UNITED STATES SECURITIES AND EXCHANGE
COMMISSION Washington, D.C. 20549  
  FORM 10-Q  (Mark
One) xQUARTERLY REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934  For the quarterly period ended
September 30, 2006  OR   ̈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
  
  13-4055775(State or Other Jurisdiction of
  Incorporation or Organization)
  
  (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 ̈   
No  x  Indicate by check mark whether the registrant
is a large accelerated filer, an accelerated filer or a non-accelerated filer. See
definition of accelerated filer and large accelerated filer in Rule 12b-2 of
the Exchange Act. (Check one):  Large Accelerated Filer ̈                Accelerated Filer    ̈           Non-Accelerated
Filer   x  Indicate by check mark whether the registrant
is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ̈    No  x  The number of shares of the Registrants
common stock, par value $0.01 per share, outstanding as of December 13,
2006 was 30,579,092.


TABLE OF CONTENTS  PageNumberAvailable Information
  
  3PART I.
  FINANCIAL INFORMATION
  
  4Item 1.
  Financial Statements
  
  4Consolidated Statements of Financial
  Condition
  September 30, 2006 (Unaudited) and December 31, 2005
  
  4Consolidated Statements of Income
  Three and Nine Months ended September 30, 2006 and 2005 (Unaudited)
  
  5Consolidated Statements of Changes in
  Mandatorily Redeemable Common Stock
  Nine Months ended September 30, 2006 and 2005(Unaudited)
  
  6Consolidated Statements of Cash Flows
  Nine Months ended September 30, 2006 and 2005(Unaudited)
  
  8Notes to Consolidated Financial Statements
  
  10Item 2.
  Managements Discussion and Analysis of
  Financial Condition and Results of Operations
  
  22Item 3.
  Quantitative and Qualitative Disclosures
  About Market Risk
  
  44Item 4.
  Controls and Procedures
  
  44PART II.
  OTHER INFORMATION
  
  45Item 1.
  Legal Proceedings
  
  45Item 1A.
  Risk Factors
  
  46Item 2.
  Unregistered Sales of Equity Securities and
  Use of Proceeds
  
  46Item 3.
  Defaults Upon Senior Securities
  
  47Item 4.
  Submission of Matters to a Vote of Security
  Holders
  
  47Item 5.
  Other Information
  
  47Item 6.
  Exhibits
  
  47SIGNATURES
  
  48EXHIBIT INDEX
  
  49  2


AVAILABLE
INFORMATION  KBW, Inc. is 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 (SEC). You may read
and copy any document KBW, Inc. files 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
KBW, Inc.s SEC filings.  KBW, Inc. will
make available free of charge through its internet site http://www.kbw.com, via
a link to the SECs internet site at http://www.sec.gov, its 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.  KBW, Inc. also
makes available, on the Investor Relations page of its website, its (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 its Board of Directors. You will need
to have Adobe Acrobat 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
Corporate Secretary, 787 Seventh Avenue, 4th Floor, 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 quarterly report.  When we use
the terms KBW, KBW, Inc., the Company, we, us and our, we mean the
combined business of KBW, Inc., a Delaware corporation, and of its consolidated
subsidiaries, unless the context otherwise indicates.  3


PART I.FINANCIAL INFORMATION  ITEM 1.Financial Statements  KBW, Inc. and Subsidiaries Consolidated
Statements of Financial Condition September 30, 2006 and December 31, 2005 (Dollars in thousands)  September 30,
  2006
  (unaudited)
  
  December 31,
  2005AssetsCash and
  cash equivalents
  
  $
  75,954
  
  $
  75,642Securities
  Owned, at fair value:Equities
  
  94,836
  
  81,018Corporate bonds
  
  229,293
  
  221,261U.S. Government and agency securities
  
  7,125
  
  11,345Mortgage Backed Securities
  
  9,437
  
  340,691
  
  313,624Securities not readily marketable, at fair
  value
  
  92,166
  
  73,012Securities purchased under resale
  agreements
  
  32,748
  
  30,633Receivables from clearing brokers
  
  133,933
  
  91,630Accounts receivable
  
  14,898
  
  25,787Furniture, equipment, and leasehold
  improvements, at cost less accumulated depreciation and amortization of
  $18,656 in 2006 and $14,348 in 2005
  
  22,123
  
  24,615Other assets
  
  13,582
  
  13,355Total assets
  
  $
  726,095
  
  $
  648,298Liabilities Including Mandatorily
  Redeemable Common StockPayable to clearing broker
  
  $
  23,924
  
  $
  78,729Securities sold under repurchase agreements
  
  86,691
  
  2,275Short-term borrowings
  
  32,250
  
  63,750Securities sold, not yet purchased, at fair
  value:Equities
  
  39,440
  
  21,187Corporate bonds
  
  8,826
  
  12,191U.S. Government and agency securities
  
  103,874
  
  63,621152,140
  
  96,999Accounts payable, accrued expenses, and
  other liabilities
  
  130,296
  
  130,386Income taxes payable
  
  8,491
  
  10,065Total operating liabilities
  
  433,792
  
  382,204Mandatorily redeemable common stock
  
  292,303
  
  266,094Total liabilities including mandatorily
  redeemable common stock
  
  $
  726,095
  
  $
  648,298  See accompanying
notes to consolidated financial statements.  4


KBW, INC. AND SUBSIDIARIES Consolidated
Statements of Income Three and Nine Months ended September 30,
2006 and 2005 (unaudited) (Dollars in thousands except per share data)  Three Months Ended
  September 30,
  
  Nine Months Ended
  September 30,2006
  
  2005
  
  2006
  
  2005Revenues:Investment banking
  
  $
  49,204
  
  $
  38,742
  
  $
  142,833
  
  $
  109,674Commissions
  
  25,479
  
  24,094
  
  86,039
  
  69,507Principal transactions, net
  
  6,670
  
  7,359
  
  24,693
  
  19,329Net gain on investments
  
  2,897
  
  1,787
  
  10,615
  
  2,156Interest and dividend income
  
  7,595
  
  3,363
  
  19,323
  
  11,745Investment advisory fees
  
  508
  
  358
  
  1,293
  
  1,089Other
  
  859
  
  2,268
  
  1,561
  
  3,220Total revenues
  
  93,212
  
  77,971
  
  286,357
  
  216,720Expenses:Compensation and benefits
  
  54,118
  
  48,284
  
  166,847
  
  133,367Occupancy and equipment
  
  4,528
  
  4,385
  
  13,047
  
  12,597Communications and data processing
  
  5,113
  
  4,685
  
  14,387
  
  14,170Brokerage and clearance
  
  3,976
  
  4,016
  
  14,993
  
  12,532Interest
  
  3,014
  
  1,331
  
  8,278
  
  5,027Other
  
  7,822
  
  8,003
  
  20,739
  
  20,953Total expenses
  
  78,571
  
  70,704
  
  238,291
  
  198,646Income before income tax expense
  
  14,641
  
  7,267
  
  48,066
  
  18,074Income
  tax expense
  
  5,331
  
  3,311
  
  20,206
  
  8,002Net income available to mandatorily
  redeemable common stockholders
  
  $
  9,310
  
  $
  3,956
  
  $
  27,860
  
  $
  10,072Net income available to mandatorily
  redeemable common stockholders per share:Basic
  
  $
  0.35
  
  $
  0.14
  
  $
  1.03
  
  $
  0.38Diluted
  
  $
  0.35
  
  $
  0.14
  
  $
  1.03
  
  $
  0.38Weighted average number of common shares
  outstanding:Basic
  
  26,749,483
  
  27,748,158
  
  27,013,417
  
  26,718,953Diluted
  
  26,749,483
  
  27,753,877
  
  27,013,417
  
  26,741,442  See
accompanying notes to consolidated financial statements.  5


KBW, INC. AND SUBSIDIARIES Consolidated Statements of Changes in
Mandatorily Redeemable Common Stock Nine Months ended September 30, 2006 and 2005 (unaudited) (Dollars in thousands)  Mandatorily
  Redeemable Common StockCommon
  Stock
  
  Paid-in
  capital
  
  Retained
  earnings
  
  Common
  treasury
  stock
  
  Notes
  receivable
  from
  stockholders
  
  Accumulated
  Other
  Comprehensive
  Income (loss)
  
  Total
  Mandatorily
  Redeemable
  Common
  StockBalance at
  December 31, 2004
  
  $
  38
  
  $
  201,709
  
  $
  340,872
  
  $
  (254,558
  )
  $
  (19,899
  )
  $
  527
  
  $
  268,689Net income
  available to mandatorily redeemable common stockholders
  
  
  
  
  
  10,072
  
  
  
  
  
  
  
  10,072Other
  comprehensive loss: currency translation adjustment, net of tax of $640
  
  
  
  
  
  
  
  
  
  
  
  (781
  )
  (781
  )Total
  comprehensive income
  
  
  
  
  
  
  
  
  
  
  
  
  
  9,291Purchase of
  242,520 common shares for treasury
  
  
  
  
  
  
  
  (2,564
  )
  
  
  
  
  (2,564
  )Issuance of 6,794
  common shares from treasury
  
  
  
  75
  
  
  
  
  
  (75
  )
  
  
  Retirement of
  24,613,802 common shares from treasury
  
  (32
  )
  (192,328
  )
  (64,762
  )
  257,122
  
  
  
  
  
  Issuance of
  1,907,609 common shares
  
  
  
  18,692
  
  
  
  
  
  (4,303
  )
  
  
  14,389Purchase of
  45,709 common shares
  
  
  
  (445
  )
  
  
  
  
  50
  
  
  
  (395
  )Amortization of
  restricted stock unit compensation
  
  
  
  1,317
  
  
  
  
  
  
  
  
  
  1,317Excess net tax
  benefit related to delivery of restricted stock units
  
  
  
  31
  
  
  
  
  
  
  
  
  
  31Repayment of
  notes receivable from stockholders
  
  
  
  
  
  
  
  
  
  5,606
  
  
  
  5,606Payment to common
  stockholders
  
  
  
  
  
  (36,725
  )
  
  
  
  
  
  
  (36,725
  )Balance at
  September 30, 2005
  
  $
  6
  
  $
  29,051
  
  $
  249,457
  
  $
  
  
  $
  (18,621
  )
  $
  (254
  )
  $
  259,639  6


KBW, INC. AND SUBSIDIARIES Consolidated
Statements of Changes in Mandatorily Redeemable Common Stock Nine Months ended September 30, 2006 and 2005 (unaudited) (Dollars in thousands except per share data)  Mandatorily
  Redeemable Common StockCommon
  Stock
  
  Paid-in
  capital
  
  Retained
  earnings
  
  Common
  treasury
  stock
  
  Notes
  receivable
  from
  stockholder
  
  Accumulated
  Other
  Comprehensive
  Income (loss)
  
  Total
  Mandatorily
  Redeemable
  Common
  StockBalance at
  December 31, 2005
  
  $
  6
  
  $
  27,410
  
  $
  256,792
  
  $
  
  
  $
  (17,644
  )
  $
  (470
  )
  $
  266,094Net income
  available to mandatorily redeemable common stockholders
  
  
  
  
  
  27,860
  
  
  
  
  
  
  
  27,860Other
  comprehensive income: currency translation adjustment, net of tax of $654
  
  
  
