NOTE 4 – Fair Value Measurements

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

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

We generally utilize third-party pricing services to value Level 1 and Level 2 available-for-sale investment securities, as well as certain derivatives designated as fair value hedges. We review the methodologies and assumptions used by the third-party pricing services and evaluate the values provided, principally by comparison with other available market quotes for similar instruments and/or analysis based on internal models using available third-party market data. We may occasionally adjust certain values provided by the third-party pricing service when we believe, as the result of our review, that the adjusted price most appropriately reflects the fair value of the particular security.

Following are descriptions of the valuation methodologies and key inputs used to measure financial assets and liabilities recorded at fair value. The descriptions include an indication of the level of the fair value hierarchy in which the assets or liabilities are classified.

Cash and Cash Equivalents

Cash equivalents include highly liquid investments with original maturities of three months or less. Due to their short-term nature, the carrying amount of these instruments approximates the estimated fair value. Actively traded money market funds are measured at their net asset value, which approximates fair value. As such, we classify the estimated fair value of these instruments as Level 1.

Financial Instruments (Trading securities and available-for-sale securities)

When available, the fair value of financial instruments are based on quoted prices in active markets and reported in Level 1. Level 1 financial instruments include highly liquid instruments with quoted prices, such as equities listed in active markets, certain corporate obligations, and U.S. treasury securities.

If quoted prices are not available, fair values are obtained from pricing services, broker quotes, or other model-based valuation techniques with observable inputs, such as the present value of estimated cash flows and reported as Level 2. The nature of these financial instruments include instruments for which quoted prices are available but traded less frequently, instruments whose fair value have been derived using a model where inputs to the model are directly observable in the market, or can be derived principally from or corroborated by observable market data, and instruments that are fair valued using other financial instruments, the parameters of which can be directly observed. Level 2 financial instruments generally include U.S. government securities, mortgage-backed securities, corporate obligations infrequently traded, certain government and municipal obligations, asset-backed securities, and certain equity securities not actively traded.

Securities classified as Level 3, of which the substantial majority is auction rate securities (“ARS”), represent securities in less liquid markets requiring significant management assumptions when determining fair value. Due to the lack of a robust secondary auction-rate securities market with active fair value indicators, fair value for all periods presented was determined using an income approach based on an internally developed discounted cash flow model.

In addition to ARS, we have classified certain corporate obligations with unobservable pricing inputs and airplane trust certificates as Level 3. The methods used to value these securities are the same as the methods used to value ARS, discussed below.

Investments

Investments carried at fair value include ARS, investments in mutual funds, U.S. treasury securities, investments in public companies, private equity securities, partnerships, and warrants of public or private companies.

Investments in certain public companies, mutual funds and U.S. treasury securities are valued based on quoted prices in active markets and reported in Level 1. The fair value of our investment in the preferred stock of Knight Capital Corp. was derived using a model where inputs to the model are directly observable in the market, or can be derived principally from or corroborated by observable market data, and is classified as Level 2.

Investments in certain private equity securities and partnerships with unobservable inputs and ARS for which the market has been dislocated and largely ceased to function are reported as Level 3 assets. The methods used to value ARS are discussed above.

Investments in partnerships and other investments include our general and limited partnership interests in investment partnerships and direct investments in non-public companies. The net assets of investment partnerships consist primarily of investments in non-marketable securities. The value of these investments is at risk to changes in equity markets, general economic conditions and a variety of other factors. We estimate fair value for private equity investments based on our percentage ownership in the net asset value of the entire fund, as reported by the fund or on behalf of the fund, after indication that the fund adheres to applicable fair value measurement guidance. For those funds where the net asset value is not reported by the fund, we derive the fair value of the fund by estimating the fair value of each underlying investment in the fund. In addition to using qualitative information about each underlying investment, as provided by the fund, we give consideration to information pertinent to the specific nature of the debt or equity investment, such as relevant market conditions, offering prices, operating results, financial conditions, exit strategy and other qualitative information, as available. The lack of an independent source to validate fair value estimates, including the impact of future capital calls and transfer restrictions, is an inherent limitation in the valuation process. Commitments to fund additional investments in nonmarketable equity securities recorded at fair value were $3.3 million and $4.0 million at September 30, 2012 and December 31, 2011, respectively.

