Stifel Financial Corp. (SF) Earnings Call Transcript & Summary

Welcome, everyone, again to the second day of Goldman Sachs' Financial Services Conference. Before we begin, we are required to make certain disclosures in public appearances about Goldman Sachs' relationship with companies we discuss. These disclosures can be found on the webcast page for your reference. Now with that, I'd like to welcome Stifel's CEO, Ron Kruszewski. As an integrated wealth management and institutional services business, 2020 has really underscored Stifel's growth and resiliency as the firm is on track to deliver record revenues despite challenging markets in the beginning of the year, and obviously very low interest rates. This was further underscored with an upside revenue guidance for the fourth quarter that Stifel announced just earlier this morning, which I'm sure we'll get to talk about as well. So with that, we look forward to getting an update from Ron on the current operating environment as well as Stifel's key growth initiatives as we look out into '21. Ron, welcome, and thank you for joining us.

Good morning. I'm pleased to be with you and thanks for having us on.

Great. Awesome. So why don't we kick things off? I have a bunch of questions, and as usual, investors can submit their questions via the webcast and we'll try to incorporate them as we have this discussion. So first, I wanted to kick things off, I guess, with a look back on 2020 and sort of your key priorities for 2021. Now 2020, obviously, has been a very challenging year and I'm wondering how Stifel's competitive opportunity set within your respective marketplace has evolved. Clearly, the revenue momentum continued into the fourth quarter given your increased guidance this morning, as I mentioned. So maybe talk to us a little bit about that as well and whether that momentum can continue into '21.

Well, look, as we all know, what a year 2020 has been. You have to go back to the March, April time frame when most of the analyst community and including myself, when I look forward, I saw a difficult operating environment. We were marking revenues down, profitability down, provisions up, and it was viewed as to be a very difficult time to work through the economic shutdown of the pandemic. What happened instead was a lot of stimulus, a lot of Fed support in asset markets and an emergence, if you will, of the digital economy by force. So clients set a crash course in all things digital: shopping, InstaCart, Netflix, mobile banking and all of that did and what -- and so what's happened at a macro level is all those unicorns that we used to talk about that were ever going to come public or new technologies, I mean it actually, this environment has provided the opportunity for these companies to come into the economy and we've been very busy. Or if they haven't come into the economy, then they've can acquire. So the pandemic itself has been very stimulant to financial services.

Right. And as far as, I guess, the momentum that you're seeing in your own business and obviously, the fourth quarter guidance that you guys provided, maybe spend a minute on that since you guys just put it out this morning and how you're thinking about the sustainability of that momentum.

I'll take it 2 ways. I mean first of all, we did put out increased revenue guidance for the fourth quarter. And then we ran through our various operating metrics. When you put it all together, you will see that we're having a very strong fourth quarter. The way I'd comment it, though -- on it, Alex, is to think about what we might have thought, again, back in March. And that would be that, in March, if you would have said to me that interest rates are going to go to 0, our net interest income is going to decline, and fees by $120 million. KBW, which is our strongest vertical, at least in the first half of the year, was going to slow down significantly as Allstate has slowed down, yet we were going to be pushing record revenue and record profitability. What it speaks to is the diversity of our business, which I talk about all the time. And so not everything runs at full speed all the time, but we have a lot of businesses that are synergistic and natural hedges. And so that's what you're seeing today. Despite the fact that some of our sectors are performing less than I would have thought and net interest being down, we're very good. As it relates to sustainability, I'll answer it this way, because the only -- I get the question -- I've been CEO for 25 years. And for 25 years, I get asked the question about whether last year's revenues are sustainable. And for 25 years, we've had record revenue the next year. So I'm going to say past is prologue.

We'll take that. So look, before getting into some of the specific businesses because I definitely want to spend time with you on both the wealth management side and institutional side, but I wanted to get your macro perspective first a little bit. You always have some interesting views, both on the markets and the economy. So with the new administration coming in, what are your latest views around the macroeconomic conditions into '21? Any changes in regulatory implications we might see for your business specifically?

