Stifel Financial Corp (SF) 2014 Q2 法說會逐字稿

Good morning my name is Shelley and I will be your conference operator today. At this time I would like to welcome everyone to the Stifel second-quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question and answer session.

(Operator Instructions)

Jim Zemlyak, you may begin your conference.

Thank you operator. Good morning. I'm Jim Zemlyak, the CFO of Stifel.

I would like to welcome everyone to our conference call today to discuss our second quarter 2014 financial results. Please note that this conference call is being recorded. If you'd like a copy of today's presentation you may download slides from the Company's website at www.Stifel.com.

Before we begin today's call, I would like to remind listeners that this presentation may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not statements of fact or guarantee of performance.

They may include statements regarding among other things: our ability to successfully integrate acquired companies or branch offices and financial advisors, general economic, political, regulatory and market conditions, investment banking and brokerage industries, our objectives and results and also may include our belief regarding this fact that various legal proceedings management expectations are liquidity and funding sources, counterparty credit risks or other similar matters. As such, they are subject to risks, uncertainties and other factors that may cause actual future results to differ materially from those discussed in the statements.

To supplement our financial statement presented in accordance with GAAP we may use certain non-GAAP measures of financial performance and liquidity. These non-GAAP measures should only be considered together with the Company's GAAP results. To the extent we discuss non-GAAP measures, the reconciliation to GAAP is available on our website at www.stifel.com

And finally for a discussion of risks and uncertainties in our business, please see the business factors affecting the Company and the financial services industry in the Company's annual report on form 10-K and MD&A of results on the Company's quarterly reports on form 10-Q. I will now turn the call over to our Chairman and CEO of Stifel, Ron Kruszewski.

Thank you Jim, good morning everyone. We are pleased with the performance of our Private Client and Investment Banking groups who contributed nicely to our results in the second quarter in what was otherwise, what I believe was a challenging market environment.

Our Global Wealth Management segment posted record net revenues and record pretax operating contributions in the quarter. Investment Banking benefited from strong equity capital raising and advisory activity and our institutional brokerage results are reflective of what was really significantly lower industry volume.

During the second quarter we announced two acquisitions; Oriel Securities, a London-based stock brokering and investments banking firm. This will build out our institutional business is already underway in London. And in June we announced the acquisition of Legg Mason Investment Counsel, which we complementary to our high net worth Private Client group.

Before I turn to our results, I would like to add a little color on the operating environment during the quarter. The second quarter was, in my opinion, a quarter of market complacency. While the S&P 500 hit new highs, up 5% from the first quarter and 6% for the year, the 10-year yield decreased 19 basis points. Volatility measured by the VIX declined 17% and equity average daily volume declined 13% from the first quarter of 2014.

Inflows to equity funds also slowed to $11 billion, down from $56 billion in the first quarter. However, this same complacency, coupled with low volatility, did help equity capital raising from both a dollar value as -- the industry both dollar value and deal count was up year-over-year and quarter-over-quarter. Our results reflect this trend.

The reverse however, was true for debt capital raising which was down on both comparable periods for the industry. For the industry, another bright spot was announced M&A. This bodes well for future periods.

And you know looking, at the yield on the S&P 500-- looking at the risk premium -- the yield on the S&P 500 was 551 and if you take away the 10-year that equates to about a 3% risk premium. This compares a risk premium of 396 last year.

Turning to our financial results for the quarter, Stifel recorded GAAP net revenues of $560 million which is our second best quarter in history. EPS from continuing operations, totaled $0.58 per diluted share and on a non-GAAP basis -- which excludes our merger-related expenses -- diluted EPS was $0.68 on net income of $51.3 million. This compares to net income of $45 million or $0.61 per diluted share last year which was up 11.5%.

Core non-comp operating expenses came in above our estimated range. It came in at $122.8 million. I'll provide some more details on that in a bit. And our effective non-GAAP effective tax rate was 39.6%. Pretax margins, non-GAAP again, hit our target at 15.1%. All in all, a solid revenue quarter and first half of the year.

You know, looking at the six-month, our net revenues for the first six months were a record $1.1 billion. Earnings per share from continuing ops was $1.20 per share and on a non-GAAP basis, our diluted EPS was $1.37. That was up 15% from the $1.19 in the comparable period -- comparable six months last year.

