savings account has enabled Stifel to increase its client deposits over the past few quarters while many in our industry have been dealing with the impact of cash sorting by clients looking for higher yields on their cash.

Also, we will continue to pursue deposits from our corporate clients as our expansion in the fund banking and other corporate banking services has further expanded our deposit base. Our institutional group has grown from essentially zero, a little less than 20 years ago into a global business that generated average total revenue in the past three years of $1.75 billion. This was accomplished through both organic growth as well as a number of strategic acquisitions. Our growth has been focused on increasing our relevancy to our clients. As we look forward, this will continue to be a driving principle. In terms of our overall business outlook, we believe that we will achieve our objective of $1 trillion in assets under management, which coupled with loan growth, would more than double the revenue generated from Wealth Management.

As such, even considering the substantial growth we expect from our institutional business, we expect Wealth Management to comprise a greater percentage of our revenue in the years ahead. In addition, given our strategic objectives for our business, we anticipate that our excess capital levels will continue to grow meaningfully. That said, we will continue our long-standing policy of focusing on generating the best risk-adjusted returns, which I’ll discuss in greater detail on the next slide. As you can see from the chart on Slide 4, at year-end, we have approximately $400 million of excess capital. And based on consensus analyst estimates, we could generate an additional $800 million in 2023. Look, it is strategic that we have the capital to be able to take advantage of opportunities in the market, particularly in down cycles.

However, as you can see from the chart on the lower left, we have a history of deploying our excess capital to both grow our business and return it to shareholders. Our approach in either case has been and will be based again on risk-adjusted returns. Over the past two years, we have focused on growing our balance sheet. And as such, we’ve deployed more than $1.8 billion in capital, supporting balance sheet growth of nearly $11 billion. Of course, this asset growth has been funded by deposits, which have grown since 2017 by $16 billion, attributable to strong recruiting as well as an increase in retail and commercial deposit gathered capabilities. While balance sheet growth has been the recent focus of our capital deployment strategy, we’ve also paid out $275 million in common and preferred dividends, we purchased nearly $280 million of common stock and allocated $136 million to acquisitions.

As we enter 2023, we have stated our intention that not to slow our bank growth, which effectively increases capital available for other uses. Further, we believe in consistently growing our dividend. And as we did again today, our dividends we did today and reinvesting in our franchise for future growth. That said, we also feel that given our current share price, our stock is attractively valued compared to others in our peer group, and we currently have 8.7 million shares remaining on our current repurchase authorization. During the quarter, we repurchased about 1.3 million shares for about $75 million. I suspect many in the analyst community had expectations for a higher level of share repurchases. I would note two factors impacting the level of buyback; first, we were only in the market two months; and second, we are working on an acquisition during late December.

Thus one should not read too much into this, and we will continue to utilize share repurchases as a tool for capital utilization. Speaking of valuation. On Slide 5, we illustrate how Stifel compares to two high-quality peers; Raymond James and Morgan Stanley. I respect these firms that would note that our business models, which combined Wealth Management, Institutional and a bank are quite similar. Much like these firms, we run our company to be recognized as a consistent high-quality performer. Look, when we compare our valuation metrics to these companies, we see that we trade at a 25% to 33% discount based on PEs or price-to-tangible book. However, since 2017, our growth in EPS and tangible book value is considerably higher than these two quality companies as is our trailing 12-month return on tangible common equity.

Simply, our team’s goal is to continue to perform consistently and as a natural result, close the valuation gap. Finally, on the next slide, I’ll discuss our outlook for 2023 in terms of current Street analyst estimates. The current consensus estimate for net revenue for 2023 is $4.8 billion, which is up about $425 million from 2022. The primary driver of the increase is the expectation that our net interest income will grow to $1.25 billion, about a $360 million increase. Of note, our fourth quarter NII totaled about $300 million, which, of course, annualizes at $1.2 billion for 2023 and does not take into account any increase in net interest margin or interest earning assets. Taking out NII. The Street is essentially predicting that our operating net revenue will be flat to up slightly.

