NOTE 4 – Fair Value Measurements

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

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 cash flow 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.

Financial Instruments Owned and Available-For-Sale Securities

When available, the fair value of financial instruments is 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 equity securities listed in active markets, corporate fixed income securities, U.S. government securities, and U.S. government agency securities.

If quoted prices are not available for identical instruments, 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 has 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 include U.S. government agency securities, mortgage-backed securities, corporate fixed income and equity securities infrequently traded, state and municipal securities, sovereign debt, and asset-backed securities, which primarily include collateralized loan obligations.

We have identified Level 3 financial instruments to include certain equity securities with unobservable pricing inputs and certain non-agency mortgage-backed securities. Level 3 financial instruments have little to no pricing observability as of the report date. These financial instruments do not have active two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

Investments

Investments carried at fair value primarily include corporate equity securities, auction-rate securities (“ARS”), and private company investments.

Corporate equity securities are valued based on quoted prices in active markets and reported in Level 1. No securities with unobservable pricing inputs are reported in Level 3.

ARS are valued based upon our expectations of issuer redemptions and using internal discounted cash flow models that utilize unobservable inputs. ARS are reported as Level 3 assets.

Direct investments in private companies, reported as Level 3 assets, may be valued using the market approach 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. 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.

Investments in Funds That Are Measured at Net Asset Value Per Share

The Company’s investments in funds measured at NAV include private company investments, partnership interests, mutual funds, private equity funds, and money market funds. Private equity funds primarily invest in a broad range of industries worldwide in a variety of situations, including leveraged buyouts, recapitalizations, growth investments and distressed investments. The private equity funds are primarily closed-end funds in which the Company’s investments are generally not eligible for redemption. Distributions will be received from these funds as the underlying assets are liquidated or distributed.

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.

The tables below present the fair value of our investments in, and unfunded commitments to, funds that are measured at NAV (in thousands):

	September 30, 2018
	Fair value of investments		Unfunded commitments
Money market funds	$	18,696	$	—
Mutual funds		10,506		—
Private equity funds		3,394		1,535
Partnership interests		4,405		1,324
Total	$	37,001	$	2,859

	December 31, 2017
	Fair value of investments		Unfunded commitments
Money market funds	$	77,441	$	—
Mutual funds		11,748		—
Private equity funds		7,677		1,825
Partnership interests		5,124		1,330
Total	$	101,990	$	3,155

Financial Instruments Sold, But Not Yet Purchased

Financial instruments sold, but not purchased, recorded at fair value based on quoted prices in active markets and other observable market data include highly liquid instruments with quoted prices, such as U.S. government securities, corporate fixed income securities, and equity securities listed in active markets, which are reported as Level 1.

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 has 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 include U.S. government agency securities, mortgage-backed securities not actively traded, corporate fixed income securities, and sovereign debt.

Derivatives

Derivatives are valued using quoted market prices for identical instruments 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, 2018, are presented below (in thousands):

	September 30, 2018
	Total		Level 1		Level 2		Level 3
Financial instruments owned:
U.S. government securities	$	36,214	$	36,214	$	—	$	—
U.S. government agency securities		167,886		—		167,886		—
Mortgage-backed securities:
Agency		380,044		—		380,044		—
Non-agency		23,747		—		23,746		1
Asset-backed securities		29,806		—		29,451		355
Corporate securities:
Fixed income securities		290,627		262		290,365		—
Equity securities		69,205		68,892		212		101
Sovereign debt		15,996		—		15,996		—
State and municipal securities		149,207		—		149,207		—
Total financial instruments owned		1,162,732		105,368		1,056,907		457
Available-for-sale securities:
U.S. government agency securities		5,165		516		4,649		—
State and municipal securities		68,876		—		68,876		—
Mortgage-backed securities:
Agency		250,808		—		250,808		—
Commercial		68,823		—		68,823		—
Non-agency		1,269		—		1,269		—
Corporate fixed income securities		1,177,315		—		1,177,315		—
Asset-backed securities		1,777,351		—		1,777,351		—
Total available-for-sale securities		3,349,607		516		3,349,091		—
Investments:
Corporate equity securities		42,495		42,495		—		—
Auction rate securities:
Equity securities		16,525		—		—		16,525
Municipal securities		799		—		—		799
Other		1,046		—		189		857
Investments in funds measured at NAV		18,305
Total investments		79,170		42,495		189		18,181
Cash equivalents measured at NAV		18,696
Derivative contracts ⁽¹⁾		11,117				11,117
	$	4,621,322	$	148,379	$	4,417,304	$	18,638

