Stifel Financial Corp. (NYSE:SF) Q4 2023 Earnings Call Transcript

Stifel Financial Corp. (NYSE:SF) Q4 2023 Earnings Call Transcript January 24, 2024

Stifel Financial Corp. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and welcome to the Stifel Financial Fourth Quarter Financial Results Conference Call. As a reminder today’s call is being recorded. At this time, I’d like to turn the call over to Mr. Joel Jeffrey, Head of Investor Relations at Stifel Financial. Please go ahead.

Joel Jeffrey: Thank you operator. I’d like to welcome everyone to Stifel Financial’s fourth quarter and full year 2023 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 and I would refer to our reconciliation of GAAP to non-GAAP as disclosures 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 by Stifel Financial and may not be duplicated, reproduced or rebroadcast without the consent of Stifel Financials. I will now turn the call over to our Chairman and CEO Ron Kruszewski.

Ron Kruszewski: Thanks Joel. To our guests, good morning, and thank you for taking the time to listen to our fourth quarter and full year 2023 conference call. Let’s begin by discussing our year-end 2023, whereby, Stifel generated strong results in an operating environment that was less than ideal. The benefits of our diversified business model enabled us to successfully navigate market conditions that included increased geopolitical risks, tightening of financial conditions, primarily due to significant increases in short-term rates and quantitative tightening by the Federal Reserve both implemented to control inflation and the failure of three major banks in the United States. Led by record results in Global Wealth Management, which produced its 21st consecutive year of record net revenue driven by record asset management revenue and net interest income, Stifel overall generated net revenue of approximately $4.4 billion.

This was essentially in line with 2022 despite a significant industry-wide slowdown in investment banking activity. As we’ll discuss later, these results are directly correlated to our consistent reinvestment in our business, our focus on servicing our clients, as well as our strategy of deploying our substantial excess capital in ways that generate strong risk-adjusted returns. Taken together we generated operating pre-tax margins and returns on tangible common equity of approximately 19%, excluding the impact of the nonrecurring legal charge in the third quarter. With respect to capital deployment, we typically deploy the excess capital we generate each year and 2023 was no different. Last year, we generated $630 million of excess capital and deployed it as follows; the repurchase of 7.2 million shares totaling approximately $440 million, $211 million in common and preferred dividends and a modest amount of balance sheet and acquisition activity.

Underscoring our confidence in improving market conditions, I’m happy to announce that our Board has authorized a 17% increase in our annual dividend on common shares from $1.44 to $1.68 per share. On slide 2, we look back at the growth of our business since 2015 and 2019. Despite constantly changing market conditions, investments we’ve made in our business results in substantial growth. Net interest income was up more than 760% since 2015 as a strategy to grow our balance sheet enables Stifel to capitalize on the increase in short-term interest rates over the past two years. Importantly, we’ve achieved this growth without taking excessive interest or credit risk. Additionally, the investments we’ve made in recruiting on both the Wealth Management and Institutional segments have led both segments to more than double revenue over the past eight years.

The operating leverage from these investments resulted in earnings per share increasing 270% over this timeframe. The comparison of 2023 to 2019 is also important as it illustrates the benefits we’ve seen from recent acquisitions recruiting and balance sheet growth. Total revenue was up 30% in the past four years as Wealth Management growth of 40% more than offset relatively flat Institutional revenue, which should not be lost here as the potential upside we see in our Institutional business. Specifically, the average number of investment banking management directors has increased by 33% since 2019, but our Advisory revenue was relatively flat due to the market conditions. If our production per MD returns to historical levels, we would experience substantial growth for both our top and bottom-lines.

Looking at our quarterly results, we had a strong rebound from the third quarter. Net revenue of nearly $1.15 billion was our third highest quarterly revenue as the combination of a pickup in Institutional revenue and continued strong Wealth Management revenue drove this improvement. Given the flexibility of our operating model, we were able to maintain our compensation ratio at 58% and generate $1.50 of EPS, which was a 27% sequential quarterly increase in operating EPS, which excludes the significant onetime legal reserve taken in the third quarter. Moving on to slide 4. We look at the variance table to consensus estimates. Total net revenue beat The Street by $60 million as each of our primary revenue lines surpassed expectations. Transactional revenue came in $30 million above The Street on stronger fixed income revenue as our Rates business has begun to rebound from the weakness tied to bank failures higher rates and an inverted yield curve.