For the first six months, our comp and benefits stood at 62.9%. And our non-GAAP operating expenses were 21.8% for a pretax operating margin of 15.3%.

Looking at our revenues for the quarter, commission revenues decreased 1% to $153 million. Principal transactions were up 13% to $126 million and that was due to an increase -- for the mostly an increase in fixed income institutional brokerage activity which was primarily helped by our Knight Capital Fixed Income business.

Investment Banking had a very good quarter, increased 19% to $142 million. The increase was a result in an increase in advisory revenues and equity and fixed income capital raising and reflects, really the results in investment banking reflects dividends that we've -- that we are now starting to get from our investments in this area.

Asset Management service fees increased 24% to $94 million. This increase is due to higher value fee-based accounts, as a result of market appreciation and net new client assets. Net interest income increased 84% to $37 million as a result of continued growth and interest-earning assets at Stifel Bank.

Turning to Brokerage revenues, looking at the Global Wealth Brokerage revenues were essentially flat quarter-over-quarter and year-over-year. Institutional Equity brokerage declined 3% quarter-over-quarter but were up 13% for the six months against really, a backdrop of flat average daily volumes, 2014 versus 2013. So we are please with those results. Institutional fixed income increased 33% mainly due, as I said before, our contributions from the team from Knight. Total institutional brokerage revenues in total increased 11% to $117 million and 4.6% for the six months.

Looking at Investment Banking. Equity capital raising increased 23% while fixed income decreased 13% from the year ago quarter. The fixed income decrease reflects difficult environment in public finance. Advisory fees were up 25% and as a result total investment banking increased 19%, a great quarter at $142 million. It's up 40% year-over-year to $274 million.

We are very pleased with our banking quarter which is our second best revenue quarter in our history. Our results show a balance between advisory and capital markets revenues. We're making progress in building our best in class capabilities and as I said, we're starting to see payoffs from our investments of the past few years.

You know, looking at -- I should note that looking at our FIG business, KBW had its best quarter since the first quarter of 2011. KBW advised on seven of the top 10 bank mergers in the first half of the year on the capital raising side. Investors Bancorp was the largest bank capital raise in the first half, it was $2.2 billion. And KBW was both the conversion agent and joint bookrunner on that deal.

Looking forward, our equity and M&A backlogs are strong and have increased from the start of the second quarter.

The next slide reviews our core non-interest expenses. Excluding non-core expenses, comp and benefits of the percentage of net revenues was within our stated goal at 63%. Transition pay as a percentage of net revenues, was 4.5%. And core non-comp operating expense were $122.8 million which was higher than our stated quarterly range of $118 million to $120 million. The difference of the increase, is primarily the results of an increase in professional fees due to regulatory compliance work directly related to the growth of our businesses and also an increase in legal expenses.

The next slide reviews our core non-interest expenses for the first six months of the year. Again, core non-comp expenses were $242 million. It was 21.8% of revenue and the explanation for that increase and the reasons above our range are the same. It's increased professional fees and increased legal.

The next slide reviews our non-core deal costs. In the quarter we incurred $7.4 million of pretax cost. That relates to our eight most recent acquisitions. On a go-forward basis, we expect to incur an additional $4 million in the third quarter and $2.5 million in the fourth quarter which should be the balance really for Acacia, De La Rosa, Keefe, Knight, Ziegler Capital and Miller Buckfire. But we also just announced, as I said Oriel and Legg Mason and those costs are undetermined at this time although we will either provide an update or will discuss it on the next call.

The next slide looks at our reporting segments. Global Wealth Management posted record net revenues of $307 million, an increase of 9%. Our Institutional Group had their second best quarter with net revenues of $256 million. It was up 19% year-over-year. Global Wealth Management's operating contribution increased 13% from the prior year to $89 million. While our Institutional Group's operating contribution was up 37% from the prior-year to $43 million.

