XNYS:KBW Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

Table of Contents

 

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x                QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2012

 

OR

 

o                   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: 001-33138

 

KBW, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

 (State or Other Jurisdiction of Incorporation or Organization)

 

13-4055775

 (I.R.S. Employer Identification No.)

 

787 Seventh Avenue, New York, New York 10019

 (Address of principal executive offices)

 

Registrant’s telephone number: (212) 887-7777

 

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 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  o

 

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x   No  o

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a 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  o   No x

 

The number of shares of the Registrant’s common stock, par value $0.01 per share, outstanding as of July 31, 2012 was 34,643,902, which number includes 4,483,513 shares representing unvested restricted stock awards and excludes 255,936 shares underlying vested restricted stock units.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

Available Information

1

 

 

PART I-FINANCIAL INFORMATION

2

 

 

Item 1. Financial Statements

2

 

 

Consolidated Statements of Financial Condition-June 30, 2012 (unaudited) and December 31, 2011

2

 

 

Consolidated Statements of Operations-Three and Six Months ended June 30, 2012 and 2011 (unaudited)

3

 

 

Consolidated Statements of Comprehensive Income-Three and Six Months ended June 30, 2012 and 2011 (unaudited)

4

 

 

Consolidated Statement of Changes in Stockholders’ Equity-Six Months ended June 30, 2012 (unaudited)

5

 

 

Consolidated Statements of Cash Flows-Six Months ended June 30, 2012 and 2011 (unaudited)

6

 

 

Notes to Consolidated Financial Statements (unaudited)

7

 

 

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

23

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

36

 

 

Item 4. Controls and Procedures

37

 

 

PART II-OTHER INFORMATION

38

 

 

Item 1. Legal Proceedings

38

 

 

Item 1A. Risk Factors

38

 

 

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

38

 

 

Item 3. Defaults Upon Senior Securities

38

 

 

Item 4. Mine Safety Disclosures

38

 

 

Item 5. Other Information

38

 

 

Item 6. Exhibits

39

 

 

SIGNATURES

40

 

 

EXHIBIT INDEX

41

 

EX-31.1:  CERTIFICATION

 

EX-31.2:  CERTIFICATION

 

EX-32.1:  CERTIFICATION

 

EX-32.2:  CERTIFICATION

 

EX-101:   INTERACTIVE DATA

 



Table of Contents

 

Available Information

 

We are required to file current, annual and quarterly reports, proxy statements and other information required by the Securities Exchange Act of 1934, as amended (the “Exchange Act”), with the Securities and Exchange Commission (the “SEC”).  You may read and copy any document we file with the SEC at the SEC’s Public Reference Room located at 100 F Street, N.E., Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an internet website at http://www.sec.gov, from which interested persons can electronically access our SEC filings.

 

We will make available, free of charge through our internet site http://www.kbw.com, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements, Forms 3, 4 and 5 filed by or on behalf of directors, executive officers and certain large stockholders, and any amendments to those documents filed or furnished pursuant to the Exchange Act.  These filings will become available as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC.

 

We also make available, on the Investor Relations page of our website, our (i) Corporate Governance Guidelines, (ii) code of Business Conduct and Ethics, (iii) Supplement to Code of Business Conduct and Ethics for CEO and Senior Financial Officers and (iv) the charters of the Audit, Compensation, and Corporate Governance and Nominations Committees of our Board of Directors.  You will need to have Adobe Reader software installed on your computer to view these documents, which are in the PDF format.  These documents will also be available in print without charge to any person who requests them by writing or telephoning:  KBW, Inc., Office of the General Counsel, 787 Seventh Avenue, New York, New York, 10019, U.S.A., telephone number (212) 887-7777.  These documents, as well as the information on our website, are not a part of this report.

 

1



Table of Contents

 

PART I—FINANCIAL INFORMATION

 

Item 1.  Financial Statements.

 

KBW, INC. and SUBSIDIARIES

Consolidated Statements of Financial Condition

(Dollars in thousands)

 

 

 

June 30, 2012
(unaudited)

 

December 31, 2011

 

ASSETS

 

 

 

 

 

Cash and cash equivalents

 

$

143,423

 

$

136,582

 

Financial instruments owned, at fair value:

 

 

 

 

 

Equities

 

103,099

 

81,068

 

Corporate and other debt

 

33,277

 

28,985

 

Mortgage-backed securities

 

15,619

 

25,690

 

Other investments

 

40,791

 

58,758

 

Total financial instruments owned, at fair value:

 

192,786

 

194,501

 

Receivables from clearing brokers

 

58,042

 

95,383

 

Accounts receivable

 

10,970

 

8,368

 

Income taxes receivable

 

15,315

 

19,293

 

Fixed assets, at cost, less accumulated depreciation and amortization of $38,512 in 2012 and $36,016 in 2011

 

13,046

 

14,952

 

Other assets

 

53,676

 

50,020

 

Total assets

 

$

487,258

 

$

519,099

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Liabilities:

 

 

 

 

 

Financial instruments sold, not yet purchased, at fair value:

 

 

 

 

 

Equities

 

$

42,524

 

$

51,453

 

Corporate debt

 

4,286

 

7,909

 

U.S. Government and agency securities

 

12,151

 

5,234

 

Total financial instruments sold, not yet purchased, at fair value:

 

58,961

 

64,596

 

Accrued compensation and benefits

 

15,419

 

36,097

 

Income taxes payable

 

10,035

 

9,539

 

Accounts payable, accrued expenses and other liabilities

 

22,462

 

25,714

 

Total liabilities

 

106,877

 

135,946

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock

 

 

 

Common stock

 

302

 

289

 

Paid-in capital

 

153,208

 

147,888

 

Retained earnings

 

238,516

 

246,939

 

Accumulated other comprehensive loss

 

(11,645

)

(11,963

)

Total stockholders’ equity

 

380,381

 

383,153

 

Total liabilities and stockholders’ equity

 

$

487,258

 

$

519,099

 

 

See accompanying notes to consolidated financial statements.

 

2



Table of Contents

 

KBW, INC. and SUBSIDIARIES

Consolidated Statements of Operations

(unaudited)

(Dollars in thousands, except per share information)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Revenues:

 

 

 

 

 

 

 

 

 

Investment banking

 

$

25,275

 

$

15,204

 

$

52,304

 

$

52,852

 

Commissions

 

24,645

 

32,190

 

53,864

 

66,619

 

Principal transactions, net

 

3,480

 

11,952

 

13,986

 

29,292

 

Interest and dividend income

 

1,721

 

3,151

 

3,506

 

6,355

 

Other

 

307

 

1,535

 

1,009

 

4,097

 

Total revenues

 

55,428

 

64,032

 

124,669

 

159,215

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Compensation and benefits

 

40,639

 

38,895

 

83,568

 

95,529

 

Occupancy and equipment

 

4,806

 

5,629

 

9,506

 

11,288

 

Communications and data processing

 

7,318

 

9,088

 

15,054

 

17,783

 

Brokerage and clearance

 

2,390

 

4,580

 

5,752

 

9,496

 

Business development

 

3,309

 

4,637

 

6,500

 

9,261

 

Professional services

 

2,184

 

4,636

 

4,026

 

8,338

 

Interest

 

197

 

356

 

389

 

665

 

Restructuring charges

 

1,200

 

 

3,444

 

 

Other

 

2,102

 

3,093

 

4,445

 

5,945

 

Total expenses

 

64,145

 

70,914

 

132,684

 

158,305

 

(Loss) / income before income taxes

 

(8,717

)

(6,882

)

(8,015

)

910

 

Income tax (benefit) / expense

 

(3,294

)

(2,634

)

(3,058

)

517

 

Net (loss) / income

 

$

(5,423

)

$

(4,248

)

$

(4,957

)

$

393

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share:

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.19

)

$

(0.14

)

$

(0.18

)

$

0.00

 

Diluted

 

$

(0.19

)

$

(0.14

)

$

(0.18

)

$

0.00

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

$

0.05

 

$

0.05

 

$

0.10

 

$

0.10

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of common shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

30,389,057

 

32,579,146

 

30,300,362

 

32,849,263

 

Diluted

 

30,389,057

 

32,579,146

 

30,300,362

 

32,849,263

 

 

See accompanying notes to consolidated financial statements.

