SECURITIES AND EXCHANGE COMMISSION

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington
, D.C.  20549
_________________________

FORM 10-Q

 

[x]

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2009

OR

 

[ ]

Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                     to                    

Commission File Number: 1-9305
_________________________

 

STIFEL FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

Delaware

43-1273600

(State or other jurisdiction of

(I.R.S. Employer

incorporation or organization)

Identification No.)

501 N. Broadway, St. Louis, Missouri  63102-2188
 (Address of principal executive offices and zip code)

(314) 342-2000
 (Registrant's telephone number, including area code)
_________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 ("the Exchange Act") during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x]            No [ ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [ ]            No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer [x]               Accelerated filer [ ]               Non-accelerated filer [ ] (Do not check if smaller reporting company)               Smaller reporting company [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ]    No [x]

The number of shares outstanding of the registrant's common stock as of April 30, 2009 was 27,380,219.

1



STIFEL FINANCIAL CORP.
Form 10-Q
TABLE OF CONTENTS

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Consolidated Statements of Financial Condition as of March 31, 2009 (unaudited) and December 31, 2008

Condensed Consolidated Statements of Operations for the three months ended March 31, 2009 and March 31, 2008 (unaudited)

Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2009 and March 31, 2008 (unaudited)

Notes to Condensed Consolidated Financial Statements

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Item 4. Controls and Procedures

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

Item 1A. Risk Factors

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Item 5. Other Information

Item 6. Exhibits

Signatures

2


Table of Contents

 

PART I - FINANCIAL INFORMATION

 ITEM 1.   FINANCIAL STATEMENTS

 

STIFEL FINANCIAL CORP.
Condensed Consolidated Statements of Financial Condition

 

March 31,
2009

 

December 31, 2008

(in thousands)

(Unaudited)

Assets

 

Cash and cash equivalents

$     286,658

$      239,725

Cash segregated under federal and other regulations

40

     40

Securities purchased under agreements to resell

69,593

     17,723

Receivable from brokers and dealers:

 

    

Securities failed to deliver

19,973

     3,837

Deposits paid for securities borrowed

75,815

     49,784

Clearing organizations

84,186

     55,793

Receivable from brokerage customers, net of allowance for doubtful receivables of $966 and $582, respectively


270,754


     280,143


Trading securities owned, at fair value


217,910


141,085

Trading securities owned and pledged, at fair value

209,185

     --

Total trading securities owned and pledged, at fair value

427,095

 

     141,085


Available-for-sale securities, at fair value


53,627


     50,397

Held-to-maturity securities, at amortized cost

7,574

     7,574

Mortgages held for sale

31,108

     31,246

Bank loans, net of allowance for loan losses of $2,710 and $2,448, respectively


171,384


     181,269

Bank foreclosed assets held for sale, net of estimated cost to sell

4,384

     2,326

Investments

62,471

     74,898

Office equipment and leasehold improvements, at cost,
net of accumulated depreciation and amortization of $57,888 and $54,075, respectively



47,547



     47,765

Goodwill

131,412

     128,278

Intangible assets, net of accumulated amortization of $9,024 and $8,290, respectively


16,926


     15,984

Loans and advances to financial advisors and other employees, net of allowance for doubtful receivables from former employees of $1,117 and $1,186, respectively

114,237

     105,767

Deferred tax assets, net

43,828

     47,337

Other assets

96,086

     77,174

Total assets

$       2,014,698

$     1,558,145

       

See accompanying Notes to Condensed Consolidated Financial Statements.

3



STIFEL FINANCIAL CORP.
Condensed Consolidated Statements of Financial Condition (continued)

 

 

March 31,
2009

 

December 31, 2008

(in thousands, except share amounts)

(Unaudited)

Liabilities and Stockholders' Equity

 

Short-term borrowings from banks

$     163,500

$                 --

Drafts payable

35,059

49,401

Securities sold under agreements to repurchase

763

2,216

Payable to brokers and dealers:

 

Securities failed to receive

25,566

8,811

Deposits received from securities loaned

29,658

16,987

Clearing organizations

903

3,893

Payable to customers

146,006

156,495

Bank deposits

459,305

284,798

Federal Home Loan Bank advances and other secured financing

6,035

6,000

Trading securities sold, but not yet purchased, at fair value

260,684

 

98,934

Accrued employee compensation

71,360

130,037

Accounts payable and accrued expenses

89,525

100,528

Debenture to Stifel Financial Capital Trust II

35,000

35,000

Debenture to Stifel Financial Capital Trust III

35,000

35,000

Debenture to Stifel Financial Capital Trust IV

12,500

12,500

Other

9,398

19,998

1,380,262

960,598

Liabilities subordinated to claims of general creditors

3,634

4,362

Stockholders' Equity:

 

Preferred stock - $1 par value; authorized 3,000,000 shares;
none issued


--


--

Common stock - $0.15 par value; authorized 30,000,000 shares; issued 27,340,886 and 26,300,135 shares, respectively


4,101


3,945

Additional paid-in capital

450,045

427,480

Retained earnings

182,450

168,993

Accumulated other comprehensive loss

(4,908)

(6,295)

631,688

594,123

Unearned employee stock ownership plan shares, at cost,
138,287 and 146,421 shares, respectively


(886)


(938)

630,802

593,185

Total liabilities and stockholders' equity

$       2,014,698

$     1,558,145

       

See accompanying Notes to Condensed Consolidated Financial Statements.

4



STIFEL FINANCIAL CORP.
Condensed Consolidated Statements of Operations
(Unaudited) 

 

Three Months Ended March 31,

(in thousands, except per share amounts)

2009

2008

Revenues:

 

Commissions

$     74,610

$      85,701

Principal transactions

97,278

66,937

Investment banking

15,504

21,844

Asset management and service fees

24,933

30,278

Interest

9,892

13,689

Other income/(loss)

115

(1,207)

Total revenues

222,332

217,242

Interest expense

2,351

5,765

Net revenues

219,981

211,477

Non-interest expenses:

 

Employee compensation and benefits

147,840

 

146,030

Occupancy and equipment rental

17,867

15,716

Communication and office supplies

11,845

11,947

Commissions and floor brokerage

4,360

481

Other operating expenses

15,914

13,378

Total non-interest expenses

197,826

187,552

Income before income taxes

22,155

23,925

Provision for income taxes

8,978

9,578

Net income

$     13,177

$   14,347

Net income per share - basic*

$         0.49

$      0.61

Net income per share - diluted*

$         0.44

$      0.54

 

Weighted average common shares outstanding - basic*

26,772

23,276

Weighted average common shares outstanding - diluted*

30,198

26,645

       

*    All share and earnings per share amounts for the three months ended March 31, 2008 have been adjusted for the June 12, 2008 three-for-two stock split.

See accompanying Notes to Condensed Consolidated Financial Statements.

5



STIFEL FINANCIAL CORP.
Condensed Consolidated Statements of Cash Flows
(Unaudited)

 

 

Three Months Ended March 31,

(in thousands)

2009

2008

Operating Activities:

 

Net income

$     13,177

$      14,347

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

Depreciation and amortization

4,753

3,568

Loans and advances amortization

6,341

4,472

Accretion of discounts on available-for-sale securities

(75)

(145)

Provision for loan losses and allowances for loans and advances to financial advisors and other employees


663


(189)

Deferred taxes and other

3,115

1,328

Excess tax benefit associated with stock based awards

(9,597)

(5,957)

Stock-based compensation

13,077

12,074

Loss on the sale of investments

2,409

3,796

Loss on sale of bank foreclosed assets

107

 

--

Decrease (increase) in assets:

 

Operating receivables

(61,171)

(49,373)

Cash segregated under federal and other regulations

--

(4,998)

Securities purchased under agreements to resell

(51,870)

(83)

Loans originated as mortgages held for sale

(240,131)

(75,896)

Proceeds from mortgages held for sale

240,270

61,929

Trading securities owned, including those pledeged

(286,010)

(26,244)

Loans and advancements to financial advisors and other employees


(15,161)


(6,448)

Other assets

(14,574)

23,988

Increase (decrease) in liabilities:

 

Operating payables

3,377

52,366

Trading securities sold, but not yet purchased

161,750

91,456

Other liabilities

(104,064)

(80,578)

Net Cash Provided by (Used in) Operating Activities

       (333,614)

       19,413

       

See accompanying Notes to Condensed Consolidated Financial Statements.

6



STIFEL FINANCIAL CORP.
Condensed Consolidated Statements of Cash Flows (continued)
(Unaudited)

 

 

Three Months Ended March 31,

(in thousands)

2009

2008

Investing Activities:

 

Proceeds from:

 

Sale or maturity of investments

$     24,848

$      8,758

Maturities, calls and principal paydowns on available-for-sale securities


9,515


9,923

Sale of property

--

766

Bank customer loan repayments

250,603

39,646

Sale of bank foreclosed assets held for sale

353

--

Payments for:

 

Bank customer loan originations

(240,578)

(46,462)

Purchase of available-for-sale securities

(10,521)

--

Purchase of bank foreclosed assets held for sale

(2,523)

(1,142)

Office equipment and leasehold improvements

(3,847)

(4,630)

Purchase of investments

(14,831)

 

(9,488)

Net Cash Provided by (Used in) Investing Activities

13,019

(2,629)

Financing Activities:

 

Increase in bank deposits, net

174,507

37,179

Net proceeds from short-term borrowings from banks

163,500

10,550

Securities loaned, net

12,570

(17,003)

Decrease in securities sold under agreements to repurchase

(1,453)

--

Reissuance of treasury stock

--

319

Issuance of stock

10,072

80

Excess tax benefits associated with stock-based awards

9,597

5,957

Federal Home Loan Bank advances and other secured financing

35

--

Payments for:

 

Repurchase agreements

--

(9)

Purchases of stock for treasury

--

(12,141)

Reduction of subordinated debt

(1,300)

(914)

Net Cash Provided by Financing Activities

367,528

24,018

Increase in cash and cash equivalents

46,933

40,802

Cash and cash equivalents at beginning of period

239,725

47,963

Cash and cash equivalents at end of period

$     286,658

$      88,765

       

See accompanying Notes to Condensed Consolidated Financial Statements.

7



STIFEL FINANCIAL CORP.
Condensed Consolidated Statements of Cash Flows (continued)
(Unaudited)

 

Three Months Ended March 31,

(in thousands)

2009

2008

Supplemental disclosure of cash flow information:

 

Cash paid for interest

$     2,264

$      5,831

Cash paid for income taxes, net of refunds

497

657

Noncash investing and financing activities:

 

Units, net of forfeitures

$    35,157

$    27,238

Payment of Ryan Beck contingent earn-out

9,807

--

       

See accompanying Notes to Condensed Consolidated Financial Statements.

8


Table of Contents

STIFEL FINANCIAL CORP.
Notes  to Condensed Consolidated Financial Statements
(in thousands, except share and per share amounts)
(Unaudited)

 

NOTE 1 - Nature of Operation and Basis of Presentation

Nature of Operations

Stifel Financial Corp. (the "Parent"), through its wholly-owned subsidiaries, principally Stifel, Nicolaus & Company, Incorporated ("Stifel Nicolaus"), Century Securities Associates, Inc. ("CSA"), Stifel Nicolaus Limited ("SN Ltd"), Butler Wick & Company, Inc. ("Butler Wick"), and Stifel Bank & Trust ("Stifel Bank"), is principally engaged in retail brokerage, securities trading, investment banking, investment advisory, retail, consumer and commercial banking and related financial services throughout the United States. Although we have offices throughout the United States and three European cities, our major geographic area of concentration is in the Midwest and Mid-Atlantic regions, with a growing presence in the Northeast, Southeast and Western United States. Our company's principal customers are individual investors, corporations, municipalities, and institutions.

Basis of Presentation

The condensed consolidated financial statements include the accounts of Stifel Financial Corp. and its wholly-owned subsidiaries, principally Stifel Nicolaus & Company, Incorporated. Intercompany balances and transactions have been eliminated. Unless otherwise indicated, the terms "we," "us" "our" or "our company" in this report refer to Stifel Financial Corp. and its wholly-owned subsidiaries.

We have prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC"). Pursuant to these rules and regulations, we have condensed or omitted certain information and footnote disclosures we normally include in our annual consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles. In management's opinion, we have made all adjustments (consisting only of normal, recurring adjustments, except as otherwise noted) necessary to fairly present our financial position, results of operations and cash flows. Our interim period operating results do not necessarily indicate the results that may be expected for any other interim period or for the full fiscal year. These financial statements and accompanying notes should be read in conjunction with the consolidated financial statements and the notes thereto in our Annual Report on Form 10-K for the year ended December 31, 2008 on file with the SEC.

Certain amounts from prior years have been reclassified to conform to the current year presentation. The effect of these reclassifications on our company's previously reported consolidated financial statements was not material.

There have been no material changes in our significant accounting policies, as compared to the significant accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2008.

On May 12, 2008, the Board of Directors authorized a 50% stock dividend, which was made in the form of a three-for-two stock split to shareholders of record on May 29, 2008 and distributed on June 12, 2008. Cash was distributed in lieu of fractional shares. All share and per share data (except par value) have been adjusted to reflect the effect of the stock split for all periods presented. The number of shares of common stock issuable upon exercise of outstanding stock options, vesting of other stock awards, and the number of shares reserved for issuance under various employee benefit plans were proportionately increased in accordance with the terms of the respective plans.

Recently Adopted Accounting Pronouncements

With the exception of those discussed below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the three months ended March 31, 2009, as compared to the recent accounting pronouncements described in our Annual Report on Form 10-K for the year ended December 31, 2008, that are of significance, or potential significance, to our company's consolidated financial statements.

9



In November 2008, the Emerging Issues Task Force ("EITF") reached a consensus on Issue No. 08-7 ("EITF 08-7"), "Accounting for Defensive Intangible Assets," which requires that a defensive intangible asset be accounted for as a separate unit of accounting and should not be included as part of the cost of the acquirer's existing intangible assets. In addition, EITF 08-7 requires that a defensive intangible asset be assigned a useful life that reflects the entity's consumption of the expected benefits related to the asset. EITF 08-7 is to be applied to all business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. We adopted the provisions of EITF 08-7 in the first quarter of 2009. Since this guidance will be applied prospectively, on adoption, there was no impact to our consolidated financial statements.

In September 2008, the Financial Accounting Standards Board ("FASB") issued FASB Staff Position ("FSP") No. 133-1 and FASB Interpretation ("FIN") FIN 45-4 ("FSP FAS 133-1 and FIN 45-4"), "Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161." FSP FAS 133-1 and FIN 45-4 amend FASB Statement No. 133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging Activities," to require disclosures by sellers of credit derivatives, including credit derivatives embedded in hybrid instruments. FSP FAS 133-1 and FIN 45-4 also amend FIN No. 45 ("FIN 45"), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to Others," to require additional disclosure about the current status of the payment/performance risk of a guarantee. We adopted the provisions of FSP FAS 113-1 and FIN 45-4 in the first quarter of 2009. FSP FAS 133-1 and FIN 45-4 also clarify the effective date in FASB Statement No. 161 ("SFAS 161"), "Disclosures about Derivative Instruments and Hedging Activities." Since FSP FAS 133-1 and FIN 45-4 only required additional disclosures, the adoption did not impact our consolidated financial statements.

In June 2008, the FASB issued FSP EITF No. 03-6-1 ("FSP EITF 03-06-1"), "Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities," which addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share under the two-class method described in FASB Statement No. 128, "Earnings per Share." FSP EITF 03-6-1 specifies that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. We adopted FSP EITF 03-06-1 in the first quarter of 2009. The adoption did not impact our calculation of earnings per share for the three months ended March 31, 2009.