Said another way, The Street consensus implies the overall market conditions for 2023 will be similar to 2022. Of course, markets can turn very quickly and improving market conditions will positively impact revenues while a recession is also possible. Considering both possibilities, we are guiding to total net revenue of $4.6 billion to $5 billion in 2023. This includes our expectation that net interest income will be in the range of $1.2 billion to $1.3 billion. Operating revenue has a little less clarity as the environment for our institutional business remains challenging. While we expect the capital raising activity will improve and M&A announcements will pick up, the overall market environment will play an important role in 2023’s revenue, thus, again, the wider range of net revenue guidance.

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I would note that given the expected increased contribution from NII in 2023 and our revenue guidance, we expect that our compensation ratio will decline to 56% to 58% and that operating non-comp will be in the range of 18% to 19% of net revenue. Now let me turn the call over to Jim Marischen to discuss our most recent quarterly results.

James Marischen: Thanks, Ron, and good morning, everyone. Stifel generated quarterly net revenue that surpassed $1.12 billion, our second strongest fourth quarter in our history, and our focus on managing expenses resulted in pretax margins of 23% and non-GAAP EPS of $1.58. This drove an annualized return-on-tangible common equity of 23%. Looking at the details of our fourth quarter results on Slide 8. We showed solid sequential improvement as revenue increased 7% and earnings per share improved 23%. I’d highlight that the fourth quarter marked the ninth consecutive quarter with a pretax margin of greater than 20%. This is of note, as prior to the beginning of this streak, we only had five quarters with pretax margins above 20% since 1993.

Moving on to our segment results. Global Wealth Management revenue increased 10% to a record $744 million, and our pretax margins were 43%. This is an increase of 810 basis points from a year-ago. For the year, we posted record revenue, driven by net interest income and asset management revenue that both reached all-time highs in 2022. During the quarter, we added a total of 36 advisers and 152 for the full-year despite an environment that was less than ideal. As market conditions normalize, we anticipate a strong pickup in the number of advisers coming to Stifel as our pipelines remain robust. The markets have also influenced our transactional and asset management revenues. Regardless, we ended the quarter with fee-based assets of $145 billion, the total client assets of $390 billion.

Speaking of growth, our net new assets increased 5% in the fourth quarter and 4% over the trailing 12 months. On the next slide, we illustrate some of the longer-term drivers in our Wealth Management business. Our new recruits typically bring substantial client assets to our platform and generate a large percentage of the revenue in advisory fees. This, combined with our increasing NII contribution has increased our percentage of recurring revenue, which adds greater stability and predictability of results. Our recurring revenue reached 76% for the full-year 2022, which surpassed our previous full-year high by 1,000 basis points. Moving on to the Institutional Group. In the quarter, revenue was $354 million, and for the full-year, institutional revenue totaled more than $1.5 billion.

In the fourth quarter, firm-wide investment banking revenue totaled $224 million. As you can see by the chart on the bottom right of the slide, we’ve significantly grown the number of investment banking managing directors. At the end of 2022, Managing Directors totaled 229, which is up more than 2.5x the number we had in 2012. While market conditions have weighed on this business, our increased scale enabled us to generate $971 million of investment banking revenue in 2022, which was our second strongest year ever. As market conditions normalize, we believe our increased scale will continue to drive revenue in this segment. Advisory revenue in the quarter was $167 million. We were once again negatively impacted by the delay in deal closings, particularly in our financials vertical.

That said, one of our larger deals was recently approved by the FDIC, and we anticipate that it will close in March, which should result in higher than seasonal norms for our advisory revenue in the first quarter. We continue to see positive signs in our business as client engagement remains high, and our investment banking pipelines remain solid, as we’ve seen in the second half of 2022, closings have slowed. On the next slide, we look at the remainder of our institutional equities and fixed income business. Fixed income generated net revenue of $105 million in the quarter and $504 million for the year. Our equities business was down approximately 50% for both the quarter and full-year. Again, due primarily €“ due to the industry-wide drought in capital raising.