  
  
  
  
  
  
  
  
  806
  
  806Total
  comprehensive income
  
  
  
  
  
  
  
  
  
  
  
  
  
  28,666Amortization of
  restricted stock unit compensation
  
  
  
  1,348
  
  
  
  
  
  
  
  
  
  1,348Restricted stock
  units redeemed
  
  
  
  (1,375
  )
  
  
  
  
  
  
  
  
  (1,375
  )Issuance of
  222,482 common shares
  
  
  
  310
  
  
  
  
  
  
  
  
  
  310Purchase of
  1,180,651 common shares
  
  
  
  (10,824
  )
  
  
  
  
  1,218
  
  
  
  (9,606
  )Excess net tax
  benefit related to delivery of restricted stock units
  
  
  
  363
  
  
  
  
  
  
  
  
  
  363Repayment of
  notes receivable from stockholders
  
  
  
  
  
  
  
  
  
  6,503
  
  
  
  6,503Balance at
  September 30, 2006
  
  $
  6
  
  $
  17,232
  
  $
  284,652
  
  $
  
  
  $
  (9,923
  )
  $
  336
  
  $
  292,303  Description
of preferred stock and details:  Par
  
  September
  
  Number of sharesvalue
  
  30
  
  Authorized
  
  Issued
  
  Outstanding$
  0.01
  
  2006
  
  1,000,000
  
  
  
  
  
  2005
  
  
  
  
  
    Description
of common stock and details:  Par
  
  September
  
  Number of sharesvalue
  
  30
  
  Authorized
  
  Issued
  
  Outstanding$
  0.01
  
  2006
  
  387,000,000
  
  25,306,618
  
  25,306,6180.01
  
  2005
  
  387,000,000
  
  26,475,702
  
  26,475,702  See accompanying
notes to consolidated financial statements.  7


KBW, INC. AND SUBSIDIARIES Consolidated
Statements of Cash Flows Nine Months ended September 30, 2006 and 2005 (unaudited) (Dollars in thousands)  September 30,2006
  
  2005Cash flows from operating activities:Net income available to mandatorily
  redeemable common stockholders
  
  $
  27,860
  
  $
  10,072Adjustments to reconcile net income
  available to mandatorily redeemable common stockholders to net cash provided
  by (used in) operating activities:Deferred income tax expense (benefit)
  
  706
  
  (630
  )Depreciation and amortization
  
  4,447
  
  4,305Compensation expense related to restricted
  stock units
  
  1,348
  
  1,317(Increase) decrease in operating assets:Securities owned, at fair value
  
  (27,067
  )
  (41,258
  )Securities not readily marketable, at fair
  value
  
  (19,154
  )
  (6,302
  )Securities purchased under resale
  agreements
  
  (2,115
  )
  46,819Receivables from clearing broker
  
  (42,303
  )
  21,559Accounts receivable
  
  10,889
  
  (7,359
  )Other assets
  
  (933
  )
  203Increase (decrease) in operating
  liabilities:Securities sold, not yet purchased, at fair
  value
  
  55,141
  
  (65,834
  )Securities sold under repurchase agreements
  
  84,416
  
  (27,815
  )Short-term borrowings
  
  (31,500
  )
  42,750Payable to clearing broker
  
  (54,805
  )
  55,921Accounts payable, accrued expenses, and
  other liabilities
  
  (90
  )
  (27,712
  )Income taxes payable
  
  (1,574
  )
  900Net cash provided by operating activities
  
  5,266
  
  6,936Cash flows from investing activities:Purchases of furniture, equipment, and
  leasehold improvements
  
  (1,955
  )
  (5,408
  )Net cash used in investing activities
  
  (1,955
  )
  (5,408
  )  8


September 30,2006
  
  2005Cash flows from financing activities:Purchase of common stock for treasury
  
  $
  
  
  $
  (2,564
  )Issuance of common stock
  
  310
  
  14,389Purchase of common stock
  
  (9,606
  )
  (395
  )Restricted stock units redeemed
  
  (1,375
  )
  Tax benefit realized from restricted stock
  units redeemed
  
  363
  
  31Repayment of notes receivable from
  stockholders
  
  6,503
  
  5,606Payment to common stockholders
  
  
  
  (36,725
  )Net cash used in financing activities
  
  (3,805
  )
  (19,658
  )Currency adjustment:Effect of exchange rate changes on cash
  
  806
  
  (781
  )Net increase (decrease) in cash and cash
  equivalents
  
  312
  
  (18,911
  )Cash and cash equivalents at beginning of
  period
  
  75,642
  
  59,713Cash and cash equivalents at end of period
  
  $
  75,954
  
  $
  40,802Supplemental disclosures of cash flow
  information:Cash paid during the period for:Income taxes
  
  $
  20,117
  
  $
  6,555Interest
  
  7,781
  
  3,230Supplemental disclosures of non-cash
  financing activities:Net income available to mandatorily
  redeemable common stockholders
  
  $
  27,860
  
  $
  10,072  See
accompanying notes to consolidated financial statements.  9


KBW, INC. AND SUBSIDIARIES NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS September 30, 2006 (unaudited) (Dollars in thousands except per share data)  (1)Organization  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), KBW Asset Management (KBWAM)
and KBW Ventures Inc. (Ventures). Keefe is a regulatory member of the New
York Stock Exchange 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, Euronext, Virt-x
and Deutsche Boerse. Keefes and KBWLs customers are predominantly
institutional investors including other brokers and dealers, commercial banks,
asset managers, and other financial institutions. Keefe has clearing
arrangements with Pershing LLC and Fortis Securities LLC on a fully disclosed
basis. KBWL has a clearing arrangement with Pershing Securities Limited on a
fully disclosed basis.  These
consolidated financial statements and these notes are unaudited and exclude
some of the disclosures required in annual financial statements. These
consolidated financial statements should be read in conjunction with the
Companys consolidated financial statements and notes thereto for the year
ended December 31, 2005 included in its registration statement on Form S-1
filed with the SEC (File No. 333-136509). These consolidated financial
statements reflect all adjustments (consisting of normal recurring adjustments)
that are, in the opinion of management, necessary for the fair statement of the
results for the interim periods. The results of operations for interim periods
are not necessarily indicative of results for the entire year.  (2)Summary of Significant
Accounting Policies  (a)Principles of
Consolidation  The
consolidated financial statements include the accounts of the Company and its
wholly owned subsidiaries. All inter-company transactions and balances have
been eliminated.  In June 2005,
the Financial Accounting Standards Board (FASB) ratified the consensus reached
by the Emerging Issue Task Force on Issue 04-05, Determining Whether
a General Partner, or the General Partners as a Group, Controls a Limited
Partnership or Similar Entity When the Limited Partners Have Certain Rights
(EITF 04-05). EITF 04-05 presumes that a general partner controls a limited
partnership, and should therefore consolidate a limited partnership, unless the
limited partners have the substantive ability to remove the general partner
without cause based on a simple majority vote or can otherwise dissolve the
limited partnership, or unless the limited partners have substantive
participating rights over decision making. This guidance became effective upon
ratification by the FASB on June 29, 2005 for all newly formed limited partnerships
and for existing limited partnerships for which the partnership agreements  10


have been modified. For all other limited partnerships, the guidance is
effective no later than the beginning of the first reporting period in fiscal
years beginning after December 15, 2005. Effective January 1, 2006, the Company
has provided limited partners with rights to remove the Company as general
partner or rights to terminate the partnership; therefore, there is no impact
on the consolidated financial statements.  (b)Use of Estimates  The
preparation of financial statements in conformity with U.S. generally accepted
accounting principles generally requires management to make estimates and
assumptions that affect the amounts reported in the Companys financial
statements and these footnotes, including securities valuation, 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 Equivalents and
Options  For purposes
of the financial statements, the Company considers all bank deposits with
maturities of three months of less to be cash equivalents.  (d)Securities
Transactions  Securities and
option transactions are recorded on a trade-date basis. Securities owned and
securities sold not yet purchased, including options, are valued at fair value.
Realized and unrealized gains and losses are included in the consolidated
statements of income in principal transactions, net.  (e)Securities Not
Readily Marketable  Securities not
readily marketable include limited partnership interests and certain
publicly-traded securities, held for long-term proprietary investment purposes,
of financial services companies. Securities not readily marketable include
investment securities (a) for which there is no market on a securities exchange
or no independent publicly quoted market price, (b) that cannot be publicly
offered or sold unless registration has been effected under the Securities Act
of 1933 or (c) that cannot be offered or sold because of other arrangements,
restrictions, or conditions applicable to the securities or to the Company. Publicly
traded investments are valued at market price. Securities not readily
marketable are valued at fair value as determined by management. The resulting
difference between cost and market or estimated fair value is included in the
consolidated statements of income.  11


(f)Securities
Purchased Under Resale Agreements and Securities Sold Under Repurchase
Agreements  Securities
purchased under resale agreements and securities sold under repurchase
agreements are accounted for as collateralized financing transactions. The
liabilities and assets that result from these agreements are recorded in the
consolidated statements of financial condition at the amounts at which the
securities were sold or purchased, respectively. It is the policy of the Company
to obtain possession of collateral with a market value equal to or in excess of
the principal amount loaned under resale agreements. Collateral is valued
daily, and the Company may require counterparties to deposit additional
collateral or return collateral pledged when appropriate.  The market
value of collateral accepted by the Company under resale agreements was $30,575
and $30,600 at September 30, 2006 and December 31, 2005, respectively,
substantially all of which has been subsequently sold or re-pledged.  (g)Receivables From and
Payable to Clearing Brokers  Receivables
from and payable to clearing brokers include proceeds from securities sold
including securities sold not yet purchased, commissions related to securities
transactions, margin loans and related interest and deposits with clearing
brokers. Proceeds related to securities sold not yet purchased may be
restricted until the securities are purchased.  (h)Investment Banking  The Company
earns fees for underwriting securities offerings, arranging private placements
and providing strategic advisory services in mergers and acquisitions (M&A)
and other transactions.  Underwriting revenues.The Company earns underwriting
revenues in securities offerings in which it acts as an underwriter, such as
initial public offerings, follow-on equity offerings and fixed income offerings.
Underwriting revenues include management fees, underwriting fees and selling
concessions, including fees related to mutual thrift conversions. Underwriting
revenues are recorded, 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.  Strategic advisory revenues.The Companys strategic
advisory revenues primarily include success fees, as well as retainer fees,
earned in connection with advising companies, both buyers and sellers,
principally in M&A. The Company also earns  12