Investment banking came in $21 million above expectations driven by higher advisory and fixed income capital markets primarily public finance. Total expenses were higher than forecast, but much of that was reflected in compensation expense due to higher revenue in the quarter as the comp ratio remained consistent at 58% and was in line with Street consensus. Non-comp expenses were $10 million higher than expectations as a result of higher occupancy costs and higher legal expenses that was partially offset by a lower loan loss provision. Before I turn the call over to Jim to go through our quarterly results, I wanted to talk about our Wealth Management business. While much of the discussion of our near-term upside is focused on our Institutional business, I want to emphasize that our Global Wealth segment has been the long-term growth engine of our firm and is a cornerstone of Stifel’s success.

As stated previously, our Wealth Management segment has posted 21 consecutive years of record revenue as our focus on recruiting serving our clients, respecting the entrepreneurial spirit of our advisers, and growing client assets has been fundamental to our success. Slide 8 illustrates these points. Since 2014, Global Wealth Management revenue has increased 150%, while the percentage of recurring revenue has increased from 44% to 78%. Again, this level of growth has been the result of our strategy to recruit high-quality advisers and provide them with extraordinary level of service. In this effort, we have continually invested in resources support and technology to reduce bureaucracy and enable our advisers to thrive. Our recruiting efforts have been one of the key elements of our growth efforts.

Since the end of 2018, we’ve added more than 700 financial advisers with cumulative trailing 12 production of approximately $435 million. We continue to see increased momentum in our recruiting efforts as the number of advisers we added to our platform increased by nearly 30% in 2023, as compared to 2022. So while we see significant upside in revenue and margins as our institutional segment gets back to historical norms our long-term growth and success has been and continues to be driven by our Wealth Management franchise. And with that, let me turn the call over to Jim Marischen to discuss our most recent quarter results.

Jim Marischen: Thanks, Ron, and good morning, everyone. Looking at the details of our fourth quarter results on slide 6. Our quarterly net revenue of $1.15 billion was up 2% year-on-year. The increase was driven by stronger client facilitation, trading and underwriting revenue that was partially offset by lower net interest income and advisory revenue. Our EPS was up 150% sequentially, due to higher revenues as well as lower non-comp operating expenses, which Ron addressed earlier. Moving on to our segment results. Global Wealth Management revenue was $766 million. Our pre-tax margins were 39%. For the full year, record net revenue of $3.05 billion, was up 8% from 2022. This was driven by record asset management revenue and net interest income as well as strong transactional revenues.

Primary driver of our growth has been our ability to recruit advisers and increase our client assets. During the quarter, we added a total of 40 advisers. This included 13 experienced advisers with trailing 12-month production of more than $8.1 million. We ended the quarter with fee-based assets of $165 billion, total client assets of $444 billion. The sequential increases were due to higher equity markets and organic growth as net new assets grew in the mid-single digits. Moving on to slide 8, where we highlight the solid trends at the bank. Net interest income of $273 million, was in the lower half of our guidance as bank NIM was impacted by higher deposit costs, larger average cash balances, and the movement of sweep deposits back into third-party banks.

The movement of cash back into the Sweep Program resulted in a few million dollars being recognized in asset management revenue rather than NII. This is simply changing the geography of where the revenue is recognized on the income statement. While we are not ready to say cash sorting is behind us, outflows from sweep accounts were essentially flat in the quarter as compared to outflows of more than $3.6 billion just two quarters earlier. I’d also note that the sweep program now has $2.1 billion in balances with third party banks. That said, we typically see some cash outflows early in the year given the timing of tax payments. In terms of our expectations for the first quarter, we project net interest income to be in a range of $250 million to $260 million.

Our credit metrics and reserve profile remains strong. Nonperforming asset ratio stands at only 15 basis points. Our credit loss provision totaled $2.3 million for the quarter and our consolidated allowance to total loans ratio was 86 basis points. During the quarter charge-offs were primarily tied to an individual C&I credit, it was fully reserved for previously. I would also note that we saw an approximate $800 million reduction in C&I balances during the quarter as we opportunistically sold certain broadly syndicated loan exposure as we continue to focus balance sheet allocations to portfolios that also provide other deposit or fee income opportunities. Lastly, our balance sheet continues to be well capitalized. Tier 1 leverage capital decreased 30 basis points sequentially to 10.5%.

I’d also like to highlight the improvement in unrealized losses in the bond portfolio. To put numbers to this and reflecting on the rally in the 10-year treasury bond and tightening of credit spreads, our unrealized losses declined by $127 million or nearly 40% during the quarter. On the next slide, I’ll discuss our Institutional Group, which had its strongest quarter in a year and half. Total revenue from the segment was $359 million in the fourth quarter, which represented a 40% sequential increase as both Investment Banking and our Transactional Business had strong quarters. Firm-wide Investment banking revenue totaled $206 million as both capital raising and advisory revenue experienced significant increases from the third quarter. Advisory revenue was $129 million, which was up 33% sequentially as we had solid results in our industrial, healthcare and technology verticals.