 

3



Table of Contents

 

KBW, INC. and SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(unaudited)

(Dollars in thousands)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Net (loss) / income

 

$

(5,423

)

$

(4,248

)

$

(4,957

)

$

393

 

Other comprehensive (loss) /income:

 

 

 

 

 

 

 

 

 

Currency translation adjustments

 

(661

)

51

 

318

 

939

 

Total other comprehensive (loss) / income

 

(661

)

51

 

318

 

939

 

Comprehensive (loss) / income

 

$

(6,084

)

$

(4,197

)

$

(4,639

)

$

1,332

 

 

See accompanying notes to consolidated financial statements.

 

4



Table of Contents

 

KBW, INC. and SUBSIDIARIES

Consolidated Statement of Changes in Stockholders’ Equity

Six Months Ended June 30, 2012

(unaudited)

(Dollars in thousands, except per share information)

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

Total

 

 

 

Preferred

 

Common

 

Paid-in

 

Retained

 

Comprehensive

 

Stockholders’

 

 

 

Stock

 

Stock

 

Capital

 

Earnings

 

(Loss) / Income

 

Equity

 

Balance at December 31, 2011

 

$

 

$

289

 

$

147,888

 

$

246,939

 

$

(11,963

)

$

383,153

 

Net loss

 

 

 

 

(4,957

)

 

(4,957

)

Other comprehensive income, currency translation adjustment

 

 

 

 

 

318

 

318

 

Dividends on common stock

 

 

 

 

(3,466

)

 

(3,466

)

Amortization of stock-based compensation

 

 

 

20,979

 

 

 

20,979

 

Cancellation of 836,298 shares of restricted stock in satisfaction of withholding tax requirements

 

 

(8

)

(14,755

)

 

 

(14,763

)

Issuance of 2,121,077 shares of common stock

 

 

21

 

39,868

 

 

 

39,889

 

Restricted stock units converted

 

 

 

(3,506

)

 

 

(3,506

)

Stock-based awards vested

 

 

 

(36,326

)

 

 

(36,326

)

Net tax shortfall related to stock-based awards

 

 

 

(940

)

 

 

(940

)

Balance at June 30, 2012

 

$

 

$

302

 

$

153,208

 

$

238,516

 

$

(11,645

)

$

380,381

 

 

Description of preferred stock and details:

 

 

 

 

 

Number of Shares

 

 

 

Par Value

 

Authorized

 

Issued

 

Outstanding

 

June 30, 2012

 

$

0.01

 

10,000,000

 

 

 

December 31, 2011

 

$

0.01

 

10,000,000

 

 

 

 

Description of common stock and details:

 

 

 

 

 

Number of Shares

 

 

 

Par Value

 

Authorized

 

Issued*

 

Outstanding*

 

June 30, 2012

 

$

0.01

 

140,000,000

 

30,160,389

 

30,160,389

 

December 31, 2011

 

$

0.01

 

140,000,000

 

28,875,610

 

28,875,610

 

 


(*) These share amounts exclude vested restricted stock units.

 

See accompanying notes to consolidated financial statements.

 

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Table of Contents

 

KBW, INC. and SUBSIDIARIES

Consolidated Statements of Cash Flows

(unaudited)

(Dollars in thousands)

 

 

 

Six Months Ended
June 30,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net (loss) / income

 

$

(4,957

)

$

393

 

Adjustments to reconcile net (loss) / income to net cash provided by operating activities:

 

 

 

 

 

Amortization of stock-based compensation

 

20,979

 

29,475

 

Depreciation and amortization

 

2,418

 

2,801

 

Deferred income tax expense

 

5,659

 

1,396

 

(Increase) decrease in operating assets:

 

 

 

 

 

Financial instruments owned, at fair value

 

1,714

 

(41,905

)

Receivables from clearing brokers

 

37,472

 

60,351

 

Accounts receivable

 

(2,575

)

12,570

 

Income taxes receivable

 

3,987

 

(325

)

Other assets

 

(9,281

)

(6,325

)

Increase (decrease) in operating liabilities:

 

 

 

 

 

Financial instruments sold, not yet purchased, at fair value

 

(5,635

)

58,711

 

Accrued compensation and benefits

 

(20,709

)

(105,893

)

Income taxes payable

 

529

 

(1,547

)

Accounts payable, accrued expenses and other liabilities

 

(3,297

)

(1,473

)

Net cash provided by operating activities

 

26,304

 

8,229

 

Cash flows from investing activities:

 

 

 

 

 

Purchase of furniture, equipment and leasehold improvements

 

(518

)

(2,177

)

Net cash used in investing activities

 

(518

)

(2,177

)

Cash flows from financing activities:

 

 

 

 

 

Cash dividends paid

 

(3,466

)

(3,676

)

Issuance of shares of common stock

 

57

 

102

 

Cancellation of restricted stock in satisfaction of withholding tax requirements

 

(14,763

)

(18,106

)

Cancellation of shares of common stock related to the stock repurchase program

 

 

(36,797

)

(Shortfall) excess net tax benefit related to stock-based awards

 

(940

)

3,506

 

Repayment of notes receivable from stockholders

 

 

100

 

Net cash used in financing activities

 

(19,112

)

(54,871

)

Currency adjustment:

 

 

 

 

 

Effect of exchange rate changes on cash

 

167

 

781

 

Net increase / (decrease) in cash and cash equivalents

 

6,841

 

(48,038

)

Cash and cash equivalents at the beginning of the period

 

136,582

 

162,272

 

Cash and cash equivalents at the end of the period

 

$

143,423

 

$

114,234

 

 

 

 

 

 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Income taxes

 

$

51

 

$

1,959

 

Interest

 

$

549

 

$

712

 

 

See accompanying notes to consolidated financial statements.

 

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Table of Contents

 

KBW, INC. and SUBSIDIARIES

Notes to Consolidated Financial Statements

(unaudited)

(Dollars in thousands, except per share information)

 

(1)                                 Organization and Basis of Presentation

 

The consolidated financial statements include the accounts of KBW, Inc., and its wholly owned subsidiaries (the “Company”), Keefe, Bruyette & Woods, Inc. (“Keefe”), Keefe, Bruyette & Woods Limited (“KBWL”), Keefe, Bruyette & Woods Asia Limited (“KBW Asia”), KBW Asset Management, Inc. and KBW Ventures, Inc. Keefe is a regulatory member of the Financial Industry Regulatory Authority (“FINRA”) and is principally a broker-dealer in securities and a market-maker in certain financial services stocks and bonds in the United States.  KBWL is authorized and regulated by the U.K. Financial Services Authority (“FSA”) and a member of the London Stock Exchange.  KBW Asia is a securities firm licensed and regulated by the Securities and Futures Commission in Hong Kong.  Keefe’s, KBWL’s and KBW Asia’s customers are predominantly institutional investors including other brokers and dealers, commercial banks, asset managers and other financial institutions. Keefe has a clearing arrangement with Pershing LLC on a fully disclosed basis.  KBWL has a clearing arrangement with Pershing Securities Limited on a fully disclosed basis and is responsible for clearance and settlement for both KBWL and KBW Asia.