fees for
related advisory work and other services such as providing fairness and
valuation opinions. Strategic advisory revenues are recorded when the
transactions or the services (or, if applicable, separate components thereof)
to be performed are substantially complete, the fees are determinable and collection
is reasonably assured.  Private placement revenues.The Company earns agency
placement fees in non-underwritten transactions such as private placements,
including securitized debt offerings collateralized by financial services
issuers securities. Private placement revenues are recorded on 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 the services to be performed, these revenues
typically vary between periods and may be considerably affected by the timing
of the closing of significant transactions.  (i)Furniture,
Equipment and Leasehold Improvements  Furniture and
equipment 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.  (j)Fair Value of
Financial Instruments  Substantially
all of the Companys financial instruments as defined in Statement of Financial
Accounting Standards (SFAS) No. 107, Disclosures About Fair
Value of Financial Instruments are recorded at fair value or
contract amounts that approximate fair value. The fair value of a financial
instrument is the amount at which the instrument could be exchanged in a
current transaction between willing parties, other than in a forced or
liquidation sale. Securities owned, securities not readily marketable and
securities sold not yet purchased, including option positions are stated at
fair value, with related changes in unrealized appreciation or depreciation
reflected in the line item principal transactions or net gain on investments in
the accompanying consolidated statements of income. Financial instruments
carried at contract amounts include receivables from clearing brokers, payable
to clearing broker, securities purchased under resale agreements and securities
sold under repurchase agreements.  Fair value of
the Companys financial instruments is generally obtained from quoted market
prices, broker or dealer price quotations, or alternative pricing methodologies
that the Company believes offer reasonable levels of price transparency. To the
extent certain financial instruments trade infrequently or are non-marketable
securities and, therefore, do not have readily determinable fair values, the
Company estimates the fair value of these instruments using various pricing
models and the information available to the Company that it deems most relevant.
Among the factors considered by the Company in determining the fair value of  13


financial instruments are discounted anticipated cash flows, the cost,
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 and
other factors generally pertinent to the valuation of financial instruments.  (k)Income Taxes  Deferred
income taxes are recognized for the future tax consequences attributable to
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 taxes
of a change in tax rates is recognized in income in the period that includes
the enactment date.  (l)Foreign Currency
Translation  The Company
translates the balance sheet of KBWL at the exchange rates in effect at the
balance sheet date. The consolidated statements of income are translated at the
average rates of exchange during the period. The resulting translation adjustments
of KBWL are recorded directly to accumulated other comprehensive income (loss).  (m)Net Income Available to
Mandatorily Redeemable Common Stockholders per Share  The Company
calculates net income available to mandatorily redeemable common stockholders
per share in a manner consistent with the provisions of SFAS No. 128, Earnings per Share.  (n)Stock Based
Compensation  On January 1,
2006, the Company adopted SFAS No. 123 (R), Share-Based Payment,
using the modified prospective method, which requires measurement of
compensation cost for all stock-based awards at fair value on the date of grant
and recognition of compensation expense over the service period for awards
expected to vest. Such grants are recognized as expenses over the service
period, net of estimated forfeitures. No adjustment to reflect the net
cumulative impact of estimating forfeitures in the determination of period
expense was deemed necessary.  (o)Contributions  Contributions
are recorded when the conditions on which they depend are substantially met in
accordance with SFAS No. 116, Accounting For
Contributions Received and Contributions Made.  14


(p)Reclassifications  Certain
amounts from prior periods have been reclassified to conform to the current
period presentation.  (3)Mandatorily Redeemable Common
Stock  The Company
accounts for its mandatorily redeemable common stock in accordance with SFAS No.
150, Accounting for Certain Financial Instruments, With
Characteristics of Both Liabilities and Equity.  Each holder of
common stock was a party to an amended and restated Stockholders Agreement (2005
Stockholders Agreement), dated as of August 1, 2005, among the Company, Keefe
and all stockholders of the Company. See Note 14 Subsequent Event.  The 2005
Stockholders Agreement provided that upon a stockholders death or retirement
(as defined in the Stockholders Agreement) the Company would repurchase the
stockholders stock at its book value (as determined by the Companys board of
directors in the manner described in the 2005 Stockholders Agreement) as of
the end of the month of such event. Payment would have been by a two year
subordinated note bearing a floating rate of interest or, at the discretion of
the Companys board of directors, cash. In accordance with SFAS No. 150, the
death of a stockholder is an event certain to occur and, accordingly,
consolidated stockholders equity is classified as a liability.  If a
stockholders employment is otherwise terminated (except for the reasons
described in the next sentence), the Company was required to repurchase the
stock at the month-end book value. If a stockholder was terminated for
violating an agreement with the Company or a regulatory body, or any applicable
regulatory rules or law, within 100 days of such event the Company could have
elected to repurchase the stockholders stock at the then month-end book value.
In either case, payment could have been by a four year subordinated note or, in
the discretion of the Companys board of directors, in cash.  The obligation
to make a repurchase was subject to certain conditions, including the
obligation of the Companys board of directors to make a determination that
such repurchase would not have resulted in an impairment of capital under
Delaware law, and was subject to other legal, regulatory and liquidity
requirements. See Note 14 Subsequent Event.  (4)Short-Term Borrowings  The Company
obtains secured short-term borrowings primarily through bank loans. The
short-term borrowings average balance for the nine months ended September 30,
2006 was $60,022. As of September 30, 2006, secured short-term borrowings were
$32,250 at the rate in  15


effect of 6.09%. Included in securities owned was $43,000 with respect
to corporate bonds in which the lender has a security interest in connection
with short-term borrowings.  (5)Commitments and Contingencies  (a)Litigation  In the ordinary course of business, the Company may be a defendant
or codefendant in legal actions. 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 SFAS No. 5, Accounting for Contingencies. Once established, reserves are
adjusted when there is more information available or when an event occurs
requiring a change.  Keefe is one of several named defendants in a putative class action,
Jeffrey H. Winokur v. Direct General, et al.,
filed by plaintiffs seeking to recover for losses allegedly caused by
misrepresentations and omissions in connection with the August 2003
initial public offering of Direct General Corporation and in connection with a
follow-on offering in March 2004. Direct General Corporation is a property
casualty insurance company specializing in automobile insurance. The aggregate
gross proceeds from these offerings were approximately $300 million. Keefe was
the lead underwriter of both the initial public offering (IPO) and the
follow-on offering. Keefe had a participation of 42.1% in the IPO and 53.0% in
the follow on offering. Plaintiffs allege Direct General securities lost more
than 31% of their value following the announcement in January 2005 of the
impact on reserves of legislation adopted in Florida which resulted in
additions to insurance loss reserves at Direct General. Plaintiffs assert
claims against Keefe and the other underwriters, among others, under the
federal securities laws. Plaintiffs seek unspecified damages, as well as fees,
costs and pre-judgment interest. The suit is pending in the United States
District Court for the Middle District of Tennessee. The Company believes that
Keefe has valid defenses to these claims and Keefe intends to vigorously defend
the action. Liabilities and costs associated with these claims may be
covered by Direct General under the indemnification and contribution provisions
of the related underwriting agreements.  (b)Limited
Partnership Commitments  As of September 30, 2006, the Company had approximately $12,979 in
outstanding commitments for additional funding to limited partnership
investments.  16


(6)           Notes Receivable from Stockholders  Notes
receivable from stockholders represent full recourse notes issued to employees
for their purchases of stock acquired pursuant to the Companys book value
stock purchase plan. At September 30, 2006, $9,923 was outstanding. Loans
are payable in annual installments and bear interest between 2.70% and 5.00%
per annum.  (7)           Financial Instruments with
Off-Balance-Sheet Risk  In
the normal course of its proprietary trading activities, the Company enters
into transactions in financial instruments with off-balance-sheet risk. These
financial instruments, primarily options, 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 are conducted
through regulated exchanges, which clear and guarantee performance of
counterparties.  Also
in connection with its proprietary 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 incur a trading loss if the market value of the securities
increases subsequent to the consolidated financial statements 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 futures on interest rate and currency products for trading purposes
and are included in securities owned at market value in the accompanying
consolidated statements of financial condition. As a writer of options, the
Company receives a cash premium at the beginning of the contract period and
bears the risk of unfavorable changes in the 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  17


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 and futures contracts as of and for the
nine months ended September 30, 2006 and as of and for the year ended
December 31, 2005 is as follows:  Contract
  notional
  amount
  
  Average fair
  value
  
  End of period
  fair valueSeptember 30, 2006:Purchased options
  
  $
  
  
  $
  63
  
  $
  Written options
  
  6,833
  
  111
  
  428Written futures contracts
  
  
  
  811
  
  December 31, 2005:Purchased options
  
  $
  975
  
  $
  9
  
  $
  23Written options
  
  
  
  20
  
  Written futures contracts
  
  750
  
  501
  
  891  (8)           Concentrations of Credit Risk  The
Company is engaged in various securities trading and brokerage activities
servicing primarily domestic and foreign institutional investors and, to a
lesser extent, individual 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
nonperformance 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.  (9)           Membership in Exchanges  Membership
in exchanges were valued at cost and included in other assets on the
consolidated statements of financial condition. On March 8, 2006 the NYSE
merged with Archipelago. The Companys seat was converted to $405 in cash and
78,601 shares of the combined entity. As of September 30, 2006, the
Company held 27,721 shares of the combined entity. Included in net gain on
investments is a gain of $4,925 relating to the conversion including unrealized
gain on shares held.  18


(10)         Restricted Stock Units  The
following table details the issuance of restricted stock units:  Nine Months
  Ended
  September 30, 2006
  
  Weighted
  Average Grant
  Date Fair ValueFuture
  Service
  Required
  
  No Future
  Service
  Required
  
  Future
  Service
  Required
  
  No Future
  Service
  RequiredRestricted stock units (RSU)Balance, January 1, 2006
  
  197,585
  
  1,553,418
  
  $
  10.11
  
  $
  6.57Granted
  
  3,698
  
  
  
  9.98
  
  Vested
  
  (91,590
  )
  91,590
  
  9.87
  
  9.87Converted and redeemed
  
  
  
  (205,153
  )
  
  
  6.70Balance, September 30, 2006
  
  109,693
  
  1,439,855
  
  10.32
  
  6.76  (11)         Net Income Available to Mandatorily
Redeemable Common Stockholders per Share (EPS)  The
computations of basic and diluted net income available to mandatorily
redeemable common stockholders per share (EPS) are set forth below:  Three Months
  Ended
  September 30,
  2006
  
  Three Months
  Ended
  September 30,
  2005
  
  Nine Months
  Ended
  September 30,
  2006
  
  Nine Months
  Ended
  September 30,
  2005Numerator for basic and diluted EPSnet income
  available to mandatorily redeemable common stockholders
  
  $
  9,310
  
  $
  3,956
  
  $
  27,860
  
  $
  10,072Denominator for basic EPSweighted average number of
  common shares
  
  26,749,483
  
  27,748,158
  
  27,013,417
  
  26,718,953Effect of dilutive securities restricted stock units
  
  
  
  5,719
  
  
  
  22,489Denominator for diluted EPSweighted average number
  of common shares and dilutive potential common shares
  
  26,749,483
  
  27,753,877
  
  27,013,417
  
  26,741,442Basic EPS
  
  $
  0.35
  
  $
  0.14
  
  $
  1.03
  
  $
  0.38Diluted EPS
  
  0.35
  
  0.14
  
  1.03
  
  0.38  19


(12)         Net Capital Requirement  Keefe
is a registered U.S. broker-dealer that is subject to the Uniform Net
Capital Rule (SEC Rule 15c3-1 or the Net Capital Rule) administered
by the SEC and NYSE, which requires the maintenance of minimum net capital.
Keefe has elected to use the basic method to compute net capital as permitted
by the Net Capital Rule, which requires that Keefe maintain minimum net
capital, as defined, of $3.0 million as of September 30, 2006. These
rules also require Keefe to notify and sometimes obtain approval from the
NYSE for significant withdrawals of capital.  The
following table details Keefes capital and capital in excess of the minimum
required, as at September 30, 2006 and December 31, 2005:  September 30,
  2006
  