In April 2008, the FASB issued FSP No. 142-3 ("FSP 142-3"), "Determination of the Useful Life of Intangible Assets." FSP 142-3 amends the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets under FASB Statement No. 142, "Goodwill and Other Intangible Assets." This new guidance applies prospectively to intangible assets that are acquired individually or with a group of other assets in business combinations and asset acquisitions. We adopted FSP 142-3 in the first quarter of 2009. FSP 142-3 will be applied prospectively to business combinations and asset acquisitions that occur on or after January 1, 2009. We will evaluate the impact of FSP 142-3 on any potential future business combinations and asset acquisitions that may occur after the effective date.

In March 2008, the FASB issued SFAS 161, "Disclosures about Derivative Instruments and Hedging Activities - an amendment of FASB Statement No. 133," which requires companies with derivative instruments to disclose information that should enable financial statement users to understand how and why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS 133 and how derivative instruments and related hedged items affect a company's financial position, financial performance and cash flows. We adopted SFAS 161 in the first quarter of 2009. Since SFAS 161 only required additional disclosure, the adoption did not impact our consolidated financial statements.

In December 2007, the FASB issued SFAS No. 141 (revised 2007) ("SFAS 141R"), "Business Combinations" and SFAS No. 160 ("SFAS 160"), "Noncontrolling Interests in Consolidated Financial Statements - an amendment of Accounting Research Bulletin No. 51." SFAS 141R will change how business acquisitions are accounted for and will impact financial statements both on the acquisition date and in subsequent periods. SFAS 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. We adopted SFAS 141R and SFAS 160 in the first quarter of 2009. The adoption of SFAS 141R and SFAS 160 did not have a material impact on our consolidated financial statements.

10



In September 2006, the FASB issued FASB Statement No. 157 ("SFAS 157"), "Fair Value Measurements," which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements and is effective for fiscal years beginning after November 15, 2007. We adopted SFAS 157 for all nonfinancial assets and nonfinancial liabilities on January 1, 2009. These nonfinancial items include assets and liabilities such as reporting units measured at fair value in a goodwill impairment test and nonfinancial assets acquired and liabilities assumed in a business combination. The adoption of SFAS 157 for nonfinancial assets and liabilities did not have a material impact on our consolidated financial statements.

Recently Issued Accounting Pronouncements

In April 2009, the FASB issued FSP No. FAS 107-1 and APB 28-1 ("FSP FAS 107-1 and APB 28-1"), "Interim Disclosures about Fair Value of Financial Instruments," which require disclosures about fair value of financial instruments for interim reporting periods. FSP FAS 107-1 and APB 28-1 relate to fair value disclosures for any financial instruments that are not currently reflected on the balance sheet of companies at fair value. Prior to adoption, we were required to disclose the fair values for these assets and liabilities in our annual audited financial statements. FSP FAS 107-1 and APB 28-1 are effective for interim periods ending after June 15, 2009. Early adoption is permitted. The adoption will expand our disclosures regarding the use of fair value in interim periods and is not expected to have a material impact on our consolidated financial statements.

In April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2 ("FSP FAS 115-2 and FAS 124-2"), "Recognition and Presentation of Other-Than-Temporary-Impairments." FSP FAS 115-2 and FAS 124-2 amend existing guidance to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. FSP FAS 115-2 and FAS 124-2 require separate display of losses related to credit deterioration and losses related to other market factors. When an entity does not intend to sell the security and it is more likely than not that an entity will not have to sell the security before recovery of its cost basis, it must recognize the credit component of an other-than-temporary impairment in earnings and the remaining portion in other comprehensive income. FSP FAS 115-2 and FAS 124-2 are effective for interim and annual periods ending after June 15, 2009. Early adoption is permitted. We are currently evaluating the impact that FSP FAS 115-2 and FAS 124-2 will have on our consolidated financial statements.

In April 2009, the FASB issued FSP No. 157-4 ("FSP FAS 157-4"), "Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly," which provides additional guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for the asset or liability have significantly decreased. FSP FAS 157-4 also includes guidance on identifying circumstances that indicate a transaction is distressed. FSP FAS 157-4 is effective for interim and annual periods ending after June 15, 2009. Early adoption is permitted. The adoption of FAP FAS 157-4 will be applied prospectively, and is not expected to have a material impact on our consolidated financial statements.

NOTE 2 - Acquisitions

On March 23, 2009, we entered into a definitive agreement with UBS Financial Services Inc. ("UBS"), which was amended May 4, 2009, to acquire up to 58 branches from the UBS Wealth Management Americas branch network. The transaction is structured as an asset purchase for cash at a premium over certain balance sheet items, subject to adjustment. The total consideration includes: (1) an upfront cash payment of up to approximately $29,000 based on the actual number of branches and financial advisors acquired; and (2) aggregate payments of up to approximately $21,100 for net fixed assets and employee loans. In addition, we will issue transition pay in the form of upfront payments of up to $37,100. Of the upfront payments issued to UBS financial advisors, we expect to pay 70% in cash and the remaining in our company's stock units. A contingent earn-out payment is payable based on the performance of UBS financial advisors who become our employees, over the two-year period following the closing. The closing of the acquisition is subject to customary conditions and the approval of all required governmental and other regulatory entities and is expected to occur during the third quarter of 2009.

11



On December 31, 2008, we closed on the acquisition of Butler Wick, a privately-held broker-dealer that provides financial advice to individuals, municipalities, and corporate clients. We acquired 100% of the voting interests of Butler Wick from United Community Financial Corp. This acquisition extends our company's geographic reach in the Ohio Valley region. The purchase price of $12,000 was funded from cash generated from operations. Under the purchase method of accounting, the assets and liabilities of Butler Wick are recorded as of the acquisition date, at their respective fair values and consolidated in our company's financial statements. Revisions to the allocation will be reported as changes to various assets and liabilities, including goodwill and other intangible assets. Pro forma information is not presented because the acquisition is not considered to be material.

On February 28, 2007, we completed the acquisition of Ryan Beck & Company, Inc. ("Ryan Beck"), a full-service brokerage and investment banking firm and wholly-owned subsidiary of BankAtlantic Bancorp, Inc. Pursuant to the stock purchase agreement, an additional earn-out payment was payable based on the achievement of defined revenues over the two year period following the closing. We paid the final earn-out payment of $9,807 related to the two-year private client contingent earn-out in 271,353 shares of our company's common stock at an average price of $34.30 per share in the first quarter of 2009, with partial shares paid in cash.

NOTE 3 - Fair Value of Financial Instruments

We measure certain financial assets and liabilities at fair value on a recurring basis, including cash equivalents, trading securities owned and pledged, available-for-sale securities, investments and trading securities sold, but not yet purchased.

The degree of judgment used in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction. Financial instruments with readily available active quoted prices for which fair value can be measured from actively quoted prices generally will have a higher degree of pricing observability and a lesser degree of judgment used in measuring fair value. Conversely, financial instruments rarely traded or not quoted will generally have less, or no, pricing observability and a higher degree of judgment used in measuring fair value.

12



The following table summarizes the valuation of our financial instruments by SFAS 157 pricing observability levels as of March 31, 2009 (in thousands):

   

 

Fair Value Measurements at Reporting Date Using

 





Total

Quoted Prices in Active Markets for Identical Assets (Level I)

Significant Other Observable Inputs
 (Level II)


Significant Unobservable Inputs
(Level III)

Assets:

Cash equivalents

$          132,456

$          132,456

$                    --

$                  --

Trading securities owned and pledged:

U.S. government and agency securities

              83,217

              12,855

             70,362

                    --

State and municipal bonds

              55,722

              18,495

             28,929

              8,298

Corporate obligations

            270,552

              73,902

           192,288

              4,362

Corporate stocks

              17,604

                5,864

                      --

            11,740

Total trading securities owned and pledged

            427,095

            111,116

           291,579

            24,400

Available-for-sale securities:

U.S. government agencies

                2,047

                      --

               2,047

                    --

State and political subdivisions

                1,538

                      --

               1,538

                    --

Mortgage-backed securities-
 agency collateralized


              12,362


                      --


             12,362


                    --

Mortgage-backed securities-
 non-agency collateralized


              18,985


                      --


             18,985


                    --

Corporate bonds

              10,360

              10,360

                      --

                    --

Asset-backed securities

                8,335

                      --

                      --

              8,335

Total available-for-sale securities

              53,627

              10,360

             34,932

              8,335

Investments:

Marketable equity securities

                2,254

                2,254

                      --

                    --

Mutual funds

              21,599

              21,599

                      --

                    --

U.S. government obligations

                7,131

                7,131

                      --

                    --

Other investments

                5,528

                     80

                  417

              5,031

Total investments

              36,512

              31,064

                  417

              5,031

Total

$          649,690

$          284,996

$         326,928

$          37,766

Liabilities:

 

         

Trading securities sold, but not yet purchased:

           

U.S. government and agency securities

$            92,707

$            86,674

$             6,033

$                  --

State and municipal bonds

                   305

                   130

                  175

                    --

Corporate obligations

            163,572

              52,128

           111,444

                    --

Corporate stocks

                4,100

                4,100

                      --

                    --

Total

$          260,684

$          143,032

$         117,652

$                  --

               

13



The  following table summarizes the valuation of our financial instruments by SFAS 157 pricing observability levels as of December 31, 2008 (in thousands):

 

 

Fair Value Measurements at Reporting Date Using

 





Total

Quoted Prices
in Active Markets for Identical Assets (Level I)

Significant Other Observable Inputs
 (Level II)


Significant Unobservable Inputs
(Level III)

Assets:

Cash equivalents

$          172,589

$          172,589

$                    --

$                  --

Trading securities owned and pledged:

U.S. government and agency securities

              40,401

              13,876

             26,525

                    --

State and municipal bonds

              32,093

                4,397

             20,553

              7,143

Corporate obligations

              43,131

              11,820

             27,150

              4,161

Corporate stocks

              25,460

              14,094

                      --

            11,366

Total trading securities owned and pledged

            141,085

              44,187

             74,228

            22,670

Available-for-sale securities:

U.S. government agencies

                8,591

                      --

               8,591

                    --

State and political subdivisions

                1,531

                      --

               1,531

                    --

Mortgage-backed securities-
 agency collateralized


              12,430


                      --


             12,430


                    --

Mortgage-backed securities-
 non-agency collateralized


              17,422


                      --


             17,422


                    --

Asset-backed securities

              10,423

                      --

                      --

            10,423

Total available-for-sale securities

              50,397

                      --

             39,974

            10,423

Investments:

Marketable equity securities

                2,668

                2,668

                      --

                    --

Mutual funds

              23,082

              23,082

                      --

                    --

U.S. government obligations

                7,132

                       9

               7,123

                    --

Other investments

                5,678

                     90

                  419

              5,169

Total investments

              38,560

              25,849

               7,542

              5,169

Total

$          402,631

$          242,625

$         121,744

$          38,262

Liabilities:

             

Trading securities sold, but not yet purchased:

             

U.S. government and agency securities

$            33,279

$            33,279

$                    --

$                  --

State and municipal bonds

                   154

                      --

                  154

                    --

Corporate obligations

              62,012

              24,081

             37,931

                    --

Corporate stocks

                3,489

                3,489

                      --

                    --

Total

$            98,934

$            60,849

$           38,085

$                  --

               

Our company's investment in a convertible promissory note issued by FSI Group, LLC ("FSI") and U.S. government securities used to fund our venture capital activities in qualified Missouri business are classified as held-to-maturity and included in "Investments" in the condensed consolidated statements of financial condition and therefore are not included in the above analysis of fair value at March 31, 2009 and December 31, 2008. See Note 19 for details regarding our investment in FSI.

14



A reconciliation of the beginning and ending balances for trading securities owned and pledged, available-for-sale securities and investments using significant unobservable inputs as of March 31, 2009 was as follows: (in thousands):

                 



Trading Securities Owned and Pledged




Available-for-Sale Securities






Investments






Total

Balance at December 31, 2008

$      22,670

$      10,423

$       5,169

$    38,262

Unrealized losses

Included in net income relating to instruments still held at the reporting date


        (1,105)


              --


         (387)


     (1,492)

Included in other comprehensive income

               --

            279

              --

          279

Realized gains (losses)

              10

              --

              --

            10

Purchases, sales, issuances, and settlements

          2,825

       (2,367)

           268

          726

Transfers out of Level III

               --

              --

          (19)

          (19)

Balance at March 31, 2009

$    24,400

$      8,335

$     5,031

$   37,766

                 

The results included in the table above are only a component of the overall trading strategies of our company. The table above does not present Level I or Level II valued assets or liabilities. We did not have any Level III liabilities at March 31, 2009 or December 31, 2008. The changes to our company's Level III classified instruments were principally a result of: purchases of auction rate securities ("ARS") from our customers; principal pay-downs of our available-for-sale securities, unrealized gains and losses; and redemptions of ARS at par during the first quarter. Investment gains and losses of our trading securities owned and pledged and our investments are included in our condensed consolidated statements of income as a component of other income/(loss).

NOTE 4 - Trading Securities Owned and Trading Securities Sold, But Not Yet Purchased

The components of trading securities owned and trading securities sold, but not yet purchased at March 31, 2009 and December 31, 2008, are as follows (in thousands):

 

 

 

 

 

2009

 

2008



Securities, at fair value

Owned

 

Sold, But
Not Yet
Purchased

 

Owned

 

Sold, But
Not Yet
Purchased

U.S. government obligations

$     83,217

 

$     92,707

$      40,401

$      33,279

State and municipal bonds

55,722

 

305

       32,093

       154

Corporate obligations

270,552

 

163,572

       43,131

       62,012

Corporate stocks

17,604

 

4,100

       25,460

       3,489

$   427,095

 

$   260,684

$   141,085

$      98,934

 

 

 

 

 

 

 

 

We pledge securities owned as collateral to counterparties who have the ability to repledge the collateral, therefore, we have reported the pledged securities under the caption "Trading securities owned and pledged, at fair value" in the condensed consolidated statements of financial condition.

15



NOTE 5 - Available-for-Sale Securities and Held-to-Maturity Securities

The following tables provide a summary of the amortized cost and fair values of Stifel Bank's available-for-sale securities and held-to-maturity securities at March 31, 2009 and December 31, 2008 (in thousands):

 

 

 

March 31, 2009

 



Amortized Cost

Gross Unrealized Gains

Gross Unrealized Losses



Fair Value

Available-for-sale:

U.S. government agencies

$      1,994

$           53

$             --

$         2,047

State and political subdivisions

        1,511

             27

              --

           1,538

Mortgage-backed securities-agency collateralized

      12,589

              --

         (227)

         12,362

Mortgage-backed securities-non-agency collateralized

      22,679

              --

       (3,694)

         18,985

Corporate bonds

      10,481

              4

         (125)

         10,360

Asset-backed securities

        9,097

              9

         (771)

           8,335

$    58,351

$           93

$     (4,817)

$       53,627

 

Held-to-maturity:

Asset-backed securities

$      7,574

              --

              --

$         7,574

 

 

   

 

December 31, 2008

 



Amortized Cost

Gross Unrealized Gains

Gross Unrealized Losses



Fair Value

Available-for-sale:

U.S. government agencies

$      8,447

$         144

$             --

$         8,591

State and political subdivisions

        1,513

             19

             (1)

           1,531

Mortgage-backed securities-agency collateralized

      12,821

              --

         (391)

         12,430

Mortgage-backed securities-non-agency collateralized

      23,091

              --

       (5,669)

          17422

Asset-backed securities

      11,400

              --

         (977)

         10,423

$    57,272

$         163

$     (7,038)

$       50,397

 

Held-to-maturity:

Asset-backed securities

$      7,574

              --

              --

$         7,574

         

During the three months ended March 31, 2009, available-for-sale securities with an aggregate par value of $6,500 were called by the issuing agencies or matured resulting in no gains or losses recorded through the condensed consolidated statement of operations. Additionally, during the three months ended March 31, 2009, Stifel Bank received principal payments on asset-backed and mortgage-backed securities of $3,015. During the three months ended March 31, 2009, unrealized gains, net of taxes, of $1,372 were recorded in accumulated other comprehensive income. During the three months ended March 31, 2008, unrealized losses, net of deferred tax benefits, of $1,332, were recorded in accumulated other comprehensive income.