 

(2)                                 Summary of Significant Accounting Policies

 

(a)               Principles of Consolidation

 

The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and include the accounts of the Company and its consolidated subsidiaries.  All intercompany transactions and balances have been eliminated.

 

The Company consolidates entities for which it has a controlling financial interest as defined in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, Consolidation.  The usual condition for a controlling financial interest is ownership of a majority voting interest.  As a result, the Company generally consolidates entities when they have ownership, directly or indirectly, of over 50 percent of the outstanding voting shares of another entity.  Since a controlling financial interest may be achieved through arrangements that do not involve voting interest, the Company also evaluates entities for consolidation under the “variable interest model” in accordance with ASC 810.  The Company consolidates variable interest entities when it has determined to hold the power that most significantly impacts the entity’s economic performance or a right to absorb a majority of the entity’s expected losses, or expected residual returns, or both.  The Company had no variable interest entities that required consolidation at June 30, 2012 and December 31, 2011.

 

In addition, the Company evaluates its investments in limited partnerships under ASC 810.  Under ASC 810, the general partners in limited partnerships are presumed to have control unless the limited partners have either a substantial ability to dissolve the limited partnership or otherwise can remove the general partner without cause or have substantial participating rights.  There were no limited partnership interests that required consolidation at June 30, 2012 and December 31, 2011.

 

(b)               Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the Company’s financial statements and footnotes including securities valuations, compensation accruals and other matters.  Management believes that the estimates used in preparing the Company’s consolidated financial statements are reasonable.  Actual results may differ from these estimates.

 

(c)                Cash and Cash Equivalents

 

Cash equivalents include investments with an original maturity of three months or less.  Due to the short-term nature of these instruments, carrying value approximates their fair value.

 

(d)               Fair Value of Financial Instruments

 

The Company accounts for financial instruments that are being measured and reported on a fair value basis in accordance with ASC 820, Fair Value Measurements and Disclosures.  ASC 820 defines fair value, establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements.  ASC 820 defines fair value as “the price that would be

 

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Table of Contents

 

KBW, INC. and SUBSIDIARIES

Notes to Consolidated Financial Statements—(Continued)

(unaudited)

(Dollars in thousands, except per share information)

 

received to sell an asset or paid to transfer a liability in an ordinary transaction between current market participants at the measurement date.”

 

Fair value is generally based on quoted market prices.  If quoted market prices are not available, fair value is determined based on other relevant factors, including dealer price quotations, price activity for equivalent instruments and valuation pricing methods.  Among the factors considered by the Company in determining the fair value of financial instruments for which there are no current quoted market prices are credit spreads, the terms and liquidity of the instrument, the financial condition, operating results and credit ratings of the issuer or underlying company, the quoted market price of publicly traded securities with similar duration and yield, assessing the underlying investments, market-based information, such as comparable company transactions, performance multiples and changes in market outlook as well as other measurements.  Financial instruments owned and financial instruments sold, not yet purchased are stated at fair value, with related changes in unrealized appreciation or depreciation reflected in principal transactions, net in the accompanying consolidated statements of operations.  Financial assets and financial liabilities carried at contract amounts may include receivables from clearing brokers, securities purchased under resale agreements, short-term borrowings and securities sold under repurchase agreements.  See Note 3 of the Notes to Consolidated Financial Statements for additional discussion of ASC 820.

 

ASC 825, Financial Instruments, provides entities the option to measure certain financial assets and financial liabilities at fair value with changes in fair value recognized in earnings each period.  ASC 825 permits the fair value option election, on an instrument-by-instrument basis, either at initial recognition of an asset or liability or upon an event that gives rise to a new basis of accounting for that instrument.  Such election must be applied to the entire instrument and not only a portion of the instrument.  The Company applied the fair value option for certain eligible instruments, including all private equity securities and limited partnership interests, as these financial instruments had been managed on a fair value basis by the Company prior to the fair value option electionGenerally, the fair values of these financial instruments have been determined based on company performance and, in those instances where market values are readily ascertainable, by reference to recent significant events occurring in the marketplace or quoted market prices.  ASC 820 permits, as a practical expedient, the use of the net asset value per share, or its equivalent, of an entity to estimate its fair value.  The Company’s partnership interests are recorded at fair value, determined by using net asset values or capital statements provided by the general partner, updated for capital contributions and distributions, and changes in market conditions up to the reporting date.

 

(e)                Receivables From and Payable to Clearing Brokers

 

Receivables from and payable to clearing brokers include the net proceeds from securities sold, including financial instruments sold not yet purchased, commissions related to securities transactions, margin loans and related interest and deposits with clearing brokers.  Proceeds related to financial instruments sold, not yet purchased may be restricted until the securities are purchased.  Balances are presented net when the right of set-off exists.

 

(f)                  Fixed Assets

 

Furniture and other equipment, computer equipment and software are carried at cost and depreciated on a straight-line basis using estimated useful lives of the related assets, generally two to five years.  Leasehold improvements are amortized on a straight-line basis over the lesser of the economic useful life of the improvement or the term of the respective leases.

 

(g)               Revenue Recognition

 

Investment Banking

 

The Company earns fees for providing strategic advisory services in mergers and acquisitions (“M&A”) and other transactions which are predominantly composed of fees based on a successful completion of a transaction, and from capital markets, which is comprised of underwriting securities’ offerings and arranging private placements.

 

Strategic advisory revenues are recorded when earned, the fees are determinable and collection is reasonably assured.  Non-refundable upfront fees are generally deferred and recognized as revenue ratably over the expected period in which the related services are rendered.  Upon successful completion of a transaction or termination of an engagement, the recognition of revenue would be accelerated.

 

8



Table of Contents

 

KBW, INC. and SUBSIDIARIES

Notes to Consolidated Financial Statements—(Continued)

(unaudited)

(Dollars in thousands, except per share information)

 

Capital markets revenue consists of:

 

·        Underwriting revenues, which are recognized on trade date, net of related syndicate expenses, at the time the underwriting is completed. In syndicated underwritten transactions, management estimates the Company’s share of transaction-related expenses incurred by the syndicate, and the Company recognizes revenue net of such expense.  On final settlement, the Company adjusts these amounts to reflect the actual transaction-related expenses and resulting underwriting fee.

 

·        Private placement revenues, net of related expenses, which are recorded when the services related to the underlying transaction are completed under the terms of the engagement.  This is generally the closing date of the transaction.

 

Since the Company’s investment banking revenues are generally recognized at the time of completion of each transaction or when the services are performed, these revenues typically vary between periods and may be considerably affected by the timing of the closing of significant transactions.

 

Commissions

 

The Company’s sales and trading business generates revenue from equity securities’ trading commissions paid by institutional investor customers.  Commissions are recognized on a trade date basis.

 

Principal transactions

 

Financial instruments owned, at fair value and financial instruments sold, not yet purchased, at fair value are recorded on a trade-date basis with realized and unrealized gains and losses reflected in principal transactions, net in the consolidated statements of operations.

 

Interest and dividend income

 

The Company recognizes contractual interest on financial instruments owned at fair value on an accrual basis as a component of interest and dividend income.  Dividend income is recognized on the ex-dividend date.

 

(h)               Stock-Based Compensation

 

Stock-based compensation is measured at fair value on the date of grant and amortized to compensation expense over the requisite service period, net of estimated forfeitures.  Compensation expense for awards with performance conditions is recognized over the requisite service period based on the probable outcome of the performance condition at each reporting date.  At the end of the performance period, the total compensation cost recognized will be the grant-date fair value of all units that actually vest based on the outcome of the performance conditions.  Stock-based awards that do not require future service (i.e. vested awards and certain awards granted to retirement eligible employees) are expensed immediately on the date of grant.  Withholding tax obligations may be satisfied by the repurchase of shares by the Company.  Such shares are cancelled upon repurchase.

