Good day, and thank you for standing by, and welcome to the Stifel Second Quarter 2022 Earnings Conference Call. Please be advised that today's call is being recorded. [Operator Instructions] I'd now like to turn the call over to Mr. Joel Jeffrey, Head of Investor Relations. Please go ahead, sir.

Thank you, operator. I'd like to welcome everyone to Stifel Financial's Second Quarter 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 Zemylak; 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 you 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 Corp. and may not be duplicated, reproduced or rebroadcast without the consent of Stifel Financial. 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 second quarter results. Let me start by saying our second quarter and first half results were good, particularly in light of the significant market headwind. As widely reported and known, financial conditions in 2022 have been challenging to say the least. The S&P 500 had its worst first half since 1970, down 21.4%. Bonds spared a little better as the Bloomberg U.S. Aggregate Bond Index declined 11%. The 10-year yield was approximately 3% at June 30, more than double the year-end yield of 1.46%. While credit spreads have also widened significantly since the beginning of the year with investment-grade spread widening to [ 1.55 ] from 93 and high yield of [ 5.69 ] from [ 2.78. ] Economic measures of inflation hit 40-year highs. In addition, the Russian-Ukraine conflict, China lockdowns, an increasing risk of recession all contributed to the economic malaise while driving sentiment much lower. To address inflation, the Federal Reserve has become very hawkish. Remember, at the beginning of the year, the markets were pricing in 3 25 basis point increases for all of 2022. Today, the markets are pricing the equivalent of 12 to 13 25 basis point rate hikes. Clearly, the actions of the Federal Reserve will continue to tighten economic conditions. Going forward, I expect increased volatility and more uncertainty. We will manage our business accordingly. Against this backdrop, we recorded our second highest net revenue and EPS for both the second quarter and first half of the year. Our second-quarter revenue totaled a little more than $1.1 billion, a 1% decline and a 4% decline from the second quarter of 2021. Earnings per share came in at $1.40. So while the market environment was…

Thanks, Ron, and good morning, everyone. I'll start by addressing net interest income. NII was up 25% sequentially to $195 million and came at the midpoint of our guidance. The growth was driven by a 44 basis point increase in our bank NIM to 288 basis points and a 6% increase in our interest-earning assets, as we continued to grow our loan portfolio and our securities holdings. Given the timing of the 50 and 75 basis point rate increases in the second quarter, we anticipate the bulk of the upside to NII from these hikes to occur in the third quarter. As such, we project net interest income in the third quarter in a range of $235 million to $245 million and a bank NIM of 320 to 330 basis points. I'll touch on our overall updated full-year guidance at the end of my comments. Moving on to the next slide. I'll quickly review the bank's loan and investment portfolios. We ended the quarter with total net loans of $19.2 billion, which was up approximately $1.4 billion from the prior quarter. Our commercial portfolio increased by $730 million with particular strength in fund banking and industrial sectors. On the consumer side, our mortgage portfolio increased by $600 million while our securities-based loan portfolio was relatively flat. Moving to the investment portfolio. Total investments increased by $600 million sequentially. This was driven by a $570 million increase in CLOs. Turning to credit metrics. The credit loss provision totaled $12 million due to loan growth and the allowance to total loans ratio remained at 75 basis points. Our nonperforming assets as a percentage of total assets were 10 basis points, indicating continued strength in our credit metrics. Moving on to capital and liquidity. Our risk-based and leverage capital ratios remained strong at…

Thanks, Jim. In short, the diversity of our business resulted in another strong start to the year as our first half net revenue and EPS are the second highest in our history. Look, market conditions are volatile and difficult to predict. And as such, we will remain both cautious and opportunistic. As a base case for the second half of the year, we are assuming an operating environment similar to the first half. That said, we anticipate an increase in revenues as compared to the first 6 months as the substantial growth in our net interest income will provide a meaningful offset to the impact that the current market could have in our more cyclical businesses. Overall, Stifel is well positioned for continued growth as our capital levels remain robust. And as we have done throughout our history, we will use periods of market dislocation to reinvest in our business for future growth. With that said, I'd like to thank all my partners at Stifel for their efforts in building our franchise into the world-class organization that has capabilities to weather market downturns and generate continued growth. With that, operator, please open the line for questions.

[Operator Instructions] And our first question will come from the line of Devin Ryan with JMP Securities.