⁽¹⁾	Included in other assets in the consolidated statements of financial condition.

	September 30, 2018
	Total		Level 1		Level 2		Level 3
Liabilities:
Financial instruments sold, but not yet purchased:
U.S. government securities	$	512,275	$	512,275	$	—	$	—
Mortgage-backed securities:
Agency		95,312		—		95,312		—
Corporate securities:
Fixed income securities		213,335		96		213,239		—
Equity securities		78,895		78,895		—		—
Sovereign debt		11,557		—		11,557		—
Total financial instruments sold, but not yet purchased	$	911,374	$	591,266	$	320,108	$	—

Assets and liabilities measured at fair value on a recurring basis as of December 31, 2017, are presented below (in thousands):

	December 31, 2017
	Total		Level 1		Level 2		Level 3
Financial instruments owned:
U.S. government securities	$	13,466	$	13,466	$	—	$	—
U.S. government agency securities		147,223		—		147,223		—
Mortgage-backed securities:
Agency		302,445		—		302,445		—
Non-agency		29,356		—		29,355		1
Asset-backed securities		76,752		—		76,395		357
Corporate securities:
Fixed income securities		325,471		362		324,867		242
Equity securities		46,802		46,411		138		253
Sovereign debt		32,470		—		32,470		—
State and municipal securities		169,699		—		169,699		—
Total financial instruments owned		1,143,684		60,239		1,082,592		853
Available-for-sale securities:
U.S. government agency securities		4,983		516		4,467		—
State and municipal securities		70,559		—		70,559		—
Mortgage-backed securities:
Agency		305,530		—		305,530		—
Commercial		72,488		—		72,488		—
Non-agency		1,568		—		1,568		—
Corporate fixed income securities		1,211,442		—		1,211,442		—
Asset-backed securities		2,106,938		—		2,106,938		—
Total available-for-sale securities		3,773,508		516		3,772,992		—
Investments:
Corporate equity securities		49,978		49,978		—		—
Auction rate securities:
Equity securities		34,789		—		—		34,789
Municipal securities		846		—		—		846
Other		1,217		—		360		857
Investments measured at NAV		24,549
Total investments		111,379		49,978		360		36,492
Cash equivalents measured at NAV		77,441
Derivative contracts ⁽¹⁾		7,995		—		7,995		—
	$	5,114,007	$	110,733	$	4,863,939	$	37,345

⁽¹⁾	Included in other assets in the consolidated statements of financial condition.

	December 31, 2017
	Total		Level 1		Level 2		Level 3
Liabilities:
Financial instruments sold, but not yet purchased:
U.S. government securities	$	442,402	$	442,402	$	—	$	—
U.S. government agency securities		10,348		—		10,348		—
Mortgage-backed securities:
Agency		86,612		—		86,612		—
Corporate securities:
Fixed income securities		180,755		—		180,755		—
Equity securities		38,510		38,070		440		—
Sovereign debt		20,236		—		20,236		—
Total financial instruments sold, but not yet purchased	$	778,863	$	480,472	$	298,391	$	—

The following table summarizes the changes in fair value associated with Level 3 financial instruments during the three months ended September 30, 2018 (in thousands):

