Piper Sandler Companies Q1 FY2023 Earnings Call

Good morning, and welcome to the Piper Sandler Companies' conference call to discuss the financial results for the first quarter of 2023. During the question-and-answer session, securities industry professionals may ask questions with management. The company will make forward-looking statements on this call that are not historical or current facts, including statements about beliefs and expectations and involve inherent risks and uncertainties. Factors that could cause actual results to differ materially from those anticipated are identified in the Company's earnings release and reports on file with the SEC, which are available on the company's website at www.pipersandler.com and on the SEC website at www.sec.gov. This call will also include statements regarding certain non-GAAP financial measures. The non-GAAP measures should be considered in addition to, and not a substitute for, measures of financial performance prepared in accordance with GAAP. Please refer to the company's earnings release issued today for a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measure. The earnings release is available on the Investor Relations page of the company's website and at the SEC website. As a reminder, this call is being recorded. And now, I'd like to turn the call over to Mr. Chad Abraham. Mr. Abraham, you may begin your call.

Good morning, everyone. Thanks for joining us. It's great to be with you to talk about our first quarter results. I am here with Deb Schoneman, our President; and Tim Carter, our CFO. Despite volatility during the first quarter of 2023, our diversified platform generated adjusted net revenues of $289 million, a 14.1% operating margin and adjusted EPS of $2.35. Persistent inflation, rapid Central Bank rate increases and stress on the banking system led to a lack of confidence that continues to reduce overall market activity. Although, volatility benefits our equity brokerage business, it adversely impacts our other businesses, which rely on constructive market conditions and a more stable outlook. The bank turmoil has further extended uncertainty and reduced confidence levels, delaying the inflection point to better market conditions. Turning to corporate investment banking. We generated total corporate investment banking revenues of $167 million during the first quarter of 2023, down from the first quarter of last year, driven by lower advisory revenue. That said, we continue to diversify our platform across sectors, products and clients. Scaling our industry groups and adding new capabilities enhances our ability to deliver strong results against mixed economic conditions. Specific to advisory services, revenues of $141 million for the quarter decreased year-over-year, reflective of the continuing challenges in the M&A and debt markets. Despite this, we completed 69 advisory transactions during the quarter and maintained our position as the number two advisor on announced U.S. M&A transactions under $1 billion. Sector performance was led by our financial services and healthcare groups with solid contributions from our energy and power and consumer teams. In addition, following a record year in 2022, our restructuring group started this year strong, with record quarterly revenues. The quality of this team combined with our market-leading industry groups is driving strong collaboration and positioned us to win two high-profile restructuring assignments. During the first quarter, we advised the FDIC on the sale of substantially all of the deposits and loans of both Silicon Valley Bank and Signature Bank. These advisory assignments demonstrate our market-leading restructuring capabilities and financial services expertise. The near-term outlook for M&A remains soft, driven by economic uncertainties and difficult debt financing conditions, which continue to impact deal timelines and the conversion of our pipeline. We remain cautiously optimistic towards the second half of 2023, but that will depend on sustained market improvements. Turning to corporate financing. Although our equity financings increased from a year ago, overall market activity remains below historic levels. Commercial banking concerns increased volatility resulting in a pause in equity financings late in the quarter. We generated $27 million of financing revenues during the first quarter of 2023, up year-over-year. We completed 23 equity debt and preferred financings raising over $4 billion for corporate clients. Activity for us was concentrated in the healthcare sector, with additional contributions from financial services and energy and power. Equity capital markets have been largely shut down for over five quarters, a long period by historical standards. As we look ahead, we expect financing activities to build as we progress through 2023. Turning to investment banking managing director headcount. We remain focused on building out our subsector coverage. We added 13 MDs, finishing the quarter at 171 managing directors, the most in our history. Development of our own talent continues to be a priority, and 2023 was a large promote class, adding 10 new managing directors across our industry and product teams. We also hired three managing directors to our platform during the quarter, broadening our coverage in healthcare services, asset and wealth management and real estate. Adding new MD talent is critical to our strategic goals and key to driving incremental revenues over time. We continue to increase the earnings power of our franchise and we see significant opportunity to grow our market share further over the long term. We remain focused on helping our clients navigate a highly dynamic economic landscape. When markets stabilize, we expect activity levels to accelerate from both sponsor and strategic clients, and we believe that we are uniquely positioned to advise our clients to meet their objectives. We remain focused on our strategic goals, scaling our industry groups, consistently expanding market reach and share over time, increasing transaction fee size and adding MDs and competencies. With that, I will turn the call over to Deb to discuss our public finance and brokerage businesses.