 

(i)                  Income Taxes

 

Deferred tax assets and liabilities are recognized for the future tax effect of differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in earnings in the period that includes the enactment date.  In the event it is more likely than not that a deferred tax asset will not be realized, a valuation allowance is recorded.

 

The Company applies ASC 740, Income Taxes, which prescribes a single, comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on its tax returns.  Income tax expense is based on pre-tax accounting income, including adjustments made for the recognition or derecognition related to uncertain tax positions.

 

9



Table of Contents

 

KBW, INC. and SUBSIDIARIES

Notes to Consolidated Financial Statements—(Continued)

(unaudited)

(Dollars in thousands, except per share information)

 

(j)                  Earnings Per Common Share (“EPS”)

 

Basic EPS is computed by dividing net income applicable to common shareholders, which represents net income reduced by the allocation of earnings to participating securities, by the weighted average number of common shares.  Losses are not allocated to participating securities.  The weighted average number of common shares outstanding includes restricted stock units for which no future service is required as a condition to the delivery of the underlying common stock.  Diluted EPS includes the determinants of basic EPS and, in addition, gives effect to potentially dilutive common shares related to Company stock compensation plans.

 

ASC 260, Earnings Per Share, 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 calculating EPS under the two-class method. Accordingly, the Company treats unvested share-based payment awards that have non-forfeitable rights to dividend or dividend equivalents as a separate class of securities in calculating EPS.

 

The Company has granted performance equity awards (“Performance Awards”) that vest and convert to shares of common stock only if the Company achieves predetermined performance goals.  Since the issuance of the shares is contingent upon the satisfaction of certain conditions, the Performance Awards are included in diluted EPS based on the number of shares (if any) that would be issuable if the end of the reporting period were the end of the contingency period.

 

(k)               Foreign Currency Translation

 

The Company translates the statements of financial condition of the Company’s foreign subsidiaries at the exchange rates in effect as of the end of each reporting period.  The consolidated statements of operations are translated at the average rates of exchange during the period.  The resulting translation adjustments of the Company’s foreign subsidiaries are recorded directly to other comprehensive income (loss) in the consolidated statements of comprehensive income.  Gains or losses resulting from foreign currency transactions are included in net income.

 

(3)                                 Financial Instruments

 

The Company accounts for financial instruments that are being measured and reported on a fair value basis in accordance with ASC 820.  This includes those items currently reported in financial instruments owned, at fair value and financial instruments sold, not yet purchased, at fair value on the consolidated statements of financial condition.

 

As defined in ASC 820, fair value is 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.  In determining fair value, the Company uses various methods, primarily market and income approaches.  Based on these approaches, the Company utilizes assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation technique.  These inputs can be readily observable, market corroborated, or generally unobservable firm inputs.  The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the valuation techniques, the Company is required to provide the information set forth below according to the fair value hierarchy.  The fair value hierarchy ranks the quality and reliability of the information used to determine fair values.  Financial instrument assets and liabilities carried at fair value have been classified and disclosed in one of the following three categories:

 

Level 1

Quoted market prices in active markets for identical assets or liabilities.

Level 2

Observable market based inputs or unobservable inputs that are corroborated by market data.

Level 3

Unobservable inputs that are not corroborated by market data.

 

Level 1 primarily consists of listed financial instruments whose value is based on quoted market prices, such as listed equities, equity options and warrants, and preferred stock.  This category also includes U.S. Government securities for which the Company typically receives independent external valuation information.  There were no transfers in or out of Level 1 during the three and six months ended June 30, 2012.

 

Level 2 includes those financial instruments that are valued using multiple valuation techniques, primarily the market and income approaches.  The valuation methodologies utilized are calibrated to observable market inputs.  The Company considers

 

10



Table of Contents

 

KBW, INC. and SUBSIDIARIES

Notes to Consolidated Financial Statements—(Continued)

(unaudited)

(Dollars in thousands, except per share information)

 

recently executed transactions, market price quotations and various assumptions, including credit spreads, the terms and liquidity of the instrument, the financial condition, operating results and credit ratings of the issuer or underlying company, the quoted market price of publicly traded securities with similar duration and yield, time value, yield curve, as well as other measurements. In order to be classified as Level 2, substantially all of these assumptions would need to be observable in the marketplace or can be derived from observable data or supported by observable levels at which transactions are executed in the marketplace.  Financial instruments in this category include certain corporate debt and collateralized debt obligations (“CDOs”) primarily collateralized by company trust preferred and capital securities, certain convertible preferred stock and residential and commercial mortgage-backed securities.  There were no transfers in or out of Level 2 during the three and six months ended June 30, 2012.

 

Fair value of corporate debt, certain convertible preferred stock, residential and commercial mortgage-backed securities classified as Level 2 was determined by using quoted market prices, broker or dealer quotes, or alternate pricing sources with reasonable levels of price transparency.  Fair value of CDOs primarily collateralized by banking and insurance company trust preferred and capital securities was determined primarily by considering recently executed transactions of similar securities and certain assumptions, including the financial condition, operating results and credit ratings of the issuer or underlying companies.

 

Level 3 is comprised of financial instruments whose fair value is estimated based on multiple valuation techniques, primarily market and income approaches.  The valuation methodologies utilized may include significant inputs that are unobservable from objective sources.  The Company considers various market inputs and assumptions, such as recently executed transactions, market price quotations, discount margins, market spreads applied, the terms and liquidity of the instrument, the financial condition, operating results and credit ratings of the issuer or underlying company, the quoted market price of publicly traded securities with similar duration and yield, time value, yield curve, default rates, as well as other measurements.  Included in this category are private equity securities and other investments including limited and general partnership interests.

 

Fair value of corporate debt securities classified as Level 3 was determined based on discounted cash flow techniques.  Fair value of private equity securities classified as Level 3 was determined by assessing market-based information, such as performance multiples, comparable company transactions, changes in market outlook and the terms and liquidity of the instrument. Fair value of limited and general partnership interests classified as Level 3 was determined by using net asset values or capital statements provided by the general partner, updated for capital contributions and distributions and changes in market conditions, if significant, up to the reporting date or by assessing market-based information.  Private equity securities and limited and general partnership interests generally trade infrequently.

 

The following table provides information related to financial instruments where a practical expedient was used as the basis to measure the fair value of certain entities that calculate a net asset value per share (or equivalent):

 

 

 

As of June 30, 2012

 

As of December 31, 2011

 

 

 

 

 

Type of Investment

 

Fair Value

 

Unfunded
Commitments

 

Fair Value

 

Unfunded
Commitments

 

Redemption
Frequency

 

Notice
Period

 

Long/short hedge funds (a)

 

$

 

$

 

$

19,379

 

$

 

Monthly

 

30 Days

 

Public/private equity funds (b)

 

39,501

 

11,852

 

39,379

 

11,876

 

n/a

 

n/a

 

 

 

$

39,501

 

$

11,852

 

$

58,758

 

$

11,876

 

 

 

 

 

 


(a)          This category includes investments in hedge funds that invest primarily in domestic long/short positions in equity securities and various derivatives, including options on securities and stock index options with respect to companies in the financial services sector. Management of these funds also has the ability to invest in foreign equities and fixed income securities. The fair values of investments in this category have been estimated using the net asset value per share, or equivalent, of the investments.  Investments in this category can be redeemed monthly; however, the general partner may impose a “gate” for any withdrawal over 20% of the total fund net asset value.