16



On June 30, 2008, Stifel Bank transferred $10,000 par value asset backed security, consisting of investment-grade trust preferred securities related primarily to banks, with an amortized cost basis of $10,069 from its available-for-sale securities portfolio to its held-to-maturity portfolio. This security was transferred at the estimated fair value of $7,574. The gross unrealized loss of $2,495 included in accumulated other comprehensive income is being amortized as an adjustment of yield over the remaining life of the security. Amortization of $15, net of tax, related to the unrealized loss was recorded as an adjustment of yield during the first quarter of 2009. The estimated fair value of this held-to-maturity security at March 31, 2009 was $6,045. The estimated fair value was determined using several factors; however, primary weight was given to discounted cash flow modeling techniques that incorporated an estimated discount rate based upon recent observable debt security issuances with similar characteristics. Based upon the results of this analysis and Stifel Bank's intent and ability to hold this investment to maturity, we do not consider this security to be other-than-temporarily impaired as of March 31, 2009.

The amortized cost and fair value of available-for-sale and held-to-maturity securities at March 31, 2009 by contractual maturity, is shown below (in thousands). Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

 

 

 

 

 

 

 

 

Available-for-Sale

 

Held-to-Maturity

 

Amortized Cost

 


Fair Value

 

Amortized Cost

 


Fair Value

U.S. government and state and political agencies and other non-mortgage debt securities:

Within one year

$       4,306

$      4,096

$           --

$          --

One to three years

       15,776

      15,143

             --

            --

Three to five years

         2,001

        2,027

             --

            --

Five to ten years

         1,000

        1,014

             --

            --

Over ten years

              --

             --

        7,574

       6,045

Mortgage-backed securities:

Five to ten years

         9,968

        9,102

             --

            --

Over twenty-five years

       25,300

      22,245

             --

            --

$     58,351

$    53,627

$      7,574

$     6,045

               

The carrying value of securities pledged as collateral to secure public deposits and other purposes was $34,129 and $39,570 at March 31, 2009 and December 31, 2008, respectively.

Certain investments in the available-for-sale portfolio at March 31, 2009 are reported in the condensed consolidated statements of financial condition at an amount less than their amortized cost. The total fair value of these investments at March 31, 2009 was $47,595, which was 89% of our company's available-for-sale investment portfolio. The amortized cost basis of these investments was $52,409 at March 31, 2009. The declines in the available-for-sale portfolio primarily resulted from changes in interest rates, the widening of credit spreads and liquidity issues that have had a pervasive impact on the market.

17



The following table is a summary of the amount of gross unrealized losses and the estimated fair value by length of time that the securities have been in an unrealized loss position at March 31, 2009 (in thousands):

       

 

Less than 12 months

12 months or more

Total

 

Gross Unrealized Losses


Fair Value

Gross Unrealized Losses


Fair Value

Gross Unrealized Losses


Fair Value

Available-for-sale

           

Mortgage-backed securities-agency collateralized


$           --


$        --


$       (227)


$   12,362


$       (227)


$   12,362

Mortgage-backed securities- non-agency collateralized


     (2,828)


     9,883


        (866)


      9,102


      (3,694)


     18,985

Corporate bonds

       (125)

   10,360

              --

            --

         (125)

     10,360

Asset-backed securities

             --

          --

        (771)

      6,915

         (771)

      6,915

 

$   (2,953)

$ 20,243

$    (1,864)

$   28,379

$    (4,817)

$   48,622

 

Stifel Bank's investment in a held-to-maturity asset-backed security consists of investment grade pools of trust preferred securities related to banks. Unrealized losses were caused primarily by: 1) widening of credit spreads; 2) illiquid markets for collateralized debt obligations; 3) global disruptions in the credit markets; and 4) increased supply of collateralized debt obligation secondary market securities from distressed sellers. There have been no adverse changes to the estimated cash flows of these securities.

Stifel Bank's available-for-sale securities and held-to-maturity security are reviewed quarterly in accordance with its accounting policy for other-than-temporary impairment and since the decline in fair value of the securities presented in the table above is attributable to changes in interest rates and the widening of credit spreads, and the liquidity issues that have had a pervasive impact on the market and not credit quality and because we have the ability and intent to hold these investments until a fair value recovery or maturity, we do not consider these securities to be other-than-temporarily impaired as of March 31, 2009.

NOTE 6 - Bank Loans

The following table presents the balance and associated percentage of each major loan category in Stifel Bank's loan portfolio at March 31, 2009 and December 31, 2008 (in thousands, except percentages):

       

 

2009

 

2008

 

Balance

%

 

Balance

%

Commercial real estate

$     43,059

25%

$     41,563

22%

Construction and land

5,977

3%

13,968

8%

Commercial (1)

20,041

12%

27,538

15%

Residential real estate

52,460

30%

55,661

30%

Home equity lines of credit

29,781

17%

28,612

15%

Consumer (2)

22,146

13%

19,628

10%

Other

22

--%

52

--%

173,486

100%

187,022

100%

Unamortized loan origination costs, net of loan fees

536

 

591

Loans in process

72

 

(3,896)

Allowance for loan losses

(2,710)

 

(2,448)

$   171,384

 

$   181,269

 

(1)   Includes stock-secured loans of $1,073 and $1,770 at March 31, 2009 and December 31, 2008, respectively.
(2)   Includes stock-secured loans of $21,568 and $18,861 at March 31, 2009 and December 31, 2008, respectively.

18



Changes in the allowance for loan losses at Stifel Bank for the three months ended March 31, 2009 and 2008 were as follows (in thousands):

 

2009

2008

Allowance for loan losses, beginning of period

$   2,448

$   1,685

Provision for loan loss charged to operations

533

135

Charge-offs:

 

Commercial real estate

(219)

(253)

Real estate construction loans

(21)

--

Construction and land

(31)

--

Total charge-offs

(271)

(253)

Recoveries

--

--

Allowances for loan losses, end of period

$   2,710

$   1,567

 

Net charge-offs to average bank loans, net outstanding

0.12%

0.19%

       

At March 31, 2009, Stifel Bank had $31,108 in mortgage loans held for sale. For the three months ended March 31, 2009, Stifel Bank recognized a gain of $933 from the sale of loans originated for sale, net of fees and costs to originate these loans.

Included in the loan portfolio at March 31, 2009 and December 31, 2008 are impaired loans totaling $2,519 and $573, respectively, for which there are specific loss allowances of $697 and $189, respectively. At March 31, 2009, Stifel Bank had $2,075 of nonperforming loans, which was comprised of $1,982 in non-accruing loans that were less than 90 days past due and $93 in non-accruing loans that were more than 90 days past due, for which there was a specific allowance of $986. There were no non-accruing loans and there were no accruing loans delinquent 90 days or more at December 31, 2008. Stifel Bank has no exposure to sub-prime mortgages. The gross interest income related to impaired loans, which would have been recorded had these loans been current in accordance with their original terms, and the interest income recognized on these loans during the year, were immaterial to the condensed consolidated financial statements.

At March 31, 2009 and December 31, 2008, Stifel Bank had loans outstanding to its executive officers, directors and significant stockholders and their affiliates in the amount of $0 and $1,578, respectively, and loans outstanding to other Stifel Financial Corp. executive officers, directors and significant stockholders and their affiliates in the amount of $1,014 and $48, respectively. Such loans and other extensions of credit were made in the ordinary course of business and were made on substantially the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions with other persons.

19



NOTE 7 - Goodwill and Intangible Assets

The carrying amount of goodwill and intangible assets attributable to each of our company's reportable segments is presented in the following table (in thousands):

 

 

 

 

 

 

 


Private
Client
Group


Equity
Capital Markets

Fixed Income Capital Markets



Stifel Bank




Total

Goodwill

         

Balance at December 31, 2008

$    58,373

$    41,868

$     11,352

$   16,685

$   128,278

Purchase price adjustments

       2,049

          868

           217

             --

        3,134

Balance at March 31, 2009

    60,422

     42,736

     11,569

    16,685

   131,412

           

Intangible Assets

         

Balance at December 31, 2008

      10,888

        2,657

         1,085

       1,354

      15,984

Net additions

       1,676

             --

              --

             --

        1,676

Amortization of intangible assets

         (511)

           (92)

           (34)

          (97)

         (734)

Balance at March 31, 2009

    12,053

       2,565

       1,051

      1,257

     16,926

         

Total goodwill and intangible assets

$  72,475

$     45,301

$   12,620

$  17,942

$       148,338

           

The changes in goodwill during the three months ended March 31, 2009 primarily consist of payments for the contingent earn-out of $4,338 for the Ryan Beck acquisition and purchase price adjustments related to our acquisition of Butler Wick on December 31, 2008.

Intangible assets consist of acquired customer lists, core deposits, and non-compete agreements that are amortized to expense over their contractual or determined useful lives, as well as backlog, which is amortized against revenue as specific transactions are closed. Intangible assets subject to amortization as of March 31, 2009 were as follows (in thousands):

 

 

 

 

 

 

 


Cost

 

Accumulated
Amortization

 


Net

Amortized intangible assets

Customer lists

$    21,004

$    5,918

$    15,086

Core deposits

2,157

901

1,256

Other

2,789

2,205

584

 

$   25,950

$    9,024

$    16,926

 

20



Intangible assets subject to amortization as of December 31, 2008 were as follows (in thousands):

 

 

 

 

 

 

 


Cost

 

Accumulated
Amortization

 


Net

Amortized intangible assets

Customer lists

$    19,533

$    5,371

$    14,162

Core deposits

2,157

804

1,353

Other

2,584

2,115

469

 

$   24,274

$    8,290

$    15,984

 

Amortization expense related to intangible assets was $734 and $825 for the three months ended March 31, 2009 and 2008, respectively.

The weighted-average remaining lives of the following intangible assets at March 31, 2009 are: customer lists 6.2 years; core deposits 6.1 years; and non-compete agreements 0.9 years. As of March 31, 2009, we expect amortization expense in future periods to be as follows (in thousands):

 

 

 

Fiscal Year

 

 

Remainder of 2009

$    1,996

2010

2,317

2011

2,104

2012

1,743

2013

1,575

Thereafter

7,191

 

$  16,926

 

NOTE 8 - Bank Deposits

Deposits consist of customer bank deposits, savings accounts and time deposits. Deposits at March 31, 2009 and December 31, 2008 were as follows (in thousands):

 

 

 

 

 

2009

 

2008

Demand deposits-non-interest bearing

$     12,765

$      23,162

Demand deposits-interest bearing

4,492

4,258

Money market accounts

421,288

232,935

Savings accounts

344

341

Certificates of deposit, less than $100

11,498

13,436

Certificates of deposit, $100 and greater

8,918

10,666

$   459,305

$      284,798

       

The weighted average interest rate on deposits was 0.6% and 0.4% at March 31, 2009 and December 31, 2008, respectively.

21



Scheduled maturities of certificates of deposit at March 31, 2009 and December 31, 2008 were as follows (in thousands):

 

 

 

 

 

2009

 

2008

Certificates of deposit, less than $100:

Within one year

$     7,058

$      8,525

One to three years

3,088

3,562

Over three years

1,352

1,349

$    11,498

$    13,436

Certificates of deposit, $100 and greater:

   

Within one year

$     6,110

$      7,455

One to three years

1,494

1,949

Over three years

1,314

1,262

$     8,918

$    10,666

At March 31, 2009 and December 31, 2008, the amount of deposits includes deposits of related parties, including $417,995 and $228,653, respectively, of brokerage customer's deposits from Stifel Nicolaus, and interest-bearing and time deposits of executive officers, directors and significant stockholders and their affiliates of $440 and $750, respectively. Such deposits were made in the ordinary course of business and were made on substantially the same terms (including interest rates) as those prevailing at the time for comparable transactions with other persons.

At March 31, 2009 and December 31, 2008, customer demand deposit overdrafts of $13 and $34, respectively, have been recorded as "Bank loans" on the condensed consolidated statements of financial condition.

NOTE 9 - Commitments and Contingencies

Concentration of Credit Risk

We provide investment, capital-raising and related services to a diverse group of domestic customers, including governments, corporations, and institutional and individual investors. Our company's exposure to credit risk associated with the non-performance of customers in fulfilling their contractual obligations pursuant to securities transactions can be directly impacted by volatile securities markets, credit markets and regulatory changes. This exposure is measured on an individual customer basis and on a group basis for customers that share similar attributes. To alleviate the potential for risk concentrations, counterparty credit limits have been implemented for certain products and are continually monitored in light of changing customer and market conditions. As of March 31, 2009 and December 31, 2008, we did not have significant concentrations of credit risk with any one customer or counterparty, or any group of customers or counterparties.

Other Commitments

In the normal course of business, we enter into underwriting commitments. Settlement of transactions relating to such underwriting commitments, which were open at March 31, 2009, had no material effect on the condensed consolidated financial statements.

In connection with margin deposit requirements of The Options Clearing Corporation, we pledged customer-owned securities valued at $69,858 to satisfy the minimum margin deposit requirement of $56,136 at March 31, 2009.

In connection with margin deposit requirements of the National Securities Clearing Corporation, we deposited $32,000 in cash at March 31, 2009, which satisfied the minimum margin deposit requirements of $11,236.

We also provide guarantees to securities clearinghouses and exchanges under their standard membership agreement, which requires members to guarantee the performance of other members. Under the agreement, if another member becomes unable to satisfy its obligations to the clearinghouse, other members would be required to meet shortfalls. Our company's liability under these agreements is not quantifiable and may exceed the cash and securities it has posted as collateral. However, the potential requirement for our company to make payments under these arrangements is considered remote. Accordingly, no liability has been recognized for these arrangements.

22



We have received inquiries from the SEC, the Financial Industry Regulatory Authority ("FINRA"), and several state regulatory authorities requesting information concerning our transactions in auction rate securities ("ARS"). Additionally, our company and its subsidiary Stifel Nicolaus have been named in civil suits. See further information regarding the civil suits in Note 10.

In the ordinary course of business, Stifel Bank has commitments to extend credit in the form of commitments to originate loans, standby letters of credit, and lines of credit. See Note 13 for further details.