The next slide looks -- and I just wanted to point out again the non-comp operating expenses by segment. And you'll see that we've had leverage in our reporting segments in non-comp OpEx both Global Wealth Management and our Institutional segments. But we -- our other segment has significant increases in non-comp OpEx and as I said, it's that we've been investing a lot in our infrastructure and in our regulatory compliance that we need to do. And as it stands, I think other expenses in future periods will remain somewhat elevated as we continue to invest in our systems to be compliant in today's high focused regulatory environment.

Turning to the segments, our Global Wealth Management had a great quarter. Margins of 29%. Commission revenues were up 3% from the prior year. Principal transactions are down slightly. Primarily to a decline in our fixed income business within Global Wealth Management. Asset Management fees increased 24%. As I said it's an increase of assets in our Management for market performance and increase in client assets.

And interest revenues were up 46% due to our performance at Stifel Bank. Investment Banking within the segment declined to $10 million. We are down 36% and it was -- we didn't do as much in the equity underwriting business within Global Wealth Management.

Our other income declined due to a decrease in mortgage fees from loan originations of Stifel Bank which is consistent with what's been going on in the industry. Comp and benefits are the percentage of net revenues was well within our range of 56% for the quarter compared to 57.7% in the prior year.

Non-comp operating expenses increased 14% which is reflective of the growth in assets and the growth of what we've been doing in Global Wealth Management. Looking next at Stifel Bank assets increased compared to the prior year ago quarter just a year ago, assets are up 17% to $5.1 billion. Similarly, deposits increased 16% and retained loans grew 79% versus the year ago. The balance of loans to bonds which now stands at 39% to 61% is getting closer to our desired -- our goal of 50%-50% as loan origination capacity has increased at the Bank.

The transition to loans from investments has also increased. Our net interest margin from 213 basis points a year ago to 257 basis points. Asset quality remains very solid with only 0.1% nonperforming assets and 0.23% nonperforming loans.

There was an increase in past due and nonperforming loans during the quarter. Most of the increase was comprised of residential mortgage loans acquired in the Acacia transaction. These loans have a -- I just want to point out that these loans have approximately a 15% discount to the unpaid principal balance owed as a result of the fact that we bought these loans at a substantial discount. That discount represents a $42 million credit mark that is recorded as a discount. So it's not in our loan allowance. And while this is required by personal accounting rules, it needs to be understood when looking at credit risk in the portfolio.

Loan servicing was also converted during as Stifel System during the quarter, causing some of the increase in delinquencies due to payments, address changes and resetting of automated payments. It was not unexpected when you change some servicers, that you will have an increase in -- people will miss a payment.

But the 15% discount provides a very large cushion within our credit metrics. Net, net credit quality is very strong with limited loss history and we have very strong credit metrics within the Bank.

Next slide looks at our Institutional Group. We've had, as I said, a very good quarter. Net revenues of $256 million up 19% from a year ago quarter. It's up 3% sequentially. The increase compared to last year was due to an increase in activity across the board as well as contributions from our acquisitions in KBW, Miller Buckfire and Knight. Comp and benefits of the percentage of net revenues in our Institutional Group was consistent at 61.6%. Non-comp expense ratio was 21.7% and we had pretax operating increase income of $43 million which is up 37%.

Margins for the quarter a little under 17%, 16.7% to be exact. Which is an increase over last year but down from the first quarter. Still below our stated goal of the mid to low 20s for this group.

The next slide looks at our capital structure which we view as conservatively levered. Total assets on a consolidated basis are $9.6 billion. Our total capitalization debt and equity is $2.9 billion. Our debt -- that's on a pro forma basis, the $2.9 billion but I'll come back to that. Our debt equity ratio at the end of the quarter was 18.8%.

On July 15, we issued $300 million principal amount of 4.25% senior notes due 2024. Interest on the notes accrue from July 18 and will be paid semi-annually. The notes are intended for general corporate purposes but I would like to point out that we maintain two depositions: $175 million of senior notes bearing interest at 6.7%, which is callable at par in January 2015; and $150 million senior notes bearing interest at 5.38% which is call above par in December 2015.

Looking at our capital ratios, tier 1 leverage ratio was 15.4%. Our tier 1 risk-based capital ratio remains high at 25.5%.

