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

Thank you, operator. I'd like to welcome everyone to Stifel Financial's First Quarter 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 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 consent of Stifel. 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 first quarter conference call. We had a strong first quarter. Stifel generated our third highest first quarter revenue as record Global Wealth Management revenues continue to drive our business and offset the market headwinds in our institutional group. Revenue came in a little over $1.1 billion with non-GAAP earnings per share of $1.40. We generated a pretax margin of 21% and return on tangible common equity of 20%. All things considered, these are solid numbers. I would also note that these results include the impact of a loss on sub debt we held in the bank bond portfolio that equated to $0.05 of earnings per share. I believe this quarter's performance once again demonstrated our ability to generate strong returns in light of ever-changing market conditions. This is the direct result of the diversity of our business and our long-term growth strategy. Overall, I am pleased with the continued growth in wealth management, our recruiting and the performance of our bank. Frankly, the banking crisis had a bigger impact on our institutional business because of increased volatility and uncertainty than its impact on our bank, which frankly saw deposit inflows, although the events did put a higher focus on cash sorting. When the operating environment improves, and I believe it will, there's a lot of business to do in our institutional segment, whether in private markets, capital raising or strategic advisory. We are well positioned for this outcome. That said, all anyone wants to talk about is bank metrics and trends. So let's do. Over the past few years, we've deployed significant capital into growing our bank. Although we've grown our assets, we have also effectively managed both credit risk and interest…

Thanks, Ron, and good morning, everyone. Looking at the details of our first quarter results on Slide 6. Our revenue of $1.11 billion represented our third strongest first quarter and was essentially in line with our average revenue during the prior 4 quarters. The consistency of our revenue over the past year was a result of the diversity of our business and primarily the investments we've made in our Global Wealth Management segment and particularly in our bank. This has resulted in our tenth consecutive quarter of pretax margins above 20% despite headwinds to some of our businesses, as you can see from the revenue bridge on the slide. All this produced earnings per share of $1.40. Moving on to our segment results. The Global Wealth Management revenue increased 11% and to a record $757 million, and our pretax margins were 42%, an increase of 860 basis points from a year ago. During the quarter, we added a total of 49 advisers, including 20 experienced advisers with trailing 12-month production of more than $12 million. Our recruiting pipeline remains robust, and we believe that the stability of our platform will further enhance our position as a premier destination for high-caliber financial advisers. We ended the quarter with fee-based assets of $150 billion and total client assets of $406 billion as our net new asset growth in the quarter was in the mid-single digits. We highlight our long-term growth drivers of our Wealth Management business on Slide 8. The continued growth in the contribution from our asset management revenue and net interest income further drove our wealth management revenues towards more recurring sources. In the first quarter, our recurring revenue reached a record 78%, which continues to drive greater stability in our results. Moving on to Slide 9. Our net interest…

Thanks, Jim. As I stated last quarter, there's a significant amount of uncertainty in the operating environment so far in 2023. And I don't think anything we saw in the first quarter has changed my opinion. However, as we detailed on our earnings call, Stifel is well positioned to perform through these economic cycles. While the markets remain uncertain, I remain optimistic. We will benefit from strong net interest income and our asset management revenue continues to benefit from our recruiting efforts and market appreciation. The cyclicality of our institutional business remains well positioned to benefit from increased market stability and will provide a hedge against any decline in interest rates. And with that, operator, please open the line for questions.

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

Steven, you cut out a little bit. We didn't hear what you first said there.

Sorry, you hear me now?

Yes.

Okay. Perfect. Well, first off, I was trying to give you guys a complement. Really just the best cash deposit disclosure, we've come across this earnings season. So I really appreciate you guys taking the time to provide that. The piece I did want to dig into was unpacking the NII guidance and the fact that you're expecting NII to come in at the lower end of the range, it's definitely a better outcome than we and many investors were anticipating at the same time, annualizing that 1Q NII and actually the first half, it's below the guidance and NII declined sequentially, just suggesting a less favorable trend. So I was hoping you could spend some time unpacking your assumptions across a whole host of variables, just in terms of Fed policy actions, loan growth, deposit beta, sweep remixing that supports that higher NII run rate over the course of the year.

