Stifel Financial Corp. (SF) Q3 2017 Earnings Report, Transcript and Summary

Good afternoon. My name is Christine and I will be your conference operator today. At this time, I would like to welcome everyone to the third quarter earnings conference call 2017. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. Jim Zemlyak, CFO, you may begin your conference.

Thank you operator. Good afternoon. I am Jim Zemlyak, CFO of Stifel. I would like to welcome everyone to our conference call to discuss our third quarter 2017 financial results. Before we discuss our results, I would like to remind everyone that today's call may include forward-looking statements. These statements represent the firm's belief regarding future events that by their nature are uncertain and outside of the firm's control. The firm's actual results and financial condition may differ possibly materially from what is indicated in those forward-looking statements. For a discussion of those risks and factors that could affect the firms' future results, please see the description of risk factors in our current Annual Report on Form 10-K for the year ended December 2016. I would also direct you to read the forward-looking disclaimers in our quarterly earnings release, particularly as it relates to our ability to successively integrate acquired companies or the branch offices and financial advisors, changes in the interest rate environment, changes in legislative and regulation. You should also read the information on the calculations of non-GAAP financial measures that is posted on the Investor Relations portion of our website at stifel.com. This audio cast is copyrighted material of Stifel Financial Corp. and it may not be duplicated, reproduced or rebroadcast of consent. Our chairman and CEO, Ron Kruszewski, will now review the results, Ron?