  December 31,
  2005Net Capital
  
  $
  104,929
  
  $
  53,070Excess
  
  $
  102,104
  
  $
  45,041  KBWL
is an investment firm authorized and regulated by the FSA and is subject to the
capital requirements of the FSA. As of September 30, 2006, KBWL was in
compliance with its local capital adequacy requirements.  (13)         Recently Issued Accounting Standards,
Not Yet Adopted  (a)           FASB
Interpretation No. 48, Accounting for Uncertainty in Income TaxesAn
Interpretation of FASB Statement No. 109 (FIN 48). In
July 2006, the Financial Accounting Standards Board (FASB) issued FIN
48, which will become effective for us on January 1, 2007. This standard
clarifies the accounting for uncertainty in income taxes recognized in a
companys financial statements. A company can only recognize the tax position
in the financial statements if the position is more-likely-than-not to be
upheld on audit based only on the technical merits of the tax position. This
accounting standard also provides guidance on thresholds, measurement,
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition that is intended to provide better
financial-statement comparability among different companies. We do not expect
implementation of the standard will have a material effect on our results of
operations or financial position.  (b)           SFAS
No. 157, Fair Value Measurements (SFAS 157). In
September 2006, FASB issued SFAS 157 which will become effective for us
January 1, 2008. This standard establishes a consistent framework for
measuring fair value in accordance with Generally Accepted Accounting
Principles, and expands disclosures with respect to fair value measurements. We
are assessing SFAS No. 157 to determine the financial impact, if any, on
our consolidated statements of financial condition and income.  20


(c) 
SAB 108, In September 2006, the
Securities and Exchange Commission released Staff Accounting Bulletin
No. 108 (SAB 108). SAB 108 permits KBW, Inc. to adjust the
cumulative effect of immaterial errors relating to prior years in the carrying
amount of assets and liabilities as of the beginning of the 2006, with an
offsetting adjustment to the retained earnings at January 1, 2006. SAB 108
also requires the adjustment of interim financial statements within 2006 for
the effects of such errors on the quarters when the information is next
presented. Such adjustments will not require the previously filed reports with
the SEC to be amended. We are assessing SAB 108 determine the financial impact,
if any, on our consolidated statements of financial condition and income.  (14)         Subsequent Event  Initial Public Offering and the Amended and Restated Stockholders
Agreement  At
September 30, 2006, all of KBW, Inc.s shares were directly or
beneficially owned by its employees. In August 2006, KBW, Inc. filed
a registration statement with the SEC on Form S-1 under the Securities Act
of 1933, as amended, with respect to the offering of its common stock. The IPO
became effective November 8, 2006 and the Company issued 3.9 million
shares of common stock at an offering price of $21.00 per share. The net
proceeds to the Company were approximately $75,200, net of the Company's
offering cost. KBW, Inc. intends to use the net proceeds for general
corporate purposes, including support and expansion of our existing business.
In additional KBW, Inc.s employees sold approximately 3.9 million of
their shares in the IPO.  In
addition, on November 8, 2006, the 2005 Stockholders Agreement was terminated
and a new amended and restated Stockholders Agreement (the 2006 Stockholders
Agreement) was entered into by certain employees who are stockholders of the
Company. The 2006 Stockholders Agreement provides that certain stockholders
who are employees are limited in their disposition of their shares during the
first five years following the completion of the IPO. Under the 2006
Stockholders Agreement the Company will no longer be obligated to repurchase
common stock at its book value. As a result, in accordance with SFAS 150, the
Companys common stock is classified as equity.  In
connection with the IPO, the Company completed a 43 for 1 stock split in the
form of a dividend on all then outstanding shares. All references to
number of shares and restricted stock units and per share amounts in these
consolidated financial statements and accompanying notes have been adjusted to
reflect the stock split on a retroactive basis as if such stock split had
occurred on January 1, 2005.  21


ITEM
2.           Managements Discussion and
Analysis of Financial Condition and Results of Operations  The
following Managements Discussion and Analysis of Financial Condition and
Results of Operations (MD&A) should be read together with the unaudited
condensed consolidated financial statements and the related notes included
elsewhere herein this Quarterly Report on Form 10-Q.  Cautionary Statement
Regarding Forward Looking Statements  This
MD&A and other sections of this report contain forward looking statements.
In some cases, you can identify these statements by forward-looking words such
as may, might, will, should, expect, plan, anticipate, believe,
estimate, predict, potential or continue, the negative of these terms
and other comparable terminology. These forward-looking statements, which are
based on various underlying assumptions and expectations and are subject to
risks, uncertainties and other unknown factors, may include projections of
our future financial performance based on our growth strategies and anticipated
trends in our business. These statements are only predictions based on our
current expectations and projections about future events. There are or
may be important factors that could cause our actual results, level of
activity, performance or achievements to differ materially from the historical
or future results, level of activity, performance or achievements expressed or
implied by such forward-looking statements. These factors include, but are not
limited to, those discussed under the caption Risk Factors in our
Registration Statement on Form S-1 (File No. 333-136509), which was
declared effective on November 8, 2006.  Although
we believe the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, level of activity, performance
or achievements. Moreover, neither we nor any other person assumes
responsibility for the accuracy or completeness of any of these forward-looking
statements. You should not rely upon forward-looking statements as predictions
of future events. We are under no duty to update any of these forward-looking
statements after the date of filing of this report to conform such
statements to actual results or revised expectations.  Overview  We
are a leading full service investment bank specializing in the financial
services industry. Our business includes the following areas:  ·Investment banking, including M&A and other strategic advisory and
offerings of equity and fixed income securities;  ·Equity and fixed income sales and trading; and  ·Equity and fixed income research.  22


Our
clients include banks and thrifts, insurance companies, broker-dealers,
mortgage banks, asset management companies, mortgage REITs, consumer and
specialty finance firms, financial processing companies and securities
exchanges. We provide sales and trading services to many institutional
customers in the United States and Europe interested in the financial services
industry.  Many
external factors affect our revenues and profitability, including economic and
market conditions, the level and volatility of interest rates, inflation,
political events, investor sentiment, legislative and regulatory developments and
competition. These factors influence levels of equity security issuance and
M&A activity generally including the financial services industry, which
affect our investment banking business. The same factors also affect trading
volumes and valuations in secondary financial markets, which affect our sales
and trading business. Commission rates, market volatility and other factors
also affect our sales and trading revenues and may cause our sales and
trading revenues to vary from period to period. Because of these operating
issues with respect to our business are unpredictable and beyond our control,
our earnings may fluctuate significantly from year to year and quarter to
quarter. We are also subject to various legal and regulatory actions that
impact our business and financial results.  Our
revenues and expenses over the past four years reflect the re-staffing and
replacement of personnel, facilities and equipment following the World Trade
Center attacks in September 2001. The rebuilding was most significant in
the research, equity sales and trading and fixed income sales and trading
areas. As we expanded our research coverage and successfully rebuilt the equity
sales department our commission revenue increased while overall equity
commissions for the entire brokerage industry were decreasing. Our fixed income
department was almost completely re-staffed and grew quickly in the relatively
favorable fixed income market environment of 2002 and 2003. Beginning in 2004
and through 2005, our fixed income sales and trading was impacted by a flat
yield curve which reduced bank, thrift and other financial institutions
customer activity.  Consistent
with our income statement presentation, we manage our business and analyze our
financial performance based on the nature of the services rendered to our
clients. Employee compensation is our primary cost, and we base our
compensation structure on fixed salaries plus year-end bonuses. Our
non-compensation costs generally do not relate directly to the service revenue
we receive. We do not calculate marginal costs of providing services, nor do we
price our services using marginal costs. Prices for our services are determined
based primarily on active competition in the marketplace.  We
do not price or bill for any of our services based on time or expenses incurred
to provide the service, other than out-of-pocket expense reimbursements. In
determining whether to pursue opportunities in the marketplace, costs are not a
primary driver of our decision. Further, should we attempt to price our
services based on costs, we would expect that such efforts would be of little
value or concern to our clients who will seek to negotiate price based solely
on pricing in the competitive marketplace for services of similar quality.  23


Revenues  We
operate our business as a single segment. However, we derive revenues from two
primary sources, investment banking and sales and trading.  Investment Banking  We
earn fees for underwriting securities offerings, arranging private placements
and providing strategic advisory services in M&A and other transactions.  ·Underwriting revenues.
We earn underwriting revenues in securities offerings in which we act as an
underwriter, such as initial public offerings, follow-on equity offerings and
fixed income offerings. Underwriting revenues include management fees,
underwriting fees and selling concessions, including fees related to mutual
thrift conversions. We record underwriting revenues, net of related expenses,
at the time the underwriting is completed. In syndicated underwritten
transactions management estimates our share of transaction-related expenses
incurred by the syndicate, and we recognize revenue net of such expenses. On
final settlement, we adjust these amounts to reflect the actual
transaction-related expenses and our resulting underwriting fee. We receive a
higher proportion of total fees in underwritten transactions in which we act as
lead manager.  ·Strategic advisory revenues. Our strategic advisory revenues primarily include success fees, as
well as retainer fees, earned in connection with advising companies, both
buyers and sellers, principally in M&A. We also earn fees for related
advisory work and other services such as providing fairness and valuation
opinions. We record strategic advisory revenues when the transactions or the
services (or, if applicable, separate components thereof) to be performed are
substantially complete, the fees are determinable and collection is reasonably
assured.  ·Private placement revenues. We earn agency placement fees in non-underwritten transactions such
as private placements, including securitized debt offerings collateralized by
financial services issuers securities ("PreTSL"). We record private
placement revenues on the closing date of the transaction.  Since
our investment banking revenues are generally recognized at the time of
completion of each transaction or the services to be performed, these revenues
typically vary between periods and may be considerably affected by the
timing of the closing of significant transactions.  Sales and Trading  Our
sales and trading revenues consist of commissions and principal transactions
revenues. The trading gains and losses include net gains from proprietary
trading and the results of activities that support the facilitation of customer
orders in both listed and over-the-counter stocks and fixed income securities.  24


Commissions. Our 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. With respect
to our principal transactions, there are two sources of sales and trading
revenuesFixed Income and Equities.  Fixed Income. our sales and trading revenues
include net trading gains and losses from acting as a principal in the
facilitation of customer orders. Our fixed income sales and trading includes
new issue and secondary market trading in mortgage backed securities, U.S.
government and agency securities and corporate debt securities. We also
maintain a financial strategies group that advises customers on the structure
of their investment portfolios. Our loan portfolio sales group also performs
similar services arranging for the purchase or sale of performing or
non-performing loans.  Equities. our sales and trading revenues
include net trading gains and losses from principal transactions, which include
investing in securities for our own account. In addition, we act as a
market-maker in over-the-counter common equity securities. Our market-maker
positions are typically held for a very short duration.  Net Gains on Investments  Net
gains on investments include realized and unrealized gains and losses on
securities that are considered not readily marketable. Such securities include
limited partnership interests in private equity funds and long-term proprietary
investments in financial services companies. Long-term proprietary investments in
financial services companies are considered non-marketable because there is no
market or the quoted market prices may not reflect fair value or because
they cannot be publicly offered or sold unless registration has been effected
under the Securities Act or cannot be offered or sold because of other
arrangements, restrictions or conditions.  Interest and Dividend Income  Interest
and dividend income primarily consists of interest earned on our interest
bearing assets including securities held for securitization and interest and
dividends on securities maintained in investment accounts or trading accounts
related to our sales and trading business.  Investment Advisory Fees  Investment
advisory fees consist of management and investment performance fees accrued on
assets under management by KBW Asset Management, a wholly-owned registered
investment advisor subsidiary. Investment performance fees are not included in
revenues until the end of the performance period.  25