Well, I would -- let me start at the highest level, which is, at the macro level, I think there's 2 things that the market is certainly counting on. One is a stimulus package or aid, however you want to do that, but -- want to do it. But at least $900 billion to a -- $900 billion is a number that there's going to be a lot of disappointment because we do have shutdowns in a lot of part of the economy. So I do think there's a bipartisan to get that done, and I think that will be good for markets. The Fed, even though they're doing away with some of the programs, the Fed's stance is still going to be accommodative to the market. So those 2 things together will provide a good backdrop on the macroeconomic side. Flipping to the regulatory side, I think that we will see more challenges on the regulatory side than we've seen in the last 4 years as the new administration obviously changes the heads of the SEC and the Department of Labor and even Treasury. And so will there be additional challenges and/or modifications to Reg BI? I believe so. Yet that rule's on the books and I think that's a good rule. And so I'm not -- I don't see anything really that difficult as it relates to the regulatory front in a new administration. I think there can be some tweaks. I've been CEO through 2 Democrats, 2 Republican administrations and the regulatory front seems to be something we can always deal with. The last thing though, is one that -- well, before I get to that. Infrastructure spend, I do think is bipartisan. And I've been saying it's bipartisan for 5 years. Nothing's gotten done. But I do think that, 2021, we'll see infrastructure. That will be very good for our business as we're one of the largest public finance firms in the country. And I certainly see the interplay between public and private on an infrastructure bill. We do have to keep an eye on the Georgia elections. There's a number of people who aren't discounting certainly, at least that Perdue wins and that the Republicans retain control. And that's not a foregone conclusion in my mind. And I think that if that were not to happen, then the math changes, and then now you're talking about tax increases, corporate tax increases, capital gains, taxes above $400,000, a Senate that can supposedly push through a lot more things. And from an economic point of view, I think the market likes divided government. I don't think that the market would react well to that scenario.

Got it. That makes sense. All right. Why don't we spend a little bit of time with -- on each individual business and starting with the Wealth Management business. Following a pause in the height of the COVID concerns in the beginning of the year, recruiting obviously slowed down and then we saw a steady strengthening throughout the second quarter. You adapted to recruiting models to kind of the new work-from-home environment. So maybe we'll start there and spend a couple of minutes on recruiting trends. Can you tell us a little bit what's changed? What kind of changes you made to the business? How sticky those changes maybe going to be? And given significant increase in recruiting a few of you have seen recently, how should we think about, again, sustainability of that recruiting pipeline heading into '21?

Again, over in the last decade, we have -- we're over threefold the number of advisers. We continually are a net recruiter. We are an attractive destination for advisers primarily that are leaving more homogenized business models at the larger firms. That, plus our investments in technology and our investments, which support an adviser in a relationship-based relationship, if you will, with their clients, we've got a long and deep pipeline that I see no signs of abating. So we're going to continue to grow. We're not going to win every adviser, obviously. But in our space and what we do as a diversified wealth management investment banking firm, we win more than our fair share. And we're going to continue to do so.

Yes. Let's put maybe some numbers around that, and I wanted to kind of zone into the characteristics of the advisers you guys are bringing in. So last quarter, I think you brought in 45 advisers with $38 million in trailing 12-month production. And that number has been rising, right? It's like you've been recruiting more advisers, and those advisers that you've been recruiting have generally been more productive. How representative do you think those figures are of sort of what you see in the recruiting pipeline in terms of the type of advisers that are coming in? And more importantly, how does that translate into organic fee growth? So net of attrition, does it take 6 months, 12 months, 18 months for that to actually translate into revenues?

It doesn't take -- at the long end of that is 6 months to get most of the assets and -- over, and especially if it's fee based, it could be faster. I mean there is some transition period. As it relates to the productivity of the advisers that we've been hiring, you do see higher numbers. That's highly correlated to the markets that we're recruiting in. We have become more successful in what I would maybe characterize as the NFL cities, all right? And in those markets, there are a lot more advisers, a lot more big firms, but the productivity, almost by definition, is higher in bigger urban areas than they are in smaller towns. And so one of the things that I've noticed that we've been able to do is our ability to attract advisers from the largest firms. There was a time when not just Stifel, big -- advisers would say, "I can't go into a regional firm." Well, news flash, we're not a regional firm. We've got offices in nearly every state, U.K., Europe, Asia. We're all over the place, and we're a very diverse and capable firm. So the -- if you want to talk about it, 5 years ago, our addressable market, call it, one: to recruit. Our addressable market today is 3x what that was because of now who we can attract and support on this platform.