Warrants are valued based upon the Black-Scholes option-pricing model that uses discount rates and stock volatility factors of comparable companies as inputs. These inputs are subject to management judgment to account for differences between the measured investment and comparable companies and are reported as Level 3 assets.

Securities Sold, But Not Yet Purchased

Equity securities that are valued based on quoted prices in active markets and reported in Level 1.

Derivatives

Derivatives are valued using quoted market prices when available or pricing models based on the net present value of estimated future cash flows. The valuation models used require market observable inputs, including contractual terms, market prices, yield curves, credit curves, and measures of volatility. We manage credit risk for our derivative positions on a counterparty-by-counterparty basis and calculate credit valuation adjustments, included in the fair value of these instruments, on the basis of our relationships at the counterparty portfolio/master netting agreement level. These credit valuation adjustments are determined by applying a credit spread for the counterparty to the total expected exposure of the derivative after considering collateral and other master netting arrangements. We have classified our interest rate swaps as Level 2.

Assets and liabilities measured at fair value on a recurring basis as of September 30, 2012 and December 31, 2011 are presented below:


	September 30, 2012
	Total		Level 1		Level 2		Level 3
Assets:
Cash equivalents	$	26,675	$	26,675	$	-	$	-
Trading securities owned:
U.S. government agency securities		144,286		-		144,286		-
U.S. government securities		8,059		8,059		-		-
Corporate securities:
Fixed income securities		391,981		68,005		320,505		3,471
Equity securities		39,829		37,482		2,347		-
State and municipal securities		162,058		-		162,058		-
Total trading securities owned		746,213		113,546		629,196		3,471
Available-for-sale securities:
U.S. government agency securities		1,115		-		1,115		-
State and municipal securities		142,586		-		58,490		84,096
Mortgage-backed securities:
Agency		520,332		-		520,332		-
Commercial		269,808		-		269,808		-
Non-agency		14,765		-		14,765		-
Corporate fixed income securities		500,982		331,244		158,209		11,529
Asset-backed securities		27,093		-		27,093		-
Total available-for-sale securities		1,476,681		331,244		1,049,812		95,625
Investments:
Corporate equity securities		26,111		25,413		698		-
Corporate preferred securities		46,558		-		46,558
Mutual funds		17,750		17,750		-		-
U.S. government securities		7,068		7,068		-		-
Auction rate securities:
Equity securities		67,887		-		-		67,887
Municipal securities		10,778		-		-		10,778
Other		38,609		1,551		341		36,717
Total investments		214,761		51,782		47,597		115,382
	$	2,464,330	$	523,247	$	1,726,605	$	214,478

Liabilities:
Trading securities sold, but not yet purchased
U.S. government securities	$	148,876	$	148,876	$	-	$	-
U.S. government agency securities		8,464		-		8,464		-
Corporate securities:
Fixed income securities		173,157		45,814		127,343		-
Equity securities		39,284		37,928		1,356		-
State and municipal securities		105		-		105		-
Total trading securities sold, but not yet purchased		369,886		232,618		137,268		-
Securities sold, but not yet purchased		22,194		22,194		-		-
Derivative contracts⁽¹⁾		22,455		-		22,455		-
	$	414,535	$	254,812	$	159,723	$	-

⁽¹⁾ Included in accounts payable and accrued expenses in the consolidated statements of financial condition.