Other  Other
income includes sublease income and increases in the cash surrender value of
whole life insurance policies that we own covering certain former senior
officers.  Expenses  In
mid 2004, we expanded our research and equity sales and trading to include
European financial services industry equities. This expansion resulted in
substantial growth in our London office personnel which increased employee
compensation and related communication and data processing expense and
occupancy expense. In addition, the majority of the personnel who joined us in
2004 in connection with this expansion had employment contracts that included
guaranteed year-end bonuses for 2004 and 2005, which guarantees did not carry
over to 2006.  A
significant portion of our expense base is variable, including employee
compensation and benefits, brokerage and clearance, communication and data
processing and travel and entertainment expenses. We intend to maintain our
employee compensation and benefits expense within a general target range of 55%
to 60% of total revenues, although we may change this rate at any time.
This percentage range includes all cash and non-cash compensation and benefit
expense.  Certain
data processing systems that support equity and fixed income trading, research,
payroll, human resources and employee benefits are service bureau based. This
means that they are operated in the vendors data centers. We believe that this
stabilizes our fixed costs associated with data processing. We also license
vendor information databases to support investment banking, sales and trading
and research. Vendors may, at the end of contractual terms, terminate our
rights or modify or significantly alter product and service offerings or
related fees, which may affect our ongoing business activities or related
costs.  Most
of our offices were replaced in the last five years, substantially upgrading
the nature of the space we occupy and creating a uniformly up-to-date
infrastructure, and are generally under long-term leases. We believe that as a
result our occupancy costs are likely to be relatively stable and fixed for the
next several years.  Compensation Expense  Compensation
and benefits expense for our employees is the principal component of our
expenses and includes salaries, overtime, bonuses, grants of awards based on
our common stock, benefits, employment taxes and other employee costs. As is
the widespread practice in our industry, we pay bonuses on an annual basis,
which for senior employees typically make up a large portion of their total
compensation. Compensation is generally accrued based on a ratio of total
compensation and benefits to total revenues. We accrue for the estimated amount
of these bonus payments ratably over the applicable service period. Bonus
payments may have a greater impact on our cash position and liquidity in
the periods in which they are paid than would otherwise be reflected in our
consolidated statements of income.  26


Non-Compensation Expense  Occupancy and Equipment  These
expenses include rent and utilities associated with our various offices,
depreciation of leasehold improvements and furniture and fixtures, occupancy
and premises taxes and other fixed asset service fees.  Communications and Data Processing  These
expenses include costs for data processing and telephone and data
communication, primarily consisting of expenses for obtaining third-party
market data primarily used by personnel in sales and trading. We also incur
expenses related to electronic trading network connections and depreciation of
computer and communication equipment.  Brokerage and Clearance  These
expenses include floor brokerage, local broker commissions and clearance
charges paid to clearing firms that fluctuate depending on the volume of trades
we complete.  Interest  Interest
expense is incurred on bank loans, repurchase agreements, interest bearing
securities sold short and securities owned financing provided by clearing
firms.  Other  Other
expenses include consulting fees, professional fees, travel and entertainment
expenditures, charitable contributions and research delivery costs.  In
November 2006, we completed the IPO. We anticipate that other expenses
will increase as a result of increased regulatory requirements, compliance with
the mandates of the Sarbanes-Oxley Act, and various other costs related to operating
as a public company.  Provision for Income Taxes  We
account for income taxes consistent with the asset and liability method
prescribed by FASB Statement No. 109, Accounting for Income
Taxes. Under this method, deferred income taxes reflect the net tax
effects of temporary differences between the carrying amount of assets and
liabilities for financial statement and income tax purposes, as determined under
applicable tax laws and rates. A valuation allowance is provided for deferred
tax assets when it is more likely than not that the benefits of net deductible
temporary differences and net operating loss carryforwards will not be
realized.  27


Consolidated Results of
Operations  Nine Months Ended September 30, 2006 Compared with Nine Months
Ended September 30, 2005  Overview  Total
revenues increased $69.6 million, or 32.1%, to $286.4 million for the nine months
ended September 30, 2006 compared with $216.7 million for the nine months
ended September 30, 2005. This increase was primarily due to increases in
investment banking revenues of $33.2 million and commissions of $16.5 million.  Total
expenses increased $39.6 million or 20.0%, to $238.3 million for the nine
months ended September 30, 2006 compared with $198.6 million for the nine
months ended September 30, 2005, primarily due to an increase in
compensation and benefits expense resulting from the increase in revenues.
Non-compensation expenses increased $6.2 million during this period primarily
as a result of an increase of $2.5 million in brokerage and clearance due to
increased trading volume in European equities including commissions paid to
local brokers and increased interest expense of $3.3 million.  The
effective tax rate was 42.0% for the nine months ended September 30, 2006
compared to an effective tax rate of 44.3% for the same period of 2005. The
decrease in the effective tax rate reflects the reversal of 2005 tax provisions
as a result of the finalization and filing of 2005 state and local tax returns
in the third quarter of 2006. Such final returns reflected lower than estimated
tax liabilities for 2005 for state and local taxes as a result of favorable
allocations of taxable income among various state and local jurisdictions for
2005.  We
recorded net income available to mandatorily redeemable common stockholders of
$27.9 million for the nine months ended September 30, 2006 compared with
$10.1 million for the nine months ended September 30, 2005.  The
following table provides a comparison of our revenues and expenses for the
periods presented:  28


Nine Months Ended
  September 30,
  
  Period-to-Period2006
  
  2005
  
  $ Change
  
  % Change(unaudited)(dollars in thousands)Revenues:Investment banking
  
  $
  142,833
  
  $
  109,674
  
  $
  33,159
  
  30.2
  %Commissions
  
  86,039
  
  69,507
  
  16,532
  
  23.8Principal transactions, net
  
  24,693
  
  19,329
  
  5,364
  
  27.8Net gain on investments
  
  10,615
  
  2,156
  
  8,459
  
  392.3Interest and dividend income
  
  19,323
  
  11,745
  
  7,578
  
  64.5Investment advisory fees
  
  1,293
  
  1,089
  
  204
  
  18.7Other
  
  1,561
  
  3,220
  
  (1,659
  )
  (51.5
  )Total revenues
  
  286,357
  
  216,720
  
  69,637
  
  32.1Expenses:Compensation and benefits
  
  166,847
  
  133,367
  
  33,480
  
  25.1Occupancy and equipment
  
  13,047
  
  12,597
  
  450
  
  3.6Communications and data processing
  
  14,387
  
  14,170
  
  217
  
  1.5Brokerage and clearance
  
  14,993
  
  12,532
  
  2,461
  
  19.6Interest
  
  8,278
  
  5,027
  
  3,251
  
  64.7Other
  
  20,739
  
  20,953
  
  (214
  )
  (1.0
  )Total non-compensation expense
  
  71,444
  
  65,279
  
  6,165
  
  9.4Total expenses
  
  238,291
  
  198,646
  
  39,645
  
  20.0Income before income tax expense
  
  48,066
  
  18,074
  
  29,992
  
  165.9Income tax expense
  
  20,206
  
  8,002
  
  12,204
  
  152.5Net income available to mandatorily redeemable
  common stockholders
  
  $
  27,860
  
  $
  10,072
  
  $
  17,788
  
  176.6
  %  Revenues  Investment Banking  Investment
banking revenues increased $33.2 million, or 30.2%, to $142.8 million for the
nine months ended September 30, 2006 compared with $109.7 million for the
nine months ended September 30, 2005. The increase reflects significant
improvements in our underwriting revenues partially offset by a decrease in our
M&A related fees. Private placement revenue increased $28.5 million or 74.4%
to $66.8 million for the nine months ended September 30, 2006 compared to
$38.3 million for the same period in 2005. This increase was due to larger
structured finance transactions in 2006. Our underwriting revenues increased $10.3
million, or 33.2%, to $41.3 million for the nine months ended
September 30, 2006 compared with $31.0 million for the nine months ended
September 30, 2005. The net increase in underwriting revenues was a result
of more equity underwriting transactions in 2006. This was partly offset by a
decrease in revenues with respect to fixed income underwritings. M&A and
advisory fees decreased $5.8 million, or 14.3%, to $34.7 for the nine months
ended September 30, 2006 compared with $40.5  29


million for the nine months ended September 30, 2005. This
decrease was primarily related to a decrease in the number of transactions
closed. In addition, several larger than average M&A transaction fees were
earned during the nine months ended September 30, 2005.  Commissions  Commissions
increased $16.5 million, or 23.8%, to $86.0 million for the nine months ended
September 30, 2006 compared with $69.5 million for the nine months end
September 30, 2005, primarily as a result of a $11.9 million increase in
European equities commission revenue, attributable to new accounts and
increased customer activity.  Principal Transactions, Net  Principal
transactions revenues were derived from transactions with customers in
fixed-income securities, market-making in equity securities and proprietary
trading in equity securities. These revenues increased by $5.4 million, or
27.8%, to $24.7 million for the nine months ended September 30, 2006
compared with $19.3 million for the nine months ended September 30, 2005.
This increase was the net result of:  ·an increase of realized and unrealized profits from proprietary trading
in equity securities;  ·lower realized and unrealized losses from market-making positions in
equity securities; and  ·decreased volume in transactions with customers in fixed-income
securities, leading to lower aggregate markups.  Net Gain on Investments  Net
gain on investments increased $8.5 million to $10.6 million for the nine months
ended September 30, 2006 compared with a net gain of $2.2 million for the
nine months ended September 30, 2005. The increase was primarily the
result of a gain of $4.8 million earned in the first quarter 2006 with respect
to the exchange of our New York Stock Exchange seat for cash and shares of the
merged NYSE Group, Inc.  Interest and Dividend Income  Interest
and dividend income increased $7.6 million, or 64.5%, to $19.3 million for the
nine months ended September 30, 2006 compared with $11.7 million for the
nine months ended September 30, 2005. This increase resulted from
increased levels of capital securities held pending securitization transactions,
higher average balances of equity securities owned and higher interest rates in
the nine months ended September 30, 2006 relative to the same period in
2005.  30