 

(b)         This category includes several funds that invest primarily in domestic public and private companies operating in the financial services sector.  Management of these funds also have the ability to invest in foreign public and private equities, debt financial instruments, warrants, hybrid securities and membership interests in the financial services sector.  The fair values of investments in this category have been estimated using asset values based on capital statements provided by the general partner, updated, as necessary, for capital contributions and distributions and changes in market conditions up to the reporting date.  These investments generally cannot be redeemed, unless approved by the general partners.  Upon liquidation of the underlying investments prior to the life expectancy / maturity of the funds, management of the funds can elect to make

 

11



Table of Contents

 

KBW, INC. and SUBSIDIARIES

Notes to Consolidated Financial Statements—(Continued)

(unaudited)

(Dollars in thousands, except per share information)

 

distributions to the limited partners.  The time horizon for such distributions is at the discretion of the general partners but should not exceed the time horizon of the fund’s life expectancy.  It is estimated that these investments would be liquidated approximately ten years following the initial investment date, some with options to extend for up to a two year period, ranging from 2013 — 2020.  Additional expenses, such as legal and administrative associated with the final liquidation can be incurred.  Therefore, it is possible that upon final liquidation of the investments, the final funds distributed could be different from the estimated value of the investment.  However, these differences are not expected to be material.

 

In determining the appropriate levels, the Company performed a detailed analysis of the assets and liabilities that are subject to ASC 820.  At each reporting period, all assets and liabilities for which the fair value measurement is based on significant unobservable inputs are classified as Level 3.

 

Assets at Fair Value as of June 30, 2012

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Financial instruments owned, at fair value:

 

 

 

 

 

 

 

 

 

Equities

 

$

60,402

 

$

19,849

 

$

22,595

 

$

102,846

 

Corporate and other debt:

 

 

 

 

 

 

 

 

 

Corporate debt

 

393

 

29,362

 

337

 

30,092

 

CDOs

 

 

3,185

 

 

3,185

 

Total corporate and other debt

 

393

 

32,547

 

337

 

33,277

 

Mortgage-backed securities:

 

 

 

 

 

 

 

 

 

Agency residential mortgage-backed securities

 

 

8,415

 

 

8,415

 

Commercial mortgage-backed securities

 

 

7,204

 

 

7,204

 

Total mortgage-backed securities

 

 

15,619

 

 

15,619

 

Other investments(1) 

 

 

 

40,791

 

40,791

 

Total non-derivative trading assets

 

60,795

 

68,015

 

63,723

 

192,533

 

Equity options/warrants

 

144

 

109

 

 

253

 

Total financial instruments owned

 

$

60,939

 

$

68,124

 

$

63,723

 

$

192,786

 

 

(1) Consists of limited and general partnership interests.

 

Liabilities at Fair Value as of June 30, 2012

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Financial instruments sold, not yet purchased, at fair value:

 

 

 

 

 

 

 

 

 

Equities

 

$

42,431

 

$

 

$

 

$

42,431

 

Corporate debt

 

 

4,286

 

 

4,286

 

U.S. Government and agency securities

 

12,151

 

 

 

12,151

 

Total non-derivative trading liabilities

 

54,582

 

4,286

 

 

58,868

 

Equity options/warrants

 

93

 

 

 

93

 

Total financial instruments sold, not yet purchased

 

$

54,675

 

$

4,286

 

$

 

$

58,961

 

 

12



Table of Contents

 

KBW, INC. and SUBSIDIARIES

Notes to Consolidated Financial Statements—(Continued)

(unaudited)

(Dollars in thousands, except per share information)

 

Assets at Fair Value as of December 31, 2011

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Financial instruments owned, at fair value:

 

 

 

 

 

 

 

 

 

Equities

 

$

61,280

 

$

2,418

 

$

16,422

 

$

80,120

 

Corporate and other debt:

 

 

 

 

 

 

 

 

 

Corporate debt

 

332

 

23,527

 

 

23,859

 

CDOs

 

 

5,126

 

 

5,126

 

Total corporate and other debt

 

332

 

28,653

 

 

28,985

 

Mortgage-backed securities:

 

 

 

 

 

 

 

 

 

Agency residential mortgage-backed securities

 

 

22,783

 

 

22,783

 

Non-agency residential mortgage-backed securities

 

 

2,907

 

 

2,907

 

Total mortgage-backed securities

 

 

25,690

 

 

25,690

 

Other investments(1)

 

 

 

58,758

 

58,758

 

Total non-derivative trading assets

 

61,612

 

56,761

 

75,180

 

193,553

 

Equity options/warrants

 

948

 

 

 

948

 

Total financial instruments owned

 

$

62,560

 

$

56,761

 

$

75,180

 

$

194,501

 

 


(1) Consists of limited and general partnership interests.

 

Liabilities at Fair Value as of December 31, 2011

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Financial instruments sold, not yet purchased, at fair value:

 

 

 

 

 

 

 

 

 

Equities

 

$

51,392

 

$

 

$

 

$

51,392

 

Corporate debt

 

 

7,909

 

 

7,909

 

U.S. Government and agency securities

 

5,234

 

 

 

5,234

 

Total non-derivative trading liabilities

 

56,626

 

7,909

 

 

64,535

 

Equity options/warrants(2)

 

61

 

 

 

61

 

Total financial instruments sold, not yet purchased

 

$

56,687

 

$

7,909

 

$

 

$

64,596

 

 


(2) To-be-announced securities are accounted for as derivative transactions and the unrealized losses were reported in accounts payable, accrued expenses and other liabilities on the consolidated statements of financial condition. The associated payable of $43 has been excluded from the above table. These to-be-announced securities would be classified as Level 2.

 

The non-derivative trading assets/liabilities categories were reported in financial instruments owned, at fair value and financial instruments sold, not yet purchased, at fair value on the Company’s consolidated statements of financial condition.

 

The derivative financial instruments were reported on a gross basis by level.  The Company’s derivative activities included in financial instruments owned and financial instruments sold, not yet purchased consist of writing and purchasing listed equity options and warrants.

 

The following table provides quantitative information about significant unobservable inputs for Level 3 fair value measurements:

 

13



Table of Contents

 

KBW, INC. and SUBSIDIARIES

Notes to Consolidated Financial Statements—(Continued)

(unaudited)

(Dollars in thousands, except per share information)

 

Instrument

 

Fair Value at
6/30/12

 

Technique

 

Input

 

Range (W/Avg.)

 

Equities: Financial Services

 

$

22,595

 

Market comparable companies

 

Book value multiple (a)

 

0.8 - 1.1 (0.9)

 

 

 

 

 

 

 

Tangible book value multiple (a)

 

0.6 - 1.3 (1.0)

 

 

 

 

 

 

 

Marketability discount (b)

 

3% - 12% (4%)

 

 

 

 

 

 

 

 

 

 

 

Corporate Debt: Financial Services

 

$

337

 

Discounted cash flows

 

Yield

 

60%

 

 

 

 

 

 

 

 

 

 

 

Limited Partnerships: Financial Services

 

$

1,290

 

Market comparable companies

 

Marketability discount (b)

 

8 - 12%

 

 


(a) Represents amounts used when the reporting entity has determined that market participants would use such multiples when measuring the fair value of these investments.

(b) Represents amounts used when the reporting entity has determined that market participants would take these discounts into account in a fair value measurement.