Thanks Jim. Good afternoon to everyone and thank you for taking the time to listen to our third quarter 2017 results. This afternoon we issued a press release with our third quarter results and we posted a slide deck on our website. I am very pleased with the strength of our quarter. We generated net revenue of $721 million, the second best quarter in our history and down less than $5 million from our record results in the second quarter of this year. After adjusting for roughly $13 million of nonrecurring or deal related charges, we generated non-GAAP pretax income of $121 million, net income of $74 million and EPS of $0.89 as increased global wealth management revenue was offset by a modest sequential decline in our institutional businesses. Also on a non-GAAP basis, annualized returns on common equity and tangible common equity were nearly 11% and 18%, respectfully. GAAP diluted EPS came in at $0.79. In addition to the strength of our revenue in the quarter, our non-GAAP comp ratio and operating ratio declined sequentially to 61.1% for comp and 22.1% for non-comp operating expenses, respectfully and helped drive our non-GAAP pretax margins to nearly a seven-year high of 16.8%. On the capital front, we issued $225 million of 30 years senior notes to take advantage of attractive yields and to round out our capital structure and we announced and paid a regular quarterly dividend during the quarter, giving us another way to return capital to our shareholders. This morning, we announced acquisition of Ziegler Wealth Management. This was relatively small transaction, so we didn't disclose the transaction purchase price. However, this is an important transaction as it adds nearly 60 financial advisors and approximately $5 billion of client assets under management to our platform. Said another way, this is essentially just another form of recruiting for us. We expect the transaction to be mildly accretive. In speaking to the culture at Ziegler, I am pleased that as of this morning, 100% of the advisors who were offered continuation agreements with Stifel have agreed and have signed on to be part of the Stifel family. With that, let me go through in more detail our business lines and segment results. Looking at the next slide, I will walk through the general revenue trends that we experienced in our business during the quarter and I will get into more specific detail in the institutional group and global wealth management in later slides. Overall, our total net revenue increased 12% from the third quarter of 2016 driven by increases in investment banking, asset management and net interest income. These increases were offset by weaknesses in institutional brokerage. I would note the weakness in institutional brokerage is being experienced industry-wide. Our ability to grow revenues despite low market volatility and the continued slide in market volumes is a direct result of our strategy to invest and focus on businesses such as advisory, fee based accounts and private client and the growth in our bank balance sheet. I have noted in the past that the composition of our revenues over the past six years has changed and the results on this slide indicate how we are moving to a greater percentage of fee-based and balance sheet driven revenue streams than in the past. These recurring revenue streams accounted for nearly 39% of our total net revenue during the quarter, up from only 32% in the same period a year ago. Additionally, these revenues increased nearly 40% over that same timeframe. The benefits to these revenue streams is that that they add greater consistency to our results and in the case of our bank generate higher margins. Our year-to-date revenues totaled more than $2.1 billion, up 11%. Moving on to the next slide. We take a closer look at our investment banking brokerage and asset management revenue. With respect investment banking, we recorded our second best quarter in history. As compared to the prior quarter, investment banking increased 26% and was down less than 2% from the record we posted in the previous quarter. Our advisory business was very strong for the second straight quarter and remains healthy going into the fourth quarter. Our results were broad-based as we did benefit from any outside fees in the quarter and we had solid results from a number of verticals, including FIG and technology as well as a number of private placement closings. Revenue from FIG, which is our largest vertical, continued to be strong so far this year, as KBW has advised on 10 of the top 12 deals in the banking space. Technology continues to be another strong vertical for us. I am very pleased with the traction we are getting in both industrial and energy as these are growth areas that we have focused on recently. I would note that our advisory revenue for the first nine months of 2017 is $237 million and is up 19% year-over-year. This reflects the impact of the investments we have made in this business. Our capital raising business increased 37% from the prior year quarter. The increase was primarily the result of strong equity underwriting revenues. Our public finance business remains strong, but was down from the record performance in the second quarter of 2017. Our equity underwriting revenue remained solid increased more than 100% year-over-year as the tone of the new issue market continues to improve despite industry-wide volume and fee pools in the quarter that were relatively flat year-over-year. Our revenues declined sequentially as activity in FIG in healthcare remains solid but pulled back from second quarter levels while technology revenues were more similar to the first quarter levels. I am also pleased that our London office continues to gain traction as they contributed a significant fee to our equity business in the quarter. Looking at debt underwriting. We generated an 8% year-over-year increase despite the fact that market volumes in public finance have declined from record 2016 levels due primarily to lower refunding activity. We continue to be number one ranked nationally in the number of senior managed negotiated new issues ending the quarter with 12.3% market share. Looking at our brokerage revenue. This business continues to face industry-wide headwinds in the quarter as sequential declines in our revenues were relatively in line with overall market volume declines. Global wealth management brokerage revenues declined by 6% sequentially due to lower activity levels of mutual funds and corporate debt as well as typically seasonally lower activity levels in the summer months. I would also note that we continue to see a shift from brokerage to advisory fee revenue. In institutional equity brokerage, our revenues continue to be negatively impacted by historic lows and volatility, depressed volumes, the trends toward passive investing and the seasonal slowness of the summer months. Our sequential decline of 11% was relatively in line with the nearly 12% decline in industry-wide equity average daily volumes. The story is similar for our fixed income brokerage business as the industry continues to face the headwinds that included low interest rate, a flattening yield curve and low volatility. Our sequential revenue declined 6%, which was relatively in line with the 5% sequential decline in average daily volume as reported on trades. Lastly, we continue to see our asset management revenue increase as a result of strong growth in our client fee-based accounts and to a lesser extent from the increase in fed funds rate that benefits our client cash deposits held at third-party banks. As noted, this growth in fee-based revenues in our wealth management business has been an ongoing trend as this increase mirrors slowdown in brokerage activity in this segment as investors move toward fee-based accounts. The next slide focuses on our growth in net interest income, which has increased nearly 81% year-over-year as we continue to grow our bank balance sheet and improve our net interest margin. Total consolidated assets increased to $20.5 billion. We grew our average interest-earning assets at our bank by nearly $800 million sequentially, which increased our firm-wide average interest earning assets by 5% to nearly $17 billion. Along with the continued increase in our interest earning assets, our net interest margin has continued to improve as a result of increases in the fed funds rate, as well as improvements in the yields in our loan portfolio. We have included a table on the slide to illustrate the yields on our assets and liabilities. As you could see, the growth in our