Investment Advisory Fees  Investment
advisory fees were approximately $1.3 million for the nine months ended
September 30, 2006 and $1.1 million for the nine month period ended September 30,
2005.  Other  Other
revenues decreased $1.7 million, or 51.5% to $1.6 million for the nine months
ended September 30, 2006 compared with $3.2 million for the nine months
ended September 30, 2005. The decrease in other revenues is primarily due
to lower miscellaneous fees in 2006.  Expenses  Compensation and Benefits  Compensation and benefits expense increased
$33.5 million, or 25.1%, to $166.8 million for the nine months ended
September 30, 2006 compared with $133.4 million for the nine months ended
September 30, 2005. This increase was primarily due to an increase in
compensation expense resulting from the increase in accrued bonuses as a result
of increased total revenues. Compensation and benefits as a percentage of total
revenues were 58.3% for the nine months ended September 30, 2006 compared
with 61.5% for the nine months ended September 30, 2005. Occupancy and Equipment Occupancy and equipment expense increased $0.5 million, or 3.6%, to
$13.0 million for the nine months ended September 30, 2006 compared with
$12.6 million for the nine months ended September 30, 2005. The increase
is attributable to higher leasehold improvements and equipment depreciation
expense and higher rent expense associated with the London office expansion and
relocation of the San Francisco office. Communications and Data Processing  Communications
and data processing expense increased $0.2 million, or 1.5%, to $14.4 million
for the nine months ended September 30, 2006 compared with $14.2 million
for the nine months ended September 30, 2005.  Brokerage and Clearance  Brokerage
and clearance expense increased $2.5 million, or 19.6%, to $15.0 million for
the nine months ended September 30, 2006 compared with $12.5 million for
the nine months ended September 30, 2005. This increase was attributable
to greater volume of execution through local brokers in certain European
markets in which we were not a member of the local stock exchange and higher
European equities clearance costs that resulted from higher volume.  31


Interest  Interest
expense increased $3.3 million, or 64.7%, to $8.3 million for the nine months
ended September 30, 2006 compared with $5.0 million for the nine months
ended September 30, 2005. The increase was primarily the result of an
increase in short-term bank debt secured by capital securities held for
securitization in 2006 and generally higher interest rates in the first nine
months of 2006 compared to the same period of 2005.  Other  Other
expenses were $20.7 million for the nine months ended September 30, 2006
and $21.0 million for the nine months ended September 30, 2005.  Income Tax Expense  Income
tax expense was $20.2 million in the nine months September 30, 2006, which
equates to an effective tax rate of 42.0%, compared with $8.0 million in the
nine months ended September 30, 2005 which equates to an effective tax
rate of 44.3%. The decrease in the effective tax rate reflects the reversal of
2005 tax provisions as a result of the finalization and filing of 2005 state
and local tax returns in the third quarter of 2006. Such final returns
reflected lower than estimated tax liabilities for 2005 for state and local
taxes as a result of favorable allocations of taxable income among various
state and local jurisdictions for 2005.  Three Months Ended September 30, 2006 Compared with Three Months
Ended September 30, 2005  Overview  Total
revenues increased $15.2 million, or 19.5%, to $93.2 million for the three
months ended September 30, 2006 compared with $78.0 million for the three
months ended September 30, 2005. This increase was primarily due to an
increase in investment banking revenues of $10.5 million and interest and
dividend income of $4.2 million.  Total
expenses increased $7.9 million or 11.1%, to $78.6 million for the three months
ended September 30, 2006 compared with $70.7 million for the three months
ended September 30, 2005, primarily due to an increase in compensation and
benefits expense resulting from the increase in revenues. Non-compensation
expenses increased $2.0 million primarily as a result of an increase in
interest expense due to higher levels of capital securities held pending
securitization transactions.  The
effective tax rate was 36.4% for the three months ended September 30, 2006
compared to an effective tax rate of 45.6% for the same period of 2005. The
decrease in the effective tax rate reflects the reversal of 2005 tax provisions
as a result of the finalization and filing of 2005 state and local tax returns
in the third quarter. Such final returns reflected lower than estimated tax
liabilities for 2005 for state and local taxes as a result of permanent
favorable allocations of taxable income among various state and local
jurisdictions.  32


We
recorded net income available to mandatorily redeemable common stockholders of
$9.3 million for the three months ended September 30, 2006 compared with
$4.0 million for the three months ended September 30, 2005.  The
following table provides a comparison of our revenues and expenses for the
periods presented:  Three Months Ended
  September 30,
  
  Period-to-Period2006
  
  2005
  
  $ Change
  
  % Change(unaudited)(dollars in thousands)Revenues:Investment banking
  
  $
  49,204
  
  $
  38,742
  
  $
  10,462
  
  27.0
  %Commissions
  
  25,479
  
  24,094
  
  1,385
  
  5.7Principal transactions, net
  
  6,670
  
  7,359
  
  (689
  )
  (9.4
  )Net gain on investments
  
  2,897
  
  1,787
  
  1,110
  
  62.1Interest and dividend income
  
  7,595
  
  3,363
  
  4,232
  
  125.8Investment advisory fees
  
  508
  
  358
  
  150
  
  41.9Other
  
  859
  
  2,268
  
  (1,409
  )
  (62.1
  )Total revenues
  
  93,212
  
  77,971
  
  15,241
  
  19.5Expenses:Compensation and benefits
  
  54,118
  
  48,284
  
  5,834
  
  12.1Occupancy and equipment
  
  4,528
  
  4,385
  
  143
  
  3.3Communications and data processing
  
  5,113
  
  4,685
  
  428
  
  9.1Brokerage and clearance
  
  3,976
  
  4,016
  
  (40
  )
  (1.0
  )Interest
  
  3,014
  
  1,331
  
  1,683
  
  126.4Other
  
  7,822
  
  8,003
  
  (181
  )
  (2.3
  )Total non-compensation expense
  
  24,453
  
  22,420
  
  2,033
  
  9.1Total expenses
  
  78,571
  
  70,704
  
  7,867
  
  11.1Income before income tax expense
  
  14,641
  
  7,267
  
  7,374
  
  101.5Income tax expense
  
  5,331
  
  3,311
  
  2,020
  
  61.0Net income available to mandatorily redeemable
  common stockholders
  
  $
  9,310
  
  $
  3,956
  
  $
  5,354
  
  135.3
  %  Revenues  Investment Banking  Investment
banking revenues increased $10.5 million, or 27.0%, to $49.2 million for the
three months ended September 30, 2006 compared with $38.7 million for the
three months ended September 30, 2005. Private placements revenue
increased $10.5 million, or 88.2% to $22.4 million for the three
months ended September 30, 2006 compared with $11.9 million for the
three months ended September 30, 2005. The increase in private placements
was a result of the larger size of structured finance private placements in the
three months ended September 30, 2006 compared to the same period in 2005.
M&A and advisory fees increased $7.1 million, or 74.7%, to $16.6 million
for the three months ended September 30, 2006 compared with $9.5 million
for the same quarter in 2005 as a result of an increase in the number of
transactions closed. Our underwriting revenues decreased $7.2 million, or
41.4% to $10.2 million for the three months ended September 30, 2006
compared with $17.4 million for the three months ended September 30,
2005 as a result of fewer transactions in 2006 and larger size transactions in
2005. 33


Commissions  Commissions
increased $1.4 million, or 5.7%, to $25.5 million for the three months ended
September 30, 2006 compared with $24.1 million for the three months ended
September 30, 2005 primarily as a result of a $1.3 million increase
in European equities commission revenue.  Principal Transactions, Net  Principal
transactions revenues were derived from transactions with customers in
fixed-income securities, market-making in equity securities and proprietary
trading in equity securities. These revenues decreased by $0.7 million, or
9.4%, to $6.7 million for the three months ended September 30, 2006
compared with $7.4 million for the three months ended September 30, 2005.
This decrease was the net result of:  ·decreased volume in transactions with customers in fixed-income
securities, leading to lower aggregate markups and markdowns;  ·net realized and unrealized gains in the three months ended
September 30, 2006 compared to a net loss for the three months ended
September 30, 2005 from market making positions on equity securities; and  ·partially offset by higher realized and unrealized gains from
proprietary trading in equity securities.  Net Gain on Investments  Net
gain on investments was $2.9 million in the three months ended
September 30, 2006 and $1.8 million for the same period in 2005.  Interest and Dividend Income  Interest
and dividend income increased $4.2 million or 125.8%, to $7.6 million for the
three months ended September 30, 2006 compared with $3.4 million for the
three months ended September 30, 2005, resulting from increased levels of
capital securities held pending securitization transactions, higher average balances
of equity securities owned and higher interest rates in the three months ended
September 30, 2006 compared with the three months ended September 30,
2005.  34


Investment Advisory Fees  Investment
advisory fees were $0.5 million and $0.4 for the three months ended
September 30, 2006 and 2005, respectively.  Other  Other
revenues decreased $1.4 million, or 62.1% to $0.9 million for the three months
ended September 30, 2006 compared with $2.3 million for the three months
ended September 30, 2005. The decrease in other revenue is primarily due
to lower miscellaneous fees in 2006.  Expenses  Compensation and Benefits  Compensation
and benefits expense increased $5.8 million, or 12.1% to $54.1 million for the
three months ended September 30, 2006 compared with $48.3 million for the
three months ended September 30, 2005. This increase was primarily due to
an increase in compensation expense resulting from the increase in accrued
bonuses based on increased total revenues. Compensation and benefits as a
percentage of total revenues were 58.1% for the three months ended
September 30, 2006 compared with 61.9% for the three months ended
September 30, 2005.  Occupancy and Equipment  Occupancy
and equipment expense increased $0.1 million, or 3.3%, to $4.5 million for the
three months ended September 30, 2006 compared with $4.4 million for the
three months ended September 30, 2005.  Communications and Data Processing  Communications
and data processing expense increased $0.4 million, or 9.1%, to $5.1 million
for the three months ended September 30, 2006 compared with $4.7 million
for the three months ended September 30, 2005.  Brokerage and Clearance  Brokerage
and clearance expense was $4.0 million for the three months ended
September 30, 2006 and 2005.  Interest  Interest
expense increased $1.7 million, or 126.4%, to $3.0 million for the three months
ended September 30, 2006 compared with $1.3 million for the three months
ended September 30, 2005. The increase in interest expense was primarily
the result of an increase in short-term bank debt secured by capital securities
held for securitization in the third quarter of 2006  35


compared to that same quarter in 2005 and higher interest rates during
the three months ended September 30, 2006 compared to the three months
ended September 30, 2005.  Other  Other
expenses decreased $0.2 million, or 2.3%, to $7.8 million for the three months
ended September 30, 2006 compared to $8.0 million for the three months
ended September 30, 2005.  Income Tax Expense  Income
tax expense was $5.3 million in the three months ended September 30, 2006,
which equates to an effective tax rate of 36.4%, compared to $3.3 million in
the three months ended September 30, 2005, which equates to an effective
tax rate of 45.6%. The decrease in the effective tax rate reflects the reversal
of 2005 tax provisions as a result of the finalization and filing of 2005 state
and local tax returns in the third quarter of 2006. Such final returns
reflected lower than estimated tax liabilities for 2005 for state and local
taxes as a result of favorable allocations of taxable income among various
state and local jurisdictions for 2005.  Liquidity and Capital
Resources  We
are the parent of Keefe, Bruyette & Woods, Inc. (Keefe), Keefe,
Bruyette & Woods Limited (KBWL), KBW Asset Management, Inc. and
KBW Ventures, Inc. Dividends and other transfers from our subsidiaries are
our primary source of funds to satisfy our capital and liquidity requirements.
Applicable laws and regulations, primarily the net capital rules discussed
below, restrict dividends and transfers from Keefe and KBWL to us. Our rights
to participate in the assets of any subsidiary are also subject to prior claims
of the subsidiarys creditors, including customers and trade creditors of
Keefe, KBWL and KBW Asset Management.  We
monitor and evaluate the composition and size of our assets and operating
liabilities. As a result of our market making, customer and proprietary
activities (including securitization activities), the overall size of total
assets and operating liabilities fluctuate from period to period. Our assets
generally consist of cash and cash equivalents, securities, resale agreement
balances and receivables.  Our
operating activities generate cash resulting from net income available to
mandatorily redeemable common stockholders earned during the period and
fluctuations in our current assets and liabilities. The most significant
fluctuations in current assets and liabilities have resulted from changes in
the level of customer activity, changes in securities owned on a proprietary
basis and investment positions in response to changing trading strategies and
market conditions.  We
have historically satisfied our capital and liquidity requirements through
capital raised from our stockholders and internally generated cash from
operations. As of September 30, 2006, we had liquid assets of $242.6
million, primarily consisting of cash and cash equivalents, securities
purchased under resale agreements and receivables from clearing brokers. We
also  36