Note 10 - Legal Proceedings

Our company and its subsidiaries are named in and subject to various proceedings and claims arising primarily from our securities business activities, including lawsuits, arbitration claims, class actions, and regulatory matters. Some of these claims seek substantial compensatory, punitive, or indeterminate damages. Our company and its subsidiaries are also involved in other reviews, investigations and proceedings by governmental and self-regulatory organizations regarding our business which may result in adverse judgments, settlements, fines, penalties, injunctions and other relief.  We are contesting the allegations in these claims, and we believe that there are meritorious defenses in each of these lawsuits, arbitrations and regulatory investigations. In view of the number and diversity of claims against the company, the number of jurisdictions in which litigation is pending and the inherent difficulty of predicting the outcome of litigation and other claims, we cannot state with certainty what the eventual outcome of pending litigation or other claims will be. In our opinion, based on currently available information, review with outside legal counsel, and consideration of amounts provided for in our consolidated financial statements with respect to these matters, the ultimate resolution of these matters will not have a material adverse impact on our financial position. However, resolution of one or more of these matters may have a material effect on the results of operations in any future period, depending upon the ultimate resolution of those matters and depending upon the level of income for such period.

The regulatory investigations include inquiries from the SEC, FINRA and several state regulatory authorities requesting information concerning our activities with respect to ARS, and inquiries from the SEC and a state regulatory authority requesting information relating to our role in investments made by five Southeastern Wisconsin school districts (the "school districts") in transactions involving collateralized debt obligations ("CDOs"). We intend to cooperate fully with the SEC, FINRA and the several states in these investigations.

Current claims include a civil lawsuit filed in the United States District Court for the Eastern District of Missouri (the "Missouri Federal Court") on August 8, 2008 seeking class action status for investors who purchased and continue to hold ARS offered for sale between June 11, 2003 and February 13, 2008, the date when most auctions began to fail and the auction market froze, which alleges misrepresentation about the investment characteristics of ARS and the auction markets (the "ARS Class Action"). We believe that based upon currently available information and review with outside counsel that we have meritorious defenses to this lawsuit, and intend to vigorously defend all claims asserted therein.

We are also named in an action filed in the Circuit Court of Franklin County, Missouri, on March 12, 2009, by the Missouri Secretary of State concerning sales of ARS to our customers. The Secretary of State seeks relief, which includes requiring us to pay restitution with interest to those customers who purchased ARS from Stifel Nicolaus and continue to hold ARS, disgorgement of commissions and fees earned on the ARS sales and financial penalties. The case was removed to the United States District Court for the Eastern District of Missouri on April 13, 2009. Furthermore, on May 7, 2009, the State Corporation Commission of the Commonwealth of Virginia filed a Rule to Show Cause against Stifel Nicolaus with the Virginia State Corporation Commission concerning sales of ARS to Virginia residents seeking various remedies under the Virginia statutes, including penalties, assessments and injunctive relief.  We believe that, based upon currently available information and review with outside counsel, we have meritorious defenses to these matters and intend to vigorously defend the claims made by the Missouri Secretary of State and Commonwealth of Virginia.

Additionally, we are named in a civil lawsuit filed in the Circuit Court of Milwaukee, Wisconsin (the "Wisconsin State Court") on September 29, 2008. The lawsuit has been filed against our company and Stifel Nicolaus, Royal Bank of Canada Europe Ltd. ("RBC") and certain other RBC entities by the school districts and the individual trustees for other post-employment benefit ("OPEB") trusts established by those school districts (the "Plaintiffs"). The suit was removed to the United States District Court for the Eastern District of Wisconsin (the "Wisconsin Federal Court") on October 31, 2008. On April 10, 2009, the Wisconsin Federal Court issued an order remanding the case to the Wisconsin State Court on the basis that it did not have subject matter jurisdiction over the suit.

23



The suit arises out of the purchase of certain CDOs by the OPEB trusts. The RBC entities structured and served as "arranger" for the CDOs. We served as placement agent/broker in connection with the OPEB trusts purchase of the investments. The total amount of the investments made by the OPEB trusts was $200,000. Plaintiffs assert that the school districts contributed $37,500 to the OPEB trusts to purchase the investments. The balance of $162,500 used to purchase the investments was borrowed by the OPEB trusts. The recourse of the lender is the OPEB trust assets and the moral obligation of the school districts. The legal claims asserted include violation of the Wisconsin Securities Act, fraud and negligence. The lawsuit seeks equitable relief, unspecified compensatory damages, treble damages, punitive damages and attorney's fees and costs. The Plaintiffs claim that the RBC entities and our company either made misrepresentations or failed to disclose material facts in connection with the sale of the CDOs in violation of the Wisconsin Securities Act. We believe the Plaintiffs reviewed and understood the relevant offering materials and that the investments were suitable based upon, among other things, our receipt of a written acknowledgement of risks from the Plaintiffs. We believe, based upon currently available information and review with outside counsel, that we have meritorious defenses to this lawsuit, and intend to vigorously defend all of the Plaintiffs' claims.

Several large banks and brokerage firms, most of which were the primary underwriters of, and supported the auctions for, ARS have announced agreements, usually as part of a regulatory settlement, to repurchase ARS at par from some of their clients. Other brokerage firms have entered into similar agreements. We are, in conjunction with other industry participants, actively seeking solutions to ARS' illiquidity, which may include the restructuring and refinancing of those ARS. Should issuer redemptions and refinancings continue, our clients' holdings could be reduced further; however, there can be no assurance these events will continue.

On April 9, 2009, we announced that Stifel Nicolaus was providing its clients with details on how they can participate in the previously announced voluntary repurchase plan of eligible ARS purchased at Stifel Nicolaus prior to the collapse of the ARS market in February 2008. The voluntary plan will, upon acceptance by clients, contractually obligate us to repurchase up to 100 percent of eligible ARS. We estimate that our retail clients held approximately $172,000 of eligible ARS as of April 30, 2009.

In the voluntary program's first phase, we are offering to repurchase at par the greater of ten percent or twenty-five thousand dollars of eligible ARS. We anticipate that this initial repurchase will be completed by June 30, 2009. After the initial repurchases, the voluntary plan provides for additional repurchases from eligible investors during each of the next three years, as follows: (i) the greater of ten percent or twenty-five thousand dollars to be completed by June 30, 2010; (ii) the greater of ten percent or twenty-five thousand dollars to be completed by June 30, 2011; and (iii) the balance of outstanding ARS to be repurchased by June 30, 2012.

On April 17, 2009, counsel for the putative class in the ARS Class Action filed a motion for a temporary restraining order seeking a court order from the Missouri Federal Court requiring Stifel Nicolaus to make additional disclosures to its clients regarding its voluntary repurchase plan and to delay the date upon which clients are required to accept the offer (currently May 15, 2009) until the nature and extent of the disclosure has been determined. Stifel Nicolaus opposed the request and the Court denied the motion on April 29, 2009.

We have recorded a liability for our estimated exposure to the voluntary repurchase plan based upon a net present value calculation, which is subject to change and future events, including redemptions. ARS redemptions have been at par and we believe will continue to be at par over the voluntary repurchase period. Future periods' results may be affected by changes in estimated redemption rates or changes in fair value of ARS.

24



NOTE 11 - Regulatory Capital Requirements

Broker-dealers may be prohibited from expanding their business and declaring cash dividends. A broker-dealer that fails to comply with the Uniform Net Capital Rule may be subject to disciplinary actions by the SEC and self-regulatory organization, such as FINRA, including censures, fines, suspension, or expulsion. Stifel Nicolaus and Butler Wick have chosen to calculate their net capital under the alternative method, which prescribes that their net capital shall not be less than the greater of $1,000 and $250, respectively, or two percent of aggregate debit balances (primarily receivables from customers) computed in accordance with the SEC's Customer Protection Rule (Rule 15c3-3). CSA calculates its net capital under the aggregate indebtedness method whereby its aggregate indebtedness may not be greater than fifteen times its net capital (as defined). CSA has consistently operated in excess of their capital adequacy requirements. The only restriction with regard to the payment of cash dividends by our company is its ability to obtain cash through dividends and advances from its subsidiaries, if needed.

At March 31, 2009, Stifel Nicolaus had net capital of $163,323, which was 49.5% of aggregate debit items and $156,726 in excess of its minimum required net capital. CSA had net capital of $2,345, which was $2,055 in excess of minimum required net capital. Butler Wick had net capital of $6,127, which was $5,877 in excess of its minimum required net capital.

Our international subsidiary, SN Ltd, is subject to the regulatory supervision and requirements of the Financial Services Authority ("FSA") in the United Kingdom. At March 31, 2009, SN Ltd's capital and reserves were $7,939, which was $7,561 in excess of the financial resources requirement under the rules of the FSA.

Our company, as a bank holding company, and Stifel Bank are subject to various regulatory capital requirements administered by the Federal Reserve Board and the Missouri State Division of Finance, respectively. Additionally, Stifel Bank is regulated by the Federal Depository Insurance Corporation ("FDIC"). Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on our company's and Stifel Bank's financial results. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, our company and Stifel Bank must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Our company's and Stifel Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

25



Quantitative measures established by regulation to ensure capital adequacy require our company, as a bank holding company, and Stifel Bank to maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and Tier 1 capital to average assets (as defined). Management believes, as of March 31, 2009, that our company and Stifel Bank meet all capital adequacy requirements to which they are subject and are considered to be categorized as "well capitalized" under the regulatory framework for prompt corrective action. To be categorized as "well capitalized," our company and Stifel Bank must maintain total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the tables below.

Stifel Financial Corp. - Federal Reserve Capital Amounts

 

 

 

 

 

 




Actual

 



For Capital Adequacy Purposes

 

To Be Well Capitalized Under Prompt Corrective Action Provisions

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

Total capital to risk-weighted assets

$ 532,119

51.2%

$ 83,083

8.0%

$103,853

10.0%

Tier 1 capital to risk-weighted assets

$ 529,409

51.0%

$41,541

4.0%

$   62,312

6.0%

Tier 1 capital to adjusted average total assets

$ 529,409

32.3%

$65,543

4.0%

$   81,928

5.0%

                       

Stifel Bank - Federal Reserve Capital Amounts

 

 

 

 

 

 




Actual

 



For Capital Adequacy Purposes

 

To Be Well Capitalized Under Prompt Corrective Action Provisions

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

Total capital to risk-weighted assets

$ 53,908

17.5%

$ 24,363

8.0%

$  30,795

10.0%

Tier 1 capital to risk-weighted assets

$ 51,198

16.6%

$ 12,318

4.0%

$  18,477

6.0%

Tier 1 capital to adjusted average total assets

$ 51,198

10.7%

$ 19,154

4.0%

$  23,943

5.0%

                       

 

26



NOTE 12 - Stock-Based Compensation Plans

We maintain several incentive stock award plans that provide for the granting of stock options, stock appreciation rights, restricted stock, performance awards and stock units to our employees. Awards under our company's incentive stock award plans are granted at market value at the date of grant. Options expire ten years from the date of grant. The awards generally vest ratably over a three- to eight-year vesting period.

All stock-based compensation plans are administered by the Compensation Committee of the Board of Directors of the Parent, which has the authority to interpret the plans, determine to whom awards may be granted under the plans, and determine the terms of each award. According to these plans, we are authorized to grant an additional 5,988,009 shares at March 31, 2009.

Stock-based compensation expense included in "Employee compensation and benefits" in the condensed consolidated statements of operations for our company's incentive stock award plans was $12,708 and $11,650 for the three months ended March 31, 2009 and 2008, respectively. The related income tax benefit recognized in income was $9,597 and $5,957 for the three months ended March 31, 2009 and 2008, respectively.

Stock Options

We have substantially eliminated the use of stock options as a form of compensation. During the three months ended March 31, 2009, no options were granted. As of March 31, 2009, there were 1,156,925 options outstanding at a weighted-average exercise price of $8.36 and a weighted-average contractual life of 3.54 years. As of March 31, 2009, there was $595 of unrecognized compensation cost related to non-vested option awards. The cost is expected to be recognized over a weighted-average period of 1.55 years. We received $1,169 in cash from the exercise of stock options during the three months ended March 31, 2009.

Stock Units

A stock unit represents the right to receive a share of common stock from our company at a designated time in the future without cash payment by the employee and is issued in lieu of cash incentive, principally for deferred compensation and employee retention plans. At March 31, 2009, the total number of stock units outstanding was 6,189,545.

A summary of the status of our company's nonvested stock units as of March 31, 2009 and changes during the three months ended March 31, 2009 is presented below:

 

 

 

 




Stock Units




Shares

 

Weighted Average Grant-Date Fair Value

Nonvested at beginning of year

4,427,974

 

Granted

890,538

 

       $ 36.65

Converted

(860,240)

 

Cancelled

--

 

Nonvested at end of year

4,458,272

 
 

Deferred Compensation Plans

Our company's Deferred Compensation Plan (the "Plan") is provided to certain revenue producers, officers, and key administrative employees, whereby a certain percentage of their incentive compensation is deferred as defined by the Plan into company stock units with a 25% matching contribution by our company. Participants may elect to defer up to an additional 15% of their incentive compensation with a 25% matching contribution. Units generally vest over a three- to five-year period and are distributable upon vesting or at future specified dates. Deferred compensation costs are amortized on a straight-line basis over the vesting period. Elective deferrals are 100% vested. We charged $9,055 and $8,330 to "Employee compensation and benefits" for the three months ended March 31, 2009 and 2008, respectively, relating to units granted under this Plan. As of March 31, 2009, there were 2,658,779 units outstanding under the Plan.

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Additionally, Stifel Nicolaus maintains a deferred compensation plan for its financial advisors who achieve certain levels of production, whereby a certain percentage of their earnings are deferred as defined by the plan, of which 50% is deferred into company stock units with a 25% matching contribution and 50% earns a return based on optional investments chosen by financial advisors. Financial advisors may elect to defer an additional 1% of earnings into company stock units with a 25% matching contribution. Financial advisors may choose to base their return on the performance of an index mutual fund as designated by our company or a fixed income option. Financial advisors have no ownership in the mutual funds. Included on the condensed consolidated statements of financial condition under the caption "Investments" are $21,599 and $23,082 at March 31, 2009 and December 31, 2008, respectively, in mutual funds that were purchased by our company to economically hedge, on an after-tax basis, its liability to the financial advisors who choose to base the performance of their return on the index mutual fund option. At March 31, 2009 and December 31, 2008, the deferred compensation liability of $17,298 and $19,580, respectively, is included in "Accrued employee compensation" on the condensed consolidated statements of financial condition.

In addition, certain financial advisors, upon joining our company, may receive company stock units in lieu of transition cash payments. Deferred compensation related to this plan generally cliff vests over a five to eight-year period. Deferred compensation costs are amortized on a straight-line basis over the deferral period. Charges to "Employee compensation and benefits" related to these plans were $3,391 and $2,996 for the three months ended March 31, 2009 and 2008, respectively. As of March 31, 2009, there were 2,566,210 units outstanding under the Plan.

NOTE 13 - Off-Balance Sheet Credit Risk

In the normal course of business, we execute, settle, and finance customer and proprietary securities transactions. These activities expose our company to off-balance sheet risk in the event that customers or other parties fail to satisfy their obligations.

In accordance with industry practice, securities transactions generally settle within three business days after trade date. Should a customer or broker fail to deliver cash or securities as agreed, we may be required to purchase or sell securities at unfavorable market prices.

We borrow and lend securities to finance transactions and facilitate the settlement process, utilizing customer margin securities held as collateral. We monitor the adequacy of collateral levels on a daily basis. We periodically borrow from banks on a collateralized basis utilizing firm and customer margin securities in compliance with SEC rules. Should the counterparty fail to return customer securities pledged, we are subject to the risk of acquiring the securities at prevailing market prices in order to satisfy our customer obligations. We control our exposure to credit risk by continually monitoring our counterparties' positions and, where deemed necessary, we may require a deposit of additional collateral and/or a reduction or diversification of positions. Our company sells securities it does not currently own (short sales) and is obligated to subsequently purchase such securities at prevailing market prices. We are exposed to risk of loss if securities prices increase prior to closing the transactions. We control our exposure to price risk from short sales through daily review and setting position and trading limits.