commercial loans and security based loans have been significant drivers of the year-over-year and sequential growth in asset yield and we believe this trend will continue. On the liability side, you can also see the increased cost to deposits as they doubled sequentially to 15 basis points. Last quarter, we commented that the bank net interest margins would likely be flat. However, I am please to note that it increased three basis points to 280 basis points due to the June rate increase as well as additional interest accretion resulting from the refinancing activity in our CLO portfolio. As a result of the pickup in net interest margin of the bank and increased margin rates, our firm-wide net interest margin was 240 basis points. In terms of expectations for the bank and consolidated NIM in the fourth quarter, we would expect it to be flat to up five basis points. In the next few slides, I will touch on the quarterly results from our two primary segments. So starting with global wealth management. I am pleased to report another record quarter for wealth management as net revenues were up modestly from the prior quarter's record results and increased 16% from the prior year quarter. Looking at the quarter sequentially, net revenue growth was driven by record asset management service fees as well as record net interest income. The growth in asset management and net interest income more than offset sequential decline in brokerage due, as I said, to slower seasonal activity as well as a shift toward fee-based accounts. As a result of this shift to asset management revenue, we continue to see fee-based asset growth outpace overall client asset growth. We ended the third quarter with record fee-based assets of $83 billion, up 5% sequentially versus record total client assets which were up 3% sequentially to $265 billion. As our fee-based accounts are priced off of trailing quarter and asset levels, a 5% increase in fee-based assets should give us another solid base for fourth quarter asset management revenues. Net interest income rose 8% sequentially as net interest margin and average interest-earning assets of the bank increased from second quarter levels and continue to be a significant driver on revenue and earnings growth. The continued growth in revenues and asset management and the bank continues to benefit global wealth management's cost and operating expense ratios. The comp ratio declined 610 basis points year-over-year and our operating expense ratio declined 170 basis points, which resulted in a pretax margin of nearly 36%. On the next slide, we will take a closer look at Stifel Bank & Trust. Total bank assets increased to approximately $14.55 billion as average interest earning assets increased nearly $800 million sequentially to $13.9 billion. Bank loans increased 10% sequentially. The majority of loan growth was from commercial and motor mortgage lending. I would note that most of the growth in our commercial portfolio was to existing clients. Investment securities increased 7% sequentially and the growth in the quarter was consistent with our long term strategy of emphasizing high credit quality, short duration assets that provide attractive risk adjusted returns. As such, the portfolio's average yield was 262 basis points and the duration was approximately 1.5 years. The provision for loan loss expense in the quarter increased to approximately $8 million, as a higher sequential provision expense was due to increased loan growth in the quarter. Our allowance for loan loss as a percentage of loans increased sequentially to 92 basis points, again due to growth in our C&I loans. Overall, our credit metrics remain strong as the nonperforming asset ratio was 15 basis points, which was flat sequentially. I commented on our last earnings call that we raised the yield we pay on client assets by an average of approximately 10 basis points at the end of June as yields on money market funds increased and deposit betas picked during the second quarter. We did not see further competitive pressure to raise our deposits during the third quarter. The current market environment faces headwinds such as tighter credit spreads in commercial related loan and securities as well as a flatter yield curve. The negative implication for our bank is yield compression as we reinvest in short duration, high quality assets. However, we continue to generate meaningful after-tax return on assets of approximately 130 basis points and our lending capacity has expanded in all key lending areas, resulting in higher incremental yield compared to the yields in our securities portfolio. Moving to the next slide. In our institutional business, it increased 2% from the prior year and was down 4% sequentially. Our equities business benefited for the second straight quarter from strong advisory revenue that was up 17% sequentially. Our advisory business remains healthy going into the fourth quarter. Overall, our current pipeline is similar to where it was at the end of last quarter and we continue to believe that barring any material changes in the market, that advisory revenue in the second half of the year will exceed the first half of 2017. For equity underwriting, we feel good about our pipeline going into the fourth quarter and heading into 2018. We continue to see solid interest in capital raising particularly in financials and technology. That said, I would remind everyone from last year's fourth quarter, we saw a substantial pickup following the November election. So the year-over-year comparison will be much more difficult than in prior quarters of this year. Our fixed income business overall slowed sequentially following a very strong second quarter in public finance. While debt capital raising was down sequentially, we would expect to see improvement in the fourth quarter given the seasonal trends in this business. The outlook for the business remains good but changes in interest rates could impact activity levels and overall industry volumes continue to lag 2016 levels. Our institutional brokerage revenue for both equities and fixed income will continue to be driven by market conditions that are still very challenging. While the yield curve is steep than some in the past few weeks, volatility remain near its five year low and industry-wide equity average daily volumes so far in the fourth quarter are down sequentially and year-over-year. While industry-wide fixed income volumes have improved modestly quarter-to-date, market conditions remain challenging. Although we continue look for some improvement in the business in the fourth quarter, the primary drivers of the improvement in this business are changes to the market conditions, which were in fact the headwinds for the industry in 2017. Overall, I am pleased with our institutional business as our diversified business model continues to show strong revenues despite less than ideal market conditions for certain businesses. Our trailing 12 month revenues increased despite significant decline in institutional brokerage revenue. This not only illustrates the strength of our investment banking business but our ability to perform in various market conditions. Our institutional revenues in the quarter were third strongest but a sequential decline from our record second quarter at a modest negative impact on the segment comp ratio, which came in at 60%, up 40 basis points sequentially. Although our comp ratio was up in the quarter, our operating expense ratio continued to decline reaching 20.5% which is the lowest level since the third quarter of 2012. This resulted in institutional operating margins of nearly 20%, up 30 basis points sequentially. Moving on to our balance sheet. We finished the quarter at $20.5 billion in assets on our consolidated balance sheet, up roughly $1 billion from the prior quarter levels due primarily to growth at Stifel Bank. As I said last quarter, although we expect that our annual balance sheet growth should approximately $2 billion, our growth will not necessarily be linear growth. Growth in the first half of the year was tracking slightly below our targeted run rate as we thought market conditions were less attractive. In the third quarter, we were able to opportunistically grow our loan portfolio while continuing to invest in short duration securities. Despite accelerated growth in the third quarter, we continue to believe that an annual run rate of $2 billion is an appropriate way to think about future asset growth as we will continue to focus on generating the best risk-adjusted returns with our capital. At the end of