	Three Months Ended September 30, 2018
	Financial instruments owned							Investments
	Mortgage- Backed Securities – Non-Agency		Asset-Backed Securities		Equity Securities			Auction Rate Securities – Equity			Auction Rate Securities – Municipal			Other
Balance at June 30, 2018	$	1	$	355	$	123		$	25,303		$	846		$	857
Unrealized gains/(losses):
Included in changes in net assets ⁽¹⁾		—		—		—			997			3			—
Realized gains/(losses) ⁽¹⁾		—		—		(22	)		—			—			—
Purchases		—		—		—			—			—			—
Sales		—		—		—			—			—			—
Redemptions		—		—		—			(9,775	)		(50	)		—
Transfers:
Into Level 3		—		—		—			—			—			—
Out of Level 3		—		—		—			—			—			—
Net change		—		—		(22	)		(8,778	)		(47	)		—
Balance at September 30, 2018	$	1	$	355	$	101		$	16,525		$	799		$	857

⁽¹⁾	Realized and unrealized gains/(losses) related to financial instruments owned and investments are reported in other income in the consolidated statements of operations.

The following table summarizes the change in fair value associated with Level 3 financial instruments during the nine months ended September 30, 2018 (in thousands):

	Nine Months Ended September 30, 2018
	Financial instruments owned											Investments
	Mortgage- Backed Securities – Non-Agency		Asset-Backed Securities			Fixed Income Securities			Equity Securities			Auction Rate Securities – Equity			Auction Rate Securities – Municipal			Other
Balance at December 31, 2017	$	1	$	357		$	242		$	253		$	34,789		$	846		$	857
Unrealized gains/(losses):
Included in changes in net assets ⁽¹⁾		—		3			—			(130	)		1,086			3			—
Realized gains/(losses) ⁽¹⁾		—		—			—			(22	)		—			—			—
Purchases		—		—			—			—			—			—			—
Sales		—		—			—			—			—			—			—
Redemptions		—		(5	)		(242	)		—			(19,350	)		(50	)		—
Transfers:
Into Level 3		—		—			—			—			—			—			—
Out of Level 3		—		—			—			—			—			—			—
Net change		—		(2	)		(242	)		(152	)		(18,264	)		(47	)		—
Balance at September 30, 2018	$	1	$	355		$	—		$	101		$	16,525		$	799		$	857

⁽¹⁾	Realized and unrealized gains/(losses) related to financial instruments owned and investments are reported in other income in the consolidated statements of operations.

The results included in the tables above are only a component of the overall investment strategies of our company. The tables above do not present Level 1 or Level 2 valued assets or liabilities. The changes in unrealized gains/(losses) recorded in earnings for the three and nine months ended September 30, 2018, relating to Level 3 assets still held at September 30, 2018, 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, 2018.

	Valuation technique	Unobservable input	Range	Weighted average
Investments:
Auction rate securities:
Equity securities	Discounted cash flow	Discount rate	0.6% - 6.5%	3.8%
		Workout period	2-3 years	2.4 years
Municipal securities	Discounted cash flow	Discount rate	0.5% - 9.9%	3.2%
		Workout period	1-4 years	2.0 years

The fair value of certain Level 3 assets was determined using various methodologies, as appropriate, including third-party pricing vendors and broker quotes. 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.

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 ongoing basis, management verifies the fair value by reviewing the appropriateness of the discounted cash flow model and its significant inputs.

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 no transfers of financial assets from Level 2 to Level 1 during the three months ended September 30, 2018. There were $0.6 million of transfers of financial assets from Level 2 to Level 1 during the nine months ended September 30, 2018. There were $0.1 million and $0.7 million of transfers of financial assets from Level 1 to Level 2 during the three and nine months ended September 30, 2018, respectively, primarily related to corporate fixed income securities for which there were low volumes of recent trade activity observed. There were no transfers into or out of Level 3 during the nine months ended September 30, 2018.

Fair Value of Financial Instruments

The following reflects the fair value of financial instruments as of September 30, 2018 and December 31, 2017, whether or not recognized in the consolidated statements of financial condition at fair value (in thousands).