 

Sensitivity of Level 3 Inputs to Fair Value Measurements

 

The significant unobservable inputs used in the fair value measurement of the Company’s Level 3 private equity securities included in the table above were market comparable company performance multiples, including book value and tangible book value multiples, and marketability discounts.  Significant increases (decreases) in any of the market comparable performance multiple inputs in isolation would result in a significantly higher (lower) fair value measurement.  Significant increases (decreases) in the marketability discount input in isolation would result in a significantly lower (higher) fair value measurement.

 

The significant unobservable input used in the fair value measurement of the Company’s Level 3 corporate debt security included in the table above was the yield.  Significant increases (decreases) in the yield input in isolation would result in a significantly lower (higher) fair value measurement.

 

The significant unobservable input used in the fair value measurement of the Company’s Level 3 limited partnership investment included in the table above (excludes financial instruments where a practical expedient was used as a basis to measure fair value) was the marketability discount.  Significant increases (decreases) in the marketability discount input in isolation would result in a significantly lower (higher) fair value measurement.

 

The following table provides a reconciliation of the beginning and ending balances for the non-derivative trading assets measured at fair value using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2012 and 2011:

 

Level 3 Financial Assets

 

Three Months Ended
June 30, 2012

 

Balance as of
March 31,
2012

 

Total gains
and (losses)
(realized and
unrealized)

 

Purchases

 

(Sales)

 

Transfers
in/(out) of
Level 3

 

Balance as
of
June 30,
2012

 

Changes in
unrealized
gains and
(losses)
included in
earnings
related to
assets still held
at reporting
date

 

Equities

 

$

22,570

 

$

(8

)

$

34

 

$

(1

)

$

 

$

22,595

 

$

(18

)

Corporate debt

 

 

337

 

 

 

 

337

 

337

 

Other investments

 

41,961

 

583

 

380

 

(2,133

)

 

40,791

 

588

 

Total Level 3 financial assets

 

$

64,531

 

$

912

 

$

414

 

$

(2,134

)

$

 

$

63,723

 

$

907

 

 

14



Table of Contents

 

KBW, INC. and SUBSIDIARIES

Notes to Consolidated Financial Statements—(Continued)

(unaudited)

(Dollars in thousands, except per share information)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Changes in

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

unrealized gains

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and (losses)

 

 

 

 

 

Total gains

 

 

 

 

 

 

 

 

 

included in

 

 

 

 

 

and (losses)

 

 

 

 

 

 

 

 

 

earnings related

 

 

 

 

 

(realized

 

 

 

 

 

Transfers

 

 

 

to assets still

 

Three Months Ended

 

Balance as of

 

and

 

 

 

 

 

in/(out) of

 

Balance as of

 

held at reporting

 

June 30, 2011

 

March 31, 2011

 

unrealized)

 

Purchases

 

(Sales)

 

Level 3

 

June 30, 2011

 

date

 

Equities

 

$

16,826

 

$

1,069

 

$

58

 

$

 

$

 

$

17,953

 

$

1,069

 

Corporate and other debt:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CDOs

 

1

 

 

 

(1

)

 

 

 

Other debt obligations

 

10,203

 

1,002

 

 

(5,259

)

 

5,946

 

(172

)

Total corporate and other debt

 

10,204

 

1,002

 

 

(5,260

)

 

5,946

 

(172

)

Other investments

 

58,942

 

1,202

 

395

 

(1,053

)

 

59,486

 

1,200

 

Total Level 3 financial assets

 

$

85,972

 

$

3,273

 

$

453

 

$

(6,313

)

$

 

$

83,385

 

$

2,097

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Changes in

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

unrealized

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

gains and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(losses)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

included in

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

earnings

 

 

 

 

 

Total gains

 

 

 

 

 

 

 

Balance as

 

related to

 

 

 

Balance as of

 

and (losses)

 

 

 

 

 

Transfers

 

of

 

assets still held

 

Six Months Ended

 

December 31,

 

(realized and

 

 

 

 

 

in/(out) of

 

June 30,

 

at reporting

 

June 30, 2012

 

2011

 

unrealized)

 

Purchases

 

(Sales)

 

Level 3

 

2012

 

date

 

Equities

 

$

16,422

 

$

(994

)

$

7,291

(a)

$

(124

)

$

 

$

22,595

 

$

(965

)

Corporate debt

 

 

337

 

 

 

 

337

 

337

 

Other investments

 

58,758

 

1,340

 

3,357

(a)

(22,664

)

 

40,791

 

1,354

 

Total Level 3 financial assets

 

$

75,180

 

$

683

 

$

10,648

 

$

(22,788

)

$

 

$

63,723

 

$

726

 

 


(a)          Equities include $7,249 and other investments include $2,918 of financial instruments received from a distribution-in-kind from the redemption of the KBW Financial Services Fund, L.P., see Note 9 of the Notes to Consolidated Financial Statements for additional information.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Changes in

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

unrealized gains

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

and (losses)

 

 

 

 

 

Total gains

 

 

 

 

 

 

 

 

 

included in

 

 

 

 

 

and (losses)

 

 

 

 

 

 

 

 

 

earnings related

 

 

 

Balance as of

 

(realized

 

 

 

 

 

Transfers

 

 

 

to assets still

 

Six Months Ended

 

December 31,

 

and

 

 

 

 

 

in/(out) of

 

Balance as of

 

held at reporting

 

June 30, 2011

 

2010

 

unrealized)

 

Purchases

 

(Sales)

 

Level 3

 

June 30, 2011

 

date

 

Equities

 

$

16,654

 

$

1,241

 

$

58

 

$

 

$

 

$

17,953

 

$

1,241

 

Corporate and other debt:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CDOs

 

1

 

29

 

 

(30

)

 

 

 

Other debt obligations

 

11,806

 

1,462

 

 

(7,322

)

 

5,946

 

63

 

Total corporate and other debt

 

11,807

 

1,491

 

 

(7,352

)

 

5,946

 

63

 

Other investments

 

51,336

 

2,103

 

7,804

 

(1,757

)

 

59,486

 

1,762

 

Total Level 3 financial assets

 

$

79,797

 

$

4,835

 

$

7,862

 

$

(9,109

)

$

 

$

83,385

 

$

3,066

 

 

Total gains and losses represent the total gains and/or losses (realized and unrealized) recorded for the Level 3 financial assets and were reported in principal transactions, net in the accompanying consolidated statements of operations.  Additionally, the change in the unrealized gains and losses may be offset by realized gains and losses during the period.

 

Purchases and sales represent the amount of purchases and/or sales of Level 3 financial assets during the period.  The amounts were recorded on the transaction dates at the transaction amounts.

 

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KBW, INC. and SUBSIDIARIES

Notes to Consolidated Financial Statements—(Continued)

(unaudited)

(Dollars in thousands, except per share information)

 

Transfers in/(out) of Level 3 represent existing financial assets that were previously categorized at a higher/lower level.  Transfers in or out of Level 3 result from changes in the observability of inputs used in determining fair values for different types of financial assets.  Transfers were reported at their fair value as of the actual date in which such changes in the fair value inputs occurred.

 

The amount of unrealized gains and losses included in earnings attributable to the change in unrealized gains and losses relating to Level 3 assets still held at the end of the period were reported in principal transactions, net in the accompanying consolidated statements of operations.  The change in unrealized gains and losses may be offset by realized gains and losses during the period.

 

(4)                                 Commitments and Contingencies

 

(a)               Litigation

 

In the ordinary course of business, the Company may be a defendant or codefendant in legal proceedings.  At June 30, 2012, the Company believes, based on currently available information, that the results of such proceedings, in the aggregate, will not have a material adverse effect on the Company’s financial condition.  The results of such proceedings could be material to the Company’s operating results for any particular period, depending, in part, upon additional developments affecting such matters and the operating results for such period.  Legal reserves have been established in accordance with ASC 450, Contingencies. Once established, reserves are adjusted when there is more information available or when an event occurs requiring a change.