September 2017, our capital ratios were 10.4% for Tier 1 leverage and 20.5% for Tier 1 risk-based capital. Our leverage ratio was up modestly from the second quarter due to stronger retained earnings while our risk-based capital ratio declined due to strong growth in our C&I loan portfolio. As I mentioned earlier, we announced a regular quarterly dividend in August. This gives us another tool to help manage our capital but as you can see from the elevated sequential growth in our balance sheet, this remains an attractive way to deploy our capital given its the best way to focus on generating returns on a risk-adjusted basis. At the end of the quarter, we raised $225 million of 30 years senior notes as we felt it was an opportunistic time to lock in long-term financing at attractive rates and round out our capital structure. In the short term, the most likely use of funding will be continue our bank growth, but longer term this funding gives us added flexibility to enhance existing businesses. Book value of $40.67 increased $1.20 the quarter. The growth was the result of more than $87 million sequential increase in equity. We did not repurchase any shares in the quarter and we currently have just over seven million shares remaining on our existing authorization. Next we move onto the reconciliation of our GAAP and non-GAAP results. On slide 12, we will review our expenses for the quarter and the impact of our non-GAAP adjustments. In the third quarter, we incurred approximately $13 million in merger-related charges primarily related to acquisition related compensation that included Barclays, lease write-downs and severance. At this point we estimate that, barring additional legal or unexpected charges, our remaining pretax non-GAAP charges for 2017 will be approximately $10 million. After these charges, which primarily represent the last of the Barclays acquisition cost, we expect any charges in 2018 to be minimal. In terms of our non-GAAP expense results, they were better than consensus expectations. Our comp ratio of 61.1% continued to decline and was in line with the consensus estimates as we continue to generate revenue growth in our advisory business and in our bank. At this time, we are maintaining our full year comp ratio guidance of 60.5% to 62.5%. Operating expenses, excluding the loan loss provision, were just under $152 million at the lower end of our guidance of $151 million to $158 million. The sequential decrease was due to lower legal, travel and insurance expense. For the fourth quarter, we are maintaining our quarterly operating expense guidance of $151 million to $158 million, excluding the provision for loan losses. But I would note that there is a seasonal impact in the last quarter of every year that could put our operating expenses closer to the top end of the range. Lastly, in terms of share count, fully diluted share increased by nearly 900,000 during the quarter as a higher average share price during the quarter increased the dilutive impact of unvested grants. We did not, as I said, repurchase any shares during the quarter. However, barring any share repurchases or material fluctuations in our share price, we continue to anticipate our year-end diluted share count to be approximately 81 million shares. Now let me give a brief update on some regulatory issues and our interest rate sensitivity. First, MiFID. On October 26, the SEC and European Commission simultaneously published new Q&A and exemptive concerning the new MiFID II framework for inducements. This timely development occurs with the backdrop of a January 3, 2018 implementation date for Europe provides loss from financial market participants. In my view, this no-action is highlighted by two items. First, the SEC's desire not to simply import this regulation to U.S. market. And two, the fact that the exemptive relief applies to MiFID related research expenses. Therefore, this appears to ring fence this issue. That said, our institutional brokerage seems to have been actively meeting with our clients to discuss how this could alter their business and we are in the process of fine-tuning strategies on how to handle any changes the industry will face. We continue to believe that our franchise has the breadth, depth and flexibility to adapt and succeed regardless of how this turns out. With regards to DOL, we continue to monitor developments in Washington. We expect the department's recommended 18 month delay will be made official any day, frankly, this week I believe. We would anticipate seeing the SEC working more closely with the DOL to craft a better proposal that protects investor choice. Just last week, the Treasury Department made similar comments and endorsed the SEC's involvement while also encouraging a delay of this rule. As an industry participant, we look forward to working with the DOL and the SEC on a best interest standard that preserves choice. In terms of rate sensitivity, I mentioned previously that we saw benefit in rates earned on third-party bank sweep deposits that equated to an additional $2 million, $3 million of pretax in our asset management revenues, which was in line with our prior guidance. In regards to future rate hikes, we believe that the deposit beta will be driven by competition but that a greater percentage of future rate hikes will be passed along to deposit holders. Excluding the impact of increased competition, we would expect a similar impact from rate increases to what we experienced in the third quarter. On the next slide, before I open it to questions, I want to talk a little bit about what we have accomplished in the last seven quarters. During 2016, we indicated that we would emphasize the optimization of our existing businesses and that this would lead to an improvement in our margins, a reduction to the non-GAAP differential of GAAP EPS and would generate higher returns on equity. As you can see from the table on this slide, we have accomplished what we said we would in a relatively short period of time. Our annualized third quarter revenue would be up $550 million or 24% from fall 2015 results. We have appropriately leveraged excess capital by growing our balance sheet 54% to $20.5 billion. The increase in revenues and asset that significantly improved our operating leverage as pretax margins have increased from 10% to nearly 17% as we have maintained our expense discipline while growing revenue and our improved margins are not just a result of our bank growth strategy as our institutional margins have improved by 500 basis points despite challenging market conditions in equity and fixed income trading. Our revenue growth and expense management strategies has resulted in significantly higher annualized GAAP and non-GAAP EPS, up 170% and 90%, respectfully and we have followed through on our commitment to reducing the difference between GAAP and non-GAAP EPS. As we have forecast in the past, we expect this to close further by the end of 2017. Lastly, our improved bottomline results has significantly improved our return on common equity and our return on tangible common equity. While I am pleased with these results and the hard work that my colleagues put in to achieve them, we are by no means finished. Given our improved performance, Stifel is in a much stronger position as a company than we were just a few years ago. We will continue to manage our capital with a focus on the best risk-adjusted returns and continue to maintain cost discipline in managing our businesses. In terms of opportunities going forward, we will leverage our growing business to recruit talented professionals in both private client and our institutional businesses, either organically or through acquisitions. Additionally, we will continue to use our capital to further grow our bank, repurchase shares and fund our dividend. As I look forward into the fourth quarter, I feel good about our business and the operating environment in general. The stock market ended last week at record high and followed strong third-quarter GDP numbers, upbeat earnings results and increased confidence in U.S. tax reform, especially after the passing of the federal budget by Congress, I feel that the environment is definitely improving. However, I would say that tax reform is a key indicator to the economic outlook for the country as it could help drive further GDP and job growth while also moving markets higher. Given our business model and our high corporate tax rates, Stifel would be a primary beneficiary of these changes, if in fact enacted. And with that operator, I will open the line for questions.