	December 31, 2011
	Total		Level 1		Level 2		Level 3
Assets:
Cash equivalents	$	14,156	$	14,156	$	-	$	-
Trading securities owned:
U.S. government agency securities		66,424		-		66,424		-
U.S. government securities		32,845		32,845		-		-
Corporate securities:
Fixed income securities		244,535		31,398		209,395		3,742
Equity securities		19,859		19,506		353		-
State and municipal securities		111,288		-		111,288		-
Total trading securities owned		474,951		83,749		387,460		3,742
Available-for-sale securities:
U.S. government agency securities		1,103		-		1,103		-
State and municipal securities		86,932		-		20,036		66,896
Mortgage-backed securities:
Agency		404,662		-		404,662		-
Commercial		271,510		-		271,510		-
Non-agency		17,460		-		17,460		-
Corporate fixed income securities		405,985		153,855		240,130		12,000
Asset-backed securities		26,489		-		26,489		-
Total available-for-sale securities		1,214,141		153,855		981,390		78,896
Investments:
Corporate equity securities		23,921		23,921		-		-
Mutual funds		33,958		33,958		-		-
Auction rate securities:
Equity securities		103,176		-		-		103,176
Municipal securities		11,729		-		-		11,729
Other		38,424		1,055		336		37,033
Total investments		211,208		58,934		336		151,938
	$	1,914,456	$	310,694	$	1,369,186	$	234,576

Liabilities:
Trading securities sold, but not yet purchased
U.S. government securities	$	109,776	$	109,776	$	-	$	-
U.S. government agency securities		954		-		954		-
Corporate securities:
Fixed income securities		149,460		74,719		74,741		-
Equity securities		6,060		6,019		41		-
State and municipal securities		583		-		583		-
Total trading securities sold, but not yet purchased		266,833		190,514		76,319		-
Securities sold, but not yet purchased		19,223		19,223		-		-
Derivative contracts⁽¹⁾		24,877		-		24,877		-
	$	310,933	$	209,737	$	101,196	$	-

⁽¹⁾ Included in accounts payable and accrued expenses in the consolidated statements of financial condition.

Our investment in a senior preferred interest in Miller Buckfire & Co. LLC (“Miller Buckfire”), which is included in investments in the consolidated statements of financial condition, is carried at cost and therefore not included in the above analysis of fair value at September 30, 2012 and December 31, 2011.

The following table summarizes the changes in fair value carrying values associated with Level 3 financial instruments during the three and nine months ended September 30, 2012 (in thousands):


	Three Months Ended September 30, 2012
							Investments
	Corporate Fixed Income Securities⁽¹⁾		State & Municipal Securities		Corporate Fixed Income Securities			Auction Rate Securities - Equity		Auction Rate Securities - Municipal		Other

Balance June 30, 2011	$	12,808	$	100,730	$	12,000		$	80,037	$	11,503	$	39,091
Unrealized gains/(losses):
Included in changes in net assets⁽²⁾		-		-		-			(350)		25		(172)
Included in OCI⁽³⁾		-		366		-			-		-		-
Realized gains/(losses) ⁽²⁾		233		-		-			-		-		(132)
Purchases		2,786				-			50				117
Sales		(8,798)		-		-			-		-		(2,187)
Redemptions		(434)		(17,000)		(471)			(11,850)		(750)		-
Transfers:
Into Level 3		-		-		-			-		-		-
Out of Level 3		(3,124)		-		-			-		-		-
Net change		(9,337)		(16,634)		(471)			(12,150)		(725)		(2,374)
Balance September 30, 2012	$	3,471	$	84,096	$	11,529		$	67,887	$	10,778	$	36,717


	Nine Months Ended September 30, 2012
							Investments
	Corporate Fixed Income Securities⁽¹⁾		State & Municipal Securities		Corporate Fixed Income Securities			Auction Rate Securities - Equity		Auction Rate Securities - Municipal		Other

Balance December 31, 2011	$	3,742	$	66,896	$	12,000		$	103,176	$	11,729	$	37,033
Unrealized gains/(losses):
Included in changes in net assets⁽²⁾		47		-		-			86		94		2,659
Included in OCI⁽³⁾		-		(918)		-			-		-		-
Realized gains/(losses) ⁽²⁾		361		118		-			-		-		521
Purchases		24,694		37,000		-			2,850		2,255		1,361
Sales		(20,225)		-		-			-		-		(4,857)
Redemptions		(434)		(19,000)		(471)			(38,225)		(3,300)		-
Transfers:
Into Level 3		2,686		-		-			-		-		-
Out of Level 3		(7,400)		-		-			-		-		-
Net change		(271)		17,200		(471)			(35,289)		(951)		(316)
Balance September 30, 2012	$	3,471	$	84,096	$	11,529		$	67,887	$	10,778	$	36,717