 

(b)     Investment Commitments

 

As of June 30, 2012, the Company had approximately $11,852, including $7,378 to an affiliated fund which is limited to additional investments in existing portfolio holdings, in outstanding commitments for additional funding to limited partnership investments.

 

(5)                                 Financial Instruments with Off-Balance-Sheet Risk

 

In the normal course of its principal trading activities, the Company enters into transactions in financial instruments with off-balance-sheet risk.  These financial instruments, such as options, warrants, futures and mortgage-backed to-be-announced (“TBA”) securities, contain off-balance-sheet risk inasmuch as ultimate settlement of these transactions may have market and/or credit risk in excess of amounts which are recognized in the consolidated financial statements.  Transactions in listed options and warrants are conducted through regulated exchanges, which clear and guarantee performance of counterparties.

 

Also, in connection with its principal trading activities, the Company has sold securities that it does not currently own and will, therefore, be obligated to purchase such securities at a future date.  The Company has recorded this obligation in the financial statements at market values of the related securities and will record a trading loss if the market value of the securities increases subsequent to the purchase date.

 

(a)     Broker-Dealer Activities

 

The Company clears securities transactions on behalf of customers through its clearing brokers.  In connection with these activities, customers’ unsettled trades may expose the Company to off-balance-sheet credit risk in the event customers are unable to fulfill their contracted obligations.  The Company seeks to control the risk associated with its customer activities by monitoring the creditworthiness of its customers.

 

(b)               Derivative Financial Instruments

 

The Company’s derivative activities consist of writing and purchasing listed equity options and/or warrants and, from time to time, futures on interest rate, currency and equity products and mortgage-backed TBA securities for trading for our own account.  Options and warrants are included in financial instruments owned, at fair value and financial instruments sold, not yet purchased, at fair value in the accompanying consolidated statements of financial condition.  See also Note 3 of the Notes to Consolidated Financial Statements for additional details.  As a writer of options, the Company receives a cash premium at the beginning of the contract period

 

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Table of Contents

 

KBW, INC. and SUBSIDIARIES

Notes to Consolidated Financial Statements—(Continued)

(unaudited)

(Dollars in thousands, except per share information)

 

and bears the risk of unfavorable changes in the fair value of the financial instruments underlying the options.  Options written do not expose the Company to credit risk since they obligate the Company (not its counterparty) to perform.

 

In order to measure derivative activity, notional or contract amounts are frequently utilized.  Notional contract amounts, which are not included on the consolidated statements of financial condition, are used as a basis to calculate contractual cash flows to be exchanged and generally are not actually paid or received.

 

A summary of the Company’s listed options, warrants, futures contracts and TBA securities is as follows:

 

 

 

Current

 

Average

 

End of

 

 

 

Notional

 

Fair

 

Period

 

 

 

Value

 

Value

 

Fair Value

 

June 30, 2012:

 

 

 

 

 

 

 

Purchased options/warrants

 

$

4,013

 

$

724

 

$

253

 

Written options/warrants

 

$

2,040

 

$

58

 

$

93

 

Short agency mortgage-backed TBA securities

 

$

7,760

 

$

13

 

$

1

 

 

 

 

 

 

 

 

 

December 31, 2011:

 

 

 

 

 

 

 

Purchased options/warrants

 

$

18,398

 

$

3,694

 

$

948

 

Written options/warrants

 

$

2,756

 

$

388

 

$

61

 

Short agency mortgage-backed TBA securities

 

$

21,960

 

$

28

 

$

43

 

 

The following table summarizes the net gains from trading activities included in principal transactions, net with respect to the consolidated statements of operations for the three and six months ended June 30, 2012 and 2011:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

Type of Instrument

 

2012

 

2011

 

2012

 

2011

 

Equities

 

$

(1,386

)

$

1,503

 

$

(252

)

$

6,903

 

Corporate and other debt

 

2,949

 

6,723

 

8,164

 

12,685

 

Mortgage and other asset-backed securities

 

2,026

 

2,525

 

5,195

 

7,601

 

Other investments

 

(109

)

1,201

 

879

 

2,103

 

Total

 

$

3,480

 

$

11,952

 

$

13,986

 

$

29,292

 

 

The revenue related to the equities and mortgage and other asset-backed securities categories included realized and unrealized gains and losses on both derivative instruments and non-derivative instruments.  Corporate and other debt and other investments included realized and unrealized gains and losses on non-derivative instruments.

 

(6)                                 Concentrations of Credit Risk

 

The Company is engaged in various securities trading and brokerage activities servicing primarily domestic and foreign institutional investors.  Nearly all of the Company’s transactions are executed with and on behalf of institutional investors, including other brokers and dealers, commercial banks, mutual funds, and other financial institutions.  The Company’s exposure to credit risk associated with the non-performance of these customers in fulfilling their contractual obligations pursuant to securities transactions can be directly impacted by volatile securities markets.

 

A substantial portion of the Company’s marketable securities are common stock and debt of financial institutions.  The credit and/or market risk associated with these holdings can be directly impacted by factors that affect this industry such as volatile equity and credit markets and actions of regulatory authorities.

 

17



Table of Contents

 

KBW, INC. and SUBSIDIARIES

Notes to Consolidated Financial Statements—(Continued)

(unaudited)

(Dollars in thousands, except per share information)

 

(7)                                 Stockholders’ Equity

 

Dividends Declared on Common Stock

 

During the six months ended June 30, 2012, the Company’s board of directors declared and the Company paid dividends of $0.10 per share totaling $3,499.

 

Stock Repurchase Program

 

On July 28, 2010, the Company’s board of directors approved a stock repurchase program, authorizing the Company to repurchase in the aggregate up to $70,000 of its outstanding common stock.  On October 26, 2011, the Company’s board of directors authorized an additional $50,000 for its stock repurchase program.  Purchases by the Company under this program may be made from time to time at prevailing market prices in open market purchases, privately negotiated transactions, block purchase techniques or otherwise, as determined by the Company’s management.  There was no activity during the six months ended June 30, 2012 and the Company has $48,695 available for future purchases.

 

This program does not obligate the Company to acquire any particular amount of common stock.  The timing, frequency and amount of repurchase activity will depend on a variety of factors such as levels of cash generation from operations, cash requirements for investments in the Company’s business, current stock price, market conditions and other factors.  The stock repurchase program may be suspended, modified or discontinued at any time and has no set expiration date.

 

(8)                                 Stock-Based and Other Incentive Compensation

 

Stock-Based Compensation

 

At June 30, 2012, the Company had one effective incentive compensation arrangement under the 2009 Incentive Compensation Plan (the “Plan”).  The Plan permits the Company to issue shares of common stock pursuant to the grant or exercise of stock options, stock appreciation rights, restricted stock awards (“RSAs”), restricted stock units, performance unit awards and performance share awards, as well as grant cash-based awards and other awards to directors, officers, employees and consultants.

 

Restricted Stock Awards

 

As part of the 2011 year-end performance award process the Company granted 2,471,786 RSAs under the Plan to certain employees in March 2012 (“2011 Bonus Awards”).  The aggregate fair value of the RSAs granted in connection with the 2011 Bonus Awards in March 2012 was $40,290.  This value was based upon the grant date share price of $16.30.  RSAs are actual shares of common stock issued to the participant that are restricted.  The stock granted in connection with the 2011 Bonus Awards generally vests over a three year period.  Vesting would accelerate on a change in control, death or permanent disability.  Unvested RSAs are eligible to receive dividends but are subject to forfeiture upon termination of employment.