Got it. Sorry, getting a little background noise here. So I want to spend a couple of minutes on the competitive landscape for financial advisers there. So I feel like with your rates, net economics for wealth platforms have obviously changed pretty significantly. How are these dynamics impacting various transition assistance packages offered in the marketplace, with a greater emphasis on fees? Perhaps, do you think you have to pay out more to bring in recruiting? Or the profitability of those recruits generally have been the same?

In our case, we -- in a 0 rate environment -- obviously, in a higher rate environment, you -- the deposits have value, primarily to be -- to my competitors that don't have banks. And so they're sweeping those deposits away and receiving deposit fees that got as high as 150 basis points. Those fees are dwindling to 0. It may be there's a little bit of tail risk or tail impact on them, but those are going to 0. In our case, that was a very small part of what we were doing. We were sweeping historically a lot of our deposits to our bank. And so while we've taken NIM compression, we still are earning net interest income in our bank and are positioned for when rates rise, coupled with the fact that while we don't have a bad comparison because we didn't have them, our deposits are up significant. So we have -- we've kept our bank flat, as we've told you and analysts. For the last 1.5 years, we haven't grown it because we haven't got that rate environments, right? But for us, we still want to attract deposits. We have a place to put them. We have a place to earn an acceptable return on capital and build on our franchise. So it's not as challenging for us in terms of recruiting as it might be for a competitor that the only thing they do with those deposits is sweep them to another institution.

Got it. You talked about your addressable market having expanded significantly over the years. But primarily, you guys obviously still focusing on employee channel. How are you guys thinking about opportunities to expand into other, whether it's the independent side or the RIA side? Do you feel like, over time, those are the channels you ultimately will need to go after? Or do you see yourself sort of sticking with the employee channel?

I see us primarily focusing on the employee channel. The independent channel feels all -- often to me is it's more of a clearing model. Even the way they report earnings, it's gross profit after payout, is margins that are lower. But probably more importantly is that who we're attracting are clients that -- or are advisers that have clients that value and want banking services: laddered munis, IPOs, access to private markets. What I'm explaining is a banking, brokerage and advisory model, where you have a client has a lot of choice to be able to meet their financial goals. In an RIA model, often you have a fee base, but you don't have the brokerage and you don't have the bank. We view that our model, and I think it's going to become competitively more important to have that as fintech makes it easier to assimilate those assets, we think we're in the right spot. So -- and we'll always look at things, but my focus is on the employee channel.

Got it. That makes sense. Why don't we shift gears a little bit to your institutional business? And that's an area where, really, over the course of 2020, I think you surprised the market to the upside and even earlier today, you obviously talked about the consistency of the businesses that are underpinning your institutional services business that remains sort of overlooked by the market. So why don't we spend a couple of minutes on that? You've significantly diversified that business over the years. So as you look out 2 to 3 years, which part of the model you're most excited about? Which part of the model you think are most overlooked by the market? And kind of how do you think about organic growth in that business over the next several years?

Well, again, at the -- first of all, I want to just talk -- there was a slide in our update today that despite all the growth and where we've gone, the relative contribution of wealth management, institutional has stayed about the same. So we've stayed very diversified in that. We're growing wealth management nicely, but we are institutional as well. So it's not like the institutional business, which was, call it, low 40% to 45% of our business, suddenly it's 60%. It's not. It's still the same percentage because both businesses are growing. I think that what is -- what's hard to understand, and I've talked about being underappreciated, is what we've actually built and the diversity of our business. And so as I've said, we're very strong in FIG. We're very strong in technology. We've made big investments in health care. We've made investments in consumer. On the product side, we have 144As. We've done a lot of SPACs. We've been involved in the SPAC market. We obviously do private equity. We raise capital for private equity. We do interest rate derivatives. And then we have greenshoots in Canada, London and in Europe, all of which that we think are going to grow. So when I sit and look forward, I see growth and increased margins because we've been seeding a lot of investments. And I see that and I've seen it for the last 4 years and have proven it out for the last 4 years. So as I look forward, I see the same thing. I see increased market share, increased capabilities and increased profitability. Now of course, we're not immune to market cycles. So as long as we're marked up or down with the industry, I can live with that. Where I think we're misunderstood is often our peers are marked up and people say, "Well, golly, Stifel did a lot of business. That must not be sustainable." And that's something you and I talked about, Alex. I just think it goes to not understanding the breadth and capability of what we have here.