[Operator Instructions]. Your first question comes from the line of Devin Ryan from JMP. Your line is open.

Hi Ron. Good afternoon. How are you?

Good, Devin.

Good. Maybe starting with a two-part question. Earlier today, Morgan Stanley announced that it is going to exit the protocol for broker recruiting which I guess was set up to limit litigation amongst the other member firms there. And so there is already speculation that other larger peers will follow on that front. So I am not sure if you have had a chance to look at this at all or if you have a view, but if you do, I was just curious if it makes it more challenging to recruit away from certain firms if you take away or I guess if you a allow more litigation there? And then the second part of the question, just more broadly, it does seem that some of the largest wire-houses are taking a less aggressive stance on recruiting, which I guess maybe suggest moderating competition. So I am just curious if you look at your advisor backlog today, is it more from the larger firms? Because they may be more of less aggressive on the packages or if it's smaller firms?

I am not sure it was a two-part of three-part, but I will try to answer, okay. Look, first of all, I am not sure I think that the largest firms came up with protocol frankly and came up protocol for, in my view, the self interest of the large firms and reducing litigation, but helping their recruiting. And so as they decide they don't want to recruit any more, it doesn't surprise me that you would see an exit from protocol. What I would say is there was a lot of recruiting prior to protocol. There is right ways to do it. If everyone would exit, it would increase litigation. Although I am shocked by the fact that, seems hard to me in and this is just my own personal view that if you recruit a bunch of people on protocol and then you want to say, but you can't leave because we are changing the rules, I find that maybe not legally interesting, but certainly business-wise interesting. So there is a lot to play out here, but at the end of the day, the advisors have always had the relationship with the client. We have known that in the industry and I don't expect that to change. But we will see how it plays out. With respect to overall recruiting, again, it's more interesting to see who will now exit the protocol. My personal prediction is that protocol probably will unravel here. When the large the largest firms brought it in, the largest firms will take it out.