Our full-year fixed income transactional revenue increased 3%. It was the second highest in our history. Our business benefited from the higher activity levels earlier in the year, particularly in our rates business as a result of the addition of Vining Sparks. Fixed income capital raising for the year was $134 million. Our business was negatively impacted by lower industry-wide issuance activity in both the municipal and credit markets. However, I would highlight that our market share for the number of negotiated transactions increased to 15.3% in 2022, which was 710 basis points ahead of the next highest firm. For the quarter, revenue came in at $28 million, which is up 3% sequentially and compares favorably with the 25% industry-wide decline in public finance issuance.

Equity transactional revenue totaled $52 million, up 13% sequentially. This increase compares favorably to industry-wide volumes that were down 3%. Overall, we see increased engagement in electronic trading as we continue to gain market share as our clients embrace our electronic offerings and value our best-in-class research. In terms of equity underwriting, the market continues to face headwinds from increased volatility. We anticipate that as markets stabilize, activity levels will begin to return to historical norms. Moving on to Slide 13. Our net interest income has been a standout in 2022 as we benefited from the growth in our balance sheet and the impact of higher interest rates. For the year, NII totaled nearly $900 million, which came in slightly above our full-year guidance.

For the quarter, NII was up 24% sequentially to $302 million and also came above the high end of our guidance. I would note that NII in the quarter was positively impacted by a benefit in the mortgage portfolio as a result of higher interest rates, increasing the duration of that portfolio, which results in deferred costs being amortized over a longer time frame. This accounted for approximately $5 million of the increase in NII during the quarter. We project net interest income in the first quarter in a range of $295 million to $305 million and bank NIM of 380 basis points to 390 basis points. For the full-year, NII guidance mentioned earlier for 2023, I would note that this is based on loan growth of up to $2 billion, a bank NIM of 405 basis points to 425 basis points and a full-cycle deposit beta of 40% to 50%.

I would add that we ended the year with $8.7 billion in the Smart Rate program. The range of our NIM guidance reflects our assumptions for various levels of additional cash sorting throughout the year. Moving on to the next slide. A quicker we review the bank’s loan and investment portfolios. We ended the quarter with total loans of just under $21 billion, which was down approximately $200 million from the prior quarter. Our commercial portfolio decreased by $300 million, primarily due to the decline in broadly syndicated C&I loans. On the consumer side, our mortgage portfolio increased by more than $300 million, while our securities-based loan portfolio fell by $60 million. Moving to the investment portfolio. We continue to see improved marks on the available-for-sale and held-to-maturity portfolios, which improved $4 million and $75 million, respectively, during the quarter.

Turning to credit metrics. Our credit loss provision totaled $6 million. For consolidated allowance-to-total loans ratio was 74 basis points, which is up slightly due to the provision expense and the decrease in the loan portfolio. Overall, our credit metrics remain very strong. Our non-performing assets as a percentage of total assets were 4 basis points, while our non-performing loans were 5 basis points. On the next slide, we go through expenses. Our comp-to-revenue ratio in the fourth quarter was 56.5%, a 150 basis point sequential decline as we continue to benefit from the NII contribution. For the year, we came in at 58%, which was in line with the high end of our updated guidance. Non-compensation operating expenses, excluding the credit loss provision and expenses related to investment banking transactions, totaled approximately $219 million, which is up $10 million from the prior quarter due to seasonal increases in travel and entertainment expenses.

For the full-year, our non-comp operating expenses as a percentage of revenue were 19%. The core effective tax rate during the quarter came in at 24.5%. Finally, our average fully diluted share count came at above our guidance as the benefit of our share repurchases were more than offset by the increase in our share price. Absent any assumption for additional share repurchases and assuming a stable stock price, we would expect the first quarter fully diluted share count to be 115.9 million shares. And with that, let me turn the call back over to Ron for his closing remarks.

Ronald Kruszewski: Thanks, Jim. As you can tell from our guidance, there is still a significant amount of uncertainty in the operating environment in 2023. U.S. economy faces the prospect of a recession. The impact of the war in Ukraine continues to be a drag on the global economy and China’s reopening could further impact the global supply chain, just to name a few. However, as Stifel has shown time and time again, our business is built to perform throughout economic cycles. To summarize, in 2022, we generated our second highest net revenue in EPS in an environment where our institutional revenues were down 30%. Our focus on reinvesting in our business resulted in record Global Wealth Management revenue and a 79% increase in net interest income.