Looking at financial data, total stockholders equity came in at $2.2 billion. Book value per share of 33.19%. Our total leverage ratio at the end of the quarter was 3.7 times, again its lower at the broker dealer at two times and higher at Stifel Bank, which is our intention. Stifel Bank's a little over 13 times. Client assets reached $173 billion which is up 15% from last year.

Before I conclude the call and take questions, I'll give a brief update on a recently announced acquisitions. Legg Mason Investment Counsel is expected to close in the fourth quarter of the year. We are currently working through customary regulatory mutual fund conversion and count change processes.

Oriel Securities, the London-based stock brokering investment bank closed on July 31. The Oriel team will conduct business as usual through the balance of the year as the integration conversion efforts are scheduled for the first quarter of 2015. From a financial perspective, their results will contribute to Stifel in the second half of the year.

De La Rosa close April 3, 2014. Their results are part of our second quarter number. And they are fully integrated now into Stifel's Public Finance business.

Ziegler closed on November 30 last year. We've had strong asset and earnings growth since the acquisition. Assets have grown by $500 million since the end of 2013.

Acacia closed October 31 last year. As I said, Acacia furthers our goal of migrating our asset mix to a more balanced mix of securities and loans. The single branch that Acacia have is now closed. Cost-saving targets have been fully achieved. And our target of an annualized run rate of more than $10 million a year, we are on target with that.

Knight closed on July 1 last year so when I look at the full-year results, the group has within our revenue targets, actually exceeded my expectations. It was a good first year for Knight.

And finally, KBW closed on February 15 of last year. As I mentioned, the second quarter of this year was KBW's best quarter since the first quarter of 2011. And this merger continues to exceed our expectations. Client facing and major system integrations are complete at KBW.

In conclusion, we had a solid start. We've had a solid start to the year. I'm very pleased with our revenues in the first half of the year which are up 19% to a record $1.1 billion. Our business has performed well in a rising market. Albeit the declining volumes and the VIX, the volatility and the complacency in the market is challenging for our flow business.

As I look forward, the market feels strong as it relates to investment banking. Retail engagement, if I look at just July, July was strong compared to the first half of the year. I think revenues were about 9% above the monthly average, so the market feels -- the market has a tone. I'm just not sure that the market necessary -- the complacency in the market doesn't seem to square my view with some of what's going on in the tensions in the world.

It feels a little off from that perspective from me. But from our perspective, given a continuing of these market conditions, I expect it to continue to perform well and continue our strong performance for the remainder of the year. So with that, I will open up the call for questions.

(Operator Instructions)

Your first question comes from the line of Devin Ryan from JMP Securities. Your line is now open

Just with respect to money market balances. Just let me get some thoughts. Are you seeing cash moving back into the market just giving some of your comments.

And can you remind us maybe where the money market fee waivers are today? And then just more broadly, how the Bank is positioned for the potential of rates moving higher?

Look, I think the Bank -- all financial institutions I believe, or most financial institutions including ours will benefit from rising interest rates. We will benefit in the Bank from rising interest rates. For no other reason, than that we finance a lot of our assets with equity and that will help. But we are positioned and it is in our queue as to some of the what happens with increase in interest rates.

With spect, I think our money fund balances have been -- they haven't decreased they've been relatively consistent. They grow, you know as we grow the Company. And you know fee waivers, I don't remember what these were like on money funds to be honest with you. I guess we used to get them.

I almost quit talking about it, Devin. I think if I quit talking about the fact that we will get them back at some time, we may actually get them back if we quit talking about it.

Okay. Fair enough. We can go back to your last remarks when you did talk about it and make an assumption there.

I guess with respect to the loan origination, comments in the capacity -- comments that you made about the Bank kind of increasing capacity. You did have a nice step up and retained loans, a few hundred million dollars in the quarter.

Let me get any more detail around what the drivers where there and then understanding how big of an opportunity the Bank is for the Firm. Should we expect further acceleration in -- from here there is $300 million we saw this quarter. Was that, in your mind, a very good quarter or is it still moving higher based on those comments of increasing capacity?

Well look, no, I would -- definitely moving higher I mean the increases in the C&I -- we're building the capability in the Bank prudently. I would say that, however, the overall growth in the Bank was relatively muted for the quarter. And it's just a reflection of the environment. I've always said that we're not going to just add assets in the Bank to increase pretax income.