⁽¹⁾ Included in trading securities owned in the consolidated statements of financial condition.
⁽²⁾ Realized and unrealized gains/(losses) related to trading securities and investments are reported in other income in the consolidated statements of operations.
⁽³⁾ Unrealized gains/(losses) related to available-for-sale securities are reported in accumulated other comprehensive loss in the consolidated statements of financial condition.

The results included in the table above are only a component of the overall investment strategies of our company. The table above does not present Level 1 or Level 2 valued assets or liabilities. The changes to our company’s Level 3 classified instruments were principally a result of: unrealized gains and losses, and redemptions of ARS at par during the three and nine months ended September 30, 2012. The changes in unrealized gains/(losses) recorded in earnings for the three and nine months ended September 30, 2012 relating to Level 3 assets still held at September 30, 2012 were immaterial.

The following table summarizes quantitative information related to the significant unobservable inputs utilized in our company’s Level 3 recurring fair value measurements as of September 30, 2012.




	Valuation Technique	Unobservable input	Range	Weighted average

Available-for-sale securities:
State and municipal securities	Discounted cash flow	Discount rate	1.8% - 9.6%	4.9%
		Workout period	2 - 4 years	3.1 years

Investments:
Auction rate securities
Equity securities	Discounted cash flow	Discount rate	1.5% - 11.7%	6.8%
		Workout period	1 - 3 years	2.7 years

Municipal securities	Discounted cash flow	Discount rate	0.4% - 10.0%	5.0%
		Workout period	1 - 4 years	2.6 years

Other
Investments in partnerships	Market approach	Revenue multiple	1.5 - 3.7	2.8
		EBITDA multiple	6.3 - 14.6	10.4

Private equity investments	Market approach	Revenue multiple	1.4 - 3.2	2.8
		EBITDA multiple	7.8 - 17.4	12.5

The fair value of certain Level 3 assets was determined using various methodologies as appropriate, including NAVs of underlying investments, third-party pricing vendors, broker quotes and market and income approaches. These inputs are evaluated for reasonableness through various procedures, including due diligence reviews of third-party pricing vendors, variance analyses, consideration of current market environment and other analytical procedures.

Stifel Bank’s investment in a senior preferred interest in Miller Buckfire, which is included in the available for sale portfolio as a Level 3 asset, is carried at the transaction price until significant transactions or development indicate that a change in the fair value is appropriate.

The fair value for our auction-rate securities was determined using an income approach based on an internally developed discounted cash flow model. The discounted cash flow model utilizes two significant unobservable inputs: discount rate and workout period. The discount rate was calculated using credit spreads of the underlying collateral or similar securities. The workout period was based on an assessment of publicly available information on efforts to re-establish functioning markets for these securities and our company’s own redemption experience. Significant increases in any of these inputs in isolation would result in a significantly lower fair value. On an on-going basis, management verifies the fair value by reviewing the appropriateness of the discounted cash flow model and its significant inputs.

General and limited partnership interests in investment partnerships totaled $21.4 million at September 30, 2012. The general and limited partnership interests in investment partnerships were primarily valued based upon NAVs received from third-party fund managers. The various partnerships are investment companies, which record their underlying investments at fair value based on fair value policies established by management of the underlying fund. Fair value policies at the underlying fund generally require the funds to utilize pricing/valuation information, including independent appraisals, from third-party sources. However, in some instances, current valuation information for illiquid securities or securities in markets that are not active may not be available from any third-party source or fund management may conclude that the valuations that are available from third-party sources are not reliable. In these instances, fund management may perform model-based analytical valuations that may be used as an input to value these investments.