	September 30, 2018				December 31, 2017
	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value
Financial assets:
Cash and cash equivalents	$	694,302	$	694,302	$	696,283	$	696,283
Cash segregated for regulatory purposes		21,585		21,585		90,802		90,802
Securities purchased under agreements to resell		622,361		622,361		512,220		512,220
Financial instruments owned		1,162,732		1,162,732		1,143,684		1,143,684
Available-for-sale securities		3,349,607		3,349,607		3,773,508		3,773,508
Held-to-maturity securities		4,565,453		4,506,385		3,698,098		3,710,478
Loans held for sale		262,063		262,063		226,068		226,068
Bank loans		8,253,989		8,330,974		6,947,759		6,953,328
Investments		79,170		79,170		111,379		111,379
Derivative contracts ⁽¹⁾		11,117		11,117		7,995		7,995

Financial liabilities:
Securities sold under agreements to repurchase	$	495,484	$	495,484	$	233,704	$	233,704
Bank deposits		14,502,952		13,711,447		13,411,935		12,702,746
Financial instruments sold, but not yet purchased		911,374		911,374		778,863		778,863
Federal Home Loan Bank advances		1,064,000		1,064,000		745,000		745,000
Borrowings		140,030		140,030		256,000		256,000
Senior notes		1,015,714		1,012,374		1,014,940		1,044,768
Debentures to Stifel Financial Capital Trusts		67,500		68,839		67,500		64,962

⁽¹⁾	Included in other assets 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 as of September 30, 2018 and December 31, 2017 (in thousands):

	September 30, 2018
	Total		Level 1		Level 2		Level 3
Financial assets:
Cash	$	675,606	$	675,606	$	—	$	—
Cash segregated for regulatory purposes		21,585		21,585		—		—
Securities purchased under agreements to resell		622,361		586,829		35,532		—
Held-to-maturity securities		4,506,385		—		4,345,021		161,364
Loans held for sale		262,063		—		262,063		—
Bank loans		8,330,974		—		8,330,974		—
Financial liabilities:
Securities sold under agreements to repurchase	$	495,484	$	126,378	$	369,106	$	—
Bank deposits		13,711,447		—		13,711,447		—
Federal Home Loan Bank advances		1,064,000		1,064,000		—		—
Borrowings		140,030		140,030		—		—
Senior notes		1,012,374		1,012,374		—		—
Debentures to Stifel Financial Capital Trusts		68,839		—		—		68,839

	December 31, 2017
	Total		Level 1		Level 2		Level 3
Financial assets:
Cash	$	618,842	$	618,842	$	—	$	—
Cash segregated for regulatory purposes		90,802		90,802		—		—
Securities purchased under agreements to resell		512,220		428,740		83,480		—
Held-to-maturity securities		3,710,478		—		3,517,781		192,697
Loans held for sale		226,068		—		226,068		—
Bank loans		6,953,328		—		6,953,328		—
Financial liabilities:
Securities sold under agreements to repurchase	$	233,704	$	92,278	$	141,426	$	—
Bank deposits		12,702,746		—		12,702,746		—
Federal Home Loan Bank advances		745,000		745,000		—		—
Borrowings		256,000		256,000		—		—
Senior notes		1,044,768		1,044,768		—		—
Debentures to Stifel Financial Capital Trusts		64,962		—		—		64,962

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, 2018 and December 31, 2017.

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, 2018 and December 31, 2017 approximate fair value due to their 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 agency mortgage-backed securities, asset-backed securities, consisting of collateralized loan obligation securities and corporate fixed income securities. 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 market value. Market 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, with similar remaining maturities, would be made 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, 2018 and December 31, 2017 approximate fair value due to the short-term nature.

Bank Deposits

The fair value of interest-bearing deposits, including certificates of deposits, demand deposits, savings, and checking accounts, was calculated by discounting the future cash flows using discount rates based on the replacement cost of funding of similar structures and terms.

Borrowings

The carrying amount of borrowings approximates fair value due to the relative short-term nature of such borrowings. In addition, Stifel Bancorp’s FHLB advances reflect terms that approximate current market rates for similar borrowings.

Senior Notes

The fair value of our 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 4.250% senior notes due 2024.

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.