Steven, there are a lot of factors that you just pointed out, and a lot of people are trying to avoid that we're not. We're trying to give our best look at this. I think we came in, Jim, NII of $297 million. And look, one of the things that happened in the quarter was in the last part of March, I'll just tell you, we got a lot of cash coming our way. And because of the uncertainty, we held some cash in the quarter, which would probably account for some of the -- that shortfall from $300 million. So if you -- we're at $300 million, and we think that for the first half, we're going to be at $600 million based on everything we're seeing, that supports the low end of our range of $1.2 billion. Now there's many things that can happen in terms of policy but our best guess is that today are our best estimate is that we would be at the low end of our guidance range for NII.

And to add a little bit to that, Obviously, we talked a little bit about our thoughts in terms of cash sorting. We've kind of broken through historical lows in terms of transactional cash as a percentage of AUM. We're still assuming some additional sorting in 2Q, but basically saying from there forward, we've kind of reached near the end of it, no material further sorting. And then another thing to think about is we were a little bit early when we move to smart rate to 4.5%. I think with the potential for the next rate hikes, given the forward curve, you're not going to see nearly as high of a beta on those. If we do get to the point where you do see rate cuts, you're going to see a higher beta on the way down, particularly on the Smart Rate program. The other piece I would highlight is our original guidance came out before we hired the individuals from SVB. They're going to provide additional liquidity and some loans. It's -- that's going to have an impact on this. And then I'd say as well as we have come in a little bit higher than we originally were projecting in some of the nonbank NII, particularly in our broker-dealer than we originally expected. So you combine all those factors together, that's really what's driving it to the $1.2 billion.

Last thing I'll add is that, as I said in my remarks, Steven, that we were really early with Smart Rate and thinking about having that product, as I said, we did it 3 years ago. And if you look at our consolidated interest-bearing deposits, that's about 2.02%, which is higher than if you benchmark that. And the reason for that is because we got ahead of the cash sorting. So no matter where we are, we think we're farther along than whatever is going on across the math of client cash.

No, it makes complete sense. And for my follow-up, just a broader question on capital management, certainly active in terms of buyback, which is great to see, given the strength of your excess capital position that you cited expectations for more tepid balance sheet growth, is this $170 million a reasonable cadence or run rate for us to be contemplating at least for the near term? And as far as M&A opportunities are concerned, do you see the recent bank fallout is providing some attractive opportunities to be more active on the M&A front?

M&A for banks specifically?

For banks, yes, what you have done in the past.

Yes, the bank environment is clearly uncertain and the fallout anyways, is reflecting some holes in bank's capital positions, especially if you try to do an acquisition that would -- that becomes crystallized. So I'm not sure that I would -- obviously, if the right opportunity comes along, we always look at everything. But it's a tough environment to assume someone else's liquidity or capital shortfall issues in this environment. And certainly, the accounting doesn't help. So I would say -- I would say that. And as it relates to buybacks, yes, it's an effective tool for returning capital. We've always said it to lever. The fact remains that in terms of uncertainty like this and times of uncertainty, the Board and everyone husbands their capital a little bit, and that's what we've been doing. But we haven't suspended our buyback.

Our next question comes from Alex Blostein from Goldman Sachs.

So maybe just picking up on the topic of sorting again. It's encouraging to hear your comments that you're starting to see maybe a little bit of a slowdown. And I think the general market convention is that most people anticipate things sort of to trough out in the middle of the year, kind of consistent with your comments. But I guess, one, maybe just give us an update on where Sweep deposits stand today and where the smart deposit -- Smart Rate deposits stand today? And more of, I guess, philosophical question, when organic growth resumes or where the organic deposit growth resumes, call it, in the back half of the year, why would they go into the Sweep Program and not remain in a higher rate options. So I understand new client money comes in, but what kind of gives you confidence that all of that effectively will accrue to the Sweep Program at a lower rate when the underlying kind of market rates will continue to be at a pretty wide spread to that?

So I'll take the last question first. There's no -- really no better environment, if you will, for cash sorting than what we're sitting in today, right? We have the yield curve inverted and just a tremendous amount of focus when you can get short-term rates near 5% in the 10 years where it is. It's just a lot of focus on that. And frankly, it's a pretty good investment alternative for clients that just aren't sure what to do. And so all of that leads to a lot of cash sorting. If you normalize, say, get to a 3% set funds in steepening yield curve, that will take some of that focus off of that just historically speaking. So I think it's a unique environment, we are at historical lows of transactional cash to our AUM. I don't think we're alone. But I believe that as the yield curve normalizes, you'll actually see this transactional cash, which is dividends and liquidity and all the things that have been historical, I believe that it will begin to normalize back.