We manage our risks associated with the aforementioned transactions through position and credit limits, and the continuous monitoring of collateral. Additional collateral is required from customers and other counterparties when appropriate.

We have accepted collateral in connection with resale agreements, securities borrowed transactions, and customer margin loans. Under many agreements, we are permitted to sell or repledge these securities held as collateral and use these securities to enter into securities lending arrangements or to deliver to counterparties to cover short positions. At March 31, 2009, the fair value of securities accepted as collateral where we are permitted to sell or repledge the securities was $492,011, and the fair value of the collateral that had been sold or repledged was $232,522. At December 31, 2008, the fair value of securities accepted as collateral where we are permitted to sell or repledge the securities was $432,751, and the fair value of the collateral that had been sold or repledged was $123,415.

28



In the ordinary course of business, Stifel Bank has commitments to originate loans, standby letters of credit and lines of credit. Commitments to originate loans are agreements to lend to a customer as long as there is no violation of any condition established by the contract. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash commitments. Each customer's creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if necessary, is based on the credit evaluation of the counterparty. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate.

At March 31, 2009 and December 31, 2008, Stifel Bank had outstanding commitments to originate loans aggregating $125,516 and $86,327, respectively. The commitments extended over varying periods of time with all commitments at March 31, 2009 scheduled to be disbursed in the following two months.

Standby letters of credit are irrevocable conditional commitments issued by Stifel Bank to guarantee the performance of a customer to a third-party. Financial standby letters of credit are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. Performance standby letters of credit are issued to guarantee performance of certain customers under non-financial contractual obligations. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loans to customers. Should Stifel Bank be obligated to perform under the standby letters of credit, it may seek recourse from the customer for reimbursement of amounts paid. At March 31, 2009 and December 31, 2008, Stifel Bank had outstanding letters of credit totaling $235 and $414, respectively. For all but one of the standby letters of credit commitments at March 31, 2009, the expiration terms range from one month to one year. The remaining commitment, in the amount of $10, has an expiration term of April 2013.

Lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Lines of credit generally have fixed expiration dates. Since a portion of the line may expire without being drawn upon, the total unused lines do not necessarily represent future cash requirements. Each customer's creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if necessary, is based on the credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate. Stifel Bank uses the same credit policies in granting lines of credit as it does for on-balance sheet instruments. At March 31, 2009 and December 31, 2008, Stifel Bank had granted unused lines of credit to commercial and consumer borrowers aggregating $35,578 and $18,153, respectively.

NOTE 14 - Income Taxes

The liability for unrecognized tax benefits was $2,138 and $2,105 as of March 31, 2009 and December 31, 2008, respectively. The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate for income before taxes are $2,138 and $2,105 at March 31, 2009 and December 31, 2008, respectively.

We recognize the accrual of interest and penalties related to income tax matters in the "Provision for income taxes" on the condensed consolidated statements of operations. As of March 31, 2009 and December 31, 2008, accrued interest and penalties included in the unrecognized tax benefits liability were $657 and $647, respectively.

We file income tax returns in the U.S. federal jurisdiction and various states, and foreign jurisdictions with varying statutes of limitation. For the U.S. and most state and foreign jurisdictions, the years 2005 through 2008 remain subject to examination by their respective authorities. We are subject to examination by state tax jurisdictions. It is possible that these examinations will be resolved in the next twelve months. We do not anticipate that payments made during the next twelve month period for these examinations will be material, nor do we expect that the reduction to unrecognized tax benefits as a result of a lapse of applicable statue of limitations will be significant. Our company's foreign jurisdictions are generally fully taxable by the United States.

29



NOTE 15 - Segment Reporting

We currently operate through the following five business segments: Private Client Group; Equity Capital Markets; Fixed Income Capital Markets; Stifel Bank; and various corporate activities combined in the Other segment. The business segments are based upon factors such as the services provided and the distribution channels served and are consistent with how management assesses performance and determines how to allocate resources throughout our company and its subsidiaries. The allocation of resources is based on various factors, including prospects for growth, return on investment, and return on revenues. Segment data includes charges allocating corporate overhead and benefits to each segment. Intersegment revenues, charges, receivables and payables are eliminated between segments upon consolidation.

The Private Client Group segment includes branch offices and independent contractor offices of our company's broker-dealer subsidiaries located throughout the U.S., primarily in the Midwest and Mid-Atlantic regions with a growing presence in the Northeast, Southeast and Western United States. These branches provide securities brokerage services, including the sale of equities, mutual funds, fixed income products, and insurance, as well as offering Stifel Bank banking products to their private clients.

The Equity Capital Markets segment includes corporate finance management and participation in underwritings (exclusive of sales credits, which are included in the Private Client Group segment), mergers and acquisitions, institutional sales, trading, research, and market making.

The Fixed Income Capital Markets segment includes public finance, institutional sales and competitive underwriting, and trading.

The Stifel Bank segment includes residential, consumer, and commercial lending activities, as well as FDIC-insured deposit accounts to customers of our broker-dealer subsidiaries and to the general public.

The Other segment includes certain corporate activities of our company.

Information concerning operations in these segments of business for the three months ended March 31, 2009 and 2008 is as follows (in thousands):

 

 

2009

 

2008

Net Revenues: (1)

Private Client Group

$     110,524

$    114,853

Equity Capital Markets

47,083

49,228

Fixed Income Capital Markets

58,389

44,002

Stifel Bank

3,640

2,082

Other

345

1,312

 

$    219,981

$    211,477

Income Before Income Taxes:

 

Private Client Group

$      15,460

$      25,605

Equity Capital Markets

5,725

6,927

Fixed Income Capital Markets

20,309

14,913

Stifel Bank

1,774

309

Other/Unallocated Overhead

(21,113)

(23,829)

 

$      22,155

$      23,925

 

 

(1)    No individual client accounted for more than 10 percent of total net revenues for the three months ended March 31, 2009 or 2008.

30



The following table presents our company's total assets on a segment basis at March 31, 2009 and December 31, 2008 (in thousands):

 

 

2009

 

2008

Total Assets:

Private Client Group

$        718,974

$       625,854

Equity Capital Markets

69,173

68,192

Fixed Income Capital Markets

509,948

174,938

Stifel Bank

521,224

333,784

Other

195,379

355,377

 

$     2,014,698

$    1,558,145

 

 

We have operations in the United States, United Kingdom and Europe. Our company's foreign operations are conducted through its wholly-owned subsidiary, SN Ltd. Substantially all long-lived assets are located in the United States.

Revenues, classified by the major geographic areas in which they are earned for the three months ended March 31, 2009 and 2008, were as follows (in thousands):

 

 

2009

 

2008

Net Revenues:

United States

$   215,452

$   202,932

United Kingdom

3,074

5,677

Other European

1,455

2,868

$   219,981

$   211,477

 

NOTE 16 - Other Comprehensive income

The following table sets forth the components of other comprehensive income for the three months ended March 31, 2009 and 2008 (in thousands):

 

 

2009

 

2008

Net income

$     13,177

$      14,347

 

Other comprehensive income:

 

Change in unrealized gains (losses) on available-for-sale securities, net of tax


1,387


(1,332)

Other comprehensive income, net of tax

$     14,564

$      13,015

 

31



NOTE 17 - Earnings per Share

The following table sets forth the computation of basic and diluted earnings per share for the three months ended March 31, 2009 and 2008 (in thousands, except per share data):

 

 

2009

 

2008*

Net income

$     13,177

$      14,347

 

Weighted average common shares outstanding during the period

26,772

23,276

Dilutive effect of stock options and units (1)

3,426

3,369

Weighted average dilutive common shares (1) (2)

30,198

26,645

 

Net income per share - basic

$     0.49

$      0.61

 

 

Net income per share - diluted

$     0.44

$      0.54

 

*    March 31, 2008 amounts have been adjusted for the June 12, 2008 three-for-two stock split.

(1)  Diluted earnings per share is computed on the basis of the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury method. Diluted earnings per share include stock options and units.

(2)  For the three month period ended March 31, 2009 and 2008, there were no securities excluded from the weighted average diluted common shares calculation because their effect would be antidilutive.

NOTE 18 - Stockholders' Equity

On May 5, 2005, the board of directors authorized the repurchase of up to 3,000,000 additional shares in addition to an existing authorization of 1,500,000 shares. These purchases may be made on the open market or in privately negotiated transactions, depending upon market conditions and other factors. Repurchased shares may be used to meet obligations under our employee benefit plans and for general corporate purposes. Under existing board authorizations at March 31, 2009, we are permitted to buy an additional 2,010,831 shares. During the three months ended March 31, 2009, we issued 1,040,751 new shares for employee benefit plans.

During the first quarter of 2009, we paid $9,807 related to the Ryan Beck two-year private client contingent earn-out in 271,353 shares of our company's common stock at an average price of $34.30 per share, with partial shares paid in cash.

Note 19 - Variable Interest Entities ("VIE")

FASB Interpretation No. 46® ("FIN46R"), "Consolidation of Variable Interest Entities (revised December 2003) - an Interpretation of ARB No. 51" applies to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The primary beneficiary of a VIE is the party that absorbs a majority of the entity's expected losses, receives a majority of its expected residual returns or both as a result of holding variable interests.

We determine whether we are the primary beneficiary of a VIE by first performing a qualitative analysis of the VIE's expected losses and expected residual returns. This analysis includes a review of, among other factors, the VIE's capital structure, contractual terms, which interests create or absorb variability, related party relationships and the design of the VIE. Where qualitative analysis is not conclusive, we perform a quantitative analysis.

Based on a quantitative and qualitative analysis of each entity determined to be a VIE under the provisions of FIN 46R, we do not absorb a majority of the VIEs expected losses or receive the VIE's expected residual returns or both and therefore, are not required to consolidate any of the VIEs described below.

32



Debenture to Stifel Financial Capital Trusts

We have completed private placements of cumulative trust preferred securities through Trust II, Trust III, and Trust IV (collectively, the "Trusts"). The Trusts are non-consolidated wholly-owned subsidiaries of our company and were established for the limited purpose of issuing trust securities to third parties and lending the proceeds to our company. The trusts were determined to be VIEs pursuant to the provisions of FIN 46R because the holders of the equity investment at risk do not have adequate decision making ability over the Trust's activities.

The trust preferred securities represent an indirect interest in junior subordinated debentures purchased from our company by the Trusts, and we effectively provide for the full and unconditional guarantee of the securities issued by the Trusts. We make timely payments of interest to the Trusts as required by contractual obligations, which are sufficient to cover payments due on the securities issued by the Trusts and believe that it is unlikely that any circumstances would occur that would make it necessary for our company to make payments related to these Trusts other than those required under the terms of the debenture agreements and the trust preferred securities agreements.

Investment in FSI

On April 16, 2008, we invested $12,000 in a convertible promissory note issued by FSI, a limited liability company specializing in investing in banks, thrifts, insurance companies, and other financial services firms. On July 1, 2008, under the terms of the note purchase agreement, we exercised an option to increase our investment in the convertible promissory note to $18,000. The note is convertible at our election into a 49.9% interest in FSI at any time after the third anniversary or during the defined conversion period. The convertible promissory note has a minimum coupon rate equal to 10% per annum plus additional interest related to certain defined cash flows of the business, not to exceed 18% per annum. Our company's exposure to loss is limited to its investment. We have the discretion to make additional capital contributions. Our company's involvement with the VIE has not had a material effect on its consolidated financial position, operations or cash flows. Our investment in FSI, a non-consolidated VIE, of $18,000 at March 31, 2009 is included on the condensed consolidated statements of financial condition under the caption "Investments." See Note 3 for further discussion of our investment in FSI.

33


Table of Contents

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of the financial condition and results of operations of our company should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2008, and the accompanying condensed consolidated financial statements and notes thereto contained in this Quarterly Report on Form 10-Q.

Certain statements in this report may be considered forward-looking. Statements that are not historical or current facts, including statements about beliefs and expectations, are forward-looking statements. These forward-looking statements cover, among other things, statements made about general economic and market conditions, the investment banking industry, our objectives and results, and also may include our belief regarding the effect of various legal proceedings, management expectations, our liquidity and funding sources, counterparty credit risk, or other similar matters. Forward-looking statements involve inherent risks and uncertainties, and important factors could cause actual results to differ materially from those anticipated, including those factors discussed below under "External Factors Impacting Our Business" as well as the factors identified under "Risk Factors" in Part II, Item 1A of this report. These reports are available at our web site at www.stifel.com and at the SEC web site at www.sec.gov.

Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. In addition, our past results of operations do not necessarily indicate our future results. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update them in light of new information or future events, unless we are obligated to do so under federal securities laws.

Unless otherwise indicated, the terms "we," "us," "our" or "our company" in this report refer to Stifel Financial Corp. and its wholly-owned subsidiaries.

Executive Summary

Stifel Financial Corp. (the "Parent") through its wholly-owned subsidiaries, principally Stifel Nicolaus & Company, Incorporated ("Stifel Nicolaus"), Century Securities Associates, Inc. ("CSA"), Stifel Nicolaus Limited ("SN Ltd"), Butler Wick & Company, Inc. ("Butler Wick") and Stifel Bank & Trust ("Stifel Bank"), we are engaged in retail brokerage, securities trading, investment banking, investment advisory, residential, consumer and commercial banking and related financial services throughout the United States and three European offices. Although we have offices across the United States, our major geographic area of concentration is in the Midwest and Mid-Atlantic regions with a growing presence in the Northeast, Southwest and Western United States. Our principal customers are individual investors, corporations, municipalities and institutions.

We plan to maintain our focus on revenue growth with a continued focus on developing quality relationships with our clients. Within our private client business, our efforts will be focused on recruiting experienced financial advisors with established client relationships. Within our capital markets business, our focus continues to be on providing quality client management and product diversification. In executing our growth strategy, we take advantage of the consolidation among middle market firms, which we believe provides us opportunities in our private client and capital markets businesses.

On March 23, 2009, we entered into a definitive agreement with UBS Financial Services Inc. ("UBS"), which was amended May 4, 2009, to acquire up to 58 branches from the UBS Wealth Management Americas branch network. The transaction is structured as an asset purchase for cash at a premium over certain balance sheet items, subject to adjustment. The closing of the acquisition is subject to customary conditions and the approval of all required governmental and other regulatory entities and is expected to occur during the third quarter of 2009.

Our ability to attract and retain highly skilled and productive employees is critical to the success of our business. Accordingly, compensation and benefits comprise the largest component of our expenses, and our performance is dependent upon our ability to attract, develop and retain highly skilled employees who are motivated and committed to providing the highest quality of service and guidance to our clients.

34



Our overall financial results continue to be highly and directly correlated to the direction and activity levels of the United States equity and fixed income markets, our expansion of the Equity Capital Markets and Fixed Income Capital Markets segments, the continued expansion of our Private Client Group, and the increased activity from the successful integrations of the following acquisitions: Legg Mason ("LM Capital Markets") business acquired on December 1, 2005, the acquisition of Ryan Beck & Company, Inc. ("Ryan Beck") on February 28, 2007, the First Service acquisition on April 2, 2007 and the Butler Wick acquisition on December 31, 2008. Since March 31, 2008, we have increased our number of financial advisors and branch offices by hiring  225 financial advisors and opening 54 branches, of which 75 financial advisors and 17 branches were part of our acquisition of Butler Wick on December 31, 2008. In addition, we added 95 revenue producing investment bankers, traders, institutional sales staff and mortgage bankers along with 246 branch and home office support staff.