I mean that we could do but what we're not going to do it if it's going to do know significantly dilute our return on equity. We want to maintain and build our return on equity. And it's been a difficult environment with credit spreads where they are and the general interest rate environment to do that.

So we've been making loans but we've also shrunk our investment portfolio as we're not reinvesting at this point in the cycle. So again you know, Devin, if it was about pretax income and earnings per share, we could lever the bank, but I don't want to do that and significantly dilute our return on equity.

Great. Understood. And then just lastly the increase in legal expenses, it sounded like that is something that could be recurring moving forward? I just want to make sure that I heard that correctly and then any additional detail on what may be driving that would be helpful?

We had a few legal items I think hit in the quarter -- I wouldn't say that legal would increase and I didn't mean to imply that if I did. I think legal was elevated for the quarter but I wouldn't anticipate that going forward. We don't have any real significant legal items, but we did lose an arbitration case and that impacted, not significant but it did elevate for the quarter.

What I do expect, although it will come to an end at some point, is the amount of fees and professional fees that we're spending as we invest in our risk systems in the market risk rule and a lot of the requirements that you've all been reading about that is being imposed by the regulatory environment. And we've made some significant investments to be compliant with that. And I see it -- those are not permanent but they're elevated in the quarter and probably for the remainder of the year.

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

Good morning. Hey, Ron. Thanks for the commentary, Ron, about the acquisitions.

Just had a couple follow-ups on those. How should we be thinking about the revenue and pretax income contribution for LMIC and Oriel?

We haven't really disclosed -- I guess I can on this call a little bit -- the LMIC acquisition in terms of revenue is approximately $50 million in revenue and we think will be nicely profitable. And so I would tell you in the 20% margin range is what we're thinking.

As it relates to Oriel I'm not prepared at this point to talk about that because what we're doing over there. We have now, just to give you some sense of scale, we have I think we have an excess of 200 people in London primarily and in Europe. And we can see revenue from London in the $160 million to $200 million range but we're spending some time integrating. So I'll give you more color on that either the next quarter or prior to the quarter if we have some estimates on the merger costs.

But I'm very optimistic about our growth aspects. While we are going to continue to grow in the domestic US, the net result of some of the deals we've done between Knight, KBW, what we had organically at Stifel and selling our US research in Europe, now plus Oriel. Oriel is an umbrella that allows us to pull all of this together and I see some significant growth opportunities in London and in Europe and I think we can make some nice profits there. But I'll have to get back to you -- I'll update probably next quarter on the outlook for that and the revenue and contributions from London.

Okay. Great. That's definitely helpful. Maybe asking a different question then, on your Global Wealth Management business.

This quarter, some of your peers seemed to really accelerate the growth and advisor hiring and it looks like you guys only added a few advisors this quarter. And I know everybody's different obviously, but just wanted maybe to get your thoughts on how the pipeline for new advisors is looking? And then if you guys are kind benefiting from the concept of kind of retention packages rolling off for some of these guys that were put in place during the crisis era?

I think we've been very disciplined on our assumptions about recruiting packages that we will offer. And so similar to the Bank, we're not going to chase the market just for the purpose of meeting metrics.

To me, return on invested capital is a very important metric. And we want to continue to do that. And while I thought that there was sort of a pullback in the competitive nature of deals that I don't think that return on invested capital, frankly it hasn't occurred.

And so we are seeing a lot of people, I think we hired 16 that do more than $1 million and we are being selective and we're recruiting on our terms. And it's not a numbers game in terms of gross numbers it's about net income. And I think you see that in our private client results.

I expect to grow. I just think the environment is ultracompetitive right now and I would rather stay disciplined versus chase some gross targets which dilute our returns.

So I've been saying for a while it's been very competitive, but I think we're doing just fine there. We're just not going to throw caution to the wind from a recruiting perspective.

And your next question comes from the line of Steven Chubak from Nomura. Your line is now open.

So just wanted to dig into the Bank for a little bit. The net interest income growth, given the robust growth we saw in the your underlying loans, was a little bit more modest than what we had anticipated. And given the favorable mix shift, I was hoping you can clarify why after you know -- I suppose that the string of four consecutive quarters of double-digit sequential growth in NII that we did see this slowdown this quarter?