periodically utilize short term bank debt to finance certain capital
securities positions held at the holding company level to support the PreTSL
product pool formation. On one occasion in the past three years, we obtained a
short term subordinated loan from one of our clearing brokers to support
underwriting activity over a very short time period. See Subsequent Event
page 43.  The
timing of bonus and retention compensation payments to our employees
may significantly affect our cash position and liquidity from period to
period. While our employees are generally paid salaries semi-monthly during the
year, bonus and retention compensation payments, which make up a larger portion
of total compensation, are generally paid once a year. Bonus and retention
compensation payments for a given year are generally paid in February of
the following year. We continually monitor our liquidity KBW, Inc. and
Subsidiaries position and believe our available liquidity will be sufficient to
fund our ongoing activities over the next twelve months.  As
a registered broker-dealer and member firm of the NYSE, Keefe is subject to the
uniform net capital rule of the SEC. We use the basic method
permitted by the uniform net capital rule, which generally requires that
the ratios of aggregate indebtedness to net capital shall not exceed 15 to 1.
The NYSE may prohibit a member firm from expanding its business or paying
dividends if resulting net capital would be below the regulatory limit. We
expect these limits will not impact our ability to meet current and future
obligations.  At
September 30, 2006, Keefes net capital under the SECs Uniform Net
Capital Rule was $104.9 million, or $102.1 million in excess of the
minimum required net capital.  KBWL
is subject to the capital requirements of the U.K. Financial Services
Authority.  Cash Flows  Nine
months ended September 30, 2006.Cash increased by $0.3 million for the nine months ended
September 30, 2006, primarily as a result of cash provided by operating
activities partially offset by cash used in financing and investing activities.  Our
operating activities provided cash of $5.3 million due to net income available
to mandatorily redeemable common stockholders of $34.4 million, adjusted for
non-cash expense items of $6.5 million and increases in operating liabilities
of $51.6 million, offset by cash used by increases in operating assets of $80.7
million. Non-cash expenses consisted primarily of depreciation and amortization
of $4.4 million and compensation expense related to restricted stock units of
$1.3 million. Cash used by increases in operating assets consisted primarily of
a $42.3 million increase in receivables from clearing brokers, a $27.1 million
increase in securities owned, at fair value and a $19.2 million increase in
securities not readily marketable, at fair value partially offset by a decrease
of $10.9 million in accounts receivable. Cash provided by operating liabilities
consisted primarily of increases of $84.4 million in securities sold under
repurchase agreements and $55.1 million in securities sold, not yet purchased,
at fair value partially offset by a $54.8 million decrease in payable to
clearing broker and a $31.5 million decrease in short-term borrowings.  37


Our
financing activities used $3.8 million primarily as a result of purchases of
common stock from stockholders of $9.6 million and the issuance and our
purchases of common stock issued on restricted stock units redeemed of $1.4
million partially offset by repayments of notes receivable from stockholders of
$6.5 million.  Our
investing activities used cash of $2.0 million in the purchases of furniture,
equipment and leasehold improvements.  Contractual Obligations  Contractual
obligations with respect to operating lease obligations have not materially
changed since December 31, 2005. The following table provides a summary of
our contractual obligations as of December 31, 2005:  Payments Due by PeriodTotal
  
  2006
  
  2007-2008
  
  2009-2010
  
  2011 and
  thereafter(in thousands)Operating lease obligations(1)
  
  $
  105,556
  
  $
  10,834
  
  $
  19,918
  
  $
  19,112
  
  $
  55,692Other contractual obligations(2)
  
  
  
  
  
  
  
  
  
  Total
  
  $
  105,556
  
  $
  10,834
  
  $
  19,918
  
  $
  19,112
  
  $
  55,692  
 (1)
  Excludes future lease obligations related to a new office location in
  London because the sub-lease has not yet been executed.(2)
  Excludes capital commitments that can be called at any time on
  private limited partnership interests of $11.2 million at December 31,
  2005 and $13.0 million at September 30, 2006.  Off-Balance Sheet
Arrangements  We
had no material off-balance sheet arrangements as of September 30, 2006.
However, as described below under Qualitative and Quantitative Disclosures
About Market RiskCredit Risk, through indemnification provisions in our
clearing agreements with our clearing brokers, customer activities
may expose us to off-balance sheet credit risk, which we seek to mitigate
through customer screening and collateral requirements.  We
are a member of various exchanges that trade and clear securities or futures
contracts. As a member of these exchanges, we may be required to pay a
proportionate share of the financial obligations of another member who
may default on its obligations to the exchange. To mitigate these
performance risks, the exchanges often require members to post collateral as
well as meet minimum financial standards. While the rules governing
different exchange memberships vary, our guarantee obligations generally would
arise only if the exchange had previously exhausted its resources. In addition,
any such guarantee obligation would be apportioned among the other
non-defaulting members of the exchange. Any potential contingent liability
under these membership agreements cannot be estimated. We have not recorded any  38


contingent liability in our consolidated financial statements for these
agreements and believe that any potential requirement to make payments under
these agreements is remote.  Qualitative and Quantitative
Disclosures About Market Risk  Market Risk  Market
risk represents the risk of loss that may result from the change in value
of a financial instrument due to fluctuations in its market price. Market risk
may be exacerbated in times of trading illiquidity when market
participants refrain from transacting in normal quantities and/or at normal
bid-offer spreads. Our exposure to market risk is directly related to our role
as a financial intermediary in customer trading and to our market making and
investment activities. Market risk is inherent in financial instruments.  We
trade in equity and debt securities as an active participant in both listed and
over the counter markets. We typically maintain securities in inventory to
facilitate our market making activities and customer order flow. We
may use a variety of risk management techniques and hedging strategies in
the ordinary course of our trading business to manage our exposures.  In
connection with our sales and trading business, management also reviews reports
appropriate to the risk profile of specific trading activities. Management
monitors risks in its trading activities by establishing limits for each
trading desk and reviewing daily trading results, inventory aging, securities
concentrations and ratings. Typically, market conditions are evaluated and
transaction details and securities positions are reviewed. These activities
seek to ensure that trading strategies are within acceptable risk tolerance
parameters. Activities include price verification procedures, position
reconciliations and reviews of transaction bookings. We believe these
procedures, which stress timely communications between traders, trading
management and senior management, are important elements of the risk management
process.  The
following table sets forth our month-end high, low and average long/short
securities owned for the nine months ended September 30, 2006:  High
  
  Low
  
  Average(in thousands)Long ValueEquities
  
  $
  114,074
  
  $
  82,848
  
  $
  99,934Corporate Debt
  
  264,156
  
  176,441
  
  210,567Government/Agency Debt
  
  21,763
  
  1,924
  
  10,025Mortgage Backed Securities
  
  9,437
  
  
  
  1,049Short ValueEquities
  
  $
  45,005
  
  $
  27,498
  
  $
  35,285Corporate Debt
  
  18,066
  
  176
  
  6,570Government/Agency Debt
  
  103,874
  
  39,429
  
  66,918  39


Interest Rate Risk  Interest
rate risk represents the potential loss from adverse changes in market interest
rates. As we may hold debt securities from time to time, we are exposed to
interest rate risk arising from changes in the level and volatility of interest
rates and in the shape of the yield curve. Interest rate risk is primarily
managed through the use of short positions in U.S. Treasury and corporate debt
securities.  Credit Risk  We
engage in various securities underwriting, trading and brokerage activities
servicing a diverse group of domestic and foreign corporations and
institutional investor clients. Our exposure to credit risk associated with the
nonperformance of these clients in fulfilling their contractual obligations
pursuant to securities transactions can be directly impacted by volatile
trading markets which may impair the clients ability to satisfy its
obligations to us. Our principal activities are also subject to the risk of
counterparty nonperformance. Pursuant to our Clearing Agreements with Pershing
LLC, Pershing Securities Limited and Fortis Securities LLC, we are required to
reimburse our clearing broker without limit for any losses incurred due to a
counterpartys failure to satisfy its contractual obligations. In these
situations, we may be required to purchase or sell financial instruments
at unfavorable market prices to satisfy obligations to other customers or
counterparties. We seek to mitigate the risks associated with sales and trading
services through active customer screening and selection procedures and through
requirements that clients maintain collateral in appropriate amounts where
required or deemed necessary.  Inflation Risk  Because
our assets are, to a large extent, liquid in nature, they are not significantly
affected by inflation. However, the rate of inflation affects such expenses as
employee compensation and communications charges, which may not be readily
recoverable in the prices of services we offer. To the extent inflation results
in rising interest rates and has other adverse effects on the securities
markets, it may adversely affect our combined financial condition and
results of operations in certain businesses.  Operational Risk  Operational
risk is the risk of loss resulting from inadequate or failed internal
processes, people and systems or from external events. We are focused on
maintaining our overall operational risk management framework and minimizing or
mitigating these risks through continual assessment, reporting and monitoring
of potential operational risks.  Critical Accounting Policies
and Estimates  The
preparation of our consolidated financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and of revenues and expenses during the reporting periods. We base
our estimates and assumptions on historical  40


experience and on various other factors that we believe are reasonable
under the circumstances. The use of different estimates and assumptions could
produce materially different results. For example, if factors such as those
described in the Risk Factors section of our registration statement on Form
S-1 (File No. 333-136509) cause actual events to differ from the assumptions we
used in applying the accounting policies, our results of operations, financial
condition and liquidity could be materially adversely affected.  On
an ongoing basis, we evaluate our estimates and assumptions, particularly as
they relate to accounting policies that we believe are most important to the
presentation of our financial condition and results of operations. We regard an
accounting estimate or assumption to be most important to the presentation of
our financial condition and results of operations where:  the nature of the estimate or assumption is
material due to the level of subjectivity and judgment necessary to account for
highly uncertain matters or the susceptibility of such matters to change; and  the impact of the estimate or assumption on
our financial condition or operating performance is material.  Using
these criteria, we believe the following to be our critical accounting
policies:  Valuation of Financial Instruments  Substantially
all of our financial instruments, as defined in Statement of Financial
Accounting Standards (SFAS) No. 107, Disclosure About Fair
Value of Financial Instruments, are recorded at fair value or
contract amounts that approximate fair value. The fair value of a financial
instrument is the amount at which the instrument could be exchanged in a
current transaction between willing parties, other than in a forced or
liquidation sale. Securities owned, securities not readily marketable and
securities sold, not yet purchased, including options positions, are stated
at fair value, with related changes in unrealized appreciation or depreciation
reflected in the line item Principal transactions or net gain on
investments in our consolidated statements of income. Financial instruments
carried at contract amounts include receivables from clearing brokers,
payable to clearing broker, securities purchased under resale agreements
and securities sold under repurchase agreements.  Fair
value of our financial instruments is generally obtained from quoted market
prices, broker or dealer price quotations, or alternative pricing methodologies
that we believe offer reasonable levels of price transparency. To the extent
certain financial instruments trade infrequently or are non-marketable
securities and, therefore, do not have readily determinable fair values, we
estimate the fair value of these instruments using various pricing models and
the information available to us that we deem most relevant.  Among
the factors that we consider in determining the fair value of KBW, Inc.
and Subsidiaries financial instruments are discounted anticipated cash flows,
the cost, terms and liquidity of the instrument, the financial condition,
operating results and credit ratings of the issuer or  41