So I guess, is that a good thing for Stifel? It seems like you have been talking about and may be more recently the dynamics changed, but just as the recruiting environment which is not economic. And so to the extent, the largest firms are kind of moderating on the recruiting for different reasons, is that a good thing or is that the reflection of just the backdrop being challenging? I am just kind of curious on your thought on that.

Well, again on one hand there is significant pullback and some of the recruiting deals improve the environment. But if you are going to just spend that on increased litigation, it's hard to judge that today, as I sit here. Overall, I still believe that we have always been a firm that has the platform where you want to work, a platform where you choose to come here and you chose to stay. And we think that that will win in the long run regardless of some of these hurdles of that are either being put in place or dismantled.

Got it. Okay. I really appreciate the thoughts there. And then with respect to the Ziegler deal announced this morning, it sounds like there was kind of an existing relationship, the firms knew each other. But I am just curious, would you frame this as the idiosyncratic circumstance amongst the firms? Or maybe does it suggest that there is just more interest from other firms today that think about selling for different reasons? Or maybe it's the Stifel dynamic of just having more of an appetite?

Well, we knew the firm. But I don't want to suggest to you or say in any way that it was some deal just between us. I think there were other firms interested. I think that we, for a combination of factors, are the party that they are with. And overall I believe that that transaction underscores the need for a little bit of scale in this business. I hate using that word, but it's hard to have all the products with 60 advisors and I think a lot of firms are facing that reality. But look, I am excited. I have known the firm for long time. I used to live in Wisconsin. It's primarily a Wisconsin-based firm. Cultures are very similar. As I said, 100% of their advisors in a matter of days have signed agreements to support this transaction. So I am thrilled by it and I think it's a typical Stifel type deal.

Yes. Got it. Okay. Yes, it was interesting. It was good to see. And then just pulled maybe one more and I will get back in the queue. Just recently, I know Ron you have spoken a lot about making investments in technology and that's where some of the spend has been going and it's definitely been a theme, I think, over the past several quarters just in the industry of ramping technology and digital spend. And so I guess the question is around how you feel about your pace of investments in the technology right now? And then just bigger picture, some of the things that Stifel is doing on the technology front where either you feel like these are interesting initiatives or even things that you feel like maybe helps differentiate Stifel?

Well, look, I think that the industry is at almost an inflection point between the intersection of advice and technology. And I believe that we have to embrace technology. And we at Stifel are doing that. So we have a number of initiatives, I believe, that will put us at the forefront, but using technology to supplement it by, it's not using technology to replace human advice. And we believe that that will be a strategic advantage for us, both in our organic growth or recruitment growth but also with clients, because I firmly believe, Devin I have said this, it sounds like an advertisement, but I firmly believe that technology properly deployed with clients raises more questions for an advisor to answer than it answers questions for the client. And if we embrace technology, which we doing, we are putting significant investments in our technologies including mobile, including our bank, we believe we will be at a strategic advantage.

And in terms of how you are going about it? Is it you creating through Stifel? Or is it finding the right third-party vendors and FinTech companies to partner so that you are introducing the right platforms for your advisors?

Geez, Devin, I feel like I am giving you competitive secrets here. Look, we have always been a firm that deploys technology in the most efficient manner. We won't build it if we can buy it. But we also have our own views. So it's a combination of both. But I am excited about some of the things that we are going to be doing to address this need. And again I will say that technology, either through our artificial intelligence, the ability to aggregate, ability to communicate through mobile is moving very fast. And when we as a firm feel that it's very important we invest and understand the technology.

Okay. That's good enough for me. Thanks Ron. I appreciate it. I will hop back in the queue.

Thanks Devin.

Your next question comes from the line of Steven Chubak from Nomura Instinet. Your line is open.

Hi Ron. Good afternoon.

Steven, how are you?

Yes, doing good. Thanks. So I wanted to start off with a question on MiFID. I appreciate a lot of the detail that you have provided about the SEC guidance. But one of the things that's quite interesting is that one of your research competitors actually acquired a large-scale equities player in an effort to help bolster their execution offering and while you really have considerable scale in the research side, I was just wondering if you can help us get a better sense of just how you are higher thinking about the execution platform? How you want to position that to be competitive in the MiFID world? And whether you have any plans to re-orient the business, not just on the execution side but on the research side as well?