For the three months ended March 31, 2009, our net revenues increased 4% to $220.0 million compared to $211.5 million during the comparable period in 2008. Net income decreased 8% to $13.2 million for the three months ended March 31, 2009 compared to $14.3 million during the comparable period in 2008. Profit margins have diminished resulting from the increased overhead added as we took advantage of the opportunities created by market displacement.

Our revenue growth was primarily derived from increased principal transactions; however, certain of our business activities were impacted by the particularly challenging equity market conditions as evidenced by the decline of our investment banking and asset management and service fee revenues of $6.3 million and $5.4 million, respectively, from the comparable three month period in 2008. The market turmoil has contributed to increased principal transactions revenues for the Equity Capital Markets and Fixed Income Capital Markets segments as institutions rebalanced their portfolios and their exposure to the markets. Additionally, the market upheaval and the resultant failure of some Wall Street firms have led to increased market share of institutional business for our company. Market volatility has led to a decrease in the value of our customers' assets and a decrease in customer margin receivables. As a result, commissions, asset management and service fees, and margin interest income decreased in the first quarter and may diminish in the future. Our business does not produce predictable earnings and is affected by many risk factors such as the global economic and credit slowdown, among others.

We have recorded a liability for our estimated exposure to the voluntary repurchase plan based upon a net present value calculation, which is subject to change and future events, including redemptions. Auction rate securities ("ARS") redemptions have been at par and we believe will continue to be at par over the voluntary repurchase period. Future periods' results may be affected by changes in estimated redemption rates or changes in fair value of ARS.

External Factors Impacting our Business

Performance in the financial services industry in which we operate is highly correlated to the overall strength of economic conditions and financial market activity. Overall market conditions are a product of many factors, which are beyond our control and mostly unpredictable. These factors may affect the financial decisions made by investors, including their level of participation in the financial markets. In turn, these decisions may affect our business results. With respect to financial market activity, our profitability is sensitive to a variety of factors, including the demand for investment banking services as reflected by the number and size of equity and debt financings and merger and acquisition transactions, the volatility of the equity and fixed income markets, the level and shape of various yield curves, the volume and value of trading in securities, and the value of our customers' assets under management.

Although we do not engage in any significant proprietary trading for our own account, the inventory of securities held to facilitate customer trades and our market making activities are sensitive to market movements. We do not have any significant direct exposure to the sub-prime market, but are subject to market fluctuations resulting from news and corporate events in the sub-prime mortgage markets, associated write-downs by other financial services firms and interest rate fluctuations. Stock prices for companies in this industry, including Stifel Financial Corp., have been volatile as a result of reactions to the global credit crisis and the continued volatility in the financial services industry. We will continue to monitor our market capitalization and review for potential goodwill asset impairment losses if events or changes in circumstances occur that would more likely than not reduce the fair value of the asset below its carrying amount.

35



In connection with ARS, our broker-dealer subsidiaries have been subject to ongoing investigations, which include inquiries from the Securities and Exchange Commission (the "SEC"), the Financial Industry Regulation Authority ("FINRA") and several state regulatory agencies, with which we are cooperating fully. We are also named in a class action lawsuit similar to that filed against a number of brokerage firms alleging various securities law violations, which we are vigorously defending. We are, in conjunction with other industry participants actively seeking a solution to ARS' illiquidity. See Item 1, "Legal Proceedings," in Part II of this report for further details regarding ARS investigations and claims.

Results of Operations - Total Company

The following table presents consolidated financial information for the periods indicated (in thousands, except percentages):

   

Three Months Ended

March 31, 2009

 

March 31, 2008


Amount

% of Net
Revenues

 

%
Change

 


Amount

% of Net
Revenues

Revenues:

Commissions and principal transactions

$    171,888

78%

13%

$    152,638

72%

Investment banking

15,504

7

(29)

21,844

10

Asset management and service fees

24,933

11

(18)

30,278

14

Interest

9,892

5

(28)

13,689

7

Other income/(loss)

115

--

*

(1,207)

--

Total revenues

222,332

101

2

217,242

103

Interest expense

2,351

1

(59)

5,765

3

Net revenues 

219,981

100

4

211,477

100

Non-Interest Expenses:

Employee compensation and benefits

147,840

67

1

146,030

69

Occupancy and equipment rental

17,867

8

14

15,716

8

Communication and office supplies

11,845

6

(1)

11,947

6

Commissions and floor brokerage

4,360

2

*

481

--

Other operating expenses

15,914

7

19

13,378

6

Total non-interest expenses

197,826

90

6

187,552

89

Income before income taxes

22,155

10

(7)

23,925

11

Provision for income taxes

8,978

4

(6)

9,578

4

Net Income

$      13,177

6%

  (8)%

$    14,347

7%

 

*   Percentage is not meaningful.

Net Interest Analysis

The following table presents average balance data and operating interest income and expense data, as well as related interest yields for the periods indicated (in thousands, except rates):

   

 

Three Months Ended

 

March 31, 2009

 

March 31, 2008

 


Average
Balance

Operating
Interest
Inc./Exp.

Average
Yield/
Cost

 


Average
Balance

Operating
Interest
Inc./Exp.

Average
Yield/
Cost

Interest-Earning Assets:

Margin balances of Stifel Nicolaus

$   250,509

$    2,654

    4.24%

$   432,243

$    6,718

    6.22%

Interest-earnings assets of Stifel Bank

470,364

3,656

    3.11%

238,634

3,551

    5.95%

Stock borrow of Stifel Nicolaus

57,431

8

    0.06%

85,400

266

    1.25%

Other

3,574

3,154

Total interest income

$    9,892

$   13,689

Interest-Bearing Liabilities:

             

Stifel Nicolaus short-term borrowings

$    63,948

$       130

    0.81%

$   114,688

$        786

    2.74%

Interest-bearing liabilities of Stifel Bank

420,096

686

    0.65%

190,692

1,716

    3.60%

Stock loan of Stifel Nicolaus

44,285

93

    0.84%

162,888

1,329

    3.26%

Interest-bearing liabilities of unconsolidated subsidiaries


82,500


1,364


    6.61%


95,000


1,612


    6.79%

Other

78

322

Total interest expense

2,351

5,765

Net interest income

$    7,541

$    7,924

 

36



Three Months Ended March 31, 2009 Compared with Three Months Ended March 31, 2008

Except as noted in the following discussion of variances for total Company and the ensuing segment results, the underlying reasons for the increase in revenue and expense categories can be attributed principally to the increased number of Private Client Group offices and financial advisors, the increased number of revenue producers in our Equity Capital Markets and Fixed Income Capital Markets segments, the increased administrative overhead to support the growth in our segments and the acquisition of Butler Wick on December 31, 2008. Butler Wick's results of operations are included in our results of operations prospectively from December 31, 2008, the date of acquisition. For the three months ended March 31, 2009, Butler Wick generated $5.7 million in net revenues and a loss before income taxes of $0.9 million.

Our net revenues (total revenues less interest expense) increased $8.5 million to $220.0 million for the three months ended March 31, 2009; a 4% increase over the $211.5 million recorded for the three months ended March 31, 2008.

Commissions and principal transactions revenues increased 13% to $171.9 million for the three months ended March 31, 2009 from $152.6 million in the comparable period in 2008, with increases of 5%, 6%, and 34% in the Private Client Group, Equity Capital Markets, and Fixed Income Capital Markets segments, respectively, primarily resulting from the aforementioned growth and increased principal transactions, primarily in corporate debt and equity and municipal debt, offset by decreased commissions as a result of market volatility and decreased trading volumes. The change in the mix from commissions-based revenues to principal transactions revenue has created an increase in our trading inventory levels primarily related to fixed income products.

Investment banking revenues decreased 29% to $15.5 million for the three months ended March 31, 2009 from $21.8 million in the comparable period in 2008 due to the industry-wide decline in common stock offerings and mergers and acquisitions caused by challenging capital market conditions. Capital raising revenues decreased 58% to $5.5 million for the three months ended March 31, 2009 from $13.0 million in the comparable period in 2008 and strategic advisory fees increased 14% to $10.0 million for the three months ended March 31, 2009 from $8.8 million in the comparable period in 2008.

Asset management and service fee revenues decreased 18% to $24.9 million for the three months ended March 31, 2009 from $30.3 million in the comparable period of 2008, primarily resulting from a 29% decrease in the value of assets in fee-based accounts, offset by an 11% increase in the number of managed accounts attributable principally to the continued growth of the Private Client Group. See Assets in Fee-based Accounts included in the table in "Results of Operations - Private Client Group."

Other revenues increased $1.3 million to $0.1 million for the three month period ended March 31, 2009 from a loss of $1.2 million during the comparable period in 2008, principally as a result of the reduction of investment losses during the three months ended March 31, 2009.

Interest revenues decreased 28%, or $3.8 million, to $9.9 million for the three months ended March 31, 2009 from $13.7 million in the comparable period in 2008, principally as a result of a $4.1 million decrease in interest revenue from customer margin borrowing. The average margin balances of Stifel Nicolaus decreased to $250.5 million during the three months ended March 31, 2009 compared to $432.2 million during the comparable period in 2008 at weighted average interest rates of 4.24% and 6.22%, respectively. The average interest-earning assets of Stifel Bank increased to $470.4 million during the three months ended March 31, 2009 compared to $238.6 million during the comparable period in 2008 at weighted average interest rates of 3.11% and 5.95%, respectively. Interest expense decreased 59%, or $3.4 million, to $2.4 million for the three months ended March 31, 2009 from $5.8 million in the comparable period in 2008, principally as a result of decreased interest rates charged by banks on decreased levels of borrowings to finance customer borrowing and firm inventory and decreased interest rates on stock loan borrowings. See "Net Interest Analysis" above for more details.

37



Employee compensation and benefits increased 1%, or $1.8 million, to $147.8 million for the three months ended March 31, 2009 from $146.0 million during the comparable period in 2008, principally due to increased headcount associated with the expansion of our Private Client Group, Equity Capital Markets and Fixed Income Capital Markets segments during the first quarter of 2009, partially offset by lower production-based variable compensation compared to the first quarter of 2008. As a percentage of net revenues, employee compensation and benefits totaled 67% for the three months ended March 31, 2009 compared to 69% for the comparable period in 2008. A portion of employee compensation and benefits includes transition pay, principally in the form of upfront notes, signing bonuses and retention awards in connection with our continuing expansion efforts, of $9.6 million (4% of net revenues) and $6.9 million (3% of net revenues) for the three months ended March 31, 2009 and 2008, respectively. The upfront notes are amortized over a five to ten year period. In addition, for the three months ended March 31, 2008, employee compensation and benefits includes $6.3 million for amortization of units awarded to LM Capital Markets associates. As these units were fully amortized as of December 31, 2008, we had no unit amortization expense during the three months ended March 31, 2009.

Occupancy and equipment rental, commissions and floor brokerage, and other operating expenses increased principally due to our expansion of the Equity Capital Markets and Fixed Income Capital Markets segments and continued expansion of the Private Client Group. Additionally, a change in the second quarter of 2008 to a third party vendor for services resulted in $2.4 million of expenses previously recorded as communication and office supplies that are now recorded as commissions and floor brokerage. In addition, we received a rebate of $1.5 million during the first quarter of 2008 related to clearing fees paid in 2007. There were no rebates received during the first quarter of 2009.

The provision for income taxes was $9.0 million for the three months ended March 31, 2009, representing an effective tax rate of 40.5%, compared to $9.6 million for the comparable period in 2008, representing an effective tax rate of 40.0%. The higher effective tax rate in 2009 was due to the proportionately higher level of non-deductible expenses to net income and the decrease in pre-tax net income.

Net income decreased 8%, or $1.1 million, to $13.2 million for the three months ended March 31, 2009, compared to $14.3 million during the comparable period in 2008, principally due to increased costs associated with our continued growth initiatives during the quarter.

Segment Analysis

Our reportable segments include the Private Client Group, Equity Capital Markets, Fixed Income Capital Markets, Stifel Bank, and Other.

The Private Client Group segment includes branch offices and independent contractor offices of our broker-dealer subsidiaries located throughout the United States, primarily in the Midwest and Mid-Atlantic regions with a growing presence in the Northeast, Southeast and Western United States. These branches provide securities brokerage services, including the sale of equities, mutual funds, fixed income products, and insurance, as well as offering banking products to their private clients through Stifel Bank.

The Equity Capital Markets segment includes corporate finance management and participation in underwritings (exclusive of sales credits, which are included in the Private Client Group segment), mergers and acquisitions, institutional sales, trading, research, and market making.

The Fixed Income Capital Markets segment includes public finance, institutional sales and competitive underwriting, and trading.

The Stifel Bank segment includes residential, consumer, and commercial lending activities, as well as Federal Depository Insurance Corporation ("FDIC")-insured deposit accounts to customers of our broker-dealer subsidiaries and to the general public.

The Other segment includes interest income from stock borrow activities, unallocated interest expense, interest income and gains and losses from investments held, and all unallocated overhead cost associated with the execution of orders; processing of securities transactions; custody of client securities; receipt, identification, and delivery of funds and securities; compliance with regulatory and legal requirements; internal financial accounting and controls; acquisition charges related to the LM Capital Markets and Ryan Beck acquisitions, and general administration.

We evaluate the performance of our segments and allocate resources to them based on various factors, including prospects for growth, return on investment, and return on revenues.

38



Results of Operations - Private Client Group

The following table presents consolidated financial information for the Private Client Group segment for the periods indicated (in thousands, except percentages):

   

Three Months Ended

March 31, 2009

 

March 31, 2008


Amount

% of Net
Revenues

 

%
Change

 


Amount

% of Net
Revenues

Revenues:

Commissions and principal transactions

$    81,653

74%

5%

$    77,952

68%

Investment banking

2,070

2

(50)

4,103

4

Asset management and service fees

24,831

22

(18)

30,147

26

Interest

3,155

3

(56)

7,189

6

Other income/(loss)

(467)

--

*

(469)

--

Total revenues

111,242

101

(7)

118,922

104

Interest expense

718

1

(82)

4,069

4

Net revenues 

110,524

100

(4)

114,853

100

Non-Interest Expenses:

Employee compensation and benefits

72,218

65

(1)

72,845

63

Occupancy and equipment rental

10,220

9

27

8,026

7

Communication and office supplies

5,284

5

26

4,197

4

Commissions and floor brokerage

1,841

2

*

(68)

--

Other operating expenses

5,501

5

30

4,248

4

Total non-interest expenses

95,064

86

7

89,248

78

Income before income taxes

$      15,460

14%

(40)%

$    25,605

22%

 

*  Percentage is not meaningful.

 

 

March 31, 2009

March 31, 2008

Branch offices (actual)

210

152

Financial advisors (actual)

1,218

972

Independent contractors (actual)

176

197

 

Assets in Fee-based Accounts

Value (in thousands)

$    4,755,030

$   6,702,167

Number of accounts (actual)

25,364

22,840

     

Three Months Ended March 31, 2009 Compared with Three Months Ended March 31, 2008

Private Client Group net revenues decreased 4% to $110.5 million for the three months ended March 31, 2009, compared to $114.9 million for the comparable period in 2008 as a result of decreases in asset management and service fees, investment banking, and other revenues, partially offset by an increase in commissions and principal transactions. Commissions and principal transactions increased primarily due to increased principal transactions, primarily in municipal debt and corporate debt, offset by decreased commissions as a result of market volatility and decreased trading volumes. Investment banking, which represents sales credits for investment banking underwritings, decreased 50%, principally reflecting a decline in industry-wide equity offerings. Asset management and service fees decreased principally due to a 29% decrease in the value of assets in fee-based accounts, offset by an increase in the number of managed accounts attributable principally to the continued growth of the Private Client Group.