Right, right. When I look at the capital markets businesses on the institutional side, one of the bigger trends and themes that we've seen over the years is increased digitization of trading, so to speak, and particularly, that's upholding within fixed income. So electronification of fixed income markets has obviously accelerated pretty meaningfully over the years, in particular in 2020. How does that impact your fixed income trading franchise? How do you think about either adapting to some of these changes or making changes in that business as that market evolves?

Well, again, I think that through market structure and electronification and digitization and all of those things, we've been dealing with this since NMS back in the early 2000s. So market structure continually changes. And we evolve and we have very sophisticated trading systems. We believe in -- that there is a human element, primarily because there's, what, 50,000 CUSIPs in fixed income, a lot of munis, a lot of things that are not just necessarily put in on an electronic system and let it trade. We actually trade against those systems and do quite well. So I'm not just saying everything is electronic. But have we evolved? Of course we have. The same on the equity side. I would say that one of the things that has helped us is the percentage of our low-touch business, meaning the trades that we're getting without human hands that's being put through our algos and our liquidity pools is increasing meaningfully. So again, we're gaining market share in areas that we didn't participate before, again, because of, a, the investments in technology but also the investments in people that we have made. And when I look at the addressable market, in the middle market and where Stifel plays in the middle market and look at where we are today, I think we're in the early innings of our growth, not the late innings. And to put context to that, 25 years, our market cap has gone from $40 million to $5 billion. And we see it, we see this growth continuing.

Great. Well, let's move down the P&L a little bit. I want to spend a few minutes on net interest income. And obviously, look, it's been a challenging environment from a rates perspective, not a surprise. The encouraging thing, of course, is that your net interest income has generally stabilized. You kind of guided to flattish guidance for Q4 versus Q3. That's what you, again, kind of reaffirmed earlier this morning. But you also talked about seeing a path to resuming some of the NII growth. And we've seen, obviously, a significant amount of cash still sitting on the sidelines. You guys have built capital. So technically, there is capacity for you guys to grow the balance sheet from here. So walk us through maybe how you're thinking about that path for NII. From these kind of low levels, what sort of needs to happen? And what are you seeing in the business, whether it's loan demand or something you guys are doing from an idiosyncratic perspective, to get NII growing again?

No. I think if NII growth was the sole objective, we could do it starting tomorrow, okay? And we have everything in place to add assets and funding to our balance sheet. And we have the capital now, too, because we've been retaining some capital. So the question of increasing NII is a rather easy lever to pull. The question, of course, that investors want us to be answering is NII with a proper return on equity. And then that becomes a little more challenging in this rate environment and the shape of the yield curve. So as we look at it, it's been a tough year. Our NII has compressed nearly $100 million. You see it in most of the banks, and you can see it in the performance of most banks that are just banks. For us, there's 2 good things: one is our asset mix has allowed us to have visibility that we believe our NII is bottoming at this, assuming no negative rates; and two is -- well, I think it is our ability to reposition assets in loans with higher net interest margins. So we see an ability to continue to grow the bank. We have a lot of funding capabilities. We're being a little patient because it still feels to me like credit spreads are really tight and we can be patient before we're deploying capital. But again, we're earning these kind of returns in light of NIMs that are around 2%, not 3.30%, which is where they can go back. And by the way, Alex, that's the whole thing of diversification. The things that will cause some of our institutional business to slow down are going to be the very things that's going to bring our NIM back.