Thanks, Chad. During the first quarter of 2023, our public finance business generated $17 million of municipal financing revenues, down year-over-year. With higher nominal rates, increased interest rate volatility and weak investor demand, municipal issuance has declined significantly across the industry. Market issuance during the quarter was approximately $75 billion, down roughly 25% from a year ago, and represented one of the slowest quarters in the last decade. High yield new issuance volume declined even more by approximately 57% relative to the first quarter of last year. This negatively impacted our relative performance as a meaningful component of our public finance business is in high yield specialty sectors. As we look ahead, our pipeline is large and diverse, but we believe a period of sustained municipal fund inflows and interest rate stability is needed for issuance to increase from current levels. Our equity brokerage business was a bright spot, as it generated quarterly revenues of $54 million, up from the first quarter of last year. Equity markets saw elevated volatility during March, however, overall volatility and volumes for the first quarter of 2023 were lower year-over-year. Market share gains and the addition of Cornerstone Macro drove our strong relative performance. We traded 2.8 billion shares during the quarter on behalf of our clients, as they reposition portfolios and set our premier trade execution capabilities. In periods of heightened volatility, clients consistently trust our brand and broad trading expertise to execute quickly and efficiently. With client research votes continuing to increase and our ability to further cross-sell products to clients, we see opportunity for continued market share gains in this business over time, which should help mitigate the declining fee pool and less volatility. Moving to fixed income. For the first quarter of 2023, we generated revenues of $42 million, down compared to the first quarter of last year. Market conditions in fixed income were challenging during the quarter, with large interest rates swings. Uncertainty on the direction of interest rates largely kept most clients on the sidelines. Trading among our depository clients was particularly slow, as banks focused on building liquidity and continued to evaluate their capital and funding position. Activity among our municipal-centric clients was also subdued, as municipal bonds remain expensive on a relative basis compared to treasuries, driven by the lack of new supply. The breadth of our client relationships and product capabilities provided some level of resiliency to our results. Insurance companies and public entity clients were active as they found relative value in the short end of the yield curve. Advising clients on hedging strategies drove an increase in derivative activity. However, we expect the near-term outlook to remain challenging. Like our investment banking group, we remain focused on broadening our fixed income platform, and during the quarter, we hired five talented and seasoned professionals to help build out our trading and distribution capabilities, primarily in non-agency structured credit. Our recruiting pipeline is robust and we see opportunities to continue expanding our market reach.

Thanks, Deb. As a reminder, my comments will be focused on our adjusted non-GAAP financial results, which should be considered in addition to and not a substitute for the corresponding GAAP financial measures. We generated net revenues of $289 million for the first quarter of 2023, down 26% from the fourth quarter of 2022 and 20% from the first quarter of last year. Market conditions remained uncertain and have largely kept our investment banking and fixed income clients on the sidelines. Equity brokerage continues to be a highlight, generating their second strongest quarterly revenues on record. Despite tough conditions, we generated solid results and continue to manage the business to reflect current market conditions. Turning to operating expenses and margin. Our compensation ratio for the first quarter of 2023 was 63.3%, slightly elevated from both the fourth and first quarters of last year, driven by lower net revenues. We continue to maintain our philosophy of managing compensation levels to be a balance of employee retention, investment opportunities and operating margins. Based on our current outlook, we expect our compensation ratio to be around Q1 levels, but will be dependent on recruiting opportunities, which could accelerate. Non-compensation expenses for the first quarter of 2023, excluding reimbursed deal expenses, were $59 million, slightly below our expectations as we focus on managing our costs and benefited from the timing of certain expenses. Non-compensation costs, excluding reimbursed deal expenses, increased 8% compared to the first quarter of last year, primarily because of the additions of Cornerstone Macro, Stanford and DBO to our platform. Looking ahead, we expect our non-compensation costs, excluding reimbursed deal expenses, to be closer to our previously provided guidance of around $62 million per quarter. During the first quarter of 2023, we generated adjusted operating income of $41 million and an operating margin of 14.1%, demonstrating the resiliency of our diversified platform. For the current quarter, adjusted income tax expense was reduced by $14 million of tax benefits related to restricted stock vestings, which resulted in a net adjusted income tax benefit for the quarter. Excluding these benefits, our first quarter adjusted tax rate was 28%. We continue to expect our full year 2023 adjusted tax rate will be within a range of 27% to 29%, excluding the impact from stock vestings. During the first quarter of 2023, we generated net income of $42 million and diluted EPS of $2.35. We've made great strides over the last few years to increase the long-term earnings power of our platform. Although our results this quarter reflect the challenging market conditions, we believe we are in a position of strength once markets open up, to continue to realize the benefits of our expanded and more diversified business. Let me finish with an update on capital allocation. During the first quarter of 2023, we returned an aggregate of $112 million to shareholders through buybacks and dividends paid. We repurchased approximately 426,000 shares of our common stock or $61 million, which more than offset the share count dilution from this year's annual stock grants. We also paid an aggregate of $51 million, or $1.85 per share, to our shareholders through our quarterly and special dividends. In addition, today, the Board approved a quarterly cash dividend of $0.60 per share to be paid on June 9 to shareholders of record as of the close of business on May 26. With that, we'll open up the call for questions.