The other thing to note there is we are seeing increased inflows in other bank deposits, not necessarily within the Wealth channel, but within VC and other traditional commercial. And that's supplementing the liquidity of the bank when you think forward. Obviously, there's a differential in the cost there relative to sweep, but it's cheaper than Smart Rate in general. And so I think you need to keep that in mind as you think about the potential liquidity for bank growth.

Great. Jim, you actually saved me my follow-up on that other bank deposits. So I'll pivot a little bit maybe to lending. You guys, I think, previously talked about slowing down the bank growth, and we've seen that for the last couple of quarters. On the fund finance side of things, there's been definitely capacity that's come out of that market and it may be somewhat concentrated in parts of the private equity in DC world. So how are you thinking about growth in the fund finance space? I don't know if you could break down between subscription lines and now blending kind of what does that business look like for you today? And could that change sort of your view on the overall loan growth for the rest of the year if that business continues to pick up?

I think in terms of fund bank on the bilateral lines, we're doing more of that activity. We're participating less in some of the larger transactions, but more of the direct transactions, we see opportunities we also see terms tightening there and the overall return prospects of that improving relative to where we were before March.

Yes. Look, I think we look at fund banking and what we're doing in venture banking. By the way, we were in these businesses, Alex. We just -- we see obviously opportunity with a lot of the players obviously have exited. And this business is highly integrated with our investment bank. And so we just see opportunity on both the fund banking and on the venture side. But boy, there's been some capacity brought out of this business. So from my perspective, kind of a good time to get in.

And we'll take our next question from Devin Ryan from JMP Securities.

I just want to dig in a little more on kind of intermediate term out what KBW is doing, just whether things are becoming better or more challenged in March? And then also interrelated to the fixed income growth early where you're helping banks manage their securities portfolios? How do you see that environment evolving? And does that improve from here as well?

Yes. Well, look, I think the environment, there's a lot to do in the bank, I'll take the fixed income side first. Clearly, that really slowed down as everyone just almost a little bit with looking at their portfolio and trying to understand the available for sale, the marks and the HTM. But there's a lot of restructuring that needs to be done in bank portfolios and we see that activity certainly picking up from here. With respect to KBW, there's a lot to do on bank line, too. In M&A, we've -- I think we're in one of those periods where we're completing our backlog from prior deals and a little bit of a lull, and then we'll pick up strategic advisory in the banking space. I don't think there's any question that the recent events is going to spur strategic activity in the banking space.

Yes. Got it. Makes sense. A follow-up just on...

And at some level, capital -- go ahead.

Yes. I appreciate that. I guess a follow-up for Jim, just on expense management. And just given some of the shifting in the revenue environment here, anything you guys are looking to do differently on expenses? And then also how the kind of evolution is impacting your comp ratio leverage and expectations for the full year would be appreciated?

So in regards to expenses, we originally guided to an adjusted noncomp OpEx of 18% to 19%. And obviously, we're higher than that at 20.5%. A lot of that is a higher ratio within the institutional business given some of the new challenges from a revenue perspective. Now when we talked about original guidance, we're talking roughly flat operating revenues. And so if you think about extrapolating out the first quarter for the institutional group, that would be more like a $1.3 billion run rate, a 15-ish percent decline. And we're not managing the business with that expectation. And so I think some of these things will normalize as we pick up some revenues through the back half of the year, particularly on the Institutional Group. In terms of the comp ratio, we still feel very comfortable with the numbers we talked about for the full year guidance. obviously, we've brought down our starting point. You can go back over time and look how we've kind of stair stepped down the comp ratio throughout the first quarter through the fourth quarter on an annual basis. And I think given the affirmation of still being in the range of NII, it should give some confidence in what we can do from a comp ratio expectation.

Let me just supplement that by saying, and I agree with all of that, obviously, yes. It's times like this over certainly my career that we have been able to add talented individuals and businesses. I've mentioned the people we've hired just this disruption creates opportunity. And I am focused on adding to our historical growth. And I guess do not want to leave an impression that we're just going to manage to a comp ratio without taking advantage of what we see some real, real opportunity to build our client franchise here.

Yes, totally agree with that, Ron. You guys have very opportunistic over the years. So I appreciate that. And maybe if I can [indiscernible] one in related just since you touched on it, the financial adviser movement, the environment you had kind of a nice quarter there. It sounds like the pipeline is still good. It's just a good environment for Stifel to move? What do you see in that part of the business and kind of the outlook for the ability to continue to recruit financial advisers?