Interest revenues for the Private Client Group decreased 56% to $3.2 million for the three months ended March 31, 2009 compared to $7.2 million for the comparable period in 2008, principally due to lower average interest rates on customer margin borrowing to finance trading activity and lower average customer margin balances. Interest expense decreased 82% to $0.7 million for the three months ended March 31, 2009 compared to $4.1 million for the comparable prior year period, principally as a result of decreased interest rates charged by banks on decreased levels of borrowings to finance customer borrowings.

39



Non-interest expenses increased 7% to $95.1 million for the three months ended March 31, 2009 compared to $89.2 million for the comparable period in 2008. Employee compensation and benefits decreased 1% principally as a result of decreased variable compensation as a result of decreased production, offset by increased overhead, a component of fixed compensation, as a result of the continued expansion of the Private Client Group. Employee compensation and benefits includes transition pay of $7.9 million (7% of net revenues) and $6.5 million (6% of net revenues) for the three month period ended March 31, 2009 and 2008, respectively, principally in the form of upfront notes, signing bonuses and retention awards in conjunction with our expansion efforts. As a percentage of net revenues, employee compensation and benefits increased to 65% for the three month period ended March 31, 2009 compared to 63% for the comparable period in 2008 as a result of decreased net revenues and increased enhanced pay, which primarily consists of the amortization of upfront notes. Other non-employee compensation and benefits expenses increased principally due to the increase in new branch offices and financial advisors, and the increased depreciation expense associated with the investment in infrastructure, primarily communication and quote equipment.

Income before income taxes for the Private Client Group decreased 40% to $15.5 million for the three months ended March 31, 2009 compared to $25.6 million for the comparable period in 2008 as a result of decreased net revenues and increased costs associated with the continued growth of the Private Client Group.

Results of Operations - Equity Capital Markets

The following table presents consolidated financial information for the Equity Capital Markets segment for the periods indicated (in thousands, except percentages):

   

Three Months Ended

March 31, 2009

 

March 31, 2008


Amount

% of Net
Revenues

 

%
Change

 


Amount

% of Net
Revenues

Revenues:

Commissions and principal transactions

$    36,787

78%

6%

$    34,654

70%

Investment banking

10,098

22

(29)

14,267

29

Other income/(loss)

222

--

(41)

375

1

Total revenues

47,107

100

(4)

49,296

100

Interest expense

24

--

(65)

68

--

Net revenues 

47,083

100

(4)

49,228

100

Non-Interest Expenses:

Employee compensation and benefits

29,311

62

(6)

31,294

64

Occupancy and equipment rental

2,694

6

38

1,933

4

Communication and office supplies

3,345

7

(32)

4,946

10

Commissions and floor brokerage

2,179

5

*

562

1

Other operating expenses

3,829

8

7

3,566

7

Total non-interest expenses

41,358

88

(2)

42,301

86

Income before income taxes

$      5,725

12%

(17)%

$    6,927

14%

 

*   Percentage is not meaningful.

Three Months Ended March 31, 2009 Compared with Three Months Ended March 31, 2008

Equity Capital Markets recorded net revenues of $47.1 million for the three months ended March 31, 2009, a decrease of 4% compared to $49.2 million for the comparable period in 2008, principally due to the decrease in investment banking activity resulting from the industry-wide difficult capital market conditions, partially offset by increased commissions and principal transactions, which increased 6% to $36.8 million. Investment banking revenues decreased 29% to $10.1 million for the three months ended March 31, 2009, reflecting a 90% decrease in equity financing revenues to $0.7 million, offset by a 25% increase in financial advisory fees to $9.4 million.

Non-interest expenses decreased $0.9 million to $41.4 million for the three months ended March 31, 2009 compared to $42.3 million for the comparable period in 2008. Employee compensation and benefits as a percentage of net revenues decreased to 62% for the three months ended March 31, 2009 compared to 64% for the comparable period in 2008; principally due to decreased production-based variable compensation compared to the first quarter of 2008 and decreased net revenues. Increases in occupancy and equipment rental, commission and floor brokerage, and other operating expenses can be attributed to our expansion of the Equity Capital Markets segment. Additionally, with our change in a third party vendor for services, $2.4 million previously recorded as communication and office supplies are now being recorded as commission and floor brokerage.

40



Income before income taxes decreased 17% to $5.7 million for the three months ended March 31, 2009 compared to $6.9 million for the comparable period in 2008, principally as a result of the increased costs attributable to the growth of the segment and the decrease in investment banking revenues during the three months ended March 31, 2009.

Results of Operations - Fixed Income Capital Markets

The following table presents consolidated financial information for the Fixed Income Capital Markets segment for the periods indicated (in thousands, except percentages):

   

Three Months Ended

March 31, 2009

 

March 31, 2008


Amount

% of Net
Revenues

 

%
Change

 


Amount

% of Net
Revenues

Revenues:

Commissions and principal transactions

$    53,448

91%

34%

$    40,032

91%

Investment banking

3,337

6

(4)

3,474

8

Interest

2,070

4

(5)

2,167

5

Other income/(loss)

3

--

(41)

6

--

Total revenues

58,858

101

29

45,679

104

Interest expense

469

1

(72)

1,677

4

Net revenues 

58,389

100

33

44,002

100

Non-Interest Expenses:

Employee compensation and benefits

33,207

57

28

25,936

59

Occupancy and equipment rental

993

2

28

777

2

Communication and office supplies

1,434

2

1

1,424

3

Commissions and floor brokerage

341

1

*

(13)

--

Other operating expenses

2,105

3

*

965

2

Total non-interest expenses

38,080

65

31

29,089

66

Income before income taxes

$      20,309

35%

36%

$    14,913

34%

 

*   Percentage is not meaningful.

Three Months Ended March 31, 2009 Compared with Three Months Ended March 31, 2008

Fixed Income Capital Markets net revenues for the three months ended March 31, 2009 increased 33% to $58.4 million compared to net revenues of $44.0 million for the comparable period in 2008, principally due to an increase in principal transactions, primarily corporate debt, municipal debt, and mortgage-backed bonds due to turbulent markets and institutional customers returning to traditional fixed income products. Interest revenues for the three months ended March 31, 2009 decreased 5% to $2.1 million principally as a result of decreased fixed income inventory held for sale to clients. Interest expense for the three months ended March 31, 2009 decreased 72% to $0.5 million as a result of decreased interest expense incurred to carry the lower levels of such inventory.

Non-interest expenses increased $9.0 million or 31% to $38.1 million for the three months ended March 31, 2009 principally due to a 28% increase in employee compensation and benefits, which primarily increased as a result of increased productivity. Employee compensation and benefits as a percentage of net revenues decreased to 57% for the three months ended March 31, 2009 from 59% for the comparable period in 2008, reflecting increased production. Occupancy and equipment rental, communications and office supplies, commissions and floor brokerage, and other operating expenses increased principally due to the increase in the number of public finance offices compared to the first quarter of 2008.

Income before income taxes increased $5.4 million to $20.3 million for the three months ended March 31, 2009 from $14.9 million for the comparable period in 2008 as a result of the increased net revenues and the scalability of increased production.

41



Results of Operations - Stifel Bank

The following table presents consolidated financial information for the Stifel Bank segment for the periods indicated (in thousands, except percentages):

   

Three Months Ended

March 31, 2009

 

March 31, 2008


Amount

% of Net
Revenues

 

%
Change

 


Amount

% of Net
Revenues

Revenues:

Interest

$    3,656

101%

3%

$    3,551

170%

Other income/(loss)

670

18

*

247

12

Total revenues

4,326

119

14

3,798

182

Interest expense

686

19

(60)

1,716

82

Net revenues 

3,640

100

75

2,082

100

Non-Interest Expenses:

Employee compensation and benefits

411

11

(46)

759

36

Occupancy and equipment rental

231

6

5

220

11

Communication and office supplies

114

3

(6)

122

6

Provision for loan losses

533

15

*

135

6

Other operating expenses

577

16

8

537

26

Total non-interest expenses

1,866

51

5

1,773

85

Income before income taxes

$      1,774

49%

*

$    309

15%

 

*   Percentage is not meaningful.

As a bank holding company, we are required to meet capital requirements as defined. See Note 11 of the Notes to the Condensed Consolidated Financial Statements for the calculation of our Federal Reserve Capital Amounts.

The growth in Stifel Bank has been primarily driven by the growth in deposits associated with brokerage customers of Stifel Nicolaus. At March 31, 2009, the balance of Stifel Nicolaus brokerage customer deposits at Stifel Bank was $418.0 million compared to $228.7 million at December 31, 2008.

Interest revenues of $3.7 million for the three months ended March 31, 2009 were generated from weighted average interest-earning assets of $470.4 million at a weighted average interest rate of 3.11%. Interest revenues of $3.6 million for the comparable period in 2008 were generated from weighted average interest-earning assets of $238.6 million at a weighted average interest rate of 5.95%. Interest-earning assets principally consist of residential, consumer, and commercial loans, securities, and federal funds sold.

Other revenues principally reflect the gain on sale of mortgage loans, which increased due to the growth in mortgage loans originated and sold.

Interest expense represents interest on customer money market and savings accounts, interest on time deposits and other interest expense. The weighted average balance of interest-bearing liabilities during the first three months of 2009 was $420.1 million at a weighted average interest rate of 0.65%. The weighted average balance of interest-bearing liabilities for the comparable period in 2008 was $190.7 million at a weighted average interest rate of 3.60%. See the average balances and interest rates for Stifel Bank presented later in this section for more information regarding average balances, interest income and expense, and average interest rate yields.

Non-interest expenses includes employee compensation and benefits, occupancy and equipment rental, and communication and office supplies primarily related to Stifel Bank's branch location and leased executive office space, the provision for loan losses, and other operating expenses, principally legal and accounting, data processing, and other miscellaneous expenses.

42



During the three months ended March 31, 2009, the provision for loan loss charged to operations was $0.5 million, with charge-offs of $0.3 million during the period. During the comparable period in 2008, the provision for loan loss charged to operations was $0.1 million with charge-offs of $0.3 million fully recovered. Included in the loan portfolio at March 31, 2009 are impaired loans totaling $2.5 million for which there are specific loss allowances of $0.7 million compared to impaired loans totaling $0.6 million at December 31, 2008 for which there were specific loss allowances of $0.2 million. At March 31, 2009, Stifel Bank had $2.1 million of nonperforming loans, which was comprised of $2.0 million in non-accruing loans that were less than 90 days past due and $0.1 million in non-accruing loans that were more than 90 days past due, for which there was a specific allowance of $1.0 million. There were no non-accruing loans and there were no accruing loans delinquent 90 days or more at December 31, 2008. Stifel Bank has no exposure to sub-prime mortgages.

The following table sets forth a summary of average balances and interest rates for the periods presented (in thousands, except rates):

 

 

 

Three Months Ended

 

March 31, 2009

 

March 31, 2008

 

Average
Balance

Interest Income/
Expense

Average Interest Rate

 

Average
Balance

Interest Income/
Expense

Average Interest Rate

Assets:

Federal funds sold

$    183,137

$         221

       0.48%

$      21,366

$         157

       2.94 %

U.S. government agencies

          3,011

             89

      11.77

        18,661

           271

        5.81

State and political subdivisions-taxable

                 --

               --

            --

        11,332

           165

        5.81

State and political subdivisions-non taxable (1)

          1,512

             16

        4.17

          1,537

             13

        3.47

Mortgage backed securities

        35,723

           374

        4.19

        27,596

           369

        5.36

Corporate bonds

          6,046

             51

        3.34

          2,993

             53

        7.05

Asset backed securities

        17,583

           242

        5.51

        17,849

           312

        6.99

Federal Home Loan Bank ("FHLB") and other capital stock

            
719

              
--

       
0.11

            
310

              
 4

       
 4.78

Loans (2)

      189,011

        2,293

        4.85

      125,435

        2,092

        6.67

Loans held for sale

        33,622

           370

        4.41

        11,555

           115

        4.00

Total interest-earning assets

      470,364

        3,656

      3.11%

      238,634

        3,551

        5.95%

Cash and due from banks

          4,222

                 --

Other non-interest-earning assets

        21,344

        23,026

Total assets

$    495,930

$    261,660

Liabilities:

Deposits:

Demand deposits

$        6,501

$             4

        0.25 %

$        2,230

$           15

        2.59%

Money market

      385,411

           448

        0.46

      141,847

        1,148

        3.24

Savings

             349

               --

        0.05

             367

               1

        1.61

Time deposits

        21,820

           189

        3.48

        46,194

           552

        4.78

FHLB advances

          6,000

             45

        2.97

                --

               --

            --

Federal funds and repurchase agreements

               15

               --

        0.08

               54

               --

            --

Total interest-bearing liabilities

      420,096

           686

        0.65 %

      190,692

        1,716

        3.60%

Non-interest-bearing deposits

        16,354

                --

Other non-interest-bearing liabilities

          1,564

        14,710

Total liabilities

      438,014

      205,402

Shareholders' equity

        57,916

        56,258

Total liabilities and shareholders' equity

$    495,930

$    261,660

Net interest margin

$      2,970

        2.53 %

$      1,835

        3.08%

               

(1)  Due to immaterial amount of income recognized on tax-exempt securities, yields were not calculated on a tax equivalent basis.

(2)  Loans on non-accrual status are included in average balances.

43



The following table sets forth an analysis of the effect on net interest income of volume and rate changes for the three months ended March 31, 2009 compared to the three months ended March 31, 2008 (in thousands):

 

 

 

 

 

 

 

Increase (Decrease) Due to

 

Volume

 

Rate

 

Total

Interest income:

Federal funds sold

$     1,002

$     (938)

$     64

U.S. government agencies

(1,082)

900

(182)

State and political subdivisions-taxable

(83)

(82)

(165)

State and political subdivisions-non taxable

(1)

4

3

Mortgage backed securities

373

(368)

5

Corporate bonds

145

(147)

(2)

Asset backed securities

(5)

(65)

(70)

FHLB and other capital stock

14

(18)

(4)

Loans

435

(234)

201

Loans held for sale

242

13

255

 

$     1,040

$     (935)

$     105

 

 

 

 

 

 

 

 

Increase (Decrease) Due to

 

Volume

 

Rate

 

Total

Interest expense:

Deposits:

Demand deposits

$          (20)

$          9

$         (11)

Money market accounts

(1,395)

695

(700)

Savings

--

(1)

(1)

Time deposits

(239)

(124)

(363)

FHLB advances

23

22

45

Federal funds and repurchase agreements

--

--

--

 

$     (1,631)

$     601

$    (1,030)

 

Increases and decreases in interest income and interest expense result from changes in average balances (volume) of interest-earning bank assets and liabilities, as well as changes in average interest rates. The effect of changes in volume is determined by multiplying the change in volume by the previous year's average yield/cost. Similarly, the effect of rate changes is calculated by multiplying the change in average yield/cost by the previous year's volume. Changes applicable to both volume and rate have been allocated proportionately.