Steven, that's a deep, deep question, okay, especially as it relates to execution. Market structure across the board has a number of initiatives that are going on. What I want to take a step back on is that the implementation of MiFID, including how you have to execute, there was a lot of questions about how the exchanges would deal with this, I believe that the SEC's no-action letter, in many ways, punks us for a while, okay. And I don't want to really get into the execution side, it's technical to this call. I believe though that we will be able to execute very similar, we will be able to do it. The bigger thing is really on right now research payments and my view of it is that the SEC ring-fences in saying, you can not under the 40 Act, accept hard payments from U.S. domestic-only firms without registering as an investment advisor. And the no-action release does not provide relief for that. So in many ways, it's business as usual for U.S. asset management that don't have European clients. And the way I read the SEC no-action is that it does provide the ability to get payments so long as it relates to MiFID related accounts. And it's actually technical in the way it says that. So my view is that sort of ring-fences this and I believe that the SEC does not want to upend U.S. market structure by importing a European rule. It's still complicated but the interpretive guidance on the no-action, I thought was very positive as it least relates to the January implementation.

Got it. Very helpful color Ron. And maybe just switching over to the capital management side. In relation to $2 billion annual bank growth target, as I start to look at the pace of capital build in relation to that, it still leaves you with a fair amount of excess capacity to support deployment elsewhere. And just thinking about other capital management priorities whether it's additional acquisitions, divis or buybacks, how should we expect that to be deployed?

You know, I never really answer that question other than to say the most cap and the best risk-adjusted returns. And right now we are trying to give guidance up to $2 billion. We could grow more than $2 billion. Frankly, we are just trying to not have people factor in the significant growth we have had in the last three years. But overall, we are generating a lot of capital. That's why we instituted a dividend. We have authorization for share repurchases. We have and we can grow the bank or we can invest in other businesses or in acquisitions, all of which have to meet our return hurdles. So I would agree with you that at this point, we are generating a lot of capital and it's a high-class problem. But we are focused on it and shareholders should understand it. We are large shareholders. I am a large shareholder, a much large shareholder and I focus on deployment of capital.

Understood. And one last one for me is just on fee-based profitability. It's something you touched on in your prepared remarks, Ron. It appears that fee-based conversions are poised to continue for a pretty extended period of time. There seems to be a good amount of runway there. I know that there is higher revenue yields associated with fee-based versus brokerage. I was hoping you can give us a better sense as to whether the profitability or earnings profile associated with those conversions is in fact better as well?

Look, I for a long time have said that you need an integrated investment bank like Stifel needs, brokerage and fee-based accounts. We do IPOs, we sell IPOs, we do public finance, we sweep deposits to our bank. And clients need the choice between fee-based and brokerage. So I don't believe that fee-based is inherently more profitable. I believe I am sort of indifferent to it as a profitability perspective. And that echoes comments I have made for 20 years. When you consider all the factors, you look at [indiscernible] and the fact that we make SPA loans generally or margin loans that's generally in brokerage accounts. So I think that what you have seen, Steven, is the tail-end of the acceleration that was driven by firms preparing for DOL. DOL clearly preferred fee-based accounts over brokerage accounts and many of us in the industry, including Stifel, had to adapt and put into place and encourage fee-based accounts, I actually think that that trend will slow a little bit now that there is a delay.

Okay. Very helpful insights, Ron. I appreciate you taking my questions.

Yes.

Your next question comes from the line of Chris Harris from Wells Fargo. Your line is open.

Thanks. Hi Ron.

Hi Chris.

So looking at your slide here that shows the improvement since 2015, obviously a lot of things trending in a good direction here. Just the obvious questions to ask then is, it what else is really left to do internally as you guys look at the platform at obviously trying to run as it is efficiently as you can? And I know you guys could benefit clearly from a better overall environment, but that's obviously outside your control.

Well, I believe that we can drive margins higher. I believe that we can, even in this environment, have higher margin. We can continue to grow. We can continue to do acquisitions like Ziegler or similar ones. We can continue to do this. So Chris, it's always hard to predict the future and I am not going to try today. I just feel that, over the years I have been asked this question a lot and it's how you are going to grow and what's next. And the fact is that we think we are a firm that is filling a significant void in the markets and for middle market companies. And when you look at things that can occur like rolling back a regulation, encouragement of capital formation, tax reform, our utilization of technology, I believe that we can continue to grow and drive meaningful returns. I certainly don't sit here, I think I gave common view of the next five years as very attractive if we get some of the policy decisions done that we talked about. So I don't, in anyway, feel like, okay, we are done.