Look, I think it's good. Our pipeline is good. I always say that our recruiting, if anything, mutes our recruiting, it's our discipline on how we view cash on cash returns. So it will generally be more related to the competitive market for transition deals. Again, that now is the time, frankly, with some of the upheaval and some of the players that have exited that were some of the higher payers. And this, it's going to be an opportunity for us to pick up recruiting.

And our next question comes from Brennan Hawken from UBS.

I'd actually like to reiterate Steven's comments. Thanks a lot for the additional deposit disclosure. I guess one question, is that going to be a one-off disclosure? Or are we going to see it regularly? And then how should we think about the 3.5% of that Sweep deposits represent of client assets? I believe you said it's below trough, but how far below trough? Where was the prior trough for that metric?

No, that is the new trough, okay. That's not -- that's what that is.

So taking the order a little bit, yes, the deposit disclosure will continue. When you're calculating that number out, you need to separate out PCG assets. The number is actually a little bit higher than that. I can point you to the supplement where you can see kind of the bifurcation of those assets, it's higher than 3.5%. But obviously, we had talked historically 5-ish, 4.5%, and we've gotten now below 4%. And so again, we're reiterating that we're taking additional cash loading from here in our guidance and still able to get to the NII levels we're talking about.

Okay. Great. And when -- just a follow-up on that point, Jim, the -- when you said you're taking a little bit of additional sorting here in 2Q, Ron referenced some expectation for a reversal of sorting. Is there a reversal of some of that embedded in the back half given that the forward curve is calling for some cuts?

No. We're not talking about reversal of sorting in the back half, more so the potential cuts resulting in a higher beta on the way down. I think that's the point we're trying to get across there.

I mean what I was saying, Brennan, I'm just saying that we're -- this focus is in version of the yield curve. Everything today that makes one of the great investment opportunities here to just invest in the short end of the curve. When that changes, we'll get back to a more traditional mix of transactional cash in AUM. That's all I'm trying to say. And I think that's just the most wealth management firms would say that in a more normalized yield curve environment.

Okay. And then one on the point around the Institutional business and it being a counterbalance with rates. I hear that. I think that's an important point to make. One of the things that I've been trying to think about is we probably -- it seems as though regional banks are big constituent around your client base in the fixed income business. Given that there's likely to be changes in the capital rules, what would you -- if you end up seeing less of an ability to hold longer duration and buy purchase longer duration securities and they end up shorter and the types of impacts that would happen if there are subject to the LCR, what kind of a headwind do you think that could represent to the institutional revenue? Obviously, not a headwind from current levels, because they're very, very low. But when we think about the chance of it normalizing, how do you think we should factor that in, in considering that as a potential to limit a full normalization?

Brennan, I'm not sitting on the desk. But just if you talk about the need for bank management to suddenly manage more liquidity and shorter-term liquidity and reexamine their portfolios and how they're structured and potentially with new regulatory things that might be similar to LCR and liquidity, that's a tailwind. That's not a headwind, okay. That's actually going to be a lot of activity on the -- for a tailwind. And again, all of those things as well are going to be a tailwind for what's going on in KBW, certainly from this point. And then you note also that one of the other big things that's going on and has been going on that we have made an investment in a fintech. So fintechs not far removed from all of our expertise in the depositories. And we see a fair amount of activity there. So that portion of our business, I think, is going to have some tailwinds coming versus headwinds.

I think I would also say that you're probably never going to see banks use HTM as much as they have historically. And the more securities in AFS, the more trading you're going to see. So that's helpful. And I think there's also probably going to be a lot more active hedging of these books. And that's an opportunity as well.

And as it relates to -- yes. Brennan, I also want to say, because I think it's -- this is important as to our market share. We're just not order takers on the fixed income desk. Our business is primarily and significantly as balance sheet advisers to banks and CFOs, and we do a lot of their reporting, and we do a lot of their and then we help them position their balance sheet. So we not only have sales and traders, we have analysts and balance sheet strategist. So we have a pretty holistic approach to a business, which frankly has been really, really slow.

Yes. No, the premise of the question was more around the idea that maybe shorter duration, the economics aren't as good as trading it, but it's a really good point about AFS and the hedging.

And we have no further questions at this time.

Well, very good. Those were very good questions from our analysts. I appreciate those, and I appreciate everyone taking the time to listen to our results and we look forward to reporting to you, I believe, in August for our second quarter results -- actually July, as Joel is just reminding me. So thank you very much, and have a great day.

Thank you. Ladies and gentlemen, that does conclude today's conference. We appreciate your participation. Have a wonderful day.