Why an investment bank deal matters

Stifel Financial agreed to buy investment bank KBW, which specialize in advising on financial services mergers, for $575 million in cash and stock. Stifel decided to take the KBW name, indicating it’s a valuable brand.

Here are a few excerpts from the New York Times story:

The combination, announced on Monday, signals what many think could be the beginning of a period of consolidation in the financial services industry. While banks and brokerage firms have recovered since the economic crisis, a number of factors — increased regulatory burdens, pressure on commissions, and persistently low interest rates — have combined to crimp profitability.

Stifel’s acquisition deal echoes the very advice that KBW has been giving its clients — that now is the time to invest in financial services companies. Banks have seen signs of stabilization, including credit trends improving across their loan portfolios. Year-to-date, banks and insurers are outperforming the broader stock market for the first time since 2006.

“You’ve told me a number of times that now is the time to invest in financial services,” Ronald Kruszewski, the chief executive of Stifel, said to KBW’s chief, Thomas B. Michaud, during a call announcing the transaction. Mr. Kruszewski then joked: “It’s probably a little late for me to change my mind.”

 The acquisition of KBW, which is based in New York, extends Stifel’s aggressive expansion strategy executed over the last five years. Stifel, based in St. Louis, bought the technology-focused investment bank Thomas Weisel Partners in 2010 and last year made a large investment in Miller Buckfire, a New York firm specializing in restructuring.

Other companies that it has picked up include the fixed income specialists Stone & Youngberg and the New Jersey brokerage firm Ryan Beck & Company.

It’s interesting to note that in a time where many banks are retrenching, looking at different strategies and in general trying to figure out how to make money or reduce staff, Stifel is expanding. The firm is moving into different businesses and areas of risk. Contrast that with firms like UBS that are announcing cutbacks or others that just simply aren’t doing business.

Here’s an interesting fact from the Wall Street Journal:

Small shops such as KBW, with 448 employees, now compete with giants such as Goldman Sachs Group Inc. and Morgan Stanley amid a dearth of deal making. U.S. commercial-bank mergers are on track for their lowest annual total in at least two decades.

KBW, which last year announced a plan to reduce staff by 15%, has posted $36 million in losses since the start of 2011 amid a series of restructuring charges.

Bank investors have been expecting a wave of consolidation since the crisis, but they have been largely frustrated by the slow U.S. economy and low interest rates, which crimp industry profits by compressing the spread banks earn borrowing and lending.

And this from Barron’s is also noteworthy about the transaction:

Stifel derives more than half of its net revenue from its global wealth management group, which earns commission catering to the investment needs of high-net-worth individuals.

The firm has a small commercial bank, which currently accounts for a minimal portion of revenue. Meanwhile, investment-banking activities such as fixed-income underwriting, institutional trading and financial advisory generate the other 40% of Stifel’s business.

On Monday, KBW reported that its third-quarter loss narrowed as total revenue rose, amid a 34% increase in its principal transactions revenue.

Roughly $250 million in excess capital on KBW’s balance sheet is expected to be immediately available to Stifel upon closing. Plus, the deal is expected to increase return on equity by 10% to 16% and would be 5% to 7% accretive to earnings after expected cost savings were achieved.

So Stifel gets a name, top-notch specialized investment bankers and $250 million in capital to put to work. KBW gets to stick around in name and the diversified earnings from both firms should help the business be less cyclical.

As the average person, this seems like an inside-finance type story, but it does matter. Mid-market investment banks make loans to companies that might be too small for the bigger guys. They also tend to be located outside New York, providing diversification in a consolidated industry.

Bankers for bankers might seem redundant, but KBW has built a solid firm that needed cash, something Stifel seems more than ready to provide these days.