underlying company, the quoted market price of publicly traded
securities with similar duration and yield and other factors generally
pertinent to the valuation of financial instruments.  Recently Issued Accounting
Standards, Not Yet Adopted  (a)           FASB Interpretation
No. 48, Accounting for Uncertainty in Income TaxesAn Interpretation of
FASB Statement No. 109 (FIN 48). In July 2006, the
Financial Accounting Standards Board (FASB) issued FIN 48, which will become
effective for us on January 1, 2007. This standard clarifies the
accounting for uncertainty in income taxes recognized in a companys financial
statements. A company can only recognize the tax position in the financial
statements if the position is more-likely-than-not to be upheld on audit based
only on the technical merits of the tax position. This accounting standard also
provides guidance on thresholds, measurement, derecognition, classification,
interest and penalties, accounting in interim periods, disclosure, and
transition that is intended to provide better financial-statement comparability
among different companies. We do not expect implementation of the standard will
have a material effect on our results of operations or financial position.  (b)           SFAS
No. 157, Fair Value Measurements (SFAS 157). In
September 2006, FASB issued SFAS 157 which will become effective for us
January 1, 2008. This standard establishes a consistent framework for
measuring fair value in accordance with Generally Accepted Accounting
Principles, and expands disclosures with respect to fair value measurements. We
are assessing SFAS No. 157 to determine the financial impact, if any, on
our consolidated statements of financial condition and income.  (c)
          SAB
108 In September 2006, the Securities and Exchange Commission
released Staff Accounting Bulletin No. 108 (SAB 108). SAB 108 permits
KBW, Inc. to adjust the cumulative effect of immaterial errors relating to
prior years in the carrying amount of assets and liabilities as of the
beginning of the 2006, with an offsetting adjustment to the retained earnings
at January 1, 2006. SAB 108 also requires the adjustment of interim
financial statements within 2006 for the effects of such errors on the quarters
when the information is next presented. Such adjustments will not require the
previously filed reports with the SEC to be amended. We are assessing SAB 108 to
determine the financial impact, if any, on our consolidated statements of
financial condition and income.  42


Subsequent Event  Initial Public Offering and the Amended and Restated Stockholders
Agreement  At
September 30, 2006, all of KBW, Inc.s shares were directly or
beneficially owned by its employees. In August 2006, KBW, Inc. filed
a registration statement with the SEC on Form S-1 under the Securities Act
of 1933, as amended, with respect to the offering of its common stock. The IPO
became effective November 8, 2006 and the Company issued 3.9 million
shares of common stock at an offering price of $21.00 per share. The net
proceeds to the Company were approximately $75.2 million, net of the Company's
offering cost. KBW, Inc. intends to use the net proceeds for general
corporate purposes, including support and expansion of our existing business.
In additional KBW, Inc.s employees sold approximately 3.9 million of
their shares in the IPO.  In
addition, on November 8, 2006, the 2005 Stockholders Agreement was
terminated and a new amended and restated Stockholders Agreement (the 2006
Stockholders Agreement) was entered into by certain employees who are
stockholders of the Company. The 2006 Stockholders Agreement provides that
certain stockholders who are employees are limited in their disposition of
their shares during the first five years following the completion of the IPO.
Under the 2006 Stockholders Agreement the Company will no longer be obligated
to repurchase Common Stock at its book value. As a result, in accordance with
SFAS 150, the Companys Common Stock is classified as equity.  In
connection with the IPO, the Company completed a 43 for 1 stock split in the
form of a dividend on all then outstanding shares. All references to
number of shares, restricted stock units and per share amounts including in the
consolidated financial statements and accompanying notes included herein have
been adjusted to reflect the stock split on a retroactive basis as if that such
stock split had occurred on January 1, 2005.  43


ITEM
3.Quantitative
and Qualitative Disclosures About Market Risk  Quantitative
and qualitative disclosures about market risk are set forth under the caption
Item 2. Managements Discussion and Analysis of Financial Condition and
Results of OperationsQuantitative and Qualitative Disclosures About Market
Risk.  ITEM
4.Controls
and Procedures  Our
Management with the participation of the Chairman and Chief Executive Officer
and the Chief Financial Officer (our principal executive officer and principal
financial officer, respectively), evaluated our disclosure controls and
procedures as of the end of the period covered by this report.  Based
on that evaluation, our Chairman and Chief Executive Officer and Chief
Financial Officer have concluded that, as of the end of the current quarter
covered by this report, our disclosure controls and procedures are effective to
ensure that information required to be disclosed by us in the reports filed or
submitted by us under the Exchange Act, is recorded, processed, summarized and
reported within the time periods specified in the SECs rules and forms,
and include controls and procedures designed to ensure that information
required to be disclosed by us in such reports is accumulated and communicated
to our management, including the Chairman and Chief Executive Officer and the
Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure.  There
was no change in our internal control over financial reporting that occurred
during the period covered by this report that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.  44


KBW, Inc. PART IIOTHER INFORMATION  ITEM
1.Legal
Proceedings  None.  45


ITEM 1A.Risk Factors  There
have not been any material changes from the risk factors previously disclosed
in our Registration Statement on Form S-1 (File No. 333-136509),
which was declared effective November 8, 2006.  ITEM
2.Unregistered
Sales of Equity Securities and Use of Proceeds  On
November 14, 2006, a total of 6,800,000 shares of our common stock, par
value $0.01 per share (the Common Stock), were sold in a registered public
offering, of which 3,900,000 shares were sold by us and 2,900,000 shares were
sold by certain selling stockholders. Such shares were sold pursuant to a
registration statement on Form S-1 (Commission file number 333-136509)
(the Registration Statement) which was declared effective by the Securities
and Exchange Commission on November 8, 2006. On November 14, 2006 our
underwriters exercised in full their option to acquire an additional 1,020,000
shares of our Common Stock from the selling stockholders. The offering has
terminated, and all securities registered pursuant to our Registration
Statement have been sold. Keefe, Bruyette & Woods, Inc (our
wholly-owned subsidiary) (Keefe) and Merrill Lynch, Pierce, Fenner &
Smith Incorporated acted as representatives of the underwriters.  7,820,000
shares of Common Stock were registered pursuant to the Registration Statement
at an aggregate estimated offering price of $164,220,000 (based upon the
estimated maximum price of $21.00 per share that was estimated by us in
accordance with Rule 457 of the Securities Act of 1933, as amended, prior
to the pricing of the initial public offering). Including the full exercise of
the overallotment option, all 7,820,000 shares were sold at an aggregate actual
offering price of $164,220,000 (based upon the price of $21.00 per share at
which the shares actually sold). Of such shares, 3,900,000 were sold by us at
an aggregate actual offering price of $81,900,000 and 3,920,000 were sold by
the selling stockholders (including 1,020,000 pursuant to the overallotment
option exercise) at an aggregate actual offering price of $82,320,000. All net
proceeds from the sale of Common Stock by the selling stockholders was retained
by those selling stockholders. The underwriters discount was $1.47 per share,
or approximately $11.5 million in the aggregate, including the overallotment
exercise. Since the portion of the aggregate underwriters discount
attributable to Keefe was approximately $3.7 million, the total unaffiliated
underwriters discount was approximately $7.8 million in the aggregate.
Additional expenses incurred by us in connection with the issuance and
distribution of the Common Stock are approximately $2.7 million. The net
offering proceeds to us after subtracting the portion of the unaffiliated underwriters
discount attributable to the primary offering and these other expenses was
approximately $75.2 million.  46


The
net proceeds from the offering remain invested in a money market fund. It is
our expectation that such proceeds will be used by us for general corporate
purposes, including support and expansion of our existing businesses.  ITEM
3.Defaults
Upon Senior Securities  None.  ITEM
4.Submission
of Matters to a Vote of Security Holders  A
special meeting of stockholders of KBW, Inc. was held on October 30,
2006. 532,722 shares, or approximately 90.5% of all shares then outstanding and
eligible to vote, were present at the meeting. The following is a brief
description of the matters voted upon at such meeting, as well as voting
results for each matter:  ·Amend and restate the Companys amended and
restated certificate of incorporation to, among other things, increase the
authorized capitalization of the Company, and otherwise modify it to be
appropriate for a public company (all 532,722 shares voted for the proposal).  ·Approve an amended and restated stockholders
agreement between the Company and its stockholders that reflected the Companys
planned initial public offering (528,856 shares voted for the proposal; 3,577
shares voted against; 289 shares abstained).  ·Approve the equity incentive plan that had
been adopted by the Companys board of directors (532,002 shares voted for the
proposal; 0 shares voted against; 720 shares abstained).  ·Approve the annual bonus plan that had been
adopted by the Companys board of directors (532,002 shares voted for the
proposal; 0 shares voted against; 720 shares abstained).  ITEM
5.Other
Information  None.  ITEM
6.Exhibits  See
Exhibit Index.  47


SIGNATURES  Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.  Date: December 15, 2006  KBW, INC.By:
  /s/ JOHN G. DUFFYName: John G. DuffyTitle: Chairman and Chief Executive
  OfficerBy:
  /s/ ROBERT GIAMBRONEName: Robert GiambroneTitle: Chief Financial Officer  48


EXHIBIT INDEX  Exhibit
  Number
  
  Description3.1
  
  
  Second Amended
  and Restated Certificate of Incorporation of KBW, Inc.3.2
  
  
  Amended and
  Restated Bylaws of KBW, Inc.4.1
  
  
  Second Amended
  and Restated Stockholders Agreement.10.1
  
  
  Employment
  Agreement with John G. Duffy.10.2
  
  
  Employment
  Agreement with Thomas B. Michaud.10.3
  
  
  Employment Agreement
  with Andrew M. Senchak.10.4
  
  
  2006 Equity
  Incentive Plan.10.5
  
  
  Bonus Plan.31.1
  
  
  Certification of
  Chief Executive Officer pursuant to Rule 13a-14(a) or
  15d-14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to
  Section 302 of the Sarbanes-Oxley Act of 2002.31.2
  
  
  Certification of
  Chief Financial Officer pursuant to Rule 13a-14(a) or
  15d-14(a) of the Securities Exchange Act of 1934, as Adopted Pursuant to
  Section 302 of the Sarbanes-Oxley Act of 2002.32.1
  
  
  Certification of
  Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as Adopted
  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
  
  
  Certification of
  Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as Adopted
  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.  
 
Indicates a management contract or compensatory arrangement.  49