Got you. Okay. And then, I wanted to ask you about the fixed income brokerage revenues. You highlighted that the decline is very similar to what's going on in the industry and that's true. But some of the reasons that we have heard, low rates, flat yield curve, it just seems like these declines in revenues suggest that perhaps is something more structural in nature versus those cyclical factors. Would you disagree with that statement? Do you think this all just like a cyclical issue right now affecting the fixed income business? It sounds like you are a little bit optimistic that things might recover a bit as we had into next year?

Look, what's happened to credit spreads and what's happened to volatility and what's happened to the yield curve, what's happened in many ways in the treasury market have been a perfect storm the other way of reduced volumes and so it's absolutely something that, I believe, will improve. On the other hand, you have had some changes in electronic trading that might be secular in nature in terms of margins. But they are talking about things that for instance, trades, I believe the trade should be suspended for block sizes that I think will allow risk-taking and can encouraged flows again. So there is a number of things that can change. Margins have been declining in this business for since I have been in the business for 30 years. But they are made up with volume. I think the fixed income business will improve. I don't believe we are going to be in this environment. All things being equal, would it get back to the level it was before? Probably not because there are some secular changes in here. But overall I believe fixed income will improve from these levels.

Got you. Thank you.

Your next question comes from line of Conor Fitzgerald from Goldman Sachs. Your line is open.

Hi. Good afternoon. I just wanted to ask two on M&A and one just to make sure I heard your near-term comments right on 4Q looking a little bit more like the first half? And then, from a bigger picture perspective, just wanted to your outlook on small cap bank M&A and if you are seeing any pickup in dialogue here? It feels like activities are increasing?

Yes. Well, first of all, I think what I said was that I just repeated that we thought the second half of 2017 would be higher than the first half of 2017. I don't think I said how much or anything like that. I just felt it would be better. But that said, I feel that the pipeline is good, okay. And so let's just be clear on that. I wasn't really trying to say anything other than that. With respect to what's going on in the bank space, there is a just a change of thought in the regulatory front in Washington. You see it in a lot of ways. You see deals being approved a lot faster than they ever did. We have a new Vice Chair of Regulation. You have a number of things that are pointing to increased activity in the bank space. I actually am optimistic about that. If I al less optimistic in the space, it's just the number of new banks, which there are none being formed, right. That concerns me on a different front. So I think an industry that's innovative and growing needs new entrants into the marketplace. But as things are shaping up today, I believe that the activity that we have seen in the financial institution space can continue, if not even improve going into 2018.

Got it. That's helpful. Thanks. And then just on the acquisition front in private wealth. What are your thought processes around larger deals? I know you been a little bit hesitant just given what was happening with the DOL. Given that rule has been delayed, does that change your thought process for looking at deals or it would be larger than the one you have announced today?

Well, there really haven't been many, first of all, right. It's not like they are going on left and right and we are not doing them. I mean we did, there's really been three large ones relatively large and we did one of them. We did Barclays and then you had Credit Suisse and Deutsche. So we are and we will continue to be a participant in the process. But right now. I don't see a huge rush to the sellers rushing to sell. I think there are plenty of buyers. I think we are one of them. Historically, we have proven that. But I think the environment is not one that necessarily has firms rushing to sell.

That's helpful. Thanks. And then just last one for me. I know it's come up a couple times and you don't have a crystal ball on how the revenue outlook is looking in the institutional equity trading business. But how should investors think about the incremental margin here, if revenue does come under pressure?

Well, in any business, with fixed costs margins come under pressure, revenues decline. This is math. We have seen some pretty significant declines in the volatility in the past, all the things we have talked about. Will it continue? Yes. And I think those margins are under pressures. So as revenues decline, margins are going to be under pressure. Firms will be reacting faced with always the question of whether you are cutting muscle or something else. So it's an ongoing thing. I am believing that what I am hearing and what I hear out of the SEC and what I see about capital formation and regulation, I believe that this business will improve from these levels.

That's helpful. Thanks for taking my questions.

Sure.

There are no further questions at this time. Mr. Ron Kruszewski, I will turn the call back over to you.

That was pretty good for announcing my name, operator. I will thank everyone for being on the call. I look forward to getting tax reform done. I think that will be good for money and motions, as I like to say and good for GDP growth and look forward to reporting on our fourth quarter in early February. So thank you for your time and interest in Stifel. Bye.

This concludes today's conference call. You may now disconnect.