44



Results of Operations - Other Segment

The following table presents consolidated financial information for the Other segment for the periods presented (in thousands, except percentages):

   

Three Months Ended

March 31, 2009

 

March 31, 2008


Amount

% of Net
Revenues

 

%
Change

 


Amount

% of Net
Revenues

Net Revenues:

$            345

100%

(74)%

$      1,312

100%

Non-Interest Expenses:

Employee compensation and benefits

12,693

*

(17)

15,197

*

Other operating expenses

8,765

*

(12)

9,944

*

Total non-interest expenses

21,458

*

(15)

25,141

8

Loss before income taxes

$    (21,113)

*

11%

$  (23,829)

*

 

*   Percentage is not meaningful.

Three Months Ended March 31, 2009 Compared with Three Months Ended March 31, 2008

Net revenues decreased 74% to $0.3 million for the three months ended March 31, 2009 compared to $1.3 million for the comparable period in 2008, principally as a result of a $1.9 million decrease in net interest revenues to $0.5 million for the three months ended March 31, 2009 as a result of decreased interest charged for short-term borrowings.

Employee compensation and benefits decreased 17% to $12.7 million for the three months ended March 31, 2009 compared to $15.2 million for the comparable period in 2008. Employee compensation and benefits decreased primarily due to lower production-based variable compensation related to decreased profitability compared to the first quarter of 2008, partially offset by an increase in support personnel during the first quarter of 2009 as we continue our growth initiatives. Additionally, included in "Employee compensation and benefits" are acquisition-related expenses associated with the LM Capital Markets acquisition consisting principally of compensation charges of $6.3 million for the three months ended March 31, 2008 primarily for amortization of units awarded to LM Capital Markets associates. As these units were fully amortized as of December 31, 2008, we had no unit amortization expense during the first quarter of 2009.

Other operating expenses decreased 12% to $8.8 million for the three months ended March 31, 2009 compared to $9.9 million for the comparable period in 2008. Other operating expenses decreased primarily due to a decrease in data processing expense compared to the first quarter of 2008 resulting from lower trading volumes as a result of the continued market downturn.

Analysis of Financial Condition

Our company's consolidated statements of financial condition consist primarily of cash and cash equivalents, receivables, trading inventory, bank loans, investments, goodwill, loans and advances to financial advisors and payables. Total assets of $2.0 billion at March 31, 2009 were up 30% over December 31, 2008. The increase is primarily attributable to increased trading inventory. Our broker-dealer subsidiary's gross assets and liabilities, including trading inventory, stock loan/borrow, receivables and payables from/to brokers, dealers and clearing organizations and clients, fluctuate with our business levels and overall market conditions.

As of March 31, 2009, our liabilities were comprised primarily of deposits of $459.3 million at Stifel Bank and brokerage client payables of $146.0 million at our broker-dealer subsidiaries, as well as accounts payable and accrued expenses, including accrued employee compensation of $160.9 million. To meet our obligations to clients and operating needs, we have approximately $286.7 million in cash. We also have client brokerage receivables of $270.8 million and $171.4 million in loans at Stifel Bank.

45



Liquidity and Capital Resources

Liquidity is essential to our business. We regularly monitor our liquidity position, including our cash and net capital positions, and we have implemented a liquidity strategy designed to enable our business to continue to operate even under adverse circumstances, although there can be no assurance that our strategy will be successful under all circumstances.

Our assets, consisting mainly of cash or assets readily convertible into cash, are our principal source of liquidity. The liquid nature of these assets provides for flexibility in managing and financing the projected operating needs of the business. These assets are financed primarily by our equity capital, debentures to trusts, client credit balances, short-term bank loans, proceeds from securities lending, and other payables. We currently finance our client accounts and firm trading positions through ordinary course borrowings at floating interest rates from various banks on a demand basis and securities lending, with company-owned and client securities pledged as collateral. Changes in securities market volumes, related client borrowing demands, underwriting activity, and levels of securities inventory affect the amount of our financing requirements.

Our bank assets consist principally of retained loans, available-for-sale securities, and cash and cash equivalents. Stifel Bank's current liquidity needs are generally met through deposits from bank clients and equity capital. We monitor the liquidity of Stifel Bank daily to ensure its ability to meet customer deposit withdrawals, maintain reserve requirements and support asset growth.

We rely exclusively on financing activities and distributions from our subsidiaries for funds to implement our business and growth strategies. Net capital rules, restrictions under our long-term debt, or the borrowing arrangements of our subsidiaries, as well as the earnings, financial condition, and cash requirements of our subsidiaries, may each limit distributions to us from our subsidiaries.

We have an ongoing authorization, as amended, from the Board of Directors to repurchase our common stock in the open market or in negotiated transactions. In May 2005, the Board of Directors authorized the repurchase of an additional 3,000,000 shares, for a total authorization to repurchase up to 4,500,000 shares (as adjusted for the three-for-two stock split in June 2008). The share repurchase program will manage our equity capital relative to the growth of our business and help to meet obligations under our employee benefit plans. Under existing board authorizations at March 31, 2009, we are permitted to buy an additional 2,010,831 shares. During the three months ended March 31, 2009, we issued 1,040,751 new shares for employee benefit plans.

We currently do not pay cash dividends on our common stock.

We believe our existing assets, most of which are liquid in nature, together with the funds from operations, available informal short-term credit arrangements, long-term borrowings, and our ability to raise additional capital will provide sufficient resources to meet our present and anticipated financing needs.

Cash Flow

Cash and cash equivalents increased $47.0 million to $286.7 million at March 31, 2009 from $239.7 million at December 31, 2008. Operating activities used $333.6 million of cash primarily due an increase in operating assets and liabilities, offset by the net effect of non-cash expenses and cash from earnings. Investing activities provided cash of $13.0 million due to net proceeds from the sale of our available-for-sale securities and proprietary investments and bank customer loan repayments, offset by cash used for bank customer loan originations, and fixed asset purchases. During the three months ended March 31, 2009, we purchased $3.8 million in fixed assets, consisting primarily of information technology equipment, leasehold improvements and furniture and fixtures. Financing activities provided cash of $367.5 million due to an increase in bank deposits due to the growth of our bank and proceeds received from borrowings from banks during the three months ended March 31, 2009.

46



Funding Sources

Our short-term financing is generally obtained through the use of bank loans and securities lending arrangements. We borrow from various banks on a demand basis with company-owned and customer securities pledged as collateral. The value of the customer-owned securities is not reflected in the consolidated statements of financial condition. We maintain available ongoing credit arrangements with banks that provided a peak daily borrowing of $263.8 million during the three months ended March 31, 2009. There are no compensating balance requirements under these arrangements. At March 31, 2009, short-term borrowings from banks were $163.5 million at an average rate of 1.06%, which were collateralized by company-owned securities valued at $201.6 million. At December 31, 2008, there were no short-term borrowings from banks. The average bank borrowing was $63.9 million and $114.7 million during the three months ended March 31, 2009 and 2008, respectively, at weighted average daily interest rates of 0.81%, and 2.74%, respectively. At March 31, 2009 and December 31, 2008, Stifel Nicolaus had a stock loan balance of $29.7 million and $17.0 million, respectively, at weighted average daily interest rates of 0.63% and 0.52%, respectively. The average outstanding securities lending arrangements utilized in financing activities were $44.3 million and $162.9 million during the three months ended March 31, 2009 and 2008, respectively, at weighted average daily effective interest rates of 0.84%, and 3.26%, respectively. Customer-owned securities were utilized in these arrangements.

The impact of the tightened credit markets has resulted in decreased financing through stock loan as our counterparties sought liquidity. As a result, bank loan financing used to finance trading inventories increased.

Stifel Bank has borrowing capacity with the Federal Home Loan Bank of $121.9 million at March 31, 2009, of which $115.9 million was unused, and a $12.7 million federal funds agreement for the purpose of purchasing short-term funds should additional liquidity be needed. Stifel Bank receives overnight funds from excess cash held in Stifel Nicolaus brokerage accounts, which are deposited into a money market account. These balances totaled $418.0 million at March 31, 2009.

Our liquidity requirements may change in the event we need to raise more funds than anticipated to increase inventory positions, support more rapid expansion, develop new or enhanced services and products, acquire technologies, or respond to other unanticipated liquidity requirements. We rely exclusively on financing activities and distributions from our subsidiaries for funds to implement our business and growth strategies, and repurchase our shares. Net capital rules, restrictions under our long-term debt, or the borrowing arrangements of our subsidiaries, as well as the earnings, financial condition, and cash requirements of our subsidiaries, may each limit distributions to us from our subsidiaries.

In the event existing internal and external financial resources do not satisfy our needs, we may have to seek additional outside financing. The availability of outside financing will depend on a variety of factors, such as market conditions, the general availability of credit, the volume of trading activities, the overall availability of credit to the financial services industry, credit ratings, and credit capacity, as well as the possibility that lenders could develop a negative perception of our long-term or short-term financial prospects if we incurred large trading losses or if the level of our business activity decreased due to a market downturn or otherwise. We currently do not have a credit rating, which could adversely affect our liquidity and competitive position by increasing our borrowing costs and limiting access to sources of liquidity that require a credit rating as a condition to providing funds.

Use of Capital Resources

In connection with ARS, our broker-dealer subsidiaries have been subject to ongoing investigations, which include inquiries from the SEC, FINRA and several state regulatory agencies, with which we are cooperating fully. We are also named in a class action lawsuit similar to that filed against a number of brokerage firms alleging various securities law violations, which we are vigorously defending. We are, in conjunction with other industry participants actively seeking a solution to ARS' illiquidity, which may include the restructuring and refinancing of those ARS. See Item 1, "Legal Proceedings," in Part II of this report for a discussion of our legal matters (including ARS).

47



On March 23, 2009, we entered into a definitive agreement with UBS Financial Services Inc. ("UBS"), which was amended May 4, 2009,  to acquire up to 58 branches from the UBS Wealth Management Americas branch network. The transaction is structured as an asset purchase for cash at a premium over certain balance sheet items, subject to adjustment. The total consideration includes: (1) an upfront cash payment of up to approximately $29.0 million based on the actual number of branches and financial advisors acquired; and (2) aggregate payments of up to approximately $21.1 million for net fixed assets and employee loans. In addition, we will issue transition pay in the form of upfront payments of up to $31.7 million. Of the upfront payments issued to UBS financial advisors, we expect to pay 70% in cash and the remaining in our company's stock units. A contingent earn-out payment is payable based on the performance of UBS financial advisors, who become our employees, over the two-year period following the closing. The closing of the acquisition is subject to customary conditions and the approval of all required governmental and other regulatory entities and is expected to occur during the third quarter of 2009.

We have paid $30.0 million in the form of upfront notes to investment executives for transition pay during the period January 1, 2009 through April 30, 2009. As we continue to take advantage of the opportunities created by market displacement and as competition for skilled professionals in the industry increases, we may have to devote more significant resources to attracting and retaining qualified personnel.

We expect to pay out the contingent earn-out liability of $26.6 million related to our acquisition of the LM Capital Markets business from Citigroup Inc. during the second quarter of 2009.

Net Capital Requirements

We operate in a highly regulated environment and are subject to net capital requirements, which may limit distributions to our company from our broker-dealer subsidiaries. Distributions from our broker-dealer subsidiaries are subject to net capital rules. These subsidiaries have historically operated in excess of minimum net capital requirements. However, if distributions were to be limited in the future due to the failure of our subsidiaries to comply with the net capital rules or a change in the net capital rules, it could have a material and adverse affect to our company by limiting our operations that require intensive use of capital, such as underwriting or trading activities, or limit our ability to implement our business and growth strategies, pay interest on and repay the principal of our debt, and/or repurchase our common stock. Our non broker-dealer subsidiary, Stifel Bank is also subject to various regulatory capital requirements administered by the federal banking agencies.

At March 31, 2009, Stifel Nicolaus had net capital of $163.3 million, which was 49.5% of its aggregate debit items, and $156.7 million in excess of its minimum required net capital; CSA had net capital of $2.3 million, which was $2.1 million in excess of its minimum required net capital; Butler Wick had net capital of $6.1 million which was $5.9 million in excess of its minimum required net capital. At March 31, 2009, SN Ltd had capital and reserves of $7.9 million, which was $7.6 million in excess of the financial resources requirement under the rules of the FSA. At March 31, 2009, Stifel Bank was considered well capitalized under the regulatory framework for prompt corrective action. See Note 11 of the Notes to Condensed Consolidated Financial Statements for details of our regulatory capital requirements.

Critical Accounting Policies and Estimates

In preparing our consolidated financial statements in accordance with generally accepted accounting principles and pursuant to the rules and regulations of the SEC, we make assumptions, judgments and estimates that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. On a regular basis, we evaluate our assumptions, judgments and estimates. We also discuss our critical accounting policies and estimates with the Audit Committee of the Board of Directors.

We believe that the assumptions, judgments and estimates involved in the accounting policies described below have the greatest potential impact on our consolidated financial statements. These areas are key components of our results of operations and are based on complex rules that require us to make assumptions, judgments and estimates, so we consider these to be our critical accounting policies. Historically, our assumptions, judgments and estimates relative to our critical accounting policies and estimates have not differed materially from actual results.

For a full description of these and other accounting policies, see Note 1 of the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2008.

48



Valuation of Financial Instruments

Trading securities owned and pledged and trading securities sold, but not yet purchased, are carried at fair value on the consolidated statements of financial condition, with unrealized gains and losses reflected in the condensed consolidated statements of operations.

We adopted SFAS No. 157, "Fair Value Measurements" ("SFAS 157") during the first quarter of 2008. SFAS 157 defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. During the fourth quarter of 2008, both the Financial Accounting Standards Board ("FASB") and the staff of the SEC re-emphasized the importance of sound fair value measurement in financial reporting. In October 2008, the FASB issued FASB Staff Position No. FAS 157-3 ("FSP FAS 157-3"), "Determining Fair Value of a Financial Asset When the Market for That Asset is Not Active." This statement clarifies that determining fair value in an inactive market or dislocated market depends on facts and circumstances and requires significant judgment. This statement specifies that it is acceptable to use inputs based on management estimates or assumptions, or for management to make adjustments to observable inputs to determine fair value when markets are not active and relevant observable inputs are not available. Our fair value measurement policies are consistent with the guidance in FSP FAS 157-3.

SFAS 157 defines "fair value" as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, or an exit price. The degree of judgment used in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Financial instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices in active markets generally have more pricing observability and less judgment used in measuring fair value. Conversely, financial instruments rarely traded or not quoted have less pricing observability and are measured at fair value using valuation models that require more judgment. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established, the characteristics specific to the transaction, and overall market conditions generally.

When available, we use observable market prices, observable market parameters, or broker or dealer prices (bid and ask prices) to derive the fair value of financial instruments. In the case of financial instruments transacted on recognized exchanges, the observable market prices represent quotations for completed transactions from the exchange on which the financial instrument is principally traded.

A substantial percentage of the fair value of our trading securities and other investments owned, trading securities pledged as collateral, and trading securities sold, but not yet purchased, are based on observable market prices, observable market parameters, or derived from broker or dealer prices. The availability of observable market prices and pricing parameters can vary from product to product. Where available, observable market prices and pricing or market parameters in a product may be used to derive a price without requiring significant judgment. In certain markets, observable market prices or market parameters are not available for all products, and fair value is determined using techniques appropriate for each particular product. These techniques involve some degree of judgment.

For investments in illiquid or privately held securities that do not have readily determinable fair values, the determination of fair value requires us to estimate the value of the securities using the best information available. Among the factors we consider in determining the fair value of investments are the cost of the investment, terms and liquidity, developments since the acquisition of the investment, the