Great. First question just on the outlook for the back half of the year. So when we think about investment banking, there's a lot of uncertainty, I think, in terms of just completion of backlog. But can you just help us think about, like in your expectations, I guess, what the backlog looks like today relative to starting the year? And then we're hearing a lot from other firms about elongation of processes, deals taking a lot of time to close, but not a lot about deals breaking yet. I mean are you guys seeing deals break, and so therefore, expectations are lower because of that? Or just any other flavor around kind of some of the puts and takes for more on the investment banking side in the back half of the year.

I would echo the elongation comments, all right? We're definitely talking, we're engaging with clients. The advice is that it's a difficult market to execute transactions, especially capital markets. It's very difficult to finance a merger in the leveraged loan market today. And what we're seeing is a pause, especially on the capital raising side due to volatility in the market. And as it relates to the second half of the year, we were assuming, just for a base case, that I'm not going to pick the point that, that changes. I do know, Devin, that when it does change, it changes fast, I can point to a number of instances where you have to be ready, as bankers like to say, because the markets can change fast. But in terms of what we're thinking about, we're just thinking that it will be similar to the first half where we had no basically equity capital markets revenue. So that's how we're thinking about it. But the clients are engaged and will, this is a market where deals will get done. They're just being delayed.

Yes. Appreciate that. Yes, I was just trying to get a sense of the conservatism, we're not baked into that outlook. But I think you guys hit on that. Then just a follow-up for Jim. You gave a lot of details on net interest income and expectations kind of the exit rate on the year. So that's all helpful. And then you also touched on cash sorting. Can you maybe just help us with like how much more you expect and what history would suggest in terms of additional cash sorting from here. So any other detail you can give us in terms of what's baked into your customer cash expectations kind of exiting the year would be helpful.

Let me jump in on that and then I'll let Jim get to this because I think it's an important point, Devin, and I'm going to speak to cash forwarding a little bit. In June, I forget the exact time, there was a significant increase in the 2-year [indiscernible] rates. And what happened and what -- where it is today, is the yield curve became very steep from Fed funds effective to the 2-year and then, of course, the yield curve inverts. And so in a deposit environment, it's what I would expect. Cash-yielding products are -- there's a big difference between the money market rates and the cash sweep deposits and laddering a 2-year treasury. And that is -- so what we're seeing is what we would expect, especially in an adviser-led business to that. Now what's going to happen and is going to happen today is that steepness that yield core is going to flatten pretty quick. Today, it's 50 to 75 basis points of that steepness will go away that will happen in September. And in that environment, will lead to a more conducive environment for deposits. So I think that's been lost a little bit and what's been going on is effectively the steepness from Fed funds effective to the 2-year.

And maybe on top of that rate dynamic, a couple of things. Obviously, there's always some seasonal outflows related to tax payments. I think you've heard a number of competitors discuss similar type trends during the quarter. And I think as we sit here and think long term and one of the things we put on that chart is just our long-term growth in deposits, and that's going to continue to be driven by financial adviser recruiting, which remains strong. I'll also say we'll highlight the smart rate deposit program where we're capturing more of that yield-seeking cash and keeping that on our balance sheet. And then, again, we're growing our capabilities with venture and fund banking. And kind of going back to smart rate, I think we're going to be able to compete against some of that $6-plus billion in the money funds. And I think that is a key area for us to kind of combat some of the things in the near term that Ron talked about.

Your next question will come from the line of Steven Chubak with Wolfe Research.

So one of the questions I just wanted to unpack is around -- the topics I want to unpack is around the NII guidance. Jim, I believe you noted you're contemplating Fed funds of 325 million to 350 certainly helpful to hear the exit rate for the year does support some pretty strong momentum at the bank. But the curve is actually reflecting cuts in 2023. That's certainly something that started to garner increased attention. I just wanted to understand because you do tend to have a lot of short-end sensitivity, whether you're taking any actions to protect the margins if the Fed reverses course maybe adding some fixed rate MBS just to add some duration in lieu of CLO products, which you've had greater appetite for historically.

No. That makes sense, what you're talking about. I would highlight that we did add over $600 million of mortgage product, all that's adjustable rate mortgage during the quarter. And so we've had conversations talking about the environment for 2023. We can see, obviously, what Fed fund future are looking at. The thing I would say at that point, I think if you're looking at an environment where we're seeing rate cuts, the dynamic Ron talked about in terms of cash sorting probably goes away. And you think about the starting point of where our asset yields are at today, we would be able to generate a sufficient return. We're talking about 320 to 330 basis point NIM in the third quarter. So you think about our ability to generate -- meet our return hurdles at lower rates than that, I would view that more as just an opportunity to grow NII at that point as we see more cash deposits coming in.