I highlight that although we benefited from year-end seasonality, the quarter was again negatively impacted by continued delays in closings. We continue to expect these deals to close the timing remains uncertain. However, our pipelines remain strong and we are seeing momentum begin to build in our activity levels, but the timing of the sustained rebound in the business remains very much market dependent. Equity revenues totaled $89 million in the quarter, which was our strongest quarter since the fourth quarter of 2021. Equity transactional revenue totaled $57 million, up 20% from the prior quarter, represented our highest quarterly revenue in two years. We continue to gain transaction — I’m sorry we continue to gain traction in our electronic offerings and see strong engagement with our high-touch trading and best-in-class research.

Fixed Income generated net revenue of $142 million, an increase of $50 million from the third quarter. Much of the increase was driven by the $35 million increase in Transactional revenue. We are starting to see the rates market open up as banks are beginning to trade their investment portfolios given the more dovish Fed outlook and more stable deposits. Underwriting revenues increased 60% sequentially as we continue to be a leader in the municipal underwriting business as activity increased and we continue to be ranked number one in the number of negotiated transactions as our market share was nearly 15% in 2023. On the next slide we go through expenses. Our comp-to-revenue ratio in the fourth quarter was 58%, which was in line with our forecast.

Non-compensation operating expenses excluding the credit loss provision and expenses related to investment banking transactions totaled approximately $249 million. Our non-comp OpEx as a percentage of revenue was 21.8%. The effective tax rate during the quarter came in at 21.6%. The lower tax rate was primarily due to the impact of the increase in our share price and related excess tax benefit on stock-based compensation. Before I turn the call back over to Ron, let me discuss our capital position. In the third quarter we repurchased more than 2.3 million shares. We have nearly 12 million remaining on our authorization. We have approximately $170 million of excess capital based on a 10% Tier 1 leverage target. Additionally, we continued to generate substantial amounts of excess cash as illustrated by our 2023 net income of $530 million.

We remain focused generating strong risk-adjusted returns when deploying capital and we’ve done this through reinvesting in the business making acquisitions as well as through share repurchases and our recently increased dividend. Absent any assumption for additional share repurchases and assuming a stable stock price, we’d expect the first quarter fully diluted share count to be 110 million shares. And with that let me turn the call back over to Ron.

Ron Kruszewski: Thanks Jim. Let me conclude by discussing our outlook for 2024 in terms of the current Street estimate. The current consensus estimates for net revenue for 2024 is $4.7 billion, which is up about $320 million from 2023. The primary driver of the increase is the expectation that our Wealth Management and Institutional revenue will increase by a combined $400 million, which will be — which will more than offset the roughly $80 million expected decline in net interest income. As you can see from the table, we are guiding to total net revenue of $4.55 billion to $4.9 billion in 2024. This includes our expectation that net interest income will be in the range of $1 billion to $1.1 billion. Overall, we believe that the pressure on net interest margin can be offset by an increase in interest-bearing assets.

Simply considering the multiple factors impacting the banking industry, we see the current period as an opportunity to make great loans. While we anticipate an improvement in our operating revenue particularly in institutional we remain conservative given the recent industry-wide weakness in investment banking. Considering this we expect our compensation ratio will be in the range of 56% to 58% and that non-operating non-comp — net operating non-comp will be 19% to 21%. I’ve heard the term transition year apply to 2024 and I believe that’s a relatively accurate description of the environment. We don’t believe that 2024 will be a “normalized operating environment” as there remains uncertainty regarding the number of rate cuts that the Federal Reserve will make the timing of the pickup in investment banking revenue, the Presidential elections, and how the equity markets will react to these changes.

Personally, I believe that The Street estimate of 11% EPS growth for the S&P 500 in five to six rate cuts is optimistic. We believe that earnings will grow for the S&P of 6% and approximately two to three rate cuts is more realistic. But I wouldn’t be upset with the consensus that would likely have a meaningful positive effect on our operating results. Lastly, while not giving guidance beyond 2024, I did want to touch on how we are looking at the next few years. I must say that while we are cautiously optimistic for 2024, we see the potential for significant exit velocity into 2025. Last quarter, we discussed the potential results of $5 billion in revenue and $8 in earnings per share in a more normalized market environment. For 2025, be such a year, it’s certainly possible if the markets cooperate as we don’t believe that reaching these numbers would require significant outperformance in any of our businesses.