Well, wait a minute let me see if I understand your question. I mean, net interest margins expanded. Correct? I mean --

No. NII in a dollar basis.

I think it expanded.

It did. It was modest. And a robust growth rate.

Okay look, as I said on the call, this is the first quarter where we were not continuing to grow the investment portfolio and grow banks. What I was saying was that the quarter was marked by relatively limited asset growth on a consolidated basis and that the investments that matured rolled off and we increased loans.

But the market environment for the investment portfolio did not meet our return hurdles. And so we weren't growing the Bank in total assets. So what you're really seeing was a muted growth in the Bank assets.

And that's not limited by our deposit capabilities or our funding capabilities. We have plenty of funding. It's limited by what we view is the right time to be investing with respect to return on equity, which is our major metric here.

And so I think I answered that before and I'm trying to answer it now, but I just -- it's been a challenging market from an investment perspective with where credit spreads are and just where the yield curve is. It's a very, very difficult market to put money to work which would you know, meet our return hurdles.

No understood. I appreciate that detailed color, Ron.

Sure.

Switching gears just to the M&A business. You noted the growth in the Investment Banking backlog which is consistent with the broader industry trend that we're seeing. And I was hoping you could just provide some more detail and commentary in terms of which sectors are exhibiting the strongest growth? And maybe given the strength in KBW's results, what's your outlook for bank M&A more broadly?

I think bank M&A has still been marked by you know -- what we've gotten we think, excellent market share. Marked by small deals still primarily. And I would expect that to continue. I don't see that trend really changing any time -- I mean not in the next quarter or maybe for the remainder of this year.

The overall markets -- the markets hit a new high with low volatility. While not good for flow business, it does provide a good backdrop for Equity Capital Raising, And you have seen it across the board and in a number of industries but especially healthcare. And we've made some nice investments in healthcare and that's paid dividends for us.

But, technology and I would say across-the-board it's been good. When I look at our backlog absent a significant change in market dynamics, I'm optimistic about the both M&A and capital raising. Although a caution is always that that can be lumpy quarter-to-quarter.

But I think we had said that if we could do $500 million, up from whatever it was last year $450 million, that would be a good quarter. And we're certainly exceeding that pace based on the first six months of this year.

And so look I think the environment remains favorable as I sit here today.

Your next question comes from Hugh Miller for Sidoti. Your line is now open.

Good morning, Hugh.

Good morning how are you doing. I guess piggybacking of the discussion on the Equity Capital Market segment.

Was wondering if you could give us your sense of where I guess competition stands now and as we think about maybe risk on the horizon? We've seen kind of maybe a push of interest towards some competitors kind of increasing their research staff, you know through M&A. You know and trying to kind of be able to take more share of the ECM pie and the expectations for maybe a strong operating environment to continue.

But how do you view the competitive landscape now and what you think will happen in the coming year or so?

You are talking about the most recent merger announced?

Yes. We've seen a handful of them but obviously there was one that was larger in size with a focus on kind of growing the ECM business and are you seeing any increase in competition? Do you anticipate the competition could meaningfully increase or is that not the case?

Well, I never discount competition and I think what you saw, that was consolidation and the consolidation's occurring. I think it's a difficult market environment at 6 billion shares a day, average daily volume.

Which is really -- and that's not, that was sort of, in the second quarter, that was sort of masked by the fact that we had a pretty good April. But May and June was significantly below that and July hasn't really changed.

So I am encouraged that market participants have invested in the flow business as it relates to the competitive landscape. I didn't really see it change for us as much. With competition, we welcome competition let's put it that way. We're doing just fine and we're going to continue to build a best in class investment bank and I think my prior comments talk about my outlook.

Okay. And I guess aside from the Institutional Equities business, obviously you know, the research front leading to the potential to participate in underwriting activity. Do you view any changes in competitive pressure from that standpoint? I know you commented that the backlog looks strong, but pricing terms there and do you anticipate that there could be risk there on the horizon?