Direct investments in private equity companies totaled $13.1 million at September 30, 2012. Direct investments in private equity companies may be valued using the market approach or the income approach, or a combination thereof, and were valued based on an assessment of each underlying investment, incorporating evaluation of additional significant third-party financing, changes in valuations of comparable peer companies, the business environment of the companies, market indices, assumptions relating to appropriate risk adjustments for nonperformance and legal restrictions on disposition, among other factors. The fair value derived from the methods used are evaluated and weighted, as appropriate, considering the reasonableness of the range of values indicated. Under the market approach, fair value may be determined by reference to multiples of market-comparable companies or transactions, including earnings before interest, taxes, depreciation and amortization (“EBITDA”) multiples. Under the income approach, fair value may be determined by discounting the cash flows to a single present amount using current market expectations about those future amounts. Unobservable inputs used in a discounted cash flow model may include projections of operating performance generally covering a five-year period and a terminal value of the private equity direct investment. For securities utilizing the discounted cash flow valuation technique, a significant increase (decrease) in the discount rate, risk premium or discount for lack of marketability in isolation could result in a significantly lower (higher) fair value measurement. For securities utilizing the market comparable companies valuation technique, a significant increase (decrease) in the EBITDA multiple in isolation could result in a significantly higher (lower) fair value measurement.

Transfers Within the Fair Value Hierarchy

We assess our financial instruments on a quarterly basis to determine the appropriate classification within the fair value hierarchy. Transfers between fair value classifications occur when there are changes in pricing observability levels. Transfers of financial instruments among the levels are deemed to occur at the beginning of the reporting period. There were $6.2 million and $10.2 million of transfers of financial assets from Level 2 to Level 1 during the three and nine months ended September 30, 2012, respectively, primarily related to tax-exempt securities for which market trades were observed that provided transparency into the valuation of these assets. There were $3.0 million and $17.1 million of transfers of financial assets from Level 1 to Level 2 during the three and nine months ended September 30, 2012, respectively, primarily related to tax-exempt securities for which there were low volumes of recent trade activity observed. There were $3.1 million and $7.4 million of transfers of financial assets from Level 3 to Level 2 during the three and nine months ended September 30, 2012, respectively, related to corporate fixed income securities for which market trades were observed that provided transparency into the valuation of these assets. There were no transfers of financial assets into Level 3 during the three months ended September 30, 2012. There were $2.7 million of transfers of financial assets into Level 3 during the nine months ended September 30, 2012 related to corporate fixed income securities for which there were low volumes of recent trade activity observed.

Fair Value of Financial Instruments

The following reflects the fair value of financial instruments, as of September 30, 2012 and December 31, 2011, whether or not recognized in the consolidated statements of financial condition at fair value (in thousands).


	September 30, 2012				December 31, 2011
	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Financial assets:
Cash and cash equivalents	$	193,333	$	193,333	$	167,671		167,671
Restricted cash		6,589		6,589		6,883		6,883
Cash segregated for regulatory purposes		28		28		26		26
Securities purchased under agreements to resell		141,964		141,964		75,455		75,455
Trading securities owned		746,213		746,213		474,951		474,951
Available-for-sale securities		1,476,681		1,476,681		1,214,141		1,214,141
Held-to-maturity securities		657,933		664,593		190,484		189,071
Loans held for sale		209,358		209,358		131,754		131,754
Bank loans		746,567		765,467		632,140		639,341
Investments		242,674		242,674		239,208		239,208
Financial liabilities:
Securities sold under agreements to repurchase	$	78,437	$	78,437	$	80,176	$	80,176
Bank deposits		2,923,671		2,924,394		2,071,738		2,067,324
Trading securities sold, but not yet purchased		369,886		369,886		266,833		266,833
Securities sold, but not yet purchased		22,194		22,194		19,223		19,223
Derivative contracts⁽¹⁾		22,455		22,455		24,877		24,877
Senior notes		175,000		185,034		-		-
Debentures to Stifel Financial Capital Trusts		82,500		53,517		82,500		67,594
Liabilities subordinated to claims of general creditors		5,318		5,162		6,957		6,671

⁽¹⁾ Included in accounts payable and accrued expenses in the consolidated statements of financial condition.