Right. I guess it sounds like you guys are holding back a little bit on the loan side just given where the spreads are, but in terms of loan demand, I know you guys have been trying to push into the mortgage space within your wealth channel. How is that initiative going? And again, anything else from an idiosyncratic perspective that you guys are doing to generate loan growth?

There's certain loans, the characteristics of which we like in this environment. 5 and 7 ARM mortgages are 1 of them, and we've been building that. Security-based loans are another. For, again, a variety of reasons, those loans tend to be attached to other aspects of our business. So we have been growing those loans. I mean obviously, we were never big in -- fortunately -- but we were never big in the sectors that were really impacted by the pandemic. So the entertainment, restaurants, travel were never big sectors of ours. And while there is loan demand out there, I certainly think we remain cautious on sectors that we haven't participated in historically.

Understood. Sorry, why don't we shift gears and talk a little bit about expenses and the margins? As part of the guidance update this morning, you took the comp ratio to 58.5% to 59.5% for the fourth quarter. And the non-comp ratio, brought that down a little bit, 18% to 20% versus 19% to 21% previously. When you kind of take a step back and, look, obviously, this was a bumpy year, right, with rates and credit provisions building, but when I look at Stifel's overall kind of pretax, pre-provision margin for the year somewhere between 18% and 19%, how should we think about that on a forward basis given the growth you've seen in the business, given the investments you're still making in the business but also addressing the benefit of scale that you've been able to build up over the years?

Well, I think that, as I've said, our margins get compressed primarily. The simple math of it is, is that net interest income for the most part's a non-comp compensable line item, and that is -- we view those as returns on our balance sheet, not necessarily returns that drive direct comp. So as NII declined by $100 million, which is what it's done, it's about 1.5 points to our comp ratio. And that's just math. You run through what it is and we go from 58% to 59.5% and we've offset that this year by being more efficient on the non-comp OpEx, which is obviously travel and all of those things. I don't expect that to continue, but I'll tell you that I expect that to pick back up but nor do I expect provision expense, which totaled about $40 million, I don't expect that to continue. So those will offset. So net-net, in a 0 rate environment, we see where we can maintain not only these kind of margins but returns on tangible equity that are north of 22%. So we feel that we're in a good environment, especially as a financial services company that is impacted by 0 rates. It's just that our NII is only 15% of our business. So it's -- I feel good about where we sit today.

Got it. All right. Well, with a couple of minutes left, I wanted to hit on capital priorities for Stifel. And if you look at your capital ratios, obviously, they've been rising given the fact you've been holding back on the share buybacks over the last couple of quarters. What's your appetite for share repurchases today? The environment feels a little better than it was, obviously, a few months ago, and I know that macroeconomic uncertainty was one of the key factors why you wanted to hold back a little bit. And then secondly, there's clearly been a lot more chatter around M&A, asset management, specifically, but really broadly within financial services that feels like there's still a considerable amount of consolidation opportunities. Kind of how do you think about both of those things for Stifel?

Well, as always, Alex, we do what we think is in the best interest of our shareholders. So we did just announce, it'll take effect in about a week, a 3-for-2 stock split. But in conjunction with that, when you go through all the math, we raised our dividend 33%. So we're very confident in our dividend payout, which still remains on the low end of peers, but we're increasing our dividend. We'll always look at stock buybacks. We do look at them opportunistically. And we see also some opportunities to make investments to grow not only the bank but some other acquisition targets that when they meet our criteria, we'll look at it. So today, we've increased the dividend and we're -- we'll always buy back stock opportunistically, but we're also -- we see the need for growth capital to continue to grow. And like I said, our EPS in the last 4 years has grown 27% a year per year. And we see opportunities to continue to do that. And again, I end with what I always feel are my sour grapes, Alex, but I just want to talk about the underappreciation of our stock and our earnings growth, our revenue growth. And we're a growth company trading at a 3 turns discount like a value company. And therein lies opportunity for investors. I certainly see it.

Yes. Well, look, I think that's a good point to wrap it up, on that note. Ron, thank you very much for joining us this morning. Really appreciate you being here.

I look forward to having a good day with all your investors, and thank you for getting me off first. I appreciate it. Go write your update.

Yes. We'll look forward to doing this in person soon.

All right. See you.

Take it easy.