No. I mean again, I think it's competitive but I really don't see any major changes in the competitive or the risks to the Business. Other than I think the biggest risk to the capital raising front is just the general market environment.

There's a lot of business to do. We have a strong backlog and we continue to win our share. And I think we are gaining -- in fact I know we are gaining market share. But if you'd asked me what I would be most worried about, it would be the general market conditions.

And you gave us some color on the NIM expansion. Some of that just being a function of the earning asset mix shift towards loans from securities. But you commented as well about seeing C&I production improving and I suspect that that's a higher yielding asset relative to the overall loan portfolio which has some residential lending exposure. Can you just give us a sense of how we should be thinking about the yields on those C&I loans relative to the overall loan portfolio yield?

They are generally higher, right? And we had an increase in -- we focus on spot loans.

The yield on the Acacia loans, considering where we bought it, alright? And the way we are accreting that, that's also very favorable. You can't -- I'm certainly not going to discount the increase in residential, the yield on residential.

But you know the net-net of the loan portfolio including C&I is a significantly higher net interest margin than investments and we just want to make sure that were being compensated for credit. It's net interest margin minus credit. And I've been encouraged by our steady progress in that area.

But I've as I've always said, it just goes to our under philosophy. If it was just about increasing pretax income and driving some accretion through increased earnings we could do that tomorrow. And by just sweeping in deposits and investing them at sub-10% return on investments, we're just not interested in doing that.

We want to build our return on equity and build our core franchise and do it by lending to a natural clients whether they be individuals or institutions of this Company. Not do wholesale asset generation to drive pretax income at sub return on equity thresholds.

Okay. Appreciate the thoughts there.

And you had mentioned just a metric about the retail engagement being 9% above the average. Was wondering if you could just -- I didn't catch exactly what it was pertaining to -- and the comparison period? Was a for the second quarter or --?

I probably should -- July on average was for the month, although it's generally a longer month so I should be a little cautious about that but the engagement was stronger. It sort of fell off and you see we had flattish results.

So I saw that trend, the slowing down reverse itself somewhat in July. Maybe I should say it that way. Because I didn't necessarily quote that number on a same day basis.

Right. Okay. So I guess it's for the month and not an average daily basis but is that commission?

It is still stronger. The overall revenue.

And that's a combination of asset-based fees which get booked based on June values versus March. So they are going to be up naturally as you look forward to this quarter. But activity was also was better.

Okay, so that's just for the retail segment engagement overall revenue?

Right.

And that's relative to what would be considered the first half of the year or the second quarter?

First half of the year.

Okay. Appreciated. Thank you so much.

And your next question comes from Alex Ballston from Goldman Sachs.

Quick question for you guys on expenses. I just wanted to dissect the trends we are seeing there. When we look at compensation for the first six months of the year it's up roughly in line with overall revenues.

But when I look at the revenue mix, it seems like it should have been a little bit more of a positive operating leverage. Meaning your NII is significantly higher. Investment Banking is significantly higher. So where are the incremental expense dollars going because I would have thought we would see better operating leverage on the comp line.

Yes, I think look historically, I think that compensation is an estimate. We pay a substantial amount through the Firm. We pay a substantial amount of our compensation and incentive-based compensation at the end of the year and we tend to, historically, book compensation, I believe, on the conservative side of those estimates.

And if you look historically, you'll see that as we get around to actually paying and set-up but you know, we want to make sure that we're probably accrued. And that's the way I'd answer your question. It's a big chunk of our compensation is incentive-based. And we actually finalize those numbers in February of next year.

Right. I guess what I was trying to get to when I think about the expenses associated with growing things like NII, it feels like they should come with a high-margin. So I guess what you're saying it's all kind of will flush itself out in the fourth quarter?

That's what I think I said, right? I agree.

On the non-comp side, can you just go through one more time which part of regulatory compliance procedures you guys our investing in? How long do you think that's going to be a drag on non-comp expenses and kind of overall how much incremental do you need to spend there?

I don't really have Alex, that. In the quarter and in a comparative basis, I mean I think what I saw was we've taken -- I've been saying that there's a number of merger-type things, occupancy being one. You'll see leverage, operating leverage and occupancy and we've been looking at communications. And we have been looking at our execution costs and a number of things.