Thanks, and good morning everyone.

Hey, Devin.

Hey, Devin.

Good morning.

Hey. Maybe just start on the M&A advisory business. I appreciate we're in a pretty uncertain moment here in the market. But let me just get a little bit more color around just the pipeline or maybe the pipeline of mandates, just to get a sense of like where dialog is today, appreciate stuff moving slowly, but just how active dialogs are maybe increasing relative to a year ago? And then, also on the sponsor side of the business, what you think the trigger point will be to kind of maybe speed things back up again?

The advisory numbers for Q1 were slower compared to Q4 and the same period last year, partly due to the lower volume of activities we initiated in Q3 and Q4 of last year. Additionally, there was significant volatility in late March related to banking issues, which affected our pipeline. However, in April, we've become more active in launching transactions. It's still early to determine if we'll meet price expectations or secure all necessary financing, but I'm optimistic about the current pace of new launches and the positive feedback received on the deals presented to sponsors, although I recognize it's still early in the process.

I understand. I may explore the banking sector and financials more generally in light of the recent banking issues. Are you noticing any changes in capital raising demand or a potential increase in capital raising activities that may be necessary? I'm assuming M&A will still face challenges in the banking sector, but are there any other forms of strategic guidance that might be needed in the near future to help navigate this uncertain time for the industry?

I would say we're currently in a phase of stagnation. People are noticing the challenging reports from various banks, which have resulted in tougher quarters. I believe that in the long run, this situation will lead to an increase in advisory activity, but it will take some time to begin. We are also aware that the regulatory environment takes time to navigate. We do anticipate more capital raising, but we need further guidance to understand the regulatory landscape and what our peers are pursuing. Overall, while we see this turmoil as potentially beneficial for our depository business in the long term, it's going to require some time. This won't significantly affect us in the next quarter or two.

Got it. Okay, that's helpful. And I'll just close out here on the restructuring business. You had another nice hire over the last couple of days there and you've been building out that team and capability. It sounds like you've had some momentum there. So, maybe just if possible kind of size, scale, where you are in that business today, and then, also the opportunity ahead? How much appetite there is to grow that and the whitespace you see just particularly as we're getting into a little bit of a restructuring cycle, but could be an extended moment if interest rates stay higher here for the next couple of years?

Yes. Just a reminder, we started our restructuring business at the end of 2020 with a very small team. We have grown that team and increased revenues, although from a small base. I would say we are beginning to see an inflection point with some transactions, and the volume is continuing to increase. We expect this business will set another record for us this year. However, it still stems from a small base, and while it's starting to affect the total advisory line, it will take a few more years to scale up. We are pleased with the hires we've made, and we are beginning to see their overall impact on our advisory line.

Got it. Okay. Great. I will hop back in the queue. I got a couple of more, but let other people ask. Thanks.

Great.

Thanks.

Good morning, and thanks for taking my questions. Maybe we could just start with the hiring backdrop that you're seeing. A number of your peers have talked about this being a much stronger backdrop on the recruitment side and this could impact their comp ratio from here. Does it like higher comp ratio that you put up this quarter or you discount better hiring drop? And what do you see as the opportunity to expand the business from here?

I would certainly agree. In recent months, I have noticed more opportunities for our industry teams and product groups. We have been consistent with our hiring, and despite the challenges in the last few quarters, we have increased our headcount, particularly in managing directors. I believe we are at another turning point this spring with the number of discussions and activities taking place. We are cautious when assessing the compensation rate quarterly as we consider our hiring strategy. If the compensation rate increases from here, I think it will be only slightly and will depend on whether we accelerate hiring further. I agree that we are seeing more opportunities, and we are open to raising the compensation rate a bit, but this is comparative to what we've heard from others in the industry.

Okay, that's very helpful. Maybe just turning to fixed income. I think the results there were impacted by market volatility, which I would imagine in part to do with the recent banking stress. Maybe just speak to whether client engagement has improved so far in the second quarter? Or if not, what do you think the timing will be for this part of the business to inflect positively?