Couple of color. And just for my follow-up on the noncomps. They did come in a little bit higher than we were anticipating. You did note that the ratio in the quarter was running above what you had guided to at least for the full year. Some of that could certainly be seasonal. It was encouraging to hear the comp ratio guidance for the full year was unchanged, was hoping you could just help frame how we should be thinking about the cadence for dollar in noncomps. You cited the elevated bizdev in the quarter. Certainly, we're seeing some normalization in T&E. But just trying to frame how we should think about the noncomp trajectory in the back half of the year?

Well, first of all, I'll let Jim get into it, we do provide guidance in noncomp as a percent of net revenue. So the first thing that happens, you get to the high end of the range when your revenue comes in lower. A lot of that is being driven on a ratio basis versus an absolute basis. Now that said, we've said that our T&E and our comps and those expenses were going to increase. But some of it is the fact that our Institutional business has been muted in this time frame. So that's driving that ratio higher. The same reason that comp ratio was coming lower because we're driving higher NII.

Yes. I mean, maybe a little color to what Ron just mentioned. If we would have hit the original midpoint of our revenue guidance, we'd be at a 16.5% adjusted noncomp ratio. That would be right in the middle of our original guidance. So in terms of absolute dollars, we're right where we thought, we would be, just more of a function of the revenue shortfall.

[Operator Instructions] The next question will come from the line of Alex Blostein with Goldman Sachs.

I wanted to go back to some of the funding dynamics of the bank. So it looks like you guys will exhaust the third-party bank sweep fairly quickly here, I think there's less than $2 billion left. And Jim, I know you talked about money market funds and the smart deposit program that's meant to be more competitive with money market fund yield. But I guess with industry money fund yields now kind of north of 1%, probably approaching 2% by the end of the year, should we be thinking about deposit cost on these incremental deposits sort of beyond what you could move from third-party bank sweep coming in closer to the money market fund rates?

Yes. So if you think about our deposit rate thus far in this rate, but it's been about 25%. We've talked about a 25% to 50% deposit beta. And when you look at smart rate today, before today's movement, it's going to be -- it's at 1.25%. So it's already in that -- baked into that map. But I think what we're saying is we still have the capability to go above 50% composite beta on future rate hikes and still meet those NII guides based upon what we've done thus far. And so I think we have some flexibility there to be more aggressive and still hit our NII targets for the year.

Yes. And I would say -- I think, Alex, embedded in your question is a good question, one that we look at and that is ultimately what your cost of fund is going to be, all right? I mean that's really what we're talking about. And we're comfortable -- first of all, I'm comfortable with our ability to source funding. We've been doing this a long time and we did this when the bank was half of its size. So we will be able to fund the bank. I'll go back to the dynamic that we saw before, which is the steepness of the yield curve, which has some cash-seeking deposits at the high end. And we're -- it's just not Stifel, that's across the industry, in my opinion, and that will begin to taper today with an increase in Fed funds effective again in September. So we're confident in our forecast, certainly through the end of the year, with our growth and our cost of funds effectively factors in what we're doing with smart rate.

Got it. And then on the asset side of the balance sheet, just another quick follow-up. As you think about the appetite for loans versus securities at this point in the credit cycle, kind of obviously heard your comments for the back half of the year. But as you think a little bit further than that, should we be expecting a similar pace of loan growth? Or that's likely to moderate as we kind of progress through slower periods of economic growth?

I think what we said before is we still feel confident in our $4 billion to $6 billion growth target for the year, which we said is predominantly going to be loans. Now that being said, there's number of verticals on the loan -- various different loan channels that we've been pretty good at generating balances with. That said, we still see attractive opportunities in CLOs and so that will be somewhat of a mixture of that. But if I look forward to the third quarter and into the fourth, I would say it's predominantly going to be loan growth.

And in terms of asset class, we've always sold a lot more mortgages than we keep on balance sheet. And there are some -- alluding to the previous question, there are some opportunities for us for very short-term nature in our -- where we move with the yield curve in that short term. So we certainly have a lot of home demand. Looking forward past this year, it's going to really depend on economic conditions in the market and whether or not there's a recession looming, all the things that will shape our views as we go forward. But overall, I would say that we're going to continue to grow our balance sheet into the future.

And there are no further questions at this time, so I'd like to turn the call back over to Mr. Ron Kruszewski.

Thank you, operator. Everyone -- hope everyone is enjoying their summer, certainly been hot here in the Midwest. And I look forward to catching up with everyone on our third-quarter earnings call. So have a great rest of the summer, and look forward to catching up again. Thank you.

And that does conclude today's conference. We thank everyone again for their participation.