We've realized some of the things that I was talking about. But it was offset primarily by -- and that's why I said -- the professional fees that we're spending to be compliant. The market risk rule which, we are subject to is a significant investment in putting in those.

Bolstering our Enterprise Risk Management systems is investments that we are making that we've been spending some time with consultants that I view as short-term. Albeit not short-term meaning it ends next week but probably through the end of the year. And you know again, net-net between that and the legal, my estimate would be it's about 1% of those operating expenses that I would say is elevated that we think at these revenue levels fallaway.

That's helpful. And then just one last one. To clarify comments around net interest income.

Did you guys say some there is some discount accretion that's still being recognized through NII? And if so, I guess how much per quarter? And when is that expected to runoff?

Well look it goes on for years. I mean it's not -- you'll see I think I said the numbers so I'll say it again. I think it's some, we bought a very attractive in our view, financial transaction in Acacia and have $40-plus million of discount that is a combination of accretion and credit.

And that's just -- it was an attractive financial transaction. That sort of -- I don't want to say its all accretion because what I was really to try to point to was the fact that that provides credit cushion that you don't see in our allowance. A lot of banks talk about this when they do purchase accounting. You have to do fair value accounting and you record loans at a discount. Not gross less than allowance.

So we have very conservative marks and we've got that residential mortgage yield is over 5% is what I'll tell you. And that's going to continue until it rolls off which is years. So it's not a short-term phenomenon. I was more Alex, talking about the fact that I think that not only does that enhance our yield in the loan portfolio it has -- it is very adequately accounted for if you will, on a credit perspective.

Got it. All right. Thanks for the color.

And your final question comes from Douglas Sipkin from Susquehanna. Your line is now open.

So you guys put up a presentation I think last quarter talking about sort of how you are over-capitalized and it was an opportunity to grow assets or shrink equity effectively given your low sort of straight leverage assets to equity, what have you. It sounds like you guys are maybe a little bit more guarded about ramping up assets given the tough conditions or harder market in the loan market.

So I guess the flip side of that is, you know, any thoughts incremental more of your decision to lean more towards shrinking equity? I'm just curious because I thought that was an interesting slide that you guys put up last quarter.

Hey Doug look, I would say the commentary is the same. I would say we think a lot about the fact that our return on equity is hampered by our over-capitalization. As I said then, we are not going to rush to just grow assets because we want to grow return on equity. And so we're going to be balanced about that.

All that said, there is a numerator and there is a denominator component to dealing with this. And we're considering everything appropriately and as market conditions dictate. And I'm not ignoring it, I didn't forget about it. I got a lot of comments about that slide, I will admit, but the objectives remain the same. And that is to properly capitalize and provide proper shareholder returns whether that be by growing assets or returning capital.

Great. That's helpful. And maybe just to add onto that and I doubt I get an answer, but I figured I try.

I mean embedded in that, obviously you are weighing the growth of the assets versus equity. Do you guys have a framework where buying equity comes a little bit more attractive?

I mean do you actually have hard numbers, valuation metrics that you guys look at where you would say, okay, if the stock comes in to book value by X or trades at a multiple to book value of some multiple, then all of a sudden the equation shifts more to shrinking equity? Or is it still more strategic oriented completely versus movements in the stock?

Well I can answer that question, Doug. The answer is of course we do.

And I can tell you that there are points where the lines cross versus dealing with the denominator versus the numerator growing assets versus doing that. But to save your next question, I'm not going to tell you where that is. But of course I do. Don't ask me where.

There are no further questions. I will now turn the call back over to Mr. Kruszewski for closing remarks.

Well, thank you everyone. Thanks for your time and your interest in the Company. As I've said, I'm very pleased with our growth.

We have challenges, but we are continuing to build a best in class Investment Banking and Wealth Management Firm. I think this last quarter underscores our progress in that.

I'm pleased with the both our integration of our most of our deals or mergers of the last year. And I'm excited about Oriel which just closed and the addition of Legg Mason Investment Management to our fold. And I'm optimistic about our ability to continue to create shareholder value for you, our shareholders.

So I look forward to reporting continued progress next quarter. Thank you. And have a great day.

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