At the end of 2022, we began noticing challenges, particularly with banks and credit unions that were experiencing lower liquidity. This situation has worsened, leading to a decrease in activity among banks. We've been engaging with them to assist in asset-liability management and hedging interest rate risk with our derivatives strategy. However, if they lack liquidity and are inactive in the market, there's limited action we can take. So far in the second quarter, we haven't observed any improvement. We need to see a decrease in rate volatility, but it's difficult to predict when that might occur. On the other hand, we did see some support from our diversification into public entities and insurance companies benefitting from shorter-term strategies. Yet, overall, clients are currently hesitating as they assess the direction of rates and decide when to extend their duration exposure.

Okay, that's very helpful. Thank you for taking my questions.

Thank you.

And we'll take the next question from Steven Chubak with Wolfe Research. Please go ahead.

Good morning. This is Brendan O'Brien filling in for Steven. So, just to start on the advisory side, we've heard from you and a number of your peers talk about a few different conditions that are needed for an M&A recovery, including the narrowing of bid-ask spreads, greater macro clarity, and more financing availability. Want to get a mark-to-market on these various factors at the moment relative to where we were last quarter? And how you see them evolving from here?

I would say the top concern is the macroenvironment, especially regarding the strategic side of the business. CEO confidence is crucial, and people need to feel optimistic about the upcoming quarters before making transactions. I don't think we've reached a turning point yet, so we need to see significant improvement in macro conditions. On the financing front, I do see some positive indicators, particularly from our debt advisory business. It varies by market segment; in the middle market and for smaller transactions, sponsors might be contributing larger equity checks, and if they previously received 6x leverage, now it might be closer to 5x. The market isn't frozen; it's active but more challenging due to lower leverage ratios and higher costs, making transactions tougher. However, we are seeing potential paths for financing in many of our deals in the middle market. By the way, what was the third part of your question, Brendan?

Bid-ask spreads and valuation?

Yeah, I would say we're valuation, bid-ask spreads, that always takes a few quarters, but we're at least three or four quarters into that. So that's probably the part I start to feel the best about. Certainly, with some of the private equity, I mean, they've been out of the market on some of their sell sides. And many of them are always raising money. They don't go an entire year without some liquidity, some in, some out. So, again, on the bid-ask spread, I think we're a lot closer to seeing transactions there.

That's great color. Thanks for that. And I guess, pivoting to the corporate finance business, you saw a fairly sizable step down this quarter after seeing momentum steadily build throughout the last year. We've heard from some of your peers that they're beginning to see underwriting pipelines build and that they believe that activity could inflect positively in the back half. Could you speak to what you're seeing in terms of pipelines and dialogs in the business? And whether you feel there is an increased need from biotech or healthcare firms to get out and raise capital given we're now, as you indicated in the prepared remarks, five quarters into this ECM slowdown?

We have a few components in our corporate financing line, including ECM and debt capital raising, particularly in financial services. In January and February, we experienced similar run rates to the second half of last year, which wasn't a strong market, but definitely an improvement over the first half of last year. However, after the first 10 days of March, the situation changed dramatically due to developments with the banks, significantly affecting ECM for that month. By April, we found ourselves back at the levels we saw in January and February. The market is okay, and we're progressing with some healthcare transactions. We believe there's potential for continued improvement, particularly if market volatility remains low. While the fee pool is still relatively small, we anticipate steady growth throughout the year.

Okay. Thanks for taking my questions.

And we'll take our next question from Mike Grondahl with Northland Securities. Please go ahead.

Hey, thanks, guys. A lot of my questions have been asked. But, Chad, maybe an update on the DBO Partners' acquisition from last fall, the tech investment there and how is that going?

We're about four or five months into the integration, and we're pleased with the team. We've effectively integrated our leadership and established our approach to transactions and account management. Although this sector poses challenges in terms of announcement levels, which is affecting new transactions, we've learned to be patient with the timeline and process. We're quite satisfied with the platform we have now for conducting business, and I believe that in the latter half of the year and beyond, it will significantly enhance our advisory services.

Great. And in the last several years, there has been a bunch of these tuck-in acquisitions. Any others to really call out that are performing nicely above plan?

Yeah. I mean, it obviously depends on the stage and the quarter we're in. I would say, obviously, now TRS had a really good end to last year, really good start to this year and the restructuring market, obviously, the market is pretty conducive to that. Frankly, one of the best performers is Cornerstone with our Macro business. Obviously, the environment was really good for that last year, continued volatility in Q1 was really good for that. So those would probably be a couple of examples I'd give you.

Great. Good luck the rest of '23.

Thanks, Mike.

Thank you.

And it appears there are no further questions at this time. I'll turn the conference back to Mr. Abraham for any additional or closing remarks.

All right. Thank you, operator, and thanks, everyone. We look forward to updating you on our second quarter results. Have a great day. Thank you.

And this concludes today's call. Thank you for your participation. You may now disconnect.