What we need is to return to historical productivity levels in banking, continued growth in wealth management and some future balance sheet growth. The bottom line is that, as the operating environment improves, Stifel is well positioned to continue our legacy of profitable growth, which we believe will continue to drive shareholder value. This is consistent with our strategy of continuing to build our market-leading wealth management franchise, with an achievable goal of $1 trillion of client assets while also being a premier middle market investment bank. And with that operator, please open the line for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] We’ll take our first question from Devin Ryan with JMP Securities.

Q – Devin Ryan: Great. Good morning Ron and Jim, how are you?

Ron Kruszewski: Good morning, Devin.

Q – Devin Ryan: First question just want to, want to start just on deposit betas. And assuming interest rates do move on at least, with the current forward curve, how you guys are thinking about kind of the movement over the first and second 100 basis points? And I guess, the question is obviously, we know smart rate is over half of the cash x money markets and so that should be one for one. And so really kind of what are you expecting just for the sweep deposit piece of the equation? Thanks.

Ron Kruszewski: Well, I think half of our approximately are in smart rate and that is highly correlated to effective Fed funds. I think the question on deposit betas, on the way down are going to be driven by competitive factors, just as they were sort of on the way up. Jim, I don’t know if you want to…

Jim Marischen: No. I mean, the correlation effect of Fed Funds is essentially because of the competition. The competitions are money market mutual funds and treasury bonds. And those that by its nature is tied to the short end of the curve. And so you’ll see near 100% beta, on the way down on the first couple of cuts and probably beyond that.

Ron Kruszewski: Yes, for smart rate. I think Devin, I think you’re trying to get to what will happen with sweep balances, which is more transactional balances versus savings balances. And we expect them to decline. I’m not sure that I would be comfortable giving you a deposit beta on those balances.

Q – Devin Ryan: But it would be modest like it was modest on the way out?

Ron Kruszewski: It was modest both ways actually.

Q – Devin Ryan: Yes. Okay. That’s fair. You figured it. I see what you guys would say there. And then, I guess on the financial advisor evolution of the firm, I get this question a fair amount. Your Independent contractors is still very small less than 5% of overall financial advisor headcount. And I’d just love to get your thoughts Ron around, what do you think that looks like maybe five years from now? How much of an objective of the firm; is it to grow independent relative to employee if it is at all? And if it is kind of some of the steps you’re taking to either drive that growth, whether it’s organic or inorganic or just make the platform more compelling for independents as well as employees? Thanks.

Ron Kruszewski: Yes. I think the answer to your question would be what you finished that with, which is we would like to provide an opportunity and a compelling platform for independents to utilize simply our platform, our technology and our capabilities. There is no particular focus on growing the independent channel relative to the employee channel. There just hasn’t been. We will deal with that as supply and demand sort of dictates. We have the platform and it’s a good alternative. What you’ll see though is our focus has been historically and this is nothing against the independent channel. I just want to say our focus over the years has been on the employee channel. And that’s simply because we are a diversified firm with a lot of capabilities that the employee model, it’s more – it’s been tailored over the last 25 years to the employee model. So I can see both growing. I’m frankly indifferent, the way we look at the business.

Devin Ryan: Yes. Okay, appreciate it. I’ll leave it there. Thanks, guys.

Operator: We’ll take our next question from Alex Blostein with Goldman Sachs.

Alex Blostein: Hi. Thanks, guys. Good morning. First question around NNA. I heard you talk about a mid-single-digit NNA rate for the quarter. Can you talk a little bit broader kind of what it’s been for the year and what’s been the contribution from same-store sales, new FA recruiting and maybe your outlook for organic growth in that business for 2024?

Jim Marischen: I would say, the results we saw in the fourth quarter were consistent with what we saw over the full year. The net new asset number was relatively consistent in the mid-single digits across each of the quarters in 2023. I think it’s a fairly even mix between existing advisers and recruiting. I wouldn’t say either side is particularly driving the addition of net new assets there. And I think it’s fairly balanced.

Ron Kruszewski: Yes. And look I think I don’t have in front of me Alex the same-store sales. Certainly the last half of the year helped the overall slow business in the Wealth Management sector. If you ask me just to look forward though, I would say generally speaking that I would expect the increase in same-store sales to be higher in 2024 than it was in 2023. We got off to a rocky start in 2023. And with the equity markets where they are today and our outlook, I see some relatively good performance over 2023 for 2024 versus 2023 versus 2022.

Alex Blostein: I got you. That’s helpful. My second question just wanted to dig into the interplay on capital management, as well as you look out into next year. So it sounded like your appetite for loan growth perhaps was a little bit better as you look out versus maybe what we’ve seen over the course of 2023. So maybe just expand on that a little bit and just tease out what that means for share repurchases for 2024 as well?