The following table presents the estimated fair values of financial instruments not measured at fair value on a recurring basis (in thousands):


	September 30, 2012 (1)
	Total		Level 1		Level 2		Level 3
Financial assets:
Cash	$	166,658	$	166,658	$	-	$	-
Restricted cash		6,589		6,589		-		-
Cash segregated for regulatory purposes		28		28		-		-
Securities purchased under agreements to resell		141,964		141,964		-		-
Held-to-maturity securities		664,593		14,796		39,672		610,125
Loans held for sale		209,358		-		209,358		-
Bank loans		765,467		-		765,467		-
Investments		-		-		-
Financial liabilities:
Securities sold under agreements to repurchase	$	78,437	$	32,841	$	45,596	$	-
Bank deposits		2,924,394		-		2,924,394		-
Senior notes		185,034		185,034		-		-
Debentures to Stifel Financial Capital Trusts		53,517		-		-		53,517
Liabilities subordinated to claims of general creditors		5,162		-		-		5,162

⁽¹⁾We adopted the provisions of Update No. 2011-04 in the first quarter of 2012 on a prospective basis. Accordingly, disclosures for prior periods are not presented.

The following, as supplemented by the discussion above, describes the valuation techniques used in estimating the fair value of our financial instruments as of September 30, 2012 and December 31, 2011.

Financial Assets

Securities Purchased Under Agreements to Resell

Securities purchased under agreements to resell are collateralized financing transactions that are recorded at their contractual amounts plus accrued interest. The carrying values at September 30, 2012 and December 31, 2011 approximate fair value due to the short-term nature.

Held-to-Maturity Securities

Securities held to maturity are recorded at amortized cost based on our company’s positive intent and ability to hold these securities to maturity. Securities held to maturity include asset-backed securities, consisting of corporate obligations, collateralized debt obligation securities and ARS. The estimated fair value, included in the above table, is determined using several factors; however, primary weight is given to discounted cash flow modeling techniques that incorporated an estimated discount rate based upon recent observable debt security issuances with similar characteristics.

Loans Held for Sale

Loans held for sale consist of fixed-rate and adjustable-rate residential real estate mortgage loans intended for sale. Loans held for sale are stated at lower of cost or fair value. Fair value is determined based on prevailing market prices for loans with similar characteristics or on sale contract prices.

Bank Loans

The fair values of mortgage loans and commercial loans were estimated using a discounted cash flow method, a form of the income approach. Discount rates were determined considering rates at which similar portfolios of loans would be made under current conditions and considering liquidity spreads applicable to each loan portfolio based on the secondary market.

Financial Liabilities

Securities Sold Under Agreements to Repurchase

Securities sold under agreements to repurchase are collateralized financing transactions that are recorded at their contractual amounts plus accrued interest. The carrying values at September 30, 2012 and December 31, 2011 approximate fair value due to the short-term nature.

Bank Deposits

The fair value for demand deposits is equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying amounts of variable-rate money-market and savings accounts approximate their fair values at the reporting date as these are short-term in nature. The fair value of other interest-bearing deposits, including certificates of deposit, was calculated by discounting the future cash flows using discount rates based on the expected current market rates for similar products with similar remaining terms.

Senior Notes

The fair value of our 6.70% senior notes is estimated based upon quoted market prices.

Debentures to Stifel Financial Capital Trusts

The fair value of our trust preferred securities is based on the discounted value of contractual cash flows. We have assumed a discount rate based on the coupon achieved in our 6.7% senior notes due 2022.

Liabilities Subordinated to Claims of General Creditors

The fair value of subordinated debt was measured using the interest rates commensurate with borrowings of similar terms.

These fair value disclosures represent our best estimates based on relevant market information and information about the financial instruments. Fair value estimates are based on judgments regarding future expected losses, current economic conditions, risk characteristics of the various instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in the above methodologies and assumptions could significantly affect the estimates.