 

For 2011 Bonus Awards that were granted to retirement-eligible employees, the Company recognized the grant date fair value as compensation expense for such awards on the date of grant instead of over the service period specified in the award terms. For employees who will be retirement-eligible prior to vesting of the 2011 Bonus Awards, the Company recognizes compensation expense ratably from the grant date to the retirement eligibility date.  The Company recorded accelerated non-cash incremental compensation expense of $6,162 in the first quarter of 2012 related to 2011 Bonus Awards granted to retirement-eligible employees.

 

Long Term Incentive Program

 

In February 2010, the Company adopted a Long Term Incentive Program (the “LTIP”) under the Plan.  The LTIP allows the Company to make awards under the Plan to selected employees, which awards will provide for payments of such amounts pursuant to such terms and conditions as the Company shall determine.  The LTIP provides that amounts specified or calculated pursuant to awards may be earned during a performance cycle established for such an award upon the achievement of specified performance goals.

 

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Table of Contents

 

KBW, INC. and SUBSIDIARIES

Notes to Consolidated Financial Statements—(Continued)

(unaudited)

(Dollars in thousands, except per share information)

 

During the first quarter of 2010, the Company approved awards under the Plan to three members of senior management.  The LTIP awards have established performance cycles (2010, 2010 through 2011 and 2010 through 2012) and amounts payable based on the achievement of certain levels of cumulative growth in adjusted earnings per share during the performance cycle.  For the 2010 through 2011 performance cycle, LTIP awards were not earned as the cumulative growth in adjusted earnings per share was below the established minimum level.  As of June 30, 2012, there was no accrual for the 2010 through 2012 performance cycle as the cumulative growth in adjusted earnings per share is expected to be below the established minimum level.

 

Performance Equity Awards

 

In March 2011, the Company granted Performance Equity Awards to three members of senior management.  The Performance Equity Awards provide for the issuance of up to 120,240 shares of Common Stock to the recipients in the aggregate, contingent upon achievement of a target level of “Return on KBW Average Equity” as defined in the Performance Equity Awards.  The share price of the Performance Equity Awards on grant date was $24.93.  The three year performance period began on January 1, 2011 and ends on December 31, 2013.  The range of possible Performance Equity Awards vesting is between 0% and 200% of the target, so that the minimum number of shares that may be awarded to the recipients in the aggregate is zero and the maximum number is 240,480.  In addition, these Performance Equity Awards contain “clawback” provisions that provide for repayment of all or a portion of shares issued in the event of certain accounting restatements, thereby creating at-risk performance units for these executives.  Unvested Performance Equity Awards are subject to forfeiture upon termination of employment.  Under the Performance Equity Award agreements, in the event of (i) termination by us without “cause,” (ii) termination by the employee for “good reason” or (iii) the employee’s death, “disability,” or “retirement,” (as each such term is defined in the Plan) during any performance cycle or period, such employee will be entitled to payment of a pro-rata portion (based on the portion of such performance cycle or period that such employee was actively employed by us) of such employee’s award with respect to such performance cycle or period, provided that the performance goals with respect to such performance cycle or period are achieved.  In the event of a change in control, as defined in the Plan, the target performance goals applicable to any outstanding Performance Equity Awards shall be deemed to have been attained in full (unless actual performance exceeds the target performance goal, in which case actual performance shall be used) and all of the applicable shares will be deemed vested and subject to payment as provided in the Plan.  As of June 30, 2012, there was no accrual for Performance Equity Awards based on the probable outcome of the performance condition.

 

(9)                                 Transactions with Affiliated Funds

 

The Company completed the full redemption of investors in the KBW Financial Services Funds (KBW Financial Services Master Fund, Ltd., KBW Financial Services Fund, L.P., KBW Financial Services Fund, Ltd.) and ended the capital commitment period of the KBW Capital Partners I, L.P (“Capital Partners”).  In January 2012, the Company received cash and securities totaling $19,379 upon full redemption of the KBW Financial Services Fund, L.P.  Capital Partners is a nonconsolidated investment fund that was formed by the Company with third-party investors and has been externally managed beginning January 2012.  The realization phase of Capital Partners is expected to be completed in the next few years, which is not expected to materially impact the Company’s financial statements.  The aggregate carrying value of the Company’s interest in Capital Partners was $4,835 and $4,948 as of June 30, 2012 and December 31, 2011, respectively.  The Company elected to apply the fair value option to this affiliated fund.  See Note 4 of the Notes to Consolidated Financial Statements for the Company’s commitments related to this affiliated fund.

 

(10)                          Restructuring Charges

 

Commencing in the third quarter of 2011, the Company undertook steps to reduce its workforce and certain other costs to better align its resources to the current business environment.  These efforts continued through the first half of 2012 with further headcount reductions.  As a result of the workforce reduction, the Company has also consolidated office workspace in New York City and terminated several market data contracts.  These actions resulted in restructuring charges to earnings relating to severance, lease obligation accruals for vacant office space and contract termination costs in 2011.  The continuing difficulties in global markets, particularly those affecting financial services companies, led the Company to make further headcount reductions in the second quarter of 2012 resulting in additional severance costs of $1,200 for the three months ended June 30, 2012.  The cumulative amount of severance costs incurred from this workforce reduction program since it began in 2011 was $10,443.  The accrual related to severance was included in accrued compensation and benefits and the accruals related to the consolidation of space in our New York office and the termination of several market data services contracts were included in accounts payable, accrued expenses and other liabilities on the accompanying statements of financial condition.

 

19



Table of Contents

 

KBW, INC. and SUBSIDIARIES

Notes to Consolidated Financial Statements—(Continued)

(unaudited)

(Dollars in thousands, except per share information)

 

The following tables provide reconciliations of the beginning and ending balances of accruals related to restructuring charges.

 

Three Months Ended June 30, 2012

 

 

 

Severance

 

Lease
Obligations

 

Market Data
Service
Contracts

 

Total

 

Accrual for restructuring charges, balance at March 31, 2012

 

$

149

 

$

6,704

 

$

324

 

$

7,177

 

Additional accrual for restructuring charges

 

1,200

 

 

 

1,200

 

Costs paid or settled

 

(618

)

(849

)

(14

)

(1,481

)

Accrual for restructuring charges, balance at June 30, 2012

 

$

731

 

$

5,855

 

$

310

 

$

6,896

 

 

Six Months Ended June 30, 2012

 

 

 

Severance

 

Lease
Obligations

 

Market Data
Service
Contracts

 

Total

 

Accrual for restructuring charges, balance at December 31, 2011

 

$

2,369

 

$

7,553

 

$

375

 

$

10,297

 

Additional accrual for restructuring charges

 

3,444

 

 

 

3,444

 

Costs paid or settled

 

(5,082

)

(1,698

)

(65

)

(6,845

)

Accrual for restructuring charges, balance at June 30, 2012

 

$

731

 

$

5,855

 

$

310

 

$

6,896

 

 

(11)                         Earnings Per Share

 

The computations of basic and diluted earnings per share are set forth below:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2012

 

2011

 

2012

 

2011

 

Net (loss) / income

 

$

(5,423

)

$

(4,248

)

$

(4,957

)

$

393

 

Less: Dividends and allocation of undistributed earnings to participating securities(1)

 

210

 

197

 

429

 

390

 

Net (loss) / income applicable to common shareholders

 

$

(5,633

)

$

(4,445

)

$

(5,386

)

$

3

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of common shares outstanding(1)(2):

 

 

 

 

 

 

 

 

 

Basic

 

30,389,057

 

32,579,146

 

30,300,362

 

32,849,263

 

Effect of dilutive securities - restricted stock