The growth in our investment banking managing directors enabled us to offset the 64% decline and capital raising with strong advisory results. We generated pretax margins of return-on-tangible common equity of nearly 22%, while growing our tangible book value per share by 9%. As I look into the current year, I am optimistic in our Global Wealth segment, we anticipate further NII growth despite the slower growth rate of our balance sheet. Our strong recruiting outputs will lead to further net new asset growth in our Private Client business. Our Institutional business is more cyclical, but remains well positioned to benefit from any pickup in capital raising activity and we will continue to focus on increasing our relevance to our clients. Lastly, we continue to generate significant excess capital and given our expectations for significantly less balance sheet growth in 2023, we anticipate additional available capital for share repurchases, dividend increases as we just did and potential acquisitions.

And considering all of the above, I look forward to closing Stifel’s valuation gap. And with that, operator, please open the line for questions.

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Q&A Session

Operator: Our first question will come from Devin Ryan with JMP Securities.

Devin Ryan: Hey. Good morning, guys. How are you?

Ronald Kruszewski: Good morning, Devin.

James Marischen: Good morning.

Devin Ryan: Maybe just to start on the guidance, appreciate heading into 2023, there’s a lot of uncertainty. But I’m assuming kind of a big input here is just trying to understand what happens in investment banking. That’s going to be a pretty big toggle. And so I’d love to just maybe think about some of the underlying assumptions that you guys have in that revenue guidance around equity market movements kind of on the plus and minus side. And then just overall kind of how you’re thinking about the guardrails for investment banking for 2023.

Ronald Kruszewski: Devin, I think I tried to address it in the call, let me just state it again. Our guidance started with consensus guidance on The Street, which is about $4.8 billion. And as I said, other than an increase in NII, which we can forecast pretty well as we’ve shown, and we’re confident in that number, and The Street is effectively having flat operating revenues. So 2022 on the institutional side was a difficult year as well advertised across the Street. So that $4.8 billion, which is the middle of our revenue guidance assumes for us basically the same kind of environment. I would say that if you look at investment banking, I would say that capital raising would be up, advisory would be down, maybe offsetting each other, but operating revenue is flat in an environment that will be similar to 2022 as the Fed figures out what it’s going to do in the economy, either has a soft landing or a recession.

So the middle is sort of like report stayed the same as 2022. Now if the market gets better, which you can turn on a dime and we’ve seen, and I expect at some point it will, then you get to the higher end of our guidance, which would be driven by improved asset management fees and improved investment banking. The lower end of our range would say that the market environment worsens from 2022, and therefore, it may be a recession. And therefore, you get to the lower end of our guidance, which would be even more difficult institutional markets and asset management fees that would be down because equity markets would correct even more. So that’s the give and take on that. Jim, do you have anything to add?

James Marischen: No, the only thing I would emphasize there is the comment on some of the advisory fees that slipped out of the fourth quarter and into the first and just emphasize the fact that, that’s going to result in some seasonality differences in advisory in the first quarter, particularly the large financial deal. There’s been a couple of other deals that slipped out of the fourth quarter into the first and just would emphasize that as well.

Ronald Kruszewski: Yes. We got a little bit of a head start on advisory, but okay. So hopefully, that gives some color again. We’re using The Street consensus and then commenting from there, Devin.

Devin Ryan: Yes. Appreciate that. Good context. Maybe just a big-picture question, Ron. Like the Slide 5, where you frame out kind of the growth of the company and the valuation. Just at a high level, you talked a lot about kind of Wealth Management and that becoming bigger and getting to $1 trillion in assets. Just as you look out over the next handful of years, you grew earnings to 142% over the last five years. Is that type of growth as a firm is obviously the larger scale today? You think you can do that over the next five? And just what are some of the €“ if you were to kind of highlight a couple of the biggest drivers or opportunities for Stifel right now, what are you most excited about?